PCAOB releases criteria to ease implementation of Rule 4012, enabling more reliance on foriegn auditing regulators
The Public Company Accounting Oversight Board (PCAOB) born out of the Sarbanes-Oxley Act is set to depend more on non-US auditing firms and oversight structures in monitoring public companies. As far back as 2005, it had predicted international auditing standards would greatly improve. Under Rule 4012, the board gave itself room to ‘adjust its reliance’ on the inspections of foreign auditors as it gained confidence in the level of independence and rigor of those entities.
Up until now, however, the framework for PCAOB cooperation with foreign regulators on audit firm oversight mainly consisted of joint inspections of firms and only partial reliance on each other’s resources. But in early December, the board voted to issue a proposed policy providing criteria to help define the factors that would lead it to ‘full reliance’ on the inspections of its non-US counterparts. This move speaks to a new confidence in trusting foreign regulators to conduct firm inspections, report on those inspections and assess companies’ actions to remedy problems.
With over 800 foreign audit firms registered in 80 countries, handing more of the auditing responsibility over to foreign regulators could ease the strain on the PCAOB. In her opening statement on the guidance, PCAOB board member Kayla Gillan, who has since stepped down, concurred. Given that nearly half of the firms that the board deal with are foreign-registered, she said, ‘It is impossible, for logistical as well as legal reasons, for the PCAOB to completely fulfill this inspection responsibility with regard to non-US firms unless we find a way to work with and leverage the resources of home country audit regulators.’
Research proves readiness
Observing foreign auditor regulators over the last three years, the PCAOB gained confidence, noting an increase in shared values in the areas of ‘investor protection, improved audit quality and effective oversight of firms.’ At a late 2007 conference in Brussels sponsored by the European Federation of Accountants, PCAOB chairman Mark Olson indicated his satisfaction with these changes. ‘Our mutual oversight and cooperation is fundamental to the global strengthening of audit quality, which is vital to the efficient operation of our increasingly interconnected capital markets,’ he said.
Rhonda Schnare, the PCAOB’s director of international affairs who was heavily involved in determining the criteria for the new Rule 4012 guidance, said the PCAOB is dedicated to cooperating with non-US entities: ‘Our recent proposed policy statement further facilitates cooperation by allowing the board to move toward full reliance; it was precipitated by changes over the past three years that show an evolution in auditor oversight around the world, bringing us closer to our counterparts through the shared objectives of protecting investors, improving audit quality and ensuring effective oversight of audit firms.’
Schnare thinks the impact will be positive: ‘The guidance on Rule 4012 will contribute to more efficient and effective supervision of audit firms that serve US public companies to the benefit of all investors in US public companies – domestic and international.’
Toby Lucich, founder of the website ‘Inside Sarbanes-Oxley’ agrees, emphasizing the benefit to international investors: ‘International public companies will no longer need to trade in their existing domestic audit firm relationships to access US capital markets. ... For public companies already trading and being audited by accounting firms in the EU, Japan, Canada, Australia, Korea and Singapore, access to US capital markets will become far easier.’
The limits
Now that we know the benefits, what exactly does full reliance mean? According to Gillan, the new guidance explains what it means to ‘fully rely on a home country’s system of inspecting audit firm quality and performance,’ and spells out how that external system would be examined. Gillan quibbles with the use of the word ‘full’, stating it isn’t quite appropriate since the PCAOB will continue to monitor foreign auditors. ‘I think it is disingenuous for the PCAOB to suggest that it will, under appropriate circumstances, rely on another regulator when what we really mean is that we will continue to perform all of the work and control all of the activities,’ she says.
Gillan is optimistic, however, that the guidance provides the necessary components for US investors to feel confident that a foreign regulator is doing the right thing as long as it ‘demonstrates after a period of observation that it is willing and able to inspect audit firms for compliance with the standards and rules applicable to auditors of US-traded companies.’
Although this new guidance indicates a great deal of comfort on the part of the PCAOB, experts still worry about standards. Using a sliding scale when assessing regulators is one solution. Schnare notes Rule 4012 makes room for firms with a range of competence, stating that ‘the more independent and rigorous the home-country oversight system, the greater the board’s reliance on that system. ... Not every oversight entity will necessarily meet the essential criteria immediately, but that should not foreclose the opportunity for the PCAOB to cooperate with such oversight bodies.’
Judging audit authorities on an individual basis has been widely praised among members of the PCAOB. In his statement, PCAOB board member Charles Niemeier observed, ‘When we use a sliding scale to calibrate our use of the work of other regulators, we can manage our inspections to make up for such differences.’
Niemeier wants to assure this broad approach is maintained, but worries that, ‘By attempting to define conditions for full reliance, the proposal risks interfering with the flexibility intended in Rule 4012.’ With that view in mind, Schnare suggests ‘reliance may be less than full during the early experiences with an oversight entity.’
Time for independence
Some within the PCAOB worry that foreign regulators won’t be subject to the same restrictions with respect to the requirement for independence of all members of their governing bodies. Rule 4012 allows the PCAOB to place ‘full reliance on a regulator whose governing body includes people who are practicing auditors or accountants, as long as they constituted a minority of that body.’ The PCAOB, on the other hand, is not entitled to have practicing auditors on the board.
Niemeier is concerned that the proposed policy statement is not clear enough on the issue of board independence, and raises questions about how the US will deal with the problem.
Gillan is looking at the big picture, and thinks other countries may not be as invested in improving regulations. ‘There are important differences between our inspections and those of other regulators, such that even the most robust of those other regulators have faced scope limitations and other challenges that we would not countenance,’ she says.
Mass appeal
So how will US auditing firms be affected by greater reliance on foreign auditing firms? Lucich predicts the US auditing firms will face increased competition and we will see a number of international firms opening new offices in local markets.
The trend is undeniable: markets are converging. And, for the most part, regulatory and accounting standards are improving. ‘Transparent and reliable financial information are a shared interest the world over,’ says Lucich. Last year, the SEC took steps to allow foreign companies to use IFRS in place of US GAAP.
‘Just as convergence discussions have been occurring around international GAAP, the same convergence discussions must be occurring on evaluation of the compliance with these shared reporting standards,’ says Lucich.
Lucich also paints a rather apocalyptic picture of the market impact on some auditing firms unused to so much international competition if full reliance takes off: ‘Corporates will be able to pursue the most attractive rate structure [from a range of global providers].’
As for what US auditors are wondering, Lucich thinks their main questions are: ‘Will the investing public be getting a clear picture of international investments?’ and ‘What risks are introduced when a publicly traded company monitored by a European audit firm but accessing US capital markets wants to now be evaluated by a US-based audit organization?’ Their concerns are real, he says, because ‘no firm wants to uncover a financial restatement when proper oversight could have avoided this.’
Better oversight
Many believe the combination of clear criteria for reliance on foreign auditing firms, and the surety of consistent review by the PCAOB will provide greater overall protection for investors in US securities.
If the policy goes through, it will be ‘implemented through bilateral arrangements which would set forth the anticipated progression toward full reliance,’ the board says. And as comments on the proposed guidance are filed through March, we’ll get an idea of whether US companies and other interested parties feel the world’s auditing regulators meet the rigorous criteria that the US has come to expect.
