[Federal Register Volume 73, Number 95 (Thursday, May 15, 2008)]
[Notices]
[Pages 28190-28208]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-10818]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY


Draft Report of the Advisory Committee on the Auditing Profession

AGENCY: Office of the Undersecretary for Domestic Finance, Treasury.

ACTION: Notice; request for comments.

-----------------------------------------------------------------------

SUMMARY: The Advisory Committee on the Auditing Profession is 
publishing a Draft Report and soliciting public comment.

DATES: Comments should be received on or before June 13, 2008.

ADDRESSES: Comments may be submitted to the Advisory Committee by any 
of the following methods:

Electronic Comments

     Use the Department's Internet submission form (http://www.treas.gov/offices/domestic-finance/acap/comments); or

Paper Comments

     Send paper comments in triplicate to Advisory Committee on 
the Auditing Profession, Office of Financial Institutions Policy, Room 
1418, Department of the Treasury, 1500 Pennsylvania Avenue, NW., 
Washington, DC 20220.
    In general, the Department will post all comments on its Web site 
(http://www.treas.gov/offices/domestic-finance/acap/comments) without 
change, including any business or personal information provided such as 
names, addresses, e-mail addresses, or telephone numbers. The 
Department will also make such comments available for public inspection 
and copying in the Department's Library, Room 1428, Main Department 
Building, 1500 Pennsylvania Avenue, NW., Washington, DC 20220, on 
official business days between the hours of 10 a.m. and 5 p.m. Eastern 
Time. You can make an appointment to inspect comments by telephoning 
(202) 622-0990. All comments, including attachments and other 
supporting materials, received are part of the public record and 
subject to public disclosure. You should submit only information that 
you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Kristen E. Jaconi, Senior Policy 
Advisor to the Under Secretary for Domestic Finance, Department of the 
Treasury, Main Department Building, 1500 Pennsylvania Avenue, NW., 
Washington, DC 20220, at (202) 927-6618.

SUPPLEMENTARY INFORMATION: At the request of the two Co-Chairs of the 
Department of the Treasury's Advisory Committee on the Auditing 
Profession, the Department is publishing this notice soliciting public 
comment on the Advisory Committee's Draft Report. The text of this 
Draft Report is found in the appendix to this notice and may be found 
on the Web page of the Advisory Committee at http://www.treas.gov/offices/domestic-finance/acap/index.shtml. The appendices to the Draft 
Report are not included in this notice, but may be found on the Web 
page of the Advisory Committee at http://www.treas.gov/offices/domestic-finance/acap/index.shtml. The Draft Report contains the 
Advisory Committee's developed proposals on improving the 
sustainability of a strong and vibrant public company auditing 
profession. All interested parties are invited to submit their comments 
in the manner described above.

    Dated: May 8, 2008.
Taiya Smith,
Executive Secretary.

Appendix: Advisory Committee on the Auditing Profession, Draft Report--
May 5, 2008, The Department of the Treasury

Draft Report of the Advisory Committee on the Auditing Profession to 
the U.S. Department of the Treasury

Table of Contents

I. Transmittal Letter [Placeholder]
II. Executive Summary [Placeholder]
III. Committee History
IV. Background [Placeholder]
V. Human Capital
VI. Firm Structure and Finances
VII. Concentration and Competition
VIII. Separate Statements [Placeholder]
IX. Appendices
    A. Official Notice of Establishment of Committee
    B. Committee Charter
    C. Treasury Secretary Henry M. Paulson, Jr., Remarks at the 
Economic Club of New York, New York, NY on Capital Market 
Competitiveness (Nov. 20, 2006)
    D. Treasury Secretary Henry M. Paulson, Jr., Opening Remarks at 
the Treasury Department's Capital Markets Competitiveness Conference 
at Georgetown University (Mar. 13, 2007)
    E. Paulson Announces First Stage of Capital Markets Action Plan, 
Treasury Press Release No. HP-408 (May 17, 2007)
    F. Paulson: Financial Reporting Vital to U.S. Market Integrity, 
Strong Economy, Treasury Press Release No. HP-407 (May 17, 2008)
    G. Paulson Announces Auditing Committee Members To Make 
Recommendations for a More Sustainable, Transparent Industry, 
Treasury Press Release No. HP-585 (Oct. 2, 2007)
    H. Under Secretary for Domestic Finance Robert K. Steel, Welcome 
and

[[Page 28191]]

Introductory Remarks Before the Initial Meeting of the Department of 
the Treasury's Advisory Committee on the Auditing Profession, 
Treasury Press Release No. HP-610 (Oct. 15, 2007)
    I. Committee By-Laws
    J. List of Witnesses
    K. List of Committee Members, Observers, and Staff
    L. Working Discussion Outline
    M. Working Bibliography

I. Transmittal Letter

Advisory Committee on the Auditing Profession

[July 2008].

The Honorable Henry M. Paulson, Jr., Secretary, U.S. Department of 
the Treasury, 1500 Pennsylvania Avenue, NW., Washington, DC 20220.

    Dear Secretary Paulson: On behalf of the Department's Advisory 
Committee on the Auditing Profession, we are pleased to submit our 
Final Report.

    [Contents of letter to be included in Final Report.]

    Respectfully Submitted on behalf of the Committee,

-----------------------------------------------------------------------
Arthur Levitt, Jr.,

Committee Co-Chair.

-----------------------------------------------------------------------
 Donald T. Nicolaisen,

Committee Co-Chair.
Enclosure.
    cc: Undersecretary for Domestic Finance
Robert K. Steel.

II. Executive Summary

    [Contents of Executive Summary to be included in subsequent 
drafts of this Report.]

III. Committee History

    On November 20, 2006, the Secretary of the Treasury, Henry M. 
Paulson, Jr., delivered a speech on the competitiveness of the U.S. 
capital markets, highlighting the need for a sustainable auditing 
profession.\1\ In March 2007, Secretary Paulson hosted a conference 
at Georgetown University with investors, current and former policy 
makers, and market participants to discuss issues impacting the 
competitiveness of the U.S. capital markets, including the 
sustainability of the auditing profession.\2\
---------------------------------------------------------------------------

    \1\ Treasury Secretary Henry M. Paulson, Jr., Remarks on the 
Competitiveness of U.S. Capital Markets at the Economic Club of New 
York (Nov. 20, 2006), in Press Release No. HP-174, U.S. Dep't of 
Treas. (Nov. 20, 2006) (included as Appendix C).
    \2\ Treasury Secretary Henry M. Paulson, Jr., Opening Remarks at 
Treasury's Capital Markets Competitiveness Conference at Georgetown 
University (Mar. 13, 2007), in Press Release No. HP-306, U.S. Dep't 
of Treas. (Mar. 13, 2007) (included as Appendix D).
---------------------------------------------------------------------------

    On May 17, 2007, Secretary Paulson announced the Department of 
the Treasury's (the Department) intent to establish the Advisory 
Committee on the Auditing Profession (the Committee) to consider and 
develop recommendations relating to the sustainability of the 
auditing profession.\3\ At the same time, Secretary Paulson 
announced that he had asked Arthur Levitt, Jr. and Donald T. 
Nicolaisen to serve as Co-Chairs of the Committee. The Department 
published the official notice of establishment and requested 
nominations for membership on the Committee in the Federal Register 
on June 18, 2007.\4\ Secretary Paulson announced the Committee's 
membership on October 2, 2007, with members drawn from a wide range 
of professions, backgrounds and experiences.\5\ The Department filed 
the Committee's Charter with the Senate Committee on Banking, 
Housing, and Urban Affairs, the Senate Committee on Finance, the 
House Committee on Financial Services and the House Committee on 
Ways and Means on July 3, 2007.\6\
---------------------------------------------------------------------------

    \3\ Press Release, U.S. Dep't of Treas., Paulson Announces First 
Stage of Capital Markets Action Plan (May 17, 2007) (included as 
Appendix E); Press Release, U.S. Dep't of Treas., Paulson: Financial 
Reporting Vital to U.S. Market Integrity, Strong Economy (May 17, 
2008) (included as Appendix F).
    \4\ Notice of Intent to Establish; Request for Nominations, 72 
FR 33560 (U.S. Dep't of Treas. June 18, 2007) (included as Appendix 
A).
    \5\ Press Release, U.S. Dep't of Treas., Paulson Announces 
Auditing Committee Members to Make Recommendations for a More 
Sustainable, Transparent Industry (Oct. 2, 2007) (included as 
Appendix G). This press release describes the diverse backgrounds of 
the Committee members. For a list of Members, Observers, and Staff, 
see Appendix K.
    \6\ See Committee Charter (included as Appendix B).
---------------------------------------------------------------------------

Committee Activities

    The Committee held its initial meeting on October 15, 2007 in 
Washington, DC.\7\ Under Secretary for Domestic Finance Robert K. 
Steel welcomed the Committee members and provided introductory 
remarks.\8\ Also on October 15, 2007, the Committee adopted its by-
laws \9\ and considered a Working Discussion Outline to be published 
for public comment.\10\ The Working Discussion Outline identified in 
general terms issues for the Committee's consideration. A Working 
Bibliography, updated intermittently throughout the course of the 
Committee's deliberations, provided the members with articles, 
reports, studies, and other written materials relating to the 
auditing profession.\11\ All full Committee meetings were open to 
the public and conducted in accordance with the requirements of the 
Federal Advisory Committee Act.\12\ The meetings of the full 
Committee were also Web or audio cast over the Internet.
---------------------------------------------------------------------------

    \7\ The Record of Proceedings of this and subsequent meetings of 
the Committee are available on the Department's Web site at http://www.treas.gov/offices/domestic-finance//acap/press.shtml. See Record 
of Proceedings, Meeting of the Committee (Oct. 15, 2007, Dec. 3, 
2007, Feb. 4, 2008, Mar. 13, 2008, Apr. 1, 2008, and [--]) 
[hereinafter Record of Proceedings (with appropriate date)] (on file 
in the Department's Library, Room 1428), available at http://www.treas.gov/offices/domestic-finance/acap/press.shtml.
    \8\ Under Secretary for Domestic Finance Robert K. Steel, 
Welcome and Introductory Remarks Before the Initial Meeting of the 
Treasury Department's Advisory Committee on the Auditing Profession 
(Oct. 15, 2007), in Press Release No. HP-610, U.S. Dep't of Treas. 
(Oct. 15, 2007) (included as Appendix H).
    \9\ The Committee By-Laws are included as Appendix I.
    \10\ The Working Discussion Outline is included as Appendix L.
    \11\ The Working Bibliography is included as Appendix M. The 
Working Bibliography was subsequently updated in December 2007 and 
February 2008.
    \12\ 5 U.S.C. App. 2 Sec.  1.
---------------------------------------------------------------------------

    The Committee held its second meeting on December 3, 2007 in 
Washington, DC. The agenda for this meeting consisted of hearing 
oral statements from witnesses and considering written submissions 
that those witnesses had filed with the Committee. The oral 
statements and written submissions focused on the issues impacting 
the sustainability of the auditing profession, including issues 
mentioned in the Working Discussion Outline. Nineteen witnesses 
testified at this meeting.\13\ The Committee held a subsequent 
meeting on February 4, 2008 in Los Angeles, California at the 
University of Southern California. The agenda for this meeting 
consisted of hearing oral statements from witnesses and considering 
written submissions that those witnesses had filed with the 
Committee. The oral statements and written submissions focused on 
the issues impacting the sustainability of the auditing profession, 
including issues mentioned in the Working Discussion Outline. 
Seventeen witnesses testified at this meeting.\14\ The Committee 
held additional meetings on March 13, 2008, April 1, 2008, and [--]. 
All were face-to-face meetings held at the Department in Washington, 
DC, except for February 4, 2008, which was held in Los Angeles, 
California, and the meetings on April 1, 2008, and [--], which were 
telephonic meetings.
---------------------------------------------------------------------------

    \13\ Appendix J contains a list of witnesses who testified 
before the Committee.
    \14\ Appendix J contains a list of witnesses who testified 
before the Committee.
---------------------------------------------------------------------------

    The Committee, through the Department, published [--] releases 
in the Federal Register formally seeking public comment on issues 
under consideration. On October 31, 2007, the Committee published a 
release seeking comment on the Working Discussion Outline,\15\ in 
response to which we received seventeen written submissions. In 
addition, the Department announced each meeting of the Committee in 
the Federal Register, and in each announcement notice included an 
invitation to submit written statements to be considered in 
connection with the meeting.\16\ In response to these meeting 
notices, the Committee received [--] written submissions. In total, 
the Committee received [--] written submissions in response to 
Federal Register releases.\17\ All of the submissions made to the

[[Page 28192]]

Committee will be archived and available to the public through the 
Department's Library.
---------------------------------------------------------------------------

    \15\ Request for Comments, 72 FR 61709 (U.S. Dep't of Treas. 
Oct. 31, 2007).
    \16\ Notice of Meeting, 72 FR 55272 (U.S. Dep't of Treas. Sept. 
28, 2007); Notice of Meeting, 72 FR 64283 (U.S. Dep't of Treas. Nov. 
15, 2007); Notice of Meeting, 73 FR 2981 (U.S. Dep't of Treas. Jan. 
16, 2008); Notice of Meeting, 73 FR 10511 (U.S. Dep't of Treas. Feb. 
27, 2008); Notice of Meeting, 73 FR 13070 (U.S. Dep't of Treas. Mar. 
11, 2008); Notice of Meeting, 73 FR 21016 (U.S. Dep't of Treas. Apr. 
17, 2008).
    \17\ All of the written submissions made to the Committee are 
available in the Department's Library, Room 1428 and on the 
Department's Committee's Web page at http://www.treas.gov/offices/domestic-finance/acap/press.shtml. To avoid duplicative material in 
footnotes, citations to the written submissions made to the 
Committee in this Final Report do not reference the Department's 
Library, Room 1428.
---------------------------------------------------------------------------

    In addition to work carried out by the full Committee, fact 
finding and deliberations also took place within three Subcommittees 
appointed by the Co-Chairs. The Subcommittees were organized 
according to their principal areas of focus: Human Capital, Firm 
Structure and Finances, and Concentration and Competition.\18\ Each 
of the Subcommittees prepared recommendations for consideration by 
the full Committee.
---------------------------------------------------------------------------

    \18\ For a list of members and their Subcommittee assignments, 
see Appendix K.
---------------------------------------------------------------------------

IV. Background

    [Contents of Background to be included in subsequent drafts of 
this Report.]

V. Human Capital

    The Committee devoted considerable time and effort surveying the 
human capital issues impacting the auditing profession, including 
education, licensing, recruitment, retention, and training of 
accounting and auditing professionals. The charter of the Committee 
charged its members with developing recommendations relating to the 
sustainability of the public company auditing profession. Likewise, 
the Committee directs the following recommendations and related 
commentary to those practicing public company auditing. However, the 
Committee recognizes that several of its recommendations regarding 
human capital matters would have impact beyond the public company 
auditing profession, impacting the accounting profession as a whole. 
The Committee views the accelerating pace of change in the global 
corporate environment and capital markets and the increasing 
complexity of business transactions and financial reporting as among 
the most significant challenges facing the profession as well as 
financial statement issuers and investors. These are directly 
impacted by human capital issues. To ensure its viability and 
resilience and its ability to meet the needs of investors, the 
public company auditing profession needs to continue to attract and 
develop professionals at all levels who are prepared to perform high 
quality audits in this dynamic environment. It is essential that 
these professionals be educated and trained to review, judge, and 
question all accounting and auditing matters with skepticism and a 
critical perspective. The recommendations presented below reflect 
these needs.
    After receiving testimony from witnesses and from comment 
letters, the Committee identified specific areas where the Committee 
believed it could develop recommendations to be implemented in the 
relatively short term to enhance the sustainability of the auditing 
profession. These specific areas include accounting curricula, 
accounting faculty, minority representation and retention, and 
development and maintenance of human capital data. The Committee has 
also developed a recommendation to study the possible future of 
higher accounting education's institutional structure.
    The Committee recommends that regulators, the auditing 
profession, educators, educational institutions, accrediting 
agencies, and other bodies, as applicable, effectuate the following:
    Recommendation 1. Implement market-driven, dynamic curricula and 
content for accounting students that continuously evolve to meet the 
needs of the auditing profession and help prepare new entrants to 
the profession to perform high quality audits.
    The Committee considered the views of all witnesses who provided 
input regarding accounting curricula at educational 
institutions.\19\ The Committee believes that the accounting 
curricula in higher education are critical to ensuring individuals 
have the necessary knowledge, mindset, skills, and abilities to 
perform quality public company audits. In order to graduate from an 
educational institution with an accounting degree, students must 
have completed a certain number of hours in accounting and business 
courses. Accounting curricula typically include courses in auditing, 
financial accounting, cost accounting and U.S. federal income 
taxation. Business curricula typically include courses in ethics, 
information systems and controls, finance, economics, management, 
marketing, oral and written communication, statistics, and U.S. 
business law.\20\ Since the 1950s, several private sector groups 
have studied and recommended changes to the accounting 
curricula,\21\ but notwithstanding these pleas for reform, curricula 
are characteristically slow to change.\22\
---------------------------------------------------------------------------

    \19\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Joseph V. Carcello, Director of Research, Corporate 
Governance, University of Tennessee, Knoxville, 8), available at 
http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Carcello120307.pdf (noting the market's expectations that 
university accounting curricula will expose students to recent 
financial reporting developments, such as international financial 
reporting standards and eXtensible Business Reporting Language); 
Record of Proceedings (Feb. 4, 2008) (Written Submission of Cynthia 
Fornelli, Executive Director, Center for Audit Quality, 3) available 
at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf (stating the need to ``[d]edicate funds 
and people to work with accounting professors to ensure that the 
curriculum is keeping pace with developments in business 
transactions, international economics and financial reporting'' and 
specifying the need to focus on ethical standards and international 
accounting and auditing standards); Record of Proceedings (Dec. 3, 
2007) (Written Submission of Dennis Nally, Chairman and Senior 
Partner, PriceWaterhouseCoopers LLP, 4), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Nally120307.pdf (stating the need to ``[m]odernize and enhance the 
university accounting curriculum, which should include consideration 
of other global curriculum models to increase knowledge of 
International Financial Reporting Standards (IFRS), finance and 
economics, and process controls'').
    \20\ Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Phillip M.J. Reckers, Professor of Accountancy, Arizona State 
University, 13), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf (commenting that 
business students typically take two sophomore-level introductory 
accounting classes and accounting majors take six additional 
accounting courses in their final two years of schooling).
    \21\ See e.g., Franklin Pierson, et al., The Education of 
American Businessmen (1959) (noting that the main goal of a business 
education should be the development of an individual with broad 
training in both the humanities and principles of business); Robert 
A. Gordon and James E. Howell, Higher Education for Business (1959) 
(suggesting that accounting curriculum abandon its emphasis on 
financial accounting and auditing while emphasizing humanities); 
Robert H. Roy and James H. MacNeill, Horizons for a Profession 
(1967) (emphasizing the importance of a humanities background for 
accountants and recommending accounting graduate study); American 
Institute of Certified Public Accountants, Committee on Education 
and Experience Requirements for CPAs, Report of the Committee on 
Education and Experience Requirements for CPAs (1969) (recommending 
a five-year education requirement for accounting students); American 
Institute of Certified Public Accountants, Education Requirements 
for Entry into the Accounting Profession: A Statement of AICPA 
Policies (1978) (recommending a change from five years to 150 
semester-hours and recommending that a graduate degree requirement 
at the conclusion of the 150-hours should be explicitly stated); 
American Accounting Association, Committee on the Future Structure, 
Content, and Scope of Accounting Education, Future Accounting 
Education: Preparing for the Expanding Profession, Issues in 
Accounting Education (Spring 1986) (examining accounting education 
and accounting practice since 1925 and concluding that since 1925, 
the profession has changed while accounting education has not 
changed); American Institute of Certified Public Accountants, 
Education Requirements for Entry into the Accounting Profession: A 
Statement of AICPA Policies, Second Edition, Revised (1988) 
(requiring that at least 150 semester hours are needed to obtain a 
CPA license); Perspectives on Education: Capabilities for Success in 
the Accounting Profession (1989) (noting that graduates entering 
public accounting need to have greater interpersonal, communication, 
and thinking skills as well as greater business knowledge); and 
Accounting Education Change Commission, Objectives of Education for 
Accountants: Position Statement Number One, Issues in Accounting 
Education (Fall 1990a) (awarding grants to schools as a catalyst for 
curricula changes in accounting programs).
    \22\ Record of Proceedings (Dec. 3, 2007) (Written Submission of 
Ira Solomon, R.C. Evans Distinguished Professor, and Head, 
Department of Accountancy, University of Illinois, 14-15), available 
at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Solomon120307.pdf (lamenting the slow pace of change in 
accounting curricula and education).
---------------------------------------------------------------------------

