Public Company Accounting Oversight Board; Notice of Filing of Proposed Rules on Firm and Engagement Metrics and Related Amendments to PCAOB Standards, 99968-100090 [2024-28142]

Download as PDF 99968 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices SECURITIES AND EXCHANGE COMMISSION A. Board’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rules [Release No. 34–101724; File No. PCAOB– 2024–06] (a) Purpose Public Company Accounting Oversight Board; Notice of Filing of Proposed Rules on Firm and Engagement Metrics and Related Amendments to PCAOB Standards November 25, 2024. Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the ‘‘Act’’), notice is hereby given that on November 22, 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 November 21, 2024, the Board adopted Firm and Engagement Metrics and related amendments to its rules and forms (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 Boards website at https://pcaobus.org/ about/rules-rulemaking/rulemakingdockets/docket-041, and at the Commission’s Public Reference Room. lotter on DSK11XQN23PROD with NOTICES2 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, the Board is requesting that the Commission approve the proposed rules, pursuant to Section 103(a)(3)(C) of the Sarbanes-Oxley Act, 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. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 The Board has adopted a set of firmand engagement-level metrics (the ‘‘final rules’’ or ‘‘final metrics’’) that certain registered public accounting firms (‘‘firms’’ or ‘‘audit firms’’) will be required to publicly report relating to their audit practices and the audits they lead. The Board believes these metrics will provide valuable additional information, context, and perspective on auditors and audit engagements, which can be used by investors, audit committees, and other stakeholders, and which will further the Board’s oversight activities. The Board believes this will advance investor protection and promote the public interest by enabling stakeholders to make better-informed decisions, promoting auditor accountability, and ultimately enhancing capital allocation and confidence in our capital markets. The new reporting requirements will apply to firms that audit at least one company that is an ‘‘accelerated filer’’ or ‘‘large accelerated filer’’ (as those terms are defined in SEC rules).1 Lack of Consistent, Comparable Data About Audits and Auditors Investors and audit committees cannot easily observe the services performed by auditors. This can limit investors’ ability to make informed decisions about investing their capital, ratifying the selection of auditors, and voting for members of the board of directors, including directors who serve on the audit committee, and audit committees’ ability to choose among and monitor the performance of auditors. At the same time, there is a lack of incentive for firms, acting on their own or collectively, to provide accurate, standardized, and decisionrelevant information about their firms and the engagements they perform. In response to these challenges, the Board has studied ways to measure audit firm and audit engagement performance, primarily with a view to providing information useful to investors in their investment and proxy voting decisions, but also recognizing that metrics could potentially be informative to other stakeholders. In addition, the Board itself would benefit from having additional tools to use in its oversight activities, including its inspections program, standard-setting initiatives, and research activities. 1 vSee PO 00000 17 CFR 240.12b–2 (‘‘Rule 12b–2’’). Frm 00002 Fmt 4701 Sfmt 4703 The Board has observed that many of the firms that issue audit reports for more than 100 issuers annually and audit companies that account for the majority of U.S. public company market capitalization already publicly disclose certain firm-level metrics through audit quality reports, transparency reports, or similar documents. However, these disclosures generally do not contain engagement-level information, which investors have indicated would be the most useful to them, and are inconsistent across firms and year to year, with no common definitions or calculations that would allow for meaningful comparisons. Moreover, most of the disclosures are voluntary, so firms are free to revise or discontinue such reporting at any time. In the Board’s view, the current voluntary reporting regime cannot provide consistent, comparable information that stakeholders can rely on to inform their decisions over time. And it would appear that firms’ attempts at voluntary reporting have not, in fact, satisfactorily addressed investor desire for additional information about audits and auditors. On the contrary, support from investors and investor-related groups for this rulemaking initiative has been consistent throughout its history, even as the practice of firm voluntary reporting has evolved and spread. Metrics at Firm and Engagement Level The final rules require reporting of metrics at both the firm and the engagement levels. Firm-level metrics relate to aspects of the firm’s audit practice (e.g., average experience at a public accounting firm of the firm’s partners) and engagement-level metrics relate to individual audit engagements (e.g., experience at a public accounting firm of the engagement partner and the engagement quality reviewer (‘‘EQR’’) and average experience of certain other engagement team members). The Board is requiring firm-level metrics because it believes information relevant to the firm will be beneficial in providing context for engagement-level metrics and in evaluating the firm’s audit practice and its related system of quality control. The Board is requiring engagement-level metrics because it believes that information will be useful in gaining a richer understanding of a particular audit and because investors have stressed the importance to them of engagement-level information to assist them in evaluating the performance of the auditor and the audit committee. Most metrics will be reported at both firm- and engagement-level. However, the final rules require reporting at only E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 the firm level in cases where the Board believes engagement-level data would not be meaningful or would be disproportionally challenging to collect in relation to the incremental benefit. Final Metrics The Board adopted metrics in the following eight areas: Partner and Manager Involvement. Hours worked by senior professionals relative to more junior staff across the firm’s large accelerated and accelerated filer engagements and on the specific engagement. Workload. Average weekly hours worked on a quarterly basis by senior professionals who incurred hours on large accelerated and accelerated filer engagements, including time attributable to engagements, administrative duties, and all other matters, both firm-wide and on the core engagement team. Training Hours for Audit Personnel. Average annual training hours for partners, managers, and staff of the firm, combined, both firm-wide and on the core engagement team. Experience of Audit Personnel. Average number of years worked at a public accounting firm (whether or not PCAOB-registered) by senior professionals across the firm and on the engagement. Industry Experience. Average years of career experience of senior professionals in key industries audited by the firm at the firm level and the audited company’s primary industry at the engagement level. Retention of Audit Personnel (firmlevel only). Continuity of senior professionals (through departures, reassignments, etc.) across the firm. Allocation of Audit Hours. Percentage of hours incurred prior to and following an issuer’s year end across the firm’s large accelerated and accelerated filer engagements and on the specific engagement. Restatement History (firm-level only). Restatements of financial statements and management reports on internal control over financial reporting (‘‘ICFR’’) that were audited by the firm over the past three years. Firms are permitted, but not required, to accompany the metrics with narrative disclosure to provide additional context. The final suite of metrics focuses primarily on information about audit personnel. The Board believes these metrics will provide new insights into how engagements are staffed, including the extent of involvement of senior personnel; auditors’ overall workload; retention of personnel across the firm; and levels of training, audit experience, VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 and industry-specific expertise. The final metrics will also provide information about the extent of audit work completed prior to the issuer’s year-end, an aspect of the audit process that the Board believes is associated with improved audit outcomes, and about the firm’s history of restatements, a key measure of audit outcomes. This new information will allow users to draw inferences about audits and audit forms that are not possible today. Some may relate to specific metrics. For example, a heavy workload for a particular engagement team relative to the firm average or compared to peer firms may raise questions about the quality of the work performed. Conversely, a relatively high level of industry experience, particularly for an engagement in an industry that benefits from specific accounting and auditing expertise, would be a positive signal. Other inferences may relate to combinations of metrics. For example, the personnel-related metrics, taken together, give an overall sense of how an engagement is staffed that can be compared to firm averages and to engagements for similar issuers. It is possible that the precise numerical values of metrics may be important in some cases but, in general, the Board believes the metrics will be more useful to convey a sense of whether a particular engagement or firm appears fairly typical or is an outlier in one or more respects. This should provide a richer context for understanding the work of the auditor than the current environment of almost no publicly available information. The Board also believes that gathering data and calculating the final metrics, given the subjects they address, will not be overly costly, time-consuming, or burdensome. Based on the Board’s oversight activities, it appears that the largest firms are already tracking data in many of these areas. Many of the metrics are based on data that firms already track or will be required to track for purposes of other PCAOB requirements. For example, Partner and Manager Involvement and Allocation of Audit Hours are based on the same time reporting required for Form AP purposes. Training hours will reflect the same information that firms track to ensure proper licensing of their personnel. Restatement data, to the extent firms are not already tracking it, is required to be tracked under QC 1000. In addition to required data, many firms track the experience of their personnel, as well as industry experience, for use in marketing materials and for inclusion in requests for proposals, and some firms already track staff retention and PO 00000 Frm 00003 Fmt 4701 Sfmt 4703 99969 turnover metrics as part of their human capital management. Firms should be able to generate other data required by the final metrics, such as Workload, from their existing timekeeping systems with minimal additional effort. Responding to Commenter Concerns After considering commenter input, the Board has made a number of changes from the proposal. The final rules eliminate four proposed metrics areas (Audit Resources—Use of Specialists and Shared Service Centers, Audit Hours and Risk Areas, Quality Performance Ratings and Compensation, and Audit Firms’ Internal Monitoring) and add one new metric area (Training Hours for Audit Personnel). In addition, only firm-level reporting will be required for one area (Retention of Audit Personnel) that was proposed to be reported at both the firm and engagement level. The Board has also made revisions to simplify and clarify some of the other metrics and exempted firms with a small issuer practice from reporting on their industry experience. In addition, the Board has expanded the optional narrative disclosure from 500 to 1,000 characters and has provided additional direction that the narrative should be concise and focused on the reported metrics, with a view to facilitating the reader’s understanding of the metrics. The Board believes that these changes will address commenter concerns about challenges of data collection, potential sensitivity of data, and potential ambiguity of the metrics, and that the final suite of metrics will provide consistent, comparable information on auditors and audit engagements, giving investors, audit committees, and other stakeholders valuable new context and perspective. The Board considered comments questioning the value of metrics, whether they will be used by investors and other stakeholders or would represent only a ‘‘check the box’’ compliance exercise, and whether they might contribute to information overload or have other negative consequences. Based on the other stakeholder input received, the Board does not share those views. In comments provided in the Board’s rulemaking process and surveys conducted by a firm-related group, investors and investor-related groups have repeatedly indicated that the metrics will be useful. As one investorrelated group noted: Auditors say they want to be seen or evaluated as something other than a commodity business evaluated based upon price. For this to happen, auditors need to provide investors with information such that E:\FR\FM\11DEN2.SGM 11DEN2 99970 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices they can value the work of the auditor—just as they evaluate and value the business and the work of management.2 The Board also notes that similar objections—that the new information would not be used or would be confusing or misleading—were raised by many of the same commenters in connection with its last two rulemakings requiring disclosure of additional information about audits and auditors: Form AP reporting of the name of the engagement partner and information about other firms participating in the audit, and auditor communication of critical audit matters (‘‘CAMs’’). In both cases, these commenter concerns appear unsubstantiated. The Form AP data set is now one of the most frequently visited areas of the PCAOB’s website.3 As for CAMs, while academic studies have shown mixed results about the impact of CAMs, in a recent investor survey conducted by a firm-related group, over 90% of the respondents indicated that CAMs play an important role in their investment decisionmaking.4 In addition, data aggregators, such as Audit Analytics, compile and make available data on CAMs, which suggests market demand for that information. The Board’s experience therefore suggests that, contrary to concerns about irrelevance and information overload, stakeholders seek out additional information about auditors and audit engagements when it is available. Filing Requirements Under the Board’s final rules, firmlevel reporting is required of every firm that audits at least one ‘‘accelerated filer’’ or ‘‘large accelerated filer’’ under SEC rules during the reporting period. Engagement-level reporting will be required for every audit of an accelerated or large accelerated filer. The thresholds will apply to the audits, and auditors, of companies that account for the majority of U.S. public company market capitalization, and the Board believes they will capture the situations where investment and proxy voting decisions will be most likely to benefit from additional information about the audit and the auditor. The final rules: lotter on DSK11XQN23PROD with NOTICES2 2 Letter from CFA Institute, August 30, 2024, at 17. 3 In 2023, there were over 333,000 unique searches performed on AuditorSearch and the Form AP data set was downloaded over 2,000 times. Information related to usage statistics can be found on the PCAOB’s website (https://pcaobus.org/ resources/auditorsearch). 4 The Center for Audit (‘‘CAQ’’) Quality Critical Audit Matters Survey (July 2024) at 9. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 • Require reporting of firm-level metrics annually on a new Form FM, Firm Metrics, pursuant to a new Rule 2203C, Firm Metrics, for firms that issued an audit report with respect to at least one accelerated filer or large accelerated filer during the reporting period; • Require reporting of engagementlevel metrics for audits of accelerated filers and large accelerated filers on a revised Form AP, renamed ‘‘Audit Participants and Metrics’’; and • Allow, but not require, limited narrative disclosures on both Form FM and Form AP to provide context and explanation for the required metrics. Background The final rules build on other actions the Board has taken to provide stakeholders with additional information about registered firms and the audits they perform, including information about firms available through its registration and reporting forms, information about auditors and engagements on Form AP, and communication of critical audit matters and auditor tenure in the auditor’s report. The Board concurrently adopted other changes to firm reporting requirements.5 The Board believes the final rules will complement these efforts by providing investors, audit committees, and other stakeholders with additional information in a consistent format and compiled with sufficient rigor to assist them in making decisions. For example, the metrics could inform investors’ decision-making regarding whether to ratify the audit committee’s selection of an auditor or to vote for members of the board of directors, including directors who serve on the audit committee, as well as potentially assisting in audit committee oversight, supporting continuous improvement of firms’ quality control systems, and facilitating the Board’s own oversight and rulemaking efforts. The Board further believes that the value of these metrics will likely increase over time as firm reporting practices develop and trends become observable. As in its proposal, the Board uses the term ‘‘firm and engagement metrics’’ rather than ‘‘audit quality indicators’’ (‘‘AQIs’’) to describe the metrics that it adopted. The Board believes this avoids the potential misimpression that any set of metrics can comprehensively measure audit quality and emphasizes the Board’s goal of promoting informed 5 See Firm Reporting, PCAOB Rel. No. 2024–013 (Nov. 21, 2024) (adopting amendments to reporting requirements for Form 2, Annual Report Form, and Form 3, Special Reporting Form). PO 00000 Frm 00004 Fmt 4701 Sfmt 4703 decision-making through robust disclosure requirements. Some commenters were critical of that change in terminology, suggesting that it evidenced that the Board is no longer focused on audit quality. It is simply a clarification. Because some of the most important elements of a high-quality audit, such as application of due care and professional skepticism, cannot be measured and quantified directly, the metrics employ proxies, such as years of experience, auditor workloads, and percentage of audit hours attributable to more senior members of the engagement team, which can only partially capture these concepts. Even though these proxies cannot provide a complete picture of audit quality, the Board believes they will nevertheless convey important information about auditors and the engagements they lead that stakeholders will find relevant and useful. The Board believes that consideration of the metrics in combination, together with any additional context a firm may choose to provide, will help users interpret the data, and that the metrics, analyzed across firms and over time, will yield important, currently unavailable information that will assist investors, audit committees, and other stakeholders in their decision-making, oversight, and evaluation related to audits. The Board developed the proposal after considering input from numerous sources, including the recommendations of the U.S. Department of Treasury’s Advisory Committee on the Auditing Profession (‘‘ACAP’’), including the October 6, 2008 Final Report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury (‘‘ACAP Final Report’’); the Concept Release on Audit Quality Indicators, PCAOB Rel. No. 2015–005 (July 1, 2015) (‘‘Concept Release’’), and the comments received; the voluntary practices of firms; recommendations from the PCAOB’s Investor Advisory Group (‘‘IAG’’); and the initiatives of international regulators. The Board has carefully considered this input and believes that the final amendments strike an appropriate balance between the expected benefits of the new reporting requirements and the associated costs of implementation and compliance. Effective Dates If the Commission approves the final rules and final metrics, both firm-level and engagement-level reporting will be required for periods beginning October 1, 2027. The Board also adopted a phased implementation period for both E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices firm- and engagement-level reporting, where firms that issue audit reports for more than 100 issuers will begin reporting in the first year that reporting is required and other firms beginning one year later. (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 rules for public comment in PCAOB Release No. 2024–002 on April 9, 2024. Previously, the Board issued a concept release for public comment in PCAOB Release No. 2015–055 on July 1, 2015. The Board received over 45 comment letters in response to the proposing release and 50 letters in response to the concept release. See Exhibits 2(a)(B) and 2(a)(C). 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. Background lotter on DSK11XQN23PROD with NOTICES2 Project History 1. Importance and Potential Benefits of Increased Information About Audit Firms and Engagements With the passage of the SarbanesOxley Act of 2002 (‘‘Sarbanes-Oxley’’) and the establishment of the PCAOB, Congress acknowledged and reemphasized the auditor’s important gatekeeping role.6 Reflecting that importance, the Board believes requiring audit firms to provide additional information about the firm and the engagements it performs will advance investor protection and promote the public interest by enabling investors to make better-informed decisions. As discussed in more detail below, the Board has also heard from investors and other stakeholders that they believe such information will be beneficial. Sarbanes-Oxley also mandated new exchange requirements regarding the responsibilities of audit committees of listed companies, including requiring 6 See Section 101(a) of Sarbanes-Oxley, 15 U.S.C. 7211(a); Senate Report No. 107–205, at 5–6 (July 3, 2002). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 that audit committees be charged with responsibility for the appointment, compensation, and oversight of the auditor.7 The Board believes that making information available to audit committees regarding both the specific audit and auditor they oversee and the audits and auditors of their peer companies will assist them in carrying out this statutory mandate. Over the years, the Board has received significant input on the importance and potential benefits to stakeholders of additional information about audits and auditors. The key elements of that input are summarized below. i. ACAP Recommendations In 2007, the U.S. Treasury constituted the ACAP to consider and develop recommendations relating to the sustainability of the auditing profession.8 On October 6, 2008, ACAP published a report detailing recommendations intended to enhance the sustainability of a strong and vibrant public company auditing profession.9 One of the ACAP recommendations was that the PCAOB, in consultation with auditors, investors, public companies, audit committees, boards of directors, academics, and others, ‘‘determine the feasibility of developing key indicators of audit quality and effectiveness and requiring auditing firms to publicly disclose those indicators’’ 10 and, assuming that development and disclosure of indicators of audit quality are feasible, that the PCAOB be required to monitor these indicators. ii. 2013 and 2017 PCAOB Investor Advisory Group Recommendations At its October 2013 IAG Meeting,11 the IAG working group on AQIs made recommendations for the PCAOB to prescribe informative, forward-looking disclosures and indicators intended to measure the quality of audits and enhance auditor accountability. They emphasized that investors and audit committees generally care more about the quality and credibility of audit work on specific engagements—the 7 See Securities Exchange Act of 1934, Section 10A(m)(2), 15 U.S.C. 78j–1(m)(2). 8 See ACAP Final Report, at IV:1. 9 See ACAP’s Fact Sheet: Final Report of the Advisory Committee on the Auditing Profession, available at https://home.treasury.gov/news/pressreleases/hp1158#:∼:text=The%20U.S.%20 Treasury%20Department%20%27s%20 Advisory%20Committee%20on,into%20three %20sections%20by%20principal%20areas%20of %20focus. 10 See ACAP Final Report, at VIII:14. 11 See Oct. 2013 IAG meeting and presentations, Report from the Working Group: Audit Quality Indicators, available at IAG Meeting Archive, https://pcaobus.org/news-events/events/eventdetails/pcaob-investor-advisory-group-meeting_758. PO 00000 Frm 00005 Fmt 4701 Sfmt 4703 99971 companies in which they have invested or were considering investing, or the company on whose board of directors they served—rather than firms’ more general efforts to improve quality. Accordingly, in addition to disclosures and metrics to be reported at the firm level, they also recommended disclosures and metrics to be reported at the engagement level. At the October 2017 IAG meeting, an IAG working group discussed three topics: (i) why audit quality and AQIs matter to investors, (ii) the PCAOB’s authority and efforts to date to enact AQIs, and (iii) audit quality initiatives in other jurisdictions.12 The 2017 working group also endorsed the 2013 AQI working group’s recommendations. The recommendations provided by the 2013 and 2017 IAG working groups are reflected in many of the metrics the Board adopted. 2. PCAOB Initiatives This section provides further background and expands on the history of PCAOB activities related to providing additional information about audit firms and audits, including firm and engagement metrics. i. 2015 AQI Concept Release In July 2015, the PCAOB issued the Concept Release and sought comment on 28 potential indicators. The indicators were organized into three groups: • Audit professionals—Measures dealing with the availability, competence, and focus of those performing the audit. • Audit process—Measures related to an audit firm’s tone at the top and leadership, incentives, independence, attention to infrastructure, and record of monitoring and remediation. • Audit results—Financial statements, internal control, going concern, communications between auditors and audit committees, and enforcement and litigation. The Concept Release discussed (i) the nature of the potential indicators and potential calculations, (ii) the usefulness of the indicators, (iii) suggestions for other indicators, (iv) potential users of the indicators, and (v) the approach to implementation. In response to the Concept Release, the PCAOB received 50 comment letters. Most commenters expressed support for the general idea that AQIs may be 12 See Oct. 2017 IAG meeting and presentation, available at IAG Meeting Archive, https:// pcaobus.org/news-events/events/event-details/ pcaob-investor-advisory-group-meeting_1085. E:\FR\FM\11DEN2.SGM 11DEN2 99972 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 useful.13 However, commenter views varied widely. Comments from firms and firm-related groups suggested that no standard group of indicators could advance a person’s understanding of audit quality. These commenters suggested that AQIs should be voluntary, should be reported to audit committees through two-way discussions to provide context for the indicators, or should be required only at the firm level. Investors and investorrelated groups recommended that indicators should be made public as they could be used to stimulate competition based on quality among audit firms, remedy the deficiency of information about audits, and give shareholders meaningful information to help them in voting on auditor selection. Some commenters suggested that engagement-level metrics are more useful than firm-level metrics. One commenter suggested that promoting competition around an implied variability in audit quality may not always be appropriate and in the public interest because audit quality should be nonnegotiable and a fundamental goal for all audits. Another commenter suggested that it was critical to define what AQIs do and do not represent so that they are used appropriately. ii. PCAOB Rulemakings To Increase Audit Transparency: Identification of the Engagement Partner and Other Audit Participants on Form AP and Auditor Communication of Critical Audit Matters In 2015, the PCAOB adopted rules requiring information on Form AP, Auditor Reporting of Certain Audit Participants, regarding the engagement partner and other accounting firms that participate in audits of issuers.14 The rulemaking was initially in response to the ACAP recommendation that the engagement partner should be required to sign the audit report.15 As the rulemaking evolved, it also took account of stakeholder input, including IAG recommendations to identify the engagement partner and the firms, other than the firm signing the audit report, that participate in audits. The Board’s intention was to make available information about the engagement partner and other firms that participated in the audit, saying that such information, even if not useful in every instance or meaningful to every investor, would make an overall 13 See Nov. 2015 Standing Advisory Group (SAG) Briefing Paper available at SAG Meeting Archive, https://pcaobus.org/news-events/events/eventdetails/standing-advisory-group-meeting_910. 14 See PCAOB Rule 3211. 15 See ACAP Final Report, at VII:19. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 contribution to the information available to investors in making voting and investment decisions. The Board also asserted that increased transparency should promote increased accountability in the audit process. The Form AP reporting requirements became effective in 2017, and the data gathered via Form AP has many users; the Form AP data set is frequently searched through AuditorSearch, the PCAOB’s online search tool, as well as downloaded by users performing more detailed analyses.16 In 2017, the PCAOB adopted AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, which includes requirements regarding the disclosure of auditor tenure and auditor determination and communication of ‘‘critical audit matters.’’ 17 This project was also initiated in response to ACAP’s recommendation that the PCAOB undertake a standard-setting initiative to consider improvements to the auditor’s standard reporting model.18 The rulemaking explored potential ways to increase the transparency and relevance of the auditor’s report, including by requiring expanded auditor reporting regarding the audit and the company’s financial statements.19 In the adopting release, the Board noted ACAP’s statement that the complexity of financial reporting supports improving the content of the auditor’s report beyond the then-current pass/fail model to include a more relevant discussion about the audit of the financial statements. After multiple rounds of Board releases and stakeholder input, the requirements took effect in 2019 and 2020. iii. Recent PCAOB Standard-Setting and Rulemaking Activities At the November 2022 Standards and Emerging Issues Advisory Group (SEIAG) and the October 2022 and 2023 IAG meetings, several members continued to urge the Board to take action on firm and engagement metrics. Other members stated that some firms already publish similar metrics through transparency reports and audit quality reports. Some members of the IAG and 16 See below. AS 3101.11–.16. 18 See ACAP Final Report, at VII:13. 19 See Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements and Related Amendments to PCAOB Standards; Notice of Roundtable (June. 21, 2011), available at https://pcaobus.org/newsevents/news-releases/news-release-detail/pcaobissues-concept-release-on-auditor’s-reportingmodel_337. 17 See PO 00000 Frm 00006 Fmt 4701 Sfmt 4703 SEIAG have requested increased information at the firm and engagement levels through easily accessible and quantified metrics, potentially with accompanying context provided by the auditors.20 In response to the Board’s request for comment on the draft 2022–2026 Strategic Plan, some commenters encouraged the Board to continue to consider this topic.21 Additionally, in a January 2023 comment letter on the PCAOB’s proposed quality control standard, members of the IAG advocated for ‘‘a minimum requirement of eight indicators.’’ 22 These eight indicators were (i) staffing leverage; (ii) partner workload; (iii) manager and staff workload; (iv) audit hours and risk areas; (v) quality ratings and compensation; (vi) audit fees, effort, and client risk; (vii) audit firm’s internal quality review results; and (viii) PCAOB inspection results. a. QC 1000: Requirements The Board adopted a new quality control standard for firms, QC 1000, A Firm’s System of Quality Control (‘‘QC 1000’’),23 which contains provisions that are relevant to firm reporting of firm- and engagement-level metrics. QC 1000 will become effective in December 2025. (1) Public Communication of Firm-Level or Engagement-Level Information QC 1000 includes a quality objective that, if a firm communicates firm-level or engagement-level information with respect to the firm’s audit practice, firm personnel, or engagements, such as firm or engagement metrics, to external parties, such information is accurate and not misleading and, with respect to any such metrics that are communicated 20 See Nov. 2022 SEIAG meeting, available at https://pcaobus.org/news-events/events/eventdetails/pcaob-standards-and-emerging-issuesadvisory-group-meeting-2022. See Oct. 2022 IAG meeting, available at https://pcaobus.org/newsevents/events/event-details/pcaob-investoradvisory-group-meeting and Oct. 2023 IAG meeting, available at https://pcaobus.org/news-events/ events/event-details/pcaob-investor-advisory-groupmeeting-october-2023. 21 See comments on 2022–2026 Strategic Plan Documents, available at https://pcaobus.org/about/ strategic-plan-budget/comments-on-pcaob-draftstrategic-plan-2022-2026. 22 See A Firm’s System of Quality Control and Other Proposed Amendments to PCAOB Standards, Rules, and Forms, PCAOB Rel. No. 2022–006 (Nov. 18, 2022). The comment letters received in response to the proposal are available on the Board’s website in Docket 046. See comment letter from members of the IAG, available at https://assets.pcaobus.org/ pcaob-dev/docs/defaultsource/rulemaking/ docket046/4_iag.pdf?sfvrsn=1941e7c0_4. 23 See A Firm’s System of Quality Control and Other Amendments to PCAOB Standards, Rules, and Forms, PCAOB Rel. No. 2024–005 (May 13, 2024) (‘‘QC Adopting Release’’). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices in writing, the communication explains in reasonable detail how the metrics were determined and, if applicable, how the method of determining them changed since the metrics were last communicated.24 (With respect to metrics reported on Form FM and Form AP, the form itself provides the required explanation.) The final firm and engagement metrics include reporting elements that focus on the firm’s responsibility to produce and report information that is accurate and not misleading, for example, an optional narrative to accompany the metrics. This element is discussed further below. (2) Use of Metrics in Monitoring the Firm’s QC System Under QC 1000, in determining the nature, timing, and extent of QC systemlevel monitoring activities, the firm is required to take into account any metrics that the firm may use in its QC system.25 QC 1000 does not require the use of any specific metrics; firms have the ability both to develop metrics on their own and to use any or all of the metrics required to be reported under Rule 2203C and Rule 3211 in their QC system, but that is not required. The Board believes these metrics would provide information that could be used in the firm’s system of quality control. However, not all firms may find all metrics useful in operating or monitoring their QC system, and the Board is not mandating their use in connection with monitoring a firm’s QC system at this time. lotter on DSK11XQN23PROD with NOTICES2 b. Firm Reporting Concurrently with this rulemaking, the Board adopted certain updates to its annual and special reporting requirements to facilitate the disclosure of more complete, standardized, and timely information regarding audit firms. Among other new requirements, the updates will (i) require firms to disclose additional information on Form 2 about their fees, leadership and governance structure, and network arrangements; (ii) require, in connection with QC 1000, a one-time update to the statement on a firm’s quality control policies and procedures on a new Form QCPP; and (iii) expand the scope of special reporting to include events that pose a material risk, or represent a material change, to the firm’s organization, operations, liquidity or financial resources, in such a manner that it will affect the provision of audit 24 QC 25 QC 1000.53e. 1000.65c. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 99973 services, as well as new cybersecurity reporting requirements.26 firm- and engagement-level information to be provided to various stakeholders. c. Proposed Firm and Engagement Metrics In April 2024, the Board proposed amendments to the PCAOB’s rules and reporting forms to require the reporting of specified firm-level metrics on new Form FM, Firm Metrics, and specified engagement-level metrics on an amended and renamed Form AP, Audit Participants and Metrics. In the Board’s proposal, it proposed a set of firm-level and engagement-level metrics across 11 areas to be publicly reported for the firms that serve as lead auditor for at least one accelerated filer or large accelerated filer. The Board received over 45 comment letters on the proposal.27 Commenters included investor-related groups, firms, firm-related groups, academics, and others. Some commenters expressed concerns about the speed of rulemaking by the Board. Some commenters asked the PCAOB for more than 60 days to respond to the proposal, citing overlapping comment proposal periods, the duration of comment periods, the length and complexity of various proposals, and overlapping SEC 19b–4 filing comment periods. On the other hand, a commenter urged the Board not to delay this rulemaking because investors need a relatively standardized data set to analyze and compare over time and across companies. The Board believes that 60 days was a sufficient period for commenting on the proposal. Despite that, the Board considered comment letters that were submitted after the 60-day period closed. The Board received robust comments on the proposal, which informed the final metrics or final rules.28 These comments are addressed throughout this Exhibit 1 and in the Board’s adopting release (Exhibit 3). i. Available Information Related to Firms 3. Overview of Existing Requirements Under current PCAOB rules and standards, certain information about PCAOB-registered firms is already made available to investors, audit committees, and other stakeholders. The disclosure of firm- and engagement-level metrics would supplement this information. This section discusses the key PCAOB standards and rules that require certain 26 See PCAOB Rel. No. 2024–013. comment letters received on the proposal are available at https://pcaobus.org/about/rulesrulemaking/rulemaking-dockets/docket-041/ comment-letters. 28 See also below for consideration of the 2015 AQI Concept Release (including comments received) and the PCAOB IAG recommendations. 27 The PO 00000 Frm 00007 Fmt 4701 Sfmt 4703 PCAOB rules require firms to file Form 2 (Annual Report Form) to report basic information about the firm and its audit practice and Form 3 (Special Reporting Form) after the occurrence of certain events.29 In addition, the PCAOB makes portions of inspection reports publicly available for firms that are subject to annual or triennial PCAOB inspections. a. Form 2 and Form 3 As required by Section 102(d) of Sarbanes-Oxley and PCAOB Rule 2200, each year registered firms must file an annual report with the Board. Under PCAOB rules, firms must do so by filing Form 2. The annual reporting period runs from April 1 to March 31, and the due date for filing is June 30.30 In addition to basic identifying information about the firm,31 firms report on Form 2 general information about their audit practices and other business relationships. Information required to be provided on Form 2 includes: • Whether the firm issued audit reports for issuers, brokers, or dealers or played a substantial role in issuer or broker-dealer audits; 32 • Percentage of total fees billed to issuers for audit services, other accounting services, tax services, and non-audit services; 33 • For each issuer or broker-dealer for which the firm issued an audit report, the issuer’s or broker-dealer’s name, its Central Index Key (CIK) number and Central Registration Depository (CRD) number (if any), and the date of the audit report, as well as the total number 29 PCAOB Rule 2200, Annual Report; PCAOB Rule 2201, Time for Filing of Annual Report; PCAOB Rule 2203, Special Reports; Instructions to Form 2, available at https://pcaobus.org/about/ rules-rulemaking/rules/form_2; Instructions to Form 3, available at https://pcaobus.org/about/ rules-rulemaking/rules/form_3. Information reported on Forms 2 and 3 is publicly available unless a firm requests confidential treatment. 30 PCAOB Rule 2201; General Instructions 3–4 to Form 2 (registered public accounting firm that has its application for registration approved by the Board in the period between and including April 1 and June 30 of any year not required to file an annual report in that year). 31 Instructions to Form 2, Item 1.1. 32 Id., Item 3.1. The Board’s release uses the terms ‘‘issuer,’’ ‘‘broker,’’ and ‘‘dealer’’ as those terms are defined under Sections 2(a)(7) and 110(3)–(4) of Sarbanes-Oxley. 15 U.S.C. 7201(a)(7), 7220(3)–(4). See also paragraphs (b)(iii), (d)(iii), and (i)(iii) of PCAOB Rule 1001, Definitions of Terms Employed in Rules. Entities that are brokers or dealers or both are sometimes referred to as ‘‘broker-dealers.’’ 33 Instructions to Form 2, Item 3.2. E:\FR\FM\11DEN2.SGM 11DEN2 99974 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices of firm personnel who exercised authority to sign the firm’s name to an audit report for an issuer or brokerdealer during the reporting period; 34 • Physical address (and, if different, mailing address) of each firm office; 35 • Whether the firm has any memberships, affiliations, or similar arrangements involving certain activities related to audit or accounting services (including use of name in connection with audit services, marketing of audit services, and employment or lease of personnel to perform audit services), and the entities with which the firm has those relationships; 36 • Total number of accountants, certified public accountants, and personnel; 37 • Relationships with certain individuals and entities with disciplinary or other histories (if not previously identified); 38 and • Acquisitions of another public accounting firm or a substantial portion of another firm’s personnel.39 In addition to annual reporting on Form 2, firms are required to file Form 3 within 30 days after the occurrence of certain events, such as when the firm’s legal name has changed while otherwise remaining the same legal entity, the firm has withdrawn an audit report on the financial statements of an issuer or has resigned, declined to stand for reappointment, or been dismissed from an audit engagement as principal auditor, and the issuer has failed to comply with applicable Form 8–K reporting requirements for such events.40 a substantial role, and the Board has not historically inspected those firms. The PCAOB provides each inspected firm with a report summarizing any deficiencies identified through the inspections process. Portions of these inspection reports are publicly available on the PCAOB’s website.42 Recently the PCAOB introduced enhanced search tools that enable investors and others to better access and understand data from PCAOB inspection reports.43 critical accounting policies and practices, critical accounting estimates, and significant unusual transactions; 47 (iii) the auditor’s evaluation of the quality of the company’s financial reporting; 48 and (iv) other matters that are significant to the oversight of the company’s financial reporting process.49 In addition, other PCAOB standards and rules and SEC rules independently require certain audit committee communications.50 ii. Available Information Related to Issuer Engagements b. Firm Inspection Reports Sarbanes-Oxley authorizes the PCAOB to inspect firms for the purpose of assessing compliance with certain laws, rules, and professional standards in connection with a firm’s audit work for issuers, brokers, and dealers. Firms that issue audit reports for more than 100 issuers per year are inspected annually. Firms that issue 100 or fewer audit reports per year for issuers are generally inspected at least once every three years. The Board also inspects firms that play a substantial role in audits of issuers. Many firms registered with the Board perform no audit work for issuers or broker-dealers,41 or only participate in audits below the level of 42 See https://pcaobus.org/oversight/inspections for inspection reports, basics of inspections, and inspection procedures. Sarbanes-Oxley provides that no portions of an inspection report that deal with criticisms of or potential defects in the quality control systems of the firm shall be made public if those criticisms or defects are addressed by the firm, to the satisfaction of the Board, no later than 12 months after the issuance of the inspection report. See Sarbanes-Oxley Section 104(g)(2). Full (expanded) inspection reports are publicly available on the PCAOB’s website when a firm fails to satisfactorily remediate within 12 months. 43 See https://pcaobus.org/news-events/newsreleases/news-release-detail/pcaob-launches-newonline-tools-to-help-users-find-and-compareinspection-report-data for a summary of the enhancements, including six new search filters, including Part I.A deficiency rate, to help users analyze and compare more than 3,700 inspection reports. 44 See Auditing Standard No. 16, Communications with Audit Committees; Related Amendments to PCAOB Standards; and Transitional Amendments to AU Sec. 380, PCAOB Rel. No. 2012–004 (Aug. 15, 2012), at 2, available at https://assets.pcaobus.org/pcaob-dev/docs/ default-source/rulemaking/docket030/release_2012004.pdf?sfvrsn=7872effb_0. 45 Id. (‘‘Communications with the audit committee provide auditors with a forum separate from management to discuss matters about the audit and the company’s financial reporting process.’’). 46 See AS 1301.09. b. Auditor’s Public Communications of Certain Information AS 3101 and Rule 3211 require firms to publicly disclose certain engagementspecific information in the auditor’s report and on Form AP. In addition to specifying the requirements for an unqualified opinion on the financial statements, AS 3101 requires the auditor’s report to describe (i) critical audit matters, which inform investors and other financial statement users of matters arising from the audit that required especially challenging, subjective, or complex auditor judgment; and (ii) how the auditor addressed those matters. AS 3101 further requires the auditor’s report to include a statement disclosing the year in which the auditor began serving consecutively as the company’s auditor. Other standards require additional information to be included in the auditor’s report, including AS 2415, Consideration of an Entity’s Ability to Continue as a Going Concern, which requires an explanatory paragraph when the auditor concludes that there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time.51 PCAOB Rule 3211 requires auditors to file Form AP, which, among other things, provides information to investors and other financial statement users about the engagement partner and other accounting firms participating in the audit of issuers. Disclosures on Form AP provide increased transparency about certain audit participants. The key provisions include annual disclosures of (a) the name of the engagement partner and (b) the name and extent of participation of other accounting firms in the audit.52 lotter on DSK11XQN23PROD with NOTICES2 34 Id., Items 4.1, 4.3. 35 Id., Item 5.1. 36 Id., Item 5.2. 37 Id., Item 6.1. 38 Id., Items 7.1, 7.2. 39 Id., Item 8.1 40 General Instruction 3 to Form 3; Instructions to Form 3, Items 2.17, 2.1, 2.1–C, 3.1, 3.2. 41 See QC Adopting Release at 54. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 a. Auditor’s Communications With Audit Committees Investors and other financial statement users are the beneficiaries of the audit. Audit committees protect the interests of investors by assisting the board of directors in fulfilling its responsibility to oversee the integrity of the company’s accounting and financial reporting processes, including the audit of the company’s financial statements— and in carrying out that duty, they also benefit other financial statement users. To support the audit committee in this crucial role, PCAOB standards and rules and SEC rules require auditors to provide certain firm- and engagementlevel information to audit committees.44 AS 1301, Communications with Audit Committees, requires various communications to facilitate the audit committee’s financial reporting oversight.45 Among other things, AS 1301 requires the auditor to communicate: (i) significant risks; 46 (ii) PO 00000 Frm 00008 Fmt 4701 Sfmt 4703 47 See AS 1301.12 AS 1301.13. 49 See AS 1301.24. 50 See Appendix B of AS 1301 (listing other PCAOB standards and rules requiring audit committee communications); see also 17 CFR 210.2–07; PCAOB Rule 3526, Communication with Audit Committees Concerning Independence. 51 See AS 2415.12. 52 See Instructions to Form AP. Form AP requires different disclosures regarding other accounting 48 See E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices The PCAOB makes the Form AP data set available on AuditorSearch, by which users can conduct live searches or download the entire data set in a searchable, machine-readable format.53 Using this data, a user can determine, for example, the changes in engagement partner for any given issuer or obtain a list of all issuers for which an engagement partner is responsible. After identifying an engagement partner, a user can then compile information from other sources, including information about whether the partner is associated with restatements of financial statements, has been subject to public disciplinary proceedings, or has experience as an engagement partner for issuers of a particular size or in a particular industry. Similarly, starting from the Form AP data set, users may perform further research on the other accounting firms that participate in an audit, such as whether those firms are registered with the PCAOB, whether they have any publicly available disciplinary history, whether they have been inspected, and, if so, the results of those inspections. lotter on DSK11XQN23PROD with NOTICES2 4. Voluntary Firm Reporting Since the Concept Release, many of the audit firms that issue audit reports for more than 100 issuers and audit the majority of the market capitalization for issuers have been publicly disclosing certain firm-level information discussed in the Concept Release through their audit quality reports, transparency reports, or other published reports. A firm-related group has published a framework to assist its members in these efforts.’’ 54 Many firms may also be developing and monitoring certain firm firms that participate in an audit depending on their level of participation. For other accounting firms with individually 5% or greater participation in the audit, the Form AP filer must disclose the legal name of the other accounting firm, the city and state (or, if outside the United States, the city and country) of that firm’s headquarters, and the percentage of total audit hours (either as a single number or within a range provided on the form) attributable to each other accounting firm. For other accounting firms with individually less than 5% participation, the filer must disclose the total number of such other accounting firms and the aggregate percentage (either as a single number or within a range provided on the form) of total audit hours for all such firms. 53 See AuditorSearch, available at https:// pcaobus.org/resources/auditorsearch. 54 CAQ, Audit Quality Disclosure Framework (Update) (June 2023). The framework provides that metrics ‘‘may provide those overseeing the audit and other stakeholders with information and additional transparency into the firm’s systems and processes that impact audit quality. However, the CAQ believes that a combination of metrics—taken as a whole and supplemented with robust discussion—may provide those overseeing the audit and other stakeholders with information and additional transparency into the firm’’s systems and processes that impact audit quality.’’ Id. at 4. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 and engagement metrics to be used internally by the firm. In 2023, the same firm-related group published a summary analysis of the most recent audit quality reports issued by the eight firms represented on the group’s governing board.55 The report indicated that firms were reporting similar firm-level quantitative metrics related to several areas, including audit firm inspections; training; use of auditor’s specialists; audit report reissuances and financial statement restatements; measures of experience, such as tenure with the firm; and personnel turnover. The report further noted that some firms disclosed qualitative as well as quantitative information, including information relating to audit methodology and execution, people and firm culture, quality management and inspections, and technology and innovation. The Board has observed the firms that report firm-level metrics generally do not report engagement-level metrics.56 Where firm-level metrics are reported, the firms report different metrics, calculated in different ways, and using different definitions, thereby preventing users from making comparisons across firms. One commenter on the Concept Release stated that many firms are using the 28 AQIs identified in the Concept Release at some level to (i) manage the firm and (ii) manage the quality of audits at the office level and at the engagement level. Another commenter specifically indicated that its audit committee reviewed the engagementlevel AQIs identified in the Concept Release that were provided by their auditor. One commenter on the proposal asserted that the voluntary reporting firms already do through transparency and audit quality reports includes firmlevel metrics, as well as explanations of how they are calculated, including changes in the calculation that could 55 See CAQ Audit Quality Reports Analysis: A Year in Review (Mar. 2023), available at https:// www.thecaq.org/aqr-analysis-yir (‘‘CAQ Report’’). The eight firms on the CAQ’s governing board are BDO USA, LLP, Crowe LLP, Deloitte & Touche LLP, Ernst & Young LLP, Grant Thornton LLP, KPMG LLP, PricewaterhouseCoopers LLP, and RSM US LLP. 56 In connection with the Nov. 2022 SEIAG meeting, the Board staff researched various reports issued during the prior three years by the top 20 accounting firms (by 2022 revenue) and identified nine firms that disclosed firm-level metrics. See Firm and Engagement Performance Metrics Briefing Paper and Related Attachments from Nov. 2022 SEIAG meeting, available at https://pcaobus.org/ news-events/events/event-details/pcaob-standardsand-emerging-issues-advisory-group-meeting-2022. For each firm-level metric reported by those nine firms, the PCAOB staff included examples of how firms calculated the metric as well as the number of firms reporting that metric. PO 00000 Frm 00009 Fmt 4701 Sfmt 4703 99975 affect comparability, as well as context necessary for understanding the metrics, and would be preferable to the mandatory metrics that the Board proposed. On the other hand, an investor-related group presented an analysis of firm transparency and audit quality reports, finding that the measures used in transparency reports and audit quality reports by different firms are not consistent or comparable across firms in their computations, presentation and inclusion, and are not provided at the engagement level, which the commenter believes is the level at which they would be most useful. This commenter stated that having both firmand engagement-level metrics enhances the metrics’ usefulness because it provides broader context for understanding at both levels. Actions in Other Jurisdictions Some jurisdictions outside the United States have moved forward with mandatory or voluntary initiatives related to the monitoring and disclosure of metrics. In May 2022, Accountancy Europe published a factsheet about recent related initiatives in Europe and elsewhere.57 The Accountancy Europe Report described initiatives conducted in 10 countries (including the United Kingdom (U.K.), South Africa and Canada) by various organizations, including audit oversight bodies (including the U.K.’s Financial Reporting Council (FRC), Portugal’s Securities Market Commission (CMVM), South Africa’s Independent Regulatory Board for Auditors (IRBA), and the Canadian Public Accountability Board (CPAB)),58 professional organizations,59 a group of independent experts,60 and the CAQ. Additionally, the FRC in the U.K. issued a consultation document and a feedback statement in 2022 on publishing AQIs for the largest U.K. audit firms,61 the IRBA in South Africa 57 See Accountancy Europe, Factsheet, Audit Quality Indicators—A Global Overview of Initiatives (May 2022), available at https://www.accountancy europe.eu/wp-content/uploads/220401-FactsheetAudit-Quality-Indicators.pdf (‘‘Accountancy Europe Report’’). 58 Id. Other oversight bodies in the Accountancy Europe Report include the Federal Audit Oversight Authority (FAOA) in Switzerland and the Accounting and Corporate Regulatory Authority (ACRA) in Singapore. 59 Id. Professional organizations in the Accountancy Europe Report include the Institute of Public Auditors (IDW), Germany and The Institute of Chartered Accountants (ICAI), India. 60 Id. Quartermasters, Netherlands. 61 See FRC, Consultation Document: Firm-level Audit Quality Indicators (June 2022), available at https://media.frc.org.uk/documents/FRC_AQI_ Consultation.pdf. See FRC, Feedback Statement: Firm-level Audit Quality Indicators Consultation (Dec. 2022), available at https://www.frc.org.uk/ E:\FR\FM\11DEN2.SGM Continued 11DEN2 99976 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 requested firms auditing listed companies to submit AQI-related information to the IRBA,62 and the CPAB launched an exploratory pilot project to solicit feedback on AQIs’ usefulness in support of broader national and international discussions.63 The primary users of the metrics from these initiatives were audit committees, oversight bodies, and professional organizations. Although many of the metrics in these initiatives were nonpublic, public reporting was encouraged or anticipated in the future for half of the initiatives.64 The Accountancy Europe Report suggested that several factors should be considered when selecting, evaluating, and reporting metrics and recommended that a combination of metrics would provide ‘‘profound insight into audit quality.’’ In January 2023, Accountancy Europe published a position paper.65 The position paper defined key concepts related to audit quality, presented considerations for developing AQIs, and explained what, in its view, can and cannot be achieved by reporting such indicators (for example, the paper pointed out that all metrics have limitations, that metrics are not a proxy for financial reporting quality, and that user expectations should be managed to make them aware that metrics do not provide definitive results). The paper stated as part of its conclusion that ‘‘[AQIs] should not be considered as an end in themselves but could be a useful tool to drive audit quality’’ and reiterated that a combination of metrics would provide insight into audit quality. Some commenters noted that initiatives in other jurisdictions do not currently require public disclosure. getattachment/afbf3bc4-cf15-468a-85daafb8e5af222a/Feedback-Statement_-2022.pdf (‘‘FRC Feedback Statement’’). 62 See IRBA 2021 Survey Report Audit Quality Indicators, available at https://www.irba.co.za/ upload/IRBA%20AQI%20Report%202021.pdf and IRBA 2022 Survey Report Audit Quality Indicators, available at https://www.irba.co.za/upload/ 2022%20AQI%20Report.pdf. 63 See CPAB Audit Quality Indicators Final Report, available at https://cpab-ccrc.ca/docs/ default-source/thought-leadership-publications/ 2018-aqi-final-report-en.pdf?sfvrsn=5af68dba_ 12&sfvrsn=af68dba_12 (‘‘CPAB Final Report’’). See also CPAB Audit Quality Indicators: How to put them to work, available at https://cpab-ccrc.ca/ docs/default-source/thought-leadershippublications/2019-aqi-put-to-worken.pdf?sfvrsn=246de787_10. 64 See Accountancy Europe Report (public reporting encouraged or anticipated by ACRA, CAQ, FRC, IDW, and Quartermasters). 65 See Accountancy Europe, Position Paper, Key Factors to Develop and Use Audit Quality Indicators (Jan. 2023), available at https:// accountancyeurope.eu/wp-content/uploads/ 221206-AQIs-Position-Paper_FINAL.pdf. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Others suggested that the requirements that the Board proposed were more onerous than other jurisdictions and may cause reporting of different calculations for similar metrics in different jurisdictions. One commenter provided examples in other jurisdictions including providing optional guidance, allowing engagement-level metrics to be shared confidentially with audited entities, and allowing for voluntary adoption. Another commenter expressed its belief that the Board is attempting to justify individual metrics based on certain jurisdictions’ use but have not fully considered the context in how they are being used or the process that has been undertaken in those jurisdictions. An additional commenter stated that the comparability problem between jurisdictions could be solved by allowing firms to voluntarily disclose the metrics as defined. One commenter expressed the hope that audit regulators globally will seek to align requirements relating to the reporting of metrics. While other jurisdictions have not historically required public reporting, the U.K. FRC has announced that it will begin to require public reporting in 2025.66 The Board considered the actions taken in other jurisdictions in developing the final metrics. While substantially all the final metrics are the same as, or similar to, metrics used in some other jurisdictions, the Board acknowledges that no other jurisdiction has embraced either the full set of metrics or the public reporting requirements the Board has adopted. However, the Board’s objective in understanding actions in other jurisdictions was not to conform to what they have done but rather to consider those actions in the context of the Board’s own rulemaking, which is addressed further below. The Board believes that its approach to evaluating and determining which metrics should be disclosed is appropriate in light of its statutory investor-protection mission. Discussion of the Final Rules Overview As noted above, the Board considered ways to measure audit firm and audit performance, primarily with a view to providing information that investors can 66 See https://www.frc.org.uk/consultations/aqisconsultation. In June 2025, the FRC is requiring firms that audit 20 or more public interest entities to publicly report ten firm-level metrics across five areas. These areas include (i) Performance monitoring and remediation, (ii) Quality monitoring, (iii) Resource planning and people management, (iv) Information and communication, and (v) Governance and leadership. PO 00000 Frm 00010 Fmt 4701 Sfmt 4703 use in making decisions regarding their investments, such as ratifying the selection of the auditor and voting for members of the board of directors, including directors who serve on the audit committee. The Board also believes that firm and engagement metrics will benefit other stakeholders. For audit committees, metrics will provide additional context, including consistent comparative information that is not currently available, that can be used when deciding whether to select or retain a firm and when overseeing the auditor’s performance. For audit firms, metrics will provide standardized information about themselves and their peers that can be used in designing, implementing, monitoring, and remediating their systems of quality control. The Board will also benefit from having additional tools to use in its inspections program and standardsetting initiatives. This rulemaking addresses the need for information by requiring consistent, comparable disclosures that the Board believes will provide insight into aspects of the firm and the engagement team conducting the audit, including information relating to workloads, retention, allocation of audit hours, experience, and restatements. 1. Purpose of the Metrics Investors and other stakeholders lack information that is available to company management. The federal securities laws seek to reduce this information asymmetry through various disclosure, internal control, and other requirements, including requirements for public companies to prepare and disclose financial statements accompanied by audit reports issued by an independent public accounting firm. Investors and other stakeholders also lack information available to the auditor and cannot observe the auditor’s work or other aspects of a public company audit. Instead, they must rely on the audit committee, which is charged with overseeing the external auditor, and on other available public information, such as the reputation of the firm issuing the audit report or the name of the engagement partner. These difficulties in evaluating the audit and the auditor may lead to reduced accountability for auditors and an inefficient allocation of audit effort. Such allocations allow audit risk to remain insufficiently evaluated, ultimately risking suboptimal investment decisions, hampering the efficient functioning of the audit profession, and negatively affecting the E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 capital markets.67 Furthermore, while the audit committee has more information regarding the specific auditor it oversees, it lacks insight into other audit engagements and other firms; such comparable information would assist the audit committee in more effectively selecting and monitoring the auditor. Investors and other stakeholders may seek to reduce these information disparities by gathering additional information about the firm responsible for the audit and the relevant audit engagement. As discussed above, the PCAOB has previously sought to facilitate those efforts through rules and standards requiring the disclosure of such information. From its inception, the Board’s registration and reporting program has yielded important information about registered firms. Annual updates on Form 2 include information such as the issuers audited by the firm, a breakdown of fees charged to issuers, and network affiliations, and current reporting on Form 3 discloses significant events such as the withdrawal of an audit report and certain legal actions involving the firm or its professionals. The Board concurrently adopted amendments to both of those reporting forms to mandate the disclosure of standardized and timely information by firms.68 Firms are required to disclose on Form AP the name of the engagement partner and certain audit participants.69 The Board also made the auditor’s report more relevant and informative by, among other things, requiring communication of critical audit matters and the tenure of the auditor.70 The Board intends the firm and engagement metrics to complement these other initiatives and to add to the mix of information available to investors and other stakeholders when evaluating the auditor and the audit.71 The Board’s oversight activities have revealed that there are identifiable performance differences across firms and among engagement teams within 67 There is a long stream of research regarding the effects that information asymmetry about product features, such as quality, and disclosure have on markets. See, e.g., George A. Akerlof, The Market for ‘‘Lemons’’: Quality Uncertainty and the Market Mechanism, 84 The Quarterly Journal of Economics 488 passim (1970); and Robert E. Verrecchia, Essays on Disclosure, 32 Journal of Accounting and Economics 97 (2001). 68 See PCAOB Rel. No. 2024–013. 69 See PCAOB Rule 3211. 70 See AS 3101.10.b, .11–.16. 71 In addition to disclosures on Form AP and in the audit report, the Board previously required information on periodic and special reports to be publicly available. See Rules on Periodic Reporting by Registered Public Accounting Firms, PCAOB Rel. No. 2008–004 (June 10, 2008), 28–32. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 the same firm, including variations among firms belonging to global networks. The Board considered such differences when performing regulatory functions. For example, the Division of Registration and Inspections uses, among other factors, information about the firm and the engagement to identify audit engagements for risk-based selections in the Board’s inspections program. Mandating public disclosure of firmand engagement-level metrics will provide investors, audit committees, and other stakeholders with comparable information that is not currently available and will otherwise be difficult or impossible to obtain. These stakeholders will be able to learn about both specific engagements and specific firms and have a basis to compare them to other engagements and other firms. The firms themselves could also benefit from access to information about their peers, both in gaining new perspective on how their practices compare and in potentially gaining new opportunities for competition based on markers that users come to associate with quality. Required disclosures will facilitate development of standardized data for consistent comparison and analysis over time, which the Board believes will be more valuable than the ad hoc, individualized disclosures that some firms have made on a voluntary basis. Mandatory public disclosure will also ensure that the information will be accessible to all stakeholders, so that any decision-useful information can be readily evaluated. The Board believes this information will enable investors, audit committees, and other stakeholders to make better-informed decisions.72 The Board believes the metrics will also assist the PCAOB in a variety of ways. Metrics will help to inform the Board’s inspection activities, including in the selection of firms, engagements, and focus areas for review. For example, the final metrics could refine the selection models used to aid in predicting negative audit outcomes, enhancing the Board’s risk-based 72 Under Section 102 of Sarbanes-Oxley, the Board may require registered public accounting firms to submit periodic and special reports containing financial or other information as is ‘‘necessary or appropriate in the public interest or for the protection of investors.’’ 15 U.S.C. 7212(d). Section 103 of Sarbanes-Oxley tasks the Board with adopting quality control and other standards to be used by registered 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.’’ 15 U.S.C. 7213(a)(1). See also 15 U.S.C. 7211(a), (c)(5), 7213(a)(2)(B). The Board believes the proposed metrics would further the public interest and would protect investors in accordance with these provisions. PO 00000 Frm 00011 Fmt 4701 Sfmt 4703 99977 inspections. They could also enrich the discussions the Board has with audit committee chairs as part of the Board’s inspections process. Metrics may also inform future standard-setting activities by helping the Board to identify areas where regulatory action is needed and suggesting potential approaches. In addition, the Board expects metrics to enhance the PCAOB’s ability to produce impactful research and to provide valuable information sources for the public, including academic research, helping to create new insights into the audit. The Board’s discussion of the potential benefits of the final metrics in greater detail below. 2. Public Reporting of Metrics Many commenters on the proposal addressed the fundamental question of whether there was value in mandating a set of publicly reported metrics, expressing conflicting views. Investors and investor-related groups were generally supportive. Many other commenters, primarily firms and firmrelated groups criticized the proposal. These commenters either supported public reporting of some firm-level metrics but not others while generally opposing any public reporting of engagement-level metrics, or opposed all public reporting of metrics at both the firm and engagement levels. Among the commenters that supported the metrics proposal, several stressed the benefits of increased transparency for key stakeholders and the public overall. Several commenters generally agreed with the PCAOB’s rationale for the metrics, including increasing competition among audit firms, including on the basis of audit quality; promoting auditor accountability, which will lead to greater audit quality; and providing investors with decision-useful comparable information that will assist them in making decisions about auditrelated matters (e.g., ratifying the appointment of the auditor or voting for reelection of Board members that serve on the audit committee). Two of these commenters asserted that investors currently lack information to make an independent and informed decision regarding ratification of the appointment of the auditor and to hold audit committee members to account in the performance of their duties. In that context, one of these commenters pointed out that most failures to ratify the appointment of the auditor occur after a financial reporting failure, and argued that metrics would provide information allowing investors to make E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 99978 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices an ex ante, rather than ex post, evaluation of the auditor’s work. Two commenters particularly favored engagement-level metrics. One said it would enable the compilation of engagement-level data for all public company audit engagements within a specific office to compare data for competing offices within the same geographic area. In this commenter’s view, metrics such as workload would provide great value to prospective employees and would improve the talent pipeline issue because firms’ workload need to be competitive in the eyes of prospective employees. Another argued that engagement-level metrics are most useful to investors, using firmlevel metrics to provide context. This commenter also emphasized the importance of firm-level metrics, which will provide context in evaluating engagement-level metrics and a firm’s audit practice and its related system of quality control. Several commenters said that the benefits of metrics would likely evolve over time, for example, as users are able to aggregate multiple data points, make comparisons, and observe trends. The Board agrees and believes that analyzing the metrics over time, across engagements and across firms, in the context of known good practices and indicators of audit failure, will enable the PCAOB, as well as academics and users of the metrics, to gain a new perspective on the audit and potentially deeper insights into some of the drivers of audit quality. Many larger firms generally supported certain firm-level metrics. These commenters generally agreed that firmlevel reporting could provide stakeholders with relevant information through consistent disclosure by all firms required to report. While some of the commenters raised concerns about the usefulness, comparability, and risk of misinterpretation of certain firm-level metrics; the risk that standardization of metrics limits their adaptability to change in the business and auditing environment; and more generally concerns that the costs may outweigh the benefits, commenters agreed that the proposed firm-level metrics are generally consistent with voluntary disclosures that some firms are already making in firm transparency and audit quality reports. A discussion of the comments made with regard to particular metrics is provided below. However, firms and firm-related groups generally opposed engagementlevel metrics. Some questioned whether investors would use the metrics. Others expressed concern that publicly available metrics could contribute to VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 information overload. Many said that it would not be possible to provide sufficient context to enable users to understand the metrics, even with the firm-level metrics or narrative disclosures. Some commenters asserted that, because the underlying circumstances of engagement-level metrics are not homogeneous and users would not have necessary context, engagement-level metrics would not be comparable.73 Others focused on the significance of qualitative factors such as professional judgment and the duty to exercise due care, including professional skepticism, saying that metrics were inappropriately ‘‘one size fits all’’ or not decision-useful because they do not capture these key concepts. Many commenters expressed concern that users would not find metrics meaningful and may even misunderstand them and reach inappropriate conclusions. Absent providing substantial context and understanding how stakeholders would use the metrics, in one commenter’s view, investors may make capital allocation decisions based on a misinterpretation of a metric, resulting in a new element of volatility in the capital markets. Two commenters raised a concern that the proposal does not provide a tie between assessing audit quality and the proposed metrics. Some commenters went on to say that providing metrics in isolation without context and effective two-way communication would have very minimal, or even negative, impact on audit quality. Another commenter stated that most of the data points required as part of the proposal are currently available to the PCAOB. One commenter expressed concern that overemphasis on metrics could lead firms to focus on consistency of the metrics to avoid the implication of weak auditing or other potential misinterpretations, which in the commenter’s view could lead to commoditization of the audit and reduce incentives to innovate the audit approach. On the other hand, several other commenters argued that metrics would support more robust competition based on quality, making the audit less of a commodity. Some commenters said that the metrics seemed particularly focused on 73 Commenters listed various types of contexts that in their view would be necessary for proper understanding of the engagement-level metrics, including variations across firms (e.g., differences in operations, structures, methodologies, and resources), the unique circumstances of each engagement (e.g., differences in risk areas, team compositions, and timelines), and the unique circumstances of each issuer (e.g., differences in policies and resources). PO 00000 Frm 00012 Fmt 4701 Sfmt 4703 larger firms or would be especially burdensome for smaller firms. The Board believes the final metrics call for data that will be relevant to and obtainable by firms regardless of size. The potential differential cost impacts are discussed below. Some commenters questioned whether public reporting of metrics would undermine the authority of the audit committee. For example, one expressed concern that there would be public pressure on the audit committee to appoint auditors whose metrics were perceived to be within some acceptable range, even if the committee was satisfied with the work of the current auditor. Another commenter asserted that it is not investors’ responsibility to oversee the auditor, and raised a concern that public reporting of metrics could undermine confidence in audit committees and the PCAOB, both of which have responsibilities for direct oversight of audits and audit firms and have the context to properly understand these metrics. However, an investorrelated group specifically disagreed with this reasoning and asserted that this rulemaking exhibits commitment to faithfully executing the PCAOB’s responsibilities and working to improve audit quality and trust in the audit market. Several commenters opposed both firm- and engagement-level metrics. One asserted that the proposal did not provide sufficient evidence that public disclosure of the proposed metrics will have any meaningful impact on the quality of audit services. Another commenter said that the metrics were not grounded in or intended to have any nexus with audit quality, focusing instead on auditor accountability, and on that basis went beyond the PCAOB’s remit. The commenter asserted that the proposed metrics would overload audit committees and investors with a large set of complex data that was not sought, needed, meaningful, or obviously usable by them, suggesting that the current voluntary approach should be maintained instead. Another expressed concern that public disclosure of the information specified in the proposals could do more harm than good, particularly in relation to an increase in litigation and reputational risk and potentially furthering the talent crisis in the profession. That commenter particularly questioned the potential value of metrics for audit committees, saying that they already have access to most of the information that would be mandated and that annual reporting would be unhelpful since evaluation of the auditor is a continuous process. One commenter who advocated delay and E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices further study before the Board takes further action on the metrics expressed skepticism that metrics would influence shareholder votes on ratification of the appointment of the auditor or benefit most investors, because metrics are only indirectly related to audit quality and there would not be sufficient incentive for users to engage with them. Most of the commenters who objected to public reporting of metrics recommended alternatives, including mandatory or voluntary communication with the audit committee, particularly for engagement-level metrics. Many commenters asserted that the audit committee is the appropriate party to whom engagement-level metrics should be communicated, because the audit committee has the statutory responsibility to appoint, compensate, and replace the external auditor and is sufficiently informed to understand the context of the company, the audit, and the auditor. Commenters said that audit committees could engage in dialog with the auditor, enabling them to understand the metrics in the context of the specific audit, promoting accountability in the performance of the audit on behalf of investors. Another commenter asserted that providing information to, and allowing the assessment by, audit committees would be more likely to provide greater benefits to investors and the capital markets than public reporting, while minimizing unintended consequences (such as users reaching inappropriate conclusions), and would be consistent with the PCAOB’s objective to improve audit quality. Another commenter, who questioned the value of metrics for most investors, said metrics had the potential to be quite useful for audit committees, who could use their direct access to the auditor to gain valuable context and would have the opportunity, using metrics, to communicate more about the audit process in their audit committee report. On the other hand, an investorrelated group pointed out that audit committees are reliant on communications from the auditor regarding the company’s audit issues and the quality of the audit; their principal tool is inquiry, not observation, which, in audit parlance, is the weakest form of audit evidence. Many commenters that objected to publicly available metrics like the ones the Board proposed advocated a nonprescriptive, principles-based approach, whereby auditors and audit committees would discuss potential metrics and the audit committee would determine which metrics and other information it finds meaningful and when it wants to receive and evaluate them. This VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 approach, the commenters said, would encourage more tailored metrics that could be appropriately discussed in context and could change over time, adapting to changes in the audit environment, regulation, technology and audit processes, and the information needs of audit committees and investors and would prioritize relevance rather than consistency. Some commenters specifically recommended amending AS 1301 to mandate such a discussion (for example, initially in connection with audit planning and later as part of reporting on audit results). However, one investor-related group disagreed with this principlesbased approach, asserting that it would not promote comparability or accountability because a set of principles would inevitably result in qualitative rather than quantitative disclosure and the information would not be comparable between firms and engagements and over time. This commenter asserted that the standardized metrics the Board proposed would be more useful to investors. This commenter also provided analysis of audit quality reports published by the Big 4 firms, observing that elements of the proposed firm-level metrics are already presented in those reports under a principles-based approach whereby each firm has developed its own metrics.74 The commenter noted that some of these metrics are qualitative, some are quantitative, some use different definitions, and some unfavorable metrics or facts may be excluded. This commenter also asserted that because metrics voluntarily published by firms are self-defined and principles-based and are only at the firm level and not at the engagement level, they are largely unused by the investment community; they are regarded as marketing materials rather than investor information. This commenter emphasized that investors need more standardized information contextualized at the engagement-level to the company they are investing in and that are anchored to the firm-level standardized information. Several commenters noted that it would be possible for audit committees to provide additional public disclosure via the audit committee report in the issuer’s proxy statement,75 which 74 This commenter provided several examples of inconsistencies in reporting metrics. For example, it stated while all Big 4 firms provide data on turnover or attrition, they are defined and calculated in different ways and any comparison among the firms is stymied. 75 See Schedule 14A. Information required in proxy statement, 17 CFR 240.14a–101. If action is PO 00000 Frm 00013 Fmt 4701 Sfmt 4703 99979 investors could consider in deciding whether to ratify the audit committee’s selection of auditor and whether to vote for the board members who serve on the audit committee. Some of these suggested that the SEC could take action instead of, or along with, the PCAOB. Two argued that expanded audit committee disclosure would result in more relevant and decision-useful information for investors than the proposed metrics or would be a more direct way to address the information asymmetry than through this rulemaking. The other suggested that the SEC, together with the New York Stock Exchange and Nasdaq, should require inclusion of the metrics in the proxy statement to provide context for existing fee disclosures and to make investors aware of the metrics without having to search for them separately. One firm suggested that the PCAOB gather the information underlying the metrics via inspection. However, this would defeat the objective of enhancing transparency to enable better informed decision-making by stakeholders. Another firm expressed concern that engagement-level metrics may not be useful because they will become available only once a year, with a delay of up to 35 days after the audit is completed until Form AP is filed. However, an investor-related group disagreed with this argument indicating that the financial results for companies are delivered with the same, or a more significant delay, to investors and usefulness of the information is not simply its immediate discrete disclosure but the trends in the information within and between companies over time. In addition, commenters raised general concerns about metrics requirements, including • the risk that publishing metrics would involve releasing confidential or nonpublic information, which may violate confidentiality obligations imposed by the American Institute of CPAs (‘‘AICPA’’) Code of Professional Conduct or conflict with non-US laws and regulations; • diverting the attention of the engagement team and firm resources away from performing quality audits; • lessening competition by releasing competitively sensitive information and reducing the number of registered public accounting firms, particularly in foreign jurisdictions, that would be available to play a substantial role in a large multinational group audit; to be taken at a shareholders’ meeting with respect to the election of directors, Item 7 of Schedule 14A requires the proxy statement to contain a report of the audit committee as specified in Item 407 of Regulation S–K, 17 CFR 229.407. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 99980 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices • being burdensome and costly to compile data for each individual engagement; • becoming a ‘‘check the box’’ or compliance exercise that may not improve audit quality or provide meaningful transparency to stakeholders; and • implying that audit committees have a legal duty to consider metrics even though the PCAOB has no authority over audit committees. The Board adopted requirements for firms to provide both firm- and engagement-level metrics, with changes from its proposal as described in further detail below. The Board continues to believe that public reporting of a mandated set of firm- and engagementlevel metrics will provide stakeholders with comparable information that is not currently available, would otherwise be difficult or impossible to obtain, and will position them to make betterinformed decisions. Further, the Board believes that required public disclosures will facilitate development of standardized data for consistent comparison and analysis over time, which will be more valuable than the ad hoc, individualized disclosures that some firms have made on a voluntary basis or the information that could be provided by individual firms to audit committees or investors without any basis for cross-firm comparisons. The Board believes the new data points, when analyzed together with the audited financial statements, critical audit matters, auditor tenure, and other information about the firm and the engagement on Form 2 and Form AP, will provide more information about the audit and, therefore, the reliability of the auditor’s report. The Board considered comments questioning the value of metrics, whether they will be used by investors and other stakeholders or would represent only a ‘‘check the box’’ compliance exercise, and whether they might contribute to information overload or have other negative consequences. Based on comments received from investors and other data provided, among other factors, the Board does not share those concerns. Investors and investor-related groups have commented throughout the course of this rulemaking that the metrics will be useful. A firm-related group commented that, in a recent investor survey it conducted, almost all of the metrics the Board proposed were regarded as ‘‘extremely helpful’’ by between 30% and 50% of participating investors. (The commenter did not indicate whether the survey allowed positive responses other than VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 ‘‘extremely helpful’’—for example, ‘‘helpful’’ or ‘‘somewhat helpful’’—and, if so, what the results were inclusive of those responses.) By contrast, the Board understands—including from one commenter that argues that the voluntary approach should be maintained—that voluntarily provided metrics have not proven useful to investors. The Board believes that the value of voluntary metrics is undermined by a lack of the consistency and comparability, as well as enhanced credibility, that can be achieved through common definitions and calculations and required reporting. The Board also noted that similar objections—that the new information would not be used or would be confusing or misleading—were raised by many of the same commenters in connection with the Board’s last two rulemakings requiring disclosure of additional information about audits and auditors: Form AP reporting of the name of the engagement partner and information about other firms participating in the audit, and auditor communication of critical audit matters. In both cases, these commenter concerns appear unsubstantiated. The Form AP data set is now one of the most frequently visited areas of the PCAOB website.76 Indeed, in an investor survey conducted by one commenter, 79% of respondents indicated that they often or very often navigate to AuditorSearch, the search tool for Form AP data on the PCAOB website. As for CAMs, in a recent investor survey conducted by the same commenter, over 90% of the respondents indicated that CAMs play an important role in their investment decision-making.77 In addition, data aggregators, such as Audit Analytics, compile and make available data on CAMs, which suggests market demand for that information. The Board’s experience suggests that contrary to concerns about irrelevance and information overload, stakeholders seek out additional information about auditors and audit engagements when it is available. In lieu of public reporting, the Board considered the alternative of encouraging or mandating communication of engagement-level metrics to the audit committee, as many commenters suggested. However, such an approach would not achieve the 76 In 2023, there were over 333,000 unique searches performed on AuditorSearch and the Form AP data set was downloaded over 2,000 times. Information related to usage statistics can be found on the PCAOB’s website (https://pcaobus.org/ resources/auditorsearch). 77 The Center for Audit Quality Critical Audit Matters Survey (July 2024) at 9. PO 00000 Frm 00014 Fmt 4701 Sfmt 4703 Board’s goals of increasing the information about audit engagements and audit firms available to investors and other stakeholders, and fostering comparability of data through mandated reporting based on common definitions and specified calculations. The Board also believes that a non-prescriptive, principles-based approach, whereby firms would potentially develop and discuss different metrics for different audit committees, drawn from different data and based on different definitions and calculations and changing over time, could itself create significant costs and challenges for firms without necessarily contributing to the audit committee’s ability to understand the audit it oversees in a broader context. Of course, under the Board’s final requirements auditors and audit committees will be free to discuss performance metrics—whether the metrics required under the Board’s rules or additional or alternative metrics they develop themselves—through the kinds of discussions the commenters recommend. The Board is not requiring that auditors make metrics-specific communications at this time. However, where matters addressed by the metrics are the subject of an otherwise required communication, discussion of the metrics may be a useful part of the communication. The Board appreciates that the audit committee is charged by statute with responsibility for oversight of the auditor, and the Board cannot, and do not purport to, impose any obligations on audit committees or imply that audit committees have any specific duties in relation to metrics. The Board assumes that audit committees will fulfill their responsibilities as they see fit; whether that entails, for example, discussion of metrics with auditors or proxy statement disclosure regarding their consideration of metrics will be for them to determine. But the Board also notes that investors—including many investors that are themselves fiduciaries for others—have their own investment and voting decisions that they are called upon to make, like decisions about electing members of the board of directors, including those who serve on the audit committee, and ratifying the appointment of the auditor. And in the current environment, they have extremely limited access to information about the auditor’s work—work that, after all, is undertaken for their benefit. By requiring public reporting of metrics, the Board is not suggesting that investors will have the ability or the responsibility to oversee the work of the auditor. However, they will have the E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 opportunity to gain new perspective to inform their decision-making. The Board agrees with a commenter that, far from undermining investor trust, this new transparency should enhance that trust by helping investors better understand the audit and the audit committee’s oversight of it. The Board has determined to go forward with published metrics so that investors and other stakeholders will have direct access to the metrics and so that comparative data can be accumulated that will allow comparisons to be made across different firms and different engagements. As discussed below, the Board believes it has addressed many of the challenges associated with potential lack of comparability by narrowing the metrics to a group that it believes will send relatively clear, comprehensible signals that users will be able to interpret when taken together with the other information about the issuer and the auditor that is available to them. In the Board’s view, public reporting is the most practical way for comparative data to be created and disseminated. While two commenters suggested that audit committees could obtain comparative data when they consider changing auditors, the Board’s understanding is that is a relatively infrequent occurrence, and in any case is not a route available to other stakeholders. The Board also believes that gathering data and calculating the final metrics, given the subjects they address, will not be overly time-consuming or burdensome, and will not entail disclosure of confidential or otherwise protected information, as discussed below. Regarding the concerns of possibly disclosing confidential information and competition lessening effect due to public reporting of metrics; unintended consequences, including attention diversion, litigation and reputation risks, competition lessening effect, and audit labor market impacts; and costs, see discussions below. 3. Legal Authority Some commenters questioned the Board’s statutory authority to require all or some of the proposed firm and engagement metrics. In addition, one commenter stated that the statement in the proposal that ‘‘this [rulemaking] would advance investor protection and promote the public interest by enabling stakeholders to make better informed decisions, promoting auditor accountability and ultimately enhancing capital allocation and confidence in our capital markets’’ is beyond the Board’s rulemaking authority. Other VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 commenters questioned the Board’s authority with respect to specific aspects of the rulemaking. Two commenters questioned how the requirements could extend beyond the accounting firms’ issuer and brokerdealer audit practices. One of these commenters stated that it believes including non-issuer information could be misleading to stakeholders who may mistake such disclosures as being within the PCAOB’s purview and that including the non-issuer portion of a firm’s audit practice appears contradictory to the Board’s pursuit of clarity through its proposed PCAOB Rule 2400, Proposals Regarding False or Misleading Statements Concerning PCAOB Registration and Oversight and Constructive Requests to Withdraw from Registration. This commenter suggested that if the Board intends to make clear what lies within and outside its purview through proposed PCAOB Rule 2400, the rulemaking related to firm- and engagement-level metrics should reflect similar principles.78 Another commenter suggested that several new requirements seem to require public production of information that is confidential or otherwise outside of or unnecessary for the Board’s oversight function. In accordance with Sarbanes-Oxley, the PCAOB is endowed with regulatory powers designed to ensure transparency, uphold high professional standards, and protect investors in the auditing process. This discussion outlines the statutory basis for this rulemaking as outlined in Sections 101, 102, and 103 of Sarbanes-Oxley. In particular, here and throughout the release, the Board discussed how the final rules will increase transparency regarding audit practices, increase the comparability and accessibility of information available to investors and others, and enhance investors’ ability to efficiently and effectively make investment and voting decisions, in line with the Board’s statutory mandate. Section 102 of Sarbanes-Oxley mandates that each registered firm must submit an annual report to the Board. Beyond this, Section 102 grants to the Board the authority to require more frequent and detailed reporting, empowering the Board to require registered firms to report ‘‘such additional information as the Board or the Commission may specify.’’ 79 This authority must be exercised through PCAOB rulemaking that deems the information ‘‘necessary or appropriate 78 To date, the Board has not adopted proposed PCAOB Rule 2400. 79 15 U.S.C. 7212(d). PO 00000 Frm 00015 Fmt 4701 Sfmt 4703 99981 in the public interest or for the protection of investors.’’ 80 This statutory language supports the Board’s authority to adapt its reporting requirements to the evolving needs of audit oversight, thereby enhancing investor protection and public confidence in the financial markets. The metrics the Board adopted in its release are important for increasing transparency regarding the practices of registered firms, particularly in their audits of issuers. By mandating the disclosure of this information, the PCAOB will enable investors and other market participants to have a clearer and more comprehensive view of the operational practices of the registered firms that audit issuers. This enhanced transparency will allow investors and other market participants to make more informed decisions, contributing to the integrity and reliability of financial reporting and audit practices. Additionally, Section 103 of Sarbanes-Oxley grants the Board authority to establish auditing standards and quality control 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.’’ 81 Although the information the PCAOB requires from registered firms does not appear directly within audit reports, it is comfortably within the ambit of the Board’s rulemaking mandate under Section 103—especially given the flexibility inherent in the statutory language.82 In brief, this mandate involves establishing the procedures and practices of registered firms that promote the quality and accuracy of audit reports, which extends to 80 15 U.S.C. 7212(b)(2)(H). U.S.C. 7213(a)(1). 82 See Loper Bright Enters v. Raimondo, 144 S. Ct. 2244, 2263 (2024) (the term ‘‘appropriate’’ ‘‘leaves agencies with flexibility’’ (citation and quotation marks omitted)); Kisor v. Wilkie, 588 U.S. 558, 632 (2019) (Kavanaugh, J., concurring in the judgment) (the word ‘‘appropriate’’ ‘‘afford[s] agencies broad policy discretion’’); 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 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.). 81 15 E:\FR\FM\11DEN2.SGM 11DEN2 99982 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 overseeing how firms report their operational conduct. In alignment with Section 103 of Sarbanes-Oxley, the PCAOB views the rule, form, and associated amendments requiring the metrics as fundamental auditing and quality control standards at their core. The information required by the metrics relates to practices of the firm that directly bear on the conduct of audits and ultimately the quality and accuracy of audit reports. By mandating the submission of this information to the PCAOB, the Board provides deeper transparency into the auditing practices that support issuer audits. The information required by the metrics will also support the Board’s oversight and enhance the reliability of audit performance.83 Finally, the Board notes that Section 101 of Sarbanes-Oxley provides ancillary authority that supports the Board’s primary powers in Sections 102 and 103.84 This provision enables the PCAOB to develop standards that protect investors and serve the public interest. Some firms and firm-related groups questioned the Board’s statutory authority to require the reporting of the proposed metrics on the basis that the Board’s rulemaking authority should correspond directly with the type of information outlined in Sarbanes-Oxley Section 102(b)(2) for the contents of registration applications. However, this interpretation significantly misreads the reporting provisions of Sarbanes-Oxley. Sections 102(b)(2)(H) and 102(d) clearly grant to the Board broad authority to require additional information in periodic reports that it finds necessary or appropriate to serve the public interest or protect investors. Section 102(b)(2) generally details baseline requirements for reported information and Section 102(b)(2)(H) primarily details requirements for any additional information the Board 83 See, e.g., Mark DeFond and Jieying Zhang, A Review of Archival Auditing Research, 58 Journal of Accounting and Economics 275, (2014) (asserting that audit quality improves financial reporting quality by increasing the credibility of the financial reports). 84 For example, Section 101(c)(5) empowers the Board to perform additional duties or functions that are ‘‘necessary or appropriate to promote high professional standards among, and improve the quality of audit services offered by’’ registered firms and their associated persons. 15 U.S.C. 7211(c)(5). This provision empowers the PCAOB to implement measures that enhance the integrity and efficacy of the auditing profession. In addition, Section 101(g)(1) provides rulemaking authority to the Board, specifying that the Board’s rules, subject to the approval of the Commission, are to ‘‘provide for the operation and administration of the Board, the exercise of its authority, and the performance of its responsibilities under’’ Sarbanes-Oxley. 15 U.S.C. 7211(g)(1). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 requires, providing that additional information in reports must be deemed ‘‘necessary or appropriate in the public interest.’’ It is incorrect to construe those provisions as imposing a rigid limitation that restricts the content of reports exclusively to the types of information specified in Section 102(b)(2)(A)–(G) for initial registration applications. Indeed, Section 102(b)(2)(H) expressly contemplates the provision of ‘‘other information’’ the Board may require through rulemaking. This provision shows that Congress intended to provide the Board authority to require additional information beyond that enumerated in Section 102(b).85 By referencing this provision, Section 102(d) applies this broader authority to periodic reports that the Board finds necessary or appropriate to serve the public interest or protect investors. The Board’s release has outlined how the disclosures mandated by the metrics will enhance transparency and bolster the PCAOB’s oversight capabilities. Such enhancements are designed to ultimately improve audit quality. For example, as discussed more completely below, the final metrics will enhance (i) audit committees’ ability to efficiently and effectively monitor and select auditors as well as (ii) investors’ ability to efficiently and effectively make decisions about ratifying the appointment of their auditors and allocating capital. In addition, as an important indirect benefit, the final rules could further spur competition to the benefit of investors. Thus, the final rules align with the overarching objectives of Sarbanes-Oxley, and therefore are appropriate exercises of the Board’s authority under Section 102. In response to the concerns raised by firm commenters regarding the Board’s use of Sarbanes-Oxley’s relevant ‘‘necessary and appropriate’’ clauses, it is important to clarify that the Board has not claimed any implicitly delegated authority beyond the regulatory 85 See Navajo Nation v. Dalley, 896 F.3d 1196, 1212–13 (10th Cir. 2018) (‘‘Congress expressed its scope in broad terms, to encompass ‘any other subjects that are directly related to the operation of gaming activities.’ But the key word here is ‘other.’ . . . And applying the ordinary and everyday meaning of the word ‘other’ . . ., it becomes patent that Congress did not intend for that clause to address the ‘subjects’ covered in the preceding clauses of subsection (C)[.]’’ (citation omitted)); see also, e.g., Madison v. Virginia, 474 F.3d 118, 133 (4th Cir. 2006) (‘‘other Federal statute prohibiting discrimination’’ is a ‘‘catch-all provision’’); Meehan v. Atl. Mut. Ins. Co., 2008 WL 268805, at *7 (E.D.N.Y. Jan. 30, 2008) (‘‘The term ‘other policies’ now accomplishes the task of including all governmental activity and becomes a catch-all phrase including all other policies not already implied[.]’’ (citations and quotation marks omitted)). PO 00000 Frm 00016 Fmt 4701 Sfmt 4703 parameters established by Congress. The use of the Section 101, 102, and 103 authorities in this rulemaking is firmly grounded within the explicit mandates provided by Sarbanes-Oxley, and is consistent with the statutory limitations and directives outlined in those provisions. The Board’s application of these authorities has been specifically aimed at enhancing the transparency and quality of audits of issuers and broker-dealers, which directly aligns with the Board’s core mission to protect investors and the public interest. The Board has utilized the tools provided by Sarbanes-Oxley to carry out the responsibilities entrusted to it. Other commenters raised concerns about the Board’s authority to include metrics extending beyond a registered firm’s issuer and broker-dealer audit practice. One of these commenters asserted that including non-issuer information could be misleading to stakeholders who may mistake such disclosures as being within the PCAOB’s regulatory purview. The Board disagrees with these comments. The metrics the Board is requiring are designed to provide information that directly relates to firms’ audits of issuers, and will be important for such matters as assessing auditor performance and resource allocation as it relates to issuer audits. For instance, in the Workload metric, firms are required to report not only the hours worked dedicated to issuer engagements but the entire workload of the personnel involved. This includes hours spent on non-issuer engagements, training, practice development, staff development, or other firm activities. A narrower focus, which only accounts for hours worked on issuer engagements, could provide an incomplete picture. It would fail to reflect the true extent of the auditor’s commitments and how these may impact their capacity and focus on tasks in issuer audit work. Without this comprehensive view, investors and other stakeholders would lack important information to assess the potential risks over overcommitment on audit quality and auditor performance in audits of issuers. By requiring firms to report certain narrowly tailored information regarding their audit engagements and audit practices, the Board is not seeking to extend its purview to regulate those aspects of the firm’s operations. Rather, in line with the Board’s statutory authority, it is enhancing the transparency and the depth of information available to investors and other stakeholders concerning firms’ audits of issuers. E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 4. Summary of the Metrics lotter on DSK11XQN23PROD with NOTICES2 The Board adopted a set of firm-level and engagement-level metrics across eight areas. Firm-level metrics will provide a basis for drawing comparisons between firms as well as a baseline for evaluating engagement-level metrics. Engagement-level metrics will elicit more granular information and will enable comparisons over time and across engagements both within the firm and across other firms. Firm-level metrics will be disclosed on a new Form FM, Firm Metrics, and engagement-level metrics will be disclosed on a revised and renamed Form AP, together with the other engagement-specific information currently required (the name of the engagement partner and information regarding other firms participating in the audit). Most of the metrics the Board has adopted will be presented at both the firm and the engagement level. However, two metrics will be reported only at the firm level, because the Board believes aggregated data will be most meaningful or appropriate. The metrics are: • Partner and Manager Involvement. Hours worked by senior professionals relative to more junior staff across the firm’s large accelerated and accelerated filer engagements and on the specific engagement. • Workload. For senior professionals who incurred hours on large accelerated and accelerated filer engagements, average weekly hours worked on a quarterly basis, including time attributable to all engagements, administrative tasks, training, and all other matters. • Training Hours for Audit Personnel. Average annual training hours for partners, managers, and staff of the firm, combined, across the firm and on the engagement. • Experience of Audit Personnel. Average number of years worked at a public accounting firm (whether or not PCAOB-registered) by senior 99983 professionals across the firm and on the engagement. • Industry Experience. Average years of career experience of senior professionals in key industries audited by the firm at the firm level and the audited company’s primary industry at the engagement level. • Retention of Audit Personnel (firmlevel only). Continuity of senior professionals (through departures, reassignments, etc.) across the firm. • Allocation of Audit Hours. Percentage of hours incurred prior to and following an issuer’s year end across the firm’s large accelerated and accelerated filer engagements and on the specific engagement. • Restatement History (firm-level only). Restatements of financial statements and management reports on ICFR that were audited by the firm over the past three years. Figure 1. Firm and Engagement Metrics Reporting Firm and engagement metrics reporting Firmlevel Engagementlevel Partner and Manager Involvement .......................................................................................................................... Workload .................................................................................................................................................................. Training Hours for Audit Personnel ......................................................................................................................... Experience of Audit Personnel ................................................................................................................................ Industry Experience ................................................................................................................................................. Retention of Audit Personnel ................................................................................................................................... Allocation of Audit Hours ......................................................................................................................................... Restatement History ................................................................................................................................................ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ X ✓ X The final suite of metrics focuses primarily on information about audit personnel. The Board believes these metrics will provide new insights into how engagements are staffed, including the extent of involvement of senior personnel; auditors’ overall workload; retention of personnel across the firm; and levels of training, audit experience, and industry-specific expertise. The final metrics will also provide information about the extent of audit work completed prior to the issuer’s year end, an aspect of the audit process that the Board believes is associated with improved audit outcomes, and about the firm’s history of restatements, a key measure of audit outcomes. This new information will allow users to draw inferences about audits and audit firms that are not possible today. Some may relate to specific metrics. For example, a heavy workload for a particular engagement team relative to the firm average or compared to peer firms may raise questions about the quality of the work performed. Conversely, a relatively high level of industry-specific experience, VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 particularly for an engagement in an industry requiring specific accounting and auditing expertise, would be a positive signal. Other inferences may relate to combinations of metrics. For example, the personnel-related metrics, taken together, give an overall sense of how an engagement is staffed that can be compared to firm averages and to engagements for similar issuers. It is possible that the precise numerical values of metrics may be important in some cases, but in general the Board believes the metrics will be more useful to convey a sense of whether a particular engagement or firm appears fairly typical or is an outlier in one or more respects. This should provide a richer context for understanding the work of the auditor than the current environment of almost no publicly available information. Based on the Board’s oversight activities, it appears that the largest firms are already tracking data in many of these areas,86 and the Board believes that all firms should be able to capture 86 This PO 00000 point is discussed more fully below. Frm 00017 Fmt 4701 Sfmt 4703 the data required by the metrics without undue burden. Many of the metrics are based on data that firms already track or will be required to track for purposes of other PCAOB requirements. For example, Partner and Manager Involvement and Allocation of Audit Hours are based on the same ‘‘total audit hours’’ that firms are already required to track for Form AP reporting. Training hours will reflect the same information that firms track to ensure proper licensing of their personnel. Restatement data, to the extent firms are not already tracking it, is required to be tracked under QC 1000.87 In addition to required data, many firms track the experience of their personnel, as well as industry experience, for use in marketing materials and for inclusion in requests for proposals, and some firms already track staff retention and turnover metrics as part of their human capital management. Firms should be able to generate other data required by the final metrics, such as Workload, 87 See E:\FR\FM\11DEN2.SGM QC 1000.64g, Note to QC 1000.67e. 11DEN2 99984 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 from their existing timekeeping systems with minimal additional effort. Below, the Board provides a detailed discussion of key terms and concepts used in the metrics, as well as a description of each final metric and its calculations. 5. Comparability Developing comparable data regarding firms and engagements has been one of the Board’s key objectives throughout this rulemaking. As noted previously, the information currently provided in firm transparency reports is not based on common definitions or methods of calculation, which prevents users from being able to make comparisons across firms or over time. The Board believes that an important benefit of mandatory reporting will be the ability of investors and other stakeholders to compare the metrics, within the same firm over time, among firms, and among engagements. The basic approach of the Board’s final rules—a required set of metrics, derived from specified calculations incorporating consistently defined terms and concepts—is designed to generate comparable data with respect to firms and engagements that are subject to the reporting requirements. One investorrelated group agreed that standardized and contextualized metrics will provide investors with a consistent data set for analysis over time and for comparison between companies and firms and a set of standardized data is more valuable than the ad hoc individual measures that some firms have made on a voluntary basis. In some cases, considering the importance of scalability, the Board has also designed the proposed metrics as percentages (e.g., relative to total audit hours) or averages where the Board believes that will provide more comparability across firms and engagements than methods based on absolute amounts. Several firms and firm-related groups expressed skepticism about whether the metrics could generate comparable data because of inherent differences across firms and engagements, either with regard to any metrics or engagementlevel metrics specifically. For example, one commenter said that differences between firms and among engagements will create heterogeneity in the underlying data, so that cross-sectional differences and changes over time will be unclear and challenging to interpret, and will cause confusion. Another commenter emphasized the importance of comparability between larger and smaller firms so that investors and audit committees can interpret them appropriately. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Two commenters stated that if context, including qualitative aspects of data, is necessary to understand the metrics, that would suggest that the data are not comparable, which could mean that the metrics are not decision-useful and are at risk of misinterpretation. One commenter expressed the opposite concern, that metrics would become homogenized over time due to peer comparisons, making them considerably less useful to investors. One commenter asserted that the Board’s choices in defining terms and specifying calculations undermine the comparability of the metrics—for example, because some metrics include issuers other than accelerated or large accelerated filers, the Board’s proposed industry classification taxonomy differs from the one used by the SEC, and its proposed period for measuring restatements differs from the period used by a commonly-used data provider. These issues are addressed below in the discussion of the final metrics. With regard to firm-level metrics, several commenters expressed concern that some or all of the metrics would not be comparable across firms. They cited factors such as the size of the firm (including the number of issuer and non-issuer engagements), specialization of the firm’s audit practice, strategies, priorities, investments, organizational structure and quality control system of the firm, and size of the issuer (which affects, among other things, whether an integrated audit is required). Several commenters expressed particular concern about comparability between U.S. and non-U.S. firms because non-U.S. firms tend to have structural, jurisdictional, and cultural aspects that differ from U.S. firms. In addition, non-U.S. firms may have a relatively smaller issuer audit practice, which could skew metrics that are based on the entire practice because there may be significant differences between issuer audits and the rest of the firm’s audit practice, and could increase the volatility of metrics based on the issuer practice because of its small size. One of these commenters also criticized the application of metrics to non-U.S. firms because they would not capture the qualitative benefits of being a part of a global network (e.g., use of consistent policies and procedures that drive use of training, technology, consultation and other centrally available support across the network). Another commenter also noted that some non-U.S. firms may publicly report firm-level metrics on similar topics, such as workload, using different calculation methods under PCAOB and local reporting PO 00000 Frm 00018 Fmt 4701 Sfmt 4703 requirements, which would be costly for these firms and potentially confusing to the users. Many commenters expressed concern that engagement-level metrics are inherently incomparable. Commenters suggested a number of factors that could affect the comparability of engagementlevel metrics, some relating to the firm (e.g., the firm’s organizational structure, IT systems, resources, and audit methodologies), some to the individual audit engagement (e.g., selected audit approaches including substantive analytical procedures or test of details, audit findings including internal control deficiencies, use of technology, first year or recuring engagement, and risk of material misstatement), and some to the issuer (e.g., business structure (including the extent of centralization or decentralization and number of business units), complexity of the organizational structure and IT infrastructures, number of significant unusual transactions, and business and industry risks affecting the issuer). In addition, one commenter noted that there are significant developments (e.g., in delivery models, technology, and professional rules and standards) that affect the way audits are performed each year. The Board solicited comment on whether comparability could be enhanced by further segmenting firmlevel reporting (for example, on the basis of the size of the firm or the size of the issuer) or engagement-level reporting (for example, on the basis of industry sector, region, or whether it is a first-year audit). One commenter stated that all stakeholders would benefit from a consistent calculation methodology and comparable presentation format of firm-level reporting. Several commenters indicated that more disaggregated data for engagement- or office-level reporting could be useful, though one acknowledged that this benefit would need to be weighed with the cost of requiring this data. Other commenters cited challenges associated with providing subsets of information, including that firm and issuer sizes change over time and that smaller firms’ metrics could disclose individual client information. One of these asserted, however, that the reported data could be disaggregated and compared without additional data fields being collected. The Board determined not to collect additional data fields or require additional segmentation of the metrics at this time because of the potential cost and complexity it would add to the process of compiling and reporting the metrics. Stakeholders that want to perform more detailed analysis (for E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices example, segmenting data based on size of the issuer, size of the firm, region, or industry sector) will be able to do so using information that is already publicly available in combination with the metrics. The Board understands that firms differ from each other in the number and types of audits they perform and in their resources, such as the number, experience, and degree of specialization of their people as well as their access to technological resources and resources provided by networks. The Board also understands that engagements differ based on factors such as the size of the engagement, the industry of the company, the risks related to the company and the audit, whether it is a new engagement for the firm or the engagement partner. However, the Board does not believe that such differences make useful, comparable metrics impossible. As one commenter noted, investors are experienced in using a wide array of performance metrics, such as non-GAAP measures and key performance indicators, and are able to analyze them despite a lack of perfect comparability between companies or over time. Indeed, the commenter argued that, due to the nature of the audit process and audit firms, the proposed firm and engagement metrics have a greater propensity for comparability than many companies whose financial results investors already analyze. The Board believes it has also addressed many of the challenges associated with potential lack of comparability by narrowing the metrics to a group that should send relatively clear, comprehensible signals in a variety of different contexts. Metrics on workload, training hours, experience in public accounting, retention of personnel, and restatement history should send a clear signal, regardless of the circumstances of the firm and the engagement. Metrics on partner and management involvement and allocation of audit hours may be more influenced by those circumstances. For example, unusually high involvement by senior professionals could signal an especially complex audit or one that encountered unexpected problems; a relatively low percentage of audit hours incurred before year end could signal a poorly planned audit or simply that, due to the nature and scope of a company’s business, it was unnecessary or impractical to perform many audit procedures prior to year end. The Board has limited the scope of the Partner and Manager Involvement, Workload, and Allocation of Audit Hours metrics to large accelerated filer and accelerated VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 filer engagements to enhance the comparability of the underlying data. The metric on relevant industry experience may also be influenced by the circumstances of the firm and the engagement in that industry experience may be more important in some industries than others. However, the Board believes users will be able to interpret this metric when taken together with the other information about the issuer and the auditor that is available to them. Common definitions and consistent methodology will also contribute to comparability. Taken together, the metrics should enable users to make both broad comparisons across the full population of reporting firms and accelerated filer and large accelerated filer audits, and more targeted comparisons across smaller subgroups of similar firms and engagements, and will be a very significant improvement over the information that is currently available— ad hoc reporting by the largest firms at the firm level, and essentially no information at the engagement level. Of course, any additional context that firms believe is necessary for proper understanding can be provided as narrative disclosure. While narrative disclosure will not make the metrics comparable, it will balance the comparability of standardized metrics disclosure with the ability to provide further context if needed. For example, a firm could provide an explanation for why a metric changed significantly from what was reported in the prior year. 6. Time Period Covered by the Metrics Firm-level metrics are reported as of September 30, generally covering the period from October 1 of the previous year through September 30.88 Specific commenter feedback regarding the reporting period is discussed in detail below. Firms are required to file Form FM on or before November 30, 61 days after the end of the reporting period, also discussed below. Related to the Training Hours for Audit Personnel metric, the Board understands that many firms already have defined periods or cycles that may not align with the final reporting date (e.g., for which the firm tracks training data in order to comply with state continuing professional education (‘‘CPE’’) reporting requirements). Therefore, the firm is permitted to use its already-established training calendar 88 For two of the metrics areas the Board proposed, Quality Performance Ratings and Compensation and Audit Firms’ Internal Monitoring, firms would have reported based on their own internally established cycles. Neither of these is included in the metrics the Board adopted. PO 00000 Frm 00019 Fmt 4701 Sfmt 4703 99985 cycle for calculation and reporting of this metric, provided that the cycle covers a 12-month period (which is expected to be consistently applied). The Board does not believe that the data will be especially sensitive related to any particular 12-month period. The Board believes allowing firms flexibility to use their internally established dates for this metric is appropriate and still provides the comparability discussed above since all firms would be reporting this metric based on a 12-month period. For engagement-level metrics, which will be reported on Form AP, the data and information underlying the reported metrics will generally be based on the most recent period’s audit. However, some engagement-level metrics relate to information about personnel on the engagement, such as Experience of Audit Personnel, and these metrics will reflect information that may not be directly related to the most recent period’s audit. Specific commenter feedback regarding the reporting period and filing date of Form AP is discussed in detail below. In addition, the time period covered by each metric also is discussed in more detail below. 7. Rounding and Use of Estimates Many of the metrics involve the calculation of a numerical value that may result in very small fractional parts. Consistent with the proposal, firms are required to report metrics that are rounded to the nearest whole number, except where additional decimal places (no more than two) are needed to properly interpret the result or to enable comparison to prior periods. In calculating the firm- and engagement-level metrics, actual amounts should be used, if available. However, if actual amounts are unavailable, firms are permitted to use a reasonable method to estimate the components of a calculation. This approach is consistent with existing Form AP, which allows firms to use a reasonable method to estimate certain information required in the calculation of total audit hours.89 Firms are also required to document in their files the method(s) used to estimate amounts when actual amounts are unavailable. Commenters generally agreed with the proposed approaches, with one commenter agreeing that rounding and estimation should be permitted for all metrics. Other commenters stated that rounding and estimation will be 89 See Instructions to Part IV of Form AP as currently in effect. Under the amendments to Form AP adopted by the Board, this appears in General Instruction 9, as amended. E:\FR\FM\11DEN2.SGM 11DEN2 99986 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices especially important for metrics related to the reporting of hours, with two of these pointing to the subjectivity involved with the proposed metrics that would require allocation of hours to specific audit areas.90 One commenter stated that the PCAOB should not restrict the number of decimal places. However, the Board believes that limiting reporting to hundredths will allow for the presentation of an appropriate level of detail while ensuring comparability of presentation and avoiding the technical issues that could arise with unlimited digits. lotter on DSK11XQN23PROD with NOTICES2 8. Operational Narrative Disclosure In order to give firms the ability to provide any context they thought necessary for an appropriate understanding of the reported metrics, the Board proposed that firms would be permitted, but not required, to provide a brief narrative disclosure (no more than 500 characters per metric) to accompany any, or all, of the firm-level and engagement-level metrics reported on Form FM or Form AP. While some commenters agreed with the proposal to provide firms with the ability to include an optional narrative to accompany the metrics, one commenter explicitly agreed with the proposed 500-character limit, one commenter asserted that the 500-character limit greatly limits the context that could be provided, and one commenter suggested revising the character limit to no more than 1,000 characters. Two commenters suggested increasing the character limit beyond 500 characters without suggesting an upper limit. Approximately half of the commenters suggested that there should be no character limit imposed on the optional narrative. A firm-related organization also suggested that the narrative be mandatory and not optional, while a firm suggested that the utility of metrics would be diminished without potentially extensive accompanying narrative. One commenter suggested that firms can also provide a link in the narrative to their transparency reports and audit quality reports if they wish to provide further context to the metrics. One commenter stated that there should be guidelines such as the narratives being factual, directly relevant to the metric, and free from promotional or marketing language. Another commenter stated that it would provide the following narrative in Form FM, potentially with respect to every firm metric: 90 The proposed Audit Hours and Risk Areas metric is not included in the metric that the Board adopted, as discussed further below. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 We do not believe any one metric or even a combination of metrics is necessarily indicative of audit quality, nor is it useful or productive to speculate on the questions reviewers of this information may have on each metric for every audit. We further discuss this metric in our Audit Quality Report, along with the measures we believe are better indications of our audit quality.91 Taking into consideration commenter feedback, the Board is retaining the option to provide narrative disclosure with each metric but expanding the character limit to 1,000 characters. The Board believes this character limit strikes the right balance between allowing firms the ability to provide any contextual information they believe is necessary to interpret the results of a particular metric while also managing the length of the forms and keeping them to a manageable size.92 In addition, in an effort to assist firms in making the optional narrative disclosures as helpful and substantive as possible, to help remind firms of their responsibility under QC 1000 to produce and report information that is accurate and not misleading, and to reduce the possibility that users will find the narrative confusing or in conflict with the required metrics, the following provision has been added as a general instruction to Form FM and a note to Part VI of Form AP to provide additional direction to those firms electing to provide an optional narrative for any metric: ‘‘When the Firm elects to provide a brief narrative to accompany any of the Items in [the part of the form in which metrics are reported], language should be concise and focused on the reported metrics, with a view to facilitating the reader’s understanding of the metrics.’’ Firm and Engagement Metrics 1. General Comments Investors and investor-group commenters were broadly supportive of the proposed metrics, saying that the metric areas would provide investors with decision-useful information about audit firms and audits. However, they expressed mixed views on certain specific metric areas. These commenters also suggested additional metric areas, including investments in both training audit professionals and in technology, and further details related to PCAOB inspection results (e.g., Part I.A deficiencies). The Board has addressed these comments in the discussion of 91 See Letter from PricewaterhouseCoopers LLP (June 7, 2024). 92 Nothing in PCAOB rules and forms, including Form FM and Form AP, provides for incorporation by reference of external documents or other materials. PO 00000 Frm 00020 Fmt 4701 Sfmt 4703 each metric area below. On the topic of implementation of the proposed metrics, one commenter requested analytical tools and research showing how investors might use metrics. The information disclosed on Form FM will be available in a searchable database on the Board’s website, similar to the Form AP database, and will provide users of the information the ability to perform comparisons across engagements. Firms and firm-related groups were broadly supportive of some of the proposed firm-level metrics. However, they generally opposed public reporting of engagement-level metrics, asserting that no amount of context around engagement-level metrics would provide an appropriate basis for public reporting. These commenters suggested that the audit committee, being deeply familiar with the company, the audit, and the independent auditor, is the only party equipped to appropriately interpret the metrics. Instead of public reporting, they suggested several alternatives, including adding a requirement for communication to the audit committee under AS 1301; expanding SEC requirements for audit committee disclosures; encouraging voluntary reporting; issuing PCAOB Spotlights, practice alerts, or guidance; and performing further outreach before adopting any requirements. These alternatives are discussed in greater detail above. One commenter suggested that the PCAOB take a proactive role in educating all users as to the proper use of reported metrics, including the need for them to be interpreted in context and making users aware of potential dangers and drawbacks associated with a mere comparison of isolated metrics between firms. The Board discussed the forms and how the data can be accessed in more detail below. Commenters generally expressed concern that proposed metrics were not all calculated from the same data sources. Some metrics were calculated on the basis of all audit engagements, others on the basis of issuer engagements, and engagement-level metrics on the basis of large accelerated and accelerated filer engagements. Some commenters suggested that calculating firm-level metrics based solely on total audit hours on large accelerated and accelerated filer engagements may result in more comparable data among firms. The Board discussed this in greater detail below. Other commenters recommended that the PCAOB establish criteria for determining which metric areas warrant public disclosure, so as to build in flexibility over time and minimize the risk of misinterpretation. The following E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices criteria were among those suggested by these commenters: • Is the metric’s relation with audit quality unambiguous? • Can the metric be appropriately interpreted on its own, without additional context (e.g., client mix or complexity—size, industry, international operations; firm’s audit approach; etc.)? • If disclosure of the metric results in behavioral change in audit firms, does research suggest the change will improve audit quality or, at least, not adversely impact audit quality? • Will the metric require firms to develop systems, processes, and procedures that they do not already have and at a reasonable cost? • Will the metric impose ongoing administrative burdens on engagement teams that result in a reallocation of effort away from audit quality enhancing activities? • Will the metrics align with measures used in the system of quality control to manage the audit practice? • Will the metrics meet the information needs of the users? • Will the disclosure of metrics not result in the communication of proprietary information? In responding to commenters and articulating the rationale for adopting the firm- and engagement-level metrics below, the Board considered the views of commenters, including these suggested evaluation criteria. The Board believes some of the suggested criteria would impose an unworkable framework that is inconsistent with the Board’s regulatory objectives. For example, the Board does not think it is necessarily practicable to establish an ‘‘unambiguous’’ relationship to audit quality, as suggested, for any individual metric, nor would such an exercise be consistent with the intended uses of the metrics, which envisions their being considered as part of the total mix of information available to stakeholders. Moreover, the Board believes that imposing rigid criteria for each proposed metric imposes too high a burden and is not conducive to effective regulation. It does not permit the Board to account for facts and circumstances unique to individual metrics and their potential uses, nor does it account for the holistic manner in which the Board intends for the metrics to be used or developing information about the utility of the metrics over time. A number of commenters recommended that the PCAOB engage in additional stakeholder outreach, sponsor pilot programs, or otherwise engage in further study and research before finalizing the metrics VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 requirements, or even withdraw the proposal. Based on the lengthy project history described in Section II, which includes repeated input over time from the Board’s advisory groups, multiple rounds of public notice and comment, study of relevant academic literature, study of voluntary firm disclosures, and consideration of actions taken in other jurisdictions, the Board does not believe further study is necessary or that the Board’s investor protection mission would be served by delaying adoption of the final rules. However, the Board will monitor and determine if further implementation resources or support is appropriate for users of these metrics. 2. Key Terms and Concepts As described below, the Board developed certain key terms and concepts that were used in calculating the proposed metrics. Where practical and relevant, these key terms and concepts align with existing definitions in PCAOB standards and rules. In other cases, the Board has developed new definitions and new descriptions of terms specifically for use in the metrics, which are not intended to inform the interpretation of other rules, standards, or forms of the PCAOB. The Board provided the key terms and concepts along with formulas for calculating each metric to drive consistency among firms and engagement teams. One investor-related group said that the units of account (e.g., hours, years of experience) or measurement used within the proposed metrics are sufficiently standardized and adaptable by firms as they are commonly used within audit practice or defined within the existing standards. Some commenters raised concerns about the definitions and descriptions of the population used for various metrics or about not having a defined set of terms applicable to all standards and rules. Other commenters questioned whether the PCAOB had provided sufficient guidance to address potential variations in the interpretation and application of terminology used in the metrics or asserted that not having sufficient guidance would add complexity and challenges in calculating the metrics and understanding them or result in inconsistent reporting of metrics or lack of comparability across audit firms and audits engagements. Two of these commenters recommended that the PCAOB create a glossary of defined terms to support consistent use of terms throughout the standards and rules or conduct additional study to evaluate the defined terms in the proposal against terms already defined in other PCAOB PO 00000 Frm 00021 Fmt 4701 Sfmt 4703 99987 standards and rules. Another commenter raised a concern that defining terms and specifying computations for each metric undermines their comparability. Some firms offered examples of areas where they suggested that clarification would be needed, which the Board discussed below in the context of the relevant metrics. In general, however, the Board continues to believe that the use of defined terms is critical to driving consistent calculation of the metrics. Other firms questioned why different metrics are based on different underlying data (for example, total audit hours vs. total hours worked or engagement team vs. core engagement team). In general, the Board’s choice of the data on which to base a metric is tailored to the intended objective of the metric, and also takes into account the practicality and potential costs associated with gathering data and calculating the metrics. The Board does not believe that metrics based on a single data set would be as clear or as informative. The Board addresses specific concerns raised in the discussion of each metric below. The Board has clarified certain terms and concepts used or revised the descriptions of proposed terms and concepts after consideration of the specific comments received. i. Populations Covered by the Metrics a. Partners and Managers (Used in All Metric Areas Except for Allocation of Audit Hours and Restatement History); Staff (Used in Training Hours for Audit Personnel) While some of the functional roles played by individuals involved in an audit are otherwise defined and used in the Board’s standards (e.g., engagement partner 93 and EQR),94 the Board proposed to clarify following additional functional roles referred to in the metrics to ensure consistent reporting by firms. Partners—Partners or persons in an equivalent position (e.g., shareholders, members, or other principals) who participate in audits; 95 93 See paragraph .A1 of AS 1201, Supervision of the Audit Engagement (‘‘the member of the engagement team with primary responsibility for the audit’’). 94 See AS 1220, Engagement Quality Review, for a description of the engagement quality reviewer’s role. 95 As noted in the proposing release, the Board believes this is consistent with the use of the term ‘‘partner’’ in the Board’s auditing standards. Although the Board does not usually state expressly that partners are limited to those who participate E:\FR\FM\11DEN2.SGM Continued 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 99988 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Managers—Accountants or other professional staff commonly referred to as managers or senior managers (or persons in an equivalent position) who participate in audits; and Staff—Accountants or other professional staff who participate in audits and are not partners or managers. Some engagement-level metrics differentiate between engagement partner and the other partners who participate in the audit. The Board believes the differences between the responsibilities borne by engagement partner and those of other participating partners justify presenting data for the two categories separately in those metrics. For firm-level metrics, ‘‘engagement partners’’ include all partners who served as the engagement partner on any audit the firm performed of an accelerated filer or large accelerated filer. Partners that are included in the metrics as an engagement partner are not included as an ‘‘other partner,’’ even if they served in a non-engagement partner role in other audits (in other words, partners are only counted once within any metric). The Board adopted the definitions of partners, managers, and staff as proposed, with clarifications discussed below. The Board solicited comment on whether the proposed definitions of partners, managers, and staff are clear and appropriate. Two commenters agreed that the proposed definitions for partners, managers, and staff are clear and appropriate, one saying that linking the definitions used in the metrics to existing definitions would help in preventing multiple definitions throughout the auditing standards. However, some commenters expressed concern that titles and roles are not consistent across firms or most firms have roles which do not clearly or obviously reconcile to the roles listed. One of these commenters also raised a concern about continuing emphasis on the engagement staffing model that currently exists, on the basis that artificial intelligence and other tools could affect the staffing of audit engagements in the future. This commenter recommended including ‘‘contractors’’ engaged by firms in the definition and clarifying whether the definitions are meant to be descriptions of the roles rather than legal interpretations of the roles. Another commenter recommended aligning the definitions of partners, managers and staff with the definition of engagement in audits, as a practical matter the Board’s auditing standards apply only in those circumstances. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 team, by using the phrase ‘‘who perform audit procedures’’ instead of ‘‘who participate in audits’’ to avoid inclusion of personnel who may participate in audits in an administrative or project management function, but who do not perform audit procedures. Another commenter expressed concern that audit effort associated with roles typically referred to as ‘‘national office’’ and ‘‘professional practice development,’’ especially for managers through partners, would be excluded from the definitions and calculations of the metrics. For the definition of partners, one commenter questioned whether the definition is intended to have any alignment with ownership interests in a firm and requested clarification as to how a leadership level role such as a managing director would be classified because, in the commenter’s view, that role does not appear to meet the definition of either a partner or a manager. For the definition of managers, the same commenter requested clarification on whether the manager title is based on the person’s general title in the firm because, for example, in certain cases an experienced supervisor may serve a manager capacity on a less complex engagement. Another commenter suggested adding a specific number of years of audit experience to the definition of managers because of the risk that firms could inflate percentage of audit hours incurred by managers by changing the titles of more junior professionals to increase the number of managers. The Board adopted the definitions of partners, managers, and staff as proposed. Because there are differing legal structures and titles among firms, the Board is providing foundational definitions so that each firm can allocate its professionals in three levels: partners, managers, and staff. The Board believes that the vast majority of firms have these three levels, and that, although staffing models may change over time, these levels are likely to be retained for the foreseeable future. The Board also believes that other job titles, such as managing director, can be fit into the appropriate category based on the level of responsibility assigned to them. For example, in a firm where managing directors are given similar responsibilities as the firm’s principals (for example, signing authority on audit engagements), they would be treated as partners under the Board’s definition; otherwise, they would align with managers. Similarly, professionals in a firm that does not use the title ‘‘manager’’ would be reported as PO 00000 Frm 00022 Fmt 4701 Sfmt 4703 managers if they are assigned the duties that are typically carried out by managers and senior managers at firms that do use those titles. Professionals who work under the firm’s direction and control and function as the firm’s employees, such as secondees and contractors, may or may not have these titles but would be reported based on their level of responsibility and decision-making authority. In all cases, the determination would be made based on the responsibilities, decision-making authority, and scope of duties of the person. If necessary, firms could utilize the optional narrative disclosure to describe how the firm aligned their categories of professionals with partners, managers, or staff levels. The Board considered adding a specified minimum number of years of audit experience in the definition of manager but determined not to. Some managers qualify for promotion with fewer years of audit experience due to other relevant education or experience. The Board was concerned that building a minimum number of years of audit experience into the definition would result in people with the responsibilities and title of manager being required to be reported as staff, making the metrics less meaningful while increasing the administrative burden associated with reporting. The Board did not use the phrase ‘‘who performed audit procedures’’ in the definitions of partners, managers, and staff because use of this term would exclude professionals who do not perform audit procedures—for example, partners who only conduct engagement quality reviews 96 or national office personnel in connection with certain types of consultations that are not audit procedures. Because the definitions of managers and staff are limited to ‘‘accountants or other professional staff,’’ administrative personnel are not included. In the Board’s proposal, the Board generally did not specify how to account for promotions within the reporting period from one level to another (e.g., from manager to partner),97 although the Board noted that firms would be expected to be consistent in their approach across metrics. The only commenter to address this issue supported the flexibility 96 Engagement quality review is not considered the performance of an audit procedure. See AS 1220.07 (The EQR ‘‘should not make decisions on behalf of the engagement team or assume any of the responsibilities of the engagement team.’’). 97 Note, however, that the Retention of Audit Personnel metric treats promotions as if they had occurred at the beginning of the year. See note to Item 4.6 of Form FM. E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 proposed with respect to the treatment of promotions. Consistent with the proposal, the final rules do not impose any prescriptive requirements regarding the reporting of professionals whose job title or responsibilities change during the reporting period. However, the Board believes that treating such transitions inconsistently, whether within a metric or across metrics, would be misleading and the Board expects firms to report such changes in a consistent way. (1) Participate in Audits (Used in the Terms Partners, Managers, and Staff) ‘‘Participate in audits’’ is a broad concept that would include the work of all professionals (partners, managers, and staff) that are involved in the firm’s audits, including tax personnel, information technology (‘‘IT’’) personnel, and employed specialists. The Board proposed the phrase ‘‘participate in audits’’ rather than referring to the activities of individuals assigned to a specific business line, such as the firm’s audit practice, because some firms do not assign individuals to specific business lines. However, the Board solicited comment on whether the relevant population would be partners, managers, and staff of the firm’s audit practice, if the firm assigns its professionals to specific business lines. Some commenters agreed with the phrase ‘‘participate in audits’’ as used in the proposal. One of these commenters suggested that, because firms have different structures, attempting to separate members of the engagement team based on a firm’s structure could lead to less comparability across metrics. One firm stated that it assigns individuals to specific business lines, and collecting data based on that assigned business line would be more practical to implement versus the proposal’s requirement to include all individuals participating in audits. Some other commenters stated that firm-level metrics should look only to the firm’s audit practice because (i) the inclusion of other service lines in the metrics would impair comparability between firms due to the varying size and scope of non-assurance practices and (ii) the work of tax professionals and consultants would not improve the usefulness of these metrics for the purposes outlined in the Board’s proposal. Another commenter requested clarification on how to account for individuals who move between audit support roles and engagement-facing functions. The final definitions of ‘‘partners,’’ ‘‘managers,’’ and ‘‘staff’’ include the VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 phrase, ‘‘who participate in audits,’’ as proposed. Because some firms do not assign partners and other professionals to a specific business line, the Board believes this approach is the best way to drive consistent reporting by firms with different organizational structures. In the proposal, the Board clarified that members of the engagement team who participate in audits would include every partner and manager who worked on any aspect of the audit, even if their involvement was extremely limited. The Board proposed not to provide a participation threshold, such as a minimum number of hours, because the Board believes, based on the objectives of these metrics, that the metrics should capture all partners, managers, and staff who participate in audits in any capacity. However, the Board solicited comment on whether the concept should include a participation threshold. One commenter agreed there was no need to create a minimum threshold for participation on the basis that it would increase the complexity and cost of calculating the metrics without a corresponding benefit. Another commenter recommended establishing a minimum threshold for participation because exclusion of professionals with certain firm roles (e.g., firm leadership, national office, or specialist line of service individuals with limited participation during the year in any specific engagement) would not reduce the reliability of the metric. This commenter further recommended creating a minimum threshold for purposes of firm-level metrics, such as individuals who spent more than 10% of their time participating on audit engagements, and engagement-level metrics (e.g., similar to the concept of core engagement team). This commenter and another commenter recommended the additional threshold as optional for firms to use due to cost-benefit considerations, particularly for smaller firms, and should only be considered if additional thresholds allow for simpler aggregation or preparation of the data. The Board did not adopt additional thresholds to be used for firm-level or engagement-level metrics, except for the concept of core engagement team used in certain engagement-level metrics discussed below. The objectives of the five metrics that use ‘‘partners, managers, and staff of the firm’’ are to understand the firm’s professionals who participate in audits in totality, and the Board believes imposing a threshold on what counts as participation would defeat that objective. PO 00000 Frm 00023 Fmt 4701 Sfmt 4703 99989 (2) Partners, Managers, and Staff ‘‘of The Firm’’ (Used in Workload, Training Hours for Audit Personnel, Experience of Audit Personnel, Industry Experience, and Retention of Audit Personnel) Because firm-level metrics provide information about the firm, in calculating some firm-level metrics, the Board proposed to include partners, managers, and staff ‘‘of the firm,’’ which refers to individuals participating in audits who work for the firm or work under the firm’s direction and control and function as the firm’s employees (e.g., secondees and contractors), regardless of whether the audits are performed under PCAOB standards or other auditing standards.98 The Board believes including individuals in the firm-level metrics who participate on any firm audit is appropriate because these metrics would provide information about the firm and not about specific engagements (for example, in the area of firm-level industry experience, which would be relevant across a firm’s entire audit practice). The Board added a new section to Part III, Terminology in Form FM to clarify the meaning of these phrases. The Board also clarified that participation in audits means any involvement (including, for example, consultation on specific matters), and thus may include individuals outside the engagement team, such as national office personnel. b. Engagement Team (Used in Partner and Manager Involvement) The Board proposed to provide information about partners and managers on the engagement team, a term defined in AS 2101, Audit Planning.99 The Board believes it is 98 This should be interpreted consistently with ‘‘firm personnel,’’ as defined in QC 1000.A5. 99 The ‘‘engagement team’’ is defined in AS 2101.A3 [as adopted by the Board in Planning and Supervision of Audits Involving Other Auditors and Dividing Responsibility for the Audit with Another Accounting Firm, PCAOB Rel. No. 2022–002 (June 21, 2022), to take effect with respect to audits of fiscal years ending on or after December 15, 2024] as follows (footnotes omitted): .A3 Engagement team— a. Engagement team includes: 1. Partners, principals, and shareholders of, and accountants and other professional staff employed or engaged by, the lead auditor or other accounting firms who perform audit procedures on an audit or assist the engagement partner in fulfilling his or her planning or supervisory responsibilities on the audit pursuant to this standard or AS 1201, Supervision of the Audit Engagement; and 2. Specialists who, in connection with the audit, (i) are employed by the lead auditor or an other auditor participating in the audit and (ii) assist that auditor in obtaining or evaluating audit evidence E:\FR\FM\11DEN2.SGM Continued 11DEN2 99990 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Figure 2. Engagement Team Members Engagement partner • Auditor-engaged specialists 100 • Personnel from the engagement partner's firm who perform audit procedures on the audit • Engagement quality reviewer and those assisting the reviewer 101 • Service auditors of a third-party service organization102 • A firm professional who performs a contemporaneous quality control function (e.g., internal inspection or quality control review) but does not perform audit procedures or help plan or supervise the audit work • Individuals employed or engaged by the company being audited, such as a company's internal auditors, a company's specialists, and a company's consultants 103 • lotter on DSK11XQN23PROD with NOTICES2 The Board adopted the AS 2101 term ‘‘engagement team,’’ as proposed. The definition of engagement team in AS 2101 includes specialists who, in connection with the audit, (i) are employed by the lead auditor or an other auditor participating in the audit and (ii) assist that auditor in obtaining or evaluating audit evidence with respect to a relevant assertion of a significant account or disclosure. It excludes engaged specialists. • • Personnel of accounting firms and individual accountants outside the engagement partner's firm who perform audit procedures on the audit supervised under AS 1201 A firm professional in the national office or centralized group in the firm (including within the firm's network) who performs audit procedures on the audit or assists in planning or supervising the audit with respect to a relevant assertion of a significant account or disclosure. b. Engagement team does not include: 1. The engagement quality reviewer and those assisting the reviewer (to which AS 1220, Engagement Quality Review, applies); VerDate Sep<11>2014 alternative definition of partners and managers on the engagement team compared to AS 2101, which is aligned to other PCAOB standards, and recommended providing clarity as to the treatment of specialists. Another commenter expressed concern that the definition of ‘‘engagement team’’ under AS 2101 could have ramifications for the calculation of engagement-level metrics, but did not provide any indication of what those ramifications might be. 19:02 Dec 10, 2024 Jkt 265001 2. Partners, principals, and shareholders of, and other individuals employed or engaged by, another accounting firm in situations in which the lead auditor divides responsibility for the audit with the other firm under AS 1206, Dividing Responsibility for the Audit with Another Accounting Firm; or PO 00000 Frm 00024 Fmt 4701 Sfmt 4703 3. Engaged specialists. E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.022</GPH> appropriate to provide metrics related specifically to the engagement team because this would provide investors and other stakeholders with relevant information related to the audit as a whole, who perform audit procedures on the audit or assist in planning or supervising the audit. One commenter suggested clarifying whether ‘‘engagement team’’ for purposes of this rule includes internal specialists. Another commenter stated that the proposal appeared to provide an Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices c. Core Engagement Team (Used in Workload, Training Hours for Audit Personnel, Experience of Audit Personnel, and Industry Experience)100 101 102 103 For some engagement-level metrics, the Board proposed to include information about members of the ‘‘core engagement team’’ rather than the full ‘‘engagement team,’’ so as to focus the metrics on the individuals who make the primary decisions regarding planning and performance of the audit and determine the final conclusions supporting the auditor’s opinion. With the ‘‘core engagement team’’ concept, the Board intends to provide more meaningful and focused data by excluding information about certain partners and managers with lesser participation. The Board also simplifies the data collection effort by limiting these metrics to firm personnel. The Board proposed that the core engagement team would include the engagement partner and members of the engagement team who are partners or employees of the firm issuing the audit report. In addition, under the proposal, core engagement team would include 99991 either a partner (excluding the engagement partner as described above) who worked ten or more hours on the engagement or a manager or staff who worked on the engagement for 40 or more hours or, if less, 2% or more of the total hours.104 Figure 3 illustrates how partners, managers, and staff used in the calculation of the metrics, relate to the firm, engagement team, and the core engagement team. Figure 3. Relationship Between the Groups of Individuals Included in Metric Calculations Partners, Managers, and Staff lotter on DSK11XQN23PROD with NOTICES2 The Board solicited comments on whether the proposed definition of core engagement team, and the proposed participation thresholds for inclusion in the core engagement team, were appropriate. One commenter agreed that at the engagement level, metrics related to only the core engagement team will be more useful to investors and other stakeholders. Two commenters supported the proposed 10-hour minimum threshold for partners other than engagement partners. One of these 100 See AS 1210, Using the Work of an AuditorEngaged Specialist. 101 AS 1220 applies to those persons. 102 AS 2601, Consideration of an Entity’s Use of a Service Organization, sets forth the auditor’s responsibilities with respect to using the work of service auditors who issue reports on the controls of a third-party service organization. 103 Because of their roles at the company, the work of individuals employed or engaged by the company is not subject to supervision under AS 1201; they are not considered members of the engagement team under the adopted definition. PCAOB standards include requirements regarding the auditor’s use of work performed by some of these individuals. See, e.g., AS 1105, Audit Evidence, Appendix A; AS 2201, An Audit of Internal Control Over Financial Reporting That Is Integrated With An Audit of Financial Statements; AS 2605, Consideration of the Internal Audit Function. 104 See below for the discussion of ‘‘total audit hours.’’ VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00025 Fmt 4701 Sfmt 4703 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.000</GPH> Engagement Team Firm 99992 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 also supported the proposed threshold for managers and staff. This commenter suggested, however, that the Board includes only partners and employees of the lead audit firm and exclude component auditors. One commenter suggested aligning the definition of ‘‘core engagement team’’ with the ‘‘lead auditor’’ definition in amended AS 1201 and AS 2101. Another commenter indicated that the creation of thresholds would conflict with other existing aspects of Form AP. This commenter further stated there would be challenges for firms to accumulate and report this data, specifically obtaining the data from firms that are not required to report on Form FM or Form AP and additional time may be needed for implementation of these metrics. Another commenter recommended replacing the phrase ‘‘who worked’’ in the proposed definition to ‘‘who performed audit procedures’’ to be consistent with the definitions of engagement team because this commenter was concerned that wording inconsistencies may cause confusion as to whether the same criteria apply across the various definitions. One commenter indicated that it is not clear on what basis the proposed threshold is determined and further indicated that the concept of core engagement team suggests that certain work in the engagement would be either not important or optional and recommended further study. The proposal also asked whether other individuals involved in the audit (e.g., individuals in the firm’s national office, the EQR, employees of shared service centers, or individuals involved in loaned staff arrangements and alternative practice structures) should be treated differently in the metrics and, if so, how they should be considered in the definition of core engagement team. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 One commenter sought clarification as to whether shared service center employees should be included in the definition of core engagement team and recommended considering the nature and use of centralized services and how service centers continue to evolve across a changing professional landscape. Another commenter suggested including the EQR and specialists in the core engagement team but not treating them differently from other individuals involved in the audit. Two commenters recommended the definition to simply include all individuals who charged time to the engagement or whose cost was included within the engagement to minimize the cost of reporting the metrics, but one of the two commenters recommended excluding the quality functions such as the EQR to avoid any impression that they are part of the engagement team. The Board adopted the proposed definition of core engagement team substantially as proposed: 1. The engagement partner and 2. Members of the engagement team who are: a. Partners or employees of the registered public accounting firm issuing the audit report (or individuals who work under that firm’s direction and control and function as the firm’s employees); and b. Either of the following: i. A partner (excluding the engagement partner) who reported ten or more hours on the engagement; or ii. Managers and staff who reported 40 or more hours on the engagement or, if less, 2% or more of the total audit hours. As suggested by two commenters, the Board reformatted the presentation of core engagement team to clarify that the engagement partner is part of the core engagement team. In addition, the Board modified the descriptions of core PO 00000 Frm 00026 Fmt 4701 Sfmt 4703 engagement team members by substituting ‘‘who reported’’ for ‘‘who worked’’ to make clear that the basis for determining whether hours thresholds have been reached is time reported in the firm’s timekeeping system. The Board did not align the definition of ‘‘core engagement team’’ with the ‘‘lead auditor’’ definition because including information from all of the partners and managers of the firm, rather than just those with significant participation in the engagement, would potentially skew or dilute the data, making the metrics less meaningful. As the Board proposed and the Board adopted, the term core engagement team excludes other auditors. As a result, there will be no need to obtain data from other auditors, and the definition will not encompass firms that are not required to file Form AP. Under current reporting requirements for Form AP, the lead auditor has to accumulate all of the hours worked on issuer engagements.105 While it will require some disaggregation of this data, the Board does not believe reporting the data for the engagement team for Partner and Manager Involvement and total audit hours for Allocation of Audit Hours will create a significant challenge for firms. Regarding individuals at shared service centers, if partners or managers employed by a shared service center meet the definition of core engagement team, they will be included. As further discussed below, the Board did not include the EQR in the definition of the ‘‘core engagement team’’; the core engagement team is a subset of the engagement team, and the EQR is not a part of the engagement team. Figure 4. Core Engagement Team Members 105 See discussion of ‘‘total audit hours’’ used for Form AP reporting below. E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 99993 Example firm-level calculation: Total audit hours of the firm's accelerated filer and large accelerated filer engagements Accelerated filer and large accelerated filer engagements Total Audit Hours Total Audit Hours incurred by partners and managers on the engagement team CompanyX 3,900 1,400 CompanyY 2,500 625 Company Z 1,500 300 Total 7,900 2,325 Total audit hours incurred by partners and managers on the engagement team for all accelerated filer and large accelerated filer engagements/ Total audit hours for all accelerated filer and large accelerated filer engagements Calculation: 2,325 / 7,900 = 29% Example firm-level reporting for Form FM: Partner and Manager Involvement Percentage of total audit hours for partners and managers for all accelerated filer and large accelerated filer engagements 29% Example engagement-level calculation: • Lead auditor issues the audit report for Company X. • Total audit hours for the engagement: 3,900 Details for partners and managers VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00027 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.003</GPH> lotter on DSK11XQN23PROD with NOTICES2 Details for total audit hours of the accelerated filer or large accelerated filer engagement 99994 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 d. Engagement Quality Reviewer (Used in Experience of Audit Personnel and Industry Experience) The objective of the EQR is to perform an evaluation of the significant judgments made by the engagement team and the related conclusions reached in forming the overall conclusion on the engagement and in preparing the engagement report, if a report is to be issued, in order to determine whether to provide concurring approval of issuance.107 The EQR must possess the level of knowledge and competence related to accounting, auditing, and financial reporting required to serve as the engagement partner on the engagement under review.108 While reporting on specific hours spent by the EQR or including the EQR’s time in engagement-level metrics may have a negligeable quantitative impact, the Board believes reporting on EQR’s competency for two of the engagementlevel metric areas will be important and valuable for stakeholders. Because the EQR is not a member of the engagement team as defined in AS 2101, EQRs were not included in the proposed metrics when the proposed metrics required disclosure of the engagement team’s information unless the disclosure of EQRs was specifically called out in the proposed metric area. Therefore, the Board solicited comment about whether EQRs should be added to any of the proposed metrics, separately or together with a group such as the engagement team. Some commenters agreed that EQRs should be excluded from the engagement-level metrics. These commenters indicated not to add them as a separate category because the EQR is not a part of the engagement team as defined by AS 2101 and the inclusion of the EQR would be inconsistent with AS 2101. One commenter suggested that the EQR should be included in the metrics but presented separately, to ensure that there is no impression that the EQR is not independent. One commenter recommended including EQR in firmlevel metrics because firms generally do not assign partners to solely perform engagement quality reviews and firmlevel metrics should include all partners with no requirement to allocate their time spent between the roles of an engagement partner and an EQR. Two investor-related commenters generally supported including EQR hours in the metrics. Another commenter questioned 107 See 108 See AS 1220.02. AS 1220.05. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 the rationale for not including metrics relating specifically to engagement quality reviewers, despite the fact that they are not part of the engagement team. In the final requirements, EQRs are included in the two experience-related metrics (Experience of Audit Personnel and Industry Experience), where the Board believes that the information would be significant to users. EQRs are not included in other metrics, primarily due to their quantitatively insignificant impact on the metrics and to avoid any confusion regarding whether they are part of the engagement team. For metrics that depend on total audit hours (i.e., Partner and Manager Involvement and Allocation of Audit Hours), this approach also aligns with the reporting required for purposes of Form AP, from which EQRs are excluded. ii. Total Audit Hours (Used in Partner and Manager Involvement and Allocation of Audit Hours) For several metric areas, the Board proposed to use ‘‘total audit hours,’’ which would be the same as the hours used to compute the extent of participation in an audit of other accounting firms in Form AP.109 Total audit hours include hours attributable to: (1) the financial statement audit; (2) reviews pursuant to AS 4105, Reviews of Interim Financial Information; and (3) the audit of ICFR pursuant to AS 2201.110 Under the proposal, some firm-level metrics were based on total audit hours across all issuer engagements while others were based on specific subsets of total audit hours (e.g., partner and manager hours). The Board also clarified that some engagement-level metrics would also use a subset of total audit hours (e.g., those incurred by partners and managers, on certain areas of the audit, or within stated time periods before or after the issuer’s year end). The Board adopted the definition of total audit hours as proposed. Two commenters criticized the use of hours in metrics. One expressed concern that basing metrics on hours 109 See Part IV of Form AP. audit hours’’ [as amended and adopted by the Board in PCAOB Rel. No. 2024–005, to take effect on December 15, 2025] exclude the hours incurred by: (1) the engagement quality reviewer; (2) specialists engaged, not employed, by the firm; (3) accounting firms in performing the audit of entities in which the issuer has an investment that is accounted for using the equity method; (4) internal auditors, other company personnel, or third parties working under the direction of management or the audit committee who provided direct assistance in the audit of internal control over financial reporting; and (5) internal auditors who provided direct assistance in the audit of the financial statements. 110 ‘‘Total PO 00000 Frm 00028 Fmt 4701 Sfmt 4703 would encourage stakeholders to focus on time spent rather than on whether the work was effective, and potentially exacerbate the notion that auditors should reduce the hours spent on an engagement. The other, while generally not objecting to the use of the hours in specific metrics, asserted that many firms have moved away from the burden of time reporting and that there is no incentive to track time on fixed fee engagements. The Board continues to believe that basing certain metrics on audit hours is appropriate. It will allow firms to leverage systems already in place for purposes of Form AP reporting and human capital management. Moreover, the Board is not aware of any alternative method of tracking auditor work that is commonly accepted by firms and could be implemented without the creation of entirely new systems. Commenters responding to the specific questions in the proposal on total audit hours generally expressed support for using Form AP hours for the total audit hours in the metrics. A few commenters recommended including engagement quality review hours in total audit hours. A commenter stated that hours from shared service centers should be excluded from both the partner and manager involvement metrics. A few commenters asked that the Board either include or exclude certain specialist hours in total audit hours. Two commenters suggested that hours spent on quarterly reviews should either be excluded or disaggregated, one stating that otherwise the metric area related to allocation of audit hours would generally show that most hours were incurred before year end. Another commenter requested clarification as to whether hours spent on quarterly reviews are included or excluded from total audit hours, stating that if excluded, firms may need to implement more detailed time tracking mechanisms or estimations of time between quarterly review and year-end audit procedures. In general, as required for Form AP, total audit hours is comprised of the hours of the lead auditor, other accounting firms participating in the audit with whom the principal auditor does not divide responsibility for the audit, and nonaccounting firm participants that assist the principal auditor or other accounting firms. Consistent with the calculation of total audit hours for Form AP, total audit hours exclude hours incurred by certain persons and entities. In addition, existing Form AP includes reviews performed pursuant to AS 4105 because these reviews are an integral part of the overall audit process. The Board E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices continues to believe that using total audit hours, as already defined by Form AP and collected by firms, will provide an appropriate and cost-effective basis for calculating metrics. Commenters, mostly firms and firmrelated groups, noted that several metric areas use total audit hours, which includes information from other auditors. According to these commenters, referring to such metrics as ‘‘firm-level metrics’’ is misleading, and they recommended the firm-level metrics be limited to data related solely to the firm filing the Form FM and exclude information from other accounting firms. The Board is retaining the label of ‘‘firm-level metrics’’ for the metric areas in question as the Board believes it is important to include all of the relevant information for the lead auditor’s engagements. In addition, the Board believes this information will provide key insights into the way that engagements are conducted by the firm that is the lead auditor. iii. Terms Used in Metrics In addition to the terms discussed above, many of the terms used in the metrics are defined elsewhere in the Board’s standards and rules. Other terms will be defined specifically for use in the metric calculations and may differ from the way such terms are used elsewhere in PCAOB rules and standards.111 Terms that are used in only one metric are discussed in greater length below, in the context of discussing the relevant metric. The Board has italicized the terminology in the final calculations. lotter on DSK11XQN23PROD with NOTICES2 3. Metric Descriptions and Calculations This section describes the firm-level and engagement-level performance metrics the Board adopted. The Appendix provides illustrative examples to show how metrics would be calculated based on specific facts and circumstances presented therein. a. Partner and Manager Involvement Partners and managers are responsible for oversight of the engagement team, which includes less experienced staff. Spending time to oversee the work of the audit staff is critical to the engagement. Included in this oversight is the engagement partner’s responsibility to exercise due professional care related to supervision 111 For example, the Board adopted the definition of ‘‘partner’’ to include only persons who participate in audits. While the Board believes that is consistent with the use of that term in the Board’s auditing standards (see footnote above), it is narrower than the use of the term in connection with registration and reporting requirements. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 and review of the audit, including evaluating whether significant findings or issues are appropriately addressed and determining that the significant judgments and conclusions on which the auditor’s report is based are appropriate and supported by sufficient appropriate audit evidence.112 Less extensive supervision raises the risk of less effective audit procedures. With a lower ratio of senior engagement team time to staff time, the risk may be greater that partners and managers may not be devoting sufficient time to supervise and review staff work and evaluate audit judgments. Academic research also suggests that greater partner or manager involvement in the audit is positively associated with proxies for the quality of the audit.113 The proposal set forth requirements for firms to calculate firm-level and engagement-level metrics for the percentage of total audit hours incurred by partners and managers. As described in the proposal, this metric area could provide users with information regarding each firm’s oversight of their engagements and the supervision of less experienced engagement team members. The Board adopted this metric area substantially as proposed, with one modification discussed in more detail below. Commenters generally agreed with requiring public reporting of the proposed firm-level metrics for Partner and Manager Involvement. Investorrelated commenters stated that disclosure of hours worked by senior 112 See General Responsibilities of the Auditor in Conducting an Audit and Amendments to PCAOB Standards, PCAOB Rel. No. 2024–004 (May 13, 2024), as adopted by the Board and approved by the SEC, to take effect with respect to audits of fiscal years beginning on or after December 15, 2025, at 8–11 (describing responsibilities of engagement partners under existing PCAOB standards) and 17 (describing clarification for the existing responsibilities of engagement partners); see also, e.g., In the Matter of Melissa K. Koeppel, CPA, PCAOB File No. 105–2011–007, at 78 (Dec. 29, 2017) (concluding that, as the individual with final responsibility for the audit, the engagement partner must act with due professional care to ensure that the audit team performs all required audit procedures). 113 See, e.g., a research paper, Joshua Khavis, Mengtian Li, and Brandon Szerwo, Manager Staffing Leverage at the Audit Office and Audit Quality, available at https://papers.ssrn.com/sol3/ .cfm?abstract_id=4856541; a study using Korean data, Suyon Kim, Does Engagement Partners’ Effort Affect Audit Quality? With a Focus on the Effects of Internal Control System, 9 Risks 225, (2021); a study using Japanese data, Sarowar Hossain, Kenichi Yazawa, and Gary S. Monroe, The Relationship Between Audit Team Composition, Audit Fees, and Quality, 36 AUDITING: A Journal of Practice and Theory 115, (2017); and Agnes WY Lo, Kenny Z. Lin, and Raymond MK Wong, Does Availability of Audit Partners Affect Audit Quality? Evidence from China, 37 Journal of Accounting, Auditing & Finance 407, (2022). PO 00000 Frm 00029 Fmt 4701 Sfmt 4703 99995 professionals relative to more junior staff across the firm and on the engagement is valuable. One investorrelated group noted that information regarding the hours worked by senior professionals who have more experience in making judgments and evaluating estimates relative to more junior staff provides important insights into the oversight, supervision, and review of the engagement team. One commenter agreed that the proposed metrics would provide useful information to investors, audit committees, or other stakeholders because it would provide a salient indicator of audit quality. Another commenter agreed that the firm-level metric is clear and appropriate because it provides an indication of the level of involvement of partners and managers in the firm’s audit engagements. At the same time, a few commenters were concerned that the engagement-level metric could be misunderstood because the level of supervision and review should vary based on the nature of the company (e.g., size and complexity), the nature of the work assigned to engagement team members, the risks of material misstatement, and the knowledge, skill, and ability of each engagement team member. Further, a commenter stated that the engagementlevel metric would not provide meaningful information without contextual information obtained through a discussion with the audit committee. The Board solicited comment on whether data for partners and managers should be presented separately, including whether there should be a separate calculation for the engagement partner. Two commenters expressly supported this disaggregation, one stating that because the engagement partner is the person signing the opinion, it would appear to be more consistent to separate this data. The other commenters on this topic said that further disaggregation of the involvement of partners and managers is not warranted and could create unnecessary complexity. For example, a commenter stated that segregation of involvement by levels in the firm does not provide incremental value and would dilute or potentially mischaracterize what can be inferred from this metric (e.g., disaggregation of the engagement partner role is not likely to be meaningful due to the engagement partner’s ability to have assistance). Two commenters expressed concern that adding up partner and manager data and calculating these metrics for all issuer engagements could be very time consuming and unnecessarily increase E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 99996 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices compliance costs. Another commenter expressed concern that further breakdown by role could lead to more inconsistencies in reporting across engagements (e.g., differences in how firms are structured, such as a managing director role). Commenters also recommended further study by the PCAOB. The Board notes, in response to commenter concerns about the need for further study, there is extensive academic literature on this topic and widespread support among investorrelated groups (see above discussion). The Board does not believe that adding up partner and manager data and calculating and reporting these metrics will unnecessarily increase compliance costs as firms are already required to track these hours in aggregate for purposes of Form AP reporting. While the Board acknowledges the importance of the engagement partner’s role, as this person is primarily responsible for the engagement as evidenced by the fact that they sign the opinion and is required to be identified on Form AP, the Board continues to believe that the aggregation of partner and manager involvement and reporting of one percentage provides a more holistic picture of the overall supervision and review of the audit engagement. The Board agrees with most commenters who said that further disaggregation of the involvement of partners and managers is not warranted. Some commenters, mostly firms and firm-related groups, suggested excluding hours from other accounting firms and focusing only on the involvement of partners and managers of the reporting firm. These commenters were concerned that in situations where accounting firms outside the lead auditor’s network are involved, both the firm- and engagement-level metrics would require information from outside the lead auditor’s system of quality control. Another commenter requested that firms should present partner and manager involvement across high-, medium-, and low-risk engagements. According to this commenter, it would enhance comparability across firms. The Board believes the metric area on partner and manager involvement could be less informative or even potentially misleading if it were based only on the lead auditor, rather than the entire engagement team (including other auditors). Moreover, since relevant data in aggregated form is already collected for purposes of Form AP reporting, it is subject to existing quality controls over firm reporting. The Board does not believe the additional administrative burden of reporting partner and VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 manager hours will be significant. As to the suggestion to present partner and manager involvement across different engagement risk profiles, the Board notes there is no requirement in PCAOB standards or rules for such categorization and no established framework for differentiating among engagements in that way. Therefore, the Board does not believe this suggestion would yield comparable information. However, firms will have the ability to provide context in an optional narrative disclosure if they believe information as to relative risk profiles is helpful in interpreting the metric. The Board adopted the firm- and engagement-level metrics for partner and manager involvement substantially as proposed. The Board believes they will provide useful information to assist in understanding hours worked by senior professionals relative to more junior staff and gauging the associated risks. However, the final requirements have been modified in one respect, to narrow the population of engagements covered by firm-level reporting. Considering comments received expressing concern with the potential lack of comparability across different types of issuers, the Board has limited firm-level reporting to only engagements for accelerated filers and large accelerated filers—that is, the engagements for which engagementlevel reporting is required—rather than all issuer engagements. The Board believes this narrower scope will yield better alignment between firm- and engagement-level metrics and more comparable information across engagements. Additionally, this modification should further reduce data collection and reduce the administrative burden associated with calculating and reporting these metrics. (See Exhibit A, ‘‘Partner and Manager Involvement.’’) b. Workload The Board believes that in general, the greater the workload, the greater the likelihood that members of the engagement team may have insufficient time to appropriately perform the necessary audit procedures and make the appropriate judgments that an audit requires. Professionals may become less effective when working long hours,114 114 See, e.g., Julie S. Persellin, Jaime J. Schmidt, Scott D. Vandervelde, and Michael S. Wilkins, Auditor Perceptions of Audit Workloads, Audit Quality, and Job Satisfaction, 33 Accounting Horizons 95, 101 (2019) and Brant E. Christensen, Nathan J. Newton, and Michael S. Wilkins, How Do Team Workloads and Team Staffing Affect the Audit? Archival Evidence from U.S. Audits, 92 PO 00000 Frm 00030 Fmt 4701 Sfmt 4703 and such an environment may affect the level of due professional care they exercise. For example, a heavy workload may create pressure on the audit staff to focus too much on efficiency in executing auditing procedures rather than on ensuring the effectiveness of those procedures or on supervising less experienced engagement team members. The Board believes heavy workloads could prevent an engagement partner from providing adequate and focused attention to an audit engagement. The information provided by the metrics at the engagement level may help audit committee members and other stakeholders understand the various activities competing for an engagement partner’s time. Studies find that excessive audit partner workloads can have negative impacts on audit effectiveness, although the literature also suggests that partners may be less affected than more junior staff.115 The proposal set forth requirements for firms to calculate firm-level and quarterly engagement-level workload metrics for (i) engagement partners and (ii) other partners, managers, and staff. The Board proposed separate reporting for engagement partners at both the firm and engagement level, as they have primary responsibility for the audit. At the engagement level, the Board proposed limiting reporting to the core engagement team, which the Board believes would be more useful to investors and other stakeholders than information regarding the entire engagement team (some of whom may have extremely limited participation in the audit). The proposed calculations for workload at both the firm and engagement levels included all working hours incurred during the relevant periods: hours incurred on issuer and non-issuer engagements as well as on training, practice development, staff development, or other firm activities.116 The Board adopted this metric area substantially as proposed, with modifications discussed in more detail below. Accounting, Organizations and Society 101225, (2021). 115 See, e.g., Seokyoun Hwang and Philip Keejae Hong, Auditors’ Workload and Audit Quality under Audit Hour Budget Pressure: Evidence from the Korean Audit Market, 26 International Journal of Auditing 371, (2022); John Goodwin and Donghui Wu, What is the Relationship Between Audit Partner Busyness and Audit Quality?, 33 Contemporary Accounting Research 341, (2016); Persellin, et al., Auditor Perceptions. 116 Hours worked for purposes of the proposed metrics excluded hours that were not considered working hours (e.g., paid time off and holiday time). E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Some commenters agreed with requiring firm- and engagement-level metrics in this area, stating that the proposed workload metrics ensure there is appropriate attention and focus on audit engagements. One commenter asserted that the proposed firm-level metric is significantly less complicated than the engagement-level metric and should be sufficient for assessing a firm’s capacity to accept new clients. However, the same commenter expressed concern that the proposed engagement-level metric is very complicated and would take considerable effort for firms to compile and calculate for every engagement. Further, the commenter expressed concern that the cost of calculating this metric likely exceeds any benefit. Another commenter stated that just having higher workload during peak months does not necessarily impact audit quality. While some firms and firm-related groups generally expressed support for public disclosure of the firm-level workload metrics, they also expressed concerns with the metrics or requested modifications be considered for firmlevel workload calculations. Some firms and firm-related groups questioned what benefits stakeholders would gain from the information. Commenters suggested that alternative measures, such as an annual utilization metric as reported in firms’ audit quality reports, may be more meaningful to reflect how a firm is measuring and monitoring the activities competing for their professionals’ time.117 Further, some of these commenters expressed concern about the effort involved in collecting, analyzing, and reporting the data for average weekly hours on a quarterly basis. The Board continues to believe that disclosing the firm-level workload metrics quarterly as opposed to annually will provide a comparative basis for the engagement-level metrics. At the engagement level, the Board believes that information for members of the core engagement team will be especially useful to investors and other stakeholders for the quarter in which the auditor’s report is issued, usually the busiest time of the year for the auditor. The Board also believes that a workload metric based on actual hours worked (i.e., productivity) versus a utilization metric based on a standard number of work hours (e.g., a 40-hour 117 One example of a utilization metric reported in firms’ audit quality reports is ‘‘average annual hours worked by audit professionals over 40 hours per week.’’ VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 week, including time off) will provide more useful information. The Board solicited comment on hours worked, including whether the proposed term should be changed. Some commenters expressed support for including all hours worked including time spent on audits and time spent on activities other than audits. One commenter expressed concern that many firms do not require detailed recording of ‘‘non-chargeable’’ time, so the disclosure of hours worked will be a rough estimate at best for some firms. This commenter expressed a view that the benefits of the workload metrics would not justify the burden of asking firm professionals to spend more time and energy tracking all of their ‘‘nonchargeable’’ time. Another commenter suggested that the Board break out training and development from the rest of the hours worked. Further, a commenter stated that a clearer definition of the proposed term ‘‘hours’’ is required if this metric is to be used. For example, firms may be inconsistent on how they report hours spent on travel for work purposes. A commenter stated the proposed metrics exclude time off, which is a key component of workload and may vary significantly between levels. By excluding time off or leaves of absences, this commenter expressed concern that the workload metric would not provide consistent and comparable information. The Board continues to believe it is important to capture the sum of hours that are incurred on engagements and hours spent on training, practice development, personnel development, or other firm activities in the workload metrics, while excluding holiday or other paid time off (i.e., when individuals would not be working). The Board believes the potential additional administrative burden of including ‘‘non-chargeable’’ time for partners and managers on issuer engagements (firmlevel workload metric) will not be burdensome based on the Board’s understanding that many firms track this time already. Disaggregating the hours worked, as suggested by one commenter, will further complicate the workload metrics. Finally, the Board believes the definition of hours worked is sufficiently clear and does not require further explanation for certain types of non-engagement hours. Firms and firm-related groups stated that because the proposed workload metrics were based on the definitions of partner, manager, and staff, which determination is based on ‘‘participation in the audit,’’ it was not clear whether and where certain individuals should be included in this metric as they move PO 00000 Frm 00031 Fmt 4701 Sfmt 4703 99997 between audit support and engagementserving functions (e.g., individuals who provide tax reporting and compliance services to other clients). One commenter stated that including these individuals would dilute the value that could be derived from metrics related to workload, as peak periods for these other services and activities would mask meaningful trends in the workload of other members of the engagement team whose primary responsibility is performing audit work. At the engagement level, the Board does not believe the commenter’s concern is relevant because the individuals in question are not likely to be part of the core engagement team (see above for discussion of the definition). At the firm level, the Board believes the workload of these individuals will still be relevant as they presumably shift between engagement work and nonengagement work as needed. Further, trying to figure out a systematic approach for excluding these individuals will only add to the administrative burden of gathering the data and calculating and reporting the metrics. Other commenters requested that the Board reconsider the inclusion in the workload metrics of partners and professional staff who do not work on issuer audits. One expressed concern that comingling statistics associated with professionals who do not participate in any way on the firm’s issuer audits would be contrary to the stated objective of ‘‘advancing investor protection and promoting the public interest by enabling stakeholders to make better-informed decisions . . .’’ Another stated that the metric as proposed would encompass individuals who work on engagements other than issuer audits (e.g., audits of non-issuer employee benefit plans or governmental entities), who may have a different ‘‘busy season’’ than individuals working on issuer audits. As a result, this metric may show a relatively consistent average weekly hour throughout the year across the firm, even though specific individuals may have more variability in their schedules. The Board streamlined the workload metrics in some respects, in part based on commenter input. To provide a more useful metric, the Board is limiting the firm-level metric to partners and managers who participate in accelerated filer and large-accelerated filer engagements for which the firm issued an audit report. The Board believes this will provide information that will be comparable to the engagement level information. The Board excluded staff from the firm- and engagement-level E:\FR\FM\11DEN2.SGM 11DEN2 99998 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 calculations in order to focus the metric area on the more senior members of the engagement team—those individuals determining that the significant judgments and conclusions on which the auditor’s report is based are appropriate. In addition, this will also lessen the administrative burden of gathering the data and calculating and reporting the metrics. Some commenters found the proposed requirement to segregate engagement partners from other partners in the proposed calculations to be impractical to implement and not a meaningful distinction in the metric. A commenter pointed out that segregating the roles may create a practical challenge in calculating the metrics, as in practice a large portion of partners generally fill both roles. Another commenter asserted that because the proposal provided no justification for distinguishing between ‘‘engagement partners’’ and ‘‘other partners,’’ the distinction between engagement and non-engagement partners should be eliminated for purposes of calculating the firm-level workload metric. The Board adopted a firm-level metric that does not require differentiating between engagement partners and other partners in reporting on workload because the Board questions whether useful information could be derived from that distinction, given that many partners serve in both capacities. In addition, the Board understands it may be a difficult and manual process to identify and track the distinction between the types of partners. As stated above, the Board continues to believe it is important for firms to disclose their engagement partners’ workloads at the engagement level. Overall, the Board believes the modifications will improve or maintain the value of the information provided by this metric area compared to the proposal, while reducing the administrative burden associated with gathering data and calculating and reporting the metrics. (See Exhibit A, ‘‘Workload.’’) c. Training Hours for Audit Personnel The professional development training auditors receive should enhance their competence and therefore their ability to perform effective audits. Competence encompasses having the knowledge, skill, and ability to perform assigned activities in accordance with applicable professional and legal requirements and the firm’s policies and procedures.118 Training is a critical 118 See PCAOB Rel. No. 2024–004, at 8–9 (describing competence to perform an audit under existing PCAOB standards). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 aspect of developing auditor competence. Licensing requirements for continuing education for public accountants to obtain and retain certification speak to the relationship between quality and appropriate training and education.119 Additionally, QC 1000 mandates certain training requirements, including with respect to ethics and independence.120 While the Board did not propose a training metric, the Board’s proposal solicited comment on training as a potential additional metric. Commenters on the topic all agreed about the importance of training to the development of auditors. One commenter included training hours per professional as one of six metrics they believed would increase technical excellence, and other commenters suggested an alternative training metric focused on the percentage of revenue firms spend on training. Other commenters highlighted challenges to defining a training metric that would provide decision-useful information. One commenter stated that training is important for development and building awareness, but on-the-job training is invaluable, yet not measurable. One commenter suggested that training metrics may not be informative given they would be quantitative and not qualitative and also suggested that these concerns would be best addressed through the implementation of QC 1000 and related standards. The Board believes there are benefits to having firms report information regarding training. Indeed, academic research provides evidence that certain proxies for auditor training are positively associated with some proxies for audit quality, although the results vary depending on the type of training 121 The Board also observes that almost all of the firms that provide voluntary reporting include their average training hours as well as information about their policies and procedures regarding training, which appears to emphasize the value those firms place on the development of their professionals as well as the potential informativeness of an hours-based 119 See paragraph .08 of AS 1000, General Responsibilities of the Auditor in Conducting and Audit. 120 See QC 1000.50 (‘‘The firm should design, implement, and maintain policies and procedures regarding licensure such that the firm and firm personnel hold licenses or other qualifications required by the relevant jurisdiction(s) under applicable professional and legal requirements.’’). See also QC 1000.34(e) and PCAOB Rel. No. 2024– 005, at 151–52 (describing mandatory training under PCAOB standards). 121 See below for additional discussion on the academic literature. PO 00000 Frm 00032 Fmt 4701 Sfmt 4703 quantitative measure. The Board’s research also indicates that at least eight other jurisdictions include training as a firm-level metric.122 The Board recognizes that quantitative measures such as the number of professional development training hours cannot capture qualitative factors, such as the skill of trainers, the quality and relevance of training content, whether the training is in a specialized area specific to the trainee, and the degree of trainee engagement, that contribute to the effectiveness of training. However, the average number of training hours per audit professional provides an indication of the importance the firm places on the training of its professionals. In addition, given that the metrics are presented as a suite of metrics and are not expected to be considered in isolation, providing some visibility into firm’s commitments and efforts to promote the development of their professionals through ensuring they receive adequate training will provide an additional data point for consideration in that context. Metrics the Board considered in this area, both at the firm level and the engagement level, include (i) the average total number of CPE hours per professional; (ii) average number of CPE hours received by audit professionals in specified fields of study, such as (a) accounting and auditing and (b) ethics and independence; and (iii) CPE compliance rates at the firm or specific to engagement teams. In consideration of the importance of training to the development of audit professionals and the impracticality of measuring training through qualitative means, the Board adopted metrics for average annual professional development training hours 123 for audit partners, managers, and staff, both firm-wide and for the core engagement team. These metrics will create visibility into training at both the firm and engagement level, using 122 See Accountancy Europe Report at 6, 7, 8, 11, 12, 13, and 14 for IDW (Germany), Quartermasters (Netherlands), CMVM (Portugal), CPAB (Canada), ICAI (India), ACRA (Singapore), and IRBA (South Africa). See also FRC Feedback Statement, at 18. 123 Professional development training hours are training hours for credit in support of obtaining or maintaining a professional accounting license in a jurisdiction in which the auditor is licensed or pursuing a license. For example, in the United States, professional development training hours would be synonymous with CPE credits as defined by the National Association of State Boards of Accountancy (NASBA). In some jurisdictions, including the United States, a training hour may be less than 60 minutes. If a jurisdiction does not impose training requirements in support of professional licensure, professional development training hours are hours of training associated with acquiring and maintaining professional competence. E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices data that the Board believes will be readily accessible to firms. The Board considered the suggested alternative of a training metric focused on the percentage of a firm’s revenue invested in training. However, the Board believes that any approach based on the costs of training would be difficult to implement. For example, some firms develop their own training, some firms purchase training, and other firms may reimburse their professionals for thirdparty training. Also, firms may develop training for non-audit professionals within the organization and then subsequently provide that training to audit professionals, further adding to the complexity of suggested cost-based training metrics. By contrast, the Board expects that firms will generally already be tracking training hours as part of monitoring ongoing compliance with CPE requirements, which should ease implementation of the hours-based metrics the Board adopted. The Board believes that the difficulties associated with measuring costs would outweigh the advantages of a cost-based metric, as compared to the hours-based approach. (See Exhibit A, ‘‘Training Hours for Audit Personnel.’’) lotter on DSK11XQN23PROD with NOTICES2 iv. Experience of Audit Personnel The auditor’s years of experience at a public accounting firm can provide useful information about how the auditor staffs the audit. Academic studies show that auditor experience is related to improved audit effort and skill, through both pre-client and clientspecific experience,124 and through behavioral adaptations associated with managing their clients.125 At the firm level, an experience metric can provide information regarding the ‘‘bench depth’’ of firm personnel and the ability of the firm to staff its engagements. At the engagement level, the engagement team’s years of experience can provide useful information about the depth of experience of the engagement team for that particular engagement. The Board proposed firm-level reporting of the average years of experience at a public accounting firm of the firm’s engagement partners, partners other than engagement partners, and managers; and engagement-level reporting of the years 124 See, e.g., Wuchun Chi, Linda A. Myers, Thomas C. Omer, and Hong Xie, The Effects of Audit Partner Pre-Client and Client-Specific Experience on Audit Quality and on Perceptions of Audit Quality, 22 Review of Accounting Studies 361, 363 (2016). 125 See, e.g., G. Bradley Bennett and Richard C. Hatfield, The Effect of the Social Mismatch Between Staff Auditors and Client Management on the Collection of Audit Evidence, 88 The Accounting Review 31, (2012). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 of experience at a public accounting firm of the engagement partner and the EQR, as well as the average years of experience of other partners and managers on the core engagement team. Both metrics captured all experience at a public accounting firm, whether or not the firm was registered with the PCAOB, and included audits of issuers and nonissuers, as well as non-audit work. Some commenters agreed in concept with firm- and engagement-level metrics for experience, stating that they agreed that auditor’s years of experience at a public accounting firm may provide useful information about how the auditor staffs the audit. One of these commenters broadly supported both metrics but suggested a number of potential refinements, discussed below. One commenter suggested that an employee experience metric could identify firms that are more likely to have a firm culture that contributes to audit quality. Another commenter suggested that a metric depicting years of experience after CPA licensing would provide insight into whether a firm has more experienced professionals. Several commenters generally supported the firm-level experience metric, while objecting to all proposed engagement-level metrics, including the experience metric. One of these commenters stated that the proposed firm-level metric met its criteria of being readily interpretable, aligning with measures used by the firm in its system of quality control, having broad linkage to audit quality, having minimal unintended consequences, and meeting the information needs of users. Some commenters asserted that proposed experience metrics, both at the engagement and firm levels, were not useful or meaningful, saying that there is great potential for misunderstanding and misuse with little value to be derived. Another said that the emphasis on years of experience overlooks the centrality of technology in the future. Some commenters raised questions about the professionals covered by the metrics. Two commenters suggested that the firm-level metric cover only individuals who have been assigned to issuer audits, one of whom said that firms may use different personnel on issuer audits than non-issuer audits, so a metric that includes personnel regardless of whether they work on issuer audits would not provide an accurate view of personnel that may be staffed on an issuer audit. One commenter questioned whether it was appropriate to provide engagement-level reporting regarding the experience of the EQR, because it might imply that the EQR was part of the engagement team. PO 00000 Frm 00033 Fmt 4701 Sfmt 4703 99999 Commenters also questioned the appropriate level of disaggregation for reporting. One commenter described the requirement to segregate engagement partners from other partners as impractical to implement and not a meaningful distinction in the metric. Another suggested further disaggregation, with partner and manager experience reported separately and data broken down by industry. Commenters reacted to the proposal to count only experience in public accounting as relevant. One agreed that experience metrics should be limited to audit experience. Several others suggested that experience in addition to years worked at a public accounting firm, such as industry experience or time spent working at a relevant regulator, should be included. For example, one said that limiting relevant experience exclusively to auditing experience could potentially overlook the comprehensive skill set that individuals gain from various roles throughout their career. Two commenters said that context is needed to understand metrics depicting experience, as the depth of experience and whether it is current may differ considerably. Some commenters expressed concern about the challenges of gathering data regarding experience, particularly if the experience metric is not limited to time spent at the individual’s current firm. Commenters also raised issues with the calculation of the proposed metric. One remarked that the experience metrics provided an incentive to have a number of very experienced partners provide modest assistance in order for their experience to be included in, and significantly improve, the metric. This commenter suggested that requiring a weighted average for this metric would act as a deterrent. One commenter expressed that the calculation did not address how to treat personnel role changes at the firm level. One commenter suggested that further outreach was needed to determine the ability to prepare such information and for investors and audit committees to understand how such firm-level metrics would be used in decision making. After considering commenter input, the Board adopted the firm- and engagement-level metrics with the modifications described below. While the Board appreciates that there are limits to the information an experience metric can provide, the Board believes that it is and will continue to be a useful element in a suite of metrics, even in the context of technological advances and other changes in the audit market. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100000 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices The Board considered whether, as some commenters suggested, the firmlevel experience metric should be narrowed to cover only professionals who worked on an issuer audit in the most recent year. However, the Board does not believe that approach would increase the information value of the metric, because individuals may participate in issuer audits in some years but not others, so it would cover only a portion of the total talent pool. Such an approach would also add significant complexity to the calculation, as well as variability year over year. Accordingly, the Board concluded that it would be more appropriate for firms to report the experience of all audit professionals, as proposed. The Board also considered whether to eliminate engagement-level reporting of the experience of the EQR, based on commenter concern that this could imply that the EQR is a member of the engagement team. However, the Board does not believe that concern is well founded. There is nothing in Form AP to support such an implication, and the Board’s standards are clear that the EQR is not a member of the engagement team. Because of the significance of the EQR role, the Board continues to believe that EQR experience is important and should be separately reported. The Board is eliminating the requirement to provide separate firmlevel reporting of the experience of engagement partners. Instead, the final rules require firm-level reporting of (i) the average experience of all partners in aggregate, both those who serve as engagement partners and those who do not, and (ii) the average experience of all managers in aggregate. After considering commenter responses, the Board is concerned that separate reporting of engagement partner experience may not add significant information value but will increase the complexity and administrative burden associated with the metric. The Board believes these metrics, with all partners in aggregate, will also serve as a useful baseline for comparison of the engagement-level reporting of engagement partner and EQR experience. The Board has also separated the partner and manager experience metrics at the engagement level for consistency and comparability with the firm-level metrics. The Board considered broadening the scope of relevant experience beyond public accounting but decided to adopt that aspect of the metric as proposed. The Board notes that the commenters who recommended a broader scope had inconsistent recommendations as to VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 what would constitute relevant experience (e.g., experience in a financial accounting role, previous experience at a regulator, etc.), reflecting the difficulty of arriving at an agreedupon view of the non-audit experience that would be relevant and should be included. The Board believes a metric focused on experience in public accounting will be better focused and would avoid that difficulty. Several commenters raised concerns about the ability to track the historical information called for by the metric, some implying that the experience metric should be limited to experience with the individual’s current firm. The Board is concerned that such a limited metric could be misleading, as it would understate the experience of anyone who changed jobs. Moreover, the Board believes that firms could readily capture the information from current personnel and otherwise during the hiring and onboarding process, and the information would therefore generally be available to firms without a significant ongoing administrative burden. The Board noted the questions commenters raised about how to calculate averages, including how to treat partial years of experience and whether the average at the engagement level should be calculated on a weighted basis to reflect the extent of participation in the audit. As to partial years of experience, firms will be free to report in whole years on a rounded basis or, if they wish, more precisely. While the Board appreciates that it may be possible to make staffing changes in an effort to manage this or other metrics, the Board believes that calculating the experience metric for the other partners and managers as a weighted average would add unnecessary complexity. The Board also considered that the risk of managing the engagement-level experience metrics is minimized by other considerations, such as industry or other specialized experience needs, that go into staffing decisions. In addition, the Board expects that comparisons of trends in the reported metrics over time will provide balance. The Board also notes that, if a firm believed additional information or context would be required for a reader to understand the metrics provided, the firm could provide it as narrative. (See Exhibit A, ‘‘Experience of Audit Personnel.’’) v. Industry Experience As part of the planning activities of an audit, auditors have a responsibility to gain an understanding of the company’s business. These activities include gaining an understanding of matters PO 00000 Frm 00034 Fmt 4701 Sfmt 4703 affecting the industry in which the company operates, such as financial reporting practices, economic conditions, laws and regulations, and technological changes.126 Experience in a particular industry helps an auditor understand the industry’s operating practices, the critical accounting issues confronting companies in that industry, the risks of material misstatement of the financial statements specific to industry factors, and any industry-specific audit procedures. Understanding the experience of firms’ audit personnel across industries is an important factor in assessing the firm’s capacity and resources to perform audits of issuer engagements that benefit from specific industry knowledge. The Board believes industry experience metrics will assist in gaining that understanding.127 Importantly, academic literature has long identified auditor industry specialization as related to the effectiveness of audits.128 One study that examines the impact of auditor industry specialization on the assessment of audit risk and in audit planning found that auditors with industry-specific knowledge improved the auditor’s assessment of differential audit risk and the quality of their audit planning decisions.129 Investor-related commenters were generally supportive of industry experience metrics stating they believe that it is critical for auditors to have an elevated level of industry-specific knowledge. One investor-related group stated that experience in a particular industry helps an auditor understand that industry’s operating practices, critical accounting issues faced in that industry, the risks of material misstatement of the financial statements specific to industry factors, and any industry specific audit procedures. Another commenter suggested that further guidance on the classification of 126 See AS 2101.07. 1000.38a.(2)(d) requires firms to establish quality objectives that address the firm’s judgments about the extent to which the firm has or can obtain resources to perform the engagement as part of its acceptance and continuance of engagements. 128 See, e.g., W. Robert Knechel, Vic Naiker, and Gail Pacheco, Does Auditor Industry Specialization Matter? Evidence from Market Reaction to Auditor Switches, 26 Auditing: A Journal of Practice and Theory 19, (2007); Steven Balsam, Jagan Krishnan, and Joon S. Yang, Auditor Industry Specialization and Earnings Quality, 22 Auditing: A Journal of Practice and Theory 71, (2003); and Allen T. Craswell, Jere R. Francis, and Stephen L. Taylor, Auditor Brand Name Reputations and Industry Specializations, 20 Journal of Accounting and Economics 297 (1995). 129 See Kin-Yew Low, The Effects of Industry Specialization on Audit Risk Assessments and Audit-Planning Decisions, 79 The Accounting Review 201, 202 and 214 (2004). 127 QC E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices industries would be helpful and also suggested that weighting current experience should be considered. One commenter suggested that the metric be disaggregated between partners and managers. While most firm and firm-related commenters opposed industry experience metrics, one firm commenter stated that they understand in principle why industry metrics may be perceived as meaningful. Some commenters stated that the proposed industry experience metrics were not useful due to issues with comparability and complexity. Some commenters believed that the industry metrics gave rise to the potential for confusion and misunderstanding, in part because any classification system could group together very different types of issuers that could result in inappropriate comparisons. One commenter suggested that the proposed metric does not address the issue that not all audits require specific industry experience and that audit quality is enhanced when an engagement team includes personnel with diverse experiences. Another commenter stated that metrics depicting experience would need context to be meaningful. After considering commenter input, the Board has retained industry experience metrics, but simplified them from the proposal. The changes include limiting the scope for reporting at the firm level and limiting the requirements for reporting at the engagement level to the engagement partner, the engagement quality reviewer and certain members of the core engagement team among other changes further discussed below. At a high level, the Board believes this addresses the concerns of commenters regarding complexity, certain data collection concerns, the potential for confusion and misunderstanding, and also provides for more comparable information. lotter on DSK11XQN23PROD with NOTICES2 a. Thresholds The Board proposed that the metrics would count partners who have at least five years of experience throughout their careers in a particular industry and managers who have at least three years of such experience.130 For determining 130 A note to the calculations clarifies that industry experience is accumulated throughout an individual’s career (i.e., aggregates experience obtained at all career levels). When determining whether an individual has experience in a specific industry the following may be taken into account: (i) industry experience may be, but is not required to be, exclusive to experience on audit engagements, or exclusive to experience gained at an accounting firm, but must be relevant, and (ii) industry experience can be acquired in non- VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 what counted as a year’s experience, the Board proposed a minimum threshold of 250 hours, or 25% of hours worked, focused on an industry in a given year. The proposed instructions for reporting the metric included qualitative considerations to assist in determining whether an individual had experience in a specific industry, including consideration that industry experience may be, but is not required to be, exclusive to experience on audit engagements, or exclusive to experience gained at a public accounting firm, but must be relevant, which includes experience in accounting or auditing roles and other specializations, such as experience that is related to fair value estimates in the industry. The instructions also clarified that industry experience may be acquired in nonconsecutive years. One commenter expressly agreed with the proposed requirement of 250 hours or 25% of the auditor’s time as being a reasonable criterion for a year of qualifying industry experience. However, several other commenters criticized the proposed threshold. Some of the concerns raised included tracking the information throughout the career of professionals, particularly at the global network level; obtaining historical data; complying with the proposed 250 hour or 25% thresholds; and maintaining documentation to support the metrics. Another commenter expressed that the thresholds were not meaningful as different individuals may perform the same tasks in different amounts of time. This commenter also expressed that without research supporting the thresholds, it is not possible to recommend how much industry experience would be necessary. While one commenter acknowledged the proposal allowed self-reporting as an option, they had concerns about the ability of personnel to accurately determine whether they worked 250 hours or more in a specific industry going back many years, potentially decades, and encouraged qualitative thresholds for determining industry experience. One commenter agreed with the proposed 3- and 5-year thresholds for measuring industry experience and also suggested adding an additional threshold of 10-years at the partner level. Other commenters raised other concerns with the proposed reporting requirements. Some commenters consecutive years. Relevant experience includes experience in accounting or auditing roles and other specializations, such as experience that is related to fair value estimates in the industry. See Note 2 to Item 4.5 of Form FM, Note 1 to Item 6.5 of Form AP. PO 00000 Frm 00035 Fmt 4701 Sfmt 4703 100001 disagreed with the proposal to count managers with three years of experience and partners with five years of experience. Among these commenters, some expressed that it would unfairly exclude some partners and managers, could be a disadvantage to smaller firms, could be time consuming to compile data to support, and should not include individuals with de minimis involvement. Commenters that responded to the question of whether industry experience should be limited to audit experience or rather should include all relevant experience agreed with the proposal to include all relevant experience. They also agreed that it need not be consecutive years. Several additional commenters voiced concern about whether industry experience was required to be recent. Two commenters claimed that the Board’s recently adopted quality control standard acknowledges that there is no right level of industry experience,131 and each audit may require different background and experience. After considering commenter feedback, the Board retained the 3- and 5-year thresholds for determining whether partners and managers should be included in the industry experience metrics. The Board has also retained the threshold of 250 hours or 25% of hours worked as the baseline to determine whether a year qualifies as industry experience but recast it as a general expectation rather than a requirement to allow firms to exercise reasonable judgment. At the firm level, once the 3or 5-year industry experience threshold has been attained, partners and managers should be included in the metrics until or unless a firm determines, in its reasonable judgment, that the particular industry experience is no longer relevant. At the engagement level the Board has simplified the reporting requirements by limiting the metrics to the years of experience of the engagement partner, the EQR, and members of the core engagement team. The metrics will not include a requirement to determine the industry experience of other partners and managers who participated in the audit who are not members of the core engagement team. The Board believes these changes will appropriately address commenter concerns about potential difficulties in gathering and verifying data while continuing to allow 131 QC 1000.47 requires firms to design, implement, and maintain policies and procedures such that their personnel obtain and maintain the competence to fulfill their respective assigned engagement roles, including an understanding of, among other things, the industry in which the company operates and its relevant characteristics. E:\FR\FM\11DEN2.SGM 11DEN2 100002 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 firms to take into account matters like experience in related industries, the nature of non-audit experience, and whether experience is recent or remote in time. In addition, consistent with the proposal, the final rules do not specify how the relevant information should be accumulated. Because experience may be obtained in different ways at different points throughout a professional’s career, there are many ways in which information could be accumulated to support the firm’s judgment, including personnel selfreporting or a firm’s own time-keeping system. b. Industry Classification The proposal set forth requirements for firms to provide information regarding partner and manager experience in particular industries. In order for firms to use a consistent approach to industry identification, the Board proposed the Industry Classification Benchmark (ICB), operated and managed by FTSE Russell. The ICB is used by global stock exchanges, including the London Stock Exchange, Euronext, and NASDAQ OMX, to categorize listed companies. Based on the ICB classification system, firms would have selected from among a total of 31 possible industry classifications.132 Several commenters agreed that the proposed index was an appropriate reference for industry classification. One commenter acknowledged that there was a potential for imprecision when reporting on large conglomerate companies that operate in many different industries, but stated their belief that using the ICB rather than the legacy Standard Industrial Classification (SIC) codes is a better strategy from the outset of the creation of the metrics. This commenter also expressed their understanding that there could be some imprecision at the margins. On the other hand, several commenters stated that it would be inconsistent with other reporting required by the SEC using the SIC codes or the North American Industrial Classification system (NAICS). Some commenters stated that firms do not necessarily align with the industries proposed. One commenter pointed out that the ICB listing does not include public sector or government and asked whether these should be omitted from the reporting requirements. Commenters responding to the proposal’s question about whether reporting should be expanded to allow 132 See FTSE Russell Industry Classification Benchmark (ICB), available at https:// www.lseg.com/en/ftse-russell. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 for industries in addition to an issuer’s primary industry stated that industry reporting for large issuers is complex, some stating that changes over time from mergers and other activities would add to the complexity. Some commenters also stated that the proposed industry metrics would provide challenges with respect to data collection. In response to these concerns and after further considering recent voluntary public reporting by firms,133 the Board has expanded the classification taxonomy and added flexibility. With respect to the proposed industry classification listing, the final requirements continue to provide a listing from which to select industries for reporting purposes, but have been revised to include certain additional industries such as agriculture and forestry and government and public services categories to facilitate reporting for firms that have large practices in these industries or sectors. In addition, for certain industry groupings, such as finance and health care, an ‘‘other’’ subgrouping has been added to provide flexibility while maintaining a level of comparability at the overall industry level. Firms are also permitted to specify additional industries for reporting in the event that the listing does not include an industry that accurately represents the industries that they serve. The taxonomy the Board adopted is as follows: [Form FM and Form AP will provide drop-down menus for industry classifications] Industry Classification 1 2 3 4 5 6 7 Agriculture and Forestry 1.1 Agriculture and Forestry Automotive 2.1 Automotive: Manufacturing 2.2 Automotive: Retail Basic Resources 3.1 Basic Resources: Chemicals 3.2 Basic Resources: Industrial Materials 3.3 Basic Resources: Industrial Metals and Mining Construction and Materials 4.1 Construction and Materials Consumer Products and Services 5.1 Consumer Products and Services Energy 6.1 Energy: Alternative Energy 6.2 Energy: Oil, Gas, and Coal 6.3 Energy: Other Energy and Transportation Finance 133 Consideration was given to recent Transparency Reports and information available on public firm websites. PO 00000 Frm 00036 Fmt 4701 Sfmt 4703 7.1 Finance: Banks (Excluding Investment Banking and Brokerage Services) 7.2 Finance: Investment Banking and Brokerage Services 7.3 Finance: Finance and Credit Services 7.4 Finance: Insurance 7.5 Finance: Real Estate 7.6 Finance: Other 8 Government and Public Services 8.1 Government and Public Services: Government 8.2 Government and Public Services: Public Services 9 Health Care 9.1 Health Care: Health Care Providers 9.2 Health Care: Pharmaceuticals and Biotechnology 9.3 Health Care: Medical Equipment and Services 9.4 Health Care: Other 10 Industrial Goods and Services 10.1 Industrial Goods and Services: Aerospace and Defense 10.2 Industrial Goods and Services: General 11 Technology, Media, and Telecommunication 11.1 Technology, Media, and Telecommunication: Media 11.2 Technology, Media, and Telecommunication: Technology Hardware and Equipment 11.3 Technology, Media, and Telecommunication: Telecommunication 11.4 Technology, Media, and Telecommunication: Other 12 Trades and Services 12.1 Trades and Services: Travel and Leisure 12.2 Trades and Services: Retail 12.3 Trades and Services: Wholesale 12.4 Trades and Services: Other 13 Utilities 13.1 Utilities: Electricity 13.2 Utilities: Gas, Water, and Multiutilities 13.3 Utilities: Waste and Disposal Services 14 Other Industry [specify] 14.1 [Industry] The Board acknowledges that its taxonomy does not align with issuer reporting using SIC or NAICS codes. As discussed in the Board’s proposal, the Board rejected those systems, as well as others, based on several considerations, including that the SIC system has not been updated since the 1980s, the NAICS system uses a productionoriented and North America-centric structure that would not be appropriate as applied to many issuers, and that none of the alternative systems the Board considered would provide a basis for a meaningful metric. For example, E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices the SIC code system, in addition to being dated, is highly fragmented, employing more than 440 different industry classifications as listed on the SEC’s website.134 The Board believes this fragmentation would dramatically impair the utility of the metrics, particularly because there is no logical hierarchy by which industries with a need for similar accounting or auditing specializations can be grouped together. By comparison, the Board believes that the curated taxonomy that the Board developed and refined in consideration of the ICB system most closely aligns with the industries that firms generally disclose in their transparency reporting and will provide the most relevant basis for comparison among firms. lotter on DSK11XQN23PROD with NOTICES2 c. Metrics The firm-level metrics provide information related to the firm’s industry specialization and the engagement-level metrics provide information related to experience in the issuer’s primary industry of engagement partners and engagement quality reviewers. The following sections discuss the proposed metrics, comments received, responses to those comments, and the final requirements for firm- and engagement-level metrics. (1) Firm-Level Metrics At the firm level, having industry experience may provide a group of professionals who can both work on engagements and advise members of engagement teams when additional technical, industry-specific knowledge is needed. Firm-level industry experience may indicate that the firm has specific industry-based audit knowledge, industry-specific tools related to risk assessment, and industryspecialized methodologies for accounting and auditing. As a firm-level metric, the Board proposed that firms report, for each industry that represents at least 10% of the firm’s revenue from audit services, the number of partners and managers who have accumulated five or more years or three or more years, respectively, of industry experience throughout their careers. The Board also proposed to allow firms to provide the same information for additional industries voluntarily. As discussed above, the proposed reporting instructions specified a minimum threshold number of years of industry experience for reporting and how those years were to be calculated. Some commenters questioned the proposed 10% of revenue threshold for 134 See https://www.sec.gov/search-filings/ standard-industrial-classification-sic-code-list. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 identifying the firm’s top industries. One commenter stating that considering both the proposed threshold and the fact that the proposed index is not inclusive of all industries in which the firm earned revenue from audit services, the calculation would be problematic or would result in the exclusion of those industries. Another commenter questioned what period the 10% was meant to be measured over and whether it was meant to be aligned with the firm’s fiscal year or another period. One firm commenter expressed concern that the proposed metric would require it to compile data for industries in which it did not perform any issuer audits. This commenter, and another, suggested an alternative of calculating the metric based on 10% of a firm’s issuer audit practice rather than its overall audit practice. Other commenters suggested that the metric be narrowed to a firm’s issuer audit practice, particularly in light of the proposed 10% of the firm’s revenue from audit services threshold. One of these commenters additionally suggested that the metric include only partners who serve on issuer audits. In the Board’s proposal, the Board solicited comment on alternatives to the 10% threshold, such as requiring firms to disclose their top five or top ten industries by revenue from audit services. One commenter stated that this approach would be more practical and clearer for stakeholders. Some commenters suggested potential alternative approaches. One commenter suggested requiring public disclosure of industry expertise at the firm level based on the percentage of a firm’s issuer clients according to the industry marked on those issuers’ SEC filings. Another suggested reporting the number of entities under audit in a certain industry rather than partner and managers with years of experience. Other commenters suggested that, rather than focusing on the percentage of revenue and using the ICB listing, each firm should be allowed to list the industries, presumably not limited to the proposed ICB listing, and to choose the number of industries, for which they have specific expertise and report on those. Several commenters suggested that further study or outreach was needed to determine the ability to prepare such information and for investors and audit committees to understand how such firm-level metrics would be used in decision-making. After considering the comments received, the Board simplified firm-level reporting of industry experience in several ways: PO 00000 Frm 00037 Fmt 4701 Sfmt 4703 100003 • The Board is limiting reporting requirements to firms that issued five or more audit reports for accelerated filers and large accelerated filers during the reporting period, combined. The Board believes this will reduce the chances that a firm’s top industries will not include the industries represented in its issuer audit practice, resulting in a more meaningful data set, while also alleviating compliance burdens on firms with a small issuer practice.135 • Rather than requiring reporting with respect to industries that account for at least 10% of the firm’s revenue from audit services, the Board is requiring firms to report the top five industry sectors based on such revenue, regardless of the percentage of revenue they represent. The Board believes this will address commenter concerns regarding potential complexities of the calculation. The Board has also clarified the instructions to provide that the determination is based on revenue for the firm’s most recently completed fiscal year. While this means that the top five industries will be measured over a different period than the years of experience, the Board believes that consequences of that misalignment are likely to be immaterial, while it will simplify data collection and align it with the firm’s business cycle. The Board has also provided the ability for firms to report additional industries if the Board’s list does not include an appropriate industry grouping. While the Board considered commenter suggestions to limit the metric to firm revenue from issuer audits rather than revenue from all audit services, the Board continues to believe that the metric is more relevant if it includes all audit services. The information it provides offers a user of the information a view to the firm’s entire audit practice, not just its issuer audit practice, which informs users of the depth of industry experience of the firm’s people. The Board believes this information is more relevant than the number of issuers a firm audits in a particular industry because, in absence of an understanding of the specific issuer population, that data may be less easily interpreted. (2) Engagement-level Metrics At the engagement level, industry experience provides professionals with 135 Based on PCAOB staff’s analysis performed on the data obtained from Audit Analytics, Standard & Poor’s, and publicly available data from the PCAOB’s Registration, Annual and Special Reporting (RASR), available at https:// rasr.pcaobus.org. For the two-year period ended September 30, 2023, the Board expects that approximately 50 firms will be required to report this metric each year. E:\FR\FM\11DEN2.SGM 11DEN2 100004 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 an understanding of risks unique to the industry and industry-specific auditing and accounting considerations. The proposed engagement-level metrics required disclosure of the years of experience in the issuer’s primary industry for the engagement partner and the engagement quality reviewer. In addition, the Board proposed that the number of partners (excluding the engagement partner) and managers on the engagement team with experience in the issuer’s primary industry also be disclosed. Commenters raised questions with respect to personnel to be included in the engagement-level industry metrics. One commenter suggested that industry experience metrics be limited to the core engagement team, suggesting that including the EQR implies that the EQR is part of the engagement team, when they are not. This commenter, and some others, suggested that industry experience should be limited to recent experience. A commenter stated that these metrics should be limited to the engagement partner and the EQR, while another commenter stated that partners, other than the engagement partner, and managers, should be disaggregated. As discussed above, many commenters had concerns with the calculations, including the thresholds to be used in the calculations. In response to these concerns, the Board has limited reporting to the engagement partner and the engagement quality reviewer, and other partners (excluding the engagement partner) and managers on the core engagement team. The Board has eliminated the proposed reporting for other firm partners and managers who are not members of the core engagement team. The Board believes, given the key roles played by the engagement partner and the EQR, and other partners and managers on the core engagement team that this will focus the metric on the most salient information. (See Exhibit A, ‘‘Industry Experience.’’) vi. Retention of Audit Personnel The retention rate and the headcount change inform the overall readiness, availability, and ability of the firm to conduct effective and efficient audits. While some turnover is expected within audit firms,136 a comparatively high rate of turnover or higher-than-expected turnover could adversely affect audits.137 It could diminish the 136 See, e.g., Kris Hardies, A Survival Analysis of Organizational Turnover in the Auditing Profession, 97 MAB 5 (2023). 137 See Christophe Van Linden, Marie-Laure Vandenhaute, and Aleksandra Zimmerman, Audit Firm Employee Turnover and Audit Quality, VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 available pool of talent who have the appropriate competency. It may take time and resources for the firm to replace the competency lost, likely through effective recruiting and further training. Academic literature consistently finds the same conclusion: turnover negatively affects audit quality, more so at longer-tenured engagements than newer engagements.138 The proposal set forth requirements for firms to calculate the average annual retention rate and the average annual headcount change of partners and managers both at the firm- and engagement-level. At the firm level, the Board also proposed to require disclosing the average number of partners and managers to provide context for the retention and headcount change metrics. For example, a 67% retention rate at a larger firm (200 departures out of 600 professionals) would involve a different level of employee continuity and hence imply a different magnitude of possible impact on the firm’s human resource management, than at a smaller firm (e.g., one departure out of three professionals) because this larger firm will likely need to replace 200 professionals while the smaller firm will only need to replace one professional assuming all things are consistent. At the engagement level, the Board also proposed to require disclosing the average tenure on the engagement for partners and managers to quantify the overall continuity of the engagement team members. Average annual retention rate is a year-over-year metric, but tenure would provide overall engagement-level experience as an important component to understand the experience of the engagement team on the specific audit. a. Firm-Level Reporting The annual retention rate measures the percentage of firm personnel continuously employed for the reporting period to demonstrate the continuity of firm personnel. The average annual headcount change measures changes in the firm’s overall headcount of Working Paper, Vrije Universiteit Brussel, SSRN (2023). 138 See, e.g., Joshua Khavis and Brandon Szerwo, Audit-Employee Turnover, Audit Quality, and the Auditor-Client Relationship, SSRN Electronic Journal, (2023); Linden, et al., Audit Firm Employee Turnover and Audit Quality; W. Robert Knechel, Juan Mao, Baolei Qi, and Zili Zhuang, Is There a Brain Drain in Auditing? the Determinants and Consequences of Auditors Leaving Public Accounting, 38 Contemporary Accounting Research 2461 (2021); and Brant E. Christensen, et al., How Do Team Workloads and Team Staffing Affect the Audit? Archival Evidence from U.S. Audits. The Board notes that SSRN does not peer review its submissions. PO 00000 Frm 00038 Fmt 4701 Sfmt 4703 managers or partners, giving an indication of the firm’s success in replacing professionals who left roles performing audits and the overall availability of firm personnel. The annual retention rate and the annual headcount change are closely related; however, the annual retention rate would measure the ‘‘same people’’ within the firm, while the annual headcount change would measure the ‘‘same number of people.’’ The annual retention rate measures whether the same individuals are still holding their positions at the firm while the annual headcount change is focused on the change in the number of individuals serving in those positions. Changes in annual headcount over time could result from a variety of reasons, for example, changes in a firm’s human resource strategy (e.g., greater use of technological resources, shifting more work to shared service centers), or a downturn in the economy. Commenters generally supported the proposed firm-level metrics. Some said they were sufficiently objective or straightforward and easy to interpret. One of these commenters also indicated that some firms already published similar metrics in firm audit quality reports and another commenter indicated that these metrics allow for some comparisons and may help a user in better understanding a firm. Two investor-related groups agreed with the proposal that a comparatively high rate of turnover or higher-than-expected turnover could adversely affect the audit, while another commenter indicated that staff turnover reporting is directionally supporting audit quality improvement through better continuity year-over-year. One of these commenters also stated that retention metrics will add to the mix of information provided in the final metrics without drawing a specific inference as to an ‘‘ideal’’ retention rate, considering the need to strike a balance between maintaining continuity of the engagement team members and introducing new personnel who will take a ‘‘fresh look’’ at the audit. Another commenter stated that a benefit of the headcount change metric is that it will provide context for the retention metric. A commenter stated if a firm reports favorable employee retention metric, the firm’s culture is ideal to contribute to higher audit quality. One commenter supported the firm-level metrics and acknowledged the importance of assessing the readiness and availability of the firm for conducting effective audits, but requested the Board determine how the metrics correlate E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices with audit quality before requiring public reporting. One commenter supported firm-level reporting of this metric area, but expressed concern that users could misinterpret the average annual headcount change metric due to unfamiliarity with the distinction between the turnover rate and headcount change. This commenter urged the PCAOB to host a roundtable discussion or pilot test to determine how audit committees or investors may interpret and use this information. Another commenter agreed that the turnover at various levels could have an impact on audit quality. Two commenters did not support the firm-level reporting of these metrics. While one commenter agreed with the proposed calculation and description of the metrics, this commenter was concerned that it could be misconstrued and present firms with a competitive disadvantage for recruiting talent without providing context (e.g., turnover due to changes in firm structure, shifting industry concentration, performance, ethical, or independence issues). Another commenter claimed the metric was convoluted and would be at the risk of misinterpretation. Additionally, two other commenters raised a concern; one of them questioned whether these metrics would be meaningful or of value to investors and whether firms would be sufficiently consistent in calculating the metrics to make them worthwhile and another questioned that the inclusion of all the firm’s managers and partners may make this metric meaningless for firms whose issuer audit practice is small in relation to the total practice and recommended more outreach regarding the usefulness for stakeholders. Regarding the description and calculation of these metrics, several commenters asked questions or suggested refinements. One commenter questioned how the metrics would be calculated in a case of voluntary partner rotation. Another commenter recommended clarifying whether ‘‘other service lines within the firm’’ includes ‘‘other accounting services’’ as defined by PCAOB Rule 1001(o)(i). Additionally, one commenter recommended renaming the description of the average annual headcount change to align with the calculation to avoid confusion; as proposed, it would provide current year headcount as a percent of the prior year headcount, not a change as a percent of the prior year. This commenter also suggested clarifying the meaning of ‘‘holding the same position,’’ used in the retention VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 calculation and ‘‘transferred out of audit practice,’’ and ‘‘continuously employed during the 12-month period’’ used in the illustrative example of the firm’s average annual retention rate calculation. One commenter suggested disaggregating partners and managers. Three commenters did not support separately reporting senior or all staff level annual retention and annual headcount change metrics. Taking into account commenter feedback, the Board adopted the retention metric as proposed and adopted the headcount change metric with some modifications. As noted above, academic literature consistently supports that turnover negatively affects audit quality. The Board believes the retention metric is objective, provides important data, and is already publicly reported by a number of firms in their audit quality or other reports. This metric was also generally supported by commenters from the different constituencies, including firm, firm-related groups, investor-related groups, and others. Since this or similar metrics are already reported by firms, the Board does not believe there will be a disadvantage in recruiting, difficulty in consistently reporting of this metric, or a risk of misinterpretation. Firms could also use the expanded narrative disclosures to provide context, if necessary. The Board also continues to believe the inclusion of all partners and managers who participate in audits, not a subset of partners and managers who serve issuer engagements, is appropriate because the retention rate and the headcount change inform the overall readiness, availability, and ability of the firm to conduct an effective and efficient audit. While this metric area provides historical information, the Board believes historical data signals impact on the firm’s near-future staffing needs and ability to conduct effective audits due to the time it takes to hire and train additional resources. Firms with sufficient overall headcount could reallocate staffing due to a possible staffing shortage on issuer engagements. The Board does not believe that partner rotation, whether mandatory or voluntary, is likely to affect firm-level reporting of this metric, as the rotating partner will likely continue to participate in audits in the subsequent year (albeit on different engagements). The term used in the calculation ‘‘holding the same position’’ means that a partner remains as a partner and a manager remains as a manager of the firm during the reporting period. The term ‘‘continuously employed within the 12 months’’ means the individual is PO 00000 Frm 00039 Fmt 4701 Sfmt 4703 100005 continuously employed by the firm throughout the 12 months, without departing to another employment. The Board revised the average annual headcount change calculation to address concerns raised by commenters, specifically that users may misunderstand this metric as a turnover rate and that the calculation should align with the title. The Board believes that the revision will help a user’s understanding of the metric and align with the title of this metric by reporting the headcount change as a percentage of prior year. For example, using the illustrative example in the proposal, Firm A had 204 managers and 200 managers as of October 1, 20X0 and September 30, 20X1, respectively. Under the revised calculation, the average annual headcount change will be ¥2% based on (200–204)/ 204 = ¥1.96%. The Board believes this change will help users understand that the average annual headcount change of –2% means a 2% decrease in headcount from prior reporting year end to current reporting year end. This information is often used as a human resource management metric. Lastly, regarding the description and the calculation of the proposed average number of the firm’s partners and managers, one commenter indicated that they are clear and appropriate. Another commenter indicated that it would help to provide context for the retention metric but use a simple average of the count at the beginning and end of the year. This commenter also agreed with treating the promotions to another level of seniority as if they occurred at the beginning of the year. Based on commenters’ feedback on firm-level reporting of average number of managers and partners, the Board adopted this metric as proposed because comments received agreed with the proposed description and calculation and this metric will help provide context for retention and headcount change metrics. The proposed calculation provided a simple average of the number of partners or managers as of the previous reporting period end and the current reporting period end so that the numbers at the end of each reporting period will be used consistently in the calculation. Because the proposed calculation was not significantly different from using the simple average of the count at the beginning and end of the year, as suggested by a commenter, the Board adopted the calculation as proposed. