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TRANSPARENCY AND AUDIT REGULATION
By: James Sylph, Technical Director, International Federation of Accountants
This
speech was given by Mr. James Sylph to the Fédération des Experts
Comptables Mediterranéens Conference in Istanbul on 13 December, 2005.
Given
the corporate scandals of recent years, the audit profession is now in
the forefront of the minds of investors, businesses, regulators and
others. Financial reporting, corporate governance and accounting and
auditing practices must keep up with the needs of these groups.
Effective regulation of the audit profession is one means of ensuring
that the profession and the private sector keep pace with these
challenges.
In
addressing these challenges, the Fédération des Experts Comptables
Mediterranéens and the International Federation of Accountants share
common goals: facilitating communication and cooperation among
accountancy bodies and with the larger business and regulatory
community; providing technical assistance to accountants in all
sectors; and promoting high quality standards of accounting, auditing
and ethics. It is no wonder, then, that accountancy organisations in
Mediterranean region are active in IFAC and that numerous volunteers
from your member organisations serve on IFAC boards and committees –
helping to develop high-quality international standards, encouraging
convergence to those standards and undertaking all these activities in
the public interest. We thank these volunteers for their support and
dedication.
As
the global organisation for the accountancy profession, with 163 member
bodies in 120 countries around the world, IFAC firmly believes that
effective audit regulation is critical to protecting the public
interest.
Before
I present IFAC’s view on regulation of the audit profession and what we
are doing to support high-quality international standards for audits, I
think it is important to understand the historical development of the
profession’s regulatory structures and why, today, there is an
increased global focus on them.
Broadly
defined, regulation refers to the making and implementing of rules
which direct or constrain the behaviour of a person or group of people
being regulated. That said, I think it is important to acknowledge the
role of the profession in the evolution of its regulation. In most
developed nations, the licensing and regulation of the accountancy
profession was founded through the initiative of practicing
professional accountants who often sponsored legislation to set minimum
requirements to be designated as a professional public accountant.
Historically, leading practitioners then established a code of
professional conduct and, eventually, accounting, auditing and other
practice standards.
Through
much of the 20th century, the requisite knowledge of professional
practice standards that protected the public resided nearly exclusively
with professional practitioners who founded professional associations
to promote their profession and its standards. This led many government
regulators who had the legal authority to mandate compliance to choose
to adopt the standards of the professional associations by reference or
as acceptable interpretations. Over time and in many countries, such as
the United States, this approach evolved into a sophisticated system of
government-sanctioned self regulation that for many years was
considered adequate, efficient and protected the public.
In
more recent years, businesses have become increasingly more complex and
globalisation has taken hold. At the same time, to meet new marketplace
needs professional accountants and their firms have expanded the range
and types of business services they offered their clients well beyond
the traditional attest and assurance and taxation advice. These
changes, when combined with major public company failures involving
inadequate corporate governance and perceived or adjudicated
shortcomings in auditor performance, resulted in a widespread
conviction of the need for re-examination of accounting regulation and
standard-setting structures.
Regulation
of the audit profession has typically been included as part of the
overall regulation of the accountancy profession and has covered the
following areas:
• Education and admission standards;
• Audit standards;
• Ethical standards; and
• Disciplinary action.
A
key change in the regulation of the audit profession in recent years
has been the move to increased regulation of the performance of
auditors and/or the performance of the professional accountancy bodies.
So there are now two additional areas of regulation. These are:
• Monitoring of audit quality, for example, audit inspections; and
• Monitoring the self-regulatory activities of the professional accountancy bodies as they apply to audits and auditors.
Trends in Regulation
How
can this regulation of the profession today best be carried out? In any
number of ways and combinations. As I already mentioned, generally, the
audit profession is regulated by the profession and/or the government.
Where the regulation has been carried out primarily by the profession,
it is often referred to as “self-regulation” and when it is carried out
by the government, is often just called “regulation,” but for clarity,
“direct regulation” is a better term.
It
is important to keep in mind that there is no pure model of either
self-regulation or direct regulation. The profession rarely regulates
without some form of government mandate to do so, and similarly, the
government rarely regulates without some form of interaction with the
profession.
In
general, the IFAC member bodies, the professional institutes, act under
a delegation from their respective governments. The government has
given legal recognition to the profession and has given the
professional institute a set of roles and responsibilities and some
form of reporting requirement. These responsibilities can include
admission criteria, continuing education requirements, disciplinary
provisions, standard setting and so on. Reporting requirements often
take the form of annual reports by the professional body. Under
self-regulation then, the government has delegated the responsibility
for regulation to the profession and the profession regulates itself
within that framework and then reports on its activities. There can be
a greater or a lesser degree of government monitoring and oversight.
