Thank you for this wonderful honor. It is a privilege to be chosen as a recipient of this award, and be included with the distinguished Henry Kaufman, who will also be honored here tonight.
I want to thank the members of the Foreign Policy Association and Noel Lateef for their interest in the work we are doing at the PCAOB to improve the reliability, credibility and transparency of public company audits.
I also want to thank Paul Volcker, for the support you have provided the Public Company Accounting Oversight Board for its mission and through your service as a wise advisor to us for many years.
For nearly a century, the Foreign Policy Association has guided our nation to a deeper level of discussion and intellectual debate about foreign policy matters that have a direct effect on the direction of our country. I very much appreciate that the FPA sees the importance of accounting and auditing to providing the groundwork for many of the most important, "Great Decisions" — to use the FPA's inspiring lexicon — that the American people and their elected representatives must make.
President Franklin Delano Roosevelt once said, in a letter to Major General Frank McCoy, who was then President of the FPA, that "In a democracy the government functions with the consent of the whole people. The latter must be guided by the facts."
President Roosevelt recognized the FPA's significant contribution made to the advancement of great decisions by, in a non-partisan way, educating people about the facts. This, of course, is the objective of audits too, which Major General McCoy would have understood well.
McCoy began his military career as an aide to Leonard Wood in Cuba during the Spanish-American War. After the war, he and Wood, who became Military Governor of Cuba, worked together to establish democratic reforms in Cuba.
Their efforts were assisted by the work of Charles Waldo Haskins and Elijah Watts Sells, two prominent accountants who were hired by the U.S. government to examine the accounts of Cuba after the Spanish left.
In 1902, Wood moved on to the Philippines, where he served as commander of the Philippines Division. McCoy followed him, and after the conflict was won, Haskins and Sells again came in to assess the financial status of the state.
These experiences in building democracy influenced the careers of all these men. McCoy of course went on to become President of the FPA. Haskins and Sells formed an accounting firm that today is the cornerstone of one of the largest global accounting firm networks in the world.
As elusive as democracy proved to be in Cuba and the Philippines, the relationship between the development of a stable democracy and accounting for assets of the state was clear to these men, and remains a determining factor today.
Democracies depend on transparency. They depend on the accuracy of information to support informed decisions by the people and their elected representatives. They depend on a system of accountability, in which officials' decisions are disciplined by the full disclosure of both the facts that support an action and disconfirming evidence that does not.
Years before the Berlin Wall came down, President Ronald Reagan famously called for the United States and its friends "to foster the infrastructure of democracy, the system of a free press, unions, political parties, universities, which allows a people to choose their own way to develop their own culture, to reconcile their own differences through peaceful means."
Accounting and auditing are and have been important tools for laying the foundation of such an infrastructure. They are tools of business and capitalism, because they are tools of truth. Applied properly — and I will get to that — they are blind to power. They can serve the people by enabling mechanisms for accountability and transparency, just as they served John Pierpont Morgan's need to govern his appointed managers.
Accounting and auditing also promote civil societies by supporting systems of legal property. As Hernando de Soto has taught, "Respect in Western nations for property and transactions is hardly encoded in their citizens' DNA; it is rather the result of having enforceable formal property systems."
De Soto's thesis is that the lack of legal property prevents citizens in developing and former communist nations from rising out of poverty. If one cannot establish the right to property — and, I would add, if one cannot account for it in terms that are reliable and credible — then one cannot convert that property to capital for use in contracts, obtaining credit, or financing an enterprise.
This is an exciting time for democracy advocates, across vast swaths of the globe. But the speed with which changes occurred belies long, hard struggles for freedom, fairness and truth, which may still confront those societies.
Now exposed to the harsh elements of poverty, ignorance enforced by decades of repression, and a global economic crisis, democratic hopes risk foundering.
They will need, perhaps as quickly, to gain self-assurance that they can build enduring democratic institutions. In that effort they will need access to reliable information about their resources, both communal and personal, if the people are to develop a private sector for business and economic prosperity, about their governments, and about the pros and cons of the policies that will shape their lives.
For the most part, I have been talking about matters far beyond my competence and purview as Chairman of the PCAOB. But not beyond the purview of the field of accounting and auditing, or of America's large accounting firms, which operate and have installed the tools of transparency and accountability in outposts all over the world.
As I turn to discuss the actual practice of auditing, though, let me emphasize as I must that the views I express are my own and should not be attributed to the PCAOB as a whole or any other members or staff.
I. The PCAOB
The PCAOB began operation nearly nine years ago, as the result of the Sarbanes-Oxley Act of 2002, which was passed to address the crisis in investor and public confidence the accounting scandals at Enron, Worldcom and numerous other well-known companies. There was overwhelming public and political support for the Act, which passed by 423-3 votes in the House and 99-0 votes in the Senate.
