[Federal Register Volume 89, Number 127 (Tuesday, July 2, 2024)]
[Notices]
[Pages 54895-54922]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-14487]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-100429; File No. PCAOB-2024-04]


Public Company Accounting Oversight Board; Notice of Filing of 
Proposed Rules on Amendment to PCAOB Rule 3502 Governing Contributory 
Liability

June 26, 2024.
    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 
(``Sarbanes-Oxley'' or the ``Act''), notice is hereby given that on 
June 20, 2024, the Public Company Accounting Oversight Board (the 
``Board'' or the ``PCAOB'') filed with the Securities and Exchange 
Commission (the ``Commission'') the proposed rules described in items I 
and II below, which items have been prepared by the Board. The 
Commission is publishing this notice to solicit comments on the 
proposed rules from interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rules

    On June 12, 2024, the Board adopted an amendment to PCAOB Rule 
3502, Responsibility Not to Knowingly or Recklessly Contribute to 
Violations (collectively, the ``proposed rules''). The text of the 
proposed rules appears in Exhibit A to the SEC Filing Form 19b-4 and is 
available on the Board's website at https://pcaobus.org/about/rules-rulemaking/rulemaking-dockets/docket-053 and at the Commission's Public 
Reference Room.

II. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

    In its filing with the Commission, the Board included statements 
concerning the purpose of, and basis for, the proposed rules and 
discussed any comments it received on the proposed rules. The text of 
these statements may be examined at the places specified in Item IV 
below. The Board has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements. In 
addition, to the extent that Section 103(a)(3)(C) of the Act applies to 
the proposed rules, the Board is requesting that the Commission approve 
the proposed rules, pursuant to that provision, for application to 
audits of emerging growth companies (``EGCs''), as that term is defined 
in Section 3(a)(80) of the Securities Exchange Act of 1934 (``Exchange 
Act''). The Board's request is set forth in section D.

A. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

(a) Purpose
    Congress authorized the Board to promulgate rules and standards to 
govern auditor conduct.\1\ To that end, in 2005, the Board codified 
auditors' longstanding ethical obligation not to contribute to firms' 
violations in PCAOB Rule 3502, Responsibility Not to Knowingly or 
Recklessly Contribute to Violations.\2\ For well over a decade now, the 
Board has brought enforcement proceedings against associated persons 
pursuant to Rule 3502.
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    \1\ See Section 103(a)(1) of Sarbanes-Oxley; see also, e.g., id. 
101(c)(2), (c)(4), (c)(6) & (g)(1).
    \2\ Ethics and Independence Rules Concerning Independence, Tax 
Services, and Contingent Fees, PCAOB Release No. 2005-014, at 9 
(July 26, 2005), available at https://pcaobus.org/Rulemaking/Docket017/2005-07-26_Release_2005-014.pdf (``The Board proposed 
[Rule 3502] to codify the ethical obligation of associated persons 
of registered firms not to cause registered firms to commit [ ] 
violations.'').
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    Yet Rule 3502's current formulation contains an incongruity that 
places negligent contributors to firms' violations beyond the rule's 
reach. That incongruity stems from the notion that registered firms, 
like any legal entity, can act only through natural persons. It 
logically follows that when a registered firm is found to have acted 
negligently, it is likely that such negligence is attributable to at 
least one natural person's negligence.
    Rule 3502, however, at present requires a level of culpability 
higher than negligence--at least recklessness--before the Board can 
impose sanctions against associated persons who directly and 
substantially contribute to firms' negligence-based violations. Put 
another way, Rule 3502 requires a showing of more than negligence by 
individuals for the Board to sanction them for conduct resulting in 
negligence by firms. Thus, under current Rule 3502, associated persons 
who do not exercise reasonable care and contribute to firms' violations 
may escape liability and accountability--even while the firms 
committing the violations do not. The Board believes that amending Rule 
3502 addresses this incongruity, and therefore better protects 
investors and promotes quality audits.
(b) Statutory Basis
    The statutory basis for the proposed rules is Title I of the Act.

B. Board's Statement on Burden on Competition

    Not applicable. The Board's consideration of the economic impacts 
of the proposed rules is discussed in section D below.

C. Board's Statement on Comments on the Proposed Rules Received From 
Members, Participants or Others

    The Board released the proposed rule amendment for public comment 
in PCAOB Release No. 2023-007 (September 19, 2023). The Board received 
28 written comment letters; one comment letter was subsequently 
withdrawn. The Board has carefully considered all comments received. 
The Board's response to the comments it received and the changes made 
to the rules in response to the comments received are discussed below.

Introduction

    In the Sarbanes-Oxley Act of 2002 (``Sarbanes-Oxley'' or the 
``Act''), Congress established the Board in the wake of a series of 
high-profile corporate collapses that laid bare auditor misconduct and 
the need for a new type of oversight of the public accounting 
industry.\3\ As part of its

[[Page 54896]]

comprehensive, multipronged approach to such oversight, Congress 
authorized the Board to investigate, bring charges against, and 
sanction (when appropriate) registered public accounting firms and 
associated persons \4\ thereof for violations of the laws, rules, and 
standards that Congress charged the Board with enforcing.\5\ That 
enforcement authority covers a wide array of auditor conduct, including 
negligent conduct.
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    \3\ Public Law 107-204, 15 U.S.C. 7201 et seq.; see S. Rep. No. 
107-205, at 3 (2002) (``The purpose of [Sarbanes-Oxley] is to 
address the systemic and structural weaknesses affecting our capital 
markets which were revealed by repeated failures of audit 
effectiveness and corporate financial and broker-dealer 
responsibility in recent months and years.''). As the Senate Report 
notes, ``the frequency of financial restatements by public companies 
ha[d] dramatically increased'' in the run up to the passage of 
Sarbanes-Oxley. S. Rep. No. 107-205, at 15; see id. (``From 1990-97, 
the number of public company financial restatements averaged 49 per 
year, but jumped to an average of 150 per year in 1999 and 2000.'').
    \4\ An associated person is ``any individual proprietor, 
partner, shareholder, principal, accountant, or professional 
employee of a public accounting firm, or any independent contractor 
or entity that, in connection with the preparation or issuance of 
any audit report . . . (1) shares in the profits of, or receives 
compensation in any other form from, that firm; or (2) participates 
as agent or otherwise on behalf of such accounting firm in any 
activity of that firm.'' PCAOB Rule 1001(p)(i). The definition of an 
``associated person'' does not include persons engaged only in 
clerical or ministerial tasks. See id.
    \5\ See Sections 105(b) & (c) of Sarbanes-Oxley.
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    Congress also authorized the Board to promulgate rules and 
standards to govern auditor conduct.\6\ To that end, in 2005, the Board 
codified auditors' longstanding ethical obligation not to contribute to 
firms' violations in PCAOB Rule 3502, Responsibility Not to Knowingly 
or Recklessly Contribute to Violations.\7\ For well over a decade now, 
the Board has brought enforcement proceedings against associated 
persons pursuant to Rule 3502.
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    \6\ See id. 103(a)(1); see also, e.g., id. 101(c)(2), (c)(4), 
(c)(6) & (g)(1).
    \7\ Ethics and Independence Rules Concerning Independence, Tax 
Services, and Contingent Fees, PCAOB Release No. 2005-014, at 9 
(July 26, 2005) (``2005 Adopting Release''), available at https://pcaobus.org/Rulemaking/Docket017/2005-07-26_Release_2005-014.pdf 
(``The Board proposed [Rule 3502] to codify the ethical obligation 
of associated persons of registered firms not to cause registered 
firms to commit [ ] violations.'').
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    Yet Rule 3502's current formulation contains an incongruity that 
places negligent contributors to firms' violations beyond the rule's 
reach. That incongruity stems from the notion that registered firms, 
like any legal entity, can act only through natural persons. It 
logically follows that when a registered firm is found to have acted 
negligently, it is likely that such negligence is attributable to at 
least one natural person's negligence.
    Rule 3502, however, at present requires a level of culpability 
higher than negligence--at least recklessness--before the Board can 
impose sanctions against associated persons who directly and 
substantially contribute to firms' negligence-based violations. Put 
another way, Rule 3502 requires a showing of more than negligence by 
individuals \8\ for the Board to sanction them for conduct resulting in 
negligence by firms. Thus, under current Rule 3502, associated persons 
who do not exercise reasonable care and contribute to firms' violations 
may escape liability and accountability--even while the firms 
committing the violations do not. The Board believes that amending Rule 
3502 addresses this incongruity, and therefore better protects 
investors and promotes quality audits.
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    \8\ For ease of reference, this release sometimes refers to 
associated persons who are the contributory actors for purposes of 
Rule 3502 as ``persons'' or ``individuals.'' The Board notes, 
however, that both natural persons and entities can be associated 
persons, and therefore Rule 3502 charges can be brought against both 
natural persons and entities, consistent with the meaning of the 
term ``person associated with a registered public accounting firm.''
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    Accordingly, following notice and comment, the Board has amended 
Rule 3502 by changing from recklessness to negligence the liability 
standard for associated persons' contributory conduct. As explained in 
greater detail below, the Board believes, based on its experience and 
having considered the comments received, that the amendment better 
aligns Rule 3502 with the scope of the Board's enforcement authority 
under Sarbanes-Oxley, thus further advancing the Board's mission of 
investor protection.

Rulemaking History

    On September 19, 2023, the Board proposed to amend Rule 3502 in two 
ways: (1) by changing from recklessness to negligence the standard of 
conduct for associated persons' contributory liability and (2) by 
providing that, to be charged with violating Rule 3502, an associated 
person contributing to a registered firm's violation need not be an 
associated person of the firm that commits the primary violation (i.e., 
that an associated person of one registered firm can contribute to a 
primary violation of another registered firm).\9\ The Board received 28 
comment letters on the Proposal from commenters across a range of 
affiliations.\10\ In general, commenters recognized the importance of 
an effective PCAOB enforcement program and in holding individuals 
accountable when there are violations of applicable laws, rules, and 
professional standards. The final rule amendment--which, as detailed 
below, does not include the second aspect of the Proposal--is informed 
by the comments received on the Proposal, which are discussed 
throughout this release.
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    \9\ Proposed Amendments to PCAOB Rule 3502 Governing 
Contributory Liability, PCAOB Release No. 2023-007 (Sept. 19, 2023) 
(``2023 Proposing Release'' or the ``Proposal''), available at 
https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/053/pcaob-release-no.-2023-007-rule-3502-proposal.?=7d49cc51_9.
    \10\ Comment letters on the Proposal, as well as a staff white 
paper regarding characteristics of emerging growth companies, are 
available on the Board's website in Rulemaking Docket No. 053, 
available at https://pcaobus.org/about/rules-rulemaking/rulemaking-dockets/docket-053/letters. One of the comment letters was 
withdrawn.
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Background

    PCAOB Rule 3502 codifies associated persons' ethical obligation not 
to contribute to a registered firm's violations of the laws, rules, and 
standards that the Board is charged with enforcing. The rule provides 
grounds for secondary liability when an associated person of a 
registered firm acts at least recklessly to directly and substantially 
contribute to such a violation. Although the rule as adopted in 2005 
incorporated a recklessness standard, the rule as proposed in 2004 
required that individuals only negligently contribute to a firm's 
violation to be subject to liability.\11\ Whereas negligence ``is the 
failure to exercise reasonable care or competence,'' \12\ recklessness 
requires ``an extreme departure from the standard of ordinary care'' 
that ``presents a danger to investors or to the markets that is either 
known to the (actor) or is so obvious that the actor must have been 
aware of it.'' \13\ Indeed, Sarbanes-Oxley characterizes ``reckless 
conduct'' as a subset of ``intentional or knowing conduct,'' \14\ 
whereas negligence is an ``objective'' standard that is not measured by 
``the intent of the accountant.'' \15\
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    \11\ See Proposed Ethics and Independence Rules Concerning 
Independence, Tax Services, and Contingent Fees, PCAOB Release No. 
2004-015, at 18 & n.40 (Dec. 14, 2004) (``2004 Proposing Release''), 
available at https://pcaobus.org/Rulemaking/Docket017/2004-12-14_Release_2004-015.pdf.
    \12\ In re SW Hatfield, C.P.A., SEC Release No. 34-69930, at 35 
n.169 (July 3, 2013) (citation and quotation marks omitted).
    \13\ Id. at 29 (citation and quotation marks omitted); see also 
Marrie v. SEC, 374 F.3d 1196, 1204 (D.C. Cir. 2004); 2005 Adopting 
Release at 13 (``[T]he phrase `knew, or was reckless in not knowing' 
is a well-understood legal concept, and the Board intends for the 
phrase to be given its normal meaning.'').
    \14\ See Section 105(c)(5)(A) of Sarbanes-Oxley.
    \15\ In re Melissa K. Koeppel, CPA, PCAOB File No. 105-2011-007, 
at 166 (Dec. 29, 2017) (quoting In re Kevin Hall, CPA, SEC Release 
No. 34-61162, at 12 (Dec. 14, 2009) (quotation marks omitted)).
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    The Board has adopted negligence as the liability standard for 
actionable contributory conduct under Rule 3502.

[[Page 54897]]

And for good reason: A negligence standard is appropriate based on the 
Board's extensive experience with Rule 3502 since the rule's adoption 
nearly two decades ago, it closes a gap in the PCAOB's regulatory 
framework that can lead to anomalous results, and it advances certain 
objectives in the Board's 2022-2026 Strategic Plan in furtherance of 
the Board's overall mission.
    In the first subsection below, the Board reviews the Board's 2004 
proposal and 2005 adoption of Rule 3502. Then, the Board details the 
reasons for the amendment the Board has adopted to modernize and 
strengthen the rule.

A. History of Rule 3502

    As part of a package of proposed ethics and independence rules, the 
Board proposed PCAOB Rule 3502 in 2004.\16\ In issuing the proposal, 
the Board observed that ``[w]hile certain types of violations, by their 
nature, may give rise to direct liability only for a registered public 
accounting firm, the firm's associated persons bear an ethical 
obligation not to be a cause of any violations by the firm.'' \17\ 
Accordingly, through Rule 3502, the Board sought to ``codify that 
obligation'' and ``make it clear that the obligation is enforceable by 
the Board.'' \18\ Using language ``intended to articulate a negligence 
standard,'' the proposed version of Rule 3502 subjected associated 
persons to potential contributory liability if they ``knew or should 
have known'' that an act or omission by them would contribute to a 
firm's primary violation.\19\
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    \16\ See generally 2004 Proposing Release at 18-19. As 
originally proposed (and adopted), Rule 3502 was entitled 
Responsibility Not to Cause Violations. See id. at A-4; 2005 
Adopting Release at A-5. Shortly after adoption, however, the Board 
changed the title of the rule to its current title, Responsibility 
Not to Knowingly or Recklessly Contribute to Violations. The Board 
made the change ``[a]fter discussions with the SEC'' and ``to avoid 
any misperception that the rule affects the interpretation of any 
provision of the federal securities laws.'' Ethics and Independence 
Rules Concerning Independence, Tax Services, and Contingent Fees, 
PCAOB Release No. 2005-020, at 2 (Nov. 22, 2005), available at 
https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/rulemaking/docket017/2005-11-22_release_-020.pdf?sfvrsn=69338fcd_0. 
In so doing, however, the Board clarified that ``[t]he rule, as 
amended, should be interpreted and understood to be the same as the 
rule adopted by the Board.'' Id.
    \17\ 2004 Proposing Release at 18.
    \18\ Id.
    \19\ Id. at 18 n.40; see id. at A-4 (proposed rule text).
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    Following a public comment period,\20\ the Board adopted Rule 3502 
with two modifications from the proposal. First, while affirming its 
authority to promulgate a negligence-based ethics rule prohibiting 
contributory conduct,\21\ the Board revised the liability standard from 
negligence to recklessness, which the Board at that time believed would 
``strike[ ] the right balance in the context of th[e] rule.'' \22\ 
Second, the Board modified ``contribute''--the verb that describes the 
connection between the associated person's conduct and the firm's 
primary violation--by adding the words ``directly and substantially.''
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    \20\ ``Several commenters supported the rule as proposed and 
noted that they saw the rule as essential to the Board's ability to 
carry out its disciplinary responsibilities under the Act,'' 2005 
Adopting Release at 9, while others did not fully endorse it. Their 
objections were based principally on the view that negligence might 
be an ill-suited liability standard ``in light of the complex 
regulatory requirements with which auditors must comply'' and out of 
concern that such standard ``would allow the Board, or the SEC, to 
proceed against associated persons who in good faith, albeit 
negligently, have caused a registered firm to violate applicable 
laws or standards.'' Id. at 9, 13. Certain commenters ``also 
questioned the Board's authority to adopt the proposed rule, or at 
least the proposed rule with a negligence standard.'' Id. at 9.
    \21\ See id. at 12 n.23.
    \22\ 2005 Adopting Release at 13; see id. at 12 & n.23.
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    The latter modification was made due to commenters expressing 
concern that, because of the collaborative nature of accounting work, 
each individual involved in formulating a decision or other action that 
ultimately leads to a firm violation could be held liable for causing 
the violation.\23\ The Board explained that the addition of 
``directly'' means, among other things, that an associated person's 
conduct must ``either essentially constitute[ ] the [firm's] 
violation'' or be ``a reasonably proximate facilitating event of, or a 
reasonably proximate stimulus for, the violation.'' But, the Board 
clarified, ``directly'' does not place outside the scope of Rule 3502 
contributory conduct ``just because others also contributed to the 
violation, or because others could have stopped the violation and did 
not.'' ``Substantially,'' the Board explained, means that an associated 
person's conduct must ``contribute[ ] to [a] violation in a material or 
significant way,'' though it need not be ``the sole cause of the 
violation.'' \24\
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    \23\ See id. at 9, 13.
    \24\ Id. at 13.
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B. Reasons for the Amendment

    As the Board previously recognized, when an associated person 
causes a firm to commit a violation, such conduct ``operates to the 
detriment of the protection of investors.'' \25\ The following 
subsections explain why the modification to Rule 3502 is appropriate in 
furtherance of the Board's mission to protect the interests of 
investors and further the public interest in the preparation of 
informative, accurate, and independent audit reports.
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    \25\ 2005 Adopting Release at 10.
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1. Aligning Rule 3502 With the Board's Enforcement Authority
    As the Board previously has explained, a registered firm ``can only 
act through the natural persons who serve as its agents, including its 
associated persons.'' \26\ Accordingly, ``a natural person's actions 
may render both the [firm] primarily liable and the natural person 
secondarily liable.'' \27\ Yet under the current formulation of Rule 
3502, an incongruity exists between the respective requisite mental 
states for liability of a registered firm resulting from an associated 
person's conduct and for liability of the associated person: A firm can 
commit a primary violation of certain laws, rules, or standards by 
acting negligently, but an associated person who directly and 
substantially contributed to that violation must have acted at least 
recklessly to be secondarily liable.
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    \26\ 2004 Proposing Release at 18; see 2005 Adopting Release at 
12 (``[Registered] firms . . . can only act through the natural 
persons that comprise them, many of whom are `associated persons' 
subject to the Board's ethics standards and disciplinary 
authority.''). Indeed, as one commenter on the Proposal put it, a 
firm is the sum of its parts.
    \27\ In re Timothy S. Dembski, SEC Release No. 34-80306, at 13-
14 n.35 (Mar. 24, 2017) (quoting SEC v. Koenig, 2007 WL 1074901, at 
*7 (N.D. Ill. Apr. 5, 2007)).
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    This incongruity means that associated persons may have weaker 
incentives to exercise the appropriate level of care in their audit 
work. They may not exercise reasonable care (the standard for 
negligence) if they know that they cannot be held individually liable 
by the PCAOB for a firm's primary violation unless an act or omission 
by them amounts to an ``an extreme departure from the standard of 
ordinary care for auditors'' (the standard for recklessness).\28\ The 
modification to Rule 3502's liability standard from recklessness to 
negligence closes this regulatory gap, which should incentivize 
associated persons to be more deliberate and careful in their

[[Page 54898]]

actions. Indeed, ``accountability frequently improves outcomes.'' \29\
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    \28\ Marrie, 374 F.3d at 1204; see Russell G. Pierce & Eli Wald, 
The Relational Infrastructure of Law Firm Culture and Regulation, 42 
Hofstra L. Rev. 109, 129 (2013) (explaining how rules from the legal 
industry's governing body that would restrict lawyers' limited 
liability ``will encourage lawyers to devote more energy to 
maintaining the quality of the firm because they could potentially 
face personal liability for poor quality services''); see also 
Colleen Honigsberg, The Case for Individual Audit Partner 
Accountability, 72 Vand. L. Rev. 1871, 1885 (2019) (arguing that 
``existing deterrence mechanisms have failed to produce optimal 
audit quality'' and ``are ineffective'').
    \29\ Honigsberg, supra, at 1902.
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    Numerous commenters agreed with the Board's regulatory concerns 
noted above. These commenters generally noted that the Board's concerns 
were valid and clear, and that a negligence standard would better align 
Rule 3502 with the scope of the Board's enforcement authority under 
Sarbanes-Oxley and provide a tool to eliminate incongruous results in 
liability between individuals and firms. Indeed, one commenter 
characterized the difference between negligence and recklessness as 
``substantial'' and ``consequential'' and noted that the current gap in 
liability standards directly impacts the Board's ability to fulfill its 
statutory mission.\30\
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    \30\ Comment Letter from Better Markets at 3 (Nov. 3, 2023).
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    Another commenter remarked that a negligence standard will enable 
the PCAOB and the U.S. Securities and Exchange Commission (SEC or 
``Commission'') to more efficiently and effectively pursue enforcement 
cases regardless of which entity has the resources to bring the case. 
Commenters also stated that a negligence standard would appropriately 
align Rule 3502's liability threshold with the standard of care that 
auditors currently should be exercising when performing their 
professional responsibilities and that both the Commission and civil 
plaintiffs in private litigation currently can pursue cases against 
auditors for negligence. In encouraging the PCAOB to adopt the 
Proposal, one commenter further noted that the change to negligence 
would bolster investors' expectations that accountants will be 
independent and diligent in their audit work.
    Other commenters, however, believed that the Proposal did not 
present a sufficient rationale for moving to a negligence standard 
after the Board previously declined to do so in 2005. These commenters 
opined that the same concerns about a negligence standard that existed 
in 2005 exist today and questioned whether there were significant 
enough developments to merit the change.\31\ Indeed, certain commenters 
acknowledged the incongruity discussed in the Proposal but contended 
either that it is not significant or problematic, that it is not an 
impediment to enforcement, or that closing the gap in liability 
standards would not change auditor conduct.\32\ One commenter stated 
explicitly that no incongruity or gap exists.
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    \31\ In support of such assertion, one commenter cited F.C.C. v. 
Fox Television Stations, Inc., 556 U.S. 502 (2009). The rationale 
articulated in the Proposal and this adopting release, however, more 
than satisfies Fox's criteria for a conscious change in policy. See 
id. at 515 (``[I]t suffices that the new policy is permissible under 
the statute, that there are good reasons for it, and that the agency 
believes it to be better, which the conscious change of course 
adequately indicates.''). As to auditors' reliance on the standard 
in the current rule, as in Fox, the Board is not ``punishing 
[auditors] without notice of the potential consequences of their 
action.'' Id. at 518. That is so because the adoption of a 
negligence standard, by itself, does not impose any civil money 
penalty or other sanction; rather, sanctions are available only if 
Rule 3502 is violated after the amended rule becomes effective.
    \32\ One commenter stated that the Proposal failed to articulate 
how the change to negligence would align Rule 3502 with Sarbanes-
Oxley and questioned whether there were cases where the current 
recklessness standard did not suffice to hold persons accountable. 
The Proposal, however, made both of these points clear. See 2023 
Proposing Release at 7 (describing the current misalignment with 
Sarbanes-Oxley); id. at 24-25 (discussing estimated cases in 2022). 
That commenter and one other also noted that the PCAOB has been able 
to assess significant penalties under the current Rule 3502 
formulation and that the Board's disciplinary proceedings have 
resulted in collateral consequences for firms and individuals. While 
that may be the case, the Board did not adopt a negligence standard 
for the purpose of facilitating an increase in penalties; rather, as 
the Proposal explained, the Board proposed--and has adopted--a 
negligence standard to facilitate an increase in accountability and 
deterrence. See 2023 Proposing Release at 7.
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    Several commenters also stated that auditors are subject to 
sufficient oversight under the current framework, including via the 
PCAOB's inspection program, enforcement in Commission proceedings, and 
enforcement by state regulatory agencies. Certain of these commenters 
further stated that a negligence standard would risk, among other 
things, disturbing the PCAOB's inspection process by upsetting 
inspection dynamics and threatening the cooperative and constructive 
nature of the process that has developed over time.
    The Board is mindful of the efficiencies gained through open 
dialogue with firms and individuals alike during the inspection 
process. Given that firms and individuals already are subject to a 
negligence standard for primary violations, however, the Board does not 
believe that the incremental change of moving from recklessness to 
negligence for contributory conduct will have a chilling effect on 
inspections, especially given that the Board will continue to exercise 
discretion about when to bring Rule 3502 charges.\33\
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    \33\ One commenter expressed concern over whether the inspection 
process is sufficiently robust to conclude that an associated person 
has contributed to a firm's negligence-based violation, and 
relatedly, another asserted that auditors believe that the Board is 
holding them to an inspections bar that constantly evolves. 
Inspection staff's findings, however, are not conclusive for 
purposes of imposing legal liability under Rule 3502 (or any PCAOB 
rule). See PCAOB Inspection Procedures: What Does the PCAOB Inspect 
and How Are Inspections Conducted?, available at https://pcaobus.org/oversight/inspections/inspection-procedures (``[A]ny 
references in [an inspection] report to violations or potential 
violations of law, rules, or professional standards are not a result 
of an adjudicative process and do not constitute conclusive findings 
for purposes of imposing legal liability.''). Rather, whether there 
is legal liability for a violation and whether conduct merits 
sanctions (and if so, what the sanctions are) are determined through 
the adversarial process involving the Board's Division of 
Enforcement and Investigations and only after respondents have been 
afforded the opportunity to present a defense.
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    Commenters also opined that amending Rule 3502 is unnecessary 
because the Board's then-proposed (now-adopted \34\) QC 1000 standard 
provides clearer expectations with regard to individuals in quality 
control (QC) roles.\35\ Although the Board agrees that QC 1000 
crystallizes the responsibilities of certain individuals serving in QC 
roles, Rule 3502 applies more broadly than to just those particular 
individuals. Thus, although QC 1000 and Rule 3502 could overlap to 
cover the same conduct in some circumstances, there are other 
circumstances in which there would not be overlap.\36\
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    \34\ This release references several professional standards that 
the Board has adopted but which are pending Commission approval, and 
which therefore are subject to change. See Section 107(b) of 
Sarbanes-Oxley.
    \35\ See generally A Firm's System of Quality Control and Other 
Amendments to PCAOB Standards, Rules, and Forms, PCAOB Release No. 
2024-005 (May 13, 2024) (``QC 1000 Release'').
    \36\ See, e.g., Herman & MacLean v. Huddleston, 459 U.S. 375, 
383 (1983) (``While some conduct actionable under Section 11 may 
also be actionable under Section 10(b), it is hardly a novel 
proposition that the 1934 [Securities Exchange] Act and the 1933 
[Securities] Act `prohibit some of the same conduct.' `The fact that 
there may well be some overlap is neither unusual nor unfortunate.' 
'' (citations omitted)).
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    Commenters similarly expressed mixed views about whether the change 
to negligence would incentivize auditors to more fully comply with 
applicable laws, rules, and standards that the Board is charged with 
enforcing. Multiple commenters remarked in the affirmative, noting that 
such incentivization is foreseeable and that a negligence standard will 
encourage individuals and firms to maintain a high level of quality in 
their audit work, which in turn benefits investors and financial 
markets alike. Indeed, one commenter remarked that the current 
recklessness standard inadequately incentivizes associated persons to 
exercise the appropriate level of care in their audit work. This 
commenter also noted that, beyond incentivizing individuals' 
compliance, a negligence standard also would incentivize firms to 
ensure, through training and other measures, that their

