EU Audit Rules May Trip Up U.S. Banks, Insurers -- Update

By Dow Jones Business News, 
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By Michael Rapoport

A move aimed at improving audits of European companies could complicate life for some of the biggest U.S. banks and insurers as well.

In April, European Union lawmakers voted to require EU companies to change their outside auditors every 10 years, and to limit the non-audit services auditors can provide their EU audit clients.

But those changes will also apply to many European subsidiaries of U.S. multinationals, auditing experts say-- especially financial services companies, a sector where EU authorities are particularly concerned about audits in the wake of the financial crisis.

That could leave companies like J.P. Morgan Chase & Co. and American International Group Inc. with an unpleasant choice: Should they have only their European units change auditors, which could lead to a confusing patchwork of different firms auditing different parts of the company?

Or should they switch the entire company's auditor, which would be simpler but potentially more disruptive, placing an American company under European rules harsher than those in effect in the U.S.?

"It's going to be a real challenge," said Jeremy Jennings, the accounting company Ernst & Young's regulatory and public policy leader in Europe, the Middle East, India and Africa.

It is too early to tell how many U.S. companies will be affected, or what they will decide to do.

The new rules approved by the European Parliament would limit auditors to serving a decade as an individual company's auditor, though individual EU countries could impose even shorter terms, or choose to extend the maximum term if a company puts its audit account out to bid. The changes will start taking effect in 2016, though many companies won't have to switch auditors for up to several years after that.

The latest EU rules are part of a broader move by lawmakers and regulators globally to overhaul auditing and have auditors disclose more about what they find in a company's books.

Specifically, the EU's audit-firm "rotation" is intended to address concerns that a long-tenured auditor may be too cozy with its corporate clients. The limits on non-audit services, including barring audit firms from providing tax advice and investment strategy to their audit clients, are intended to prevent those services from potentially inducing auditors to go easy.

The moves are needed to help "restore trust" and "bring back confidence in the market," said Sajjad Karim, a European Parliament member involved with the changes.

The changes apply to all EU banks and insurance companies, even if they are owned by companies outside the EU. (Banks and insurers get special attention because the EU deems them as affecting the public interest, even if they aren't publicly held.)

Nonfinancial companies based in the EU and listed on European exchanges also would be covered. That would include some subsidiaries of U.S. multinationals.

"Potentially, it could have a pretty extreme reach into the U.S.," said Cindy Fornelli, executive director of the Center for Audit Quality, which represents the U.S. accounting industry.

J.P. Morgan is one U.S. company that could feel the effects because of its large European presence. The bank saw 27% of its 2013 net income come from its Europe, Middle East and Africa operations, which also held 21% of its assets, mostly in the U.K. A J.P. Morgan spokesman declined to comment.

Similarly, AIG has subsidiaries in the U.K., Ireland and other EU countries. In its annual report, the company says it is the largest U.S.-based property-casualty insurer in Europe. About 20% of its 2013 property-casualty net premiums were written in its Europe, Middle East and Africa business segment. An AIG spokesman declined to comment.

In theory, a U.S. company following the EU rules could end up with different auditors for the parent company and each European subsidiary. The concern among some companies is that "the implementation of the rules may not be the same in each country, and firms could be left trying to reconcile a patchwork of different regulatory requirements," says Gilly Lord, the head of U.K. regulatory affairs for accounting firm PricewaterhouseCoopers.

That could lead to increased costs, difficulty in coordination and a higher risk that conflicts of interest could arise. It might add a complication to mergers between U.S. and European companies. U.S. companies could decide instead to switch the whole company's auditor, but that would effectively place EU rules above those of the U.S., where no audit-firm rotation is required.

The U.S. audit regulator, the Public Company Accounting Oversight Board, had been considering since 2011 whether to impose rotation, but the board has since dropped the issue. The PCAOB is watching the EU changes "closely," a spokeswoman said.

The accounting industry has opposed rotation, contending there is no indication it improves audit quality.

Write to Michael Rapoport at Michael.Rapoport@wsj.com

Subscribe to WSJ: http://online.wsj.com?mod=djnwires


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