Public Accounting Firms: Required Study on the Potential Effects of Mandatory Audit Firm Rotation
Published: 2003-11-21T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Following major failures in corporate financial reporting, the Sarbanes-Oxley Act of 2002 was enacted to protect investors through requirements intended to improve the accuracy and reliability of corporate disclosures and to restore investor confidence. The act included reforms intended to strengthen auditor independence and to improve audit quality. Mandatory audit firm rotation (setting a limit on the period of years a public accounting firm may audit a particular company's financial statements) was considered as a reform to enhance auditor independence and audit quality during the congressional hearings that preceded the act, but it was not included in the act. The Congress decided that mandatory audit firm rotation needed further study and required GAO to study the potential effects of requiring rotation of the public accounting firms that audit public companies registered with the Securities and Exchange Commission.
section_title: What GAO Found
paragraphs: The arguments for and against mandatory audit firm rotation concern whether the independence of a public accounting firm auditing a company's financial statements is adversely affected by a firm's long-term relationship with the client and the desire to retain the client. Concerns about the potential effects of mandatory audit firm rotation include whether its intended benefits would outweigh the costs and the loss of company-specific knowledge gained by an audit firm through years of experience auditing the client. In addition, questions exist about whether the Sarbanes-Oxley Act requirements for reform will accomplish the intended benefits of mandatory audit firm rotation. In surveys conducted as part of our study, GAO found that almost all of the largest public accounting firms and Fortune 1000 publicly traded companies believe that the costs of mandatory audit firm rotation are likely to exceed the benefits. Most believe that the current requirements for audit partner rotation, auditor independence, and other reforms, when fully implemented, will sufficiently achieve the intended benefits of mandatory audit firm rotation. Moreover, in interviews with other stakeholders, including institutional investors, stock market regulators, bankers, accountants, and consumer advocacy groups, GAO found the views of these stakeholders to be consistent with the overall views of those who responded to its surveys. GAO believes that mandatory audit firm rotation may not be the most efficient way to strengthen auditor independence and improve audit quality considering the additional financial costs and the loss of institutional knowledge of the public company's previous auditor of record, as well as the current reforms being implemented. The potential benefits of mandatory audit firm rotation are harder to predict and quantify, though GAO is fairly certain that there will be additional costs. Several years' experience with implementation of the Sarbanes-Oxley Act's reforms is needed, GAO believes, before the full effect of the act's requirements can be assessed. GAO therefore believes that the most prudent course of action at this time is for the Securities and Exchange Commission and the Public Company Accounting Oversight Board to monitor and evaluate the effectiveness of existing requirements for enhancing auditor independence and audit quality. GAO believes audit committees, with their increased responsibilities under the act, can also play an important role in ensuring auditor independence. To fulfill this role, audit committees must maintain independence and have adequate resources. Finally, for any system to function effectively, there must be incentives for parties to do the right thing, adequate transparency over what is being done, and appropriate accountability if the right things are not done.

section_title: Letter
paragraphs: Full, fair, and accurate reporting of financial information by public  companies is critical to the effective functioning of the capital and credit  markets in the United States.  Federal securities laws and regulations  require publicly owned companies to disclose financial information in a  manner that accurately depicts the results of company activities and  require that the companies’ financial statements be audited by an  independent public accountant.  Although public company management is  responsible for the company’s financial statements, public confidence in  the integrity of financial statements of publicly traded companies is  enhanced by the audit process and independence of the auditor from the  audit client.
Major failures in corporate financial reporting in recent years, including  accountability breakdowns at Enron and WorldCom and other major  corporations, that led to restatement of financial statements and  bankruptcy adversely affected thousands of shareholders and employees.  As a result, the Sarbanes-Oxley Act of 2002 was enacted to protect  investors by improving the accuracy and reliability of corporate  disclosures.  The act’s requirements included reforms to strengthen  corporate responsibility for financial reports and auditor independence and  created the Public Company Accounting Oversight Board (PCAOB).  The  PCAOB has the responsibility to register and inspect public accounting  firms that audit public companies, and the authority to investigate and  discipline registered public accounting firms and to set auditing and related  attestation, quality control, and auditor ethics and independence standards  in connection with audits of public companies.
Senate report 107-205 that accompanied the Sarbanes-Oxley Act stated that  in considering reforms to enhance auditor independence, some witnesses  believed that mandatory audit firm rotation of public accounting firms was  necessary to maintain the objectivity of audits, while other witnesses  believed that public accounting firm rotation could be disruptive to the  public company and the costs of mandatory audit firm rotation might  outweigh the benefits.  The Congress decided that mandatory audit firm  rotation needed further study and required in Section 207 of the Sarbanes- Oxley Act that GAO study the issues.  Specifically, we were asked to study  the potential effects of requiring mandatory rotation of registered public  accounting firms.  To conduct our study, we did the following:  Identified and reviewed research studies and other documents that  addressed issues concerning auditor independence and audit quality  associated with the length of a public accounting firm’s tenure and the  costs and benefits of mandatory audit firm rotation.
Analyzed the issues we identified to (1) develop detailed questionnaires  to obtain the views of public accounting firms and public company chief  financial officers and their audit committee chairs of the issues  associated with mandatory audit firm rotation, (2) hold discussions with  officials of other interested stakeholders, such as institutional investors,  federal banking regulators, U.S. stock exchanges, state boards of  accountancy, the American Institute of Certified Public Accountants  (AICPA), the Securities and Exchange Commission (SEC), and the  PCAOB to obtain their views on the issues associated with mandatory  audit firm rotation, and (3) obtain information from other countries on  their experiences with mandatory audit firm rotation.
Identified restatements of annual financial statements for Fortune 1000  public companies due to errors or fraud that were reported to the SEC  for years 2001 and 2002 through August 31, 2003,  to (1) determine  whether the restatement occurred after a change in the public  companies’ auditor of record, and (2) to obtain some insight into the  value of a “fresh look” by a new auditor of record.
Our population of public accounting firms consisted of three tiers:  Tier 1  firms included 92 public accounting firms that were members of the  AICPA’s self-regulatory program for audit quality that reported having 10 or  more SEC clients in 2001 and 5 public accounting firms that were not  members of the AICPA’s self-regulatory program but had 10 or more public  company clients registered with the SEC in 2001. Tier 2 firms included 604  public accounting firms that were members of the AICPA’s self-regulatory  program for audit quality that reported having 1 to 9 public company clients  registered with the SEC in 2001. Tier 3 firms included 421 public  accounting firms that were members of the AICPA’s self-regulatory  program for audit quality that reported having no public company clients  registered with the SEC in 2001.  We surveyed 100 percent of the 97 Tier 1,  firms and we administered our surveys to random samples of 282 of the 604  Tier 2 firms and 237 of the 421 Tier 3 firms.  We received responses from 74  of the 97 Tier 1 firms, or 76.3 percent.  Because of the more limited  participation of Tier 2 firms (85, or 30.1 percent) and Tier 3 firms (52, or  21.9 percent) in our survey, we are not projecting their responses to the  population of these firms.  The presentation of this report focuses on the  responses from the Tier 1 firms, but any substantial differences in their  overall views and those reported to us by either the Tier 2 or 3 firms that  responded to our survey is discussed where applicable.
We also drew random samples of 330 of the Fortune 1000 public  companies after removing 40 private companies from the list, 450 of the  14,887 other domestic companies and mutual funds, and 391 of 2,141  foreign companies that make up the universe of the 17,988 public  companies that are registered with the SEC as of February 2003.  For each  of these three groups of public companies, we asked their chief financial  officers and audit committee chairs to complete separate questionnaires.
Of the 330 Fortune 1000 public companies sampled, we received responses  from 201, or 60.9 percent, of their chief financial officers and 191, or 57.9  percent, of their audit committee chairs.    Because of limited participation  of the other domestic companies and mutual funds (131, or 29.1 percent, of  their chief financial officers and 96, or 21.3 percent, of their audit  committee chairs) and the foreign public companies (99, or 25.3 percent, of  their chief financial officers and 63, or 16.1 percent, of their audit  committee chairs), we are not projecting their responses to the population  of such companies. This report focuses on the responses from the Fortune  1000 public companies’ chief financial officers and their audit committee  chairs, but any substantial differences between their overall views and  those reported to us by the other groups of public companies that  responded to our surveys is discussed where applicable.
For additional information on our scope and methodology including details  of our samples, response rates, and efforts to follow up with  nonrespondents to our surveys, see appendix I.  We conducted our work in  Washington, D.C., between November 2002 and November 2003 in  accordance with U.S. generally accepted government auditing standards.
A copy of each of our questionnaires, annotated to show in total the  respondents’ answers to each question for the Tier 1 firms and the Fortune  1000 public companies chief financial officers and their audit committee  chairs, will be presented in a separate GAO report (GAO-04-217) to be  issued at a later date.
subsections: section_title: Background
paragraphs: Under federal securities laws, public companies are responsible for the  preparation and content of financial statements that are complete,  accurate, and presented in conformity with generally accepted accounting  principles (GAAP).  Financial statements, which disclose a company’s  financial position, stockholders’ equity, results of operations, and cash  flows, are an essential component of the disclosure system on which the  U.S. capital and credit markets are based.
The Securities Exchange Act of 1934 requires that a public company’s  financial statements be audited by an independent public accountant.  That  statutory independent audit requirement in effect granted a franchise to the  nation’s public accountants, as an audit opinion on a public company’s  financial statements must be secured before an issuer of securities can go  to market, have the securities listed on the nation’s stock exchanges, or  comply with the reporting requirements of the securities laws.  As of  February 2003, there were about 17,988 public companies that were  registered with the SEC and subject to the federal securities laws (15,847  domestic and 2,141 foreign public companies). Based on 2001 annual  reports of public accounting firms submitted to the AICPA, about 700  public accounting firms that were members of the AICPA's former self- regulatory program for audit quality reported having approximately 15,000  public company clients registered with the SEC, of which the Big 4 public  accounting firms had about 70 percent of these public company clients  and another 88 public accounting firms had about 20 percent of these  public company clients.  The other approximately 600 public accounting  firms had the remaining 10 percent of the reported public company clients.
The independent public accountant’s audit is critical in the financial  reporting process because the audit subjects financial statements, which  are management’s responsibility, to scrutiny on behalf of shareholders and  creditors to whom management is accountable.  The auditor is the  independent link between management and those who rely on the financial  statements.
Ensuring auditor independence—both in fact and appearance—is a long- standing issue.  There has long been an arguably inherent conflict in the  fact that an auditor is paid by the public company for which the audit was  being performed.  Various study groups over the past 20 years have  considered the independence and objectivity of auditors as questions have  arisen from (1) significant litigation involving auditors, (2) the auditor’s  performance of nonaudit services for audit clients, which prior to the  Sarbanes-Oxley Act, had risen to 50 percent of total revenues on average  for the large accounting firms, (3) “opinion shopping” by clients, and   (4) reports of public accountants advocating questionable client positions  on accounting matters.
The major accountability breakdowns at Enron and WorldCom, and other  failures in recent years such as Qwest, Tyco, Adelphia, Global Crossing,  Waste Management, Micro Strategy, Superior Federal Savings Bank, and  Xerox, led to the reforms contained in the Sarbanes-Oxley Act to enhance  auditor independence and audit quality and to restore investor confidence  in the nation’s capital markets.  To enhance auditor independence and audit  quality, the act’s reforms included  establishing the PCAOB, as an independent  nongovernmental entity, to  oversee the audit of public companies that are subject to the securities  laws;  making the PCAOB responsible for (1) establishing auditing and related  attestation, quality control, ethics, and independence standards  applicable to audits of public companies, (2) conducting inspections,  investigations, and disciplinary proceedings of public accounting firms  registered with the PCAOB, and (3) imposing appropriate sanctions;  making the public company’s audit committee responsible for the  appointment, compensation, and oversight of the registered public  accounting firm;  requiring management and auditors’ reports on internal control over   prohibiting the registered public accounting firm from providing certain  nonaudit services to a public company if the auditor is also providing  audit services;  requiring the audit committee to preapprove all audit and nonaudit  services not otherwise prohibited;  requiring mandatory rotation of lead and reviewing audit partners after  they have provided audit services to a particular public company for 5  consecutive years; and  prohibiting the public accounting firm from providing audit services if  the public company’s chief financial officer, chief accounting officer, or  any person serving in an equivalent position was employed by the firm  and participated in the audit of the public company during the 1-year  period preceding the date of starting the audit.
Mandatory audit firm rotation was also discussed in congressional hearings  to enhance auditor independence and audit quality, but given the mixed  views of various stakeholders, the Congress decided the effects of such a  practice needed further study.
section_title: Pros and Cons of Requiring Mandatory Audit Firm Rotation
paragraphs: Our review of research studies, technical articles, and other publications  and documents showed that generally the arguments for and against  mandatory audit firm rotation concern auditor independence, audit  quality, and increased audit costs.  A breakdown in auditor independence  or audit quality can result in an audit failure and adversely affect those  parties who rely on the fair presentation of the financial statements in  conformity with GAAP.
Those who support mandatory audit firm rotation contend that pressures  faced by the incumbent auditor to retain the audit client coupled with the  auditor’s comfort level with management developed over time can  adversely affect the auditor’s actions to appropriately deal with financial  reporting issues that materially affect the company’s financial statements.   Those who oppose audit firm rotation contend that the new auditor’s lack  of knowledge of the company’s operations, information systems that  support the financial statements, and financial reporting practices and the  time needed to acquire that knowledge increase the risk of an auditor not  detecting financial reporting issues that could materially affect the  company’s financial statements in the initial years of the new auditor’s  tenure, resulting in financial statements that do not comply with GAAP.
In addition, those who oppose mandatory audit firm rotation believe that it  will increase costs incurred by both the public accounting firms and the  public companies.  They believe the increased risk of an audit failure and  the added costs of audit firm rotation outweigh the value of a periodic  “fresh look” by a new public accounting firm.  Conversely, those who  support audit firm rotation believe the value of the “fresh look” to protect  shareholders, creditors, and other parties who rely on the financial  statements outweigh the added costs associated with mandatory firm  rotation.
More recently, the Sarbanes-Oxley Act’s requirements that concern auditor  independence and audit quality have added to the mixed views about  whether mandatory audit firm rotation should also be required to enhance  auditor independence and audit quality.
section_title: Results of Our Surveys
paragraphs: The results of our surveys show that while auditor tenure at Fortune 1000  public companies averages 22 years, about 79 percent of Tier 1 firms and  Fortune 1000 public companies are concerned that changing public  accounting firms increases the risk of an audit failure in the initial years of  the audit as the new auditor acquires the knowledge of a public company’s  operations, systems, and financial reporting practices.  Further, many  Fortune 1000 public companies will only use Big 4 public accounting firms  and believe that the limited choices, that are likely to be further reduced by  the auditor independence requirements of the Sarbanes-Oxley Act, coupled  with the likely increased costs of financial statement audits and increased  risk of an audit failure under mandatory audit firm rotation strongly argue  against the need for mandatory rotation.
In addition, most Tier 1 firms and Fortune 1000 public companies believe  that the pressures faced by the incumbent auditor to retain the client are  not a significant factor adversely affecting the auditor appropriately dealing  with financial reporting issues that may materially affect a public  company’s financial statements.  Most Tier 1 firms, and nearly all Fortune  1000 public companies, and their audit committee chairs believe that the  Sarbanes-Oxley Act’s requirements concerning auditor independence and  audit quality, when fully implemented, will sufficiently achieve the intended  benefits of mandatory audit firm rotation, and therefore, they believe it  would be premature to impose mandatory audit firm rotation at this time.
