Notice2024-18984
Public Company Accounting Oversight Board; Order Granting Approval of Amendment to PCAOB Rule 3502 Governing Contributory Liability
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
August 23, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
<html>
<head>
<title>Federal Register, Volume 89 Issue 164 (Friday, August 23, 2024)</title>
</head>
<body><pre>
[Federal Register Volume 89, Number 164 (Friday, August 23, 2024)]
[Notices]
[Pages 68223-68225]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-18984]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-100772; File No. PCAOB-2024-04]
Public Company Accounting Oversight Board; Order Granting
Approval of Amendment to PCAOB Rule 3502 Governing Contributory
Liability
August 20, 2024.
I. Introduction
On June 20, 2024, the Public Company Accounting Oversight Board
(the ``Board'' or the ``PCAOB'') filed with the Securities and Exchange
Commission (the ``Commission''), pursuant to section 107(b) \1\ of the
Sarbanes-Oxley Act of 2002 (``SOX'') and section 19(b) \2\ of the
Securities Exchange Act of 1934 (the ``Exchange Act''), a proposal to
adopt an amendment to PCAOB Rule 3502, Responsibility Not to Knowingly
or Recklessly Contribute to Violations, the Board's ethics rule
governing the liability of associated persons who directly and
substantially contribute to a registered public accounting firm's
primary violation (the ``Amendment''). The Amendment was published for
comment in the Federal Register on July 2, 2024.\3\ The Commission
received one comment letter in response to the Notice of Filing of
Proposed Rules.\4\ This order approves the Amendment, which we find to
be consistent with the requirements of Title I of SOX and the rules and
regulations thereunder and is necessary or appropriate in the public
interest or for the protection of investors.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 7217(b).
\2\ 15 U.S.C. 78s(b).
\3\ See Public Company Accounting Oversight Board; Notice of
Filing of Proposed Rules on Amendment to PCAOB Rule 3502 Governing
Contributory Liability, Release No. 34-100429 (June 26, 2024 [89 FR
54895 (July 2, 2024)] (``Notice of Filing of Proposed Rules''),
available at <a href="https://www.sec.gov/files/rules/pcaob/2024/34-100429.pdf">https://www.sec.gov/files/rules/pcaob/2024/34-100429.pdf</a>.
\4\ The Commission received a comment letter from the
Pennsylvania Institute of Certified Public Accountants (July 22,
2024). This comment letter is available on the Commission's website
at <a href="https://www.sec.gov/comments/pcaob-2024-04/pcaob202404.htm">https://www.sec.gov/comments/pcaob-2024-04/pcaob202404.htm</a>.
---------------------------------------------------------------------------
II. Description of the Amendment
Existing PCAOB Rule 3502 codifies associated persons' ethical
obligation not to contribute to a registered firm's violations of the
laws, rules, and standards that the Board is charged with enforcing.\5\
The rule provides grounds for secondary liability when an associated
person of a registered firm acts at least recklessly to directly and
substantially contribute to such a violation. On June 12, 2024, the
Board unanimously adopted the Amendment,\6\ which changes from
recklessness to negligence the liability standard for actionable
contributory conduct by associated persons under Rule 3502. Whereas
negligence is ``the failure to exercise reasonable care or
competence,'' \7\ recklessness requires ``extreme departure from the
standard of ordinary care'' that ``presents a danger to investors or to
the markets that is either known to the (actor) or is so obvious that
the actor must have been aware of it.'' \8\
---------------------------------------------------------------------------
\5\ Section 103(a) of SOX directs the Board, by rule, to
establish ``ethics standards . . . to be used by registered public
accounting firms in the preparation and issuance of audit reports,
as required by [SOX] or the rules of the Commission, or as may be
necessary or appropriate in the public interest or for the
protection of investors.''
