Keynote Address 

It is an honor and a pleasure to be here for the 43rd installment of this important institute. It gives both regulators and securities law practitioners a chance each November to take stock of events and regulatory developments that have emerged during the year.

For busy lawyers, the day-to-day changes, the news, the near constant regulatory responses, consume most of our ever more constrained time. Without a pause for reflection, as PLI's Annual Institute offers, we can miss the subtle, but broader changes, or dismiss them as natural evolution that we should expect.

I will begin my remarks today on one such phenomenon, the evolution of which many of us have perceived over the course of a few decades — the globalization of securities offerings and the singular implications for audit integrity. 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.  Companies Around the World Borrow U.S. Investor Protection Institutions to Improve Access to Capital Here and at Home

The United States has maintained a vibrant IPO market for decades. That market has provided the funding necessary for numerous entrepreneurs with great ideas to pursue their vision. Our system of financial regulation affords market participants information on which to establish a price for funding such ideas, adjusted to account for perceived business risk. The system has for some time accommodated evolving regulations: to encourage investment, to reduce agency costs and thus provide a low cost of capital, and to protect investors from fraud.

Our federal securities laws were not founded on the notion that business should be constrained. They were based on a vision that aggressive investor protection was the best means to pursue our national economic interest in promoting the formation of capital to fund business ventures that would grow our economy as well as jobs.

It worked. Capital allocation through securities offerings in public markets has been an effective component of our nation's economic success, in no small part because of the protections our laws and institutions afford investors.

Investors need reliable financial reporting in order that they, or intermediaries on their behalf, can fairly evaluate a potential investment as well as management's stewardship of the companies in which they have purchased interests. Based on this paradigm, millions of Americans have been willing to invest their savings in those companies to fuel growth that results in, among other things, broader employment. It also promotes wealth, even as the United States has moved away from the defined benefit pension systems that weigh on the economies of many other developed nations.

Our system of securities regulation is available to the world to copy. As we sit here, elements of Sarbanes-Oxley that were best practices before 2002 are only emerging in other legal systems. Even today, for all the weaknesses we identify in our own system, and seek to correct through reforms, no country has completely emulated the transparency and rigorous enforcement of professional integrity in our markets.

Instead, beginning more than two decades ago, demonstrating the subtle but powerful force of what we call globalization, companies have taken direct advantage of our markets. Globalization is evidenced by companies seeking funding that is either unavailable in their home markets or more costly in their home markets than the present value of their growth project can justify.

The headlines are of centripetal and centrifugal forces locked in a struggle over the fate of the Euro-zone. That reminds us that in the face of economic necessity, political centrifugal forces are as strong as ever. Markets understand differences; they account for them in price and liquidity.

When I use the term "globalization," I'm focused not on any sense in which the world is getting smaller but, rather, on the expansion of choices. For individuals, it means expansion of choices on where to live and where to work.

For businesses, it means new market opportunities. Many of you hail from law firms that, within your tenure, have opened offices abroad. Many of you compete, here in New York, around the country and the globe, with law firms formed elsewhere.

Globalization also means expanded funding sources. That's where our securities markets come into play. It is not an international treaty-based regime of globalization that gives businesses access to capital in U.S. markets. It is our open legal and regulatory system, which does not deny businesses access based on domicile, that offers funding opportunities globally.

Globalization, in this sense of an expansion of choice for the world's entrepreneurs and businesses, has been the product of our legal and regulatory regime.

Let me dwell on this point a moment, because it sets a different paradigm than the one to which globalization is sometimes used to refer.

Many non-U.S. companies entering U.S. securities markets are long-standing businesses in their home countries, some state-owned. Their listing in the United States may provide the company funding for a growth opportunity and promote employment at home. Or it may help a government effect a privatization plan. There may be no relocation of business here.

In many cases, non-U.S. companies raising capital in their home countries also seek to raise capital in U.S. markets. Why? Multiple offerings increase costs, and on the surface seem less efficient. Are they?

