Toothless Term Limits Won't Improve Auditing
The idea of making companies switch audit firms every so often is a good one, except when it isn't. And here is one of those times.
The European Union unveiled a new draft agreement with its member states that would force financial institutions and publicly traded companies to occasionally rotate their outside auditors. The objective is to keep auditors and their clients from getting too cozy with each other. The problem is it still gives them a very long time to remain cozy with each other, sometimes as long as a generation.
Companies would have to change their outside audit firms after 10 years, with some exceptions. They could extend that period by 10 years if they put out their audit work for bid -- and by 14 years in the case of joint audits, in which companies hire more than one firm to carry out their audit.
In addition, there would be a six-year transition period. So, it could be as long as 30 years before some companies have to switch auditors. In a way, that would make this the perfect law, because its full effects won't be felt until most of the people who passed it are long gone from office, leaving the next generation to deal with the consequences.
Some of the profession's heavyweights are displeased nonetheless. The Big Four accounting firm PricewaterhouseCoopers issued a statement today responding to the EU's draft agreement that was wonderful for its unintended hilarity.
"By definition mandatory audit firm rotation reduces competition and choice which is an odd outcome given the European Commission's stated desire to increase competition," said Richard Sexton, Pricewaterhouse's vice chairman for global assurance.
Firms such as Pricewaterhouse love it when governments require companies to buy audit services. They don't want their clients to have a choice about that. Surely the firms would complain even louder if the world's governments suddenly passed laws saying that audits no longer are mandatory, which truly would be freedom of choice.
There is no sign yet that U.S. authorities will impose term limits on outside auditors. The Public Company Accounting Oversight Board's chairman, Jim Doty, tried floating this idea back in 2011, but it went nowhere. The pushback from the big accounting firms was immediate and relentless.
I've argued for some time that Congress should remove the audit requirement from U.S. securities laws and put the decisions about whether to hire auditors up for votes by shareholders. That way, to get hired, audit firms would have to demonstrate to the investing public that their services have value. After so many audit failures over the past few decades, audits are widely viewed by investors as irrelevant. The firms' opinion letters seldom are anything but useless boilerplate.
Removing the audit requirement would remove the government seal of approval on the audit firms' work. The business model for audit firms is the same as the one for credit-rating companies, such as Standard & Poor's and Moody's Investors Service. The client pays for the opinions, rendering the process hopelessly conflicted, no matter how many rules on auditor independence the regulators may pass. Regulators shouldn't force anyone to buy credit ratings from these for-profit businesses either, although often they still do.
If Pricewaterhouse and the other big accounting firms are such staunch advocates for freedom of choice, they should learn to stand on their own, rather than depend on government subsidies and mandates to hold on to their paying customers.
(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter.)