\6\ See Amendment to PCAOB Rule 3502 Governing Contributory
Liability, PCAOB Release No. 2024-008 (June 12, 2024) (``Adopting
Release''), available at <a href="https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/053/2024-008-rule-3502-adoption.pdf?sfvrsn=9819bcd3_2">https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/053/2024-008-rule-3502-adoption.pdf?sfvrsn=9819bcd3_2</a>.
\7\ In re S.W. Hatfield, C.P.A., SEC Release No. 34-69930, at 35
n.169 (July 3, 2013) (describing the standards for recklessness and
negligence) (citation and quotation marks omitted).
\8\ Id. at 29 (citation and quotation marks omitted).
---------------------------------------------------------------------------
Following notice and comment, and based on its experience with Rule
3502 since the Commission approved the ethics rule in 2006,\9\ the
PCAOB determined that the Amendment would better align Rule 3502 with
the scope of the PCAOB's enforcement authority under SOX, thus further
advancing the PCAOB's mission of investor protection.
---------------------------------------------------------------------------
\9\ See Public Company Accounting Oversight Board; Order
Approving Proposed Ethics and Independence Rules Concerning
Independence, Tax Services, and Contingent Fees and Notice of Filing
and Order Granting Accelerated Approval of the Amendment Delaying
Implementation of Certain of these Rules, Release No. 34-53677 (Apr.
19, 2006), available at <a href="https://www.sec.gov/files/rules/pcaob/2006/34-53677.pdf">https://www.sec.gov/files/rules/pcaob/2006/34-53677.pdf</a>.
---------------------------------------------------------------------------
The PCAOB determined that under the current formulation of Rule
3502, an incongruity exists between the respective requisite mental
states for liability of a registered firm resulting from an associated
person's conduct and for liability of the associated person.
Specifically, a firm, which acts through its associated persons, can
commit a primary violation of certain laws, rules, or standards by
acting negligently, but an associated person who directly and
substantially contributed to that violation must have acted at least
recklessly to be secondarily liable. The PCAOB determined that this
incongruity means that associated persons may have weaker incentives to
exercise the appropriate level of care in their audit work, and that
the modification to Rule 3502's liability standard from recklessness to
negligence would incentivize associated persons to be more deliberate
and careful in their actions.
The PCAOB also determined that the current version of Rule 3502
prevents the Board from executing its investor-protection mandate to
the fullest extent that Congress authorized in SOX. According to the
PCAOB, in the instances in which the Board has instituted proceedings
against firms for negligence-based violations, the Board has not been
able to charge individuals who negligently, directly, and substantially
contributed to the firms' violations. The Amendment would allow the
Board to do so.
[[Page 68224]]
III. Effective Date
The Amendment will be effective 60 days from the date of this
order.
IV. Comment Letters
The comment period on the Amendment ended on July 23, 2024. The
Commission received one comment letter.\10\ That comment letter
reiterated comments that had been submitted to the PCAOB on its
proposing release and that were addressed by the Board in its Adopting
Release. The commenter questioned whether the PCAOB had legal authority
for the Amendment, and was generally critical about the need for the
Amendment and the economic and investor-protection rationales put forth
by the Board. For example, the commenter argued that any benefit from
additional enforcement actions does not justify the costs, potential
negative effects on the talent pool, and anticompetitive outcomes, and
urged the Commission to conduct a comprehensive impact assessment of
the Amendment on the accounting and auditing sectors. The commenter
also argued that the Amendment may cause some firms to exit the market
for audit services and result in greater market concentration for
auditors.
---------------------------------------------------------------------------
\10\ See supra note 4.
---------------------------------------------------------------------------
We have considered the concerns raised by the commenter, all of
which were considered by the Board prior to finalizing the Amendment,
and believe that the Amendment is consistent with the requirements of
Title I of SOX and the rules and regulations thereunder and necessary
or appropriate in the public interest or for the protection of
investors.
