By Jill P. Giles, Elizabeth K. Venuti, and Richard C. Jones
The Sarbanes-Oxley Act of 2002 represents the most significant securities law reforms since the Securities Act of 1933 and the Securities Exchange Act of 1934. Due to widespread outrage over financial frauds, including Enron and WorldCom, Congress acted swiftly to pass laws that increase federal oversight of all matters related to corporate governance, in order to restore investor confidence in the U.S. securities markets. By increasing auditor independence requirements, articulating the professional and ethical responsibilities of auditors, directors, and officers, and enhancing disclosure requirements, Sarbanes-Oxley increases oversight of the audit and accounting profession and attempts to improve the quality and transparency of the financial statements issued by publicly traded corporations. The most sweeping audit reform introduced by Sarbanes-Oxley was the creation of the Public Company Accounting Oversight Board (PCAOB), which was established to oversee audits of public companies and their auditors.
Sarbanes-Oxley gives the PCAOB the authority to set auditing standards and auditor independence rules. It also has the authority to perform inspections to ensure that auditors are in compliance with the act, with the rules of the PCAOB and the SEC, and with other professional standards. Furthermore, the PCAOB has the power to investigate and bring disciplinary action against public accounting firms and persons associated with those firms who are accused of and found to be in violation of the provisions of the act, the rules of the PCAOB, or the SEC.
Prior to Sarbanes-Oxley, the AICPA set standards on auditing, quality control, independence, and ethics. The Public Oversight Board (POB), an independent private-sector body charged with overseeing and reporting on the peer review program of the SEC Practice Section (SECPS) of the AICPA Division of Firms, reviewed the quality of audits and the firms performing those audits. The SECPS established quality-control requirements for member firms and required each member firm (all firms that audited SEC registrants) to undergo peer review every three years. The SECPS was also responsible for reviewing allegations of audit failure to determine if there was any breakdown in a firm’s quality-control system. Sarbanes-Oxley shifts all of these regulatory responsibilities from the AICPA, the POB, and the SECPS to the PCAOB, effectively ending the profession’s self-regulation. This change in oversight and standards-setting responsibility temporarily derailed the efforts of global standards setters to attain convergence of global auditing and assurance standards.
The Exhibit summarizes the regulatory and standards-setting responsibilities before and after the Sarbanes-Oxley Act.
The PCAOB’s Powers
The full-time PCAOB is a five-person board appointed by the SEC with consultation from the Board of Governors of the Federal Reserve and the Secretary of the Treasury. The PCAOB must report on its operations to the SEC, and the SEC must report to various Congressional oversight committees annually.
The PCAOB has been granted extensive regulatory powers over the audit and accounting profession, including the following:
- Registering firms that audit public companies, and collecting registration and annual fees from these companies.
- Establishing standards for conducting audits of public companies.
- Establishing quality-control, ethics, and independence rules for auditing firms.
- Conducting inspections of registered auditing firms. Inspections will be conducted annually for firms that audit 100 or more public companies, and once every three years for firms that audit fewer than 100 public companies.
- Establishing procedures for investigating and disciplining public accounting firms for violations of provisions of the act.
In addition, the act permits, but does not require, the PCAOB to adopt preexisting rules established by other professional groups, such as those issued by the AICPA through its various committees. Much as the Securities Acts of 1933 and 1934 granted authority to the SEC to establish accounting principles to be used in financial statements filed with the SEC, Sarbanes-Oxley allows the PCAOB to establish auditing standards for the accounting profession.
The Emerging Global Framework
The International Federation of Accountants (IFAC) is a nonprofit global professional organization of national accounting groups, including the AICPA, that represent audit and accounting professionals all over the world. Through its various committees and task forces, IFAC has promoted convergence of the self-regulatory aspects of the audit and accounting profession. In order to gain worldwide acceptance, especially in the U.S., IFAC remodeled its organizational structure to resemble the structure of the U.S. profession before Sarbanes-Oxley.
In promoting its convergence goals, IFAC has been responsive to the concerns about convergence expressed by national regulatory organizations worldwide, particularly the SEC, whose securities regulatory system governs the trading in more than half the world’s equity market capitalization and in the world’s most heavily regulated market. In 2000, the SEC issued a Concepts Statement on international accounting and auditing standards that called for a global audit and accounting environment with the following features:
- Effective, independent, and high-quality accounting and auditing standards setters;
- High-quality auditing standards;
- Audit firms with effective quality controls worldwide;
- Profession-wide quality assurance; and
- Active regulatory oversight.
