The PCAOB proposal would amend Rule 3502, Responsibility Not to Knowingly or Recklessly Contribute to Violations, by updating the threshold for liability from recklessness to negligence—allowing the PCAOB to hold auditors accountable for failing to exercise the same standard of reasonable care and competence they are already required to exercise anytime they are executing their professional duties.

The rule, originally enacted in 2005, governs the liability of associated persons who contribute to registered public accounting firms’ violations of the laws, rules, and standards that the PCAOB enforces.

“This proposal is simply updating PCAOB rules to match what investors already expect: that auditors act with reasonable care whenever they are performing their duties—and when an auditor’s negligence results in firm violations that can put investors at risk, the PCAOB has tools to hold them accountable,” said PCAOB Chair Erica Y. Williams.

Rule 3502’s purpose is to enable the Board to hold accountable associated persons of PCAOB-registered firms who directly and substantially contribute to violations committed by registered firms.

The PCAOB proposal intends to better protect investors with two key updates:

1. It strengthens accountability for those who put investors at risk by updating the threshold for liability.

Auditors are already required to exercise reasonable care anytime they perform an audit – and failure to do so constitutes “negligence.”

The current Rule 3502, however, only allows auditors to be held liable for firms’ violations when they “recklessly” contribute to those violations – which represents a greater departure from the standard of care than negligence. This means even when a firm commits a violation negligently, an associated person who directly and substantially contributed to the firm’s violation can be sanctioned only if the PCAOB shows that the associated person acted recklessly.

The proposal, if adopted, would update Rule 3502’s liability standard from recklessness to negligence, aligning it with the same standard of reasonable care auditors are already required to exercise anytime they are executing their professional duties. Similarly, the U.S. Securities and Exchange Commission already has the ability to bring enforcement actions against associated persons when they negligently cause firm violations.

The proposal maintains the requirement under the current version of Rule 3502 that an associated person must have contributed to the firm’s violation both “directly and substantially” in order to be held liable.

2. It clarifies the relationship between the contributory actor and the primary violator.

To be held liable under the current Rule 3502, an associated person who contributes to a firm’s violation must be an associated person of that particular firm. Given the increasing complexity of arrangements among firms and the constantly evolving nature of technology, the proposal clarifies that associated persons of any firm can be held liable as long as their conduct at least negligently, and directly and substantially, contributes to any firm’s violation, not just violations by a firm with which they are associated.

“It is important to understand, auditors are already required to exercise reasonable care or competence anytime they perform an audit—meaning they are prohibited from being negligent today,” said Chair Williams in a recent speech on the proposal. “Similarly, the U.S. Securities and Exchange Commission already has the ability to seek penalties in enforcement actions against associated persons when they negligently cause firm violations. So, there is no reason this proposal should cost auditors significant time, resources, or money,” she said.

Throughout the proposal, the Board requests comments on specific aspects of the proposed amendments. The deadline for public comment on the proposal is November 3, 2023.  

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The regulatory agency said it decided not to impose any civil penalties against View, however, “because the company self-reported the misconduct to the SEC, promptly undertook remedial measures, and cooperated with the staff’s investigation.”

“We are committed to imposing remedies that both hold market participants accountable and deter future violations,” said Monique Winkler, Director of the SEC’s San Francisco Regional Office. “At the same time, as this resolution demonstrates, there are real benefits to parties that meaningfully cooperate with the SEC’s investigations, including reduced penalties or even no penalties at all.”

View Window’s Violations

According to the SEC order, in a series of reports and statements filed with the SEC from December 2020 to May 2021, “View disclosed warranty liabilities of $22 million to $25 million, consisting largely of projected costs to manufacture replacements for certain defective windows. However, View failed to include in its disclosures the additional cost to ship and install the new windows, which View had decided to cover and which, therefore, should have been disclosed under U.S. generally accepted accounting principles, the SEC stated.

