Auditor Resigns over Rotation Rule

Critics say the Sarbox clause requiring lead partners to change within five years puts pressure on the smallest audit firms, and Cordovano and Honeck says it's hurt them twice.

As the Sarbanes-Oxley Act approaches its fifth anniverary, some small independent auditors may soon feel a squeeze from the legislation’s “audit partner rotation” rule. Independent accounting firm Cordovano and Honeck LLP has cited the rotation rule as the reason it severed ties with Signature Leisure Inc., an investor relations firm, according to a Signature Leisure 8-K filing last week.

The Sarbox rotation rule, designed to prevent auditors and client companies from becoming too closely involved, mandates that a registered public accounting firm must not use the same lead audit partner or other partner responsible for a client’s audit review for a five-year period. While this is rarely a problem for a larger auditing firm, which can replace lead audit partners regularly, it could be a burden for small firms short on available partners, according to critics in the profession.

“Cordovano and Honeck LLP has provided audit services to Signature Leisure for the December 31, 2002 through 2006 calendar years. In each of these years, Mr. Cole Honeck and Mr. Sam Cordovano acted as the lead and reviewing partners, respectively,” according to the 8-K. “As a result, the firm will not be able to perform the December 31, 2007 audit of Signature Leisure.”

“Since they’ve done it for five years, they have nobody else to do their peer review,” says Stephen Carnes, president and CEO of Casselberry, Fla.-based Signature Leisure. The two-person auditing firm “had to gratiously bow out.” Carnes said that since he did not know the nuances of the Sarbanes-Oxley act, he was surprised when he got the call that Cordovano and Honeck was resigning. The replacement firm that Signature Leisure has contracted, which he did not identify, is bigger and will not be affected by the partner rotation rule.

The rotation rule also has been criticized for adding costs for auditors and clients, requiring additional time to process new information during the switch. In 2003 the American Institute of Certified Public Accountants said, “The potential reduction of firms performing audit services and the resulting increase in costs to small business by mandatory audit partner rotation is not in the public interest.” The Institute feared that small audit firms, with just three or four partners, would be hit the hardest, potentially dampening competition and raising the costs of audits. On Wednesday, an AICPA spokeswoman declined to comment on the matter.

“You lose intellectual capital,” says Steven Sacks, executive director at Moore Stephens North America Inc., which represents small audit firms. “I certainly understand the heightened sensitivity, but you lose the relationship between auditors and management.”

In 2004, a Government Accountability Office study said that the additional auditor independence gained through auditor rotation may not be worth the additional costs and loss of “institutional knowledge” incurred by changing a company’s auditor of record.

Denrer-based Cordovano and Honeck also resigned earlier this year from Nickelby’s.com, an online business that sells antiques and collectibles, citing the audit rotation regulation.

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