In the real world, political corruption doesn’t always look like it does in the movies. There are ideologies and political-economic theories one has to sift through before getting to the good stuff — you don’t have transparently odious, obviously greedy bad guys stuffed away in a back-room somewhere scheming.
So when there actually are odious, greedy bad guys stuffed away in a back-room scheming, it’s pretty good politics to bust it up and take credit for doing so. Just such a racket is happening right now in an obscure corner of the executive branch, and all it would take to end it is some muscle from the President and one of his most-praised appointees.
The History
The corner in question is the Public Company Accounting Oversight Board, or PCAOB (inexplicably pronounced “peekaboo” in DC insider circles; it’s silly, but not knowing stuff like this is how This Town justifies dismissing the public’s input). PCAOB was created after the 2001 Enron scandal, which was supposed to be the greatest financial calamity of our lifetimes until the 2008 crisis happened. To make a long story short, a Texas oil company called Enron used extremely creative (read: fraudulent) accounting to mask billions of dollars of debt, and when Wall Street started to smell a rat, the firm went from one of the highest-traded blue-chip stocks to bankruptcy in a matter of months. That left Enron investors massively in the hole. Pension funds lost more than $1.5 billion nationwide, even though they couldn’t have reasonably been expected to know how shaky the firm actually was.
A great deal of blame fell on the accountants who’d cooked Enron’s books. Its accounting firm, Arthur Andersen, was one of the five largest auditing firms in the world at the time. By the end of the scandal, Arthur Andersen had effectively dissolved. In hopes of preventing this kind of illegal numbers game in the future, Congress created the PCAOB in 2002 as part of its main legislative response to the Enron scandal, the Sarbanes-Oxley Act.
The Agency
PCAOB was intended to be a watchman for the watchmen. Auditing firms — just four of which serve 100 percent of publicly-traded Fortune 500 companies — are supposed to be neutral semi-annual investigators of a firm’s assets and liabilities, to ensure that the information they provide to investors and the government is accurate. But auditors are paid by the firms they audit. Especially since so few auditing firms compete for the most lucrative clients, the so-called Big Four have strong institutional incentives to produce reports favorable to the companies they audit…even if the companies, and the reports, are dishonest.
Moreover, each of the Big Four auditing firms also has a management consulting arm, so if the auditors unearth some damning information, the management consultants might themselves be implicated. Plus, the competition among these supposed watchdogs to secure clients is intense: the Big Four spend on “client hospitality and engagement” — i.e. free dinners, sports tickets, and so on for client-firm bigwigs — in the millions of dollars annually.
PCAOB doesn’t really have power over these underlying issues with the economic structure of American auditing, but it is supposed to ensure that the audits which are actually produced are honest. Auditing firms register with the PCAOB, it establishes rules and regulations for the industry, it checks that the audits conducted by firms comply with those rules, and it’s supposed to sanction firms whose audits are noncompliant.
As was fashionable policy in the early aughts, PCAOB isn’t technically a government agency: it’s a non-profit corporation that is funded through fees it collects from the auditing firms. The model here was self-regulatory agencies on Wall Street, like the Financial Industry Regulatory Authority (FINRA). That means taxpayers don’t have to pay the salaries of PCAOB Board members, which are surprisingly exorbitant. On the theory that higher pay would attract better (which apparently means “private-sector”) talent, Commissioners receive well over half a million dollars per year, higher even than the President’s $400,000 salary.
It hasn’t worked out as intended. From 2003 – 2019, according to the Project on Government Oversight, PCAOB found 808 cases in which the Big Four produced audits so faulty as to be effectively worthless. Yet it’s only brought 18 — yes, 18 — cases against the Big Four, regarding a total of 21 audits. Further POGO data found that the reported failure rates of different Big Four firms range from as little as 20 percent to as much as half of all the audits inspected by the PCAOB. These auditors, again, are the people in charge of making sure that the Fortune 500 companies aren’t flagrantly lying to the public about their profits and liabilities.
The PCAOB has issued only 344 enforcement actions in its entire history, or about 18 per year, mostly against much smaller, non-Big Four firms. Even this overall number, no matter how misguided the enforcement priorities, is quite small. For context, the SEC’s accounting and auditing enforcement division brought 57 enforcement actions in 2019 alone, which was down 11 percent from the 64 enforcement actions the previous year.
The Chairman
If the PCAOB was a flawed, if young, agency before the Trump administration, then those four years turned it into a husk of a watchdog. SEC Commissioners get to appoint or fire PCAOB Board members under Sarbanes-Oxley. In 2017, Trump SEC Chairman Jay Clayton seized on an admittedly corrupt scandal — PCAOB staffers were providing partners at the auditing firm KPMG with insider information about inspections — to fire all five Board members, including Chair James Doty.
To replace Doty, Clayton tapped William Duhnke, a man with no experience in financial services whatsoever. What Duhnke did have was years of loyalty to a particularly important Congressional Republican — Senator Richard Shelby of Alabama. As the American Prospect’s David Dayen has reported, Shelby’s staffers have a curious trend of being nominated to key roles across the executive branch (either under Republican Presidents or as minority Commissioners on independent agencies when Democrats are president), where they undermine regulatory agencies from within while scratching each others’ backs. This powerful clique is known as the “Shelby mafia.”
