International developments in auditor independence
Paragraph 225(2B)(e) of the ASIC Act provides that the FRC is to monitor international developments in auditor independence, assess the adequacy of the Australian auditor independence requirements provided for in the Corporations Act and the codes of professional conduct in light of those developments and give the Minister, and the professional accounting bodies, reports and advice on any additional measures needed to enhance the independence of Australian auditors.
Monitoring developments
In 2005-06, the FRC continued the programme commenced in the previous year of monitoring international developments through examination of publicly-available inspection reports issued by overseas oversight bodies (such as the US Public Company Accounting Oversight Board, the Canadian Public Accountability Board and the Audit Inspection Unit of the UK Professional Oversight Board), other material placed on the internet websites of these oversight bodies and associated regulatory agencies and general media reports about audit independence issues.
The FRC Chairman also met with representatives of overseas oversight bodies during visits to Europe and North America in November 2005 and July 2006.
Comparative review of Australian requirements
In its last report, the FRC indicated that during 2005-06 it intended researching Australia’s requirements on auditor independence compared with those applicable in other major jurisdictions worldwide. The review, which was undertaken by the Treasury to provide assistance to the FRC, compared the Australian auditor independence requirements with the equivalent requirements applying in Canada, the EU, the UK and the US.
The review focused on the following core elements of auditor independence:
- general standard of auditor independence;
- specific restrictions applying to employment, financial and business relationships;
- provision of non-audit services;
- employment restrictions applying to former audit partners and senior audit personnel; and
- audit rotation.
The overall conclusion of the review is that, notwithstanding differences in terminology, institutional arrangements and legal frameworks, there is a substantial underlying equivalence between the Australian auditor independence requirements and ‘best practice’ standards adopted internationally.
The FRC has identified from the review the following areas in which some aspects of the Australian independence requirements differ from the requirements applicable in some or all of the other jurisdictions. Areas of difference include:
- employment and financial restrictions;
- employment restrictions applying to former audit partners and senior audit personnel (‘cooling-off’ periods);
- multiple former partners of an audit firm/audit company directors restriction; and
- auditor rotation.
The following paragraphs provide further information about these areas of difference and the FRC’s views on what, if any, action should be taken.
Employment and financial relationships
The review noted that the SEC independence rules in the US have applied a ‘covered person’ test in relation to a number of the specific employment and financial relationship restrictions in place of an ‘all partner approach’. Canada has adopted an ‘all partner’ approach in relation to dual employment restrictions but has adopted a ‘restricted person’ regime in relation to financial relationship restrictions. The employment and financial relationship restrictions in the EU Recommendation apply to the statutory auditor and those persons in the firm in a position to influence the outcome of the audit, rather than an ‘all partner’ approach.
The ‘covered person’ concept has not been applied under the auditor independence requirements in Australia and the UK. Australia and the UK have adopted an ‘all partner’ approach in relation to dual employment restrictions and in relation to restrictions on financial investments. However, the restrictions in Australia and the UK relating to loans and guarantees have not adopted an ‘all partner’ approach.
The FRC will consider this issue as part of its work programme for 2006-07, with a view to submitting appropriate recommendations for consideration by the Government.
Employment restrictions applying to former audit partners and senior audit personnel
‘Cooling-off periods’
The two year ‘cooling-off’ period in Australia8 is similar to the periods in the other jurisdictions although in Canada the period is only one year. The Sarbanes Oxley Act 2002 (US) also refers to one year but the way the provision is drafted, the period in fact is longer than one year but not more than two years.
The obligation under the Australian restriction is placed on the former partner while in other jurisdictions the burden falls on the audit firm as it is not regarded as being independent if the ‘cooling-off’ restriction is breached. (The Australian position is explained by the fact that breach of the restriction is a criminal offence and it would not be appropriate to prosecute the firm after the partner has resigned from the firm.)
The Australian two year ‘cooling-off’ period applies to a former partner of the firm who was a member of the audit team, regardless as to how far back the partner’s participation on the audit team took place. Canada, the UK and the US place a limit on the time of participation in an audit prior to the partner’s date of departure from the firm.
However, the scope of the Australian ‘cooling-off’ period only applies to a partner or director of an authorised audit company who has been a professional member of the audit team. The UK requirement includes other partners in the ‘chain of command’. The US requirement is even more extensive and applies to any person who participated ‘in any capacity’ in the audit.
- The FRC will consider this issue as part of its work programme for 2006-07, with a view to submitting appropriate recommendations for consideration by the Government.
Multiple former partners of an audit firm/audit company directors restriction
Section 324CK of the Corporations Act implements a recommendation of the HIH Royal Commission that a prohibition be introduced preventing more than one former partner of an audit firm, or director of an audit company, at any time becoming an officer of the audit client. The restriction has been criticised by the accounting profession because of its potential negative impact on the employment market and recruiting practices of audit firms.
The report of the Taskforce on Reducing Regulatory Burdens on Business has recommended that the Australian Government review the multiple former audit partner restriction. While the Treasury comparative review did not identify an equivalent restriction in any of the relevant overseas jurisdictions, it notes that the existing restriction implements a recommendation of the HIH Royal Commission which concluded that the cumulative effect of three former partners of HIH’s auditor, Andersen, being appointed to the board of HIH, resulted in the perception that Andersen was not independent of HIH.
The Australian Government has announced that it will review the multiple former audit partner restriction by the end of 2006.9
- The FRC will consider this issue as part of its work programme for 2006-07, with a view to submitting appropriate recommendations for consideration by the Government.
Audit rotation
The review found that, while Australia and the relevant overseas jurisdictions have all adopted auditor rotation requirements for auditors of listed companies, there are subtle differences between the requirements adopted in each jurisdiction. None of the jurisdictions require audit firm rotation.
The auditor rotation requirements in each jurisdiction extend to the lead engagement auditor and the review auditor.
Australia, Canada, the UK and the SEC Rules in the US, require rotation after five successive years (although Australia has an additional requirement that a lead or review auditor may not audit a particular audit client for more than five out of seven successive years). The EU requires rotation after seven years.
Australia and the EU have adopted a two year time-out period before a ‘rotated’ auditor is allowed to resume involvement with the same audit client. Canada, the UK and the SEC have adopted a five year time-out period.
However, the SEC Rules provide an exemption from the rotation requirements for smaller audit firms (fewer than five audit clients and less than ten audit partners) provided the PCAOB conducts a review at least once every three years of each of the firm’s audit client engagements.
- The FRC will consider this issue as part of its work programme for 2006-07, with a view to submitting appropriate recommendations for consideration by the Government.
8 The ASX Corporate Governance Guidelines recommend a three year ‘cooling-off’ period.
9 Australian Government’s Response to the Rethinking Regulation Task Force report: 15 August 2006.