Thoughts on Improving the PCAOB Investigative and Enforcement Process
By Richard Marmaro and Charles Walker, Skadden, Arps, Slate, Meagher & Flom LLP
The Public Company Accounting Oversight Board (the “PCAOB” or the “Board”), established by Congress in 2002 as a nonprofit corporation charged with overseeing public company auditors, investigates and disciplines registered public accounting firms and persons associated with them for violations of the federal securities laws and PCAOB regulations.1Since its creation, the PCAOB Division of Enforcement and Investigations has undertaken scores of investigations of accounting firms big and small and has filed dozens of cases against auditors and individuals. For a firm or individual, the consequences of an investigation are enormous. PCAOB investigations present not only a tremendous strain on resources, taking up huge amounts of time at significant expense, but for individual professionals, these investigations can prove a “death sentence” in themselves, with firms often taking employment action early in the process before facts are established.
Despite the tremendous impact of an investigation, the PCAOB has only a skeletal framework of rules to guide its enforcement staff and has provided no clear guidance on its investigative policies and procedures. Unfortunately, the PCAOB enforcement staff has filled this void by creating a lengthy and painful track record of aggressive and burdensome investigations.
To be sure, the PCAOB, its staff and those subject to PCAOB investigations all share a mutual interest in moving enforcement matters forward fairly and expeditiously. That shared interest also includes a desire that the staff’s investigative and enforcement practices and procedures not only be rational, fair and effective, but that they be perceived by all involved as rational, fair and effective.
We believe, however, that current practice does not further these goals as well as it might. For example, in our experience, and the experience of others, investigative testimony and accounting board demands for documents are often unfocused, with overbroad document requests requiring burdensome and expensive collection and production efforts, and multiple days of testimony that consume large amounts of time from individuals and counsel. At the other end of the process, the penalties sought by the staff in settlement are often so draconian that individuals may feel compelled to litigate. We briefly describe below key aspects of the PCAOB investigative process, and contrast the PCAOB’s approach with that of other regulators. We also offer some suggestions on how aspects of the PCAOB investigative process may be improved.
Planning the Investigation.
A significant perceived problem with the staff’s investigative conduct is their “fishing expedition” approach to matters under inquiry. As discussed further below, broad document demands are common, and the staff is often reluctant to narrow the production demand, even after receiving assurance that documents will be preserved. Testimony requests seek multiple days of testimony, usually with only the broadest outlines of topics provided in advance. It is apparent that the staff’s investigations are in many cases not being calibrated to the facts at hand.
Other government agencies require that investigative staff carefully plan and focus before commencing an investigation. For example, the Department of Justice Antitrust Division Manual requires that “[a]t the beginning of any investigation, staff should immediately determine the scope and focus of its investigative effort” and “establish a plan describing what is to be done, how and when it will be done, and who will do each task.”2 The investigative plan “should address, at least … theories of [liability]; evidence that would support each theory, and from where the evidence could be obtained; the specific tasks that are necessary to obtain the necessary evidence; when staff plans to accomplish those tasks; and which staff members will be primarily responsible for those tasks.”3 The Manual notes that “[t]he most effective investigations are very often the result of carefully planned strategies that are well developed at the outset of the investigation.”4
The Investigative Process.
PCAOB Rule 5103, promulgated pursuant to SOX Section 105, governs demands for production of audit workpapers and other documents from registered public accounting firms and associated persons. That rule provides:
The Board, and the staff of the Board designated in an order of formal investigation, may issue an accounting board demand for the production of audit work papers or any other document or information in the possession of a registered public accounting firm or any associated person thereof, wherever domiciled, that the Board or its staff considers relevant or material to the investigation.
The Rule also provides that an accounting board demand for documents “set forth a reasonable time and place for production”; that copies and not original documents may be produced (unless originals are expressly required by the demand); and that any originals not produced “be maintained in a reasonably accessible manner,” “be readily available for inspection by the staff,” and “not be destroyed without the staff’s consent.” In addition, the Rule provides that unless the demand indicates otherwise, documents that exist in electronic form must be produced in that form.
