Shell games over the real story of an audit partner rotation violation
I can't get a straight answer from Shell plc or EY UK over what really happened with EY's unexpected admission of a significant auditor independence violation.
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On July 2, The Financial Times Ellesheva Kissin and Malcom Moore in London reported that "EY broke US audit rules on Shell mandate two years in a row." (Gift link.)
Although it was a crossover story — UK and US — the US FT Accountancy reporter Stephen Foley did not participate. It turns out he was very busy readying a blockbuster story about Boston Consulting Group that came out on July 4! (Gift link.)
BCG modelled plan to ‘relocate’ Palestinians from Gaza
Consulting firm had multimillion-dollar role in contentious new aid scheme for shattered enclave
Boston Consulting Group modelled the costs of “relocating” Palestinians from Gaza and entered into a multimillion-dollar contract to help launch an aid scheme for the shattered enclave, a Financial Times investigation has found.
The consulting firm helped establish the Israel- and US-backed Gaza Humanitarian Foundation and supported a related security company but then disavowed the project, which has been marred by the deaths of hundreds of Palestinians, and fired two partners last month.
BCG’s role was more extensive than it has publicly described, according to people familiar with the project, stretching over seven months, covering more than $4mn of contracted work and involving internal discussion at senior levels of the firm.
Foley has updated that story with Jim Pickard in London on July 6: (Gift link.)
Tony Blair’s staff took part in ‘Gaza Riviera’ project with BCG
Former UK prime minister’s institute participated in meetings on plan to turn shattered enclave into trading hub
The Tony Blair Institute participated in a project to develop a postwar Gaza plan that envisaged kick-starting the enclave’s economy with a “Trump Riviera” and an “Elon Musk Smart Manufacturing Zone”. The plan outlined in a slide deck, seen by the Financial Times, was led by Israeli businessmen and used financial models developed inside Boston Consulting Group (BCG) to reimagine Gaza as a thriving trading hub.
More on that story later. I had this to say on BlueSky and LinkedIn:
Back to the Shell story...
There were several outlets reporting the news, but no one really had much detail except prepared statements and what EY told Shell plc and then Shell repeated in a filing to the SEC, in revised 20-F filings on the same day, July 2, and UK has same requirement as US -5 year limit on engagement or “key” partner and review/QC partner and five years in between. Via the FT:
Shell said on Wednesday that the EY partner who led the audit of its 2023 and 2024 financial results had exceeded the period allowed under strict rotation rules set by US regulators, meaning the individual was not eligible to perform that role. EY also told Shell that it had breached UK rotation rules...
Shell said EY had informed the energy group’s audit and risk committee on Tuesday that it had fallen foul of rules set by the US Securities and Exchange Commission, and that its US opinions on the company’s financial statements and effectiveness of internal control over financial reporting for 2023 and 2024 could no longer be relied upon. EY had moved a different partner into the role of lead audit partner for Shell since discovering the issue and concluded that no changes to the previously issued financial statements were necessary, Shell said.
Shell will amend its regulatory filings with the SEC for the two years EY had breached the rules, while the FRC said it was aware and reviewing the issue in the UK. The FRC will then decide whether to open a formal investigation. Shell’s financial statements remain unchanged. EY earned $66mn from work for Shell in 2024, according to the company’s annual report.
Comments on LinkedIn, on the articles and then directly to me asked the question: How in the world could this happen?
The US tightened rules for audit partner rotation after Enron and the collapse of Arthur Andersen. The time limit was shortened from seven years to five, and despite efforts in the proposed rules to include all key partners such as tax, IT, and advisory in the rotation scheme it only covers the key engagement partner and the QC partner.
With respect to determining which partners, principals and shareholders should be included, the proposed rules would go beyond the minimum specified by the Act. As noted above, the Act requires that the lead or coordinating audit partner and the audit partner responsible for reviewing the audit rotate every five years. Clearly, the lead partner as well as the concurring review partner perform critical functions that affect the conduct and effectiveness of the engagement. However, in many larger engagements, the engagement team will include more than just the lead partner and the concurring review partner. Obviously, the larger the registrant and the more diversified the registrant's activities, the more likely that the engagement team will include multiple partners, principals or shareholders.
While under this proposal, firms would be required to rotate multiple partners in these situations, nothing in this proposal is intended to imply that all partners would need to be rotated at the same time. Indeed, we would expect that firms would stagger the rotation of partners to ensure that the engagement team continues to have appropriate expertise to allow the audit engagement to be conducted in accordance with GAAS.