Finally, about 50 percent of Tier 1 firms and 62 percent of Fortune 1000  public companies stated that mandatory audit firm rotation would have no  effect on the perception of auditor independence held by the capital  markets and institutional investors.  However, 65 percent of Fortune 1000  public companies reported that individual investors’ perception of auditor  independence would be increased, while the Tier 1 firms had mixed views  on the effect on individual investors’ perceptions.  At the same time, most  Tier 1 firms reported that mandatory audit firm rotation may negatively  affect audit assignment staffing, causing an increased risk of audit failures,  and may create some confusion as currently a change in a public company’s  auditor of record sends a “red flag” signal as to why the change may have  occurred.  In contrast, most Fortune 1000 public companies did not believe  scheduled changes in the auditor of record would result in a “red flag”  signal.
subsections: section_title: Auditor of Record Tenure, Independence, and Audit Quality
paragraphs: Currently, neither the SEC nor the PCAOB has set any regulatory limits on  the length of time that a public accounting firm may function as the auditor  of record for a public company.  Based on the responses to our surveys, we  estimate that about 99 percent of Fortune 1000 public companies and their  audit committees currently do not have a public accounting firm rotation  policy, although we estimate that about 4 percent are considering such a  policy. Unlimited tenure and related pressure on the public accounting firm  and applicable partner responsible for providing audit services to the  company to retain the client and the related continuing revenues are  factors cited by those who support mandatory audit firm rotation.  They  believe that periodically having a new auditor will bring a “fresh look” to  the public company’s financial reporting and help the auditor appropriately  deal with financial reporting issues since the auditor’s tenure would be  limited under mandatory audit firm rotation.  Those who oppose  mandatory audit firm rotation believe that changing auditors increases the  risk of an audit failure during the initial years as the new auditor acquires  the knowledge of the public company’s operations, systems, and financial  reporting practices.
The Conference Board’s Commission on Public Trust and Private  Enterprise in its January 9, 2003, report recommended that audit  committees should consider rotating audit firms when there is a  combination of circumstances that could call into question the audit firm’s  independence from management.  The Commission believed that the  existence of some or all of the following circumstances particularly merit  consideration of rotation:  (1) significant nonaudit services are provided by  the auditor of record to the company—even if they have been approved by  the audit committee, (2) one or more former partners or managers of the  audit firm are employed by the company, or (3) the audit firm has been  employed by the company for a substantial period of time, such as over 10  years.
To initially examine the issues surrounding the length of the auditors’  tenure, we asked public companies and public accounting firms to provide  information on the length of auditor tenure.  According to our survey,  Fortune 1000 public companies’ average auditor tenure is 22 years.  Two  contrasting factors greatly influence this 22-year average—the recent  increased changes in auditors lowered the average and the long audit  tenure period associated with approximately 10 percent of Fortune 1000  public companies raised the average.  About 20 percent of the Fortune 1000  public companies had their current auditor of record for less than 3 years, a  rate of change in auditors over the last 2 years substantially greater than  the nearly 3 percent annual change rate historically observed.  This  increased rate of auditor change was driven largely by the recent  dissolution of Arthur Andersen LLP.  More than 80 percent of Fortune 1000  public companies that changed auditors over the last 2 years did so to replace Andersen.  Increasing the overall average audit tenure period for  Fortune 1000 public companies were the approximately 10 percent of  public companies that had the same auditing firm for more than 50 years  and have an average tenure period of more than 75 years.  Excluding those  Fortune 1000 public companies that have replaced Andersen in the last 2  years as well as those companies that had the same auditor of record for  more than 50 years, the average for the remaining Fortune 1000 public  companies is 19 years.  See figure 1 for the Fortune 1000 public companies’  estimated audit firm tenure.
An intended effect of mandatory audit firm rotation is to decrease the  existing lengthy auditor tenure periods, thus lessening concerns about the  firm’s desire to retain a client adversely affecting auditor independence.
The Fortune 1000 public companies that hired a new audit firm to replace Andersen over  the last 2 years reported that Andersen had served as their companies’ auditor of record for  an average of 26 years.
About 97 percent of Fortune 1000 public companies expected that  mandatory audit firm rotation would lower the number of consecutive  years that a public accounting firm could serve as their auditor of record.   The Fortune 1000 public companies were not given a possible limit on the  number of years that a public accounting firm could serve as their auditor  of record under mandatory audit firm rotation.  Therefore, they reported  their general belief that mandatory rotation would have the effect of  decreasing auditor tenure based on their past experiences.
section_title: Impact of Auditor Knowledge and Experience on the Auditor’s Detection of Misstatements
paragraphs: Since the new auditor’s knowledge and experience with auditing a public  company after a change in auditors is a concern, we asked public  accounting firms and public companies a number of questions about  factors important to detecting material misstatements of financial  statements.  Tier 1 firms noted that a number of factors affect the auditor’s  ability to detect financial reporting issues that may indicate material  misstatements in a public company’s financial statements, including  education, training, and experience; knowledge of GAAP and GAAS;  experience with the company’s industry; appropriate audit team staffing;  effective risk assessment process for determining client acceptance; and  knowledge of the client’s operations, systems, and financial reporting  practices.  Although each of the above factors affects the quality of an  audit, opponents of mandatory audit firm rotation focus on the increased  risk of audit failure that may result from the new auditor’s lack of specific  knowledge of the client’s operations, systems, and financial reporting  practices.  Based on the responses to our survey, we estimated that about  95 percent of Tier 1 firms would rate such specific knowledge as either of  very great importance or great importance in the auditor’s ability to detect  financial reporting issues that may indicate material misstatements in a  public company’s financial statements.
GAAS require the auditor to obtain a sufficient knowledge of the client’s  operations, systems, and financial reporting practices to assess audit risk  and to gather sufficient competent evidential matter.  About 79 percent of  Tier 1 firms and Fortune 1000 public companies believed that the risk of an  audit failure is higher in the early years of audit tenure as the new firm is  more likely to not have fully developed and applied an in-depth  understanding of the public company’s operations and processes affecting  financial reporting.  More than 83 percent of Tier 1 firms and Fortune 1000  public companies that expressed a view stated that it generally takes 2 to 3  years or more to become sufficiently familiar with the companies’  operations and processes before the additional resources often needed to  become knowledgeable are no longer needed.  Tier 1 firms had mixed  views about whether mandatory audit firm rotation (e.g., the “fresh look”)  would either increase, decrease or have no effect on the new auditor’s  likelihood of detecting financial reporting issues that may materially affect  the financial statements that the previous auditor may not have detected.   However, 50 percent of Fortune 1000 public companies reported that  mandatory audit firm rotation would have no effect on the auditor’s  likelihood of detecting such financial reporting issues, while other Fortune  1000 public companies were generally split regarding whether mandatory  audit firm rotation would either increase or decrease the auditor’s  likelihood of detecting such financial reporting issues.
As shown in figure 2, Tier 1 firms had mixed views of the value of additional  audit procedures during the initial years of a new auditor’s tenure, although  72 percent reported that additional audit procedures would be of at least  some value in helping to reduce audit risk to an acceptable level.
Most Fortune 1000 public companies believed such additional audit  procedures would decrease audit risk, as shown in figure 3.
The Tier 1 firms were also asked about the potential value of having  enhanced access to key members of the previous audit team and its audit  documentation to help reduce audit risk.  The Tier 1 firms generally saw  more potential value in having enhanced access to the previous audit team  and its audit documentation than in performing additional audit procedures  and verification of the public company’s data during the initial years of the  auditor’s tenure.  Nearly all of the Tier 1 firms believed that access to the  previous audit team and its audit documentation could be accomplished  under current GAAS.
section_title: Pressures Faced by Firms in Dealing with Financial Reporting Issues
paragraphs: Proponents of mandatory audit firm rotation cite that pressures to retain  the client can adversely affect the auditor’s decision to appropriately deal  with financial reporting issues when public company management is not  supportive of the auditor’s position on what is required by GAAP.  They  believe that mandatory audit firm rotation would serve as an incentive for  the auditor to take the appropriate action since the auditor would know  that tenure as auditor of record and the related revenues are for a limited  term.
We asked public accounting firms and public companies based on their  experiences whether the auditor’s length of tenure is a factor in whether  the auditor appropriately deals with material financial reporting issues and  whether mandatory audit firm rotation would affect the pressures the firms  face.  About 69 percent of Tier 1 firms and 73 percent of Fortune 1000  public companies do not believe that the risk of an audit failure increases  due to the auditors’ long-term relationship with the public companies’  management under a long audit tenure and the auditors’ desire to retain the  clients.  About 55 percent of the other Tier 1 firms and 65 percent of the  other Fortune 1000 public companies were uncertain whether the risk of  an audit failure would increase or decrease due to the auditors’ long-term  tenure.
About 71 percent of Tier 1 firms and 67 percent of Fortune 1000 public  companies believe that pressure on the engagement partner to retain the  client is currently small or not a factor in whether the auditor appropriately  deals with financial reporting issues that may materially affect a public  company’s financial statements.  However, 28 percent of Tier 1 firms and 33  percent of Fortune 1000 public companies believe such pressures are  moderate or stronger.  About 18 percent of Tier 1 firms and Fortune 1000  public companies believed that under mandatory audit firm rotation, the  pressures on the engagement partner would still be a moderate or stronger  factor in retaining the audit client and in appropriately dealing with  financial reporting issues.  Therefore, based on these views, mandatory  audit firm rotation would likely somewhat reduce the pressures on the  engagement partner to retain the client.  However, most Tier 1 firms and  Fortune 1000 public companies generally considered these pressures to be  small or not a factor in the auditor appropriately dealing with material  financial reporting issues.
Tier 1 firms and Fortune 1000 public companies expressed similar views,  that mandatory audit firm rotation would not significantly change the  pressures on the engagement partner to retain the client as a factor in  whether the engagement partner appropriately challenges overly  aggressive/optimistic financial reporting by management.
As shown in figure 4, overall about 54 percent of Tier 1 firms and 71 percent  of Fortune 1000 public companies believe mandatory audit firm rotation  overall would have no effect on the new auditor’s potential for  appropriately dealing with material financial reporting issues.
The remaining Tier 1 firms are split between whether mandatory audit firm  rotation would increase or decrease their potential to appropriately deal  with material financial reporting issues.  However, about 67 percent of the  remaining Fortune 1000 public companies believe that mandatory audit  firm rotation would increase the potential for the new auditor to deal  appropriately with such financial reporting issues.  In contrast, either with  or without mandatory audit firm rotation, about 62 percent of Tier 1 firms  and 63 percent of Fortune 1000 public companies believe the potential of a  subsequent lawsuit, regulatory action, or both against the public  accounting firm and its engagement partner is a moderate or stronger  pressure for them to deal appropriately with financial reporting issues that  may materially affect a public company’s financial statements.
section_title: How Mandatory Audit Firm Rotation May Affect Perception of Auditors’ Independence
paragraphs: Researchers have also raised questions about how the capital markets’ and  investors’ current perceptions of auditor independence and audit quality  would be affected by mandatory audit firm rotation.  Under mandatory  audit firm rotation, about 52 percent of Tier 1 firms and about 62 percent of  Fortune 1000 public companies believed that the current perception of  auditor independence held by capital markets and institutional investors  would not be affected by requiring mandatory audit firm rotation while 34  percent of Tier 1 firms and about 38 percent of Fortune 1000 public  companies believed the perception of auditor independence would  increase.  However, about 65 percent of Fortune 1000 public companies  believed that perception of auditors’ independence held by individual  investors would more likely increase under mandatory audit firm rotation  while the Tier 1 firms had mixed views on the effect on individual investors.   See the Overall Views of Other Knowledgeable Individuals on Mandatory  Audit Firm Rotation section of the report for the results of our discussions  with other knowledgeable individuals, including institutional investors, for  their views on how mandatory audit firm rotation may affect their  perception of auditor independence.
section_title: How Mandatory Audit Firm Rotation May Affect Audit Assignment Staffing
paragraphs: Our research into the effects of mandatory audit firm rotation identified  concerns about whether public accounting firms would move their most  knowledgeable and experienced audit personnel from the current audit to  other audits as the end of their tenure as auditor of record approached in  order to attract or retain other clients.  In response to our survey questions  about whether mandatory audit firm rotation would affect assignment of  audit staff, about 59 percent of Tier 1 firms indicated that they would likely  move their most knowledgeable and experienced audit staff to other work  to enhance the firm’s ability to attract or retain other clients and another 28  percent were undecided.  Only about 13 percent of Tier 1 firms stated it was  unlikely that an accounting firm would move staff to other work.  Of the  Tier 1 firms that stated they would likely move their most knowledgeable  and experienced staff, 86 percent believe that moving these staff would  increase the risk of an audit failure.  About 92 percent of Fortune 1000  public companies also believed that by moving these audit staff, the risk of  an audit failure would be increased.
section_title: How Mandatory Audit Firm Rotation May Affect Public Accounting Firms’ Investment in Audit Tools
paragraphs: Opponents of mandatory audit firm rotation expressed concern that limited  audit tenure under mandatory rotation could cause public accounting firms  to not invest in audit tools related to the effectiveness of auditing a specific  client or industry.  About 76 percent of Tier 1 firms stated that their average  audit tenure would likely decrease under mandatory audit firm rotation,  and about 97 percent of Fortune 1000 public companies expected the  length of their auditors’ tenure would decrease compared to their previous  experience with changing auditors.  In response to our survey questions  about this possibility, about 64 percent of these Tier 1 firms said mandatory  audit firm rotation would not likely decrease incentives to invest the  resources needed to understand the client’s operations and financial  reporting practices in order to devise effective audit procedures and tools,  while 36 percent said it would.  Conversely, about 67 percent of Fortune  1000 public companies were concerned that mandatory audit firm rotation  could negatively affect incentives for public accounting firms to invest in  effective audit procedures and tools.
section_title: How Mandatory Audit Firm Rotation May Affect the Current “Red Flag” Signal to Investors When a Change in a Public Company’s Auditor of Record Occurs
paragraphs: Currently, when a change in the auditor of record occurs it acts as a “red  flag” signal to investors to question why the change occurred and if the  change may have occurred because of reasons related to the presentation  of the public company’s financial statements, such as differences in views  of public company management and the auditor of record regarding  financial reporting issues.  Researchers have raised concerns that the “red  flag” signal may be eliminated by mandatory audit firm rotation, as  investors may not be able to distinguish a scheduled change from a  nonscheduled change in a public company’s auditor of record.
Regarding the “red flag” signal, most Tier 1 firms believed that mandatory  audit firm rotation would not change the current reaction by investors to a  change in the auditor of record, and therefore a “red flag” signal is likely to  be perceived by investors for both scheduled and unscheduled changes in  the public company’s auditor of record.  Several Tier 1 firms commented  that users of financial statements would not be able to readily track  scheduled rotations and therefore would be confused whether the change  in auditors was scheduled or unscheduled.  In contrast, most Fortune 1000  public companies believed that scheduled auditor changes under  mandatory audit firm rotation would likely not produce a “red flag” signal  and that the “red flag” signal for unscheduled changes in the auditor of  record would be retained.  Fortune 1000 public companies did not provide  any comments to further explain their beliefs.  However, currently, public  companies are required by SEC regulations to report changes in their  auditor of record to the SEC.  Therefore, public companies could use this  reporting requirement to disclose whether the change in auditor of record  under mandatory audit firm rotation was scheduled or unscheduled.
section_title: Potential Impact on Audit- Related Costs and Fees
paragraphs: Opponents of mandatory audit firm rotation believe that the more frequent  change in auditors likely to occur under mandatory audit firm rotation will  result in the public accounting firms and ultimately public companies  incurring increased costs for audits of financial statements.  These costs  include  marketing costs (the costs incurred by public accounting firms related  to their efforts to acquire or retain financial statement audit clients),  audit costs (the costs incurred by a public accounting firm to perform an  audit of a public company’s financial statements),  audit fee (the amount a public accounting firm charges the public  company to perform the financial statement audit),  selection costs (the internal costs incurred by a public company in  selecting a new public accounting firm as the public company’s auditor  of record), and  support costs (the internal costs incurred by a public company in  supporting the public accounting firm’s efforts to understand the public  company’s operations, systems, and financial reporting practices).
