CFOs reject mandatory audit rotation: CFO Forum chair Christine Ramon

The forum rejects the decision of the Independent Regulatory Board for Auditors (IRBA) to introduce mandatory audit firm rotation, saying IRBA followed the wrong consultation process and disregarded valid concerns of various stakeholders in order to reach a predetermined outcome. CFO South Africa spoke to Christine about her personal view on mandatory audit firm rotation (MAFR) and that of the CFO Forum.

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"I am not against audit rotation, but it should be the duty of the audit committee to assess when and if auditor rotation is required. The mandatory part of the IRBA proposal is concerning," says Christine, adding that cited positive effects on audit quality, transformation and market concentration are unproven at best and highly doubtful or absent at worst. "There are some benefits, like a new pair of eyes reviewing the financial results and a possible reduction in the audit fees. It could also create a platform for smaller companies to audit companies that operate in one jurisdiction, but these potential advantages are far outweighed by the negatives."

More CFO SA exclusives about mandatory audit firm rotation:

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• Longer tenure mulled for joint-audits: IRBA CEO Bernard Agulhas
• Mandatory Audit Firm Rotation is a good thing, says Nkonki's Mitesh Patel
• Only nine out of 353 South African audit partners are black

According to Christine, the CFO Forum feels that IRBA's research and consultation was done with only one possible outcome in mind. "The process has completely disregarded valid concerns of stakeholders thus opening up an opportunity for the motives and objectives of IRBA to be called into question. There has been no process to discuss IRBA's conclusions, thus implying that the outcome of this consultation process was predetermined. IRBA has not made its research available to stakeholders and we feel that the correct way to legislate MAFR is through changes to the Companies Act, as shareholders' rights are fundamentally diluted. This requires extensive consultation with businesses, their shareholders and various other stakeholders including investor groups, both here and abroad."

Predetermined outcome
IRBA is the regulator for South Africa's audit profession and can, by prescribing new regulations, create new rules for the audit firms to comply with. By default, its rulings also affect the businesses which are subject to these audits. "Nobody I know is in favour of this. The outcome appears to have been predetermined and important parties, like the SA Reserve Bank, have not been appropriately consulted to my knowledge."

Most members of the CFO Forum feel that transformation and independence are two different issues, which should not be mixed by addressing them through MAFR, says Christine. "IRBA does seem to be moving ahead with these regulations, which is a concern." Various sources in the industry have already suggested that legal action could be instituted based on the unstructured process followed by IRBA. "I don't want to pre-empt the legal side, because we can't do anything until it is legislated. First of all, IRBA's research needs to be shared and then we need to see a policy paper that all stakeholders, including the CFO Forum members, can comment on. We find it highly unusual that none of those things have happened in advance of such an important regulations being passed."

Not too cosy
Christine refutes IRBA claims that management often "gets too cosy" with auditors. "Companies go through corporate restructuring, both audit and company management rotates, so these relationships change all the time. I have been in my role for two years, our CEO for three years. We don't have the cosy relationships that IRBA talks about. When I started at AngloGold Ashanti, our auditors were very important for me, because they had years of experience. For me to be able to sit down with them and talk about the issues in the different jurisdictions of our business and about the different management teams, was very valuable."

Sasol was one of the companies that decided to voluntarily change auditors, given the new regulations in Europe. When that happened, in 2013, Christine was CFO. "Our incumbent auditor was KPMG, for over 60 years, and the change had a lot to do with perception. The process was very structured under the lead of a project manager involving the major international firms and a local firm tendering. This was a costly and time consuming exercise. Unfortunately, the local firm had not been PCAOB-reviewed, which precluded them from issuing opinions in the US. They also didn't have the geographic footprint, which would allow for a consistent audit methodology to be applied across all jurisdictions."

Christine is also non-executive director at MTN, which - like Telkom and Discovery - has joint-auditors, a practice IRBA is keen to encourage, At MTN, the joint audit is done by PwC and SizweNtsalubaGobodo. "In some instances it is beneficial to have joint audits to serve a multi-national corporate across Africa and the Middle East, as the big four audit firms may be restricted in operating in certain jurisdictions, where local firms may have greater flexibility in these markets. MTN is not listed in the US, which makes it easier for a local firm to get involved. For companies that operate in multiple jurisdictions MAFR is a significant administrative challenge. It requires management to spend additional time, effort and resources on the tendering process and getting the incoming auditors up to speed."

Overlooking matters
Many measures have been put in place over the years to increase auditor independence, including mandatory audit partner rotation, says Christine, adding that most audit trainees change and will only be on the same client for a few years, all of which helps ensure that an independent, arm's length relationship is maintained. "The result of the introduction of mandatory audit partner rotation has also already had the desired effect that the client is viewed with a 'fresh pair of eyes' on a regular basis. It is doubtful whether MAFR will further enhance independence."