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100006 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices b. Engagement-Level Reporting For the engagement-level reporting, commenters generally did not support metrics in this area, while several commenters supported both firm- and engagement-level reporting. Many commenters who did not support such metrics cited the lack of context in the metrics itself or difficulties in explaining a wide range of factors that caused the engagement-level turnover (e.g., mandatory partner rotation, personal issues (i.e., family or medical leave, or relocations), firm’s strategic resources management (i.e., scheduling conflicts, resource constraints, independence issues, or need for additional expertise)). Some commenters also cited the difficulty in interpreting the information, the risk of misinterpretation, misuse and misleading users, and even potentially being punitive to engagement teams and issuers. Others offered further reasons for not including this metric, which included difficulty in tracking and having consistent reporting on Form AP to make these metrics worthwhile. One commenter indicated the possibility of being detrimental to audit quality if these metrics incentivize firms to manage to achieve certain metrics, based on the commenter’s view that engagement staffing should be based on identified risks of material misstatement of the issuer. This commenter and another commenter further expressed concerns that the engagement-level retention rate for smaller engagement teams will be significantly more sensitive to any turnover relative to the retention rate for larger engagement teams because the size of engagement teams tends to vary with the size of the engagement. Two commenters also indicated that this metric is unnecessary because engagement resource management is already covered by the firm’s quality control system. One commenter indicated that the engagement partner is responsible for determining the sufficiency and appropriateness of engagement resources and prior year information will not be relevant in evaluating the quality of an engagement team in the current year. Another commenter emphasized that properly managed turnover will increase audit quality to reduce familiarity biases. Some commenters believe these metrics will be more relevant to the audit committee or audit committee and management or should be provided only to the audit committee to allow for robust discussions. One commenter only supported disclosure of the engagement-level tenure metric to the VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 audit committee because it will provide meaningful information to assist audit committees in exercising their duties to oversee the auditor; however, this commenter did not support other retention metrics as the engagement team staffing is a firm-level decision with factors that are not engagement specific or local laws and regulations that the firms may not be able to disclose. One commenter indicated that these metrics should be considered in conjunction with other metrics reported rather than presuming a specific correlation with audit quality or auditor’s independence, indicating as an example that there are specific legal and ethical mandatory rotation of key audit partners requirements in Europe. Another commenter asked various questions in the calculation of the engagement-level metrics for inclusion or exclusion of certain specific conditions (e.g., whether there is a time limit in how far back a partner or manager’s tenure to be included). Based on comments received, the Board did not adopt the engagementlevel reporting of these metrics at this time, primarily due to some of the challenges described by commenters including difficulty in providing context (including some information that is not permitted for public disclosure), consistent reporting, and interpreting this metric area at the engagement level, due to, for example, sensitivity of engagement-level turnover on smaller engagements compared to larger engagements because turnover will have more direct and significant impact to engagement-level reporting due to the relatively smaller size of the managers and partners involved in each engagement. (See Exhibit A, ‘‘Retention of Audit Personnel.’’) vii. Allocation of Audit Hours At the engagement level, the Board believes performing audit procedures prior to the issuer’s year end will allow the engagement team to identify significant issues in a timely manner and provide the engagement team with the opportunity to address those issues earlier. The Board also believes it will enable engagement teams to have the resources available to appropriately respond to significant issues identified after year end. Discussing this metric with the audit committee could provide the audit committee with information regarding aspects of the engagement’s performance. Academic literature suggests that allocation of a greater proportion of total hours to earlier audit phases, prior to a company’s year end, PO 00000 Frm 00040 Fmt 4701 Sfmt 4703 is associated with a lower likelihood of restatements 139 and late Form 10–K filings and also decreased total audit hours.140 As proposed, the firm-level and engagement-level metrics related to allocation of audit hours would have required firms to report the percentage of total audit hours incurred both prior to the issuer’s year end and following the issuer’s year end, separately. Several commenters supported the reporting of this metric as proposed (i.e., at both the firm and engagement level), while some commenters only supported required reporting of this metric at the firm level. Of those commenters that supported reporting this metric at only the firm level, two commenters requested the following clarifications regarding various elements of the calculation: • Whether the period being reported at the firm level should be based on audit reports dated from 10/1—9/30 or based on engagements with a fiscal yearend from 10/1—9/30. This commenter expressed concern that if the proposal’s intention was the latter, significant challenges with the proposed 11/30 reporting period for Form FM should be anticipated. • How this metric would be applied to an initial public offering (‘‘IPO’’) engagement where the audit covers up to three years where often the work doesn’t follow the traditional audit cycle or timeline. A commenter expressed concern that because the reporting period for Form FM is different than the engagement period for which total audit hours are calculated for Form AP, this will create a challenge with data collection and validation for different periods. This commenter also expressed concern that this metric requires the use of total audit hours, which relies on information from other auditors. The commenter recommended that the Board consider whether the use of other auditor information is necessary to meet the Board’s objective. One commenter expressed concern that the firm-level metric would not be comparable due to changes in circumstances of specific issuers because while individual issuer circumstances may not be significant enough to move the metrics for larger 139 Daniel Aobdia, Preeti Choudhary, and Noah Newberger, The Economics of Audit Production: What Matters for Audit Quality? An Empirical Analysis of the Role of Midlevel Managers within the Audit Firm, The Accounting Review (2024). 140 Brant E. Christensen, Nathan J. Newton, Michael S. Wilkins, Archival Evidence on the Audit Process: Determinants and Consequences of Interim Effort, 38 Contemporary Accounting Research 2 (2021). E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices firms, for smaller firms individual issuer circumstances could impact the overall results. As an example, for a smaller firm with an issuer that had a large acquisition during the fourth quarter, that would lead to a significant shift of hours after the end of the year. As described above, the reporting period for firm-level metrics reported on Form FM will generally be the 12-month period ended September 30 in each year. When reporting this metric, the firm could use the information reported at the engagement level on Form AP for this metric to calculate the firm-level metric for reporting on Form FM. For multi-year audit engagements, including IPO engagements, because the audited financial statements would be included in one auditor’s report, it is not possible to identify one particular year-end that a firm should use that would not skew the reported metric. Therefore, the Board excluded multi-year audits from the required reporting of this metric. Given the commenter concerns raised around the collection and data validation of this metric for all issuer engagements, the Board has modified the firm-level description and calculation of this metric area to include only those accelerated filer and large accelerated engagements that will be reported at the engagement level. The Board believes this narrower scope will yield better alignment between firmand engagement-level metrics and more comparable information across engagements. Related to commenter concerns about the collection of information from other auditors, Form AP currently requires firms to collect information regarding the hours of other auditors in calculating total audit hours. Total audit hours collected for Form AP already includes hours related to the quarterly reviews, so those hours would also be included in the numerator and denominator for this metric, see also discussion above. Some commenters stressed the importance of providing narrative context in relation to the reporting of this metric, for example: • One commenter (that only supported reporting at the firm level) asserted that reported metrics may be misleading without proper narrative disclosure to provide the necessary context to users. This commenter elaborated that circumstances beyond the auditor’s control may influence the allocation of overall audit hours, and users should be cautioned against making presumptions that a higher proportion of hours after the issuers’ year ends is a signal of lower quality. • One commenter expressed the view that comparability of these metrics can VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 be highly dependent on factors such as industry, type of audit (i.e., financial statement audit or integrated audit), and transaction timing and volume, among others and that stakeholders will need appropriate context to interpret the significance of these metrics. This commenter also stated that there is a risk that stakeholders may be biased towards inferring that a quantitative metric for allocation of audit hours is a proxy for audit quality, which further supports the need for sufficient appropriate context to interpret the results. The Board agrees that allowing firms to provide a narrative disclosure will be important in certain situations to help users understand the context of a specific metric. See additional discussion related to this optional narrative disclosure above. Several commenters, firms and firmrelated groups, disagreed with the proposal to report this metric at the engagement level publicly and instead suggested that this metric would be more effectively addressed via dialogue with the audit committee. These commenters expressed the following views: • For the engagement-level metrics to achieve the Board’s stated objectives, such metrics would best be delivered through effective two-way communication between the auditor and the audit committee to provide the relevant and necessary context. • Even if offered the opportunity to provide narrative context, auditors may not be inclined to provide a full explanation as to why hours allocation may have skewed to after year end for a particular issuer, as doing so might disclose confidential information about the issuer’s preparedness for the audit or other facts, which might result in disputes. • There are a variety of factors that influence the allocation of hours before or after the entity’s year-end which are beyond the control of the auditor and may drive a disproportionate allocation of hours before or after the entity’s yearend in a given audit, including those related to the entity entering into transactions and changes in the entity’s operations or systems. Other commenters disagreed with the proposal to report this metric entirely. These commenters expressed the following concerns: • The timing of audit procedures (and resulting hours) is primarily a function of audit strategy decisions based on the assessment of a company’s ICFR and inadequate ICFR may require most hours to be incurred after the balance sheet date. This commenter stated that PO 00000 Frm 00041 Fmt 4701 Sfmt 4703 100007 more hours incurred after the balance sheet date may, in fact, indicate a proper evaluation of ICFR and higher audit quality and therefore this metric would provide little insight into audit quality. • This metric is not directly related to audit quality. The timing of the engagement procedures depends on many variables, including the nature of the audit areas, specific risks on an engagement, the effectiveness of interim and roll-forward procedures, the availability of staff, when the client is available, the client’s specific financial reporting systems, and internal controls. This commenter stated that this information could potentially be misleading or misinterpreted. • This metric seems somewhat arbitrary and may provide misleading information for those smaller engagements where a higher proportion of the work is performed post-year end. • It is unclear whether the metric is meaningful because it might be impacted by among other factors, macro-economic trends, company controls and activities, and use of shared service centers and more generally, may require too much explanation to provide meaningful comparisons. • This metric would not be comparable between larger firms and other firms and could have unintended consequences. In an audit of a smaller reporting company, it is frequently impracticable to perform much work prior to an issuer’s year end, both out of concerns for efficiency and because small companies, who might have an outsourced finance function, cannot support significant interim work. • Since most companies have a calendar year end, firms have strong incentives to perform work as of an interim date to move hours outside of the traditional busy season. A firm’s ability to shift work to an interim period is dependent upon a variety of factors, many of which are unrelated to audit quality. The Board considered commenter feedback, and in particular commenter concerns related to the fact that particular facts and circumstances surrounding an engagement could significantly skew a firm’s reported metric when compared to other firms that may have a different portfolio of issuer engagements. While the Board understands that each engagement is affected by the specific facts and circumstances, the Board continues to believe that users of this information will benefit from understanding how audit hours are allocated on engagements, supplemented by E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100008 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices narrative disclosure to provide context, as needed. At the engagement level, it may be more relevant for a firm to provide a narrative disclosure to explain the particular facts and circumstances related to the current reporting period’s metric for this area. One firm stated that ‘‘Pulling work forward, where feasible and appropriate, enables engagement teams more time to focus on areas of highest risk in the audit.’’ Based on the Board’s oversight activities, the Board agrees with this statement, and the Board believes that this information will be beneficial to users at both the firm level and the engagement level. As with all the metrics, the Board encourages the auditor and audit committee to have a robust dialogue. The proposal asked whether a different, more granular, metric would be more appropriate, for example allocation of audit hours devoted to each phase of the audit—planning, quarterly reviews, interim field work, final field work up until report release date, and post-report release date until audit documentation completion date. Most commenters who commented on this question did not agree that a different, more granular, metric would be more appropriate. Views provided by these commenters included the following: • A more granular metric devoted to different phases of an engagement would be very challenging to measure and interpret as the audit is an iterative process. In addition, audit procedures may be performed to meet more than one specific objective and thus may relate for instance to both planning and execution phases of the engagement. • It will be costly to assemble the information to report and such additional time spent on data reporting diverts very important time during the audit and creates an unnecessary dilemma for engagement teams as to whether it is more important to comply with audit quality standards or reporting requirement rules. The Board agrees with these commenters that a more granular metric is not necessary to achieve the objectives of this metric and did not modify the proposed metric to make it more granular. Other than clarifying that multiyear audits are outside the scope of the reporting requirement and revising the scoping of the firm level metric to limit it to only those accelerated filers and large accelerated filers of the firm, the Board adopted this metric as proposed. (See Exhibit A, ‘‘Allocation of Audit Hours.’’) VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 viii. Restatement History Restatements for errors (e.g., not for changes in accounting principles) are generally considered a signal of potential difficulties in at least parts of a firm’s audit practice. Academic literature suggests that restatements provide the cleanest empirical measure of audit failure.141 Overall, the Board believes the academic literature supports a measure that accumulates the pattern of restatements for firms, as this would provide a strong measure against which other metrics may be identified in the future. The proposed firm-level metric set forth requirements for firms to report information related to restatements,142 including both revision restatements (sometimes referred to as ‘‘little r’’ restatements) 143 and reissuance restatements (sometimes referred to as ‘‘Big R’’ restatements) 144 of audited financial statements for all issuer engagements of the firm. The proposal also included reporting of reissuance restatements of management’s report on ICFR.145 The Board adopted this metric area with several modifications discussed in more detail below. The proposal asked whether the proposed descriptions of revision restatement and reissuance restatement were clear and appropriate. The two commenters on this question agreed that the proposed descriptions were clear 141 See, e.g., DeFond and Zhang, A Review of Archival Auditing Research. 142 The term ‘‘restatements’’ has the same meaning as defined in the FASB Accounting Standards Codification (‘‘FASB ASC’’) Topic 250, Accounting Changes and Error Corrections; see also, ‘‘retrospective restatement’’ as defined in IFRS Accounting Standard (IAS) 8, Accounting Policies, Changes in Accounting Estimates and Errors. The phrase ‘‘error in previously issued financial statements’’ has the same meaning as defined in the FASB ASC 250; see also ‘‘prior period errors’’ as defined in IAS 8. 143 A ‘‘revision restatement’’ of audited financial statements was described in the proposal as ‘‘when an immaterial error in previously-issued audited financial statements, that is material to the current period financial statements, is corrected by an issuer in the current period comparative financial statements by restating the prior period information and disclosing the revision.’’ 144 A ‘‘reissuance restatement’’ of audited financial statements was described in the proposal as ‘‘when a material error in previously-issued audited financial statements, report on management’s assessment of the effectiveness of ICFR, or both, is identified and disclosed by an issuer in a filing with the SEC (e.g., on Form 8–K Item 4.02, Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review).’’ 145 A ‘‘reissuance restatement of management’s report on ICFR’’ was described in the proposal as ‘‘When a material error in a previously-issued report on management’s assessment of the effectiveness of internal control over financial reporting is identified and disclosed by an issuer in a filing with the SEC.’’ PO 00000 Frm 00042 Fmt 4701 Sfmt 4703 and appropriate. The descriptions were adopted with modifications: (i) in addition to referring to restatements identified and disclosed by the issuer in a filing with the SEC, the final description of reissuance restatement also refers to circumstances in which the firm is required to file a notice pursuant to Item 2.1 of Form 3,146 and (ii) the final description of revision restatement was revised to improve the alignment with the description used by the SEC in its adopting release for exchange listing ‘‘clawback’’ rules 147 and to clarify that the restated financial information and the disclosure appear in a filing with the SEC. The revisions to the description of reissuance restatement ensure that the data set is complete because it captures circumstances where the issuer fails to comply with its reporting obligations. The revisions to the description of revision restatement avoid potential misalignment with the SEC’s characterization of little r restatements and also provide a clear trigger (SEC filing) for when a restatement is included in the metrics. Accordingly, the descriptions of reissuance restatement and revision restatement in the final rules provide as follows (footnotes omitted): Reissuance restatement: When a material error in previously-issued financial statements is identified and disclosed by an issuer in a filing with the SEC (e.g., on Form 8–K Item 4.02, Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review) or the firm is required to file a notice pursuant to Item 2.1 of Form 3. Revision restatement: When an error in previously-issued financial statements that did not result in a reissuance restatement, but would give rise to a material misstatement if (a) the error was left uncorrected in the current report or (b) the error correction was recognized in the current period, is corrected and disclosed by an issuer in a filing with the SEC. 146 Item 2.1 applies when a firm: has withdrawn an audit report on an issuer’s financial statements, or withdrawn its consent to the use of its name in a report, document, or written communication containing an issuer’s financial statements, and the issuer has failed to comply with a Commission requirement to make a report concerning the matter pursuant to Item 4.02 of Commission Form 8–K. 147 See Listing Standards for Recovery of Erroneously Awarded Compensation, SEC Rel. No. 34–96159 (Oct. 26, 2022) at 28 (‘‘restatements that correct errors that are not material to previously issued financial statements, but would result in a material misstatement if (a) the errors were left uncorrected in the current report or (b) the error correction was recognized in the current period’’). E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices The proposed metric included only restatements that related to corrections of errors and excluded all other restatements, including those resulting from changes in accounting principles. The proposed metric also excluded corrections in the current period financial statements of errors that were not material to the previously-issued financial statements and are not material to the current period financial statements (e.g., a voluntary restatement or an out-of-period adjustment), because these are not restatements as described in this rulemaking. One commenter suggested that the metric should explicitly exclude restatements resulting from stock splits and similar activities that result in non-error restatements. As proposed, the metric addressed only restatements for errors, and the Board does not believe it is necessary to list specific types of non-error restatements. Commenters generally supported the reporting of a restatement metric, including all of the investors and investor-related groups that addressed the topic. Some pointed out that firm transparency or audit quality reports often include a similar metric. However, two commenters questioned the usefulness of the proposed metric and asserted that such a metric alone could provide only limited insight into the quality of public oversight over issuers and auditors. One commenter stated that this information was already publicly available, and it did not appear necessary to require firms to report it but if it were reported, a streamlined metric that merely reported on the total number of restatements for the year would be preferable. One commenter, who generally supported the proposed metric, stated that it should only include those audits where the auditor withdrew and amended the opinion. Some commenters generally supported the proposed metric but suggested changes to various elements discussed in more detail below, including: • Removing revision restatements from the proposed required reporting. • Counting multi-year restatements as one restatement, not separately. • Reducing the number of reporting periods to be reported from five to three. • Not requiring engagement-level reporting. One aspect of the proposal that did not draw comment, and which the Board adopted as proposed, was the proposed reporting of reissuance restatements of management’s report on ICFR, together with reporting of the number of issuer engagements for which the firm initially issued an audit report VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 expressing an opinion on ICFR.148 Firms are required to report those reissuance restatements of management’s report on ICFR that disclose an additional material weakness or additional elements to a previously disclosed material weakness for all issuer engagements. a. Revision and Reissuance Restatements The proposed metric set forth requirements for firms to include information related to both reissuance restatements and revision restatements for all issuer engagements of the firm in the firm’s required reporting. Three commenters agreed specifically with this aspect of the required reporting with one commenter stating that providing information related to revision restatements gives a holistic picture of the firm’s audit performance, reliability of the financial statements, and transparency from the fact that all restatements are reported and not just reissuance restatements. The other commenters on this aspect of the proposal, all firms or firm-related groups, disagreed with the proposed requirement to include revision restatements in the metric. They expressed the following concerns: • Such restatements are not material to the prior periods and to report them suggests an inappropriate level of importance to information deemed immaterial. • These types of restatements are not currently separately tracked by some smaller firms, given that revision restatements are not material to the year to which they relate, thus are not necessary or useful to decision-making. • Requiring the disclosure of these instances in the same context as reissuance restatements could inappropriately suggest that there are potential implications for the quality of the audit performed. The Board continues to believe that the restatement history metric should include all restatements for errors, both revision restatements and reissuance restatements. As noted above, several commenters were supportive of the Board’s proposed scope, including all the investors and investor-related groups that addressed the issue. The Board believes that this scope will provide a more complete picture of the extent to which financial statements 148 Under Sarbanes-Oxley, the auditor is required to attest to management’s assessment of the effectiveness of the company’s internal control only for companies that qualify as ‘‘large accelerated filers’’ or ‘‘accelerated filers,’’ other than ‘‘emerging growth companies.’’ See Section 404 of SarbanesOxley, 15 U.S.C. 7262. PO 00000 Frm 00043 Fmt 4701 Sfmt 4703 100009 audited by the firm contain errors that subsequently have to be corrected. The Board also believes that its reporting requirements should not distinguish between revision restatements and reissuance restatements in a way that may create inappropriate incentives for auditors and issuers as they make materiality determinations with respect to previous period errors. The SEC addressed this concern in its rulemaking regarding exchange listing ‘‘clawback’’ rules, which also apply to both revision restatements and reissuance restatements.149 The Board understands that revision restatements and reissuance restatements do not necessarily convey the same information, particularly as to the performance of the auditor. As the Board proposed, revision restatements will be reported on a separate line from reissuance restatements, which will enable users to analyze the two different types separately. In the final metric, both revision restatements and reissuance restatements will be measured based on disclosure in an SEC filing. Reissuance restatements will also include circumstances in which the issuer is required to make an SEC filing under Form 8–K Item 4.02 150 and fails to do so, which triggers a requirement for the firm to file a notice pursuant to Item 2.1 of PCAOB Form 3. Disclosure in an SEC filing could take a variety of forms, such as checking the box on the cover page of Form 10–K and Form 20–F to indicate correction of error in a previously issued financial statement, as one commenter suggested; filing a Form 8–K in response to Item 4.02; or simply including restated prior period information in a periodic report or registration statement. The Board believes that measuring restatements based on SEC filings will provide an objective point of reference that will enable firms to track the relevant data. 149 See SEC Rel. No. 34–96159 at 35–6 (in connection with including both revision restatements and reissuance restatements in its clawback rules, stating that ‘‘this construction of the statutory language addresses concerns that issuers could manipulate materiality and restatement determinations to avoid application of the compensation recovery policy’’). See also Assessing Materiality: Focusing on the Reasonable Investor When Evaluating Errors (Mar. 9, 2022), available at https://www.sec.gov/newsroom/speechesstatements/munter-statement-assessing-materiality030922, (observing that some materiality analyses appear to be biased toward supporting an outcome that an error is not material to previously-issued financial statements, resulting in ‘‘little r’’ revision restatements). 150 See Form 8–K Item 4.02, Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review. E:\FR\FM\11DEN2.SGM 11DEN2 100010 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices The Board notes that one commenter asserted that some smaller firms do not currently track revision restatements. As mentioned above, under QC 1000 firms are required to track restatement data (i.e., both types of restatements) in order to design engagement monitoring activities and determine whether engagement deficiencies exist. In addition, given the public availability of the data and the ease with which the SEC’s electronic data gathering analysis and retrieval (‘‘EDGAR’’) database can be searched, the Board does not believe that gathering the data will be overly burdensome, regardless of whether it is a firm’s current practice to do so lotter on DSK11XQN23PROD with NOTICES2 b. Multi-Year Audit Restatements The proposal contemplated that, in the case of multi-year audits where one auditor’s report covers the audits of multiple years of financial statements, the metric would treat every year that is restated as a separate restatement. While one commenter supported the proposed treatment of these types of audit restatements, firms and firm-related groups stated that multi-year restatements should be based only on the initial year audited, and should not be counted separately for each year. These commenters expressed concern that, as proposed, the metric would reduce understandability and comparability as it would misalign with how the audit was classified when reporting the metrics in the initial year the audit report was issued, creating the potential for a misleading multiplier effect. One firm stated that some restatements may be triggered by a distinct issue in one year, which may or may not be material to other years presented, but those other years are still corrected in the restatement process. Another firm expressed concern about the potential complexity and difficulty of the proposed reporting. A firmrelated group suggested that, as an alternative, the multi-year-audit restatements might instead be covered by providing total years impacted by restatements as a supplementary metric. The Board considered commenter input on this issue, but the Board continues to believe that the most accurate and appropriate presentation of multi-year audit restatements is to count each year that is restated as a separate restatement when reporting this metric. If a firm has additional context related to a multi-year audit restatement that it believes will assist users in properly interpreting the metric, the firm could describe it as optional narrative accompanying the metric. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 c. Number of Reporting Periods to Present The proposal provided that this metric would be reported for the current reporting period and each of the preceding four years, for a total of five years.151 One firm agreed with the proposal, stating that the five-year period strikes a balance between providing sufficient historical context to identify trends and patterns in audit quality and restatements and it also maintains the current relevance. The other commenters on this aspect of the metric, all firms and firm-related groups, disagreed with the proposal and instead suggested that firms be required to report the current period and each of the two preceding years, for a total of three years. These commenters offered the following rationales: • Three years would be consistent with an issuer’s reporting of periods in an annual report in accordance with SEC rules and regulations. • It would be better to require firms to report three years because it will greatly reduce the burden on terminated firms to track the restatements of their former audit clients (e.g. newly implemented monitoring and communication protocols with successor audit firms and previously audited companies). Since issuers are required to present three years of income statements in the financial statements included in Form 10–K, they will need to obtain consents from former auditors for those prior periods. As a result, terminated firms will be made aware of any restatements when requested to provide consents. • Five years is unnecessarily long given this information is readily available via the SEC’s EDGAR system. The Board considered the comments received and determined to limit the metric to three years, rather than the five years initially proposed. As commenters have pointed out, this will better align with SEC requirements regarding financial statement presentation and may therefore reduce any potential efforts or costs associated with implementation. While the change may result in some reissuance restatements falling outside the reporting period, the Board believes that focusing on more current information will provide users with a more relevant metric. 151 Based on an internal evaluation of restatement patterns covering the period from Q1 2008 to Q2 2018 by the PCAOB’s Office of Economic Risk and Analysis, 98% of restatements during this period were announced with a delay of approximately five years or less and about 80% of the restatements were announced with a delay of three years or less. PO 00000 Frm 00044 Fmt 4701 Sfmt 4703 d. Engagement-level Reporting The proposal stated that since restatements are disclosed in the financial statements, the Board was not proposing to require that firms report this metric at the engagement level. Commenters who expressed views on this aspect of the proposal agreed with this view stating that this information is already publicly available from the SEC. One firm supported engagement-level reporting of this metric explaining that it could lead to deeper accountability to assess the performance of audit teams by linking the restatements to the responsible engagement team, and it would result in promoting higher standards of audit quality. Taking into account commenter feedback, the Board continues to believe that reporting restatement information at the engagement level is unnecessary because it is already publicly available in a searchable format for any particular issuer through the SEC’s EDGAR filing system. Conversely, for users to aggregate restatement information for all of a firm’s issuer engagements could require significant time and effort, which is why the Board only adopted this metric at the firm level. Engagement-level reporting is not required under the final rules. e. Other Commenter Feedback Other commenter suggestions included: • Predecessor and successor auditor. Under the proposal, the restatement metric would apply with respect to audit reports ‘‘initially issued by the firm.’’ As a result, restatements would be included in the metric of the firm that issued the original audit report on the financial statements or on the audit of ICFR, regardless of whether the firm had itself identified the error or continued to serve as the issuer’s auditor. Firms, in particular those that resign from the engagement or are otherwise replaced, would need to monitor whether previously-issued audited financial statements, reports on management’s assessment of the effectiveness of ICFR, or both, are subsequently restated for at least three years. Two commenters that addressed this aspect of the metric agreed with the treatment provided under the proposal, and the Board adopted it as proposed. • Prospective reporting upon effective date. Several commenters suggested that if the Board proceeded with the proposal to include revision restatements in the required reporting for this metric, prospective reporting upon implementation would be more practicable. As discussed above, under E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices companies; 153 employee stock purchase, savings, and similar plans that are required to file reports with the SEC on Form 11–K; 154 and many smaller reporting companies.155 It also excludes firm-level information about firms whose PCAOB practice was limited to such audits.156 QC 1000 firms are required to track restatement data in order to design engagement monitoring activities and determine whether engagement deficiencies exist, therefore firms will already have been tracking this information upon the effective date of the requirements in this rulemaking. (See Exhibit A, ‘‘Restatement History.’’) Reporting lotter on DSK11XQN23PROD with NOTICES2 1. Thresholds for Required Reporting The Board proposed to apply the same threshold for both firm-level and engagement-level reporting, focused on auditors and audit engagements for issuers that qualify as accelerated filers or large accelerated filers under SEC rules. The Board proposed that firmlevel reporting would be required of every firm that audits at least one company that has self-identified as an accelerated filer or large accelerated filer by checking the box on an SEC filing (or, because Form 40–F does not contain such a check box, at least one Form 40– F filer that meets the criteria to be an accelerated filer or large accelerated filer under SEC rules) 152 during the reporting period. The Board also proposed that engagement-level reporting would be required for every audit of such an accelerated or large accelerated filer. The Board believes the proposed threshold would focus the reporting requirements on the firms and engagements in which investors and other stakeholders have the greatest interest in additional information, and that establishing the same threshold for firm- and engagement-level reporting would foster comparability across both issuers and firms and provide richer context for the evaluation of engagement-level information. The proposal also contemplated that firms that were not subject to the reporting requirements could choose to report voluntarily. This approach excludes engagementlevel information about audits of nonissuers, including broker-dealers, and of issuers that are not accelerated filers or large accelerated filers under SEC rules. These include, for example, investment 152 See Exchange Act Rule 12b–2, 17 CFR 240.12b–2. Generally, under Rule 12b–2, a large accelerated filer is an issuer that meets certain reporting conditions and has a public float (aggregate worldwide market value of voting and non-voting common equity held by nonaffiliates) of $700 million or more. An accelerated filer is generally an issuer that meets the same reporting conditions; has a public float of $75 million or more, but less than $700 million; and had revenue of $100 million or more in the most recent fiscal year for which audited financial statements are available. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 i. Firm- and Engagement-Level Reporting Thresholds The Board solicited comment on whether the proposed reporting thresholds for firm- and engagementlevel were appropriate. Investors and investor-related groups generally supported the proposed thresholds for both firm- and engagement-level reporting. They agreed that the proposed requirements would appropriately apply to the audits, and auditors, of companies that account for the majority of the U.S. public company market capitalization, and would capture the situations where investment and proxy voting decisions would be most likely to benefit from additional information about the audit and auditor. One firm-related group broadly agreed with the thresholds for both firm- and engagement-level reporting because it believes different reporting requirements are not warranted. Another firm-related group also agreed with the proposed reporting thresholds as appropriately targeting the largest companies having a significant impact on the market capitalization of issuers. Two commenters recommended extending the reporting requirements to all PCAOB-registered firms, either immediately or over time. 153 Section 3(a)(1) of the Investment Company Act of 1940, 15 U.S.C. 80a–3(a)(1), defines an ‘‘investment company’’ as an issuer which (A) is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities; (B) is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or has been engaged in such business and has any such certificate outstanding; or (C) is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis. Audits of business development companies (BDCs) that met the criteria to be an accelerated filer or large accelerated filer would be included. 154 See Exchange Act Rule 15d–21, 17 CFR 240.15d–21. 155 See Regulation S–K, Item 10(f)(1), 17 CFR 229.10(f)(1). 156 Firms that do themselves not serve as lead auditor for an accelerated filer or large accelerated filer but play a substantial role in audits led by other firms would also not be subject to the proposed reporting requirements. See PCAOB Rule 1001(p)(ii) for the definition of ‘‘play a substantial role in the preparation or furnishing of an audit report.’’ PO 00000 Frm 00045 Fmt 4701 Sfmt 4703 100011 On the other hand, all firms and a firm-related group that commented on the firm-level reporting threshold objected to it, generally suggesting instead that firm-level reporting should be required of firms that are annually inspected by the PCAOB, with some recommending voluntary reporting by smaller firms. One commenter suggested reporting only for annually inspected firms that audit at least one accelerated filer or large accelerated filer. Another commenter recommended that firmlevel reporting should be required only of firms with 25 or more large accelerated and accelerated filer engagements, saying that firms with a small number of large accelerated and accelerated filer engagements would not produce meaningful metrics with sufficient anonymity as their metrics can be unduly influenced by a single engagement. Some of these commenters asserted that requiring reporting only from annually-inspected firms would balance scalability concerns with the need for investor protection, as it would still capture a large majority of the U.S. public company market capitalization. One commenter stated that the issuer portfolio at firms with less than 100 issuers is not sufficiently like those firms inspected by the PCAOB annually to provide valuable comparisons and another commenter expressed concern about issuers that frequently move above or below the accelerated or large accelerated filer thresholds.157 One commenter added that there is precedent to use an alternative threshold based on firms that issue audit reports for more than 100 issuers, such as PCAOB’s annual inspection and QC 1000.18 requirements. Several commenters also raised concerns about the cost of metrics reporting and stated that requiring reporting only from annually-inspected firms will better support the cost to comply with the proposed requirements and alleviate related unintended consequences, particularly greatly reducing the burden for smaller firms and firms in foreign jurisdictions. Another commenter supported requiring reporting only from annuallyinspected firms because it would alleviate concerns about privacy and confidentiality, particularly for firms 157 Based on the PCAOB staff’s analysis performed on the data obtained from Audit Analytics, Standard & Poor’s, and publicly available data from the RASR, available at https:// rasr.pcaobus.org. In the four-year period ended September 30, 2022, on average, approximately 4% of filers that reported on Form 10–K and Form 20– F and had not previously self-identified as either a large accelerated filer or accelerated filer newly selfidentified as either a large accelerated or accelerated filer each year. E:\FR\FM\11DEN2.SGM 11DEN2 100012 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 outside the United States that issue a limited number of large accelerated or accelerated filer auditor reports annually and are subject to laws and regulations in those areas, because firmlevel metrics may effectively result in the disclosure of engagement-level information. They further noted that such a threshold may avoid redundant reporting burdens for these firms and disclosure of confidential information of specific issuers, but still achieve the objectives of reporting firm level metrics as ‘‘firm-level reporting would consist only of summary data’’ as proposed. For the engagement-level reporting threshold, because firms objected to any public reporting of engagement-level metrics, most firms did not comment further on the threshold for engagementlevel reporting except for offering some other suggestions. See below for other comments received. The Board adopted the thresholds for both firm-level and engagement-level reporting with one change. Firm-level reporting will be required of every firm that audits at least one company that has self-identified as an ‘‘accelerated filer’’ or ‘‘large accelerated filer’’ by checking the box on an SEC filing during the reporting period. Engagement-level reporting will be required for every audit of such an accelerated or large accelerated filer. The final threshold does not refer to Form 40–F filers that meet the definition of ‘‘accelerated filer’’ or ‘‘large accelerated filer’’ under SEC rules, which were included in the proposal, based on the Board’s understanding that such companies are not regarded as accelerated filers or large accelerated filers. Companies that file both Form 40–F and another SEC annual reporting form, and that check the box to self-identify as an accelerated filer or large accelerated filer on that other form, will still be included. The Board continues to believe that requiring reporting for auditors and audits of large accelerated filers and accelerated filers is the most appropriate approach. As stated in the proposal, the Board estimated that the firm-level reporting requirements will apply to approximately 210 firms,158 including 22 of the top 25 U.S. firms by total firm 158 The data was obtained from Audit Analytics, Standard & Poor’s, and publicly available data from the RASR, available at https://rasr.pcaobus.org. Firms that issued audit opinions for issuers that met the large accelerated or accelerated filer definition in the 12 months ended September 30, 2023, were included in this number. Large accelerated filer or accelerated filer status was based on the most recently filed quarterly or annual report as of February 10, 2024. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 revenue,159 and all of the 2022 PCAOB annually inspected firms that continue to audit issuers,160 and that the proposed engagement-level reporting requirements would apply to approximately 3,400 issuer audits, representing 99% of the total market capitalization of issuers reporting on Form 10–K and Form 20–F.161 The Board analyzed the other reporting thresholds suggested by commenters based on the same data. Coverage would be significantly reduced if the Board required reporting only from annually inspected firms: 13 firms,162 including 12 of the top 25 U.S. firms by total revenue compared to 22 firms.163 Similarly, if only annually inspected firms were required to provide engagement-level reporting, it would apply to approximately 2,700 issuer audits, representing 83% of the total market capitalization of issuers reporting on Form 10–K and Form 20– F. If only firms with 25 or more large accelerated or accelerated filers were required to report, then firm-level reporting would apply to 11 firms, including 9 of the top 25 U.S. firms by total revenue, and engagement-level reporting would apply to approximately 2,800 issuer audits, representing 84% of the total market capitalization of issuers reporting on Form 10–K and Form 20– F. In addition to the significant coverage decreases, limiting metrics reporting to annually inspected firms would exclude 159 See Accounting Today, 2024 Top 100 Firms + Accounting’s Regional Leaders (March 2024), for a listing of the top 25 U.S. Firms. Based on staff analysis, the three firms in the top 25 firms that would be excluded from the reporting requirements are Aprio, LLP; Carr, Riggs & Ingram LLC; and Citrin Cooperman & Company, LLP. 160 See the 14 firms listed as 2022 Annually Inspected Firms, available at https://pcaobus.org// inspections/basics-of-inspections. B F Borgers CPA PC was removed for the purpose of this analysis as its registration withdrawal is currently pending. 161 The data was obtained from Audit Analytics, Standard & Poor’s, and publicly available data from the RASR, available at https://rasr.pcaobus.org. Large accelerated filers and accelerated filers were included in this number. Large accelerated filer or accelerated filer status was based on the most recent quarterly or annual filing as of February 10, 2024. Market capitalization was calculated as of December 31, 2023. Because in some instances multiple audit reports were issued in the same year, the total number of audit reports issued during the same time period using the same data source would be approximately 3,500. 162 From the 14 firms listed as 2022 Annually Inspected Firms as described above, B F Borgers CPA PC was removed for the purpose of this analysis as its registration withdrawal is currently pending. 163 See Accounting Today, 2024 Top 100 Firms + Accounting’s Regional Leaders (March 2024), for a listing of the top 25 Firms. Based on staff analysis, two annually inspected firms (B F Borgers CPA PC and Cohen & Company, Ltd.) were not included in the top 25 firms. PO 00000 Frm 00046 Fmt 4701 Sfmt 4703 non-US firms that audit a small number of non-US based issuers with substantial market capitalizations. If the Board ranks firms based on the market capitalization of the issuers they audit, the top 30 firms audited 94% of the total market capitalization of accelerated filer and large accelerated filer issuers. However, only five of these top 30 firms are annually inspected. The remaining 25 firms are all non-U.S., and all but one of them audited large accelerated filers averaging at least $10 billion in market capitalization. Similarly, limiting metrics reporting to firms with 25 or more large accelerated or accelerated filers would result in only six of the top 30 firms (ranked based on the total market capitalization of the issuers firms audit) reporting the metrics, and would exclude most non-U.S. firms that audit non-U.S. based issuers with substantial market capitalizations. The Board considered applying the reporting requirements to all registered firms, as one commenter suggested. However, the Board continues to believe that investors and other stakeholders have the greatest interest in additional information regarding large accelerated and accelerated filers and the firms that audit them, and the comments supporting the proposal that the Board received from investors and investorrelated groups tend to confirm that view. For that reason, the Board believes that requiring metrics reporting for all registered firms could impose costs that are not justified in light of the anticipated benefits. Regarding the concerns of privacy or possibly disclosing confidential or otherwise protected information, particularly for firms outside the United States, the Board is not aware of any specific issues and no commenter identified any particular requirements that would conflict with the disclosure of the metrics the Board adopted. See below for further discussion of privacy and confidentiality issues. ii. Other Commenter Feedback The Board solicited comment on whether smaller firms should have different reporting requirements than larger firms. In addition to comments described above, several commenters recommended having different reporting requirements for smaller firms than for larger firms. In addition, two firms requested clarification or application guidance regarding the treatment of issuers that change filer status into an accelerated or large accelerated filer during the reporting period. These commenters recommended allowing these issuers to have one full year of implementation E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 period after the changes in filer status. The Board notes that firm-level reporting will be required of all firms that issued an audit report for at least one large accelerated filer or accelerated filer during the reporting period, and that engagement-level reporting will be required in connection with each audit report issued for a large accelerated filer or accelerated filer. Accordingly, the relevant date to determine large accelerated filer or accelerated filer status will be the date the audit report is issued. Because SEC requirements regarding becoming a large accelerated filer or accelerated filer include at least six months lag time,164 the Board does not believe that an additional transition period would be necessary under the Board’s rules. The Board solicited comment on whether the Board should require engagement-level metrics for audits of investment companies (other than BDCs that are accelerated filers or large accelerated filers) or non-accelerated filers. Several commenters supported excluding one or more categories of such entities from metrics reporting because the proposed metrics would be less likely to assist in investment and voting decisions. On the other hand, one commenter recommended including publicly traded ‘‘closed end’’ investment companies, registered open end investment companies, and brokerdealers that are publicly traded on the basis that some mutual fund investors ratify the appointment of the auditor and audit committees presumably approve for the auditor for these companies. As proposed, the Board is not requiring engagement-level reporting on these investment companies and nonaccelerated filers. For audits of investment companies, the Board continues to believe that the arguments underpinning requests for additional information about audits and auditors will not apply, or apply with the same force, in these situations, where shareholder ratification of the appointment of the auditor may not be 164 Under the SEC definitions of ‘‘large accelerated filer’’ and ‘‘accelerated filer,’’ the determination that an issuer has become a large accelerated filer or accelerated filer is generally based on the public float as of the end of the issuer’s second fiscal quarter, to take effect as of the end of the fiscal year. See Exchange Act Rule 12b–2(3), 17 CFR 240.12b–2(3). The Board notes that issuers that are eligible to use the requirements for smaller reporting companies under the revenue test in paragraph (2) or (3)(iii)(B) of the SEC’s ‘‘smaller reporting company’’ definition could cease to be accelerated filers based on a determination made at or after the fiscal year end. However, since metrics requirements would not apply in such a case, the Board does not believe any transition period is necessary. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 typical and the metrics would be less likely to assist in investment and voting decisions. Regarding the reporting of non-accelerated filers, as discussed above, these issuers have significantly smaller market capitalization per issuer on average, and the Board is concerned that the benefits associated with such reporting would not justify the costs. 2. Reporting of Firm-Level Metrics (Form FM) The Board proposed that firms report their firm-level metrics annually on a new Form FM, Firm Metrics. Of those commenters that support reporting firmlevel metrics, some also explicitly expressed support for reporting annually on Form FM. One commenter recommended that Form FM be amended to explicitly include the definitions of the metrics and metric formulas to provide pertinent information to enhance the context and understandability for users. The proposal asked whether, rather than reporting on Form FM, firms should report firm-level metrics, as of March 31 on Form 2, which is due on June 30. One commenter stated that the firm-level metrics could be reported on Form 2 to simplify the reporting for firms and consolidate the information. One commenter did not support reporting firm-level metrics on Form 2 stating that between issuer filings through March 31 and the performance of procedures on the first quarter filings through May, firms are exceptionally busy through the middle of May each calendar year. Another commenter questioned whether the information, being reported only annually, would be too old to assist decision-making. Taking into account commenter feedback, the Board continues to believe that reporting firm-level metrics publicly on a new Form FM filed by November 30 will provide investors and other stakeholders with timely and useful information about auditors and will provide a basis of comparison for the engagement-level metrics, where applicable. The Board does not believe that Form 2 would be the appropriate place to report the firm-level metrics because the due date of Form 2, June 30, falls after the general timing of shareholder meetings (typically April through June for issuers with a calendar fiscal year) and this information would generally arrive too late to be considered in deciding how to vote on ratification of the appointment of the auditor. The Board believes audit committees would also benefit from having this information earlier, since it could be useful when determining whether to PO 00000 Frm 00047 Fmt 4701 Sfmt 4703 100013 reappoint the auditor.165 While firm metrics would be reported only once a year, the Board believes that the information they convey would still be useful, both to investors (who otherwise have access to extremely limited information about the auditor) and to audit committees (who may benefit from standardized firm-wide information that helps put their engagement in context). The information disclosed on Form FM will be available in a searchable database on the Board’s website, similar to the Form AP database. As noted above, in addition to the required firmlevel metrics, firms will have the option to provide a brief narrative to accompany each metric. In response to the commenter that emphasized the importance of including all definitions and metric formulas in Form FM, the Board has expanded Part III of Form FM, Terminology, to include all of the definitions used in the metrics, not just those used in multiple metrics. As proposed, the formula for each required metric is included in Part IV, Metric Calculations, Reporting and Discussion of Form FM. The proposal provided that the reporting period for Form FM would generally be the 12-month period ended September 30 in each year 166 and filed on or before November 30, 61 days after the end of the reporting period. Some commenters expressed support for the proposed reporting period ending on September 30. One of these commenters also suggested that consideration be given to allowing firms to pick a reporting period based on their firm’s cycles. A few commenters expressed concern with the reporting date of September 30 and instead suggested firms be permitted to choose their own timing for Form FM. These commenters expressed the following views: 165 See Letter from Center for Audit Quality (Aug. 1, 2024) at 3 (‘‘The majority [59%] of audit committee members surveyed agree some standard information about auditors should be considered when making their selection and performing their oversight responsibilities’’). 166 Exceptions to the proposed reporting period of firm-level metrics reported on Form FM included the proposed metrics for Quality Performance Ratings and Compensation and Audit Firms’ Internal Monitoring. The proposal stated that ‘‘[these] proposed firm-level metrics relate to activities for which firms may already have defined periods or cycles that may not align with [the Board’s] proposed reporting date. In these cases, [the Board] proposes that the time period covered by the metrics may be tailored to a firm’s existing processes and procedures.’’ Neither of these metrics are included in the metrics the Board adopted. However, the Board adopted a metric related to the Training Hours for Audit Personnel metric which will permit firms to use an already-established training calendar cycle for calculation and reporting of this metric, which may not align with the Form FM reporting period. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100014 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices • The reporting date for firm-level metrics should not matter to investors, therefore the PCAOB should consider firm input as to the date that best aligns with their internal processes. • Concern about the amount of work firms will be required to do on this new form along with the QC 1000 requirements and the relationship with information reported on Form 2 on a different time period. This commenter suggested that the Board should undertake a comprehensive review of all reporting requirements, systems, reporting, and dates. • Concern that small- and mid-sized firms will be particularly burdened with having to evaluate the quality control system under the newly adopted quality control standard, support the annual inspection, and assemble data for reporting in Form FM all at the same time. The Board does not believe that permitting firms to choose their own timing for Form FM would ultimately serve the users of the metrics, because of the enhanced comparability that a common measurement date and measurement period provide. In particular, audit committees, who may seek to consider comparative metrics when determining which audit firm to appoint, would not be served by using potentially outdated or non-comparable data from a firm. The proposed reporting date aligns with the date the firm is required to evaluate its QC system under QC 1000, which was adopted by the Board and approved by the SEC on September 9, 2024. While the Board understands that this date will cause some firms to have additional PCAOB reporting responsibilities simultaneously, the Board continues to believe that this timing is preferable since it is prior to the calendar year end and the traditional busy period for many firms, which the Board believes would reduce potential resource or time constraints and further benefit firms. Two commenters supported the proposed November 30 due date of Form FM. One commenter, who supported the proposed November 30 due date, specifically found it helpful that the date aligned with QC 1000. Some firms expressed concern that the proposed due date would create challenges going forward for firms to support their annual inspections, evaluate the quality control system, and assemble data for reporting in Form FM all at the same time. One commenter suggested that the due date for Form FM should be three months from the end of the reporting period, or December 31. Another commenter expressed concern that a 61-day period may not be VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 sufficient to allow firms to accurately and completely collect, assemble, and report the metrics and instead suggested that firms should be permitted to choose their own filing date. One commenter, who supported the proposed reporting date of September 30, suggested the PCAOB consider a longer period of time in which to submit Form FM in the initial years after the effective date. The Board believes the 61-day period will provide sufficient time for firms to accumulate data and calculate the metrics and report to the PCAOB. In addition, as discussed above, the Board has reduced the scope of the following metric areas in particular: (i) Partner and Manager Involvement, Workload, and Allocation of Audit Hours, to include only large accelerated filer and accelerated filer engagements; and (ii) Industry Experience, to limit the reporting to those firms that issued five or more audit reports for accelerated filers and large accelerated filers, combined, during the reporting period. All of these changes should further reduce the reporting effort and help to address commenter concerns. A benefit of aligning the Form FM reporting period and filing deadline with QC 1000 is that some firms, if they choose, could also use these metrics in their monitoring and remediation process as part of the QC system, enabling the firm to use comparable information underlying both reporting obligations for Form QC and Form FM. Under the final rules, as proposed, reporting on Form FM is due on or before November 30, 61 days after the end of the reporting period. In addition, see discussion of the effective date below. Form FM was adopted with the following modifications: • Making conforming revisions to reflect the changes to metrics discussed above. • Related to the optional narrative, (i) expanding the character limit to 1,000 characters and (ii) adding additional instructions for firms that elect to provide the optional narrative (discussed above). • Rearranging instructional language within the form and expanding Part III of Form FM to include all terminology used in the metrics (discussed above). • Removing references to 40–F filers (see above). Together with new Form FM, the Board also proposed a new reporting rule, PCAOB Rule 2203C, which did not draw comment and was adopted substantially as proposed, and making conforming changes to Rules 2205 and 2206. The text of PCAOB Rule 2203C; Form FM, together with the form PO 00000 Frm 00048 Fmt 4701 Sfmt 4703 instructions; and the conforming amendments are included below. 3. Reporting of Engagement–Level Metrics (Form AP) The Board proposed to require firms to report engagement-level metrics on Form AP, along with the already required disclosure of the name of the engagement partner and information about other firms involved in the audit.167 The Board believes that Form AP provides an established mechanism for conveying engagement-level information that is familiar to investors and other stakeholders.168 Reporting on Form AP will allow access to the engagement-level metrics in a centralized location and will allow for the dissemination of the metrics through already established data channels. Form AP is also downloadable, which will provide users of the information the ability to perform comparisons across engagements, including analyses of the entire Form AP data set. The Board proposed adding a new section to Form AP for firms to report the required metrics. As noted above, in addition to the specific engagementlevel metrics, the Board proposed that the firm would be able to provide an optional narrative description to accompany each metric. As proposed, the firm would have been able to provide up to 500 characters as part of their narrative description to provide context to facilitate the reader’s understanding of the metric. To reflect Form AP’s broader content, the Board also proposed to rename it ‘‘Audit Participants and Metrics.’’ The text of the Form AP amendments and the form instructions are included below. Commenters who supported public reporting of engagement-level metrics generally agreed with reporting on Form AP. However, several commenters 167 See PCAOB Rule 3211. PCAOB Rule 3211 requires the filing of a report on Form AP regarding an audit report the first time the audit report is included in a document filed with the SEC. In the event of any change to the audit report, including any change in the dating of the report, PCAOB Rule 3211 requires the filing of a new Form AP the first time the revised audit report is included in a document filed with the SEC. If the auditor’s report is reissued and dual-dated, the firm is required to file a new Form AP that would reflect the most updated information of the proposed engagementlevel metrics (e.g., total audit hours as of the latest audit report date based on the cumulative total audit hours). For most audits, Form AP is due within 35 days after an audit report is first included in an issuer SEC filing. The entire Form AP data set (updated daily) and data dictionary are available to download in CSV format under the section, ‘‘Download the entire data set,’’ at https:// pcaobus.org/resources/auditorsearch. 168 Information related to usage statistics can be found on the PCAOB’s website (https://.org// auditorsearch). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices disagreed with public reporting of engagement-level metrics. The Board has addressed these comments above. One commenter suggested that the reporting date should be changed to November to align to the audit committee’s considerations of reapproving a firm and when considering the following year’s audit plan. Additionally, one commenter voiced their concern that there is mixed evidence on the influence of Form AP disclosures on decision-making. The Board adopted the requirement as set forth in the proposal to report engagement-level metrics on Form AP and rename the form Audit Participants and Metrics. Correspondingly, the Board has retitled PCAOB Rule 3211 as Audit Participants and Metrics and made a conforming amendment to AS 3101.20. The Board made certain amendments to the requirements for reporting on Form AP as follows: • Conforming revisions to reflect the changes to include the metrics discussed above. • Related to the optional narrative, (i) expanding the character limit to 1,000 characters and (ii) adding additional instructions for firms that elect to provide the optional narrative. Form AP’s deadline of 35 days after the issuance of the auditor’s report already takes into account the timing of the proxy vote for most issuers. 4. Amendments to Form FM and Form AP lotter on DSK11XQN23PROD with NOTICES2 As is required for other PCAOB forms, the Board proposed that firms be required to amend Form FM or Form AP to correct inaccurate information or provide omitted information that should have been included.169 Some commenters requested that the Board consider adopting some level of materiality or de minimis threshold for the proposed metrics reporting and specifically address how firms should consider whether to amend their reporting when differences arise. These commenters expressed the following views: • Although a materiality concept, on its own, will not eliminate the challenges currently identified and those that are unknown, it may help reduce confusion to investors and other stakeholders resulting from the need to report amendments caused by 169 The requirements for amendment of Form FM are similar to those that apply to Form 2. See https://pcaobus.org/about/rules-rulemaking/rules/ form_2; see also, e.g., Staff Questions and Answers Annual Reporting on Form 2, at Q34, available at https://assets.pcaobus.org/pcaob-dev/docs/defaultsource/registration/rasr/documents/staff_qaannual_reporting.pdf?sfvrsn=5e7259ff_0. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 immaterial changes in estimates and unintentional errors and to help avoid unnecessary penalties for materially correct reporting. • The risk of enforcement for minor, unintentional errors in reporting may also play a role in public accounting firms’ decision to cease auditing public companies. • Guidance would be essential for implementing any final standard effectively to balance the costs of compiling and reporting the information and this guidance should extend to the evaluation of differences that may arise in the disclosure of participating firms on Form AP. • The proposal should be amended for the application of materiality thresholds based on reasonable assurance. • The Board should consider revisions to PCAOB Rule 3211 to add materiality thresholds based on reasonable assurance and clarify whether the current guidance regarding amendments would extend to all metrics as well as how routine corrections and re-allocations of time entries and other matters affecting metrics reported on Forms FM are expected to be handled. • If the PCAOB does not adopt a materiality threshold for Form FM, firms may need to consider which controls need to operate at a level of absolute assurance, which the firm stated would add significant effort and cost. • The final rule should include a safe harbor for reporting that includes unintentional and immaterial deviations from an otherwise accurate reflection of a metric. • The amendments should include a mechanism for revisions and a statute of limitations, such as reporting of time, should be included in the final rule. The Board believes that the reference to statute of limitations is intended to request a specified period after filing beyond which no amendments would be required for corrections. One investor-related group indicated that they would not object if the PCAOB established a de minimis threshold for unintentional inaccuracy in reporting metrics. Another commenter recommended that the PCAOB establish a de minimis threshold for unintentional inaccuracy that applies to all firm reporting, not just in relation to the proposal. The Board did not adopt a materiality or de minimis threshold in connection with the obligation to amend forms to correct information that was incorrect at the time the report was filed or to provide information that was omitted PO 00000 Frm 00049 Fmt 4701 Sfmt 4703 100015 from the report and was required to be provided at the time the report was filed. Historically, the Board has not established, and has not found necessary, materiality or de minimis thresholds in connection with form amendments. As a commenter acknowledged, a materiality or de minimis threshold will not necessarily eliminate challenges commenters have identified or those that have yet to be identified in connection with potential corrections. Indeed, the Board believes that implementing a materiality or de minimis threshold would introduce unnecessary complexity and uncertainty to the form amendment process and, further, would potentially threaten, or be perceived to threaten, the accuracy and reliability of reported information, thereby undermining the intended purpose of the amendments. Similarly, the Board has not historically provided, or believed necessary, a safe harbor provision for unintentional errors and such a provision would potentially compromise the accuracy and reliability of reported information. Likewise, the Board has not historically provided, or believed necessary, a ‘‘statute of limitations’’ to limit the time period for which amendments would be necessary, and such a provision could potentially compromise the value of the forms in conducting historical research. In the inspection and enforcement context, the Board can exercise its discretion on a case-by-case basis. Consistent with existing Form AP guidance, no amendments to Form FM or Form AP would be needed solely to reflect changes in the metrics that would result from differences between reasonably estimated data and actual data, in the event such information becomes available after the filing deadlines of the forms. As discussed above, in calculating both firm- and engagement-level metrics, actual data is required to be used, if available. If actual data is unavailable, firms may use a reasonable method to estimate such data. For example, if a firm used a reasonable method to estimate hours worked by partners and managers at the end of a reporting period, and those partners and managers subsequently submit timesheets for that period that include additional hours worked above the estimate used by the firm on Form FM or Form AP, the firm would not be expected to file an amended report for any deviations. At present, the Board believes applying the existing Form AP guidance is appropriate and sufficient for the final rules. The Board will monitor for issues connected to form amendments and E:\FR\FM\11DEN2.SGM 11DEN2 100016 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices consider updates to implementation guidance as appropriate. Addressing issues as they arise through implementation guidance—as opposed to establishing a materiality or de minimis threshold in the adopting release or through a rule amendment— will help ensure that any guidance is informed by, and better tailored to, issues raised by experience under the final rules rather than speculative concerns. The Board believes monitoring for the need for guidance is a better solution than implementing a materiality or de minimis threshold in the adopting release or through rule amendment. Lastly, regarding the comment that the amendments should include a ‘‘mechanism for revisions,’’ the Board is not aware of any deficiencies in the current mechanism for amending forms and believes it suffices. 5. Inclusion of Metrics in the Audit Report In addition to the proposed reporting on Form FM and Form AP, the Board solicited comment on whether some or all of the firm-level and engagementlevel metrics, together with any additional narrative that the firm may choose to provide, should also be included in the audit reports the firm issues for audits of large accelerated filers and accelerated filers. While some commenters supported inclusion of the metrics in the audit report, many commenters disagreed with this approach citing that, for example, it could potentially detract from the clarity and purpose of the report, could result in delays in the issuance of audit reports, and amendments to the audit report for corrections to metrics could create unnecessary burden for issuers and confusion for investors. Taking into account commenter feedback, including both the potential benefits and unintended consequences, the Board did not require inclusion of the metrics in the audit report at this time. 6. Confidential Treatment and Conflicts With Non-U.S. Law lotter on DSK11XQN23PROD with NOTICES2 i. Requests for Confidential Treatment Not Permitted The primary objective of the Board’s rulemaking is to enhance public transparency regarding audits and auditors, which inherently involves the disclosure of new information. The Board did not propose to allow firms to request confidential treatment for the proposed metrics but requested comment on this approach and specifically requested that commenters VerDate Sep<11>2014 19:26 Dec 10, 2024 Jkt 265001 identify any laws that realistically might prevent a firm from disclosing the information required by the metrics. In response, firms and firm-related groups expressed general concern about the potential for conflicts or focused on the proposed disclosure of engagementlevel metrics, such as hours worked per week on an engagement, engagement team tenure, and experience by industry, and the percentage of hours contributed by specialists and shared service centers. However, the Board disagrees with the assertion that all previously undisclosed information should be considered sensitive by default. The information called for by the metrics does not pertain to proprietary methodologies or operational strategies that could give competitive advantages if disclosed. Rather, the information called for is descriptive of the audit process itself. The Board believes that general claims of sensitivity, absent specific legal prohibitions or clear practical ramifications, are not sufficient to outweigh the benefits of increased transparency. The Board’s rulemaking is guided by the goal of deepening the public’s understanding of audit practices in audits of issuers, consistent with the Board’s statutory responsibilities. Some firms and firm-related groups raised concerns regarding the potential antitrust implications of disclosing detailed metrics about engagement staffing and workload allocations. One of these commenters referenced the Supreme Court’s ruling in United States v. Container Corporation of America,170 which highlights the competitive risks associated with the exchange of confidential information among competitors, particularly in concentrated industries. However, it is important to distinguish between the exchange of information directly among competitors—which may indeed raise antitrust issues—and this rulemaking’s mandate for public disclosure. The information that the PCAOB is requiring firms to disclose is not shared privately among competing firms but is made publicly available to all stakeholders, including investors, audit committees, and the general public. This type of disclosure is fundamentally different from the scenarios associated with anticompetitive behavior under antitrust laws.171 In light of these factors, the 170 393 U.S. 333 (1969). purpose of these disclosures is to enhance transparency and accountability in the audits of issuers, allowing investors and other stakeholders to make informed decisions and hold auditors accountable. This aligns with the Board’s statutory mission to protect investors and the public interest, 171 The PO 00000 Frm 00050 Fmt 4701 Sfmt 4703 Board believes the metrics do not contravene the antitrust laws, and the public benefit of these disclosures outweighs any theoretical competitive risks suggested by the commenters. Two commenters raised concerns regarding Section 105(b)(5) of SarbanesOxley, which protects information prepared or received by or specifically for the Board in connection with a PCAOB inspection or investigation. It is important to note that Section 105(b)(5) specifically protects only information that is prepared or received by or specifically for the Board in connection with a PCAOB inspection or investigation. The metrics the Board has required, however, are not prepared or received under such confidential circumstances. These metrics are intended for public disclosure to enhance transparency across the audits of issuers and to provide stakeholders— including investors, audit committees, and the general public—with important insights into audit practices. Therefore, requiring the public disclosure of these metrics does not violate the provisions of Section 105(b)(5). Additionally, one firm and a firmrelated group raised concerns regarding the AICPA Code of Professional Conduct,172 which provides that a member in public practice shall not disclose confidential client information without the specific consent of the client. It is important to differentiate the information required by the metrics from the client-specific confidential information covered under the AICPA Code. The metrics require information such as workload data, staffing allocations, and experience levels of personnel involved in audits of issuers. This information does not include confidential client information or specific details about client engagements that would be protected under the AICPA Code. Instead, it focuses on the operational aspects of registered firms and the audits they perform that are important for the public to understand and assess the audits of issuers. The objective of this rulemaking is to enhance transparency and accountability within the audits of rather than to facilitate or enable competitive positioning among firms. Furthermore, the disclosure of such information by a regulatory authority for the purposes of transparency and accountability does not fall under the purview of antitrust concerns, as it does not facilitate collusion or the sharing of competitively secret information in a manner that would distort market dynamics. Instead, it ensures that all market participants and stakeholders have access to the same information. 172 See, e.g., AICPA Code of Professional Conduct 1.700.001 (‘‘A member in public practice shall not disclose any confidential client information without the specific consent of the client’’). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 issuers, and the information required by the metrics supports this goal without requiring auditors to breach their confidentiality obligations to clients.173 Finally, although some firms raised generalized concerns about potential conflicts with foreign laws, they did not provide specific examples that would justify prohibiting the public disclosure of the information in the metrics or warranting its confidential treatment. As discussed more fully below, the Board does not believe that any law, whether foreign or domestic, provides a reasonable basis for withholding the information in the metrics from public disclosure. As such, the Board did not permit firms to request confidential treatment for the metrics. This approach is consistent with the Board’s belief that these metrics will provide valuable additional information, context, and perspective on audit firms and audit engagements, which can be used by investors, audit committees, and other stakeholders. However, the Board is mindful of the Board’s obligation to protect information that is confidential under applicable laws relating to the confidentiality of proprietary, personal, or other sensitive information. To balance these concerns, the final metrics have been specifically designed to exclude information that could reasonably qualify for confidential treatment protection, such as personally identifiable, methodological, or clientspecific information. Additionally, the Board provides firms the option to include a narrative description with each metric to explain or contextualize the disclosures, allowing firms to clarify any potentially misleading information that could be viewed as sensitive. By adopting this approach, the Board believes that prohibiting confidential treatment requests on Forms FM and AP will further the public interest while adhering to the Board’s obligation to protect certain categories of firm information. In light of the objectives of this rulemaking, the Board decided not to permit confidential treatment for the metrics required on Forms FM and AP. 173 Similarly, some firms raised concerns about optional narrative disclosures, particularly regarding the need to maintain client confidentiality and protect commercially sensitive information. The Board has carefully designed the required metrics to avoid such issues. The Board expects firms to tailor their optional narrative responses in a similar manner, should they choose to provide them. This will enable firms to meet the transparency objectives of Forms FM and AP without compromising client confidentiality or disclosing sensitive commercial information. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 ii. Assertions of Conflicts With Non-U.S. Law The Board did not propose to allow firms the opportunity to assert conflicts with non-U.S. laws on either proposed Form FM or Form AP, as proposed to be amended. The proposal acknowledged that there may be certain limitations with respect to the data or information about a firm, its personnel, or the performance of the firm’s engagements that a firm may communicate publicly because it may conflict with a non-U.S. law, and asked commenters to describe any such laws and the proposed metrics to which it was realistically foreseeable that they would apply. Some commenters disagreed with the proposal not to allow firms to assert conflicts. One commenter strongly urged the Board to maintain the wellestablished rulemaking history that recognizes and respects non-U.S. firms’ distinct legal obligations and preserves the right for firms to assert a conflict of law. The Board is committed to cooperation and reasonable accommodation in its oversight of registered non-U.S. firms, and in the past has generally provided non-U.S. firms the opportunity to at least preliminarily withhold some information from its existing forms on the basis of an asserted conflict with non-U.S. laws. However, the Board has not provided for firms to assert such a conflict with respect to all information required by those PCAOB forms. Moreover, the Board notes that the Board has never permitted such withholding of information for Form AP. In addition, even where the Board has allowed registered firms to assert legal conflicts in connection with other forms, that accommodation does not entail a right for a firm to continue to withhold the information if it is sufficiently important.174 Other commenters suggested there were potential conflicts between reporting of the proposed metrics and current laws: • One commenter strongly recommended the Board consult with others, including the International Forum of Independent Audit Regulators 174 See Improving the Transparency of Audits: Rules to Require Disclosure of Certain Audit Participants on a New PCAOB Form and Related Amendments to Auditing Standards, PCAOB Rel. No. 2015–008 at 37; PCAOB Rel. No. 2008–004 at 37–38 n.38 (‘‘Rule 2207(e) preserves the Board’s authority to obtain information by preserving the possibility that, in an appropriate case involving sufficiently important information that is not otherwise forthcoming (e.g., through cooperation with non-U.S. regulators), the Board can ultimately put the firm to the choice of providing the information or being subject to a sanction for violating the Board’s rules.’’). PO 00000 Frm 00051 Fmt 4701 Sfmt 4703 100017 (IFIAR), to determine whether any law would prohibit a firm from providing information requested in the proposal and further diminish comparability (or increase the risk of misuse) of affected metrics. • A commenter also asserted that there are laws in various jurisdictions (e.g., France and Switzerland) that could have a significant impact on crossborder transfer of data and the comparability of such data. • Other commenters stated that firms with a small number of relevant issuer engagements, for example, disclosure of certain engagement-level metrics may lead to breach of confidentiality for client information, issues with disclosure of commercially sensitive information (e.g., time spent) or disclosure of personal data in breach of regulations, and potentially violate laws and regulations within some non-U.S. jurisdictions. (e.g., General Data Protection Regulation (‘‘GDPR’’)).175 • A commenter stated that based on their understanding from non-U.S. firms (although the commenter firm itself is not a non-U.S. firm) some of the proposed new required disclosures go beyond what non-U.S. regulators require and may lead to violations of local laws resulting from disclosure of information that non-U.S. auditors are required to keep confidential under professional secrecy obligations and/or laws and regulations governing disclosure of personal information. • Another commenter stated that the proposed expansion of mandatory disclosures directly increases the likelihood that a non-U.S. firm may be legally barred from providing the relevant information. One commenter encouraged the Board to include a specific provision that acknowledges that any required disclosure by a firm would need to comply with applicable local laws and regulations, while another stated that allowing firms to assert conflicts with non-U.S. laws would still require those firms to obtain legal opinions to support withholding the information. One of those commenters stated that information published where only one engagement is performed will be clearly identifiable to an individual engagement, which they asserted may breach personal data requirements 175 See Regulation (EU) 2016/679. The GDPR was passed by the European Union and became effective on May 25, 2018. The complete text of the regulation is available at https://eur-lex.europa.eu/ eli/reg/2016/679/oj. Section 1 of Article 2 of the GDPR applies to ‘‘processing of personal data wholly or partly by automated means and to the processing other than by automated means of personal data which form part of a filing system or are intended to form part of a filing system.’’ E:\FR\FM\11DEN2.SGM 11DEN2 100018 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 under legislation such as GDPR. However, neither this commenter nor any other articulated how any of the required metrics could reveal information allowing any individual to be directly or indirectly identified in contravention of GDPR or similar laws. In considering whether to allow the opportunity to assert conflicts, the Board considered both whether it is realistically foreseeable that any law would prohibit providing the required information and, even if it were realistically foreseeable, whether allowing a firm preliminarily to withhold the information is consistent with the Board’s broader responsibilities and the particular regulatory objective.176 The comments provided on this subject have not identified with sufficient specificity a realistically foreseeable likelihood that a law would prohibit providing the required information. The concerns that were mentioned were expressed in very general and hypothetical terms. Moreover, with respect to the suggestion that the Board consult with IFIAR, the Board notes that PCAOB staff did advise a number of its non-U.S. counterparts regarding the proposal with a view to facilitating their participation in the Board’s notice and comment process if they so chose, and none submitted comment letters. In addition, the Board continues to believe that allowing a firm preliminarily to withhold the required information is inconsistent with the Board’s broader responsibilities and the particular regulatory objective of this rulemaking, namely public transparency.177 This is the case notwithstanding that firms, as a commenter observed, have to provide a legal opinion regarding a conflict of law under the Board’s rules relating to asserted conflicts. Accordingly, the Board did not permit assertions of conflicts for Form AP or Form FM in the final amendments.178 With respect to the commenter suggestion that the Board includes a specific provision that acknowledges that any required disclosure by a firm would need to comply with applicable local laws and regulations, the Board believes such a provision could be construed as tacit permission to 176 See PCAOB Rel. No. 2015–008 at 37; PCAOB Rel. No. 2008–004 at 36. 177 Id. 178 If an actual conflict were to materialize, the Board would have tools to address it. For example, Section 106(c) of Sarbanes-Oxley authorizes the Board to, subject to the approval of the Commission, exempt any foreign public accounting firm, or any class of such firms, from any provision of the rules of the Board. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 withhold information without complying even with the existing requirements under the Board’s rules related to the assertion of conflicts. Given that this would be an even more permissive framework than currently exists for withholding information where assertions of conflicts are permitted under the Board’s rules, the same analysis applies with more force to this suggestion. The Board believes its notice and comment process, together with its oversight experience, sufficiently inform this policy choice. 7. Structure of Metrics Data Several commenters suggested that data on Form AP and Form FM be filed using eXtensible Business Reporting Language (‘‘XBRL’’) to be consistent with SEC registrant filings. The Board notes that the data on Form AP will continue to be downloadable and machine-readable. However, making a change to require reporting using XBRL would introduce additional costs for all firms that file Form AP. Therefore, reporting on Form AP and Form FM will be done using the same platform as the Board’s other reporting forms (currently, the Board’s web-based RASR system which uses XML and, in the future, potentially new means of information exchanges as the PCAOB continues to modernize its reporting technology aimed at simplifying and automating data collection, processing, and interoperability). Documentation For firm- and engagement-level metrics, the Board proposed that the firm would be required to retain documentation in sufficient detail to enable an experienced auditor, having no previous connection with the determination of the metrics, to understand the calculations, the data on which they are based, and the method used to estimate data when actual amounts were unavailable. This is similar to the ‘‘experienced auditor’’ threshold specified in AS 1215, Audit Documentation. The Board solicited comment on whether the proposed documentation requirement was clear and appropriate. One commenter agreed that the documentation requirement was clear and appropriate, while another commenter recommended further clarifications. The commenter recommended explicitly referring to AS 1215 as the commenter believed there were no explicit documentation requirements within Proposed Rule 2203C and Form FM instructions related to firm-level metrics. PO 00000 Frm 00052 Fmt 4701 Sfmt 4703 The Board adopted the proposed documentation requirement as proposed. The Board described the documentation requirement for Form FM in General Instruction 7 that the firm should retain documentation in sufficient detail to enable an experienced auditor, having no previous connection with the determination of the metrics, to understand the computations of amounts, the amounts on which they are based, and the method(s) used to estimate the amounts when actual amounts were unavailable.179 The Board believes this is sufficient to introduce the concept of ‘‘experienced auditor’’ into the documentation requirement for Form FM, similar to the ‘‘experienced auditor’’ threshold specified in AS 1215. Existing Form AP included a similar documentation requirement and under the amendments to Form AP that the Board has adopted, this requirement appears in General Instruction 10, as amended. Additional Firm and Engagement Metrics Considered In addition to the firm and engagement metrics the Board adopted, the Board considered and solicited comment on a number of (i) proposed metrics included in Section III.B.2 of the proposal and (ii) potential additional metrics included in Section III.E of the proposal. The Board determined not to adopt these additional firm and engagement metrics at this time. The additional metrics are discussed below. 1. Proposed Firm and Engagement Metrics i. Audit Resources—Use of Auditor’s Specialists and Shared Service Centers The proposal included metrics relating to the use of auditor’s specialists 180 and shared service centers (‘‘SSCs’’),181 which were intended to 179 Rule 2203C requires that firms file Form FM by following the instructions on Form FM. 180 A specialist, as used in this context, includes both auditor-employed specialists, as defined in AS 1201.C1, and auditor-engaged specialists, as described in AS 1210.01. Under those definitions, a specialist is a person possessing special skill or knowledge in a particular field other than accounting or auditing. Specialists would generally not include members of the engagement team whose specialization is in the fields of either IT or income taxes (tax) because IT and tax are specialized areas of auditing and accounting. However, if IT or tax specialists are employed or engaged in a capacity other than specialized auditing and accounting as part of the issuer engagement, it may be appropriate to include them as specialists. 181 A shared service center is described as an associated entity of a firm, set up by a network of accounting firms, that, among other things, supplies those firms with personnel to assist in the performance of audits, and that is not itself an other E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices help users gain a greater understanding of the use of these audit resources, including the frequency with which firms use specialists and SSCs on their engagements at the firm level generally and, at the engagement level, to provide the context required to understand the extent of the use of auditor’s specialists and SSCs on a particular issuer engagement. At the firm level, the proposal set forth requirements for firms to provide the percentages of issuer engagements that used auditor’s specialists and shared service centers, respectively. At the engagement level, the proposal provided that firms would report the percentage of total audit hours provided by auditor’s specialists and by shared service centers for each audit the firm performed of an accelerated filer and large accelerated filer. Commenters on the proposed use of audit resources metrics who generally opposed the disclosure of the metrics stated that the information was unlikely to be readily interpretable or useful because of comparability challenges. In contrast, one commenter found the proposed descriptions for the resource metrics to be appropriate. Some commenters who supported these metrics noted that challenges with comparability might be able to be overcome through use of the proposed voluntary narrative. Some commenters, who were not generally supportive of the proposed Audit Resources metrics, suggested that if they were adopted they should be limited to firms’ issuer audit practices. lotter on DSK11XQN23PROD with NOTICES2 a. Use of Auditor’s Specialists Some commenters were generally supportive of the firm-level metric for specialists. One commenter stated it would be supportive of disclosure of the specialist metrics with modifications to disclose the percentage of hours incurred by specialists on issuer audit engagements. Another commenter suggested disaggregating time among independent specialists, auditoraffiliated specialists, and managementaffiliated specialists, and breaking down the specialist metrics by industry. Among the commenters that were not supportive of the specialist metrics, several concerns were raised including accounting firm. See PCAOB, Staff Guidance: Form AP, Auditor Reporting of Certain Audit Participants, and Related Voluntary Audit Report Disclosure Under AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, (updated July 1, 2024) (‘‘Staff Guidance on Form AP’’), at n. 24, available at https://assets.pcaobus.org/pcaob-dev/ docs/default-source/standards/documents/07-012024-transparency-implementationguidance.pdf?sfvrsn=b9753eb_2. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 concerns with the proposed method for calculating auditor-engaged specialists’ hours when actual hours were not available, the lack of visibility to the hours incurred by specialists, the need to rely on information from other auditors, challenges with comparability and data collection, and the overall complexity of the proposed metrics. One commenter suggested that the engagement-level metric for specialists would be inconsistent with other Form AP instructions and may be misleading. Some commenters responded that the amount of specialist involvement on an engagement and overall at the firm level is highly contextual and the relationship to audit quality is not one dimensional. One commenter refuted the objective of providing investors a basis for discussion with management with respect to the use of specialists, stating that investors almost never take advantage of the opportunity to ask questions. Alternative approaches for specialist metrics were also suggested by commenters. One suggested an alternative approach for engagementlevel specialist metrics such as utilization metrics and qualitative descriptions, supported by narrative disclosures to provide necessary context and clarity. This commenter also suggested an alternative firm-level metric for specialists based on the average percentage of usage of specialists across all of the firm’s engagements, potentially covering only engagements where specialist hours exceeded a minimum percentage of total audit hours. Two commenters suggested the Board add an additional metric disclosing the percentage of audit hours incurred by specialists on issuer audit engagements (as a percentage of the total audit hours on issuers). Another commenter also suggested that using hours worked rather than the number of engagements as the basis for the calculation would provide more useful information at the firm level. This commenter also suggested disclosure of the use of specialists, and their hours on a CAM-by-CAM basis, as well as overall. Two commenters responded to the question in the Board’s proposal about including thresholds for resource metrics. One stated that including de minimis amounts would result in implementation challenges. The second, however, made the opposite argument, stating that including all specialist and SSC hours in audit resource metrics without a threshold would ensure that the metric remains straightforward and inclusive of all relevant contributions and provide a more complete picture of a firm’s audit processes and resource PO 00000 Frm 00053 Fmt 4701 Sfmt 4703 100019 utilization. Most commenters that responded to the question as to whether resource metrics should be further disaggregated, e.g., by industry, replied that this would be overly burdensome without added value. However, another commented that use of auditor specialists would be more helpful if broken down by industry. b. Use of Shared Service Centers Some commenters were supportive of SSC metrics. One of them stated that the use of SSCs was growing but not well understood, and that narrative context would be necessary. Other commenters raised multiple questions with respect to SSCs. Several of these were in relation to the definition of an SSC, which was proposed to be consistent with the definition used in Form AP, stating that there are many different approaches to the use of other resources than what is encompassed in that definition, which could lead to misunderstanding and lack of comparability. One of these commenters stated that the work of SSCs is dependent on the structure and resources of each firm and its SSCs and the specific needs of the individual engagement. Another commenter stated that the definition proposed a shared service center encompassed only those centers that are set up by a ‘‘network’’ of accounting firms and would not encompass an outsourcing center set up by a single firm. This commenter suggested the definition be revised to encompass all services that are not under the direct supervision of the engagement partner. Some commenters were concerned that SSC metrics would be misinterpreted as indicating that greater SSC hours indicated lower quality. Some commenters supported evaluation of the use of SSCs at the engagement level, but did not support publicly disclosing this information. Another commenter said that, given that engagement team members routinely work remotely, there should not be a difference between that arrangement and SSCs and, as a result, the metric would not be meaningful. This commenter also stated that it would not be meaningful to provide an explanation of work performed at an SSC because it is all ultimately the responsibility of the audit partner. The Board has taken commenter input, as well as observations from PCAOB oversight activities and the relevant academic literature, into account, and have determined not to adopt the proposed firm- and engagement-level audit resources metrics at this time. In doing so, the Board recognized, as discussed above, E:\FR\FM\11DEN2.SGM 11DEN2 100020 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices that several commenters suggested there would be challenges relative to comparability and data collection, and there would also be the potential for misunderstanding by users of the information. As the Board stated in the proposal, these are highly contextual measurements because the use of the work of specialists is generally performed to satisfy needs specific to an industry or issuer and the use of the work of SSCs is dependent on the structure and resources of both the firm and the SSC, as well as the specific needs of individual engagement teams. The Board acknowledges that the nature and uses of SSCs continue to expand. As they do, the Board expects to continue to study and focus inquiries in this area to better understand the impact of SSCs on audit quality, firm economics, and engagement staffing models. The Board anticipates these efforts will inform future consideration of whether additional guidance or other regulatory action is warranted. ii. Audit Hours and Risk Areas lotter on DSK11XQN23PROD with NOTICES2 The proposed engagement-level metric would have required firms to calculate the time incurred by all partners and managers on the engagement team in auditing the areas of significant risks,182 critical accounting policies and practices,183 and critical accounting estimates,184 in aggregate, as a percentage of total audit hours incurred by partners and managers on the engagement team. Because a firm-level metric would have been heavily influenced by the mix of companies that a firm audits, the Board did not propose to require firms to report this metric at the firm level. Two commenters supported this metric as proposed, while several other commenters generally supported this metric with revisions; suggestions included reporting the absolute number of audit hours as well as the percentage, and adding time spent on performing 182 As defined in paragraph .A5 of AS 2110, Identifying and Assessing Risks of Material Misstatement (‘‘risk of material misstatement that requires special audit consideration’’). 183 As defined in AS 1301.A4 (‘‘A company’s accounting policies and practices that are both most important to the portrayal of the company’s financial condition and results, and require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.’’). 184 As defined in AS 1301.A3 (‘‘An accounting estimate where (a) the nature of the estimate is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change and (b) the impact of the estimate on financial condition or operating performance is material.’’). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 fraud procedures. Another commenter, an investor-related group, supported this metric as proposed, but further suggested reporting the total audit hours incurred by staff on the engagement team in the areas of significant risks, critical accounting policies and practices, and critical accounting estimates because these areas are considered the most significant for the audit. This commenter also suggested reporting hours by specialists, senior professionals, and staff in connection with critical audit matters. Many other commenters criticized the proposed metric. These commenters provided the following reasons as the basis for their decision not to support this metric: • The metric does not consider the evolving role of technology in the audit and the use of technology can significantly contribute to audit effort. • Risk assessment is an iterative process throughout the audit which means that identifying significant risks and critical accounting policies, practices, and accounting estimates may change during an audit, resulting in changes in how auditors track their time for reporting under this metric. • An individual’s hours charged to auditing a particular account balance may include work performed that is unrelated to an identified significant risk. • The nature of the audit procedures performed could include overlap with other areas of the audit depending on discussions held and procedures performed. • Tracking time at the granular level needed to accurately capture hours for significant risks and critical accounting policies, practices, and accounting estimates would require additional resources, including time and costs, that are not directly associated with audit quality. • Reporting this information would require coordination across firms for audits involving other auditors, who may be using different systems to track the underlying information. • Since the risk of management override of controls is a presumed risk in all audits, how should it be considered since the response is pervasive to the audit. Several commenters, including firms, stated that firms are not currently tracking this information, or they believe that firms are not currently tracking this information. One commenter added that although they do not believe firms are currently tracking this information, it should be possible to extract this data from internal PO 00000 Frm 00054 Fmt 4701 Sfmt 4703 monitoring systems with considerable time and complexity. Commenter views were divided on whether the metric should be revised to also include engaged specialist hours given that, under the proposal, the definition of engagement team includes employed specialists, but not engaged specialists. Some commenters agreed that this metric should include engaged specialist hours, while other commenters did not. Taking into account commenter feedback as well as the fact that firms’ approach to identifying and classifying significant risks can vary greatly, the Board was concerned that the potential for misinterpretation of this metric and the costs associated with establishing systems to collect the necessary data may not be justified. The Board did not adopt the metric related to audit hours and risk areas at this time. iii. Quality Performance Ratings and Compensation The proposal set forth firm-level reporting requirements for firms to calculate (i) the distribution of quality performance ratings across partners and (ii) a comparison of average annual compensation adjustments (as a percentage of the average adjustment received by the highest rated group) for partners in each quality performance rating category over a one-year period. Overall, some commenters supported this metric area, agreeing with the proposed rationale that comparing the relationship between internal firm quality performance ratings and changes in compensation levels could provide evidence of the extent of any correlation between quality performance ratings and compensation, and thereby provide an important signal of the value of a quality commitment for the firm. However, other commenters did not support this metric area or expressed concerns because of the number of difficulties in reporting and using the metric. Commenters raised the possibility of a lack of comparability or consistency (e.g., differences in firm’s structure, strategies and systems used in performance evaluations, and definition of compensation, and inclusion of nonequity partner and directors in the calculation), resulting in potential misuse of the metrics or providing no or limited value to stakeholders. Many also pointed to variability in firms’ quality performance rating systems both across firms and within the firm over time. Some commenters also indicated that there are many factors that firms consider in determining compensation, and that firms use mechanisms to drive accountability of partners that would E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices not be taken into account in the metrics calculation, resulting in no direct oneon-one relationship between the compensation adjustments and performance ratings. Some commenters expressed a number of concerns about the definition of compensation, as well as the treatment of non-equity partners. Several commenters expressed concerns about confidential information. One commenter specifically cited the risk of disclosing confidential business information that is proprietary and protected from disclosure under Sarbanes-Oxley Section 102(e). Another commenter indicated (i) the possibility of identifying specific partners’ compensation at smaller firms and (ii) the disclosure of this metric area may be prohibited by laws and regulations outside of the United States. A commenter also said that PCAOB registered firms are for-profit entities that should have flexibility in designing a compensation strategy that is tailored to their business model and needs. Instead of the proposed metrics, several commenters suggested disclosing firms’ policies related to partner compensation and performance ratings, including how partner audit quality is measured and how that measurement influences compensation. Some of these commenters said that disclosing these policies would demonstrate the firms’ quality commitment and the value it places on quality while alleviating the comparability and confidentiality concerns and meeting the objective of this proposed metric. Some commenters stated that qualitative disclosures related to performance management and compensation policies are already disclosed in the firms’ annual transparency reports. One commenter indicated the complexity of the performance measurement goes beyond mechanical calculation. Another commenter indicated that the metric is not useful as it is an unambiguous indicator of audit quality and likely focuses on matters unrelated to audit quality. Two commenters explicitly supported the exemption granted to firms that are not within the scope of the SEC’s partner rotation rule. One commenter questioned whether this metric would relate to all issuer audit engagements or all audit engagements and another indicated that combining issuer and non-issuer information would conflict with proposed PCAOB Rule 2400. Furthermore, a commenter indicated that this metric encompasses all partners of the firm and would not be useful when the issuer audit practice is VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 a small portion of the overall firm operations. While there was some support from commenters, the Board did not adopt this metric area at this time, primarily due to the challenges described by commenters (e.g., lack of comparability and variability in establishing a firm’s quality rating system) and the ambiguity in relation to audit quality, which may be difficult to overcome for this metric area to be meaningful for stakeholders. Because this rulemaking project is focused on requiring certain firms to report certain quantitative metrics that will foster comparability, the Board is also did not adopt the alternatives suggested by various commenters that the firms disclose policies regarding the partner compensation and performance ratings. iv. Audit Firms’ Internal Monitoring The proposal set forth firm-level requirements for firms to calculate the percentage of issuer engagements that were selected for internal monitoring in the firm’s most recently completed cycle (i.e., the number of completed issuer engagements internally monitored, divided by the number of total issuer engagements) and the percentage of those issuer engagements with engagement deficiencies.185 At the engagement level, the proposal set forth requirements for firms to disclose whether a previous engagement was selected for internal monitoring in the most recently completed monitoring cycle, the year-end date of the engagement subject to review, whether any engagement deficiencies were identified, and the nature of those deficiencies. The nature of the engagement deficiencies would be one of the following: (i) financial statement line item, (ii) disclosure, or (iii) other noncompliance with applicable professional or legal requirements.186 The Board also proposed that certain details be provided about the engagement deficiency, including the area of noncompliance and the type of deficiency. Some commenters, primarily investorrelated, expressed support for both the proposed firm- and engagement-level metrics. One investor-related commenter suggested that Part I.A 185 The term ‘‘engagement deficiency’’ as used in the proposal is defined in QC 1000.A4 (‘‘An instance of noncompliance with applicable professional and legal requirements by the firm, firm personnel, or other participants with respect to an engagement of the firm, or by the firm or firm personnel with respect to an engagement of another firm’’). 186 The term ‘‘applicable professional and legal requirements,’’ as used in this rulemaking, has the same meaning as defined in QC 1000.A2. PO 00000 Frm 00055 Fmt 4701 Sfmt 4703 100021 deficiencies be included separately in addition to the proposed requirements. Other commenters stated the proposed metrics would provide useful information into understanding firms’ monitoring procedures and outcomes, facilitating comparisons regarding the quantity and types of engagement deficiencies detected, while one commenter stated that the monitoring and remediation process was an essential component of firms’ quality management systems and agreed that providing a certain level of transparency in this area could be useful for interested stakeholders. The firm-level metric was generally supported by some firm and firm-related commenters. One noted that it reports certain of this information in its transparency reports. Another highlighted that its internal monitoring was broader in scope, including targeted monitoring of its team’s use of certain tools or technologies, adding that may be inconsistent with the PCAOB’s intent with respect to firm-level reporting. Some of these commenters suggested reducing the scope by requiring reporting of only PCAOB Inspection Report Part I.A inspection findings. Another suggested reporting the percentage of compliant internal reviews rather than deficient engagements. Conversely, several firm commenters were opposed to the proposed internal monitoring metrics at the firm level. The concerns raised by these commenters included noting that differences in monitoring programs would render the information provided inconsistent and uninformative and also that it could be disadvantageous to smaller firms that may have more variability in their internal monitoring year over year. In addition, several firm and firm-related commenters disagreed with the deficiencies required to be disclosed in the proposed firm-level metrics being aligned to QC 1000. One stated that presentation of such a broad range of deficiencies into a single metric without distinction could lead a user to inappropriately conclude that the firm had significant quality issues, which could in turn negatively impact their confidence in the reliability of the firm’s audit reports. Another commenter expressed their belief that firm-level public reporting of internal inspection findings could be a disincentive for finding deficiencies. This commenter also stated that firms should be allowed to request confidential treatment for metrics related to internal monitoring. At the engagement level, virtually all firm commenters objected to the proposed internal monitoring metrics. E:\FR\FM\11DEN2.SGM 11DEN2 100022 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Specific objections raised included those related to confidentiality concerns, comparability challenges, and the potential for confusion or misunderstanding. Several commenters expressed concerns that the proposed metrics risked undermining internal inspection programs if they cause firms to move from broad monitoring processes to align more closely with PCAOB inspections in response to the proposed requirements. One commenter stated that once these metrics become public, firms could come under pressure from various constituencies to report results that are within a perceived acceptable range. Another commenter voiced concern that firms could be incentivized to alter their internal monitoring processes in a manner inconsistent with the objectives of the proposal. Some commenters suggested that an alternative could be to require communication with an issuer’s audit committee. Taking commenter input into account, the Board determined not to adopt the proposed firm- and engagement-level internal monitoring metrics at this time. lotter on DSK11XQN23PROD with NOTICES2 2. Potential Additional Firm and Engagement Metrics In the Board’s proposal, it discussed three particular areas—training, access to technical resources, and investment in audit infrastructure—that it did not propose to require for reporting but, in light of the significance of these areas, for which the Board solicited specific commenter input. All of these potential metrics related to aspects of a firm’s ongoing investment in audit quality, which the Board believes is critically important. However, in working to develop metrics in these areas, the Board encountered challenges in defining what to measure and how to measure it, questions about whether metrics would be informative and appropriately free from bias, and concerns about potential unintended consequences. After considering commenter feedback, the Board adopted a modified metric related to training, which is discussed in detail above. However, the Board did not adopt metrics in the areas of access to technical resources or investments in audit infrastructure, as discussed further below. In addition to the metrics the Board considered, as noted above, some commenters on the proposal suggested a metric for PCAOB Part I.A deficiencies. The Board’s response to this suggestion is discussed further below. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 i. Access to Technical Resources The Board solicited comment on possible firm-level metrics relating to the relative size of a firm’s central personnel (or other resources engaged by the firm) available to provide engagement teams with advice on complex, unusual, or unfamiliar issues and the extent to which such resources were used in the firms’ engagements. Metrics that were considered at the engagement level focused on consultations that were performed with professionals outside of the engagement team on difficult or contentious matters. Commenters who responded to questions about the potential metric for access to technical resources largely agreed with the considerations and conclusions in the proposal. Some of those commenters replied that the metrics would not be useful, be difficult to measure, not be comparable, and could be seen as being biased towards larger firms. One commenter mentioned that arguments could be made for or against many metrics, but they broadly agreed access to [technical] resources should be dropped. One commenter expressed that it would be difficult to define national office in a way that was meaningful. After considering these comments, and in light of the Board’s original analysis, the Board did not adopt a metric related to access to technical resources. ii. Investment in Audit Infrastructure Metrics the Board considered in relation to investment in audit infrastructure were primarily at the firm level and were focused on the expenditures that firms self-identified as being in support of audit quality either in total or on a per headcount basis. Commenters generally stated that such a metric would be very facts and circumstances dependent, such that meaningful comparisons could not be made. One commenter suggested that investment in infrastructure was best discussed with an in-depth understanding of the circumstances to obtain appropriate context. Another suggested that the data would be stale by the time it was reported, adding to its lack of usefulness. One commenter mentioned that arguments could be made for or against many metrics, but they broadly agreed investment in audit infrastructure should be dropped. However, one commenter stated that they would support a metric that provides the percentage of firm revenues invested in technology accessible by audit teams. Similarly, another commenter supported including PO 00000 Frm 00056 Fmt 4701 Sfmt 4703 a metric that provides the percentage of firm revenues invested in technology and stated they believe this metric could offer useful information to investors about the firm’s ability to adapt to future challenges. After considering commenter feedback, the Board did not adopt a requirement to disclose a metric on investment in audit infrastructure. The Board considered the commenters that supported a metric related to revenue invested in technology, but weighing the challenges presented by doing so, specifically with respect to comparability and concerns in potential bias with respect to smaller firms, the Board continues to believe the unintended consequences and the costs would not be justified by the benefits such a metric might provide. iii. PCAOB Part I.A Deficiencies Some commenters recommended requiring a metric which the Board did not include as a potential additional metric in the proposal—a percentage of the PCAOB Part I.A deficiencies relative to ‘‘the total inspections.’’ The commenters acknowledged that this information is already publicly available. However, they suggested that including this percentage with other required metrics would highlight its importance and provide valuable information. One of the commenters went on to state that increasing the visibility of the PCAOB’s inspection results would increase the importance of the results of the inspection process to audit firms, which they believe will lead to an improvement in overall audit quality. After considering commenter feedback, the Board did not adopt a requirement to disclose a metric for PCAOB Part I.A deficiencies. Principally, the Board has concerns that the time lag implicit in such a metric would be potentially confusing. The other metrics would report as of September 30 or for the 12 months then ended, but a metric based on PCAOB inspection results would relate to audits conducted one or more years previously and may reflect issues that have long since been remediated.187 In the Board’s view, presenting data on inspection findings from previous years together with a suite of other metrics that all relate to the current period may confuse users. Of course, inspection reports, including discussion of Part I.A. 187 The PCAOB inspects audits completed in the prior year, and the ensuing reports have historically been released a year or more after the inspection is completed. E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices deficiencies, will continue to be available on the PCAOB website.188 Effective Date lotter on DSK11XQN23PROD with NOTICES2 For firm-level metrics, the Board proposed an effective date beginning October 1 of the year after approval by the SEC, with the first reporting period ending the following September 30. The Board also proposed a phased implementation period: • Firms that issued audit reports with respect to more than 100 issuers in the calendar year preceding the effective date would begin reporting firm-level metrics in the first year; and • All other firms would begin reporting firm-level metrics one year later. For engagement-level metrics, the Board also proposed a phased implementation period: • Firms that issued audit reports with respect to more than 100 issuers in the calendar year preceding the effective date—for audits of companies with fiscal years beginning on or after October 1 of the year after the year in which SEC approval is obtained; and • All other firms—for audits of companies with fiscal years beginning on or after October 1 two years after the year in which SEC approval is obtained. The Board solicited comment on whether the proposed effective date would provide challenges for auditors and how these challenges should be addressed. The Board also solicited comment on whether the phased implementation period would be appropriate and whether the phased implementation should be based on the number of issuer audit reports issued or some other basis. One investor-related group suggested that extending the implementation period would allow smaller firms to adapt incrementally, ensuring they are not disproportionately affected by the new requirements. This commenter further suggested that the Board could identify and make certain metrics optional for smaller firms without making all the metrics optional. 188 See, e.g., PCAOB charts illustrating much of the data in the U.S. global network firms (‘‘GNFs’’) and U.S. annual non-affiliated firms (‘‘NAFs’’) inspection reports, available at https://pcaobus.org/ oversight/inspections/global-network-firmsinspection-data and https://pcaobus.org/oversight/ inspections/non-affiliated-firms-inspection-data, respectively. GNFs are the member firms of the six global accounting firm networks (BDO International Ltd., Deloitte Touche Tohmatsu Ltd., Ernst & Young Global Ltd., Grant Thornton International Ltd., KPMG International Ltd., and PricewaterhouseCoopers International Ltd.). NAFs are both U.S. and non-U.S. accounting firms registered with the Board that are not GNFs. Some of the NAFs belong to international networks. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Primarily, firms and firm-related groups recommended extending the proposed effective date. While many firms did not provide a specific implementation time period, other than stating that more time is needed, other firms recommended an effective date at least three years after the SEC’s approval, and others recommended at least two years after the SEC’s approval. Some commenters specifically stated that additional time (i.e., one more year) would be needed for smaller firms. Another commenter recommended an effective date of at least three years after the SEC’s approval, if adopted as proposed, or shorter if engagement-level metrics will be communicated to the audit committee, rather than reported publicly, as proposed. These commenters provided reasons for extending the implementation period including more time to implement systems or system changes, develop processes, train professionals, and accumulate and test data and calculations. Some commenters specifically emphasized the need for more time to make changes in the global network firms or other firms who are participating in the audit that may or may not have the same systems or policies. Other commenters stated that more time would be needed to implement this rulemaking because of other recently adopted standards. The Board considered these comments and provided additional time before the reporting rules become effective. The final rules will become effective beginning October 1 of two years after approval by the SEC, with the first reporting period ending the following September 30 with a phased implementation period: • Firms that issued audit reports with respect to more than 100 issuers in the calendar year in which the effective date occurs will begin reporting firm-level metrics in the first year reporting is required; and • All other firms would begin reporting firm-level metrics one year later. If approved by the SEC, the effective date of the firm-level metrics will be October 1, 2027. For firms that issued audit reports with respect to more than 100 issuers in 2027, the first reporting period would end on September 30, 2028, with the first Form FM due by November 30, 2028. For all other firms, the first reporting period would end on September 30, 2029, with the first Form FM due by November 30, 2029. For engagement-level metrics, the Board is also adopting a phased implementation period: PO 00000 Frm 00057 Fmt 4701 Sfmt 4703 100023 • Firms that issued audit reports with respect to more than 100 issuers in the calendar year preceding the effective date—for audits of companies with fiscal years beginning on or after October 1 of two years after the approval by the SEC; and • All other firms—for audits of companies with fiscal years beginning on or after October 1 of three years after the approval by the SEC. If approved by the SEC, reporting of engagement-level metrics would start for firms that issue audit reports with respect to more than 100 issuers in 2026 for the audits of companies with fiscal years beginning on or after October 1, 2027. For other firms, it will start with audits of companies with fiscal years beginning on or after October 1, 2028. The reporting will be on Form AP, which is generally due 35 days after the issuance of the auditor’s report. As discussed in earlier sections, the Board adopted a smaller number of firm- and engagement-level metrics than proposed. Specifically, the Board adopted [ten] eight metrics areas (as opposed to 11 proposed metric areas), which should reduce the administrative burden and cost of calculating and reporting the metrics. Therefore, the Board believes that the smaller number of metrics, the extension of the effective date, and the phased implementation should provide sufficient time for firms, including smaller firms, to implement new or enhanced systems and processes, train professionals, and conduct internal testing and reporting before reporting of the metrics. D. Economic Considerations and Application to Audits of Emerging Growth Companies The Board is mindful of the economic impacts of its standard setting. This economic analysis describes the economic baseline, need, and expected economic impacts of the final rules, as well as alternative approaches considered. Because there are limited data to quantitatively estimate the economic impacts of the final rules, much of the Board’s economic analysis is qualitative. However, where feasible, the economic analysis incorporates quantitative information, including analysis of internal PCAOB data, publicly available data, and results from academic literature. Baseline This section establishes the economic baseline against which the impact of the final rules can be considered. Important components of the baseline, specifically a discussion of current firm- and engagement-level disclosure E:\FR\FM\11DEN2.SGM 11DEN2 100024 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 requirements, voluntary reporting practices, and actions in other jurisdictions relevant to the final rules are described above. Below, the Board highlights information presented above most relevant to the economic baseline and provides additional academic references and statistics. Current PCAOB rules and standards do not require registered firms to publicly disclose firm or engagementlevel information like the final metrics. As discussed above, firms are currently required to publicly disclose some information related to the firm and its engagements in a variety of PCAOB forms (e.g., Form AP, Form 2).189 Usage statistics suggest that the public actively seeks out the information contained in these forms. For example, PCAOB usage statistics show that during calendar year 2023, there were close to 7.4 million page views, and just over 23,000 unique visitors, for PCAOB’s RASR Web service that provides public access to firm filings, including Forms 1, 2, 3, 4, and AP.190 Additionally, in 2023 there were over 333,000 unique searches performed on AuditorSearch, the PCAOB’s online search tool, and the Form AP data set was downloaded over 2,000 times.191 In addition to the information that the firm makes public through required form filings, the PCAOB provides firmlevel public disclosure through firm inspection reports.192 For the 2023 calendar year, firm inspection reports were downloaded approximately 113,000 times. Academic research suggests that audit committees use the information contained in PCAOB inspection reports.193 Additionally, some academic research suggests that PCAOB inspection reports provide useful information to investors.194 189 The Board concurrently adopted new reporting requirements for registered firms. See PCAOB Rel. No. 2024–013. 190 The RASR database can be found on the PCAOB’s website (https://rasr.pcaobus.org/.aspx). The usage statistics underestimate actual public interest because investors, researchers, auditors, audit committees, and issuer management may source PCAOB information through external thirdparty data service providers—such as Ideagen’s Audit Analytics. However, they also overestimate actual public interest to some extent because the usage statistics include internal PCAOB users. 191 Information related to usage statistics can be found on the PCAOB’s website (https:// pcaobus.org/resources/auditorsearch). 192 Firm inspection reports can be found on the PCAOB’s website (https://pcaobus.org/oversight/ inspections/firm-inspection-reports). 193 See, e.g., Daniel Aobdia, The Impact of the PCAOB Individual Engagement Inspection Process—Preliminary Evidence, 93 The Accounting Review 53 (2018) (finding that ‘‘the client is more likely to switch auditor’’ when offices or partners receive a Part I auditing deficiency). 194 See, e.g., Andrew Acito, Amir Amel-Zadeh, James Anderson, William L. Anderson, Daniel VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 However, some research suggests that institutional investors may not be aware of or find value in PCAOB inspection reports.195 One commenter noted that the proposal did not provide information on who was accessing the website information or why they were accessing it. The PCAOB does not collect information on who is accessing the website information (e.g., IP addresses) or why they are accessing it. In addition to PCAOB information, investors and audit committees may be able to obtain information related to audit quality from auditor legal proceedings—e.g., pursuant to SEC enforcement actions.196 However, due to the investigation and litigation process, engagement-specific information may be publicly available only after a substantial lag. Furthermore, academic researchers have also used a variety of publicly available firm and engagementlevel proxies for audit quality including audit firm size, issuer restatements, and industry specialization.197 One commenter noted that the auditor’s tenure with the company is available in the auditor’s report and audit fee information is available in the company’s proxy statement. As discussed above, some large U.S. audit firms voluntarily publicly disclose Aobdia, Francois Brochet, Huaizhi Chen, Jonathan T. Fluharty-Jaidee, Martin Schmalz, Manyun Tang, and Scott Jinzhiyang Wang, Market-Based Incentives for Optimal Audit Quality, SSRN Electronic Journal (2024) (finding that when PCAOB inspection reports can be easily linked to the issuer being audited, issuers whose audit was not found to be deficient significantly outperform issuers whose audit was found to be deficient); Nemit Shroff, Real Effects of PCAOB International Inspections, 95 The Accounting Review 399 (2020) (finding, using a sample of foreign companies, that companies enjoy greater access to capital when their auditor’s PCAOB inspection report does not include Part I deficiencies). The Board notes that SSRN does not peer review its submissions. 195 See, e.g., Center for Audit Quality, Perspectives on Corporate Reporting, the Audit, and Regulatory Environment Institutional Investor Research Findings, (Nov. 2023) (‘‘CAQ 2023 Survey’’) (finding that most institutional investors interviewed were unaware of PCAOB inspections reports, and to the extent investors were aware, found the report results to be expected) and Clive Lennox and Jeffrey Pittman, Auditing the Auditors: Evidence on the Recent Reforms to the External Monitoring of Audit Firms, 49 Journal of Accounting and Economics 84 (2010) (finding that companies do not perceive that the PCAOB’s disclosed inspection reports are valuable for signaling audit quality). 196 See, e.g., the SEC’s Accounting and Auditing Enforcement Releases available at https:// www.sec.gov/divisions/enforce/friactions. 197 See, e.g., Daniel Aobdia, Do Practitioner Assessments Agree with Academic Proxies for Audit Quality? Evidence from PCAOB and Internal Inspections, 67 Journal of Accounting and Economics 144 (2019); Jere R. Francis, A Framework for Understanding and Researching Audit Quality, 30 AUDITING: A Journal of Practice & Theory 125 (2011); and DeFond and Zhang, A Review of Archival Auditing Research. PO 00000 Frm 00058 Fmt 4701 Sfmt 4703 certain firm-level information through their firm transparency reports—e.g., general discussions of turnover rates, independence policies and practices, or aggregated staff headcounts. PCAOB staff reviewed the most recent audit quality report for each of the eight firms considered in the CAQ Report. As these firms’ audit quality reports generally do not provide quantitative engagementlevel information, the PCAOB staff’s analysis focused on whether they provide quantitative firm-level information substantially similar to the final firm-level metrics. Overall, the PCAOB staff’s analysis indicates that voluntary firm reporting addresses many of the areas included in the final metrics, though in most instances more narrowly. The reports generally provide quantitative information related to staff training and retention, which the Board believes is substantially similar to the final metrics for Training Hours for Audit Personnel and Retention of Audit Personnel, respectively. However, the Board notes that the reports that include a retention metric define it in different ways and report it at different levels of aggregation. The reports generally provide quantitative information related to staffing leverage. However, the quantitative information is generally at the head-count level and no report accounts for audit hours, as the final Partner and Manager Involvement metrics require. Half of the reports provide quantitative information related to the frequency of restatements which are similar to the final Restatement History metric. However, in these cases, the reports do not indicate whether the reported restatements include reissuance restatements, revision restatements, or both. Some other reports provide quantitative information related to the frequency of restatements associated with PCAOB-inspected engagements only. Half of the reports provide quantitative information related to years of experience. However, the quantitative information does not include managers’ experience as the final Experience of Audit Personnel metric requires. Some reports provide metrics similar to the final Workload metric. However, in these cases, the calculations may differ from the final Workload metric in important ways (e.g., they are limited to the busy season only or include more staff than required) and it is unclear whether the calculations include the same types of hours required under the final rules (e.g., PTO hours). The reports generally do not provide quantitative information related to the allocation of audit hours E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices and no report provides quantitative information related to industry experience. However, the Board notes that these firms generally provide information related to the industries they serve on their websites which is similar to the component of the firmlevel industry expertise metric that identifies the five top industries of the firm’s audit practice. One commenter said that, though only a small portion of firms voluntarily disclose metrics, these firms cover most U.S. public companies. The Board acknowledges that this point implies that most audit committees and investors have some information about topics covered by the final metrics. However, PCAOB staff found that the existing disclosures are not uniform or comparable across firms. Furthermore, PCAOB staff found that firms generally do not voluntarily publicly report engagement-level metrics and one investor group said that the firms’ transparency reports are seen as marketing material rather than investor information. One commenter emphasized that firms already publish transparency reports and urged the PCAOB to analyze firms’ current transparency reporting practices and solicit feedback from investors, audit committees, and other stakeholders on their contents. The Board performed such an analysis as described above and has addressed comments on the economic baseline that the Board received from stakeholders as part of the Board’s notice and comment process. The limitations of voluntary firm transparency reports, along with the related academic literature, are further discussed below. Audit committees can receive other information through sources not available to the public. Auditing standards and PCAOB and SEC rules require specific communications from auditors to audit committees regarding a variety of matters related to the audit engagement. For example, under AS 1301, the auditor is required to communicate to the audit committee inter alia (i) all critical accounting policies and practices to be used; (ii) a description of the process management used to develop critical accounting estimates; and (iii) significant risks identified during the auditor’s risk assessment process.198 Moreover, audit committees may obtain information under other disclosure requirements— e.g., reporting under Section 10A of the 198 See above for additional discussion related to auditor communications with audit committees. See also Section 10A(k) of the Exchange Act, 15 U.S.C. 78j–1(k) and 17 CFR 210.2–07. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Exchange Act, where the auditor must report to the issuer’s board of directors, in certain situations, related to illegal acts at an issuer.199 In exercising their oversight responsibilities, audit committees may also request more firmor engagement-specific information from their auditor. For example, audit committees may seek information from the auditor about PCAOB inspections, including information not contained in the PCAOB’s public inspection reports.200 Audit committees may also request information from other audit firms as part of a request for proposal if they are considering engaging a new auditor. Audit firms, partners, and engagement teams have developed reputations based on the public and non-public information discussed above, as well as audit committees’ direct experience with them. Through surveys and interviews with audit committee members, one study concluded that the firm’s reputation for industry experience and the audit partner’s accessibility, ability to address accounting issues on a timely basis, and ability to liaise with the firm’s national office are the key characteristics that audit committees consider when selecting an auditor.201 This finding suggests that audit committees currently receive and use information like some of the final metrics (e.g., Industry Experience and Workload). The Board believes many firms internally track some information related to the final metrics. One commenter on the Concept Release stated that they believe that many firms are using the 28 AQIs identified in the Concept Release at some level to (i) manage the firm and (ii) manage the quality of audits at the office level and at the engagement level. Three U.S. GNFs stated in their comments on the Concept Release that they track some of the proposed metrics discussed in the Concept Release for monitoring purposes. Information gathered by PCAOB staff in 2018 and 2019 pursuant to PCAOB oversight activities indicate that U.S. GNFs generally had identified and were tracking performance metrics at both the firm and engagement level. At the firm level, U.S. GNFs generally tracked PCAOB inspection history, restatements, voluntary turnover rates/ 199 See, e.g., Section 10A of the Exchange Act, 15 U.S.C. 78j–1. 200 See Information for Audit Committees About The PCAOB Inspection Process, PCAOB Rel. No. 2012–003 (Aug. 1, 2012). 201 See Elizabeth D. Almer, Donna R. Philbrick, and Kathleen H. Rupley, What Drives Auditor Selection?, 8 Current Issues in Auditing A26, A27 (2014). PO 00000 Frm 00059 Fmt 4701 Sfmt 4703 100025 retention rates, partner to staff ratios/ professionals by level, average partner workload, and investment in audit quality. At the engagement level, U.S. GNFs generally tracked distribution of engagement hours during the year, partner workload and utilization, partner years of experience (by industry, level, or issuer), engagement leverage, engagement milestone compliance, involvement in pre-issuance review programs, and use of IT and other specialists. One firm tracked audit hours performed at SSCs. However, several commenters representing firms and firm-related groups explained that they do not currently track information in a form that will be required for several of the metrics. For example, one commenter said that firms have no internal tracking of personnel’s total experience prior to joining the firm. One commenter said that smaller and medium-sized firms do not track the industry experience of audit personnel. Though this information suggests that a significant amount of information is collected by the U.S. GNFs at both the firm and engagement levels, one academic study suggests that partners seldom use metrics related to audit quality when evaluating the quality of their work or the work of their colleagues.202 Commenters noted that the PCAOB already has access to information about audit firms. One commenter suggested that the Board describe the information currently requested from firms. The PCAOB requests a variety of information from firms to inform its inspections process, which focuses on evaluating whether firms are in compliance with PCAOB standards. Some of the information is related to some of the final metrics. However, the information is generally not comparable across firms, engagements, and time; the quality of the information is inconsistent; and the information is generally not available for all firms and engagements.203 To better understand the adequacy of currently available information or need for additional disclosures, one commenter suggested that the Board consider data on: (i) attendance at annual shareholder meetings; (ii) votes on auditor ratification; or (iii) passive 202 See, Marion Brivot, Mélanie Roussy, and Maryse Mayer, Conventions of Audit Quality: The Perspective of Public and Private Company Audit Partners, 37 Auditing: A Journal of Practice & Theory 51, 68 (2018). 203 The Board believes this is driven, in part, by variation in firms’ approaches to quality control and how they record information. The Board notes that, under Section 105(b)(5) of Sarbanes-Oxley, this information is only available for PCAOB regulatory use. E:\FR\FM\11DEN2.SGM 11DEN2 100026 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 versus active investors. The Board was unable to identify any data sources regarding attendance at annual meetings. However, the Board notes that shareholder votes are typically cast electronically by proxy and not inperson at annual meetings.204 Moreover, anecdotal evidence suggests that attendance, particularly among retail investors, is generally low.205 This may reflect the fact that material information relevant to investor decision-making is typically provided through the proxy statement and annual report, rather than being newly disclosed at the annual meeting. The Board does not believe this provides strong evidence for or against the adequacy of currently available data or investors’ information preferences. Regarding votes on auditor ratification, the Board’s economic analysis is informed by and cites several academic studies on shareholder voting to ratify the appointment of the auditor. Additionally, data from Audit Analytics suggests that the proportion of investors opposing ratification, while still infrequent, has been increasing.206 Overall, the research suggests that investors, primarily institutional investors, use information related to audit performance. In cases where they do not, the Board believes this is more likely driven by the costs of gathering and understanding the information rather than a lack of demand.207 Regarding passive versus active investors, research suggests that household direct holdings comprise roughly 50% of U.S. equity capital with the remaining 50% held by ETFs, passive mutual funds, active mutual funds, or hedge funds.208 Among funds, roughly 50% are actively managed.209 Based on the Board’s review of academic literature and the Board’s consideration of costs, the Board 204 See, e.g., Broadridge, 2023 Proxy Season Key Stats and Performance Ratings, (2023) (reporting that, of the votes Broadridge processed, 97% of shares were voted electronically by retail and institutional shareholders). 205 See, e.g., Yaron Nili and Megan Wischmeier Shaner, Virtual Annual Meetings: A Path Toward Shareholder Democracy and Stakeholder Engagement, SSRN Electronic Journal (2022) (discussing how ‘‘[m]eaningful participation at the yearly gathering of corporate shareholders has become a relic of the mid-twentieth century’’ and ‘‘[l]ow retail investor attendance and participation is a well-documented problem in public corporations’’) and cites therein. The Board notes that SSRN does not peer review its submissions. 206 See WSJ, Investor Votes Against Big Companies’ Auditors Climb, (June 18, 2024). 207 See below for additional discussion. 208 See Nicolae Garleanu and Lasse Heje Pedersen, Active and Passive Investing: Understanding Samuelson’s Dictum, 12 The Review of Asset Pricing Studies 389 (2020). 209 See John Rekenthaler, Index Funds Have Officially Won, Morningstar (Feb. 13, 2024). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 believes that individual retail investors will be less likely to use the final metrics than institutional investors.210 Therefore, this research suggests that investors who are more likely to use the final metrics will use the final metrics to inform their capital allocation decision-making own or manage roughly 25% of U.S. equity capital. However, the Board notes that, by investing in proportion to the market value of a company, passive investors freeride on the decisions of the active investors, thus amplifying the effects of improved decision-making of the more active investors who are more likely to use the final metrics.211 Also, one audit committee chair said at the September 26, 2024 IAG meeting (‘‘September 2024 IAG meeting’’) that passive investors take corporate governance very seriously. Similarly, an investor group commenter said that passive portfolio managers’ stewardship counterparts will use the information in their voting decisions. As such, in contrast to capital allocation decision-making, the final metrics may inform passive funds’ governance-related decision-making. One commenter suggested that the prevalence of Part I.A deficiencies is an important reason for the proposal and recommended that the Board provide an analysis of the causes of Part I.A deficiencies to help stakeholders assess the benefits of the final rules. Part I.A deficiency trends are available in PCAOB Rel. No. 2024–005.212 Firms have recently indicated to PCAOB staff that unusually high staff turnover and use of less experienced staff may have contributed to rising auditing deficiencies. PCAOB inspection staff also found that utilization of individuals with specialized skill or knowledge and significant, timely, and detailed supervision and review were good practices.213 The final metrics will reflect several of these aspects of the audit (e.g., Partner and Manager Involvement). However, based in part on other comments the Board received on the proposal, the Board is not 210 See below. e.g., Jeffrey L. Coles, Davidson Heath, and Matthew C. Ringgenberg, On Index Investing, 145 Journal of Financial Economics 665 (2022) (discussing how ‘‘[p]assive investors are necessarily freeriding on the research and effort exerted by active managers’’) and Ruggero Jappelli, Dynamic Asset Pricing with Passive Investing, unpublished working paper (2024) (finding that ‘‘the effect of standardized unexpected earnings on abnormal returns is significantly amplified by the wealth passively tracking the stock’’). 212 See PCAOB Rel. No. 2024–005, at 315. 213 See Spotlight: Staff Update and Preview of 2022 Inspection Observations (July 2023) (‘‘2022 Inspection Observations Preview’’), at 4, available at https://pcaobus.org/resources/staff-publications. 211 See, PO 00000 Frm 00060 Fmt 4701 Sfmt 4703 adopting metrics related to the use of specialists.214 One commenter said that to the extent investors need additional information to inform their voting decisions, the audit committee has the ability to provide that information in their report in the proxy statement, including a summary of the metrics they used to assess the auditor. However, another commenter said that proxy statements provide little information to shareholders on which they can base their decision to ratify the appointment of the auditor and no information related to the quality of the audit or the audit firm is required to be disclosed on the proxy statement. One commenter said that several Form AP studies were excluded from the Board’s baseline.215 The Board recognizes that some of these analyses detect little impact of prior PCAOB disclosure rules. The Board notes that Section IV.C.1.i. of the proposal described how the benefits of prior PCAOB disclosure rules vary by rule and analysis. Referring to an academic article, the same commenter suggested that the baseline section had not provided ample research to show that investors would use the proposed metrics.216 The proposal and the discussion below refer to the article cited by the commenter as well as several others regarding how investors may respond to the metrics. Lastly, as discussed above, PCAOB staff estimates that approximately 210 firms will be subject to the final firmlevel disclosure requirements, including 22 of the top 25 U.S. firms by 2023 total firm revenue and all of the 2022 annually inspected firms that continue to audit issuers. Approximately 50 firms will be required to report the final firmlevel Industry Experience metrics. Approximately 3,400 issuer audits will be subject to the final engagement-level disclosures, covering approximately 99% of the total market capitalization of issuers reporting on Form 10–K and Form 20–F. Need This section discusses the economic problem to be addressed and explains how the final rules address it. In general, two observations suggest that there is an economic need for the final rules: 214 See above for additional discussion on the Board’s decision not to adopt the proposed use of auditor’s specialists metric. 215 The Board discussed this comment including the studies referred to below. 216 See J. Owen Brown and Velina K. Popova, How Do Investors Respond to Disclosure of Audit Quality Indicators?, 38 AUDITING: A Journal of Practice & Theory 31, 47 (2019). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 • Investors and audit committees cannot easily observe the services performed by auditors. This restricts (i) audit committees’ ability to more efficiently and effectively monitor and select auditors as well as (ii) investors’ ability to more efficiently and effectively ratify the appointment of the auditor and allocate capital. As a result, there is a risk that auditors will not supply an efficient level of assurance to the market.217 • Furthermore, there are currently insufficient incentives for firms to fully meet the market demand for accurate, standardized, and decision-relevant information.218 There is also a challenge coordinating firms on a system of comparable disclosures. As a result of the lack of incentives and coordination challenges, the Board believes auditors are not supplying the market with additional information even when doing so would be efficient. Indeed, information about audit engagements and firms that would allow (i) audit committees to more efficiently and effectively monitor and select auditors and (ii) investors to more efficiently and effectively ratify the appointment of the auditor and allocate capital, as sought by the market, is often limited or difficult to obtain. The final rules will help address these problems in two primary ways: • First, the final rules will require certain firms to publicly report specified metrics relating to certain audits and their audit practices. Through this disclosure, the final metrics will aid investor and audit committee decisionmaking. • Second, the final rules will impose standardized calculations and require regular public reporting of those metrics. The resulting comparability will further aid investor and audit committee decision-making. Importantly, the Board notes that the final metrics are not intended to be used in isolation to ascertain audit quality at an audit firm or for an audit engagement because audit quality is driven by a complex array of factors beyond those that can be addressed by metrics. The Board believes investors’ and audit committees’ ability to use the metrics is likely to increase over time as users are 217 An efficient allocation of resources occurs when total surplus is maximized. Total surplus is maximized when the good or service in question is supplied until the marginal benefit is equal to the marginal cost. See N. Gregory Mankiw, Principles of Economics 146–148 (6th edition 2008). 218 Given the considerations discussed below, it appears reasonable to assume that this lack of incentive for firms to provide such information is likely to cause the apparent undersupply of information, rather than the cost of providing the information being greater than the social benefit. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 able to aggregate multiple data points, make comparisons, and observe trends. 1. Problem To Be Addressed i. Allocative Inefficiency in the Market for Audit Services The auditor has a responsibility to obtain reasonable assurance about whether the issuer’s financial statements are free of material misstatement. Reliable financial statements help investors evaluate issuers’ performance and monitor management’s stewardship of investor capital. However, because audits possess many of the attributes of a credence good, investors find it challenging to evaluate the quality of the services provided by auditors.219 As a result, the lack of transparency into the audit process could enable auditors to act on their private incentives and under-audit (i.e., deploy insufficient auditor resources) or over-audit (i.e., undertake procedures that do not efficiently contribute to forming an opinion on the financial statements).220 In effect, there is a risk that auditors will not supply an efficient level of service to the market. While the Board acknowledges that audit quality is difficult to observe, the PCAOB is able to obtain insights into audit quality through inspection of firms’ compliance with auditing standards. The results of recent PCAOB inspections indicate that room for improvement exists.221 219 See Daniel Aobdia, Saad Siddiqui, and Andres Vinelli, Heterogeneity in Expertise in a Credence Goods Setting: Evidence from Audit Partners, 26 Review of Accounting Studies 693 (2021) (finding evidence consistent with audits being credence goods). 220 See, e.g., Monika Causholli and W. Robert Knechel, An Examination of the Credence Attributes of an Audit, 26 Accounting Horizons 631, 632, 633 (2012) (discussing how audits have attributes of a credence good, namely the outcome of an audit is unobservable and the auditor is best informed regarding how much effort is necessary to perform the audit). 221 See, e.g., Spotlight Staff Update and Preview of 2022 Inspection Observations (July 2023), available at https://pcaobus.org/resources/staffpublications (discussing the ‘‘concerning trend’’ in ‘‘the percentage of audit engagements reviewed that are expected to be included in Part I.A of an inspection report’’). One commenter said that many audit quality studies reveal that audit quality is improving, deficiencies are narrowly focused, and financial statement restatements are down. The Board notes that the commenter did not provide support for these assertions. By contrast, and as stated here and in the proposal, the PCAOB has pointed to a concerning trend in auditing deficiencies. Indeed, the trend appears to be continuing in the aggregate. See, e.g., Spotlight Staff Update on 2023 Inspection Activities (Aug. 2024), available at https://pcaobus.org/resources/staffpublications. Furthermore, while the incidence of restatements has been decreasing since 2013, there was an uptick in 2022. See, e.g., Center for Audit Quality, Financial Restatement Trends in the United States: 2013–2022, (June 2024). The Board PO 00000 Frm 00061 Fmt 4701 Sfmt 4703 100027 One commenter agreed with the characterization of the audit as a credence good. Several commenters agreed that investors and other stakeholders cannot easily observe services performed by auditors, which limits their ability to make informed decisions about investing capital, ratifying the selection of auditors, and voting for members of the board of directors, including directors who serve on the audit committee. Several commenters said that the audit has become commodified and that firms compete primarily on cost due to a lack of information on audit quality. One commenter said that this results in audit firms ‘‘squeezing’’ professional staff for productivity. The issuer’s board of directors is generally required to establish an audit committee that is statutorily entrusted to appoint, compensate, and oversee the work of the auditor.222 One commenter said that audit committees of accelerated and large accelerated filers are composed entirely of independent directors.223 However, similar to investors—though to a lesser degree— audit committees cannot easily observe the services performed by auditors. Moreover, audit committees may focus on the interests of current shareholders rather than the broader public interest (e.g., market confidence, potential future shareholders, or investors in other issuers). Furthermore, there are risks that the audit committee may not monitor the auditor effectively. For example, the auditor may seek to satisfy the interests of management rather than investors if management is able to exercise influence over the audit committee’s supervision of the auditor.224 One commenter said that notes that the uptick in restatements could increase further because some financial statements that have not yet restated may do so in the future. 222 Companies whose securities are listed on national securities exchanges are generally required to constitute an audit committee. See Section 301 of Sarbanes-Oxley; Section 10A(m)(2) of the Exchange Act. As an additional safeguard, the auditor is also required to be independent of the audit client. See 17 CFR 210.2–01; see also PCAOB Rule 3520, Auditor Independence. 223 Pursuant to Exchange Act Section 10A(m)(1) and Exchange Act Rule 10A–3, the listing rules of national securities exchanges generally require that all members of a listed company’s audit committee be independent. See, e.g., New York Stock Exchange Listing Manual Section 303a.06; Nasdaq Rule 5605(c). Companies that do not have securities listed on an exchange are not subject to such a requirement. 224 See, e.g., Joshua Ronen, Corporate Audits and How to Fix Them, 24 Journal of Economic Perspectives 189 (2010) (explaining that audit committee members are paid by the company and can be dependent on top company management for a variety of benefits, including referrals as a possible member on the board of directors and audit E:\FR\FM\11DEN2.SGM Continued 11DEN2 100028 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices audit committee members are incentivized to ingratiate themselves to management and that this does not serve investors who need to hold the audit committee accountable. Such circumstances can lead to a de facto principal-agent relationship between company management and the auditor. Also, as one panelist said during the September 2024 IAG, there is a wide range of financial expertise among audit committees and audit committee chairs. As a result, investors have an important, albeit indirect, role overseeing the work of both the auditor and the audit committee. Indeed, while the audit committee more directly oversees the auditor, most publicly traded companies allow investors to vote to ratify the appointment of the auditor. This mechanism allows investors to voice their preferences on auditor selection.225 At the September 2024 IAG meeting, one investor said that shareholders have an important role holding both auditors and audit committees to account. By contrast, another IAG member said that investors should not oversee the audit because that is the role of the audit committee and one commenter said that the proposal would challenge the legal structure of corporate governance. However, a lack of transparency into the audit process may leave investors unable to make well-informed decisions when voting on selections made by the audit committee or on re-election of audit committee members to the board of directors.226 Figure 5 illustrates oversight relationships pertinent to the final rules. The dotted line indicates that investors’ oversight relationship with the auditor is less direct than the audit committee’s oversight relationship. Figure 5. Oversight Relationships Pertinent to the Final Rules ..... • ....• Investors committees of other companies); Liesbeth Bruynseels and Eddy Cardinaels, The Audit Committee: Management Watchdog or Personal Friend of the CEO?, 89 The Accounting Review 113 (2014) (finding that companies whose audit committees have ‘‘friendship’’ ties to the CEO purchase fewer audit services and engage more in earnings management); Cory A. Cassell, Linda A. Myers, Roy Schmardebeck, and Jian Zhou, The Monitoring Effectiveness of Co-Opted Audit Committees, 35 Contemporary Accounting Research 1732 (2018) (finding that the likelihood of a financial statement misstatement is higher and that absolute discretionary accruals are larger when audit committee co-option, as measured by the proportion of audit committees who joined the board of directors after the current CEO’s appointment, is higher); and Nathan Berglund, Michelle Draeger, and Mikhail Sterin, Management’s Undue Influence over Audit Committee Members: Evidence from Auditor Reporting and Opinion Shopping, 41 AUDITING: A Journal of Practice & Theory 49 (2022) (finding that greater management influence over audit committee members is associated with a lower propensity of the auditor to issue a modified going concern opinion to a distressed company under audit and with increased opinion shopping behavior). 225 Shareholder ratification of the appointment of the auditor is not statutorily required in the U.S. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 and in many cases the ratification vote is nonbinding. One commenter agreed with this point. The commenter also suggested that it is rare for shareholders to not ratify the audit committee’s selection. However, according to Audit Analytics, accessed on Mar. 1, 2024, in 2023, ratification votes were held by 2,802 distinct companies included in the Russell 3000 index, which comports with other estimates that indicate between 80 and 95 percent of companies hold votes on ratification proposals as part of their proxy voting process. See also ACAP Final Report, at VIII.20 (finding that 95 percent of S&P 500 companies and 70–80 percent of smaller companies put ratification proposals to an annual shareholder vote) and Lauren M. Cunningham, Auditor Ratification: Can’t Get No (Dis)Satisfaction, 31 Accounting Horizons 159, 161 (2017) (finding that more than 90 percent of a sample of Russell 3000 companies voluntarily include a ratification vote on the ballot). The Board notes that broker discretionary voting is permitted on ratification proposals and ratification proposals may be used as a mechanism by some companies to achieve a quorum to conduct an annual meeting as a result of brokers exercising discretionary votes. Although the ratification vote is in many cases non-binding, it can still be impactful as it sends a signal of shareholder views. Academic studies show that non-binding votes in other settings can pressure boards to reconsider its policies and are considered PO 00000 Frm 00062 Fmt 4701 Sfmt 4725 by proxy advisors in setting their recommendation for board members. See, e.g., Yonca Ertimur, Fabrizio Ferri, and Stephen R. Stubben, Board of Directors’ Responsiveness to Shareholders: Evidence from Shareholder Proposals, 16 Journal of Corporate Finance 53 (2010) (finding a ‘‘positive relation between the percentage of votes cast in favor of the [non-binding] proposal and the likelihood of implementation.’’); and Aiyesha Dey, Austin Starkweather, and Joshua White, Proxy Advisory Firms and Corporate Shareholder Engagement, 37 Review of Financial Studies (3877 (2024) (showing that when non-binding Say-On-Pay voting support falls below 70 percent, managers respond by increasing shareholder engagement). The ability to vote on ratification of the appointment of the auditor is recognized by investor groups as an important element of corporate governance. See, e.g., Council of Institutional Investors, Policies on Corporate Governance, (Sept. 11, 2023) at 2.13f available at https://www.cii.org/corp_gov_policies. 226 The IAG indicated in their comment letter regarding proposed QC 1000 that investors need information to make better decisions when voting to ratify the appointment of the auditor and the election to the board of directors of the Chair or members of the audit committee. E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.002</GPH> lotter on DSK11XQN23PROD with NOTICES2 Auditor Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices ii. The Market for Information Related to Auditors and Their Engagements is Inefficient lotter on DSK11XQN23PROD with NOTICES2 Supply-Side Problems Some basic economic theories suggest that high-quality firms should have an incentive to voluntarily disclose information to the extent it allows them to differentiate themselves from lowquality competitors.227 However, economic theory also suggests that there may be countervailing incentives that limit voluntary disclosure in practice. For example, firms may be deterred by the costs they would incur privately, such as how their competitors could leverage the disclosures to capture market share.228 There may also be no mechanism for firms to credibly disclose certain non-verifiable or difficult to verify information, which can lead to the failure of such information markets to exist entirely.229 There could also be a status-quo bias whereby a firm prefers to continue a non-disclosure policy despite investors’ calls for additional information.230 Limited competition for the largest issuers could also reduce the largest firms’ incentives to voluntarily disclose information. Finally, firms may tend to underprovide information due to: (i) the positive externalities 231 conferred by comparable and uniform public disclosures (i.e., firms may not directly benefit from some of the value provided to investors and audit committees); and (ii) the challenges of coordinating on a single comparable and uniform reporting framework.232 227 See, e.g., Kip W. Viscusi, A Note on ‘‘Lemons’’ Markets with Quality Certification, 9 The Bell Journal of Economics 277 (1978). 228 See, e.g., id.; Oliver Board, Competition and Disclosure, 57 The Journal of Industrial Economics 197 (2009) (finding that companies may be reluctant to voluntarily disclose in competitive markets); and Daniel A. Bens, Philip G. Berger, and Steven J. Monahan, Discretionary Disclosure in Financial Reporting: An Examination Comparing Internal Firm Data to Externally Reported Segment Data, 86 The Accounting Review 417 (2011) (finding that companies provide fewer segment disclosures due to proprietary costs or competitive concerns). 229 See Akerlof, The Market for ‘‘Lemons.’’ 230 There are a variety of reasons why individuals may choose the status quo outcome in lieu of an unknown outcome, including aversion to the uncertainty inherent in moving from the status quo to another option. For additional discussion on status quo bias, see William Samuelson and Richard Zeckhauser, Status Quo Bias in Decision Making, 1 Journal of Risk and Uncertainty 7 (1988). 231 See Mankiw, Principles of Economics 196 (‘‘An externality arises when a person engages in an activity that influences the well-being of a bystander but neither pays nor receives any compensation for that effect . . . . If it is beneficial, it is called a positive externality.’’). 232 See, e.g., Anat R. Admati and Paul Pfleiderer, Forcing Firms to Talk: Financial Disclosure Regulation and Externalities, 13 The Review of Financial Studies 479 (2000) (discussing how VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Auditors could in principle supply information to investors and audit committees individually depending on their unique preferences. However, the costs to the firm to do so would grow with the number of interested investors and audit committees and the extent of information they would request. By contrast, under the final rules, the costs to produce the final metrics will not grow with the number of interested users. Demand-Side Problems While investors may seek to acquire information from the issuer, they could incur significant private costs in doing so.233 At the September 2024 IAG meeting, one investor said that her asset management firm is generally denied meetings with audit committee chairs of U.S. issuers. Further, the company may need to publicly disclose information provided on a selective basis.234 Indeed, at the September 2024 IAG meeting, several audit committee chairs said audit committees are reluctant to meet with shareholders individually due to the risk of violating disclosure laws. Hence the potential benefits of the information to an individual investor would be dissipated because all other investors would have the same information and any informational advantage would be lost. This would further reduce individual investors’ incentives to obtain the information. A free-rider problem thus exists among investors in which the costs incurred by one or more investors to convince firms to disclose information would not be shared by all investors who benefit from the disclosure.235 As a result, economic theory suggests there should be an under-provision of such information relevant to investors. As discussed above, audit committees are already privy to certain information about their auditors beyond what is publicly available. In particular, audit committees could request the final metrics from their auditors or other tendering auditors. However, that individual firms ‘‘internalize less than fully the social value of the information they release’’) and George Loewenstein, Cass R. Sunstein, and Russell Golman, Disclosure: Psychology Changes Everything, 6 Annual Review of Economics 391, 397 (2014). 233 See, e.g., Nickolay Gantchev, The Costs of Shareholder Activism: Evidence from a Sequential Decision Model, 107 Journal of Financial Economics 610 (2013). 234 See Regulation Fair Disclosure, 17 CFR 243.100(b)(1)(iv). 235 See Mankiw, Principles of Economics 220 and 222 (‘‘A free rider is a person who receives the benefit of a good but avoids paying for it . . . . A free-rider problem arises when the number of beneficiaries is large and exclusion of any one of them is impossible.’’). PO 00000 Frm 00063 Fmt 4701 Sfmt 4703 100029 information would not necessarily be comparable with other engagements or other firms. Requesting comparable information from multiple auditors could be burdensome or even impracticable. As a result, while the audit committee can use information from their auditor to better understand their current engagements, the audit committee likely has a limited view as to how other engagements—such as those of their peers—might be conducted. Furthermore, less effective audit committees may not be aware of the information and therefore would not request it in the first instance. If audit committees were aware of the information and made such a request, some audit firms may resist providing it to avoid the costs of gathering the information and potential negative reputational effects. Firms could also manipulate the information. As one commenter said, the audit committee’s principal tool is that of inquiry, not observation, and inquiry, in audit parlance, is the weakest form of audit evidence. Evidence Due in part to the problems discussed above, there is currently limited information available to investors specifically related to audit engagements. Indeed, investors know the least about the audit engagement, as they are less involved in the issuer’s operations compared to management, the board of directors, and the audit committee—and are even further removed from the audit process. Over the last decade and a half, there have been sustained requests from investors for increased transparency into the audit process. As discussed above, investorrelated groups have requested increased disclosures at the firm and engagement levels—notably in the form of easily accessible and quantifiable metrics, potentially with accompanying context provided by the auditor. Furthermore, the ACAP Final Report recommended that the PCAOB, in consultation with auditors, investors, public companies, audit committees, boards of directors, academics, and others, ‘‘determine the feasibility of developing key indicators of audit quality and effectiveness and requiring auditing firms to publicly disclose those indicators.’’ 236 There would likely be a significant cost to investors to conduct an exhaustive search of all existing publicly available information related to audit performance. For example, gathering the information could require an investor to process various types of 236 See E:\FR\FM\11DEN2.SGM ACAP Final Report, at VIII:14. 11DEN2 100030 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 data from various sources. Only the largest institutional investors likely have the economies of scale to profitably gather this information.237 Further still, the presence of significant block holdings by diversified, passive investment-style funds, which often do not hold board seats, means that such information may not be provided by audit firms to a significant control group in cases where the fund managers do not hold a board seat.238 Even proxy advisors rely upon relatively limited publicly available information in making voting recommendations, which investors may then rely upon in their own decision-making.239 Due to the lack of information currently available, it may be several financial reporting cycles before audit committees and investors accumulate enough information (e.g., through restatements, CAMs, audit committee communications, other public events bearing on the auditor’s reputation) to be able to effectively judge the auditor’s performance and act accordingly. Compared to investors, audit committees are better able to accumulate information in less time due to their ability to more easily request and receive information from their auditor. As described in the baseline, a small group of auditors voluntarily disclose some firm-level information through firm transparency reports.240 However, many smaller firms do not voluntarily release transparency reports and for those that do provide such information, the metrics are not uniform or comparable across firms.241 One 237 Some research suggests that institutional investors are better-informed than retail investors. See, e.g., Cory A. Cassell, Tyler J. Kleppe, and Jonathan E. Shipman, Retail Shareholders and the Efficacy of Proxy Voting: Evidence from Auditor Ratification, Review of Accounting Studies 75 (2022) and cites therein. 238 See, e.g., Amir Amel-Zadeh, Fiona Kasperk, and Martin C. Schmalz, Mavericks, Universal, and Common Owners—The Largest Shareholders of U.S. Public Firms, SSRN Electronic Journal, (2022). The Board notes that SSRN does not peer review its submissions. 239 See, e.g., Cunningham, Auditor Ratification 163. 240 Audit firm transparency reports are voluntary and unregulated disclosures, as they are not required by PCAOB standards or applicable U.S. law. Consequently, audit firms can disclose metrics of their own choosing and construction. In practice, as discussed in above, audit firms that do publish transparency reports include the disclosure of metrics that are required in reports pursuant to disclosure rules in other jurisdictions, such as in the European Union (i.e., EU—No 537/2014 Article 13), or similarly adopted domestic requirements in the U.K. under the FRC’s authority (i.e., the Companies Act of 2006, and Statutory Auditors and Third Country Auditors Regulations of 2016). 241 Some research suggests that lack of comparability can be a problem even when VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 commenter provided several examples of how firms’ voluntary reporting is not comparable across firms. Furthermore, PCAOB staff found that firms generally do not voluntarily report engagementlevel metrics publicly. Some research on audit firm transparency reporting in foreign jurisdictions suggests that the information is not useful while other research finds that disclosure requirements improve audit quality for impacted firms.242 Some academic studies find that, because the information contained in transparency reports is relatively unregulated, the disclosures and contextual discussion lack uniformity and comparability across or within audit firms.243 Pointedly, audit firms could alter the methodology and construction of any metric they voluntarily choose to disclose. A lack of uniformity means that the voluntary disclosures have limited comparative value, inhibiting their usefulness in allowing investors to evaluate the efficacy of their auditors. Two commenters said that the proposal cited no studies demonstrating that there is a lack of information about auditors and their engagements or evidence that the market is seeking additional information. One commenter said that without sufficient dialogue with investors, audit committees, and firms, it is unclear whether there are information gaps in what is already provided and whether there is any opportunity to expand or enhance what is already done today to meet their expectations. The proposal discussed disclosures are required. See, e.g., Thomas Bourveau, Maliha Chowdhury, Anthony Le, and Ethan Rouen, Human Capital Disclosures, SSRN Electronic Journal (2023) (finding that, after the SEC adopted principles-based human capital disclosure requirements in 2020, the resulting human-capital disclosures lacked comparability). The Board notes that SSRN does not peer review its submissions. 242 See, e.g., FRC, Transparency Reporting: AQR Thematic Review, (Sept. 2019) (finding that surveyed investors and audit committee chairs are either unaware of or perceive limited use in audit firm transparency reporting in the U.K.) Rogier Deumes, Caren Schelleman, Heidi V. Bauwhede, and Ann Vanstraelen, Audit Firm Governance: Do Transparency Reports Reveal Audit Quality?, 31 AUDITING: A Journal of Practice & Theory 193, 194 (2012) (finding that EU audit firm transparency reporting is not associated with proxies for audit quality); and Shireenjit K. Johl, Mohammad Badrul Muttakin, Dessalegn Getie Mihret, Samuel Chung, and Nathan Gioffre, Audit Firm Transparency Disclosures and Audit Quality, 25 International Journal of Auditing 508 (2021) (finding that a requirement for audit firm transparency reporting in Australia led to an improvement in audit quality for the impacted entities). 243 See, e.g., Sakshi Girdhar and Kim Klarskov Jeppesen, Practice Variation in Big-4 Transparency Reports, 31 Accounting, Auditing & Accountability Journal 261 (2018) (finding that ‘‘the content of transparency reports is inconsistent and the transparency reporting practice is not uniform within the Big-4 networks’’). PO 00000 Frm 00064 Fmt 4701 Sfmt 4703 evidence related to the lack of information despite a market demand, including several studies related to the decision-relevance of current voluntary firm transparency reporting.244 The proposal also discussed the demand from various investor groups for additional information related to the quality of firms and their engagements.245 Investor-related groups’ support for the proposal provides additional evidence that there is an information gap and demand for information like the final metrics. Indeed, one commenter said that existing information, including firms’ transparency reports, is insufficient and largely unused by the investment community because it is seen as marketing material rather than substantive, actionable data. According to the commenter, the lack of information leads audit committee members to prefer Big 4 auditors to protect or validate their decisionmaking in an environment where the audit and auditor are credence goods. The Board notes that transparency reports may also be unused because the information lacks standardization. One commenter said that the proposal appeared to acknowledge that there is a lack of market demand for the proposed metrics. To the contrary, as discussed in the proposal and again above, given the considerations of benefits discussed below, the Board believes the lack of incentive for firms to provide such information is likely the cause of the apparent undersupply of information rather than a lack of market demand.246 That is, the Board believes the limited availability of information is more likely due to the supply and demand-side problems discussed above rather than a lack of market demand. By contrast, two commenters agreed that certain aspects of the market create limited incentives to provide sufficient information to users of the financial statements regarding audit quality. One commenter said that some research suggests that investors want more information on the inputs to audit production.247 2. How the Final Rules Address the Need i. Mandatory Disclosure of Metrics The final rules address the need by requiring mandatory public disclosure of metrics relating to auditors and audit 244 See Proposing Release at 132–134. Proposing Release at Section IV.B.1. 246 See Proposing Release at n. 212. 247 See Brant E. Christensen, Steven M. Glover, Thomas C. Omer, and Marjorie K. Shelley, Understanding Audit Quality: Insights from Audit Professionals and Investors, 33 Contemporary Accounting Research 1648 (2016). 245 See E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 engagements. Under the final rules, auditors will have the opportunity to discuss the context of their metrics. The final rules could thus reduce opacity in the audit market and reduce frictions in the information market, thereby enhancing (i) audit committees’ ability to efficiently and effectively monitor and select auditors as well as (ii) investors’ ability to efficiently and effectively make decisions about ratifying the appointment of their auditors and allocating capital. The final metrics will quantify various aspects of firms’ audit practice as a whole and engagements performed. As described above, the collective history of these final metrics will be publicly available. Moreover, as noted above, the final metrics will be subject to requirements designed to ensure their accuracy, including certification by the firm and specific quality control requirements. Investors and audit committees could use the final metrics to better understand how their auditor has conducted their engagement and how that compares to how other engagements were conducted.248 This should improve their decision-making. Some commenters agreed that the information about auditors and their engagements required by the metrics would provide value to the decisionmaking process for stakeholders. For example, the final metrics should help audit committees engage in active discussions with their current auditors regarding the audit process and interview candidate auditors when or if a replacement auditor is desired.249 Audit committee disclosures indicate that some audit committees consider a variety of public and nonpublic information when engaging their auditor.250 The Board believes the information could also inform investors’ auditor appointment ratification decisions. Research finds that investors are more likely to challenge auditor appointments when they have access to information that calls into question the quality or independence of the firm, which suggests that, in some cases, 248 See, e.g., Christensen, et al. Understanding Audit Quality (finding that surveyed investors believe information similar to several of the final metrics [i.e., the sufficiency of engagement team staffing, having well-trained auditors on the engagement team, having auditors on the engagement team with appropriate expertise, and the lack of financial statement restatements] impacts audit quality). 249 See, e.g., AICPA, Hiring a Quality Auditor 9, (2018) (discussing how audit committees should obtain all necessary information from the auditor). 250 See, e.g., CAQ, 2023 Audit Committee Transparency Barometer, 15–18 (2023) (presenting examples of audit committee disclosures that summarize the information the audit committee considered when appointing the auditor). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 investors will use standardized information across firms and over time to make better decisions.251 Referring to academic research, one commenter said that investors do react to audit outcomes, audit behavior, and regulatory-induced disclosures in the audit report. However, the commenter also noted that: (i) the results are nuanced and context-specific; and (ii) mixed for non-professional investors.252 251 See, e.g., Paul Tanyi, Dasaratha Rama, and Kannan Raghunandan, Shareholder Ratification of Auditors after PCAOB Censures, SSRN Electronic Journal (2021) (finding that first-time PCAOB censures of the largest accounting firms are associated with a higher percentage of shareholders not voting to ratify the appointment of the firm after the censure); Suchismita Mishra, K. Raghunandan, and Dasaratha V. Rama, Do Investors’ Perceptions Vary with Types of Nonaudit Fees? Evidence from Auditor Ratification Voting, 24 Auditing: A Journal of Practice and Theory 9 (2005) (finding that the SEC’s requirement for companies to disclose partitioned information about tax and other nonaudit fees paid to a company’s independent audit firm had a positive association with the proportion of votes against ratifying the appointment of the firm in 2003); Paul N. Tanyi, Dasaratha V. Rama, and K. Raghunandan, Auditor Tenure Disclosure and Shareholder Ratification Voting, 35 Accounting Horizons 167 (2021) (finding that in the case of companies with long [short] auditor tenure, the proportion of shareholder votes against ratifying the appointment of the auditor increased [decreased] after PCAOB mandated public disclosure of auditor tenure). The Board notes that research also indicates that retail investors may not necessarily use information regarding an audit firm in their decisions to vote on a proposal to ratify the appointment of the firm. See, e.g., Cassell, et al., Retail Shareholders (finding that, on average, shareholder votes against ratifying the appointment of the firm are not associated with audit failures but are associated with investment performance). However, the same study also suggests that nonretail investors are relatively better informed. One commenter said it would be useful to know whether the PCAOB had found any evidence of shareholders responding to the persistently high rates of Part I.A deficiencies. One study finds some evidence that shareholders vote against auditor ratification when their auditors receive unfavorable PCAOB inspection reports. However, the study finds the relationship only for the subset of companies where corporate governance is weak. See Myungsoo Son, Hakjoon Song, and Youngkyun Park, PCAOB Inspection Reports and Shareholder Ratification of the Auditor, 17 Accounting and the Public Interest 107 (2017). The Board notes that SSRN does not peer review its submissions. 252 See Robert W. Knechel, Gopal V. Krishnan, Mikhail Pevzner, Lori B. Shefchik, and Uma K. Velury, Audit Quality: Insights From the Academic Literature, 32 Auditing: A Journal of Practice & Theory 385, 387–388 (2013); DeFond and Zhang, A Review of Archival Auditing Research; Peter Carey and Roger Simnett, Audit Partner Tenure and Audit Quality, 81 The Accounting Review 653 (2006); Allison K. Beck, Robert M. Fuller, Leah Muriel, and Colin D. Reid, Audit Fees and Investor Perceptions of Audit Characteristics, 25 Behavioral Research in Accounting 71 (2013); W. Brooke Elliott, Jessen L. Hobson, and Brian J. White, Earnings Metrics, Information Processing, and Price Efficiency in Laboratory Markets, 53 Journal of Accounting Research 555 (2015); Christensen, et al., Understanding Audit Quality; Eric T. Rapley, Jesse C. Robertson, and Jason L. Smith, The Effects of Disclosing Critical Audit Matters and Auditor Tenure on Nonprofessional Investors’ Judgments, PO 00000 Frm 00065 Fmt 4701 Sfmt 4703 100031 Furthermore, investor-related groups have indicated that they use the information contained in Form AP. This suggests that they are familiar with Form AP and may be interested in reviewing additional information provided there. However, citing academic research, one commenter noted that the influence of Form AP on investor decision-making is mixed.253 By making the final metrics public and therefore available to all potential beneficiaries, the final rules should help ameliorate the positive externality problem associated with public disclosure.254 Moreover, because these final metrics will be public, the increased reputational risk they bring for auditors may, in turn, create incremental incentives for auditors that will be subject to the final requirements to maintain their reputation, or face a loss of business, thereby increasing accountability.255 Public disclosure also addresses investors’ free-rider problem by eliminating the need for a private actor to force firms to disclose.256 One commenter said there are several mechanisms already in place to hold auditors accountable and questioned whether accountability could be further improved. The Board acknowledges that such mechanisms are in place (e.g., PCAOB inspections). However, the Board believes the final rules will complement existing accountability mechanisms. For example, the final rules may enhance the PCAOB inspections approach.257 Another 40 Journal of Accounting and Public Policy 106847 (2021); and Sarah Judge, Brian M. Goodson, and Chad M. Stefaniak, Audit Firm Tenure Disclosure and Nonprofessional Investors’ Perceptions of Auditor Independence: The Mitigating Effect of Partner Rotation Disclosure, 41 Contemporary Accounting Research 1284 (2024). 253 See Jenna J. Burke, Rani Hoitash, and Udi Hoitash, Audit Partner Identification and Characteristics: Evidence from US Form AP Filings, 38 Auditing: A Journal of Practice & Theory 71 (2019); Lauren M. Cunningham, Chan Li, Sarah E. Stein, and Nicole S. Wright, What’s in a Name? Initial Evidence of US Audit Partner Identification Using Difference-in-Differences Analyses, 94 The Accounting Review 139 (2019); Marcus M. Doxey, James G. Lawson, Thomas J. Lopez, and Quinn T. Swanquist, Do Investors Care Who Did the Audit? Evidence from Form AP, 59 Journal of Accounting Research 1741 (2021); Jeffrey Pittman, Sarah E. Stein, and Delia F. Valentine, The Importance of Audit Partners’ Risk Tolerance to Audit Quality, 40 Contemporary Accounting Research 2512 (2023). 254 See discussion above. 255 Two investor groups generally agreed with this benefit. 256 For additional discussion of the role of mandatory disclosure as a regulatory tool, see, e.g., Admati and Pfleiderer, Forcing Firms to Talk; and John C. Coffee, Jr., Market Failure and the Economic Case for a Mandatory Disclosure System, 70 Virginia Law Review 717 (1984). 257 See below for additional discussion on the benefits to the PCAOB’s inspection program. E:\FR\FM\11DEN2.SGM 11DEN2 100032 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 commenter suggested that the Board consider firm incentives related to legal liability, damage to reputation through restatement and deficiencies, and PCAOB sanctions. The Board acknowledges that these forces create some incentive for firms to keep audit quality above a certain threshold. However, restatements are relatively rare events and PCAOB sanctions are sporadic. Furthermore, PCAOB inspections are constrained by existing PCAOB rules and standards. One commenter said that while enforcement actions and inspection reports provide valuable data, their extended delays often diminish their relevance for key stakeholders. Several commenters said that investors are not making use of existing information that is similar to the proposed metrics, suggesting that they would not make use of the proposed metrics either. As support, two commenters referred to comments made during the November 2, 2022 meeting of the PCAOB SEIAG.258 Citing a survey of institutional investors, another commenter said that most institutional investors are either unfamiliar with or unaware of firms’ current audit quality reports.259 Another commenter questioned whether investors who are not fully utilizing the information contained in inspection reports would also not use the proposed metrics. Citing a market research report, one commenter noted that shareholders play a limited role in practice when ratifying the appointment of the auditor.260 At the September 2024 IAG meeting, one investor said that the average investor is not engaging with the audit process or audit committees. The Board appreciates these statements and research findings and notes that they are consistent with some of the research cited in the proposal and 258 One commenter referred to a discussant on the panel who made the following statement: ‘‘My experience has been that investors don’t read the firm-level [PCAOB inspection] report. A lot of them don’t know they necessarily exist, right.’’ Another commenter did not refer to a specific discussant and referred to the Nov. 2, 2023 meeting of the PCAOB SEIAG. However, the Board believes the commenter intended to refer to the Nov. 2, 2022 PCAOB SEIAG meeting because firm and engagement metrics were not a topic of discussion during the Nov. 2, 2023 meeting. 259 See CAQ 2023 Survey. The survey was comprised in interviews with 38 institutional investors working at companies with a minimum of $500M in assets under management. The participants were portfolio managers or investment analysts at buy side firms or research directors or similar roles at sell side firms. The survey did not describe how the participants were found or the questions that were asked. 260 See Glass Lewis, 2024 Benchmark Policy Guidelines—United States, (2024). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 above.261 However, the Board notes that the CAQ 2023 Survey also finds that almost all surveyed institutional investors assess audit quality by considering the firm’s reputation, years of experience, people, and technological resources. Apart from technological resources, the final metrics will provide investors with related information.262 The surveyed institutional investors also expressed an interest in learning more about auditor communications to audit committees through disclosures. The Board believes audit committee members likely do occasionally request information like the final metrics from their auditor. Indeed, one audit committee chair said at the September 2024 IAG meeting that he requested information on industry specialization from his auditor. A majority of the surveyed institutional investors indicated that metrics related to the lead engagement partner’s background, engagement team tenure, and specialist experience or related information would be useful. The survey also states that engagement-level metrics were of greater interest to the surveyed institutional investors than firm-level metrics because they are specific to a company, objective, and measurable. The final metrics will provide investors with engagement-level metrics. Collectively, the Board believes this information supports the Board’s view that investors, particularly institutional investors, will find the final metrics useful and indeed an improvement in the quality of information over the limited information currently available. One commenter suggested that the PCAOB consider how much information investors will have about auditors compared to the amount of information they will have about issuers. The Board does not believe that such a comparison is relevant to the economic analysis and the commenter did not explain how it would be relevant. The Board acknowledges that, in some cases, the final metrics could provide investors information about certain aspects of audit firms and their engagements that they might not have about issuers. However, the Board notes that, on balance, there is considerably more public disclosure available regarding issuers than audit firms. Many commenters representing firm or industry groups were skeptical that investors could effectively use the information. One commenter said that publication of metrics alone does not 261 See Proposing Release at Section IV.B.2. 262 See below for a discussion of alternative metrics considered related to the use of technical resources. PO 00000 Frm 00066 Fmt 4701 Sfmt 4703 guarantee that investors will use or be aware of them. Two commenters said that the metrics’ relationship to audit quality may not be clear. Several commenters noted that, unlike audit committees, investors would not be able to have a two-way conversation directly with auditors to appreciate the full context of the firm and its audit. One commenter questioned whether investors or audit committees would find the information useful. One commenter noted some of the proposed firm-level metrics (e.g., Partner and Manager Involvement, Workload) would be useful to audit committees but expressed doubt that others (e.g., Use of Auditor’s Specialists, Allocation of Audit Hours, Experience of Audit Personnel) would be useful. However, the commenter believed some of the proposed metrics (e.g., Experience of Audit Personnel, Industry Experience) could be useful at the engagement level. Several commenters suggested that some or all of the proposed metrics would be useless without context. Citing academic research that was also cited in the proposal, one commenter said that retail investors would rely on the proposed metrics only if they were clearly trending over time.263 One commenter expressed concern that investors and audit committees could have trouble utilizing the proposed metrics because there is a lack of benchmarks, and it will be unclear to them how the proposed metrics relate to audit quality. Two commenters said that tracking metrics would become a compliance exercise and therefore would not transmit useful information for stakeholders. One commenter said that there are qualitative benefits of being a part of a GNF that cannot be properly captured or measured through the proposed metrics. While most investors will not have the same context as audit committees, the Board believes that many investors, particularly institutional investors, do have sufficient context to make effective use of the final metrics. Indeed, investors have access to much of the contextual information that some commenters felt was critical, such as the firm’s size, the issuer’s size, network membership, or the issuer’s industry. Many companies have robust shareholder engagement programs, where managers and/or board members communicate directly with shareholders.264 These programs could 263 See Brown and Popova, How do Investors Respond. 264 See, e.g., Ali Kakhbod, Uliana Loginova, Andrey Malenko, and Nadya Malenko, Advising the Management: A Theory of Shareholder E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 raise investors’ awareness of the metrics, provide an opportunity for twoway conversation, and encourage them to vote on corporate governance matters or raise concerns outside of the voting process. Furthermore, even if investors decline to participate in outreach efforts or no shareholder engagement program exists, proxy advisory firms can use the information to inform their voting recommendations on both auditor ratification and audit committee members.265 Thus, the final metrics can still inform shareholder voting.266 Two investor groups agreed with the Board’s view that investors would use the proposed metrics to make better decisions about ratifying the appointment of their audit firm and allocating capital. Several other commenters said that the metrics would be beneficial to investors and other users of the audit report. The Board also notes that auditors will be able to provide investors with context through optional narrative disclosure. Commenters had mixed views on the usefulness of the proposed narrative disclosure. Some commenters believed the narrative disclosure would allow firms to provide context necessary for appropriate understanding and would allow firms to communicate critical context that may be beneficial. However, several commenters believed it would not be sufficient. The Board recognizes that the optional narrative disclosures may not capture all relevant context. In such cases, firms could provide additional voluntary disclosure (e.g., through their transparency or quality reports).267 One commenter suggested the Board had ignored significant work conducted by the CAQ over the past decade regarding AQIs. The commenter referred specifically to three reports published by the CAQ (the ‘‘2014 CAQ Report,’’ ‘‘2016 CAQ Report,’’ and ‘‘2023 CAQ Engagement, 36 Review of Financial Studies 1319 4 (2023) and cites therein (discussing how communication between management and shareholders has become increasingly prevalent). 265 Proxy voting guidelines do not currently appear to reference audit quality, but do refer to poor accounting practices. See, e.g., ISS, United States Proxy Voting Guidelines Benchmark Policy Recommendations, (Jan. 2024), 16 (listing ‘‘poor accounting practices’’ as a factor influencing its voting recommendations on members of the audit committee.) 266 Research shows that proxy advisor recommendations influence shareholder voting outcomes. See, e.g., Nadya Malenko, and Yao Shen, The Role of Proxy Advisory Firms: Evidence from a Regression-Discontinuity Design, 29 Review of Financial Studies 3394 (2016) (finding ‘‘that the recommendations of proxy advisory firms are a major factor affecting shareholder votes.’’). 267 See above for a discussion on the optional narrative disclosure, including commenters’ views and how the final rules address commenters’ views. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Report’’).268 The Board has reviewed each report. The 2014 CAQ Report and 2016 CAQ Report summarize the results of stakeholder outreach and therefore inform the Board’s understanding of the need for standard setting and how the final metrics address the need. The 2023 CAQ Report opines on transparency reporting best practices. Based on outreach to various stakeholders, the 2014 CAQ Report expresses optimism that AQIs can be useful to audit committees and help promote audit quality. For example, the report concludes that communication of engagement-level AQIs can help the audit committee evaluate the actions taken or untaken by their auditor and help maintain or increase audit quality. This is consistent with the benefits related to audit committee monitoring of their auditor discussed below. It also emphasizes the importance of context, which the Board acknowledged in the proposal and discuss below in this subsection. The report suggests a flexible approach to the communication of metrics. The Board acknowledges this suggestion is in tension with the adopted approach that specifies calculations for each metric.269 However, for the reasons discussed in this subsection and highlighted below, the Board believes that the current voluntary or flexible approach would not sufficiently address the need for comparable information. In the 2016 CAQ Report, the CAQ expressed a belief that reliable, quantitative metrics related to the audit can: (i) inform audit committees about matters that may contribute to the quality of an audit and (ii) help audit committees make decisions related to auditor appointment or reappointment as well as the selection of lead engagement partners. Based on the result of a pilot study with audit committees, and in addition to the findings summarized by the commenter, the report found that participants: (i) 268 See Center for Audit Quality, Approaches to Audit Quality Indicators, (Apr. 2014) (‘‘2014 CAQ Report’’); Center for Audit Quality, Audit Quality Indicators: The Journey and Path Ahead, (Jan. 2016) (‘‘2016 CAQ Report’’); and Center for Audit Quality, Audit Quality Disclosure Framework (Update), (June 2023) (‘‘2023 CAQ Report’’). By ‘‘AQI,’’ the 2014 CAQ Report and 2016 CAQ Report are referring to measures that may provide further insight into audit quality, as outlined in a PCAOB briefing paper presented to the PCAOB’s Standing Advisory Group Meeting on May 15–16, 2013. See PCAOB, Discussion—Audit Quality Indicators (May 15–16, 2013), available at https://pcaobus.org/news/ events/documents/05152013_sagmeeting/audit_ quality_indicators.pdf. Most of the final metrics are very similar to an AQI discussed therein. 269 See below for additional discussion on the Board’s decision to standardize the calculation of the metrics. PO 00000 Frm 00067 Fmt 4701 Sfmt 4703 100033 generally supported discussion of AQIs with the engagement team; (ii) felt that key aspects of audit quality cannot be quantified such as professional skepticism; (iii) acknowledge growing interest from investors regarding how audit committees are fulfilling their responsibilities; and (iv) recognized that AQIs can help audit committees oversee the quality of the external audit. The Board’s economic analysis is largely consistent with these views, in particular the Board’s discussion of improved monitoring of both the auditor and the audit committees below. However, participants in the CAQ’s pilot study also: (i) expressed a preference for a flexible approach to AQI communication; (ii) noted that they already have access to the information they need; and (iii) cautioned that public disclosure of engagement-level metrics could lead to unintended consequences such as benchmarking behavior or excessive focus on measurable metrics. The Board acknowledges that there may be some benefits to a more flexible approach to audit committee communications. However, the Board believes a completely flexible approach could result in audit committees having insufficient information or information with limited utility, limit PCAOB oversight, limit comparability of metrics, and exacerbate other unintended effects (e.g., manipulation of the metrics).270 The proposal acknowledged that audit committees can already seek to obtain information like the final metrics from their incumbent auditors and the Board acknowledges this again below. Several commenters agreed that audit committees already have access to information about auditors and their engagements. Finally, the Board notes that the proposal also discussed the potential unintended consequences raised by participants in the pilot study, and the Board discussed them again below. Two factors limit the relevance of the 2014 CAQ Report and 2016 CAQ Report. First, the reports contemplate voluntary communications by auditors to audit committees rather than mandatory public disclosure. Second, the auditing environment has evolved significantly since then. For example, investors and audit committees now have access to Form AP information and CAMs. One commenter suggested that audit committees have access to relevant 270 See below for additional discussions on the Board’s decision to standardize the calculation of the metrics and on the potential for auditors to manipulate their metrics. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100034 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices comparable data by reference to information firms are already currently required to disclose pursuant to PCAOB rules (e.g., Form 2). The proposal acknowledged the availability of this information and the Board acknowledges it again above. However, as described above and discussed further below, the final metrics will make new relevant information available in a way that is much more accessible and comparable than existing information sources. The commenter also said that audit committees can seek relevant data from potential new audit firms. The proposal acknowledged this and the Board discussed this topic again below. Importantly, the Board notes that audit committees may have trouble obtaining comparable information from potential new auditors. One commenter suggested that audit committees would likely prefer to obtain information through conversation with their auditor directly rather than refer to a database of metrics. Under the final rules, audit committees will be free to request the final metrics or any other related information from their auditor directly. One commenter performed a survey of audit committee chairs of large U.S. public companies. The commenter did not indicate the number of participants, how participants were selected, demographic information, or the questions they were asked. The participants said that they already receive or have access to most of the information in the proposal as part of the audit process and any other information would likely not be valuable to them. The Board discussed this limitation along with important caveats in the proposal and discusses it again below. The Board also notes that, at the same time, participants also expressed desire for additional information on artificial intelligence.271 Participants also opined on the extent to which investors would use the information. First, some participants said information like the proposed metrics is rarely requested by or discussed with investors. The Board discussed in the proposal and above the challenges investors face obtaining information through this channel. The Board also discussed above how investors may be less vocal because they do not believe it is possible to obtain useful information in the current environment. The Board also notes that commenters representing a broad array of investors, investment managers, 271 The Board’s decision not to include a metric related to the use of technical resources is explained in Section IV.D.3.iv.d of the proposal and below. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 investor advocates, and other financial reporting experts said that the metrics would be useful. Second, some participants noted that the information would only be available to investors annually and therefore would be stale. The Board acknowledges that investors will have access to the metrics on an annual basis. The Board believes that requiring firms to disclose the metrics on a more continuous basis would require a significantly greater investment in time and resources by the firms. The Board also notes that a broad range of commenters generally agreed that audit committees will find most or all of the information useful, especially engagement-level metrics. One commenter representing a firmrelated group performed a survey of audit committee members by way of its member firms. The same commenter also commissioned a third party to perform an investor survey.272 Each survey provides information related to the need for and potential benefit of the proposed metrics. The Board discussed each survey below. The audit committee members survey involved 242 participants. The participating audit committee members sit on audit committees of a range of companies by size and industry sector. The commenter did not completely describe the basis on which audit committees were invited to participate in the survey. The commenter did provide the survey questions. Fifty-nine percent of participants said the information available to them to fulfill their external auditor oversight responsibilities meets all of their needs. Thirty-six percent said the information meets most of their needs and the remaining 5% said the information meets less than most of their needs. These results suggest that most audit committees believe the current information environment is sufficient. However, the results do not imply that additional information cannot be useful to audit committee members. Indeed, 27% of the surveyed audit committee members seek more information about how their audit engagement is being performed, about the audit firm, or about other audit firms. Furthermore, some participants may have been reluctant to say that the information available to them to fulfill their responsibilities does not meet most or all of their needs because it would imply they are not fulfilling their responsibilities. Other results of the survey are largely consistent with 272 See Letter from Center for Audit Quality (Aug. 1, 2024) available at https://pcaobus.org/about/ rules-rulemaking/rulemaking-dockets/docket-041. PO 00000 Frm 00068 Fmt 4701 Sfmt 4703 information presented in the proposal and above. For example, 78% of participants agreed that there could be unintended consequences and 73% said there would be challenges interpreting the proposed metrics. Eighty-two percent of participants said they had concerns about data specific to their audit being available publicly; however, the specific concerns were not raised and, by contrast, only 40% were concerned that the proposed mandatory reporting could increase director liability. Fifty-nine percent of participants agreed that some standard information about auditors should be considered. Eighty percent of participants said they rarely or never use PCAOB Form AP and 78% said they rarely or never use PCAOB registrations data; rather, the quality of conversation with the auditor is the top way audit committees evaluate the quality and reliability of the audit. Finally, 90% of participants said that PCAOB standards and rules are well-suited or have mostly kept up with change. Use of technology in the audit was more commonly ranked than firm and engagement metrics as an area where the audit committee would like to see the PCAOB modernize its auditing standards. The Board notes that the PCAOB recently adopted amendments to auditing standards related to auditors’ use of technologyassisted analysis and recently proposed a standard related to auditors’ use of substantive analytical procedures.273 The Board also notes that, while informative to the PCAOB generally, such comparisons are less relevant to the economic analysis of the final rules. The investor survey involved 100 participants. Participants were screened to ensure they are professional institutional investors employed at companies that manage at least $500 million in assets and have at least five years of experience and serve at the director level or higher. Besides these requirements, the participating investors cover a variety of job levels, experience levels, and ages, cover both genders, and primarily (80%) focus on both large accelerated filers and accelerated filers. The commenter did not completely describe the basis on which investors were invited to participate in the 273 See Amendments Related to Aspects of Designing and Performing Audit Procedures that Involve Technology-Assisted Analysis of Information in Electronic Form, PCAOB Rel. No. 2024–007 (June 12, 2024); Proposed Auditing Standard—Designing and Performing Substantive Analytical Procedures and Amendments to Other PCAOB Standards, PCAOB Rel. No. 2024–006 (June 12, 2024). The SEC approved the PCAOB’s amendments to auditing standards related to auditors’ use of technology-assisted analysis on Aug. 20, 2024. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices survey. The commenter did provide the survey questions. Eighty-six percent of the participants work for banks or credit unions, 13% for other types of funds, and 1% for family offices. Fifty-three percent of participating investors indicate they trust the audit of public company financial statements completely and 40% trust them a great deal. Furthermore, 57% of participating investors feel the information available to assess the quality of the audit meets all their needs and 35% feel it meets most of their needs. However, the Board believes the respondents may be focusing on whether information currently available permits them to fulfill their fiduciary responsibilities narrowly defined, similar to the audit committee members. First, just 17% of participating investors said they do not want to see any additional information about the audit to evaluate its quality. All others wanted additional information about the auditing process, team specifics, qualifications, and more generally, other information. The final metrics will provide such information. Second, almost all of the proposed metrics were indicated as being extremely helpful by between 30% and 50% of participated investors. The commenter did not indicate whether the survey allowed less favorable responses and, if so, what the participants’ responses were. The commenter noted that there were variances between these percentages and the portion of participating investors who said they would likely seek out the information on the PCAOB website. The commenter interpreted these variances as being consistent with their view that understanding how investors would use the information is necessary. The Board agrees that understanding how investors would use the information is important. Indeed, the Board discussed through the economic analysis how the Board believes investors will use the information. However, the Board believes these variances are difficult to interpret because it is unclear what the practical difference is between finding a metric helpful and being likely to proactively seek it out. Therefore, the variances may be driven by confusion among respondents. Notably, despite broad agreement that engagement-level metrics would be helpful and 83% wanting some additional information about audit quality in the companies they invest in, 83% of surveyed investors somewhat or strongly agreed with the statement that mandated public disclosure of engagement-level performance metrics could lead to unintended consequences VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 and as such should be voluntary. The survey did not indicate what unintended consequences the surveyed investors thought might occur or whether they were aware that the final rules would permit firms to provide an optional narrative disclosure along with each metric.274 Other results of the investor survey are largely consistent with information presented in the proposal and above. For example, investors use a variety of publicly available information to assess audit quality (e.g., audit quality reports, inspection reports, reputation and the auditor’s opinion and ICFR evaluation, PCAOB website). Investors also agree that context would be important for understanding the proposed metrics. The Board notes that the views of participating investors were different from the views of audit committee members in two important ways. First, investors are more optimistic that the proposed metrics would be useful to audit committees. Indeed, 30% of participating investors strongly agree that audit committees lack access to the information they need to make informed decisions about selecting an auditor (39% somewhat agree) and 34% strongly agree that mandatory and standardized firm and engagement metrics are necessary for company management and audit committees to uphold fiduciary responsibilities to shareholders (47% somewhat agree). Second, investors more strongly believe that PCAOB standards and rules are in need of updating. Where 90% of surveyed audit committee members said that PCAOB standards and rules are well-suited or have mostly kept pace with change, just 26% of surveyed investors said PCAOB standards and regulations are well-suited for their intended purpose and 42% believed they had mostly kept up with change. More specifically, where 17% of surveyed audit committee chairs cited firm and engagement areas among the top three areas they would like to see the PCAOB modernize auditing standards, 28% of surveyed investors cited it among their top three areas. A commenter representing an investor-related group pointed to another survey of investors.275 This survey was conducted by the commenter in July 2017. The survey was limited to members of the commenter’s group and targeted 274 See above for a discussion on the limitations of voluntary auditor reporting. 275 See CFA Institute, CFA Institute Member Survey Report: Audit Value, Quality, and Priorities, (July 2017) (‘‘2017 CFA Institute Survey’’), available at https://rpc.cfainstitute.org/en/research/surveys/ audit-value-quality-priorities-survey-report. PO 00000 Frm 00069 Fmt 4701 Sfmt 4703 100035 primarily buy-side portfolio managers and research analysts, sell-side analysts, credit analysts, and corporate financial analysts. There were 284 initial respondents. The commenter did not completely describe the basis on which investors were invited to participate in the survey. The commenter did provide the questions asked. The survey’s finding, as highlighted by the commenter, underscores that (i) the quality of information communicated to investors, including AQIs, is very important to how investors perceive the value of an audit and (ii) developing and monitoring AQIs is a high standardsetting priority for investors.276 According to the commenter, the results of the survey suggest that firm and engagement metrics are a priority for investors, a viewpoint with which the Board agrees and that accords with other investor feedback the Board has received over the course of this project. The Board notes that survey respondents rated information like the final metrics (e.g., restatement of company financials, industry expertise of audit personnel, training and accreditation of audit personnel, tenure of engagement partner, number of audit staff per audit partner, audit firm recruitment and retention practices) between 2.71 and 3.66 in importance (one being ‘‘not important’’ and four being ‘‘very important.’’). While the Board believes the final metrics will help reduce opacity in the audit market and reduce frictions in the information market, the Board notes that the final metrics will not be direct measures of audit quality. Audit quality is an abstract concept, and there is no single comprehensive measure of audit quality. Audit quality is a concept designed to describe the characteristics of, and participants in, audit engagements in which the auditors are more likely to identify and report material misstatements. Or, more broadly, audit quality reflects all of the components of the audit that align with desirable outcomes.277 The desired outcomes of the framework depend (to some extent) upon the stakeholders involved, even if there are certain consistent areas of focus. As a result, the final metrics cannot directly measure audit quality. And they are not intended to do so, as—without additional context—it is unlikely they can be interpreted directly as measurements of audit quality. The final metrics are not 276 Id. at Table 1. The Board notes that the 2017 CFA Institute Survey did not define ‘‘AQI.’’ 277 For a review of various definitions and discussions of the latent attributes of audit quality, see, Knechel, et al., Audit Quality. E:\FR\FM\11DEN2.SGM 11DEN2 100036 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 intended to imply that an increase (decrease) in a particular metric, or a group of metrics, necessarily relates to an increase (decrease) in audit quality. Lastly, the Board does not believe that the final metrics, individually or taken together, could be appropriately used in isolation to ascertain audit quality at an audit firm or for an audit engagement. For example, some of the most important elements of a high-quality audit, such as application of due care and professional skepticism, are not capable of being entirely measured and quantified directly. Two commenters agreed that no single metric can be viewed as having a causal relationship to audit quality. Several other commenters agreed that the correlation between the proposed metrics and audit quality is far from perfect. However, two commenters interpreted this caveat regarding the relationship between the proposed metrics and audit quality to imply that the proposed metrics cannot be decision-relevant to investors and audit committees. The Board does not believe this to be the case. The Board continues to believe that certain aspects of audit quality cannot be measured. However, the Board does not believe this implies that the final metrics will be irrelevant to investors and audit committees. To the contrary, as said by one commenter, the Board believes certain aspects of the audit can be measured. One commenter said that the purpose and use of the metrics are not consistently correlated with stakeholders’ needs because the proposal lacked an explicit definition of audit quality. The Board does not believe a definition of audit quality is necessary for the metrics to be correlated with stakeholders’ needs. Investors’ and audit committees’ information needs are explicitly stated above. The Board believes the arguments made in this subsection, in conjunction with the discussion of benefits below, establish a correlation between the final metrics and stakeholders’ needs. ii. Uniform and Comparable Metrics In addition to mandating disclosure, the final rules will also specify the data sources and calculations for each final metric and require their disclosure in PCAOB forms in an electronic, structured data format. Collecting and reporting information in this manner will likely enhance the usefulness of the information to investors and audit committees by allowing them to more easily access the information and compare firms and engagements. Regular annual reporting should also VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 allow investors and audit committees to form judgments regarding the quality of their auditor sooner (e.g., compared to restatements which may take several years to occur or PCAOB inspection reports which may be released several years after an audit engagement was performed). Commenters’ views on comparability are discussed above. Overall, commenters questioned whether the engagement-level metrics would be comparable due to the importance of company-specific context, which in their view is necessary for understanding the metrics. Two commenters suggested that even firmlevel metrics are not comparable. One commenter said that differences in the centralization or complexity of issuers’ IT infrastructures could be a reason for cross-sectional differences in the engagement-level metrics rather than differences in the audit. One commenter suggested that comparability would improve if the metrics would account for firm size, issuer size, and industry. One commenter suggested that the standardized calculations, rather than facilitate comparability, could reduce it because they would not be appropriate for every firm. Several commenters suggested that the standardized calculations would not be flexible enough to evolve over time as the auditing environment changes. Relatedly, one commenter suggested that the PCAOB revisit in the future the appropriate calculations. One commenter said the proposed metrics would be meaningless without sufficient context. By contrast, one commenter said that investors are aware that the metrics will not be perfectly comparable and that they are trained to analyze this type of information. The Board agrees that context could be important to understanding any individual metrics. As discussed above in this subsection, the Board believes that no set of metrics, individually or collectively, can completely measure audit quality. Accordingly, the Board has provided auditors the opportunity to disclose additional context for each metric. The Board acknowledges that firm size, issuer size, and industry could be important context when interpreting a metric. However, the Board notes that this information about issuers is already available to the public, and the Board believes that stakeholders will be better served by a rule that permits them to consider this information alongside the metrics as they see fit rather than by prescribing how they should be accounted for. The Board also notes that, under the final rules, firms will be free to provide additional information PO 00000 Frm 00070 Fmt 4701 Sfmt 4703 voluntarily to their stakeholders (e.g. through audit quality or firm transparency reporting) that they believe better captures the changing environment. The Board recognizes that the standardized calculations will not explicitly account for all relevant facts and circumstances for each firm. However, notwithstanding the potential importance of context for understanding any individual metric, the comparability of information about firms and their engagements will be improved overall compared to the current largely voluntary state by mandating specific metrics and calculations. The Board discussed a potential postimplementation review (PIR) below. Economic Impacts This section discusses the expected benefits, costs, and potential unintended consequences of the final rules. The magnitudes of the benefits and costs are likely to be affected by the degree to which firms have already voluntarily adopted disclosure practices that are similar to those required under the final rules or produce similar metrics for non-public purposes. As discussed above, as of the 2018 and 2019 inspection years, the U.S. GNFs already track some metrics like those being adopted. Though their practices may have evolved since then, the Board believes they will need to gather additional information or adjust their calculations. The magnitude of the impacts may also vary by stakeholder depending on how useful the metrics are for the decisions they face. Stakeholders who find the final metrics more useful will be more likely to incur the costs and benefits of integrating the final metrics into their decision-making. The Board believes the final rules will have a greater impact on smaller firms which likely have less developed practices in this area. Several commenters suggested that the PCAOB should consider the cumulative effects of the reporting requirements in this rulemaking along with other rules and standards that have recently been proposed or adopted. One commenter reported results of a survey of audit committee member respondents in which 76 percent of 145 respondents indicated concern about the cumulative impact of PCAOB standard-setting and rulemaking on audit quality and 24 percent indicated no concern.278 Consistent with long-standing practice and the PCAOB’s staff guidance on economic analysis, the Board’s economic analysis for each rulemaking 278 The survey is discussed in greater detail above. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices considers the incremental benefit and costs for the specific rule—i.e., the benefits and costs stemming from that rule compared with the baseline.279 There could be implementation activities for certain provisions of other rules and standards that overlap in time with implementation of the final rules, which may impose costs on resource constrained firms affected by multiple rules. This may be particularly true for smaller and mid-sized firms with more limited resources. In determining effective dates and implementation periods, the Board considered the benefits of rules as well as the costs of delayed implementation periods and potential overlapping implementation periods. The Board also considered that in some cases, overlapping implementation periods may have benefits because firms will not need to revise or redo previous process or system changes where rules interact with each other. For example, firms could benefit in this regard by implementing the final rules while also implementing QC 1000 and, if approved by the SEC, the PCAOB’s Firm Reporting rules because all three rulemakings address external reporting. Several investor group commenters stated they believe the benefits of the proposal would exceed the costs. In contrast, other commenters stated they believe the costs of the proposed metrics will not be proportionate to the benefits. One commenter said there was a lack of academic evidence about whether the benefits exceed the costs. One reason that academic evidence related directly to whether the benefits of the proposal exceed the costs is limited is likely that, for the reasons discussed above, the necessary data do not exist. However, the economic analysis incorporates where appropriate academic evidence related to certain impacts of the proposal. Furthermore, as described above, the Board has quantified certain impacts to the extent feasible. One commenter suggested that a more complete economic analysis of the proposal would reveal that the costs exceed the potential benefits. The commenter did not indicate a data source or methodology that would allow for a quantitative analysis of all benefits and costs. The commenter also did not indicate how they know what the results of such an analysis would be. One commenter suggested that the PCAOB expand the proposal to consider 279 See Staff Guidance on Economic Analysis in PCAOB Standard-Setting (Feb. 14, 2024) (‘‘Staff Guidance on Economic Analysis’’), available at https://pcaobus.org/oversight/standards/economicanalysis/05152014_guidance. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 whether the benefits outweigh the costs. Another commenter said that they saw no indication that the Board had addressed whether investors and other stakeholders would place greater weight on the asserted benefits against increased audit fees. The economic analysis separately analyzes benefits and costs, and as stated above, the Board is not able to quantify all relevant benefits and costs due to data limitations. However, the Board notes that one commenter representing an investor-related group said that investors recognize they ultimately bear the cost of creating such information and metrics and are generally willing to pay for information and metrics. 1. Benefits As discussed above, the final metrics could enhance (i) audit committees’ ability to efficiently and effectively monitor and select auditors as well as (ii) investors’ ability to efficiently and effectively make decisions about ratifying the appointment of their auditors and allocating capital. Moreover, there will likely be improvements to the PCAOB’s oversight programs (i.e., selection of firms, engagements, and focus areas for review), as well as to policy research. As an important indirect benefit, the final rules could further spur competition to the benefit of investors. Thus, while the metrics do not represent a comprehensive measure of audit quality, stakeholders may use the metrics in ways that could improve audit quality.280 Several investor-related groups generally agreed with these benefits. One commenter said that reporting of proposed metrics would improve audit quality across the profession. Auditors have a responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatement. If use of the metrics leads to higher audit quality, it could increase the likelihood that the auditor will discover a material misstatement or will qualify its audit opinion when a material misstatement exists and is not corrected by management. 280 While some of the most important elements of high-quality audit, such as the application of due care and professional skepticism, cannot be fully measured or quantified, the final metrics provide proxies for certain aspects of audit quality, such as years of experience, auditor workload, and the percentage of audit hours attributable to senior members of the audit team. These proxies, while not a complete measure of audit quality, offer important information about auditors and the engagements they lead, which stakeholders can use to inform their decisions. PO 00000 Frm 00071 Fmt 4701 Sfmt 4703 100037 The SEC does not consider the requirements for audited or certified financial statements in Rule 2–02(b) of Regulation S–X to be met when the auditor’s report is qualified. 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. Financial statements that are free of material misstatement are of higher quality and more useful to investors.281 An investorrelated group said that investors demand high-quality audits because reliable audited financial statement are critical to investors in making informed decisions. In the following discussion, the Board discussed the direct benefits related to enhancing the information available to investors, audit committees, and other stakeholders and follow up with a discussion of the potential indirect benefits. The Board then reviews the extant literature related to the final metrics and examine how each final metric could contribute to achieving the final rules’ intended benefits. i. Direct Benefits to Investors, Audit Committees, and the PCAOB The direct benefits of the final rules relate to (i) improved investor and audit committee monitoring, (ii) improved 281 The Board notes several caveats. First, some theoretical research finds that changes to auditing standards can have counterintuitive effects on audit quality. For example, some research finds that increased precision in auditing standards can reduce audit quality. See Marleen Willekens and Dan A. Simunic, Precision in Auditing Standards: Effects on Auditor and Director Liability and the Supply and Demand for Audit Services, 37 Accounting and Business Research 217 (2007). Other research finds that setting a higher minimum bar can reduce audit quality. See Pingyang Gao and Gaoqing Zhang, Auditing Standards, Professional Judgment, and Audit Quality, 94 The Accounting Review 201 (2019). The Board acknowledges that these studies examine the impacts of audit performance standards. By contrast, the Board adopted a disclosure standard. This may limit the relevance of these studies to the final rules. The Board is also unaware of empirical evidence that directly tests these theories. Second, the conclusion that financial statements that are free of material misstatement are more useful to investors hinges on the assumption that investors value compliance with the applicable financial reporting framework (e.g., U.S. GAAP). The various market reactions to restatements that have been documented in academic literature suggests that this is the case. Third, the conclusion that improved audit quality would improve financial reporting quality assumes that issuers would not switch to sufficiently lower quality auditors in sufficient number as a result of the final rules. Finally, one commenter said, and the Board agrees, that the proposed metrics cannot be viewed as the only proxy for measuring financial reporting quality. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100038 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices auditor selection, and (iii) improved PCAOB oversight and scholarly auditing research. The Board believes these benefits will arise because the final metrics will significantly augment the information set available to stakeholders and thereby enhance their decisionmaking. Each of the final metrics and how they would enhance decision-making is discussed in detail above. To summarize, the final metrics relate broadly to audit personnel, allocation of audit hours, and audit outcomes. The final metrics related to audit personnel will provide information on the audit team’s involvement and workload (i.e., Partner and Manager Involvement, and Workload), turnover (i.e., Retention of Audit Personnel), experience (i.e., Experience of Audit Personnel), industry specialization (i.e., Industry Experience), and training (i.e., Training Hours for Audit Personnel). The final metrics related to the allocation of audit hours will provide information on the allocation of audit hours prior to the issuer’s year end (i.e., Allocation of Audit Hours). The final metrics related to outcomes will provide information on restatement trends (i.e., Restatement History). These metrics could enhance decision-making by helping stakeholders assess whether auditors are appropriately staffing their engagements, budgeting their time, and achieving desirable outcomes. As the following examples illustrate, stakeholders will likely make these judgments based primarily on their experience and by comparison to similar firms or engagements and in conjunction with other information available to them (e.g., the other metrics, issuer’s unique facts and circumstances, or research).282 These examples are meant as illustrations only; investors and audit committee members may interpret the final metrics differently depending on specific circumstances. • An investor may observe that one issuer’s auditor has more industry experience than a comparable issuer’s auditor. Depending on the magnitude of the difference and other information available to the investor, the investor may take this as a sign regarding the relative reliability of the audit and, consequently, the issuer’s financial statements. This could influence the investor’s voting or capital allocation decisions. • An audit committee member may observe that an engagement’s partners 282 Academic literature on how various proxies for the final metrics relate to various proxies for audit quality is summarized below. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 and managers were more involved than the audit committee member expected based on their experience. While the audit committee member may believe partner and manager involvement is, as a general matter, a sign of good quality control, the audit committee member may, depending on the facts and circumstances, suspect there was a problem that required the partner’s attention. As a result, the audit committee member may request additional information from the auditor. • An investor may observe that the auditor’s retention metric is a low outlier compared to prior years. This may lead the investor to question the auditor’s ability to gather sufficient appropriate audit evidence and, depending on other information available, may inform the investor’s vote on ratification of the auditor or reelection of audit committee members to the board of directors. • An audit committee member may observe that the auditor’s allocation of audit hours prior to the year’s end indicates, based on academic research, an elevated risk of audit deficiency and restatement. As a result, the audit committee member may work with the auditor to find ways to improve the planning of a future audit. The Board notes that the benefits of mandatory disclosure are well-studied and have been measured in other markets such as credit ratings, health care, and financial reporting.283 283 For example, in the context of credit ratings, research has found that the introduction of additional credit ratings information into the market leads relatively higher quality borrowers to obtain lower borrowing costs by 20 basis points. See Tony Tang, Information Asymmetry and Firms’ Credit Market Access: Evidence from Moody’s Credit Rating Format Refinement, 92 Journal of Financial Economics 325 (2009). The Board notes that the relevance of this finding is limited by the fact that the studied disclosure relates to the quantity of information provided by the credit rating agency rather than the quality of service provided by the credit ratings agency. In the context of nursing home care, one study finds that mandatory disclosure of quality indices leads to improvement in two of the five indices. See Dana B. Mukamel, David L. Weimer, William D. Spector, Heather Ladd, and Jacqueline S. Zinn, Publication of Quality Report Cards and Trends in Reported Quality Measures in Nursing Homes, 43 Health Services Research 1244 (2008). For a discussion of potential benefits of mandatory financial reporting quality as well as potential unintended consequences, see Christian Leuz and Peter D. Wysocki, The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research, 54 Journal of Accounting Research 525 (2016) and cites therein. However, some research also finds that mandatory disclosure can have little effect. For example, in the context of HMOs, one study finds that, following the introduction of public disclosure of six quality scores, only one—customer satisfaction— subsequently drove HMO market share and the effect was most pronounced in markets where true quality varied the most. See Leemore Dafny and PO 00000 Frm 00072 Fmt 4701 Sfmt 4703 Likewise, the benefits of comparable information have been observed in financial reporting.284 There are important similarities between the markets for credit ratings, health care, and financial reporting and the audit market. For example, credit ratings services, like audit services, are opaque and operate under an ‘‘issuer-pays’’ business model. Therefore, the impacts of disclosure observed in those markets provide some indication of the potential impacts the final rules could have on the audit market. However, there are also significant differences. For example, the quality of health care services may, in some cases, be more visible than the quality of audit services. These differences limit the relevance of these studies. The disclosures studied in these markets may also not be directly comparable to the final metrics and therefore are less relevant. The Board also notes that the benefits of prior PCAOB disclosure rules vary by rule and analysis.285 Citing academic research, one commenter said studies show that, while the information contained in Form AP may improve the perception of auditors and financial reporting, Form AP is not influencing investors’ decision-making. Referring to research discussed above and in the David Dranove, Do Report Cards Tell Consumers Anything They Don’t Already Know? The Case of Medicare HMOs, 39 The Rand Journal of Economics 790 (2008). 284 See, e.g., Mark L. DeFond, Xuesong Hu, Mingyu Hung, and Siqi Li, The Impact of Mandatory IFRS Adoption on Foreign Mutual Fund Ownership: The Role of Comparability, 51 Journal of Accounting and Economics 240, 241 (2011) (finding that greater financial reporting comparability leads to greater investment); Luigi Zingales, The Future of Securities Regulation, 47 Journal of Accounting Research 395 (2009) (concluding that a more subtle benefit of disclosure regulation is the standardization it entails); and Bingyi Chen, Ahmet C. Kurt, and Irene Gunnan Wang, Accounting Comparability and the Value Relevance of Earnings and Book Value, 31 Journal of Corporate Accounting & Finance 82 (2020) (finding that ‘‘accounting comparability increases the value relevance of earnings, but not book value’’). 285 See, e.g., Michael J. Gurbutt and Wei-Kang Shih, Staff White Paper: Econometric Analysis on the Initial Implementation of CAM Requirements, Public Company Accounting Oversight Board 4 (2020) (discussing how PCAOB staff did not find ‘‘systematic evidence that investors respond to the information contents in CAMs’’ but nevertheless did find that ‘‘some investors are reading CAMs and find the information beneficial.’’); Kose John and Min Liu, Does the Disclosure of an Audit Engagement Partner’s Name Improve the Audit Quality? A Difference-in-difference Analysis, 14 Journal of Risk and Financial Management 1 (2021) (suggesting that there was an increase in audit quality and audits costs as a result of PCAOB Rule 3211); and Cunningham, et al., What’s in a Name? (finding evidence that any immediate impact of PCAOB Rule 3211 on audit quality or audit fees is limited to specific dimensions of audit quality, specific control groups, and/or specific company characteristics). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 proposal, the commenter also said that CAMs are not driving decision-making by investors.286 By contrast, a recent survey finds that institutional investors generally rely on CAMs when making investment decisions and read the CAMs section in the Form10–K.287 Approximately half said that additional information would be even more beneficial. There are important similarities between these disclosure rules and the final rules. For example, CAM reporting and Form AP reporting requirements were significant changes in auditor reporting and the final engagement-level disclosures will be reported on Form AP. Therefore, the results of these studies provide some indication of how the final metrics could impact the audit market. However, there are also significant differences between prior PCAOB disclosure rules and the final rules. For example, the final rules will likely require firms to gather more engagement-level information than CAM and Form AP reporting requirements do. These differences limit the relevance of these studies. One commenter suggested that the benefits of the proposed metrics would be limited by the fact that they are focused on the past and therefore may have limited value predicting future performance. The Board recognizes that the metrics will be computed using historic data and the Board believes this is a natural limit. The Board also disagrees with the premise that historic information, by definition, cannot have value predicting future performance. Historical metrics can inform futureoriented decisions by increasing the reliability of the data investors and audit committees use to form their expectations. One commenter suggested that benefits would only accrue to data aggregators, the plaintiff’s bar, and academics and not to investors. The Board agrees that data aggregators may aggregate and resell the information. However, the Board notes that the existence of such a market would be evidence that there is a market demand 286 See Doxey, et al., Do Investors Care; Candice T. Hux, How Does Disclosure of Component Auditor Use Affect Nonprofessional Investors’ Perceptions and Behavior?, 40 Auditing: A Journal of Practice & Theory 35 (2021); Gurbutt and Shih, Econometric Analysis on the Initial Implementation of CAM Requirements; Jenna J. Burke, Rani Hoitash, Udi Hoitash, and Summer Xiao, The Disclosure and Consequences of US Critical Audit Matters, 98 The Accounting Review 59 (2023). Referring to a U.K. auditor disclosure requirement similar to CAMs, another commenter said that the extent and quality of dialogue between investors and audit committees was not as expected. 287 See Center for Audit Quality, Critical Audit Matters Survey (July 2024). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 for the final metrics. Data aggregators may also allow retail investors to benefit more from the final metrics by making them even more accessible. Similarly, to the extent there is future reliance on the metrics by academics and plaintiffs’ lawyers, it would serve as evidence of their information value and, by extension, their relevance to investors. Pointing to pages 135 and 168 of the proposal, the same commenter stated that the proposal acknowledged that the required metrics are not likely to be decision-useful to retail investors. In fact, the proposal states on page 135 that ‘‘[r]esearch also indicates that retail investors may not necessarily use information regarding an audit firm in their decisions to vote on a proposal to ratify the appointment of the firm.’’ The proposal states at p. 168 that ‘‘[d]ue to economies of scale, the Board believes institutional investors would be more likely to incur these costs than retail investors.’’ To be clear, the Board believes that institutional investors are more likely to use the final metrics than retail investors. One commenter suggested that all the metrics must help retail investors make informed decisions. The Board considered the benefits and costs to all stakeholders, not just retail investors. As such, the Board does not believe that a metric should be excluded on the basis that it may not help retail investors make informed decisions because doing so could deprive other stakeholders of useful information. Subject to this caveat, the Board believes some retail investors will use the metrics, albeit likely less so than institutional investors. Furthermore, as discussed in above, the Board believes more passive retail investors may indirectly benefit from the improved decision-making of more active institutional investors. a. Improved Monitoring The final rules will increase the set of information available to audit committees and investors regarding their auditor. This should improve both investors’ and audit committees’ ability to monitor their auditors.288 For example, an audit committee could engage in more meaningful discussions with their auditor regarding the 288 For a discussion of the same principle, but in the context of issuer financial reporting, see, e.g., Leuz and Wysocki, The Economics of Disclosure and Financial Reporting Regulation (explaining that the disclosure of operating performance and governance arrangements by public companies can lower the cost of monitoring by providing investors with useful benchmarks that help investors evaluate other companies’ managerial efficiency or potential agency conflicts). PO 00000 Frm 00073 Fmt 4701 Sfmt 4703 100039 auditor’s performance.289 In response to improved monitoring, auditors may improve audit efficiency as well as audit outcomes as they become more responsive to investors’ and audit committees’ audit service needs.290 The final rules could also reduce costs related to information gathering that are incurred by investors and audit committees when monitoring their auditor. Some of the cost reductions could reflect reductions in duplicative work to the extent that various investors or audit committees collect the same information. One commenter suggested that the PCAOB should not focus on overauditing or audit inefficiencies. Another commenter was concerned by the suggestion that investors should be expected to ratify auditor selection or make decisions related to capital allocation on the basis of auditor efficiency (e.g., by reviewing auditors’ allocation of time or resources). Consistent with the PCAOB’s staff guidance on economic analysis, the Board considered the most likely impacts. As discussed in the proposal, the Board believes that some reduction in over-auditing or some improvement in auditing efficiency could result from 289 One study reviewed the comment letters to the Concept Release and found that audit firms agreed with the notion that audit committees may benefit from enhanced dialog between the auditor and the audit committee. See Kathleen M. Harris, and L. Tyler Williams, Audit Quality Indicators: Perspectives from Non-Big Four Audit Firms and Small Company Audit Committees, 50 Advances in Accounting 1 (2020). 290 See, e.g., Bengt Holmström, Moral Hazard and Observability, The Bell Journal of Economics 74 (1979) (finding that efficiency improves when contractable information about an agent’s performance is available to the agent’s principal) and Mai Dao, K. Raghunandan, and Dasaratha V. Rama, Shareholder Voting on Auditor Selection, Audit Fees, and Audit Quality, 87 The Accounting Review 168 (2012) (finding evidence that shareholder involvement in firm selection is associated with higher audit fees and improved audit quality). Some research suggests that audit committees with financial expertise are more effective monitors (i.e., financial reporting quality improves). To the extent that providing additional information to audit committees is analogous to increasing their expertise, this suggests that the final rules could lead to more effective audit committee monitoring. See Dina El Mahdy, Jia Hao, and Yu Cong, Audit Committee Financial Expertise and Information Asymmetry, Journal of Financial Reporting and Accounting (2022). In principle, improved monitoring could lead to a reduction in the overall quality of audit services. For example, some issuers may seek lower audit fees at the expense of audit quality. As the final disclosures will be public, the Board believes, in most cases, this would be less likely. See Section below for additional discussion. Some issuers may have very strong financial reporting quality independent of their auditor (e.g., they have a lender with strong oversight). In these cases, the most suitable auditor may not necessarily be the ‘‘highest quality’’ auditor and over-auditing may be more of a concern than under-auditing. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100040 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices the final rules. However, the Board does not believe they will be central benefits and the Board has emphasized other benefits accordingly. Two caveats could limit the extent to which improved investor and audit committee monitoring and reduced monitoring costs will lead to improved audit performance. First, the Board notes that improvements in audit performance will be limited by the fact that audit committees are able to request information like the final metrics from their auditor. Indeed, one survey of audit committee members from smaller public companies, including audit committee members of accelerated filers, reports that most of the survey participants believed there were no ‘‘gaps’’ in the information they were receiving from their audit firms.291 Furthermore, at the September 2024 IAG meeting, one audit committee chair said that he has unfettered access to his auditor, has requested information related to industry expertise from his auditor in the past, and has never been denied access to information requested. As discussed above, one commenter provided a survey suggesting that most audit committees believe the current information environment is sufficient. However, the Board believes that, by making these disclosures mandatory and standardized across firms and engagements, the final rules will increase the accessibility, reliability, and comparability of information about auditors and their engagements. For example, audit committees will be better able to compare their auditors to peers. Moreover, at the September 2024 IAG meeting one audit committee chair described how their auditor can be reluctant to provide information deemed confidential by the auditor. Second, the benefit of improved monitoring of auditors could also vary depending on the abilities of the audit committee. As one IAG member said, audit committee members that do not have a background in accounting may not know what questions to ask their auditor. For example, more proactive audit committees with greater financial or audit expertise may be able to make better use of the final metrics than other audit committees. However, under the final rules, investors considering votes for election to the board of audit committee members could consider whether they expect candidates to be able to effectively use the final metrics when executing their oversight responsibilities. 291 See Harris and Williams, Audit Quality Indicators Table 6. VerDate Sep<11>2014 19:26 Dec 10, 2024 Jkt 265001 In addition to helping investors monitor the auditor’s performance, the final metrics may assist investors in monitoring and evaluating the performance of the audit committee. For example, investors could observe audit committee performance and express any potential concerns through open dialogues with the board of directors or election of board and audit committee members. The audit committee is responsible for overseeing the auditor and the final metrics may assist investors in determining whether the audit committee was effective in this capacity (e.g., whether the audit committee continues to delay replacing the auditor despite the presence of metrics that suggest potential concerns about audit performance).292 This improved monitoring could improve audit committee effectiveness (e.g., more effective monitoring of the auditors, better selection of auditors, etc.) 293 One commenter supported the view that the metrics will help investors hold audit committees accountable. However, another commenter suggested that audit 292 See above for a discussion on how the final metrics could assist decision-making. 293 Some academic research suggests that audit committee effectiveness is associated with audit committee incentives. See, e.g., Jeffrey Cohen, Ganesh Krishnamoorthy, and Arnold M. Wright, The Corporate Governance Mosaic and Financial Reporting Quality, 23 Journal of Accounting Literature 87 (2004) and cites therein. Some research suggests that investors are willing to pay for audit committee effectiveness and hold audit committees accountable for negative audit quality. See, e.g., Ellen Engel, Rachel M. Hayes, and Xue Wang, Audit Committee Compensation and the Demand for Monitoring of the Financial Reporting Process, 49 Journal of Accounting and Economics 136, 138 (2010) (suggesting a willingness by companies to deviate from the historically prevalent one-size-fits-all approach to director pay in response to increased demands on audit committees and differential director expertise) and Suraj Srinivasan, Consequences of Financial Reporting Failure for Outside Directors: Evidence from Accounting Restatements and Audit Committee Members, 43 Journal of Accounting Research 291 (2005) (concluding that audit committee members bear reputational costs for financial reporting failure). Some research suggests that audit committee members without Big 4 audit experience are more likely to favor auditors that are rated as ‘‘attractive.’’ See, e.g., Baugh, Matthew, Nicholas J. Hallman, and Steven J. Kachelmeier, A Matter of Appearances: How Does Auditing Expertise Benefit Audit Committees When Selecting Auditors?, 39 Contemporary Accounting Research 234 (2022). Together, this research suggests that audit committee effectiveness could respond to improved investor monitoring. Other research suggests that audit committee effectiveness is positively associated with proxies for audit quality. See, e.g., Brian Bratten, Monika Causholli, and Valbona Sulcaj, Overseeing the External Audit Function: Evidence from Audit Committees’ Reported Activities, 41 Auditing: A Journal of Practice & Theory 1 (2022) (finding that the strength of audit committee oversight, as implied by audit committee disclosures, is positively associated with proxies for audit quality). PO 00000 Frm 00074 Fmt 4701 Sfmt 4703 committees that currently execute their statutory mandate with an insufficient level of interest and attention will continue to do so despite the availability of the final metrics. Another commenter suggested that metrics were an inappropriate way for investors to oversee audit committees and would override the gatekeeping function of audit committees. The Board acknowledges that the final rules’ impact may vary by audit committee. However, for the reasons discussed above, the Board believes that the final rules will, on average, lead to a valuable improvement in investors’ ability to monitor audit committees and, by extension, audit committee performance. The Board does not believe the final rules will supplant audit committees’ gatekeeper function. Rather, audit committees will continue to play a critical corporate governance function. Indeed, by enabling investors to better monitor and evaluate audit committees, the Board believes the final metrics will enhance the audit committee’s role and reinforce its effectiveness in overseeing auditors. One commenter suggested that interaction between investors and directors is unlikely and directed us to industry research suggesting that engagement between directors of large issuers and their investors is decreasing.294 The Board acknowledges that direct interaction may occur more for institutional investors. However, the Board notes that the survey cited by the commenter notes that the decline between 2022 and 2023 was ‘‘slight’’ overall but larger for the largest companies (75% to 58%). The cited survey also says that ‘‘directors are regularly engaging with shareholders and the vast majority consider those interactions ‘productive.’ ’’ Moreover, as discussed in greater detail above, the Board notes that many public companies have robust investor outreach programs, some of which target retail investors. Academic research on the frequency of shareholder outreach programs shows they are increasing over time.295 Therefore, the Board believes there is no strong evidence supporting the comment that director engagement with shareholders is unlikely to occur. Mandatory disclosure of the final metrics could also improve audit firms’ internal monitoring of their (i) audit 294 See PriceWaterhouseCoopers, 2023 Annual Corporate Directors Survey. 295 See Dey et al., Proxy Advisory Firms and Corporate Shareholder Engagement, Figure 2 (showing a monotonic increase in the proportion of sampled firms reporting shareholder engagement in their proxy statement from 5.5% in 2011 to 36.3% in 2019.) E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices practices and related system of quality control, and (ii) individual engagements. This could improve governance, accountability, and overall quality control within the audit firm. The final metrics may also help auditors identify efficiencies or room for improvement in their audit approach by comparing their final metrics to their competitors. One commenter noted that the proposal recognized that firms may not find the certain metrics useful in monitoring their quality control systems. While the Board continues to believe that the final metrics could improve audit firms’ internal monitoring, the Board acknowledges that some firms, due to their unique facts and circumstances, may find some metrics less useful than others. lotter on DSK11XQN23PROD with NOTICES2 b. Improved Selection The final rules may also enhance auditor selection to the extent that the rules improve the ability of investors and audit committees to compare their current auditor to an alternative auditor.296 When considering an alternative auditor, audit committees may find the auditor’s engagement-level metrics for similar engagements (e.g., an issuer of similar size and/or within the same industry to the audit committee’s issuer) most useful. As discussed above, investors and audit committees could electronically search for firm-level metrics and download engagement-level metrics when constructing rosters of candidate auditors. Moreover, audit committees will benefit to the extent that they are able to engage in more meaningful discussions and interviews with candidate auditors during the selection process—improving the efficiency of auditor-issuer matching.297 For example, the final metrics (e.g., Industry Experience and Workload) could help audit committees select an auditor that has the capacity to perform the audit.298 Requiring mandatory, 296 One recent experimental study finds that participants playing the role of CFO, director, or individual investors strongly prefer auditors that have stronger metrics and are willing to pay more for those auditors. See Dennis Ahn, Radhika Lunawat, and Patricia Wellmeyer, Firm and Engagement Performance Metrics and Auditor Contracting Decisions, SSRN Electronic Journal, at Table 1 and Table 2 (2024). The Board notes that SSRN does not peer review its submissions. 297 See, e.g., Gene M. Grossman and Carl Shapiro, Informative Advertising with Differentiated Products, 51 The Review of Economic Studies 63 (1984) (finding that reduced information frictions (i.e., decreased informational advertising costs) could result in improved matching between sellers and buyers). 298 Some academic research finds that audit committees do select auditors based on observable aspects of the quality of their services. See, e.g., Vivek Mande and Myungsoo Son, Do Financial Restatements Lead to Auditor Changes?, 32 VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 comparable, and uniform disclosure of the final metrics—across engagement teams and audit firms, and over time— should further enhance this benefit by helping audit committees to compare auditors on a common basis.299 The final rules may also improve investors’ decision-making regarding auditor ratification and appointment of board members.300 For instance, investors may decide that a particular final metric is especially important to their views on the auditor’s efficacy and the quality of the financial statements.301 Investors that rely on proxy advisors for these decisions may also benefit from the final disclosures because proxy advisors could use the information in their recommendations. Improved auditor selection could improve audit efficiency as well as audit outcomes as incoming auditors may be better equipped to meet investors’ and audit committees’ audit service needs.302 The final rules could also reduce costs related to information gathering incurred by audit committees when selecting their auditor and by investors when voting to ratify the appointment of the auditor.303 Some of the cost reductions could reflect reductions in duplicative work to the extent that various investors or audit committees collect the same information. Improved investor decision-making regarding voting for members of the board of directors, including directors who serve on the Auditing: A Journal of Practice & Theory 119 (2013). 299 See above for discussion of academic literature related to the benefits of comparability in financial reporting. 300 Some research suggests that more informed shareholders make better audit ratification decisions (e.g., auditor ratification decisions are more closely associated with public signals of audit failure). See, e.g., Cassell, et al., Retail Shareholders and cites therein. 301 Some experimental research suggests that investors are less likely to support auditor ratification if metrics like those discussed in the Concept Release are trending downward. See, e.g., Brown and Popova, How do Investors Respond. 302 In principle, improved auditor selection could lead to a reduction in the overall quality of audit services. For example, some issuers may seek lower audit fees at the expense of audit quality. Due to the fact that the final disclosures will be public, the Board believes, in most cases, this would be less likely. See below for additional discussion. Some issuers may have very strong financial reporting quality independent of their auditor (e.g., they have a lender with strong oversight). In these cases, the most suitable auditor may not necessarily be the ‘‘highest quality.’’ 303 Although investor voting on auditor ratification is non-binding, it could be a meaningful mechanism for expressing views on audit-related issues. If investors are dissatisfied with auditor selection, they can also vote against the re-election of board members, including those who serve on the audit committee, to potentially influence future auditor oversight. PO 00000 Frm 00075 Fmt 4701 Sfmt 4703 100041 audit committee, could improve audit committee performance as incoming board members may be better equipped to meet investors’ expectations regarding auditor oversight. One commenter said that the proposed metrics have the capacity to make investors’ vote on ratification of the auditor and the vote on audit committee members substantially more meaningful. Two caveats could limit the potential benefit of improved auditor selection and the reduction in the associated information gathering costs. First, the Board notes that the impact will be limited by the fact that audit committees could in principle request information like the final metrics from alternative auditors. However, auditors may not be willing to voluntarily provide an audit committee with engagement-level metrics regarding their engagements with other issuers, information that may be particularly useful to audit committees in selecting an auditor. Furthermore, while audit committees can currently request tailored metrics, this approach imposes substantial collective costs and limits comparability across firms. The Board believes that, by making these disclosures mandatory and standardized, the final rules will increase the accessibility, reliability, and comparability of information available and therefore help audit committees. Second, the Board notes that, to the extent that benefits are derived from the ability to readily switch between auditors based on an evaluation of the auditors’ metrics, those benefits could be limited due to stickiness in existing auditor-audited company relationships which creates switching costs. Furthermore, large multinational issuers may, as a practical matter, need a GNF auditor, which limits the pool of available alternatives—which may be in turn further limited by auditor geographic/ industry specialization (e.g., a need for financial services expertise in a particular office/city), or by auditor independence rules (e.g., the existence of an independence-impairing financial or consulting relationship between the issuer and a potential alternative auditor).304 Therefore, the benefit of improved auditor selection could be more limited for the largest issuers. However, the Board believes that the final metrics could also help the audit committees of the largest issuers select 304 See United States Government Accountability Office, Continued Concentration in Audit Market for Large Public Companies Does Not Call for Immediate Action 21 (Jan. 8, 2008). E:\FR\FM\11DEN2.SGM 11DEN2 100042 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices specific engagement partners within the larger audit firms. c. Benefits to the PCAOB’s Inspection and Enforcement Programs and Scholarly Auditing Research lotter on DSK11XQN23PROD with NOTICES2 The final metrics are expected to provide direct benefits to the PCAOB’s internal operating effectiveness. In the PCAOB’s oversight capacity, it engages in inspection and enforcement activities for audits of issuers and, in the course of doing so, it uses data from issuers and audit firms. The final metrics will expand the basis on which selections may be made. For example, the final metrics could improve the selection models used to aid in predicting negative audit outcomes, such as restatements or the potential for audit deficiencies. As discussed above, QC 1000 will help to ensure that the final metrics will be reliable. Greater insight into audit risks could improve the PCAOB’s ability to select potential enforcement matters. Overall, improved PCAOB oversight may give auditors additional incentive to comply with PCAOB professional standards and rules.305 Moreover, the PCAOB actively engages in policy research related to the market for assurance services to further the PCAOB’s mission by informing the standard-setting and rulemaking agendas among other purposes. The additional data provided by the final rules could enhance the PCAOB’s ability to produce impactful research and recirculate that gained knowledge into improved standards and rules. Relatedly, the additional data could also provide valuable information sources for the public, including academic research. Commenters agreed that academics could benefit from the metrics. Improved research quality is an important element of the PCAOB’s standard-setting and rulemaking projects. One commenter said it was unclear how the PCAOB would use the information. As described in the proposal and above, the Board expects that the metrics will at least inform the PCAOB selection of engagements and focus areas for review and future academic research that utilizes the metrics could inform PCAOB rulemaking projects. Several 305 Some academic research suggests that PCAOB oversight is beneficial. For example, one study of audit firms in foreign jurisdictions finds that PCAOB inspections access is positively associated with proxies for audit quality. See Phillip T. Lamoreaux, Does PCAOB inspection Access Improve Audit Quality? An Examination of Foreign Firms Listed in the United States, 61 Journal of Accounting and Economics 313 (2016). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 commenters agreed that the information would be useful to the PCAOB. One commenter suggested that the PCAOB should be able to articulate which of the final metrics provide critical insights for effective monitoring by inspection teams using information obtained through PCAOB inspections. The PCAOB uses information like the final metric in various ways as part of its inspections approach. However, the Board believes the final metrics will on the whole provide additional value because they will be more comparable across firms, engagements, and time and the engagement-level metrics will be available to PCAOB staff at an earlier point in time than engagement-specific information provided pursuant to the review of an engagement. The same commenter said that public disclosure of the proposed metrics would not be necessary for the PCAOB to benefit from them. The Board agrees that some of the benefits to the PCAOB do not derive specifically from the public nature of the reporting. However, the PCAOB expects that it will benefit from academic research that the Board believes will be conducted using the publicly reported final metrics and broader stakeholder engagement. Public availability of the final metrics could also improve the quality of other stakeholder input received by the PCAOB (e.g., public comment or roundtable discussions). One commenter suggested that reliance on the metrics by PCAOB oversight could create a risk of enforcement for minor, unintentional errors in reporting. The commenter said this risk could manifest as a cost to smaller and mid-sized firms. The Board believes the commenter may have misinterpreted the benefit to PCAOB oversight as a suggestion that the PCAOB intends to make reporting of the final metrics an inspection focus area. While PCAOB inspectors may do so in the future, the Board is not suggesting this will benefit PCAOB oversight per se. Rather, the Board are suggesting that the final metrics themselves may help PCAOB inspections staff select firms, engagements, or focus areas for review. However, the Board acknowledges that, by relying on the final metrics, potential deficiencies in how firms are reporting them may become apparent to PCAOB staff. To the extent PCAOB oversight does consider firms’ compliance with the final rules, the Board believes the PCAOB would exercise appropriate discretion. Overall, the benefit to the PCAOB is difficult to quantify, as the social and economic benefits of enhanced regulatory oversight that is more PO 00000 Frm 00076 Fmt 4701 Sfmt 4703 efficient in its allocation of resources are difficult to monetize. The benefits of additional scholarly research are also difficult to quantify because there are a broad set of beneficiaries. ii. Indirect Benefits Linked to Competition Capital Market Effects Assuming that the additional information, context, and perspective on auditors and audit engagements helps investors assess audit performance, it may help investors assess financial reporting quality.306 For example, investors may incorporate the metrics into their portfolio selection decisions.307 One commenter said that the final metrics were necessary for auditors to have their work judged as something other than a commodity (i.e., competition on price alone). Issuers audited by auditors whose metrics capital markets associate with greater financial reporting quality may experience reduced cost of capital or other capital market benefits and investors may reallocate their capital accordingly. Taken in isolation, this would tend to result in a reallocation of capital from issuers with less reliable financial reporting quality to issuers with higher financial reporting quality. These capital market reactions could provide audit committees with a stronger incentive to appoint an auditor whose final metrics capital markets associate with greater financial reporting quality. These effects could lead to changes in audit fees as auditors respond to changing demand for their services. Facing capacity constraints, some audit firms may turn down engagements or recruit additional staff to expand capacity. Auditor Competition Against the backdrop of capital market reactions to the final metrics and as auditors become better able to 306 The IAG indicated in their comment letter regarding proposed QC 1000 that information related to audit quality would provide investors with ‘‘a level of confidence in the financial statements of companies in which they invest. Their level of confidence in the financial statements has a bearing on the prices they will be willing to pay or demand for investments.’’ The comment letters received in response to proposed QC 1000 are available on the Board’s website in Docket 046. See comment No. 4 on the proposed rule from the IAG, available at https://assets.pcaobus.org/pcaobdev/docs/default-source/rulemaking/docket046/4_ iag.pdf?sfvrsn=1941e7c0_4. See above for a discussion on the association between audit quality and financial reporting quality. 307 There is an extensive body of academic literature suggesting that financial markets incorporate information into securities prices. See, e.g., Eugene F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 25 The Journal of Finance 383 (1970). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 monetize their reputations, auditors could have an incentive to compete on the final metrics.308 For example, to win engagements, auditors may seek to manage their final metrics by redeploying staff resources or providing additional training. This competitive dynamic could improve audit quality and, by extension, financial reporting quality.309 Reduced search costs could increase auditor competition.310 In addition to facilitating issuers’ selection of a preferred auditor, the increase in competition could potentially reduce audit fees.311 The Board notes that the benefits linked to competition between audit firms could be reduced for the larger issuer segment of the market because larger issuers have fewer audit firms available to choose from that are able to perform large, complex audits, without violating independence rules and other constraints. However, the final metrics could help promote competition between partners within the larger 308 Improved competition following mandatory disclosure regimes has been observed in other markets. See above for additional discussion. One study finds that non-U.S. auditors inspected by the PCAOB gain market share from competing auditors after PCAOB inspection reports are made public, more so when the PCAOB inspection report has fewer engagement-level deficiencies. See Daniel Aobdia and Nemit Shroff, Regulatory Oversight and Auditor Market Share, 63 Journal of Accounting and Economics 262, (2017). 309 See above for a discussion on the relationship between audit quality and financial reporting quality. 310 Economic theory suggests that a reduction in search costs helps to make markets more competitive. See, e.g., Helmut Bester, Bargaining, Search Costs and Equilibrium Price Distributions, 55 The Review of Economic Studies 201 (1988). There is an extensive literature in industrial organization economics studying the impact of search and advertising costs on competition. For example, Jean Tirole, The Theory of Industrial Organization, MIT Press 294 (1988) studies informative advertising (i.e., costs borne by sellers to inform buyers of the seller’s existence, product quality, and pricing) in a model involving differentiated sellers, and finds that prices fall as information costs fall. See also Grossman and Shapiro, Informative Advertising; and Glenn Ellison and Alexander Wolitzky, A Search Cost Model of Obfuscation, 43 The RAND Journal of Economics 417 (2012). Glenn Ellison and Sarah F. Ellison, Search, Obfuscation, and Price Elasticities on the internet, 77 Econometrica 427 (2009) also show that reductions in search costs increase the pricesensitivity of demand, resulting in decreased prices for near-substitute goods, and that sellers may attempt to engage in obfuscation strategies to reduce competitive pressure. 311 The positive relationship between increased competition and lower audit fees is wellestablished, see, e.g., Wieteke Numan and Marleen Willekens, An Empirical Test of Spatial Competition in the Audit Market, 53 Journal of Accounting and Economics 450 (2012); and Andrew R. Kitto, The Effects of Non-Big 4 Mergers on Audit Efficiency and Audit Market Competition, 77 Journal of Accounting and Economics 101618 (2024). Other potential unintended impacts the proposal may have on competition are discussed below. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 firms.312 One commenter suggested that the ability of the proposed metrics to spark competition between firms is an important condition for rulemaking and one which the proposal abandons because the proposed metrics are divorced from audit quality and excessively burdensome. The Board agrees that the effect on competition is an important impact for the Board to consider, but the Board disagrees with the commenter’s assertions that the proposal abandoned it. To the contrary, the Board’s economic analysis considered all potential impacts of the final rules, competition among them. Indeed, based on the Board’s careful consideration of academic research, public comment, and the Board’s experience, the Board believes the final metrics could enhance competition and the Board’s economic analysis reflects this view. One commenter questioned whether firms’ management of their metrics to win market share would improve audit quality. As discussed in the proposal and below, the Board acknowledges that management of the final metrics may not always lead firms to improve their audit approach. However, economic theory suggests that if management of the metrics is entirely manipulatory, then users of the information will entirely discount it as ‘‘cheap talk.’’ 313 The Board believes this extreme ‘‘cheap talk’’ outcome is unlikely, in part, because the final rules will be subject to PCAOB oversight as well as firms’ QC systems, which are in turn subject to QC 1000.314 iii. Indirect Benefits of Improved Financial Reporting Quality As described above, to the extent the final rules improve audit performance, the final rules will also improve financial reporting quality. More reliable financial information would allow investors to improve the efficiency of their capital allocation decisions (e.g., investors may more accurately identify companies with the strongest prospects for generating future risk-adjusted returns and reallocate their 312 See Ahrum Choi, Sunhwa Choi, and Jaeyoon Yu, Does Internal Competition among Audit Partners Affect Audit Pricing Decisions?, Auditing: A Journal of Practice & Theory 1 (2024) (finding that U.S. audit partners compete for clients with other partners within their office who perform audits in the same industry). 313 See Vincent P. Crawford and Joel Sobel, Strategic Information Transmission, Econometrica: Journal of the Econometric Society 1431 (1982). 314 See below for additional discussion on how PCAOB oversight would mitigate potential manipulation of the final metrics. PO 00000 Frm 00077 Fmt 4701 Sfmt 4703 100043 capital accordingly).315 Investors may also perceive less risk in capital markets generally, leading to an increase in the supply of capital.316 An increase in the supply of capital could increase capital formation while also reducing the cost of capital to companies.317 A reduction in the cost of capital reflects a welfare gain because it implies investors perceive less risk in the capital markets. The Board is unaware of any literature that would provide a basis for quantifying the magnitude of financial reporting quality improvement associated with the final rules. However, academic literature has attempted to quantify the impact of improved financial reporting quality on cost of capital by measuring the association between various quantitative proxies for financial reporting quality and cost of capital after controlling for other potential drivers of cost of capital. Subject to the caveats discussed below, this literature suggests, overall, that even small improvements in financial reporting quality can result in reductions in issuers’ cost of capital of multiple basis points in magnitude. Due to the size of the U.S. capital markets, even a single basis point reduction in the cost of capital implies substantial welfare gains. Some studies examine the relationship between improved 315 See, e.g., Acito, et al., Market-Based Incentives for Optimal Audit Quality. 316 See, e.g., Hanwen Chen, Jeff Zeyun Chen, Gerald J. Lobo, and Yanyan Wang, Effects of Audit Quality on Earnings Management and Cost of Equity Capital: Evidence from China, 28 Contemporary Accounting Research 892 (2011); Richard Lambert, Christian Leuz, and Robert E. Verrecchia, Accounting Information, Disclosure, and the Cost of Capital, 45 Journal of Accounting Research 385 (2007) (concluding that improving the quality of accounting disclosures can influence the cost of capital and under certain conditions can unambiguously lower the cost of capital). 317 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, among others, on 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. In the context of a particular company or portfolio of companies, the weighted average cost of capital is the average of the cost of equity capital and the cost of debt capital, weighted by the market values of the underlying equity and debt securities, respectively. See, e.g., R. A. Brealey, S. C. Myers, and F. Allen, Principles of Corporate Finance, 10th Edition McGraw-Hill 8, 90, and Chapter 7, (2011). For theoretical discussion on the link between financial reporting quality and cost of capital, see, e.g., Richard A. Lambert, Christian Leuz, and Robert E. Verrecchia, Information Asymmetry, Information Precision, and the Cost of Capital, 16 Review of Finance 1, 16–18 (2012); and David Easley and Maureen O’Hara, Information and the Cost of Capital, 59 Journal of Finance 1553, 1571 (2005). E:\FR\FM\11DEN2.SGM 11DEN2 100044 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices financial reporting quality and companies’ cost of equity capital. For example, one study quantified the relationship between earnings transparency and cost of equity capital.318 The study found that, compared to a baseline of no transparency, companies with an average level of earnings transparency had between 1.7 and 3.4 percentage points lower cost of equity capital, depending on the estimation methodology. Using restatements as a proxy for financial reporting quality, another study found that a restatement increases the cost of equity capital by between six and 15 percent in the longer term.319 Assuming a 10 percent cost of capital, this result corresponds to between a 60 and 150 basis point increase in the cost of equity capital. One study found that companies with the highest accruals quality had a 210 basis point lower cost of equity capital compared to companies with the lowest accruals quality.320 Using disclosure quality ratings (determined by an index prepared by analysts) as a proxy for financial reporting quality, another study found that companies with the highest disclosure quality ratings had roughly a 0.7 percentage point lower cost of equity capital compared to companies with the lowest.321 From an international perspective, one study found that companies in countries in the 75th percentile of strength of disclosure rules and associated enforcement had roughly a 200 basis point lower costs of equity capital than countries at the 25th percentile (i.e., countries with weaker disclosure rules and enforcement).322 Another study found that, compared to companies in countries at the 75th percentile of earnings opacity, the cost of equity capital for companies in the 25th percentile (i.e., countries with less lotter on DSK11XQN23PROD with NOTICES2 318 See Mary E. Barth, Yaniv Konchitchki, and Wayne R. Landsman, Cost of Capital and Earnings Transparency, 55 Journal of Accounting and Economics 206, 216–217 (2013). 319 See Paul Hribar and Nicole Thorne Jenkins, The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital, 8 Review of Accounting Studies 337, 337 (2004). 320 See Jennifer Francis, Ryan LaFond, Per Olsson, and Katherine Schipper, The Market Pricing of Accruals Quality, 39 Journal of Accounting and Economics 295, 297 (2005). 321 See Christine A. Botosan and Marlene A. Plumlee, A Re-examination of Disclosure Level and the Expected Cost of Equity Capital, 40 Journal of Accounting Research 21, 22 (2002). 322 See Luzi Hail and Christian Leuz, International Differences in the Cost of Equity Capital: Do Legal Institutions and Securities Regulation Matter?, 44 Journal of Accounting Research 485, 488 (2006). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 opaque earnings) had a 2.8 percentage point lower cost of equity capital.323 While the above studies examine the impact of improved financial reporting quality on companies’ cost of equity capital, several studies examine instead the impact of improved financial reporting quality on companies’ cost of debt capital. For example, one study found that companies with the highest disclosure quality ratings (determined by an index prepared by analysts) have roughly 1.1 percentage points lower cost of debt capital than companies with the lowest disclosure quality ratings.324 Another study found that companies in the highest decile of accruals quality had a 126-basis point lower cost of debt capital than companies in the lowest decile of accruals quality.325 While the Board believes these studies are indicative of the potential impacts improved financial reporting quality may have on capital markets, the Board acknowledges that the studies are subject to certain caveats.326 First, the studies do not indicate the degree to which the disclosure of firm and engagement metrics could impact financial reporting quality in the first instance. Therefore, the magnitudes must be treated as illustrative examples, rather than point estimates, of the potential benefits of the final rules. Second, some of the studies may be subject to some endogeneity bias.327 For example, companies with high financial reporting quality may also be wellmanaged, a form of omitted variable bias. Similarly, companies that voluntarily provide higher quality information may do so because they are in a stronger financial position already, a form of self-selection bias. Due to these potential biases, some of the studies may overestimate the extent to which improved financial reporting quality reduces companies’ cost of capital. Controlling for endogeneity bias is challenging and the results of any one methodology may be sensitive to the 323 See Utpal Bhattacharya, Hazem Daouk, and Michael Welker, The World Price of Earnings Opacity, 78 Journal of Accounting and Economics 641, 643 (2003). 324 See Partha Sengupta, Corporate Disclosure Quality and the Cost of Debt, 73 The Accounting Review 459 (1998). 325 See Francis, et al., The Market Pricing 297. 326 For a more general discussion of challenges identifying causal relationships in financial reporting research, see Leuz and Wysocki, The Economics of Disclosure and Financial Reporting Regulation. 327 Endogeneity occurs when an explanatory variable in a multiple regression model is correlated with unobserved factors that affect the dependent variable. See Jeffrey M. Wooldridge, Introductory Econometrics: A Modern Approach, South-Western Cengage Learning, 4th edition 838 (2008). PO 00000 Frm 00078 Fmt 4701 Sfmt 4703 methodology’s assumptions.328 Indeed, after attempting to statistically control for endogeneity bias, one study found that the association between financial reporting quality and cost of equity capital remains while another found that it disappears.329 Third, while most research tends to find positive associations between financial reporting quality and the cost of capital, some studies have found counterintuitive or unexpected associations. For example, one study found that the timeliness of disclosures is negatively associated with the cost of equity capital.330 The results of another study suggest that the association between improved financial reporting quality and reduced cost of capital may apply only to companies with low analyst following.331 Despite these caveats, the Board believes that the academic literature suggests overall that improved financial reporting quality results in lower costs of capital and, moreover, that even small improvements can reduce the cost of capital by one or more basis points. The studies discussed above found multiple percentage point reductions in cost of capital when companies (or countries) with the weakest financial reporting proxies are compared to the companies (or countries) with the strongest financial reporting proxies. As such, just one hundredth of the improvement in those measures could result in reductions in the cost of capital by multiple basis points. Due to the size of U.S. capital markets, even small reductions in the cost of capital, on the order of multiple basis points, can generate significant welfare gains. For example, using recent data on the size of the U.S. equity and debt capital markets, a single basis point reduction in the weighted average cost of capital 328 See David F. Larcker and Tjomme O. Rusticus, On the Use of Instrumental Variables in Accounting Research, 49 Journal of Accounting and Economics 186, 203 (2010). 329 See, e.g., Christian Leuz and Robert E. Verrecchia, The Economic Consequences of Increased Disclosure, 38 Journal of Accounting Research 91, 121 (2000) (using bid-ask spreads for German companies as a proxy for cost of capital) and David A. Cohen, Does Information Risk Really Matter? An Analysis of the Determinants and Economic Consequences of Financial Reporting Quality, 15 Asia-Pacific Journal of Accounting & Economics 69, 70 (2010). 330 The authors suggest that the result may be attributable to increased stock price volatility arising from excessive focus on short-term profits. See Botosan and Plumlee, A Re-examination 21 and 37. 331 See Christine A. Botosan, Disclosure Level and the Cost of Equity Capital, 72 The Accounting Review 323 (1997). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 would imply at least $99.0 billion in welfare gains.332 One commenter suggested that a review of the academic literature on cost of capital should allow the Board to quantify the impact of the final metrics on cost of capital decisions. The proposal provided a review of academic literature on cost of capital. That review appears here in essentially the same form. As discussed above, the Board believes this literature does provide evidence of the quantitative benefits of improved financial reporting quality generally. However, the Board is unaware of any literature that would provide a basis for quantifying the magnitude of financial reporting quality improvement (and thus the magnitude of cost of capital reduction) associated with the final rules and the commenter did not identify such literature. One commenter said that the proposal assumed that investors have homogenized interests when in fact there will always be a buyer and a seller with conflicting objectives. The Board recognizes that, with respect to secondary trading of issuer securities, buyers and sellers have conflicting objectives. To the extent the final metrics inform traders’ perceptions of the value of issuer securities or otherwise improve financial reporting quality, the final metrics could in the short run benefit one trading counterparty at the expense of the other. However, for the reasons discussed above, the Board believes that more 332 (1 basis point/(8% average cost of capital—1 basis point)) × ($68.1 trillion in equity market capitalization + $11.0 trillion in debt market capitalization) = $99.0 billion. Source: S&P Capital IQ and SIFMA. The debt market capitalization figure reflects U.S. corporate bonds outstanding as of 2024 Q2. It does not include private debt. The Board notes several key assumptions and limitations of the calculation. The calculation assumes that debt and equity capital comprise all forms of capital (i.e., the calculation disregards other potential forms of capital) and that their total value is equal to the sum of all future cash flows discounted by the weighted average cost of capital. It assumes a weighted average cost of capital of 8% based on historic averages for the Russell 3000. See Michael J. Mauboussin and Dan Callahan, Cost of Capital: A Practical Guide to Measuring Opportunity Cost, Morgan Stanely Investment Management Counterpoint Global Insights, Exhibit 16 (2023). The calculation does not account for the potential beneficial impact of changes in the quantity of capital supplied nor does it account for potential general equilibrium effects in other markets. As discussed above, the calculation pertains to weighted average cost of capital reductions only. It does not capture potential increases in total market capitalization arising from improved management or improved capital allocation. The Board acknowledges that some issuers that contribute to the Board’s market capitalization figures are not audited by firms that will be subject to the final requirements and therefore will not be impacted by the final requirements. However, the Board believes they make up a small share of total market capitalization. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 reliable financial reporting quality benefits capital markets overall in the long run. iv. Academic Literature and Comments Related to Specific Final Firm and Engagement Metrics In the following discussion the Board reviews the extant literature related to the final metrics. In doing so, the Board separates the final metrics into three categories: (i) metrics related to audit personnel; (ii) metrics related to the allocation of audit hours; and (iii) metrics related to audit outcomes. The Board notes three important caveats. First, as most of the final metrics are not currently publicly available, academic studies principally rely on information obtained from audit firms directly, surveys, or foreign jurisdictions. Their relevance is thus limited by the fact that the metrics they study are not equivalent to the final metrics and their results may not be directly applicable to the U.S. audit market more generally. Second, while the extant literature may draw conclusions regarding a particular metric’s relationship to publicly available proxies for audit quality, this does not imply that a final metric will provide any new insights to investors and audit committees incremental to the insights already provided by the publicly available proxies for audit quality. Finally, those relationships may be non-linear or difficult to fully evaluate. One commenter said that some studies cited in the proposal feature investors or investor groups who may not be representative of the broader population of investors. The commenter did not refer to any specific study. The Board acknowledges that the samples featured in some of the empirical studies discussed below may not be perfectly representative of the population of stakeholders that will be impacted by the final rules. While this fact limits their relevance, the Board believes their samples are similar enough to the impacted population that their results inform the economic analysis of the final rules. Consistent with the PCAOB’s staff guidance on economic analysis, the Board highlighted key aspects of the studies (e.g., the representativeness of their data sample) that may limit their relevance. Several commenters suggested that the PCAOB should, as a starting point, demonstrate that any final metric has an unambiguous impact on audit quality. One commenter suggested that the PCAOB obtain research suggesting that any behavioral change produced by a final metric should not harm audit PO 00000 Frm 00079 Fmt 4701 Sfmt 4703 100045 quality. The commenter also suggested that the univariate disclosures should provide a complete picture of the engagement and firm. As the commenter acknowledged, the Board performed an extensive literature review, the substance of which the commenter did not dispute. The Board also considered all academic research provided by commenters. While the Board considered the potential effects of the metrics on audit quality and auditor behavior, the Board does not believe that the rigid criteria suggested by commenters are necessary or appropriate. As the Board stated above, and as many commenters affirmed including this commenter, audit quality is complex and requires significant context to fully appreciate. As such, no metric taken in isolation can provide a complete picture of a firm and its engagements and thus have an unambiguous impact on audit quality. Furthermore, research cannot prove that any future behavioral changes would not harm audit quality. However, in selecting each of the final metrics, the Board considered whether the evidence on its relationship to the quality of firms and their engagements, which the Board believes reflects the spirit of the selection approach suggested by the commenter. The same commenter also suggested that the Board consider whether the disclosures would meet the SEC’s goals for required disclosures. The SEC’s goals on required disclosures have traditionally focused on corporate disclosure, although they may include auditor disclosure in certain contexts. The Board has carefully considered whether the required disclosures would help the PCAOB achieve its objectives in furtherance of its statutory mandate. The same commenter also questioned whether many of the academic studies surveyed in the academic literature review supported the proposal because they use statistical methods to identify causal relationship that hold other elements of the audit process fixed. The Board assumes that the commenter intended to contrast this standard statistical approach with the fact that, in practice, investors and audit committees will be comparing firms and engagements where other elements of the audit process are not fixed. The Board agrees that no single academic study that the Board reviewed provides dispositive proof that investors or audit committees will be able to interpret any individual metric in practice without also understanding the full context. Indeed, the Board has acknowledged that no individual metric can measure audit quality and a fuller appreciation of E:\FR\FM\11DEN2.SGM 11DEN2 100046 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices audit quality requires consideration of a broad array of factors, many of which are unquantifiable (e.g., professional skepticism). However, the Board does not believe this implies that the academic studies surveyed provide no support for the final rules. One commenter said that the proposal did not provide sufficient evidence that public disclosure of the proposed metrics would meaningfully impact audit quality. Given that data using the specific final metrics is not currently available, evidence of their effects on audit quality is necessarily limited. Nevertheless, the Board believes the academic literature discussed below and the analysis discussed throughout this section provide evidence that the final metrics, taken as a whole, could have meaningful impacts to audit quality, which the Board believes could lead to significant benefits to investors, audit committees, and other stakeholders. a. Metrics Related to Audit Personnel lotter on DSK11XQN23PROD with NOTICES2 The Partner and Manager Involvement metrics will indicate the hours worked by senior professionals relative to more junior staff across the firm’s large accelerated and accelerated filer engagements and on the specific engagement. Investors and audit committees could use this information to evaluate whether partners and managers are giving their engagement appropriate attention. Although the academic literature related to audit partner and manager involvement is limited, one study using Korean data suggests that audit partner involvement is positively associated with audit quality.333 Another study finds that the offices of U.S. Big 4 audit firms with relatively more CPAs tend to provide higher audit quality.334 While the number of staff with CPAs is not equivalent to the share of senior staff hours reflected in the metric, the finding does suggest that greater involvement of experienced staff is beneficial to audit quality.335 Another study using Chinese data finds that a greater partner to staff ratio is positively associated with audit quality.336 However, using U.S. data, another study finds partner time spent 333 See, e.g., Suyon Kim, Engagement Partners’ Effort, 9 Risks 1 (2021). 334 See, e.g., Albert L. Nagy, Matthew G. Sherwood, and Aleksandra B. Zimmerman, CPAs and Big 4 Office Audit Quality, 42 Journal of Accounting and Public Policy 107018 (2023). 335 Another study using Japanese data finds that the number of CPA holders staffed to an audit engagement is positively associated with audit quality while the number of non-CPA holders is not. See Hossain, et al., The Relationship. 336 See, e.g., Lo, et al., Does Availability of Audit Partners. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 concurrently on other audits is not associated with audit quality.337 The Workload metrics will indicate the average weekly hours worked on a quarterly basis by senior professionals, including time attributable to engagements, administrative duties, and all other matters, both firm-wide and on the core engagement team. Investors and audit committees could use this information to evaluate whether partners and managers are overworked or potentially distracted by other responsibilities. In certain circumstances, higher workloads could indicate that partners and managers are working longer to ensure audit quality is high. While there is no established optimal workload level for audit teams or their staffing components, academic literature suggests that auditors have high workloads, particularly during the busy season.338 Furthermore, several academic studies, primarily using international data, find that high workload levels (e.g., workloads that exceed 60 hours per week), particularly during the busy season, negatively impact audit quality.339 Auditors that work on multiple engagements in different environments and scopes may also experience issues with memoryrelated errors.340 However, the impacts of workload may depend on the auditor’s ability to handle such normal workloads.341 Furthermore, one study finds that audit partner busyness is not related to audit quality under equilibrium market conditions.342 337 See, e.g., Christensen, et al., Team Workloads. e.g., Persellin, et al., Auditor Perceptions Table 2; Dana R. Hermanson, Richard W. Houston, Chad M. Stefaniak, and Anne M. Wilkins, The Work Environment in Large Audit Firms: Current Perceptions, 10 Current Issues in Auditing A38 (2016); and John T. Sweeney and Scott L. Summers, The Effect of the Busy Season Workload on Public Accountants’ Job Burnout, 14 Behavioral Research in Accounting 223 (2002). 339 See, e.g., Christensen, et al., Team Workloads; Jun Chen, Wang Dong, Hongling Han, and Nan Zhou, Does Audit Partner Workload Compression Affect Audit Quality?, 29 European Accounting Review 1021 (2020); Jin Suk Heo, Soo Young Kwon, and Hun-Tong Tan, Auditors’ Responses to Workload Imbalance and the Impact on Audit Quality, 38 Contemporary Accounting Research 338 (2021); Hwang and Hong, Auditors’ Workload; Dennis M. Lopez and Gary F. Peters, The Effect of Workload Compression on Audit Quality, 31 Auditing: A Journal of Practice & Theory 139 (2012); Persellin, et al., Auditor Perceptions; and Ferdinand A. Gul, Shuai Mark Ma, and Karen Lai, Busy Auditors, Partner-Client Tenure, and Audit Quality: Evidence from an Emerging Market, 16 Journal of International Accounting Research 83 (2017). 340 See, e.g., Sudip Bhattacharjee, Mario J. Maletta, and Kimberly K. Moreno, The Cascading of Contrast Effects on Auditors’ Judgments in Multiple Client Audit Environments, 82 The Accounting Review 1097 (2007). 341 See Persellin, et al., Auditor Perceptions. 342 See Goodwin and Wu, What is the Relationship. 338 See, PO 00000 Frm 00080 Fmt 4701 Sfmt 4703 The Retention of Audit Personnel metrics will indicate the continuity of senior professionals (through departures, reassignments, etc.) across the firm. Discontinuity of senior professionals at the firm could be a signal of dysfunction within the firm and a loss of valuable issuer and firmspecific human capital. Some research suggests that excessive levels of turnover, particularly at the staff level, could lead to a deterioration in audit quality.343 One study finds that auditor turnover at U.S. Big 4 firms has a significant negative effect on audit quality as measured by the prevalence of restatements.344 Using Belgian data collected from private and public companies, another study finds that abnormal turnover is more likely to affect audit quality than expected (i.e., normal or average) levels of turnover, and the negative consequences of turnover impact existing clients more than new clients.345 Firms with larger internal labor pools may be better positioned to mitigate the negative consequences of turnover. For example, using data from Chinese audit firms on auditor departure from public accounting, one study finds that the negative effect of departure on audit quality is stronger for non-Big 4 firms.346 The Experience of Audit Personnel metrics will indicate the average number of years worked at a public accounting firm (whether or not PCAOB-registered) by senior professionals across the firm and on the engagement. Greater experience of audit personnel metrics may indicate to investors and audit committee members that senior professionals are more effective and efficient auditors. The extant academic literature shows mixed results regarding the association between auditor experience and audit quality. One study of U.S. audit partners finds that absolute discretionary accruals, a proxy for audit quality, is increasing (decreasing) in the number of years the partner has been a CPA 343 See, e.g., Khavis and Szerwo, Audit-Employee Turnover, Audit Quality, and the Auditor-Client Relationship 27; and Christensen, et al., Team Workloads. 344 See Tao Ma, Chi Wan, Yakun Wang, and Yuping Zhao, Individual Auditor Turnover and Audit Quality—Large Sample Evidence from US Audit Offices, 99 The Accounting Review 297 (2024). 345 See, e.g., Linden, et al., Audit Firm Employee Turnover and Audit Quality 4. 346 See, e.g., W. Robert Knechel, Juan Mao, Baolei Qi, and Zili Zhuang, Is There a Brain Drain in Auditing? The Determinants and Consequences of Auditors Leaving Public Accounting, 38 Contemporary Accounting Research 2461 (2021). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 licensee early (late) in their career.347 One experimental study from the United States found that less-experienced auditors may be less willing to request additional evidence from company controllers.348 However, another U.S. study finds that audit partner experience is not associated with audit quality.349 Using data from Taiwan, one study finds that an auditor’s experience is positively associated with proxies for audit quality.350 One study on Chinese audit firms finds that the number of years that the partner has been engaged in audit work is negatively associated with absolute discretionary accruals, a proxy for audit quality.351 However, another study using data from Chinese audit firms finds that the an auditor’s birth year, a proxy for total experience, is not associated with several proxies for audit quality.352 The Industry Experience metrics will indicate the average years of career experience of senior professionals in key industries audited by the firm at the firm level and the audited company’s primary industry at the engagement level. The academic literature shows that industry experience, primarily using market share proxies, are related to audit quality.353 One study of U.S. 347 See Chenyong Liu and Chunhao Xu, The Effect of Audit Engagement Partner Professional Experience on Audit Quality and Audit Fees: Early Evidence from Form AP Disclosure, 29 Asian Review of Accounting 128 (2021). 348 See, e.g., Bennett and Hatfield, The Effect of the Social Mismatch 46–47. 349 See, e.g., Hye Seung Lee, Albert L. Nagy, and Aleksandra B. Zimmerman, Audit Partner Assignments and Audit Quality in the United States, 94 The Accounting Review 297 (2019). 350 See, e.g., Chi, et al., The Effects of Audit Partner 363. 351 See Steven F. Cahan and Jerry Sun, The Effect of Audit Experience on Audit Fees and Audit Quality, 30 Journal of Accounting, Auditing & Finance 78 (2015). 352 See, e.g., Ferdinand A. Gul, Donghui Wu, and Zhifeng Yang, Do Individual Auditors Affect Audit Quality? Evidence from Archival Data, 88 The Accounting Review 1993, Table 6 (2013). 353 See, e.g., Craswell, et al., Auditor Brand Name (finding, using a sample of Australian firms, that industries that require greater specialization are associated with greater audit fees, consistent with ‘‘demand for audit quality’’); Mark L. DeFond, Jere R. Francis, and T. J. Wong, Auditor Industry Specialization and Market Segmentation: Evidence from Hong Kong, 19 AUDITING: A Journal of Practice & Theory 49 (2000) (finding, using a sample of publicly listed Hong Kong companies, that industry specialization, as proxied by being among the top three firms in an industry by market share, is associated with greater audit fees among Big 6 auditors but lower audit fees among non-Big 6 auditors); Balsam, et al., Auditor Industry Specialization and Earnings Quality 95 (finding audit quality proxies are positively associated with the auditor being the largest auditor in an industry); Gopal V. Krishnan, Does Big 6 Auditor Industry Expertise Constrain Earnings Management?, 17 Accounting Horizons 1, 3 (2003) (finding that a firm’s audit fee share within an industry is associated with higher audit quality [lower absolute VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Big 4 firms finds that audit quality is positively associated with the number of years that the auditor is an industry specialist (i.e., it has the largest market share in an industry and at least 10% more market share than the next-largest competitor).354 One experimental study finds that auditor participants that have experience in an industry are more likely to understand the specific financial reporting requirements and risks that issuers in those industries face.355 However, some research suggests that the impact of industry specialization on audit quality may depend on other contextual factors (e.g., whether the auditor is local to the client or the difficulty of the audit).356 The Board also notes that some studies indicate that research on experience and industry specialization may be sensitive to design, proxy, and stratification level (i.e., office-level and national-level). However, as one of the studies notes, the Board believes these findings do not imply that industry expertise is unrelated to audit quality.357 The Training Hours for Audit Personnel metrics would indicate average annual training hours for partners, managers, and staff of the firm, combined, both firm-wide and on the core engagement team. Overall, the academic literature provides mixed evidence regarding how auditor training relates to audit quality, but provides some evidence to support the association between specialized training and audit quality. Some studies find that certain proxies for auditor training are positively associated with some proxies for audit quality. For example, discretionary accruals]); and Knechel, et al., Does Auditor Industry Specialization Matter? (finding that issuers that switch to auditors that have at least a 30% market share in the issuer’s industry experience significant positive anormal returns). 354 See Jennifer J. Gaver and Steven Utke, Audit Quality and Specialist Tenure, 94 The Accounting Review 113 (2019). 355 See, e.g., Low, The Effects of Industry Specialization 202. 356 See, e.g., Jere R. Francis, Kenneth Reichelt, and Dechun Wang, The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market, 80 The Accounting Review 113, 114 (2005) and Aobdia et al., Heterogeneity in Expertise in a Credence Goods Setting. 357 See, e.g., Terry L. Neal and Richard R. Riley, Auditor Industry Specialist Research Design, 23 AUDITING: A Journal of Practice & Theory 169 (2004); Steven F. Cahan, Debra C. Jeter, and Vic Naiker, Are All Industry Specialist Auditors the Same?, 30 AUDITING: A Journal of Practice & Theory 191 (2011); and Miguel Minutti-Meza, Does Auditor Industry Specialization Improve Audit Quality?, 51 Journal of Accounting Research 779, 813 (2013) (finding that ‘‘auditor industry specialization, measured using the auditor’s withinindustry market share, is not a reliable indicator of audit quality’’ and that ‘‘these findings do not imply that industry knowledge is not important for auditors’’). PO 00000 Frm 00081 Fmt 4701 Sfmt 4703 100047 one survey of junior auditors at large U.S. public accounting firms found that the perceived effectiveness of training was associated with lower turnover intentions.358 A study on Norwegian audit partners found that CPE hours were positively associated with audit effort and going concern opinion accuracy.359 A survey of auditors working in small audit firms in Sweden found that participation in four or more training activities or 50 or more hours of education per year were negatively associated with self-reported ‘‘dysfunctional’’ behaviors.360 However, other studies suggest that the benefits of training are driven primarily by specialized training. For example, one study on the Spanish audit market found that only partners’ specialized, or non-generic audit knowledge (as proxied by industry-specific experience), was significantly positively associated with audit quality.361 An older experimental study found that specialized indirect experience (i.e., training), resulted in a stronger understanding for the auditor, but had a greater impact of knowledge unrelated to financial statement errors.362 Another experimental study found that specialized training and experience were more strongly associated with improved audit outcomes than general knowledge.363 358 See Hossein Nouri and Robert J. Parker, Career Growth Opportunities and Employee Turnover Intentions in Public Accounting Firms, 45 The British Accounting Review 138 (2013). 359 See Limei Che, John Christian Langli, and Tobias Svanström, Education, Experience, and Audit Effort, 37 Auditing: A Journal of Practice & Theory 91 (2018). The study judged the accuracy of the auditor’s going concern evaluation by reference to subsequent bankruptcy of the audited company. Note that there are several limitations to this proxy. See Marshall A. Geiger, Anna Gold, and Phillip Wallage, Auditor Going Concern Reporting: A Review of Global Research and Future Research Opportunities (2021). 360 See Tobias Svanström, Time Pressure, Training Activities and Dysfunctional Auditor Behaviour: Evidence from Small Audit Firms, 20 International Journal of Auditing 42 (2016). The study defines ‘‘dysfunctional behaviors’’ as: (1) making superficial reviews of client documents; (2) incorrectly signing off on an audit step; (3) prematurely signing-off on an audit step; (4) accepting weak client explanations; or (5) putting a greater level of trust in the audit client than is reasonable. 361 See Josep Garcı́a-Blandon, Josep Marı́a Argilés-Bosch, and Diego Ravenda, Learning by Doing? Partners Audit Experience and the Quality of Audit Services, 23 Revista de Contabilidad (Spanish Accounting Review) 197 (2020). 362 See Ira Solomon, Michael D. Shields, O. Ray Whittington, What Do Industry-Specialist Auditors Know?, 37 Journal of Accounting Research 191 (1999). 363 See Sarah E. Bonner and Barry L. Lewis, Determinants of Auditor Expertise, 28 Studies on Judgment Issues in Accounting and Auditing 1 (1990) 16. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100048 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices By requiring auditors to disclose these personnel related metrics, investors and audit committees could, for example, identify auditors with sustainable workloads, with the implicit outcome that sustainable workloads could improve auditor attentiveness and reduce error rates. Additionally, investors and audit committees may find the final metrics to be useful in evaluating the risk that the auditor has overlooked errors or material misstatements due to overworked partners or managers or that the engagement team was not sufficiently qualified or specialized. Moreover, investors may find the final metrics beneficial in understanding whether the engagement, and therefore the issuer, had significant risks or the issuer’s operations were particularly complex compared to peer issuers. For example, if there was a significantly higher workload across partners, managers, and staff—or excessive turnover—compared to another investment opportunity of similar issuer size, the investor may then infer that the issuer had unique risks that necessitated increased audit effort. Such a signal may be particularly useful if the investor could ascertain whether peer issuers were more, or less, complex compared to the issuer under consideration. The investor may also be reasonably assured if there were positive audit outcomes as it may signal to the investor that the auditor exerted considerable or appropriate effort in obtaining a reasonable level of assurance on the issuer’s financial statements in the context of their peers for that issuer’s complexity and risk level. Audit committees may also find these final metrics to be beneficial, as the audit committee may view them as confirming that the auditor is appropriately staffing the engagement. In addition, during the selection process for a new auditor, the audit committee may review the final metrics of potential candidate auditors in the context of peer-group engagements, thereby using the final metrics to make auditor selection decisions more effectively. By selecting an auditor based on their experience or industry-specific knowledge, audit committees could be better able to choose the preferred candidate auditor for their engagement—thereby improving the matching efficiency of human capital within and across firms by helping to align the demand for resources with the supply. Audit firms may find the final metrics beneficial as they may be better able to monitor whether they are unintentionally over- or under-auditing, VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 as they will be able to compare their audit personnel metrics to other firms’ metrics. Audit firms may also benefit from identifying lead industry-specialist auditors and improve their own audit services to compete with these industry specialists on the quality of those services. Importantly, incumbent auditors (i.e., current auditors of an issuer) know more about the issuer’s operations than rival competitor auditors.364 The disclosure of the final metrics could provide these competitor auditors with the ability to observe signals regarding the effort and experience required on the engagement, and those auditors may be able to use that information to compete against the incumbent auditor for the issuer’s prospective engagement more effectively.365 The final metrics related to audit personnel and commenters’ views are discussed and summarized above. Here the Board highlighted the comments that are most relevant to the economic analysis. Citing academic research, one commenter said that human capital inputs to audit production are crucial to audit quality.366 The same comment letter referred to a working paper written by the letter’s authors which finds the manager-to-employee ratio at the audit office level is positively associated with audit quality.367 The commenter cited two academic studies that suggest audit offices are core functional units.368 Several commenters expressed concern that the benefits to reporting partner and manager involvement may be dampened by the fact that greater partner and manager involvement is not necessarily correlated with greater audit quality. Some of these commenters pointed out that partner and manager involvement is likely to vary with the complexity of the audit. For example, one commenter suggested that a less complex audit may require little additional supervision 364 See, e.g., Monika Causholli, W. Robert Knechel, and Haijin Lin, and David E. M. Sappington, Competitive Procurement of Auditing Services with Limited Information, 22 European Accounting Review 573, 576–578 (2013). 365 Id. 366 See Jeffrey L. Hoopes, Kenneth J. Merkley, Joseph Pacelli, and Joseph H. Schroeder, Audit Personnel Salaries and Audit Quality, 23 Review of Accounting Studies 1096 (2018); Brandon Gipper, Luzi Hail, and Christian Leuz, On the Economics of Mandatory Audit Partner Rotation and Tenure: Evidence from PCAOB Data, 96 The Accounting Review 303 (2021); Christensen, et al., Team Workloads. 367 See Joshua Khavis et al., Manager Staffing Leverage. 368 See Kenneth L. Bills, Quinn T. Swanquist, and Robert L. Whited, Growing Pains: Audit Quality and Office Growth, 33 Contemporary Accounting Research 288 (2016); Christensen, et al., Team Workloads. PO 00000 Frm 00082 Fmt 4701 Sfmt 4703 while a more complicated audit may require more supervision. One commenter said that the firm-level workload metric would not be comparable across firms due to variation in the size of each firm’s issuer practice. Another commenter suggested that presenting firm-level average experience will be difficult to interpret because the distribution of personnel experience varies vastly. Several commenters agreed that defining a training metric that would provide decision-useful information would be challenging. One commenter said they think training increases technical competence. Another said that training builds awareness and on-the-job training is invaluable. However, the same commenter said that on-the-job-training could not be quantified. Another commenter supported a training metric but preferred an alternative calculation. The Board acknowledges that the final metrics are imperfect proxies for audit quality.369 For example, the Board recognizes that average experience only partially describes the distribution of experience within a firm and, by extension, two firms with the same average experience could have quite different experience distributions. However, the Board believes that the final metrics will, on average, improve investors’ decision-making.370 The Board agrees that the partner and manager involvement metric may vary with the complexity of the audit. The Board also agrees that the firm-level workload metric may vary by the size of the firm’s issuer practice. However, the size of the firm’s issuer practice and other proxies for the complexity of the audit are public information so stakeholders can adjust for any systematic variation in the partner and manager involvement and workload metrics. The Board also agrees that stakeholders may misinterpret the experience of audit personnel or training metrics. While some misunderstanding may reduce the usefulness of the final metrics, the Board believes that reporting the experience of audit personnel and training metrics will likely still be beneficial to investors.371 369 See above for a more general discussion of commenters’ concerns regarding comparability of the final metrics. 370 See above for a more general discussion of commenters’ concerns regarding the relationship between the proposed metrics and audit quality. 371 See below for a more general discussion of commenters’ concerns regarding potential misinterpretation by investors, audit committees, and auditors. E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 b. Metrics Related to the Allocation of Audit Hours The Allocation of Audit Hours metric would indicate the percentage of hours incurred prior to and following an issuer’s year end across the firm’s large accelerated and accelerated filer engagements and on the specific engagement. This metric may provide insight into whether the audit team is being efficiently and effectively deployed. Generally, the academic literature related to the allocation of audit hours is limited, as information pertinent to studying this topic is nonpublic. However, one recent study used PCAOB inspections data and found that audit engagements in which relatively more audit effort was spent prior to the issuer’s fiscal year end had overall improvements in audit effectiveness and a lower likelihood of negative audit outcomes.372 As noted in that study, other researchers have identified that work conducted earlier in the audit process may lead to an earlier identification of issues that could improve the possibility those issues would then be corrected.373 Another study, using data from one global accounting firm, also finds that a greater proportion of audit work performed earlier in the audit is associated with improved audit outcomes.374 The final Allocation of Audit Hours metric could allow investors and audit committees to better evaluate how their auditor plans its audit and compare their audit and auditor to peers. For example, it could indicate that their auditor has left substantial issues to the end of the engagement. The effective deployment of resources is of critical importance to a well-planned audit.375 The final metric may also help auditors understand whether they are effectively planning their audit. Auditors may compare their allocations of audit hours to those of other firms and adjust accordingly. The final Allocation of Audits Hours metric could also provide supplemental value to the final Workload and Partner and Manager Involvement metrics. The final metrics related to allocation of audit hours and summarizes commenters’ views are discussed above. Here the Board highlighted the comments that are most relevant to the economic analysis. Several commenters 372 See, e.g., Aobdia, et al., The Economics of Audit Production 1, 6 and 11. 373 See id. at 12. 374 See Christensen, et al., Archival Evidence. 375 See, e.g., Causholli, et al., Competitive Procurement (for an economic model describing the intersection of efficiency, quality, and competition in the market for audit services). See also Aobdia, et al., The Economics of Audit Production. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 cautioned that allocation of audit hours may not be a useful signal of audit quality because circumstances outside of the auditor’s control may influence it (e.g., significant unusual, and unanticipated, transactions near the balance sheet date, going concern issues that arise after the balance sheet date, other unforeseen company delays). One commenter said that for the largest firms, individual issuer circumstances may not be significant enough to move the firm-level metric, but for smaller firms, individual issuer circumstances could impact the overall results. The Board recognizes that the allocation of audit hours will be an imperfect proxy for audit quality. However, the Board believes the academic literature provides evidence that the final metrics will likely be associated with audit effectiveness and audit outcomes and thus aid decision-making.376 c. Metrics Related to Audit Outcomes The Restatement History metrics will summarize restatements of financial statements and management reports on internal control over financial reporting (‘‘ICFR’’) that were audited by the firm over the past three years. In the academic literature, restatements are widely regarded as the strongest indicator of poor audit quality.377 Restatements have been shown to result in auditor dismissal or increased resources committed by the auditor to the issuer.378 Using data from Japanese audit firms, one study finds that auditors devote additional resources to companies the year they restate their 376 See above for a more general discussion of commenters’ concerns regarding the relationship between the proposed metrics and audit quality. 377 See, e.g., DeFond and Zhang, A Review of Archival Auditing Research (specifically, the discussion marked Section 2.3.1 Output-based audit quality measures). The Board notes that ‘‘little r’’ restatements are a less-widely used proxy for audit quality than ‘‘Big R’’ restatements. See Jayanthi Krishnan and Mengtian Li, Are Referred-to Auditors Associated with Lower Audit Quality and Efficiency?, 42 Auditing: A Journal of Practice & Theory 101 (2023) for one study that uses ‘‘little r’’ restatements as a proxy for audit quality. By contrast to ‘‘Big R’’ restatements, one study found muted or absent market reactions to ‘‘little r’’ restatements. See Daniel Aobdia, Vincent Castellani, and Paul Richardson, Do Investors Care Who Led the Audit in the U.S.? Evidence from Announcements of Accounting Restatements, SSRN Electronic Journal (2024). The Board notes that SSRN does not peer review its submissions. 378 See, e.g., Karen M. Hennes, Andrew J. Leone, and Brian P. Miller, Determinants and Market Consequences of Auditor Dismissals after Accounting Restatements, 89 The Accounting Review 1051 (2014); and Li-Lin Liu, K. Raghunandan, and Dasaratha Rama, Financial Restatements and Shareholder Ratifications of the Auditor, 28 Auditing: A Journal of Practice & Theory 225 (2009). PO 00000 Frm 00083 Fmt 4701 Sfmt 4703 100049 financial statements.379 However, it is important to note that restatements are often observed after a significant lag following the restatement event—which causes a reduction in the informativeness of the restatement event, if such information is viewed as stale by investors and audit committees. Furthermore, the absence of a restatement does not imply audit quality was high and the occurrence of a restatement identified by a successor auditor may signal improved audit quality when the auditor increases audit effort to identify errors in the work of prior auditors.380 The Board acknowledges that the incremental value of the final metric will be limited by the fact that restatements are public information already (e.g., U.S. issuers must file Form 8–K when they materially restate their financial statements and the public financial statements themselves indicate when a restatement has occurred). However, the Board believes that there is value in having the restatements aggregated and presented along with the other metrics. The final metrics related to restatement history and commenters’ views are discussed and summarized above. Overall, commenters were supportive of the proposed metrics related to restatement history. Two nonU.S. firm-related groups suggested that financial reporting quality is complex, and restatements are not a perfect proxy for audit quality. The Board agrees that it is not a perfect indicator. However, as the Board noted in the proposal, restatements are a widely-used proxy for audit quality. The Board agrees that context will be important to understand the final metrics, including the final Restatement History metric.381 Two commenters said that restatements are already publicly available and therefore the metric would not be useful. The Board noted this in the proposal. The Board continues to believe that providing information on restatement history in Form FM would make the information more accessible to stakeholders. 379 See, e.g., Chi, Wuchun and Chien-min Kevin Pan, How Do Auditors Respond to Accounting Restatements? Evidence on Audit Staff Allocation, 58 Review of Quantitative Finance and Accounting 1 (2022). 380 See, e.g., Stephen P. Rowe and Padmakumar Sivadasan, Higher Audit Quality and Higher Restatement Rates: An Examination of Big Four Auditee Restatements, SSRN Electronic Journal, (2021). The Board notes that SSRN does not peer review its submissions. 381 See above for a more general discussion of commenters’ concerns regarding the relationship between the proposed metrics and audit quality. E:\FR\FM\11DEN2.SGM 11DEN2 100050 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 2. Costs commenter did not discuss what portion of these figures would be impacted by the proposal. The Board notes that the final rules will apply only to the auditors and audits of accelerated filers and large accelerated filers. However, the Board recognizes that some accelerated filers and larger accelerated filers may not be audited by the largest audit firms. For example, 24.0% of accelerated filers (representing 19.3% of total accelerated filer market capitalization) and 4.5% of large accelerated filers (representing 0.3% of total large accelerated filer market capitalization) are audited by nonaffiliated firms.385 Several commenters said that the proposal did not fully consider the costs and complexities associated with complying with the proposed rules. Two commenters said that the proposal’s economic analysis largely disregards costs and does not attempt to quantify the related costs of some requirements. To the contrary, the proposal’s economic analysis included both a discussion of the available evidence about costs and PCAOB staff’s attempt to quantify costs of the proposal to the extent feasible. The Board has carefully reviewed stakeholders’ input regarding the potential costs of the proposal. Based on outreach to audit firms, one commenter agreed that firms’ processes and systems would need to be established or updated. One commenter suggested that the PCAOB should, as a starting point, consider whether the metrics would require additional systems, processes, or procedures. The Board considered these costs and quantified several of them in the proposal and, with modification to account for stakeholder feedback, address them again below. One commenter suggested that it would be helpful if the Board could match each cost to each benefit. The Board does not believe such an analysis is feasible or reasonable. For example, it is not possible to match fixed costs (e.g., IT investments) to a particular benefit because they do not drive the benefit alone. Furthermore, the variable cost categories (e.g., gathering, calculating, and disclosing the metrics) cannot be matched to specific benefit categories (e.g., competition). Rather, these lotter on DSK11XQN23PROD with NOTICES2 In the following discussion, the Board considered direct and indirect costs related to the final rules. The Board has attempted to quantify certain costs where possible. However, most of the costs are intractable to quantify, particularly the indirect costs. • First, auditors may incur direct costs building an appropriate reporting infrastructure or updating existing infrastructure. • Second, auditors may incur direct costs producing the firm and engagement metrics. • Third, auditors, investors, and audit committees may incur indirect costs understanding and integrating the final metrics into their current decisionmaking frameworks. • Fourth, auditors may incur indirect costs revising their audit approaches. • Fifth, investors, audit committees, and auditors may incur indirect costs to the extent that issuers switch auditors more frequently as a result of the final rules. • Sixth, issuers and investors may bear indirect costs to the extent that costs incurred by auditors are passed on in the form of higher audit fees. Larger firms should be able to take advantage of economies of scale by distributing any fixed costs over a higher number of audit engagements. Smaller firms will likely distribute any fixed costs over a lower number of audit engagements, which, taking fixed costs as given, would make implementation relatively more costly for smaller firms.382 Many commenters agreed that smaller firms, including non-U.S. firms, could be disproportionately impacted. However, the fixed costs may also be less for smaller firms than for larger firms (e.g., they may not require significant IT systems if they need to track only a few engagements).383 Referring to research from the SEC, one commenter noted that 99.9% of businesses are small businesses, 43.5% of the U.S. GDP is created by small businesses, and 63% of net new jobs are created by small businesses.384 The 382 See, e.g., Michael Minnis and Nemit Shroff, Why Regulate Private Firm Disclosure and Auditing?, 47 Accounting and Business Research 473, 498–499 (2017) (explaining that increased financial reporting regulation is disproportionately costly for smaller companies because complying with regulation has large fixed costs, and unlike larger companies, smaller companies do not benefit from economies of scale). 383 Among the firms that will be impacted by the final rules approximately 41%, 19%, and 11% had a total of one, two, or three accelerated filer or large accelerated filer engagements, respectively, during the 12-month period ending September 30, 2023. 384 See U.S. Securities and Exchange Commission, Office of the Advocate for Small VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Business Capital Formation, Annual Report Fiscal Year 2023. 385 Source: S&P and Audit Analytics. The Board’s calculations use market capitalization data as of the second quarter of 2024. ‘‘Non-affiliated firms’’ are firms not affiliated with BDO International Limited, Deloitte Touche Tohmatsu Limited, Ernst & Young Global Limited, Grant Thornton International Limited, KPMG International Cooperative, or PricewaterhouseCoopers International Limited. PO 00000 Frm 00084 Fmt 4701 Sfmt 4703 variable cost categories are each associated with producing the metrics, while disclosing the metrics drives all the benefits. Where feasible and reasonable, the Board highlighted in the proposal and below connections between certain qualitative cost categories and certain qualitative benefit categories. For example, the Board has highlighted that audit switching costs may arise from improved competition. The Board also acknowledges how certain metrics may be more costly or beneficial than others to allow the Board and commenters to consider each metric individually (e.g., by surveying academic literature by metric and highlighting challenges gathering data required for certain metrics). One commenter noted that the use of data analytics at firms should enable them to more efficiently implement the final rules. The Board has observed that firms are increasingly using data analytics in their audits.386 However, the extent to which these capabilities lend themselves to regulatory compliance and management of the audit practice itself is less clear. i. Direct Costs To Comply With the Final Rules a. Modifying or Building a System To Produce the Final Metrics Auditors may incur certain initial fixed costs (i.e., costs that are generally independent of the number of audits performed) related to modifying existing systems or building new systems that could collect the relevant data that is needed to generate the final metrics and produce compliant filings. The Board believes most firms will likely modify existing systems rather than build entirely new systems. These costs may include acquiring necessary IT infrastructure, establishing an appropriate system of controls, creating system documentation, and conducting system testing (e.g., with historical data or by conducting dry runs before the effective date of the final requirements). There could also be costs related to training personnel in how to use the new or modified system. This could include training: (i) engagement-level personnel on how to collect and document information relevant to the final metrics; (ii) centralized personnel on how to aggregate and produce the final metrics; and (iii) administrative personnel on how to create filings and ensure proper control over the system; all in compliance with QC 1000.387 386 See PCAOB Rel. No. 2024–007, 35 and cites therein for additional discussion on this topic. 387 See Michael J. Gurbutt, Wei-Kang Shih, Carrie von Bose, and Tasneem Raihan, Staff White Paper: E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices The fixed costs associated with these efforts will likely depend on the extent to which firms already have automated systems in place that may be adapted to comply with the final requirements. As discussed above, the Board believes many firms track much of the information that would be required to calculate the final metrics. In particular, information gathered by PCAOB staff in 2018 and 2019 pursuant to PCAOB oversight activities indicates that U.S. GNFs generally track some metrics similar to the final metrics and voluntarily provide quantitative information that is similar to many of the final metrics. With respect to roughly half of the engagements that will be subject to the final engagementlevel reporting requirements, firms are already gathering total audit hours information from other auditors pursuant to Form AP reporting requirements. Furthermore, firms should be tracking CPE credits pursuant to licensing requirements and restatements pursuant to QC 1000. The Board believes firms likely have systems in place to help them track this information. As a result, these firms may be able to leverage their existing internal systems to comply with the final rules. Moreover, firms may be able to leverage existing systems related to their compliance with other PCAOB reporting requirements (e.g., QC 1000 and Form AP). Indeed, one GNF commenter, in response to the Concept Release, noted that some of the metrics discussed therein and included in the final rules would be ‘‘easy to compute.’’ However, the Board has also considered that existing systems may not be functionally joined together, and that systems designed and operated for internal monitoring or informal reporting purposes may need to be enhanced to meet the needs of public reporting. There are, therefore, likely to be costs associated with integrating the various reporting systems and enhancing or updating current systems to comply with the final requirements. One GNF commenter on the Concept Release suggested that this would likely be especially true for NAFs. The required changes would depend on a firm’s size and the nature of their engagements. Depending on their facts and circumstances, some firms may avoid the costs associated with modifying or building an automated system by opting for a more manual approach. Larger firms are more likely to build automated Second Stakeholder Outreach on the Initial Implementation of CAM Requirements, Public Company Accounting Oversight Board 11 (2022). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 systems, or increase automation in existing systems, given the scale of their operations and the scope of data that will need to be collected to calculate the final metrics (i.e., they have a larger number of employees and engagements). Smaller firms may choose to build or expand upon existing manual systems (e.g., collecting information in spreadsheets or simple databases) because, for these firms, the scope of information to be collected and processed may be effectively collated in a spreadsheet-based tool. Firms may also opt for automated systems to the extent that the final metrics will require a larger number of individual components, a broader pool of individuals, or more complicated calculations (e.g., the final metrics related to audit-team retention, auditor experience, or industry expertise). The fixed costs to build or modify existing automated systems are likely to be greater than manual systems. However, automated systems should reduce variable costs in the long run. The Board is unaware of any data or research relevant to the potential costs of modifying firms’ existing automated systems, which the Board believes would be the most likely scenario for many firms, particularly the largest firms which audit a significant majority of the audit market.388 However, the costs to build an automated system from the ground up—that is, if a firm did not have any existing systems that track the inputs to the final metrics—could be comparable to the costs to implement an enterprise resources planning (ERP) system (but such costs are not exactly analogous). Using surveys of companies that have implemented ERP systems, some studies find that ERP system implementation costs scale with the company’s revenues and staff count. Using audit fees as a proxy for revenue and number of accountants as a proxy for staff count, an illustrative calculation suggests that the total costs (e.g., adding over all impacted firms), if every such firm were to implement an automated system from the ground up, could range from approximately $371 million to $512 million.389 This would 388 See, e.g., Ideagen Audit Analytics, 20-Year Review of Audit Fee Trends 2003–2022, (July 2023) at 2. 389 The Board identified two publicly available reports related to the costs of implementing ERP systems. Referring to the experiences of over 1,000 client and non-client companies that had implemented a digital transformation effort in the past twenty years, one consulting firm estimated that implementation costs for companies with revenues under $1 billion were approximately 3– 5% of annual revenue, and implementation costs for companies with revenues over $1 billion were approximately 2–3% of annual revenue (The 2020 PO 00000 Frm 00085 Fmt 4701 Sfmt 4703 100051 represent a one-time cost of approximately 2% to 3% of audit fees paid by issuers to covered firms in a year. However, as discussed in more detail below, the fixed costs associated with modifying or building a system to produce the final metrics are likely to be a fraction of this amount given that the Board expects most firms would modify existing systems rather than build entirely new systems. For this reason, this range likely represents an upper bound of the potential costs. There are several reasons to expect the implementation costs will be substantially less than the cost of building a new ERP system. First, as noted above, the Board believes it is likely that firms, particularly the largest firms with the greatest market share, are already gathering much of the information that would be required to calculate the final metrics. For example, roughly half of the engagements that will be subject to the final engagementlevel reporting requirements are already gathering total audit hours information from other auditors pursuant to Form AP reporting requirements. Furthermore, firms should be tracking CPE credits pursuant to licensing requirements and restatements pursuant to QC 1000. Second, the Board believes most larger firms have automated systems in place that could be leveraged to comply with the final rules. Third, smaller firms could opt for a manual approach. Indeed, firms are only expected to invest in an automated system if it would be efficient to do so. ERP Report, Third-Stage Consulting Group, (2020)). Each of the U.S. Big 4 firms had over $1 billion of revenue for the 2023 issuer fiscal year, while all other firms that will be impacted had less than $1 billion. Using the midpoint of the ranges, 2.5% for U.S. Big 4 firms and 4% for all other firms, implementation costs related to building a new system to produce the final metrics will be approximately $12.7 billion × 2.5% + $4.8 billion × 4% = $512 million. The Board notes that 13 firms, which had a combined $22 million in audit fees in 2022, had zero audit fees in 2023. Using information on client implementation projects active between January 2021 and December 2021, another consulting firm reported that companies having over 500, between 50 and 499, or less than 50 employees project spent $11,000, $9,000, or $8,571 per ERP system user over a 5-year ERP implementation period and that 7.27%, 20.13%, and 34.8% of employees used the ERP system, respectively (2022 ERP Software Report, Software Path, (2022)). Information provided by registered firms that will be impacted by the final requirements on Form 2 indicates that, for the 2023 reporting year, 130, 58, and 19 firms employed over 500, between 50 and 499, or less than 50 accountants, employing a total of 431,680, 14,274, and 474 accountants, respectively. Using the number of accountants employed by a registered firm as a proxy for the number of employees, implementation costs related to building a new system to produce the final metrics would be approximately 430,074 × 7.27% × $11,000 + 14,142 × 20.13% × $9,000 + 444 × 34.8% × $8,571 = $371 million. Source: Audit Analytics and RASR. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100052 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Fourth, ERP systems possess many features that would not be necessary in an automated system for compliance. Finally, audit firms are likely to need to make similar investments in their internal systems in the near term, owing to the rapid pace of technological advancement and other rules and standards currently being adopted, thus potentially reducing the incremental costs attributable to the final rules. However, at the same time, and as suggested by commenters, the Board recognizes that implementing new systems may be especially costly for audit firms if staff resources are strained due to the need to comply with other standards being implemented in the same time period, such as QC 1000.390 The Board’s estimate does not account for these capacity constraints. Overall, for these reasons, the Board believes these figures likely reflect an upper bound on the potential implementation costs and the actual implementation costs will likely be significantly less. One commenter suggested that the Board’s cost estimates are strawmen because they have too many caveats. The PCAOB’s staff guidance on economic analysis recommends quantifying impacts to the extent feasible. However, it also notes that reliably quantifying impacts can be difficult. The SEC’s current guidance on economic analysis in SEC rulemakings recommends ‘‘identify[ing] and discuss[ing] uncertainties underlying the estimates of benefits and costs.’’ 391 Consistent with these recommendations, the Board has provided an exhaustive discussion of uncertainties in the Board’s cost estimates because the Board believes it provides commenters with important context necessary to understand the economic analysis. One commenter apportioned the Board’s quantitative estimate of the cost to implement an automated system from the ground up to their firm by market share. Using this approach, the commenter estimated the cost would be between $7 million and $10 million. The commenter said that they believe their estimate is low because larger firms have greater economies of scale. The commenter also said that this cost could increase the audit fees they charge their issuer clients by between $50,000 and $70,000 per issuer assuming they pass through the entire implementation cost and raise each issuer’s audit fee by the same amount. The Board notes some limitations to applying its numerical illustration in this way. First, as discussed in the proposal and again above, the Board’s methodology assumes costs are a non-linear function of revenue which the commenter did not account for. Second, the Board notes that the commenter’s estimate is subject to the same caveats described above regarding the Board’s quantification methodology. Finally, the Board also notes it would not expect that the cost of implementing a new system would be passed through to issuers in the form of a permanent audit fee increase, both because it is a one-time cost and because it is a fixed rather than a variable cost. It also overestimates the true pass through to the extent the commenter is unable to pass through 100% of the implementation cost. One commenter provided academic research that finds the costs to implement new systems is proportionally lower for larger firms.392 The Board agrees, and the Board’s quantification methodology reflects this. The same commenter also noted that the press has reported that larger firms have already invested significantly into their IT systems. As discussed above, the Board recognizes that larger firms likely already have systems in place that they would be able to leverage when implementing the final rules. Finally, the Board also notes the implementation costs could be offset in part by benefits to auditors. For example, technological enhancements to auditors’ systems may, in the long run, increase operational efficiency and profitability. 390 Commenters’ concerns about the cumulative impacts of multiple PCAOB standards and rules with overlapping implementation periods including potential benefits are discussed above. 391 See Memorandum from Division of Risk, Strategy, and Financial Innovation (now, Division of Economic and Risk Analysis) and Office of the General Counsel to Staff of the Rulewriting Divisions and Offices re: Current Guidance on Economic Analysis in SEC Rulemakings (Mar. 16, 2012) (SEC Staff Guidance), 12. 392 See Kathleen M. Bakarich and Patrick E. O’Brien, The Robots are Coming . . . But Aren’t Here Yet: The Use of Artificial Intelligence Technologies in the Public Accounting Profession, 18 Journal of Emerging Technologies in Accounting 27, (2021) and Dereck Barr-Pulliam and Amanda Carlson, Breaking Barriers to Change: The COVID– 19 Pandemic’s Impact on Attitudes Toward and Willingness to Pay for Audit Innovation, SSRN Electronic Journal (2024). The Board notes that SSRN does not peer review its submissions. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 b. Producing the Final Metrics Auditors may incur engagement-level and firm-level variable costs related to producing the final metrics. For example, the final rules may lead auditors to spend additional time recording, collating, and reporting information for relevant engagementlevel, and then aggregated firm-level, metrics. As discussed above, the final rules do not impose new performance requirements other than the calculation PO 00000 Frm 00086 Fmt 4701 Sfmt 4703 and disclosure of metrics. In addition, reviews by others, such as the engagement quality reviewer or the national office, may result in additional recurring costs. Audit firms are also likely to experience costs, or administrative time, related to legal review and quality control for the final metrics. Specifically, variable costs may arise from the following activities related to producing the final metrics: Recording & Collecting Information Audit firms may incur variable costs recording the necessary information and collecting it in a centralized location. The magnitude of the costs will likely depend on the extent to which existing practice differs from the final requirements. As discussed above, the Board believes many firms already internally track information related to the final metrics. This will reduce the variable costs attributable to the final rules. The magnitude of the variable costs may also depend on the size of the firm. As discussed, based on information obtained through inspections and oversight activities, the Board believes that the final rules will likely affect engagements performed by all firms but may have a greater impact on engagements performed by NAFs. However, NAFs that choose to use a manual recording system may face recurring costs associated with the continued collection of data and reporting of the final metrics. These costs likely will vary with the size of the audit team. Finally, the magnitude of the variable costs to record and collect information may depend on the final metric. For example, collecting the information needed to calculate the final Workload metrics will likely be relatively straightforward as such information is likely already stored in firms’ extant timekeeping systems. One commenter said that the proposed engagement-level Workload metric would take considerable effort to compile and calculate. The commenter did not articulate a basis for their conclusion. To the contrary, the Board believes the final Workload metric area will not be burdensome to calculate for several reasons. First, based on commenters’ views, the Board decided to exclude staff from the final Workload metric calculations. The Board believes this should reduce the effort required by firms to compile and calculate the metrics. Second, firms that use other auditors or serve as an other auditor should already be tracking partner and manager hours in order to calculate total E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices audit hours pursuant to Form AP reporting. PCAOB staff analysis of AuditorSearch data finds that approximately 48% of audits of accelerated filers or large accelerated filers involved other auditors. Third, firms that track time electronically should be able to access hours information by staffing level and time period and make the required calculations electronically. The Board believes most larger firms track their time electronically already. However, the Board recognizes that some of the smaller firms may not. Indeed, one commenter said that many firms have moved away from the burden of time reporting. As discussed above, some of these smaller firms may choose to build a system that would track the information needed to efficiently produce the final metrics, including in the final Workload metric area. Finally, the Board also notes that firms will be permitted to use a reasonable method to estimate the components of a calculation when actual amounts are unavailable. One commenter said that there could be costs associated with coordinating data collection efforts across firms. The Board recognizes that such costs would likely arise. However, the Board notes that the adjustments the Board has made to the set of required metrics and their calculations should alleviate this burden. Furthermore, firms should generally already be coordinating data collection efforts for Form AP reporting purposes and this data will be subject to quality controls over firm reporting. To the extent such coordination is necessary, academic research finds that 94% of component auditors identified on Form AP are associated with the lead auditor.393 This provides additional evidence there is a strong existing relationship between these firms which should facilitate any additional transfer of information required to implement the final rules. lotter on DSK11XQN23PROD with NOTICES2 Aggregating & Calculating Firm and Engagement Metrics Once the information is collected, it will need to be aggregated and the final metrics will need to be derived following the calculation requirements discussed above. Costs will likely be incurred to make those calculations and to make and validate the filing. Moreover, these costs will be greater for 393 See William M. Docimo, Joshua L. Gunn, Chan Li, and Paul N. Nichas, Do Foreign Component Auditors Harm Financial Reporting Quality? A Subsidiary-Level Analysis of Foreign Component Auditor Use, 38 Contemporary Accounting Research 3113 (2021). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 firms that will use manual systems than firms that will use automated systems. Making the Filing Once collected, aggregated, and calculated, the final metrics will then need to be filed with the PCAOB. There will be costs associated with developing the filing, validating the information, and drafting any voluntary textual disclosures. This could entail administrative costs such as legal review of the textual disclosures. Firms may also need to extend their existing quality control processes around PCAOB filings to cover these new filings. Overall, it is difficult to estimate the potential costs that audit firms will incur to produce the final metrics owing in part to the variability in firms’ current systems (e.g., automated versus manual) and the extent to which firms already produce similar metrics for internal reporting to national offices or external reporting in firm transparency reports. However, the Board may extrapolate from the economic impacts of prior PCAOB disclosure rules. For example, as a result of the implementation of AS 3101 in 2019, the largest four audit firms surveyed through the PCAOB’s outreach activities indicated they incurred, on average, 23,000 hours to develop the processes and procedures to support the implementation of CAMs. The PCAOB staff monetized the economic impact to those largest four audit firms to be approximately $4.4 million dollars each.394 Those audit firms also each reported 14,600 hours of training, estimated at $2.1 million dollars. The next four largest audit firms reportedly incurred 3,700 hours, on average, to develop processes and procedures, and 3,100 hours in training their personnel to support the implementation of CAMs—estimated at $610,000 and $435,000, respectively, on average for each firm.395 As estimated through April 2021, the smallest of audit firms, after excluding outliers, reported only 400 hours implementing the CAM requirements, with 600 hours associated with CAM related training. The average implementation costs for these smallest of firms was estimated to be approximately $185,000 per firm.396 394 See, e.g., Michael J. Gurbutt, Wei-Kang Shih, Carrie von Bose, Staff White Paper: Stakeholder Outreach on the Initial Implementation of CAM Requirements, PCAOB 1, 8 (2020). 395 Id. The ‘‘next four largest firms’’ refers to BDO USA LLP, Crowe LLP, Grant Thornton LLP, and RSM US LLP. See Gurbutt et al., Stakeholder Outreach at n. 4. 396 See Gurbutt, et al., Staff White Paper: Second Stakeholder Outreach on the Initial Implementation PO 00000 Frm 00087 Fmt 4701 Sfmt 4703 100053 Extrapolating these data points to the population of firms expected to be impacted by the final requirements implies a total cost of approximately $67 million.397 Following the implementation of processes, procedures, and training, surveyed audit partners report that 1% of total audit engagement hours were spent identifying, developing, and communicating CAMs.398 PCAOB staff research found no systematic evidence of increased engagement hours for audits of large accelerated filers 399 and a statistically significant 6.6% increase in engagement hours for audits of nonlarge accelerated filers.400 The findings suggest that there could potentially be variable costs associated with the final requirements that persist after the implementation phase. Auditors of large accelerated filers realized efficiencies in developing and communicating critical audit matters in the second year of implementation, reporting that they generally spent the same or less time on critical audit matters compared to the initial year of implementation.401 Accordingly, the Board expects that the costs to produce the final metrics will be most significant for the initial filings under the final rules because firm personnel will need to familiarize themselves with new reporting requirements and forms. In subsequent reporting periods, the Board anticipates that firms will incur lower costs as personnel become more familiar with the reporting requirements. As noted above, AS 3101 and the final rules are different in ways that may of CAM Requirements 1, 13. ‘‘Smaller audit firms’’ refers to Marcum LLP; Moss Adams LLP, Baker Tilly US LLP; BKD LLP; CohnReznick LLP; Dixon Hughes Goodman LLP (DHG); EisnerAmper LLP; Mayer Hoffman McCann P.C. (MHM); Plante & Moran, PLLC; and WithumSmith + Brown, PC. 397 As an example, aggregating these costs across active firms in the market implies roughly $6.5 million in procedures and training for the largest four audit firms ($4.4 million for processes and procedures and $2.1 million for training), $1.045 million for the next four largest firms, and $185,000 for 202 smaller impacted firms, would amount to a combined $67.0 million in costs to produce the final metrics outside of implementation costs associated with the systems ($6.5 million × 4 larger firms + $1.045 million × 4 next-largest firms + $0.185 × 199 smaller firms = $67.0 million). 398 See Gurbutt and Shih, Econometric Analysis on the Initial Implementation of CAM Requirements 4. 399 See Gurbutt and Shih, Econometric Analysis on the Initial Implementation of CAM Requirements 4. 400 See Jonathan T. Fluharty-Jaidee, Michael J. Gurbutt, and Wei-Kang Shih, Staff White Paper: Second Econometric Analysis on the Initial Implementation of CAM Requirements, Public Company Accounting Oversight Board, (2022). 401 See, e.g., Interim Analysis Report: Further Evidence on the Initial Impact of Critical Audit Matter Requirements, PCAOB Rel. No. 2022–007 (Dec. 7, 2022). E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100054 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices limit the relevance of the costs of AS 3101 to the potential costs of the final rules. For example, as discussed above, the final metrics will require the collection of a broader array of engagement-level information whereas CAM requirements focus more on narrative description. However, the processes, procedures, and training aspects are likely more comparable. One commenter agreed with the Board’s caveat that the CAMs requirements are not a perfect analogy for the proposed metrics. More specifically, the commenter said that the proposal would require significantly more effort to implement than AS 3101 due, in part, to the need to update QC policies and procedures. Furthermore, commenters pointed to specific facts and circumstances that could exacerbate the costs of the final metrics (e.g., coincidence with other new PCAOB standards). One commenter asserted, incorrectly, that the proposal included no quantification of costs associated with reporting. One commenter suggested that the Board perform further analysis of the firms’ current data collection efforts and the data collection efforts that will be required under the final requirements. As part of the Board’s economic analysis, the Board considered all relevant information available to the Board including information gathered through the Board’s oversight activities, academic research, and comments received on the proposing release. Commenters agreed that firms will incur some costs to report the final metrics. Two commenters said validating personnel’s total experience prior to joining the firm will be challenging and expensive because firms do not generally track this information. Another commenter said that reporting industry experience of audit personal would be costly because sufficient information to report this metric is not usually held in the human resources administration of firms. One commenter said the proposed engagement-level Workload metrics were very complicated and would take considerable effort to prepare. One commenter said that many firms do not track non-chargeable hours. Commenters also said that they do not usually track restatements of former clients’ financial statements. The Board considered these costs and have made several modifications to the required calculations which the Board believes will help mitigate them. The Board also notes that, under the final rules, firms would be permitted to use a reasonable method to estimate the components of a VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 calculation for which data are unavailable. One commenter said that producing some of the proposed firm-level metrics (e.g., Partner and Manager Involvement and Allocation of Audit Hours) would be challenging because it would require aggregation of engagement-level data, including data from other auditors, for a period different from that required for the corresponding proposed engagement-level metrics. The Board agrees there could be some incremental costs associated with collecting and validating data from other auditors. However, when producing the final firm-level metrics, firms would be able to leverage the audit hours information they already collected and validated pursuant to Form AP reporting for audit reports issued during the 12-month period ended September 30. Therefore, the Board does not believe the difference between the period covered by the firm-level metric and the period covered by Form AP presents unique challenges. To the contrary, the Board believes that adopted approach is an efficient way to provide information to stakeholders while minimizing costs to firms. The adjustments the Board has made to the calculations (e.g., reducing the scope of the Partner and Management Involvement, Workload, and Allocation of Audit Hours calculation to large accelerated and accelerated filers only) and the Board’s decision not to adopt the proposed Use of Shared Service Centers metric should attenuate any concerns like those raised by this commenter. Several commenters said that there could be costs associated with correcting immaterial errors, particularly with regard to engagementlevel metric reporting on Form AP. The Board agrees cost related to this aspect of the final rules could arise, either though extra up-front quality control costs or costs associated with amending an inaccurate Form AP. However, the Board believes investors and audit committees need reliable information, and correction of errors is an important part of ensuring the reliability of the information. ii. Indirect Costs Arising From Market Reactions to the Final Metrics The Board also reviewed and considered costs that could arise from how investors, audit committees, and auditors may react to the final metrics. For example, improved decision-making on the part of audit committees could lead to costs from switching auditors. Most of these costs are not feasible to quantify. However, they are likely to be incurred only to the extent that they are PO 00000 Frm 00088 Fmt 4701 Sfmt 4703 deemed reasonable from a business perspective. a. Understanding the Final Metrics Investors that use the metrics will incur costs to understand the final metrics and incorporate them into their decision-making. Investors will choose to bear these costs only if they anticipate that the costs are outweighed by the benefits of using the metrics. Due to economies of scale, the Board believes institutional investors will be more likely to incur these costs than retail investors. Audit committees may incur costs to understand the final metrics because their fiduciary duties may prompt them to do so. Moreover, audit committees may spend additional time discussing the final metrics with their auditor, which would require both audit committees’ and auditors’ time.402 Auditors may spend time and resources developing materials to explain or contextualize their metrics for the audit committee (e.g., presentations and decision aids). Furthermore, investors and audit committees may incur costs in monitoring the final metrics and learning to extract decision-making information from them. Investors may incur costs incorporating the final metrics into their investment decisions or exercising oversight over issuers and audit committees. Audit committees may incur costs to review the final metrics in support of their auditor oversight responsibilities. There may also be costs associated with interpreting certain final metrics in relation to final metrics across other firms and engagements. For example, partner and manager involvement on an engagement may be more informative when considered in the context of the firm’s overall partner and manager involvement or other firms’ partner and manager involvement metrics. Moreover, investors and audit committees may spend time researching the state of the market for assurance services to provide more context to the final metrics.403 Auditors may also incur costs to monitor how their final metrics compare to those of their competitors. GNFs, in particular, could deploy significant resources in this way. NAFs may have less ability to fully evaluate the information contained in the final 402 See below for additional discussion of attention diversion of audit committees. 403 For example, some literature suggests that the implications of staff turnover are better understood in the context of accounting labor supply. See Khavis and Szerwo, Audit-Employee Turnover, Audit Quality, and the Auditor-Client Relationship 2. E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices metrics and choose instead to retain outside experts to provide such research. Firms may also use the final engagement-level metrics to inform their acceptance and continuance policies (e.g., by considering industry experience). Referring to academic research on information processing costs, one commenter incorrectly stated that the Board had not considered the costs incurred understanding the proposed metrics.404 The commenter also said there would be costs associated with misunderstanding the metrics. The Board discussed such costs in the proposal and again below. lotter on DSK11XQN23PROD with NOTICES2 b. Revising Audit Approaches Armed with the new information discussed above, audit committees may question their auditor’s audit approach. This may prompt auditors to make changes to their audit approaches. For example, an audit committee may come to the belief that the audit partners have too many other duties and may express this concern to the auditor. This may prompt auditors to adjust how they are staffing the audit. Similarly, audit firms could incur costs making those changes. Some of these costs may be greater than others. For example, reducing excessive turnover and workloads, to the extent they exist, could require a significant investment in resources. As discussed above, the final rules may lead audit firms to compete on the final metrics. This could lead some firms to update their audit approaches, provide additional training, or increase their specialization. For example, auditors may increase training in industry-specific areas or hire additional individuals with specialized knowledge. As another example, to the extent issuer preferences show an increased demand for auditors with lower workloads, firms may increase staffing. Such an increase in humancapital investment will likely increase labor and overhead costs for audit firms. Auditors may also increase the quality review of their work to reduce the likelihood of restatements or enhance their audit procedures to compete on the basis of higher-quality audit services. c. Switching Auditors As discussed above, the final rules could result in increased auditor switching as investors and audit committees compare and evaluate current and alternative auditors. Should 404 See, e.g., Charles M.C. Lee and Qinlin Zhong, Shall We Talk? The Role of Interactive Investor Platforms in Corporate Communication, 74 Journal of Accounting and Economics 101524 (2022). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 audit committees ultimately choose to change auditors, there may be switching costs, both to the issuer and the auditor. For example, an auditor’s work may be less efficient or less effective in the first years of auditing a new issuer as the auditor works to build an understanding of the issuer’s business and financial reporting risks. There would likely be a transitory period of increased auditor switching, after which auditor switching would stabilize as the audit market reaches a new equilibrium. iii. Other Indirect Costs Economic theory suggests that auditors may pass on to issuers costs incurred as a result of the final rules in the form of higher audit fees.405 In addition, the degree to which increases in variable costs, such as certain firm compliance costs, are expected to be passed on will vary based on how widespread the costs are across competitors. Increases in variable costs that impact all sellers in an imperfectly competitive market are more likely to be passed on than cost increases that impact only a subset of sellers.406 If compliance costs have a greater impact on a subset of firms, such as smaller firms, those firms may be less inclined to pass on the incremental costs in order to stay competitive with larger firms. Accelerated filers and large accelerated filers may be disproportionately impacted by a cost passthrough because (i) auditors that do not audit accelerated filers or large accelerated filers would be out of scope and (ii) accelerated filer and large accelerated filer engagements would require additional data collection efforts. Evidence from the PCAOB’s PIR of AS 3101 suggests that there was no statistically significant increase in audit fees for the audits of large accelerated filers but a statistically significant 3.0% increase for the audits of non-large accelerated filers.407 Financial statement preparers and audit committees interviewed during the PCAOB’s investor outreach efforts indicated that there were minimal or immaterial 405 Economic theory suggests that fixed costs are less likely to be passed on. Only changes to variable costs are generally expected to impact sellers’ pricing decisions. See, e.g., Mankiw, Principles of Economics 284 and 307 (showing that the profitmaximizing price is a function of marginal cost rather than fixed costs). 406 See, e.g., Erich Muehlegger and Richard L. Sweeney, Pass-Through of Own and Rival Cost Shocks: Evidence from the U.S. Fracking Boom, 104 Review of Economics & Statistics 1361 (2022). 407 See Gurbutt and Shih, Econometric Analysis on the Initial Implementation of CAM Requirements; and Fluharty-Jaidee, et al., Staff White Paper: Second Econometric Analysis on the Initial Implementation of CAM Requirements. PO 00000 Frm 00089 Fmt 4701 Sfmt 4703 100055 costs.408 One academic study found a small, statistically insignificant audit fee increases as a result of PCAOB Rule 3211.409 Another study found that audit fees increased by a statistically significant 7.9 percentage points.410 One commenter noted that the proposal failed to consider impacts on entities that are neither issuers nor broker dealers but are required or may be required under SEC rules to use a PCAOB-registered and inspected firm. The Board notes that the commenter provided just two examples of such SEC rules. One rule was recently vacated and the other is a proposal.411 The Board acknowledges that, to the extent any such entities are required under SEC rules to obtain an audit from a PCAOBregistered firm, they could be indirectly impacted by the final rules if their auditor is both (I) subject to the final requirements and either (ii) chooses to pass on to these entities any part of the costs associated with the final rules or (iii) exits the market as a result of final rules.412 Any passthrough of cost will likely be limited by the fact that the engagement-level reporting requirements will not apply to the audits of these entities and most of the firm-level metrics will not require information from their audits. This means that the final rules should have little or no effect on the cost of their audits. Furthermore, the Board notes that any costs to such entities could be offset by benefits. For example, stakeholders in the audit of these entities may use the final metrics to inform their decision-making. 408 See Gurbutt, et al., Staff White Paper: Second Stakeholder Outreach on the Initial Implementation of CAM Requirements 21. 409 See Cunningham, et al., What’s in a Name? 141 and 156 (finding no statistically significant increase in fees following the implementation of AS 3211, Form AP, in 2017). 410 See, e.g., John and Liu, Disclosure of an Audit Engagement Partner’s Name. 411 See SEC Final Rules on Private Fund Advisers: Documentation of Registered Investment Advisers Compliance Reviews, SEC Rel. No. IA–6383 (Aug. 23, 2023). See also SEC Proposed Rule on Safeguarding Advisory Client Assets, SEC Rel. IA– 6384 (Mar. 9, 2023). 412 SEC rules require the use of PCAOB-registered or PCAOB-registered and inspected audit firms by entities other than issuers and registered brokerdealers, including certain investment advisers, pooled investment vehicles, security-based swap data repositories, and clearing agencies. See, e.g., 17 CFR 275.206(4)–2 (custody of funds or securities of clients by investment advisors); 17 CFR 240.13n–11 (chief compliance officer of security-based swap data repository; compliance reports and financial reports); 17 CFR 240.17ad–22 (standards and clearing agencies); 17 CFR 240.15c3–1g (conditions for ultimate holding companies of certain brokers and dealers, Appendix G to 17 CFR 240.15c3–1); and 17 CFR 240.18a–1 (net capital requirements for security-based swap dealers for which there is not a prudential regulator). E:\FR\FM\11DEN2.SGM 11DEN2 100056 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 3. Unintended Consequences In addition to the benefits and costs discussed above, the final rules could have unintended consequences. The following discussion describes potential unintended consequences the Board considered and, where applicable, any mitigating or countervailing factors. lotter on DSK11XQN23PROD with NOTICES2 i. Auditors May Exit the Market for Accelerated Filers and Large Accelerated Filers Due to Increased Competition and Costs The final rules may lead auditors to compete on the final metrics. The Board believes this new competitive dynamic will be beneficial.413 However, firms that are less able to compete on the final metrics could lose market share or be forced to lower their audit fees, resulting in strains on their profitability. Profitability could also be negatively impacted by the costs of the final rules. In some cases, these auditors may exit the public audit market for accelerated filer and large accelerated filer audits. This could reduce the number of potential auditors some accelerated filers or large accelerated filers may consider thereby reducing competition. One commenter noted that (i) the Big 4 firms already audit over 88% of the large accelerated filers and (ii) research shows that the population of firms with less than 100 clients has decreased by over 50% in recent years.414 Many commenters said that the proposal could lead smaller firms to exit the market for accelerated filer or large accelerated filer audits and increase concentration. One commenter said that the proposed reporting requirements would be particularly onerous on nonU.S. firms that carry out only one or a small number of relevant PCAOB engagements. One commenter suggested that smaller firms may exit the public company audit market as a result of the proposed requirements, in conjunction with other standards recently issued and proposed by the PCAOB, and this could negatively impact smaller public companies that are seeking a smaller audit firm. The commenter referred to a 413 See above for a discussion on the benefits linked to competition. 414 See Xiaohong Liu and Dan A. Simunic, Profit Sharing in an Auditing Oligopoly, 80 The Accounting Review 677 (2005); Mark L. DeFond and Clive S. Lennox, The Effect of SOX on Small Auditor Exits and Audit Quality, 52 Journal of Accounting and Economics 21 (2011); Vincent Rylan, The Big Four Continue to Dominate Auditing: Weekly Stat, CFO Magazine, (June 29, 2022) available at https://www.cfo.com/news/thebig-four-continue-to-dominate-auditing-weekly-stat/ ; Brant Christensen, Kecia Williams Smith, Dechun Wang, and Devin Williams, The Audit Quality Effects of Small Audit Firm Mergers in the United States, 42 Auditing: A Journal of Practice & Theory 75 (2023). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 working paper on smaller firm exits to support their view. However, the cited paper finds the opposite result, namely that changes in PCAOB regulations play little if any role in a firm’s decision to deregister.415 One commenter noted that smaller firm exit could also reduce the benefits associated with firms competing on the proposed metrics. One mid-sized firm said that smaller firms would have fewer issuers to spread their fixed costs over. The same commenter said the proposal would put considerable strain on firms that provide audit services to the 40% of issuers that represent the remaining, at most, 2% of capital markets. The commenter did not indicate how they believe these issuers would be impacted by the proposal. One commenter who represents CPAs said that the costs of the proposal could disproportionately impact smaller firms which could lead to the exit of some of the smaller firms. The commenter provided additional comments based on the results of a survey of small and midsized firms administered by the commenter. The commenter’s survey was distributed to the 500 largest CPA firms in the United States. Eighty-eight firms responded. The respondent firms’ revenues range from less than $10 million to greater than $500 million. The commenter provided the survey questions. All respondents that perform U.S. public company audits reported that the proposal would require a very heavy or substantial effort and would strain resources, driven in part by economies of scale. The Board notes that this data point is based on 36 survey participants, some of whom do not perform audits of accelerated filers or large accelerated filers and therefore would not be subject to the final requirements. The survey reports that 23% of respondents (approximately eight or nine respondents) would definitely or strongly consider exiting the public company audit market entirely.416 However, the survey provides no information that would help the Board assess the significance of these firms to the overall audit market or whether they even audit accelerated filers or large accelerated filers, and therefore would be impacted by the 415 See Michael Ettredge, Juan Mao, and Mary S. Stone, Small Audit Firm De-Registrations From the PCAOB-Regulated Audit Market: Strategic Considerations and Consequences. 416 Citing the result of the survey provided by this commenter, another commenter said that nearly 75% of respondents would consider eliminating their public company audit process as a result of the proposal. However, this is not what the survey found. Rather, the survey found that 50% of respondents would at least consider getting out of the public company market. PO 00000 Frm 00090 Fmt 4701 Sfmt 4703 final requirements. The survey also reports that another 25% of respondents (9 respondents) that perform U.S. public company audits would eliminate or manage their client base of accelerated filers. However, in addition to the lack of information that would help the Board assess the significance of these firms to the overall audit market, the relevance of this result is obscured by the conflation of ‘‘elimination’’ and ‘‘management’’ of accelerated filers. Finally, the commenter provided little detail on how the survey was performed (e.g., how the proposal was described to the survey participants). The potential negative consequences of firm exit could be mitigated by several factors. First, exit may be limited primarily to the smaller firms among those that would be impacted by the final rules, since smaller firms may be disproportionately impacted by the fixed costs of complying with the final rules. Reduced competition will thus tend to impact smaller accelerated filers rather than larger large accelerated filers, which typically require larger auditors. Second, there is little reason to expect exit from the market for nonaccelerated filer audits. In fact, competition may increase in the nonaccelerated filer issuer audit market to the extent firms exiting the accelerated filer and large accelerated filer issuer markets redeploy capacity to the nonaccelerated filer issuer audit market. Finally, firms that remain profitable in the accelerated filer and large accelerated filer issuer audit markets could expand their market share, perhaps by acquiring additional capacity from exiting firms. One commenter provided research suggesting that firms that exited the market following the Sarbanes-Oxley Act were not of lower quality than firms that remained.417 The Board believes the commenter implied that issuers or broker-dealers may not necessarily obtain a higher quality audit after switching to a new auditor that has remained in the market. The study acknowledged that prior research using other audit quality proxies finds the opposite result, namely, that exiting firms indeed have lower audit quality.418 Firm size is a widely accepted proxy for audit quality.419 The 417 See Neil L. Fargher, Alicia Jiang, and Yangxin Yu, Further Evidence on the Effect of Regulation on the Exit of Small Auditors from the Audit Market and Resulting Audit Quality, 37 Auditing: A Journal of Practice & Theory 95 (2018). 418 See DeFond and Lennox, The Effect of SOX on Small Auditor Exits and Audit Quality. 419 See DeFond and Zhang, A Review of Archival Auditing Research. Though firm size is widely accepted as a proxy for audit quality, it is not a E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Board’s oversight activities indicate that noncompliance with auditing standards is higher among smaller firms.420 Therefore, to the extent smaller firms tend to exit rather than larger firms, as commenters contended, then audit quality could improve on average as issuers switch to larger firms. The Board recognizes there is currently some debate on the extent to which the largefirm audit quality effect is driven by correlated issuer characteristics rather than auditor effects.421 The Board believes compliance with auditing standards is less sensitive to issuer characteristics than other audit quality proxies (e.g., absolute discretionary accruals). After assessing the available evidence, the Board believes it is likely that the firms that any issuers or brokerdealers would switch to would likely not provide lower quality audits. Two commenters said that the final rules would disproportionately impact smaller firms, leading them to increase their audit fees. Several commenters suggested that regulatory burdens incentivize companies to go or remain private. Referring to the SEC Office of the Advocate for Small Business Capital Formation Fiscal Year 2023 annual report as support (‘‘SEC Small Business Advocate Annual Report’’), one commenter highlighted that: (i) in 2022, the number of exchange-listed IPOs dropped to its lowest point since 2009; (ii) small exchange-listed companies accounted for the vast majority of the decline; and (iii) smaller companies are disproportionately impacted by regulatory costs because a large portion of regulatory costs are fixed.422 The Board agrees that the final rules could disproportionately impact the smaller in-scope firms. However, smaller issuers—those that the commenter contended are most sensitive to regulatory burden and at greatest risk of eschewing the capital markets—would be minimally impacted by the final rules for several reasons. First, firms that do not audit accelerated filers or large accelerated filers (that is, all but approximately 207 firms) would be out of scope and therefore there would be no effect on audit fees for their nonaccelerated filer issuers. Second, to the extent in-scope firms choose to pass through all or part of the cost of the final rules, they would be less likely to do so for their non-accelerated filer issuers because their audits will not be subject to the engagement-level reporting requirements. Third, the Board does not believe issuers will incur any significant fixed costs, which the commenter asserted disproportionately impact smaller companies. Therefore, any disincentive among smaller companies to participate in capital markets arising from increased audit fees would likely be minimal. Among accelerated filer and large accelerated filer issuers, the Board notes that audit fees, on average, comprise roughly 0.15% to 0.2% of issuer revenue and any increase in audit fees attributable to the final rules would be a fraction of this.423 Therefore, any disincentive among larger companies to participate in capital markets arising from increased audit fees would also likely be minimal. Fourth, while the SEC Small Business Advocate Annual Report demonstrates that smaller exchange-listed companies accounted for the vast majority of the decline in exchange-listed companies, the report also cites a paper that concludes regulatory cost itself is unlikely to explain the full magnitude of IPO decline in the United States over the past two decades.424 Indeed, PCAOB staff analysis finds that accounting fees typically comprise roughly 4.5% of the costs of an initial public offering (0.3% of the proceeds).425 With respect to the perfect predictor of audit quality. Some large firms may provide low quality audits and some small firms may provide high quality audits. 420 See, e.g., Spotlight Staff Update on 2023 Inspection Activities (Aug. 2024), available at https://pcaobus.org/resources/staff-publications and PCAOB Rel. No. 2024–005 at Figure 1. 421 See Alastair Lawrence, Miguel Minutti-Meza, and Ping Zhang, Can Big 4 Versus non-Big 4 Differences in Audit-Quality Proxies be Attributed to Client Characteristics?, 86 The Accounting Review 259 (2011); Mark DeFond, David H. Erkens, and Jieying Zhang, Do Client Characteristics Really Drive the Big N Audit Quality Effect? New Evidence from Propensity Score Matching, 63 Management Science 3628 (2017). 422 See U.S. Securities and Exchange Commission, Office of the Advocate for Small Business Capital Formation, Annual Report Fiscal Year 2023 citing an earlier working paper version of Michael Ewens, Kairong Xiao, and Ting Xu, Regulatory Costs of Being Public: Evidence from Bunching Estimation, 153 Journal of Financial Economics 103775 (2024). 423 See Ideagen Audit Analytics, 20-Year Review of Audit Fee Trends 2003–2022, (July 2023) at 16. 424 See Ewens, et al., Regulatory Costs of Being Public (explaining that non-regulatory factors—such as decline in business dynamism, shifting investment to intangibles, abundant private equity financing, changing economies of scale and scope, and changing acquisition behavior—are likely to play a more important role than regulatory cost in the decline of IPOs). 425 PCAOB staff obtained data on accounting fees and legal fees from Audit Analytics and investment bank underwriting fees from a PwC market research report. See PwC, Considering an IPO? First, Understand the Costs, available at https:// www.pwc.com/us/en/services/consulting/deals/ library/cost-of-an-ipo.html and Audit Analytics, 2018–2019 IPO Accounting and Legal Fees, (Feb. 20, 2020). PCAOB staff calculated deal proceeds by multiplying the quantity of shares issued by their price at issue. PCAOB staff calculated the accounting fee share of proceeds as the proceedsweighted average accounting fee share of proceeds across all deals in the Board’s sample. The Board VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00091 Fmt 4701 Sfmt 4703 100057 recurring costs of remaining a public company, one market research report indicates that accounting fees comprise 32% of the costs.426 Any incremental costs associated with IPOs or remaining a public company attributable to the final rules would be a fraction of these costs. In connection with their concerns regarding potential disproportionate costs to smaller firms, one commenter said the PCAOB should evaluate and identify the characteristics of investors in smaller companies and determine if the needs of investors in those companies are the same as the potential needs of investors in large companies. The Board notes that one recent working paper finds that institutional ownership is, on average, lower for smaller companies.427 Since institutional investors may be more likely to use the metrics, these data suggest that investors in smaller public companies may, on average, be less likely to use the metrics. However, the Board believes that investors in smaller companies could still benefit from the metrics because: (i) retail investors could benefit from the improved accessibility and comparability of information about firms and their engagements; and (ii) institutional ownership in smaller companies, though less than larger companies, is not trivial (41.6% for the lowest quintile of companies by market capitalization).428 Furthermore, as the Board discussed below, financial reporting quality may be relatively more important for smaller companies. Finally, the Board notes that the final rules require engagement-level reporting only for accelerated filers and large accelerated filers and firm-level reporting only for firms that audit at least one accelerated filer or large accelerated filer. This should help mitigate any concern that investors in smaller companies do not have a need for the final metrics. notes that the accounting fee share of proceeds is decreasing in deal proceeds. PCAOB staff calculated the accounting fee share of IPO costs as the ratio of all accounting fees to all IPO costs across all deals in the Board’s sample. The PCAOB staff’s analysis assumes IPO costs are equal to the sum of accounting, legal, and investment bank underwriting fees. The PwC market research report indicates that there are other IPO cost categories, but they are relatively small. 426 See PwC, Considering an IPO?. 427 See Jonathan Lewellen and Katharina Lewellen, The Ownership Structure of U.S. Corporations, SSRN Electronic Journal (2022), at Table 3. The Board notes that SSRN does not peer review its submissions. 428 Id. E:\FR\FM\11DEN2.SGM 11DEN2 100058 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices ii. Some Auditors May Strategically Manage Their Issuer Portfolios lotter on DSK11XQN23PROD with NOTICES2 As discussed above, auditors that do not audit accelerated filers or large accelerated filers will not be subject to the final reporting requirements. Some auditors may strategically seek to audit only non-accelerated filers to avoid disclosure of the final metrics, either to avoid costs of complying or out of concern that disclosing the metrics could potentially damage their reputation.429 As a result, there could be a separating equilibrium in the audit market.430 One commenter agreed that smaller firms may manage their engagement portfolios to avoid being required to comply with the final requirements and one commenter provided the results of a survey indicating that some firms may eliminate or manage their client base of accelerated filers. Assuming that lowerquality auditors are more likely to avoid accelerated filers in this way, this would increase the supply of low-quality auditors to non-accelerated filers and decrease the supply of low-quality auditors to accelerated filers. For nonaccelerated filers, this supply shock could increase competition among audit firms for non-accelerated filers and therefore reduce audit fees. However, because the supply shock would consist primarily of low-quality auditors, it could also lower audit quality for nonaccelerated filers. For accelerated filers, the opposite would occur. Reduced availability of auditors would tend to reduce competition and therefore increase audit fees. However, because higher-quality auditors would remain, audit quality could increase. As a result of these complex and countervailing influences, it is unclear whether this unintended consequence would have a net positive or negative impact. Auditors may also attempt to manage their metrics via their acceptance and 429 Commenters on proposed QC 1000 said that mid-sized firms would deliberately manage their portfolios to avoid the proposed scalability requirements that apply only to annually inspected firms. Therefore, the Board believes that such portfolio management is possible in relation to the final rules. Among the firms that will be impacted by the final rules, approximately 41%, 19%, and 11% had one, two, or three accelerated filer or large accelerated filer engagements during the 12-month period ending September 30, 2023. 430 Contextually, a separating equilibrium occurs when incentives cause a division in the market in which one type of auditor gravitates towards a particular market segment. See, e.g., Michael Rothschild and Joseph E. Stiglitz, Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information, 90 The Quarterly Journal of Economics 629, 634 (1976) (specifically, the discussion marked I.6 Imperfect Information: Equilibrium with Two Classes of Customers). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 continuance policies. Reputation risks to the auditor associated with individual engagements may start to play a greater role in firms’ acceptance and continuance decisions as well as their audit fee decisions because new engagements could impact firms’ metrics and hence their ability to charge audit fees on existing engagements. For example, a prospective issuer engagement may present a higher risk of restatement. Since restatements will be reported on Form FM in a uniform and comparable way, auditors may require a fee premium for this issuer to offset any negative effect the issuer may have on the auditor’s metrics. In extreme cases, risky issuers may not be able to find an auditor, may be forced to hire a lowquality auditor, or may be forced to delist. To avoid such adverse outcomes, issuers may take steps to reduce their contribution to audit risk.431 For example, issuers may become more forthcoming with information or opt for less aggressive financial reporting. This potential unintended consequence would also be mitigated to the extent capital markets recognize that an auditor’s metrics are driven in part by the riskiness of the auditor’s client portfolio rather than the quality of the auditor.432 Indeed, auditors will have the opportunity to explain important context like this in the qualitative portion of the final disclosures. iii. Investors, Audit Committees, and Auditors May Misinterpret or Misuse the Final Metrics As discussed above, it is possible that the final metrics may not relate to audit quality in a straightforward way. As a result, there is a risk that investors, audit committees, and auditors could misinterpret, or misuse, the final metrics (e.g., by assuming they are strongly related to audit quality). The outcomes of misinterpretation or misuse are difficult to predict because they would be rooted in complex aspects of human psychology.433 As one example, investors and audit committees could rely too heavily on a final metric (e.g., when making capital allocation or auditor selection decisions). In response 431 Economic theory suggests that private negotiations yield efficient allocations of decision rights. See Ronald Coase, The Problem of Social Cost, 3 The Journal of Law and Economics 1 (1960). 432 Some research finds that poor financial reporting outcomes are attributable to client risk rather than poor audit quality. See Minutti-Meza, Does Auditor Industry Specialization Improve Audit Quality? 433 See, e.g., Loewenstein et al., Disclosure (discussing how ‘‘[p]sychological factors severely complicate the standard arguments for the efficacy of disclosure requirements.’’). PO 00000 Frm 00092 Fmt 4701 Sfmt 4703 to market forces or requests from audit committees, some auditors could make changes to their audit approach that could negatively impact audit quality. As another example, auditors could mistakenly attribute other firms’ competitiveness to one final metric and adjust their audit approach in a way that compromises the quality of their services. Many commenters agreed that there would be a risk that users, particularly investors, of the proposed metrics would misunderstand the metrics. One commenter said the proposed metrics would be misinterpreted. The commenter suggested that this may undermine the benefits of the proposal. Another commenter said that users would not understand some of the proposed metrics. One commenter suggested that this potential unintended consequence should be acknowledged as a cost because the negative effects would be borne by investors. One commenter performed a survey of audit committee chairs.434 Some survey participants agreed that the proposed metrics could lead to inappropriate conclusions. One commenter said that the risk of misusing the proposed metrics by audit committees could lead to increased director insurance costs. One commenter said investors or other stakeholders could pressure audit committees to only appoint auditors whose metrics fall within a certain range without considering other aspects of the firm’s audit quality. One commenter said that overemphasis on metrics by auditors could commoditize the profession and reduce incentives to innovate the audit approach. The Board agrees that, as with other financial information made available to investors, some investors may misunderstand the metrics and make poor decisions as a result. If so, this could negatively impact them. However, the Board believes that the final metrics will likely, on average, improve investors’ decision-making and therefore have chosen to acknowledge improved decision-making as a benefit. The Board acknowledges that some misunderstanding could also reduce the magnitude of this benefit. However, the Board believes this unintended consequence, should it arise, would diminish over time as investors learn how to effectively integrate the final metrics into their decision-making. Though the Board believes the metrics will spur competition on quality by allowing firms to credibly differentiate themselves, the Board recognizes it is possible that some firms would 434 See E:\FR\FM\11DEN2.SGM above for more discussion on the survey. 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices coordinate their metrics. The Board discussed this potential unintended consequence below. Commenters described specific ways the proposed metrics could create confusion. Several commenters said that some of the definitions in the proposal conflict with other definitions in PCAOB standards or otherwise lead to confusion. The Board does not believe there are any direct conflicts with other PCAOB standards. The Board has attempted to draft the definitions in the proposal as precisely and clearly as possible. Commenters suggest that the ICB industry classification used for the industry specialization metric could create confusion because the SEC uses the SIC system. One commenter agreed that it is appropriate to use the ICB for industry classification. The Board acknowledges that a taxonomy based on the ICB industry classification could create some confusion. However, crosswalks between the ICB system, the SIC system, and other industry classification systems are available. The Board describes in the proposal and above why the Board based the taxonomy on the ICB system rather than the SIC system. One commenter said that the proposed restatements metrics would be difficult to compare with public data because Audit Analytics categorizes restatements in a different way than the proposed requirements would require firms to categorize them. The commenter did not explain what Audit Analytics categorization they are referring to. The Board does not believe a user of the final metrics who is also familiar with Audit Analytics data and wishes to reconcile the two data sources would find it challenging to do so. One commenter pointed to research that suggests more information, including via mandatory financial disclosure, is not always better for investors.435 Several other commenters lotter on DSK11XQN23PROD with NOTICES2 435 See Allen G. Schick, Lawrence A. Gordon, and Susan Haka, Information Overload: A Temporal Approach, 15 Accounting, Organizations and Society 199 (1990); Eugene G. Chewning Jr and Adrian M. Harrell, The Effect of Information Load on Decision Makers’ Cue Utilization Levels and Decision Quality in a Financial Distress Decision Task, 15 Accounting, Organizations and Society 527 (1990); Herbert A. Simon, Rationality in Psychology and Economics, 59 Journal of Business S209 (1986); J. Richard Dietrich, Steven J. Kachelmeier, Don N. Kleinmuntz, and Thomas J. Linsmeier, Market Efficiency, Bounded Rationality, and Supplemental Business Reporting Disclosures, 39 Journal of Accounting Research 243 (2001); Morris H. Stocks and Adrian Harrell, The Impact of an Increase in Accounting Information Level on the Judgment Quality of Individuals and Groups, 20 Accounting, Organizations and Society 685 (1995); Knechel, et al., Audit Quality; DeFond and Zhang, A Review of Archival Auditing Research; Joost Impink, Mari Paananen, and Annelies Renders, Regulation-Induced Disclosures: Evidence of VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 also suggested information overload would be a concern. The Board appreciates this research and agrees that there will be opportunity costs to understand the final metrics. However, the Board notes that investors will be free to disregard the final metrics if they find the costs to understand them exceed their benefits. Furthermore, the Board agrees with one commenter who said that technology would obviate this potential unintended consequence. Several commenters were concerned that certain calculations would drive misinterpretation. These comments are discussed above. For example, one commenter suggested that users may misinterpret the proposed headcount changes as turnover. One commenter said industry experience of audit personnel could be misleading because it does not distinguish between recent and past experience. The Board also acknowledges that some investors may misunderstand this metric and make poor decisions as a result that will negatively impact them. However, the Board believes that the final requirements would, on average, improve investors’ decision-making and therefore have chosen to acknowledge improved decision-making as a benefit. In the final rules, the Board has modified some of the scoping and calculations, which likely will reduce some of the potential for confusion. iv. Auditors May Attempt To Manipulate the Final Metrics As discussed above, the final rules could lead firms to compete on the final metrics. As a result, the Board believes some firms will take steps to provide higher service quality. However, it is possible that some firms could instead manipulate the final metrics in ways that create an impression of providing higher service quality when in fact this Information Overload?, 58 Abacus 432 (2022); Cornelius J. Casey Jr., Variation in Accounting Information Load: The Effect on Loan Officers’ Predictions of Bankruptcy, 55 Accounting Review 36 (1980); Brad Tuttle and F. Greg Burton, The Effects of a Modest Incentive on Information Overload in an Investment Analysis Task, 24 Accounting, Organizations and Society 673 (1999); Michael B. Clement, Analyst Forecast Accuracy: Do Ability, Resources, and Portfolio Complexity Matter?, 27 Journal of Accounting and Economics 285 (1999); Brian P. Miller, The Effects of Reporting Complexity on Small and Large Investor Trading, 85 The Accounting Review 2107 (2010); Christine A. Botosan and Mary S. Harris, Motivations for a Change in Disclosure Frequency and its Consequences: An Examination of Voluntary Quarterly Segment Disclosures, 38 Journal of Accounting Research 329 (2000); and John L. Campbell, Hsinchun Chen, Dan S. Dhaliwal, Hsinmin Lu, and Logan B. Steele, The Information Content of Mandatory Risk Factor Disclosures in Corporate Filings, 19 Review of Accounting Studies 396 (2014). PO 00000 Frm 00093 Fmt 4701 Sfmt 4703 100059 is not the case. For example, firms could increase training hours by introducing training that has little benefit for audit quality, or could adjust staffing in ways that they believe make their metrics look better but that do not improve audit quality. This unintended consequence will be analogous, in some regards, to earnings management by financial statement preparers.436 Some final metrics will be more difficult to manage than others. To the extent firms are able to manage a final metric, management of the final metric will tend to reduce the overall informativeness of the corresponding disclosures and could lead investors and audit committees to doubt the quality of other firms’ disclosures as well. This could degrade existing empirical relationships between the final metrics and audit quality that have been found in the literature discussed above.437 Referring to academic research, one commenter agreed that firms could try to manipulate their metrics, comparing this incentive to the incentive companies face to manage earnings.438 The same commenter agreed that firms’ attempts to manipulate could be detrimental to audit quality. The commenter also suggested that oversight by the PCAOB would create an incentive to intentionally manage the 436 See, e.g., Graham, John R., Campbell R. Harvey, and Shiva Rajgopal, The Economic Implications of Corporate Financial Reporting, 40 Journal of Accounting and Economics 3, 4 (discussing how ‘‘[a] surprising 78% of the Board’s sample admits to sacrificing long-term value to smooth earnings’’). Firms could manipulate the final metrics in ways analogous to both accountingbased earnings management and real earnings management. For example, they might adjust training hours or reported experience levels without substantive improvements (analogous to accounting-based earnings management) or make operational changes, such as altering client portfolios, solely to improve metrics (analogous to real earnings management). 437 Such behavior can be ascribed to Goodhart’s law in that, once the final metrics are disclosed and market participants act upon them, previously defined relationships change, and the final metrics may become unrelated to the alignments previously discussed. 438 See Mark S. Beasley, Joseph V. Carcello, Dana R. Hermanson, Fraudulent Financial Reporting: 1987–1997: An Analysis of US Public Companies, Committee of Sponsoring Organizations of the Treadway Commission (1999); Mark S. Beasley, Dana R. Hermanson, Joseph V. Carcello, and Terry L. Neal, Fraudulent Financial Reporting: 1998– 2007: An Analysis of US Public Companies, Committee of Sponsoring Organizations of the Treadway Commission (2010); Ilia D. Dichev, John R. Graham, Campbell R. Harvey, and Shiva Rajgopal, Earnings Quality: Evidence from the Field, 56 Journal of Accounting and Economics 1 (2013); Graham et al., The Economic Implications; and Jaime L. Grandstaff and Lori L. Solsma, Financial Statement Fraud: A Review from the Era Surrounding the Financial Crisis, 13 Journal of Forensic and Investigative Accounting 421 (2021). E:\FR\FM\11DEN2.SGM 11DEN2 100060 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 metrics. While the Board agrees that PCAOB oversight could put pressure on firms, the Board notes that, in addition to informing the Board’s selection of firms, engagements, and focus areas for review, PCAOB oversight will be focused on compliance with the final rules which should deter any efforts to manipulate the final metrics. The commenter also suggested that disclosure of the metrics may change behavior in ways that are harmful to audit quality. The commenter provided specific examples of how this could occur for the proposed internal monitoring and compensation metrics. The Board is not adopting these metrics. As discussed above, the Board believes behavioral responses to the metrics by firms would be largely beneficial. Referring to the evolution of CAMs, one commenter suggested that the metrics could become boilerplate. The Board agrees that the narrative discussion could potentially become boilerplate to some extent. However, as the quantitative calculations are not boilerplate, the Board believes the corresponding optional narrative discussion will be less susceptible to boilerplate. In general, QC 1000 should help mitigate this potential unintended consequence by explicitly subjecting the final metrics to firms’ QC systems. Furthermore, firms’ QC systems and their disclosure practices, including compliance with the final rules, will be subject to PCAOB oversight.439 The required documentation will also constrain firms’ ability to manipulate their metrics because it will allow PCAOB inspections staff to understand how the metrics were calculated.440 The Board believes the PCAOB will exercise appropriate discretion in its oversight. Furthermore, firms will also be constrained by the fact that manipulations may be detected by comparison to peers. Indeed, academic research on earnings management suggests that peer comparisons help stakeholders identify deceptive reporting practices, serving as a disincentive to manage earnings.441 Finally, the final rules require that any optional narrative disclosure should be concise and focused on the reported metrics, with a view to facilitating the 439 Some research finds that SEC oversight reduces some forms of earnings management. See, e.g., Lauren M. Cunningham, Bret A. Johnson, E. Scott Johnson, and Ling Lei Lisic, The Switch-Up: An Examination of Changes in Earnings Management after Receiving SEC Comment Letters, 37 Contemporary Accounting Research 917 (2020). 440 See above for a discussion on the final documentation requirements. 441 See, e.g., Dichev, et al., Earnings Quality: Evidence from the Field. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 reader’s understanding of the metrics. The Board believes this should help mitigate the risk that auditors would use the optional narrative disclosure to manipulate users’ perceptions of the metrics. Firms may attempt to improve their metrics by shifting resources from nonaccelerated filer engagements to accelerated filer or large accelerated filer engagements. This could reduce the quality of service on non-accelerated filer engagements. However, subject to the audit labor market concerns discussed below, firms would be able to mitigate this effect by acquiring additional resources for their accelerated filer and large accelerated filer engagements (e.g., hiring additional staff). Furthermore, the effect would be mitigated by the fact that nonaccelerated filers have additional time to file their financial statements with the SEC compared to accelerated and large accelerated filers. Firms may also attempt to improve certain metrics by shifting resources within an engagement. For example, a firm may attempt to reduce its workload metrics by shifting manager audit hours to more junior staff. However, attempting to do so may not be beneficial to firms because it could at the same time degrade other metrics. For example, if a firm attempted to reduce its workload metrics by shifting manager audit hours to more junior staff, it would at the same time reduce their partner and manager involvement metrics. Furthermore, the firm’s QC system operates over all its PCAOB engagements and should limit the extent to which resources can be diverted. v. Audit Labor Market Impacts The final metrics could lead to increased public scrutiny of firms and their engagements. This could negatively impact the issuer audit labor market if individual auditors believe the increased public scrutiny negatively impacts their personal reputations or otherwise increases their work pressures. Some commenters agreed that the proposed requirements could make the audit market less attractive to auditors.442 One commenter suggested 442 One commenter referred to a market research report that finds downwards trends in the number of accounting graduates and the number of hires but upwards trends in the number of new CPA candidates. See Association of International Certified Professional Accountants, 2021 Trends: A Report on Accounting Education, the CPA Exam and Public Accounting Firms’ Hiring of Recent Graduates, (2022). The commenter also referred to an article discussing the perceived talent shortage, firms’ efforts to address it, and commentators views. See Stephen Foley, Accountants Work to Shed ‘Boring’ Tag Amid Hiring Crisis, Financial Times (Oct 3. 2022). PO 00000 Frm 00094 Fmt 4701 Sfmt 4703 that the potential negative impact on individual auditors could lead individual auditors to exit the labor market which would in turn drive up labor costs to audit firms. The commenter suggested this could potentially increase labor costs for issuers as well to the extent audit firms seek to hire individuals from issuers that have relevant industry experience.443 Based on discussions with audit committee chairs, one commenter said that survey participants were ‘‘very concerned’’ that the proposal could render the profession less appealing to new auditors.444 Referring to a survey commissioned by the commenter’s parent organization, one commenter reported that, among undergraduate accounting majors not pursuing or undecided on CPA licensure, 94% cite the regulatory environment as either a major or partial reason.445 The Board notes that this statistic ignores the facts that: (i) undergraduate accounting majors not pursuing or undecided on CPA licensure reflect just 20% of the participants in the survey (80% of the participants in the survey are planning to pursue a CPA); and (ii) respondents to the question were allowed to select multiple reasons. Indeed, 10 out of 14 of the possible reasons were cited by over 85% of the respondents as a major or partial reason for not pursuing or being undecided on CPA licensure. Thus, the findings suggest, at most, that the regulatory environment is one of many factors discouraging some students from pursuing a CPA. Furthermore, one commenter suggested that, rather than the regulatory environment, the 150-credit hour requirement to apply for a CPA license and work-life balance concerns are the key reasons college graduates are discouraged from becoming auditors. The commenter said that the challenges finding qualified auditors are especially pronounced for smaller firms. The Board notes that individual auditors could also use the final metrics to gain insights into workplace conditions and find firms more suitable 443 In the context of this comment, the commenter referred to an academic article where discussion on dysfunctional manager and investor behavior in response to differential audit quality could be found. The Board is unsure how such a discussion or the article itself are relevant to the topic at hand. See Patrick J. Hurley, Brian W. Mayhew, Kara M. Obermire, and Amy C. Tegeler, The Impact of Risk and the Potential for Loss on Managers’ Demand for Audit Quality, 38 Contemporary Accounting Research 2795 (2021). 444 See above for more discussion on the survey. 445 See Center for Audit Quality, Increasing Diversity in the Accounting Profession Pipeline: Challenges and Opportunities, (July 2023). E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 to their skillsets and workplace preferences. This may lead firms to compete for labor by improving their workplace conditions. One commenter explained that the industry’s challenges attracting staff may be driven in part by the commodification of the audit, which the proposal would help reduce by providing transparency around the quality of the audit. The same commenter agreed that the proposed metrics could empower potential employees when shopping for a potential audit firm employer. One commenter said that the firmlevel retention metric could present firms with a competitive disadvantage for recruiting talent if high turnover rates are provided without sufficient context (e.g., changes in firm structure, shifting industry concentrations, eliminating personnel due to performance or ethical concerns, independence issues resulting in the departure of firm personnel, etc.). The retention metric may result in additional recruiting costs to some firms. However, the Board believes that auditors will benefit from using this metric to shop for employers. Firms would also be able to provide additional context through the optional narrative disclosure. Some commenters said that the costs would be increased by the need to implement multiple significant PCAOB standards at the same time.446 Relatedly, one commenter said that the costs would be exacerbated by the proposed timing for Form FM, which would fall during the same time as PCAOB inspections and the QC system evaluation. The Board acknowledges that the issuer audit labor market may be relatively inelastic in the short run, particularly so given recent concerns about inadequate labor supply, which could increase the cost implications of the additional staffing that would be required to implement multiple PCAOB standards in relatively quick succession. This could exacerbate the costs of the final rules or lead to improper implementation. vi. Litigation and Reputations Risks Two commenters suggested that the proposed rules would exacerbate audit firm litigation and reputation risks. One commenter performed a survey of audit committee chairs.447 Some participants in the survey agreed that the proposal could create litigation and reputation risk. Regarding litigation risk, the Board 446 Commenters’ concerns about the cumulative impacts of multiple PCAOB standards and rules with overlapping implementation periods including potential benefits are discussed above. 447 See above for more discussion on the survey. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 agrees that plaintiffs’ lawyers may use the final metrics to support their cases. Supporting this view, some research finds that PCAOB inspection reports with audit deficiencies are positively associated with the number of lawsuits subsequently filed against the inspected auditor.448 However, while the Board acknowledges this could encourage some frivolous lawsuits, the Board believes it would largely contribute positively to audit quality as it would create an incentive for firms to produce high quality audits. Indeed, the Board believes it would help drive more competition on audit quality, a criterion that the same commenter urged the Board to consider. Regarding reputation risk, the Board believes that the impact on reputation is central to the intended impacts of the final rules. vii. Tacit Collusion Some commenters suggested that the proposal could have anticompetitive effects. One commenter analogized the proposed metrics to (i) the sharing of compensation practices in the poultryprocessing market; (ii) information sharing in healthcare; and (iii) information benchmarking in the meatpacking market. Relatedly, several commenters suggested that the proposed metrics could reveal competitively sensitive information. The Board acknowledges commenters’ concerns about potential anticompetitive effects which, if obtained, could reduce quality or increase price. For example, in addition to the largely procompetitive effects discussed in the proposal and above, there could be an offsetting negative effect on competition to the extent the final metrics facilitate tacit collusion among audit firms.449 Some research suggests that public disclosure can negatively impact competition. For example, one academic study suggests that U.S. public companies opportunistically use their public financial disclosures to tacitly collude.450 Another academic study 448 See, e.g., Brant E. Christensen, Nathan G. Lundstrom, and Nathan J. Newton, Does the Disclosure of PCAOB Inspection Findings Increase Audit Firms’ Litigation Exposure?, 96 The Accounting Review 191, (2021). 449 Tacit collusion refers to coordinated action among competitors intended to raise profits that does not involve explicit communication. See, e.g., Rama Cont and Wei Xiong, Dynamics of Market Making Algorithms in Dealer Markets: Learning and Tacit Collusion, 34 Mathematical Finance 467 (2024). The concentrated nature of the audit market may enhance the possibility of tacit collusion. 450 See Thomas Bourveau, Guoman She, and Alminas Žaldokas, Corporate Disclosure as a Tacit Coordination Mechanism: Evidence from Cartel Enforcement Regulations, 58 Journal of Accounting Research 295 (2020) (finding that ‘‘after a rise in cartel enforcement, U.S. firms start sharing more PO 00000 Frm 00095 Fmt 4701 Sfmt 4703 100061 shows that public disclosure of transaction-level pricing data by Danish antitrust authorities led to an increase in prices for ready-mix concrete.451 Similarly, another academic study shows that legacy airlines use their earnings calls to coordinate capacity reductions on competitive routes.452 However, this research may not necessarily apply to the audit market. For example, the relationship between competition and audit quality is ambiguous with some research suggesting that increased competition is negatively associated with audit quality.453 As a result, to the extent the final rules facilitate tacit collusion, this effect could either raise or lower audit quality in certain segments of the market. By contrast, the Board believes the procompetitive effects of the final rules described above will be significant due to the dearth of information currently available to audit committees and investors. Furthermore, competition in the audit market is limited by the presence of switching costs, reducing firms’ incentives to tacitly collude. viii. Opportunistic Behavior by Preparers One commenter suggested that financial statement preparers may be able to use the proposed metrics to evade their auditor’s scrutiny.454 The Board agrees that preparers might be able to exploit some of the final metrics in this way (e.g., partner and manager involvement) but for others it will be detailed information in their financial disclosure about their customers, contracts, and products. This new information potentially benefits peers by helping to tacitly coordinate actions in product markets.’’). 451 See Svend Alb#k, Peter M<llgaard, and Per B. Overgaard, Government-Assisted Oligopoly Coordination? A Concrete Case, 45 The Journal of Industrial Economics 429 (1997). 452 See Gaurab Aryal, Federico Ciliberto, and Benjamin T. Leyden, Coordinated Capacity Reductions and Public Communication in the Airline Industry, 89 Review of Economic Studies 3055 (2022). 453 See, e.g., Yue Pan, Nemit Shroff, and Pengdong Zhang, The Dark Side of Audit Market Competition, 75 Journal of Accounting and Economics 101520 (2023) (explaining how greater competition can, on one hand, ‘‘foster audit process innovation’’ and, on the other hand, lead auditors to ‘‘focus on appeasing clients by reducing professional skepticism and allowing clients excessive financial reporting discretion’’) and cites therein. The Board notes that controlling for all potential drivers of audit quality and fees is challenging. As such, the results obtained by these studies may be affected by omitted variable biases. 454 The commenter referred to two articles about ‘‘the fraud diamond,’’ a heuristic that approximates the conditions under which fraud may occur. See David T. Wolfe and Dana R. Hermanson, The Fraud Diamond: A 20-year Retrospective, The CPA Journal 16 (2024) and David T. Wolfe and Dana R. Hermanson, The Fraud Diamond: Considering the Four Elements of Fraud, The CPA Journal 38 (2004). E:\FR\FM\11DEN2.SGM 11DEN2 100062 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices less likely (e.g., restatements). The effect will be limited by the fact that preparers already have some familiarity with their auditor’s processes. For example, auditors are required to provide a variety of audit committee communications which preparers may be privy to.455 Indeed, one key premise of the economic analysis is that auditors and preparers have better information than investors and audit committees do about the audit process and outcomes. The same commenter suggested that financial statement preparers could use the proposed metrics to shop for a lower quality auditor. The Board agrees this will be possible but, as the Board discussed in the proposal and above, the Board believes that the public nature of the metrics will tend to suppress this. More specifically, the broader financial statement user community will be able to observe how auditor switches correlate with company characteristics and firms’ metrics and judge the company’s financial reporting quality, and the audit committee’s execution of its auditor oversight responsibilities, accordingly. However, the Board acknowledges that, because companies will be better informed about the nuances of the audit process, the final metrics could make it easier for some companies to shop for a lower quality auditor without significant negative consequence. lotter on DSK11XQN23PROD with NOTICES2 ix. Attention Diversion One commenter suggested that the proposed rules could reduce audit quality by diverting engagement teams’ attention away from other activities. Another commenter suggested that this risk would be greater for smaller audit firms and provided numerous research articles suggesting that auditors are overburdened.456 The same commenter suggested that the PCAOB should, as a starting point, consider whether the proposed metrics place burdens on engagement teams that would distract them from audit quality. Several commenters suggested that the time required to prepare the proposed metrics would necessarily divert attention from audit work and thus reduce audit quality. One commenter suggested that strains on the audit labor market could increase audit deficiencies. Another commenter suggested that the proposed metrics 455 See AS 1301. Kimberly D. Westermann, Jeffrey Cohen, and Greg Trompeter, PCAOB Inspections: Public Accounting Firms on ‘‘Trial’’, 36 Contemporary Accounting Research 694 (2019); Persellin, et al., Audit Perceptions. 456 See VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 would distract audit committees from their oversight responsibilities. The Board acknowledges that the final rules could require some engagement team members’ time. For example, some engagement team members may be tasked with gathering information from the engagement team and forwarding it to the national office (e.g., experience, hours). Subject to the audit labor market concerns discussed above, firms will be able to relieve some of this burden by hiring additional staff or by centralizing or automating certain aspects of the implementation effort.457 The Board also rejects the premise that the presence of any engagement-level burden should automatically disqualify a metric. Such a criterion ignores the metric’s associated benefits. Regarding audit committees, as discussed in the proposal and again above, the Board recognizes that audit committees could incur costs understanding the metrics. One type of cost could be the opportunity cost associated with spending less time on other oversight activities to the extent audit committees choose to do so. However, the Board notes that audit committees could minimize this opportunity cost by spending more total time overseeing the audit. Also, the various ways the final metrics would improve audit committee oversight is discussed above. x. Non-PCAOB Registered Firms One commenter suggested the proposed metrics could have cost implications for non-PCAOB registered firms. The Board agrees. For example, non-substantial role firms may incur costs providing information to firms subject to the final requirements. However, they already should be providing total audit hours for Form AP reporting purposes. Also, any incremental cost will be limited to the Partner and Manager Involvement and Allocation of Audit Hours final metrics. xi. Unintentional Engagement-Level Disclosures Several commenters said that, for firms that issue a limited number of audit reports for accelerated filers and large accelerated filers, many of the firm-level metrics could result in the disclosure of engagement-level information.458 One commenter cited the internal monitoring metric as an example. However, for most of the final firm-level metrics, corresponding 457 See above. the firms that will be impacted by the final rules, approximately 41%, 19%, and 11% had a total of one, two, or three accelerated filer or large accelerated filer engagements, respectively, during the 12-month period ending September 30, 2023. 458 Among PO 00000 Frm 00096 Fmt 4701 Sfmt 4703 engagement-level information will also be publicly available independent of the public disclosure of the firm-level metric itself. The Board does not believe that the possibility of making engagement-level inferences from the final metrics that are required only at the firm level would impose costs on firms. Furthermore, the Board notes that the proposed internal monitoring metric is not among the final metrics. Alternatives Considered The development of the final rules involved considering alternative approaches to address the problems described above. This section explains: (i) why standard setting is preferable to other policy-making approaches, such as providing interpretive guidance or enhancing inspection or enforcement efforts, (ii) other standard-setting approaches that were considered, and (iii) key policy choices made in determining the details of the final standard-setting approach. 1. Why Standard Setting Is Preferable to Another Approach As potential alternatives to standard setting, the Board considered whether interpretive guidance or greater focus on inspections or enforcement could better address the need described above. One commenter suggested the PCAOB could communicate to stakeholders observations related to audit quality based on the outcomes of its inspections and its enforcement actions, noting that the PCAOB has unique access to information and people and has the context to understand quality risks. The Board determined that, despite longterm requests by investors to disclose additional metrics, similar initiatives by other standard setters, and the apparent ability of firms to voluntarily disclose metrics, the fact that most auditors have not voluntarily acted to disclose effective metrics on a uniform basis at the firm and engagement level points to the need for regulatory intervention through standard setting. Increased focus on inspections or enforcement is unlikely to incentivize audit firms to voluntarily disclose the final metrics. Likewise, interpretive guidance is unlikely to address audit firms’ lack of incentives to voluntarily disclose the final metrics. While some firms may choose to disclose information similar to the final metrics voluntarily, the lack of a standardized approach would result in inconsistencies that prevent effective comparisons across the profession. Similarly, standardization without mandated disclosure is not sufficient to ensure the availability of comparable E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 public reporting of metrics.459 As discussed above, required mandatory and uniform reporting will help audit committees make more informed decisions in retaining and monitoring auditors, and investors make more informed decisions when ratifying auditor appointments, electing board members (including those who serve on the audit committee), and allocating capital. The Board believes that standard setting addresses the problem in the most effective way. One commenter said that the commenter’s experienced implementing the Form AP amendments proved to them that calculations require a robust implementation support infrastructure. Several commenters suggested that guidance regarding the final amendments would reduce the complexity and challenges associated with calculating the metrics. One commenter said that guidance would be essential to balance the costs of compiling and reporting the information and this guidance should extend to the evaluation of differences that may arise in the disclosure of participating firms on Form AP. Another commenter said that the Board should clarify whether the current Form AP Staff Guidance regarding amendments would extend to all metrics as well as how routine corrections and re-allocations of time entries and other matters affecting metrics reported on Forms FM are expected to be handled.460 The Board acknowledges that guidance could help reduce the complexity and costs associated with implementing the final rule. As discussed above, the Board will monitor for issues and consider updates to implementation guidance as appropriate. 2. Other Standard-Setting Alternatives Considered During the development of the final rules, the Board considered two alternatives to the current disclosure rules: (i) publishing benchmarks on the final firm and engagement metrics, and (ii) requiring additional audit committee communications. First, the Board considered collecting the final metrics from the firms on a non-public basis and then publicly publishing benchmarks based on those metrics. This approach would benefit the Board in the ways described above. However, the Board believes that investors and audit committees will be able to effectively interpret the final 459 See, e.g., Patrick Bolton and Marcin T. Kacperczyk, Firm Commitments, SSRN Electronic Journal (2024). The Board notes that SSRN does not peer review its submissions. 460 See PCAOB Staff Guidance on Form AP. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 metrics in their disaggregated form when made directly available to the public. Therefore, public transparency will be important. Moreover, as discussed above, benchmarking could even have potentially harmful unintended consequences. Second, the Board considered requiring auditors to communicate the final metrics just to their audit committees and not to members of the public. One commenter suggested that the benefits of the proposal would be the same under this alternative. However, such a policy choice would not directly benefit the decision-making capabilities of investors and other stakeholders in the public securities markets. Moreover, it would limit audit committees’ ability to compare the final metrics across different firms and engagements and thus impair their decision-making (e.g., auditor selection) by depriving audit committees of the broader context needed to make informed choices. One commenter suggested that the Board adopt a specific plan to conduct a PIR. The Board has an established PIR program under which staff of the Office of Economic and Risk Analysis (OERA) conduct an analysis of the overall effect of new rules or amendments on key stakeholders in the audit process, including whether the rules or amendments are accomplishing their intended purpose and identifying benefits, costs, and unintended consequences flowing from them. In determining whether to conduct a PIR, PCAOB staff will consider the nature of the rules or amendments (including the magnitude of and degree of uncertainty around the key economic effects), the feasibility (including research design and data availability), and the potential utility to the Board (including whether the PIR might identify a demand for additional guidance or amendments). Under the established PIR program, the Board expects that OERA staff will consider whether, based on these factors, a PIR might be warranted and, if so, OERA staff will recommend that the Board determine to conduct one. In other words, this deliberation should take place without any commitment. By contrast, a commitment to conduct a PIR can be counter-productive if OERA staff would otherwise determine that a PIR is not warranted or feasible. In addition, a well-designed PIR is one that is itself based on some early experience (even if only anecdotal), and thus, the Board believes having a specific plan of PIR at this stage may be premature. The Board believes having an established PIR program tends to increase the net expected value of the PCAOB’s adopted PO 00000 Frm 00097 Fmt 4701 Sfmt 4703 100063 rules and standards. Should future PIRs lead to potential modification or revision of these rules and standards, this dynamic approach to assessing the impact of the PCAOB’s rules and standards compares favorably with a static analysis of costs and benefits.461 Several commenters that opposed aspects of the rulemaking suggested that the Board should pilot test the final rules. One commenter suggested pilot testing would allow the PCAOB to obtain feedback on the nature, timing, extent, and usefulness of reporting. The commenter referred to a pilot program planned by another regulator. Another commenter said that pilot testing should occur prior to adoption of the final rules to confirm whether the final metrics can be consistently collected and reported by firms and whether they would be useful to stakeholders. One commenter suggested that pilot testing would provide the Board with data to quantitatively estimate the economic impacts of the proposal. The Board agrees that a pilot study could theoretically provide useful preliminary compliance data.462 For example, a pilot study could provide insights on the impacts of the proposed requirements or alternative approaches. However, the Board believes several concerns would challenge the utility of such an approach. First, participation in a pilot study would likely be voluntary, potentially with a limited group of participating firms, which may not be representative of all firms. This could skew results and would limit the applicability of any findings to a broader set of firms. Second, the impacts of the metrics on competition and capital allocation in the markets are complex and may require analysis across a broad set of firms and market conditions. A pilot study would not capture this diversity or the broader impacts on competition and capital markets, potentially leading to 461 See, e.g., Yoon-Ho Alex Lee, An OptionsApproach to Agency Rulemaking, 65 Administrative Law Review 881 (2013); see also OMB Circular A–4 at 69 (‘‘The assessment of real options allows you to monetize the benefits and costs of changing the timing of regulatory effects in light of the value of information about potential states of the world that can be learned over time.’’). In short, when a policy is reversible (as in the case with the final rules) and the policy outcome is probabilistically determined between an efficient outcome and an inefficient outcome, a case can be made for moving forward with the policy even when the net expected benefit under the static costbenefit analysis is negative because of the option of repealing the policy in the future in case the inefficient outcome is realized. 462 See Admin. Conf. of the U.S., Recommendation 2017–6, Learning from Regulatory Experience, 82 FR 61738 (Dec. 29, 2017), available at https://www.acus.gov/recommendation/learningregulatory-experience. E:\FR\FM\11DEN2.SGM 11DEN2 100064 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices incomplete or misleading conclusions. Third, the full implications of the metrics on competition and capital formation might take several years to manifest, as stakeholders would need time to adapt to and fully integrate the final metrics effectively. This delay could postpone the benefits expected from the final rules, especially if the pilot study would need to run for multiple years to capture the necessary information and trends. Finally, as stakeholders (including firms, issuers, investors, and others) adapt to the new metrics, their behaviors and the resulting data might change over time, potentially rendering early data from a pilot study less relevant or useful for long-term policy decisions. For these reasons, a pilot study, while potentially yielding some initial insights, would have limited overall benefits in this case. It would not offer a comprehensive view of the metrics’ implications across the entire spectrum of firms and could unduly delay the transparency objectives of the rulemaking. The Board notes that the proposal considered the work of other regulators, including the planned pilot study referred to by one of the commenters.463 That discussion appears above in substantially the same form. 3. Key Policy Choices During the development of the final rules, the Board considered different approaches to addressing key policy issues. i. Definitions and Calculations of the Final Metrics The Board considered a variety of alternative definitions and calculations of the final metrics, including several suggested by commenters and those initially proposed. See above for a discussion of these considerations. lotter on DSK11XQN23PROD with NOTICES2 ii. Applicability The conditions under which firms will be required to comply with the final engagement and firm-level reporting requirements are described above. During the development of the final rules, the Board considered limiting applicability to firms that met a certain aggregate issuer market capitalization threshold. The Board also considered broadening the set of applicable filer statuses. The Board noted that compared to the proposed approach, an aggregate issuer market capitalization threshold could help focus the final rules on auditors 463 See FRC, Consultation Document: Firm-level Audit Quality Indicators. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 and engagements that investors are most interested in. Commenters during the development of QC 1000 indicated that a threshold based on market capitalization was perhaps preferable to a threshold based on issuer count because many auditors audit numerous small engagements with limited operations (e.g., special purpose acquisition companies). However, such an approach could present challenges. As one commenter noted, thresholds based on market capitalization may be subject to the volatility of the market. During a review of the potential methodologies, the Board found that such a threshold would also be sensitive to auditor switches, particularly if the switching issuer had a large market capitalization. Some auditors near the threshold could move back and forth between applicability and nonapplicability. The Board also considered alternative transition thresholds for market capitalizations, or a phase-out period in attempting to mitigate the negative aspects of these options. Ultimately, the Board has determined that there was limited benefit to using these alternative applicability thresholds.464 The Board also considered broadening the applicability of the final firm-level metrics to include all firms that audited at least one operating company. This would increase the number of firms impacted by the final firm-level metrics by approximately 160 and increase the number of engagements and market capitalization covered by the final firmlevel metrics by approximately 16% and less than 0.1%, respectively.465 Expanding the scope to cover all firms that audit at least one operating company could reduce any potential negative stigma associated with smaller firms for not being required to disclose the final metrics. However, these firms tend to be smaller and hence may lack the infrastructure and economies of scale to efficiently implement the final rules. Furthermore, the gain of information to audit committees and investors would be limited by the fact that these firms tend to have smaller or fewer issuers on average. It also could create confusion to have different thresholds for the final firm-level reporting requirements and the final engagement-level reporting requirements. Finally, firms that will not be subject to the final firm-level 464 See above for a discussion of phased implementation. 465 See above for discussion on data sourcing. The Board excludes firms that filed an audit opinion during the sample period but whose registration has since been withdrawn, revoked, or is pending withdrawal. PO 00000 Frm 00098 Fmt 4701 Sfmt 4703 disclosure requirements could voluntarily disclose the final metrics. The Board also considered broadening applicability of the final engagementlevel metrics to include non-accelerated filer issuers. While the importance of audit quality may be more significant for smaller issuers,466 PCAOB staff analysis finds that non-accelerated filers are proportionately smaller—at the median—than accelerated filer and large accelerated filers in terms of audit fees and total assets.467 One survey of audit committees of smaller public companies found that five of the 28 metrics discussed in the Concept Release were evaluated by more than half of the audit committees surveyed.468 PCAOB staff also reviewed the relative trading volume associated with these filer status groups and found that non-accelerated filer issuers have higher average daily (unit) volume than accelerated filer issuers but lower average daily (unit) volume than large accelerated filers.469 466 See below for additional discussion. on 2023 fiscal year data sourced through Audit Analytics’ Web service, nonaccelerated filers paid median audit fees of $320,000 and had median total assets of $66 million. Comparatively, accelerated filers paid median fees of $1,300,000 and had median total assets of $765 million. Large accelerated filers paid median fees of $3,010,000 and had median total assets of $5,509 million. Only issuers filing pursuant to the Exchange Act (a.k.a. Act–34 filers) were retained in the sample. 468 See, e.g., Harris and Williams, Audit Quality Indicators. 469 Sourcing data across the University of Chicago’s Center for Research and Security Prices (CRSP) Annual flat-file to collect annual volume, along with Compustat, and Audit Analytics, the Board identified, using filer statuses reported by Audit Analytics, that the median average daily volume (the quantity of share units traded per year divided by 252 trading days) for large accelerated filers in 2020 and 2021 was roughly 867,000 units per day and 762,000 units per day, respectively. For accelerated filers, the average daily volume was 183,000 and 168,000 respectively. For nonaccelerated filers, the average daily volume was 528,000 and 756,000, units per day, for 2020 and 2021. One reason for this is possibly the relatively lower share price non-accelerated filer issuers have, resulting in a higher unit-volume (per trade lot) compared to accelerated filer issuers. The Board maintains share codes 10, 11 (i.e., U.S. issuers), and 12 (foreign issuers trading on U.S. exchanges) in the Board’s analysis, and remove American depositary receipts, shares of beneficial interest, real estate investment trusts, SBIs, REITs, and closed-end funds. Additionally, the Board retains only Exchange Act 1934 filers and volumes related to the first audit opinion filed with the SEC for a given fiscal year. Filer status, as sourced through Audit Analytics, may be an imperfect proxy of the true filer status of the entity-issuer due to errors in reporting and or collection. Furthermore, the Board retains only observations in which there is recorded to be complete volume for the entire annual period. There were 1,350 large accelerated filer issuers in the Board’s sample in 2020, and 1,358 in 2021. For accelerated filers there are 337 and 329 issuers in each 2020 and 2021 that remain in the Board’s sample, and for non-accelerated filers there are 121 and 134 issuers, respectively. The Board attempts to remove issuers additionally classified as Small 467 Based E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Neither issuer group, in general, was ‘‘thinly traded,’’ as measured by average daily volume.470 Given these differences, the costs of the final rules associated with non-accelerated filer issuer engagements could be proportionally higher than the costs associated with accelerated filer or large accelerated filer issuers engagements. As a result, the Board has restricted the applicability of the final engagementlevel metrics to accelerated filer and large accelerated filer engagements. Firms that will not be subject to the final engagement-level disclosure requirements could voluntarily disclose the final metrics. The Board also considered whether the scope for engagement-level reporting should be extended to non-operating company issuers whose financial statements are required under SEC rules to be audited under PCAOB standards (i.e., investment companies, employee stock plans) and broker-dealers. While these additional disclosures could be informative, commenters indicated that the proposed metrics would be less beneficial for these entities compared to accelerated filers and large accelerated filers.471 The Board agrees, and therefore are not requiring disclosure of these metrics for issuers that are not accelerated filers or large accelerated filers under the final rules. iii. Reporting lotter on DSK11XQN23PROD with NOTICES2 Several commenters suggested that the Board could alleviate the burden on smaller firms by raising the reporting threshold. One commenter said that firms that issue audit reports for 100 issuers or more are the firms whose metrics investor-related groups would be most interested in reviewing, given these firms audit a significant majority of the market capitalization of issuers reporting on Form 10–K, Form 20–F, and Form 40–F. Another commenter suggested a threshold of 25 or more large accelerated filer and accelerated filer issuer engagements combined. The same commenter said that metrics of firms with few engagements could be unduly influenced by a single Reporting Companies from the reported statistics. Lastly, not all issuers, particularly smaller issuers, trade on exchanges observed in the CRSP data set— as a result the Board’s sample may be biased towards larger issuers, or issuers that trade on exchanges observed by CRSP. 470 For a discussion of ‘‘thinly traded’’ markets, see Division of Trading and Markets: Background Paper on the Market Structure for Thinly Traded Securities, Roundtable on Market Structure for Thinly Traded Securities (April 23, 2018), available at https://www.sec.gov/rules/policy/2019/thinlytraded-securities-tm-background-paper.pdf. 471 See above for additional discussion on commenters’ views on this alternative. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 engagement. By contrast, one commenter suggested making the reporting requirements apply to all PCAOB-registered firms. As discussed in the proposal and above, the Board recognizes the potential disproportionate cost to smaller firms and have considered this in the Board’s decision to scope in all firms that audit at least one accelerated filer or large accelerated filer.472 The Board believes audit committees and investors will benefit from information related to the audits of accelerated filers and large accelerated filers and the firms that perform these audits. Two commenters agreed that the proposed scope captures situations where investment and proxy voting decisions would be most likely to benefit from additional information about the audit and the auditor. As discussed above, firms subject to the final engagement-level reporting requirements will be required to disclose the final engagement-level metrics in Form AP, to be filed by the 35th day (for most audits) after the date the audit report is first included in a document filed with the SEC. Firms subject to the final firm-level reporting requirements will also be required to disclose the final firm-level metrics in the newly created Form FM. As contemplated above, the Board considered requiring that the final metrics be included in the audit report in addition to on Form AP and Form FM. Under this alternative, costs incurred by investors and audit committees when gathering information to inform their decision-making could be further reduced. Investors would be able to look down from the auditor’s opinion and immediately review the final metrics. Moreover, this would serve as a prime opportunity for the firm to communicate critical context through narratives that might be beneficial for investors in reviewing the final metrics. The disclosure of the proposed metrics in the audit report would not impair the usefulness of their disclosure through Form AP and Form FM. Indeed, such additional reporting may enhance their usefulness by setting the proposed metrics within the full context of the issuer’s financial reporting. However, some investors and audit committees may prefer to obtain the information from Form AP and Form FM, or from other sources (e.g., a subscription-based data provider), and hence may find little use for metrics in the audit report. There likely would not be appreciable costs associated with this additional reporting, outside of costs to include the 472 See above for additional discussion on this policy alternative. PO 00000 Frm 00099 Fmt 4701 Sfmt 4703 100065 report in the filing of the audit opinion. Firms will already be required to collate information and compute the final metrics for reporting to the PCAOB in their relevant forms. Many commenters disagreed with this approach citing that, for example, it could potentially detract from the clarity and purpose of the report, could result in delays in the issuance of audit reports, and amendments to the audit report for corrections to metrics could create unnecessary burden for issuers and confusion for investors. One commenter suggested the proposed metrics would be better placed in audit committee reports in company proxy statements. One commenter said that the proposed metrics: (i) would create a misimpression that the metrics are indicative of audit quality; (ii) would be impractical to implement in a timely manner; and (iii) could distract auditors. However, several commenters, primarily investor-related groups, were supportive of reporting in the auditor’s report. One commenter said that the proposed engagement performance metrics are as important to understanding audit risks as CAMs and thus merit inclusion in the auditor’s report. The Board is persuaded by commenter feedback that this alternative would be burdensome and could diminish the value of the auditor’s report. Therefore, the Board is not adopting this alternative at this time. The Board also considered requiring firms subject to the final firm-level reporting requirements to disclose the firm-level metrics on Form 2 rather than Form FM. This approach could benefit some investors or audit committees because the firm-level metrics would appear in the context of other firm-level information. It could also reduce compliance costs for firms because firms are already familiar with Form 2. However, information reported on Form 2 is currently not downloadable as a structured data set. This could reduce the accessibility of the final firm-level metrics to investors and audit committees. Furthermore, the final firmlevel metrics use terms that have different meanings in the context of Form 2 (e.g., ‘‘Partners’’). This could lead some investors or audit committees to misunderstand the final firm-level metrics or lead some firms to mistakenly provide incorrect information in Form 2. Finally, the due date of Form 2, June 30, falls after the general timing of shareholder meanings and therefore would generally arrive too late to inform shareholders’ voting decisions. This alternative and commenter feedback are discussed above. Overall, the Board is persuaded by commenters’ concerns E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100066 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices that this alternative would place burdens on firms during their busy season. Therefore, the Board is not adopting this alternative at this time. While several commenters suggested that the Board limit the disclosure of engagement-level metrics to audit committees—citing audit committees’ ability to engage in dialogue with the auditor and to understand the context of the metrics—the Board believes public disclosure will provide the benefits associated with investor decisionmaking as well as some benefits related to improved audit committee decisionmaking. For example, public disclosure allows investors to make more informed decisions regarding board directors (including audit committee members), and auditor ratification. It also will provide audit committees with comparative information about other firms and engagements which may improve their auditor selection and oversight decisions. Furthermore, the Board believes that the public nature of the metrics will be a key driver of the pro-competitive effects in the auditing market, by making it easier to compare an existing auditor’s metrics to the same metrics for other potential auditors. The Board therefore believes public transparency will foster a competitive auditing environment and support robust governance by providing all stakeholders, not just audit committees, with information to make well-informed decisions. Two commenters suggested the Board refer to work performed by the SEC when it considered requiring additional audit committee disclosures.473 One commenter suggested that the 2015 SEC Concept Release could inform the Board’s consideration of requiring auditors to disclose engagement-level metrics to audit committees only. Staff reviewed the 2015 Concept Release. The 2015 SEC Concept Release sought comment on, among other things, whether the reporting of additional information by the audit committee with respect to its oversight of the audit may provide useful information to investors as they evaluate the audit committee’s performance in connection with, among other things, their vote for or against directors who are members of the audit committee, the ratification of the auditor, or their investment decisions. The Board believes this request for comment is consistent with the questions included in the Board’s proposal, the feedback from investor473 See SEC Concept Release on Possible Revisions to Audit Committee Disclosures, SEC Rel. No. 33–9862 (July 1, 2015) (‘‘2015 SEC Concept Release’’). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 related groups the Board received, and the Board’s view that investors need more information to: (i) evaluate the performance of auditors and audit committees; (ii) vote for or against directors who are members of the audit committee; (iii) ratify the appointment of the auditor; and (iv) invest capital. The 2015 SEC Concept Release also stated that to the extent the audit committee uses indicators or metrics in assessing the quality of the auditor and the audit, disclosure about the use and consideration of such metrics may provide useful information about the audit committee’s process for assessing the auditor. The Board notes that the relevance of the 2015 SEC Concept Release is limited by the fact that it: (i) contemplates public disclosures by audit committees rather than by auditors; and (ii) aims to solicit feedback rather than provide a costbenefit analysis. As explained previously, the Board believes that restricting the disclosure of these metrics solely to audit committees would cause investors and other stakeholders to forgo the benefits of disclosure. Some commenters suggested a more flexible approach to engagement-level reporting, such as voluntary disclosure. One commenter suggested that competition among auditors should be the primary source of practice enhancements as opposed to regulatory control. One commenter suggested that voluntary disclosure allows for refinements and innovation in response to the evolving auditing environment. Another commenter suggested that voluntary disclosure could facilitate a market for enhanced disclosures. Relatedly, referring academic research, one commenter said that relevant metrics could evolve over time and that many metrics could be useful.474 Also citing academic research, another commenter recommended a principlesbased approach.475 The Board recognizes that a purely voluntary or 474 See Gillian Rose Barnes and Dana R. Hermanson, Fraud Brainstorming Sessions and Interviews in a Remote World: Initial Evidence, 15 Journal of Forensic and Investigative Accounting 248 (2023); Lazarus Elad Fotoh and Johan Ingemar Lorentzon, Audit Digitalization and its Consequences on the Audit Expectation Gap: A Critical Perspective, 37 Accounting Horizons 43 (2023); Jean C. Bedard, Karla M. Johnstone, and Edward F. Smith, Audit Quality Indicators: A Status Update on Possible Public Disclosures and Insights from Audit Practice, 4 Current Issues in Auditing C12 (2010); Knechel, et al., Audit Quality; and Christensen et al., Understanding Audit Quality. 475 See Arianna S. Pinello, Ara G. Volkan, Justin Franklin, Michael Levatino, and Kimberlee Tiernan, The PCAOB Audit Quality Indicator Framework Project: Feedback from Stakeholders, 16 Journal of Business & Economics Research 1 (2019). PO 00000 Frm 00100 Fmt 4701 Sfmt 4703 principles-based approach could foster innovation. However, for reasons discussed above the Board believes the benefits associated with a mandatory approach, with clearly articulated calculations relative to the current practice baseline of voluntary disclosure, are substantial. For example, as discussed above, the Board believes that the market does not provide sufficient incentives for auditors to disclose information akin to the metrics voluntarily. Furthermore, even under the mandatory framework the Board is adopting, firms would still have the freedom to innovate beyond the required metrics through additional voluntary disclosures. One commenter suggested that an analysis of analogous initiatives in foreign jurisdictions would inform the PCAOB of potential alternatives to the final rules that may be less costly or present less risk of unintended consequences. One commenter suggested that the Board more carefully consider the context in which those metrics are used, emphasizing their voluntary nature. As discussed in the proposal, PCAOB staff reviewed initiatives in foreign jurisdictions and noted their generally less prescriptive approaches compared to the metrics the Board is adopting. While these international approaches may involve lower costs and possibly fewer unintended consequences, ’they are also likely to mean that metrics are less comparable and less comprehensively available, implying less-substantial benefits. The Board believes that the Board’s approach, although potentially more prescriptive, is necessary to achieve the desired level of transparency and oversight in audit practices. Two commenters representing investor groups suggested that, if the Board adopts the final rules, the PCAOB could amplify the value of the final metrics by providing tools, research, or periodic reviews of the information. The Board will consider these suggestions. However, the Board notes that, under the final rules, users will be able to analyze the data using tools of their choice. Additionally, the PCAOB plans to have programs to sponsor research which may consider the final metrics. The Board will be alert to how the metrics are utilized and their impact. iv. Alternative Firm and Engagement Metrics Considered The Board considered but at this time are not adopting metrics related to: (i) auditor proficiency testing; surveys of firms and audit committees; and auditor absenteeism; (ii) legal proceedings E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices against audit firms and firm ownership structures; (iii) engagement-level PCAOB deficiencies; (iv) access to national office or other technical resources and staff and investments in infrastructure to support audit quality; (v) auditor independence and financial reporting quality; (vi) timely issuance of internal controls weaknesses and going concern opinions and fraud or other financial reporting misconduct; (vii) audit fees, effort, and client risk; (viii) audit personnel; (ix) allocation of audit hours; and (x) internal monitoring and incentives. In the following discussion the Board briefly describes and evaluates the literature on these metrics and provides the Board’s rationale for not adopting them. a. Metrics Related to Auditor Proficiency Testing, Surveys of Firms and Audit Committees, and Auditor Absenteeism Metrics related to proficiency testing, surveys of firms and audit committees, and auditor absenteeism would generally speak to the ‘‘Tone at the Top’’ or workplace culture of the audit firm. There is a lack of literature covering the economic impacts that disclosure of these metrics might engender. While some academic literature suggests strong work culture and a ‘‘Tone at the Top’’ is associated with audit quality,476 it is unclear how an informative metric could be constructed. Similarly, while some academic literature suggests competence is associated with audit quality, there is limited research related to proficiency testing per se and it is unclear how an informative metric on proficiency testing could be constructed.477 Finally, the Board is unaware of any literature related to auditor absenteeism. At this time, the Board is not requiring disclosure of these metrics under the final rules. lotter on DSK11XQN23PROD with NOTICES2 b. Metrics Related to Legal Proceedings Against Audit Firms and Firm Ownership Structures Some academic literature suggests there may be no relationship between the quality of audit services or the auditor’s provision of reasonable assurance and the likelihood that an 476 See, e.g., Stephen Perreault, James Wainberg, and Benjamin L. Luippold, The Impact of Client Error-Management Climate and the Nature of the Auditor-Client Relationship on External Auditor Reporting Decisions, 29 Behavioral Research in Accounting 37 (2017) and Donna D. Bobek, Derek W. Dalton, Brian E. Daugherty, Amy M. Hageman, Robin R. Radtke, An Investigation of Ethical Environments of CPAs: Public Accounting versus Industry, 29 Behavioral Research in Accounting 43 (2017). 477 See, e.g., Christensen et al., Understanding Audit Quality. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 auditor could be sued, have a case settled, or be taken through court.478 Many cases brought against auditors fail to meet the threshold of fault required to show the auditor is liable for the damages incurred by investors. Information related to legal proceedings may also be confidential or otherwise sensitive. Furthermore, the incidence of lawsuits against auditors has declined in recent years.479 One investor survey finds that investors perceive private litigation as being unrelated to audit quality.480 Additionally, information regarding proceedings initiated by government entities against firms and certain of their personnel is already reported on PCAOB Form 3. Metrics related to firm ownership structure are being considered by the PCAOB’s Firm Reporting rulemaking project. At this time, the Board is not requiring disclosure of these metrics under the final rules. c. Metrics Related to Engagement-Level PCAOB Deficiencies The Board’s considerations regarding potential metrics related to engagementlevel PCAOB deficiencies are discussed above. Several commenters suggested the Board include metrics related to deficiencies identified during PCAOB inspections. Several commenters suggested the Board require firms to report the percentage of their reviewed audits that received Part I.A deficiencies in their PCAOB inspection reports. These commenters highlighted the critical nature of Part I.A deficiencies and suggested that requiring this information to be disclosed along with the other final metrics would increase its prominence. While the Board acknowledges the significance of Part I.A deficiencies—indicating deficiencies that were of such significance that the Board believes the firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion on the issuer’s financial statements and/or ICFR—the Board notes that this information is already publicly available and stakeholders already utilize this information, compiling it in their analyses. One commenter suggested that the Board consider requiring auditors to disclose which of their audits had Part I.A deficiencies included in their 478 See, e.g., Colleen Honigsberg, Shivaram Rajgopal, and Suraj Srinivasan, The Changing Landscape of Auditors’ Liability, 63 The Journal of Law and Economics 367 (2020). 479 See Honigsberg et al., The Changing Landscape. 480 See Christensen et al., Understanding Audit Quality. PO 00000 Frm 00101 Fmt 4701 Sfmt 4703 100067 PCAOB inspection reports. The commenter suggested that this disclosure would obviate need for most, if not all, of the proposed firm- and engagement-level metrics. The Board acknowledges that information on engagement deficiencies identified through PCAOB inspection could provide investors and other stakeholders with additional insight on audit quality. However, PCAOB inspection reports are typically published well after the reporting deadlines for engagement-level metrics on Form AP, making it impractical to include such inspection results in that form. The Board also disagrees that disclosure of PCAOB inspection findings would obviate the need for the metrics. The final metrics will be available for the full population of accelerated filer and large accelerated filer issuers, whereas the presence of Part I.A deficiencies are available for the much more limited sample of inspected firm engagements. Furthermore, the Board believes the final metrics would provide information on aspects of audit quality not entirely captured by Part I.A deficiencies. While academic literature suggests that engagement-level PCAOB auditing deficiencies are indicative of low audit quality, Sarbanes-Oxley already provides a robust framework for making PCAOB inspection findings and sanctions public.481 At this time, the Board is not requiring the disclosure of engagement-level PCAOB auditing deficiencies under the final rules. d. Metrics Related to Access to the National Office or Other Technical Resources and Staff and Investments in Infrastructure To Support Audit Quality The Board’s considerations regarding potential metrics related to access to technical resources is discussed above. Overall, metrics related to audit teams’ access to such technical resources and staff could indicate how accessible individuals, decision aids, or technical audit-process manuals are to audit teams. For example, in larger firms, individuals in the national office may provide consultation on complex, unusual, or unfamiliar issues. One study using PCAOB data found that national office consultations are common among PCAOB-inspected engagements and that national office consultation use is associated with engagement characteristics and proxies for audit quality.482 Smaller firms may retain 481 See, e.g., Aobdia et al., Practitioner Assessments. 482 See, e.g., Matthew G. Sherwood, Miguel Minutti-Meza, and Aleksandra B. Zimmerman, Auditors’ National Office Consultations, SSRN E:\FR\FM\11DEN2.SGM Continued 11DEN2 100068 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices individuals with such expertise from outside the firm. Metrics related to infrastructure that supports audit quality could provide information on resources audit teams have available to them that could support audit quality. However, due to the variety of ways firms provide technical resources and infrastructure to support audit quality, the Board believes that metrics related to these areas would likely not be informative or comparable for all firms. Furthermore, disclosures related to network relationships currently being considered as part of the PCAOB’s Firm Reporting rulemaking project would provide some information to investors and audit committees regarding firms’ access to technical resources. At this time, the Board is not requiring disclosure of metrics related to access to technical resources under the final rules. The Board’s considerations regarding potential metrics related to investment in audit infrastructure is discussed above. In particular, one commenter suggested that the Board consider requiring firms to report the percentage of the firm’s revenues invested in technology accessible by audit teams. The Board believes the broad range of what constitutes ‘‘technology’’ and how it is used across different firms could lead to inconsistencies in how such a metric is calculated and reported. Overall, the Board does not believe such a metric would be informative and comparable. At this time, the Board is not requiring disclosure of metrics related to access to investment in audit infrastructure under the final rules. lotter on DSK11XQN23PROD with NOTICES2 e. Metrics Related to Auditor Independence and Financial Reporting Quality Disclosures related to audit fees and non-audit fees are being considered as part of the PCAOB’s Firm Reporting rulemaking project. Furthermore, the final rules already include a metric for restatements, a well-accepted proxy for financial reporting quality. Therefore, the Board does not think there is a need to expand disclosures related to this information under the final rules. f. Metrics Related to the Timely Issuance of Internal Controls Weaknesses and Going Concern Opinions, and Fraud or Other Financial Reporting Misconduct Academic research suggests that (i) markets react to going concern reporting and (ii) timely reporting of a going concern opinion is an indicator of audit Electronic Journal (2024). The Board notes that SSRN does not peer review its submissions. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 quality.483 However, there is a lack of academic research related to timely reporting of internal control weaknesses. The final rules include metrics related to restatement history, which the Board believes will provide a clearer signal of audit quality. Firms’ reporting of internal control weaknesses and their inclusion of going concern explanatory paragraphs in the audit report are also publicly available already, as are indicators of auditors’ timeliness (e.g., subsequent restatements or bankruptcies). Additionally, the Board is considering other standardsetting opportunities related to the reporting of fraud or other financial reporting misconduct as well as the auditor’s going concern evaluation. At this time, the Board does not think there is a need to require disclosure of these metrics under the final rules. g. Metrics Related to Audit Fees, Effort, and Client Risk Regarding audit fees, the Board notes that engagement-level audit fees are already publicly available and firm-level audit fees may be constructed by summing engagement-level audit fees. Regarding audit effort, the Board notes that, while some academic research finds that proxies for audit effort are associated with audit quality, the level of association diminishes in certain settings when considered jointly with other information correlated with audit effort.484 Indeed, stakeholders will have access to information correlated to audit effort. For example, engagement-level audit hours, a commonly used proxy for audit effort, are highly correlated with engagement-level audit fees which are publicly available.485 Additionally, the final metrics related to Partner and Manager Involvement, Workload, Training Hours for Audit Personnel, and Allocation of Audit Hours will provide information related to audit effort. Regarding client risk, the Board has observed through the Board’s oversight activities that firms classify clients as 483 See DeFond and Zhang, A Review of Archival Auditing Research. 484 See, e.g., Aobdia et al., The Economics of Audit Production, Table 3 and Table 4 (finding that audit effort is not related to various proxies for audit quality after holding other factors constant); Constantinos Caramanis and Clive Lennox, Audit Effort and Earnings Management, 45 Journal of Accounting and Economics 116 (2008) (studying Greek audit firms, finding that lower audit hours are associated with decreases in various proxies for audit quality) and Dafydd Mali and Hyoung-Joo Lim, Can Audit Effort (Hours) Reduce a Firm’s Cost of Capital? Evidence from South Korea, 45 Accounting Forum 171 (2020) (finding, using data on Korean audit firms, that audit effort is negatively associated with weighted average cost of capital). 485 See, e.g., Aobdia, Practitioner Assessments, Table 4. PO 00000 Frm 00102 Fmt 4701 Sfmt 4703 high risk in various ways. At this time, the Board is not requiring disclosure of these metrics under the final rules. h. Metrics Related To Audit Personnel The Board proposed but are not adopting engagement-level metrics related to turnover (i.e., Retention and Tenure). Academic literature related to turnover generally and commenters’ views on the proposed metric are discussed above. Overall, commenters generally did not support engagementlevel metrics in this area. Several commenters said that mandatory partner rotation, personal issues, and strategic resource management concerns could drive the proposed engagement-level metric related to turnover. Commenters said that for these and other reasons the metrics would be especially difficult for stakeholders to interpret and would need to be considered in conjunction with other metrics. After considering these comments, and in light of the Board’s original analysis, the Board is not adopting the proposed engagementlevel Retention and Tenure metric under the final rules. i. Certain Metrics Related to the Allocation of Audit Hours The Board proposed but is not adopting several metrics related to the allocation of audit hours (i.e., Audit Hours and Risk Areas, Audit Resources—Use of Auditor’s Specialists and Shared Service Centers). These proposed metrics predominantly focus on whether the audit team is being efficiently and effectively deployed. The proposed metrics were intended to improve transparency into the audit process and help investors and audit committees to review: (i) whether the auditor is effectively allocating hours in response to areas of significant risk, (ii) whether the auditor is efficiently and effectively deploying individuals with expertise to address areas that require their specialized knowledge; and (iii) whether the auditor is efficiently and effectively using SSCs. Section IV.C.1.iv.b of the proposal provides additional discussion on the potential benefits of these metrics and relevant academic literature. Comments related to the discussion of academic literature are addressed above. The Board addresses below more specific comments related to the impacts of these metrics. Commenters’ views on the proposed Audit Hours and Risk Areas metric including alternative approaches suggested are discussed above. Overall, many commenters did not support the proposed metric and said that it would be challenging to calculate. Several E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 commenters said that, because risk assessment is an iterative process, highrisk areas could change over the course of the audit, leading to challenges tracking the required hours information. Several commenters also said that calculating the proposed metric would require extensive coordination among other auditors. Several commenters also said that hours charged to particular accounts may include work that is unrelated to an identified significant risk. After considering these comments, and in light of the Board’s original analysis, the Board is not adopting the proposed Audit Hours and Risk Areas metric under the final rules. Commenters’ views on the proposed Audit Resources metrics including alternative approaches suggested are discussed above. Overall, commenters generally opposed these metrics. For example, one commenter said that the use of auditor’s specialists would not be comparable across firms of different sizes without sufficient context. The same commenter said that smaller firms are more likely to engage outside specialists compared to larger firms with in-house specialists. One commenter said firms are already required to communicate their use of specialists to audit committees on an engagement. One commenter said that the use of specialists is highly contextual. One commenter said it would be difficult obtain the hours information to calculate the proposed use of specialists metric. Referring to several academic articles, one commenter suggests that smaller firms and larger firms’ metrics related to the use of specialists would not be comparable because smaller firms feel regulatory pressure to use specialists and typically retain outside specialists.486 One commenter said that the SSC metric would be misinterpreted as indicating that greater SSC hours indicated lower quality. After considering these comments, and in light of the Board’s original analysis, the 486 See J. Efrim Boritz, Natalia KochetovaKozloski, and Linda Robinson, Are Fraud Specialists Relatively More Effective Than Auditors at Modifying Audit Programs in the Presence of Fraud Risk?, 90 The Accounting Review 881 (2015); Candice T. Hux, Use of Specialists on Audit Engagements: A Research Synthesis and Directions for Future Research, 39 Journal of Accounting Literature 23 (2017); Zimmerman, et al., Auditor’s Use; Dereck Barr-Pulliam, Stephani Mason, and Kerri Ann Sanderson, The Joint Effects of Work Content and Work Context on Valuation Specialists’ Perceptions of Organizational-Professional Conflict, SSRN Electronic Journal (2022); Aleksandra B. Zimmerman, Dereck Barr-Pulliam, Joon-Suk Lee, and Miguel Minutti-Mezza, Auditors’ Use of InHouse Specialists, 61 Journal of Accounting Research 1363 (2023). The Board notes that SSRN does not peer review its submissions. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 Board is not adopting the proposed Audit Resources metrics under the final rules. j. Metrics Related to Internal Monitoring and Incentives The Board proposed but is not adopting metrics related to internal audit quality review (i.e. Audit Firms’ Internal Monitoring) and incentive alignment (i.e., Quality Performance Ratings and Compensation). Metrics related to internal audit quality review and incentive alignment focus on the positive and negative incentives auditors face. Unlike the final metrics related to audit personnel and allocation of audit hours, which would provide additional transparency into the inner workings and characteristics of the audit team, the disclosure of these proposed metrics would provide information related to audit outcomes and the incentives that led to those results. Section IV.C.1.iv.c of the proposal provides additional discussion on the potential benefits of these metrics and relevant academic literature. Comments related to the discussion of academic literature are addressed above. The Board addresses below more specific comments related to the impacts of these metrics. Commenters’ views on these proposed metrics including alternative approaches raised are discussed above. Two commenters agreed that the proposed metrics related to firms’ internal monitoring would be useful for stakeholders. One firm reported that it provides similar firm-level information in its transparency report. However, others expressed several concerns, particularly regarding the engagementlevel metrics. By way of background, survey research cited in the proposal finds that internal monitoring programs are valued by audit partners for their focus on the firm’s audit methodology, their timeliness, and the quality of the feedback.487 Pointing to this research, one commenter suggested that the proposed internal monitoring metric would undermine the efficacy of audit firm internal inspection programs and audit quality. Some commenters said that the information would not be comparable due to differences in firms’ monitoring programs. One commenter said that smaller firms would be disadvantaged because the results of their monitoring programs tend to be more variable. Regarding incentive alignment, some commenters supported 487 See Richard W. Houston and Chad M. Stefaniak, Audit Partner Perceptions of Post-Audit Review Mechanisms: An Examination of Internal Quality Reviews and PCAOB Inspections, 27 Accounting Horizons 23, (2013). PO 00000 Frm 00103 Fmt 4701 Sfmt 4703 100069 a metric for incentive alignment and agreed with the Board’s rationale for proposing it. One commenter said that investors routinely evaluate executive compensation packages and understand that compensation may be driven by a variety of factors which could be discussed in the voluntary narrative discussion. However, other commenters said it would lack comparability, would not capture other important drivers of compensation, and would raise confidentiality concerns. After considering these comments, and in light of the Board’s original analysis, the Board did not adopt these metrics under the final rules. Special Considerations for Audits of Emerging Growth Companies Section 104 of the Jumpstart Our Business Startups (‘‘JOBS’’) Act imposes certain limitations to the application of the Board’s standards to audits of Emerging Growth Companies (‘‘EGCs’’), as defined in Section 3(a)(80) of the Exchange Act. Under Section 104, the JOBS Act provides that any additional rules adopted by the Board subsequent to April 5, 2012, ‘‘shall not apply to an audit of any [EGC] 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 would promote efficiency, competition, and capital formation.’’ 488 As a result, the final rules are subject to a separate determination by the SEC regarding their applicability to audits of EGCs.489 To inform consideration of the application of PCAOB standards and rules to audits of EGCs, the PCAOB staff publishes a white paper annually that provides general information about characteristics of EGCs. The data on EGCs outlined in the most recent white paper, released in February 2024, remains generally consistent with the data outlined in prior EGC white 488 See Pub. L. 112–106 (Apr. 5, 2012). Section 103(a)(3)(C) of Sarbanes-Oxley, as added by Section 104 of the JOBS Act. 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 financial statements of the issuer (auditor discussion and analysis) shall not apply to an audit of an EGC. The final mandatory disclosure rules do not fall within either of these two categories. 489 The Board provided this analysis of the impact on EGCs to assist the SEC in making the determination required under Section 104 to the extent that the requirements apply to ‘‘the audit of any emerging growth company’’ within the meaning of Section 104 of the JOBS Act. E:\FR\FM\11DEN2.SGM 11DEN2 lotter on DSK11XQN23PROD with NOTICES2 100070 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices papers.490 As of the November 15, 2022, measurement date, PCAOB staff identified 3,031 companies that selfidentified with the SEC as EGCs and filed with the SEC audited financial statements in the 18 months preceding the measurement date.491 The discussion of benefits, costs, and unintended consequences of the final rules above is generally applicable to all audits performed pursuant to PCAOB standards, including audits of EGCs. The economic impacts of the final rules on an individual EGC audit will depend on factors such as the auditor’s ability to distribute implementation costs across its audit engagements and whether the auditor has already incorporated the final metrics into its audit approach. One survey of audit committees of smaller public companies found that five of the 28 metrics discussed in the Concept Release were evaluated by more than half of the audit committees surveyed.492 EGCs are more likely to be newer companies, which are typically smaller in size and receive lower analyst coverage.493 For example, smaller companies have very little, if any, analyst coverage, which reduces the amount of information made available to financial statement users and therefore makes markets less efficient.494 These factors may increase the importance to investors of the higher audit quality expected to result from the final rules, as high-quality audits generally enhance the credibility of management disclosures.495 The costs of the final rules may disproportionately impact smaller audit firms, and in so much as smaller audit firms tend to audit smaller issuers, pass through of these costs may disproportionately impact EGCs.496 However, two important caveats will limit the impact of the final rules on EGCs. First, the vast majority of EGC engagements will not be subject to the final engagement-level reporting requirements because an EGC cannot be a large accelerated filer and few accelerated filers maintain the EGC status.497 The Board believes these EGCs will therefore not be impacted by the final engagement-level reporting requirements. Second, approximately 23% of EGC engagements (712 out of 3,031) will not be included in any final firm-level reporting because they are not audited by a firm that will be subject to the final firm-level reporting requirements. The Board believes these EGCs will therefore not be impacted by the final firm-level reporting requirements. Overall, among the impacted EGCs, the final rules are expected to enhance the quality of EGC audits and financial reporting quality.498 To the extent the final rules will improve EGCs’ financial reporting quality, it may also improve the efficiency of capital allocation, lower the cost of capital, and enhance capital formation. For example, investors may improve their capital allocation by more accurately identifying EGCs with the strongest prospects for generating future riskadjusted returns and reallocating their capital accordingly. Investors may also perceive less risk in the impacted EGC capital markets generally, leading to an increase in the supply of capital to the impacted EGCs. This may increase capital formation and reduce the cost of capital to impacted EGCs. The final rules could reduce competition in an EGC’s product market if the indirect costs to audited companies disproportionately impact EGCs relative to their competitors. As discussed above, the Board considered broadening the applicability of the final rules to include information from audits of EGCs generally. However, for the reasons described there, the Board is not doing so at this time. In particular, non-accelerated filer EGCs may be disproportionately impacted by cost passthrough and tend to be smaller than in-scope issuers. Comments related to this alternative are discussed above. There were no comments related to the EGC analysis specifically. Accordingly, and for the reasons explained above, the Board recommends that the Commission determine that it 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, to apply the final rules to audits of EGCs. 490 See PCAOB, White Paper on Characteristics of Emerging Growth Companies and Their Audit Firms at November 15, 2022 (Feb. 20, 2024), available at https://pcaobus.org/resources/other-researchprojects (‘‘EGC White Paper’’). 491 The EGC White Paper uses a lagging 18-month window to identify companies as EGCs. Please refer to the ‘‘Current Methodology’’ section in the EGC White Paper for details. Using an 18-month window enables PCAOB 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 that have exceeded the eligibility or time limits. See id. 492 See, e.g., Harris and Williams, Audit Quality Indicators. 493 See EGC White Paper at Figure 9 and Figure 12 (indicating that exchange-listed EGCs have less market capitalization and revenue than exchangelisted non-EGCs). 494 See SEC, Final Report of the Advisory Committee on Smaller Public Companies to the U.S. Securities and Exchange Commission (Apr. 23, 2006) at 73. 495 Researchers have developed a number of proxies that are thought to be correlated with information asymmetry, including small issuer size, lower analyst coverage, larger insider holdings, and higher research and development costs. To the extent that EGCs exhibit one or more of these properties, there may be a greater degree of information asymmetry for EGCs than for the broader population of companies, which increases the importance to investors of the external audit to enhance the credibility of management disclosures. See, e.g., Steven A. Dennis and Ian G. Sharpe, Firm Size Dependence in the Determinants of Bank Term Loan Maturity, 32 Journal of Business Finance and Accounting 31 (2005); Michael J. Brennan and Avanidhar Subrahmanyam, Investment Analysis and Price Formation in Securities Markets, 38 Journal of Financial Economics 361 (1995); David Aboody and Baruch Lev, Information Asymmetry, R&D, and Insider Gains, 55 Journal of Finance 2747 (2000); Raymond Chiang and P. C. Venkatesh, Insider Holdings and Perceptions of Information Asymmetry: A Note, 43 Journal of Finance 1041 (1988); and Molly Mercer, How Do Investors Assess the Credibility of Management Disclosures?, 18 Accounting Horizons 185 (2004). 496 PCAOB staff analysis indicates that, compared to exchange-listed non-EGCs, exchange-listed EGCs are approximately 2.6 times as likely to be audited by an NAF and approximately 1.3 times as likely to be audited by a triennially inspected firm. Source: EGC White Paper and S&P. 497 As of November 15, 2022, among the 2,562 EGCs for which ‘‘accelerated filer’’ status information is available, just 163 identified as accelerated filers. See EGC White Paper at 26. 498 See above for a discussion on the link between audit quality and financial reporting quality. 499 As noted in Form FM and Form AP, hours worked are the sum of hours that are incurred on issuer and non-issuer engagements and include hours spent on training, practice development, personnel development, or other firm activities. Hours worked exclude hours that are not considered working hours (e.g., paid time off and holiday time). VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00104 Fmt 4701 Sfmt 4703 Appendix—Illustrative Examples of Metric Calculations The examples below are based on hypothetical situations and have been prepared for illustrative purposes only, to show how metrics would be calculated based on the facts presented. They are not intended to provide guidance or suggestions regarding what the numerical values of the metrics themselves, or of the inputs on which they are based, are likely to be or should be. They are qualified in their entirety by reference to Rule 2203C, Firm Metrics, Rule 3211, Audit Participants and Metrics, Form FM, Firm Metrics, and Form AP, Audit Participants and Metrics. I. Partner and Manager Involvement E:\FR\FM\11DEN2.SGM 11DEN2 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 100071 Example firm-level calculation: Total audit hours of the firm's accelerated filer and large accelerated filer engagements Accelerated filer and large accelerated filer engagements Total Audit Hours Total Audit Hours incurred by partners and managers on the engagement team CompanyX 3,900 1,400 Company Y 2,500 625 Company Z 1,500 300 Total 7,900 2,325 Total audit hours incurred by partners and managers on the engagement team for all accelerated filer and large accelerated filer engagements/ Total audit hours for all accelerated filer and large accelerated filer engagements Calculation: 2,325 / 7,900 = 29% Example firm-level reporting for Form FM: Partner and Manager Involvement Percentage of total audit hours for partners and managers for all accelerated filer and large accelerated filer engagements 29% Example engagement-level calculation: Details for total audit hours of the accelerated filer or large accelerated filer engagement • Lead auditor issues the audit report for Company X. • Total audit hours for the engagement: 3,900 VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00105 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.003</GPH> lotter on DSK11XQN23PROD with NOTICES2 Details for partners and managers 100072 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices CompanyX Total audit hours incurred by partners and managers on the engagement team Engagement Partner 300 U.S. (partners other than the engagement partner and managers) 700 France (partners and managers) 150 Germany (managers) 125 Italy (managers) 60 China (managers) 15 India shared service center (managers) 50 1,400 Total Total audit hours incurred by partners and managers on the engagement team I Total audit hours for the engagement Calculation: l,400/3,900 = 36% Example engagement-level reporting/or Form AP: Partner and Manager Involvement Percentage of total audit hours for partners and managers 36% VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00106 Fmt 4701 Sfmt 4703 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.004</GPH> lotter on DSK11XQN23PROD with NOTICES2 II. Workload 100073 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Example firm-level calculations: Details for hours worked499 by the firm's 12artners who worked on accelerated filer and large accelerated filer engagements Quarter Number of partners who incurred hours on accelerated filer and large accelerated filer engagements Total hours worked for the quarter Average Weeks number in the of hours quarter worked in the quarter Average weekly workload Sep 30, 2024 5,400 10 540 13 42 Jun 30, 2024 5,300 10 530 13 41 Mar 31, 2024 6,700 10 670 13 52 Dec 31, 2023 5,750 10 575 13 44 Average number of hours worked by partners who incurred hours on accelerated filer and large accelerated filer engagements in the calendar quarter/ Number of weeks in the calendar quarter Calculation (September 30, 2024): 540/13 = 42 Details for hours worked by the firm's managers who worked on accelerated filer and large accelerated filer engagements VerDate Sep<11>2014 Total hours worked for the quarter 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Number of managers who incurred hours on accelerated filer and large Frm 00107 Fmt 4701 Sfmt 4725 Average number of hours Weeks in the quarter E:\FR\FM\11DEN2.SGM 11DEN2 Average weekly workload EN11DE24.005</GPH> lotter on DSK11XQN23PROD with NOTICES2 Quarter 100074 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices accelerated filer engagements worked in the quarter Sep 30, 2024 14,000 25 560 13 43 Jun 30, 2024 13,750 25 550 13 42 Mar 31, 2024 18,000 25 720 13 55 Dec 31, 2023 14,750 25 590 13 45 Average number of hours worked by managers who incurred hours on accelerated tiler and large accelerated filer engagements in the calendar quarter/ Number of weeks in the calendar quarter Calculation (September 30, 2024): 560/13 = 43 Example firm-level reporting for Form FM: Average weekly hours worked Quarter ended Workload Partners Managers Sep 30, 2024 42 43 Jun 30, 2024 41 42 Mar 31, 2024 52 55 Dec 31, 2023 44 45 Example engagement-level calculations: Company A has a fiscal year end of December 31. The audit report was issued on March 1, 2024 and the firm filed Porm AP on March 15, 2024. Details for hours worked by the engagement ~artner VerDate Sep<11>2014 19:02 Dec 10, 2024 Number of hours worked in the quarter Jkt 265001 PO 00000 Frm 00108 Number of weeks in the quarter Fmt 4701 Average weekly workload Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.006</GPH> lotter on DSK11XQN23PROD with NOTICES2 Quarter 100075 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Jun 30, 2023 546 13 42 Sep 30, 2023 559 13 43 Dec 31, 2023 585 13 45 Mar 1, 2024500 468 8.6 54 Number of hours worked by the engagement partner in the fiscal quarter/ Number of weeks in the fiscal quarter Calculation (September 30, 2023): 559/13 = 43 Details for hours worked by :gartners (excluding engagement i;1artner) and managers on the core engagement team Quarter Number of partners (excluding the engagement partner) and managers on the core engagement team Total hours worked for the quarter Average number of hours worked in the quarter Weeks in the quarter Average weekly workload Jun 30, 2023 2,260 4 565 13 43 Sep 30, 2023 2,300 4 575 13 44 Dec 31, 2023 2,400 4 600 13 46 Mar 1, 2024 1,975 4 494 8.65 57 Average number of hours worked by partners (excluding the engagement partner) and managers who are on the core engagement team in the fiscal quarter/ Number of weeks in the fiscal quarter 500 The number of weeks for the quarter ended March 1, 2024, represents the number of weeks through the issuance of the audit report. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00109 Fmt 4701 Sfmt 4703 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.007</GPH> lotter on DSK11XQN23PROD with NOTICES2 Calculation (September 30, 2023): 575/13 = 44 100076 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Example engagement-level reporting/or Form AP: Average weekly hours worked during the engagement lotter on DSK11XQN23PROD with NOTICES2 Workload VerDate Sep<11>2014 19:02 Dec 10, 2024 Partners (excluding the engagement partner) and Managers Jun 30, 2023 42 43 Sep 30, 2023 43 44 Dec 31, 2023 45 46 March 1, 2024 54 57 Jkt 265001 PO 00000 Frm 00110 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.008</GPH> Engagement Partner Period ended Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 100077 III. Training Hours for Audit Personnel 501 Example firm-level calculation: Details for total professional development training hours The firm tracks its annual partner and staff training based on the calendar year. 501 The firm has a combined headcount of partners, managers, and staff of 1,400. Total professional development training hours recorded from January 1, 2024, through December 31, 2024, were 68,600. The hours were distributed as follows: Total Professional Development Training Hours Total Audit Personnel 4,100 100 Managers 17,200 400 Staff 47,300 900 Total 68,600 1,400 Partners Total professional development training hours incurred by partners, managers and staff of the firm I Total number of partners, managers, and staff of the firm Calculation: 68,60011,400 = 49 Example reporting/or Form FM: Average annual professional development training hours Training Hours for Audit Personnel 49 Example engagement-level calculation: The firm tracks its annual partner and staff training based on the calendar year. The core engagement team has a combined headcount of partners, managers, and staff of 12. Total professional development training hours for all members of the core engagement team recorded from January 1, 2024, through December 31, 2024, were 564. The hours were distributed as follows: 501 As noted in Form FM and Form AP, training metrics should be calculated for the same 12-month period, either ended September 30, or based on the firm’s training calendar. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00111 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.009</GPH> lotter on DSK11XQN23PROD with NOTICES2 Details for total professional development training hours 100078 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Total Professional Development Training Hours Partners Total Audit Personnel 96 2 Managers 168 3 Staff 300 7 Total 564 12 Total professional development training hours incurred by partners, managers and staff on the core engagement team /Total number of partners, managers, and staff on the core engagement team Calculation: 564/12 = 47 Example reporting/or Form AP: Training Hours for Audit Personnel Average annual professional development training hours 47 VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00112 Fmt 4701 Sfmt 4703 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.010</GPH> lotter on DSK11XQN23PROD with NOTICES2 IV. Experience of Audit Personnel Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 100079 Example firm-level calculations: • The Firm has 100 partners and 500 managers. Years of experience Number Partners 100 2,000 Managers 500 4,000 (i) Average experience at a public accounting firm of the firm's partners: Total experience at a public accounting firm of all partners I Total number of partners Calculation: 2,000/100 = 20 (ii) Average experience at a public accounting firm of the firm's managers: Total experience at a public accounting firm of managers /Total number of managers Calculation: 4,000/500 = 8 Example firm-level reporting/or Form FM: Partners Experience of Audit Personnel Average years of experience at a public accounting firm Managers 20 8 Example engagement-level calculations: VerDate Sep<11>2014 Total experience at a public accounting firm Engagement Partner 1 23 Engagement Quality Reviewer 1 19 Core engagement team partners (excluding the engagement partner) 3 45 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00113 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.011</GPH> lotter on DSK11XQN23PROD with NOTICES2 Number 100080 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 8 Core engagement team managers (i) 80 Total experience at a public accounting firm of the engagement partner: Total experience at a public accounting firm of the engagement partner Calculation: 23 (ii) Total experience at a public accounting firm of the engagement quality reviewer: Total experience at a public accounting firm of the engagement quality reviewer Calculation: 19 (iii) Average experience at a public accounting firm of the core engagement team members who are partners (excluding the engagement partner): Total experience at a public accounting firm of the core engagement team members who are partners (excluding the engagement partner) I Total number of people on the core engagement team who are partners (excluding the engagement partner) Calculation: 45/3 = 15 (iv) Average experience at a public accounting firm of the core engagement team members who are managers: Total experience at a public accounting firm of the core engagement team members who are managers /Total number of people on the core engagement team who are managers Calculation: 80/8 = 10 Example engagement-level reporting/or Form AP: Years of experience at a public accounting firm ofthe Engagement Quality Reviewer Average years of experience of Partners (excluding the engagement partner) on the Core Engagement Team Average years of experience of Managers on the Core Engagement Team 15 10 19 23 V. Industry Experience VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00114 Fmt 4701 Sfmt 4703 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.012</GPH> lotter on DSK11XQN23PROD with NOTICES2 Experience of Audit Personnel Years of experience at a public accounting firm ofthe Engagement Partner 100081 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Example firm-level calculation: The top five industries based on revenue from audit services for the most recently completed fiscal year are the following: • Consumer products and services, • Banks, • Health care providers, • Industrial goods and services, and • Government services The firm took into account a number of factors in determining career industry experience, such as the extent to which non-audit experience and experience in auditing companies in adjacent industries could reasonably be considered as industry experience. The firm determined there were several partners and managers that had career industry experience of five or more years for partners and three or more years for managers in its top five industries. % of firm revenue from audit services Industry 1. Number of partners with 5 or more years of career industry experience 2. Number of managers with 3 or more years of career industry experience Consumer products and services 18% 15 45 Banks 11% 10 30 Health care providers 9% 12 43 Industrial goods and services 8% 5 13 Government services 4% 4 6 VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00115 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.013</GPH> lotter on DSK11XQN23PROD with NOTICES2 Note: While not required, a firm may choose to report on additional industries that are not among its top five by revenue from audit services. 100082 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Example firm-level reporting for Form FM: Top five industries based on the firm's revenue from audit services Industry Experience Number of Partners with 5 or more years of career industry experience Number of Managers with 3 or more years of career industry experience Consumer products and services 15 45 Finance: Banks 10 30 Health care: Health Care Providers 12 43 Industrial Goods and Services: General 5 13 Government and Public Services: Government 4 6 Example engagement-level calculation: The company's primary industry is Banks. The engagement partner and the EQR have 16 and 24 years, respectively, of career industry experience. The core engagement team also has several other partners and managers who work on different aspects of the audit throughout the year, including those who have focused on other industries and have not yet met the five- and three-year requirements. The following table depicts their career industry experience: VerDate Sep<11>2014 Engagement partner 16 years Engagement quality reviewer 24 years IT partner Does not meet criteria for five years Tax partner Meets criteria for 5 years Actuarial partner Does not meet criteria for five years Other assisting partner Meets criteria for five years Audit lead senior manager Meets criteria for three years Manager 2 Meets criteria for three years 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00116 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.014</GPH> lotter on DSK11XQN23PROD with NOTICES2 Bank career industry experience 100083 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Manager 3 Meets criteria for three years Manager 4 Does not meet criteria for three years Manager 5 Does not meet criteria for three years Tax senior manager Meets criteria for three years IT manager Does not meet criteria for three years Example engagement-level reporting/or Form AP: Issuer's Primary Industry Financial Services: Banks Years of Career Industry Experience Engagement Partner 16 24 lotter on DSK11XQN23PROD with NOTICES2 Number of core engagement Partners (excluding the Managers team members with industry engagement partner) expenence 2 VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00117 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 4 EN11DE24.015</GPH> Industry Experience Engagement Quality Reviewer 100084 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices VI. Retention of Audit Personnel 502 503 Example calculations (only manager calculations provided): Firm A had 204 managers, 204 managers, and 200 managers as of September 30, 2023, October 1, 2023 and September 30, 2024, respectively. During the 12-month period, 38 managers left the firm, 2 managers did not participate in audits, 5 managers were promoted to partner, 37 staff were promoted to manager, and 4 managers were newly hired or served on audits and did not in the prior year. • Average number of managers-The total number of managers as of October 1, 2023 was 204 and the total number of managers as of September 30, 2024 was 200. The number of r,partners/managers] as of October 1 (Year 1) + the number of r,partners/managers] as of September 30 (Year 2) / 2 Calculation: (204+200) / 2 = 202 • Average annual retention rate Calculation of the numerator - Calculate the total number of managers who were continuously employed and held the same position from October 1, 2023 to September 30, 2024 Calculation of the numerator Managers as of October 1, 2023 204 Adjust for managers who were not continuously employed and holding the same position throughout the period (38) Left the firm Did not participate in audits (2) Promoted to partner (5) Staff promoted to manager 1 37 196 502 As provided in the Note to Item 4.6 of Form FM, promotion is treated as if it had occurred at the beginning of the period for the calculation of retention of audit personnel metric. 503 As noted in Form FM, only partners and managers with one or more years of service and who were employed continuously during the 12month period are included in the numerator. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00118 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.016</GPH> lotter on DSK11XQN23PROD with NOTICES2 Because the 4 managers who were newly hired or transferred into the audit practice were not included in the beginning number of 204, no specific adjustment to the numerator relating to these 4 is necessary. 2 100085 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Calculation of the denominator - Adjust the number of managers as of October 1, 2023 (204 managers) for the promotions as if they had occurred at the beginning of the period (the denominator). Calculation of the denominator Managers as of October 1, 2023 204 Adjust for managers who did not continuously hold the same position Promoted to partner (5) Staff promoted to manager 37 236 The number of rPartnerslmanagers] continuously holding the same position from October 1 (Year 1) to September 30 (Year 2) /Number of rPartnerslmanagers] as of October 1 (Year 1) Calculation: 196 / 236 = 83% • Average annual headcount change --- The total number of current year-end managers was 200 and the total number of prior year managers was 204. Number of wartnerslmanagers] as of September 30 (Year 2) - Number of wartners/managers] as of September 30 (Year 1) / Number of wartners/managers] as of September 30 (Year 1) Calculation: (200-204) / 204 = -2% Example firm-level reporting/or Form FM: Retention of Audit Personnel Manager s Partners Average number 85 202 Average annual retention rate 96% 83% Average annual headcount change -1% -2% 504 As noted in Form FM and Form AP, multiyear audits are excluded from both the firm- and engagement-level calculations. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00119 Fmt 4701 Sfmt 4703 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.017</GPH> lotter on DSK11XQN23PROD with NOTICES2 VII. Allocation of Audit Hours 504 100086 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Example firm-level calculations: The firm issued audit reports with respect to eight accelerated filer or large accelerated filer engagements with various year ends during the reporting period ended September 30, 2024. The hours incurred by the engagement teams during the audits were: Issuer year end Hours incurred prior to issuer year end Hours incurred following issuer year end Issuer A December 31, 2023 20,415 12,056 Issuer B December 31, 2023 7,856 3,020 Issuer C March 31, 2024 10,583 8,023 Issuer D June 30, 2024 5,570 3,502 Issuer E March 31, 2024 4,508 3,752 Issuer F December 31, 2023 1,575 1,208 Issuer G December 31, 2023 3,301 1,833 Issuer H (Initial public offering engagement) December 31, 2023, - - 53,808 33,394 1 December 31, 2022, and December 31, 2021 Total Total audit hours incurred prior to issuers'year ends for all accelerated filer and large accelerated filer engagements/ Total audit hours for all accelerated filer and large accelerated filer engagements Calculation: 53,808 / (53,808+33,394) = 62% VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00120 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.018</GPH> lotter on DSK11XQN23PROD with NOTICES2 Total audit hours incurred following issuers'year ends for all accelerated filer and large accelerated filer engagements/ Total audit hours for all accelerated filer and large accelerated filer engagements Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices 100087 Calculation: 33,394 / (53,808+33,394) = 38% Example firm-level reporting for Form FM: Allocation of Audit Hours Percentage of audit hours incurred prior to issuers' year ends for all accelerated filer and large accelerated filer engagements 62% Percentage of audit hours incurred follo"ing issuers' year ends for all accelerated filer and large accelerated filer engagements 38% Example engagement-level calculations: The firm audits Issuer G with a December 31 year end. The hours incurred by the engagement team during the audit were: Hours incurred prior to and including December 31 U.S. (lead auditor) Hours incurred following December 31 2,015 1,350 Germany 682 265 China 452 163 South Africa 152 55 3,301 1,833 Total Total audit hours incurred prior to the issuer's year end/ Total audit hours Calculation: 3,301 I (3,301 +1,833) = 64% Total audit hours incurred following the issuer's year end/ Total audit hours Calculation: 1,833 / (3,301 +1,833) = 36% Example engagement-level reporting for Form AP: 64% Percentage of total audit hours incurred following the issuer's year end 36% VIII. Restatement History VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00121 Fmt 4701 Sfmt 4703 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.019</GPH> lotter on DSK11XQN23PROD with NOTICES2 Allocation of Audit Hours Percentage of total audit hours incurred prior to the issuer's year end 100088 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Example calculation: The following is true for Firm X's audit practice for the 12-month periods ended September 30 for the last three years: • For 09/30/2022, Firm X issued 110 audit reports for its issuer engagements, 40 of which were integrated audits. • For 09/30/2023, Firm X issued 105 audit reports for its issuer engagements, 35 of which were integrated audits. • For 09/30/2024, Firm X issued 100 audit reports for its issuer engagements, 30 of which were integrated audits. During the 12-month period ended September 30, 2024, Firm X had the following restatements for its issuer engagements: • 9 revision restatements. These restatements relate to audit reports initially issued during the following reporting periods: o 2022-6 • o 2023 -3 0 2024-0* 4 reissuance restatements relate to the financial statements. These restatements relate to audit reports initially issued during the following reporting periods: o 2022-2 2023 -1 o 2024-1 2 reissuance restatements of management's report on ICFR. These restatements relate to audit reports on ICFR initially issued during the following reporting periods: o 2022 - 1 o 2023 - 1 0 2024-0* * Note that for the 12-month period ended September 30, 2024, there were no restatements of this type of audit report issued during that 12-month period. VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 PO 00000 Frm 00122 Fmt 4701 Sfmt 4725 E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.020</GPH> lotter on DSK11XQN23PROD with NOTICES2 • o 100089 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices Example reporting for Form FM: Audit Report Initially Issued 0 3 6 Reissuance restatements of the financial statements for errors 1 1 2 Reissuance restatements of management's report on ICFR 0 1 1 100 105 110 30 35 40 Total issuer engagements with audits of ICFR III. Date of Effectiveness of the Proposed Rules and Timing for Commission (B) Institute proceedings to determine whether the proposed rules should be disapproved. 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 IV. Solicitation of Comments VerDate Sep<11>2014 19:02 Dec 10, 2024 2022 Revision restatements of the financial statements for errors Restatement Total issuer History engagements lotter on DSK11XQN23PROD with NOTICES2 2023 Jkt 265001 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: PO 00000 Frm 00123 Fmt 4701 Sfmt 4703 Electronic Comments • Use the Commission’s internet comment form (https://www.sec.gov/ rules/pcaob); or • Send an email to rule-comments@ sec.gov. Please include PCAOB–2024– 06 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. E:\FR\FM\11DEN2.SGM 11DEN2 EN11DE24.021</GPH> 2024 100090 Federal Register / Vol. 89, No. 238 / Wednesday, December 11, 2024 / Notices lotter on DSK11XQN23PROD with NOTICES2 All submissions should refer to PCAOB–2024–06. 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 VerDate Sep<11>2014 19:02 Dec 10, 2024 Jkt 265001 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 PO 00000 Frm 00124 Fmt 4701 Sfmt 9990 part or withhold entirely from publication submitted material that is obscene or subject to copyright protection. All submissions should refer to PCAOB–2024–06 and should be submitted on or before January 2, 2025. For the Commission, by the Office of the Chief Accountant.505 Vanessa A. Countryman, Secretary. [FR Doc. 2024–28142 Filed 12–10–24; 8:45 am] BILLING CODE 8011–01–P 505 17 E:\FR\FM\11DEN2.SGM CFR 200.30–11(b)(1) and (3). 11DEN2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 89, Number 238 (Wednesday, December 11, 2024)]
[Notices]
[Pages 99968-100090]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-28142]

