I appreciate the opportunity this morning to participate in your discussion of global risk and regulation. When I received the invitation to speak here today, I initially wondered what perspective I could offer a group of tax experts that would be of value. The literature describing the intent of this conference provided the answer. Your focus during these two days will include analysis of the impact of regulatory and control regimes, financial disclosures and multi-jurisdictional oversight. Further, I only had to get to the second paragraph of the introductory letter from Roger LeMaster and Douglas Bates before the Sarbanes-Oxley Act was mentioned. At that point I had a clear sense of how I could contribute to your deliberation at this conference. My themes today will include the evolution of regulatory entities such as the Public Company Accounting Oversight Board (PCAOB), multi-jurisdictional challenges for entities such as ours, and the growing importance of cross-border coordination. Hopefully, our experience can contribute to your understanding of these important issues.
Before I go further, I must note that the views I express today are my own, and not necessarily those of other Board members or staff of the PCAOB.
Financial disclosure played a fundamental role in the creation of the PCAOB. That is, the PCAOB is a creature of a crisis of confidence in financial reporting. This fits with a historical pattern. In the United States, Congressional responses to crises over time have created today’s regulatory infrastructure. In passing the Sarbanes-Oxley Act of 2002, Congress sought to restore investor confidence and address serious gaps in the U.S. regulatory framework that were identified through the financial scandals of 2001-2002. Congress called for the establishment of the PCAOB to oversee the auditing profession with respect to the profession's audit work for companies whose securities trade publicly in U.S. markets. While the crisis in confidence has abated, the regulatory entity (the PCAOB) remains This too is consistent with regulatory history in the United States – the Federal Reserve, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission, to name a few, all are entities established by Congress post-crisis that remain in operation today and have evolved over time.
With regard to your theme of multi-jurisdictional challenges, it is worth pointing out that the PCAOB’s oversight mandate specifically includes the audits of non-U.S. issuers that elect to have their securities trade in U.S. markets. Thus, certain non-U.S. audit firms became subject to PCAOB oversight. From the outset these were challenging and somewhat controversial provisions that required careful consideration and implementation by the PCAOB. While we have begun to implement many aspects of these provisions, they continue to evolve as we learn more from our experience. Most importantly, since the PCAOB was created, we have seen a number of similar auditor oversight bodies established throughout the world. This will have an increasingly important and positive impact on our work.
The PCAOB is seeking to implement the provisions impacting non-U.S. firms in a balanced and effective way. In my judgment, the best way for the PCAOB to achieve its mandate is for it to closely coordinate its work, where possible, with non-U.S. counterparts. Coordination is critical in light of the fact that firms often audit issuers in more than one country, and because audits of globally active issuers often require that the auditor coordinate the work of multiple affiliated and/or non-affiliated audit firms that may be headquartered in numerous jurisdictions. As other auditor oversight bodies have emerged around the world, coordination in order to achieve mutual objectives and reduce unnecessary overlap has become a greater possibility for the PCAOB.
There is a natural degree of variation in the approach to auditor oversight taken by other bodies, and we are cognizant that certain differences may provide opportunities for what a tax practitioner might call regulatory arbitrage. This is one of the many motivations for auditor oversight bodies to coordinate globally and share approaches. As oversight bodies have the common goal of enhancing confidence in financial reporting through effective auditor oversight, coordination will not only enhance mutual understanding among oversight bodies but also assure that we are not promoting a regulatory "race to the bottom."
To give you context, I should give those of you who may not have dealt with the PCAOB before a brief synopsis of our mandate. As I just mentioned, the Sarbanes-Oxley Act established the PCAOB as the independent auditor oversight body in the United States. The PCAOB’s mission is to oversee the auditors of public companies, protect the interests of investors, and further the public interest in the preparation of informative, accurate, and independent audit reports. The PCAOB does this through its standards setting, inspections, enforcement, and outreach programs.
