The Legal Affairs Committee of the European Parliament voted Thursday to require public companies to change audit firms after up to 14 years, which could increase to 25 years if safeguards are put in place.

The European Commission had proposed a six-year period before audit firm rotation would be required, but a majority of the committee decided that this would be a costly and unwelcome intervention in the audit market (see Europe Proposes Splitting Audit Firms and Europe Moves toward Audit Firm Overhaul).

Along with requiring companies to switch auditors regularly, the Legal Affairs Committee also voted to prohibit auditors from supplying certain non-auditing services. The draft law aims to open up the audit services market in the European Union in an effort to improve audit quality and transparency.

The role of auditors has been called into question due to the financial crisis, the lead rapporteur on audit for the Legal Affairs Committee noted. “We need to win back the confidence of investors, who are looking for high-quality and independent auditing to give them the assurance that they need when investing in Europe's companies," said Sajjad Karim, a member of the European Parliament representing the northwest of England.

The committee decided by 15 votes to 10 to enter into negotiations with the European Council, with a view to agreeing on a common text. The S&D, Greens/EFA and GUE/NGL groups in the European Parliament voted against the draft law. Informal talks will begin as soon as possible.

The law would require auditors in the European Union to publish audit reports according to international auditing standards. For auditors of public interest entities, such as banks, insurance companies and listed companies, the committee agreed that audit firms would have to provide shareholders and investors with a detailed understanding of what the auditor did and an overall assurance of the accuracy of the company's accounts.

As part of a series of measures to open up the market and improve transparency, the committee supported the proposed prohibition of “Big Four only” contractual clauses requiring that the audit be done by one of these firms.

Companies would be obliged to issue a call for tenders when selecting a new auditor. To ensure that relations between the auditor and the audited company do not become too cozy, members of the European Parliament approved a mandatory rotation rule whereby an auditor may inspect a company’s books for a maximum of 14 years, which could be increased to 25 years if safeguards are put in place.

Independence of Non-auditing Services
To preclude conflicts of interest and threats to independence, EU audit firms would be required to abide by rules mirroring those in effect internationally. Most committee members saw the proposed general prohibition on offering non-auditing services as counterproductive for audit quality. They agreed to prohibit only those non-auditing services that could potentially jeopardize auditor independence. They also approved a list of services that would be prohibited under the new law.

For example, auditing firms would be able to continue to provide certification of compliance with tax requirements, but they would be prohibited from supplying tax advisory services that directly affect the company’s financial statements and might be subject to question by national tax authorities.

The full European Parliament is expected to take up the draft law later this year.

In reaction to the vote by the Legal Affairs Committee, Michael Izza, chief executive of the Institute of Chartered Accountants in England and Wales, pointed out that a number of the changes voted through by the members of the European Parliament seem to align the EU audit reform proposals more closely with international standards, which he considers a positive.

“Much of the focus of this debate has been on rotation and the largest audit firms,” Izza said in a statement Thursday. “However, it is important to remember that the audit reform will impact on all businesses having an audit, their shareholders and audit firms of all sizes across the European Union. There is a lot in the proposals beyond those issues that have received the most attention. We need a resolution and certainty over what the audit legal reform will entail. A lot of resources have been invested by a broad range of stakeholders in understanding the proposals’ possible implications. The vote today takes us one step closer to the end; hopefully an agreement between Council and the full European Parliament, which together have the ultimate say in finalizing the law, can be found soon.”

In the U.S., the Public Company Accounting Oversight Board has also been considering a concept release on auditor independence that proposes mandatory audit firm rotation. The PCAOB held a series of meetings around the country last year to discuss the proposals with accountants, shareholders and other interested parties.