State Board Report

April 2012

Whether or not the PCAOB should have the authority to require auditor firm rotation was among the issues addressed at a March 28 hearing on “Accounting and Auditing Oversight: Pending Proposals and Emerging Issues Confronting Regulators, Standard Setters, and the Economy,” held by the Capital Markets and Government Sponsored Enterprises Subcommittee of the House Financial Services Committee. A cornerstone of that hearing was an amendment to the Sarbanes-Oxley Act drafted by Michael Fitzpatrick (R-PA). He proposed that Section 103 of SOX include: “( c) LIMITATION ON AUTHORITY – The Board shall have no authority under this title to require that audits conducted for a particular issuer in accordance with the standards set forth under this section be conducted by specific auditors, or that such audits be conducted by an issuer by different auditors on a rotating basis.”

Subcommittee Chairman Scott Garrett (R-NJ) voiced his support for the amendment as he opened the hearing. He observed the PCAOB’s concept release on mandatory rotation “is concerning.” In his opening remarks, Committee Chair Spencer Bachus (R-AL) stated: “Regulatory overreach seems to be alive at the PCAOB.” Ranking Member Maxine Waters (D-CA) said she was eager to explore ideas other than firm rotation.

Gary Kabureck, chairman of Financial Executives International’s (FEI) Subcommittee on Relations with the Financial Accounting Standards Board and chief accounting officer of Xerox Corporation, outlined for the Congress the FEI’s reasons for opposing mandatory rotation: only the Big Four firms have global resources to effectively audit the larger multinational corporations; selecting and transitioning to a new auditor will be extremely costly for the auditor and the company; non-audit relationships with a Big 4 firm would need to be curtailed and replaced if they were to be selected as the next auditor; industry expertise among the Big 4 varies and may limit potential selection as a new auditor; and complex transactions may extend over several periods and it would be desirable to have the same auditor present at the beginning and end of these transactions. He referenced Section 301 of the Sarbanes- Oxley Act and stated: “Mandating auditor rotation would circumvent this external director governance responsibility and compromise the audit committee’s ability to effectively engage, oversee and terminate an audit firm.”

In the U.S. Chamber of Commerce’s statement to the Subcommittee, they repeated their charge that the PCAOB was engaging in “mission creep,” which had drawn a sharp response from PCAOB Chair Doty at their March 22 forum. According to the Chamber, the PCAOB “is leaving the realm of audit regulation and crossing the threshold of regulating corporate governance, a subject area that has been left to state corporate law and the Securities and Exchange Commission. Moreover, the PCAOB should clarify that their recent proposal for auditors to understand executive compensation is for risk assessment rather than trying to regulate corporate governance.”

The academic literature on the benefits of mandatory rotation is mixed, Joseph V. Carcello, director of research at the Corporate Governance Center of the University of Tennessee, Knoxville, advised the Subcommittee. He recommended they allow the PCAOB to continue its examination of the issue of auditor independence and professional skepticism, under the active supervision of the SEC.

Professor Carcello pointed out to the Subcommittee members that the legislation proposed by Representative Fitzpatrick has a potential flaw as it “would prohibit the PCAOB from requiring public companies to use specific auditors. PCAOB Auditing Standard No. 5 (AS5) already requires an issuer to use the same auditor to audit the financial statements and internal control over financial reporting. This requirement in AS5 could be interpreted as the Board requiring an issuer to use a specific auditor. Eliminating this AS5 requirement would likely make audits more expensive and less effective.”

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