By GUNDI JEFFREY A fter endless debate and comments on the U.S. Public Company Accounting Oversight Board’s con- cept release on auditor rotation — with most interested parties totally opposed — a member of the House of Representatives has stepped into the fray to propose a legislative amendment that would put an end to the idea once and for all. Republican Rep. Mike Fitzpat- rick’s proposed amendment to the Sarbanes-Oxley Act of 2002, “would prohibit the PCAOB from requiring public companies to use specific auditors or require the use of different auditors on a rotating basis.” The March 21 amendment came during the PCAOB’s two- day roundtable on auditor rotation. The House financial services committee then scheduled a hearing on the proposal for March 28, calling on standard setters and other interested parties to debate the issue — again. The PCAOB aired its concept release issued last August to invite discussion on how to enhance auditor independence, objectivity and professional skepticism. The release primarily focused on man- datory audit firm rotation and audit term limits of no more than 10 years as a way to achieve those objectives. “Independence, objectivity, and professional skepticism form the foundation for investor confi- dence in the integrity of the audit, and our inspections have made clear that improvement is needed in these areas,” said PCAOB chairman James Doty in February, when he announced the March 21-22 roundtable on mandatory audit firm rotation. The concept release drew more than 600 comments — with 94 per cent strongly opposed to the notion — and Doty wanted to “further explore these issues.” Forty-seven regulators, investors, corporate officials, heads of audit committees, academics and leaders of the audit profession came to offer their views. Regulators were divided on the need for mandatory audit firm rotation. One of the first speakers, former Federal Reserve chairman Paul Volcker, supported the idea, saying it would “provide a powerful incentive to maintain professional discipline.” It seemed to him that “regular audits should not become a long- term annuity for the accounting firm paid for by the company being audited, rather than being responsive … to the investing public.” Former U.S. comptroller Charles Bowsher agreed. “There’s an inherent conflict of interest when big corporate clients pay the fees of their auditors.” But Bow- sher wants the measure introduced for only the biggest 25 to 40 com- panies in the country, such as GE or GM and all the major financial institutions, as well as companies with significant accounting and auditing problems. Former SEC chairman Richard Breeden was more worried about auditor concentration, which he said “limits practical choices.” Large companies may be reluc- tant to have the same audit firm as their principal competitors, Breeden suggested. “There may be many reasons, including lack of industry depth or geographic presence, that make one or more of the non-incumbent firms unattractive as a business matter. Therefore, for many large companies, there may at worst be no viable alternative to the incum- bent auditor and, at most, only one or two viable alternatives The benefits of rotation in enhancing objectivity may well be offset by increased conflicts, loss of a non- audit service provider or other adverse impacts.” Another former SEC chair, Arthur Levitt, was also in favour of rotation. “Investors deserve the perspectives of different profes- sionals every so often, especially when an auditor’s independence can reasonably be called into question.” But Harvey Pitt, yet another former SEC chairman, was decid- edly anti-rotation. “I believe this board should be reluctant simply to command that, after the passage of a specified number of years — irrespective of the particular number of years chosen — all companies must replace their cur- rent outside audit firm, no matter how well, capably and independ- ently those auditors have per- formed.” Pitt recommended that independent audit committees be required to consider (and docu- ment their consideration) whether the performance of their auditors over a prescribed period of time — say five years — warrants their reappointment or another firm should get the job. Most corporate panelists were also anti-rotation. Steven Buller, managing dir- ector of BlackRock Inc., voiced concern about restrictions in a company’s ability to select the most qualified audit firm, the loss of institutional knowledge and the reduced incentive for audit firms to invest in the audit relationship when their time horizon is short. Because BlackRock sponsors a variety of investment funds, “man- datory rotation would be a logis- tical challenge given our monthly fund year-end cycles and the need to co-ordinate auditor selection with over a dozen corporate and fund boards of directors that must select auditors.” Theodore Bunting, senior vice- president and chief accounting officer of Entergy Corp., believes that “a mandatory audit firm rota- tion diminishes audit quality and becomes an unnecessary distrac- tion to the company, which, in turn, creates more financial state- ment risk.” Academics had decidedly split opinions. Max Bazerman, a professor at the Harvard School of Business, wants auditors to be hired under fixed contracts stipulating rotation of both individual auditors and the auditing firm. “During that con- tracted period, the client should not be able to fire the audit firm.” On the other hand, Greg Jen- kins, an accounting professor at the Virginia Polytechnic Institute, cited research showing that KPMG audits the