About 96 percent of Tier 1 firms stated that their initial year audit costs are  likely to be more than in subsequent years in order to acquire the necessary  knowledge during a first year audit of a public company’s operations,  systems, and financial reporting practices.  Nearly all of these Tier 1 firms  estimated initial year audit costs would be more than 20 percent higher  than subsequent years’ costs.  Similar responses were received from  Fortune 1000 public companies.  (See fig. 5.)
About 85 percent of Tier 1 firms stated that currently they are more likely  to absorb their higher initial year audit costs than to pass them on to the  public companies in the form of higher audit fees because of the firms’  interest in retaining the audit client.  However, about 87 percent said such  costs would likely be passed on to the public companies during the more  limited audit firm tenure period under mandatory rotation.  Similarly, about  77 percent of Fortune 1000 public companies stated that currently when a  change in the companies’ auditor of record occurs, the additional initial  year audit costs are likely to be absorbed by the public accounting firms.   However, about 97 percent of the Fortune 1000 public companies expected  the higher initial year audit costs would be passed on to them under  mandatory audit firm rotation.
Comments received from a number of the Tier 1 firms indicated that  currently initial years’ audit costs are recovered from the public companies  over the firms’ tenure as auditor of record.  However, the firms under  mandatory audit firm rotation expected not to be able to recover the costs  within a more limited tenure as auditor of record.  Therefore, they would  pass the costs on to the public companies through higher audit fees.   Similarly, about 89 percent of Fortune 1000 public companies believed that  mandatory audit firm rotation would lead to higher audit fees over time.
With the likely more frequent opportunities to compete for providing audit  services to public companies under mandatory audit firm rotation, about 79  percent of Tier 1 firms expect to incur increased marketing costs  associated with their efforts to acquire audit clients, and about 79 percent  of the Tier 1 firms expect to pass these costs on to the public companies  through higher audit fees.
As shown in figure 6, most of the Tier 1 firms expecting higher marketing  costs estimated that the cost would add at least more than 1 percent to  their initial year audit fees, and about 37 percent of these Tier 1 firms  believed their additional marketing costs would be more than 10 percent of  their initial year audit fees.
A number of Tier 1 firms commented that they would have to spend more  time marketing auditing services, including writing new proposals to  compete for audit services.  About 85 percent of Fortune 1000 public  companies expected that public accounting firms would likely incur  additional marketing costs under mandatory audit firm rotation, and about  92 percent of these Fortune 1000 public companies believed the costs  would be passed on to them.
In addition to higher audit fees, nearly all Fortune 1000 public companies  believed they would incur selection costs in hiring a new auditor of record  under mandatory audit firm rotation.  As shown in figure 7, most of those  Fortune 1000 public companies expected the selection costs to be at least 6  percent or higher as a percentage of initial year audit fees.
In addition, nearly all Fortune 1000 public companies expected to incur  some additional initial year auditor support costs under mandatory audit  firm rotation.  As shown in figure 8, nearly all of those Fortune 1000 public  companies believed their additional support costs would be 11 percent or  higher as a percentage of initial year audit fees.
Tier 1 firms’ views on the likelihood of public companies incurring  selection costs and additional auditor support costs were similar to the  views of Fortune 1000 public companies.
To provide some perspective on the possible impact of higher audit-related  costs (audit fees, company selection, and support cost) on public company  operating costs, we analyzed financial reports filed with the SEC for a  selection of large and small public companies for the most recent fiscal  year available—one of each from 23 broad industry sectors, such as  agriculture, manufacturing, and information services.  Where available, for  each industry sector, we selected a public company with annual revenues  of more than $5 billion and a public company with annual revenues of less  than $1 billion.  The audit fees reported by the larger public companies we  selected ranged from .007 percent to .11 percent of total operating costs and averaged .04 percent.  The audit fees reported by the smaller public  companies we selected ranged from 0.017 percent to 3.0 percent and  averaged 0.08 percent.
Utilizing the predominant responses from Tier 1 firms, we estimate the  additional first year audit costs following a change in auditor to likely range  from 21 percent to 39 percent more than annual costs of recurring audits of  the same client.  In addition, we estimate the additional firm marketing  costs under mandatory audit firm rotation to likely range from 6 percent to  11 percent of the firm’s initial year audit fees.  Based on the predominant  responses from Fortune 1000 public companies, we also estimate the  additional public company selection costs to range from 1 percent to 14  percent of the new auditor’s initial year audit fees and possible additional  public company support costs to range from 11 percent to 39 percent of the  new auditor’s initial year audit fees. Utilizing these ranges, we estimate that  following a change in auditor under mandatory audit firm rotation, the  possible additional first year audit-related costs could range from 43  percent to 128 percent higher than the likely recurring audit costs had there  been no change in auditor.  We also calculated a weighted average  percentage for each additional cost category using all responses from Tier  1 firms and Fortune 1000 public companies (as opposed to the predominant  responses only).  Using the resulting weighted averages for all responses,  we calculated the potential additional first year audit-related costs to be  102 percent higher than the likely recurring audit costs had there been no  change in auditor.  This illustration is intended only to provide insights into  how Tier 1 firms and Fortune 1000 public companies reported that  mandatory audit firm rotation could affect the initial year audit costs and is  not intended to be representative.
section_title: Competition-Related Issues
paragraphs: Although mandatory audit firm rotation is generally considered by its  proponents as a means of enhancing auditor independence and audit  quality, mandatory rotation may also provide increased opportunities for  some public accounting firms to compete to provide audit services to  public companies.  About 52 percent of Tier 1 firms believed that  mandatory audit firm rotation would increase the opportunity to compete  for public company audits and 30 percent were uncertain whether  opportunities to compete to provide audit services would increase or  decrease.
However, when asked how mandatory audit firm rotation would likely  affect the number of firms actually willing and able to compete for public  company audits, about 54 percent of Tier 1 firms said mandatory rotation  would likely decrease the number of firms competing for audits of public  companies, 14 percent expected an increase in the number of firms, and 22  percent expected no effect on the number of firms competing.
Although nearly all Tier 1 firms planned to register with the PCAOB to  provide audit services to public companies, about 24 percent of Tier 1  firms that currently provide audit services were uncertain whether they  would continue to provide audit services to public companies if mandatory  audit firm rotation were required.  Firms in Tier 2 that responded to our  survey showed more uncertainty regarding whether to register with the  PCAOB, with about two-thirds planning to continue to provide audit  services to public companies and most of the remaining respondents  uncertain if they would continue to provide audit services to public  companies.  However, if mandatory audit firm rotation were required, 55  percent of the Tier 2 firms that responded to our survey that currently  provide audit services to public companies were uncertain whether they  would continue to provide the audit services to public companies, and  another 12 percent said they would discontinue providing audit services to  public companies.
The view of many Tier 1 firms that mandatory audit firm rotation may lead  to fewer firms willing and able to compete for public company audits,  which would lead to higher audit fees, should also be considered along  with the results of our study of consolidation of the Big 8 firms into the  current Big 4 firms.  In that respect, we previously reported that the Big 4  audit over 78 percent of all U.S. public companies and 99 percent of public  company annual sales.  However, we found no empirical evidence of  impaired competition.  Further, we previously reported that smaller public  accounting firms were unable to successfully compete for the audits of  large national and multinational public companies because of factors such  as lack of capacity and capital limitations.
About 83 percent of Tier 1 firms and 66 percent of Fortune 1000 public  companies stated that under mandatory audit firm rotation, the market  share of public company audits would either become more concentrated in  a small number of larger public accounting firms or the already highly  concentrated market share would remain about the same.  About 44  percent of Tier 1 firms believed that incentives to create or maintain large  firms would be increased while 32 percent believed mandatory audit firm  rotation would have no effect on incentives to create or maintain large  firms.
About 52 percent of Fortune 1000 public companies were at least  somewhat concerned that the dissolution of Arthur Andersen LLP, resulting  now in the Big 4 public accounting firms, would significantly limit the  options their companies have in selecting a capable auditor of record.   Under mandatory audit firm rotation, the number of Fortune 1000 public  companies expressing such concern increased to 79 percent.
About 48 percent of Tier 1 firms believed mandatory audit firm rotation  would decrease the number of firms willing and able to compete for audits  of public companies in specialized industries, while 29 percent of Tier 1  firms believed mandatory audit firm rotation would have no effect.  As  noted in our July 2003 report, we found that in certain specialized  industries, the number of firms with expertise in auditing those industries  can limit the number of choices such public companies have to two public  accounting firms.  Contributing to this situation is that many public  companies will use only Big 4 firms for audit services.  Also, public  companies may have fewer choices in the future as auditor independence  rules under the Sarbanes-Oxley Act prohibiting the auditor of record from  also providing certain nonaudit services could further reduce the number  of eligible auditors.  In that respect, mandatory audit firm rotation would  further affect the number of eligible auditors.  For example, if a public  company in a specialized industry has only three or four choices for its  auditor of record, the current auditor of record is not eligible to repeat as  auditor of record under mandatory audit firm rotation, and another firm is  not eligible because it provided prohibited nonaudit services that affect  auditor independence to the public company, then the number of eligible  firms would be reduced to one or two firms.
About 35 percent of Fortune 1000 public companies were at least  somewhat concerned that the Sarbanes-Oxley Act auditor independence  requirements would significantly limit their options in selecting a capable  auditor of record.  However, 53 percent of Fortune 1000 public companies  expressed such concern if mandatory audit firm rotation were required.
The Sarbanes-Oxley Act requires the audit committee to hire, compensate,  and oversee the public accounting firm serving as auditor of record for the  public company.  About 92 percent of the Fortune 1000 audit committee  chairs stated that their public companies currently use Big 4 firms as  auditor of record, and 94 percent of those that do stated that they would  not realistically consider using non-Big 4 firms as the public companies’  auditor of record.  Table 1 provides reasons given by the audit committee  chairs for only using Big 4 firms and the importance of those reasons to  them.
Although the Sarbanes-Oxley Act now makes the audit committee  responsible for hiring the public company’s auditor of record, 96 percent of  Fortune 1000 public companies currently using Big 4 firms also stated that  they would not realistically consider using non-Big 4 firms as the  companies’ auditor of record.  They generally gave the same reasons as the  audit committee chairs.
section_title: Overall Views on Mandatory Audit Firm Rotation
paragraphs: In our surveys, we asked public accounting firms, public companies, and  their audit committee chairs to provide their overall views on the potential  costs and benefits that may result under mandatory audit firm rotation.   About 85 percent of Tier 1 firms, 92 percent of Fortune 1000 public  companies, and 89 percent of Fortune 1000 audit committee chairs  believed that costs are likely to exceed benefits.
Our surveys also requested views whether the Sarbanes-Oxley Act auditor  independence and related audit quality requirements could also achieve the  intended benefits of mandatory audit firm rotation.  The act, as  implemented by SEC rules, requires the mandatory rotation of both lead  and reviewing audit engagement partners after 5 years and after 7 years for  other partners with significant involvement in the audit engagement.  Other  related provisions of the act concerning auditor independence and audit  quality include prohibiting the auditor of record from also providing certain  nonaudit services, requiring audit committee preapproval of audit and  nonaudit services not otherwise prohibited and related public disclosures,  establishing certain auditor reporting requirements to the audit committee,  requiring time restrictions before certain auditors could be hired by the  client as employees, expanding audit committee responsibilities, and  establishing the PCAOB as an independent nongovernmental entity  overseeing registered public accounting firms in the audit of public  companies.
About 66 percent of Tier 1 firms believe the audit partner rotation  requirements sufficiently achieve the intended benefits of a “fresh look” of  mandatory audit firm rotation.  Another 27 percent of the Tier 1 firms  believe that the audit partner rotation requirements may not be as effective  as mandatory audit firm rotation in achieving the intended benefits of a  “fresh look,” but is a better choice given the higher cost of mandatory audit  firm rotation.  Fortune 1000 public companies and audit committee chairs  responding to our survey expressed similar views.
We asked those Tier 1 firms and Fortune 1000 public companies and their  audit committee chairs who did not believe that the partner rotation  requirement by itself sufficiently achieved the intended benefits of  mandatory audit firm rotation to consider the auditor independence, audit  quality, and partner rotation requirements of the Sarbanes-Oxley Act as  implemented by SEC rules and their views on whether these requirements  in total would likely achieve the intended benefits of mandatory audit firm  rotation when fully implemented.  About 25 percent of these Tier 1 firms  believed these requirements of the Sarbanes-Oxley Act, when fully  implemented, would sufficiently achieve the intended benefits of  mandatory audit firm rotation, while 63 percent believed these  requirements would only somewhat or minimally achieve the intended  benefits of mandatory audit firm rotation when fully implemented.   Conversely, 76 percent of Fortune 1000 public companies and 72 percent  of their audit committee chairs believed these requirements would  sufficiently achieve the intended benefits of mandatory audit firm rotation.   Combining the responses to the above two questions for those who  believed either the partner rotation requirements or the partner rotation  requirements coupled with the other Sarbanes-Oxley Act auditor  independence and audit quality requirements would sufficiently achieve  the benefits of mandatory audit firm rotation shows that about 75 percent  of the Tier 1 firms, 95 percent of Fortune 1000 public companies, and about  92 percent of the audit committee chairs believe these requirements, when  fully implemented, would sufficiently achieve the benefits of mandatory  audit firm rotation.
Most Tier 1 firms and Fortune 1000 public companies and their audit  committee chairs believe the Sarbanes-Oxley Act auditor independence  and audit quality requirements, when fully implemented, would sufficiently  achieve the benefits of mandatory audit firm rotation, and most of these  groups when asked their overall opinion on mandatory audit firm rotation  did not support mandatory rotation.  A minority within these groups  supports the concept of mandatory audit firm rotation, but believes more  time is needed to evaluate the effectiveness of the various Sarbanes-Oxley  Act requirements for enhancing auditor independence and audit quality.   (See fig. 9.)
section_title: Overall Views of Other Knowledgeable Individuals on Mandatory Audit Firm Rotation
paragraphs: As part of our review, we spoke to a number of knowledgeable individuals  to obtain their views on mandatory audit firm rotation to provide additional  perspective on issues addressed in the survey.  These individuals had  experience in a variety of fields, such as institutional investment; regulation  of the stock markets, the banking industry, and the accounting profession;  and consumer advocacy.  Generally, the views expressed by these  knowledgeable individuals were consistent with the overall views  expressed by survey respondents.  Most did not favor implementing a  requirement for mandatory audit firm rotation at this time because they  believe the costs of implementing such a requirement outweigh the benefits  and greater experience with implementing the requirements of the  Sarbanes-Oxley Act should be gained prior to adding new requirements.
Many individuals acknowledged that conceptually, audit firm rotation  could provide certain benefits in the areas of auditor independence and  audit quality.  For example, audit firm rotation may increase the perception  of auditor independence because long-term relationships between the  auditor of record and the client that could undermine independence would  not likely develop under the limited term as auditor of record.  Some  individuals also believe that under mandatory audit firm rotation, the  auditor might be less likely to succumb to management pressure to accept  questionable accounting practices because the incentive to keep the client  is gone and another audit firm would be looking at the firm’s work in the  future.  Some also believed that audit quality may also be increased through  a change in auditors because a new auditor of record would provide a  "fresh look" at an entity’s financial reporting practices and accounting  policies.  In addition, some individuals noted that mandatory audit firm  rotation might cause a company to reexamine its audit needs and seek  more knowledgeable and experienced audit firm personnel when  negotiating for a new auditor of record.
The individuals we spoke to, however, acknowledged a number of practical  concerns related to mandatory audit firm rotation, one of the most  important being the limited number of audit firms available from which to  choose.  For example, some companies, especially those with  geographically diverse operations or those operating in certain industries,  may be somewhat limited in the choice of auditing firms capable of  performing the audit.  Not all audit firms have offices or staff located in all  the geographic areas, whether domestically or internationally, where the  clients conduct their operations, nor do all audit firms have personnel with  certain industry knowledge to be able to perform audits of clients that  operate in specific environments.