    In this regard, the Committee makes the following 
recommendations:
    (a) Regularly update the accounting certification examinations 
to reflect changes in the accounting profession, its relevant 
professional and ethical standards, and the skills and knowledge 
required to serve increasingly global capital markets.
    Accounting and auditing professionals commonly complete the 
requirements of professional examinations in order to comply with 
legal or professional association requirements. To become licensed 
at the state level as a certified public accountant, an individual 
must, among other things, pass the Uniform CPA Examination. 
Professional examinations, such as the Uniform CPA

[[Page 28193]]

Examination, influence the content of the technical, ethical, and 
professional materials comprising the accounting curricula.\23\
---------------------------------------------------------------------------

    \23\ Gary Sundem, The Accounting Education Change Commission: 
Its History and Impact Chapter 6 (1999), available at http://aaahq.org/AECC/history/index.htm (``[T]he CPA examination has 
certainly had a major influence on the accounting curriculum and on 
other aspects of accounting programs.'').
---------------------------------------------------------------------------

    The Committee believes that evolution of professional 
examination content serves as an important catalyst for curricular 
changes to reflect the dynamism and complexity of auditing public 
companies in global capital markets. The American Institute of 
Certified Public Accountants (AICPA) already regularly analyzes and 
updates its examination content, through practice content analysis 
and in conjunction with the AICPA Board of Examiners, which 
comprises members from the profession and state boards of 
accountancy. The Committee recommends that such changes remain a 
focus to ensure that examination content reflects in a timely manner 
important ongoing market developments and investor needs, such as 
the increasing use of international financial reporting standards 
(IFRS), expanded fair value measurement and reporting, increasingly 
complex transactions, new Public Company Accounting Oversight Board 
(PCAOB) auditing and professional standards,\24\ risk-based business 
judgment, and technological innovations in financial reporting.
---------------------------------------------------------------------------

    \24\ See e.g., An Audit of Internal Control Over Financial 
Reporting That Is Integrated with An Audit of Financial Statements, 
Auditing Standard No. 5 (Pub. Company Accounting Oversight Bd. 
2007).
---------------------------------------------------------------------------

    Moreover, the Committee believes that professional \25\ and 
ethical standards \26\ and subject matter relating to their 
application are an essential component of the accounting curricula 
and accordingly should be reflected in the professional examinations 
and throughout business and accounting coursework.
---------------------------------------------------------------------------

    \25\ See PCAOB Standards and Related Rules, available at http://www.pcaobus.org/Standards/Standards_and_Related_Rules/index.aspx.
    \26\ See PCAOB Interim Ethics Standards, availabe at http://www.pcaobus.org/Standards/Interim_Standards/Ethics/index.aspx.
---------------------------------------------------------------------------

    Finally, the Committee recommends that the market developments 
outlined in this section be reflected in professional examination 
content as soon as practicable, but not later than 2011. In 
addition, the Committee recommends that new evolving examination 
content be widely and promptly communicated to college and 
university faculty and administrators so that corresponding 
curricular changes in educational institutions can continually occur 
on a timely basis.
    (b) Reflect real world changes in the business environment more 
rapidly in teaching materials.
    Students are expected to use a variety of sources, such as 
textbooks and online materials, to learn. Such materials are an 
important element of higher education. The Committee learned that 
these commercial materials are generally conservatively managed and 
follow rather than lead recent market developments.\27\ Because 
developing accounting materials involves a significant investment of 
time and resources, commercial content providers carefully consider 
the potential risks and rewards before publishing new materials, 
even where a more prompt response to new developments might be 
beneficial to students.
---------------------------------------------------------------------------

    \27\ Subcommittee on Human Capital Record of Proceedings (Jan. 
16, 2008) (Oral Remarks of Bruce K. Behn, President, Federation of 
Schools of Accountancy, and Ergen Professor of Business, Department 
of Accounting and Information Management, University of Tennessee, 
Knoxville).
---------------------------------------------------------------------------

    The Committee believes that accounting educational materials can 
contribute to inducing curricular changes that reflect the dynamism 
and complexity of the global capital markets and that commercial 
content providers should recognize the importance of capturing 
recent developments in their published materials. Specifically, the 
Committee recommends that organizations, such as the AICPA and the 
American Accounting Association (AAA), meet with commercial content 
providers and encourage them to update their materials promptly to 
reflect recent developments such as the increasing use of IFRS, new 
PCAOB auditing and professional standards, risk-based business 
judgment and expanded fair value reporting, as well as technological 
developments in financial reporting and auditing such as eXtensible 
Business Reporting Language (XBRL).
    Further, in order to ensure access to such materials, the 
Committee recommends that authoritative bodies and agencies should 
be encouraged to provide low-cost, affordable access to digitized 
searchable authoritative literature and materials, such as Financial 
Accounting Standards Board (FASB) codification and eIFRS, to 
students and faculty members. Moreover, since the content of 
professional examinations, such as the Uniform CPA Examination, is 
based upon research using digitized materials, students need to have 
access to, among other things, searchable accounting standards.\28\ 
The Committee believes that low-cost affordable access to such 
primary materials would thus enhance student learning and 
performance and technical research.
---------------------------------------------------------------------------

    \28\ See Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Phillip M.J. Reckers, Professor of Accountancy, 
Arizona State University, 14), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf 
(affirming the need for student access to digitized searchable 
accounting and auditing materials).
---------------------------------------------------------------------------

    (c) Require that schools build into accounting curricula current 
market developments.
    A common theme of our first set of recommendations is that 
accounting curricula should reflect recent developments, including 
globalization and evolving market factors. As a further catalyst to 
curricula development and evolution by educational institutions, the 
Committee recommends ongoing attention to responsiveness to recent 
developments by the bodies that accredit educational institutions. 
Accrediting agencies review institutions of higher education and 
their programs and establish that overall resources and strategies 
are conformed to the mission of the institutions. For example, the 
Association to Advance Collegiate Schools of Business (AACSB) and 
the Association of Collegiate Business Schools and Programs (ACBSP) 
accredit business administration and accounting programs. Since 
1919, the AACSB has accredited business administration programs and, 
since 1980, accounting programs offering undergraduate and graduate 
degrees. The AACSB has accredited over 450 U.S. business programs 
and over 150 U.S. accounting programs. Since 1988, the ACBSP has 
accredited business programs offering associate, baccalaureate and 
graduate degrees. As of February 2008, over 400 educational 
institutions have achieved ACBSP accreditation. The accreditation 
standards at both accrediting agencies relate to, among other 
things, curricula, program and faculty resources, and faculty 
development.
    The Committee believes that the accreditation process and 
appropriate accreditation standards can contribute to curricular 
changes. In particular, accreditation standards that embody 
curricular requirements to reflect the dynamism and complexity of 
the global capital markets and that evolve to keep pace in the 
future can be helpful in maintaining and advancing the quality of 
accounting curricula. The AACSB has emphasized in its accreditation 
standards that accounting curricula should reflect recent market 
developments. For example, educational institutions must include in 
their curricula international accounting issues in order to receive 
AACSB accreditation. The Committee supports the accrediting 
agencies' efforts to continually develop standards specifically 
emphasizing the need to update accounting programs.
    Recommendation 2. Improve the representation and retention of 
minorities in the auditing profession so as to enrich the pool of 
human capital in the profession.
    The auditing profession presents challenging and rewarding 
opportunities for those who pursue a career in auditing and the 
profession actively recruits talent from all backgrounds. Yet, the 
Committee was concerned by what it heard from individuals with 
various backgrounds about minority representation and retention in 
the auditing profession.\29\ In 2004, minorities accounted for 23% 
of bachelor's degrees awarded in accounting, 21% of master's 
graduate degrees awarded in accounting, and 38% of doctoral

[[Page 28194]]

degrees awarded in accounting-related studies.\30\ In 2004, African 
Americans represented 1% of all CPAs, Hispanic/Latino, 3%, and 
Asian/Pacific Islander, 4%.\31\ African Americans accounted for 5.4% 
of new hires in 2007 in the largest six accounting firms, Hispanics, 
4.6%, and Asians, 21.3%.\32\ In 2007, 1.0% of the partners in the 
six largest accounting firms were African American, 1.6% were 
Hispanic/Latino, 3.4% were Asian, and less than 1.0% were Native 
Hawaiian/Pacific Islander or American Indian/Alaska Native, 
aggregating less than 7% of the total partners.\33\
---------------------------------------------------------------------------

    \29\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Ira Solomon, R.C. Evans Distinguished Professor, and 
Head, Department of Accountancy, University of Illinois, 13), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Solomon120307.pdf; Record of Proceedings (Dec. 
3, 2007) (Questions for the Record of George S. Willie, Managing 
Partner, Bert Smith & Co., 2 (Jan. 30, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Willie120307.pdf; Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Julie K. Wood, Chief People Officer, Crowe Chizek and 
Company LLC, 2) available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Wood120307.pdf.
    \30\ Beatrice Sanders, and Leticia B. Romeo, The Supply of 
Accounting Graduates and the Demand for Public Accounting Recruits--
2005: For Academic Year 2003-2004 10 (2005), available at http://ceae.aicpa.org/NR/rdonlyres/11715FC6-F0A7-4AD6-8D28-6285CBE77315/0/Supply_DemandReport_2005.pdf.
    \31\ Beatrice Sanders, and Leticia B. Romeo, The Supply of 
Accounting Graduates and the Demand for Public Accounting Recruits--
2005: For Academic Year 2003-2004 1 (2005), available at http://ceae.aicpa.org/NR/rdonlyres/11715FC6-F0A7-4AD6-8D28-6285CBE77315/0/Supply_DemandReport_2005.pdf.
    \32\ Center For Audit Quality, Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession 59 (Jan. 23, 2008).
    \33\ Center For Audit Quality, Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession 60 (Jan. 23, 2008).
---------------------------------------------------------------------------

    The Committee recognizes that important groups within the 
minority population are significantly under-represented in the 
accounting and auditing profession, especially at senior levels, and 
this under-representation of minorities in the profession is 
unacceptable from both a societal and business perspective. As the 
demographics of the global economy continue to expand ethnic 
diversity, it is imperative that the profession also reflect these 
changes. The auditing profession's historic role in performing 
audits in an increasingly diverse global setting and in establishing 
investor trust cannot be maintained unless the profession itself is 
viewed as open and representative. To ensure the continued health 
and vibrancy of the profession, it is imperative that all 
participants in the financial, investor, educator, and auditor 
community adopt and implement policies, programs, practices, and 
curricula designed to attract and retain minorities. In order for 
minority participation in the accounting and auditing profession to 
grow and sustain itself, minority recruitment and retention needs to 
be a multi-faceted, multi-year effort, implemented and championed by 
community leaders, families, and most importantly business and 
academic leaders who educate, recruit, employ, and rely on 
accountants and auditors.
    In this regard, the Committee recognizes the importance of 
setting goals and measuring progress against these goals and thus 
makes the following recommendations:
    (a) Recruit minorities into the auditing profession from other 
disciplines and careers.
    The Committee heard from witnesses that the auditing profession 
has ``fallen short'' on its minority recruitment goals.\34\ 
Accordingly, the Committee recommends that auditing firms actively 
market to and recruit from minority non-accounting graduate 
populations, both at the entry and experienced hire level, utilizing 
cooperative efforts by academics and firm-based training programs to 
assist in this process. Generally, auditing firms hire individuals 
for the audit practice who are qualified to sit for the Uniform CPA 
Examination.\35\
---------------------------------------------------------------------------

    \34\ See e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Julie K. Wood, Chief People Officer, Crowe Chizek and 
Company LLC, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Wood120307.pdf (admitting an 
auditing firm had not met its goals in minority recruitment).
    \35\ See Record of Proceedings (Dec. 3, 2007) (Questions for the 
Record of James S. Turley, Chairman and Chief Executive Officer, 
Ernst & Young LLP, 4 (Feb. 1, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/QFRs-12-3-07.pdf (noting 
that since 1997, Ernst & Young LLP has typically hired individuals 
qualified to sit for the Uniform CPA Examination).
---------------------------------------------------------------------------

    Further, the Committee recommends that auditing firms expand 
their recruitment initiatives at historically black colleges and 
universities (HBCUs), and explore the use of proprietary schools as 
another way to recruit minorities into the profession. Currently 
over 100 educational institutions established before 1964 to serve 
the African American community are designated as HBCUs and over 
fifty of these HBCUs maintain accounting programs. Approximately 
290,000 students are enrolled in HBCUs \36\ and HBCUs enroll 14% of 
all African American students in higher education.\37\ Twenty-seven 
HBCUs have one or more of the six largest accounting firms 
recruiting professional staff on their campus.\38\ Both the number 
of these schools visited by the largest firms and the number of 
firms recruiting at these schools should increase. Proprietary 
schools are for-profit businesses that teach vocational or 
occupational skills and there are over 2,000 proprietary schools in 
the United States.\39\ In 2005, these schools enrolled over 1 
million students: African Americans accounted for 23% of these 
students, Hispanics, 13%, and Asian/Pacific Islander, 4%.\40\
---------------------------------------------------------------------------

    \36\ Stephen Provasnik and Linda L. Shafer, Historically Black 
Colleges and Universities, 1976 to 2001 2 (NCES 2004-062), available 
at http://nces.ed.gov/pubs2004/2004062.pdf.
    \37\ White House Initiative on Historically Black Colleges and 
Universities, available at http://www.ed.gov/about/inits/list/whhbcu/edlite-index.html.
    \38\ Center For Audit Quality, Supplement to Report of the Major 
Public Company Audit Firms to the Department of the Treasury 
Advisory Committee on the Auditing Profession 1 (Mar. 5, 2008).
    \39\ Thomas D. Snyder, Sally A. Dillow, and Charlene M. Hoffman, 
Digest of Education Statistics 2007 Table 5 (NCES 2008-022), 
available at http://nces.ed.gov/pubs2008/2008022.pdf.
    \40\ Thomas D. Snyder, Sally A. Dillow, and Charlene M. Hoffman, 
Digest of Education Statistics 2007 Table 220 (NCES 2008-022), 
available at http://nces.ed.gov/pubs2008/2008022.pdf.
---------------------------------------------------------------------------

    (b) Emphasize the role of community colleges in the recruitment 
of minorities into the auditing profession.
    Community colleges are a vital part of the postsecondary 
education system. They provide open access to post-secondary 
education, preparing students for transfer to four-year 
institutions, providing workforce development and skills training, 
and offering non-credit programs. Moreover, as the cost of higher 
education continues its upward climb, more and more high-achieving 
students are beginning their post-secondary study through the 
community college system.
    As of January 2008, approximately 11.5 million students were 
enrolled in the 1,200 community colleges in the United States: 
African Americans accounted for 13% of these students, Hispanics, 
15%, and Asian/Pacific Islander, 6%.\41\
---------------------------------------------------------------------------

    \41\ American Association of Community Colleges, available at 
http://www2.aacc.nche.edu/research/index.htm.
---------------------------------------------------------------------------

    In August 1992, the Accounting Education Change Commission 
(AECC), created in the late 1980s by the academic community to 
examine potential changes to accounting education, recognized the 
importance of two-year colleges in accounting education. The AECC 
noted that over half of all students taking their first course in 
accounting do so at two-year colleges and that approximately one-
fourth of the students entering the accounting profession take their 
initial accounting coursework at two-year colleges. The AECC called 
for ``greater recognition within the academic and professional 
communities of the efforts and importance of two-year accounting 
programs.'' \42\
---------------------------------------------------------------------------

    \42\ Accounting Education Change Commission, Issues Statement 
Number 3: The Importance of Two-Year Colleges for Accounting 
Education (Aug. 1992) available at http://aaahq.org/aecc/PositionsandIssues/issues3.htm.
---------------------------------------------------------------------------

    The Committee also heard from witnesses emphasizing the need to 
expand minority recruitment initiatives at community colleges.\43\
---------------------------------------------------------------------------

    \43\ Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Gilbert R. Vasquez, Managing Partner, Vasquez & Company LLP, 4), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Vasquez02042008.pdf (noting that auditing firms 
overlook community colleges where minorities, and specifically 
Latinos, represent a large student population); Record of 
Proceedings (Dec. 3, 2007) (Questions for the Record of George S. 
Willie, Managing Partner, Bert Smith & Co., 2 (Jan. 30, 2008)), 
available at http://www.treas.gov/offices/domestic-finance/acap/QFRs-12-3-07.pdf (recommending that the auditing profession increase 
it visibility at community colleges).
---------------------------------------------------------------------------

    The Committee believes that more attention to community colleges 
may provide, in addition to an increase in the overall supply of 
students, another avenue for minorities to become familiar with and 
attracted to the auditing profession. Currently none of the largest 
auditing firms recruit at community colleges because ``individuals 
who only have associate degrees typically will not have sufficient 
qualifications to satisfy state licensing requirements.'' \44\ The 
Committee recommends that accreditation of two-year college 
accounting programs at

[[Page 28195]]

community colleges be explored and implemented when viable, so that 
these programs can be relied upon as one of the requisite steps 
toward fulfilling undergraduate educational requirements. Further, 
the Committee recommends that auditing firms and educational 
institutions at all levels support and cooperate in building strong 
fundamental academic accounting programs at community colleges, 
including providing internships or financial support for students 
who begin their studies in two-year programs and may be seeking 
careers in the auditing profession. The Committee also recommends 
that auditing firms and four-year colleges and universities and 
their faculty focus on outreach to community college students in 
order to support students' transition from community colleges to 
four-year educational institutions.
---------------------------------------------------------------------------

    \44\ Center For Audit Quality, Supplement to Report of the Major 
Public Company Audit Firms to the Department of the Treasury 
Advisory Committee on the Auditing Profession 1 (Mar. 5, 2008).
---------------------------------------------------------------------------

