Auditor independence is a key provision in the Sarbanes Oxley Act of 2002. In the wake of the Enron, Worldcom and other scandals the Act focused in part on auditor independence and audit quality, creating the Public Company Accounting Oversight Board as the industry watchdog, in addition to the SEC. The Act also incorporated specific provisions to ensure auditor independence and quality. Section 201, for example, largely precludes audit firms from performing consulting services for its audit clients. Section 203 requires that the engagement partner rotate every five year. That provision is enhanced by SEC rules which require that the lead and concurring partner be rotated every five years to ensure that a “new look” is taken periodically at the financial statements.

The PCAOB is now considering further enhancements. The SOX created board considering whether the audit firm itself should be rotated periodically. A concept release issued this week solicits comments by mid-December on “ways that auditor independence, objectivity and professional skepticism can be enhanced, including through mandatory rotation of audit firms.”

Under this concept there would be a kind of term limit for audit firms. After a specific period of years the firm would have to terminate the engagement. According to PCAOB Chairman James R. Doty, “One cannot talk about audit quality without discussing independence, skepticism, and objectivity. Any serious discussion of these qualities must take into account the fundamental conflict of the audit client paying the auditor.”

Those favoring the concept of limiting the time which an auditor can serve a client contend that this would free the audit firm to a large degree from the effects of client pressure. It would also provide an opportunity for a fresh look at the financial reporting of the company. This of course is the same rational which underlies Section 203 of Sarbanes Oxley.

Those who disfavor the firm term limit or rotation concept point out that the cost may be prohibitive. Perhaps more importantly, critics argue that mandatory rotation could undermine audit quality by brining in a new team that is unfamiliar with the company.

While the concept of firm rotation has been discussed for years it has never been implemented. The Board is holding a public roundtable on the concept in Marcy 2012.

Tagged with: , , , ,