U.K. Watchdog Softens Stance on Auditor Rotation

Companies will have to put out their audit contract for tender every ten years, rather than every five years.

In another blow to advocates for full and mandatory audit rotation, the U.K. Competition Commission has decided against requiring listed firms to put their audit contract out for tender every five years, instead requiring them to do it every ten years.

The Commission, which proposed final measures on audit rotation this week, says the longer time horizon for tendering along with other requirements “better serve the needs of shareholders.”  It still maintains, however, that companies would actually benefit from going out to tender more frequently.

“The Competition Commission has listened to feedback from the business and regulatory communities about the additional costs and disruption five-yearly re-tendering would cause,” said Michael Izza, chief executive officer of the London-based Institute of Chartered Accountants in England and Wales (ICAEW) in a statement.  “At a time when economic recovery is still hanging in the balance and businesses need to focus on driving growth, this is the right decision.”

U.K.-based companies listed on the FTSE 350 Index will have to inquire about other audit engagements at least every 10 years, and if companies choose not to comply, the firm’s audit committee will be required to report in which financial year it plans to put the audit engagement out to tender. It will also have to then report why that decision was in the best interests of shareholders.

“We would urge businesses to do a broader survey of audit firms and the capabilities before determining their preferred suppliers for audit and non-audit services,” added Izza.

The new requirements support some views of the Financial Reporting Council, the U.K.’s independent regulator for corporate governance and reporting, which called five-year tendering “disproportionately costly for companies and audit firms” and said the practice “could undermine the Commission’s goal of promoting competition in the audit market.” However, the FRC had previously recommended tendering with a looser requirement of having firms “comply or explain.”

The Competition Commission’s stance is also in line with similar anti-audit-rotation moves in the United States, though they could still butt heads with European Commission proposals that have yet to be finalized. In July, the House of Representatives dealt a blow to the Public Company Accounting Oversight Board (PCAOB) when it passed a bill prohibiting it from requiring public companies to rotate auditors.

In addition, the U.K. Competition Commission took a stronger stance on the use of traditional top-tier auditors. The measures specifically prohibited the use of “Big-4-Only” clauses in loan agreements, which were quite common in practice, limiting a company’s choice of auditor to the top, large accounting firms such as Ernst & Young, Deloitte, KPMG and PricewaterhouseCoopers.

The new measures also firmed up audit-committee responsibilities by outlining specific audit-committee requirements. Only the audit committee is permitted to negotiate audit fees and influence the scope of audit work, initiate tender processes, make recommendations for the appointment of auditors and authorize the external audit firm to carry out non-audit services.

The Commission noted that competition is restricted in the audit market, in part, due to the incentives that auditors have to satisfy management as opposed to shareholders.

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