Japan’s auditing industry is preparing to undergo its most profound change in decades, with auditors achieving new levels of independence from their paying clients—and assuming new responsibilities for their performance.
Lawmakers approved the overhaul to laws governing Japan’s audit industry in the Diet session just ended.
Auditors, especially at large firms, should become more independent with stipulations such as shortened rotations on carrying a client at a listed company. New penalties for misconduct will also be added, including a first-ever potential for fines. The amendments kick in next spring.
Seki
“This is like the J-SOX for auditors,” says Tetsuo Seki, senior corporate auditor, or kansayaku, for Nippon Steel Corp. Seki was the chairman of a Financial Services Agency committee that studied the issue and proposed the rule changes.
The changes come on the heels of a string of major accounting scandals in Japan in the last few years, such as those involving Seibu Railway, Kanebo, and Livedoor, where accountants played a role in the crime.
“The new rules should bring Japanese accountants and auditor-related rules close to Western standards,” Seki says. His committee modeled the new auditing rules on laws that exist in the European Union, aiming to establish a system where auditing firms are fully able to explain their actions.
The E.U. directive, for example, asks for the disclosure of items such as financial documents, governance structure of auditing firms, structure of quality control, and breakdown of sales. Japan’s current law doesn’t call for the disclosure of basics including financial information. This will change with the amendment.
Osaki
Sadakazu Osaki, a law professor at the University of Tokyo and a member of Seki’s committee, says the panel studied how to update accounting rules for a year. The main points include giving auditors the choice of registering as a limited liability corporation after completing certain requirements such as disclosure of its financial statements with larger auditors to attach a statement of audit.
Fining firms for accounting violations is a first in Japan. Until now, there wasn’t much choice in how auditing firms could be punished. Firms first would get a kaikoku or warning. Next comes an order of gyomu teishi or business suspension. The final step is an order for kaisan, which disbands the business.
The second step alone recently resulted in the demise of Misuzu Audit Corp., formerly ChuoAoyama PricewaterhouseCoopers. ChuoAoyama PwC was one of the four major accounting firms in Japan, counting top Japanese corporations among its clientele. The company’s existence will cease at the end of July. ChuoAoyama received the sentence for its role in falsifying years’ worth of financial statements from Kanebo, a large cosmetics firm in Japan.
The amended law will expand and include penalties such as kaizen meirei, or the order to improve business operations. Prosecution of accountants on an individual basis will be possible too. Japan’s Certified Public
Accountants and Auditing Oversight Board (CPAAOB), which operates under the purview of the Financial Services Agency and is comparable to the Public Company Accounting Oversight Board in the United States—will oversee such new penalties and enforcement action.
“Clients of ChuoAoyama have been terribly inconvenienced because of what happened,” Seki says. “ChuoAoyama was given a kaikoku … The next thing you know, they are suspended from doing business. They had no choice but to close shop. There should have been better ways to deal with such situations.”
Koichi Masuda, chairman of the Japanese Institute of Certified Public Accountants, gave the new rules a moderate endorsement.
Masuda
“I’d give the amendments a score of 60, 65, with the perfect score being 100,” Masuda says. “Some amendments may be on the harsh side for our members. Overall, it’s good.” The penalty fine is a bit high, Masuda says.
With the amendments, if an auditing firm is found guilty of willfully participating in falsifying statements, the firm is responsible to pay a penalty of 1.5 times the auditing fee it charged for that time period. The statute of limitations is seven years.
Masuda praises the introduction of penalty fines instead of criminal penalties. The FSA committee considered such penalties, but it ultimately decided criminal penalties didn’t work well under Japanese laws.
Masuda says the disbandment of Misuzu was an unfortunate and unfair result for 99 percent of its employees, who did nothing wrong. “Having financial penalties instead of forcing companies to close with innocent workers scurrying for jobs is a lot better than the current system,” Masuda says.
Increasing Independence
Other than giving more options for companies to pay for its actions, the rule changes should make auditors more independent. Previously, large auditing firms were able to keep the same lead accountant with clients at listed companies for seven consecutive years, followed by a period of two years under another partner.
The rule change will curb that to five consecutive years with five-year intervals. The aim is to avoid accountants at large auditing firms from getting too cozy with clients at listed companies. To be sure, JICPA had been recommending this 5-years-on and 5-years-off rule for listed companies already. Now it will be the law.
Additional changes include auditing firms being able to hire non-CPA employees, thus allowing those such as IT professionals or lawyers to join and bring more diversity to firms. The goal here is to strengthen a firm’s governance by having more of a mix in profession at firms, Osaki says.
“The new rules should bring Japanese accountants and auditor-related rules close to Western standards.”
— Tetsuo Seki,
Senior Corporate Auditor,
Nippon Steel Corp.
There is a key concern that wasn’t included in the amendments, both Seki and Osaki say. “We need to allow kansayaku more independence by letting them appoint other auditors and also allow them to set the pay,” Seki says. “If those changes are made, Japan will be up to Western standards.”
At the base of the debate is how to energize Japan’s capital market. “We need to make corporate accounting scandals something out of the question in Japan,” Seki says. “We can’t have a market you can’t trust.”
Masuda’s JICPA isn’t waiting for the new rules to kick in. JICPA proposes to give transparency and trust back to Japan’s market by checking on the largest auditing firms themselves.
Auditing firms that have listed companies as clients will report to the JICPA, and the group has a corps of 30 auditors called “reviewers,” who evaluate the firms to make sure they are up to par with accounting standards. So far the JICPA has 160 auditing firms registered in this system that just started in April. Several dozen more firms are scheduled to be included by the end of this month, amounting to about 200.
Seki raises another auditing problem that can’t be easily dismissed. “There just aren’t enough accountants in Japan,” Seki says. “There is not enough ‘atsumi’ [depth] with the quantity and quality of auditors. We need to broaden their base.”
A few years ago, Seki says his government study group concluded Japan needed 60,000 auditors, three times the number it has. There are about 17,250 active certified public accountants at the moment, according to JICPA.
With the introduction of Japan’s version of SOX this year, Japanese companies are scrambling to find accountants. Some companies that were involved in scandals are deemed as “risky” clients and are believed to be having difficulty finding auditors to do their financial statements, says Seki. The Japanese even have a phrase for it: kansa nanmin, or “audit refugees.”
Others say there are enough accountants in Japan.
Nishimuro
“I’m not under the impression that there is any such serious shortage of accountants with J-SOX,” says Taizo Nishimuro, the Tokyo Stock Exchange’s former president and CEO, who recently spoke to reporters in Tokyo.
Nishimuro says that J-SOX wouldn’t make any sense if there weren’t enough accountants to carry out the law.
“There may be the problem of each accounting firm not having enough accountants, but as a total, I think there should be enough accountants as a whole,” Nishimuro says.
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