The Independent Regulatory Board for Auditors' Bernard Agulhas
The cosy club of big audit firms may be facing a shakeup in both its makeup and its opaque practices
IF the white-dominated auditing industry does not transform itself, the Independent Regulatory Board for Auditors may have to make it transform, says CEO Bernard Agulhas.
Basically, he is talking about the so-called “big four” audit firms — PwC, Deloitte, EY and KPMG. Members of parliament were horrified when he told them this month that these firms dominate 96% of the listed-company audit market.
Agulhas admits he is between a rock and a hard place with regard to transformation in the industry he regulates. On the one hand transformation is not in the regulator’s mandate. Strictly speaking, he has no business getting involved. If he does get involved he will compromise its independence, which he says he is loath to do.
On the other hand he now has MPs expressing outrage at the lack of transformation, and they’re clearly expecting the regulatory board to do something about it.
The board will have to consider whether and how it should get more involved.
“Our approach at the moment is that we cannot force firms to do things they don’t want to do. But there is an expectation from stakeholders that we should be more firm about what we expect from audit firms.” And more proactive about ensuring delivery, he adds.
His appearance before irate members of the finance committee has left him in little doubt that “we probably need more and different interventions for transformation”.
The big four would, and do, argue that they have black partners, black CEOs and even black chairmen. What clearer sign can there be of how serious they are about transformation?
“We do not dispute that the big four have invested in transformation,” says Agulhas. “But if you have 50% black partners, we are surprised that only nine black partners are signing off on 300 or so listed companies.
“Transformation is not about numbers, it’s about real empowerment. You can appoint more black partners but unless you empower them you haven’t really transformed.”
If they seriously believe that this is good enough they’re deluding themselves, he says.
“We don’t dispute the fact that they are trying to transform, but clearly we might not be on the same page when we define what we mean and expect by transformation.”
Transformation might not be in his mandate but strengthening auditor independence very much is. To this end, the board has decided to introduce mandatory rotation of auditing firms, some of which have been auditing the same companies for more than 100 years.
“Strengthening auditor independence comes first.”
He is acutely aware that the government wants transformation to come first. It supports mandatory rotation as a means of bringing about transformation by weakening the market domination of the big four and allowing smaller, mainly black, firms to access the magic circle.
Agulhas is rather cautious about this. The aim of rotation is not transformation, he says, “but we believe rotation can also achieve transformation by addressing concentration in the market”.
This, however, will be up to the players themselves.
“Everyone, companies and firms, must commit to transformation.”
Mandatory rotation alone will not make it happen because although companies will be obliged to rotate their audit firms, they will be under no obligation to rotate outside the big four.
“Mandatory rotation does not take away the right of shareholders and audit committees to appoint their own auditors.”
The only way to ensure they use firms outside the big four would be to give companies a list of audit firms they must choose from. “I do not think we’ll get to that stage,” says Agulhas.
“Nobody can force the audit committee and shareholders to appoint the auditors they want to appoint. As the audit regulator we won’t tell committees and shareholders to appoint certain firms.”
So mandatory rotation or not, transformation will continue to depend on how much firms want it. “If audit committees were committed to transformation and addressing concentration in the market, they would consider these things when they appoint auditors, instead of just moving the deck chairs around,” says Agulhas.
If they stick to the big four, there is nothing the Independent Regulatory Board of Auditors can do about it. This will come as a serious disappointment to smaller, mostly black, audit firms hoping that mandatory rotation will open doors for them. Experience in Italy, the only country that has had mandatory rotation for any length of time, suggests that it won’t.
Agulhas says an audit committee that decided to rotate to another big-four firm could not necessarily be accused of being anti-transformation “as long as the audit committee goes through a thorough process of considering independence and if at the same time it thinks carefully about transformation and the current concentration of the market”.
He admits that the regulator cannot do much more than appeal to their consciences.
“Currently, we don’t have jurisdiction over audit committees. That is why they themselves must be committed to these other objectives.
“We don’t want them to just shift the deck chairs amongst the big four, but they must not compromise on standards. They have to appoint a firm that can do the audit. But at least consider the other firms and open the market.”
Mandatory rotation, which is being strongly opposed by the Institute of Directors, the CFO Forum and the King Committee, among others, may or may not lead to more transformation. But will it necessarily lead to more independent audits, which is the stated aim?
“A fresh pair of eyes might bring out issues that might be overlooked when you have longstanding relationships,” says Agulhas.
Even if different individuals do the audits?
Even if partners are switched every five or seven years, “it’s naive to think a new partner would raise irregularities committed by the previous partner”, he says.
“We have no example of where a partner reported another partner in the firm to the [regulatory board]. It has never happened. So our concern is that while it stays within the firm, if there are any irregularities they are unlikely to be reported.
“If the outgoing firm knows that new auditors are coming in we believe they will ensure that they don’t miss anything. It will keep all audit firms on their toes.”
Agulhas says that the auditing environment is more complex today than ever before. “There are more pressures, more regulations. In an environment of financial crisis and increased corruption, there is a greater risk of something being missed now than 10 years ago, and therefore auditors are more at risk.”
Isn’t this why audit committees are unlikely to rotate outside the big four unless forced to do so? Would smaller firms have the resources to cope with increasingly demanding conditions?
“This is why we will only be implementing mandatory rotation in 2023,” he says. “This provides seven years for any small or medium firm to build up capacity if they want to enter specific markets. We’re giving them the opportunity to prepare.”
Those opposed argue that the King 4 codes and the Companies Act already address issues of independence and so there is no need for mandatory rotation.
If this were the case “we wouldn’t have seen audit tenures of 114 years”, he says. “And we wouldn’t have seen the close relationships between chief financial officers and audit firms and audit committees.”
Auditors frequently become CFOs at companies they have been auditing.
This puts them in a good position to ensure that the relationship between certain audit
Clearly we might not be on the same page on what we expect by transformation We’re surprised only nine black partners are signing off on 300 or so listed companies The aim of rotation is not transformation, but we believe rotation can also achieve it
firms and companies continues.
The fact that the loudest voices against mandatory rotation are not audit committee chairs but CFOs is cause for concern, says Agulhas.
“It is the CFOs who are supposed to be audited by independent auditors appointed by the audit committees who are objecting loudest. These are the things that worry us quite a lot.
“If the King Code and Companies Act were working, we wouldn’t be as concerned as we are.”
As things stand, the regulatory board has no intention of forcing companies to rotate outside the big four.
But Agulhas tacitly admits this may change.
“Our mandate is not to address transformation. But government wants to see transformation and access to the markets. We are a body of government and therefore we have to support those initiatives.” Comment on this: write to letters@businesstimes.co.za or SMS us at 33971 www.sundaytimes.co.za