PCAOB: Be On the Lookout for Fraud in Emerging Markets

The PCAOB on Monday published a Staff Audit Practice Alert to increase auditors’ awareness of risks when performing audits of companies with operations in emerging markets. Specifically, the alert cited a number of reports originating from audits of companies based in the People’s Republic of China.

Staff Audit Practice Alert no. 8: Audit Risks in Certain Emerging Markets focuses on the risks of misstatement due to fraud that auditors might encounter in audits of companies with operations in emerging markets, auditors’ responsibilities for addressing those risks, and certain other auditor responsibilities under PCAOB auditing standards. The alert says that local business practices and cultural norms in emerging markets may differ from those in more developed markets, and auditors should be alert to the effect of these differences on the risks of material misstatement and should focus on the audit procedures required to respond to those risks.

“While this practice alert is for auditors, it also is a good reminder to investors and audit committees of the heightened fraud risk found in some emerging market companies that trade on U.S. exchanges, especially those in countries where the PCAOB is blocked from conducting inspections of auditors’ work,” PCAOB Chairman James Doty said in a press release.

The PCAOB said it has observed from its oversight activities, and companies have reported in filings with the SEC, some conditions and situations in certain companies in emerging markets that indicate to auditors a heightened fraud risk. They include, for example, discrepancies between a company’s financial records and audit evidence obtained from third parties; auditor difficulties in confirming cash and receivable balances; and the recognition of revenue from contracts or customers whose existence cannot be corroborated.
 
The alert says that in just two months this year, more than 24 companies with their principal place of business in China filed Forms 8-K with the SEC reporting auditor resignations, accounting irregularities, or both. In some instances, the auditor’s letter of resignation stated that the auditor resigned because of circumstances that could constitute illegal acts for purposes of section 10A of the Securities Exchange Act of 1934. Since then, the SEC’s actions have expanded, including instituting stop order proceedings against two China-based companies.

The PCAOB said that, although the conditions, situations and fraud risks described in the alert have been observed in audits of companies in certain emerging markets, they might also be present at companies in other markets. The matters discussed in the alert are relevant whenever such conditions, situations or fraud risks are present in audits of companies located in emerging or developed markets, the PCAOB said.

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