Dear Ms. Countryman:
The U.S. Chamber of Commerce (“Chamber”) Center for Capital Markets Competitiveness appreciates the opportunity to comment on the Securities and Exchange Commission (“SEC” or “Commission”) Notice of Filing of the Public Company Accounting Oversight Board (“PCAOB” or “Board”) Proposed Rules on A Firm’s System of Quality Control and Related Amendments to PCAOB Standards (“QC 1000” or “adopting release”). The Chamber urges the SEC to reject the QC 1000 update from the PCAOB.
The QC 1000 standard directly conflicts with Section 104(g) (2) of the Sarbanes Oxley Act of 2002 (“SOX”) which prohibits public disclosure of items in an inspection report that have been corrected. The PCAOB cannot override the legal requirements as established by Congress. Accordingly, in its current form QC 1000 violates SOX and the Commission should reject it.
On its own, the SEC should reject the PCAOB’s final QC 1000 standard because it contains fundamental failures and flaws, as subsequently discussed. Alarmingly, the QC 1000 standard represents the first time since the inception of the PCAOB that a Board vote to adopt a final standard or rule has not been unanimous. [1]
The QC 1000 standard adopted by the PCAOB contains a new requirement for an External Quality Control Function (“EQCF”) that is not a logical outgrowth of what the Board proposed in November 2022 (“QC 1000 Proposal”) – denying the public an opportunity to comment – and that is fundamentally flawed. Further, QC 1000 fails to comport with the PCAOB’s authority under SOX and fails to comply with the standards the Board and SEC are required to satisfy when adopting new PCAOB standards, among other matters.
As detailed further below, the Board’s approval of QC 1000 rests on an economic analysis that falls far short of what is legally required and is not one on which the SEC may therefore rely. Instead, the SEC must conduct its cost-benefit analysis of the standard with due regard of the Commission’s statutory mandate as interpreted by the courts, then publish that analysis for public comment. Failure to do so places any finally-adopted standard in legal peril.
In addition to the potential for increasing concentration and reducing competition in the smaller firm market for issuer and broker-dealer audit engagements, as discussed below, the QC 1000 has broader implications for the SEC. The SEC has both promulgated and proposed rules requiring the use of PCAOB registered and inspected audit firms by other than issuers and broker-dealers.[2] The SEC needs to consider the consequences of QC 1000 for these segments of the market and the ability of non-issuers/non-broker-dealers to engage the requisite audit firms and comply with the rules the SEC imposes on their organizations.
Under Section 103 of SOX, the Board may adopt professional practice standards “as required by this Act or the rules of the Commission, or as may be necessary or appropriate in the public interest or for the protection of investors.” After the Board adopts a standard, Section 107(b)(2) of SOX requires that it then must be approved by the SEC in order to take legal effect.[3] In evaluating a Board rule, Section 107(b)(4) of SOX in turn directs the SEC to follow the process under Section 19(b) of the Securities Exchange Act of 1934.
In the case of a PCAOB rulemaking, the SEC must consider the standard according to Section 107(b)(3) of SOX and may approve it “if it finds that the rule is consistent with the requirements of [the Sarbanes-Oxley] Act and the securities laws, or is necessary or appropriate in the public interest or for the protection of investors.”[4] In addition, Section 103(a)(3)(C) of SOX, added under the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), provides that in order for a new standard to apply to audits of emerging growth companies (“EGCs”), the Commission must determine “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.”
The use of the term “public interest” binds the Board’s process under SOX and the Commission’s process under Section 19(b). Section 3(f) of the Securities Exchange Act is clear that whenever the SEC “is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.”[5] Therefore, because SOX includes the same “public interest” standard as the Securities Exchange Act, the SEC’s decision to approve a rule or standard proposed by the PCAOB is subject to statutory cost-benefit analysis.
The “public interest” standard tightly constrains the abilities of both the PCAOB to adopt audit standards and the SEC to approve them. Under the Administrative Procedure Act, a court must “set aside” agency actions found to be “in excess of statutory jurisdiction, authority, or limitations,” or that is “arbitrary, capricious, . . . or otherwise not in accordance with law.”[6] Once the SEC has approved a PCAOB rule, aggrieved parties may initiate a judicial challenge.[7]
Courts reviewing SEC action must be sure the agency has “examined the relevant data and articulated a satisfactory explanation for its action including a rational connection between the facts found and the choices made.”[8] The SEC also has a “statutory obligation to determine as best it can the economic implications of the rule.”[9] The SEC’s “failure to ‘apprise itself — and hence the public and the Congress — of the economic consequences of a proposed regulation’ ” renders the SEC action arbitrary and capricious.[10]
In light of the foregoing, the SEC has a “statutory obligation to determine as best it can the economic implications of the rule it has proposed.”[11] The SEC must “quantify the certain costs” or explain why those costs cannot be calculated.[12] As part of its cost-benefit analysis, the SEC “must identify benefits that ‘bear a rational relationship to the . . . costs imposed.’”[13] In doing so, the SEC may not ignore data it does not want to consider.[14] Courts will vacate an SEC rule that relies “upon insufficient empirical data.”[15]
Because the PCAOB fails to satisfy these requirements, among a host of other issues with QC 1000, the Chamber urges the SEC to reject the PCAOB’s QC 1000 standard.
Read the full letter here.
[1] See the Statement on QC 1000 Adoption – Demise to Audit Competition by Board Member Christina Ho (May 13, 2024).
[2] For example, see the SEC Final Rules on Private Fund Advisers: Documentation of Registered Investment Advisers Compliance Reviews (S7-03-22, IA-6282; August 23, 2023) and the SEC Proposed Rule on Safeguarding Advisory Client Assets (88 Fed. Reg. 14,672-14,792; March 9, 2023). Although, the former rule is subject to legal challenges (see “Fund Managers Win Case Against SEC’s Fee Rules” in the Wall Street Journal, June 6, 2024).
[3] See also Free Enterprise Fund v. PCAOB, 561 U.S. 477, 486 (2010) (“The Act places the Board under the SEC’s oversight, particularly with respect to the issuance of rules.”)
[4] 15 U.S.C. § 7217(b)(3).
[5] Id. § 78c(f).
[6] 5 U.S.C. § 706(2).
[7] Free Enterprise Fund, 561 U.S. at 489.
[8] Business Roundtable and Chamber of Commerce v. SEC, 647 F.3d 1144, 1148 (citing Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983)).
[9] Id. at 1148 (citing Chamber of Commerce v. SEC, 412 F.3d 133, 143 (D.C. Cir. 2005)).
[10] Id. (citing Chamber of Commerce, 412 F.3d at 144).
[11] Chamber of Commerce, 412 F.3d at 143.
[12] See Business Roundtable, 647 F.3d at 1149.
[13] Chamber of Commerce v. SEC, 85 F.4th 760, 777 (5th Cir. 2023) (citing Pub. Citizen v. EPA, 343 F.3d 449, 455 (5th Cir. 2003)).
[14] Id. at 776.
[15] See Business Roundtable, 647 F.3d at 1150-51.
