Tuesday, November 14, 2006

Inquiring Minds


If your eyes glaze over at the sight of so many acronyms, I sympathize. However, there is one in the group that merits attention from every investor. PCAOB stands for
Public Company Accounting Oversight Board. The Wall Street Journal recently reported that they are behind in their work.

The PCAOB was set up under the Sarbanes-Oxley (SOX) legislation passed in 2002. The private, non-profit organization was set up to oversee auditors of public companies. This is an important element of the reforms envisioned by Congress in passing SOX. The PCAOB is charged with inspecting audit firms which audit public companies to assess performance. Firms which perform more than 100 public companies audits per year at to get inspected every year themselves and the rest get an inspection once every three years.

Inspections culminate in a written report for use by companies in deciding which auditor to hire and by the rest of us in evaluating the integrity of the audited financials. This is the data upon which we rely to make investment choices. Investors in small companies may be more dependent than others upon the financial audit as well as the annual review of internal controls. Overall there are fewer other professionals visiting with management, touring corporate offices and facilities and otherwise turning over the rocks that would reveal problems.

We did our own inspection and found the PCOAB has issued approximately 170 such reports so far in 2006, up from 160 in the entire year 2005.

What caught the attention of reporters at the Wall Street Journal, and ours, is that the reports on the Big Four appear to be getting stale. The
PCAOB Inspection Reports on Deloitte & Touche and PriceWaterhouseCoopers were published in November 2005, but the report on KPMG and Ernst & Young appear to be past due as the last one came out in September and October last year. The inspection of KPMB, for example, was completed in the five months between June 2004 and October 2004 and took an entire year to reach the light of day. No doubt inspections of small audit firms are also dated.

Here is the real irritation. Portions of those reports issued in 2005 have not been made public - the negative portions! The PCAOB gives the audit firms the benefit of the doubt on those areas that were subjects of criticism if the audit firm promises to address those matters in the next year. So the question is: was the audit firm successful with the remedy? If not, what is the PCAOB going to do about it.

For example, the last review of KPMG was on work completed by that firm two years ago. What does a deficiency mean for the integrity of the audits completed by KPMG since then?

Inquiring minds want to know!

No comments: