By: Eric Ettorre
The Sarbanes Oxley Act of 2002 was created in the wake of the Enron scandal, in which the company committed planned accounting fraud.[1]Section 106 of the Sarbanes Oxley Act codifies audit rules for foreign public accounting firms.[2]It states that any foreign public accounting firm that prepares or furnishes an audit report with respect to any issuer, shall be subject to Sarbanes Oxley rule to the same extent as public accounting firms that are organized and operate under U.S. laws.[3]Sarbanes Oxley creates a central oversight board tasked with registering auditors, defining the specific process and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of Sarbanes Oxley.[4]This article focuses on Section 106 of Sarbanes Oxley, explaining that the SEC needs access to critical audit information from non-U.S. firms in China to ensure investor safety and to give investors insight into possible future investments.[5]
Though Sarbanes Oxley was designed to mitigate audit issues, the U.S. Securities and Exchange Commission (“SEC”) continues to struggle with access to audit papers to oversee the quality of audit firms in China.[6]On December 7, 2018, the SEC issued a statement that the Public Company Accounting Oversight Board (“PCAOB”) cannot gain access to inspect the audit work and practices of PCAOB-registered auditing firms in China.[7]The PCAOB wishes to inspect the audit work of U.S.-listed companies with operations in China.[8]For example, there are 224 U.S.-listed companies (with $1.8 trillion in combined market capitalization) where the PCAOB faces obstacles in inspecting the principal auditor’s work.[9]
Undoubtedly, this raises issues for the SEC, whose three-part mission is to protect investors, maintain fair and efficient markets, and facilitate capital formation.[10]The SEC regulates the world’s largest securities markets; therefore, the SEC must regulate beyond the U.S. border. For this exact reason, institutions and systemized paperwork like the International Organization of Securities Commissions (“IOSCO”) and Multilateral Memoranda of Understanding exist.[11]These two forms of international cooperation facilitate interactions in the growing multilateral securities market.[12]With global cooperation, audit firms can fulfill necessary audit filing requirements, like those in Section 106 of Sarbanes Oxley.[13]Moreover, the SEC gives jurisdiction to the PCAOB on a case-by-case basis to help companies struggling to provide high quality audit papers by implementing different, prescriptive practices and procedures to improve future audits.[14]
A quality audit paper is beneficial to both the United States and China. More investors can partake in purchasing shares in Chinese companies and more investors become sophisticated in investment practices in the United States.[15]If more people invest in the stock market, then economic growth is facilitated in the United States.[16]For example, consider a company with all or substantially all of its operations in Hong Kong. Through a listing and offering in the U.S, the company raises a substantial portion of its capital in the U.S.[17]It would not be suitable for the financial regulators in the U.S. to limit their review of the company’s financial reporting solely to activities in the U.S.[18]Therefore, the information in Hong Kong is essential to effective oversight.[19]Investors in the U.S. markets should expect U.S. regulators to have access to review of a consolidated audit of a multinational company.[20]
Access to credible audit working papers is incredibly important to fulfilling the SEC’s regulatory mission.[21]It creates certainty for investors and strengthens the global trend of integrated markets.[22]Continued misguidance is a significant detriment to both the U.S. and China’s markets.[23]Audit information is critical to make investment decisions for all investors, and until the Chinese-based audit firms become more transparent, the SEC will struggle to rectify this conundrum.
[1]William W. Bratton, Enron and the Dark Side of Shareholder Value, 76 Tul. L. Rev.1275, 1276-77 (2002).
[2]The Sarbanes Oxley Act, 15 U.S.C. 7216 (2002).
[3]Id.
[4]See id.
[5]See Jay Clayton, 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(Dec. 7, 2018), https://www.sec.gov/news/public-statement/statement-vital-role-audit-quality-and-regulatory-access-audit-and-other[hereinafter SEC Audit Quality Discussion]
[6]Id.
[7]Id.
[8]See generally id.(considering the PCAOB needs audit information on non-US firms that have a substantive impact on the U.S. markets).
[9]Public Companies that are Audit Clients of PCAOB-Registered Firms from Non-U.S. Jurisdiction where the PCAOB is Denied Access to Conduct Inspections, Pub. Co. Accounting Oversight Bd.(Sept. 20, 2019), https://pcaobus.org/International/Inspections/Pages/IssuerClientsWithoutAccess.aspx[hereinafter PCAOB Denied Access].
[10]SEC Audit Quality Discussion, supranote 6.
[11]Id.
[12]See id.
[13]The Sarbanes Oxley Act, 15 U.S.C. 7216 (2002).
[14]PCAOB Denied Access, supranote 7.
[15]See id.
[16]SEC Audit Quality Discussion, supranote 5 (understanding that a goal of the SEC is to facilitate capital market growth and that more clarity from audit papers will allow more investors to take adequate steps into investing in these particular countries).
[17]See id.
[18]See id.
[19]See id.
[20]See id.
[21]The Sarbanes Oxley Act, 15 U.S.C. 7216 (2002).
[22]See SEC Audit Quality Discussion, supranote 5.
[23]Id.
