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Auditor-Client Conflicts of Interest

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Auditor-Client Conflicts of Interest Submission dated 28 October 2019 Parliamentary Joint Committee on Corporations and Financial Services: Regulation of Auditing in Australia By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. This "public watchdog" function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust. - Chief Justice Warren Burger, writing on behalf of a unanimous United States Supreme Court in the case of United States v. Arthur Young & Co. (1984) Auditor-client conflicts of interest In corporate Australia it is the client, not the creditors, stockholders or investing public, who pays, hires and fires the ‘independent’ auditor. Yet it is to the public trust that the auditor owes complete fidelity. In these circumstances can the auditor maintain total independence from the client? University research, referred to below, suggests not. The Joint Accounting Bodies Independence Guide (‘the Guide’) is, ‘intended to assist professional accountants in understanding and applying the auditor independence requirements of the APES 110 Code of Ethics for Professional Accountants (the Code) issued by the Accounting Professional & Ethical Standards Board’.1 The Guide states: In today’s competitive world trust and confidence are essential to the stability of capital markets. The auditing profession plays a critical role in the orderly functioning of capital markets by performing independent audits. The independence of the auditor is crucial to this process and helps to build the trust of shareholders, regulators and other stakeholders in financial information which has been subject to audit... Independence requires an individual member to act with integrity and to exercise objectivity and professional scepticism. Members are obliged to be straightforward and honest in professional and business relationships and not to allow their judgement to be compromised by bias, conflict of interest or the undue influence of others. Independence comprises both: • Independence of mind 1 Joint Accounting Bodies Independence Guide, Fourth Edition, February 2013 The major professional accounting bodies in Australia established the Joint Accounting Bodies to speak with a united voice to government bodies, standard setters and regulators on non-competitive matters affecting the profession: the Guide p.2 1 • Independence in appearance This means that members must not only be independent in action but they must also be perceived, by an informed third party, to be independent. This is particularly relevant when providing assurance services. 2 Implicit is an expectation that the auditor faced with a conflict of interest should, or will, have the mental wherewithal, the conscious ability, not to allow their judgement to be ‘compromised by bias, conflict of interest or the undue influence of others’. Implied also is the assumption that independence and objectivity stem from conscious action and motivation. But is that assumption reasonable? Again, university research, referred below, suggests otherwise. In Australia, the independent audit is regulated by legislation, predominantly the Corporations Act, Australian Auditing Standards, and APES 110 Code of Ethics for Professional Accountants (the Code) issued by the Accounting Professional & Ethical Standards Board (APESB).3 The Australian Securities & Investment Commission states: An auditor is required to be independent from the entity it audits. ... Maintaining independence has a number of aspects that the auditor must be mindful of throughout the client/auditor relationship. A brief overview of the areas an auditor must be aware of and implement appropriate responses to include: conflict of interest situations o general requirements, including the provision of certain non-audit services, and o specific relationships of the auditor and/or audit team members with the audited entity, auditor rotation for listed companies. In certain limited circumstances auditor rotation relief may be granted by ASIC auditors must be diligent in identifying and evaluating threats to independence and applying appropriate safeguards. If a conflict of interest situation remains in existence after seven days, the auditor must inform ASIC in writing that the conflict of interest situation or that the relevant relationship still exists. More information about breach notification. When conducting an audit or review of a financial report, the auditor must provide a written declaration confirming that there have been no contraventions of the auditor independence requirements or applicable code of professional conduct.4 The auditor-independence model is thus based on self-assessment - by the auditor and/or audit team member. Only in the event of actual or alleged breach does the independent regulator step in. 2 ibid pp.6,9 3 ibid p.6 4 https://asic.gov.au/regulatory-resources/financial-reporting-and-audit/auditors/auditor-independence-and- audit-quality/ 2 The Corporations Act has a general requirement for auditors to avoid and eliminate ‘conflict of interest situations’: sections 324CA, 324CB and 324CC. The situations themselves are not particularised but defined in terms of an actual, potential or perceived absence of capacity for exercising objective and impartial judgement: (1) For the purposes of sections 324CA, 324CB and 324CC, a conflict of interest situation exists in relation to an audited body at a particular time if, because of circumstances that exist at that time: (a) the auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body; or (b) a reasonable person, with full knowledge of all relevant facts and circumstances, would conclude that the auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body (2) ... .5 The Guide refers to the definition6 and additionally adopts a conceptual framework of identifying threats, evaluating their significance and applying various ‘safeguards’.7 One such threat category is the ‘self-interest threat’: ‘the threat that a financial or other interest will inappropriately influence the member’s judgement or behaviour.8 In a described Scenario of a self- interest threat - where the audit manager has an outstanding, apparently contested, motor vehicle insurance claim against the insurance company being audited - the audit manager is said to be obliged to disclose the situation to the audit firm, while the partner is said to be obliged to: ... consider and avoid a conflict of interest situation whereby a member of the audit team is not capable of exercising objective and impartial judgement (refer to Section 220 of the Code and the ‘General requirements’ in s. 324CB and s. 324CD of the Act). The audit partner will need to decide whether a reasonable person, with full knowledge of all relevant facts and circumstances, would conclude that the audit manager is not capable of exercising objective and impartial judgement in relation to the conduct of the audit. It may require safeguards to be implemented, or the audit manager may have to be removed from the audit.9 The example would seem fairly obvious. More critically, however, neither the Corporations Act nor the Guide identifies as a ‘conflict of interest situation’ or ‘self-interest threat’ the ubiquitous circumstance of an audit firm (as distinct from an audit partner, audit manager or team member) receiving a fee from an audit client for conducting their audit. The Guide’s one exception is where: 5 section 324CD 6 e.g. ibid p.29 7 ibid. p.12 8 ibid. p.12 9 ibid.p.29 3 ... total fees from a client and its related entities represents more than 15 per cent of the total fees of the firm for two consecutive years.10 It is not apparent why an underlying audit fee-for-service relationship is not expressly seen as a self- interest threat, why 15% is the percentage figure of total fees below which a threat is not treated as significant or why a specific dollar amount is not also, or alternatively, a threat benchmark. Generally, a conflict of interest may be said to to exist ‘when there is a clash between professional responsibilities and personal (often material) interests’.11 Personal and material interests may include financial interests. The Guide – but not, relevantly, the Corporations Act - refers to a ‘financial interest’ and cites a Scenario where the audit partner has an interest in a body corporate that is considering borrowing from the audit-client blank. Here, members of the audit team are said to be required to: ... determine whether a known financial interest ... creates a self-interest threat. The nature of the relationship between the partner and the audit team and the firm’s operational structure could be factors in this assessment. The firm’s quality control procedures may require the partner to disclose the matter to the firm. The firm will also need to consider whether the audit partner should be informed.12 Again, the example seems obvious without addressing the more fundamental issue of an audit firm’s financial interests
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