“Oh yeah?!” PCAOB Bars Foreign Auditors which do not Allow Board Inspections

Oct 11, 2010   

The Public Company Accounting Oversight Board (PCAOB) has announced rule changes that could bar audit firms based outside the United States from auditing U.S. companies.

Under the new rules promulgated on October 7, 2010, foreign audit firms applying to the PCAOB for registration will be required to state their understanding of whether a PCAOB inspection of the firm would currently be allowed by local law or local authorities. If the applicant indicates that PCAOB inspections would not be allowed, the a Notice of Hearing will be issued by the PCAOB to determine whether approval of the application would run counter to the Sarbanes-Oxley Act of 2002.

Under the Sarbanes-Oxley Act of 2002, audit firms are required to register with the PCAOB and submit to regular inspections by the Board if the firm audits financial statements filed by issuers with the Securities and Exchange Commission. In recent years, however, the PCAOB has been frustrated by foreign audit firms blocking Board inspections because of asserted legal restrictions or objections of local authorities.

PCAOB Acting Chairman Daniel Goelzer stated:

Since 2004, the Board has approved registration applications of non-U.S. firms with the expectation that any potential obstacles to inspections would be resolved through cooperative efforts with foreign regulators. Although we are still pursuing those efforts, the continuing obstacles to inspections in some jurisdictions have forced us to re-evaluate that approach to registration.

Earlier this year, the PCAOB published a list of PCAOB-registered auditors which the Board currently cannot inspect because of asserted non-U.S. legal obstacles. The list includes numerous subsidiaries and affiliates of firms such as Deloitte Touche, Ernst & Young, PricewaterhouseCoopers, KPMG and Grant Thornton. (http://pcaobus.org/International/Inspections/Documents/issuer_audit_clients_of_certain_non-US_firms_by_jurisdiction.pdf) The listed firms audit over 400 non-U.S. companies whose securities trade in U.S. markets.

Regulators in countries throughout Europe and Asia deny the PCAOB access to inspect non-US applicants, arguing that these firms should be inspected by local authorities. They further believe that any information shared by these firms with the PCAOB should be transmitted under the auspices of an equivalence arrangement rather than the non U.S. firm directly being inspected by the Board.

However, in its statement on the new rules and citing the Sarbanes-Oxley Act, the Board countered:

These inspections are fundamental to the Board’s ability to carry out its oversight responsibilities “in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.” Obstacles to those inspections frustrate the oversight system put in place by the Act and, in turn, threaten the public interest by impeding the Board’s ability to detect conduct that violates U.S. law and professional standards.

These new rules will have a substantial effect on how U.S .companies and their foreign subsidiaries are audited. U.S. companies will be deterred from engaging unregistered auditors in jurisdictions where PCAOB inspections would be denied. For their part, unregistered global audit firms will have a much harder time pursing cross-border business with U.S. companies. While PCAOB staffers deny that the rules are an attempt to strong-arm foreign audit firms into inspections, they are optimistic that the pace of negotiations on PCAOBs foreign inspections will greatly increase as a result of the tactic.