Monday, August 22, 2011

Comm. Barnier Says European Commission Will Propose Legislation in November Possibly Mandating Audit Firm Rotation; Pure Audit Firm Being Explored

Working from an earlier Green Paper, the European Commission intends to propose legislation in November to enhance auditor independence, eliminate conflicts of interest and address audit concentration by possibly mandating rotation of audit firms and encouraging joint audits that include a non-Big Four audit firm. The Commission is also exploring the concept of the pure audit firm. This was the message delivered by EU Commissioner for the Internal Market Michel Barnier to the European Federation of Accountants.

Commissioner Barnier also said that he is following with a great deal of interest the discussions in the United States on these issues; and he particularly welcomed James Doty as Chair of the PCAOB, adding that Chairman Doty’s presence is especially important in the field of auditing since regulators and standard setters must find global solutions to global problems.

Recently, the PCAOB issued a concept release on auditor independence and audit firm rotation. In its concept release, the PCAOB cited the European Commission consultation on mandatory audit rotation as evidence that questions regarding auditor objectivity and independence are being raised not only in the United States but elsewhere as well. The PCAOB concept release also noted Commissioner Barnier’s remarks to the European Federation of Accountants expressing interest in audit firm rotation.

The European Commission’s overriding concern is the quality and credibility of auditing, said Mr. Barnier, and outside auditors play a key role in this context. The Commission finds that many parties do not fully trust company financial statements and are not convinced that the auditor who checks the accounts is completely independent. This climate of suspicion can have a negative impact on investment, he said, with the risk of a vicious circle emerging. The independence of auditors is the condition sine qua non for their reports being fully trusted, reasoned the Commissioner, and thus auditors must be above all suspicion. He added that in this area perceptions are important.

Auditors are sometimes too closely linked to the companies they audit. When many companies use the same audit firm decade after decade, he said, that damages the auditing profession. In the same way, the fact that auditors are not chosen using regular and transparent invitations to tender damages the profession.

The Commission is considering the benefits of making it obligatory for a company to change its audit firm after a certain time period. Any mandatory audit rotation legislation must find the right balance between changing too often, which would damage the quality of the audit, and ensuring auditor independence.

Another symptom of over-familiarity between auditors and their clients is the provision of too many ancillary or non-audit services, he noted, which generate more revenue than the audit itself for most of the large audit groups. The Commissioner questioned if an audit firm can impartially judge a company that it is also advising on corporate development strategy.

Commissioner Barnier believes there is a need to restrict or even prohibit non-audit services being provided to audited clients. The Commission is even considering going further and proposing the concept of the pure audit firm, which would not be allowed to provide services other than auditing. This would also have the benefit of opening up these non-audit markets to a whole range of small and medium enterprises that have no chance faced with the predominance of the major audit companies. The Commission is considering the feasibility of this option and its proportionality.

There is also the question of audit firm concentration that must be addressed. Audit firms operate in a very concentrated market, noted Comm. Barnier, with four large firms controlling 80 percent of the European market for the auditing of listed companies. The situation is even more concentrated in certain countries where the market is divided up not among the Big Four, but among the Big Three or even the Big Two. He pointed out that in the largest European economy just two firms hold 90 percent of the contracts for companies listed on the DAX 30. In Spain, there is just the Big One, as a single firm certifies the accounts of the largest banks and holds 58 percent of the market.

The Commission assured that, while he is not ``conducting a witch hunt’’ against the Big Four, he is concerned that the audit market is so dominated by four firms while there are at least as many other firms wanting to break into this market in Europe. He wants more players and more dynamism in this market segment.

Commissioner Barnier also noted recent concentration developments both in Europe, where PricewaterhouseCoopers is currently acquiring Grant Thornton in Denmark and elsewhere, citing KPMG's recent acquisition of BDO in Brazil. The acquisition by the Big Four of firms belonging to medium-sized groups is cause for concern, said the Commissioner, since it impacts the competitiveness of medium-sized groups and effectively removes any opportunities for breaking into the market for large audits.

The Commission is considering the joint audit approach and also the option of regular,transparent and fairer compulsory tendering procedures. Mr. Barnier also favors banning restrictive contractual clauses that benefit the Big Four. He said that this practice is totally unacceptable in a European market where competition should be real and free.

Paradoxically, this market, which is so concentrated, remains very fragmented nationally. Thus, the Commission will propose a solution based on European integration. In this regard, the Commission is exploring the idea of a European passport for auditors. It is unacceptable that auditors have to pass additional examinations in each country where they wish to work, he said, adding that the mobility of auditors is vital for reinforcing competitiveness and growth.

Another way of promoting mobility is to harmonize auditing standards at the European Union level. The Commission is looking at how best to call on the Member States to introduce the international standards on auditing. It is important to have common rules, said the Commissioner, which would also contribute to professional mobility.

Finally, it is important to improve communication between audit firms and regulators to strengthen the preventive role of auditors. During the audit, auditors gain an in-depth knowledge of the company in question and privileged access to a great deal of information, observed the Commissioner, but unfortunately they do not always pass on that information in a very structured way for the regulators, directors, audit committees and shareholders. This must change, emphasized Commissioner Barnier, while respecting the role of each party and in particular that of the supervisory authorities.

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