Late last summer, the Public Company Accounting Oversight Board (PCAOB) issued a concept release on auditor independence and audit firm rotation. The release asked for recommendations of measures to improve auditor independence, objectivity and skepticism and, specifically, whether the board should mandate audit firm rotation to achieve these goals.
While the PCAOB voiced concerns regarding the length of some auditor tenures and a rise in the number of PCAOB’s inspections findings, it was unable to show a correlation between inspection findings and auditor tenure. Moreover, the PCAOB was careful to state that it was not suggesting that all of the audit failures or other audit deficiencies its inspections staff had detected necessarily resulted from a lack of objectivity or professional skepticism. The PCAOB further noted that audit failures may also reflect a lack of technical competence or experience, which may be exacerbated by staffing pressures or some other problem.
The concept release caught the attention of financial reporting stakeholders: well over 600 letters were submitted to the PCAOB, including letters from auditor regulators outside of the United States. The majority of comment letters—over 90 percent—opposed mandatory firm rotation and did not see a sufficient link between auditor tenure and audit quality to support such a profound change in our current governance regime where audit committees are responsible for hiring and overseeing the external auditor.
The largest numbers of comments were written and submitted by audit committee members and preparers of financial statements. Approximately one-third of the more than 600 comment letters were submitted by audit committees and individual audit committee members—all of whom oppose mandatory firm rotation. One of the respondents included the NACD, which represents more than 11,000 board members. Audit committee/director comments disputed the PCAOB’s theory that firm rotation would improve auditor independence, skepticism and objectivity. They also identified some very negative effects that would result, including that mandatory firm rotation would undermine the statutory authority of audit committees to hire, fire and oversee the auditor in the interests of investors; would engender immense cost and disruption for issuers; and would cause a scarcity in the choice of auditors with sufficient expertise for certain sectors and for global companies.
Preparers filed as many letters representing another third of all comment letters and they also universally oppose mandatory firm rotation. A number of industry and professional associations—including the U.S. Chamber of Commerce, the Investment Company Institute and the American Bankers Association, representing literally thousands of their own members—provided comments.
Almost incredibly, only a small handful of investors filed letters.
The PCAOB is holding a two-day public meeting on auditor independence and firm rotation in Washington, D.C. on March 21 and 22). The meeting is open to the public and will be streamed from the PCAOB’s website. To read the concept release, click here.
This is a matter of great interest to audit committee members and I urge you to follow the proceedings and give thought to what more audit committees can do to promote auditor independence, objectivity and skepticism. Audit committees should ask themselves whether mandatory firm rotation or alternative mechanisms should be further pursued.
Christopher Y. Clark is publisher of NACD Directorship magazine and Directorship.com.