Audit firm rotation also creates concerns, especially in the first two to three years after rotation, because the new auditor takes time to get fully acquainted with the business and industry issues of its new client and sometimes this may result in overlooking of significant matters, Christine argues. "Firm rotation results in significant loss of collective intellectual knowledge of the company that the previous audit firm possessed."

While transformation is crucial for the future of South Africa, Christine says it is not clear how MAFR will contribute to achieving that goal. "There is no evidence available to suggest that audit firm rotation will accelerate transformation at audit sign-off partner level. In fact, it might deter large audit firms from continuing to invest significant funds in driving transformation in the industry, through funding initiatives like Thuthuka and also within their own firms. Let's not forget that the Big 4 firms have the same ratings, as some of the smaller, black-owned firms."

Not an international trend
Christine's view is supported by a number of reputable bodies, including the Global Network of Director Institute (GNDI) and King III. She dismisses the notion that MAFR is an international trend. "There are a number of countries that have considered MAFR and decided not to implement this, mostly notably the USA, Japan, Australia, Canada and New Zealand. Countries that did implement it, but subsequently repealed it include South Korea, Singapore, Spain, Argentina and Brazil. Only the EU, UK, India and China have adopted MAFR, but there has not yet been any evidence to support the contention that it leads to greater audit quality and auditor independence."

IRBA often mentions AngloGold Ashanti as a 'bad example', with EY's audit tenure spanning more than 72 years. AngloGold Limited, the forerunner of AngloGold Ashanti, was only formed in 1998 through the combination - and subsequent spin-off - of Anglo American's global gold portfolio. According to Christine, EY had been the auditor for one of the South African companies that formed the holding company of the current multinational group, but until 1998, the various other entities that merged to form the group had various other auditors, like KPMG who were the auditors at Western Deep Levels and Deloitte who were the auditors at Freegold

Christine also put together a list of pros and cons of mandatory audit firm rotation for CFO South Africa:

Pros for MAFR:

• Can possibly aid and support auditor independence and audit quality initiatives already introduced, but requires much deeper analysis and research before it is introduced. It should be considered to possibly first introduce mandatory firm tendering before MAFR.
• Appointment of a new audit firm often will result in a 'new pair of eyes' reviewing the results, thus potentially improving the potential to identify issues that the long standing incumbent auditor might not have necessarily identified.
• Could provide a platform for smaller firms to participate in the market with the Big 4 firms (though this is limited by their lack of global reach).

Cons for MAFR:

• Responsibility of audit committees and shareholders to have oversight of audit appointments is negatively impacted. Therefore, well-understood corporate governance principles are undermined. This would also undermine the principles of auditor independence, which the audit committee has a statutory duty to oversee. The statutory right of the shareholders to appoint auditors would be entirely abrogated.
• MAFR could enhance risk of audit failures especially in the first two to three years after audit firm rotation; also this increases the risk for shareholders due to the loss of company and industry specific knowledge at arbitrary times. This in turn would result in loss of investor confidence thus impeding companies' access to local and global capital markets.
• Business would potentially be detrimentally influenced if rigorous MAFR is introduced, e.g. certain value-adding transactions (merger & acquisitions or disposals) may not occur at appropriate times given the auditors requirement to rotate in periods where the company may be involved in, or contemplating these transactions.
• Although MAFR may be implemented for smaller single jurisdiction entities without major concerns as the pool of available audit firms from would be broad, it will have significant implications for major multi-jurisdictional entities, which based on their unique circumstances and geographical spread of their assets, probably only have the Big 4 audit firms and possibly only a very small number of second tier audit firms to choose from.
• It would be increasingly difficult, costly and time-consuming for audit committees to manage the rotation of auditors across various jurisdictions if there are differing requirements across the various jurisdictions. This will reduce the ability of the audit committee to properly assess and manage auditor performance as part of its duties.
• In scenarios where joint-audits are already in place, e.g. the South African banking industry, MAFR will simply create further compliance burden, further limiting the ability of audit firms to tender due to the fact that the other audit firms provide them with additional services (e.g. consulting), thus further limiting the choices of the audit committee and not adding any further value.
• Big multinational companies require access to audit firms with a global footprint, but also access to international expertise and specific industry experience. Hence despite the introduction of MAFR, this would not necessarily encourage large multinationals to transition to smaller firms due to lack of access to these services.
• The cost, complexity and management effort to rotate auditors whilst maintaining a clear focus on core operations in a complex macroeconomic environment (especially in the SA market) cannot be justified to shareholders as there is no compelling support for MAFR reducing audit failures and improving auditor independence.
• In order for SA companies to access capital on a global scale, investors and financiers require reliable audited financial statements. It would be almost impossible for a large company to access capital on global markets unless it is audited by one of the Big 4 firms.