Speeches: IOSCO Strategies & Regulatory Issues for International Banks

The Regulation of Auditors from the Perspective of the International Organisation of Securities Commissions

Jane Diplock AO
Chairman
IOSCO Executive Committee

New Zealand Institute of Chartered Accountants Seminar: Regulation of Auditors
Auckland
16 November 2005

There is an African proverb that says "The best time to plant a tree is twenty years ago".

The accounting and auditing profession should be one of the strong tall trees providing protection for investors and other users of financial statements.

With the benefit of hindsight we may all wish that recent advances in both regulation and the accounting and auditing profession had occurred 20 years ago. In that couple of decades we have seen the excesses of the 1980s and more recently the large corporate collapses that have raised questions about the profession.

Arthur Andersens, to continue the tree analogy, now remains merely as an awkward stump. Yet Andersens was a strong tree in the early part of the last century, widely regarded as the gold-plated audit service provider. And just when we may have thought that the major problems might be over, we now have the Refco case in the United States.

All this points to the need to reshape the profession and the structures surrounding it. We need to nurture the tall strong trees and plant more trees now.

I have been asked today to talk from an international perspective and so I am speaking in my role as the Chairman of the Executive Committee of the International Organisation of Securities Commissions. I hasten to add though that nothing I have to say today conflicts in any way with my opinions as the Chairman of the New Zealand Securities Commission.

In addressing the issue of regulation of auditors today I want to raise a number of aspects.

Firstly, the key drivers for change to the way in which auditors are regulated; then the minimum regulatory standards and institutional arrangements countries should be seeking to implement for regulating auditors; and thirdly, how different regulatory approaches to achieving the same outcomes can be accommodated within IOSCO's policy recommendations.

I'll also talk about IOSCO's initiatives on aspects of auditing; and finally, what I believe may be the likely direction of future reform.

I would like to commend the International Federation of Accountants, the Public Interest Oversight Board and the International Auditing and Assurance Services Board for the work they are doing to address issues relating to auditors - particularly the development of global auditing standards, matters relating to auditor independence, and progress on auditor oversight.

I also commend the New Zealand Institute of Chartered Accountants for their wisdom in recognising that the best way forward is to adopt the International Standards on Auditing.

The need for change is being driven by several factors. Firstly, the need to remove barriers to integration of capital markets; secondly, the need to maintain and enhance investor confidence in these markets; and thirdly, the collapses and frauds are continuing.

Many of the enforcement matters that come before regulators involve financial reporting, accounting and audit.

These actions in areas such as insider trading and corporate fraud often have fundamental issues relating to the validity of the financial reporting and auditing processes.

Investor confidence is fundamental to the successful operation of the world's financial markets. That confidence depends on investors having credible and reliable financial information when making decisions about capital allocation.

The objectives of securities regulation include the protection of investors; ensuring that markets are fair, efficient, and transparent; and the reduction of systemic risk. A critical aspect of these objectives is full, timely, and accurate disclosure of financial results and other information that is material to investors' decisions. Independent auditors play a critical role in enhancing the reliability of financial information. Effective oversight of the accounting profession and of independent auditors is critical to the reliability and integrity of the financial reporting process. Hence the interest by IOSCO in auditor oversight.

I am encouraged by the growing resolve by various international agencies and most jurisdictions to address these issues. As a practical example of the co-operation that exists between IOSCO and these other international agencies - the PIOB has decided to establish its headquarters in the same building as IOSCO's General Secretariat in Madrid.

Collapses and frauds continue, and they raise questions about the audit profession, audit oversight and the appropriate regulatory response. The profession and regulators need to work together to address the causes of continuing collapses and frauds. We need to find solutions that can be applied across a wide range of jurisdictional structures in a way that is consistent with the global principles but which recognises and accommodates local differences.

The work is not finished. The key drivers for change seem to persist. Clearly there is much to be done and we welcome the useful dialogue taking place in meetings and conferences like this one. This will help to develop a shared vision for audit and auditor oversight that will ensure that audits meet the needs of investors and others in society.

We need to consider what should be the minimum regulatory standards and institutional arrangements that countries need to implement for regulating auditors. New Zealand has work to do in this area and I understand that the Ministry for Economic Development is planning to review auditor regulation in New Zealand next year. Overseas jurisdictions are looking at the oversight of auditors. Several jurisdictions have moved, or announced their intentions to move, to strengthen the regulation of auditors to incorporate external monitoring and oversight of auditor competence and independence.

In October 2002 the IOSCO Technical Committee issued a Statement of Principles for Auditor Oversight and Principles of Auditor Independence and the Role of Corporate Governance in Monitoring an Auditor's Independence. The Committee while noting that oversight of auditors can occur in several ways stressed that "within a jurisdiction auditors should be subject to oversight by a body that acts and is seen to act in the public interest".

Although the nature of the auditor oversight body and the process through which it carries out its activities may differ among jurisdictions, IOSCO believes that effective oversight generally must include several mechanisms.

