Yesterday, NACD submitted a comment letter to the PCAOB regarding its new concept release on audit firm rotation. In an effort to promote professional objectivity and skepticism, the PCAOB believes that more frequent turnover of audit firms may help promote these goals. Proponents of such a proposal argue that changing audit firms would “free the auditor, to a significant degree, from the effects of management pressure and offer an opportunity for a fresh look at the company’s financial reporting.” While the overall intent of increased auditor independence and high quality audits is laudable, NACD believes that this approach is not practical and may have strong negative consequences.
NACD believes that auditor independence, reinforced through the rigorous application of professional objectivity and skepticism, provides the foundation for a quality audit. Further, NACD believes that the audit committee has, and should retain, responsibility for overseeing the work of auditors in an effort to ensure that they perform at a high level of quality. While auditor rotation can be beneficial at times and should periodically be considered by the audit committee, we do not support making this rotation mandatory.
Our primary concern is that the PCAOB seems to be implying that audit committees, acting on behalf of all shareholders, are not able to determine the best auditor for their companies on an ongoing basis. To that end, the PCAOB seems willing to interfere with private contracts between audit committees and auditors. This interference may constrain the ability of audit committees to select the audit firms that are best able to meet the particular accounting and auditing challenges presented—including an incumbent firm.
Additionally, mandatory audit firm rotation may engender significant disruption and prohibitive cost for companies without offering substantial benefits. For example, the impact of mandatory firm rotation may be particularly severe if it occurs at a time when a company is going through a significant event such as a corporate financing, merger or acquisition, or change in management. Changing auditors at such a time would greatly expand the cost of the transaction or transition, and potentially affect the ability of the company to execute a transaction.
As an alternative to mandatory rotation, audit committees could employ some of the following practices to improve audit quality:
Evaluating the audit plan in a more diligent fashion, taking a close look at the auditor’s risk assessment and the procedures planned to address those risks, as well as milestones for completion.
Using the annual evaluation of the audit firm to gauge the firm’s understanding of the business and its helpfulness in the early identification of important issues.
Analyzing and discussing the results of the annual evaluation and being responsible for providing feedback to the audit firm.
Taking the lead role in interviewing and selecting the lead engagement partner.
Monitoring the auditor’s performance by inspecting the firm’s quality and competency.
While NACD supports the PCAOB’s efforts to enhance audit quality, we do not believe that mandatory auditor rotation is the way to do so. We look forward to working with the PCAOB in the future to develop ways of improving the professional objectivity and skepticism of auditors.
This week, the SEC decided to delay their decision on whetherU.S. companies will be required to convert from GAAP to IFRS. The decision came after nearly two years of anticipation. In February 2010, the SEC stated that it would decide whether or not to require a change in accounting standards after completion of its own work plan as well as convergence projects being undertaken by FASB and IASB. The SEC originally planned to make a final decision in mid-2011, but then extended the date to late 2011. In a speech on Monday, James Kroeker, chief accountant for the SEC, announced that both the work plan and the convergence projects were delayed and consequently a final decision from the SEC is “still many months away.”
The SEC’s delay is due, in part, to a determination by FASB and IASB to slow down and continue consideration on several “key” projects. This decision came after multiple convergence observers suggested adding time for deliberation and due process. This highlights the difficulty in crafting final standards that “represent long-term, implementable, and sustainable improvements,” according to Kroeker.
The delay may relieve many executives across the United States. According to a 2011 PwC survey, 43 percent of respondents believed the pace of recent standard-setting activity was too fast. The same respondents also indicated that the proposed changes to accounting standards would have a “pervasive impact” on their companies. Given the significance of a potential change in accounting standards, the SEC’s decision to delay a decision may be welcome for many in Corporate America.
On Tuesday of this week, NACD held the second Nominating and Governance Committee Chair Advisory Council Meeting. The purpose of this Council is to bring the perspective of boardroom leaders, shareholders, and regulators to the table to identify potential challenges in the current environment and leading practices to meet them. This informal event provided an opportunity for the various stakeholders to speak frankly and seek common ground on the issues they face.
During the meeting, a theme emerged from the participant discussion: It became obvious that communication will be the greatest challenge for boardrooms moving forward. The theme began to materialize in an overview of the rulemaking progress at the SEC. A council member highlighted a need to improve disclosures regarding director skills and attributes. He remarked that many companies listed the skills their directors possess but did not articulate how the directors’ skills match the corporate strategy. On the other hand, it was acknowledged that executive compensation disclosures are becoming more transparent as more companies use executive summaries to explain pay plan rationales.
Conversation then turned to the challenges of shareowner and board engagement. The institutional shareholders viewed the new Dodd-Frank rules—such as say on pay—as extra tools to spur communication with directors. While the Council members did not see eye-to-eye on all facets of the director-shareholder relationship, it was agreed that communication is a year-round battle and waiting until proxy season to reach out to shareholders is too late.
The communication theme continued in response to a suggestion to say more about committee and full board procedures in proxy statements. While all agreed that boards need to do a better job of communicating their work and value, some said that detailed explanations may not be appropriate in public filings due to liability reasons. Rather, boards were encouraged to explain their practices and procedures on company websites, which provide much greater latitude for meaningful disclosures.
The meeting covered a variety of topics and provided practical advice for nom/gov committee chairs and board members in general. The most valuable takeaways will be available in a future summary of proceedings published by NACD.