The impact of Sarbanes-Oxley act on non-U.S. accounting firms.

Hsu, Kathy H.Y. ; Cheek, Ronald G. ; Etheridge, Harlan L. 等

ABSTRACT

The Sarbanes-Oxley (Public Company Accounting Reform and Investor Protection) Act of 2002 is the most far reaching legislation to reform American business practices in recent time. This legislation changes the business landscape in the U.S. by creating a new oversight body, the Public Company Accounting Oversight Board, to oversee the corporate governance, accounting and auditing practices of all publicly held companies in the U.S. and to implement regulatory requirements for better corporate governance, accounting, and auditing practices.

Many of these new regulatory changes affect not only U.S. corporations and the U.S. accounting and auditing professions, but also have a far reaching impact on all of the non-U.S. corporations that seek capital in the U.S. security markets as well as those non-U. S. accounting/ auditing firms that service these foreign entities. While the intention of the Sarbanes-Oxley Act is to protect U.S. investors in general and the legitimacy of an U.S. oversight body to regulate publicly held companies in the U.S. is not being challenged, some of the specific requirements within the Act pose challenges for non-U.S. companies that are also subject to their home country's regulatory requirements that may be substantially different or in conflict with the requirements of this new act. Strong opposition also has been expressed by non-U.S. accounting firms that are fearful that implementation of this new Act may place them in a disadvantageous position compared to their U.S. counterparts and change the international market for auditing services. This study reviews the specific requirements of the Sarbanes-Oxley Act that are applicable to non-U.S. accounting firms and provides insight on how these requirements affect the global accounting and audit market.

INTRODUCTION

On July 30, 2002, President Bush signed the Sarbanes-Oxley Act of 2002 into law. This Act not only is applicable to all companies listed in the U.S., both domestic and foreign, Section 106 of the Act also subjects any non-U.S. accounting firms who "prepare or furnish" an audit report involving U.S. registrants or any foreign accounting firms whose audit opinion is relied upon by a registered U.S. accounting firm to be subject to the authority of the Act. This new Act not only imposes registration requirements with an U.S. oversight body on foreign accounting/auditing firms, it also redefines many aspects of accounting and auditing practices for foreign accounting firms that may or may not be practically feasible or legally possible in their home countries.

The main areas of the Sarbanes-Oxley Act that affect the accounting profession in general include (1) defining new roles for the corporate audit committee and its relationship with corporate external auditor in that auditors will report to and be overseen by a company's audit committee, not management, and the requirement of audit committees to pre-approve of all services (both audit and non-audit services) provided by its auditor, and (2) auditor independence requirements including audit partner rotation and employment restriction, specification of consulting services that are "unlawful" if provided to a publicly held company by its auditor, as well as (3) the requirement that every audit report attest to the assessment made by management of the company's internal control structures, including a specific notation about any significant defects or material noncompliance found. There are also specific provisions within the Act regarding preservation of audit or review working papers and the requirement of management assessment of internal controls.

As the U.S. accounting profession focuses on adapting to this new era of change, foreign accounting firms have expressed grave concerns that the new U.S. legislation may create an "unlevel playing field" that favors U.S. accounting firms over non-U.S. accounting firms because the non-U.S. firms will now be subject to both their national oversight board as well as U.S. oversight. Currently, the negotiation, debates and discussions are still ongoing between foreign accounting firms and the U.S. Public Company Accounting Oversight Board (PCAOB) in the hope that some relief can be granted in consideration of the differences between the legal and operating environments in the U.S. and the local legal and operating environments of foreign accounting firms. However, foreign regulatory bodies have threatened to retaliate against U.S. audit firms by imposing requirements similar to those of the Sarbanes-Oxley Act (European Report, 2004).

The next section examines the specific requirements of the Sarbanes-Oxley Act that are applicable to foreign accounting firms followed by a discussion of the impact that these new requirements impose on foreign accounting firms and the current state of development of a global co-operative system of accounting/auditing oversight.