[[Page 54899]]

employees are complying with applicable professional standards.
    By contrast, other commenters argued that a negligence standard 
will not incentivize compliance, for a variety of reasons. Multiple 
commenters premised such view on the downstream effects that oversight 
with respect to firms has on individuals. According to certain of these 
commenters, such effects (e.g., reduced responsibility on audits, 
compensation- and promotion-related consequences), as well as other 
firm policies and preventative measures (such as training), are 
sufficient to guard against negligence and incentivize individual 
compliance. Another commenter opined that the auditor reporting model 
and the identification of auditors in Form AP suffice to address 
individual accountability.
    While the Board agrees that each of the above factors may play a 
role in driving individual accountability in certain respects, none is 
a form of regulatory accountability that is akin to the Board's 
authority to bring enforcement proceedings and impose publicly a range 
of disciplinary sanctions as remedial measures. Moreover, the market-
driven consequences relating to the auditor reporting model and 
identification of auditors on Form AP are felt primarily (if not 
exclusively) by the engagement partner on an audit, while Rule 3502 
applies more broadly.
    Another commenter questioned whether a negligence standard would 
have a deterrent effect (or close any gap) given that auditors already 
are subject to a negligence standard for contributory liability in 
Commission actions. One commenter noted that, given that auditors 
already are subject to negligence actions by other entities (including 
the Commission and state regulators), empirical evidence should be 
provided to support how auditor behavior would change under a 
negligence standard for Rule 3502.\37\ As the Board previously noted, 
however, an increase in the number of regulators on alert for the same 
or similar violative conduct increases the likelihood of that conduct 
being detected and, consequently, the likelihood that the conduct would 
be sanctioned.\38\
---------------------------------------------------------------------------

    \37\ This commenter did not provide the source of any data or 
propose any methods by which to generate empirical evidence on this 
subject.
    \38\ 2023 Proposing Release at 14 n.51.
---------------------------------------------------------------------------

    In other commenters' views, a negligence standard would not 
incentivize compliance because sanctions are ineffective to deter mere 
errors in judgment. As explained below, however, the amendment does not 
target mere errors in judgment, but rather unreasonable conduct. 
Multiple commenters also posited that a lower threshold for auditor 
liability may have a negative impact on audit quality, including at 
smaller firms. Indeed, one commenter asserted that the impact of the 
proposed rule change (and proceedings brought pursuant to it) would be 
felt more acutely by firms that are not affiliated with the largest 
global networks, despite those firms having a significantly smaller 
share in auditing the market capitalization of U.S. issuers. These 
commenters generally attributed what they view as a potential loss in 
audit quality to several factors, including recruiting, retention, and 
staffing challenges; reduced collaboration among auditors; and auditors 
engaging in unproductive, excessive self-protective behavior. The Board 
addresses below commenters' concerns about the amendment's potential 
impacts on audit quality and smaller firms, respectively.
2. The Board's Implementation Experience
    Although the Board viewed Rule 3502's recklessness liability 
threshold as ``strik[ing] the right balance in the context of th[e] 
rule'' at the time of the rule's adoption in 2005, the threshold had 
not yet been tested in practice by the PCAOB, and experience has shown 
that it prevents the Board from executing its investor-protection 
mandate to the fullest extent that Congress authorized in Sarbanes-
Oxley.
    In the instances in which the Board has instituted proceedings 
against firms for negligence-based violations, the Board has not been 
able to charge Rule 3502 violations against the individuals that 
negligently contributed to those firms' violations. Although the 
decision not to bring charges against individuals varies case by case 
and is at the Board's discretion, it remains that the Board has been 
legally barred by the current formulation of Rule 3502 from holding 
accountable under Rule 3502 individuals who negligently, directly, and 
substantially contributed to the firms' violations.\39\
---------------------------------------------------------------------------

    \39\ As the 2005 Adopting Release notes, however, Rule 3502 ``is 
not the exclusive means for the Board to enforce applicable Board 
rules and standards against associated persons.'' 2005 Adopting 
Release at 14 n.25.
---------------------------------------------------------------------------

    The Board's application of Rule 3502 in various contexts supplies 
experience-based reasons for the proposed amendment to the liability 
standard. For example, when dealing with the design and implementation 
of firm QC policies and procedures under applicable QC standards, the 
Board has observed that registered firms that commit a QC violation 
often have multiple individuals with overlapping QC responsibility but 
that no single individual was reckless in failing to act, and thus no 
individual can be held personally accountable for the firm's QC 
failure.\40\ And yet, individuals with QC responsibility at a firm are 
often in some of the most important decision-making roles within the 
firm because a compliant QC system serves as the backstop to ensure 
that all other professional standards are followed.\41\
---------------------------------------------------------------------------

    \40\ The Board's recently adopted QC 1000 standard mitigates 
this concern to an extent by requiring firms to assign one or more 
individuals to certain roles with designated responsibilities within 
a firm's QC system. See QC 1000 Release at 82-86. The concern 
remains, though, because ``[a] firm may have multiple individuals or 
multiple layers of personnel supporting these roles.'' Id. at 83.
    \41\ See QC Sec.  20.03, System of Quality Control (``A firm has 
a responsibility to ensure that its personnel comply with the 
professional standards applicable to its accounting and auditing 
practice. A system of quality control is broadly defined as a 
process to provide the firm with reasonable assurance that its 
personnel comply with applicable professional standards and the 
firm's standards of quality.''); QC 1000 Release at 70-71 (setting 
forth, in QC 1000.05, the objective of a firm's QC system).
---------------------------------------------------------------------------

    Multiple commenters suggested that a negligence standard should not 
apply to enforcement of QC matters because the Board's inspection 
function already provides it with transparency into a firm's QC system. 
Inspections (and, relatedly, remediation) of QC matters, however, are 
distinct from enforcement, including with respect to the available 
potential consequences for firms and individuals, respectively. Yet 
Congress also expressly envisioned that the Board's inspections program 
would inform its enforcement activities.\42\ Such entwinement is 
therefore a feature of Sarbanes-Oxley--not a flaw or a reason not to 
adopt a negligence standard.
---------------------------------------------------------------------------

    \42\ See, e.g., Section 104(c)(3) of Sarbanes-Oxley (requiring 
the Board, ``in each inspection,'' to ``begin a formal investigation 
or take disciplinary action, if appropriate, with respect to any 
[potential] violation [identified during an inspection], in 
accordance with this Act and the rules of the Board'').
---------------------------------------------------------------------------

    One commenter also appeared to interpret the Proposal as the Board 
suggesting that having multiple people with overlapping responsibility 
for a firm's QC system is an obstacle to investor protection or 
enhanced audit quality and that a single individual needs to be held 
accountable for a QC violation in the absence of reckless behavior. 
That was not the Board's intent; rather, the Board meant simply what it 
said: When there are multiple individuals involved in the QC function, 
it could be that no individual's conduct rose to the level of 
recklessness

[[Page 54900]]

despite a firm's QC failure, thus allowing persons who negligently, 
directly, and substantially contribute to a QC failure to avoid 
individual accountability under Rule 3502.\43\
---------------------------------------------------------------------------

    \43\ See 2023 Proposing Release at 9.
---------------------------------------------------------------------------

    Moreover, the Board did not mean to imply that a single person 
``needs'' to be held individually accountable in all circumstances for 
negligence contributing to a firm's QC failure.\44\ The Board exercises 
discretion about whom to charge and what charges to bring, and even in 
the absence of a charge, the potential to be held individually liable 
for contributory negligence may increase the amount of care and 
attention dedicated to QC by responsible individuals. Indeed, while 
reflecting only a modest change, the Board anticipates that the 
amendment will have a positive impact on audit quality as a result of 
its deterrent effect.
---------------------------------------------------------------------------

    \44\ Comment Letter from PricewaterhouseCoopers LLP at A4 (Nov. 
2, 2023).
---------------------------------------------------------------------------

    Another comment letter posited that a negligence standard would 
place an unfair burden on national office partners responsible for a 
firm's QC functions and engagement quality review partners, who the 
comment letter asserted typically do not have the authority to 
establish firm strategies or allocate resources. This commenter 
expressed concern that the Board would pursue enforcement actions 
against a single individual when a firm's partners collectively are 
responsible for the strategy and resource allocation decisions that led 
to a firm's violation. Regardless of whether collective responsibility 
is uniformly the practice, the Board should not be precluded from 
exercising its discretion to pursue a Rule 3502 charge against an 
individual who failed to exercise reasonable care and competence, even 
in cases involving a firm's strategy or resource-allocation decisions 
that led to a QC failure.
    In addition to the QC context, Rule 3502 also arises in sole-
proprietorship cases, in which the sole owner and sole partner of a 
firm causes the firm to commit a violation. Yet for some types of 
violations, there is not always sufficient evidence of reckless 
behavior. A negligence standard thus would promote greater 
accountability by the sole proprietor and prevent that person from 
being shielded from individual liability under Rule 3502.
    One commenter sought clarity regarding how Rule 3502 might be 
applied to sole proprietors. The Board notes that examples include 
instances in which firms fail to obtain an engagement quality review 
\45\ or fail to file (or file timely) required PCAOB forms.\46\ In each 
scenario, the respective primary violations can be committed only by a 
firm because the obligations are imposed solely on the firm,\47\ yet a 
sole proprietor of a firm could negligently, directly, and 
substantially contribute to the firm's violation of the relevant PCAOB 
rules and standard.
---------------------------------------------------------------------------

    \45\ E.g., In re Jack Shama, PCAOB Release No. 105-2024-004 
(Jan. 23, 2024); In re Robert C. Duncan Accountancy Corp., PCAOB 
Release No. 105-2022-010 (June 22, 2022); In re Tamba S. Mayah, CPA, 
PCAOB Release No. 105-2021-007 (Sept. 13, 2021).
    \46\ See, e.g., In re Jeffrey T. Gross, Ltd., PCAOB Release No. 
105-2019-016 (July 23, 2019) (primary violation of PCAOB Rule 3211 
relating to Form AP).
    \47\ See AS 1220, Engagement Quality Review; PCAOB Rule 2200, 
Annual Report (Form 2 filing rule); PCAOB Rule 2203, Special Reports 
(Form 3 filing rule); PCAOB Rule 3211, Auditor Reporting of Certain 
Audit Participants (Form AP filing rule).
---------------------------------------------------------------------------

    Another commenter identified independence violations as a common 
type of case not mentioned above and for which the commenter believes 
that a negligence standard of contributory liability would promote 
greater individual accountability. The Board agrees.\48\ Another 
commenter identified a data compilation regarding cases and fact 
patterns that the commenter said could be a resource in confirming and 
validating the change to Rule 3502.\49\
---------------------------------------------------------------------------

    \48\ Indeed, as the Board has previously stated, Rule 3502 is 
``essential to the proper functioning of the Board's independence 
rules.'' 2004 Proposing Release at 19; see 2005 Adopting Release at 
14.
    \49\ The resource is available at https://wp.nyu.edu/compliance_enforcement/category/artificial-intelligence. PCAOB 
staff's review indicates that what the commenter referred to as 
qualitative data mainly consists of blog posts written on a wide 
array of legal issues and news articles that are much broader in 
scope, cannot be analyzed readily in their entirety, and are not 
directly relevant to the Board's analysis.
---------------------------------------------------------------------------

3. Advancing the Board's Investor-Protection Mandate
    In the Board's 2022-2026 Strategic Plan, the Board expressed a 
rejuvenated focus on the PCAOB's investor-protection mandate and stated 
its intent ``to modernize and streamline our existing standards . . . 
where necessary to meet today's needs.'' \50\ The Board also expressed 
an intent to ``engag[e] in vigorous and fair enforcement that promotes 
accountability and deterrence,'' including by ``tak[ing] a more 
assertive approach to bringing enforcement actions'' and ``hold[ing] 
accountable'' those who commit ``violations that result from negligent 
conduct.'' \51\ The amendment to Rule 3502 is consistent with those 
goals.
---------------------------------------------------------------------------

    \50\ PCAOB, Strategic Plan 2022-2026, at 10, available at 
https://assets.pcaobus.org/pcaob-dev/docs/default-source/about/administration/documents/strategic_plans/strategic-plan-2022-2026.pdf?sfvrsn=b2ec4b6a_4/.
    \51\ Id. at 3, 13; see also id. at 8 (``[W]e are focused on 
aggressively pursuing all statutory legal theories for charging 
respondents and remedies available in executing our enforcement 
program, which is central to protecting investors and promoting the 
public interest.'').
---------------------------------------------------------------------------

    When Congress enacted Sarbanes-Oxley, it empowered the Board to 
promulgate and adopt certain standards and rules, to inspect registered 
firms for compliance with those standards and rules, and to enforce 
compliance by firms and their associated persons. Among the tools that 
Congress provided to the Board for enforcement is the ability to impose 
certain sanctions for negligent conduct, including single instances of 
negligence.\52\ That liability threshold serves a dual function: It 
incentivizes auditors to conduct their work knowing that reasonable 
care is the standard for assessing it (i.e., deterrence), and it allows 
the Board to publicly discipline auditors who were found to have not 
exercised an appropriate degree of care (i.e., accountability).\53\ 
Each of those functions--one ex ante to auditors' conduct and the other 
ex post--goes to the core of the Board's mission of protecting 
investors and promoting high-quality audits.
---------------------------------------------------------------------------

    \52\ See Sections 105(c)(4) & (c)(5) of Sarbanes-Oxley; Rules on 
Investigations and Adjudications, PCAOB Release No. 2003-015, at A2-
58 (Sept. 29, 2003), available at https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/docket_005/release2003-015.pdf?sfvrsn=35827b4_0 (``The Act plainly contemplates that 
disciplinary proceedings can be instituted for a violation based on 
a single negligent act.''). The Board received multiple comments 
regarding its authority to pursue enforcement proceedings based on 
single instances of negligence, and the Board addresses those 
comments below.
    \53\ See Honigsberg, supra, at 1899 (``Individual accountability 
could provide a counterweight to the current incentive structure. . 
. . [A]udit partners do not internalize the full consequences of an 
audit failure. Promoting individual brands will better address this 
inefficiency and reduce externalities by causing audit partners to 
internalize these failures.''); see also Gina-Gail S. Fletcher, 
Deterring Algorithmic Manipulation, 74 Vand. L. Rev. 259, 268-69 
(2021) (``[I]f the applicable laws are narrow, only capturing the 
most blatant misconduct, wrongdoers may not be deterred from 
breaking the law. . . . [D]eterrence is effective if regulators have 
strong, suitable tools to enforce the regime and market actors know 
whether they are violating the law.'').
---------------------------------------------------------------------------

    The current formulation of Rule 3502, however, stops short of 
deploying the Board's authority to sanction negligent conduct to the 
fullest extent by requiring at least reckless conduct before an 
associated person can be held secondarily liable. The amendment that 
the Board has adopted to Rule 3502's liability standard removes this 
constraint and makes the rule both a more effective deterrent and a 
more

[[Page 54901]]

effective enforcement tool, and in so doing, better aligns the rule 
with Sarbanes-Oxley.\54\
---------------------------------------------------------------------------

    \54\ See PCAOB, Strategic Plan 2022-2026, at 10 (``Effective 
auditing, attestation, quality control, ethics, and independence 
standards advance audit quality and are foundational to the PCAOB's 
execution of its mission to protect investors.'').
---------------------------------------------------------------------------

    Several commenters stated that it is clear and understandable how 
the amendment to Rule 3502 advance the Board's statutory mandate to 
protect investors, including by promoting the twin goals of 
accountability and deterrence. One such commenter remarked that a 
negligence standard ``may be needed'' to enhance accountability to 
investors,\55\ while another noted that such standard ``fall[s] 
squarely'' within the scope of the Board's mission and ``clearly and 
unambiguously advances'' the Board's cause.\56\ Still another opined 
that the amendment would ensure consistency between the liability 
standard and investor expectations and that ``it makes no sense'' to 
have differing standards for firms and individuals.\57\
---------------------------------------------------------------------------

    \55\ Comment Letter from Council of Institutional Investors at 5 
(Oct. 26, 2023).
    \56\ Comment Letter from Better Markets at 8.
    \57\ Comment Letter from Center for American Progress at 2 (Nov. 
3, 2023).
---------------------------------------------------------------------------

    As to deterrence, multiple commenters stated that the amendments 
should result in auditors being more likely to comply with their 
respective legal requirements. One commenter further opined that a 
negligence standard ``sends a strong message'' to auditors regarding 
the requisite level of care that they should be applying in their 
work.\58\
---------------------------------------------------------------------------

    \58\ Comment Letter from Better Markets at 5.
---------------------------------------------------------------------------

    Other commenters expressed a different view of the amendments 
relative to investor protection. One commenter stated that, should the 
amendment discourage certain individuals from accepting important QC 
roles for fear of being held liable, the public's interest would not be 
served by having less cautious or less qualified individuals fill those 
roles. Another opined that the amendments would incentivize high-
quality talent to avoid the audit profession, which could lead to lower 
audit quality, increased audit fees, and a large number of delistings. 
As certain other commenters pointed out and as the Board observed in 
the Proposal, however, auditors already are subject to liability and 
disciplinary schemes that encourage them to comply--and not just avoid 
reckless noncompliance--with applicable statutory, regulatory, and 
professional standards.
    Still another commenter expressed uncertainty about how a change to 
negligence will achieve further investor-protection benefits. This 
commenter remarked that the Board currently has means to hold 
accountable individuals who are negligent in various contexts and that 
investors are best protected when noncompliance is avoided in the first 
place. While the Board agrees that avoiding noncompliance in the first 
instance promotes audit quality and benefits investors, the Board views 
the addition of another enforcement tool to deter negligent conduct 
(including conduct that currently is beyond the Board's reach), and to 
hold accountable those who engage in such conduct, as a complement to--
not mutually exclusive from--avoiding noncompliance.
    Beyond deterrence and accountability, multiple commenters remarked 
that the amendments should enhance investors' confidence, both in 
audits and in the information provided in companies' financial 
statements. Some commenters noted that a change to a negligence 
standard would protect investors by encouraging auditors to be more 
careful about their work and positively affecting capital-market 
efficiency. Another commenter offered several additional downstream 
investor-protection benefits, including that as audit quality improves, 
the likelihood of auditors being subjected to meritorious litigation, 
and the risks and costs to investors resulting from that litigation (as 
well as misstatements and omissions in audited financial statements), 
should be reduced.

Discussion of the Amendment

    As discussed above, the Board has amended PCAOB Rule 3502 by 
changing the liability standard from recklessness to negligence. The 
details of the amendment are discussed in the following subsections.

