Sarbanes-Oxley begins to bite

Enacted following the debilitating accounting scandals of Enron, WorldCom and Tyco, to name just three, it was aimed at restoring investor confidence in the financial results put out by listed companies. It did this by ensuring that company directors and auditors enforce a duty of care in their work when preparing statements.

In the past few months, what has been up until now a dirty word whispered in company boardrooms has begun to show very sharp teeth indeed.

Last month, the Securities & Exchange Commission, using its powers under Sarbanes-Oxley, fined the chief executive of Rica Foods, a poultry group.

It accused the business of certifying its financial statements despite not having a report from the external auditor.

The £25,000 fine itself was hardly hefty, but it signified that the SEC was deadly serious about its insistence that chief executive officers and chief financial officers swear to the honesty of their company accounts.

Then early this month, the SEC used its new powers to freeze a controversial £14m compensation payment by embattled media group Vivendi Universal to its former boss Jean Marie Messier.

Just two cases so far, but the numbers are likely to grow in the months ahead, particularly since the deadline for US audit firms to register with the new audit watchdog and Sarbanes-Oxley enforcer, the Public Company Accounting Oversight Board, is now just weeks away.

The PCAOB has already set up its official inspections office in New York with a dedicated band of 80 personnel. This figure will grow to more than 200 by the end of the year.

The head of the PCAOB, William McDonough, has also signalled in no uncertain terms that it will adopt a hardline approach to enforcement.

In a speech earlier this month to New York accountants, McDonough warned: ‘I approach this job as I approached my job as the top regulator at the New York Federal Bank.

‘I expect that you, as members of a regulated profession, know what the rules are. I expect that you are following those rules both in their letter and their spirits.’

He added that if the spirit of the law was broken by a company ‘woe be unto you’, and that the consequences would be severe.

McDonough also spelt out what is likely to become the mantra of the PCAOB and Sarbanes-Oxley: registration, inspection, enforcement and standards-setting. The Big Four in the US have all applied for registration, along with other big names such as Grant Thornton and PKF.

Once the PCAOB has voted on inspection rules at the end of the month, it intends to carry out yearly inspections on all firms with 100 audit clients or more and three-year checks on the rest.

The Big Four, in particular, will be under greater surveillance than at any other time in their history.

Despite this, it is actually the smaller firms in the US that are finding the going particularly hard with just 88 small firms registering at last count.

A recent survey by the Washington Post discovered that many small firms were struggling to cope with the requirements of Sarbanes-Oxley, with some even looking to move out of auditing public companies and focus instead on private clients.

In the UK and across the globe, audit firms that have clients with US listings have won a reprieve for a year at least from Sarbanes-Oxley and the clutches of the PCAOB. It will also be the smaller players here that could struggle to cope.

‘Sarbanes-Oxley will have little impact on the bigger firms in the UK, because they already have to comply with the SEC on such things as auditor independence, although there will be an extra compliance cost,’ explains Tony Bromell, head of the ethic standards policy at the ICAEW.

‘For smaller firms it will change things a lot, as currently they have relatively little regulation to comply with in the UK.’

The effect could be fairly widespread. Under Sarbanes-Oxley, it is not just auditors that have listed clients in the US that must register with PCAOB. Firms which audit a major subsidiary – defined as one-fifth of the parent company – of a publicly-listed US company, even if that subsidiary operates purely in the UK, will also be forced to sign-up with the US watchdog.

Recently, correspondence between the ICAEW and some smaller firms, has revealed that they feel they might be affected by the ‘major subsidiary’ ruling.

As a result, according to Bromell, some small firms might not even bother to register in such cases. ‘Some may well drop these audit clients after considering that it is not worth the effort,’ he says.

But at least for them, there is still a year to prepare. Come Christmas time this year, US auditors are likely to be feeling the affects of the new regime.

The requirements are simple, but hard-edged, as McDonough explained in that same fiery speech in New York: ‘We’re going to look for the “tone at the top of” the firm. Do you as managing partner, do you as an audit team leader, understand what is demanded of the accounting firm in this new era of regulation and oversight?

‘Do you understand the standards for audits and, just as important, do you understand why those standards are in place? Do you lead your firms and your teams by example, demonstrating every day the value of those standards?’

While the European Commission tries to come to some kind of arrangement with the PCAOB, it is probable that when October 2004 rolls around there will exist a direct relationship between many UK auditors and the US watchdog.

According to Bromell: ‘There is still a chance for some kind of permanent concession, but I would not put odds on it.

‘The US view is becoming extremely hardline. They are saying: “You must do what we tell you to do”.’

With this in mind, the UK profession should begin preparing itself now for similar hell-fire and brimstone sermons from across the pond.

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