The rules before the Board today present one of the more difficult policy decisions we have faced in the nearly six years that the Board has been operating. I support adopting the one-year deferral of certain 2008 inspections and proposing for comment the three-year deferral of certain 2009 first inspections. However, the road to that conclusion has not been easy.
Section 104 of the Sarbanes-Oxley Act directs the Board to inspect every registered firm that regularly provides audit reports on 100 or fewer SEC-registered companies once every three years. Section 106 makes clear that non-U.S. firms should be treated the same as U.S. firms in this and other respects. By rule, the Board has provided that the first inspection of a firm that registered in 2003 or 2004 need not occur for four years. Another rule provides that the four years does not begin to run until the year after the year in which a firm audit report is filed with the SEC. Under this regime, the latest year in which many non-U.S. firms that registered in 2004 must have their first inspections is 2009. Proposed Rule 4003(g) would extend that deadline from 2009 to 2012 for 50 firms in countries where we have not yet conducted an inspection.
While the Board has successfully inspected 123 non-U.S. firms in 24 jurisdictions, there are practical limits on our ability to rapidly increase the number of countries in which we perform inspections. Overseas inspections generally must be preceded by time-consuming discussions with the home country regulator. In addition, foreign inspections sometimes require the resolution of thorny issues under non-U.S. privacy and other laws. These factors, along with a desire to work cooperatively with our non-U.S. counter-parts and to be respectful of the sovereignty of other nations, have understandably slowed the first cycle of foreign inspections.
Nonetheless, I have been reluctant to support any proposal, like Rule 4003(g), that could have the effect of delaying until 2012 the first inspection of firms that registered with the Board in 2004 and that have issued one -- and perhaps more -- audit reports that are filed with the SEC. The Board was created to further the interest of U.S. investors in informative, accurate, and independent audit reports on the financial statements of companies that have SEC-registered securities. Lengthy deferrals of first inspections of non-U.S. firms seem to me to undermine what Congress sought to accomplish in creating the Board and directing it to perform inspections according to a regular cycle.
Despite these reservations, I have become persuaded that the three-year deferral in proposed Rule 4003(g) strikes an acceptable balance between the practical difficulties of laying the groundwork for inspections in multiple jurisdictions and the Board’s statutory mandate. I base that conclusion on four elements of the release we are considering today.
- First, the scheduling of the 50 deferred inspections would take the protection of U.S. investors into account. In 2009, the Board would commit to inspecting at least four firms that together audit over 35 percent of the total market capitalization of all of the deferred firms. Market capitalization, while not a perfect measure, is relevant to the potential impact of these firms on U.S. investors. By the end of 2010, the percentage of deferred firm market cap that will have been inspected would climb to 90 percent.
- Second, in order to make the Board’s foreign inspection plans clear, we will publish at the beginning of each year a list of the countries in which inspections will be performed. Countries will not be deleted from that list without a public explanation.
- Third, the proposed 2009 deferral is accompanied by a proposal to publish a list naming every firm that has not been inspected despite the passage of four years since an audit report prepared by that firm was filed with the SEC. This list would afford investors transparency concerning cases in which they may be relying on audit reports of firms that have not been inspected according to the Board’s normal schedule.
- Fourth, the release invites comment on steps the Board might take by rule when non-U.S. firms decline to cooperate in a Board inspection. These include disclosure to investors in the firm’s audit reports of the absence of an inspection and similar disclosure in audit reports of other firms that use the non-inspected firm’s work in their audits. Of course, the Board would also consider taking enforcement action against non-cooperating foreign firms.
Linking the proposed deferral with these measures is intended to address the interests of investors in U.S. securities, and I hope investors will comment on that approach. I recognize, however, that non-U.S. firms and regulators may be less than enthusiastic. My support of the release is not intended to suggest that I have lost interest in cooperating with other audit oversight bodies. On the contrary, I believe that, in the long run, we will only be able to fully accomplish our mission if we work jointly and cooperatively with our counter-parts. I view the proposed release as consistent with both that goal and with our obligation to conduct the statutorily-required first inspections of audit firms based outside the U.S.
I want to conclude by noting that this release has not had an easy birth. Carl Calendar, Rhonda Schnare, and Michael Stevenson have devoted much time, effort, and thought to the project. As the draftsman, Michael, in particular, has had to tolerate an even higher than usual number of Board-level editors and critics -- which he has done with his usual professionalism. I want to thank all three of you for your dedication and hard work.