    (c) Emphasize the utility and effectiveness of cross-sabbaticals 
and internships with faculty and students at Historically Black 
Colleges and Universities.
    As discussed above, African Americans are significantly under-
represented in the auditing profession.
    The Committee recommends encouraging a concerted effort to 
increase the focus upon HBCUs in order to raise the number of 
African Americans in the auditing profession and urging the HBCUs, 
auditing firms, corporations, federal and state governments, and 
other entities to emphasize the use of cross-sabbaticals. Cross-
sabbaticals are interactive relationships where faculty and seasoned 
professionals are regularly represented in the practice and academic 
environments through exchanges. Evidence suggests that such 
exchanges can be beneficial, and continued development of such 
exchanges is expected to provide substantial benefits for all 
parties.\45\ Cross-sabbaticals present an opportunity for 
``reflective thinking'' for seasoned professionals.\46\
---------------------------------------------------------------------------

    \45\ See Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Cynthia Fornelli, Executive Director, Center for Audit 
Quality, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf (recommending 
encouraging sabbaticals, internships, and fellowship opportunities, 
structured to give faculty opportunities to conduct research for 
promotion and tenure); Record of Proceedings (Feb. 4, 2008) (Oral 
Remarks of Phillip M.J. Reckers, Professor of Accountancy, Arizona 
State University, 68), available at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-2-4-08.pdf (stating that 
sabbaticals deliver professors ``a wealth of knowledge they could 
bring back in the classroom'').
    \46\ See Record of Proceedings (Mar. 13, 2008) (Oral Remarks of 
H. Rodgin Cohen, Chairman, Sullivan & Cromwell LLP, 69), available 
at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-03-13-08.pdf (noting that spending time in the classroom 
should ``give the [practicing accountant] the time to do the 
reflective thinking.''); Record of Proceedings (Mar. 13, 2008) (Oral 
Remarks of Zoe-Vonna Palmrose, Deputy Chief Accountant, SEC), 
available at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-03-13-08.pdf (commenting that sabbaticals provide 
the ``opportunity for reflective thinking'').
---------------------------------------------------------------------------

    In addition, the Committee recommends that the over fifty HBCUs 
with accounting programs require one member of their accounting 
faculty annually to participate in a cross-sabbatical with a private 
or public sector entity. The Committee also recommends that the 
private and public sector entities provide these opportunities, as 
well as focus on other arrangements to build relationships at these 
educational institutions.
    The Committee received testimony regarding the lack of minority 
mentors and role models \47\ and notes that the profession has 
recognized this situation.\48\ Thus, the Committee also recommends 
that public company auditing firms intensify their efforts to create 
internships and mentoring programs for students in accounting and 
other complementary disciplines, including those from HBCUs and 
community colleges, as a means to increase the awareness of the 
accounting profession and its attractiveness among minority 
students.
---------------------------------------------------------------------------

    \47\ See Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Gilbert R. Vasquez, Managing Partner, Vasquez & 
Company LLP, 4), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Vasquez02042008.pdf (highlighting 
the lack of Hispanic role models and mentors in the accounting 
profession).
    \48\ See Record of Proceedings (Dec. 3, 2007) (Questions for the 
Record of George S. Willie, Managing Partner, Bert Smith & Co., 2 
(Jan. 30, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Willie120307.pdf 
(recommending the establishment of a mentor program for minority 
accounting students); Record of Proceedings (July 12, 2006) (Written 
Testimony of Manuel Fernandez, National Managing Partner--Campus 
Recruiting, KPMG LLP, to the Subcommittee on Oversight and 
Investigations of the House Financial Services Committee, 5), 
available at http://financialservices.house.gov/media/pdf/071206mf.pdf (identifying the lack of minority faculty mentors and 
role models and noting ``[w]hen students of color do not see 
professors of their own ethnic background on the accounting faculty, 
they are less apt to consider the option of a career in 
accountancy'').
---------------------------------------------------------------------------

    (d) Increase the numbers of minority accounting doctorates 
through focused efforts.
    Some dedicated programs have succeeded in attracting minorities 
to enter and complete accounting doctoral studies.\49\ In 
particular, the PhD Project, an effort of the KPMG Foundation, has 
worked to increase the diversity of business school faculty.\50\ The 
PhD Project focuses on attracting minorities to business doctoral 
programs, and provides a network of peer support. Since the PhD 
Project's establishment in 1994, the number of minority professors 
at U.S. business schools has increased from 294 to 889.\51\ Ninety 
percent who enter the PhD Project earn their doctorates, and 99% of 
those who completed their doctorates go on to teach.\52\ The PhD 
Project has received over $17.5 million \53\ in funding since 1994 
from corporations, foundations, universities, and other interested 
parties.\54\
---------------------------------------------------------------------------

    \49\ For a list of educational support programs that auditing 
firms are sponsoring, see Record of Proceedings (Feb. 4, 2008) 
(Written Submission of Barry Salzberg, Chief Executive Officer, 
Deloitte LLP, Appendix A), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Salzberg020408.pdf.
    \50\ For further information on the PhD Project, see http://www.phdproject.org/mission.html.
    \51\ Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Barry Salzberg, Chief Executive Officer, Deloitte LLP, Appendix A), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Salzberg020408.pdf.
    \52\ See Jane Porter, Going to the Head of the Class: How the 
PhD Project is Helping to Boost the Number of Minority Professors in 
B-schools, BUSINESS WEEK ONLINE, Dec. 27, 2006, available at http://www.businessweek.com/bschools/content/dec2006/bs20061227_926455.htm.
    \53\ See Record of Proceedings (July 12, 2006) (Written 
Testimony of Manuel Fernandez, National Managing Partner--Campus 
Recruiting, KPMG LLP, to the Subcommittee on Oversight and 
Investigations of the House Financial Services Committee, 5), 
available at http://financialservices.house.gov/media/pdf/071206mf.pdf.
    \54\ For further information on the PhD Project, see http://www.phdproject.org/corp_sponsors.html.
---------------------------------------------------------------------------

    The Committee believes that programs such as these can 
successfully recruit minorities to accounting doctoral studies. The 
Committee recommends that auditing firms, corporations, and other 
interested parties advertise existing and successful efforts to 
increase the number of minority doctorates by developing further 
dedicated programs. Additionally, the Committee recommends that 
auditing firms, corporations, and other interested parties maintain 
and increase the funding of these programs.
    Recommendation 3. Ensure a sufficiently robust supply of 
qualified accounting faculty to meet demand for the future and help 
prepare new entrants to the profession to perform high quality 
audits.
    The Committee heard testimony from individuals regarding the 
need to have an adequate supply of faculty with the knowledge and 
experience to develop qualified professionals for the increasingly 
complex and global auditing profession.\55\
---------------------------------------------------------------------------

    \55\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of David W. Leslie, Chancellor Professor of Education, 
College of William and Mary), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Leslie120307.pdf 
(noting a 13.3% decline in accounting faculty from 1988 to 2004); 
Record of Proceedings (Feb. 4, 2008) (Written Submission of Edward 
E. Nusbaum, Chief Executive Officer, Grant Thornton LLP, and 
Chairman, Grant Thornton International Board of Governors, 5), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf (stating that ``recent years 
have seen a reduction in accounting faculty, based on a wave of 
retirements and lack of accounting PhDs coming into the system.''); 
Record of Proceedings (Dec. 3, 2007) (Written Submission of Ira 
Solomon, R.C. Evans Distinguished Professor, and Head, Department of 
Accountancy, University of Illinois, 4), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Solomon120307.pdf (stating that ``the number of persons entering 
accountancy doctoral programs is too low to sustain the accountancy 
professoriate.'').
---------------------------------------------------------------------------

    The Committee recognizes that there is a high level of concern 
about the adequacy of both the near and the long-term supply of 
doctoral faculty, especially given the anticipated pace of faculty 
retirements. According to National Study of Postsecondary Faculty 
data, the number of

[[Page 28196]]

full- and part-time accounting faculty at all types of educational 
institutions fell by 13.3% from 20,321 in 1993 to 17,610 in 2004, 
while student (undergraduate) enrollment has increased by 12.3% over 
the same period.\56\ Moreover, the current pipeline of doctoral 
faculty is not keeping pace with anticipated retirements. In 
November 2006, it was estimated that one-third of the approximately 
4,000 accounting doctoral faculty in the United States were 60 years 
old or older, and one-half were 55 years old or older.\57\ The 
average retirement age of accounting faculty was 62.4 years.
---------------------------------------------------------------------------

    \56\ Record of Proceedings (Dec. 3, 2007) (Written Submission of 
David W. Leslie, Chancellor Professor of Education, College of 
William and Mary), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Leslie120307.pdf.
    \57\ James R. Hasselback, 2007 Analysis of Accounting Faculty 
Birthdates, available at http://aaahq.org/temp/phd/JimHasselbackBirthdateSlide.pdf.
---------------------------------------------------------------------------

    In terms of specialization within the accounting discipline, an 
AAA study concluded that only 22% and 27% of the projected demand 
for doctoral faculty in auditing and tax, respectively, will be met 
by expected graduations in the coming years.\58\ However, 91% and 
79% of the projected demand for doctoral faculty in financial 
accounting and managerial accounting, respectively, will be met.\59\
---------------------------------------------------------------------------

    \58\ R. David Plumlee, Steven J. Kachelmeier, Silvia A. Madeo, 
Jamie H. Pratt, and George Krull, Assessing the Shortage of 
Accounting Faculty, 21 Issues in Accounting Education, No. 2, 119 
(May 2006).
    \59\ R. David Plumlee, Steven J. Kachelmeier, Silvia A. Madeo, 
Jamie H. Pratt, and George Krull, Assessing the Shortage of 
Accounting Faculty, 21 Issues in Accounting Education, No. 2, 119 
(May 2006).
---------------------------------------------------------------------------

    In addition to the accounting faculty supply issues, the 
Committee heard testimony from witnesses on the need to ensure 
faculty are qualified and able to teach students the latest market 
developments, such as fair value accounting and IFRS. The Committee 
learned that often new accounting faculty may have little practical 
experience.\60\ Witnesses testified to the difficulty of academics' 
acquiring ``practice-oriented'' knowledge as the bond between the 
profession and academia is underdeveloped. Witnesses did suggest 
improving these relationships with incentives for sabbaticals and 
sharing practice experience.\61\
---------------------------------------------------------------------------

    \60\ Record of Proceedings (Dec. 3, 2007) (Written Submission of 
Joseph V. Carcello, Director of Research, Corporate Governance, 
University of Tennessee, Knoxville, 21), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Carcello120307.pdf.
    \61\ Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Cynthia Fornelli, Executive Director, Center for Audit Quality, 2), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf (noting that the auditing 
firms recognize the need to be more active in sharing practical 
experiences with academics); Record of Proceedings (Feb. 4, 2008) 
(Written Submission of Phillip M.J. Reckers, Professor of 
Accountancy, Arizona State University, 19), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf (``[R]elationships between practitioners and 
academics have so diminished that they are little more than formal 
liaison assignments involving very few parties from any side * * * 
[w]here there have been opportunities for interaction (curriculum 
issues, policy deliberations, research matters), those opportunities 
have been embraced perceptibly less often'').
---------------------------------------------------------------------------

    In this regard, the Committee makes the following 
recommendations:
    (a) Increase the supply of accounting faculty through public and 
private funding and raise the number of professionally qualified 
faculty that teach on campuses.
    The Committee recognizes that ensuring an adequate supply of 
doctoral accounting faculty in higher education is crucial to both 
retaining the academic standing of the discipline on campus and 
developing well-prepared and educated entry-level professionals. The 
resource represented by these professionals is essential for high 
quality audits. The Committee believes that high quality audits are 
critical to well-functioning capital markets, and therefore the 
funding necessary to provide the healthy pipeline of doctoral 
accounting faculty to assist in providing these human capital 
resources must be provided. The Committee therefore recommends 
expanding government funding, at both the federal and state level, 
for accounting doctoral candidates. The Committee also recommends 
that private sources (including corporations, institutional 
investors, and foundations as well as auditing firms) continue to be 
encouraged to fund accounting doctoral candidates. The Committee 
recognizes and commends the auditing firms' support of doctoral 
candidates.\62\
---------------------------------------------------------------------------

    \62\ See Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Cynthia Fornelli, Executive Director, Center for Audit 
Quality, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf.
---------------------------------------------------------------------------

    Currently, minimum accreditation requirements for accountancy 
faculty typically require that approximately 50% of full-time 
faculty have a doctoral degree. Commonly, business school deans and 
academic vice presidents (those making the budgetary decisions 
regarding faculty allotments on campuses) interpret this 
accreditation requirement to require that a minimum of 50% of a 
department's faculty hold an earned doctorate and are actively 
engaged in research and publication activity. Although a high 
percentage of faculty are expected to be professionally qualified 
(i.e., having recent direct business experience), at times 
gatekeepers for budget allocations may be less enthusiastic about 
maximizing the number of professionally qualified teaching slots in 
a given program. The Committee sees benefits to the increased 
participation of professionally qualified and experienced faculty, 
who would bring additional practical business experience to the 
classrooms, and notes that witnesses and commenters have underscored 
the benefits of professionally qualified and experienced 
faculty.\63\ Therefore, the Committee recommends that accrediting 
agencies continue to actively support faculty composed of 
academically and professionally qualified and experienced faculty.
---------------------------------------------------------------------------

    \63\ See Andrew D. Bailey, Jr., Professor of Accountancy-
Emeritus, University of Illinois, and Senior Policy Advisor, Grant 
Thornton LLP, Comment Letter Regarding Discussion Outline 19 (Jan. 
30, 2008), available at http://comments.treas.gov/_files/BAILEYCOMMENTSONTREASURYADVISORYCOMMITTEEOUTLINEFINALSUBMISSION13008.
doc (stating that ``[t]here are clearly practice professionals that 
make excellent contributions to some of the most highly rated 
accounting programs in the country''); Record of Proceedings (Feb. 
4, 2008) (Written Submission of Cynthia Fornelli, Executive 
Director, Center for Audit Quality, 3) available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf (stating that accreditation bodies ``revise 
accreditation standards to allow the employment of more audit 
professionals, either active or retired, as adjunct professors'').
---------------------------------------------------------------------------

    (b) Emphasize the utility and effectiveness of cross-
sabbaticals.
    As discussed above, cross-sabbaticals are interactive 
relationships where faculty and seasoned professionals are regularly 
represented in the practice and academic environments through 
exchanges. For example, currently, the Securities and Exchange 
Commission (SEC) and the FASB offer fellowship programs for 
professional accountants and accounting academics. Evidence suggests 
that such exchanges can be beneficial, and continued development of 
such exchanges is expected to provide substantial benefits for all 
parties.\64\ Cross-sabbaticals present an opportunity for 
``reflective thinking'' for seasoned professionals.\65\ Academics 
often face the disincentive of being forced to forgo their full 
salaries in order to engage in such sabbaticals,\66\ and colleges 
and universities may not encourage professional practice 
sabbaticals, preferring that the focus of faculty be directed 
exclusively toward academic research and the number and placement of 
scholarly articles. The Committee believes that changing both the 
academic and practice culture will require a

[[Page 28197]]

plan and commitment of support at the highest institutional levels.
---------------------------------------------------------------------------

    \64\ See Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Cynthia Fornelli, Executive Director, Center for Audit 
Quality, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf (recommending 
encouraging sabbaticals, internships, and fellowship opportunities, 
structured to give faculty opportunities to conduct research for 
promotion and tenure); Record of Proceedings (Feb. 4, 2008) (Oral 
Remarks of Phillip M.J. Reckers, Professor of Accountancy, Arizona 
State University, 68), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf 
(stating that sabbaticals deliver professors ``a wealth of knowledge 
they could bring back in the classroom'').
    \65\ See Record of Proceedings (Mar. 13, 2008) (Oral Remarks of 
H. Rodgin Cohen, Chairman, Sullivan & Cromwell LLP, 69), available 
at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-03-13-08.pdf; Record of Proceedings (Mar. 13, 2008) (Oral 
Remarks of Zoe-Vonna Palmrose, Deputy Chief Accountant, SEC, 67), 
available at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-03-13-08.pdf.
    \66\ Record of Proceedings (Feb. 4, 2008) (Oral Remarks of 
Phillip M.J. Reckers, Professor of Accountancy, Arizona State 
University, 67-69), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf (noting 
the financial disincentives associated with sabbaticals).
---------------------------------------------------------------------------

    Specifically, the Committee recommends that educational 
institutions, auditing firms, corporations, federal and state 
regulators, and others engage in a two-fold strategy to both 
encourage cross-sabbaticals and eliminate financial or career 
disincentives for participating in such experiences. Further, the 
Committee recommends that university administrators place as high a 
value on professional sabbaticals for purposes of promotion and 
tenure for research and scholarly publication.
    The Committee also recommends that accrediting agencies 
establish an expectation that at least one full-time member per year 
of each accounting faculty group participate in a sabbatical with a 
private sector or a governmental entity. Auditing firms, 
corporations, government agencies, and universities should be 
expected to provide these opportunities with the elimination of any 
financial disincentives. Further, the Committee recommends expanding 
faculty fellowship programs in agencies, such as those at the SEC 
and the FASB, and making them available at the PCAOB. The successful 
long-term operation of these programs at the SEC and the FASB and 
the application of appropriate conflict-of-interest and recusal 
rules have demonstrated that these programs can be maintained and 
expanded while protecting against conflicts of interest.
    (c) Create a variety of tangible and sufficiently attractive 
incentives that will motivate private sector institutions to fund 
both accounting faculty and faculty research, to provide practice 
materials for academic research and for participation of 
professionals in behavioral and field study projects, and to 
encourage practicing accountants to pursue careers as academically 
and professionally qualified faculty.
    As discussed above, there are concerns about the adequate supply 
of accounting faculty and about the need to have faculty who can 
inject more practical experience into classroom learning. Currently, 
there are few specific financial incentives encouraging private 
sector funding of accounting doctoral faculty or sponsoring of 
professional accountants to teach at educational institutions. 
Nonetheless, the Committee notes that the profession recognizes the 
need to support initiatives to increase faculty and is currently 
directing its efforts to raise funds for such a new initiative.\67\
---------------------------------------------------------------------------

    \67\ See Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Cynthia Fornelli, Executive Director, Center for Audit 
Quality, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf (stating that 
``[b]ecause of the profession's concern over the shortage of 
qualified faculty to teach accounting, the AICPA Foundation, along 
with the 80 largest CPA firms, are working to raise more than $17 
million to fund additional PhD candidates at participating 
universities'').
---------------------------------------------------------------------------

    The Committee also heard from several witnesses regarding the 
unavailability of data relating to auditing practice and the impact 
this lack of data has on research and potentially on the 
profession's sustainability. In particular, witnesses stated that 
the decline in auditing research materials, including archival or 
experimental data will lead to a further decline in faculty and 
doctoral students specializing in auditing.\68\ Since educational 
institutions normally require publications in top tier journals for 
promotion or tenure, faculty and doctoral students will conduct 
research in accounting areas where data are prevalent.
---------------------------------------------------------------------------