A. Text of the Amended Rule and the Negligence Standard Generally

    The Board has amended Rule 3502's liability standard as proposed by 
deleting the phrase ``knowing, or recklessly not knowing'' (and certain 
ancillary surrounding text) and inserting elsewhere into the rule the 
phrase ``knew or should have known'' (and certain ancillary surrounding 
text). The outgoing phrase describes conduct that amounts to at least 
recklessness,\59\ whereas the incoming phrase sets a negligence 
standard using ``classic negligence language.'' \60\ Consequently, the 
Board is changing the standard for contributory liability from an 
``extreme departure from the standard of ordinary care'' \61\ 
(recklessness) to ``the failure to exercise reasonable care or 
competence'' (negligence).\62\
---------------------------------------------------------------------------

    \59\ See 2005 Adopting Release at 12 n.23.
    \60\ In re KPMG Peat Marwick LLP, SEC Release No. 34-43862 (Jan. 
19, 2001) (``Ordinarily, the phrase `should have known' . . . is 
classic negligence language.''), pet. for review denied, KPMG, LLP 
v. SEC, 289 F.3d 109 (D.C. Cir. 2002); see also Erickson Prods., 
Inc. v. Kast, 921 F.3d 822, 833 (9th Cir. 2019) (`` `[S]hould have 
known' . . . is a negligence standard. To say that a defendant 
`should have known' of a risk, but did not know of it, is to say 
that he or she was `negligent' as to that risk.''); KPMG, 289 F.3d 
at 120 (``knew or should have known'' is language that ``virtually 
compel[s]'' a negligence standard).
    \61\ Marrie, 374 F.3d at 1204 (citation and quotation marks 
omitted).
    \62\ SW Hatfield, SEC Release No. 34-69930, at 35 n.169 
(citation and quotation marks omitted).
---------------------------------------------------------------------------

    Such a change addresses the incongruity and related issues noted 
above. Specifically, it aligns the requisite mental states for 
liability of a registered firm and for liability of an associated 
person whose conduct directly and substantially contributed to the 
firm's violation.\63\ In so doing, the modification should better 
incentivize associated persons to exercise the appropriate level of 
care, thus promoting investor protection.
---------------------------------------------------------------------------

    \63\ However, the sanctions to which a contributory actor may be 
subject upon being found to have violated Rule 3502--including 
whether the Board may impose any of the heightened sanctions in 
Section 105(c)(5) of Sarbanes-Oxley--depend on the associated 
person's conduct and not that of the firm that commits the primary 
violation.
---------------------------------------------------------------------------

    Numerous commenters remarked that a change to negligence is 
appropriate, and with limited exception, commenters remarked that the 
proposed language to effectuate that change--which the Board has 
adopted--is clear and understandable.
    One commenter called the proposed rule text (``knew or should have 
known'') ``overly vague and broad'' and asserted that, in contrast to 
an accountability framework that sets forth clear expectations, the 
proposed rule does not provide notice of specific conduct that may lead 
to a violation.\64\ As the Proposal explained (and as repeated above), 
however, the ``knew or should have known'' phrasing is ``classic 
negligence language,'' and negligence is ``the failure to exercise 
reasonable care or competence.'' \65\ Indeed, one commenter remarked 
that such language is ``familiar in the American legal system.'' \66\ 
Moreover, as discussed in the 2005 Adopting Release and the Proposal 
(and as discussed below), the Board has delineated through its 
explanation of ``directly and substantially'' the nexus and magnitude 
that an auditor's conduct must have to

[[Page 54902]]

a firm's primary violation to be actionable. The Board is thus 
satisfied that such a well-known standard in the law, supplemented by 
additional parameters that have been in place for nearly two decades, 
is neither vague nor overly broad.
---------------------------------------------------------------------------

    \64\ Comment Letter from RSM US LLP at 1 (Nov. 3, 2023).
    \65\ 2023 Proposing Release at 13 & n.45.
    \66\ Comment Letter from Center for Audit Quality at 11 (Nov. 2, 
2023).
---------------------------------------------------------------------------

    Several commenters sought clarity over how the adopted text of Rule 
3502 (``knew or should have known''), as well as the definition of 
negligence (``failure to exercise reasonable care or competence''), 
would interact with other standards of conduct applicable to auditors, 
and in particular the obligation of exercising due professional care 
under then-proposed (now-adopted) AS 1000, General Responsibilities of 
the Auditor in Conducting an Audit.\67\ To be sure, due professional 
care and reasonable care and competence are largely overlapping 
concepts.\68\ However, the Board wishes to emphasize three points.
---------------------------------------------------------------------------

    \67\ See General Responsibilities of the Auditor in Conducting 
an Audit and Amendments to PCAOB Standards, PCAOB Release No. 2024-
004, at 30-39 (May 13, 2024) (``AS 1000 Release'') (subject to 
Commission approval); see also AS 1015, Due Professional Care in the 
Performance of Work.
    \68\ See AS 1000 Release at A1-3 (``due professional care'' 
includes ``acting with reasonable care and diligence''); see also QC 
1000 Release at 81 (``We are adopting this provision [QC 1000.10] 
with modifications to align with the descriptions of due 
professional care and professional skepticism being adopted in AS 
1000.'').
---------------------------------------------------------------------------

    First, while there may be overlap, AS 1000 does not apply to all 
conduct for which the Board has enforcement authority; \69\ thus, there 
is a need for a separate rule with a negligence standard. Second, 
because Rule 3502 includes the ``directly and substantially'' modifier, 
it will not always be the case that conduct that violates the 
obligation of due professional care also violates Rule 3502; thus, Rule 
3502 is not duplicative of AS 1000, even if conduct violating the 
latter may also violate the former in certain circumstances. Third, 
Rule 3502--located within the ``Ethics and Independence'' section of 
the Board's rules regarding professional practice standards--reflects 
an overarching ethical obligation, and the Board believes it 
appropriate to codify that general obligation, even if it overlaps with 
more specific provisions in particular professional standards.
---------------------------------------------------------------------------

    \69\ See AS 1000 Release at 30-31 (delineating the parameters of 
``all matters related to the audit'' to which AS 1000's requirement 
to exercise due professional care applies).
---------------------------------------------------------------------------

    A substantial number of commenters did not appear to support the 
change. In general, these commenters stated that they do not believe 
that negligence is an appropriate standard for assessing conduct and 
compliance on complex audit engagements, which commenters said require 
a wide range of judgments. For instance, one commenter opined that what 
could be labeled as a ``violation'' of professional standards instead 
may be only a difference of opinions between accountants about a 
particular pronouncement(s). That commenter further opined that, by 
proposing a negligence standard, the Board misunderstands the nature of 
audits. Several other commenters opined that it is bad policy to 
penalize errors in judgment and for the PCAOB to second-guess auditors' 
good-faith decisions in situations involving the application of 
professional judgment.
    As noted above, however, firms and associated persons already are 
subject to a negligence standard for their primary violations, 
including for single instances of negligence that violate professional 
standards.\70\ The amendment to Rule 3502 therefore affects only an 
incremental (albeit important) change, and only for contributory 
conduct. Given the Board's nearly two decades of experience 
distinguishing isolated, good-faith errors in professional judgment 
from conduct that warrants disciplinary action, as well as the modest 
estimated increase in Rule 3502 cases that would result from the 
amendment, the Board does not anticipate that a change in the liability 
standard for contributory conduct will be used to sanction isolated, 
good-faith errors in professional judgment--let alone be wielded as a 
``blunt'' or ``draconian'' instrument, as one commenter suggested 
\71\--including with respect to less senior engagement team 
members.\72\ The amendment focuses on unreasonable conduct; it does not 
impose strict liability.\73\
---------------------------------------------------------------------------

    \70\ See, e.g., In re Sassetti, LLC, PCAOB Release No. 105-2024-
018 (Mar. 28, 2024); In re Berkower, LLC, PCAOB Release No. 105-
2024-016 (Mar. 28, 2024).
    \71\ Comment Letter from U.S. Chamber of Commerce at 2 (Nov. 7, 
2023).
    \72\ To iterate what the Board said in 2005, Rule 3502 is not 
``a vehicle to pursue compliance personnel who act in an 
appropriate, reasonable manner that, in hindsight, turns out to have 
not been successful.'' 2005 Adopting Release at 14.
    \73\ ``Strict liability is imposed upon a defendant without 
proof that he was at fault. In other words, when liability is 
strict, neither negligence nor intent must be shown.'' Dobbs' Law of 
Torts Sec.  437.
---------------------------------------------------------------------------

    One commenter opined that a Rule 3502 charge could cause associated 
persons to ``lose their livelihood'' due to ``career-ending penalties'' 
under the Proposal.\74\ Several other commenters expressed a similar 
concern about the negligence threshold and the potential collateral 
effects and impacts on auditors' careers. While the Board appreciates 
that disciplinary orders have consequences--as they should--research 
suggests that auditors remain gainfully employed following a 
culpability finding.\75\ And in all events, the Board emphasizes that 
it is not the Board's intent to pursue, through Rule 3502 charges, what 
one commenter described as ``foot-faults'' or ``unintentional slips, 
pure errors of judgment, and innocuous errors on `technicalities.' '' 
\76\ Nor do the Board's standards require that auditors exercise 
``perfect judgment at all times,'' as one commenter put it,\77\ to 
avoid an enforcement proceeding (under Rule 3502 or otherwise).\78\
---------------------------------------------------------------------------

    \74\ Comment Letter from RSM US LLP at 1, 2.
    \75\ See J. Krishnan, M. Li, M. Mehta & H. Park, Consequences 
for Culpable Auditors, available at https://ssrn.com/abstract=4627460. In their working paper studying audit 
professionals subject to Commission or PCAOB enforcement proceedings 
between 2003 and 2019, the authors make three key findings: First, a 
substantial number of culpable auditors remain gainfully employed by 
their firms one year after the enforcement event (26% of Big 4 and 
43% of non-Big 4 culpable auditors). Second, culpable individuals 
leaving Big 4 firms primarily move to the corporate sector and 
secure senior or mid-level executive positions at private firms. By 
contrast, culpable auditors departing from non-Big 4 firms tend to 
join other non-Big 4 public accounting firms, often as partners. 
Third, . . . the large majority of culpable auditors do not engage 
in liquidity-increasing real estate transactions around enforcement.
    \76\ Comment Letter from U.S. Chamber of Commerce at 9, 10.
    \77\ Comment Letter from RSM US LLP at 3.
    \78\ See AS 1015.03, Due Professional Care in the Performance of 
Work (quoting a treatise describing the obligation of due care as: 
``[N]o man, whether skilled or unskilled, undertakes that the task 
he assumes shall be performed successfully, and without fault or 
error; he undertakes for good faith and integrity, but not for 
infallibility, and he is liable to his employer for negligence, bad 
faith, or dishonesty, but not for losses consequent upon pure errors 
of judgment.'' (citation omitted)); AS 1000 Release at 31 (``We 
continue to believe that the description of due professional care in 
the final standard is consistent with the description in AS 1015.03 
(and the reference in the current standard to the legal treatise, 
Cooley on Torts), which uses the terms `reasonable care and 
diligence' and `good faith and integrity but not infallibility' to 
describe due care.'').
---------------------------------------------------------------------------

    Some commenters expressed concern over the notion that, as a result 
of the amendment, the Board would be able to pursue conduct that is not 
itself a violation but that merely contributes to a violation. One 
commenter characterized this as a ``significant change from current 
PCAOB enforcement policy,'' \79\ but in fact it is no change at all; 
under the current version of Rule 3502, the Board can bring charges for 
conduct that is not itself a primary violation. The amendment merely 
changes the standard for when an individual's contributory conduct 
becomes actionable; it does not alter whether the

[[Page 54903]]

contributory conduct must be an independent violation apart from the 
firm's underlying primary violation.
---------------------------------------------------------------------------

    \79\ Comment Letter from U.S. Chamber of Commerce at 2.
---------------------------------------------------------------------------

    Several commenters expressed concern regarding a negligence 
standard in Rule 3502 in light of the current regulatory environment--
specifically amidst the Board's other standard-setting projects, 
including the then-proposed (now-adopted) quality control standard, QC 
1000. These commenters opined that new requirements in proposed and 
adopted other standards may put auditors at greater risk of violating 
Rule 3502, including based on the introduction or modification of key 
concepts and their interrelation to negligence.
    The Board appreciates that audits, especially of large enterprises, 
have the potential to be quite complex and can require input from 
various individuals, including individuals not on the engagement team. 
QC systems likewise can be quite complex and require input from 
numerous people. And as in 2005, ``[t]he Board also recognizes that 
persons subject to its jurisdiction must comply with complex 
professional and regulatory requirements in performing their jobs.'' 
\80\ But complexity is not a reason to allow negligent auditors--
individuals who by definition have acted unreasonably--to contribute 
directly and substantially to firms' violations without consequence. 
Indeed, as one commenter noted, the complexity of audits and the 
current environment in which companies operate--which is rapidly 
changing and subject to emerging risks--supports amending Rule 3502 
because audited financial statements are becoming increasingly 
important.
---------------------------------------------------------------------------

    \80\ 2005 Adopting Release at 14.
---------------------------------------------------------------------------

    The Board also recognizes that it recently has adopted amendments 
to several standards \81\ and has proposed amendments to other 
standards \82\ and to certain PCAOB rules.\83\ This is consistent with 
the Board's Strategic Plan, which states: ``We expect to propose and 
adopt numerous amendments and new standards over the coming years, in 
accordance with our standard-setting and research agendas. We also plan 
to evaluate certain existing standards to determine whether they are 
outmoded.'' \84\ Many of the newly adopted standards, moreover, have 
staggered effective dates, and thus auditors will not be required to 
come into compliance with each of them at the same time.\85\ And in all 
events, as firms make efforts to comply with new standards, it 
necessarily follows that individuals who could be subject to Rule 3502 
also would be making such efforts because firms can act only through 
their natural persons.
---------------------------------------------------------------------------

    \81\ See generally Amendments Related to Aspects of Designing 
and Performing Audit Procedures that Involve Technology-Assisted 
Analysis of Information in Electronic Form, PCAOB Release No. 2024-
007 (June 12, 2024) (subject to Commission approval); QC 1000 
Release; AS 1000 Release; The Auditor's Use of Confirmation, and 
Other Amendments to PCAOB Standards, PCAOB Release No. 2023-008 
(Sept. 28, 2023); Planning and Supervision of Audits Involving Other 
Auditors and Dividing Responsibility for the Audit with Another 
Accounting Firm, PCAOB Release No. 2022-002 (June 21, 2022).
    \82\ See, e.g., Proposed Auditing Standard--Designing and 
Performing Substantive Analytical Procedures and Amendments to Other 
PCAOB Standards, PCAOB Release No. 2024-006 (June 12, 2024); 
Proposing Release: Amendments to PCAOB Auditing Standards related to 
a Company's Noncompliance with Laws and Regulations And Other 
Related Amendments, PCAOB Release No. 2023-003 (June 6, 2023).
    \83\ See, e.g., Proposing Release: Firm Reporting, PCAOB Release 
No. 2024-003 (Apr. 9, 2024); Firm and Engagement Metrics, PCAOB 
Release No. 2024-002 (Apr. 9, 2024); Proposals Regarding False or 
Misleading Statements Concerning PCAOB Registration and Oversight 
and Constructive Requests to Withdraw from Registration, PCAOB 
Release No. 2024-001 (Feb. 27, 2024).
    \84\ PCAOB, Strategic Plan 2022-2026, at 10.
    \85\ See PCAOB Release No. 2022-002, at 58 (effective for audits 
of financial statements for fiscal years ending on or after December 
15, 2024); PCAOB Release No. 2023-008, at 96 (effective for audits 
of financial statements for fiscal years ending on or after June 15, 
2025); AS 1000 Release at 96 (with limited exception, effective for 
audits of financial statements for fiscal years beginning on or 
after December 15, 2024); QC 1000 Release at 378 (effective December 
15, 2025); PCAOB Release No. 2024-007, at 61 (effective for audits 
of financial statements for fiscal years beginning on or after 
December 15, 2025).
---------------------------------------------------------------------------

    The Board does not intend for any of its new or revised standards, 
either alone or in conjunction with the amendment the Board has 
adopted, to ``create[ ] a trap for the unwary,'' as one commenter 
opined.\86\ Far from it, the Board's standard-setting agenda seeks to 
modernize standards in a way that promotes high-quality audits through 
compliance in the first instance. Enforcement proceedings promote this 
same ex ante focus on compliance insofar as they serve as a deterrent 
to other auditors from engaging in the same or similar misconduct.
---------------------------------------------------------------------------

    \86\ Comment Letter from U.S. Chamber of Commerce at 10.
---------------------------------------------------------------------------

    Finally, some commenters expressed concern about whether an 
associated person could be liable for negligence under Rule 3502 in 
situations where a primary violation by a firm requires a standard 
higher than negligence. One commenter remarked that holding an 
associated person liable in such circumstances would be ``unprecedented 
(and unlawful)'' and stated that the Board should consider specifically 
exempting violation-causing conduct when a primary violation involves 
intentional conduct.\87\ Another commenter sought clarity from the 
Board on the issue and asked whether the Board believes that individual 
liability in such a scenario would be appropriate. Although the Board 
will continue to evaluate whether to bring Rule 3502 charges on a case-
by-case basis, when the firm's primary violation requires more than 
negligence, the Board does not anticipate charging individuals for 
negligently contributing to such violations.\88\
---------------------------------------------------------------------------

    \87\ Comment Letter from RSM US LLP at 3.
    \88\ See Howard v. SEC, 376 F.3d 1136, 1141 (D.C. Cir. 2004) 
(``Although we held in KPMG, LLP v. SEC, that the `knew or should 
have known' language in Sec.  21C embodied a negligence standard for 
purposes of that case, it does not necessarily follow that 
negligence is the standard'' where ``scienter [is] an element of the 
primary violations.''); KPMG Peat Marwick, SEC Release No. 34-43862 
(``We hold today that negligence is sufficient to establish 
`causing' liability under Exchange Act Section 21C(a), at least in 
cases in which a person is alleged to `cause' a primary violation 
that does not require scienter.'').
---------------------------------------------------------------------------

B. Retention of ``Directly and Substantially''

    As proposed, the Board has decided to retain the ``directly and 
substantially'' modifier to describe the connection between a 
contributory actor's conduct and a registered firm's primary 
violation.\89\ Thus, for conduct to ``directly'' contribute to a 
primary violation, it must ``either essentially constitute[ ] the 
violation''--in which case the conduct necessarily is a direct cause of 
it \90\--or be ``a reasonably proximate facilitating event of, or a 
reasonably proximate stimulus for, the violation''; but it need not 
``be the final step in a chain of actions leading to the violation.'' 
\91\ Moreover, ``directly'' does not excuse an associated person who 
negligently ``engages in conduct that substantially contributes to a 
violation, just because others also contributed to the violation, or 
because others could have stopped the violation and did

[[Page 54904]]

not.'' \92\ Nor would it necessarily excuse an associated person's 
conduct when another actor engages in intentional misconduct that might 
otherwise break the chain of causation--in particular where the 
associated person's conduct is at least negligent and created the 
situation for the other actor to engage in intentional misconduct, and 
where the associated person realized or should have realized the 
potential for, and likelihood of, such third-party intentional 
misconduct.\93\
---------------------------------------------------------------------------

    \89\ See 2005 Adopting Release at 13. As discussed above, the 
``directly and substantially'' modifier was added in response to 
commenters' concerns that a negligence standard might sweep too 
broadly. See also 2005 Adopting Release at 13. Because the Board is 
retaining ``directly and substantially,'' as explained herein, the 
guardrails that the Board put in place in 2005 in response to such 
concerns remain in Rule 3502.
    \90\ Cf. Paul F. Newton & Co. v. Tex. Commerce Bank, 630 F.2d 
1111, 1118 (5th Cir. 1980) (``[C]ommon law agency principles, 
including the doctrine of respondeat superior, remain viable in 
actions brought under the Securities Exchange Act and provide a 
means of imposing secondary liability for violations of the Act 
independent of Sec.  20(a). The federal securities statutes are 
remedial legislation and must be construed broadly, not technically 
and restrictively.'').
    \91\ See 2005 Adopting Release at 13.
    \92\ Id.
    \93\ See Restatement (Second) of Torts Sec.  448 (``The act of a 
third person in committing an intentional [violation] is a 
superseding cause of harm to another resulting therefrom, although 
the actor's negligent conduct created a situation which afforded an 
opportunity to the third person to commit such a [violation], unless 
the actor at the time of his negligent conduct realized or should 
have realized the likelihood that such a situation might be created, 
and that a third person might avail himself of the opportunity to 
commit such a [violation].'').
---------------------------------------------------------------------------

    For its part, ``substantially'' continues to require that the 
associated person's conduct ``contribute[ ] to the violation in a 
material or significant way,'' though it ``does not need to have been 
the sole cause of the violation.'' \94\ The Board stresses that Rule 
3502 is not intended to ``reach an associated person's conduct that, 
while contributing to the violation in some way, is remote from, or 
tangential to, the firm's violation.'' \95\
---------------------------------------------------------------------------

    \94\ 2005 Adopting Release at 13.
    \95\ Id.; see also id. at 14 (the Board does not ``seek to reach 
those whose conduct, unbeknownst to them, remotely contributes to a 
firm's violation''). One commenter opined that the distinction 
between obligations placed on individuals and firms, respectively, 
should not be disturbed insofar as there may be instances where it 
is appropriate for a firm to be sanctioned for a violation but where 
no particular individual played a sufficient role in that violation. 
This commenter urged the Board to not use Rule 3502 to ``collapse 
this distinction.'' Comment Letter from Center for Audit Quality at 
9. The Board agrees--there are indeed instances where it is 
appropriate to sanction a firm but not any individual(s) (under Rule 
3502 or otherwise). The amendment the Board has adopted does nothing 
to collapse that distinction: It changes only the actionable 
standard of conduct, but does nothing to alter the nexus and 
magnitude requirements of ``directly and substantially,'' i.e., it 
does not alter the requisite sufficiency of an individual's role 
relative to a firm's violation.
---------------------------------------------------------------------------

    Commenters generally encouraged the Board to retain the ``directly 
and substantially'' modifier, including one commenter remarking that 
the Board's reasons for retaining it ``remain valid.'' \96\ Multiple 
commenters, moreover, stated that these terms are clear and 
understandable. One commenter posited that the Board should not retain 
``directly and substantially'' as part of Rule 3502.
---------------------------------------------------------------------------

    \96\ Comment Letter from Ernst & Young LLP at 4 (Nov. 3, 2023).
---------------------------------------------------------------------------

    Several commenters sought additional clarity around the terms 
``directly and substantially.'' For instance, one commenter noted that 
the terms are not defined in Rule 3502 and claimed that the purported 
lack of clarity will make the rule inoperable. This commenter suggested 
that the Board instead import a more established legal doctrine of 
causation. Another commenter called the terms ``subjective'' and asked 
for a clearer articulation of them,\97\ and another asked whether the 
terms ``will be applied differently moving forward.'' \98\
---------------------------------------------------------------------------

    \97\ Comment Letter from Accounting & Auditing Steering 
Committee of the Pennsylvania Institute of Certified Public 
Accountants at 5 (Nov. 2, 2023).
    \98\ Comment Letter from Audit and Assurance Services Committee 
of the Illinois CPA Society at 3 (Nov. 2, 2023).
---------------------------------------------------------------------------

    Having considered all commenters' views, the Board is satisfied 
that the modifier ``directly and substantially'' is sufficiently clear 
and operable and believes that no further delineation of the terms is 
needed at this time. The Board notes that, going back to the 2005 
Adopting Release, the explanation of ``directly and substantially'' 
includes concepts from established legal principles (e.g., ``directly'' 
includes circumstances where an individual's conduct is a ``reasonably 
proximate facilitating event of, or a reasonably proximate stimulus 
for, the [firm's] violation'').
    The Board further notes that, based on the amended rule text, 
``directly and substantially'' would apply only to the sufficiency of 
the connection between an associated person's conduct and a firm's 
violation. Thus, to be liable under Rule 3502, a person must have 
known, or should have known, that an act or omission by them would 
contribute--but not that it would directly and substantially 
contribute--to a firm's violation.
    One commenter remarked that the Board failed to explain its 
intention behind this aspect of the amendment and that the wording 
creates potential ambiguities and unfairness. The Board, however, sees 
it differently--by eliminating the need for any inquiry into 
individuals' mental states regarding the manner in which their conduct 
contributes to the firm's violation, the Board believes that the rule 
has the potential to be applied more uniformly (and thus more fairly). 
Moreover, if an associated person knew or should have known that his or 
her conduct would contribute to a violation in any way, then that 
individual should not be able to evade liability simply because the 
individual did not know the extent of the nexus and magnitude of such 
contribution. But in all events, the Board iterates that, absent 
conduct ``directly and substantially'' contributing to a firm's 
violation, an individual's actions or omissions are not subject to 
discipline under Rule 3502.
    Two commenters opined that the Proposal suggested that the Board 
was open to a tertiary liability theory, in which a first associated 
person's conduct contributes to the conduct of a second associated 
person, which in turn contributes to a registered firm's violation. But 
as those commenters also recognized, the rule still would require the 
first person's conduct to directly and substantially contribute to the 
firm's violation.\99\ Thus, contrary to those commenters' concerns, the 
definition of ``directly'' is not stretched beyond what it would be if 
there were no second person involved, let alone beyond common usage of 
the word.
---------------------------------------------------------------------------

    \99\ See 2023 Proposing Release at 17 n.65; e.g., In re Shandong 
Haoxin Certified Public Accountants Co., Ltd., PCAOB Release No. 
105-2023-045, at ] 65 (Nov. 30, 2023) (multiple individuals violated 
Rule 3502 in connection with the same primary violation by the firm 
through different (though related) contributory conduct).
---------------------------------------------------------------------------

    Finally, some commenters suggested other phrases or concepts to 
incorporate into the rule to modify ``contribute.'' One commenter 
called for limiting liability to ``egregious actions.'' \100\ Such a 
standard, however, more aptly describes conduct that is reckless (as 
opposed to negligent),\101\ which would be contrary to what the Board 
intends for the amendment to accomplish.
---------------------------------------------------------------------------

    \100\ Comment Letter from Accounting & Auditing Steering 
Committee of the Pennsylvania Institute of Certified Public 
Accountants at 5.
    \101\ See, e.g., In re Gately & Assocs., LLC, SEC Release No. 
34-62656, at 18 (Aug. 5, 2010) (``Recklessness can be established by 
an `egregious refusal to investigate the doubtful and to see the 
obvious.' '' (citation omitted)).
---------------------------------------------------------------------------

    That same commenter expressed the view that the negligence standard 
should not apply to a professional who spends only a de minimis amount 
of time on an engagement, and further suggested that the Board add 
language to clarify that liability would only extend to a professional 
having a substantive level of participation on the engagement. Another 
commenter similarly suggested that the Board require that an associated 
person's conduct be a ``substantial factor'' in bringing about the 
firm's violation.\102\ The Board, however, believes that the contours 
of ``substantially'' (in ``directly and substantially'') suffice to 
help ensure that Rule 3502 is applied only to those individuals with a 
substantive level of participation or responsibility on an engagement 
with respect to a firm's violation in connection with an audit. And as 
the Board previously has

[[Page 54905]]

expressed--in the 2005 Adopting Release, in the Proposal, and above--
Rule 3502 is not intended to reach an associated person's conduct that, 
while contributing to the violation in some way, is remote from, or 
tangential to, the firm's violation.
---------------------------------------------------------------------------

    \102\ Comment Letter from RSM US LLP at 7.
---------------------------------------------------------------------------

C. No New Liability Standard in Light of the Commission's Authority

    As explained in the Proposal, associated persons already are 
subject to potential liability--including money penalties--for 
negligently contributing to registered firms' violations of numerous 
laws and rules governing the preparation and issuance of audit reports 
via the Securities Exchange Act of 1934 (``Exchange Act''). 
Specifically, Section 21C of the Exchange Act authorizes the Commission 
to institute cease-and-desist proceedings against any ``person that is, 
was, or would be a cause of [a] violation [of the Exchange Act or any 
rule or regulation thereunder], due to an act or omission the person 
knew or should have known would contribute to such violation,'' \103\ 
and Section 21B further authorizes the Commission to ``impose a civil 
penalty'' upon finding that such person ``is or was a cause of [such] 
violation.'' \104\ Section 3(b)(1) of Sarbanes-Oxley, in turn, provides 
that ``[a] violation by any person of . . . any rule of the Board shall 
be treated for all purposes in the same manner as a violation of the 
[Exchange Act] or the rules and regulations issued thereunder.'' Thus, 
the amendment to Rule 3502's liability threshold does not subject 
auditors to any new or different standard to govern their conduct in 
light of the Commission's authority.\105\
---------------------------------------------------------------------------

