Above: “Fraud can occur in any market … but in emerging markets, we do see some difficulty in getting accurate information,” PCAOB Chief Auditor Martin F. Baumann told attendees at the FAE’s SEC Conference on Oct. 4.
Below: The PCAOB’s Division of Registration and Inspections Director Helen A. Munter speaks about growing concern over multinational audits during the FAE’s Oct. 4 SEC Conference.
PCAOB examines multinational audits for fraud
By CHRIS GAETANO
Public Company Accounting Oversight Board representatives discussed two of the board’s recent efforts to expand its role in audit supervision both in the United States and overseas at the FAE’s SEC Conference on Oct. 4.
Increasing concern about multinational audits—some of which are performed outside PCAOB standards and specifications—has already prompted the PCAOB to issue a staff alert informing auditors about the matter and instructing them on how to deal with potentially increased audit risks, said Helen A. Munter, the new director of the board’s division of registration and inspections, during her speech. A letter from SEC Chair Mary Schapiro to Rep. Patrick T. McHenry (R-N.C.) in April revealed that, as early as two months into 2011, more than 24 China-based companies filed Forms 8-K to report auditor resignations, accounting irregularities or both.
The PCAOB has been working to better understand how such audits are performed and has prioritized working out agreements with regulators from other countries in order to do so, she said.
“We want to be able to see all aspects of multinational audits,” Munter explained. Audit quality is of particular concern when engagements are performed, not only across national borders, but also through third-party affiliated firms outside the U.S., Munter said. For example, the PCAOB has observed some registered U.S. auditors issuing audit reports on financial statements of entities operating mostly outside the U.S., and basing those reports on work performed by non-PCAOB registered auditors in countries that don’t follow board standards, she said. This issue is mostly associated with developing economies and poses increased audit risk that the PCAOB seeks to address, Munter added.
“Work done in emerging markets, particularly China, do contain more risk. …We will tend to select some of those audits to look at and we would expect to see the work that was done,” she said.
PCAOB Chief Auditor Martin F. Baumann, during his own presentation at the conference, agreed that there has been increased audit risk associated with emerging markets, since it can be tough to assess the accuracy of information that comes out of them.
“Fraud can occur in any market … but in emerging markets, we do see some difficulty
in getting accurate information,” Baumann said.
He pointed to the case of reverse mergers, a practice that the PCAOB is “looking deeply” into. Reverse mergers allow a company to go public just by being acquired by a publicly traded U.S. company—usually a shell company set up for the sole purpose of engaging in the merger.
The board released a staff audit practice alert in July 2010, informing practitioners of some of the more problematic aspects of reverse mergers. It followed up with a PCAOB research note on March 14, which revealed that reverse mergers involving Chinese companies from January 2007 to March 31, 2010, were almost triple the number of initial public offerings conducted in the U.S. by Chinese companies during that time. The PCAOB, in the research note, said that while reverse mergers aren’t “inherently inappropriate,” they can result in a company that has all of its operations based in China, its securities traded in the U.S., and financial statements prepared by U.S. auditors who may not be conducting their work in accordance with PCAOB standards. In such cases, the U.S.-registered firm may have provided auditing services of which most or all of the work was done by another company, possibly located in another country.
To address this, the PCAOB is working with foreign regulators to conduct international inspections of international audits, Munter said. In 2012, the PCAOB expects to increase the number of international audit inspections it conducts, she said. The board has already conducted 290 inspections of non-U.S. firms in 35 different jurisdictions, she said.
The PCAOB has also established cooperative agreements with several countries, including Israel, Norway, Switzerland, Taiwan and, most recently, Dubai, which allow its inspectors to share information and conduct joint inspections with regulators in each country. Forging a similar arrangement with China “is one of our highest priorities,” Munter said. But China has concerns about what such an agreement might mean for its own sovereignty and has been reticent so far, she said.
“Which is especially troubling” in the context of China’s rapid economic growth, she pointed out.
During the question-and-answer period, one audience member asked whether the PCAOB would consider deregistering Chinese companies that don’t allow American inspectors to examine their audits.
Munter said the board is still working hard to reach an appropriate agreement and that she still thinks that inspections are the best way to address the concerns the board has about Chinese audits. “If we can’t make progress, we will have to deal with that” and look into other options, she added.
But the PCAOB isn’t only focused on international affairs. Baumann said that the board is working to expand the use of its auditing standards in the U.S. as well, by taking on a pilot program for broker-dealer auditor inspections.
Under the Dodd-Frank Act, the PCAOB is vested with oversight authority of the audits of SEC-registered broker-dealers, which means the board is capable of inspecting the work of broker-dealer auditors— similar to how it inspects audits of public companies. The board has already adopted an interim program to begin inspecting auditors of broker-dealers in order to identify and address significant issues it finds with these audits.
However, unlike the public company inspection program, the board will not issue firm-specific reports for broker-dealers. The initiative will inform the PCAOB’s efforts to eventually craft a permanent program expected to be proposed by 2013, according to the PCAOB’s website.
Baumann was confident that the PCAOB had the capabilities to properly inspect broker- dealer auditors. “By and large, audits of broker-dealers are not that much different than other financial institutions, like a bank,” he said.
Baumann said broker-dealer audit inspections would emphasize the testing of assets, noting that the PCAOB’s expanded jurisdiction was in direct response to the Bernie Madoff scandal.
“Those assets, your assets … I want to know that those assets do, in fact, exist,” he said. Munter, who also discussed the initiative, said that the PCAOB hopes to inspect five or six firms this year as part of the interim inspection program. They’re not looking at large numbers because the board is currently in the information-gathering stage, and wants to gain a better understanding of who these firms are and how they operate, she said.