    \68\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Joseph V. Carcello, Director of Research, Corporate 
Governance, University of Tennessee, Knoxville, 21), available at 
http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Carcello120307.pdf (``[D]octoral students in * * * [a 2007] 
Deloitte [Foundation] study indicated that lack of access to public 
accounting firm and client data represented a severe obstacle to the 
research they want to conduct, and that this difficulty might result 
in them focusing on a different accounting sub-area. This issue must 
be addressed, or auditing may cease to exist as a discipline on many 
university campuses.''); Record of Proceedings (Feb. 4, 2008) 
(Written Submission of Phillip M.J. Reckers, Professor of 
Accountancy, Arizona State University, 8), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf (recommending the development of a means ``for 
researchers to gain access to auditing related data'' and noting, 
without this means, interest in doctoral auditing programs will 
continue to decline); Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Ira Solomon, R.C. Evans Distinguished Professor, and 
Head, Department of Accountancy, University of Illinois, 7), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Solomon120307.pdf (noting the lack of auditing 
research data and the ``drastic decline in auditing research among 
extant accountancy faculty and among accountancy doctoral 
students'').
---------------------------------------------------------------------------

    The Committee also heard that encouraging more professionally 
qualified and experienced faculty will foster a stronger 
relationship between academia and the profession.\69\ Currently, 
there exists a need for more interaction between academia and the 
profession.\70\ Encouraging practicing accountants to pursue careers 
as academically and professionally qualified faculty would bring 
practical business experience to classrooms so that students are 
better prepared to perform quality audits in the dynamic business 
environment.
---------------------------------------------------------------------------

    \69\ Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Cynthia Fornelli, Executive Director, Center for Audit Quality, 2), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf.
    \70\ Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Phillip M.J. Reckers, Professor of Accountancy, Arizona State 
University, 19), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf.
---------------------------------------------------------------------------

    Finally, the Committee recommends that Congress pass legislation 
creating a variety of tangible incentives for private sector 
institutions to establish support for accounting and auditing 
faculty and faculty research, to facilitate access to research data 
and individuals, and to sponsor transition of professional 
accountants from practice to teaching positions. These incentives 
must be sufficiently attractive to companies and auditing firms to 
effect rapid behavioral change, and should avoid cumbersome levels 
of administration. The Committee believes that these incentives 
would provide the necessary impetus to private sector institutions 
to help increase the number of accounting faculty as well as faculty 
with significant practical experience.
    Recommendation 4. Develop and maintain consistent demographic 
and higher education program profile data.
    The Committee heard testimony regarding the lack of consistent 
demographic and higher education program profile data concerning the 
profession.\71\ The need for comparable, consistent, periodic 
information regarding the demographic profile of professional 
accountants and auditors, related higher education program capacity, 
entry-level supply and demand of personnel, accounting firm 
retention and compensation practices, and similar particulars are 
fundamental to a meaningful understanding of the human capital 
circumstances which affect the public company auditing profession 
and its future and sustainability.
---------------------------------------------------------------------------

    \71\ See e.g., Record of Proceedings (Dec. 3, 2007) (Questions 
for the Record of David A. Costello, President and Chief Executive 
Officer, National Association of State Board of Accountancy, 2-4 
(Feb. 6, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/QFRs-12-3-07.pdf (stating that ``[s]ince 1970, * * * 
NASBA and the AICPA have recognized the need for a national database 
for Certified Public Accountants and have taken steps leading to the 
development of the database * * * [c]urrently, NASBA is not aware of 
a mechanism or database which would provide an accurate count of 
CPAs, without the effect of `double counting.' ''); Julia Grant, 
Demographic Challenges Facing the CPA Profession, 20 Research in 
Accounting Regulations 5 (2007) (forthcoming); Record of Proceedings 
(Dec. 3, 2007) (Written Submission of Ira Solomon, R.C. Evans 
Distinguished Professor, and Head, Department of Accountancy, 
University of Illinois, 13), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Solomon120307.pdf 
(noting the lack of comprehensive accounting profession supply and 
demand data and recommending the ``establishment of a continuous and 
comprehensive system that produces more timely and reliable supply 
and demand data'').
---------------------------------------------------------------------------

    Historically, there has been neither an ongoing collection of 
data nor a centralized location where the general public can access 
data. For instance, the AICPA publishes a supply and demand study 
every two years. Additionally, various other groups, such as the 
AAA, NASBA, colleges and universities, and individuals collect some 
of these data but not in a manner available and useful for research.
    Materials such as those supplied by the Center for Audit Quality 
to the Committee,\72\ previous AICPA Supply and Demand studies \73\ 
and AAA-commissioned demographic research \74\ provide examples of

[[Page 28198]]

the necessary information. In addition, AICPA membership trends, 
augmented by data available from state boards of accountancy 
regarding numbers of licensees, may be useful data.
---------------------------------------------------------------------------

    \72\ Center For Audit Quality, Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession (Jan. 23, 2008).
    \73\ Beatrice Sanders and Leticia B. Romeo, The Supply of 
Accounting Graduates and the Demand for Public Accounting Recruits--
2005: For Academic Year 2003-2004 (2005), available at http://ceae.aicpa.org/NR/rdonlyres/11715FC6-F0A7-4AD6-8D28-6285CBE77315/0/Supply_DemandReport_2005.pdf.
    \74\ David Leslie, Accounting Faculty in U.S. Colleges and 
Universities: Status and Trends, 1993-2004, A Report of the American 
Accounting Association (Feb. 19, 2008).
---------------------------------------------------------------------------

    Therefore, the Committee recommends the establishment of a 
national cooperative committee, comprised of organizations such as 
the AICPA and the AAA, to encourage periodic consistent demographic 
and higher education program profile data. The Committee believes 
that having such data available will increase the ability of 
auditing firms, corporations, investors, academics, policy makers, 
and others to understand more fully, monitor and evaluate, and take 
necessary or desirable actions with respect to the human capital in 
the auditing profession and its future and sustainability.
    Recommendation 5. Encourage the AICPA and the AAA to jointly 
form a commission to provide a timely study of the possible future 
of the higher education structure for the accounting profession.
    The Committee heard testimony regarding the feasibility of 
establishing a free-standing, post-graduate professional educational 
structure.\75\ Currently, there is no post-graduate institutional 
arrangement dedicated to accounting and auditing. Graduate programs 
in accounting are generally housed within business schools and 
linked with undergraduate accounting programs.
---------------------------------------------------------------------------

    \75\ See e.g., Record of Proceedings (Dec. 3, 2007) (Oral 
Submission of Joseph V. Carcello, Director of Research, Corporate 
Governance, University of Tennessee, Knoxville, 3), available at 
http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/CarcelloOralStatement120307.pdf (recommending that ``the 
Advisory Committee consider a different model--an education model 
involving professional schools of auditing * * * ''); Record of 
Proceedings (Feb. 4, 2008) (Written Submission of Phillip M.J. 
Reckers, Professor of Accountancy, Arizona State University, 3), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Reckers020408.pdf (discounting the feasibility 
of free-standing professional schools).
---------------------------------------------------------------------------

    The history of the development of U.S. educational programs and 
preparation for accounting careers reveals a pattern of evolution of 
increasing formal higher education, with accreditation standards 
following and reinforcing this evolution, and with market needs 
providing the impetus and context. Today, accrediting agencies have 
recognized over 150 accounting programs as the result of these 
programs' improving accounting education as envisioned by prior 
studies and reports.
    In a November 2006 Vision Statement, the chief executive 
officers of the principal international auditing networks noted the 
challenges in educating future auditing professionals, including the 
sheer quantity and complexity of accounting and auditing standards, 
rapid technological advancements, and the need for specialized 
industry knowledge.\76\ This development in the market leads to a 
clear need to anticipate and enhance the human capital elements of 
the auditing profession. As such, this vision statement provides the 
impetus to commission a group to study and propose a long-term 
institutional arrangement for accounting and auditing education.
---------------------------------------------------------------------------

    \76\ Global Capital Markets and the Global Economy: A Vision 
From the CEOs of the International Audit Networks 15 (Nov. 2006).
---------------------------------------------------------------------------

    As in the past, in the face of challenges of the changing 
environment for the profession, the Committee believes that the 
educational system should thoughtfully consider the feasibility of a 
visionary educational model. Therefore, the Committee recommends 
that the AICPA and the AAA jointly form a body to provide a timely 
study of the possible future of the higher education structure for 
the accounting profession. This commission may include 
representation from higher education, practitioners from the wide 
spectrum of the accounting and auditing profession, regulators, 
preparers, users of the profession's services, and others. The 
commission would consider the potential role of a postgraduate 
professional school model to enhance the quality and sustainability 
of a vibrant accounting and auditing profession. The commission 
should consider developments in accounting standards and their 
application, auditing needs, regulatory framework, globalization, 
the international pool of candidates, and technology. Finally, a 
blueprint for this sort of enhanced professional educational 
structure would also require the consideration of long-term market 
circumstances, academic governance, operations, programs, funding 
and resources, the role of accreditation, and experiential learning 
processes.

Other Issues Under Consideration

    The Committee is also considering and debating a variety of 
other issues. Further elaboration on these issues will be included 
in subsequent drafts of this Report.

VI. Firm Structure and Finances

    In addressing the sustainability of the auditing profession, the 
Committee sought input on and considered a number of matters 
relating directly to auditing firms, including audit quality, 
governance, transparency, global organization, financial strength, 
ability to access capital, the investing public's understanding of 
auditors' responsibilities and communications, the limitations of 
audits, particularly relating to fraud detection and prevention, as 
well as the effect of litigation where audits are alleged to have 
been ineffective. The Committee also considered the regulatory 
system applicable to auditing firms.
    While much data was available to the Committee, such information 
was not exhaustive. Certain information regarding auditors of public 
companies, the auditor of record, and audit fees is readily 
available. Auditing firms also provide on a voluntarily basis 
certain other information they believe useful to clients, 
regulators, and/or investors. Also, in connection with the work of 
the Committee, the largest firms provided certain additional input, 
through the Center for Audit Quality (CAQ), sometimes by individual 
firm and sometimes in summarized format.\77\
---------------------------------------------------------------------------

    \77\ Center For Audit Quality, Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession (Jan. 23, 2008); Center for 
Audit Quality, Second Supplement to Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession (Apr. 16, 2008).
---------------------------------------------------------------------------

    After reviewing these data and receiving testimony from 
witnesses and comment letters, the Committee focused on a few 
specific areas: Fraud prevention and detection; federal and state 
regulatory system; governance; and disclosure of auditor changes.
    The Committee recommends that regulators, the auditing 
profession, and others, as applicable, effectuate the following:
    Recommendation 1. Strengthen auditing firms' fraud detection and 
prevention skills and clarify communications with investors 
regarding auditing firms' fraud detection responsibilities.
    Public Company Accounting Oversight Board (PCAOB) standards 
currently require auditors to plan and perform audits to obtain 
reasonable assurance whether financial statements are free of 
material misstatement, including those caused by fraud.\78\ The 
Committee considered testimony and commentary regarding auditing 
firms' responsibilities and practices relating to fraud prevention 
and detection.\79\ The auditing profession itself has recognized the 
significance of its duties with respect to fraud: ``Perhaps no 
single issue is the subject of more confusion, yet is more 
important, than the nature of the obligation of auditors to detect 
fraud--or intentional material misstatement of financial information 
by public companies.'' \80\
---------------------------------------------------------------------------

    \78\ Consideration of Fraud in a Financial Statement, Interim 
Auditing Standard AU 316 (Pub. Company Accounting Oversight Bd. 
2002).
    \79\ See, e.g., Andrew D. Bailey, Jr., Professor of Acountancy-
Emeritus, University of Illinois, and Senior Policy Advisor, Grant 
Thornton LLP, Comment Letter Regarding Discussion Outline 4 (Jan. 
30, 2008), available at http://comments.treas.gov/_files/BAILEYCOMMENTSONTREASURYADVISORYCOMMITTEEOUTLINEFINALSUBMISSION13008.
doc; Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Dennis Johnson, Senior Portfolio Manager, Corporate Governance, 
California Public Employees' Retirement System, 5), available at 
http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Johnson020408.pdf.
    \80\ Serving Global Capital Markets and the Global Economy: A 
View from the CEOs of the International Audit Networks 12 (Nov. 
2006).
---------------------------------------------------------------------------

    The Committee believes that continued enhancement of auditors' 
fraud prevention and detection skills will improve financial 
reporting and audit quality and enhance investor confidence in 
financial reporting and the auditing function. In that regard, the 
Committee recommends the following:
    (a) Urge the creation of a national center to facilitate 
auditing firms' and other market participants' sharing of fraud 
prevention and detection experiences, practices, and data and 
innovation in fraud prevention and detection methodologies and 
technologies, and commission research and other fact-finding 
regarding fraud prevention and detection, and further, the 
development of best practices regarding fraud prevention and 
detection.
    No formal forum currently exists where auditors and other market 
participants

[[Page 28199]]

regularly share their views and experiences relating to fraud 
prevention and detection in the context of fraudulent financial 
reporting. The Committee received testimony that it would improve 
audit quality and benefit the capital markets and investors and 
other financial statement users for auditing firms to share their 
fraud detection experiences \81\ and to develop best practices 
relating to fraud prevention and detection.\82\
---------------------------------------------------------------------------

    \81\ See, e.g., Record of Proceedings (Feb. 4, 2008) (Questions 
for the Record of Cynthia M. Fornelli, Executive Director, Center 
for Audit Quality, 6 (Mar. 31, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/agendas/QFRs-2-4-08.pdf; 
Record of Proceedings (Dec. 3, 2007) (Written Submission of James S. 
Turley, Chairman and Chief Executive Officer, Ernst & Young LLP, 7), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Turley120307.pdf.
    \82\ See, e.g., Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Edward E. Nusbaum, Chief Executive Officer, Grant 
Thornton LLP, and Chairman, Grant Thornton International Board of 
Governors, 10), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf (stating that 
``[s]uccess also requires that the profession work with standard 
setters and regulators to develop best practices and the 
infrastructure for effective audits designed to detect material 
financial fraud'').
---------------------------------------------------------------------------

    The Committee believes that a collective sharing of fraud 
prevention and detection experiences among auditors and other market 
participants will provide a broad view of auditor practices and 
ultimately improve fraud prevention and detection capabilities and 
enable the development of best practices. The Committee also 
believes that research into industry trends and statistics will help 
auditors focus and develop procedures to identify areas and 
situations at greater risk for fraud. The Committee believes that 
best practices regarding fraud prevention and detection will enhance 
the internal processes and procedures of auditing firms.
    The Committee recommends the creation of a national center both 
to facilitate auditing firms' sharing of fraud prevention and 
detection experiences, practices, and data and innovation in fraud 
prevention and detection methodologies and technologies and to 
commission research and other fact-finding regarding fraud 
prevention and detection. The Committee also recommends that the 
auditing firms, forensic accounting firms, certified fraud 
examiners, investors, other financial statement users, public 
companies, and academics develop, in consultation with the PCAOB, 
the Securities and Exchange Commission (SEC), international 
regulators, and the National Association of State Boards of 
Accountancy (NASBA), best practices regarding fraud prevention and 
detection. The Committee also recognizes that a national center and 
best practices will have greater impact if these concepts are 
ultimately extended and embraced internationally.
    (b) Urge that the PCAOB and the SEC clarify in the auditor's 
report the auditor's role in detecting fraud under current auditing 
standards and further that the PCAOB periodically review and update 
these standards.
    The Committee considered testimony and commentary regarding a 
long-standing ``expectations gap'' between the public's expectations 
regarding auditor responsibility for fraud detection and the 
auditor's required and capable performance of fraud detection.\83\ 
The public may believe that auditors will detect more fraud than 
those in the profession believe can be reasonably expected. This 
belief may be unreasonable in some circumstances given the 
difficulties of detecting fraud, especially before it has resulted 
in a material misstatement. On the other hand, public investors have 
raised questions when large frauds have gone undetected. The 
auditing standard governing fraud detection, AU Section 316, 
Consideration of Fraud in a Financial Statement Audit, notes that 
fraud may involve deliberate concealment and collusion with third 
parties.\84\ AU Section 316 states that the ``auditor has a 
responsibility to plan and perform the audit to obtain reasonable 
assurance about whether the financial statements are free of 
material misstatement, whether caused by error or fraud.'' This gap 
between public expectation and the auditor's performance causes 
confusion and ultimately undermines investor confidence in financial 
reporting and the capital markets.
---------------------------------------------------------------------------

    \83\ See, e.g., Andrew D. Bailey, Jr., Professor of 
Accountancy--Emeritus, University of Illinois, and Senior Policy 
Advisor, Grant Thornton LLP, Comment Letter Regarding Discussion 
Outline 4 (Jan. 30, 2008), available at http://comments.treas.gov/_files/BAILEYCOMMENTSONTREASURYADVISORYCOMMITTEEOUTLINEFINALSUBMISSION13008.
doc (stating that ``[i]f the discovery of material errors and fraud 
is not a major part of what the audit is about, it is not clear what 
value-added service the auditor offers the investor and capital 
markets''); Record of Proceedings (Feb. 4, 2008) (Questions for the 
Record of Cynthia M. Fornelli, Executive Director, Center for Audit 
Quality, 5 (Mar. 31, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/agendas/QFRs-2-4-08.pdf (``While 
auditors provide reasonable assurance that fraud material to the 
financial statements will be detected, they cannot be expected to 
provide absolute assurance that all material fraud will be found. 
Cost-benefit constraints and the lack of governmental subpoena and 
investigative powers, among other factors, make absolute assurance 
impossible.''); Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Dennis Johnson, California Public Employees' 
Retirement System, 5), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Johnson020408.pdf 
(stating that ``[o]f critical importance to investors is the 
responsibility of auditors to detect fraud and improve the timely 
communication of these frauds to investors and shareowners.''); 
Serving Global Capital Markets and the Global Economy: A View from 
the CEOs of the International Audit Networks 12 (Nov. 2006) 
(``Nonetheless, there is a significant `expectations gap' between 
what various stakeholders believe auditors should do in detecting 
fraud, and what audit networks are actually capable of doing, at the 
prices that companies or investors are willing to pay for 
audits.'').
    \84\ Consideration of Fraud in a Financial Statement, Interim 
Auditing Standard AU 316 (Pub. Company Accounting Oversight Bd. 
2002).
---------------------------------------------------------------------------

    Commentary has suggested that auditors must more effectively 
communicate their responsibility regarding fraud detection and 
prevention with investors and the capital markets. The Committee 
agrees with this suggestion. Accordingly, the Committee believes 
that the auditor's report should articulate clearly to investors the 
auditor's role and limitations in detecting fraud. The Committee 
believes that expressly communicating to investors, other financial 
statement users, and the public the role of auditors in fraud 
detection would help narrow the ``expectations gap.''
    The Committee recommends that the PCAOB and the SEC clarify in 
the auditor's report the auditor's role and limitations in detecting 
fraud under current auditing standards. In addition, the Committee 
recommends, in light of this continuing ``expectations gap,'' that 
the PCAOB review the auditing standards governing fraud detection 
and fraud reporting. Specifically, the Committee recommends that the 
PCAOB periodically review and update these standards.
    Recommendation 2. Encourage greater regulatory cooperation and 
oversight of the public company auditing profession to improve the 
quality of the audit process and enhance confidence in the auditing 
profession and financial reporting.
    The SEC, the PCAOB, and individual state boards of accountancy 
regulate the auditing profession. The SEC and the PCAOB enforce the 
securities laws and regulations addressing public company audits. 
Individual state accountancy laws in 55 jurisdictions in the United 
States govern the licensing and regulation of both individuals and 
firms who practice as certified public accountants.\85\ State boards 
of accountancy enforce these laws and also administer the Uniform 
CPA Examination. NASBA serves as a forum for these boards to enhance 
their regulatory effectiveness and communication.
---------------------------------------------------------------------------