    \103\ 15 U.S.C. 78u-3(a); see also 15 U.S.C. 77h-1(a), 80a-
9(f)(1), 80b-3(k)(1).
    \104\ 15 U.S.C. 78u-2(a)(2). The Commission's Section 21B 
authority to impose civil penalties for violations in Section 21C 
cease-and-desist proceedings was added in 2010 as part of the Dodd-
Frank Wall Street Reform and Consumer Protection Act. See Public Law 
111-203.
    \105\ Nor does the Commission's authority to sanction associated 
persons' negligent contributory conduct detract from the proposed 
amendment's deterrent effect. As previously noted, as an increase in 
the number of regulators on the lookout for the same or similar 
violative conduct increases the likelihood of that conduct being 
detected and, consequently, the likelihood that the conduct would be 
sanctioned. See Anton R. Valukas, White-Collar Crime and Economic 
Recession, 2010 U. Chi. Legal F. 1, 12 (2010) (``One of the most 
powerful deterrents to misconduct is an increased threat of 
prosecution. . . . A `can do' accountant is less likely to provide 
questionable opinions if there is a substantial certainty that he 
will be caught and punished.''); see also Fletcher, supra, at 268 
(``Certainty of punishment''--including ``the possibility of 
detection, apprehension, conviction, and sanctions''--is one of two 
``primary factors'' that drive deterrence.).
---------------------------------------------------------------------------

    Numerous commenters seemed to disagree with that proposition for 
several reasons. Some commenters pointed out that the Commission cases 
cited in footnote 52 of the Proposal, while each a proceeding under 
Section 21C of the Exchange Act, were also proceedings under Commission 
Rule of Practice 102(e), which requires either ``[a] single instance of 
highly unreasonable conduct that results in a violation'' or ``repeated 
instances of unreasonable conduct, each resulting in a violation of 
applicable professional standards.'' \106\ Sanctions are not available 
under Rule 102(e) when an auditor engages in a single instance of 
unreasonable (but not highly unreasonable) conduct.\107\ Thus, certain 
commenters said that the cases were not ``on par'' with what the Board 
intends through the amendment to Rule 3502.\108\
---------------------------------------------------------------------------

    \106\ 17 CFR 201.102(e); see In re David S. Hall, P.C., SEC 
Initial Decision Release No. 1114 (Mar. 7, 2017) (ALJ Op.), decision 
made final, SEC Release No. 34-80949 (June 15, 2017); In re Gregory 
M. Dearlove, CPA, SEC Release No. 34-57244 (Jan. 31, 2008); In re 
Philip L. Pascale, CPA, SEC Release No. 34-51393 (Mar. 18, 2005).
    \107\ See Amendment to Rule 102(e) of the Commission's Rules of 
Practice, SEC Release No. 34-40567 (Oct. 26, 1998) (``[T]he 
Commission is not adopting a standard that reaches single acts of 
simple negligence.'').
    \108\ Comment Letter from Center for Audit Quality at 7; Comment 
Letter from Moss Adams LLP at 3 (Nov. 3, 2023). One commenter 
observed that the Commission proposed but ultimately declined to 
adopt an ordinary negligence standard for contributory conduct by 
accountants under Rule 102(e). But as that commenter also 
recognized, the Commission did so while expressly acknowledging that 
an ordinary negligence standard in Rule 102(e) would have been 
duplicative of authority that it already possessed. See SEC Release 
No. 34-40567 (``Moreover, the Commission possesses authority, wholly 
independent of Rule 102(e), to address and deter such errors through 
its enforcement of provisions of the federal securities laws that 
impose liability on persons, including accountants, for negligent 
conduct.''). The Board, by contrast, lacks ability to pursue 
contributory negligent conduct based on the current formulation of 
Rule 3502.
---------------------------------------------------------------------------

    To be sure, those commenters are correct that the cases cited in 
footnote 52 of the Proposal involve proceedings under Commission Rule 
102(e), as well as under Section 21C. Commenters, however, did not 
appear to contest that the Commission has the authority to bring 
proceedings for single acts of ordinary negligence under Section 21C, 
including for civil money penalties (authorized by Section 21B), 
without also proceeding under Commission Rule 102(e).\109\ Rather, 
commenters instead suggested only that the Commission rarely exercises 
such authority in practice. While that may be the case, the Board's 
point nonetheless remains: The amendment to Rule 3502's liability 
threshold does not subject auditors to any new or different standard to 
govern their conduct.
---------------------------------------------------------------------------

    \109\ Indeed, civil money penalties are not available under 
Commission Rule 102(e)--only censure or denial (temporary or 
permanent) of the privilege of appearing or practicing before the 
Commission. 17 CFR 201.102(e). Thus, the Commission would not need 
to meet Rule 102(e)'s ``highly unreasonable conduct'' standard to 
impose a civil money penalty for a single act of negligence under 
Section 21B of the Exchange Act.
---------------------------------------------------------------------------

    The Commission release cited by certain commenters when advancing 
the contrary argument makes this point abundantly clear. In it, the 
Commission stated that a single act of negligence ``may result in a 
violation of the federal securities laws'' and that ``the person 
committing such an error, though not subject to discipline under Rule 
102(e), would be exposed to the sanctions available under [such] other 
provisions.'' \110\ The Commission noted elsewhere in its release that 
a single act of ordinary negligence ``could have legal consequences.'' 
\111\
---------------------------------------------------------------------------

    \110\ SEC Release No. 34-40567 at n.28; see also id. at n.38 
(``In other instances, the federal securities laws expressly subject 
auditors to liability without requiring intentional misconduct. . . 
. [S]ection 21C of the Exchange Act imposes liability when a person 
is a `cause' of a violation `due to an act or omission the person 
knew or should have known would contribute to such violation.' '').
    \111\ Id. at n.47.
---------------------------------------------------------------------------

    One commenter suggested that Section 21C proceedings are an inapt 
analog for charges under Rule 3502 because Section 21C was intended to 
quickly enjoin conduct that may lead to violations, but was not 
designed to be a sanctions-imposing provision. Whether that was the 
original intent of Section 21C,\112\ Section 21B now indisputably 
allows for sanctions (in the form of monetary penalties) in a 
proceeding under Section 21C when an auditor or any other person was 
negligent in causing violations by others. Indeed, much like Section 
21B's direct-violation provision, the text of the secondary-violation 
provision in Section 21B expressly contemplates the imposition of a 
penalty based on conduct that already occurred.\113\
---------------------------------------------------------------------------

    \112\ The commenter's cited authority does not appear to support 
that view. See Andrew M. Smith, SEC Cease-and-Desist Orders, 51 
Admin. L. Rev. 1197, 1226 (1999) (``The legislative history of the 
[statute that includes Section 21C] is not clear as to whether 
Congress intended to require the SEC to find a reasonable likelihood 
of future violation before imposing a cease-and-desist order, 
although a strong argument can be made that Congress did not intend 
to require the SEC to make such a finding. In addition, most, if not 
all, of the proponents and architects of cease-and-desist authority, 
and many who have commented on the [relevant statute] and its 
predecessor legislative proposals, believe that such a finding is 
not necessary.'').
    \113\ 15 U.S.C. 78u-2(a)(2)(B) (``In any proceeding instituted 
under [Section 21C] against any person, the Commission may impose a 
civil penalty, if the Commission finds, on the record after notice 
and opportunity for hearing, that such person . . . is or was a 
cause of the violation of any provision of this chapter, or any rule 
or regulation issued under this chapter.'' (emphasis added)); see 
also Smith, supra, at 1199 (``[Section 21C's] plain language--`has 
violated'--appears to authorize the SEC to base a cease-and-desist 
order upon a single past violation, without any showing that the 
violator is likely to break the law in the future.'' (emphasis 
added)).

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

[[Page 54906]]

    This commenter also posited that, in addition to a primary 
violation, Section 21C also requires a finding of harm to the public 
that was in part caused by a contributory negligent act. While that may 
be the case for issuance of a temporary order pursuant to Section 
21C(c), no such finding is required for imposition of a monetary 
penalty under Section 21B.\114\ And regardless, although harm is not an 
element of proof for a Rule 3502 violation, inherent in any proceeding 
under Rule 3502 is the foundational principle that the Board is 
bringing the proceeding and imposing sanctions ``to protect the 
interests of investors and further the public interest in the 
preparation of informative, accurate, and independent audit reports.'' 
\115\
---------------------------------------------------------------------------

    \114\ Compare 15 U.S.C. 78u-3(c)(1), with id. 78u-2(a)(2). In 
any event, it would appear that harm to the public interest is 
sufficient, but not required, for a temporary restraining order 
under Section 21C, as that provision allows the Commission to enter 
a temporary restraining order ``[w]henever the Commission determines 
that the alleged violation or threatened violation . . . is likely 
to result in significant dissipation or conversion of assets, 
significant harm to investors, or substantial harm to the public 
interest.'' Id. 78u-3(c)(1) (emphasis added).
    \115\ Section 101(a) of Sarbanes-Oxley. As the Commission has 
recognized, moreover, even ``unreasonable, or negligent, accounting 
or auditing errors . . . could undermine accurate financial 
reporting.'' SEC Release No. 34-40567.
---------------------------------------------------------------------------

    Another commenter remarked that in a Commission proceeding for 
ordinary negligence under Section 21C (and not also for highly 
unreasonable conduct under Rule 102(e)), the Exchange Act limits what 
sanctions the Commission can impose, and in the commenter's view, the 
Commission lacks the authority to impose certain sanctions that the 
Board can impose. But while the available sanctions for a single act of 
negligence might be different in a proceeding under Rule 3502 compared 
with one under Section 21C--indeed, the Commission can seek certain 
sanctions that the Board cannot \116\--Sarbanes-Oxley does place 
express limits on what sanctions the Board can impose.\117\ In the 
Board's view, that the limitations on sanctions in the Exchange Act and 
in Sarbanes-Oxley, respectively, might not be the same in all respects 
does not render the Board's enforcement authority ``unprecedented.'' 
\118\
---------------------------------------------------------------------------

    \116\ The Commission's authority is more expansive in other 
ways, as well. For example, as noted in the Proposal, the Commission 
is not limited to holding accountable auditors for contributory 
conduct with respect to primary violations committed only by 
registered firms; rather, the Commission also may hold accountable 
auditors who cause violations by any other person, including 
issuers. See 2023 Proposing Release at 9 n.33. Additionally, while 
Rule 3502 applies only to associated persons of registered firms, 
the Commission's authority under Section 21C is not so limited; it 
applies to ``any person,'' including nonaccounting professionals. 15 
U.S.C. 78u-3(a); see also id. 78c(a)(9) (defining ``person'').
    \117\ See Section 105(c)(5) of Sarbanes-Oxley. One commenter 
sought clarity with respect to footnote 48 of the Proposal, and 
specifically the circumstances under which the Board would be 
permitted to impose heightened sanctions. The Board takes this 
opportunity to clarify that, although the amendment to Rule 3502 
allows the Board to sanction single instances of negligent 
contributory conduct, the heightened sanctions referenced in Section 
105(c)(5) of Sarbanes-Oxley--specifically, those sanctions listed in 
subparagraphs (A) through (C) and (D)(ii) of Section 105(c)(4)--
would not be available for a Rule 3502 violation absent a finding 
that the individual who violated Rule 3502 acted at least recklessly 
or committed repeated acts of negligence each resulting in a 
violation of an applicable statutory, regulatory, or professional 
standard.
    \118\ Comment Letter from Center for Audit Quality at 8. This 
commenter also sought to cast as inappropriate a negligence standard 
for Rule 3502 in light of the mental state required for aiding and 
abetting liability. The Board agrees with the commenter that aiding 
and abetting generally requires knowing conduct, which is why the 
Board has not relied on that theory of liability--in 2004, in 2005, 
in the Proposal, or now--as an analog or basis for Rule 3502. See, 
e.g., 2005 Adopting Release at 11 n.20 (``Rule 3502, of course, 
differs from an aiding-and-abetting cause of action in important 
respects. Among other things, the rule does not apply whenever an 
associated person causes another to violate relevant laws, rules and 
standards. Rather, Rule 3502 applies only when an associated person 
causes a violation by the registered firm with which the person is 
associated.'').
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D. Authority for the Amendment

    Several commenters expressed doubt regarding the Board's statutory 
authority for the amendment in two respects: They questioned whether 
the Board has the authority to sanction single acts of ordinary 
negligence as a general matter (i.e., in cases of direct violations or 
otherwise), and they questioned the Board's authority to promulgate a 
contributory liability rule at the negligence standard. In general, 
these commenters asserted that the Board's authority in these respects 
is either unclear or rests on questionable interpretations of Sarbanes-
Oxley. One commenter further opined that the Proposal ignores 
congressional intent and that the Board's authority is ``not as settled 
as the Proposal assumes,'' \119\ and still another comment letter 
posited that Sarbanes-Oxley is clear that in the absence of repeated 
negligence, sanctions should not be imposed.
---------------------------------------------------------------------------

    \119\ Comment Letter from U.S. Chamber of Commerce at 2.
---------------------------------------------------------------------------

    Although the Board believes that its authority in both respects is 
well-settled for reasons the Board has previously explained,\120\ the 
Board nonetheless addresses these commenters' views.
---------------------------------------------------------------------------

    \120\ See 2004 Proposing Release at 18; 2005 Adopting Release at 
10-12; see also 2023 Proposing Release at 12 n.43.
---------------------------------------------------------------------------

1. Authority To Sanction Single Acts of Negligence Generally
    The text of Section 105 of Sarbanes-Oxley plainly permits the Board 
to impose liability for single acts of negligence. Specifically, 
Section 105(c)(4) authorizes the Board to impose an array of 
sanctions--listed in subparagraphs (A) through (G)--upon finding that a 
registered firm or associated person engaged in violative conduct, 
without reference to the level of culpability required but ``subject to 
applicable limitations'' in Section 105(c)(5). Section 105(c)(5), in 
turn, provides that ``[t]he sanctions and penalties described in 
subparagraphs (A) through (C) and (D)(ii) of [Section 105(c)(4)] shall 
only apply to [ ] intentional or knowing conduct, including reckless 
conduct,'' or ``repeated instances of negligent conduct each resulting 
in a violation of the applicable statutory, regulatory, or professional 
standard.'' Section 105(c)(5) thus does not restrict the Board's 
authority to impose for single acts of negligence certain sanctions--
those in subparagraphs (D)(i) and (E) through (G) of Section 105(c)(4).
    The Board has long recognized this grant of authority,\121\ as did 
multiple commenters. One commenter agreed that the Board has had 
authority to bring enforcement proceedings for negligence ``[s]ince the 
PCAOB's creation,'' \122\ and another posited that Congress ``clearly'' 
intended for the Board to sanction associated persons for negligent 
conduct.\123\ Still another asserted that Sarbanes-Oxley ``empowers'' 
the Board

[[Page 54907]]

to sanction associated persons in instances ``when their conduct was 
not intentional or reckless.'' \124\ Indeed, this latter commenter 
opined that the Proposal created a ``misimpression'' that associated 
persons currently can only be sanctioned for intentional or reckless 
misconduct.\125\ This of course was not the Board's intent.
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    \121\ Two decades ago, the Board stated:
    The Act plainly contemplates that disciplinary proceedings can 
be instituted for a violation based on a single negligent act. 
Section 105(c)(5) of the Act provides that the Board may impose the 
more severe sanctions authorized by section 105(c)(4) only in cases 
that involve intentional or knowing conduct (including reckless 
conduct) or repeated instances of negligent conduct. Implicit in 
that provision is that a violation based on a single instance of 
negligent conduct is sufficient to warrant a disciplinary proceeding 
to impose lesser sanctions.
    PCAOB Release No. 2003-015, at A2-58-59 (emphases added); see 
also id. at A2-76 (``[S]ection 105(c)(5) of the Act requires 
scienter or repeated negligence for imposition of the most severe 
sanctions. The Act does not limit the standard that must be met for 
imposition of other sanctions.''); 2005 Adopting Release at 12 n.23.
    \122\ Comment Letter from North American Securities 
Administrators Association, Inc. at 1 (Nov. 13, 2023).
    \123\ Comment Letter from Center for American Progress at 3.
    \124\ Comment Letter from Ernst & Young LLP at 2.
    \125\ Id.
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    Other commenters, however, took the opposite view. One comment 
letter opined that, when read together, the provisions of Sections 
105(c)(4) and (c)(5) discussed above make clear that unless negligent 
conduct is repeated, sanctions and penalties ``should not be applied.'' 
\126\ If Congress had intended for all sanctions listed in Section 
105(c)(4) to be unavailable absent reckless conduct or repeated acts of 
negligence, however, then it would have had no reason to make the 
specific carve-outs that it did in Section 105(c)(5); there would be no 
point to them. Such an interpretation thus runs contrary to both 
Section 105(c)(5)'s text and the bedrock principle of statutory 
construction to not read a statute in a way that renders language 
superfluous.\127\
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    \126\ Comment Letter from Eight Accounting Professors (Cannon, 
et al.) at 4 (Nov. 2, 2023).
    \127\ See, e.g., FCC v. NextWave Personal Cmmc'ns Inc., 537 U.S. 
293, 302 (2003) (``[E]ven Sec.  525(a) itself contains explicit 
exemptions for certain Agriculture Department programs. These latter 
exceptions would be entirely superfluous if we were to read Sec.  
525 as the Commission proposes--which means, of course, that such a 
reading must be rejected.''); see also TRW Inc. v. Andrews, 534 U.S. 
19, 31 (2001) (``[W]ere we to adopt [respondent's] construction of 
the statute, the express exception would be rendered insignificant, 
if not wholly superfluous.'' (citation and quotation marks 
omitted)).
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2. Authority for a Negligence-Based Contributory-Liability Rule
    Congress intended to grant to the Board ``plenary authority'' to 
establish or adopt ethics standards.\128\ To that end, Section 
103(a)(1) of Sarbanes-Oxley mandates that the Board
---------------------------------------------------------------------------

    \128\ S. Rep. 107-205, at 8.

shall, by rule, establish . . . and amend or otherwise modify or 
alter, such auditing and related attestation standards, such quality 
control standards, such ethics standards, and such independence 
standards to be used by registered public accounting firms in the 
preparation and issuance of audit reports . . . as may be necessary 
or appropriate in the public interest or for the protection of 
investors.\129\
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    \129\ See also Section 101(c)(2) of Sarbanes-Oxley.

    As the Board twice recognized nearly two decades ago--once when it 
proposed Rule 3502 and again when the Board adopted it--a contributory 
liability rule merely codifies auditors' longstanding ethics 
obligations.\130\
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    \130\ 2004 Proposing Release at 18; see 2005 Adopting Release at 
9. Beyond codifying auditors' ethics obligations, Rule 3502 is also 
``essential to the proper functioning of the Board's independence 
rules.'' 2004 Proposing Release at 19; see also 2005 Adopting 
Release at 14. As the Board previously explained:
    For example, Rule 3521 provides, in part, that a registered firm 
is not independent of its audit client if the firm provides that 
audit client with a service for a contingent fee. When an associated 
person causes . . . the registered firm to provide that service for 
a contingent fee, Rule 3502 would allow the Board to discipline the 
associated person for that conduct.
    2005 Adopting Release at 14.
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    Some commenters nonetheless expressed doubt about whether the 
statutory authority to regulate ethical conduct equates to a statutory 
authority to sanction negligent conduct. In doing so, one such 
commenter appeared to interpret the Proposal's discussion of the 
Commission's authority under Section 21C of the Exchange Act to mean 
that the Board was relying on that provision as authority for the 
amendment. The Board, however, did not rely (and is not relying) on 
Section 21C of the Exchange Act as a source of authority for its 
negligent contributory-liability standard; rather, the Board agrees 
with the commenter that such provision applies only to the Commission. 
The Proposal's discussion of Section 21C instead was meant to show 
that, by adopting a negligence threshold in Rule 3502, the Board would 
not be subjecting auditors to any new standard to govern their 
contributory conduct.\131\
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    \131\ 2023 Proposing Release at 14 (discussing Section 21C and 
concluding: ``Thus, the proposed amendment to Rule 3502's liability 
threshold would not subject auditors to any new or different 
standard to govern their conduct.'').
---------------------------------------------------------------------------

    As the Board previously explained, ``an associated person's ethical 
obligation is not merely to refrain from knowingly causing a violation 
but also to act with sufficient care to avoid negligently causing a 
violation.'' \132\ Such obligation has deep historical roots. For 
instance, the AICPA's Code of Professional Conduct at the time that 
Sarbanes-Oxley was enacted (and still today) made it an ``act 
discreditable to the profession''--and therefore a violation of its 
ethics rules \133\--for a member accountant to ``permit[ ] or direct[ ] 
another to make[ ] materially false and misleading entries in the 
financial statements or records of an entity'' ``by virtue of his or 
her negligence.'' \134\ Just the same if a member were to ``permit[ ] 
or direct[ ] another to sign[ ] a document containing materially false 
and misleading information'' ``by virtue of his or her negligence.'' 
\135\
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    \132\ 2005 Adopting Release at 9.
    \133\ The AICPA's Ethics Rulings are a body of decisions made by 
the AICPA's professional ethics division's executive committee that 
``summarize the application of Rules of Conduct and Interpretations 
to a particular set of factual circumstances.'' Introduction, Code 
of Professional Conduct (as Adopted January 12, 1988), available at 
https://us.aicpa.org/content/dam/aicpa/research/standards/codeofconduct/downloadabledocuments/2014december14codeofprofessionalconduct.pdf; see also AICPA Code of 
Professional Conduct Sec.  0.500.01 (updated June 2020) (``The code 
is the only authoritative source of AICPA ethics rules and 
interpretations.'' (italics omitted)).
    \134\ AICPA Code of Professional Conduct, ET Sec.  501.05(a), 
Negligence in the Preparation of Financial Statements or Records 
(emphases added), recodified at Section 1.400.040.01.
    \135\ Id. Sec.  501.05(c) (emphases added).
---------------------------------------------------------------------------

    Congress clearly had in mind the AICPA Code of Professional Conduct 
when it authorized the Board to promulgate ethics standards. The AICPA 
had a prominent presence during the drafting of Sarbanes-Oxley and in 
the run up to its passage,\136\ and beyond Congress empowering the 
Board to write its own ethics standards, it also empowered the Board to 
``adopt as its rules[ ] . . . any portion of any statement of auditing 
standards or other professional standards'' and to ``modify, 
supplement, revise, or subsequently amend, modify, or repeal, in whole 
or in part, any portion of any [such] statement.'' \137\ In other 
words, Congress authorized the Board to adopt (and later amend or 
modify) parts of the AICPA's Code of Professional Conduct as the 
Board's ethics standards, and at the time of Sarbanes-Oxley's 
enactment, that Code included prohibitions on negligent contributory 
conduct.
---------------------------------------------------------------------------

    \136\ During committee hearings for Sarbanes-Oxley, the Senate 
heard testimony from five individuals who were serving, or 
previously had served, in leadership roles within the AICPA 
(including the AICPA's then-current Chair and its former Chair), and 
also relied on data provided by the AICPA. See S. Rep. 107-205, at 
3-4, 61, 63; see also H.R. Rep. No. 107-414, at 19 (2002) (noting 
that the AICPA's then-President and CEO provided testimony to a 
House of Representatives committee on a related bill).
    \137\ Section 103(a)(3) of Sarbanes-Oxley (emphasis added). In 
2003, the Board adopted parts of the AICPA Code of Professional 
Conduct as its interim ethics standards, Establishment of Interim 
Professional Auditing Standards, PCAOB Release No. 2003-006, at 10 
(Apr. 18, 2003), and the Commission approved such adoption ``as 
consistent with the requirements of [Sarbanes-Oxley],'' Order 
Regarding Section 103(a)(3)(B) of the Sarbanes-Oxley Act of 2002, 
SEC Release No. 34-47745 (Apr. 25, 2003).
---------------------------------------------------------------------------

    One commenter cited a provision of the AICPA Code of Professional 
Conduct that has a ``knowingly'' standard for contributory conduct 
(Section 0.200.020.04). This commenter also cited the Board's then-
proposed (now-adopted) EI 1000, Integrity and Objectivity, to note that 
the definition of ``integrity'' in that standard includes

[[Page 54908]]

``[n]ot knowingly or recklessly misrepresenting facts,'' without 
reference to negligence.\138\ However, this commenter did not 
acknowledge that the AICPA Code also has contributory-conduct 
provisions at the negligence standard, as discussed above.
---------------------------------------------------------------------------

    \138\ QC 1000 Release at A4-1.
---------------------------------------------------------------------------

    Certain commenters compared the Board's authority for a 
contributory negligence standard in Rule 3502 to private plaintiffs' 
inability to bring suit under Section 10(b) of the Exchange Act \139\ 
for aiding and abetting securities fraud. To be sure, in Central Bank 
of Denver, the U.S. Supreme Court held that ``there is no private 
aiding and abetting liability under Sec.  10(b)'' ``[b]ecause the text 
of Sec.  10(b) does not prohibit aiding and abetting.'' \140\ But that 
holding regarding an implied private right of action has little bearing 
on the Board's authority for the amendment.
---------------------------------------------------------------------------

