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PCAOB panel to debate contentious auditor rotation idea

March 20, 2012

Tomorrow is day one of the Public Company Accounting Oversight Board’s high-profile gathering of accounting and financial luminaries debating the topic of auditor rotation.

Among the marquee names who will join the discussion: heads of each of the Big Four audit firms, three former SEC chiefs, former Fed Chairman Paul Volcker, and founder of The Vanguard Group John Bogle. On Thursday, a second day will feature top finance executives and audit board chairs from many of the largest U.S. public companies.

Fireworks are likely.

Following an August announcement that the auditor overseer would delve into whether or not to require companies periodically switch their audit firm, the PCAOB has been barraged with over six hundred comment letters on the idea and has extended the time for public comment until April 22.

Those who support rotation contend that auditors over time can become too close to clients.  As Reuter’s Dena Aubin, who has been covering the issue closely, has reported, something like 175 companies in the S&P 500 have used the same auditor for 25 years or more. Since it went to work almost a decade ago, the PCAOB has found hundreds of audit failures, PCAOB Chairman Jim Doty notes, and he’s concerned that auditors may simply not be skeptical enough.

Auditor rotation has been contemplated before, but never gained traction in the US. It was not mandated in the Sarbanes-Oxley reform of 2002, which instead required the periodic changing of the audit partner assigned to the company,  not the audit firm itself.

A 2003 study by the General Accounting Office, which included a survey of the largest corporations as well as input from other experts, highlights some of the concerns that have held rotation back, among them:

  1. Lack of sufficient audit options: With only four major audit firms competing for multinational corporate audit commissions, there may not be enough options for companies facing mandatory rotation.
  2. Added expense of as much as 20 percent extra for a first year audit by a new firm.
  3. Less knowledgeable auditors, and a potential for audit problems as the new firm ramps up.

The GAO report concludes:

The potential benefits of mandatory audit firm rotation are harder to predict and quantify, though we are fairly
certain that there will be additional costs…. mandatory audit firm rotation is not a panacea that totally removes the pressures on the auditors in appropriately resolving financial reporting issues that may materially affect the public companies’ financial statements. These inherent pressures are likely to continue even if the term of the auditor is limited under any mandatory rotation process.

One possible compromise would be to just shed a little sunshine on the whole relationship, an idea  promoted by the $40 billion United Brotherhood of Carpenters pension fund.

Similar to requirement put in place in the early 2000s requiring that companies disclose what they paid their auditor for different services, this would mandate that corporations disclose how long they have used the same outside auditor without putting their audit up for competitive bidding. 

Ed Durkin, director of corporate affairs for the pension fund, and John Biggs, former chief of TIAA-CREF and a supporter of the idea, are both among those speaking tomorrow.

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