It is an honor and a pleasure to be here for this auspicious symposium on international audit regulation. I want to thank Nick Le Pan and Brian Hunt for convening it. The Canadian Public Accountability Board has done a great service in synthesizing the many issues that confront the auditing profession. The Pre-Reading Materials that CPAB circulated, summarizing various problems and initiatives to address them, are excellent. We are well prepared for a day of discussion tomorrow about solutions that we can collectively achieve.
Tonight, I would like to provide some context, as I see it, for the discussions we will have. I will discuss some common themes pervading the regulation of audits, regardless of what country you are in. Certain structural challenges threaten the relevance of auditing. These threats rise at a time when confidence in business reporting is more important than ever. We are also affected by geopolitical forces that threaten both the regulation of audits as well as the audits themselves.
I am here tonight because I do not believe any of these challenges, or the threats accompanying them, are insurmountable. But they must be confronted. I do believe overcoming them will require concerted, collective commitment and action. Before I go further, though, I must say that the views I express are my own and should not be attributed to the PCAOB as a whole or any other members or staff.
I want to begin with the motivating idea for this conference. A prolonged global financial crisis continues to jeopardize economies everywhere: in the Americas, in Europe, in Australia and Asia. Our people have a shared agenda to restore hope in their futures. Our families have shared agendas to be assured they have the resources to maintain their homes, rear their children with confidence in their ability to prosper, and provide for elders with dignity and respect for the achievements of their generations.
In the United States and Canada, and to a growing degree elsewhere, we ask our people to plan for their own savings. Some among us may have pensions, but our grown children often do not, and our grandchildren probably will not.
It is not because we lack resources. To the contrary, our economies are rich, even in the face of the crisis, because millions have been willing to take their savings into their own hands and invest in business enterprises to fuel growth, growth that results in more workers, more savings and more investment. This cycle promotes economic wealth. It is so accepted in U.S. culture that, decades ago, it allowed the United States to move away from the defined benefit pension systems that weigh on the economies of some nations.
We are free societies. It is not the case everywhere, but I daresay in all the countries represented here tonight, we are free not because we have benevolent governments, but because we govern ourselves.
But to sustain our model of using grand scale popular investment to fuel our economy, we have – in some ways more explicitly than others – made a compact. We do not regulate to constrain business. We regulate to champion business, by honoring a compact that our markets will be fair and transparent. Regulators must do what we can to enable free markets to provide free investors with reliable information upon which to make their own, free investment decisions.
We cannot, should not, force people to pay for business growth like a tax. We must elicit investment through confidence in the legitimacy of the markets' judgments, and that may only be done through establishing and enforcing appropriate standards to satisfy investors' needs for confidence that savings applied to a purpose will not be squandered. Investors take risk, but they need to know that they will not be the last to learn that risk has sunk the endeavor.
The financial audit is the linchpin for this confidence. In a world of hyper-charged incentive compensation to ignite management initiative, fraught with risk of self-promotion if not outright self-dealing, the auditor stands apart. Independent, objective, skeptical.
If the story, if the numbers, are too good to be true, the auditors are supposed to call it.
And they do. For all the reports of colossal investor damage that could have been avoided but for missed opportunity, auditors do enforce the rules. They do avoid disasters. They do protect investors.
Our job at the PCAOB and at audit regulators around the world is to make sure that auditors do so consistently, reliably.
Our inspections suggest there is considerable room for improvement in this regard.
For example, in an area critical to public concern as we continue to weather financial crisis, inspectors have found instances where firms failed to understand the assumptions and valuation methods used by their clients to determine the fair value of financial instruments. In some cases, they have failed to consider the effects of significant differences between the fair value measurements they obtain themselves and the issuer's recorded fair value.
Internal control audits are not the leading indicators of the risk of misstatements in financial reporting that they are meant to be. Too often, auditors rely on imprecise business processes that are inapt as financial reporting controls. Or, they have failed to understand the flow of transactions in order to identify the points within a client's processes where a material misstatement could arise.
These are important examples of where audits need to improve, but there are others. In many cases, these flaws were found at firms that are clearly comprised of highly competent and ethical professionals.
From my perspective, based on a lifetime of admiring auditors' skill and professionalism, I point to two great impediments. There are more. But these two are formidable, as formidable as any, and they are two that audit regulators can and should do something about.
The first challenge is to find the solution to the bias of the payment model: the auditor is hired and fired by the company itself. This creates perverse incentives for the auditor not to call the fouls. The second challenge is to deal with the global nature of the audit, when notwithstanding what auditors' marketing materials say, audit firms and audit regulators are, as with politics, local, and the auditor has a client to keep.
