Is Mandatory Auditor Rotation a Good Thing?

A few months ago I blogged about the suggestion by James Doty, the head of the Public Company Oversight Board (PCAOB) that forcing companies to rotate audit firms after a set period (i.e., 5 years) would ultimately enhance auditor independence, the bedrock of performing an audit in accordance with generally accepted auditing standards, and better serve the public interest than the current system that has no mandatory switching requirement.

Late last year, the PCAOB sought opinions on whether it should require listed companies to rotate their accounting firms every few years. An overwhelming 94% were opposed to term limits.

Auditors say it helps to know their clients’ business intimately. The Big Four accounting firms—PwC, Deloitte, Ernst & Young and KPMG— agree that forced rotation will impair audit quality. PricewaterhouseCoopers and Deloitte pointed to studies casting doubt on whether changing auditors improve financial reporting.

The accounting profession is one of the most effective lobbying groups that exist so it was not surprising to me to learn that on July 8, the U.S. House of Representatives approved legislation that would prevent the PCAOB from implementing a system of mandatory rotation for audit firms.

The bill, HR 1564, also known as the Audit Integrity and Job Protection Act, was passed by a vote of 321 to 62. The House Financial Services Committee unanimously approved the legislation by a vote of 52 to 0 on June 19. The bill will now go before the Senate for a vote.

The amount of money spent by the Big-Four accounting firms is unconscionable. In 2011, these firms spent a combined $9.4 million on in-house and outside lobbyists, according to a Reuters analysis of congressional disclosure reports. Deloitte led the firms in spending $3 million. PricewaterhouseCoopers was next at $2.7 million, followed by Ernst & Young at $2.2 million and KPMG at $1.5 million.

The ranks have swelled, too. For instance, Deloitte since 1999 has more than doubled its stable of registered lobbyists to 25, including eight in-house staffers, according to the disclosure reports. A significant portion of the Big Four's lobbying efforts goes to trying to influence the PCAOB.

The Big Four's lobbying activities are mainly targeted to auditing services. Other Big Four lobbying efforts involve topics other than auditing, such as policies that would affect the consulting work that the firms do on contract for U.S. agencies. The proportion of lobbying money spent on varying subjects could not be determined from congressional disclosure reports.

To analyze the Big Four's spending on lobbying, Reuters examined reports that lobbying organizations must file quarterly. Usually just a few pages long, they list issues and bills that a firm is interested in, the names of lobbyists, the agencies the firm tried to influence, and other information. The amounts reported cover salaries for lobbyists and expenses such as targeted marketing, dinners and entertainment.

Some other industries sink far more money into lobbying than do the Big Four. The biggest spender on lobbying in 2011, as in most years, was the pharmaceutical and medical-products industry at $237 million, said the Center for Responsive Politics, a research group.

The lobbying efforts of the accounting profession and underlying motivation for those practices undermines the professionalism and integrity of the profession that, regrettably, was lost years ago when commercialism overtook professionalism as the mantra for the profession’s efforts to ‘serve the public interest.’ That is why the accounting profession is now called the accounting industry.

The reaction of one of the Big-Four, PricewaterhouseCoopers, is indicative of the accounting profession’s desire to have its cake and eat it to. A spokesman for PwC said his firm was "absolutely aligned" with the PCAOB on broad goals such as improving audit quality. On specifics, such as audit firm rotation, he said the industry sees the danger of taking steps backward or assigning auditors to industries they know little about.

This is laughable. The statements that auditor rotation would be a step backwards and lead to auditors doing work on industries they know little about belies the fact that the Big-Four have multiple clients in virtually every industry so losing a client to mandatory rotation in one industry would lead to gaining a different client in the same industry. If the firms are not capable of reviewing the work-papers of the previous firm and doing a quality audit, then they shouldn’t be in the audit business in the first place.

PCAOB Chairman James Doty hit the nail on the head when he said some change was needed to ensure auditors keep a skeptical eye. "Without independence, you don't have skepticism; without skepticism you can't form an objective judgment."

Blog posted by Steven Mintz, aka Ethics Sage, on July 16, 2013