Wednesday, April 04, 2012

House Legislation Would Prohibit PCAOB from Mandating Auditor Rotation

Against the backdrop of a PCAOB concept release on mandatory auditor rotation, Rep. Michael Fitzgerald (R-PA) has prepared draft legislation prohibiting the Board from mandating auditor rotation. Specifically, the measure would amend Section 103 of the Sarbanes-Oxley Act to provide that the PCAOB will have no authority to require that audits conducted for a particular company in accordance with the standards set forth under this section be conducted by specific auditors, or that such audits be conducted for a company by different auditors on a rotating basis.

The legislation is supported by Rep. Scott Garrett (R-NJ), Chair of the Capital Markets Subcommittee, who hopes to conduct a mark-up of the bill. In recent remarks at a hearing on accounting and auditing oversight, Chairman Garrett found the PCAOB concept release on mandatory audit firm rotation especially disconcerting. He wondered what specific problem the Board is trying to solve and what data they are looking at. He also questioned what kind of specific cost-benefit analysis was done. Too many times with many federal regulators, he noted, the policy outcome is predetermined before the hard work is done to determine what the best solution should be.

More pointedly, the Chairman reminded the PCAOB that it is not a policy-making entity. Congress and the committee are the policy makers, he said, and the PCAOB’s job is to regulate and oversee the auditing profession. Chairman Garrett emphasized his concern about some of the recent activist proposals put forth by the PCAOB. He believes that the PCAOB is engaged in mission-creep, crossing the threshold of audit regulation in an attempt to regulate corporate governance.

In a prepared statement at the hearing, PCAOB Chair James Doty noted that the Subcommittee’s invitation letter invited comment on a discussion draft of potential legislation that would prohibit the PCAOB from requiring public companies to use specific auditors or require the use of different auditors on a rotating basis. Chairman Doty pointed out that the Board has not proposed mandatory audit firm rotation. Rather, the PCAOB is engaged in a deep and wide-ranging public dialogue about ways to enhance the independence, objectivity and professional skepticism of public company auditors.

The Board initiated this discussion by issuing a concept release, which asked not only whether others agree or disagree that the Board should focus on this issue, but also sought specific ideas for improving independence, objectivity, and skepticism, including the possibility of rotation. This dialogue was prompted by, among other things, concerns developed over the last nine years of the PCAOB’s inspections of public company audits.

It was also prompted by the GAO’s statutorily required 2003 report on mandatory audit firm rotation, which noted the significant implementation issues that would be associated with mandatory audit firm rotation and concluded that the PCAOB and the SEC would need more time and experience to evaluate whether term limits are necessary to preserve auditor independence. With the benefit of nearly a decade of inspections, noted the Chair, the Board has begun that evaluation.

The PCAOB is not alone in its concern over the number of deficiencies found in inspections and the larger questions that arise from these findings. Similar concerns have been expressed by regulators in Canada, Germany, the U.K., the Netherlands, Australia and elsewhere
As an independent standard setter, the PCAOB has brought people with a variety of viewpoints together to explore this critical issue in greater depth. If this process results in the PCAOB proposing any rules, whether they involve term limits or not, they will be subject to further public comment and SEC approval.

For these reasons, Chairman Doty urged the Subcommittee to respect the decision made by Congress to entrust these judgments to the independent standard-setting process of the body charged with examining public company audits and, based on that examination, considering what improvements are needed in those audits to protect investors and further the public interest.

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