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As the audit rotation debate hots up, businesses are recognising the change in climate and starting to look at retendering, but the practicalities are proving worryingly challenging, as Robert Bruce explains

Changing auditors, or simply considering changing auditors, can seem sensible and positive. It makes sense to the thoughtful onlooker. So how come, as a Competition Commission survey suggests, 10% of FTSE 100 companies appointed their auditors so long ago that they have no clear idea when it was? Some relationships go back to the century before last. How could you argue against the idea of encouraging or regulating for change now?

But then comes the practical stuff. Take one example of the insane amount of time and complexity all this drives. Back in 1998, Price Waterhouse and Coopers merged and, as the audit clients of each firm came under one roof, a complicated process to sort out any conflicts of interest began. Walt Disney was one such client. The US regulatory body, the Securities and Exchange Commission (SEC), has a very long list of things that might breach independence. And it fined the merged firm because the young child of one of its partners had a framed Disney share certificate, depicting Mickey Mouse and his chums, hanging above her bed. Doting grandparents had been to Disney World, thought it might be a nice present and hung it, suitably framed, in their grandchild’s bedroom as a memento. A conflict of interest for the firm, said the SEC.

Disruption

We are entering an extraordinary period of disruption for companies and audit firms, inspired by competing regulators. The Financial Reporting Council (FRC) got in first. A year ago it suggested, on a ‘comply or explain’ basis, that the larger companies should put their audits out for tender every 10 years. And then in February the Competition Commission suggested that it was looking at mandatory change, on a seven, 10 or 14-year basis. The prospect of compulsion has raised the temperature.

Under mandatory rotation, says Richard Sexton, head of reputation and policy at PwC, ‘everyone loses choice – there is one less to choose from and you can be forced to change at a difficult time’. This is what happened in Singapore, which changed its rule of mandatory rotation when it realised that all the bank audits were going to have to change in the midst of the financial crisis. ‘There is no evidence that people are better off with mandatory rotation,’ says Jonathan Hayward of consultancy Independent Audit. ‘Any freshness brought by the auditor is countered by the ignorance.’

What has happened since the FRC proposals came into force is that the market, recognising the change in the climate, has started to get on with change at a much faster rate than people expected. ‘There has been a clear call for change and so there will be activity,’ says Steve Maslin, head of external professional affairs at accounting firm Grant Thornton, positioned a rung below the Big Four firms and hence eager for some of the action to come its way. ‘You are already seeing some pretty significant entities thinking about change.’

Breaking up is hard to do

But how far an initial flurry of activity will turn into a flood of action is unclear. One high-profile effort at change ended in tears at the hands of the complexities of regulation. Last September the FTSE 100 asset manager Schroders was said to be thinking of changing auditors after more than 50 years of using PwC and in January it announced that KPMG would take over. A month later came the bombshell that, because of a conflict of interest, it was sticking with PwC.

This is how Schroders described the reasons for the debacle: ‘KPMG provide a range of non-audit services to Schroders across the group, each of which had to be assessed in relation to independence regulations in each jurisdiction where Schroders operates. One of these was a service in support of certain regulated risk management activities, which meant they were not able to confirm their independence for all group companies.’ KPMG declined to comment. But you would have thought that if Schroders was really enthusiastic about changing auditors, it would have found a way, particularly after you see the exhaustive, costly and time-consuming process it had put itself through (see box).

Certainly the revolution ahead is going to shake up corporate governance systems and pile more pressure on audit committees. ‘Our message to audit committee chairs is that life is going to change for them,’ says Maslin. He expects investors to step in. ‘They want more colour on how the audit committees are looking after their interests and they want a robust view taken on audit.’ And he predicts much greater forward planning. ‘They need to be planning the retendering now,’ he says, ‘and reaching out to as broad a church as they can for auditors.’

For a firm like Grant Thornton, just outside of the Big Four world, this is important. ‘If we are to be a future solution we need to have a meaningful relationship with the company well before audit tendering,’ says Maslin.

Among the largest companies this might be wishful thinking; among the FTSE 350 companies it might not. ‘It will be a merry-go-round among the Big Four firms,’ says Hayward. ‘There is no indication that companies are choosing the non-Big Four and there is no reason why they should.’

Doomed to failure

The same complexities, particularly in financial services companies, that create the mayhem of conflicting out also act as a bar to entry by smaller audit firms. ‘We will see lots of tenders with medium-sized firms tendering,’ says Hayward. ‘They will get very few and eventually give up.’ Certainly the resources required, if the Schroders tendering example is anything to go by, would be prohibitive over time.

And, pulling back from the theory, people are arguing the practicalities more. ‘The senior players already change regularly,’ says Sexton. ‘US CEOs average three years, CFOs probably less than 10, non-executive directors cannot go past nine years. That provides continuing independence.’

‘It annoys me,’ says Hayward. ‘Lloyds Bank has had the same auditors for over 100 years. I was on the audit 25 years ago. Very few people,’ he says wryly, ‘have remained on that audit for the full 100 years. It does change naturally all the time. The question is whether the auditor has the right mindset, not how long the firm has done it.’

Robert Bruce is an accountancy commentator and journalist

 

Last updated: 12 May 2013