Partners, principals or shareholders who are members of the audit engagement team70 make significant decisions that can affect the conduct and effectiveness of the audit. As a result, the proposed rules would require rotation not just of the lead and reviewing partner,71 but of partners who perform audit services for the issuer.72 This rotation requirement would include the lead partner, the concurring review partner, the client service partner, and other "line" partners directly involved in the performance of the audit. The proposed rules ensure that professionals do not "grow-up" or spend their entire career on one engagement.
In the end, only the lead engagement partner and the review partner were included in the rotation scheme and the "time-out” period was expanded from two years to five, also.
Section 203 adds sub-section (j), which establishes mandatory rotation of the engagement partner, and the reviewing (or "concurring") partner every five years. These proposed rules expand the number of engagement personnel covered by the rotation requirement and clarify the "time out" period.
In addition, Section 10A of the Securities and Exchange Act of 1934 and Section 203 of Sarbanes-Oxley Act (j) say that a firm is no longer independent if it violates the partner rotation requirements. “It shall be unlawful…”
The UK adopted similar rules, but that cover all key partners on the engagement, following the model of Sarbanes-Oxley.
For listed audit clients, the rules are more prescriptive and mandate rotation as follows:
· No one can act as engagement partner for more than five years, and then has to have a five-year gap.
· No one can act as the engagement quality control reviewer for a period longer than seven years and then has to have a five-year gap.
· No one can act as a key partner for a period longer than seven years and then has to have a two-year gap.
· There are additional rules for combinations of roles.
· Threats and safeguards of long association need reviewing for all senior staff after seven years.
· Other rules may apply where the entity is listed overseas
The FT did not, but the Times of London did name the partner who, according to Shell, violated the rotation rules, in the US and UK, beginning in 2023.
EY told Shell that Gary Donald, its partner who heads up the team signing off Shell’s accounts, had “exceeded the period allowed under partner rotation rules”.
Because of that, Donald should not have signed off the 2023 and 2024 accounts and so as a result of “EY’s non-compliance”, Shell has had to republish its annual reports in the US for those years, with EY getting a different partner to oversee them. The new lead partner did not make any changes to the financial statements or the audit opinion.
However, the audit partner signer for the Shell plc audit is public record both via UK Companies House, where the name of the partner must be included on the face of the audit opinion, and in the US, where listed firms must file Form AP with the PCAOB.
According to Companies House physical filings of the annual reports and audit opinions, Gary Donald began signing the Shell plc audit opinion beginning with the 2021 annual report. Based on the publicly available records that Shell filed with Companies House and the US audit regulator the PCAOB on Form AP, Gary Donald was the lead engagement partner of record for Shell plc for four years — 2021, 2022, 2023, and 2024.
So how could he be already in violation of a five year rotation requirement after only two years, in 2023?
The auditor named on the opinions filed with Companies House is consistent with the records filed with Form AP at the PCAOB.
For 2020 and 2021 Gary Donald was also lead engagement partner signing for BHP in Australia!
Before Gary Donald, Companies House and PCAOB Form AP filings say Alistair Ian Wilson signed the Shell plc (previously Royal Dutch Shell, same CIK) opinions for the 2016, 2017, 2018, 2019, and 2020 annual reports. Per Companies House:
Before that PwC audited Royal Dutch Shell.
Per the PCAOB, Form AP and Companies House:
One thing to note is that even though both the US and UK say that firms must have a rotation schedule and comply with rotation requirements for both the lead engagement partner and the review/QC partner, only the lead engagement partner name is publicly available.
One possibility is that Gary Donald was the Royal Dutch Shell audit Review/QC partner for 2020, 2019, and 2018. Then, with the first two years of his service as lead engagement partner, and no 5 year cooling off period as required, Donald would have exceeded the five year term and violated the auditor independence rules in both jurisdictions. Even though Donald is the EY Global Oil and Gas Assurance Leader, that is not allowed! Given that the public, investors, journalists and others on the outside can not see the Review/QC partner names, we have no way of knowing if that is the case.
I asked Shell Plc what happened, how did EY partners violate the rules and if it related to service by Gary Donald as Review/QC partner.
Spokesman Nick Ravenscroft responded:
All good questions, but I am afraid they are all questions for EY.
If you do not have their contacts, I can probably put you in contact with someone..
I told Nick Ravenscroft that it was now Shell plc's problem, too. Why? Shell made a filing to SEC that repeated EY's claims and if there was a lack of timely partner rotation — and it is not clear to me based on EY’s filings what that was — Shell’s Audit Committee either missed it or was complicit in allowing it. I did follow up with EY UK.
