Striking the Right Balance on NOCLAR

A recent proposal from the Public Company Accounting Oversight Board (PCAOB) warrants a review. The proposal, Amendments to PCAOB Auditing Standards related to a Company’s Noncompliance with Laws and Regulations and Other Related Amendments (NOCLAR for short), has admirable objectives but is concerning in its current form.

The proposal is framed as intending to modernize and strengthen auditing standards related to the auditor’s consideration of a company’s noncompliance with laws and regulations, including fraud, that has or may have occurred by improving the auditor’s identification, evaluation, and communication requirements. At first glance, this may seem practical, but the language of the proposal is a dramatic expansion of the auditor's scope of work and will result in a substantial increase in the cost of the audit. The only two certified public accountants on the PCAOB objected to the proposal, with member Christina Ho stating the proposed standard is “a breathtaking expansion of the auditors’ responsibilities, which I believe will hurt investors.”

Existing standards focus audit efforts on those laws and regulations that have a direct and material effect on the determination of financial statement amounts. The proposed standard would expand the auditor’s requirement to identify those laws and regulations where noncompliance "could reasonably have a material effect" on the company’s financial statements. To do this in practical terms, auditors would need to identify every law and regulation applicable to a company and make a determination about its potential impact on the financial statements. A multinational business subject to US Securities and Exchange Commission filing requirements can be subjected to hundreds of new laws each year.

The proposal would expand the auditor’s role to require skills, knowledge, and expertise that likely lie outside the auditor’s core competencies and expertise. Additionally, management will likely need to design and implement controls over compliance and enable access for the external auditor to the information gathered.

As a result of the expansive scope, if the rule was adopted as proposed it could have the unintended consequence of distracting the auditor from material audit issues, among other potential consequences. As this proposal and others evolve, audit committee members should consider the following to make sure that their voices are heard in these important rulemakings:

• Familiarize yourself with the PCAOB’s proposals. If you have not already, be sure to check out the PCAOB’s recent proposals aimed at modernizing the role of the auditor. You can also sign up for PCAOB updates here.
• Make your voice heard. If you agree with these concerns, it’s important to share your point of view. You can submit a comment to the PCAOB or join the effort of others to comment. In response to requests from stakeholders, the Center for Audit Quality is coordinating a sign-on letter for individual audit committee members to join. You can learn more about our campaign and sign the letter here.

As an audit committee member, you play a vital role in our financial reporting ecosystem. Therefore, the views and opinions of audit committees should not be missing from the PCAOB’s current and future proposals. I offer the above tips to help you think about how you can activate your audit committee and get engaged in these critical discussions.

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