The Big Four accounting firm Deloitte & Touche LLP took a beating in the news media last week after its regulator unsealed a confidential portion of an inspection report about its audit work. Articles focused on the parade of horribles found with Deloitte’s quality controls.
There was another important story, however, that the Public Company Accounting Oversight Board kept hidden: Three of its five board members had recused themselves from participating in meetings or discussions this year concerning Deloitte, because of past or current ties to the firm, according to three people with knowledge of the matter.
The board members -- Lewis Ferguson, Jay Hanson and the board’s chairman, James Doty -- were appointed by the Securities and Exchange Commission in January. Doty had been a partner at the law firm Baker Botts LLP, where Deloitte is a client. Ferguson was a partner at the law firm Gibson Dunn & Crutcher LLP, which also represents Deloitte. Hanson, a former partner at the accounting firm McGladrey & Pullen LLP, has a daughter who works for Deloitte in its Phoenix office.
The board’s policy is to not disclose recusals, in spite of its mission to “further the public interest,” as if these are none of the public’s business. “Recusals are confidential,” Colleen Brennan, a board spokeswoman, said. Doty, Ferguson and Hanson declined to comment. A Deloitte spokesman, Jonathan Gandal, said: “The PCAOB itself does not comment on recusals, and as such it would be inappropriate for us to do so.”
You have to wonder how good a job this board can do when a majority of its members can’t make decisions about one of the largest firms it oversees. No agency’s ties to the industry it regulates should run this deep. Yet this is where things stand, thanks to the SEC’s latest appointments.
The accounting board won’t answer even basic questions about its recusal policies. For example: Is Hanson prohibited from weighing in on inspections or investigations of Deloitte’s major competitors? The ethics code posted on the board’s website provides no guidance.
This isn’t only a Deloitte problem. On its website, Baker Botts says it also represents Big Four auditor Ernst & Young LLP and Grant Thornton LLP. Gibson Dunn counts all four Big Four firms as clients, including PricewaterhouseCoopers LLP and KPMG LLP. The board won’t say if Doty or Ferguson has been disqualified from any matters as a result.
And talk about being wired: The SEC’s chief accountant, James Kroeker, is a Deloitte alumnus. At the Financial Accounting Standards Board, which writes U.S. accounting rules, the wife of one board member, Russell Golden, is a Deloitte partner.
Other Big Four firms have had similar kinds of links over the years. (One former oversight board member, Kayla Gillan, became SEC Chairman Mary Schapiro’s deputy chief of staff in 2009, then quit this year to join PricewaterhouseCoopers’ “regulatory relations” group.) It’s something special, though, when a single firm can knock out most of its chief regulator’s board. In that respect even the bankers at Government Sachs, aka Goldman Sachs Group Inc., would have reason to envy the auditors at DeFeds & Touche.
The oversight board was created by the Sarbanes-Oxley Act in 2002 as a private-sector arm of the government, subject to SEC oversight. Last week marked the first time it released a copy of a report on a Big Four auditor’s quality controls. By statute, those sections must stay confidential for at least a year, to give firms time to show the board they’re making ample progress on fixing major problems.
The board’s inspectors did their work in 2007. Their May 2008 report cited deficiencies in 27 of the 61 audits they reviewed. Quality-control problems included “a firm culture that allows, or tolerates, audit approaches that do not consistently emphasize the need for an appropriate level of critical analysis and collection of objective evidence, and that rely largely on management representations.” In nine instances, the inspectors said Deloitte had failed to obtain sufficient evidence to support its audit opinions.
The board didn’t name any clients, in keeping with its usual practice. Nor did the agency explain why it took 41 months to disclose the once-secret evaluation. The timeline suggests the board first voted to publish the confidential portion sometime before the three new members joined this year; presumably Deloitte appealed to the SEC, delaying the report’s release.
At least with the SEC, we sometimes know when officials there have recused themselves. Schapiro in 2009 signed a two-year pledge to stay out of matters involving the Financial Industry Regulatory Authority, where she had been chief executive officer. Likewise, when Harvey Pitt became SEC chairman in 2001, he released a list of 112 former clients from his old law firm and promised to sit out votes for one year on any cases related to them. The accounting board’s members make no such disclosures.
Under the board’s ethics code, Doty and Ferguson would be allowed to vote on matters involving former clients starting in January, once they’ve been at the board for a year. Meanwhile, there’s an open seat to replace departing board member Daniel Goelzer. Surely the SEC could find a qualified person without Big Four allegiances to fill his slot, if it wants to. As for the board’s other members, here’s a modest proposal: Come clean.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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