Australia's long awaited report on auditor independence comes with no guarantees
Everyone's talking about auditor independence. Apart from the high profile company collapses that have recently catapulted the issue into the public spotlight, the ability of an accounting firm to perform an independent audit, while also providing other accounting, taxation and business consulting services, has long been recognized as a potential conflict of interest.
In Australia, it's an issue that started receiving attention early in 2001, when the Federal Government commissioned what is now known as the Ramsay Report. Prepared by Ian Ramsay, Harold Ford professor of commercial law and director of the Center for Corporate Law and Securities Regulation at the University of Melbourne, it reviews Australia's existing legislative and professional requirements for company auditors. It also makes comparisons with overseas requirements, and presents a series of recommendations to improve Australian auditing standards.
Better late than never
The Ramsay Report was a long time coming. Before 2001, legislation and codes of conduct for the auditing profession had not been reviewed in Australia for 40 years. Indeed, Australian law currently contains no specific reference to auditor independence. When Australia was hit with a spate of corporate collapses last year, it became apparent that the auditing function and corresponding law and codes had to be reassessed immediately.
Other catalysts for the report were the activities of regulators and a number of professional accounting bodies around the world. Organizations such as the US Securities & Exchange Commission and the International Federation of Accountants (IFAC) started making noises about auditor independence two years ago. For the Australian government, these activities highlighted the fact that their standards were below international best practice and that change was needed urgently. In Ramsay's words, 'There was pressure on the auditing profession to demonstrate that systems can be put in place to ensure investors have confidence and to minimize collapses.'
Ramsay's central recommendation is to create an independent supervisory body with the power to discipline aberrant auditors. Its other function would be to monitor audit firms' disclosures of non-audit services.
'There's a strong cohesion of support for that sort of body, and there are precedents, for example in the UK,' says Ramsay.
The report also suggests that ethical rules driven by Australia's two accounting bodies, CPA Australia and the Institute of Chartered Accountants in Australia (ICAA), be revised and updated. And it recommends mandatory disclosure of non-audit services performed by auditors, and the fees paid for those services.
Should Ramsay's recommendations be implemented in their entirety, listed companies would also be required to produce an annual declaration of auditor independence.
The role of the audit committee is also highlighted in the report. Ramsay suggests legislation be amended to make audit committees mandatory for listed companies, and sets out a number of ways in which the audit committee's role could be expanded.
The main legislative change recommended by the report is the inclusion of a statement in Australia's Corporations Act regarding auditor independence.
What would it achieve?
If Ramsay's recommendations are implemented in full, they will go a long way toward helping restore investor confidence in the auditing profession. Investors rely on auditors to produce genuinely independent reports on a company's financial statements. But the controversy that has surrounded the collapse of US energy giant Enron has led the market to question the efficacy of the audit. Indeed, some extremists are calling for the profession to be scrapped altogether.
'You don't stop driving cars just because you have an accident,' retorts Stephen Harrison, CEO of the ICAA. 'We'll never be able to eliminate mistakes entirely, but we do need to look at what can be done constructively to improve the situation.'
A permanent supervisory board overseeing the accounting industry would help restore investor confidence in the auditing profession. A permanent body would also avoid the problem of auditing practices being ignored for 40 years. 'This is one of the key reasons for the board,' says Ramsay.
What can't be achieved, however, is the complete elimination of mistakes in the auditing process altogether. 'There are unrealistic expectations about auditors.
They will never find everything that's gone on,' states Ian Mackintosh, head accountant at the Australian Securities & Investments Commission (Asic).
International push
Recent events indicate Ramsay's recommendations are compatible with international trends in auditor independence. A recent move by the SEC even mirrors the report's recommendation for a supervisory board.
The SEC recently announced it would strip the American Institute of Certified Practicing Accountants (AICPA) of its disciplinary powers over auditors, and it would establish a new body to take over disciplinary matters.
The chairman of the SEC, Harvey Pitt, has said the body would have 'real teeth', and would have the power to take evidence and obtain corporate documents and data. It would also have the power to oversee disciplinary actions and would have the ability to perform investigations, conduct disciplinary proceedings and restrict firms that are in breach of the law. A similar body already exists in the UK: the Investigations and Disciplinary Board.
The similarities between these bodies demonstrate that requirements governing auditor independence are beginning to fall into line around the world. As part of this process, the IFAC has prepared a code of conduct for auditors upon which it expects national regulators to base their own codes of conduct. This globalization of auditing standards is particularly important as cross-border transactions are increasing exponentially, requiring a standardized set of rules for auditor independence the world over.
Where to next?
The Australian federal government must officially respond to Ramsay's recommendations before any of his suggestions can be implemented. 'It's solely for the government to decide how best to proceed,' says Ramsay. 'The report called for the government to update legislation and I would hope that they would do that.'
The government is still taking comments about the report and Ian Campbell, the senate minister responsible for managing the implementation of the report's recommendations, has said there will be an official response later this year. Given the public interest in the issue, not just in Australia but worldwide, it's thought an announcement will be made sooner rather than later.
Although corporate Australia has applauded most of Ramsay's recommendations, controversy surrounds others. For instance, the report calls for the listing rules of the Australian Stock Exchange (ASX) to be changed to make independent audit committees obligatory for listed companies, something the ASX believes may not be appropriate.
Gervase Green, a spokesperson for the ASX, says the exchange is still considering the issue. 'Our question is whether the listing rules are the appropriate place to have such a requirement, as opposed to the Corporations Act,' he states. 'While we recognize it's easier to change the listing rules than to change legislation, that's not a good enough reason to go down the listing rules track.'
The other big sticking point is the real value of the supervisory board, considering there are already two bodies that oversee accounting and auditing in Australia. While neither currently have any disciplinary powers (Asic has that right at the moment) both would no doubt feel threatened by the emergence of another body with powers and responsibilities over and above their own.
'The response to the independent board has been supportive overall. There's been some resistance from CPA Australia, but the big five don't have a problem,' Ramsay maintains.
Jim Dixon, a director of CPA Australia, has said that 'the government needs to make up its mind whether to have a supervisory board, expand the role of Asic, or put in place a financial reporting council.'
'I don't think CPA Australia is right,' counters Ramsay, 'What's needed is a multi-pronged approach to deal with the issue - which is why it can't be left solely to the professional bodies.'
Despite the fact that the government is yet to give an official response to Ramsay's report, actions are already being taken by industry to implement some of his suggestions. Harrison of the ICAA says many companies are already acting on Ramsay's recommendations. 'Many auditors are already giving detail in their reports about the additional services they provide to their audit clients,' he observes.
In addition, CPA Australia and the ICAA have issued a joint exposure draft on new auditor independence rules which follow the IFAC's guidelines.
Ramsay's recommendations
- The creation of an independent supervisory body with disciplinary powers over the auditing profession.
- A review of ethical guidelines administered by CPA Australia and the Institute of Chartered Accountants in Australia.
- Mandatory disclosure of the non-audit services performed by auditors.
- Mandatory annual declaration of auditor independence by all listed companies.
- Compulsory audit committees for every listed company board of directors.
- Legislative change to amend the Corporations Act to include a statement of auditor independence.