Auditing the auditors

By Peter Morton
Illustration: Alain Pilon

A one-stop registration process for auditors is just the start of what CPAB and PCAOB hope will become a more integrated operation

Gordon Thiessen and William McDonough go back a long way. As two former central bankers, one Canadian, the other American, they have spent endless hours together working on international banking issues and along the way have forged a friendship.

And that's a good thing as Thiessen and McDonough are facing one of their toughest challenges yet — setting up, running and working on coordinating both the registration and the auditing of auditors under the auspices of Canada's and the US's new public accountability boards.

"Gordon and I are old friends. I've known him a long time and have a tremendously high opinion of him," says McDonough. "It certainly makes it easy in the sense that the two chairmen know each other well and relate very well."

 The former president of the Federal reserve Bank of New York, McDonough is taking on a new role — auditing the auditors as chairman of the US Public company Accounting Oversight Board (PCAOB). Like the US, Canada has also set up a public accountability board. The Canadian Public Accountability Board (CPAB) has its new offices in downtown Toronto and has registered about 200 domestic firms, with another 20 pending. Thiessen, the former governor of the Bank of Canada, is its chairman.

One key goal of the US board is to set up reciprocal arrangements with the major industrialized countries, and Canada in particular. "We had to establish how we carry out our responsibilities, recognizing that while the world economy may be global, the nation state is still what we are looking at politically," says McDonough.

It was the collapse of Houston-based energy trader Enron Corp. — and the implication of its auditing firm Arthur Andersen in the massive debacle — that brought about the broad Sarbanes-Oxley Act that is demanding sweeping changes to how auditors of publicly traded companies will be policed. "Our view is that Sarbanes-Oxley, at least simplistically, is to protect investors in the US market," says McDonough. The new US rules of corporate governance have essentially two components. One, they demand much tougher rules on publicly traded companies, their executives and audit committees. Among some of the most contentious rules is that CEOs and their financial officers sign off on their financial statements attesting to their accuracy. "Some of them reacted that this is threatening," says McDonough. "My reaction was 'what the hell did they think they were responsible for before?' "

The second component is the onus put on auditors of companies publicly traded in the US. Besides going through a detailed registration process, auditors will be hit with inspections as often as once a year — if they audit more than 100 publicly traded companies — or as little as once every three years.

"Some of them feel this is a bit of a bum rap," says McDonough. "But it doesn't make any difference whether it's a bum rap or not — it's the reality."

That is why the distinguished looking banker especially likes his new digs in the eighth-storey office overlooking Washington's powerful lobbyist enclave, K Street. Before he and the PCAOB moved in, the offices belonged to the now-defunct ar-thur Andersen. "It's nice, don't you think?" asks McDonough, gazing around his new office space.

So far, about 1,003 auditing firms (of which 186 are foreign, including 22 Canadian) have registered with the PCAOB  — all done electronically in a move McDonough hopes will eliminate some paperwork. "We are getting a fair amount of concern expressed by small and medium-sized companies as to whether the requirements of Sarbanes-Oxley were a heavy tax on them," McDonough says.

Not only will there be sweeping changes for US auditors but because so many foreign public companies trade in the huge US public market, the changes touch auditors around the world — and none so much as Canada. By far, Canadian companies are the largest foreign players in the US market, everything from trading stocks to bonds. At last count, there were some 498 Canadian firms trading somewhere in the US.

For Canadian auditors of public companies trading in the US, that imposes a unique burden — the time and energy of registering on both sides of the border.

While it may seem a struggle, McDonough firmly believes working out some sort of deal with his counterpart Thiessen should not be a problem. After all, Canada and the US have virtually integrated economic markets and share many of the same values, he says. "There are two countries that are a model on how to cope: Canada and the United States. Economic links are so omnipresent and the Federal Reserve and the Bank of Canada have an incredibly good relationship so we are building on that tradition."

McDonough envisions a day when auditors on either side of the border will simply have to make one stop to sign up for both boards. "The registration process is one in which we will work out an ar-rangement with the Canadian authorities in which Canadian accounting firms that want to register with us can do so simultaneously with the Canadian and US authorities," he says.

Sorting out the registration process in Canada and the US is just the beginning of what both board chairmen hope will develop into a much more integrated operation. For example, there is the issue of auditing the auditors. Both boards will hold periodic inspections of auditing firms, depending on the number of publicly traded companies they audit.

