New Spin on Engagements

The audit community is proposing alternatives to mandatory auditor rotation.
Kathy HoffelderOctober 8, 2012

Almost a decade after the Government Accountability Office first studied mandatory audit-firm rotation, the idea still riles CFOs. The Public Company Accounting Oversight Board’s (PCAOB) concept release on the subject last year provoked a flood of critical responses from finance executives. But new approaches to promoting auditor objectivity, and a second look at some old alternatives, just might calm everyone down.

Companies have routinely balked at mandating auditor rotation, contending that the Sarbanes-Oxley Act of 2002 has enough checks and balances in place already to allow for the accuracy and reliability of corporate disclosures. Under Sarbox, companies are required to switch the lead partner of their audit firms every five years. Rotating audit firms would be disruptive, costly, and time consuming, say critics, especially for larger companies.

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One alternative being mulled in the audit community is a tenure-based approach, in which auditors would perform for a set number of years, such as a 6-year or 10-year term, and couldn’t be fired without the approval of a regulator. This approach might be more acceptable to industry participants, says Peter Bible, partner-in-charge of the public companies group of audit and accounting firm EisnerAmper. It would eliminate the pressures on an audit firm to go along with a client because it is paying the bill, or because it might put out a bid for another auditor, says Bible.

“It takes a lot of the human-nature side of it off the table,” he says. “If you really want to make it so the auditors are independent, then make it so the auditors can’t be fired.”

Rotating Actuaries
For organizations that use actuaries to analyze and forecast financial risks, such as life insurers and pension funds, rotating actuaries may be preferable to rotating auditors. The idea makes sense to Robin Madsen, CFO of the California State Teachers’ Retirement System. CalSTRS periodically hires an actuarial firm to audit the work of its internal actuaries, Madsen said at a PCAOB meeting in June. “The actuaries actually sign their opinions with their names,” she said. “There’s just a difference in the standards of practice [between actuaries and auditors].”

An old idea — having a third party hire a company’s auditor, instead of the company’s audit committee — may be making a comeback. Michael Doron, an assistant professor at California State University at Northridge, examined the concept in a recent paper, explaining that the third-party audit-payer idea is still being considered by various industry participants. A 2010 European Commission green paper on audit policy discussed the concept, saying the idea could be useful to large companies and systemic financial institutions.

At a meeting in March, PCAOB chairman James Doty discussed having a third party or insurance fund pay for a company’s audit. The idea is still one of many being reviewed, according to a PCAOB spokesperson (the board briefly reopened the comment period for the concept release this summer). A sticking point with any kind of third-party format for auditing is how much government intervention should be allowed. The federal government’s hand in the auditor process is not typically welcomed, notes Bible. He says that putting a private-sector self-regulatory organization in charge of such a third-party-payer model would appease industry executives and could potentially work well with regulators.

A Matter of Choice?
To others, however, the benefits from rotating audit firms can outweigh the costs. Some companies have even started rotating auditors on their own. Smaller businesses already rotate auditors faster than most other companies and thus are less likely to be disturbed by the proposed mandatory rotation requirements, says Bible.

Madsen acknowledged at the PCAOB meeting that while she believes it is expensive to rotate auditors, a “new set of eyes” from using a new audit firm could provide unexpected benefits. But even though CalSTRS recently switched auditors, it is opposed to mandatory rotation in general, reasoning that it should be a matter of choice.

David Eaton, vice president of proxy research at proxy advisory Glass, Lewis & Co., noted at the June PCAOB meeting that the “independence and objectivity of auditors has improved over the past decade,” which makes a rotation mandate less necessary. Meanwhile, the GAO’s own study in 2003 concluded that mandatory audit-firm rotation may not be the most efficient way to strengthen auditor independence and improve audit quality.

The PCAOB does not expect further action on the auditor-rotation proposal until 2013. More public meetings could still take place before then, according to the board spokesperson.

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