[[Page 99967]]

Vol. 89

Wednesday,

No. 238

December 11, 2024

Part II

Securities and Exchange Commission

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Public Company Accounting Oversight Board; Notice of Filing of Proposed
Rules on Firm and Engagement Metrics and Related Amendments to PCAOB
Standards; Notice

Federal Register / Vol. 89 , No. 238 / Wednesday, December 11, 2024 /
Notices

[[Page 99968]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-101724; File No. PCAOB-2024-06]

Public Company Accounting Oversight Board; Notice of Filing of
Proposed Rules on Firm and Engagement Metrics and Related Amendments to
PCAOB Standards

November 25, 2024.
Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the
``Act''), notice is hereby given that on November 22, 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 November 21, 2024, the Board adopted Firm and Engagement Metrics
and related amendments to its rules and forms (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 Boards website
at https://pcaobus.org/about/rules-rulemaking/rulemaking-dockets/docket-041, 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, the Board is requesting that the Commission approve the
proposed rules, pursuant to Section 103(a)(3)(C) of the Sarbanes-Oxley
Act, 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
The Board has adopted a set of firm- and engagement-level metrics
(the ``final rules'' or ``final metrics'') that certain registered
public accounting firms (``firms'' or ``audit firms'') will be required
to publicly report relating to their audit practices and the audits
they lead. The Board believes these metrics will provide valuable
additional information, context, and perspective on auditors and audit
engagements, which can be used by investors, audit committees, and
other stakeholders, and which will further the Board's oversight
activities. The Board believes this will advance investor protection
and promote the public interest by enabling stakeholders to make
better-informed decisions, promoting auditor accountability, and
ultimately enhancing capital allocation and confidence in our capital
markets. The new reporting requirements will apply to firms that audit
at least one company that is an ``accelerated filer'' or ``large
accelerated filer'' (as those terms are defined in SEC rules).\1\
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\1\ vSee 17 CFR 240.12b-2 (``Rule 12b-2'').
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Lack of Consistent, Comparable Data About Audits and Auditors
Investors and audit committees cannot easily observe the services
performed by auditors. This can limit investors' ability to make
informed decisions about investing their capital, ratifying the
selection of auditors, and voting for members of the board of
directors, including directors who serve on the audit committee, and
audit committees' ability to choose among and monitor the performance
of auditors. At the same time, there is a lack of incentive for firms,
acting on their own or collectively, to provide accurate, standardized,
and decision-relevant information about their firms and the engagements
they perform. In response to these challenges, the Board has studied
ways to measure audit firm and audit engagement performance, primarily
with a view to providing information useful to investors in their
investment and proxy voting decisions, but also recognizing that
metrics could potentially be informative to other stakeholders. In
addition, the Board itself would benefit from having additional tools
to use in its oversight activities, including its inspections program,
standard-setting initiatives, and research activities.
The Board has observed that many of the firms that issue audit
reports for more than 100 issuers annually and audit companies that
account for the majority of U.S. public company market capitalization
already publicly disclose certain firm-level metrics through audit
quality reports, transparency reports, or similar documents. However,
these disclosures generally do not contain engagement-level
information, which investors have indicated would be the most useful to
them, and are inconsistent across firms and year to year, with no
common definitions or calculations that would allow for meaningful
comparisons. Moreover, most of the disclosures are voluntary, so firms
are free to revise or discontinue such reporting at any time.
In the Board's view, the current voluntary reporting regime cannot
provide consistent, comparable information that stakeholders can rely
on to inform their decisions over time. And it would appear that firms'
attempts at voluntary reporting have not, in fact, satisfactorily
addressed investor desire for additional information about audits and
auditors. On the contrary, support from investors and investor-related
groups for this rulemaking initiative has been consistent throughout
its history, even as the practice of firm voluntary reporting has
evolved and spread.
Metrics at Firm and Engagement Level
The final rules require reporting of metrics at both the firm and
the engagement levels. Firm-level metrics relate to aspects of the
firm's audit practice (e.g., average experience at a public accounting
firm of the firm's partners) and engagement-level metrics relate to
individual audit engagements (e.g., experience at a public accounting
firm of the engagement partner and the engagement quality reviewer
(``EQR'') and average experience of certain other engagement team
members). The Board is requiring firm-level metrics because it believes
information relevant to the firm will be beneficial in providing
context for engagement-level metrics and in evaluating the firm's audit
practice and its related system of quality control. The Board is
requiring engagement-level metrics because it believes that information
will be useful in gaining a richer understanding of a particular audit
and because investors have stressed the importance to them of
engagement-level information to assist them in evaluating the
performance of the auditor and the audit committee. Most metrics will
be reported at both firm- and engagement-level. However, the final
rules require reporting at only

[[Page 99969]]

the firm level in cases where the Board believes engagement-level data
would not be meaningful or would be disproportionally challenging to
collect in relation to the incremental benefit.
Final Metrics
The Board adopted metrics in the following eight areas:
Partner and Manager Involvement. Hours worked by senior
professionals relative to more junior staff across the firm's large
accelerated and accelerated filer engagements and on the specific
engagement.
Workload. Average weekly hours worked on a quarterly basis by
senior professionals who incurred hours on large accelerated and
accelerated filer engagements, including time attributable to
engagements, administrative duties, and all other matters, both firm-
wide and on the core engagement team.
Training Hours for Audit Personnel. Average annual training hours
for partners, managers, and staff of the firm, combined, both firm-wide
and on the core engagement team.
Experience of Audit Personnel. Average number of years worked at a
public accounting firm (whether or not PCAOB-registered) by senior
professionals across the firm and on the engagement.
Industry Experience. Average years of career experience of senior
professionals in key industries audited by the firm at the firm level
and the audited company's primary industry at the engagement level.
Retention of Audit Personnel (firm-level only). Continuity of
senior professionals (through departures, reassignments, etc.) across
the firm.
Allocation of Audit Hours. Percentage of hours incurred prior to
and following an issuer's year end across the firm's large accelerated
and accelerated filer engagements and on the specific engagement.
Restatement History (firm-level only). Restatements of financial
statements and management reports on internal control over financial
reporting (``ICFR'') that were audited by the firm over the past three
years.
Firms are permitted, but not required, to accompany the metrics
with narrative disclosure to provide additional context.
The final suite of metrics focuses primarily on information about
audit personnel. The Board believes these metrics will provide new
insights into how engagements are staffed, including the extent of
involvement of senior personnel; auditors' overall workload; retention
of personnel across the firm; and levels of training, audit experience,
and industry-specific expertise. The final metrics will also provide
information about the extent of audit work completed prior to the
issuer's year-end, an aspect of the audit process that the Board
believes is associated with improved audit outcomes, and about the
firm's history of restatements, a key measure of audit outcomes.
This new information will allow users to draw inferences about
audits and audit forms that are not possible today. Some may relate to
specific metrics. For example, a heavy workload for a particular
engagement team relative to the firm average or compared to peer firms
may raise questions about the quality of the work performed.
Conversely, a relatively high level of industry experience,
particularly for an engagement in an industry that benefits from
specific accounting and auditing expertise, would be a positive signal.
Other inferences may relate to combinations of metrics. For example,
the personnel-related metrics, taken together, give an overall sense of
how an engagement is staffed that can be compared to firm averages and
to engagements for similar issuers. It is possible that the precise
numerical values of metrics may be important in some cases but, in
general, the Board believes the metrics will be more useful to convey a
sense of whether a particular engagement or firm appears fairly typical
or is an outlier in one or more respects. This should provide a richer
context for understanding the work of the auditor than the current
environment of almost no publicly available information.
The Board also believes that gathering data and calculating the
final metrics, given the subjects they address, will not be overly
costly, time-consuming, or burdensome. Based on the Board's oversight
activities, it appears that the largest firms are already tracking data
in many of these areas. Many of the metrics are based on data that
firms already track or will be required to track for purposes of other
PCAOB requirements. For example, Partner and Manager Involvement and
Allocation of Audit Hours are based on the same time reporting required
for Form AP purposes. Training hours will reflect the same information
that firms track to ensure proper licensing of their personnel.
Restatement data, to the extent firms are not already tracking it, is
required to be tracked under QC 1000. In addition to required data,
many firms track the experience of their personnel, as well as industry
experience, for use in marketing materials and for inclusion in
requests for proposals, and some firms already track staff retention
and turnover metrics as part of their human capital management. Firms
should be able to generate other data required by the final metrics,
such as Workload, from their existing timekeeping systems with minimal
additional effort.
Responding to Commenter Concerns
After considering commenter input, the Board has made a number of
changes from the proposal. The final rules eliminate four proposed
metrics areas (Audit Resources--Use of Specialists and Shared Service
Centers, Audit Hours and Risk Areas, Quality Performance Ratings and
Compensation, and Audit Firms' Internal Monitoring) and add one new
metric area (Training Hours for Audit Personnel). In addition, only
firm-level reporting will be required for one area (Retention of Audit
Personnel) that was proposed to be reported at both the firm and
engagement level. The Board has also made revisions to simplify and
clarify some of the other metrics and exempted firms with a small
issuer practice from reporting on their industry experience. In
addition, the Board has expanded the optional narrative disclosure from
500 to 1,000 characters and has provided additional direction that the
narrative should be concise and focused on the reported metrics, with a
view to facilitating the reader's understanding of the metrics. The
Board believes that these changes will address commenter concerns about
challenges of data collection, potential sensitivity of data, and
potential ambiguity of the metrics, and that the final suite of metrics
will provide consistent, comparable information on auditors and audit
engagements, giving investors, audit committees, and other stakeholders
valuable new context and perspective.
The Board considered comments questioning the value of metrics,
whether they will be used by investors and other stakeholders or would
represent only a ``check the box'' compliance exercise, and whether
they might contribute to information overload or have other negative
consequences. Based on the other stakeholder input received, the Board
does not share those views. In comments provided in the Board's
rulemaking process and surveys conducted by a firm-related group,
investors and investor-related groups have repeatedly indicated that
the metrics will be useful. As one investor-related group noted:

Auditors say they want to be seen or evaluated as something
other than a commodity business evaluated based upon price. For this
to happen, auditors need to provide investors with information such
that

[[Page 99970]]

they can value the work of the auditor--just as they evaluate and
value the business and the work of management.\2\
---------------------------------------------------------------------------

\2\ Letter from CFA Institute, August 30, 2024, at 17.

