Accounting Firms That Take Pentagon Contracts Will Need to Disclose Previous Disciplinary Actions

By:
Chris Gaetano
Published Date:
Feb 5, 2019
1280px-The_Pentagon_US_Department_of_Defense_building

A new law set to take effect later this month will require any accounting firm with a Defense Department contract to disclose any prior disciplinary proceedings from regulators, according to Bloomberg

The measure was part of last year's defense appropriations act, which was signed into law in August. The one-paragraph provision (Section 1006) reads:

"For all contract actions (including awards, renewals, and amendments) occurring more than 180 days after the date of the enactment of this Act, the Secretary of Defense shall require any accounting firm providing financial statement auditing or audit remediation services to the Department of Defense in support of the audit required under section 3521 of title 31, United States Code, to provide the Department with a statement setting forth the details of any disciplinary proceedings with respect to the accounting firm or its associated persons before any entity with the authority to enforce compliance with rules or laws applying to audit services offered by accounting firms."

This provision means that a firm would have to disclose to the Pentagon any enforcement actions or investigations from any regulator that can oversee an accounting firm, such as the Public Company Accounting Oversight Board (PCAOB), whose disciplinary proceedings are generally kept from the public until many years after the fact.

Former PCAOB Director of Enforcement Claudius Modesti criticized the delayed disclosure policy—established in the Sarbanes-Oxley Act, which initially gave the PCAOB life—in a 2010 speech: "This nonpublic nature of board disciplinary proceedings has serious adverse consequences for the investing public, audit committees, the auditing profession, the Board, and other interested parties, such as Congress." He said it denies vital information to the public and encourages firms to litigate regardless of whether they believe they will win, because continued litigation delays disclosure.

Senators Jack Reed (D-R.I.) and Chuck Grassley (R-Iowa) have long agreed with Modesti's assessment, as the lawmakers have several times jointly proposed bills that would open this information up to the public, the most recent effort coming in March 2017. 

“The PCAOB is responsible for ensuring that auditors of public companies meet the highest standards of quality, independence, and ethics," said Reed at the time. "Reliable financial reporting is vital to the health of our economy and we must take the legislative steps necessary to enhance transparency in the PCAOB’s enforcement process.  Currently, Congress, investors, and others are being denied critical information about an auditor’s disciplinary process.  Investors and companies alike should be aware when the auditors and accountants they rely on have been charged or sanctioned for violating professional auditing standards.”

Bloomberg said that this new requirement has caught the Big Four by surprise, and they are reportedly trying to get the requirement scaled back, although there is little time to do so before the provision comes into effect. According to Bloomberg, the Defense Department has yet to offer details on how it intends to implement the requirement. Each of the Big Four firms has done business with the Pentagon to some degree or another. They have argued that the provision is broad and will put audit firms at a competitive disadvantage compared to other consultants; they are also concerned that the disclosures will be visible to the public, which could then be seized upon by short sellers, or simply reveal sensitive information about employees and audit clients. On the other hand, Sen. Reed, who was responsible for the provision, said that taxpayers have a right to know that the Defense Department is selecting the most qualified auditors, and knowing the extent of past disciplinary proceedings is a vital part of that transparency effort. 

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