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.