    \85\ Record of Proceedings (Dec. 3, 2007) (Written Submission of 
David A. Costello, President and Chief Executive Officer, National 
Association of State Board of Accountancy, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Costello120307.pdf.
---------------------------------------------------------------------------

    The Committee believes that enhancing regulatory cooperation and 
reducing duplicative oversight of the auditing profession by federal 
and state authorities and enhancing licensee practice mobility among 
the states are in the best interest of the public and the effective 
operation of the capital markets. In this regard, the Committee 
recommends the following:
    (a) Institute the following mechanism to encourage the states to 
substantially adopt the mobility provisions of the Uniform 
Accountancy Act, Fifth Edition (UAA): \86\ If states have failed to 
adopt the mobility provisions of the UAA by December 31, 2010, 
Congress should pass a federal provision requiring the adoption of 
these provisions.
---------------------------------------------------------------------------

    \86\ Uniform Accountancy Act (Fifth Ed. July 2007).
---------------------------------------------------------------------------

    The American Institute of Certified Public Accountants (AICPA) 
and NASBA jointly author the UAA, a model bill which focuses on the 
education, examination, and experience requirements for certified 
public accountants. As the name of the bill suggests, the UAA 
advances the goal of uniformity, in addition to protecting the 
public interest and promoting high professional standards. In 2006 
and 2007, recognizing the changing global economy and the impact of 
electronic commerce, the AICPA and NASBA proposed amendments to the 
UAA to allow for a streamlined framework for CPA ``mobility'' of

[[Page 28200]]

practice among the states; that is, a CPA's practice privileges 
would be valid and portable across all state jurisdictions beyond 
that of the CPA's resident state.\87\
---------------------------------------------------------------------------

    \87\ See Record of Proceedings (Dec. 3, 2007) (Questions for the 
Record of David A. Costello, President and Chief Executive Officer, 
National Association of State Board of Accountancy, 1 (Feb. 6, 
2008)), available at http://www.treas.gov/offices/domestic-finance/acap/QFRs-12-3-2007.pdf (``As the global business community 
continues to expand, CPAs will be required to practice beyond the 
state in which they reside. Inefficiencies are created when those 
individuals are required to complete paperwork and submit a fee for 
every state in which they perform professional services.'').
---------------------------------------------------------------------------

    According to NASBA, to date twenty-two states have passed 
mobility legislation. Twelve other states currently have mobility 
legislation introduced and other bills are anticipated in the 2008 
legislative session. Almost every state is now discussing or 
considering mobility, and a number of other state boards of 
accountancy have voted to support and move forward with mobility.
    The Committee considered testimony and commentary on the 
importance to auditing firms' multi-state practices of the adoption 
of the UAA's mobility provisions.\88\ A NASBA representative 
testified, ``In order for our capital market system to continue to 
prosper and grow, NASBA recognized the need to ensure that an 
efficient, effective mobility system is in place that will allow 
CPAs and their firms, as professional service providers, to serve 
the needs of American businesses, where ever they are located.'' 
\89\
---------------------------------------------------------------------------

    \88\ See, e.g., Amper, Politziner and Mattia, P.C., Comment 
Letter Regarding Discussion Outline 2 (Nov. 14, 2007) available at 
http://comments.treas.gov/_files/AmperPolitzinerMattia.pdf (noting 
that ``[t]he ease of performing audits in any state by a valid CPA * 
* * without requiring to be licensed by each state would be 
beneficial.''); Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Dennis Nally, Chairman and Senior Partner, 
Pricewaterhouse Coopers LLP, 5) (Dec. 3, 2008), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Nally120307.pdf (noting that a number of states are cooperating and 
working towards adopting uniform mobility requirements); Record of 
Proceedings (Dec. 3, 2007) (Written Sumission of James S. Turley, 
Chairman and Chief Executive Officer, Ernst & Young LLP, 5), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Turley120307.pdf (``The Treasury Committee 
should suggest that the states eliminate barriers to interstate 
practice by universal adoption of the mobility provisions of the 
Uniform Accountancy Act.'').
    \89\ Record of Proceedings (Dec. 3, 2007) (Written Submission of 
David A. Costello, President and Chief Executive Officer, National 
Association of State Board of Accountancy, 6), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Costello120307.pdf.
---------------------------------------------------------------------------

    The Committee believes that, given the multi-state operations of 
many public companies and the multi-state practices of many auditing 
firms, practice mobility will foster a more efficient operation of 
the capital markets. The Committee recommends the following 
mechanism to encourage the states to adopt the UAA's mobility 
provisions: If states have failed to adopt the mobility provisions 
of the UAA by December 31, 2010, Congress should pass a federal 
provision requiring the adoption of these provisions. The Committee 
recognizes that some state legislatures meet biannually, and for 
such legislatures this deadline poses a challenge. However, such a 
deadline should be attainable and will encourage such legislatures 
to place this issue high on their agenda. The Committee also 
recommends that the states participate in NASBA's Accountancy 
Licensee Database (ALD) as a mechanism to assist in maintaining 
appropriate oversight of CPAs throughout the country regardless of 
where they practice and that appropriate authorities interpret 
federal and state privacy regulations to facilitate implementation 
of the ALD.
    (b) Require regular and formal roundtable meetings of regulators 
and other governmental enforcement bodies in a cooperative effort to 
improve regulatory effectiveness and reduce the incidence of 
duplicative and potentially inconsistent enforcement regimes.
    Under the federal securities laws, the SEC has enforcement 
authority over public company auditing firms and oversight authority 
over the PCAOB under the Sarbanes-Oxley Act of 2002 (Sarbanes-
Oxley). Sarbanes-Oxley provides the PCAOB with registration, 
reporting, inspection, standard-setting, and enforcement authority 
over public company auditing firms.\90\ In addition, the fifty-five 
boards of accountancy license, regulate, and enforce state 
accountancy laws pertaining to certified public accountants and 
their firms. In addition, the Department of Justice (DOJ) and state 
attorneys general can bring enforcement actions against auditing 
firms and their employees.
---------------------------------------------------------------------------

    \90\ Sarbanes-Oxley Act of 2002, 15 U.S.C. Sec. Sec.  7211-7219.
---------------------------------------------------------------------------

    The Committee considered testimony from auditing firms on the 
duplicative and sometimes inconsistent federal and state oversight 
of the profession.\91\ The Committee does recognize that both 
federal and state regulators have made attempts to coordinate better 
their enforcement activities.\92\ One witness suggested the possible 
formation of a commission to help improve regulatory 
effectiveness.\93\ Another witness urged state and federal 
regulatory cooperation to ensure harmonized regulation and 
licensure.\94\
---------------------------------------------------------------------------

    \91\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Dennis Nally, Chairman and Senior Partner, 
PricewaterhouseCoopers LLP, 5), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Nally120307.pdf; 
Record of Proceedings (Feb. 4, 2008) (Written Submission of Edward 
E. Nusbaum, Chief Executive Officer, Grant Thornton LLP, and 
Chairman, Grant Thornton International Board of Governors, 7), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf; Record of Proceedings (Feb. 
4, 2008) (Questions for the Record of Barry Salzberg, Chief 
Executive Officer, Deloitte LLP, App. A 4 (Mar. 31, 2008)), 
available at http://www.treas.gov/offices/domestic-finance/acap/agendas/QFRs-2-4-08.pdf (criticizing duplicative auditing firm 
investigations by states with no nexus to alleged conduct).
    \92\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Oral 
Remarks of David A. Costello, President and Chief Executive Officer, 
National Association of State Board of Accountancy, 98), available 
at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-12-3-07.pdf (noting that ``[NASBA] has been working with the 
PCAOB very closely coordinating efforts, trying to diminish as much 
as possible the redundancy in enforcement'') Record of Proceedings 
(Dec. 3, 2007) (Written Submission of David A. Costello, President 
and Chief Executive Officer, National Association of State Board of 
Accountancy, 6), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Costelllo120307.pdf (stating that 
NASBA is assisting state boards in enforcement cases involving 
multi-state activities).
    \93\ Record of Proceedings (Feb. 4, 2008) (Written Submission of 
Edward E. Nusbaum, Chief Executive Officer, Grant Thornton LLP, and 
Chairman, Grant Thornton International Board of Governors, 7), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf (noting that, ``it would be 
useful to evaluate the possibility of an interstate commission for 
the whole of the audit profession. Such a commission would bring 
together state licensing authorities, the PCAOB, and appropriate 
professional organizations. It would be the means to rationalize 
existing disparities in licensing qualifications, continuing 
education requirements and peer review for non-public company audit 
practices. It would also enable enforcement of common regulations 
and license discipline across state and federal jurisdictions.'').
    \94\ Record of Proceedings (Dec. 3, 2007) (Written Submission of 
Dennis Nally, Chairman and Senior Partner, PricewaterhouseCoopers 
LLP, 5), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Nally120307.pdf.
---------------------------------------------------------------------------

    The Committee recommends mandating regular and formal 
roundtables of the PCAOB, the SEC, the DOJ, the state boards of 
accountancy, and the state attorneys general, to periodically review 
the overall enforcement regimes applicable to the public company 
auditing profession. These roundtables also should focus on 
regulatory coordination, improvement, and consistent approaches to 
enforcement to minimize duplicative efforts. Because of the 
difficulty and cost of bringing together many different state 
agencies on a regular basis, the Committee recommends that NASBA 
assist states by taking a leadership role in coordinating their 
responsibilities and interests.
    (c) Urge the states to create greater financial and operational 
independence of their state boards of accountancy.
    The Committee is concerned about the financial and operational 
independence of state boards of accountancy from outside influences, 
such as other state agencies, and the possible effect on the 
regulation and oversight of the accounting profession. A number of 
state boards are under-funded \95\ and lack the wherewithal to incur 
the cost of investigations leading to enforcement. In addition, some 
state boards fall under the centralized administrative ``umbrella'' 
of other state agencies and lack control of financial resources and/
or operational independence necessary to carry out their mandate of 
public protection.\96\ In some

[[Page 28201]]

cases, board members are nominated by private associations whose 
constituencies are not necessarily focused on the protection of the 
public.
---------------------------------------------------------------------------

    \95\ National Association of State Boards of Accountancy, 
Submission in Connection with the December 3, 2007 Meeting of the 
Advisory Committee on the Auditing Profession (Jan. 2008) 
(documenting the wide spectrum of funding for individual state 
boards of accountancy and noting the number of full-time staff per 
state boards of accountancy office).
    \96\ Statement of Ronald J. Rotaru, Executive Director, 
Accountancy Board of Ohio, before Ohio H. Finance Committee of the 
Ohio House of Representatives 1 (Mar. 18, 2005) (``The evidence 
shows that `consolidated' states have difficulty in effectively 
enforcing the statutes governing the profession under their central 
agency umbrella.'').
---------------------------------------------------------------------------

    The Committee believes that greater independence of state boards 
of accountancy would enhance their regulatory effectiveness. The 
Committee recommends that, working with NASBA, states evaluate and 
develop means to make their respective state boards of accountancy 
more operationally and financially independent of outside 
influences. The Committee notes that this Recommendation to ensure 
the independence of state boards of accountancy is not meant to 
limit in any way the efforts of regulators and other governmental 
enforcement bodies to coordinate their regulatory and enforcement 
activities as recommended in Recommendation 2(b).
    Recommendation 3. Urge the PCAOB and the SEC, in consultation 
with other federal and state regulators, auditing firms, investors, 
other financial statement users, and public companies, to analyze, 
explore, and enable, as appropriate, the possibility and feasibility 
of firms appointing independent members with full voting power to 
firm boards and/or advisory boards with meaningful governance 
responsibilities to improve governance and transparency at auditing 
firms.
    In response to the recent corporate accounting scandals, related 
legislative and regulatory requirements and best practices, public 
companies enhanced their corporate governance. One of the most 
prominent alterations to the corporate governance scheme was the 
increased representation and strengthening of independent members of 
boards of directors. The New York Stock Exchange and the Nasdaq 
enhanced their public company listing standards to call for a 
majority of independent board members.\97\ Best practices have gone 
even further, calling for a ``substantial majority'' of independent 
directors.\98\
---------------------------------------------------------------------------

    \97\ New York Stock Exchange, Listed Company Manual Sec.  
303A.01 (2003); Nasdaq, Manual, Rule 4350(c).
    \98\ See, e.g., The Business Roundtable, Principles of Corporate 
Governance (May 2002) (recommending, among other things, a 
substantial majority of independent directors and fully independent 
audit, corporate governance/nominating, and compensation 
committees); The Conference Board, Commission on Public Trust and 
Private Enterprise (Jan. 9, 2003) (recommending, among other things, 
a substantial majority of independent directors and regular 
executive sessions of the independent directors).
---------------------------------------------------------------------------

    A combination of Sarbanes-Oxley provisions and exchange listing 
standards mandate fully independent audit committees, nominating/
corporate governance, and compensation committees.\99\ In addition, 
independent directors' responsibilities have increased. For example, 
the independent audit committee now appoints, oversees, and 
compensates the auditor.\100\ Although difficult to quantify the 
benefits of these enhancements, many have extolled these reforms as 
improving the quality of board oversight, reducing conflicts of 
interest, and enhancing investor confidence in public company 
operations and financial reporting.\101\
---------------------------------------------------------------------------

    \99\ Sarbanes-Oxley Act, 15 U.S.C. Sec.  78-j (2002) (mandating 
audit committees comprised solely of independent directors); New 
York Stock Exchange, Listed Company Manual Sec.  303A.04 (2004) 
(requiring nominating/corporate governance committees comprised 
solely of independent directors); New York Stock Exchange, Listed 
Company Manual Sec.  303A.05 (2004) (requiring compensation 
committees comprised solely of independent directors); New York 
Stock Exchange, Listed Company Manual Sec.  303A.06 (2003) 
(mandating compliance with SEC rules requiring audit committees 
comprised solely of independent directors); Nasdaq, Manual, Rule 
4350(d) (mandating compliance with SEC rules requiring audit 
committees comprised solely of independent directors). Note that the 
Nasdaq listing standards do not require the existence of nominating/
corporate governance committees and compensation committees.
    \100\ Sarbanes-Oxley Act, 15 U.S.C. Sec.  78-j (2002).
    \101\ For example, see the commentary accompanying New York 
Stock Exchange, Listed Company Manual Sec.  303A.01 (``Requiring a 
majority of independent directors will increase the quality of board 
oversight and lessen the possibility of damaging conflicts of 
interest.'').
---------------------------------------------------------------------------

    Public company auditing firms as private partnerships are not 
subject to these requirements. Instead, state laws and partnership 
agreements determine the governance of auditing firms.\102\ Often a 
firm's governing body is comprised of elected firm partners.\103\ 
Some firms are currently using advisory boards, although these may 
not be well-publicized or transparent.
---------------------------------------------------------------------------

    \102\ Center For Audit Quality, Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession 2 (Jan. 23, 2008).
    \103\ Center For Audit Quality, Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession 2-22 (Jan. 23, 2008) (detailing 
the various governance structures of the largest six auditing 
firms); Cynthia M. Fornelli, Executive Director, Center for Audit 
Quality, and James S. Turley, Chair, Governing Board, Center for 
Audit Quality, and Chairman and CEO, Ernst & Young LLP, Comment 
Letter Regarding Discussion Outline 13 (Nov. 30, 2007), available at 
http://comments.treas.gov/_files/Treasurycommentletterfinal11302007.pdf (noting the largest auditing 
firms have supervisory boards overseeing management).
---------------------------------------------------------------------------

    Several witnesses testified to the benefits of improving 
auditing firm governance and suggested the addition of independent 
members to the boards of directors.\104\ One witness called for an 
entirely independent board with enhanced responsibilities, including 
chief executive officer selection, determining partner compensation, 
and monitoring potential conflicts of interest and audit 
quality.\105\ An auditing firm representative noted that his firm 
was considering adding independent members on its international 
governing board.\106\
---------------------------------------------------------------------------

    \104\ See, e.g., Andrew D. Bailey, Jr., Professor of 
Accountancy-Emeritus, University of Illinois, and Senior Policy 
Advisory, Grant Thornton LLP, Comment Letter Regarding Discussion 
Outline 12 (Jan. 30, 2008), available at http://comments.treas.gov/_files/BAILEYCOMMENTSONTREASURYADVISORYCOMMITTEEOUTLINEFINALSUBMISSION13008 
(``[I]ndependent board members similar to those found on public 
company boards would be a good governance practice and would signal 
the markets about the firms' positive commitment to the public 
good.''); Record of Proceedings (Feb. 4, 2008) (Written Submission 
of Dennis Johnson, Senior Portfolio Manager, Corporate Governance, 
California Public Employees' Retirement System, 3), available at 
http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Johnson020408.pdf (stating that independent board of 
directors could possibly decrease potential conflicts of interest).
    \105\ Record of Proceedings (Feb. 4, 2008) (Written Submission 
of Paul G. Haaga Jr., Vice Chairman, Capital Research and Management 
Company, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Haaga020408.pdf.
    \106\ Record of Proceedings (Feb. 4, 2008) (Written Submission 
of Edward E. Nusbaum, Chief Executive Officer, Grant Thornton LLP, 
and Chairman, Grant Thornton International Board of Governors, 7), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf.
---------------------------------------------------------------------------

    The Committee believes that enhancing corporate governance of 
auditing firms through the appointment of independent board members, 
whose duties run to the auditing firm and its partners/owner, to 
advisory boards with meaningful governance responsibilities 
(possible under the current business model), and/or to firm boards 
could be particularly beneficial to auditing firm management and 
governance.\107\ The Committee also believes that such advisory 
boards and independent board members could improve investor 
protection through enhanced audit quality and firm transparency. The 
Committee is particularly intrigued by the idea of independent board 
members with duties and responsibilities similar to those of public 
company non-executive board members.
---------------------------------------------------------------------------

    \107\ Record of Proceedings (Feb. 4, 2008) (Written Submission 
of Edward E. Nusbaum, Chief Executive Officer, Grant Thornton LLP, 
and Chairman, Grant Thornton International Board of Governors, 7), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf (``Such a change in the 
governance model may be one way to strengthen our ability to serve 
market participants and reinforce independence.'').
---------------------------------------------------------------------------

    The Committee recognizes the multiple challenges that 
instituting a governance structure with independent board members 
might entail, including compliance with state partnership laws and 
independence requirements, insurance availability for such 
directors, and liability concerns. Accordingly, the Committee 
recommends that the PCAOB and the SEC, in consultation with federal 
and state regulators, auditing firms, investors, other financial 
statement users, and public companies, analyze, explore, and enable, 
as appropriate, the possibility and feasibility, within the current 
context of independence requirements and the liability regime, of 
firms' appointing independent board members and advisory boards. The 
Committee notes that the PCAOB and the SEC should consider the size 
of auditing firms in analyzing and developing any governance 
proposals.
    Recommendation 4. Urge the SEC to amend Form 8-K disclosure 
requirements to characterize appropriately and report every

[[Page 28202]]

public company auditor change and to require auditing firms to 
notify the PCAOB of any premature engagement partner changes on 
public company audit clients.
    In 2006, over 1,300 public companies changed their auditor and 
from 2002 to 2006 over 6,500 public companies changed their 
auditor.\108\ Under current SEC regulations, a public company must 
disclose any auditor change on Form 8-K.\109\ SEC regulations 
require disclosure of any disagreements on financial disclosures 
during the preceding two years prior to the resignation and whether 
some issue, such as the auditor's inability to rely on management's 
representations, may put into question financial disclosure 
reliability. SEC regulations also allow a public company to request 
that the auditor respond with a letter addressed to the SEC stating 
whether it agrees with the company's disclosure and, if it does not 
agree, stating why.
---------------------------------------------------------------------------

