CalSTRS wants auditor selection put to vote
Say on pay, move over, it’s time for say on auditor. And it’s no wonder, given the incredible mismanagement of some companies’ risk exposures over the past two years and the impact this has on balance sheets, that shareholders should want a little more control over who’s judging the financial health of companies in which they invest.
California State Teachers’ Retirement System (CalSTRS) took the bull by the horns in September when it petitioned the SEC to amend Rule 10A-3 to require that issuers submit their choice of auditor to a non-binding vote of shareholders for ratification. According to the pension fund, 78 percent of companies within its portfolio already consider this best practice.
Most companies do submit auditor choice to a non-binding shareholder vote. CalSTRS just wants to make absolutely sure that all public companies follow this practice. The man behind the petition, CalSTRS CIO Christopher Ailman, stated that less than 6 percent of the firms held in its portfolio with a market cap of $10 billion or more fail to submit their choice of auditor to a vote. However, this number drops off dramatically when it comes to smaller companies. A mere 28 percent of companies with market cap below $250 million choose to hold such votes. Ailman’s reasoning behind his argument was made clear in the following statement from a letter he wrote to the SEC: ‘We believe that a rule requiring issuers to submit an audit committee’s choice of auditor to a vote of shareholders will strengthen auditor independence and integrity.’
CalSTRS isn’t alone in its quest. The Treasury Department’s advisory committee on the auditing profession has recommended public companies adopt shareowner ratification of company auditors. Ailman used this information to back up his claim.
One of the major questions is what happens if shareholders do not approve the choice of auditor. Ailman recognized this and offered several options. In a situation where the company is proposing a change of auditor and the change is not ratified, it could stay with its existing auditor. The most obvious and useful approach would be to address shareowner concerns, review the selection and make a change if the concerns are found to be valid.
Not going far enough
Some interested parties want the SEC to go further and allow shareowners to not just select from a list of names put forward by a company, but to choose a specific auditor. Mark Latham, founder of the Corporate Monitoring Project, which is now called VoterMedia.org, has been advocating for years that shareowners be permitted to choose auditors by competitive vote. He filed this idea in a series of shareowner proposals in 2002 and 2003. Companies responded by requesting ‘no action’ letters from the SEC on the grounds that auditor selection should be considered ordinary business and therefore is not appropriate for shareowner consideration. The SEC agreed with the companies and permitted the proposals to be excluded from the proxy.
Latham’s model would enable shareowners to choose from a selection, encouraging auditors to build their reputations with shareholders as well as the company. The idea is that management would therefore no longer be the only group to be appeased. ‘I’m mainly an advocate of the owners of a business choosing the auditors, so having the owners say yes or no on management’s selection of auditors, well, it’s a small step in the right direction,’ says Latham. As for making it mandatory, he says it’s not the government’s issue, but a matter for the owners. ‘If owners make a proposal to vote on an issue regarding auditors, the SEC will allow management to leave that off the proxy.’
At present the SEC still considers auditor choice to be ordinary business. ‘CalSTRS is an owner,’ expands Latham, saying, ‘Here they are making a petition to the SEC asking for a mandatory vote on auditors. The consistent SEC response is: You’re an owner, you have nothing to do with choice of auditors, don’t bother us, that’s management’s business. I think that’s the wrong answer.’
Boosting competition
Advocates are not saying they are unhappy with or do not trust auditors. There are two types of auditors, posits Latham: the tough and the easy. Understandably, he explains, ‘It’s in the director’s interest to have easy auditors, and it’s in the shareholder’s interest to have tough auditors.’
Though management and shareholders have certain issues on which they agree, Latham says, like compensation, ‘choice of auditors is a conflicting interest.’ And that’s why these issues should come up for owner vote.
Another relevant possibility is that, should owners have a hand in selecting auditors, they could increase competition among audit firms, and possibly, the number of relevant firms in the market. ‘If owners got to choose, I think [the current] number would quickly increase to say, seven or eight,’ says Latham. In terms of gathering information to appropriately select auditors, he adds, that will be based on reputation, which will be tangible given that there are very few auditors to begin with. If shareowners are given the opportunity to choose, it could take some time before the information on which they need to base their decisions reaches critical mass. ‘Right now, we don’t have auditors chosen by shareowners so they haven’t had an incentive to build a reputation for serving shareowner interests,’ observes Latham.
Ghosts of auditors past
Enron comes to mind when discussing poor auditing. Latham draws attention to the fact that his confidence in the Big Four auditors is quite similar to our confidence in a fifth firm, Arthur Andersen. ‘I don’t think Arthur Andersen was all that different,’ he explains, believing it was used basically as a scapegoat for the others.
What Enron did help was to make shareholders aware of the connection between auditors and company performance. ‘If you had a tough auditor, the Enron problem should have been caught earlier,’ notes Latham. This is an important observation as we wade through another irksome financial nightmare where many will be looking to point the finger in order to divert attention from their own role in this disaster.
