August 17, 2011

The PCAOB’s New Concept Release on Auditor Rotation & Independence

Yesterday, the PCAOB issued a concept release on auditor rotation and independence, as first warned was coming by Chair Jim Doty in a speech shortly after he arrived at the agency two months ago. This is bound to be quite controversial and it appears that the PCAOB will take its time considering the concept as a roundtable on the topic isn’t scheduled until March ’12. Comments made by some of the newer PCAOB Board Members during the open meeting yesterday indicate that the PCAOB’s inspection staff has found numerous problems with independence that has led to this concept release.

The perceived independence issues associated with a company paying the fees of an auditor who performs the company’s audits were dealt with in Sarbanes-Oxley in ’02 when the lead audit partner and audit review partner were required to be rotated every 5 years. Here’s an excerpt from Board Member Steven Harris’ remarks during the meeting:

Over the years, many alternatives have been considered to further strengthen auditor independence. For example, prominent individuals such as Paul Volcker and Michel Barnier, the European Commissioner for Internal Market and Service, have suggested at various times consideration of “audit-only” firms. Under this concept, in exchange for the statutory franchise given to the audit profession, auditing firms would perform only accounting and audit related services and not provide non-audit services. Others have suggested lengthening the list of prohibited non-audited services. And it has also been suggested that the mandatory tendering of audit contracts could be required at regular intervals.

While some of these or other alternatives may merit further consideration, they do not address the fundamental conflict of interest inherent in the system. The auditor is paid by the company that he or she audits. And, as a natural and inevitable result of that arrangement, auditors know that if they push management too hard, they risk losing the fee not just for the current audit but, potentially, the fees for an unlimited number of audits in the future. In essence, they risk losing an annuity.

And the stat in this excerpt from Chair Doty’s remarks surprised me as I thought changing auditors was fairly rare:

To be sure, when auditors change, there may be a learning curve for the new auditors. But consider this: according to the research firm Glass Lewis, between 2003 and 2006, more than 6,500 public companies, or nearly 52 percent of all public companies, voluntarily changed their auditors. How did auditors and companies manage those changes? What did auditors, and the audit committees that oversee them, do to make sure the new auditors were in a position to provide reasonable assurance in the early years of an engagement? This experience should inform the responses of preparers and auditors to this concept release. The learning curve, and cost-based issues involved in changing audit firms, cannot be fairly described as uncharted waters.

SEC Approves NYSE Rule Allowing Exchange to Favor Certain IR Services

As noted by Dominic Jones in his “IR Web Report,” the SEC’s Division of Trading and Markets recently approved new Section 907.00 of the NYSE’s Listed Company Manual, which will result in the NYSE including information about a suite of “complementary” investor relations services available to listed issuers, including investor relations website and news distribution services from giant Thomson Reuters and shareholder identification services from Ipreo.

Although I didn’t submit a comment letter, I did blog my disapproval of the concept that the NYSE’s rules should favor secondary services offered by the exchange. And I agree with Dominic’s conclusion expressed in this excerpt from his blog:

In its decision, the SEC conceded that by subsidizing the services of some vendors and not others, the NYSE would cause some companies to shift their business to its preferred service providers, but it said that competition between exchanges would lead the NYSE to provide better quality services. The SEC also said it recognized that “some small service vendors may be placed at a disadvantage” by its approval of the rule given that the NYSE contracts only with large vendors capable of providing services to all of its listed companies.

“Nonetheless, the Commission does not believe that the proposal harms the market for the complimentary products and services in a way that constitutes an inappropriate burden on competition or an inequitable allocation of fees, or fails to promote just and equitable principles of trade, in a manner inconsistent with the Act,” it said.

My view is that the SEC’s decision is disappointing as it will lead to a continuation of the broad stagnation we have seen in the US investor relations services market over the past few years.
Smaller IR service providers will continue to struggle to compete against those vendors subsidized by the NYSE. Meanwhile, the big, subsidized vendors will have little incentive to improve their services when no other vendors are large enough to replace them.

Query: How Many Bald Guys Does It Take To…

Just back from vacation and digging out. Enjoyed our time in Seattle, including a visit with the Pacific Northwest Chapter of the Society of Corporate Secretaries to talk social media. Great pic of the three wise bald men, PACCAR’s Kevin Fay; me; and Microsoft’s Peter Krause:


– Broc Romanek