The Public Company Accounting Oversight Board (PCAOB) recently noted that it will provide an opportunity for audit committee chairs of certain companies whose audits are subject to inspection to “engage in a dialogue with the inspections staff” during 2019. The dialogue idea arose out of the PCAOB’s strategic plan which anticipates enhanced external engagement and more proactive communication with its stakeholders, including audit committees, to inform them about its core activities—such as inspections. While we assume the PCAOB’s motive is in good faith to obtain a better mutual understanding of the PCAOB process on one hand and the audit committee process on the other, the dialogue may be a gateway to enforcement activity or create unnecessary surprises for companies and audit committees.

Accordingly, we believe companies should approach any such engagement cautiously, if at all. Perhaps the only circumstance for which this may be appropriate is upon assurance by the PCAOB that the inspection of the company is complete and final and no potential deficiencies have been identified. Even then, companies should consider whether there is any benefit to the dialogue. It is especially worth consideration because the PCAOB also announced it intends to publish additional updates to audit committees regarding its inspections including observations from these interviews and its inspection findings.

Why the caution?

Inspection findings can lead to restatements and potential liability for companies. Inspections are also the root of many PCAOB enforcement actions. While the PCAOB’s Division of Enforcement and Investigations (DEI) only has the authority to act against auditors (at present), it is DEI’s practice to share investigative results with government enforcement agencies, including those who have the authority to bring actions against companies or their audit committees, such as the Securities and Exchange Commission (SEC) or the Department of Justice. For example, the SEC could bring an action against the company alleging the company failed to maintain internal controls over financial reporting as required by law, and such failure caused inaccurate financial reporting. The PCAOB’s proposed “dialogue” could eventually become the typical route by which the PCAOB obtains statements from audit committee chairs that are shared with and used by DEI (and potentially other interested enforcement agencies). Furthermore, DEI would obtain access to this information without having to first obtain an SEC subpoena—a departure from the ordinary requirements of its investigative process.

As a result of open and unchecked dialogue between an unprepared audit committee chair and the PCAOB, the PCAOB may come to believe that the audit committee was deficient in its oversight of the audit process and report those circumstances to other law enforcement agencies. An audit committee chair could also inadvertently reveal privileged information from discussions with counsel regarding a restatement leading to a problematic waiver in litigation related to the restatement. 

Even if there are no deficiencies, companies will not have any control over how the PCAOB reports the results of its interviews to the public. There is a risk that audit committee chairs or companies could be cast in a negative light.

So what can companies do to prepare?

Companies should include a requirement in their audit engagement letters that the auditor must notify the company (within 14 days) if: (i) the PCAOB selects one of their audits for inspection, (ii) the company or its audit is the subject of an investigation, or (iii) the company otherwise becomes connected to an inquiry from the PCAOB or the SEC. With this early warning, companies can then monitor the situation to the extent possible and contain liability if necessary.

While perhaps more controversial, companies also should consider including a requirement in their audit engagement letter that the work papers of the auditor will be shared with or available to the company if there is a triggering event such as selection of an audit for inspection by the PCAOB. Otherwise, work papers are the property of the auditor, and without this right the company cannot access key documents to investigate fault of either the auditor or its own personnel.

Finally, what should companies do if the PCAOB wants to talk to the audit committee chair or if companies otherwise become aware that an audit has become subject to inspection and deficiencies have been noted? If the conduct of the company is questioned as part of the inspection, or if the inspection could result in a restatement, the company or perhaps its audit committee should retain counsel to conduct a privileged internal investigation. Counsel should then retain a forensic auditor to assist in the investigation in a privileged manner.

We believe that counsel for the company or the audit committee is the proper person to engage in dialogue with the PCAOB. If an audit committee member is invited to dialogue with the PCAOB’s director of registration and inspections, they may want to bring counsel along, or first send counsel in their place to get a preview. Alternatively, to keep the engagement on a narrowly defined track, counsel should request that the PCAOB submit its questions in writing and work with the company to provide responses in writing through counsel. Follow up dialogue can then be scheduled for a subsequent phone call with the audit committee member, counsel and the PCAOB to resolve any open questions.

Note: Joel Schwartz, a partner with Stinson Leonard Street LLP, is a former assistant director of enforcement at the PCAOB.