SPECIFIC REQUIREMENTS APPLICABLE TO FOREIGN ACCOUNTING FIRMS

The Sarbanes-Oxley Act requirements discussed in this section apply to both domestic (U.S.) and foreign accounting firms. However, complying with these requirements may prove to be especially problematic for some foreign accounting firms.

Registration Requirements

Section 101 of the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board (PCAOB) and gave the PCAOB authority over all U.S. listed companies, including foreign issuers. The PCAOB is appointed and overseen by the SEC and it oversees and investigates the audits and auditors of public companies and has the authority to sanction both firms and individuals for violations of laws, regulations and rules. The PCAOB has the right to issue new auditing standards or adopt auditing standards set by other groups or organizations. And it is empowered to regularly inspect registered accounting firms for potential violations of securities laws, standards, competency, and conduct. Sanctions that the PCAOB can impose include revocation or suspension of an accounting firm's registration, prohibition from auditing public companies, and civil penalties.

Section 102 of the Sarbanes-Oxley Act requires that any public accounting firm prepares or issues an audit report for any U.S. issuer of stock must be registered with the Public Company Accounting Oversight Board (PCAOB) and Section 106 further requires foreign public accounting firms who audit US companies to register with the PCAOB. This requirement covers foreign firms that perform some audit work, such that for a foreign subsidiary of a U.S. company, which is relied on by the primary auditor. Registration is a key to the PCAOB's oversight powers in that registration with the PCAOB opens registering firms to inspections and sanctions by the PCAOB (Illustration 1).

The foreign public accounting firm registered with the PCAOB is assumed to have consented to 1) producing its working papers for the PCAOB or the SEC in connection with any investigation, and 2) subjecting themselves to the jurisdiction of U.S. courts for the purpose of enforcing any request for the production of audit working papers. Illustration 1 shows the possible relationship between the foreign and domestic audit firms with an U.S. company under section 106.

Independence Provisions

The Sarbanes-Oxley Act is based on three fundamental principles of auditor independence: (1) auditors cannot function in the role of management, (2) auditors cannot audit their own work, and (3) auditors cannot serve in an advocacy role for their client. Section 201 of the Act also lists nine non-audit services that impair a foreign or domestic auditor's independence: (1) bookkeeping or other services related to the accounting records or financial statements of the audit, (2) financial information systems design and implementation, (3) appraisal or valuation services, fairness of opinions, or contribution-in-kind reports, (4) actuarial services, (5) internal audit outsourcing services, (6) management functions or human resources, (7) broker or dealer, investment adviser, or investment banking services, (8) legal services, and (9) expert services unrelated to the audit

All bookkeeping services, such as maintaining or preparing the audit client's accounting records, preparing financial statements or the information that forms the basis of financial statements, would impair auditor independence, unless it is reasonable to conclude that the results of the non-audit services will not be subject to audit procedures. These rules also prohibit domestic and foreign auditors from providing any service related to the audit client's information system, but this will not prevent an auditor from working on hardware or software systems that are unrelated to the audit client's financial statements or accounting records as long as those services are pre-approved by the audit committee.

Appraisal and valuation services include any process of valuing assets, both tangible and intangible, or liabilities. Fairness opinions and contribution-in-kind reports are opinions and reports in which the accounting firm provides its opinion on the adequacy of consideration in a transaction. A foreign and domestic auditor also cannot provide any actuarially oriented advisory service involving the determination of amounts recorded in the financial statements and related accounts for the audit client. However, they may assist a client in understanding the methods, models, assumptions, and inputs used in computing the amount.

The Sarbanes-Oxley rules also prohibit the auditor from providing any internal audit service that has been outsourced by the audit client that relates to internal accounting controls, but the auditor may make recommendations to the audit client for improvements to the internal controls during the conduct of the audit. Further, independence is impaired when auditors seek out prospective candidates for managerial, executive or director positions, act as negotiator on the audit client's behalf, or undertake reference checks of prospective candidates. Also, acting as a broker-dealer, promoter or underwriter, making investment decisions on behalf of the audit client or otherwise having discretionary authority over an audit client's investments, or executing a transaction to buy or sell investments, or having custody of assets of the audit client are prohibited.

