RegulationCorporate GovernanceTransatlantic audit row between regulators rages

Transatlantic audit row between regulators rages

Agreement between US and European regulators over information sharing remains illusive.

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

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

“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”.

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