The Board's powers include authority to —
- register public accounting firms that prepare, or substantially contribute to the preparation of, audit reports for public companies and, since the Dodd-Frank-Act, brokers and dealers;
- conduct inspections of registered public accounting firms in connection with their public company and broker-dealer auditing practices;
- conduct investigations and disciplinary proceedings concerning, and to impose appropriate sanctions where justified upon, registered public accounting firms and associated persons of such firms; and
- establish auditing and related professional practice standards for audits within our mandate.
The PCAOB is a non-profit corporation. But all of the Board's responsibilities and regulatory powers are discharged under the oversight of the Securities and Exchange Commission.
There are currently approximately 2,400 accounting firms registered with the Board. This includes more than 900 non-U.S. firms.
We have nearly 700 staff, including approximately 400 experienced auditors with who conduct our inspections.
II. Auditor Skepticism is the Foundation for Investor and Public Confidence in Financial Reporting.
The need for rigorous oversight has borne out in the nine years since the PCAOB was established. PCAOB inspectors have conducted inspections of portions of approximately 3,000 audits by major firms, and they have found hundreds of audit deficiencies. The case is similar at small firms.
In many cases, these flaws were found at firms that are clearly comprised of highly competent and ethical professionals. As we identify problems, we can motivate firms to correct them. But we also look at culture, as it manifests in the critical element of skepticism.
Skepticism is what makes the auditor's work relevant to investors and the financial system more broadly. Auditor skepticism is the foundation for investor confidence in financial reporting. But it can fail in spite of both fundamental competence and high ethical standards.
Because skepticism is a state of mind, objectivity a silent success, their absence is rarely documented and can be particularly difficult to detect. But too often, audit failures identified by PCAOB inspectors do not appear to be explainable by any lack of knowledge, on the auditor's part, about what audit steps are required in the circumstances.
The value of the audit to investors and the public derives from the auditor's objectivity, not service to management. Management may prefer a less objective audit that accommodates management's short-term self interest. But in such cases, deference to management increases cost to investors and, ultimately, the company.
The PCAOB is focused on auditor independence and on what can be done to enhance auditor skepticism. We are self-consciously looking at skepticism as a psychological and behavioral issue. The PCAOB has been deeply engaged in new initiatives to enhance the relevance, credibility and transparency of audits.
We have embarked on a deep examination of potential changes to the standard form auditor's report, to respond to investors' call for more insights based on the auditor's work.
In the financial crisis, a better early warning system, based on more relevant and reliable financial information about risks, and about leverage and liquidity, would undoubtedly have made a difference to corporate boards, investors and the public.
The question is: what kind of insights can and should be provided to the public? I believe this question has broader implications for the global economy than just securities markets.
Yesterday, German Chancellor Angela Merkel and French President Nicolas Sarkozy called for a new European treaty to provide better economic governance for the 17 countries of the euro zone.
As ambitious as the Maastricht Treaty was, the people of Europe now see the need for enhanced accountability and transparency to support their monetary union, ensure the fair distribution of burden, and move from ambition to reality.
The path the euro has taken might have been a predictable scenario, but the extensive arbitraging of sovereign debt shows that it was only one. In the absence of clear facts about member states' true financial position, many experts were able to envision, and put enormous bets on, competing possibilities. It appears even senior managers would have benefited from more transparency about the risks such trades, and traders, took.
Guesswork, or the lack of visibility into the underlying structural problems in the euro zone economies and state balance sheets, has brought Europe and the global financial system to its knees. More robust accounting and auditing reports could not, alone, have averted this crisis. The crisis has, however, focused public attention globally on the need for more relevant audit reports, which the PCAOB's project is exploring.
In addition, the PCAOB has mooted a proposal to enhance audit transparency. This is an important matter for investors, who want to know about the work that stands behind individual audits.
Among other things, the proposal would provide investors disclosure about other accounting firms and certain other participants in the audit. For many large, multi-national companies, a significant portion of the audit may be conducted abroad — even half or more of the total audit hours.
The idea is to provide enhanced transparency into the composition of cross-border audits, so that investors and the public will have a better understanding of how an audit was conducted and make more informed decisions about how to use the audit report.
III. Joint Inspections of Global Audits by National Audit Regulators are Taking Hold.
I've touched on global audits, but let me turn now to discuss them more directly. Borders are almost nothing now for capital flow, or they need not be if we can obtain adequate assurance about the capabilities of the people who want capital, who want to effect de Soto's dream.
