Speech by SEC Staff:
U.S. Perspective on Accountancy Regulation and Reforms
Acting Director, Office of International Affairs
U.S. Securities and Exchange Commission
Annual Conference of the Institute of Chartered Accountants in England & Wales
July 8, 2003
Good afternoon. I am pleased to be here with you today. I would like to thank the Institute of Chartered Accountants, and particularly Peter Wyman, for the kind invitation. Considering that I am neither British nor an Accountant, it is truly an honor!
Before beginning my remarks, I must give the standard disclaimer and state that the views expressed are my own and do not necessarily reflect those of the Commission or its staff.1
Today you have heard a great deal about accounting and auditing reforms internationally and in the United Kingdom. I wanted to take a few moments to discuss the reform of auditor oversight in the United States and its international implications.
The past couple of years have been marked by financial upheavals in the United States. The impact of the financial trouble is far-reaching affecting investors, public companies, and others, including the accounting community. Regulators and lawmakers on both sides of the Atlantic have responded to the wrongdoing with reforms in a variety of areas. As we approach the one-year anniversary of the Sarbanes-Oxley Act, one is left amazed at the speed and breadth of regulatory changes in the United States and around the world. Indeed, the myriad of financial frauds and accounting scandals have led to a fast-developing international consensus on the changes critical to ensuring investor confidence in securities markets, including changes in the areas of disclosure, corporate governance, accountability and, of course, auditor oversight.
Many countries have embarked on ambitious reforms with respect to auditor oversight, and the International Organization of Securities Commissions, in unprecedented fashion, issued a statement noting the basics of robust and effective oversight. Certainly, there is not just one right approach to effective auditor oversight. And while we may pursue different solutions, regulators in Europe and the United States share the same goal to ensure that investors have access to consistent, accurate and reliable information on which to base their investment decisions. I believe that the transatlantic accounting profession also shares this goal, and has a real stake in the success of regulators' efforts to restore investor trust in financial reports. Although it may not always be easy, securities regulators, auditor oversight bodies and accountants must continue to dialogue and work together to achieve our common objective.
For their part, regulators must continue to be mindful that their rules affect the way that public companies and those that serve them -- including accounting firms -- do business. In addition, we must remain aware that our rules frequently have an impact outside our national boundaries. In this regard, we at the SEC recognize the importance of balancing the interests of US investors with the need for practical, measured solutions in the application of our rules to foreign actors. Accordingly, we will continue to establish high standards of investor protection, while striving to avoid unnecessary regulatory burdens, or subjecting foreign market participants to conflicts of law.
In commenting on the US approach to auditor oversight, I will touch upon three areas:
- First, I will give a brief description of how and why the US Public Company Accounting Oversight Board (which I will refer to as the "PCAOB" or "Board") was created;
- Second, I will take a brief look at the PCAOB's registration rules and the accommodations that have been crafted for foreign accounting firms; and
- Third, by way of example, I will give a description of the manner in which the SEC and its counterparts have handled cross-border inspections and investigations.
Background: PCAOB's Mandate
As you are all well aware, the US Congress adopted the Sarbanes-Oxley Act of 2002 in response to financial fraud and accounting scandals in the United States. The Act clearly recognizes that financial reporting is meaningless if investors lack confidence that the information presented is accurate and reliable.
To this end, Congress created the PCAOB a private sector board charged with overseeing public accounting firms that perform audits of US listed issuers. As we discuss the role of the Board and the implications for foreign accounting firms, it is useful to keep in mind the Board's responsibilities. These include:
- Registering accounting firms that prepare audit reports on US listed issuers;
- Writing and administering standards governing: (1) auditing and attestation; (2) quality control; (3) ethics; and (4) independence, in relation to audits of US listed companies;
- Conducting inspections of registered accounting firms in relation to audits of US listed companies; and
- Conducting investigations, bringing disciplinary proceedings and imposing sanctions in relation to audits of US listed companies.
I should note that the Board is not charged with licensing individual accountants. That responsibility remains under the purview of the 50 States.
The SEC oversees the PCAOB. Accordingly, the rules of the Board must be approved by the Commission in order to become effective. Also, final disciplinary sanctions imposed by the PCAOB are subject to Commission review. However, the Board is an independent body. In light of the agencies' respective mandates, the staffs of the Board and SEC have developed a strong working relationship built on consultation and coordination.
