Buried in the President’s 200-page proposed budget for 2021 is the proposal to “consolidate the functions and responsibilities of the Public Company Accounting Oversight Board (PCAOB) into the Securities and Exchange Commission (SEC) beginning in 2022.” While this proposal is sure to be unpopular in the Democrat-controlled House, it is adding to an increasing amount of public critique of the PCAOB and efforts to loosen its grip on the broker-dealer community. It is worth exploring why the PCAOB is so unloved by administration and congressional republicans alike, and what its fate might be if the 2020 elections shift control over to the Republicans.
The Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010 were enacted in response to many financial market disasters, with one goal being the tightening up of financial audits of participants in the financial markets. The 2010 Act’s regulatory strictures were put in place in response to the most notorious financial market disaster ever—Bernard L. Madoff Investment Securities—a humiliating failure for financial regulators, not least the Securities and Exchange Commission (SEC). Some $65 billion of investor funds disappeared into a swamp audited by a one-accountant auditing firm located in a far-off suburb of New York City.
Through these Acts, the PCAOB promulgated strict rules for auditing, not only of broker-dealers having custody of client funds (effectively ceding control of those funds to the broker-dealer) but also of broker-dealers without custody of client funds. In late 2019, the Small Business Audit Correction Act (the Bill) was introduced in both houses of Congress by Republican members desirous of reducing the burdens, both in time and auditor fees, for what these legislators saw as a waste of time for all concerned.
In the view of the Bill’s sponsors, the vast majority of small non-custody broker-dealers are forced to engage in an expensive, time-wasting exercise. These broker-dealers saw the amount of time staff spent on audits and audit fees skyrocket under the PCAOB’s mandate. The Bill’s provisions apply to non-custody broker-dealers that are in good standing and are privately held (detailed standards are provided). The broker-dealer and its associated persons (in effect, owners and professional staff) must have a clean record and there must be no more than 150 associated persons as of the last day of the year for which exemption from the PCAOB rules is sought.
These standards appear to be self-certifying; the non-custody broker-dealer itself would determine whether it is exempt or not and no mechanism is provided for a broker-dealer claiming exemption to make a filing to that effect with the PCAOB or any other regulator. There are instances where a financial market regulator requires a market participant claiming an exemption to file a notice of exemption with that regulator even if the regulator’s consent to the exemption is not a requirement of the exemption.
Opposition to the Bill on the part of legislators from the Democratic Party is heated; statistics cited by them indicate that deficiencies in PCAOB-mandated audits of smaller brokers, including non-custody brokers, far exceeds the statistics for the industry as a whole. These Democratic Party legislators are unfazed by statistics showing a huge drop in the number of smaller broker-dealers subject to the PCAOB audit mandate.
President Trump’s proposed merging of the PCAOB into the SEC reflects the intent of the Bill and the sentiment of the broker-dealer community. The SEC, of course, has its own extensive accounting oversight function. Arguably, merging the two accounting functions has appeal. Further, the PCAOB is unloved in many sectors of the economy and its disappearance into the SEC would be most welcome in many circles.
If Republicans take control of both houses of Congress and the White House in November, we hazard a guess that the PCAOB/SEC merger is more likely to become reality than the Bill is. We suggest that the current atmosphere in which the PCAOB is being critiqued can only be a healthy development.