NACD Submits Comment Letter to the PCAOB

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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.

1 Comment

  • Rich McCune says:

    Right on! I would also argue that an audit firm that has just gone through an extensive selection process and competed hard to obtain a nice new client is far less independent than an incumbent firm. The afterglow of just having won the beauty contest does not instantly transform into the professional skepticism we all are seeking.

    Rotating the audit partner provides the “fresh look” without all of the added cost and unintended consequences. Those who are proposing mandatory audit firm rotation do not, in my opinion, have an understanding of what is involved for both the firm and the client.