[Federal Register Volume 89, Number 164 (Friday, August 23, 2024)]
[Notices]
[Pages 68223-68225]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-18984]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-100772; File No. PCAOB-2024-04]


Public Company Accounting Oversight Board; Order Granting 
Approval of Amendment to PCAOB Rule 3502 Governing Contributory 
Liability

August 20, 2024.

I. Introduction

    On June 20, 2024, the Public Company Accounting Oversight Board 
(the ``Board'' or the ``PCAOB'') filed with the Securities and Exchange 
Commission (the ``Commission''), pursuant to section 107(b) \1\ of the 
Sarbanes-Oxley Act of 2002 (``SOX'') and section 19(b) \2\ of the 
Securities Exchange Act of 1934 (the ``Exchange Act''), a proposal to 
adopt an amendment to PCAOB Rule 3502, Responsibility Not to Knowingly 
or Recklessly Contribute to Violations, the Board's ethics rule 
governing the liability of associated persons who directly and 
substantially contribute to a registered public accounting firm's 
primary violation (the ``Amendment''). The Amendment was published for 
comment in the Federal Register on July 2, 2024.\3\ The Commission 
received one comment letter in response to the Notice of Filing of 
Proposed Rules.\4\ This order approves the Amendment, which we find to 
be consistent with the requirements of Title I of SOX and the rules and 
regulations thereunder and is necessary or appropriate in the public 
interest or for the protection of investors.
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    \1\ 15 U.S.C. 7217(b).
    \2\ 15 U.S.C. 78s(b).
    \3\ See Public Company Accounting Oversight Board; Notice of 
Filing of Proposed Rules on Amendment to PCAOB Rule 3502 Governing 
Contributory Liability, Release No. 34-100429 (June 26, 2024 [89 FR 
54895 (July 2, 2024)] (``Notice of Filing of Proposed Rules''), 
available at https://www.sec.gov/files/rules/pcaob/2024/34-100429.pdf.
    \4\ The Commission received a comment letter from the 
Pennsylvania Institute of Certified Public Accountants (July 22, 
2024). This comment letter is available on the Commission's website 
at https://www.sec.gov/comments/pcaob-2024-04/pcaob202404.htm.
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II. Description of the Amendment

    Existing 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.\5\ 
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. On June 12, 2024, the 
Board unanimously adopted the Amendment,\6\ which changes from 
recklessness to negligence the liability standard for actionable 
contributory conduct by associated persons under Rule 3502. Whereas 
negligence is ``the failure to exercise reasonable care or 
competence,'' \7\ recklessness requires ``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.'' \8\
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    \5\ Section 103(a) of SOX directs the Board, by rule, to 
establish ``ethics standards . . . to be used by registered public 
accounting firms in the preparation and issuance of audit reports, 
as required by [SOX] or the rules of the Commission, or as may be 
necessary or appropriate in the public interest or for the 
protection of investors.''
    \6\ See Amendment to PCAOB Rule 3502 Governing Contributory 
Liability, PCAOB Release No. 2024-008 (June 12, 2024) (``Adopting 
Release''), available at https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/053/2024-008-rule-3502-adoption.pdf?sfvrsn=9819bcd3_2.
    \7\ In re S.W. Hatfield, C.P.A., SEC Release No. 34-69930, at 35 
n.169 (July 3, 2013) (describing the standards for recklessness and 
negligence) (citation and quotation marks omitted).
    \8\ Id. at 29 (citation and quotation marks omitted).
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    Following notice and comment, and based on its experience with Rule 
3502 since the Commission approved the ethics rule in 2006,\9\ the 
PCAOB determined that the Amendment would better align Rule 3502 with 
the scope of the PCAOB's enforcement authority under SOX, thus further 
advancing the PCAOB's mission of investor protection.
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    \9\ See Public Company Accounting Oversight Board; 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, Release No. 34-53677 (Apr. 
19, 2006), available at https://www.sec.gov/files/rules/pcaob/2006/34-53677.pdf.
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    The PCAOB determined that 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. 
Specifically, a firm, which acts through its associated persons, 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. The PCAOB determined that this 
incongruity means that associated persons may have weaker incentives to 
exercise the appropriate level of care in their audit work, and that 
the modification to Rule 3502's liability standard from recklessness to 
negligence would incentivize associated persons to be more deliberate 
and careful in their actions.
    The PCAOB also determined that the current version of Rule 3502 
prevents the Board from executing its investor-protection mandate to 
the fullest extent that Congress authorized in SOX. According to the 
PCAOB, in the instances in which the Board has instituted proceedings 
against firms for negligence-based violations, the Board has not been 
able to charge individuals who negligently, directly, and substantially 
contributed to the firms' violations. The Amendment would allow the 
Board to do so.

[[Page 68224]]

III. Effective Date

    The Amendment will be effective 60 days from the date of this 
order.