In response to the SEC Concepts Statement, IFAC issued a paper titled “Enhancing Financial Reporting and Auditing,” containing initiatives proposed to strengthen IFAC and to improve the global professional accounting regulatory structure. Initiatives proposed in the paper have resulted in the formation of the Forum of Firms, an organization of audit and accounting firms that perform transnational audits that agree to comply with certain quality standards, including accepting quality reviews among its members. IFAC also introduced a program for monitoring the compliance by IFAC member bodies with IFAC standards and other pronouncements. Another initiative has been strengthening and broadening the membership of the International Auditing and Assurance Standards Board (IAASB).
Despite its willingness to work with national regulatory agencies to find workable solutions to local convergence challenges, IFAC has been hard-pressed to resolve its convergence model. Having been heavily influenced by the regulatory framework of the audit and accounting profession in the United States, IFAC had adopted a self-regulatory model. Sarbanes-Oxley, however, caused a sudden shift away from self-regulation in the United States toward a public-private-partnership approach. In order to promote acceptance and to continue to work toward convergence, IFAC has announced plans to restructure its organization and adapt to the changes in the U.S. model.
In November 2003, the IFAC Council announced a set of reforms designed to strengthen the international auditing standards-setting processes and to achieve convergence of international auditing standards. A significant reform was the formation of the Public Interest Oversight Board (PIOB) to oversee IFAC’s standards-setting activities, particularly with respect to auditing, assurance, ethics, and independence. The PIOB will also oversee IFAC’s proposed compliance program. According to IFAC, the objective of the reforms is to increase confidence that the activities of IFAC are properly responsive to the public interest and will lead to the establishment of high-quality standards and practices in auditing and assurance. When the reforms have been enacted, increased public oversight of IFAC’s activities will move IFAC away from its self-regulatory structure toward a more public-private partnership.
The PCAOB and Global Convergence of Auditing Standards
Similar to the manner in which the Auditing Standards Board (ASB) writes auditing and assurance standards under the auspices of the AICPA, the International Auditing and Assurance Board (IAASB; formerly the International Auditing Practices Committee) writes standards under the auspices of IFAC. The IAASB’s 2002 and 2003 annual reports note that more than 70 countries have either adopted its International Standards on Auditing (ISA) or exhibit no material differences between their national standards and the ISAs. The AICPA, one of the organizations that helped found IFAC, has supported the global convergence effort and the common goal of developing one set of high-quality auditing and assurance standards. Prior to Sarbanes-Oxley, conversations had begun about shortening the time frame for reaching this common goal.
The Sarbanes-Oxley Act does not preclude the PCAOB from delegating the task of writing auditing, attestation, quality-control, independence, and ethics standards to a private-sector body such as the IAASB or the ASB. In 1938, the SEC’s first chief accountant, Carman G. Blough, delegated the SEC’s accounting standards-setting authority to the American Institute of Accountants (predecessor to the AICPA). In contrast, it appears that the PCAOB will not designate a professional group to prepare auditing, attestation, quality-control, ethics, and independence rules, and will instead perform these functions from within. In April 2003, the PCAOB issued Release 2003-006, “Establishment of Interim Professional Auditing Standards,” wherein the PCAOB articulated its plans to accept existing AICPA standards on auditing, attestation, quality control, independence, and ethics until such time as it could issue its own. In November 2003, the PCAOB issued Release 2003-023, “Proposed Auditing Standard on Audit Documentation and Proposed Amendment to Interim Standards on Auditing.” This very prescriptive standard confirmed that the PCAOB would be working independently of the IAASB, and elevated concerns that the PCAOB might issue standards that were in conflict with those issued by the IAASB.
