Analysis: Decades-old auditor ties under scrutiny in U.S.

NEW YORK Wed Aug 3, 2011 1:03am EDT

The entrances to the offices of Ernst & Young is seen in New York April 28, 2009. REUTERS/Shannon Stapleton

The entrances to the offices of Ernst & Young is seen in New York April 28, 2009.

Credit: Reuters/Shannon Stapleton

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NEW YORK (Reuters) - Goldman Sachs has stuck with the same auditing firm since 1926, Coca Cola since 1921, General Electric since 1909 and Procter & Gamble since 1890. That's going back 85, 90, 102 and 121 years.

Each has relied on a different one of what are known today as the Big Four accounting firms. And now some U.S. accounting reformers are thinking that perhaps enough is enough: the time has come to rotate auditing firms.

Quashed a decade ago during congressional audit reform debates, the hot-button topic of auditor rotation is back, setting up a potential clash between reformers and the firms themselves.

Broached at a meeting of the U.S. Public Company Accounting Oversight Board in March, mandatory auditor rotation is expected to be part of a "concept release" due soon from the PCAOB, which is looking for ways to assure tougher, more independent audits.

While the partner on an accounting job must be switched every five years, there are no term limits on the audit firms themselves -- a policy that has left intact long-term client relationships and raised questions about how independent such auditors can be.

"It's not to say that anyone who has had the same auditor 20 years or longer is corrupt, or the auditor is not doing what they should be doing," said Mark Grothe, an analyst at Glass Lewis, an investment research and proxy advisory firm.

Yet after 50 years "there's no way you could think the auditor is remaining as skeptical as a new auditor coming in," he said. "They're almost an outsourced part of the accounting department at that point."

Strong pushback is expected from the audit industry, which could be forced to surrender some of its most lucrative clients if the PCAOB were to require mandatory auditor rotation.

Any rule change is far from certain at this point. The PCAOB has yet to issue a concept release; that would have to be followed by a proposed rule and then a final rule, which would have to be approved by the Securities and Exchange Commission.

FRAUD LINK TO LONG STINTS

About 175 companies in the S&P 500 index have had the same auditor for 25 years or more, according to data compiled by Audit Analytics at the end of last year. Seven companies have had the same auditor for over a century.

Ultra-long auditor stints have for years been a concern to investor groups. Entrenched audit firms were linked to some of the biggest financial frauds of the past.

"When you look at some of the big audit failures over the years, whether it's Enron or Waste Management, you find instances where they've had the same auditor for in some cases decades," said Barbara Roper, head of investor protection for the Consumer Federation of America.

Auditors might be inclined to perform tougher audits if they knew their work would be checked when their term ends and a new audit firm comes in, said Lynn Turner, head of a PCAOB subcommittee that recommended mandatory rotation.

Rotation could also take pressure off auditors, who would not have to worry as much about losing their firms' longest-standing clients, he said.

"If you're a partner on one of these big clients' audits, that's a big part of your billings for the year," he said. "If you lose that client, you may very well see your compensation cut at the firm."

Others say the need for rotation is questionable because audits have improved and frauds are much rarer than in the past.

"I don't know that the lack of skepticism is as high as they (proponents) are suggesting to warrant a complete upheaval of the entire industry," said Charles Mulford, an accounting professor at Georgia Institute of Technology. "It's strictly a cost-benefit trade-off that doesn't work."

Switching audit firms too frequently would be disruptive, said Scott Magnuson, senior principal at GHP Horwath.

"To do a good audit, an auditor has to really have a good, detailed understanding of what that client does -- their operations, their industry -- and a lot of that knowledge is cumulative," he said.

LIMITED CHOICES FOR MULTINATIONALS

Switching auditors also may be difficult for the largest companies, given that only the Big Four auditors -- Deloitte, PwC, KPMG and Ernst & Young -- have the resources to audit big, multinational firms, some experts said.

"Your universe in these large, multinational companies gets limited," said Jeffrey Weiner, managing partner at accounting firm Marcum LLP. "There could be issues of lack of choice, and mandatory firm rotation might be difficult."

Upfront costs would also increase because of the time needed to screen new clients, get familiar with their operations and create new audit files, he said.

"There's a benefit and detriment," he said. "The question is, does the attempt to assure greater independence and objectivity outweigh the cost of switching?"

Congress considered auditor firm rotations during debates over the sweeping 2002 Sarbanes-Oxley reform act. The issue was shelved for more study and a 2003 report from the U.S. General Accounting Office concluded that rotation might not be the best way to strengthen auditor independence.

Eight years later, however, PCAOB officials say the idea needs another look.

"Too often, PCAOB inspectors find that auditors have failed to exercise the required skepticism," PCAOB Chairman Jim Doty said in a speech in June. Though he stopped short of endorsing auditor rotation, Doty said the PCAOB at least needs to take up the debate again.

From the auditors' perspective, it would be a bitter pill.

"It would be weird to go into any business and say, "Your best clients, the ones you have had for 20-plus years -- you have to get rid of all of those," said Glass Lewis's Grothe.

On the other hand, some would argue that investors, not companies, are an auditor's true clients, he said. "It's under that thinking that mandatory rotation makes more sense."

(Editing by Howard Goller)

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