If you were to seek out one issue that even John Oliver would find too boring for an episode of Last Week Tonight, you might come up with the Public Company Accounting Oversight Board (PCAOB). It contains everything to deaden the soul: corporate financial audits, regulatory oversight, interagency appointments, the Sarbanes-Oxley Act.
Yet this obscure corner of the federal government has produced serious drama over the past couple of months. Whistleblowers have charged that board Chair William Duhnke, a former aide to Senator Richard Shelby (R-AL), has pushed out senior officials and retaliated against others. Republicans on the Securities and Exchange Commission, where the PCAOB is housed, dumped a Democrat off the five-member board in favor of a Trump White House staffer. The ousted Democrat, Kathleen Hamm, wasn’t told about the change until communications staff called her hours before the press release went out to confirm a resignation quote they wrote for her, sources told the Prospect.
Does any of this matter? Yes. The consequences of this chaos could encourage systemic corporate fraud and a collapse of confidence in the stock market. Simply put, PCAOB is the board you didn’t know you needed to know about.
BROUGHT INTO EXISTENCE by the aforementioned Sarbanes-Oxley Act in 2002, PCAOB was created as a quasi-public, quasi-private agency, monitoring what at the time seemed like a broken auditing industry. All publicly traded companies must submit financial records for independent review, and in the Enron era, those audits failed to catch (and in a few cases abetted) massive accounting fraud. “PCAOB was supposed to address two things: the underlying fraud in the system, and that the market no longer trusted the books of these companies,” says Graham Steele, who worked on PCAOB legislation in the Senate Banking Committee and now directs the Corporations and Society Initiative at Stanford Graduate School of Business.
Auditing is dominated by the Big Four accounting firms (Deloitte, KPMG, Ernst & Young, and PricewaterhouseCoopers), which inspect the books of 99 percent of all large companies in America. They also all consult for the same corporations, giving them incentives to keep companies happy while performing allegedly independent examinations. PCAOB was supposed to keep them honest through specialized scrutiny and enforcement. It’s self-funded through corporate fees.
The Securities and Exchange Commission must approve all PCAOB regulations, and chooses the five-member board. Unusually for the federal government, those members are paid competitively. The PCAOB chair is among the highest-paid government officials, at $672,676 per year, and other members get over half a million each. “It was supposed to be lucrative enough that you could get people used to a lifestyle to come in and act with integrity,” says Steele.
It didn’t really work out that way. A recent report from the Project on Government Oversight revealed that the Big Four have mismanaged 31 percent of all public-company audits surveyed since 2009. But that has translated into precious little enforcement—only 18 actions in the 16-year life span of the board, a little over one per year. Fines have totaled just $6.5 million, barely a blip next to the Big Four’s billions in annual revenue.
In 2017, problems with the board reached new heights. Partners at KPMG obtained confidential information from PCAOB staffers about upcoming annual inspections, and then revised audit work in response. A former PCAOB inspector was sentenced to nine months in prison over the scandal. Staffers at KPMG even cheated on internal ethics and integrity tests mandated by a previous enforcement action, sharing answers and manipulating the testing system to ensure they’d pass.
Trump’s SEC, led by Chair Jay Clayton, sanctioned KPMG (a $50 million penalty created hardly a dent), but more consequentially, it overhauled the oversight board.
The understanding at the time was that PCAOB members were granted new terms, but Clayton dumped all five at the end of 2017, including Chair James Doty, which may have been the plan all along.
Tom Williams/CQ Roll Call via AP Images
William Duhnke, seen in 2014 during his time as Republican staff director for the Senate Appropriations Committee
A former general counsel under George H.W. Bush and a lifelong accounting executive, Doty had proved more committed to oversight than anyone expected, pushing rules and increased inspections that rankled the Chamber of Commerce, among others. In particular, he’d wanted individual auditors to sign their names to audit reports, so they would be held accountable if the audit proved incorrect. Because of an industry-friendly Democrat’s presence on the committee, many of these ideas were stifled. Big business had wanted to get rid of Doty since at least 2015; Democrats on the SEC supported him, allowing him to stick around. But the “steal the exam” scandal gave Clayton the opportunity to toss out this thorn in the side of the industry.
Shelby, Duhnke’s boss for two decades, had openly tapped him to run PCAOB for years, despite a relatively thin record on financial issues. Duhnke came out of naval intelligence, and had initially signed up with Shelby to work on the Senate Intelligence Committee. His tenure there included suspicions of leaking classified information and mass retaliatory firings of subordinates, matching a reputation earned on the Hill as mean and vindictive.