The Board also notes that similar objections--that the new
information would not be used or would be confusing or misleading--were
raised by many of the same commenters in connection with its last two
rulemakings requiring disclosure of additional information about audits
and auditors: Form AP reporting of the name of the engagement partner
and information about other firms participating in the audit, and
auditor communication of critical audit matters (``CAMs''). In both
cases, these commenter concerns appear unsubstantiated. The Form AP
data set is now one of the most frequently visited areas of the PCAOB's
website.\3\ As for CAMs, while academic studies have shown mixed
results about the impact of CAMs, in a recent investor survey conducted
by a firm-related group, over 90% of the respondents indicated that
CAMs play an important role in their investment decision-making.\4\ In
addition, data aggregators, such as Audit Analytics, compile and make
available data on CAMs, which suggests market demand for that
information. The Board's experience therefore suggests that, contrary
to concerns about irrelevance and information overload, stakeholders
seek out additional information about auditors and audit engagements
when it is available.
---------------------------------------------------------------------------

\3\ In 2023, there were over 333,000 unique searches performed
on AuditorSearch and the Form AP data set was downloaded over 2,000
times. Information related to usage statistics can be found on the
PCAOB's website (https://pcaobus.org/resources/auditorsearch).
\4\ The Center for Audit (``CAQ'') Quality Critical Audit
Matters Survey (July 2024) at 9.
---------------------------------------------------------------------------

Filing Requirements
Under the Board's final rules, firm-level reporting is required of
every firm that audits at least one ``accelerated filer'' or ``large
accelerated filer'' under SEC rules during the reporting period.
Engagement-level reporting will be required for every audit of an
accelerated or large accelerated filer. The thresholds will apply to
the audits, and auditors, of companies that account for the majority of
U.S. public company market capitalization, and the Board believes they
will capture the situations where investment and proxy voting decisions
will be most likely to benefit from additional information about the
audit and the auditor.
The final rules:
Require reporting of firm-level metrics annually on a new
Form FM, Firm Metrics, pursuant to a new Rule 2203C, Firm Metrics, for
firms that issued an audit report with respect to at least one
accelerated filer or large accelerated filer during the reporting
period;
Require reporting of engagement-level metrics for audits
of accelerated filers and large accelerated filers on a revised Form
AP, renamed ``Audit Participants and Metrics''; and
Allow, but not require, limited narrative disclosures on
both Form FM and Form AP to provide context and explanation for the
required metrics.
Background
The final rules build on other actions the Board has taken to
provide stakeholders with additional information about registered firms
and the audits they perform, including information about firms
available through its registration and reporting forms, information
about auditors and engagements on Form AP, and communication of
critical audit matters and auditor tenure in the auditor's report. The
Board concurrently adopted other changes to firm reporting
requirements.\5\ The Board believes the final rules will complement
these efforts by providing investors, audit committees, and other
stakeholders with additional information in a consistent format and
compiled with sufficient rigor to assist them in making decisions. For
example, the metrics could inform investors' decision-making regarding
whether to ratify the audit committee's selection of an auditor or to
vote for members of the board of directors, including directors who
serve on the audit committee, as well as potentially assisting in audit
committee oversight, supporting continuous improvement of firms'
quality control systems, and facilitating the Board's own oversight and
rulemaking efforts. The Board further believes that the value of these
metrics will likely increase over time as firm reporting practices
develop and trends become observable.
---------------------------------------------------------------------------

\5\ See Firm Reporting, PCAOB Rel. No. 2024-013 (Nov. 21, 2024)
(adopting amendments to reporting requirements for Form 2, Annual
Report Form, and Form 3, Special Reporting Form).
---------------------------------------------------------------------------

As in its proposal, the Board uses the term ``firm and engagement
metrics'' rather than ``audit quality indicators'' (``AQIs'') to
describe the metrics that it adopted. The Board believes this avoids
the potential misimpression that any set of metrics can comprehensively
measure audit quality and emphasizes the Board's goal of promoting
informed decision-making through robust disclosure requirements. Some
commenters were critical of that change in terminology, suggesting that
it evidenced that the Board is no longer focused on audit quality. It
is simply a clarification. Because some of the most important elements
of a high-quality audit, such as application of due care and
professional skepticism, cannot be measured and quantified directly,
the metrics employ proxies, such as years of experience, auditor
workloads, and percentage of audit hours attributable to more senior
members of the engagement team, which can only partially capture these
concepts. Even though these proxies cannot provide a complete picture
of audit quality, the Board believes they will nevertheless convey
important information about auditors and the engagements they lead that
stakeholders will find relevant and useful. The Board believes that
consideration of the metrics in combination, together with any
additional context a firm may choose to provide, will help users
interpret the data, and that the metrics, analyzed across firms and
over time, will yield important, currently unavailable information that
will assist investors, audit committees, and other stakeholders in
their decision-making, oversight, and evaluation related to audits.
The Board developed the proposal after considering input from
numerous sources, including the recommendations of the U.S. Department
of Treasury's Advisory Committee on the Auditing Profession (``ACAP''),
including the October 6, 2008 Final Report of the Advisory Committee on
the Auditing Profession to the U.S. Department of the Treasury (``ACAP
Final Report''); the Concept Release on Audit Quality Indicators, PCAOB
Rel. No. 2015-005 (July 1, 2015) (``Concept Release''), and the
comments received; the voluntary practices of firms; recommendations
from the PCAOB's Investor Advisory Group (``IAG''); and the initiatives
of international regulators. The Board has carefully considered this
input and believes that the final amendments strike an appropriate
balance between the expected benefits of the new reporting requirements
and the associated costs of implementation and compliance.
Effective Dates
If the Commission approves the final rules and final metrics, both
firm-level and engagement-level reporting will be required for periods
beginning October 1, 2027. The Board also adopted a phased
implementation period for both

[[Page 99971]]

firm- and engagement-level reporting, where firms that issue audit
reports for more than 100 issuers will begin reporting in the first
year that reporting is required and other firms beginning one year
later.
(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 rules for public comment in PCAOB
Release No. 2024-002 on April 9, 2024. Previously, the Board issued a
concept release for public comment in PCAOB Release No. 2015-055 on
July 1, 2015. The Board received over 45 comment letters in response to
the proposing release and 50 letters in response to the concept
release. See Exhibits 2(a)(B) and 2(a)(C). 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.
Background
Project History
1. Importance and Potential Benefits of Increased Information About
Audit Firms and Engagements
With the passage of the Sarbanes-Oxley Act of 2002 (``Sarbanes-
Oxley'') and the establishment of the PCAOB, Congress acknowledged and
re-emphasized the auditor's important gatekeeping role.\6\ Reflecting
that importance, the Board believes requiring audit firms to provide
additional information about the firm and the engagements it performs
will advance investor protection and promote the public interest by
enabling investors to make better-informed decisions. As discussed in
more detail below, the Board has also heard from investors and other
stakeholders that they believe such information will be beneficial.
---------------------------------------------------------------------------

\6\ See Section 101(a) of Sarbanes-Oxley, 15 U.S.C. 7211(a);
Senate Report No. 107-205, at 5-6 (July 3, 2002).
---------------------------------------------------------------------------

Sarbanes-Oxley also mandated new exchange requirements regarding
the responsibilities of audit committees of listed companies, including
requiring that audit committees be charged with responsibility for the
appointment, compensation, and oversight of the auditor.\7\ The Board
believes that making information available to audit committees
regarding both the specific audit and auditor they oversee and the
audits and auditors of their peer companies will assist them in
carrying out this statutory mandate.
---------------------------------------------------------------------------

\7\ See Securities Exchange Act of 1934, Section 10A(m)(2), 15
U.S.C. 78j-1(m)(2).
---------------------------------------------------------------------------

Over the years, the Board has received significant input on the
importance and potential benefits to stakeholders of additional
information about audits and auditors. The key elements of that input
are summarized below.
i. ACAP Recommendations
In 2007, the U.S. Treasury constituted the ACAP to consider and
develop recommendations relating to the sustainability of the auditing
profession.\8\ On October 6, 2008, ACAP published a report detailing
recommendations intended to enhance the sustainability of a strong and
vibrant public company auditing profession.\9\ One of the ACAP
recommendations was that the PCAOB, in consultation with auditors,
investors, public companies, audit committees, boards of directors,
academics, and others, ``determine the feasibility of developing key
indicators of audit quality and effectiveness and requiring auditing
firms to publicly disclose those indicators'' \10\ and, assuming that
development and disclosure of indicators of audit quality are feasible,
that the PCAOB be required to monitor these indicators.
---------------------------------------------------------------------------

\8\ See ACAP Final Report, at IV:1.
\9\ See ACAP's Fact Sheet: Final Report of the Advisory
Committee on the Auditing Profession, available at https://
home.treasury.gov/news/press-releases/
hp1158#:~:text=The%20U.S.%20Treasury%20Department%20%27s%20Advisory%2
0Committee%20on,into%20three%20sections%20by%20principal%20areas%20of
%20focus.
\10\ See ACAP Final Report, at VIII:14.
---------------------------------------------------------------------------

ii. 2013 and 2017 PCAOB Investor Advisory Group Recommendations
At its October 2013 IAG Meeting,\11\ the IAG working group on AQIs
made recommendations for the PCAOB to prescribe informative, forward-
looking disclosures and indicators intended to measure the quality of
audits and enhance auditor accountability. They emphasized that
investors and audit committees generally care more about the quality
and credibility of audit work on specific engagements--the companies in
which they have invested or were considering investing, or the company
on whose board of directors they served--rather than firms' more
general efforts to improve quality. Accordingly, in addition to
disclosures and metrics to be reported at the firm level, they also
recommended disclosures and metrics to be reported at the engagement
level.
---------------------------------------------------------------------------

\11\ See Oct. 2013 IAG meeting and presentations, Report from
the Working Group: Audit Quality Indicators, available at IAG
Meeting Archive, https://pcaobus.org/news-events/events/event-details/pcaob-investor-advisory-group-meeting_758.
---------------------------------------------------------------------------

At the October 2017 IAG meeting, an IAG working group discussed
three topics: (i) why audit quality and AQIs matter to investors, (ii)
the PCAOB's authority and efforts to date to enact AQIs, and (iii)
audit quality initiatives in other jurisdictions.\12\ The 2017 working
group also endorsed the 2013 AQI working group's recommendations.
---------------------------------------------------------------------------

\12\ See Oct. 2017 IAG meeting and presentation, available at
IAG Meeting Archive, https://pcaobus.org/news-events/events/event-details/pcaob-investor-advisory-group-meeting_1085.
---------------------------------------------------------------------------

The recommendations provided by the 2013 and 2017 IAG working
groups are reflected in many of the metrics the Board adopted.
2. PCAOB Initiatives
This section provides further background and expands on the history
of PCAOB activities related to providing additional information about
audit firms and audits, including firm and engagement metrics.
i. 2015 AQI Concept Release
In July 2015, the PCAOB issued the Concept Release and sought
comment on 28 potential indicators. The indicators were organized into
three groups:
Audit professionals--Measures dealing with the
availability, competence, and focus of those performing the audit.
Audit process--Measures related to an audit firm's tone at
the top and leadership, incentives, independence, attention to
infrastructure, and record of monitoring and remediation.
Audit results--Financial statements, internal control,
going concern, communications between auditors and audit committees,
and enforcement and litigation.
The Concept Release discussed (i) the nature of the potential
indicators and potential calculations, (ii) the usefulness of the
indicators, (iii) suggestions for other indicators, (iv) potential
users of the indicators, and (v) the approach to implementation. In
response to the Concept Release, the PCAOB received 50 comment letters.
Most commenters expressed support for the general idea that AQIs
may be

[[Page 99972]]

useful.\13\ However, commenter views varied widely. Comments from firms
and firm-related groups suggested that no standard group of indicators
could advance a person's understanding of audit quality. These
commenters suggested that AQIs should be voluntary, should be reported
to audit committees through two-way discussions to provide context for
the indicators, or should be required only at the firm level. Investors
and investor-related groups recommended that indicators should be made
public as they could be used to stimulate competition based on quality
among audit firms, remedy the deficiency of information about audits,
and give shareholders meaningful information to help them in voting on
auditor selection. Some commenters suggested that engagement-level
metrics are more useful than firm-level metrics. One commenter
suggested that promoting competition around an implied variability in
audit quality may not always be appropriate and in the public interest
because audit quality should be nonnegotiable and a fundamental goal
for all audits. Another commenter suggested that it was critical to
define what AQIs do and do not represent so that they are used
appropriately.
---------------------------------------------------------------------------

\13\ See Nov. 2015 Standing Advisory Group (SAG) Briefing Paper
available at SAG Meeting Archive, https://pcaobus.org/news-events/events/event-details/standing-advisory-group-meeting_910.
---------------------------------------------------------------------------

ii. PCAOB Rulemakings To Increase Audit Transparency: Identification of
the Engagement Partner and Other Audit Participants on Form AP and
Auditor Communication of Critical Audit Matters
In 2015, the PCAOB adopted rules requiring information on Form AP,
Auditor Reporting of Certain Audit Participants, regarding the
engagement partner and other accounting firms that participate in
audits of issuers.\14\ The rulemaking was initially in response to the
ACAP recommendation that the engagement partner should be required to
sign the audit report.\15\ As the rulemaking evolved, it also took
account of stakeholder input, including IAG recommendations to identify
the engagement partner and the firms, other than the firm signing the
audit report, that participate in audits.
---------------------------------------------------------------------------

\14\ See PCAOB Rule 3211.
\15\ See ACAP Final Report, at VII:19.
---------------------------------------------------------------------------

The Board's intention was to make available information about the
engagement partner and other firms that participated in the audit,
saying that such information, even if not useful in every instance or
meaningful to every investor, would make an overall contribution to the
information available to investors in making voting and investment
decisions. The Board also asserted that increased transparency should
promote increased accountability in the audit process. The Form AP
reporting requirements became effective in 2017, and the data gathered
via Form AP has many users; the Form AP data set is frequently searched
through AuditorSearch, the PCAOB's online search tool, as well as
downloaded by users performing more detailed analyses.\16\
---------------------------------------------------------------------------

\16\ See below.
---------------------------------------------------------------------------

In 2017, the PCAOB adopted AS 3101, The Auditor's Report on an
Audit of Financial Statements When the Auditor Expresses an Unqualified
Opinion, which includes requirements regarding the disclosure of
auditor tenure and auditor determination and communication of
``critical audit matters.'' \17\ This project was also initiated in
response to ACAP's recommendation that the PCAOB undertake a standard-
setting initiative to consider improvements to the auditor's standard
reporting model.\18\ The rulemaking explored potential ways to increase
the transparency and relevance of the auditor's report, including by
requiring expanded auditor reporting regarding the audit and the
company's financial statements.\19\ In the adopting release, the Board
noted ACAP's statement that the complexity of financial reporting
supports improving the content of the auditor's report beyond the then-
current pass/fail model to include a more relevant discussion about the
audit of the financial statements.
---------------------------------------------------------------------------

\17\ See AS 3101.11-.16.
\18\ See ACAP Final Report, at VII:13.
\19\ See Concept Release on Possible Revisions to PCAOB
Standards Related to Reports on Audited Financial Statements and
Related Amendments to PCAOB Standards; Notice of Roundtable (June.
21, 2011), available at https://pcaobus.org/news-events/news-releases/news-release-detail/pcaob-issues-concept-release-on-auditor's-reporting-model_337.
---------------------------------------------------------------------------

After multiple rounds of Board releases and stakeholder input, the
requirements took effect in 2019 and 2020.
iii. Recent PCAOB Standard-Setting and Rulemaking Activities
At the November 2022 Standards and Emerging Issues Advisory Group
(SEIAG) and the October 2022 and 2023 IAG meetings, several members
continued to urge the Board to take action on firm and engagement
metrics. Other members stated that some firms already publish similar
metrics through transparency reports and audit quality reports. Some
members of the IAG and SEIAG have requested increased information at
the firm and engagement levels through easily accessible and quantified
metrics, potentially with accompanying context provided by the
auditors.\20\
---------------------------------------------------------------------------

\20\ See Nov. 2022 SEIAG meeting, available at https://pcaobus.org/news-events/events/event-details/pcaob-standards-and-emerging-issues-advisory-group-meeting-2022. See Oct. 2022 IAG
meeting, available at https://pcaobus.org/news-events/events/event-details/pcaob-investor-advisory-group-meeting and Oct. 2023 IAG
meeting, available at https://pcaobus.org/news-events/events/event-details/pcaob-investor-advisory-group-meeting-october-2023.
---------------------------------------------------------------------------

In response to the Board's request for comment on the draft 2022-
2026 Strategic Plan, some commenters encouraged the Board to continue
to consider this topic.\21\ Additionally, in a January 2023 comment
letter on the PCAOB's proposed quality control standard, members of the
IAG advocated for ``a minimum requirement of eight indicators.'' \22\
These eight indicators were (i) staffing leverage; (ii) partner
workload; (iii) manager and staff workload; (iv) audit hours and risk
areas; (v) quality ratings and compensation; (vi) audit fees, effort,
and client risk; (vii) audit firm's internal quality review results;
and (viii) PCAOB inspection results.
---------------------------------------------------------------------------

\21\ See comments on 2022-2026 Strategic Plan Documents,
available at https://pcaobus.org/about/strategic-plan-budget/comments-on-pcaob-draft-strategic-plan-2022-2026.
\22\ See A Firm's System of Quality Control and Other Proposed
Amendments to PCAOB Standards, Rules, and Forms, PCAOB Rel. No.
2022-006 (Nov. 18, 2022). The comment letters received in response
to the proposal are available on the Board's website in Docket 046.
See comment letter from members of the IAG, available at https://assets.pcaobus.org/pcaob-dev/docs/defaultsource/rulemaking/docket046/4_iag.pdf?sfvrsn=1941e7c0_4.
---------------------------------------------------------------------------

a. QC 1000: Requirements
The Board adopted a new quality control standard for firms, QC
1000, A Firm's System of Quality Control (``QC 1000''),\23\ which
contains provisions that are relevant to firm reporting of firm- and
engagement-level metrics. QC 1000 will become effective in December
2025.
---------------------------------------------------------------------------

\23\ See A Firm's System of Quality Control and Other Amendments
to PCAOB Standards, Rules, and Forms, PCAOB Rel. No. 2024-005 (May
13, 2024) (``QC Adopting Release'').
---------------------------------------------------------------------------

(1) Public Communication of Firm-Level or Engagement-Level Information
QC 1000 includes a quality objective that, if a firm communicates
firm-level or engagement-level information with respect to the firm's
audit practice, firm personnel, or engagements, such as firm or
engagement metrics, to external parties, such information is accurate
and not misleading and, with respect to any such metrics that are
communicated

[[Page 99973]]

in writing, the communication explains in reasonable detail how the
metrics were determined and, if applicable, how the method of
determining them changed since the metrics were last communicated.\24\
(With respect to metrics reported on Form FM and Form AP, the form
itself provides the required explanation.) The final firm and
engagement metrics include reporting elements that focus on the firm's
responsibility to produce and report information that is accurate and
not misleading, for example, an optional narrative to accompany the
metrics. This element is discussed further below.
---------------------------------------------------------------------------

\24\ QC 1000.53e.
---------------------------------------------------------------------------

(2) Use of Metrics in Monitoring the Firm's QC System
Under QC 1000, in determining the nature, timing, and extent of QC
system-level monitoring activities, the firm is required to take into
account any metrics that the firm may use in its QC system.\25\ QC 1000
does not require the use of any specific metrics; firms have the
ability both to develop metrics on their own and to use any or all of
the metrics required to be reported under Rule 2203C and Rule 3211 in
their QC system, but that is not required. The Board believes these
metrics would provide information that could be used in the firm's
system of quality control. However, not all firms may find all metrics
useful in operating or monitoring their QC system, and the Board is not
mandating their use in connection with monitoring a firm's QC system at
this time.
---------------------------------------------------------------------------

\25\ QC 1000.65c.
---------------------------------------------------------------------------

b. Firm Reporting
Concurrently with this rulemaking, the Board adopted certain
updates to its annual and special reporting requirements to facilitate
the disclosure of more complete, standardized, and timely information
regarding audit firms. Among other new requirements, the updates will
(i) require firms to disclose additional information on Form 2 about
their fees, leadership and governance structure, and network
arrangements; (ii) require, in connection with QC 1000, a one-time
update to the statement on a firm's quality control policies and
procedures on a new Form QCPP; and (iii) expand the scope of special
reporting to include events that pose a material risk, or represent a
material change, to the firm's organization, operations, liquidity or
financial resources, in such a manner that it will affect the provision
of audit services, as well as new cybersecurity reporting
requirements.\26\
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\26\ See PCAOB Rel. No. 2024-013.
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c. Proposed Firm and Engagement Metrics
In April 2024, the Board proposed amendments to the PCAOB's rules
and reporting forms to require the reporting of specified firm-level
metrics on new Form FM, Firm Metrics, and specified engagement-level
metrics on an amended and renamed Form AP, Audit Participants and
Metrics. In the Board's proposal, it proposed a set of firm-level and
engagement-level metrics across 11 areas to be publicly reported for
the firms that serve as lead auditor for at least one accelerated filer
or large accelerated filer.
The Board received over 45 comment letters on the proposal.\27\
Commenters included investor-related groups, firms, firm-related
groups, academics, and others.
---------------------------------------------------------------------------

\27\ The comment letters received on the proposal are available
at https://pcaobus.org/about/rules-rulemaking/rulemaking-dockets/docket-041/comment-letters.
---------------------------------------------------------------------------

Some commenters expressed concerns about the speed of rulemaking by
the Board. Some commenters asked the PCAOB for more than 60 days to
respond to the proposal, citing overlapping comment proposal periods,
the duration of comment periods, the length and complexity of various
proposals, and overlapping SEC 19b-4 filing comment periods. On the
other hand, a commenter urged the Board not to delay this rulemaking
because investors need a relatively standardized data set to analyze
and compare over time and across companies. The Board believes that 60
days was a sufficient period for commenting on the proposal. Despite
that, the Board considered comment letters that were submitted after
the 60-day period closed. The Board received robust comments on the
proposal, which informed the final metrics or final rules.\28\ These
comments are addressed throughout this Exhibit 1 and in the Board's
adopting release (Exhibit 3).
---------------------------------------------------------------------------

\28\ See also below for consideration of the 2015 AQI Concept
Release (including comments received) and the PCAOB IAG
recommendations.
---------------------------------------------------------------------------

3. Overview of Existing Requirements
Under current PCAOB rules and standards, certain information about
PCAOB-registered firms is already made available to investors, audit
committees, and other stakeholders. The disclosure of firm- and
engagement-level metrics would supplement this information. This
section discusses the key PCAOB standards and rules that require
certain firm- and engagement-level information to be provided to
various stakeholders.
i. Available Information Related to Firms
PCAOB rules require firms to file Form 2 (Annual Report Form) to
report basic information about the firm and its audit practice and Form
3 (Special Reporting Form) after the occurrence of certain events.\29\
In addition, the PCAOB makes portions of inspection reports publicly
available for firms that are subject to annual or triennial PCAOB
inspections.
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\29\ PCAOB Rule 2200, Annual Report; PCAOB Rule 2201, Time for
Filing of Annual Report; PCAOB Rule 2203, Special Reports;
Instructions to Form 2, available at https://pcaobus.org/about/rules-rulemaking/rules/form_2; Instructions to Form 3, available at
https://pcaobus.org/about/rules-rulemaking/rules/form_3. Information
reported on Forms 2 and 3 is publicly available unless a firm
requests confidential treatment.
---------------------------------------------------------------------------

a. Form 2 and Form 3
As required by Section 102(d) of Sarbanes-Oxley and PCAOB Rule
2200, each year registered firms must file an annual report with the
Board. Under PCAOB rules, firms must do so by filing Form 2. The annual
reporting period runs from April 1 to March 31, and the due date for
filing is June 30.\30\ In addition to basic identifying information
about the firm,\31\ firms report on Form 2 general information about
their audit practices and other business relationships. Information
required to be provided on Form 2 includes:
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\30\ PCAOB Rule 2201; General Instructions 3-4 to Form 2
(registered public accounting firm that has its application for
registration approved by the Board in the period between and
including April 1 and June 30 of any year not required to file an
annual report in that year).
\31\ Instructions to Form 2, Item 1.1.
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Whether the firm issued audit reports for issuers,
brokers, or dealers or played a substantial role in issuer or broker-
dealer audits; \32\
---------------------------------------------------------------------------

\32\ Id., Item 3.1. The Board's release uses the terms
``issuer,'' ``broker,'' and ``dealer'' as those terms are defined
under Sections 2(a)(7) and 110(3)-(4) of Sarbanes-Oxley. 15 U.S.C.
7201(a)(7), 7220(3)-(4). See also paragraphs (b)(iii), (d)(iii), and
(i)(iii) of PCAOB Rule 1001, Definitions of Terms Employed in Rules.
Entities that are brokers or dealers or both are sometimes referred
to as ``broker-dealers.''
---------------------------------------------------------------------------

Percentage of total fees billed to issuers for audit
services, other accounting services, tax services, and non-audit
services; \33\
---------------------------------------------------------------------------

\33\ Instructions to Form 2, Item 3.2.
---------------------------------------------------------------------------

For each issuer or broker-dealer for which the firm issued
an audit report, the issuer's or broker-dealer's name, its Central
Index Key (CIK) number and Central Registration Depository (CRD) number
(if any), and the date of the audit report, as well as the total number

[[Page 99974]]

of firm personnel who exercised authority to sign the firm's name to an
audit report for an issuer or broker-dealer during the reporting
period; \34\
---------------------------------------------------------------------------

\34\ Id., Items 4.1, 4.3.
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Physical address (and, if different, mailing address) of
each firm office; \35\
---------------------------------------------------------------------------

\35\ Id., Item 5.1.
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Whether the firm has any memberships, affiliations, or
similar arrangements involving certain activities related to audit or
accounting services (including use of name in connection with audit
services, marketing of audit services, and employment or lease of
personnel to perform audit services), and the entities with which the
firm has those relationships; \36\
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\36\ Id., Item 5.2.
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Total number of accountants, certified public accountants,
and personnel; \37\
---------------------------------------------------------------------------

\37\ Id., Item 6.1.
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Relationships with certain individuals and entities with
disciplinary or other histories (if not previously identified); \38\
and
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\38\ Id., Items 7.1, 7.2.
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Acquisitions of another public accounting firm or a
substantial portion of another firm's personnel.\39\
---------------------------------------------------------------------------

\39\ Id., Item 8.1
---------------------------------------------------------------------------

In addition to annual reporting on Form 2, firms are required to
file Form 3 within 30 days after the occurrence of certain events, such
as when the firm's legal name has changed while otherwise remaining the
same legal entity, the firm has withdrawn an audit report on the
financial statements of an issuer or has resigned, declined to stand
for re-appointment, or been dismissed from an audit engagement as
principal auditor, and the issuer has failed to comply with applicable
Form 8-K reporting requirements for such events.\40\
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\40\ General Instruction 3 to Form 3; Instructions to Form 3,
Items 2.17, 2.1, 2.1-C, 3.1, 3.2.
---------------------------------------------------------------------------

b. Firm Inspection Reports
Sarbanes-Oxley authorizes the PCAOB to inspect firms for the
purpose of assessing compliance with certain laws, rules, and
professional standards in connection with a firm's audit work for
issuers, brokers, and dealers. Firms that issue audit reports for more
than 100 issuers per year are inspected annually. Firms that issue 100
or fewer audit reports per year for issuers are generally inspected at
least once every three years. The Board also inspects firms that play a
substantial role in audits of issuers. Many firms registered with the
Board perform no audit work for issuers or broker-dealers,\41\ or only
participate in audits below the level of a substantial role, and the
Board has not historically inspected those firms. The PCAOB provides
each inspected firm with a report summarizing any deficiencies
identified through the inspections process. Portions of these
inspection reports are publicly available on the PCAOB's website.\42\
Recently the PCAOB introduced enhanced search tools that enable
investors and others to better access and understand data from PCAOB
inspection reports.\43\
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\41\ See QC Adopting Release at 54.
\42\ See https://pcaobus.org/oversight/inspections for
inspection reports, basics of inspections, and inspection
procedures. Sarbanes-Oxley provides that no portions of an
inspection report that deal with criticisms of or potential defects
in the quality control systems of the firm shall be made public if
those criticisms or defects are addressed by the firm, to the
satisfaction of the Board, no later than 12 months after the
issuance of the inspection report. See Sarbanes-Oxley Section
104(g)(2). Full (expanded) inspection reports are publicly available
on the PCAOB's website when a firm fails to satisfactorily remediate
within 12 months.
\43\ See https://pcaobus.org/news-events/news-releases/news-release-detail/pcaob-launches-new-online-tools-to-help-users-find-and-compare-inspection-report-data for a summary of the
enhancements, including six new search filters, including Part I.A
deficiency rate, to help users analyze and compare more than 3,700
inspection reports.
---------------------------------------------------------------------------

ii. Available Information Related to Issuer Engagements
a. Auditor's Communications With Audit Committees
Investors and other financial statement users are the beneficiaries
of the audit. Audit committees protect the interests of investors by
assisting the board of directors in fulfilling its responsibility to
oversee the integrity of the company's accounting and financial
reporting processes, including the audit of the company's financial
statements--and in carrying out that duty, they also benefit other
financial statement users. To support the audit committee in this
crucial role, PCAOB standards and rules and SEC rules require auditors
to provide certain firm- and engagement-level information to audit
committees.\44\ AS 1301, Communications with Audit Committees, requires
various communications to facilitate the audit committee's financial
reporting oversight.\45\ Among other things, AS 1301 requires the
auditor to communicate: (i) significant risks; \46\ (ii) critical
accounting policies and practices, critical accounting estimates, and
significant unusual transactions; \47\ (iii) the auditor's evaluation
of the quality of the company's financial reporting; \48\ and (iv)
other matters that are significant to the oversight of the company's
financial reporting process.\49\ In addition, other PCAOB standards and
rules and SEC rules independently require certain audit committee
communications.\50\
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\44\ See Auditing Standard No. 16, Communications with Audit
Committees; Related Amendments to PCAOB Standards; and Transitional
Amendments to AU Sec. 380, PCAOB Rel. No. 2012-004 (Aug. 15, 2012),
at 2, available at https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/docket030/release_2012-004.pdf?sfvrsn=7872effb_0.
\45\ Id. (``Communications with the audit committee provide
auditors with a forum separate from management to discuss matters
about the audit and the company's financial reporting process.'').
\46\ See AS 1301.09.
\47\ See AS 1301.12
\48\ See AS 1301.13.
\49\ See AS 1301.24.
\50\ See Appendix B of AS 1301 (listing other PCAOB standards
and rules requiring audit committee communications); see also 17 CFR
210.2-07; PCAOB Rule 3526, Communication with Audit Committees
Concerning Independence.
---------------------------------------------------------------------------

b. Auditor's Public Communications of Certain Information
AS 3101 and Rule 3211 require firms to publicly disclose certain
engagement-specific information in the auditor's report and on Form AP.
In addition to specifying the requirements for an unqualified opinion
on the financial statements, AS 3101 requires the auditor's report to
describe (i) critical audit matters, which inform investors and other
financial statement users of matters arising from the audit that
required especially challenging, subjective, or complex auditor
judgment; and (ii) how the auditor addressed those matters. AS 3101
further requires the auditor's report to include a statement disclosing
the year in which the auditor began serving consecutively as the
company's auditor. Other standards require additional information to be
included in the auditor's report, including AS 2415, Consideration of
an Entity's Ability to Continue as a Going Concern, which requires an
explanatory paragraph when the auditor concludes that there is
substantial doubt about the entity's ability to continue as a going
concern for a reasonable period of time.\51\
---------------------------------------------------------------------------

\51\ See AS 2415.12.
---------------------------------------------------------------------------

PCAOB Rule 3211 requires auditors to file Form AP, which, among
other things, provides information to investors and other financial
statement users about the engagement partner and other accounting firms
participating in the audit of issuers. Disclosures on Form AP provide
increased transparency about certain audit participants. The key
provisions include annual disclosures of (a) the name of the engagement
partner and (b) the name and extent of participation of other
accounting firms in the audit.\52\
---------------------------------------------------------------------------

\52\ See Instructions to Form AP. Form AP requires different
disclosures regarding other accounting firms that participate in an
audit depending on their level of participation. For other
accounting firms with individually 5% or greater participation in
the audit, the Form AP filer must disclose the legal name of the
other accounting firm, the city and state (or, if outside the United
States, the city and country) of that firm's headquarters, and the
percentage of total audit hours (either as a single number or within
a range provided on the form) attributable to each other accounting
firm. For other accounting firms with individually less than 5%
participation, the filer must disclose the total number of such
other accounting firms and the aggregate percentage (either as a
single number or within a range provided on the form) of total audit
hours for all such firms.

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

[[Page 99975]]

The PCAOB makes the Form AP data set available on AuditorSearch, by
which users can conduct live searches or download the entire data set
in a searchable, machine-readable format.\53\ Using this data, a user
can determine, for example, the changes in engagement partner for any
given issuer or obtain a list of all issuers for which an engagement
partner is responsible. After identifying an engagement partner, a user
can then compile information from other sources, including information
about whether the partner is associated with restatements of financial
statements, has been subject to public disciplinary proceedings, or has
experience as an engagement partner for issuers of a particular size or
in a particular industry. Similarly, starting from the Form AP data
set, users may perform further research on the other accounting firms
that participate in an audit, such as whether those firms are
registered with the PCAOB, whether they have any publicly available
disciplinary history, whether they have been inspected, and, if so, the
results of those inspections.
---------------------------------------------------------------------------

\53\ See AuditorSearch, available at https://pcaobus.org/resources/auditorsearch.
---------------------------------------------------------------------------

4. Voluntary Firm Reporting
Since the Concept Release, many of the audit firms that issue audit
reports for more than 100 issuers and audit the majority of the market
capitalization for issuers have been publicly disclosing certain firm-
level information discussed in the Concept Release through their audit
quality reports, transparency reports, or other published reports. A
firm-related group has published a framework to assist its members in
these efforts.'' \54\ Many firms may also be developing and monitoring
certain firm and engagement metrics to be used internally by the firm.
In 2023, the same firm-related group published a summary analysis of
the most recent audit quality reports issued by the eight firms
represented on the group's governing board.\55\ The report indicated
that firms were reporting similar firm-level quantitative metrics
related to several areas, including audit firm inspections; training;
use of auditor's specialists; audit report reissuances and financial
statement restatements; measures of experience, such as tenure with the
firm; and personnel turnover. The report further noted that some firms
disclosed qualitative as well as quantitative information, including
information relating to audit methodology and execution, people and
firm culture, quality management and inspections, and technology and
innovation.
---------------------------------------------------------------------------

\54\ CAQ, Audit Quality Disclosure Framework (Update) (June
2023). The framework provides that metrics ``may provide those
overseeing the audit and other stakeholders with information and
additional transparency into the firm's systems and processes that
impact audit quality. However, the CAQ believes that a combination
of metrics--taken as a whole and supplemented with robust
discussion--may provide those overseeing the audit and other
stakeholders with information and additional transparency into the
firm''s systems and processes that impact audit quality.'' Id. at 4.
\55\ See CAQ Audit Quality Reports Analysis: A Year in Review
(Mar. 2023), available at https://www.thecaq.org/aqr-analysis-yir
(``CAQ Report''). The eight firms on the CAQ's governing board are
BDO USA, LLP, Crowe LLP, Deloitte & Touche LLP, Ernst & Young LLP,
Grant Thornton LLP, KPMG LLP, PricewaterhouseCoopers LLP, and RSM US
LLP.
---------------------------------------------------------------------------

The Board has observed the firms that report firm-level metrics
generally do not report engagement-level metrics.\56\ Where firm-level
metrics are reported, the firms report different metrics, calculated in
different ways, and using different definitions, thereby preventing
users from making comparisons across firms.
---------------------------------------------------------------------------

\56\ In connection with the Nov. 2022 SEIAG meeting, the Board
staff researched various reports issued during the prior three years
by the top 20 accounting firms (by 2022 revenue) and identified nine
firms that disclosed firm-level metrics. See Firm and Engagement
Performance Metrics Briefing Paper and Related Attachments from Nov.
2022 SEIAG meeting, available at https://pcaobus.org/news-events/events/event-details/pcaob-standards-and-emerging-issues-advisory-group-meeting-2022. For each firm-level metric reported by those
nine firms, the PCAOB staff included examples of how firms
calculated the metric as well as the number of firms reporting that
metric.
---------------------------------------------------------------------------

One commenter on the Concept Release stated that many firms are
using the 28 AQIs identified in the Concept Release at some level to
(i) manage the firm and (ii) manage the quality of audits at the office
level and at the engagement level. Another commenter specifically
indicated that its audit committee reviewed the engagement-level AQIs
identified in the Concept Release that were provided by their auditor.
One commenter on the proposal asserted that the voluntary reporting
firms already do through transparency and audit quality reports
includes firm-level metrics, as well as explanations of how they are
calculated, including changes in the calculation that could affect
comparability, as well as context necessary for understanding the
metrics, and would be preferable to the mandatory metrics that the
Board proposed. On the other hand, an investor-related group presented
an analysis of firm transparency and audit quality reports, finding
that the measures used in transparency reports and audit quality
reports by different firms are not consistent or comparable across
firms in their computations, presentation and inclusion, and are not
provided at the engagement level, which the commenter believes is the
level at which they would be most useful. This commenter stated that
having both firm- and engagement-level metrics enhances the metrics'
usefulness because it provides broader context for understanding at
both levels.
Actions in Other Jurisdictions
Some jurisdictions outside the United States have moved forward
with mandatory or voluntary initiatives related to the monitoring and
disclosure of metrics. In May 2022, Accountancy Europe published a
factsheet about recent related initiatives in Europe and elsewhere.\57\
The Accountancy Europe Report described initiatives conducted in 10
countries (including the United Kingdom (U.K.), South Africa and
Canada) by various organizations, including audit oversight bodies
(including the U.K.'s Financial Reporting Council (FRC), Portugal's
Securities Market Commission (CMVM), South Africa's Independent
Regulatory Board for Auditors (IRBA), and the Canadian Public
Accountability Board (CPAB)),\58\ professional organizations,\59\ a
group of independent experts,\60\ and the CAQ. Additionally, the FRC in
the U.K. issued a consultation document and a feedback statement in
2022 on publishing AQIs for the largest U.K. audit firms,\61\ the IRBA
in South Africa

[[Page 99976]]

requested firms auditing listed companies to submit AQI-related
information to the IRBA,\62\ and the CPAB launched an exploratory pilot
project to solicit feedback on AQIs' usefulness in support of broader
national and international discussions.\63\ The primary users of the
metrics from these initiatives were audit committees, oversight bodies,
and professional organizations. Although many of the metrics in these
initiatives were nonpublic, public reporting was encouraged or
anticipated in the future for half of the initiatives.\64\ The
Accountancy Europe Report suggested that several factors should be
considered when selecting, evaluating, and reporting metrics and
recommended that a combination of metrics would provide ``profound
insight into audit quality.''
---------------------------------------------------------------------------

\57\ See Accountancy Europe, Factsheet, Audit Quality
Indicators--A Global Overview of Initiatives (May 2022), available
at https://www.accountancyeurope.eu/wp-content/uploads/220401-Factsheet-Audit-Quality-Indicators.pdf (``Accountancy Europe
Report'').
\58\ Id. Other oversight bodies in the Accountancy Europe Report
include the Federal Audit Oversight Authority (FAOA) in Switzerland
and the Accounting and Corporate Regulatory Authority (ACRA) in
Singapore.
\59\ Id. Professional organizations in the Accountancy Europe
Report include the Institute of Public Auditors (IDW), Germany and
The Institute of Chartered Accountants (ICAI), India.
\60\ Id. Quartermasters, Netherlands.
\61\ See FRC, Consultation Document: Firm-level Audit Quality
Indicators (June 2022), available at https://media.frc.org.uk/documents/FRC_AQI_Consultation.pdf. See FRC, Feedback Statement:
Firm-level Audit Quality Indicators Consultation (Dec. 2022),
available at https://www.frc.org.uk/getattachment/afbf3bc4-cf15-468a-85da-afb8e5af222a/Feedback-Statement_-2022.pdf (``FRC Feedback
Statement'').
\62\ See IRBA 2021 Survey Report Audit Quality Indicators,
available at https://www.irba.co.za/upload/IRBA%20AQI%20Report%202021.pdf and IRBA 2022 Survey Report Audit
Quality Indicators, available at https://www.irba.co.za/upload/2022%20AQI%20Report.pdf.
\63\ See CPAB Audit Quality Indicators Final Report, available
at https://cpab-ccrc.ca/docs/default-source/thought-leadership-publications/2018-aqi-final-report-en.pdf?sfvrsn=5af68dba_12&sfvrsn=af68dba_12 (``CPAB Final Report'').
See also CPAB Audit Quality Indicators: How to put them to work,
available at https://cpab-ccrc.ca/docs/default-source/thought-leadership-publications/2019-aqi-put-to-work-en.pdf?sfvrsn=246de787_10.
\64\ See Accountancy Europe Report (public reporting encouraged
or anticipated by ACRA, CAQ, FRC, IDW, and Quartermasters).
---------------------------------------------------------------------------

In January 2023, Accountancy Europe published a position paper.\65\
The position paper defined key concepts related to audit quality,
presented considerations for developing AQIs, and explained what, in
its view, can and cannot be achieved by reporting such indicators (for
example, the paper pointed out that all metrics have limitations, that
metrics are not a proxy for financial reporting quality, and that user
expectations should be managed to make them aware that metrics do not
provide definitive results). The paper stated as part of its conclusion
that ``[AQIs] should not be considered as an end in themselves but
could be a useful tool to drive audit quality'' and reiterated that a
combination of metrics would provide insight into audit quality.
---------------------------------------------------------------------------

\65\ See Accountancy Europe, Position Paper, Key Factors to
Develop and Use Audit Quality Indicators (Jan. 2023), available at
https://accountancyeurope.eu/wp-content/uploads/221206-AQIs-Position-Paper_FINAL.pdf.
---------------------------------------------------------------------------

Some commenters noted that initiatives in other jurisdictions do
not currently require public disclosure. Others suggested that the
requirements that the Board proposed were more onerous than other
jurisdictions and may cause reporting of different calculations for
similar metrics in different jurisdictions. One commenter provided
examples in other jurisdictions including providing optional guidance,
allowing engagement-level metrics to be shared confidentially with
audited entities, and allowing for voluntary adoption. Another
commenter expressed its belief that the Board is attempting to justify
individual metrics based on certain jurisdictions' use but have not
fully considered the context in how they are being used or the process
that has been undertaken in those jurisdictions. An additional
commenter stated that the comparability problem between jurisdictions
could be solved by allowing firms to voluntarily disclose the metrics
as defined. One commenter expressed the hope that audit regulators
globally will seek to align requirements relating to the reporting of
metrics.
While other jurisdictions have not historically required public
reporting, the U.K. FRC has announced that it will begin to require
public reporting in 2025.\66\
---------------------------------------------------------------------------

\66\ See https://www.frc.org.uk/consultations/aqis-consultation.
In June 2025, the FRC is requiring firms that audit 20 or more
public interest entities to publicly report ten firm-level metrics
across five areas. These areas include (i) Performance monitoring
and remediation, (ii) Quality monitoring, (iii) Resource planning
and people management, (iv) Information and communication, and (v)
Governance and leadership.
---------------------------------------------------------------------------

The Board considered the actions taken in other jurisdictions in
developing the final metrics. While substantially all the final metrics
are the same as, or similar to, metrics used in some other
jurisdictions, the Board acknowledges that no other jurisdiction has
embraced either the full set of metrics or the public reporting
requirements the Board has adopted. However, the Board's objective in
understanding actions in other jurisdictions was not to conform to what
they have done but rather to consider those actions in the context of
the Board's own rulemaking, which is addressed further below. The Board
believes that its approach to evaluating and determining which metrics
should be disclosed is appropriate in light of its statutory investor-
protection mission.
Discussion of the Final Rules
Overview
As noted above, the Board considered ways to measure audit firm and
audit performance, primarily with a view to providing information that
investors can use in making decisions regarding their investments, such
as ratifying the selection of the auditor and voting for members of the
board of directors, including directors who serve on the audit
committee. The Board also believes that firm and engagement metrics
will benefit other stakeholders. For audit committees, metrics will
provide additional context, including consistent comparative
information that is not currently available, that can be used when
deciding whether to select or retain a firm and when overseeing the
auditor's performance. For audit firms, metrics will provide
standardized information about themselves and their peers that can be
used in designing, implementing, monitoring, and remediating their
systems of quality control. The Board will also benefit from having
additional tools to use in its inspections program and standard-setting
initiatives.
This rulemaking addresses the need for information by requiring
consistent, comparable disclosures that the Board believes will provide
insight into aspects of the firm and the engagement team conducting the
audit, including information relating to workloads, retention,
allocation of audit hours, experience, and restatements.
1. Purpose of the Metrics
Investors and other stakeholders lack information that is available
to company management. The federal securities laws seek to reduce this
information asymmetry through various disclosure, internal control, and
other requirements, including requirements for public companies to
prepare and disclose financial statements accompanied by audit reports
issued by an independent public accounting firm. Investors and other
stakeholders also lack information available to the auditor and cannot
observe the auditor's work or other aspects of a public company audit.
Instead, they must rely on the audit committee, which is charged with
overseeing the external auditor, and on other available public
information, such as the reputation of the firm issuing the audit
report or the name of the engagement partner. These difficulties in
evaluating the audit and the auditor may lead to reduced accountability
for auditors and an inefficient allocation of audit effort. Such
allocations allow audit risk to remain insufficiently evaluated,
ultimately risking suboptimal investment decisions, hampering the
efficient functioning of the audit profession, and negatively affecting
the

[[Page 99977]]

capital markets.\67\ Furthermore, while the audit committee has more
information regarding the specific auditor it oversees, it lacks
insight into other audit engagements and other firms; such comparable
information would assist the audit committee in more effectively
selecting and monitoring the auditor.
---------------------------------------------------------------------------

\67\ There is a long stream of research regarding the effects
that information asymmetry about product features, such as quality,
and disclosure have on markets. See, e.g., George A. Akerlof, The
Market for ``Lemons'': Quality Uncertainty and the Market Mechanism,
84 The Quarterly Journal of Economics 488 passim (1970); and Robert
E. Verrecchia, Essays on Disclosure, 32 Journal of Accounting and
Economics 97 (2001).
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Investors and other stakeholders may seek to reduce these
information disparities by gathering additional information about the
firm responsible for the audit and the relevant audit engagement. As
discussed above, the PCAOB has previously sought to facilitate those
efforts through rules and standards requiring the disclosure of such
information. From its inception, the Board's registration and reporting
program has yielded important information about registered firms.
Annual updates on Form 2 include information such as the issuers
audited by the firm, a breakdown of fees charged to issuers, and
network affiliations, and current reporting on Form 3 discloses
significant events such as the withdrawal of an audit report and
certain legal actions involving the firm or its professionals. The
Board concurrently adopted amendments to both of those reporting forms
to mandate the disclosure of standardized and timely information by
firms.\68\ Firms are required to disclose on Form AP the name of the
engagement partner and certain audit participants.\69\ The Board also
made the auditor's report more relevant and informative by, among other
things, requiring communication of critical audit matters and the
tenure of the auditor.\70\ The Board intends the firm and engagement
metrics to complement these other initiatives and to add to the mix of
information available to investors and other stakeholders when
evaluating the auditor and the audit.\71\
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\68\ See PCAOB Rel. No. 2024-013.
\69\ See PCAOB Rule 3211.
\70\ See AS 3101.10.b, .11-.16.
\71\ In addition to disclosures on Form AP and in the audit
report, the Board previously required information on periodic and
special reports to be publicly available. See Rules on Periodic
Reporting by Registered Public Accounting Firms, PCAOB Rel. No.
2008-004 (June 10, 2008), 28-32.
---------------------------------------------------------------------------

The Board's oversight activities have revealed that there are
identifiable performance differences across firms and among engagement
teams within the same firm, including variations among firms belonging
to global networks. The Board considered such differences when
performing regulatory functions. For example, the Division of
Registration and Inspections uses, among other factors, information
about the firm and the engagement to identify audit engagements for
risk-based selections in the Board's inspections program.
Mandating public disclosure of firm- and engagement-level metrics
will provide investors, audit committees, and other stakeholders with
comparable information that is not currently available and will
otherwise be difficult or impossible to obtain. These stakeholders will
be able to learn about both specific engagements and specific firms and
have a basis to compare them to other engagements and other firms. The
firms themselves could also benefit from access to information about
their peers, both in gaining new perspective on how their practices
compare and in potentially gaining new opportunities for competition
based on markers that users come to associate with quality. Required
disclosures will facilitate development of standardized data for
consistent comparison and analysis over time, which the Board believes
will be more valuable than the ad hoc, individualized disclosures that
some firms have made on a voluntary basis. Mandatory public disclosure
will also ensure that the information will be accessible to all
stakeholders, so that any decision-useful information can be readily
evaluated. The Board believes this information will enable investors,
audit committees, and other stakeholders to make better-informed
decisions.\72\
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\72\ Under Section 102 of Sarbanes-Oxley, the Board may require
registered public accounting firms to submit periodic and special
reports containing financial or other information as is ``necessary
or appropriate in the public interest or for the protection of
investors.'' 15 U.S.C. 7212(d). Section 103 of Sarbanes-Oxley tasks
the Board with adopting quality control and other standards to be
used by registered 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.'' 15 U.S.C. 7213(a)(1).
See also 15 U.S.C. 7211(a), (c)(5), 7213(a)(2)(B). The Board
believes the proposed metrics would further the public interest and
would protect investors in accordance with these provisions.
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The Board believes the metrics will also assist the PCAOB in a
variety of ways. Metrics will help to inform the Board's inspection
activities, including in the selection of firms, engagements, and focus
areas for review. For example, the final metrics could refine the
selection models used to aid in predicting negative audit outcomes,
enhancing the Board's risk-based inspections. They could also enrich
the discussions the Board has with audit committee chairs as part of
the Board's inspections process. Metrics may also inform future
standard-setting activities by helping the Board to identify areas
where regulatory action is needed and suggesting potential approaches.
In addition, the Board expects metrics to enhance the PCAOB's ability
to produce impactful research and to provide valuable information
sources for the public, including academic research, helping to create
new insights into the audit.
The Board's discussion of the potential benefits of the final
metrics in greater detail below.
2. Public Reporting of Metrics
Many commenters on the proposal addressed the fundamental question
of whether there was value in mandating a set of publicly reported
metrics, expressing conflicting views. Investors and investor-related
groups were generally supportive. Many other commenters, primarily
firms and firm-related groups criticized the proposal. These commenters
either supported public reporting of some firm-level metrics but not
others while generally opposing any public reporting of engagement-
level metrics, or opposed all public reporting of metrics at both the
firm and engagement levels.
Among the commenters that supported the metrics proposal, several
stressed the benefits of increased transparency for key stakeholders
and the public overall. Several commenters generally agreed with the
PCAOB's rationale for the metrics, including increasing competition
among audit firms, including on the basis of audit quality; promoting
auditor accountability, which will lead to greater audit quality; and
providing investors with decision-useful comparable information that
will assist them in making decisions about audit-related matters (e.g.,
ratifying the appointment of the auditor or voting for reelection of
Board members that serve on the audit committee). Two of these
commenters asserted that investors currently lack information to make
an independent and informed decision regarding ratification of the
appointment of the auditor and to hold audit committee members to
account in the performance of their duties. In that context, one of
these commenters pointed out that most failures to ratify the
appointment of the auditor occur after a financial reporting failure,
and argued that metrics would provide information allowing investors to
make

[[Page 99978]]

an ex ante, rather than ex post, evaluation of the auditor's work.
Two commenters particularly favored engagement-level metrics. One
said it would enable the compilation of engagement-level data for all
public company audit engagements within a specific office to compare
data for competing offices within the same geographic area. In this
commenter's view, metrics such as workload would provide great value to
prospective employees and would improve the talent pipeline issue
because firms' workload need to be competitive in the eyes of
prospective employees. Another argued that engagement-level metrics are
most useful to investors, using firm-level metrics to provide context.
This commenter also emphasized the importance of firm-level metrics,
which will provide context in evaluating engagement-level metrics and a
firm's audit practice and its related system of quality control.
Several commenters said that the benefits of metrics would likely
evolve over time, for example, as users are able to aggregate multiple
data points, make comparisons, and observe trends. The Board agrees and
believes that analyzing the metrics over time, across engagements and
across firms, in the context of known good practices and indicators of
audit failure, will enable the PCAOB, as well as academics and users of
the metrics, to gain a new perspective on the audit and potentially
deeper insights into some of the drivers of audit quality.
Many larger firms generally supported certain firm-level metrics.
These commenters generally agreed that firm-level reporting could
provide stakeholders with relevant information through consistent
disclosure by all firms required to report. While some of the
commenters raised concerns about the usefulness, comparability, and
risk of misinterpretation of certain firm-level metrics; the risk that
standardization of metrics limits their adaptability to change in the
business and auditing environment; and more generally concerns that the
costs may outweigh the benefits, commenters agreed that the proposed
firm-level metrics are generally consistent with voluntary disclosures
that some firms are already making in firm transparency and audit
quality reports. A discussion of the comments made with regard to
particular metrics is provided below.
However, firms and firm-related groups generally opposed
engagement-level metrics. Some questioned whether investors would use
the metrics. Others expressed concern that publicly available metrics
could contribute to information overload. Many said that it would not
be possible to provide sufficient context to enable users to understand
the metrics, even with the firm-level metrics or narrative disclosures.
Some commenters asserted that, because the underlying circumstances of
engagement-level metrics are not homogeneous and users would not have
necessary context, engagement-level metrics would not be
comparable.\73\ Others focused on the significance of qualitative
factors such as professional judgment and the duty to exercise due
care, including professional skepticism, saying that metrics were
inappropriately ``one size fits all'' or not decision-useful because
they do not capture these key concepts.
---------------------------------------------------------------------------

\73\ Commenters listed various types of contexts that in their
view would be necessary for proper understanding of the engagement-
level metrics, including variations across firms (e.g., differences
in operations, structures, methodologies, and resources), the unique
circumstances of each engagement (e.g., differences in risk areas,
team compositions, and timelines), and the unique circumstances of
each issuer (e.g., differences in policies and resources).
---------------------------------------------------------------------------

Many commenters expressed concern that users would not find metrics
meaningful and may even misunderstand them and reach inappropriate
conclusions. Absent providing substantial context and understanding how
stakeholders would use the metrics, in one commenter's view, investors
may make capital allocation decisions based on a misinterpretation of a
metric, resulting in a new element of volatility in the capital
markets. Two commenters raised a concern that the proposal does not
provide a tie between assessing audit quality and the proposed metrics.
Some commenters went on to say that providing metrics in isolation
without context and effective two-way communication would have very
minimal, or even negative, impact on audit quality. Another commenter
stated that most of the data points required as part of the proposal
are currently available to the PCAOB.
One commenter expressed concern that overemphasis on metrics could
lead firms to focus on consistency of the metrics to avoid the
implication of weak auditing or other potential misinterpretations,
which in the commenter's view could lead to commoditization of the
audit and reduce incentives to innovate the audit approach. On the
other hand, several other commenters argued that metrics would support
more robust competition based on quality, making the audit less of a
commodity.
Some commenters said that the metrics seemed particularly focused
on larger firms or would be especially burdensome for smaller firms.
The Board believes the final metrics call for data that will be
relevant to and obtainable by firms regardless of size. The potential
differential cost impacts are discussed below.
Some commenters questioned whether public reporting of metrics
would undermine the authority of the audit committee. For example, one
expressed concern that there would be public pressure on the audit
committee to appoint auditors whose metrics were perceived to be within
some acceptable range, even if the committee was satisfied with the
work of the current auditor. Another commenter asserted that it is not
investors' responsibility to oversee the auditor, and raised a concern
that public reporting of metrics could undermine confidence in audit
committees and the PCAOB, both of which have responsibilities for
direct oversight of audits and audit firms and have the context to
properly understand these metrics. However, an investor-related group
specifically disagreed with this reasoning and asserted that this
rulemaking exhibits commitment to faithfully executing the PCAOB's
responsibilities and working to improve audit quality and trust in the
audit market.
Several commenters opposed both firm- and engagement-level metrics.
One asserted that the proposal did not provide sufficient evidence that
public disclosure of the proposed metrics will have any meaningful
impact on the quality of audit services. Another commenter said that
the metrics were not grounded in or intended to have any nexus with
audit quality, focusing instead on auditor accountability, and on that
basis went beyond the PCAOB's remit. The commenter asserted that the
proposed metrics would overload audit committees and investors with a
large set of complex data that was not sought, needed, meaningful, or
obviously usable by them, suggesting that the current voluntary
approach should be maintained instead. Another expressed concern that
public disclosure of the information specified in the proposals could
do more harm than good, particularly in relation to an increase in
litigation and reputational risk and potentially furthering the talent
crisis in the profession. That commenter particularly questioned the
potential value of metrics for audit committees, saying that they
already have access to most of the information that would be mandated
and that annual reporting would be unhelpful since evaluation of the
auditor is a continuous process. One commenter who advocated delay and

[[Page 99979]]

further study before the Board takes further action on the metrics
expressed skepticism that metrics would influence shareholder votes on
ratification of the appointment of the auditor or benefit most
investors, because metrics are only indirectly related to audit quality
and there would not be sufficient incentive for users to engage with
them.
Most of the commenters who objected to public reporting of metrics
recommended alternatives, including mandatory or voluntary
communication with the audit committee, particularly for engagement-
level metrics. Many commenters asserted that the audit committee is the
appropriate party to whom engagement-level metrics should be
communicated, because the audit committee has the statutory
responsibility to appoint, compensate, and replace the external auditor
and is sufficiently informed to understand the context of the company,
the audit, and the auditor. Commenters said that audit committees could
engage in dialog with the auditor, enabling them to understand the
metrics in the context of the specific audit, promoting accountability
in the performance of the audit on behalf of investors. Another
commenter asserted that providing information to, and allowing the
assessment by, audit committees would be more likely to provide greater
benefits to investors and the capital markets than public reporting,
while minimizing unintended consequences (such as users reaching
inappropriate conclusions), and would be consistent with the PCAOB's
objective to improve audit quality. Another commenter, who questioned
the value of metrics for most investors, said metrics had the potential
to be quite useful for audit committees, who could use their direct
access to the auditor to gain valuable context and would have the
opportunity, using metrics, to communicate more about the audit process
in their audit committee report. On the other hand, an investor-related
group pointed out that audit committees are reliant on communications
from the auditor regarding the company's audit issues and the quality
of the audit; their principal tool is inquiry, not observation, which,
in audit parlance, is the weakest form of audit evidence.
Many commenters that objected to publicly available metrics like
the ones the Board proposed advocated a non-prescriptive, principles-
based approach, whereby auditors and audit committees would discuss
potential metrics and the audit committee would determine which metrics
and other information it finds meaningful and when it wants to receive
and evaluate them. This approach, the commenters said, would encourage
more tailored metrics that could be appropriately discussed in context
and could change over time, adapting to changes in the audit
environment, regulation, technology and audit processes, and the
information needs of audit committees and investors and would
prioritize relevance rather than consistency. Some commenters
specifically recommended amending AS 1301 to mandate such a discussion
(for example, initially in connection with audit planning and later as
part of reporting on audit results). However, one investor-related
group disagreed with this principles-based approach, asserting that it
would not promote comparability or accountability because a set of
principles would inevitably result in qualitative rather than
quantitative disclosure and the information would not be comparable
between firms and engagements and over time. This commenter asserted
that the standardized metrics the Board proposed would be more useful
to investors.
This commenter also provided analysis of audit quality reports
published by the Big 4 firms, observing that elements of the proposed
firm-level metrics are already presented in those reports under a
principles-based approach whereby each firm has developed its own
metrics.\74\ The commenter noted that some of these metrics are
qualitative, some are quantitative, some use different definitions, and
some unfavorable metrics or facts may be excluded. This commenter also
asserted that because metrics voluntarily published by firms are self-
defined and principles-based and are only at the firm level and not at
the engagement level, they are largely unused by the investment
community; they are regarded as marketing materials rather than
investor information. This commenter emphasized that investors need
more standardized information contextualized at the engagement-level to
the company they are investing in and that are anchored to the firm-
level standardized information.
---------------------------------------------------------------------------

\74\ This commenter provided several examples of inconsistencies
in reporting metrics. For example, it stated while all Big 4 firms
provide data on turnover or attrition, they are defined and
calculated in different ways and any comparison among the firms is
stymied.
---------------------------------------------------------------------------

Several commenters noted that it would be possible for audit
committees to provide additional public disclosure via the audit
committee report in the issuer's proxy statement,\75\ which investors
could consider in deciding whether to ratify the audit committee's
selection of auditor and whether to vote for the board members who
serve on the audit committee. Some of these suggested that the SEC
could take action instead of, or along with, the PCAOB. Two argued that
expanded audit committee disclosure would result in more relevant and
decision-useful information for investors than the proposed metrics or
would be a more direct way to address the information asymmetry than
through this rulemaking. The other suggested that the SEC, together
with the New York Stock Exchange and Nasdaq, should require inclusion
of the metrics in the proxy statement to provide context for existing
fee disclosures and to make investors aware of the metrics without
having to search for them separately.
---------------------------------------------------------------------------

\75\ See Schedule 14A. Information required in proxy statement,
17 CFR 240.14a-101. If action is to be taken at a shareholders'
meeting with respect to the election of directors, Item 7 of
Schedule 14A requires the proxy statement to contain a report of the
audit committee as specified in Item 407 of Regulation S-K, 17 CFR
229.407.
---------------------------------------------------------------------------

One firm suggested that the PCAOB gather the information underlying
the metrics via inspection. However, this would defeat the objective of
enhancing transparency to enable better informed decision-making by
stakeholders.
Another firm expressed concern that engagement-level metrics may
not be useful because they will become available only once a year, with
a delay of up to 35 days after the audit is completed until Form AP is
filed. However, an investor-related group disagreed with this argument
indicating that the financial results for companies are delivered with
the same, or a more significant delay, to investors and usefulness of
the information is not simply its immediate discrete disclosure but the
trends in the information within and between companies over time.
In addition, commenters raised general concerns about metrics
requirements, including
the risk that publishing metrics would involve releasing
confidential or nonpublic information, which may violate
confidentiality obligations imposed by the American Institute of CPAs
(``AICPA'') Code of Professional Conduct or conflict with non-US laws
and regulations;
diverting the attention of the engagement team and firm
resources away from performing quality audits;
lessening competition by releasing competitively sensitive
information and reducing the number of registered public accounting
firms, particularly in foreign jurisdictions, that would be available
to play a substantial role in a large multinational group audit;

[[Page 99980]]

being burdensome and costly to compile data for each
individual engagement;
becoming a ``check the box'' or compliance exercise that
may not improve audit quality or provide meaningful transparency to
stakeholders; and
implying that audit committees have a legal duty to
consider metrics even though the PCAOB has no authority over audit
committees.
The Board adopted requirements for firms to provide both firm- and
engagement-level metrics, with changes from its proposal as described
in further detail below. The Board continues to believe that public
reporting of a mandated set of firm- and engagement-level metrics will
provide stakeholders with comparable information that is not currently
available, would otherwise be difficult or impossible to obtain, and
will position them to make better-informed decisions. Further, the
Board believes that required public disclosures will facilitate
development of standardized data for consistent comparison and analysis
over time, which will be more valuable than the ad hoc, individualized
disclosures that some firms have made on a voluntary basis or the
information that could be provided by individual firms to audit
committees or investors without any basis for cross-firm comparisons.
The Board believes the new data points, when analyzed together with the
audited financial statements, critical audit matters, auditor tenure,
and other information about the firm and the engagement on Form 2 and
Form AP, will provide more information about the audit and, therefore,
the reliability of the auditor's report.
The Board considered comments questioning the value of metrics,
whether they will be used by investors and other stakeholders or would
represent only a ``check the box'' compliance exercise, and whether
they might contribute to information overload or have other negative
consequences. Based on comments received from investors and other data
provided, among other factors, the Board does not share those concerns.
Investors and investor-related groups have commented throughout the
course of this rulemaking that the metrics will be useful. A firm-
related group commented that, in a recent investor survey it conducted,
almost all of the metrics the Board proposed were regarded as
``extremely helpful'' by between 30% and 50% of participating
investors. (The commenter did not indicate whether the survey allowed
positive responses other than ``extremely helpful''--for example,
``helpful'' or ``somewhat helpful''--and, if so, what the results were
inclusive of those responses.) By contrast, the Board understands--
including from one commenter that argues that the voluntary approach
should be maintained--that voluntarily provided metrics have not proven
useful to investors. The Board believes that the value of voluntary
metrics is undermined by a lack of the consistency and comparability,
as well as enhanced credibility, that can be achieved through common
definitions and calculations and required reporting.
The Board also noted that similar objections--that the new
information would not be used or would be confusing or misleading--were
raised by many of the same commenters in connection with the Board's
last two rulemakings requiring disclosure of additional information
about audits and auditors: Form AP reporting of the name of the
engagement partner and information about other firms participating in
the audit, and auditor communication of critical audit matters. In both
cases, these commenter concerns appear unsubstantiated. The Form AP
data set is now one of the most frequently visited areas of the PCAOB
website.\76\ Indeed, in an investor survey conducted by one commenter,
79% of respondents indicated that they often or very often navigate to
AuditorSearch, the search tool for Form AP data on the PCAOB website.
As for CAMs, in a recent investor survey conducted by the same
commenter, over 90% of the respondents indicated that CAMs play an
important role in their investment decision-making.\77\ In addition,
data aggregators, such as Audit Analytics, compile and make available
data on CAMs, which suggests market demand for that information. The
Board's experience suggests that contrary to concerns about irrelevance
and information overload, stakeholders seek out additional information
about auditors and audit engagements when it is available.
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\76\ In 2023, there were over 333,000 unique searches performed
on AuditorSearch and the Form AP data set was downloaded over 2,000
times. Information related to usage statistics can be found on the
PCAOB's website (https://pcaobus.org/resources/auditorsearch).
\77\ The Center for Audit Quality Critical Audit Matters Survey
(July 2024) at 9.
---------------------------------------------------------------------------

In lieu of public reporting, the Board considered the alternative
of encouraging or mandating communication of engagement-level metrics
to the audit committee, as many commenters suggested. However, such an
approach would not achieve the Board's goals of increasing the
information about audit engagements and audit firms available to
investors and other stakeholders, and fostering comparability of data
through mandated reporting based on common definitions and specified
calculations. The Board also believes that a non-prescriptive,
principles-based approach, whereby firms would potentially develop and
discuss different metrics for different audit committees, drawn from
different data and based on different definitions and calculations and
changing over time, could itself create significant costs and
challenges for firms without necessarily contributing to the audit
committee's ability to understand the audit it oversees in a broader
context.
Of course, under the Board's final requirements auditors and audit
committees will be free to discuss performance metrics--whether the
metrics required under the Board's rules or additional or alternative
metrics they develop themselves--through the kinds of discussions the
commenters recommend. The Board is not requiring that auditors make
metrics-specific communications at this time. However, where matters
addressed by the metrics are the subject of an otherwise required
communication, discussion of the metrics may be a useful part of the
communication.
The Board appreciates that the audit committee is charged by
statute with responsibility for oversight of the auditor, and the Board
cannot, and do not purport to, impose any obligations on audit
committees or imply that audit committees have any specific duties in
relation to metrics. The Board assumes that audit committees will
fulfill their responsibilities as they see fit; whether that entails,
for example, discussion of metrics with auditors or proxy statement
disclosure regarding their consideration of metrics will be for them to
determine.
But the Board also notes that investors--including many investors
that are themselves fiduciaries for others--have their own investment
and voting decisions that they are called upon to make, like decisions
about electing members of the board of directors, including those who
serve on the audit committee, and ratifying the appointment of the
auditor. And in the current environment, they have extremely limited
access to information about the auditor's work--work that, after all,
is undertaken for their benefit. By requiring public reporting of
metrics, the Board is not suggesting that investors will have the
ability or the responsibility to oversee the work of the auditor.
However, they will have the

[[Page 99981]]

opportunity to gain new perspective to inform their decision-making.
The Board agrees with a commenter that, far from undermining investor
trust, this new transparency should enhance that trust by helping
investors better understand the audit and the audit committee's
oversight of it.
The Board has determined to go forward with published metrics so
that investors and other stakeholders will have direct access to the
metrics and so that comparative data can be accumulated that will allow
comparisons to be made across different firms and different
engagements. As discussed below, the Board believes it has addressed
many of the challenges associated with potential lack of comparability
by narrowing the metrics to a group that it believes will send
relatively clear, comprehensible signals that users will be able to
interpret when taken together with the other information about the
issuer and the auditor that is available to them. In the Board's view,
public reporting is the most practical way for comparative data to be
created and disseminated. While two commenters suggested that audit
committees could obtain comparative data when they consider changing
auditors, the Board's understanding is that is a relatively infrequent
occurrence, and in any case is not a route available to other
stakeholders.
The Board also believes that gathering data and calculating the
final metrics, given the subjects they address, will not be overly
time-consuming or burdensome, and will not entail disclosure of
confidential or otherwise protected information, as discussed below.
Regarding the concerns of possibly disclosing confidential
information and competition lessening effect due to public reporting of
metrics; unintended consequences, including attention diversion,
litigation and reputation risks, competition lessening effect, and
audit labor market impacts; and costs, see discussions below.
3. Legal Authority
Some commenters questioned the Board's statutory authority to
require all or some of the proposed firm and engagement metrics. In
addition, one commenter stated that the statement in the proposal that
``this [rulemaking] would advance investor protection and promote the
public interest by enabling stakeholders to make better informed
decisions, promoting auditor accountability and ultimately enhancing
capital allocation and confidence in our capital markets'' is beyond
the Board's rulemaking authority. Other commenters questioned the
Board's authority with respect to specific aspects of the rulemaking.
Two commenters questioned how the requirements could extend beyond the
accounting firms' issuer and broker-dealer audit practices. One of
these commenters stated that it believes including non-issuer
information could be misleading to stakeholders who may mistake such
disclosures as being within the PCAOB's purview and that including the
non-issuer portion of a firm's audit practice appears contradictory to
the Board's pursuit of clarity through its proposed PCAOB Rule 2400,
Proposals Regarding False or Misleading Statements Concerning PCAOB
Registration and Oversight and Constructive Requests to Withdraw from
Registration. This commenter suggested that if the Board intends to
make clear what lies within and outside its purview through proposed
PCAOB Rule 2400, the rulemaking related to firm- and engagement-level
metrics should reflect similar principles.\78\ Another commenter
suggested that several new requirements seem to require public
production of information that is confidential or otherwise outside of
or unnecessary for the Board's oversight function.
---------------------------------------------------------------------------

\78\ To date, the Board has not adopted proposed PCAOB Rule
2400.
---------------------------------------------------------------------------

In accordance with Sarbanes-Oxley, the PCAOB is endowed with
regulatory powers designed to ensure transparency, uphold high
professional standards, and protect investors in the auditing process.
This discussion outlines the statutory basis for this rulemaking as
outlined in Sections 101, 102, and 103 of Sarbanes-Oxley. In
particular, here and throughout the release, the Board discussed how
the final rules will increase transparency regarding audit practices,
increase the comparability and accessibility of information available
to investors and others, and enhance investors' ability to efficiently
and effectively make investment and voting decisions, in line with the
Board's statutory mandate.
Section 102 of Sarbanes-Oxley mandates that each registered firm
must submit an annual report to the Board. Beyond this, Section 102
grants to the Board the authority to require more frequent and detailed
reporting, empowering the Board to require registered firms to report
``such additional information as the Board or the Commission may
specify.'' \79\ This authority must be exercised through PCAOB
rulemaking that deems the information ``necessary or appropriate in the
public interest or for the protection of investors.'' \80\ This
statutory language supports the Board's authority to adapt its
reporting requirements to the evolving needs of audit oversight,
thereby enhancing investor protection and public confidence in the
financial markets.
---------------------------------------------------------------------------

\79\ 15 U.S.C. 7212(d).
\80\ 15 U.S.C. 7212(b)(2)(H).
---------------------------------------------------------------------------

The metrics the Board adopted in its release are important for
increasing transparency regarding the practices of registered firms,
particularly in their audits of issuers. By mandating the disclosure of
this information, the PCAOB will enable investors and other market
participants to have a clearer and more comprehensive view of the
operational practices of the registered firms that audit issuers. This
enhanced transparency will allow investors and other market
participants to make more informed decisions, contributing to the
integrity and reliability of financial reporting and audit practices.
Additionally, Section 103 of Sarbanes-Oxley grants the Board
authority to establish auditing standards and quality control 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.'' \81\ Although
the information the PCAOB requires from registered firms does not
appear directly within audit reports, it is comfortably within the
ambit of the Board's rulemaking mandate under Section 103--especially
given the flexibility inherent in the statutory language.\82\ In brief,
this mandate involves establishing the procedures and practices of
registered firms that promote the quality and accuracy of audit
reports, which extends to

[[Page 99982]]

overseeing how firms report their operational conduct.
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\81\ 15 U.S.C. 7213(a)(1).
\82\ See Loper Bright Enters v. Raimondo, 144 S. Ct. 2244, 2263
(2024) (the term ``appropriate'' ``leaves agencies with
flexibility'' (citation and quotation marks omitted)); Kisor v.
Wilkie, 588 U.S. 558, 632 (2019) (Kavanaugh, J., concurring in the
judgment) (the word ``appropriate'' ``afford[s] agencies broad
policy discretion''); 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
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.).
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In alignment with Section 103 of Sarbanes-Oxley, the PCAOB views
the rule, form, and associated amendments requiring the metrics as
fundamental auditing and quality control standards at their core. The
information required by the metrics relates to practices of the firm
that directly bear on the conduct of audits and ultimately the quality
and accuracy of audit reports. By mandating the submission of this
information to the PCAOB, the Board provides deeper transparency into
the auditing practices that support issuer audits. The information
required by the metrics will also support the Board's oversight and
enhance the reliability of audit performance.\83\
---------------------------------------------------------------------------

\83\ See, e.g., Mark DeFond and Jieying Zhang, A Review of
Archival Auditing Research, 58 Journal of Accounting and Economics
275, (2014) (asserting that audit quality improves financial
reporting quality by increasing the credibility of the financial
reports).
---------------------------------------------------------------------------

Finally, the Board notes that Section 101 of Sarbanes-Oxley
provides ancillary authority that supports the Board's primary powers
in Sections 102 and 103.\84\ This provision enables the PCAOB to
develop standards that protect investors and serve the public interest.
---------------------------------------------------------------------------

\84\ For example, Section 101(c)(5) empowers the Board to
perform additional duties or functions that are ``necessary or
appropriate to promote high professional standards among, and
improve the quality of audit services offered by'' registered firms
and their associated persons. 15 U.S.C. 7211(c)(5). This provision
empowers the PCAOB to implement measures that enhance the integrity
and efficacy of the auditing profession. In addition, Section
101(g)(1) provides rulemaking authority to the Board, specifying
that the Board's rules, subject to the approval of the Commission,
are to ``provide for the operation and administration of the Board,
the exercise of its authority, and the performance of its
responsibilities under'' Sarbanes-Oxley. 15 U.S.C. 7211(g)(1).
---------------------------------------------------------------------------

Some firms and firm-related groups questioned the Board's statutory
authority to require the reporting of the proposed metrics on the basis
that the Board's rulemaking authority should correspond directly with
the type of information outlined in Sarbanes-Oxley Section 102(b)(2)
for the contents of registration applications. However, this
interpretation significantly misreads the reporting provisions of
Sarbanes-Oxley. Sections 102(b)(2)(H) and 102(d) clearly grant to the
Board broad authority to require additional information in periodic
reports that it finds necessary or appropriate to serve the public
interest or protect investors.
Section 102(b)(2) generally details baseline requirements for
reported information and Section 102(b)(2)(H) primarily details
requirements for any additional information the Board requires,
providing that additional information in reports must be deemed
``necessary or appropriate in the public interest.'' It is incorrect to
construe those provisions as imposing a rigid limitation that restricts
the content of reports exclusively to the types of information
specified in Section 102(b)(2)(A)-(G) for initial registration
applications. Indeed, Section 102(b)(2)(H) expressly contemplates the
provision of ``other information'' the Board may require through
rulemaking. This provision shows that Congress intended to provide the
Board authority to require additional information beyond that
enumerated in Section 102(b).\85\ By referencing this provision,
Section 102(d) applies this broader authority to periodic reports that
the Board finds necessary or appropriate to serve the public interest
or protect investors. The Board's release has outlined how the
disclosures mandated by the metrics will enhance transparency and
bolster the PCAOB's oversight capabilities. Such enhancements are
designed to ultimately improve audit quality. For example, as discussed
more completely below, the final metrics will enhance (i) audit
committees' ability to efficiently and effectively monitor and select
auditors as well as (ii) investors' ability to efficiently and
effectively make decisions about ratifying the appointment of their
auditors and allocating capital. In addition, as an important indirect
benefit, the final rules could further spur competition to the benefit
of investors. Thus, the final rules align with the overarching
objectives of Sarbanes-Oxley, and therefore are appropriate exercises
of the Board's authority under Section 102.
---------------------------------------------------------------------------

\85\ See Navajo Nation v. Dalley, 896 F.3d 1196, 1212-13 (10th
Cir. 2018) (``Congress expressed its scope in broad terms, to
encompass `any other subjects that are directly related to the
operation of gaming activities.' But the key word here is `other.' .
. . And applying the ordinary and everyday meaning of the word
`other' . . ., it becomes patent that Congress did not intend for
that clause to address the `subjects' covered in the preceding
clauses of subsection (C)[.]'' (citation omitted)); see also, e.g.,
Madison v. Virginia, 474 F.3d 118, 133 (4th Cir. 2006) (``other
Federal statute prohibiting discrimination'' is a ``catch-all
provision''); Meehan v. Atl. Mut. Ins. Co., 2008 WL 268805, at *7
(E.D.N.Y. Jan. 30, 2008) (``The term `other policies' now
accomplishes the task of including all governmental activity and
becomes a catch-all phrase including all other policies not already
implied[.]'' (citations and quotation marks omitted)).
---------------------------------------------------------------------------

In response to the concerns raised by firm commenters regarding the
Board's use of Sarbanes-Oxley's relevant ``necessary and appropriate''
clauses, it is important to clarify that the Board has not claimed any
implicitly delegated authority beyond the regulatory parameters
established by Congress. The use of the Section 101, 102, and 103
authorities in this rulemaking is firmly grounded within the explicit
mandates provided by Sarbanes-Oxley, and is consistent with the
statutory limitations and directives outlined in those provisions. The
Board's application of these authorities has been specifically aimed at
enhancing the transparency and quality of audits of issuers and broker-
dealers, which directly aligns with the Board's core mission to protect
investors and the public interest. The Board has utilized the tools
provided by Sarbanes-Oxley to carry out the responsibilities entrusted
to it.
Other commenters raised concerns about the Board's authority to
include metrics extending beyond a registered firm's issuer and broker-
dealer audit practice. One of these commenters asserted that including
non-issuer information could be misleading to stakeholders who may
mistake such disclosures as being within the PCAOB's regulatory
purview. The Board disagrees with these comments. The metrics the Board
is requiring are designed to provide information that directly relates
to firms' audits of issuers, and will be important for such matters as
assessing auditor performance and resource allocation as it relates to
issuer audits. For instance, in the Workload metric, firms are required
to report not only the hours worked dedicated to issuer engagements but
the entire workload of the personnel involved. This includes hours
spent on non-issuer engagements, training, practice development, staff
development, or other firm activities. A narrower focus, which only
accounts for hours worked on issuer engagements, could provide an
incomplete picture. It would fail to reflect the true extent of the
auditor's commitments and how these may impact their capacity and focus
on tasks in issuer audit work. Without this comprehensive view,
investors and other stakeholders would lack important information to
assess the potential risks over overcommitment on audit quality and
auditor performance in audits of issuers. By requiring firms to report
certain narrowly tailored information regarding their audit engagements
and audit practices, the Board is not seeking to extend its purview to
regulate those aspects of the firm's operations. Rather, in line with
the Board's statutory authority, it is enhancing the transparency and
the depth of information available to investors and other stakeholders
concerning firms' audits of issuers.

[[Page 99983]]

4. Summary of the Metrics
The Board adopted a set of firm-level and engagement-level metrics
across eight areas. Firm-level metrics will provide a basis for drawing
comparisons between firms as well as a baseline for evaluating
engagement-level metrics. Engagement-level metrics will elicit more
granular information and will enable comparisons over time and across
engagements both within the firm and across other firms.
Firm-level metrics will be disclosed on a new Form FM, Firm
Metrics, and engagement-level metrics will be disclosed on a revised
and renamed Form AP, together with the other engagement-specific
information currently required (the name of the engagement partner and
information regarding other firms participating in the audit).
Most of the metrics the Board has adopted will be presented at both
the firm and the engagement level. However, two metrics will be
reported only at the firm level, because the Board believes aggregated
data will be most meaningful or appropriate.
The metrics are:
Partner and Manager Involvement. Hours worked by senior
professionals relative to more junior staff across the firm's large
accelerated and accelerated filer engagements and on the specific
engagement.
Workload. For senior professionals who incurred hours on
large accelerated and accelerated filer engagements, average weekly
hours worked on a quarterly basis, including time attributable to all
engagements, administrative tasks, training, and all other matters.
Training Hours for Audit Personnel. Average annual
training hours for partners, managers, and staff of the firm, combined,
across the firm and on the engagement.
Experience of Audit Personnel. Average number of years
worked at a public accounting firm (whether or not PCAOB-registered) by
senior professionals across the firm and on the engagement.
Industry Experience. Average years of career experience of
senior professionals in key industries audited by the firm at the firm
level and the audited company's primary industry at the engagement
level.
Retention of Audit Personnel (firm-level only). Continuity
of senior professionals (through departures, reassignments, etc.)
across the firm.
Allocation of Audit Hours. Percentage of hours incurred
prior to and following an issuer's year end across the firm's large
accelerated and accelerated filer engagements and on the specific
engagement.
Restatement History (firm-level only). Restatements of
financial statements and management reports on ICFR that were audited
by the firm over the past three years.

Figure 1. Firm and Engagement Metrics Reporting

------------------------------------------------------------------------
Engagement-
Firm and engagement metrics reporting Firm- level level
------------------------------------------------------------------------
Partner and Manager Involvement....... [check] [check]
Workload.............................. [check] [check]
Training Hours for Audit Personnel.... [check] [check]
Experience of Audit Personnel......... [check] [check]
Industry Experience................... [check] [check]
Retention of Audit Personnel.......... [check] X
Allocation of Audit Hours............. [check] [check]
Restatement History................... [check] X
------------------------------------------------------------------------

The final suite of metrics focuses primarily on information about
audit personnel. The Board believes these metrics will provide new
insights into how engagements are staffed, including the extent of
involvement of senior personnel; auditors' overall workload; retention
of personnel across the firm; and levels of training, audit experience,
and industry-specific expertise. The final metrics will also provide
information about the extent of audit work completed prior to the
issuer's year end, an aspect of the audit process that the Board
believes is associated with improved audit outcomes, and about the
firm's history of restatements, a key measure of audit outcomes.
This new information will allow users to draw inferences about
audits and audit firms that are not possible today. Some may relate to
specific metrics. For example, a heavy workload for a particular
engagement team relative to the firm average or compared to peer firms
may raise questions about the quality of the work performed.
Conversely, a relatively high level of industry-specific experience,
particularly for an engagement in an industry requiring specific
accounting and auditing expertise, would be a positive signal. Other
inferences may relate to combinations of metrics. For example, the
personnel-related metrics, taken together, give an overall sense of how
an engagement is staffed that can be compared to firm averages and to
engagements for similar issuers. It is possible that the precise
numerical values of metrics may be important in some cases, but in
general the Board believes the metrics will be more useful to convey a
sense of whether a particular engagement or firm appears fairly typical
or is an outlier in one or more respects. This should provide a richer
context for understanding the work of the auditor than the current
environment of almost no publicly available information.
Based on the Board's oversight activities, it appears that the
largest firms are already tracking data in many of these areas,\86\ and
the Board believes that all firms should be able to capture the data
required by the metrics without undue burden. Many of the metrics are
based on data that firms already track or will be required to track for
purposes of other PCAOB requirements. For example, Partner and Manager
Involvement and Allocation of Audit Hours are based on the same ``total
audit hours'' that firms are already required to track for Form AP
reporting. Training hours will reflect the same information that firms
track to ensure proper licensing of their personnel. Restatement data,
to the extent firms are not already tracking it, is required to be
tracked under QC 1000.\87\ In addition to required data, many firms
track the experience of their personnel, as well as industry
experience, for use in marketing materials and for inclusion in
requests for proposals, and some firms already track staff retention
and turnover metrics as part of their human capital management. Firms
should be able to generate other data required by the final metrics,
such as Workload,

[[Page 99984]]

from their existing timekeeping systems with minimal additional effort.
---------------------------------------------------------------------------

\86\ This point is discussed more fully below.
\87\ See QC 1000.64g, Note to QC 1000.67e.
---------------------------------------------------------------------------

Below, the Board provides a detailed discussion of key terms and
concepts used in the metrics, as well as a description of each final
metric and its calculations.
5. Comparability
Developing comparable data regarding firms and engagements has been
one of the Board's key objectives throughout this rulemaking. As noted
previously, the information currently provided in firm transparency
reports is not based on common definitions or methods of calculation,
which prevents users from being able to make comparisons across firms
or over time. The Board believes that an important benefit of mandatory
reporting will be the ability of investors and other stakeholders to
compare the metrics, within the same firm over time, among firms, and
among engagements.
The basic approach of the Board's final rules--a required set of
metrics, derived from specified calculations incorporating consistently
defined terms and concepts--is designed to generate comparable data
with respect to firms and engagements that are subject to the reporting
requirements. One investor-related group agreed that standardized and
contextualized metrics will provide investors with a consistent data
set for analysis over time and for comparison between companies and
firms and a set of standardized data is more valuable than the ad hoc
individual measures that some firms have made on a voluntary basis.
In some cases, considering the importance of scalability, the Board
has also designed the proposed metrics as percentages (e.g., relative
to total audit hours) or averages where the Board believes that will
provide more comparability across firms and engagements than methods
based on absolute amounts.
Several firms and firm-related groups expressed skepticism about
whether the metrics could generate comparable data because of inherent
differences across firms and engagements, either with regard to any
metrics or engagement-level metrics specifically. For example, one
commenter said that differences between firms and among engagements
will create heterogeneity in the underlying data, so that cross-
sectional differences and changes over time will be unclear and
challenging to interpret, and will cause confusion. Another commenter
emphasized the importance of comparability between larger and smaller
firms so that investors and audit committees can interpret them
appropriately.
Two commenters stated that if context, including qualitative
aspects of data, is necessary to understand the metrics, that would
suggest that the data are not comparable, which could mean that the
metrics are not decision-useful and are at risk of misinterpretation.
One commenter expressed the opposite concern, that metrics would become
homogenized over time due to peer comparisons, making them considerably
less useful to investors.
One commenter asserted that the Board's choices in defining terms
and specifying calculations undermine the comparability of the
metrics--for example, because some metrics include issuers other than
accelerated or large accelerated filers, the Board's proposed industry
classification taxonomy differs from the one used by the SEC, and its
proposed period for measuring restatements differs from the period used
by a commonly-used data provider. These issues are addressed below in
the discussion of the final metrics.
With regard to firm-level metrics, several commenters expressed
concern that some or all of the metrics would not be comparable across
firms. They cited factors such as the size of the firm (including the
number of issuer and non-issuer engagements), specialization of the
firm's audit practice, strategies, priorities, investments,
organizational structure and quality control system of the firm, and
size of the issuer (which affects, among other things, whether an
integrated audit is required).
Several commenters expressed particular concern about comparability
between U.S. and non-U.S. firms because non-U.S. firms tend to have
structural, jurisdictional, and cultural aspects that differ from U.S.
firms. In addition, non-U.S. firms may have a relatively smaller issuer
audit practice, which could skew metrics that are based on the entire
practice because there may be significant differences between issuer
audits and the rest of the firm's audit practice, and could increase
the volatility of metrics based on the issuer practice because of its
small size. One of these commenters also criticized the application of
metrics to non-U.S. firms because they would not capture the
qualitative benefits of being a part of a global network (e.g., use of
consistent policies and procedures that drive use of training,
technology, consultation and other centrally available support across
the network). Another commenter also noted that some non-U.S. firms may
publicly report firm-level metrics on similar topics, such as workload,
using different calculation methods under PCAOB and local reporting
requirements, which would be costly for these firms and potentially
confusing to the users.
Many commenters expressed concern that engagement-level metrics are
inherently incomparable. Commenters suggested a number of factors that
could affect the comparability of engagement-level metrics, some
relating to the firm (e.g., the firm's organizational structure, IT
systems, resources, and audit methodologies), some to the individual
audit engagement (e.g., selected audit approaches including substantive
analytical procedures or test of details, audit findings including
internal control deficiencies, use of technology, first year or
recuring engagement, and risk of material misstatement), and some to
the issuer (e.g., business structure (including the extent of
centralization or decentralization and number of business units),
complexity of the organizational structure and IT infrastructures,
number of significant unusual transactions, and business and industry
risks affecting the issuer). In addition, one commenter noted that
there are significant developments (e.g., in delivery models,
technology, and professional rules and standards) that affect the way
audits are performed each year.
The Board solicited comment on whether comparability could be
enhanced by further segmenting firm-level reporting (for example, on
the basis of the size of the firm or the size of the issuer) or
engagement-level reporting (for example, on the basis of industry
sector, region, or whether it is a first-year audit). One commenter
stated that all stakeholders would benefit from a consistent
calculation methodology and comparable presentation format of firm-
level reporting. Several commenters indicated that more disaggregated
data for engagement- or office-level reporting could be useful, though
one acknowledged that this benefit would need to be weighed with the
cost of requiring this data. Other commenters cited challenges
associated with providing subsets of information, including that firm
and issuer sizes change over time and that smaller firms' metrics could
disclose individual client information. One of these asserted, however,
that the reported data could be disaggregated and compared without
additional data fields being collected.
The Board determined not to collect additional data fields or
require additional segmentation of the metrics at this time because of
the potential cost and complexity it would add to the process of
compiling and reporting the metrics. Stakeholders that want to perform
more detailed analysis (for

[[Page 99985]]

example, segmenting data based on size of the issuer, size of the firm,
region, or industry sector) will be able to do so using information
that is already publicly available in combination with the metrics.
The Board understands that firms differ from each other in the
number and types of audits they perform and in their resources, such as
the number, experience, and degree of specialization of their people as
well as their access to technological resources and resources provided
by networks. The Board also understands that engagements differ based
on factors such as the size of the engagement, the industry of the
company, the risks related to the company and the audit, whether it is
a new engagement for the firm or the engagement partner.
However, the Board does not believe that such differences make
useful, comparable metrics impossible. As one commenter noted,
investors are experienced in using a wide array of performance metrics,
such as non-GAAP measures and key performance indicators, and are able
to analyze them despite a lack of perfect comparability between
companies or over time. Indeed, the commenter argued that, due to the
nature of the audit process and audit firms, the proposed firm and
engagement metrics have a greater propensity for comparability than
many companies whose financial results investors already analyze.
The Board believes it has also addressed many of the challenges
associated with potential lack of comparability by narrowing the
metrics to a group that should send relatively clear, comprehensible
signals in a variety of different contexts. Metrics on workload,
training hours, experience in public accounting, retention of
personnel, and restatement history should send a clear signal,
regardless of the circumstances of the firm and the engagement. Metrics
on partner and management involvement and allocation of audit hours may
be more influenced by those circumstances. For example, unusually high
involvement by senior professionals could signal an especially complex
audit or one that encountered unexpected problems; a relatively low
percentage of audit hours incurred before year end could signal a
poorly planned audit or simply that, due to the nature and scope of a
company's business, it was unnecessary or impractical to perform many
audit procedures prior to year end. The Board has limited the scope of
the Partner and Manager Involvement, Workload, and Allocation of Audit
Hours metrics to large accelerated filer and accelerated filer
engagements to enhance the comparability of the underlying data. The
metric on relevant industry experience may also be influenced by the
circumstances of the firm and the engagement in that industry
experience may be more important in some industries than others.
However, the Board believes users will be able to interpret this metric
when taken together with the other information about the issuer and the
auditor that is available to them. Common definitions and consistent
methodology will also contribute to comparability. Taken together, the
metrics should enable users to make both broad comparisons across the
full population of reporting firms and accelerated filer and large
accelerated filer audits, and more targeted comparisons across smaller
subgroups of similar firms and engagements, and will be a very
significant improvement over the information that is currently
available--ad hoc reporting by the largest firms at the firm level, and
essentially no information at the engagement level.
Of course, any additional context that firms believe is necessary
for proper understanding can be provided as narrative disclosure. While
narrative disclosure will not make the metrics comparable, it will
balance the comparability of standardized metrics disclosure with the
ability to provide further context if needed. For example, a firm could
provide an explanation for why a metric changed significantly from what
was reported in the prior year.
6. Time Period Covered by the Metrics
Firm-level metrics are reported as of September 30, generally
covering the period from October 1 of the previous year through
September 30.\88\ Specific commenter feedback regarding the reporting
period is discussed in detail below. Firms are required to file Form FM
on or before November 30, 61 days after the end of the reporting
period, also discussed below.
---------------------------------------------------------------------------

\88\ For two of the metrics areas the Board proposed, Quality
Performance Ratings and Compensation and Audit Firms' Internal
Monitoring, firms would have reported based on their own internally
established cycles. Neither of these is included in the metrics the
Board adopted.
---------------------------------------------------------------------------

Related to the Training Hours for Audit Personnel metric, the Board
understands that many firms already have defined periods or cycles that
may not align with the final reporting date (e.g., for which the firm
tracks training data in order to comply with state continuing
professional education (``CPE'') reporting requirements). Therefore,
the firm is permitted to use its already-established training calendar
cycle for calculation and reporting of this metric, provided that the
cycle covers a 12-month period (which is expected to be consistently
applied). The Board does not believe that the data will be especially
sensitive related to any particular 12-month period. The Board believes
allowing firms flexibility to use their internally established dates
for this metric is appropriate and still provides the comparability
discussed above since all firms would be reporting this metric based on
a 12-month period.
For engagement-level metrics, which will be reported on Form AP,
the data and information underlying the reported metrics will generally
be based on the most recent period's audit. However, some engagement-
level metrics relate to information about personnel on the engagement,
such as Experience of Audit Personnel, and these metrics will reflect
information that may not be directly related to the most recent
period's audit. Specific commenter feedback regarding the reporting
period and filing date of Form AP is discussed in detail below.
In addition, the time period covered by each metric also is
discussed in more detail below.
7. Rounding and Use of Estimates
Many of the metrics involve the calculation of a numerical value
that may result in very small fractional parts. Consistent with the
proposal, firms are required to report metrics that are rounded to the
nearest whole number, except where additional decimal places (no more
than two) are needed to properly interpret the result or to enable
comparison to prior periods.
In calculating the firm- and engagement-level metrics, actual
amounts should be used, if available. However, if actual amounts are
unavailable, firms are permitted to use a reasonable method to estimate
the components of a calculation. This approach is consistent with
existing Form AP, which allows firms to use a reasonable method to
estimate certain information required in the calculation of total audit
hours.\89\ Firms are also required to document in their files the
method(s) used to estimate amounts when actual amounts are unavailable.
---------------------------------------------------------------------------

\89\ See Instructions to Part IV of Form AP as currently in
effect. Under the amendments to Form AP adopted by the Board, this
appears in General Instruction 9, as amended.
---------------------------------------------------------------------------

Commenters generally agreed with the proposed approaches, with one
commenter agreeing that rounding and estimation should be permitted for
all metrics. Other commenters stated that rounding and estimation will
be

[[Page 99986]]

especially important for metrics related to the reporting of hours,
with two of these pointing to the subjectivity involved with the
proposed metrics that would require allocation of hours to specific
audit areas.\90\ One commenter stated that the PCAOB should not
restrict the number of decimal places. However, the Board believes that
limiting reporting to hundredths will allow for the presentation of an
appropriate level of detail while ensuring comparability of
presentation and avoiding the technical issues that could arise with
unlimited digits.
---------------------------------------------------------------------------

\90\ The proposed Audit Hours and Risk Areas metric is not
included in the metric that the Board adopted, as discussed further
below.
---------------------------------------------------------------------------

8. Operational Narrative Disclosure
In order to give firms the ability to provide any context they
thought necessary for an appropriate understanding of the reported
metrics, the Board proposed that firms would be permitted, but not
required, to provide a brief narrative disclosure (no more than 500
characters per metric) to accompany any, or all, of the firm-level and
engagement-level metrics reported on Form FM or Form AP. While some
commenters agreed with the proposal to provide firms with the ability
to include an optional narrative to accompany the metrics, one
commenter explicitly agreed with the proposed 500-character limit, one
commenter asserted that the 500-character limit greatly limits the
context that could be provided, and one commenter suggested revising
the character limit to no more than 1,000 characters. Two commenters
suggested increasing the character limit beyond 500 characters without
suggesting an upper limit. Approximately half of the commenters
suggested that there should be no character limit imposed on the
optional narrative. A firm-related organization also suggested that the
narrative be mandatory and not optional, while a firm suggested that
the utility of metrics would be diminished without potentially
extensive accompanying narrative.
One commenter suggested that firms can also provide a link in the
narrative to their transparency reports and audit quality reports if
they wish to provide further context to the metrics. One commenter
stated that there should be guidelines such as the narratives being
factual, directly relevant to the metric, and free from promotional or
marketing language. Another commenter stated that it would provide the
following narrative in Form FM, potentially with respect to every firm
metric:

We do not believe any one metric or even a combination of metrics is
necessarily indicative of audit quality, nor is it useful or
productive to speculate on the questions reviewers of this
information may have on each metric for every audit. We further
discuss this metric in our Audit Quality Report, along with the
measures we believe are better indications of our audit quality.\91\
---------------------------------------------------------------------------

\91\ See Letter from PricewaterhouseCoopers LLP (June 7, 2024).

Taking into consideration commenter feedback, the Board is
retaining the option to provide narrative disclosure with each metric
but expanding the character limit to 1,000 characters. The Board
believes this character limit strikes the right balance between
allowing firms the ability to provide any contextual information they
believe is necessary to interpret the results of a particular metric
while also managing the length of the forms and keeping them to a
manageable size.\92\
---------------------------------------------------------------------------

\92\ Nothing in PCAOB rules and forms, including Form FM and
Form AP, provides for incorporation by reference of external
documents or other materials.
---------------------------------------------------------------------------

In addition, in an effort to assist firms in making the optional
narrative disclosures as helpful and substantive as possible, to help
remind firms of their responsibility under QC 1000 to produce and
report information that is accurate and not misleading, and to reduce
the possibility that users will find the narrative confusing or in
conflict with the required metrics, the following provision has been
added as a general instruction to Form FM and a note to Part VI of Form
AP to provide additional direction to those firms electing to provide
an optional narrative for any metric:

``When the Firm elects to provide a brief narrative to accompany any
of the Items in [the part of the form in which metrics are
reported], language should be concise and focused on the reported
metrics, with a view to facilitating the reader's understanding of
the metrics.''
Firm and Engagement Metrics
1. General Comments
Investors and investor-group commenters were broadly supportive of
the proposed metrics, saying that the metric areas would provide
investors with decision-useful information about audit firms and
audits. However, they expressed mixed views on certain specific metric
areas. These commenters also suggested additional metric areas,
including investments in both training audit professionals and in
technology, and further details related to PCAOB inspection results
(e.g., Part I.A deficiencies). The Board has addressed these comments
in the discussion of each metric area below. On the topic of
implementation of the proposed metrics, one commenter requested
analytical tools and research showing how investors might use metrics.
The information disclosed on Form FM will be available in a searchable
database on the Board's website, similar to the Form AP database, and
will provide users of the information the ability to perform
comparisons across engagements.
Firms and firm-related groups were broadly supportive of some of
the proposed firm-level metrics. However, they generally opposed public
reporting of engagement-level metrics, asserting that no amount of
context around engagement-level metrics would provide an appropriate
basis for public reporting. These commenters suggested that the audit
committee, being deeply familiar with the company, the audit, and the
independent auditor, is the only party equipped to appropriately
interpret the metrics. Instead of public reporting, they suggested
several alternatives, including adding a requirement for communication
to the audit committee under AS 1301; expanding SEC requirements for
audit committee disclosures; encouraging voluntary reporting; issuing
PCAOB Spotlights, practice alerts, or guidance; and performing further
outreach before adopting any requirements. These alternatives are
discussed in greater detail above. One commenter suggested that the
PCAOB take a proactive role in educating all users as to the proper use
of reported metrics, including the need for them to be interpreted in
context and making users aware of potential dangers and drawbacks
associated with a mere comparison of isolated metrics between firms.
The Board discussed the forms and how the data can be accessed in more
detail below.
Commenters generally expressed concern that proposed metrics were
not all calculated from the same data sources. Some metrics were
calculated on the basis of all audit engagements, others on the basis
of issuer engagements, and engagement-level metrics on the basis of
large accelerated and accelerated filer engagements. Some commenters
suggested that calculating firm-level metrics based solely on total
audit hours on large accelerated and accelerated filer engagements may
result in more comparable data among firms. The Board discussed this in
greater detail below.
Other commenters recommended that the PCAOB establish criteria for
determining which metric areas warrant public disclosure, so as to
build in flexibility over time and minimize the risk of
misinterpretation. The following

[[Page 99987]]

criteria were among those suggested by these commenters:
Is the metric's relation with audit quality unambiguous?
Can the metric be appropriately interpreted on its own,
without additional context (e.g., client mix or complexity--size,
industry, international operations; firm's audit approach; etc.)?
If disclosure of the metric results in behavioral change
in audit firms, does research suggest the change will improve audit
quality or, at least, not adversely impact audit quality?
Will the metric require firms to develop systems,
processes, and procedures that they do not already have and at a
reasonable cost?
Will the metric impose ongoing administrative burdens on
engagement teams that result in a reallocation of effort away from
audit quality enhancing activities?
Will the metrics align with measures used in the system of
quality control to manage the audit practice?
Will the metrics meet the information needs of the users?
Will the disclosure of metrics not result in the
communication of proprietary information?
In responding to commenters and articulating the rationale for
adopting the firm- and engagement-level metrics below, the Board
considered the views of commenters, including these suggested
evaluation criteria. The Board believes some of the suggested criteria
would impose an unworkable framework that is inconsistent with the
Board's regulatory objectives. For example, the Board does not think it
is necessarily practicable to establish an ``unambiguous'' relationship
to audit quality, as suggested, for any individual metric, nor would
such an exercise be consistent with the intended uses of the metrics,
which envisions their being considered as part of the total mix of
information available to stakeholders. Moreover, the Board believes
that imposing rigid criteria for each proposed metric imposes too high
a burden and is not conducive to effective regulation. It does not
permit the Board to account for facts and circumstances unique to
individual metrics and their potential uses, nor does it account for
the holistic manner in which the Board intends for the metrics to be
used or developing information about the utility of the metrics over
time.
A number of commenters recommended that the PCAOB engage in
additional stakeholder outreach, sponsor pilot programs, or otherwise
engage in further study and research before finalizing the metrics
requirements, or even withdraw the proposal. Based on the lengthy
project history described in Section II, which includes repeated input
over time from the Board's advisory groups, multiple rounds of public
notice and comment, study of relevant academic literature, study of
voluntary firm disclosures, and consideration of actions taken in other
jurisdictions, the Board does not believe further study is necessary or
that the Board's investor protection mission would be served by
delaying adoption of the final rules. However, the Board will monitor
and determine if further implementation resources or support is
appropriate for users of these metrics.
2. Key Terms and Concepts
As described below, the Board developed certain key terms and
concepts that were used in calculating the proposed metrics. Where
practical and relevant, these key terms and concepts align with
existing definitions in PCAOB standards and rules. In other cases, the
Board has developed new definitions and new descriptions of terms
specifically for use in the metrics, which are not intended to inform
the interpretation of other rules, standards, or forms of the PCAOB.
The Board provided the key terms and concepts along with formulas for
calculating each metric to drive consistency among firms and engagement
teams.
One investor-related group said that the units of account (e.g.,
hours, years of experience) or measurement used within the proposed
metrics are sufficiently standardized and adaptable by firms as they
are commonly used within audit practice or defined within the existing
standards.
Some commenters raised concerns about the definitions and
descriptions of the population used for various metrics or about not
having a defined set of terms applicable to all standards and rules.
Other commenters questioned whether the PCAOB had provided sufficient
guidance to address potential variations in the interpretation and
application of terminology used in the metrics or asserted that not
having sufficient guidance would add complexity and challenges in
calculating the metrics and understanding them or result in
inconsistent reporting of metrics or lack of comparability across audit
firms and audits engagements. Two of these commenters recommended that
the PCAOB create a glossary of defined terms to support consistent use
of terms throughout the standards and rules or conduct additional study
to evaluate the defined terms in the proposal against terms already
defined in other PCAOB standards and rules. Another commenter raised a
concern that defining terms and specifying computations for each metric
undermines their comparability.
Some firms offered examples of areas where they suggested that
clarification would be needed, which the Board discussed below in the
context of the relevant metrics. In general, however, the Board
continues to believe that the use of defined terms is critical to
driving consistent calculation of the metrics.
Other firms questioned why different metrics are based on different
underlying data (for example, total audit hours vs. total hours worked
or engagement team vs. core engagement team). In general, the Board's
choice of the data on which to base a metric is tailored to the
intended objective of the metric, and also takes into account the
practicality and potential costs associated with gathering data and
calculating the metrics. The Board does not believe that metrics based
on a single data set would be as clear or as informative.
The Board addresses specific concerns raised in the discussion of
each metric below. The Board has clarified certain terms and concepts
used or revised the descriptions of proposed terms and concepts after
consideration of the specific comments received.
i. Populations Covered by the Metrics
a. Partners and Managers (Used in All Metric Areas Except for
Allocation of Audit Hours and Restatement History); Staff (Used in
Training Hours for Audit Personnel)
While some of the functional roles played by individuals involved
in an audit are otherwise defined and used in the Board's standards
(e.g., engagement partner \93\ and EQR),\94\ the Board proposed to
clarify following additional functional roles referred to in the
metrics to ensure consistent reporting by firms.
---------------------------------------------------------------------------

\93\ See paragraph .A1 of AS 1201, Supervision of the Audit
Engagement (``the member of the engagement team with primary
responsibility for the audit'').
\94\ See AS 1220, Engagement Quality Review, for a description
of the engagement quality reviewer's role.
---------------------------------------------------------------------------

Partners--Partners or persons in an equivalent position (e.g.,
shareholders, members, or other principals) who participate in audits;
\95\
---------------------------------------------------------------------------

\95\ As noted in the proposing release, the Board believes this
is consistent with the use of the term ``partner'' in the Board's
auditing standards. Although the Board does not usually state
expressly that partners are limited to those who participate in
audits, as a practical matter the Board's auditing standards apply
only in those circumstances.

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[[Page 99988]]

Managers--Accountants or other professional staff commonly referred
to as managers or senior managers (or persons in an equivalent
position) who participate in audits; and
Staff--Accountants or other professional staff who participate in
audits and are not partners or managers.
Some engagement-level metrics differentiate between engagement
partner and the other partners who participate in the audit. The Board
believes the differences between the responsibilities borne by
engagement partner and those of other participating partners justify
presenting data for the two categories separately in those metrics. For
firm-level metrics, ``engagement partners'' include all partners who
served as the engagement partner on any audit the firm performed of an
accelerated filer or large accelerated filer. Partners that are
included in the metrics as an engagement partner are not included as an
``other partner,'' even if they served in a non-engagement partner role
in other audits (in other words, partners are only counted once within
any metric).
The Board adopted the definitions of partners, managers, and staff
as proposed, with clarifications discussed below.
The Board solicited comment on whether the proposed definitions of
partners, managers, and staff are clear and appropriate. Two commenters
agreed that the proposed definitions for partners, managers, and staff
are clear and appropriate, one saying that linking the definitions used
in the metrics to existing definitions would help in preventing
multiple definitions throughout the auditing standards. However, some
commenters expressed concern that titles and roles are not consistent
across firms or most firms have roles which do not clearly or obviously
reconcile to the roles listed. One of these commenters also raised a
concern about continuing emphasis on the engagement staffing model that
currently exists, on the basis that artificial intelligence and other
tools could affect the staffing of audit engagements in the future.
This commenter recommended including ``contractors'' engaged by firms
in the definition and clarifying whether the definitions are meant to
be descriptions of the roles rather than legal interpretations of the
roles. Another commenter recommended aligning the definitions of
partners, managers and staff with the definition of engagement team, by
using the phrase ``who perform audit procedures'' instead of ``who
participate in audits'' to avoid inclusion of personnel who may
participate in audits in an administrative or project management
function, but who do not perform audit procedures. Another commenter
expressed concern that audit effort associated with roles typically
referred to as ``national office'' and ``professional practice
development,'' especially for managers through partners, would be
excluded from the definitions and calculations of the metrics.
For the definition of partners, one commenter questioned whether
the definition is intended to have any alignment with ownership
interests in a firm and requested clarification as to how a leadership
level role such as a managing director would be classified because, in
the commenter's view, that role does not appear to meet the definition
of either a partner or a manager.
For the definition of managers, the same commenter requested
clarification on whether the manager title is based on the person's
general title in the firm because, for example, in certain cases an
experienced supervisor may serve a manager capacity on a less complex
engagement. Another commenter suggested adding a specific number of
years of audit experience to the definition of managers because of the
risk that firms could inflate percentage of audit hours incurred by
managers by changing the titles of more junior professionals to
increase the number of managers.
The Board adopted the definitions of partners, managers, and staff
as proposed. Because there are differing legal structures and titles
among firms, the Board is providing foundational definitions so that
each firm can allocate its professionals in three levels: partners,
managers, and staff. The Board believes that the vast majority of firms
have these three levels, and that, although staffing models may change
over time, these levels are likely to be retained for the foreseeable
future. The Board also believes that other job titles, such as managing
director, can be fit into the appropriate category based on the level
of responsibility assigned to them. For example, in a firm where
managing directors are given similar responsibilities as the firm's
principals (for example, signing authority on audit engagements), they
would be treated as partners under the Board's definition; otherwise,
they would align with managers. Similarly, professionals in a firm that
does not use the title ``manager'' would be reported as managers if
they are assigned the duties that are typically carried out by managers
and senior managers at firms that do use those titles. Professionals
who work under the firm's direction and control and function as the
firm's employees, such as secondees and contractors, may or may not
have these titles but would be reported based on their level of
responsibility and decision-making authority. In all cases, the
determination would be made based on the responsibilities, decision-
making authority, and scope of duties of the person. If necessary,
firms could utilize the optional narrative disclosure to describe how
the firm aligned their categories of professionals with partners,
managers, or staff levels.
The Board considered adding a specified minimum number of years of
audit experience in the definition of manager but determined not to.
Some managers qualify for promotion with fewer years of audit
experience due to other relevant education or experience. The Board was
concerned that building a minimum number of years of audit experience
into the definition would result in people with the responsibilities
and title of manager being required to be reported as staff, making the
metrics less meaningful while increasing the administrative burden
associated with reporting.
The Board did not use the phrase ``who performed audit procedures''
in the definitions of partners, managers, and staff because use of this
term would exclude professionals who do not perform audit procedures--
for example, partners who only conduct engagement quality reviews \96\
or national office personnel in connection with certain types of
consultations that are not audit procedures.
---------------------------------------------------------------------------

\96\ Engagement quality review is not considered the performance
of an audit procedure. See AS 1220.07 (The EQR ``should not make
decisions on behalf of the engagement team or assume any of the
responsibilities of the engagement team.'').
---------------------------------------------------------------------------

Because the definitions of managers and staff are limited to
``accountants or other professional staff,'' administrative personnel
are not included.
In the Board's proposal, the Board generally did not specify how to
account for promotions within the reporting period from one level to
another (e.g., from manager to partner),\97\ although the Board noted
that firms would be expected to be consistent in their approach across
metrics. The only commenter to address this issue supported the
flexibility

[[Page 99989]]

proposed with respect to the treatment of promotions. Consistent with
the proposal, the final rules do not impose any prescriptive
requirements regarding the reporting of professionals whose job title
or responsibilities change during the reporting period. However, the
Board believes that treating such transitions inconsistently, whether
within a metric or across metrics, would be misleading and the Board
expects firms to report such changes in a consistent way.
---------------------------------------------------------------------------

\97\ Note, however, that the Retention of Audit Personnel metric
treats promotions as if they had occurred at the beginning of the
year. See note to Item 4.6 of Form FM.
---------------------------------------------------------------------------

(1) Participate in Audits (Used in the Terms Partners, Managers, and
Staff)
``Participate in audits'' is a broad concept that would include the
work of all professionals (partners, managers, and staff) that are
involved in the firm's audits, including tax personnel, information
technology (``IT'') personnel, and employed specialists.
The Board proposed the phrase ``participate in audits'' rather than
referring to the activities of individuals assigned to a specific
business line, such as the firm's audit practice, because some firms do
not assign individuals to specific business lines. However, the Board
solicited comment on whether the relevant population would be partners,
managers, and staff of the firm's audit practice, if the firm assigns
its professionals to specific business lines.
Some commenters agreed with the phrase ``participate in audits'' as
used in the proposal. One of these commenters suggested that, because
firms have different structures, attempting to separate members of the
engagement team based on a firm's structure could lead to less
comparability across metrics. One firm stated that it assigns
individuals to specific business lines, and collecting data based on
that assigned business line would be more practical to implement versus
the proposal's requirement to include all individuals participating in
audits.
Some other commenters stated that firm-level metrics should look
only to the firm's audit practice because (i) the inclusion of other
service lines in the metrics would impair comparability between firms
due to the varying size and scope of non-assurance practices and (ii)
the work of tax professionals and consultants would not improve the
usefulness of these metrics for the purposes outlined in the Board's
proposal. Another commenter requested clarification on how to account
for individuals who move between audit support roles and engagement-
facing functions.
The final definitions of ``partners,'' ``managers,'' and ``staff''
include the phrase, ``who participate in audits,'' as proposed. Because
some firms do not assign partners and other professionals to a specific
business line, the Board believes this approach is the best way to
drive consistent reporting by firms with different organizational
structures.
In the proposal, the Board clarified that members of the engagement
team who participate in audits would include every partner and manager
who worked on any aspect of the audit, even if their involvement was
extremely limited. The Board proposed not to provide a participation
threshold, such as a minimum number of hours, because the Board
believes, based on the objectives of these metrics, that the metrics
should capture all partners, managers, and staff who participate in
audits in any capacity. However, the Board solicited comment on whether
the concept should include a participation threshold.
One commenter agreed there was no need to create a minimum
threshold for participation on the basis that it would increase the
complexity and cost of calculating the metrics without a corresponding
benefit. Another commenter recommended establishing a minimum threshold
for participation because exclusion of professionals with certain firm
roles (e.g., firm leadership, national office, or specialist line of
service individuals with limited participation during the year in any
specific engagement) would not reduce the reliability of the metric.
This commenter further recommended creating a minimum threshold for
purposes of firm-level metrics, such as individuals who spent more than
10% of their time participating on audit engagements, and engagement-
level metrics (e.g., similar to the concept of core engagement team).
This commenter and another commenter recommended the additional
threshold as optional for firms to use due to cost-benefit
considerations, particularly for smaller firms, and should only be
considered if additional thresholds allow for simpler aggregation or
preparation of the data.
The Board did not adopt additional thresholds to be used for firm-
level or engagement-level metrics, except for the concept of core
engagement team used in certain engagement-level metrics discussed
below. The objectives of the five metrics that use ``partners,
managers, and staff of the firm'' are to understand the firm's
professionals who participate in audits in totality, and the Board
believes imposing a threshold on what counts as participation would
defeat that objective.
(2) Partners, Managers, and Staff ``of The Firm'' (Used in Workload,
Training Hours for Audit Personnel, Experience of Audit Personnel,
Industry Experience, and Retention of Audit Personnel)
Because firm-level metrics provide information about the firm, in
calculating some firm-level metrics, the Board proposed to include
partners, managers, and staff ``of the firm,'' which refers to
individuals participating in audits who work for the firm or work under
the firm's direction and control and function as the firm's employees
(e.g., secondees and contractors), regardless of whether the audits are
performed under PCAOB standards or other auditing standards.\98\ The
Board believes including individuals in the firm-level metrics who
participate on any firm audit is appropriate because these metrics
would provide information about the firm and not about specific
engagements (for example, in the area of firm-level industry
experience, which would be relevant across a firm's entire audit
practice). The Board added a new section to Part III, Terminology in
Form FM to clarify the meaning of these phrases. The Board also
clarified that participation in audits means any involvement
(including, for example, consultation on specific matters), and thus
may include individuals outside the engagement team, such as national
office personnel.
---------------------------------------------------------------------------

\98\ This should be interpreted consistently with ``firm
personnel,'' as defined in QC 1000.A5.
---------------------------------------------------------------------------

b. Engagement Team (Used in Partner and Manager Involvement)
The Board proposed to provide information about partners and
managers on the engagement team, a term defined in AS 2101, Audit
Planning.\99\ The Board believes it is

[[Page 99990]]

appropriate to provide metrics related specifically to the engagement
team because this would provide investors and other stakeholders with
relevant information related to the audit as a whole, who perform audit
procedures on the audit or assist in planning or supervising the audit.
---------------------------------------------------------------------------

\99\ The ``engagement team'' is defined in AS 2101.A3 [as
adopted by the Board in Planning and Supervision of Audits Involving
Other Auditors and Dividing Responsibility for the Audit with
Another Accounting Firm, PCAOB Rel. No. 2022-002 (June 21, 2022), to
take effect with respect to audits of fiscal years ending on or
after December 15, 2024] as follows (footnotes omitted):
.A3 Engagement team--
a. Engagement team includes:
1. Partners, principals, and shareholders of, and accountants
and other professional staff employed or engaged by, the lead
auditor or other accounting firms who perform audit procedures on an
audit or assist the engagement partner in fulfilling his or her
planning or supervisory responsibilities on the audit pursuant to
this standard or AS 1201, Supervision of the Audit Engagement; and
2. Specialists who, in connection with the audit, (i) are
employed by the lead auditor or an other auditor participating in
the audit and (ii) assist that auditor in obtaining or evaluating
audit evidence with respect to a relevant assertion of a significant
account or disclosure.
b. Engagement team does not include:
1. The engagement quality reviewer and those assisting the
reviewer (to which AS 1220, Engagement Quality Review, applies);
2. Partners, principals, and shareholders of, and other
individuals employed or engaged by, another accounting firm in
situations in which the lead auditor divides responsibility for the
audit with the other firm under AS 1206, Dividing Responsibility for
the Audit with Another Accounting Firm; or
3. Engaged specialists.
---------------------------------------------------------------------------

One commenter suggested clarifying whether ``engagement team'' for
purposes of this rule includes internal specialists. Another commenter
stated that the proposal appeared to provide an alternative definition
of partners and managers on the engagement team compared to AS 2101,
which is aligned to other PCAOB standards, and recommended providing
clarity as to the treatment of specialists. Another commenter expressed
concern that the definition of ``engagement team'' under AS 2101 could
have ramifications for the calculation of engagement-level metrics, but
did not provide any indication of what those ramifications might be.
The Board adopted the AS 2101 term ``engagement team,'' as
proposed. The definition of engagement team in AS 2101 includes
specialists who, in connection with the audit, (i) are employed by the
lead auditor or an other auditor participating in the audit and (ii)
assist that auditor in obtaining or evaluating audit evidence with
respect to a relevant assertion of a significant account or disclosure.
It excludes engaged specialists.

Figure 2. Engagement Team Members
[GRAPHIC] [TIFF OMITTED] TN11DE24.022

[[Page 99991]]

c. Core Engagement Team (Used in Workload, Training Hours for Audit
Personnel, Experience of Audit Personnel, and Industry
Experience)^{100 101 102 103}
---------------------------------------------------------------------------

\100\ See AS 1210, Using the Work of an Auditor-Engaged
Specialist.
\101\ AS 1220 applies to those persons.
\102\ AS 2601, Consideration of an Entity's Use of a Service
Organization, sets forth the auditor's responsibilities with respect
to using the work of service auditors who issue reports on the
controls of a third-party service organization.
\103\ Because of their roles at the company, the work of
individuals employed or engaged by the company is not subject to
supervision under AS 1201; they are not considered members of the
engagement team under the adopted definition. PCAOB standards
include requirements regarding the auditor's use of work performed
by some of these individuals. See, e.g., AS 1105, Audit Evidence,
Appendix A; AS 2201, An Audit of Internal Control Over Financial
Reporting That Is Integrated With An Audit of Financial Statements;
AS 2605, Consideration of the Internal Audit Function.
---------------------------------------------------------------------------

For some engagement-level metrics, the Board proposed to include
information about members of the ``core engagement team'' rather than
the full ``engagement team,'' so as to focus the metrics on the
individuals who make the primary decisions regarding planning and
performance of the audit and determine the final conclusions supporting
the auditor's opinion. With the ``core engagement team'' concept, the
Board intends to provide more meaningful and focused data by excluding
information about certain partners and managers with lesser
participation. The Board also simplifies the data collection effort by
limiting these metrics to firm personnel.
The Board proposed that the core engagement team would include the
engagement partner and members of the engagement team who are partners
or employees of the firm issuing the audit report. In addition, under
the proposal, core engagement team would include either a partner
(excluding the engagement partner as described above) who worked ten or
more hours on the engagement or a manager or staff who worked on the
engagement for 40 or more hours or, if less, 2% or more of the total
hours.\104\
---------------------------------------------------------------------------

\104\ See below for the discussion of ``total audit hours.''
---------------------------------------------------------------------------

Figure 3 illustrates how partners, managers, and staff used in the
calculation of the metrics, relate to the firm, engagement team, and
the core engagement team.

Figure 3. Relationship Between the Groups of Individuals Included in
Metric Calculations
[GRAPHIC] [TIFF OMITTED] TN11DE24.000

The Board solicited comments on whether the proposed definition of
core engagement team, and the proposed participation thresholds for
inclusion in the core engagement team, were appropriate.
One commenter agreed that at the engagement level, metrics related
to only the core engagement team will be more useful to investors and
other stakeholders. Two commenters supported the proposed 10-hour
minimum threshold for partners other than engagement partners. One of
these

[[Page 99992]]

also supported the proposed threshold for managers and staff. This
commenter suggested, however, that the Board includes only partners and
employees of the lead audit firm and exclude component auditors.
One commenter suggested aligning the definition of ``core
engagement team'' with the ``lead auditor'' definition in amended AS
1201 and AS 2101. Another commenter indicated that the creation of
thresholds would conflict with other existing aspects of Form AP. This
commenter further stated there would be challenges for firms to
accumulate and report this data, specifically obtaining the data from
firms that are not required to report on Form FM or Form AP and
additional time may be needed for implementation of these metrics.
Another commenter recommended replacing the phrase ``who worked''
in the proposed definition to ``who performed audit procedures'' to be
consistent with the definitions of engagement team because this
commenter was concerned that wording inconsistencies may cause
confusion as to whether the same criteria apply across the various
definitions. One commenter indicated that it is not clear on what basis
the proposed threshold is determined and further indicated that the
concept of core engagement team suggests that certain work in the
engagement would be either not important or optional and recommended
further study.
The proposal also asked whether other individuals involved in the
audit (e.g., individuals in the firm's national office, the EQR,
employees of shared service centers, or individuals involved in loaned
staff arrangements and alternative practice structures) should be
treated differently in the metrics and, if so, how they should be
considered in the definition of core engagement team. One commenter
sought clarification as to whether shared service center employees
should be included in the definition of core engagement team and
recommended considering the nature and use of centralized services and
how service centers continue to evolve across a changing professional
landscape. Another commenter suggested including the EQR and
specialists in the core engagement team but not treating them
differently from other individuals involved in the audit. Two
commenters recommended the definition to simply include all individuals
who charged time to the engagement or whose cost was included within
the engagement to minimize the cost of reporting the metrics, but one
of the two commenters recommended excluding the quality functions such
as the EQR to avoid any impression that they are part of the engagement
team.
The Board adopted the proposed definition of core engagement team
substantially as proposed:
1. The engagement partner and
2. Members of the engagement team who are:
a. Partners or employees of the registered public accounting firm
issuing the audit report (or individuals who work under that firm's
direction and control and function as the firm's employees); and
b. Either of the following:
i. A partner (excluding the engagement partner) who reported ten or
more hours on the engagement; or
ii. Managers and staff who reported 40 or more hours on the
engagement or, if less, 2% or more of the total audit hours.
As suggested by two commenters, the Board reformatted the
presentation of core engagement team to clarify that the engagement
partner is part of the core engagement team. In addition, the Board
modified the descriptions of core engagement team members by
substituting ``who reported'' for ``who worked'' to make clear that the
basis for determining whether hours thresholds have been reached is
time reported in the firm's timekeeping system. The Board did not align
the definition of ``core engagement team'' with the ``lead auditor''
definition because including information from all of the partners and
managers of the firm, rather than just those with significant
participation in the engagement, would potentially skew or dilute the
data, making the metrics less meaningful.
As the Board proposed and the Board adopted, the term core
engagement team excludes other auditors. As a result, there will be no
need to obtain data from other auditors, and the definition will not
encompass firms that are not required to file Form AP. Under current
reporting requirements for Form AP, the lead auditor has to accumulate
all of the hours worked on issuer engagements.\105\ While it will
require some disaggregation of this data, the Board does not believe
reporting the data for the engagement team for Partner and Manager
Involvement and total audit hours for Allocation of Audit Hours will
create a significant challenge for firms. Regarding individuals at
shared service centers, if partners or managers employed by a shared
service center meet the definition of core engagement team, they will
be included. As further discussed below, the Board did not include the
EQR in the definition of the ``core engagement team''; the core
engagement team is a subset of the engagement team, and the EQR is not
a part of the engagement team.
---------------------------------------------------------------------------

\105\ See discussion of ``total audit hours'' used for Form AP
reporting below.
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Figure 4. Core Engagement Team Members

[[Page 99993]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.003

[[Page 99994]]

d. Engagement Quality Reviewer (Used in Experience of Audit Personnel
and Industry Experience)
The objective of the EQR is to perform an evaluation of the
significant judgments made by the engagement team and the related
conclusions reached in forming the overall conclusion on the engagement
and in preparing the engagement report, if a report is to be issued, in
order to determine whether to provide concurring approval of
issuance.\107\ The EQR must possess the level of knowledge and
competence related to accounting, auditing, and financial reporting
required to serve as the engagement partner on the engagement under
review.\108\ While reporting on specific hours spent by the EQR or
including the EQR's time in engagement-level metrics may have a
negligeable quantitative impact, the Board believes reporting on EQR's
competency for two of the engagement-level metric areas will be
important and valuable for stakeholders.
---------------------------------------------------------------------------

\107\ See AS 1220.02.
\108\ See AS 1220.05.
---------------------------------------------------------------------------

Because the EQR is not a member of the engagement team as defined
in AS 2101, EQRs were not included in the proposed metrics when the
proposed metrics required disclosure of the engagement team's
information unless the disclosure of EQRs was specifically called out
in the proposed metric area. Therefore, the Board solicited comment
about whether EQRs should be added to any of the proposed metrics,
separately or together with a group such as the engagement team.
Some commenters agreed that EQRs should be excluded from the
engagement-level metrics. These commenters indicated not to add them as
a separate category because the EQR is not a part of the engagement
team as defined by AS 2101 and the inclusion of the EQR would be
inconsistent with AS 2101.
One commenter suggested that the EQR should be included in the
metrics but presented separately, to ensure that there is no impression
that the EQR is not independent. One commenter recommended including
EQR in firm-level metrics because firms generally do not assign
partners to solely perform engagement quality reviews and firm-level
metrics should include all partners with no requirement to allocate
their time spent between the roles of an engagement partner and an EQR.
Two investor-related commenters generally supported including EQR hours
in the metrics. Another commenter questioned the rationale for not
including metrics relating specifically to engagement quality
reviewers, despite the fact that they are not part of the engagement
team.
In the final requirements, EQRs are included in the two experience-
related metrics (Experience of Audit Personnel and Industry
Experience), where the Board believes that the information would be
significant to users. EQRs are not included in other metrics, primarily
due to their quantitatively insignificant impact on the metrics and to
avoid any confusion regarding whether they are part of the engagement
team. For metrics that depend on total audit hours (i.e., Partner and
Manager Involvement and Allocation of Audit Hours), this approach also
aligns with the reporting required for purposes of Form AP, from which
EQRs are excluded.

ii. Total Audit Hours (Used in Partner and Manager Involvement and
Allocation of Audit Hours)

For several metric areas, the Board proposed to use ``total audit
hours,'' which would be the same as the hours used to compute the
extent of participation in an audit of other accounting firms in Form
AP.\109\ Total audit hours include hours attributable to: (1) the
financial statement audit; (2) reviews pursuant to AS 4105, Reviews of
Interim Financial Information; and (3) the audit of ICFR pursuant to AS
2201.\110\
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\109\ See Part IV of Form AP.
\110\ ``Total audit hours'' [as amended and adopted by the Board
in PCAOB Rel. No. 2024-005, to take effect on December 15, 2025]
exclude the hours incurred by: (1) the engagement quality reviewer;
(2) specialists engaged, not employed, by the firm; (3) accounting
firms in performing the audit of entities in which the issuer has an
investment that is accounted for using the equity method; (4)
internal auditors, other company personnel, or third parties working
under the direction of management or the audit committee who
provided direct assistance in the audit of internal control over
financial reporting; and (5) internal auditors who provided direct
assistance in the audit of the financial statements.
---------------------------------------------------------------------------

Under the proposal, some firm-level metrics were based on total
audit hours across all issuer engagements while others were based on
specific subsets of total audit hours (e.g., partner and manager
hours). The Board also clarified that some engagement-level metrics
would also use a subset of total audit hours (e.g., those incurred by
partners and managers, on certain areas of the audit, or within stated
time periods before or after the issuer's year end).
The Board adopted the definition of total audit hours as proposed.
Two commenters criticized the use of hours in metrics. One
expressed concern that basing metrics on hours would encourage
stakeholders to focus on time spent rather than on whether the work was
effective, and potentially exacerbate the notion that auditors should
reduce the hours spent on an engagement. The other, while generally not
objecting to the use of the hours in specific metrics, asserted that
many firms have moved away from the burden of time reporting and that
there is no incentive to track time on fixed fee engagements. The Board
continues to believe that basing certain metrics on audit hours is
appropriate. It will allow firms to leverage systems already in place
for purposes of Form AP reporting and human capital management.
Moreover, the Board is not aware of any alternative method of tracking
auditor work that is commonly accepted by firms and could be
implemented without the creation of entirely new systems.
Commenters responding to the specific questions in the proposal on
total audit hours generally expressed support for using Form AP hours
for the total audit hours in the metrics. A few commenters recommended
including engagement quality review hours in total audit hours. A
commenter stated that hours from shared service centers should be
excluded from both the partner and manager involvement metrics. A few
commenters asked that the Board either include or exclude certain
specialist hours in total audit hours. Two commenters suggested that
hours spent on quarterly reviews should either be excluded or
disaggregated, one stating that otherwise the metric area related to
allocation of audit hours would generally show that most hours were
incurred before year end. Another commenter requested clarification as
to whether hours spent on quarterly reviews are included or excluded
from total audit hours, stating that if excluded, firms may need to
implement more detailed time tracking mechanisms or estimations of time
between quarterly review and year-end audit procedures.
In general, as required for Form AP, total audit hours is comprised
of the hours of the lead auditor, other accounting firms participating
in the audit with whom the principal auditor does not divide
responsibility for the audit, and nonaccounting firm participants that
assist the principal auditor or other accounting firms. Consistent with
the calculation of total audit hours for Form AP, total audit hours
exclude hours incurred by certain persons and entities. In addition,
existing Form AP includes reviews performed pursuant to AS 4105 because
these reviews are an integral part of the overall audit process. The
Board

[[Page 99995]]

continues to believe that using total audit hours, as already defined
by Form AP and collected by firms, will provide an appropriate and
cost-effective basis for calculating metrics.
Commenters, mostly firms and firm-related groups, noted that
several metric areas use total audit hours, which includes information
from other auditors. According to these commenters, referring to such
metrics as ``firm-level metrics'' is misleading, and they recommended
the firm-level metrics be limited to data related solely to the firm
filing the Form FM and exclude information from other accounting firms.
The Board is retaining the label of ``firm-level metrics'' for the
metric areas in question as the Board believes it is important to
include all of the relevant information for the lead auditor's
engagements. In addition, the Board believes this information will
provide key insights into the way that engagements are conducted by the
firm that is the lead auditor.
iii. Terms Used in Metrics
In addition to the terms discussed above, many of the terms used in
the metrics are defined elsewhere in the Board's standards and rules.
Other terms will be defined specifically for use in the metric
calculations and may differ from the way such terms are used elsewhere
in PCAOB rules and standards.\111\ Terms that are used in only one
metric are discussed in greater length below, in the context of
discussing the relevant metric. The Board has italicized the
terminology in the final calculations.
---------------------------------------------------------------------------

\111\ For example, the Board adopted the definition of
``partner'' to include only persons who participate in audits. While
the Board believes that is consistent with the use of that term in
the Board's auditing standards (see footnote above), it is narrower
than the use of the term in connection with registration and
reporting requirements.
---------------------------------------------------------------------------

3. Metric Descriptions and Calculations
This section describes the firm-level and engagement-level
performance metrics the Board adopted. The Appendix provides
illustrative examples to show how metrics would be calculated based on
specific facts and circumstances presented therein.
a. Partner and Manager Involvement
Partners and managers are responsible for oversight of the
engagement team, which includes less experienced staff. Spending time
to oversee the work of the audit staff is critical to the engagement.
Included in this oversight is the engagement partner's responsibility
to exercise due professional care related to supervision and review of
the audit, including evaluating whether significant findings or issues
are appropriately addressed and determining that the significant
judgments and conclusions on which the auditor's report is based are
appropriate and supported by sufficient appropriate audit
evidence.\112\ Less extensive supervision raises the risk of less
effective audit procedures. With a lower ratio of senior engagement
team time to staff time, the risk may be greater that partners and
managers may not be devoting sufficient time to supervise and review
staff work and evaluate audit judgments. Academic research also
suggests that greater partner or manager involvement in the audit is
positively associated with proxies for the quality of the audit.\113\
---------------------------------------------------------------------------

\112\ See General Responsibilities of the Auditor in Conducting
an Audit and Amendments to PCAOB Standards, PCAOB Rel. No. 2024-004
(May 13, 2024), as adopted by the Board and approved by the SEC, to
take effect with respect to audits of fiscal years beginning on or
after December 15, 2025, at 8-11 (describing responsibilities of
engagement partners under existing PCAOB standards) and 17
(describing clarification for the existing responsibilities of
engagement partners); see also, e.g., In the Matter of Melissa K.
Koeppel, CPA, PCAOB File No. 105-2011-007, at 78 (Dec. 29, 2017)
(concluding that, as the individual with final responsibility for
the audit, the engagement partner must act with due professional
care to ensure that the audit team performs all required audit
procedures).
\113\ See, e.g., a research paper, Joshua Khavis, Mengtian Li,
and Brandon Szerwo, Manager Staffing Leverage at the Audit Office
and Audit Quality, available at https://papers.ssrn.com/sol3/.cfm?abstract_id=4856541; a study using Korean data, Suyon Kim,
Does Engagement Partners' Effort Affect Audit Quality? With a Focus
on the Effects of Internal Control System, 9 Risks 225, (2021); a
study using Japanese data, Sarowar Hossain, Kenichi Yazawa, and Gary
S. Monroe, The Relationship Between Audit Team Composition, Audit
Fees, and Quality, 36 AUDITING: A Journal of Practice and Theory
115, (2017); and Agnes WY Lo, Kenny Z. Lin, and Raymond MK Wong,
Does Availability of Audit Partners Affect Audit Quality? Evidence
from China, 37 Journal of Accounting, Auditing & Finance 407,
(2022).
---------------------------------------------------------------------------

The proposal set forth requirements for firms to calculate firm-
level and engagement-level metrics for the percentage of total audit
hours incurred by partners and managers. As described in the proposal,
this metric area could provide users with information regarding each
firm's oversight of their engagements and the supervision of less
experienced engagement team members. The Board adopted this metric area
substantially as proposed, with one modification discussed in more
detail below.
Commenters generally agreed with requiring public reporting of the
proposed firm-level metrics for Partner and Manager Involvement.
Investor-related commenters stated that disclosure of hours worked by
senior professionals relative to more junior staff across the firm and
on the engagement is valuable. One investor-related group noted that
information regarding the hours worked by senior professionals who have
more experience in making judgments and evaluating estimates relative
to more junior staff provides important insights into the oversight,
supervision, and review of the engagement team. One commenter agreed
that the proposed metrics would provide useful information to
investors, audit committees, or other stakeholders because it would
provide a salient indicator of audit quality. Another commenter agreed
that the firm-level metric is clear and appropriate because it provides
an indication of the level of involvement of partners and managers in
the firm's audit engagements. At the same time, a few commenters were
concerned that the engagement-level metric could be misunderstood
because the level of supervision and review should vary based on the
nature of the company (e.g., size and complexity), the nature of the
work assigned to engagement team members, the risks of material
misstatement, and the knowledge, skill, and ability of each engagement
team member. Further, a commenter stated that the engagement-level
metric would not provide meaningful information without contextual
information obtained through a discussion with the audit committee.
The Board solicited comment on whether data for partners and
managers should be presented separately, including whether there should
be a separate calculation for the engagement partner. Two commenters
expressly supported this disaggregation, one stating that because the
engagement partner is the person signing the opinion, it would appear
to be more consistent to separate this data. The other commenters on
this topic said that further disaggregation of the involvement of
partners and managers is not warranted and could create unnecessary
complexity. For example, a commenter stated that segregation of
involvement by levels in the firm does not provide incremental value
and would dilute or potentially mischaracterize what can be inferred
from this metric (e.g., disaggregation of the engagement partner role
is not likely to be meaningful due to the engagement partner's ability
to have assistance). Two commenters expressed concern that adding up
partner and manager data and calculating these metrics for all issuer
engagements could be very time consuming and unnecessarily increase

[[Page 99996]]

compliance costs. Another commenter expressed concern that further
breakdown by role could lead to more inconsistencies in reporting
across engagements (e.g., differences in how firms are structured, such
as a managing director role). Commenters also recommended further study
by the PCAOB.
The Board notes, in response to commenter concerns about the need
for further study, there is extensive academic literature on this topic
and widespread support among investor-related groups (see above
discussion). The Board does not believe that adding up partner and
manager data and calculating and reporting these metrics will
unnecessarily increase compliance costs as firms are already required
to track these hours in aggregate for purposes of Form AP reporting.
While the Board acknowledges the importance of the engagement partner's
role, as this person is primarily responsible for the engagement as
evidenced by the fact that they sign the opinion and is required to be
identified on Form AP, the Board continues to believe that the
aggregation of partner and manager involvement and reporting of one
percentage provides a more holistic picture of the overall supervision
and review of the audit engagement. The Board agrees with most
commenters who said that further disaggregation of the involvement of
partners and managers is not warranted.
Some commenters, mostly firms and firm-related groups, suggested
excluding hours from other accounting firms and focusing only on the
involvement of partners and managers of the reporting firm. These
commenters were concerned that in situations where accounting firms
outside the lead auditor's network are involved, both the firm- and
engagement-level metrics would require information from outside the
lead auditor's system of quality control. Another commenter requested
that firms should present partner and manager involvement across high-,
medium-, and low-risk engagements. According to this commenter, it
would enhance comparability across firms.
The Board believes the metric area on partner and manager
involvement could be less informative or even potentially misleading if
it were based only on the lead auditor, rather than the entire
engagement team (including other auditors). Moreover, since relevant
data in aggregated form is already collected for purposes of Form AP
reporting, it is subject to existing quality controls over firm
reporting. The Board does not believe the additional administrative
burden of reporting partner and manager hours will be significant. As
to the suggestion to present partner and manager involvement across
different engagement risk profiles, the Board notes there is no
requirement in PCAOB standards or rules for such categorization and no
established framework for differentiating among engagements in that
way. Therefore, the Board does not believe this suggestion would yield
comparable information. However, firms will have the ability to provide
context in an optional narrative disclosure if they believe information
as to relative risk profiles is helpful in interpreting the metric.
The Board adopted the firm- and engagement-level metrics for
partner and manager involvement substantially as proposed. The Board
believes they will provide useful information to assist in
understanding hours worked by senior professionals relative to more
junior staff and gauging the associated risks.
However, the final requirements have been modified in one respect,
to narrow the population of engagements covered by firm-level
reporting. Considering comments received expressing concern with the
potential lack of comparability across different types of issuers, the
Board has limited firm-level reporting to only engagements for
accelerated filers and large accelerated filers--that is, the
engagements for which engagement-level reporting is required--rather
than all issuer engagements. The Board believes this narrower scope
will yield better alignment between firm- and engagement-level metrics
and more comparable information across engagements. Additionally, this
modification should further reduce data collection and reduce the
administrative burden associated with calculating and reporting these
metrics.
(See Exhibit A, ``Partner and Manager Involvement.'')

b. Workload

The Board believes that in general, the greater the workload, the
greater the likelihood that members of the engagement team may have
insufficient time to appropriately perform the necessary audit
procedures and make the appropriate judgments that an audit requires.
Professionals may become less effective when working long
hours,\114\ and such an environment may affect the level of due
professional care they exercise. For example, a heavy workload may
create pressure on the audit staff to focus too much on efficiency in
executing auditing procedures rather than on ensuring the effectiveness
of those procedures or on supervising less experienced engagement team
members.
---------------------------------------------------------------------------

\114\ See, e.g., Julie S. Persellin, Jaime J. Schmidt, Scott D.
Vandervelde, and Michael S. Wilkins, Auditor Perceptions of Audit
Workloads, Audit Quality, and Job Satisfaction, 33 Accounting
Horizons 95, 101 (2019) and Brant E. Christensen, Nathan J. Newton,
and Michael S. Wilkins, How Do Team Workloads and Team Staffing
Affect the Audit? Archival Evidence from U.S. Audits, 92 Accounting,
Organizations and Society 101225, (2021).
---------------------------------------------------------------------------

The Board believes heavy workloads could prevent an engagement
partner from providing adequate and focused attention to an audit
engagement. The information provided by the metrics at the engagement
level may help audit committee members and other stakeholders
understand the various activities competing for an engagement partner's
time.
Studies find that excessive audit partner workloads can have
negative impacts on audit effectiveness, although the literature also
suggests that partners may be less affected than more junior
staff.\115\
---------------------------------------------------------------------------

\115\ See, e.g., Seokyoun Hwang and Philip Keejae Hong,
Auditors' Workload and Audit Quality under Audit Hour Budget
Pressure: Evidence from the Korean Audit Market, 26 International
Journal of Auditing 371, (2022); John Goodwin and Donghui Wu, What
is the Relationship Between Audit Partner Busyness and Audit
Quality?, 33 Contemporary Accounting Research 341, (2016);
Persellin, et al., Auditor Perceptions.
---------------------------------------------------------------------------

The proposal set forth requirements for firms to calculate firm-
level and quarterly engagement-level workload metrics for (i)
engagement partners and (ii) other partners, managers, and staff. The
Board proposed separate reporting for engagement partners at both the
firm and engagement level, as they have primary responsibility for the
audit. At the engagement level, the Board proposed limiting reporting
to the core engagement team, which the Board believes would be more
useful to investors and other stakeholders than information regarding
the entire engagement team (some of whom may have extremely limited
participation in the audit).
The proposed calculations for workload at both the firm and
engagement levels included all working hours incurred during the
relevant periods: hours incurred on issuer and non-issuer engagements
as well as on training, practice development, staff development, or
other firm activities.\116\
---------------------------------------------------------------------------

\116\ Hours worked for purposes of the proposed metrics excluded
hours that were not considered working hours (e.g., paid time off
and holiday time).
---------------------------------------------------------------------------

The Board adopted this metric area substantially as proposed, with
modifications discussed in more detail below.

