Monday, August 12, 2013

Council of Institutional Investors Endorses Comply or Explain Approach to Audit Firm Rotation

At a time when audit oversight authorities and policymakers are considering mandatory audit firm rotation, the Council of Institutional Investors took a comply or explain approach to the issue. The CII revised its corporate governance policy on auditor independence to require company boards that retain the independent outside auditor of the company’s financial statements beyond ten years to explain why doing so is in the best interest of the company’s shareholders. As with any other comply or explain provision, the explanation should be fact-specific and meaningful; and should avoid  boilerplate.

The CII also adopted a best practice standard calling on audit committees of public companies to consider several factors when deciding whether to retain their external auditor. The CII emphasized that both the audit committee and the auditor should recognize the principle that investors are the customers and end users of financial statements in the public capital markets.

Among the factors the audit committee should consider in deciding whether to retain the external auditor are inspection results and fines levied by the Public Company Accounting Oversight Board or other regulators and the quality and frequency of communication from the auditor to the audit committee. Another key factor to consider is the availability of a replacement for the existing auditor with the requisite experience and staffing required by professional standards to perform a quality audit.

Other factors that should be considered are the auditor’s tenure as independent auditor of the company, the directors’ relationships with the auditor, and the proportion of total fees attributable to non-audit services, and a determination of why these services could not have been provided by another party to safeguard the auditor’s independence.

Importantly, the audit committee should also consider the expertise and professional skepticism of the audit partner, manager and senior personnel assigned to the audit, and the extent of their involvement in performing the audit, as well as the incidence and circumstances surrounding the reporting of a material weakness in internal controls by the auditor.