Duhnke followed Shelby around to the Appropriations, Banking, and Rules Committees. His loyalty got him onto the PCAOB, as the high salaries intended to entice talented accounting professionals and resist the revolving door instead became a well-paid reward for longtime staffers.
In particular, Shelby’s office has become a prime placement agency for financial regulatory staff; veterans of the office are referred to as the “Shelby mafia.” The chairs of the Federal Housing Finance Agency and Federal Deposit Insurance Corporation are Shelby graduates, as are two members of the SEC, Hester Peirce and Elad Roisman. Perhaps most important, Andrew Olmem, the White House official responsible for vetting banking regulator nominees, is a former Shelby chief counsel. If Clayton wants good candidates for the SEC, he has to rely on a Shelby mafia member, and if he wants votes on his initiatives, the other two Republicans on the commission are Shelby mafia as well. “They’ve got him surrounded,” says Steele.
Almost immediately, Duhnke’s arrival at PCAOB led to clashes. Several top officials left, including the director of inspections, the head of enforcement, and the general counsel. The latter two positions have been unfilled for 16 months, and 50 other positions are vacant. What hires have been accomplished include a series of Shelby mafia types. Torrie Miller Matous, spokeswoman for the board, served with Duhnke in Shelby’s office. Shelby’s own granddaughter, Anna Shelby, was hired fresh out of the University of Alabama this year as a project coordinator.
The former staff members got an extra six months of compensation in exchange for signing non-disparagement agreements, amid claims that some of those firings were retaliatory in nature. A one-page whistleblower complaint, submitted in May by current and former employees, described a “sense of fear” at the agency. During this time, the actual work of inspecting auditing firms has dwindled: Inspector reports are down 27 percent in 2019, and required public meetings have not been held.
Duhnke has said on the record that he wants to spend as much time discussing the “successes” in public-company audits as the failures.
Hiring at the agency is supposed to be collaborative, with input among all five board members. Duhnke and Kathleen Hamm reportedly have fought over incoming hires and other policy disagreements, which may have led to her ouster.
THE FIVE-MEMBER PCAOB BOARD is supposed to have three members of the president’s party and two members of the opposition party. The commissioners of the SEC can recommend candidates for their party’s positions on the board. When commissioners cannot agree, the current board member stays in place. That’s how James Doty hung on for so long.
But in Kathleen Hamm’s case, she was told in September she would have to re-apply for her job. The SEC even posted a listing for the position over the summer. Sources requesting anonymity to speak freely about the situation say that Hamm was targeted with what they described as several unfair allegations.
Philip Toscano/Press Association via AP Images
Ernst & Young’s offices in London. A recent Project on Government Oversight report revealed that the Big Four accounting firms have mismanaged 31 percent of all public-company audits surveyed since 2009.
Because Allison Lee, one of two Democrats on the SEC, had to recuse herself from PCAOB issues—Lee’s husband, J. Robert Brown, is a board member—the remaining Democrat on the commission, Rob Jackson, had control of recommending Democratic replacements. According to the sources, he asked a couple dozen people to apply for the job, while also making clear that Hamm should be spared from removal. This was described to the Prospect as Jackson “going to war” for Hamm.
In the end, the memo that went to Clayton’s office had only two options: Hamm, and Rebekah Goshorn Jurata, who was serving under Andrew Olmem in the Trump White House. Jackson questioned why only two names appeared, but to no avail. Picking Jurata would represent a breach of past practice, giving a Democratic seat to a Republican despite the wishes of a Democratic commissioner.
Clayton could have just sat on the memo, allowing Hamm to continue to serve. But on October 11, the SEC announced that Jurata would take over. Jackson, the sources say, got a note that Jurata had the three SEC commissioner votes she needed to get the job—Clayton, and the other two Republican commissioners, Peirce and Roisman. Hamm didn’t get a call from anyone but Jackson in the aftermath, just the call from the press office to confirm her resignation quote. With Jackson set to leave the SEC soon, some have speculated that his Republican counterparts didn’t have to respect his position, though they did have the votes to work their will even if Jackson was staying on.
Jurata, in her thirties, lacks direct experience with the auditing process; she’s mostly been a political operative. She now gets a half-million-per-year salary as a reward for her politicking, with the PCAOB serving as a layover spot to make money before rotating elsewhere in government. Though it’s an industry regulator, it now functions as the kind of private-industry revolving-door payoff to which government officials and regulators flee for the big bucks.
