Banks Face 24-Year Auditor Limit as EU Seals Rotation Deal

Banks and companies listed on stock exchanges will be forced to change auditing teams after a maximum of 24 years under a European Union deal to water down proposals aimed at bolstering corporate oversight.

EU negotiators brokered a draft agreement in Brussels that requires companies to change accounting every 10 years, with a one-off right to an extension as long as 14 years if they carry out a tender process, Michel Barnier, the EU’s financial services chief said in an e-mailed statement. Audit firms will also face curbs on providing consulting and other services to companies whose accounts they review.

“Although less ambitious than initially proposed” by the European Commission, “landmark measures to strengthen the independence of auditors have been endorsed,” Barnier said. “Taken together, the agreed measures will considerably strengthen audit quality across the European Union”

Barnier has called for an overhaul of the rules following the collapse of Lehman Brothers Holdings Inc., arguing that it raised questions about the quality of company audits. Regional arms of the top four accounting firms -- KPMG LLP, PricewaterhouseCoopers LLP, Ernst & Young LLP, and Deloitte & Touche LLP -- have a market share that exceeds 85 percent in the majority of EU member states, according to commission data.

The rotation rules and limits to additional services are targeted at audits of listed companies, banks and insurers.

The draft deal was clinched at meetings last night and this morning by lawmakers from the European Parliament and officials from Lithuania, which holds the presidency of the EU. The provisional pact will now be reviewed by other national governments, and requires formal approval by the parliament and nations to take effect.

Ancillary Services

One of the main goals for the new rules is to limit conflicts of interest, Barnier said. Auditors will face restrictions in offering ancillary services to companies whose accounts they oversee, including “stringent limits on tax advice and on services linked to the financial and investment strategy of the audit client,” he said.

The draft deal also includes a cap on additional services - - preventing auditors from making extra money from a client that goes beyond 70 percent of their audit fee. For the purposes of the calculation, the amount would be averaged out over three years.

Bank Branches

“We are pleased that the decision makers have managed to come to an agreement, as there is now hope for all the required follow-up work to be completed before, rather than be stalled by, the EU elections next year,” Michael Izza, chief executive officer of the Institute of Chartered Accountants in England and Wales, said in an e-mailed statement.

Banks have warned that the rotation rules may also capture lenders based outside of the EU, depending on how the final accord is drafted.

“A rotation requirement considered applicable to branches could mean that it is extended to the non-EU parent banks themselves since they and their branches constitute a single legal entity,” the Association for Financial Markets in Europe said in a letter to Karim dated Dec. 13.

Large “multinational financial groups often rely on a single worldwide auditor and this restricts the choice of firms that are able to deliver quality services at global level,” said the group, which represents lenders including Goldman Sachs Group Inc., Deutsche Bank AG, and JPMorgan Chase & Co.

Extra-Territorial

These concerns “still remain,” Pablo Portugal, a director at AFME, said in an e-mail. “We urge policymakers to give careful consideration to this extra-territorial reach.”

Under the plans announced today, companies could keep the same auditors for as much as 24 years if they carry out a tender and appoint more than one auditing firm. This includes a one-off 14-year extension. Companies with one auditor would only get a 10-year prolongation if they hold a tender.

The blueprint also includes a transition period as long as six years for companies to adjust to the new rules.

These rotation periods are far longer than those in Barnier’s original proposal, which called for firms to rotate the accounting firm they use every six years. The rotation period could have been extended to nine years if a company uses more than one auditor.

The accord is “a considerable improvement on the commission’s original proposal,” Sajjad Karim, a U.K. Conservative lawmaker who led the EU parliament’s work on the draft law, said in an e-mail. “The European Parliament is optimistic that the proposal can be approved by a majority of member states and MEPs, considering it a balanced compromise,” Karim said.

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