Accountants brace for regulatory fall-out

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The penalties imposed on Chuo Aoyama PwC by Japan’s financial regulator pose a difficult problem for the 2,300 companies affected.

On the one hand, many companies will be reluctant to continue business with an auditor that has been tainted with scandal. But on the other, it will not be easy for them to drop the firm because of the severe capacity restraints afflicting the industry.

Chuo Aoyama PwC was ordered to suspend business with its largest customers for two months in July and August as punishment for its failure to establish proper internal controls and systems with regards the alleged collusion in corporate fraud at Kanebo.

Specifically, Chuo Aoyama is being punished for failing to prevent three of its former partners from allegedly assisting Kanebo’s former management to window-dress the group’s accounts. The three have been arrested and indicted.

But this is not the first time Chuo Aoyama PwC has been accused of wrongdoing at client companies.

In 2004, creditors of bankrupt Yaohan Japan, the supermarket chain, sued Chuo Aoyama over alleged accounting fraud and later settled. Chuo Aoyama is also being sued by the current management of Ashikaga Bank for allegedly assisting the previous management in cooking the bank’s books.

“Generally speaking, companies will want to dissociate themselves from a firm that has been tainted with a dirty image,” says Shinji Hatta, professor in the Graduate School of Professional Accountancy at Aoyama Gakuin University.

The penalties against Chuo Aoyama PwC – and the impact it could have on corporate Japan – have led to comparisons with Andersen, the accountancy firm that collapsed in 2002 after it admitted to shredding documents related to Enron, an audit client.

But the situation in Japan is somewhat different from what happened to Arthur Anderson, says Mr Hatta. Once Andersen was associated with Enron, clients and staff left the firm in droves, which led to its collapse.

But in Japan, companies do not have that luxury, due to a dire shortage of accountants. Chuo Aoyama PwC is one of Japan’s big four accountancy firms and all of them are currently overwhelmed with work following the closing of the financial year in March for the majority of Japanese
companies.

Furthermore, the head of the Japan Institute of Certified Public Accountants yesterday called on members to rally around Chuo Aoyama by refraining from poaching clients and staff.

Given the environment, “companies and auditors may just pretend to be dead and wait,” says Mr Hatta.

Toyota, for example, said yesterday it would wait to see what progress Chuo Aoyama was making in its reforms before taking any action.

Under Japanese law, companies will have to appoint a temporary auditor for the two months that its business is to be suspended. But it is unlikely that already stretched accountancy firms will agree to take on work for just two months.

Large companies might also face shareholder criticism if they do not switch firms in the long term.

“Some ISS clients have said that they would oppose retaining Chuo Aoyama (PwC),” says Marc Goldstein, research director at Institutional Shareholder Services in Tokyo.

PwC, for one, is clearly not taking any chances, and will set up a new auditing firm in Japan to meet the needs of its clients.

It is expected that PwC will hire staff from Chuo Aoyama, although its partners will not be able to practise as partners until the suspension period ends in September.

Mr Hatta believes PwC could get around this problem by elevating ordinary staff at Chuo Aoyama to partners and temporarily hire partners as ordinary staff. The plan would still face the opposition, if not incur the wrath of the accountancy institute.

One way for PwC to get around that problem perhaps is to establish a new firm to act as temporary auditor to clients until Chuo Aoyama’s suspension order is lifted. The new firm could then dissolve after the two months and revert to Chuo Aoyama.

As Mr Hatta says: “This is the first case in Japan. We have never experienced such a thing before.”

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