Similar to the views of Fortune 1000 public companies and audit committee  chairs, individuals we spoke to noted that large companies are often  limited to choices among the Big 4 firms.  In some cases, the choices are  further restricted because the accounting profession has become  segmented by industry, and a lack of industry-specific knowledge may  preclude some firms from performing the audits.  For a company that is  limited to use of Big 4 firms, it was viewed that selection may also be  restricted because an audit firm providing certain nonaudit services or  serving as a company’s internal auditor is prohibited by independence rules  from also serving as that company’s auditor of record.  In some cases, a  company may also be limited in its choice of firms if an audit firm audits  one of the company’s major competitors and the public company decides  not to use that firm as its auditor of record.
With regard to the use of a Big 4 firm, some individuals believe that  although a new auditor provides a "fresh look" at an audit engagement, the  Big 4 audit firms have somewhat similar cultures and methodologies for  performing audits, and as a result, the benefit of a "fresh look" is more  limited today than it was in the past when the firms had different cultures  and employed a greater variety of methodologies.
Many individuals we spoke with also noted that when a change in auditor  of record occurs, a learning curve, which can last a year or more, exists  while the new auditor becomes familiar with the client’s operations, thus  increasing the audit risk associated with the engagement.  Although a new  auditor provides a "fresh look" for the audit, concern was raised that a new  auditor may challenge the previous auditor’s judgments in an overly  aggressive manner because the new auditor is not familiar with the client’s  operations or accounting policies, and this poses a problem for the public  company because the previous auditor is not present to explain the  rationale for those judgments.  It was viewed that in some cases, these are  matters of professional judgment rather than actual errors and that such a  situation could result in increased tension between the client and new  auditor of record.
Some individuals we spoke with expressed concern that if mandatory audit  firm rotation were implemented, the audit firm may rotate its most  qualified staff off the engagement during the later years of audit tenure  because the audit firm might focus its resources on obtaining or providing  services to new clients.  These individuals believe that such a practice  would increase audit risk, as did most Tier 1 firms and Fortune 1000 public  companies.  Some individuals also expressed concern that toward the end  of audit tenure, an audit firm might shift its attention to marketing nonaudit  services the firm could provide when it was no longer the auditor of record,  which may be counter to the intended benefits of mandatory audit firm  rotation.
Individuals we spoke with also noted other implementation issues with  mandatory audit firm rotation.  For example, they viewed mandatory audit  firm rotation as increasing costs to a company, not only in terms of higher  audit fees but also in additional selection and support costs.  In particular,  many individuals we spoke with, as did most Tier 1 firms and Fortune 1000  public companies, believed that when a company rotates auditors, a certain  amount of disruption occurs and the company spends a significant amount  of resources—both financial and human—educating the new auditor about  company operations and accounting matters.  Individuals we spoke with  expressed concern not only that these additional audit, selection, and  support costs are ultimately passed on to shareholders but also that audit  committees may lose control of selecting the best auditors to provide the  best quality to shareholders since the incumbent firm would not be eligible  to compete to provide audit services for some period of time.
Some individuals we spoke with noted that they have already observed a  heightened sense of corporate responsibility and better corporate  governance as a result of a change in behavior brought about by the large  corporate failures in recent years.  Overall, the majority of knowledgeable  individuals we spoke with believe that a requirement for mandatory audit  firm rotation should not be implemented at this time.  However, some  individuals suggested that regulators could require a change in the auditor  of record as an enforcement action if conditions warrant such a measure.   Most individuals we spoke with believe that the cost of requiring  mandatory audit firm rotation would exceed the benefits because of the  various practical concerns noted.  Rather, these individuals believe that  greater experience with the existing provisions of the Sarbanes-Oxley Act  should be gained and the results assessed before the need for the  mandatory audit firm rotation is considered.  Many individuals we spoke  with believe that individual Sarbanes-Oxley Act provisions, such as audit  firm partner rotation and the increased responsibilities of the audit  committee, are not a substitute for mandatory audit firm rotation, but taken  collectively, they could accomplish many of the same intended benefits of  mandatory audit firm rotation to improve auditor independence and audit  quality.  For example, some individuals believe that the existing Sarbanes- Oxley Act provisions related to audit committees have already resulted in  more time spent on audit committee activities and greater contact and  frequency of meetings with auditors.  These individuals commented that  audit committees now ask more questions of auditors because of a  heightened sense of accountability for the performance, accuracy,  reliability, and integrity of everything the independent auditors are doing.
section_title: Survey Groups Views on Implementing Mandatory Audit Firm Rotation if Required and Other Alternatives for Enhancing Audit Quality
paragraphs: If mandatory audit firm rotation were required a number of implementing  factors affecting the structure of the requirement would need to be decided  by policy makers (e.g., the Congress and regulators).  The following  provides the views of Tier 1 firms, Fortune 1000 public companies, and  their audit committee chairs on certain implementing factors, regardless of  whether they supported mandatory audit firm rotation.
Most believed that the auditor of record’s tenure should be limited to  either 5 to 7 years or 8 to 10 years.
Nearly all believed that when the incumbent auditor of record is  replaced, the public accounting firm should not be permitted to compete  for audit services for either 3 or 4 years or 5 to 7 years.
Nearly all believed that the audit committee should be permitted to  terminate the business relationship with the auditor of record at any  time if it is dissatisfied with the firm’s performance.  Likewise, most  believed that the public accounting firm should be able to terminate its  relationship with the audit committee/public company at any time if it is  dissatisfied with the working relationship.
Nearly all believed that implementation of mandatory audit firm rotation  should be staggered on a reasonable basis to avoid a significant number  of public companies changing auditors simultaneously.
Most Tier 1 firms believed that mandatory audit firm rotation should not  be applied uniformly to all public companies regardless of their nature  or size.  In contrast, most Fortune 1000 public companies and their audit  committee chairs believed mandatory audit firm rotation should be  applied to all public companies regardless of nature or size.  However,  most other domestic and mutual fund companies that responded to our  survey believed mandatory audit firm rotation should not be applied  uniformly, and their audit committee chairs who responded to our  survey were split on the subject.
The Tier 1 firms and Fortune 1000 audit committee chairs who believed  that mandatory audit firm rotation should not be applied uniformly  more frequently selected the larger public companies rather than the  smaller public companies to be subject to mandatory audit firm rotation.   However, Fortune 1000 public companies were divided on their  selection of sizes of public companies that should be subject to  mandatory audit firm rotation.
See appendix II for additional details of the responses.
Our research of studies, other documents, and survey development  activities concerning issues related to mandatory audit firm rotation  identified the following other practices for potentially enhancing auditor  independence and audit quality:  the audit committee periodically holding an open competition for   requiring audit managers to periodically rotate off the engagement for  providing audit services to the public company,  the audit committee periodically obtaining the services of a public  accounting firm to assist it in overseeing the financial statement audit or  to conduct a forensic audit in areas of the public company’s financial  statement process that present a risk of fraudulent financial reporting,  and  the audit committee hiring the auditor of record on a noncancelable  multiyear basis in which only the public accounting firm could  terminate the business relationship for cause during the contract period.
Although many Tier 1 firms, Fortune 1000 public companies, and their audit  committee chairs saw some benefit in each of the alternative practices, in  general, they most frequently reported that the alternative practices would  have limited or little benefit.  The most notable exception involved the  practice in which an audit committee would hire an auditor of record on a  noncancelable multiyear basis, for which most Fortune 1000 public  companies and their audit committee chairs reported that the practice  would have no benefit.  (See table 5 in app. III.)
Regarding practices other than mandatory audit firm rotation that may  have potential value to enhance auditor independence and audit quality, the  Sarbanes-Oxley Act provides the PCAOB with the authority to set auditing  and related attestation, ethics, independence, and quality control standards  for registered public accounting firms and for conducting inspections to  determine compliance of each registered public accounting firm with the  rules of the PCAOB, the SEC, or professional standards in connection with  the performance of audits, the issuance of audit reports, and related  matters involving public companies.  In that respect, the PCAOB’s  inspection program for registered public accounting firms could also  provide the PCAOB with the opportunity to provide a “fresh look” at the  auditor of record’s performance regarding auditor independence and audit  quality.  For example, the inspections could include factors potentially  affecting auditor independence, such as length of the auditor’s tenure,  partners or managers of the audit firm who recently left the firm and are  now employed by the public company in financial reporting roles, and  nonaudit services provided by the auditor of record, as suggested by the  Conference Board Commission on Public Trust and Private Enterprise in  its January 9, 2003, report.  Also, the inspections could consider the  auditor’s work in high-risk areas of the public company’s operations and  related financial reporting.  Further, the inspections can serve to provide  some degree of transparency of their overall results and enforcement of  PCAOB and SEC requirements that may be useful for audit committees to  consider.
section_title: Auditor Experience in Restatements of annual Financial Statements Filed with the SEC for 2001 and 2002
paragraphs: With the dissolution of Arthur Andersen LLP in 2002, Tier 1 firms reported  replacing Anderson, as auditor of record, for more than 1,200 public  company clients since December 31, 2001.  Such volume of change in  auditors provided an unprecedented opportunity to gain some actual  experience with the potential value of the “fresh look” provided by a new  auditor.  Since many of these public companies had to replace Andersen as  their auditor of record during 2002, the number of changes in their auditor  of record effectively represented a partial form of mandatory audit firm  rotation.  We identified all annual restatements of financial statements filed  on a Form 10-KA and any annual restatements included in an annual Form  10K filing with the SEC by Fortune 1000 public companies for 2001 and  2002 through August 31, 2003, and focused on which restatements were  attributable to errors or fraud where the previous financial statements did  not comply with GAAP and identified whether there was a change in the  auditor of record.
We found that 28, or 2.9 percent, of the 960 Fortune 1000 public companies  changed their auditor of record during 2001, and 204, or 21.3 percent, of the  companies changed their auditor during 2002.  The significant increase  from 2001 through 2002 was primarily due to the dissolution of Andersen.   Our analysis showed that the Fortune 1000 public companies filed 43  restatements during those 2 years that were due to errors or fraud.  The  financial statements affected ranged from years 1997 to 2002.  The  misstatement rates of these public companies’ previously issued  statements of net income ranged from a 6.7 percent overstatement of net  income for 2000 to a 37.0 percent understatement of net loss for 2001.
The restatement rates due to errors or fraud among the 43 Fortune 1000  public companies that changed their auditor of record were 10.7 percent in  2001 and 3.9 percent in 2002 compared to restatement rates of 2.5 percent  in 2001 and 1.2 percent in 2002 for companies that did not change auditors.   Although the data indicate that the overall restatement rate is  approximately 4.5 times higher for 2001 and 3.25 times higher for 2002 for  the companies that changed their auditor of record as compared to those  companies that did not change auditors, caution should be taken as further  analysis would be needed to determine whether the restatements are  associated with the “fresh look” attributed to mandatory audit firm  rotation.  In that respect, for the majority of the restatements, the public  information filed with the SEC and included in the SEC’s Electronic Data  Gathering, Analysis, and Retrieval (EDGAR) system did not provide  sufficient information to determine whether company management, the  auditor of record, or regulators identified the error or fraud, and in those  cases in which there was a change in the auditor of record, whether the  predecessor auditor or the successor auditor identified the problem and  whether it was identified before or after the change in auditor of record.   Also, the recent corporate financial reporting failures have greatly  increased the pressures on company management and their auditors  regarding honest, fair, and complete financial reporting.  See appendix IV  for additional details of our analysis.
Regarding further analysis to determine whether restatements are  associated with the “fresh look,” we believe such additional future research  could potentially add value to better predict the benefits of mandatory  audit firm rotation and the future need for mandatory audit firm rotation.   See the observations section of this report for our views on mandatory  audit firm rotation considering the Sarbanes-Oxley Act’s requirements for  enhancing auditor independence and audit quality and other factors to  consider in evaluating the need for mandatory audit firm rotation.
section_title: Experience of Foreign Countries with Mandatory Audit Firm Rotation
paragraphs: To obtain other countries’ current or previous experience with or  consideration of mandatory audit firm rotation, we surveyed the securities  regulators of the Group of Seven Industrialized Nations (G-7), which  included the United Kingdom, Germany, France, Japan, Canada, and Italy.   In addition to the G-7 countries’ securities regulators, we also surveyed the  following members of the International Organization of Securities  Commissions (IOSCO): Australia, Austria, Belgium, Brazil, China, Hong  Kong, Luxembourg, Mexico, the Netherlands, Singapore, Spain, Sweden,  and Switzerland.  The IOSCO members represent these foreign countries’  organizations with duties and responsibilities which are similar to the SEC  in the United States.  We received responses from 11 of the 19 countries’  securities regulators surveyed.
Italy and Brazil reported having mandatory audit firm rotation for public  companies, and Singapore reported the requirement for banks that are  incorporated in Singapore.  Austria also reported that beginning in 2004,  mandatory audit firm rotation will be required for the auditor of record of  public companies.  Spain and Canada reported that they previously had  mandatory audit firm rotation requirements.  Generally, reasons reported  for requiring mandatory audit firm rotation related to auditor  independence, audit quality, or increased competition for providing audit  services.  Reasons for abandoning the requirements for mandatory audit  firm rotation related to its lack of cost-effectiveness, cost, and having  achieved the objective of increased competition for audit services.  Many of  the survey respondents also reported either requiring or considering audit  partner rotation requirements that are similar to the requirements of the  Sarbanes-Oxley Act.  See appendix V for additional information on the  survey respondents’ experiences and consideration of mandatory audit  firm rotation and audit partner rotation.
section_title: GAO Observations
paragraphs: The Sarbanes-Oxley Act contains significant reforms intended to enhance  auditor independence and audit quality, which are viewed by the groups of  stakeholders we surveyed or held discussions with as likely to sufficiently  achieve the same intended benefits as mandatory audit firm rotation when  fully implemented.  In that respect, the SEC’s regulations to implement the  auditor independence and audit quality requirements of the act have only  recently been issued, and the PCAOB is in the process of implementing its  inspection program.  Therefore, we believe it will take at least several years  to gain some experience with the effectiveness of the act’s requirements  concerning auditor independence and audit quality.
We believe that it is critical for both the SEC and the PCAOB, through its  oversight and enforcement programs, to formally monitor the effectiveness  of the regulations and programs intended to implement the Sarbanes-Oxley  Act.  This information will be valuable in considering whether changes,  including mandatory audit firm rotation, may be needed to further protect  the public interest.  We noted that survey responses from Tier 1 firms show  that the potential for lawsuits or regulatory action is a major incentive for  the firms to appropriately deal with public company management in  resolving financial reporting issues.  We believe that the SEC’s and  PCAOB’s rigorous enforcement of regulations and other requirements will  be critical to the effectiveness of the act’s requirements.
It is clear that the likely additional costs associated with mandatory  rotation have influenced the views of Tier 1 firms and Fortune 1000 public  companies and their audit committee chairs to not support mandatory  rotation.  However, we believe that these additional costs need to be  balanced with the need to protect the public interest, especially  considering the recent significant accountability breakdowns and their  impact on investors and other interested parties.  Although expecting to  have zero financial reporting/audit failures is not a realistic expectation,  Enron, WorldCom, and others have recently demonstrated that a single  financial reporting/audit failure of a major public company can have  significant consequences to shareholders and other interested parties.  We  believe it is fairly certain that mandatory audit firm rotation would result in  selection costs and additional support costs for public companies.  Also,  most Tier 1 firms and Fortune 1000 public companies believe that  mandatory audit firm rotation would also result in higher audit fees,  primarily due to higher initial years’ audit costs.
