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Audit firms urge SEC to reject PCAOB firm and engagement metrics and reporting standards

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Auditing firms are asking the Securities and Exchange Commission to reject the Public Company Accounting Oversight Board’s recently adopted standards on firm and engagement metrics and firm reporting

The PCAOB voted to adopt the standards in November after making some modifications to assuage several of the concerns raised during the comment process on the rules originally proposed last April. But for many firms, the changes didn’t go far enough.

“The rule introduces a new public oversight model to issuer audits that, in our opinion, has not been adequately studied and is based on metrics susceptible to misinterpretation and misuse that will be costly to produce,” said a comment letter from Ernst & Young.

“We continue to believe that the PCAOB has not sufficiently demonstrated how the metrics within the Release directly relate to or enhance audit quality, which should be the primary objective of any PCAOB rule or standard,” said a comment letter from KPMG. “In fact, our own internal analyses of years of internal and external inspection data indicate that many of the metrics that the PCAOB is proposing do not have a strong correlation to an engagement receiving an inspection comment.” 

The firm and engagement metrics standard would require firms to disclose more information about partner and manager involvement in audits; workload; training hours; audit and industry experience; retention of audit personnel; allocation of audit hours; and restatement history. The PCAOB made some changes to the original proposal, reducing the number of metric areas to eight from 11; refining the metrics to simplify and clarify the calculations; increasing the ability to provide optional narrative disclosure (from 500 to 1,000 characters); and changing the effective date.

“We appreciate the revisions the Board made in its final rules in response to comments received,” said a comment letter from Crowe.  “We remained concerned, however, that the PCAOB does not sufficiently articulate the benefits that are likely to result from this rulemaking, calling into question if the rules are necessary or appropriate in the public interest or for the protection of investors.  As such, we do not support the SEC’s approval of the final Firm and Engagement Metrics rules in their current form.”

Some firms objected to the hurried process behind the new standards. “The speed with which the final rule was approved suggests that sufficient due process was not undertaken, and we believe certain concerns raised by commenters, including tangible operational challenges, were not adequately addressed by the Board in the final rule,” said a comment letter from Grant Thornton. “For such reasons, we ask the SEC not to approve the final rule.” 

The firm reporting standard also underwent modifications from the original proposal in response to comments, reducing the fee disclosure requirements, as well as streamlining disclosures about firm governance and network arrangements. But again the modifications did not go far enough for slime firms. 

“While certain noteworthy improvements have been made to the final rules, concerns persist that elements of the reporting procedures will undermine the confidentiality framework in SOX,” said a comment letter from PwC. “Because alternative effective and less costly measures could be used to gather the information, these concerns should preclude the SEC from approving the final rules.”

Another Big Four firm, Deloitte, pointed out that the burden on smaller firms would be especially acute, particularly in tandem with other recently approved PCAOB standards. 

“These challenges will be compounded by the need for all PCAOB registered firms to simultaneously focus on numerous other new or revised PCAOB requirements currently being considered, or that were recently adopted,” said Deloitte in a comment letter. “We therefore encourage the SEC to consider the cumulative resources needed for firms to implement multiple new standards and other requirements in a short period of time when assessing the costs of the rules. The scope of the Firm Reporting Rules, combined with other PCAOB requirements, will be especially challenging to smaller firms, as the significant resource commitment necessary to implement systems and processes may be necessary even where only a small portion of those firms’ audit practices are subject to PCAOB oversight.”

The American Institute of CPAs has also urged the SEC to reject the new standards. “We believe the recently adopted PCAOB rules will pose significant challenges for accounting firms, especially mid-sized and smaller firms, and may not achieve the intended benefits of improved oversight and audit quality,” said a comment letter from Susan Coffey, CEO of public accounting at the AICPA. “Therefore, we respectfully urge the SEC to refrain from approving these rules. Instead, alternative approaches that better balance transparency, cost, and the needs of audit committees, while continuing to support the quality of audit services and choice of audit providers available to perform public company audits and serve the public interest should be pursued, rather than introducing potentially detrimental unproven regulations.”

