The U.S. Treasury Department got an earful last week on how it should address growing concerns that the auditing business may not be sustainable under current market and regulatory forces.
The department assembled its Advisory Committee on the Auditing Profession for an all-day hearing with leaders from audit firms, academic circles, law firms, other professional service providers, and leading finance and accounting associations. Absent, however, was any contingent from the regulatory community itself, except for a sole representative of state boards of accountancy.
Experts offered varied views on what’s wrong with the current environment surrounding the audit profession: too much concentration of talent among too few firms, too much exposure to catastrophic liability, and too little latitude to exercise professional judgment, among many other concerns. The speakers also offered public policy initiatives that might address their worries.
Carcello
Joseph Carcello, director of research at the University of Tennessee Corporate Governance Center, said the core problem for the audit profession is that it does not directly work for its end consumer (the investor relying on audits), but rather for corporate audit committees trusted to act in investors’ interests.
“A direct market for audit services—a market between the auditor and the ultimate beneficiary of the auditor’s work product—does not exist,” Carcello said. “The question is whether our existing market mechanisms approximate the result that would be obtained in a direct market.”
Carcello said audit committees too often focus on audit costs rather than audit quality, and shareholders under current proxy rules have little leverage over board make-up. That underscores the need for more auditors with an appreciation for the public responsibility of the audit profession, he said. As such, he believes the Public Company Accounting Oversight Board, already charged with regulating auditors, should also assume responsibility for educating and licensing auditors.
Workforce development concerns were another prominent theme. Too few college graduates are entering the audit profession, witnesses said; just as alarming is a lack of accounting professors to teach the subject. Ira Solomon, accounting professor at the University of Illinois, said the professor shortage is partly due to the “highly constrained availability of data” to conduct auditing research, a vital part of any professor’s effort to get tenure and long-term job success.
Julie Wood, chief people officer at Crowe Chizek, called for new incentives to provide financial support for doctoral candidates, to attract more college students to the profession, and to support retention of experienced auditors. “Policymakers should look for ways to reduce professional risks that may drive veteran auditors out of the profession,” she said. “They also should work to remove regulatory and other policy barriers to professional advancement.”
Wood wanted to see greater uniformity of standards among the more than 50 state and other jurisdictional bodies that license auditors now. Louis Grumet, executive director of the New York State Society of Certified Public Accountants, agreed that licensing should somehow be more streamlined.
Grumet stopped short of endorsing a single, nationwide license for certified professional auditors. Instead, he said, “The profession needs one set of professionally developed standards that can be the basis for regulation on a state, national, and international level. What it does not need is 50 jurisdictions setting separate regulations.”
He suggested policymakers consider an interstate compact, or a contract between states that allows them to solve multistate, regional, and national problems through voluntary agreement.
The Consolidation Concern
AUDITOR COMMENTS
Below are excerpts of testimony given by James Turley, CEO of Ernst & Young, to the Auditing Profession Advisory Committee.
Ernst & Young agrees with the Advisory Committee’s over-arching principles stating that “[t]he audit market
benefits from a competitive and innovative population of auditing firms.” We support sensible efforts to
encourage greater participation by more accounting firms in the public company audit market.
In the context of the public company audit market, we see the three words—concentration, choice and
competition—as being quite distinct. There clearly is concentration in the audit market, particularly when one
considers the percentage of market capitalization audited by the largest accounting firms. The degree of choice
available in the selection of an audit firm can be an issue only for the very largest of companies where the
global reach and capacity of the largest firms is important (independence rules also have an impact on choice as
discussed later).
Yet even within this segment of the market—serving large multi-national corporations—and certainly across all
market segments, it is important to recognize the level of intense competition that exists between accounting
firms. Competition is based on accounting expertise, industry expertise, client service models, firm culture,
geographic reach, price and other factors. In its 2003 report on audit firm concentration, the U.S. Government Accountability Office (GAO) “found no empirical evidence that competition in the audit services market has
been impaired to date.” We understand GAO is in the process of updating their report.
Mid-tier or medium sized firms have the depth and reach to handle all but the largest multinational companies.
