My thinking is slowly starting to change on the issue of the day: mandatory auditor rotation. I’m coming closer and closer to becoming a full time advocate. Many thanks to the U.S. Chamber of Commerce for helping me see the light.
The current audit model can be fairly described as a means of giving investors the shaft. Companies, required by law to secure an audit opinion of their financial statements, have for decades shopped for audit firms willing to give favorable opinions to managed or manipulated financial statements. Once a company friendly auditor is found, companies tend to keep them employed for decades. Audit quality is a euphemism for weak audits in which the auditor has capitulated to corporate reporting demands.
After the most recent economic crash, numerous cases of shoddy auditing have hit the business press. The worst offenders not-so-coincidentally are the larger and more popular audit firms.
In an heroic attempt to reform the audit function so that it might eventually serve the interests of investors, proposals have been tendered in both Europe (Michel Barnier) and the U.S. (James Doty) to mandate frequent auditor rotation. The primary justification for these proposals is that forcing corporations to switch away from the most friendly auditor will necessarily result in a less friendly auditor offering an opinion on the financial statements. It is hoped that eventually auditor rotation will sufficiently modify incentives so that auditors will no longer be as corporate friendly.
Opponents of auditor rotation [(1) corporations wishing to manipulate their financial statements and (2) large audit firms] claim it will damage existing audit quality. Proponents of auditor rotation respond, “You’re kidding me, right?”
Jim Hamilton, of the highly respected and useful blog Jim Hamilton’s World of Securities Regulation, has a new post out, “Chamber of Commerce Supports Expected Legislation Prohibiting PCAOB from Mandating Auditor Rotation.” Please keep in mind that the Chamber of Commerce openly advocates for corporate interests. I quote Hamilton:
In a letter to Rep. Spencer Bachus (R-ALA), Chair of the House Financial Services Committee, the US Chamber of Commerce expressed support for an amendment the Chairman is expected to offer to H.R. 3213, the Small Company Job Growth and Regulatory Relief Act, prohibiting the SEC and PCAOB from issuing rules requiring mandatory rotation of a public company’s auditor or accounting firm. Mandatory audit firm rotation could increase costs and the incidence of fraud, said the Chamber, while degrading financial reporting.
Currently, HR 3213 would exempt smaller companies from the auditor attestation provisions of Section 404(b) of the Sarbanes-Oxley Act. The House Capital Markets Subcommittee has approved HR 3213, which expanding the exemption from 404(b) beyond the $75 million public float provided by the Dodd-Frank Act to a $350 million public float. HR 3213 is expected to be marked up in the near future by the full Financial Services Committee.
In an earlier letter to the PCAOB, the Chamber listed a number of reasons that it opposes mandatory audit firm rotation.
This is scary stuff. Outlawing consideration of auditor rotation will snuff the light of the public eye on this issue. Such light is sorely and surely needed.
If the U.S. Chamber of Commerce (advocate for big business interests) is for something, I (a small investor) am squarely against it. So, I’m coming out in favor of mandatory auditor rotation.
Debit and credit – – David Albrecht
Not to mention the fact that the other firms probably don’t have the expertise to serve those clients in those smaller markets. So the firms are going to do what exactly? Transfer people in that have the expertise, or more likely serve the client with accountants that are less experienced in that industry. It’s easy to say auditor rotation is the answer, but nobody really thinks about how practical it really is to rotate auditors every few years.
My concern with mandatory auditor rotation is the problems it places on Big 4 firms in smaller regional cities. For example, in Des Moines, if Ernst & Young had to rotate off of Principal or if KPMG rotates off Wells Fargo, there probably isn’t enough other business in Des Moines for either firm to maintain an office. Then what happens? Will the firms set up temporary shops, then when they rotate off the client shut down, and force everyone else to transfer elsewhere? Just something else to think about.