Importantly, there should be a body, independent of the profession and acting in the public interest, to oversee the quality of auditing, independence, and ethical standards. This body must have an appropriate membership, an adequate charter of responsibilities and powers, and adequate funding that is not under the control of the auditing profession, to carry out those responsibilities.

It should have processes to review the audit procedures and practices of firms that audit listed public companies; it should be able to stipulate remedial measures for problems, and to initiate disciplinary proceedings to impose sanctions on auditors and audit firms where appropriate.

The auditor oversight Principles also say that where companies operate across borders, IOSCO members should give each other the fullest assistance to examine or investigate matters in which improper auditing may have occurred and on any other matters relating to auditor oversight.

The recent adoption of a new strategic direction by IOSCO and the encouragement for members to sign the Multilateral MOU by 2010 focus on information exchange and assistance between regulators.

At present, there are various systems for auditor oversight in IOSCO's member jurisdictions. Many of these systems are being reviewed as a result of financial reporting failures, weaknesses discovered in self-regulatory structures, changes in public expectations, or requirements of new legislation.

The IOSCO Technical Committee proposed that all securities regulators encourage suitable arrangements within their jurisdictions so that the auditor oversight system is consistent with maintaining and enhancing investor confidence in published financial statements.

All round the world we have seen independent oversight established. At the international level IOSCO, the World Bank, the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors and the Financial Stability Forum, in conjunction with IFAC, have established the Public Interest Oversight Board. This oversees the work of the International Federation of Accountants auditing, ethics and education standard-setting committees and its Member Body Compliance Program.

Also at the international level there is the Audit Oversight Roundtable Group of independent audit regulators which is trying to bring structure and clarity to audit oversight given that not all IOSCO members have audit oversight roles. The group includes organisations already working on auditing issues including the Financial Stability Forum, the World Bank, IOSCO, the Basel Committee, the Public Interest Oversight Board and the European Commission. The group will meet again in Australia in March 2006.

Last month the Group met to discuss progress on establishing audit regulators independent of the accountancy profession, arrangements for cross-border exchange of information, concentration in the audit market, the independence of auditors, and issues raised by the multi-jurisdictional structure both of audit firms and the entities they audit.

The Group also discussed a global approach to supervision of the Big 4. The number of truly global audit firms has reduced as a result of mergers and the loss of Andersens. This is of real concern. People do not want to see another Big 4 firm collapse. These firms are needed to be able to effectively audit the very large global corporates.

During 2004/2005 the United Kingdom's Audit Inspection Unit undertook its first independent audit of the Big 4 accountancy firms. The AIU is a unit of the Professional Oversight Board for Accounting in turn part of the Financial Reporting Council in the UK.

Examples of some of the national auditor oversight structures are the Public Company Accounting Oversight Board in the United States and the Professional Oversight Board for Accountancy in the United Kingdom. Australia has the Auditing and Assurance Standards Board responsible for setting auditing standards which have force of law, and the Financial Reporting Council which monitors auditor independence.

This call for oversight bodies is not a reflection on the integrity of the profession. International auditors are welcoming independent oversight bodies. The profession in New Zealand should also welcome such a body.

To what extent is it sensible to standardise the regulation of auditors across jurisdictions? Alternatively to what extent can there be local variations in different jurisdictions?

Jurisdictions do have different institutional arrangements to deal with issues relating to auditors. I will talk later about the results of the IOSCO Survey that found considerable variation in practice.

These variations have developed for legal, historical and political reasons and it is not possible to prescribe a standard arrangement for auditor oversight. Hence IOSCO's principles-based approach.

The beauty of this approach is that each jurisdiction can craft a regulatory response that fits its domestic arrangements but which achieves the overriding principles. This achieves the wider outcomes and best practices that we are all seeking. Based on its announced principles IOSCO is working with other agencies to see global auditor oversight established.

Best practice is not expected to come down to specific institutional arrangements. An exception to this may be where a group of countries may decide to adopt similar arrangements for wider policy reasons, such as development of common markets or promotion of business. For example, several countries within a region see benefits from having very similar structures - either one structure for the whole region or cross memberships of similar organisations. But this is the choice of that regional group rather than something that IOSCO would expect to mandate.

What we may see first is cooperation between auditor oversight bodies. We do observe different regulators working together for dually listed entities for example the Australian Securities and Investments Commission and the PCAOB.

Whether regulators combine across jurisdictions will remain to be seen. The issue of maintaining domestic control of an oversight body is likely to continue for some time.

In the interim the IOSCO Multilateral MOU, which enables exchange of information between signatories, provides a way for cross border cooperation between securities regulators to facilitate a "virtual" approach until structural or legislative solutions are worked out.

In 2004 IOSCO's Technical Committee developed a Survey on the Regulation and Oversight of Auditors. The goal was to obtain a point-in-time, baseline description of the structures and processes in place to regulate and oversee auditing around the world.

This information would assist regulators, oversight bodies and other organisations working to enhance auditor oversight and international auditor quality.

The survey also sought to identify the extent to which the auditor oversight arrangements in place in 2004 encompassed the recommendations in IOSCO's Principles for Auditor Oversight and Auditor Independence.