Unfortunately, Matthew Lower, the "Global Reputation Leader" for EY based in the United States fielded my inquiry to the UK-based Rachel Lloyd, and provided the same bland statement that had been previously provided to media outlets:
“EY UK deeply regrets this occurred and has remediated the matter. There has been no change to the financial information previously prepared by Shell plc, for the applicable years, and EY UK has provided updated, unqualified, SEC audit opinions. We are committed to the highest standards of audit quality and will continue to take any necessary steps to ensure these standards are upheld.”
I provided more time to Lower and Lloyd, saying, "This is unfortunate and just raises more questions. It is not clear from the public filings why EY UK says that the partner for 2023 and 2024 exceeded his tenure. I will be publishing all the records and raising the issue of whether there is something that EY UK is not telling the public or perhaps even not telling Shell."
However, they were unwilling to say more.
It seems highly unlikely EY UK filed incorrect names to Companies House and to the PCAOB. More likely there is a detail, such as service as Review/QC partner that is not apparent from the officially filed records. At this point there are no updates to PCAOB Form AP or Companies House indicating the name of the new partner assigned to re-sign 2024 and 2023.
Shell plc did file two new Form 20-Fs on July 2 with the SEC, in conjunction with the announcement, via a 6-F, of the partner rotation violation and the resultant auditor independence breaches. (20-F filings do not include the opinions with the partner name that are filed to Companies House.) Because new audit opinions for 2023 and 2024 were reissued by a new partner, and given a new updated date, the company is obligated to add any subsequent events to the filing between the year-end and the new opinion date.
There does not appear to be any material new items in the subsequent events that would justify bringing up the rotation issue in public. A few of them, such as a disposition of a business in Nigeria, were in the original 20-F as well and were just slightly updated.
There are organization changes that do not strike me as something that Shell would be so desperate to report in a 20-F that they would conjure up a partner rotation issue with EY. Another new subsequent event is an authorization to issue shares shortly after repurchasing shares in Q1 2025. It is also interesting (Why did they do it?) but also does not seem to justify bringing attention to the auditor rotation issue.
It's a good time to remind readers why these rules were tightened after Enron/Andersen and the stricter rules incorporated into the Sarbanes Oxley Act and reforms in the UK. (UK and EU reform also tightened audit firm rotation rules, but similar efforts to implement any type of audit firm mandatory rotation in the US were forcefully blocked by the largest global firms. That's despite strenuous efforts by the then PCAOB Chair Jim Doty to get them approved.)
"On the Economics of Mandatory Audit Partner Rotation and Tenure: Evidence from PCAOB Data", is a research paper by Brandon Gipper, Stanford University Graduate School of Business, Luzi Hail, The Wharton School, University of Pennsylvania, and Christian Leuz, Booth School of Business, University of Chicago & NBER, published in The Accounting Review (2021).
They explain:
Does tenure of an audit partner at a given client influence audit quality? How disruptive and costly are mandated partner rotations? Do audit firms rotate engagement partners along with senior managers or review partners? Questions like these are central to audit practice and regulation and have been studied extensively in academic research (see, e.g., DeFond and Zhang, 2014, and Lennox and Wu, 2018, for overviews).
This literature recognizes information asymmetry, conflicts of interest, learning, and competition in audit markets as key forces shaping the economic tradeoffs with regard to mandatory partner rotations. On one hand, engagement partners develop closer relationships with their clients over time, which could compromise audit quality or make them reluctant to update audit procedures (e.g., Bamber and Iyer, 2007; Corona and Randhawa, 2010).
The new partner that comes in after mandatory rotation does not have these ties and is not wedded to prior audit procedures and, hence, can take a “fresh look” (e.g., Hamilton, Ruddock, Stokes, and Taylor, 2005). On the other hand, engagement partners develop a deeper understanding and specific knowledge of their clients and industries, which should enable them to perform audits better and more efficiently (e.g., DeAngelo, 1981). Newly assigned partners need time to acquire this knowledge, which is costly and could temporarily decrease audit quality (e.g., Dodgson, Agoglia, Bennett, and Cohen, 2020). This short discussion highlights a myriad of potential effects and economic tradeoffs.
The premise of the paper is to determine if audit partner rotation influences audit quality. How is audit quality defined?
We begin with audit quality and examine a large set of proxies (absolute accruals, restatements and their announcements, opinions on internal control weaknesses, and PCAOB and audit-firm inspection findings). We show that, for the average engagement of a Big-6 firm, audit quality is unrelated to partner tenure, except for announcements of restatements, which are more frequent in the first two years after rotation (consistent with Laurion et al., 2017).