If public accounting firms under mandatory audit firm rotation have (1) a  shorter tenure as auditor of record to recover higher initial year audit costs  and (2) fewer opportunities to also sell nonaudit services due to the  Sarbanes-Oxley Act requirements concerning prohibited nonaudit services,  then we believe it is reasonable to assume, as public accounting firms and  public companies have done, that the higher initial year audit costs  associated with a new auditor are likely to be passed on to the public  companies, along with increased marketing costs.  However, competition  among public accounting firms for providing audit services should to some  extent also affect audit fees.  Therefore, we believe it is uncertain at this  time how these dynamics would play out in the market for audit services  and their effect on audit fees over the long term.  However, if intensive  price competition were to occur, the expected benefits of mandatory audit  firm rotation could be adversely affected if audit quality suffers due to audit  fees that do not support an appropriate level of audit work.
We believe that mandatory audit firm rotation may not be the most efficient  way to enhance auditor independence and audit quality, considering the  costs of changing the auditor of record and the loss of auditor knowledge  that is not carried forward to the new auditor.  We also believe that the  potential benefits of mandatory audit firm rotation are harder to predict  and quantify while we are fairly certain there will be additional costs.  In  that respect, mandatory audit firm rotation is not a panacea that totally  removes pressures on the auditor in appropriately resolving financial  reporting issues that may materially affect the public companies’ financial  statements.  Those pressures are likely to continue even if the term of the  auditor is limited under any mandatory rotation process.  Furthermore,  most public companies will only use the Big 4 firms for their auditor of  record for a variety of reasons, including the firms’ having sufficient  industry knowledge and resources to audit their companies and  expectations of the capital markets to use Big 4 firms.  These public  companies may only have 1 or 2 choices for their auditor of record under  any mandatory rotation system.  However, over time a mandatory audit  firm rotation requirement may result in more firms transitioning into  additional industry sectors if the market for such audits has sufficient  profit margins.
The current environment has greatly increased the pressures from  regulators and investors on public company management and public  accounting firms to have financial statements issued by public companies  that comply with GAAP and provide full disclosure.  These pressures and  the reforms of the Sarbanes-Oxley Act provide incentives to have financial  reporting that is honest, fair, and complete and that serves the public  interest.  If such reporting is widely and consistently achieved then the  likelihood of the “fresh look” serving to identify financial reporting issues  that may materially affect financial statements that were either overlooked  or not appropriately dealt with by the previous auditor of record will be  reduced.  However, it is uncertain at this time if the current climate and  pressures for accurate and complete financial reporting and for restoring  public trust will be sustained over the long term.
Regarding the need for mandatory audit firm rotation, we believe the most  prudent course at this time is for the SEC and the PCAOB to monitor and  evaluate the effectiveness of the Sarbanes-Oxley Act’s requirements for  enhancing auditor independence and audit quality, and ultimately restoring  investor confidence.  In that respect, the PCAOB’s inspection program for  registered public accounting firms could also provide an opportunity to  provide a “fresh look,” which would enhance auditor independence and  audit quality through the program’s inspection activities, and may provide  new insights regarding (1) public companies’ financial reporting practices  that pose a high risk of issuing materially misstated financial statements for  the audit committees to consider and (2) possibly either using the auditor  of record or another firm to assist in reviewing these areas.  In addition,  future research on the potential benefits of mandatory audit firm rotation  as suggested by our analysis of restatements of financial statements may  also be valuable to consider along with the evaluations of the effectiveness  of the Sarbanes-Oxley Act.
Further, we also believe that currently audit committees, with their  increased responsibilities under the Sarbanes-Oxley Act, can play a very  important role in enhancing auditor independence and audit quality.  In that  respect, the Conference Board Commission on Public Trust and Private  Enterprise in its January 9, 2003, report stated that auditor rotation is a  useful tool for building shareholder confidence in the integrity of the audit  and of the company’s financial statements.  The commission advocated that  audit committees consider rotating audit firms when there are  circumstances that could call into question the audit firm’s independence  from management.  The circumstances that merited consideration included  when (1) significant nonaudit services are provided to the company by the  auditor of record (even if they have been approved by the audit  committee), (2) one or more former partners or managers of the audit firm  are employed by the company, or (3) lengthy tenure of the auditor of  record, such as over 10 years—which our survey results show is prevalent  at many Fortune 1000 public companies.  In such cases, we believe audit  committees need to be especially vigilant in the oversight of the auditor and  in considering whether a “fresh look” is warranted.  We also believe that if  audit committees regularly evaluate whether audit firm rotation would be  beneficial, given the facts and circumstances of their companies’ situation,  and are actively involved in helping to ensure audit independence and audit  quality, many of the intended benefits of audit firm rotation could be  realized at the initiative of the audit committee rather than through a  mandatory requirement.
However, audit committees need to have access to adequate resources,  including their own budgets, to be able to operate with the independence  necessary to effectively perform their responsibilities under the Sarbanes- Oxley Act.  Further, we believe that an audit committee’s ability to operate  independently is directly related to the independence of the public  company’s board of directors.  It is not realistic to believe that audit  committees will unilaterally resolve financial reporting issues that  materially affect a public company’s financial statements without vetting  those issues with the board of directors.  Also, the ability of the board of  directors to operate independently may also be affected in corporate  governance structures where the public company’s chief executive officer  also serves as the chair of the board of directors.  Like audit committees,  boards of directors also need to be independent and to have adequate  resources and access to independent attorneys and other advisors when  they believe it is appropriate.  Finally, for any system to function effectively,  there must be incentives for parties to do the right thing, adequate  transparency to provide reasonable assurance that people will do the right  thing, and appropriate accountability when people do not do the right  thing.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided copies of a draft of this report to the SEC, AICPA, and PCAOB  for their review.  Representatives of the AICPA and the PCAOB provided  technical comments, which we have incorporated where applicable.   Representatives of the SEC had no comments.
We are sending copies of this report to the Chairman and Ranking Minority  Member of the House Committee on Energy and Commerce.  We are also  sending copies of this report to the Chairman of the Securities and  Exchange Commission, the Chairman of the Public Company Accounting  Oversight Board, and other interested parties.  This report will also be  available at no charge on GAO’s Web site at http://www.gao.gov.
If you or your staffs have any questions concerning this report, please  contact me at (202) 512-9471 or John J. Reilly, Jr., Assistant Director, at  (202) 512-9517.  Key contributors are acknowledged in appendix VI.
section_title: Objectives, Scope, and Methodology
paragraphs: As mandated by Section 207 of the Sarbanes-Oxley Act of 2002 and as  agreed with your staff, to perform our study and review of the potential  effects of requiring mandatory rotation of registered public accounting  firms, we  1. identified and reviewed research studies and related literature that  addressed issues concerning auditor independence and audit quality  associated with the length of a public accounting firm’s tenure and the  costs and benefits of mandatory audit firm rotation;  2. analyzed the issues we identified to   develop detailed questionnaires to obtain the views of public accounting  firms and public company chief financial officers and their audit  committee chairs on the potential effects of mandatory audit firm  rotation,   hold discussions with officials of other interested stakeholders, such as  institutional investors, federal banking regulators, U.S. stock exchanges,  state boards of accountancy, the American Institute of Certified Public  Accountants (AICPA), the Securities and Exchange Commission (SEC),  and the Public Company Accounting Oversight Board (PCAOB), to  obtain their views on the issues associated with mandatory audit firm  rotation, and   obtain information from other countries on their experiences with  mandatory audit firm rotation; and 3. identified restatements of annual 2001 and 2002 financial statements of  Fortune 1000 public companies due to errors or fraud that were  reported to the SEC during 2002 and 2003 through August 31, 2003, to   determine whether the restatement occurred before or after a change in  the public companies’ auditor of record, and   test the value of the “fresh look” commonly attributed to mandatory  audit firm rotation.
We conducted our work in Washington, D.C., between November 2002 and  November 2003 in accordance with U.S. generally accepted government  auditing standards.
subsections: section_title: Identifying Research Studies Concerning Auditor Independence and Audit Quality
paragraphs: To identify existing research related to mandatory audit firm rotation, we  utilized several methods including general Internet searches, requests from  the AICPA library, the AICPA’s Web site (www.aicpa.org), the American  Accounting Association’s Web site (http://accounting.rutgers.edu/raw/aaa/),  the SEC’s Web site (www.sec.gov), requests from GAO’s internal library  resources, and suggestions provided by communities of interest.  Also,  many studies were identified through bibliographies of previously  identified research.  We used the following keywords in our searches:  “mandatory audit firm rotation,” “mandatory auditor rotation,”  “compulsory audit firm rotation,” “compulsory auditor rotation,” “auditor  rotation,” “auditor change(s),” and “auditor switching.”
We identified a total of 80 studies, articles, position papers, and reports  from our searches.  We then applied the following criteria to these studies.
We focused on studies that (1) were mostly published no earlier than 1980,   (2) contained some original data analyses, and (3) focused on some aspect  of mandatory audit firm rotation.  Using these criteria, 27 studies were  subjected to further methodological review to evaluate the design and  approach of the studies, the quality of the data used, and the  reasonableness of the studies’ conclusions and to determine if any  limitations of a study were of sufficient severity to call into question the  reasonableness of the conclusion.  We eliminated 10 of these studies  because they were actually position papers or literature summaries, and  did not include any original data analyses.  One additional study was  eliminated because of fundamental methodological flaws.
Of the remaining 16 studies that were subjected to a high-level  methodological review, 7 have major caveats that should be considered  along with the results of the studies, while the other 9 have some more  minor methodological limitations, such as limited application to the  subject; limited data availability; or insufficient information on issues  including choice of samples, response rates, and nonresponse analyses.  In  developing the survey instruments covering issues concerning auditor  independence and audit quality associated with the length of a public  accounting firm’s tenure and the costs and benefits of mandatory audit firm  rotation, we primarily used the studies from among this latter group of 9 as  listed below.
The Relationship of Audit Failures and Audit Tenure, by Jeffrey  Casterella of Colorado State University, W. Robert Knechel of University of  Florida and University of Auckland, and Paul Walker of the University of  Virginia, November 2002.
Auditor Rotation and Retention Rules: A Theoretical Analysis (Rotation  Rules), by Eric C. Weber of Northwestern University, June 1998.
Audit-Firm Tenure and the Quality of Financial Reports, by Van E.  Johnson of Georgia State University, Inder K. Khurana of the University of  Missouri-Columbia, and J. Kenneth Reynolds of Louisiana State University,  Winter 2002. “The Effects of Auditor Change on Audit Fees: Tests of Price Cutting and  Price Recovery”, The Accounting Review, by D.T. Simon, and J.R. Francis,  April 1988. “Does Auditor Quality and Tenure Matter to Investors?” Evidence from the  Bond Market.  Sattar Mansi of Virginia Polytechnic Institute, William F.  Maxwell of University of Arizona, and Darius P. Miller of Kelley School of  Business, February 2003 paper under revision for the Journal of  Accounting Research.
An Analysis of Restatement Matters: Rules, Errors, Ethics, for the Five  Years Ended December 31, 2002, The Huron Consulting Group, January  2003.
The Commission on Auditors’ Responsibilities: Report of Tentative  Conclusions, The Cohen Commission (an independent commission  established by the AICPA), 1977. (Limited to Section 9, “Maintaining the  Independence of Auditors, Rotation of Auditors”). “Audit Fees and Auditor Change; An Investigation of the Persistence of Fee  Reduction by Type of Change”, Journal of Business Finance and  Accounting, by A. Gregory, and P. Collier, January 1996. “Auditor Changes and Tendering: UK Interview Evidence”, Accounting,  Auditing and Accountability Journal, v11n1, V. Beattie, and S. Fearnley,  1998.
section_title: Obtaining the Views of Public Accounting Firms and Public Company Chief Financial Officers and Their Audit Committee Chairs on Mandatory Audit Firm Rotation
paragraphs: We analyzed the issues identified from our review of studies, articles,  position papers, and reports to develop an understanding of the  background and related advantages and disadvantages of mandatory audit  firm rotation.  We developed three separate survey instruments  incorporating a variety of issues related to auditor independence, audit  quality, mandatory audit firm rotation and the potential effects on audit  costs, audit fees, audit quality, audit risk, and competition that may arise  with a mandatory audit firm rotation requirement.  In addition, these survey  instruments solicited views on the impact of specific provisions of the  Sarbanes-Oxley Act intended to enhance auditor independence and audit  quality, other practices for enhancing audit quality, views on implementing  mandatory audit firm rotation, and overall opinions on requiring mandatory  audit firm rotation.
We performed field tests of the survey instruments to help ensure that the  survey questions would be understandable to different groups of  respondents, eliminate factual inaccuracies, and obtain feedback and  recommendations to improve the surveys.  We took the feedback and  comments we received into consideration in developing our final survey  instruments.  Specifically, during March and April of 2003, we performed  field tests of the survey instrument for public accounting firms with eight  different public accounting firms, including two of the Big 4 firms, two  national firms, and four regional or local firms.  During May 2003, we  conducted field tests of the survey instrument for public company chief  financial officers with four public companies, including two Fortune 1000  companies and two commercial banks not included in the Fortune 1000.   We tailored the survey instrument for public company audit committee  chairpersons by incorporating the feedback and comments we received  from the chief financial officers during the field tests we performed with  public companies.
section_title: Surveys of Public Accounting Firms
paragraphs: Section 207 of the Sarbanes-Oxley Act mandated that GAO study the  potential effects of mandatory audit firm rotation of registered public  accounting firms, referring to public accounting firms that would be  registered with the new PCAOB.  During the January 2003 time frame when  we were framing the population, since the PCAOB was in the process of  getting organized and becoming operational, there were no public  accounting firms registered with the PCAOB at that time.   Therefore, we  coordinated with the AICPA to establish a population of public accounting  firms that would most likely register with the PCAOB.  The AICPA provided  a complete list of the more than 1,100 public accounting firms that were  registered with the AICPA’s Securities and Exchange Commission Practice  Section (SECPS) as of January 2003.  Prior to the restructuring of the  SECPS, AICPA bylaws required that all members that engage in the  practice of public accounting with a firm auditing one or more SEC clients  join the SECPS.  Public accounting firms that did not have any SEC clients  could join the SECPS voluntarily.  Based on the information submitted in  their 2001 annual reports, these SECPS member firms collectively had  nearly 15,000 SEC clients.  Therefore, the public accounting firms  registered with the SECPS at that time were used to frame an alternative  source of public accounting firms that perform audits of issuers registered  with the SEC.
Based on the AICPA-provided SECPS membership list and the number of  SEC clients reported in these SECPS member firms’ 2001 annual reports, of  1,117 SECPS members, 696 firms had 1 or more SEC clients and 421 firms  were SECPS members but did not audit any public companies.  The 696  members of the SECPS collectively audited 14,928 of the 17,956 issuers  registered with the SEC.  Since approximately 3,000 issuers were audited  by public accounting firms that were not members of the SECPS, we  obtained a list from the SEC that included the names of over 1,000 public  accounting firms that performed the audits of public companies registered  with the SEC.  We compared the 696 SECPS member firms to all of the  public accounting firms that were included in the SEC’s list in order to  identify the non-SECPS member public accounting firms, which were  mainly consisted of foreign public accounting firms or domestic firms that  are not AICPA members.  Since the PCAOB has indicated that it will not  exempt foreign public accounting firms that audit issuers registered with  the SEC from registering with the PCAOB, we included non-SECPS  member public accounting firms that reported to the SEC that they had 10  or more SEC clients in the population.
section_title: Stratification of Public Accounting Firm Population
paragraphs: In order to identify differences in views on the potential effects of  mandatory audit firm rotation for respondents that vary based on the size  of the public accounting firm, location (e.g., domestic versus foreign firms)  and other factors, we stratified the population into three tiers based on the  number of SEC clients reported to the SECPS in the SECPS member firms’  2001 annual reports and the aforementioned SEC data for non-SECPS  member public accounting firms:  1. Tier 1 firms:  92 SECPS member and 5 non-SECPS public accounting  firms that had 10 or more 2001 SEC clients in 2001,  2. Tier 2 firms: 604 SECPS member firms that had from 1 to 9, 2001 SEC  clients in 2001, and  3. Tier 3 firms: 421 SECPS member firms that reported having no SEC  clients.