greatest number of companies in the financial industry, while PwC audits the lar- gest proportion of the industry based on market capitalization. Ernst & Young audits 40 per cent of the companies in the pharma- ceutical industry, yet PwC audits almost 50 per cent of the industry based on market capitalization. Other industries, such as retail and utilities, are mostly audited by Ernst & Young and Deloitte, both in terms of the number of clients and the relative market capitalization. “Mandatory firm rotation may have significant unintended nega- tive consequences for companies that require specialist auditors if they are required to retain an audit firm that possesses less industry specialization than their former firm.” Not surprisingly, audit firms are not enthusiastic about rotation. Stephen Howe, Jr., managing partner of Ernst & Young believes “audit quality has improved in recent years, and the board and profession should seek to build on this foundation rather than strike out in a new and, we believe, dam- aging direction that poses risk not only to audit quality but to our capital markets as well.” Joe Echevarria, CEO of Deloitte, would prefer to see work on reinforcing the audit commit- tee’s responsibility for overseeing the audit firm, expanding com- munications between audit firms and audit committees, enhancing the expertise of audit committees and creating audit quality councils to advise audit firms. “One of the ironies of this pro- fession is that the public rarely hears or sees anything when an audit is done well,” said PwC chairman and senior partner Robert Moritz. “A lot of good work is done behind the scenes. Our auditors make the tough calls, and 92 per cent of our audit firm staff reported that in the last two years they had a difficult conver- sation with a client about an audit firm judgment or suggested an improvement.” And KPMG LLP’s chair and CEO John Veihmeyer said “we don’t find a nexus between audit tenure and insufficient scepticism, and we see significant disadvan- tages to term limits, including dif- ficulty in attracting and retaining talented people. My view is that a ‘sales culture’ that some contend is increasing in accounting firms, is far more likely to exist in a system of mandatory firm rotation — where every year a significant percentage of a firm’s audit engagements will be lost and will have to be replaced.” Robert Pozen, also from the Harvard Business School, wants the PCAOB to adopt a middle ground — requiring the audit committees of public companies to periodically issue a request for proposal for auditing services, but allowing the existing auditor to bid on this RFP. “In my view, this approach would reinforce the accountability of the external aud- itor to the audit committee, rather than management, without imposing some of the costs asso- ciated with mandatory auditor rotation.” Larry Harrington, chairman of the Institute of Internal Auditors, cited a survey showing that the majority of internal auditors Auditor rotation idea on thin ice 4 The Bottom Line May 2012 NEWS Publisher Julie Murtha Advertising Sales Jim Grice tel: (905) 415-5807 fax: (905) 479-3758 toll-free 1-800-668-6481 email: jim.grice@lexisnexis.ca Circulation Controller Scott Welsh email: scott.welsh@lexisnexis.ca Circulation and Subscriptions: tel: (905) 479-2665 toll-free 1-800-668-6481 fax: (905) 479-3758 toll-free 1-800-461-3275 Subscription rates 1 year (16 issues) $112, plus tax 2 years (32 issues) $180, plus tax U.S. / Int’l subscriptions: $175/year Accounting student rate: $40, plus tax Individual copies: $12, plus tax Managing Editor Robert Kelly robert.kelly@lexisnexis.ca Associate Editor Layout Editor Adam Malik adam.malik@lexisnexis.ca Production Coordinator Pauline Braithwaite Cover Illustration Paul Lawrence Editorial Offices 123 Commerce Valley Drive East, Suite 700, Markham, ON L3T 7W8 tel: (905) 479-2665 toll-free 1-800-668-6481 fax: (905) 479-3758 toll-free 1-800-461-3275 Internet: www.lexisnexis.ca THE BOTTOM LINE Copyright © 2012 LexisNexis Canada Inc. All rights re served. No part of this publication may be reproduced in any material form (including photocopying or storing it in any medium by electron ic means and whether or not transiently or incidentally to some other use of this publication) without the written permission of the copyright owner or in the case of photocopying or other reprographic copying, a licence from CANCOPY (Canadian Copyright Licensing Agency) ex cept in accordance with the provisions of the Copyright Act. Applic ations for the copyright owner’s written permission to reproduce any part of this publication should be ad dressed to the publisher. Warning: The doing of an unauthorized act in re lation to a copy- right work may re sult in both a civil claim for damage and criminal prosecution. The Bottom Line is published 16 times a year. Send changes to: Subscriptions, 123 Commerce Valley Drive East, Suite 700, Markham, ON L3T 7W8. Return postage guaranteed. Return undeliverable Canadian addresses to: Circ. Dept., 123 Commerce Valley Drive East, Suite 700, Markham, ON L3T 7W8. e-mail: scott.welsh@lexisnexis.ca Publications Mail Agreement Number: 40065517. ISSN 0831-5477 GST/HST/QST R100588607 Regional Correspondents Geoff Kirbyson (Western Canada); Jeff Buckstein (Ottawa); Luis Millan (Quebec); donalee Moulton (Halifax); Special Correspondent: Gundi Jeffrey “The benefits of rotation in enhancing objectivity may well be offset by increased conflicts, loss of a non-audit service provider or other adverse impacts.” Richard Breeden, former SEC chairman BReeden See Chamber on