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Sunday,
December 09, 2018 09.25PM / By SEC Chairman Jay
Clayton, SEC Chief Accountant Wes Bricker, PCAOB Chairman William D. Duhnke III
Statement
On The Vital Role Of Audit Quality And Regulatory Access To Audit And Other
Information Internationally — Discussion Of Current Information Access
Challenges With Respect To U.S.-Listed Companies With Significant Operations In
China, SEC Chairman Jay Clayton, SEC Chief Accountant Wes Bricker, PCAOB
Chairman William D. Duhnke III
Introduction[1]
As we
are nearing the end of the fiscal year for many reporting companies, it is
important to remember that complete, accurate financial statements and credible
audits are things we—investors, issuers, and regulators worldwide—all care
about.
The
world’s capital markets are global, as are the world’s largest companies.[2]
Over the past decades, capital investment has increasingly flowed
internationally, including to and from the United States.[3]
Moreover, both U.S.-based and non-U.S.-based companies rely on the U.S. markets
to raise capital and establish a reliable and consistent trading presence for
their securities.[4]
While often taken for granted, it is difficult to overstate the value of
this daily, multi-industry price transparency and liquidity to the
economy—regionally, nationally, and globally.
The
bedrock of this capital market system is high quality, reliable financial
statements. This is indisputable. Without high quality and reliable
financial information, capital markets do not function well.
In
turn, confidence in the quality and reliability of financial statements is
driven by a combination of quality audit services and regulatory
oversight. Effective audits and regulatory oversight require timely
access to comprehensive information. For U.S.-listed companies with
international operations, this access must be multi-jurisdictional, and due to
the size of our capital markets, U.S. regulators have a particularly
significant responsibility to access audit-related information relating to
U.S.-listed companies on a global basis. As context, we note that
U.S.-listed companies accounted for approximately 40% of the market
capitalization of global public companies in 2017. We also recognize that
for investors—both U.S. and non-U.S. investors—a U.S. listing carries with it
the assumption that U.S. rules and regulatory oversight apply.[5]
This
level of international interconnectedness creates regulatory challenges,
including that information reasonably necessary for regulatory oversight with
respect to U.S.-listed companies does not always flow to U.S. capital markets
regulators from foreign jurisdictions to the extent it should. Barriers
to information may come in various forms, including data protection, privacy,
confidentiality, bank secrecy, state secrecy, or national security laws.
These laws, many of which have rational objectives unrelated to our capital
markets, can restrict access to oversight information, even though the subject companies
agree to provide the information and avail themselves of the U.S. capital
markets.
Over
the past decade, there has been substantial cooperation among international
regulators to address these barriers and facilitate the timely flow of
information reasonably necessary for capital markets regulators to carry out
their oversight responsibilities. For context, consider the following:
Although
substantial progress has been made, issues relating to information access
remain, and our experience leads us to expect that new access issues are likely
to arise. One of the most significant current issues relates to the
ability of the PCAOB to inspect the audit work and practices of
PCAOB-registered auditing firms in China (including Hong Kong-based audit
firms, to the extent their audit clients have operations in mainland China)
with respect to their audit work of U.S.-listed companies with operations in
China. The PCAOB has faced similar issues in the past with respect to
other jurisdictions.[6]
While
the analysis of the quality of financial reporting is principally an
issuer-specific exercise, on a collective basis, the size and scope of the
current issue is meaningful. For example, consider the following data
points:[7]
The
efforts of the SEC and PCAOB to obtain access to this information have been
significant and are ongoing. Below, we discuss in more detail the roles
of audit firms, the SEC, and the PCAOB in connection with the financial
reporting and auditing of U.S.-listed companies and the need for international
cooperation. The following discussion also provides more detail on the
current China-related information access issues.
External Audits of Multinational Companies Require Global Coordination
A
multinational company must comply with financial reporting obligations in many
of the countries in which it has operations and activities, and it must prepare
consolidated financial statements that include its financial transactions and
events worldwide. Critical to a company’s compliance with these financial
reporting obligations is the work of the company’s external auditor.
Accordingly, an external audit firm must be able to conduct or coordinate the
delivery of its audit services on a worldwide basis.
The
largest of these audits are conducted or coordinated through global networks
and other affiliations of individual firms. The individual firms are
subject to jurisdiction-based ownership, licensing, registration, and other
regulatory requirements, even as they draw on, for example, globally common
technologies, tools, methodologies, training, and quality assurance monitoring.[11]
The
auditor’s report for a company’s consolidated financial statements is typically
signed by only one firm in the audit firm’s global network. For
U.S.-listed companies, publicly available disclosure forms filed with the PCAOB
enable investors and others to identify whether other firms, including firms
affiliated through a global network, participated in the audit and, when
certain thresholds are met, the extent of their participation.
