SEC Commissioner Luis Aguilar spoke at an American Institute of CPAs conference on December 3. He says it is past time for the audit access issue to be resolved. If audit firms "are unable or unwilling to comply with U.S. law, the question to ask is whether the companies they audit should be allowed to trade in the U.S. securities markets". I have copied the relevant portion of his speech below.
U.S. Investors Must Be Able to Rely on the Integrity of Foreign Audits
This is not just important in the United States. It is also important to recognize that capital formation is a global process. Many large U.S. companies have operations all over the world, and businesses of all sizes from other countries come to the United States to access our capital markets. Accordingly, foreign operations of U.S. issuers are often reviewed by foreign auditors, including the local affiliates of the major global accounting networks, as well as independent firms.
U.S. investors rely on the work product of these foreign auditors when making investment decisions, often without knowing the role the foreign accounting firm played in the audit. This lack of transparency, made worse by news reports of audit failures in China and other countries, can create uncertainty in the capital markets. Last year, with a goal toward improving transparency, the Public Company Accounting Oversight Board (PCAOB) proposed amendments that, among other things, would require disclosure in the audit report of other accounting firms that took part in the audit, including foreign firms. This transparency regarding the audit participants would be a step forward for investors.
In addition, I remain seriously concerned about the lack of effective oversight regarding foreign auditors that issue audit reports or participate in the audits of U.S. issuers. Like U.S. firms that audit public companies, these foreign audit firms must register with the PCAOB. As such, they are subject to periodic inspections, including review of work papers for selected audits.
Unfortunately however, although many foreign-based firms currently cooperate with the inspection regime, the PCAOB has been prevented from inspecting the audit work of accounting firms in certain European countries, China, and – to the extent their audit clients have operations in China – Hong Kong. Chinese regulators have resisted direct inspections by U.S. regulators for years.
The PCAOB's inability to inspect the Chinese operations of registered accounting firms is a particular problem, given the number of claims in recent years regarding potential fraud or other irregularities at China-based companies traded on U.S. markets. I have spoken before about my concerns regarding the many claims related to smaller companies that entered the U.S. markets through reverse merger transactions, further reducing transparency.
It has been widely reported that the PCAOB has been working to resolve this situation, and I commend the PCAOB for its efforts. In fact, just last month, for the first time, representatives of the PCAOB were able to observe audit inspections by Chinese regulators. While this is by no means a substitute for a PCAOB inspection, I am hopeful it is a first step to achieving the ultimate goal of a full inspection.
A related issue has been the difficulty in obtaining access to accounting work papers and other documentation. It's no secret that the SEC has been investigating accounting irregularities at dozens of China-based companies that are publicly traded in the United States. However, those investigations have been hampered by the lack of access to relevant documents, many of which are located overseas.
It is obvious that SEC enforcement staff often need access to audit work papers to investigate possible financial fraud claims. In fact, Section 106 of the Sarbanes-Oxley Act, as amended, requires foreign public accounting firms to provide audit work papers concerning U.S. issuers to the SEC upon request. Unfortunately, when we made these requests of audit firms in China, it was an act of futility. As a result, in May of this year, the Commission filed an enforcement action against the Shanghai member firm of a Big Four global accounting network for its refusal to provide the Commission with audit work papers. This particular action related to a China-based company under investigation for potential accounting fraud against U.S. investors.
Commission staff had sought to obtain such documents for more than two years before bringing that action. The Shanghai-based auditor refused to provide the documents, citing Chinese law as the reason for its refusal.
Regardless of Chinese law, however, the fact remains that foreign auditors in China and elsewhere have voluntarily registered with the PCAOB and have chosen to perform audit work for U.S.-listed issuers, knowing full well that U.S. investors would be relying on their audit reports and other work product. If these firms are unable or unwilling to comply with U.S. law, the question to ask is whether the companies they audit should be allowed to trade in the U.S. securities markets?
This is a question that must be answered with the needs of investors in mind – both to protect investors and to promote capital formation. Uncertainty regarding audited financial statements hurts investor confidence in the securities of all issuers whose operations are based in places opaque to regulatory oversight.
This has been an open issue for some time, and it is past time that it be resolved.