[[Page 99997]]

Some commenters agreed with requiring firm- and engagement-level
metrics in this area, stating that the proposed workload metrics ensure
there is appropriate attention and focus on audit engagements. One
commenter asserted that the proposed firm-level metric is significantly
less complicated than the engagement-level metric and should be
sufficient for assessing a firm's capacity to accept new clients.
However, the same commenter expressed concern that the proposed
engagement-level metric is very complicated and would take considerable
effort for firms to compile and calculate for every engagement.
Further, the commenter expressed concern that the cost of calculating
this metric likely exceeds any benefit. Another commenter stated that
just having higher workload during peak months does not necessarily
impact audit quality.
While some firms and firm-related groups generally expressed
support for public disclosure of the firm-level workload metrics, they
also expressed concerns with the metrics or requested modifications be
considered for firm-level workload calculations. Some firms and firm-
related groups questioned what benefits stakeholders would gain from
the information. Commenters suggested that alternative measures, such
as an annual utilization metric as reported in firms' audit quality
reports, may be more meaningful to reflect how a firm is measuring and
monitoring the activities competing for their professionals' time.\117\
Further, some of these commenters expressed concern about the effort
involved in collecting, analyzing, and reporting the data for average
weekly hours on a quarterly basis.
---------------------------------------------------------------------------

\117\ One example of a utilization metric reported in firms'
audit quality reports is ``average annual hours worked by audit
professionals over 40 hours per week.''
---------------------------------------------------------------------------

The Board continues to believe that disclosing the firm-level
workload metrics quarterly as opposed to annually will provide a
comparative basis for the engagement-level metrics. At the engagement
level, the Board believes that information for members of the core
engagement team will be especially useful to investors and other
stakeholders for the quarter in which the auditor's report is issued,
usually the busiest time of the year for the auditor. The Board also
believes that a workload metric based on actual hours worked (i.e.,
productivity) versus a utilization metric based on a standard number of
work hours (e.g., a 40-hour week, including time off) will provide more
useful information.
The Board solicited comment on hours worked, including whether the
proposed term should be changed. Some commenters expressed support for
including all hours worked including time spent on audits and time
spent on activities other than audits. One commenter expressed concern
that many firms do not require detailed recording of ``non-chargeable''
time, so the disclosure of hours worked will be a rough estimate at
best for some firms. This commenter expressed a view that the benefits
of the workload metrics would not justify the burden of asking firm
professionals to spend more time and energy tracking all of their
``non-chargeable'' time. Another commenter suggested that the Board
break out training and development from the rest of the hours worked.
Further, a commenter stated that a clearer definition of the proposed
term ``hours'' is required if this metric is to be used. For example,
firms may be inconsistent on how they report hours spent on travel for
work purposes. A commenter stated the proposed metrics exclude time
off, which is a key component of workload and may vary significantly
between levels. By excluding time off or leaves of absences, this
commenter expressed concern that the workload metric would not provide
consistent and comparable information.
The Board continues to believe it is important to capture the sum
of hours that are incurred on engagements and hours spent on training,
practice development, personnel development, or other firm activities
in the workload metrics, while excluding holiday or other paid time off
(i.e., when individuals would not be working). The Board believes the
potential additional administrative burden of including ``non-
chargeable'' time for partners and managers on issuer engagements
(firm-level workload metric) will not be burdensome based on the
Board's understanding that many firms track this time already.
Disaggregating the hours worked, as suggested by one commenter, will
further complicate the workload metrics. Finally, the Board believes
the definition of hours worked is sufficiently clear and does not
require further explanation for certain types of non-engagement hours.
Firms and firm-related groups stated that because the proposed
workload metrics were based on the definitions of partner, manager, and
staff, which determination is based on ``participation in the audit,''
it was not clear whether and where certain individuals should be
included in this metric as they move between audit support and
engagement-serving functions (e.g., individuals who provide tax
reporting and compliance services to other clients). One commenter
stated that including these individuals would dilute the value that
could be derived from metrics related to workload, as peak periods for
these other services and activities would mask meaningful trends in the
workload of other members of the engagement team whose primary
responsibility is performing audit work.
At the engagement level, the Board does not believe the commenter's
concern is relevant because the individuals in question are not likely
to be part of the core engagement team (see above for discussion of the
definition). At the firm level, the Board believes the workload of
these individuals will still be relevant as they presumably shift
between engagement work and non-engagement work as needed. Further,
trying to figure out a systematic approach for excluding these
individuals will only add to the administrative burden of gathering the
data and calculating and reporting the metrics.
Other commenters requested that the Board reconsider the inclusion
in the workload metrics of partners and professional staff who do not
work on issuer audits. One expressed concern that comingling statistics
associated with professionals who do not participate in any way on the
firm's issuer audits would be contrary to the stated objective of
``advancing investor protection and promoting the public interest by
enabling stakeholders to make better-informed decisions . . .'' Another
stated that the metric as proposed would encompass individuals who work
on engagements other than issuer audits (e.g., audits of non-issuer
employee benefit plans or governmental entities), who may have a
different ``busy season'' than individuals working on issuer audits. As
a result, this metric may show a relatively consistent average weekly
hour throughout the year across the firm, even though specific
individuals may have more variability in their schedules.
The Board streamlined the workload metrics in some respects, in
part based on commenter input. To provide a more useful metric, the
Board is limiting the firm-level metric to partners and managers who
participate in accelerated filer and large-accelerated filer
engagements for which the firm issued an audit report. The Board
believes this will provide information that will be comparable to the
engagement level information. The Board excluded staff from the firm-
and engagement-level

[[Page 99998]]

calculations in order to focus the metric area on the more senior
members of the engagement team--those individuals determining that the
significant judgments and conclusions on which the auditor's report is
based are appropriate. In addition, this will also lessen the
administrative burden of gathering the data and calculating and
reporting the metrics.
Some commenters found the proposed requirement to segregate
engagement partners from other partners in the proposed calculations to
be impractical to implement and not a meaningful distinction in the
metric. A commenter pointed out that segregating the roles may create a
practical challenge in calculating the metrics, as in practice a large
portion of partners generally fill both roles. Another commenter
asserted that because the proposal provided no justification for
distinguishing between ``engagement partners'' and ``other partners,''
the distinction between engagement and non-engagement partners should
be eliminated for purposes of calculating the firm-level workload
metric.
The Board adopted a firm-level metric that does not require
differentiating between engagement partners and other partners in
reporting on workload because the Board questions whether useful
information could be derived from that distinction, given that many
partners serve in both capacities. In addition, the Board understands
it may be a difficult and manual process to identify and track the
distinction between the types of partners. As stated above, the Board
continues to believe it is important for firms to disclose their
engagement partners' workloads at the engagement level. Overall, the
Board believes the modifications will improve or maintain the value of
the information provided by this metric area compared to the proposal,
while reducing the administrative burden associated with gathering data
and calculating and reporting the metrics.
(See Exhibit A, ``Workload.'')
c. Training Hours for Audit Personnel
The professional development training auditors receive should
enhance their competence and therefore their ability to perform
effective audits. Competence encompasses having the knowledge, skill,
and ability to perform assigned activities in accordance with
applicable professional and legal requirements and the firm's policies
and procedures.\118\ Training is a critical aspect of developing
auditor competence.
---------------------------------------------------------------------------

\118\ See PCAOB Rel. No. 2024-004, at 8-9 (describing competence
to perform an audit under existing PCAOB standards).
---------------------------------------------------------------------------

Licensing requirements for continuing education for public
accountants to obtain and retain certification speak to the
relationship between quality and appropriate training and
education.\119\ Additionally, QC 1000 mandates certain training
requirements, including with respect to ethics and independence.\120\
---------------------------------------------------------------------------

\119\ See paragraph .08 of AS 1000, General Responsibilities of
the Auditor in Conducting and Audit.
\120\ See QC 1000.50 (``The firm should design, implement, and
maintain policies and procedures regarding licensure such that the
firm and firm personnel hold licenses or other qualifications
required by the relevant jurisdiction(s) under applicable
professional and legal requirements.''). See also QC 1000.34(e) and
PCAOB Rel. No. 2024-005, at 151-52 (describing mandatory training
under PCAOB standards).
---------------------------------------------------------------------------

While the Board did not propose a training metric, the Board's
proposal solicited comment on training as a potential additional
metric. Commenters on the topic all agreed about the importance of
training to the development of auditors. One commenter included
training hours per professional as one of six metrics they believed
would increase technical excellence, and other commenters suggested an
alternative training metric focused on the percentage of revenue firms
spend on training. Other commenters highlighted challenges to defining
a training metric that would provide decision-useful information. One
commenter stated that training is important for development and
building awareness, but on-the-job training is invaluable, yet not
measurable. One commenter suggested that training metrics may not be
informative given they would be quantitative and not qualitative and
also suggested that these concerns would be best addressed through the
implementation of QC 1000 and related standards.
The Board believes there are benefits to having firms report
information regarding training. Indeed, academic research provides
evidence that certain proxies for auditor training are positively
associated with some proxies for audit quality, although the results
vary depending on the type of training \121\ The Board also observes
that almost all of the firms that provide voluntary reporting include
their average training hours as well as information about their
policies and procedures regarding training, which appears to emphasize
the value those firms place on the development of their professionals
as well as the potential informativeness of an hours-based quantitative
measure. The Board's research also indicates that at least eight other
jurisdictions include training as a firm-level metric.\122\
---------------------------------------------------------------------------

\121\ See below for additional discussion on the academic
literature.
\122\ See Accountancy Europe Report at 6, 7, 8, 11, 12, 13, and
14 for IDW (Germany), Quartermasters (Netherlands), CMVM (Portugal),
CPAB (Canada), ICAI (India), ACRA (Singapore), and IRBA (South
Africa). See also FRC Feedback Statement, at 18.
---------------------------------------------------------------------------

The Board recognizes that quantitative measures such as the number
of professional development training hours cannot capture qualitative
factors, such as the skill of trainers, the quality and relevance of
training content, whether the training is in a specialized area
specific to the trainee, and the degree of trainee engagement, that
contribute to the effectiveness of training. However, the average
number of training hours per audit professional provides an indication
of the importance the firm places on the training of its professionals.
In addition, given that the metrics are presented as a suite of metrics
and are not expected to be considered in isolation, providing some
visibility into firm's commitments and efforts to promote the
development of their professionals through ensuring they receive
adequate training will provide an additional data point for
consideration in that context.
Metrics the Board considered in this area, both at the firm level
and the engagement level, include (i) the average total number of CPE
hours per professional; (ii) average number of CPE hours received by
audit professionals in specified fields of study, such as (a)
accounting and auditing and (b) ethics and independence; and (iii) CPE
compliance rates at the firm or specific to engagement teams. In
consideration of the importance of training to the development of audit
professionals and the impracticality of measuring training through
qualitative means, the Board adopted metrics for average annual
professional development training hours \123\ for audit partners,
managers, and staff, both firm-wide and for the core engagement team.
These metrics will create visibility into training at both the firm and
engagement level, using

[[Page 99999]]

data that the Board believes will be readily accessible to firms.
---------------------------------------------------------------------------

\123\ Professional development training hours are training hours
for credit in support of obtaining or maintaining a professional
accounting license in a jurisdiction in which the auditor is
licensed or pursuing a license. For example, in the United States,
professional development training hours would be synonymous with CPE
credits as defined by the National Association of State Boards of
Accountancy (NASBA). In some jurisdictions, including the United
States, a training hour may be less than 60 minutes. If a
jurisdiction does not impose training requirements in support of
professional licensure, professional development training hours are
hours of training associated with acquiring and maintaining
professional competence.
---------------------------------------------------------------------------

The Board considered the suggested alternative of a training metric
focused on the percentage of a firm's revenue invested in training.
However, the Board believes that any approach based on the costs of
training would be difficult to implement. For example, some firms
develop their own training, some firms purchase training, and other
firms may reimburse their professionals for third-party training. Also,
firms may develop training for non-audit professionals within the
organization and then subsequently provide that training to audit
professionals, further adding to the complexity of suggested cost-based
training metrics. By contrast, the Board expects that firms will
generally already be tracking training hours as part of monitoring
ongoing compliance with CPE requirements, which should ease
implementation of the hours-based metrics the Board adopted. The Board
believes that the difficulties associated with measuring costs would
outweigh the advantages of a cost-based metric, as compared to the
hours-based approach.
(See Exhibit A, ``Training Hours for Audit Personnel.'')
iv. Experience of Audit Personnel
The auditor's years of experience at a public accounting firm can
provide useful information about how the auditor staffs the audit.
Academic studies show that auditor experience is related to improved
audit effort and skill, through both pre-client and client-specific
experience,\124\ and through behavioral adaptations associated with
managing their clients.\125\ At the firm level, an experience metric
can provide information regarding the ``bench depth'' of firm personnel
and the ability of the firm to staff its engagements. At the engagement
level, the engagement team's years of experience can provide useful
information about the depth of experience of the engagement team for
that particular engagement.
---------------------------------------------------------------------------

\124\ See, e.g., Wuchun Chi, Linda A. Myers, Thomas C. Omer, and
Hong Xie, The Effects of Audit Partner Pre-Client and Client-
Specific Experience on Audit Quality and on Perceptions of Audit
Quality, 22 Review of Accounting Studies 361, 363 (2016).
\125\ See, e.g., G. Bradley Bennett and Richard C. Hatfield, The
Effect of the Social Mismatch Between Staff Auditors and Client
Management on the Collection of Audit Evidence, 88 The Accounting
Review 31, (2012).
---------------------------------------------------------------------------

The Board proposed firm-level reporting of the average years of
experience at a public accounting firm of the firm's engagement
partners, partners other than engagement partners, and managers; and
engagement-level reporting of the years of experience at a public
accounting firm of the engagement partner and the EQR, as well as the
average years of experience of other partners and managers on the core
engagement team. Both metrics captured all experience at a public
accounting firm, whether or not the firm was registered with the PCAOB,
and included audits of issuers and non-issuers, as well as non-audit
work.
Some commenters agreed in concept with firm- and engagement-level
metrics for experience, stating that they agreed that auditor's years
of experience at a public accounting firm may provide useful
information about how the auditor staffs the audit. One of these
commenters broadly supported both metrics but suggested a number of
potential refinements, discussed below. One commenter suggested that an
employee experience metric could identify firms that are more likely to
have a firm culture that contributes to audit quality. Another
commenter suggested that a metric depicting years of experience after
CPA licensing would provide insight into whether a firm has more
experienced professionals.
Several commenters generally supported the firm-level experience
metric, while objecting to all proposed engagement-level metrics,
including the experience metric. One of these commenters stated that
the proposed firm-level metric met its criteria of being readily
interpretable, aligning with measures used by the firm in its system of
quality control, having broad linkage to audit quality, having minimal
unintended consequences, and meeting the information needs of users.
Some commenters asserted that proposed experience metrics, both at
the engagement and firm levels, were not useful or meaningful, saying
that there is great potential for misunderstanding and misuse with
little value to be derived. Another said that the emphasis on years of
experience overlooks the centrality of technology in the future.
Some commenters raised questions about the professionals covered by
the metrics. Two commenters suggested that the firm-level metric cover
only individuals who have been assigned to issuer audits, one of whom
said that firms may use different personnel on issuer audits than non-
issuer audits, so a metric that includes personnel regardless of
whether they work on issuer audits would not provide an accurate view
of personnel that may be staffed on an issuer audit. One commenter
questioned whether it was appropriate to provide engagement-level
reporting regarding the experience of the EQR, because it might imply
that the EQR was part of the engagement team.
Commenters also questioned the appropriate level of disaggregation
for reporting. One commenter described the requirement to segregate
engagement partners from other partners as impractical to implement and
not a meaningful distinction in the metric. Another suggested further
disaggregation, with partner and manager experience reported separately
and data broken down by industry.
Commenters reacted to the proposal to count only experience in
public accounting as relevant. One agreed that experience metrics
should be limited to audit experience. Several others suggested that
experience in addition to years worked at a public accounting firm,
such as industry experience or time spent working at a relevant
regulator, should be included. For example, one said that limiting
relevant experience exclusively to auditing experience could
potentially overlook the comprehensive skill set that individuals gain
from various roles throughout their career. Two commenters said that
context is needed to understand metrics depicting experience, as the
depth of experience and whether it is current may differ considerably.
Some commenters expressed concern about the challenges of gathering
data regarding experience, particularly if the experience metric is not
limited to time spent at the individual's current firm.
Commenters also raised issues with the calculation of the proposed
metric. One remarked that the experience metrics provided an incentive
to have a number of very experienced partners provide modest assistance
in order for their experience to be included in, and significantly
improve, the metric. This commenter suggested that requiring a weighted
average for this metric would act as a deterrent. One commenter
expressed that the calculation did not address how to treat personnel
role changes at the firm level.
One commenter suggested that further outreach was needed to
determine the ability to prepare such information and for investors and
audit committees to understand how such firm-level metrics would be
used in decision making.
After considering commenter input, the Board adopted the firm- and
engagement-level metrics with the modifications described below. While
the Board appreciates that there are limits to the information an
experience metric can provide, the Board believes that it is and will
continue to be a useful element in a suite of metrics, even in the
context of technological advances and other changes in the audit
market.

[[Page 100000]]

The Board considered whether, as some commenters suggested, the
firm-level experience metric should be narrowed to cover only
professionals who worked on an issuer audit in the most recent year.
However, the Board does not believe that approach would increase the
information value of the metric, because individuals may participate in
issuer audits in some years but not others, so it would cover only a
portion of the total talent pool. Such an approach would also add
significant complexity to the calculation, as well as variability year
over year. Accordingly, the Board concluded that it would be more
appropriate for firms to report the experience of all audit
professionals, as proposed.
The Board also considered whether to eliminate engagement-level
reporting of the experience of the EQR, based on commenter concern that
this could imply that the EQR is a member of the engagement team.
However, the Board does not believe that concern is well founded. There
is nothing in Form AP to support such an implication, and the Board's
standards are clear that the EQR is not a member of the engagement
team. Because of the significance of the EQR role, the Board continues
to believe that EQR experience is important and should be separately
reported.
The Board is eliminating the requirement to provide separate firm-
level reporting of the experience of engagement partners. Instead, the
final rules require firm-level reporting of (i) the average experience
of all partners in aggregate, both those who serve as engagement
partners and those who do not, and (ii) the average experience of all
managers in aggregate. After considering commenter responses, the Board
is concerned that separate reporting of engagement partner experience
may not add significant information value but will increase the
complexity and administrative burden associated with the metric. The
Board believes these metrics, with all partners in aggregate, will also
serve as a useful baseline for comparison of the engagement-level
reporting of engagement partner and EQR experience. The Board has also
separated the partner and manager experience metrics at the engagement
level for consistency and comparability with the firm-level metrics.
The Board considered broadening the scope of relevant experience
beyond public accounting but decided to adopt that aspect of the metric
as proposed. The Board notes that the commenters who recommended a
broader scope had inconsistent recommendations as to what would
constitute relevant experience (e.g., experience in a financial
accounting role, previous experience at a regulator, etc.), reflecting
the difficulty of arriving at an agreed-upon view of the non-audit
experience that would be relevant and should be included. The Board
believes a metric focused on experience in public accounting will be
better focused and would avoid that difficulty.
Several commenters raised concerns about the ability to track the
historical information called for by the metric, some implying that the
experience metric should be limited to experience with the individual's
current firm. The Board is concerned that such a limited metric could
be misleading, as it would understate the experience of anyone who
changed jobs. Moreover, the Board believes that firms could readily
capture the information from current personnel and otherwise during the
hiring and onboarding process, and the information would therefore
generally be available to firms without a significant ongoing
administrative burden.
The Board noted the questions commenters raised about how to
calculate averages, including how to treat partial years of experience
and whether the average at the engagement level should be calculated on
a weighted basis to reflect the extent of participation in the audit.
As to partial years of experience, firms will be free to report in
whole years on a rounded basis or, if they wish, more precisely. While
the Board appreciates that it may be possible to make staffing changes
in an effort to manage this or other metrics, the Board believes that
calculating the experience metric for the other partners and managers
as a weighted average would add unnecessary complexity. The Board also
considered that the risk of managing the engagement-level experience
metrics is minimized by other considerations, such as industry or other
specialized experience needs, that go into staffing decisions. In
addition, the Board expects that comparisons of trends in the reported
metrics over time will provide balance.
The Board also notes that, if a firm believed additional
information or context would be required for a reader to understand the
metrics provided, the firm could provide it as narrative.
(See Exhibit A, ``Experience of Audit Personnel.'')
v. Industry Experience
As part of the planning activities of an audit, auditors have a
responsibility to gain an understanding of the company's business.
These activities include gaining an understanding of matters affecting
the industry in which the company operates, such as financial reporting
practices, economic conditions, laws and regulations, and technological
changes.\126\ Experience in a particular industry helps an auditor
understand the industry's operating practices, the critical accounting
issues confronting companies in that industry, the risks of material
misstatement of the financial statements specific to industry factors,
and any industry-specific audit procedures.
---------------------------------------------------------------------------

\126\ See AS 2101.07.
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Understanding the experience of firms' audit personnel across
industries is an important factor in assessing the firm's capacity and
resources to perform audits of issuer engagements that benefit from
specific industry knowledge. The Board believes industry experience
metrics will assist in gaining that understanding.\127\
---------------------------------------------------------------------------

\127\ QC 1000.38a.(2)(d) requires firms to establish quality
objectives that address the firm's judgments about the extent to
which the firm has or can obtain resources to perform the engagement
as part of its acceptance and continuance of engagements.
---------------------------------------------------------------------------

Importantly, academic literature has long identified auditor
industry specialization as related to the effectiveness of audits.\128\
One study that examines the impact of auditor industry specialization
on the assessment of audit risk and in audit planning found that
auditors with industry-specific knowledge improved the auditor's
assessment of differential audit risk and the quality of their audit
planning decisions.\129\
---------------------------------------------------------------------------

\128\ See, e.g., W. Robert Knechel, Vic Naiker, and Gail
Pacheco, Does Auditor Industry Specialization Matter? Evidence from
Market Reaction to Auditor Switches, 26 Auditing: A Journal of
Practice and Theory 19, (2007); Steven Balsam, Jagan Krishnan, and
Joon S. Yang, Auditor Industry Specialization and Earnings Quality,
22 Auditing: A Journal of Practice and Theory 71, (2003); and Allen
T. Craswell, Jere R. Francis, and Stephen L. Taylor, Auditor Brand
Name Reputations and Industry Specializations, 20 Journal of
Accounting and Economics 297 (1995).
\129\ See Kin-Yew Low, The Effects of Industry Specialization on
Audit Risk Assessments and Audit-Planning Decisions, 79 The
Accounting Review 201, 202 and 214 (2004).
---------------------------------------------------------------------------

Investor-related commenters were generally supportive of industry
experience metrics stating they believe that it is critical for
auditors to have an elevated level of industry-specific knowledge. One
investor-related group stated that experience in a particular industry
helps an auditor understand that industry's operating practices,
critical accounting issues faced in that industry, the risks of
material misstatement of the financial statements specific to industry
factors, and any industry specific audit procedures. Another commenter
suggested that further guidance on the classification of

[[Page 100001]]

industries would be helpful and also suggested that weighting current
experience should be considered. One commenter suggested that the
metric be disaggregated between partners and managers.
While most firm and firm-related commenters opposed industry
experience metrics, one firm commenter stated that they understand in
principle why industry metrics may be perceived as meaningful. Some
commenters stated that the proposed industry experience metrics were
not useful due to issues with comparability and complexity. Some
commenters believed that the industry metrics gave rise to the
potential for confusion and misunderstanding, in part because any
classification system could group together very different types of
issuers that could result in inappropriate comparisons.
One commenter suggested that the proposed metric does not address
the issue that not all audits require specific industry experience and
that audit quality is enhanced when an engagement team includes
personnel with diverse experiences. Another commenter stated that
metrics depicting experience would need context to be meaningful.
After considering commenter input, the Board has retained industry
experience metrics, but simplified them from the proposal. The changes
include limiting the scope for reporting at the firm level and limiting
the requirements for reporting at the engagement level to the
engagement partner, the engagement quality reviewer and certain members
of the core engagement team among other changes further discussed
below. At a high level, the Board believes this addresses the concerns
of commenters regarding complexity, certain data collection concerns,
the potential for confusion and misunderstanding, and also provides for
more comparable information.
a. Thresholds
The Board proposed that the metrics would count partners who have
at least five years of experience throughout their careers in a
particular industry and managers who have at least three years of such
experience.\130\ For determining what counted as a year's experience,
the Board proposed a minimum threshold of 250 hours, or 25% of hours
worked, focused on an industry in a given year.
---------------------------------------------------------------------------

\130\ A note to the calculations clarifies that industry
experience is accumulated throughout an individual's career (i.e.,
aggregates experience obtained at all career levels). When
determining whether an individual has experience in a specific
industry the following may be taken into account: (i) industry
experience may be, but is not required to be, exclusive to
experience on audit engagements, or exclusive to experience gained
at an accounting firm, but must be relevant, and (ii) industry
experience can be acquired in non-consecutive years. Relevant
experience includes experience in accounting or auditing roles and
other specializations, such as experience that is related to fair
value estimates in the industry. See Note 2 to Item 4.5 of Form FM,
Note 1 to Item 6.5 of Form AP.
---------------------------------------------------------------------------

The proposed instructions for reporting the metric included
qualitative considerations to assist in determining whether an
individual had experience in a specific industry, including
consideration that industry experience may be, but is not required to
be, exclusive to experience on audit engagements, or exclusive to
experience gained at a public accounting firm, but must be relevant,
which includes experience in accounting or auditing roles and other
specializations, such as experience that is related to fair value
estimates in the industry. The instructions also clarified that
industry experience may be acquired in non-consecutive years.
One commenter expressly agreed with the proposed requirement of 250
hours or 25% of the auditor's time as being a reasonable criterion for
a year of qualifying industry experience. However, several other
commenters criticized the proposed threshold. Some of the concerns
raised included tracking the information throughout the career of
professionals, particularly at the global network level; obtaining
historical data; complying with the proposed 250 hour or 25%
thresholds; and maintaining documentation to support the metrics.
Another commenter expressed that the thresholds were not meaningful as
different individuals may perform the same tasks in different amounts
of time. This commenter also expressed that without research supporting
the thresholds, it is not possible to recommend how much industry
experience would be necessary. While one commenter acknowledged the
proposal allowed self-reporting as an option, they had concerns about
the ability of personnel to accurately determine whether they worked
250 hours or more in a specific industry going back many years,
potentially decades, and encouraged qualitative thresholds for
determining industry experience.
One commenter agreed with the proposed 3- and 5-year thresholds for
measuring industry experience and also suggested adding an additional
threshold of 10-years at the partner level. Other commenters raised
other concerns with the proposed reporting requirements. Some
commenters disagreed with the proposal to count managers with three
years of experience and partners with five years of experience. Among
these commenters, some expressed that it would unfairly exclude some
partners and managers, could be a disadvantage to smaller firms, could
be time consuming to compile data to support, and should not include
individuals with de minimis involvement. Commenters that responded to
the question of whether industry experience should be limited to audit
experience or rather should include all relevant experience agreed with
the proposal to include all relevant experience. They also agreed that
it need not be consecutive years.
Several additional commenters voiced concern about whether industry
experience was required to be recent. Two commenters claimed that the
Board's recently adopted quality control standard acknowledges that
there is no right level of industry experience,\131\ and each audit may
require different background and experience.
---------------------------------------------------------------------------

\131\ QC 1000.47 requires firms to design, implement, and
maintain policies and procedures such that their personnel obtain
and maintain the competence to fulfill their respective assigned
engagement roles, including an understanding of, among other things,
the industry in which the company operates and its relevant
characteristics.
---------------------------------------------------------------------------

After considering commenter feedback, the Board retained the 3- and
5-year thresholds for determining whether partners and managers should
be included in the industry experience metrics. The Board has also
retained the threshold of 250 hours or 25% of hours worked as the
baseline to determine whether a year qualifies as industry experience
but recast it as a general expectation rather than a requirement to
allow firms to exercise reasonable judgment. At the firm level, once
the 3- or 5-year industry experience threshold has been attained,
partners and managers should be included in the metrics until or unless
a firm determines, in its reasonable judgment, that the particular
industry experience is no longer relevant. At the engagement level the
Board has simplified the reporting requirements by limiting the metrics
to the years of experience of the engagement partner, the EQR, and
members of the core engagement team. The metrics will not include a
requirement to determine the industry experience of other partners and
managers who participated in the audit who are not members of the core
engagement team. The Board believes these changes will appropriately
address commenter concerns about potential difficulties in gathering
and verifying data while continuing to allow

[[Page 100002]]

firms to take into account matters like experience in related
industries, the nature of non-audit experience, and whether experience
is recent or remote in time. In addition, consistent with the proposal,
the final rules do not specify how the relevant information should be
accumulated. Because experience may be obtained in different ways at
different points throughout a professional's career, there are many
ways in which information could be accumulated to support the firm's
judgment, including personnel self-reporting or a firm's own time-
keeping system.
b. Industry Classification
The proposal set forth requirements for firms to provide
information regarding partner and manager experience in particular
industries. In order for firms to use a consistent approach to industry
identification, the Board proposed the Industry Classification
Benchmark (ICB), operated and managed by FTSE Russell. The ICB is used
by global stock exchanges, including the London Stock Exchange,
Euronext, and NASDAQ OMX, to categorize listed companies. Based on the
ICB classification system, firms would have selected from among a total
of 31 possible industry classifications.\132\
---------------------------------------------------------------------------

\132\ See FTSE Russell Industry Classification Benchmark (ICB),
available at https://www.lseg.com/en/ftse-russell.
---------------------------------------------------------------------------

Several commenters agreed that the proposed index was an
appropriate reference for industry classification. One commenter
acknowledged that there was a potential for imprecision when reporting
on large conglomerate companies that operate in many different
industries, but stated their belief that using the ICB rather than the
legacy Standard Industrial Classification (SIC) codes is a better
strategy from the outset of the creation of the metrics. This commenter
also expressed their understanding that there could be some imprecision
at the margins. On the other hand, several commenters stated that it
would be inconsistent with other reporting required by the SEC using
the SIC codes or the North American Industrial Classification system
(NAICS). Some commenters stated that firms do not necessarily align
with the industries proposed. One commenter pointed out that the ICB
listing does not include public sector or government and asked whether
these should be omitted from the reporting requirements.
Commenters responding to the proposal's question about whether
reporting should be expanded to allow for industries in addition to an
issuer's primary industry stated that industry reporting for large
issuers is complex, some stating that changes over time from mergers
and other activities would add to the complexity. Some commenters also
stated that the proposed industry metrics would provide challenges with
respect to data collection.
In response to these concerns and after further considering recent
voluntary public reporting by firms,\133\ the Board has expanded the
classification taxonomy and added flexibility. With respect to the
proposed industry classification listing, the final requirements
continue to provide a listing from which to select industries for
reporting purposes, but have been revised to include certain additional
industries such as agriculture and forestry and government and public
services categories to facilitate reporting for firms that have large
practices in these industries or sectors. In addition, for certain
industry groupings, such as finance and health care, an ``other'' sub-
grouping has been added to provide flexibility while maintaining a
level of comparability at the overall industry level. Firms are also
permitted to specify additional industries for reporting in the event
that the listing does not include an industry that accurately
represents the industries that they serve.
---------------------------------------------------------------------------

\133\ Consideration was given to recent Transparency Reports and
information available on public firm websites.
---------------------------------------------------------------------------

The taxonomy the Board adopted is as follows:
[Form FM and Form AP will provide drop-down menus for industry
classifications]
Industry Classification
1 Agriculture and Forestry
1.1 Agriculture and Forestry
2 Automotive
2.1 Automotive: Manufacturing
2.2 Automotive: Retail
3 Basic Resources
3.1 Basic Resources: Chemicals
3.2 Basic Resources: Industrial Materials
3.3 Basic Resources: Industrial Metals and Mining
4 Construction and Materials
4.1 Construction and Materials
5 Consumer Products and Services
5.1 Consumer Products and Services
6 Energy
6.1 Energy: Alternative Energy
6.2 Energy: Oil, Gas, and Coal
6.3 Energy: Other Energy and Transportation
7 Finance
7.1 Finance: Banks (Excluding Investment Banking and Brokerage
Services)
7.2 Finance: Investment Banking and Brokerage Services
7.3 Finance: Finance and Credit Services
7.4 Finance: Insurance
7.5 Finance: Real Estate
7.6 Finance: Other
8 Government and Public Services
8.1 Government and Public Services: Government
8.2 Government and Public Services: Public Services
9 Health Care
9.1 Health Care: Health Care Providers
9.2 Health Care: Pharmaceuticals and Biotechnology
9.3 Health Care: Medical Equipment and Services
9.4 Health Care: Other
10 Industrial Goods and Services
10.1 Industrial Goods and Services: Aerospace and Defense
10.2 Industrial Goods and Services: General
11 Technology, Media, and Telecommunication
11.1 Technology, Media, and Telecommunication: Media
11.2 Technology, Media, and Telecommunication: Technology Hardware
and Equipment
11.3 Technology, Media, and Telecommunication: Telecommunication
11.4 Technology, Media, and Telecommunication: Other
12 Trades and Services
12.1 Trades and Services: Travel and Leisure
12.2 Trades and Services: Retail
12.3 Trades and Services: Wholesale
12.4 Trades and Services: Other
13 Utilities
13.1 Utilities: Electricity
13.2 Utilities: Gas, Water, and Multi-utilities
13.3 Utilities: Waste and Disposal Services
14 Other Industry [specify]
14.1 [Industry]
The Board acknowledges that its taxonomy does not align with issuer
reporting using SIC or NAICS codes. As discussed in the Board's
proposal, the Board rejected those systems, as well as others, based on
several considerations, including that the SIC system has not been
updated since the 1980s, the NAICS system uses a production-oriented
and North America-centric structure that would not be appropriate as
applied to many issuers, and that none of the alternative systems the
Board considered would provide a basis for a meaningful metric. For
example,

[[Page 100003]]

the SIC code system, in addition to being dated, is highly fragmented,
employing more than 440 different industry classifications as listed on
the SEC's website.\134\ The Board believes this fragmentation would
dramatically impair the utility of the metrics, particularly because
there is no logical hierarchy by which industries with a need for
similar accounting or auditing specializations can be grouped together.
By comparison, the Board believes that the curated taxonomy that the
Board developed and refined in consideration of the ICB system most
closely aligns with the industries that firms generally disclose in
their transparency reporting and will provide the most relevant basis
for comparison among firms.
---------------------------------------------------------------------------

\134\ See https://www.sec.gov/search-filings/standard-industrial-classification-sic-code-list.
---------------------------------------------------------------------------

c. Metrics
The firm-level metrics provide information related to the firm's
industry specialization and the engagement-level metrics provide
information related to experience in the issuer's primary industry of
engagement partners and engagement quality reviewers. The following
sections discuss the proposed metrics, comments received, responses to
those comments, and the final requirements for firm- and engagement-
level metrics.
(1) Firm-Level Metrics
At the firm level, having industry experience may provide a group
of professionals who can both work on engagements and advise members of
engagement teams when additional technical, industry-specific knowledge
is needed. Firm-level industry experience may indicate that the firm
has specific industry-based audit knowledge, industry-specific tools
related to risk assessment, and industry-specialized methodologies for
accounting and auditing. As a firm-level metric, the Board proposed
that firms report, for each industry that represents at least 10% of
the firm's revenue from audit services, the number of partners and
managers who have accumulated five or more years or three or more
years, respectively, of industry experience throughout their careers.
The Board also proposed to allow firms to provide the same information
for additional industries voluntarily. As discussed above, the proposed
reporting instructions specified a minimum threshold number of years of
industry experience for reporting and how those years were to be
calculated.
Some commenters questioned the proposed 10% of revenue threshold
for identifying the firm's top industries. One commenter stating that
considering both the proposed threshold and the fact that the proposed
index is not inclusive of all industries in which the firm earned
revenue from audit services, the calculation would be problematic or
would result in the exclusion of those industries. Another commenter
questioned what period the 10% was meant to be measured over and
whether it was meant to be aligned with the firm's fiscal year or
another period. One firm commenter expressed concern that the proposed
metric would require it to compile data for industries in which it did
not perform any issuer audits. This commenter, and another, suggested
an alternative of calculating the metric based on 10% of a firm's
issuer audit practice rather than its overall audit practice. Other
commenters suggested that the metric be narrowed to a firm's issuer
audit practice, particularly in light of the proposed 10% of the firm's
revenue from audit services threshold. One of these commenters
additionally suggested that the metric include only partners who serve
on issuer audits.
In the Board's proposal, the Board solicited comment on
alternatives to the 10% threshold, such as requiring firms to disclose
their top five or top ten industries by revenue from audit services.
One commenter stated that this approach would be more practical and
clearer for stakeholders.
Some commenters suggested potential alternative approaches. One
commenter suggested requiring public disclosure of industry expertise
at the firm level based on the percentage of a firm's issuer clients
according to the industry marked on those issuers' SEC filings. Another
suggested reporting the number of entities under audit in a certain
industry rather than partner and managers with years of experience.
Other commenters suggested that, rather than focusing on the percentage
of revenue and using the ICB listing, each firm should be allowed to
list the industries, presumably not limited to the proposed ICB
listing, and to choose the number of industries, for which they have
specific expertise and report on those.
Several commenters suggested that further study or outreach was
needed to determine the ability to prepare such information and for
investors and audit committees to understand how such firm-level
metrics would be used in decision-making.
After considering the comments received, the Board simplified firm-
level reporting of industry experience in several ways:
The Board is limiting reporting requirements to firms that
issued five or more audit reports for accelerated filers and large
accelerated filers during the reporting period, combined. The Board
believes this will reduce the chances that a firm's top industries will
not include the industries represented in its issuer audit practice,
resulting in a more meaningful data set, while also alleviating
compliance burdens on firms with a small issuer practice.\135\
---------------------------------------------------------------------------

\135\ Based on PCAOB staff's analysis performed on the data
obtained from Audit Analytics, Standard & Poor's, and publicly
available data from the PCAOB's Registration, Annual and Special
Reporting (RASR), available at https://rasr.pcaobus.org. For the
two-year period ended September 30, 2023, the Board expects that
approximately 50 firms will be required to report this metric each
year.
---------------------------------------------------------------------------

Rather than requiring reporting with respect to industries
that account for at least 10% of the firm's revenue from audit
services, the Board is requiring firms to report the top five industry
sectors based on such revenue, regardless of the percentage of revenue
they represent. The Board believes this will address commenter concerns
regarding potential complexities of the calculation. The Board has also
clarified the instructions to provide that the determination is based
on revenue for the firm's most recently completed fiscal year. While
this means that the top five industries will be measured over a
different period than the years of experience, the Board believes that
consequences of that misalignment are likely to be immaterial, while it
will simplify data collection and align it with the firm's business
cycle. The Board has also provided the ability for firms to report
additional industries if the Board's list does not include an
appropriate industry grouping.
While the Board considered commenter suggestions to limit the
metric to firm revenue from issuer audits rather than revenue from all
audit services, the Board continues to believe that the metric is more
relevant if it includes all audit services. The information it provides
offers a user of the information a view to the firm's entire audit
practice, not just its issuer audit practice, which informs users of
the depth of industry experience of the firm's people. The Board
believes this information is more relevant than the number of issuers a
firm audits in a particular industry because, in absence of an
understanding of the specific issuer population, that data may be less
easily interpreted.
(2) Engagement-level Metrics
At the engagement level, industry experience provides professionals
with

[[Page 100004]]

an understanding of risks unique to the industry and industry-specific
auditing and accounting considerations. The proposed engagement-level
metrics required disclosure of the years of experience in the issuer's
primary industry for the engagement partner and the engagement quality
reviewer. In addition, the Board proposed that the number of partners
(excluding the engagement partner) and managers on the engagement team
with experience in the issuer's primary industry also be disclosed.
Commenters raised questions with respect to personnel to be
included in the engagement-level industry metrics. One commenter
suggested that industry experience metrics be limited to the core
engagement team, suggesting that including the EQR implies that the EQR
is part of the engagement team, when they are not. This commenter, and
some others, suggested that industry experience should be limited to
recent experience. A commenter stated that these metrics should be
limited to the engagement partner and the EQR, while another commenter
stated that partners, other than the engagement partner, and managers,
should be disaggregated.
As discussed above, many commenters had concerns with the
calculations, including the thresholds to be used in the calculations.
In response to these concerns, the Board has limited reporting to the
engagement partner and the engagement quality reviewer, and other
partners (excluding the engagement partner) and managers on the core
engagement team. The Board has eliminated the proposed reporting for
other firm partners and managers who are not members of the core
engagement team. The Board believes, given the key roles played by the
engagement partner and the EQR, and other partners and managers on the
core engagement team that this will focus the metric on the most
salient information.
(See Exhibit A, ``Industry Experience.'')
vi. Retention of Audit Personnel
The retention rate and the headcount change inform the overall
readiness, availability, and ability of the firm to conduct effective
and efficient audits. While some turnover is expected within audit
firms,\136\ a comparatively high rate of turnover or higher-than-
expected turnover could adversely affect audits.\137\ It could diminish
the available pool of talent who have the appropriate competency. It
may take time and resources for the firm to replace the competency
lost, likely through effective recruiting and further training.
Academic literature consistently finds the same conclusion: turnover
negatively affects audit quality, more so at longer-tenured engagements
than newer engagements.\138\
---------------------------------------------------------------------------

\136\ See, e.g., Kris Hardies, A Survival Analysis of
Organizational Turnover in the Auditing Profession, 97 MAB 5 (2023).
\137\ See Christophe Van Linden, Marie-Laure Vandenhaute, and
Aleksandra Zimmerman, Audit Firm Employee Turnover and Audit
Quality, Working Paper, Vrije Universiteit Brussel, SSRN (2023).
\138\ See, e.g., Joshua Khavis and Brandon Szerwo, Audit-
Employee Turnover, Audit Quality, and the Auditor-Client
Relationship, SSRN Electronic Journal, (2023); Linden, et al., Audit
Firm Employee Turnover and Audit Quality; W. Robert Knechel, Juan
Mao, Baolei Qi, and Zili Zhuang, Is There a Brain Drain in Auditing?
the Determinants and Consequences of Auditors Leaving Public
Accounting, 38 Contemporary Accounting Research 2461 (2021); and
Brant E. Christensen, et al., How Do Team Workloads and Team
Staffing Affect the Audit? Archival Evidence from U.S. Audits. The
Board notes that SSRN does not peer review its submissions.
---------------------------------------------------------------------------

The proposal set forth requirements for firms to calculate the
average annual retention rate and the average annual headcount change
of partners and managers both at the firm- and engagement-level.
At the firm level, the Board also proposed to require disclosing
the average number of partners and managers to provide context for the
retention and headcount change metrics. For example, a 67% retention
rate at a larger firm (200 departures out of 600 professionals) would
involve a different level of employee continuity and hence imply a
different magnitude of possible impact on the firm's human resource
management, than at a smaller firm (e.g., one departure out of three
professionals) because this larger firm will likely need to replace 200
professionals while the smaller firm will only need to replace one
professional assuming all things are consistent.
At the engagement level, the Board also proposed to require
disclosing the average tenure on the engagement for partners and
managers to quantify the overall continuity of the engagement team
members. Average annual retention rate is a year-over-year metric, but
tenure would provide overall engagement-level experience as an
important component to understand the experience of the engagement team
on the specific audit.
a. Firm-Level Reporting
The annual retention rate measures the percentage of firm personnel
continuously employed for the reporting period to demonstrate the
continuity of firm personnel. The average annual headcount change
measures changes in the firm's overall headcount of managers or
partners, giving an indication of the firm's success in replacing
professionals who left roles performing audits and the overall
availability of firm personnel. The annual retention rate and the
annual headcount change are closely related; however, the annual
retention rate would measure the ``same people'' within the firm, while
the annual headcount change would measure the ``same number of
people.'' The annual retention rate measures whether the same
individuals are still holding their positions at the firm while the
annual headcount change is focused on the change in the number of
individuals serving in those positions. Changes in annual headcount
over time could result from a variety of reasons, for example, changes
in a firm's human resource strategy (e.g., greater use of technological
resources, shifting more work to shared service centers), or a downturn
in the economy.
Commenters generally supported the proposed firm-level metrics.
Some said they were sufficiently objective or straightforward and easy
to interpret. One of these commenters also indicated that some firms
already published similar metrics in firm audit quality reports and
another commenter indicated that these metrics allow for some
comparisons and may help a user in better understanding a firm. Two
investor-related groups agreed with the proposal that a comparatively
high rate of turnover or higher-than-expected turnover could adversely
affect the audit, while another commenter indicated that staff turnover
reporting is directionally supporting audit quality improvement through
better continuity year-over-year. One of these commenters also stated
that retention metrics will add to the mix of information provided in
the final metrics without drawing a specific inference as to an
``ideal'' retention rate, considering the need to strike a balance
between maintaining continuity of the engagement team members and
introducing new personnel who will take a ``fresh look'' at the audit.
Another commenter stated that a benefit of the headcount change metric
is that it will provide context for the retention metric. A commenter
stated if a firm reports favorable employee retention metric, the
firm's culture is ideal to contribute to higher audit quality. One
commenter supported the firm-level metrics and acknowledged the
importance of assessing the readiness and availability of the firm for
conducting effective audits, but requested the Board determine how the
metrics correlate

[[Page 100005]]

with audit quality before requiring public reporting.
One commenter supported firm-level reporting of this metric area,
but expressed concern that users could misinterpret the average annual
headcount change metric due to unfamiliarity with the distinction
between the turnover rate and headcount change. This commenter urged
the PCAOB to host a roundtable discussion or pilot test to determine
how audit committees or investors may interpret and use this
information. Another commenter agreed that the turnover at various
levels could have an impact on audit quality.
Two commenters did not support the firm-level reporting of these
metrics. While one commenter agreed with the proposed calculation and
description of the metrics, this commenter was concerned that it could
be misconstrued and present firms with a competitive disadvantage for
recruiting talent without providing context (e.g., turnover due to
changes in firm structure, shifting industry concentration,
performance, ethical, or independence issues). Another commenter
claimed the metric was convoluted and would be at the risk of
misinterpretation.
Additionally, two other commenters raised a concern; one of them
questioned whether these metrics would be meaningful or of value to
investors and whether firms would be sufficiently consistent in
calculating the metrics to make them worthwhile and another questioned
that the inclusion of all the firm's managers and partners may make
this metric meaningless for firms whose issuer audit practice is small
in relation to the total practice and recommended more outreach
regarding the usefulness for stakeholders.
Regarding the description and calculation of these metrics, several
commenters asked questions or suggested refinements. One commenter
questioned how the metrics would be calculated in a case of voluntary
partner rotation. Another commenter recommended clarifying whether
``other service lines within the firm'' includes ``other accounting
services'' as defined by PCAOB Rule 1001(o)(i). Additionally, one
commenter recommended renaming the description of the average annual
headcount change to align with the calculation to avoid confusion; as
proposed, it would provide current year headcount as a percent of the
prior year headcount, not a change as a percent of the prior year. This
commenter also suggested clarifying the meaning of ``holding the same
position,'' used in the retention calculation and ``transferred out of
audit practice,'' and ``continuously employed during the 12-month
period'' used in the illustrative example of the firm's average annual
retention rate calculation. One commenter suggested disaggregating
partners and managers.
Three commenters did not support separately reporting senior or all
staff level annual retention and annual headcount change metrics.
Taking into account commenter feedback, the Board adopted the
retention metric as proposed and adopted the headcount change metric
with some modifications.
As noted above, academic literature consistently supports that
turnover negatively affects audit quality. The Board believes the
retention metric is objective, provides important data, and is already
publicly reported by a number of firms in their audit quality or other
reports. This metric was also generally supported by commenters from
the different constituencies, including firm, firm-related groups,
investor-related groups, and others. Since this or similar metrics are
already reported by firms, the Board does not believe there will be a
disadvantage in recruiting, difficulty in consistently reporting of
this metric, or a risk of misinterpretation. Firms could also use the
expanded narrative disclosures to provide context, if necessary.
The Board also continues to believe the inclusion of all partners
and managers who participate in audits, not a subset of partners and
managers who serve issuer engagements, is appropriate because the
retention rate and the headcount change inform the overall readiness,
availability, and ability of the firm to conduct an effective and
efficient audit. While this metric area provides historical
information, the Board believes historical data signals impact on the
firm's near-future staffing needs and ability to conduct effective
audits due to the time it takes to hire and train additional resources.
Firms with sufficient overall headcount could reallocate staffing due
to a possible staffing shortage on issuer engagements.
The Board does not believe that partner rotation, whether mandatory
or voluntary, is likely to affect firm-level reporting of this metric,
as the rotating partner will likely continue to participate in audits
in the subsequent year (albeit on different engagements). The term used
in the calculation ``holding the same position'' means that a partner
remains as a partner and a manager remains as a manager of the firm
during the reporting period. The term ``continuously employed within
the 12 months'' means the individual is continuously employed by the
firm throughout the 12 months, without departing to another employment.
The Board revised the average annual headcount change calculation
to address concerns raised by commenters, specifically that users may
misunderstand this metric as a turnover rate and that the calculation
should align with the title. The Board believes that the revision will
help a user's understanding of the metric and align with the title of
this metric by reporting the headcount change as a percentage of prior
year. For example, using the illustrative example in the proposal,

Firm A had 204 managers and 200 managers as of October 1, 20X0 and
September 30, 20X1, respectively. Under the revised calculation, the
average annual headcount change will be -2% based on (200-204)/204 = -
1.96%.

The Board believes this change will help users understand that the
average annual headcount change of -2% means a 2% decrease in headcount
from prior reporting year end to current reporting year end. This
information is often used as a human resource management metric.
Lastly, regarding the description and the calculation of the
proposed average number of the firm's partners and managers, one
commenter indicated that they are clear and appropriate. Another
commenter indicated that it would help to provide context for the
retention metric but use a simple average of the count at the beginning
and end of the year. This commenter also agreed with treating the
promotions to another level of seniority as if they occurred at the
beginning of the year.
Based on commenters' feedback on firm-level reporting of average
number of managers and partners, the Board adopted this metric as
proposed because comments received agreed with the proposed description
and calculation and this metric will help provide context for retention
and headcount change metrics. The proposed calculation provided a
simple average of the number of partners or managers as of the previous
reporting period end and the current reporting period end so that the
numbers at the end of each reporting period will be used consistently
in the calculation. Because the proposed calculation was not
significantly different from using the simple average of the count at
the beginning and end of the year, as suggested by a commenter, the
Board adopted the calculation as proposed.

[[Page 100006]]

b. Engagement-Level Reporting
For the engagement-level reporting, commenters generally did not
support metrics in this area, while several commenters supported both
firm- and engagement-level reporting. Many commenters who did not
support such metrics cited the lack of context in the metrics itself or
difficulties in explaining a wide range of factors that caused the
engagement-level turnover (e.g., mandatory partner rotation, personal
issues (i.e., family or medical leave, or relocations), firm's
strategic resources management (i.e., scheduling conflicts, resource
constraints, independence issues, or need for additional expertise)).
Some commenters also cited the difficulty in interpreting the
information, the risk of misinterpretation, misuse and misleading
users, and even potentially being punitive to engagement teams and
issuers. Others offered further reasons for not including this metric,
which included difficulty in tracking and having consistent reporting
on Form AP to make these metrics worthwhile. One commenter indicated
the possibility of being detrimental to audit quality if these metrics
incentivize firms to manage to achieve certain metrics, based on the
commenter's view that engagement staffing should be based on identified
risks of material misstatement of the issuer. This commenter and
another commenter further expressed concerns that the engagement-level
retention rate for smaller engagement teams will be significantly more
sensitive to any turnover relative to the retention rate for larger
engagement teams because the size of engagement teams tends to vary
with the size of the engagement.
Two commenters also indicated that this metric is unnecessary
because engagement resource management is already covered by the firm's
quality control system. One commenter indicated that the engagement
partner is responsible for determining the sufficiency and
appropriateness of engagement resources and prior year information will
not be relevant in evaluating the quality of an engagement team in the
current year. Another commenter emphasized that properly managed
turnover will increase audit quality to reduce familiarity biases.
Some commenters believe these metrics will be more relevant to the
audit committee or audit committee and management or should be provided
only to the audit committee to allow for robust discussions. One
commenter only supported disclosure of the engagement-level tenure
metric to the audit committee because it will provide meaningful
information to assist audit committees in exercising their duties to
oversee the auditor; however, this commenter did not support other
retention metrics as the engagement team staffing is a firm-level
decision with factors that are not engagement specific or local laws
and regulations that the firms may not be able to disclose.
One commenter indicated that these metrics should be considered in
conjunction with other metrics reported rather than presuming a
specific correlation with audit quality or auditor's independence,
indicating as an example that there are specific legal and ethical
mandatory rotation of key audit partners requirements in Europe.
Another commenter asked various questions in the calculation of the
engagement-level metrics for inclusion or exclusion of certain specific
conditions (e.g., whether there is a time limit in how far back a
partner or manager's tenure to be included).
Based on comments received, the Board did not adopt the engagement-
level reporting of these metrics at this time, primarily due to some of
the challenges described by commenters including difficulty in
providing context (including some information that is not permitted for
public disclosure), consistent reporting, and interpreting this metric
area at the engagement level, due to, for example, sensitivity of
engagement-level turnover on smaller engagements compared to larger
engagements because turnover will have more direct and significant
impact to engagement-level reporting due to the relatively smaller size
of the managers and partners involved in each engagement.
(See Exhibit A, ``Retention of Audit Personnel.'')
vii. Allocation of Audit Hours
At the engagement level, the Board believes performing audit
procedures prior to the issuer's year end will allow the engagement
team to identify significant issues in a timely manner and provide the
engagement team with the opportunity to address those issues earlier.
The Board also believes it will enable engagement teams to have the
resources available to appropriately respond to significant issues
identified after year end. Discussing this metric with the audit
committee could provide the audit committee with information regarding
aspects of the engagement's performance. Academic literature suggests
that allocation of a greater proportion of total hours to earlier audit
phases, prior to a company's year end, is associated with a lower
likelihood of restatements \139\ and late Form 10-K filings and also
decreased total audit hours.\140\
---------------------------------------------------------------------------

\139\ Daniel Aobdia, Preeti Choudhary, and Noah Newberger, The
Economics of Audit Production: What Matters for Audit Quality? An
Empirical Analysis of the Role of Midlevel Managers within the Audit
Firm, The Accounting Review (2024).
\140\ Brant E. Christensen, Nathan J. Newton, Michael S.
Wilkins, Archival Evidence on the Audit Process: Determinants and
Consequences of Interim Effort, 38 Contemporary Accounting Research
2 (2021).
---------------------------------------------------------------------------

As proposed, the firm-level and engagement-level metrics related to
allocation of audit hours would have required firms to report the
percentage of total audit hours incurred both prior to the issuer's
year end and following the issuer's year end, separately.
Several commenters supported the reporting of this metric as
proposed (i.e., at both the firm and engagement level), while some
commenters only supported required reporting of this metric at the firm
level. Of those commenters that supported reporting this metric at only
the firm level, two commenters requested the following clarifications
regarding various elements of the calculation:
Whether the period being reported at the firm level should
be based on audit reports dated from 10/1--9/30 or based on engagements
with a fiscal year-end from 10/1--9/30. This commenter expressed
concern that if the proposal's intention was the latter, significant
challenges with the proposed 11/30 reporting period for Form FM should
be anticipated.
How this metric would be applied to an initial public
offering (``IPO'') engagement where the audit covers up to three years
where often the work doesn't follow the traditional audit cycle or
timeline.
A commenter expressed concern that because the reporting period for
Form FM is different than the engagement period for which total audit
hours are calculated for Form AP, this will create a challenge with
data collection and validation for different periods. This commenter
also expressed concern that this metric requires the use of total audit
hours, which relies on information from other auditors. The commenter
recommended that the Board consider whether the use of other auditor
information is necessary to meet the Board's objective. One commenter
expressed concern that the firm-level metric would not be comparable
due to changes in circumstances of specific issuers because while
individual issuer circumstances may not be significant enough to move
the metrics for larger

[[Page 100007]]

firms, for smaller firms individual issuer circumstances could impact
the overall results. As an example, for a smaller firm with an issuer
that had a large acquisition during the fourth quarter, that would lead
to a significant shift of hours after the end of the year.
As described above, the reporting period for firm-level metrics
reported on Form FM will generally be the 12-month period ended
September 30 in each year. When reporting this metric, the firm could
use the information reported at the engagement level on Form AP for
this metric to calculate the firm-level metric for reporting on Form
FM. For multi-year audit engagements, including IPO engagements,
because the audited financial statements would be included in one
auditor's report, it is not possible to identify one particular year-
end that a firm should use that would not skew the reported metric.
Therefore, the Board excluded multi-year audits from the required
reporting of this metric. Given the commenter concerns raised around
the collection and data validation of this metric for all issuer
engagements, the Board has modified the firm-level description and
calculation of this metric area to include only those accelerated filer
and large accelerated engagements that will be reported at the
engagement level. The Board believes this narrower scope will yield
better alignment between firm- and engagement-level metrics and more
comparable information across engagements. Related to commenter
concerns about the collection of information from other auditors, Form
AP currently requires firms to collect information regarding the hours
of other auditors in calculating total audit hours. Total audit hours
collected for Form AP already includes hours related to the quarterly
reviews, so those hours would also be included in the numerator and
denominator for this metric, see also discussion above.
Some commenters stressed the importance of providing narrative
context in relation to the reporting of this metric, for example:
One commenter (that only supported reporting at the firm
level) asserted that reported metrics may be misleading without proper
narrative disclosure to provide the necessary context to users. This
commenter elaborated that circumstances beyond the auditor's control
may influence the allocation of overall audit hours, and users should
be cautioned against making presumptions that a higher proportion of
hours after the issuers' year ends is a signal of lower quality.
One commenter expressed the view that comparability of
these metrics can be highly dependent on factors such as industry, type
of audit (i.e., financial statement audit or integrated audit), and
transaction timing and volume, among others and that stakeholders will
need appropriate context to interpret the significance of these
metrics. This commenter also stated that there is a risk that
stakeholders may be biased towards inferring that a quantitative metric
for allocation of audit hours is a proxy for audit quality, which
further supports the need for sufficient appropriate context to
interpret the results.
The Board agrees that allowing firms to provide a narrative
disclosure will be important in certain situations to help users
understand the context of a specific metric. See additional discussion
related to this optional narrative disclosure above.
Several commenters, firms and firm-related groups, disagreed with
the proposal to report this metric at the engagement level publicly and
instead suggested that this metric would be more effectively addressed
via dialogue with the audit committee. These commenters expressed the
following views:
For the engagement-level metrics to achieve the Board's
stated objectives, such metrics would best be delivered through
effective two-way communication between the auditor and the audit
committee to provide the relevant and necessary context.
Even if offered the opportunity to provide narrative
context, auditors may not be inclined to provide a full explanation as
to why hours allocation may have skewed to after year end for a
particular issuer, as doing so might disclose confidential information
about the issuer's preparedness for the audit or other facts, which
might result in disputes.
There are a variety of factors that influence the
allocation of hours before or after the entity's year-end which are
beyond the control of the auditor and may drive a disproportionate
allocation of hours before or after the entity's year-end in a given
audit, including those related to the entity entering into transactions
and changes in the entity's operations or systems.
Other commenters disagreed with the proposal to report this metric
entirely. These commenters expressed the following concerns:
The timing of audit procedures (and resulting hours) is
primarily a function of audit strategy decisions based on the
assessment of a company's ICFR and inadequate ICFR may require most
hours to be incurred after the balance sheet date. This commenter
stated that more hours incurred after the balance sheet date may, in
fact, indicate a proper evaluation of ICFR and higher audit quality and
therefore this metric would provide little insight into audit quality.
This metric is not directly related to audit quality. The
timing of the engagement procedures depends on many variables,
including the nature of the audit areas, specific risks on an
engagement, the effectiveness of interim and roll-forward procedures,
the availability of staff, when the client is available, the client's
specific financial reporting systems, and internal controls. This
commenter stated that this information could potentially be misleading
or misinterpreted.
This metric seems somewhat arbitrary and may provide
misleading information for those smaller engagements where a higher
proportion of the work is performed post-year end.
It is unclear whether the metric is meaningful because it
might be impacted by among other factors, macro-economic trends,
company controls and activities, and use of shared service centers and
more generally, may require too much explanation to provide meaningful
comparisons.
This metric would not be comparable between larger firms
and other firms and could have unintended consequences. In an audit of
a smaller reporting company, it is frequently impracticable to perform
much work prior to an issuer's year end, both out of concerns for
efficiency and because small companies, who might have an outsourced
finance function, cannot support significant interim work.
Since most companies have a calendar year end, firms have
strong incentives to perform work as of an interim date to move hours
outside of the traditional busy season. A firm's ability to shift work
to an interim period is dependent upon a variety of factors, many of
which are unrelated to audit quality.
The Board considered commenter feedback, and in particular
commenter concerns related to the fact that particular facts and
circumstances surrounding an engagement could significantly skew a
firm's reported metric when compared to other firms that may have a
different portfolio of issuer engagements. While the Board understands
that each engagement is affected by the specific facts and
circumstances, the Board continues to believe that users of this
information will benefit from understanding how audit hours are
allocated on engagements, supplemented by

[[Page 100008]]

narrative disclosure to provide context, as needed.
At the engagement level, it may be more relevant for a firm to
provide a narrative disclosure to explain the particular facts and
circumstances related to the current reporting period's metric for this
area. One firm stated that ``Pulling work forward, where feasible and
appropriate, enables engagement teams more time to focus on areas of
highest risk in the audit.'' Based on the Board's oversight activities,
the Board agrees with this statement, and the Board believes that this
information will be beneficial to users at both the firm level and the
engagement level. As with all the metrics, the Board encourages the
auditor and audit committee to have a robust dialogue.
The proposal asked whether a different, more granular, metric would
be more appropriate, for example allocation of audit hours devoted to
each phase of the audit--planning, quarterly reviews, interim field
work, final field work up until report release date, and post-report
release date until audit documentation completion date. Most commenters
who commented on this question did not agree that a different, more
granular, metric would be more appropriate. Views provided by these
commenters included the following:
A more granular metric devoted to different phases of an
engagement would be very challenging to measure and interpret as the
audit is an iterative process. In addition, audit procedures may be
performed to meet more than one specific objective and thus may relate
for instance to both planning and execution phases of the engagement.
It will be costly to assemble the information to report
and such additional time spent on data reporting diverts very important
time during the audit and creates an unnecessary dilemma for engagement
teams as to whether it is more important to comply with audit quality
standards or reporting requirement rules.
The Board agrees with these commenters that a more granular metric
is not necessary to achieve the objectives of this metric and did not
modify the proposed metric to make it more granular.
Other than clarifying that multiyear audits are outside the scope
of the reporting requirement and revising the scoping of the firm level
metric to limit it to only those accelerated filers and large
accelerated filers of the firm, the Board adopted this metric as
proposed.
(See Exhibit A, ``Allocation of Audit Hours.'')
viii. Restatement History
Restatements for errors (e.g., not for changes in accounting
principles) are generally considered a signal of potential difficulties
in at least parts of a firm's audit practice. Academic literature
suggests that restatements provide the cleanest empirical measure of
audit failure.\141\ Overall, the Board believes the academic literature
supports a measure that accumulates the pattern of restatements for
firms, as this would provide a strong measure against which other
metrics may be identified in the future.
---------------------------------------------------------------------------

\141\ See, e.g., DeFond and Zhang, A Review of Archival Auditing
Research.
---------------------------------------------------------------------------

The proposed firm-level metric set forth requirements for firms to
report information related to restatements,\142\ including both
revision restatements (sometimes referred to as ``little r''
restatements) \143\ and reissuance restatements (sometimes referred to
as ``Big R'' restatements) \144\ of audited financial statements for
all issuer engagements of the firm. The proposal also included
reporting of reissuance restatements of management's report on
ICFR.\145\ The Board adopted this metric area with several
modifications discussed in more detail below.
---------------------------------------------------------------------------

\142\ The term ``restatements'' has the same meaning as defined
in the FASB Accounting Standards Codification (``FASB ASC'') Topic
250, Accounting Changes and Error Corrections; see also,
``retrospective restatement'' as defined in IFRS Accounting Standard
(IAS) 8, Accounting Policies, Changes in Accounting Estimates and
Errors. The phrase ``error in previously issued financial
statements'' has the same meaning as defined in the FASB ASC 250;
see also ``prior period errors'' as defined in IAS 8.
\143\ A ``revision restatement'' of audited financial statements
was described in the proposal as ``when an immaterial error in
previously-issued audited financial statements, that is material to
the current period financial statements, is corrected by an issuer
in the current period comparative financial statements by restating
the prior period information and disclosing the revision.''
\144\ A ``reissuance restatement'' of audited financial
statements was described in the proposal as ``when a material error
in previously-issued audited financial statements, report on
management's assessment of the effectiveness of ICFR, or both, is
identified and disclosed by an issuer in a filing with the SEC
(e.g., on Form 8-K Item 4.02, Non-Reliance on Previously Issued
Financial Statements or a Related Audit Report or Completed Interim
Review).''
\145\ A ``reissuance restatement of management's report on
ICFR'' was described in the proposal as ``When a material error in a
previously-issued report on management's assessment of the
effectiveness of internal control over financial reporting is
identified and disclosed by an issuer in a filing with the SEC.''
---------------------------------------------------------------------------

The proposal asked whether the proposed descriptions of revision
restatement and reissuance restatement were clear and appropriate. The
two commenters on this question agreed that the proposed descriptions
were clear and appropriate. The descriptions were adopted with
modifications: (i) in addition to referring to restatements identified
and disclosed by the issuer in a filing with the SEC, the final
description of reissuance restatement also refers to circumstances in
which the firm is required to file a notice pursuant to Item 2.1 of
Form 3,\146\ and (ii) the final description of revision restatement was
revised to improve the alignment with the description used by the SEC
in its adopting release for exchange listing ``clawback'' rules \147\
and to clarify that the restated financial information and the
disclosure appear in a filing with the SEC. The revisions to the
description of reissuance restatement ensure that the data set is
complete because it captures circumstances where the issuer fails to
comply with its reporting obligations. The revisions to the description
of revision restatement avoid potential misalignment with the SEC's
characterization of little r restatements and also provide a clear
trigger (SEC filing) for when a restatement is included in the metrics.
---------------------------------------------------------------------------

\146\ Item 2.1 applies when a firm:
has withdrawn an audit report on an issuer's financial
statements, or withdrawn its consent to the use of its name in a
report, document, or written communication containing an issuer's
financial statements, and the issuer has failed to comply with a
Commission requirement to make a report concerning the matter
pursuant to Item 4.02 of Commission Form 8-K.
\147\ See Listing Standards for Recovery of Erroneously Awarded
Compensation, SEC Rel. No. 34-96159 (Oct. 26, 2022) at 28
(``restatements that correct errors that are not material to
previously issued financial statements, but would result in a
material misstatement if (a) the errors were left uncorrected in the
current report or (b) the error correction was recognized in the
current period'').
---------------------------------------------------------------------------

Accordingly, the descriptions of reissuance restatement and
revision restatement in the final rules provide as follows (footnotes
omitted):
Reissuance restatement: When a material error in previously-issued
financial statements is identified and disclosed by an issuer in a
filing with the SEC (e.g., on Form 8-K Item 4.02, Non-Reliance on
Previously Issued Financial Statements or a Related Audit Report or
Completed Interim Review) or the firm is required to file a notice
pursuant to Item 2.1 of Form 3.
Revision restatement: When an error in previously-issued financial
statements that did not result in a reissuance restatement, but would
give rise to a material misstatement if (a) the error was left
uncorrected in the current report or (b) the error correction was
recognized in the current period, is corrected and disclosed by an
issuer in a filing with the SEC.

[[Page 100009]]

The proposed metric included only restatements that related to
corrections of errors and excluded all other restatements, including
those resulting from changes in accounting principles. The proposed
metric also excluded corrections in the current period financial
statements of errors that were not material to the previously-issued
financial statements and are not material to the current period
financial statements (e.g., a voluntary restatement or an out-of-period
adjustment), because these are not restatements as described in this
rulemaking. One commenter suggested that the metric should explicitly
exclude restatements resulting from stock splits and similar activities
that result in non-error restatements. As proposed, the metric
addressed only restatements for errors, and the Board does not believe
it is necessary to list specific types of non-error restatements.
Commenters generally supported the reporting of a restatement
metric, including all of the investors and investor-related groups that
addressed the topic. Some pointed out that firm transparency or audit
quality reports often include a similar metric.
However, two commenters questioned the usefulness of the proposed
metric and asserted that such a metric alone could provide only limited
insight into the quality of public oversight over issuers and auditors.
One commenter stated that this information was already publicly
available, and it did not appear necessary to require firms to report
it but if it were reported, a streamlined metric that merely reported
on the total number of restatements for the year would be preferable.
One commenter, who generally supported the proposed metric, stated that
it should only include those audits where the auditor withdrew and
amended the opinion.
Some commenters generally supported the proposed metric but
suggested changes to various elements discussed in more detail below,
including:
Removing revision restatements from the proposed required
reporting.
Counting multi-year restatements as one restatement, not
separately.
Reducing the number of reporting periods to be reported
from five to three.
Not requiring engagement-level reporting.
One aspect of the proposal that did not draw comment, and which the
Board adopted as proposed, was the proposed reporting of reissuance
restatements of management's report on ICFR, together with reporting of
the number of issuer engagements for which the firm initially issued an
audit report expressing an opinion on ICFR.\148\ Firms are required to
report those reissuance restatements of management's report on ICFR
that disclose an additional material weakness or additional elements to
a previously disclosed material weakness for all issuer engagements.
---------------------------------------------------------------------------

\148\ Under Sarbanes-Oxley, the auditor is required to attest to
management's assessment of the effectiveness of the company's
internal control only for companies that qualify as ``large
accelerated filers'' or ``accelerated filers,'' other than
``emerging growth companies.'' See Section 404 of Sarbanes-Oxley, 15
U.S.C. 7262.
---------------------------------------------------------------------------

a. Revision and Reissuance Restatements
The proposed metric set forth requirements for firms to include
information related to both reissuance restatements and revision
restatements for all issuer engagements of the firm in the firm's
required reporting. Three commenters agreed specifically with this
aspect of the required reporting with one commenter stating that
providing information related to revision restatements gives a holistic
picture of the firm's audit performance, reliability of the financial
statements, and transparency from the fact that all restatements are
reported and not just reissuance restatements.
The other commenters on this aspect of the proposal, all firms or
firm-related groups, disagreed with the proposed requirement to include
revision restatements in the metric. They expressed the following
concerns:
Such restatements are not material to the prior periods
and to report them suggests an inappropriate level of importance to
information deemed immaterial.
These types of restatements are not currently separately
tracked by some smaller firms, given that revision restatements are not
material to the year to which they relate, thus are not necessary or
useful to decision-making.
Requiring the disclosure of these instances in the same
context as reissuance restatements could inappropriately suggest that
there are potential implications for the quality of the audit
performed.
The Board continues to believe that the restatement history metric
should include all restatements for errors, both revision restatements
and reissuance restatements. As noted above, several commenters were
supportive of the Board's proposed scope, including all the investors
and investor-related groups that addressed the issue. The Board
believes that this scope will provide a more complete picture of the
extent to which financial statements audited by the firm contain errors
that subsequently have to be corrected.
The Board also believes that its reporting requirements should not
distinguish between revision restatements and reissuance restatements
in a way that may create inappropriate incentives for auditors and
issuers as they make materiality determinations with respect to
previous period errors. The SEC addressed this concern in its
rulemaking regarding exchange listing ``clawback'' rules, which also
apply to both revision restatements and reissuance restatements.\149\
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\149\ See SEC Rel. No. 34-96159 at 35-6 (in connection with
including both revision restatements and reissuance restatements in
its clawback rules, stating that ``this construction of the
statutory language addresses concerns that issuers could manipulate
materiality and restatement determinations to avoid application of
the compensation recovery policy''). See also Assessing Materiality:
Focusing on the Reasonable Investor When Evaluating Errors (Mar. 9,
2022), available at https://www.sec.gov/newsroom/speeches-statements/munter-statement-assessing-materiality-030922, (observing
that some materiality analyses appear to be biased toward supporting
an outcome that an error is not material to previously-issued
financial statements, resulting in ``little r'' revision
restatements).
---------------------------------------------------------------------------

The Board understands that revision restatements and reissuance
restatements do not necessarily convey the same information,
particularly as to the performance of the auditor. As the Board
proposed, revision restatements will be reported on a separate line
from reissuance restatements, which will enable users to analyze the
two different types separately.
In the final metric, both revision restatements and reissuance
restatements will be measured based on disclosure in an SEC filing.
Reissuance restatements will also include circumstances in which the
issuer is required to make an SEC filing under Form 8-K Item 4.02 \150\
and fails to do so, which triggers a requirement for the firm to file a
notice pursuant to Item 2.1 of PCAOB Form 3. Disclosure in an SEC
filing could take a variety of forms, such as checking the box on the
cover page of Form 10-K and Form 20-F to indicate correction of error
in a previously issued financial statement, as one commenter suggested;
filing a Form 8-K in response to Item 4.02; or simply including
restated prior period information in a periodic report or registration
statement. The Board believes that measuring restatements based on SEC
filings will provide an objective point of reference that will enable
firms to track the relevant data.

[[Page 100010]]

The Board notes that one commenter asserted that some smaller firms do
not currently track revision restatements. As mentioned above, under QC
1000 firms are required to track restatement data (i.e., both types of
restatements) in order to design engagement monitoring activities and
determine whether engagement deficiencies exist. In addition, given the
public availability of the data and the ease with which the SEC's
electronic data gathering analysis and retrieval (``EDGAR'') database
can be searched, the Board does not believe that gathering the data
will be overly burdensome, regardless of whether it is a firm's current
practice to do so
---------------------------------------------------------------------------

\150\ See Form 8-K Item 4.02, Non-Reliance on Previously Issued
Financial Statements or a Related Audit Report or Completed Interim
Review.
---------------------------------------------------------------------------

b. Multi-Year Audit Restatements
The proposal contemplated that, in the case of multi-year audits
where one auditor's report covers the audits of multiple years of
financial statements, the metric would treat every year that is
restated as a separate restatement. While one commenter supported the
proposed treatment of these types of audit restatements, firms and
firm-related groups stated that multi-year restatements should be based
only on the initial year audited, and should not be counted separately
for each year. These commenters expressed concern that, as proposed,
the metric would reduce understandability and comparability as it would
misalign with how the audit was classified when reporting the metrics
in the initial year the audit report was issued, creating the potential
for a misleading multiplier effect. One firm stated that some
restatements may be triggered by a distinct issue in one year, which
may or may not be material to other years presented, but those other
years are still corrected in the restatement process. Another firm
expressed concern about the potential complexity and difficulty of the
proposed reporting. A firm-related group suggested that, as an
alternative, the multi-year-audit restatements might instead be covered
by providing total years impacted by restatements as a supplementary
metric.
The Board considered commenter input on this issue, but the Board
continues to believe that the most accurate and appropriate
presentation of multi-year audit restatements is to count each year
that is restated as a separate restatement when reporting this metric.
If a firm has additional context related to a multi-year audit
restatement that it believes will assist users in properly interpreting
the metric, the firm could describe it as optional narrative
accompanying the metric.
c. Number of Reporting Periods to Present
The proposal provided that this metric would be reported for the
current reporting period and each of the preceding four years, for a
total of five years.\151\ One firm agreed with the proposal, stating
that the five-year period strikes a balance between providing
sufficient historical context to identify trends and patterns in audit
quality and restatements and it also maintains the current relevance.
---------------------------------------------------------------------------

\151\ Based on an internal evaluation of restatement patterns
covering the period from Q1 2008 to Q2 2018 by the PCAOB's Office of
Economic Risk and Analysis, 98% of restatements during this period
were announced with a delay of approximately five years or less and
about 80% of the restatements were announced with a delay of three
years or less.
---------------------------------------------------------------------------

The other commenters on this aspect of the metric, all firms and
firm-related groups, disagreed with the proposal and instead suggested
that firms be required to report the current period and each of the two
preceding years, for a total of three years. These commenters offered
the following rationales:
Three years would be consistent with an issuer's reporting
of periods in an annual report in accordance with SEC rules and
regulations.
It would be better to require firms to report three years
because it will greatly reduce the burden on terminated firms to track
the restatements of their former audit clients (e.g. newly implemented
monitoring and communication protocols with successor audit firms and
previously audited companies). Since issuers are required to present
three years of income statements in the financial statements included
in Form 10-K, they will need to obtain consents from former auditors
for those prior periods. As a result, terminated firms will be made
aware of any restatements when requested to provide consents.
Five years is unnecessarily long given this information is
readily available via the SEC's EDGAR system.
The Board considered the comments received and determined to limit
the metric to three years, rather than the five years initially
proposed. As commenters have pointed out, this will better align with
SEC requirements regarding financial statement presentation and may
therefore reduce any potential efforts or costs associated with
implementation. While the change may result in some reissuance
restatements falling outside the reporting period, the Board believes
that focusing on more current information will provide users with a
more relevant metric.
d. Engagement-level Reporting
The proposal stated that since restatements are disclosed in the
financial statements, the Board was not proposing to require that firms
report this metric at the engagement level. Commenters who expressed
views on this aspect of the proposal agreed with this view stating that
this information is already publicly available from the SEC. One firm
supported engagement-level reporting of this metric explaining that it
could lead to deeper accountability to assess the performance of audit
teams by linking the restatements to the responsible engagement team,
and it would result in promoting higher standards of audit quality.
Taking into account commenter feedback, the Board continues to believe
that reporting restatement information at the engagement level is
unnecessary because it is already publicly available in a searchable
format for any particular issuer through the SEC's EDGAR filing system.
Conversely, for users to aggregate restatement information for all of a
firm's issuer engagements could require significant time and effort,
which is why the Board only adopted this metric at the firm level.
Engagement-level reporting is not required under the final rules.
e. Other Commenter Feedback
Other commenter suggestions included:
Predecessor and successor auditor. Under the proposal, the
restatement metric would apply with respect to audit reports
``initially issued by the firm.'' As a result, restatements would be
included in the metric of the firm that issued the original audit
report on the financial statements or on the audit of ICFR, regardless
of whether the firm had itself identified the error or continued to
serve as the issuer's auditor. Firms, in particular those that resign
from the engagement or are otherwise replaced, would need to monitor
whether previously-issued audited financial statements, reports on
management's assessment of the effectiveness of ICFR, or both, are
subsequently restated for at least three years. Two commenters that
addressed this aspect of the metric agreed with the treatment provided
under the proposal, and the Board adopted it as proposed.
Prospective reporting upon effective date. Several
commenters suggested that if the Board proceeded with the proposal to
include revision restatements in the required reporting for this
metric, prospective reporting upon implementation would be more
practicable. As discussed above, under

[[Page 100011]]

QC 1000 firms are required to track restatement data in order to design
engagement monitoring activities and determine whether engagement
deficiencies exist, therefore firms will already have been tracking
this information upon the effective date of the requirements in this
rulemaking.
(See Exhibit A, ``Restatement History.'')
Reporting
1. Thresholds for Required Reporting
The Board proposed to apply the same threshold for both firm-level
and engagement-level reporting, focused on auditors and audit
engagements for issuers that qualify as accelerated filers or large
accelerated filers under SEC rules. The Board proposed that firm-level
reporting would be required of every firm that audits at least one
company that has self-identified as an accelerated filer or large
accelerated filer by checking the box on an SEC filing (or, because
Form 40-F does not contain such a check box, at least one Form 40-F
filer that meets the criteria to be an accelerated filer or large
accelerated filer under SEC rules) \152\ during the reporting period.
The Board also proposed that engagement-level reporting would be
required for every audit of such an accelerated or large accelerated
filer.
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\152\ See Exchange Act Rule 12b-2, 17 CFR 240.12b-2. Generally,
under Rule 12b-2, a large accelerated filer is an issuer that meets
certain reporting conditions and has a public float (aggregate
worldwide market value of voting and non-voting common equity held
by nonaffiliates) of $700 million or more. An accelerated filer is
generally an issuer that meets the same reporting conditions; has a
public float of $75 million or more, but less than $700 million; and
had revenue of $100 million or more in the most recent fiscal year
for which audited financial statements are available.
---------------------------------------------------------------------------

The Board believes the proposed threshold would focus the reporting
requirements on the firms and engagements in which investors and other
stakeholders have the greatest interest in additional information, and
that establishing the same threshold for firm- and engagement-level
reporting would foster comparability across both issuers and firms and
provide richer context for the evaluation of engagement-level
information. The proposal also contemplated that firms that were not
subject to the reporting requirements could choose to report
voluntarily.
This approach excludes engagement-level information about audits of
non-issuers, including broker-dealers, and of issuers that are not
accelerated filers or large accelerated filers under SEC rules. These
include, for example, investment companies; \153\ employee stock
purchase, savings, and similar plans that are required to file reports
with the SEC on Form 11-K; \154\ and many smaller reporting
companies.\155\ It also excludes firm-level information about firms
whose PCAOB practice was limited to such audits.\156\
---------------------------------------------------------------------------

\153\ Section 3(a)(1) of the Investment Company Act of 1940, 15
U.S.C. 80a-3(a)(1), defines an ``investment company'' as an issuer
which (A) is or holds itself out as being engaged primarily, or
proposes to engage primarily, in the business of investing,
reinvesting, or trading in securities; (B) is engaged or proposes to
engage in the business of issuing face-amount certificates of the
installment type, or has been engaged in such business and has any
such certificate outstanding; or (C) is engaged or proposes to
engage in the business of investing, reinvesting, owning, holding,
or trading in securities, and owns or proposes to acquire investment
securities having a value exceeding 40 per centum of the value of
such issuer's total assets (exclusive of Government securities and
cash items) on an unconsolidated basis. Audits of business
development companies (BDCs) that met the criteria to be an
accelerated filer or large accelerated filer would be included.
\154\ See Exchange Act Rule 15d-21, 17 CFR 240.15d-21.
\155\ See Regulation S-K, Item 10(f)(1), 17 CFR 229.10(f)(1).
\156\ Firms that do themselves not serve as lead auditor for an
accelerated filer or large accelerated filer but play a substantial
role in audits led by other firms would also not be subject to the
proposed reporting requirements. See PCAOB Rule 1001(p)(ii) for the
definition of ``play a substantial role in the preparation or
furnishing of an audit report.''
---------------------------------------------------------------------------

i. Firm- and Engagement-Level Reporting Thresholds
The Board solicited comment on whether the proposed reporting
thresholds for firm- and engagement-level were appropriate. Investors
and investor-related groups generally supported the proposed thresholds
for both firm- and engagement-level reporting. They agreed that the
proposed requirements would appropriately apply to the audits, and
auditors, of companies that account for the majority of the U.S. public
company market capitalization, and would capture the situations where
investment and proxy voting decisions would be most likely to benefit
from additional information about the audit and auditor. One firm-
related group broadly agreed with the thresholds for both firm- and
engagement-level reporting because it believes different reporting
requirements are not warranted. Another firm-related group also agreed
with the proposed reporting thresholds as appropriately targeting the
largest companies having a significant impact on the market
capitalization of issuers. Two commenters recommended extending the
reporting requirements to all PCAOB-registered firms, either
immediately or over time.
On the other hand, all firms and a firm-related group that
commented on the firm-level reporting threshold objected to it,
generally suggesting instead that firm-level reporting should be
required of firms that are annually inspected by the PCAOB, with some
recommending voluntary reporting by smaller firms. One commenter
suggested reporting only for annually inspected firms that audit at
least one accelerated filer or large accelerated filer. Another
commenter recommended that firm-level reporting should be required only
of firms with 25 or more large accelerated and accelerated filer
engagements, saying that firms with a small number of large accelerated
and accelerated filer engagements would not produce meaningful metrics
with sufficient anonymity as their metrics can be unduly influenced by
a single engagement. Some of these commenters asserted that requiring
reporting only from annually-inspected firms would balance scalability
concerns with the need for investor protection, as it would still
capture a large majority of the U.S. public company market
capitalization. One commenter stated that the issuer portfolio at firms
with less than 100 issuers is not sufficiently like those firms
inspected by the PCAOB annually to provide valuable comparisons and
another commenter expressed concern about issuers that frequently move
above or below the accelerated or large accelerated filer
thresholds.\157\ One commenter added that there is precedent to use an
alternative threshold based on firms that issue audit reports for more
than 100 issuers, such as PCAOB's annual inspection and QC 1000.18
requirements.
---------------------------------------------------------------------------

\157\ Based on the PCAOB staff's analysis performed on the data
obtained from Audit Analytics, Standard & Poor's, and publicly
available data from the RASR, available at https://rasr.pcaobus.org.
In the four-year period ended September 30, 2022, on average,
approximately 4% of filers that reported on Form 10-K and Form 20-F
and had not previously self-identified as either a large accelerated
filer or accelerated filer newly self-identified as either a large
accelerated or accelerated filer each year.
---------------------------------------------------------------------------

Several commenters also raised concerns about the cost of metrics
reporting and stated that requiring reporting only from annually-
inspected firms will better support the cost to comply with the
proposed requirements and alleviate related unintended consequences,
particularly greatly reducing the burden for smaller firms and firms in
foreign jurisdictions.
Another commenter supported requiring reporting only from annually-
inspected firms because it would alleviate concerns about privacy and
confidentiality, particularly for firms

[[Page 100012]]

outside the United States that issue a limited number of large
accelerated or accelerated filer auditor reports annually and are
subject to laws and regulations in those areas, because firm-level
metrics may effectively result in the disclosure of engagement-level
information. They further noted that such a threshold may avoid
redundant reporting burdens for these firms and disclosure of
confidential information of specific issuers, but still achieve the
objectives of reporting firm level metrics as ``firm-level reporting
would consist only of summary data'' as proposed.
For the engagement-level reporting threshold, because firms
objected to any public reporting of engagement-level metrics, most
firms did not comment further on the threshold for engagement-level
reporting except for offering some other suggestions. See below for
other comments received.
The Board adopted the thresholds for both firm-level and
engagement-level reporting with one change. Firm-level reporting will
be required of every firm that audits at least one company that has
self-identified as an ``accelerated filer'' or ``large accelerated
filer'' by checking the box on an SEC filing during the reporting
period. Engagement-level reporting will be required for every audit of
such an accelerated or large accelerated filer.
The final threshold does not refer to Form 40-F filers that meet
the definition of ``accelerated filer'' or ``large accelerated filer''
under SEC rules, which were included in the proposal, based on the
Board's understanding that such companies are not regarded as
accelerated filers or large accelerated filers. Companies that file
both Form 40-F and another SEC annual reporting form, and that check
the box to self-identify as an accelerated filer or large accelerated
filer on that other form, will still be included.
The Board continues to believe that requiring reporting for
auditors and audits of large accelerated filers and accelerated filers
is the most appropriate approach. As stated in the proposal, the Board
estimated that the firm-level reporting requirements will apply to
approximately 210 firms,\158\ including 22 of the top 25 U.S. firms by
total firm revenue,\159\ and all of the 2022 PCAOB annually inspected
firms that continue to audit issuers,\160\ and that the proposed
engagement-level reporting requirements would apply to approximately
3,400 issuer audits, representing 99% of the total market
capitalization of issuers reporting on Form 10-K and Form 20-F.\161\
---------------------------------------------------------------------------

\158\ The data was obtained from Audit Analytics, Standard &
Poor's, and publicly available data from the RASR, available at
https://rasr.pcaobus.org. Firms that issued audit opinions for
issuers that met the large accelerated or accelerated filer
definition in the 12 months ended September 30, 2023, were included
in this number. Large accelerated filer or accelerated filer status
was based on the most recently filed quarterly or annual report as
of February 10, 2024.
\159\ See Accounting Today, 2024 Top 100 Firms + Accounting's
Regional Leaders (March 2024), for a listing of the top 25 U.S.
Firms. Based on staff analysis, the three firms in the top 25 firms
that would be excluded from the reporting requirements are Aprio,
LLP; Carr, Riggs & Ingram LLC; and Citrin Cooperman & Company, LLP.
\160\ See the 14 firms listed as 2022 Annually Inspected Firms,
available at https://pcaobus.org//inspections/basics-of-inspections.
B F Borgers CPA PC was removed for the purpose of this analysis as
its registration withdrawal is currently pending.
\161\ The data was obtained from Audit Analytics, Standard &
Poor's, and publicly available data from the RASR, available at
https://rasr.pcaobus.org. Large accelerated filers and accelerated
filers were included in this number. Large accelerated filer or
accelerated filer status was based on the most recent quarterly or
annual filing as of February 10, 2024. Market capitalization was
calculated as of December 31, 2023. Because in some instances
multiple audit reports were issued in the same year, the total
number of audit reports issued during the same time period using the
same data source would be approximately 3,500.
---------------------------------------------------------------------------

The Board analyzed the other reporting thresholds suggested by
commenters based on the same data. Coverage would be significantly
reduced if the Board required reporting only from annually inspected
firms: 13 firms,\162\ including 12 of the top 25 U.S. firms by total
revenue compared to 22 firms.\163\ Similarly, if only annually
inspected firms were required to provide engagement-level reporting, it
would apply to approximately 2,700 issuer audits, representing 83% of
the total market capitalization of issuers reporting on Form 10-K and
Form 20-F. If only firms with 25 or more large accelerated or
accelerated filers were required to report, then firm-level reporting
would apply to 11 firms, including 9 of the top 25 U.S. firms by total
revenue, and engagement-level reporting would apply to approximately
2,800 issuer audits, representing 84% of the total market
capitalization of issuers reporting on Form 10-K and Form 20-F.
---------------------------------------------------------------------------

\162\ From the 14 firms listed as 2022 Annually Inspected Firms
as described above, B F Borgers CPA PC was removed for the purpose
of this analysis as its registration withdrawal is currently
pending.
\163\ See Accounting Today, 2024 Top 100 Firms + Accounting's
Regional Leaders (March 2024), for a listing of the top 25 Firms.
Based on staff analysis, two annually inspected firms (B F Borgers
CPA PC and Cohen & Company, Ltd.) were not included in the top 25
firms.
---------------------------------------------------------------------------

In addition to the significant coverage decreases, limiting metrics
reporting to annually inspected firms would exclude non-US firms that
audit a small number of non-US based issuers with substantial market
capitalizations. If the Board ranks firms based on the market
capitalization of the issuers they audit, the top 30 firms audited 94%
of the total market capitalization of accelerated filer and large
accelerated filer issuers. However, only five of these top 30 firms are
annually inspected. The remaining 25 firms are all non-U.S., and all
but one of them audited large accelerated filers averaging at least $10
billion in market capitalization. Similarly, limiting metrics reporting
to firms with 25 or more large accelerated or accelerated filers would
result in only six of the top 30 firms (ranked based on the total
market capitalization of the issuers firms audit) reporting the
metrics, and would exclude most non-U.S. firms that audit non-U.S.
based issuers with substantial market capitalizations.
The Board considered applying the reporting requirements to all
registered firms, as one commenter suggested. However, the Board
continues to believe that investors and other stakeholders have the
greatest interest in additional information regarding large accelerated
and accelerated filers and the firms that audit them, and the comments
supporting the proposal that the Board received from investors and
investor-related groups tend to confirm that view. For that reason, the
Board believes that requiring metrics reporting for all registered
firms could impose costs that are not justified in light of the
anticipated benefits.
Regarding the concerns of privacy or possibly disclosing
confidential or otherwise protected information, particularly for firms
outside the United States, the Board is not aware of any specific
issues and no commenter identified any particular requirements that
would conflict with the disclosure of the metrics the Board adopted.
See below for further discussion of privacy and confidentiality issues.
ii. Other Commenter Feedback
The Board solicited comment on whether smaller firms should have
different reporting requirements than larger firms. In addition to
comments described above, several commenters recommended having
different reporting requirements for smaller firms than for larger
firms.
In addition, two firms requested clarification or application
guidance regarding the treatment of issuers that change filer status
into an accelerated or large accelerated filer during the reporting
period. These commenters recommended allowing these issuers to have one
full year of implementation

[[Page 100013]]

period after the changes in filer status. The Board notes that firm-
level reporting will be required of all firms that issued an audit
report for at least one large accelerated filer or accelerated filer
during the reporting period, and that engagement-level reporting will
be required in connection with each audit report issued for a large
accelerated filer or accelerated filer. Accordingly, the relevant date
to determine large accelerated filer or accelerated filer status will
be the date the audit report is issued. Because SEC requirements
regarding becoming a large accelerated filer or accelerated filer
include at least six months lag time,\164\ the Board does not believe
that an additional transition period would be necessary under the
Board's rules.
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\164\ Under the SEC definitions of ``large accelerated filer''
and ``accelerated filer,'' the determination that an issuer has
become a large accelerated filer or accelerated filer is generally
based on the public float as of the end of the issuer's second
fiscal quarter, to take effect as of the end of the fiscal year. See
Exchange Act Rule 12b-2(3), 17 CFR 240.12b-2(3). The Board notes
that issuers that are eligible to use the requirements for smaller
reporting companies under the revenue test in paragraph (2) or
(3)(iii)(B) of the SEC's ``smaller reporting company'' definition
could cease to be accelerated filers based on a determination made
at or after the fiscal year end. However, since metrics requirements
would not apply in such a case, the Board does not believe any
transition period is necessary.
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The Board solicited comment on whether the Board should require
engagement-level metrics for audits of investment companies (other than
BDCs that are accelerated filers or large accelerated filers) or non-
accelerated filers. Several commenters supported excluding one or more
categories of such entities from metrics reporting because the proposed
metrics would be less likely to assist in investment and voting
decisions. On the other hand, one commenter recommended including
publicly traded ``closed end'' investment companies, registered open
end investment companies, and broker-dealers that are publicly traded
on the basis that some mutual fund investors ratify the appointment of
the auditor and audit committees presumably approve for the auditor for
these companies.
As proposed, the Board is not requiring engagement-level reporting
on these investment companies and non-accelerated filers. For audits of
investment companies, the Board continues to believe that the arguments
underpinning requests for additional information about audits and
auditors will not apply, or apply with the same force, in these
situations, where shareholder ratification of the appointment of the
auditor may not be typical and the metrics would be less likely to
assist in investment and voting decisions. Regarding the reporting of
non-accelerated filers, as discussed above, these issuers have
significantly smaller market capitalization per issuer on average, and
the Board is concerned that the benefits associated with such reporting
would not justify the costs.
2. Reporting of Firm-Level Metrics (Form FM)
The Board proposed that firms report their firm-level metrics
annually on a new Form FM, Firm Metrics. Of those commenters that
support reporting firm-level metrics, some also explicitly expressed
support for reporting annually on Form FM. One commenter recommended
that Form FM be amended to explicitly include the definitions of the
metrics and metric formulas to provide pertinent information to enhance
the context and understandability for users.
The proposal asked whether, rather than reporting on Form FM, firms
should report firm-level metrics, as of March 31 on Form 2, which is
due on June 30. One commenter stated that the firm-level metrics could
be reported on Form 2 to simplify the reporting for firms and
consolidate the information. One commenter did not support reporting
firm-level metrics on Form 2 stating that between issuer filings
through March 31 and the performance of procedures on the first quarter
filings through May, firms are exceptionally busy through the middle of
May each calendar year. Another commenter questioned whether the
information, being reported only annually, would be too old to assist
decision-making.
Taking into account commenter feedback, the Board continues to
believe that reporting firm-level metrics publicly on a new Form FM
filed by November 30 will provide investors and other stakeholders with
timely and useful information about auditors and will provide a basis
of comparison for the engagement-level metrics, where applicable. The
Board does not believe that Form 2 would be the appropriate place to
report the firm-level metrics because the due date of Form 2, June 30,
falls after the general timing of shareholder meetings (typically April
through June for issuers with a calendar fiscal year) and this
information would generally arrive too late to be considered in
deciding how to vote on ratification of the appointment of the auditor.
The Board believes audit committees would also benefit from having this
information earlier, since it could be useful when determining whether
to reappoint the auditor.\165\ While firm metrics would be reported
only once a year, the Board believes that the information they convey
would still be useful, both to investors (who otherwise have access to
extremely limited information about the auditor) and to audit
committees (who may benefit from standardized firm-wide information
that helps put their engagement in context).
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\165\ See Letter from Center for Audit Quality (Aug. 1, 2024) at
3 (``The majority [59%] of audit committee members surveyed agree
some standard information about auditors should be considered when
making their selection and performing their oversight
responsibilities'').
---------------------------------------------------------------------------

The information disclosed on Form FM will be available in a
searchable database on the Board's website, similar to the Form AP
database. As noted above, in addition to the required firm-level
metrics, firms will have the option to provide a brief narrative to
accompany each metric. In response to the commenter that emphasized the
importance of including all definitions and metric formulas in Form FM,
the Board has expanded Part III of Form FM, Terminology, to include all
of the definitions used in the metrics, not just those used in multiple
metrics. As proposed, the formula for each required metric is included
in Part IV, Metric Calculations, Reporting and Discussion of Form FM.
The proposal provided that the reporting period for Form FM would
generally be the 12-month period ended September 30 in each year \166\
and filed on or before November 30, 61 days after the end of the
reporting period.
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\166\ Exceptions to the proposed reporting period of firm-level
metrics reported on Form FM included the proposed metrics for
Quality Performance Ratings and Compensation and Audit Firms'
Internal Monitoring. The proposal stated that ``[these] proposed
firm-level metrics relate to activities for which firms may already
have defined periods or cycles that may not align with [the Board's]
proposed reporting date. In these cases, [the Board] proposes that
the time period covered by the metrics may be tailored to a firm's
existing processes and procedures.'' Neither of these metrics are
included in the metrics the Board adopted. However, the Board
adopted a metric related to the Training Hours for Audit Personnel
metric which will permit firms to use an already-established
training calendar cycle for calculation and reporting of this
metric, which may not align with the Form FM reporting period.
---------------------------------------------------------------------------

Some commenters expressed support for the proposed reporting period
ending on September 30. One of these commenters also suggested that
consideration be given to allowing firms to pick a reporting period
based on their firm's cycles. A few commenters expressed concern with
the reporting date of September 30 and instead suggested firms be
permitted to choose their own timing for Form FM. These commenters
expressed the following views:

[[Page 100014]]

The reporting date for firm-level metrics should not
matter to investors, therefore the PCAOB should consider firm input as
to the date that best aligns with their internal processes.
Concern about the amount of work firms will be required to
do on this new form along with the QC 1000 requirements and the
relationship with information reported on Form 2 on a different time
period. This commenter suggested that the Board should undertake a
comprehensive review of all reporting requirements, systems, reporting,
and dates.
Concern that small- and mid-sized firms will be
particularly burdened with having to evaluate the quality control
system under the newly adopted quality control standard, support the
annual inspection, and assemble data for reporting in Form FM all at
the same time.
The Board does not believe that permitting firms to choose their
own timing for Form FM would ultimately serve the users of the metrics,
because of the enhanced comparability that a common measurement date
and measurement period provide. In particular, audit committees, who
may seek to consider comparative metrics when determining which audit
firm to appoint, would not be served by using potentially outdated or
non-comparable data from a firm. The proposed reporting date aligns
with the date the firm is required to evaluate its QC system under QC
1000, which was adopted by the Board and approved by the SEC on
September 9, 2024. While the Board understands that this date will
cause some firms to have additional PCAOB reporting responsibilities
simultaneously, the Board continues to believe that this timing is
preferable since it is prior to the calendar year end and the
traditional busy period for many firms, which the Board believes would
reduce potential resource or time constraints and further benefit
firms.
Two commenters supported the proposed November 30 due date of Form
FM. One commenter, who supported the proposed November 30 due date,
specifically found it helpful that the date aligned with QC 1000. Some
firms expressed concern that the proposed due date would create
challenges going forward for firms to support their annual inspections,
evaluate the quality control system, and assemble data for reporting in
Form FM all at the same time. One commenter suggested that the due date
for Form FM should be three months from the end of the reporting
period, or December 31. Another commenter expressed concern that a 61-
day period may not be sufficient to allow firms to accurately and
completely collect, assemble, and report the metrics and instead
suggested that firms should be permitted to choose their own filing
date. One commenter, who supported the proposed reporting date of
September 30, suggested the PCAOB consider a longer period of time in
which to submit Form FM in the initial years after the effective date.
The Board believes the 61-day period will provide sufficient time
for firms to accumulate data and calculate the metrics and report to
the PCAOB. In addition, as discussed above, the Board has reduced the
scope of the following metric areas in particular: (i) Partner and
Manager Involvement, Workload, and Allocation of Audit Hours, to
include only large accelerated filer and accelerated filer engagements;
and (ii) Industry Experience, to limit the reporting to those firms
that issued five or more audit reports for accelerated filers and large
accelerated filers, combined, during the reporting period. All of these
changes should further reduce the reporting effort and help to address
commenter concerns. A benefit of aligning the Form FM reporting period
and filing deadline with QC 1000 is that some firms, if they choose,
could also use these metrics in their monitoring and remediation
process as part of the QC system, enabling the firm to use comparable
information underlying both reporting obligations for Form QC and Form
FM. Under the final rules, as proposed, reporting on Form FM is due on
or before November 30, 61 days after the end of the reporting period.
In addition, see discussion of the effective date below.
Form FM was adopted with the following modifications:
Making conforming revisions to reflect the changes to
metrics discussed above.
Related to the optional narrative, (i) expanding the
character limit to 1,000 characters and (ii) adding additional
instructions for firms that elect to provide the optional narrative
(discussed above).
Rearranging instructional language within the form and
expanding Part III of Form FM to include all terminology used in the
metrics (discussed above).
Removing references to 40-F filers (see above).
Together with new Form FM, the Board also proposed a new reporting
rule, PCAOB Rule 2203C, which did not draw comment and was adopted
substantially as proposed, and making conforming changes to Rules 2205
and 2206. The text of PCAOB Rule 2203C; Form FM, together with the form
instructions; and the conforming amendments are included below.
3. Reporting of Engagement-Level Metrics (Form AP)
The Board proposed to require firms to report engagement-level
metrics on Form AP, along with the already required disclosure of the
name of the engagement partner and information about other firms
involved in the audit.\167\ The Board believes that Form AP provides an
established mechanism for conveying engagement-level information that
is familiar to investors and other stakeholders.\168\ Reporting on Form
AP will allow access to the engagement-level metrics in a centralized
location and will allow for the dissemination of the metrics through
already established data channels. Form AP is also downloadable, which
will provide users of the information the ability to perform
comparisons across engagements, including analyses of the entire Form
AP data set.
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\167\ See PCAOB Rule 3211. PCAOB Rule 3211 requires the filing
of a report on Form AP regarding an audit report the first time the
audit report is included in a document filed with the SEC. In the
event of any change to the audit report, including any change in the
dating of the report, PCAOB Rule 3211 requires the filing of a new
Form AP the first time the revised audit report is included in a
document filed with the SEC. If the auditor's report is reissued and
dual-dated, the firm is required to file a new Form AP that would
reflect the most updated information of the proposed engagement-
level metrics (e.g., total audit hours as of the latest audit report
date based on the cumulative total audit hours). For most audits,
Form AP is due within 35 days after an audit report is first
included in an issuer SEC filing. The entire Form AP data set
(updated daily) and data dictionary are available to download in CSV
format under the section, ``Download the entire data set,'' at
https://pcaobus.org/resources/auditorsearch.
\168\ Information related to usage statistics can be found on
the PCAOB's website (https://.org//auditorsearch).
---------------------------------------------------------------------------

The Board proposed adding a new section to Form AP for firms to
report the required metrics. As noted above, in addition to the
specific engagement-level metrics, the Board proposed that the firm
would be able to provide an optional narrative description to accompany
each metric. As proposed, the firm would have been able to provide up
to 500 characters as part of their narrative description to provide
context to facilitate the reader's understanding of the metric. To
reflect Form AP's broader content, the Board also proposed to rename it
``Audit Participants and Metrics.'' The text of the Form AP amendments
and the form instructions are included below.
Commenters who supported public reporting of engagement-level
metrics generally agreed with reporting on Form AP. However, several
commenters

[[Page 100015]]

disagreed with public reporting of engagement-level metrics. The Board
has addressed these comments above. One commenter suggested that the
reporting date should be changed to November to align to the audit
committee's considerations of reapproving a firm and when considering
the following year's audit plan. Additionally, one commenter voiced
their concern that there is mixed evidence on the influence of Form AP
disclosures on decision-making.
The Board adopted the requirement as set forth in the proposal to
report engagement-level metrics on Form AP and rename the form Audit
Participants and Metrics. Correspondingly, the Board has retitled PCAOB
Rule 3211 as Audit Participants and Metrics and made a conforming
amendment to AS 3101.20. The Board made certain amendments to the
requirements for reporting on Form AP as follows:
Conforming revisions to reflect the changes to include the
metrics discussed above.
Related to the optional narrative, (i) expanding the
character limit to 1,000 characters and (ii) adding additional
instructions for firms that elect to provide the optional narrative.
Form AP's deadline of 35 days after the issuance of the auditor's
report already takes into account the timing of the proxy vote for most
issuers.
4. Amendments to Form FM and Form AP
As is required for other PCAOB forms, the Board proposed that firms
be required to amend Form FM or Form AP to correct inaccurate
information or provide omitted information that should have been
included.\169\
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\169\ The requirements for amendment of Form FM are similar to
those that apply to Form 2. See https://pcaobus.org/about/rules-rulemaking/rules/form_2; see also, e.g., Staff Questions and Answers
Annual Reporting on Form 2, at Q34, available at https://assets.pcaobus.org/pcaob-dev/docs/default-source/registration/rasr/documents/staff_qa-annual_reporting.pdf?sfvrsn=5e7259ff_0.
---------------------------------------------------------------------------

Some commenters requested that the Board consider adopting some
level of materiality or de minimis threshold for the proposed metrics
reporting and specifically address how firms should consider whether to
amend their reporting when differences arise. These commenters
expressed the following views:
Although a materiality concept, on its own, will not
eliminate the challenges currently identified and those that are
unknown, it may help reduce confusion to investors and other
stakeholders resulting from the need to report amendments caused by
immaterial changes in estimates and unintentional errors and to help
avoid unnecessary penalties for materially correct reporting.
The risk of enforcement for minor, unintentional errors in
reporting may also play a role in public accounting firms' decision to
cease auditing public companies.
Guidance would be essential for implementing any final
standard effectively to balance the costs of compiling and reporting
the information and this guidance should extend to the evaluation of
differences that may arise in the disclosure of participating firms on
Form AP.
The proposal should be amended for the application of
materiality thresholds based on reasonable assurance.
The Board should consider revisions to PCAOB Rule 3211 to
add materiality thresholds based on reasonable assurance and clarify
whether the current guidance regarding amendments would extend to all
metrics as well as how routine corrections and re-allocations of time
entries and other matters affecting metrics reported on Forms FM are
expected to be handled.
If the PCAOB does not adopt a materiality threshold for
Form FM, firms may need to consider which controls need to operate at a
level of absolute assurance, which the firm stated would add
significant effort and cost.
The final rule should include a safe harbor for reporting
that includes unintentional and immaterial deviations from an otherwise
accurate reflection of a metric.
The amendments should include a mechanism for revisions
and a statute of limitations, such as reporting of time, should be
included in the final rule. The Board believes that the reference to
statute of limitations is intended to request a specified period after
filing beyond which no amendments would be required for corrections.
One investor-related group indicated that they would not object if
the PCAOB established a de minimis threshold for unintentional
inaccuracy in reporting metrics. Another commenter recommended that the
PCAOB establish a de minimis threshold for unintentional inaccuracy
that applies to all firm reporting, not just in relation to the
proposal.
The Board did not adopt a materiality or de minimis threshold in
connection with the obligation to amend forms to correct information
that was incorrect at the time the report was filed or to provide
information that was omitted from the report and was required to be
provided at the time the report was filed. Historically, the Board has
not established, and has not found necessary, materiality or de minimis
thresholds in connection with form amendments. As a commenter
acknowledged, a materiality or de minimis threshold will not
necessarily eliminate challenges commenters have identified or those
that have yet to be identified in connection with potential
corrections. Indeed, the Board believes that implementing a materiality
or de minimis threshold would introduce unnecessary complexity and
uncertainty to the form amendment process and, further, would
potentially threaten, or be perceived to threaten, the accuracy and
reliability of reported information, thereby undermining the intended
purpose of the amendments.
Similarly, the Board has not historically provided, or believed
necessary, a safe harbor provision for unintentional errors and such a
provision would potentially compromise the accuracy and reliability of
reported information. Likewise, the Board has not historically
provided, or believed necessary, a ``statute of limitations'' to limit
the time period for which amendments would be necessary, and such a
provision could potentially compromise the value of the forms in
conducting historical research. In the inspection and enforcement
context, the Board can exercise its discretion on a case-by-case basis.
Consistent with existing Form AP guidance, no amendments to Form FM
or Form AP would be needed solely to reflect changes in the metrics
that would result from differences between reasonably estimated data
and actual data, in the event such information becomes available after
the filing deadlines of the forms. As discussed above, in calculating
both firm- and engagement-level metrics, actual data is required to be
used, if available. If actual data is unavailable, firms may use a
reasonable method to estimate such data. For example, if a firm used a
reasonable method to estimate hours worked by partners and managers at
the end of a reporting period, and those partners and managers
subsequently submit timesheets for that period that include additional
hours worked above the estimate used by the firm on Form FM or Form AP,
the firm would not be expected to file an amended report for any
deviations.
At present, the Board believes applying the existing Form AP
guidance is appropriate and sufficient for the final rules. The Board
will monitor for issues connected to form amendments and

[[Page 100016]]

consider updates to implementation guidance as appropriate. Addressing
issues as they arise through implementation guidance--as opposed to
establishing a materiality or de minimis threshold in the adopting
release or through a rule amendment--will help ensure that any guidance
is informed by, and better tailored to, issues raised by experience
under the final rules rather than speculative concerns. The Board
believes monitoring for the need for guidance is a better solution than
implementing a materiality or de minimis threshold in the adopting
release or through rule amendment.
Lastly, regarding the comment that the amendments should include a
``mechanism for revisions,'' the Board is not aware of any deficiencies
in the current mechanism for amending forms and believes it suffices.
5. Inclusion of Metrics in the Audit Report
In addition to the proposed reporting on Form FM and Form AP, the
Board solicited comment on whether some or all of the firm-level and
engagement-level metrics, together with any additional narrative that
the firm may choose to provide, should also be included in the audit
reports the firm issues for audits of large accelerated filers and
accelerated filers. While some commenters supported inclusion of the
metrics in the audit report, many commenters disagreed with this
approach citing that, for example, it could potentially detract from
the clarity and purpose of the report, could result in delays in the
issuance of audit reports, and amendments to the audit report for
corrections to metrics could create unnecessary burden for issuers and
confusion for investors.
Taking into account commenter feedback, including both the
potential benefits and unintended consequences, the Board did not
require inclusion of the metrics in the audit report at this time.
6. Confidential Treatment and Conflicts With Non-U.S. Law
i. Requests for Confidential Treatment Not Permitted
The primary objective of the Board's rulemaking is to enhance
public transparency regarding audits and auditors, which inherently
involves the disclosure of new information. The Board did not propose
to allow firms to request confidential treatment for the proposed
metrics but requested comment on this approach and specifically
requested that commenters identify any laws that realistically might
prevent a firm from disclosing the information required by the metrics.
In response, firms and firm-related groups expressed general concern
about the potential for conflicts or focused on the proposed disclosure
of engagement-level metrics, such as hours worked per week on an
engagement, engagement team tenure, and experience by industry, and the
percentage of hours contributed by specialists and shared service
centers. However, the Board disagrees with the assertion that all
previously undisclosed information should be considered sensitive by
default. The information called for by the metrics does not pertain to
proprietary methodologies or operational strategies that could give
competitive advantages if disclosed. Rather, the information called for
is descriptive of the audit process itself. The Board believes that
general claims of sensitivity, absent specific legal prohibitions or
clear practical ramifications, are not sufficient to outweigh the
benefits of increased transparency. The Board's rulemaking is guided by
the goal of deepening the public's understanding of audit practices in
audits of issuers, consistent with the Board's statutory
responsibilities.
Some firms and firm-related groups raised concerns regarding the
potential antitrust implications of disclosing detailed metrics about
engagement staffing and workload allocations. One of these commenters
referenced the Supreme Court's ruling in United States v. Container
Corporation of America,\170\ which highlights the competitive risks
associated with the exchange of confidential information among
competitors, particularly in concentrated industries. However, it is
important to distinguish between the exchange of information directly
among competitors--which may indeed raise antitrust issues--and this
rulemaking's mandate for public disclosure. The information that the
PCAOB is requiring firms to disclose is not shared privately among
competing firms but is made publicly available to all stakeholders,
including investors, audit committees, and the general public. This
type of disclosure is fundamentally different from the scenarios
associated with anti-competitive behavior under antitrust laws.\171\ In
light of these factors, the Board believes the metrics do not
contravene the antitrust laws, and the public benefit of these
disclosures outweighs any theoretical competitive risks suggested by
the commenters.
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\170\ 393 U.S. 333 (1969).
\171\ The purpose of these disclosures is to enhance
transparency and accountability in the audits of issuers, allowing
investors and other stakeholders to make informed decisions and hold
auditors accountable. This aligns with the Board's statutory mission
to protect investors and the public interest, rather than to
facilitate or enable competitive positioning among firms.
Furthermore, the disclosure of such information by a regulatory
authority for the purposes of transparency and accountability does
not fall under the purview of antitrust concerns, as it does not
facilitate collusion or the sharing of competitively secret
information in a manner that would distort market dynamics. Instead,
it ensures that all market participants and stakeholders have access
to the same information.
---------------------------------------------------------------------------

Two commenters raised concerns regarding Section 105(b)(5) of
Sarbanes-Oxley, which protects information prepared or received by or
specifically for the Board in connection with a PCAOB inspection or
investigation. It is important to note that Section 105(b)(5)
specifically protects only information that is prepared or received by
or specifically for the Board in connection with a PCAOB inspection or
investigation. The metrics the Board has required, however, are not
prepared or received under such confidential circumstances. These
metrics are intended for public disclosure to enhance transparency
across the audits of issuers and to provide stakeholders--including
investors, audit committees, and the general public--with important
insights into audit practices. Therefore, requiring the public
disclosure of these metrics does not violate the provisions of Section
105(b)(5).
Additionally, one firm and a firm-related group raised concerns
regarding the AICPA Code of Professional Conduct,\172\ which provides
that a member in public practice shall not disclose confidential client
information without the specific consent of the client. It is important
to differentiate the information required by the metrics from the
client-specific confidential information covered under the AICPA Code.
The metrics require information such as workload data, staffing
allocations, and experience levels of personnel involved in audits of
issuers. This information does not include confidential client
information or specific details about client engagements that would be
protected under the AICPA Code. Instead, it focuses on the operational
aspects of registered firms and the audits they perform that are
important for the public to understand and assess the audits of
issuers. The objective of this rulemaking is to enhance transparency
and accountability within the audits of

[[Page 100017]]

issuers, and the information required by the metrics supports this goal
without requiring auditors to breach their confidentiality obligations
to clients.\173\
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\172\ See, e.g., AICPA Code of Professional Conduct 1.700.001
(``A member in public practice shall not disclose any confidential
client information without the specific consent of the client'').
\173\ Similarly, some firms raised concerns about optional
narrative disclosures, particularly regarding the need to maintain
client confidentiality and protect commercially sensitive
information. The Board has carefully designed the required metrics
to avoid such issues. The Board expects firms to tailor their
optional narrative responses in a similar manner, should they choose
to provide them. This will enable firms to meet the transparency
objectives of Forms FM and AP without compromising client
confidentiality or disclosing sensitive commercial information.
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Finally, although some firms raised generalized concerns about
potential conflicts with foreign laws, they did not provide specific
examples that would justify prohibiting the public disclosure of the
information in the metrics or warranting its confidential treatment. As
discussed more fully below, the Board does not believe that any law,
whether foreign or domestic, provides a reasonable basis for
withholding the information in the metrics from public disclosure.
As such, the Board did not permit firms to request confidential
treatment for the metrics. This approach is consistent with the Board's
belief that these metrics will provide valuable additional information,
context, and perspective on audit firms and audit engagements, which
can be used by investors, audit committees, and other stakeholders.
However, the Board is mindful of the Board's obligation to protect
information that is confidential under applicable laws relating to the
confidentiality of proprietary, personal, or other sensitive
information. To balance these concerns, the final metrics have been
specifically designed to exclude information that could reasonably
qualify for confidential treatment protection, such as personally
identifiable, methodological, or client-specific information.
Additionally, the Board provides firms the option to include a
narrative description with each metric to explain or contextualize the
disclosures, allowing firms to clarify any potentially misleading
information that could be viewed as sensitive.
By adopting this approach, the Board believes that prohibiting
confidential treatment requests on Forms FM and AP will further the
public interest while adhering to the Board's obligation to protect
certain categories of firm information.
In light of the objectives of this rulemaking, the Board decided
not to permit confidential treatment for the metrics required on Forms
FM and AP.
ii. Assertions of Conflicts With Non-U.S. Law
The Board did not propose to allow firms the opportunity to assert
conflicts with non-U.S. laws on either proposed Form FM or Form AP, as
proposed to be amended. The proposal acknowledged that there may be
certain limitations with respect to the data or information about a
firm, its personnel, or the performance of the firm's engagements that
a firm may communicate publicly because it may conflict with a non-U.S.
law, and asked commenters to describe any such laws and the proposed
metrics to which it was realistically foreseeable that they would
apply.
Some commenters disagreed with the proposal not to allow firms to
assert conflicts. One commenter strongly urged the Board to maintain
the well-established rulemaking history that recognizes and respects
non-U.S. firms' distinct legal obligations and preserves the right for
firms to assert a conflict of law. The Board is committed to
cooperation and reasonable accommodation in its oversight of registered
non-U.S. firms, and in the past has generally provided non-U.S. firms
the opportunity to at least preliminarily withhold some information
from its existing forms on the basis of an asserted conflict with non-
U.S. laws. However, the Board has not provided for firms to assert such
a conflict with respect to all information required by those PCAOB
forms. Moreover, the Board notes that the Board has never permitted
such withholding of information for Form AP. In addition, even where
the Board has allowed registered firms to assert legal conflicts in
connection with other forms, that accommodation does not entail a right
for a firm to continue to withhold the information if it is
sufficiently important.\174\
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\174\ See Improving the Transparency of Audits: Rules to Require
Disclosure of Certain Audit Participants on a New PCAOB Form and
Related Amendments to Auditing Standards, PCAOB Rel. No. 2015-008 at
37; PCAOB Rel. No. 2008-004 at 37-38 n.38 (``Rule 2207(e) preserves
the Board's authority to obtain information by preserving the
possibility that, in an appropriate case involving sufficiently
important information that is not otherwise forthcoming (e.g.,
through cooperation with non-U.S. regulators), the Board can
ultimately put the firm to the choice of providing the information
or being subject to a sanction for violating the Board's rules.'').
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Other commenters suggested there were potential conflicts between
reporting of the proposed metrics and current laws:
One commenter strongly recommended the Board consult with
others, including the International Forum of Independent Audit
Regulators (IFIAR), to determine whether any law would prohibit a firm
from providing information requested in the proposal and further
diminish comparability (or increase the risk of misuse) of affected
metrics.
A commenter also asserted that there are laws in various
jurisdictions (e.g., France and Switzerland) that could have a
significant impact on cross-border transfer of data and the
comparability of such data.
Other commenters stated that firms with a small number of
relevant issuer engagements, for example, disclosure of certain
engagement-level metrics may lead to breach of confidentiality for
client information, issues with disclosure of commercially sensitive
information (e.g., time spent) or disclosure of personal data in breach
of regulations, and potentially violate laws and regulations within
some non-U.S. jurisdictions. (e.g., General Data Protection Regulation
(``GDPR'')).\175\
---------------------------------------------------------------------------

\175\ See Regulation (EU) 2016/679. The GDPR was passed by the
European Union and became effective on May 25, 2018. The complete
text of the regulation is available at https://eur-lex.europa.eu/eli/reg/2016/679/oj. Section 1 of Article 2 of the GDPR applies to
``processing of personal data wholly or partly by automated means
and to the processing other than by automated means of personal data
which form part of a filing system or are intended to form part of a
filing system.''
---------------------------------------------------------------------------

A commenter stated that based on their understanding from
non-U.S. firms (although the commenter firm itself is not a non-U.S.
firm) some of the proposed new required disclosures go beyond what non-
U.S. regulators require and may lead to violations of local laws
resulting from disclosure of information that non-U.S. auditors are
required to keep confidential under professional secrecy obligations
and/or laws and regulations governing disclosure of personal
information.
Another commenter stated that the proposed expansion of
mandatory disclosures directly increases the likelihood that a non-U.S.
firm may be legally barred from providing the relevant information.
One commenter encouraged the Board to include a specific provision
that acknowledges that any required disclosure by a firm would need to
comply with applicable local laws and regulations, while another stated
that allowing firms to assert conflicts with non-U.S. laws would still
require those firms to obtain legal opinions to support withholding the
information.
One of those commenters stated that information published where
only one engagement is performed will be clearly identifiable to an
individual engagement, which they asserted may breach personal data
requirements

[[Page 100018]]

under legislation such as GDPR. However, neither this commenter nor any
other articulated how any of the required metrics could reveal
information allowing any individual to be directly or indirectly
identified in contravention of GDPR or similar laws.
In considering whether to allow the opportunity to assert
conflicts, the Board considered both whether it is realistically
foreseeable that any law would prohibit providing the required
information and, even if it were realistically foreseeable, whether
allowing a firm preliminarily to withhold the information is consistent
with the Board's broader responsibilities and the particular regulatory
objective.\176\ The comments provided on this subject have not
identified with sufficient specificity a realistically foreseeable
likelihood that a law would prohibit providing the required
information. The concerns that were mentioned were expressed in very
general and hypothetical terms. Moreover, with respect to the
suggestion that the Board consult with IFIAR, the Board notes that
PCAOB staff did advise a number of its non-U.S. counterparts regarding
the proposal with a view to facilitating their participation in the
Board's notice and comment process if they so chose, and none submitted
comment letters.
---------------------------------------------------------------------------

\176\ See PCAOB Rel. No. 2015-008 at 37; PCAOB Rel. No. 2008-004
at 36.
---------------------------------------------------------------------------

In addition, the Board continues to believe that allowing a firm
preliminarily to withhold the required information is inconsistent with
the Board's broader responsibilities and the particular regulatory
objective of this rulemaking, namely public transparency.\177\ This is
the case notwithstanding that firms, as a commenter observed, have to
provide a legal opinion regarding a conflict of law under the Board's
rules relating to asserted conflicts. Accordingly, the Board did not
permit assertions of conflicts for Form AP or Form FM in the final
amendments.\178\
---------------------------------------------------------------------------

\177\ Id.
\178\ If an actual conflict were to materialize, the Board would
have tools to address it. For example, Section 106(c) of Sarbanes-
Oxley authorizes the Board to, subject to the approval of the
Commission, exempt any foreign public accounting firm, or any class
of such firms, from any provision of the rules of the Board.
---------------------------------------------------------------------------

With respect to the commenter suggestion that the Board includes a
specific provision that acknowledges that any required disclosure by a
firm would need to comply with applicable local laws and regulations,
the Board believes such a provision could be construed as tacit
permission to withhold information without complying even with the
existing requirements under the Board's rules related to the assertion
of conflicts. Given that this would be an even more permissive
framework than currently exists for withholding information where
assertions of conflicts are permitted under the Board's rules, the same
analysis applies with more force to this suggestion.
The Board believes its notice and comment process, together with
its oversight experience, sufficiently inform this policy choice.
7. Structure of Metrics Data
Several commenters suggested that data on Form AP and Form FM be
filed using eXtensible Business Reporting Language (``XBRL'') to be
consistent with SEC registrant filings. The Board notes that the data
on Form AP will continue to be downloadable and machine-readable.
However, making a change to require reporting using XBRL would
introduce additional costs for all firms that file Form AP. Therefore,
reporting on Form AP and Form FM will be done using the same platform
as the Board's other reporting forms (currently, the Board's web-based
RASR system which uses XML and, in the future, potentially new means of
information exchanges as the PCAOB continues to modernize its reporting
technology aimed at simplifying and automating data collection,
processing, and interoperability).
Documentation
For firm- and engagement-level metrics, the Board proposed that the
firm would be required to retain documentation in sufficient detail to
enable an experienced auditor, having no previous connection with the
determination of the metrics, to understand the calculations, the data
on which they are based, and the method used to estimate data when
actual amounts were unavailable. This is similar to the ``experienced
auditor'' threshold specified in AS 1215, Audit Documentation.
The Board solicited comment on whether the proposed documentation
requirement was clear and appropriate. One commenter agreed that the
documentation requirement was clear and appropriate, while another
commenter recommended further clarifications. The commenter recommended
explicitly referring to AS 1215 as the commenter believed there were no
explicit documentation requirements within Proposed Rule 2203C and Form
FM instructions related to firm-level metrics.
The Board adopted the proposed documentation requirement as
proposed. The Board described the documentation requirement for Form FM
in General Instruction 7 that the firm should retain documentation in
sufficient detail to enable an experienced auditor, having no previous
connection with the determination of the metrics, to understand the
computations of amounts, the amounts on which they are based, and the
method(s) used to estimate the amounts when actual amounts were
unavailable.\179\ The Board believes this is sufficient to introduce
the concept of ``experienced auditor'' into the documentation
requirement for Form FM, similar to the ``experienced auditor''
threshold specified in AS 1215. Existing Form AP included a similar
documentation requirement and under the amendments to Form AP that the
Board has adopted, this requirement appears in General Instruction 10,
as amended.
---------------------------------------------------------------------------

\179\ Rule 2203C requires that firms file Form FM by following
the instructions on Form FM.
---------------------------------------------------------------------------

Additional Firm and Engagement Metrics Considered
In addition to the firm and engagement metrics the Board adopted,
the Board considered and solicited comment on a number of (i) proposed
metrics included in Section III.B.2 of the proposal and (ii) potential
additional metrics included in Section III.E of the proposal. The Board
determined not to adopt these additional firm and engagement metrics at
this time. The additional metrics are discussed below.
1. Proposed Firm and Engagement Metrics
i. Audit Resources--Use of Auditor's Specialists and Shared Service
Centers
The proposal included metrics relating to the use of auditor's
specialists \180\ and shared service centers (``SSCs''),\181\ which
were intended to

[[Page 100019]]

help users gain a greater understanding of the use of these audit
resources, including the frequency with which firms use specialists and
SSCs on their engagements at the firm level generally and, at the
engagement level, to provide the context required to understand the
extent of the use of auditor's specialists and SSCs on a particular
issuer engagement.
---------------------------------------------------------------------------

\180\ A specialist, as used in this context, includes both
auditor-employed specialists, as defined in AS 1201.C1, and auditor-
engaged specialists, as described in AS 1210.01. Under those
definitions, a specialist is a person possessing special skill or
knowledge in a particular field other than accounting or auditing.
Specialists would generally not include members of the engagement
team whose specialization is in the fields of either IT or income
taxes (tax) because IT and tax are specialized areas of auditing and
accounting. However, if IT or tax specialists are employed or
engaged in a capacity other than specialized auditing and accounting
as part of the issuer engagement, it may be appropriate to include
them as specialists.
\181\ A shared service center is described as an associated
entity of a firm, set up by a network of accounting firms, that,
among other things, supplies those firms with personnel to assist in
the performance of audits, and that is not itself an other
accounting firm. See PCAOB, Staff Guidance: Form AP, Auditor
Reporting of Certain Audit Participants, and Related Voluntary Audit
Report Disclosure Under AS 3101, The Auditor's Report on an Audit of
Financial Statements When the Auditor Expresses an Unqualified
Opinion, (updated July 1, 2024) (``Staff Guidance on Form AP''), at
n. 24, available at https://assets.pcaobus.org/pcaob-dev/docs/default-source/standards/documents/07-01-2024-transparency-implementation-guidance.pdf?sfvrsn=b9753eb_2.
---------------------------------------------------------------------------

At the firm level, the proposal set forth requirements for firms to
provide the percentages of issuer engagements that used auditor's
specialists and shared service centers, respectively. At the engagement
level, the proposal provided that firms would report the percentage of
total audit hours provided by auditor's specialists and by shared
service centers for each audit the firm performed of an accelerated
filer and large accelerated filer.
Commenters on the proposed use of audit resources metrics who
generally opposed the disclosure of the metrics stated that the
information was unlikely to be readily interpretable or useful because
of comparability challenges. In contrast, one commenter found the
proposed descriptions for the resource metrics to be appropriate. Some
commenters who supported these metrics noted that challenges with
comparability might be able to be overcome through use of the proposed
voluntary narrative. Some commenters, who were not generally supportive
of the proposed Audit Resources metrics, suggested that if they were
adopted they should be limited to firms' issuer audit practices.
a. Use of Auditor's Specialists
Some commenters were generally supportive of the firm-level metric
for specialists. One commenter stated it would be supportive of
disclosure of the specialist metrics with modifications to disclose the
percentage of hours incurred by specialists on issuer audit
engagements. Another commenter suggested disaggregating time among
independent specialists, auditor-affiliated specialists, and
management-affiliated specialists, and breaking down the specialist
metrics by industry.
Among the commenters that were not supportive of the specialist
metrics, several concerns were raised including concerns with the
proposed method for calculating auditor-engaged specialists' hours when
actual hours were not available, the lack of visibility to the hours
incurred by specialists, the need to rely on information from other
auditors, challenges with comparability and data collection, and the
overall complexity of the proposed metrics. One commenter suggested
that the engagement-level metric for specialists would be inconsistent
with other Form AP instructions and may be misleading. Some commenters
responded that the amount of specialist involvement on an engagement
and overall at the firm level is highly contextual and the relationship
to audit quality is not one dimensional. One commenter refuted the
objective of providing investors a basis for discussion with management
with respect to the use of specialists, stating that investors almost
never take advantage of the opportunity to ask questions.
Alternative approaches for specialist metrics were also suggested
by commenters. One suggested an alternative approach for engagement-
level specialist metrics such as utilization metrics and qualitative
descriptions, supported by narrative disclosures to provide necessary
context and clarity. This commenter also suggested an alternative firm-
level metric for specialists based on the average percentage of usage
of specialists across all of the firm's engagements, potentially
covering only engagements where specialist hours exceeded a minimum
percentage of total audit hours. Two commenters suggested the Board add
an additional metric disclosing the percentage of audit hours incurred
by specialists on issuer audit engagements (as a percentage of the
total audit hours on issuers). Another commenter also suggested that
using hours worked rather than the number of engagements as the basis
for the calculation would provide more useful information at the firm
level. This commenter also suggested disclosure of the use of
specialists, and their hours on a CAM-by-CAM basis, as well as overall.
Two commenters responded to the question in the Board's proposal
about including thresholds for resource metrics. One stated that
including de minimis amounts would result in implementation challenges.
The second, however, made the opposite argument, stating that including
all specialist and SSC hours in audit resource metrics without a
threshold would ensure that the metric remains straightforward and
inclusive of all relevant contributions and provide a more complete
picture of a firm's audit processes and resource utilization. Most
commenters that responded to the question as to whether resource
metrics should be further disaggregated, e.g., by industry, replied
that this would be overly burdensome without added value. However,
another commented that use of auditor specialists would be more helpful
if broken down by industry.
b. Use of Shared Service Centers
Some commenters were supportive of SSC metrics. One of them stated
that the use of SSCs was growing but not well understood, and that
narrative context would be necessary.
Other commenters raised multiple questions with respect to SSCs.
Several of these were in relation to the definition of an SSC, which
was proposed to be consistent with the definition used in Form AP,
stating that there are many different approaches to the use of other
resources than what is encompassed in that definition, which could lead
to misunderstanding and lack of comparability. One of these commenters
stated that the work of SSCs is dependent on the structure and
resources of each firm and its SSCs and the specific needs of the
individual engagement. Another commenter stated that the definition
proposed a shared service center encompassed only those centers that
are set up by a ``network'' of accounting firms and would not encompass
an outsourcing center set up by a single firm. This commenter suggested
the definition be revised to encompass all services that are not under
the direct supervision of the engagement partner. Some commenters were
concerned that SSC metrics would be misinterpreted as indicating that
greater SSC hours indicated lower quality. Some commenters supported
evaluation of the use of SSCs at the engagement level, but did not
support publicly disclosing this information. Another commenter said
that, given that engagement team members routinely work remotely, there
should not be a difference between that arrangement and SSCs and, as a
result, the metric would not be meaningful. This commenter also stated
that it would not be meaningful to provide an explanation of work
performed at an SSC because it is all ultimately the responsibility of
the audit partner.
The Board has taken commenter input, as well as observations from
PCAOB oversight activities and the relevant academic literature, into
account, and have determined not to adopt the proposed firm- and
engagement-level audit resources metrics at this time. In doing so, the
Board recognized, as discussed above,

[[Page 100020]]

that several commenters suggested there would be challenges relative to
comparability and data collection, and there would also be the
potential for misunderstanding by users of the information. As the
Board stated in the proposal, these are highly contextual measurements
because the use of the work of specialists is generally performed to
satisfy needs specific to an industry or issuer and the use of the work
of SSCs is dependent on the structure and resources of both the firm
and the SSC, as well as the specific needs of individual engagement
teams. The Board acknowledges that the nature and uses of SSCs continue
to expand. As they do, the Board expects to continue to study and focus
inquiries in this area to better understand the impact of SSCs on audit
quality, firm economics, and engagement staffing models. The Board
anticipates these efforts will inform future consideration of whether
additional guidance or other regulatory action is warranted.
ii. Audit Hours and Risk Areas
The proposed engagement-level metric would have required firms to
calculate the time incurred by all partners and managers on the
engagement team in auditing the areas of significant risks,\182\
critical accounting policies and practices,\183\ and critical
accounting estimates,\184\ in aggregate, as a percentage of total audit
hours incurred by partners and managers on the engagement team. Because
a firm-level metric would have been heavily influenced by the mix of
companies that a firm audits, the Board did not propose to require
firms to report this metric at the firm level.
---------------------------------------------------------------------------

\182\ As defined in paragraph .A5 of AS 2110, Identifying and
Assessing Risks of Material Misstatement (``risk of material
misstatement that requires special audit consideration'').
\183\ As defined in AS 1301.A4 (``A company's accounting
policies and practices that are both most important to the portrayal
of the company's financial condition and results, and require
management's most difficult, subjective, or complex judgments, often
as a result of the need to make estimates about the effects of
matters that are inherently uncertain.'').
\184\ As defined in AS 1301.A3 (``An accounting estimate where
(a) the nature of the estimate is material due to the levels of
subjectivity and judgment necessary to account for highly uncertain
matters or the susceptibility of such matters to change and (b) the
impact of the estimate on financial condition or operating
performance is material.'').
---------------------------------------------------------------------------

Two commenters supported this metric as proposed, while several
other commenters generally supported this metric with revisions;
suggestions included reporting the absolute number of audit hours as
well as the percentage, and adding time spent on performing fraud
procedures. Another commenter, an investor-related group, supported
this metric as proposed, but further suggested reporting the total
audit hours incurred by staff on the engagement team in the areas of
significant risks, critical accounting policies and practices, and
critical accounting estimates because these areas are considered the
most significant for the audit. This commenter also suggested reporting
hours by specialists, senior professionals, and staff in connection
with critical audit matters.
Many other commenters criticized the proposed metric. These
commenters provided the following reasons as the basis for their
decision not to support this metric:
The metric does not consider the evolving role of
technology in the audit and the use of technology can significantly
contribute to audit effort.
Risk assessment is an iterative process throughout the
audit which means that identifying significant risks and critical
accounting policies, practices, and accounting estimates may change
during an audit, resulting in changes in how auditors track their time
for reporting under this metric.
An individual's hours charged to auditing a particular
account balance may include work performed that is unrelated to an
identified significant risk.
The nature of the audit procedures performed could include
overlap with other areas of the audit depending on discussions held and
procedures performed.
Tracking time at the granular level needed to accurately
capture hours for significant risks and critical accounting policies,
practices, and accounting estimates would require additional resources,
including time and costs, that are not directly associated with audit
quality.
Reporting this information would require coordination
across firms for audits involving other auditors, who may be using
different systems to track the underlying information.
Since the risk of management override of controls is a
presumed risk in all audits, how should it be considered since the
response is pervasive to the audit.
Several commenters, including firms, stated that firms are not
currently tracking this information, or they believe that firms are not
currently tracking this information. One commenter added that although
they do not believe firms are currently tracking this information, it
should be possible to extract this data from internal monitoring
systems with considerable time and complexity.
Commenter views were divided on whether the metric should be
revised to also include engaged specialist hours given that, under the
proposal, the definition of engagement team includes employed
specialists, but not engaged specialists. Some commenters agreed that
this metric should include engaged specialist hours, while other
commenters did not.
Taking into account commenter feedback as well as the fact that
firms' approach to identifying and classifying significant risks can
vary greatly, the Board was concerned that the potential for
misinterpretation of this metric and the costs associated with
establishing systems to collect the necessary data may not be
justified. The Board did not adopt the metric related to audit hours
and risk areas at this time.
iii. Quality Performance Ratings and Compensation
The proposal set forth firm-level reporting requirements for firms
to calculate (i) the distribution of quality performance ratings across
partners and (ii) a comparison of average annual compensation
adjustments (as a percentage of the average adjustment received by the
highest rated group) for partners in each quality performance rating
category over a one-year period.
Overall, some commenters supported this metric area, agreeing with
the proposed rationale that comparing the relationship between internal
firm quality performance ratings and changes in compensation levels
could provide evidence of the extent of any correlation between quality
performance ratings and compensation, and thereby provide an important
signal of the value of a quality commitment for the firm.
However, other commenters did not support this metric area or
expressed concerns because of the number of difficulties in reporting
and using the metric. Commenters raised the possibility of a lack of
comparability or consistency (e.g., differences in firm's structure,
strategies and systems used in performance evaluations, and definition
of compensation, and inclusion of non-equity partner and directors in
the calculation), resulting in potential misuse of the metrics or
providing no or limited value to stakeholders. Many also pointed to
variability in firms' quality performance rating systems both across
firms and within the firm over time. Some commenters also indicated
that there are many factors that firms consider in determining
compensation, and that firms use mechanisms to drive accountability of
partners that would

[[Page 100021]]

not be taken into account in the metrics calculation, resulting in no
direct one-on-one relationship between the compensation adjustments and
performance ratings. Some commenters expressed a number of concerns
about the definition of compensation, as well as the treatment of non-
equity partners.
Several commenters expressed concerns about confidential
information. One commenter specifically cited the risk of disclosing
confidential business information that is proprietary and protected
from disclosure under Sarbanes-Oxley Section 102(e). Another commenter
indicated (i) the possibility of identifying specific partners'
compensation at smaller firms and (ii) the disclosure of this metric
area may be prohibited by laws and regulations outside of the United
States. A commenter also said that PCAOB registered firms are for-
profit entities that should have flexibility in designing a
compensation strategy that is tailored to their business model and
needs.
Instead of the proposed metrics, several commenters suggested
disclosing firms' policies related to partner compensation and
performance ratings, including how partner audit quality is measured
and how that measurement influences compensation. Some of these
commenters said that disclosing these policies would demonstrate the
firms' quality commitment and the value it places on quality while
alleviating the comparability and confidentiality concerns and meeting
the objective of this proposed metric. Some commenters stated that
qualitative disclosures related to performance management and
compensation policies are already disclosed in the firms' annual
transparency reports. One commenter indicated the complexity of the
performance measurement goes beyond mechanical calculation. Another
commenter indicated that the metric is not useful as it is an
unambiguous indicator of audit quality and likely focuses on matters
unrelated to audit quality.
Two commenters explicitly supported the exemption granted to firms
that are not within the scope of the SEC's partner rotation rule. One
commenter questioned whether this metric would relate to all issuer
audit engagements or all audit engagements and another indicated that
combining issuer and non-issuer information would conflict with
proposed PCAOB Rule 2400. Furthermore, a commenter indicated that this
metric encompasses all partners of the firm and would not be useful
when the issuer audit practice is a small portion of the overall firm
operations.
While there was some support from commenters, the Board did not
adopt this metric area at this time, primarily due to the challenges
described by commenters (e.g., lack of comparability and variability in
establishing a firm's quality rating system) and the ambiguity in
relation to audit quality, which may be difficult to overcome for this
metric area to be meaningful for stakeholders. Because this rulemaking
project is focused on requiring certain firms to report certain
quantitative metrics that will foster comparability, the Board is also
did not adopt the alternatives suggested by various commenters that the
firms disclose policies regarding the partner compensation and
performance ratings.
iv. Audit Firms' Internal Monitoring
The proposal set forth firm-level requirements for firms to
calculate the percentage of issuer engagements that were selected for
internal monitoring in the firm's most recently completed cycle (i.e.,
the number of completed issuer engagements internally monitored,
divided by the number of total issuer engagements) and the percentage
of those issuer engagements with engagement deficiencies.\185\
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\185\ The term ``engagement deficiency'' as used in the proposal
is defined in QC 1000.A4 (``An instance of noncompliance with
applicable professional and legal requirements by the firm, firm
personnel, or other participants with respect to an engagement of
the firm, or by the firm or firm personnel with respect to an
engagement of another firm'').
---------------------------------------------------------------------------

At the engagement level, the proposal set forth requirements for
firms to disclose whether a previous engagement was selected for
internal monitoring in the most recently completed monitoring cycle,
the year-end date of the engagement subject to review, whether any
engagement deficiencies were identified, and the nature of those
deficiencies. The nature of the engagement deficiencies would be one of
the following: (i) financial statement line item, (ii) disclosure, or
(iii) other noncompliance with applicable professional or legal
requirements.\186\ The Board also proposed that certain details be
provided about the engagement deficiency, including the area of
noncompliance and the type of deficiency.
---------------------------------------------------------------------------

\186\ The term ``applicable professional and legal
requirements,'' as used in this rulemaking, has the same meaning as
defined in QC 1000.A2.
---------------------------------------------------------------------------

Some commenters, primarily investor-related, expressed support for
both the proposed firm- and engagement-level metrics. One investor-
related commenter suggested that Part I.A deficiencies be included
separately in addition to the proposed requirements. Other commenters
stated the proposed metrics would provide useful information into
understanding firms' monitoring procedures and outcomes, facilitating
comparisons regarding the quantity and types of engagement deficiencies
detected, while one commenter stated that the monitoring and
remediation process was an essential component of firms' quality
management systems and agreed that providing a certain level of
transparency in this area could be useful for interested stakeholders.
The firm-level metric was generally supported by some firm and
firm-related commenters. One noted that it reports certain of this
information in its transparency reports. Another highlighted that its
internal monitoring was broader in scope, including targeted monitoring
of its team's use of certain tools or technologies, adding that may be
inconsistent with the PCAOB's intent with respect to firm-level
reporting. Some of these commenters suggested reducing the scope by
requiring reporting of only PCAOB Inspection Report Part I.A inspection
findings. Another suggested reporting the percentage of compliant
internal reviews rather than deficient engagements.
Conversely, several firm commenters were opposed to the proposed
internal monitoring metrics at the firm level. The concerns raised by
these commenters included noting that differences in monitoring
programs would render the information provided inconsistent and
uninformative and also that it could be disadvantageous to smaller
firms that may have more variability in their internal monitoring year
over year. In addition, several firm and firm-related commenters
disagreed with the deficiencies required to be disclosed in the
proposed firm-level metrics being aligned to QC 1000. One stated that
presentation of such a broad range of deficiencies into a single metric
without distinction could lead a user to inappropriately conclude that
the firm had significant quality issues, which could in turn negatively
impact their confidence in the reliability of the firm's audit reports.
Another commenter expressed their belief that firm-level public
reporting of internal inspection findings could be a disincentive for
finding deficiencies. This commenter also stated that firms should be
allowed to request confidential treatment for metrics related to
internal monitoring.
At the engagement level, virtually all firm commenters objected to
the proposed internal monitoring metrics.

[[Page 100022]]

Specific objections raised included those related to confidentiality
concerns, comparability challenges, and the potential for confusion or
misunderstanding. Several commenters expressed concerns that the
proposed metrics risked undermining internal inspection programs if
they cause firms to move from broad monitoring processes to align more
closely with PCAOB inspections in response to the proposed
requirements. One commenter stated that once these metrics become
public, firms could come under pressure from various constituencies to
report results that are within a perceived acceptable range. Another
commenter voiced concern that firms could be incentivized to alter
their internal monitoring processes in a manner inconsistent with the
objectives of the proposal. Some commenters suggested that an
alternative could be to require communication with an issuer's audit
committee.
Taking commenter input into account, the Board determined not to
adopt the proposed firm- and engagement-level internal monitoring
metrics at this time.
2. Potential Additional Firm and Engagement Metrics
In the Board's proposal, it discussed three particular areas--
training, access to technical resources, and investment in audit
infrastructure--that it did not propose to require for reporting but,
in light of the significance of these areas, for which the Board
solicited specific commenter input.
All of these potential metrics related to aspects of a firm's
ongoing investment in audit quality, which the Board believes is
critically important. However, in working to develop metrics in these
areas, the Board encountered challenges in defining what to measure and
how to measure it, questions about whether metrics would be informative
and appropriately free from bias, and concerns about potential
unintended consequences. After considering commenter feedback, the
Board adopted a modified metric related to training, which is discussed
in detail above. However, the Board did not adopt metrics in the areas
of access to technical resources or investments in audit
infrastructure, as discussed further below.
In addition to the metrics the Board considered, as noted above,
some commenters on the proposal suggested a metric for PCAOB Part I.A
deficiencies. The Board's response to this suggestion is discussed
further below.
i. Access to Technical Resources
The Board solicited comment on possible firm-level metrics relating
to the relative size of a firm's central personnel (or other resources
engaged by the firm) available to provide engagement teams with advice
on complex, unusual, or unfamiliar issues and the extent to which such
resources were used in the firms' engagements. Metrics that were
considered at the engagement level focused on consultations that were
performed with professionals outside of the engagement team on
difficult or contentious matters.
Commenters who responded to questions about the potential metric
for access to technical resources largely agreed with the
considerations and conclusions in the proposal. Some of those
commenters replied that the metrics would not be useful, be difficult
to measure, not be comparable, and could be seen as being biased
towards larger firms. One commenter mentioned that arguments could be
made for or against many metrics, but they broadly agreed access to
[technical] resources should be dropped. One commenter expressed that
it would be difficult to define national office in a way that was
meaningful.
After considering these comments, and in light of the Board's
original analysis, the Board did not adopt a metric related to access
to technical resources.
ii. Investment in Audit Infrastructure
Metrics the Board considered in relation to investment in audit
infrastructure were primarily at the firm level and were focused on the
expenditures that firms self-identified as being in support of audit
quality either in total or on a per headcount basis.
Commenters generally stated that such a metric would be very facts
and circumstances dependent, such that meaningful comparisons could not
be made. One commenter suggested that investment in infrastructure was
best discussed with an in-depth understanding of the circumstances to
obtain appropriate context. Another suggested that the data would be
stale by the time it was reported, adding to its lack of usefulness.
One commenter mentioned that arguments could be made for or against
many metrics, but they broadly agreed investment in audit
infrastructure should be dropped. However, one commenter stated that
they would support a metric that provides the percentage of firm
revenues invested in technology accessible by audit teams. Similarly,
another commenter supported including a metric that provides the
percentage of firm revenues invested in technology and stated they
believe this metric could offer useful information to investors about
the firm's ability to adapt to future challenges.
After considering commenter feedback, the Board did not adopt a
requirement to disclose a metric on investment in audit infrastructure.
The Board considered the commenters that supported a metric related
to revenue invested in technology, but weighing the challenges
presented by doing so, specifically with respect to comparability and
concerns in potential bias with respect to smaller firms, the Board
continues to believe the unintended consequences and the costs would
not be justified by the benefits such a metric might provide.
iii. PCAOB Part I.A Deficiencies
Some commenters recommended requiring a metric which the Board did
not include as a potential additional metric in the proposal--a
percentage of the PCAOB Part I.A deficiencies relative to ``the total
inspections.'' The commenters acknowledged that this information is
already publicly available. However, they suggested that including this
percentage with other required metrics would highlight its importance
and provide valuable information. One of the commenters went on to
state that increasing the visibility of the PCAOB's inspection results
would increase the importance of the results of the inspection process
to audit firms, which they believe will lead to an improvement in
overall audit quality.
After considering commenter feedback, the Board did not adopt a
requirement to disclose a metric for PCAOB Part I.A deficiencies.
Principally, the Board has concerns that the time lag implicit in such
a metric would be potentially confusing. The other metrics would report
as of September 30 or for the 12 months then ended, but a metric based
on PCAOB inspection results would relate to audits conducted one or
more years previously and may reflect issues that have long since been
remediated.\187\ In the Board's view, presenting data on inspection
findings from previous years together with a suite of other metrics
that all relate to the current period may confuse users. Of course,
inspection reports, including discussion of Part I.A.

[[Page 100023]]

deficiencies, will continue to be available on the PCAOB website.\188\
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\187\ The PCAOB inspects audits completed in the prior year, and
the ensuing reports have historically been released a year or more
after the inspection is completed.
\188\ See, e.g., PCAOB charts illustrating much of the data in
the U.S. global network firms (``GNFs'') and U.S. annual non-
affiliated firms (``NAFs'') inspection reports, available at https://pcaobus.org/oversight/inspections/global-network-firms-inspection-data and https://pcaobus.org/oversight/inspections/non-affiliated-firms-inspection-data, respectively. GNFs are the member firms of
the six global accounting firm networks (BDO International Ltd.,
Deloitte Touche Tohmatsu Ltd., Ernst & Young Global Ltd., Grant
Thornton International Ltd., KPMG International Ltd., and
PricewaterhouseCoopers International Ltd.). NAFs are both U.S. and
non-U.S. accounting firms registered with the Board that are not
GNFs. Some of the NAFs belong to international networks.
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Effective Date
For firm-level metrics, the Board proposed an effective date
beginning October 1 of the year after approval by the SEC, with the
first reporting period ending the following September 30. The Board
also proposed a phased implementation period:
Firms that issued audit reports with respect to more than
100 issuers in the calendar year preceding the effective date would
begin reporting firm-level metrics in the first year; and
All other firms would begin reporting firm-level metrics
one year later.
For engagement-level metrics, the Board also proposed a phased
implementation period:
Firms that issued audit reports with respect to more than
100 issuers in the calendar year preceding the effective date--for
audits of companies with fiscal years beginning on or after October 1
of the year after the year in which SEC approval is obtained; and
All other firms--for audits of companies with fiscal years
beginning on or after October 1 two years after the year in which SEC
approval is obtained.
The Board solicited comment on whether the proposed effective date
would provide challenges for auditors and how these challenges should
be addressed. The Board also solicited comment on whether the phased
implementation period would be appropriate and whether the phased
implementation should be based on the number of issuer audit reports
issued or some other basis.
One investor-related group suggested that extending the
implementation period would allow smaller firms to adapt incrementally,
ensuring they are not disproportionately affected by the new
requirements. This commenter further suggested that the Board could
identify and make certain metrics optional for smaller firms without
making all the metrics optional.
Primarily, firms and firm-related groups recommended extending the
proposed effective date. While many firms did not provide a specific
implementation time period, other than stating that more time is
needed, other firms recommended an effective date at least three years
after the SEC's approval, and others recommended at least two years
after the SEC's approval. Some commenters specifically stated that
additional time (i.e., one more year) would be needed for smaller
firms. Another commenter recommended an effective date of at least
three years after the SEC's approval, if adopted as proposed, or
shorter if engagement-level metrics will be communicated to the audit
committee, rather than reported publicly, as proposed. These commenters
provided reasons for extending the implementation period including more
time to implement systems or system changes, develop processes, train
professionals, and accumulate and test data and calculations. Some
commenters specifically emphasized the need for more time to make
changes in the global network firms or other firms who are
participating in the audit that may or may not have the same systems or
policies. Other commenters stated that more time would be needed to
implement this rulemaking because of other recently adopted standards.
The Board considered these comments and provided additional time
before the reporting rules become effective. The final rules will
become effective beginning October 1 of two years after approval by the
SEC, with the first reporting period ending the following September 30
with a phased implementation period:
Firms that issued audit reports with respect to more than
100 issuers in the calendar year in which the effective date occurs
will begin reporting firm-level metrics in the first year reporting is
required; and
All other firms would begin reporting firm-level metrics
one year later.
If approved by the SEC, the effective date of the firm-level
metrics will be October 1, 2027. For firms that issued audit reports
with respect to more than 100 issuers in 2027, the first reporting
period would end on September 30, 2028, with the first Form FM due by
November 30, 2028. For all other firms, the first reporting period
would end on September 30, 2029, with the first Form FM due by November
30, 2029.
For engagement-level metrics, the Board is also adopting a phased
implementation period:
Firms that issued audit reports with respect to more than
100 issuers in the calendar year preceding the effective date--for
audits of companies with fiscal years beginning on or after October 1
of two years after the approval by the SEC; and
All other firms--for audits of companies with fiscal years
beginning on or after October 1 of three years after the approval by
the SEC.
If approved by the SEC, reporting of engagement-level metrics would
start for firms that issue audit reports with respect to more than 100
issuers in 2026 for the audits of companies with fiscal years beginning
on or after October 1, 2027. For other firms, it will start with audits
of companies with fiscal years beginning on or after October 1, 2028.
The reporting will be on Form AP, which is generally due 35 days after
the issuance of the auditor's report.
As discussed in earlier sections, the Board adopted a smaller
number of firm- and engagement-level metrics than proposed.
Specifically, the Board adopted [ten] eight metrics areas (as opposed
to 11 proposed metric areas), which should reduce the administrative
burden and cost of calculating and reporting the metrics. Therefore,
the Board believes that the smaller number of metrics, the extension of
the effective date, and the phased implementation should provide
sufficient time for firms, including smaller firms, to implement new or
enhanced systems and processes, train professionals, and conduct
internal testing and reporting before reporting of the metrics.