The payment model forces auditors into a difficult position of having to serve two masters – company management and investors – at the same time. True, they both want to grow the fruits of the enterprise. But their interests diverge from there.
Shareholders know that they risk being misinformed by management, and that they depend on an independent skeptic with unfettered access to the corporate records – the auditor – to protect their interest in accurate and fair financial reporting. But the auditor's rewards – a continuing stream of fees – come from the company itself.
As U.S. Rep. Richard Baker, former Chairman of the House Subcommittee on Capital Markets, said during hearings in the United States Congress to consider the Sarbanes-Oxley Act, "After all, should we really be surprised when you pay the piper, the piper plays your tune?" 
Policy makers such as Mr. Baker periodically question whether the payment model itself can be changed, such as by providing for stock exchanges to hire and pay the auditor. Such a structural reform – to separate the company from the fee – may yet be demanded and take hold, if new scandals continue to erode lawmakers' confidence in auditors' ability to maintain independence.
As a more modest effort, over the course of the last decade, many countries have established auditor oversight bodies to devise and enforce more specific and tailored counterweights to management influence over auditors, through regulation and rigorous inspection to identify and correct audit failures before they become connected to outright financial reporting scandals.
The need for rigorous oversight has borne out in the nine years since the PCAOB was established. PCAOB inspectors have conducted inspections of portions of approximately 3,000 audits by major firms, and they have found hundreds of audit deficiencies. The case is similar at small firms.
Because skepticism is a state of mind, objectivity a silent success, their absence is rarely documented and can be particularly difficult to detect. But too often, audit failures identified by PCAOB inspectors do not appear to be explainable by any lack of knowledge, on the auditor's part, about what audit steps are required in the circumstances.
The pre-reading materials include a summary of inspection findings in Australia, Canada, and the U.K., as well as the U.S. That summary discusses common findings of audit regulators. I was struck by the consistency of results, and the conclusion that "Insufficient Professional Skepticism . . . is undoubtedly the most common finding – that auditors are too often accepting or attempting to validate management evidence and representations without sufficient challenge and independent corroboration." 
Skepticism can fail in spite of both fundamental competence and high ethical standards. Inspections are an important tool to identify ways audits can be improved. There is no telling how many more failures there would have been had auditors not felt the scrutiny of the PCAOB's fresh set of eyes.
But the underlying conflict has not been resolved. I don't pretend that it can ever be completely resolved, when the intended beneficiaries of the audit – public investors – are not in privity with the auditor. But I believe we can better insulate auditors from client pressures. And I believe we ought to try, before the public demands more basic structural change.
This is the reason for our symposium tomorrow. It is the reason for the many policy initiatives that have emanated from countries that are concerned with preserving the audit profession's purpose and relevance.
In particular, I applaud Commissioner Barnier of the European Commission for his leadership in engendering an essential reexamination in Europe of the audit and its role in investor protection. He unveiled a new set of proposals yesterday. I look forward to studying and discussing them.
The PCAOB has also been deeply engaged in enhancing the relevance, credibility and transparency of audits through some important policy initiatives. We have three major projects underway.
First, the PCAOB has initiated a broad debate on the form and content of the standard auditor's report. In June, the PCAOB released a concept release on potential changes to the auditor's reporting model to respond to investors' call for more insights based on the auditor's work.
Because of the payment model, most auditors don't see investors as their direct or even ultimate masters, unless they are dealing with a private investor, such as to conduct due diligence for a potential acquisition. This needs fixing. Our audits and audit reports ought to better reflect the needs of dispersed owners.
There are many practical challenges to changing the auditor's perspective of who the client is, so that auditors' reports are more informative for investors. For example, we need to think hard about what auditors are capable of producing for general use within the short filing periods now required.
We will also need to consider ways to enforce consistency of reporting. "Boilerplate" has a negative, even evasive connotation. At the same time, investors ought to be able to expect that differences in reports reflect differences in the quality of the financial reporting subject to audit, not differences between engagement partners.
The alternatives described in the PCAOB's concept release are focused on enhancing the relevance of the auditor's communication to investors. They would not change the fundamental role of the auditor to perform an audit and attest to management's assertions as embodied in management's financial statements. They are not intended to put the auditor in the position of reporting financial information for management.
We have received more than 150 comment letters to date, including from CPAB and the Canadian Auditing and Assurance Standards Board, the U.K.'s Financial Reporting Council, as well as the Institute of Chartered Accountants in Australia. In addition, in September we held a public roundtable to foster further discussion.
