Position paper: The rotation of heads of audit
Download this policy paper in format of a briefing document
What do we want?
- The appointment and removal of the HIA should be a board responsibility.
- The IIA does not support automatic rotation after an arbitrary period.
- The tenure of the HIA is more appropriately considered as part of the individual appraisal and external quality assurance processes, on the basis of performance, effectiveness, independence and objectivity of the internal audit function.
Supporting points
The responsibility for appointing the Chief Internal Auditor and removing him/her from post should be the preserve of the board, normally through the audit committee. Boards should manage the internal audit function in ways that promote and enhance internal audit's independence and objectivity. The appointment of a new HIA (rotation) should be considered in that context. Rotation of the HIA is one of many possible ways of enhancing independence and objectivity, but it should not be seen as a silver bullet.
The key consideration for any audit committee or board should be the performance of its internal audit function, the role in that played by the HIA, and the appropriate skills and experience required.
We agree that the tenure of the HIA should be considered by the board / audit committee at appropriate intervals. This could be as part of the regular evaluation of internal audit's independence, objectivity and effectiveness which forms part of the external quality assessment that takes place at least every five years.
We welcome the response of the Prudential Regulatory Authority (PRA) and Financial Conduct Authority (FCA) to the IIA's Financial Services Code indicating that, in exercising their supervisory judgement, they will consider the nature and extent of compliance with the Code in any assessment of internal audit effectiveness within regulated firms.
The Code concludes that 'The Chairman of the Audit Committee should be accountable for setting the objectives of the Chief Internal Auditor and appraising his/her performance. It would be expected that the objectives and appraisal would take into account the views of the Chief Executive. This appraisal should consider the independence, objectivity and tenure of the Chief Internal Auditor. '
We recognise that changing an HIA can bring fresh outlooks or views that strengthen internal audit's role in challenging the executive. It can bring new skills or experience to the role and help promote the adoption of best practice. Rotation could also help remove the danger of HIAs in divisions and subsidiaries losing touch with the centre, and counter shareholder or public perceptions of too cosy a relationship between the HIA and the executive.
Rotation can also play a part in an internal auditor's career development, either by moving to a different role in the same organisation or to another internal audit role in a different organisation.
But there are also potential downsides to rotating the HIA, such as the possible loss of continuity in an organisation experiencing rapid change, the loss of valuable specific experience, or the reduction in internal audit effectiveness while a new HIA climbs the learning curve.
Much of the pressure for the rotation of external auditors comes from shareholders - major stakeholders who are remote from the external audit process. In contrast the main stakeholders of internal audit are the board and senior management, who are not remote and have an informed view of independence and objectivity and can act to preserve it in various ways. By removing the board's discretion on deciding how long to employ its HIA, compulsory rotation undermines the role of the board in corporate governance.
HIAs are subject to annual appraisals, which should be led by the Chair of the audit committee. Part of this appraisal should concern the independence and objectivity of the HIA, and whether these are in any way being undermined. The effectiveness review of internal audit required under the annual disclosure provisions of the UK Corporate Governance Code is also an opportunity to consider these issues.
Similarly internal audit, under the international standards, must be subject to an external quality assessment at least every five years. This too will cover questions about the independence and objectivity of the function as well as its performance.
Boards should also consider the position of the HIA and the internal audit function after major corporate changes to ensure the size and staffing is appropriate in new circumstances. Major corporate failures (e.g. failed takeover or operational failure) could also trigger such a review, in particular if internal audit were deemed to have missed key warning signs.
In its review of the Turnbull Guidance the FRC should consider expanding its coverage of how boards manage the internal audit function to preserve and enhance independence and objectivity. This should include the correct positioning of internal audit in the organisation, reporting lines, tasking and appraisal, remuneration and rotation of the HIA, skills and experience, and adherence to The IIA's International Standards.
Background
The issue of compulsory rotation of Heads of Internal Audit has arisen as a result of pressure in the external audit sector to break long-term links between organisations and their auditors.
It is argued that rotation will enhance independence and objectivity by eliminating familiarity and the temptation to tone down negative findings to preserve long-term relationships. Some have questioned whether similar pressures undermining independence and objectivity might not apply to internal audit. They argue that internal audit should not be treated differently.
Regarding external auditors, The IFAC Handbook of the Code of Ethics for Professional Accountants states 'The long association of other partners with an audit client that is a public interest entity creates familiarity and self-interest threats. It calls for a limit of seven years for an individual remaining a key audit partner.
In its draft report published in July 2013 the Competition Commission provisionally recommended compulsory re-tendering of external audit contracts every five years, although the FRC does not agree with the period chosen nor its mandatory nature, arguing that it takes an important judgement out of the hands of audit committees and undermines the 'comply or explain ' principle.
The IIA Financial Services Committee's recommendations include the following:
- 16. The Audit Committee should be responsible for appointing the Chief Internal Auditor and removing him/her from post.
- 17. The Chairman of the Audit Committee should be accountable for settingthe objectives of the Chief Internal Auditor and appraising his/herperformance. It would be expected that the objectives and appraisal would take into account the views of the Chief Executive. This appraisal should consider the independence, objectivity and tenure of the Chief Internal Auditor. '
27 August 2013
