European Commission Proposes Regulatory Changes for Audits

The European Commission today proposed sweeping regulations that would, if approved, trigger major changes in the relationships between European public companies and their auditors.

The changes include:

  • Limiting to six years the period that an outside auditing firm can perform audits for a company. A cooling-off period of four years would be imposed before a firm could audit again for the same client. Companies that opt for a voluntary joint audit would be allowed a nine-year window.
  • Prohibiting audit firms from providing nonaudit consultancy services to their audit clients, and requiring large audit firms to separate audit activities from nonaudit activities.
  • Public-interest entities would be required to have an “open and transparent tender procedure” when picking a new auditor.
  • Creating a single market for statutory audits by introducing a European passport for the audit profession, allowing firms to provide services across the European Union.

The proposed changes have to be approved by European Union states and the European Parliament. If approved, the changes could alter the European market share of the Big Four audit firms of Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers, which would be required to separate their audit and nonaudit services in Europe.

In response to the ongoing financial crisis, the EC launched in October 2010 a broad consultation asking whether audit regulations could be changed to mitigate new financial risks in the future. The EC said the crisis exposed weaknesses in the audit sector.

"Investor confidence in audit has been shaken by the crisis,” European financial services commissioner Michel Barnier said in a statement, “and I believe changes in this sector are necessary. We need to restore confidence in the financial statements of companies. Today's proposals address the current weaknesses in the EU audit market, by eliminating conflicts of interest, ensuring independence and robust supervision and by facilitating more diversity in what is an overly concentrated market."

The package of proposed changes has been scaled back from measures Barnier reportedly favored.

Critics of the reforms have said the regulations will erode quality while increasing costs. In a December 2010, response to an EC’s green paper on the issue, the AICPA cited numerous studies that indicate that mandatory audit firm rotation can result in significant costs without enhancing audit quality.

PwC issued a statement today saying audit-only firms and mandatory rotation would raise costs and reduce quality.

“Some of the proposals will add significant costs, increase regulatory complexity and threaten audit quality, all at a time of major financial upheaval and when growth is an imperative," Ian Powell, Chair of PwC UK, who heads that firm’s region that includes the European Union, said in the statement.

In the United States, the PCAOB also is examining potential limits on audit firms’ tenure with public companies. The PCAOB is particularly focused on weighing the advantages and disadvantages of audit terms of 10 years or greater. Feedback on the issue will be gathered by mid-December, with a public forum scheduled for March 2012.

Restricting nonaudit services would mark a significant shift in many parts of Europe, where audit firms are allowed to provide other consulting services to their public company audit clients. In the United States, the Sarbanes-Oxley Act of 2002 forbids auditors from providing many nonaudit services.

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