Preventing European "Enronitis": how European regulators are handling the spillover effects of Sarbanes-Oxley.

• Author: Engelen, Klaus C.
• Position: Sarbanes-Oxley Act of 2002

Are the international spill over effects of the U.S. Sarbanes-Oxley legislation becoming another nightmare for European businessmen, investors, and policymakers? Will the outreach of this U.S. legislation and its conflicts with legal and regulatory systems in EU member states escalate into another major strain on transatlantic relations? Most European accountants, financial executives, regulators, and corporate lawyers--haunted by the far-reaching extraterritoriality of the new law--would say "yes." Anger over the new post-Enron U.S. capital market laws is vented in the sarcastic reply given by the spokesman of a leading European industry association to the question: "What does Sarbanes-Oxley mean? That's when two members of U.S. Congress fiddle and half a million accountants in Europe start dancing."

But there is also a less pessimistic scenario from a European perspective for two reasons. First, under mounting pressure from global markets and an increasingly critical general public, most European governments, lawmakers, and regulators are being forced to speed up long-delayed modernizations of oversight structures for accountants as part of a broader overhaul of corporate governance structures. This makes it easier for EU Commissioners such as Frits Bolkestein to push modernization directives in areas such as EU financial market supervision, accounting oversight, and corporate governance standards reform initiatives that for many years have been blocked by national governments and private sector interests. Second, at both the new U.S. oversight board and at the EU Commission, extremely experienced and skillful negotiators are pulling the strings.

LUCK IN ADVERSITY: EXPERIENCED NEGOTIATORS Since June 2003, William McDonough, 69, has headed the newly established Public Company Accounting Oversight Board (PCAOB). A former president of the New York Federal Reserve Bank, McDonough became the "super diplomat" on the world financial stage when, in July 1998, as chairman of the Basel Committee on Banking Supervision, he began negotiating the new risk-adjusted bank capital accord called "Basel II," a centerpiece in reforming the international financial architecture. And at the outgoing EU Commission, Frits Bolkestein, Commissioner in charge of Internal Market and thus chief Brussels negotiator on matters such as auditing, accounting, corporate governance, and financial supervision, is a skilled negotiator, having played a key role in adjusting Europe's internal markets to the new challenges of globalization.

Since early December 2001--when U.S. energy giant Enron filed for Chapter 11 in what was at the time the largest-ever bankruptcy--U.S. authorities and legislators have responded to the revelations of massive systematic fraud surrounding this corporate failure with great resolve and lightning speed. Enron's collapse was followed by revelations of fraudulent accounting practices, willfully misleading disclosure, and other wrongdoing at major publicly traded corporations including Global Crossing, Tyco, Adelphia Communications, WorldCom, and Xerox.

While U.S. authorities and legislators acted swiftly and forcefully, Europeans needed time to realize how much "Enronitis" was a global disease. When similar excesses and abuses came to light in several prominent European firms--starting with Vivendi Universal, ABB, and Royal Ahold and leading to such spectacular corporate failures as Parmalat--the minds of European policymakers, regulators, companies, investors, and the general public finally focused on the weaknesses of corporate governance systems and the threats posed to the integrity and stability of financial markets. "The Parmalat affair," notes the Bank for International Settlements (BIS) in its 2004 Annual Report, "indicated shortcomings at every possible level: senior management, internal audit, external audit, bank lenders, bond underwriters, rating agencies, investment bank analysts, and the overseers of many of the above."

EUROPEAN UNION'S EXEMPTION CALLS IGNORED IN WASHINGTON

By the time Europeans woke up to the spillover effects of the post Enron legislation, the comprehensive Sarbanes-Oxley Act--authored by Maryland Democratic Senator Paul Sarbanes and Ohio Republican Representative Michael Oxley--was already on the U.S. statute books.

The legislation, signed by President Bush on July 30, 2002, applies to all publicly held companies, their audit firms, and all actively working auditors. The changes in U.S. capital market laws through Sarbanes-Oxley have far-reaching irreconcilable differences with the laws, regulations, and corporate govemance systems of EU member states.

EU finance ministers reacted angrily last year, urging the EU Commission to negotiate with U.S. authorities to obtain exemptions for EU corporations and audit firms. At the top of their list was a full exemption for audit firms from registration with the newly established Public Company Accounting Oversight Board. In addition, while recognizing the importance of audit work papers to effective auditor oversight, the finance ministers raised concerns about U.S. authorities' access to a foreign firm's audit work papers. In some EU member states, the law requires audit firms to keep audit papers confidential.

But drafting an impressive list of calls for exemptions for EU auditing firms under the Sarbanes-Oxley Act is one thing. For the EU Commission to actually obtain concessions from those U.S. agencies that must implement the new law--the Securities and Exchange Commission and the PCAOB--is quite another.

At the outset, the Commission offered harsh criticism. Considering the potential impact of Sarbanes-Oxley on foreign companies and audit firms, the fact that the SEC only...