Neither SOX nor the PCAOB Rules place any constraints on the PCAOB staff with respect to the scope or extent of its document demands, other than those noted above. At the time Rule 5103 was promulgated, one commenter proposed that the rule include a “reasonableness” requirement.8 The PCAOB declined to include that requirement in the rule.9 Another commenter suggested that the rules permit Board review of the scope of a staff-issued accounting board demand for documents. That suggestion was also rejected by the Board.10
With each demand for documents, and with each demand for testimony, the staff should be aware of the tremendous burdens the demand is placing on the firms and individuals involved.
In practice, accounting board demands for documents are often extremely broad in scope, asking for all documents that could conceivably bear on multiple years of audit work. In many cases, despite assurances by a firm or individual that all documents relevant to the investigation will be preserved, the staff often requires the physical production of all documents subject to the demand, and is frequently reluctant to negotiate the scope of a request.
Accounting board demands for testimony raise similar concerns. The PCAOB staff’s ability to take testimony from associated persons of registered public accounting firms is governed by PCAOB Rule 5102, which was promulgated pursuant to SOX Section 105. This authority allows the staff to “require the testimony of any registered public accounting firm or any person associated with a registered public accounting firm, with respect to any matter that the Board considers relevant or material to an investigation.”
PCAOB Rule 5102(b) states that an accounting board demand for testimony shall:
- “give reasonable notice of the time and place for the taking of testimony;”
- “state the method or methods by which the testimony shall be recorded, which may be by sound or sound-and-visual, but shall include by stenographic means;” and
- “if the person to be examined is a registered public accounting firm, [provide] a description with reasonable particularity of the matters on which examination is requested.”
Neither SOX nor the PCAOB Rules place any constraints on the PCAOB staff with regard to investigative testimony other than those noted above.12 In practice, the staff will often issue sequential demands for multiple days of testimony, resulting in three or four days of testimony, followed by a subsequent request or requests weeks or months later for additional days of testimony. It is not uncommon for the staff to cover the same topics on different occasions, and for the staff to shift their focus in the course of the investigation in order to cover new or different topics. Little guidance is offered to counsel prior to testimony. The practice often appears haphazard, and is extremely burdensome to witnesses.
Considerations for Improving the Document and Testimony Process.
We recognize that in some cases, perhaps many cases, the staff may be undertaking a broad-ranging investigation that may not permit, in the staff’s view, an initial limit on the scope of the inquiry. Nevertheless, in every case, with each demand for documents, and with each demand for testimony, the staff should be aware of the tremendous burdens the demand is placing on the firms and individuals involved.
Other government agencies recognize the burdens of the investigative process and require limits on the staff in that process. For example, the Federal Energy Regulatory Commission Revised Policy Statement on Enforcement13 provides that “the Commission and staff recognize the financial and time burdens that compliance with discovery requests impose on companies, which must continue to conduct their ordinary business while at the same time meeting staff’s needs.” As a result, the “staff targets its discovery requests to the specific demands of the investigation, refrains from seeking information unnecessary to the resolution of the issues and conduct examined, and works with the subject of an investigation to accommodate reasonable requests regarding the production of data.”14
The IRS’s QEP noted above calls for discussion of document requests with the taxpayer; that the taxpayer be informed of the intent of the document request; that the purpose of the document request be plainly stated in its text; that there be discussion of the issues involved; and that a required response time be established.15
Similarly, Rule 30 of the Federal Rules of Civil Procedure requires a party to obtain leave of court or agreement of the opposing party to conduct more than 10 depositions, depose a person more than once, or depose a person for longer than one day of seven hours.19 An objective of this Rule, according to the Advisory Committee Notes, “is to emphasize that counsel have a professional obligation to develop a mutual cost-effective plan for discovery in the case.”20
The PCAOB’s available sanctions against registered public accounting firms and associated persons are found in SOXSection 105(c)(4): (i) temporary suspension or permanent revocation of registration; (ii) temporary or permanent suspension or bar of a person from further association with any registered public accounting firm; (iii) temporary or permanent limitation on the activities, functions or operations of a firm or person (other than in connection with required additional professional education or training); (iv) civil money penalties; (v) censure; (vi) required additional professional education or training; or (vii) any other appropriate sanction provided for in the rules of the Board.
