In response to the wave of corporate crises, the Sarbanes-Oxley Act includes a provision regarding mandatory audit partner rotation for firms auditing public companies. This should not be confused with audit firm rotation and it is important to make the distinction. The Act requires the lead audit partner and audit review partner (or concurring reviewer) to be rotated every five years on all public company audits. The Act requires a concurring review of all audits of issuers (as defined in the Act). The focus of this document is audit partner rotation. However, it also discusses the circumstances in which audit partner rotation can be tantamount to audit firm rotation.
A Reasoned Approach
A reasoned, logical approach should be taken in considering imposing mandatory audit partner rotation at the state level. On January 28, 2003 the SEC adopted rules to effectuate the statutory requirement of audit partner rotation found in Sec. 203 of the Sarbanes-Oxley Act. In addition to the five-year rotation requirement of the lead and concurring audit partners, the rules also mandate a five-year “timeout” period after rotation. The rules, as adopted, specify that certain other significant audit partners will be subject to a seven-year rotation requirement with a two-year “timeout” period. The rule provides an alternative for firms with fewer than five public audit clients and fewer than ten partners. The alternative requires the Public Company Accounting Oversight Board (PCAOB) to review all of the firm’s engagements subject to the rule at least once every three years. Further, the Sarbanes-Oxley Act requires the Government Accounting Office (GAO) to conduct a study of the effectiveness and implications of audit firm rotation.
In a reasoned approach at the state level, it would not be logical to attempt to replicate what has already been done at the federal level regarding audit partner rotation. It would also be logical to await the results of the GAO study regarding audit firm rotation before taking any action on that issue. The following is a discussion of several factors to consider which may provide a broader understanding of the implications of mandating audit partner rotation for firms auditing nonpublic entities.
Audit Practice Considerations and the Public Interest
As noted above, the Sarbanes-Oxley Act requires the lead audit partner and audit review partner (or concurring reviewer) to be rotated every five years on all public company audits. Generally Accepted Auditing Standards, which apply to SEC and non-SEC engagements alike, do not require a concurring partner review. If the concurring partner review requirement were enacted for all engagements, sole practitioners would have to either give up their audit practice or outsource the concurring review function to another firm.
In addition, for sole practitioners and small firms with a limited number of audit partners, adopting a mandatory audit partner rotation requirement would be tantamount to firm rotation. They could not meet the rotation requirement and would therefore have to give up the audit to another firm. Because smaller audit firms would need to employ more professionals to meet the audit partner rotation mandate, many firms could cease providing audit services, thus eliminating competition and the cost and quality benefits associated with competition. Small businesses that employ these firms would be at a disadvantage either as a result of potentially higher costs of audit services (due to a reduced supply of auditors) or their total inability to engage an auditor because local firms may opt to eliminate audit services from their practices.
Limiting the number of firms performing audits or imposing rules that inadvertently cause firm rotation is not in the public interest.
It is clear that Congress believed that audit partner rotation was an important element to achieving a...