Last week, I attended a meeting of the Standing Advisory Group of the Public Company Accounting Oversight Board (PCAOB), of which I am a member. In his introduction, PCAOB Chairman James Doty gave an update of the international inspections program.
There are 240 non-US audit firms in over 50 jurisdictions that issue opinions and accordingly need to be inspected triennially. The PCAOB has inspected 220 of these firms in 40 jurisdictions. One fourth of 2012 PCAOB inspections were conducted outside the United States.
There have been legal impediments to inspections in Europe and China. Doty reported that the PCAOB has been making great progress in reaching agreements on cooperative inspections. In 2012, new cooperative inspections began in Germany, the Netherlands, and Spain, and there was continued cooperation in Norway, Switzerland, and the United Kingdom.
Doty reported that negotiations had concluded at the staff level with France and Finland. Agreements were close with Denmark, Luxembourg, Poland, and Sweden. Negotiations are continuing with Italy and other EU countries.
Doty indicated that progress with China is slow. In August, the PCAOB concluded an observation protocol which allowed a team of PCAOB inspectors and the PCAOB’s Office of International Affairs to observe a quality control inspection. The purpose of this exercise was to build trust as a first step for greater cooperation.
China has blocked PCAOB inspectors from inspecting accounting firms because it views allowing foreign regulators to operate on Chinese soil to be a violation of China’s national sovereignty. In a letter to the SEC in 2009, China stated that “any oversight of Chinese accounting firms should rely solely on the CSRC”. In the CSRC's annual report for 2011, it pointed out that the EU had in 2011 recognized the equivalence of the audit oversight systems in 10 third countries including China, and that the third countries and EU member states can now mutually rely on each others’ inspections of audit firms. I believe that China wants the same treatment from the United States - complete reliance on Chinese regulators to do the job.
I do not believe that the CSRC has the expertise or the interest to regulate the audits of U.S. listed Chinese companies, other than those of the large SOEs. MOF, the other Chinese accounting regulator, is only interested in audits that result in reports used in China. So for large U.S. multinationals operating in China, Chinese audit oversight applies only to the statutory reports prepared in accordance with Chinese Accounting Standards, not to the U.S. GAAP statements that are consolidated in the parent company's financial statements. Chinese regulators do not have expertise in U.S. GAAP or PCAOB auditing standards, and are unlikely to be very interested in developing those skills.
The significant progress that has been made in Europe is increasingly making China an international outlier. The PCAOB is going to miss its December 31, 2012 deadline to complete international inspections. It was earlier disclosed that Chinese regulators are headed to Washington in December for negotiations. I believe this is the last chance for the PCAOB and China to cut a deal. If there is not a satisfactory breakthrough in December, I don’t see that the PCAOB has any realistic alternative but to begin the process of deregistering Chinese accounting firms. That is a near certainty if SEC negotiations over access to Deloitte’s Longtop working papers also fail. This end game was not discussed in the SAG meeting in Washington, and it is only my personal opinion.