Lemons into lemonade: how the United States turned an ugly accounting scandal into a mighty lever for global financial oversight and regulation.

• Author: Engelen, Klaus C.

In the tumultuous and rapid process of globalization, there are watersheds of historical dimensions. Historians writing about the Pax Americana reaching into the 21st century should include a chapter describing how the United States was able to turn the adversity of the largest wave of corporate bankruptcies it ever experienced into an opportunity to further strengthen its dominant position in the global financial markets via the mighty levers of extraterritorial oversight and regulation.

Who could have imagined that as a consequence of high-profile corporate scandals in the United States, accounting firms the world over would be forced under the supervision of a newly established agency in Washington, the Public Company Accounting Oversight Board? Comprehensive new capital market legislation--the Sarbanes-Oxley Act, authored by Maryland Democratic Senator Paul Sarbanes and Ohio Republican Representative Michael Oxley--has brought about:

* Far-reaching changes in the way major accounting and auditing firms are supervised around the world:

* A push toward aligning corporate governance in Europe and other parts of the world with the standards and practices prevailing in the capital market-based U.S. financial and corporate system:

* EU reform initiatives to modernize company law and enhance corporate governance aimed at strengthening shareholders' rights, reinforcing protection for employees and creditors, increasing the efficiency and competitiveness of European business, and boosting confidence in capital markets; and

* Governments willing to bring forward on a national level long-delayed legislation on financial disclosure for corporate management and tougher regulations designed to curtail fraud in the financial industry.

Despite spectacular European corporate failures, a critical general public, and mounting pressure from markets, policymakers, and regulators, these changes have not unexpectedly met stiff resistance from powerful interests. After all, these interests are defending corporate governance structures and practices rooted in the different national bank-based systems prevailing in Continental Europe.

How Europe is struggling to handle the spillover effects of Sarbanes-Oxley for Europe's accounting profession was explored by this author in "Preventing European Enronitis" (TIE, Summer 2004). The article featured key trans-Atlantic negotiators William McDonough, chairman of the newly established PCAOB, and Frits Bolkestein, the former EU Commissioner for Internal Markets, as they succeeded in defusing a potentially explosive situation arising from extraterritorial conflicts in law and regulation by building on new European oversight structures under which the principle of reciprocity could be accepted.

THE HAMMER FALLS ON FOREIGN ACCOUNTING FIRMS

In this respect, July 19, 2004, marked a watershed in terms of the United States extending its oversight to other jurisdictions and regulatory systems despite far-reaching conflicts in law and regulation. On that day, non-U.S. accounting firms subject to Sarbanes-Oxley and the PCAOB had to be registered "to the same extent as a public accounting firm that is organized and operates under the laws of the United States." McDonough, who took over the helm of the PCAOB in June of last year, told the U.S. Congress that around four hundred non-U.S. accounting firms would fall under the Sarbanes-Oxley oversight.

All over Europe and throughout the world, non-U.S. accountants are concerned about the legal and regulatory uncertainties that the PCAOB registration might bring. Take the example of Germany, Europe's largest economy. Days before the deadline, the major German accounting firms appeared on the Web site of the PCAOB as registered--Bayern Revision, BDO, Deloitte & Touche, Ernst & Young, Grant Thornton, KPMG, Mazars, PricewaterhouseCoopers, and S.Audit.

But Reiner Veidt, executive director of Germany's Wirtschaftspruferkammer (WPK), the professional association of accountants in Berlin, points to the risk of "legal conflicts that may arise from regular inspections of the PCAOB." The oversight agency intends to inspect registered firms every three years. "Part of the inspections will be a review of specific engagements and thus access to audit working papers," says Veidt. "This conflicts with German confidentiality rules and data protection law. Until now, the PCAOB has not given adequate solutions as to how to deal with legal conflicts in inspections." Veidt concedes that so far, "The PCAOB tries to follow a cooperative approach by accepting inspections by foreign oversight bodies, provided that those oversight bodies follow procedures similar to those in the United States. However, even when fully complying with U.S. procedures, the PCAOB still insists on the participation of its own examiners at inspections of foreign audit firms."

The big hope for accounting firms in the European Union? That in time for the first PCAOB inspections in 2007, new oversight structures will be in place that could take over much of the inspection work under new agreements of reciprocity. Such an overhaul also advances on a national level. In Germany, for instance, the Federal Ministry of Economics and Labor has recently put forward proposals for legally implementing a new oversight system on German accountants (Wirtschaftsprufer). The oversight structure would be supervised by a public oversight board formed by non-professionals.

WPK's president, Hubert Graf von Treuberg, says: "The new law will contribute to...