Including those costs, View should have disclosed total warranty liabilities of $48 to $53 million. Consequently, the SEC found that View “materially misstated its warranty liability for fiscal years 2019 and 2020 and the first quarter of 2021.”

The SEC also found that View violated negligence-based antifraud, proxy disclosure, reporting, books and records, internal accounting controls, and disclosure controls provisions of federal securities laws. Without admitting or denying the SEC’s findings, View agreed to cease and desist from future violations of the charged securities laws.

The SEC also brought charges against Vidul Prakash, View’s former chief financial officer, for failing to ensure that the warranty-related liabilities were disclosed. The SEC’s complaint against Prakash, filed in the U.S. District Court for the Northern District of California, charges him with “violating negligence-based antifraud, proxy disclosure, and books and records provisions of the federal securities laws and seeks permanent injunctions, civil penalties, and an officer and director bar.” 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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Friedman consented to the PCAOB’s order and the disciplinary action without admitting or denying the findings.

According to the PCAOB’s order, Friedman allowed two unregistered accounting firms based in the People’s Republic of China—Peking Certified Public Accountants and Beijing Baijielai Financial Consulting—“to play a substantial role in audits of the financial statements of 12 issuer clients for fiscal years 2017 and 2018.”

“Friedman knew, or should have known, that the unregistered firms were required to register with the Board before the firms played a substantial role in any issuer audits,” the PCAOB stated in its order. “Friedman, however, failed to take any steps to ensure that the unregistered firms’ participation in the audits was consistent with PCAOB registration requirements and that the unregistered firms did not ‘play a substantial role’ in the audits.”

The PCAOB found that “participation by the unregistered firms in the audits in many instances far exceeded the 20 percent substantial role threshold, including two audits in which Peking CPAs incurred 52 percent of the total audit hours,” according to its order. Due to “inadequate planning and oversight,” Friedman “failed to reasonably supervise its associated persons pursuant to Section 105(c)(6) of the Act and failed to comply with PCAOB rules and standards concerning due professional care and audit planning.”

These repeated violations further demonstrate that “Friedman failed to establish and implement adequate quality control policies and procedures, including monitoring procedures, concerning the use of work of other accounting firms, in violation of PCAOB quality control standards,” the PCAOB order stated.

“PCAOB rules are crystal clear: Firms playing a substantial role in the audits of public companies must register with the PCAOB. Those who break the rules and put investors at risk will be held accountable,” said PCAOB Chair Erica Williams. 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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According to the SEC’s Feb. 14 cease-and-desist order, from at least July 2013 through January 2017, Roadrunner manipulated its financial reports to hit prior earnings guidance and analyst projections. Specifically, Roadrunner “hid incurred expenses by improperly deferring them and spreading them over multiple quarters to minimize their impact on Roadrunner’s net earnings, avoided writing down assets that were worthless and receivables that were uncollectable, and manipulated earnout liabilities related to Roadrunner’s acquisitions which, in practical effect, created an income ‘cushion’ that could be accessed in future quarters to offset expenses,” the SEC’s order stated.

In January 2018, following a yearlong internal investigation into the allegations, Roadrunner announced in a regulatory filing that it had materially misstated its financial results in its earnings releases, earnings calls, and quarterly and annual reports from at least the second quarter of 2013 through the third quarter of 2016.

Roadrunner’s investigation “identified accounting errors that impacted substantially all financial statement line items and disclosures and identified material weaknesses in its internal control over financial reporting,” the SEC order stated. Roadrunner overstated its net income by at least $66 million and had to re-evaluate its goodwill and other intangibles resulting in non-cash impairment charges of $373.7 million, the order added.

Roadrunner disclosed to the SEC that it had concealed the fraud from its independent directors, the audit committee, and independent auditor. It also shared with SEC staff the results of its internal investigation and provided information regarding its remedial efforts, the SEC said.