The Center for Audit Quality pointed out that any last-minute standards approved by the SEC at the close of the Biden administration could be overturned by the incoming Trump administration or by Congress under the Congressional Review Act. “Notably, any final order approving the rule would be subject to review by a new session of Congress and a new President,” wrote CAQ CEO Julie Bell Lindsay in a comment letter

The U.S. Chamber of Commerce has also come out against the rules, as it did last year in conjunction with the CAQ in opposition to the proposed PCAOB standard on noncompliance with laws and regulations, also known as NOCLAR. That standard is currently on hold.

“The Proposed Rules mandating disclosure of audit firm and engagement metrics represent rushed and problematic due process at the PCAOB,” wrote Tom Quaadman, senior vice president of economic policy at the U.S. Chamber of Commerce. “The Proposed Rules are not fit for purpose, are costly and burdensome, and will be detrimental to audit quality. The adopting release does not meet the threshold requirements for economic analysis, including appropriate consideration of need, benefits, costs, consequences and alternatives.”

With SEC chair Gary Gensler planning to step aside on Jan. 20, the SEC will be controlled by Republicans. The two Republican members of the Commission, Mark Uyeda and Hester Peirce, met with Quaadman in December to discuss extending the comment deadline.

The standards did win support from some investor and consumer groups. “There needs to be transparency throughout the process that results in the appointment and oversight of the audit firms and the audit process to ensure there is accountability to investors by the PCAOB (the regulator) and the audit committee which is charged with protecting investors interests,” said a comment letter from the CFA Institute on the firm reporting standard. “Investors themselves need this transparency to accomplish their stewardship responsibilities and to hold their agents (i.e., audit committees, management and regulators) accountable.”

“CII, therefore, supports the Commission approving the Proposed Rules because we believe the final metrics represent an important, albeit long overdue, step forward in responding to investors’ information needs relating to the audit,” said a comment letter on the firm and engagement metrics standards from the Council of Institutional Investors.

The Consumer Federation of America expressed its support. “Current PCAOB rules and standards do not require registered audit firms to publicly disclose firm or engagement-level information,” said a comment letter from Micah Hoffman, director of investor protection at the group. “As a result, investors and audit committees lack access to consistent, comparable data on audit services, which hinders their ability to make informed decisions in selecting auditors and allocating their capital. Audit firms have little incentive to voluntarily provide standardized and decision-useful information, and existing voluntary disclosures fail to meet investor needs. The amendments would help address these issues.”

“We applaud the PCAOB’s efforts to modernize its annual and special reporting requirements for audit firms,” said a comment letter from AARP legislative counsel David Certner. “Greater disclosure will support investor protection and enhance the PCAOB’s oversight capabilities. The importance of investor protections is especially key for older adults.”

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Senate unveils plan to fast-track tax cuts, debt limit hike

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Senate Republicans unveiled a budget blueprint designed to fast-track a renewal of President Donald Trump’s tax cuts and an increase to the nation’s borrowing limit, ahead of a planned vote on the resolution later this week. 

The Senate plan will allow for a $4 trillion extension of Trump’s tax cuts and an additional $1.5 trillion in further levy reductions. The House plan called for $4.5 trillion in total cuts.

Republicans say they are assuming that the cost of extending the expiring 2017 Trump tax cuts will cost zero dollars.

The draft is a sign that divisions within the Senate GOP over the size and scope of spending cuts to offset tax reductions are closer to being resolved. 

Lawmakers, however, have yet to face some of the most difficult decisions, including which spending to cut and which tax reductions to prioritize. That will be negotiated in the coming weeks after both chambers approve identical budget resolutions unlocking the process.