The answer is that the costs associated with a U.S. listing, including compliance costs, and intermediary fees, do not outweigh the benefits of the listing, or the company would not engage in the extra listing.

Indeed, it is the compliance costs — or the effort to comply with U.S. requirements and submit to U.S.-style enforcement — that reduce the cost of capital, both in the U.S. and at home. It is the commitment of dedicated professional intermediaries, counsel, auditors and others, to full and fair disclosure that gives investors confidence in the company's reporting and stewardship, in every market in which its securities are available.

Through scholarship of financial economists at Cornell and elsewhere, we know that when a non-U.S. company offers securities in the United States, it is in effect using U.S. institutions to improve its cost of capital.^[1] These economists hold that the underlying pattern of this activity is the search for the "cross-listing premium" that occurs when issuers list at home and abroad — that, they observe, is the phenomenon of globalization of the securities markets. Globalization makes it possible for enterprises, even other governments engaged in privatizations, to borrow institutions from the United States and improve their cost of capital in all markets.

This should not be surprising to those of you engaged in securities law practice, whether at the offering stage or in enforcement. It is the reason clients engage you.

But it reveals facts that are inconvenient to those who decry rigorous securities regulation in favor of a more laissez faire approach. Loosening our investor protections would not be cheaper for businesses in the long run.

Some detractors point to changes in IPO activity as evidence that Sarbanes-Oxley has somehow weakened U.S. markets, or U.S. companies' access to capital, which this audience knows are two different things. The evidence supports neither claim.

The facts are that world IPO activity peaked in 1996, well before Sarbanes-Oxley was enacted in 2002.^[2] It reached another peak in 2000, reflecting the surge in technology IPOs and, for a brief period of years, a bonanza for Silicon Valley venture capitalists looking to realize quick returns on investments in start-ups. Then, all over the world, the count fell for three years, before increasing again to reach a new record in 2007.

The fluctuation in annual counts until 2003 occurred for both home country IPOs (including in the U.S.) and IPOs involving listing, partially or completely, outside the company's home country, often in the U.S.^[3] But the increase in IPOs after 2003 was substantially attributable to the foreign listing phenomenon.^[4]

Locally in the U.S., IPOs of U.S.-domiciled companies did increase after 2003, making it hard to support an argument that Sarbanes-Oxley — or any of the work you all do to help companies implement it — deterred valid business growth opportunities.^[5]

A telling aspect of IPO activity is that, despite the dramatic global trend among non-U.S. companies, U.S. companies have never in any material way sought listings outside their home country.^[6]

If Sarbanes-Oxley did deter offerings, they may well have been appropriate offerings to deter. To be sure, many foreign companies list elsewhere. The system depends on lawyers, auditors, exchanges and other gatekeepers to perform a screening function.

Lowering our standards to attract companies that cannot, or choose not to, meet them would reduce the value of our institutions to those companies as well as to all the companies that were able to meet our standards.

An important U.S. institution is the independent audit, and the U.S. system of auditor oversight. What many don't realize, though, is that this component of the system involves not only U.S. accounting firms, but also non-U.S. affiliates that frequently play large roles in audits of U.S. companies.

These affiliations of firms hold themselves out, for many purposes, as a seamless global network sharing a name with a well-recognized U.S. firm. But they are separately registered with the PCAOB and, at present, many of them escape the auditor oversight component of the U.S. system.

II.  The PCAOB's Inability to Inspect All Non-U.S. Registered Audit Firms is a Gap in U.S. Investor Protections

With that backdrop, let me now focus more closely on the audits of those foreign companies that have sought capital in our markets. While U.S. company IPOs only modestly increased in the last decade, 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.^[7]

The PCAOB has registered a significant number of non-U.S. firms that audit or wish to participate in audits of issuers in U.S. markets. To date, the PCAOB has conducted 301 inspections of non-U.S. registered firms located in 36 jurisdictions.

The inspections we have conducted have been valuable, both to the public interest and, I believe, to the firms' interest. Our critical review and dialogue with firms during these inspections have focused them on impediments to quality to make them better firms.

