The Securities Exchange Act of 1934 requires that a public company’s  financial statements be audited by an independent public accountant. Mandatory audit firm rotation was also discussed in congressional hearings  to enhance auditor independence and audit quality, but given the mixed  views of various stakeholders, the Congress decided the effects of such a  practice needed further study. In addition, most Tier 1 firms and Fortune 1000 public companies believe  that the pressures faced by the incumbent auditor to retain the client are  not a significant factor adversely affecting the auditor appropriately dealing  with financial reporting issues that may materially affect a public  company’s financial statements. We asked those Tier 1 firms and Fortune 1000 public companies and their  audit committee chairs who did not believe that the partner rotation  requirement by itself sufficiently achieved the intended benefits of  mandatory audit firm rotation to consider the auditor independence, audit  quality, and partner rotation requirements of the Sarbanes-Oxley Act as  implemented by SEC rules and their views on whether these requirements  in total would likely achieve the intended benefits of mandatory audit firm  rotation when fully implemented. Therefore, we believe it will take at least several years  to gain some experience with the effectiveness of the act’s requirements  concerning auditor independence and audit quality. We believe that mandatory audit firm rotation may not be the most efficient  way to enhance auditor independence and audit quality, considering the  costs of changing the auditor of record and the loss of auditor knowledge  that is not carried forward to the new auditor. We also believe that the  potential benefits of mandatory audit firm rotation are harder to predict  and quantify while we are fairly certain there will be additional costs. Regarding the need for mandatory audit firm rotation, we believe the most  prudent course at this time is for the SEC and the PCAOB to monitor and  evaluate the effectiveness of the Sarbanes-Oxley Act’s requirements for  enhancing auditor independence and audit quality, and ultimately restoring  investor confidence. Further, we also believe that currently audit committees, with their  increased responsibilities under the Sarbanes-Oxley Act, can play a very  important role in enhancing auditor independence and audit quality. Finally, for any system to function effectively,  there must be incentives for parties to do the right thing, adequate  transparency to provide reasonable assurance that people will do the right  thing, and appropriate accountability when people do not do the right  thing. Objectives, Scope, and Methodology

As mandated by Section 207 of the Sarbanes-Oxley Act of 2002 and as  agreed with your staff, to perform our study and review of the potential  effects of requiring mandatory rotation of registered public accounting  firms, we  1. identified and reviewed research studies and related literature that  addressed issues concerning auditor independence and audit quality  associated with the length of a public accounting firm’s tenure and the  costs and benefits of mandatory audit firm rotation;  2. analyzed the issues we identified to   develop detailed questionnaires to obtain the views of public accounting  firms and public company chief financial officers and their audit  committee chairs on the potential effects of mandatory audit firm  rotation,   hold discussions with officials of other interested stakeholders, such as  institutional investors, federal banking regulators, U.S. stock exchanges,  state boards of accountancy, the American Institute of Certified Public  Accountants (AICPA), the Securities and Exchange Commission (SEC),  and the Public Company Accounting Oversight Board (PCAOB), to  obtain their views on the issues associated with mandatory audit firm  rotation, and   obtain information from other countries on their experiences with  mandatory audit firm rotation; and 3. identified restatements of annual 2001 and 2002 financial statements of  Fortune 1000 public companies due to errors or fraud that were  reported to the SEC during 2002 and 2003 through August 31, 2003, to   determine whether the restatement occurred before or after a change in  the public companies’ auditor of record, and   test the value of the “fresh look” commonly attributed to mandatory  audit firm rotation.
Why GAO Did This Study

Following major failures in corporate financial reporting, the Sarbanes-Oxley Act of 2002 was enacted to protect investors through requirements intended to improve the accuracy and reliability of corporate disclosures and to restore investor confidence. The act included reforms intended to strengthen auditor independence and to improve audit quality. Mandatory audit firm rotation (setting a limit on the period of years a public accounting firm may audit a particular company's financial statements) was considered as a reform to enhance auditor independence and audit quality during the congressional hearings that preceded the act, but it was not included in the act. The Congress decided that mandatory audit firm rotation needed further study and required GAO to study the potential effects of requiring rotation of the public accounting firms that audit public companies registered with the Securities and Exchange Commission.

What GAO Found

The arguments for and against mandatory audit firm rotation concern whether the independence of a public accounting firm auditing a company's financial statements is adversely affected by a firm's long-term relationship with the client and the desire to retain the client. Concerns about the potential effects of mandatory audit firm rotation include whether its intended benefits would outweigh the costs and the loss of company-specific knowledge gained by an audit firm through years of experience auditing the client. In addition, questions exist about whether the Sarbanes-Oxley Act requirements for reform will accomplish the intended benefits of mandatory audit firm rotation. In surveys conducted as part of our study, GAO found that almost all of the largest public accounting firms and Fortune 1000 publicly traded companies believe that the costs of mandatory audit firm rotation are likely to exceed the benefits. Most believe that the current requirements for audit partner rotation, auditor independence, and other reforms, when fully implemented, will sufficiently achieve the intended benefits of mandatory audit firm rotation. Moreover, in interviews with other stakeholders, including institutional investors, stock market regulators, bankers, accountants, and consumer advocacy groups, GAO found the views of these stakeholders to be consistent with the overall views of those who responded to its surveys. GAO believes that mandatory audit firm rotation may not be the most efficient way to strengthen auditor independence and improve audit quality considering the additional financial costs and the loss of institutional knowledge of the public company's previous auditor of record, as well as the current reforms being implemented. The potential benefits of mandatory audit firm rotation are harder to predict and quantify, though GAO is fairly certain that there will be additional costs. Several years' experience with implementation of the Sarbanes-Oxley Act's reforms is needed, GAO believes, before the full effect of the act's requirements can be assessed. GAO therefore believes that the most prudent course of action at this time is for the Securities and Exchange Commission and the Public Company Accounting Oversight Board to monitor and evaluate the effectiveness of existing requirements for enhancing auditor independence and audit quality. GAO believes audit committees, with their increased responsibilities under the act, can also play an important role in ensuring auditor independence. To fulfill this role, audit committees must maintain independence and have adequate resources. Finally, for any system to function effectively, there must be incentives for parties to do the right thing, adequate transparency over what is being done, and appropriate accountability if the right things are not done.