NOCLAR for Corporate Governance

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State Board Report

November

Why did the International Ethics Standards Board for Accountants (IESBA) feel they had to change the long-standing rule on how accountants are to respond to a client’s noncompliance with laws and regulations (NOCLAR)? IESBA Deputy Chair Richard Fleck explained to the NASBA Annual Meeting audience: “There was growing concern about whether or not the public had confidence that accountants disclosed what they became aware of – not just auditors.” He assured all that it was not part of IESBA’s objective “to have accountants operate as policemen,” but there was concern that the principle of absolute confidentiality was operating to the detriment of the public interest.

“Fundamentally it is about good corporate governance,” Mr. Fleck stated. IESBA’s new rules require when accountants become aware of a breach they are to disclose what they have found to the appropriate level of company management, so management can take the proper course of action, and then the accountant has to evaluate how management has responded. “Only after all that has happened and management has decided not to do anything, then the accountant has to decide to report to an outside party, or resign, depending on how the accountant believes the public will be impacted,” he stated.

Catherine Allen (NY), NASBA Northeast Regional Director and Standard Setting Committee Chair, pointed out that the proposed ethics interpretation released by the AICPA Professional Ethics Executive Committee in March reflected IESBA’s changed rules but differed on whether confidentiality could be overridden and if the rule should be expanded to non-auditors as well as auditors.

The basic points of NOCLAR are similar to what is covered under Section 10a of the Securities Exchange Act, which requires the auditor to inform the audit committee of NOCLAR and if the auditor determines appropriate actions are not taken then the auditor has to report to the SEC within 24 hours, but there is a big difference in the IESBA rule, Michael Young, Wilkie Farr & Gallagher litigation partner, explained. “The big change is that NOCLAR disconnects from the fairness of presentation in the financial statements,” he pointed out. In the U.S. environment, it is hard to overstate the significance of potentially extending the accountant’s determination to non-financial matters, such as health and safety. “The objective is laudable, but we would be putting in place an extraordinary and new expectation – and the profession would need to be prepared to fulfill it. Absent a confidentiality constraint, the accountant would have to report on any possible problem,” Mr. Young contended.

Corporate violations are happening every 90 seconds and most turn out to be nothing, Mr. Young stated, “But how do you determine the one that will blow up? How can we operationalize it?”

Mr. Fleck responded that probably the same argument was raised when Section 10a was proposed “and people learned to behave in an increasingly responsible way.” He stated that the rule is working in the United Kingdom. “I contend this can and should operate properly in the United States. Companies have to assess risk all through the year, and to understand risk down the table as to whether their operation is effective. The accountant is encouraging them to take the appropriate action.” The IESBA Deputy Chair said: “We are not there trying to produce standards for the profession — but for the public interest.”

The Public Company Accounting Oversight Board’s Consultative Advisory Group is actively looking at updating their auditing standard, Ms. Allen added. “It is not enough to just satisfy 10a, but there is an ethical standard beyond your auditing duties. For all of us, as regulators, we need to lay this issue to rest. It goes back to our relevance.”

NASBA Uniform Accountancy Act Committee Chair J. Coalter Baker (TX) said NOCLAR will be one of the topics being considered by the Committee this year.