Finally, the rules prohibit a domestic and foreign auditor from providing expert opinions or other expert services or legal representation that could be provided by someone licensed, admitted, or otherwise qualified to practice law in the jurisdiction in which the service is provided. However, providing factual accounts or testimony describing work that they performed will not impair independence, or explaining the positions taken or conclusions reached during the performance of any service by the auditor. The Act also provides that the provision of any non-audit service, including tax services, that is not described as a prohibited service can be provided by the auditor without impairing the auditor's independence only if the service has been pre-approved by the issuer's audit committee.

Section 202 states that a reporting issuer's audit committee must pre-approve allowable services to be provided by the auditor of the issuer's financial statements. The new rules will require the audit committees of U.S.-listed foreign firms to pre-approve all services, and they may establish policies and procedures for pre-approval provided they are consistent with the Act and designed to safeguard the continued independence of the auditor.

Section 203 specifies that the lead and compatible partner, which is defined as a member of the audit engagement team who has the responsibility for decision-making on significant auditing, accounting and reporting matters that effect the financial statements, must be subject to rotation after five years. The rules specify that these partners must be subject to a five-year "time out" period after rotation. Additionally, certain audit partners will be subject to a seven-year rotation requirement with a two-year time out period. An auditor will not be independent if an audit partner receives compensation based on selling services to that client, other than audit, review and attest services, at any point during the engagement period. The rules also state that firms with fewer than five audit clients and fewer than ten partners may be exempt from the partner rotation and compensation provisions with each of the activities subject to a special review by the PCAOB at least every three years.

Reporting Responsibility of Auditor to the Audit Committee

Section 204 of the Act directs the Commission to issue rules requiring timely reporting of specific information by auditors to the audit committee. These rules require foreign auditors to report prior to filing the audit report: (1) all critical accounting policies and practices used by the issuer, (2) all material alternative accounting treatments of financial information within GAAP that have been discussed with management, including the ramifications of the use of such alternative treatments and disclosures and the treatment preferred by the auditor, and (3) other material written communications between the auditor and management.

THE IMPACT OF SARBANES-OXLEY ACT ON FOREIGN ACCOUNTING FIRMS

The initial responses by foreign accounting firms to the PCAOB's authority over foreign accounting firms were very negative (illustration 2). As a result, the PCAOB decided to permit foreign accounting firms an additional 90 days (to April 19, 2004) before requiring registration with the PCAOB (1) and decided to allow foreign applicants to withhold information from applications for registration with the PCAOB where disclosure of the information would cause the applicant to violate non-U.S. laws; however, no provision has been granted to foreign public accounting firms exempting them from the registration requirements under section 106 (c) of the Sarbanes-Oxley Act (Evans, 2003).

Many foreign accounting firms view the registration requirement under section 106 as creating unfair advantage for U.S. accounting firms since foreign accounting firms are subject to two layers of professional oversight, domestic and U.S., while U.S. accounting firms are subject to only one layer of professional oversight (U.S.). This complaint is particularly intense from accounting firms within the European Union member states since each EU member state has established or is planning to establish an effective system for the approval, registration and professional oversight of statutory auditors with regard to the single EU capital market from 2005 onwards. The additional administrative and financial burden posed by the Sarbanes-Oxley Act on these foreign accounting firms can be quite enormous (2).

In addition, although the PCAOB allows a foreign applicant to withhold information from its application for registration with the PCAOB where disclosure of the information would cause the applicant to violate non-U.S. laws (Rule 2105, PCAOB), the application must provide a legal opinion that the non-U.S. law would in fact prevent disclosure of required information as well as an explanation of the applicant's efforts to seek consents or waivers to eliminate the conflict and, if applicable, a representation that the applicant was unable to obtain such consents or waivers to eliminate the conflict. The explanation of the applicant's efforts to seek consents or waivers adds no value to investor protection and will result in extremely time-consuming and ineffective attempts to seek consents or waivers, as employees would in many cases refuse to give their consent. Foreign accounting firms also contend that they have to bear the burden of this obligation; most U.S. accounting firms probably will not be affected.

