Re:Balance -- Jim Peterson

Mandatory Auditor Rotation -- The PCAOB Bites Off More Than It Can Chew

            “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.

(The PCAOB’s release of August 2011 announced its initiative; it links to the overwhelmingly negative public reaction. My own long-standing pessimism is partly here, here and here.)

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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PCAOB Chairman Doty Takes His Mandatory Auditor Rotation Proposal On Tour

 

Boone: “This is ridiculous.”

Pinto: “What are we going to do?”             

Boone and Otter: “Road trip.”

 -- Animal House, 1978

 Of all the goofy reasons for government inaction, the Public Company Accounting Oversight Board’s new tactics on mandatory auditor rotation may take the prize.

A release on March 7 from Chairman James Doty announced the extension from last December to the end of this April, for still further comments – along with public meetings in Washington on March 21–22 and, according to his interview with “Accounting Today,” a roadshow of “meetings of similar importance in at least three or four cities around the country.”

Those searching for sense are left agape.

Doty continues to flog the idea of mandatory rotation, re-raised in the agency’s concept release of August 16, 2011, despite its lack of evidentiary support and its long prior history of rejection (here, here, here and here), and in the face of uniform opposition from those knowledgeable enough to be worthy of attention.

Exhaustively discussed for decades, and deservedly consigned to the dustbin of bad ideas, mandatory rotation cannot be revived with credibility through either of Doty’s attempts to troll for support.

First, the announced list for the Washington meetings reveals a pre-loaded attempt to pimp the agenda. Jamming a two-day program with 47 speakers, mainly old-timers well used to hearing their own pontifications on the panel-and-symposium circuit, guarantees that most of the time will be spent in chair shuffling, self-important CV recitations and bathroom breaks.

The positions of the panelists are all well known and require no further display: stale recycling of four former SEC chairman plus various agency alumni, predictable sanctimony from such “investor advocates” as ex-TIAA-CREF head John Biggs and Vanguard founder John Bogle, automatic resistance from the Chamber of Commerce, and sitting-duck defensiveness by the large accounting firms themselves.

Perhaps least credible is the callback of the leaders of the Treasury Department’s Advisory Committee on the Auditing Profession -- convened as a bearding exercise by Bush-era Secretary Paulson and, to its embarrassment, so riven by division that its 2008 valedictory could not even agree that there really was a grave challenge to the audit function (here and here) – and whose singularly brainless idea, advanced from aloft by Paul Volcker, was the implausible notion of management replacement contingency plans by the large private accounting partnerships if falling into Andersen-like distress (here).

As for Doty’s out-of-town tryouts – what else but a further source of delay and inaction?

That any wisdom will be garnered from beyond the Washington Beltway clashes with the record -- successful delivery of over 600 comment letters, from (as Doty seeks) “communities across and up and down the axis of the United States”– none indicating need of his outreach because all are evidently well-connected to the nation’s capital by e-mail and standard postal service.

Indeed, Doty concedes the can-kicking. As he put it, “We’ll be working on this at this time next year …. This is a protracted process, and should be for an issue that is this fundamental.”

Fundamental it may be – and protracted for certain. But not persuasive. Those like my friends Tom Selling, Dave Albrecht and Caleb Newquist, who support mandatory rotation if only because they recoil by instinct from the large firms and others who oppose it, are urged to consider:

• Weakness in an antagonist’s position, however apparent, is not affirmative support for the soundness of the opposite.

• Human nature consistently underestimates the cost, disruption and unintended consequences of acts taken for the politically motivated sake of “doing something.” 

• Finally, the PCAOB still has no answer to this central question, which should be posed to all the panelists and should lead the agenda of all further dialogue:

Where is there any empirical evidence that the incidence of “audit failures”– however defined – correlates at all with the length of auditor tenure?

The same tired script of clichés, recited by the same dumbshow cast, will not answer.

Chairman Doty should recall that in the old days of Broadway theater, revival productions failing their previews in the provinces of New Haven or Philadelphia never made it to the big stage. The third-rate slapstick comedy, “Mandatory Auditor Rotation,” deserves the posting of its closing notice.

 

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