PCAOB Registration Rules and Foreign Accommodations
On May 8th, the Board filed with the SEC a proposed rule requiring the registration of all public accounting firms, foreign or domestic, that:
- issue or prepare audit reports on the financial statements of US public companies, or
- play a substantial role in the preparation of such audit reports.
The Board's proposed registration system has generated a great deal of concern and comment from the international community, to say the least. Although the Board determined not to exempt foreign accounting firms from registration, it recognized the need to work with its foreign counterparts to avoid unnecessary burdens or legal conflicts. In a fashion similar to that taken by the SEC in its implementation of the various provisions of the Sarbanes-Oxley Act, the Board, together with the international community, has sought to identify any conflicts of law resulting from the registration rules. The Board has reached out through public roundtables, informal discussions and requests for comment letters.
It is certainly in no one's interest to put a foreign firm in a position where it must risk violation of its home country laws in order to do business in the United States, and the proposed rule reflects careful consideration of such conflicts of law. Accordingly, the Board has made certain accommodations for foreign firms with respect to registration, consistent with the spirit and intent of the Sarbanes-Oxley Act. These include:
- Not requiring foreign audit firms to provide registration information to the PCAOB, where provision of such information would violate home country laws;
- Granting foreign audit firms an additional six months to register; and
- Limiting associated person designation only to proprietors, partners and principals of registered foreign audit firms that provide over 10 hours of services on a particular audit.
We realize that some do not think that the PCAOB has gone far enough in accommodating foreign accounting firms. They have called, instead, for full exemption from registration. However, it is hard to argue that it is unreasonable for the Board, or any other national regulator or oversight body, to identify those who operate in its jurisdiction and to require permission for such operation. The challenge is to undertake this exercise in a manner that is measured and fair.
The PCAOB's registration rules are now before the Commission. The SEC published the proposal on June 11th and requested comments by July 2nd. The Commission must make a decision on whether to approve the Board's rules by July 16. I hope that those of you with an interest had an opportunity to submit your views. I understand that we received approximately 14 letters from foreign commenters. We, of course, always remain open to hear from you.
Oversight Issues Going Forward
While registration has been the cause of consternation, I believe that the heart of the issue is oversight. Oversight of audit firms that provide services in multiple jurisdictions presents challenges. These challenges are significant but certainly not insurmountable. In the interest of meeting them, the Board has set the stage for meaningful dialogue with its foreign counterparts regarding cooperative oversight. Indeed, the PCAOB has indicated a desire to work with non-US accounting regulatory bodies to develop cooperative registration, inspection and disciplinary procedures. The PCAOB has also stated its hopes to quickly make substantial progress with its foreign colleagues in developing such coordinated registration and oversight models.
I would like to spend the remainder of my time today discussing a couple of the challenges relating to oversight of globally-active audit firms, and exploring the role that cooperation and collaboration may play in meeting those challenges.
Section 104 of the Sarbanes-Oxley Act directs the PCAOB to conduct a continuing program of inspections of registered accounting firms. In this connection, the Board will examine compliance with US standards in auditing US listed companies.
The PCAOB envisions two types of inspections those conducted on a regularly scheduled basis and special inspections. The Sarbanes-Oxley Act specifies that regularly scheduled inspections, subject to adjustment by the Board, will be conducted:
- Annually for public accounting firms that regularly provide audit reports for more than 100 issuers; and
- Not less than every three years for public accounting firms that regularly provide audit reports for 100 or fewer issuers.
The international community has expressed concern that inspections of foreign audit firms may:
- violate national sovereignty; and
- conflict with privacy laws, such as the EU data protection directive, and professional secrecy laws.
The need to conduct inspections of registered firms is clear. Without a means to ensure compliance, the Board's rules are meaningless. However, it is equally clear that the concerns associated with inspecting foreign firms must be addressed. These are among the issues on which the Board seeks to engage its foreign counterparts and which suggest a cooperative solution.
It is useful to note that the SEC has faced similar issues in the past with respect to investment advisers providing services in the United States. And like the PCAOB's, our mandate calls for inspection of these entities.
In the case of investment advisers, the SEC has developed a comprehensive program of joint inspections with several key foreign counterparts, including the UK FSA. Joint inspections afford the best of both worlds. They allow each national regulator to do what it does best determine compliance with its own rules. At the same time, joint inspections improve the efficiency of oversight, especially in the case of large, multinational firms. In this manner, regulators can better allocate resources and avoid duplicating each other's efforts. As an added benefit, the respective staffs learn and benefit from sharing their experiences. In short, collaborative efforts serve to maximize the quality and efficiency of each national regulator's inspection program and allow different regulatory systems to work compatibly.
