The PCAOB and the SEC should impose mandatory audit firm rotation after ten years, said a former Chair of TIAA-CREF, which would coincide with the second statutorily required rotation of the managing auditor. In a letter to the PCAOB, John Biggs said that mandatory auditor rotation produces a kind of real time peer review. The outgoing auditor wants the work papers to be complete and of high quality with all problems clearly resolved, he reasoned, while the new firm reviews them and could either challenge their results, or start with fresh eyes. Mr. Biggs was Chair and CEO of TIAA-CREF from 1993 to 2002 and has served on the audit committees of major US companies.
If mandatory auditor rotation is deemed too strong a medicine, the former Chair recommends at a minimum that the SEC require in the proxy that the company disclose the years of tenure of the audit firm, which he believes is important to users of the financial statements. In his view, requiring proxy disclosure of the tenure of a company’s auditor might alone increase the likelihood that audit committees would consider their obligations under the Sarbanes-Oxley Act to appoint an auditor with a fresh point of view.
He noted that the two audit firm rotations during his decade of leadership at TIAA-CREF strengthened the audit and did not result itself in higher fees. It also instigated a healthy review of the firm’s financial management policies and practices. Mr. Biggs described this auditor rotation experience in testimony before the Senate Banking Committee chaired by Senator Paul Sarbanes as the committee was considering the auditing provisions of what became the Sarbanes-Oxley Act.
He recommended rotation in that testimony, which he believed would limit a seriously flawed business model of the auditing profession. In fact, many of the other provisions of Sarbanes-Oxley that were adopted were designed to correct that model. In particular, the Act eliminated the abusive use of the audit relationship and the brand names of the firms to sell non-audit services of all types; from technology consulting to tax advice to executive relocation services. Mr. Biggs regrets that the Sarbanes Committee did not include rotation in the legislation.
In his Senate testimony, Mr. Biggs noted the benefits of rotation for the issue of auditor independence. Auditor rotation would reduce dramatically the financial incentives for the audit firms to placate management. If the audit firm has a kind of virtual perpetuity of millions in fees every year, he said, the present value of that relationship is enormous: On the other hand, if the audit firm has a limited term the present value is cut by two-thirds or more, he emphasized, and in the final year of a five-year term it has little value.
His testimony also stressed the peer review aspects of mandatory auditor rotation. Had rotation been in effect at Enron in 1996, and Arthur Andersen had known that a new auditor would be appointed for 1997, and that the new auditor would do an exhaustive review of the former audit work papers, he posited, it is likely that Arthur Andersen would have assured that transactions and documentation were fully transparent. A thorough real-time peer review would be truly effective.