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 Statement on Public Meeting On Auditor Independence and Audit Firm Rotation

DATE: March 21, 2012
SPEAKER: Lewis H. Ferguson, Board Member
EVENT: PCAOB Public Meeting
LOCATION: Washington, DC

I look forward to hearing the views of the many distinguished individuals who have agreed to appear at this roundtable. When the PCAOB issued its concept release on auditor independence raising the possibility of mandatory audit firm rotation as a means of increasing the auditor's independence, we were aware that it would be controversial and it certainly was. The Board has received hundreds of comment letters on this issue from many different commentators expressing a variety of views.

This Board member at least approaches the issue of auditor independence and its relation to the question of audit firm rotation as a curious skeptic.

Simple human experience tells us that any arrangement in which one party pays for the services of another is likely to lead to a certain commonality of interest between the parties. That commonality of interest raises the question whether the party being paid can ever truly be independent of the payer as our accounting and auditing standards and securities laws require. To use a humble analogy, most creatures do not bite the hand that feeds them. In the case of the auditing profession, a panoply of independence rules and professional standards are designed to counteract the potential for conflict that seems inherent in the current auditor payment model and judicial decisions have at times imposed heavy penalties on auditors who fail to meet those standards. Indeed, the Board itself has been the source of some of those rules. One of the questions for consideration here is whether these constraints have achieved their purpose or, indeed, whether they can achieve their purposes in light of the existing structure of auditor compensation.

Despite the numerous rules, regulations and judicial decisions intended to promote auditor independence, the Board's inspection program, now having included the detailed examination of several thousand independent audits, continues to reveal a troubling number of audit deficiencies in many areas but many of which appear to be attributable to a lack of appropriate skepticism on the part of the auditor. This apparent absence of skepticism may be attributable to many factors, but the question before us today is whether one of those factors is the existing auditor compensation structure coupled with an absence of auditor term limits. Put simply, does the existing auditor compensation model coupled with no auditor term limits exert a subtle restraint on the auditor's willingness to challenge management judgments for fear of losing a long standing client and a predictable stream of revenue?

Even if that were the case, what would the costs of a mandatory audit firm rotation regime be? What would it cost for a new auditor to learn a complex business? What would the costs be in terms of the time of the client's management that would be diverted from the core business? What human capital costs would be involved, particularly where large audit clients are located in places where the only significant audit firm office is the client's long standing auditor? Would audit deficiencies in fact increase in the early years of a new auditor's tenure as it learned the client's business? Would any increase in independence outweigh whatever these costs were? These are questions on which we seek your views.

Another area of inquiry that deserves focus is whether auditor independence and its correlative, auditor skepticism, is even related to the structure of auditor compensation or auditor tenure. In other words, are we barking up the wrong tree? But if so, what are your suggestions for improving what the Board's inspection program reveals to be serious deficiencies in auditor skepticism that seem to underlie many audit failures.

I hope that participants in this roundtable will also discuss whether audit committees are able effectively to monitor auditor independence and to counteract whatever force the existing auditor compensation and tenure models exert in undermining independence. Do participants believe that audit committees (to the extent one can generalize this way) even perceive a problem? If so, do they possess the technical skills or have access to the technical skills to ask the right questions?

Any rule that would overthrow longstanding and well accepted practices that are not obviously wrong bears a heavy burden of proof, but the Board is faced with stubborn and persistent issues of audit deficiency that raise serious and fundamental questions about how the current independent audit model for public companies works. On these issues, we seek your wisdom.