PCAOB Sanctions Foreign Affiliates of Global Accounting Firms


The Public Company Accounting Oversight Board has recently shown a renewed interest in the activities of foreign affiliates of major global accounting networks. Last week, in settled enforcement actions, the Board suspended the former chairman of Deloitte’s Brazilian affiliate for at least five years, and permanently barred the firm’s former CEO. The Board actions against the Brazilian firm executives follow on the heels of an action at the end of 2016 in which the PCAOB levied a record $8 million fine on Deloitte Brazil. These actions arose in connection with an alleged scheme by senior officials at Deloitte Brazil to conceal auditing errors from oversight authorities.

The PCAOB followed up the Deloitte cases by settling lesser unrelated charges against the foreign affiliates of PricewaterhouseCoopers, Ernst & Young, KPMG, Nexia and Grant Thornton, involving firms based in Spain, Argentina, South Korea, Brazil and Colombia. The settled charges involved allegations that the foreign affiliates failed to file reports on PCAOB Form 3, as required under PCAOB Rule 2203, to disclose home country civil or criminal enforcement actions brought against the firms or their personnel. The fines imposed by the Board were relatively minor, ranging from $10,000 to $25,000, but the fact that affiliates of all Big Four firms, as well as other major players such as Nexia and Grant Thornton, have settled PCAOB enforcement actions within the space of a week suggests that foreign affiliates of global firms should be prepared for closer PCAOB scrutiny.

Foreign audit firms whose audit reports are included in SEC filings must register with the PCAOB. Currently, more than 900 foreign audit firms are registered with the Board. Affiliates of global audit networks can be a source of particular concern to both regulators and investors. Despite the fact that these affiliates operate under the banners of some of the most recognized financial firms in the world, these companies are separate and distinct legal entities from the umbrella organization. Foreign firms are often organized as limited liability entities that are regulated by home country oversight authorities, and the umbrella organization will often have little control of the day-to-day operations of these firms.

PCAOB Director of Enforcement Claudius B. Modesti highlighted the risks inherent in the globalization of the audit process in a 2014 speech:

While the benefits of globalization to capital formation and investment opportunities are significant, globalization also introduces unique audit risks. These risks include divergent cultural biases and business norms, inadequate knowledge of U.S. accounting and audit standards, and differing corporate governance practices. Business norms and corporate governance practices that might be deemed appropriate in one place may be improper or even illegal in another … While the risk of fraud is present in audits of companies in any region, audit risk is particularly acute in emerging markets. In certain instances local regulatory oversight and reporting requirements may be less sophisticated than in more developed markets, and other aspects of the business environment may not promote investor safeguards that have become standard in more developed regulatory regimes.

Board member Steven B. Harris recognized in December 2016, that it is critical for "regulators around the world to work increasingly collaboratively to address improper behavior." He characterized the violations seen in the Deloitte Brazil cases “as extremely serious violations which raise fundamental issues relating to global firm governance, culture and tone at the top.”

From a securities law standpoint, it is doubtful that domestic accounting firms or the umbrella organizations would incur fraud liability in private securities litigation based on affiliate misconduct. For example, in a 2013 decision, In re China MediaExpress Holdings, Inc. Shareholder Litigation, the U.S. District Court for the Southern District of New York found that the Supreme Court’s Janus decision, which limits securities fraud liability to “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it,” precluded an imposition of liability on the umbrella organization.

Even though securities fraud liability is unlikely, global accounting firms would be well-advised to review their relationships with their foreign affiliates and the firm governance structures of these operations. While the small fine amounts imposed in the failure to report cases cited above are hardly material to the operations of a major international accounting firm, the reputational harm can be significant. In addition, as the $8 million fine imposed on Deloitte Brazil suggests, both local firms and global accounting networks have a vested interest in minimizing their exposure to PCAOB inquiries.