The PCAOB is also focused on auditor independence. In August, the Board issued a concept release to seek public comment on how to enhance it, including whether audit firms should be subject to term limits. We asked particularly for comment on terms of more than ten years, and on the suitability of rotation for the largest issuers.
I recognize that audit firm term limits present considerable operational challenges. But these challenges are overcome routinely by companies that choose to change auditors, for good or bad reasons.
Opponents of mandatory term limits cite practical difficulties some companies could face in finding a new independent auditor competent in the relevant industry or, once found, educating them in the company's business and financial reporting systems. Yet these difficulties must exist today when companies choose to change auditors.
Client acceptance standards and policies are meant to prevent firms from taking on engagements they are ill-equipped to handle. If they need to be improved, they can be. Weaknesses in this area, if there are any, are not a good reason to put off independence concerns.
I am also suspect of arguments that a new auditor will be less useful as an advisor to the company. The role of the auditor, as attestor, is supposed to be quite different from the role of an advisor or counselor. The auditor is decidedly not supposed to be a trusted advisor to the company.
We are dealing in the subtle effects of human nature. What motivates the auditor to exercise skepticism? What pulls him back from it? How do we free him from that influence?
This is not an easy subject. We have a long comment period, extending to December 14. We discussed the topic at a public meeting recently with the Board's Standing Advisory Group, made up of investors, auditors, preparers, securities lawyers and others. And in March 2012, we will convene our first public roundtable to further discuss the subject.
The third policy initiative the PCAOB has mooted relates to audit transparency. In October, the Board proposed amendments to its auditing standards to improve audit transparency by enhancing disclosure about the participants in audits, including disclosure about the partner in charge of the audit, as well as other firms involved in the audit.
This proposal stems from a concept release that the Board issued in July, 2009 to obtain comment on whether the Board should require engagement partners to sign audit reports.
The names of key management executives, not to mention corporate board members, have long been disclosed. The names of audit engagement partners are also disclosed in many countries, but to this point not in the United States.
The proposal would also provide investors disclosure about other accounting firms and certain other participants in the audit. Enhanced transparency into the composition of cross-border audits should help investors gain a better understanding of how an audit was conducted and make more informed decisions about how to use the audit report. Investors will see, for example, the significant participation of audit firms from jurisdictions where we cannot inspect.
Our comment period for this proposal extends through January 9, 2012.
Let me now turn to the second impediment to audit quality that I cited at the outset: the fact that while audits are global, audit firms and regulators are not.
Audits are global both because companies are multi-national and because, whether multi-national or not, companies are increasingly seeking capital by listing outside their home market.
Foreign company listings in the United States have dramatically increased. Twenty percent of the companies listed on the New York Stock Exchange hail from abroad. Fifty of the 100 largest companies listed on the NYSE are foreign. 
Indeed, listings by foreign companies on exchanges outside their home country are up everywhere.  There are many reasons that a company may list outside its home market, such as to link to an established market index.
In the U.S., when foreign companies list, they earn a documented cross-listing premium for bonding themselves to U.S. institutions and committing to U.S. compliance activities aimed at protecting minority investors. 
The bonding effect – that is, the commitment to abide by the standards and laws of a strict investor protection regime – rewards companies located in markets without developed investor protection regimes. Indeed, the rewards include a better cost of capital even in their home markets.
Companies from countries with established markets also benefit from and thus choose to cross-list. Economists study the price differentials such dual-listed companies experience at home and in their adoptive markets.
Interestingly, researchers have found that the average price deviations between the cross-listed and home-market shares among Canadian stocks cross-listed in the U.S. via direct listing in the U.S. are smaller in magnitude than those of any other paired listings around the world.  To my mind, this is a sign of how related our markets have become, and how deep the U.S. trading of Canadian stocks is.
It is right, indeed a necessity, that U.S. and Canadian authorities work together to protect investors in both countries' markets. Fifty-one Canadian audit firms have registered with the Board, and 34 of them are subject to inspection because they regularly issue audit reports on U.S. issuers.
The PCAOB and the CPAB have a strong relationship. We began our program of joint inspections with the CPAB. We are now in our seventh year.
With new authority under the Dodd-Frank Act, the Board can share inspection findings in the U.S. with the CPAB. The CPAB also conducts its own inspections in the U.S., and we provide assistance as requested.
Our relationship allows each of us to conserve resources and concentrate on those audits that concern us. PCAOB inspectors do not review engagements for companies listed only in Canada. But we benefit from the insights CPAB inspectors glean from their reviews and how their findings may bear on quality control matters that do concern us.
Moreover, together we are able to increase our coverage of the public company audit practices of the largest firms that engage in global audits. We can look at both the Canadian and the U.S. components of the audit, as well as others in relevant jurisdictions.