The Jurata pick revealed another string-puller pushing personnel decisions behind the scenes at the SEC: former Commissioner Dan Gallagher. Jurata had served as a counsel to Gallagher, as was current SEC Commissioner Roisman. Fellow GOP Commissioner Peirce was counsel to SEC Commissioner Paul Atkins, at the same time as Dan Gallagher.
Other current PCAOB board members include James Kaiser, a 38-year lifer from PricewaterhouseCoopers, Duane DesParte, who served at now-defunct Arthur Andersen and Deloitte before becoming in-house accountant at energy giant Exelon, and Brown. Jurata officially started last Thursday.
The press release announcing Jurata’s appointment also noted that Peirce would serve as the SEC’s liaison to coordinate efforts with the PCAOB. Sarbanes-Oxley rules state that the entire SEC has oversight authority for the board, not one member. Peirce is famously anti-regulatory, and having previously worked with Duhnke in Shelby’s office, would almost certainly roll back pressure on auditing firms even more. Without Hamm to resist those rollbacks, they can continue unimpeded, discarding the agency’s mission and diminishing its independence in favor of ideological aims.
The implications of these changes are profound. “The PCAOB’s institutional independence and resilience is crucial for the ordinary American families who rely on financial statements to reflect the truth about the companies they own,” Commissioner Jackson said in a statement to the Prospect. A hands-off attitude toward financial accounting could herald a return to the bad old days of the 2000s, when nobody could be confident in the underlying strength of public companies. The mess at WeWork, whose valuation has plummeted several-fold since the moment it sought to go public, shows how a laissez-faire attitude toward accounting standards can backfire spectacularly.
“Even the Bush administration took the Enron collapse seriously,” says David Segal of Demand Progress Education Fund, which has been following the situation closely. “But as Trump and Senate and SEC Republicans turn the PCAOB into a sinecure for well-connected corporatists, it is adopting the spirit of the companies whose self-dealing it is supposed to police.
THE CARNAGE AT PCAOB has gotten plenty of attention on the Hill. Senators Sherrod Brown (D-OH) and Jack Reed (D-RI), both senior members of the Senate Banking Committee, wrote a letter to Clayton, decrying the “questionable judgment and an alarming lack of transparency” around the whistleblower complaint. Brown and Reed raised questions about Peirce’s unusual coordinator role, given her connection to Duhnke.
For its part, the SEC announced that former Chair Harvey Pitt would conduct an investigation into PCAOB’s corporate governance, which Brown and Reed viewed skeptically. Pitt selected the initial PCAOB chair, former FBI and CIA Director William Webster, and had to quickly reverse that decision, because Webster had run the audit committee for a company accused of accounting fraud. “Mr. Pitt’s brief tenure as Chair of the SEC was marred by controversies,” Brown and Reed wrote. “Selecting Mr. Pitt to undertake this review seems unwise.” The senators asked Clayton to reconsider the Pitt selection, as well as other questions they wanted answers to this week. There’s no timeline for the Pitt investigation.
The SEC did not respond to a request for comment. The PCAOB similarly declined to comment.
Arthur Levitt, another former SEC chair, went public with his concerns about PCAOB in The New York Times last week, saying that the situation “should alarm the investing public and anyone who cares about objective and experienced oversight of the audit profession.” He added, “Members of the auditing profession would love nothing more than to see their PCAOB audit quality inspections get a little softer and more deferential.”
There is a remedy to this down the road. The Supreme Court has ruled that the SEC can remove PCAOB members at any time. If the presidency changes hands in 2020, and subsequently the balance of power on the SEC, you can probably expect big changes at PCAOB, bringing the board back in line with its mission of protecting investors from accounting fraud.
UPDATE: In a lengthy statement, PCAOB spokeswoman Torrie Miller Matous defended the board’s work over the past year. “The number of inspections we conduct remains consistent with prior years,” she wrote, adding that the report’s format is changing to a more “user-friendly” model, based on discussions with stakeholders. Chair Duhnke “has worked to reach consensus with the board” on personnel matters, Miller Matous stated, adding that the head of enforcement should be filled soon. Regarding the lack of fines, Miller Matous said that the Sarbanes-Oxley Act did not require PCAOB to enact disciplinary sanctions in all instances of non-compliance. “Through our public reporting of findings in accordance with the Act, our inspections program gives firms a strong incentive to comply with applicable laws and professional standards,” she wrote, adding that the board has “finite resources” for enforcement.