Roadrunner’s remedial efforts included terminating those responsible for the misconduct and enhancing its internal controls. “Among other things, pursuant to Roadrunner’s agreement with its current lender, Roadrunner has retained an outside consulting firm to provide additional financial oversight, with a focus on accounts receivable and payables,” the SEC order stated.

“Roadrunner also implemented a new compliance program that includes a whistleblower hotline, employee policy and training updates, a new bad debt review process, and monthly reconciliation of accounts receivable aging to the general ledger balance,” the SEC order continued.

In September 2019, the U.S. District Court for the Eastern District of Wisconsin approved a class-action settlement against Roadrunner, alleging securities law violations arising from Roadrunner’s restatements. Roadrunner paid $20 million, $16.4 million of which was distributed to shareholders.

CFO Found Guilty

In July, 2021, a federal jury convicted Roadrunner’s former chief financial officer, Peter Armbruster, for his role in the complex securities and accounting fraud. The former CFO was convicted on four counts of violating federal securities laws for his role in scheme. Armbruster was convicted of one count of securities fraud, one count of misleading the company’s auditors and two counts of falsifying Roadrunner’s books and records. He was found not guilty on 11 additional charges.

The Wisconsin jury found former controllers for Roadrunner’s truck loading division, Mark Wogsland and Brett Naggs, not guilty on all charges.

Without admitting or denying the findings, Roadrunner agreed to cease and desist from committing or causing any future violations of these provisions and to pay disgorgement of $7 million and prejudgment interest of $2.5 million, which the SEC deemed satisfied by the 2019 class-action settlement. 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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Charges were also brought against Gentex Chief Financial Officer Kevin Nash for related violations. He agreed to a cease-and-desist order and $75,000 penalty. Neither Gentex nor Nash admitted or denied the SEC’s findings.

Fraud Analytics

The actions arose from the Division of Enforcement’s Earnings Per Share (EPS) Initiative, which utilizes risk-based data analytics to uncover potential accounting and disclosure violations caused by, among other things, earnings management practices.

The deficiencies at issue “were caused by an ineffective system of internal accounting controls, which made it possible for the company’s then-Chief Accounting Officer, Nash, and others in the accounting group, to make certain adjustments to the bonus compensation accruals without the required accounting analysis or without adequate supporting documentation,” according to the SEC order.

“Nash departed from Gentex’s procedure for estimating the bonus compensation accruals,” the SEC order stated. “He also failed to sufficiently document the basis for his accounting judgments related to certain accrual estimates.”

The SEC also found that Nash directed a reduction of an accrual for a performance-based bonus program, resulting in Gentex reporting EPS that met consensus research analyst estimates. “Nash directed the reduction without performing an analysis of relevant criteria under U.S. GAAP and without documenting the basis for his decision,” the SEC said.

Consequently, Nash violated Section 13(b)(5) of the Exchange Act, as well as Rule 13b2-1, the SEC said. Additionally, the order stated, “Gentex failed to devise and maintain a sufficient system of internal accounting controls related to its closing process, including its accounting for bonus compensation, and failed to maintain internal control over financial reporting.” 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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The SEC separately has initiated litigation against Joshua Abrahams, Mattel’s former lead engagement partner, who resigned from PwC in 2019, “to determine whether he engaged in improper professional conduct and violated auditor independence rules,” the SEC said.

According to the SEC’s order, Mattel understated the tax-related valuation allowance for the third quarter of 2017 by $109 million and overstated the tax expense for the fourth quarter of 2017 by the same amount. As a result, Mattel’s third quarter and fourth quarter 2017 net loss and net loss per share were understated by 15 percent and overstated by 63 percent, respectively.

Mattel had been alerted to the alleged material misstatements in August 2019, when Mattel disclosed in a Form 8-K that it was made aware of an anonymous whistleblower letter alleging accounting errors and questioning Abrahams’s independence. An investigation by the audit committee concluded that there were material misstatements, according to the SEC order. “The audit committee also concluded (as did PwC in its own investigation) that Abrahams violated auditor independence rules,” the SEC order stated.

