PCAOB Report On Auditing Deficiencies Shows “Leveling Off” … But Still Shocking Percentages Of Failed Audits.

WILL BAD AUDITOR GRADES SPILL OVER TO YOUR AGM? PREPARE NOW, WE SAY

We were greatly encouraged by remarks from the recently reorganized PCAOB board leadership promising much greater scrutiny of public company auditors and a much stronger focus on the number of audit failures at the top-four U.S. firms. But the latest report, on their studies of 2022 financial statements, where a Wall Street Journal article headed “Big Four Auditing Deficiencies Level Off in Latest Inspections” – seems to us to be a total whitewashing of the actual results.

For starters, the article noted that the 2022 study covered 230 audits conducted by the big four – up a mere 7% from the year earlier, and a mere 6% of the 3500 “investment worthy” companies out there – and with no information at all as to the composition of the companies studied in terms of how they were selected, or their market caps, or what percentage were “investment grade” or even “listed companies” – so pretty useless info, we’d say, from a “statistical” point of view.

Then the reporter noted that “The firms collectively had an average deficiency rate of about 26%” (a quarter of all the audits studied!) but “the same as a year earlier.” But THEN, the reporter noted, “The big four averaged a rate of 20% over the previous five years” so the “leveling off” over two years was considerably worse than the average failure rate over five years!

And when the reporter got down to the details, the actual results were truly startling: Deloitte’s and PWC’s U.S. Units had rates of 21% and 18% - but UP from 17% and 9% a year earlier! A DOUBLING of PWC’s failure rate! EY had a whopping 37% deficiency rate – “down from 46% the year before” but still horrendous - while “KPMG’s rate fell to 26% from 30%.” What kind of “leveling off” is THIS?

The news from the two major global accounting firms was absolutely horrific: Grant Thornton, with a 54% failure rate went up from 21% and BDO came in with an 86% failure rate – up from 66% the year earlier – and scarier yet, these results were based on a mere 57 audits studied, with the demographics of the subject companies - and the size of their customer bases - basically unknown.

We are absolutely convinced that numbers like these indicate a situation that can’t be allowed to continue – and that, inevitably, investors will catch on here and demand changes. We DO note slightly larger Votes-No where the worst offending firms are up for shareholder “ratification” or when the auditor recently served at one or more high-profile audit failures – and we ourselves no longer check the Yes Box automatically. And, as we have written here before, we no longer think that a reasonable person would or should consider the appointment of outside auditors – particularly those with high failure rates in the PCAOB studies - to be a “routine matter.”

In any event, we believe that smart companies – and smart boards – should better prepare themselves to ask better, and more deeply-probing questions of their outside auditors – and should prepare themselves for better and more probing questions from investors too. The smartest of the smart will, we think, be very wise to be much more transparent about these matters in their Proxy Materials as well.