australian auditor independence...

Australian Auditor Independence Requirements

A Comparative Review

The Treasury

November 2006

© Commonwealth of Australia 2006

ISBN 0 642 74369 X

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the:

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Consultation

Comments are sought on this comparative review by no later than 15 December 2006. Submissions should be sent by mail, fax or email to: The General Manager Corporations and Financial Services Division Department of the Treasury Langton Crescent PARKES ACT 2600

Facsimile: 02 6263 2770 Email: [email protected] Phone: 02 6263 3971

Confidentiality

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FOREWORD

Auditors perform a critical role in the efficient operation of capital markets. The audit function constitutes the principal external check on the integrity of financial statements and auditor independence is fundamental to the credibility and reliability of auditors’ reports.

The Australian Government significantly enhanced Australia’s auditor independence requirements with the comprehensive regime introduced by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 which commenced on 1 July 2004.

The comparative review of Australian Auditor Independence Requirements compares the Australian requirements with those in Canada, the European Union, the United Kingdom and the United States. With the globalisation of capital markets and cross-border activities of companies and audit firms, it is now essential that the design of the regulatory framework in one jurisdiction should take account of developments in other jurisdictions.

The overall conclusion of the comparative review is that, notwithstanding differences in terminology, institutional arrangements and legal frameworks, there is a substantial underlying equivalence between the Australian requirements and ‘best practice’ standards adopted internationally.

I am pleased to release the comparative review of Australian Auditor Independence Requirements. A number of the key findings in the review are directly relevant to the Australian Government’s commitment to simplifying the regulatory system and reducing unnecessary or excessive red tape.

Among its key findings, the comparative review identifies the Australian multiple former audit firm partner restriction as having no overseas equivalent. The Australian Government announced in its response to the report of the Taskforce on Reducing Regulatory Burdens on Business that it will review this restriction by the end of 2006.

While the comparative review does not attempt to make policy recommendations, a number of the other key findings suggest that there may be scope, in line with overseas developments, to make further refinements which would result in a reduction in the compliance burden, without changing or weakening the existing, robust regulatory framework.

To this end, Treasury’s comparative review will make a significant contribution in factually informing the policy debate in Australia on auditor independence issues among key stakeholders.

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Treasury will be conducting a targeted consultative process with key stakeholders, including the Australian Securities and Investments Commission, the Financial Reporting Council, the major audit firms and the three main professional accounting bodies. I also invite other stakeholders to comment on the key findings in the comparative review.

Through stakeholder consultation, my intention is to identify any additional measures that could be included in the proposed Simpler Regulatory System Bill which is scheduled to be introduced into Parliament in 2007.

The Hon Chris Pearce MP Parliamentary Secretary to the Treasurer

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CONTENTS

FOREWORD ........................................................................................................ III

ABBREVIATIONS ................................................................................................VII

PART 1: INTRODUCTION .......................................................................................1 Background to the comparative review........................................................................... 1 Scope of the review......................................................................................................... 2

PART 2: EXECUTIVE SUMMARY ............................................................................5 Part 1: Introduction......................................................................................................... 5 Part 3: Auditor independence: policy goals, institutional arrangements and

legal framework .................................................................................................. 6 Part 4: General standard of auditor independence........................................................ 9 Part 5: Specific auditor independence requirements applying to employment,

financial and business relationships.................................................................10 Part 6: Provision of non-audit services ........................................................................13 Part 7: Employment restrictions applying to former audit partners and senior

audit personnel .................................................................................................15 Part 8: Auditor rotation .................................................................................................17 Conclusion.....................................................................................................................19

PART 3: AUDITOR INDEPENDENCE: POLICY GOALS, INSTITUTIONAL ARRANGEMENTS AND LEGAL FRAMEWORK..........................................................25 Introduction....................................................................................................................25 Loss of credibility in financial reporting has been the major policy driver of reforms ..........................................................................................................................25 International efforts to address crisis ............................................................................25 Australia ........................................................................................................................28 Canada ..........................................................................................................................33 European Union ............................................................................................................37 United Kingdom.............................................................................................................38 United States.................................................................................................................42

PART 4: GENERAL STANDARD OF AUDITOR INDEPENDENCE ................................47 The auditor independence concept...............................................................................47 Australian and US ‘statute-based’ requirements...........................................................48 Canada ..........................................................................................................................51 European Union ............................................................................................................51 United Kingdom.............................................................................................................52

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Australian auditor independence requirements

PART 5: SPECIFIC AUDITOR INDEPENDENCE REQUIREMENTS APPLYING TO EMPLOYMENT, FINANCIAL AND BUSINESS RELATIONSHIPS ...................................53 Restrictions on employment relationships ....................................................................53 Australia ........................................................................................................................54 Comparison between Australian and overseas employment relationship restrictions .....................................................................................................................58 Financial relationships...................................................................................................66 Prohibited business relationships..................................................................................79

PART 6: PROVISION OF NON-AUDIT SERVICES .....................................................83 Introduction....................................................................................................................83 Australia ........................................................................................................................84 Canada ..........................................................................................................................86 European Union ............................................................................................................86 United Kingdom.............................................................................................................86 United States.................................................................................................................87 Comparative table .........................................................................................................89 Concluding comments...................................................................................................91

PART 7: EMPLOYMENT RESTRICTIONS APPLYING TO FORMER PARTNERS OF AUDIT FIRMS AND SENIOR AUDIT PERSONNEL .................................................93 ‘Cooling-off’ periods ......................................................................................................93 Multiple former partner of audit firm/audit company director restriction........................99

PART 8: AUDITOR ROTATION............................................................................101 Introduction..................................................................................................................101 Australia ......................................................................................................................102 Canada ........................................................................................................................104 European Union ..........................................................................................................105 United Kingdom...........................................................................................................105 United States...............................................................................................................107 Concluding comments.................................................................................................108

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ABBREVIATIONS

AICPA The American Institute of Certified Public Accountants

APB Auditing Practices Board, UK

APESB Accounting Professional and Ethical Standards Board

APES 110 The Australian Code of Ethics for Professional Accountants APES 110

AQRB The Audit Quality Review Board

ASIC Australian Securities and Investments Commission

ASIC Act Australian Securities and Investments Commission Act 2001

CALDB The Companies Auditors and Liquidators Disciplinary Board

CICA Canadian Institute of Chartered Accountants

CPAB Canadian Public Accountability Board

CLERP 9 Act Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004

Corporations Act Corporations Act 2001

CSA Canadian Securities Administrators

EU European Union

EU Recommendation EU Recommendation: Statutory Auditors’ Independence in the EU: A Set of Fundamental Principles (May 2002)

FRC Financial Reporting Council

FRCUK Financial Reporting Council, UK

FRP Financial Reporting Panel

HIH HIH Insurance Limited

ICAA The Institute of Chartered Accountants in Australia

ICAEW The Institute of Chartered Accountants in England and Wales

ICAO The Institute of Chartered Accountants of Ontario

ICAO Rules The Rules of Professional Conduct adopted by the ICAO

IFAC International Federation of Accountants

IFAC Code Code of Ethics for Professional Accountants, IFAC

IOSCO International Organisation of Securities Commissions

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Abbreviations (continued)

ISB The Independence Standards Board, US

PCAOB Public Company Accounting Oversight Board

PIOB Public Interest Oversight Board

POB Professional Oversight Board, UK

NIA National Institute of Accountants

Ramsay report Review of the Independence of Australian Company Auditors (October 2001)

SEC Securities and Exchange Commission

SOX Act Sarbanes-Oxley Act of 2002

UK United Kingdom

US United States

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Part 1: Introduction

BACKGROUND TO THE COMPARATIVE REVIEW

1.1 The Financial Reporting Council’s (FRC) auditor independence functions are conferred on it under paragraphs 225(1)(c) and (d), and subsection 225(2B) of the Australian Securities and Investments Commission Act 2001 (ASIC Act).

1.2 Under subsection 225(1) of the ASIC Act, the FRC is required to monitor the effectiveness of auditor independence requirements in Australia and to give the Minister reports and advice about those requirements.

1.3 In addition, the FRC has been given a number of specific auditor independence functions under subsection 225(2B) of the ASIC Act. Paragraph 225(2B)(e) of the ASIC Act provides that these functions include, monitoring international developments in auditor independence, assessing the adequacy of the Australian auditor independence requirements provided for in the Corporations Act 2001 (the Corporations Act) and codes of professional conduct, in the light of those developments, and giving the Minister, and professional accounting bodies, reports and advice on any additional measures needed to enhance the independence of Australian auditors.

1.4 In view of its functions under paragraph 225(2B)(e) of the ASIC Act, the FRC sought Treasury’s assistance in undertaking a comparative review of the Australian auditor independence requirements with the equivalent requirements applying in Canada, the European Union, the United Kingdom, and the United States (the relevant overseas jurisdictions).

1.5 The Treasury agreed to assist the FRC in undertaking this comparative review in order to facilitate the preparation of the FRC’s 2005-06 Report on Auditor Independence. Auditor independence encompasses an extensive area and raises many complex issues. The new auditor independence regime in the Corporations Act was the most far-reaching and substantial measure included in the reforms introduced by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the CLERP 9 Act).

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1.6 Treasury considers that the preparation of a comparative review is timely given that nearly five years have passed since a comparable exercise was undertaken by Professor Ian Ramsay in the review of the Independence of Australian Company Auditors (the Ramsay report1) and there have been two years of practical implementation since the commencement of the reforms. Treasury also proposes to use the comparative review for purposes of its central agency policy advisory role to the Government and in particular, the Treasurer and the Parliamentary Secretary to the Treasurer. Treasury will also be able to use the paper in its ongoing policy liaison responsibilities on behalf of the Government with other key stakeholders on auditor independence, such as ASIC, the major audit firms and the professional accounting bodies.

SCOPE OF THE REVIEW

1.7 Auditor independence is a complex and wide-ranging subject involving many difficult public policy decisions. In defining the scope of the review, Treasury has been selective in terms of:

• the independence topics covered in the review; and

• the jurisdictional focus of the review in relation to those overseas jurisdictions that have adopted federal systems of government.

1.8 In selecting the issues to be covered, we have concentrated on the following topics which we regard as core auditor independence requirements:

• General standard of auditor independence.

• Specific restrictions applying to employment, financial and business relationships.

• Provision of non-audit services.

• Employment restrictions applying to former audit partners and senior audit personnel.

• Auditor rotation.

1.9 In a comparative review of this sort, we also considered that it would be useful in a context setting sense, to examine, early in the review, the underlying policy goals, institutional arrangements and legal framework applying in each jurisdiction in relation to auditor independence.

1 Independence of Australian Company Auditors: Review of Current Australian Requirements and Proposals for Reform: Report to the Minister for Financial Services and Regulation: October 2001.

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Part 1: Introduction

1.10 Canada and the United States (US) have federal constitutions where the federal, provincial and state authorities have responsibility for audit regulation. The scope of the review in relation to these two federal jurisdictions has been limited:

• to the national system administered by the Canadian Public Accountability Board (CPAB), although the provincial requirements are addressed insofar as they impact on the CPAB framework; and

• to the federal securities regime in the US which includes the auditor independence rules of the Securities and Exchange Commission (SEC), the auditor independence requirements in the Sarbanes-Oxley Act 2002 (SOX Act) and the functions and role of the Public Company Accounting Oversight Board (PCAOB).

1.11 The European Union has issued a Recommendation and a Directive in relation to the independence of statutory auditors. The review will focus on the EU Recommendation and Directive but will not extend to auditor independence requirements in each of the EU member states (other than the United Kingdom (UK)).

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Part 2: Executive Summary

PART 1: INTRODUCTION

Background to the comparative review

2.1 The Treasury agreed to undertake the comparative review in order to assist the FRC prepare the FRC’s 2005-06 Report on Auditor Independence. The review focuses on the independence requirements in Australia, Canada, the European Union, the United Kingdom and the United States (the relevant overseas jurisdictions).

2.2 The Treasury also proposes to use the comparative review for purposes of its central agency policy advisory role to the Government and in particular, the Treasurer and the Parliamentary Secretary to the Treasurer. The review will also inform Treasury in its ongoing policy liaison responsibilities on behalf of the Government with other key stakeholders on auditor independence, such as ASIC, the major audit firms and the professional accounting bodies.

Scope of the review

2.3 The new auditor independence regime in the Corporations Act was the most far-reaching and substantial measure introduced by the CLERP 9 Act. The review is timely because it is nearly five years since a comparable exercise was undertaken by the Ramsay report.

2.4 The review focuses on the following core elements of auditor independence:

• General standard of auditor independence.

• Specific restrictions applying to employment, financial and business relationships.

• Provision of non-audit services.

• Employment restrictions applying to former audit partners and senior audit personnel.

• Auditor rotation.

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PART 3: AUDITOR INDEPENDENCE: POLICY GOALS, INSTITUTIONAL ARRANGEMENTS AND LEGAL FRAMEWORK

2.5 For purpose of background and context setting of the review, we examined the policy goals, institutional arrangements and legal framework in relation to auditor independence in each of the jurisdictions covered by the review.

2.6 A major policy driver of the reforms that have taken place over the past five years in relation to auditor independence and audit regulation generally has been the loss of credibility in financial reporting that followed the collapse of Enron and other major companies from late 2001. The reforms relating to audit regulation, including auditor independence, were one component of broader corporate governance reforms introduced in the wake of the collapse of Enron and other corporate failures.

2.7 With the globalisation of capital markets, this was recognised as a world-wide crisis and important initiatives have been taken at the international level to address these problems. In this context, the review has recognised the important contributions that have been made by governmental authorities, such as the International Organisation of Securities Commissions (IOSCO) and by the international accounting profession such as the revised Code of Ethics adopted by the International Federation of Accountants (IFAC). Common themes identified in the work of these bodies is that there is a trend towards greater consistency in global regulatory standards, and a recognition of the need for greater international cooperation and for the pursuit of the public interest at the international level.

2.8 While the review has found that many of the core elements of the auditor independence requirements in each jurisdiction are similar, there are substantial differences in the institutional arrangements relating to audit regulation and the legal framework applicable to the auditor independence requirements.

• While Australia has a federal constitutional system, it has been able to achieve a national system of corporations regulation as a result of an agreement between the Australian Government and the governments of the States and Territories involving the referral of powers to the Federal Government.

– ASIC, the key corporate regulator, is a statutory body established under federal legislation. All the other bodies performing specified functions in relation to the audit regulatory framework, including the FRC, have also been established under the umbrella of the national corporations legislation.

– Another distinguishing feature of the Australian auditor independence requirements is that the detailed requirements have been enacted by the Federal Parliament in the Corporations Act. This implements a key aspect of the Ramsay report that most of the enhanced auditor independence requirements recommended in the review should be placed in the Corporations Act, within a co-regulatory model. The HIH Royal Commission report also made some

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important recommendations on the audit function and most of these recommendations were premised on the basis that they would be implemented in the Corporations Act.

• Canada’s audit oversight institutional framework has been strongly influenced by the division of powers between the federal and provincial jurisdictions under its federal constitutional system. In Canada, the Canadian provinces and territories are responsible for securities regulation. To ensure that Canada has a national approach to securities regulation, the provincial securities regulators have formed the Canadian Securities Administrators (CSA). The accounting profession is also regulated at the provincial level.

– To ensure a national approach to the oversight of the audits of publicly listed entities, the CSA, the Canadian Institute of Chartered Accountants (CICA) and the Federal Superintendent of Financial Institutions created the Canadian Public Accountability Board (CPAB) in 2003. The CPAB is a federal not-for-profit corporation. It was not possible to establish CPAB as a statutory body because of the federal-provincial jurisdictional arrangements in Canada.

– The auditor independence rules that apply within the CPAB oversight framework are the standards for auditor independence that have been adopted by the provincial Institutes of Chartered Accountants. The CSA and CICA have been active in ensuring that the provincial standards have adopted the IFAC Code as well as some of the auditor independence requirements under the US SOX Act. In contrast to the position in Australia, where ASIC is responsible for the enforcement of the auditor independence requirements, enforcement of the independence rules in Canada is the function of the provincial Institutes of Chartered Accountants as part of the self-regulation of their members.

– The provincial auditor independence rules are substantially uniform. For purposes of the review, we have focused on the Rules of Professional Conduct of the Institute of Chartered Accountants of Ontario (ICAO Rules).

• The European Union (EU) is a union of 25 independent states based on the European Communities and founded to enhance political, economic and social cooperation. Treasury included the EU in the review in order to obtain a window on European policy consideration in relation to the issue of the independence of the statutory auditor. We have not attempted to study the EU’s internal governance arrangements or the auditor independence regimes in the member states, other than the United Kingdom.

• The United Kingdom (UK) undertook a wide-ranging work program to review the UK’s regulatory practices for statutory audit and financial reporting following the collapse of Enron and other high profile companies from late 2001 onwards. The UK Government sought a ‘relatively light touch’ approach by building on the existing framework for the regulation of the statutory auditor which devolved to recognised supervisory bodies (professional accounting bodies) the day to day

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responsibility for ensuring the training and authorisation of registered auditors and the supervision of audit firms.

– The key reform proposal was to expand significantly the scope of the responsibilities and powers of the Financial Reporting Council (FRCUK) to create a unified, non-statutory regulator. The FRCUK’s functions are principally exercised by its five operating bodies.

: For purposes of the review, the most relevant operating body is the Auditing Practices Board (APB). The APB’s responsibilities in relation to the development of auditing and assurance standards have been extended to the development of ethical standards relating to the independence, objectivity and integrity of auditors. The recognised supervisory bodies have been required to adopt the APB’s Ethical Standards for Auditors for purposes of their professional conduct rules.

• Under the federal constitutional system in the United States, the auditor independence framework consists of a matrix of federal securities laws, professional conduct rules and state laws relating to the licensing and regulation of the practice of accounting. For purposes of the review, we have focussed primarily on the federal auditor independence requirements, and particularly the rules of the SEC which were made in 2001 and then further enhanced in 2003 following the enactment of the SOX Act. There are important similarities between the Australian and US auditor independence regimes. Australia and the US have both adopted independence requirements that have legislative backing. The key regulators, ASIC, the SEC and the PCAOB are manifestly independent from the accounting profession. There are however some important differences:

– In accordance with the ‘internal affairs’ doctrine in the US, the states govern internal corporate affairs, while the federal rule-makers, particularly through the SEC, govern the external trading of a company’s securities. This is unlike the national system of corporate regulation that has been achieved in Australia.

– ASIC does not have the power to make rules of the kind made by the SEC or the PCAOB. In the US, the independent federal regulatory agencies, such as the SEC, have been granted extensive, quasi-legislative and quasi-judicial powers which have been held not to violate the separation of powers doctrine enshrined in the US constitution.

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Key finding 1 While many of the core elements of the auditor independence requirements, including their underlying policy objectives, in each jurisdiction are similar, the review has found substantial differences in the institutional arrangements and the legal framework applying to audit regulation in each jurisdiction. These differences can be explained by the unique combination of circumstances applying in each jurisdiction, including constitutional arrangements, history relating to the regulation of corporations and financial services and system of government.

Key finding 2 A distinguishing feature of the Australian auditor independence requirements compared with the overseas jurisdictions covered by the review, is that the detailed independence requirements have been enacted by the Federal Parliament in the Corporations Act to provide a comprehensive legislative code.

PART 4: GENERAL STANDARD OF AUDITOR INDEPENDENCE

2.9 The review discusses the widely accepted concept of independence which involves independence of mind and independence in appearance.

2.10 Both Australia and the US have adopted a general standard of auditor independence incorporating the concepts of independence of mind and appearance. The wording of the Australian general requirement of auditor independence is closely based on the SEC’s general standard. The Australian and SEC requirements are a cornerstone of their respective auditor independence regulatory frameworks.

2.11 Canada, the EU and the UK have not adopted a general standard of auditor independence along the lines of the Australian and SEC requirements. The review notes though that the UK’s APB Ethical Standard 1, in discussing the concept of ‘independence’, adopts language which limits the subjective application of the standard and, given that the standards are mandatory, looks very much like a general standard of independence.

