The endlessly
tiresome proposal that mandatory auditor rotation would improve audit quality –
a mis-perceived solution long and desperately in search of a problem – approaches
its defining moment – taking one of the forms I predicted last spring. 

The Financial Reporting
Council – regulator of accounting and auditing standards and practices in the
United Kingdom – on September 28 slipped this subtle sentence into section
C.3.7 of its Governance Code: 

“FTSE
350 companies should put the external audit contract out to tender at least
every ten years.”

Called “limited changes” by the FRC, this stealth provision has been
little remarked at home and virtually ignored in the United States. But the
impact and effects – once the dust settles – will be profound, if difficult to
predict.

Consider first the
global market for audit services. The largest 100 and second 250 British companies
span the globe in their size and reach – from the agency giant WPP to BP in the
energy sector to consumer leaders Diageo, SABMiller and Unilever to global
bankers HSBC and Lloyds – with dominant business operations, dual stock
listings and deep capital market participation across the world’s developed
economies.

Audits of their
financial statements are, with a handful of exceptions, the exclusive province
of the Big 4 firms – 99 of the largest 100 and 234 of the next 250, when last
surveyed (here and here). For reasons of cost and efficiency in any process of
re-tender, the CFO’s and audit committees of those companies will invariably
seek either the retention of the incumbent auditor, or the ability to transfer
to another single provider. So choices made in London will be reflected in the
structure of the audit market across the globe.

But, given the
spotty and unequal world-wide distribution of audit competence and technical
expertise, it is predictable that any auditor shifts resulting from the FRC’s
dictate will, if anything, further tighten concentration at the top of the
market.

Will any real
changes actually emerge? The debate on mandatory rotation has been conducted in
a vacuum of either evidence or intelligence on these two fundamental questions:

1.
Why is there a total absence of facts even
suggesting a causal connection between audit quality and the length of
auditor tenure?

2.
And, are choices for auditor replacement truly constrained by either disabling
scope-of-practice conflicts or the firms’ unwillingness to surrender the value
of such other services as tax, banking and consulting?

Two competing
assessments are offered. One would be reluctance to tender – with the audit
firms unwilling to invest the considerable time and expense to build sufficient
size, expertise and geographic presence to pursue the uncertain process,
especially when obliged to forego the certain revenue streams now generated by
their non-audit work for these global giants.

In that case, the
non-incumbents will take a pass; the result of re-tendering will only be the rationalized
re-engagement of incumbents – a public relations exercise in “comply or
explain” that may buy a decade or two of rhetorical peace but little else.

A second scenario rests
on the hypothesis that large global companies now concentrate their non-audit
services mainly in a single alternate Big Four provider. That firm might be a
rotation candidate, assuming a “shadow cabinet” of existing skills enabling it to
switch over to the audit with minimal disruption – and likely resumption of the
non-audit status quo ante when it
yields back the audit brief a decade hence.

A skeptic would be
entitled to question whether professional skills are so fungible and transferable,
much less available; or that the large firms’ current client relationships organize
into such neat duopolies; or that, indeed, such a “pass-the-parcel” exercise is
quite what the proponents of mandated rotation have in mind.

It is sure that
London is already a-flutter. Fund manager Schroders has announced a re-tender after forty years of audits by PwC,
for one example – despite no indication of either dissatisfaction or impaired
quality.

About the only
certainty is that the UK initiative will finesse both the already speed-bumped
path to rotation urged by EU markets commissioner Michel Barnier and, in the US, PCAOB chairman Jim Doty’s extended
series of hearings — the latest, set for Houston on October 18^th which shows Doty’s willingness to
pursue out-of-town try-outs in the futile search for an adult witness with a
fact-based case in his favor.

Put another way, the
FRC has now kicked down the road of mandatory rotation a can that bears the
label, “Made in the UK — for world-wide consumption.”

Thanks for joining this dialog. Please share
with friends and colleagues. Comments are welcome, and subscription is easy and
free, both at the Main
page.