Wednesday, October 19, 2011

Views of Former SEC Chairs on Auditor Rotation Relevant as PCAOB and European Commission Consider the Concept

With the PCAOB having set out a concept release on audit firm rotation and the European Commission considering mandatory auditor rotation, the views of four former SEC Chairs who have examined the question of whether auditors should be rotated as an antidote to the Enron-type problems found in the auditing process are instructive. In Feb. 12, 2002 testimony before the Senate Banking Committee, former SEC Chairman Arthur Levitt proposed that companies be required to change their audit firm, not just the partners, every five to seven years to ensure that "fresh and skeptical eyes are always looking at the numbers."

Former SEC Chairman Harold Williams suggested a fixed retention and rotation policy, requiring that a company retain its auditor for a fixed term with no right to terminate. After that fixed term, the company would have to change auditors. As a consequence, he reasoned, the auditor would be assured of the assignment and, therefore, would not be threatened with the loss of the client and could exercise truly independent judgment. Under this system, the client would lose its ability to threaten to change auditors if in its judgment the assigned audit team was inadequate.

It would also reduce the client's ability to negotiate on fees, continued Mr. Williams. There would be costs, he admitted, as the required rotation of auditors would involve the inefficiency of the learning curve for the new auditor. But Mr. Williams emphasized that the costs are acceptable if the policy reinforces the auditor's independence and makes the work more comprehensive. Finally, he said that the client could be given a right to appeal to a reconstituted independent oversight organization if it believes that it is not well-served by its auditor and needs some relief.

Former SEC Chairman Richard Breeden agreed that one way of insulating audit firms from the pressure of keeping the audit engagement would be to provide for mandatory limits on engagements to a specified period of time, such as five years. But also noting that mandatory rotation would cause considerable costs, Mr. Breeden offered the less drastic alternative of requiring the audit committee to conduct a formal reproposal process at least every four to five years, but leaving the decision up to management and the board.

For his part, former SEC Chairman Rod Hills said that forcing a change of auditors can only lower the quality of audits and increase their costs. The longer an auditor is with a company the more it learns about its personnel, its business and its intrinsic values. To change every several years will simply create a merry-go-round of mediocrity, said the former Chair. He suggested that an effective audit committee can mandate a rotation of partners in the same firm that can achieve the same result as changing firms.