December 6, 2011

EU Proposes Audit Reform

Here's news from Lynn Turner: On Wednesday, the European Commission proposed new legislation that would result in much greater oversight of the auditing profession within the European Union. Much of the legislation catches Europe up to the current status of regulation of the profession in the U.S. This is interesting in that ten years ago, politicians, Ambassadors, businesses, audit firms, etc. from the EU vehemently opposed Sarbanes-Oxley. Now in many regards, they are embracing it - but only after their investors have paid a very serious price for past lack of action.

The "devil is in the details" of the proposal, such as:

- While in the US investors have been asking for a separate report from the auditors providing information the auditors know, the EC would require such a report but prohibit it from being made available to investors.

- The EC proposal discusses the "client" of the auditor being the company, rather than investors.

- The EC would require substantial expansion of the audit report, in what appears to be a very positive development, including requiring the auditor to set forth how they assessed materiality. The PCAOB has also taken up this topic, but not yet issued a proposal.

- The EC would require auditors to disclose financial information. But that information is very, very limited such as to revenues, which the firms already disclose. It does not require disclosure of basic financial information necessary for any regulator to assess the financial stability, liquidity, viability or performance of the firms they are charged with regulating. In 2008, The U.S. Treasury Committee made a recommendation with respect to increasing transparency of the audit firms, which the PCAOB has yet to act on.

- While mandatory rotation is proposed every 6 years, there are mechanisms put in place to extend this out for up to 12 years. The PCAOB has previously taken up this topic in the US and issued a concept release, but has not yet issued a proposal.

- The EC proposes that non-CPA's be allowed to own audit firms. This is a change the large audit firms have been requesting for over a decade, as a way to monetize their stock and let the older partners reap the benefit. This is a very dangerous proposal as it would allow for outside investors, or allow the firm to go public, putting the profit motive far ahead of the public interest obligation, and likely resulting in significantly lower audit quality. This idea has been debated and rejected here in the US. It also raises very serious independence issues, for example, when a private equity or hedge fund invests in a CPA audit firm, would the audit firm be able to audit other companies the investment firm holds? If so, could investors ever believe the audit firm would ever bring to light a problem in the company, such as an Olympus, if it would have negative consequences for the investment fund?

Ultimately, the real problem is the fact the company being audited still pays the bill. That is not changing under the EC proposal and will remain as the real problem, just as it is for credit rating companies. Until that problem is directly addressed it is likely audits will remain problematic, although some of the proposals may be beneficial.

EU Proposes Disclosure Requirements for Payments to Governments for Natural Resources Development

It's not only Sarbanes-Oxley that is being somewhat cloned in Europe. As this memo summarizes, the EU recently issued two proposals to amend the European Union Transparency Directive that together contain new requirements for the disclosure of payments to governments by certain companies engaged in natural resource extraction or logging. This is a big deal for companies in the extractive industry with operations in the EU a la Dodd-Frank.

In the "Dodd-Frank Blog," Jill Radloff of Leonard Street & Deinard provides an update on the OECD Conflict Minerals Project, including this new OECD report that establishes a baseline of current due-diligence practices of downstream companies.

EU Summarizes Comments on its Governance Green Paper

Recently, the European Union issued a summary of the 400+ comments submitted in response to its corporate governance green paper that it proposed back in April.

- Broc Romanek