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Chapter 5 - Compliance plan auditing
External compliance monitoring
5.1
When applying for registration, a scheme must
lodge a copy of the scheme’s compliance plan with ASIC.[1] The compliance plan must set
out adequate measures which the RE is to apply to ensure compliance with the
Act and the scheme’s constitution when operating the scheme. The plan must
specify arrangements for the holding and valuation of scheme property, the
proper constitution and functioning of the compliance committee, the auditing
of compliance with the plan and the maintenance of adequate records.[2]
5.2
In addition to the requirements already
mentioned, all the directors of the RE must sign the copy of the compliance
plan (or the amended or new compliance plan) lodged with ASIC.[3] ASIC is empowered to require
additional information about a compliance plan and may direct the RE to modify
the compliance plan to ensure consistency with legislative requirements.[4]
5.3
These provisions all highlight the importance of
the compliance plan in the MIA framework.
The compliance plan audit
5.4
Under the MIA, a
registered company auditor must conduct an annual audit of compliance with the
scheme’s compliance plan.[5]
5.5
The compliance plan audit is intended to provide
an independent check on the in-house monitoring of a scheme’s compliance
plan. This explains why the compliance plan auditor must be independent of the RE’s scheme and also why
the same auditor cannot be the auditor of the RE’s financial statements
(although both auditors may work for the same firm of auditors).[6]
5.6
The spate of high-profile corporate
collapses overseas and in Australia over the past two years has highlighted the
importance of good corporate governance and the need for reporting to be
transparent and reliable. As mentioned earlier, the United States has recently
introduced the Sarbanes-Oxley Act of 2002, which aims to increase
the accountability of directors, ensure the independence and quality of
financial auditing, and improve disclosure so it is more reliable.
5.7
Closer to home, the Government recently released
its CLERP 9 issues paper. This presages legislative amendments to strengthen
auditor independence, enhance the transparency of on-going disclosure and
encourage shareholder participation.
5.8
Although the discussion in this report concerns
performance-based, qualitative auditing as opposed to financial auditing,
the principles regarding independence are considered to be the same. The
Committee has consequently been able to draw on overseas legislative
initiatives and numerous commentaries and reports dealing with governance
issues.[7]
5.9
The Committee did not hear a great deal of
evidence on the independence of external compliance monitoring per se. Of the
evidence presented, however, the major issue was whether merely prohibiting the
same auditor from auditing both the scheme’s financial statements and the
compliance plan was a sufficient guarantee of independence.
5.10
The possibility of allowing professionals other
than accountants to undertake compliance plan auditing was also raised.
5.11
The MIA requires
the compliance plan auditor to report to the RE on whether the scheme complied
with its compliance plan during the year under examination and whether the plan
meets the requirements of the Act.[8] If there
are deficiencies, then the audit must be qualified, and contraventions of the
Act reported as soon as possible to ASIC.[9]
5.12
At the Committee’s hearing on
7 August 2002, ASIC provided the Committee with results of a survey
it had conducted on qualified audits for the year ended
30 June 2001. It advised that, of just over 2,000 compliance plan
audits lodged for the year, 12.9 per cent had been qualified. Of these
qualifications, ASIC reported that the top five deficiencies were more
administrative in nature and included late lodgement of returns, breaches of
net tangible asset (NTA) requirements, ineffectiveness of the compliance plan
(i.e. failure to comply with the provisions of the plan), poor monitoring and
reporting processes.[10]
5.13
ASIC proposed several legislative amendments to
upgrade the integrity of compliance plan audits and said they would be best
introduced as a package.[11]
These had been submitted to the Turnbull Review which suggested development
through industry consultation. [12]
These were that:
- the auditor of the compliance plan should be required
to report to scheme members and not just to the RE;
- the auditor’s opinion should relate to the
performance of the scheme throughout the whole year, and not just at certain
times or at the end of the financial year (section 601HG is unclear, and a majority
of auditors reported only that the plan was adequate as at the end of the