Direct
regulation, for example, through the establishment of an audit
oversight body, simply means that the government itself has assumed
responsibility to regulate part, or, rarely, all of the profession.
However, like self-regulation, this regulation is taking place within a
set of roles, responsibilities and reporting arrangements that have
been set by government and established in legislation. To be
successful, the regulator needs to have an effective working
relationship with the profession.
In
discussing methods of regulation, it is important to remember that
accountancy is a profession. That means that professional accountants
have an overriding responsibility to the community in which they live,
not just to their current clients or to themselves. So even in
circumstances where there is total direct regulation, there is still a
need for the profession to regulate the activities and conduct of its
members to ensure that this responsibility to the community is
fulfilled. The only caveat is that this regulation needs to be
efficient and effective.
In
IFAC’s view, there is no “one size fits all” solution and so the answer
to the question “which option is best,” is the economist’s answer “it
depends.” Regardless, the regulator must act in the public interest.
Whatever regulatory framework is used, be it administered by the
profession or government, it must give the regulator appropriate
incentives to act in the public interest. Regulators must have a clear,
overarching purpose and the ability to resist any moves towards
regulation that are self-interested or motivated by special interest
groups.
Serving
the public interest means having regulations that achieve their aim of
being effective and efficient without imposing unnecessary costs. The
benefits of the regulation – that is, its effectiveness in protecting
the public interest – must exceed its costs.
The
International Organisation of Securities Commissions (IOSCO) has
undertaken work in this area and has developed a series of principles
for regulators. These principles hold that:
• The responsibilities of the regulator should be clear and objectively stated;
• The regulator should be operationally independent and accountable in the exercise of its functions and powers;
• The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers;
• The regulator should adopt clear and consistent regulatory processes; and
• The staff of the regulator should observe the highest professional
standards, including appropriate standards of confidentiality.
The
choice between self-regulation and direct regulation primarily depends
on who can meet the IOSCO principles and carry out the required
functions most efficiently. For example, a professional body often has
considerable expertise regarding the profession so it may be better
placed to regulate where this expertise is needed. As well, the
professional body’s separation from government can mean that it can
react faster and more flexibly than a comparable government agency. In
those countries where the profession needs to be strengthened, granting
the profession self-regulatory powers can assist it in gaining the
necessary expertise.
Direct
regulation can be the most appropriate solution if there is a need for
the regulator to be completely independent of the profession, or if it
is considered inappropriate for the profession to carry out certain
functions.
Taking
into account these factors and differences in history, culture,
commercial law and varying stages of economic development, we see at a
national level a huge diversity of regulatory approaches. In some
countries, particularly former command and control economies, in the
former Soviet Union or in China, they are grappling with the issue of
how the government can move away from direct regulation and increase
the amount of self-regulation so that the national profession can be
strengthened.
In
recent years, two clear trends have emerged in regulation of the audit
profession; a move towards direct regulation and, at an international
level, pressure for regulatory convergence. The trend towards more
direct regulation emerged out of the financial scandals of Enron,
WorldCom and a loss of credibility in the profession. But this move is
not without controversy as new regulations have often been expensive
and cost estimates inaccurate. Take a well known example, the US
Sarbanes-Oxley Act. This Act requires companies to report on their
internal controls. The SEC estimated that the aggregate cost would be
about US$1.24 billion or $94,000 per public company. Unfortunately,
they were wrong. According to surveys, actual costs were around twenty
times higher . As a result, questions have been raised as to what
regulation is necessary and whether the increases in regulation are
appropriate. Paul Boyle, CEO of the UK Financial Reporting Council,
considers that “We are reaching a high point of regulation...there is
widespread concern that regulation has gone beyond the point at which
it is useful. The balance between investor protection and creating
prosperity may have been overstepped.”
So
we may see in the coming years a move towards less regulation and less
costly regulation of the audit profession. In those countries that have
increased the amount of direct regulation, the government regulator is
likely to face increasing pressure to justify the benefits of its
actions and to find less costly methods of regulation.
The
pressure for convergence has come from an increasing realisation among
regulators and the profession that capital markets are much more global
and that convergence would assist in making the international financial
system more efficient and robust. But regulating at an international
level cannot simply mirror the national approach. There is no central
government, no ability to levy or raise taxes and no ability to compel
other nation states. Instead, at the international level, we are seeing
increasing dialogue and cooperation between regulatory agencies and
moves to express agreement through the development of principles.
