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. 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. 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. 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.