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Key finding 3 Canada, the European Union and the UK have not adopted a general standard of auditor independence along the lines of the general requirement for auditor independence in the Corporations Act or the general standard in the SEC Rule in the US.

The Australian and SEC requirements are a cornerstone of their respective auditor independence regulatory frameworks. The Australian general requirement on auditor independence applies to all circumstances relating to an audit and is in addition to, and does not derogate from any other obligation imposed by the Corporations Act or a code of professional conduct.

PART 5: SPECIFIC AUDITOR INDEPENDENCE REQUIREMENTS APPLYING TO EMPLOYMENT, FINANCIAL AND BUSINESS RELATIONSHIPS

Employment and financial relationships

2.12 The existence of employment and financial relationships between an audit firm and an audit client can give the impression that an auditor is not independent of the client, irrespective of the actual situation. Where such relationships exist, there may be a range of circumstances which make it difficult for the auditor to adopt an unbiased approach to the audit engagement, with the result that the audit client could receive a more favourable audit report than the facts or circumstances justify.

2.13 The CLERP 9 Act substantially implemented the recommendations of the Ramsay report which sought to achieve ‘best practice’ restrictions on employment and financial relationships building on the existing requirements in the Corporations Act and drawing on recent overseas developments, particularly under the IFAC Code and the SEC Rules on auditor independence.

2.14 When comparing the Australian requirements with the overseas specific requirements, it is important to understand how the criminal liability rules in Australia operate in relation to audit firms where the partners of an audit firm can be made vicariously liable for a breach of the requirements. The review explains how these provisions operate and the way in which they have been designed to encourage a ‘culture of compliance’ within audit firms.

2.15 For purposes of its comparative analysis, Treasury adopted the methodology of comparing each prohibited employment and financial relationship in the Corporations Act with the corresponding restrictions in the relevant jurisdictions. We considered that this form of analysis was the only way we would be able to draw informed

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conclusions as to whether there is substantial equivalence between the Australian requirements and ‘best practice’ standards adopted internationally.

2.16 Our analysis is contained in the tables set out in Part 5 of the Review. Notwithstanding the fact that differences in terminology used in the various legislative and professional requirements make precise comparisons of the Australian and overseas requirements difficult, we believe that the analysis indicates clearly that there is a substantial underlying equivalence between the Australian requirements and those in the relevant overseas jurisdictions.

Key finding 4 The detailed comparative analysis undertaken by Treasury in relation to the specific employment and financial relationship restrictions in each jurisdiction, clearly indicates that there is substantial underlying equivalence between the Australian requirements and those in the relevant overseas jurisdictions.

2.17 We noted though that in relation to some of the employment and financial restrictions, the SEC has introduced a ‘covered person’ concept rather than applying an ‘all partner approach’. In commenting on the adoption of its final auditor independence rules in 2001, the SEC said that ‘we believe that independence will be protected and the rules will be more workable by focussing on those persons who can influence the audit, instead of all partners in an accounting firm’. Canada has also adopted a ‘restricted person’ regime, rather than an ‘all partner’ approach, in relation to financial relationships. The restrictions in the EU Recommendation apply to the statutory auditor and those persons in the firm in a position to influence the outcome of the audit, rather than an ‘all partner’ approach. The ‘covered person’ concept has not been applied under the auditor independence requirements in Australia and the UK. Australia and the UK have adopted an ‘all partner’ approach in relation to restrictions on financial investments but not in relation to loans and guarantees where a narrower range of prohibited relationships apply.

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Key finding 5 The review noted that the SEC auditor independence rules in the US have applied a ‘covered person’ test in relation to a number of the specific employment and financial relationship restrictions in place of an ‘all partner approach’. Canada has adopted an ‘all partner’ approach in relation to dual employment restrictions but has adopted a ‘restricted person’ regime in relation to financial relationship restrictions. The employment and financial relationship restrictions in the EU Recommendation apply to the statutory auditor and those persons in the firm in a position to influence the outcome of the audit, rather than an ‘all partner’ approach. The ‘covered person’ concept has not been adopted under the auditor independence requirements in Australia and the UK. Australia and the UK have adopted an ‘all partner’ approach in relation to dual employment restrictions and in relation to restrictions on financial investments. However, the restrictions in Australia and the UK relating to loans and guarantees have not adopted an ‘all partner’ approach.

Business relationships

2.18 The Government accepted the recommendation of the Ramsay report that detailed rules on close business relationships between an audit firm and the audit client be dealt with in the ethical rules of the professional accounting bodies. The general requirement on auditor independence in the Corporations Act also applies to business relationships between an auditor and audit client. The Australian Code of Ethics for Professional Accountants APES 110 (APES 110) was issued in June 2006 by the Accounting Professional and Ethical Standards Board. APES 110 reflects the latest revisions in the IFAC Code.

2.19 The requirements in Australia, Canada and the EU focus on the need for the financial interest created by the business relationship being immaterial and the relationship itself being insignificant to the audit firm and the audit client.

2.20 The requirements in the UK and the US will only permit purchase of goods and services in the ordinary course of business, in the case of the UK, and in the case of the US, the provision of professional services to the audit client or where the audit firm is a consumer in the ordinary course of business.

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Key finding 6 In Australia, detailed rules on close business relationships are contained in the professional conduct rules, although the general requirement on auditor independence in the Corporations Act would still apply to business relationships between the auditor and audit client. The Australian Code of Ethics for Professional Accountants APES 110 imposes restrictions on close business relationships between the auditor and audit client and requires that the financial interest is immaterial and clearly insignificant to the firm and the audit client. Close business relationships are also regulated under the auditor independence requirements applying in the other jurisdictions. The UK and US requirements will only permit the purchase of goods and services in the ordinary course of business, in the case of the UK, and in relation to the US, professional services to the audit client or where the audit firm is a consumer in the ordinary course of business.

PART 6: PROVISION OF NON-AUDIT SERVICES

2.21 The Australian APES 110 has noted that audit firms have traditionally provided audit clients a range of non-audit services that are consistent with the firm’s skills and expertise. The fundamental concern raised by those who oppose the provision on non-audit services is that when an audit firm provides non-audit services to a client it is serving two different sets of clients: management in the case of non-audit services and the audit committee, the shareholders and all those who rely on the audited financial statement in the case of the audit. In serving these different clients, it is argued that the audit firm is subject to conflicts of interest.

2.22 The fundamental policy issue confronting policy makers is whether to ban some or all non-audit services or whether to allow non-audit services provided auditors are made aware of the potential threats to their independence and require safeguards to be put in place in order to minimise these threats to acceptable levels. When a threat cannot be reduced to an acceptable level, the auditor should either resign from the audit or refrain from providing the non-audit service.

2.23 The Australian Government decided not to impose a legislative ban on non-audit services when the CLERP 9 Act reforms were introduced. The Ramsay report noted that it had not uncovered any evidence to suggest that there were systemic failures within the accounting profession in complying with the ethical rules for providing non-audit services to clients.

2.24 Canada, the EU, and the UK have adopted a similar approach to Australia. The US on the other hand, prohibits eight specific categories of non-audit services and requires that any other non-audit services must be pre-approved by the audit client’s audit committee.

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2.25 The review compares the specific non-audit services that are either banned in the US, or discussed in terms of threats to independence and the safeguards that need to be taken. The review found that the coverage of specific non-audit services in APES 110 is substantially similar to those identified in the other jurisdictions, except the EU which is not as comprehensive. We noted however that Canada, the UK and the US specifically address actuarial services which are not specifically covered in APES 110. The general requirement on auditor independence in the Corporations Act also applies to the provision of non-audit services by an auditor to an audit client.

Key finding 7 Australia has not imposed a legislative ban on non-audit services. Canada, the European Union and the United Kingdom have adopted a similar approach to Australia. In the US, the Sarbanes-Oxley Act prohibits eight specific categories of non-audit services and requires that any other non-audit services must be pre-approved by the audit client’s audit committee.

Key finding 8 The coverage of specific non-audit services in the Australian Code of Ethics for Professional Accountants APES 110 is substantially similar to those identified in the other jurisdictions, except the EU which is not as comprehensive. The review noted, however, that Canada, the UK and the US specifically address actuarial services which are not specifically covered in Australia’s APES 110. The general requirement on auditor independence in the Corporations Act also applies to the provision of non-audit services by an auditor to an audit client.

2.26 Tax services are not prohibited in any of the jurisdictions. We noted though that in the UK the potential threats that can arise from the provision of tax services are analysed in detail under an ethical standard (APB Ethical Standard 5). This compares with the position adopted under APES 110 which states that generally tax services do not create any auditor independence threats.

Key finding 9 Tax services are not prohibited in any of the jurisdictions, including the US. The Australian Code of Ethics for Professional Accountants APES 110 states that generally tax services do not create any auditor threats. This can be compared with the treatment of tax services in the UK under APB Ethical Standard 5 where the potential threats that can arise from the provision of tax services are analysed in detail.

2.27 IOSCO is currently undertaking a detailed survey of the regulation of non-audit services in various jurisdictions. IOSCO is aware that jurisdictions have differing views as to which non-audit services might give rise to an actual or perceived conflict of interest. Differing interpretations can raise important issues for corporations and audit firms that operate on a global basis. ASIC considers that in light of these cross border

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issues, the IOSCO study of the regulation on non-audit services will be useful to IOSCO members in determining how best to deal with independence requirements, not only in their local jurisdictions, but also in a global context.

Key finding 10 IOSCO is currently undertaking a detailed survey of the regulation of non-audit services in various jurisdictions. IOSCO is aware that jurisdictions have differing views as to which non-audit services might give rise to an actual or perceived conflict of interest. Where different interpretations occur, this raises important issues for corporations and audit firms that operate on a global basis. ASIC considers that the IOSCO study will be useful to IOSCO members in determining how best to deal with auditor independence requirements in relation to non-audit services, not only in their local jurisdictions, but also in a global context.

PART 7: EMPLOYMENT RESTRICTIONS APPLYING TO FORMER AUDIT PARTNERS AND SENIOR AUDIT PERSONNEL

‘Cooling-off periods’

2.28 Objectivity and independence may be threatened where an officer or employee of an audit client who is in a position to exert direct and significant influence over the preparation of the financial statements has recently been a partner in the audit firm or a member of the audit engagement team.

2.29 Australia and each of the other jurisdictions have addressed these concerns by requiring a ‘cooling-off’ period between the partner’s or professional employee’s departure from the firm and his or her joining the audit client. There are however, subtle differences between the requirements in each jurisdiction. These differences are analysed in the review.

2.30 The two year ‘cooling-off’ period in Australia is similar to the periods in the other jurisdictions although in Canada, the period is only one year. The SOX Act also refers to one year but the way the provision is drafted, the period in fact is longer than one year but not more than two years.

2.31 The obligation under the Australian restriction is placed on the former partner while in other jurisdictions the burden falls on the audit firm as it is not regarded as being independent if the ‘cooling-off’ restriction is breached. The Australian position is explained by the fact that breach of the restriction is a criminal offence and it would not be appropriate to prosecute the firm after the partner has resigned from the firm.

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Key finding 11 The obligation under the Australian restriction is imposed on the former partner because it would be inappropriate to impose a criminal sanction on the audit firm after a former partner has resigned from the firm and is beyond the control of the firm. The restriction in the relevant overseas jurisdictions falls on the audit firm because the firm is not regarded as being independent of the audit client if the ‘cooling-off’ restriction is breached.

2.32 The Australian two year ‘cooling-off’ period applies to a former partner who was a member of the audit team, regardless as to when the partner participated as a member of the audit team. Canada, the UK and the US place a limit on the time of participation in an audit prior to the partner’s date of departure.

2.33 However, the scope of the Australian requirement only applies to a partner or director of an authorised audit company who has been a professional member of the audit team. The UK requirement extends beyond membership of the audit team to other partners in the ‘chain of command’. The US requirement is even more extensive and applies to any person who participated ‘in any capacity’ in the audit.

Key finding 12 The Australian ‘cooling-off’ period restriction applies to a former partner of the firm who was a member of the audit team, regardless as to how far back the partner’s participation on the audit team took place. Canada, the UK and the US place a limit on the time of participation in an audit prior to the partner’s date of departure from the firm.

Key finding 13 In contrast to key finding 12, the scope of the Australian ‘cooling-off’ period only applies to a partner or director of an authorised audit company who has been a professional member of the audit team. The UK requirement includes other partners in the ‘chain of command’. The US requirement is even more extensive and applies to any person who participated ‘in any capacity’ in the audit.

Multiple former partner of audit firm/audit company director restriction

2.34 Section 324CK of the Corporations Act implements a recommendation of the HIH Royal Commission that a prohibition be introduced preventing more than one former partner of an audit firm, or director of an audit company, at any time becoming an officer of the audit client.

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2.35 The restriction has been criticised by the accounting profession because of its potential negative impact on the employment market and recruiting practices of audit firms. The report of the Taskforce on Reducing Regulatory Burdens on Business has recommended that the Australian Government should review the multiple former audit partner restriction.

2.36 Treasury is unaware of any equivalent requirement in the overseas jurisdictions covered in the comparative review. However, we note that the HIH Royal Commission Report linked the recommendation to the fact that there were three former partners of Andersen appointed to the board of HIH.

2.37 The Government has announced that it will review the multiple former audit partner restriction by the end of 2006.2

Key finding 14 The report of the Taskforce on Reducing Regulatory Burdens on Business has recommended that the Australian Government should review the multiple audit firm partner restriction. While Treasury is unaware of an equivalent restriction in any of the relevant overseas jurisdictions, the existing restriction implements a recommendation of the HIH Royal Commission which concluded that the cumulative effect of three former partners of HIH’s auditor, Andersen, being appointed to the board of HIH, resulted in the perception that Andersen was not independent of HIH.

The Australian Government has announced that it will review the multiple former audit firm partner restriction by the end of 2006.

PART 8: AUDITOR ROTATION

2.38 The IFAC Code notes that using the same senior audit personnel on an audit engagement over a long period of time may create a familiarity threat. One of the safeguards that the IFAC Code recommends to address this threat is to rotate senior audit personnel off the audit team.

2.39 The review discusses the auditor rotation requirements in Australia and the other relevant overseas jurisdictions. The approach taken in each jurisdiction can be summarised as follows:

• All the jurisdictions covered in the review applied the rotation requirements to the lead engagement auditor and the review auditor.

2 Australian Government’s Response to the Rethinking Regulation Task Force report: 15 August 2006.

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• The length of time an auditor is allowed to remain on an audit engagement before being required to rotate is addressed in the following way:

– In Australia, the basic rule is that the lead and review auditors must rotate after five successive years and also may not audit a particular audit client for more than five out of seven successive financial years.

– Canada, the UK and the SEC Rules require rotation after five successive years.

– The EU Recommendation requires rotation after seven years.

• The following ‘time-out’ periods apply before a ‘rotated’ auditor is allowed to resume involvement with the same audit client:

– Australia and the EU have adopted a two year time-out period.

– Canada, the UK and the SEC have adopted a five year time-out period.

• The requirements in Australia, Canada, the UK and the SEC only apply to listed companies (‘reporting issuers’ in Canada and ‘issuers’ under the SEC Rules).

• Under the SEC Rules, audit firms with fewer than five audit clients who are ‘issuers’ for purpose of the securities laws and which have less than ten partners, are exempt from the rotation requirements provided the PCAOB conducts a review at least once every three years of each of the firm’s audit client engagements.

Key finding 15 While Australia and the relevant overseas jurisdictions have all adopted auditor rotation requirements, there are subtle differences between the requirements adopted in each jurisdiction. None of the jurisdictions require audit firm rotation.

The auditor rotation requirements in each jurisdiction extend to the lead engagement auditor and the review auditor.

Australia, Canada, the UK and the SEC Rules in the US, require rotation after five successive years. Australia has an additional requirement that a lead or review auditor may not audit a particular audit client for more than five out of seven successive years. The EU requires rotation after seven years.

Australia and the EU have adopted a two year time-out period before a ‘rotated’ auditor is allowed to resume involvement with the same audit client. Canada, the UK and the SEC have adopted a five year time-out period.

Only the SEC Rules provide an exemption from the rotation requirements for smaller audit firms (fewer than five audit clients and less than ten audit partners) provided the PCAOB conducts a review at least once every three years of each of the firm’s audit client engagements.

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CONCLUSION

2.40 Audited financial statements play a key role in relation to the efficiency of capital markets and the independent auditor constitutes the principal external check on the integrity of financial statements. Australia and all the relevant overseas jurisdictions recognise that auditor independence is fundamental to the credibility and reliability of auditor’s reports.

2.41 Our overall conclusion is that the comparative review that Treasury has undertaken establishes conclusively that, notwithstanding differences in terminology, institutional arrangements and legal frameworks, there is a substantial underlying equivalence between the Australian requirements and ‘best practice’ standards adopted internationally. The key findings do, however, identify some important areas where the approach by particular jurisdictions on a specific issue has diverged.

Conclusion Treasury’s overall conclusion is that notwithstanding differences in terminology, institutional arrangements and legal frameworks, there is a substantial underlying equivalence between the Australian auditor independence requirements and ‘best practice’ standards adopted internationally.

2.42 The key findings of the review are detailed below.

Key finding 1 While many of the core elements of the auditor independence requirements, including their underlying policy objectives, in each jurisdiction are similar, the review has found substantial differences in the institutional arrangements and the legal framework applying to audit regulation in each jurisdiction. These differences can be explained by the unique combination of circumstances applying in each jurisdiction, including constitutional arrangements, history relating to the regulation of corporations and financial services and system of government.

Key finding 2 A distinguishing feature of the Australian auditor independence requirements compared with the overseas jurisdictions covered by the review, is that the detailed independence requirements have been enacted by the Federal Parliament in the Corporations Act to provide a comprehensive legislative code.

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Key finding 3 Canada, the European Union and the UK have not adopted a general standard of auditor independence along the lines of the general requirement for auditor independence in the Corporations Act or the general standard in the SEC Rule in the US.

The Australian and SEC requirements are a cornerstone of their respective auditor independence regulatory frameworks. The Australian general requirement on auditor independence applies to all circumstances relating to an audit and is in addition to, and does not derogate from any other obligation imposed by the Corporations Act or a code of professional conduct.

Key finding 4 The detailed comparative analysis undertaken by Treasury in relation to the specific employment and financial relationship restrictions in each jurisdiction clearly indicated that there is substantial underlying equivalence between the Australian requirements and those in the relevant overseas jurisdictions.

Key finding 5 The review noted that the SEC auditor independence rules in the US have applied a ‘covered person’ test in relation to a number of the specific employment and financial relationship restrictions in place of an ‘all partner approach’. Canada has adopted an ‘all partner’ approach in relation to dual employment restrictions but has adopted a ‘restricted person’ regime in relation to financial relationship restrictions. The employment and financial relationship restrictions in the EU Recommendation apply to the statutory auditor and those persons in the firm in a position to influence the outcome of the audit, rather than an ‘all partner’ approach. The ‘covered person’ concept has not been adopted under the auditor independence requirements in Australia and the UK. Australia and the UK have adopted an ‘all partner’ approach in relation to dual employment restrictions and in relation to restrictions on financial investments. However, the restrictions in Australia and the UK relating to loans and guarantees have not adopted an ‘all partner’ approach.

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Key finding 6 In Australia, detailed rules on close business relationships are contained in the professional conduct rules, although the general requirement on auditor independence in the Corporations Act would still apply to business relationships between the auditor and audit client. The Australian Code of Ethics for Professional Accountants APES 110 imposes restrictions on close business relationships between the auditor and audit client and requires that the financial interest is immaterial and clearly insignificant to the firm and the audit client. Close business relationships are also regulated under the auditor independence requirements applying in the other jurisdictions. The UK and US requirements will only permit the purchase of goods and services in the ordinary course of business, in the case of the UK, and in relation to the US, professional services to the audit client or where the audit firm is a consumer in the ordinary course of business.