IFAC
is very supportive of these international developments and has been an
active participant. A principles-based approach at an international
level allows the focus of regulation to be on what needs to be achieved
and allows for national differences in implementation. It is,
therefore, more flexible and adaptable to individual countries and
circumstances.
IFAC
sets international standards for the profession in a number of areas
including auditing and assurance. It has undertaken reforms to help
ensure that IFAC’s standard-setting activities reflect the public
interest and are fully transparent to those affected by the standards.
One of the most important reforms has been the establishment of the
international Public Interest Oversight Board (PIOB) to oversee IFAC’s
standard-setting activities. IFAC considers that this oversight is
critical to building credibility and confidence in international
standards. The 10 member PIOB is chaired by a European, Professor
Stavros Thomadakis from Athens and has two European members – Antoine
Bracchi from France and Arnold Schilder from the Netherlands as well as
two EC observers.
Setting of Auditing Standards
Auditing
standards are a key factor in the regulation of the audit profession.
If the profession is to perform high quality work in the public
interest, it needs to have high quality standards that are set in the
public interest. The primary duty of all professional accountants,
wherever they work, is to serve the public interest.
So,
what skills and processes are required to set high quality audit
standards? First, and most obvious, is technical expertise. Those
responsible for setting the standards need to have sufficient technical
expertise and understanding of auditing and audit processes. This
expertise is generally found within the audit profession, and is not
limited to auditors in public practice.
Secondly,
the standard-setting process needs to be informed by all those involved
in auditing; the profession, companies, regulators and so on. So there
needs to be input into the process from these groups.
As
the technical expertise is found in the profession and the profession
is responsible for carrying out audits, there is a potential for a lack
of independence in fact or in appearance. This independence issue needs
to be addressed if audit standards are to be acceptable to the wider
community. Overcoming independence concerns means having a strong and
robust process and public interest oversight.
Within
IFAC, the International Auditing and Assurance Standards Board (IAASB)
is dedicated to operating as transparently as possible. It is one of,
if not the most, transparent standard setters in the world. IAASB
meetings are open to the public and agenda papers, background documents
and meeting summaries are posted on the IFAC website. Visitors can view
project histories and may download audio recordings of the IAASB
meeting proceedings. They can also download IAASB exposure drafts and
view all comments made on those drafts by regulators, firms, standard
setters and others.
The
IAASB makes it a priority to reach out to other stakeholders including
small- and medium-sized practices and other standards setters as we did
in the recent Clarity Forum.
Public
oversight of the standard-setting process through the PIOB is crucial
as it assists in building creditability and confidence in international
standards, which then contribute to confidence in the financial
information produced by companies; in the examinations carried out by
their auditors; and, ultimately, in the capital markets that rely on
such information.
Conclusion
In
IFAC’s view there is no “one size fits all” answer to the issue of how
to regulate the audit profession at the national level.
A
cornerstone of our free enterprise system is “freedom of choice.”
Consumers are free to choose what they wish to purchase and from whom.
This simple concept is the powerful engine that drives economies in
free markets. At the same time, there is an appropriate role for
government oversight in the free market process to ensure that the
consuming public is not being misled or defrauded by unethical business
practices. At IFAC, we recognise that the role of governments, as well
as the role of the profession, will vary, but they should be guided by
the principle of striking the right balance – to protect consumers
without comprising free enterprise and without inflicting undue costs
on the profession or the public.
It
is critical that, regardless of whether there is self-regulation,
direct regulation or some combination, that both the profession and the
regulator act in the public interest and that the benefits of
regulation outweigh the costs.
I
would like to conclude on a personal note. While regulation contributes
to the quality of services that accountants provide, there is an even
more powerful motivator for accountants: that is “reputation.” Every
decision made by every accountant every day around the world affects
his or her reputation and ultimately the reputation of ALL professional
accountants. We have, in recent years, seen reputations destroyed by
bad decisions and wrongful compromises and, as a result, companies
collapsed. I believe that regulation and reputation go hand in hand.
Every accountant must make a commitment not only to follow the rules of
a specific regulatory regime, but even more importantly, to protect his
or her reputation by acting ethically and putting the public interest
first. In this way, we will continue to earn the respect of the
investors, governments, and regulators worldwide.
from "the accountant" magazine
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