With respect to the Board's authority, in its 2006 order approving
Rule 3502, the Commission stated that ``the rule is within the scope of
the PCAOB's authority, particularly its authority to establish ethical
standards.'' \11\ The Amendment, which changes the standard for
actionable contributory conduct but not the rule's basic ethical
obligation, does not alter that conclusion. Section 103(a)(1) of SOX
expressly authorizes the Board to establish or adopt ethics standards
to be used by registered public accounting firms in the preparation and
issuance of audit reports. As the Board observed when proposing the
existing rule, an associated person has an ethical obligation not to
cause any violations by the firm, and Rule 3502 codifies that
obligation.\12\ We view that obligation as fundamental given that a
firm can only act through its associated persons and believe that it is
reasonable to conclude, as the Board did, that such an obligation
should extend to situations in which an associated person fails to
exercise sufficient care to avoid negligently causing a violation
rather than being limited to reckless conduct. In this regard, we note
that a contributory liability rule based on negligence is consistent
with other longstanding ethical obligations that apply to associated
persons when conducting audits.\13\
---------------------------------------------------------------------------
\11\ See supra note 9 at 9.
\12\ See Proposed Ethics and Independence Rules Concerning
Independence, Tax Services, and Contingent Fees, PCAOB Release 2004-
015 (Dec. 14, 2004) at 18, available at <a href="https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/docket017/2004-12-14_release_2004-015.pdf?sfvrsn=b15567fb_0">https://assets.pcaobus.org/pcaob-dev/docs/default-source/rulemaking/docket017/2004-12-14_release_2004-015.pdf?sfvrsn=b15567fb_0</a>.
\13\ Indeed, the American Institute of Certified Public
Accountants (``AICPA'') Code of Professional Conduct at the time
that SOX was enacted (and still today) makes it an ``act
discreditable to the profession''--and therefore a violation of its
ethics rules--for a member accountant to ``permit[ ] or direct[ ]
another to make[ ] materially false and misleading entries in the
financial statements or records of an entity'' ``by virtue of his or
her negligence.'' AICPA Code of Professional Conduct, ET Section
501.05(a), Negligence in the Preparation of Financial Statements or
Records, recodified at Section 1.400.040.01. That is also the case
if a member were to ``permit[ ] or direct[ ] another to sign[ ] a
document containing materially false and misleading information''
``by virtue of his or her negligence.'' Id. Section 501.05(c).
---------------------------------------------------------------------------
In addition, section 105 of SOX permits the Board to impose
liability for single acts of negligence. Specifically, section
105(c)(4) authorizes the Board to impose an array of sanctions--listed
in subparagraphs (A) through (G)--upon finding that a registered firm
or associated person engaged in violative conduct, without reference to
the level of culpability required but ``subject to applicable
limitations'' in section 105(c)(5). Section 105(c)(5), in turn,
provides that ``[t]he sanctions and penalties described in
subparagraphs (A) through (C) and (D)(ii) of [Section 105(c)(4)] shall
only apply to [ ] intentional or knowing conduct, including reckless
conduct,'' or ``repeated instances of negligent conduct each resulting
in a violation of the applicable statutory, regulatory, or professional
standard.'' Section 105(c)(5) thus does not restrict the Board's
authority to impose for single acts of negligence certain sanctions--
those in subparagraphs (D)(i) and (E) through (G) of section 105(c)(4).
With respect to the Amendment's potential adverse effects, we
acknowledge (as the PCAOB did) that the Amendment could result in some
incremental legal costs and operational adjustments for firms,
individuals, and issuers. However, for the reasons discussed below, we
agree with the Board's conclusion that any unintended consequences of
the Amendments are likely to be limited and that, on balance, the
Amendment will enhance audit quality, not diminish it, for the benefit
of investors.\14\
---------------------------------------------------------------------------
\14\ See Adopting Release, supra note 6 at 57-63.