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

The Board is mindful of the economic impacts of its standard
setting. This economic analysis describes the economic baseline, need,
and expected economic impacts of the final rules, as well as
alternative approaches considered. Because there are limited data to
quantitatively estimate the economic impacts of the final rules, much
of the Board's economic analysis is qualitative. However, where
feasible, the economic analysis incorporates quantitative information,
including analysis of internal PCAOB data, publicly available data, and
results from academic literature.
Baseline
This section establishes the economic baseline against which the
impact of the final rules can be considered. Important components of
the baseline, specifically a discussion of current firm- and
engagement-level disclosure

[[Page 100024]]

requirements, voluntary reporting practices, and actions in other
jurisdictions relevant to the final rules are described above. Below,
the Board highlights information presented above most relevant to the
economic baseline and provides additional academic references and
statistics.
Current PCAOB rules and standards do not require registered firms
to publicly disclose firm or engagement-level information like the
final metrics. As discussed above, firms are currently required to
publicly disclose some information related to the firm and its
engagements in a variety of PCAOB forms (e.g., Form AP, Form 2).\189\
Usage statistics suggest that the public actively seeks out the
information contained in these forms. For example, PCAOB usage
statistics show that during calendar year 2023, there were close to 7.4
million page views, and just over 23,000 unique visitors, for PCAOB's
RASR Web service that provides public access to firm filings, including
Forms 1, 2, 3, 4, and AP.\190\ Additionally, in 2023 there were over
333,000 unique searches performed on AuditorSearch, the PCAOB's online
search tool, and the Form AP data set was downloaded over 2,000
times.\191\
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\189\ The Board concurrently adopted new reporting requirements
for registered firms. See PCAOB Rel. No. 2024-013.
\190\ The RASR database can be found on the PCAOB's website
(https://rasr.pcaobus.org/.aspx). The usage statistics underestimate
actual public interest because investors, researchers, auditors,
audit committees, and issuer management may source PCAOB information
through external third-party data service providers--such as
Ideagen's Audit Analytics. However, they also overestimate actual
public interest to some extent because the usage statistics include
internal PCAOB users.
\191\ Information related to usage statistics can be found on
the PCAOB's website (https://pcaobus.org/resources/auditorsearch).
---------------------------------------------------------------------------

In addition to the information that the firm makes public through
required form filings, the PCAOB provides firm-level public disclosure
through firm inspection reports.\192\ For the 2023 calendar year, firm
inspection reports were downloaded approximately 113,000 times.
Academic research suggests that audit committees use the information
contained in PCAOB inspection reports.\193\ Additionally, some academic
research suggests that PCAOB inspection reports provide useful
information to investors.\194\ However, some research suggests that
institutional investors may not be aware of or find value in PCAOB
inspection reports.\195\ One commenter noted that the proposal did not
provide information on who was accessing the website information or why
they were accessing it. The PCAOB does not collect information on who
is accessing the website information (e.g., IP addresses) or why they
are accessing it.
---------------------------------------------------------------------------

\192\ Firm inspection reports can be found on the PCAOB's
website (https://pcaobus.org/oversight/inspections/firm-inspection-reports).
\193\ See, e.g., Daniel Aobdia, The Impact of the PCAOB
Individual Engagement Inspection Process--Preliminary Evidence, 93
The Accounting Review 53 (2018) (finding that ``the client is more
likely to switch auditor'' when offices or partners receive a Part I
auditing deficiency).
\194\ See, e.g., Andrew Acito, Amir Amel-Zadeh, James Anderson,
William L. Anderson, Daniel Aobdia, Francois Brochet, Huaizhi Chen,
Jonathan T. Fluharty-Jaidee, Martin Schmalz, Manyun Tang, and Scott
Jinzhiyang Wang, Market-Based Incentives for Optimal Audit Quality,
SSRN Electronic Journal (2024) (finding that when PCAOB inspection
reports can be easily linked to the issuer being audited, issuers
whose audit was not found to be deficient significantly outperform
issuers whose audit was found to be deficient); Nemit Shroff, Real
Effects of PCAOB International Inspections, 95 The Accounting Review
399 (2020) (finding, using a sample of foreign companies, that
companies enjoy greater access to capital when their auditor's PCAOB
inspection report does not include Part I deficiencies). The Board
notes that SSRN does not peer review its submissions.
\195\ See, e.g., Center for Audit Quality, Perspectives on
Corporate Reporting, the Audit, and Regulatory Environment
Institutional Investor Research Findings, (Nov. 2023) (``CAQ 2023
Survey'') (finding that most institutional investors interviewed
were unaware of PCAOB inspections reports, and to the extent
investors were aware, found the report results to be expected) and
Clive Lennox and Jeffrey Pittman, Auditing the Auditors: Evidence on
the Recent Reforms to the External Monitoring of Audit Firms, 49
Journal of Accounting and Economics 84 (2010) (finding that
companies do not perceive that the PCAOB's disclosed inspection
reports are valuable for signaling audit quality).
---------------------------------------------------------------------------

In addition to PCAOB information, investors and audit committees
may be able to obtain information related to audit quality from auditor
legal proceedings--e.g., pursuant to SEC enforcement actions.\196\
However, due to the investigation and litigation process, engagement-
specific information may be publicly available only after a substantial
lag. Furthermore, academic researchers have also used a variety of
publicly available firm and engagement-level proxies for audit quality
including audit firm size, issuer restatements, and industry
specialization.\197\ One commenter noted that the auditor's tenure with
the company is available in the auditor's report and audit fee
information is available in the company's proxy statement.
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\196\ See, e.g., the SEC's Accounting and Auditing Enforcement
Releases available at https://www.sec.gov/divisions/enforce/friactions.
\197\ See, e.g., Daniel Aobdia, Do Practitioner Assessments
Agree with Academic Proxies for Audit Quality? Evidence from PCAOB
and Internal Inspections, 67 Journal of Accounting and Economics 144
(2019); Jere R. Francis, A Framework for Understanding and
Researching Audit Quality, 30 AUDITING: A Journal of Practice &
Theory 125 (2011); and DeFond and Zhang, A Review of Archival
Auditing Research.
---------------------------------------------------------------------------

As discussed above, some large U.S. audit firms voluntarily
publicly disclose certain firm-level information through their firm
transparency reports--e.g., general discussions of turnover rates,
independence policies and practices, or aggregated staff headcounts.
PCAOB staff reviewed the most recent audit quality report for each of
the eight firms considered in the CAQ Report. As these firms' audit
quality reports generally do not provide quantitative engagement-level
information, the PCAOB staff's analysis focused on whether they provide
quantitative firm-level information substantially similar to the final
firm-level metrics.
Overall, the PCAOB staff's analysis indicates that voluntary firm
reporting addresses many of the areas included in the final metrics,
though in most instances more narrowly. The reports generally provide
quantitative information related to staff training and retention, which
the Board believes is substantially similar to the final metrics for
Training Hours for Audit Personnel and Retention of Audit Personnel,
respectively. However, the Board notes that the reports that include a
retention metric define it in different ways and report it at different
levels of aggregation. The reports generally provide quantitative
information related to staffing leverage. However, the quantitative
information is generally at the head-count level and no report accounts
for audit hours, as the final Partner and Manager Involvement metrics
require. Half of the reports provide quantitative information related
to the frequency of restatements which are similar to the final
Restatement History metric. However, in these cases, the reports do not
indicate whether the reported restatements include reissuance
restatements, revision restatements, or both. Some other reports
provide quantitative information related to the frequency of
restatements associated with PCAOB-inspected engagements only. Half of
the reports provide quantitative information related to years of
experience. However, the quantitative information does not include
managers' experience as the final Experience of Audit Personnel metric
requires. Some reports provide metrics similar to the final Workload
metric. However, in these cases, the calculations may differ from the
final Workload metric in important ways (e.g., they are limited to the
busy season only or include more staff than required) and it is unclear
whether the calculations include the same types of hours required under
the final rules (e.g., PTO hours). The reports generally do not provide
quantitative information related to the allocation of audit hours

[[Page 100025]]

and no report provides quantitative information related to industry
experience. However, the Board notes that these firms generally provide
information related to the industries they serve on their websites
which is similar to the component of the firm-level industry expertise
metric that identifies the five top industries of the firm's audit
practice.
One commenter said that, though only a small portion of firms
voluntarily disclose metrics, these firms cover most U.S. public
companies. The Board acknowledges that this point implies that most
audit committees and investors have some information about topics
covered by the final metrics. However, PCAOB staff found that the
existing disclosures are not uniform or comparable across firms.
Furthermore, PCAOB staff found that firms generally do not voluntarily
publicly report engagement-level metrics and one investor group said
that the firms' transparency reports are seen as marketing material
rather than investor information. One commenter emphasized that firms
already publish transparency reports and urged the PCAOB to analyze
firms' current transparency reporting practices and solicit feedback
from investors, audit committees, and other stakeholders on their
contents. The Board performed such an analysis as described above and
has addressed comments on the economic baseline that the Board received
from stakeholders as part of the Board's notice and comment process.
The limitations of voluntary firm transparency reports, along with the
related academic literature, are further discussed below.
Audit committees can receive other information through sources not
available to the public. Auditing standards and PCAOB and SEC rules
require specific communications from auditors to audit committees
regarding a variety of matters related to the audit engagement. For
example, under AS 1301, the auditor is required to communicate to the
audit committee inter alia (i) all critical accounting policies and
practices to be used; (ii) a description of the process management used
to develop critical accounting estimates; and (iii) significant risks
identified during the auditor's risk assessment process.\198\ Moreover,
audit committees may obtain information under other disclosure
requirements--e.g., reporting under Section 10A of the Exchange Act,
where the auditor must report to the issuer's board of directors, in
certain situations, related to illegal acts at an issuer.\199\ In
exercising their oversight responsibilities, audit committees may also
request more firm- or engagement-specific information from their
auditor. For example, audit committees may seek information from the
auditor about PCAOB inspections, including information not contained in
the PCAOB's public inspection reports.\200\ Audit committees may also
request information from other audit firms as part of a request for
proposal if they are considering engaging a new auditor.
---------------------------------------------------------------------------

\198\ See above for additional discussion related to auditor
communications with audit committees. See also Section 10A(k) of the
Exchange Act, 15 U.S.C. 78j-1(k) and 17 CFR 210.2-07.
\199\ See, e.g., Section 10A of the Exchange Act, 15 U.S.C. 78j-
1.
\200\ See Information for Audit Committees About The PCAOB
Inspection Process, PCAOB Rel. No. 2012-003 (Aug. 1, 2012).
---------------------------------------------------------------------------

Audit firms, partners, and engagement teams have developed
reputations based on the public and non-public information discussed
above, as well as audit committees' direct experience with them.
Through surveys and interviews with audit committee members, one study
concluded that the firm's reputation for industry experience and the
audit partner's accessibility, ability to address accounting issues on
a timely basis, and ability to liaise with the firm's national office
are the key characteristics that audit committees consider when
selecting an auditor.\201\ This finding suggests that audit committees
currently receive and use information like some of the final metrics
(e.g., Industry Experience and Workload).
---------------------------------------------------------------------------

\201\ See Elizabeth D. Almer, Donna R. Philbrick, and Kathleen
H. Rupley, What Drives Auditor Selection?, 8 Current Issues in
Auditing A26, A27 (2014).
---------------------------------------------------------------------------

The Board believes many firms internally track some information
related to the final metrics. One commenter on the Concept Release
stated that they believe that many firms are using the 28 AQIs
identified in the Concept Release at some level to (i) manage the firm
and (ii) manage the quality of audits at the office level and at the
engagement level. Three U.S. GNFs stated in their comments on the
Concept Release that they track some of the proposed metrics discussed
in the Concept Release for monitoring purposes. Information gathered by
PCAOB staff in 2018 and 2019 pursuant to PCAOB oversight activities
indicate that U.S. GNFs generally had identified and were tracking
performance metrics at both the firm and engagement level. At the firm
level, U.S. GNFs generally tracked PCAOB inspection history,
restatements, voluntary turnover rates/retention rates, partner to
staff ratios/professionals by level, average partner workload, and
investment in audit quality. At the engagement level, U.S. GNFs
generally tracked distribution of engagement hours during the year,
partner workload and utilization, partner years of experience (by
industry, level, or issuer), engagement leverage, engagement milestone
compliance, involvement in pre-issuance review programs, and use of IT
and other specialists. One firm tracked audit hours performed at SSCs.
However, several commenters representing firms and firm-related groups
explained that they do not currently track information in a form that
will be required for several of the metrics. For example, one commenter
said that firms have no internal tracking of personnel's total
experience prior to joining the firm. One commenter said that smaller
and medium-sized firms do not track the industry experience of audit
personnel. Though this information suggests that a significant amount
of information is collected by the U.S. GNFs at both the firm and
engagement levels, one academic study suggests that partners seldom use
metrics related to audit quality when evaluating the quality of their
work or the work of their colleagues.\202\
---------------------------------------------------------------------------

\202\ See, Marion Brivot, M[eacute]lanie Roussy, and Maryse
Mayer, Conventions of Audit Quality: The Perspective of Public and
Private Company Audit Partners, 37 Auditing: A Journal of Practice &
Theory 51, 68 (2018).
---------------------------------------------------------------------------

Commenters noted that the PCAOB already has access to information
about audit firms. One commenter suggested that the Board describe the
information currently requested from firms. The PCAOB requests a
variety of information from firms to inform its inspections process,
which focuses on evaluating whether firms are in compliance with PCAOB
standards. Some of the information is related to some of the final
metrics. However, the information is generally not comparable across
firms, engagements, and time; the quality of the information is
inconsistent; and the information is generally not available for all
firms and engagements.\203\
---------------------------------------------------------------------------

\203\ The Board believes this is driven, in part, by variation
in firms' approaches to quality control and how they record
information. The Board notes that, under Section 105(b)(5) of
Sarbanes-Oxley, this information is only available for PCAOB
regulatory use.
---------------------------------------------------------------------------

To better understand the adequacy of currently available
information or need for additional disclosures, one commenter suggested
that the Board consider data on: (i) attendance at annual shareholder
meetings; (ii) votes on auditor ratification; or (iii) passive

[[Page 100026]]

versus active investors. The Board was unable to identify any data
sources regarding attendance at annual meetings. However, the Board
notes that shareholder votes are typically cast electronically by proxy
and not in-person at annual meetings.\204\ Moreover, anecdotal evidence
suggests that attendance, particularly among retail investors, is
generally low.\205\ This may reflect the fact that material information
relevant to investor decision-making is typically provided through the
proxy statement and annual report, rather than being newly disclosed at
the annual meeting. The Board does not believe this provides strong
evidence for or against the adequacy of currently available data or
investors' information preferences. Regarding votes on auditor
ratification, the Board's economic analysis is informed by and cites
several academic studies on shareholder voting to ratify the
appointment of the auditor. Additionally, data from Audit Analytics
suggests that the proportion of investors opposing ratification, while
still infrequent, has been increasing.\206\ Overall, the research
suggests that investors, primarily institutional investors, use
information related to audit performance. In cases where they do not,
the Board believes this is more likely driven by the costs of gathering
and understanding the information rather than a lack of demand.\207\
Regarding passive versus active investors, research suggests that
household direct holdings comprise roughly 50% of U.S. equity capital
with the remaining 50% held by ETFs, passive mutual funds, active
mutual funds, or hedge funds.\208\ Among funds, roughly 50% are
actively managed.\209\ Based on the Board's review of academic
literature and the Board's consideration of costs, the Board believes
that individual retail investors will be less likely to use the final
metrics than institutional investors.\210\ Therefore, this research
suggests that investors who are more likely to use the final metrics
will use the final metrics to inform their capital allocation decision-
making own or manage roughly 25% of U.S. equity capital. However, the
Board notes that, by investing in proportion to the market value of a
company, passive investors freeride on the decisions of the active
investors, thus amplifying the effects of improved decision-making of
the more active investors who are more likely to use the final
metrics.\211\ Also, one audit committee chair said at the September 26,
2024 IAG meeting (``September 2024 IAG meeting'') that passive
investors take corporate governance very seriously. Similarly, an
investor group commenter said that passive portfolio managers'
stewardship counterparts will use the information in their voting
decisions. As such, in contrast to capital allocation decision-making,
the final metrics may inform passive funds' governance-related
decision-making.
---------------------------------------------------------------------------

\204\ See, e.g., Broadridge, 2023 Proxy Season Key Stats and
Performance Ratings, (2023) (reporting that, of the votes Broadridge
processed, 97% of shares were voted electronically by retail and
institutional shareholders).
\205\ See, e.g., Yaron Nili and Megan Wischmeier Shaner, Virtual
Annual Meetings: A Path Toward Shareholder Democracy and Stakeholder
Engagement, SSRN Electronic Journal (2022) (discussing how
``[m]eaningful participation at the yearly gathering of corporate
shareholders has become a relic of the mid-twentieth century'' and
``[l]ow retail investor attendance and participation is a well-
documented problem in public corporations'') and cites therein. The
Board notes that SSRN does not peer review its submissions.
\206\ See WSJ, Investor Votes Against Big Companies' Auditors
Climb, (June 18, 2024).
\207\ See below for additional discussion.
\208\ See Nicolae Garleanu and Lasse Heje Pedersen, Active and
Passive Investing: Understanding Samuelson's Dictum, 12 The Review
of Asset Pricing Studies 389 (2020).
\209\ See John Rekenthaler, Index Funds Have Officially Won,
Morningstar (Feb. 13, 2024).
\210\ See below.
\211\ See, e.g., Jeffrey L. Coles, Davidson Heath, and Matthew
C. Ringgenberg, On Index Investing, 145 Journal of Financial
Economics 665 (2022) (discussing how ``[p]assive investors are
necessarily freeriding on the research and effort exerted by active
managers'') and Ruggero Jappelli, Dynamic Asset Pricing with Passive
Investing, unpublished working paper (2024) (finding that ``the
effect of standardized unexpected earnings on abnormal returns is
significantly amplified by the wealth passively tracking the
stock'').
---------------------------------------------------------------------------

One commenter suggested that the prevalence of Part I.A
deficiencies is an important reason for the proposal and recommended
that the Board provide an analysis of the causes of Part I.A
deficiencies to help stakeholders assess the benefits of the final
rules. Part I.A deficiency trends are available in PCAOB Rel. No. 2024-
005.\212\ Firms have recently indicated to PCAOB staff that unusually
high staff turnover and use of less experienced staff may have
contributed to rising auditing deficiencies. PCAOB inspection staff
also found that utilization of individuals with specialized skill or
knowledge and significant, timely, and detailed supervision and review
were good practices.\213\ The final metrics will reflect several of
these aspects of the audit (e.g., Partner and Manager Involvement).
However, based in part on other comments the Board received on the
proposal, the Board is not adopting metrics related to the use of
specialists.\214\
---------------------------------------------------------------------------

\212\ See PCAOB Rel. No. 2024-005, at 315.
\213\ See Spotlight: Staff Update and Preview of 2022 Inspection
Observations (July 2023) (``2022 Inspection Observations Preview''),
at 4, available at https://pcaobus.org/resources/staff-publications.
\214\ See above for additional discussion on the Board's
decision not to adopt the proposed use of auditor's specialists
metric.
---------------------------------------------------------------------------

One commenter said that to the extent investors need additional
information to inform their voting decisions, the audit committee has
the ability to provide that information in their report in the proxy
statement, including a summary of the metrics they used to assess the
auditor. However, another commenter said that proxy statements provide
little information to shareholders on which they can base their
decision to ratify the appointment of the auditor and no information
related to the quality of the audit or the audit firm is required to be
disclosed on the proxy statement.
One commenter said that several Form AP studies were excluded from
the Board's baseline.\215\ The Board recognizes that some of these
analyses detect little impact of prior PCAOB disclosure rules. The
Board notes that Section IV.C.1.i. of the proposal described how the
benefits of prior PCAOB disclosure rules vary by rule and analysis.
Referring to an academic article, the same commenter suggested that the
baseline section had not provided ample research to show that investors
would use the proposed metrics.\216\ The proposal and the discussion
below refer to the article cited by the commenter as well as several
others regarding how investors may respond to the metrics.
---------------------------------------------------------------------------

\215\ The Board discussed this comment including the studies
referred to below.
\216\ See J. Owen Brown and Velina K. Popova, How Do Investors
Respond to Disclosure of Audit Quality Indicators?, 38 AUDITING: A
Journal of Practice & Theory 31, 47 (2019).
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Lastly, as discussed above, PCAOB staff estimates that
approximately 210 firms will be subject to the final firm-level
disclosure requirements, including 22 of the top 25 U.S. firms by 2023
total firm revenue and all of the 2022 annually inspected firms that
continue to audit issuers. Approximately 50 firms will be required to
report the final firm-level Industry Experience metrics. Approximately
3,400 issuer audits will be subject to the final engagement-level
disclosures, covering approximately 99% of the total market
capitalization of issuers reporting on Form 10-K and Form 20-F.
Need
This section discusses the economic problem to be addressed and
explains how the final rules address it. In general, two observations
suggest that there is an economic need for the final rules:

[[Page 100027]]

Investors and audit committees cannot easily observe the
services performed by auditors. This restricts (i) audit committees'
ability to more efficiently and effectively monitor and select auditors
as well as (ii) investors' ability to more efficiently and effectively
ratify the appointment of the auditor and allocate capital. As a
result, there is a risk that auditors will not supply an efficient
level of assurance to the market.\217\
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\217\ An efficient allocation of resources occurs when total
surplus is maximized. Total surplus is maximized when the good or
service in question is supplied until the marginal benefit is equal
to the marginal cost. See N. Gregory Mankiw, Principles of Economics
146-148 (6th edition 2008).
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Furthermore, there are currently insufficient incentives
for firms to fully meet the market demand for accurate, standardized,
and decision-relevant information.\218\ There is also a challenge
coordinating firms on a system of comparable disclosures. As a result
of the lack of incentives and coordination challenges, the Board
believes auditors are not supplying the market with additional
information even when doing so would be efficient. Indeed, information
about audit engagements and firms that would allow (i) audit committees
to more efficiently and effectively monitor and select auditors and
(ii) investors to more efficiently and effectively ratify the
appointment of the auditor and allocate capital, as sought by the
market, is often limited or difficult to obtain.
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\218\ Given the considerations discussed below, it appears
reasonable to assume that this lack of incentive for firms to
provide such information is likely to cause the apparent undersupply
of information, rather than the cost of providing the information
being greater than the social benefit.
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The final rules will help address these problems in two primary
ways:
First, the final rules will require certain firms to
publicly report specified metrics relating to certain audits and their
audit practices. Through this disclosure, the final metrics will aid
investor and audit committee decision-making.
Second, the final rules will impose standardized
calculations and require regular public reporting of those metrics. The
resulting comparability will further aid investor and audit committee
decision-making.
Importantly, the Board notes that the final metrics are not
intended to be used in isolation to ascertain audit quality at an audit
firm or for an audit engagement because audit quality is driven by a
complex array of factors beyond those that can be addressed by metrics.
The Board believes investors' and audit committees' ability to use the
metrics is likely to increase over time as users are able to aggregate
multiple data points, make comparisons, and observe trends.
1. Problem To Be Addressed
i. Allocative Inefficiency in the Market for Audit Services
The auditor has a responsibility to obtain reasonable assurance
about whether the issuer's financial statements are free of material
misstatement. Reliable financial statements help investors evaluate
issuers' performance and monitor management's stewardship of investor
capital. However, because audits possess many of the attributes of a
credence good, investors find it challenging to evaluate the quality of
the services provided by auditors.\219\ As a result, the lack of
transparency into the audit process could enable auditors to act on
their private incentives and under-audit (i.e., deploy insufficient
auditor resources) or over-audit (i.e., undertake procedures that do
not efficiently contribute to forming an opinion on the financial
statements).\220\ In effect, there is a risk that auditors will not
supply an efficient level of service to the market. While the Board
acknowledges that audit quality is difficult to observe, the PCAOB is
able to obtain insights into audit quality through inspection of firms'
compliance with auditing standards. The results of recent PCAOB
inspections indicate that room for improvement exists.\221\
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\219\ See Daniel Aobdia, Saad Siddiqui, and Andres Vinelli,
Heterogeneity in Expertise in a Credence Goods Setting: Evidence
from Audit Partners, 26 Review of Accounting Studies 693 (2021)
(finding evidence consistent with audits being credence goods).
\220\ See, e.g., Monika Causholli and W. Robert Knechel, An
Examination of the Credence Attributes of an Audit, 26 Accounting
Horizons 631, 632, 633 (2012) (discussing how audits have attributes
of a credence good, namely the outcome of an audit is unobservable
and the auditor is best informed regarding how much effort is
necessary to perform the audit).
\221\ See, e.g., Spotlight Staff Update and Preview of 2022
Inspection Observations (July 2023), available at https://pcaobus.org/resources/staff-publications (discussing the
``concerning trend'' in ``the percentage of audit engagements
reviewed that are expected to be included in Part I.A of an
inspection report''). One commenter said that many audit quality
studies reveal that audit quality is improving, deficiencies are
narrowly focused, and financial statement restatements are down. The
Board notes that the commenter did not provide support for these
assertions. By contrast, and as stated here and in the proposal, the
PCAOB has pointed to a concerning trend in auditing deficiencies.
Indeed, the trend appears to be continuing in the aggregate. See,
e.g., Spotlight Staff Update on 2023 Inspection Activities (Aug.
2024), available at https://pcaobus.org/resources/staff-publications. Furthermore, while the incidence of restatements has
been decreasing since 2013, there was an uptick in 2022. See, e.g.,
Center for Audit Quality, Financial Restatement Trends in the United
States: 2013-2022, (June 2024). The Board notes that the uptick in
restatements could increase further because some financial
statements that have not yet restated may do so in the future.
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One commenter agreed with the characterization of the audit as a
credence good. Several commenters agreed that investors and other
stakeholders cannot easily observe services performed by auditors,
which limits their ability to make informed decisions about investing
capital, ratifying the selection of auditors, and voting for members of
the board of directors, including directors who serve on the audit
committee. Several commenters said that the audit has become
commodified and that firms compete primarily on cost due to a lack of
information on audit quality. One commenter said that this results in
audit firms ``squeezing'' professional staff for productivity.
The issuer's board of directors is generally required to establish
an audit committee that is statutorily entrusted to appoint,
compensate, and oversee the work of the auditor.\222\ One commenter
said that audit committees of accelerated and large accelerated filers
are composed entirely of independent directors.\223\ However, similar
to investors--though to a lesser degree--audit committees cannot easily
observe the services performed by auditors. Moreover, audit committees
may focus on the interests of current shareholders rather than the
broader public interest (e.g., market confidence, potential future
shareholders, or investors in other issuers). Furthermore, there are
risks that the audit committee may not monitor the auditor effectively.
For example, the auditor may seek to satisfy the interests of
management rather than investors if management is able to exercise
influence over the audit committee's supervision of the auditor.\224\
One commenter said that

[[Page 100028]]

audit committee members are incentivized to ingratiate themselves to
management and that this does not serve investors who need to hold the
audit committee accountable. Such circumstances can lead to a de facto
principal-agent relationship between company management and the
auditor. Also, as one panelist said during the September 2024 IAG,
there is a wide range of financial expertise among audit committees and
audit committee chairs.
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\222\ Companies whose securities are listed on national
securities exchanges are generally required to constitute an audit
committee. See Section 301 of Sarbanes-Oxley; Section 10A(m)(2) of
the Exchange Act. As an additional safeguard, the auditor is also
required to be independent of the audit client. See 17 CFR 210.2-01;
see also PCAOB Rule 3520, Auditor Independence.
\223\ Pursuant to Exchange Act Section 10A(m)(1) and Exchange
Act Rule 10A-3, the listing rules of national securities exchanges
generally require that all members of a listed company's audit
committee be independent. See, e.g., New York Stock Exchange Listing
Manual Section 303a.06; Nasdaq Rule 5605(c). Companies that do not
have securities listed on an exchange are not subject to such a
requirement.
\224\ See, e.g., Joshua Ronen, Corporate Audits and How to Fix
Them, 24 Journal of Economic Perspectives 189 (2010) (explaining
that audit committee members are paid by the company and can be
dependent on top company management for a variety of benefits,
including referrals as a possible member on the board of directors
and audit committees of other companies); Liesbeth Bruynseels and
Eddy Cardinaels, The Audit Committee: Management Watchdog or
Personal Friend of the CEO?, 89 The Accounting Review 113 (2014)
(finding that companies whose audit committees have ``friendship''
ties to the CEO purchase fewer audit services and engage more in
earnings management); Cory A. Cassell, Linda A. Myers, Roy
Schmardebeck, and Jian Zhou, The Monitoring Effectiveness of Co-
Opted Audit Committees, 35 Contemporary Accounting Research 1732
(2018) (finding that the likelihood of a financial statement
misstatement is higher and that absolute discretionary accruals are
larger when audit committee co-option, as measured by the proportion
of audit committees who joined the board of directors after the
current CEO's appointment, is higher); and Nathan Berglund, Michelle
Draeger, and Mikhail Sterin, Management's Undue Influence over Audit
Committee Members: Evidence from Auditor Reporting and Opinion
Shopping, 41 AUDITING: A Journal of Practice & Theory 49 (2022)
(finding that greater management influence over audit committee
members is associated with a lower propensity of the auditor to
issue a modified going concern opinion to a distressed company under
audit and with increased opinion shopping behavior).
---------------------------------------------------------------------------

As a result, investors have an important, albeit indirect, role
overseeing the work of both the auditor and the audit committee.
Indeed, while the audit committee more directly oversees the auditor,
most publicly traded companies allow investors to vote to ratify the
appointment of the auditor. This mechanism allows investors to voice
their preferences on auditor selection.\225\ At the September 2024 IAG
meeting, one investor said that shareholders have an important role
holding both auditors and audit committees to account. By contrast,
another IAG member said that investors should not oversee the audit
because that is the role of the audit committee and one commenter said
that the proposal would challenge the legal structure of corporate
governance. However, a lack of transparency into the audit process may
leave investors unable to make well-informed decisions when voting on
selections made by the audit committee or on re-election of audit
committee members to the board of directors.\226\ Figure 5 illustrates
oversight relationships pertinent to the final rules. The dotted line
indicates that investors' oversight relationship with the auditor is
less direct than the audit committee's oversight relationship.
---------------------------------------------------------------------------

\225\ Shareholder ratification of the appointment of the auditor
is not statutorily required in the U.S. and in many cases the
ratification vote is non-binding. One commenter agreed with this
point. The commenter also suggested that it is rare for shareholders
to not ratify the audit committee's selection. However, according to
Audit Analytics, accessed on Mar. 1, 2024, in 2023, ratification
votes were held by 2,802 distinct companies included in the Russell
3000 index, which comports with other estimates that indicate
between 80 and 95 percent of companies hold votes on ratification
proposals as part of their proxy voting process. See also ACAP Final
Report, at VIII.20 (finding that 95 percent of S&P 500 companies and
70-80 percent of smaller companies put ratification proposals to an
annual shareholder vote) and Lauren M. Cunningham, Auditor
Ratification: Can't Get No (Dis)Satisfaction, 31 Accounting Horizons
159, 161 (2017) (finding that more than 90 percent of a sample of
Russell 3000 companies voluntarily include a ratification vote on
the ballot). The Board notes that broker discretionary voting is
permitted on ratification proposals and ratification proposals may
be used as a mechanism by some companies to achieve a quorum to
conduct an annual meeting as a result of brokers exercising
discretionary votes. Although the ratification vote is in many cases
non-binding, it can still be impactful as it sends a signal of
shareholder views. Academic studies show that non-binding votes in
other settings can pressure boards to reconsider its policies and
are considered by proxy advisors in setting their recommendation for
board members. See, e.g., Yonca Ertimur, Fabrizio Ferri, and Stephen
R. Stubben, Board of Directors' Responsiveness to Shareholders:
Evidence from Shareholder Proposals, 16 Journal of Corporate Finance
53 (2010) (finding a ``positive relation between the percentage of
votes cast in favor of the [non-binding] proposal and the likelihood
of implementation.''); and Aiyesha Dey, Austin Starkweather, and
Joshua White, Proxy Advisory Firms and Corporate Shareholder
Engagement, 37 Review of Financial Studies (3877 (2024) (showing
that when non-binding Say-On-Pay voting support falls below 70
percent, managers respond by increasing shareholder engagement). The
ability to vote on ratification of the appointment of the auditor is
recognized by investor groups as an important element of corporate
governance. See, e.g., Council of Institutional Investors, Policies
on Corporate Governance, (Sept. 11, 2023) at 2.13f available at
https://www.cii.org/corp_gov_policies.
\226\ The IAG indicated in their comment letter regarding
proposed QC 1000 that investors need information to make better
decisions when voting to ratify the appointment of the auditor and
the election to the board of directors of the Chair or members of
the audit committee.
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Figure 5. Oversight Relationships Pertinent to the Final Rules
[GRAPHIC] [TIFF OMITTED] TN11DE24.002

[[Page 100029]]

ii. The Market for Information Related to Auditors and Their
Engagements is Inefficient
Supply-Side Problems
Some basic economic theories suggest that high-quality firms should
have an incentive to voluntarily disclose information to the extent it
allows them to differentiate themselves from low-quality
competitors.\227\ However, economic theory also suggests that there may
be countervailing incentives that limit voluntary disclosure in
practice. For example, firms may be deterred by the costs they would
incur privately, such as how their competitors could leverage the
disclosures to capture market share.\228\ There may also be no
mechanism for firms to credibly disclose certain non-verifiable or
difficult to verify information, which can lead to the failure of such
information markets to exist entirely.\229\ There could also be a
status-quo bias whereby a firm prefers to continue a non-disclosure
policy despite investors' calls for additional information.\230\
Limited competition for the largest issuers could also reduce the
largest firms' incentives to voluntarily disclose information. Finally,
firms may tend to underprovide information due to: (i) the positive
externalities \231\ conferred by comparable and uniform public
disclosures (i.e., firms may not directly benefit from some of the
value provided to investors and audit committees); and (ii) the
challenges of coordinating on a single comparable and uniform reporting
framework.\232\
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\227\ See, e.g., Kip W. Viscusi, A Note on ``Lemons'' Markets
with Quality Certification, 9 The Bell Journal of Economics 277
(1978).
\228\ See, e.g., id.; Oliver Board, Competition and Disclosure,
57 The Journal of Industrial Economics 197 (2009) (finding that
companies may be reluctant to voluntarily disclose in competitive
markets); and Daniel A. Bens, Philip G. Berger, and Steven J.
Monahan, Discretionary Disclosure in Financial Reporting: An
Examination Comparing Internal Firm Data to Externally Reported
Segment Data, 86 The Accounting Review 417 (2011) (finding that
companies provide fewer segment disclosures due to proprietary costs
or competitive concerns).
\229\ See Akerlof, The Market for ``Lemons.''
\230\ There are a variety of reasons why individuals may choose
the status quo outcome in lieu of an unknown outcome, including
aversion to the uncertainty inherent in moving from the status quo
to another option. For additional discussion on status quo bias, see
William Samuelson and Richard Zeckhauser, Status Quo Bias in
Decision Making, 1 Journal of Risk and Uncertainty 7 (1988).
\231\ See Mankiw, Principles of Economics 196 (``An externality
arises when a person engages in an activity that influences the
well-being of a bystander but neither pays nor receives any
compensation for that effect . . . . If it is beneficial, it is
called a positive externality.'').
\232\ See, e.g., Anat R. Admati and Paul Pfleiderer, Forcing
Firms to Talk: Financial Disclosure Regulation and Externalities, 13
The Review of Financial Studies 479 (2000) (discussing how
individual firms ``internalize less than fully the social value of
the information they release'') and George Loewenstein, Cass R.
Sunstein, and Russell Golman, Disclosure: Psychology Changes
Everything, 6 Annual Review of Economics 391, 397 (2014).
---------------------------------------------------------------------------

Auditors could in principle supply information to investors and
audit committees individually depending on their unique preferences.
However, the costs to the firm to do so would grow with the number of
interested investors and audit committees and the extent of information
they would request. By contrast, under the final rules, the costs to
produce the final metrics will not grow with the number of interested
users.
Demand-Side Problems
While investors may seek to acquire information from the issuer,
they could incur significant private costs in doing so.\233\ At the
September 2024 IAG meeting, one investor said that her asset management
firm is generally denied meetings with audit committee chairs of U.S.
issuers. Further, the company may need to publicly disclose information
provided on a selective basis.\234\ Indeed, at the September 2024 IAG
meeting, several audit committee chairs said audit committees are
reluctant to meet with shareholders individually due to the risk of
violating disclosure laws. Hence the potential benefits of the
information to an individual investor would be dissipated because all
other investors would have the same information and any informational
advantage would be lost. This would further reduce individual
investors' incentives to obtain the information. A free-rider problem
thus exists among investors in which the costs incurred by one or more
investors to convince firms to disclose information would not be shared
by all investors who benefit from the disclosure.\235\ As a result,
economic theory suggests there should be an under-provision of such
information relevant to investors.
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\233\ See, e.g., Nickolay Gantchev, The Costs of Shareholder
Activism: Evidence from a Sequential Decision Model, 107 Journal of
Financial Economics 610 (2013).
\234\ See Regulation Fair Disclosure, 17 CFR 243.100(b)(1)(iv).
\235\ See Mankiw, Principles of Economics 220 and 222 (``A free
rider is a person who receives the benefit of a good but avoids
paying for it . . . . A free-rider problem arises when the number of
beneficiaries is large and exclusion of any one of them is
impossible.'').
---------------------------------------------------------------------------

As discussed above, audit committees are already privy to certain
information about their auditors beyond what is publicly available. In
particular, audit committees could request the final metrics from their
auditors or other tendering auditors. However, that information would
not necessarily be comparable with other engagements or other firms.
Requesting comparable information from multiple auditors could be
burdensome or even impracticable. As a result, while the audit
committee can use information from their auditor to better understand
their current engagements, the audit committee likely has a limited
view as to how other engagements--such as those of their peers--might
be conducted. Furthermore, less effective audit committees may not be
aware of the information and therefore would not request it in the
first instance. If audit committees were aware of the information and
made such a request, some audit firms may resist providing it to avoid
the costs of gathering the information and potential negative
reputational effects. Firms could also manipulate the information. As
one commenter said, the audit committee's principal tool is that of
inquiry, not observation, and inquiry, in audit parlance, is the
weakest form of audit evidence.
Evidence
Due in part to the problems discussed above, there is currently
limited information available to investors specifically related to
audit engagements. Indeed, investors know the least about the audit
engagement, as they are less involved in the issuer's operations
compared to management, the board of directors, and the audit
committee--and are even further removed from the audit process. Over
the last decade and a half, there have been sustained requests from
investors for increased transparency into the audit process. As
discussed above, investor-related groups have requested increased
disclosures at the firm and engagement levels--notably in the form of
easily accessible and quantifiable metrics, potentially with
accompanying context provided by the auditor. Furthermore, the ACAP
Final Report recommended that the PCAOB, in consultation with auditors,
investors, public companies, audit committees, boards of directors,
academics, and others, ``determine the feasibility of developing key
indicators of audit quality and effectiveness and requiring auditing
firms to publicly disclose those indicators.'' \236\
---------------------------------------------------------------------------

\236\ See ACAP Final Report, at VIII:14.
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There would likely be a significant cost to investors to conduct an
exhaustive search of all existing publicly available information
related to audit performance. For example, gathering the information
could require an investor to process various types of

[[Page 100030]]

data from various sources. Only the largest institutional investors
likely have the economies of scale to profitably gather this
information.\237\ Further still, the presence of significant block
holdings by diversified, passive investment-style funds, which often do
not hold board seats, means that such information may not be provided
by audit firms to a significant control group in cases where the fund
managers do not hold a board seat.\238\ Even proxy advisors rely upon
relatively limited publicly available information in making voting
recommendations, which investors may then rely upon in their own
decision-making.\239\ Due to the lack of information currently
available, it may be several financial reporting cycles before audit
committees and investors accumulate enough information (e.g., through
restatements, CAMs, audit committee communications, other public events
bearing on the auditor's reputation) to be able to effectively judge
the auditor's performance and act accordingly. Compared to investors,
audit committees are better able to accumulate information in less time
due to their ability to more easily request and receive information
from their auditor.
---------------------------------------------------------------------------

\237\ Some research suggests that institutional investors are
better-informed than retail investors. See, e.g., Cory A. Cassell,
Tyler J. Kleppe, and Jonathan E. Shipman, Retail Shareholders and
the Efficacy of Proxy Voting: Evidence from Auditor Ratification,
Review of Accounting Studies 75 (2022) and cites therein.
\238\ See, e.g., Amir Amel-Zadeh, Fiona Kasperk, and Martin C.
Schmalz, Mavericks, Universal, and Common Owners--The Largest
Shareholders of U.S. Public Firms, SSRN Electronic Journal, (2022).
The Board notes that SSRN does not peer review its submissions.
\239\ See, e.g., Cunningham, Auditor Ratification 163.
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As described in the baseline, a small group of auditors voluntarily
disclose some firm-level information through firm transparency
reports.\240\ However, many smaller firms do not voluntarily release
transparency reports and for those that do provide such information,
the metrics are not uniform or comparable across firms.\241\ One
commenter provided several examples of how firms' voluntary reporting
is not comparable across firms. Furthermore, PCAOB staff found that
firms generally do not voluntarily report engagement-level metrics
publicly. Some research on audit firm transparency reporting in foreign
jurisdictions suggests that the information is not useful while other
research finds that disclosure requirements improve audit quality for
impacted firms.\242\ Some academic studies find that, because the
information contained in transparency reports is relatively
unregulated, the disclosures and contextual discussion lack uniformity
and comparability across or within audit firms.\243\ Pointedly, audit
firms could alter the methodology and construction of any metric they
voluntarily choose to disclose. A lack of uniformity means that the
voluntary disclosures have limited comparative value, inhibiting their
usefulness in allowing investors to evaluate the efficacy of their
auditors.
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\240\ Audit firm transparency reports are voluntary and
unregulated disclosures, as they are not required by PCAOB standards
or applicable U.S. law. Consequently, audit firms can disclose
metrics of their own choosing and construction. In practice, as
discussed in above, audit firms that do publish transparency reports
include the disclosure of metrics that are required in reports
pursuant to disclosure rules in other jurisdictions, such as in the
European Union (i.e., EU--No 537/2014 Article 13), or similarly
adopted domestic requirements in the U.K. under the FRC's authority
(i.e., the Companies Act of 2006, and Statutory Auditors and Third
Country Auditors Regulations of 2016).
\241\ Some research suggests that lack of comparability can be a
problem even when disclosures are required. See, e.g., Thomas
Bourveau, Maliha Chowdhury, Anthony Le, and Ethan Rouen, Human
Capital Disclosures, SSRN Electronic Journal (2023) (finding that,
after the SEC adopted principles-based human capital disclosure
requirements in 2020, the resulting human-capital disclosures lacked
comparability). The Board notes that SSRN does not peer review its
submissions.
\242\ See, e.g., FRC, Transparency Reporting: AQR Thematic
Review, (Sept. 2019) (finding that surveyed investors and audit
committee chairs are either unaware of or perceive limited use in
audit firm transparency reporting in the U.K.) Rogier Deumes, Caren
Schelleman, Heidi V. Bauwhede, and Ann Vanstraelen, Audit Firm
Governance: Do Transparency Reports Reveal Audit Quality?, 31
AUDITING: A Journal of Practice & Theory 193, 194 (2012) (finding
that EU audit firm transparency reporting is not associated with
proxies for audit quality); and Shireenjit K. Johl, Mohammad Badrul
Muttakin, Dessalegn Getie Mihret, Samuel Chung, and Nathan Gioffre,
Audit Firm Transparency Disclosures and Audit Quality, 25
International Journal of Auditing 508 (2021) (finding that a
requirement for audit firm transparency reporting in Australia led
to an improvement in audit quality for the impacted entities).
\243\ See, e.g., Sakshi Girdhar and Kim Klarskov Jeppesen,
Practice Variation in Big-4 Transparency Reports, 31 Accounting,
Auditing & Accountability Journal 261 (2018) (finding that ``the
content of transparency reports is inconsistent and the transparency
reporting practice is not uniform within the Big-4 networks'').
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Two commenters said that the proposal cited no studies
demonstrating that there is a lack of information about auditors and
their engagements or evidence that the market is seeking additional
information. One commenter said that without sufficient dialogue with
investors, audit committees, and firms, it is unclear whether there are
information gaps in what is already provided and whether there is any
opportunity to expand or enhance what is already done today to meet
their expectations. The proposal discussed evidence related to the lack
of information despite a market demand, including several studies
related to the decision-relevance of current voluntary firm
transparency reporting.\244\ The proposal also discussed the demand
from various investor groups for additional information related to the
quality of firms and their engagements.\245\ Investor-related groups'
support for the proposal provides additional evidence that there is an
information gap and demand for information like the final metrics.
Indeed, one commenter said that existing information, including firms'
transparency reports, is insufficient and largely unused by the
investment community because it is seen as marketing material rather
than substantive, actionable data. According to the commenter, the lack
of information leads audit committee members to prefer Big 4 auditors
to protect or validate their decision-making in an environment where
the audit and auditor are credence goods. The Board notes that
transparency reports may also be unused because the information lacks
standardization.
---------------------------------------------------------------------------

\244\ See Proposing Release at 132-134.
\245\ See Proposing Release at Section IV.B.1.
---------------------------------------------------------------------------

One commenter said that the proposal appeared to acknowledge that
there is a lack of market demand for the proposed metrics. To the
contrary, as discussed in the proposal and again above, given the
considerations of benefits discussed below, the Board believes the lack
of incentive for firms to provide such information is likely the cause
of the apparent undersupply of information rather than a lack of market
demand.\246\ That is, the Board believes the limited availability of
information is more likely due to the supply and demand-side problems
discussed above rather than a lack of market demand. By contrast, two
commenters agreed that certain aspects of the market create limited
incentives to provide sufficient information to users of the financial
statements regarding audit quality. One commenter said that some
research suggests that investors want more information on the inputs to
audit production.\247\
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\246\ See Proposing Release at n. 212.
\247\ See Brant E. Christensen, Steven M. Glover, Thomas C.
Omer, and Marjorie K. Shelley, Understanding Audit Quality: Insights
from Audit Professionals and Investors, 33 Contemporary Accounting
Research 1648 (2016).
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2. How the Final Rules Address the Need
i. Mandatory Disclosure of Metrics
The final rules address the need by requiring mandatory public
disclosure of metrics relating to auditors and audit

[[Page 100031]]

engagements. Under the final rules, auditors will have the opportunity
to discuss the context of their metrics. The final rules could thus
reduce opacity in the audit market and reduce frictions in the
information market, thereby enhancing (i) audit committees' ability to
efficiently and effectively monitor and select auditors as well as (ii)
investors' ability to efficiently and effectively make decisions about
ratifying the appointment of their auditors and allocating capital. The
final metrics will quantify various aspects of firms' audit practice as
a whole and engagements performed. As described above, the collective
history of these final metrics will be publicly available. Moreover, as
noted above, the final metrics will be subject to requirements designed
to ensure their accuracy, including certification by the firm and
specific quality control requirements.
Investors and audit committees could use the final metrics to
better understand how their auditor has conducted their engagement and
how that compares to how other engagements were conducted.\248\ This
should improve their decision-making. Some commenters agreed that the
information about auditors and their engagements required by the
metrics would provide value to the decision-making process for
stakeholders. For example, the final metrics should help audit
committees engage in active discussions with their current auditors
regarding the audit process and interview candidate auditors when or if
a replacement auditor is desired.\249\ Audit committee disclosures
indicate that some audit committees consider a variety of public and
nonpublic information when engaging their auditor.\250\ The Board
believes the information could also inform investors' auditor
appointment ratification decisions. Research finds that investors are
more likely to challenge auditor appointments when they have access to
information that calls into question the quality or independence of the
firm, which suggests that, in some cases, investors will use
standardized information across firms and over time to make better
decisions.\251\ Referring to academic research, one commenter said that
investors do react to audit outcomes, audit behavior, and regulatory-
induced disclosures in the audit report. However, the commenter also
noted that: (i) the results are nuanced and context-specific; and (ii)
mixed for non-professional investors.\252\ Furthermore, investor-
related groups have indicated that they use the information contained
in Form AP. This suggests that they are familiar with Form AP and may
be interested in reviewing additional information provided there.
However, citing academic research, one commenter noted that the
influence of Form AP on investor decision-making is mixed.\253\
---------------------------------------------------------------------------

\248\ See, e.g., Christensen, et al. Understanding Audit Quality
(finding that surveyed investors believe information similar to
several of the final metrics [i.e., the sufficiency of engagement
team staffing, having well-trained auditors on the engagement team,
having auditors on the engagement team with appropriate expertise,
and the lack of financial statement restatements] impacts audit
quality).
\249\ See, e.g., AICPA, Hiring a Quality Auditor 9, (2018)
(discussing how audit committees should obtain all necessary
information from the auditor).
\250\ See, e.g., CAQ, 2023 Audit Committee Transparency
Barometer, 15-18 (2023) (presenting examples of audit committee
disclosures that summarize the information the audit committee
considered when appointing the auditor).
\251\ See, e.g., Paul Tanyi, Dasaratha Rama, and Kannan
Raghunandan, Shareholder Ratification of Auditors after PCAOB
Censures, SSRN Electronic Journal (2021) (finding that first-time
PCAOB censures of the largest accounting firms are associated with a
higher percentage of shareholders not voting to ratify the
appointment of the firm after the censure); Suchismita Mishra, K.
Raghunandan, and Dasaratha V. Rama, Do Investors' Perceptions Vary
with Types of Nonaudit Fees? Evidence from Auditor Ratification
Voting, 24 Auditing: A Journal of Practice and Theory 9 (2005)
(finding that the SEC's requirement for companies to disclose
partitioned information about tax and other non-audit fees paid to a
company's independent audit firm had a positive association with the
proportion of votes against ratifying the appointment of the firm in
2003); Paul N. Tanyi, Dasaratha V. Rama, and K. Raghunandan, Auditor
Tenure Disclosure and Shareholder Ratification Voting, 35 Accounting
Horizons 167 (2021) (finding that in the case of companies with long
[short] auditor tenure, the proportion of shareholder votes against
ratifying the appointment of the auditor increased [decreased] after
PCAOB mandated public disclosure of auditor tenure). The Board notes
that research also indicates that retail investors may not
necessarily use information regarding an audit firm in their
decisions to vote on a proposal to ratify the appointment of the
firm. See, e.g., Cassell, et al., Retail Shareholders (finding that,
on average, shareholder votes against ratifying the appointment of
the firm are not associated with audit failures but are associated
with investment performance). However, the same study also suggests
that non-retail investors are relatively better informed. One
commenter said it would be useful to know whether the PCAOB had
found any evidence of shareholders responding to the persistently
high rates of Part I.A deficiencies. One study finds some evidence
that shareholders vote against auditor ratification when their
auditors receive unfavorable PCAOB inspection reports. However, the
study finds the relationship only for the subset of companies where
corporate governance is weak. See Myungsoo Son, Hakjoon Song, and
Youngkyun Park, PCAOB Inspection Reports and Shareholder
Ratification of the Auditor, 17 Accounting and the Public Interest
107 (2017). The Board notes that SSRN does not peer review its
submissions.
\252\ See Robert W. Knechel, Gopal V. Krishnan, Mikhail Pevzner,
Lori B. Shefchik, and Uma K. Velury, Audit Quality: Insights From
the Academic Literature, 32 Auditing: A Journal of Practice & Theory
385, 387-388 (2013); DeFond and Zhang, A Review of Archival Auditing
Research; Peter Carey and Roger Simnett, Audit Partner Tenure and
Audit Quality, 81 The Accounting Review 653 (2006); Allison K. Beck,
Robert M. Fuller, Leah Muriel, and Colin D. Reid, Audit Fees and
Investor Perceptions of Audit Characteristics, 25 Behavioral
Research in Accounting 71 (2013); W. Brooke Elliott, Jessen L.
Hobson, and Brian J. White, Earnings Metrics, Information
Processing, and Price Efficiency in Laboratory Markets, 53 Journal
of Accounting Research 555 (2015); Christensen, et al.,
Understanding Audit Quality; Eric T. Rapley, Jesse C. Robertson, and
Jason L. Smith, The Effects of Disclosing Critical Audit Matters and
Auditor Tenure on Nonprofessional Investors' Judgments, 40 Journal
of Accounting and Public Policy 106847 (2021); and Sarah Judge,
Brian M. Goodson, and Chad M. Stefaniak, Audit Firm Tenure
Disclosure and Nonprofessional Investors' Perceptions of Auditor
Independence: The Mitigating Effect of Partner Rotation Disclosure,
41 Contemporary Accounting Research 1284 (2024).
\253\ See Jenna J. Burke, Rani Hoitash, and Udi Hoitash, Audit
Partner Identification and Characteristics: Evidence from US Form AP
Filings, 38 Auditing: A Journal of Practice & Theory 71 (2019);
Lauren M. Cunningham, Chan Li, Sarah E. Stein, and Nicole S. Wright,
What's in a Name? Initial Evidence of US Audit Partner
Identification Using Difference-in-Differences Analyses, 94 The
Accounting Review 139 (2019); Marcus M. Doxey, James G. Lawson,
Thomas J. Lopez, and Quinn T. Swanquist, Do Investors Care Who Did
the Audit? Evidence from Form AP, 59 Journal of Accounting Research
1741 (2021); Jeffrey Pittman, Sarah E. Stein, and Delia F.
Valentine, The Importance of Audit Partners' Risk Tolerance to Audit
Quality, 40 Contemporary Accounting Research 2512 (2023).
---------------------------------------------------------------------------

By making the final metrics public and therefore available to all
potential beneficiaries, the final rules should help ameliorate the
positive externality problem associated with public disclosure.\254\
Moreover, because these final metrics will be public, the increased
reputational risk they bring for auditors may, in turn, create
incremental incentives for auditors that will be subject to the final
requirements to maintain their reputation, or face a loss of business,
thereby increasing accountability.\255\ Public disclosure also
addresses investors' free-rider problem by eliminating the need for a
private actor to force firms to disclose.\256\ One commenter said there
are several mechanisms already in place to hold auditors accountable
and questioned whether accountability could be further improved. The
Board acknowledges that such mechanisms are in place (e.g., PCAOB
inspections). However, the Board believes the final rules will
complement existing accountability mechanisms. For example, the final
rules may enhance the PCAOB inspections approach.\257\ Another

[[Page 100032]]

commenter suggested that the Board consider firm incentives related to
legal liability, damage to reputation through restatement and
deficiencies, and PCAOB sanctions. The Board acknowledges that these
forces create some incentive for firms to keep audit quality above a
certain threshold. However, restatements are relatively rare events and
PCAOB sanctions are sporadic. Furthermore, PCAOB inspections are
constrained by existing PCAOB rules and standards. One commenter said
that while enforcement actions and inspection reports provide valuable
data, their extended delays often diminish their relevance for key
stakeholders.
---------------------------------------------------------------------------

\254\ See discussion above.
\255\ Two investor groups generally agreed with this benefit.
\256\ For additional discussion of the role of mandatory
disclosure as a regulatory tool, see, e.g., Admati and Pfleiderer,
Forcing Firms to Talk; and John C. Coffee, Jr., Market Failure and
the Economic Case for a Mandatory Disclosure System, 70 Virginia Law
Review 717 (1984).
\257\ See below for additional discussion on the benefits to the
PCAOB's inspection program.
---------------------------------------------------------------------------

Several commenters said that investors are not making use of
existing information that is similar to the proposed metrics,
suggesting that they would not make use of the proposed metrics either.
As support, two commenters referred to comments made during the
November 2, 2022 meeting of the PCAOB SEIAG.\258\ Citing a survey of
institutional investors, another commenter said that most institutional
investors are either unfamiliar with or unaware of firms' current audit
quality reports.\259\ Another commenter questioned whether investors
who are not fully utilizing the information contained in inspection
reports would also not use the proposed metrics. Citing a market
research report, one commenter noted that shareholders play a limited
role in practice when ratifying the appointment of the auditor.\260\ At
the September 2024 IAG meeting, one investor said that the average
investor is not engaging with the audit process or audit committees.
---------------------------------------------------------------------------

\258\ One commenter referred to a discussant on the panel who
made the following statement: ``My experience has been that
investors don't read the firm-level [PCAOB inspection] report. A lot
of them don't know they necessarily exist, right.'' Another
commenter did not refer to a specific discussant and referred to the
Nov. 2, 2023 meeting of the PCAOB SEIAG. However, the Board believes
the commenter intended to refer to the Nov. 2, 2022 PCAOB SEIAG
meeting because firm and engagement metrics were not a topic of
discussion during the Nov. 2, 2023 meeting.
\259\ See CAQ 2023 Survey. The survey was comprised in
interviews with 38 institutional investors working at companies with
a minimum of $500M in assets under management. The participants were
portfolio managers or investment analysts at buy side firms or
research directors or similar roles at sell side firms. The survey
did not describe how the participants were found or the questions
that were asked.
\260\ See Glass Lewis, 2024 Benchmark Policy Guidelines--United
States, (2024).
---------------------------------------------------------------------------

The Board appreciates these statements and research findings and
notes that they are consistent with some of the research cited in the
proposal and above.\261\ However, the Board notes that the CAQ 2023
Survey also finds that almost all surveyed institutional investors
assess audit quality by considering the firm's reputation, years of
experience, people, and technological resources. Apart from
technological resources, the final metrics will provide investors with
related information.\262\ The surveyed institutional investors also
expressed an interest in learning more about auditor communications to
audit committees through disclosures. The Board believes audit
committee members likely do occasionally request information like the
final metrics from their auditor. Indeed, one audit committee chair
said at the September 2024 IAG meeting that he requested information on
industry specialization from his auditor. A majority of the surveyed
institutional investors indicated that metrics related to the lead
engagement partner's background, engagement team tenure, and specialist
experience or related information would be useful. The survey also
states that engagement-level metrics were of greater interest to the
surveyed institutional investors than firm-level metrics because they
are specific to a company, objective, and measurable. The final metrics
will provide investors with engagement-level metrics. Collectively, the
Board believes this information supports the Board's view that
investors, particularly institutional investors, will find the final
metrics useful and indeed an improvement in the quality of information
over the limited information currently available.
---------------------------------------------------------------------------

\261\ See Proposing Release at Section IV.B.2.
\262\ See below for a discussion of alternative metrics
considered related to the use of technical resources.
---------------------------------------------------------------------------

One commenter suggested that the PCAOB consider how much
information investors will have about auditors compared to the amount
of information they will have about issuers. The Board does not believe
that such a comparison is relevant to the economic analysis and the
commenter did not explain how it would be relevant. The Board
acknowledges that, in some cases, the final metrics could provide
investors information about certain aspects of audit firms and their
engagements that they might not have about issuers. However, the Board
notes that, on balance, there is considerably more public disclosure
available regarding issuers than audit firms.
Many commenters representing firm or industry groups were skeptical
that investors could effectively use the information. One commenter
said that publication of metrics alone does not guarantee that
investors will use or be aware of them. Two commenters said that the
metrics' relationship to audit quality may not be clear. Several
commenters noted that, unlike audit committees, investors would not be
able to have a two-way conversation directly with auditors to
appreciate the full context of the firm and its audit. One commenter
questioned whether investors or audit committees would find the
information useful. One commenter noted some of the proposed firm-level
metrics (e.g., Partner and Manager Involvement, Workload) would be
useful to audit committees but expressed doubt that others (e.g., Use
of Auditor's Specialists, Allocation of Audit Hours, Experience of
Audit Personnel) would be useful. However, the commenter believed some
of the proposed metrics (e.g., Experience of Audit Personnel, Industry
Experience) could be useful at the engagement level. Several commenters
suggested that some or all of the proposed metrics would be useless
without context. Citing academic research that was also cited in the
proposal, one commenter said that retail investors would rely on the
proposed metrics only if they were clearly trending over time.\263\ One
commenter expressed concern that investors and audit committees could
have trouble utilizing the proposed metrics because there is a lack of
benchmarks, and it will be unclear to them how the proposed metrics
relate to audit quality. Two commenters said that tracking metrics
would become a compliance exercise and therefore would not transmit
useful information for stakeholders. One commenter said that there are
qualitative benefits of being a part of a GNF that cannot be properly
captured or measured through the proposed metrics.
---------------------------------------------------------------------------

\263\ See Brown and Popova, How do Investors Respond.
---------------------------------------------------------------------------

While most investors will not have the same context as audit
committees, the Board believes that many investors, particularly
institutional investors, do have sufficient context to make effective
use of the final metrics. Indeed, investors have access to much of the
contextual information that some commenters felt was critical, such as
the firm's size, the issuer's size, network membership, or the issuer's
industry. Many companies have robust shareholder engagement programs,
where managers and/or board members communicate directly with
shareholders.\264\ These programs could

[[Page 100033]]

raise investors' awareness of the metrics, provide an opportunity for
two-way conversation, and encourage them to vote on corporate
governance matters or raise concerns outside of the voting process.
Furthermore, even if investors decline to participate in outreach
efforts or no shareholder engagement program exists, proxy advisory
firms can use the information to inform their voting recommendations on
both auditor ratification and audit committee members.\265\ Thus, the
final metrics can still inform shareholder voting.\266\ Two investor
groups agreed with the Board's view that investors would use the
proposed metrics to make better decisions about ratifying the
appointment of their audit firm and allocating capital. Several other
commenters said that the metrics would be beneficial to investors and
other users of the audit report.
---------------------------------------------------------------------------

\264\ See, e.g., Ali Kakhbod, Uliana Loginova, Andrey Malenko,
and Nadya Malenko, Advising the Management: A Theory of Shareholder
Engagement, 36 Review of Financial Studies 1319 4 (2023) and cites
therein (discussing how communication between management and
shareholders has become increasingly prevalent).
\265\ Proxy voting guidelines do not currently appear to
reference audit quality, but do refer to poor accounting practices.
See, e.g., ISS, United States Proxy Voting Guidelines Benchmark
Policy Recommendations, (Jan. 2024), 16 (listing ``poor accounting
practices'' as a factor influencing its voting recommendations on
members of the audit committee.)
\266\ Research shows that proxy advisor recommendations
influence shareholder voting outcomes. See, e.g., Nadya Malenko, and
Yao Shen, The Role of Proxy Advisory Firms: Evidence from a
Regression-Discontinuity Design, 29 Review of Financial Studies 3394
(2016) (finding ``that the recommendations of proxy advisory firms
are a major factor affecting shareholder votes.'').
---------------------------------------------------------------------------

The Board also notes that auditors will be able to provide
investors with context through optional narrative disclosure.
Commenters had mixed views on the usefulness of the proposed narrative
disclosure. Some commenters believed the narrative disclosure would
allow firms to provide context necessary for appropriate understanding
and would allow firms to communicate critical context that may be
beneficial. However, several commenters believed it would not be
sufficient. The Board recognizes that the optional narrative
disclosures may not capture all relevant context. In such cases, firms
could provide additional voluntary disclosure (e.g., through their
transparency or quality reports).\267\
---------------------------------------------------------------------------

\267\ See above for a discussion on the optional narrative
disclosure, including commenters' views and how the final rules
address commenters' views.
---------------------------------------------------------------------------

One commenter suggested the Board had ignored significant work
conducted by the CAQ over the past decade regarding AQIs. The commenter
referred specifically to three reports published by the CAQ (the ``2014
CAQ Report,'' ``2016 CAQ Report,'' and ``2023 CAQ Report'').\268\ The
Board has reviewed each report. The 2014 CAQ Report and 2016 CAQ Report
summarize the results of stakeholder outreach and therefore inform the
Board's understanding of the need for standard setting and how the
final metrics address the need. The 2023 CAQ Report opines on
transparency reporting best practices.
---------------------------------------------------------------------------

\268\ See Center for Audit Quality, Approaches to Audit Quality
Indicators, (Apr. 2014) (``2014 CAQ Report''); Center for Audit
Quality, Audit Quality Indicators: The Journey and Path Ahead, (Jan.
2016) (``2016 CAQ Report''); and Center for Audit Quality, Audit
Quality Disclosure Framework (Update), (June 2023) (``2023 CAQ
Report''). By ``AQI,'' the 2014 CAQ Report and 2016 CAQ Report are
referring to measures that may provide further insight into audit
quality, as outlined in a PCAOB briefing paper presented to the
PCAOB's Standing Advisory Group Meeting on May 15-16, 2013. See
PCAOB, Discussion--Audit Quality Indicators (May 15-16, 2013),
available at https://pcaobus.org/news/events/documents/05152013_sagmeeting/audit_quality_indicators.pdf. Most of the final
metrics are very similar to an AQI discussed therein.
---------------------------------------------------------------------------

Based on outreach to various stakeholders, the 2014 CAQ Report
expresses optimism that AQIs can be useful to audit committees and help
promote audit quality. For example, the report concludes that
communication of engagement-level AQIs can help the audit committee
evaluate the actions taken or untaken by their auditor and help
maintain or increase audit quality. This is consistent with the
benefits related to audit committee monitoring of their auditor
discussed below. It also emphasizes the importance of context, which
the Board acknowledged in the proposal and discuss below in this
subsection. The report suggests a flexible approach to the
communication of metrics. The Board acknowledges this suggestion is in
tension with the adopted approach that specifies calculations for each
metric.\269\ However, for the reasons discussed in this subsection and
highlighted below, the Board believes that the current voluntary or
flexible approach would not sufficiently address the need for
comparable information.
---------------------------------------------------------------------------

\269\ See below for additional discussion on the Board's
decision to standardize the calculation of the metrics.
---------------------------------------------------------------------------

In the 2016 CAQ Report, the CAQ expressed a belief that reliable,
quantitative metrics related to the audit can: (i) inform audit
committees about matters that may contribute to the quality of an audit
and (ii) help audit committees make decisions related to auditor
appointment or reappointment as well as the selection of lead
engagement partners. Based on the result of a pilot study with audit
committees, and in addition to the findings summarized by the
commenter, the report found that participants: (i) generally supported
discussion of AQIs with the engagement team; (ii) felt that key aspects
of audit quality cannot be quantified such as professional skepticism;
(iii) acknowledge growing interest from investors regarding how audit
committees are fulfilling their responsibilities; and (iv) recognized
that AQIs can help audit committees oversee the quality of the external
audit.
The Board's economic analysis is largely consistent with these
views, in particular the Board's discussion of improved monitoring of
both the auditor and the audit committees below. However, participants
in the CAQ's pilot study also: (i) expressed a preference for a
flexible approach to AQI communication; (ii) noted that they already
have access to the information they need; and (iii) cautioned that
public disclosure of engagement-level metrics could lead to unintended
consequences such as benchmarking behavior or excessive focus on
measurable metrics. The Board acknowledges that there may be some
benefits to a more flexible approach to audit committee communications.
However, the Board believes a completely flexible approach could result
in audit committees having insufficient information or information with
limited utility, limit PCAOB oversight, limit comparability of metrics,
and exacerbate other unintended effects (e.g., manipulation of the
metrics).\270\ The proposal acknowledged that audit committees can
already seek to obtain information like the final metrics from their
incumbent auditors and the Board acknowledges this again below. Several
commenters agreed that audit committees already have access to
information about auditors and their engagements. Finally, the Board
notes that the proposal also discussed the potential unintended
consequences raised by participants in the pilot study, and the Board
discussed them again below.
---------------------------------------------------------------------------

\270\ See below for additional discussions on the Board's
decision to standardize the calculation of the metrics and on the
potential for auditors to manipulate their metrics.
---------------------------------------------------------------------------

Two factors limit the relevance of the 2014 CAQ Report and 2016 CAQ
Report. First, the reports contemplate voluntary communications by
auditors to audit committees rather than mandatory public disclosure.
Second, the auditing environment has evolved significantly since then.
For example, investors and audit committees now have access to Form AP
information and CAMs.
One commenter suggested that audit committees have access to
relevant

[[Page 100034]]

comparable data by reference to information firms are already currently
required to disclose pursuant to PCAOB rules (e.g., Form 2). The
proposal acknowledged the availability of this information and the
Board acknowledges it again above. However, as described above and
discussed further below, the final metrics will make new relevant
information available in a way that is much more accessible and
comparable than existing information sources. The commenter also said
that audit committees can seek relevant data from potential new audit
firms. The proposal acknowledged this and the Board discussed this
topic again below. Importantly, the Board notes that audit committees
may have trouble obtaining comparable information from potential new
auditors. One commenter suggested that audit committees would likely
prefer to obtain information through conversation with their auditor
directly rather than refer to a database of metrics. Under the final
rules, audit committees will be free to request the final metrics or
any other related information from their auditor directly.
One commenter performed a survey of audit committee chairs of large
U.S. public companies. The commenter did not indicate the number of
participants, how participants were selected, demographic information,
or the questions they were asked. The participants said that they
already receive or have access to most of the information in the
proposal as part of the audit process and any other information would
likely not be valuable to them. The Board discussed this limitation
along with important caveats in the proposal and discusses it again
below. The Board also notes that, at the same time, participants also
expressed desire for additional information on artificial
intelligence.\271\ Participants also opined on the extent to which
investors would use the information. First, some participants said
information like the proposed metrics is rarely requested by or
discussed with investors. The Board discussed in the proposal and above
the challenges investors face obtaining information through this
channel. The Board also discussed above how investors may be less vocal
because they do not believe it is possible to obtain useful information
in the current environment. The Board also notes that commenters
representing a broad array of investors, investment managers, investor
advocates, and other financial reporting experts said that the metrics
would be useful. Second, some participants noted that the information
would only be available to investors annually and therefore would be
stale. The Board acknowledges that investors will have access to the
metrics on an annual basis. The Board believes that requiring firms to
disclose the metrics on a more continuous basis would require a
significantly greater investment in time and resources by the firms.
The Board also notes that a broad range of commenters generally agreed
that audit committees will find most or all of the information useful,
especially engagement-level metrics.
---------------------------------------------------------------------------

\271\ The Board's decision not to include a metric related to
the use of technical resources is explained in Section IV.D.3.iv.d
of the proposal and below.
---------------------------------------------------------------------------

One commenter representing a firm-related group performed a survey
of audit committee members by way of its member firms. The same
commenter also commissioned a third party to perform an investor
survey.\272\ Each survey provides information related to the need for
and potential benefit of the proposed metrics. The Board discussed each
survey below.
---------------------------------------------------------------------------

\272\ See Letter from Center for Audit Quality (Aug. 1, 2024)
available at https://pcaobus.org/about/rules-rulemaking/rulemaking-dockets/docket-041.
---------------------------------------------------------------------------

The audit committee members survey involved 242 participants. The
participating audit committee members sit on audit committees of a
range of companies by size and industry sector. The commenter did not
completely describe the basis on which audit committees were invited to
participate in the survey. The commenter did provide the survey
questions. Fifty-nine percent of participants said the information
available to them to fulfill their external auditor oversight
responsibilities meets all of their needs. Thirty-six percent said the
information meets most of their needs and the remaining 5% said the
information meets less than most of their needs. These results suggest
that most audit committees believe the current information environment
is sufficient. However, the results do not imply that additional
information cannot be useful to audit committee members. Indeed, 27% of
the surveyed audit committee members seek more information about how
their audit engagement is being performed, about the audit firm, or
about other audit firms. Furthermore, some participants may have been
reluctant to say that the information available to them to fulfill
their responsibilities does not meet most or all of their needs because
it would imply they are not fulfilling their responsibilities. Other
results of the survey are largely consistent with information presented
in the proposal and above. For example, 78% of participants agreed that
there could be unintended consequences and 73% said there would be
challenges interpreting the proposed metrics. Eighty-two percent of
participants said they had concerns about data specific to their audit
being available publicly; however, the specific concerns were not
raised and, by contrast, only 40% were concerned that the proposed
mandatory reporting could increase director liability. Fifty-nine
percent of participants agreed that some standard information about
auditors should be considered. Eighty percent of participants said they
rarely or never use PCAOB Form AP and 78% said they rarely or never use
PCAOB registrations data; rather, the quality of conversation with the
auditor is the top way audit committees evaluate the quality and
reliability of the audit. Finally, 90% of participants said that PCAOB
standards and rules are well-suited or have mostly kept up with change.
Use of technology in the audit was more commonly ranked than firm and
engagement metrics as an area where the audit committee would like to
see the PCAOB modernize its auditing standards. The Board notes that
the PCAOB recently adopted amendments to auditing standards related to
auditors' use of technology-assisted analysis and recently proposed a
standard related to auditors' use of substantive analytical
procedures.\273\ The Board also notes that, while informative to the
PCAOB generally, such comparisons are less relevant to the economic
analysis of the final rules.
---------------------------------------------------------------------------

\273\ See Amendments Related to Aspects of Designing and
Performing Audit Procedures that Involve Technology-Assisted
Analysis of Information in Electronic Form, PCAOB Rel. No. 2024-007
(June 12, 2024); Proposed Auditing Standard--Designing and
Performing Substantive Analytical Procedures and Amendments to Other
PCAOB Standards, PCAOB Rel. No. 2024-006 (June 12, 2024). The SEC
approved the PCAOB's amendments to auditing standards related to
auditors' use of technology-assisted analysis on Aug. 20, 2024.
---------------------------------------------------------------------------

The investor survey involved 100 participants. Participants were
screened to ensure they are professional institutional investors
employed at companies that manage at least $500 million in assets and
have at least five years of experience and serve at the director level
or higher. Besides these requirements, the participating investors
cover a variety of job levels, experience levels, and ages, cover both
genders, and primarily (80%) focus on both large accelerated filers and
accelerated filers. The commenter did not completely describe the basis
on which investors were invited to participate in the

[[Page 100035]]

survey. The commenter did provide the survey questions. Eighty-six
percent of the participants work for banks or credit unions, 13% for
other types of funds, and 1% for family offices.
Fifty-three percent of participating investors indicate they trust
the audit of public company financial statements completely and 40%
trust them a great deal. Furthermore, 57% of participating investors
feel the information available to assess the quality of the audit meets
all their needs and 35% feel it meets most of their needs. However, the
Board believes the respondents may be focusing on whether information
currently available permits them to fulfill their fiduciary
responsibilities narrowly defined, similar to the audit committee
members. First, just 17% of participating investors said they do not
want to see any additional information about the audit to evaluate its
quality. All others wanted additional information about the auditing
process, team specifics, qualifications, and more generally, other
information. The final metrics will provide such information. Second,
almost all of the proposed metrics were indicated as being extremely
helpful by between 30% and 50% of participated investors. The commenter
did not indicate whether the survey allowed less favorable responses
and, if so, what the participants' responses were.
The commenter noted that there were variances between these
percentages and the portion of participating investors who said they
would likely seek out the information on the PCAOB website. The
commenter interpreted these variances as being consistent with their
view that understanding how investors would use the information is
necessary. The Board agrees that understanding how investors would use
the information is important. Indeed, the Board discussed through the
economic analysis how the Board believes investors will use the
information. However, the Board believes these variances are difficult
to interpret because it is unclear what the practical difference is
between finding a metric helpful and being likely to proactively seek
it out. Therefore, the variances may be driven by confusion among
respondents.
Notably, despite broad agreement that engagement-level metrics
would be helpful and 83% wanting some additional information about
audit quality in the companies they invest in, 83% of surveyed
investors somewhat or strongly agreed with the statement that mandated
public disclosure of engagement-level performance metrics could lead to
unintended consequences and as such should be voluntary. The survey did
not indicate what unintended consequences the surveyed investors
thought might occur or whether they were aware that the final rules
would permit firms to provide an optional narrative disclosure along
with each metric.\274\
---------------------------------------------------------------------------

\274\ See above for a discussion on the limitations of voluntary
auditor reporting.
---------------------------------------------------------------------------

Other results of the investor survey are largely consistent with
information presented in the proposal and above. For example, investors
use a variety of publicly available information to assess audit quality
(e.g., audit quality reports, inspection reports, reputation and the
auditor's opinion and ICFR evaluation, PCAOB website). Investors also
agree that context would be important for understanding the proposed
metrics.
The Board notes that the views of participating investors were
different from the views of audit committee members in two important
ways. First, investors are more optimistic that the proposed metrics
would be useful to audit committees. Indeed, 30% of participating
investors strongly agree that audit committees lack access to the
information they need to make informed decisions about selecting an
auditor (39% somewhat agree) and 34% strongly agree that mandatory and
standardized firm and engagement metrics are necessary for company
management and audit committees to uphold fiduciary responsibilities to
shareholders (47% somewhat agree). Second, investors more strongly
believe that PCAOB standards and rules are in need of updating. Where
90% of surveyed audit committee members said that PCAOB standards and
rules are well-suited or have mostly kept pace with change, just 26% of
surveyed investors said PCAOB standards and regulations are well-suited
for their intended purpose and 42% believed they had mostly kept up
with change. More specifically, where 17% of surveyed audit committee
chairs cited firm and engagement areas among the top three areas they
would like to see the PCAOB modernize auditing standards, 28% of
surveyed investors cited it among their top three areas.
A commenter representing an investor-related group pointed to
another survey of investors.\275\ This survey was conducted by the
commenter in July 2017. The survey was limited to members of the
commenter's group and targeted primarily buy-side portfolio managers
and research analysts, sell-side analysts, credit analysts, and
corporate financial analysts. There were 284 initial respondents. The
commenter did not completely describe the basis on which investors were
invited to participate in the survey. The commenter did provide the
questions asked. The survey's finding, as highlighted by the commenter,
underscores that (i) the quality of information communicated to
investors, including AQIs, is very important to how investors perceive
the value of an audit and (ii) developing and monitoring AQIs is a high
standard-setting priority for investors.\276\ According to the
commenter, the results of the survey suggest that firm and engagement
metrics are a priority for investors, a viewpoint with which the Board
agrees and that accords with other investor feedback the Board has
received over the course of this project. The Board notes that survey
respondents rated information like the final metrics (e.g., restatement
of company financials, industry expertise of audit personnel, training
and accreditation of audit personnel, tenure of engagement partner,
number of audit staff per audit partner, audit firm recruitment and
retention practices) between 2.71 and 3.66 in importance (one being
``not important'' and four being ``very important.'').
---------------------------------------------------------------------------

\275\ See CFA Institute, CFA Institute Member Survey Report:
Audit Value, Quality, and Priorities, (July 2017) (``2017 CFA
Institute Survey''), available at https://rpc.cfainstitute.org/en/research/surveys/audit-value-quality-priorities-survey-report.
\276\ Id. at Table 1. The Board notes that the 2017 CFA
Institute Survey did not define ``AQI.''
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While the Board believes the final metrics will help reduce opacity
in the audit market and reduce frictions in the information market, the
Board notes that the final metrics will not be direct measures of audit
quality. Audit quality is an abstract concept, and there is no single
comprehensive measure of audit quality. Audit quality is a concept
designed to describe the characteristics of, and participants in, audit
engagements in which the auditors are more likely to identify and
report material misstatements. Or, more broadly, audit quality reflects
all of the components of the audit that align with desirable
outcomes.\277\ The desired outcomes of the framework depend (to some
extent) upon the stakeholders involved, even if there are certain
consistent areas of focus. As a result, the final metrics cannot
directly measure audit quality. And they are not intended to do so,
as--without additional context--it is unlikely they can be interpreted
directly as measurements of audit quality. The final metrics are not

[[Page 100036]]

intended to imply that an increase (decrease) in a particular metric,
or a group of metrics, necessarily relates to an increase (decrease) in
audit quality. Lastly, the Board does not believe that the final
metrics, individually or taken together, could be appropriately used in
isolation to ascertain audit quality at an audit firm or for an audit
engagement. For example, some of the most important elements of a high-
quality audit, such as application of due care and professional
skepticism, are not capable of being entirely measured and quantified
directly.
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\277\ For a review of various definitions and discussions of the
latent attributes of audit quality, see, Knechel, et al., Audit
Quality.
---------------------------------------------------------------------------

Two commenters agreed that no single metric can be viewed as having
a causal relationship to audit quality. Several other commenters agreed
that the correlation between the proposed metrics and audit quality is
far from perfect. However, two commenters interpreted this caveat
regarding the relationship between the proposed metrics and audit
quality to imply that the proposed metrics cannot be decision-relevant
to investors and audit committees. The Board does not believe this to
be the case. The Board continues to believe that certain aspects of
audit quality cannot be measured. However, the Board does not believe
this implies that the final metrics will be irrelevant to investors and
audit committees. To the contrary, as said by one commenter, the Board
believes certain aspects of the audit can be measured.
One commenter said that the purpose and use of the metrics are not
consistently correlated with stakeholders' needs because the proposal
lacked an explicit definition of audit quality. The Board does not
believe a definition of audit quality is necessary for the metrics to
be correlated with stakeholders' needs. Investors' and audit
committees' information needs are explicitly stated above. The Board
believes the arguments made in this subsection, in conjunction with the
discussion of benefits below, establish a correlation between the final
metrics and stakeholders' needs.
ii. Uniform and Comparable Metrics
In addition to mandating disclosure, the final rules will also
specify the data sources and calculations for each final metric and
require their disclosure in PCAOB forms in an electronic, structured
data format. Collecting and reporting information in this manner will
likely enhance the usefulness of the information to investors and audit
committees by allowing them to more easily access the information and
compare firms and engagements. Regular annual reporting should also
allow investors and audit committees to form judgments regarding the
quality of their auditor sooner (e.g., compared to restatements which
may take several years to occur or PCAOB inspection reports which may
be released several years after an audit engagement was performed).
Commenters' views on comparability are discussed above. Overall,
commenters questioned whether the engagement-level metrics would be
comparable due to the importance of company-specific context, which in
their view is necessary for understanding the metrics. Two commenters
suggested that even firm-level metrics are not comparable. One
commenter said that differences in the centralization or complexity of
issuers' IT infrastructures could be a reason for cross-sectional
differences in the engagement-level metrics rather than differences in
the audit. One commenter suggested that comparability would improve if
the metrics would account for firm size, issuer size, and industry. One
commenter suggested that the standardized calculations, rather than
facilitate comparability, could reduce it because they would not be
appropriate for every firm. Several commenters suggested that the
standardized calculations would not be flexible enough to evolve over
time as the auditing environment changes. Relatedly, one commenter
suggested that the PCAOB revisit in the future the appropriate
calculations. One commenter said the proposed metrics would be
meaningless without sufficient context. By contrast, one commenter said
that investors are aware that the metrics will not be perfectly
comparable and that they are trained to analyze this type of
information.
The Board agrees that context could be important to understanding
any individual metrics. As discussed above in this subsection, the
Board believes that no set of metrics, individually or collectively,
can completely measure audit quality. Accordingly, the Board has
provided auditors the opportunity to disclose additional context for
each metric. The Board acknowledges that firm size, issuer size, and
industry could be important context when interpreting a metric.
However, the Board notes that this information about issuers is already
available to the public, and the Board believes that stakeholders will
be better served by a rule that permits them to consider this
information alongside the metrics as they see fit rather than by
prescribing how they should be accounted for. The Board also notes
that, under the final rules, firms will be free to provide additional
information voluntarily to their stakeholders (e.g. through audit
quality or firm transparency reporting) that they believe better
captures the changing environment. The Board recognizes that the
standardized calculations will not explicitly account for all relevant
facts and circumstances for each firm. However, notwithstanding the
potential importance of context for understanding any individual
metric, the comparability of information about firms and their
engagements will be improved overall compared to the current largely
voluntary state by mandating specific metrics and calculations. The
Board discussed a potential post-implementation review (PIR) below.
Economic Impacts
This section discusses the expected benefits, costs, and potential
unintended consequences of the final rules. The magnitudes of the
benefits and costs are likely to be affected by the degree to which
firms have already voluntarily adopted disclosure practices that are
similar to those required under the final rules or produce similar
metrics for non-public purposes. As discussed above, as of the 2018 and
2019 inspection years, the U.S. GNFs already track some metrics like
those being adopted. Though their practices may have evolved since
then, the Board believes they will need to gather additional
information or adjust their calculations. The magnitude of the impacts
may also vary by stakeholder depending on how useful the metrics are
for the decisions they face. Stakeholders who find the final metrics
more useful will be more likely to incur the costs and benefits of
integrating the final metrics into their decision-making. The Board
believes the final rules will have a greater impact on smaller firms
which likely have less developed practices in this area.
Several commenters suggested that the PCAOB should consider the
cumulative effects of the reporting requirements in this rulemaking
along with other rules and standards that have recently been proposed
or adopted. One commenter reported results of a survey of audit
committee member respondents in which 76 percent of 145 respondents
indicated concern about the cumulative impact of PCAOB standard-setting
and rulemaking on audit quality and 24 percent indicated no
concern.\278\ Consistent with long-standing practice and the PCAOB's
staff guidance on economic analysis, the Board's economic analysis for
each rulemaking

[[Page 100037]]

considers the incremental benefit and costs for the specific rule--
i.e., the benefits and costs stemming from that rule compared with the
baseline.\279\ There could be implementation activities for certain
provisions of other rules and standards that overlap in time with
implementation of the final rules, which may impose costs on resource
constrained firms affected by multiple rules. This may be particularly
true for smaller and mid-sized firms with more limited resources. In
determining effective dates and implementation periods, the Board
considered the benefits of rules as well as the costs of delayed
implementation periods and potential overlapping implementation
periods. The Board also considered that in some cases, overlapping
implementation periods may have benefits because firms will not need to
revise or redo previous process or system changes where rules interact
with each other. For example, firms could benefit in this regard by
implementing the final rules while also implementing QC 1000 and, if
approved by the SEC, the PCAOB's Firm Reporting rules because all three
rulemakings address external reporting.
---------------------------------------------------------------------------

\278\ The survey is discussed in greater detail above.
\279\ See Staff Guidance on Economic Analysis in PCAOB Standard-
Setting (Feb. 14, 2024) (``Staff Guidance on Economic Analysis''),
available at https://pcaobus.org/oversight/standards/economic-analysis/05152014_guidance.
---------------------------------------------------------------------------

Several investor group commenters stated they believe the benefits
of the proposal would exceed the costs. In contrast, other commenters
stated they believe the costs of the proposed metrics will not be
proportionate to the benefits. One commenter said there was a lack of
academic evidence about whether the benefits exceed the costs. One
reason that academic evidence related directly to whether the benefits
of the proposal exceed the costs is limited is likely that, for the
reasons discussed above, the necessary data do not exist. However, the
economic analysis incorporates where appropriate academic evidence
related to certain impacts of the proposal. Furthermore, as described
above, the Board has quantified certain impacts to the extent feasible.
One commenter suggested that a more complete economic analysis of the
proposal would reveal that the costs exceed the potential benefits. The
commenter did not indicate a data source or methodology that would
allow for a quantitative analysis of all benefits and costs. The
commenter also did not indicate how they know what the results of such
an analysis would be. One commenter suggested that the PCAOB expand the
proposal to consider whether the benefits outweigh the costs. Another
commenter said that they saw no indication that the Board had addressed
whether investors and other stakeholders would place greater weight on
the asserted benefits against increased audit fees. The economic
analysis separately analyzes benefits and costs, and as stated above,
the Board is not able to quantify all relevant benefits and costs due
to data limitations. However, the Board notes that one commenter
representing an investor-related group said that investors recognize
they ultimately bear the cost of creating such information and metrics
and are generally willing to pay for information and metrics.
1. Benefits
As discussed above, the final metrics could enhance (i) audit
committees' ability to efficiently and effectively monitor and select
auditors as well as (ii) investors' ability to efficiently and
effectively make decisions about ratifying the appointment of their
auditors and allocating capital. Moreover, there will likely be
improvements to the PCAOB's oversight programs (i.e., selection of
firms, engagements, and focus areas for review), as well as to policy
research. As an important indirect benefit, the final rules could
further spur competition to the benefit of investors. Thus, while the
metrics do not represent a comprehensive measure of audit quality,
stakeholders may use the metrics in ways that could improve audit
quality.\280\ Several investor-related groups generally agreed with
these benefits. One commenter said that reporting of proposed metrics
would improve audit quality across the profession.
---------------------------------------------------------------------------

\280\ While some of the most important elements of high-quality
audit, such as the application of due care and professional
skepticism, cannot be fully measured or quantified, the final
metrics provide proxies for certain aspects of audit quality, such
as years of experience, auditor workload, and the percentage of
audit hours attributable to senior members of the audit team. These
proxies, while not a complete measure of audit quality, offer
important information about auditors and the engagements they lead,
which stakeholders can use to inform their decisions.
---------------------------------------------------------------------------

Auditors have a responsibility to obtain reasonable assurance about
whether the financial statements are free of material misstatement. If
use of the metrics leads to higher audit quality, it could increase the
likelihood that the auditor will discover a material misstatement or
will qualify its audit opinion when a material misstatement exists and
is not corrected by management.
The SEC does not consider the requirements for audited or certified
financial statements in Rule 2-02(b) of Regulation S-X to be met when
the auditor's report is qualified. 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. Financial statements that are
free of material misstatement are of higher quality and more useful to
investors.\281\ An investor-related group said that investors demand
high-quality audits because reliable audited financial statement are
critical to investors in making informed decisions.
---------------------------------------------------------------------------

\281\ The Board notes several caveats. First, some theoretical
research finds that changes to auditing standards can have
counterintuitive effects on audit quality. For example, some
research finds that increased precision in auditing standards can
reduce audit quality. See Marleen Willekens and Dan A. Simunic,
Precision in Auditing Standards: Effects on Auditor and Director
Liability and the Supply and Demand for Audit Services, 37
Accounting and Business Research 217 (2007). Other research finds
that setting a higher minimum bar can reduce audit quality. See
Pingyang Gao and Gaoqing Zhang, Auditing Standards, Professional
Judgment, and Audit Quality, 94 The Accounting Review 201 (2019).
The Board acknowledges that these studies examine the impacts of
audit performance standards. By contrast, the Board adopted a
disclosure standard. This may limit the relevance of these studies
to the final rules. The Board is also unaware of empirical evidence
that directly tests these theories. Second, the conclusion that
financial statements that are free of material misstatement are more
useful to investors hinges on the assumption that investors value
compliance with the applicable financial reporting framework (e.g.,
U.S. GAAP). The various market reactions to restatements that have
been documented in academic literature suggests that this is the
case. Third, the conclusion that improved audit quality would
improve financial reporting quality assumes that issuers would not
switch to sufficiently lower quality auditors in sufficient number
as a result of the final rules. Finally, one commenter said, and the
Board agrees, that the proposed metrics cannot be viewed as the only
proxy for measuring financial reporting quality.
---------------------------------------------------------------------------

In the following discussion, the Board discussed the direct
benefits related to enhancing the information available to investors,
audit committees, and other stakeholders and follow up with a
discussion of the potential indirect benefits. The Board then reviews
the extant literature related to the final metrics and examine how each
final metric could contribute to achieving the final rules' intended
benefits.
i. Direct Benefits to Investors, Audit Committees, and the PCAOB
The direct benefits of the final rules relate to (i) improved
investor and audit committee monitoring, (ii) improved

[[Page 100038]]

auditor selection, and (iii) improved PCAOB oversight and scholarly
auditing research. The Board believes these benefits will arise because
the final metrics will significantly augment the information set
available to stakeholders and thereby enhance their decision-making.
Each of the final metrics and how they would enhance decision-
making is discussed in detail above. To summarize, the final metrics
relate broadly to audit personnel, allocation of audit hours, and audit
outcomes. The final metrics related to audit personnel will provide
information on the audit team's involvement and workload (i.e., Partner
and Manager Involvement, and Workload), turnover (i.e., Retention of
Audit Personnel), experience (i.e., Experience of Audit Personnel),
industry specialization (i.e., Industry Experience), and training
(i.e., Training Hours for Audit Personnel). The final metrics related
to the allocation of audit hours will provide information on the
allocation of audit hours prior to the issuer's year end (i.e.,
Allocation of Audit Hours). The final metrics related to outcomes will
provide information on restatement trends (i.e., Restatement History).
These metrics could enhance decision-making by helping stakeholders
assess whether auditors are appropriately staffing their engagements,
budgeting their time, and achieving desirable outcomes. As the
following examples illustrate, stakeholders will likely make these
judgments based primarily on their experience and by comparison to
similar firms or engagements and in conjunction with other information
available to them (e.g., the other metrics, issuer's unique facts and
circumstances, or research).\282\ These examples are meant as
illustrations only; investors and audit committee members may interpret
the final metrics differently depending on specific circumstances.
---------------------------------------------------------------------------

\282\ Academic literature on how various proxies for the final
metrics relate to various proxies for audit quality is summarized
below.
---------------------------------------------------------------------------

An investor may observe that one issuer's auditor has more
industry experience than a comparable issuer's auditor. Depending on
the magnitude of the difference and other information available to the
investor, the investor may take this as a sign regarding the relative
reliability of the audit and, consequently, the issuer's financial
statements. This could influence the investor's voting or capital
allocation decisions.
An audit committee member may observe that an engagement's
partners and managers were more involved than the audit committee
member expected based on their experience. While the audit committee
member may believe partner and manager involvement is, as a general
matter, a sign of good quality control, the audit committee member may,
depending on the facts and circumstances, suspect there was a problem
that required the partner's attention. As a result, the audit committee
member may request additional information from the auditor.
An investor may observe that the auditor's retention
metric is a low outlier compared to prior years. This may lead the
investor to question the auditor's ability to gather sufficient
appropriate audit evidence and, depending on other information
available, may inform the investor's vote on ratification of the
auditor or re-election of audit committee members to the board of
directors.
An audit committee member may observe that the auditor's
allocation of audit hours prior to the year's end indicates, based on
academic research, an elevated risk of audit deficiency and
restatement. As a result, the audit committee member may work with the
auditor to find ways to improve the planning of a future audit.
The Board notes that the benefits of mandatory disclosure are well-
studied and have been measured in other markets such as credit ratings,
health care, and financial reporting.\283\ Likewise, the benefits of
comparable information have been observed in financial reporting.\284\
There are important similarities between the markets for credit
ratings, health care, and financial reporting and the audit market. For
example, credit ratings services, like audit services, are opaque and
operate under an ``issuer-pays'' business model. Therefore, the impacts
of disclosure observed in those markets provide some indication of the
potential impacts the final rules could have on the audit market.
However, there are also significant differences. For example, the
quality of health care services may, in some cases, be more visible
than the quality of audit services. These differences limit the
relevance of these studies. The disclosures studied in these markets
may also not be directly comparable to the final metrics and therefore
are less relevant.
---------------------------------------------------------------------------

\283\ For example, in the context of credit ratings, research
has found that the introduction of additional credit ratings
information into the market leads relatively higher quality
borrowers to obtain lower borrowing costs by 20 basis points. See
Tony Tang, Information Asymmetry and Firms' Credit Market Access:
Evidence from Moody's Credit Rating Format Refinement, 92 Journal of
Financial Economics 325 (2009). The Board notes that the relevance
of this finding is limited by the fact that the studied disclosure
relates to the quantity of information provided by the credit rating
agency rather than the quality of service provided by the credit
ratings agency. In the context of nursing home care, one study finds
that mandatory disclosure of quality indices leads to improvement in
two of the five indices. See Dana B. Mukamel, David L. Weimer,
William D. Spector, Heather Ladd, and Jacqueline S. Zinn,
Publication of Quality Report Cards and Trends in Reported Quality
Measures in Nursing Homes, 43 Health Services Research 1244 (2008).
For a discussion of potential benefits of mandatory financial
reporting quality as well as potential unintended consequences, see
Christian Leuz and Peter D. Wysocki, The Economics of Disclosure and
Financial Reporting Regulation: Evidence and Suggestions for Future
Research, 54 Journal of Accounting Research 525 (2016) and cites
therein. However, some research also finds that mandatory disclosure
can have little effect. For example, in the context of HMOs, one
study finds that, following the introduction of public disclosure of
six quality scores, only one--customer satisfaction--subsequently
drove HMO market share and the effect was most pronounced in markets
where true quality varied the most. See Leemore Dafny and David
Dranove, Do Report Cards Tell Consumers Anything They Don't Already
Know? The Case of Medicare HMOs, 39 The Rand Journal of Economics
790 (2008).
\284\ See, e.g., Mark L. DeFond, Xuesong Hu, Mingyu Hung, and
Siqi Li, The Impact of Mandatory IFRS Adoption on Foreign Mutual
Fund Ownership: The Role of Comparability, 51 Journal of Accounting
and Economics 240, 241 (2011) (finding that greater financial
reporting comparability leads to greater investment); Luigi
Zingales, The Future of Securities Regulation, 47 Journal of
Accounting Research 395 (2009) (concluding that a more subtle
benefit of disclosure regulation is the standardization it entails);
and Bingyi Chen, Ahmet C. Kurt, and Irene Gunnan Wang, Accounting
Comparability and the Value Relevance of Earnings and Book Value, 31
Journal of Corporate Accounting & Finance 82 (2020) (finding that
``accounting comparability increases the value relevance of
earnings, but not book value'').
---------------------------------------------------------------------------

The Board also notes that the benefits of prior PCAOB disclosure
rules vary by rule and analysis.\285\ Citing academic research, one
commenter said studies show that, while the information contained in
Form AP may improve the perception of auditors and financial reporting,
Form AP is not influencing investors' decision-making. Referring to
research discussed above and in the

[[Page 100039]]

proposal, the commenter also said that CAMs are not driving decision-
making by investors.\286\ By contrast, a recent survey finds that
institutional investors generally rely on CAMs when making investment
decisions and read the CAMs section in the Form10-K.\287\ Approximately
half said that additional information would be even more beneficial.
There are important similarities between these disclosure rules and the
final rules. For example, CAM reporting and Form AP reporting
requirements were significant changes in auditor reporting and the
final engagement-level disclosures will be reported on Form AP.
Therefore, the results of these studies provide some indication of how
the final metrics could impact the audit market. However, there are
also significant differences between prior PCAOB disclosure rules and
the final rules. For example, the final rules will likely require firms
to gather more engagement-level information than CAM and Form AP
reporting requirements do. These differences limit the relevance of
these studies.
---------------------------------------------------------------------------

\285\ See, e.g., Michael J. Gurbutt and Wei-Kang Shih, Staff
White Paper: Econometric Analysis on the Initial Implementation of
CAM Requirements, Public Company Accounting Oversight Board 4 (2020)
(discussing how PCAOB staff did not find ``systematic evidence that
investors respond to the information contents in CAMs'' but
nevertheless did find that ``some investors are reading CAMs and
find the information beneficial.''); Kose John and Min Liu, Does the
Disclosure of an Audit Engagement Partner's Name Improve the Audit
Quality? A Difference-in-difference Analysis, 14 Journal of Risk and
Financial Management 1 (2021) (suggesting that there was an increase
in audit quality and audits costs as a result of PCAOB Rule 3211);
and Cunningham, et al., What's in a Name? (finding evidence that any
immediate impact of PCAOB Rule 3211 on audit quality or audit fees
is limited to specific dimensions of audit quality, specific control
groups, and/or specific company characteristics).
\286\ See Doxey, et al., Do Investors Care; Candice T. Hux, How
Does Disclosure of Component Auditor Use Affect Nonprofessional
Investors' Perceptions and Behavior?, 40 Auditing: A Journal of
Practice & Theory 35 (2021); Gurbutt and Shih, Econometric Analysis
on the Initial Implementation of CAM Requirements; Jenna J. Burke,
Rani Hoitash, Udi Hoitash, and Summer Xiao, The Disclosure and
Consequences of US Critical Audit Matters, 98 The Accounting Review
59 (2023). Referring to a U.K. auditor disclosure requirement
similar to CAMs, another commenter said that the extent and quality
of dialogue between investors and audit committees was not as
expected.
\287\ See Center for Audit Quality, Critical Audit Matters
Survey (July 2024).
---------------------------------------------------------------------------

One commenter suggested that the benefits of the proposed metrics
would be limited by the fact that they are focused on the past and
therefore may have limited value predicting future performance. The
Board recognizes that the metrics will be computed using historic data
and the Board believes this is a natural limit. The Board also
disagrees with the premise that historic information, by definition,
cannot have value predicting future performance. Historical metrics can
inform future-oriented decisions by increasing the reliability of the
data investors and audit committees use to form their expectations.
One commenter suggested that benefits would only accrue to data
aggregators, the plaintiff's bar, and academics and not to investors.
The Board agrees that data aggregators may aggregate and resell the
information. However, the Board notes that the existence of such a
market would be evidence that there is a market demand for the final
metrics. Data aggregators may also allow retail investors to benefit
more from the final metrics by making them even more accessible.
Similarly, to the extent there is future reliance on the metrics by
academics and plaintiffs' lawyers, it would serve as evidence of their
information value and, by extension, their relevance to investors.
Pointing to pages 135 and 168 of the proposal, the same commenter
stated that the proposal acknowledged that the required metrics are not
likely to be decision-useful to retail investors. In fact, the proposal
states on page 135 that ``[r]esearch also indicates that retail
investors may not necessarily use information regarding an audit firm
in their decisions to vote on a proposal to ratify the appointment of
the firm.'' The proposal states at p. 168 that ``[d]ue to economies of
scale, the Board believes institutional investors would be more likely
to incur these costs than retail investors.'' To be clear, the Board
believes that institutional investors are more likely to use the final
metrics than retail investors.
One commenter suggested that all the metrics must help retail
investors make informed decisions. The Board considered the benefits
and costs to all stakeholders, not just retail investors. As such, the
Board does not believe that a metric should be excluded on the basis
that it may not help retail investors make informed decisions because
doing so could deprive other stakeholders of useful information.
Subject to this caveat, the Board believes some retail investors will
use the metrics, albeit likely less so than institutional investors.
Furthermore, as discussed in above, the Board believes more passive
retail investors may indirectly benefit from the improved decision-
making of more active institutional investors.
a. Improved Monitoring
The final rules will increase the set of information available to
audit committees and investors regarding their auditor. This should
improve both investors' and audit committees' ability to monitor their
auditors.\288\ For example, an audit committee could engage in more
meaningful discussions with their auditor regarding the auditor's
performance.\289\ In response to improved monitoring, auditors may
improve audit efficiency as well as audit outcomes as they become more
responsive to investors' and audit committees' audit service
needs.\290\ The final rules could also reduce costs related to
information gathering that are incurred by investors and audit
committees when monitoring their auditor. Some of the cost reductions
could reflect reductions in duplicative work to the extent that various
investors or audit committees collect the same information.
---------------------------------------------------------------------------

\288\ For a discussion of the same principle, but in the context
of issuer financial reporting, see, e.g., Leuz and Wysocki, The
Economics of Disclosure and Financial Reporting Regulation
(explaining that the disclosure of operating performance and
governance arrangements by public companies can lower the cost of
monitoring by providing investors with useful benchmarks that help
investors evaluate other companies' managerial efficiency or
potential agency conflicts).
\289\ One study reviewed the comment letters to the Concept
Release and found that audit firms agreed with the notion that audit
committees may benefit from enhanced dialog between the auditor and
the audit committee. See Kathleen M. Harris, and L. Tyler Williams,
Audit Quality Indicators: Perspectives from Non-Big Four Audit Firms
and Small Company Audit Committees, 50 Advances in Accounting 1
(2020).
\290\ See, e.g., Bengt Holmstr[ouml]m, Moral Hazard and
Observability, The Bell Journal of Economics 74 (1979) (finding that
efficiency improves when contractable information about an agent's
performance is available to the agent's principal) and Mai Dao, K.
Raghunandan, and Dasaratha V. Rama, Shareholder Voting on Auditor
Selection, Audit Fees, and Audit Quality, 87 The Accounting Review
168 (2012) (finding evidence that shareholder involvement in firm
selection is associated with higher audit fees and improved audit
quality). Some research suggests that audit committees with
financial expertise are more effective monitors (i.e., financial
reporting quality improves). To the extent that providing additional
information to audit committees is analogous to increasing their
expertise, this suggests that the final rules could lead to more
effective audit committee monitoring. See Dina El Mahdy, Jia Hao,
and Yu Cong, Audit Committee Financial Expertise and Information
Asymmetry, Journal of Financial Reporting and Accounting (2022). In
principle, improved monitoring could lead to a reduction in the
overall quality of audit services. For example, some issuers may
seek lower audit fees at the expense of audit quality. As the final
disclosures will be public, the Board believes, in most cases, this
would be less likely. See Section below for additional discussion.
Some issuers may have very strong financial reporting quality
independent of their auditor (e.g., they have a lender with strong
oversight). In these cases, the most suitable auditor may not
necessarily be the ``highest quality'' auditor and over-auditing may
be more of a concern than under-auditing.
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One commenter suggested that the PCAOB should not focus on over-
auditing or audit inefficiencies. Another commenter was concerned by
the suggestion that investors should be expected to ratify auditor
selection or make decisions related to capital allocation on the basis
of auditor efficiency (e.g., by reviewing auditors' allocation of time
or resources). Consistent with the PCAOB's staff guidance on economic
analysis, the Board considered the most likely impacts. As discussed in
the proposal, the Board believes that some reduction in over-auditing
or some improvement in auditing efficiency could result from

[[Page 100040]]

the final rules. However, the Board does not believe they will be
central benefits and the Board has emphasized other benefits
accordingly.
Two caveats could limit the extent to which improved investor and
audit committee monitoring and reduced monitoring costs will lead to
improved audit performance. First, the Board notes that improvements in
audit performance will be limited by the fact that audit committees are
able to request information like the final metrics from their auditor.
Indeed, one survey of audit committee members from smaller public
companies, including audit committee members of accelerated filers,
reports that most of the survey participants believed there were no
``gaps'' in the information they were receiving from their audit
firms.\291\ Furthermore, at the September 2024 IAG meeting, one audit
committee chair said that he has unfettered access to his auditor, has
requested information related to industry expertise from his auditor in
the past, and has never been denied access to information requested. As
discussed above, one commenter provided a survey suggesting that most
audit committees believe the current information environment is
sufficient. However, the Board believes that, by making these
disclosures mandatory and standardized across firms and engagements,
the final rules will increase the accessibility, reliability, and
comparability of information about auditors and their engagements. For
example, audit committees will be better able to compare their auditors
to peers. Moreover, at the September 2024 IAG meeting one audit
committee chair described how their auditor can be reluctant to provide
information deemed confidential by the auditor. Second, the benefit of
improved monitoring of auditors could also vary depending on the
abilities of the audit committee. As one IAG member said, audit
committee members that do not have a background in accounting may not
know what questions to ask their auditor. For example, more proactive
audit committees with greater financial or audit expertise may be able
to make better use of the final metrics than other audit committees.
However, under the final rules, investors considering votes for
election to the board of audit committee members could consider whether
they expect candidates to be able to effectively use the final metrics
when executing their oversight responsibilities.
---------------------------------------------------------------------------

\291\ See Harris and Williams, Audit Quality Indicators Table 6.
---------------------------------------------------------------------------

In addition to helping investors monitor the auditor's performance,
the final metrics may assist investors in monitoring and evaluating the
performance of the audit committee. For example, investors could
observe audit committee performance and express any potential concerns
through open dialogues with the board of directors or election of board
and audit committee members. The audit committee is responsible for
overseeing the auditor and the final metrics may assist investors in
determining whether the audit committee was effective in this capacity
(e.g., whether the audit committee continues to delay replacing the
auditor despite the presence of metrics that suggest potential concerns
about audit performance).\292\ This improved monitoring could improve
audit committee effectiveness (e.g., more effective monitoring of the
auditors, better selection of auditors, etc.) \293\
---------------------------------------------------------------------------

\292\ See above for a discussion on how the final metrics could
assist decision-making.
\293\ Some academic research suggests that audit committee
effectiveness is associated with audit committee incentives. See,
e.g., Jeffrey Cohen, Ganesh Krishnamoorthy, and Arnold M. Wright,
The Corporate Governance Mosaic and Financial Reporting Quality, 23
Journal of Accounting Literature 87 (2004) and cites therein. Some
research suggests that investors are willing to pay for audit
committee effectiveness and hold audit committees accountable for
negative audit quality. See, e.g., Ellen Engel, Rachel M. Hayes, and
Xue Wang, Audit Committee Compensation and the Demand for Monitoring
of the Financial Reporting Process, 49 Journal of Accounting and
Economics 136, 138 (2010) (suggesting a willingness by companies to
deviate from the historically prevalent one-size-fits-all approach
to director pay in response to increased demands on audit committees
and differential director expertise) and Suraj Srinivasan,
Consequences of Financial Reporting Failure for Outside Directors:
Evidence from Accounting Restatements and Audit Committee Members,
43 Journal of Accounting Research 291 (2005) (concluding that audit
committee members bear reputational costs for financial reporting
failure). Some research suggests that audit committee members
without Big 4 audit experience are more likely to favor auditors
that are rated as ``attractive.'' See, e.g., Baugh, Matthew,
Nicholas J. Hallman, and Steven J. Kachelmeier, A Matter of
Appearances: How Does Auditing Expertise Benefit Audit Committees
When Selecting Auditors?, 39 Contemporary Accounting Research 234
(2022). Together, this research suggests that audit committee
effectiveness could respond to improved investor monitoring. Other
research suggests that audit committee effectiveness is positively
associated with proxies for audit quality. See, e.g., Brian Bratten,
Monika Causholli, and Valbona Sulcaj, Overseeing the External Audit
Function: Evidence from Audit Committees' Reported Activities, 41
Auditing: A Journal of Practice & Theory 1 (2022) (finding that the
strength of audit committee oversight, as implied by audit committee
disclosures, is positively associated with proxies for audit
quality).
---------------------------------------------------------------------------

One commenter supported the view that the metrics will help
investors hold audit committees accountable. However, another commenter
suggested that audit committees that currently execute their statutory
mandate with an insufficient level of interest and attention will
continue to do so despite the availability of the final metrics.
Another commenter suggested that metrics were an inappropriate way for
investors to oversee audit committees and would override the
gatekeeping function of audit committees. The Board acknowledges that
the final rules' impact may vary by audit committee. However, for the
reasons discussed above, the Board believes that the final rules will,
on average, lead to a valuable improvement in investors' ability to
monitor audit committees and, by extension, audit committee
performance. The Board does not believe the final rules will supplant
audit committees' gatekeeper function. Rather, audit committees will
continue to play a critical corporate governance function. Indeed, by
enabling investors to better monitor and evaluate audit committees, the
Board believes the final metrics will enhance the audit committee's
role and reinforce its effectiveness in overseeing auditors.
One commenter suggested that interaction between investors and
directors is unlikely and directed us to industry research suggesting
that engagement between directors of large issuers and their investors
is decreasing.\294\ The Board acknowledges that direct interaction may
occur more for institutional investors. However, the Board notes that
the survey cited by the commenter notes that the decline between 2022
and 2023 was ``slight'' overall but larger for the largest companies
(75% to 58%). The cited survey also says that ``directors are regularly
engaging with shareholders and the vast majority consider those
interactions `productive.' '' Moreover, as discussed in greater detail
above, the Board notes that many public companies have robust investor
outreach programs, some of which target retail investors. Academic
research on the frequency of shareholder outreach programs shows they
are increasing over time.\295\ Therefore, the Board believes there is
no strong evidence supporting the comment that director engagement with
shareholders is unlikely to occur.
---------------------------------------------------------------------------

\294\ See PriceWaterhouseCoopers, 2023 Annual Corporate
Directors Survey.
\295\ See Dey et al., Proxy Advisory Firms and Corporate
Shareholder Engagement, Figure 2 (showing a monotonic increase in
the proportion of sampled firms reporting shareholder engagement in
their proxy statement from 5.5% in 2011 to 36.3% in 2019.)
---------------------------------------------------------------------------

Mandatory disclosure of the final metrics could also improve audit
firms' internal monitoring of their (i) audit

[[Page 100041]]

practices and related system of quality control, and (ii) individual
engagements. This could improve governance, accountability, and overall
quality control within the audit firm. The final metrics may also help
auditors identify efficiencies or room for improvement in their audit
approach by comparing their final metrics to their competitors. One
commenter noted that the proposal recognized that firms may not find
the certain metrics useful in monitoring their quality control systems.
While the Board continues to believe that the final metrics could
improve audit firms' internal monitoring, the Board acknowledges that
some firms, due to their unique facts and circumstances, may find some
metrics less useful than others.
b. Improved Selection
The final rules may also enhance auditor selection to the extent
that the rules improve the ability of investors and audit committees to
compare their current auditor to an alternative auditor.\296\ When
considering an alternative auditor, audit committees may find the
auditor's engagement-level metrics for similar engagements (e.g., an
issuer of similar size and/or within the same industry to the audit
committee's issuer) most useful. As discussed above, investors and
audit committees could electronically search for firm-level metrics and
download engagement-level metrics when constructing rosters of
candidate auditors. Moreover, audit committees will benefit to the
extent that they are able to engage in more meaningful discussions and
interviews with candidate auditors during the selection process--
improving the efficiency of auditor-issuer matching.\297\ For example,
the final metrics (e.g., Industry Experience and Workload) could help
audit committees select an auditor that has the capacity to perform the
audit.\298\ Requiring mandatory, comparable, and uniform disclosure of
the final metrics--across engagement teams and audit firms, and over
time--should further enhance this benefit by helping audit committees
to compare auditors on a common basis.\299\ The final rules may also
improve investors' decision-making regarding auditor ratification and
appointment of board members.\300\ For instance, investors may decide
that a particular final metric is especially important to their views
on the auditor's efficacy and the quality of the financial
statements.\301\ Investors that rely on proxy advisors for these
decisions may also benefit from the final disclosures because proxy
advisors could use the information in their recommendations.
---------------------------------------------------------------------------

\296\ One recent experimental study finds that participants
playing the role of CFO, director, or individual investors strongly
prefer auditors that have stronger metrics and are willing to pay
more for those auditors. See Dennis Ahn, Radhika Lunawat, and
Patricia Wellmeyer, Firm and Engagement Performance Metrics and
Auditor Contracting Decisions, SSRN Electronic Journal, at Table 1
and Table 2 (2024). The Board notes that SSRN does not peer review
its submissions.
\297\ See, e.g., Gene M. Grossman and Carl Shapiro, Informative
Advertising with Differentiated Products, 51 The Review of Economic
Studies 63 (1984) (finding that reduced information frictions (i.e.,
decreased informational advertising costs) could result in improved
matching between sellers and buyers).
\298\ Some academic research finds that audit committees do
select auditors based on observable aspects of the quality of their
services. See, e.g., Vivek Mande and Myungsoo Son, Do Financial
Restatements Lead to Auditor Changes?, 32 Auditing: A Journal of
Practice & Theory 119 (2013).
\299\ See above for discussion of academic literature related to
the benefits of comparability in financial reporting.
\300\ Some research suggests that more informed shareholders
make better audit ratification decisions (e.g., auditor ratification
decisions are more closely associated with public signals of audit
failure). See, e.g., Cassell, et al., Retail Shareholders and cites
therein.
\301\ Some experimental research suggests that investors are
less likely to support auditor ratification if metrics like those
discussed in the Concept Release are trending downward. See, e.g.,
Brown and Popova, How do Investors Respond.
---------------------------------------------------------------------------

Improved auditor selection could improve audit efficiency as well
as audit outcomes as incoming auditors may be better equipped to meet
investors' and audit committees' audit service needs.\302\ The final
rules could also reduce costs related to information gathering incurred
by audit committees when selecting their auditor and by investors when
voting to ratify the appointment of the auditor.\303\ Some of the cost
reductions could reflect reductions in duplicative work to the extent
that various investors or audit committees collect the same
information. Improved investor decision-making regarding voting for
members of the board of directors, including directors who serve on the
audit committee, could improve audit committee performance as incoming
board members may be better equipped to meet investors' expectations
regarding auditor oversight. One commenter said that the proposed
metrics have the capacity to make investors' vote on ratification of
the auditor and the vote on audit committee members substantially more
meaningful.
---------------------------------------------------------------------------

\302\ In principle, improved auditor selection could lead to a
reduction in the overall quality of audit services. For example,
some issuers may seek lower audit fees at the expense of audit
quality. Due to the fact that the final disclosures will be public,
the Board believes, in most cases, this would be less likely. See
below for additional discussion. Some issuers may have very strong
financial reporting quality independent of their auditor (e.g., they
have a lender with strong oversight). In these cases, the most
suitable auditor may not necessarily be the ``highest quality.''
\303\ Although investor voting on auditor ratification is non-
binding, it could be a meaningful mechanism for expressing views on
audit-related issues. If investors are dissatisfied with auditor
selection, they can also vote against the re-election of board
members, including those who serve on the audit committee, to
potentially influence future auditor oversight.
---------------------------------------------------------------------------

Two caveats could limit the potential benefit of improved auditor
selection and the reduction in the associated information gathering
costs. First, the Board notes that the impact will be limited by the
fact that audit committees could in principle request information like
the final metrics from alternative auditors. However, auditors may not
be willing to voluntarily provide an audit committee with engagement-
level metrics regarding their engagements with other issuers,
information that may be particularly useful to audit committees in
selecting an auditor. Furthermore, while audit committees can currently
request tailored metrics, this approach imposes substantial collective
costs and limits comparability across firms. The Board believes that,
by making these disclosures mandatory and standardized, the final rules
will increase the accessibility, reliability, and comparability of
information available and therefore help audit committees. Second, the
Board notes that, to the extent that benefits are derived from the
ability to readily switch between auditors based on an evaluation of
the auditors' metrics, those benefits could be limited due to
stickiness in existing auditor-audited company relationships which
creates switching costs. Furthermore, large multinational issuers may,
as a practical matter, need a GNF auditor, which limits the pool of
available alternatives--which may be in turn further limited by auditor
geographic/industry specialization (e.g., a need for financial services
expertise in a particular office/city), or by auditor independence
rules (e.g., the existence of an independence-impairing financial or
consulting relationship between the issuer and a potential alternative
auditor).\304\ Therefore, the benefit of improved auditor selection
could be more limited for the largest issuers. However, the Board
believes that the final metrics could also help the audit committees of
the largest issuers select

[[Page 100042]]

specific engagement partners within the larger audit firms.
---------------------------------------------------------------------------

\304\ See United States Government Accountability Office,
Continued Concentration in Audit Market for Large Public Companies
Does Not Call for Immediate Action 21 (Jan. 8, 2008).
---------------------------------------------------------------------------

c. Benefits to the PCAOB's Inspection and Enforcement Programs and
Scholarly Auditing Research
The final metrics are expected to provide direct benefits to the
PCAOB's internal operating effectiveness. In the PCAOB's oversight
capacity, it engages in inspection and enforcement activities for
audits of issuers and, in the course of doing so, it uses data from
issuers and audit firms. The final metrics will expand the basis on
which selections may be made. For example, the final metrics could
improve the selection models used to aid in predicting negative audit
outcomes, such as restatements or the potential for audit deficiencies.
As discussed above, QC 1000 will help to ensure that the final metrics
will be reliable. Greater insight into audit risks could improve the
PCAOB's ability to select potential enforcement matters. Overall,
improved PCAOB oversight may give auditors additional incentive to
comply with PCAOB professional standards and rules.\305\
---------------------------------------------------------------------------

\305\ Some academic research suggests that PCAOB oversight is
beneficial. For example, one study of audit firms in foreign
jurisdictions finds that PCAOB inspections access is positively
associated with proxies for audit quality. See Phillip T. Lamoreaux,
Does PCAOB inspection Access Improve Audit Quality? An Examination
of Foreign Firms Listed in the United States, 61 Journal of
Accounting and Economics 313 (2016).
---------------------------------------------------------------------------

Moreover, the PCAOB actively engages in policy research related to
the market for assurance services to further the PCAOB's mission by
informing the standard-setting and rulemaking agendas among other
purposes. The additional data provided by the final rules could enhance
the PCAOB's ability to produce impactful research and recirculate that
gained knowledge into improved standards and rules. Relatedly, the
additional data could also provide valuable information sources for the
public, including academic research. Commenters agreed that academics
could benefit from the metrics. Improved research quality is an
important element of the PCAOB's standard-setting and rulemaking
projects.
One commenter said it was unclear how the PCAOB would use the
information. As described in the proposal and above, the Board expects
that the metrics will at least inform the PCAOB selection of
engagements and focus areas for review and future academic research
that utilizes the metrics could inform PCAOB rulemaking projects.
Several commenters agreed that the information would be useful to the
PCAOB.
One commenter suggested that the PCAOB should be able to articulate
which of the final metrics provide critical insights for effective
monitoring by inspection teams using information obtained through PCAOB
inspections. The PCAOB uses information like the final metric in
various ways as part of its inspections approach. However, the Board
believes the final metrics will on the whole provide additional value
because they will be more comparable across firms, engagements, and
time and the engagement-level metrics will be available to PCAOB staff
at an earlier point in time than engagement-specific information
provided pursuant to the review of an engagement. The same commenter
said that public disclosure of the proposed metrics would not be
necessary for the PCAOB to benefit from them. The Board agrees that
some of the benefits to the PCAOB do not derive specifically from the
public nature of the reporting. However, the PCAOB expects that it will
benefit from academic research that the Board believes will be
conducted using the publicly reported final metrics and broader
stakeholder engagement. Public availability of the final metrics could
also improve the quality of other stakeholder input received by the
PCAOB (e.g., public comment or roundtable discussions).
One commenter suggested that reliance on the metrics by PCAOB
oversight could create a risk of enforcement for minor, unintentional
errors in reporting. The commenter said this risk could manifest as a
cost to smaller and mid-sized firms. The Board believes the commenter
may have misinterpreted the benefit to PCAOB oversight as a suggestion
that the PCAOB intends to make reporting of the final metrics an
inspection focus area. While PCAOB inspectors may do so in the future,
the Board is not suggesting this will benefit PCAOB oversight per se.
Rather, the Board are suggesting that the final metrics themselves may
help PCAOB inspections staff select firms, engagements, or focus areas
for review. However, the Board acknowledges that, by relying on the
final metrics, potential deficiencies in how firms are reporting them
may become apparent to PCAOB staff. To the extent PCAOB oversight does
consider firms' compliance with the final rules, the Board believes the
PCAOB would exercise appropriate discretion.
Overall, the benefit to the PCAOB is difficult to quantify, as the
social and economic benefits of enhanced regulatory oversight that is
more efficient in its allocation of resources are difficult to
monetize. The benefits of additional scholarly research are also
difficult to quantify because there are a broad set of beneficiaries.
ii. Indirect Benefits Linked to Competition
Capital Market Effects
Assuming that the additional information, context, and perspective
on auditors and audit engagements helps investors assess audit
performance, it may help investors assess financial reporting
quality.\306\ For example, investors may incorporate the metrics into
their portfolio selection decisions.\307\ One commenter said that the
final metrics were necessary for auditors to have their work judged as
something other than a commodity (i.e., competition on price alone).
---------------------------------------------------------------------------

\306\ The IAG indicated in their comment letter regarding
proposed QC 1000 that information related to audit quality would
provide investors with ``a level of confidence in the financial
statements of companies in which they invest. Their level of
confidence in the financial statements has a bearing on the prices
they will be willing to pay or demand for investments.'' The comment
letters received in response to proposed QC 1000 are available on
the Board's website in Docket 046. See comment No. 4 on the proposed
rule from the IAG, available at https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/docket046/4_iag.pdf?sfvrsn=1941e7c0_4. See above for a discussion on the
association between audit quality and financial reporting quality.
\307\ There is an extensive body of academic literature
suggesting that financial markets incorporate information into
securities prices. See, e.g., Eugene F. Fama, Efficient Capital
Markets: A Review of Theory and Empirical Work, 25 The Journal of
Finance 383 (1970).
---------------------------------------------------------------------------

Issuers audited by auditors whose metrics capital markets associate
with greater financial reporting quality may experience reduced cost of
capital or other capital market benefits and investors may reallocate
their capital accordingly. Taken in isolation, this would tend to
result in a reallocation of capital from issuers with less reliable
financial reporting quality to issuers with higher financial reporting
quality. These capital market reactions could provide audit committees
with a stronger incentive to appoint an auditor whose final metrics
capital markets associate with greater financial reporting quality.
These effects could lead to changes in audit fees as auditors respond
to changing demand for their services. Facing capacity constraints,
some audit firms may turn down engagements or recruit additional staff
to expand capacity.
Auditor Competition
Against the backdrop of capital market reactions to the final
metrics and as auditors become better able to

[[Page 100043]]

monetize their reputations, auditors could have an incentive to compete
on the final metrics.\308\ For example, to win engagements, auditors
may seek to manage their final metrics by redeploying staff resources
or providing additional training. This competitive dynamic could
improve audit quality and, by extension, financial reporting
quality.\309\ Reduced search costs could increase auditor
competition.\310\ In addition to facilitating issuers' selection of a
preferred auditor, the increase in competition could potentially reduce
audit fees.\311\
---------------------------------------------------------------------------

\308\ Improved competition following mandatory disclosure
regimes has been observed in other markets. See above for additional
discussion. One study finds that non-U.S. auditors inspected by the
PCAOB gain market share from competing auditors after PCAOB
inspection reports are made public, more so when the PCAOB
inspection report has fewer engagement-level deficiencies. See
Daniel Aobdia and Nemit Shroff, Regulatory Oversight and Auditor
Market Share, 63 Journal of Accounting and Economics 262, (2017).
\309\ See above for a discussion on the relationship between
audit quality and financial reporting quality.
\310\ Economic theory suggests that a reduction in search costs
helps to make markets more competitive. See, e.g., Helmut Bester,
Bargaining, Search Costs and Equilibrium Price Distributions, 55 The
Review of Economic Studies 201 (1988). There is an extensive
literature in industrial organization economics studying the impact
of search and advertising costs on competition. For example, Jean
Tirole, The Theory of Industrial Organization, MIT Press 294 (1988)
studies informative advertising (i.e., costs borne by sellers to
inform buyers of the seller's existence, product quality, and
pricing) in a model involving differentiated sellers, and finds that
prices fall as information costs fall. See also Grossman and
Shapiro, Informative Advertising; and Glenn Ellison and Alexander
Wolitzky, A Search Cost Model of Obfuscation, 43 The RAND Journal of
Economics 417 (2012). Glenn Ellison and Sarah F. Ellison, Search,
Obfuscation, and Price Elasticities on the internet, 77 Econometrica
427 (2009) also show that reductions in search costs increase the
price-sensitivity of demand, resulting in decreased prices for near-
substitute goods, and that sellers may attempt to engage in
obfuscation strategies to reduce competitive pressure.
\311\ The positive relationship between increased competition
and lower audit fees is well-established, see, e.g., Wieteke Numan
and Marleen Willekens, An Empirical Test of Spatial Competition in
the Audit Market, 53 Journal of Accounting and Economics 450 (2012);
and Andrew R. Kitto, The Effects of Non-Big 4 Mergers on Audit
Efficiency and Audit Market Competition, 77 Journal of Accounting
and Economics 101618 (2024). Other potential unintended impacts the
proposal may have on competition are discussed below.
---------------------------------------------------------------------------

The Board notes that the benefits linked to competition between
audit firms could be reduced for the larger issuer segment of the
market because larger issuers have fewer audit firms available to
choose from that are able to perform large, complex audits, without
violating independence rules and other constraints. However, the final
metrics could help promote competition between partners within the
larger firms.\312\ One commenter suggested that the ability of the
proposed metrics to spark competition between firms is an important
condition for rulemaking and one which the proposal abandons because
the proposed metrics are divorced from audit quality and excessively
burdensome. The Board agrees that the effect on competition is an
important impact for the Board to consider, but the Board disagrees
with the commenter's assertions that the proposal abandoned it. To the
contrary, the Board's economic analysis considered all potential
impacts of the final rules, competition among them. Indeed, based on
the Board's careful consideration of academic research, public comment,
and the Board's experience, the Board believes the final metrics could
enhance competition and the Board's economic analysis reflects this
view.
---------------------------------------------------------------------------

\312\ See Ahrum Choi, Sunhwa Choi, and Jaeyoon Yu, Does Internal
Competition among Audit Partners Affect Audit Pricing Decisions?,
Auditing: A Journal of Practice & Theory 1 (2024) (finding that U.S.
audit partners compete for clients with other partners within their
office who perform audits in the same industry).
---------------------------------------------------------------------------

One commenter questioned whether firms' management of their metrics
to win market share would improve audit quality. As discussed in the
proposal and below, the Board acknowledges that management of the final
metrics may not always lead firms to improve their audit approach.
However, economic theory suggests that if management of the metrics is
entirely manipulatory, then users of the information will entirely
discount it as ``cheap talk.'' \313\ The Board believes this extreme
``cheap talk'' outcome is unlikely, in part, because the final rules
will be subject to PCAOB oversight as well as firms' QC systems, which
are in turn subject to QC 1000.\314\
---------------------------------------------------------------------------

\313\ See Vincent P. Crawford and Joel Sobel, Strategic
Information Transmission, Econometrica: Journal of the Econometric
Society 1431 (1982).
\314\ See below for additional discussion on how PCAOB oversight
would mitigate potential manipulation of the final metrics.
---------------------------------------------------------------------------

iii. Indirect Benefits of Improved Financial Reporting Quality
As described above, to the extent the final rules improve audit
performance, the final rules will also improve financial reporting
quality. More reliable financial information would allow investors to
improve the efficiency of their capital allocation decisions (e.g.,
investors may more accurately identify companies with the strongest
prospects for generating future risk-adjusted returns and reallocate
their capital accordingly).\315\ Investors may also perceive less risk
in capital markets generally, leading to an increase in the supply of
capital.\316\ An increase in the supply of capital could increase
capital formation while also reducing the cost of capital to
companies.\317\ A reduction in the cost of capital reflects a welfare
gain because it implies investors perceive less risk in the capital
markets.
---------------------------------------------------------------------------

\315\ See, e.g., Acito, et al., Market-Based Incentives for
Optimal Audit Quality.
\316\ See, e.g., Hanwen Chen, Jeff Zeyun Chen, Gerald J. Lobo,
and Yanyan Wang, Effects of Audit Quality on Earnings Management and
Cost of Equity Capital: Evidence from China, 28 Contemporary
Accounting Research 892 (2011); Richard Lambert, Christian Leuz, and
Robert E. Verrecchia, Accounting Information, Disclosure, and the
Cost of Capital, 45 Journal of Accounting Research 385 (2007)
(concluding that improving the quality of accounting disclosures can
influence the cost of capital and under certain conditions can
unambiguously lower the cost of capital).
\317\ 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, among
others, on 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. In the context of a
particular company or portfolio of companies, the weighted average
cost of capital is the average of the cost of equity capital and the
cost of debt capital, weighted by the market values of the
underlying equity and debt securities, respectively. See, e.g., R.
A. Brealey, S. C. Myers, and F. Allen, Principles of Corporate
Finance, 10th Edition McGraw-Hill 8, 90, and Chapter 7, (2011). For
theoretical discussion on the link between financial reporting
quality and cost of capital, see, e.g., Richard A. Lambert,
Christian Leuz, and Robert E. Verrecchia, Information Asymmetry,
Information Precision, and the Cost of Capital, 16 Review of Finance
1, 16-18 (2012); and David Easley and Maureen O'Hara, Information
and the Cost of Capital, 59 Journal of Finance 1553, 1571 (2005).
---------------------------------------------------------------------------

The Board is unaware of any literature that would provide a basis
for quantifying the magnitude of financial reporting quality
improvement associated with the final rules. However, academic
literature has attempted to quantify the impact of improved financial
reporting quality on cost of capital by measuring the association
between various quantitative proxies for financial reporting quality
and cost of capital after controlling for other potential drivers of
cost of capital. Subject to the caveats discussed below, this
literature suggests, overall, that even small improvements in financial
reporting quality can result in reductions in issuers' cost of capital
of multiple basis points in magnitude. Due to the size of the U.S.
capital markets, even a single basis point reduction in the cost of
capital implies substantial welfare gains.
Some studies examine the relationship between improved

[[Page 100044]]

financial reporting quality and companies' cost of equity capital. For
example, one study quantified the relationship between earnings
transparency and cost of equity capital.\318\ The study found that,
compared to a baseline of no transparency, companies with an average
level of earnings transparency had between 1.7 and 3.4 percentage
points lower cost of equity capital, depending on the estimation
methodology. Using restatements as a proxy for financial reporting
quality, another study found that a restatement increases the cost of
equity capital by between six and 15 percent in the longer term.\319\
Assuming a 10 percent cost of capital, this result corresponds to
between a 60 and 150 basis point increase in the cost of equity
capital. One study found that companies with the highest accruals
quality had a 210 basis point lower cost of equity capital compared to
companies with the lowest accruals quality.\320\ Using disclosure
quality ratings (determined by an index prepared by analysts) as a
proxy for financial reporting quality, another study found that
companies with the highest disclosure quality ratings had roughly a 0.7
percentage point lower cost of equity capital compared to companies
with the lowest.\321\ From an international perspective, one study
found that companies in countries in the 75th percentile of strength of
disclosure rules and associated enforcement had roughly a 200 basis
point lower costs of equity capital than countries at the 25th
percentile (i.e., countries with weaker disclosure rules and
enforcement).\322\ Another study found that, compared to companies in
countries at the 75th percentile of earnings opacity, the cost of
equity capital for companies in the 25th percentile (i.e., countries
with less opaque earnings) had a 2.8 percentage point lower cost of
equity capital.\323\
---------------------------------------------------------------------------

\318\ See Mary E. Barth, Yaniv Konchitchki, and Wayne R.
Landsman, Cost of Capital and Earnings Transparency, 55 Journal of
Accounting and Economics 206, 216-217 (2013).
\319\ See Paul Hribar and Nicole Thorne Jenkins, The Effect of
Accounting Restatements on Earnings Revisions and the Estimated Cost
of Capital, 8 Review of Accounting Studies 337, 337 (2004).
\320\ See Jennifer Francis, Ryan LaFond, Per Olsson, and
Katherine Schipper, The Market Pricing of Accruals Quality, 39
Journal of Accounting and Economics 295, 297 (2005).
\321\ See Christine A. Botosan and Marlene A. Plumlee, A
Re[hyphen]examination of Disclosure Level and the Expected Cost of
Equity Capital, 40 Journal of Accounting Research 21, 22 (2002).
\322\ See Luzi Hail and Christian Leuz, International
Differences in the Cost of Equity Capital: Do Legal Institutions and
Securities Regulation Matter?, 44 Journal of Accounting Research
485, 488 (2006).
\323\ See Utpal Bhattacharya, Hazem Daouk, and Michael Welker,
The World Price of Earnings Opacity, 78 Journal of Accounting and
Economics 641, 643 (2003).
---------------------------------------------------------------------------

While the above studies examine the impact of improved financial
reporting quality on companies' cost of equity capital, several studies
examine instead the impact of improved financial reporting quality on
companies' cost of debt capital. For example, one study found that
companies with the highest disclosure quality ratings (determined by an
index prepared by analysts) have roughly 1.1 percentage points lower
cost of debt capital than companies with the lowest disclosure quality
ratings.\324\ Another study found that companies in the highest decile
of accruals quality had a 126-basis point lower cost of debt capital
than companies in the lowest decile of accruals quality.\325\
---------------------------------------------------------------------------

\324\ See Partha Sengupta, Corporate Disclosure Quality and the
Cost of Debt, 73 The Accounting Review 459 (1998).
\325\ See Francis, et al., The Market Pricing 297.
---------------------------------------------------------------------------

While the Board believes these studies are indicative of the
potential impacts improved financial reporting quality may have on
capital markets, the Board acknowledges that the studies are subject to
certain caveats.\326\ First, the studies do not indicate the degree to
which the disclosure of firm and engagement metrics could impact
financial reporting quality in the first instance. Therefore, the
magnitudes must be treated as illustrative examples, rather than point
estimates, of the potential benefits of the final rules.
---------------------------------------------------------------------------

\326\ For a more general discussion of challenges identifying
causal relationships in financial reporting research, see Leuz and
Wysocki, The Economics of Disclosure and Financial Reporting
Regulation.
---------------------------------------------------------------------------

Second, some of the studies may be subject to some endogeneity
bias.\327\ For example, companies with high financial reporting quality
may also be well-managed, a form of omitted variable bias. Similarly,
companies that voluntarily provide higher quality information may do so
because they are in a stronger financial position already, a form of
self-selection bias. Due to these potential biases, some of the studies
may overestimate the extent to which improved financial reporting
quality reduces companies' cost of capital. Controlling for endogeneity
bias is challenging and the results of any one methodology may be
sensitive to the methodology's assumptions.\328\ Indeed, after
attempting to statistically control for endogeneity bias, one study
found that the association between financial reporting quality and cost
of equity capital remains while another found that it disappears.\329\
---------------------------------------------------------------------------

\327\ Endogeneity occurs when an explanatory variable in a
multiple regression model is correlated with unobserved factors that
affect the dependent variable. See Jeffrey M. Wooldridge,
Introductory Econometrics: A Modern Approach, South-Western Cengage
Learning, 4th edition 838 (2008).
\328\ See David F. Larcker and Tjomme O. Rusticus, On the Use of
Instrumental Variables in Accounting Research, 49 Journal of
Accounting and Economics 186, 203 (2010).
\329\ See, e.g., Christian Leuz and Robert E. Verrecchia, The
Economic Consequences of Increased Disclosure, 38 Journal of
Accounting Research 91, 121 (2000) (using bid-ask spreads for German
companies as a proxy for cost of capital) and David A. Cohen, Does
Information Risk Really Matter? An Analysis of the Determinants and
Economic Consequences of Financial Reporting Quality, 15 Asia-
Pacific Journal of Accounting & Economics 69, 70 (2010).
---------------------------------------------------------------------------

Third, while most research tends to find positive associations
between financial reporting quality and the cost of capital, some
studies have found counterintuitive or unexpected associations. For
example, one study found that the timeliness of disclosures is
negatively associated with the cost of equity capital.\330\ The results
of another study suggest that the association between improved
financial reporting quality and reduced cost of capital may apply only
to companies with low analyst following.\331\
---------------------------------------------------------------------------

\330\ The authors suggest that the result may be attributable to
increased stock price volatility arising from excessive focus on
short-term profits. See Botosan and Plumlee, A Re-examination 21 and
37.
\331\ See Christine A. Botosan, Disclosure Level and the Cost of
Equity Capital, 72 The Accounting Review 323 (1997).
---------------------------------------------------------------------------

Despite these caveats, the Board believes that the academic
literature suggests overall that improved financial reporting quality
results in lower costs of capital and, moreover, that even small
improvements can reduce the cost of capital by one or more basis
points. The studies discussed above found multiple percentage point
reductions in cost of capital when companies (or countries) with the
weakest financial reporting proxies are compared to the companies (or
countries) with the strongest financial reporting proxies. As such,
just one hundredth of the improvement in those measures could result in
reductions in the cost of capital by multiple basis points. Due to the
size of U.S. capital markets, even small reductions in the cost of
capital, on the order of multiple basis points, can generate
significant welfare gains. For example, using recent data on the size
of the U.S. equity and debt capital markets, a single basis point
reduction in the weighted average cost of capital

[[Page 100045]]

would imply at least $99.0 billion in welfare gains.\332\
---------------------------------------------------------------------------

\332\ (1 basis point/(8% average cost of capital--1 basis
point)) x ($68.1 trillion in equity market capitalization + $11.0
trillion in debt market capitalization) = $99.0 billion. Source: S&P
Capital IQ and SIFMA. The debt market capitalization figure reflects
U.S. corporate bonds outstanding as of 2024 Q2. It does not include
private debt. The Board notes several key assumptions and
limitations of the calculation. The calculation assumes that debt
and equity capital comprise all forms of capital (i.e., the
calculation disregards other potential forms of capital) and that
their total value is equal to the sum of all future cash flows
discounted by the weighted average cost of capital. It assumes a
weighted average cost of capital of 8% based on historic averages
for the Russell 3000. See Michael J. Mauboussin and Dan Callahan,
Cost of Capital: A Practical Guide to Measuring Opportunity Cost,
Morgan Stanely Investment Management Counterpoint Global Insights,
Exhibit 16 (2023). The calculation does not account for the
potential beneficial impact of changes in the quantity of capital
supplied nor does it account for potential general equilibrium
effects in other markets. As discussed above, the calculation
pertains to weighted average cost of capital reductions only. It
does not capture potential increases in total market capitalization
arising from improved management or improved capital allocation. The
Board acknowledges that some issuers that contribute to the Board's
market capitalization figures are not audited by firms that will be
subject to the final requirements and therefore will not be impacted
by the final requirements. However, the Board believes they make up
a small share of total market capitalization.
---------------------------------------------------------------------------

One commenter suggested that a review of the academic literature on
cost of capital should allow the Board to quantify the impact of the
final metrics on cost of capital decisions. The proposal provided a
review of academic literature on cost of capital. That review appears
here in essentially the same form. As discussed above, the Board
believes this literature does provide evidence of the quantitative
benefits of improved financial reporting quality generally. However,
the Board is unaware of any literature that would provide a basis for
quantifying the magnitude of financial reporting quality improvement
(and thus the magnitude of cost of capital reduction) associated with
the final rules and the commenter did not identify such literature.
One commenter said that the proposal assumed that investors have
homogenized interests when in fact there will always be a buyer and a
seller with conflicting objectives. The Board recognizes that, with
respect to secondary trading of issuer securities, buyers and sellers
have conflicting objectives. To the extent the final metrics inform
traders' perceptions of the value of issuer securities or otherwise
improve financial reporting quality, the final metrics could in the
short run benefit one trading counterparty at the expense of the other.
However, for the reasons discussed above, the Board believes that more
reliable financial reporting quality benefits capital markets overall
in the long run.
iv. Academic Literature and Comments Related to Specific Final Firm and
Engagement Metrics
In the following discussion the Board reviews the extant literature
related to the final metrics. In doing so, the Board separates the
final metrics into three categories: (i) metrics related to audit
personnel; (ii) metrics related to the allocation of audit hours; and
(iii) metrics related to audit outcomes.
The Board notes three important caveats. First, as most of the
final metrics are not currently publicly available, academic studies
principally rely on information obtained from audit firms directly,
surveys, or foreign jurisdictions. Their relevance is thus limited by
the fact that the metrics they study are not equivalent to the final
metrics and their results may not be directly applicable to the U.S.
audit market more generally. Second, while the extant literature may
draw conclusions regarding a particular metric's relationship to
publicly available proxies for audit quality, this does not imply that
a final metric will provide any new insights to investors and audit
committees incremental to the insights already provided by the publicly
available proxies for audit quality. Finally, those relationships may
be non-linear or difficult to fully evaluate.
One commenter said that some studies cited in the proposal feature
investors or investor groups who may not be representative of the
broader population of investors. The commenter did not refer to any
specific study. The Board acknowledges that the samples featured in
some of the empirical studies discussed below may not be perfectly
representative of the population of stakeholders that will be impacted
by the final rules. While this fact limits their relevance, the Board
believes their samples are similar enough to the impacted population
that their results inform the economic analysis of the final rules.
Consistent with the PCAOB's staff guidance on economic analysis, the
Board highlighted key aspects of the studies (e.g., the
representativeness of their data sample) that may limit their
relevance.
Several commenters suggested that the PCAOB should, as a starting
point, demonstrate that any final metric has an unambiguous impact on
audit quality. One commenter suggested that the PCAOB obtain research
suggesting that any behavioral change produced by a final metric should
not harm audit quality. The commenter also suggested that the
univariate disclosures should provide a complete picture of the
engagement and firm. As the commenter acknowledged, the Board performed
an extensive literature review, the substance of which the commenter
did not dispute. The Board also considered all academic research
provided by commenters. While the Board considered the potential
effects of the metrics on audit quality and auditor behavior, the Board
does not believe that the rigid criteria suggested by commenters are
necessary or appropriate. As the Board stated above, and as many
commenters affirmed including this commenter, audit quality is complex
and requires significant context to fully appreciate. As such, no
metric taken in isolation can provide a complete picture of a firm and
its engagements and thus have an unambiguous impact on audit quality.
Furthermore, research cannot prove that any future behavioral changes
would not harm audit quality. However, in selecting each of the final
metrics, the Board considered whether the evidence on its relationship
to the quality of firms and their engagements, which the Board believes
reflects the spirit of the selection approach suggested by the
commenter.
The same commenter also suggested that the Board consider whether
the disclosures would meet the SEC's goals for required disclosures.
The SEC's goals on required disclosures have traditionally focused on
corporate disclosure, although they may include auditor disclosure in
certain contexts. The Board has carefully considered whether the
required disclosures would help the PCAOB achieve its objectives in
furtherance of its statutory mandate.
The same commenter also questioned whether many of the academic
studies surveyed in the academic literature review supported the
proposal because they use statistical methods to identify causal
relationship that hold other elements of the audit process fixed. The
Board assumes that the commenter intended to contrast this standard
statistical approach with the fact that, in practice, investors and
audit committees will be comparing firms and engagements where other
elements of the audit process are not fixed. The Board agrees that no
single academic study that the Board reviewed provides dispositive
proof that investors or audit committees will be able to interpret any
individual metric in practice without also understanding the full
context. Indeed, the Board has acknowledged that no individual metric
can measure audit quality and a fuller appreciation of

[[Page 100046]]

audit quality requires consideration of a broad array of factors, many
of which are unquantifiable (e.g., professional skepticism). However,
the Board does not believe this implies that the academic studies
surveyed provide no support for the final rules.
One commenter said that the proposal did not provide sufficient
evidence that public disclosure of the proposed metrics would
meaningfully impact audit quality. Given that data using the specific
final metrics is not currently available, evidence of their effects on
audit quality is necessarily limited. Nevertheless, the Board believes
the academic literature discussed below and the analysis discussed
throughout this section provide evidence that the final metrics, taken
as a whole, could have meaningful impacts to audit quality, which the
Board believes could lead to significant benefits to investors, audit
committees, and other stakeholders.
a. Metrics Related to Audit Personnel
The Partner and Manager Involvement metrics will indicate the hours
worked by senior professionals relative to more junior staff across the
firm's large accelerated and accelerated filer engagements and on the
specific engagement. Investors and audit committees could use this
information to evaluate whether partners and managers are giving their
engagement appropriate attention. Although the academic literature
related to audit partner and manager involvement is limited, one study
using Korean data suggests that audit partner involvement is positively
associated with audit quality.\333\ Another study finds that the
offices of U.S. Big 4 audit firms with relatively more CPAs tend to
provide higher audit quality.\334\ While the number of staff with CPAs
is not equivalent to the share of senior staff hours reflected in the
metric, the finding does suggest that greater involvement of
experienced staff is beneficial to audit quality.\335\ Another study
using Chinese data finds that a greater partner to staff ratio is
positively associated with audit quality.\336\ However, using U.S.
data, another study finds partner time spent concurrently on other
audits is not associated with audit quality.\337\
---------------------------------------------------------------------------

\333\ See, e.g., Suyon Kim, Engagement Partners' Effort, 9 Risks
1 (2021).
\334\ See, e.g., Albert L. Nagy, Matthew G. Sherwood, and
Aleksandra B. Zimmerman, CPAs and Big 4 Office Audit Quality, 42
Journal of Accounting and Public Policy 107018 (2023).
\335\ Another study using Japanese data finds that the number of
CPA holders staffed to an audit engagement is positively associated
with audit quality while the number of non-CPA holders is not. See
Hossain, et al., The Relationship.
\336\ See, e.g., Lo, et al., Does Availability of Audit
Partners.
\337\ See, e.g., Christensen, et al., Team Workloads.
---------------------------------------------------------------------------

The Workload metrics will indicate the average weekly hours worked
on a quarterly basis by senior professionals, including time
attributable to engagements, administrative duties, and all other
matters, both firm-wide and on the core engagement team. Investors and
audit committees could use this information to evaluate whether
partners and managers are overworked or potentially distracted by other
responsibilities. In certain circumstances, higher workloads could
indicate that partners and managers are working longer to ensure audit
quality is high. While there is no established optimal workload level
for audit teams or their staffing components, academic literature
suggests that auditors have high workloads, particularly during the
busy season.\338\ Furthermore, several academic studies, primarily
using international data, find that high workload levels (e.g.,
workloads that exceed 60 hours per week), particularly during the busy
season, negatively impact audit quality.\339\ Auditors that work on
multiple engagements in different environments and scopes may also
experience issues with memory-related errors.\340\ However, the impacts
of workload may depend on the auditor's ability to handle such normal
workloads.\341\ Furthermore, one study finds that audit partner
busyness is not related to audit quality under equilibrium market
conditions.\342\
---------------------------------------------------------------------------

\338\ See, e.g., Persellin, et al., Auditor Perceptions Table 2;
Dana R. Hermanson, Richard W. Houston, Chad M. Stefaniak, and Anne
M. Wilkins, The Work Environment in Large Audit Firms: Current
Perceptions, 10 Current Issues in Auditing A38 (2016); and John T.
Sweeney and Scott L. Summers, The Effect of the Busy Season Workload
on Public Accountants' Job Burnout, 14 Behavioral Research in
Accounting 223 (2002).
\339\ See, e.g., Christensen, et al., Team Workloads; Jun Chen,
Wang Dong, Hongling Han, and Nan Zhou, Does Audit Partner Workload
Compression Affect Audit Quality?, 29 European Accounting Review
1021 (2020); Jin Suk Heo, Soo Young Kwon, and Hun-Tong Tan,
Auditors' Responses to Workload Imbalance and the Impact on Audit
Quality, 38 Contemporary Accounting Research 338 (2021); Hwang and
Hong, Auditors' Workload; Dennis M. Lopez and Gary F. Peters, The
Effect of Workload Compression on Audit Quality, 31 Auditing: A
Journal of Practice & Theory 139 (2012); Persellin, et al., Auditor
Perceptions; and Ferdinand A. Gul, Shuai Mark Ma, and Karen Lai,
Busy Auditors, Partner-Client Tenure, and Audit Quality: Evidence
from an Emerging Market, 16 Journal of International Accounting
Research 83 (2017).
\340\ See, e.g., Sudip Bhattacharjee, Mario J. Maletta, and
Kimberly K. Moreno, The Cascading of Contrast Effects on Auditors'
Judgments in Multiple Client Audit Environments, 82 The Accounting
Review 1097 (2007).
\341\ See Persellin, et al., Auditor Perceptions.
\342\ See Goodwin and Wu, What is the Relationship.
---------------------------------------------------------------------------

The Retention of Audit Personnel metrics will indicate the
continuity of senior professionals (through departures, reassignments,
etc.) across the firm. Discontinuity of senior professionals at the
firm could be a signal of dysfunction within the firm and a loss of
valuable issuer and firm-specific human capital. Some research suggests
that excessive levels of turnover, particularly at the staff level,
could lead to a deterioration in audit quality.\343\ One study finds
that auditor turnover at U.S. Big 4 firms has a significant negative
effect on audit quality as measured by the prevalence of
restatements.\344\ Using Belgian data collected from private and public
companies, another study finds that abnormal turnover is more likely to
affect audit quality than expected (i.e., normal or average) levels of
turnover, and the negative consequences of turnover impact existing
clients more than new clients.\345\ Firms with larger internal labor
pools may be better positioned to mitigate the negative consequences of
turnover. For example, using data from Chinese audit firms on auditor
departure from public accounting, one study finds that the negative
effect of departure on audit quality is stronger for non-Big 4
firms.\346\
---------------------------------------------------------------------------

\343\ See, e.g., Khavis and Szerwo, Audit-Employee Turnover,
Audit Quality, and the Auditor-Client Relationship 27; and
Christensen, et al., Team Workloads.
\344\ See Tao Ma, Chi Wan, Yakun Wang, and Yuping Zhao,
Individual Auditor Turnover and Audit Quality--Large Sample Evidence
from US Audit Offices, 99 The Accounting Review 297 (2024).
\345\ See, e.g., Linden, et al., Audit Firm Employee Turnover
and Audit Quality 4.
\346\ See, e.g., W. Robert Knechel, Juan Mao, Baolei Qi, and
Zili Zhuang, Is There a Brain Drain in Auditing? The Determinants
and Consequences of Auditors Leaving Public Accounting, 38
Contemporary Accounting Research 2461 (2021).
---------------------------------------------------------------------------

The Experience of Audit Personnel metrics will indicate the average
number of years worked at a public accounting firm (whether or not
PCAOB-registered) by senior professionals across the firm and on the
engagement. Greater experience of audit personnel metrics may indicate
to investors and audit committee members that senior professionals are
more effective and efficient auditors. The extant academic literature
shows mixed results regarding the association between auditor
experience and audit quality. One study of U.S. audit partners finds
that absolute discretionary accruals, a proxy for audit quality, is
increasing (decreasing) in the number of years the partner has been a
CPA

[[Page 100047]]

licensee early (late) in their career.\347\ One experimental study from
the United States found that less-experienced auditors may be less
willing to request additional evidence from company controllers.\348\
However, another U.S. study finds that audit partner experience is not
associated with audit quality.\349\ Using data from Taiwan, one study
finds that an auditor's experience is positively associated with
proxies for audit quality.\350\ One study on Chinese audit firms finds
that the number of years that the partner has been engaged in audit
work is negatively associated with absolute discretionary accruals, a
proxy for audit quality.\351\ However, another study using data from
Chinese audit firms finds that the an auditor's birth year, a proxy for
total experience, is not associated with several proxies for audit
quality.\352\
---------------------------------------------------------------------------

\347\ See Chenyong Liu and Chunhao Xu, The Effect of Audit
Engagement Partner Professional Experience on Audit Quality and
Audit Fees: Early Evidence from Form AP Disclosure, 29 Asian Review
of Accounting 128 (2021).
\348\ See, e.g., Bennett and Hatfield, The Effect of the Social
Mismatch 46-47.
\349\ See, e.g., Hye Seung Lee, Albert L. Nagy, and Aleksandra
B. Zimmerman, Audit Partner Assignments and Audit Quality in the
United States, 94 The Accounting Review 297 (2019).
\350\ See, e.g., Chi, et al., The Effects of Audit Partner 363.
\351\ See Steven F. Cahan and Jerry Sun, The Effect of Audit
Experience on Audit Fees and Audit Quality, 30 Journal of
Accounting, Auditing & Finance 78 (2015).
\352\ See, e.g., Ferdinand A. Gul, Donghui Wu, and Zhifeng Yang,
Do Individual Auditors Affect Audit Quality? Evidence from Archival
Data, 88 The Accounting Review 1993, Table 6 (2013).
---------------------------------------------------------------------------

The Industry Experience metrics will indicate the average years of
career experience of senior professionals in key industries audited by
the firm at the firm level and the audited company's primary industry
at the engagement level. The academic literature shows that industry
experience, primarily using market share proxies, are related to audit
quality.\353\ One study of U.S. Big 4 firms finds that audit quality is
positively associated with the number of years that the auditor is an
industry specialist (i.e., it has the largest market share in an
industry and at least 10% more market share than the next-largest
competitor).\354\ One experimental study finds that auditor
participants that have experience in an industry are more likely to
understand the specific financial reporting requirements and risks that
issuers in those industries face.\355\ However, some research suggests
that the impact of industry specialization on audit quality may depend
on other contextual factors (e.g., whether the auditor is local to the
client or the difficulty of the audit).\356\ The Board also notes that
some studies indicate that research on experience and industry
specialization may be sensitive to design, proxy, and stratification
level (i.e., office-level and national-level). However, as one of the
studies notes, the Board believes these findings do not imply that
industry expertise is unrelated to audit quality.\357\
---------------------------------------------------------------------------

\353\ See, e.g., Craswell, et al., Auditor Brand Name (finding,
using a sample of Australian firms, that industries that require
greater specialization are associated with greater audit fees,
consistent with ``demand for audit quality''); Mark L. DeFond, Jere
R. Francis, and T. J. Wong, Auditor Industry Specialization and
Market Segmentation: Evidence from Hong Kong, 19 AUDITING: A Journal
of Practice & Theory 49 (2000) (finding, using a sample of publicly
listed Hong Kong companies, that industry specialization, as proxied
by being among the top three firms in an industry by market share,
is associated with greater audit fees among Big 6 auditors but lower
audit fees among non-Big 6 auditors); Balsam, et al., Auditor
Industry Specialization and Earnings Quality 95 (finding audit
quality proxies are positively associated with the auditor being the
largest auditor in an industry); Gopal V. Krishnan, Does Big 6
Auditor Industry Expertise Constrain Earnings Management?, 17
Accounting Horizons 1, 3 (2003) (finding that a firm's audit fee
share within an industry is associated with higher audit quality
[lower absolute discretionary accruals]); and Knechel, et al., Does
Auditor Industry Specialization Matter? (finding that issuers that
switch to auditors that have at least a 30% market share in the
issuer's industry experience significant positive anormal returns).
\354\ See Jennifer J. Gaver and Steven Utke, Audit Quality and
Specialist Tenure, 94 The Accounting Review 113 (2019).
\355\ See, e.g., Low, The Effects of Industry Specialization
202.
\356\ See, e.g., Jere R. Francis, Kenneth Reichelt, and Dechun
Wang, The Pricing of National and City-Specific Reputations for
Industry Expertise in the U.S. Audit Market, 80 The Accounting
Review 113, 114 (2005) and Aobdia et al., Heterogeneity in Expertise
in a Credence Goods Setting.
\357\ See, e.g., Terry L. Neal and Richard R. Riley, Auditor
Industry Specialist Research Design, 23 AUDITING: A Journal of
Practice & Theory 169 (2004); Steven F. Cahan, Debra C. Jeter, and
Vic Naiker, Are All Industry Specialist Auditors the Same?, 30
AUDITING: A Journal of Practice & Theory 191 (2011); and Miguel
Minutti-Meza, Does Auditor Industry Specialization Improve Audit
Quality?, 51 Journal of Accounting Research 779, 813 (2013) (finding
that ``auditor industry specialization, measured using the auditor's
within-industry market share, is not a reliable indicator of audit
quality'' and that ``these findings do not imply that industry
knowledge is not important for auditors'').
---------------------------------------------------------------------------

The Training Hours for Audit Personnel metrics would indicate
average annual training hours for partners, managers, and staff of the
firm, combined, both firm-wide and on the core engagement team.
Overall, the academic literature provides mixed evidence regarding how
auditor training relates to audit quality, but provides some evidence
to support the association between specialized training and audit
quality. Some studies find that certain proxies for auditor training
are positively associated with some proxies for audit quality. For
example, one survey of junior auditors at large U.S. public accounting
firms found that the perceived effectiveness of training was associated
with lower turnover intentions.\358\ A study on Norwegian audit
partners found that CPE hours were positively associated with audit
effort and going concern opinion accuracy.\359\ A survey of auditors
working in small audit firms in Sweden found that participation in four
or more training activities or 50 or more hours of education per year
were negatively associated with self-reported ``dysfunctional''
behaviors.\360\ However, other studies suggest that the benefits of
training are driven primarily by specialized training. For example, one
study on the Spanish audit market found that only partners'
specialized, or non-generic audit knowledge (as proxied by industry-
specific experience), was significantly positively associated with
audit quality.\361\ An older experimental study found that specialized
indirect experience (i.e., training), resulted in a stronger
understanding for the auditor, but had a greater impact of knowledge
unrelated to financial statement errors.\362\ Another experimental
study found that specialized training and experience were more strongly
associated with improved audit outcomes than general knowledge.\363\
---------------------------------------------------------------------------

\358\ See Hossein Nouri and Robert J. Parker, Career Growth
Opportunities and Employee Turnover Intentions in Public Accounting
Firms, 45 The British Accounting Review 138 (2013).
\359\ See Limei Che, John Christian Langli, and Tobias
Svanstr[ouml]m, Education, Experience, and Audit Effort, 37
Auditing: A Journal of Practice & Theory 91 (2018). The study judged
the accuracy of the auditor's going concern evaluation by reference
to subsequent bankruptcy of the audited company. Note that there are
several limitations to this proxy. See Marshall A. Geiger, Anna
Gold, and Phillip Wallage, Auditor Going Concern Reporting: A Review
of Global Research and Future Research Opportunities (2021).
\360\ See Tobias Svanstr[ouml]m, Time Pressure, Training
Activities and Dysfunctional Auditor Behaviour: Evidence from Small
Audit Firms, 20 International Journal of Auditing 42 (2016). The
study defines ``dysfunctional behaviors'' as: (1) making superficial
reviews of client documents; (2) incorrectly signing off on an audit
step; (3) prematurely signing-off on an audit step; (4) accepting
weak client explanations; or (5) putting a greater level of trust in
the audit client than is reasonable.
\361\ See Josep Garc[iacute]a-Blandon, Josep Mar[iacute]a
Argil[eacute]s-Bosch, and Diego Ravenda, Learning by Doing? Partners
Audit Experience and the Quality of Audit Services, 23 Revista de
Contabilidad (Spanish Accounting Review) 197 (2020).
\362\ See Ira Solomon, Michael D. Shields, O. Ray Whittington,
What Do Industry-Specialist Auditors Know?, 37 Journal of Accounting
Research 191 (1999).
\363\ See Sarah E. Bonner and Barry L. Lewis, Determinants of
Auditor Expertise, 28 Studies on Judgment Issues in Accounting and
Auditing 1 (1990) 16.