Regulatory Oversight of International Financial Reporting and Auditing
Requires Significant Cross-Border Regulatory Cooperation
The
reality of today’s global business and audit environment drives regulatory
cooperation, in much the same way as it has driven jurisdiction-based audit
firms to form networks and other affiliations. In short, for oversight to
be effective, regulators around the globe must work together. This makes
sense as the world’s securities and audit regulators share a common mission to
protect investors and foster market integrity. In the case of
multinational companies, fulfilling this all-important function is not possible
if the work of the principal regulators—typically the country or countries with
the primary listings—is limited by national borders.
A
regulator, confined to only a view from within its own national borders, can
only see a portion, and oftentimes a small portion, of the activities and risks
of a company or the work of its auditor. To put the point starkly,
consider a company with all or substantially all of its operations in country A
that, through a listing and offering in country B, raises a substantial portion
of its capital in country B. It would not be satisfactory for the
financial regulators in country B to limit their review of the company’s
financial reporting solely to activities in country B. Access to
information in country A is essential to effective oversight. Moreover,
investors in country B’s markets would expect country B’s regulators to have
such access. Said more generally, review of a consolidated audit of a
multinational company cannot be performed effectively in country-specific
silos.
The Approach of the Principal U.S. Capital Markets Regulators to
International Financial Reporting and Auditing is Multifaceted
Role
and Approach of the SEC
The
SEC’s three-part mission is to protect investors, maintain fair, orderly, and
efficient markets, and facilitate capital formation. The SEC advances its
mission by, among other responsibilities, administering and enforcing
requirements for public companies, funds, and broker-dealers to provide audited
financial statements to investors. As the primary regulator of the
world’s largest securities markets, administering and enforcing the
requirements for reliable financial reporting requires the SEC to be engaged in
many topics that extend beyond the U.S. borders. Indeed, the flow of
international capital investment presents challenges, not just for U.S.-listed
companies and economic interests, but also for the SEC’s efforts to protect
transparency and accountability in financial reporting globally.
Protecting transparency and accountability in financial reporting is
vital.
One
way the SEC seeks to address these challenges is to engage in frequent
communication with market regulators and law enforcement authorities in other
jurisdictions, directly and through our participation in international
organizations—such as IOSCO, the Monitoring Group, which provides monitoring of
international audit and ethics standards, and the Monitoring Board, which
provides monitoring of international accounting standards. The SEC also
works bilaterally and multi-laterally with foreign authorities, both on policy
issues with a cross-border dimension, and on supervisory and enforcement
issues.
As
noted above, the SEC makes extensive use of the IOSCO Multilateral Memorandum
of Understanding, and also is party to cooperative arrangements with foreign
regulators and law enforcement agencies. These
arrangements further facilitate the sharing of critical enforcement and
supervisory information.[12]
Even with these cooperation agreements in place, the SEC’s ability to obtain
access to some types of mission-critical information remains limited in both
timing and scope of access.
Role
and Approach of the PCAOB
The
SEC oversees the PCAOB, which, in turn, is the principal U.S. regulator that
oversees the audits of public companies and SEC-registered brokers and dealers.
The PCAOB is required by U.S. law to conduct regular inspections of all
registered public accounting firms, both domestic and foreign, that issue such
audit reports or play a substantial role in the preparation of them.
These inspections seek to protect investors in the U.S. public capital markets
by ensuring that audit firms adhere to, among other things, PCAOB standards.
The
PCAOB conducts inspections of PCAOB-registered firms across the globe and has
inspected PCAOB-registered firms in 50 different non-U.S. jurisdictions.[13]
With respect to foreign-registered public accounting firms, the PCAOB
cooperates closely with audit regulators outside the United States, and the
scope of that cooperation is extensive.
An
example of this cross-border collaboration and cooperation is the PCAOB’s
active membership in the International Forum of Independent Audit Regulators
(IFIAR), which consists of 53 independent audit regulators from around the
world.[14]
Created in 2006, IFIAR’s stated purpose is to enable independent audit
regulators to share among each other their knowledge and experiences, with a
focus on inspections of auditors and audit firms.