Absolute accruals, restatements, and opinions on internal control weaknesses are output metrics that are the standard in the audit literature to proxy audit quality. If you don't use them in your paper and reference other papers that use them your paper does not get published. Occasionally you will also see audit fees as an output proxy, as in “if audit fees are higher than for comparable audits or if they increase over time it indicates higher quality.” The idea is the auditor is doing more work and that means higher quality. Lower fees compared to similar firms, auditing similar size companies, etc. means that a firm is skimping on the work or using the audit as a loss leader to gain other non-audit work.
What have others said on the subject?
Prior literature finds mixed evidence for the effects of partner tenure and rotation on audit quality.1 However, many of these studies rely on small samples obtained from individual audit firms or on settings outside the United States with engagement partner disclosure. It is not obvious that their audit quality results carry over to the U.S. setting, where auditors face substantial litigation risk, relatively strict oversight, and ample monitoring by capital-market participants.
What's different about this paper?
In this paper, we provide novel evidence on the economic tradeoffs related to partner tenure and mandatory rotation for a large cross-section of U.S. publicly listed issuers. Specifically, we examine how audit quality, pricing and production evolve over the mandated five-year partner cycle and how these patterns differ with competitive pressure, client size, and partner experience as well as when multiple members of the audit team commence at a new client engagement.
To do so, we exploit a proprietary dataset from the Public Company Accounting Oversight Board (PCAOB) that matches audit partners with client issuers...
1 For instance, studies find decreases (Litt, Sharma, Simpson, and Tanyi, 2014), increases (Lennox, Wu, and Zhang, 2014; and Laurion, Lawrence, and Ryans, 2016), and no change (Chi, Huang, Liao, and Xie, 2009) in audit quality following mandatory partner rotation. Studies on audit partner tenure find evidence of decreases (Carey and Simnett, 2006; Fitzgerald, Omer, and Thompson, 2018), increases (Chen, Lin, and Lin, 2008; Manry, Mock, and Turner, 2008), or an initial increase followed by a decrease (Chi and Huang, 2005) in audit quality.
What were the results?
This paper provides the first partner-tenure and rotation analysis for a large cross-section of U.S. publicly listed audit clients. We find no evidence that, on average, audit quality declines over the mandated tenure cycle, inconsistent with the notion that partners compromise audit quality in the five-years’ time (e.g., Bamber and Iyer, 2007). Thus, for the average Big-6 client engagement, mandatory rotation appears to be short enough or the U.S. audit environment robust enough to prevent auditor capture. At the same time, we only find limited evidence of fresh-look benefits (e.g., Hamilton et al., 2005) which, if anything, seem most pronounced around the arrival of new audit teams at the client.
So, a few comments.
I have said more than once that the standard output proxies for audit quality are corrupted. No one manipulates results to get a share price boost or to boost their executive compensation metrics using abnormal accruals or GAAP results anymore. Not when you can just create and manipulate non-GAAP metrics.
Restatements are completely corrupted as a metric of whether the audit was done well, because of the influence of potential clawbacks and because of the subjectivity of the materiality decision. In both cases the auditor's incentives are the same as the issuer's management: No Big R restatement if you can avoid it.
Again, only the disingenuous claim victory over accounting fraud based on the Big R restatement stats.
No one wants a material weakness in internal controls, not the company or the auditors. Auditors are penalized for issuing adverse ICFR opinions. And if it has to be done, if you are forced to it by media or SEC comment letters, investors rarely pay attention to it.
Or unless it is a huge surprise!
So many companies have never had a material weakness in internal controls cited when you would think that it just has to be: Tesla, CrowdStrike, Silicon Valley Bank...
Even PCAOB audit inspection findings are too variable and the selection criteria also still too risk-based to be a proxy for audit quality, despite what some who support the continued existence of the PCAOB may think.
I also made an inquiry on Monday morning to the UK regulator, the FRC.
"I am confused about the EY statements and Shell PLC filings regarding partner rotation issue. Can you please clarify?"
I wondered why, and how, EY identified this apparent violation of partner rotation rules.
As most of the media reports mentioned, EY UK was recently fined and sanctioned for violating audit firm rotation rules in April. KPMG UK has also recently broken the audit partner rules and, therefore, compromised its independence. From the FT:
The update comes after the Big Four firm was fined in April by the UK accounting watchdog for a similar breach. The Financial Reporting Council issued EY with a £325,000 penalty for auditing listed company Stirling Water Seafield Finance for more than 10 years without publicly retendering for the contract. The FRC fined rival firm KPMG for breaching the same rules in June.
I asked the FRC to tell me if EY's violation at Shell plc's was identified due to the prior enforcement action against EY for auditor rotation violations.
I have not yet heard back.
© Francine McKenna, The Digging Company LLC, 2025