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Posts Tagged ‘Auditor rotation’

In the United States, today is election day.  In the last presidential election, the candidates were clearly divided on accounting issues.  But what about 2012?

In 2008, Barak Obama was solidly behind moving the U.S. to IFRS.  During his first term he was unsuccessful, and earlier this year the SEC waved the white flag on moving the country to IFRS.  So far in this campaign, Obama has not signaled his intentions with respect to future actions on the issue.

In 2008, John McCain emphatically endorsed American control of its own accounting standards.  However, this appeared to be a personal stance as opposed to a Republican political position.

I have not been able to uncover any statement by Mitt Romney revealing his position on global accounting standards.

Most Washington observers expect SEC Chair Mary Schapiro to step down shortly after today’s election.  The appointment of her successor (and we have had no clues) would say a lot about future U.S. government intentions on who is to set American accounting standards.

With respect to auditor rotation, both candidates are mum. Although it is true that several Democrats threatened legislation banning a PCAOB rule requiring auditor rotation, President Obama has not commented on the issue.  Mitt Romney is a client of PriceWaterhouseCoopers.  In 2008, the large auditing firms heavily favored Obama with political contributions.

There appears to be no desire from either candidate about changing the status quo on the position of audit firms in the American capital markets.  Sigh.

Both candidates have been active in discussing tax policy, but that is not the focus of The Summa.

Debit and credit – – David Albrecht

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Sarah N. Lynch is a young business reporter for Reuters.  She has previously published such good work that I’ve started looking for her by-line.  Her story on Friday, June 29, 2012 alerts us to an important auditing issue.

Lynch’s story is “SEC official backs shareholders on auditor independence.”  In this story, she reports on a speech by SEC Commissioner Louis A Aguilar (Democrat) to the NAPPA 2012 Legal Education Conference in Philadelphia, PA, on June 27, 2012.

Aguilar’s speech is noteworthy for two reasons.  First, it was one of two speeches last week by SEC Commissioners in which it was emphasized that audit quality is deteriorating and investor confidence in securities markets is waning.  Second, Commissioner Aguilar disagrees with SEC staffers who have blocked shareholder proposals to rotate auditors at their company or to promote other forms of improving auditor quality.

Really?  Companies have received at least two dozen shareholder proposals to vote on auditor rotation and increased auditor disclosure, and the SEC’s Division of Corporation Finance let companies block them from shareholder vote?  Aguilar’s comments on this are highlighted below.

It is apparent that pressure is being directed at the PCAOB from the lofty heights of the Commissioners of the SEC.

Aguilar’s speech is important.  To promote your reading of relevant portions, I’m publishing them in this blog post.

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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

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EurActive is reporting that tomorrow, Internal Affairs Commissioner Michel Barnier will present a proposal affecting audit firms in the EU:
1.       Big 4 to be audit-only firms
2.       Maximum tenure of 9 years
3.       Two audit firms per client company, a maximum of one Big 4 firm.

Barnier has been floating his idea for the past six months, and apparently has the support needed to push it through.

This proposal reflects compromises that have been made.   The tenure of nine years is fairly long, and much longer than the American proposal of five years.  That smaller firms are to be included in the audit reflects a compromise of not breaking up the Big 4.

The American PCAOB is considering mandatory auditor rotation after five years, but most comment letters to the proposal are opposed to the idea.  If EU is successful in forcing auditing rotation, pressure will be put on the Americans to go along.

Tune in tomorrow for the latest developments

Debit and credit – – David Albrecht

 

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On August 16, 2011, the PCAOB opened a 120 day comment period on the concept release in which it proposes mandatory auditor rotation.  Relevant information about the matter are included in Docket 37, “Concept Release on Auditor Independence and Audit Firm Rotation.”

With two weeks left in the comment period, the only audit firm to submit a comment letter is Ernst & Young.  Expect KPMG, PWC, Deloitte, McGladrey, Grant Thornton and BDO to submit their comments soon.   I’m certain that each letter will be similar in message to that of Ernst & Young.,

Ernst & Young submitted its letter on November 18, about four weeks before the December 14, 2011, deadline.  In general E&Y’s message is that auditors are sufficiently skeptical of management’s assertions that in general, financial reporting is a benefit to investors.  Because the system works at the current time, no changes are needed.  In any case, E&Y does not like the idea of mandatory rotation.

Mandatory audit firm rotation, in our view, is not a necessary or constructive means to promote
auditor skepticism. There is no evidence that we are aware of suggesting that mandatory firm rotation will improve audit quality. Moreover, there are many identifiable and known downsides to such a policy with little to no certain benefit. A mandatory audit firm rotation model would not only give rise to substantial costs and disruptions, but also would, we believe, impair audit quality, undermine sound corporate governance, and detract from the ability to maintain a robust accounting profession —all to the ultimate disadvantage of the interests of investors. We believe the mandatory retendering approach suffers from the same or even greater disadvantages.