---------------------------------------------------------------------------
As a threshold matter, the Amendment does not establish a novel
burden on individuals to refrain from acting negligently and thereby
contributing to a firm's violation: the Commission already has the
ability to bring cases against associated persons for negligently
contributing to registered firms' violations of numerous laws and rules
governing the preparation and issuance of audit reports.\15\ Rather,
the Amendment merely provides a mechanism for the PCAOB to discipline
individuals who fail to act reasonably. And while we appreciate that
complex audit engagements can involve a wide range of judgments, we
concur with the Board's observation from the Adopting Release that the
Amendment does not target mere errors in judgment, but rather
unreasonable conduct.\16\ With respect to market concentration,
although the Amendment could lead some firms to exit the issuer audit
market, it is unclear that this effect would necessarily detract from
the provision of associated persons' services. For example, such exit
might involve low-quality auditors and lead to a higher concentration
of more capable and compliant audit firms. At the same time, the
Amendment is likely to result in significant benefits in the form of
more efficient enforcement, while encouraging individuals to exercise
the appropriate level of care, thereby raising audit quality.
---------------------------------------------------------------------------
\15\ Section 21C of the Exchange Act authorizes the Commission
to institute cease-and-desist proceedings against any ``person that
is, was, or would be a cause of [a] violation [of the Exchange Act
or any rule or regulation thereunder], due to an act or omission the
person knew or should have known would contribute to such
violation,'' and Section 21B further authorizes the Commission to
``impose a civil penalty'' upon finding that such person ``is or was
a cause of [such] violation.''
\16\ See Adopting Release, supra note 6 at 10.
---------------------------------------------------------------------------
SOX requires us to determine whether the Amendment is consistent
with the requirements of Title I of SOX and the rules and regulations
thereunder and is necessary or appropriate in the public interest or
for the protection of investors. In making this determination, we have
considered the comments received, as well as the feedback received and
modifications made by the PCAOB throughout its rulemaking process.
[[Page 68225]]
V. Effect on Emerging Growth Companies
Section 103(a)(3)(C) of SOX, as amended by section 104 of the
Jumpstart Our Business Startups Act of 2012, requires that any rules of
the Board requiring mandatory audit firm rotation or a supplement to
the auditor's report in which the auditor would be required to provide
additional information about the audit and the financial statements of
the issuer (auditor discussion and analysis) shall not apply to an
audit of an emerging growth company (``EGC'').\17\ Section 103(a)(3)(C)
further provides that ``[a]ny additional rules'' adopted by the PCAOB
do not apply to audits of EGCs ``unless the Commission determines that
the application of such additional requirements is necessary or
appropriate in the public interest, after considering the protection of
investors and whether the action will promote efficiency, competition,
and capital formation.''
---------------------------------------------------------------------------
\17\ The term ``emerging growth company'' is defined in Section
3(a)(80) of the Exchange Act (15 U.S.C. 78c(a)(80)). See also
Inflation Adjustments under Titles I and III of the JOBS Act,
Release No. 33-11098 (Sept. 9, 2022) [87 FR 57394 (Sept. 20, 2022)],
available at <a href="https://www.sec.gov/files/rules/final/2022/33-11098.pdf">https://www.sec.gov/files/rules/final/2022/33-11098.pdf</a>.
---------------------------------------------------------------------------
The Board expressed its view that section 103(a)(3)(C) does not
apply to the Amendment because the provisions of the Amendment do not
fall into those categories and do not impose additional requirements on
the audits of EGCs.\18\ To the extent that section 103(a)(3)(C) does
apply, however, the Board recommended that the Commission determine
that the Amendment apply to audits of EGCs.\19\
---------------------------------------------------------------------------
\18\ See Adopting Release, supra note 6 at 66-68.
\19\ Id.
---------------------------------------------------------------------------
With respect to the Commission's determination of whether the
Amendment will apply to audits of EGCs, the PCAOB provided information,
including data and analysis of EGCs, that sets forth its views as to
why it believes the Amendment should apply to audits of EGCs.\20\ In
addition, the Board sought public input on the application of the
Amendment to the audits of EGCs. Some commenters agreed the Amendment
should apply to the audits of EGCs, although one commenter suggested
that the Amendment would have a greater impact on smaller firms with
fewer resources to defend personnel and navigate an uncertain liability
environment.\21\
---------------------------------------------------------------------------
\20\ Id.