The basis for selecting public accounting firms with 10 or more SEC clients  was twofold.  First, the 92 SECPS member firms included in Tier 1  collectively had approximately 90 percent of all of the SEC clients reported  to the SECPS in the member firms’ 2001 annual reports.  Second, the public  accounting firms with 10 or more SEC clients were viewed to collectively  have the most experience and knowledge about changing auditors for  public company clients and accordingly were considered to have a great  interest in the potential effects of mandatory audit firm rotation.  Tier 2 was  established because the 604 SECPS member firms with 1 to 9 SEC clients  comprises approximately 10 percent of the total SEC clients reported to the  the SECPS in member firms’ 2001 annual reports and were also considered  to have a great interest in, as well as important views on, the potential  effects of mandatory audit firm rotation based on their experience and  knowledge of being auditors for public companies.  Lastly, we included the  421 SECPS member public accounting firms that had no SEC clients in Tier  3 of our population in order to determine if there would be greater or less  interest in providing financial statement audit services to public companies  if mandatory audit firm rotation were required.  We requested that the  public accounting firms’ chief executive officers or managing partners, or  their designated representatives, complete the survey.
section_title: Method of Administration
paragraphs: In order to conduct our survey, we selected a 100 percent certainty sample  of Tier 1 public accounting firms consisted of all 92 SECPS member firms  and all 5 non-SECPS member firms.  In addition, we selected separate  random samples from each of the two remaining strata.  We created two  separate Web sites for the public accounting firm surveys.  The top tier  firms were surveyed independently of the second and third tiers because  the Tier 1 survey was administered jointly with another study dealing with  consolidation of major public accounting firms since 1989 as mandated by  Section 701 of the Sarbanes-Oxley Act.  The survey for the Tier 2 and Tier 3  firms, which dealt only with the potential effects of mandatory audit firm  rotation, was created at a separate Web site.  A unique password and user  ID was assigned to each selected public accounting firm in our sample to  facilitate completion of the survey online.   The surveys were made  available to the Tier 1 firms during the week of May 27, 2003, and the  surveys to the Tier 2 and Tier 3 firms were made available during the week  of June 12, 2003.  Both survey Web sites remained open until September  2003.  Responses to surveys completed online were automatically stored on  GAO’s Web sites.  From August through September 2003, we performed  follow-up efforts to increase the overall response rates by telephoning the  selected public accounting firms that had not completed the survey, and  requested that they take advantage of the opportunity to express their  views on this important issue by doing so.
Lastly, in order to gain knowledge about whether the views of the Tier 1  public accounting firms that did not complete our survey were materially  different from the overall views of the Tier 1 public accounting firms that  completed our survey, we asked the following key questions of those public  accounting firms that did not complete our survey and that we contacted  during our telephone follow-up efforts.  Specifically, we asked whether  their firms believed the benefits of mandatory audit firm rotation would  exceed the costs of implementing such a requirement and whether their  firms would support requiring mandatory audit firm rotation.  As more fully  described in the body of this report, the overall views expressed by the Tier  1 public accounting firms that completed our survey generally indicated  that the costs of mandatory audit firm rotation would exceed the benefits  and that their firms were not in favor of supporting such a requirement.   The views of the Tier 1 public accounting firms that did not complete our  survey and that we contacted in our telephone follow-up efforts were  generally consistent with the overall views of the Tier 1 public accounting  firms that completed our survey.
section_title: Public Accounting Firm Survey Results
paragraphs: As disclosed in our survey instruments, all survey results were to be  compiled and presented in summary form only as part of our report, and  we will not release individually identifiable data from these surveys, unless  compelled by law or required to do so by the Congress.  We received  responses from 74 of the 97 Tier 1 firms, or 76.3 percent.  Because of the  more limited participation of Tier 2 firms (85, or 30.1 percent) and Tier 3  firms (52, or 21.9 percent) in our survey, we are not projecting their  responses to the population of firms in these tiers.  The presentation of this  report focuses on the responses from the Tier 1 firms, but any substantial  differences in their overall views and those reported to us by either Tier 2  or 3 firms are discussed where applicable.
Table 2 summarizes the population, sample sizes, and overall responses  received for all three tiers of public accounting firms surveyed on the  potential effects of mandatory audit firm rotation.
section_title: Surveys of Public Company Chief Financial Officers and Audit Committee Chairs
paragraphs: As a part of fulfilling our objective to study the potential effects of  mandatory audit firm rotation, we obtained the views on the advantages  and disadvantages and related costs and benefits from a random sample of  chief financial officers and audit committee chairs of public companies  registered with the SEC.  We solicited the views of chief financial officers  of public companies because they were considered to be very  knowledgeable about the issues involving financial statement audits of  public companies.  We also solicited the views of audit committee chairs  because under the Sarbanes-Oxley Act, the audit committee has expanded  responsibilities for monitoring and overseeing public companies’ financial  reporting and the financial statement audit process.  We obtained such  views by administering a survey to randomly selected samples of public  company chief financial officers and their audit committee chairs.
Section 207 of the Sarbanes-Oxley Act defines “mandatory rotation” as the  imposition of a limit on the period of years for which a particular registered  public accounting firm may be the auditor of record for a particular issuer.   Therefore, in framing the population  from which we planned to draw our  sample of public companies, we researched what the definition of an  “issuer” is with the SEC, with GAO’s General Counsel, and the AICPA’s  SECPS.  The primary purpose of conducting this research was to determine  whether mutual funds (or mutual fund complexes) and other types of  investment companies such as investment trusts, should be included in the  population.  Based on discussions with the Director of the SEC’s Office of  Investment Management, mutual funds and investment trusts are issuers  that are required to file periodic reports with the SEC under the Securities  Exchange Act of 1934 or the Investment Company Act of 1940.  Also,  officials in the SEC’s Office of Investment Management indicated that there  are nearly 10,000 individual mutual funds grouped into 877 mutual fund  complexes (also known as families).   A mutual fund complex is  responsible for hiring the auditor of record, either collectively or  individually, for the individual mutual funds that are included in the family  or complex.  As such, investment trusts and the 877 mutual fund complexes  were included in our population for the purpose of administering our  survey.
We obtained lists of public company issuers from the SEC in developing the  population as follows:  The SEC’s Office of Corporation Finance provided a  list of 17,079 public companies from the SEC’s Electronic Data Gathering,  Analysis, and Retrieval (EDGAR) system.  This list included registrants that  were listed as current issuers registered with the SEC as of February 2003  and included 14,938 domestic public companies (including investment  trusts) and 2,141 foreign public companies (i.e., companies that are  domiciled outside of the United States but are registered with the SEC).  Our comparison of this SEC list to a separate list of Fortune 1000  companies identified an additional 32 public companies that were added to  the original list of 17,079, bringing the total population to an adjusted total  of 17,111.  As noted above, we also obtained a complete list of 877 mutual  fund complexes from the SEC that included current issuers registered with  the SEC’s Office of Investment Management.  Therefore, the population of  public company issuers as of February 2003 totaled 17,988, consisted of  17,111 public companies and 877 mutual fund complexes.
section_title: Stratification of Chief Financial Officer and Audit Committee Chair Population
paragraphs: In order to identify differences in views on the potential effects of  mandatory audit firm rotation based on differences in company industry,  size, or geographic location, we stratified the population into the following  three strata: (1) domestic Fortune 1000 companies, (2) other (non-Fortune  1000) domestic companies and mutual fund complexes, and (3) foreign  companies.
Fortune 1000 stratum:  Based on Fortune’s list of the Fortune 1000 as of  March 2003, we identified 960 public companies in the Fortune 1000; the  remaining 40 companies were privately owned.  Since private companies  are not subject to SEC rules or the Sarbanes-Oxley Act’s provisions, these  40 companies were not included in the stratum.  We used the file provided  by the SEC listing the 17,079 domestic and foreign public companies to  extract a separate stratum of the 960 public companies in the Fortune 1000.   In addition, in comparing Fortune’s list of the Fortune 1000 to the SEC’s  listing of public companies, we identified 32 additional companies that  were included in the Fortune 1000 but which were not included in the SEC  list.  In connection with framing the Fortune 1000 stratum, we added these  32 companies to the list of domestic and foreign public companies provided  to us by the SEC to ensure that it was complete.
Foreign company stratum:  Using the “state code” identifier included in  the adjusted SEC list of 17,111 domestic and foreign public companies, we  extracted a separate stratum of 2,141 foreign companies.
Other domestic companies and mutual fund complexes stratum:  After  extracting the 960 domestic Fortune 1000 public companies and the 2,141  foreign public companies from the adjusted SEC list of 17,111 domestic and  foreign public companies, a separate stratum of 14,010 non-Fortune 1000  public companies was created from the SEC file representing the “other  domestic” public companies.  These 14,010 other domestic public  companies (which included investment trusts) were combined with the 877  mutual fund complexes provided by the SEC’s Office of Investment  Management to create a total population for this stratum of 14,887.
section_title: Method of Administration
paragraphs: In order to conduct these surveys, we selected a separate random sample  from each of the three public company strata.  We mailed a survey package  to the chief financial officer of each public company issuer included in our  sample.  This survey package provided the chief financial officer with the  option of completing the enclosed hard copy of the survey and returning it  in the mail to our Atlanta Field Office or of completing the survey online.   We created a Web site with the public company survey for the chief  financial officers.  A unique password and user ID was assigned to each  selected company in our sample of companies to facilitate completion of  the survey online.   In addition, a separate survey directed to the chair of  the audit committee (or head of an equivalent body) was included in the  mail survey package.  The chief financial officer was asked to forward this  survey to the audit committee chair.  The survey for the public company  audit committee chairs was not made available online.  As such, these  surveys could only be completed on hard copy and returned to our Atlanta  Field Office.  The survey packages were mailed to all 1,171 public  companies in June 2003.  The survey Web site for public company chief  financial officers remained open until September 2003.  The cutoff date for  accepting mailed surveys from public company chief financial officers and  audit committee chairs was September 2003.  Responses to surveys  completed online were automatically stored into GAO’s Web sites, and  mailed survey responses of chief financial officers and audit committee  chairs were entered into a separate compilation database by GAO  contractor personnel who were hired to perform such data inputting.  From  August through September 2003, we also performed follow-up efforts to  increase the overall response rates by telephoning public company chief  financial officers, who had not completed or returned the survey, and  requesting that the chief financial officer and the audit committee chair  complete our survey and return it to us.
section_title: Public Company Survey Results
paragraphs: As disclosed in our surveys, all survey results were to be compiled and  presented in summary form only as part of our report, and we will not  release individually identifiable data from these surveys, unless compelled  by law or required to do so by the Congress.  Of the 330 Fortune 1000 public  companies sampled, we received responses from 201, or 60.9 percent, of  their chief financial officers and 191, or 57.9 percent, of their audit  committee chairs.    Because of limited participation of the other domestic  companies and mutual funds (131, or 29.1 percent, of their chief financial  officers and 96, or 21.3 percent, of their audit committee chairs) and the  foreign public companies (99, or 25.3 percent, of their chief financial  officers and 63, or 16.1 percent, of their audit committee chairs), we are not  projecting their responses to the population of companies in these strata.   The presentation of this report focuses on the responses from the Fortune  1000 public companies’ chief financial officers and their audit committee  chairs, but any substantial differences in their overall views and those  reported to us by the other groups of public companies we surveyed is  discussed where applicable.
Tables 3 and 4 summarize the population, sample size, and survey  responses received for all three strata of public company chief financial  officers and their audit committee chairs surveyed on the potential effects  of mandatory audit firm rotation.
section_title: Additional Survey Considerations
paragraphs: We initially requested information from all 97 Tier 1 firms (firms with 10 or  more SEC clients).  We received responses from 74 of them.  We conducted  follow-up with a limited number of the nonrespondents and did not find  substantive differences between the respondents and the nonrespondents  on key questions related to mandatory audit firm rotation.  We requested  information from 330 Fortune 1000 public companies and their audit  committee chairs and received 201 and 191 responses from them,  respectively.  While we did not conduct follow-up with the nonrespondents  from our surveys of Fortune 1000 public companies and their audit  committee chairs, we had no reason to believe that respondents and  nonrespondents to our original samples from these strata would  substantively differ on issues related to mandatory audit firm rotation.   Therefore, we analyzed respondent data from the Tier 1 and Fortune 1000  public companies and their audit committees as probability samples from  these respective populations.
Survey results based on probability samples are subject to sampling error.   Each of the three samples (Tier 1 and Fortune 1000 public companies and  their audit committee chairs) is only one of a large number of samples we  might have drawn from the respective populations.  Since each sample  could have provided different estimates, we express our confidence in the  precision of our three particular samples’ results as 95 percent confidence  intervals.  These are intervals that would contain the actual population  values for 95 percent of the samples we could have drawn.  As a result, we  are 95 percent confident that each of the confidence intervals in this report  will include the true values in the respective study populations.  All  percentage estimates from the survey of Tier 1 firms have sampling errors  not exceeding +/- 7 percentage points unless otherwise noted.  All  percentage estimates from the surveys of Fortune 1000 public companies  and their audit committee chairs have sampling errors not exceeding +/- 6  percentage points unless otherwise noted.  Also, estimated percentages for  subgroups of Tier 1 firms and Fortune 1000 public companies and their  audit committee chairs often have sampling errors exceeding these  thresholds, which are noted where they are reported.  In addition, all  numerical estimates other than percentages have sampling errors of not  more than +/- 14 percent of the value of those numerical estimates.
Despite our judgment that respondents and nonrespondents do not differ  on issues related to mandatory audit firm rotation, our survey estimates  may nevertheless contain errors to the extent that there truly are  differences between these groups on issues related to this topic.
The practical difficulties of conducting any survey also introduce other  types of nonsampling errors. Differences in how a particular question is  interpreted and differences in the sources of information available to  respondents can also be sources of nonsampling errors.  We included steps  in both the data collection and data analysis stages to minimize such  nonsampling errors. These steps included developing our survey questions  with the aid of our survey specialists, conducting pretests of the public  accounting firm and public company questions and questionnaires,  verifying computer analysis by an independent analyst, and double  verification of survey data entry where applicable.
section_title: Discussions Held with Officials of Other Interested Stakeholders
paragraphs: To supplement the responses to our survey, we identified other  knowledgeable individuals associated with a broad range of communities  of interest and conducted telephone or in-person discussions to obtain  their views on mandatory audit firm rotation.  The communities of interest  included significant institutional investors (pension funds, mutual funds,  and insurance companies), self-regulatory organizations (such as stock  exchanges), consumer advocacy groups, regulators (state boards of  accountancy, banking regulators), the AICPA, the SEC, the PCAOB, and  recognized experts in corporate governance.
The questions for these discussions were based on key questions from the  surveys for public accounting firms and public companies.  The results of  the discussions were compiled and presented in summary form only as part  of our report, and we will not release individually identifiable data from  these discussions, unless compelled by law or required to do so by the  Congress.
section_title: Obtaining Information from Other Countries on Their Experiences with Mandatory Audit Firm Rotation
paragraphs: In order to obtain other countries’ current or previous experience with or  consideration of mandatory audit firm rotation, we administered surveys to  the securities regulators of the Group of Seven Industrialized Nations (G- 7), which included the United Kingdom, Germany, France, Japan, Canada,  and Italy.  In addition to the G-7 countries’ securities regulators, we also  administered surveys to the following members of the International  Organization of Securities Commissions (IOSCO): Australia, Austria,  Belgium, Brazil, China, Hong Kong, Luxembourg, Mexico, the Netherlands,  Singapore, Spain, Sweden, and Switzerland.  The IOSCO members  represent these foreign countries’ organizations with duties and  responsibilities similar to those of the SEC in the United States.
