Auditing in the 51st state

Speaking to the great and the good of corporate America, Bush spelt out just how he would double jail sentences for corporate fraudsters from five to ten years and throw an extra $120m (£82m) at the Securities & Exchange Commission to fund more investigators and some extra computers in the war on corruption.

But the real action was taking place in the US Congress, which is currently considering two Bills, one in the Senate, the other in the House of Representatives, that will radically alter accounting regulation.

And if the Senate Bill is passed unamended, the powers of a new regulator will stretch beyond US borders, taking the fight against corruption into foreign jurisdictions.

This ‘extra-territoriality’ is enshrined in section 106 of the Public Accounting Reform and Investor Protection Act 2002 – the so-called Sarbanes Bill, sponsored by Maryland senator Paul Sarbanes, Democrat chairman of the Senate’s powerful banking committee.

Under the Bill ‘any foreign public accounting firm that prepares or furnishes an audit report with respect to any issuer, shall be subject to this Act and the rules of the Board and the Commission issued under this Act.’

Further still, the Board – the proposed new, five-man regulator – could rule that even though the foreign accounting firm might not issue an audit report, so long as it plays ‘a substantial role in the preparation and furnishing of such reports’ it will still fall under the terms of the bill.

So if any firm carries out audit-related work for a US listed company, it will be subject to the new provisions. This could include being forced by US courts to produce working papers in connection with an investigation.

Sarbanes has very cleverly written into the bill an acceptance of these powers – it will be assumed that any foreign accountancy firm that carries out work for an overseas subsidiary of a US listed company will have agreed to these powers.US firms would be deemed to have ‘secured the agreement of that foreign public accounting firm’ to produce working papers on demand and ‘to be subject to the jurisdiction of the courts of the United States for purposes of enforcement of any request for production of such work papers’.

The ICAEW’s president, Peter Wyman, is concerned by the proposals. He says: ‘The extra-territoriality of the whole of US regulation is troubling us quite a bit, and Sarbanes is the latest worrisome trend.’

This is a view shared across the Atlantic where some auditors believe that extra-territoriality did not represent good policy as it would create confrontation and create difficulties in the process of harmonisation.

As a minimum, it is believed the foreign firms would be subject to new independence regulations, document retention requirements and internal control systems.

And there is the real possibility that liability issues could extend beyond the US borders as well.

It is this last point that could be a particular worry for the large firms – in the past they have been able to use jurisdiction boundaries to avoid liability spreading around their international networks; under Sarbanes, this might prove more problematic.

But the international firms are understood to be in constant contact with the policy makers to, as one observer put it, ‘preserve the goal but avoid the unintended harm’ of the legislation.

Wyman believes there is no need for the extra-territorial powers, stressing the importance of mutual recognition of regulation.

‘We have arrangement in place which they [the US] can rely upon – the FSA should be sufficient for the US,’ he argues.

Wyman also says the institute was in full dialogue with the Department of Trade & Industry.

Although the DTI has adopted a ‘wait and see’ policy, preferring to wait for the results of its own review of auditing practices to be published later this month, Wyman says it is ‘fully aware’ of the issues raised by the Sarbanes Bill.

And the DTI may need to look at these issues very soon – there is a political will to pass the legislation, which ultimately will be a compromise between the Senate bill and the similar House of Representatives bill, before the summer recess.

The proposals will not be popular this side of the Atlantic – the European Commission is keeping a very close eye on developments – but there is also mounting opposition in the US, but this may prove to be a futile rearguard action in the current climate.

According to one expert, if the bill becomes law there will be an ‘enormous opening of liability exposure’.

President Bush favours a watered down version, but the bill has received overwhelming support on both sides of the political divide, so it might prove difficult for him not to put his signature to the legislation.In the rush, it is possible that section 106 may be overlooked.