12 Nov Cosy audit relationships challenged under 10-year rule
Edmund Tadros – The Financial Review – Thursday 12 November 2020
Listed companies could be forced to put their audit up for tender, or explain to investors why they won’t open up the role to other providers, as MPs push ahead with proposals designed to disrupt the cosy relationship that can develop between company directors and their long-time auditors.
The change, opposed by auditing giants PwC and EY, is one of 10 recommendations coming out of a parliamentary committee looking into audit quality in Australia.
The recommendations in the committee’s final majority report, tabled in Parliament on Wednesday, remain broadly in line with the interim proposals published in February but with some changes made to take into account the COVID-19 pandemic.
The committee now says the 10-year audit tendering rule, originally set to begin in 2022, should be introduced in a “staggered” manner to “allow boards sufficient time to establish a strategic response to the recommendation and address concerns raised by the sector regarding current pressures and unintended consequences of a rapid implementation schedule”.
It has been left up to the government to decide upon a timetable for this recommendation.
The average tenure of audit firms at the largest 20 companies is more than two decades. Woodside Petroleum has had the former Ernst & Young check its books for more than 65 years. ANZ Bank has retained KPMG as its auditor for more than 50 years, while Westpac has had PwC check its financials for almost 20 years.
More than 500 listed companies would be obliged to go to market once the rule is introduced given the tenure of their current auditor.
The 10-year audit tendering rule, along with another recommendation for companies to disclose the tenure of an audit firm, are designed to limit the formation of long-term relationships between audit firms and directors that can compromise the independence of auditors.
The role of auditors is critical to the function of markets, with investors relying on an auditor’s independent review of the financial statements of a company.
The committee has also backed away from another recommendation to adopt aspects of the US Sarbanes-Oxley Act 2002, which would see auditors report on the accuracy of management’s assertion that their internal financial reporting systems are effective.
The Sarbanes-Oxley Act was enacted in the US after financial scandals in the early 2000s involving the collapse of companies such as Enron and WorldCom. It was designed to protect investors from fraudulent financial reporting.
The committee noted that “the markedly different economic conditions since February 2020 mean the government will need to consider both appropriate timelines and thresholds” of the recommendation.
The final report stated that the committee did “not resile from the importance of this recommendation” but “recognises that now may not be the time to impose additional transitional costs on businesses”.
The committee also reiterated it still wanted to force companies to publish financial results using a common digital format, as is standard practice in the US since 2009.
They stated the government should do a review “to identify and resolve any remaining barriers to the use of digital financial reports, with a view to making digital financial reporting standard practice in Australia in the near future”.
The committee reiterated recommendations about developing a list of non-audit services that could be supplied by firms to their audit clients and enhancements to the way the corporate regulator, the Australian Securities and Investments Commission, reports on the audit quality of the major firms.
Liberal senator and committee chair James Paterson said not much had changed in auditing since the interim report, “but everything has changed about our economy”.
He said the committee was not presented with strong evidence of problems in auditing in Australia but rather perceptions about the problem of audit quality.
“Many stakeholders, whether they were shareholders or academics or industry associations or other groups, believed there were perception issues in the industry that needed to be addressed,” he said.
If the recommendations are faithfully implemented, Senator Paterson said “the reputation of the audit industry in this country will be enhanced and greater confidence will be restored”.
“Huge gains” could be secured from digitising financial reporting by firms.
The inquiry was held following bipartisan concerns by the Joint Committee on Corporations and Financial Services about the quality of auditing in Australia.
The committee held four days of hearings and received more than 100 submissions with general agreement from the firms, the corporate regulator and some experts that the current state in audit was not serving the users of financial information adequately.
The inquiry particularly focused on the audit quality and operations of the big four consulting firms – Deloitte, EY, KPMG and PwC.
ASIC’s most recent audit inspections found that the big four firms failed to obtain sufficient assurance in up to 32 per cent of the key audit areas scrutinised, with the regulator again noting that the auditors needed to “work on improving audit quality”.
The committee has stopped short of banning audit firms from performing non-audit work for clients, supported by former ACCC chairman Graeme Samuel, or the more drastic measure called for by another former ACCC chairman, Allan Fels, of separating the audit and consulting operations of the big four.
The Labor committee members, led by Senator Deborah O’Neill, said they remained concerned that the workplace practices of the firms and their clients “dissuade internal or external whistleblowing” about wrongdoing.
“In the workplace settings of both the major firms and major companies to whom they supply assurance services, confidential disclosure of unethical and coercive behaviour and sexual harassment continue to be reported to senators (and members of Parliament),” the Labor committee members noted.
In a dissenting report, committee member and Greens senator Nick McKim called for the big four to be broken up into separate auditing and consulting arms.
Non-audit work for audit clients, which he noted compromises the independence of the auditing work, was collectively worth more than $600 million in fees to the firms in FY20.
Senator McKim said that “structural separation” of the big four “is the surest solution to the inherent conflict of interest” that arises when firms provide both auditing and consulting work to the same clients.
He also wants reform of the regulatory regime for audit work, pointing out that the five government bodies overseeing audit standard setting and regulation create “a tangle of responsibilities”.
Senator McKim also raised issue with the role of the Financial Reporting Council in carrying out the audit reform recommendations because its chairman, Bill Edge, continues to be paid by PwC as part of its retirement plan.
“It was confirmed through the inquiry that Mr Edge continues to receive annual payments as part of PwC’s retirement payment plan,” Senator McKim said.
“Literally, he is being paid by one of the companies he advises the government on how to regulate. What’s more, he doesn’t consider this to be a conflict interest. This level of blindness is astounding, and it speaks volumes to the extent to which the big four are in control.”
Mr Edge told the inquiry his payments were not in conflict with his role because the FRC required members who had the “appropriate expertise, experience and credibility in the carrying out of the role.
“To my mind it’s a need to ensure the right outcomes, and I do not see it as a conflict of interest,” he said.