Not only are the PCAOB’s standards-setting efforts an impediment to global convergence, they have also created a fissure in domestic standards-setting. The mandate granted to the PCAOB by Sarbanes-Oxley applies only to audits of SEC registrants. Because the auditing, quality-control, ethics, and independence standards written by the PCAOB are not mandatory for auditors of nonregistrants, there arises the possibility that an auditing firm with a combination of public and nonpublic clients worldwide must be mindful of the standards of the IAASB, the PCAOB, and the AICPA’s ASB, as well as the GAO (Government Accountability Office) “Yellow Book” standards. This represents greater potential for divergence than convergence. In the event that the two or more of these bodies issue contradictory standards, questions will inevitably arise as to which standards take precedence.
As of this writing, the PCAOB has not issued formal comments on its views or intentions concerning the ongoing global convergence of the audit and accounting profession. With its new authorities, one might suggest that the PCAOB lacks any real interest in IFAC’s current efforts to promote convergence. With the formation of the PCAOB, the U.S. regulatory structure has significantly reduced the role of self-regulation in the accounting profession. By declining to discuss convergence, the PCAOB has implied that it would like to see the global regulatory framework restructured in a manner similar to the United States’.
Through its ability to register all firms that audit public companies, including foreign auditors, and to require those auditors to participate in its quality-control and quality-review programs, the PCAOB will be able to regulate both national and foreign audit firms involved in the U.S. securities market. Thus, with the ability to regulate foreign audit firms operating in U.S. public markets, the PCAOB lacks a strong vested interest in global convergence.
Unlike earlier securities laws, Sarbanes-Oxley failed to exempt or make special allowances for non-U.S. issuers and their auditors. The act states that “a non-U.S. public accounting firm that prepares or furnishes an audit report with respect to any U.S. public company is subject to the Act and rules of the Board and the Securities and Exchange Commission, in the same manner and to the same extent as a public accounting firm that is organized and operates under the laws of any state in the United States.” This means that non-U.S. registered firms are subject to the PCAOB’s system of inspections and investigations. The objections to these requirements have been strong and numerous. The PCAOB responded with a proposed rule that would permit reliance on the work of oversight systems in other jurisdictions, based on a sliding scale: The more independent and more rigorous a local oversight system, the greater the PCAOB’s reliance on that system. In evaluating the oversight system, the PCAOB would consider the adequacy and integrity of the system; the independence of the system’s operation from the auditing profession; the nature of the system’s source of funding; the transparency of the system; and the system’s historical performance. In other words, the PCAOB would rely on local oversight systems that were in essence structured the same as its own.
At present, the U.S. political environment may hamper any effort by the PCAOB to get significantly involved in global convergence. When it formed the PCAOB, Congress was addressing real and perceived audit failures and the cost of such failures, which occurred in the audits of U.S. public companies. The PCAOB has no official mandate to involve itself in global convergence and related activities, except to the extent that those efforts are related to improving the conduct of audits of public companies in the United States. Projects that might interfere with or delay the PCAOB’s efforts will likely expose the board to significant criticism from Congress and the SEC.
Outside of the United States, some market regulators have responded to the change in the U.S. regulatory environment with similar regulatory proposals. For example, the European Union (EU) recently issued a series of proposals to improve the quality of statutory audits conducted within its member countries. The EU proposals include a number of elements that are now part of the U.S. regulatory environment, including the following:
- Establishing a legal basis for the conduct of the audit;
- Establishing an audit regulatory oversight organization, thus reducing professional self-regulation;
- Working toward EU member-state adoption of auditing standards issued by the IAASB by 2005;
- Studying the need for revisions to the auditor code of ethics and independence standards; and
- Establishing enforcement and sanctioning procedures for auditors that violate EU regulatory requirements.
Other than the proposal to adopt the uniform auditing standards issued by the IAASB, the EU proposals suggest that the new U.S. audit and accounting regulatory environment, particularly in limiting the role of the profession, will probably have a major influence on future efforts to establish a convergence model for a global auditing and accounting profession.
Jill P. Giles, PhD, CPA, is an assistant professor in the department of accounting and taxation at the Stillman School of Business of Seton Hall University, South Orange, N.J.
Elizabeth K. Venuti, PhD, CPA, is an assistant professor in the department of accounting, taxation, and legal studies in business at the Zarb School of Business, Hofstra University, Hempstead, N.Y., and a member of the NYSSCPA’s International Accounting and Auditing Committee.
Richard C. Jones, PhD, CPA, is an associate professor, also in the department of accounting, taxation, and legal studies, at the Zarb School of Business, Hofstra University.