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Global accounting firms warned over use of local affiliates

Washington, October 5, 2022 

Flawed audits more likely to be found at overseas arms, says US regulator.

The biggest global accounting firms have been told to expect tougher scrutiny by US regulators of their overseas affiliates, amid concerns about lower standards in China and elsewhere.

In an interview with the Financial Times, the chair of the Public Company Accounting Oversight Board, Erica Williams, vowed to hold overseas affiliates to the same standards as US firms, as she strengthens the industry regulator’s enforcement efforts.

The US Securities and Exchange Commission has also signalled it is paying closer attention to the issue of substandard audit work abroad, and last week took action against Deloitte’s Chinese affiliate for failing to properly check clients’ financial transactions.

The PCAOB has jurisdiction over audits of all US-listed companies, regardless of where the auditors are based. The world’s largest audit firms are structured as a network of local partnerships, and US firms that rely on local affiliates for some work on multinational clients have a duty to properly oversee that work, Williams said.

“They know that we are inspecting around the world and that we will hold any firms to account, including affiliates, that break our rules, and we recently enhanced our ‘other auditors’ rules to make that even more clear,” she said.

“If you are engaging other auditors to assist with your audits, you need to be able to hold them to the same quality-control standards that are required everywhere else in the world.”

PCAOB inspection data show overseas affiliates of the global firms are more likely to produce deficient audit work than the US partnership. The agency can censure, fine or even bar auditors for breaches of their standards.

In 2020, the most recent year for which data has been published, deficiencies were found in 16 per cent of inspected audits carried out by the US arm of big global firms. At non-US arms of the global firms, 33 per cent of inspections revealed deficiencies.

Unlike the deficiency rate for the US firms, which had fallen from more than 30 per cent in 2015, deficiencies at non-US affiliates have not fallen in five years.

The data does not include Chinese affiliates, because for many years the PCAOB has been unable to conduct inspections in China. Beijing signed an agreement to let inspectors in earlier this year, and the agency has begun its first inspections of work by Chinese affiliates of KPMG, PwC and others.

The agency has said it will determine by the end of the year if Beijing is fully co-operating, and the SEC says it will force Chinese companies to delist from US exchanges if audit inspectors are blocked.

Some US-listed Chinese companies have switched their main auditor from a local affiliate to the US arm of a big global firm, in the hope of sidestepping the delisting threat, if the inspections deal between Washington and Beijing breaks down.

The SEC’s chief accountant, Paul Munter, last month said this tactic would attract scrutiny and could create legal liability for the new lead auditor if it subsequently continued to rely on the local affiliate to provide assistance.

Williams, who became PCAOB chair in January, promised to stiffen penalties for flawed audit work and reduce leniency for first offences, and try to ratchet audit quality higher through updated standards.

“We have strong enforcement tools,” she said. “What we’re doing is trying to make sure that we’re using all of those tools.”

The PCAOB in June introduced new rules on how a company’s main auditor should oversee the work of other firms it employs. It said the issue had taken on greater significance because of the increasingly global operations of public companies. The new rules go into force in 2024.

Last Thursday, the SEC charged Deloitte China with falling “woefully short” of proper standards by having clients complete their own audit tasks, including selecting which financial transactions should be checked.

Most of the audits that the SEC said were flawed were conducted by Deloitte US for multinational corporations with operations in China. Deloitte subcontracted auditing work on the Chinese operations to its affiliate in China, but it was a US partner that signed off on the work in US regulatory filings.

Deloitte US, which was not itself the subject of the SEC’s enforcement action, declined to comment on the flawed audits or its oversight procedures.

[The Financial Times]