The Public Company Accounting Oversight Board issued a concept release on auditor independence and mandatory firm rotation this summer. The release seeks public comment on ways to enhance the independence, objectivity, and professional skepticism of external auditors, with a focus on mandatory audit firm rotation by Securities and Exchange Commission registrants. While the concept release is only the initial stage toward possible rulemaking in this area, auditor rotation is a very important subject that could have a significant effect on the cost and quality of audit services and on the relationship between public companies, audit committees and boards, and external auditors. It is worth noting that regulators in the European Union have also begun exploring possible mandatory audit firm rotation.
As discussed in the PCAOB’s concept release, the subject of mandatory audit firm rotation has been explored at various times over the past 35 years, most recently in connection with the drafting of the Sarbanes-Oxley Act of 2002 following the financial reporting scandals a decade ago. Advocates of term limits for audit engagements believe that limiting the number of consecutive years that an accounting firm can retain an audit client would help address the fundamental conflict of the auditor being paid by the auditee, which they believe can undermine auditor independence, objectivity, professional skepticism, and overall audit quality. Critics of the current external auditing system point to the fact that many public companies have had the same audit firm for decades and argue that audit quality would be enhanced if an accounting firm knew that its stream of audit fees from one client was limited and that its judgments on accounting and audit matters would be subject to subsequent review by a fresh set of eyes when the next firm takes over.