But who actually does the auditing has yet to be sorted out. What Thiessen and McDonough hope to work out is a reciprocal system whereby inspections are done by the boards in which the auditing firm is based. "What I hope is the essence of our approach is that if we had to inspect, the Canadian overseers would do it on our behalf," he says, as long as the Canadian board meets the standards required. "Similarly, if Canadian authorities had to inspect a firm in the United States because of an issuance in Canada, we assume Gord Thiessen would ask me and my people to do the inspection."

In addition, McDonough says PCAOB will likely send a couple of its inspectors to Canada when the Canadian auditor of US registered companies is due for an audit — and vice versa. But since both boards are just recently up and running — both plan to issue inaugural annual reports, likely every spring — that kind of detail still has to be finalized, says Thiessen. While no formal arrangements have been made, "I'm sure we will have a mutual arrangement that will work for each other," he adds.

But there are other issues for Canadian auditors. Last December, the PCAOB published proposed rules for foreign firms that demand they follow the same disclosure rules as US auditors. It did acknowledge that the new rules "raise special concerns" for foreign auditors such as "unnecessary duplicative costs and potential conflicts of law." A key concern for Canadian auditors is the demand that they disclose certain information that they are prohibited to under Canadian law. Called Rule 2105, the PCAOB plans to deal with each case individually but will demand a legal opinion on why the information can't be disclosed.

How that will be sorted out remains to be seen.

In addition, there is the delicate issue of independence — is the accountability board truly at arm's length from the industry it monitors? The PCAOB, which was created after the Sarbanes-Oxley Act and whose members were named by the SEC but collects its estimated annual bud-get of US$103 million from publicly reg-istered companies and accounting firms, sees it this way: PCAOB would generally rely on the work of oversight boards in other countries "based on a sliding scale — the more independent and more rigorous an oversight system, the greater the board's reliance [is] on that system."

In other words, says McDonough, "if it is not dependent on the profession organizationally and financially, then it has the degree of independence that we would think put it at the top of the scale."

From the Canadian perspective, CPAB should fit the rules, says its CEO, David Scott. The Big Four accounting firms were initially assessed $500,000 for the first stage of registration in which they signified their intent to participate in CPAB's oversight program. Other smaller firms were assessed varying amounts starting at $1,000. Now, each firm will be assessed annual participation fees of CPAB's costs of $6 million based on revenue from auditing publicly traded companies and subject to a minimum amount. "The accounting firms will get an invoice based on their revenues and they [will] have to write a cheque" or they can pay electronically, says Scott. "Essentially, it's a tax on their revenue, and I suspect they will pass that along to their clients."

While the CPAB is funded by auditors based on revenues, there are actually three levels of scrutiny in play in the country, according to Axel Thesberg, the Canadian managing partner of professional standards and risk management at KPMG Canada. "There is the accounting standards oversight council, the auditing and assurance oversight council and CPAB," he says. And that should go a long way to overcoming concerns that the profession is too close to the body regulating it.

"What we've done in Canada is very much a Canadian-made solution — it reflects our different environment here," says David Smith, president of the Canadian Institute of Chartered Accountants.

And at least for now, Scott says, Canadian auditors with US clients will have to register at both boards. While the two bodies have developed a positive working relationship, the precise contours of their cooperation have yet to be defined. "There really wasn't much to be gained," says Scott, a former senior partner with PricewaterhouseCoopers, but the day may come when the two boards will more closely coordinate the information they are looking for. In the meantime, all for-eign auditors handling companies with US securities have until this July 19 to register with the PCAOB.

That is a hoop Sheldon Krakower, partner at Montreal's Goldsmith Hersh S.E.N.C.R.L., has already jumped through. "We had no choice but to register with both boards," he says from his Montreal office on Fort Street. "We sign the statements so we had to comply."

Goldsmith Hersh S.E.N.C.R.L. and about 16 Canadian accounting firms were the first firms to register both with the US and Canada. And there were some differences, he says. "Everything from the US side went smoothly — the Canadian process was grueling and time-consuming," says Krakower, whose firm audits the books of Dorel Industries Inc., a major Canadian manufacturer of consumer products that trades on the Nasdaq stock market and Canadian exchanges. "No contest," he says, "Canada wins the 'paperwork' war!"

Bill Davidson, partner at Davidson & Co. in Vancouver, has a similar take on registering on both sides of the border. "The US process was simpler and seemed to go more smoothly than the Canadian process," he says.

