On August 16, 2011, the Public Company Accounting Oversight Board (“PCAOB”) issued a Concept Release on Auditor Independence and Audit Firm Rotation (“Concept Release”). The Concept Release, available at http://pcaobus.org/Rules/Rulemaking/Docket037/Release_2011-006.pdf, solicits public comment on steps it could take under its existing authority to enhance auditor independence, objectivity, and professional skepticism, including, most notably, imposing for the first time mandatory audit firm rotation on public companies.
The deadline for submitting comments to the PCAOB is December 14, 2011, and the PCAOB will host a public “roundtable” discussion in March 2012 to hear from interested parties. Any rule ultimately proposed by the PCAOB would have to be approved by the Securities and Exchange Commission (“SEC”).
The PCAOB is considering a mandatory audit firm rotation requirement in large measure because it is concerned that, in some cases, auditors may not have demonstrated a sufficient degree of professional skepticism in evaluating management’s assumptions as a result of the potential bias that some have suggested arises from an issuer’s potentially unlimited retention of an audit firm. The PCAOB seeks comment because there is a belief that imposing mandatory firm rotation might combat even a perceived lack of professional skepticism by “ending an audit firm’s ability to turn each new engagement into a long-term income stream,” thereby “fundamentally chang[ing] the firm’s relationship with its audit client” and “significantly enhanc[ing] the auditor’s ability to serve as an independent gatekeeper.”
Congress considered imposing mandatory audit firm rotation in 2002 during the debates over Sarbanes-Oxley (the “Act”), but it decided instead to direct the General Accounting Office (“GAO”) to submit a report on the subject. The GAO report, issued in 2003, questioned the efficacy of term limits, but signaled the need for the SEC and the PCAOB to deepen their experience with the Act’s auditor-independence provisions. Since the GAO report, the PCAOB’s Concept Release says that it has noticed an improvement in audit quality, but it still “believes that more can be done to bolster auditors’ ability and willingness to resist management pressure,” and that a mandatory rotation requirement might serve that purpose.
The PCAOB seeks public comment on general and specific issues regarding the benefits, risks, and potential scope of a rule mandating auditor rotation. In some of its key questions, the PCAOB inquires about the rationale behind required rotation, including the perception that payment by audit clients adversely affects an audit firm’s willingness to dissent from the views of management. The PCAOB also asks about the mechanics of a potential rotation proposal, including whether (1) an engagement term of ten years is appropriate, and whether terms should vary based on type of engagement, industry, or some other factor; (2) whether term limits should apply to all public companies or only to audits of large companies; and (3) whether mandating audit rotation would lead to poorer audit quality or inhibit clients’ choice of auditors. Also noteworthy is the PCAOB’s query whether to bar public companies from removing, without good cause, an audit firm prior to the end of the allowable term. These and other questions are set forth in more detail in the Concept Release.
Mandatory firm rotation would have a significant effect on public companies as well as audit firms. Given the importance of the issues addressed in the Concept Release, the PCAOB is actively seeking comment from interested parties by the December 14, 2011, deadline.