In comments to the SEC, large global audit networks, including the Big Four, said that a new extraterritorial private action for cross-border securities fraud in connection with purchases and sales of securities outside the United States should not be created. The comments were submitted at the SEC’s invitation as the Commission prepares a report mandated by Section 929Y of Dodd-Frank to address whether the rule announced by the Supreme Court in Morrison v. National Australia Bank, Ltd. should remain in force or, instead, be overridden to allow such private securities fraud actions. In Morrison, the Court ruled that Rule 10b-5 does not provide a cause of action to foreign plaintiffs suing foreign and US defendants for misconduct in connection with securities traded on foreign exchanges since the antifraud rule reaches the use of a manipulative or deceptive device only in connection with the purchase or sale of a security listed on a US exchange, and the purchase or sale of any other security in the US. In addition to Ernst & Young, KPMG, Deloitte and PricewaterhouseCoopers, the letter was signed by BDO, Grant Thornton and RSM International.
The non-U.S. member firms of the audit networks audit very large numbers of companies whose securities are publicly traded on exchanges outside the US, noted the letter, as well as thousands of other non-U.S. entities whose securities are not publicly traded. Creation of a new, extraterritorial private cause of action would impose on these non-U.S. audit firms the litigation burdens and threats now faced by U.S. audit firms.
According to the audit firms, increasing the exposure of non-U.S.firms to U.S. private securities litigation is not needed to promote audit quality. The home country regulators of these audit firms possess and exercise broad authority to oversee auditors and to detect and punish poor quality auditing. This regulatory oversight, supplemented by private liability deemed appropriate under local law, provides powerful incentives for audit firms to comply with applicable professional standards. The audit firms see no evidence of a gap in monitoring, deterrence, or compensation that must be filled by the creation of new private liability under U.S. law, which is especially true in light of Dodd-Frank provisions conferring authority on U.S. regulators to combat cross-border securities fraud.
Also, the overturning of the Supreme Court’s Morrison decision would raise a greater risk of further concentration in the market for audit services. The audit firms said that the US stands alone in concluding that combining expansive private class action rules with the permissive liability standards of U.S. law provides benefits to investors that counterbalance these harms. Because the pre-Morrison legal standard is unpredictable, said the letter, its reinstatement would render it extremely difficult to know in advance whether any particular securities transaction might later give rise to a U.S. cause of action. This unpredictability makes it impossible to justify extraterritorial private actions by reference to deterrence principles. And any US interest in providing compensation to defrauded investors is attenuated with respect to investors who buy or sell securities on exchanges outside the United States.
Home country regulators outside the US are committed to maintaining the fairness and transparency of those markets and to detecting and punishing wrongful conduct by any market participant, noted the letter, and this commitment extends to the activities of auditors. In almost all of these jurisdictions, the regulatory bodies responsible for the oversight of auditors are either the same as, report directly to, or cooperate closely with, those authorities responsible for the regulation of the securities markets. Moreover, the PCAOB has recognized that many regulators and enforcement authorities have broad authority over accounting firms within their jurisdiction, including comprehensive powers to investigate alleged wrongdoing and impose sanctions in the event wrongdoing has in fact occurred. The penalties can include criminal penalties and the suspension or revocation of an auditor’s license to practice.
Similarly, home country authorities are much better situated to police local audit firms in their markets. Local regulators can use compulsory process within the country in which the alleged fraud occurred and thus are able to obtain relevant evidence and impose effective sanctions. By their actions, reasoned the audit firms, U.S. regulators have confirmed that home country regulators are effective, noting that the PCAOB has established contact or cooperative arrangements with numerous non-U.S. regulators. For example, 29 of the Board’s 82 inspections of non-U.S. firms in 2009 were performed on a joint basis with the local auditor oversight authority pursuant to negotiated cooperative arrangements.
Further, the audit firms pointed out that, in appropriate circumstances and to the extent necessary, U.S. regulation can serve as a backstop to foreign regulation. For example, the PCAOB has broad authority to conduct inspections of non-U.S. audit firms, has already conducted inspections of non-U.S. audit firms in a significant number of countries, and has announced its intention to inspect firms in 31 countries in 2011. Moreover, if a particular alleged fraud by an audit firm involving securities purchased on markets outside the United States raises a critical need for U.S. intervention, the SEC and the DOJ are authorized to take action under the fortified extraterritorial enforcement authority conferred by Dodd-Frank.
Finally, the audit firms noted that the extension of a private right of action for securities fraud under U.S. law would supersede the policy choices of other sovereign nations by effectively regulating securities transactions in those nations and thereby interfere with the jurisdiction of their regulatory authorities which, in turn, would disrupt cross-border regulatory cooperation and disrupt relationships between the PCAOB and non-US regulators.
The SEC, PCAOB, and DOJ rely to a significant degree on assistance from other national regulators in overseeing auditors and in investigating and prosecuting securities fraud when the activity in question is based outside the United States. The audit firms feared that non-US authorities could be alienated and cooperation diminished if the US created a private cause of action that imposed its policy choices on other jurisdictions.