TWIST IN AUDITOR ROTATION SAGA

After accounting scandals at Steinhoff and Tongaat Hulett (never mind auditor firms’ involvement in state capture) the 2017 decision to make auditor rotation mandatory seemed prescient. Last week it was overturned in the appeals court

In late May 2017, two months after then president Jacob Zuma terrified South Africa by replacing finance minister Pravin

Gordhan with the almost entirely unknown Malusi

Gigaba, the controversial proposal to make audit firm rotation mandatory was pushed through parliament.

The necessary change to the Auditing Profession Act was announced at a press conference led by Gigaba and Bernard

Agulhas, then CEO of the

Independent Regulatory

Board for Auditors (Irba).

On June 5 2017 the Mandatory Audit Firm Rotation

(MAFR) rule was gazetted; from then on, companies’ audit firms had to be changed every 10 years.

That announcement was probably as unexpected as last week’s Supreme Court of Appeal (SCA) decision to set aside the MAFR on the grounds that Irba doesn’t have the authority to impose that obligation on audit firms.

Sadly, for those who opposed the MAFR from day one, the ruling has come too late. Though the implementation date was April 2023, most listed companies started to make the change within a year or two of the 2017 announcement. Irba says 91% of listed companies made the change before the April deadline. For them, the hefty costs of handing over decades of audit history to a new firm had already been absorbed. And while few reckon mandatory rotation will put an end to accounting scandals, it has become accepted practice, for now.

Asked for comment on the SCA ruling, Agulhas tells the FM that Irba’s objective has already been achieved. “I believe they [companies] will continue to do what is in the public interest,” he says.

Though Agulhas appeared to be out on a limb in 2017, within 12 months he looked remarkably prescient. The “accounting irregularities” at Steinhoff, controversial accounting at Tongaat Hulett and unearthing of wide-scale involvement of big audit firms in state capture put an abrupt end to any thought that auditors were untouchable. The MAFR looked like one way of reining them in. Little wonder companies rushed to implement the rule.

Well, not all of them. AfroCentric was one of a handful that held out. Ironically, on the day the SCA issued its ruling, AfroCentric told shareholders the appointment of KPMG, to replace PwC, would be put to a vote at its November AGM.

The highest-profile holdout was Naspers. Since its establishment in 1915, the company has used the various iterations of PwC for its audits. It was only at its 2022 AGM that 99.8% of shareholders voted in favour of switching to Deloitte, effective for financial 2024.

At this stage, the disruption and expense has been incurred, so companies are unlikely to change back, whether or not they buy into the tenure-independence argument. So even if Irba is able to successfully challenge the judgment, there will be little auditor rotation for several years.

But, who knows — if the SCA ruling is left in place, another round of mandatory rotation may not seem such a good idea after 10 years.

Irba CEO Imre Nagy has avoided any mention of an appeal, saying in a release that the regulator will work urgently with parliament and stakeholders to address the technical issue raised in the judgment. Meanwhile, he urges companies to remain vigilant.

“We encourage audit committees and registered auditors to continue to consider threats to independence and ensure that any independence threats are thoroughly identified and address

ed by the auditor at the outset of the audit, especially where tenure exceeds 10 years,” he said.

For anyone looking for guidance, KPMG was the best prepared. It reminded companies that if Irba appeals against the SCA decision, the MAFR will remain in force until the Constitutional Court rules on the matter.

Still, listed companies that have made the change are unlikely to alter course at this stage. “Most clients we are speaking to have indicated that audit firm rotation has become a reality in many jurisdictions across the world, and many of their key investors and stakeholders expect the same,” KPMG communications head Dudu Ndlovu tells the FM.

And, as Ndlovu points out, key institutional investors have voted against long audit tenure for some years. It has been a consistent feature of the Public Investment Corp’s AGM voting strategy since 2018.

Both EY and Deloitte say they are considering the matter.

Gigaba’s May 2017 announcement must have surprised almost everyone involved in the parliamentary process looking into the legislative changes. At a hearing of the standing committee on finance in mid-March that year, the consensus had been that the issue needed to be investigated further.