While audit reports for multi-national companies are signed by one audit firm, that firm will generally refer relevant work to its local affiliates in countries where the audit client has operations. Those affiliates are typically themselves separate legal entities. And if they audit or play a substantial role in an audit of an issuer, they will be separately registered with the PCAOB.
It has been suggested since the recent financial crisis that the global audit firm networks pose systemic risk to the various economies in which they operate. I do not believe they do. I am not in favor of efforts to shrink the global networks, because I believe that would likely further weaken their ability to audit the large, multi-national companies that may themselves be systemically important.
The global networks are not too big to fail, but they are too important to leave unregulated. I consider the PCAOB's relationship with CPAB to be a model of investor protection through intersecting and overlapping regulatory oversight of global audits.
This model is beginning to take hold elsewhere in Europe, Asia and Africa. The PCAOB has made substantial progress in helping other jurisdictions see the benefits of rigorous and joint auditor oversight.
Moreover, after reaching cooperative arrangements earlier this year with fellow regulators in the U.K., Switzerland, and Norway, we have commenced, with each of them, joint inspections of PCAOB-registered firms in those countries. I am confident that more joint inspection arrangements with European authorities are on the way.
As has been widely reported, though, the PCAOB remains unable to inspect auditors that perform or participate in audits of companies that access capital through U.S. markets but reside in China or some parts of Europe. I am hopeful that we will be able to resolve concerns raised by authorities in these countries.
Some jurisdictions have resisted joint inspections, professing preference for a policy of "mutual" or "full" reliance. Investor protection is put at risk, not advanced, by such an approach. Audits do not stop at borders, and neither can effective cross-border audit regulation.
As in the case of global audits themselves, reliance on high-level summaries of work performed by another regulator presents an unmitigated hand-off risk. Leaving oversight of the components of cross-border audits to the inconsistencies of separate regulatory processes should not be a goal.
New research on the effect of the U.S. Supreme Court's decision in Morrison v. National Australia Bank shows that investors value U.S. enforcement of its laws on cross-listed companies. Indications that U.S. enforcement may not extend to certain investors are reflected in the spread between the price of a cross-listed company's shares traded in U.S. markets versus the price of shares traded at home.
I hope Chinese authorities, like other countries, will also embrace joint inspections. I view this as an urgent matter. There have been numerous reports of auditors for Chinese and other emerging-market issuers resigning because of concerns about management misrepresentations, or, in some cases, falsified audit documentation.
Some of these companies are also listed in Canada. Therefore, I know CPAB shares my concern.
The Chinese government has just announced leadership change among financial regulators. I look forward to working with the new Chairman of the CSRC, Guo Shuqing, and his staff early in the new year.
Although more than 100 firms from China and Hong Kong have registered with the PCAOB, only a handful claim to perform or play a substantial role in audits of U.S. issuers. But they audit some of the largest companies in the world.
Chinese businesses benefit from their involvement in globalization. They benefit from our securities institutions. And they benefit from employment opportunities U.S., Canadian and other non-Chinese companies offer when they open operations in China. Markets are already speaking. I believe Chinese authorities will see that businesses that want to remain in foreign markets benefit from the credibility joint inspections bring.
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I want to thank the CPAB for providing the opportunity for us to discuss these important issues. I look forward to the discussion tomorrow.
 See Hearings on the Enron Collapse: Implications to Investors and the Capital Markets Before the H. Comm. On Financial Services, Subcomm. On Capital Markets, Insurance, and Government Sponsored Enterprises, 107th Cong., Part 2 15 (2002).
 See Ronald Brownstein, Post-Enron, Congress Must Reassure Investors, L.A. Times, Feb. 11, 2002, at A13.
 See Pre-Reading Materials, at 36.
 Based on data from Bloomberg and CapitalIQ.
 See Doidge, C., Karolyi, G.A., Stulz, R.M., The U.S. Left Behind? Financial Globalization and the Rise of IPO Activity Around the World. Working paper version Sept. 2011.
 See Doidge, C., Karolyi, G.A., Stulaz, R.M., 2009. Has New York Become Less Competitive Than London in Global Markets" Evaluating Foreign Listing Choices Over Time. Journal of Financial Economics 92, 253-277.
 See Gagnon, L., Karolyi, G.A., 2010. Multi-market Trading and Arbitrage. Journal of Financial Economics 97, 53-80.
 See Gagnon, L., Karolyi, G.A., The Economic Consequences of the U.S. Supreme Court's Morrison v. National Australia Bank Decision for Foreign Stocks Cross-listed in U.S. Markets. Working paper version Nov. 2011.