The Senate budget plan would also increase the debt ceiling by up to $5 trillion, compared with the $4 trillion hike in the House plan. Senate Republicans say they want to ensure that Congress does not need to vote on the debt ceiling again before the 2026 midterm elections. 

“This budget resolution unlocks the process to permanently extend proven, pro-growth tax policy,” Senate Finance Chairman Mike Crapo, an Idaho Republican, said. 

The blueprint is the latest in a multi-step legislative process for Republicans to pass a renewal of Trump’s tax cuts through Congress. The bill will renew the president’s 2017 reductions set to expire at the end of this year, which include lower rates for households and deductions for privately held businesses. 

Republicans are also hoping to include additional tax measures to the bill, including raising the state and local tax deduction cap and some of Trump’s campaign pledges to eliminate taxes on certain categories of income, including tips and overtime pay.

The plan would allow for the debt ceiling hike to be vote on separately from the rest of the tax and spending package. That gives lawmakers flexibility to move more quickly on the debt ceiling piece if a federal default looms before lawmakers can agree on the tax package.

Political realities

Senate Majority Leader John Thune told reporters on Wednesday, after meeting with Trump at the White House to discuss the tax blueprint, that he’s not sure yet if he has the votes to pass the measure.

Thune in a statement said the budget has been blessed by the top Senate ruleskeeper but Democrats said that it is still vulnerable to being challenged later.

The biggest differences in the Senate budget from the competing House plan are in the directives for spending cuts, a reflection of divisions among lawmakers over reductions to benefit programs, including Medicaid and food stamps. 

The Senate plan pares back a House measure that calls for at least $2 trillion in spending reductions over a decade, a massive reduction that would likely mean curbing popular entitlement programs.

The Senate GOP budget grants significantly more flexibility. It instructs key committees that oversee entitlement programs to come up with at least $4 billion in cuts. Republicans say they expect the final tax package to contain much larger curbs on spending.

The Senate budget would also allow $150 billion in new spending for the military and $175 billion for border and immigration enforcement.

If the minimum spending cuts are achieved along with the maximum tax cuts, the plan would add $5.8 trillion in new deficits over 10 years, according to the Committee for a Responsible Federal Budget.

The Senate is planning a vote on the plan in the coming days. Then it goes to the House for a vote as soon as next week. There, it could face opposition from spending hawks like South Carolina’s Ralph Norman, who are signaling they want more aggressive cuts. 

House Speaker Mike Johnson can likely afford just two or three defections on the budget vote given his slim majority and unified Democratic opposition.

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How asset location decides bond ladder taxes

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Financial advisors and clients worried about stock volatility and inflation can climb bond ladders to safety — but they won’t find any, if those steps lead to a place with higher taxes.

The choice of asset location for bond ladders in a client portfolio can prove so important that some wealthy customers holding them in a taxable brokerage account may wind up losing money in an inflationary period due to the payments to Uncle Sam, according to a new academic study. And those taxes, due to what the author described as the “dead loss” from the so-called original issue discount compared to the value, come with an extra sting if advisors and clients thought the bond ladder had prepared for the rise in inflation.

Bond ladders — whether they are based on Treasury inflation-protected securities like the strategy described in the study or another fixed-income security — provide small but steady returns tied to the regular cadence of maturities in the debt-based products. However, advisors and their clients need to consider where any interest payments, coupon income or principal accretion from the bond ladders could wind up as ordinary income, said Cal Spranger, a fixed income and wealth manager with Seattle-based Badgley + Phelps Wealth Managers.

“Thats going to be the No. 1 concern about, where is the optimal place to hold them,” Spranger said in an interview. “One of our primary objectives for a bond portfolio is to smooth out that volatility. … We’re trying to reduce risk with the bond portfolio, not increase risks.”