    \108\ See Mark Grothe and Blaine Post, Speak No Evil, GLASS 
LEWIS & CO RESEARCH 12 (May 21, 2007).
    \109\ Form 8-K, available at http://www.sec.gov/about/forms/form8-k.pdf.
---------------------------------------------------------------------------

    While the SEC does attempt to uncover through its rules whether 
the auditor change relates to disagreements over accounting and 
reporting matters, the SEC rules do not require a public company to 
provide a reason for the auditor's departure in the vast majority of 
cases. The limitations of the existing disclosure requirements have 
resulted in companies failing to disclose any reason for their 
auditor changes in approximately 70% of the more than 1,300 auditor 
changes occurring in 2006.\110\
---------------------------------------------------------------------------

    \110\ See Mark Grothe and Blaine Post, Speak No Evil, GLASS 
LEWIS & CO RESEARCH 12 (May 21, 2007).
---------------------------------------------------------------------------

    The Committee considered testimony and commentary regarding the 
lack of clear disclosure surrounding auditor changes. Testimony and 
commentary viewed the lack of transparency surrounding auditor 
changes as detrimental to investor confidence in financial 
reporting. \111\ Testimony and commentary suggested greater 
transparency regarding auditor changes would compel audit committees 
to more closely evaluate auditor selection decisions and lead to 
greater competition in the audit market.\112\
---------------------------------------------------------------------------

    \111\ See, e.g., Andrew D. Bailey, Jr., Professor of 
Accountancy-Emeritus, University of Illinois, and Senior Policy 
Advisor, Grant Thornton LLP, Comment Letter Regarding Discussion 
Outline 4 (Jan. 30, 2008), available at http://comments.treas.gov/_files/BAILEYCOMMENTSONTREASURYADVISORYCOMMITTEEOUTLINEFINALSUBMISSION13008.
doc (recommending SEC and PCAOB disclosures of auditor changes to 
enhance the growth of smaller auditing firms); Record of Proceedings 
(Feb. 4, 2008) (Oral Remarks of Edward E. Nusbaum, Chief Executive 
Officer, Grant Thornton LLP, and Chairman, Grant Thornton 
International Board of Governors, 193-94), available at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-2-4-08.pdf (calling for expanded Form 8-K disclosure requirements as 
``in the best interest of investors'').
    \112\ See e.g., Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Edward E. Nusbaum, Chief Executive Officer, Grant 
Thornton LLP, and Chairman, Grant Thornton International Board of 
Governors, 3), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf (noting that the 
Committee should examine ``[c]omprehensive disclosures about reasons 
for auditor switches'').
---------------------------------------------------------------------------

    The Committee believes that explicitly stating the reason for an 
auditor change will assist investors in determining the quality of 
financial reporting and subsequent investment decisions. The 
Committee recommends that the SEC amend its Form 8-K disclosure on 
auditor changes by providing for the following mechanism: The public 
company would file within four days of an auditor change a Form 8-K 
disclosing that an auditor had resigned, was terminated, or did not 
seek reappointment; the company would appropriately characterize and 
state in all cases in plain English the reason or reasons for the 
change. The company would also disclose whether its audit committee 
agreed with the disclosure it has provided. The company would also 
provide the auditor with a copy of the disclosure and request a 
response as to the accuracy of the disclosure. The company would 
include any response as an exhibit to the company's Form 8-K filing, 
or if received following the due date for the Form 8-K, in a 
subsequent Form 8-K. As discussed above under current SEC 
regulations, the public company can request that the auditor respond 
to the company's statements in the Form 8-K regarding disagreements 
over accounting and financial matters.
    In addition, the Committee recommends that auditing firms notify 
the PCAOB of any engagement partner changes on public company audits 
if made before the normal rotation period and, other than for 
retirement, the reasons for those changes.\113\
---------------------------------------------------------------------------

    \113\ But cf., Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Paul G. Haaga Jr., Vice Chairman, Capital Research and 
Management Company, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Haaga020408.pdf (calling 
for public disclosure on audit partner changes other than for 
rotation requirements); Record of Proceedings (Feb. 4, 2008) (Oral 
Remarks of D. Paul Regan, President and Chairman, Hemming Morse 
Inc., 194-195 (Feb. 4, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-2-4-08.pdf (commenting 
that ``if an audit partner is * * * rotated [early] off of an 
issuer, there ought to be a disclosure, and there ought to be 
communication from the partner who was rotated off early as to [the 
reason for the early rotation] * * * because in many instances * * * 
there [i]s controversy* * *'').
---------------------------------------------------------------------------

    Other Issues Under Consideration
    While the work of the Committee is incomplete at this point, the 
Committee has tentatively concluded it will not make a 
recommendation regarding vehicles to access outside capital. The 
Committee notes that some witnesses have suggested changing the 
capital structure of auditing firms to allow access to capital.\114\
---------------------------------------------------------------------------

    \114\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Questions 
for the Record of James R. Doty, Partner, Baker Botts LLP, 3 (Feb. 
19, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/QFRs-12-3-2007.pdf (suggesting allowing auditing firms 
to organize as limited liability companies or corporate entities to 
allow for the issuance of equity or debt securities).
---------------------------------------------------------------------------

    The Committee is also considering and debating a variety of 
other issues. Further elaboration on these issues will be included 
in subsequent drafts of this Report.

VII. Concentration and Competition

    The Committee analyzed public company audit market concentration 
and competition. In its work the Committee focused on concentration 
and competition in the context of their impact on audit quality and 
effectiveness. In turn, consideration of the sustainability of the 
auditing profession was also subject to examination in the context 
of audit quality and effectiveness. The recommendations set out 
below reflect this focus.
    During the course of its deliberations, the Committee received 
testimony and commentary from the Government Accountability Office 
(GAO), the Public Company Accounting Oversight Board (PCAOB), 
academics, auditing firms, investors, and others regarding audit 
market concentration and competition.
    In January 2008, the GAO issued Audits of Public Companies: 
Continued Concentration in Audit Market for Large Public Companies 
Does Not Call for Immediate Action,\115\ updating its 2003 report on 
audit market concentration.\116\ The GAO concluded that the four 
largest auditing firms continue to dominate the large public company 
audit market. In 2006, the four largest auditing firms audited 98% 
of the 1500 largest public companies with annual revenues over $1 
billion and 92% of public companies with annual revenues between 
$500 million and $1 billion. However, concentration in the small and 
mid-size public company audit market has eased during the past five 
years. The largest firms' share in auditing small public companies 
with annual revenues under $100 million has declined from 44% in 
2002 to 22% in 2006 and in auditing mid-size public companies with 
annual revenue between $100 million and $500 million from 90% in 
2002 to 71% in 2006.\117\
---------------------------------------------------------------------------

    \115\ U.S. Government Accountability Office, Audits of Public 
Companies: Continued Concentration in Audit Market for Large Public 
Companies Does Not Call for Immediate Action, GAO-08-163 (Jan. 2008) 
[hereinafter 2008 GAO Report].
    \116\ GAO, Public Accounting Firms: Mandated Study on 
Consolidation and Competition, GAO-03-864 (July 2003) (finding that 
``although audits for large public companies were highly 
concentrated among the largest accounting firms, the market for 
audit services appeared competitive according to various 
indicators'').
    \117\ 2008 GAO Report 19. The GAO also found that the largest 
firms collected 94% of all audit fees paid by public companies in 
2006, slightly less than the 96% they collected in 2002. 2008 GAO 
Report 16.
---------------------------------------------------------------------------

    The Committee considered the testimony of several witnesses 
regarding the reasons for the continued concentration in the large 
public company audit market. Auditing firms, public companies, 
market participants, academics, investors and others reasoned that 
large public companies with operations in multiple countries need 
auditing firms with global resources and technical and industry 
expertise to deal with an increasingly complex business and 
financial reporting environment.\118\ These needs limit

[[Page 28203]]

auditor choice to only the largest auditing firms for many large 
public companies. The Committee heard from witnesses who also 
described barriers to the growth of smaller auditing firms, 
including the behavior of underwriters and other capital market 
participants.\119\
---------------------------------------------------------------------------

    \118\ See, e.g., 2008 GAO Report 21 (surveyed companies most 
frequently cited size and complexity of their operations (92%), the 
auditor's technical capability with accounting principles and 
auditing standards (80%), and the need for industry specialization 
or expertise (67%)); Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Wayne Kolins, National Director of Assurance and 
Chairman, BDO Seidman LLP, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Kolins120307.pdf; 
Record of Proceedings (Feb. 4, 2008) (Written Submission of Neal D. 
Spencer, Managing Partner, BKD, LLP, 1-4), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Spencer020408.pdf.
    \119\ Record of Proceedings (Feb. 4, 2008) (Oral Remarks of Brad 
Koenig, Former Managing Director and Head of Global Technology 
Investment Banking, Goldman Sachs, 219-220), available at http://www.treas.gov/offices/domestic-finance/acap/Koenig020408.pdf 
(describing underwriters' views of auditing firms other than the 
largest four auditing firms).
---------------------------------------------------------------------------

    In analyzing these data on concentration and limited auditor 
choice in the large public company audit market, the Committee 
focused on the potential negative impact of concentration on audit 
quality. Some have suggested the lack of competition may not provide 
sufficient incentive for the dominant auditing firms to deliver high 
quality and innovative audit services.\120\ Notwithstanding the 
increasing number of public company financial restatements,\121\ the 
Committee heard from several witnesses that audit quality had 
improved.\122\ For example, the GAO observed that market 
participants and public company officials had noted improvement in 
recent years in audit quality, including auditing firm staff's 
technical expertise, responsiveness to client needs, and ability to 
identify material financial reporting matters.\123\ Much of the 
improvement was credited to the Sarbanes-Oxley Act of 2002 
(Sarbanes-Oxley), which enhanced auditor independence, replaced the 
self-regulation of the auditing profession with the PCAOB, mandated 
evaluation and disclosure of the effectiveness of internal controls 
over financial reporting,\124\ and strengthened audit committee 
membership, independence, and responsibilities.
---------------------------------------------------------------------------

    \120\ 2008 GAO Report 31-32.
    \121\ See, e.g., Susan Scholz, The Changing Nature and 
Consequences of Public Company Financial Restatements 1997-2006 
(April 2008).
    \122\ 2008 GAO Report 5; Public Company Accounting Oversight 
Board, Report on the PCAOB's 2004, 2005, and 2006 Inspections of 
Domestic Triennially Inspected Firms, PCAOB Rel. No. 2007-010 (Oct. 
22, 2007).
    \123\ Record of Proceedings (Dec. 3, 2007) (Questions for the 
Record of Ms. Jeanette M. Franzel, Director, Financial Management 
and Assurance Team, U.S. Government Accountability Office, 2 (Jan. 
30, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/QFRs-12-3-2007.pdf (observing that the market believes 
the ``bar had been raised'' on audit quality). See also Center for 
Audit Quality, Report on the Survey of Audit Committee Members 
(March 2008) (concluding that: 17% of surveyed audit committee 
members view audit quality as good, 53% as very good, 25% as 
excellent, while 82% say overall quality has improved somewhat/
significantly over the past several years).
    \124\ 2008 GAO Report 32.
---------------------------------------------------------------------------

    Although industry concentration can lead to increased prices, 
the Committee notes that the GAO concluded that higher audit market 
concentration has not been associated with higher fees. Public 
companies, auditing firms, and other market participants believe the 
considerable increase in audit fees in recent years is due not to 
market power of a concentrated industry, but to the increased 
requirements under Sarbanes-Oxley, the complexity of accounting and 
financial reporting standards, the need to hire and retain qualified 
audit staff, and the independence requirements (which have led to 
the possible re-pricing of audits to their unbundled market 
price).\125\ The Committee also considered the impact of the 
possible loss of one of the four largest accounting firms in light 
of the high degree of concentration of public company auditing, and 
especially large public company auditing, in those firms. The GAO 
noted the possibility of this loss due to issues arising out of firm 
conduct, such as civil litigation, federal or state regulatory 
action or criminal prosecution, or economic events, such as a 
merger.\126\ The GAO posited potential negative effects of such a 
loss, including the following: Further limitations on large public 
company auditor choice, costs associated with changing auditors, and 
companies' inability to obtain timely financial statement 
audits.\127\ However, the GAO did not recommend insulating auditing 
firms directly from either the legal or market consequences of their 
actions.
---------------------------------------------------------------------------

    \125\ 2008 GAO Report 27-29. On the re-pricing of audits, see 
also James D. Cox, The Oligopolistic Gatekeeper: The U.S. Accounting 
Profession, in After Enron: Improving Corporate Law and Modernizing 
Securities Regulation in Europe and the U.S., Chapter 9, Oxford, 
forthcoming, available at http://ssrn.com/abstract=926360.
    \126\ 2008 GAO Report 34-35.
    \127\ 2008 GAO Report 35-36.
---------------------------------------------------------------------------

    With the above considerations in mind, the Committee recommends 
that regulators, the auditing profession, and other bodies, as 
applicable, effectuate the following:
    Recommendation 1. Reduce barriers to the growth of smaller 
auditing firms consistent with an overall policy goal of promoting 
audit quality. Because smaller auditing firms are likely to become 
significant competitors in the market for larger company audits only 
in the long term, the Committee recognizes that Recommendation 2 
will be a higher priority in the near term.
    The GAO concluded that concentration in the large public company 
audit market will not be reduced in the near term by smaller 
auditing firms. The Committee considered testimony regarding the 
reasons that smaller auditing firms are unable or unwilling to enter 
the large public company audit market. Challenges facing these 
firms' entry into this market typically include the following: lack 
of staffing and geographic limitations on both the physical span of 
their practices and experience and expertise with global auditing 
complexities; inability to create global networks necessary to serve 
global clients, due to lack of auditing firms abroad to act as 
potential partners; the need for greater technical capability and 
industry specialization; lack of name recognition and reputation; 
and limited access to capital.\128\ In addition, expanding into the 
large public company audit market may be unattractive for some 
smaller auditing firms for a variety of reasons,\129\ including 
increased exposure to litigation, the possibility that their 
business model is not scaleable, and the fact that for some smaller 
firms other aspects of their business (such as private company 
auditing and other work) has greater potential for expansion.
---------------------------------------------------------------------------

    \128\ 2008 GAO Report 37. See also Record of Proceedings (Dec. 
3, 2007) (Written Submission of Wayne Kolins, National Director of 
Assurance and Chairman, BDO Seidman LLP, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Kolins120307.pdf (describing as barriers for smaller auditing firms 
liability risks, overly complex independence rules, and an array of 
factors that audit committees may review in choosing an auditor that 
best matches the company); Record of Proceedings (Feb. 4, 2008) 
(Written Submission of Neal D. Spencer, Managing Partner, BKD, LLP, 
1), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Spencer020408.pdf (noting that barriers include 
resources, institutional bias, insurability, and liability).
    \129\ 2008 GAO Report 38.
---------------------------------------------------------------------------

    To address these issues, the Committee recommends that policy 
makers press for the reduction of barriers, to the extent consistent 
with audit quality and other public interest factors, to the growth 
of smaller auditing firms. For smaller firms, this includes 
encouraging and promoting development of technical resources in such 
areas as international financial reporting standards and fair value 
accounting, and development of specialized or ``niche'' practices or 
industry ``verticals'' where they are in the best interests of 
investors and can lead to more effective competition. Pressure also 
should be applied against non-justifiable resistance to using 
smaller firms on the part of a variety of market actors.
    The Committee believes that the following specific and 
incremental actions would assist in the growth of the smaller firms 
and their entry into the large public company audit market:
    (a) Require disclosure by public companies in their annual 
reports and proxy statements of any provisions in agreements with 
third parties that limit auditor choice.
    The Committee considered testimony and commentary that certain 
market participants, such as underwriters, banks, and lenders, may 
influence and effectively limit public company auditor selection 
decisions.\130\ For instance, certain contractual arrangements limit 
public companies' auditor choice.\131\

[[Page 28204]]

Consistent with the large public company audit market, this practice 
is particularly prevalent in the initial public offering (IPO) 
arena, where an underwriter may include in the underwriting 
agreement a provision limiting the company's auditor choice to a 
specified group of auditing firms.\132\ Evidence suggests that 
auditor choice may be more limited among the largest IPOs: While 
midsize and smaller firms' combined share of the IPO market (by 
number of IPOs) has increased progressively (rising from 18% in 2003 
to 40% in 2007),\133\ the largest firms continue to audit the 
majority of the largest IPOs.\134\
---------------------------------------------------------------------------

    \130\ See, e.g., Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Edward E. Nusbaum, Chief Executive Officer, Grant 
Thornton LLP, and Chairman, Grant Thornton International Board of 
Governors, 3), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf (noting that 
transparency regarding ``restrictive contracts with underwriters'' 
could improve auditor choice). See also 2008 GAO Report 47.
    \131\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Lewis H. Ferguson, III, Partner, Gibson Dunn & 
Crutcher, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Ferguson120307.pdf (``Sometimes 
lenders, investors, investment bankers or credit rating agencies 
will insist that a company seeking to access the capital markets 
have its financial statements audited by one of the largest 
accounting firms, adding a bias that has the practical effect of 
being a barrier to entry.'').
    \132\ See, e.g., Record of Proceedings (Feb. 4, 2008) (Oral 
Remarks of Brad Koenig, Former Managing Director and Head of Global 
Technology Investment Banking, Goldman Sachs, 219-220), available at 
http://www.treas.gov/offices/domestic-finance/acap/Koenig020408.pdf 
(noting underwriter practices in auditor selection). See also Edwin 
J. Kliegman, CPA, Comment Letter Regarding Discussion Outline 2 
(Nov. 26, 2007).
    \133\ 2008 GAO Report 44.
    \134\ Record of Proceedings (Feb. 4, 2008) (Written Submission 
of Brad Koenig, Former Managing Director and Head of Global 
Technology Investment Banking, Goldman Sachs, 2), available at 
http://www.treas.gov/offices/domestic-finance/acap/Koenig020408.pdf 
(noting that from 2002-2007 the largest four auditing firms had an 
87% market share of the 817 initial public offerings that exceeded 
$20 million). See also 2008 GAO Report 44 (``Staff from some 
investment firms that underwrite stock issuances for public 
companies told [GAO] that in the past they generally had expected 
the companies for which they raised capital to use one of the 
largest firms for IPOs but that now these organizations were more 
willing to accept smaller audit firms * * *. However, * * * most of 
the companies that went public with a mid-size or smaller auditor 
were smaller. In addition, these firms' share of IPOs of larger 
companies (those with revenues greater than $150 million) rose from 
none in 2003 to about 13 percent in 2007.'').
---------------------------------------------------------------------------

    The Committee believes these provisions impair competition by 
limiting public company auditor choice and the ability of smaller 
auditors to serve a greater share of the public company audit 
market. Accordingly, the Committee recommends that the Securities 
and Exchange Commission (SEC) require public companies to disclose 
any provisions in agreements limiting auditor choice. The disclosure 
should identify the agreement and include the names of the parties 
to the agreement and the actual provisions limiting auditor 
choice.\135\
---------------------------------------------------------------------------