Most who arrived at the hearing were passionately opposed to mandatory rotation. Most, that is, apart from the Association for the Advancement of Black Accountants of Southern Africa, and Mantelli’s Biscuits CEO Simon Mantell, who had suffered first-hand experience of the lack of independence between audit firms.

But almost everyone at that hearing assumed the consultation process would drag on for a very long time, such was the strength of opposition.

One individual close to the process tells the FM it seemed Gigaba saw the MAFR as a quick and easy victory over the white business community. For Irba, concerns had arisen about declining audit quality, overly long tenures and increasing worries around a lack of independence that could negatively affect the quality of audit opinions. But Agulhas was also hoping mandatory rotation would open up room for black companies to get a foothold in a market dominated by the “big four” international firms.

It’s unlikely Gigaba had the enthusiastic backing of the Reserve Bank.

During the mid-March hearing the

Bank warned that further research was needed to assess possible unintended consequences, as well as the benefits compared with the cost. It noted that some countries had decided not to adopt equivalent regulations, and others had later retracted them.

The Bank also asked that the MAFR not be imposed on banks “as joint audits are applied to enhance audit quality and independence together with stringent prudential requirements already imposed by the regulator”.

As expected, the big audit firms weren’t one bit happy about the proposal. For them it would mean huge disruption to their long-term stable and profitable business model, and they really didn’t see the need for it. At the March 2017 hearing, EY and PwC argued that the country’s auditors were sufficiently independent of their clients and performed firstclass work.

PwC told the committee there were already measures in place contributing to auditor independence. “We are not convinced that there is credible and empirical evidence that supports the decision to implement MAFR, or that it is reasonable to conclude that it will strengthen auditor independence, let alone the question whether or not there is a failure by the current measures to protect auditor independence,” said PwC CEO Dion Shango.

As far as PwC was concerned, Irba hadn’t made the case to justify the extreme move. “Given the low instances of independence breaches documented and sanctioned by Irba, the adverse effect of MAFR does not appear proportionate to the objective it seeks to achieve,” he added.

EY CEO Ajen Sita said audit firm independence was already baked into the system. In particular, the rule of partner (as opposed to firm) rotation precluded audit partners from serving clients for more than five years.

“South Africa can pride itself that we are not aware of an audit failure in the past 20 years that is attributable to a failure of independence,” said Sita, adding: “The World Economic Forum’s [WEF’s] assessment of South African audit standards and capital markets as being number one in the world for the past seven consecutive years is testament to the fact that existing regulations and practices are already working.”

That so many of the presenters latched on to the “WEF’s assessment” was deeply concerning, given that the relevant section of the annual WEF competitiveness report was based on opinion from South African business leaders, many of them probably auditors or accountants themselves. Hardly a rigidly scientific assessment. Yet all these presenters took it at face value. Not what you want from a vigorous and questioning profession.

But it wasn’t just the big audit firms that pushed back. The East Rand Member District of Chartered Accountants (ERD) argued that Irba was wrong to assume that long-term audit appointments “are the breeding ground of familiarity and a concomitant drop in standards and independence”. Nothing could be further from the truth, it said.

ERD presented international evidence challenging Irba’s claim that mandatory rotation would encourage independence. Other measures existed, it said, including company audit committees determining if rotation was needed. Also, shareholders had the right, under the Companies Act, to hire and fire auditors. And Irba was there to enforce professional ethics.

“Irba has presented not a shred of evidence that independence and/or transformation will be benefited by MAFR,” it said.

ERD, which represents small to medium-sized audit companies, didn’t leave it there. Unrestrained by the public outcry that followed the corporate and state scandals in May 2018, it took the fight to the high court. After failing there, it went to the SCA, where it was successful.

ERD’s Jari Cerny tells the FM the group is happy with the ruling, which didn’t come too late for its members. “Most ... would only have had auditor rotation in February 2024, therefore noone in our community needed or changed auditors,” he says.