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[[Page 100048]]

By requiring auditors to disclose these personnel related metrics,
investors and audit committees could, for example, identify auditors
with sustainable workloads, with the implicit outcome that sustainable
workloads could improve auditor attentiveness and reduce error rates.
Additionally, investors and audit committees may find the final metrics
to be useful in evaluating the risk that the auditor has overlooked
errors or material misstatements due to overworked partners or managers
or that the engagement team was not sufficiently qualified or
specialized. Moreover, investors may find the final metrics beneficial
in understanding whether the engagement, and therefore the issuer, had
significant risks or the issuer's operations were particularly complex
compared to peer issuers. For example, if there was a significantly
higher workload across partners, managers, and staff--or excessive
turnover--compared to another investment opportunity of similar issuer
size, the investor may then infer that the issuer had unique risks that
necessitated increased audit effort. Such a signal may be particularly
useful if the investor could ascertain whether peer issuers were more,
or less, complex compared to the issuer under consideration. The
investor may also be reasonably assured if there were positive audit
outcomes as it may signal to the investor that the auditor exerted
considerable or appropriate effort in obtaining a reasonable level of
assurance on the issuer's financial statements in the context of their
peers for that issuer's complexity and risk level.
Audit committees may also find these final metrics to be
beneficial, as the audit committee may view them as confirming that the
auditor is appropriately staffing the engagement. In addition, during
the selection process for a new auditor, the audit committee may review
the final metrics of potential candidate auditors in the context of
peer-group engagements, thereby using the final metrics to make auditor
selection decisions more effectively. By selecting an auditor based on
their experience or industry-specific knowledge, audit committees could
be better able to choose the preferred candidate auditor for their
engagement--thereby improving the matching efficiency of human capital
within and across firms by helping to align the demand for resources
with the supply.
Audit firms may find the final metrics beneficial as they may be
better able to monitor whether they are unintentionally over- or under-
auditing, as they will be able to compare their audit personnel metrics
to other firms' metrics. Audit firms may also benefit from identifying
lead industry-specialist auditors and improve their own audit services
to compete with these industry specialists on the quality of those
services. Importantly, incumbent auditors (i.e., current auditors of an
issuer) know more about the issuer's operations than rival competitor
auditors.\364\ The disclosure of the final metrics could provide these
competitor auditors with the ability to observe signals regarding the
effort and experience required on the engagement, and those auditors
may be able to use that information to compete against the incumbent
auditor for the issuer's prospective engagement more effectively.\365\
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\364\ See, e.g., Monika Causholli, W. Robert Knechel, and Haijin
Lin, and David E. M. Sappington, Competitive Procurement of Auditing
Services with Limited Information, 22 European Accounting Review
573, 576-578 (2013).
\365\ Id.
---------------------------------------------------------------------------

The final metrics related to audit personnel and commenters' views
are discussed and summarized above. Here the Board highlighted the
comments that are most relevant to the economic analysis. Citing
academic research, one commenter said that human capital inputs to
audit production are crucial to audit quality.\366\ The same comment
letter referred to a working paper written by the letter's authors
which finds the manager-to-employee ratio at the audit office level is
positively associated with audit quality.\367\ The commenter cited two
academic studies that suggest audit offices are core functional
units.\368\ Several commenters expressed concern that the benefits to
reporting partner and manager involvement may be dampened by the fact
that greater partner and manager involvement is not necessarily
correlated with greater audit quality. Some of these commenters pointed
out that partner and manager involvement is likely to vary with the
complexity of the audit. For example, one commenter suggested that a
less complex audit may require little additional supervision while a
more complicated audit may require more supervision. One commenter said
that the firm-level workload metric would not be comparable across
firms due to variation in the size of each firm's issuer practice.
Another commenter suggested that presenting firm-level average
experience will be difficult to interpret because the distribution of
personnel experience varies vastly. Several commenters agreed that
defining a training metric that would provide decision-useful
information would be challenging. One commenter said they think
training increases technical competence. Another said that training
builds awareness and on-the-job training is invaluable. However, the
same commenter said that on-the-job-training could not be quantified.
Another commenter supported a training metric but preferred an
alternative calculation.
---------------------------------------------------------------------------

\366\ See Jeffrey L. Hoopes, Kenneth J. Merkley, Joseph Pacelli,
and Joseph H. Schroeder, Audit Personnel Salaries and Audit Quality,
23 Review of Accounting Studies 1096 (2018); Brandon Gipper, Luzi
Hail, and Christian Leuz, On the Economics of Mandatory Audit
Partner Rotation and Tenure: Evidence from PCAOB Data, 96 The
Accounting Review 303 (2021); Christensen, et al., Team Workloads.
\367\ See Joshua Khavis et al., Manager Staffing Leverage.
\368\ See Kenneth L. Bills, Quinn T. Swanquist, and Robert L.
Whited, Growing Pains: Audit Quality and Office Growth, 33
Contemporary Accounting Research 288 (2016); Christensen, et al.,
Team Workloads.
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The Board acknowledges that the final metrics are imperfect proxies
for audit quality.\369\ For example, the Board recognizes that average
experience only partially describes the distribution of experience
within a firm and, by extension, two firms with the same average
experience could have quite different experience distributions.
However, the Board believes that the final metrics will, on average,
improve investors' decision-making.\370\ The Board agrees that the
partner and manager involvement metric may vary with the complexity of
the audit. The Board also agrees that the firm-level workload metric
may vary by the size of the firm's issuer practice. However, the size
of the firm's issuer practice and other proxies for the complexity of
the audit are public information so stakeholders can adjust for any
systematic variation in the partner and manager involvement and
workload metrics. The Board also agrees that stakeholders may
misinterpret the experience of audit personnel or training metrics.
While some misunderstanding may reduce the usefulness of the final
metrics, the Board believes that reporting the experience of audit
personnel and training metrics will likely still be beneficial to
investors.\371\
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\369\ See above for a more general discussion of commenters'
concerns regarding comparability of the final metrics.
\370\ See above for a more general discussion of commenters'
concerns regarding the relationship between the proposed metrics and
audit quality.
\371\ See below for a more general discussion of commenters'
concerns regarding potential misinterpretation by investors, audit
committees, and auditors.

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[[Page 100049]]

b. Metrics Related to the Allocation of Audit Hours
The Allocation of Audit Hours metric would indicate the percentage
of hours incurred prior to and following an issuer's year end across
the firm's large accelerated and accelerated filer engagements and on
the specific engagement. This metric may provide insight into whether
the audit team is being efficiently and effectively deployed.
Generally, the academic literature related to the allocation of audit
hours is limited, as information pertinent to studying this topic is
non-public. However, one recent study used PCAOB inspections data and
found that audit engagements in which relatively more audit effort was
spent prior to the issuer's fiscal year end had overall improvements in
audit effectiveness and a lower likelihood of negative audit
outcomes.\372\ As noted in that study, other researchers have
identified that work conducted earlier in the audit process may lead to
an earlier identification of issues that could improve the possibility
those issues would then be corrected.\373\ Another study, using data
from one global accounting firm, also finds that a greater proportion
of audit work performed earlier in the audit is associated with
improved audit outcomes.\374\
---------------------------------------------------------------------------

\372\ See, e.g., Aobdia, et al., The Economics of Audit
Production 1, 6 and 11.
\373\ See id. at 12.
\374\ See Christensen, et al., Archival Evidence.
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The final Allocation of Audit Hours metric could allow investors
and audit committees to better evaluate how their auditor plans its
audit and compare their audit and auditor to peers. For example, it
could indicate that their auditor has left substantial issues to the
end of the engagement. The effective deployment of resources is of
critical importance to a well-planned audit.\375\ The final metric may
also help auditors understand whether they are effectively planning
their audit. Auditors may compare their allocations of audit hours to
those of other firms and adjust accordingly. The final Allocation of
Audits Hours metric could also provide supplemental value to the final
Workload and Partner and Manager Involvement metrics.
---------------------------------------------------------------------------

\375\ See, e.g., Causholli, et al., Competitive Procurement (for
an economic model describing the intersection of efficiency,
quality, and competition in the market for audit services). See also
Aobdia, et al., The Economics of Audit Production.
---------------------------------------------------------------------------

The final metrics related to allocation of audit hours and
summarizes commenters' views are discussed above. Here the Board
highlighted the comments that are most relevant to the economic
analysis. Several commenters cautioned that allocation of audit hours
may not be a useful signal of audit quality because circumstances
outside of the auditor's control may influence it (e.g., significant
unusual, and unanticipated, transactions near the balance sheet date,
going concern issues that arise after the balance sheet date, other
unforeseen company delays). One commenter said that for the largest
firms, individual issuer circumstances may not be significant enough to
move the firm-level metric, but for smaller firms, individual issuer
circumstances could impact the overall results. The Board recognizes
that the allocation of audit hours will be an imperfect proxy for audit
quality. However, the Board believes the academic literature provides
evidence that the final metrics will likely be associated with audit
effectiveness and audit outcomes and thus aid decision-making.\376\
---------------------------------------------------------------------------

\376\ See above for a more general discussion of commenters'
concerns regarding the relationship between the proposed metrics and
audit quality.
---------------------------------------------------------------------------

c. Metrics Related to Audit Outcomes
The Restatement History metrics will summarize restatements of
financial statements and management reports on internal control over
financial reporting (``ICFR'') that were audited by the firm over the
past three years. In the academic literature, restatements are widely
regarded as the strongest indicator of poor audit quality.\377\
Restatements have been shown to result in auditor dismissal or
increased resources committed by the auditor to the issuer.\378\ Using
data from Japanese audit firms, one study finds that auditors devote
additional resources to companies the year they restate their financial
statements.\379\ However, it is important to note that restatements are
often observed after a significant lag following the restatement
event--which causes a reduction in the informativeness of the
restatement event, if such information is viewed as stale by investors
and audit committees. Furthermore, the absence of a restatement does
not imply audit quality was high and the occurrence of a restatement
identified by a successor auditor may signal improved audit quality
when the auditor increases audit effort to identify errors in the work
of prior auditors.\380\ The Board acknowledges that the incremental
value of the final metric will be limited by the fact that restatements
are public information already (e.g., U.S. issuers must file Form 8-K
when they materially restate their financial statements and the public
financial statements themselves indicate when a restatement has
occurred). However, the Board believes that there is value in having
the restatements aggregated and presented along with the other metrics.
---------------------------------------------------------------------------

\377\ See, e.g., DeFond and Zhang, A Review of Archival Auditing
Research (specifically, the discussion marked Section 2.3.1 Output-
based audit quality measures). The Board notes that ``little r''
restatements are a less-widely used proxy for audit quality than
``Big R'' restatements. See Jayanthi Krishnan and Mengtian Li, Are
Referred-to Auditors Associated with Lower Audit Quality and
Efficiency?, 42 Auditing: A Journal of Practice & Theory 101 (2023)
for one study that uses ``little r'' restatements as a proxy for
audit quality. By contrast to ``Big R'' restatements, one study
found muted or absent market reactions to ``little r'' restatements.
See Daniel Aobdia, Vincent Castellani, and Paul Richardson, Do
Investors Care Who Led the Audit in the U.S.? Evidence from
Announcements of Accounting Restatements, SSRN Electronic Journal
(2024). The Board notes that SSRN does not peer review its
submissions.
\378\ See, e.g., Karen M. Hennes, Andrew J. Leone, and Brian P.
Miller, Determinants and Market Consequences of Auditor Dismissals
after Accounting Restatements, 89 The Accounting Review 1051 (2014);
and Li[hyphen]Lin Liu, K. Raghunandan, and Dasaratha Rama, Financial
Restatements and Shareholder Ratifications of the Auditor, 28
Auditing: A Journal of Practice & Theory 225 (2009).
\379\ See, e.g., Chi, Wuchun and Chien-min Kevin Pan, How Do
Auditors Respond to Accounting Restatements? Evidence on Audit Staff
Allocation, 58 Review of Quantitative Finance and Accounting 1
(2022).
\380\ See, e.g., Stephen P. Rowe and Padmakumar Sivadasan,
Higher Audit Quality and Higher Restatement Rates: An Examination of
Big Four Auditee Restatements, SSRN Electronic Journal, (2021). The
Board notes that SSRN does not peer review its submissions.
---------------------------------------------------------------------------

The final metrics related to restatement history and commenters'
views are discussed and summarized above. Overall, commenters were
supportive of the proposed metrics related to restatement history. Two
non-U.S. firm-related groups suggested that financial reporting quality
is complex, and restatements are not a perfect proxy for audit quality.
The Board agrees that it is not a perfect indicator. However, as the
Board noted in the proposal, restatements are a widely-used proxy for
audit quality. The Board agrees that context will be important to
understand the final metrics, including the final Restatement History
metric.\381\ Two commenters said that restatements are already publicly
available and therefore the metric would not be useful. The Board noted
this in the proposal. The Board continues to believe that providing
information on restatement history in Form FM would make the
information more accessible to stakeholders.
---------------------------------------------------------------------------

\381\ See above for a more general discussion of commenters'
concerns regarding the relationship between the proposed metrics and
audit quality.

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[[Page 100050]]

2. Costs
In the following discussion, the Board considered direct and
indirect costs related to the final rules. The Board has attempted to
quantify certain costs where possible. However, most of the costs are
intractable to quantify, particularly the indirect costs.
First, auditors may incur direct costs building an
appropriate reporting infrastructure or updating existing
infrastructure.
Second, auditors may incur direct costs producing the firm
and engagement metrics.
Third, auditors, investors, and audit committees may incur
indirect costs understanding and integrating the final metrics into
their current decision-making frameworks.
Fourth, auditors may incur indirect costs revising their
audit approaches.
Fifth, investors, audit committees, and auditors may incur
indirect costs to the extent that issuers switch auditors more
frequently as a result of the final rules.
Sixth, issuers and investors may bear indirect costs to
the extent that costs incurred by auditors are passed on in the form of
higher audit fees.
Larger firms should be able to take advantage of economies of scale
by distributing any fixed costs over a higher number of audit
engagements. Smaller firms will likely distribute any fixed costs over
a lower number of audit engagements, which, taking fixed costs as
given, would make implementation relatively more costly for smaller
firms.\382\ Many commenters agreed that smaller firms, including non-
U.S. firms, could be disproportionately impacted. However, the fixed
costs may also be less for smaller firms than for larger firms (e.g.,
they may not require significant IT systems if they need to track only
a few engagements).\383\
---------------------------------------------------------------------------

\382\ See, e.g., Michael Minnis and Nemit Shroff, Why Regulate
Private Firm Disclosure and Auditing?, 47 Accounting and Business
Research 473, 498-499 (2017) (explaining that increased financial
reporting regulation is disproportionately costly for smaller
companies because complying with regulation has large fixed costs,
and unlike larger companies, smaller companies do not benefit from
economies of scale).
\383\ Among the firms that will be impacted by the final rules
approximately 41%, 19%, and 11% had a total of one, two, or three
accelerated filer or large accelerated filer engagements,
respectively, during the 12-month period ending September 30, 2023.
---------------------------------------------------------------------------

Referring to research from the SEC, one commenter noted that 99.9%
of businesses are small businesses, 43.5% of the U.S. GDP is created by
small businesses, and 63% of net new jobs are created by small
businesses.\384\ The commenter did not discuss what portion of these
figures would be impacted by the proposal. The Board notes that the
final rules will apply only to the auditors and audits of accelerated
filers and large accelerated filers. However, the Board recognizes that
some accelerated filers and larger accelerated filers may not be
audited by the largest audit firms. For example, 24.0% of accelerated
filers (representing 19.3% of total accelerated filer market
capitalization) and 4.5% of large accelerated filers (representing 0.3%
of total large accelerated filer market capitalization) are audited by
non-affiliated firms.\385\
---------------------------------------------------------------------------

\384\ See U.S. Securities and Exchange Commission, Office of the
Advocate for Small Business Capital Formation, Annual Report Fiscal
Year 2023.
\385\ Source: S&P and Audit Analytics. The Board's calculations
use market capitalization data as of the second quarter of 2024.
``Non-affiliated firms'' are firms not affiliated with BDO
International Limited, Deloitte Touche Tohmatsu Limited, Ernst &
Young Global Limited, Grant Thornton International Limited, KPMG
International Cooperative, or PricewaterhouseCoopers International
Limited.
---------------------------------------------------------------------------

Several commenters said that the proposal did not fully consider
the costs and complexities associated with complying with the proposed
rules. Two commenters said that the proposal's economic analysis
largely disregards costs and does not attempt to quantify the related
costs of some requirements. To the contrary, the proposal's economic
analysis included both a discussion of the available evidence about
costs and PCAOB staff's attempt to quantify costs of the proposal to
the extent feasible. The Board has carefully reviewed stakeholders'
input regarding the potential costs of the proposal. Based on outreach
to audit firms, one commenter agreed that firms' processes and systems
would need to be established or updated.
One commenter suggested that the PCAOB should, as a starting point,
consider whether the metrics would require additional systems,
processes, or procedures. The Board considered these costs and
quantified several of them in the proposal and, with modification to
account for stakeholder feedback, address them again below.
One commenter suggested that it would be helpful if the Board could
match each cost to each benefit. The Board does not believe such an
analysis is feasible or reasonable. For example, it is not possible to
match fixed costs (e.g., IT investments) to a particular benefit
because they do not drive the benefit alone. Furthermore, the variable
cost categories (e.g., gathering, calculating, and disclosing the
metrics) cannot be matched to specific benefit categories (e.g.,
competition). Rather, these variable cost categories are each
associated with producing the metrics, while disclosing the metrics
drives all the benefits. Where feasible and reasonable, the Board
highlighted in the proposal and below connections between certain
qualitative cost categories and certain qualitative benefit categories.
For example, the Board has highlighted that audit switching costs may
arise from improved competition. The Board also acknowledges how
certain metrics may be more costly or beneficial than others to allow
the Board and commenters to consider each metric individually (e.g., by
surveying academic literature by metric and highlighting challenges
gathering data required for certain metrics).
One commenter noted that the use of data analytics at firms should
enable them to more efficiently implement the final rules. The Board
has observed that firms are increasingly using data analytics in their
audits.\386\ However, the extent to which these capabilities lend
themselves to regulatory compliance and management of the audit
practice itself is less clear.
---------------------------------------------------------------------------

\386\ See PCAOB Rel. No. 2024-007, 35 and cites therein for
additional discussion on this topic.
---------------------------------------------------------------------------

i. Direct Costs To Comply With the Final Rules
a. Modifying or Building a System To Produce the Final Metrics
Auditors may incur certain initial fixed costs (i.e., costs that
are generally independent of the number of audits performed) related to
modifying existing systems or building new systems that could collect
the relevant data that is needed to generate the final metrics and
produce compliant filings. The Board believes most firms will likely
modify existing systems rather than build entirely new systems. These
costs may include acquiring necessary IT infrastructure, establishing
an appropriate system of controls, creating system documentation, and
conducting system testing (e.g., with historical data or by conducting
dry runs before the effective date of the final requirements). There
could also be costs related to training personnel in how to use the new
or modified system. This could include training: (i) engagement-level
personnel on how to collect and document information relevant to the
final metrics; (ii) centralized personnel on how to aggregate and
produce the final metrics; and (iii) administrative personnel on how to
create filings and ensure proper control over the system; all in
compliance with QC 1000.\387\
---------------------------------------------------------------------------

\387\ See Michael J. Gurbutt, Wei-Kang Shih, Carrie von Bose,
and Tasneem Raihan, Staff White Paper: Second Stakeholder Outreach
on the Initial Implementation of CAM Requirements, Public Company
Accounting Oversight Board 11 (2022).

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[[Page 100051]]

The fixed costs associated with these efforts will likely depend on
the extent to which firms already have automated systems in place that
may be adapted to comply with the final requirements. As discussed
above, the Board believes many firms track much of the information that
would be required to calculate the final metrics. In particular,
information gathered by PCAOB staff in 2018 and 2019 pursuant to PCAOB
oversight activities indicates that U.S. GNFs generally track some
metrics similar to the final metrics and voluntarily provide
quantitative information that is similar to many of the final metrics.
With respect to roughly half of the engagements that will be subject to
the final engagement-level reporting requirements, firms are already
gathering total audit hours information from other auditors pursuant to
Form AP reporting requirements. Furthermore, firms should be tracking
CPE credits pursuant to licensing requirements and restatements
pursuant to QC 1000. The Board believes firms likely have systems in
place to help them track this information. As a result, these firms may
be able to leverage their existing internal systems to comply with the
final rules. Moreover, firms may be able to leverage existing systems
related to their compliance with other PCAOB reporting requirements
(e.g., QC 1000 and Form AP). Indeed, one GNF commenter, in response to
the Concept Release, noted that some of the metrics discussed therein
and included in the final rules would be ``easy to compute.''
However, the Board has also considered that existing systems may
not be functionally joined together, and that systems designed and
operated for internal monitoring or informal reporting purposes may
need to be enhanced to meet the needs of public reporting. There are,
therefore, likely to be costs associated with integrating the various
reporting systems and enhancing or updating current systems to comply
with the final requirements. One GNF commenter on the Concept Release
suggested that this would likely be especially true for NAFs. The
required changes would depend on a firm's size and the nature of their
engagements.
Depending on their facts and circumstances, some firms may avoid
the costs associated with modifying or building an automated system by
opting for a more manual approach. Larger firms are more likely to
build automated systems, or increase automation in existing systems,
given the scale of their operations and the scope of data that will
need to be collected to calculate the final metrics (i.e., they have a
larger number of employees and engagements). Smaller firms may choose
to build or expand upon existing manual systems (e.g., collecting
information in spreadsheets or simple databases) because, for these
firms, the scope of information to be collected and processed may be
effectively collated in a spreadsheet-based tool. Firms may also opt
for automated systems to the extent that the final metrics will require
a larger number of individual components, a broader pool of
individuals, or more complicated calculations (e.g., the final metrics
related to audit-team retention, auditor experience, or industry
expertise). The fixed costs to build or modify existing automated
systems are likely to be greater than manual systems. However,
automated systems should reduce variable costs in the long run.
The Board is unaware of any data or research relevant to the
potential costs of modifying firms' existing automated systems, which
the Board believes would be the most likely scenario for many firms,
particularly the largest firms which audit a significant majority of
the audit market.\388\ However, the costs to build an automated system
from the ground up--that is, if a firm did not have any existing
systems that track the inputs to the final metrics--could be comparable
to the costs to implement an enterprise resources planning (ERP) system
(but such costs are not exactly analogous). Using surveys of companies
that have implemented ERP systems, some studies find that ERP system
implementation costs scale with the company's revenues and staff count.
Using audit fees as a proxy for revenue and number of accountants as a
proxy for staff count, an illustrative calculation suggests that the
total costs (e.g., adding over all impacted firms), if every such firm
were to implement an automated system from the ground up, could range
from approximately $371 million to $512 million.\389\ This would
represent a one-time cost of approximately 2% to 3% of audit fees paid
by issuers to covered firms in a year. However, as discussed in more
detail below, the fixed costs associated with modifying or building a
system to produce the final metrics are likely to be a fraction of this
amount given that the Board expects most firms would modify existing
systems rather than build entirely new systems. For this reason, this
range likely represents an upper bound of the potential costs.
---------------------------------------------------------------------------

\388\ See, e.g., Ideagen Audit Analytics, 20-Year Review of
Audit Fee Trends 2003-2022, (July 2023) at 2.
\389\ The Board identified two publicly available reports
related to the costs of implementing ERP systems. Referring to the
experiences of over 1,000 client and non-client companies that had
implemented a digital transformation effort in the past twenty
years, one consulting firm estimated that implementation costs for
companies with revenues under $1 billion were approximately 3-5% of
annual revenue, and implementation costs for companies with revenues
over $1 billion were approximately 2-3% of annual revenue (The 2020
ERP Report, Third-Stage Consulting Group, (2020)). Each of the U.S.
Big 4 firms had over $1 billion of revenue for the 2023 issuer
fiscal year, while all other firms that will be impacted had less
than $1 billion. Using the midpoint of the ranges, 2.5% for U.S. Big
4 firms and 4% for all other firms, implementation costs related to
building a new system to produce the final metrics will be
approximately $12.7 billion x 2.5% + $4.8 billion x 4% = $512
million. The Board notes that 13 firms, which had a combined $22
million in audit fees in 2022, had zero audit fees in 2023. Using
information on client implementation projects active between January
2021 and December 2021, another consulting firm reported that
companies having over 500, between 50 and 499, or less than 50
employees project spent $11,000, $9,000, or $8,571 per ERP system
user over a 5-year ERP implementation period and that 7.27%, 20.13%,
and 34.8% of employees used the ERP system, respectively (2022 ERP
Software Report, Software Path, (2022)). Information provided by
registered firms that will be impacted by the final requirements on
Form 2 indicates that, for the 2023 reporting year, 130, 58, and 19
firms employed over 500, between 50 and 499, or less than 50
accountants, employing a total of 431,680, 14,274, and 474
accountants, respectively. Using the number of accountants employed
by a registered firm as a proxy for the number of employees,
implementation costs related to building a new system to produce the
final metrics would be approximately 430,074 x 7.27% x $11,000 +
14,142 x 20.13% x $9,000 + 444 x 34.8% x $8,571 = $371 million.
Source: Audit Analytics and RASR.
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There are several reasons to expect the implementation costs will
be substantially less than the cost of building a new ERP system.
First, as noted above, the Board believes it is likely that firms,
particularly the largest firms with the greatest market share, are
already gathering much of the information that would be required to
calculate the final metrics. For example, roughly half of the
engagements that will be subject to the final engagement-level
reporting requirements are already gathering total audit hours
information from other auditors pursuant to Form AP reporting
requirements. Furthermore, firms should be tracking CPE credits
pursuant to licensing requirements and restatements pursuant to QC
1000. Second, the Board believes most larger firms have automated
systems in place that could be leveraged to comply with the final
rules. Third, smaller firms could opt for a manual approach. Indeed,
firms are only expected to invest in an automated system if it would be
efficient to do so.

[[Page 100052]]

Fourth, ERP systems possess many features that would not be necessary
in an automated system for compliance. Finally, audit firms are likely
to need to make similar investments in their internal systems in the
near term, owing to the rapid pace of technological advancement and
other rules and standards currently being adopted, thus potentially
reducing the incremental costs attributable to the final rules.
However, at the same time, and as suggested by commenters, the Board
recognizes that implementing new systems may be especially costly for
audit firms if staff resources are strained due to the need to comply
with other standards being implemented in the same time period, such as
QC 1000.\390\ The Board's estimate does not account for these capacity
constraints. Overall, for these reasons, the Board believes these
figures likely reflect an upper bound on the potential implementation
costs and the actual implementation costs will likely be significantly
less.
---------------------------------------------------------------------------

\390\ Commenters' concerns about the cumulative impacts of
multiple PCAOB standards and rules with overlapping implementation
periods including potential benefits are discussed above.
---------------------------------------------------------------------------

One commenter suggested that the Board's cost estimates are
strawmen because they have too many caveats. The PCAOB's staff guidance
on economic analysis recommends quantifying impacts to the extent
feasible. However, it also notes that reliably quantifying impacts can
be difficult. The SEC's current guidance on economic analysis in SEC
rulemakings recommends ``identify[ing] and discuss[ing] uncertainties
underlying the estimates of benefits and costs.'' \391\ Consistent with
these recommendations, the Board has provided an exhaustive discussion
of uncertainties in the Board's cost estimates because the Board
believes it provides commenters with important context necessary to
understand the economic analysis.
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\391\ See Memorandum from Division of Risk, Strategy, and
Financial Innovation (now, Division of Economic and Risk Analysis)
and Office of the General Counsel to Staff of the Rulewriting
Divisions and Offices re: Current Guidance on Economic Analysis in
SEC Rulemakings (Mar. 16, 2012) (SEC Staff Guidance), 12.
---------------------------------------------------------------------------

One commenter apportioned the Board's quantitative estimate of the
cost to implement an automated system from the ground up to their firm
by market share. Using this approach, the commenter estimated the cost
would be between $7 million and $10 million. The commenter said that
they believe their estimate is low because larger firms have greater
economies of scale. The commenter also said that this cost could
increase the audit fees they charge their issuer clients by between
$50,000 and $70,000 per issuer assuming they pass through the entire
implementation cost and raise each issuer's audit fee by the same
amount. The Board notes some limitations to applying its numerical
illustration in this way. First, as discussed in the proposal and again
above, the Board's methodology assumes costs are a non-linear function
of revenue which the commenter did not account for. Second, the Board
notes that the commenter's estimate is subject to the same caveats
described above regarding the Board's quantification methodology.
Finally, the Board also notes it would not expect that the cost of
implementing a new system would be passed through to issuers in the
form of a permanent audit fee increase, both because it is a one-time
cost and because it is a fixed rather than a variable cost. It also
overestimates the true pass through to the extent the commenter is
unable to pass through 100% of the implementation cost.
One commenter provided academic research that finds the costs to
implement new systems is proportionally lower for larger firms.\392\
The Board agrees, and the Board's quantification methodology reflects
this. The same commenter also noted that the press has reported that
larger firms have already invested significantly into their IT systems.
As discussed above, the Board recognizes that larger firms likely
already have systems in place that they would be able to leverage when
implementing the final rules.
---------------------------------------------------------------------------

\392\ See Kathleen M. Bakarich and Patrick E. O'Brien, The
Robots are Coming . . . But Aren't Here Yet: The Use of Artificial
Intelligence Technologies in the Public Accounting Profession, 18
Journal of Emerging Technologies in Accounting 27, (2021) and Dereck
Barr-Pulliam and Amanda Carlson, Breaking Barriers to Change: The
COVID-19 Pandemic's Impact on Attitudes Toward and Willingness to
Pay for Audit Innovation, SSRN Electronic Journal (2024). The Board
notes that SSRN does not peer review its submissions.
---------------------------------------------------------------------------

Finally, the Board also notes the implementation costs could be
offset in part by benefits to auditors. For example, technological
enhancements to auditors' systems may, in the long run, increase
operational efficiency and profitability.
b. Producing the Final Metrics
Auditors may incur engagement-level and firm-level variable costs
related to producing the final metrics. For example, the final rules
may lead auditors to spend additional time recording, collating, and
reporting information for relevant engagement-level, and then
aggregated firm-level, metrics. As discussed above, the final rules do
not impose new performance requirements other than the calculation and
disclosure of metrics. In addition, reviews by others, such as the
engagement quality reviewer or the national office, may result in
additional recurring costs. Audit firms are also likely to experience
costs, or administrative time, related to legal review and quality
control for the final metrics.
Specifically, variable costs may arise from the following
activities related to producing the final metrics:
Recording & Collecting Information
Audit firms may incur variable costs recording the necessary
information and collecting it in a centralized location. The magnitude
of the costs will likely depend on the extent to which existing
practice differs from the final requirements. As discussed above, the
Board believes many firms already internally track information related
to the final metrics. This will reduce the variable costs attributable
to the final rules.
The magnitude of the variable costs may also depend on the size of
the firm. As discussed, based on information obtained through
inspections and oversight activities, the Board believes that the final
rules will likely affect engagements performed by all firms but may
have a greater impact on engagements performed by NAFs. However, NAFs
that choose to use a manual recording system may face recurring costs
associated with the continued collection of data and reporting of the
final metrics. These costs likely will vary with the size of the audit
team.
Finally, the magnitude of the variable costs to record and collect
information may depend on the final metric. For example, collecting the
information needed to calculate the final Workload metrics will likely
be relatively straightforward as such information is likely already
stored in firms' extant timekeeping systems. One commenter said that
the proposed engagement-level Workload metric would take considerable
effort to compile and calculate. The commenter did not articulate a
basis for their conclusion. To the contrary, the Board believes the
final Workload metric area will not be burdensome to calculate for
several reasons. First, based on commenters' views, the Board decided
to exclude staff from the final Workload metric calculations. The Board
believes this should reduce the effort required by firms to compile and
calculate the metrics. Second, firms that use other auditors or serve
as an other auditor should already be tracking partner and manager
hours in order to calculate total

[[Page 100053]]

audit hours pursuant to Form AP reporting. PCAOB staff analysis of
AuditorSearch data finds that approximately 48% of audits of
accelerated filers or large accelerated filers involved other auditors.
Third, firms that track time electronically should be able to access
hours information by staffing level and time period and make the
required calculations electronically. The Board believes most larger
firms track their time electronically already. However, the Board
recognizes that some of the smaller firms may not. Indeed, one
commenter said that many firms have moved away from the burden of time
reporting. As discussed above, some of these smaller firms may choose
to build a system that would track the information needed to
efficiently produce the final metrics, including in the final Workload
metric area. Finally, the Board also notes that firms will be permitted
to use a reasonable method to estimate the components of a calculation
when actual amounts are unavailable.
One commenter said that there could be costs associated with
coordinating data collection efforts across firms. The Board recognizes
that such costs would likely arise. However, the Board notes that the
adjustments the Board has made to the set of required metrics and their
calculations should alleviate this burden. Furthermore, firms should
generally already be coordinating data collection efforts for Form AP
reporting purposes and this data will be subject to quality controls
over firm reporting. To the extent such coordination is necessary,
academic research finds that 94% of component auditors identified on
Form AP are associated with the lead auditor.\393\ This provides
additional evidence there is a strong existing relationship between
these firms which should facilitate any additional transfer of
information required to implement the final rules.
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\393\ See William M. Docimo, Joshua L. Gunn, Chan Li, and Paul
N. Nichas, Do Foreign Component Auditors Harm Financial Reporting
Quality? A Subsidiary-Level Analysis of Foreign Component Auditor
Use, 38 Contemporary Accounting Research 3113 (2021).
---------------------------------------------------------------------------

Aggregating & Calculating Firm and Engagement Metrics
Once the information is collected, it will need to be aggregated
and the final metrics will need to be derived following the calculation
requirements discussed above. Costs will likely be incurred to make
those calculations and to make and validate the filing. Moreover, these
costs will be greater for firms that will use manual systems than firms
that will use automated systems.
Making the Filing
Once collected, aggregated, and calculated, the final metrics will
then need to be filed with the PCAOB. There will be costs associated
with developing the filing, validating the information, and drafting
any voluntary textual disclosures. This could entail administrative
costs such as legal review of the textual disclosures. Firms may also
need to extend their existing quality control processes around PCAOB
filings to cover these new filings.
Overall, it is difficult to estimate the potential costs that audit
firms will incur to produce the final metrics owing in part to the
variability in firms' current systems (e.g., automated versus manual)
and the extent to which firms already produce similar metrics for
internal reporting to national offices or external reporting in firm
transparency reports. However, the Board may extrapolate from the
economic impacts of prior PCAOB disclosure rules. For example, as a
result of the implementation of AS 3101 in 2019, the largest four audit
firms surveyed through the PCAOB's outreach activities indicated they
incurred, on average, 23,000 hours to develop the processes and
procedures to support the implementation of CAMs. The PCAOB staff
monetized the economic impact to those largest four audit firms to be
approximately $4.4 million dollars each.\394\ Those audit firms also
each reported 14,600 hours of training, estimated at $2.1 million
dollars. The next four largest audit firms reportedly incurred 3,700
hours, on average, to develop processes and procedures, and 3,100 hours
in training their personnel to support the implementation of CAMs--
estimated at $610,000 and $435,000, respectively, on average for each
firm.\395\ As estimated through April 2021, the smallest of audit
firms, after excluding outliers, reported only 400 hours implementing
the CAM requirements, with 600 hours associated with CAM related
training. The average implementation costs for these smallest of firms
was estimated to be approximately $185,000 per firm.\396\ Extrapolating
these data points to the population of firms expected to be impacted by
the final requirements implies a total cost of approximately $67
million.\397\
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\394\ See, e.g., Michael J. Gurbutt, Wei-Kang Shih, Carrie von
Bose, Staff White Paper: Stakeholder Outreach on the Initial
Implementation of CAM Requirements, PCAOB 1, 8 (2020).
\395\ Id. The ``next four largest firms'' refers to BDO USA LLP,
Crowe LLP, Grant Thornton LLP, and RSM US LLP. See Gurbutt et al.,
Stakeholder Outreach at n. 4.
\396\ See Gurbutt, et al., Staff White Paper: Second Stakeholder
Outreach on the Initial Implementation of CAM Requirements 1, 13.
``Smaller audit firms'' refers to Marcum LLP; Moss Adams LLP, Baker
Tilly US LLP; BKD LLP; CohnReznick LLP; Dixon Hughes Goodman LLP
(DHG); EisnerAmper LLP; Mayer Hoffman McCann P.C. (MHM); Plante &
Moran, PLLC; and WithumSmith + Brown, PC.
\397\ As an example, aggregating these costs across active firms
in the market implies roughly $6.5 million in procedures and
training for the largest four audit firms ($4.4 million for
processes and procedures and $2.1 million for training), $1.045
million for the next four largest firms, and $185,000 for 202
smaller impacted firms, would amount to a combined $67.0 million in
costs to produce the final metrics outside of implementation costs
associated with the systems ($6.5 million x 4 larger firms + $1.045
million x 4 next-largest firms + $0.185 x 199 smaller firms = $67.0
million).
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Following the implementation of processes, procedures, and
training, surveyed audit partners report that 1% of total audit
engagement hours were spent identifying, developing, and communicating
CAMs.\398\ PCAOB staff research found no systematic evidence of
increased engagement hours for audits of large accelerated filers \399\
and a statistically significant 6.6% increase in engagement hours for
audits of non-large accelerated filers.\400\ The findings suggest that
there could potentially be variable costs associated with the final
requirements that persist after the implementation phase.
---------------------------------------------------------------------------

\398\ See Gurbutt and Shih, Econometric Analysis on the Initial
Implementation of CAM Requirements 4.
\399\ See Gurbutt and Shih, Econometric Analysis on the Initial
Implementation of CAM Requirements 4.
\400\ See Jonathan T. Fluharty-Jaidee, Michael J. Gurbutt, and
Wei-Kang Shih, Staff White Paper: Second Econometric Analysis on the
Initial Implementation of CAM Requirements, Public Company
Accounting Oversight Board, (2022).
---------------------------------------------------------------------------

Auditors of large accelerated filers realized efficiencies in
developing and communicating critical audit matters in the second year
of implementation, reporting that they generally spent the same or less
time on critical audit matters compared to the initial year of
implementation.\401\ Accordingly, the Board expects that the costs to
produce the final metrics will be most significant for the initial
filings under the final rules because firm personnel will need to
familiarize themselves with new reporting requirements and forms. In
subsequent reporting periods, the Board anticipates that firms will
incur lower costs as personnel become more familiar with the reporting
requirements.
---------------------------------------------------------------------------

\401\ See, e.g., Interim Analysis Report: Further Evidence on
the Initial Impact of Critical Audit Matter Requirements, PCAOB Rel.
No. 2022-007 (Dec. 7, 2022).
---------------------------------------------------------------------------

As noted above, AS 3101 and the final rules are different in ways
that may

[[Page 100054]]

limit the relevance of the costs of AS 3101 to the potential costs of
the final rules. For example, as discussed above, the final metrics
will require the collection of a broader array of engagement-level
information whereas CAM requirements focus more on narrative
description. However, the processes, procedures, and training aspects
are likely more comparable.
One commenter agreed with the Board's caveat that the CAMs
requirements are not a perfect analogy for the proposed metrics. More
specifically, the commenter said that the proposal would require
significantly more effort to implement than AS 3101 due, in part, to
the need to update QC policies and procedures. Furthermore, commenters
pointed to specific facts and circumstances that could exacerbate the
costs of the final metrics (e.g., coincidence with other new PCAOB
standards). One commenter asserted, incorrectly, that the proposal
included no quantification of costs associated with reporting.
One commenter suggested that the Board perform further analysis of
the firms' current data collection efforts and the data collection
efforts that will be required under the final requirements. As part of
the Board's economic analysis, the Board considered all relevant
information available to the Board including information gathered
through the Board's oversight activities, academic research, and
comments received on the proposing release.
Commenters agreed that firms will incur some costs to report the
final metrics. Two commenters said validating personnel's total
experience prior to joining the firm will be challenging and expensive
because firms do not generally track this information. Another
commenter said that reporting industry experience of audit personal
would be costly because sufficient information to report this metric is
not usually held in the human resources administration of firms. One
commenter said the proposed engagement-level Workload metrics were very
complicated and would take considerable effort to prepare. One
commenter said that many firms do not track non-chargeable hours.
Commenters also said that they do not usually track restatements of
former clients' financial statements. The Board considered these costs
and have made several modifications to the required calculations which
the Board believes will help mitigate them. The Board also notes that,
under the final rules, firms would be permitted to use a reasonable
method to estimate the components of a calculation for which data are
unavailable.
One commenter said that producing some of the proposed firm-level
metrics (e.g., Partner and Manager Involvement and Allocation of Audit
Hours) would be challenging because it would require aggregation of
engagement-level data, including data from other auditors, for a period
different from that required for the corresponding proposed engagement-
level metrics. The Board agrees there could be some incremental costs
associated with collecting and validating data from other auditors.
However, when producing the final firm-level metrics, firms would be
able to leverage the audit hours information they already collected and
validated pursuant to Form AP reporting for audit reports issued during
the 12-month period ended September 30. Therefore, the Board does not
believe the difference between the period covered by the firm-level
metric and the period covered by Form AP presents unique challenges. To
the contrary, the Board believes that adopted approach is an efficient
way to provide information to stakeholders while minimizing costs to
firms. The adjustments the Board has made to the calculations (e.g.,
reducing the scope of the Partner and Management Involvement, Workload,
and Allocation of Audit Hours calculation to large accelerated and
accelerated filers only) and the Board's decision not to adopt the
proposed Use of Shared Service Centers metric should attenuate any
concerns like those raised by this commenter.
Several commenters said that there could be costs associated with
correcting immaterial errors, particularly with regard to engagement-
level metric reporting on Form AP. The Board agrees cost related to
this aspect of the final rules could arise, either though extra up-
front quality control costs or costs associated with amending an
inaccurate Form AP. However, the Board believes investors and audit
committees need reliable information, and correction of errors is an
important part of ensuring the reliability of the information.
ii. Indirect Costs Arising From Market Reactions to the Final Metrics
The Board also reviewed and considered costs that could arise from
how investors, audit committees, and auditors may react to the final
metrics. For example, improved decision-making on the part of audit
committees could lead to costs from switching auditors. Most of these
costs are not feasible to quantify. However, they are likely to be
incurred only to the extent that they are deemed reasonable from a
business perspective.
a. Understanding the Final Metrics
Investors that use the metrics will incur costs to understand the
final metrics and incorporate them into their decision-making.
Investors will choose to bear these costs only if they anticipate that
the costs are outweighed by the benefits of using the metrics. Due to
economies of scale, the Board believes institutional investors will be
more likely to incur these costs than retail investors. Audit
committees may incur costs to understand the final metrics because
their fiduciary duties may prompt them to do so. Moreover, audit
committees may spend additional time discussing the final metrics with
their auditor, which would require both audit committees' and auditors'
time.\402\ Auditors may spend time and resources developing materials
to explain or contextualize their metrics for the audit committee
(e.g., presentations and decision aids).
---------------------------------------------------------------------------

\402\ See below for additional discussion of attention diversion
of audit committees.
---------------------------------------------------------------------------

Furthermore, investors and audit committees may incur costs in
monitoring the final metrics and learning to extract decision-making
information from them. Investors may incur costs incorporating the
final metrics into their investment decisions or exercising oversight
over issuers and audit committees. Audit committees may incur costs to
review the final metrics in support of their auditor oversight
responsibilities.
There may also be costs associated with interpreting certain final
metrics in relation to final metrics across other firms and
engagements. For example, partner and manager involvement on an
engagement may be more informative when considered in the context of
the firm's overall partner and manager involvement or other firms'
partner and manager involvement metrics. Moreover, investors and audit
committees may spend time researching the state of the market for
assurance services to provide more context to the final metrics.\403\
---------------------------------------------------------------------------

\403\ For example, some literature suggests that the
implications of staff turnover are better understood in the context
of accounting labor supply. See Khavis and Szerwo, Audit-Employee
Turnover, Audit Quality, and the Auditor-Client Relationship 2.
---------------------------------------------------------------------------

Auditors may also incur costs to monitor how their final metrics
compare to those of their competitors. GNFs, in particular, could
deploy significant resources in this way. NAFs may have less ability to
fully evaluate the information contained in the final

[[Page 100055]]

metrics and choose instead to retain outside experts to provide such
research. Firms may also use the final engagement-level metrics to
inform their acceptance and continuance policies (e.g., by considering
industry experience).
Referring to academic research on information processing costs, one
commenter incorrectly stated that the Board had not considered the
costs incurred understanding the proposed metrics.\404\ The commenter
also said there would be costs associated with misunderstanding the
metrics. The Board discussed such costs in the proposal and again
below.
---------------------------------------------------------------------------

\404\ See, e.g., Charles M.C. Lee and Qinlin Zhong, Shall We
Talk? The Role of Interactive Investor Platforms in Corporate
Communication, 74 Journal of Accounting and Economics 101524 (2022).
---------------------------------------------------------------------------

b. Revising Audit Approaches
Armed with the new information discussed above, audit committees
may question their auditor's audit approach. This may prompt auditors
to make changes to their audit approaches. For example, an audit
committee may come to the belief that the audit partners have too many
other duties and may express this concern to the auditor. This may
prompt auditors to adjust how they are staffing the audit. Similarly,
audit firms could incur costs making those changes. Some of these costs
may be greater than others. For example, reducing excessive turnover
and workloads, to the extent they exist, could require a significant
investment in resources.
As discussed above, the final rules may lead audit firms to compete
on the final metrics. This could lead some firms to update their audit
approaches, provide additional training, or increase their
specialization. For example, auditors may increase training in
industry-specific areas or hire additional individuals with specialized
knowledge. As another example, to the extent issuer preferences show an
increased demand for auditors with lower workloads, firms may increase
staffing. Such an increase in human-capital investment will likely
increase labor and overhead costs for audit firms. Auditors may also
increase the quality review of their work to reduce the likelihood of
restatements or enhance their audit procedures to compete on the basis
of higher-quality audit services.
c. Switching Auditors
As discussed above, the final rules could result in increased
auditor switching as investors and audit committees compare and
evaluate current and alternative auditors. Should audit committees
ultimately choose to change auditors, there may be switching costs,
both to the issuer and the auditor. For example, an auditor's work may
be less efficient or less effective in the first years of auditing a
new issuer as the auditor works to build an understanding of the
issuer's business and financial reporting risks. There would likely be
a transitory period of increased auditor switching, after which auditor
switching would stabilize as the audit market reaches a new
equilibrium.
iii. Other Indirect Costs
Economic theory suggests that auditors may pass on to issuers costs
incurred as a result of the final rules in the form of higher audit
fees.\405\ In addition, the degree to which increases in variable
costs, such as certain firm compliance costs, are expected to be passed
on will vary based on how widespread the costs are across competitors.
Increases in variable costs that impact all sellers in an imperfectly
competitive market are more likely to be passed on than cost increases
that impact only a subset of sellers.\406\ If compliance costs have a
greater impact on a subset of firms, such as smaller firms, those firms
may be less inclined to pass on the incremental costs in order to stay
competitive with larger firms. Accelerated filers and large accelerated
filers may be disproportionately impacted by a cost passthrough because
(i) auditors that do not audit accelerated filers or large accelerated
filers would be out of scope and (ii) accelerated filer and large
accelerated filer engagements would require additional data collection
efforts.
---------------------------------------------------------------------------

\405\ Economic theory suggests that fixed costs are less likely
to be passed on. Only changes to variable costs are generally
expected to impact sellers' pricing decisions. See, e.g., Mankiw,
Principles of Economics 284 and 307 (showing that the profit-
maximizing price is a function of marginal cost rather than fixed
costs).
\406\ See, e.g., Erich Muehlegger and Richard L. Sweeney, Pass-
Through of Own and Rival Cost Shocks: Evidence from the U.S.
Fracking Boom, 104 Review of Economics & Statistics 1361 (2022).
---------------------------------------------------------------------------

Evidence from the PCAOB's PIR of AS 3101 suggests that there was no
statistically significant increase in audit fees for the audits of
large accelerated filers but a statistically significant 3.0% increase
for the audits of non-large accelerated filers.\407\ Financial
statement preparers and audit committees interviewed during the PCAOB's
investor outreach efforts indicated that there were minimal or
immaterial costs.\408\ One academic study found a small, statistically
insignificant audit fee increases as a result of PCAOB Rule 3211.\409\
Another study found that audit fees increased by a statistically
significant 7.9 percentage points.\410\
---------------------------------------------------------------------------

\407\ See Gurbutt and Shih, Econometric Analysis on the Initial
Implementation of CAM Requirements; and Fluharty-Jaidee, et al.,
Staff White Paper: Second Econometric Analysis on the Initial
Implementation of CAM Requirements.
\408\ See Gurbutt, et al., Staff White Paper: Second Stakeholder
Outreach on the Initial Implementation of CAM Requirements 21.
\409\ See Cunningham, et al., What's in a Name? 141 and 156
(finding no statistically significant increase in fees following the
implementation of AS 3211, Form AP, in 2017).
\410\ See, e.g., John and Liu, Disclosure of an Audit Engagement
Partner's Name.
---------------------------------------------------------------------------

One commenter noted that the proposal failed to consider impacts on
entities that are neither issuers nor broker dealers but are required
or may be required under SEC rules to use a PCAOB-registered and
inspected firm. The Board notes that the commenter provided just two
examples of such SEC rules. One rule was recently vacated and the other
is a proposal.\411\ The Board acknowledges that, to the extent any such
entities are required under SEC rules to obtain an audit from a PCAOB-
registered firm, they could be indirectly impacted by the final rules
if their auditor is both (I) subject to the final requirements and
either (ii) chooses to pass on to these entities any part of the costs
associated with the final rules or (iii) exits the market as a result
of final rules.\412\ Any passthrough of cost will likely be limited by
the fact that the engagement-level reporting requirements will not
apply to the audits of these entities and most of the firm-level
metrics will not require information from their audits. This means that
the final rules should have little or no effect on the cost of their
audits. Furthermore, the Board notes that any costs to such entities
could be offset by benefits. For example, stakeholders in the audit of
these entities may use the final metrics to inform their decision-
making.
---------------------------------------------------------------------------

\411\ See SEC Final Rules on Private Fund Advisers:
Documentation of Registered Investment Advisers Compliance Reviews,
SEC Rel. No. IA-6383 (Aug. 23, 2023). See also SEC Proposed Rule on
Safeguarding Advisory Client Assets, SEC Rel. IA-6384 (Mar. 9,
2023).
\412\ SEC rules require the use of PCAOB-registered or PCAOB-
registered and inspected audit firms by entities other than issuers
and registered broker-dealers, including certain investment
advisers, pooled investment vehicles, security-based swap data
repositories, and clearing agencies. See, e.g., 17 CFR 275.206(4)-2
(custody of funds or securities of clients by investment advisors);
17 CFR 240.13n-11 (chief compliance officer of security-based swap
data repository; compliance reports and financial reports); 17 CFR
240.17ad-22 (standards and clearing agencies); 17 CFR 240.15c3-1g
(conditions for ultimate holding companies of certain brokers and
dealers, Appendix G to 17 CFR 240.15c3-1); and 17 CFR 240.18a-1 (net
capital requirements for security-based swap dealers for which there
is not a prudential regulator).

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[[Page 100056]]

3. Unintended Consequences
In addition to the benefits and costs discussed above, the final
rules could have unintended consequences. The following discussion
describes potential unintended consequences the Board considered and,
where applicable, any mitigating or countervailing factors.
i. Auditors May Exit the Market for Accelerated Filers and Large
Accelerated Filers Due to Increased Competition and Costs
The final rules may lead auditors to compete on the final metrics.
The Board believes this new competitive dynamic will be
beneficial.\413\ However, firms that are less able to compete on the
final metrics could lose market share or be forced to lower their audit
fees, resulting in strains on their profitability. Profitability could
also be negatively impacted by the costs of the final rules. In some
cases, these auditors may exit the public audit market for accelerated
filer and large accelerated filer audits. This could reduce the number
of potential auditors some accelerated filers or large accelerated
filers may consider thereby reducing competition. One commenter noted
that (i) the Big 4 firms already audit over 88% of the large
accelerated filers and (ii) research shows that the population of firms
with less than 100 clients has decreased by over 50% in recent
years.\414\
---------------------------------------------------------------------------

\413\ See above for a discussion on the benefits linked to
competition.
\414\ See Xiaohong Liu and Dan A. Simunic, Profit Sharing in an
Auditing Oligopoly, 80 The Accounting Review 677 (2005); Mark L.
DeFond and Clive S. Lennox, The Effect of SOX on Small Auditor Exits
and Audit Quality, 52 Journal of Accounting and Economics 21 (2011);
Vincent Rylan, The Big Four Continue to Dominate Auditing: Weekly
Stat, CFO Magazine, (June 29, 2022) available at https://www.cfo.com/news/the-big-four-continue-to-dominate-auditing-weekly-stat/; Brant Christensen, Kecia Williams Smith, Dechun Wang, and
Devin Williams, The Audit Quality Effects of Small Audit Firm
Mergers in the United States, 42 Auditing: A Journal of Practice &
Theory 75 (2023).
---------------------------------------------------------------------------

Many commenters said that the proposal could lead smaller firms to
exit the market for accelerated filer or large accelerated filer audits
and increase concentration. One commenter said that the proposed
reporting requirements would be particularly onerous on non-U.S. firms
that carry out only one or a small number of relevant PCAOB
engagements. One commenter suggested that smaller firms may exit the
public company audit market as a result of the proposed requirements,
in conjunction with other standards recently issued and proposed by the
PCAOB, and this could negatively impact smaller public companies that
are seeking a smaller audit firm. The commenter referred to a working
paper on smaller firm exits to support their view. However, the cited
paper finds the opposite result, namely that changes in PCAOB
regulations play little if any role in a firm's decision to
deregister.\415\ One commenter noted that smaller firm exit could also
reduce the benefits associated with firms competing on the proposed
metrics. One mid-sized firm said that smaller firms would have fewer
issuers to spread their fixed costs over. The same commenter said the
proposal would put considerable strain on firms that provide audit
services to the 40% of issuers that represent the remaining, at most,
2% of capital markets. The commenter did not indicate how they believe
these issuers would be impacted by the proposal.
---------------------------------------------------------------------------

\415\ See Michael Ettredge, Juan Mao, and Mary S. Stone, Small
Audit Firm De-Registrations From the PCAOB-Regulated Audit Market:
Strategic Considerations and Consequences.
---------------------------------------------------------------------------

One commenter who represents CPAs said that the costs of the
proposal could disproportionately impact smaller firms which could lead
to the exit of some of the smaller firms. The commenter provided
additional comments based on the results of a survey of small and mid-
sized firms administered by the commenter. The commenter's survey was
distributed to the 500 largest CPA firms in the United States. Eighty-
eight firms responded. The respondent firms' revenues range from less
than $10 million to greater than $500 million. The commenter provided
the survey questions. All respondents that perform U.S. public company
audits reported that the proposal would require a very heavy or
substantial effort and would strain resources, driven in part by
economies of scale. The Board notes that this data point is based on 36
survey participants, some of whom do not perform audits of accelerated
filers or large accelerated filers and therefore would not be subject
to the final requirements. The survey reports that 23% of respondents
(approximately eight or nine respondents) would definitely or strongly
consider exiting the public company audit market entirely.\416\
However, the survey provides no information that would help the Board
assess the significance of these firms to the overall audit market or
whether they even audit accelerated filers or large accelerated filers,
and therefore would be impacted by the final requirements. The survey
also reports that another 25% of respondents (9 respondents) that
perform U.S. public company audits would eliminate or manage their
client base of accelerated filers. However, in addition to the lack of
information that would help the Board assess the significance of these
firms to the overall audit market, the relevance of this result is
obscured by the conflation of ``elimination'' and ``management'' of
accelerated filers. Finally, the commenter provided little detail on
how the survey was performed (e.g., how the proposal was described to
the survey participants).
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\416\ Citing the result of the survey provided by this
commenter, another commenter said that nearly 75% of respondents
would consider eliminating their public company audit process as a
result of the proposal. However, this is not what the survey found.
Rather, the survey found that 50% of respondents would at least
consider getting out of the public company market.
---------------------------------------------------------------------------

The potential negative consequences of firm exit could be mitigated
by several factors. First, exit may be limited primarily to the smaller
firms among those that would be impacted by the final rules, since
smaller firms may be disproportionately impacted by the fixed costs of
complying with the final rules. Reduced competition will thus tend to
impact smaller accelerated filers rather than larger large accelerated
filers, which typically require larger auditors. Second, there is
little reason to expect exit from the market for non-accelerated filer
audits. In fact, competition may increase in the non-accelerated filer
issuer audit market to the extent firms exiting the accelerated filer
and large accelerated filer issuer markets redeploy capacity to the
non-accelerated filer issuer audit market. Finally, firms that remain
profitable in the accelerated filer and large accelerated filer issuer
audit markets could expand their market share, perhaps by acquiring
additional capacity from exiting firms.
One commenter provided research suggesting that firms that exited
the market following the Sarbanes-Oxley Act were not of lower quality
than firms that remained.\417\ The Board believes the commenter implied
that issuers or broker-dealers may not necessarily obtain a higher
quality audit after switching to a new auditor that has remained in the
market. The study acknowledged that prior research using other audit
quality proxies finds the opposite result, namely, that exiting firms
indeed have lower audit quality.\418\ Firm size is a widely accepted
proxy for audit quality.\419\ The

[[Page 100057]]

Board's oversight activities indicate that noncompliance with auditing
standards is higher among smaller firms.\420\ Therefore, to the extent
smaller firms tend to exit rather than larger firms, as commenters
contended, then audit quality could improve on average as issuers
switch to larger firms. The Board recognizes there is currently some
debate on the extent to which the large-firm audit quality effect is
driven by correlated issuer characteristics rather than auditor
effects.\421\ The Board believes compliance with auditing standards is
less sensitive to issuer characteristics than other audit quality
proxies (e.g., absolute discretionary accruals). After assessing the
available evidence, the Board believes it is likely that the firms that
any issuers or broker-dealers would switch to would likely not provide
lower quality audits.
---------------------------------------------------------------------------

\417\ See Neil L. Fargher, Alicia Jiang, and Yangxin Yu, Further
Evidence on the Effect of Regulation on the Exit of Small Auditors
from the Audit Market and Resulting Audit Quality, 37 Auditing: A
Journal of Practice & Theory 95 (2018).
\418\ See DeFond and Lennox, The Effect of SOX on Small Auditor
Exits and Audit Quality.
\419\ See DeFond and Zhang, A Review of Archival Auditing
Research. Though firm size is widely accepted as a proxy for audit
quality, it is not a perfect predictor of audit quality. Some large
firms may provide low quality audits and some small firms may
provide high quality audits.
\420\ See, e.g., Spotlight Staff Update on 2023 Inspection
Activities (Aug. 2024), available at https://pcaobus.org/resources/staff-publications and PCAOB Rel. No. 2024-005 at Figure 1.
\421\ See Alastair Lawrence, Miguel Minutti-Meza, and Ping
Zhang, Can Big 4 Versus non-Big 4 Differences in Audit-Quality
Proxies be Attributed to Client Characteristics?, 86 The Accounting
Review 259 (2011); Mark DeFond, David H. Erkens, and Jieying Zhang,
Do Client Characteristics Really Drive the Big N Audit Quality
Effect? New Evidence from Propensity Score Matching, 63 Management
Science 3628 (2017).
---------------------------------------------------------------------------

Two commenters said that the final rules would disproportionately
impact smaller firms, leading them to increase their audit fees.
Several commenters suggested that regulatory burdens incentivize
companies to go or remain private. Referring to the SEC Office of the
Advocate for Small Business Capital Formation Fiscal Year 2023 annual
report as support (``SEC Small Business Advocate Annual Report''), one
commenter highlighted that: (i) in 2022, the number of exchange-listed
IPOs dropped to its lowest point since 2009; (ii) small exchange-listed
companies accounted for the vast majority of the decline; and (iii)
smaller companies are disproportionately impacted by regulatory costs
because a large portion of regulatory costs are fixed.\422\ The Board
agrees that the final rules could disproportionately impact the smaller
in-scope firms. However, smaller issuers--those that the commenter
contended are most sensitive to regulatory burden and at greatest risk
of eschewing the capital markets--would be minimally impacted by the
final rules for several reasons. First, firms that do not audit
accelerated filers or large accelerated filers (that is, all but
approximately 207 firms) would be out of scope and therefore there
would be no effect on audit fees for their non-accelerated filer
issuers. Second, to the extent in-scope firms choose to pass through
all or part of the cost of the final rules, they would be less likely
to do so for their non-accelerated filer issuers because their audits
will not be subject to the engagement-level reporting requirements.
Third, the Board does not believe issuers will incur any significant
fixed costs, which the commenter asserted disproportionately impact
smaller companies. Therefore, any disincentive among smaller companies
to participate in capital markets arising from increased audit fees
would likely be minimal. Among accelerated filer and large accelerated
filer issuers, the Board notes that audit fees, on average, comprise
roughly 0.15% to 0.2% of issuer revenue and any increase in audit fees
attributable to the final rules would be a fraction of this.\423\
Therefore, any disincentive among larger companies to participate in
capital markets arising from increased audit fees would also likely be
minimal. Fourth, while the SEC Small Business Advocate Annual Report
demonstrates that smaller exchange-listed companies accounted for the
vast majority of the decline in exchange-listed companies, the report
also cites a paper that concludes regulatory cost itself is unlikely to
explain the full magnitude of IPO decline in the United States over the
past two decades.\424\ Indeed, PCAOB staff analysis finds that
accounting fees typically comprise roughly 4.5% of the costs of an
initial public offering (0.3% of the proceeds).\425\ With respect to
the recurring costs of remaining a public company, one market research
report indicates that accounting fees comprise 32% of the costs.\426\
Any incremental costs associated with IPOs or remaining a public
company attributable to the final rules would be a fraction of these
costs.
---------------------------------------------------------------------------

\422\ See U.S. Securities and Exchange Commission, Office of the
Advocate for Small Business Capital Formation, Annual Report Fiscal
Year 2023 citing an earlier working paper version of Michael Ewens,
Kairong Xiao, and Ting Xu, Regulatory Costs of Being Public:
Evidence from Bunching Estimation, 153 Journal of Financial
Economics 103775 (2024).
\423\ See Ideagen Audit Analytics, 20-Year Review of Audit Fee
Trends 2003-2022, (July 2023) at 16.
\424\ See Ewens, et al., Regulatory Costs of Being Public
(explaining that non-regulatory factors--such as decline in business
dynamism, shifting investment to intangibles, abundant private
equity financing, changing economies of scale and scope, and
changing acquisition behavior--are likely to play a more important
role than regulatory cost in the decline of IPOs).
\425\ PCAOB staff obtained data on accounting fees and legal
fees from Audit Analytics and investment bank underwriting fees from
a PwC market research report. See PwC, Considering an IPO? First,
Understand the Costs, available at https://www.pwc.com/us/en/services/consulting/deals/library/cost-of-an-ipo.html and Audit
Analytics, 2018-2019 IPO Accounting and Legal Fees, (Feb. 20, 2020).
PCAOB staff calculated deal proceeds by multiplying the quantity of
shares issued by their price at issue. PCAOB staff calculated the
accounting fee share of proceeds as the proceeds-weighted average
accounting fee share of proceeds across all deals in the Board's
sample. The Board notes that the accounting fee share of proceeds is
decreasing in deal proceeds. PCAOB staff calculated the accounting
fee share of IPO costs as the ratio of all accounting fees to all
IPO costs across all deals in the Board's sample. The PCAOB staff's
analysis assumes IPO costs are equal to the sum of accounting,
legal, and investment bank underwriting fees. The PwC market
research report indicates that there are other IPO cost categories,
but they are relatively small.
\426\ See PwC, Considering an IPO?.
---------------------------------------------------------------------------

In connection with their concerns regarding potential
disproportionate costs to smaller firms, one commenter said the PCAOB
should evaluate and identify the characteristics of investors in
smaller companies and determine if the needs of investors in those
companies are the same as the potential needs of investors in large
companies. The Board notes that one recent working paper finds that
institutional ownership is, on average, lower for smaller
companies.\427\ Since institutional investors may be more likely to use
the metrics, these data suggest that investors in smaller public
companies may, on average, be less likely to use the metrics. However,
the Board believes that investors in smaller companies could still
benefit from the metrics because: (i) retail investors could benefit
from the improved accessibility and comparability of information about
firms and their engagements; and (ii) institutional ownership in
smaller companies, though less than larger companies, is not trivial
(41.6% for the lowest quintile of companies by market
capitalization).\428\ Furthermore, as the Board discussed below,
financial reporting quality may be relatively more important for
smaller companies. Finally, the Board notes that the final rules
require engagement-level reporting only for accelerated filers and
large accelerated filers and firm-level reporting only for firms that
audit at least one accelerated filer or large accelerated filer. This
should help mitigate any concern that investors in smaller companies do
not have a need for the final metrics.
---------------------------------------------------------------------------

\427\ See Jonathan Lewellen and Katharina Lewellen, The
Ownership Structure of U.S. Corporations, SSRN Electronic Journal
(2022), at Table 3. The Board notes that SSRN does not peer review
its submissions.
\428\ Id.

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[[Page 100058]]

ii. Some Auditors May Strategically Manage Their Issuer Portfolios
As discussed above, auditors that do not audit accelerated filers
or large accelerated filers will not be subject to the final reporting
requirements. Some auditors may strategically seek to audit only non-
accelerated filers to avoid disclosure of the final metrics, either to
avoid costs of complying or out of concern that disclosing the metrics
could potentially damage their reputation.\429\ As a result, there
could be a separating equilibrium in the audit market.\430\ One
commenter agreed that smaller firms may manage their engagement
portfolios to avoid being required to comply with the final
requirements and one commenter provided the results of a survey
indicating that some firms may eliminate or manage their client base of
accelerated filers. Assuming that lower-quality auditors are more
likely to avoid accelerated filers in this way, this would increase the
supply of low-quality auditors to non-accelerated filers and decrease
the supply of low-quality auditors to accelerated filers. For non-
accelerated filers, this supply shock could increase competition among
audit firms for non-accelerated filers and therefore reduce audit fees.
However, because the supply shock would consist primarily of low-
quality auditors, it could also lower audit quality for non-accelerated
filers. For accelerated filers, the opposite would occur. Reduced
availability of auditors would tend to reduce competition and therefore
increase audit fees. However, because higher-quality auditors would
remain, audit quality could increase. As a result of these complex and
countervailing influences, it is unclear whether this unintended
consequence would have a net positive or negative impact.
---------------------------------------------------------------------------

\429\ Commenters on proposed QC 1000 said that mid-sized firms
would deliberately manage their portfolios to avoid the proposed
scalability requirements that apply only to annually inspected
firms. Therefore, the Board believes that such portfolio management
is possible in relation to the final rules. Among the firms that
will be impacted by the final rules, approximately 41%, 19%, and 11%
had one, two, or three accelerated filer or large accelerated filer
engagements during the 12-month period ending September 30, 2023.
\430\ Contextually, a separating equilibrium occurs when
incentives cause a division in the market in which one type of
auditor gravitates towards a particular market segment. See, e.g.,
Michael Rothschild and Joseph E. Stiglitz, Equilibrium in
Competitive Insurance Markets: An Essay on the Economics of
Imperfect Information, 90 The Quarterly Journal of Economics 629,
634 (1976) (specifically, the discussion marked I.6 Imperfect
Information: Equilibrium with Two Classes of Customers).
---------------------------------------------------------------------------

Auditors may also attempt to manage their metrics via their
acceptance and continuance policies. Reputation risks to the auditor
associated with individual engagements may start to play a greater role
in firms' acceptance and continuance decisions as well as their audit
fee decisions because new engagements could impact firms' metrics and
hence their ability to charge audit fees on existing engagements. For
example, a prospective issuer engagement may present a higher risk of
restatement. Since restatements will be reported on Form FM in a
uniform and comparable way, auditors may require a fee premium for this
issuer to offset any negative effect the issuer may have on the
auditor's metrics. In extreme cases, risky issuers may not be able to
find an auditor, may be forced to hire a low-quality auditor, or may be
forced to delist.
To avoid such adverse outcomes, issuers may take steps to reduce
their contribution to audit risk.\431\ For example, issuers may become
more forthcoming with information or opt for less aggressive financial
reporting. This potential unintended consequence would also be
mitigated to the extent capital markets recognize that an auditor's
metrics are driven in part by the riskiness of the auditor's client
portfolio rather than the quality of the auditor.\432\ Indeed, auditors
will have the opportunity to explain important context like this in the
qualitative portion of the final disclosures.
---------------------------------------------------------------------------

\431\ Economic theory suggests that private negotiations yield
efficient allocations of decision rights. See Ronald Coase, The
Problem of Social Cost, 3 The Journal of Law and Economics 1 (1960).
\432\ Some research finds that poor financial reporting outcomes
are attributable to client risk rather than poor audit quality. See
Minutti-Meza, Does Auditor Industry Specialization Improve Audit
Quality?
---------------------------------------------------------------------------

iii. Investors, Audit Committees, and Auditors May Misinterpret or
Misuse the Final Metrics
As discussed above, it is possible that the final metrics may not
relate to audit quality in a straightforward way. As a result, there is
a risk that investors, audit committees, and auditors could
misinterpret, or misuse, the final metrics (e.g., by assuming they are
strongly related to audit quality). The outcomes of misinterpretation
or misuse are difficult to predict because they would be rooted in
complex aspects of human psychology.\433\ As one example, investors and
audit committees could rely too heavily on a final metric (e.g., when
making capital allocation or auditor selection decisions). In response
to market forces or requests from audit committees, some auditors could
make changes to their audit approach that could negatively impact audit
quality. As another example, auditors could mistakenly attribute other
firms' competitiveness to one final metric and adjust their audit
approach in a way that compromises the quality of their services.
---------------------------------------------------------------------------

\433\ See, e.g., Loewenstein et al., Disclosure (discussing how
``[p]sychological factors severely complicate the standard arguments
for the efficacy of disclosure requirements.'').
---------------------------------------------------------------------------

Many commenters agreed that there would be a risk that users,
particularly investors, of the proposed metrics would misunderstand the
metrics. One commenter said the proposed metrics would be
misinterpreted. The commenter suggested that this may undermine the
benefits of the proposal. Another commenter said that users would not
understand some of the proposed metrics. One commenter suggested that
this potential unintended consequence should be acknowledged as a cost
because the negative effects would be borne by investors. One commenter
performed a survey of audit committee chairs.\434\ Some survey
participants agreed that the proposed metrics could lead to
inappropriate conclusions. One commenter said that the risk of misusing
the proposed metrics by audit committees could lead to increased
director insurance costs. One commenter said investors or other
stakeholders could pressure audit committees to only appoint auditors
whose metrics fall within a certain range without considering other
aspects of the firm's audit quality. One commenter said that
overemphasis on metrics by auditors could commoditize the profession
and reduce incentives to innovate the audit approach.
---------------------------------------------------------------------------

\434\ See above for more discussion on the survey.
---------------------------------------------------------------------------

The Board agrees that, as with other financial information made
available to investors, some investors may misunderstand the metrics
and make poor decisions as a result. If so, this could negatively
impact them. However, the Board believes that the final metrics will
likely, on average, improve investors' decision-making and therefore
have chosen to acknowledge improved decision-making as a benefit. The
Board acknowledges that some misunderstanding could also reduce the
magnitude of this benefit. However, the Board believes this unintended
consequence, should it arise, would diminish over time as investors
learn how to effectively integrate the final metrics into their
decision-making. Though the Board believes the metrics will spur
competition on quality by allowing firms to credibly differentiate
themselves, the Board recognizes it is possible that some firms would

[[Page 100059]]

coordinate their metrics. The Board discussed this potential unintended
consequence below.
Commenters described specific ways the proposed metrics could
create confusion. Several commenters said that some of the definitions
in the proposal conflict with other definitions in PCAOB standards or
otherwise lead to confusion. The Board does not believe there are any
direct conflicts with other PCAOB standards. The Board has attempted to
draft the definitions in the proposal as precisely and clearly as
possible. Commenters suggest that the ICB industry classification used
for the industry specialization metric could create confusion because
the SEC uses the SIC system. One commenter agreed that it is
appropriate to use the ICB for industry classification. The Board
acknowledges that a taxonomy based on the ICB industry classification
could create some confusion. However, crosswalks between the ICB
system, the SIC system, and other industry classification systems are
available. The Board describes in the proposal and above why the Board
based the taxonomy on the ICB system rather than the SIC system. One
commenter said that the proposed restatements metrics would be
difficult to compare with public data because Audit Analytics
categorizes restatements in a different way than the proposed
requirements would require firms to categorize them. The commenter did
not explain what Audit Analytics categorization they are referring to.
The Board does not believe a user of the final metrics who is also
familiar with Audit Analytics data and wishes to reconcile the two data
sources would find it challenging to do so.
One commenter pointed to research that suggests more information,
including via mandatory financial disclosure, is not always better for
investors.\435\ Several other commenters also suggested information
overload would be a concern. The Board appreciates this research and
agrees that there will be opportunity costs to understand the final
metrics. However, the Board notes that investors will be free to
disregard the final metrics if they find the costs to understand them
exceed their benefits. Furthermore, the Board agrees with one commenter
who said that technology would obviate this potential unintended
consequence.
---------------------------------------------------------------------------

\435\ See Allen G. Schick, Lawrence A. Gordon, and Susan Haka,
Information Overload: A Temporal Approach, 15 Accounting,
Organizations and Society 199 (1990); Eugene G. Chewning Jr and
Adrian M. Harrell, The Effect of Information Load on Decision
Makers' Cue Utilization Levels and Decision Quality in a Financial
Distress Decision Task, 15 Accounting, Organizations and Society 527
(1990); Herbert A. Simon, Rationality in Psychology and Economics,
59 Journal of Business S209 (1986); J. Richard Dietrich, Steven J.
Kachelmeier, Don N. Kleinmuntz, and Thomas J. Linsmeier, Market
Efficiency, Bounded Rationality, and Supplemental Business Reporting
Disclosures, 39 Journal of Accounting Research 243 (2001); Morris H.
Stocks and Adrian Harrell, The Impact of an Increase in Accounting
Information Level on the Judgment Quality of Individuals and Groups,
20 Accounting, Organizations and Society 685 (1995); Knechel, et
al., Audit Quality; DeFond and Zhang, A Review of Archival Auditing
Research; Joost Impink, Mari Paananen, and Annelies Renders,
Regulation[hyphen]Induced Disclosures: Evidence of Information
Overload?, 58 Abacus 432 (2022); Cornelius J. Casey Jr., Variation
in Accounting Information Load: The Effect on Loan Officers'
Predictions of Bankruptcy, 55 Accounting Review 36 (1980); Brad
Tuttle and F. Greg Burton, The Effects of a Modest Incentive on
Information Overload in an Investment Analysis Task, 24 Accounting,
Organizations and Society 673 (1999); Michael B. Clement, Analyst
Forecast Accuracy: Do Ability, Resources, and Portfolio Complexity
Matter?, 27 Journal of Accounting and Economics 285 (1999); Brian P.
Miller, The Effects of Reporting Complexity on Small and Large
Investor Trading, 85 The Accounting Review 2107 (2010); Christine A.
Botosan and Mary S. Harris, Motivations for a Change in Disclosure
Frequency and its Consequences: An Examination of Voluntary
Quarterly Segment Disclosures, 38 Journal of Accounting Research 329
(2000); and John L. Campbell, Hsinchun Chen, Dan S. Dhaliwal, Hsin-
min Lu, and Logan B. Steele, The Information Content of Mandatory
Risk Factor Disclosures in Corporate Filings, 19 Review of
Accounting Studies 396 (2014).
---------------------------------------------------------------------------

Several commenters were concerned that certain calculations would
drive misinterpretation. These comments are discussed above. For
example, one commenter suggested that users may misinterpret the
proposed headcount changes as turnover. One commenter said industry
experience of audit personnel could be misleading because it does not
distinguish between recent and past experience. The Board also
acknowledges that some investors may misunderstand this metric and make
poor decisions as a result that will negatively impact them. However,
the Board believes that the final requirements would, on average,
improve investors' decision-making and therefore have chosen to
acknowledge improved decision-making as a benefit. In the final rules,
the Board has modified some of the scoping and calculations, which
likely will reduce some of the potential for confusion.
iv. Auditors May Attempt To Manipulate the Final Metrics
As discussed above, the final rules could lead firms to compete on
the final metrics. As a result, the Board believes some firms will take
steps to provide higher service quality. However, it is possible that
some firms could instead manipulate the final metrics in ways that
create an impression of providing higher service quality when in fact
this is not the case. For example, firms could increase training hours
by introducing training that has little benefit for audit quality, or
could adjust staffing in ways that they believe make their metrics look
better but that do not improve audit quality. This unintended
consequence will be analogous, in some regards, to earnings management
by financial statement preparers.\436\
---------------------------------------------------------------------------

\436\ See, e.g., Graham, John R., Campbell R. Harvey, and Shiva
Rajgopal, The Economic Implications of Corporate Financial
Reporting, 40 Journal of Accounting and Economics 3, 4 (discussing
how ``[a] surprising 78% of the Board's sample admits to sacrificing
long-term value to smooth earnings''). Firms could manipulate the
final metrics in ways analogous to both accounting-based earnings
management and real earnings management. For example, they might
adjust training hours or reported experience levels without
substantive improvements (analogous to accounting-based earnings
management) or make operational changes, such as altering client
portfolios, solely to improve metrics (analogous to real earnings
management).
---------------------------------------------------------------------------

Some final metrics will be more difficult to manage than others. To
the extent firms are able to manage a final metric, management of the
final metric will tend to reduce the overall informativeness of the
corresponding disclosures and could lead investors and audit committees
to doubt the quality of other firms' disclosures as well. This could
degrade existing empirical relationships between the final metrics and
audit quality that have been found in the literature discussed
above.\437\
---------------------------------------------------------------------------

\437\ Such behavior can be ascribed to Goodhart's law in that,
once the final metrics are disclosed and market participants act
upon them, previously defined relationships change, and the final
metrics may become unrelated to the alignments previously discussed.
---------------------------------------------------------------------------

Referring to academic research, one commenter agreed that firms
could try to manipulate their metrics, comparing this incentive to the
incentive companies face to manage earnings.\438\ The same commenter
agreed that firms' attempts to manipulate could be detrimental to audit
quality. The commenter also suggested that oversight by the PCAOB would
create an incentive to intentionally manage the

[[Page 100060]]

metrics. While the Board agrees that PCAOB oversight could put pressure
on firms, the Board notes that, in addition to informing the Board's
selection of firms, engagements, and focus areas for review, PCAOB
oversight will be focused on compliance with the final rules which
should deter any efforts to manipulate the final metrics. The commenter
also suggested that disclosure of the metrics may change behavior in
ways that are harmful to audit quality. The commenter provided specific
examples of how this could occur for the proposed internal monitoring
and compensation metrics. The Board is not adopting these metrics. As
discussed above, the Board believes behavioral responses to the metrics
by firms would be largely beneficial.
---------------------------------------------------------------------------

\438\ See Mark S. Beasley, Joseph V. Carcello, Dana R.
Hermanson, Fraudulent Financial Reporting: 1987-1997: An Analysis of
US Public Companies, Committee of Sponsoring Organizations of the
Treadway Commission (1999); Mark S. Beasley, Dana R. Hermanson,
Joseph V. Carcello, and Terry L. Neal, Fraudulent Financial
Reporting: 1998-2007: An Analysis of US Public Companies, Committee
of Sponsoring Organizations of the Treadway Commission (2010); Ilia
D. Dichev, John R. Graham, Campbell R. Harvey, and Shiva Rajgopal,
Earnings Quality: Evidence from the Field, 56 Journal of Accounting
and Economics 1 (2013); Graham et al., The Economic Implications;
and Jaime L. Grandstaff and Lori L. Solsma, Financial Statement
Fraud: A Review from the Era Surrounding the Financial Crisis, 13
Journal of Forensic and Investigative Accounting 421 (2021).
---------------------------------------------------------------------------

Referring to the evolution of CAMs, one commenter suggested that
the metrics could become boilerplate. The Board agrees that the
narrative discussion could potentially become boilerplate to some
extent. However, as the quantitative calculations are not boilerplate,
the Board believes the corresponding optional narrative discussion will
be less susceptible to boilerplate.
In general, QC 1000 should help mitigate this potential unintended
consequence by explicitly subjecting the final metrics to firms' QC
systems. Furthermore, firms' QC systems and their disclosure practices,
including compliance with the final rules, will be subject to PCAOB
oversight.\439\ The required documentation will also constrain firms'
ability to manipulate their metrics because it will allow PCAOB
inspections staff to understand how the metrics were calculated.\440\
The Board believes the PCAOB will exercise appropriate discretion in
its oversight. Furthermore, firms will also be constrained by the fact
that manipulations may be detected by comparison to peers. Indeed,
academic research on earnings management suggests that peer comparisons
help stakeholders identify deceptive reporting practices, serving as a
disincentive to manage earnings.\441\ Finally, the final rules require
that any optional narrative disclosure should be concise and focused on
the reported metrics, with a view to facilitating the reader's
understanding of the metrics. The Board believes this should help
mitigate the risk that auditors would use the optional narrative
disclosure to manipulate users' perceptions of the metrics.
---------------------------------------------------------------------------

\439\ Some research finds that SEC oversight reduces some forms
of earnings management. See, e.g., Lauren M. Cunningham, Bret A.
Johnson, E. Scott Johnson, and Ling Lei Lisic, The Switch-Up: An
Examination of Changes in Earnings Management after Receiving SEC
Comment Letters, 37 Contemporary Accounting Research 917 (2020).
\440\ See above for a discussion on the final documentation
requirements.
\441\ See, e.g., Dichev, et al., Earnings Quality: Evidence from
the Field.
---------------------------------------------------------------------------

Firms may attempt to improve their metrics by shifting resources
from non-accelerated filer engagements to accelerated filer or large
accelerated filer engagements. This could reduce the quality of service
on non-accelerated filer engagements. However, subject to the audit
labor market concerns discussed below, firms would be able to mitigate
this effect by acquiring additional resources for their accelerated
filer and large accelerated filer engagements (e.g., hiring additional
staff). Furthermore, the effect would be mitigated by the fact that
non-accelerated filers have additional time to file their financial
statements with the SEC compared to accelerated and large accelerated
filers. Firms may also attempt to improve certain metrics by shifting
resources within an engagement. For example, a firm may attempt to
reduce its workload metrics by shifting manager audit hours to more
junior staff. However, attempting to do so may not be beneficial to
firms because it could at the same time degrade other metrics. For
example, if a firm attempted to reduce its workload metrics by shifting
manager audit hours to more junior staff, it would at the same time
reduce their partner and manager involvement metrics. Furthermore, the
firm's QC system operates over all its PCAOB engagements and should
limit the extent to which resources can be diverted.
v. Audit Labor Market Impacts
The final metrics could lead to increased public scrutiny of firms
and their engagements. This could negatively impact the issuer audit
labor market if individual auditors believe the increased public
scrutiny negatively impacts their personal reputations or otherwise
increases their work pressures. Some commenters agreed that the
proposed requirements could make the audit market less attractive to
auditors.\442\ One commenter suggested that the potential negative
impact on individual auditors could lead individual auditors to exit
the labor market which would in turn drive up labor costs to audit
firms. The commenter suggested this could potentially increase labor
costs for issuers as well to the extent audit firms seek to hire
individuals from issuers that have relevant industry experience.\443\
Based on discussions with audit committee chairs, one commenter said
that survey participants were ``very concerned'' that the proposal
could render the profession less appealing to new auditors.\444\
---------------------------------------------------------------------------

\442\ One commenter referred to a market research report that
finds downwards trends in the number of accounting graduates and the
number of hires but upwards trends in the number of new CPA
candidates. See Association of International Certified Professional
Accountants, 2021 Trends: A Report on Accounting Education, the CPA
Exam and Public Accounting Firms' Hiring of Recent Graduates,
(2022). The commenter also referred to an article discussing the
perceived talent shortage, firms' efforts to address it, and
commentators views. See Stephen Foley, Accountants Work to Shed
`Boring' Tag Amid Hiring Crisis, Financial Times (Oct 3. 2022).
\443\ In the context of this comment, the commenter referred to
an academic article where discussion on dysfunctional manager and
investor behavior in response to differential audit quality could be
found. The Board is unsure how such a discussion or the article
itself are relevant to the topic at hand. See Patrick J. Hurley,
Brian W. Mayhew, Kara M. Obermire, and Amy C. Tegeler, The Impact of
Risk and the Potential for Loss on Managers' Demand for Audit
Quality, 38 Contemporary Accounting Research 2795 (2021).
\444\ See above for more discussion on the survey.
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Referring to a survey commissioned by the commenter's parent
organization, one commenter reported that, among undergraduate
accounting majors not pursuing or undecided on CPA licensure, 94% cite
the regulatory environment as either a major or partial reason.\445\
The Board notes that this statistic ignores the facts that: (i)
undergraduate accounting majors not pursuing or undecided on CPA
licensure reflect just 20% of the participants in the survey (80% of
the participants in the survey are planning to pursue a CPA); and (ii)
respondents to the question were allowed to select multiple reasons.
Indeed, 10 out of 14 of the possible reasons were cited by over 85% of
the respondents as a major or partial reason for not pursuing or being
undecided on CPA licensure. Thus, the findings suggest, at most, that
the regulatory environment is one of many factors discouraging some
students from pursuing a CPA. Furthermore, one commenter suggested
that, rather than the regulatory environment, the 150-credit hour
requirement to apply for a CPA license and work-life balance concerns
are the key reasons college graduates are discouraged from becoming
auditors. The commenter said that the challenges finding qualified
auditors are especially pronounced for smaller firms.
---------------------------------------------------------------------------

\445\ See Center for Audit Quality, Increasing Diversity in the
Accounting Profession Pipeline: Challenges and Opportunities, (July
2023).
---------------------------------------------------------------------------

The Board notes that individual auditors could also use the final
metrics to gain insights into workplace conditions and find firms more
suitable

[[Page 100061]]

to their skillsets and workplace preferences. This may lead firms to
compete for labor by improving their workplace conditions. One
commenter explained that the industry's challenges attracting staff may
be driven in part by the commodification of the audit, which the
proposal would help reduce by providing transparency around the quality
of the audit. The same commenter agreed that the proposed metrics could
empower potential employees when shopping for a potential audit firm
employer.
One commenter said that the firm-level retention metric could
present firms with a competitive disadvantage for recruiting talent if
high turnover rates are provided without sufficient context (e.g.,
changes in firm structure, shifting industry concentrations,
eliminating personnel due to performance or ethical concerns,
independence issues resulting in the departure of firm personnel,
etc.). The retention metric may result in additional recruiting costs
to some firms. However, the Board believes that auditors will benefit
from using this metric to shop for employers. Firms would also be able
to provide additional context through the optional narrative
disclosure.
Some commenters said that the costs would be increased by the need
to implement multiple significant PCAOB standards at the same
time.\446\ Relatedly, one commenter said that the costs would be
exacerbated by the proposed timing for Form FM, which would fall during
the same time as PCAOB inspections and the QC system evaluation. The
Board acknowledges that the issuer audit labor market may be relatively
inelastic in the short run, particularly so given recent concerns about
inadequate labor supply, which could increase the cost implications of
the additional staffing that would be required to implement multiple
PCAOB standards in relatively quick succession. This could exacerbate
the costs of the final rules or lead to improper implementation.
---------------------------------------------------------------------------

\446\ Commenters' concerns about the cumulative impacts of
multiple PCAOB standards and rules with overlapping implementation
periods including potential benefits are discussed above.
---------------------------------------------------------------------------

vi. Litigation and Reputations Risks
Two commenters suggested that the proposed rules would exacerbate
audit firm litigation and reputation risks. One commenter performed a
survey of audit committee chairs.\447\ Some participants in the survey
agreed that the proposal could create litigation and reputation risk.
Regarding litigation risk, the Board agrees that plaintiffs' lawyers
may use the final metrics to support their cases. Supporting this view,
some research finds that PCAOB inspection reports with audit
deficiencies are positively associated with the number of lawsuits
subsequently filed against the inspected auditor.\448\ However, while
the Board acknowledges this could encourage some frivolous lawsuits,
the Board believes it would largely contribute positively to audit
quality as it would create an incentive for firms to produce high
quality audits. Indeed, the Board believes it would help drive more
competition on audit quality, a criterion that the same commenter urged
the Board to consider. Regarding reputation risk, the Board believes
that the impact on reputation is central to the intended impacts of the
final rules.
---------------------------------------------------------------------------

\447\ See above for more discussion on the survey.
\448\ See, e.g., Brant E. Christensen, Nathan G. Lundstrom, and
Nathan J. Newton, Does the Disclosure of PCAOB Inspection Findings
Increase Audit Firms' Litigation Exposure?, 96 The Accounting Review
191, (2021).
---------------------------------------------------------------------------

vii. Tacit Collusion
Some commenters suggested that the proposal could have
anticompetitive effects. One commenter analogized the proposed metrics
to (i) the sharing of compensation practices in the poultry-processing
market; (ii) information sharing in healthcare; and (iii) information
benchmarking in the meat-packing market. Relatedly, several commenters
suggested that the proposed metrics could reveal competitively
sensitive information. The Board acknowledges commenters' concerns
about potential anticompetitive effects which, if obtained, could
reduce quality or increase price. For example, in addition to the
largely procompetitive effects discussed in the proposal and above,
there could be an offsetting negative effect on competition to the
extent the final metrics facilitate tacit collusion among audit
firms.\449\ Some research suggests that public disclosure can
negatively impact competition. For example, one academic study suggests
that U.S. public companies opportunistically use their public financial
disclosures to tacitly collude.\450\ Another academic study shows that
public disclosure of transaction-level pricing data by Danish antitrust
authorities led to an increase in prices for ready-mix concrete.\451\
Similarly, another academic study shows that legacy airlines use their
earnings calls to coordinate capacity reductions on competitive
routes.\452\ However, this research may not necessarily apply to the
audit market. For example, the relationship between competition and
audit quality is ambiguous with some research suggesting that increased
competition is negatively associated with audit quality.\453\ As a
result, to the extent the final rules facilitate tacit collusion, this
effect could either raise or lower audit quality in certain segments of
the market. By contrast, the Board believes the procompetitive effects
of the final rules described above will be significant due to the
dearth of information currently available to audit committees and
investors. Furthermore, competition in the audit market is limited by
the presence of switching costs, reducing firms' incentives to tacitly
collude.
---------------------------------------------------------------------------

\449\ Tacit collusion refers to coordinated action among
competitors intended to raise profits that does not involve explicit
communication. See, e.g., Rama Cont and Wei Xiong, Dynamics of
Market Making Algorithms in Dealer Markets: Learning and Tacit
Collusion, 34 Mathematical Finance 467 (2024). The concentrated
nature of the audit market may enhance the possibility of tacit
collusion.
\450\ See Thomas Bourveau, Guoman She, and Alminas
[Zcaron]aldokas, Corporate Disclosure as a Tacit Coordination
Mechanism: Evidence from Cartel Enforcement Regulations, 58 Journal
of Accounting Research 295 (2020) (finding that ``after a rise in
cartel enforcement, U.S. firms start sharing more detailed
information in their financial disclosure about their customers,
contracts, and products. This new information potentially benefits
peers by helping to tacitly coordinate actions in product
markets.'').
\451\ See Svend Alb[aelig]k, Peter M[oslash]llgaard, and Per B.
Overgaard, Government[hyphen]Assisted Oligopoly Coordination? A
Concrete Case, 45 The Journal of Industrial Economics 429 (1997).
\452\ See Gaurab Aryal, Federico Ciliberto, and Benjamin T.
Leyden, Coordinated Capacity Reductions and Public Communication in
the Airline Industry, 89 Review of Economic Studies 3055 (2022).
\453\ See, e.g., Yue Pan, Nemit Shroff, and Pengdong Zhang, The
Dark Side of Audit Market Competition, 75 Journal of Accounting and
Economics 101520 (2023) (explaining how greater competition can, on
one hand, ``foster audit process innovation'' and, on the other
hand, lead auditors to ``focus on appeasing clients by reducing
professional skepticism and allowing clients excessive financial
reporting discretion'') and cites therein. The Board notes that
controlling for all potential drivers of audit quality and fees is
challenging. As such, the results obtained by these studies may be
affected by omitted variable biases.
---------------------------------------------------------------------------

viii. Opportunistic Behavior by Preparers
One commenter suggested that financial statement preparers may be
able to use the proposed metrics to evade their auditor's
scrutiny.\454\ The Board agrees that preparers might be able to exploit
some of the final metrics in this way (e.g., partner and manager
involvement) but for others it will be

[[Page 100062]]

less likely (e.g., restatements). The effect will be limited by the
fact that preparers already have some familiarity with their auditor's
processes. For example, auditors are required to provide a variety of
audit committee communications which preparers may be privy to.\455\
Indeed, one key premise of the economic analysis is that auditors and
preparers have better information than investors and audit committees
do about the audit process and outcomes.
---------------------------------------------------------------------------

\454\ The commenter referred to two articles about ``the fraud
diamond,'' a heuristic that approximates the conditions under which
fraud may occur. See David T. Wolfe and Dana R. Hermanson, The Fraud
Diamond: A 20-year Retrospective, The CPA Journal 16 (2024) and
David T. Wolfe and Dana R. Hermanson, The Fraud Diamond: Considering
the Four Elements of Fraud, The CPA Journal 38 (2004).
\455\ See AS 1301.
---------------------------------------------------------------------------

The same commenter suggested that financial statement preparers
could use the proposed metrics to shop for a lower quality auditor. The
Board agrees this will be possible but, as the Board discussed in the
proposal and above, the Board believes that the public nature of the
metrics will tend to suppress this. More specifically, the broader
financial statement user community will be able to observe how auditor
switches correlate with company characteristics and firms' metrics and
judge the company's financial reporting quality, and the audit
committee's execution of its auditor oversight responsibilities,
accordingly. However, the Board acknowledges that, because companies
will be better informed about the nuances of the audit process, the
final metrics could make it easier for some companies to shop for a
lower quality auditor without significant negative consequence.
ix. Attention Diversion
One commenter suggested that the proposed rules could reduce audit
quality by diverting engagement teams' attention away from other
activities. Another commenter suggested that this risk would be greater
for smaller audit firms and provided numerous research articles
suggesting that auditors are overburdened.\456\ The same commenter
suggested that the PCAOB should, as a starting point, consider whether
the proposed metrics place burdens on engagement teams that would
distract them from audit quality. Several commenters suggested that the
time required to prepare the proposed metrics would necessarily divert
attention from audit work and thus reduce audit quality. One commenter
suggested that strains on the audit labor market could increase audit
deficiencies. Another commenter suggested that the proposed metrics
would distract audit committees from their oversight responsibilities.
---------------------------------------------------------------------------

\456\ See Kimberly D. Westermann, Jeffrey Cohen, and Greg
Trompeter, PCAOB Inspections: Public Accounting Firms on ``Trial'',
36 Contemporary Accounting Research 694 (2019); Persellin, et al.,
Audit Perceptions.
---------------------------------------------------------------------------

The Board acknowledges that the final rules could require some
engagement team members' time. For example, some engagement team
members may be tasked with gathering information from the engagement
team and forwarding it to the national office (e.g., experience,
hours). Subject to the audit labor market concerns discussed above,
firms will be able to relieve some of this burden by hiring additional
staff or by centralizing or automating certain aspects of the
implementation effort.\457\ The Board also rejects the premise that the
presence of any engagement-level burden should automatically disqualify
a metric. Such a criterion ignores the metric's associated benefits.
Regarding audit committees, as discussed in the proposal and again
above, the Board recognizes that audit committees could incur costs
understanding the metrics. One type of cost could be the opportunity
cost associated with spending less time on other oversight activities
to the extent audit committees choose to do so. However, the Board
notes that audit committees could minimize this opportunity cost by
spending more total time overseeing the audit. Also, the various ways
the final metrics would improve audit committee oversight is discussed
above.
---------------------------------------------------------------------------

\457\ See above.
---------------------------------------------------------------------------

x. Non-PCAOB Registered Firms
One commenter suggested the proposed metrics could have cost
implications for non-PCAOB registered firms. The Board agrees. For
example, non-substantial role firms may incur costs providing
information to firms subject to the final requirements. However, they
already should be providing total audit hours for Form AP reporting
purposes. Also, any incremental cost will be limited to the Partner and
Manager Involvement and Allocation of Audit Hours final metrics.
xi. Unintentional Engagement-Level Disclosures
Several commenters said that, for firms that issue a limited number
of audit reports for accelerated filers and large accelerated filers,
many of the firm-level metrics could result in the disclosure of
engagement-level information.\458\ One commenter cited the internal
monitoring metric as an example. However, for most of the final firm-
level metrics, corresponding engagement-level information will also be
publicly available independent of the public disclosure of the firm-
level metric itself. The Board does not believe that the possibility of
making engagement-level inferences from the final metrics that are
required only at the firm level would impose costs on firms.
Furthermore, the Board notes that the proposed internal monitoring
metric is not among the final metrics.
---------------------------------------------------------------------------

\458\ Among the firms that will be impacted by the final rules,
approximately 41%, 19%, and 11% had a total of one, two, or three
accelerated filer or large accelerated filer engagements,
respectively, during the 12-month period ending September 30, 2023.
---------------------------------------------------------------------------

Alternatives Considered
The development of the final rules involved considering alternative
approaches to address the problems described above. This section
explains: (i) why standard setting is preferable to other policy-making
approaches, such as providing interpretive guidance or enhancing
inspection or enforcement efforts, (ii) other standard-setting
approaches that were considered, and (iii) key policy choices made in
determining the details of the final standard-setting approach.
1. Why Standard Setting Is Preferable to Another Approach
As potential alternatives to standard setting, the Board considered
whether interpretive guidance or greater focus on inspections or
enforcement could better address the need described above. One
commenter suggested the PCAOB could communicate to stakeholders
observations related to audit quality based on the outcomes of its
inspections and its enforcement actions, noting that the PCAOB has
unique access to information and people and has the context to
understand quality risks. The Board determined that, despite long-term
requests by investors to disclose additional metrics, similar
initiatives by other standard setters, and the apparent ability of
firms to voluntarily disclose metrics, the fact that most auditors have
not voluntarily acted to disclose effective metrics on a uniform basis
at the firm and engagement level points to the need for regulatory
intervention through standard setting.
Increased focus on inspections or enforcement is unlikely to
incentivize audit firms to voluntarily disclose the final metrics.
Likewise, interpretive guidance is unlikely to address audit firms'
lack of incentives to voluntarily disclose the final metrics. While
some firms may choose to disclose information similar to the final
metrics voluntarily, the lack of a standardized approach would result
in inconsistencies that prevent effective comparisons across the
profession. Similarly, standardization without mandated disclosure is
not sufficient to ensure the availability of comparable

[[Page 100063]]

public reporting of metrics.\459\ As discussed above, required
mandatory and uniform reporting will help audit committees make more
informed decisions in retaining and monitoring auditors, and investors
make more informed decisions when ratifying auditor appointments,
electing board members (including those who serve on the audit
committee), and allocating capital. The Board believes that standard
setting addresses the problem in the most effective way.
---------------------------------------------------------------------------

\459\ See, e.g., Patrick Bolton and Marcin T. Kacperczyk, Firm
Commitments, SSRN Electronic Journal (2024). The Board notes that
SSRN does not peer review its submissions.
---------------------------------------------------------------------------

One commenter said that the commenter's experienced implementing
the Form AP amendments proved to them that calculations require a
robust implementation support infrastructure. Several commenters
suggested that guidance regarding the final amendments would reduce the
complexity and challenges associated with calculating the metrics. One
commenter said that guidance would be essential to balance the costs of
compiling and reporting the information and this guidance should extend
to the evaluation of differences that may arise in the disclosure of
participating firms on Form AP. Another commenter said that the Board
should clarify whether the current Form AP Staff Guidance regarding
amendments would extend to all metrics as well as how routine
corrections and re-allocations of time entries and other matters
affecting metrics reported on Forms FM are expected to be handled.\460\
The Board acknowledges that guidance could help reduce the complexity
and costs associated with implementing the final rule. As discussed
above, the Board will monitor for issues and consider updates to
implementation guidance as appropriate.
---------------------------------------------------------------------------

\460\ See PCAOB Staff Guidance on Form AP.
---------------------------------------------------------------------------

2. Other Standard-Setting Alternatives Considered
During the development of the final rules, the Board considered two
alternatives to the current disclosure rules: (i) publishing benchmarks
on the final firm and engagement metrics, and (ii) requiring additional
audit committee communications.
First, the Board considered collecting the final metrics from the
firms on a non-public basis and then publicly publishing benchmarks
based on those metrics. This approach would benefit the Board in the
ways described above. However, the Board believes that investors and
audit committees will be able to effectively interpret the final
metrics in their disaggregated form when made directly available to the
public. Therefore, public transparency will be important. Moreover, as
discussed above, benchmarking could even have potentially harmful
unintended consequences.
Second, the Board considered requiring auditors to communicate the
final metrics just to their audit committees and not to members of the
public. One commenter suggested that the benefits of the proposal would
be the same under this alternative. However, such a policy choice would
not directly benefit the decision-making capabilities of investors and
other stakeholders in the public securities markets. Moreover, it would
limit audit committees' ability to compare the final metrics across
different firms and engagements and thus impair their decision-making
(e.g., auditor selection) by depriving audit committees of the broader
context needed to make informed choices.
One commenter suggested that the Board adopt a specific plan to
conduct a PIR. The Board has an established PIR program under which
staff of the Office of Economic and Risk Analysis (OERA) conduct an
analysis of the overall effect of new rules or amendments on key
stakeholders in the audit process, including whether the rules or
amendments are accomplishing their intended purpose and identifying
benefits, costs, and unintended consequences flowing from them. In
determining whether to conduct a PIR, PCAOB staff will consider the
nature of the rules or amendments (including the magnitude of and
degree of uncertainty around the key economic effects), the feasibility
(including research design and data availability), and the potential
utility to the Board (including whether the PIR might identify a demand
for additional guidance or amendments). Under the established PIR
program, the Board expects that OERA staff will consider whether, based
on these factors, a PIR might be warranted and, if so, OERA staff will
recommend that the Board determine to conduct one. In other words, this
deliberation should take place without any commitment. By contrast, a
commitment to conduct a PIR can be counter-productive if OERA staff
would otherwise determine that a PIR is not warranted or feasible. In
addition, a well-designed PIR is one that is itself based on some early
experience (even if only anecdotal), and thus, the Board believes
having a specific plan of PIR at this stage may be premature. The Board
believes having an established PIR program tends to increase the net
expected value of the PCAOB's adopted rules and standards. Should
future PIRs lead to potential modification or revision of these rules
and standards, this dynamic approach to assessing the impact of the
PCAOB's rules and standards compares favorably with a static analysis
of costs and benefits.\461\
---------------------------------------------------------------------------

\461\ See, e.g., Yoon-Ho Alex Lee, An Options-Approach to Agency
Rulemaking, 65 Administrative Law Review 881 (2013); see also OMB
Circular A-4 at 69 (``The assessment of real options allows you to
monetize the benefits and costs of changing the timing of regulatory
effects in light of the value of information about potential states
of the world that can be learned over time.''). In short, when a
policy is reversible (as in the case with the final rules) and the
policy outcome is probabilistically determined between an efficient
outcome and an inefficient outcome, a case can be made for moving
forward with the policy even when the net expected benefit under the
static cost-benefit analysis is negative because of the option of
repealing the policy in the future in case the inefficient outcome
is realized.
---------------------------------------------------------------------------

Several commenters that opposed aspects of the rulemaking suggested
that the Board should pilot test the final rules. One commenter
suggested pilot testing would allow the PCAOB to obtain feedback on the
nature, timing, extent, and usefulness of reporting. The commenter
referred to a pilot program planned by another regulator. Another
commenter said that pilot testing should occur prior to adoption of the
final rules to confirm whether the final metrics can be consistently
collected and reported by firms and whether they would be useful to
stakeholders. One commenter suggested that pilot testing would provide
the Board with data to quantitatively estimate the economic impacts of
the proposal.
The Board agrees that a pilot study could theoretically provide
useful preliminary compliance data.\462\ For example, a pilot study
could provide insights on the impacts of the proposed requirements or
alternative approaches. However, the Board believes several concerns
would challenge the utility of such an approach. First, participation
in a pilot study would likely be voluntary, potentially with a limited
group of participating firms, which may not be representative of all
firms. This could skew results and would limit the applicability of any
findings to a broader set of firms. Second, the impacts of the metrics
on competition and capital allocation in the markets are complex and
may require analysis across a broad set of firms and market conditions.
A pilot study would not capture this diversity or the broader impacts
on competition and capital markets, potentially leading to

[[Page 100064]]

incomplete or misleading conclusions. Third, the full implications of
the metrics on competition and capital formation might take several
years to manifest, as stakeholders would need time to adapt to and
fully integrate the final metrics effectively. This delay could
postpone the benefits expected from the final rules, especially if the
pilot study would need to run for multiple years to capture the
necessary information and trends. Finally, as stakeholders (including
firms, issuers, investors, and others) adapt to the new metrics, their
behaviors and the resulting data might change over time, potentially
rendering early data from a pilot study less relevant or useful for
long-term policy decisions. For these reasons, a pilot study, while
potentially yielding some initial insights, would have limited overall
benefits in this case. It would not offer a comprehensive view of the
metrics' implications across the entire spectrum of firms and could
unduly delay the transparency objectives of the rulemaking. The Board
notes that the proposal considered the work of other regulators,
including the planned pilot study referred to by one of the
commenters.\463\ That discussion appears above in substantially the
same form.
---------------------------------------------------------------------------

\462\ See Admin. Conf. of the U.S., Recommendation 2017-6,
Learning from Regulatory Experience, 82 FR 61738 (Dec. 29, 2017),
available at https://www.acus.gov/recommendation/learning-regulatory-experience.
\463\ See FRC, Consultation Document: Firm-level Audit Quality
Indicators.
---------------------------------------------------------------------------

3. Key Policy Choices
During the development of the final rules, the Board considered
different approaches to addressing key policy issues.
i. Definitions and Calculations of the Final Metrics
The Board considered a variety of alternative definitions and
calculations of the final metrics, including several suggested by
commenters and those initially proposed. See above for a discussion of
these considerations.
ii. Applicability
The conditions under which firms will be required to comply with
the final engagement and firm-level reporting requirements are
described above. During the development of the final rules, the Board
considered limiting applicability to firms that met a certain aggregate
issuer market capitalization threshold. The Board also considered
broadening the set of applicable filer statuses.
The Board noted that compared to the proposed approach, an
aggregate issuer market capitalization threshold could help focus the
final rules on auditors and engagements that investors are most
interested in.
Commenters during the development of QC 1000 indicated that a
threshold based on market capitalization was perhaps preferable to a
threshold based on issuer count because many auditors audit numerous
small engagements with limited operations (e.g., special purpose
acquisition companies). However, such an approach could present
challenges. As one commenter noted, thresholds based on market
capitalization may be subject to the volatility of the market. During a
review of the potential methodologies, the Board found that such a
threshold would also be sensitive to auditor switches, particularly if
the switching issuer had a large market capitalization. Some auditors
near the threshold could move back and forth between applicability and
non-applicability. The Board also considered alternative transition
thresholds for market capitalizations, or a phase-out period in
attempting to mitigate the negative aspects of these options.
Ultimately, the Board has determined that there was limited benefit to
using these alternative applicability thresholds.\464\
---------------------------------------------------------------------------

\464\ See above for a discussion of phased implementation.
---------------------------------------------------------------------------

The Board also considered broadening the applicability of the final
firm-level metrics to include all firms that audited at least one
operating company. This would increase the number of firms impacted by
the final firm-level metrics by approximately 160 and increase the
number of engagements and market capitalization covered by the final
firm-level metrics by approximately 16% and less than 0.1%,
respectively.\465\ Expanding the scope to cover all firms that audit at
least one operating company could reduce any potential negative stigma
associated with smaller firms for not being required to disclose the
final metrics. However, these firms tend to be smaller and hence may
lack the infrastructure and economies of scale to efficiently implement
the final rules. Furthermore, the gain of information to audit
committees and investors would be limited by the fact that these firms
tend to have smaller or fewer issuers on average. It also could create
confusion to have different thresholds for the final firm-level
reporting requirements and the final engagement-level reporting
requirements. Finally, firms that will not be subject to the final
firm-level disclosure requirements could voluntarily disclose the final
metrics.
---------------------------------------------------------------------------

\465\ See above for discussion on data sourcing. The Board
excludes firms that filed an audit opinion during the sample period
but whose registration has since been withdrawn, revoked, or is
pending withdrawal.
---------------------------------------------------------------------------

The Board also considered broadening applicability of the final
engagement-level metrics to include non-accelerated filer issuers.
While the importance of audit quality may be more significant for
smaller issuers,\466\ PCAOB staff analysis finds that non-accelerated
filers are proportionately smaller--at the median--than accelerated
filer and large accelerated filers in terms of audit fees and total
assets.\467\ One survey of audit committees of smaller public companies
found that five of the 28 metrics discussed in the Concept Release were
evaluated by more than half of the audit committees surveyed.\468\
PCAOB staff also reviewed the relative trading volume associated with
these filer status groups and found that non-accelerated filer issuers
have higher average daily (unit) volume than accelerated filer issuers
but lower average daily (unit) volume than large accelerated
filers.\469\

[[Page 100065]]

Neither issuer group, in general, was ``thinly traded,'' as measured by
average daily volume.\470\ Given these differences, the costs of the
final rules associated with non-accelerated filer issuer engagements
could be proportionally higher than the costs associated with
accelerated filer or large accelerated filer issuers engagements. As a
result, the Board has restricted the applicability of the final
engagement-level metrics to accelerated filer and large accelerated
filer engagements. Firms that will not be subject to the final
engagement-level disclosure requirements could voluntarily disclose the
final metrics.
---------------------------------------------------------------------------

\466\ See below for additional discussion.
\467\ Based on 2023 fiscal year data sourced through Audit
Analytics' Web service, non-accelerated filers paid median audit
fees of $320,000 and had median total assets of $66 million.
Comparatively, accelerated filers paid median fees of $1,300,000 and
had median total assets of $765 million. Large accelerated filers
paid median fees of $3,010,000 and had median total assets of $5,509
million. Only issuers filing pursuant to the Exchange Act (a.k.a.
Act-34 filers) were retained in the sample.
\468\ See, e.g., Harris and Williams, Audit Quality Indicators.
\469\ Sourcing data across the University of Chicago's Center
for Research and Security Prices (CRSP) Annual flat-file to collect
annual volume, along with Compustat, and Audit Analytics, the Board
identified, using filer statuses reported by Audit Analytics, that
the median average daily volume (the quantity of share units traded
per year divided by 252 trading days) for large accelerated filers
in 2020 and 2021 was roughly 867,000 units per day and 762,000 units
per day, respectively. For accelerated filers, the average daily
volume was 183,000 and 168,000 respectively. For non-accelerated
filers, the average daily volume was 528,000 and 756,000, units per
day, for 2020 and 2021. One reason for this is possibly the
relatively lower share price non-accelerated filer issuers have,
resulting in a higher unit-volume (per trade lot) compared to
accelerated filer issuers. The Board maintains share codes 10, 11
(i.e., U.S. issuers), and 12 (foreign issuers trading on U.S.
exchanges) in the Board's analysis, and remove American depositary
receipts, shares of beneficial interest, real estate investment
trusts, SBIs, REITs, and closed-end funds. Additionally, the Board
retains only Exchange Act 1934 filers and volumes related to the
first audit opinion filed with the SEC for a given fiscal year.
Filer status, as sourced through Audit Analytics, may be an
imperfect proxy of the true filer status of the entity-issuer due to
errors in reporting and or collection. Furthermore, the Board
retains only observations in which there is recorded to be complete
volume for the entire annual period. There were 1,350 large
accelerated filer issuers in the Board's sample in 2020, and 1,358
in 2021. For accelerated filers there are 337 and 329 issuers in
each 2020 and 2021 that remain in the Board's sample, and for non-
accelerated filers there are 121 and 134 issuers, respectively. The
Board attempts to remove issuers additionally classified as Small
Reporting Companies from the reported statistics. Lastly, not all
issuers, particularly smaller issuers, trade on exchanges observed
in the CRSP data set--as a result the Board's sample may be biased
towards larger issuers, or issuers that trade on exchanges observed
by CRSP.
\470\ For a discussion of ``thinly traded'' markets, see
Division of Trading and Markets: Background Paper on the Market
Structure for Thinly Traded Securities, Roundtable on Market
Structure for Thinly Traded Securities (April 23, 2018), available
at https://www.sec.gov/rules/policy/2019/thinly-traded-securities-tm-background-paper.pdf.
---------------------------------------------------------------------------

The Board also considered whether the scope for engagement-level
reporting should be extended to non-operating company issuers whose
financial statements are required under SEC rules to be audited under
PCAOB standards (i.e., investment companies, employee stock plans) and
broker-dealers. While these additional disclosures could be
informative, commenters indicated that the proposed metrics would be
less beneficial for these entities compared to accelerated filers and
large accelerated filers.\471\ The Board agrees, and therefore are not
requiring disclosure of these metrics for issuers that are not
accelerated filers or large accelerated filers under the final rules.
---------------------------------------------------------------------------

\471\ See above for additional discussion on commenters' views
on this alternative.
---------------------------------------------------------------------------

iii. Reporting
Several commenters suggested that the Board could alleviate the
burden on smaller firms by raising the reporting threshold. One
commenter said that firms that issue audit reports for 100 issuers or
more are the firms whose metrics investor-related groups would be most
interested in reviewing, given these firms audit a significant majority
of the market capitalization of issuers reporting on Form 10-K, Form
20-F, and Form 40-F. Another commenter suggested a threshold of 25 or
more large accelerated filer and accelerated filer issuer engagements
combined. The same commenter said that metrics of firms with few
engagements could be unduly influenced by a single engagement. By
contrast, one commenter suggested making the reporting requirements
apply to all PCAOB-registered firms. As discussed in the proposal and
above, the Board recognizes the potential disproportionate cost to
smaller firms and have considered this in the Board's decision to scope
in all firms that audit at least one accelerated filer or large
accelerated filer.\472\ The Board believes audit committees and
investors will benefit from information related to the audits of
accelerated filers and large accelerated filers and the firms that
perform these audits. Two commenters agreed that the proposed scope
captures situations where investment and proxy voting decisions would
be most likely to benefit from additional information about the audit
and the auditor.
---------------------------------------------------------------------------

\472\ See above for additional discussion on this policy
alternative.
---------------------------------------------------------------------------

As discussed above, firms subject to the final engagement-level
reporting requirements will be required to disclose the final
engagement-level metrics in Form AP, to be filed by the 35th day (for
most audits) after the date the audit report is first included in a
document filed with the SEC. Firms subject to the final firm-level
reporting requirements will also be required to disclose the final
firm-level metrics in the newly created Form FM.
As contemplated above, the Board considered requiring that the
final metrics be included in the audit report in addition to on Form AP
and Form FM. Under this alternative, costs incurred by investors and
audit committees when gathering information to inform their decision-
making could be further reduced. Investors would be able to look down
from the auditor's opinion and immediately review the final metrics.
Moreover, this would serve as a prime opportunity for the firm to
communicate critical context through narratives that might be
beneficial for investors in reviewing the final metrics.
The disclosure of the proposed metrics in the audit report would
not impair the usefulness of their disclosure through Form AP and Form
FM. Indeed, such additional reporting may enhance their usefulness by
setting the proposed metrics within the full context of the issuer's
financial reporting. However, some investors and audit committees may
prefer to obtain the information from Form AP and Form FM, or from
other sources (e.g., a subscription-based data provider), and hence may
find little use for metrics in the audit report. There likely would not
be appreciable costs associated with this additional reporting, outside
of costs to include the report in the filing of the audit opinion.
Firms will already be required to collate information and compute the
final metrics for reporting to the PCAOB in their relevant forms.
Many commenters disagreed with this approach citing that, for
example, it could potentially detract from the clarity and purpose of
the report, could result in delays in the issuance of audit reports,
and amendments to the audit report for corrections to metrics could
create unnecessary burden for issuers and confusion for investors. One
commenter suggested the proposed metrics would be better placed in
audit committee reports in company proxy statements. One commenter said
that the proposed metrics: (i) would create a misimpression that the
metrics are indicative of audit quality; (ii) would be impractical to
implement in a timely manner; and (iii) could distract auditors.
However, several commenters, primarily investor-related groups, were
supportive of reporting in the auditor's report. One commenter said
that the proposed engagement performance metrics are as important to
understanding audit risks as CAMs and thus merit inclusion in the
auditor's report. The Board is persuaded by commenter feedback that
this alternative would be burdensome and could diminish the value of
the auditor's report. Therefore, the Board is not adopting this
alternative at this time.
The Board also considered requiring firms subject to the final
firm-level reporting requirements to disclose the firm-level metrics on
Form 2 rather than Form FM. This approach could benefit some investors
or audit committees because the firm-level metrics would appear in the
context of other firm-level information. It could also reduce
compliance costs for firms because firms are already familiar with Form
2. However, information reported on Form 2 is currently not
downloadable as a structured data set. This could reduce the
accessibility of the final firm-level metrics to investors and audit
committees. Furthermore, the final firm-level metrics use terms that
have different meanings in the context of Form 2 (e.g., ``Partners'').
This could lead some investors or audit committees to misunderstand the
final firm-level metrics or lead some firms to mistakenly provide
incorrect information in Form 2. Finally, the due date of Form 2, June
30, falls after the general timing of shareholder meanings and
therefore would generally arrive too late to inform shareholders'
voting decisions. This alternative and commenter feedback are discussed
above. Overall, the Board is persuaded by commenters' concerns

[[Page 100066]]

that this alternative would place burdens on firms during their busy
season. Therefore, the Board is not adopting this alternative at this
time.
While several commenters suggested that the Board limit the
disclosure of engagement-level metrics to audit committees--citing
audit committees' ability to engage in dialogue with the auditor and to
understand the context of the metrics--the Board believes public
disclosure will provide the benefits associated with investor decision-
making as well as some benefits related to improved audit committee
decision-making. For example, public disclosure allows investors to
make more informed decisions regarding board directors (including audit
committee members), and auditor ratification. It also will provide
audit committees with comparative information about other firms and
engagements which may improve their auditor selection and oversight
decisions. Furthermore, the Board believes that the public nature of
the metrics will be a key driver of the pro-competitive effects in the
auditing market, by making it easier to compare an existing auditor's
metrics to the same metrics for other potential auditors. The Board
therefore believes public transparency will foster a competitive
auditing environment and support robust governance by providing all
stakeholders, not just audit committees, with information to make well-
informed decisions.
Two commenters suggested the Board refer to work performed by the
SEC when it considered requiring additional audit committee
disclosures.\473\ One commenter suggested that the 2015 SEC Concept
Release could inform the Board's consideration of requiring auditors to
disclose engagement-level metrics to audit committees only. Staff
reviewed the 2015 Concept Release. The 2015 SEC Concept Release sought
comment on, among other things, whether the reporting of additional
information by the audit committee with respect to its oversight of the
audit may provide useful information to investors as they evaluate the
audit committee's performance in connection with, among other things,
their vote for or against directors who are members of the audit
committee, the ratification of the auditor, or their investment
decisions. The Board believes this request for comment is consistent
with the questions included in the Board's proposal, the feedback from
investor-related groups the Board received, and the Board's view that
investors need more information to: (i) evaluate the performance of
auditors and audit committees; (ii) vote for or against directors who
are members of the audit committee; (iii) ratify the appointment of the
auditor; and (iv) invest capital. The 2015 SEC Concept Release also
stated that to the extent the audit committee uses indicators or
metrics in assessing the quality of the auditor and the audit,
disclosure about the use and consideration of such metrics may provide
useful information about the audit committee's process for assessing
the auditor. The Board notes that the relevance of the 2015 SEC Concept
Release is limited by the fact that it: (i) contemplates public
disclosures by audit committees rather than by auditors; and (ii) aims
to solicit feedback rather than provide a cost-benefit analysis. As
explained previously, the Board believes that restricting the
disclosure of these metrics solely to audit committees would cause
investors and other stakeholders to forgo the benefits of disclosure.
---------------------------------------------------------------------------

\473\ See SEC Concept Release on Possible Revisions to Audit
Committee Disclosures, SEC Rel. No. 33-9862 (July 1, 2015) (``2015
SEC Concept Release'').
---------------------------------------------------------------------------

Some commenters suggested a more flexible approach to engagement-
level reporting, such as voluntary disclosure. One commenter suggested
that competition among auditors should be the primary source of
practice enhancements as opposed to regulatory control. One commenter
suggested that voluntary disclosure allows for refinements and
innovation in response to the evolving auditing environment. Another
commenter suggested that voluntary disclosure could facilitate a market
for enhanced disclosures. Relatedly, referring academic research, one
commenter said that relevant metrics could evolve over time and that
many metrics could be useful.\474\ Also citing academic research,
another commenter recommended a principles-based approach.\475\ The
Board recognizes that a purely voluntary or principles-based approach
could foster innovation. However, for reasons discussed above the Board
believes the benefits associated with a mandatory approach, with
clearly articulated calculations relative to the current practice
baseline of voluntary disclosure, are substantial. For example, as
discussed above, the Board believes that the market does not provide
sufficient incentives for auditors to disclose information akin to the
metrics voluntarily. Furthermore, even under the mandatory framework
the Board is adopting, firms would still have the freedom to innovate
beyond the required metrics through additional voluntary disclosures.
---------------------------------------------------------------------------

\474\ See Gillian Rose Barnes and Dana R. Hermanson, Fraud
Brainstorming Sessions and Interviews in a Remote World: Initial
Evidence, 15 Journal of Forensic and Investigative Accounting 248
(2023); Lazarus Elad Fotoh and Johan Ingemar Lorentzon, Audit
Digitalization and its Consequences on the Audit Expectation Gap: A
Critical Perspective, 37 Accounting Horizons 43 (2023); Jean C.
Bedard, Karla M. Johnstone, and Edward F. Smith, Audit Quality
Indicators: A Status Update on Possible Public Disclosures and
Insights from Audit Practice, 4 Current Issues in Auditing C12
(2010); Knechel, et al., Audit Quality; and Christensen et al.,
Understanding Audit Quality.
\475\ See Arianna S. Pinello, Ara G. Volkan, Justin Franklin,
Michael Levatino, and Kimberlee Tiernan, The PCAOB Audit Quality
Indicator Framework Project: Feedback from Stakeholders, 16 Journal
of Business & Economics Research 1 (2019).
---------------------------------------------------------------------------

One commenter suggested that an analysis of analogous initiatives
in foreign jurisdictions would inform the PCAOB of potential
alternatives to the final rules that may be less costly or present less
risk of unintended consequences. One commenter suggested that the Board
more carefully consider the context in which those metrics are used,
emphasizing their voluntary nature. As discussed in the proposal, PCAOB
staff reviewed initiatives in foreign jurisdictions and noted their
generally less prescriptive approaches compared to the metrics the
Board is adopting. While these international approaches may involve
lower costs and possibly fewer unintended consequences, 'they are also
likely to mean that metrics are less comparable and less
comprehensively available, implying less-substantial benefits. The
Board believes that the Board's approach, although potentially more
prescriptive, is necessary to achieve the desired level of transparency
and oversight in audit practices.
Two commenters representing investor groups suggested that, if the
Board adopts the final rules, the PCAOB could amplify the value of the
final metrics by providing tools, research, or periodic reviews of the
information. The Board will consider these suggestions. However, the
Board notes that, under the final rules, users will be able to analyze
the data using tools of their choice. Additionally, the PCAOB plans to
have programs to sponsor research which may consider the final metrics.
The Board will be alert to how the metrics are utilized and their
impact.
iv. Alternative Firm and Engagement Metrics Considered
The Board considered but at this time are not adopting metrics
related to: (i) auditor proficiency testing; surveys of firms and audit
committees; and auditor absenteeism; (ii) legal proceedings

[[Page 100067]]

against audit firms and firm ownership structures; (iii) engagement-
level PCAOB deficiencies; (iv) access to national office or other
technical resources and staff and investments in infrastructure to
support audit quality; (v) auditor independence and financial reporting
quality; (vi) timely issuance of internal controls weaknesses and going
concern opinions and fraud or other financial reporting misconduct;
(vii) audit fees, effort, and client risk; (viii) audit personnel; (ix)
allocation of audit hours; and (x) internal monitoring and incentives.
In the following discussion the Board briefly describes and evaluates
the literature on these metrics and provides the Board's rationale for
not adopting them.
a. Metrics Related to Auditor Proficiency Testing, Surveys of Firms and
Audit Committees, and Auditor Absenteeism
Metrics related to proficiency testing, surveys of firms and audit
committees, and auditor absenteeism would generally speak to the ``Tone
at the Top'' or workplace culture of the audit firm. There is a lack of
literature covering the economic impacts that disclosure of these
metrics might engender. While some academic literature suggests strong
work culture and a ``Tone at the Top'' is associated with audit
quality,\476\ it is unclear how an informative metric could be
constructed. Similarly, while some academic literature suggests
competence is associated with audit quality, there is limited research
related to proficiency testing per se and it is unclear how an
informative metric on proficiency testing could be constructed.\477\
Finally, the Board is unaware of any literature related to auditor
absenteeism. At this time, the Board is not requiring disclosure of
these metrics under the final rules.
---------------------------------------------------------------------------

\476\ See, e.g., Stephen Perreault, James Wainberg, and Benjamin
L. Luippold, The Impact of Client Error-Management Climate and the
Nature of the Auditor-Client Relationship on External Auditor
Reporting Decisions, 29 Behavioral Research in Accounting 37 (2017)
and Donna D. Bobek, Derek W. Dalton, Brian E. Daugherty, Amy M.
Hageman, Robin R. Radtke, An Investigation of Ethical Environments
of CPAs: Public Accounting versus Industry, 29 Behavioral Research
in Accounting 43 (2017).
\477\ See, e.g., Christensen et al., Understanding Audit
Quality.
---------------------------------------------------------------------------

b. Metrics Related to Legal Proceedings Against Audit Firms and Firm
Ownership Structures
Some academic literature suggests there may be no relationship
between the quality of audit services or the auditor's provision of
reasonable assurance and the likelihood that an auditor could be sued,
have a case settled, or be taken through court.\478\ Many cases brought
against auditors fail to meet the threshold of fault required to show
the auditor is liable for the damages incurred by investors.
Information related to legal proceedings may also be confidential or
otherwise sensitive. Furthermore, the incidence of lawsuits against
auditors has declined in recent years.\479\ One investor survey finds
that investors perceive private litigation as being unrelated to audit
quality.\480\ Additionally, information regarding proceedings initiated
by government entities against firms and certain of their personnel is
already reported on PCAOB Form 3. Metrics related to firm ownership
structure are being considered by the PCAOB's Firm Reporting rulemaking
project. At this time, the Board is not requiring disclosure of these
metrics under the final rules.
---------------------------------------------------------------------------

\478\ See, e.g., Colleen Honigsberg, Shivaram Rajgopal, and
Suraj Srinivasan, The Changing Landscape of Auditors' Liability, 63
The Journal of Law and Economics 367 (2020).
\479\ See Honigsberg et al., The Changing Landscape.
\480\ See Christensen et al., Understanding Audit Quality.
---------------------------------------------------------------------------

c. Metrics Related to Engagement-Level PCAOB Deficiencies
The Board's considerations regarding potential metrics related to
engagement-level PCAOB deficiencies are discussed above. Several
commenters suggested the Board include metrics related to deficiencies
identified during PCAOB inspections. Several commenters suggested the
Board require firms to report the percentage of their reviewed audits
that received Part I.A deficiencies in their PCAOB inspection reports.
These commenters highlighted the critical nature of Part I.A
deficiencies and suggested that requiring this information to be
disclosed along with the other final metrics would increase its
prominence. While the Board acknowledges the significance of Part I.A
deficiencies--indicating deficiencies that were of such significance
that the Board believes the firm, at the time it issued its audit
report, had not obtained sufficient appropriate audit evidence to
support its opinion on the issuer's financial statements and/or ICFR--
the Board notes that this information is already publicly available and
stakeholders already utilize this information, compiling it in their
analyses.
One commenter suggested that the Board consider requiring auditors
to disclose which of their audits had Part I.A deficiencies included in
their PCAOB inspection reports. The commenter suggested that this
disclosure would obviate need for most, if not all, of the proposed
firm- and engagement-level metrics. The Board acknowledges that
information on engagement deficiencies identified through PCAOB
inspection could provide investors and other stakeholders with
additional insight on audit quality. However, PCAOB inspection reports
are typically published well after the reporting deadlines for
engagement-level metrics on Form AP, making it impractical to include
such inspection results in that form. The Board also disagrees that
disclosure of PCAOB inspection findings would obviate the need for the
metrics. The final metrics will be available for the full population of
accelerated filer and large accelerated filer issuers, whereas the
presence of Part I.A deficiencies are available for the much more
limited sample of inspected firm engagements. Furthermore, the Board
believes the final metrics would provide information on aspects of
audit quality not entirely captured by Part I.A deficiencies. While
academic literature suggests that engagement-level PCAOB auditing
deficiencies are indicative of low audit quality, Sarbanes-Oxley
already provides a robust framework for making PCAOB inspection
findings and sanctions public.\481\ At this time, the Board is not
requiring the disclosure of engagement-level PCAOB auditing
deficiencies under the final rules.
---------------------------------------------------------------------------

\481\ See, e.g., Aobdia et al., Practitioner Assessments.
---------------------------------------------------------------------------

d. Metrics Related to Access to the National Office or Other Technical
Resources and Staff and Investments in Infrastructure To Support Audit
Quality
The Board's considerations regarding potential metrics related to
access to technical resources is discussed above. Overall, metrics
related to audit teams' access to such technical resources and staff
could indicate how accessible individuals, decision aids, or technical
audit-process manuals are to audit teams. For example, in larger firms,
individuals in the national office may provide consultation on complex,
unusual, or unfamiliar issues. One study using PCAOB data found that
national office consultations are common among PCAOB-inspected
engagements and that national office consultation use is associated
with engagement characteristics and proxies for audit quality.\482\
Smaller firms may retain

[[Page 100068]]

individuals with such expertise from outside the firm. Metrics related
to infrastructure that supports audit quality could provide information
on resources audit teams have available to them that could support
audit quality. However, due to the variety of ways firms provide
technical resources and infrastructure to support audit quality, the
Board believes that metrics related to these areas would likely not be
informative or comparable for all firms. Furthermore, disclosures
related to network relationships currently being considered as part of
the PCAOB's Firm Reporting rulemaking project would provide some
information to investors and audit committees regarding firms' access
to technical resources. At this time, the Board is not requiring
disclosure of metrics related to access to technical resources under
the final rules.
---------------------------------------------------------------------------

\482\ See, e.g., Matthew G. Sherwood, Miguel Minutti-Meza, and
Aleksandra B. Zimmerman, Auditors' National Office Consultations,
SSRN Electronic Journal (2024). The Board notes that SSRN does not
peer review its submissions.
---------------------------------------------------------------------------

The Board's considerations regarding potential metrics related to
investment in audit infrastructure is discussed above. In particular,
one commenter suggested that the Board consider requiring firms to
report the percentage of the firm's revenues invested in technology
accessible by audit teams. The Board believes the broad range of what
constitutes ``technology'' and how it is used across different firms
could lead to inconsistencies in how such a metric is calculated and
reported. Overall, the Board does not believe such a metric would be
informative and comparable. At this time, the Board is not requiring
disclosure of metrics related to access to investment in audit
infrastructure under the final rules.
e. Metrics Related to Auditor Independence and Financial Reporting
Quality
Disclosures related to audit fees and non-audit fees are being
considered as part of the PCAOB's Firm Reporting rulemaking project.
Furthermore, the final rules already include a metric for restatements,
a well-accepted proxy for financial reporting quality. Therefore, the
Board does not think there is a need to expand disclosures related to
this information under the final rules.
f. Metrics Related to the Timely Issuance of Internal Controls
Weaknesses and Going Concern Opinions, and Fraud or Other Financial
Reporting Misconduct
Academic research suggests that (i) markets react to going concern
reporting and (ii) timely reporting of a going concern opinion is an
indicator of audit quality.\483\ However, there is a lack of academic
research related to timely reporting of internal control weaknesses.
The final rules include metrics related to restatement history, which
the Board believes will provide a clearer signal of audit quality.
Firms' reporting of internal control weaknesses and their inclusion of
going concern explanatory paragraphs in the audit report are also
publicly available already, as are indicators of auditors' timeliness
(e.g., subsequent restatements or bankruptcies). Additionally, the
Board is considering other standard-setting opportunities related to
the reporting of fraud or other financial reporting misconduct as well
as the auditor's going concern evaluation. At this time, the Board does
not think there is a need to require disclosure of these metrics under
the final rules.
---------------------------------------------------------------------------

\483\ See DeFond and Zhang, A Review of Archival Auditing
Research.
---------------------------------------------------------------------------

g. Metrics Related to Audit Fees, Effort, and Client Risk
Regarding audit fees, the Board notes that engagement-level audit
fees are already publicly available and firm-level audit fees may be
constructed by summing engagement-level audit fees. Regarding audit
effort, the Board notes that, while some academic research finds that
proxies for audit effort are associated with audit quality, the level
of association diminishes in certain settings when considered jointly
with other information correlated with audit effort.\484\ Indeed,
stakeholders will have access to information correlated to audit
effort. For example, engagement-level audit hours, a commonly used
proxy for audit effort, are highly correlated with engagement-level
audit fees which are publicly available.\485\ Additionally, the final
metrics related to Partner and Manager Involvement, Workload, Training
Hours for Audit Personnel, and Allocation of Audit Hours will provide
information related to audit effort. Regarding client risk, the Board
has observed through the Board's oversight activities that firms
classify clients as high risk in various ways. At this time, the Board
is not requiring disclosure of these metrics under the final rules.
---------------------------------------------------------------------------

\484\ See, e.g., Aobdia et al., The Economics of Audit
Production, Table 3 and Table 4 (finding that audit effort is not
related to various proxies for audit quality after holding other
factors constant); Constantinos Caramanis and Clive Lennox, Audit
Effort and Earnings Management, 45 Journal of Accounting and
Economics 116 (2008) (studying Greek audit firms, finding that lower
audit hours are associated with decreases in various proxies for
audit quality) and Dafydd Mali and Hyoung-Joo Lim, Can Audit Effort
(Hours) Reduce a Firm's Cost of Capital? Evidence from South Korea,
45 Accounting Forum 171 (2020) (finding, using data on Korean audit
firms, that audit effort is negatively associated with weighted
average cost of capital).
\485\ See, e.g., Aobdia, Practitioner Assessments, Table 4.
---------------------------------------------------------------------------

h. Metrics Related To Audit Personnel
The Board proposed but are not adopting engagement-level metrics
related to turnover (i.e., Retention and Tenure). Academic literature
related to turnover generally and commenters' views on the proposed
metric are discussed above. Overall, commenters generally did not
support engagement-level metrics in this area. Several commenters said
that mandatory partner rotation, personal issues, and strategic
resource management concerns could drive the proposed engagement-level
metric related to turnover. Commenters said that for these and other
reasons the metrics would be especially difficult for stakeholders to
interpret and would need to be considered in conjunction with other
metrics. After considering these comments, and in light of the Board's
original analysis, the Board is not adopting the proposed engagement-
level Retention and Tenure metric under the final rules.
i. Certain Metrics Related to the Allocation of Audit Hours
The Board proposed but is not adopting several metrics related to
the allocation of audit hours (i.e., Audit Hours and Risk Areas, Audit
Resources--Use of Auditor's Specialists and Shared Service Centers).
These proposed metrics predominantly focus on whether the audit team is
being efficiently and effectively deployed. The proposed metrics were
intended to improve transparency into the audit process and help
investors and audit committees to review: (i) whether the auditor is
effectively allocating hours in response to areas of significant risk,
(ii) whether the auditor is efficiently and effectively deploying
individuals with expertise to address areas that require their
specialized knowledge; and (iii) whether the auditor is efficiently and
effectively using SSCs. Section IV.C.1.iv.b of the proposal provides
additional discussion on the potential benefits of these metrics and
relevant academic literature. Comments related to the discussion of
academic literature are addressed above. The Board addresses below more
specific comments related to the impacts of these metrics.
Commenters' views on the proposed Audit Hours and Risk Areas metric
including alternative approaches suggested are discussed above.
Overall, many commenters did not support the proposed metric and said
that it would be challenging to calculate. Several

[[Page 100069]]

commenters said that, because risk assessment is an iterative process,
high-risk areas could change over the course of the audit, leading to
challenges tracking the required hours information. Several commenters
also said that calculating the proposed metric would require extensive
coordination among other auditors. Several commenters also said that
hours charged to particular accounts may include work that is unrelated
to an identified significant risk. After considering these comments,
and in light of the Board's original analysis, the Board is not
adopting the proposed Audit Hours and Risk Areas metric under the final
rules.
Commenters' views on the proposed Audit Resources metrics including
alternative approaches suggested are discussed above. Overall,
commenters generally opposed these metrics. For example, one commenter
said that the use of auditor's specialists would not be comparable
across firms of different sizes without sufficient context. The same
commenter said that smaller firms are more likely to engage outside
specialists compared to larger firms with in-house specialists. One
commenter said firms are already required to communicate their use of
specialists to audit committees on an engagement. One commenter said
that the use of specialists is highly contextual. One commenter said it
would be difficult obtain the hours information to calculate the
proposed use of specialists metric. Referring to several academic
articles, one commenter suggests that smaller firms and larger firms'
metrics related to the use of specialists would not be comparable
because smaller firms feel regulatory pressure to use specialists and
typically retain outside specialists.\486\ One commenter said that the
SSC metric would be misinterpreted as indicating that greater SSC hours
indicated lower quality. After considering these comments, and in light
of the Board's original analysis, the Board is not adopting the
proposed Audit Resources metrics under the final rules.
---------------------------------------------------------------------------

\486\ See J. Efrim Boritz, Natalia Kochetova-Kozloski, and Linda
Robinson, Are Fraud Specialists Relatively More Effective Than
Auditors at Modifying Audit Programs in the Presence of Fraud Risk?,
90 The Accounting Review 881 (2015); Candice T. Hux, Use of
Specialists on Audit Engagements: A Research Synthesis and
Directions for Future Research, 39 Journal of Accounting Literature
23 (2017); Zimmerman, et al., Auditor's Use; Dereck Barr-Pulliam,
Stephani Mason, and Kerri Ann Sanderson, The Joint Effects of Work
Content and Work Context on Valuation Specialists' Perceptions of
Organizational-Professional Conflict, SSRN Electronic Journal
(2022); Aleksandra B. Zimmerman, Dereck Barr-Pulliam, Joon-Suk Lee,
and Miguel Minutti-Mezza, Auditors' Use of In-House Specialists, 61
Journal of Accounting Research 1363 (2023). The Board notes that
SSRN does not peer review its submissions.
---------------------------------------------------------------------------

j. Metrics Related to Internal Monitoring and Incentives
The Board proposed but is not adopting metrics related to internal
audit quality review (i.e. Audit Firms' Internal Monitoring) and
incentive alignment (i.e., Quality Performance Ratings and
Compensation). Metrics related to internal audit quality review and
incentive alignment focus on the positive and negative incentives
auditors face. Unlike the final metrics related to audit personnel and
allocation of audit hours, which would provide additional transparency
into the inner workings and characteristics of the audit team, the
disclosure of these proposed metrics would provide information related
to audit outcomes and the incentives that led to those results. Section
IV.C.1.iv.c of the proposal provides additional discussion on the
potential benefits of these metrics and relevant academic literature.
Comments related to the discussion of academic literature are addressed
above. The Board addresses below more specific comments related to the
impacts of these metrics.
Commenters' views on these proposed metrics including alternative
approaches raised are discussed above. Two commenters agreed that the
proposed metrics related to firms' internal monitoring would be useful
for stakeholders. One firm reported that it provides similar firm-level
information in its transparency report. However, others expressed
several concerns, particularly regarding the engagement-level metrics.
By way of background, survey research cited in the proposal finds that
internal monitoring programs are valued by audit partners for their
focus on the firm's audit methodology, their timeliness, and the
quality of the feedback.\487\ Pointing to this research, one commenter
suggested that the proposed internal monitoring metric would undermine
the efficacy of audit firm internal inspection programs and audit
quality. Some commenters said that the information would not be
comparable due to differences in firms' monitoring programs. One
commenter said that smaller firms would be disadvantaged because the
results of their monitoring programs tend to be more variable.
Regarding incentive alignment, some commenters supported a metric for
incentive alignment and agreed with the Board's rationale for proposing
it. One commenter said that investors routinely evaluate executive
compensation packages and understand that compensation may be driven by
a variety of factors which could be discussed in the voluntary
narrative discussion. However, other commenters said it would lack
comparability, would not capture other important drivers of
compensation, and would raise confidentiality concerns. After
considering these comments, and in light of the Board's original
analysis, the Board did not adopt these metrics under the final rules.
---------------------------------------------------------------------------

\487\ See Richard W. Houston and Chad M. Stefaniak, Audit
Partner Perceptions of Post-Audit Review Mechanisms: An Examination
of Internal Quality Reviews and PCAOB Inspections, 27 Accounting
Horizons 23, (2013).
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Special Considerations for Audits of Emerging Growth Companies
Section 104 of the Jumpstart Our Business Startups (``JOBS'') Act
imposes certain limitations to the application of the Board's standards
to audits of Emerging Growth Companies (``EGCs''), as defined in
Section 3(a)(80) of the Exchange Act. Under Section 104, the JOBS Act
provides that any additional rules adopted by the Board subsequent to
April 5, 2012, ``shall not apply to an audit of any [EGC] 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 would
promote efficiency, competition, and capital formation.'' \488\ As a
result, the final rules are subject to a separate determination by the
SEC regarding their applicability to audits of EGCs.\489\
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\488\ See Pub. L. 112-106 (Apr. 5, 2012). Section 103(a)(3)(C)
of Sarbanes-Oxley, as added by Section 104 of the JOBS Act. 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 financial
statements of the issuer (auditor discussion and analysis) shall not
apply to an audit of an EGC. The final mandatory disclosure rules do
not fall within either of these two categories.
\489\ The Board provided this analysis of the impact on EGCs to
assist the SEC in making the determination required under Section
104 to the extent that the requirements apply to ``the audit of any
emerging growth company'' within the meaning of Section 104 of the
JOBS Act.
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To inform consideration of the application of PCAOB standards and
rules to audits of EGCs, the PCAOB staff publishes a white paper
annually that provides general information about characteristics of
EGCs. The data on EGCs outlined in the most recent white paper,
released in February 2024, remains generally consistent with the data
outlined in prior EGC white

[[Page 100070]]

papers.\490\ As of the November 15, 2022, measurement date, PCAOB staff
identified 3,031 companies that self-identified with the SEC as EGCs
and filed with the SEC audited financial statements in the 18 months
preceding the measurement date.\491\
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\490\ See PCAOB, White Paper on Characteristics of Emerging
Growth Companies and Their Audit Firms at November 15, 2022 (Feb.
20, 2024), available at https://pcaobus.org/resources/other-research-projects (``EGC White Paper'').
\491\ The EGC White Paper uses a lagging 18-month window to
identify companies as EGCs. Please refer to the ``Current
Methodology'' section in the EGC White Paper for details. Using an
18-month window enables PCAOB 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 that have exceeded the eligibility
or time limits. See id.
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The discussion of benefits, costs, and unintended consequences of
the final rules above is generally applicable to all audits performed
pursuant to PCAOB standards, including audits of EGCs. The economic
impacts of the final rules on an individual EGC audit will depend on
factors such as the auditor's ability to distribute implementation
costs across its audit engagements and whether the auditor has already
incorporated the final metrics into its audit approach. One survey of
audit committees of smaller public companies found that five of the 28
metrics discussed in the Concept Release were evaluated by more than
half of the audit committees surveyed.\492\ EGCs are more likely to be
newer companies, which are typically smaller in size and receive lower
analyst coverage.\493\ For example, smaller companies have very little,
if any, analyst coverage, which reduces the amount of information made
available to financial statement users and therefore makes markets less
efficient.\494\ These factors may increase the importance to investors
of the higher audit quality expected to result from the final rules, as
high-quality audits generally enhance the credibility of management
disclosures.\495\ The costs of the final rules may disproportionately
impact smaller audit firms, and in so much as smaller audit firms tend
to audit smaller issuers, pass through of these costs may
disproportionately impact EGCs.\496\
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\492\ See, e.g., Harris and Williams, Audit Quality Indicators.
\493\ See EGC White Paper at Figure 9 and Figure 12 (indicating
that exchange-listed EGCs have less market capitalization and
revenue than exchange-listed non-EGCs).
\494\ See SEC, Final Report of the Advisory Committee on Smaller
Public Companies to the U.S. Securities and Exchange Commission
(Apr. 23, 2006) at 73.
\495\ Researchers have developed a number of proxies that are
thought to be correlated with information asymmetry, including small
issuer size, lower analyst coverage, larger insider holdings, and
higher research and development costs. To the extent that EGCs
exhibit one or more of these properties, there may be a greater
degree of information asymmetry for EGCs than for the broader
population of companies, which increases the importance to investors
of the external audit to enhance the credibility of management
disclosures. See, e.g., Steven A. Dennis and Ian G. Sharpe, Firm
Size Dependence in the Determinants of Bank Term Loan Maturity, 32
Journal of Business Finance and Accounting 31 (2005); Michael J.
Brennan and Avanidhar Subrahmanyam, Investment Analysis and Price
Formation in Securities Markets, 38 Journal of Financial Economics
361 (1995); David Aboody and Baruch Lev, Information Asymmetry, R&D,
and Insider Gains, 55 Journal of Finance 2747 (2000); Raymond Chiang
and P. C. Venkatesh, Insider Holdings and Perceptions of Information
Asymmetry: A Note, 43 Journal of Finance 1041 (1988); and Molly
Mercer, How Do Investors Assess the Credibility of Management
Disclosures?, 18 Accounting Horizons 185 (2004).
\496\ PCAOB staff analysis indicates that, compared to exchange-
listed non-EGCs, exchange-listed EGCs are approximately 2.6 times as
likely to be audited by an NAF and approximately 1.3 times as likely
to be audited by a triennially inspected firm. Source: EGC White
Paper and S&P.
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However, two important caveats will limit the impact of the final
rules on EGCs. First, the vast majority of EGC engagements will not be
subject to the final engagement-level reporting requirements because an
EGC cannot be a large accelerated filer and few accelerated filers
maintain the EGC status.\497\ The Board believes these EGCs will
therefore not be impacted by the final engagement-level reporting
requirements. Second, approximately 23% of EGC engagements (712 out of
3,031) will not be included in any final firm-level reporting because
they are not audited by a firm that will be subject to the final firm-
level reporting requirements. The Board believes these EGCs will
therefore not be impacted by the final firm-level reporting
requirements.
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\497\ As of November 15, 2022, among the 2,562 EGCs for which
``accelerated filer'' status information is available, just 163
identified as accelerated filers. See EGC White Paper at 26.
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Overall, among the impacted EGCs, the final rules are expected to
enhance the quality of EGC audits and financial reporting quality.\498\
To the extent the final rules will improve EGCs' financial reporting
quality, it may also improve the efficiency of capital allocation,
lower the cost of capital, and enhance capital formation. For example,
investors may improve their capital allocation by more accurately
identifying EGCs with the strongest prospects for generating future
risk-adjusted returns and reallocating their capital accordingly.
Investors may also perceive less risk in the impacted EGC capital
markets generally, leading to an increase in the supply of capital to
the impacted EGCs. This may increase capital formation and reduce the
cost of capital to impacted EGCs. The final rules could reduce
competition in an EGC's product market if the indirect costs to audited
companies disproportionately impact EGCs relative to their competitors.
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\498\ See above for a discussion on the link between audit
quality and financial reporting quality.
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As discussed above, the Board considered broadening the
applicability of the final rules to include information from audits of
EGCs generally. However, for the reasons described there, the Board is
not doing so at this time. In particular, non-accelerated filer EGCs
may be disproportionately impacted by cost passthrough and tend to be
smaller than in-scope issuers. Comments related to this alternative are
discussed above. There were no comments related to the EGC analysis
specifically.
Accordingly, and for the reasons explained above, the Board
recommends that the Commission determine that it 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, to apply the final rules to audits of EGCs.

Appendix--Illustrative Examples of Metric Calculations

The examples below are based on hypothetical situations and have
been prepared for illustrative purposes only, to show how metrics would
be calculated based on the facts presented. They are not intended to
provide guidance or suggestions regarding what the numerical values of
the metrics themselves, or of the inputs on which they are based, are
likely to be or should be. They are qualified in their entirety by
reference to Rule 2203C, Firm Metrics, Rule 3211, Audit Participants
and Metrics, Form FM, Firm Metrics, and Form AP, Audit Participants and
Metrics.

I. Partner and Manager Involvement
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\499\ As noted in Form FM and Form AP, hours worked are the sum
of hours that are incurred on issuer and non-issuer engagements and
include hours spent on training, practice development, personnel
development, or other firm activities. Hours worked exclude hours
that are not considered working hours (e.g., paid time off and
holiday time).

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[[Page 100072]]

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II. Workload

[[Page 100073]]

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[[Page 100074]]

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[[Page 100075]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.007

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\500\ The number of weeks for the quarter ended March 1, 2024,
represents the number of weeks through the issuance of the audit
report.

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[[Page 100076]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.008

[[Page 100077]]

III. Training Hours for Audit Personnel ⁵⁰¹
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\501\ As noted in Form FM and Form AP, training metrics should
be calculated for the same 12-month period, either ended September
30, or based on the firm's training calendar.
[GRAPHIC] [TIFF OMITTED] TN11DE24.009

[[Page 100078]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.010

IV. Experience of Audit Personnel

[[Page 100079]]

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[[Page 100080]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.012

V. Industry Experience

[[Page 100081]]

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[[Page 100082]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.014

[[Page 100083]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.015

[[Page 100084]]

VI. Retention of Audit Personnel ^{502 503}
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\502\ As provided in the Note to Item 4.6 of Form FM, promotion
is treated as if it had occurred at the beginning of the period for
the calculation of retention of audit personnel metric.
\503\ As noted in Form FM, only partners and managers with one
or more years of service and who were employed continuously during
the 12-month period are included in the numerator.
[GRAPHIC] [TIFF OMITTED] TN11DE24.016

[[Page 100085]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.017

VII. Allocation of Audit Hours ⁵⁰⁴
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\504\ As noted in Form FM and Form AP, multi-year audits are
excluded from both the firm- and engagement-level calculations.

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[[Page 100087]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.019

VIII. Restatement History

[[Page 100088]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.020

[[Page 100089]]

[GRAPHIC] [TIFF OMITTED] TN11DE24.021

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-2024-06 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.

[[Page 100090]]

All submissions should refer to PCAOB-2024-06. 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-2024-06
and should be submitted on or before January 2, 2025.

For the Commission, by the Office of the Chief Accountant.\505\
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\505\ 17 CFR 200.30-11(b)(1) and (3).
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Vanessa A. Countryman,
Secretary.
[FR Doc. 2024-28142 Filed 12-10-24; 8:45 am]
BILLING CODE 8011-01-P

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