NEW YORK (Reuters) - Auditors are not properly testing U.S. companies’ internal accounting controls, the head of the main auditor watchdog said, while also reiterating urgent concerns about audit firm inspections in China.
Internal controls on books and records — a requirement imposed on corporations by 2002’s post-Enron Sarbanes-Oxley laws to combat accounting fraud — are not being properly tested by outside auditors, Public Company Accounting Oversight Board (PCAOB) Chairman James Doty said on Thursday.
“This is a very major issue for us,” Doty told Reuters on the sidelines of a securities regulation conference.
Internal control rules for ensuring the adequacy of accounting record-keeping and checks were among the costliest changes mandated by Sarbanes-Oxley, often requiring sophisticated electronic systems and detailed audits.
Auditors are supposed to gain an understanding of the controls put in place by companies and test them, but “some auditors are just taking the business process that the company has put in place as a control,” Doty said.
Touching on another key issue for his group and auditors, Doty said the PCAOB needs to gain entrance soon to China to inspect firms that audit U.S.-listed companies.
“We are not talking about something that should happen three years from now. It needs to happen now,” he said.
A meeting planned for October between U.S. and Chinese regulators to talk about inspections was canceled by the Chinese, possibly because of leadership changes at their regulatory body, Doty said.
Late last month, China announced the appointment of Guo Shuqing as the new head of the China Securities Regulatory Commission, in a reshuffle of key financial regulators.
The PCAOB and the U.S. Securities and Exchange Commission have been encouraging the new CSRC chairman to resume talks over inspections, Doty said.
The PCAOB negotiated agreements this year to inspect audit firms in the United Kingdom, Switzerland and Norway, but Chinese regulators have resisted U.S. inspections on the grounds that it would infringe on their authority.
The PCAOB is struggling over whether audit firms in China should lose their U.S. registration if that country does not allow inspections of its auditors, Doty said.
“It is not something we want to have happen,” he said.
In a speech at a Practicing Law Institute conference, Doty indicated a controversial proposal to require term limits for audit firms to increase their independence could be difficult to put into practice.
“I recognize now that audit firm rotation presents considerable operational challenges,” he said.
The PCAOB in August issued a “concept release,” or initial report, on rotation, the first step in drafting changes in auditor standards. It is seeking comments on the proposal through December 14.
Considered as early as the 1970s, audit firm rotation has been strongly opposed by audit firms, which would lose some of their most lucrative clients if it went into effect.
Sarbanes-Oxley mandated that lead auditors be switched every five years, but put no term limits on audit firms.
About 175 companies in the Standard & Poor’s 500 index have had the same auditor for 25 years or more, according to Audit Analytics, and some of relationships date back more than a century.
The PCAOB has found hundreds of audit failures in the eight years it has been doing inspections, where auditors failed to get reasonable assurance to back up their opinions, Doty said.
“You have to ask yourself whether there’s an independence issue that has adversely affected skepticism,” he said.
Reporting by Dena Aubin and Sarah N. Lynch; Editing by Richard Chang