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CAQ Urges Caution with European Commission Proposals to Reform the Financial Statement Audit Process

By Jim Hamilton

The Center for Audit Quality takes a cautious view of European Commission proposals to reform the financial statement audit process to enhance the role of auditors, eliminate conflicts of interest by mandating rotation of audit firms and ending the issuer pay model. In a letter to the Commission on its recent Green Paper, CAQ said that mandatory audit firm rotation is likely to undermine audit quality by reducing the responsibility of the audit committee to select the auditors. Mandatory rotation is also costly for companies, and increases the burdens on audit committees to oversee the work of the auditor. CAQ noted that private and public sector studies consistently have recommended against mandatory firm rotation because of cost and other inefficiencies for companies and their shareholders.

CAQ is opposed to the Commission?s suggestion that the focus of outside audits should be extended beyond the current historical information to assessing forward looking information provided by the company and giving an economic and financial outlook of the company. Independent audits are designed to give assurance on financial information provided by management of a company as of a point in time, said CAQ, and are not designed to provide an opinion on a company?s business model or likely earnings, which is the role of analysts, rating agencies and the company itself. Care should be taken to assure that new roles do not jeopardize auditor independence or confuse the auditor?s role with those of analysts, rating agencies and company management

With respect to providing assurance on the reliability of corporate social and environmental responsibility reports, continued CAQ, reporting frameworks are still in the development stage and there is no agreement on definitions or on how to integrate nonfinancial information with financial information. On the issue of whether auditors should have regular communications with external stakeholders, CAQ recommend looking first at ways to improve the communications and reporting provided by companies to external stakeholders, including the possibility of expanded reporting by audit committees.

The Commission suggests a number of measures that might be implemented to further reinforce auditor independence, some of which, such as appointment of the auditor by a third party and a blanket prohibition on non-audit services, would, in CAQ?s view, go far beyond what is needed to accomplish this goal. CAQ believes that the conflict of interest that exists when an auditor is appointed and paid by the company whose books it is auditing can be mitigated through independence rules, ethics requirements and, importantly, placing responsibility on audit committees to oversee the auditor. CAQ does not support having a third party appoint the auditor as that would completely undermine the role of the audit committee and investor choice and implicate the government in private corporate matters.

Full post as published by Jim Hamilton's World of Securities Regulation on December 11, 2010 (boomark / email).