financial year);
- the first compliance plan audit for a new scheme
should be completed and lodged within nine months of the scheme’s registration
(and not up to 21 months later);
- an auditor’s opinion on the adequacy of a new
scheme’s compliance plan should be lodged with other documents when the scheme
applies for registration; and
- the legislation should specify that the
compliance plan audit should focus on ‘material’ issues.[13]
5.14
In relation to the last point about materiality,
Mr Johnston, Executive Director, Financial Services Regulation, ASIC,
suggested that the development of a ‘materiality’ test would promote
efficiencies by avoiding qualification of audits for trivial, immaterial
matters.[14]
5.15
The Trustee Corporations Association of
Australia (TCAA) shared ASIC’s view that compliance plan auditors should not
only report to ASIC but also to scheme members. In addition it proposed a more
extensive role for the compliance plan auditor which would include:
- more frequent and timely monitoring of scheme operations;
- monitoring of related party dealings;
- acting as the ‘investor champion’ if action against the RE was
required; and
- more frequent reporting—say, quarterly—to ASIC and, as referred
to before, to scheme members. [15]
5.16
In a joint submission, CPA Australia and the
Institute of Chartered Accountants in Australia thought compliance plan audits
should be more frequent.[16]
5.17
The TCAL asserted in its submission that
potential conflicts of interest arising with the compliance plan audit had not
been properly dealt with by the MIA.
5.18
On this point, Mr Jonathan Sweeney, Managing
Director, TCAL, commented at the hearing on 11 July 2002 that:
Under the Managed Investments Act, basically, we now have
self-regulation by a single responsible entity subject to after-the-event,
semiannual financial audit, a compliance plan operation, a periodic review and
an annual compliance plan audit. That is typically conducted by a partner of
the auditor of that entity’s finances. So you have the auditor of the company on the finance side with another
partner auditing on the compliance side. Again, with the spotlight put on the
role of auditors and the expansion of these roles, you can see there could be
some issues there.
The operational nature of the compliance plan audit and the
potential for consulting work further adds to the potential for conflict...[17]
5.19
The TCAA envisaged other ways in which the
independence of compliance monitors could be safeguarded. In evidence to the
Committee, Mr Michael Shreeve, National Director, suggested opening up the
field:
We believe access to this compliance monitoring role should be
widened. Allowing qualified professionals other than accountants to take on
this work would introduce more competition into the area. It would also improve
options to avoid conflicts of interest between financial audit and other work.
We understand that this is being considered for superannuation. It is also
relevant that the compliance monitoring role involves operational and other
risk management issues that a financial auditor is not necessarily equipped to
review. We
see positive influences from this arrangement in placing downward pressure on
costs. Increased competition in the compliance monitoring role and the
monitoring of related party dealings should better ensure arms-length pricing.
We see a stronger compliance monitor reducing the need for compliance
committees and external board members.[18]
5.20
Asked whether the MIA had sufficient protections
to ensure that compliance plan auditors would not be unfairly or unduly
influenced by the RE, the Department of the Treasury responded that the
Department:
...[was] not aware that the new regime [had] put any more
pressures on auditors or...diminished their independence...There are various
issues...about whether the auditor of the responsible entity as a company should
be different from the auditor who does the audit of the compliance plan for the
various schemes. In the [Turnbull Review] there were some people who said that
they should be separate firms—that you should never let the same firm do the
two audits. At the other extreme there were people who said that the same
person in the same firm should be able to do both audits. The legislation now
has what everyone acknowledges to be a compromise—it can be the same firm, but
different people within the firm should do the two audits. ...we did not think
there was enough justification to change that...[19]
The Committee’s views
5.21
The Committee notes the findings of several reports
and surveys on auditor independence which indicate unequivocally that there is
a need for reform to strengthen auditor independence in Australia.