The
PCAOB also has cooperative agreements with 23 foreign regulators as a result of
which the PCAOB either conducts joint inspections or shares inspection findings
with regulators in those jurisdictions.[15]
Under these cooperative agreements, the PCAOB has conducted international
inspections, in many cases jointly, with the local regulator. In joint
inspections, each regulator not only learns from the other, but these
inspections also have the potential to improve regulatory oversight
globally.
Addressing Country-Specific Restrictions on Access to Information and
Auditor Inspections is a Complex Task that Requires Extensive Cooperation and
Ongoing Attention
An
important issue affecting the oversight responsibilities of U.S. capital
markets regulators involves foreign privacy and other data protection laws,
which significantly impact cross-border information sharing. Various
countries’ laws, including blocking statutes and data protection, privacy,
confidentiality, bank secrecy, state secrecy, and national security laws, are
designed to achieve national objectives. But they also frequently create
obstacles to cross-border flows of information between regulators and
foreign-domiciled registrants, thus complicating, and in some instances
impeding, the ability to carry out regulatory responsibilities.
Some
of these laws, for example, act to prohibit foreign-domiciled registrants in
certain jurisdictions from responding directly to SEC requests for information
and documents or doing so, in whole or in part, only after protracted delays in
obtaining authorization. Other laws can prevent the SEC from being able
to conduct any type of examination, either onsite or by correspondence.
Accordingly, securities regulators around the world seek agreements with one
another for access to business books and records or auditor documentation as
part of regulatory efforts to enforce laws that protect investors. This
is particularly important in countries where records are required by domestic
law to be maintained in the home country.
Positions
taken by some foreign authorities currently prevent or significantly impair the
PCAOB’s ability to inspect non-U.S. audit firms in certain countries, even
though these firms are registered with the PCAOB. To facilitate the
PCAOB’s ability to inspect registered non-U.S. audit firms, the PCAOB often
enters into formal cooperative arrangements with foreign audit
regulators. In many cases, these cooperative arrangements permit the
PCAOB to carry out inspections jointly with the home-country regulators.
It is
incumbent that we and our international counterparts continue to work through
these issues, including as new issues arise such as those that may be posed by
the recent, increased focus on data privacy. We must do this while
recognizing that we do not operate in a one-size-fits-all world and that there
are, for good reason, significant differences across various markets, as well
as regulatory regimes. That said, in the case of public companies that
have substantial operations in jurisdictions other than the listing
jurisdiction, for many important reasons, including legal requirements,
investor expectations and the inefficiencies and ineffectiveness of a
country-specific, silo approach, deference is not appropriate. Primary
financial regulators must be able to supervise the entities and persons
registered with them to the extent reasonably necessary to ensure compliance
with the financial disclosure and other key securities laws in their
jurisdiction.[16]
We
also expect audit firms to work with the SEC and the PCAOB in addressing the
issues that affect them. Any audit firm that registers with the PCAOB is
legally obligated to cooperate and provide documents and testimony, if
requested, in connection with inspections and investigations regardless of
their locations.[17]
We note that a refusal to cooperate, either in an inspection or an
investigation, could subject the firm to SEC or PCAOB sanctions and remedial
measures.
Restrictions
on Access to Books and Records Maintained in China
While
international cooperation and coordination have increased significantly in many
parts of the world in recent years, the SEC and PCAOB still face challenges
from laws and practices that can impede strong regulation, supervision, and
enforcement. For example, both the SEC and the PCAOB currently face
significant challenges in overseeing the financial reporting for U.S.-listed
companies whose operations are based in China—a market where U.S. investors’
interest has increased and is significant.[18]
The business books and records related to transactions and events
occurring within China are required by Chinese law to be kept and maintained
there. China also restricts the auditor’s documentation of work performed
in the country from being transferred out of China.[19]
China’s
state security laws are invoked at times to limit U.S. regulators’ ability to
oversee the financial reporting of U.S.-listed, China-based companies. In
particular, Chinese laws governing the protection of state secrets and national
security have been invoked to limit foreign access to China-based business
books and records and audit work papers. As a result, for certain
China-based companies listed on U.S. stock exchanges, the SEC and PCAOB have
not had access to the books and records and audit work papers to an extent
consistent with other jurisdictions both in scope and timing.
Restrictions
on PCAOB Audit Inspections
Another
significant challenge is with regard to PCAOB audit inspections and the related
regulatory uses of the information. The PCAOB is currently restricted
from inspecting audit work and practices of PCAOB-registered firms in China (including
Hong Kong, to the extent their audit clients have operations in China).
