As others have noted, this has been a challenging rulemaking, The Board is in the undesirable position of having to delay certain inspections . It’s important to consider the lessons we should learn from this experience. But it’s also necessary to chart a new course for the future. Our paramount concern must be to protect the interests of investors in U.S. securities. I think the proposal before us today would provide a responsible foundation to do so.
Let me address briefly the lessons our experience should teach. First, at a time when we should have been focusing on how to complete our inspections, we took a detour. One year ago, the Board proposed a policy to place full reliance on other countries’ local inspections, if they met certain conditions. But that policy could never have helped the Board complete the inspections that were necessary this year, or that will be necessary in the next few years.
Even in the best of situations, our counterparts typically do not retain the work papers we need for our inspections. Moreover, many jurisdictions – even those with large markets and very large and complex accounting firms – have only a handful of inspectors. The future will tell whether such limited resources will be adequate to address even their own needs, much less ours.
Second, the approach the Board has taken to put off non-U.S. inspections to allow countries time to set up their own oversight bodies has resulted in some cooperation. But in many jurisdictions the time has been used to set up impediments. Firms, their clients and others have a strong incentive to lobby for such roadblocks. Our approach needed to counterbalance this incentive.
Make no mistake. I have supported achieving our mandate through cooperation with local authorities as a way to avoid unnecessary conflicts. But avoidance of conflict cannot mean avoidance of inspection.
The Board’s release includes a description of the ramifications of firms’ failure to cooperate. Importantly, the release also states that non-U.S. legal restrictions and sovereignty concerns of local authorities are not a sufficient defense in a Board disciplinary hearing for failing to provide information requested in an inspection. Firms register voluntarily in order to audit the financial statements of U.S. public companies, and they may withdraw from registration if they do not believe they can comply with the conditions that attach to registration. The Congress that passed the Sarbanes-Oxley Act was no doubt familiar with the types of legal conflict issues that might be raised to resist cooperation with an inspection, but the Act makes no exception for them. Our release asks for comment on actions that may be necessary and appropriate to protect investors, and I encourage the public to provide us that comment.
As for the proposed deferrals, the Board’s need to put off the 21 uncompleted inspections required in 2008 has become a fait accompli. The proposal to spread the 50 inspections required by 2009 over a period of four years is just that – a proposal. It presents the Board with an important trade-off to consider. That is, setting aside the problems we’ve encountered commencing inspections, when we do conduct them, they must be meaningful and not mere compliance exercises.
We still have much work to do to build our non-U.S. inspections program. I’d like to say we can complete all required inspections with the highest quality. But the reality is that deferring an inspection may allow us to do a better inspection in the end. Specifically, as I discussed last week at our open meeting on the budget, our inspections need to focus on the substantial risk that referred work on multi-national audits presents. Today, they don’t. In addition, many registered non-U.S. firms are members of global networks and rely on regional quality control functions. Our Inspections division needs to develop a strategy to evaluate those quality control functions in the context of local non-U.S. inspections, which we’ve only begun to consider in past inspections.
Closely related, our Office of Research and Analysis has had limited involvement in non-U.S. inspections to date. At home, the group provides substantial risk assessment materials to assist in planning individual inspections. I hope the additional time would also allow ORA to institute a practice of providing planning advice for non-U.S. inspections too. Indeed, risk assessment is particularly important in these inspections, given that many of the firms are quite large and yet our window into them is limited to a small number of audits.
I welcome comment on the trade-off the proposed 2009 deferral presents. If the deferral would enhance inspection quality, I think it’s worth considering. But it is by no means a clear solution. The risk associated with non-U.S. registered firms is significant for investors. Moreover, that risk is increased by the fact that non-U.S. firms are not subject to our interim standard requiring concurring partner reviews, which might have provided provisional investor protection pending an inspection. In February, we proposed a new concurring review standard that would apply to all registered firms. I hope we will act on that standard soon, but it will not be in place for at least part of the deferral period.