Yes, the House Bill That Bans Auditor Rotation Is Terrible But There May Be an Upside

As you know, yesterday the House of Representatives passed H.R. 1564, the Audit Integrity and Job Protection Act, with bipartisan support, 321-62. The charge was led by the bill's co-sponsors, Rep. Robert Hurt (R-VA) and Rep. Gregory Meeks (D-NY). Here's an enthusiastic statement from Rep. Hurt via Accounting Today:
The Audit Integrity and Job Protection Act would prevent the threat of federal over-regulation so that our businesses can continue to focus on creating the jobs that our local communities need rather than cutting through more government red tape,” Hurt [said]. “By passing this legislation, the House of Representatives has taken one more step toward our goal of creating certainty for our job creators and getting our economy back on track so that our small business owners can get back to creating the jobs that 5th District Virginians and Americans across the country need and deserve.”
None of this actually means anything, of course. The only businesses that are affected here are the firms subject to oversight by the PCAOB, and the majority of those businesses are 1) not small and 2) not dissuaded from hiring people because of the "threat of federal over-regulation."
 
But never mind that, the accounting profession loves this bill. Here's the nauseating statement from AICPA CEO Barry Melancon that was sent to every reporter with an email address: 
“In the absence of evidence that mandatory audit firm rotation would enhance audit quality, the House has sent regulators in the United States and Europe a clear message that the time has come to end the debate over rotation. In Europe, there is a misimpression that the continued consideration of the PCAOB’s concept release means that the U.S. is headed toward adoption of a mandatory firm rotation requirement. Today's House vote will go a long way toward alleviating confusion and uncertainty for policy makers and stakeholders on both sides of the Atlantic. I want to thank the measure's co-sponsors, Representatives Robert Hurt of Virginia and Gregory Meeks of New York, as well as its many congressional supporters.”
It's pretty funny that Melancon would have you believe that the Europeans actually think auditor rotation is under serious consideration when it's barely on the PCAOB's agenda anymore. 
 
Francine McKenna's takedown of bill is worth a read, but here's the jist:
Yesterday the U.S. House of Representatives voted 321-62 for the H.R. 1564, the Audit Integrity and Job Protection Act. I’ve got news for the Congressmen and Congresswomen:  The integrity of the audit industry is already shot to hell. Again. The only jobs you’re protecting belong to the audit industry, in business by virtue of the laws Congress enacted and the SEC enforces, albeit less strenuously lately, that require an audit be performed by a PCAOB registered public accounting firm for every public company and broker-dealer.
And Justin Fox at Harvard Business Review is also right to be suspicious:
If an overwhelming bipartisan majority in the U.S. Congress decides to delve deep into the details of a corporate regulatory process and tell the rule-makers they can't do something, that overwhelming bipartisan majority is up to no good. 
This is an awful bill. Everyone knows it -- even the people who voted for it -- and I'd be shocked if a Senate bill was taken up, but something that was brought to our attention, by a source familiar with the situation, is a wrinkle in SEC rules that could be an opening for shareholder activists and the new ambitious-about-accounting-and-auditing-fraud SEC.  
 
Last year, Dena Aubin of Reuters reported that the United Brotherhood of Carpenters pension fund, a shareholder rights activist, wanted more transparency from companies about their relationships with their audit firms. Ed Durkin, director of corporate affairs for the carpenters' union pension fund said at the time, "There needs to be an independence report provided every year that gets into this relationship."
 