Since the PCAOB opened its doors in January 2003, it has registered more than 1,750 accounting firms that audit, or wish to audit, U.S. public companies. Once registered, these firms become subject to the PCAOB’s supervisory oversight and must use PCAOB standards when they audit public companies.
In carrying out its mandates, the PCAOB cooperates closely with the Securities and Exchange Commission, not only because the SEC oversees the PCAOB’s activities, but because the PCAOB and the SEC share the mutual objective of investor protection.
The PCAOB continues to explore ways to improve its audit requirements and their implementation by audit firms, while preserving the intended benefits. For example, at the moment, the SEC and the PCAOB are closely coordinating work on implementing Section 404 of the Act, which covers internal control over financial reporting.
In order to discuss global coordination, it is worth going into a bit more detail on the PCAOB’s inspection role, which is a key component of the PCAOB auditor oversight program.
As I mentioned, public accounting firms that are required to register with the PCAOB are subject to the Board’s inspection program. PCAOB inspections replaced the audit profession’s previous peer reviews, which focused on compliance with applicable standards but did not address the overall audit environment. PCAOB inspections are risk-based and designed to identify auditing problems at an early stage and focus firms on correcting them. This approach is designed to provide a constructive exchange between firms and the PCAOB, and we have observed that concerns identified during inspections are often promptly addressed by the firm being inspected.
As a former banking supervisor, I am very comfortable with the concept of “home” and “host” supervisors. I understand the value of supervisory frameworks where the responsibility for overseeing globally-active entities can be shared among a number of financial regulators. By doing so, supervision is enhanced and the burden on the supervised organization can be controlled. In banking supervision, the home-host model has evolved over time.
Twenty years ago, and particularly prior to the Bank of Credit and Commerce International (BCCI) scandal, banking supervisors had a less-developed approach to cross-border supervision. Coordination was more episodic, unlike today’s more continuous coordination model. Importantly, at that time, banking organizations themselves often conducted operations in a relatively decentralized manner and local activities were not heavily dependent on either services or risk management infrastructure that resided in other locations. Banking organizations and supervisors were primarily focused on understanding and managing the individual pieces of the organization as opposed to looking at the consolidated organization.
Of course, it is important to observe that the risk management challenges faced by global banking organizations -- with their ability to book and manage highly correlated risks in numerous physical locations, and their ability to transmit risk directly into the financial system -- are different from those faced by global audit firms. However, as I mentioned earlier, today’s global banking organizations and audit firms are both often critically dependent on the activities occurring in multiple geographic locations.
In the wake of BCCI, global banking organizations and their supervisors moved toward enterprise-wide risk management models, where risk exposures and interdependencies can be appropriately assessed and managed on a consolidated basis. For the largest and most globally-active banking organizations this often involves ongoing coordination by the responsible parties.
In the banking supervisory model, each supervisory authority - whether home or host – must maintain a robust oversight system, which includes not only the ability to coordinate with other supervisors on a routine basis, but also to respond quickly and effectively to any supervisory concerns. This can become more challenging when an entity is subject to oversight in multiple jurisdictions, due to the potential for different statutory objectives between home and host authorities. I would say that auditor oversight bodies are aware of this challenge, and we are in the early stages of developing mechanisms of coordination.
As I mentioned, the PCAOB faces an interesting challenge with respect to the inspection of registered firms located outside of the United States. Congress mandated that public accounting firms, whether located in the United States or elsewhere, would be subject to PCAOB oversight with respect to that part of their practice that relates to preparing audit reports for issuers whose securities trade in U.S. markets and who must file audited financial statements with the SEC.
When the Act was passed, representatives of foreign regulators, governmental bodies, and firms expressed concern about the prospect of PCAOB oversight of non-U.S. firms.
Due to these concerns and the practicalities involved in developing an effective oversight program, the PCAOB has made it a priority to reach out to its non-U.S. counterparts. The early fruits of these relationships already are evident. In the short time that the PCAOB has been in operation, it has developed a registration and inspection program that takes into consideration the factors unique to non-U.S. firms.