The SEC’s order further found that, at the time, Mattel had no internal control specifically related to calculating a valuation allowance. Until Mattel’s November 2019 restatement, the $109 million tax expense error remained uncorrected, and the lack of internal control for financial reporting related to the error remained undisclosed, according to the order. Neither Mattel’s CEO nor its audit committee were allegedly informed of the expense error.

The SEC’s order against Mattel, which neither admitted nor denied the findings, found the company violated the negligence-based antifraud provisions and the reporting, books and records, and internal controls provisions of the securities laws. In determining to accept Mattel’s settlement offer, the SEC said it considered the company’s cooperation with the investigation and its remediation measures.

‘Failure to Maintain Independence’

The SEC’s order against Abrahams alleges he violated “numerous professional standards” in the third quarter 2017 interim review and the 2017 annual audit of Mattel’s financial statements. According to the order, Abrahams failed to verify that the uncorrected $109 million error was documented, “despite knowing of it,” the SEC said. He also allegedly “failed to communicate the error to Mattel’s audit committee,” the SEC stated.

The order further alleged “Abrahams failed to maintain independence by providing prohibited human resource advice to Mattel, including suggesting to Mattel’s then-CFO which candidate would be the best fit for a senior position at the company, as well as who should not be hired.”

“An auditor’s adherence to professional standards and independence is critical to preserving investors’ trust in a company’s financial statements,” said Alka Patel, Associate Director of the SEC’s Los Angeles Regional Office. “Auditors who advise their clients on who to hire will have an interest in the success of such hires and could therefore be less critical of their effectiveness, all of which undermines the auditor’s independence.”

A public hearing before the Commission will be scheduled to decide if the Enforcement Division has proven the allegations in the order and what, if any, remedial actions are appropriate. 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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In settlements announced Oct. 18, the PCAOB imposed civil money penalties of $150,000 each against audit partner, Jonathan Taylor, and New York-based accounting firm Spielman Koenigsberg & Parker (SKP), where Taylor was a partner.

Additionally, the PCAOB has censured and permanently barred Taylor from association with a registered public accounting firm and further revoked SKP’s PCAOB registration and censured the firm “for failing to establish and implement adequate quality control policies and procedures with respect to audits of issuers.”

The PCAOB said SKP can reapply for registration after five years if the firm “adopts policies and conducts training related to audits of issuers before filing any future registration application.”

Audit Misconduct
In anticipation of a PCAOB inspection in 2021, “Taylor coordinated a months-long effort involving other SKP professionals to alter and backdate audit work papers and then made those work papers available to the inspectors,” the PCAOB said in its order. Taylor then “made false statements to the inspectors about whether those work papers had been improperly altered, even after they pointed out modification dates appearing in the firm’s audit software that suggested the contrary.”

Specifically, Taylor and other SKP professionals backdated multiple work papers for 2019 audits. Approximately 80 of 145 work papers beared false signoffs, the PCAOB said. In a subsequent PCAOB investigation regarding the alleged conduct, Taylor repeatedly provided investigators with false and misleading information.

“Taylor misled investigators regarding whether engagement quality reviews (EQRs) were performed, when and what kinds of alterations were made to work papers, and whether SKP had certain documents in its possession,” the PCAOB said in its order. “Taylor also represented that his productions on SKP’s behalf in response to document demands from the investigators were complete—while withholding thousands of responsive documents, including documents that evidenced Taylor’s misconduct.”

Quality Control Failures
According to the PCAOB, the only issuer clients SKP has ever audited were a pair of contribution plans covering certain salaried and hourly employees of clothing company PVH. “Having decided to perform audits of issuers, however, SKP was obligated to design and implement policies and procedures, including monitoring procedures, to provide reasonable assurance of compliance with regulatory requirements applicable to issuer audits,” the PCAOB said in its order against the firm. “SKP failed to do so.”

