VIEWPOINT | THE CASE AGAINST AUDITOR ROTATION RULES

Many publicly traded companies in the US may not realize that a growing number of countries are adopting rules that limit the number of years a public accounting firm may audit their financial statements. Mandated audit firm rotations vary in length and sometimes the type of companies to which they apply.

These requirements are common in Europe, where the European Parliament is considering legislation that would help standardize them, although wide diversity would remain due to the options and choices left open to Member States. India is finalizing new legislation that would mandate nonrenewable rotations every 10 years.

Audit firm rotation rules are intended to maintain auditor independence and guard against overly close relationships between the auditor and management. But EY says mandatory rotation increases costs, reduces a company's choice of audit suppliers, increases concentration in the audit market and can undermine the ability to perform a quality audit. Stephane Lagut, Global Automotive Assurance Leader for EY, discusses the issue and its implications for global companies.

How widespread are audit rotation rules?

About 30 countries currently mandate some form of audit firm rotation. In China, audit firm rotation applies only to government-owned companies, and administrative guidance by the state-owned Assets Supervision and Administration Commission (SASAC) may put pressure on their joint venture partners. In Italy, companies must choose another auditor every nine years, and in France, where joint audit is mandated, auditors serve for six-year terms but may be renewed indefinitely.

Countries that have recently added or expanded such rules include Brazil, the Netherlands and Turkey. Interestingly, several countries have adopted mandatory audit firm rotation rules but then abolished them, including Canada, Czech Republic, Singapore and South Korea.

What does this mean for companies with global operations?

Things can get complicated very quickly. If a company has a joint venture in China, a business in India and another in the EU, it must comply with three separate sets of rules governing how long it may retain a given audit firm in each location. It may have group auditors in countries that have no rules about rotation, but it is required to change auditors at varying frequencies in other countries.

Multiple rotation requirements obviously make it more complicated for a group auditor to serve multinational companies. EY considers continuity of auditors important for the quality of the audit itself. It's also what clients expect. They want consistent and accurate applications of group accounting rules, and they need internal control reporting worldwide.

Many companies aren't aware of mandated rotation schedules and how they vary from one country to another. As more countries adopt or adjust such regulations, it will make operations more complex for multinational companies at a time when they are trying to simplify their businesses.

How do rotation rules affect the ability to integrate the opinion of independent auditors?

Again, it varies by region. In the US, when the group auditor forms an opinion for a certain component, it may incorporate the opinion of another auditor used in the process. Europe, for one, does not permit this option and requires the group auditor to take full responsibility. EY monitors pending legislation that could affect mandatory rotation and other aspects of audit services, and we fully comply with whatever rules prevail.

Why does EY oppose scheduled rotation regulations?

We believe prescribing the timing of firm rotation creates more cost, raises unnecessary risks and undermines corporate governance structures. Combined with independence requirements, it also reduces the choice for global groups to select their preferred service providers.

Costs are higher due to the learning curve audit firms face with any new audit. There's also the issue of forcing companies solely because of a mandated rotation requirement to periodically find new auditors with expertise in their industries.

Prescribing the timing of a rotation can create additional costs for a company if, for example, it is in the middle of a major business transaction or merger. We also believe company audit committees are a more effective way of determining whether the current auditor is acting with independence and producing a high-quality audit. Mandatory rotations reduce rather than reinforce this role.

What does EY suggest as an alternative?

We believe there are several options that can more effectively strengthen auditor independence without damaging audit quality. One is simply to rotate the key audit partners, which removes the risk of self-interest while retaining the auditor's institutional knowledge. This option is already embodied in the International Ethics Standards Board for Accountants (IESBA) Code of Ethics.

Another constructive step is to ensure that audit committees have sufficient power, independence and transparency. Still another is to strengthen external regulatory auditor oversight. In our view, auditor independence also would be strengthened by the international adoption of a single strong and robust ethical standard, such as the IESBA Code of Ethics.

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[The views reflected in this article are those of the author and do not necessarily reflect the views of the global EY organization or its member firms.]