21 Dec ASIC, audit quality need urgent shake-up
Adele Ferguson – Australian Financial Review – Monday 21 December 2020
This week, Treasurer Josh Frydenberg will receive the findings of an investigation into Australian Securities and Investments Commission chairman James Shipton’s hefty taxadvice invoices paid for by taxpayers to KPMG.
Frydenberg has also promised to overhaul ASIC’s deeply flawed structure to make sure the corporate watchdog is fit for purpose.
Under the current model, there is no board or chief executive, which makes the chairman the “accountable authority”.
It means everyone reports to the chairman, including the commissioners and executives.
He should also revisit the Hayne banking royal commission’s recommendation to create a new oversight body for the Australian Prudential Regulation Authority and ASIC independent of government to “assess the effectiveness of each regulator in discharging its functions and meeting its statutory objects”.
The new body would comprise three part-time members, supported by permanent staff, and report to the minister at least twice a year.
It would have the power to conduct inspections of both regulators and also issue them with notices to produce documents or provide information in any form.
While Frydenberg is at it, he should consider recommendations made recently by a joint parliamentary inquiry into auditing and auditors.
The role of auditors goes to the heart of financial reporting integrity. It has a profound impact on the markets and the economy as an auditor’s job is to assess whether an organisation’s financial accounts are true and fair and ensure compliance with internal controls.
When auditing is sub-standard or conflicted, it creates uncertainty, damages confidence and can result in scandals. Former ASIC chairman Greg Medcraft saw it as a sleeper issue that could lead to an Enron-style corporate collapse.
Over the years, ASIC has raised a series of red flags about the deteriorating quality of auditing in Australia based on its own audit inspections.
The Australian Financial Review can confirm that the advisory body to Treasury, the Financial Reporting Council, met on December 16 to confirm its position on recommendations outlined in the final report into auditors.
In a statement, it said it had confirmed its position on its advice to the government.
The parliamentary inquiry into the auditing was triggered by growing concerns about the cosy relationship between audit firms and their clients. It was headed by James Paterson.
It made a series of recommendations to improve transparency, including requiring companies to go to public tender for auditors every 10 years or explain why not in their annual reports.
Other recommendations include ASIC having to revise its audit inspection regime to attach a grading system to the severity of auditing defects and publish each firm’s inspection results – something that is already beginning.
The recommendations are a good start.
But in light of some recent scandals, auditors also need to assess whether they do enough to pick up irregularities and whether there should be more hands-on inspections of sites to ensure the integrity of the numbers.
On November 30, Freedom Foods Group told shareholders it had made a whopping $591 million of restatements and writedowns dating back years.
Some of the writedowns were from tens of millions of dollars of out-of-date UHT milk and cereal products left in warehouses. That’s a hell of a lot of UHT milk and cereal packets that weren’t picked up in any of the accounts.
A shareholder class action has been filed against the company and its auditors Deloitte for any shareholders who bought shares between December 2014 and June 24, 2020, alleging they paid an inflated price because of misleading conduct by Freedom Foods and Deloitte.
It alleges Deloitte failed in its duties in signing off on Freedom’s accounts each financial year between 2014 and the first half of 2020.
“The proceeding also alleges that Freedom Foods’ half-year and full-year financial reports did not provide a true and fair view of Freedom’s financial position and that Deloitte had not obtained sufficient audit evidence to provide a basis for its audit opinions in each of those reports between FY14 and FY19,” the law firm said.
Phoslock Environmental Technologies (PET) shocked shareholders in September when it suspended its shares to investigate “accounting irregularities” in its China division.
It said the irregularities were first discovered during an internal review of its controls “instigated by head office” and were subsequently brought to the attention of its auditors KPMG, which then launched an investigation.
Preliminary findings confirmed fraudulent activity, including false accounting, falsification of invoices and service contracts, misappropriation of funds, including improper payment of bonuses and several undisclosed related party transactions.
In another update on November 12, the company flagged a restatement of its financial accounts for 2019 and 2020.
It said this would be released to the market once completed. Why nobody picked up the fraud earlier is an issue that needs to be explained by the board and its auditors. Quality auditing is also important in the government sector.
The NSW AuditorGeneral’s report on government agencies slapped a “high risk” finding on the country’s biggest workers compensation scheme, icare. After reviewing icare’s accounts, it said the government-run organisation may have breached the law by funding $188 million of its indirect operating costs with money from the workers compensation Nominal Insurer.
“In the absence of documentation supported by robust supporting analysis, there is a risk of the workers compensation Nominal Insurer being overcharged, and the allocation of costs being in breach of legislative requirements,” the Auditor-General’s report said.
It said icare had several IT system user access control weaknesses, which increased the risk of privacy breaches and fraud. It said icare’s procurement policies did not reflect government procurement requirements and it did not comply with the Government Information Public Access contract disclosure requirements.
It said significant procurements had not been disclosed. They include $386 million worth of contracts with EML to provide claims management services for the Nominal Insurer from January 2018 to December 2020. Others include $135 million of contracts with Comensura for contingent labour-hire requirements for the Nominal Insurer from August 2017 and contracts with Capgemini Australia for the build and operation of the Nominal Insurer’s core claim platform and Guidewire for $92 million.
In previous years, the Auditor General endorsed icare’s accounts saying “in my opinion the financial statements give a true and fair view of the financial position of the scheme … and of its financial performance and its cash flows … in accordance with Australian Accounting Standards”.
However, after increased scrutiny following a joint media investigation by The Sydney Morning Herald – which is owned by Nine – which uncovered serious mismanagement in the agency and revealed the regulator had “grave concerns” about its deteriorating financial position and plunging return to work rates.
The controversy engulfing icare has claimed the scalp of its chief executive, John Nagle, who told a parliamentary inquiry on August 3 that he was sanctioned by the board and reported to the anti-corruption watchdog ICAC because of a failure to properly disclose a contract handed out to his wife.
It also claimed Perrottet’s chief of staff after it emerged that icare was paying the salaries of two of his ministerial staff, including his senior policy adviser Ed Yap, in breach of regulations.
And it has lost its chairman and two directors.
The scandals should be a warning bell to professional accounting bodies, auditors and boards across Australia to ensure the integrity of financial accounts.
It is why Frydenberg, the Financial Reporting Council and ASIC need to reform the quality and regulation of auditing posthaste.
Auditing firms get paid well to audit accounts and have been given a lot of latitude to manage conflicts. It is time to hold them to account. Why nobody picked up the fraud earlier is an issue that needs to be explained by the board and its auditors.