Key finding 7 Australia has not imposed a legislative ban on non-audit services. Canada, the European Union and the United Kingdom have adopted a similar approach to Australia. In the US, the Sarbanes-Oxley Act prohibits eight specific categories of non-audit services and requires that any other non-audit services must be pre-approved by the audit client’s audit committee.

Key finding 8 The coverage of specific non-audit services in the Australian Code of Ethics for Professional Accountants APES 110 is substantially similar to those identified in the other jurisdictions, except the EU which is not as comprehensive. The review noted, however, that Canada, the UK and the US specifically address actuarial services which are not specifically covered in Australia’s APES 110. The general requirement on auditor independence in the Corporations Act also applies to the provision of non-audit services by an auditor to an audit client.

Key finding 9 Tax services are not prohibited in any of the jurisdictions, including the US. The Australian Code of Ethics for Professional Accountants APES 110 states that generally tax services do not create any auditor threats. This can be compared with the treatment of tax services in the UK under APB Ethical Standard 5 where the potential threats that can arise from the provision of tax services are analysed in detail.

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Key finding 10 IOSCO is currently undertaking a detailed survey of the regulation of non-audit services in various jurisdictions. IOSCO is aware that jurisdictions have differing views as to which non-audit services might give rise to an actual or perceived conflict of interest. Where different interpretations occur, this raises important issues for corporations and audit firms that operate on a global basis. ASIC considers that the IOSCO study will be useful to IOSCO members in determining how best to deal with auditor independence requirements in relation to non-audit services, not only in their local jurisdictions, but also in a global context.

Key finding 11 The obligation under the Australian restriction is imposed on the former partner because it would be inappropriate to impose a criminal sanction on the audit firm after a former partner has resigned from the firm and is beyond the control of the firm. The restriction in the relevant overseas jurisdictions falls on the audit firm because the firm is not regarded as being independent of the audit client if the ‘cooling-off’ restriction is breached.

Key finding 12 The Australian ‘cooling-off’ period restriction applies to a former partner of the firm who was a member of the audit team, regardless as to how far back the partner’s participation on the audit team took place. Canada, the UK and the US place a limit on the time of participation in an audit prior to the partner’s date of departure from the firm.

Key finding 13 In contrast to key finding 12, the scope of the Australian ‘cooling-off’ period only applies to a partner or director of an authorised audit company who has been a professional member of the audit team. The UK requirement includes other partner’s in the ‘chain of command’. The US requirement is even more extensive and applies to any person who participated ‘in any capacity’ in the audit.

Key finding 14 The report of the Taskforce on Reducing Regulatory Burdens on Business has recommended that the Australian Government should review the multiple audit firm partner restriction. While Treasury is unaware of an equivalent restriction in any of the relevant overseas jurisdictions, the existing restriction implements a recommendation of the HIH Royal Commission which concluded that the cumulative effect of three former partners of HIH’s auditor, Andersen, being appointed to the board of HIH, resulted in the perception that Andersen was not independent of HIH.

The Australian Government has announced that it will review the multiple former audit firm partner restriction by the end of 2006.

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Key finding 15 While Australia and the relevant overseas jurisdictions have all adopted auditor rotation requirements, there are subtle differences between the requirements adopted in each jurisdiction. None of the jurisdictions require audit firm rotation.

The auditor rotation requirements in each jurisdiction extend to the lead engagement auditor and the review auditor.

Australia, Canada, the UK and the SEC Rules in the US, require rotation after five successive years. Australia has an additional requirement that a lead or review auditor may not audit a particular audit client for more than five out of seven successive years. The EU requires rotation after seven years.

Australia and the EU have adopted a two year time-out period before a ‘rotated’ auditor is allowed to resume involvement with the same audit client. Canada, the UK and the SEC have adopted a five year time-out period.

Only the SEC Rules provide an exemption from the rotation requirements for smaller audit firms (fewer than five audit clients and less than ten audit partners) provided the PCAOB conducts a review at least once every three years of each of the firm’s audit client engagements.

Conclusion Treasury’s overall conclusion is that notwithstanding differences in terminology, institutional arrangements and legal frameworks, there is a substantial underlying equivalence between the Australian auditor independence requirements and ‘best practice’ standards adopted internationally.

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Part 3: Auditor independence: Policy goals, institutional arrangements and legal framework

INTRODUCTION

3.1 A sound knowledge of the auditor independence requirements applying in each jurisdiction is not possible without an understanding of the institutional arrangements and the legal framework within which those requirements operate.

3.2 While many of the core elements of the auditor independence requirements in each jurisdiction are similar, there are substantial differences between the jurisdictions in terms of the legal framework and institutional arrangements that have been adopted.

LOSS OF CREDIBILITY IN FINANCIAL REPORTING HAS BEEN THE MAJOR POLICY DRIVER OF REFORMS

3.3 Concerns about the credibility of financial reporting and the audit function surfaced during the 1997 Asian financial crisis when major companies in apparent sound financial health dramatically collapsed or went into deep financial distress. This was perceived though, as largely an Asian phenomenon. It was not until the jolt of the collapse of the US Corporation, Enron in late 2001, and subsequent failures of other high profile companies, that a worldwide debate on the crisis affecting financial reporting and the audit function was triggered, and led to the introduction of substantial reforms in relation to financial disclosure and the regulation of auditors.

INTERNATIONAL EFFORTS TO ADDRESS CRISIS

3.4 While the regulatory framework in relation to corporate disclosure and the effectiveness of the audit function operates primarily at the national level, it is important to acknowledge the multilateral action that has been initiated at the international level.

3.5 There is a current trend towards greater consistency in global regulatory standards as evidenced by work undertaken, for example, by the International Organisation of Securities Commissions (IOSCO), the International Monetary Fund and the World Bank.

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3.6 IOSCO has released a range of best-practice standards and principles which provide an international benchmark for the development of securities and corporate regulatory standards. IOSCO’s Principles of Auditor Independence and the Role of Corporate Governance in Monitoring an Auditor’s Independence3 notes that ‘the importance of auditor independence standards that are reasonable and enforceable has been underlined by several significant corporate failures in which questions have been raised about the quality of financial reporting and, in particular, the independence of the auditor’.

3.7 The International Federation of Accountants4 (IFAC) represents 163 member organisations in 120 countries. IFAC is widely recognised as the voice of the international accounting profession. An important part of IFAC’s mission is to develop and promote adherence to high quality professional standards in the areas of auditing, education, ethics and public sector financial reporting. The following IFAC initiatives are worth noting in the context of the international measures that have been taken to enhance auditor independence and audit quality standards:

• IFAC’s International Ethics Standards Board for Accountants updated the Code of Ethics for Professional Accountants (the IFAC Code) in June 2005. The IFAC Code emphasises five fundamental values which are integrity, objectivity, professional competence, due care, confidentiality and professional behaviour. The IFAC Code contains a conceptual framework which identifies threats to these values and the safeguards that could be taken to address these threats. This conceptual framework forms the basis of the auditor independence rules adopted by each of the professional body members of IFAC. All IFAC member organisations must ensure that they adopt auditor independence rules that are no less stringent than those laid down in the IFAC Code. For purposes of Treasury’s comparative review, the standards set by the IFAC Code are particularly important in those jurisdictions where the auditor independence rules of recognised professional bodies constitute the primary auditor independence requirements for the particular jurisdiction.

• IFAC established the Public Interest Oversight Board5 (PIOB) in February 2005, to oversee IFAC’s standard-setting activities. The establishment of the PIOB was the result of a collaborative effort by the international financial regulatory community (IOSCO, the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors, the World Bank and the Financial Stability Forum) working with IFAC, to ensure that auditing and assurance, ethics and educational standards for the accounting profession are set in a transparent manner that reflects the public interest. It was mutually recognised that high quality, transparent standard-setting processes with public and regulatory input, together with regulatory monitoring and public interest oversight, are necessary to enhance the quality of external audits of entities.

3 A Statement of the Technical Committee of IOSCO: October 2002: www.iosco.org. 4 Background information on IFAC is available on its website www.ifac.org. 5 Further background information on the PIOB is available on its website: www.ipiob.org.

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http://www.iosco.org/


• Another noteworthy initiative by IFAC was to establish a Task Force on Rebuilding Public Confidence in Financial Reporting.6 The Task Force was commissioned to provide an international perspective on the causes of the loss of credibility in financial reporting and corporate disclosure and to recommend causes of action to restore credibility. The Task Force reported in July 2003. The key recommendations of the Task Force were built on three basic assumptions:

– the financial credibility of financial reporting is both a national issue in each country and an international issue, with action required at both levels;

– to improve the credibility of financial reporting, action will be necessary at all points along the information supply chain that delivers financial reporting to the market. In this context, the Task Force made a number of recommendations relating to audit independence and audit effectiveness through greater attention being given to audit control processes; and

– integrity, both individual and institutional, is essential for effective remedial action. The Task Force said that failure to recognise the primacy of integrity was a major contributor to the financial scandals of recent years.

3.8 The worldwide reform measures introduced to strengthen auditor independence rules and audit quality processes must also be considered in the context of the institutional reforms that governments have made at the national level to enhance auditor independence and audit quality.

• The PIOB explained these institutional developments in its First Public Report issued on 16 May 2006:

National audit regulators and oversight authorities have become a very important institutional feature of the regulatory landscape. This has been the result of many national responses to the same proximate causes that spearheaded the creation of the international PIOB: corporate scandals and audit failures. In some cases these new national authorities wield standard-setting powers while in others they do not. Such authorities constitute a new reality in the world architecture of regulation.

• IOSCO has noted that there is a growing consensus that ‘the adequacy and effectiveness of audit firms’ internal systems and processes relating to independence must be assessed and evaluated by an external oversight system’.7

6 The report of the Task Force was published by IFAC in 2003 and is available on the IFAC website, op. cit. 4. Professor Ian Ramsay was a member of the Task Force.

7 op. cit. 3 at page 4.

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AUSTRALIA

Legislative requirements

3.9 The CLERP 9 Act established a comprehensive statutory regime on auditor independence8, substantially implementing the recommendations of the Ramsay report and some of the relevant recommendations of the HIH Royal Commission.9

3.10 The Government decided to commission the review by Professor Ramsay in 2001 because there was a generally accepted view that the Australian auditor independence requirements could no longer be regarded as best practice, having fallen behind equivalent requirements in the US and Europe. Auditor independence issues had also been raised in the publicity relating to a number of corporate failures during the first half of 2001. Shortly before the Ramsay report was released in October 2001, HIH Insurance Ltd (HIH) was placed into final liquidation on 27 August 2001. The collapse of HIH represents the largest corporate failure experienced in Australia.

3.11 While the Ramsay report was adopted by the Government as the basic blueprint for the auditor independence reforms in the CLERP 9 Act, the development of these reforms was also informed by overseas developments from late 2001 following the collapse of Enron and other high profile companies in the US and Europe and the detailed recommendations in relation to the audit function contained in the report of the HIH Royal Commission which was completed in April 2003.

3.12 A salient feature of the Ramsay report was that the great majority of the detailed auditor independence requirements which it proposed were recommended to be included in the Corporations Act. Similarly, most of the recommendations that the HIH Royal Commission made in relation to auditor independence, involved the making of amendments to the Corporations Act. In other words, both the Ramsay report and the HIH Royal Commission recommended that most of the enhanced auditor independence rules should have the force of law within the framework of the Corporations Act.

8 Most of the auditor independence requirements are contained in Division 3 of Part 2M.4 of the Corporations Act.

9 The HIH Royal Commission: The failure of HIH Insurance: Volume 1: A corporate collapse and its lessons. Published by the Australian Government in April 2003: www.hihroyalcom.gov.au.

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3.13 The inclusion of the auditor independence rules in the Corporations Act, has resulted in the Parliament enacting the detailed requirements. This can be contrasted with the position in the relevant overseas jurisdictions:

• the federal auditor independence regime in the US, which also has a statutory basis, relies primarily on the detailed rules made by the SEC10 and the rules and standards made by the PCAOB11 (the SOX Act contains prescriptive requirements in relation to audit committees, auditor rotation and non-audit services, but even in these cases, they require supporting rules being made by the SEC);

• in Canada, the detailed auditor independence requirements rely primarily on the rules in the professional codes of ethics of the provincial Institutes of Chartered Accountants which have adopted the IFAC conceptual framework approach;

• in the UK, the recognised professional accounting bodies have been required to adopt, for purposes of the auditor independence requirements in their respective codes of ethics, the ethical standards issued by the Auditing Practices Board12 (APB) (one of the UK Financial Reporting Council’s (FRCUK) operating bodies); and

• the EU has adopted in its Directive and Council Recommendation on the independence of the statutory auditor, a principles-based approach within a conceptual framework similar to the IFAC approach.

3.14 Another consequence of including the detailed auditor independence requirements in the Corporations Act, is that, in framing each auditor independence requirement, it is necessary to determine the persons who should be made liable in the event of a contravention of a particular requirement. As the liability rules under the criminal law apply differently depending on whether the auditor is an individual auditor (sole proprietor), a firm or an authorised audit company, the auditor independence regime in the Corporations Act deals with each of these forms of audit practice separately, even though the underlying auditor independence concept is the same.

• As an example, we explain how the liability rules operate in relation to the specific employment and financial relationship restrictions in Part 5 of the review because an understanding of the liability rules applicable to the specific auditor independence requirements is essential to a proper understanding of how the auditor independence obligations operate from a compliance perspective.

• To facilitate our analysis of the detailed auditor independence requirements in the comparative review, we focus primarily on the rules applicable in Australia to an

10 Information on the SEC’s functions and role are available on the SEC website www.sec.gov. 11 Information about the PCAOB’s functions and role are available on the PCAOB website

www.pcaobus.org. 12 The APB’s Ethical Standards are available on the APB website www.org.uk/apb/.

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audit firm and only mention the application of a particular rule to an individual auditor or an authorised audit company where this may warrant some special consideration.

Rules of professional conduct

3.15 The Ramsay report described the pre-CLERP 9 Act regulatory environment for the independence of auditors as co-regulatory. The Ramsay report recognised that prior to the CLERP 9 reforms, the major regulatory role was played by the professional accounting bodies through their professional requirements and the code of ethics.

3.16 While the Ramsay report recommended the substantial strengthening of the auditor independence requirements in the Corporations Act, one of the key objectives contained in the report was to continue the co-regulatory environment.

At the same time, we see a strengthened role for the professional accounting bodies in updating their professional requirements and codes of ethics and providing leadership to the profession in terms of auditor independence. We believe the professional accounting bodies are well placed to play a central role in ensuring that auditors remain independent of their clients. Market outcomes can be improved and there can be lower regulatory costs on business where professional bodies are both willing to, and have the ability to, play a key role in regulation.13

3.17 The leadership role that the professional bodies play in self-regulating their members through their codes of ethics is critical in terms of the overall effectiveness of the auditor regulatory framework in Australia. The codes of ethics instil a culture of personal integrity within the profession which supplements the statutory framework enacted by the Parliament.

3.18 While the legislative regime in the Corporations Act has primacy, the professional conduct rules continue to play an important role in supplementing the legislative requirements in relation to auditor independence.

3.19 The three main professional accounting bodies in Australia (CPA Australia, The Institute of Chartered Accountants in Australia (ICAA) and the National Institute of Accountants (NIA)) are all members of IFAC and are required to use their best endeavours to ensure that their rules of professional conduct reflect, as a minimum, the standards in the IFAC Code of Ethics for Professional Accountants.

3.20 CPA Australia and the ICAA announced on 2 November 2005 that they had established an independent ethical standards board, the Accounting Professional and


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Ethical Standards Board14 (APESB), to set the code of professional conduct applicable to their members. The APESB replaced the existing Joint Code of Professional Conduct (commonly referred to as the F1 Statement) in June 2006 with APES 110, the Code of Ethics for Professional Accountants. In the preface to APES 110, the APESB notes that one of the purposes of the Code of Ethics for Professional Accountants is to take account of the revised IFAC Code. The APESB has also taken into account the fact that auditing standards issued by the Auditing and Assurance Standards Board (AUASB) have the force of law from 1 July 2006 and that these standards make reference to compliance with ‘relevant ethical requirements’. The APESB has noted that the Code of Ethics for Professional Accountants will therefore have ‘the force of law’ in respect of Corporations Act audits.

3.21 The substantive changes from the former code are minimal, but we note that the main features of the Code of Ethics for Professional Accountants are that:

• the structure of the Code and the numbering of paragraphs have been revised to conform with the IFAC Code;

• for the most part, the wording of the IFAC Code has been adopted; and

• certain paragraphs that have no equivalent in the IFAC Code have been identified as Australian paragraphs by inserting the letters AUST before the paragraph number.

Audit Quality Review Board

3.22 The Audit Quality Review Board (AQRB) is the accounting profession’s own quality initiative and was officially launched by the Parliamentary Secretary to the Treasurer on 17 February 2006.

3.23 The objective of the AQRB is to monitor the processes by which its participating audit firms seek to ensure their compliance with independence and quality-related professional standards and law. The AQRB seeks to ensure greater transparency and robustness in the quality monitoring processes for audits of publicly listed entities.

3.24 The AQRB’s monitoring process has adopted a two-tiered approach:

• Each audit firm that chooses to do so becomes a participating audit firm, submitting to AQRB an annual self-assessment of its quality control activities, including professional independence, ethics and compliance with auditing standards and regulations. This is provided in a standard format, known as the Quality Control

14 The Code of Ethics for Professional Accountants (APES 110) is available on the APESB website at www.apesb.org.au.

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Report (QCR), which is placed on both the AQRB and the individual firm’s website, accompanied by a suitable disclaimer.

• Participating audit firms then have the option of becoming a participating monitored audit firm by subjecting their QCR details to an examination by AQRB.

– Firms which audit more than 100 publicly listed entities will have an annual examination of their quality control monitoring systems.

– Firms which audit fewer than 100 publicly listed entities have a three-yearly examination.

3.25 The Government has welcomed the establishment of the AQRB, acknowledging that it reflects the profession’s desire to support the audit and financial reporting reforms introduced under the CLERP 9 Act. The Government also considers that the AQRB model fits well into the overall framework established by the CLERP 9 Act reforms, which envisaged a continuing role for the audit profession. The AQRB aims to complement, but not displace or alter, ASIC’s regulatory role.

Institutional oversight arrangements

3.26 Australia does not have a separate audit oversight body. Rather, the functions that would be conferred on such a body are conferred on the corporate regulator, ASIC, and, to a lesser extent, other bodies in the financial reporting framework such as the FRC. The role of each of the key bodies is summarised below.

Australian Securities and Investments Commission

3.27 Australian Securities and Investments Commission (ASIC) is established under the ASIC Act as an independent statutory body that regulates corporations, managed investment schemes and providers of financial products and services.

3.28 As the key corporate regulator, the functions of surveillance, investigation and enforcement of the responsibilities of companies and auditors in relation to financial reporting, including the enforcement of auditor independence requirements and compliance with auditing standards, are vested in ASIC.

Financial Reporting Council

3.29 The Financial Reporting Council (FRC) is established under the ASIC Act. The members of the FRC are appointed by the Government. They include members appointed from nominations put forward by key stakeholder groups, as well as members appointed independently.

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3.30 The FRC has responsibility for the oversight of the accounting standards and auditing standards setting framework. Although the FRC does not set standards, it is responsible for determining the broad strategic direction and appointing the members (other than the Chairpersons who are appointed by the Government) of the two major standard setting bodies, the Australian Accounting Standards Board and the Auditing and Assurance Standards Board.

3.31 The FRC’s functions were significantly expanded from 1 July 2004, following legislative amendments made by the CLERP 9 Act, to include monitoring the effectiveness of auditor independence requirements in Australia and giving the Minister reports and advice about those requirements.