IV. Comment Letters

    The comment period on the Amendment ended on July 23, 2024. The 
Commission received one comment letter.\10\ That comment letter 
reiterated comments that had been submitted to the PCAOB on its 
proposing release and that were addressed by the Board in its Adopting 
Release. The commenter questioned whether the PCAOB had legal authority 
for the Amendment, and was generally critical about the need for the 
Amendment and the economic and investor-protection rationales put forth 
by the Board. For example, the commenter argued that any benefit from 
additional enforcement actions does not justify the costs, potential 
negative effects on the talent pool, and anticompetitive outcomes, and 
urged the Commission to conduct a comprehensive impact assessment of 
the Amendment on the accounting and auditing sectors. The commenter 
also argued that the Amendment may cause some firms to exit the market 
for audit services and result in greater market concentration for 
auditors.
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    \10\ See supra note 4.
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    We have considered the concerns raised by the commenter, all of 
which were considered by the Board prior to finalizing the Amendment, 
and believe that the Amendment is consistent with the requirements of 
Title I of SOX and the rules and regulations thereunder and necessary 
or appropriate in the public interest or for the protection of 
investors.
    With respect to the Board's authority, in its 2006 order approving 
Rule 3502, the Commission stated that ``the rule is within the scope of 
the PCAOB's authority, particularly its authority to establish ethical 
standards.'' \11\ The Amendment, which changes the standard for 
actionable contributory conduct but not the rule's basic ethical 
obligation, does not alter that conclusion. Section 103(a)(1) of SOX 
expressly authorizes the Board to establish or adopt ethics standards 
to be used by registered public accounting firms in the preparation and 
issuance of audit reports. As the Board observed when proposing the 
existing rule, an associated person has an ethical obligation not to 
cause any violations by the firm, and Rule 3502 codifies that 
obligation.\12\ We view that obligation as fundamental given that a 
firm can only act through its associated persons and believe that it is 
reasonable to conclude, as the Board did, that such an obligation 
should extend to situations in which an associated person fails to 
exercise sufficient care to avoid negligently causing a violation 
rather than being limited to reckless conduct. In this regard, we note 
that a contributory liability rule based on negligence is consistent 
with other longstanding ethical obligations that apply to associated 
persons when conducting audits.\13\
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    \11\ See supra note 9 at 9.
    \12\ See Proposed Ethics and Independence Rules Concerning 
Independence, Tax Services, and Contingent Fees, PCAOB Release 2004-
015 (Dec. 14, 2004) at 18, available at https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/docket017/2004-12-14_release_2004-015.pdf?sfvrsn=b15567fb_0.
    \13\ Indeed, the American Institute of Certified Public 
Accountants (``AICPA'') Code of Professional Conduct at the time 
that SOX was enacted (and still today) makes it an ``act 
discreditable to the profession''--and therefore a violation of its 
ethics rules--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.'' AICPA Code of Professional Conduct, ET Section 
501.05(a), Negligence in the Preparation of Financial Statements or 
Records, recodified at Section 1.400.040.01. That is also the case 
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.'' Id. Section 501.05(c).
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    In addition, section 105 of SOX 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).
    With respect to the Amendment's potential adverse effects, we 
acknowledge (as the PCAOB did) that the Amendment could result in some 
incremental legal costs and operational adjustments for firms, 
individuals, and issuers. However, for the reasons discussed below, we 
agree with the Board's conclusion that any unintended consequences of 
the Amendments are likely to be limited and that, on balance, the 
Amendment will enhance audit quality, not diminish it, for the benefit 
of investors.\14\
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    \14\ See Adopting Release, supra note 6 at 57-63.
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    As a threshold matter, the Amendment does not establish a novel 
burden on individuals to refrain from acting negligently and thereby 
contributing to a firm's violation: the Commission already has the 
ability to bring cases against associated persons for negligently 
contributing to registered firms' violations of numerous laws and rules 
governing the preparation and issuance of audit reports.\15\ Rather, 
the Amendment merely provides a mechanism for the PCAOB to discipline 
individuals who fail to act reasonably. And while we appreciate that 
complex audit engagements can involve a wide range of judgments, we 
concur with the Board's observation from the Adopting Release that the 
Amendment does not target mere errors in judgment, but rather 
unreasonable conduct.\16\ With respect to market concentration, 
although the Amendment could lead some firms to exit the issuer audit 
market, it is unclear that this effect would necessarily detract from 
the provision of associated persons' services. For example, such exit 
might involve low-quality auditors and lead to a higher concentration 
of more capable and compliant audit firms. At the same time, the 
Amendment is likely to result in significant benefits in the form of 
more efficient enforcement, while encouraging individuals to exercise 
the appropriate level of care, thereby raising audit quality.
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    \15\ 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,'' 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.''
    \16\ See Adopting Release, supra note 6 at 10.
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    SOX requires us to determine whether the Amendment is consistent 
with the requirements of Title I of SOX and the rules and regulations 
thereunder and is necessary or appropriate in the public interest or 
for the protection of investors. In making this determination, we have 
considered the comments received, as well as the feedback received and 
modifications made by the PCAOB throughout its rulemaking process.

