Former board member of audit regulator to join EY advisory board, raising conflict questions

A former board member of the regulator of auditors is now going to give advice to one of the largest firms, Ernst & Young, on fixing problems with audit quality she highlighted as a regulator.

Jeanette Franzel, a former board member of the Public Company Accounting Oversight Board, is one of three people on a panel EY set up to get an outside perspective on aspects of its operations, culture or strategy that relate to audit quality.

F. William McNabb III, a former chief executive and chairman of Vanguard Group and Charles Noski, a former chief financial officer at Bank of America Corp., Northrop Grumman Corp. and AT&T Inc., also will be on the independent advisory body.

Franzel, who served as a PCAOB board member beginning in Feb 2012 left the PCAOB in January 2018 so a one-year cooling off period for “practicing” before her own agency has expired.

Franzel is also prohibited from disseminating or otherwise disclosing “any information obtained in the course and scope of his or her employment, and which has not been released, announced, or otherwise made available publicly.”

Franzel emailed MarketWatch, via an EY spokesman, with this statement:

“As a former PCAOB board member, I am well aware of the PCAOB’s ethics requirements. I am fully compliant with those requirements and will of course remain so. In my role as a member of EY’s Independent Audit Quality Committee, I have not discussed, and will not discuss, with EY any matters over which I presided or with which I was involved during my tenure as a PCAOB Board member. I am confident my service on this committee will enable EY to continue to enhance audit quality.”

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An EY spokesman emailed MarketWatch that the firm is “delighted” that Franzel has joined committee.

“Throughout her distinguished career in public service, and as a certified public accountant, Ms. Franzel has been committed to the highest levels of audit quality. Her insights and experience will be of great value to EY as we deliver on our commitment to the highest quality in audits. EY and Ms. Franzel are aware of the ethical requirements resulting from her role as a former PCAOB Board member, and we are confident of her and our ongoing compliance with those obligations,” the statement said.

One study, “The Revolving Door between the PCAOB and Large Audit Firms,”published by the Kenan Institute of Private Enterprise, finds that unfavorable PCAOB inspection reports lead firms to targeted hiring of individuals with specific knowledge of the PCAOB inspection process, not hiring individuals with high levels of accounting expertise.

The researchers identified two potential ways former PCAOB personnel may help audit firms improve future inspection results. Former employees could use “their human capital and detailed knowledge of the PCAOB inspection process to alter the firm’s audit processes such that they align better with PCAOB standards.”

However, the researchers were also unable to rule out the possibility that the future reductions in inspection findings by the regulator may be attributable to former PCAOB employees obtaining confidential information about future inspections via former colleagues at the PCAOB.

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Bradley Hendricks, a professor of accounting at the University of North Carolina and one of the authors of the study, told MarketWatch, “There are reasons to hope that Ms. Franzel will use her expertise to improve audit quality at Ernst & Young. However, one study found that because audit quality can be compromised when a company is audited by a firm that previously employed one of the company’s senior officers, her appointment also raises major concerns that the PCAOB’s oversight of Ernst & Young could be impaired. To reduce this risk, it behooves Ernst & Young to limit direct communication between Ms. Franzel and the PCAOB as her close relationships with many of their senior staff, directors, and other personnel may impair the integrity of the PCAOB inspection process.”

Jeff Hauser, founder and director of the Revolving Door Project at the left-leaning think tank the Center for Economic and Policy Research, is not satisfied with Franzel’s and EY’s reassurances.

“The hiring of Franzel shows how technical compliance with inadequate ethics laws does little to protect the public interest. Knowing what problematic practices are unlikely to concern a regulator can be enormously valuable information for any company contemplating aggressive line pushing. Franzel needn’t disclose anything she is unauthorized to share in order to give EY an unfair insight into not only the PCAOB’s capabilities and focus, but also the PCAOB’s institutional blind spots,” Hauser told MarketWatch in an email.

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Hauser added that, in his opinion, a one-year cooling off period is inadequate to address revolving door concerns.

EY U.S.’s performance on the PCAOB’s inspections has been steadily improving. From a 48% deficiency rate in 2012 and 50% in 2013, EY U.S. deficiency rate fell to 36% in 2014, 29% in 2015, and 27% in the most recent inspections published for 2016.

During Franzel’s tenure, the PCAOB board approved three enforcement cases against EY firms, including against the U.S. firm, and several EY partners.

The PCAOB and its board members including Franzel also published 62 audit inspection reports for EY firms all over the world, including the U.S. member firm, that cited deficiencies in EY audits for thousands of audit clients of the firm all over the world.

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