Our inspectors often see more than the principal auditor — or signing firm — does. In many cases the signing firm relies on high-level reports from subsidiary auditors. They often don't review the work papers of the other auditors. When PCAOB inspectors do, many times they have found problems in that work, of which the signing firm was unaware.

This is one of the reasons why it's so important that we look at audit work performed outside the U.S. We need to have access to the whole audit to protect investors adequately.

Many foreign private issuers have been responsible participants in our markets, aided by able securities law counsel. But because of conflicts in national laws and policy goals, others have not fully implemented the protections to which investors are entitled.

As has been widely reported, the PCAOB remains unable to inspect registered firms 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 audits, 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.

I believe we have made substantial progress in helping other jurisdictions see this point: after achieving cooperative arrangements 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.

We also aspire to make progress on a joint inspection arrangement with Chinese authorities, but there the progress is slower. Unfortunately, the risks to investors are every bit as great, if not greater in some respects. For example, 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.

The reports are that Chinese authorities are concerned about companies or their auditors imparting any information that could be considered to be a state secret to any person outside China, including the company's auditors and relevant regulators. The scope of the concern apparently even extends to companies with no state ownership.

If Chinese authorities act on this concern to prevent appropriate information from reaching U.S. auditors and regulators, auditors could be faced with more limitations. That would further damage investors' confidence in China-based issuers and jeopardize the arrangements that allow those companies to participate in U.S. markets.

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 issuers. But they audit some of the largest companies in the world.

Regardless of what happens to the China-based issuers, the PCAOB will need to address its current inability to inspect registered firms that audit them and Chinese operations of issuers based in the U.S. or elsewhere.

My hope is that Chinese authorities, like other countries, will embrace joint inspections. This is not an unfounded hope. 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 I believe our work and interactions with the former chairman, Shang Fulin, and the staff of the CSRC will be time well spent and will put us in a good position to move forward with all due speed.

For all the reasons I've explained, Chinese businesses benefit from their involvement in globalization. They benefit from our securities institutions. And they benefit from employment opportunities our 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 U.S. markets benefit from the credibility joint inspections bring.

III.  The PCAOB's Policy Agenda to Enhance the Relevance, Credibility and Transparency of Audits

While we work these diplomatic matters out, the PCAOB has also been deeply engaged in some important policy initiatives that go to the relevance and value of audits, wherever conducted. We have three major projects underway.

A.  The Auditor's Reporting Model

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.

Embedded in investors' call for more information from the auditor, is a call for auditors to better serve investors. I dare say 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 disconnect permeates the advice we have received. To my mind, the Board's evaluation of recommendations on the model form of the audit report should start with the unique nature of U.S. securities markets.

Our audits and audit reports ought to reflect the needs of dispersed owners. This is a starting principle for me. It is not the conclusion of the analysis. Based on this principle, we will need to consider many practical challenges, such as what auditors are capable of producing for mass consumption 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 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.

That said, they are intended to spur debate over how to change auditing, from a culture that emphasizes client service to a culture that emphasizes public service.

We have received more than 150 comment letters to date. In addition, in September we held a public roundtable to foster further discussion.

I am grateful for the letters we received from two securities law firms and the Association of the Bar of the City of New York. While the letters point to risks associated with changing the reporting model, there are also some constructive ideas to improve the quality of financial reporting, based on deep experience with the securities offering and periodic reporting processes.

B.  Auditor Independence

The PCAOB is also focused on auditor independence. Our inspectors have conducted annual inspections of the largest U.S. audit firms for eight years. They have reviewed significant aspects of approximately 3,000 engagements of such firms and discovered and analyzed hundreds of cases involving what they determined to rise to the level of an audit failure.^[8]

Sometimes, inspectors can trace an audit failure to a competence issue, such as in the design of the audit methodology or in relation to a new or complex accounting standard. But, on the whole, these firms are highly competent. And yet the failures continue to occur, in spite of firms' remediation efforts.