\21\ Id. at 67-68.
---------------------------------------------------------------------------
We agree with the Board's assessment and believe that applying the
Amendment to the audits of EGCs is necessary or appropriate in the
public interest, after considering the protection of investors and
whether the Amendment will promote efficiency, competition, and capital
formation. Specifically, by applying the Amendment to all associated
persons of registered public accounting firms engaged in the audits of
issuers and registered broker-dealers, including audits of EGCs,
investors will benefit from higher standards of audit quality and
enhancements to investor protection brought about by the Amendment.
Because EGCs are likely to be newer public companies, investors may
place greater importance on external audits' adherence to applicable
audit standards, in order to enhance and test the credibility of
management disclosures, including whether financial statements are free
from material misstatement due to error or fraud. Therefore, all else
equal, the benefits of the higher audit quality resulting from the
Amendment may be more significant for EGCs than for non-EGCs, including
improved efficiency of capital allocation, lower cost of capital, and
enhanced capital formation. Because investors who lack confidence in a
company's financial statements may require a larger risk premium that
increases the cost of capital to companies, the improved audit quality
resulting from applying the Amendment to associated persons engaged in
EGC audits could reduce the cost of capital to those EGCs.
Also, given the Commission's existing authority to sanction
associated persons of accounting firms for single acts of contributory
negligence, the costs to EGCs associated with the Amendment are
expected to be small. Therefore, the Amendment's impact on competition,
if any, is expected to be limited.
Accordingly, after considering the protection of investors and
whether the action will promote efficiency, competition, and capital
formation, we believe that the application of the Amendment to
associated persons engaged in the audits of EGCs is necessary or
appropriate in the public interest.\22\
---------------------------------------------------------------------------
\22\ Although the Board expressed the view that Section
103(a)(3)(C) does not apply to the Amendment given that it does not
impose any additional audit requirements, we note that Section
103(a)(3)(C) refers to ``[a]ny additional rules'' adopted by the
PCAOB. Therefore, to avoid any ambiguity regarding the application
of the Amendments within the context of EGC audits, we are making
the finding required by Section 103(a)(3)(C).
---------------------------------------------------------------------------
VI. Conclusion
The Commission has reviewed and considered the Amendment, the
information submitted therewith by the PCAOB, the comment letter
received, and the recommendation of the Commission's staff. The
Commission concludes that the determinations made by the PCAOB as
described in the Adopting Release are reasonable. In particular, the
Amendment will make Rule 3502 both a more effective deterrent against
unethical contributory conduct by associated persons and a more
effective enforcement tool. The Amendment also should prompt
individuals to exercise the appropriate level of care in their audit
work and lead firms to allocate resources more efficiently, which will
raise audit quality. In doing so, the Amendment will advance the
Board's investor protection mandate under SOX. Therefore, in connection
with the PCAOB's filing and the Commission's review:
A. The Commission finds that the Amendment is consistent with the
requirements of Title I of SOX and the rules and regulations thereunder
and is necessary or appropriate in the public interest or for the
protection of investors; and
B. Separately, the Commission finds that the application of the
Amendment to associated persons engaged in the audits of EGCs is
necessary or appropriate in the public interest, after considering the
protection of investors and whether the action will promote efficiency,
competition, and capital formation.
It is therefore ordered, pursuant to section 107 of SOX and section
19(b)(2) of the Exchange Act, that the Amendment (File No. PCAOB-2024-
04) be and hereby is approved.
By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2024-18984 Filed 8-22-24; 8:45 am]
BILLING CODE 8011-01-P
</pre></body>
</html>Indexed from Federal Register on August 23, 2024.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.