5.22
Professor Ian Ramsay’s report, Independence
of Australian Company Auditors: Review of Current Australian Requirements and
Proposals for Reform, commissioned by the Government
and released in October 2001, commented that the growth of
large accounting firms and an increase in non-audit services provided by
these firms increased scope for conflicts of interest. The report also noted
that Australia lagged behind other parts of the world, particularly the United
States and Europe, in the development of measures to improve audit
independence.[20]
5.23
The findings of an auditor independence survey
conducted by ASIC and concluded in December 2001, were consistent with
those of Professor Ramsay’s report. ASIC’s survey indicated practices in the
use of audit services that would appear to militate against auditor
independence. The respondents’ use of non-audit services was widespread
and accounted for about 50 per cent of the total fees paid to auditing firms.
Although most respondents had audit committees, it was found that better
mechanisms to deal with potential conflicts of interest were needed. Partner
rotation was inconsistent and rotation of firms was almost non-existent.[21]
5.24
An Ernst & Young study into Australia’s top
200 companies, indicated that more than 25 per cent would not meet the basic
requirements for audit committees under United States law, namely, that all
members must be fully independent and at least one a ‘financial expert’.[22]
5.25
The Committee is satisfied on the basis of
evidence presented to it during the inquiry and also taking into account the
numerous studies on the subject, that additional measures are needed to ensure
the independence of external auditing.
5.26
The Committee notes that the Joint Committee of
Public Accounts and Audit (JCPAA) proposed several measures to enhance auditor
independence. These included:
- the establishment of an independent audit committee in all
publicly listed companies with the statutory prescription of minimum
requirements for the role, responsibilities and composition of the committee;
- a clear statement in the Corporations Act 2001 requiring
an auditor to be independent when undertaking his or her functions (which can
be assessed by reference to a Code of Professional Conduct of the professional
accounting bodies);
- requirements for auditors of publicly listed companies to report
annually to ASIC regarding the management of independence issues according to
benchmarks developed by ASIC, with ASIC having the relevant investigatory and
enforcement powers;
- the imposition of greater accountability on directors of
companies being audited;
- to cater for an expansion in the role of auditors, the principle
of joint and several liability should be replaced with proportional liability,
and audit firms should be permitted to operate within limited liability
structures and a cap should apply to professional liability claims; and
- the provision in the Corporations Act 2001 of
‘whistleblower’ protection for those raising concerns about corporate fraud and
other irregularities.
5.27
The Government’s CLERP 9 paper, in common with
the JCPAA’s recommendations, proposed the inclusion in the Corporations Act
2001 of a general statement of principle requiring the independence of
auditors. It also proposed the establishment of an audit committee but,
diverging from the JCPAA’s recommendation, for the top 500 listed companies
only.
5.28
Some of the other proposals in CLERP 9 which are
relevant to the Committee’s inquiry included the amendment of the Corporations
Act 2001 to require:
- auditors to make an annual declaration to the company’s board
that they have maintained their independence according to the Act and the rules
of their professional accounting bodies;
- the application of the Joint Code of Professional Conduct of the
Institute of Chartered Accountants in Australia (ICAA) and CPA Australia
dealing with professional independence;
- the rotation of audit partners every five years;
- auditors to attend AGMs of listed companies to answer reasonable
questions about the audit;
- auditors to report
to ASIC any attempts to influence, coerce, manipulate or mislead the auditor;
and
- the application of
qualified privilege and ‘whistleblower’ protection to company employees
reporting to ASIC in good faith and with reasonable cause, any suspected breach
of the law.
5.29
The Committee
further notes the ICAA and CPA Australia’s new Australian standard for audit
independence which bans the provision of non-audit
services such as material asset valuations where, in also conducting the audit,
a firm could be required to check their own work.[23]
5.30
The Committee
believes there is substantial merit in the proposals made in the JCPAA report, CLERP
9’s issues paper, and the ICAA and CPA Australia’s new audit standard outlined
above. The Committee’s recommendations consequently draw on several of these
proposals.