There are also additional concerns over confidentiality and data protection issues relating to the general "duty to co-operate with inspectors" and "... comply with any request ... to provide access to, and the ability to copy, any record in the possession, custody, or control of such a firm ..." (Rule 4006 of the PCAOB), as well as the provision regarding "Production of audit work papers and other documents" in investigations (Rule 5103). For audit firms operating in legal environments where the confidentiality requirements and data protection legislation may make it difficult to provide all the information which the PCAOB may request, investor confidence and perception of the quality of audits may be eroded.

There are also additional concerns over undue administrative and financial burdens placed on the non-big four accounting firms in their current and future engagement choices. As smaller foreign accounting firms withdraw from and avoid audit engagements to minimize the burden of the Sarbanes-Oxley Act, there will be an increased concentration of audits of publicly listed clients with the "big four" firms. This potential concentration of the international audit market with the big four accounting firms may cause more harm to auditor independence.

INTERNATIONAL HARMONIZATION OF OVERSIGHT SYSTEMS

In response to the Sarbanes-Oxley Act in the U.S., there has been a wave of international initiatives both by national governments and by international accounting professionals to promote accounting and audit reform. For example, in May 2003 the EU Commission launched a communication to reinforce the statutory audit required of the EU public firms and there is a proposal underway to revise the Eighth Directive. Last December, the U.K. government introduced the Companies (Audit, Investigations and Community Enterprise) Bill to the House of Lords with the intention improve the reliability of financial reporting and the independence of auditors, and to strengthen the powers of company investigators. The Japanese Financial Services Agency also has initiated "new comprehensive program for promoting security markets reform" in 2002 (FSA, 2003).

One of the main arguments presented by foreign accounting firms to support their exemption from the Sarbanes-Oxley Act requirements is that there should be a mutual recognition of professional oversight systems. In additional to the mutual respect for each jurisdiction's sovereignty (FSA, 2003), the differences in the national audit oversight systems due to the historical, cultural and legal differences between the U.S. and other countries need to be respected. This means that if the U.S. were to develop the principles and criteria upon which an equivalence, i.e., mutual recognition of accounting/auditing oversight systems, can be accepted by the U.S, a foreign national audit oversight system can deem to be "equivalent" to the U.S. oversight system even if they are not identical.

In light of the recent global harmonization of the accounting and financial reporting standards, many have argued that this international coordination and reciprocal recognition of regulations for global capital markets would benefit not only the foreign accounting professions but also the global capital markets in general. However, this "mutual co-operation with other high quality regulatory systems that respects the cultural and legal differences of the regulatory regimes that exist around the world" was not supported in a recent PCAOB Briefing Paper on "Oversight of Non-U.S. Public Accounting Firms" (PCAOB Rulemaking Docket Matter No. 013). While the PCAOB announced a co-operative approach to the oversight of non-U.S. public accounting firms and included in its release paper certain criteria intended to be used in its evaluation of the independence and rigor of a particular home country oversight system, the examples of the criteria that may be used to assess the adequacy and integrity of the home country system are still based primarily on the U.S. system for inspections and investigations of U.S. public accounting firms. The FEE (Federation des Experts Comptables Europeens--European Federation of Accountants) explicitly expressed (3) concerns that if the PCAOB largely ignores the established or developing systems for quality assurance in the EU, or rates certain systems as weak because of the way in which they achieve oversight, it is unlikely to contribute to the most effective global oversight and may undermine the perception of audit quality for publicly listed companies in the EU (FEE comment letter to the PCAOB, 2004).