    \139\ 15 U.S.C. 78j.
    \140\ Cent. Bank of Denver, N.A. v. First Interstate Bank of 
Denver, N.A., 511 U.S. 164, 191 (1994).
---------------------------------------------------------------------------

    The Board draws its authority for the amendment from different text 
in a different statute. As explained above, Congress empowered the 
Board to promulgate ethics standards pursuant to Section 103(a) of 
Sarbanes-Oxley, which is distinct from any congressional grant of 
authority to the Commission, including those in Sections 10(b) or 21C 
of the Exchange Act.\141\ There is no analogous statutory mandate for 
the Commission to ``establish . . . ethics standards'' in the area of 
auditors' professional responsibility.
---------------------------------------------------------------------------

    \141\ Section 105 of Sarbanes-Oxley also supplies authority to 
adopt the proposed amendment. See 2005 Adopting Release at 12; 2023 
Proposing Release at 12 n.43. As the Board previously explained, 
``Section 105 authorizes the Board to investigate and, when 
appropriate, discipline registered firms and their associated 
persons,'' and because (1) ``[c]ertain types of violations, by their 
nature, may give rise to direct liability only for a registered 
public accounting firm,'' and (2) ``[s]uch firms . . . can only act 
through the natural persons that comprise them,'' it follows that 
(3) ``[w]hen one or more of those associated persons has caused that 
firm to'' commit a violation, ``it is appropriate, and consistent 
with the Board's duty to discipline registered firms and their 
associated persons under Section 101(c)(4) of the Act, that the 
Board be able to discipline the associated person for that 
misconduct.'' 2005 Adopting Release at 12.
---------------------------------------------------------------------------

    The Board, however, indisputably does have such a mandate in 
Section 103(a)(1) of Sarbanes-Oxley,\142\ and with that distinct 
mandate comes distinct authority.\143\ Indeed, as the Commission 
recognized when approving the Board's adoption of Rule 3502 in 2006, 
``the rule is within the scope of the PCAOB's authority, particularly 
its authority to establish ethical standards.'' \144\ Section 
103(a)(1), moreover, is an enabling (or authorizing) statute that 
permits the Board to establish standards to govern the preparation and 
issuance of audit reports ``as may be necessary or appropriate in the 
public interest,'' which text provides broad rulemaking authority.\145\
---------------------------------------------------------------------------

    \142\ One commenter remarked that Section 103 ``is not 
untethered'' from the rest of Sarbanes-Oxley. Comment Letter from 
U.S. Chamber of Commerce at 4. The Board agrees: Section 103 tethers 
directly to Section 101(c)(2), which mandates that the Board 
``establish or adopt, or both, by rule, auditing, quality control, 
ethics, independence, and other standards . . . in accordance with 
section 7213 [103] of this title.'' Indeed, doing so is an express 
``Dut[y] of the Board'' under Section 101(c). Section 101(c)(2) is 
thus another source of authority for the Board's amendment.
    \143\ Nor does Section 103(a) of Sarbanes-Oxley include the 
telltale terms of a statute that requires a mental state higher than 
negligence, as does Section 10(b) of the Exchange Act. See Ernst & 
Ernst v. Hochfelder, 425 U.S. 185, 197 (1976) (``Section 10(b) makes 
unlawful the use or employment of `any manipulative or deceptive 
device or contrivance' in contravention of Commission rules. The 
words `manipulative or deceptive' used in conjunction with `device 
or contrivance' strongly suggest that Sec.  10(b) was intended to 
proscribe knowing or intentional misconduct.''); id. at 199 (``The 
argument simply ignores the use of the words `manipulative,' 
`device,' and `contrivance' [are] terms that make unmistakable a 
congressional intent to proscribe a type of conduct quite different 
from negligence.'').
    \144\ Order Approving Proposed Ethics and Independence Rules 
Concerning Independence, Tax Services, and Contingent Fees and 
Notice of Filing and Order Granting Accelerated Approval of the 
Amendment Delaying Implementation of Certain of these Rules, SEC 
Release No. 34-53677, at 9 (Apr. 19, 2006).
    \145\ See, e.g., AT&T Corp. v. Iowa Utils. Bd., 525 U.S. 366, 
377-78 & n.5 (1999) (construing a provision allowing the FCC to 
``prescribe such rules and regulations as may be necessary in the 
public interest to carry out'' the relevant statute as a ``general 
grant of rulemaking authority'' sufficient for the FCC to promulgate 
the regulations at issue); Metrophones Telecommc'ns, Inc. v. Global 
Crossing Telecommc'ns, Inc., 423 F.3d 1056, 1068 (9th Cir. 2005) 
(``Given the reach of the [FCC's] rulemaking authority under Sec.  
201(b)''--which granted to the FCC the ``broad power to enact such 
`rules and regulations as may be necessary in the public interest to 
carry out the provisions of this Act' ''--``it would be strange to 
hold that Congress narrowly limited the Commission's power to deem a 
practice `unjust or unreasonable.' ''); Brown v. Azar, 497 F. Supp. 
3d 1270, 1281 (N.D. Ga. 2020) (``[W]hen an agency is authorized to 
`prescribe such rules and regulations as may be necessary in the 
public interest to carry out the provisions of the Act,' Congress' 
intent to give an agency broad power is clear.''), appeal dismissed 
as moot, 20 F.4th 1385 (11th Cir. 2021) (mem.).
---------------------------------------------------------------------------

    So, too, is Section 101(g)(1) of Sarbanes-Oxley--yet another source 
of authority for the amendment. That provision authorizes the Board to 
promulgate rules to ``provide for . . . the exercise of its authority, 
and the performance of its responsibilities under this Act,'' which 
include ``enforc[ing] compliance'' with applicable laws, rules, and 
standards; ``conduct[ing] investigations and disciplinary 
proceedings''; and ``impos[ing] appropriate sanctions where 
justified.'' \146\ Section 101(g)(1) thus empowers the Board to 
implement the Board's ``ultimate purposes'' under Sarbanes-Oxley of 
``protect[ing] the interests of investors and further[ing] the public 
interest in the preparation of informative, accurate, and independent 
audit reports.'' \147\ The amendment, and Rule 3502 generally, do 
precisely that.
---------------------------------------------------------------------------

    \146\ Sections 101(c)(4) and (6) of Sarbanes-Oxley.
    \147\ Section 101(a) of Sarbanes-Oxley; In re Permian Basin Area 
Rate Cases, 390 U.S. 747, 780 (1968) (``We are, in the absence of 
compelling evidence that such was Congress' intention, unwilling to 
prohibit administrative action imperative for the achievement of an 
agency's ultimate purposes.''); see Doe v. FEC, 920 F.3d 866, 870-71 
(D.C. Cir. 2019) (``When an agency's `empowering provision' '' 
permits the agency ```to make, amend, and repeal such rules . . . as 
are necessary to carry out the provisions of' '' the statute, ``the 
courts will sustain a regulation that is `reasonably related' to the 
purposes of the legislation.'' (citations omitted)).
---------------------------------------------------------------------------

Statement Regarding the Proposed Amendment To Clarify the Relationship 
Between Contributory Actor and Primary Violator

    As noted above, in addition to proposing a change in Rule 3502's 
liability standard, the Proposal also contemplated amending Rule 3502 
to provide that an associated person contributing to a violation need 
not be an associated person of the registered firm that commits the 
primary violation (i.e., that an associated person of one registered 
firm can contribute to a primary violation of another registered 
firm).\148\ Specifically, the Board proposed changing the word ``that'' 
to ``any'' immediately before the reference to the registered public 
accounting firm that commits the primary violation. After due 
consideration, the Board has decided not to adopt any changes to Rule 
3502 to implement this aspect of the Proposal, for two primary reasons.
---------------------------------------------------------------------------

    \148\ See 2023 Proposing Release at 16-17.
---------------------------------------------------------------------------

    First, as the Proposal explained, the Board's rules already 
contemplate that associated persons can be associated with more than 
one registered firm at the same time.\149\ Specifically, PCAOB Rule 
1001(p)(i)'s definition of an ``associated person'' provides that if a 
firm reasonably believes that one of its associated persons is 
primarily associated with another registered firm, then that person is 
excluded from the definition of an ``associated person,'' but only 
``for purposes of completing a registration application on Form 1, Part 
IV of an annual report on Form 2, or Part IV of a Form 4 to succeed to 
the registration status of a predecessor.'' For all other purposes, 
that carveout does not apply, thus underscoring that, in the context of 
Rule 3502's reference to an

[[Page 54909]]

``associated person,'' a person can be associated with two or more 
registered firms at once.
---------------------------------------------------------------------------

    \149\ See id. at 10 n.36.
---------------------------------------------------------------------------

    Second, an individual who ``directly and substantially'' 
contributes to a firm's violation (consistent with the meaning of that 
phrase in Rule 3502, as described above) in all instances likely also 
will have ``participate[d] as agent or otherwise on behalf of such [ ] 
firm in any activity of that firm'' ``in connection with the 
preparation or issuance of any audit report,'' and thus be an 
``associated person'' of that firm.\150\ In the Board's view, this 
definition of ``associated person,'' in combination with the notion 
that a person can be associated with multiple firms at the same time, 
renders unnecessary the proposed change from ``that'' to ``any'' in 
Rule 3502.
---------------------------------------------------------------------------

    \150\ See Section 2(a)(9) of Sarbanes-Oxley (emphases added); 
PCAOB Rule 1001(p)(i).
---------------------------------------------------------------------------

    The Board appreciates commenters' feedback on this aspect of the 
Proposal. As one commenter surmised, this aspect of the Proposal was 
aimed at providing for equal accountability by associated persons as 
firm structures evolve. Based on the two points noted above, however, 
the Board believes that such accountability currently exists.\151\ It 
was not the Board's intent through this aspect of the Proposal to deter 
collaboration or the sharing of perspectives between firms. And, to the 
extent that commenters believe that this aspect of the Proposal would 
exacerbate their concerns with respect to a negligence standard, the 
Board's decision not to adopt any amendment in this regard should help 
to alleviate those concerns.
---------------------------------------------------------------------------

    \151\ Beyond these two points, one commenter opined that ``in 
most, if not all, cases,'' an auditor's direct and substantial 
contribution to a primary violation by a firm with which the auditor 
is not associated also would have at least negligently, directly, 
and substantially contributed to a primary violation by a firm with 
which the auditor is associated. Comment Letter from Ernst & Young 
LLP at 4. This proposition further underscores the point that no 
clarifying amendment is needed given the current regulatory 
framework.
---------------------------------------------------------------------------

Effective Date

    If the amendment to PCAOB Rule 3502 is approved by the Commission, 
then (as proposed) the Board intends that it would become effective 60 
days from the date of Commission approval.\152\ In that regard, the 
Board anticipates that conduct occurring more than 60 days after 
Commission approval would be subject to Rule 3502, as amended, but that 
conduct occurring prior to, or within 60 days after, Commission 
approval would not be subject to the amendment to Rule 3502.
---------------------------------------------------------------------------

    \152\ See 2023 Proposing Release at 31.
---------------------------------------------------------------------------

    Commenters expressed mixed views regarding the effective date. One 
commenter agreed that 60 days after Commission approval is appropriate, 
and another stated that it did not disagree with the Board's basis for 
an effective date 60 days after Commission approval. Another commenter 
stated that it could not comment on an appropriate effective date 
because the Board should redeliberate and repropose amendments to Rule 
3502. Other commenters encouraged the Board to delay the effectiveness 
until the Board more fulsomely assesses the costs of the amendment and 
considers the amendment's impact on the profession and audit quality.
    Several commenters suggested that the Board delay the effectiveness 
of any amendment to Rule 3502 to provide for time to gauge the impact 
of other then-pending proposals, including QC 1000 and AS 1000 (both of 
which have since been adopted). In general, these commenters opined 
that the impact of the amendment to Rule 3502 could depend on how the 
amendment interacts with, and the potential unintended consequences of, 
changes to other professional standards. Another commenter encouraged 
the Board to delay the effectiveness of the amendment for medium-sized 
and smaller firms, including those in non-U.S. jurisdictions, to 
appropriately understand the amendment's ramifications and to respond 
accordingly.
    The Board recognizes that it is in various stages of the process of 
modernizing several of its standards and rules to protect the interests 
of investors and further the public interest. Those updates (both 
adopted and proposed) reflect that, over the years, audits and the 
audit industry have evolved, and the Board's standards and rules should 
as well.\153\ The Board also appreciates that its revised standards and 
rules may require adjustment by individuals and firms, which is why 
each of those standards also includes (or proposes to include, in the 
case of proposals) a delay in its respective effective date following 
the date of Commission approval.\154\ The notion that multiple 
standards are being modernized in parallel, however, is not a basis for 
permitting individuals--regardless of the size of the firm(s) with 
which they are associated--to negligently, directly, and substantially 
contribute to firms' primary violations. And as noted above, as firms 
make efforts to comply with new standards, it necessarily follows that 
individuals who could be subject to Rule 3502 also would be making such 
efforts (because firms can act only through their natural persons).
---------------------------------------------------------------------------

    \153\ See PCAOB, Strategic Plan 2022-2026, at 10 (``[A]s 
important as [auditing, attestation, quality control, ethics, and 
Independence] standards are, some of them were written by the audit 
profession prior to the PCAOB's establishment and have not been 
updated since we adopted them in 2003 on what was intended to be an 
interim basis. The world has changed since 2003, and our standards 
must adapt to keep up with developments in auditing and the capital 
markets. We intend to modernize and streamline our existing 
standards and to issue new standards where necessary to meet today's 
needs.'').
    \154\ See PCAOB Release No. 2022-002, at 58 (effective for 
audits of financial statements for fiscal years ending on or after 
December 15, 2024); PCAOB Release No. 2023-008, at 96 (effective for 
audits of financial statements for fiscal years ending on or after 
June 15, 2025); AS 1000 Release at 96 (with limited exception, 
effective for audits of financial statements for fiscal years 
beginning on or after December 15, 2024); QC 1000 Release at 378 
(effective December 15, 2025); PCAOB Release No. 2024-007, at 61 
(effective for audits of financial statements for fiscal years 
beginning on or after December 15, 2025); see also PCAOB Release No. 
2024-006, at 61 (contemplating effectiveness for audits of fiscal 
years beginning on or after December 15 in the year of approval by 
the Commission); PCAOB Release No. 2024-003, at 89 (proposing 
effective dates of 90 days after Commission approval for certain 
aspects and no earlier than March 31, 2026, or one year after 
Commission approval, whichever is later, for other aspects); PCAOB 
Release No. 2024-002, at 186 (proposing phased effective dates 
beginning no earlier than October 1 in the year after Commission 
approval); PCAOB Release No. 2024-001, at 63 (proposing an effective 
date of six months after Commission approval to comply with certain 
aspects); PCAOB Release No. 2023-003, at 94 (contemplating 
effectiveness for audits of fiscal years beginning in the year after 
approval by the Commission, or if Commission approval occurs in the 
fourth quarter of a calendar year, effectiveness for audits of 
fiscal years beginning two years after the year of Commission 
approval).
---------------------------------------------------------------------------

    Accordingly, having considered the comments and for the reasons 
above, the Board continues to believe that 60 days after Commission 
approval is an appropriate effective date for the amendment to Rule 
3502. That period provides sufficient time for associated persons to 
familiarize themselves with the applicable legal standards and to 
increase their diligence as necessary and appropriate, which enhances 
audit quality and therefore serves the interests of the public and 
better protects investors.

D. Economic Considerations and Application to Audits of Emerging Growth 
Companies

    The Board is mindful of the economic impacts of its rulemaking. 
This section describes the baseline for evaluating the economic impacts 
of the amendment to Rule 3502, the need for rulemaking, its expected 
economic impacts (including benefits, costs, and potential

[[Page 54910]]

unintended consequences), and reasonable alternatives considered. Due 
to data limitations, much of the economic analysis is qualitative; 
however, it incorporates quantitative information, including PCAOB 
enforcement data and academic and industry research, where feasible.
    The Board sought information relevant to the economic analysis 
throughout this rulemaking and has carefully considered the comments 
submitted, including the data and studies suggested by the commenters.

A. Baseline

    Section C above describes the important components of the baseline 
against which the amendment's economic impacts are considered, 
including the current formulation of Rule 3502 and the Board's 
implementation experience. The Board discusses below the Board's 
enforcement activities. Table 1 presents PCAOB enforcement data on Rule 
3502 charges from 2009-2024.\155\ This table provides historical 
information on how frequently individuals have been charged under the 
current formulation of Rule 3502.
---------------------------------------------------------------------------

    \155\ Table 1 contains data through April 30, 2024. The Board 
brought the first Rule 3502 charge in 2009 for conduct committed 
after the effective date of Rule 3502 in April 2006.

                          Table 1--Number and Incidence of Rule 3502 Charges, 2009-2024
----------------------------------------------------------------------------------------------------------------
                                                Cases with Rule 3502                          Incidence of Rule
                     Year                              charges          Firms sanctioned      3502 charges (%)
                                                                 (A)                   (B)               C = A/B
----------------------------------------------------------------------------------------------------------------
2009..........................................                     2                     5                    40
2010..........................................                     0                     2                     0
2011..........................................                     2                     6                    33
2012..........................................                     3                     4                    75
2013..........................................                     5                    10                    50
2014..........................................                     2                    20                    10
2015..........................................                    17                    37                    46
2016..........................................                    14                    30                    47
2017..........................................                    15                    42                    36
2018..........................................                     8                    13                    62
2019..........................................                     8                    19                    42
2020..........................................                     2                    13                    15
2021..........................................                     3                    14                    21
2022..........................................                     6                    30                    20
2023..........................................                     5                    43                    12
2024..........................................                     4                    20                    20
                                               -----------------------------------------------------------------
    Total.....................................                    96                   308                    31
----------------------------------------------------------------------------------------------------------------
Source: Settled and Adjudicated Disciplinary Orders Reported by the Board to the Public Pursuant to Section
  105(d) of Sarbanes-Oxley, available at https://pcaobus.org/oversight/enforcement/enforcement-actions.

    Column A shows the number of cases in which associated persons were 
found to have violated Rule 3502 (includes settled and adjudicated 
cases); column B shows the number of cases in which registered firms 
were sanctioned (for any violation); and column C is the ratio of the 
two, expressed as a percentage to reflect the proportion of firm cases 
when an associated person was charged with Rule 3502 by the Board.
    From 2009 through April 30, 2024, there have been a total of 96 
cases with Rule 3502 violations. At an average of six per year, the 
number of Rule 3502 cases was highest in 2015 at 17 and lowest in 2010, 
when no Rule 3502 violations were found.\156\ The 96 cases represent 31 
percent of the total number of cases in which the Board sanctioned 
firms for violations from 2009-2024. The data presented in the table 
does not predict how many Rule 3502 violations the Board might find 
because of the amendment; it indicates that in over two-thirds of the 
cases in which a firm was sanctioned, no contributory actor was held 
accountable under Rule 3502.\157\
---------------------------------------------------------------------------

    \156\ Column Year refers to the year the firms were sanctioned. 
Column A reflects Rule 3502 cases involving sanctions of one or more 
respondents as one instance. Some firms were sanctioned in different 
years than associated persons were sanctioned for the corresponding 
Rule 3502 violations. In such cases, Rule 3502 violations by 
associated persons are counted in the same year the firms were 
sanctioned. Therefore, column A can be interpreted as a subset of 
cases in Column B.
    \157\ One commenter asserted that Table 1 in the Proposal did 
not illuminate whether the cases without Rule 3502 charges would 
have merited or supported a Rule 3502 charge for individual 
negligence had that option been available, and suggested that the 
PCAOB perform that analysis, even if for a shortened period of 5 
years. Another commenter also suggested that this analysis does not 
indicate cases where a Rule 3502 charge would have been 
inappropriate or where the absence of charges was supported by the 
Board's exercise of prosecutorial discretion. However, the Board 
notes that staff has already performed an analysis of that nature 
for the immediately preceding two years, which forms the basis of 
the estimated increase in the number of cases discussed below. See 
also 2023 Proposing Release at 24-25 (providing estimate for 2022). 
Performing an analysis for additional older years may be potentially 
less robust, given the extremely fact-based nature of the 
evaluation; staff recollections of whether all of the available 
investigatory evidence could have supported a negligence claim are 
naturally less reliable for older matters; and relevant staff may 
have since departed the PCAOB.
---------------------------------------------------------------------------

    Commenters suggested alternative means of assessing the baseline 
for this amendment. Some commenters suggested that the Board consider 
the Commission's enforcement data. However, PCAOB enforcement data is a 
more relevant comparison because this data is limited to cases brought 
by the PCAOB, offering a more precise perspective for understanding the 
baseline of the amendment. Although the Commission's enforcement data 
is valuable, it is impacted by various factors, including the 
Commission's case mix, prosecutorial discretion, resource allocation 
decisions, and enforcement priorities. While the Commission and the 
PCAOB coordinate enforcement efforts as required by Sarbanes-Oxley, 
their respective mandates are separate from each other. Given these 
separate mandates,

[[Page 54911]]

inclusion of the Commission's data herein would not contribute to a 
fuller understanding of the PCAOB's historical practices.
    Other commenters suggested that, rather than the comparison 
provided in Table 1 of individual Rule 3502 cases to firm cases, a more 
relevant comparison would be PCAOB enforcement proceedings against 
firms to PCAOB enforcement proceedings against individuals (under Rule 
3502 and otherwise). One of these commenters acknowledged, however, 
that such a comparison would not shed meaningful light on the need for 
the proposed change, and the Board agrees. Because contributory 
liability under Rule 3502 is distinct from primary liability, 
aggregating individual liability for all types of violations would not 
contribute to an understanding of the PCAOB's historical application of 
Rule 3502. Column A in Table 1 focuses on contributory liability only 
and therefore more clearly illuminates the baseline of the PCAOB's use 
of Rule 3502 as currently formulated.
    Another commenter suggested conducting a survey regarding the 
resulting internal impact of PCAOB enforcement proceedings at the firm 
level on associated individuals. While a well-designed survey may 
provide additional insights, the Board believes that staff analysis 
based on PCAOB enforcement activities provides a sufficiently reliable 
basis for assessing the need for and scope of the amendment to Rule 
3502.\158\
---------------------------------------------------------------------------

    \158\ Further, the suggested survey would have shed light on 
firms' internal disciplinary measures taken against associated 
individuals, which, as discussed below, are important but not 
equivalent in effect to public proceedings.
---------------------------------------------------------------------------

B. Need

    This section discusses the problem the amendment intends to address 
and how the amendment addresses the problem.
1. Problems To Be Addressed
    The need for the amendment arises from a current gap in the PCAOB's 
regulatory framework. Specifically, as described in detail in section C 
above, the gap in the PCAOB's regulatory framework relates to a 
misalignment between the liability standard for firms that commit 
violations resulting from an associated person's conduct and the 
liability standard for the associated person who contributes directly 
and substantially to the firm's violation. Under the current 
formulation of Rule 3502, while firms can be held accountable by the 
PCAOB for violations due to negligence, individuals can be held liable 
for their contributory conduct only if their conduct was at least 
reckless, a more stringent standard than negligence. That is, Rule 
3502's current formulation places negligent individual contributors to 
firms' violations beyond Rule 3502's reach.
    The gap discussed above creates regulatory inefficiency and 
undermines the PCAOB's regulatory objectives, including furthering the 
public interest in the preparation of informative, accurate, and 
independent audit reports. Inefficiency arises under the current 
regulatory framework because the PCAOB cannot hold individuals 
accountable for negligent contributory conduct while the Commission 
can, and therefore the PCAOB would have to refer one part of a broader 
case to the Commission to take action (as it deems appropriate) against 
the negligent individual. If the Commission decided to move forward 
with a separate case against the individual, Commission staff may need 
to familiarize themselves with the case, potentially reinterview 
witnesses, and undertake (as needed) additional investigative steps. 
This could result in delays and, given that these activities would 
relate to substantially the same set of facts that the PCAOB is seeking 
to establish with respect to the firm, would render duplicative the 
PCAOB's prior work in these areas, thereby creating inefficiencies. 
Moreover, if the Commission chooses not to pursue the case (for 
example, due to resource constraints or competing priorities), the 
individual's negligent conduct may go unsanctioned.\159\ This lack of 
individual accountability could hinder the effectiveness of the PCAOB's 
enforcement proceedings and may lead to under-deterrence among 
individuals within the industry, as they observe only the firm being 
penalized without consequences for the individuals responsible for the 
negligent conduct.
---------------------------------------------------------------------------

    \159\ See, e.g., Samuel B. Bonsall IV, Eric R. Holzman & Brian 
P. Miller, Wearing out the Watchdog: The Impact of SEC Case Backlog 
on the Formal Investigation Process, 99 Acct. Rev. 81, 81 (2024) 
(``We find that higher office case backlog decreases the likelihood 
of an investigation into a restating firm. . . . Backlog also 
impacts pursued investigations, leading to more prolonged 
investigations, a lower Accounting and Auditing Enforcement Releases 
likelihood, and smaller SEC penalties. Our evidence suggests that 
busyness undermines the SEC's investigation process.'').
---------------------------------------------------------------------------

