PCAOB offers guidance on auditor responsibilities for detecting, reporting illegal acts

The Public Company Accounting Oversight Board issued a new publication Tuesday providing guidance from its staff on the auditor's responsibilities when it comes to detecting, evaluating and making communications about illegal acts, as a controversial new standard that would toughen these requirements awaits approval.

The PCAOB staff did outreach in connection with the PCAOB's proposal on making changes in the existing requirements. In June 2023, the PCAOB proposed to replace its existing standard, AS 2405, Illegal Acts by Clients, with AS 2405, A Company's Noncompliance with Laws and Regulations, as well as make some related amendments to other PCAOB auditing standards. The so-called NOCLAR proposal generated pushback from auditing firms and spurred a letter-writing campaign from the Center for Audit Quality and business groups protesting the proposed changes, which would make auditors more responsible for detecting and reporting signs of fraud and rule-breaking at the companies they audit. The PCAOB has not yet voted on the proposed standard, but it decided the staff publication would help clarify what the existing requirements are right now.

The PCAOB noted that under federal securities laws, auditors have a longstanding responsibility to detect illegal acts; evaluate information indicating that an illegal act has or may have occurred; determine whether it is likely that an illegal act has occurred, and, if so, to consider the possible effect of the illegal act on the financial statements of the company; and make appropriate communications about illegal acts — unless "clearly inconsequential" — to management, the audit committee, and possibly the Securities and Exchange Commission.

The PCAOB standards include similar requirements, the board noted. Those responsibilities should also inform an auditor's obligation to plan and perform the audit to obtain reasonable assurance that the company's financial statements are free of material misstatement, whether due to error or fraud. The staff publication explains the various considerations for auditors when performing procedures to detect, evaluate, and make communications about illegal acts by a company under audit.

"Companies are subject to a variety of legal and regulatory requirements depending on a number of factors, including, among others, geographic location, the product or services provided, and the particular industry," said the report. "Violations, by act or omission, of laws and regulations that a company is subject to (i.e., illegal acts) can materially affect the financial statements and harm investors. As such, auditors' procedures related to identifying possible illegal acts are an important part of planning and performing an audit."