The New Zealand Securities Commission, assisted by the Institute and the Office of the Auditor-General, was one of the 58 respondents to the survey. The findings of the IOSCO survey were published in April 2005.

They revealed that the IOSCO principles for auditor oversight and auditor independence have been broadly implemented in most of the Technical Committee jurisdictions¹ - that is, the US, Ontario and Quebec, Mexico, Japan, Hong Kong, Australia, the UK and most European counties. However, the Survey Report concludes that "on a global basis, it is evident that a great deal remains to be accomplished to create auditor oversight structures and quality assurance processes that fully encompass the IOSCO principles."

The overall picture provided by the Survey is a mixed and changing landscape of auditor oversight arrangements. The IOSCO principles for auditor oversight and auditor independence are broadly implemented in most of the developed markets and some of the emerging markets. Many variations exist in the approaches, structures, and methodologies used in member jurisdictions, and the existence of such variations were contemplated in the general principles that were issued by IOSCO.

On a global basis, a great deal remains to be accomplished to create auditor oversight structures and quality assurance processes that fully encompass the IOSCO principles.

Nearly all responding IOSCO jurisdictions that took part in the survey have laws and regulations which specifically address the conduct of auditors and the oversight of the audit profession.

Most jurisdictions have a formal body that provides direct oversight of auditors but the characteristics of these oversight bodies differ widely in their powers and range of responsibilities, source of funding, level of activity, degree of independence from the audit profession and level of oversight by government.

Requirements for auditors, in terms of education, training, and other qualifications, vary considerably around the world and in some cases also vary within a jurisdiction.

Requirements for supervision of audits of public listed companies also vary considerably, and significant differences between members of developed markets and emerging markets.

Legal frameworks, established professional customs and practices, regulation of auditors, and corporate governance over financial reporting are areas that are currently being re-examined and enhanced in many countries. In addition to these domestic auditor oversight efforts, initiatives are underway in the European Union to strengthen auditor oversight and quality assurance. IOSCO encourages international organizations with responsibilities and interests in audit matters to use the information from this baseline survey in their efforts to enhance auditor oversight and quality assurance.

IOSCO's Technical Committee recently set up a Chairmen's Committee on Auditing to address auditing issues from the perspective of securities regulators. One area of interest is that of non-audit services provided by auditors.

The potential compromise to auditor independence when an audit firm provides non-audit services to an audit client is a primary area of concern emerging from corporate fraud and accounting scandals. If investors are given doubts about the independence of the auditor of a company's financial statements, the value they place on those financial statements may be seriously compromised.

An audit firm that provides non-audit services to its audit client creates an environment ripe for actual and perceived conflicts of interest. These conflicts may damage auditors' required objectivity and professional scepticism and consequently harm investors' confidence in the audit and the financial statements.

The ensuing harm to capital markets has caused legislatures, securities regulators and auditor oversight boards to adopt and/or strengthen laws, rules, regulations, and standards restricting or eliminating the provision of non-audit services to audit clients of public accounting firms. The heightened focus on this aspect of auditor independence is a positive development for investor assurance.

However, for capital markets around the world to benefit from increased investor confidence, the rules need to be robust, well understood and complied with across borders. This is where each jurisdiction has an important role to ensure that there is understanding of, and compliance with, the auditing requirements. Different prohibitions on non-audit services in various jurisdictions create problems for regulators and for auditors. An auditor may provide a non-audit service to a client in a jurisdiction where that service is not restricted, but that client may issue securities in a jurisdiction where the provision of such service violates securities laws and/or standards.

As a result of this increased interest in the regulation of auditors and the discussion taking place in many international forums, a number of themes are emerging. There is general agreement on the need to develop globally accepted standards on key areas relating to audits and auditors. Secondly, it is becoming clear that there is work to be done regarding the issue of non-audit services. Thirdly, there is growing acceptance of the need for truly independent auditor oversight. And finally, it is recognised that the Big 4 accounting firms need a global approach to oversight.

The increasing focus on audit matters in the international arena is clear evidence that global capital markets do require a strong auditing profession overseen by public interest bodies. We will see increasing cooperation between these bodies to achieve truly global oversight.

The cooperative work of the international agencies and arrangements such as the IOSCO MOU, which enables regulators to exchange information, are also helpful mechanisms for establishing a form of global oversight.

Public expectation of regulators and the international institutional frameworks remain high and are increasing. The profession, regulators and global agencies such as IFAC and IOSCO need to promote debate and discussion on the agenda for the future.

There needs to be further debate on issues such as the level of public expectation of audits and auditors, whether auditors should be doing more to find fraud, and whether the current training for auditors remains appropriate. The answers that emerge from these discussions will assist the setting of standards, and help determine the nature of auditor oversight.

We hope that it will not take 20 years to achieve lasting improvements to audit standards and auditor oversight. But we cannot delay planting the tree - the tree that will provide investors the protection that they are entitled to.

¹ Technical Committee members are the securities regulators of the US, Australia, France, Germany, Hong Kong, Italy, Japan, Mexico, The Netherlands, Ontario, Quebec, Spain, Switzerland, United Kingdom.