PCAOB Weighs Pros and Cons of Mandatory Audit Firm Rotation

March 23rd, 2012 | By

Earlier this week, the Public Company Accounting Oversight Board convened a public meeting to collect commentary on its concept release relating to auditor independence and audit firm rotation. The two-day meeting assembled nearly 50 experts in the fields of audit and accounting, including audit firm executives, audit committee chairs, former Securities and Exchange Commission members and investors. While the outcome is still uncertain, one thing is clear: The roundtable panelists view this issue very differently.

Those supporting mandatory audit firm rotation were primarily concerned with a perceived lack of independence in audit engagements. They contend that long-term audit engagements have the potential to weaken the auditor’s work performance. Under the current system, these critics argue, audit firms may try to please their clients in order to keep the engagement instead of remaining objective. As panelist Richard Kaplan, professor of law at the University of Illinois at Urbana-Champaign, put it, “Auditors are prone to bias their conclusions to best preserve the client relationship that pays their bills.” 

Panelists opposed to tenure limits for auditors dismiss this argument for lack of clear and convincing evidence. As Greg Jenkins, professor at Virginia Polytechnic Institute and State University, noted in his opening statement, “The academic findings on auditor rotation are mixed with no clear picture as to whether rotation is beneficial. Adding to this lack of clarity, is the increasing realization that the association between auditor tenure and audit quality is rather complex.” In other words, in the battle to improve audit quality, mandatory firm rotation is not a magic bullet.

Alex Mandl, chairman of the audit committee at Dell, shared the director’s perspective on behalf of the National Association of Corporate Directors. Mandl stressed that audit committees have dramatically improved their performance since the passage of Sarbanes-Oxley. While there is still room for improvement, mandatory audit firm rotation is not the appropriate method, he said. In her comments, Catherine Lego, chairman of the audit committee at SanDisk, suggested that audit quality improvement may lie in the education and training of directors. Greater audit committee engagement with the PCAOB and director education groups such as NACD, may be the most effective route in maintaining proper oversight of audit firms, she asserted.

NACD submitted a comment letter on this issue to the PCAOB in December. While NACD supports the PCAOB’s initiative to improve audit quality, NACD believes a term-limit system may be the wrong approach. This comment letter outlines five major issues with the proposal as drafted:

  • The board and audit committee are uniquely qualified to evaluate the work of an audit firm.
  • The board and audit committee have a statutory responsibility for the oversight of auditors. Mandatory audit firm rotation supplants this authority.
  • Audit firm rotation is unnecessary for objectivity, since there is already a requirement for mandatory audit partner rotation—as well as rules for auditor independence.
  • Developing an understanding of the company may take auditors years to develop and can require even more time to deliver the maximum benefits.
  • Mandatory audit firm rotation is disruptive and costly, particularly in special situations.

A formal proposal on this topic is still months away, if at all. NACD looks forward to engaging with the PCAOB, as well as the director community, on this important issue.

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