People in countries with less developed securities and other market institutions increasingly seek capital through global securities offerings.
Underwriting was once a local business, in which the underwriter essentially vouched for the capabilities of a management team he knew. Personal relationships cannot provide that assurance in a global offering. The providers of capital cannot rely on the discipline of common cultural norms. We depend on the global audit and the validity of the attest function.
In theory, when a networked firm signs the opinion, the audit is supposed to be seamless and of consistently high quality. In practice, that is often not the case.
To best protect investors, inspections of cross-border audits need to be as seamless as the audits are supposed to be. The PCAOB has organized its inspection division with this objective in mind. And, importantly, we have forged agreements with audit regulators wherever we can to pursue a program of overlapping and intersecting oversight.
We are now inspecting in 37 countries. In nine of those jurisdictions, we inspect jointly with the local regulator.  Yesterday, we announced a major step forward in the EU with a joint inspection protocol with the Netherlands.
Joint inspections require effort on both sides. They have also required our counterparts to stick their necks out and press their lawmakers on our behalf. But this process yields concrete benefits for investors globally, as inspection teams work side-by-side and reinforce each other's mandates.
There is now considerable momentum for joint inspections in Europe. I look forward to announcing more joint inspection arrangements in the near future.
We have not met with such success in China. But I hope Chinese authorities will also embrace joint inspections. There is considerably less transparency into the quality of referred-work performed by Chinese affiliates of the global networks for principal auditors in the U.S. and elsewhere.
But I agree with former Secretary of State and Treasury James A. Baker III, my former law partner, that China is not our enemy. Chinese and American interests converge in many areas, and I believe audit oversight should be one.
The Chinese have recently begun an enormous initiative to establish a vibrant securities market in Shanghai. They have an interest in its credibility, and how it is perceived internationally. I believe they will see that bonding their markets to the rigors of established markets, being part of a global regulatory regime, will help gain that credibility.
The Chinese government has recently announced the new leadership among financial regulators. We have corresponded and remain in communication with the new Chairman of the CSRC, Guo Shuqing, and look forward to working with him and his staff early in the new year.
* * *
People have puzzled since Adam Smith over what makes economies work. We continue to debate the merits and risks of foreign aid. But since the Marshall Plan, it has been an article of faith that with growth and economic prosperity comes freedom, and self-confident, civil societies.
The financial crisis is about whether we can foster a banking system that works globally. Here, I defer to my heroes and mentors, Paul Volcker and Henry Kaufman.
Around the world, we are occupied with the question what will restore and advance the health of our economies. We cannot make judgments based on what we wish will happen. We cannot always know how policies and political initiatives will relate to economic grown. All that becomes subject to fictionalization, unless you have reliable audits.
As President Reagan said in his speech at Westminster, which I quoted earlier, "If history teaches anything it teaches self-delusion in the face of unpleasant facts is folly."
Accounting and auditing provide the unpleasant facts. It should be no surprise that the strength of the audit — skepticism — is subject to attack. Of course it is. Audits free people with the truth. Some will spare no expense to deny the people that freedom. Corruption depends on the frustration of transparency and accountability, because in truth the people will find resolve.
But as we rebuild our economies, we must consider reinforcing the audit, and using it as a tool to provide for better decisions. Skepticism is affected by culture. It does not thrive on its own. If is discouraged, it will recede, and with it transparency and truth.
That won't happen, though, because of forums like the FPA that champion these values. I want to thank the FPA again for the award, which I accept on behalf of about 700 talented and dedicated employees of the PCAOB; and, most of all, I thank you for the opportunity to speak to these issues tonight.
 President Ronald W. Reagan, Address to Members of the British Parliament (June 8, 1982).
 Hernando de Soto, The Mystery of Capital: Why Capital Triumphs in the West and Fails Everywhere Else (New York 2000).
 Regulators outside the U.S. have raised concerns about skepticism as well. I have been struck by the consistency of international results.See Canadian Public Accountability Board, Auditing in the Decade Ahead: Challenge and Change, Audit Quality Pre-Reading Materials, at 36.
 See Doidge, C., Karolyi, G.A., Stulz, R.M., Sept. 2011 working paper.
 We now have a global network firm inspection program. It covers inspections of the largest U.S. firms and their foreign affiliates, to the extent those affiliates participate in the audits of issuers that file financial statements with the SEC. Currently there are approximately 190 non-U.S. registered firms that we consider to be affiliated with the largest global networks and are subject to triennial inspection because they have issued an audit report on an issuer within the last three years.
 We conduct joint inspections with regulators in Australia, Canada, Korea, Norway, Singapore, South Africa, Switzerland, Taiwan, and the United Kingdom.