2. How the Amendment Addresses the Need
    The amendment to Rule 3502 addresses the need by aligning the 
liability standards for firms and associated persons. It changes the 
liability standard for individual contributory conduct from 
recklessness to negligence. Doing so closes the regulatory gap 
described above and allows the Board to hold individuals accountable 
when they directly and substantially contribute to a firm's violation 
if their contributory act or failure to act was negligent but not 
reckless. By closing the gap, the amendment eliminates the obstacles in 
the public enforcement framework and helps improve regulatory 
efficiency.
    The amendment does not result in a novel expansion of liability to 
reach conduct that is currently not subject to enforcement, as the 
Commission already has authority to discipline associated persons who 
negligently cause a firm's violation. Instead, it merely provides the 
PCAOB with the ability to hold individuals accountable similar to the 
Commission.
    Some commenters agreed that the amendment would address the 
regulatory gap within the existing framework. However, other commenters 
challenged the need for the amendment. Some commenters asserted that 
the PCAOB already has tools for disciplining individuals and that the 
absence of Rule 3502 charges does not imply a lack of individual 
accountability. To be sure, the PCAOB currently has the authority to 
hold individuals accountable for violations of rules that contemplate 
individual responsibility, and the Board actively brings cases to hold 
individuals accountable for wrongdoing. But Rule 3502 is a distinct 
authority that creates and enforces a distinct obligation, and 
currently, the PCAOB is unable to hold individuals accountable under 
that rule when they act unreasonably but not recklessly. The amendment 
thus is not ``duplicative,'' as some commenters suggested,\160\ and the 
Board's analysis therefore centers on the need to close this particular 
regulatory gap to give the PCAOB the appropriate tool for these sets of 
circumstances.
---------------------------------------------------------------------------

    \160\ Comment Letter from U.S. Chamber of Commerce at 7; Comment 
Letter from Center for Audit Quality at 6.
---------------------------------------------------------------------------

    Other commenters asserted that the PCAOB's need was not sufficient 
to justify the amendment to Rule 3502 that these commenters considered 
profound, with its attendant costs and consequences. Certain of these 
commenters suggested that any change in auditor behavior that the PCAOB 
hopes to accomplish has already been accomplished by the Commission's 
ability to bring cases for negligent conduct, and that therefore the 
PCAOB has not shown a convincing need. As

[[Page 54912]]

discussed in section C above, the amendment to Rule 3502 is not a 
significant shift in the liability landscape. Rather, it allows the 
PCAOB to discipline associated persons for negligently contributing to 
firms' violations, which is misconduct that the Commission currently 
can pursue. The Board recognizes, however, that this incremental 
increase in the PCAOB's enforcement capability may in turn generate 
certain incremental effects on auditor behavior, as discussed further 
below.
    Some commenters also asserted the absence of adequate evidence to 
support the need for the amendment. However, the comments received did 
not offer data that can be used to supplement the analysis 
meaningfully, and the Board is not aware of additional data or 
quantitative analysis that could be performed. Thus, as noted at the 
outset, the Board has performed limited quantitative analysis where 
possible but relies largely on qualitative analysis to inform this 
rulemaking.
    One comment letter noted that the PCAOB's current inspection 
program is effective in enhancing audit quality, citing academic 
research to support that view.\161\ While the Board acknowledges that 
the PCAOB's inspection program plays a vital role in enhancing audit 
quality, the PCAOB's enforcement program plays a distinct but 
complementary role in holding firms and associated persons accountable 
for violations, and thereby sanctioning and deterring unlawful conduct. 
The amendment aims to fill a gap in that latter program by helping to 
ensure that individuals negligently contributing to a firm's violations 
are held accountable and that the integrity of the audit process is 
strengthened. The continued persistence of a high rate of audit 
deficiencies also suggests that, while the inspections and enforcement 
processes may be effective at enhancing audit quality, as the commenter 
describes, additional efforts are needed, including through this 
rulemaking.\162\
---------------------------------------------------------------------------

    \161\ For example, the commenter cited Lindsay M. Johnson, 
Marsha B. Keune & Jennifer Winchel, U.S. Auditors' Perceptions of 
the PCAOB Inspection Process: A Behavioral Examination, 36 Contemp. 
Acct. Res. 1540, 1557 (2019) (``Overall, participants described 
substantial modifications in their audit approach in response to 
inspection findings and the anticipation of inspections. These 
modifications are consistent with auditors and their firms actively 
working to comply with PCAOB expectations . . . .''). This 
behavioral study examined auditors' observations and behaviors in 
response to the PCAOB inspection process, focusing on factors such 
as perceived power and trust in the regulatory body.
    \162\ See, e.g., PCAOB Report: Audits with Deficiencies Rose for 
Second Year in a Row to 40% in 2022 (July 25, 2023), available at 
https://pcaobus.org/news-events/news-releases/news-release-detail/pcaob-report-audits-with-deficiencies-rose-for-second-year-in-a-row-to-40-in-2022.
---------------------------------------------------------------------------

    In general, commenters did not introduce arguments or data that 
caused the Board to rethink its assessment of the need: there is a 
regulatory gap, the gap is small because the Commission already has the 
ability to bring negligence-based secondary-liability cases, but the 
gap can nonetheless result in regulatory inefficiencies or an 
incremental absence of deterrence and accountability, respectively. The 
amendment would close this gap, yielding the economic impacts discussed 
further below.

C. Economic Impacts

    This section discusses the expected benefits and costs of the 
amendment and potential unintended consequences.
    A critical component of the Board's assessment of the economic 
impacts of this amendment is the Board's assessment of the likely 
number of PCAOB enforcement cases that would be brought under the 
amended rule. For the Proposal, staff examined enforcement matters from 
2022 to assess the potential increase in recommended cases had Rule 
3502 included the proposed amendment. Staff estimated two to three 
instances in 2022 where the amendment could have prompted staff to 
recommend a Rule 3502 charge.\163\ Staff also indicated that, based on 
its expertise, that number would be broadly consistent with other 
years.
---------------------------------------------------------------------------

    \163\ See 2023 Proposing Release at 25. This is an estimate of 
cases in which staff would likely have recommended Rule 3502 charges 
against natural persons. Because Rule 3502 charges can be brought 
against associated persons, which include both natural persons and 
legal entities, it is possible that the estimate could be higher if 
it were to include potential additional cases against legal 
entities. However, due to the complexity of the fact patterns 
presented in such cases, staff could not estimate the number of 
additional cases that would have been brought against such entities. 
Additionally, although the Proposal's estimate included the second 
aspect of the Proposal, staff has confirmed that the estimate 
remains appropriate without that aspect.
---------------------------------------------------------------------------

    For this release, staff updated its analysis to include an 
additional year (2023); for 2023, staff also believes that, had 
negligence been the standard in Rule 3502, two or three instances could 
have prompted staff to recommend a Rule 3502 charge.\164\ The Board 
continues to note that this estimate may vary to the extent that there 
are modifications to other Board standards or changes in enforcement 
priorities.
---------------------------------------------------------------------------

    \164\ Staff were limited in the ability to perform further 
analysis given the intensively fact-specific nature of investigatory 
and charging decisions. Further, the availability (or 
unavailability) of potential charges can itself shape the 
investigatory process. Finally, determining whether all the 
available facts and circumstances would have supported a staff 
recommendation against an individual for negligent contributory 
conduct also depends on an intimate familiarity with the entire 
investigatory file as it pertains to that individual's conduct and 
the relevant standard of care. As recollections fade over time, a 
case-specific analysis of what charges could have been supported 
becomes less reliable. Other staff have moved to different roles 
within the PCAOB or departed the organization entirely. The Board 
therefore focused its analysis on the most recent time period where 
relevant staff members are available and their knowledge is the 
freshest, and then confirmed staff's view of whether it has any 
reason to believe that this time period would not be representative 
of the broader trend.
---------------------------------------------------------------------------

    This analysis influenced, and continues to influence, the Board's 
assessment of the likely benefits, costs, and potential unintended 
consequences of the amendment--namely, that auditors are already held 
to a contributory negligence standard, that the change here is only 
adding the PCAOB as an enforcer, and that this change therefore would 
have meaningful but incremental benefits. As discussed further below, 
it would result in more efficient enforcement in specific cases, and it 
may prompt individuals to exercise the appropriate level of care and to 
make firms more efficiently allocate resources, which would raise audit 
quality. It would also have some incremental anticipated costs, and 
unintended consequences that parallel the anticipated costs, including 
litigation, liability, and opportunity costs, and potential 
inefficiencies in terms of self-protective behavior.
    One commenter agreed with the Board's expectation that the economic 
impact will be modest while others challenged this analysis. They took 
issue with the estimate of only a few additional cases for 2022 
resulting from the amendment, questioning the basis and relevance of 
this prediction. Based on extensive experience, staff believes that 
this number is a fair average representation across other years and 
provides an estimate of the additional cases resulting from the Board 
pursuing charges under the amendment. In fact, as discussed above, 
staff updated its analysis to include data from 2023 and that analysis 
generated an estimate of two to three additional cases in 2023, 
consistent with that for 2022. Overall, the estimation approach 
espoused here (with respect to both 2022 and 2023) applies expert 
judgment to the PCAOB's recent case data to offer a pragmatic 
perspective.\165\
---------------------------------------------------------------------------

    \165\ An alternative approach would involve providing an upper 
bound of the number of cases, i.e., the total number of firm cases 
that were brought each year. This can be easily derived from Table 
1. However, not every firm case would be associated with individual 
contributory liability, and some cases would involve individual 
primary liability too. Therefore, the Board declined to engage in 
this alternative approach and rather relied on staff's expertise in 
terms of providing a more pragmatic perspective on the additional 
number of cases under the amendment.

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

[[Page 54913]]

    Moreover, the PCAOB has existing authorities to bring charges 
against individuals--both for primary violations and for at least 
reckless contributory conduct; \166\ the amendment therefore would 
close a gap regarding one particular type of conduct (negligent 
contributory conduct) rather than supplanting these other forms of 
accountability. Staff's estimate of two to three additional cases thus 
appears objectively reasonable.
---------------------------------------------------------------------------

    \166\ Here, the Board agrees with commenters who pointed out 
that the PCAOB has alternative means of bringing charges against 
individuals.
---------------------------------------------------------------------------

    In terms of the potential variability in the future of other 
standards, including QC 1000 and AS 1000, commenters took issue with 
the uncertainty that poses. But standards and regulatory priorities are 
always evolving in a bid to keep pace with developments in the relevant 
environments (e.g., developments within the regulated industry, legal 
developments, etc.). Indeed, there could be benefits to amending Rule 
3502 in tandem with other standards if it means that individuals, in 
determining how their registered firm should implement the new 
standards, are more sharply aware of the standard of care that is 
expected of them and can design their firm's implementation strategies 
accordingly. Moreover, if the Board assumes that the number of Rule 
3502 cases increases more significantly in the future because the facts 
and circumstances of those matters show that individuals are failing to 
act reasonably under newer PCAOB requirements, and thereby contributing 
to firms' violations of other standards, then the Board expects that 
both the benefits and costs of Rule 3502 would be higher.\167\
---------------------------------------------------------------------------

    \167\ Conversely, if the number of additional cases declines 
over time due to changes in auditor behavior in response to the Rule 
3502 enforcement risk, this may translate into an increase in 
benefits discussed below.
---------------------------------------------------------------------------

    Some commenters posited that the amendment would represent a 
profound change in liability and have significant impacts on the 
profession and far-reaching unintended consequences. As previously 
discussed, the amendment does not effectuate a fundamental shift in the 
liability landscape, but rather aligns the PCAOB's secondary liability 
standard with that of the Commission. And thus, as discussed below, the 
Board has assessed that there would be recognizable but not significant 
benefits, or costs, attributable to enhanced compliance with other 
PCAOB rules and standards.
    The Board has considered this discrepancy between commenters' 
assertions of the significance of the amendment and the Board's 
analysis of the amendment's incremental effect. This discrepancy could 
be the result of unstated assumptions on commenters' parts:
     One possibility is that commenters are aware of (but do 
not acknowledge expressly) a more significant deficit in associated 
persons failing to act reasonably, which the Board has not detected 
through its oversight, such that there will be considerably more 
opportunities for enforcement under the amended rule than the Board has 
assumed in its analysis. In that case, the Board would expect to see 
more cases potentially being brought, with more benefits from enhanced 
compliance with PCAOB standards, and more costs from the actions that 
individuals would take to come into compliance and demonstrate the 
reasonableness of their actions if challenged.
     Another possibility is that commenters believe that the 
PCAOB would exercise its discretion under the amended rule 
irresponsibly--choosing to pursue cases against individuals over 
differences in reasonable judgments, or cases where an individual had 
only a remote connection to, or was responsible for only a small 
fraction of, the decision-making process that led to a firm's 
violation--and thus they believe that the unintended consequences 
(e.g., self-protective behaviors) would be more significant than staff 
estimates. The Board does not believe that commenters' concerns are 
warranted. As described, the Board intends to deploy its prosecutorial 
discretion responsibly, informed by the recommendations of its staff, 
and any sanctions imposed by the Board are subject to de novo review by 
the Commission,\168\ all of which guides the Board's exercise of 
discretion in determining what matters to pursue.
---------------------------------------------------------------------------

    \168\ See Section 107(c) of Sarbanes-Oxley; see also, e.g., SW 
Hatfield, C.P.A., SEC Release No. 34-69930, at 2-3.
---------------------------------------------------------------------------

    The Board discusses these points in more detail below.
1. Benefits
    This subsection presents the expected benefits of the amendment, 
particularly enhancements in regulatory efficiency and individual 
accountability, as well as positive impacts on capital markets. Several 
commenters agreed with the Board's analysis, while others disagreed 
with certain aspects of the Board's assessment of the benefits. The 
Board discusses these in more detail below.
    One commenter asserted that the benefits discussion in the Economic 
Analysis section of the Proposal is high-level and lacks application of 
the specifics of the amendment. The benefits discussions--in the 
Proposal and in this release--however, touch upon a crucial aspect of 
the amendment, which involves expanding the PCAOB's enforcement 
authority to discipline associated persons for negligently contributing 
to violations of a firm. While the discussion may appear broad, it is 
intended to highlight the overarching benefits of this expansion, 
including enhancing individual accountability, strengthening investor 
protection, and promoting greater adherence to applicable laws, rules, 
and professional standards.
    The following sections discuss regulatory efficiency and individual 
accountability and expected impacts on capital markets.
i. Regulatory Efficiency and Individual Accountability
    The amendment can improve regulatory efficiency by enabling the 
PCAOB to bring a case involving negligence against a firm and the 
responsible relevant associated person(s), rather than referring part 
or all of the case to the Commission or charging only the firm. Under 
the status quo, the Commission (as well as other authorities such as a 
state board of accountancy), but not the PCAOB, can bring such cases. 
By contrast, the PCAOB can only sanction the firm and defer to the 
Commission to take action against the negligent individual (as the 
Commission deems appropriate).
    By enabling the PCAOB to address violations by a firm and 
contributory violations by its associated persons concurrently, the 
amendment ensures that individuals who fail to meet their 
responsibilities with reasonable care are held accountable. This method 
of reinforcing individual accountability and facilitating improvement 
among practitioners elevates overall audit quality, benefiting both 
firms and investors by reducing the likelihood of negligent conduct.
a. Effects on Associated Persons
    Enabling the PCAOB to hold individuals accountable can lead to more 
deterrence among all individual associated persons. Currently, 
individuals may act inappropriately if they discount the likelihood of 
public sanction because the PCAOB lacks the ability to bring charges 
for negligent contributory conduct, although they

[[Page 54914]]

may not be able to avoid sanction by the Commission or private sanction 
by their firms. However, the imposition of a firm's disciplinary action 
against individuals depends on the detection and investigation of the 
individuals' misconduct. Detection, in turn, may depend on the 
frequency and efficacy of external review processes, e.g., PCAOB 
inspections. Additionally, without a noncompete agreement, a firm 
cannot prevent a partner from associating with a different registered 
public accounting firm and performing issuer or broker-dealer audit 
work, or from becoming employed by an issuer or broker-dealer in an 
accountancy or financial management capacity; in contrast, a PCAOB 
sanction may do so.\169\ Finally, a firm cannot suspend an individual's 
CPA license, but a PCAOB sanction can lead to collateral consequences 
with relevant state accountancy authorities.\170\
---------------------------------------------------------------------------

    \169\ See Section 105(c)(7) of Sarbanes-Oxley.
    \170\ See, e.g., N.Y. State Rules of the Board of Regents Sec.  
29.10(f); see also Section 105(d)(1) of Sarbanes-Oxley (requiring 
the Board to report disciplinary sanctions it imposes to, among 
others, ``any appropriate State regulatory authority or any foreign 
accountancy licensing board with which [a sanctioned] firm or person 
is licensed or certified'').
    Also, a firm may expel a partner, but such an action is unlikely 
to be public (e.g., a private settlement may contain nondisclosure 
and antidisparagement clauses) and thereby is less likely to be an 
effective deterrent to associated persons of other firms as compared 
to a public sanction. Similarly, a firm may be able to inflict a 
private financial penalty (e.g., through a claw-back or forfeiture 
of paid-in capital or deferred compensation). However, a firm may 
not have effective provisions in its partnership agreements or may 
view enforcing those clauses as uneconomical if forced to litigate 
them as a contractual dispute.
---------------------------------------------------------------------------

    Because of the reasons discussed above, adding the PCAOB as an 
additional enforcer may increase auditors' perception that negligent 
conduct may be detected, investigated, and effectively sanctioned; 
doing so therefore can provide additional deterrence against 
misconduct, even though the risk of liability resulting from the 
additional deterrence is not a large one insofar as the Commission 
currently has the authority to discipline associated persons for 
negligently causing a firm's violations. Academic literature also 
suggests that public authorities' sanctioning tools (e.g., public 
censure, fines, associational prohibitions) deter future misconduct 
more effectively than private reprimands by a firm.\171\
---------------------------------------------------------------------------

    \171\ See, e.g., John T. Scholz, Enforcement Policy and 
Corporate Misconduct: The Changing Perspective of Deterrence Theory, 
60 Law & Contemp. Probs. 253, 265 (1997). Scholz states:
    When corporations have the means of punishing subordinates for 
illegal behavior, punishing the corporation rather than individuals 
responsible for wrongdoing may serve to strengthen the corporation's 
private enforcement system. Criminal prosecution of individuals will 
be necessary, however, whenever the potential gains to the 
individual from illegal behavior far exceed the worst punishment the 
firm could impose.
    See also Michelle Hanlon & Nemit Shroff, Insights Into Auditor 
Public Oversight Boards: Whether, How, and Why They ``Work,'' 74 J. 
Acct. & Econ. 1, 4 (2022) (``We find that the majority of 
respondents think that POB [Public Oversight Board] inspectors have 
greater authority (enforcement options) than peer-reviewers and that 
the culture at POBs is more conducive to detecting auditing 
deficiencies.'').
---------------------------------------------------------------------------

    By increasing individual accountability and the potential for 
liability, the amendment can provide incremental deterrence against 
future violations and, hence, enhance incentives for individuals to 
perform important roles with reasonable care. Individuals that exercise 
reasonable care, in turn, may contribute to better compliance practices 
in their firms. This change is expected to lead to more diligent 
adherence to professional standards. In fact, in support of the 
amendment, one commenter contended that the heightened level of 
deterrence would reduce the risk of substandard audits by encouraging 
auditors to adhere to professional standards and regulations to avoid 
liability.
    The amendment's effect as a deterrent to auditor misconduct 
generated different viewpoints from commenters. Some commenters 
indicated that reducing the liability threshold from recklessness to 
negligence would deter misconduct, lead to more careful work by 
auditors, and enhance audit quality. These commenters also indicated 
the proposed change in liability would boost public confidence, 
increase investors' confidence in financial statements, and strengthen 
the financial markets. One commenter suggested that improvements in 
audit quality will reduce financial misstatements and omissions as well 
as auditor litigation risk and costs to investors resulting from such 
litigation. This is consistent with the Board's analysis presented 
here.
    By providing incremental deterrence and, hence, enhancing 
individual auditors' incentives in the performance of their audits, the 
amendment can improve audit quality. Academic literature suggests that 
auditors' incentives to perform high-quality audits can increase with 
greater enforcement.\172\ Furthermore, in general, academic research 
provides evidence that enforcement proceedings have a deterrent effect 
\173\ and can potentially improve audit quality of non-sanctioned 
entities that are aware of sanctions imposed on others.\174\ Other 
related literature also discusses the role of regulation in providing 
auditors with incentives for improving audit quality.\175\
---------------------------------------------------------------------------

    \172\ See, e.g., Ralf Ewert & Alfred Wagenhofer, Effects of 
Increasing Enforcement on Financial Reporting Quality and Audit 
Quality, 57 J. Acct. Res. 121, 123 (2019) (``Our main finding is 
that auditing and enforcement are complements in a low-intensity 
enforcement regime but can become substitutes in a strong regime. 
The auditor's incentives to perform a high-quality audit increase 
with greater enforcement because the expected penalty rises, and 
they decrease with lower anticipated earnings management.'').
    \173\ See Robert H. Davidson & Christo Pirinsky, The Deterrent 
Effect of Insider Trading Enforcement Actions, 97 Acct. Rev. 227, 
227 (2022) (``Insiders who have witnessed [a Commission] enforcement 
action have a lower probability for future conviction than their 
unexposed peers.'').
    \174\ See, e.g., Phillip Lamoreaux, Michael Mowchan & Wei Zhang, 
Does Public Company Accounting Oversight Board Regulatory 
Enforcement Deter Low-Quality Audits? 98 Acct. Rev. 335, 339 (2023) 
(``We find that audit firm responses to PCAOB enforcement only occur 
following sanctions of like-sized firms. That is, small firm 
responses only follow sanctions of small firms and large firm 
responses only follow sanctions of large firms. Specifically, 
following the PCAOB sanction of a small audit firm, the likelihood 
of misstatement is 2.2 percentage points lower for clients of 
competing non-sanctioned small audit firm offices in the same 
[Metropolitan Statistical Area]. In contrast, following PCAOB 
sanctions of a large audit firm, the likelihood of misstatements 
decreases by 2.6 percentage points for clients of non-sanctioned 
audit offices within the sanctioned audit firm.'').
    \175\ See, e.g., A.C. Pritchard, The Irrational Auditor and 
Irrational Liability, 10 Lewis & Clark L. Rev. 19, 19 (2006) 
(``Audit quality is promoted by three incentives: reputation, 
regulation, and litigation.'').
---------------------------------------------------------------------------

    By contrast, one commenter asserted the amendment does not deter 
conduct because penalties are not an effective method to deter one-time 
mistakes, inadvertence, and errors in judgement. Another commenter 
expressed a concern that the PCAOB did not explain how the amendment 
would result in Rule 3502 becoming a more effective deterrent than the 
current formulation of Rule 3502. Other commenters expressed skepticism 
that the amendment will incentivize individuals or change behavior. One 
commenter expressed concern that the amendment may not incentivize the 
negligent or reckless auditors as intended because those individuals 
may be the least risk averse. The Board considered these commenters' 
perspectives as well as academic research noted above that suggests 
enforcement proceedings have a deterrent effect.\176\ The Board 
believes that there is sufficient support for the Board's belief that 
the amendment would enhance deterrence (albeit

[[Page 54915]]

incrementally) and that the deterrence would lead to benefits.
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    \176\ See, e.g., Ralf Ewert & Alfred Wagenhofer, Effects of 
Increasing Enforcement; Robert H. Davidson & Christo Pirinsky, The 
Deterrent Effect of Insider Trading Enforcement Actions; Lamoreaux, 
et al., Does Public Company Accounting Oversight Board Regulatory 
Enforcement Deter Low-Quality Audits?
---------------------------------------------------------------------------

