While the quality of financial regulation in a country matters enormously, even the best regulation can be undone by faulty or inaccurate financial reporting. Accurate, reliable and transparent data are vital not only for financial management within a company and the supervision of a company by regulatory agencies, but also for establishing credibility with investors and the public. As such, accounting regulatory regimes, which include auditor oversight, are critical in ensuring that the plumbing of the financial system works and ultimately the stability of the economy.
Accounting scandals underscore the importance of sound accounting and auditing practices and oversight. While they have prompted reforms, particularly on audit independence, reforms do not rule out scandals as shown by the steady stream of headline news in Asia.
Over the past two decades, audit oversight and auditor independence have been the lynchpin of most audit reforms. Sound audit oversight entails but is not limited to:
- an independent audit regulator (and not the usually pre-existing, self-regulating professional bodies),
- audit quality and audit firms inspections,
- audit rotation requirements,
- restrictions on non-audit services restrictions,
- attestation on internal controls, and
- disciplinary measures.
Audit reform, focused on audit oversight and auditor independence, started in the late 1990s and solidified in the early 2000s. The scandals around the Asian Financial Crisis of 1997-1998 highlighted the need for stronger oversight. Most notably, Bangkok Bank of Commerce’s embezzlement and insider lending case triggered a bank run and sparked the regional crisis. Other impactful cases include Long-Term Credit Bank of Japan’s underestimation of loan loss allowances, Yamaichi Securities Co.’s hidden losses, Hanbo Steel Industry Co.’s embezzlement and loan bribery case, and related-party transactions in Bank Umum Nasional and Bank Bali. Unsurprisingly, strengthening accounting and auditing standards and corporate governance were high priority reforms taken after the Asian Financial Crisis.
The Enron scandal in 2001 prompted accounting regulatory reform through the Sarbanes-Oxley Act of 2002, which created the Public Company Accounting Oversight Board (PCAOB) that oversees the audit of public companies under the Securities and Exchange Commission (SEC). Following in the wake of Enron, Asian countries also implemented similar reforms for the creation of an accounting oversight organization and the tightening of auditor rules.
Established in 2006, the International Forum of Independent Audit Regulators (IFIAR) is an organization of independent audit regulators. To qualify for IFIAR membership, the audit oversight agency of the jurisdiction must be an independent body as opposed to a self-regulating professional body, which may also perform audit oversight for firms operating within their territories. IFIAR members have largely implemented some form of the aforementioned principles to varying degrees, with the most variation on auditor attestations, giving some assurance on the quality of their audit oversight regimes. (For a more in-depth discussion on account oversight in Asia, please refer to the Asia Focus report “Accounting Regulatory Architecture in Asia,” dated April 2012).
As of late 2016, the United States and eight Asian economies are IFIAR members, which total 52 economies. The Asian member jurisdictions are Indonesia, Japan, Malaysia, Singapore, South Korea, Sri Lanka, Taiwan, and Thailand.
Some Asian economies that are not IFIAR members are also taking steps to improve the independence of their audit oversight bodies, although with some opposition from the existing professional accounting bodies. Hong Kong is proposing to authorize the Financial Reporting Council as the independent audit oversight agency, which will be tabled in the 2016-2017 legislative session, in contrast to the industry-run Hong Kong Institute of Certified Public Accountants. India may eventually have an independent audit regulator with the long-awaited National Financial Reporting Authority (NFRA), as promulgated under the Companies Act, 2013. The NFRA will supersede the licensing-cum-regulating Institute of Chartered Accountants of India (ICAI) as the audit regulator and have broader judicial authority.
Despite progress, accounting scandals continue to occur in Asia, particularly during times of economic weakness, highlighting the need for accounting and audit standards to continually evolve and be persistently enforced. More recent accounting scandals related to Asia are summarized in the below table.
|U.S. traded Chinese companies: In 2011-2012, the SEC reportedly delisted or suspended the trading of over 100 Chinese companies from the New York Stock Exchange (NYSE) over embezzlement and accounting scandals, including inflated revenue and inadequate disclosures. Many of these firms had listed via reverse mergers, bypassing SEC filing requirements for initial public offerings.
|Satyam Computer Services: In 2009, the chairman confessed to falsifying accounts through fictitious sales overstating profits by INR 70 billion (USD 1 billion).
Olympus Corp: In 2011, an executive whistleblower at Olympus revealed that the company hid USD 1.7 billion in losses for 13 years by transferring them to offshore entities.
Toshiba Corp: In 2015, authorities found that Toshiba had hidden USD 1.3 billion of losses from its nuclear power operations for over 7 years.
|Daewoo Shipbuilding & Marine Engineering: In late 2015, authorities discovered that Daewoo Shipbuilding overstated its profits from 2012-2014 to hide losses of KRW 1.5 trillion (USD 1.3 billion).
Some of these scandals not only resulted in multi-million dollar fines on external auditors, usually one of the Big Four firms, but also prompted additional audit oversight reform. For example, the Satyam scandal, frequently called the equivalent of India’s Enron, helped lead to the Companies Act 2013, which addressed many of the weaknesses in India’s accounting and audit oversight laws. As a result of the Toshiba scandal, the Japanese Financial Services Agency plans to tighten audit oversight through third-party opinions. As an example of more proactive audit oversight reform, Singapore’s Banking (Amendment) Bill 2016 allows the Monetary Authority of Singapore (MAS) to remove a bank’s external auditor while also providing protection to the auditor for disclosing information in good faith to the MAS.
Recent scandals and frauds reflect that despite accounting improvements and reforms, unscrupulous corporate officers will still find ways to take creative liberties with their accounting to hide losses or divert funds for personal uses. Audit oversight reforms are also not sufficient unless properly implemented. As such, constant vigilance and oversight is needed throughout the accounting chain from the accountants to the auditors and ultimately to the regulators. Essentially, accurate and transparent financial data as well as sound audit oversight are critical to preserving the soundness of the financial system.
The views expressed here do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System.