I believe that our approach to inspections of non-U.S. firms should continue to evolve, particularly as our non-U.S. counterparts grow in numbers and capacity. I am encouraged, as I mentioned a moment ago, that in recent years we have seen a number of countries undertake similar efforts to enhance auditor oversight. While auditor oversight bodies around the world may be taking a variety of approaches in implementing auditor oversight models, we all share the objective of improving public confidence in the credibility of audits of financial statements. If closely coordinated, this will help to limit regulatory arbitrage and promote a global confidence in financial reporting, and more specifically audited financial statements. This is good for all markets.
Due to the increasingly global footprint of large audit firms and the increasing inter-relationships between capital markets, auditor oversight bodies must continue to find ways to enhance coordination of work and exchange experiences.
I place a high level of value on cross-border coordination and global dialogue among auditor oversight bodies. Most importantly, I view our auditor oversight role as a shared objective when a firm is registered in more than one jurisdiction. I see enhanced coordination as a priority for the PCAOB. Among other things, it will require that we work to ensure that the PCAOB has developed an oversight program that effectively takes into consideration the level of "home country" supervision for non-U.S. firms.
To illustrate the importance of regulatory coordination to the PCAOB, more than 750 of the over 1750 firms registered with the PCAOB are in countries outside the United States, although they may be affiliated with large, U.S. based audit firms. As required by the Sarbanes-Oxley Act, many of these firms are registered with the PCAOB because they audit non-U.S. companies whose securities trade in U.S. markets and are required to file audited financial statements with the SEC. In addition, as also provided for in the Act and the Board's rules, a number of other non-U.S. firms are registered because they audit or wish to audit significant non-U.S. subsidiaries of multinational U.S. companies. With respect to both categories of firms, the PCAOB continues to work closely with its foreign counterparts to minimize unnecessary overlap and achieve our shared objectives in the oversight of these non-US firms.
Under the PCAOB’s rules, in appropriate cases, the PCAOB may rely on the inspections and other work of those oversight bodies in achieving its own oversight mandate. Specifically, the PCAOB rules enable it to rely on the work of the home-country regulator and to assist non-U.S. authorities in their oversight of U.S. audit firms that are within the regulatory jurisdiction of the non-U.S. authorities.
The PCAOB’s degree of reliance on home-country inspections is framed by our rules to be based on the independence and rigor of the home-country system of oversight and agreement between the PCAOB and the home-country regulator on the inspection work program for individual firms. The more independent and rigorous the home-country system, the more the PCAOB rules indicate the PCAOB can rely on its counterpart to conduct an inspection of a PCAOB-registered firm. The PCAOB’s approach with its counterparts continues to evolve, as we continue to reach out to them in order to appropriately coordinate our inspections outside of the United States.
We at the PCAOB are keenly aware of the potential for unnecessary, duplicative regulatory costs, and the sensitivity surrounding issues such as data protection and having PCAOB personnel inspect the files of non-U.S. firms. We must continue to work with our counterparts around the world to minimize the burden of potential duplicative and/or contradictory regulation at the same time that we fulfill our statutory obligations to investors and the public. The establishment of new, independent auditor oversight systems in other countries will enable more efficient and effective regulation of global audit firms. This is important for investors who are also global.
Any discussion of cross-border regulatory regimes always raises the issue of a level playing field so let me use this as a segue to the important subject of how we, as overseers of the audit profession, see our work intersecting with the vitality and integrity of the capital markets.
I understand that the panel that follows my remarks this morning will discuss the costs and benefits of financial reforms – looking at the trend toward enhanced information sharing, disclosure and enforcement in response to wrongdoing. Increasingly, policy makers are involved in the debate over U.S. competitiveness, and on the ever-important need to strike the right balance with financial regulation. In the areas of financial regulation and standard setting, this balance must not only weigh costs, but also bear in mind the importance of ensuring our investors are provided ample transparency and protection. Regulators should continuously monitor the impact and value gained from their regulations.