    \135\ The Committee notes that a group of market participants 
put together by the United Kingdom's Financial Reporting Council to 
study audit market competition has suggested similar disclosure of 
contractual obligations limiting auditor choice. See Financial 
Reporting Council, FRC Update: Choice in the UK Audit Market 4 (Apr. 
2007) [hereinafter FRC Update] (recommending that ``when explaining 
auditor selection decisions, Boards should disclose any contractual 
obligations to appoint certain types of audit firms'').
---------------------------------------------------------------------------

    (b) Include representatives of smaller auditing firms in 
committees, public forums, fellowships, and other engagements.
    The Committee considered testimony that the lack of smaller 
firms' name recognition and reputation have hindered smaller 
auditing firms' ability to compete in the large public company audit 
market. The GAO noted that name recognition, reputation, and 
credibility were significant barriers to smaller auditing firm 
expansion.\136\ The PCAOB has registered and oversees 982 U.S. 
auditing firms and 857 foreign auditing firms.\137\ While it is not 
possible to include all smaller firms, the Committee received 
testimony and comment letters suggesting that there should be 
greater inclusion and participation of smaller firms in public and 
private sector committees, roundtables, and fellowships.\138\ One 
auditing firm representative suggested the creation of a PCAOB 
professional practice fellowship program, reaching out to 
professionals from auditing firms of various sizes.\139\
---------------------------------------------------------------------------

    \136\ 2008 GAO Report 44 (``Fifty percent of accounting firms 
responding to [GAO's] survey that want to audit large companies said 
that name recognition or reputation with potential clients was a 
great or very great impediment to expansion. Similarly, 54 percent 
of these firms cited name recognition or credibility with financial 
markets and investment bankers as a great or very great impediment 
to expansion.''). See also Edward J. Kliegman, Comment Letter 
Regarding Discussion Outline (Nov. 16, 2007).
    \137\ Data are as of Feb. 21, 2008.
    \138\ See, e.g., Andrew D. Bailey, Jr., Professor of 
Accountancy--Emeritus, University of Illinois, and Senior Policy 
Advisor, Grant Thornton LLP, Comment Letter Regarding Discussion 
Outline 16 (Jan. 30, 2008), available at http://comments.treas.gov/_files/BAILEYCOMMENTSONTREASURYADVISORYCOMMITTEEOUTLINEFINALSUBMISSION13008.
doc; Record of Proceedings (Dec. 3, 2007) (Questions for the Record 
of James S. Turley, Chairman and Chief Executive Officer, Ernst & 
Young LLP, 4 (Feb. 1, 2008)), available at http://www.treas.gov/offices/domestic-finance/acap/QFRs-12-3-2007.pdf.
    \139\ Record of Proceedings (Dec. 3, 2007) (Written Submission 
of Wayne Kolins, National Director of Assurance and Chairman, BDO 
Seidman LLP, 4), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Kolins120307.pdf. See Chapter V 
(recommending the creation of a PCAOB fellowship program). While 
maintenance and extension of professional fellowship programs are 
also considered in the Committee's recommendations relating to human 
capital matters, extending these opportunities increasingly to firms 
of various sizes could assist smaller firms in their ability to 
compete in the public company audit market.
---------------------------------------------------------------------------

    The Committee believes increasing name recognition and 
reputation could promote audit market competition and auditor 
choice. Accordingly, the Committee recommends that regulators and 
policymakers, such as the SEC, the PCAOB, and the Financial 
Accounting Standards Board, include representatives of smaller 
auditing firms in committees, public forums, fellowships, and other 
engagements.\140\
---------------------------------------------------------------------------

    \140\ For a similar recommendation, see SEC Advisory Committee 
on Smaller Public Companies, Final Report 114 (Apr. 23, 2006).
---------------------------------------------------------------------------

    Recommendation 2. Monitor potential sources of catastrophic risk 
faced by public company auditing firms and create a mechanism for 
the preservation and rehabilitation of troubled larger public 
company auditing firms.
    The Committee considered testimony regarding the variety of 
potentially catastrophic risks that public company auditing firms 
face. These risks include general financial risks and risks relating 
to failure in the provision of audit services and non-audit 
services, including civil litigation, regulatory actions, and loss 
of customers, employees, or auditing network partners due to a loss 
of reputation.\141\
---------------------------------------------------------------------------

    \141\ See, e.g., 2008 GAO Report 32-36; Zoe-Vonna Palmrose, 
Maintaining the Value and Viability of Independent Auditors as 
Gatekeepers under SOX: An Auditing Master Proposal, in Brookings-
Nomura Seminar: After the Horses Have Left the Barn: The Future Role 
of Financial Gatekeepers 12-13 (Sept. 28, 2005). Civil litigation 
was the risk most often cited by witnesses before the Committee. 
See, e.g., Record of Proceedings (Dec. 3, 2007) (Written Submission 
of James D. Cox, Brainerd Currie Professor of Law, Duke University 
School of Law), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Cox120307.pdf. See also Eric R. 
Talley, Cataclysmic Liability Risk among Big Four Auditors, 106 
Colum. L. Rev. 1641 (Nov. 2006)(''On one hand, the pattern of 
liability exposure during the last decade does not appear to be the 
type that would, at least on first blush, imperil the entire 
profession. On the other hand, if one predicts historical liability 
exposure patterns into the future, the risk of another firm exiting 
due to liability concerns appears to be more than trivial.'').
---------------------------------------------------------------------------

    The Committee believes these risks are real and notes that over 
the past two decades two large auditing firms have gone out of 
existence. In 1990, Laventhol & Horwath, at the time the seventh 
largest auditing firm in the United States, filed for bankruptcy 
protection due in part to a failure in the provision of non-audit 
services, and subsequent class action litigation, loss of 
reputation, and inability to attract and retain clients.\142\ In 
2002, Arthur Andersen, at the time one of the five largest auditing 
firms in the United States, dissolved. The Department of Justice 
(DOJ) had criminally indicted the auditing firm on obstruction of 
justice charges relating to the audit of Enron. The resulting 
inability to retain clients and partners and keep together its 
global affiliate network led to the collapse of Arthur 
Andersen.\143\
---------------------------------------------------------------------------

    \142\ See, e.g, 2008 GAO Report 33.
    \143\ See, e.g., U.S. Government Accountability Office, Public 
Accounting Firms: Mandated Study on Consolidation and Competition 12 
(July 2003) (``The criminal indictment of fourth-ranked Andersen for 
obstruction of justice stemming from its role as auditor of Enron 
Corporation led to a mass exodus of Andersen partners and staff as 
well as clients.'').
---------------------------------------------------------------------------

    In addition, KPMG recently faced the possibility of criminal 
indictment relating to its provision of tax-related services. In the 
end, KPMG entered into a deferred prosecution agreement with the 
DOJ.\144\ Many have suggested that a criminal indictment would have 
led to the dissolution of the firm.
---------------------------------------------------------------------------

    \144\ 2008 GAO Report 56-57, n. 60. Note that the Department of 
Justice did indict several individuals.
---------------------------------------------------------------------------

    Currently, BDO Seidman is appealing a $521 million state 
judgment involving a private company audit client. The auditing 
firm's chief executive has publicly stated that

[[Page 28205]]

such a judgment amount would threaten the firm's viability.\145\
---------------------------------------------------------------------------

    \145\ Jury Awards Rise Against BDO Seidman, Assoc. Press, Aug. 
15, 2007.
---------------------------------------------------------------------------

    As discussed above, the Committee believes that the loss of one 
of the larger auditing firms would likely have a significant 
negative impact on the capital markets. Of greatest concern is the 
potential disruption to capital markets that the failure of a large 
auditing firm would cause, due to the lack of sufficient capacity to 
audit the largest public companies and the possible inability of 
public companies to obtain timely audits.\146\ The Committee 
believes these concerns must be balanced against the importance of 
auditing firms and their partners, as private, for-profit 
businesses, being exposed to the consequences of failure, including 
both the legal consequences and economic consequences.
---------------------------------------------------------------------------

    \146\ See 2008 GAO Report 35, 36 (observing that further audit 
market concentration would ``leave large companies with potentially 
only one or two choices for a new auditor'' and that ``the market 
disruption caused by a firm failure or exit from the market could 
affect companies' abilities to obtain timely audits of their 
financial statements, reducing the audited financial information 
available to investors''). See also London Economics, Final Report 
to EC-DG Internal Market and Services, Study on the Economic Impact 
of Auditors' Liability Regimes 24 (Sept. 2006) (``The adjustment to 
a situation in which one of the Big-4 networks fails is unlikely to 
be smooth. But the long run consequences are likely to be limited 
provided the overall statutory audit capacity does not fall 
significantly. Among the various economic sectors, financial 
institutions may find such a situation particularly difficult as 
their statutory audits are viewed as more risky and * * * two Big-4 
firms dominate the market for statutory audits of financial 
institutions. The situation is likely to be much direr if a second 
Big-4 network fails shortly after the first one. Investors' 
confidence will be in all likelihood seriously affected and the 
adjustment to the new situation is likely to be difficult.'').
---------------------------------------------------------------------------

    In consideration of these competing concerns, the Committee 
makes the following recommendations:
    (a) As part of its current oversight over registered auditing 
firms, the PCAOB should monitor potential sources of catastrophic 
risk which would threaten audit quality.
    The PCAOB's mission is to oversee auditing firms conducting 
audits of public companies. Its audit quality-focused mission is 
intertwined with issues of catastrophic risk, as most often risks to 
firms' survival historically have been largely the result of 
significant audit quality failures or serious compliance issues in 
the non-audit services aspect of their business.
    Sarbanes-Oxley provides the PCAOB with registration, reporting, 
inspection, standard-setting, and enforcement authority over public 
company auditing firms.\147\ Under its inspection authority, the 
PCAOB inspects audit engagements, evaluates quality control systems, 
and tests as necessary audit, supervisory, and quality control 
procedures. For example, in its inspection of an auditing firm's 
quality control systems, the PCAOB reviews the firm's policies and 
procedures related to partner evaluation, partner compensation, new 
partner nominations and admissions, assignment of responsibilities, 
disciplinary actions, and partner terminations; compliance with 
independence requirements; client acceptance and retention policies 
and procedures; compliance with professional requirements regarding 
consultations on accounting, auditing, and SEC matters; internal 
inspection program; processes for establishing and communicating 
audit policies, procedures, and methodologies; processes related to 
review of a firm's foreign affiliate's audit performance; and tone 
at the top.\148\
---------------------------------------------------------------------------

    \147\ Sarbanes-Oxley Act of 2002, 15 U.S.C. 7211-7219.
    \148\ See, e.g., PCAOB, Observations on the Initial 
Implementation of the Process for Addressing Quality Control 
Criticisms within 12 Months after an Inspection Report, PCAOB 
Release No. 104-2006-078 (Mar. 21, 2006). See also the PCAOB's 
completed inspection reports at http://www.pcaobus.org/Inspections/Public_Reports/index.aspx#k.
---------------------------------------------------------------------------

    The PCAOB also has authority to require registered auditing 
firms to provide annual and periodic reports. In May 2006, the PCAOB 
issued Proposed Rules on Periodic Reporting by Registered Public 
Accounting Firms requiring annual and periodic reporting.\149\ The 
PCAOB has not yet finalized this proposal.
---------------------------------------------------------------------------

    \149\ PCAOB Release No. 2006-004 (May 23, 2006).
---------------------------------------------------------------------------

    The Committee therefore recommends that the PCAOB, in 
furtherance of its objective to enhance audit quality and 
effectiveness, exercise its authority to monitor meaningful sources 
of catastrophic risk that potentially impact audit quality through 
its programs, including inspections, registration and reporting, or 
other programs, as appropriate. The objective of PCAOB monitoring 
would be to alert the PCAOB to situations in which auditing firm 
conduct is resulting in increased catastrophic risk which is 
impairing or threatens to impair audit quality.
    (b) Establish a mechanism to assist in the preservation and 
rehabilitation of a troubled larger auditing firm. A first step 
would encourage larger auditing firms to adopt voluntarily a 
contingent streamlined internal governance mechanism that could be 
triggered in the event of threatening circumstances. If the 
governance mechanism failed to stabilize the firm, a second step 
would permit the SEC to appoint a court-approved trustee to seek to 
preserve and rehabilitate the firm by addressing the threatening 
situation, including through a reorganization, or if such a step 
were unsuccessful, to pursue an orderly transition.
    The Committee considered testimony regarding the importance of 
the viability of the larger auditing firms and the negative 
consequences of the loss of one of these firms on the capital 
markets. The Committee also considered commentary regarding issues 
auditing firms faced in addressing circumstances that threatened 
their viability, including, in particular, problems arising from the 
need to work with regulators and law enforcement agencies.\150\ 
Several witnesses suggested the development of a mechanism to allow 
auditing firms facing threatening circumstances to emerge from those 
situations.\151\ Committee member and former Federal Reserve 
Chairman Paul Volcker opined that, ``[I]f we had [such an] 
arrangement at the time Andersen went down, we would have saved 
it.'' \152\ The Committee recommends the following two-step 
mechanism described below.
---------------------------------------------------------------------------

    \150\ See, e.g., Securities and Exchange Commission, Temporary 
Final Rule and Final Rule: Requirements for Arthur Andersen LLP 
Auditing Clients, SEC Release No. 33-8070 (Mar. 18, 2002); 
Securities and Exchange Commission, Press Rel. No. 2002-39 and Order 
Rel. No. 33-8070 (March 18, 2002) (indictment of Arthur Andersen); 
SEC Staff Accounting Bulletin No. 90 (Feb. 7, 1991) (bankruptcy of 
Laventhol & Horwath).
    \151\ Record of Proceedings (Dec. 3, 2007) (Written Submission 
of James R. Doty, Partner, Baker Botts L.L.P., 11-13), available at 
http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Doty120307.pdf (suggesting that the Bankruptcy Code be 
amended to prevent creditors whose claims relate to violations of 
professional standards from opposing reorganization under a court-
approved plan; an automatic stay against partners facilitating 
partner retention; expanding the SEC's emergency powers to enable 
the SEC to act by summary order to address the registered firm's 
ability to continue to provide audit services; and encouraging the 
SEC or PCAOB to discourage ``client poaching'' by requiring public 
companies to show that switching auditors was not related to mega-
judgments against audit affiliates in other jurisdictions). See also 
Record of Proceedings (Dec. 3, 2007) (Written Submission of Peter S. 
Christie, Principal, Friemann Christie, LLC, 6), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Christie120307.pdf (``If it remains possible that a firm can fail 
for reasons other than liability claims it may be attention needs to 
be given to devices that will permit a firm to re-emerge.'').
    \152\ Record of Proceedings (Mar. 13, 2008) (Oral Remarks of 
Committee Member Paul Volcker, 317), available at http://www.treas.gov/offices/domestic-finance/acap/agendas/minutes-03-13-08.pdf.
---------------------------------------------------------------------------

First Step--Internal Governance Mechanism

    The Committee notes that auditing firms operate as partnerships, 
generally led by a centralized management team, with a supervisory 
board of partners overseeing management's strategy and 
performance.\153\ In the event of threatening circumstances at a 
larger auditing firm, the Committee believes that a lack of 
effective centralized governance mechanisms may delay crucial 
decision making, impede difficult decisions that could sustain the 
firm and its human assets, and lessen the firm's ability to 
communicate with maximum responsiveness and effectiveness with 
private, regulatory and judicial bodies.
---------------------------------------------------------------------------

    \153\ Center for Audit Quality, Report of the Major Public 
Company Audit Firms to the Department of the Treasury Advisory 
Committee on the Auditing Profession 13 (Jan. 23, 2008).
---------------------------------------------------------------------------

    The Committee therefore recommends that larger auditing firms 
(those with 100 or more public company audit clients that the PCAOB 
inspects annually) establish in their partnership agreements a 
contingent internal governance mechanism, involving the creation of 
an Executive Committee (made up of partners or outsiders) with 
centralized firm management powers to address threatening 
circumstances. The centralized governance mechanism would have full 
authority to negotiate with regulators, creditors, and others, and 
it would seek to hold the firm's organization intact, including 
preserving the firm's reputation, until the mitigation of the 
threat, or, failing that, the implementation of

[[Page 28206]]

the second step outlined below. The auditing firm voluntarily would 
trigger the operation of this mechanism upon the occurrence of 
potentially catastrophic events specified in the partnership 
agreement, such as civil litigation or actual or significantly 
threatened government or regulatory action. If necessary, the SEC 
and the PCAOB could encourage the firm to trigger the mechanism 
through private communications, public statements, or other means. 
Regulators could also assist in maintaining the firm's organization 
intact by, for example, increasing the time period for registrants 
that are audit clients to have audits or reviews completed and 
providing accelerated consultative guidance to registrants that are 
audit clients.\154\ The Committee recognizes the precise details of 
such a mechanism would vary from auditing firm to auditing firm, 
depending on firm structures, history, and culture.
---------------------------------------------------------------------------

    \154\ See, e.g., Securities and Exchange Commission, Temporary 
Final Rule and Final Rule: Requirements for Arthur Andersen LLP 
Auditing Clients, SEC Release No. 33-8070 (Mar. 18, 2002); 
Securities and Exchange Commission, Press Rel. No. 2002-39 and Order 
Rel. No. 33-8070 (March 18, 2002) (indictment of Arthur Andersen); 
SEC Staff Accounting Bulletin No. 90 (Feb. 7, 1991) (bankruptcy of 
Laventhol & Horwath).
---------------------------------------------------------------------------

Second Step--External Preservation Mechanism

    The Committee also recommends that the larger auditing firms 
establish in their partnership agreements a rehabilitation mechanism 
under SEC oversight. The failure of the internal governance 
mechanism to preserve the auditing firm outlined in the first step 
above would trigger this second step, which would require 
legislation. Upon triggering of the second step, either voluntarily 
by the firm or by the SEC, the SEC would appoint a trustee, subject 
to court approval, whose mandate would be to seek to address the 
circumstances that threaten survival, and failing that, to pursue a 
reorganization that preserves and rehabilitates the firm to the 
extent practicable, and finally, if reorganization fails, to pursue 
an orderly transition. If this second mechanism is to include an 
element that addresses claims of creditors (which could include 
investors with claims, audit and other clients, partners, other 
employees, and others), legislation to integrate this mechanism with 
the judicial bankruptcy process may be necessary.
    It is important that this mechanism not be used as insurance for 
partner capital; that is, this mechanism should not be developed to 
``bail out'' a larger auditing firm, but rather to preserve and 
rehabilitate the firm in order to ensure the stable functioning of 
the capital markets and the timely delivery of audited financial 
statements to investors and other financial statement users. 
Accordingly, there must be powers that can be exercised in 
furtherance of the objective of holding the firm together.\155\
---------------------------------------------------------------------------

    \155\ Record of Proceedings (Dec. 3, 2007) (Written Submission 
of James R. Doty, Partner, Baker Botts L.L.P., 11), available at 
http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Doty120307.pdf (Dec. 3, 2007) (``It is an anecdotal but 
firmly held perception of the profession that no accounting firm has 
entered bankruptcy and emerged to continue its practice. The hard 
assets of the firm are not significant: the professionals and the 
clients are the lifeblood of the registered firm. With any 
anticipation of bankruptcy, these mobile assets are gone.'').
---------------------------------------------------------------------------

