Competition Commission's mandatory audit tendering proposals would lead to "sham tendering", says FTSE 100

Forcing companies to put their statutory audit needs out to tender once every five years, as proposed by the Competition Commission (CC) last month, will lead to an "industry in sham tendering" and create unnecessary costs for businesses and audit firms, according to the 100 Group. The group, which represents the views of the finance directors of the FTSE 100 and large UK private companies, said that it was unlikely that the proposals would lead to more auditor rotation.

"There is a misconception that for a modern large scale business it is possible for an auditor to reach optimal effectiveness immediately upon appointment," said Robin Freestone, chair of the 100 Group and chief financial officer of publishing group Pearson, in a letter to the CC (2-page / 51KB PDF).

"From a cost point of view, auditors address this by increasing staffing and review processes in the short term. The cost of this tends to be spread over the life of the audit. Accordingly the commercial risk of a mandatory retender would be factored into the cost and borne by shareholders," he said.

According to the letter, there is currently little risk of "over familiarity" between auditors and members of the company's audit committee due to rules requiring partners dealing with auditors to be rotated frequently. Companies also "value auditors' ability to challenge the management", Freestone said.

"As a result it is very unlikely that frequent tenders are going to result in more auditor rotation as return on such a risk is likely to be negative for the audit committee and its shareholders," he said. "We would expect every other tender will be academic; merely adding a further tier of cost to the auditing firms and will have a highly disruptive effect on us, as businesses. Hence, one would expect these costs to be far higher than the estimated £30 million mentioned in the [CC's] report."

Freestone said that changes to the auditing rules made last year by the Financial Reporting Council (FRC) were "balanced and sensible" and needed "further time to become fully embedded in the marketplace". The FRC requires companies to tender their auditing services every 10 years on a 'comply or explain' basis, meaning that they do not need to do so if they can provide an explanation to the regulators.

The FRC, which is the UK's corporate governance regulator, has also spoken out against the proposals (11-page / 3.4MB PDF), which it says would be "disproportionately costly" and could "undermine" the CC's aims by "[undermining] the serious approach already being shown" to last year's changes. The CC is required to publish its final decision by 20 October.

The 'Big Four' auditors are PwC, KPMG, Deloitte and Ernst and Young; and between them they earned 99% of the auditing fees paid by the top 100 companies by share capital in 2010. The Office of Fair Trading (OFT), the UK's consumer protection and competition regulator, referred the market to the CC in 2011, citing concerns about lack of choice, low levels of switching and substantial barriers to entry into the market by new firms.

The CC published its provisional findings in February. As part of its investigation, it found that companies were reluctant to change auditor as they found it difficult to compare alternatives, preferred continuity and faced significant costs when doing so. In addition, auditors tended to focus on meeting the needs of senior management rather than shareholders, meaning that competition tended to focus on factors that were not aligned with shareholder demand.

In its provisional decision on remedies, published last month, the CC decided against forcing companies to rotate their statutory auditors regularly. Instead, they would be required to put their requirements out to tender five years although they would be able defer this obligation by up to two years in exceptional circumstances. It has also proposed tougher regulatory oversight by the FRC's Audit Quarterly Review team, and additional measures to strengthen the accountability of external auditors to the company's audit committee rather than management.

Competition law expert Guy Lougher of Pinsent Masons, the law firm behind Out-Law.com, previously warned that legislative proposals currently being discussed by the European Commission could result in the creation of a mandatory auditor rotation requirement regardless of the CC's final conclusions.

"The audit companies involved in the CC's review can be forgiven feeling a real sense of frustration that they still have another battle to win - this time at the EU level," he said.