Obstacles make PCAOB’s Hanson skeptical about mandatory audit firm rotation

PCAOB member Jay Hanson said Tuesday that he struggles to see how the board would ever be able to create a mandatory audit firm rotation requirement for the U.S. public company auditors it regulates.

During a question and answer session at the AICPA Conference on SEC and PCAOB Developments in Washington, Hanson said that many obstacles to mandatory audit firm rotation make its implementation unlikely. “I can’t imagine that we’d go forward,” he said.

In an interview after Tuesday’s Q&A session, Hanson elaborated on his comments. He said that in order to create a mandatory rotation requirement that would have a chance of being approved, the PCAOB would have to consider statistical evidence that firm tenure is linked to audit failures and deficiencies. The board would have to complete an analysis showing that the benefits of mandatory firm rotation would outweigh the costs, he said.

“We’ve got all those things to do before we could meaningfully propose or adopt mandatory firm rotation,” Hanson said. “I’m skeptical as to whether we’d ever get there with all those hurdles in front of us.”

Hanson emphasized that the comments were his own, and that he wasn’t speaking on behalf of the other four members of the PCAOB, which would ultimately have to vote on the topic. His comments—and those of fellow board members—suggest that the discussion is far from over.

PCAOB Chairman James Doty said Monday at the conference that it’s important to examine ways to protect auditors’ independence, “including by considering term limits.”

The PCAOB on Aug. 16, 2011, issued a concept release asking for comments on whether mandatory audit firm rotation would improve auditor independence, objectivity and professional skepticism. The release said that at the time, the average audit firm tenure for the top 100 U.S. public companies was 28 years. The PCAOB was concerned that auditors’ objectivity could be diminished if they were afraid their work jeopardized those longstanding, lucrative relationships between their firms and the companies they audit.

 A few months later, the European Commission issued mandatory audit firm recommendations that remain under debate in the European Parliament. Since then, the PCAOB has held numerous public hearings on mandatory rotation where the board has heard many alternatives that could improve objectivity and independence.

The AICPA has written a comment letter opposing mandatory audit firm rotation, saying rotation would have costly and unintended consequences and may hinder audit quality. The PCAOB has received more than 650 letters on the subject; an Ernst & Young study released in January showed that more than 90% of the letters posted at that time opposed mandatory rotation.

During a hearing in March, some of the members of the U.S. House Subcommittee on Capital Markets and Government Sponsored Enterprises grilled Doty on audit firm rotation, saying the board needed to consider the costs and benefits. Doty said the board wouldn’t implement a mandatory audit firm rotation requirement without such a study.

“We have numerous obstacles,” Hanson said.

Hanson said that while some academic studies support the notion that mandatory firm rotation would improve audit quality, many do not support that notion. He said the PCAOB possesses more audit data than the academic community, though, and could produce a more reliable study on the root causes of audit failures.

He doesn’t know what such a study would conclude with respect to audit tenure’s effect on audit failures and deficiencies. “It’s challenging to connect those dots between a failure, and is it because it was a client for 10 years or 15 years or 20 years,” Hanson said. “So I’m a little skeptical as to whether or not we would ever be able to make that connection.”

That—along with the costs and benefits question—have Hanson doubting whether the PCAOB could ever pass a mandatory audit firm rotation standard.

“But then again,” he said, “I’ve been wrong before, as my wife continues to remind me.”

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.