“The unspeakable chasing the uneatable.”
Oscar Wilde’s description of English fox-hunting captures the spirit of the two days staged in Washington on March 21-22 by the Public Company Accounting Oversight Board – in aide of illumination on mandatory auditor rotation.
Thankfully unable to attend, due to classroom commitments, I salute those brave and durable enough to have done – although the tedium of the webcasts accuses anyone without handsome compensation of not having enough to do.
Which is to say, the offerings from the 47 speakers crammed into the panel sessions were entirely predictable. The maxim was reinforced conclusively that the amount of intelligent substance in any agency proceeding is an upwardly-bounded constant -- the only variable being the number of witnesses among whom it is thinly spread.
Examples included the panels of academics and “investor representatives,” whose perfervid but anecdotal pro-rotation rhetoric was untroubled by the continuing absence of any relevant empirical evidence associating auditor tenure with audit quality; Paul Volcker’s plangent if irrelevant reminiscence of his brief and inconsequential association in 2002 with Arthur Andersen’s terminal state; and Jack Ciesielski’s attempt to revive the notion that insurance might backstop the auditors – a fantasy lacking credibility and long discredited (here) by the insurance industry’s manifest lack of interest.
Careful assessment of the PCAOB house-party reveals neither an empirical case for mandatory rotation nor the supportive votes among its members – leaving this question:
What will political pressure oblige the PCAOB’s members to bring forward by way of action?
Between the poles of the speakers' antagonisms, there are the faint outlines of plausible mid-range approaches:
To start – noting a plain truth by former SEC general counsel David Becker, that individual cases for mandated auditor rotation are “intensely situational”– support now emerges for the PCAOB’s use of enforcement-based mandated rotation (e.g., Harvey Pitt).
Well -- “right on,” but also “about time.” Having written to this effect way back in August 2011 (here), I put it this way:
“…In a specific case, if the PCAOB can sustain its proof that long audit tenure was causally related to its definition of “audit failure,” it could include rotation in its toolkit of post-inspection sanctions.
“Since the PCAOB looks annually at a sampling of engagements for each of the large audit firms, and claims to target its inspections on the basis of perceived engagement risk and exposure, the agency’s experience base should bring to light cases – if any – where audit quality might be affected by length of tenure.
“In which case, rotation could be proposed, and if necessary, imposed.”
The other way forward comes in two flavors – either of which would allow PCAOB chairman James Doty to declare victory; would be tolerable to the profession; and, unlike mandated rotation, would actually be achievable in the large company audit market.
The first would be by way of periodic mandatory re-tender, with the incumbent auditor eligible to be re-engaged. The estimable Bob Pozen, one of chairman Doty's "rock stars," proposed 14 years (here), so as to allow for three individual partner rotations. Others proposed far shorter periods, although five or seven years would be too short, causing the profession to spend endless time and waste prodigious sums in a musical-chairs chase for business.
Compromise should be possible. If potential replacement auditors had the commercial choice of giving up ancillary services for their clients – tax, consulting, valuation – in order to be eligible to take up the audit, the market itself would determine the range of choice and competition. That has to be better than leaving such bright lines to be drawn under the dim vision of the regulators.
The second alternative places focus on the responsibilities of corporate audit committees – supported by former SEC chairmen Richard Breeden and Harvey Pitt among many others. That body would be obliged periodically to justify the continued engagement of a long tenured auditor – a process of “comply or explain” -- not difficult for a good quality committee.
Failing which the PCAOB, challenged to focus its inspection attention on long-lasting relationships, could determine that a dysfunctional audit committee amounted to a material corporate control weakness, justifying the requirement of a re-tendering.
I have crawled out on numerous shaky limbs, and survived. So I am prepared to predict here that some variant of these ideas will emerge at the seemingly endless end of the PCAOB’s process.
(Other and deeper problems would remain untouched, much less unresolved by this outcome, unfortunately, such as the basic value and usefulness of today’s accounting and reporting model itself, the relevance of audits, and the very existential viability of the private audit franchise – all subjects postponed to other days.)
Meanwhile, audit committee leadership on either re-tendering or “comply or explain” would not cause the world of audit to come crashing down. The actual effect would be modest at most.
Which in a world of knee-jerk critics and short-sighted regulators would be no small thing -- and one the community of financial statement users could very well live with.
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