We administered the surveys to these foreign countries’ securities  regulators in December 2002.  From July and through October 2003, we  performed follow-up efforts to increase the overall response rates by  sending e-mail messages to the foreign countries’ securities regulators in  our sample who had not completed the survey and requested that they do  so.  We received responses from 11 of the 19 countries’ securities  regulators surveyed.
section_title: Identifying Restatements of Annual Financial Statements for Fortune 1000 Public Companies due to Errors or Fraud
paragraphs: To obtain some insight into the potential value of the “fresh look” provided  by a new auditor of record, we analyzed the rate of annual financial  statement restatements reported to the SEC by Fortune 1000 public  companies during 2002 and 2003 through August 31, 2003.  We particularly  focused on restatements for 2001 and 2002 and compared the financial  statement restatement rates of those Fortune 1000 public companies that  changed their auditor of record to those of Fortune 1000 public companies  that did not change their auditor of record during this period.
In connection with performing this analysis, we separately tracked the  Fortune 1000 public companies that changed auditors from the public  companies that did not change auditors during 2001 and 2002.  Financial  statement restatements filed for changes in accounting principles or  changes in organizational business structure (e.g., stock splits, mergers and  acquisitions), reclassifications, or to compliance with SEC reporting  requirements are not necessarily indications of compromised audit quality  or auditor independence.  However, financial statement restatements due  to errors or fraud raise doubt about the integrity of management’s financial  reporting practices, the quality of the audit, or the auditor’s independence.   Therefore, the focus of our analysis was on annual financial statement  restatements (hereinafter referred to as “restatements”) due to errors or  fraud.  Since not all restatements are indications of errors or fraud, we reviewed Form 10-KAs (amended 10-K filings), Form 8-Ks, and any related  SEC enforcement actions to determine if the restatements were due to  errors or fraud.  The primary purpose of this test was to determine whether  the rate of restatements due to errors or fraud of companies that changed  auditors was higher or lower than the rate of restatements due to errors or  fraud of companies that did not change auditors.
For each of the Fortune 1000 companies, we searched SEC’s EDGAR  system for Form 10-KA filings submitted to the SEC during 2002 and 2003  through August 31, 2003, that amended either 2001 or 2002 financial  statements to identify annual financial statement restatements.  We  determined if there had been a change in auditor from 2001 through 2002 by  reviewing the name of the auditor of record on the audit opinion included  in the Form 10-KA filed for 2001 and 2002, and also noted what type of audit  opinion was issued on the 2001 and 2002 financial statements.  This  allowed us to identify the restatements associated with Fortune 1000 public  companies that changed auditors and the restatements of Fortune 1000  public companies that did not change auditors.  We compared the level of  restatements for Fortune 1000 public companies that changed auditors to  the level of restatements of Fortune 1000 public companies that did not  change auditors.
For each of the restatements identified above, we reviewed underlying  Form 10-KA (amended 10-K filings), Form 8-Ks, and any related SEC  enforcement actions to quantify the dollar effect of the restatements and to  determine if the restatements were due to errors or fraud.  We  differentiated restatements caused by errors or fraud from restatements  caused by changes that were not indications of compromised audit quality  or auditor independence, such as changes in accounting principles,  mergers, stock splits, and reclassifications using appropriate classification  criteria.  In addition, we attempted to ascertain from the above sources  whether company management, the predecessor auditor, or the successor  auditor identified the error or fraud, and where applicable, whether it was  identified before or after the change in auditor.
After categorizing the 2001 and 2002 Fortune 1000 public companies’  annual financial statement restatements and annual financial statement  filings into (1) companies that did not change auditors and filed a  restatement, (2) companies that did not change auditors and did not file a  restatement, (3) companies that changed auditors and filed a restatement,  and (4) companies that changed auditors and did not file a restatement, we  compared the rates of restatements among and between these groups.
section_title: Implementation of Mandatory Audit Firm Rotation, if Required
paragraphs: If mandatory audit firm rotation were required, a number of implementing  factors affecting the structure of the requirement would need to be  decided.  As a component of our surveys of public accounting firms, public  companies, and their audit committee chairs, we asked them to provide  their views on various implementing factors, regardless of whether they  supported mandatory audit firm rotation, including  the limit on the incumbent firm’s audit tenure period,  the “cooling off” period before the incumbent firm could again compete  to provide audit services to the public company,  under what circumstances either the audit committee or the public  accounting firm could terminate the relationship for providing audit  services,  whether mandatory audit firm rotation should be implemented on a   whether mandatory audit firm rotation should be required for audits of  all public companies, and if not, to which public companies should it be  applied.
subsections: section_title: Time Limit on the Auditor of Record’s Tenure
paragraphs: Regarding the limit on the auditor of record’s tenure under mandatory audit  firm rotation, about 47 percent of Tier 1 firms stated that the limit should be  8 to 10 years. Fortune 1000 chief financial officers and audit committee  chairs selected 8 to 10 years about as often as 5 to 7 years as the limit on  the auditor of record’s tenure.  Tiers 2 and 3 firms and other public  companies’ audit committee chairs that responded to our surveys generally  favored an audit tenure of 5 to 7 years.
section_title: Time Limit Before the Auditor of Record Could Compete to Provide Audit Services to the Public Company Previously Audited
paragraphs: Most Tier 1 firms and Fortune 1000 public company chief financial officers  and their audit committee chairs believed the “cooling off” period under  mandatory audit firm rotation should be 3 or 4 years before the auditor of  record could again compete to provide audit services to the public  company previously audited.
section_title: Circumstances When the Audit Committee or the Auditor of Record Could Terminate the Business Relationship Providing Audit Services
paragraphs: Nearly all Tier 1 firms and Fortune 1000 public company chief financial  officers and their audit committee chairs stated that the audit committee  under mandatory audit firm rotation should be permitted to terminate the  auditor of record at any time if it is dissatisfied with the public accounting  firm’s performance or working relationship.  Most Tier 1 firms and Fortune  1000 public company chief financial officers and their audit committee  chairs also believed that the auditor of record should be able to terminate  its relationship with the audit committee/public company at any time if the  public accounting firm is dissatisfied with the working relationship.
section_title: Period for Implementing Mandatory Audit Firm Rotation
paragraphs: Nearly all Tier 1 firms and Fortune 1000 public company chief financial  officers and their audit committee chairs believed that mandatory audit  firm rotation should be implemented over a period of years (staggered) to  avoid a significant number of public companies changing auditors  simultaneously.
section_title: Public Companies for Which Auditor of Record Should Be Subject to Mandatory Audit Firm Rotation
paragraphs: About 70 percent of Tier 1 firms believed that mandatory audit firm  rotation should not be applied uniformly for audits of all public companies  regardless of their nature or size.  In contrast, about 81 percent of Fortune  1000 public companies and 65 percent of their audit committee chairs  believed that mandatory audit firm rotation should be applied uniformly for  audits of all public companies regardless of the nature or size.  Most chief  financial officers of other domestic and mutual fund public companies who  responded to our survey believe mandatory audit firm rotation should be  applied uniformly, and their audit committee chairs were split on the  subject.  Comments that we received from many of the Tier 1 firms,  Fortune 1000 public companies, and their audit committee chairs that  supported requiring that mandatory audit firm rotation be applied  uniformly generally took the view that there should be a level playing field  and that the benefits and the costs of mandatory audit firm rotation should  be applied to all public companies.  In contrast, those who commented  opposing requiring mandatory audit firm rotation for all public companies  generally took the view that the smaller public companies are less complex  and the costs of mandatory audit firm rotation would be more burdensome  for the smaller companies.
We asked those public accounting firms and public company chief financial  officers and their audit committee chairs who believed mandatory audit  firm rotation should not be applied uniformly to all public companies to  select by company nature and size to which companies mandatory audit  firm rotation should apply.  Tier 1 firms and Fortune 1000 audit committee  chairs more frequently selected the larger public companies.  However,  Fortune 1000 chief financial officers were about evenly split in their views  regardless of the size of the public company.  Chief financial officers and  their audit committee chairs of other domestic and mutual fund public  companies, as well as foreign public company chief financial officers and  their audit committee chairs, who responded to our survey more frequently  selected the larger public companies.
section_title: Potential Value of Practices Other Than Mandatory Audit Firm Rotation for Enhancing Auditor Independence and Audit Quality
paragraphs: We asked public accounting firms, public companies’ chief financial  officers, and their audit committee chairs to provide their views on the  potential value of the various following alternative practices we identified  through our research and other inquiries made in developing our surveys  versus the value of other than mandatory audit firm rotation for enhancing  auditor independence and audit quality.
The audit committee periodically holding an open competition for  providing audit services:  Having the audit committee periodically hold  an open competition for public accounting firms to serve as the public  company’s auditor of record, in which the incumbent auditor of record  could also compete, could potentially enhance auditor independence  and audit quality by letting the incumbent firm know that it does not  have unlimited tenure as the auditor of record and a lock on the  associated revenues, and that another firm may be selected to provide a  “fresh look” at the company’s financial reporting process, practices, and  financial statements.  Also, the public company has an opportunity to  see the quality of personnel that another public accounting firm could  provide.  However, the public company will incur some costs in holding  such a competition and, if another firm is selected, may incur additional  initial years’ audit fees and will have additional auditor support costs to  assist the new auditor of record in understanding the company’s  operations, systems, and financial reporting practices.
Requiring audit managers to periodically rotate off the engagement  for providing audit services to the public company:  Audit manager is a  senior position reporting to the engagement audit partner with  responsibility for assisting the engagement audit partner in planning,  conducting, and reporting on the audit of the public company’s financial  statements.  Larger audits will likely have multiple audit managers and  audit partners participating in the audit.  Conceptually, periodically  changing audit managers brings a “fresh look” to the audit assignment  and the associated potential benefits.  However, there is an associated  learning curve that is likely to cause both the public accounting firm and  the public company to incur some additional costs.  Some public  accounting firms commented that this practice already occurs as a  result of career enhancement policies and practices of the firms.
The audit committee periodically obtaining the services of a public  accounting firm to assist it in overseeing the financial statement  audit or to conduct a forensic audit in areas of the public company’s  financial reporting process that present a risk of fraudulent financial  reporting:  Overseeing the auditor of record’s conduct of the financial  statement audit is a significant responsibility that is especially  challenging depending on the size and complexity of a public company.   Having another public accounting firm as needed to assist the audit  committee brings a “fresh look” to help the audit committee understand  the public company’s operations, systems, and financial reporting  practices and the underlying internal controls and risks.  Also, as areas  are identified that may have greater risk of fraudulent financial  reporting, the audit committee may wish to have a public accounting  firm conduct a forensic audit to provide both a “fresh look” and a more  penetrating audit of transactions and related internal controls and  financial reporting practices in areas of high risk.  Additional costs will  be incurred by the audit committee, and some degree of coordination  and cooperation of the incumbent audit firm will be necessary, which  will also add to the audit committee’s responsibilities.
Requiring that the auditor of record be hired on a noncancelable  multiyear basis, although the public accounting firm could terminate  the relationship for cause during the contract period:  Having the audit  committee hire the auditor of record on a multiyear basis that only the  auditor of record can cancel potentially enhances auditor independence  and audit quality by assisting the auditor in dealing with any pressures  from management in appropriately dealing with financial reporting  practices that may materially affect the financial statements.  However,  this practice takes away flexibility of the audit committee to replace the  auditor of record within the period of the contract should the audit  committee be dissatisfied with the auditor of record’s performance.
Although many Tier 1 firms, Fortune 1000 public companies, and their audit  committee chairs saw some benefit in each of the alternative practices, in  general, they most frequently reported that the alternative practices would  have limited or little benefit.  The most notable exception involved the  practice in which audit committee would hire the auditor of record on a  noncancelable multiyear basis, for which most Fortune 1000 public  companies and their audit committee chairs reported that the practice  would have no benefit.  (See table 5.)
section_title: Restatements of Annual Financial Statements for Fortune 1000 Public Companies Due To Errors or Fraud
paragraphs: To obtain some insight into the potential value of the “fresh look” provided  by a new auditor of record, we analyzed the rate of annual financial  statement restatements reported to the Securities and Exchange  Commission (SEC) by Fortune 1000 public companies during 2002 and  2003 through August 31, 2003.  We particularly focused on restatements for  2001 and 2002 and compared the financial statement restatement rates of  those Fortune 1000 public companies that changed their auditor of record  to those Fortune 1000 public companies that did not change their auditor of  record during this period.
Historically, only about 3 percent of public companies change auditors in  any given year.  However, we observed that 2.9 percent (28 out of 960) of  the Fortune 1000 public companies changed auditors during 2001 and 21.3  percent (204 out of 960) of the Fortune 1000 public companies changed  auditors during 2002.  The significant increase from 2001 through 2002 was  primarily due to the dissolution of Arthur Andersen LLP in 2002, which was  caused, in part, by its criminal indictment for obstruction of justice  stemming from its role as auditor of Enron Corporation.  Since many of  these public companies had to replace Andersen as their auditor of record  during 2002, the number of changes in their auditor of record effectively  represented a partial form of mandatory audit firm rotation.
Tables 6 and 7 summarize the occurrence of the reported Fortune 1000  public companies’ restatement filings.
The combined restatement rates from tables 6 and 7 for all Fortune 1000  public companies, including those that changed auditors and those that  retained their auditor of record, was 2.9 percent in 2001 (28 restatements  out of the 960 Fortune 1000 public companies) and 1.9 percent in 2002 (18  restatements out of the 960 Fortune 1000 public companies).  The overall  restatement rates are higher in 2001 than the comparable levels of  restatements observed in 2002.  This may be due to the fact that our  analysis was limited to restatements submitted to the SEC on Form 10-KA  filings for 2001 and 2002 through August 31, 2003.  Some of the Fortune  1000 public companies that had not filed restatements with the SEC as of  August 31, 2003, may still do so in the future.   Additionally, because some  companies may require considerable amounts of time and effort to unravel  complex accounting and financial reporting issues (e.g., WorldCom, which  is in the process of working its way out of bankruptcy proceedings, and the  Federal Home Loan Mortgage Corporation, better known as Freddie Mac,  which is working to restate 3 years of previously issued financial  statements), it is reasonable to expect that additional restatements will be  included in Form 10-KAs or other filings that had not been submitted to the  SEC as of August 31, 2003.
Financial statement restatements filed for changes in accounting principles  or changes in organizational business structure (e.g., stock splits, mergers  and acquisitions), reclassifications, or compliance with SEC reporting  requirements, referred to as “rules based changes,” are not necessarily  indications of compromised audit quality or auditor independence.   However, financial statement restatements due to errors or fraud raise  doubt about the integrity of management’s financial reporting practices, the  quality of the audits, and the auditor’s independence.  Therefore, the  following focus of our analysis was on annual financial statement  restatements (hereinafter referred to as “restatements”) due to errors or  fraud.
The rate of restatement due to errors or fraud for Fortune 1000 public  companies that changed auditors were 10.7 percent in 2001 and 3.9 percent  in 2002 compared to restatement rates due to errors or fraud of 2.5 percent  in 2001 and 1.2 percent in 2002 for companies that did not change auditors.   Although the data indicate that the overall restatement rate is  approximately four times higher in 2001 and three times higher in 2002 for  those Fortune 1000 public companies that changed auditors than for those  companies that did not change auditors, caution should be exercised as  further analysis would be needed in order to determine whether the  restatements are associated with the “fresh look” of the new auditor  attributed to mandatory audit firm rotation.  In that respect, in some cases  we were able to determine from our review of the Form 10-KAs, any related  Form 8-Ks, and the results of Internet news searches, that the restatements  were identified as a result of an SEC investigation or an enforcement  action.  However, for the majority of the restatements we identified, the  information included in the SEC’s EDGAR system did not provide sufficient  information to ascertain whether company management, and in those  cases where there was a change in auditor, the predecessor auditor, or the  successor auditor identified the error or fraud and whether it was identified  before or after the change in auditor.  Also, the recent corporate financial  reporting failures have greatly increased the pressures on management and  auditors regarding honest, fair, and complete financial reporting.
subsections: section_title: Effect of Restatements Due to Errors or Fraud
paragraphs: The phrase in an auditor’s unqualified opinion, “present fairly, in all  material respects, in conformity with generally accepted accounting  principles,” indicates the auditor’s belief that the financial statements taken  as a whole are not materially misstated.  An auditor plans an audit to obtain  reasonable assurance of detecting misstatements that could be large  enough, individually or in the aggregate, to be quantitatively material to the  financial statements.  Financial statements are materially misstated when  they contain misstatements the effect of which, individually or in the  aggregate, is important enough to cause them not to be presented fairly, in  all material respects, in conformity with generally accepted accounting  principles.  As previously noted, misstatements can result from errors or  fraud.  As defined in Financial Accounting Standards Board Statement of  Financial Concepts No. 2, materiality represents the magnitude of an  omission or misstatement of an item in a financial report that, in light of  surrounding circumstances, makes it probable that the judgment of a  reasonable person relying on the information would have been changed or  influenced by the inclusion or correction of the item.
