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The Financial Services Agency has issued a business-suspension order to ChuoAoyama PricewaterhouseCoopers, a major auditing firm, over its failure to check three of their certified public accountants involved in falsifying accounting reports for Kanebo Ltd., once a leading textile and cosmetics maker.

ChuoAoyama is the only one of the nation’s top four auditing firms to receive such an order so far.

The FSA’s action came at a time when CPAs’ involvement in a series of report-falsification episodes with firms listed on the stock market has led to public loss of trust in auditing firms and the nation’s auditing services in general. The role of auditing firms is important in ensuring the accuracy and credibility of financial statements, which are the basis for the healthy operation of the stock market and the market economy. The agency’s decision is reasonable.

The three former ChuoAoyama CPAs pleaded guilty in March to falsifying Kanebo’s financial records. They are charged with collaborating with former Kanebo executives. Public prosecutors say the trio not only were aware that the financial statements they approved had been falsified but actively offered suggestions on how to cook the company’s books.

Although liabilities, in fact, exceeded Kanebo’s assets by 81.9 billion yen and 80.6 billion yen in fiscal 2001 and 2002, respectively, the company’s consolidated financial statements submitted to the Kanto Local Finance Bureau of the Finance Ministry said the company’s assets exceeded liabilities. Two of the three CPAs will have their qualifications revoked, and a one-year suspension will be slapped on the third.

Believing that ChuoAoyama’s internal-control system had serious problems, the FSA has ordered the firm to halt statutory auditing required under the Securities and Exchange Law, the new Corporate Law and other business-related laws for two months from the beginning of July. The FSA chose July 1 as the starting date of the suspension apparently because auditing work for the business year ended March 31 will peak in June.

ChuoAoyama was set up in 1968 as a Japanese affiliate of the PricewaterhouseCoopers Group. It employs about 1,800 CPAs and serves more than 5,000 companies. The operation suspension is expected to affect about 2,300 client-firms of ChuoAoyama. Some of them may switch to other auditing firms.

The FSA needs to find out why ChuoAoyama’s internal controls failed. In view of a series of scandals involving CPAs, the Japanese Institute of Certified Public Accountants, the sole professional organization for CPAs in Japan, has announced self-imposed control measures aimed at preventing a recurrence of company-account falsifications.

It calls on auditing experts to exercise “professional skepticism” and always be conscious of the possibility that the financial records they check may have been falsified. It also proposes that offices that audit listed companies be registered and submit a written promise of honest auditing to the organization. It says auditing offices that fail to live up to the self-imposed controls will lose their registration, thus becoming virtually unable to audit listed firms.

The Securities and Exchange Surveillance Commission says in its proposal to the head of the FSA that consideration should be given to meting out criminal punishment to auditing firms, if necessary, as a means of ensuring strict compliance with auditing standards. At present, the government can mete out administrative punitive measures only.

In April, for the first time in three years, the Financial System Council, an advisory body for the prime minister, began subcommittee discussions on the certified public accountant system. The discussions will center on measures to be incorporated into a CPA Law revision bill, planned to be submitted to the Diet in next year’s regular session. Introduction of criminal punishment for auditing firms could help prevent falsification of companies’ accounting records, since a majority of CPAs work as employees of auditing firms.

Apart from the introduction of criminal punishment for auditing firms, working out ways to prevent collusion between CPAs and the companies they audit will be important. In the Kanebo case, one of the three CPAs had been in charge of auditing the company since the 1970s.

Corrective measures could include limiting the period during which one auditing firm can continue to audit a particular company and abolishing the present practice of an auditing firm and its client jointly deciding on the fee amount for auditing services.

It is hoped that the FSA’s action against ChuoAoyama will give momentum to efforts to enhance the transparency and trustworthiness of the nation’s auditing services.

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