    One commenter stated that the Proposal implied that ``the 
discipline imposed by a firm (whether financial penalty or even 
expulsion) is less likely to be an effective deterrent to others' '' 
misconduct compared to public sanction, but that there was a lack of 
evidence in the Proposal to support such a claim.\177\ Unlike internal 
disciplinary measures, public sanctions are visible to everyone, 
including potential clients and employers.\178\ This public visibility 
may result in all associated individuals exercising greater care while 
carrying out their responsibilities. Therefore, as discussed in more 
detail above, the Board believes that public discipline can enhance the 
deterrence effect beyond what internal discipline can achieve, making 
it a key tool for enforcing accountability and upholding high standards 
in the audit profession.\179\
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    \177\ Comment Letter from National Association of State Boards 
of Accountancy at 2 (Oct. 24, 2023). Another commenter expressed 
that the firm's approach to prevent and respond to instances of 
negligence in response to inspection findings may impact the 
individual more, as the firm's actions may more directly dictate an 
individual's future. But as discussed above, while the Board 
acknowledges that the PCAOB's inspection program plays a vital role 
in enhancing audit quality, the PCAOB's enforcement program plays a 
distinct but complementary role in holding firms and associated 
persons accountable for violations, and thereby punishing and 
deterring unlawful conduct. In other words, there is a distinction 
to be made between firm's quality control and private sanctions 
deterring misconduct.
    \178\ On one hand, if a person receiving a private sanction 
remains an associated person of the same firm, such a firm may have 
incentives (e.g., to win new business or keep existing business) not 
to disclose the private sanction to clients, prospective clients, or 
the public, or may have agreed not to do so. On the other hand, if a 
person receiving a private sanction leaves the firm, whether as part 
of the sanction or voluntarily, and then seeks, for example, to join 
a new firm (or an issuer or broker-dealer in an accountancy or 
financial management capacity), the prior firm might not disclose 
details about the sanction to the new prospective firm or employer, 
whether per nondisclosure or anti-disparagement provisions or as a 
matter of general policy.
    Furthermore, the sufficiency of private sanctions is hard to 
square with the PCAOB's authority to discipline formerly associated 
persons of firms, as provided by Section 929F of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act. See Section 2(a)(9)(C) of 
Sarbanes-Oxley. If a private sanction (i.e., expelling the 
associated person from the firm) were sufficient, Congress 
presumably would not have given to the PCAOB the power to impose a 
public sanction against an individual who is no longer associated 
with a registered firm.
    \179\ See, e.g., Scholz, Enforcement Policy and Corporate 
Misconduct 265.
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b. Effects on Firms
    Some firms choose to invest in staffing and resources voluntarily 
to comply better with regulatory requirements. Yet, competitive 
pressures from other firms that prefer not to make similar investments 
may lead these firms to reconsider their investment decisions. With the 
amendment, however, all firms lacking adequate staffing and resources 
would now face enhanced possibility of sanctions of their associated 
persons, prompting them to make additional investments. This change is 
expected to improve audit quality by counteracting underinvestment of 
staffing and resources, thereby reducing noncompliance by audit firms. 
This collective uplift mitigates any single firm's competitive concerns 
and promotes broader societal benefits by fostering a more robust and 
reliable compliance environment resulting in improved overall audit 
quality.
    Individual auditors, perceiving greater litigation and liability 
risks, are likely to change their behavior and take their professional 
responsibilities more seriously, ensuring that their actions are 
objectively reasonable under the circumstances. This shift in 
individual behavior can lead to greater compliance by firms with their 
respective legal requirements, including auditing standards, quality 
control standards, and ethics and independence standards, which were 
enacted to promote audit quality and investor interests. In other 
words, by preventing individual negligence, the amendment can also 
mitigate firm negligence, as individuals' actions directly impact firm 
actions, such as implementing better quality control systems.\180\ One 
commenter agreed that the amendment will result in firms being more 
likely to comply with their respective legal requirements.
---------------------------------------------------------------------------

    \180\ Quality control systems play a fundamental and widespread 
role in overall audit quality. These systems are essential in 
ensuring the audit process adheres to professional standards. A 
robust quality control system can help firms to detect and address 
factors that compromise audit quality.
---------------------------------------------------------------------------

ii. Capital Market Impact
    As explained above, the amendment can introduce an incremental 
deterrent effect, which could lead to improvements in audit quality. 
Increased audit quality can improve financial reporting quality and 
enhance investors' confidence in the information provided in companies' 
financial statements. Because auditors have a responsibility to provide 
reasonable assurance about whether the financial statements are free of 
material misstatement, higher audit quality could increase the 
likelihood that the auditor would discover a material misstatement or 
would qualify its audit opinion when a material misstatement exists and 
is not corrected by management. If a Commission registrant were to 
include such a qualified audit opinion in a filing with the Commission, 
then Commission staff may deem the registrant's filing to be 
deficient.\181\ Furthermore, a qualified audit opinion may evoke 
negative market reactions. For these reasons, higher audit quality 
could incentivize issuers to take steps to ensure their financial 
statements are free of material misstatement. Issuers could take these 
steps proactively, prior to the audit, or in response to adjustments 
requested by the auditor.
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    \181\ See 17 CFR 210; see also Financial Reporting Manual Sec.  
4220, Division of Corporation Finance, SEC, available at https://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf.
---------------------------------------------------------------------------

    Financial statements that are free of material misstatement are of 
higher quality and more useful to investors. In particular, more 
reliable financial information allows investors to improve the 
efficiency of their capital allocation decisions. Investors may also 
perceive less risk in capital markets generally, leading to an increase 
in the supply of capital.\182\ An increase in the supply of capital 
could increase capital formation while also reducing the cost of 
capital to companies.\183\ A reduction in the cost of capital reflects 
a welfare gain because it implies investors perceive less risk in the 
capital markets.
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    \182\ See, e.g., Hanwen Chen, Jeff Zeyun Chen, Gerald J. Lobo & 
Yanyan Wang, Effects of Audit Quality on Earnings Management and 
Cost of Equity Capital: Evidence from China, 28 Contemp. Acct. Res. 
892 (2011); Richard Lambert, Christian Leuz & Robert E. Verrecchia, 
Accounting Information, Disclosure, and the Cost of Capital, 45 J. 
Acct. Res. 385 (2007).
    \183\ Cost of capital is the rate of return investors require to 
compensate them for the lost opportunity to deploy their capital 
elsewhere. Equivalently, cost of capital is the discount rate 
investors apply to future cash flows. Cost of capital depends on, 
among other factors, the riskiness of the underlying investment. 
Accordingly, the rate of return required by equity holders--cost of 
equity capital--and the rate of return required by debt holders--
cost of debt capital--may differ to the extent equity and debt 
securities expose investors to different levels of risks. For 
theoretical discussion on the link between the greater availability 
of information to investors and cost of capital, see, for example, 
Richard A. Lambert, Christian Leuz & Robert E. Verrecchia, 
Information Asymmetry, Information Precision, and the Cost of 
Capital, 16 Rev. Fin. 1, 16-18 (2012); David Easley & Maureen 
O'Hara, Information and the Cost of Capital, 59 J. Fin. 1553, 1571 
(2005); and William Robert Scott & Patricia C. O'Brien, Financial 
Accounting Theory 412 (Prentice Hall 3d ed. 2003).
---------------------------------------------------------------------------

    Commenters agreed that the amendment will enhance investors' 
confidence both in audits and in the information provided in companies' 
financial statements, as well as have an incremental positive effect on 
capital-market efficiency.
2. Costs
    This section discusses the expected costs of the amendment. Because 
the

[[Page 54916]]

amendment is expected to lead to an increase in the number of 
enforcement cases by the PCAOB, the Board discusses costs to firms and 
individuals, and costs to issuers.
    The Board's assessment of the degree of the anticipated costs is 
affected by the Board's estimate of the number of additional cases to 
be brought, as discussed at the outset of this section. As discussed 
there, the amendment is expected to result in a slight increase in the 
number of PCAOB enforcement cases (two to three per year) due to the 
changed liability threshold. Any additional cases due to the amendment 
will involve legal costs, which could result in substantial costs for 
the firms and individuals involved. Staff could not provide an estimate 
for the per-case cost; however, the small number of incremental cases 
could limit the aggregate cost of the amendment, in particular, when 
the total number of issuers and broker-dealers is taken into account.
i. Costs to Firms and Individuals
    With the anticipated increase of enforcement proceedings of two to 
three per year, certain firms will incur direct and indirect costs with 
respect to those proceedings as a result of the amendment. These costs 
include legal costs and broader financial and operational impacts.
    Direct costs include increased hours and resources (including 
attorneys, experts, and other personnel) to prepare for, respond to, 
and defend against investigations and charges--actual or anticipated. 
The Board expects that, in most cases, the costs of defending 
associated persons who have negligently contributed to a firm's 
violation will be borne by the firm.\184\ The direct defense costs can 
be grouped into two categories based on the stage of the matter:
---------------------------------------------------------------------------

    \184\ That is, the Board believes that the firm would have 
advancement and indemnification agreements in place with relevant 
firm personnel. In certain circumstances, it is possible that an 
individual respondent that is found liable would have to reimburse 
the firm (or the firm's insurer) for defense costs, but the extent 
and nature of that obligation depends on the facts and circumstances 
as applicable to the terms and conditions of the indemnification and 
insurance agreements.
---------------------------------------------------------------------------

     First, during the investigative stage, staff works to 
determine whether it is likely that a primary violation occurred and if 
so, whether an individual directly and substantially contributed to the 
violation. Because this inquiry already takes place (albeit to 
determine whether someone acted recklessly rather than negligently), 
the incremental resource cost to firms at the investigative stage will 
not be significant.
     Second, staff works to determine whether the individual 
acted negligently and notifies the potential respondent of that 
determination. After this point, the direct costs of the amendment to 
firms may increase more significantly.\185\ Staff lacks sufficient data 
to reliably estimate the costs of each matter because the costs depend 
on numerous factors, including the duration of the matter,\186\ the 
complexity of the matter (e.g., a complex audit case versus a simpler 
case of noncompliance with PCAOB filing requirements), the number and 
nature of counsel and expert witnesses retained, and so forth.\187\
---------------------------------------------------------------------------

    \185\ One commenter expressed concern that the PCAOB's 
investigations and enforcement could become at least marginally more 
costly given enforcement requirements of the negligence criteria. 
The Board agrees; there could be incremental costs to the PCAOB of 
pursuing negligence-based cases. The Board expects these would be 
generally proportional to the costs discussed above for potential 
individual respondents (e.g., both sides may need to hire expert 
witnesses to litigate whether conduct met the standard of care). 
Another comment letter expressed doubt that the firm would cover an 
individual's defense costs if the individual chose to mount a 
defense that involved attributing responsibility to the firm. The 
Board believes that in these circumstances, it is more likely that 
the firm would nonetheless have to continue abiding by its 
advancement and indemnification obligations, but that the firm might 
then have to retain separate counsel for the individual, which would 
increase the overall costs as discussed (given an increase in 
complexity and number of counsel).
    \186\ As set out in the PCAOB rules, a PCAOB enforcement case 
has numerous stages where the proceedings might halt. For example, a 
persuasive Rule 5109(d) submission may convince the staff not to 
recommend proceedings; the Board may determine not to institute 
proceedings under Rule 5200; the Hearing Officer might dismiss the 
matter; the matter might end with a Hearing Officer's initial 
decision; or the initial decision might be appealed to the Board, 
the Commission, or the courts. The longer the litigation, the 
greater the costs (e.g., attorney fees, expert witness fees, and 
opportunity costs).
    \187\ These factors make it impracticable to construct a 
quantitative estimate of the anticipated cost--there is no 
``typical'' case that the Board could use to construct an estimate 
that would be extensible across the two to three cases per year 
anticipated here. While the Board requested information about costs, 
including relevant data, commenters did not provide specific data 
about defense costs that would permit the Board to construct a 
quantified estimate. The Board's analysis therefore continues to be 
qualitative in nature.
---------------------------------------------------------------------------

    Apart from these direct defense costs, if the individual is 
adjudicated as having acted negligently and a sanction is imposed, the 
individual would incur potential financial costs of having been found 
liable for failing to act with reasonable care and thereby contributing 
to the firm's violation. To the extent that there are civil money 
penalties, they would be assessed against the individual.\188\
---------------------------------------------------------------------------

    \188\ If not foreclosed from doing so, individuals might seek to 
have their firm bear these financial costs pursuant to 
indemnification agreements, insurance agreements, or otherwise. 
However, such agreements or arrangements might not cover civil money 
penalties.
---------------------------------------------------------------------------

    A firm that has indemnification agreements in place that would 
compel it to bear the financial burden of defending or indemnifying 
associated persons may choose to purchase insurance to help alleviate 
the contingent financial burden. If so, it would have to buy insurance 
in the market, and the pricing of such insurance may depend on the 
risks of loss identified by the underwriting process. Or a firm may 
self-insure against such liabilities, in which case the amount held in 
reserve or reinsurance may vary based on anticipated losses.
    There may also be opportunity costs as enforcement proceedings 
distract individuals from their everyday responsibilities. The 
opportunity costs relate to diversion from engagement tasks and other 
work.
    Further, an individual may incur reputational costs, such as 
adverse employment or career events. Commenters asserted that the 
effects of the Proposal would include causing harm to individuals' 
careers (e.g., by being removed from issuer client service roles or 
being demoted) and collateral consequences (e.g., follow-on proceedings 
by state boards of accountancy or disciplinary measures by other 
regulators) consistent with having been found to have violated the 
Board's standards, and hence the federal securities laws. The Board 
agrees and recognizes that these costs could exist in any proceeding 
brought under the amendment. \189\ While the Board may consider the 
relevant facts and circumstances in determining the sanction it 
believes appropriate in the public interest, the Board recognizes that 
additional consequences beyond the sanctions imposed in the case 
frequently occur. The Board acknowledges that these consequences could 
be significant to the individual against whom they are imposed. 
However, the Board also believes that these consequences would not be 
significant in the aggregate, taking into account the number of 
associated persons across all registered firms and in light of the 
anticipated number of additional proceedings likely to be brought as a 
result of the amendment.
---------------------------------------------------------------------------

    \189\ See J. Krishnan, M. Li, M. Mehta & H. Park, Consequences 
for Culpable Auditors, available at https://ssrn.com/abstract=4627460.
---------------------------------------------------------------------------

    Certain commenters raised concerns about the potential increase in 
legal costs for firms. In particular, they noted the increased legal 
liability that

[[Page 54917]]

associated persons might face under the amendment, which may result in 
higher costs of firms defending their associated persons and liability 
insurance for firms. Other commenters voiced concerns about the 
potential for increased state-level investigations and disciplinary 
proceedings against individuals, which could lead to the suspension or 
revocation of professional licenses. However, another commenter 
asserted the amendment's contributory negligence standard would better 
align the PCAOB's liability approach with the majority of the states' 
liability approach, which does not limit individual liability for 
negligent conduct.
    The Board agrees that the amendment could increase legal and 
liability insurance costs, as well as the number of state 
investigations. Those incremental costs, however, would not be 
significant based on the two to three additional cases expected per 
year.
    Several commenters highlighted that the amendment could 
significantly increase audit firms' litigation risk and legal liability 
for small firms. They indicated that increased costs, encompassing 
defense expenditures and opportunity costs, are expected to 
disproportionately affect small firms, which may lack the resources and 
market influence to offset these expenses. The commenters cautioned 
that small firms with a limited capacity to absorb these costs or 
demand higher fees could face significant challenges.
    The Board acknowledges that litigation risk and legal liability 
involve costs, and those costs may have a greater impact on small 
firms, where direct costs and distractions are less absorbable by 
firms' other activities or personnel. For example, small firms are 
especially vulnerable to increases in legal costs, as small firms may 
disproportionately bear the burden of insuring against the risk. 
However, the Board believes certain features of the market and this 
amendment would limit these effects.
    First, smaller firms typically have simpler supervisory structures 
that may make it easier for these firms to supervise their partners to 
help to ensure that partners are acting with reasonable care.\190\ They 
also may be less impacted by the concern raised by other commenters 
that responsibility for firm compliance could be divided up among many 
individuals, with accountability for any one act of negligence being 
more difficult to establish. Second, in assessing insurance costs, the 
Board distinguishes between market-wide effects (i.e., a market-wide 
increase in directors & officers or professional liability coverage) 
and specific-firm effects (i.e., a specific firm experiencing an 
increase in the cost of insurance if it has a specific claim brought 
against its associated persons). The Board believes the market-wide 
effects are likely to be smaller: Again, the Commission already has the 
authority to bring negligence-based cases, and the staff has estimated 
that the amendment would result in an average of two to three more 
cases per year. The Board believes it less likely that the amendment or 
resulting incremental claims experience would cause a significant shift 
in underwriters' perception of risk and thus the availability or 
pricing of insurance for smaller firms in general. However, the Board 
acknowledges that the impact on a specific firm that is involved in a 
specific matter could be more significant; an increase in its 
individual claims experience could cause an increase in the cost of 
coverage and/or retention amounts in the future or make it more 
difficult to secure acceptable coverage.
---------------------------------------------------------------------------

    \190\ The Board acknowledges that smaller firms may have fewer 
resources to invest in dedicated supervisory structures. However, 
given that their respective QC systems oversee a smaller number of 
engagements, the same level of resources may not be necessary for 
the firm to nonetheless obtain reasonable assurance that their 
personnel comply with applicable professional standards and 
regulatory requirements.
---------------------------------------------------------------------------

    In addition to the direct costs described above, the amendment 
could result in indirect costs as individuals adjust their behavior and 
put forth additional effort to ensure they do not contribute to a 
firm's violation through their negligence. However, to the extent that 
these indirect costs are incurred to bring previously negligent conduct 
up to a level of reasonable care, these costs are properly allocable to 
the underlying law, rule, or standard that the firm is alleged to have 
violated, as those provisions each assume a level of costs necessary 
for the firm to comply.
    One commenter expressed concerns about a requirement in the 
Proposal that involves the application of ``directly and 
substantially'' only to the sufficiency of the connection between an 
associated person's conduct and a firm's violation. The commenter 
asserted that this is an important change from the present rule, under 
which an alleged violator must know (or recklessly not know) not only 
that they are contributing to a violation, but also that the 
contribution is direct and substantial. The Board notes that its 
analysis, which includes staff estimate of two to three additional 
cases per year based on the Proposal, takes into account the 
application of ``directly and substantially'' only on the sufficiency 
of the connection between the associated person's conduct and a firm's 
violation. The Board does not believe that this change would be a 
significant driver of costs to individuals or firms in the 
aggregate.\191\
---------------------------------------------------------------------------

    \191\ Nor would it be a significant contributor to costs in 
particular cases; indeed, it might save costs by avoiding effort 
seeking to establish the reasonableness of the individual's belief 
as to the directness and substantialness of the participation or 
lack thereof where a direct and substantial connection in fact has 
already been established.
---------------------------------------------------------------------------

ii. Costs to Issuers (Audit Fees)
    To the extent that firms pass on some of the costs to their audit 
clients, the amendment could result in audit fee increases to cover 
firms' compliance costs related to the amendment. Consistent with this 
notion, academic studies find that increased enforcement intensity can 
lead to temporary increases in audit fees for some issuers.\192\ 
Further academic research provides evidence that audit fees increase 
with the auditor's assessment of business risk, which includes risk of 
regulatory sanctions, among others.\193\ The findings indicate that the 
increases in audit fees are due to the increase in the number of audit 
hours, but not hourly rates.
---------------------------------------------------------------------------

    \192\ Annita Florou, Serena Morricone & Peter F. Pope, Proactive 
Financial Reporting Enforcement: Audit Fees and Financial Reporting 
Quality Effects, 95 Acct. Rev. 167, 167 (2020) (``We examine the 
costs and benefits of proactive financial reporting enforcement by 
the U.K. Financial Reporting Review Panel. Enforcement scrutiny is 
selective and varies by sector and over time, yet can be anticipated 
by auditors and companies. We find evidence that increased 
enforcement intensity leads to temporary increases in audit fees and 
more conservative accruals. However, cross-sectional analysis across 
market segments reveals that audit fees increase primarily in the 
less-regulated AIM segment, and especially those AIM companies with 
a higher likelihood of financial distress and less stringent 
governance. On the contrary, less reliable operating asset-related 
accruals are more conservative in the Main segment and, in 
particular, those Main companies with stronger incentives for higher 
financial reporting quality. Overall, our study indicates that 
financial reporting enforcement generates costs and benefits, but 
not always for the same companies.'').
    \193\ See, e.g., Timothy B. Bell, Wayne R. Landsman & Douglas A. 
Shackelford, Auditors' Perceived Business Risk and Audit Fees: 
Analysis and Evidence, 39 J. Acct. Res. 35 (2001).
---------------------------------------------------------------------------

3. Potential Unintended Consequences
    The following discussion describes potential unintended 
consequences that the Board considered and, where applicable, factors 
that mitigate the adverse effects, such as the steps the Board has 
taken or the existence of countervailing forces.
i. Self-Protective Behavior
    The Board recognized in the Proposal that auditors might engage in 
self-

[[Page 54918]]

protective behavior.\194\ Specifically, while the threat of enforcement 
action can motivate individuals to act in a manner consistent with 
their legal obligations, it can also result in excessive monitoring and 
self-protective behavior, leading to an inefficient allocation of time 
and resources. The effect on audit quality may change as the degree of 
intervention increases. Individuals may spend more time on a task than 
is necessary to accomplish it at the appropriate level of care. 
Similarly, individuals may excessively document the nature of their 
task performance to demonstrate compliance in a future proceeding. Time 
spent on unproductive, self-protective activities may detract from 
other important obligations and directly impact audit quality.
---------------------------------------------------------------------------

    \194\ See 2023 Proposing Release at 26.
---------------------------------------------------------------------------

    Many commenters echoed this concern and emphasized the potential 
significance of this issue, including that its effects may discourage 
effective collaboration between and among accountants, especially in 
complex audits. Some of these commenters expressed concern that moving 
to a negligence standard for contributory liability would lead to 
sanctions of professionals who make judgments in good faith. A few 
commenters asserted that emphasizing every error an auditor makes will 
encourage auditors to focus on defensive auditing--which could result 
in a decrease in audit quality. These commenters' concerns center on 
the prospect that increased liability risk could lead auditors to 
prioritize self-protective measures (e.g., overemphasizing compliance 
documentation) and excessive monitoring over more important audit 
tasks, particularly in small- and mid-sized firms with limited 
resources. Another comment letter raised concerns about the impact of 
coercive enforcement strategies on audit practices, suggesting that 
such strategies could lead to defensive behaviors rather than genuine 
quality improvements.
    The Board notes that the compliance and documentation requirements 
in applicable professional standards are designed to sufficiently 
demonstrate compliance, thus mitigating the need for excessive, 
unproductive documentation.\195\ Furthermore, the possibility of such 
self-protective behavior is not new. As discussed above, the Commission 
currently can initiate enforcement proceedings against individuals for 
negligent contributory conduct.\196\ And, as commenters have pointed 
out, the PCAOB currently possesses a robust enforcement regime covering 
negligent primary conduct. Therefore, the risk of litigation and 
sanctions is already a factor in the current regulatory environment, 
driving the existing need for individuals to act with reasonable care 
and to be able to demonstrate their compliance. Thus, while the Board 
acknowledges some inefficient behavior could result from the amendment, 
consistent with the incremental increase in deterrence that the Board 
posits above, the Board continues to believe that the likelihood that 
the amendment would drive significant increases in self-protective 
behavior is low.
---------------------------------------------------------------------------

    \195\ See, e.g., AS 1215, Audit Documentation.
    \196\ Also, as discussed in section C above, the AICPA's Code of 
Professional Conduct makes certain negligent contributory acts by 
individuals an ``act discreditable to the profession.'' See AICPA 
Code of Professional Conduct, ET Sec.  501.05(a), Negligence in the 
Preparation of Financial Statements or Records, recodified at 
Section 1.400.040.01.
---------------------------------------------------------------------------

ii. Lack of Available Personnel or Compensation Enhancements
    As recognized in the Proposal, excessive risk of enforcement action 
could unintentionally discourage auditors from accepting important 
audit roles if they fear being held liable, leaving these roles to be 
accepted by less cautious or less qualified individuals.\197\ 
Alternatively, auditors may seek to offset the increased risk by 
demanding higher compensation for taking certain roles or 
responsibilities, which could have downstream effects on audit fees.
---------------------------------------------------------------------------

    \197\ See 2023 Proposing Release at 26.
---------------------------------------------------------------------------

    Many commenters remarked about the amendment's potential negative 
impact on the accounting and audit workforce. These commenters 
highlighted an existing ``talent crisis,'' especially affecting small- 
and mid-sized firms. They noted that the amendment's threshold for 
sanctionable conduct and resulting increased liability risks could 
intensify the crisis. The commenters contended that the amendment might 
discourage talented individuals at various career stages from engaging 
in PCAOB-regulated work, potentially leading to lower audit quality, 
higher fees, and public company delisting. The commenters identified 
fear of punitive action and a culture of defensive auditing as factors 
that could deter newcomers from entering the profession and prompt 
experienced auditors to leave, further jeopardizing the talent 
pipeline. In addition, the commenters argued that the amendment would 
affect the on-the-job nature of auditors' learning. Many of the same 
commenters also raised concerns that a shift to a negligence standard 
might discourage experienced auditors from accepting essential roles 
due to the fear of increased liability for good faith judgments. 
According to these commenters, a negligence standard could dissuade 
risk-averse and diligent professionals integral to a firm's quality 
control system, thus affecting auditors' development, training, and 
monitoring. One commenter added that this amendment in combination with 
other recent proposed standards may exacerbate the talent crisis 
problem.
    Some commenters cited literature to support their concerns that 
there has been a steady decline in the number of accounting graduates 
and that this is partly due to the regulatory environment making the 
profession unappealing.\198\ While the cited studies indicate a decline 
in the number of accounting graduates and professionals or a waning 
interest in the accounting profession, they do not expressly point out 
regulatory oversight as a reason for the decline. Rather, according to 
one of these studies, the 150 CPA credit hour requirement as well as 
relatively low starting salaries are the two main reasons for not 
choosing accounting as a major among college students who considered 
accounting.\199\
---------------------------------------------------------------------------