THE SAGA CONTINUES

Since 2002, the number of new foreign listings on U.S. stock exchanges has sharply decreased (illustration 3). Many foreign companies either decided to de-list from the U.S. to avoid being subject to the Act or have decided not to list on the U.S. exchanges citing the compliance costs associated with the Sarbanes-Oxley Act. (4) The SEC intended for the Sarbanes-Oxley Act to be the most comprehensive scheme of revised corporate governance in the history of American business and it certainly has done so with far-reaching impact on both domestic as well as foreign companies. In terms of the accounting and audit markets, the resolve of the U.S. PCAOB to follow a more cooperative approach to oversight of non-US audit firms is still being tested by foreign accounting firms. As the April 2004 registration deadline approaches for foreign accounting firms, the PCAOB will meet again to vote on the proposal to extend the registration deadline for foreign auditors to July 19, 2004. The SEC is under increasing pressure from the EU and other countries to reconsider measures in Sarbanes-Oxley and to explore if there is the basis and a need for exempting foreign audit firms.

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Would there be a harmonization of the quality control standards of the international accounting and audit profession, the public oversight systems as well as the corporate governance practices on a global basis? The Sarbanes-Oxley Act certain has an impact far beyond U.S. territories. The U.K., Japan, and the EU, among other countries, have either begun their own legislative processes or have enacted regulatory changes to promote good corporate governance. As accounting and auditing standards become increasingly harmonized to facilitate global capital flows, the Sarbanes-Oxley Act certainly has created a worldwide need for coordination and reciprocal recognition of the equivalence of quality control and public oversight systems and corporate governance so that there can be consistent regulations for global capital markets.

[ILLUSTRATION OMITTED]

ENDNOTES

(1.) The registration deadline for U.S. audit firms ended Oct. 22 with 598 firms being approved.

(2.) Comment letter to the SEC from the German Institut der Wirtschaftsprufer (IDW) which represents the German accountants and Wirtschaftspruferkammer (WPK) which represents the German auditing profession. File-No. PCAOB 2003-03 PCAOB; Notice of Filing of Proposed Rules Relating to Registration System.

(3.) The FEE's comment letter, January 2004. Re: PCAOB Rulemaking Docket Matter No. 013--"Proposed Rules Relating to the Oversight of Non-U.S. Public Accounting Firms".

(4.) UK's Benfield Group and Daiwa and Fuji Film of Japan decided not to list on US capital markets citing Sarbanes-Oxley as the reason.

REFERENCES

AICPA. (2003). How The Sarbanes-Oxley Act impacts accounting profession, Summary of the Sarbanes-Oxley Act published by the AICPA.

Bowne Newsletter. (2003). Sarbanes-Oxley Seems Hostile to Foreign Listings: Foreigns Forced to Play By U.S. Rules, January.

European Report. (2003). Concern Grows over impact of New Audit Rules, European Report 16, October.

European Report. (2003). New American Regulator decides EU audit firms must register. European Report, April.

Evans,C. (2003). US softens Sarbanes-Oxley, Accountancy, Feb, 131(1314), 11, 1/2p; (AN 11938354

Financial Services Agency of Japan (2003). Major Issues on Sarbanes-Oxley Act of 2002", Reference published by the Financial Services Agency of Japan, June.

Public Companies Accounting Oversight Board. (2003). Final Auditor Registration Rules, May.

Public Companies Accounting Oversight Board. (2003). Briefing Paper, 29 October.

Postelnicu, A. (2003). A little breathing space: Sarbanes-Oxley Act: The SEC has relaxed some of its rules. Financial Times, July 7, 2.

SEC Final Rules Adopted Pursuant to Sarbanes-Oxley Act of 2002--Strengthening Auditor Independence. United States Congress, Sarbanes-Oxley Act of 2002, 2nd session: January.

Kathy H. Y. Hsu, University of Louisiana at Lafayette

Ronald G. Cheek, University of Louisiana at Lafayette

Harlan L. Etheridge, University of Louisiana at Lafayette

Illustration 2

Opinions on Foreign Compliance with
Sarbanes-Oxley Act on Foreign Registrants

UnDecided 2%
Not Agree 15%
Agree 83%

Note: Table made from pie chart.

Illustration 3

Decline In Non US New Listing American Depesitery Receipts
because of Sarbanes Oxler Act

Non US Reporting Issuers

Non US Listing In 2001 51
Non US Listing In 2002 33
Non US Listing In 2003 13

Note: Table made from bar graph.