In this regard, Sarbanes-Oxley has been the focus of intense discussion. It has now been over four years since the corporate scandals rocked investor confidence and led to the passage of Sarbanes-Oxley. We are now starting to evaluate the extent to which investors are recognizing improvement in the reliability of financial reporting by U.S. public companies. That is, today we are in a better position to reflect on the impact of the Act and whether we are on the right track in achieving its objectives. I believe we have seen a restoration of investor confidence in financial reporting. We are also seeing audit firms realign their business models to focus on quality audit services, ethics, and appropriate levels of independence. These are all positive benefits.
With regard to Sarbanes-Oxley, particularly Section 404 which addresses internal control over financial reporting, the PCAOB understands that these milestones have not been reached without cost. For example, we continue to hear concern that the costs associated with Section 404 have weakened U.S. markets, pointing to recent growth in non-U.S. markets. The PCAOB monitored the implementation of its standard issued under Section 404 closely and acted in December through the release of a proposed standard to replace this standard. The proposal package seeks to achieve a better alignment of the costs of these audits with their benefits. The PCAOB’s work will continue, but we believe that the proposal responds to many of the concerns that emerged during the early implementation of the current PCAOB standard.
Recent reports have criticized U.S. financial regulations as moving companies away from U.S. markets. To be sure, the position of the U.S. in relation to other financial markets has changed since the early 1990s.
For one, many markets outside of the United States have grown to become global players, due to a number of factors, including ease of information exchange and the reduction of certain barriers to cross-border transactions. As a result, companies today are presented with more options when they are determining where to raise capital.
Regulatory regimes as well as local political and cultural influences are often factored into this decision. We should welcome competition among markets around the globe but not support a competition that is based on cost alone. I still believe that having the right balance of oversight and regulation protects the reliability, stability and depth of U.S. capital markets, so they can continue to attract investors and issuers worldwide.
We should not lose sight of the fact that listings on U.S. markets continue to command a valuation premium. Indeed, in the two years since companies have been reporting and obtaining audits on their internal control, the amount of capital raised by non-U.S. companies on U.S. exchanges has grown, not shrunk as it did in the years directly after the scandals. Even with the expansion of equity markets in other countries, I expect that we will see a continued dominance of U.S. capital markets, particularly in the long term. However, this does not mean that there is no cause for action. It is healthy and appropriate for financial regulators, policy makers, and others to enhance our debate over the appropriate level and nature of financial supervision and regulation in the United States and other factors that may affect the decision to list on U.S. financial markets.
The PCAOB works hard to achieve its objectives, but part of this hard work is looking carefully at programs and requirements, and their impact. I am encouraged that the PCAOB oversight program is contributing to a reduction in the risk of financial reporting failures and a renewed confidence in financial reports of publicly traded companies and ultimately in the U.S. securities markets.
The Board continues to assess its oversight program, however, and will make appropriate adjustments to assure that it achieves the objectives of the Act in the most effective and efficient manner possible. The PCAOB model clearly resonates in countries that are seeking to strengthen the integrity of their own capital markets, and we are pleased that other nations are implementing similar models to auditor oversight.
While, as I have described, it is important to eliminate unnecessary regulatory costs, vigilance in that regard should not detract from the fundamental reasons for the long-standing strength of U.S. markets. That strength has been due in large part to the high quality standards and investor protections that have been the trademark of U.S. markets for decades. For the PCAOB, it is our job to identify efficiencies so that the implementation of our requirements can achieve intended results without unintended costs.
Thank you again for inviting me to speak with you today.
 Remarks of Noreen Culhane, Executive Vice President, Global Corporate Client Group, New York Stock Exchange, printed in Ernst & Young, Accelerated Growth: Global IPO Trends 2006, at 26 (An "underlying motivation for most companies listing in the U.S. is the valuation premium (average 30 percent) that accrues as a result of adhering to high standards of governance.")
 See Cowan, Lynn, “Foreign Companies Cash in on U.S. Exchanges, Wall Street Journal, August 28, 2006, at C6.