Another issue that has raised concern among the international community is Section 106 of the Sarbanes-Oxley Act. Section 106 of the Sarbanes-Oxley Act provides that:
a foreign public accounting firm that issues an opinion or performs material services on which a registered accounting firms relies shall be deemed to have consented to produce its audit workpapers to the PCAOB or the Commission in connection with an investigation.
In adopting Section 106, Congress clearly recognized the importance of foreign audit workpapers to investigations of financial fraud. They give us insight into the issuer's operations, including its accounting policies and procedures. Prompt access to audit workpapers is necessary for a quick, thorough and accurate resolution of financial fraud cases.
Despite widespread recognition of the importance of foreign audit workpapers, the SEC historically has faced obstacles and undue delays in attempts to secure documents from foreign audit firms. Non-production of the papers and delays can significantly impede an enforcement program. While we certainly respect foreign laws, national boundaries cannot serve to shield foreign participants in the US market from investigation.
Some foreign commenters have indicated that direct access to audit workpapers may violate foreign privacy and professional secrecy laws. And domestic and foreign firms alike view the confidentiality of workpapers as fundamental to the free flow of information between client and audit firm. Congress recognized the importance of affording confidential treatment to audit workpapers and, accordingly:
- Section 105 under the Act extends confidentiality protection to any non-public information provided by a registered accounting firm to the Board.
- Further, the information may not be subject to a Freedom of Information Act request, unless it has already been made public at a public proceeding.
In effect, Congress affords to audit workpapers the same level of confidential treatment that the SEC can grant to non-public information provided by its counterparts under existing information sharing arrangements. Securities regulators have long deemed such protections sufficient in compelling for, and sharing with, each other non-public documents such as trading records, bank records and other information relating to investigations of potential violations of the securities laws.
In some respects, we can draw parallels between audit workpapers and bank records by looking to the SEC's experience in the early 1980's in obtaining the latter in connection with a rash of insider trading cases. These cases involved trading on US markets with payments affected through bank accounts opened abroad. As part of the investigations, the SEC needed to identify the beneficial owners of the accounts. To this end, we sought to compel the production of the bank records through the US courts. Faced with the reality of operating in multiple jurisdictions, the foreign banks raised vociferous privacy arguments. On the one hand, foreign banks realized that unless they complied with the US court orders requiring them to divulge the identity of accountholders, they ran the risk of being ruled in criminal contempt. On the other hand, compliance with the court orders could mean violation of local confidentiality laws. The initial result of this clash was costly, protracted litigation. Rather than devolve into a jurisdictional game of "chicken," clearer heads soon prevailed. The SEC and foreign authorities began to develop rudimentary, but workable, information sharing mechanisms.
Sophisticated cooperative mechanisms among securities regulators are now standard. The SEC and its foreign counterparts have developed over 30 arrangements for information sharing. There is even a multilateral information sharing vehicle through IOSCO. Central to the success of these arrangements has been the willingness of lawmakers to enact legislative changes where necessary to provide regulators with sufficient legal authority to assist one another.
Securities regulators were quick to realize that national mandates superimposed upon global markets and globally-active firms made cross-border cooperation imperative. Without the assistance of our counterparts, it is difficult for each of us to vindicate our legitimate interest in enforcing our laws with respect to securities activity emanating from abroad.
In describing our experience, I do not mean to suggest that the manner in which securities regulators dealt with cross-border inspections and investigations is the only solution. But I do believe that our experience provides a useful illustration of the necessity and importance of cooperation and collaboration.
Congress has granted the PCAOB direct access to workpapers. Perhaps this authority may serve as a springboard for regulatory cooperation and coordination designed to produce real-time, efficient access to audit workpapers. Anything short of this will impede our ability jointly to investigate and take action against financial fraud.
In conclusion, let me assure you that the PCAOB, along with the SEC, is striving to identify a way forward that will permit the Board to meet its mandate without subjecting foreign accounting firms to unnecessary burdens or conflicts of law. We believe that cooperation and collaboration with foreign counterparts will be an important component of the US oversight structure. The Board's proposed rules, to date, reflect this spirit of cooperation. Much work remains to be done, and dialogue among regulators and oversight bodies will be critical to the process as will constructive input from the accounting profession.
We all have an important stake in reform efforts around the world designed to ensure that investors, once again, have trust in the accuracy and integrity of financial reporting. We hope that these efforts will play a major part in bringing investors back to the capital markets. A goal I know we all share.
1 The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.