Business Maverick


After the Bell: The frightening issues of compulsory audit firm rotation

After the Bell: The frightening issues of compulsory audit firm rotation

Auditors get paid a lot of money to try to keep companies on the straight and narrow, and have rule books the size of several encyclopaedias to help them with that job.

There may be no more frightening thing on the planet than a group of very angry auditors. It’s so out of their notional personality and character type. Auditors are sensible, pragmatic, thoughtful and cautious. (I know, I know, there is really no “typical” auditor, but just submitting to stereotypes for a moment…)

Anyway, if you are the kind of person who likes to live dangerously, raise the issue of mandatory audit firm rotation among a group of auditors, and voila! Big argument. 

Ordinary people might not think, amid global crises and all the rest of it, that mandatory audit rotation would be on the top of anyone’s agenda for passionate argument. But then you would be wrong, because, clearly, there are lots and lots and lots of things to say about the subject.

Anyway, the short version is this: occasionally – well, tbh, more than occasionally – companies go wildly wrong. And immediately the finger is pointed at the auditors because, theoretically, they are hired precisely to keep management in check. 

Managers think, typically, their businesses are the best thing since sliced bread; auditors are there to make sure managers don’t get too carried away, keep a grip on reality, and tell the shareholders the truth about the business, more or less.

Anybody who thinks this is the case hasn’t seen a service agreement between an auditor and the firm’s client. This is because they typically absolve the auditors upfront for any and every kind of conceivable auditing failure. So you do have to ask what you are actually paying for. But anyway, auditors get paid a lot of money to try to keep companies on the straight and narrow and have rule books the size of several encyclopaedias to help them with that job.

When companies do fail, then usually the public are mightily pissed off and insist that the industry and/or the government should “do something”. And that something has, around the world, given us the enforced rotation of audit firms. 

If you are a listed company, typically you have to change your auditors every decade. Auditors themselves generally hate the idea, but audit rotation is now required in the US, Europe, the UK, China and a host of other countries.

In SA, the Steinhoff and Tongaat corporate disasters followed the same pattern as Enron in the US years ago. The industry was put under huge pressure to “do something”, so the Independent Regulatory Board for Auditors (Irba) decided to go with the international flow and implement the rotational requirement.

And then this week, amazingly, after all the debates around the issues, the Supreme Court of Appeal suddenly scrapped the requirement in SA. If auditors were those kinds of people, there would be dancing on the desks in the offices of the northern suburbs of Johannesburg.

According to Moneyweb’s scoop report, the judgment was founded on the simple basis that Irba did not in fact have the power in terms of the relevant act to implement such a drastic change. 

But the contents of the judgment were amusing in other ways, specifically about the size of the record, which was apparently 15 volumes in length, comprising 2,633 pages. Told you that people have a lot to say on this topic.

The argument has always been that one of the reasons firms go off the rails is because auditors get too entrenched, so the way to fix that is to insist that companies change their auditors every now and then. 

There are lots of counterarguments, but mostly they are that if you change auditors often, then audit reports will be of lower quality and more expensive.

It may also not help the situation; auditors rely on the company to provide the information required to complete the audit. A good example is the recent Wirecard scandal in Germany, where auditors were apparently given falsified documents by the company. Interestingly, it was the auditors who actually discovered the fraud, as in the Steinhoff case. 

Sometimes the auditors are blamed, but the problem is more often not that they willingly and knowingly colluded with their client firms, but that they were too trusting; which may be something you are inclined to do if firms are paying you lots of cash for a service. For these reasons and others, some European countries have made huge U-turns to scrap audit firm rotation.

Are there alternatives? One is to keep audit firms but change the audit partners responsible for the audit. It’s the “new set of eyes” argument. France used to have this provision, but the EU decided this was insufficient.

But ultimately, the public needs to get its head around the fact that companies sometimes go bung, and auditors might be involved in some way, or not, but the auditors are seldom the root cause. 

The best description I have read is that compulsory audit rotation is a bit like trying to kill a fly with a cricket bat; it works, but the price you pay is lots of broken stuff.

Anyway, SA now has a second chance to think – by which I mean argue until we are blue in the face – about the issue. Go to it auditors everywhere, but calmly please! DM


Comments - Please in order to comment.

  • Keith PIGGOTT says:

    In the Aviation Safety Auditing industry (International Airline Transport Association (IATA) Operational Safety Audit (IOSA) and the Flight Safety Foundation (FSF) Basic Aviation Risk Standard (BARS)) Audit companies have to be rotated after every two audits, and auditors are not permitted to audit the same operator for more than two consecutive years.
    This is a perfectly normal practice. It keeps audit companies from becoming overly familiar with aviation operators and brings different eyes to the organisation. The professionalism of audit companies is improved because another will highlight deficiencies not identified by one company. The standard of audit reports also is improved. None of the audit companies wants to be shown up by another company. It is a process of “continuous improvement”, a fundamental concept of Quality Assurance.
    The financial audit industry does not exactly have a shiny reputation, and being against such a process makes them look even more complicit in the corporate mismanagement

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