Court sets aside audit rotation rule

The Supreme Court of Appeal has set aside a rule by SA’s audit industry body requiring listed and public interest entities to rotate their auditors every 10 years.

The Supreme Court of Appeal (SCA) has set aside a rule by SA’s audit industry body requiring listed and public interest entities to rotate their auditors every 10 years.

The May 31 ruling by the SCA found that the Independent Regulatory Board for Auditors (Irba) did not have the power to force audit firm rotation as per the Mandatory Audit Firm Rotation Rule (MAFR) it introduced in June 2017, and which became effective from April 1 2023.

The MAFR prescribed that an audit firm, including a network firm as defined in the Irba code of professional conduct for registered auditors, may not serve as the auditor of a public-interest entity for more than 10 consecutive financial years. Thereafter, the audit firm would only be eligible for reappointment after at least five financial years.

A public-interest entity is either a listed entity, or one defined by law as a public-interest entity, or any other entity that the law requires to be audited in compliance with the same independence requirements as listed entities.

The SCA found that section 4 of the Auditing Profession Act (APA), which confers powers on Irba, confines the audit body’s rule-making powers to “the prescription of standards” in defined functional areas such as professional competence, ethics and the conduct of auditors.

While Irba contended that these provisions enabled it to promulgate the MAFR, the SCA found the net effect of the MAFR imposed broad restrictions on audit committees, companies and shareholders that prevented them from appointing an audit firm of their choosing.

As a result, the SCA found that the MAFR went beyond the powers conferred on Irba by the APA and was hence unlawful. As a result the SCA set aside the rule.

The SCA ruling comes as the audit profession in SA is struggling to restore its image after a series of huge accounting scandals that have led to the near collapse of listed companies such as Steinhoff and Tongaat Hulett.

Audit firms are also under scrutiny internationally, the most recent example of which is PwC Australia, after accusations that several executives leaked sensitive government tax policy to clients.

Despite the SCA ruling, law firm Webber Wentzel said in a statement that it was important to consider the distinction between the MAFR and section 92 of the Companies Act, which prohibits the same individual — rather than an audit firm — from serving as the auditor of a company for more than five consecutive financial years. The setting aside of the MAFR therefore has no bearing on the tenure of an individual auditor as per the Companies Act.

THE SCA FOUND THE NET EFFECT OF THE MAFR IMPOSED RESTRICTIONS ON AUDIT COMMITTEES, COMPANIES AND SHAREHOLDERS

NAGY ALSO SAID THE SCA RULING WAS ON ‘A TECHNICAL LEGAL BASIS’ AND DID NOT BRING INTO QUESTION THE VALUE OF THE MAFR

“The irony of the decision is that the rule came into effect on April 1, which means that many companies would have long since made plans for its implementation,” said Webber Wentzel.

Irba CEO Imre Nagy echoed this sentiment, saying 91% of listed entities and public interest entities had already rotated audit firms ahead of the April 1 effective date.

“We want to commend those audit committees and audit firms for recognising the risks of long firm tenure and adopting the MAFR as a measure to mitigate such risks,” he said. “The shareholders and public will continue to question whether an audit firm is truly independent when reviewing financial statements in circumstances where they have audited the clients for longer than a decade.”

Nagy also said the SCA ruling was on “a technical legal basis” and did not bring into question the value of the MAFR which Irba maintains is necessary to strengthen auditor independence.

“The issue therefore is not whether MAFR is or is not the right mechanism to increase independence, but rather that there was a difference of opinion on whether the act allowed for the Irba to issue the rule,” he said. “We will therefore work urgently with parliament and stakeholders to address the technical issue raised in the judgment.”

Nagy added that Irba had not yet decided whether to approach the Constitutional Court for leave to appeal the SCA ruling.