Transatlantic audit row between regulators rages

In March 2003 Carl Levin, then ranking democrat on the US permanent investigations sub­committee, penned a letter which warned of the “ineffective, uncooperative and disturbing” practices of foreign auditors.

In the note, addressed to America’s audit regulator, the Public Company Accounting Oversight Board (PCAOB), the senator highlighted what he felt were gaping holes in the US regulatory framework.

“The purpose of the Sarbanes-Oxley Act is to increase auditing oversight to restore investor confidence in US securities markets, not push auditing services offshore to jurisdictions where board oversight would be more difficult to accomplish,” he wrote at the time.

The Sarbanes-Oxley Act, which raised standards for US accounting firms, was in its infancy, as was the PCAOB.

Scandals at Tyco, WorldCom and Enron had shaken confidence in US regulators and exposed corporate America’s willingness to pick and choose which regulatory jurisdiction best suited their purposes.

As proof, Levin cited three examples. The first involved a Dominican auditor which refused to provide information about its financial statements. The second involved a Big Four auditor based in Antigua, serving as a government appointed liquidator, which refused to hand over court documents despite being instructed to do so by the Antiguan Government. The third involved an accounting firm, also based in Antigua, which audited the subsidiary of a major US Bank. The firm claimed it did not have access to documents because they were being held by another internal division.

Levin was clearly frustrated at the situation. He said US authorities had found evidence of possible conflicts of interest, incompetent or dishonest accounting practices, inflated balance sheets, insider trading and other “questionable transactions” during his time.

Today, he could have added collapsed US bank Lehman Brothers’ use of repurchase transactions, now infamously known as Repo 105s, to his list of accounting trickery.

The bank used repo-transactions to seemingly manipulate their balance sheet, during sensitive reporting periods.

The repos were funneled through the bank’s UK subsidiary and likely inspected by the UK arm of Lehman’s auditor Ernst & Young.

The PCAOB is widely believed to be looking into the audit, but if it wants to inspect documents or conduct interviews relating to the UK dimension to the audit, it will be disappointed.

Seven years since Levin wrote his letter, the PCAOB remains a muzzled audit regulator, unable to pursue inquiries in most jurisdictions outside the US, including in the UK. What began as a frustration has now evolved into a legislative issue which threatens to become a trans-Atlantic diplomatic row.

The PCAOB must inspect most auditors of listed US companies every three years. For more substantial acc­ounting firms, these inspections must occur annually. In return auditors are able sign off on accounts in the US. In Europe, however, the PCAOB has been denied access.

In the US the PCAOB won’t allow foreign regulators access to their confidential working files and Europe returns the favour by stopping US inspections of European auditors. New US legislation is being passed to free up access, however, it’s unclear whether this will satisfy Europe.

Europe is not only seeking the working papers but also what has come to be called “full reliance”.

Under this arrangement, EU regulators would conduct an inspection on the PCAOB’s behalf and in return the PCAOB would conduct inspections on EU regulator’s behalf. The PCAOB is not prepared to accept this arrangement, preferring to conduct joint-inspections.

Last month the PCAOB released a list of 400 companies whose auditors are overseas, out of the reach of US legislation. The vast majority are based in Europe.

Michel Barnier, the EU internal markets commissioner, has denied blocking US authorities, but does acknowledge the ongoing disagreement. “The [European] Commission services have raised this issue with the US already in February last year and a constructive dialogue is ongoing,” he said.

Meanwhile, the temperature is rising. The PCAOB has pointed out that, unlike Europe, it allows foreign regulators to conduct domestic inspections on its turf.

“One could say that it is actually the European Commission and the EU audit regulators who are failing to offer reciprocity, since the PCAOB is willing to do joint inspections with foreign regulators here in the US, but the European authorities will not currently permit joint inspections in EU countries,” said Rhonda Schnare, director of the office of international affairs at the PCAOB.

Some suggest an economic element to the debate. The PCAOB has a vast inspection budget, more than $86m (£59m) according to its 2010 accounts. In the UK, that figure is £2.2m. They quietly point out that it would ease the pressure on EU budgets if the PCAOB conducted US inspections on the EU’s behalf.

The clock is ticking to resolve the issue. Schnare refers to a number of options available to the PCAOB if the impasse continues. “The PCAOB has said publicly that it will consider the array of disciplinary actions available under its rules, including the limitation of a [audit] firm’s activities, functions or operations, the suspension of a firm’s registration, or even the revocation of a firm’s registration,” she said.

“While negotiations are continuing and I remain hopeful for a resolution, I am acutely aware that in the meantime the investors of the issuer clients of these firms are not being protected”.

Further reading:

pcaobus.org