READ MORE: Why laddered bond portfolios cover all the bases

The ‘peculiarly bad location’ for a bond ladder

Risk-averse planners, then, could likely predict the conclusion of the working academic paper, which was posted in late February by Edward McQuarrie, a professor emeritus in the Leavey School of Business at Santa Clara University: Tax-deferred retirement accounts such as a 401(k) or a traditional individual retirement account are usually the best location for a Treasury inflation-protected securities ladder. The appreciation attributes available through an after-tax Roth IRA work better for equities than a bond ladder designed for decumulation, and the potential payments to Uncle Sam in brokerage accounts make them an even worse asset location.

“Few planners will be surprised to learn that locating a TIPS ladder in a taxable account leads to phantom income and excess payment of tax, with a consequent reduction in after-tax real spending power,” McQuarrie writes. “Some may be surprised to learn just how baleful that mistake in account location can be, up to and including negative payouts in the early years for high tax brackets and very high rates of inflation. In the worst cases, more is due in tax than the ladder payout provides. And many will be surprised to learn how rapidly the penalty for choosing the wrong asset location increases at higher rates of inflation — precisely the motivation for setting up a TIPS ladder in the first place. Perhaps the most surprising result of all was the discovery that excess tax payments in the early years are never made up. [Original issue discount] causes a dead loss.”

The Roth account may look like a healthy alternative, since the clients wouldn’t owe any further taxes on distributions from them in retirement. But the bond ladder would defeat the whole purpose of that vehicle, McQuarrie writes.

“Planners should recognize that a Roth account is a peculiarly bad location for a bond ladder, whether real or nominal,” he writes. “Ladders are decumulation tools designed to provide a stream of distributions, which the Roth account does not otherwise require. Locating a bond ladder in the Roth thus forfeits what some consider to be one of the most valuable features of the Roth account. If the bond ladder is the only asset in the Roth, then the Roth itself will have been liquidated as the ladder reaches its end.”

READ MORE: How to hedge risk with annuity ladders

RMD advantages

That means that the Treasury inflation-protected securities ladder will add the most value to portfolios in a tax-deferred account (TDA), which McQuarrie acknowledges is not a shocking recommendation to anyone familiar with them. On the other hand, some planners with clients who need to begin required minimum distributions from their traditional IRA may reap further benefits than expected from that location.

“More interesting is the demonstration that the after-tax real income received from a TIPS ladder located in a TDA does not vary with the rate of inflation, in contrast to what happens in a taxable account,” McQuarrie writes. “Also of note was the ability of most TIPS ladders to handle the RMDs due, and, at higher rates of inflation, to shelter other assets from the need to take RMDs.”

The present time of high yields from Treasury inflation-protected securities could represent an ample opportunity to tap into that scenario.

“If TIPS yields are attractive when the ladder is set up, distributions from the ladder will typically satisfy RMDs on the ladder balance throughout the 30 years,” McQuarrie writes. “The higher the inflation experienced, the greater the surplus coverage, allowing other assets in the account to be sheltered in part from RMDs by means of the TIPS ladder payout. However, if TIPS yields are borderline unattractive at ladder set up, and if the ladder proved unnecessary because inflation fell to historically low levels, then there may be a shortfall in RMD coverage in the middle years, requiring either that TIPS bonds be sold prematurely, or that other assets in the TDA be tapped to cover the RMD.”

READ MORE: A primer on the IRA ‘bridge’ to bigger Social Security benefits

The key takeaways on bond ladders

Other caveats to the strategies revolve around any possible state taxes on withdrawals or any number of client circumstances ruling out a universal recommendation. The main message of McQuarrie’s study serves as a warning against putting the ladder in a taxable brokerage account.

“Unsurprisingly, the higher the client’s tax rate, the worse the outcomes from locating a TIPS ladder in taxable when inflation rages,” he writes. “High-bracket taxpayers who accurately foresee a surge in future inflation, and take steps to defend against it, but who make the mistake of locating their TIPS ladder in taxable, can end up paying more in tax to the government than is received from the TIPS ladder during the first year or two.”

