Auditing firm Deloitte will face its moment of reckoning as it defends itself from damaging allegations of missing red flags and failures to disclose blips in its audit of African Bank before its spectacular collapse four years ago, writes Ray Mahlaka on Moneyweb.
A lot is at stake for the Independent Regulatory Board for Auditors (Irba) as the audit regulator is leading the disciplinary of Deloitte – the biggest case it has handled since its 2006 inception.
The disciplinary hearing could either entrench perceptions that Irba has neither bark nor bite at a time when audit firms are caught in accounting scandals, or prove sceptics wrong.
You don’t have to look far for disastrous auditing examples: Deloitte’s auditing of Steinhoff, which had to restate two sets of financial results (at the very least); KPMG bending over backward for Gupta-linked companies and its audit of VBS Mutual Bank, which was recently placed under curatorship.
At the same time as audit firms’ independence and professionalism comes under the spotlight, they are being quizzed for the fees they charge.
In these hearings Deloitte is answering questions on why it granted African Bank, and its then-parent company African Bank Investments Limited (Abil), a going concern status and gave unqualified reports on its financial statements when it appears it shouldn’t have done so.
The firm had signed off on African Bank and Abil’s financial statements since 2010.
The nub of Irba’s allegations is that Deloitte’s audit of African Bank and Abil misstated the lender’s impairment of loans and provisioning of losses – which created a false impression that the bank was in the green.
Of course, this wasn’t the case as African Bank and Abil was saved by the Reserve Bank from extinction in 2014 after placing it under curatorship.
Irba’s charge sheet makes for an astonishing read. It contains ten charges of misconduct by Deloitte’s two senior executives, Sihlalo Jordan and Danie Crowther, who were involved in the 2013 audit of African Bank. Jordan is a respondent to all ten charges while Crowther faces one charge.
According to Irba, African Bank failed to comply with International Standards on Auditing (ISA), which detail various financial models on impairing loans and accounting for a loss event on loans.
The audited financial statements of African Bank for the year ended September 2014 showed a restatement relating to differences between impairment models and the impairment provisions recognised in the 2013 financial statements. The impact of this restatement on September 2013 was a R656 million downward adjustment of African Bank’s income pre-tax.
Irba said this error (R656 million) is “material and accordingly the audited financial statements were materially misstated”.
Irba’s advocate Shem Symon SC said African Bank’s financial statements were never amended for this misstatement, thus an unqualified audit opinion was incorrectly granted by Deloitte.
The bank’s management at the time identified loan collection initiatives that could generate an uplift of about R825 million – but Deloitte’s Jordan allegedly accepted this without considering its validity. Jordan faces charges relating to African Bank’s misstatement of loan impairments, which resulted in impairments that were understated by R1.1 billion.
Other charges that Jordan faces include: failing to maintain an attitude of professional scepticism in African Bank’s use of incorrect interest rates (which excluded initiation fees) when discounting the impaired loan book, resulting in the book being overvalued by R2.3 billion; failing to obtain a proper understanding of the International Financial Reporting Standards requirements relating to loans and receivables and accepting methodologies relating to impairment provisions that were not in accordance with industry norms.
Jordan also faces charges relating to the issue of an unqualified opinion for African Bank and Abil in September 2013 despite uncertainty over the ability of the group’s furniture unit Ellerines Furniture continuing as a going concern and its turnaround strategy that would impact the bank’s cash reserves.
The final charge that Jordan and Crowther face is the most scathing:
In a meeting held in October 2013, Jordan and Crowther allegedly advised the bank’s former executive Gustav Raubenheimer to not inform Deloitte via email that Abil’s credit impairment was understated by R3.75 billion as at August 2013.
Essentially, they are accused of suppressing evidence.
“Jordan and Crowther further warned Raubenheimer not to destroy his relationship with [Leon] Kirkinis [former African Bank CEO] by sending the email to Deloitte. They advised Raubenheimer that in the event that he sent the email to Deloitte, Jordan, and Crowther would have been compelled to act thereon as if it were a fraud report,” Irba said.
Deloitte’s Jordan and Crowther are also accused of being biased towards African Bank and Abil management. In one scenario, Kirkinis allegedly told Jordan and Crowther that it would “sink” African Bank if Deloitte continued to raise concerns – since 2009 – about the bank’s accounting practices.
“Jordan and Crowther were aware, or alternatively should have reasonably been aware, that ‘sinking’ Abil and African Bank would be the likely outcome if higher impairment charges were processed, the resultant pressure led to an intimidation threat.”
Jordan and Crowther have denied all the allegations, saying they are unfounded and there’s no basis for the improper conduct charges brought by Irba.
CEO of Deloitte Africa Lwazi Bam said the firm stands by the quality of its work at African Bank and Abil.
“Deloitte also has no reason to doubt the skill, competence or independence of the two respondent partners [Jordan and Crowther] involved in the 2013 audit of African Bank and remains of the view that the audit was carried out with due professionalism,” Bam told Moneyweb.
Bam said Deloitte’s African Bank records show that Jordan and Crowther took into account all the available audit evidence, both applied professional scepticism, and complied with regulatory rules. Thus, there is no evidence to suggest a breach of independence occurred in relation to the audit of African Bank and Abil, he said.
He noted that the Myburgh Commission of Inquiry – headed by John Myburgh SC to probe the causes of African Bank’s collapse – made no adverse findings against Deloitte’s conduct. Bam said Deloitte’s own investigation supported this view. Instead, Myburgh found that the directors of Abil and African Bank acted recklessly in downplaying the implications of bad debts and credit impairments.
“The final assessment of Deloitte was, therefore, that although within an acceptable range, management’s evaluation of credit impairments was still towards the less prudent side of that acceptable range,” an extract of the 477-page Myburgh report reads.
Bam said Deloitte’s 2013 audit team ultimately forced management of African Bank to pass much larger credit provisions than they wanted, even though management was initially satisfied with lesser provisions. He said Jordan believes that the impairment provisions in 2013 and earlier years were not materially understated as “there are matters of specific accounting treatment that is complex, subjective and judgmental” and “there is scope for the professional judgment of accounts to differ… without any of them having been negligent or unprofessional.”
Regarding the going concern status of African Bank and Abil, Bam said the status was dependent largely on liquidity and not the level of impairments.
Deloitte further submits that the cash requirements to implement the turnaround strategy of Ellerines Furnishers and the various write-downs to the loan book did not impact directly on the liquidity of Abil or African Bank. Instead, its going concern status was largely dependent on the ability to raise capital via a rights issue.
Before African Bank’s collapse, the bank raised R5.5 billion in a rights issue, which Deloitte believes helped address and “sufficiently mitigated” uncertainties around the bank’s liquidity.
“African Bank went into curatorship more than ten months after the 2013 audit, not because anything was wrong with the 2013 financial statements or the audit, but because the market lost confidence in its performance during the 2014 financial year and withdrew the wholesale funding on which it depended for its survival,” said Bam.
Role of auditor
The Myburgh report concluded that the primary responsibility for the fair representation of financial statements is that of the directors of a company. However, Irba CEO Bernard Agulhas holds a different view, saying the role of an auditor goes beyond fair representation. Agulhas said auditors review and give an opinion on financial statements in line with regulation and international auditing standards.
“It’s important that the review and opinion is accurate as investors and shareholders rely on this opinion to make investment decisions…. In the current environment, there is so much interest in the audit and accounting profession. It is important to show the public that we’re taking steps to address the issues.”
If Deloitte is found guilty of misconduct, Irba might reprimand the audit firm, impose a maximum fine of R200 000 per charge, suspend its right to practice or remove the firm from its registrar.