Is Mandatory Audit Firm Rotation Necessary for True Audit Independence?

The Public Company Accounting Oversight Board, also known by the forgettable initials PCAOB, was established pursuant to the Sarbanes-Oxley Act of 2002. The PCAOB defines its mission as overseeing the audits of public companies in order to protect the interests of investors and furthering the public interest in the preparation of informative, accurate and independent audit reports. SOX considered the effectiveness of outside auditors very important in protecting investors from corporate fraud. The PCAOB, established up front in Title I of SOX, was to be the cornerstone of that effort.  SOX specifically addressed the role of outside public auditors, particularly in  Title II, “Auditor Independence.” Among other things, Title II, in Section 203, “Audit Partner Rotation,” prohibits a public accounting firm from keeping the same lead audit partners in charge of the financial statement audits of the same public company for more than five consecutive years.

The PCAOB has recently raised the possibility of the imposition, albeit not imminent, of rules requiring the rotation of the audit firm itself, not just the firm’s lead partners. On August 16, 2011, the PCAOB issued a “concept release” raising the question of whether the perpetual engagement of the same audit firm by a public company undermines auditor independence, objectivity and skepticism. The statement by PCAOB board member Steven B. Harris concerning the concept release  suggests that such a long-term auditor/company relationship may inherently contradict 40 year old professional standards of auditor independence requiring that the auditor be “free from any obligation or interest in the client, its management or its owners.” Specifically, the Harris statement asserts that existing auditor independence reforms have not “eliminated the strong incentives that lead some auditors to serve the interests of the company paying the bills rather than those of investors  . . .  .”

The concept release invites comments from the public on mandatory audit firm rotation and related auditor independence concerns, due by December 14, 2011, and announces that the PCAOB will hold a public roundtable on the concept release issues in March 2012.  We will follow developments relating to the concept release and other auditor independence issues and report on them from time to time in this forum.