3.32 To facilitate the performance of the auditor independence functions, the FRC has signed Memoranda of Understanding in relation to the sharing of information with ASIC, ASX, the Australian Prudential Regulation Authority (APRA) and the three main professional accounting bodies.

Financial Reporting Panel

3.33 The Financial Reporting Panel (FRP) has been established under the ASIC Act. The FRP, which is broadly based on the Financial Reporting Review Panel in the UK, provides an alternative method of dispute resolution by determining contested issues between ASIC and companies concerning the application of accounting standards and the true and fair view requirements in financial reports under the Corporations Act.

Companies Auditors and Liquidators Disciplinary Board

3.34 The Companies Auditors and Liquidators Disciplinary Board (CALDB) is established under the ASIC Act. The CALDB may take disciplinary action on the application of ASIC or APRA against an auditor or liquidator. CALDB has power to admonish or reprimand a person; require a person to give an undertaking to engage in, or to refrain from engaging in, specified conduct; require a person to give an undertaking to refrain from engaging in specified conduct except on specified conditions; suspend or cancel a person’s registration.

CANADA

3.35 Canada has a federal system of Government. Legislative and governing powers are divided between the federal government and provincial legislatures. Canada is a federation made up of ten provinces and three territories.

3.36 The division of powers between the federal and provincial jurisdictions has had a significant influence on the institutional arrangements relating to auditor oversight in Canada.

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3.37 The Canadian provinces and territories are responsible for securities regulation. The federal Parliament has, however, enacted the Canada Business Corporations Act in order to revise and reform the law applicable to business corporations incorporated to carry on business throughout Canada. Accountants are also regulated at the provincial and territory level.

3.38 The securities regulators from each province and territory have teamed up to form the Canadian Securities Administrators15 (CSA). The mission of the CSA is to give Canada a national securities regulatory system that provides protection to investors from unfair, improper or fraudulent practices while at the same time fostering fair and efficient capital markets and confidence in them. The CSA pursues this mission through a national system of harmonised securities regulation, policies and practices designed to provide effective protection and efficient service to market participants.

Canadian Public Accountability Board

3.39 The provincial and territory securities regulators, the Federal Superintendent of Financial Institutions and the Canadian Institute of Chartered Accountants (CICA) created the Canadian Public Accountability Board16 (CPAB) in 2003 to provide independent public oversight of auditors of entities that are reporting issuers to the securities commissions. It was not possible to have the new auditor oversight agency created by legislation because of the federal-provincial jurisdictional arrangements in Canada.

3.40 The CPAB is a federal not-for-profit corporation which operates as an independent national agency within the confines of Canada’s provincial framework of legislation for the regulation of financial markets and the accounting profession. The CSA National Instrument 52-108 requires that financial statements of reporting issuers be audited by public accounting firms that are participants in the CPAB oversight program. CPAB has contractual agreements with participating audit firms that enable it to take the actions necessary to carry out its role.

3.41 The Board of Directors of CPAB was structured to ensure that a majority of directors (seven out of eleven) come from outside the accounting profession. The other four directors bring professional accounting experience to CPAB’s Board.

3.42 The formation of CPAB was one part of a larger package of reforms in Canada in response to the loss of investor confidence in the capital markets that arose from the corporate failures and financial scandals from late 2001 onwards.

15 More information on the CSA is available on its website www.csa-acvm.ca. 16 Additional background information is available on the CPAB website: cpab-ccrc.ca.

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3.43 CPAB’s actions to promote high quality external audits of reporting issuers include:

• establishing and maintaining requirements for participation in CPAB’s oversight program, and publishing on its website a register of participating audit firms;

• conducting inspections of participating audit firms directly or in cooperation with professional regulatory authorities in order to assess the compliance of each participating audit firm with the Rules of the CPAB, professional standards and the firms’ own quality control policies, and requiring remedial action by firms to address inspection findings when necessary or appropriate;

– in setting up its inspection program, CPAB has taken account of the inspection procedures that were already in place at provincial accounting regulatory bodies in each province. CPAB conducts direct audit quality inspections of all the large audit firms, as well as smaller firms that register with the US PCAOB. The CPAB works closely with the provincial; accounting regulatory bodies to take full advantage of their accumulated knowledge and expertise and their statutory inspection and disciplinary powers. The provincial regulatory authorities will continue to inspect smaller participating firms on CPAB’s behalf and in conformity with CPAB’s procedures.

• conducting investigations of, and imposing requirements, restrictions and sanctions on, participating audit firms when necessary or appropriate;

• providing comments and recommendations on accounting and assurance standards to relevant standard-setting and professional oversight bodies; and

• reporting to the public at least annually on the results of its activities.

3.44 The CPAB funds its activities through fees charged to public accounting firms that are applying to become, or that are, participating audit firms.

3.45 The auditor independence rules that apply within the CPAB oversight framework are the standards for auditor independence that have been implemented by the provincial Institutes of Chartered Accountants. In Canada, auditor independence issues are matters for the provincial institutes and are integrated into the fabric of the profession’s self regulation in terms of the rules of professional conduct and their enforcement. These independence rules are made by authority of the Chartered Accountants Act (or other relevant legislation) applying in each province or territory.

• To facilitate the coordination and standardisation of new uniform independence standards in Canada, in 2000 the CICA Board of Directors’ Public Interest and Integrity Committee was requested to prepare new independence standards. CICA was active, with the CSA to ensure that the new auditor independence rules adopted the IFAC Code as well as incorporating some of the key auditor independence requirements under the US SOX Act. The proposed standards went

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through due process and after being subjected to a ‘province-by-province’ review and vote, were included in each province’s Rules of Professional Conduct.

• For purposes of Treasury’s analysis in the comparative review, we have focused on the Rules of Professional Conduct of The Institute of Chartered Accountants of Ontario17 (ICAO Rules). The ICAO Rules are representative of the professional conduct rules that have been adopted by all the other provincial Institutes of Chartered Accountants.

Comparison between Australian and Canadian auditor independence institutional and legal frameworks

3.46 Both Australia and Canada have federal systems of government. However, in relation to the regulation of corporations and securities, the two countries have adopted fundamentally different approaches in order to address the constitutional and jurisdictional issues that arise in a federation.

• Australia has achieved a national system of corporations regulation as a result of an agreement between the Australian Government and the governments of the States and Territories involving the referral of powers to the Federal Government. ASIC, the key corporate regulator, is a statutory body established under federal legislation. All the other bodies performing various functions in relation to the audit regulatory framework have also been established under the umbrella of the national corporations legislation.

• In Canada, the Canadian provinces and territories are responsible for securities regulation and not the federal government. To ensure that Canada has a national approach to securities regulation, it has been necessary for the provincial securities regulators to cooperate under the umbrella of the CSA. The regulation of the accounting profession is also a provincial responsibility. To ensure that there is a national system of audit oversight in relation to publicly listed entities, the CSA and the CICA and other interested bodies have cooperated in establishing CPAB. The federal-provincial jurisdictional arrangements in Canada prevented CPAB being established by legislation.

3.47 So far as the auditor independence rules applying in Australia and Canada is concerned, the Australian requirements are legislatively based and have been enacted into the Corporations Act, whereas in Canada the requirements form part of the professional conduct rules of each provincial Institute of Chartered Accountants. Enforcement of the auditor independence requirements in Australia is overseen by the independent regulator, ASIC and the obligations are imposed by law. In Canada, enforcement of the auditor independence rules relies on the contractual arrangement

17 A copy of the Rules of Professional Conduct are available on the ICAO website: www.icao.on.ca.

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between the accountant and the relevant provincial Institute of Chartered Accountant, based on the accountant’s membership of that body.

EUROPEAN UNION

Background

3.48 The European Union’s (EU) 8th Company Law Directive (84/253/EEC) regulating the approval by Member States of persons carrying out statutory audits, established the principle that auditors should not conduct statutory audits if they are not independent. However, the Directive did not indicate what has to be understood by ‘independence’. At the time of the adoption of the Directive, the European Commission (EC) noted with regret that auditor independence had not been sufficiently harmonised.

3.49 The EC’s 1998 Communication ‘The statutory audit in the European Union: the way forward’ (IP/98/399) identified auditor independence as one of the main issues to be dealt with by the EC. Consequently a Recommendation on auditor independence was included in the Financial Services Action Plan.

Recommendation on statutory auditors’ independence in the European Union

3.50 The EU released a Recommendation Statutory Auditors’ Independence in the EU: A Set of Fundamental Principles18 (the EU Recommendation) on 16 May 2002.

3.51 The Recommendation introduced a principles-based approach to auditor independence. It requires the statutory auditor to consider, for each audit engagement, independence threats and risks as well as the safeguards for mitigating those risks. The overall approach in the Recommendation is similar to that of the IFAC Code (although the IFAC Code also applies to assurance services other than the statutory audit).

3.52 The Recommendation was not equivalent to binding EU legislation. The EC considered that the release of the Recommendation would be the quickest and most effective means to bring about improvements in Member States’ current rules concerning auditors’ independence. While the Recommendation had been under preparation prior to the Enron collapse, the failure of Enron and other high profile companies from late 2001, underlined the importance of auditor independence and the need for the EC to adopt the Recommendation quickly.

18 The Recommendation is available on the EU website: http://eur-lex.europa.

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3.53 The EC said that in three years after the release of the Recommendation, it would review how the Recommendation had been applied in practice in Member States and would consider whether binding EU legislation would be required.

EU Council adopts new rules on audit of company accounts

3.54 The EU Council adopted a new Statutory Audit Directive19 on 26 April 2006 which effectively gives legal underpinning to the Recommendation on independence.20 The Statutory Audit Directive updates the 8th Company Law Directive by introducing additional EU rules on the audit of company accounts, aimed at reinforcing the reliability of company financial statements by establishing minimum requirements for statutory audit of annual accounts and consolidated accounts.

3.55 Member states will now be required to adopt legislation to comply with the new Directive within two years.

UNITED KINGDOM

Introduction

3.56 Following the collapse of Enron in late 2001 and other corporate failures in the US, the UK government initiated a wide-ranging work program to review the UK’s regulatory practices for statutory audit and financial reporting. The key consultation documents and reports21 are the Final Report of the Co-ordinating Group on Audit and Accounting Issues to the Secretary of State for Trade and Industry (January 2003); Review of the Regulatory Regime of the Accounting Profession: Legislative Proposals (Review Taskforce) and the related Report on the Public Consultation and the Government’s Conclusions (February 2004).

3.57 The Review Taskforce stated in its March 2003 consultation document that there was a case for ‘relatively light touch statutory provisions to support the recommendations of the Review’. This approach was adopted by the UK Government. The underlying regulatory philosophy was ‘to build on the existing framework for the regulation of the statutory auditor, which devolves to recognised supervisory bodies

19 The Directive is available on the EU website: http//ec.europa.eu/internal_market/auditing/directives/index_en.htm.

20 Press release issued by the European Federation of Accountants on 17 March 2006: available on website: www.fee.be.

21 These documents and reports are available on the website of the UK Department of Trade and Industry: www.dti.gov.uk/bbf/financial-reporting/acc-audit-developments.

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(professional accounting bodies) the day to day responsibility for ensuring the training and authorisation of registered auditors and the supervision of audit firms’.

3.58 During the course of its work, the Review Taskforce found no evidence that the system was seriously flawed. However, it noted that there were concerns about the perceived independence of key aspects of the current arrangements’. The Review Taskforce concluded that there was further scope to strengthen the independence of the system for the regulation of audit and to achieve a clearer, more authoritative and more transparent regulatory structure.

3.59 The key reform proposal was to significantly expand the scope of the responsibilities and powers of the Financial Reporting Council22 (FRCUK), to create a unified regulator with the following functions:

• setting, monitoring and enforcing accounting and auditing standards;

• statutory oversight and regulation of auditors;

• operating an independent investigation and discipline scheme for public interest cases;

• overseeing the regulatory activities of the professional accounting bodies; and

• promoting high standards of corporate governance.

3.60 The FRCUK’s functions are principally exercised by its five operating bodies. The Board of the FRCUK’s Board oversees the delivery by each operating body of their functions, through regular reports from operating body Chairs.

3.61 A brief summary of the functions of each of the FRCUK’s operating bodies is set out below.

• The Accounting Standards Board makes, amends and withdraws accounting standards.

• The Auditing Practices Board (APB) plays a key role in the development of auditing and assurance standards and their effective application. Its responsibilities have been extended to the development of ethical standards relating to the independence, objectivity and integrity of auditors.

• The Professional Oversight Board (POB). On 5 September 2005, the Secretary of State for Trade and Industry delegated to POB, statutory functions relating to the regulation of audits in the UK. The POB’s functions include the authorisation of professional accounting bodies to act as supervisory bodies and to offer a

22 The information below has been extracted from the FRCUK’s website: www.frc.org.uk

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recognised professional qualification. The POB has also established an independent Audit Inspection Unit to monitor the audit of major listed companies and other public interest entities.

• The Financial Reporting Review Panel makes enquiries into apparent departures from the accounting requirements of the UK Companies Act 1985 in the annual accounts of large companies and where necessary seeks remedial action, being empowered to apply to the court for that purpose.

• The Accountancy Investigation and Discipline Board is the independent, investigative and disciplinary body for accountants in the UK. The AIDB Scheme establishes the framework and sets in place the legal formalities of participation between the AIDB and the Participating Accountancy Bodies. The focus of the AIDB is on cases of public interest; other cases continue to be dealt with by the accounting body of the member concerned. The normal channel of reference to the AIDB for ‘public interest’ cases is the accounting body primarily concerned. However, the AIDB also has the power to call in cases whether or not they have been referred to it by an accounting body.

Regulatory role of professional accounting bodies within FRCUK framework

3.62 In order to be eligible for appointment in the UK as an auditor of a company, a person must be registered with a Recognised Supervisory Body (RSB) and must be eligible for appointment under the rules of the RSB.

• The POB has the function of authorising RSBs;

• The Institute of Chartered Accountants in England and Wales (ICAEW), The Institute of Chartered Accountants of Scotland, The Institute of Chartered Accountants in Ireland, the Association of Authorised Public Accountants and The Association of Chartered Certified Accountants are RSBs for the purpose of regulating auditors in the UK.

3.63 The UK Companies Act 1989 requires RSBs to have rules and practices as to the technical standards to be applied in company audit work and as to the manner in which these standards are to be applied in practice. Each RSB is also required to have arrangements in place for the effective monitoring and enforcement of compliance with these standards.

• The Audit Inspection Unit of the POB also monitors the audit of major listed companies and other public interest entities.

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• The APB has issued a number of Ethical Standards for Auditors.23 So far as auditor independence requirements are concerned, the RSBs have been required to adopt the APB’s Ethical Standards for Auditors. For example, under section 290 of the ICAEW’s new Code of Ethics, which came into effect in September 2006, members of the ICAEW are required to comply with the APB Ethical Standards when conducting audits in the UK and the Republic of Ireland and when performing audit engagements elsewhere, their members are required to comply with the independence rules in the IFAC Code of Ethics (which are replicated in the ICAEW’s Code).

• In announcing the publication of the APB Ethical Standards on 17 December 2004, the APB said that it had sought to achieve a number of objectives:

– To ensure that Ethical Standards for auditors take account of events that have called into question the integrity of financial reporting and address areas of concern identified, inter-alia, by the Government’s Co-ordinating Group on Audit and Accounting issues.

– To replace existing ethical guidance with Standards so that auditors are obligated to comply with them.

– To use language that limits the subjective application of the Standards and in so doing, facilitates the effective monitoring of them by the FRCUK’s Audit Inspection Unit and the accountancy bodies.

– To balance the costs associated with the implementation of the Standards with the benefits derived from them.

3.64 Any apparent failure by an auditor to comply with APB standards is liable to be investigated by the AIDB (see above) or by the relevant RSB. Auditors who do not comply with APB standards when performing company or other audits make themselves liable to disciplinary action which may include the withdrawal of registration and hence of eligibility to perform company audits.

Comparison between Australian and UK auditor independence institutional and legal frameworks

3.65 There are a number of fundamental differences in the institutional and legal frameworks in relation to auditor independence applying in Australia and the UK:

• The detailed auditor independence requirements in Australia have been enacted by the Parliament, are incorporated in the Corporations Act and are framed as

23 The APB Ethical Standards are available on the FRCUK website at www.frc.org.uk/apb/publications/ethical.cfm.

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contraventions under the criminal law. In the UK, while there are some basic auditor independence requirements in the Companies Act 1989, the detailed rules are contained in the Ethical Standards made by the APB which have been incorporated by reference into the professional code of conduct rules of the professional accounting bodies. The APB Ethical Standards are principles based, non-statutory rules.

• The surveillance and enforcement arrangements are also very different. In Australia, audit surveillance and enforcement responsibilities have been given to ASIC, as the corporate regulator, with the FRC being given the responsibility of monitoring and reporting to the Minister on the adequacy of the auditor independence requirements. In the UK, the FRCUK has been established, as a unified regulator, to oversee the whole of the audit regulatory framework in the UK, together with five operating bodies that have been established under the FRCUK. The FRCUK, and its operating bodies, are not statutory bodies. The UK audit regulatory framework involves the delegation of powers by the Secretary of State for Trade and Industry to the FRCUK and the POB. The UK regulatory scheme also involves much of the day to day regulation being undertaken by the professional accounting bodies which are authorised by POB to act as recognised supervisory bodies.

UNITED STATES

Introduction

3.66 Under the US federal constitutional system, the auditor independence framework consists of a matrix of federal securities laws, professional conduct rules and state laws relating to the licensing and regulation of the practice of accounting.

3.67 The discussion below provides an overview of the different layers of auditor independence regulation in the US. The purpose of this overview, however, is primarily to serve as a background context to the more detailed comparative analysis of specific auditor independence requirements which focuses on the federal requirements in the US.

Federal securities laws

3.68 The Securities Act 1933 and the Securities Exchange Act 1934, and other federal securities laws, require or permit the Securities and Exchange Commission (SEC), to make rules that financial information filed with the SEC be certified or audited by ‘independent’ public accountants.

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• The SEC auditor independence rules are contained in Rule 210. 2-01 to Regulation S-X. The rules were substantially revised in 2001 and further modifications were required to be made in 2003 following the enactment of the SOX Act.

3.69 The SOX Act was enacted in 2002 in response to a series of major financial scandals involving once prominent companies such as Enron, Worldcom, Tyco and others. These corporate failures had the potential to undermine investor confidence in the integrity of the US securities markets. Among its goals, the SOX Act sought to restore confidence in the accounting profession and improve corporate disclosure and financial reporting. The SOX Act substantially changed the US regulatory framework for corporations and auditors.

3.70 The PCAOB is a private–sector, non-profit corporation created by the SOX Act ‘to oversee the auditors of US public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair and independent audit reports.’

• The collapse of Enron and subsequent corporate failures persuaded the US Congress to order a new oversight regime for the accounting profession. The role of auditors in those corporate collapses caused the Congress ‘to question, and reject, the existing system for policing accounting firms, by which the profession regulated itself.’

• The PCAOB is subject to the oversight of the SEC which approves the substantive rules adopted by the PCAOB and the annual budget and has the authority to appoint and remove PCAOB members.

• The PCAOB’s primary responsibilities fall into four broad areas:

– registration of public accounting firms that audit US issuers. There were 1,633 audit firms registered with the PCAOB on 14 March 2006 — 31 of these firms listed Australia as the location of their headquarters’ office;

– inspections of registered public accounting firms;

– investigations and enforcement; and

– the setting of auditing, quality control, ethics and independence standards for the auditors of US public companies.

• The SEC approved on 19 April 2006 the PCAOB’s rules on Ethics and Independence concerning independence, tax services and contingent fees.

• The SOX Act recognises the paramount, residual authority of the SEC. Section 3(c) of the SOX Act provides that nothing in the SOX Act or the rules of the PCAOB shall be construed to impair or limit:

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– the authority of the SEC to regulate the accounting profession, accounting firms, or persons associated with such firms;

– the authority of the SEC to set standards for accounting or auditing practices or auditor independence; or

– the ability of the SEC to take, on the initiative of the SEC, legal, administrative or disciplinary against any registered public accounting firm or any associated persons.

