SCA strikes out the mandatory rotation of audit firms in one stroke
The Supreme Court of Appeal surprised the auditing profession this week by effectively striking out the ‘mandatory audit firm rotation rule’.
The judgment sets aside the mandatory audit firm rotation rule (MAFR), which was published in the Government Gazette in June 2017 and came into effect on 1 April this year.
Kim Rew, partner at Webber Wentzel, says the SCA ruling makes it clear that the Independent Regulatory Board for Auditors (Irba) did not have the power to mandate audit firm rotation.
“Both domestically and internationally, the auditing industry has been implicated in corporate wrongdoing,” Rew says. South African accounting scandals have included listed companies such as Tongaat Hulett, which is currently under business rescue, and the notorious fraud uncovered at Steinhoff. Both firms were audited by Deloitte.
Irba attributes this, among other things, to the long tenure of audit firms and issued the MAFR to strengthen auditor independence and enhance audit quality.
Imre Nagy, chief executive of Irba, says the court’s judgment was on a technical and legal basis and Irba stands by the ongoing need for regular rotation of audit firms.
“The crux is not whether MAFR is or is not the right measure to increase independence, but rather that there was a difference of opinion on whether the Act allowed for Irba to issue the rule,” he says.
Irba’s legal team is reviewing the judgment and Nagy says a decision is yet to be made on whether to proceed with an appeal. In the interim, he says Irba will be engaging with Parliament and stakeholders to address the technical issue raised in the judgment.
The MAFR prescribed that an audit firm may not serve as the appointed auditor of a listed company for more than 10 consecutive financial years. Following a 10-year appointment, that particular audit firm would only be eligible for reappointment to the same listed company after five financial years.
Irba submitted that it was established under the Auditing Profession Act, which empowers it to prescribe rules on standards for professional competence, ethics and conduct of auditors as well as auditing standards.
“The SCA held that the net effect of MAFR is to impose broad restrictions on audit committees, companies and shareholders from appointing an audit firm of their choice.
“At the same time, it prohibits audit firms from accepting appointments even if they are selected by a company,” says Rew, adding that this is a significant decision for the auditing profession.
Parmi Natesan, chief executive of the Institute of Directors South Africa, says with or without mandatory firm rotation, the independence of an external audit is a critical component of the financial reporting ecosystem.
“From a governance perspective, the Companies Act already places the onus on audit committees to oversee auditor independence. King IV specifically recommends that the audit committee makes a statement as to whether they are satisfied that the external auditor is independent of the organisation,” she says.
The Companies Act also prohibits the same individual auditor (not an auditing firm) from serving as the auditor of a company for more than five consecutive financial years, with a cooling-off period of two years between appointments. This legislation remains in place.
“The irony of the decision is that the rule came into effect on 1 April 2023, which means that many companies would have long since made plans for its implementation.
“Large audits are planned well in advance and, in many cases, the new auditors have already been appointed,” Ryan Hopkins, associate at Webber Wentzel, observes.
Irba’s monitoring statistics show that there has been a very positive uptake of voluntary rotation by listed companies (91%) and public interest entities in the lead-up to the effective date of 1 April 2023, and the effects will be felt for at least the next five to 10 years.
“We want to commend those audit committees and audit firms for recognising the risks of long firm tenure and adopting the MAFR as a measure to mitigate such risks.
“Whether it is a real or perceived lack of independence, the shareholders and public will continue to question whether an audit firm is truly independent when reviewing financial statements in circumstances where they have audited the clients for longer than a decade,” Nagy says. DM