Thursday, 27 February 2020
Corporations and Financial Services Committee; Report
I present the interim report of the Parliamentary Joint Committee on Corporations and Financial Services on the regulation of auditing in Australia, together with the Hansard record of proceedings and documents presented to the committee. I move:
That the Senate take note of the report.
I rise to speak on the tabling of the regulation of auditing interim report as the Chair of the Parliamentary Joint Committee on Corporations and Financial Services. This is an interim report because, although the Senate has voted to extend the committee's reporting deadline until September, committee members agreed that the policy recommendations we wish to make were already clear from the evidence we had collected in our hearings so far. We did not want to delay the action required by regulators, government and the industry by withholding our recommendations for six months.
The committee's work has been comprehensive. We received more than 110 submissions, heard from 32 witnesses at four public hearings and obtained more than 100 answers to questions taken on notice. The committee received evidence from a wide variety of witnesses, including regulators, accounting standards bodies, the big four and mid-tier accounting firms, and academics. Hearing from a diversity of voices has assisted the committee in understanding how the auditing industry is performing from a holistic perspective.
Today we make 10 recommendations to restore trust and confidence in audit services. Auditing is systemically important to a healthy financial system. It gives investors confidence that they can rely on financial statements made by companies. An audit, therefore, needs not just to be high quality but to be seen to be high quality. At the outset of the inquiry, I asked witnesses to address the following questions. Firstly, what is the evidence that the practice of auditing in this country is flawed? Secondly, are those flaws isolated or are they systemic? Thirdly, if those problems are systemic, what is driving them? Fourthly, what policy solutions are available to government to address them, and what are the costs and benefits of the solutions? If they have been implemented elsewhere in the world, how did they work? If they are entirely new, what justifies this novel approach?
I also noted that it might be the case that the evidence base of a current problem of auditing in Australia is limited but there is very good reason to believe that it will be a bigger problem in the future and, if that were the case, I'd be interested to hear from witnesses why they believe it's so.
The committee did not identify any new empirical evidence of systemic audit failure in Australia. The most commonly relied upon evidence to claim that we have a systemic audit failure in Australia was the ASIC inspection reports. These have certainly attracted significant media attention and commentary in recent years, and they are reason for some concern. But, as ASIC was at pains to point out on multiple occasions in the inquiry, the data should not be relied upon to make judgements about the entire industry because they are not designed to be either a representative or a random sample. Instead, ASIC deliberately targets audit files based on risk. This is entirely appropriate for a regulator. As ASIC says, this means we must be very careful in extrapolating on this data.
As other witnesses raised and as ASIC acknowledged, the figures incorporate all issues with audit, from the least serious to the most significant. One of the recommendations of this inquiry is to ASIC on how they report this data, and they will be asked to implement a revised framework for grading the findings based on the severity of the issues identified. In the absence of new empirical evidence of systemic audit failure, the committee was presented with some anecdotal evidence of audit failure and fears were raised by a number of witnesses about the risks of audit failure of a systemic nature in the future. This indicates a lack of trust in the audit industry. Due to the systemic importance of auditing to a market economy, a lack of trust in and of itself is a problem which must be remedied.
The committee's interim recommendations seek to address this trust deficit by providing greater transparency, clarity and confidence in the auditing industry in Australia. They include mandating the disclosure of ASIC's individual firm inspection reports, clear definitions of audit and not-audit services, expanded auditor independence declarations, restrictions on audit partner remuneration and promotion, audit firm public tendering, compulsory digital reporting and other related matters. The committee has carefully weighed international experience to make recommendations which seek to balance the competing factors of auditor competence and independence to deliver an audit market that is efficient, effective and trusted. For example, based on experience overseas, technological innovation through digital reporting has the potential to lower costs, increase accuracy and improve transparency of financial reporting. I'm personally most excited by this recommendation because the benefits it promises will not just be limited to the audit industry, but will be for all users of financial statements.
During the hearings and across the submissions, no compelling evidence was found to support the more radical proposals, which have been either abandoned or discounted internationally, such as the mandatory structural separation of audit firms. On the contrary, the committee heard significant evidence that measures like these would have profoundly negative implications for competition and audit quality. The committee will hold two more hearings and hand down its final report in September.
I rise today to speak on the tabling of a very important report. I'm pleased that it has actually come to pass. It has great implications for our economy and for the operation of business in Australia. The report is the one to which Senator Paterson has just been speaking, on the regulation of auditing in Australia, regarding the quality and conduct of auditors, but particularly the big four—EY, KPMG, PwC and Deloitte.
I want to respond to a couple of comments made by the chair, Senator Paterson, and indicate that this interim report does contain several substantive policy recommendations. The committee expressed that we do expect the government and the various regulatory agencies to respond in a timely way to recommendations in this report. But I would hate anyone watching this or reading it to get the impression that this is the job done. There is still, in my view, considerable work to be done. In fact I think the report to date and the significant recommendations that it makes gives voice to how some of those opposite, who claim to be advocates for the economy and all things financial, are completely out of touch with what is going on. In fact, Mr Falinski said, 'I don't think there's anything wrong with the auditing industry in Australia at the moment. I think the real question is around whether the accounting industry is best structured to take into account all the issues that modern finance presents'. He also criticised the terms of reference of the inquiry as being too broad.
We found an awful lot, and it matters. As the Walkley Award winning journalist Adele Ferguson says: 'Auditing is fundamental to stock markets, investors and the economy. The auditing industry escaped the royal commission, which in hindsight is a glaring omission. The Hayne royal commission shocked the nation with tales of elaborate larceny and deception by the institutions that we entrusted with our savings. Yet the auditors, the very people that markets and investors look towards to provide a credible investment of the banks, were missing in action.