There are five reasons why E&Y “… believe[s] mandatory firm rotation would harm corporate governance and investor interests and the ability to maintain a robust, highly skilled independent accounting profession performing high-quality audits.”

  1. Negative effect on shareholders, corporate governance and audit committees.”  E&Y says this would result from meddling with the duties of the audit committee.
  2. Negative effect on auditor’s knowledge of the company being audited and the effectiveness of audits.”  E&Y argues that long auditor tenures are beneficial, not detrimental.
  3. Negative effect on public companies and the interests of their shareholders.”  E&Y argues that a new auditor’s efforts would be inefficient (and therefore more costly) and less effective (thereby increasing audit failure risk).
  4. Negative effect on the audit profession.” E&Y says that there would be increased costs to auditor and audit team relocation once a five-year engagement ends.  In addition, the firm’s focus would shift away from delivering quality audits to a focus on marketing.
  5. Effect on audit fees.” E&Y thinks audit fees are bound to increase.  Since it foresees no advantages to auditor rotation, it is a negative NPV proposition.

There you have it. E&Y didn’t say anything controversial.

I can’t wait to read what the other firms have to say.

Debit and credit – – David Albrecht

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On August 16, 2011, the PCAOB opened a 120 day comment period on the concept release in which it proposes mandatory auditor rotation.  This comment period ends on Wednesday, August 14, 2011, at 5 p.m. ET.

Relevant information about the matter are included in Docket 37, “Concept Release on Auditor Independence and Audit Firm Rotation.”  There are links to a copy of the concept release, comments by each of the five board members, and comment letters received so far.

At the current time, 72 comments have been received.  Two were withdrawn, and one deals with a different concept release.  Consequently, there are 69 comments on the issue at hand.

After reading all 69 comment letters, not only do I have an intense desire to relieve the pain by hitting myself with a hammer several times in the head, but I can comment on general trends.

By my count, 47 comments (68%) oppose mandatory audit firm rotation and argue for maintaining the status quo, 12 favor mandatory auditor rotation (17%), eight (12%) suggest alternative changes, and two (3%) only raise questions instead of taking a position.  Alternatives include letting shareholders vote annually on which audit firm to hire, and having an independent agency assign new auditors.

Because the board assumes that each comment letter is a vote, retaining the status quo currently is winning the election with 68% of the vote.  I disagree with the PCAOB’s interpretation of the comment letters.  Taken as a whole, the entire collection of comment letters provide ideas and reasons for one alternative versus an idea.  Many might identify and agree with views expressed already, and therefore might not be inclined to submit a comment that is redundant to the larger argument.

Based on my analysis of the submitted comments, it appears that investors favor mandatory rotation.  On the other hand, corporations and auditors oppose rotation.

Although only one audit firm (Ernst & Young) has tendered an opinion, several retired audit partners were represented (individually or as part of a corporate audit committee) in opposing rotation.

Time to comment is growing short.  To have your voice heard, send your comment letter to:

Written comments should be sent to the Office of the Secretary, PCAOB, 1666 K Street, N.W., Washington, D.C.  20006-2803.

Comments also may be submitted by e-mail to comments@pcaobus.org or through the Board’s Web site at www.pcaobus.org.

All comments should refer to PCAOB Rulemaking Docket Matter No. 37 in the subject or reference line.

Debit and credit – – David Albrecht

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The U.S. Senate Committee on Banking, Housing and Urban Affairs, on Tuesday, February 12, 2002, held an oversight hearing on “Accounting and Investor Protection Issues Raised by Enron and Other Public Companies.”  Eventually, the Sarbanes-Oxley Act of 2002 was passed by both houses of Congress and signed into law by President George W. Bush.  A key part of the legislation is the creation of the Public Company Accounting Oversight Board (PCAOB).

In the months leading up to passage, several hearings were held including one on February 12, 2002, in which four previous SEC chairs–Arthur Levitt, Harold Williams, Richard Breeden, Roderick Hills–testified.  Jim Hamilton of the Jim Hamilton’s World of Securities Regulation blog reminds us, in “Views of Former SEC Chairs on Auditor Rotation Relevant as PCAOB and European Commission Consider the Concept,” of ideas that didn’t make it into Sarbanes-Oxley.

Three of the former chairmen spoke up in favor of auditor rotation.  Despite this support, the decision was made in 2002 not to require auditor rotation.  We now have another crisis in 2008 and again auditors are criticized for failing to require solid numbers in corporate financial reports.  Perhaps it is time to try it.  I don’t think it would hurt.

Here is what each of the former chairmen has to say. (more…)

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