Professional conduct rules

3.71 The American Institute of Certified Public Accountants (AICPA) is the national professional organisation for all Certified Public Accountants (CPAs). The AICPA’s mission is to provide members with resources, information and leadership. The AICPA works closely with State CPA organisations.

3.72 One of the key objectives of the AICPA listed in its mission statement is the establishment of professional standards.24

3.73 Section 100 of the AICPA’s Code of Conduct relates to independence, integrity and objectivity. The Professional Ethics Executive Committee (PEEC) of the AICPA adopts a risk-based approach within a conceptual framework when it develops independence standards.

3.74 The Independence Standards Board (ISB) was the private sector standard-setting body governing the independence of auditors from their public company clients. The ISB was created in 1997 through the agreement of the SEC and the AICPA to initiate research, develop standards, and engage in a public analysis and debate on auditor independence issues. The SEC and the AICPA dissolved the ISB in July 2001 because much of the ISB’s work was incorporated in the SEC’s revised auditor independence rules adopted in 2001.

• The AICPA currently maintains the ISB’s website (notwithstanding the ISB’s dissolution) in order to provide access to ISB standards and interpretations that continue to represent authoritative guidance for auditors of public companies, and to other ISB documents that might be of interest to those concerned with auditor independence matters.

• The PCAOB has adopted AICPA and ISB auditing standards on an interim basis and intends to replace these with its own.

24 The AICPA’s Code of Conduct is available on the AICPA’s website www.aicpa.org/about/code/index.html.

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State licensing and regulatory laws

3.75 Each state has its own licensing and regulatory regimes. There is a link between these state laws and the SEC auditor independence rules because SEC Rule 2-01(a) provides that the SEC will not recognise an auditor who is not in good standing and entitled to practise in the state of the auditor’s residence or principal office.

Comparison between Australian and US auditor independence institutional and legal frameworks

3.76 There are a number of significant similarities:

• Australia and US have both adopted statute-based regimes.

• The key regulators, ASIC, the SEC and the PCAOB are all manifestly independent from the accounting profession.

• ASIC, the SEC and the PCAOB each have strong enforcement authority.

3.77 There are, however, a number of differences:

• Australia, unlike other federal systems, has achieved a high level of uniform regulation of corporations as a result of the Corporations Agreement which has resulted in the States and Territories agreeing to refer relevant powers in respect of corporations to the Commonwealth. This has permitted a comprehensive system of national regulation.

• In accordance with the ‘internal affairs’ doctrine in the US, the states govern internal corporate affairs, while the federal rule-makers, particularly through the SEC, govern the external trading of the company’s securities. However, the Federal authorities often breach this demarcation line, such as with the SOX Act, with requirements addressing board structure and authority. There is in fact, an ongoing interaction between state and federal laws relating to corporate regulation.

• ASIC does not have the power to make rules of the kind made by the SEC or the PCAOB. Thus in Australia, the auditor independence requirements are made by the Parliament and are contained in the Corporations Act.

• In the US, the independent federal regulatory agencies, such as the SEC, have been granted extensive executive, quasi-legislative and quasi-judicial powers which have been held not to violate the separation of powers doctrine enshrined in the US constitution.

• The SOX Act has also granted the PCAOB rule-making powers. It is noted, however, that the PCAOB’s powers are currently subject to a constitutional challenge based on separation of powers principles. One argument that has been

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raised is that the PCAOB members perform an executive function but are not appointed or removable by the President or an entity within the Executive branch. Another ground to the claim is that Congress has violated the constitutional prohibition on delegating its legislative powers to an entity outside the legislative branch of government. The PCAOB has said that it will defend itself vigorously against the legal challenge.

• The PCAOB has been granted power under the SOX Act to make auditing standards. This function in Australia is vested in an independent statutory body, the AUASB which is under the general oversight of the FRC.

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Part 4: General standard of auditor independence

THE AUDITOR INDEPENDENCE CONCEPT

4.1 There is universal agreement that the concept of auditor independence involves independence both in fact and in appearance.25

4.2 The IFAC Code of Ethics defines ‘independence’ in the following terms:

• Independence of mind — the state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional judgment.

• Independence in appearance — the avoidance of facts and circumstances that are so significant a reasonable and informed third party, having knowledge of all relevant information, would reasonably conclude a firm’s, or a member of the assurance team’s integrity, objectivity or professional scepticism had been compromised.

4.3 This definition of auditor independence has been applied by all the professional accounting bodies in Australia and in the relevant overseas jurisdictions that are member organisations of IFAC.

4.4 The EU Recommendation also recognises that it is necessary to address both independence in mind and independence in appearance but expresses the concept in slightly different terms:

• Independence of mind: the state of mind which has regard to all considerations relevant to the task in hand, but no others; and

• Independence in appearance: avoidance of facts and circumstances which are so significant that a reasonable and informed third party would question the statutory auditor’s ability to act objectively.

25 IOSCO Principles of Auditor Oversight page 3.

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AUSTRALIAN AND US ‘STATUTE-BASED’ REQUIREMENTS

4.5 Australia and the US have incorporated a general standard of auditor independence into their statutory auditor independence requirements. The Ramsay report recommended that a general principle of auditor independence should be included in the Corporations Act.

4.6 The Australian ‘general requirement’ for auditor independence is contained in Subdivision A of Division 3 of Part 2M.4 of the Corporations Act. In accordance with the recommendation in the Ramsay report, the Australian requirement follows very closely the wording of the SEC’s general standard of auditor independence set forth in the SEC’s Rule 2-01.

4.7 The general standard of auditor independence adopted in Australia and the US is framed around the concepts of:

• whether an auditor is not capable of exercising objective and impartial judgment in relation to the conduct of an audit having regard to all relevant circumstances, including all relationships between the auditor and the audit client (the subjective test — independence in mind); or

• whether a reasonable person26, with full knowledge of all relevant facts and circumstances, would conclude that the auditor27 is not capable of exercising objective and impartial judgment in relation to an audit, having regard to all relevant circumstance, including all relationships between the auditor and the audit client (the objective test — independence in appearance).

4.8 The general standard of auditor independence is a cornerstone for both the Australian and SEC statutory requirements on auditor independence.

4.9 It is impossible to identify specifically in the statutory auditor independence requirements all the circumstances that might raise auditor independence concerns. The inclusion of the general standard, in addition to recognising that an auditor must be independent in fact and appearance, also serves the purpose of ensuring that auditor independence is a comprehensive and continuing requirement in the sense that it applies to all circumstances relating to a particular audit, including all relationships between the auditor and the audit client.

4.10 In its explanatory discussion of its general standard of independence, the SEC makes some pertinent observations which are particularly relevant to the enforcement of the standard.

26 The SEC general standard refers to a ‘reasonable investor’. 27 Includes a professional member of the audit team under the Australian requirement.

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Moreover, the general standard we are adopting merely reflects the different means of demonstrating a lack of objectivity. Objectivity is a state of mind, and except in unusual circumstances, a state of mind is not subject to direct proof. Usually, it is demonstrated by reference to circumstantial evidence. Accordingly, the final rule is formulated to indicate that an auditor’s independence is impaired either when there is evidence of subjective bias, such as through a confession or some way of recording the auditor’s thoughts, or when, as in the ordinary case, the facts and circumstances as externally observed demonstrate, under an objective standard, that an auditor would not be capable of acting without bias.28

4.11 The HIH Royal Commission Report endorsed the need for the inclusion of a general standard of independence in the Corporations Act, and also made some instructive observations on the importance of the incorporation of an objective test (independence in appearance) in the general standard.29

Inadequate independence on the part of an auditor will usually be difficult to discern. Suspicion might be excited but definite conclusions could be drawn only in extreme circumstances. Rarely would an auditor deliberately or even consciously compromise their independence. More often, as was the case with HIH, the auditor will deny that their independence was in any way compromised, even where an objective consideration might point to the opposite conclusion. Rarely will there be unequivocal evidence that conclusively establishes for example a connection between influence exerted by management upon the auditor and the provision by the auditor of an unqualified audit opinion. The existence of such a connection from a range of surrounding circumstances can usually only be inferred.

Absent independence, shareholders, creditors and other users of the financial statements can have no assurance or comfort as to the truth or fairness of the financial report or the economic entity with which they deal. Such assurance adds value to capital market efficiency because it enhances the credibility of financial statements. It is in these circumstances that the perception that an auditor is independent takes on greater importance.

In light of the above, it is critical that the auditor should be seen to be exercising impartial and objective judgment in addition to the actual exercise of that impartial and objective judgement. Any standard of audit independence must reflect this requirement.

Further, the difficulties referred to in discerning any actual lack of independence, coupled with a reluctance on the part of auditors to confront their own lack of independence, supports the introduction of an objective standard of independence.

28 SEC commentary on the release of the Final Rule on auditor independence in 2001. 29 Extracts from the HIH Royal Commission Report Volume 1, pages 166-168.

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Differences between the Australian and SEC general auditor independence standard

4.12 There are several important differences between the approach adopted in the Australian and US general standards on auditor independence.

4.13 The first distinction concerns the different legal framework applying in each jurisdiction. The SEC general standard is contained in a Rule of the SEC and is expressed in terms of a statement that the SEC ‘will not recognise an accountant as independent, with respect to an audit client’ if the accountant does not meet the subjective and objective independence criteria set forth in the general standard.

4.14 The Australian general requirement has had to be framed in quite different terms because the obligations are imposed under the Corporations Act. The core element of the general standard is contained in section 324CD (‘conflict of interest situation’) which has been linked to the different liability rules applying to an individual auditor (section 324A where liability is placed on the sole proprietor), an audit firm (section 324CB where the liability is placed on a member of the firm) and an authorised audit company (section 324CC where the liability is placed on a director of the company).

4.15 The general standard in SEC Rule 2-01(b) is directly linked with the specific circumstances and relationships that are prohibited under Rule 2-01(c). The introductory words to Rule 2-01(c) provides that ‘this paragraph sets forth a non-exclusive specification of circumstances inconsistent with paragraph (b) [the general standard] of the section’. The SEC describes this linkage in the following terms:

Rule 2-01(c) ties the general standard of paragraph (b) to specific applications. Paragraphs (c)(1) through (c)(5) address separately situations in which an accountant is not independent of an audit client because of certain: (1) financial relationships, (2) employment relationships, (3) business relationships, (4) transactions or situations involving the provision of non-audit services, or (5) transactions or situations involving the receipt of contingent fees.

4.16 In contrast to the SEC approach, the obligations imposed under the Australian general requirement for auditor independence are not linked to the various specific requirements for auditor independence and are expressed to be ‘in addition to, and not in derogation from’, any obligation imposed:

• by another provision of the Corporations Act; or

• a code of professional conduct.

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CANADA

4.17 The auditor independence requirements in Canada are contained in the codes of professional conduct of the provincial Institutes of Chartered Accountants. These rules of professional conduct do not contain a general standard of auditor independence similar to the standards adopted in Australia under the Corporations Act and in the US by SEC Rule 2-01.

Canada Business Corporations Act

4.18 The Ramsay report noted that Canada has in its corporations legislation a general statement requiring an auditor to be independent. Subsection 161(1) of the Canada Business Corporations Act is to the effect that a person is disqualified from being an auditor of a corporation if the person is not independent of the corporation, any of its affiliates, or the directors or officers of any such corporation or its affiliates.

4.19 In Treasury’s view, however, this provision cannot be regarded as establishing a general standard of independence because it does not incorporate the widely accepted concept that independence involves both independence in mind (independence in fact) and independence in appearance. Indeed, it is clear from the commentary on section 161 (when it was still a draft proposal) that it had been drafted on the basis that ‘independence must always be a question of fact in each particular case.’30

EUROPEAN UNION

4.20 The EU Directive and Recommendation on the independence of the statutory auditor have adopted a principles-based approach and do not contain a general standard of independence similar to the approach adopted in Australia and the US.

30 Proposals for a New Business Corporations Law for Canada Volume 1 paragraph 331 — published in April 1971.

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UNITED KINGDOM

4.21 The APB’s Ethical Standards are not legislatively based and thus they do not contain a general standard along the lines of the Australian and US requirements. However, because they are Standards and not mere ethical guidance, auditors are obligated to comply with them and the Standards have adopted language which limits the subjective application of the Standards. Accordingly, the language adopted in discussing the concept of ‘independence’ in APS Ethical Standard 1 comes very close to imposing a general standard of independence on auditors:

Independence is freedom from situations and relationships which make it probable that a reasonable and informed third party would conclude that objectivity either is impaired or could be impaired. Independence is related to and underpins objectivity. However, whereas objectivity is a personal behavioural characteristic concerning the auditors state of mind, independence relates to the circumstances surrounding the audit, including the financial, employment, business and personal relationships between the auditors and their client.

The need for independence arises because, in most cases, users of the financial statements and other third parties do not have all the information necessary for judging whether the auditors are in fact, objective.

Accordingly, in evaluating the likely consequences of such situations and relationships, the test to be applied is not whether the auditors consider that their objectivity is impaired but whether it is probable that a reasonable and informed third party would conclude that the auditors’ objectivity either is impaired or is likely to be impaired.31

31 Extracts taken from paragraphs 12-14 of APB Ethical Standard 1 — Integrity, Objectivity and Independence.

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Part 5: Specific auditor independence requirements applying to employment, financial and business relationships

RESTRICTIONS ON EMPLOYMENT RELATIONSHIPS

Rationale for employment relationship restrictions

5.1 The Ramsay report noted that the existence of employment relationships between an audit firm and an audit client can give the impression that an auditor is not independent of the client, irrespective of the actual situation.32 Where such relationships exist, there may be a range of circumstances which, collectively or individually, make it difficult for the auditor to adopt an unbiased approach to the audit engagement, with the result that the audit client could receive a more favourable audit report than the facts or circumstances justify.

5.2 The SEC has explained the rationale for employment relationship restrictions in the following terms:

Independence requirements related to employment relationships between accountants or their family members and audit clients are based on the premise that when an accountant is employed by an audit client, or has a close relative or former colleague employed in certain positions at an audit client, there is a significant risk that the accountant would not be capable of exercising the objective and impartial judgment that is the hall mark of independence.33

The general nature of the restrictions imposed

5.3 Governments, regulatory authorities and professional accounting bodies have sought to safeguard auditor independence by the introduction of measures which seek to ensure that:

• partners or professional employees of an accounting firm are not employed by the audit client or serve as a director of the audit client;

32 Ramsay report page 36 paragraph 5.18. 33 SEC commentary on adoption of Final Rule on auditor independence, February 2001.

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• where a former partner or professional employee of an accounting firm is employed in an accounting role or a financial reporting oversight role at an audit client, there are (with limited exceptions) no residual links with the audit firm;

• where a former officer, director or employee of an audit client becomes a member of an accounting firm, the person is not in a position to audit, or influence the audit, of financial statements concerning a period during which the person was employed by, or associated with, the audit client; and

• relatives of a member of an audit team are not directors of an audit client or employed by the audit client in a senior management position, in an accounting role, or a financial oversight role.34

AUSTRALIA

5.4 The Ramsay report discussed a number of models that could be adopted in updating the Australian auditor independence employment relationship restrictions. The Ramsay report concluded that a co-regulation model was the preferred model, in which the Corporations Act would set the core requirements, and the ethical rules of the professional bodies would provide additional guidance for considering threats to auditor independence associated with employment relationships and the safeguards available for eliminating or minimising those threats.

5.5 The Ramsay report considered that a model in which exclusive reliance is placed on ethical rules of the professional bodies may not sufficiently reflect the public interest in the important issue of auditor independence. The Ramsay co-regulation model was adopted by the Government under the CLERP 9 Act reforms.

5.6 Subdivision B of Division 3 of Part 2M.4 of the Corporations Act contains the specific auditor independence requirements (encompassing both employment and financial relationship restrictions) for an individual auditor (section 324CE), an audit firm (section 324CF) and an authorised audit company (section 324CG).

5.7 These provisions in the Corporations Act implement substantially the relevant recommendations in the Ramsay Report which described these ‘specific requirements’ as ‘a list of what can be regarded as core circumstances which, if they exist, necessarily mean that the auditor is not independent.’35

34 Ramsay report paragraph 5.19. 35 Ramsay report page 7.

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5.8 The specific requirements for individual auditors, audit firms and authorised audit companies are dealt with under separate provisions in the Corporations Act because different liability rules apply to individual auditors, firms and authorised audit companies. The comparative review will concentrate on the requirements applying to audit firms under section 324CF of the Corporations Act.

5.9 Section 324CF contains three separate but related elements:

• the criminal liability rules which apply to members of an audit firm where there is a contravention of the auditor independence requirements relating to the employment or financial relationship restrictions;

• a notification procedure relating to the termination of the audit firm’s appointment as an auditor of an audit client for breach of the auditor independence requirements under section 324CF; and

• the circumstances (the prohibited employment and financial relationships) that must be proved to exist at a particular time, as one of the essential elements of a contravention under subsections 324CF(1) or 324CF(2).

The criminal liability rules under section 324CF

5.10 It is important to understand the liability rules applying to an audit firm in relation to the specific auditor independence requirements under section 324CF because they are an integral part of the independence rules and are particularly relevant for compliance purposes.

5.11 A fundamental principle of the criminal law is that only a natural person, a body corporate or a body politic can be held criminally responsible. An audit firm, being an unincorporated body, is not a legal person and thus cannot be prosecuted and it is necessary to impose vicarious liability on the partners of the audit firm:

• a partner of an audit firm is liable to be prosecuted under a fault based offence (subsection 324CF(1)); or

• a strict liability offence that provides a statutory defence which would allow the partner to escape liability by pointing to evidence that shows that he or she had reasonable grounds to believe that the firm had in place a quality control system that provided reasonable assurance that the firm and its employees were complying with the auditor independence requirements (subsections 324CF(2), (3) and (4)).

5.12 For purposes of establishing a contravention under subsection 324CF(1), the evidential burden is placed on the prosecution to prove beyond a reasonable doubt each of the following elements of the offence:

• the audit firm was engaged in ‘audit activity’ at a particular time;

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• a prohibited employment or financial relationship exists at that time;

• the defendant was a partner of the firm at that time;

• the defendant knows about the breach (is or becomes aware that the firm was engaged in audit activity at the same time that a prohibited relationship exists); and

• the defendant has not, as soon as possible after becoming aware of those circumstances, taken all reasonable steps to ensure that the audit firm does not continue to engage in audit activity in those circumstances.

– The final element of the offence requires the prosecution to prove that the firm did not take corrective action to address the independence breach as soon as possible after the defendant partner became aware of the breach. It does not require the firm to cease engaging in audit activity until the breach is remedied. It requires the firm to ‘take all reasonable steps’ to ensure that the independence breach is remedied as soon as possible.

– The policy intention underlying the provision is to encourage a ‘culture of compliance’ within an audit firm. This policy goal is consistent with the preventive nature of the auditor independence requirements.

: The SEC has said that its approach to auditor independence has traditionally been ‘prophylactic’. ‘The independence rules are preventive both because of the difficulty in proving the link from circumstance to state of mind and because of the need to act in the public interest and protect investor confidence before it has been significantly undermined.’36

– Treasury considers that where a firm has established a sound quality control system and actively manages the system to ensure that inadvertent breaches are identified and quickly rectified once the firm becomes aware of the breach, then as a practical outcome, paragraph 324CF(1) effectively enables the firm itself to establish a virtual ‘safe harbour’ against prosecution. This is a just and logical outcome given that subsection 324CF(1) has been designed as a fault based offence directed at intentional breaches of the independence rules and not inadvertent breaches. The fact that liability will fall on any partner of the firm who has knowledge of the independence breach, and not just the lead engagement partner, encourages a firm-wide culture of compliance.