SKP’s quality control policies and procedures from 2018 to 2021 “were not suitably designed and effectively applied to provide reasonable assurance that the work performed by its engagement personnel met PCAOB audit documentation requirements,” the PCAOB said in its order against SKP.

“For example, SKP’s quality control policies and procedures did not address whether or how its engagement personnel could add, modify, or delete audit documentation following the documentation completion date” or “the need to retain records relevant to the audit for a seven-year period after conclusion of an issuer audit.”

The PCAOB said SKP also failed to design or implement other policies and procedures to prevent or detect improper alterations of audit documentation after the documentation completion date. “These quality control failures increased the risk that work papers might be improperly altered after the documentation completion date,” the PCAOB said.

Compliance Message
The PCAOB’s action comes at a time when the Board has warned it is enhancing its enforcement approach, including by increasing average penalties, pursuing first-of-their-kind enforcement actions, and taking steps to proactively seek out wrongdoing by increasing the use of enforcement sweeps against firms where a violation of PCAOB standards or rules may have occurred.

“The Board will take action to protect investors from bad actors and impose consequences on those who put the integrity of our capital markets at risk,” said PCAOB Chair Erica Williams.

“The quality control systems at audit firms are fundamental to audit quality and regulatory compliance,” said Mark Adler, PCAOB Acting Director of the Division of Enforcement and Investigation. “Registered firms must take care to establish and implement policies and procedures directed to meaningful monitoring and robust compliance with regulatory requirements.” 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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Failure to file Form APs in a timely manner is a violation of PCAOB Rule 3211, “Auditor Reporting of Certain Audit Participants.”

In its sanctions, announced Oct. 4, the PCAOB said audit firm Yarel + Partners received a $35,000 civil money penalty and censure, and the following three audit firms received a $20,000 civil penalty and censure: Shanghai Perfect CPA Partnership; James Pai; and Liebman Goldberg & Hymowitz.

The firms — without admitting or denying the findings—consented to the PCAOB’s orders and disciplinary actions. Each firm also consented to undertake remedial measures to establish policies and procedures directed toward ensuring future compliance with PCAOB reporting requirements.

“All four firms have since filed the Form APs in question, but only after the PCAOB took action,” the PCAOB said.

The PCAOB said it discovered the firms’ violations during a sweep, in which it was collecting information about potential violations from several firms simultaneously. The sanctions follow an announcement that PCAOB Board Chair Erica Williams made in July that PCAOB would be conducting sweeps as part of its overall effort to strengthen enforcement.

“Investors and the public rely on Form AP disclosures to understand exactly who has a hand in the audits of public companies,” Williams said. “Timely disclosure is critical for transparency and accountability in our capital markets, and the PCAOB will be vigilant in enforcing disclosure rules.” 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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According to SEC data, more than 200 U.S.-listed Chinese companies face the risk of being delisted from U.S. securities exchanges under the Holding Foreign Companies Accountable Act (HFCAA). Under the HFCAA, Chinese companies that cannot be fully inspected or investigated by the Public Company Accounting Oversight Board (PCAOB), the top U.S. audit regulator, by 2024 would be prohibited from being listed on U.S. securities exchanges.

To avoid trading prohibitions, many China- and Hong Kong-based companies have begun to structure their audit engagements with registered public accounting firms located either in the United States or elsewhere. However, these new arrangements raise new concerns about whether the newly engaged audit firms meet their responsibilities as a lead auditor.

In a statement, Paul Munter, acting chief accountant at the SEC, said the newly retained accounting firm “should communicate with the predecessor accounting firm and evaluate the information obtained prior to accepting the engagement. Critically, the predecessor accounting firm should respond fully to any inquiries that the new accounting firm makes under applicable PCAOB standards, including any requests for access to the work papers of the predecessor accounting firm relating to audits of previous financial statement periods.”

