The Supreme Court of Appeal has ruled that mandatory audit firm rotation be set aside.
In an unexpected twist for the audit and finance profession, the Supreme Court of Appeal (SCA) has ruled that the Independent Regulatory Board for Auditors (IRBA) did not have the power to mandate audit firm rotation. This comes after 91 percent of listed entities, as well as many public interest entities, have already rotated firms.
The mandatory audit firm rotation (MAFR) rule was promulgated by IRBA in 2017, and was supposed to come into effect in April 2023.
IRBA CEO Imre Nagy explained that at the time that IBRA identified MAFR as the preferred measure to strengthen the independence of auditors it was also highlighted that CFOs, who hold sway in the decision to appoint an audit firm, are drawn from a limited pool of auditors, often from the same auditing firms. In addition, the acquaintance between audit committee chairs and incumbent auditors exacerbates the perception of a lack of independence and poses a threat to audit outcomes.
“This is what the IRBA Code of Professional Conduct refers to as familiarity threats and specifically the independence threat of long tenure that MAFR is intended to mitigate,” Imre said.
The SCA, however, found that IRBA’s rule-making powers were confined to “the prescription of standards” in defined functional areas. MAFR did not constitute a “standard”, but instead aimed 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.
As such, the SCA has deemed MAFR unlawful and that it should be set aside.
Imre added that, while IRBA respects the Supreme Court judgment, it must continue to pursue its mandate to protect public investors and assist government to grow the economy by restoring confidence in audits.
“We still believe that MAFR is the appropriate mechanism that strengthens auditor independence.”
“We want to commend those audit committees and audit firms for recognising the risk of long firm tenure and adopting the MAFR as a measure to mitigate such risk. 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,” Imre concluded.
