The topic of mandatory audit rotations is creeping back into the news. Just recently a group of institutional investors in Europe wrote a letter to European Commissioner Michel Barnier expressing dismay that proposals to force audit rotations will be watered down. European regulators have at various points suggested a 6-year rotation, which may be moved to 9 years and possibly even 25 years.
The general idea of course is that external auditors can, or have the potential to, become lax over time as business relationships grow. This has also become a cause for the Public Company Accounting Oversight Board (PCAOB). And it’s perhaps bolstered its argument with the recent release of the results of its 2011 inspection cycle report. In it, the PCAOB found problems with with a dozen KPMG audits, out of the 52 KPMG audits the board inspected. The board found failures in the areas of loan losses, business combinations, fair value measurements, accounts receivable, revenue recognition, yields and cash flows associated with troubled loans.
In its recent letter, the group of European investors — which includes the investment arm of UK insurer Legal & General; a UK pension fund; four Swedish national pension funds; and Euroshareholders, a group of around 30 European national shareholder associations – believe the current system is failing in several areas, including the failure of auditors to provide adequate warnings; too few large audit firms; the lack of rotation; the high levels of non-audit work; and the heavy dependence on large audit firms from the regulators and standard setters. The group suggests companies change their auditors at least every 15 years and cut back on non-audit consultancy fees.
“We believe there are a number of worrying features in the audit market. At a fundamental level, we are concerned about auditor independence and professional skepticism,” the letter reportedly said. They said a lack of warning of the impending bank crisis in Europe was the result of lax audit oversight.
In the US, most companies have taken the opposite position on rotations, arguing in comment letters to the PCAOB that mandatory rotation would be costly and add no net benefit to investors and has been rejected by regulators time and time again over the last 30 years. This has been suggested by several treasurers in the NeuGroup universe as well. Some express a schadenfreudien desire to see their current auditors take a hike but acknowledge the disruptive potential of them actually leaving with a new auditor coming in.
In a letter written in April 2012, a group of nearly three dozen companies and organizations – including American Council of Life Insurers, the American Insurance Association, FedEx, Viacom, and United Healthcare – wrote the PCAOB suggesting it drop the pursuit of mandatory rotations idea.
The letter cited academic studies as well as studies from the Government Accounting Office showing rotations would be “costly and disruptive to the markets.” They also argued that the PCAOB hadn’t provided any evidence that such a rule would work. “We are troubled by the failure of the [PCAOB] to demonstrate a factual record for the need for mandatory audit firm rotation or overcome previous rejections of the concept,” they wrote. “Furthermore, we believe that mandatory firm rotation, if implemented, will harm overall corporate governance, reduce audit quality, diminish the role of audit committees, increase the incidence of undetected fraud and raise costs.”
But with this latest European push as well as the PCAOB’s report on KPMG’s error-filled audits, the proposal could again pick up steam.