Once installed at PCAOB, Duhnke wasted no time neutering it. Again according to Dayen, officials in the inspections, enforcement, and general counsel’s office left the agency while signing non-disparagement agreements with Duhnke, under rumors that they were the victims of retaliatory firings. Shelby allies, including the Senator’s granddaughter, were hired instead, but the enforcement and general counsel positions went unfilled for over a year. Inspector reports predictably plummeted, and Duhnke stated publicly that he hoped the agency would highlight the “successes” of the auditing industry as much as the failures. It is, of course, not the PCAOB’s job to cheerlead for these highly profitable firms.
Duhnke was not the only Board member appointed by Clayton, but the others have not been much better. Meanwhile, non-Republican-appointed Board members like Kathleen Hamm were forced out. Instead of customarily reappointing Hamm at the end of her term, she learned that Clayton was pushing her out of the agency when a communications staffer at the PCAOB called to confirm a resignation quote they’d written for her on a press release. Afterwards, Clayton washed his hands of the PCAOB entirely, in direct violation of Sarbanes-Oxley’s mandate that all SEC Commissioners perform oversight of the agency. Instead, he delegated all PCAOB matters to his fellow Commissioner Hester Peirce, another former Shelby staffer and among the most anti-regulatory appointees in recent history.
The Opportunity
Now, however, a new SEC Chairman is in charge of overseeing the PCAOB: Gary Gensler, who despite a concerning initial hire for his own Enforcement Director, has a long and clear history of supporting active regulation. If left in Duhnke’s hands, the PCAOB will be one of Gensler’s main obstacles to actually cracking down on fraud on Wall Street.
Given the circumstances, then, we see no reason why Gensler’s SEC shouldn’t do as Clayton’s did and clean house at PCAOB.
It’s perfectly within their power to do so. A 2010 Supreme Court decision, Free Enterprise Fund v. PCAOB, gave the SEC the power to fire any and every PCAOB board member at any time. The agency is currently led by men and women hellbent on preventing it from actually serving its function. Any reasonable superior facing a subordinate behaving as Duhnke does would fire him. The same goes for the other Board members enabling his abuses.
These abuses are not victimless crimes. We need the PCAOB now more than ever, as retail investing (the term for average people buying and selling individual stocks on their own time and money) becomes a newly popular trend in the post-COVID boom. Retail investors are the least likely to have access to information about a company besides what’s on its public disclosures, meaning if those disclosures are fraudulent, they’ll be the most likely to end up hurt.
There are also new sources of potential fraud and market froth in the financial system. Tesla, for instance, recently reported major revenues off of speculating on Bitcoin prices. How are the potential liabilities or opportunities of institutional cryptocurrency speculation being reported to investors? The PCAOB ought to be figuring that out.
We’re also living through a period when plenty of much-hyped private companies, especially in the tech sector, have had disappointing IPOs after investors realized the firms don’t, you know, make money. Theranos and WeWork are arguably the most egregious examples, but even underperformers like Uber, Lyft, and Slack could realistically have left retail investors on the hook. Again, the PCAOB ought to be thinking ahead to what auditing and disclosure standards make sense as these “unicorn” firms come to market.
Then there’s the climate angle. When regulators (finally) establish rules about climate risk disclosures, there will be a strong incentive for firms to lie about their climate impact and the extent to which they are greening their activities and investments. Presumably, each publicly-traded firm’s climate impact will appear on their public disclosures, which may require auditors to train to assess firms’ balance sheets for actual vs. stated climate impact. We’ll need a PCAOB to both help regulators establish these new expectations, and then hold the auditors in line whose job may be to expose and prevent that planetary wrongdoing.
Cleaning house at PCAOB entirely would naturally attract hypocritical accusations of partisanship and authoritarianism from the political right. This ignores two facts: one, that Clayton did the exact same thing on Republicans’ behalf over the course of the Trump administration. Second, that it is not the SEC’s job to try to satisfy partisan critics (again, Clayton certainly wasn’t worried about what we or other progressives said about his SEC.) The SEC’s job is to prevent fraud within the capital markets. Right now, one of the biggest potential sources of fraud stems from the PCAOB’s adamant refusal to do its job, meaning it is Gensler’s job to reverse that trend whether or not Republicans like it.
These new PCAOB Board members need not be partisan Democrats: Doty, the former PCAOB Chairman forced out by Jay Clayton, was once general counsel to George H.W. Bush, yet he “proved more committed to oversight than anyone expected,” according to Dayen. What matters is that they are independent of the Big Four, that they have subject-matter expertise, and that they have a clear drive to do right by the investing public.
While the Revolving Door Project supports independent agencies, the fact is that Republicans of nearly all stripes do not, and demolishing the regulatory state via the courts and deliberate mismanagement is a key priority of the conservative movement. The PCAOB under Duhnke is a pinnacle example of the latter approach, taking a flawed but well-intentioned oversight vehicle and ripping out anyone who actually believed in its mission. Democrats cannot abide this if they want to model successful leadership, and they certainly shouldn’t abide deliberate sabotage of their own agenda for the sake of maintaining an illusory bipartisan comity. What kind of peace is it if the price you pay is your enemy continuing to attack you?
Because Republicans fired the last PCAOB and installed only their own cronies, a new precedent has already been set. If Democrats default to old assumptions of norms that aren’t respected by their GOP counterparts, they are engaging in unilateral disarmament — a trend which has failed badly for decades. This is, in other words, an early test of Biden and Gensler’s willingness to walk the walk for the sake of the people. It is time to fire the board of the PCAOB.
PHOTO: “Enron, Houston Texas” by hanneorla is licensed under CC BY-ND 2.0