The PCAOB has worked to increase its access to China’s audit work papers, but
progress has been slow and satisfactory resolution remains uncertain.
Where the PCAOB is not able to conduct inspections of audits of
foreign-based companies listed in the U.S., investors in these companies do not
receive the tangible, quality-enhancing benefits that can result from PCAOB
inspections.[20]
To
better inform investors about the PCAOB’s inability to conduct inspections in
certain jurisdictions, the PCAOB publishes on its website a list of companies
whose auditors are located in jurisdictions where there are obstacles to PCAOB
inspections.[21]
The current list includes 224 unique issuers, and they represent a
significant portion of the capital markets, with a combined market
capitalization exceeding $1.8 trillion.[22]
Out of these 224 issuers, 213 have auditors based in mainland China or Hong
Kong, while the remaining 11 issuers have auditors based in Belgium.
In
addition to the list, the PCAOB also makes publicly available information in
Form AP, Auditor Reporting of Certain Audit Participants, regarding how much of
an audit was performed by audit firms in other jurisdictions, including
jurisdictions in which the PCAOB cannot currently conduct inspections.
The information helps investors assess the level of audit risk stemming
from a multi-jurisdiction engagement. For Form APs filed with the PCAOB
between June 30, 2017 and June 29, 2018, 207 are from auditors in China (and
Hong Kong) or Belgium that participated in the audit (with a range of
participation of 5% of audit hours or greater) but were not the company’s
principal auditor.
Efforts with Chinese Regulators to Improve Information Access and Audit
Inspections are Ongoing but We Have Not Yet Made Satisfactory Progress
While
information barriers certainly continue to exist in multiple jurisdictions, we
believe the resolution of these issues discussed above with China is of the
most significance to investors. The SEC and the PCAOB have sought
constructive dialogues with Chinese officials and regulators over recent years,
emphasizing the importance of investor protection and the quality of financial
reporting and audit services. Despite these efforts, we have not yet made
satisfactory progress. Our principal goal is to achieve a level of
cooperation with the Chinese authorities that both (1) respects Chinese and
U.S. sovereignty, and (2) enables the SEC and PCAOB to have timely access to
the information necessary to conduct investigations or inspections.
The
inability to date to achieve this level of regulatory cooperation with Chinese
authorities raises a number of investor protection and general oversight
issues.
The
U.S. stock markets have long been attractive to foreign companies because of
their efficiency and liquidity as well as the potential benefits offered in the
form of brand-name enhancement and increased visibility. Many China-based
companies, and companies that have significant operations in China, have sought
these benefits. The factors driving these benefits include the
application of U.S. disclosure requirements as well as regulatory oversight and
enforcement.[23]
However,
the barriers to information access discussed above may adversely affect
investors in the U.S. markets and the interests they own in companies that are
China-based or have significant operations in China, including because they
reduce the certainty provided by U.S. law and oversight. We note that
this risk is present for a company and its investors even if the company’s
financial statements are complete and accurate and the audit was appropriately
conducted. For example, when faced with increased uncertainty about the
reliability of financial reports, investors may “price protect” that risk by
increasing the companies’ cost of capital.[24]
While
a reduction in oversight, and a related increase in uncertainty, may have broad
market confidence-related effects, constraints on oversight also raise
company-specific risk. For example, information barriers that inhibit
oversight may allow bad actors to more effectively hide fraud. In
addition, as we know all too well from our experiences with Enron, WorldCom,
Adelphia and others, fraud in one company, or just a few companies, can
undermine confidence more broadly.[25]
We
believe it also is important to recognize that PCAOB inspections and SEC
regulatory activities not only help to improve audit quality for the inspected
foreign auditors’ U.S. listed clients,[26]
but also provide benefits that may spread to these auditors’ non-U.S.-listed
foreign public clients.[27]
Said another way, the PCAOB inspection process that focuses on audits of
U.S.-listed companies may drive the subject audit firm to improve its work in
respect of companies that are not U.S.-listed.
Finally, we note that, depending on various facts and circumstances, including
company-specific considerations, if significant information barriers persist,
remedial actions involving U.S.-listed companies may be necessary or
appropriate. In the past, remedial measures have included, as examples,
requiring affected companies to make additional disclosures and placing additional
restrictions on new securities issuances.
Conclusion
This
statement reflects our view that it is appropriate to bring the general issue
of SEC and PCAOB access to information held outside the United States, and the
current specific concerns discussed above, to the attention of investors in the
U.S. capital markets.
Footnotes
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