Former ASIC chairman Greg Medcraft has repeatedly warned of possible Enron-style collapses without reforms to the way audits are conducted as well as to the way companies appoint auditors and the way these are set. ASIC has been calling for action on audit quality for no less than seven years. The government did nothing. But this report changes that to a policy of action. ASIC has found increasingly adverse findings nearly every year since 2013, despite the key audit areas reviewed dropping by nearly two-thirds.
I instigated this inquiry due to my concerns that the standards of audit in Australia were dropping. I was very concerned about audits were becoming loss leaders for lucrative consulting contracts that provide most of the wealth of the big four. I was also concerned that the behaviour of management structures of the auditors was leading to high staff turnover and poor workplace cultures. It is an area that we have still to traverse. Since this inquiry started, whistleblowers have been coming to me with evidence of cultural practices in the big four that are completely inappropriate—cultures that compromise the quality of audit in Australia's sophisticated financial system. I've informed the Senate of reliable reports that EY may have been auditing its own work at ANZ due to a lack of branding of separate EY teams' cybersecurity work. I remain concerned that this instance is all too common across the entire sector.
The committee learned that KPMG failed to flag problems in two companies that collapsed in the last six years—WDF and Forge Group—and has settled six legal actions relating to its audit quality of collapsed companies in 10 years. None of the auditors involved in these cases were dismissed, and only a few suffered any kind of penalty. Deloitte too failed to discover problems in three out of eight collapsed companies it audited in the last decade, including the electronics company Dick Smith, while at the same time it was doing lucrative, non-audit work for six of the eight collapsed companies over the same period. Significantly, the committee heard evidence that the chair of the Financial Reporting Council, Mr Bill Edge, failed to disclose an ongoing profit share arrangement with PwC to the FRC. Still to this day, Mr Edge refuses to acknowledge that it is a conflict of interest in his role as the government's chief adviser on financial services, of which auditing is a critical element. This is another undeclared and ongoing conflict of interest: a government appointee overseeing the regulation of his former company but still receiving a stipend from them. I have today written to the Treasurer, Josh Frydenberg, and asked that he direct Chairman Edge to disclose to the Senate the full amount of his annual retirement package, so that a clear picture of potential influences upon his regulatory decisions can be better discerned.
The probity of the FRC, the Financial Reporting Council, must be beyond reproach. It's critical to the success of one of our most significant recommendations—a far-reaching recommendation. I am, I have to say, very pleased with the work of the committee in delivering this recommendation that the Financial Reporting Council—but in partnership with ASIC—finally develop standards to clarify categories and fee-disclosure requirements in relation to both audit and non-audit service and also to undertake a model of the Sarbanes-Oxley prohibitions which clarifies for the sector what work they can and can't do. There were many calls for that. I go to the evidence of the national managing partner of audit and assurance from Grant Thornton, who articulated that regulatory requirements regarding what an auditor or firm can or cannot do with respect to non-audit services need to be clearly defined, such that there is no ambiguity in marketplace understanding. I had this exchange with Mr Rigele:
Mr Rigele: … I think the audit profession needs to act to that and perhaps look at something where it's clearly defined what we can and cannot do—
Senator O'NEILL: Which is the US system, as revealed to this committee clearly in the evidence from ASIC.
Mr Rigele: Yes, that's right. I think we need no ambiguity around it. We need to get to a stage where everyone understands the platform. One person's perception is reality and I think we just need to react to that.
Senator O'NEILL: Clean it up and make it clear?
Mr Rigele: Make it clear.
This third recommendation of the committee enables that to happen, particularly if it is implemented promptly under the guidance of the Financial Reporting Council in concert with ASIC.
Recommendation 5 recommends:
… the Australian Professional and Ethical Standards Board consider revising the APES 110 Code of Ethics to include a safeguard that no audit partner can be incentivised, through remuneration advancement or any other means or practice, for selling non-audit services to an audited entity.
This, again, will not only stop the perception of conflicts of interest that this inquiry has uncovered between consultancies and other services and audits of companies—I believe it will stop the practices. I'm pleased that KPMG came and gave us evidence to that end saying:
We support revising the Code of Ethics standard, APES 110, to include the concept that no audit partner can be remunerated for selling non-audit services to any audit clients of a firm, as a mandatory safeguard that all firms need to apply to mitigate risks of potential conflicts of interest.
So the sector has become, in recent times, a little more alive to the reality of conflicts of interest embedded in their current prevailing business models and practices.
I want to thank the committee—all the members for their hard work in getting this interim report together—and I thank all the staff who support us for their diligence and patience in this important inquiry. I also want to thank the chair, Senator James Paterson, for his steady leadership of the committee during the inquiry and for always having an open door to give consideration to the important matters that have been raised in the course of the inquiry so far, and I want to acknowledge the leadership of the deputy chair, Mr Georganas, in the other place as well.
I also want to thank the crossbench senators, who, while they haven't participated in the inquiry themselves, have backed this inquiry since the very beginning. They gave their support at its inception. The government didn't put it to a vote, but their support was very important to me at the time. Just in the last week I had to call on them to vote, to push the government to ensure that this inquiry continues. I notice Senator Pratt here as well, and I thank her by name, as one of the committee members, for her work. I strongly believe that this inquiry is in the best interests of the Australian people, and they are only serving their constituents by doing so. We need to get on with looking in further detail at the way in which this industry operates.
Labor absolutely supports markets and the investment of capital in Australian businesses. Now more than ever—following the findings of the Hayne royal commission into banking—large businesses and small investors need confidence in the truth, fairness and quality of audits to inform sound business decision-making and investing. For any Australian who has superannuation: this stuff matters to you. The reforms proposed in the interim report will do something to restore confidence, but there is much more to do. It is a wake-up call to the industry. I seek leave to continue my remarks later.
Leave granted; debate adjourned.