How to Put More Distance Between Banks and Their Auditors

Mandatory rotation of a company's external auditors is not a popular idea among the audit firms or their clients.

The Public Company Accounting Oversight Board, the audit industry regulator, sought input last week from investors, auditors, academics and former regulators on a controversial "concept release" on the idea. More than 45 speakers gave their opinions of various ways to put rotation into practice. All of the suggestions made were intended to improve auditor independence, professional skepticism and, hopefully, audit quality.

PCAOB Chairman Jim Doty opened the meetings this week with the admission that fixed term limits for auditor relationships "would significantly alter the status quo." That is an understatement. The PCAOB received more than 600 comment letters, almost all in opposition to mandatory rotation.

Audit committee members object to such mandates because of the perceived cost. They also accuse the PCAOB of trying to usurp the enhanced role and responsibilities delegated to audit committees by the Sarbanes-Oxley Act. Audit firm CEOs say mandatory rotation would distract them from audit quality assurance and force the partners to focus on responding to constant requests for proposals and marketing activities. The auditor firms would rather collect oligopolistic fees from a government-mandated franchise without having to compete or justify those fees.

Some company representatives claim they would have to spend too much time and money getting new auditors up to speed on company culture and complex customized systems. Academics and former regulators, politically sensitive when in doubt, are divided on the advantages and disadvantages of mandatory auditor swaps.

Data firm Audit Analytics says that about 175 companies in the S&P 500 have used the same auditor for 25 years or more. The average tenure for audit firms at the top 100 U.S. companies by market cap is 28 years and 20 of those companies used the same auditor for 50 years or more.

Inertia is in evidence among the largest banks. In 2010, Citigroup (or rather the U.S. Treasury, which still owned 27% of the bank’s stock at the time), reappointed KPMG to its 41st consecutive year as auditor. JP Morgan Chase and Bank of America have both been using PricewaterhouseCoopers for a while, since 1965 and 1958 respectively. KPMG has been working with Wells Fargo since 1931.

And cozy ties between auditor and audited have an inglorious history. Consider that Ernst & Young had audited Lehman Brothers since before it was spun off from American Express in 1994, right up until the investment bank failed in 2008. Three of four chief financial officers at Lehman Brothers since 2000 were Ernst & Young alumni, including David Goldfarb, a former senior partner of the audit firm, who as Lehman’s CFO concoted the infamous Repo 105 balance sheet window-dressing technique.

But I'm not in favor of mandatory auditor rotation, in particular for the big banks. That's not because it costs too much or disrupts the company. Good corporate governance costs money and that’s a cost of doing good business.

Upsetting the relationships between banks and their auditors is, unfortunately, very disruptive to audit firms because of independence requirements. Rotation may force an audit firm to move all accounts, lines of credit, and other funding facilities to another bank. SEC rules prevent auditors from doing business with the bank that holds partner and firm money.

Moreover, I oppose mandatory auditor rotation because it's too much like term limits for elected officials. Both allow abdication of the responsibility for booting bad actors. And it’s an exercise in futility. Companies would be forced to move their audit from one potentially corruptible audit firm to another.