Two union pension funds have submitted 15 identical shareholder
proposals in recent months asking that the companies’ audit review
committees establish an audit firm rotation policy that requires
audit firms to rotate off the engagement at least every seven years
and remain off for a minimum of three years. In each instance, the
Division of Corporation Finance has agreed with the companies that
the proposals may be excluded from their proxy materials on the
basis that they relate to ordinary business operations. The
selection of independent auditors or, more generally, the management
of the independent auditor’s engagement, are excludable under Rule
14a-8(i)(7), according to the staff.
The Sheet Metal Workers National Pension Fund
noted that auditor independence is fundamental to the integrity of
public company financial reporting. In a system where audit clients
pay for-profit accounting firms to perform their audits, the fund
said that every effort must be made to ensure the firms’
independence. Mandatory auditor rotation is one way to promote
accounting firms’ independence, skepticism and objectivity,
according to the fund.
The fund cited research on the terms of audit
engagements which found that at the largest 100 companies, audit
tenure averages 28 years. The fund said that ITT Corporation, one of
the companies to receive the shareholder proposal, has paid its
audit firm more than $79 million over the last seven years.
The fund wrote that systemic accounting fraud
has led to numerous legislative and regulatory reforms to the audit
process, including audit partner rotation requirements, limits on
non-audit services and enhanced responsibilities for audit
committees. Despite these reforms, the fund pointed to recent PCAOB
investigations which have found that audit deficiencies may be
attributable to a failure to exercise the required professional
skepticism and objectivity.
The fund believes that mandatory audit firm
rotation is an important next step in improving the integrity of the
public company audit system by limiting long-term client-audit firm
relationships that may compromise audit firm independence.
ITT and the other issuers sought no-action
assurance from the SEC that the proposals could be omitted from
their proxy materials in reliance on Rule 14a-8(i)(7). Some of the
companies also sought to omit the proposals on additional grounds,
which the staff found unnecessary to address. For example, Dominion
Resources said the proposal conflicted with its proposal to have its
shareholders ratify the appointment of the independent auditor at
the same meeting. Dominion’s auditor has provided audit services to
the company continuously for more than seven years.
The United Brotherhood of Carpenters Pension
Fund asked the Commission to review the Division’s no-action
responses in connection with its audit firm rotation proposals to
Walt Disney, Hewlett-Packard and Deere & Company. The Division may
present a request to the Commission for a review of any no-action
responses that involve matters of substantial importance and where
the issues are novel or highly complex.
The fund said that audit firm rotation may once
have been a matter of ordinary business, but that no longer applies.
Both the PCAOB and the European Union are considering auditor
rotation policies to restore investor confidence in the audit
process by enhancing auditor independence.
The Division applied the standard for Commission
review to the fund’s request and determined not to present it to the
Commission.
The other companies that received the proposal
are American Electric Power Company, Dow Chemical, General Dynamics,
Prudential Financial, Sprint Nextel, Baker Hughes, Alcoa, General
Electric, U.S. Bancorp and Stanley Black & Decker.