Additionally, Munter said the newly engaged accounting firm should make inquiries of the predecessor accounting firm about the following matters:

• The integrity of the company’s management;
• Any disagreements with management that the predecessor firm may have had regarding accounting principles or other significant matters encountered during the previous audit(s);
• Communications of matters between the predecessor firm and the company’s audit committee;
• The predecessor firm’s understanding of the nature of the company’s relationships and transactions with related parties and any significant unusual transactions; and
• The predecessor auditor’s understanding as to the reasons for the change of auditors.

“If the issuer does not authorize appropriate communications, or places significant limitations on the responses of its predecessor accounting firm, the new accounting firm may not be able to accept the engagement and be in compliance with applicable PCAOB standards,” Munter stated. “The same is true if the predecessor auditor creates roadblocks and fails to engage in appropriate communications or to provide requested information, including prior work papers.”

In his closing remarks, Munter further warned, “The failure of the retained lead auditor to meet any of its legal or professional obligations with respect to PCAOB inspection and investigative demands, or the failure of the lead auditor to comply with all applicable audit standards can result in significant liability for not only the auditor and its personnel, but also for the issuer.” Thus, such compliance violations should be avoided.

Accessibility to financial statements and work papers has historically been the biggest issue concerning Chinese public companies listed on U.S. securities exchanges, because of the Chinese government’s tendency to block access to audit reports. In August, the PCAOB reached an agreement with Chinese regulators that would grant the PCAOB complete access to the audit work papers, audit personnel, and other information needed to inspect and investigate public accounting firms headquartered in mainland China and Hong Kong. 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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The Public Company Accounting Oversight Board inspects and investigates public accounting firms in more than 50 jurisdictions around the world, consistent with its mandate under the Sarbanes-Oxley Act. But for more than a decade, positions taken by authorities in the People’s Republic of China (PRC) have obstructed the PCAOB’s access to completely inspect and investigate registered public accounting firms in mainland China and Hong Kong.

The PCAOB received a leg up in 2020, when Congress passed the Holding Foreign Companies Accountable Act (HFCAA), which called on the Securities and Exchange Commission to ban trading of U.S.-listed securities of China-based companies if obstacles to PCAOB access persist. “The U.S. Congress sent a strong message with the passage of the [HFCAA] that access to the U.S. capital markets is a privilege, not a right,” stated PCAOB Chair Erica Williams. “The PCAOB has been working to execute our mandate under the law.”

As part of this ongoing effort, the PCAOB signed a “Statement of Protocol” with the China Securities Regulatory Commission and the Ministry of Finance of the People’s Republic of China this week. “On paper, the agreement…grants the PCAOB complete access to the audit work papers, audit personnel, and other information we need to inspect and investigate any firm we choose, with no loopholes and no exceptions—but the real test will be whether the words agreed to on paper translate into complete access in practice,” Williams said.

According to the PCAOB, the Statement of Protocol grants the PCAOB complete access in the following three important ways:

• The PCAOB has sole discretion to select the firms, audit engagements and potential violations it inspects and investigates—without consultation with, nor input from, Chinese authorities.
• Procedures are in place for PCAOB inspectors and investigators to view complete audit work papers with all information included and for the PCAOB to retain information as needed.
• The PCAOB has direct access to interview and take testimony from all personnel associated with the audits the PCAOB inspects or investigates.

Last year, the PCAOB said it determined the positions taken by PRC authorities prevented it from inspecting and investigating in mainland China and Hong Kong completely. The PCAOB must now reassess its determinations by the end of 2022. The PCAOB inspection team has been directed to finalize their preparations to be on the ground by mid-September to “put this agreement to the test,” Williams said.

“Our dedicated teams of professionals have been preparing for this moment for months, and they are ready to work swiftly, but thoroughly, to carry out our inspections and investigations,” Williams added. “Whether our teams are able to complete that work without obstruction will inform the PCAOB’s determinations at the end of this year.” 

Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.

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