Against this background, we cannot avoid asking whether the root of the problem is auditor skepticism, coming to ground in the bedrock of independence. The loss of independence destroys skepticism.

Inspections by other audit regulators have also given rise to concerns about auditor skepticism.^[9] Based on such concerns, the European Commission is also reportedly considering reforms to enhance auditor independence. I understand a draft of proposals from the EC is expected later this month.

In August, the PCAOB issued a concept release to seek public comment on how to enhance auditor independence, including whether audit firms should be subject to term limits.

I recognize that audit firm rotation presents considerable operational challenges. As attorneys, you may have your own perspective on them, and I'd like to hear them.

One point I leave you with, though, is that the role of the auditor, as attestor, is supposed to be quite different from the role of counsel, as advocate and advisor. And therefore the business model for auditing may need to be more different from law practice than it is today.

Lawyering should focus on client service. Lawyers are expected to act with commitment and dedication to the interests of the client, within the bounds of the law.

But the role of the auditor is different. It is not an adversarial role, such as opposing counsel would play. The auditor is supposed to remain independent of the client and skeptical of management representations.

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 remove that constraint?

This is not an easy subject. We have a long comment period, extending to December 14. We discussed the topic at a public meeting yesterday with the Board's Standing Advisory Group, made up of investors, auditors, preparers, securities lawyers and others. We will also hold a public roundtable to further discuss the subject in March of 2012.

C.  Audit Transparency

The third policy initiative I want to talk about is audit transparency. Last month, 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.

At the concept release stage, the Board received certain objections to requiring engagement partner signature, most notably that the change could unintentionally imply a reduction in the firm's overall responsibility for the audit and the audit opinion. The proposal is intended to address those concerns.

Our audit standards set forth the responsibilities of the auditor. The proposal does not change the responsibilities of the audit firm or the engagement partner.

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.

*    *    *

I want to thank you for your attention today. I look forward to the rest of the conference.

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^[2] 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; Doidge, C., Karolyi, G.A., Stulz, R.M., 2009.

^[3] See Doidge, C., Karolyi, G.A., Stulz, R.M., 2009; Doidge, C., Karolyi, G.A., Stulz, R.M., 2004.

^[4] See Doidge, C., Karolyi, G.A., Stulz, R.M., Sept. 2011 working paper.

^[5] See id. at 37 (Table 1).

^[6] See id. at 2.

^[7] Based on data from Bloomberg and CapitalIQ.

^[8] An audit failure—that is, a failure to obtain reasonable assurance about whether the financial statements are free of material misstatement—does not mean that the financial statements are, in fact, materially misstated. When an issue is described in the public portion of an inspection report as an instance of the firm having failed to obtain sufficient evidence to support its opinion, that means that the inspection staff has determined that, because of a concretely identifiable error or omission, the firm failed to perform an audit that provides reasonable assurance about whether the financial statements are free of material misstatement. In other words, the inspection staff has determined that the audit failed.

^[9] See U.K. Audit Inspection Unit, 2009/10 Annual Report 4 (July 21, 2010) (stating that "[f]irms sometimes approach the audit of highly judgmental balances by seeking to obtain evidence that corroborates rather than challenges the judgments made by their clients" and that "[a]uditors should exercise greater professional scepticism particularly when reviewing management's judgments relating to fair values and the impairment of goodwill and other intangibles and future cash flows relevant to the consideration of going concern"); AFM, Report on General Findings Regarding Audit Quality and Quality Control Monitoring 13-14 (Sept. 1, 2010); Australian Securities & Investment Commission, Audit Inspection Program Public Report for 2009-2010 (June 29, 2011); CPAB, Enhancing Audit Quality: Report on the 2010 Inspections of the Quality of Audits Conducted by Public Accounting Firms 3 (April 2011); Auditor Oversight Commission (German), Report on the Results of the Inspections According to § 62b WPO for the Years 2007-2010 (April 6, 2011); Federal Oversight Authority (Switzerland), Activity Report 2010.