Home Accounting and Auditing Why the audit profession needs reform

Why the audit profession needs reform

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The audit profession is suffering a crisis of trust. That view will be contested by the Big Four audit firms, but not by a significant percentage of the public who expected auditors to spare them the value destruction at Tongaat, Steinhoff and VBS Bank – to name a few.

Auditors have a duty in terms of section 45 of the Auditing Profession Act to report ‘reportable irregularities’ to the Independent Regulatory Board for Auditors (IRBA). IRBA guidelines make it clear that the discovery of any bribery, fraud, corruption or kickback would constitute a ‘reportable irregularity’.

The Auditing Profession Act Amendment Bill has been published for comment, and it gives IRBA teeth to crack the whip on errant auditors. It has search and seizure powers, the power of subpoena in investigations, increased financial penalties and a simplified disciplinary hearing process.

SA Institute of Chartered Accountants (SAICA) views these new search and seizure powers as “quite extreme” when compared with other legislation (such as the Tax Administration Act and the Financial Intelligence Centre Act) where search and seizure is regarded as a last resort.

This Bill is of interest to the SA Institute of Business Accountants (Saiba), many of whose members are in practice and interfacing with businesses across the economic spectrum.

All accountants have a responsibility to ensure that the self-protecting nature of the audit profession is brought under far greater public scrutiny.

Non-profit organisation Open Secrets, which “exposes and builds accountability for private sector economic crimes through investigative research, advocacy, and the law”, has recently issued its suggested amendments to the Bill.

It points out that the technical function of an audit is to verify whether the financial statements of a company fairly represent the financial position of that company, and whether they have been properly prepared.

In its submission to the Parliament’s Standing Committee on Finance, Open Secrets expresses dismay that the Big Four audit firms – Ernst & Young, PwC, Deloitte and KPMG – continue to generate vast profits despite being implicated in audit failures, which have significant public cost.

It wants these audit firms to be held to account. Public anger over their repeated professional lapses is legitimate and appropriate. “We urge the Committee to reject the argument that public anger at audit failures is misplaced because the public expects more than auditors can deliver – the so called ‘expectations gap’. The public’s anger and demand for reform is better understood as a result of auditors’ failure to deliver on legitimate expectations that it is their job to assure corporate financial probity – there is an ‘accountability gap’.”

A laundry list of audit lapses

Open Secrets reminds the Stranding Committee of the lapses to which it refers:

  • The VBS Bank heist, where R2 billion was looted while being signed off by a compromised auditor;
  • The massive misstatement of financial results at Steinhoff and Tongaat, resulting in the destruction of more than R130 billion in shareholder value (R120 billion of this at Steinhoff);
  • The failure to report wrongdoing by the Guptas at the Estina Dairy Farm in the Free State, and at SAA (where the Auditor General immediately picked up reportable irregularities);
  • The glossing over of state capture at Eskom and other state-owned entities.

“Auditors should act as a key check on these powerful corporations, at the very least contributing to greater financial probity, transparency and accountability from their private and public clients. The evidence illustrates that through complicity or negligence, auditors have failed to do this in many instances. These failures have enabled corporate elites and public officials to act in their own financial interests at the expense of the public,” says Michael Marchant, senior researcher at Open Secrets.

The PwC forensic reports into what went wrong at Steinhoff and Tongaat have been kept secret, contrary to the public right to know and auditors’ duty to act for the wider social good.

When PwC was found to have overlooked eight major financial misstatements that were later picked up by the Auditor General, IRBA investigated and concluded that the auditors failed in their professional duties to pick up procurement irregularities and failed to disclose non-compliance with legislation.

The fine for this? A paltry R200,000, of which R50,000 was suspended.

How much did PwC and its joint audit partner Nkonki earn for their work at SAA? R19 million.

With such insignificant financial penalties, this maximum fine of R200,000 is seen as “the cost of doing business”. It serves as no deterrent at all.

A 2020 investigation by Open Secrets entitled Corporations and Economic Crime Report (CECR) found that in many cases, junior auditors attempting to flag or report wrongdoing were silenced by a senior partner.

None of this appears to have interrupted the flow of profits to the Big Four, who hold oligopolistic power in the world economy. They account for 96% of all audits on the JSE and 99.4% of the top 500 publicly-traded companies on the New York Stock Exchange and Nasdaq.

The CECR report highlights the key areas of weakness in the current legislative landscape:

a. A lack of independence at the IRBA and a revolving door between industry players and the regulator;

b. Insufficient ability of the IRBA to impose appropriate and powerful sanctions on auditors and the firms they work for;

c. Insufficient powers of investigation for the IRBA, and an imbalance in the power of the IRBA compared to the corporations it is tasked with regulating; and

d. A lack of transparency on the part of the industry and the IRBA in terms of disclosure of information in the public interest.

How to fix the problem

  1. The objectives of the Act should be stronger in emphasising the audit profession’s role in safeguarding the public interest, particularly with regards to reporting, information and governance. This should be tied to the public’s right to know under section 32 of the Constitution, where fraud, corruption and other wrongdoing is involved and impacts the public.
  2. Allow a member of civil society to be represented on the committee for auditor ethics at IRBA. This person should be chosen after an open application process.
  3. Obligate auditors to respond to requests for information, not just from auditors’ clients, but from members of the public wishing to exercise a right.
  4. Prevent conflicts of interests by prohibiting auditors from offering consulting and other services to the same client, or from being rewarded by way of shares or profits in a client company.
  5. Force auditors to release to the public findings of investigations into improper conduct – this is in line with the Constitution.
  6. Substantially raise the financial penalties on auditors for wrongdoing by, for example, imposing a fine equal to a percentage of the audit firm’s profits.
  7. Temporarily suspend the audit firm’s licence for a meaningful period in egregious cases of misconduct.
  8. Remove the discretion granted to the Regulator’s enforcement committee to publish the name of auditors admitting guilt. Force them to publish the names.
  9. Disclosure of wrongdoing should be required where it is in the public interest.