U.K. proposal a second blow to mandatory audit firm rotation

Mandatory audit firm rotation was not among the measures the U.K. Competition Commission (CC) proposed Monday to promote competition in the statutory audit services market.

But the CC did include mandatory tendering every five years for the United Kingdom’s largest companies in its proposal, a significant shift from the 10-year retendering period U.K. Financial Reporting Council (FRC) rules currently require. The FRC’s 10-year retendering rule includes a “comply or explain” provision that provides some flexibility, but the CC proposal does not include a “comply or explain” provision.

Tendering is the process by which a company opens its audit to bidding by audit firms that seek a contract to perform the audit work.

A summary of the CC’s provisional decision on changes for the statutory audit services market in the U.K. was posted Monday on the CC’s website.

Although mandatory audit firm rotation remains under consideration by the European Union (EU), the CC’s decision represents a second setback in two weeks for firm rotation requirements. In Congress, the House of Representatives on July 8 approved a bipartisan bill that would prohibit the PCAOB from requiring mandatory audit firm rotation for public companies.

The bill would have to be approved by the Senate and signed by President Barack Obama to become law. But AICPA President and CEO Barry Melancon, CPA, CGMA, said the House vote would help relieve a mistaken impression in Europe that a mandatory firm rotation requirement is imminent in the United States.

The AICPA has opposed mandatory audit firm rotation, saying it would carry significant costs and could hinder audit quality. The Chartered Institute of Management Accountants (CIMA) also opposes mandatory audit firm rotation.

The CC’s full provisional decision will be published shortly, with comments invited at auditors@cc.gsi.gov.uk through Aug. 13. The CC is required to publish its final report by Oct. 20.

The proposed changes are intended to improve the bargaining power of companies, encourage rivalry between audit firms, enhance the influence of audit committees, and promote shareholder engagement in the audit process, according to the CC.

Although the proposed regulations may be affected by measures the EU is discussing, the CC is proceeding with its own proposal because the EU has not yet produced any definitive proposals, the CC said in a news release.

A draft law that would require public-interest entities to rotate audit firms every 14 years—a period that could be extended to every 25 years if certain safeguards are put into place—was approved by a European Parliament committee in April but has to go through several more steps before it becomes law.

The main measures proposed for the U.K. by the CC are:

• Requiring FTSE 350 companies to put their statutory audit engagement out to tender at least every five years; in exceptional circumstances, this obligation may be deferred by up to two years. The measure would come into full effect after a transitional period of five years.
• Mandating review of every audit engagement in the FTSE 350 every five years, on average, by the FRC’s Audit Quality Review (AQR) team. Audit committees would be required to report to shareholders on the findings of any AQR report concluded on the company’s audit engagement during the reporting period.
• An annual review and report on the larger “Mid Tier” firms by the AQR team.
• A prohibition of clauses in loan documentation that limit a company’s choice of auditor, such as “Big-Four-only” clauses.
• Requiring a shareholders’ vote on whether audit committee reports in company annual reports contain enough information.
• Measures to strengthen the accountability of the external auditor to the audit committee and reduce the influence of management. These would include a stipulation that only the audit committee is permitted to negotiate and contract audit fees and the scope of audit work, initiate tender processes, recommend appointment of auditors, and authorize the external audit firm to perform nonaudit services.
• Amending the FRC’s articles of association to include a secondary objective to have due regard for competition.

Although mandatory audit firm rotation was a measure the CC explored, it was not part of the proposal. The CC also decided against proposing requirements for:

• Further constraints on audit firms providing nonaudit services.
• Joint audits.
• Shareholder or FRC responsibility for auditor reappointment.
• Independently resourced risk and audit committees.

Laura Carstensen, who chairs the CC’s Audit Market Investigation Group, called the set of proposed measures “comprehensive” and said they will benefit shareholders by making the statutory audit market more responsive to their needs.

“More frequent tendering will ensure that companies make regular and well-informed assessments of whether their incumbent auditor is competitive and will open up more opportunities for other firms to compete,” she said. “A more dynamic, contestable market will reduce the dangers that come with overfamiliarity and long, unchallenged tenures.”

The FRC issued a statement that also expressed agreement with the omission of mandatory rotation from the proposal. But the FRC also expressed concerns over other proposed measures and their costs.

“We have previously urged the Commission to respect the 10-year audit tendering cycle introduced to the Corporate Governance Code in 2012 and to give that time frame the opportunity to prove itself,” the FRC said. “The Commission’s proposed five-year cycle for tendering also removes ‘comply or explain’ in this respect, which is a central tenet of the UK Corporate Governance Code.”

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