PCAOB Rule 5300 lists additional sanctions that may be imposed on registered public accounting firms, including requiring a firm to engage an independent monitor or consultant; to adopt or implement additional policies; or to obtain an independent review and report on one or more engagements.
At or near the conclusion of an investigation, the staff may engage in settlement discussions. In practice, the PCAOB staff is frequently unwilling to discuss sanctions for individuals lesser than revocation, bar or censure. As these penalties are of severe consequence for an individual, the settlement process often stalls, and litigation ensues, even in cases that might be resolved with lesser sanctions.
Alternatives such as deferred prosecution agreements and non-prosecution agreements should be looked at as viable alternatives to Board disciplinary proceedings.
It is not clear that the staff have clear standards with regard to available sanctions. There are no published PCAOB guidelines with regard to sanctions. Other agencies, however, have comprehensive guidelines regarding sanctions.
For example, the Financial Industry Regulatory Authority (“FINRA”), the financial regulator for the securities industry, has developed detailed guidelines for use in determining appropriate remedial sanctions for member firms and associated persons.21It publishes the guidelines so others may understand what sanctions may be applicable to various violations and use the guidelines in crafting settlements. It revises the guidelines periodically to reflect recent developments in disciplinary actions and settlements.
The FINRA guidelines detail typical securities-industry violations; recommendations as to fine amounts, suspensions, bars, or other sanctions for each violation; and potential principal considerations specific to each violation. The guidelines list “General Principles Applicable to All Sanction Determinations,” which are intended to promote consistency and uniformity in sanctions. They include designing sanctions “to deter future misconduct and to improve overall business standards,” imposing more severe sanctions for recidivists, and tailoring “sanctions to respond to the misconduct at issue.”22
The PCAOB should consider developing guidelines regarding sanctions that may be imposed against firms and individuals. Providing clear standards would provide both the staff and those under investigation a framework within which to assess a given matter, and would likely facilitate resolution in many cases.
The PCAOB should also consider whether its staff should be armed with a broader range of remedies. With individuals in particular, any PCAOB enforcement action is of most serious moment. Because even a censure of an associated person will have a profound effect on that individual – essentially ending that individual’s career in public accounting – the staff should have the ability to resolve cases short of revocation, bar or censure, and should have viable alternatives for settlement. Other agencies recognize that sanctions can be deferred or declined in a settlement. For example, the SEC’s Enforcement Manual24 describes tools available to the SEC Staff to facilitate and reward cooperation in investigations and enforcement actions, including deferred prosecution agreements and non-prosecution agreements.
The PCAOB should consider whether additional guidance should be provided to the staff to allow leeway in the sanctions sought in the context of settlement of an enforcement action. In particular, alternatives such as deferred prosecution agreements and non-prosecution agreements should be looked at as viable alternatives to Board disciplinary proceedings.
Ongoing Guidance on Process and Sanctions.
In addition to the above considerations, the PCAOB and the staff should consider providing ongoing guidance on process and sanctions in the form of an Investigations and Enforcement Manual, such as the manual promulgated by the SEC Enforcement Division and FINRA’s Sanctions Guidelines.
This would provide guidance to the staff of the Division in carrying out its duties. While such a manual would not create any substantive or procedural rights for any party, it would provide a framework of understanding for counsel and witnesses and a reference for all involved in the enforcement and investigation process. Such a framework may, in turn, lead to additional meaningful cooperation and speedier resolutions of investigations and enforcement matters.
Messrs. Marmaro and Walker are partners at Skadden, Arps, Slate, Meagher & Flom LLP, resident in the firm’s Los Angeles and Washington, D.C. offices, respectively. The views expressed in this article are solely those of the authors, and are not necessarily shared or endorsed by the firm or its partners. The authors gratefully acknowledge the assistance of Skadden counsel Joshua Ellis and associate Kate Lesker in the preparation of this article.
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