Proposed SOX Partner Rotation Requirement

By Gaylen R. Hansen, CPA, MBA, ABV, CVA

At the December CSCPA SEC Conference, it was commented that the profession is now a "regulated industry," subject to governmental control. "Self-regulation," effectively eliminated by Congressional passage of the Sarbanes-Oxley Act of 2002 (already affectionately called "SOX"), has enormous implications to the profession and small firms in particular.

Perhaps SOX's most significant impact on small practitioners is mandatory rotation of audit partners: "It shall be unlawful for a registered public accounting firm to provide audit services to an issuer if the lead (or coordinating) audit partner (having primary responsibility for the audit), or the audit partner responsible for reviewing the audit, has performed audit services for that issuer in each of the 5 previous fiscal years of that issuer.''

The concept of audit partner rotation is not new. Current SECPS requirements stipulate audit engagement partners rotate every 7 years followed by 2 years of "time out." Firms with fewer than 5 SEC clients and less than 10 partners are exempted and do not require concurring partner rotation.

On December 2, 2002, the SEC, charged by Congress to implement SOX, issued proposed regulations in Release No. 33-8154. As proposed, a partner could not serve on an audit longer than 5 years. Significantly, the SEC proposal exceeds SOX legislation by requiring the partner to then sit out 5 years. To the extent tax partners assess tax provisions on an audit; they may be subject to rotation. Rotation would also apply to quarterly reviews and attest engagements on internal controls. The proposal, therefore, requires more partners to be rotated and the engagement partner to be rotated more often. In its release the SEC notes, "Smaller firms that do not have sufficient partners to make the required replacements of the partners on an audit engagement team may be particularly affected by the proposed rules. These small accounting firms might have to accept more qualified partners into the firm or lose the audit engagement."

Other costs associated with rotation will include more frequent industry and company-specific training to learn a client's accounting and financial reporting procedures and controls. The proposed rules may also result in incremental costs to move partners between offices.

There is a 30-day comment period on the SEC proposal. Among its many questions, the SEC is seeking the following feedback:
· Should rotation be different for small firms? If so, how should small firms be defined?
· Would the proposed rules impose a cost on smaller firms disproportionate to benefits?
· Is the 5-year "time out" period necessary or appropriate? Would some shorter time period suffice? Should there be different "time out" periods based on a partner's role in the audit process?

Even national and regional firms are concerned with the impact of rotation. Some have offices with only one audit partner and will not be able to meet the requirement without importing partners to take on certain engagements.

For a practical matter most firms will need a minimum of 2 qualified audit partners and 2 outside concurring reviewers to retain clients longer than 5 years. Alternatively, some firms are considering creation of joint ventures or associations into which they would transfer their SEC clientele. Within the venture the parties would then switch engagement partners and use an outside concurring reviewer.

To the extent firms desire any input in this new era of governmental regulation, the only present recourse is to respond to the SEC's proposal and encourage clients likewise, pointing out the disproportionate cost they will incur to maintain auditor independence and objectivity in their segment of the public marketplace.

This article appeared in the January/February issue of the CSCPA NewsAccount.