For municipal or other types of tax-exempt bonds, though, a taxable account is “the optimal place,” Spranger said. Convertible Treasury or corporate bonds show more similarity with the Treasury inflation-protected securities in that their ideal location is in a tax-deferred account, he noted.

Regardless, bonds act as a crucial core to a client’s portfolio, tamping down on the risk of volatility and sensitivity to interest rates. And the right ladder strategies yield more reliable future rates of returns for clients than a bond ETF or mutual fund, Spranger said.

“We’re strong proponents of using individual bonds, No. 1 so that we can create bond ladders, but, most importantly, for the certainty that individual bonds provide,” he said.

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Why IRS cuts may spare a unit that facilitates mortgages

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Loan applicants and mortgage companies often rely on an Internal Revenue Service that’s dramatically downsizing to help facilitate the lending process, but they may be in luck.

That’s because the division responsible for the main form used to allow consumers to authorize the release of income-tax information to lenders is tied to essential IRS operations.

The Income Verification Express Service could be insulated from what NMN affiliate Accounting Today has described of a series of fluctuating IRS cuts because it’s part of the submission processing unit within wage and investment, a division central to the tax bureau’s purpose.

“It’s unlikely that IVES will be impacted due to association within submission processing,” said Curtis Knuth, president and CEO of NCS, a consumer reporting agency. “Processing tax returns and collecting revenue is the core function and purpose of the IRS.”

Knuth is a member of the IVES participant working group, which is comprised of representatives from companies that facilitate processing of 4506-C forms used to request tax transcripts for mortgages. Those involved represent a range of company sizes and business models.

The IRS has planned to slash thousands of jobs and make billions of dollars of cuts that are still in process, some of which have been successfully challenged in court.

While the current cuts might not be a concern for processing the main form of tax transcript requests this time around, there have been past issues with it in other situations like 2019’s lengthy government shutdown.

President Trump recently signed a continuing funding resolution to avert a shutdown. But it will run out later this year, so the issue could re-emerge if there’s an impasse in Congress at that time. Republicans largely dominate Congress but their lead is thinner in the Senate.

The mortgage industry will likely have an additional option it didn’t have in 2019 if another extended deadlock on the budget emerges and impedes processing of the central tax transcript form.

“It absolutely affected closings, because you couldn’t get the transcripts. You couldn’t get anybody on the phone,” said Phil Crescenzo Jr., vice president of National One Mortgage Corp.’s Southeast division.

There is an automated, free way for consumers to release their transcripts that may still operate when there are issues with the 4506-C process, which has a $4 surcharge. However, the alternative to the 4506-C form is less straightforward and objective as it’s done outside of the mortgage process, requiring a separate logon and actions.

Some of the most recent IRS cuts have targeted technology jobs and could have an impact on systems, so it’s also worth noting that another option lenders have sometimes elected to use is to allow loans temporarily move forward when transcript access is interrupted and verified later. 

There is a risk to waiting for verification or not getting it directly from the IRS, however, as government-related agencies hold mortgage lenders responsible for the accuracy of borrower income information. That risk could increase if loan performance issues become more prevalent.

Currently, tax transcripts primarily come into play for government-related loans made to contract workers, said Crescenzo.

“That’s the only receipt that you have for a self-employed client’s income to know it’s valid,” he said.

The home affordability crunch and rise of gig work like Uber driving has increased interest in these types of mortgages, he said. 

Contract workers can alternatively seek financing from the private non-qualified mortgage market where bank statements could be used to verify self-employment income, but Crescenzo said that has disadvantages related to government-related loans.

“Non QM requires higher downpayments and interest rates than traditional financing,” he said.

In the next couple years, regional demand for loans based on self-employment income could rise given the federal job cuts planned broadly at public agencies, depending on the extent to which court challenges to them go through.

Those potential borrowers will find it difficult to get new mortgages until they can establish more of a track record with their new sources of income, in most cases two years from a tax filing perspective. 

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