– The ‘principles based’ approach adopted in the drafting of the final element of the offence ensures that it is sufficiently flexible to cover all situations that may arise, for example, a situation where a single inadvertent breach occurs, or a situation where a number of inadvertent breaches may occur after an audit client merges with another company or is involved in the takeover of another company.

36 SEC commentary on the adoption of the SEC’s Final Rule on auditor independence in 2001.

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Notification procedure relating to termination of audit firm’s appointment

5.13 The CLERP 9 Act introduced notification procedures to ensure that there was a staged process in place before an auditor’s appointment was terminated on the grounds of the auditor’s failure to address a breach of a specific auditor independence requirement.37 It is important to emphasise that the operation of the notification procedure is quite separate from the offence provision under subsection 324CF(1). The staged procedure involves the following steps:

• An audit firm is required to notify ASIC within seven days if it becomes aware that there has been a breach of the independence rules that has not been resolved (subsection 324CF(1A) of the Corporations Act). Similar requirements apply to an individual auditor under subsection 324CE(1A) and to an audit company under subsection 324CG(1A) of the Corporations Act. No notification is required if the breach is resolved before the end of the seven-day period. ASIC is required to give a copy of the notice to the audit client so that the company is put on notice that its auditor has an independence issue that needs to be resolved.

• After the firm has notified ASIC, the firm has a further 21 days (the remedial period) to resolve the conflict of interest situation (subsection 327B(2B)). Similar requirements apply to an individual auditor under subsection 327B(2A) and to an audit company under subsection 327B(2C) of the Corporations Act.

• An audit firm thus has a maximum period of 28 days after it becomes aware of a conflict of interest situation to rectify the conflict (the initial seven-day period plus the 21-day remedial period).

• If the conflict of interest situation is not resolved at the end of the 21-day remedial period, the audit firm’s appointment as auditor of the particular audit client automatically terminates (subsection 327B(2B)). Similar requirements apply to an individual auditor under subsection 327B(2A) and an audit company under subsection 327B(2C) of the Corporations Act.

• ASIC has been given the power to extend the remedial period of 21 days referred to in section 327B of the Corporations Act, in appropriate circumstances.38

37 It is noted that under the pre-CLERP 9 Corporations Act an auditor’s appointment would have been immediately terminated once an independent breach occurred because there was no staged notification procedure. This would appear to be the current position under Section 28 of the UK Companies Act 1989.

38 ASIC was granted this power by regulation — see Corporations Amendment Regulations 2006 (No. 4).

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Prohibited employment relationships

5.14 The Ramsay report sought to achieve ‘best practice’ restrictions on employment relationships by:

• building on the existing requirements in the Corporations Act; and

• drawing on recent overseas developments, particularly under the IFAC Code and the SEC Rules on auditor independence.

5.15 The Government substantially adopted the Ramsay report recommendations on employment relationship restrictions in the CLERP 9 Act.

5.16 There is a small proprietary company ‘carve out’ in relation to each of the employment relationship restrictions in the Corporations Act.

COMPARISON BETWEEN AUSTRALIAN AND OVERSEAS EMPLOYMENT RELATIONSHIP RESTRICTIONS

5.17 As the Ramsay report recognised, differences in terminology used in the various legislative and professional requirements make precise comparisons of the Australian and overseas requirements difficult. Nevertheless, Treasury has attempted to compare the Australian requirements with equivalent overseas requirements in the tables below. The current prohibited specific employment relationships are set forth in the table in subsection 324CH(1) read with the list of persons and entities in the table in subsection 324CF(5) of the Corporations Act.

5.18 Treasury has adopted the methodology of comparing each prohibited employment relationship restriction in the Corporations Act with the corresponding restrictions in the relevant overseas jurisdictions in the tables below, to ensure that we are in a position to draw informed conclusions, as to whether there is substantial equivalence between the Australian requirements and ‘best practice’ standards adopted internationally.

Employment by audit client of current/former auditor/employee of auditor and their relatives

5.19 The relevant person identified below may not be an officer of the audited body (item 1 of the table of relevant relationships in subsection 324CH(1)).

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Relevant persons Reference to comparative requirement in relevant overseas jurisdictions

A member of the audit firm. Canada: The Institute of Chartered Accountants of Ontario Rules of Professional Conduct (ICAO Rules): Rule 204.4(19)(b). EU: Commission Recommendation: Statutory Auditors’ Independence in the EU: A Set of Fundamental Principles (Commission Recommendation) Annex Part B Division 3: Employment with audit client. UK:

Sections 27 and 28 of UK Companies Act 1989.APB Ethical Standard 2, paragraphs 32, 33, and 36.

US: SEC Rule 210.2-01(c)(2)(i).

A professional member of the audit team conducting the audit of the audited body.

Canada: ICAO Rule 204.4(19). EU: Commission Recommendation Annex Part B Division 3: Employment with audit client. UK:

Sections 27 and 28 of UK Companies Act 1989 (applies to person appointed a s company auditor of a company). APB Ethical Standard 2, paragraphs 32, 33, and 36.

US: SEC Rule 210.2-01(c)(2)(i).

An immediate family member of a professional member of the audit team conducting the audit of the audited body.

Canada: ICAO Rule 204.4(14). EU: Commission Recommendation Annex Part B Division 3: Employment with audit client. UK: APB Ethical Standard 2, paragraph 47. US: SEC Rule 210.2-01(c)(2)(ii) — applies to ‘close family’ member of ‘covered person’ — see discussion below in paragraphs 5.29-5.33.

A former member of the firm who does not satisfy the ‘independence’ test in subsection 324CF(7).

Canada: No equivalent requirement. EU: Commission Recommendation Annex Part B Division 3: Employment with audit client (but not mentioned specifically). UK: APB Ethical Standard 2, paragraphs 38 and 40. US: SEC Rule 210.2-01(c)(2)(iii).

A former professional employee of the firm who does not satisfy the independence test in subsection 324CF(7).

Canada: No equivalent requirement. EU: Commission Recommendation Annex Part B Division 3: Employment with audit client (but not mentioned specifically). UK: APB Ethical Standard 2, paragraphs 40 and 45 (note that the standard does not involve a prohibition but a possible change to composition of audit team). SEC Rule 210.2-01(c)(2)(iii).

5.20 The relevant person identified below cannot be an audit-critical employee of the audited body (item 2 of the table of relevant relationships in subsection 342CH(1)). The term ‘audit critical employee’ is defined in section 9 of the Corporations Act and covers an employee of the audited body who is able, because of the position in which the person is employed, to exercise significant influence over either a material aspect of the contents of the financial report being audited or the conduct or efficacy of the audit.

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A member of the audit firm. Canada: no equivalent requirement — ICAO Rule 204.4 (19) applies to officer and director of audit client. EU:

Commission Recommendation: Part B: Specific Circumstances: Division 3 — Employment with Audit Client, paragraph 1. Commission Recommendation Annex Part B Division 3: Employment with audit client.

UK: APB Ethical Standard 2, paragraphs 32, 33 and 49. US: SEC Rule 210.2-01(c)(i) and (ii).


Canada: No equivalent requirement. EU:


UK: APB Ethical Standard 2, paragraphs 32, 33 and 49. US: SEC Rule 210.2-01(c)(i) and (ii).


Canada: ICAO Rule 204.4(14). EU: Commission Recommendation Annex Part B Division 3: Employment with audit client. UK: APB Ethical Standard 2, paragraph 47. US: SEC Rule 210.2-01(c)(2)(ii) — applies to ‘close family member of ‘covered person’ — see discussion below in paragraphs 5.29-5.33.

A former member of the firm who does not satisfy the ‘independence’ test in subsection 324CF(7).

Canada: No equivalent requirement. EU: Commission Recommendation Annex Part B Division 3: Employment with audit client (but not mentioned specifically). UK: APB Ethical Standard 2, paragraphs 38 and 40. US: SEC Rule 210.2-01(c)(2)(iii).

A former professional employee of the firm who does not satisfy the ‘independence’ test in subsection 324CF(7).

Canada — No equivalent requirement. EU: Commission Recommendation Annex Part B Division 3: Employment with audit client (but not mentioned specifically). UK: APB Ethical Standard 2, paragraphs 40 and 45 (note that the standard does not involve a prohibition but a possible change to composition of audit team). US: SEC Rule 210.2-01(c)(2)(iii).

5.21 The relevant person identified below cannot be a partner of:

• an officer of the audited body; or

• an audit-critical employee of the audited body (item 3 of the table of relevant relationships in subsection 324CH(1)).

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A member of the audit firm. UK: Paragraph 27(1)(b) of the Companies Act 1989 — the prohibition relates to ineligibility for appointment as company auditor of the audit client. This requirement would be covered generally under the close business relationship restrictions in the other relevant overseas jurisdictions.


UK: Paragraph 27(1)(b) of the Companies Act 1989 — the prohibition relates to ineligibility for appointment as company auditor of the audit client. This requirement would be covered generally under the close business relationship restrictions in the other relevant overseas jurisdictions.

Employment by firm of current officers and employees of audit client

5.22 The relevant person identified below cannot be an employer of:




The firm. No equivalent requirements in other relevant overseas jurisdictions which focus only on former officers and employees of the audit client — see paragraphs 5.26-5.27 of the review.

A service company or trust acting for, or on behalf of, the firm, or another entity performing a similar function.

No equivalent requirements in other relevant overseas jurisdictions which focus only on former officers and employees of the audit client — see paragraphs 5.26-5.27 of the review.

A member of the audit firm. No equivalent requirements in other relevant overseas jurisdictions which focus only on former officers and employees of the audit client — see paragraphs 5.26-5.27.


No equivalent requirements in other relevant overseas jurisdictions which focus only on former officers and employees of the audit client — see paragraphs 5.26-5.27.

Employment of partners/employees of audit firm by officer or audit critical employee of audit client

5.23 The relevant person identified below cannot be an employee of:


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A member of the audit firm. UK: Paragraph 27(1)(b) of the Companies Act 1989 — the prohibition relates to ineligibility for appointment as company auditor of the audit client. No equivalent requirements in other relevant overseas jurisdictions.


UK: Paragraph 27(1)(b) of the Companies Act 1989 — the prohibition relates to ineligibility for appointment as company auditor of the audit client. No equivalent requirements in other relevant overseas jurisdictions.

5.24 The relevant person identified below cannot be a partner or employee of an employee of:

• an officer of the company; or

• an audit critical employee of the company (item 6 of the table of relevant relationships in subsection 324CH(1)).


A member of the audit firm No equivalent requirements in other relevant overseas jurisdictions.

A professional member of the audit team conducting the audit of the audited body

No equivalent requirements in other relevant overseas jurisdictions.

Officer/employee of audit client acting as consultant to audit firm

5.25 The relevant person identified below cannot provide remuneration to:


• an audit-critical employee of the audited body

for acting as a consultant to the person (item 7 of the table of relevant relationships in subsection 324CH(1)).

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The firm. Canada: ICAO Rule 204.4(13)(a) — the Rule relates to close business relationships. EU:

Commission Recommendation: Part B: Specific Circumstances: Division 2 — Business relationships, paragraphs 1 and 2. Commission Recommendation Annex Part B Division 2: Business Relationships.

UK: APB Ethical Standard 2, paragraph 26 — note that there is an ’immateriality’ exclusion. US: SEC Rule 210.2-01(c)(3) — note that the SEC Rule relates to ‘business relationships’.


Canada: ICAO Rule 204.4(13)(a) — the Rule relates to close business relationships. Neither the Rule nor the definition of ‘firm’ specifically refers to a service company or trust, so there may be some doubt as to whether this is covered. EU:


UK: APB Ethical Standard 2, paragraph 26 — note that there is an ‘immateriality’ exclusion. US: SEC Rule 210.2-01(c)(3) — note that the SEC Rule relates to ‘business relationships — it is assumed that a service company or trust would be covered by the definition of an ‘accounting firm’ in SEC Rule 210.2(f).

A member of the audit firm. Canada: ICAO Rule 204.4(13)(a) — the Rule relates to close business relationships. EU:


UK: APB Ethical Standard 2, paragraph 26 — note that there is an ‘immateriality’ exclusion. US: SEC Rule 210.2-01(c)(3) — note that the SEC Rule relates to ‘business relationships’. The SEC Rule also only relates to a partner who is a ‘covered person’ — see discussion below in paragraphs 5.30-5.33.

Employment by firm of former officer of the audit client

5.26 The relevant person identified below cannot be an officer of the audited body at any time during:

• the period to which the audit relates;

• the 12 months immediately preceding the beginning of the period to which the audit relates; or

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• the period during which the audit is being conducted or the audit report is being prepared (item 8 of the table of relevant relationships in subsection 324CH(1)).



Canada: ICAO Rule 204.4(17) — the Rule relates to ‘recent service with an assurance client’. Note that the Rule extends beyond an officer to include an employee of the audit client. EU:

Commission Recommendation: Part B: Specific Circumstances: Division 5 — Establishing employment with Audit Firm. Commission Recommendation Annex Part B Division 5: Establishing Employment with Audit Firm.

UK: APB Ethical Standard 2, paragraph 53. Note that the standard applies to a former director or former employee who was in a position to exert significant influence over the preparation of the audit client’s financial statements. The prohibition applies for a two year period after the director or employee left the audit client. US: SEC Rule 210.2-01(c)(iv). The Rule relates to ‘employment at accounting firm of former employee of audit client’. Note that the Rule extends beyond an officer to include an employee of the audit client.

5.27 The relevant person identified below cannot be an audit-critical employee of the audited body at any time during:

• the period to which the audit relates; or

• the 12 months immediately preceding the beginning of the period to which the audit relates; or

• the period during which the audit is being conducted or the audit report is being prepared (item 9 of the table of relevant relationships in subsection 324CH(1)).


A member of the audit firm. Canada: no equivalent requirement — ICAO Rule 204.4 (19) applies to officer and director of audit client. EU:


UK: APB Ethical Standard 2, paragraphs 32, 33 and 49. US: SEC Rule 210.2-01(c)(i) and (i).

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The Australian restrictions compared with requirements in the relevant overseas jurisdictions

5.28 While the criminal law aspects of the Australian requirements and the notification procedures are unique to Australia, Treasury is of the view that the analysis undertaken in the tables above indicates quite clearly that there is a substantial underlying equivalence between the specific employment relationship restrictions in Australia and the corresponding requirements in the relevant overseas jurisdictions. There are a few requirements which replicate provisions in the pre-CLERP 9 Corporations Act which do not have equivalent overseas requirements (see paragraphs 5.23 and 5.24).

5.29 It was noted in the tables above that the SEC has adopted the concept of a ‘covered person’ in relation to some of its employment relationship restrictions, rather than applying an ‘all partner’ approach. In the context of the comparative review, it is instructive to consider further the underlying policy rationale of the SEC’s adoption of the ‘covered person’ concept. Neither the Ramsay report nor the CLERP 9 Act adopted the ‘covered person’ approach.

SEC ‘covered person’ concept

5.30 In the introductory commentary to the SEC’s adoption of its Final Rule on auditor independence in February 2001, the SEC noted that the amendments it was making would ‘modernise the Commission’s rules’ for determining whether an auditor is independent in light of investments by auditors or their family members in audit clients and employment relationships between auditors or their family members and audit clients.

5.31 The SEC said that ‘we believe that independence will be protected and the rules will be more workable by focusing on those persons who can influence the audit, instead of all partners in an accounting firm’.

5.32 A ‘covered person’ is defined in the SEC Rules to mean the following members of an accounting firm:

• the audit engagement team;

• the chain of command;

• any other member of the firm who has provided ten or more hours of non-audit services to the audit client for the period beginning on the date such services are provided and ending on the date the accounting firm signs the report on the financial statements for the fiscal year during which those services are provided, or who expects to provide ten or more hours on non-audit services to the audit client on a recurring basis; and

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• any other member from an office of the accounting firm in which the lead audit engagement partner primarily practices in connection with the audit.

5.33 The ‘chain of command’ concept in the definition of a ‘covered person’ is defined in the SEC Rules as all persons who:

• supervise or have direct management responsibility for the audit, including at all successively senior levels through the audit firm’s chief executive;

• evaluate the performance or recommend the compensation of the audit engagement partner; or

• provide quality control or other oversight of the audit.

FINANCIAL RELATIONSHIPS

Introduction

5.34 As with employment relationships, the existence of financial relationships between an accounting firm and an audit client can give the impression that an auditor is not independent of the client.

5.35 Legislators, regulators and professional accounting bodies have introduced requirements that seek to ensure that financial relationships do not impair audit independence by prohibiting or restricting the following categories of relationship:

• investments in audit clients;

• loans and guarantees to and from audit clients; and

• other creditor/debtor relationships between an audit firm and audit client.

5.36 Business relationships with audit clients also give rise to independence threats but have traditionally been addressed separately from other financial relationships.

Australia

5.37 The Ramsay report found that Australia’s legislative and professional requirements in respect of financial relationships required significant updating to bring them into line with current and proposed overseas requirements. The report noted that the Corporations Act contained no requirements in respect of investments in audit clients.

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5.38 The CLERP 9 Act adopted the co-regulation model recommended by the Ramsay report for ensuring that financial relationships between an auditor and an audit client do not impair audit independence. The Ramsay report recommended that in view of the significant effect investments in audit clients and loans to and from clients could have on the independence of an auditor, the basic requirements in respect of these relationships should be included in the Corporations Act rather than left partly or solely to the ethical rules of the professional accounting bodies. It was proposed that the ethical rules would supplement the legislative requirements in relation to these matters.

Prohibited financial relationships

5.39 Subdivision B of Division 3 of Part 2M.4 of the Corporations Act contains the specific auditor independence requirements relating to financial relationships for an individual auditor (section 324E), an audit firm (section 324CF) and an authorised audit company (section 324CG).

5.40 As mentioned above in relation to the prohibited employment relationships, the specific requirements for individual auditors, audit firms and authorised audit companies are dealt with under separate provisions in the Corporations Act because different liability rules apply to individual auditors, firms and authorised audit companies. The comparative review will concentrate on the requirements applying to audit firms under section 324CF of the Corporations Act.

5.41 The discussion on the employment relationship restrictions in relation to the application of the criminal liability rules also apply to the specific financial relationships prohibited under the Corporations Act (see paragraphs 5.10-5.12). The explanation in relation to employment restrictions as to how the notification procedures concerning the termination of the audit firm’s appointment under section 324CF of the Corporations Act are equally applicable for purposes of the financial relationship restrictions (see paragraph 5.13).

5.42 The Ramsay report sought to achieve ‘best practice’ restrictions on financial relationships by:

• building on the existing requirements in the Corporations Act; and

• drawing on recent overseas developments, particularly under the IFAC Code and the SEC Rules on auditor independence.

5.43 The Government substantially adopted the Ramsay report recommendations on financial relationship restrictions in the CLERP 9 Act.

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Comparison between Australian and overseas financial relationship restrictions

5.44 As the Ramsay report recognised, differences in terminology used in the various legislative and professional requirements make precise comparisons of the Australian and overseas requirements difficult. Nevertheless, Treasury has attempted to compare the Australian requirements with equivalent overseas requirements in the tables below. The current prohibited specific financial relationships are set forth in the table in subsection 324CH(1) read with the list of persons and entities in the table in subsection 324CF(5) of the Corporations Act.

5.45 As in the case with employment restrictions, the Treasury has adopted the methodology of comparing each prohibited financial relationship restriction in the Corporations Act with the corresponding restrictions in the relevant overseas jurisdictions in the tables below to ensure that we are in a position to draw informed conclusions as to whether there is substantial equivalence between the Australian requirements and ‘best practice’ standards adopted internationally.

Investments

5.46 The relevant person identified below must not have an asset that is an investment in the audited body (item 10 of the table of relevant relationships in subsection 324CH(1)).

Relevant persons Reference to comparative requirement in relevant overseas jurisdiction

The firm. Canada: ICAO Rule 204.4(2). EU:

Commission Recommendation: Part B: Specific Circumstances: Division 1 — Financial interests, paragraph 2. Commission Recommendation Annex Part B Division 1: Financial interests.

UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i).


Canada: ICAO Rule 204.4(2) (Note: the Rule would only apply if the reference to the firm was interpreted as extending to a service company or trust acting on behalf of the firm). EU:


UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i).

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Relevant Persons Reference to comparative requirement in relevant overseas jurisdiction

A member of the firm. Canada: ICAO Rule 204.4(1)(a) and (2). The Rule prohibits a member participating on the audit engagement team and therefore does not adopt an ‘all partner’ restriction. In this respect it is similar to the SEC ‘covered person’ approach. EU:


UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i)(a) — the rule applies to a ‘covered person’ in the firm, so the rule would only apply to a partner in the firm who had a close connection with the audit of the audit client.


Canada: ICAO Rule 204.4 (1)(a) and (2) — note that the rule would only apply where the professional member of the audit team was a member of the ICAO. EU:

Commission Recommendation: Part B: Specific Circumstances: Division 1 — Financial interests, paragraph 2. Commission Recommendation Annex Part B Division 1: Financial Interests.

UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i)(a).


Canada: ICAO Rule 204.4(1)(a) — note that the rule would only apply where the professional member of the audit team was a member of the ICAO. EU: No equivalent requirement. UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i)(a).

A person who is a non-audit services provider and does not satisfy the maximum hours test (10 or less hours).

Canada: ICAO Rule 204.4(5) — note though that the non-audit services provider would need to be a member of the ICAO for the rule to apply. EU: No equivalent requirement. UK: No equivalent requirement — under paragraph 7 of APB Ethical Standard 2, a person providing non-audit services would only be covered if the non-audit services were provided in relation to the audit of the audit client. US: SEC Rule 210.2-01(c)(1)(i)(a) — note that a non-audit services provider who provides less than 10 hours of non-audit services to an audit client during the period relating to the relevant financial statements is excluded under the definition of a ‘covered person’ in the firm.

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Relevant Persons Reference to comparative requirement in relevant overseas jurisdiction

An immediate family member of a person who is a non-audit services provider and does not satisfy the maximum hours test (10 or less hours).

Canada: ICAO Rule 204.4(5) — note though that the non-audit services provider would need to be a member of the ICAO for the rule to apply. EU: Not addressed. UK: Not addressed — under paragraph 7 of APB Ethical Standard 2, a person providing non-audit services would only be covered if the non-audit services were provided in relation to the audit of the audit client. US: SEC Rule 210.2-01(c)(1)(i)(a) — note that a non-audit services provider who provides less than 10 hours of non-audit services to an audit client during the period relating to the relevant financial statements is excluded under the definition of a ‘covered person’ in the firm.

5.47 The relevant person identified below must not have an asset that is a beneficial interest in an investment in the audited body and has control over that asset (item 11 of the table of relevant relationships in subsection 324CH(1)).

Relevant persons Reference to comparative requirements in relevant overseas jurisdiction



UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1).


Canada: ICAO Rule 204.4(2) (Note: the rule would only apply if the reference to the firm was interpreted to also extend to a service company or trust acting on behalf of the firm. EU:

Commission Recommendation: Part B: Specific Circumstances: Division 1: Financial interests. Commission Recommendation Annex Part B Division 1: Financial interests.

UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1).

A member of the firm. Canada: ICAO Rule 204.4(1)(a) and (2). Note that the restriction only applies to a partner who participates on the audit engagement team. EU:

Commission Recommendation: Part B: Specific Circumstances: Division 1 — Financial Interests, paragraph 2. Commission Recommendation Annex Part B Division 1: Financial interests.

UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i)(A)(1) — the rule applies to a ‘covered person’ in the firm, so the rule would only apply to a partner in the firm who had a close connection with the audit of the audit client.

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Canada: ICAO Rule 204.4(1)(a) and (2) — note that the rule would only apply where the professional member of the audit team was a member of the ICAO. EU:


UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i)(A)(1).

An immediate family member of a professional member of the audit team conducting the audit.

Canada: ICAO Rule 204.4(1)(a) — note that the rule would only apply where the professional member of the audit team was a member of the audit team. EU: No equivalent requirement. UK: APB Ethical Standard 2, paragraph 7. US: SEC Rule 210.2-01(c)(1)(i)(A)(1).

A person who is a non-audit services provider and does not satisfy the maximum hours test (10 or less hours).

Canada: ICAO Rule 204.4(5) — note though that the non-audit services provider would need to be a member of the ICAO for the rule to apply. EU: No equivalent requirement. UK: Not addressed — under paragraph 7 of APB Ethical Standard 2, a person providing non-audit services would only be covered if the non-audit services were provided in relation to the audit of the audit client. US: SEC Rule 210.2-01(c)(1) — note that a non-audit services provider who provides less than 10 hours of non-audit services to an audit client during the period relating to the relevant financial statements is excluded under the definition of a ‘covered person’ in the firm.

An immediate family member of a person who is a non-audit services provider and does not satisfy the maximum hours test (10 hours or less).

Canada: ICAO Rule 204.4(5) — note though that the non-audit services provider would need to be a member of the ICAO for the rule to apply. EU: No equivalent requirement. UK: Not addressed — under paragraph 7 of APB Ethical Standard 2, a person providing non-audit services would only be covered if the non-audit services were provided in relation to the audit of the audit client. US: SEC Rule 210.2-01(c)(1) — note that a non-audit services provider who provides less than 10 hours of non-audit services to an audit client during the period relating to the relevant financial statements is excluded under the definition of a ‘covered person’ in the firm.

5.48 The relevant person identified below must not have an asset that is a beneficial interest in an investment in the audited body that is a material interest (item 12 of the table of relevant relationships in subsection 324CH(1)).

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Relevant persons Reference to comparative requirements in relevant overseas jurisdictions


Recommendation Part B: Specific Circumstances — Financial Interests: Division 1, paragraph 2. Annex to Recommendation Part B Division 1.

UK: APB Ethical Standard 2 paragraph 7(b). US: SEC Rule 2.10.2-01(c)(1).


Canada: ICAO Rule 240.4 (2) — (Note: the rule would only apply if the reference to the firm was interpreted as also extending to a service company or trust acting on behalf of the firm). EU:


UK: APB Ethical Standard 2 paragraph 7(b) — note that we assume that the reference to an ‘audit firm’ in the standard would include a service company or trust acting for or on behalf of the firm. US: SEC Rule 2.10.2-01(c)(1).

A member of the firm. Canada: ICAO Rule 240.4 (2) supplemented by Rule 240.4(4) which provides that a member who is a partner of a firm and who has a material indirect interest in an audit client shall not practice in the same office as the lead engagement partner. EU:




Canada: ICAO Rule 240.4(1)(a). EU:




Canada: ICAO Rule 240.4(1)(a). EU: No equivalent requirement. UK: APB Ethical Standard 2 paragraph 7(b). US: SEC Rule 210.2-01(c)(1).

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A person who is a non-audit service provider and does not satisfy the maximum hours test (10 hours or less).

Canada: ICAO Rule 240.4(5) — but note that the rule would only apply if the non-audit services provider was a member of the ICAO. EU: No equivalent requirement. UK: Not addressed — under paragraph 7 of APB Ethical Standard 2, a person providing non-audit services would only be covered if the non-audit services were provided in relation to the audit of the audit client. US: SEC Rule 210.2-01(c)(1) — note that a non-audit services provider who provides less than 10 hours of non-audit services to an audit client during the period relating to the relevant financial statements is excluded under the definition of a ‘covered person’ in the firm.

An immediate family member of a person who is a non-audit services provider and does not satisfy the maximum hours test (10 or less hours).

Canada: ICAO Rule 240.4(5) — but note that the rule would only apply if the non-audit services provider was a member of the ICAO. EU: No equivalent requirement. UK: Not addressed — under paragraph 7 of APB Ethical Standard 2, a person providing non-audit services would only be covered if the non-audit services were provided in relation to the audit of the audit client. US: SEC Rule 210.2-01(c)(1) — note that a non-audit services provider who provides less than 10 hours of non-audit services to an audit client during the period relating to the relevant financial statements is excluded under the definition of a ‘covered person’ in the firm.

5.49 The relevant person identified below must not have an asset that is a material investment in an entity that has a controlling interest in the audited body (item 13 of the table of relevant relationships in subsection 324CH(1)).


The firm. Canada: No corresponding rule for audit client: ICAO Rule 204.4(9)(ii) is similar but the rule applies only to assurance engagements that do not involve an audit or review client. EU: No equivalent requirement. UK: No equivalent requirement. US: SEC Rule 210.2-01(c)(1)(i)(E)(1)(ii) — applies where the accounting firm has a direct or material indirect investment in an entity where the entity has an investment in an audit client that is material to that entity and has the ability to exercise significant influence over the audit client.


Canada: No corresponding rule for audit client. EU: No equivalent requirement. UK: No equivalent requirement. US: SEC Rule 210.2-01(c)(1)(i)(E)(1)(ii).

A member of the firm. Canada: No corresponding rule for audit client. EU: No equivalent provision. UK: No equivalent provision. US: SEC Rule 210.2-01(c)(1)(i)(E)(1)(ii) — the rule applies to a ‘covered person’, thus it would only apply to partners in a firm that have a close connection with the audit of the audit client.

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5.50 The relevant person identified below must not have an asset that is a material beneficial interest in an investment in an entity that has a controlling interest in the audited body (item 14 of the table of relevant relationships in subsection 324CH(1)).


The firm. Canada: No corresponding rule for audit client: ICAO Rule 204.4(9)(ii) is similar but the rule applies only to assurance engagements that do not involve an audit or review client. EU: No equivalent requirement. UK: No equivalent requirement. US: SEC Rule 210.2-01(c)(1)(i)(E)(1)(ii) — applies where the accounting firm has a direct or material indirect investment in an entity where the entity has an investment in an audit client that is material to that entity and has the ability to exercise significant influence over the audit client.


Canada: No corresponding rule for audit client. EU: No equivalent requirement. UK: No equivalent requirement. US: SEC Rule 210.2-01(c)(1)(i)(E)(1)(ii).

A member of the firm. Canada: No corresponding rule for audit client. EU: No equivalent requirement. UK: No equivalent requirement. US: SEC Rule 210.2-01(c)(1)(i)(E)(ii) — the rule applies to a ‘covered person’, thus it would only apply to partners in a firm that have a close connection with the audit of the audit client.

Commentary on investment restrictions

5.51 The comparative tables clearly indicate that there is substantial underlying equivalence between the Australian requirements and those in the relevant overseas jurisdictions. It is noted that:

• The requirements in the EU Recommendation are not as comprehensive as the suite of rules applying in the other jurisdictions.

• The SEC Rules (and to a lesser extent the ICAO Rules) contain some additional, more prescriptive rules relating to equity holdings in the audit client.

5.52 The most significant difference in approach is that the SEC Rules have generally moved away from an ‘all partner’ approach and have introduced a ‘covered person’ approach which ensures that only those partners with a close connection with the audit of an audit client would be subject to a particular restriction. Canada has adopted a ‘restricted person’ regime in relation to financial relationships and therefore has also moved away from an ‘all partner’ approach. The EU Recommendation also has a narrower scope than the ‘all partner approach and focuses on the Statutory Auditor and those persons ‘who are in a position to influence the outcome of the Statutory Audit’. The approach adopted in Canada and by the EU and the SEC in relation to financial relationships can be compared with the position in Australia and

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the UK which have retained the ‘all partner’ approach, except in relation to the restrictions applying to loans and guarantees where a more limited range of prohibited relationships apply.

Loans and guarantees

5.53 The relevant person identified below must not make a loan to the audited body, a related body corporate or an entity that the audited body controls, unless this represents a deposit made with an Australian ADI in the ordinary course of business and on normal terms and conditions (item 16 of the table of relevant relationships in subsection 324CH(1)).


The firm. Canada: ICAO Rule 204.4 (10)(b) — note that this rule exempts a loan in the ordinary course of business and the audit client is a bank or similar financial institution. EU: Covered under Business Relationships part of the Recommendation. UK: APB Ethical Standard 2, paragraph 21 which contains specific exemption in relation to a deposit made with a bank or similar deposit taking institution in the ordinary course of business and on normal business terms. US: SEC Rule 210.2-01(c)(1)(ii)(B) which includes an exemption in relation to cheque and savings accounts.


Canada: We assume that ICAO Rule 204.4(10)(b) would cover a service company or trust. EU: Covered under Business Relationship part of the Recommendation. UK: APB Ethical Standard 2, paragraph 21. US: SEC Rule 210.2-01(c)(1)(ii)(B) which includes an exemption in relation to cheques and savings accounts.

A professional member of the audit team conducting the audit.

Canada: ICAO Rule 204.4 (10)(b). EU: Covered under Business Relationship part of the Recommendation. UK: APB Ethical Standard 2, paragraph 21. US: SEC Rule 210.2-01(c)(1)(ii)(B) which includes an exemption in relation to cheques and savings accounts.

An immediate family member of a professional member of the audit team conducting the audit (but disregard the debt where it is incurred in the ordinary course business of the audit client, of a related body corporate or of a body corporate that the audit client controls).

Canada: No equivalent requirement. EU: Not covered under Recommendation because scope of the Recommendation does not extend to immediate family members. UK: APB Ethical Standard 2, paragraph 21. US: SEC Rule 210.2-01(c)(1)(ii)(B) which includes an exemption in relation to cheques and savings accounts.

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5.54 The relevant person identified below must not become liable under a guarantee of a loan made to the audited body, a related body corporate or an entity that the audited body controls (item 17 of the table of relevant relationships in subsection 324CH(1)).


The firm. Canada: ICAO Rule 204.4 (10)(c). EU: addressed under Business Relationship part of the Recommendation. UK: APB Ethical Standard 2, paragraph 21. US: SEC Rule 210.2-01(c)(1)(ii)(B) — we assume that the reference to a loan in the rule would include liability under a guarantee of the loan.


Canada: ICAO Rule 204.4 (10)(c). EU: addressed under Business Relationship part of the Recommendation. UK: APB Ethical Standard 2, paragraph 21. US: SEC Rule 210.2-01(c)(1)(ii)(B).


Canada: ICAO Rule 204.4 (10)(c) — we assume that a professional member of the audit team would have to be a member of the ICAO. EU: addressed under Business Relationship part of the Recommendation. UK: APB Ethical Standard 2, paragraph 21. US: SEC Rule 210.2-01(c)(1)(ii)(b).


Canada: No equivalent rule. EU: no equivalent requirement. UK: APB Ethical Standard 2, paragraph 21. US: SEC Rule 210.2-01(c)(1)(ii)(B).

5.55 The relevant person identified below must not owe an amount under a loan to the audited body, a related body corporate or an entity that the audited body controls unless the loan has been made in the ordinary course of business and on normal terms and conditions (item 18 of the table of relevant relationships in subsection 324CH(1)).


The firm. Canada: ICAO Rule 204.4(10)(a). EU: addressed under Business Relationships part of the Recommendation. UK: APB Ethical Standard 2, paragraph 22. US: SEC Rule 210.2-01(c)(1)(ii)(B).


Canada: ICAO Rule 204.4(10)(a). EU: addressed under Business Relationships part of Recommendation. UK: APB Ethical Standard 2, paragraph 22. US: SEC Rule 210-01(c)(1)(ii)(B).

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Canada: ICAO Rule 204.4(10)(a). EU: addressed under Business Relationships part of Recommendation. UK: APB Ethical Standard 2, paragraph 23 — note that the standard is wider than the Australian requirement because it applies to any person in a position to influence the conduct and outcome of the audit. US: SEC Rule 210-01(c)(1)(ii)(B).


Canada: No equivalent rule. EU: no equivalent rule. UK: APB Ethical Standard 2, paragraph 23. US: SEC Rule 210-01(c)(1)(ii)(B).

5.56 The relevant person identified below must not be entitled to the benefit of a guarantee in relation to a loan given by the audited body, a related body corporate or an entity that the audited body controls unless the guarantee is made or given in the ordinary course of business and on normal terms and conditions (item 19 of the table of relevant relationships in subsection 324CH(1)).


The firm. Canada: ICAO Rule 204.4(10)(a). EU: addressed under Business Relationships part Recommendation. UK: APB Ethical Standard 2, paragraph 22. US: SEC Rule 210-01(c)(1)(ii)(B).


Canada: ICAO Rule 204.4(10)(a). EU: addressed under Business Relationship part of Recommendation. UK: APB Ethical Standard 2, paragraph 22. US: SEC Rule 210-01(c)(1)(ii)(B).


Canada: ICAO Rule 204.4(10)(a). EU: addressed under Business Relationship part of Recommendation. UK: APB Ethical Standard 2, paragraph 23. US: SEC Rule 210-01(c)(1)(ii)(B).


Canada: No equivalent rule. EU: No equivalent requirement. UK: APB Ethical Standard 2, paragraph 22. US: SEC Rule 210-01(c)(1)(ii)(B).

Commentary on loans and guarantees

5.57 The comparative tables clearly indicate that there is substantial equivalence between the Australian requirements and those in the relevant overseas jurisdictions.

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Other debtor/creditor relationships between an audit firm and audit client

Australia

5.58 The 1969-70 Company Law Advisory Report to the Standing Committee of Attorneys-General, recommended that a registered company auditor (as part of his or her qualifications) was prohibited from acting as an auditor of a company if the auditor was indebted to the audit client in an amount exceeding $1,000. This provision was included in the Uniform Companies Acts from 1971.39

5.59 This auditor independence restriction has remained in Australia’s corporations legislation for the past 35 years (although the level of indebtedness is now $5,000 and extends to all partners of the firm). The Ramsay report recommended that this requirement should remain in the Corporations Act, with some relatively minor changes. Accordingly, the restriction was effectively replicated in the CLERP 9 Act, although it was now placed within an enhanced legal framework.

5.60 Shortly after the commencement of the CLERP 9 Act reforms, the accounting profession raised concerns that the restriction was catching ‘ordinary course of business’ arrangements which did not pose any threat to an auditor’s independence. The fact that these issues were being raised for the first time so long after the requirement was first introduced into the corporations legislation, indicates that the legal framework underpinning the pre-CLERP 9 Corporations legislation allowed the restriction to be circumvented.

5.61 The Government accepted that arrangements made in the ordinary course of business and on normal terms and conditions would not as a general rule, constitute a threat to independence and introduced an ‘ordinary course of business’ exception by regulation.40

Canada, the European Union and the United Kingdom

5.62 The auditor independence requirements in Canada, the EU and the United Kingdom do not contain any requirements similar to the Australian requirement.

United States

5.63 The SEC does have rules relating to other debtor/creditor relationships but rather than having a general ‘ordinary course of business’ exception, the SEC Rules provide detailed exemptions in relation to specific commercial arrangements, for example in relation to ‘broker-dealer accounts’, ‘futures commission merchant accounts’, ‘insurance products’.

39 This recommendation was subsequently included in Section 165 of the Uniform Companies Act — it appears that NEW South Wales was the first state to introduce the amendment when it amended the Companies Act 1961 (NSW) in 1971.

40 Corporations Amendment Regulations 2006 (No. 4).

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Commentary on other debtor/creditor relationships

5.64 The Australian requirement has been a part of the corporations regulatory landscape for many years. The general approach in the CLERP 9 Act in relation to financial relationships in the context of auditor independence is to frame exceptions on the basis of an arrangement being in the ‘ordinary course of business’ and ‘on normal terms and conditions’ rather than the prescriptive approach adopted by the SEC.

PROHIBITED BUSINESS RELATIONSHIPS

Introduction

5.65 A business relationship between an audit firm or a member of the audit engagement team and the audit client or the management of the audit client involves a common commercial or financial interest and may create self-interest, advocacy or intimidation threats to the auditor’s objectivity and a perceived loss of independence.