In Canada, the prospect of spending time registering with the Canadian board has put off the smaller accounting firms, especially on the West Coast. Many of the smaller firms audit so few publicly traded companies, they don't feel it's worth the investment in meeting CPAB's quality control standards. "For accounting firms that have handled only one or two registered companies, it is a bit of a nuisance," notes Michael Essex, director of practice review and licensing for the Institute of Chartered Accountants of British Columbia. Essex says it looks like half of the institute's members have decided to drop the auditing of their publicly traded clients rather than go through the expense of registering. "Many are frustrated by the layer of bureaucracy on top," he says. "It's just not worth the firm's time."

Brian Hunt, president of the Institute of Chartered Accountants of Ontario and a board member of CPAB, has also seen  a drop-off in the industry. "In Canada a significant number of firms were doing only one or two issuers," says Hunt. And some are deciding not to register. "Nationally, about a third of the firms have dropped out," he says.

Both boards insist the registration process is not that onerous, especially because accounting firms can register online. "In a sense, there is no paper burden at all — there is a data dump required," says McDonough. "It's after the initial registration [that] we will set up an annual update that will [involve] much, much less detail."

And as for Thiessen, he insists: "It's gone pretty smoothly."

Regulatory differences aside, the goals of the Canadian and US boards are the same. "Our goal is to give the public confidence," says CPAB's CEO Scott. "The two boards may be set up differently but in the end, I think there will be more similarities than differences."

And the methods of both boards of keeping their profession in line will be generally the same. Through annual reports and news releases, they plan to detail some of the problems still facing the profession. McDonough says one technique is to give an auditor 12 months to correct some of the "criticisms" found by the board in its audit. "We won't actually make that public, and if they fix all the things in 12 months, it never becomes public," he says. "It's a tremendous pressure on them to fix."

Scott says the CPAB has identified at least a dozen Canadian firms with more than 50 Canadian reporting issuer clients, as well as other firms that have also registered with the PCAOB, that will be audited each year, while smaller firms will be audited every three years. (CPAB plans to make arrangements with the provincial accounting oversight bodies to conduct reviews of the smaller firms on CPAB's behalf.) And the Canadian board will work fast, giving auditors only 180 days to make any necessary changes. "Otherwise, we will name them and shame them," he says, adding he believes it's unlikely any auditing firm would risk being named publicly.

What the two boards will be looking for, at least in the early years, is what McDonough calls "the tone from the top" — that is, whether the managing partners and principals have figured out what Sarbanes-Oxley is all about. "As I put it, accountants have to restore the confidence of investors they lost," he says. "So we did look at the people at the top of the firm to see if they understand what is required." If that is happening, he says, it should be moving through the firm's head office and its regional offices to see whether "the auditors or the youngsters just out of school are getting the message."

Thiessen and McDonough do not expect to meet much resistance, since no single profession has a higher motivation than restoring the public's confidence. "As a profession, and they do consider themselves a profession, they went from their former reputation of being maybe not the world's most interesting people but everyone thought highly of them to one where their profession was found wanting," he says. "Boy, would they settle for that again."

RISE IN AUDIT FEES LESS THAN EXPECTED Big business paid auditors 13% more in 2003 than they did in 2002, according to the disclosures of audit and audit-related fees of 85 large Canadian companies. While this increase may seem substantial, it's less than some expected considering beefed-up requirements for auditors resulting from new regulations intended to improve investor confidence.  Data from the 85 companies (all were ranked in the top 131 by revenue in the Globe and Mail's 2003 Report on Business 1000) also indicates that the changes in fees are not consistent across the board. The averages were driven up by high-growth companies and those involved in large mergers. The largest increase in audit fees was paid by Moore Wallace Inc. (up 118%), explained by its recent merger with RR Donneley. The next largest increase was for Great-West Life Assurance, which also underwent a major merger. Some companies saw a decrease in their audit fees — for example Suncor Energy Inc. dropped by 41% and Bell Canada's dropped by 40%. The size and complexity of Canada's largest companies varies dramatically and, not surprisingly, so do their audit fees. Of the companies included in this review, Bombardier Inc. topped the list with an audit fee of $48.9 million. BCE Inc. was the next largest at $17.5 million. Thomson Corp. ($17 million), Royal Bank of Canada ($16.3 million) and Bank of Nova Scotia ($13 million) round out the top five. While auditors found some gains in the audit area, these were offset by losses in the non-audit services they provided. On average, audit fees in 2003 accounted for 73% of the total fees charged by an auditor compared with 65% of total fees in 2002. Tax is the primary area of non-audit services and this trend is growing. More than 73% of non-audit services were in the tax area for 2003, compared with 59% in 2002. John Tabone is CICA's manager of innovation

Peter Morton is the Washington bureau chief with the Financial Post