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FM Edition:

It’s not often that emotions run high in the relatively staid world of auditing, but a new rule intended to protect investors has sparked a furious behind-the-scenes battle that may yet end up in the constitutional court.

A few weeks ago the Independent Regulatory Board for Auditors (IRBA) revealed that it would implement a mandatory audit firm rotation, essentially forcing companies to change auditors every few years. It’s a practice used in European countries, where audit firms must be changed every 10 years.

Bernard Agulhas, CEO of the regulator, says the aim is nothing more than to ensure auditors are properly independent from the companies whose accounts they sign.

"If auditors aren’t properly independent and are too cosy with their clients, the audit quality will be compromised, and shareholders will not have confidence in the information reported. This change will also allow for transformation as smaller auditors can now get a foot in the door," he argues.

If tenure alone diminishes independence — an assertion that seems intuitive, but has yet to be established as fact — the statistics are worrying.

Naspers, for example, has used the same auditor, PwC, for more than 90 years, paying it R117m last year. AngloGold Ashanti has used Ernst & Young (EY) for 72 years, paying it R101m last year.

But some corporate heavyweights have taken issue with the regulator’s decision, saying the process to push through the new rules is inherently flawed.

Prof Mervyn King, the former judge who has given his name to SA’s governance codes, doesn’t pull any punches, describing it as a matter of grave concern.

"I fully support the quest for transformation, but these rules aren’t the correct tool to achieve this. Our audit quality is among the best in the world, our corporate governance is the best. Anything that interferes with this can only be adverse."

King argues that there are more than enough safeguards in SA’s existing rules to ensure auditors are independent, including the requirement that the partner in charge of auditing a company’s financials is changed every five years. In addition, he says, the Companies Act stipulates that shareholders must appoint the audit committee, which then has to ensure that auditors are independent.

He also says the IRBA didn’t do proper consultation before simply announcing the audit firm rotation as a fait accompli .

"Constitutionally, there should be consultation. But the IRBA certainly hasn’t consulted as legally required with the Institute of Directors and King committee on this. So there may well be a legal challenge on this front," he says.

Agulhas, however, says there has been plenty of consultation over the past year.

"I must say, the opposition to this has surprised me. We had numerous submissions which our board considered before [going ahead], including from the Institute of Directors, the SA Institute of Chartered Accountants and the JSE."

It has proved a heated tussle, with some of the companies lobbying Pravin Gordhan’s finance ministry to block the move — to no avail. With no other options, their last remedy may be the constitutional court.

Justifying the change, Agulhas points to worrying research that shows that 18% of the financial directors of the Top 40 JSE-listed companies previously worked for that company’s external auditor, either in a senior position or as a partner.

Equally, 25% of the audit committees of JSE-listed companies are chaired by someone who previously worked for that company’s external auditor.

"That creates a conflict, or, at the minimum, a perceived conflict. There are some very cosy relationships that pose a possible danger for investors, and it’s our job to protect those investors," he says.

However, Lwazi Bam, Deloitte’s local CEO, says the IRBA hasn’t been transparent about where its numbers come from. "[Agulhas] refers to research he’s done suggesting that auditors lack independence, but he hasn’t shared that with us. Where’s the transparency?" he asks.

Bam says the evidence just doesn’t show unequivocally that if a finance director of a JSE-listed company once worked at Deloitte, for example, he’ll be less independent than someone who never worked there.

"We should be clear about what it is that we want to address, is it auditor independence or is it transformation? If it is transformation, we don't believe that this is the instrument to use. Though we are not where we want to be in terms of transformation, we have made great strides."

Bam says that if shareholders were to raise the same concerns about independence, it would be different, "but no investors we’ve spoken to believe this is the best way to do things".

When it comes to the slack pace of transformation and the dominance of the big four auditors, the IRBA seems to have a point. Clearly, there’s heavy concentration: PwC audits 47% of the JSE-listed firms; Deloitte 21%; KPMG 11%; and EY 13.8%. And three-quarters of audit partners signing off JSE-listed companies are white, while only 3% are black.

"That’s a big concentration," says Agulhas. "What happens if one of those big auditing firms fails? Who will step in? It happened with Arthur Andersen and Enron. As the regulator, we need to do what we can do to provide opportunities to new entrants to gear up for entry."

Victor Sekese, CEO of black-owned audit firm SizweNtsalubaGobodo (SNG), says the rules will certainly help smaller companies. "It’s like having a family doctor: most companies stick with a doctor who knows their history. So market access has been pretty difficult for us. These new rules could certainly open up the market to the smaller guys," he says.

Not that SNG would count as a "smaller guy" any more; it has a client list that includes health-care company Aspen, MTN and Pick n Pay franchises.

But on the issue of whether these rules are necessary to boost the independence of auditors, Sekese says it is "arguable".

"Look, many people are arguing that we have a pretty solid regime which monitors the independence of auditors, and that’s a fact. But at the same time, a requirement to change auditors can only boost independence," he says.

Others say the new rules raise practical concerns.

Roy Andersen, a founding member of the King committee and the chair of numerous JSE-listed audit committees, says while the intention is good, more details are needed.

"We need a practical basis for a phased implementation of these rules," he says.

"This should make it possible for the small local firms to grow, while benefiting from the footprint of the large firms to service blue-chip clients with international operations. This envisages a form of co-audit in the initial years which will mature into the smaller firm jointly signing the audit opinion [later]," he says.

So, for example, in the initial years of this partnership, the smaller firm could begin auditing an increasingly large chunk of a client’s operations.

Underlying all of these moves, however, is the issue of whether SA’s auditors are truly independent. In other words, has the decades-long associations between companies and auditors caused them to be less vigilant than they ought to be?

Bam says that SA’s audit standards are higher than those in most global markets, as most of the country’s 5,000 auditors are people of high integrity.

"Obviously, there are incidents of people doing what they’re not supposed to. But would these rotten apples still be rotten if the audit firms were changed every few years? Absolutely they would. This isn’t the answer," he says.

Agulhas, however, says a mandatory rotation of firms has been adopted in many European countries for one main reason — to strengthen independence, and many multinationals already operate under these rules.

It is also not as if there are no audit red flags in SA either.

Last year, the IRBA conducted 37 "inspections" — essentially taking a deep dive into a specific audit, often after a tip-off.

The IRBA’s report said: "The majority of firms showed some form of deficiency at their initial inspection ... 16% of the inspections were referred to the [regulator’s] investigating committee."

Some of the things that had gone wrong were worrying: auditors signing off accounts riddled with errors; failing to point out Companies Act infringements; and unethical behaviour among auditors.

When it came to "unsatisfactory inspection findings", SA was worse than the average of 29 countries belonging to the International Forum of Independent Audit Regulators — particularly on areas such as ethics and monitoring.

It’s for this reason that Agulhas is ploughing ahead, arguing that as it stands, the new rules will be implemented — though the IRBA will consult with the companies over exactly how they will be implemented.

"We know many companies don’t like it, and we’re obviously keen to implement this in a practical way that doesn’t disrupt business. But if we want our audit quality to improve, while retaining our pole position for auditing standards globally, and protecting investors, this is the way to go," he says.