The SEC issued an order approving a framework the PCAOB will use in determining registered accounting firms in a foreign location that the board is unable to inspect or investigate completely because of positions taken by local authorities.
As part of its oversight activities, the SEC must sign off on any significant standards and rules the PCAOB adopts before they become effective. The rulemaking responds to the Holding Foreign Companies Accountable (HFCA) Act.
During a conference, Paul Munter, acting chief accountant of the SEC, pointed to HFCA’s emphasis on the PCAOB’s inability to inspect or investigate accounting firms “completely.” The PCAOB “might be able to inspect one or some number of audit files; [this] isn’t the same thing as being able to inspect completely,” said Munter during the Corporate Financial Reporting Insights (CFRI) Virtual Conference hosted by the Financial Executives International (FEI) on Nov. 4.
“So, the word ‘completely’ is an extremely important part of the Act,” he said.
“When they go to inspect, they need to have the ability to determine which firms they are going to inspect in a jurisdiction, and then, in particular, they have a risk-based approach that they use to determine which engagements within that firm they are going to inspect and obviously, which areas of the engagement they want to focus on,” Munter said. “So, they need to be able to have access to whatever work papers they believe are appropriate to allow them to carry on the inspection and access to the professionals of that firm to be able to carry on the inspection.”
“Impediments to any of those are likely to lead to a conclusion by the PCAOB that it is unable to inspect or investigation completely within a jurisdiction,” he added.
The SEC’s decision on the PCAOB’s framework, which becomes effective immediately, means that the board will promptly make appropriate determinations. After the board makes its determination, it will send a report to the SEC.
These identified companies then must submit documentation to the SEC establishing that they are not owned or controlled by the government in their jurisdiction. Most significantly, HFCA directs the SEC to prohibit the trading of the identified company if the PCAOB is unable to inspect its auditor for three years in a row.
The commission’s approval of the PCAOB’s determination framework is in Release No. 34-93527, Order Granting Approval of Proposed Rule Governing Board Determinations Under the Holding Foreign Companies Accountable Act.
“This is an important step to protect U.S. investors,” said SEC Chair Gary Gensler. “I believe it is critical that the Commission and the PCAOB work together to ensure that the auditors of foreign companies accessing U.S. capital markets play by the same rules.”
The PCAOB’s rule is in Release No. 2021-004, Rule Governing Board Determinations Under the Holding Foreign Companies Accountable Act, published in September.
In the new Rule 6100, the PCAOB spells out how the board will make its determination.
That assessment is based on three factors:
- the board’s ability to select engagements, audit areas, and potential violations to be reviewed or investigated;
- the board’s timely access, and the ability to retain and use, any document or information in the possession, custody or control of the firm or any associated persons thereof that the board considers relevant to an inspection or investigation; and
- the board’s ability to conduct inspections and investigations in a manner consistent with the provisions of the Act and the rules of the board, as interpreted and applied by the board.
The commission first solicited public comments on the PCAOB’s framework with the publication of Release No. 34-93112, Notice of Filing of Proposed Rule on Board Determinations Under the Holding Foreign Companies Accountable Act, issued in September.
While the SEC signed off on the PCAOB’s release, it rejected a part of the board’s conclusion that it would not apply to emerging growth companies (EGCs).
“Specifically, by establishing a framework for the Board’s determinations under the HFCAA and requiring firms to update their information promptly, all firms, including auditors of EGCs, and investors equally benefit from the transparency of the Board’s determination set forth in the Proposed Rule,” the SEC