With this recognition, many public companies have migrated to audit firms other than the four largest. In the
long term, well-conceived, market-based measures such as challenging market biases would have the best
chance to continue this trend and allow the larger mid-tier firms to increase their penetration into the large
company market …
We believe a shared commitment across the profession to pooling audit firm resources to develop certain audit
tools, techniques, and methodologies—such as anti-fraud initiatives—would help all firms in the performance
of audits and could strengthen smaller firms in the profession without requiring a commensurate level of
investment on their part. However, there is some uncertainty as to anti-trust implications of such efforts.
Therefore, the Treasury Committee could recommend that regulators explore with the profession and aid in
resolution of any anti-trust issues that may impede such efforts.
Overall, we do not believe there is a “silver bullet” that will rapidly increase auditor choice, especially at the top
end of the market. Any proposal for increasing competition must be considered for its impact not just on choice,
but on audit quality and independence. Also, a careful assessment should be made of costs versus benefits and
of unintended detrimental consequences that could result from intervention in the marketplace. For example, we
do not believe there is a persuasive case that can be made in support of proposals such as mandatory firm
rotation or a break-up of the largest firms as a means to foster increased choice. In our view, these proposals
would have a significant negative effect on audit quality, domestically and globally.
Source
Auditing Profession Advisory Committee (Dec. 3, 2007)
As for growing concern about the risk of an audit firm collapsing under a crippling liability claim, a number of experts cautioned the panel against considering any kind of protection or cap on legal liability, despite recent reports that some European countries are considering establishing just such protections.
Cunningham
Lawrence Cunningham, a law professor George Washington University, told the panel that auditors have already been given some protections as a result of various changes in the 1990s, most notably the Private Securities Litigation Reform Act. Still, he said, audit quality seems to have declined since then.
Cunningham worried that with caps on legal liability, auditor independence could be compromised. He said efforts to write rules providing such protections can’t fully anticipate all the potential circumstances involved in a given audit failure, leaving loopholes that can be exploited after the fact.
Cunningham said the panel should also remember that audit firms changed their structures in the 1990s, from traditional partnerships to limited liability entities, reducing the professional liability for audit partners. “This would reduce incentives to maintain internal control or otherwise administer performance standards and client severance policies,” he said.
Dennis Nally, chairman and senior partner at PricewaterhouseCoopers, said the committee should focus instead on the need for litigation reform more broadly. “We would urge the Committee to study first the root causes of the problem and consider whether the U.S. securities litigation system efficiently accomplishes the goals of compensation and deterrence,” Nally said. “Broad-based securities litigation reform is an important component of the U.S. capital markets competitiveness debate.”
Turley
One of Nally’s counterparts, Ernst & Young CEO James Turley, was more receptive to liability caps. The committee should consider measures to eliminate or at least significantly reduce the threat of serious harm to investors and the capital markets “from a verdict against an audit firm in private litigation so large as to destroy the audit firm,” he said.
Second-guessing of accounting decisions was another sore point with committee witnesses. “The Treasury Committee should support establishment of a framework to provide clarity as to when exercise of good-faith accounting and auditing judgments will be respected by regulators and in legal proceedings,” Turley said. “If good-faith preparer and auditor judgments would be respected, that would increase the potential for success of principles-based standards rather than a body of guidance consisting of a plethora of rules, bright lines, exceptions, and interpretations.”
Turley said the committee should also take a close look at independence rules and the extent to which they may impede choice among audit firms for audit clients. Definitions for terms like “audit client” and “affiliate” may unnecessarily restrict auditor choice, he said. Thickets of rules among various regulatory bodies—the PCAOB, the Securities and Exchange Commission, the American Institute of Certified Public Accountants, and the various state boards of accountancy, to name a few—doesn’t help.
Wayne Collins, national director of assurance at BDO Seidman, said the panel should consider measures to enhance audit capabilities and competition. One example, he said: regulatory guidance to encourage audit committees to use smaller firms, or alliances of smaller firms that approximate the reach of a national firm.
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