    \198\ See Association of International Certified Professional 
Accountants, 2023 Trends Report (2023), available at https://www.aicpa-cima.com/professional-insights/download/2023-trends-report; see also Center for Audit Quality and Edge Research, 
Increasing Diversity in the Accounting Profession Pipeline: 
Challenges and Opportunities (2023) (``CAQ-Edge Report''), available 
at https://thecaqprod.wpenginepowered.com/wp-content/uploads/2023/07/caq_increasing-diversity-in-the-accounting-profession-pipeline_2023-07.pdf.
    \199\ See CAQ-Edge Report at 7; see also Daniel Aobdia, Qin Li, 
Ke Na & Hong Wu, The Influence of Labor Market Power in the Audit 
Profession, Social Science Research Network (SSRN) (2024), available 
at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4732093 
(``[W]e confirm that audit offices in more concentrated labor 
markets have greater labor market power and exercise it in the form 
of higher skill requirements and greater required effort from their 
auditors, at similar or slightly lower wages.'').
---------------------------------------------------------------------------

    The Board acknowledges the commenters' concerns about the 
amendment's potential impact on auditing personnel. However, the lack 
of available auditing personnel is likely the result of the interplay 
between numerous factors in the labor market. On the supply side, a 
notable decline in the number of entry-level auditors, as evidenced by 
a significant decrease in the number of new CPA candidates, suggests a 
waning interest among entry-level professionals in auditing

[[Page 54919]]

careers.\200\ A study found that for graduates who have already 
completed the 150 CPA credit hour requirement, finding the time to 
study for the CPA exam and the overall rigor of the exam are the most 
significant challenges to licensure.\201\ Other contributing factors 
may include the retirement of baby boomers and a lack of diversity in 
the profession.\202\
---------------------------------------------------------------------------

    \200\ According to the 2023 Trends Report, the number of new CPA 
candidates decreased from 48,004 in 2016 to 30,251 in 2022.
    \201\ See CAQ-Edge Report at 15.
    \202\ See Drew Niehaus, Fixing the Crisis in Accounting: Five 
Steps to Attracting Tomorrow's CPAs, CPA Journal (Nov. 2022), and 
Mark Maurer, Job Security Isn't Enough to Keep Many Accountants from 
Quitting, Wall St. J. (Sept. 22, 2023), available at https://www.wsj.com/articles/accounting-quit-job-security-675fc28f.
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    On the demand side, as the economy grows, businesses evolve, and 
more companies go public, the demand for auditors will increase.\203\ 
Furthermore, technological advancements and the integration of digital 
tools into business processes have created a need for auditors with 
expertise in cybersecurity, blockchain, and data analytics.\204\ Taking 
into account the current state of supply of and demand for auditors, 
attracting talent likely would depend primarily on factors under firms' 
control, such as auditor compensation, especially given that college 
students have cited low starting salary as one of the main hurdles to 
choosing accounting as a major.
---------------------------------------------------------------------------

    \203\ See Bureau of Labor Statistics, Occupational Outlook 
Handbook: Accountants and Auditors, available at https://www.bls.gov/ooh/business-and-financial/accountants-and-auditors.htm#tab-6 (``In general, employment growth of accountants 
and auditors is expected to be closely tied to the health of the 
overall economy. As the economy grows, these workers will continue 
being needed to prepare and examine financial records. In addition, 
as more companies go public, there will be greater need for public 
accountants to handle the legally required financial documentation. 
The continued globalization of business may lead to increased demand 
for accounting expertise and services related to international trade 
and international mergers and acquisitions.'').
    \204\ See, e.g., Najoura Elommal & Riadh Manita, How Blockchain 
Innovation Could Affect the Audit Profession: A Qualitative Study, 
37 J. Innovation Econ. & Mgmt. 37, 38 (2022) (``According to Alles 
(2015), the use of advanced technologies and blockchain by audit 
clients would be the catalyst for the adoption of these technologies 
by auditors. Blockchain, associated with other digital technologies, 
could change the audit process by modifying the way in which the 
auditor accesses data, collects evidence, and analyzes data 
(Rozario, Thomas, 2019). Auditors have the choice only to integrate 
these technologies and to change their organization and their 
process at the risk of losing their legitimacy in the audit 
market.'').
---------------------------------------------------------------------------

    Thus, while the Board acknowledges the potential for this amendment 
to affect the market for audit services, the Board disagrees with 
commenters' assessment of the magnitude of these risks. First, the 
Board continues to believe that the Board is not establishing a novel 
burden on individuals to refrain from acting negligently and thereby 
contributing to a firm's violation; instead, the Board is merely 
providing a mechanism for the PCAOB to discipline individuals who fail 
to meet that standard. The effect is, therefore, the incremental 
probability of PCAOB enforcement. However, this increased probability 
is not so novel and significant that it would be expected to impact 
noticeably the market for associated persons' services. Second, firms 
have a tool at their disposal--adjusting compensation--that could tend 
to increase the supply of these services as needed, although there may 
be short-term displacements. The increased cost of labor may be 
absorbed by firms or passed to issuers and investors through increased 
audit fees.
iii. Reduced Competition in the Audit Market
    The amendment to Rule 3502 could disproportionately impact small- 
and medium-sized firms if they are less able to bear the cost of 
defending their personnel. As discussed above, these costs include 
attorney fees to defend associated persons against charges and 
distracting personnel from generating income from the performance of 
client services. In an extreme case, a firm might not be able to 
sustain its practice considering the negative impact; more broadly, 
less profitable firms may perceive that the risk of such costs is too 
significant compared to their existing net profit from issuer and 
broker-dealer audit work and, therefore, decide to exit those markets. 
This result could further consolidate the market for issuer and broker-
dealer audit services.
    Several commenters asserted that the amendment could reduce 
competition in the audit market. They noted that the increase in 
liability could discourage firms, especially non-U.S. firms, from 
participating in U.S. issuer and broker-dealer audits. One commenter 
argued that the amendment ``may inadvertently create barriers'' for 
smaller firms and those servicing emerging industries by elevating the 
risk profile of conducting audits.\205\ Another commenter asserted that 
there has been a decline in PCAOB-registered firms auditing issuers and 
broker-dealers due to regulatory burdens.
---------------------------------------------------------------------------

    \205\ Comment Letter from Chamber of Digital Commerce at 1 (Nov. 
2, 2023).
---------------------------------------------------------------------------

    The likelihood that defense costs cause substantial changes in the 
relevant markets is lowered by three factors. First, a firm may already 
defend against an allegation of negligent primary conduct (brought 
using the PCAOB's current authority) such that, in any additional cases 
brought under the amended rule, defending individuals facing a charge 
of negligent contributory conduct would likely involve common sets of 
facts and legal theories and could be done more efficiently (i.e., at 
lower additional cost) as compared to a wholly novel proceeding. 
Second, a firm may already defend an individual against an allegation 
of primary violations, involving common sets of facts and legal 
theories related to an allegation against a firm. Third, the 
Commission's existing authority to sanction associated persons for 
negligent contributory conduct means that firms' profitability 
calculations should already factor in the risk of defending personnel 
against charges of this nature, albeit with a modestly greater 
frequency in light of the amended rule. Thus, in addition to the firm's 
defense, the incremental cost of defending an individual may not be as 
significant as it appears at first glance.\206\
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    \206\ One commenter stated that the assertions in the Proposal 
that defense costs would be lowered by an increase in the volume of 
cases to defend is not based in fact. It appears that the nature of 
the Board's assertion was misinterpreted; as discussed above, the 
Board believes that individuals and firms will incur additional 
litigation costs to defend against charges brought under the amended 
rule. However, the Board has considered the nature of those costs 
and how they would relate to the way that staff might investigate 
and make recommendations regarding these cases, and the frequency of 
those charges, and the Board believes that those factors diminish 
the size of the expected increase--i.e., while costs will go up, 
they will go up less than if firms needed to defend a wholly new 
class of charges.
---------------------------------------------------------------------------

    While the Board agrees that there has been a decline in the number 
of firms performing audits of public companies, the Board notes that 
firms may decide to cease providing audits for any number of reasons, 
mostly strategic in nature.\207\ While the amendment could lead some 
firms to exit the issuer audit market because of increased risk of 
higher expected litigation expenses (thus reducing competition), this 
exit might involve low-quality auditors and lead to better matching 
between auditors and clients.\208\ While the

[[Page 54920]]

amendment may induce market shifts, the resulting landscape could be 
characterized by a higher concentration of more capable and compliant 
audit firms, mitigating the negative impacts on the competitive 
landscape.
---------------------------------------------------------------------------

    \207\ Michael Ettredge, Juan Mao & Mary S. Stone, Small Audit 
Firm De-registrations from the PCAOB-Regulated Audit Market: 
Strategic Considerations and Consequences, Social Science Research 
Network (SSRN) (2022), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3572291.
    \208\ One study suggests that PCAOB inspections incentivize low-
quality auditors to exit the market, resulting in an overall 
improvement in audit quality. See Mark L. DeFond & Clive S. Lennox, 
The Effect of SOX on Small Auditor Exits and Audit Quality, 52 J. 
Acct. & Econ. 21, 39 (2011) (``We conclude that while the PCAOB 
inspections are intended to improve audit quality primarily through 
the remediation of poor audit practices, they also improve audit 
quality by incentivizing the lower quality auditors to exit the 
market.'').
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iv. Other Distortions/Inefficiencies
    One commenter expressed concern that the amendment could change the 
dynamics of the settlement negotiation process during enforcement cases 
and ``tip the scale'' in the PCAOB's favor.\209\ The commenter further 
contended that the PCAOB may pursue weaker cases, which would divert 
its resources to less meritorious cases, while another commenter 
asserted its belief that the PCAOB will appropriately exercise its 
prosecutorial discretion. Some commenters asserted that the amendment 
could have negative effects on the PCAOB's inspections program. One 
commenter noted that the amendment could cause firms to be particularly 
reluctant to provide services to novel industries.
---------------------------------------------------------------------------

    \209\ Comment Letter from U.S. Chamber of Commerce at 12.
---------------------------------------------------------------------------

    The Board emphasizes that the amendment is designed to enhance 
regulatory oversight and accountability, not to unfairly ``tip the 
scale'' against firms and their associated persons. The PCAOB is 
committed to using its enforcement resources efficiently, and the Board 
emphasizes that enforcement proceedings are based on substantive 
evidence and legal principles, thereby helping to maintain the 
integrity and effectiveness of the PCAOB's overall enforcement process 
to protect investors' interests. Moreover, the Board believes that 
enhancements to the PCAOB's enforcement program will serve as a natural 
complement to the inspections program; even today, with a primary 
liability regime based on negligence, the vast majority of inspection 
deficiencies do not result in enforcement proceedings. The Board does 
not anticipate that the incremental effects of the amendment to Rule 
3502 will prompt significant changes in the nature of the inspections 
process that has developed over time.
    The amendment is intended to strengthen the PCAOB's ability to 
address instances of negligence that may harm investors or undermine 
the integrity of the audit process, ensuring a more effective and 
transparent regulatory framework. On balance the Board believes that 
the amendment will enhance audit quality, not diminish it. Enhancements 
in audit quality will also benefit emerging industries: while the 
amendment does not specifically target these industries, it is 
precisely because these industries operate in evolving regulatory and 
legal frameworks that they may benefit from more thorough and diligent 
auditing practices. Therefore, the Board believes that, rather than 
deterring firms from engaging with innovative sectors, the amendment 
can serve to enhance the quality and effectiveness of audits in these 
industries, ultimately benefiting both participants in the emerging 
industries and investors.

D. Alternatives Considered

    The Board considered two alternatives to the amendment, as 
discussed below.\210\
---------------------------------------------------------------------------

    \210\ As discussed in section C above, the Proposal considered 
amending Rule 3502 to provide that an associated person that 
negligently contributes to a firm's violation need not be an 
associated person of the firm that commits the primary violation. 
The Board decided not to adopt this aspect of the Proposal.
---------------------------------------------------------------------------

1. Alternative Articulations of the Standard of Liability
    Rather than amending Rule 3502 as done, the Board considered 
rewriting Rule 3502 to mirror the language in the cease-and-desist 
provisions of the Exchange Act, 15 U.S.C. 78u-3(a).
    The primary benefit of such an approach would be to facilitate 
interpretive alignment with the scope of the Commission's causing-
liability regime, which may provide associated persons with more 
clarity on the nature of the legal risk. However, for more than a dozen 
years, the Board has developed a distinguishable body of practice under 
Rule 3502 through its enforcement program--including via the rule-based 
requirement that any contribution to a primary violation be ``direct[ ] 
and substantial[ ]''--and the amended rule will maintain that familiar 
practice while narrowly adjusting only the standard of liability.
    In response to comments, the Board also considered other potential 
liability standards, including whether to adopt a framework that would 
require a showing of multiple acts of negligence to hold an individual 
liable for contributory conduct at the negligence level. Commenters 
noted that because Section 21C proceedings are usually brought in 
conjunction with Rule 102(e) proceedings, the Commission often pursues 
a multiple acts of negligence or a heightened form of negligence 
theory. Commenters also discussed their belief that it would be 
inequitable or inappropriate for the Board to hold individuals liable 
for one-time errors.
    However, as discussed in section C above, while the Commission 
often chooses to bring Section 21C and Rule 102(e) matters together, 
nothing requires it to do so. Similarly, under the amendment, the Board 
may choose to bring a case that has repeated acts of negligence, so 
that an appropriate remedial sanction can be imposed. Or, in 
appropriate facts and circumstances, it may choose to bring a case that 
involves a single act of negligence. This optionality thus mirrors that 
available to the Commission under Section 21C. Requiring multiple 
instances of negligence, moreover, would not fully close the regulatory 
gap noted above, would not give the Board authority that is co-
extensive with the Commission, and would not fully achieve the 
efficiency benefits that the amendment seeks to achieve.
2. Removing Additional Barriers to Contributory Liability
    The Board also considered an alternative that would expand the 
Board's ability to hold persons liable for contributing to firm 
violations by changing the ``directly and substantially'' modifier that 
describes the relationship of an associated person's contribution to a 
firm's primary violation, including removing it altogether. This is 
currently an element of proof required for the Board to find a 
violation of Rule 3502.
    Removing ``directly and substantially'' would enable the Board to 
use Rule 3502 to hold accountable any individual who took part in any 
way in the chain of events leading to a firm's violation, even if only 
remotely. The relationship between contributory conduct and the primary 
violation could be a discretionary factor to consider in bringing a 
proceeding in the first instance and when determining the appropriate 
sanction.
    This alternative could improve audit quality by ensuring that all 
individuals with relevant professional responsibilities are 
appropriately motivated to perform their responsibilities with 
reasonable care. However, this could exacerbate the costs and 
unintended consequences discussed above in conjunction with the 
amendment. Therefore, this alternative might lead to excessive 
motivation for auditors to increase defensive efforts that do not 
contribute to audit quality (e.g., excessive self-protective measures 
in anticipation of future litigation).
    The amended rule maintains the criteria of nexus and magnitude 
(``directly and substantially'') for an associated person's 
contribution to a firm's violation, although it does not

[[Page 54921]]

require proof that the individual knew or was negligent in not knowing 
that their conduct would be a direct and substantial contributor. These 
requirements appropriately specify the conduct the Board considers 
actionable for ``contributing'' to a primary violation, as outlined 
above. This approach tailors the incentives to individuals with the 
most direct responsibility for firm compliance. In other words, the 
amendment continues to focus on individuals most likely influenced by 
increased litigation risk leading to improved firm compliance and audit 
quality. Conversely, individuals who are less involved would experience 
lower benefits in relation to costs and unintended consequences.
3. Nonenforcement Alternatives Suggested by Commenters
    Several commenters asserted that an alternative to the amendment is 
for the Board to provide auditors with additional guidance, training, 
and tools illustrating successful and problematic practices. Commenters 
indicated that this could be achieved through enhanced communication, 
such as issuing interpretive guidance and publishing observations from 
enforcement activities, to educate auditors and to help them better 
understand accountability expectations for associated persons, or 
through implementing a real-time consultation process similar to the 
Commission's. One commenter also expressed appreciation of the PCAOB's 
Spotlight series that is published to help users of financial 
statements better understand the PCAOB's activities and observations.
    Although the Board agrees that these alternative approaches are 
beneficial, devoting additional resources to activities buttressing 
these approaches, without addressing the existing regulatory gap, would 
not yield the benefits discussed above that are associated with 
providing the PCAOB with the appropriate tool to hold individuals 
accountable for failing to act reasonably and contributing directly and 
substantially to a firm's violation. An increase in the number of 
regulators that can pursue negligent contributory conduct increases the 
likelihood of the conduct being detected and deterred through a range 
of sanctions that can be imposed by the PCAOB, including training.
    One commenter suggested an alternative to the amendment could be to 
adopt standards addressing the roles of individuals involved in 
designing and monitoring firms' systems of quality control. The 
commenter believes this approach would provide predictability in 
enforcement of PCAOB standards and would more effectively accomplish 
the PCAOB's goals. While addressing the conduct of individuals involved 
in designing and monitoring a firm's system of quality control is 
important, the scope of the amendment, and Rule 3502 generally, are 
broader than quality control.\211\ As discussed previously, the 
amendment aims to address a specific gap in the PCAOB's regulatory 
framework related to liability standards for firms and associated 
persons, ensuring a more consistent and effective regulatory framework.
---------------------------------------------------------------------------

    \211\ QC 1000, if approved by the Commission, would provide 
clear expectations for certain individuals serving in quality 
control roles. QC 1000 and Rule 3502 may overlap in some but not all 
circumstances because Rule 3502 applies to individuals more broadly 
than just quality control roles.
---------------------------------------------------------------------------

Special Considerations for Audits of Emerging Growth Companies

    The amendment does not impose additional requirements on emerging 
growth company (EGC) audits. Accordingly, the Board believes that 
Section 103(a)(3)(C) of Sarbanes-Oxley does not apply. Nevertheless, 
the discussion of benefits, costs, and potential unintended 
consequences above generally applies to the audits of EGCs, and the 
Board includes this analysis for completeness.
    Under Section 104 of the Jumpstart Our Business Startups Act (JOBS 
Act), rules adopted by the Board after April 5, 2012, generally do not 
apply to the audits of EGCs, as defined in Section 3(a)(80) of the 
Exchange Act, unless the Commission ``determines that the application 
of such additional requirements is necessary or appropriate in the 
public interest, after considering the protection of investors, and 
whether the action will promote efficiency, competition, and capital 
formation.'' \212\ As a result of the JOBS Act, the rules and related 
amendments to PCAOB standards adopted by the Board are generally 
subject to a separate determination by the Commission regarding their 
applicability to audits of EGCs.
---------------------------------------------------------------------------

    \212\ See Public Law 112-106 (Apr. 5, 2012). Section 
103(a)(3)(C) of Sarbanes-Oxley, as added by Section 104 of the JOBS 
Act, also provides that any rules of the Board requiring (1) 
mandatory audit firm rotation or (2) a supplement to the auditor's 
report in which the auditor would be required to provide additional 
information about the audit and the issuer's financial statements 
(auditor discussion and analysis) do not apply to an audit of an 
EGC. The amended Rule 3502 falls outside these two categories.
---------------------------------------------------------------------------

    To inform consideration of the application of auditing standards to 
audits of EGCs, Board staff prepares a white paper annually that 
provides general information about the characteristics of EGCs.\213\ As 
of November 15, 2022, PCAOB staff identified 3,031 companies that self-
identified with the Commission as EGCs and filed audited financial 
statements in the 18 months preceding that date.\214\
---------------------------------------------------------------------------

    \213\ For the most recent EGC report, see White Paper on 
Characteristics of Emerging Growth Companies and Their Audit Firms 
at November 15, 2022 (February 20, 2024), available at https://pcaobus.org/resources/other-research-projects (``EGC White Paper'').
    \214\ The EGC White Paper uses a lagging 18-month window to 
identify companies as EGCs. Please refer to the ``Current 
Methodology'' section of the EGC White Paper for details. Using an 
18-month window enables staff to analyze the characteristics of a 
fuller population in the EGC White Paper, but may tend to result in 
a larger number of EGCs being included for purposes of the present 
EGC analysis than would alternative methodologies. For example, an 
estimate using a lagging 12-month window would exclude some EGCs 
that are delinquent in making periodic filings. An estimate as of 
the measurement date would exclude EGCs that have terminated their 
registration or exceeded the eligibility or time limits. See id.
---------------------------------------------------------------------------

    EGCs are likely to be newer public companies, which may increase 
the importance to investors of the external audit to enhance the 
credibility of management disclosures. All else equal, the benefits of 
the higher audit quality resulting from the amendment may be more 
significant for EGCs than for non-EGCs, including improved efficiency 
of capital allocation, lower cost of capital, and enhanced capital 
formation. By increasing the likelihood that associated persons are 
held accountable for their negligent contributory roles in firm 
violations, the amendment to Rule 3502 aims to bolster investor 
confidence in the audit process. Because investors who lack confidence 
in a company's financial statements may require a larger risk premium 
that increases the cost of capital to companies, the improved audit 
quality resulting from applying the amendment to EGC audits could 
reduce the cost of capital to those EGCs.\215\
---------------------------------------------------------------------------

    \215\ For a discussion of how increasing reliable public 
information about a company can reduce risk premiums, see David 
Easley & Maureen O'Hara, Information and the Cost of Capital, 59 J. 
Fin. 1553, 1573 (2004) (``These findings suggest an important role 
for the accuracy of accounting information in asset pricing. Here, 
greater precision directly lowers a company's cost of capital 
because it reduces the riskiness of the asset to the uninformed.'').
---------------------------------------------------------------------------

    The amendment could impact competition in an EGC product market if 
the costs disproportionately affect the EGCs relative to their 
competitors. However, as discussed above, the costs associated with the 
amendment are expected to be small, particularly given the Commission's 
existing authority to sanction associated persons for single

[[Page 54922]]

acts of contributory negligence. Therefore, the amendment's impact on 
competition, if any, is expected to be limited. Overall, the amendment 
is expected to enhance audit quality and increase the credibility of 
financial reporting by EGCs, thereby fostering efficiency.
    Some commenters agreed that the amendment should apply to audits of 
EGCs and that doing so would benefit such audits. One commenter 
remarked that there was no reason not to apply the amendment to audits 
of EGCs and that the principles, standards, and scope of enforcement 
against violations involving contributory negligence should be the same 
regardless of the scale and size of the entity and of the firm. Another 
commenter posited that excluding EGCs from the application of the 
amendment would be inconsistent with protecting the public interest.
    As previously discussed, one commenter suggested that the amendment 
would have a greater impact on smaller firms with fewer resources to 
defend personnel and navigate an uncertain liability environment, and 
consequently, these firms are more likely to cease auditing entities 
that require PCAOB-registered auditors. The Board agrees that the 
amendment may have a greater impact on smaller firms to the extent that 
their individual auditors are investigated under the amended rule, and 
the firms are unable to absorb the direct costs and distractions. This 
would, in turn, impact EGCs because they are more likely than non-EGCs 
to engage small firms.\216\ The Board believes that the amendment 
should apply uniformly to audits of EGCs to maintain high standards of 
audit quality and uphold investor protection across all entities.
---------------------------------------------------------------------------

    \216\ Staff analysis indicates that, compared to exchange-listed 
non-EGCs, exchange-listed EGCs are approximately 2.6 times as likely 
to be audited by a firm that is not affiliated with the largest 
global networks, and approximately 1.3 times as likely to be audited 
by a triennially inspected firm. Source: EGC White Paper and S&P.
---------------------------------------------------------------------------

    Considering these comments and the reasons explained above, the 
Board will request that the Commission determine, to the extent that 
Section 103(a)(3)(C) of the Sarbanes-Oxley applies, that it is 
necessary or appropriate in the public interest, after considering the 
protection of investors and whether the amendment will promote 
efficiency, competition, and capital formation, to apply the amendment 
to audits of EGCs.

III. Date of Effectiveness of the Proposed Rules and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Board consents, the Commission will:
    (A) By order approve or disapprove such proposed rules; or
    (B) Institute proceedings to determine whether the proposed rules 
should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed 
rules are consistent with the requirements of Title I of the Act. 
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/pcaob); or
     Send an email to [email protected]. Please include 
PCAOB-2024-04 on the subject line.

Paper Comments

     Send paper comments in triplicate to Vanessa A. 
Countryman, Secretary, Securities and Exchange Commission, 100 F Street 
NE, Washington, DC 20549-1090.

All submissions should refer to PCAOB-2024-04. This file number should 
be included on the subject line if email is used. To help the 
Commission process and review your comments more efficiently, please 
use only one method. The Commission will post all comments on the 
Commission's internet website (https://www.sec.gov/rules/pcaob). Copies 
of the submission, all subsequent amendments, all written statements 
with respect to the proposed rules that are filed with the Commission, 
and all written communications relating to the proposed rules between 
the Commission and any person, other than those that may be withheld 
from the public in accordance with the provisions of 5 U.S.C. 552, will 
be available for website viewing and printing in the Commission's 
Public Reference Room, 100 F Street NE, Washington, DC 20549, on 
official business days between the hours of 10 a.m. and 3 p.m. Copies 
of such filing will also be available for inspection and copying at the 
principal office of the PCAOB. Do not include personal identifiable 
information in submissions; you should submit only information that you 
wish to make available publicly. We may redact in part or withhold 
entirely from publication submitted material that is obscene or subject 
to copyright protection. All submissions should refer to PCAOB-2024-04 
and should be submitted on or before July 23, 2024.

    For the Commission by the Office of the Chief Accountant.
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-14487 Filed 7-1-24; 8:45 am]
BILLING CODE 8011-01-P