    The Committee also notes that the larger auditing firms are 
members or affiliates of global networks of firms and rely on these 
networks to serve their global clients. Since the networks are 
maintained through voluntary contractual agreements, the fact that a 
U.S.-based firm may be facing threatening circumstances could lead 
to the disintegration of the network. In this regard, in developing 
this mechanism, auditing firms, regulators, policy-makers, and other 
market participants must consider the practical implications 
resulting from the relationship between the U.S.-based firms and the 
global networks.
    Recommendation 3. Recommend the PCAOB, in consultation with 
auditors, investors, public companies, audit committees, boards of 
directors, academics, and others, determine the feasibility of 
developing key indicators of audit quality and effectiveness and 
requiring auditing firms to publicly disclose these indicators. 
Assuming development and disclosure of indicators of audit quality 
are feasible, require the PCAOB to monitor these indicators.
    A key issue in the public company audit market is what drives 
competition for audit clients and whether audit quality is the most 
significant driver. Currently, there is minimal publicly available 
information regarding indicators of audit quality at individual 
auditing firms. Consequently, it is difficult to determine whether 
audit committees, who ultimately select the auditor, and management 
are focused and have the tools that are useful in assessing audit 
quality that would contribute to making the initial auditor 
selection and subsequent auditor retention evaluation processes more 
informed and meaningful.\156\ In addition, with the majority of 
public companies currently putting shareholder ratification of 
auditor selection to an annual vote, shareholders may also lack 
audit quality information important in making such a ratification 
decision.\157\
---------------------------------------------------------------------------

    \156\ See, e.g., New York Stock Exchange, Listed Company Manual 
Sec.  303A, which the SEC approved on November 4, 2003, for the 
responsibilities of exchange-listed companies' audit committees.
    \157\ Institutional Shareholder Services, U.S. Corporate 
Governance Policy--2007 Updates 3 (2006).
---------------------------------------------------------------------------

    The Committee believes that requiring firms to disclose 
indicators of audit quality may enhance not only the quality of 
audits provided by such firms, but also the ability of smaller 
auditing firms to compete with larger auditing firms, auditor 
choice, shareholder decision-making related to ratification of 
auditor selection, and PCAOB oversight of registered auditing firms.
    The Committee recognizes the challenges of developing and 
monitoring indicators of audit quality, especially in light of the 
complex factors driving the potential impact on the incentives of 
market actors, and the resulting effect on competitive dynamics 
among auditors.\158\
---------------------------------------------------------------------------

    \158\ If the idea proves to be workable, implementation could be 
a major undertaking for the PCAOB. Developing meaningful quality 
indicators, defining how they should be measured, and rolling out 
the measurement process could take significant PCAOB time and 
effort. Auditing firms, public companies, investors, and academics 
would all likely have valuable ideas as to approaches the PCAOB 
could take. However the indicators were devised, firms would have to 
build their internal processes for measuring the audit quality 
indicators and the PCAOB would have to develop procedures and 
training to monitor those processes.
---------------------------------------------------------------------------

    The Committee has considered testimony and comment letters \159\ 
as well as other studies and reports in developing this 
recommendation. A possible framework for PCAOB consideration is 
reviewing annual auditing firm reports in other jurisdictions. For 
example, one auditing firm's United Kingdom affiliate lists in its 
annual report nine ``key performance indicators, including average 
headcount, staff turnover, diversity, client satisfaction, audit and 
non-audit work, proposal win rate, revenue, profit, and profit per 
partner.'' \160\ The Financial Reporting Council recently published 
a paper setting out drivers of audit quality.\161\ In addition, the 
PCAOB also could consider some of the factors that auditing firms 
present to audit committees, such as engagement team composition, 
the nature and extent of firm training programs, and the nature and 
reason for client restatements.\162\
---------------------------------------------------------------------------

    \159\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Wayne Kolins, National Director of Assurance and 
Chairman, BDO Seidman LLP, 4), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Kolins120307.pdf 
(recommending the issuance of regulatory guidance on qualitative 
factors to be used to evaluate auditing firms); Record of 
Proceedings (Dec. 3, 2007) (Written Submission of Dennis M. Nally, 
Chairman and Senior Partner, PricewaterhouseCoopers LLP, 6), 
available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Nally120307.pdf (suggesting that disclosure of 
`` key elements that drive audit quality would be a useful benefit 
to the capital markets'' and could include a ``discussion of the 
levels of partner and staff turnover, average hours of professional 
training, risk management and compliance measurements, and metrics 
related to the quality of management and firm governance 
processes''); Anonymous Retired Big 4 partner, Comment Letter 
Regarding Discussion Outline (Nov. 2007) (recommending public 
disclosure of the following audit quality drivers: (1) Average years 
of experience of audit professionals, (2) ratio of professional 
staff to audit partners, (3) chargeable hours per audit 
professional, (4) professional chargeable hours managed per audit 
partner, (5) annual professional staff retention, and (6) average 
annual training hours per audit professional).
    \160\ See KPMG LLP, UK Annual Report 2007 46.
    \161\ FRC Update 4.
    \162\ Record of Proceedings (Dec. 3, 2007) (Written Submission 
of Wayne Kolins, National Director of Assurance and Chairman, BDO 
Seidman LLP, 2), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Kolins120307.pdf.
---------------------------------------------------------------------------

    The Committee therefore recommends that the PCAOB, in 
consultation with auditors, investors, public companies, audit 
committees, boards of directors, academics, and others, determine 
the feasibility of developing key indicators of audit quality

[[Page 28207]]

and requiring auditing firms to publicly disclose these indicators. 
Testimonies and comment letters have suggested specific audit 
quality indicators, such as the average experience level of auditing 
firm staff on individual engagements, the average ratio of auditing 
firm professional staff to auditing firm partners on individual 
engagements, and annual staff retention. The Committee also 
recommends that, if the proposal is feasible, the PCAOB, through its 
inspection process, should monitor these indicators.
    Recommendation 4. Promote the understanding of and compliance 
with auditor independence requirements among auditors, investors, 
public companies, audit committees, and boards of directors, in 
order to enhance investor confidence in the quality of audit 
processes and audits.
    The Committee considered testimony and comment letters regarding 
the significance of the independence of the public company auditor--
both in fact and appearance--to the credibility of financial 
reporting, investor protection, and the capital formation 
process.\163\ The auditor is expected to offer critical and 
objective judgment on the financial matters under consideration, and 
actual and perceived absence of conflicts is critical to that 
expectation.
---------------------------------------------------------------------------

    \163\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Dennis M. Nally, Chairman and Senior Partner, 
PricewaterhouseCoopers LLP, 5) available at, http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Nally120307.pdf 
(``Independence forms the bedrock of credibility in the auditing 
profession, and is essential to the firms' primary function in the 
capital markets.''); Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Edward E. Nusbaum, Chief Executive Officer, Grant 
Thornton LLP, and Chairman, Grant Thornton International Board of 
Governors, 3), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Nusbaum020408.pdf.
---------------------------------------------------------------------------

    The Committee believes that auditors, investors, public 
companies, and other market participants must understand the 
independence requirements and their objectives, and that auditors 
must adopt a mindset of skepticism when facing situations that may 
compromise their independence. In that regard, the Committee makes 
the following recommendations:
    (a) Compile the SEC and PCAOB independence requirements into a 
single document and make this document Web site accessible. The 
American Institute of Certified Public Accountants (AICPA) and 
states should clarify and prominently note that differences exist 
between the SEC and PCAOB standards (applicable to public companies) 
and the AICPA and state standards (applicable in all circumstances, 
but subject to SEC and PCAOB standards, in the case of public 
companies) and indicate, at each place in their standards where 
differences exist, that stricter SEC and PCAOB independence 
requirements applicable to public company auditors may supersede or 
supplement the stated requirements. This compilation should not 
require rulemaking by either the SEC or the PCAOB because it only 
calls for assembly and compilation of existing rules.
    In the United States, various oversight bodies have authority to 
promulgate independence requirements, including the SEC and PCAOB 
for public company auditors, and the AICPA and states for public and 
private company auditors.\164\ The Committee recommends that the SEC 
and PCAOB compile and publish their independence requirements in a 
single document and make this document easily accessible on their 
Web sites. The Committee recommends that the AICPA and states 
clarify and prominently state that differences exist between their 
standards and those of the SEC and the PCAOB and indicate, at each 
place in their standards where differences exist, that additional 
SEC and PCAOB independence requirements applicable to public company 
auditors may supersede or supplement the stated requirements.\165\
---------------------------------------------------------------------------

    \164\ See, e.g., SEC Regulation S-X, Article 2, Rule 2-01--
Qualifications of Accountants, 17 CFR Sec.  210.2-01; SEC Financial 
Reporting Policies, Sec. 602.01--Interpretations Relating to 
Independence; SEC Final Rule, Amendments to SEC Auditor Independence 
Requirements ``Strengthening the Commission's Requirements Regarding 
Auditor Independence'', SEC Rel. No 33-8183 (2003); SEC Final Rule, 
Revision of the Commission's Auditor Independence Requirements, SEC 
Rel. No. 33-7919 (2001); PCAOB, Interim Independence Standards, ET 
Sections 101 and 191; Independence Standards Board, Independence 
Standards Nos. 1, 2, and 3, and ISB Interpretations 99-01, 00-1, and 
00-2; PCAOB Bylaws and Rules, Section 3, Professional Standards; 
AICPA Code of Professional Conduct, ET Sections 100-102.
    \165\ The Committee took note of concerns expressed regarding 
independence issues from a variety of perspectives. See, e.g., 
Andrew D. Bailey, Jr., Professor of Accountancy--Emeritus, 
University of Illinois, and Senior Policy Advisor, Grant Thornton 
LLP, Comment Letter Regarding Discussion Outline 9 (Jan. 30, 2008), 
available at http://comments.treas.gov/_files/BAILEYCOMMENTSONTREASURYADVISORYCOMMITTEEOUTLINEFINALSUBMISSION13008.
doc (suggesting simplifying the current SEC independence standards); 
Dana R. Hermanson, Kennesaw State University, Comment Letter 
Regarding Discussion Outline 1 (Oct. 4, 2007), available at http://comments.treas.gov/_files/HermansonStatement10407.pdf (stating that 
consulting and auditing were incompatible and posed a significant 
threat to the long-term sustainability of the profession); Record of 
Proceedings (Dec. 3, 2007) (Written Submission of Dennis M. Nally, 
Chairman and Senior Partner, PricewaterhouseCoopers LLP, 5), 
availabe at http http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Nally120307.pdf (``The independence rules 
should be re-evaluated periodically to examine whether the rules 
continue to strike the right balance between cost burden and 
benefit.''); Record of Proceedings (Dec. 3, 2007) (Written 
Submission of James S. Turley, Chairman and Chief Executive Officer, 
Ernst & Young LLP, 5), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Turley120307.pdf 
(recommending consideration of potential changes to aspects of 
independence rules).
---------------------------------------------------------------------------

    (b) Develop training materials to help foster and maintain the 
application of healthy professional skepticism with respect to 
issues of independence and other conflicts among public company 
auditors, and inspect auditing firms, through the PCAOB inspection 
process, for independence training of partners and mid-career 
professionals.
    The Committee considered testimony and commentary that, to 
comply with the detailed and complex\166\ requirements, some 
auditors may be taking a ``check the box'' approach to compliance 
with independence requirements, and losing focus on the critical 
need to exercise independent judgment or professional skepticism 
about whether the substance of a potential conflict of interest may 
compromise integrity or objectivity, or create an appearance of 
doing so.\167\
---------------------------------------------------------------------------

    \166\ See, e.g., Record of Proceedings (Dec. 3, 2007) (Written 
Submission of Michael P. Cangemi, President and Chief Executive 
Officer, Financial Executives International), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/12032007/Cangemi120307.pdf; Financial Executives International, 
Recommendations to Address Complexity in Financial Reporting (March 
2007).
    \167\ See. e.g., Consideration of Fraud in a Financial 
Statement, Interim Auditing Standard AU 316, Paragraph .13 (Pub. 
Company Accounting Oversight Bd. 2002) (``Professional skepticism is 
an attitude that includes a questioning mind and a critical 
assessment of audit evidence.'').
---------------------------------------------------------------------------

    The Committee recommends that auditing firms develop appropriate 
independence training materials for auditing firms, especially 
partners and mid-career professionals, that help to foster a healthy 
professional skepticism with respect to issues of independence that 
is objectively focused and extends beyond a ``check the box'' 
mentality. The training materials should focus on lessons learned 
and best practices observed by the PCAOB in its inspection process 
and the experience of other relevant regulators as appropriate. To 
ensure the implementation of this training on an overall basis, the 
PCAOB should review this training as part of its inspection program.
    Recommendation 5. Adopt annual shareholder ratification of 
public company auditors by all public companies.
    Although not statutorily required, the majority of public 
companies in the United States--nearly 95% of S&P 500 and 70%-80% of 
smaller companies--put auditor ratification to an annual shareholder 
vote.\168\ Even though ratification of a company's auditor is non-
binding, the Committee learned that corporate governance experts 
consider this a best practice serving as a ``check'' on the audit 
committee.\169\ Pursuant to Sarbanes-Oxley, audit committees of 
exchange-listed companies must appoint, compensate, and oversee the 
auditor.\170\ SEC rules implementing Sarbanes-Oxley specifically 
permit shareholder ratification of auditor selection.\171\ 
Ratification allows shareholders to voice a view on the audit 
committee's work, including the reasonableness of audit fees and 
apparent conflicts of interest.
---------------------------------------------------------------------------

    \168\ Institutional Shareholder Services, ISS U.S. Corporate 
Governance Policy--2007 Update 3 (Nov. 15, 2006).
    \169\ Institutional Shareholder Services, Request for Comment--
Ratification of Auditors on the Ballot 1.
    \170\ Sarbanes-Oxley Act, 15 U.S.C. Sec.  78j-1 (2002).
    \171\ SEC, Final Rule: Standards Related to Listed Audit 
Committees. Release No. 33-8220 (Apr. 9, 2003).
---------------------------------------------------------------------------

    The Committee believes shareholder ratification of auditor 
selection through the annual meeting and proxy process can enhance 
the audit committee's oversight to ensure that the auditor is 
suitable for the

[[Page 28208]]

company's size and financial reporting needs.\172\ This may enhance 
competition in the audit industry. Accordingly, the Committee 
encourages such an approach as a best practice for all public 
companies. The Committee also urges exchange self-regulatory 
organizations to adopt such a requirement as a listing standard. In 
addition, to further enhance audit committee oversight and auditor 
accountability, the Committee recommends that disclosure in the 
company proxy statement regarding shareholder ratification include 
the name(s) of the senior auditing partner(s) staffed on the 
engagement.\173\
---------------------------------------------------------------------------

    \172\ See also FRC Update 5, 7 (recommending that ``the FRC 
should amend the section of the Smith Guidance dealing with 
communications with shareholders to include a requirement for the 
provision of information relevant to the auditor re-selection 
decision,'' and that ``investor groups, corporate representatives, 
firms and the FRC should promote good practices for shareholder 
engagement on auditor appointment and re-appointments'').
    \173\ As discussed above, the Committee also believes that this 
ratification process would be made more meaningful if accompanied by 
the development and disclosure of key indicators of audit quality.
---------------------------------------------------------------------------

    Recommendation 6. Enhance regulatory collaboration and 
coordination between the PCAOB and its foreign counterparts, 
consistent with the PCAOB mission of promoting quality audits of 
public companies in the United States.
    The globalization of the capital markets has compelled 
regulatory coordination and collaboration across jurisdictions. 
Regulators of public company auditors are no exception, as companies 
increasingly seek investor capital outside their home jurisdictions 
and the larger auditing firms create, expand, and, in some audits, 
increasingly rely on global networks of affiliates in order to 
provide auditing and other services to companies operating in 
multiple jurisdictions.\174\ The Committee considered commentary 
regarding the PCAOB's regulatory role on a global basis.\175\
---------------------------------------------------------------------------

    \174\ See Record of Proceedings (Feb. 4, 2008) (Written 
Submission of Cynthia M. Fornelli, Executive Director, Center for 
Audit Quality, 16), available at http://www.treas.gov/offices/domestic-finance/acap/submissions/02042008/Fornelli020408.pdf 
(noting the ``growing consensus that regulators on every continent 
would be well served by working more closely together in the 
interest of improving worldwide audit quality''); PCAOB Press 
Release, PCAOB Meets with Asian Counterparts to Discuss Cooperation 
on Auditor Oversight (Mar. 23, 2007), available at http://www.pcaobus.org/News_and_Events/News/2007/03-23.aspx (''The PCAOB 
strongly believes that dialogue and cooperation among auditor 
regulators are critical to every regulator's ability to meet the 
challenges that come with the increasingly complicated and global 
capital markets.'').
    \175\ See, e.g., PCAOB Briefing Paper, Oversight of Non-U.S. 
Public Accounting Firms (Oct. 28, 2003); PCAOB Final Rules Relating 
to the Oversight of Non-U.S. Public Accounting Firms, PCAOB Rel. No. 
2004-005 (June 9, 2004); Request for Public Comment on Proposed 
Policy Statement: Guidance Regarding Implementation of PCAOB Rule 
4012, PCAOB Rel. No. 2007-001 (Dec. 5, 2007); PCAOB Chairman Mark 
Olson and EU Commissioner Charlie McCreevy Meet to Discuss 
Furthering Cooperation in the Oversight of Audit Firms, PCAOB Press 
Rel. (March 6, 2007); PCAOB Meets with Asian Counterparts to Discuss 
Cooperation on Auditor Oversight, PCAOB Press Rel. (Mar. 23, 2007); 
Establishment of the International Forum of Independent Audit 
Regulators, Haut Conseil du Commissariat aux Comptes Press Rel. 
(Sep. 15, 2006); PCAOB Enters into Cooperative Arrangement with the 
Australian Securities and Investments Commission, PCAOB Press Rel. 
(July 16, 2007); Board Establishes Standing Advisory Group, PCAOB 
Press Rel. (Apr. 15, 2004).
---------------------------------------------------------------------------

    The PCAOB has the statutory responsibility for ensuring quality 
audits of public companies. In a world of global business operations 
and globalized capital markets, the PCAOB benefits from cooperation 
with foreign auditing firm regulators (many created and modeled 
after the PCAOB) to accomplish its inspections of registered foreign 
auditing firms, including firms that are members of global auditing 
firm networks.
    In May 2007, the PCAOB hosted its first International Auditor 
Regulatory Institute where representatives from more than 40 
jurisdictions gathered to learn more about PCAOB operations. In 
2006, the PCAOB formally joined the International Forum of 
Independent Audit Regulators, created to encourage regulatory 
collaboration and sharing of regulatory knowledge and experience.
    The Committee believes that these types of global regulatory 
coordination and cooperation are important elements in making sure 
public company auditing firms of all sizes are contributing 
effectively to audit quality. The Committee strongly supports the 
efforts of the PCAOB to enhance the efficiency and effectiveness of 
its programs by communicating with foreign regulators and 
participating in global regulatory bodies. The Committee urges the 
PCAOB and its foreign counterparts to continue to improve regulatory 
cooperation and coordination on a global basis.

Other Issues Under Consideration

    The Committee is also considering and debating a variety of 
other issues. Further elaboration on these issues will be included 
in subsequent drafts of this Report.

VIII. Separate Statements

    [The contents of Separate Statements to be included in 
subsequent drafts of this Report.]

[FR Doc. E8-10818 Filed 5-14-08; 8:45 am]
BILLING CODE 4810-25-P