Recommendation 9
The Committee recommends that
the Corporations Act 2001 should be amended to strengthen the
independence of compliance plan auditors to include:
- a general statement of
principle requiring the independence of compliance plan auditors;
- a requirement for
compliance plan auditors to report to ASIC annually about their management of
independence issues according to benchmarks developed by ASIC; and
- a requirement for
compliance plan auditors to report to ASIC any attempts to corrupt the
integrity of the audit.
5.31
The Committee
considers that the overall integrity of compliance monitoring would benefit
from the extension of qualified privilege and whistleblower protection to
employees of REs and, where the application of the legislation may be
uncertain, to employees of compliance plan auditors.
Recommendation 10
The Committee recommends the
application of qualified privilege and whistleblower protection to employees of
the RE and, if not already covered by subsection 601HG(8) of the Corporations
Act 2001 to employees of, and, the compliance plan auditor reporting any
suspected breaches of the law to ASIC in good faith and with reasonable cause.
5.32
The Committee
considers the suggestion that eligibility to conduct a compliance plan audit be
opened up to persons other than registered company auditors has sufficient
merit to justify further investigation. It is possible that persons with other
qualifications and experience could be eminently suitable to conduct compliance
plan audits for certain schemes. There would be the added benefit of
increasing the pool from which compliance plan auditors could be drawn. This
could play a part in reducing scope for conflicts of interest.
Recommendation 11
The Committee recommends that the Department of
the Treasury, in consultation with ASIC and relevant industry stakeholders,
look into the feasibility of opening up the field for compliance plan auditors
where it is considered that persons other than registered company auditors as
defined under the Corporations Act 2001 could effectively carry out the
requirements of a compliance plan auditor.
5.33
In making the
above recommendations, the Committee assumes that legislative amendments will
be made under CLERP 9 resulting in better governance of managed investment
schemes by making directors more accountable, strengthening the independence of
financial auditors and improving the continuous disclosure regime, largely
through more extensive enforcement.
5.34
The Committee has
not made recommendations regarding audit partner or audit firm rotation but
awaits with interest CLERP 9’s conclusions in this regard. In the meantime,
the Committee would encourage initiatives in the private sector to develop best
practice audit standards for performance audits.
5.35
The Committee
notes that the proposals submitted by ASIC to improve the integrity of the
compliance plan audit have been included in the Department of the Treasury’s
consultation regarding issues raised in the Turnbull Review. Of these proposals, the Department has commented in its consultation
paper that:
While they may impact on the costs faced by a RE, [the proposals]
have the potential to substantially enhance investor protection. However, they
also affect the liability and duties of auditors of compliance plans, and it is
important that auditors be given adequate opportunity to comment on the
proposals. It is therefore suggested that these matters be progressed through
consultation involving the Treasury, ASIC, the auditing profession and other
interested parties.[24]
5.36
The Committee
notes the proposals in the JCPAA report and CLERP 9’s paper to limit the
liability of auditors in response to increases in their exposure entailed in
other proposed reforms. Assuming these proposals are adopted, the Committee
believes that ASIC’s proposals will improve regulation under the MIA by:
- clarifying the legislation;
- providing for more timely
lodgments of audits for newly registered schemes;
- bringing additional expertise
to the formulation of a scheme’s compliance plan;
- imposing greater
accountability on the compliance plan auditor and increasing transparency.
5.37
The Committee
supports ASIC’s proposals for the improvement of compliance plan audits and
notes that the Department of the Treasury has sought the views of the public on
these.
The
Committee strongly believes that greater transparency in reporting should be
encouraged and therefore makes the following recommendation:
Recommendation 12
The Committee recommends that
the Corporations Act 2001 be amended to accommodate ASIC’s proposals to:
-
require the compliance
plan auditor to report to scheme members;
- clarify that the auditor’s
opinion relates to a scheme’s performance for the entire year being audited;
- require a compliance plan
audit of a newly registered scheme within the first year of its registration;
- require an auditor’s
opinion on the adequacy of the compliance plan to be included with a scheme’s
application for registration; and
- clarify that the
compliance plan audit need only focus on material issues.
The Committee further recommends that the
Department of the Treasury and ASIC should develop a test of materiality.
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