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March 25, 2010

Regulators in oversight stand-off

Audit firms are being squeezed by regulators that cannot agree how to co-operate when overseeing firms that audit companies listed in foreign countries.

In some cases, firms have been asked to break the law in one country to comply with another regulator’s demands.

The friction exists because the US has an extraterritorial arrangement in place. The Public Company Accounting Oversight Board (PCAOB) must personally conduct inspections of all firms that audit companies listed on the US capital markets at least once every three years, no matter where the firm is based.

The other major economies want oversight  based on mutual co-operation. This means the country an audit firm is located in has the main supervisory role and inspects the local audit firms, sharing the information with the regulators of other markets the firms’ audit clients are listed in.


Huge capital market

One major reason for the more stringent US regulation is the huge market capitalisation of foreign companies listed on US capital markets.

Speaking at an EC audit and accounting conference in February, PCAOB international director Rhonda Schnare said there are some 2,200 non-US companies trading on US exchanges and about 250 foreign audit firms, located in 54 jurisdictions, that audit companies listed in the US.

No other capital market has anywhere near this level of foreign participation.

The oversight standoff came to a head in 2008, when the PCAOB was not permitted to inspect a number of firms scheduled for inspection that year – located in China, Switzerland and 10 EU countries.

The issue is still unresolved and comments by Schnare and a representative from China’s Ministry of Finance (MoF) at the February EC conference indicate that in those two countries at least, neither side will budge.

Yuting Liu, the director general of the MoF’s accounting regulatory department, said China’s position in the “past, present and future” is that foreign regulators will not be allowed direct entry into the Chinese market.

“Once you have found any problems [with Chinese companies listing in the US], we have always said that this sort of issue can always be addressed through the Chinese regulatory system… and vice versa… The co-operation is necessary,” Liu said.

Schnare was just as firm about the US stance, saying that not one member of the current PCAOB board would vote for full reliance.


Difficult situation

BDO International chief executive Jeremy Newman said the situation is difficult, but he can understand both perspectives.

“China is emerging as a global power and is saying in a whole host of areas, ‘we don’t want a Western, Anglo-Saxon, liberal democratic capitalist business model imposed on us’,” he said.

American politicians will not accept reduced regulation.

“The PCAOB is under pressure from politicians [who are saying] ‘how can you trust the Chinese regulatory system? There is no democracy in China, how do we know that there are checks and balances in China to make sure that the regulators act properly?’,” Newman added.

There is also friction between the EU and the PCAOB.

“If we were in a different climate, if we hadn’t just recently had the global financial crisis and everybody worrying about regulation, I think this would be relatively easy to resolve, but everyone is too sensitive,” Newman said.

The regulatory conflict puts international audit firms in a tough spot.

“It is an absolute nightmare because you are being told either you break one law or you break another law,” Newman said, adding that some BDO firms have “been squeezed”. In every case so far, they have managed to find a compromised arrangement, for example, agreeing to defer visits.


Regulatory burden

Newman said that even if firms can comply with all regulators, they end up going through the same regulatory process multiple times.

“You get so much ridiculous regulation. You have two or three people inspecting you at the same time, looking at the same thing and coming up with different issues,” Newman said.

Steven Maijoor, chairman of the International Forum of International Audit Regulators, said balance is essential.

“We need to have an approach where we are balanced. On the one hand, we should avoid duplication of work, but on the other hand it is clear you just shouldn’t rely on things without adequate evidence,” he said.

“It’s just like how we expect auditors take evidence on internal controls before they rely on the internal controls of the clients.”


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