[[Page 68225]]

V. Effect on Emerging Growth Companies

    Section 103(a)(3)(C) of SOX, as amended by section 104 of the 
Jumpstart Our Business Startups Act of 2012, requires that any rules of 
the Board requiring mandatory audit firm rotation or a supplement to 
the auditor's report in which the auditor would be required to provide 
additional information about the audit and the financial statements of 
the issuer (auditor discussion and analysis) shall not apply to an 
audit of an emerging growth company (``EGC'').\17\ Section 103(a)(3)(C) 
further provides that ``[a]ny additional rules'' adopted by the PCAOB 
do not apply to audits of EGCs ``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.''
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    \17\ The term ``emerging growth company'' is defined in Section 
3(a)(80) of the Exchange Act (15 U.S.C. 78c(a)(80)). See also 
Inflation Adjustments under Titles I and III of the JOBS Act, 
Release No. 33-11098 (Sept. 9, 2022) [87 FR 57394 (Sept. 20, 2022)], 
available at https://www.sec.gov/files/rules/final/2022/33-11098.pdf.
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    The Board expressed its view that section 103(a)(3)(C) does not 
apply to the Amendment because the provisions of the Amendment do not 
fall into those categories and do not impose additional requirements on 
the audits of EGCs.\18\ To the extent that section 103(a)(3)(C) does 
apply, however, the Board recommended that the Commission determine 
that the Amendment apply to audits of EGCs.\19\
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    \18\ See Adopting Release, supra note 6 at 66-68.
    \19\ Id.
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    With respect to the Commission's determination of whether the 
Amendment will apply to audits of EGCs, the PCAOB provided information, 
including data and analysis of EGCs, that sets forth its views as to 
why it believes the Amendment should apply to audits of EGCs.\20\ In 
addition, the Board sought public input on the application of the 
Amendment to the audits of EGCs. Some commenters agreed the Amendment 
should apply to the audits of EGCs, although 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.\21\
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    \20\ Id.
    \21\ Id. at 67-68.
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    We agree with the Board's assessment and believe that applying the 
Amendment to the audits of EGCs 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. Specifically, by applying the Amendment to all associated 
persons of registered public accounting firms engaged in the audits of 
issuers and registered broker-dealers, including audits of EGCs, 
investors will benefit from higher standards of audit quality and 
enhancements to investor protection brought about by the Amendment. 
Because EGCs are likely to be newer public companies, investors may 
place greater importance on external audits' adherence to applicable 
audit standards, in order to enhance and test the credibility of 
management disclosures, including whether financial statements are free 
from material misstatement due to error or fraud. Therefore, 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. 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 associated persons engaged in 
EGC audits could reduce the cost of capital to those EGCs.
    Also, given the Commission's existing authority to sanction 
associated persons of accounting firms for single acts of contributory 
negligence, the costs to EGCs associated with the Amendment are 
expected to be small. Therefore, the Amendment's impact on competition, 
if any, is expected to be limited.
    Accordingly, after considering the protection of investors and 
whether the action will promote efficiency, competition, and capital 
formation, we believe that the application of the Amendment to 
associated persons engaged in the audits of EGCs is necessary or 
appropriate in the public interest.\22\
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    \22\ Although the Board expressed the view that Section 
103(a)(3)(C) does not apply to the Amendment given that it does not 
impose any additional audit requirements, we note that Section 
103(a)(3)(C) refers to ``[a]ny additional rules'' adopted by the 
PCAOB. Therefore, to avoid any ambiguity regarding the application 
of the Amendments within the context of EGC audits, we are making 
the finding required by Section 103(a)(3)(C).
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VI. Conclusion

    The Commission has reviewed and considered the Amendment, the 
information submitted therewith by the PCAOB, the comment letter 
received, and the recommendation of the Commission's staff. The 
Commission concludes that the determinations made by the PCAOB as 
described in the Adopting Release are reasonable. In particular, the 
Amendment will make Rule 3502 both a more effective deterrent against 
unethical contributory conduct by associated persons and a more 
effective enforcement tool. The Amendment also should prompt 
individuals to exercise the appropriate level of care in their audit 
work and lead firms to allocate resources more efficiently, which will 
raise audit quality. In doing so, the Amendment will advance the 
Board's investor protection mandate under SOX. Therefore, in connection 
with the PCAOB's filing and the Commission's review:
    A. The Commission finds that the Amendment is consistent with the 
requirements of Title I of SOX and the rules and regulations thereunder 
and is necessary or appropriate in the public interest or for the 
protection of investors; and
    B. Separately, the Commission finds that the application of the 
Amendment to associated persons engaged in the audits of EGCs 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.
    It is therefore ordered, pursuant to section 107 of SOX and section 
19(b)(2) of the Exchange Act, that the Amendment (File No. PCAOB-2024-
04) be and hereby is approved.

    By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2024-18984 Filed 8-22-24; 8:45 am]
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