Table 8 summarizes the net dollar effect of the restatements due to errors  or fraud on the reported net income (loss) of all 43 companies’ previously  issued annual financial statements for the fiscal years, calendar years, or  both ended from 1997 through 2002.
The misstatement rates associated with these 43 companies’ previously  issued statements of net income (loss), which ranged from a 6.7 percent  overstatement of net income (loss) for 2000 to a 37.0 percent  understatement of net income (loss) for 2001, would clearly be considered  material enough to have affected the fair presentation of the results of  operations included in these 43 companies’ financial statements.   Accordingly, it is probable that the judgment of a reasonable person relying  on the information included in these companies’ previously issued financial  statements would have been changed or influenced by the inclusion of  omitted information or correction of misstated items due to errors or fraud.
section_title: International Experience with Mandatory Audit Firm Rotation
subsections: section_title: Italy
paragraphs: Italy has required mandatory audit firm rotation of listed companies since  1975 in which the audit engagement may be retendered (recompeting for  providing audit services) every 3 years and the same public accounting firm  may serve as the auditor of record for a maximum of 9 years.  In addition,  there is a minimum time lag of 3 years before the predecessor auditor can  return.  The mandatory audit firm rotation requirement was intended to  safeguard the independence of public accounting firms.  In a meeting with  IOSCO Standing Committee one member, the Italian representative from  Commissione Nazionale per le Societa e la Borsa (CONSOB), the Italian  securities regulator, indicated that Italy’s experience with mandatory audit  firm rotation has been a good one, noting that mandatory audit firm  rotation gives the appearance of independence, which is considered very  important to maintaining investor confidence.  However, it was also noted  that there have been negative impacts, when after 3 years, there is fee  pressure by the listed company on the audit firm that contributes to  reduced audit fees.  In responding to our survey, CONSOB’s representative  indicated that there has been a progressive reduction in audit fees, which  has given rise to concern over audit firms’ ability to maintain adequate  levels of audit services and quality control.
Research in Italy concludes that mandatory audit firm rotation carries  significant threats to audit quality from competitive pressures.  However,  the CONSOB raised concerns about the study’s methodology, accuracy,  data used, and appropriateness of the conclusions.  Our review of the  executive summary of the study also identified potential limitations on the  reliability of data used and methodological concerns that created  uncertainties about the study’s conclusions.   Italy has also considered  partner rotation; however, because Italy is currently considering reducing  the maximum auditor tenure from 9 years to 6 years, partner rotation has  not been given further consideration.
section_title: Brazil
paragraphs: Brazil enacted a mandatory audit firm rotation requirement in May 1999  with a 5-year maximum term and minimum time lag of 3 years before the  predecessor auditor of record can return.  The Comissao de Valores  Mobiliarios (CVM), which is the Brazilian Securities Commission, indicated  that the primary reason mandatory audit firm rotation was enacted was to  strengthen audit supervision following accounting fraud at two banks  (Banco Economico and Banco Nacional).  Brazil does not have a partner  rotation requirement, as the CVM believes that the requirement of rotating  audit firms is stronger than changing partners within firms.  However, as a  component of its mandatory audit firm rotation requirement, Brazil  prohibits an individual auditor who changes audit firms to audit the same  corporations previously audited.
section_title: Singapore
paragraphs: Starting in March 2002, the Monetary Authority of Singapore stipulated that  banks incorporated in Singapore should not appoint the same public  accounting firm for more than 5 consecutive financial years.  However, this  requirement does not apply to foreign banks operating in Singapore.  Banks  incorporated in Singapore that have had the same public accounting firm  for more than 5 years have until 2006 to change their audit firms.  While a  “time out” period is not stipulated, banks incorporated in Singapore shall  not, except with the prior written approval of the Monetary Authority of  Singapore, appoint the same audit firm for more than 5 consecutive years.   In addition, listed companies are required under the Listing Rules of the  Singapore Exchange to rotate audit partners-in-charge every 5 years.
The primary reason Singapore instituted mandatory audit firm rotation for  local banks was to promote the independence and effectiveness of external  audits.  In addition, mandatory audit firm rotation for local banks was cited  by Singapore’s officials as a measure to help (1) safeguard against public  accounting firms having an excessive focus on maintaining long-term  commercial relationships with the banks they audit, which could make the  firms too committed or beholden to the banks, (2) maintain the  professionalism of audit firms—where with long-term relationships, audit  firms run the risk of compromising their objectivity by identifying too  closely with the banks’ practices and cultures, and (3) bring a fresh  perspective to the audit process—where with long-term relationships,  public accounting firms might become less alert to subtle but important  changes in the bank’s circumstances.
section_title: Austria
paragraphs: In Austria, Austrian Commercial Law will require mandatory audit firm  rotation every 6 years to strengthen the quality of audits and to enhance  auditor independence by limiting the time of doing business between the  audited company and its auditor of record.  The 6-year mandatory audit  firm rotation requirement will become effective from the beginning of the  year 2004, and there will be a minimum time lag of 1 year before the  predecessor auditor of record can return.  Austria does not have a partner  rotation requirement; however, anyone who serves as the audit partner of a  public company for 6 consecutive years will not be allowed to continue to  serve in that capacity by becoming employed by the company’s successor  auditor.
section_title: United Kingdom
paragraphs: In January 2003, the United Kingdom adopted the recommendations of the  Co-ordinating Group on Audit and Accounting Issues (CGAA) to  strengthen the audit partner rotation requirements by reducing the  maximum period for rotation of the lead audit partner from 7 years to 5  years.  The United Kingdom also adopted CGAA’s recommendation to limit  the maximum period for rotation of the other key audit partners to 7 years.   According to the CGAA report, the rotation of the audit engagement  partner has been a requirement in the United Kingdom for many years, and  the United Kingdom concluded that the requirements for the rotation of  audit partners played an important role in upholding auditor independence.
With respect to the issue of mandatory audit firm rotation, the United  Kingdom supports CGAA’s recommendations, which concluded that the  balance of advantage is against requiring the mandatory rotation of audit  firms.  The primary arguments against mandatory audit firm rotation, as  cited in the CGAA report, include the possible negative effects on audit  quality and effectiveness in the first years following a change, the  substantial costs resulting from a requirement to switch auditors regularly,  the lack of strong evidence of a positive impact on audit quality, the  potential difficulty or impossibility of identifying a willing and able audit  firm that can accept the audit without violating independence requirements  in a concentrated listed company audit market, and competitive  implications of such a requirement.  However, CGAA also recommended  that audit committees should consider changing their auditor of record  when the audit tenure is from 15 years to 20 years.
section_title: France
paragraphs: In France, audit partner rotation had been required since 1998 by the  French Code of Ethics of the accounting profession.  However, the  requirement was not enforceable because the Code of Ethics had not  specified any maximum length for mandatory rotation of audit partners.  In  August 2003, France promulgated the French Act on Strengthening of  Financial Security, which makes it illegal for an audit partner to sign more  than six annual audit reports.  The main requirement that serves as an  alternative to mandatory audit firm rotation is the French requirement of  having two firms engaged in the audit of entities issuing consolidated  financial statements, which has been a requirement since 1985 and has  been reincluded in the August 2003 promulgation of the French Act on  Strengthening of Financial Security.  According to the Deputy Chief  Accountant of the Commission des Operations de Bourse, mandatory audit  firm rotation is not required in France primarily because of concern over  the potential impairment of audit quality due to the new auditor’s lack of  knowledge of the company’s operations.
section_title: Spain
paragraphs: The Comision Nacional del Mercaso de Valores (CNMV)—the agency in  charge of supervising and inspecting the Spanish stock markets and the  activities of all the participants in those markets—indicated that from 1989  through 1995, Spain had a mandatory audit firm rotation requirement with  a maximum audit term of 9 years, which included mandatory retendering  every 3 years.  The main objectives of this former requirement were to  enhance auditors’ independence and promotion of fair competition.   However, in 1995, the Spanish “Company Law” and the Spanish “Audit Law”  were amended, effectively eliminating the mandatory audit firm rotation  requirement, by allowing that “after the expiration of the initial period  (minimum 3 years, maximum 9 years), the same auditor could be re-hired  by the shareholders on an annual basis.”  The Director of the CNMV  indicated that the 9-year mandatory audit firm rotation requirement was  abandoned since the main objective of increased competition among audit  firms had been achieved and because of listed companies’ increased  training costs incurred with a complete new team of auditors from a new  public accounting firm.  In November 2002, the Spanish “Audit Law” was  amended to introduce a new requirement under which “all audit-engaged  team” members (including audit partners, managers, supervisors, and  junior staff) have to rotate every 7 years in certain types of companies,  which include all listed companies, companies subject to public  supervision, and companies with annual revenues over 30 million euros.
section_title: The Netherlands
paragraphs: In January 2003, the Royal Nederlands Instituut van Register Accountants  (NIvRA) and Nederlandse Orde van Accountants-Administratieconsulenten  (NOvAA) of the Netherlands, which are the bodies that represent the  accounting profession in the Netherlands and are responsible for the  qualifications and regulation of the accounting profession, adopted the  recommendation of CGAA to strengthen the audit partner rotation  requirements by reducing the maximum period for rotation of the  engagement audit partner from 7 years to 5 years and to limit the maximum  period for rotation of the other key audit partners to 7 years.  The adoption  of these measures by both NIvRA and NOvAA made these requirements a  part of the code of conduct for auditors.   A representative of the  Netherlands Authority for the Financial Markets indicated that the Dutch  government is in the process of promulgating these audit partner rotation  regulations into law, where the requirement will only apply to public  interest entities.
section_title: Japan
paragraphs: In Japan, the Amended Certified Public Accountant Law was passed in May  2003, and beginning on April 1, 2004, audit partners and reviewing partners  will be prohibited from being engaged in auditing the same listed company  over a period of 7 consecutive years.  Mandatory audit firm rotation has  never been required in Japan, and public companies have never been  encouraged to voluntarily pursue audit firm rotation.  While Japan agreed  with the December 2002 report issued by the Subcommittee on Regulations  of Certified Public Accountants of the Financial System Council that  mandatory audit firm rotation will need further consideration in the future,  Japan’s securities regulator stated that mandatory audit firm rotation was  not supported because of the concerns that it (1) may cause confusion  given the concentration of audit business held by large public accounting  firms, (2) is not required in other major countries other than Italy, (3) may  significantly lower the quality of audits due to the need to arrange newly  organized audits, and (4) would result in greater cost of implementation  under the current concentration of audit business held by large public  accounting firms.
section_title: Canada
paragraphs: There are currently no Canadian requirements for mandatory audit firm  rotation.  However, mandatory audit firm rotation was included in banking  legislation shortly after the 1923 failure of the Home Bank and up to the  December 1991 revision of the Bank Act.  The Bank Act required that two  firms audit a chartered bank, but that the same two firms could not  perform more than two consecutive audits.  As a result, one of the two  firms would have to rotate off the audit for a minimum of 2 years.
According to Canadian officials, in practice this requirement was  implemented in two different ways.  Some banks appointed a panel of three  audit firms with one of the three firms being a permanent auditor while the  other two firms rotated every 2 years.  Other banks appointed a panel of  three audit firms and rotated among the three firms.  Generally, the firm  that was in its “off year” did not completely step away from the audit of the  bank and would maintain at least a watch on developments in the bank’s  business and financial reporting to ensure that it was knowledgeable  enough to step back in when it rotated on again.
One of the primary benefits of the system was believed to be that the use of  two firms facilitated an independent review of the loan portfolio.  This new  perspective was generally considered to be a useful safeguard, and it was  believed that the second firm would not bring with it an element of  additional cost.  The rotation element of the system was considered to  bring with it an additional element of security by ensuring that issues were  reviewed regularly by auditors with a fresh perspective, thus minimizing  the risk of a problem festering because an issue was decided on and not  reevaluated.
Since the 1923 failure of the Home Bank, the dual auditor requirement with  mandatory audit firm rotation for one of the two audit firms every 2 years  was in place for over 60 years and was considered to be one of the key  safeguards in the bank governance system.  However, in 1985 two regional  banks in the province of Alberta failed despite the existence of the dual  auditor system.  A subsequent government inquiry into the failures found  that the Office of the Inspector General of Banks, now the Office of the  Superintendent of Financial Institutions (OSFI), heavily relied on the  external auditors and recommended the need for some direct examination  by the supervisor of the quality of banks’ loan portfolios.  Until 1991, only  Canadian banks were required to rotate their auditor of record.  In 1991, in  line with a push for harmonized supervision, banking legislation was  amended to reduce the requirement to one audit firm, and the mandatory  audit firm rotation requirement was abandoned with the revision of the  Bank Act.  According to Canadian officials, one of the reasons for the  abandonment was that many argued that the cost was not matched by the  benefits and it was noted that Canada seemed to be largely alone in the  world imposing such a system.  There were few strong advocates for  retaining the system, but questions were raised as to whether it was in fact  a valuable element of protecting the safety and soundness of the banking  system.
Mandatory audit firm rotation is not currently being considered in Canada.   Instead, as of July 2003, mandatory rotation of audit partners for all public  companies was being considered by Canada’s securities regulator,  supported by a new model of independent oversight and inspection of  auditors of public companies.  The accounting profession, through the  Public Interest and Integrity Committee of the Canadian Institute of  Chartered Accountants and in collaboration with provincial institutes, is  considering developing an updated independence standard that considers  certain requirements of the Sarbanes-Oxley Act for Canadian application to  listed financial institutions regulated by OSFI.  This independence standard  will focus on mandatory rotation of the engagement partner rather than the  firm auditing a listed enterprise regulated by OSFI, as well as other key  members of the firm involved with the audit.  According to Canadian  officials, extending this requirement to nonlisted financial institutions is  under consideration but the outcome will not be known for some time.
section_title: Germany
paragraphs: In Germany, according to the German Commercial Code, a qualified auditor  or certified accounting firm, beginning with annual financial statements  issued after December 31, 2001, may not be an auditor of a stock  corporation that has issued officially listed shares if it employs a certified  accountant who has signed the certification concerning the examination of  the annual financial statements or the consolidated financial statements of  the corporation more than six times in the 10 years prior to the fiscal year  to be examined.  According to German officials, the principle of audit  partner rotation has proven to be successful, and there are no plans to  switch to a model based on mandatory audit firm rotation because the  purpose of guaranteeing an independent audit of the financial statements  of a company can be efficiently achieved by audit partner rotation.   However, in order to improve investor protection and company integrity,  Germany’s federal government published a 10-point paper, which included  a planned amendment to the corresponding Commercial Code regulations  to shorten the period of time after which an auditor of record must rotate  to every 5 years and to include all responsible audit partners in the rotation  requirement.
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section_title: Staff Acknowledgments
paragraphs: In addition to those individuals named above, William E. Boutboul,   Cheryl E. Clark, Robert W. Gramling, Wilfred B. Holloway,   Michael C. Hrapsky, Catherine M. Hurley, Charles E. Norfleet,   Judy K. Pagano, Sidney H. Schwartz, Jason O. Strange,   Partricia A. Summers, and Walter K. Vance made key contributions to this  report.
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