The resolution proposed by the fund was to "ask companies to disclose whether they periodically consider switching auditors and if not, why; how much has been paid to the audit firm over the years; and whether the board's audit committee looks at potential risks from having a long-tenured auditor." Then the article mentions this:
The carpenter's union suffered a setback late last year when the U.S. Securities and Exchange Commission ruled that companies would not be punished for leaving auditor rotation off their ballots because it was ordinary business that did not have to be put to a shareholder vote. The union had tried to place rotation on the ballot at about 40 companies.
Good so far? Okay, stick with me. There are some important details in the letters between the Commission's Division of Corporate Finance and the Brotherhood that I've looked over. (You can review it for yourself here and another one here and another one here). In its letter to the DCF -- making arguments why auditor rotation should be voted on by shareholders -- the Brotherhood explained that its denial of bringing up the proposal with the Commission (aka "no-action letter") was not consistent with SEC policy:
The Staff's No-Action Letter position that the auditor rotation proposal may be omitted under Rule 14a-8(i)(7) as "concerning the selection of independent auditors or, more generally, management of the independent auditor's engagement" is contrary to the long line of Commission pronouncements and Staff no-action decisions in which "ordinary business" objections have been rejected when an issue is a "significant policy issue" and the subject of "widespread debate." 
The letter goes on to list examples of "significant policy issues" that were subject to "widespread debate" and not considered "ordinary business" and were therefore considered for enforcement by the SEC. But as the Reuters report stated, the DCF ultimately rejected the Brotherhood's request.
 
Then, last June SEC Commissioner Luis Aguilar gave a speech that highlighted the proposals brought by the Carpenters Union, discusses the basis of the DCF's rejection of them, and his feeling that the issue of auditor rotation is beyond "ordinary business":
In addition to the PCAOB, some shareholders have also expressed concerns about audit quality by submitting shareholder proposals relating to the audit engagement process. For example, a proposal submitted to companies such as Walt Disney, Deere, Alcoa, GE, and AT&T requested that the company establish an auditor rotation policy that would have imposed a seven-year term limit on the engagement.
 
[...]
 
The companies that received these proposals generally sought to exclude them from their proxy statements on the ground that the proposal related to a matter of ordinary business that should be left to management and the board. The SEC’s Division of Corporation Finance received at least 24 requests to exclude the above proposals on such grounds, and in each case the staff sided with the issuer by issuing a “no-action letter.” However, such letters by the staff do not require Commission input, and do not represent a determination by the Commission or any of the Commissioners.
 
The staff action was predicated on current SEC rules that permit a company to exclude a shareholder proposal if the proposal deals with a matter relating to the company’s ordinary business operations. However, there is an important exception to that rule: In those cases in which a proposal's underlying subject matter transcends the day-to-day business matters of the company and raises significant policy issues, the proposal is generally not excludable on such grounds. This is particularly the case when an issue has emerged as a topic of “widespread public debate,” as this issue has been. Given the extensive public discussion occasioned by the PCAOB’s concept release, and the long history of debate on this issue, a strong case can be made that shareholder proposals relating to auditor independence and objectivity and audit quality raise significant policy issues and should not be excluded on ordinary business grounds.
Back to present day, here's something that Maxine Waters (D-CA), Ranking Member of the House Financial Services Committee, said when HR 1564 was held for markup:
[W]hile I question whether mandatory auditor rotation is the best way by which to enhance auditor independence, I am concerned about micromanaging the PCAOB and tying their hands in perpetuity, particularly since all they have done so far is to ask questions about the issue. But by introducing this bill, it has become clear that the issue of auditor rotation is worthy of widespread debate in Congress, since the issue is highly complex and of substantial importance.
According to our source, although the Congresswoman's statement seemed a little odd at the time, it may be just the thing shareholders needed to make even stronger argument that auditor rotation should be included in proxy votes.
 
Like I said earlier, it'd be surprising if the Senate actually took up its own version of the bill -- especially with SOX stalwarts like Rhode Island Senator Jack Reed still around -- but with the passage of HR 1564 by the House, there's virtually no doubt that auditor rotation is now a matter of widespread debate and substantial importance. It would be a little countproductive for the SEC, who seems to be all excited about getting tough on accounting and auditing again, to still treat the issue as one that is conducted in the ordinary course of business.
 
HR 1564 is a terrible, terrible bill, but even so, there's a possibility that it could backfire on the AICPA and the firms, giving shareholders the opening they need to argue for more transparency from management with regard to their auditors. Hey, it could be something.
 

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