PCAOB Proposes Mandatory Auditor Rotation

Wednesday, August 17, 2011 Print Email

The Public Company Accounting Oversight Board voted Tuesday to issue a concept release that would require public companies to change their auditing firms after a certain number of years.

The concept release aims to solicit comments fr om the public on this and other ways to encourage greater auditor independence, objectivity and professional skepticism. Comments are due back to the board by Dec. 14.

“I believe that the long association of the largest audit firms with their major audit clients is an issue that must be addressed in order to fulfill the mission of the PCAOB,” said PCAOB Chairman James R. Doty. “One cannot talk about audit quality without discussing independence, skepticism and objectivity. Any serious discussion of these qualities must take into account the fundamental conflict of the audit client paying the auditor. That leads to consideration of firm rotation as a counterweight to that conflict.”

Term limits may reduce the pressure that auditors face to develop and protect their long-term client relationships to the detriment of investors and capital markets, he added.

Discussions of mandatory audit firm rotation date back to the 1970s. Proponents of rotation believe that setting a term lim it on the audit relationship could free the auditor to some extent from client pressures and offer an opportunity for a fresh look at the company’s financial reporting from another audit firm.

Auditing is a business, noted PCAOB member Daniel L. Goelzer. “The professional imperative to maintain an independent attitude, and the economic imperative to maintain client relationships, can pull the auditor in opposite directions,” he said. “Forcing a company, over the objections of its management, to change its financial reporting in a way that reduces earnings or indicates a weaker financial position may not seem like the best business development strategy. Further, an auditor/client relationship that spans decades might lead to a sense of partnership or mutual interest between the auditor and the client. These kinds of biases could be unconscious and unintended. But, if they exist, they can be corrosive of the independent mental attitude that auditing requires.”

The concept release notes that opponents have expressed concerns about the costs of changing auditors. Some observers contend that audit quality might suffer in the early years of an engagement as the audit firm learns about the client and that rotation could exacerbate this phenomenon.

“I believe that we should proceed cautiously along this path,” said board member Jay D. Hanson. “The primary focus of the concept release is mandatory auditor rotation. Before we determine whether that is in the best interests of investors and the public, we will need to weigh carefully whether its benefits would outweigh its costs and potential unintended consequences. We also need to further analyze our inspection results and other available information to determine whether audit deficiencies are attributable to a lack of auditor objectivity and skepticism and, if so, whether those symptoms are best remedied through mandatory auditor rotation or some other measure.”

Commentators on the concept release are asked to respond to specific questions, including, for example, whether the PCAOB should consider a rotation requirement only for audit tenures of more than 10 years or only for audits of the largest issuers. The concept release also seeks feedback on whether there are other measures that could meaningfully enhance auditor independence, objectivity and professional skepticism.

The members of the PCAOB voted unanimously to issue the concept release. “I agree that the time has come to revisit the issue of audit firm rotation in the context of exploring all available options for enhancing auditor independence, objectivity and professional skepticism,” said board member Steven B. Harris. “The inspection findings of the PCAOB, as well as those of our international counterparts, indicate that more must be done in these areas. As is clear from the board’s concept release, inspectors have raised numerous concerns about professional skepticism in their inspections of both large and small firms, and these concerns are cited too often to ignore.”

The board plans to convene a public roundtable on auditor independence and mandatory audit firm rotation in March 2012. More details will be announced at a later date.

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