page 26 26 The Bottom Line May 2012 NEWS whose companies experienced a change in auditors did not per- ceive the independence, objec- tivity and professional skepticism of the new auditing firm as mark- edly different from that of the prior firm. “The potential benefit in this area may already have been realized through existing require- ments for rotation of lead and reviewing audit partners.” But the strongest objection came from David Hirschman, senior vice president, U.S. Chamber of Commerce. Noting that more than 90 per cent of commenters to the concept release opposed mandatory firm rotation and that the majority of investors were also against it, he said “the failure to demonstrate a need for mandatory firm rotation and a universal rejection of the concept by investors, business and governmental actors leads us to question why valuable resources, time and monies are being spent on this project.” A week after the panelists at the PCAOB roundtable stopped slugging it out, many of the same views were aired at the hearing by the House financial services committee on the proposed legis- lative amendment blocking the PCAOB from mandating auditor rotation. At that hearing, Doty pointed out that the board had not yet mandated mandatory audit firm rotation — or even proposed it — but was simply looking for a wide-ranging discussion of the idea. “If this process results in the PCAOB proposing any rules — whether they involve term limits or not — they will be sub- ject to further public comment and SEC approval.” Should the PCAOB proposal be adopted, said Barry Melancon, CEO of the American Institute of Certified Public Accountants, it would be “a very clear example of unbalanced regulation. It would impose significant strains on the audit profession and the public company business com- munity with no evidence that the Sarbanes-Oxley formula, which assigned authority to hire and fire the auditor to the independent audit committee, is not working in a way that protects the public interest.” Joseph Carcello, director of research of the Corporate Gov- ernance Center, University of Tennessee, focused on the Fitzpa- trick amendment, saying it is “potentially flawed” because it would prohibit the PCAOB from requiring public companies to use specific auditors. “PCAOB Aud- iting Standard No. 5 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.” Speaking on behalf of the Financial Executives Institute, Gary Kabureck, a vice-president with Xerox Corp., pointed out that the process for selecting and transitioning in a new auditor “will be extremely costly for both the company and the new auditor. Company time and money are finite — every hour and dollar spent on changing auditors is not available for other uses in the business or return to investors.” Tom Quaadman, vice- president, Center for Capital Mar- kets Competitiveness, U.S. Chamber of Commerce, added that “the concept releases on mandatory audit firm rotation and auditor discussion and analysis have the chamber concerned that the PCAOB is engaged in mission creep. It 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 Exchange Commission.” So, where does this issue go from here? Bruce Pounder, dir- ector of Professional Programs, Loscalzo Associates, Ltd., believes the legislative amend- ment will never see the light of day. “This is only the first stage of the federal legislative process. In my opinion, what lies ahead for this draft bill is a long and circu- itous political process, with little likelihood that the process will ever actually result in a change in federal law.” Chamber frets over ‘mission creep’ “One of the ironies of this profession is that the public rarely hears or sees anything when an audit is done well.” Robert Moritz, PwC LLP chairman Continued from page 4 • PROFESSIONAL DIRECTORY • Lori Verbeek & Associates “We customize our services to suit your needs” www.LoriVerbeekAssociates.com No job is too big or too small; we review, organize & problem solve to turn your paperwork into a set of books. We train your staff on-site and offer unlimited phone support. Don’t delay; call today to get started! 905-643-6620 Is your client ready for a new partner? www.successionfund.com The Succession Fund™buys shares from selling shareholders in owner-operated businesses. For more information call Larry Klar, (416) 867-8090 or e-mail klar@argosypartners.com ™ Argosy Partners Ltd. www.piccoloworldgifts.com ART | DÉCOR | STAMPS JEWELLERY | SCULPTURE | COINS Grand Opening Grand Opening Receive a 20-50% discount between September 9 & December 24 Lay away plan and gift certifi cates available for holiday purchases Receive a 20% discount between September 9 & December 24 www.piccolobusiness.com PICCOLO | 420 East Columbia Street, New Westminster | 604 522 4204 PICCOLO | 420 East Columbia Street, New Westminster | 604 999 4908 Reproduced withpermission ofthe copyrightowner. Furtherreproduction prohibitedwithout permission. . jim.grice@lexisnexis.ca Circulation Controller Scott Welsh email: scott.welsh@lexisnexis.ca Circulation and Subscriptions: tel: (905) 47 9-2 665 toll-free 1-8 0 0-6 6 8-6 481 fax: (905) 47 9-3 758 toll-free 1-8 0 0-4 6 1-3 275 Subscription. rotation idea on thin ice 4 The Bottom Line May 2012 NEWS Publisher Julie Murtha Advertising Sales Jim Grice tel: (905) 41 5-5 807 fax: (905) 47 9-3 758 toll-free 1-8 0 0-6 6 8-6 481 email: jim.grice@lexisnexis.ca Circulation. asso- ciated with mandatory auditor rotation. ” Larry Harrington, chairman of the Institute of Internal Auditors, cited a survey showing that the majority of internal auditors Auditor rotation