Australia

5.66 The Ramsay report noted that business relationships were not currently dealt with in the Corporations Act and recommended that the detailed rules on close business relationships be covered in the professional ethical rules of the professional accounting bodies. The Government accepted this recommendation. The general requirement on auditor independence in the Corporations Act also applies to business relationships between an auditor and audit client.

5.67 The Australian Code of Ethics for Professional Accountants APES 110, paragraph 290.132 provides that unless the financial interest is immaterial and the relationship is clearly insignificant to the firm and the audit client, no safeguards could reduce the threat to an acceptable level. APES 110 discusses various examples of business relationships, the nature of the threat created and the circumstances in which safeguards could be taken to reduce the threat.

Canada

5.68 Close business relationships are regulated under the ICAO Rule 204.4(13) which prohibits a member or the audit firm from performing an audit unless the close business relationship is limited to a financial interest that is immaterial and the relationship is clearly insignificant to the firm and to the audit client and its management.

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European Union

5.69 Business relationships are addressed in the Commission’s Recommendation on the Independence of the Statutory Auditor. The Recommendation recognises that close business relationships may cause self-interest, advocacy or intimidation threats to the statutory auditor’s independence. The Recommendation provides that such relationships should be prohibited unless the relationship is in the normal course of business and insignificant in terms of the threat it poses to the independence of the statutory auditor.

United Kingdom

5.70 The APB Ethical Standard 2 provides that ‘audit firms, persons in a position to influence the conduct and outcome of the audit and immediate family members of such persons should not enter into business relationships with an audit client or its affiliates except where they involve the purchase of goods and services from the audit firm or the audit client in the ordinary course of business and on an arm’s length basis and the value is not material to either party’.41

United States

5.71 SEC Rule 2-01(c)(3) provides that an accountant is not independent if, at any point during the audit and professional engagement period, the accounting firm or any covered person in the firm has any direct or material indirect business relationship with an audit client, or with persons associated with the audit client in a decision making capacity, such as an audit client’s officers, directors, or substantial shareholders.

5.72 An exception from the principle set forth in Rule 2-01(c)(3) is made in relation to a relationship in which the accounting firm or covered person in the firm provides professional services to an audit client or is a consumer in the ordinary course of business.

41 APB Ethical Standard 2 paragraph 26.

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Conclusion

5.73 The requirements in Australia, Canada and the EU focus on the financial interest created by the business relationship being immaterial and the relationship itself being insignificant to the audit firm and the audit client.

5.74 The requirements in the United Kingdom and the US will only permit purchases of goods and services in the ordinary course of business, in the case of the United Kingdom, and in the case of the US, professional services to the audit client or where the audit firm is a consumer in the ordinary course of business.

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Part 6: Provision of non-audit services

INTRODUCTION

6.1 Non-audit services are generally regarded as any engagement in which an audit firm provides professional services to an audit client other than pursuant to the audit of financial statements.42

6.2 The Australian Code of Ethics for Professional Accountants APES 110 (which is based on the IFAC Code) sets forth the traditional rationale in support of an audit client providing non-audit services to an audit client.

Firms have traditionally provided to their Assurance Clients a range of non-assurance services that are consistent with their skills and expertise. Assurance Clients value the benefits that derive from having these Firms, who have a good understanding of the business, bring their knowledge and skill to bear in other areas. Furthermore, the provision of such non-assurance services will often result in the Assurance Team obtaining information regarding the Assurance Client’s business and operations that is helpful in relation to the Assurance Engagement. The greater the knowledge of the Assurance Client’s business, the better the Assurance Team will understand the Assurance Client’s procedures and controls, and the business and financial risks that it faces.43

6.3 The fundamental concern raised by those who oppose the provision of non-audit services to their audit clients is that when an audit firm provides non-audit services to a client it is serving two different sets of clients: management in the case of non-audit services and the audit committee, the shareholders and all those who rely on the audited financial statement in the case of the audit. In serving these different clients, it is argued, the audit firm is subject to conflicts of interest.

6.4 Governments and regulators were also concerned about the phenomenal growth in non-audit services relative to audit services. The Ramsay report cited statistics which showed that for SEC audit clients in the US, the ratio of accounting and auditing revenues to consulting revenues dropped from approximately 6 to 1 in 1990 to 1.5 to 1 in 1999. In its commentary on its 2001 auditor independence rules, the SEC noted that at the public hearings on the rules, the SEC had heard ‘a great deal about the ‘loss leader’ phenomenon. When an auditor uses the audit as a loss leader, the auditor, in essence, low balls the audit fee — even offering to perform it at a loss — in order to

42 See for example paragraph 6 of APB Ethical Standard 5 which also excludes ‘other roles which legislation or regulation specify can be performed by the auditors of the entity’.

43 APES 110, paragraph 290.158.

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gain entry into and build a relationship with a potential client for the firm’s non-audit services’.

6.5 The fundamental policy issue which has confronted policy makers is whether to ban all or some non-audit services or whether to allow non-audit services provided auditors are made aware of the potential threats to their independence and require safeguards to be put in place in order to minimise these threats to acceptable levels. Where a threat cannot be reduced to an acceptable level, the auditor should either resign from the audit or refrain from providing the non-audit service.

AUSTRALIA

The Ramsay report

6.6 Australia opted not to impose a legislative ban on non-audit services. The Ramsay report considered whether non-audit services should be dealt with exclusively in either the Corporations Act or the ethical rules or whether a co-regulatory model might be appropriate. The Ramsay report concluded that the arguments favoured retaining the professional ethical rules, updated to reflect the IFAC Code requirements, as the basic guidance on maintaining audit independence when providing non-audit services to audit clients. In particular, the Ramsay report said that it had not uncovered any evidence to suggest that there were systemic failures within the accounting profession in complying with the ethical rules for providing non-audit services to clients.44

6.7 The Ramsay report also recommended enhanced disclosure in a company’s financial statements in relation to non-audit services provided by the external auditor, either as part of the accounting standards or as an amendment to the Corporations Act.

CLERP 9 Act

6.8 The Government adopted the basic approach recommend by the Ramsay report in the CLERP 9 reforms. The Corporations Act provides that the annual directors’ report of a listed company must disclose the fees paid for non-audit services provided by the auditor during the financial year, as well as a description of each service.45 In addition, the board of directors (in accordance with advice of the audit committee where applicable)46 must make a statement that they are satisfied that the provision of non-audit services is compatible with the general standard of independence imposed

44 Ramsay report pages 55-69. 45 Corporations Act subsection 300(11B). 46 Corporations Act subsection 300(11D).

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Part 6: Provisions of non-audit services

by the Corporations Act and an explanation of why those non-audit services do not compromise auditor independence.

6.9 The general standard of independence imposed on auditors under the Corporations Act applies to any non-audit service arrangements between an audit firm and an audit client.47

6.10 The Accounting Standards also require disclosure by an entity and by a group of details of non-audit services provided to the entity and to the group.48

Code of Ethics for Professional Accountants: APES 110

6.11 APES 110 which was adopted by the Accounting Professional and Ethical Standards Board (APESB) in June 2006, implements the IFAC Code requirements in relation to non-audit services.49

6.12 APES 110 recognises that non-audit services may create threats to the audit firm’s independence and requires auditors to evaluate the significance of any threat created by the provision of such services. APES 110 provides that in some cases it may be possible to eliminate or reduce the threat created by application of safeguards. In other cases no safeguards are available to reduce the threat to an acceptable level, and if this is the case, APES 110 requires either the audit services or the non-audit services to be refused.50

6.13 APES 110 sets out 11 examples of non-audit services where threats to independence would arise and the safeguards that would need to be taken to reduce the threats to an acceptable level.51 APES 110 notes that ‘new developments in business, the evolution of financial markets, rapid changes in information technology, and the consequences for management and control, make it impossible to draw up an all-inclusive list of all situations when providing non-assurance services to an Assurance Client might create threats to independence and of the different safeguards that might eliminate these threats or reduce them to an acceptable level’.52

47 Subdivision A — General requirement — Division 3 of Part 2M.4 of the Corporations Act. 48 AASB 101 — Presentation of Financial Statements: Aus126.1 and Aus126.2. 49 APES 110: Provision of Non-assurance Services to Assurance Clients:

paragraphs 290.158-290.205. 50 APES 110: paragraph 290.158. 51 APES 110: paragraphs 290.166-290.205. 52 APES 110: paragraph 290.162.

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CANADA

6.14 The provision of non-audit services to an audit client is regulated by the Rules of Professional Conduct adopted by the Institute of Chartered Accountants in each province. The ICAO Rules identify 12 non-audit services where an audit firm is mandated not to provide the particular non-audit service unless certain conditions are satisfied. The ICAO Rules generally adopt the IFAC approach but in the area of non-audit services, the ICAO Rules have been clearly influenced by the approach in the US where a number of specified non-audit services are prohibited. The US influence can be discerned both from the mandatory drafting style in the ICAO Rules in relation to non-audit services but also in relation to the coverage of specified non-audit services that are prohibited.

6.15 The influence of the US requirements in relation to non-audit services is also apparent in relation to the requirement in the ICAO Rules that ‘a member or firm shall not provide a professional service to an audit client that is a reporting issuer, or to a subsidiary thereof, without the prior approval of the reporting issuer’s audit committee’.53

EUROPEAN UNION

6.16 The EU Recommendation on the Independence of the Statutory Auditor adopts a principles based approach in addressing the threats and safeguards that an auditor should adopt in relation to the provision non-audit services.54

6.17 The approach is similar to that adopted by the IFAC Code. The Recommendation discusses, as examples, the threats and safeguards in relation to six specific types of non-audit services.

UNITED KINGDOM

6.18 APB Ethical Standard 5 provides requirements and guidance on specific circumstances arising from the provision of non-audit services by audit firms to their audit clients, which may create threats to the auditor’s objectivity or perceived loss of independence. It gives examples of safeguards that can in some circumstances, eliminate the threat or reduce it to an acceptable level. In circumstances where this is not possible, either the non-audit service engagement in question is not undertaken or

53 ICAO Rule 204.4(21). 54 EU Recommendation on the Independence of the Statutory Auditor: Part B — Specific

circumstances: Division 7: Non-audit services and also in the Annex to the Recommendation.

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the auditors either do not accept or withdraw from the audit engagement, as appropriate.55

6.19 APB Ethical Standard 5 has taken into account the requirements in both the IFAC Code and the EU Recommendation. It adopts a threats and safeguards approach to specific non-audit service examples, but in keeping with all the APB Ethical Standards, the language used in APB Standard 5 limits the subjective application of the Standard and, in so doing, facilitates the effective monitoring of them by the POB’s Audit Inspection Unit.56

6.20 There are 11 specific examples of non-audit services considered in APB Ethical Standard 5. It is noted that like Canada, the APB has specifically addressed the threats and safeguards applicable to actuarial services which are prohibited under the US SOX Act, but not specifically addressed in the IFAC Code.

6.21 APB Ethical Standard 5 expressly requires the audit engagement partner, before the audit firm accepts a proposed engagement to provide a non-audit service to an audit client:

• to consider whether it is probable that a reasonable and informed third party would regard the objectives of the proposed engagement as being inconsistent with the objectives of the audit of the financial statements; and

• to identify and assess the significance of any related threats to the auditors’ objectivity, including any perceived loss of independence; and

• to identify and assess the effectiveness of the available safeguards to eliminate the threats or reduce them to an acceptable level.57

UNITED STATES

6.22 Section 201 of the SOX Act prohibits an auditor from providing the following non-audit services, contemporaneously with the audit:

• bookkeeping or other services related to the accounting records or financial statements of the audit client;

• financial information systems design and implementation;

• appraisal or valuation services, fairness opinions, or contribution-in-kind reports;

55 APB Ethical Standard 5: Non-audit Services Provided to Audit Clients: paragraph 2. 56 APB press release: APB completes Ethical Standards for Auditors: issued on

17 December 2004. 57 APB Standard 5: paragraph 12.

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• actuarial services;

• internal audit outsourcing services;

• management functions or human resources;

• broker or dealer, investment adviser, or investment banking services;

• legal services and expert services unrelated to the audit; and

• any other service that the PCAOB determines, by regulation, is impermissible.

6.23 The PCAOB may, on a case by case basis, grant an exemption in relation to a firm engaging in one of the prohibited non-audit services. An exemption granted by the PCAOB is subject to review by the SEC.58

6.24 An audit firm may only engage in a non-audit service outside of the list of prohibited services provided that the particular activity is approved in advance by the audit committee of the audit client.

6.25 The SEC has amended its auditor independence rules to ensure that they are consistent with section 201 of the SOX Act.59 Prior to the enactment of the SOX Act, the SEC rules had prohibited the provision of a number of specified non-audit services to an audit client. In the commentary on the amended rules which were effective from 6 May 2003, the SEC said that its independence rules with respect to services provided by auditors are largely predicated on three basic principles, violation of which would impair the auditor’s independence: (1) an auditor cannot function in the role of management, (2) an auditor cannot audit his or her own work, and (3) an auditor cannot serve in an advocacy role for his or her client.

58 Section 201(b) of the SOX Act. 59 SEC Rule 210.2-01(c)(4).

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COMPARATIVE TABLE

6.26 The table below provides an overview of the specific non-audit services that have been specifically addressed in each jurisdiction:

Australia Canada EU UK US

Preparing accounting records and financial statements. APES 110 paras 290.166-173 Self-review threat

Preparation of journal entries and source documents: ICAO Rule 204.4(23) Preparation of accounting records and financial statements: ICAO Rule 204.4(24)

Preparing accounting records and financial statements. Recommendation Part B Div 7.2.1

Accounting Services. APB Standard 5: paras 113-125

Bookkeeping or other services related to the accounting records or financial statements of the audit client. Prohibited activity under section 201 SOX Act.

Valuation Services APES 110 paras 290.174-179 Self-review threat

Provision of valuation services ICAO Rule 204.4(25)

Valuation services Recommendation Part B Div 7.2.3

Valuation services APB Standard 5 paras 54-58

Appraisal or valuation services, fairness opinions, or contribution-in-kind reports Prohibited activity under section 201 SOX Act

Provision of taxation services APES 110 para 290.180 Generally not seen to create threats to independence

Not addressed in ICAO Rules of Professional Conduct

Not addressed in Recommendation

Tax services APB Standard 5 paras 62-77 Firms need to assess on a case by case basis Provision of tax services may give rise to a number of threats including self-interest threat, management threat, advocacy threat and self-review threat

Audit firm may engage in tax services provided approved in advance by audit committee: section 201 SOX Act. SEC position is that audit firm can provide tax services to audit clients without impairing the firm’s independence. However, the SEC cautions that merely labelling a service as a ‘tax service’ will not necessarily eliminate its potential to impair independence under the general standard.

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Provision of internal audit services to audit clients APES 110 paras 290.181-186 Self-review threat

Provision of internal audit services to audit client ICAO Rule 204.4(27)

Participation in audit client’s internal audit Recommendation Part B Div 7.2.4

Internal audit services APB Standard 5 paras 39-47

Internal audit outsourcing services Prohibited under section 201 SOX Act

Provision of IT systems services to audit clients APES 110 paras 290.187-191 Self-review threat

Provision of IT system services to audit client ICAO Rule 204.4(28)

Design and implementation of financial information technology systems Recommendation Part B Div 7.2.2

Information technology services APB Standard 5 paras 48-53

Financial information systems design and implementation Prohibited under section 201 SOX Act

Temporary staff assignments to audit clients APES 110 para 290.192 Self-review threat

Not addressed Not addressed Not addressed Not addressed

Provision of litigation support services to audit clients APES 110 paras 290.193-195 Self-review threat and possible advocacy and management threats

Provision of expert services to an audit client ICAO Rule 204.4(29)

Not addressed Litigation support services APB Standard 5 paras 78-80

Legal services and expert services unrelated to the audit Prohibited by section 201 SOX Act

Provision of legal services to audit clients APES 110 paras 290.196-202 Self-review and advocacy threats

Provision of legal services to audit or review client ICAO Rules 204.4(30) and (31)

Acting for the audit client in the resolution of litigation Recommendation Part B Div 7.2.5

Legal services APB Standard 5 paras 81-82

Legal services and expert services unrelated to the audit Prohibited by section 201 SOX Act

Recruiting senior manager APES 110 para 290.203 Self-interest threat

Human resource services for audit client ICAO Rules 204.4(32) Performance of management functions for audit client ICAO Rule 204.4(22)

Recruiting senior management Recommendation Part B Div 7.2.6

Recruitment and remuneration services APB Standard 5 paras 83-93

Management functions or human resources Prohibited by section 201 SOX Act

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Corporate finance and similar activities APES 110 paras 204-205 Advocacy and self-review threats

Provision of corporate finance and similar activities to audit client ICAO Rule 204.4(33)

Not addressed Corporate finance services APB Standard 5 paras 94-105 Transaction related services APB Standard 5 paras 106-112 Also identifies management threat

Broker or dealer, investment adviser, or investment banking services Prohibited by section 201 SOX Act

Not addressed Provision of actuarial services to audit client ICAO Rule 204.4(26)

Not addressed Actuarial valuation services APB Standard 5 paras 59-61 May give rise to self-review threat

Actuarial services Prohibited by section 201 SOX Act

CONCLUDING COMMENTS

6.27 Australia, Canada, the EU and the UK have not prohibited particular non-audit services under legislation, like the US. It is noted however, that both Canada and the UK have adopted more prescriptive language in relation to their non-audit services rules/standards in describing the threats to independence, the safeguards that should be undertaken and in mandating when an audit firm should either not provide the non-audit service or resign from the audit. The general requirement on auditor independence in the Corporations Act also applies to the provision of non-audit services by an auditor to an audit client.

6.28 The coverage in terms of specific non-audit services considered in APES 110 is substantially similar to those identified and discussed in the other jurisdictions, except the EU which is not as comprehensive. However, it is noted that:

• APES 110 has not identified the potential threats posed by actuarial services, unlike Canada and the UK. In the US, actuarial services is one of the prohibited activities; and

• in the UK, the potential threats posed by the provision of tax services are analysed in some detail under APB Ethical Standard 5. This compares with the position under APES 110 which states that generally tax services do not create any auditor independence threats.

6.29 ASIC has advised Treasury that IOSCO is currently undertaking a detailed survey of the regulation of non-audit services in various jurisdictions. The survey will collect information about the regulation of permissible, prohibited and restricted non-audit services in the various jurisdictions.

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6.30 IOSCO is aware that jurisdictions have differing views as to which non-audit services might give rise to an actual or perceived conflict of interest. Differing interpretations in particular jurisdictions can raise important issues for corporations and audit firms that operate on a global basis. ASIC has advised that in light of these cross border issues, the IOSCO study of the regulation of non-audit services will be useful to IOSCO members in determining how best to deal with auditor independence requirements, not only in their local jurisdictions, but also in a global context.

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Part 7: Employment restrictions applying to former partners of audit firms and senior audit personnel

‘COOLING-OFF’ PERIODS

Introduction

7.1 The Ramsay report noted that a particular concern in Australia has been retired audit partners joining the boards of their audit clients. The Ramsay report identified three particular concerns when professionals leave firms to join audit clients:

• Partners or other audit team members who resign to accept positions with audit clients may not have exercised an appropriate level of scepticism during the audit process prior to their departure.

• The departing partner or other professional may be familiar enough with the audit approach and testing strategy so as to be able to circumvent them once he or she begins employment with the client.

• The remaining members of the audit team may be reluctant to challenge the decisions of the former partner or professional and, as a result, might accept the client’s proposed accounting without exercising appropriate scepticism or maintaining objectivity.60

7.2 The UK’s APB has explained the auditor independence concerns in the following way:

Objectivity and independence may be threatened where a director, an officer or an employee of the audit client who is in a position to exert direct and significant influence over the preparation of the financial statements has recently been a partner in the audit firm or a member of the engagement team. Such circumstances may create self-interest, familiarity and intimidation threats, particularly when significant connections remain between the individual and the audit client. Similarly, objectivity and independence may be threatened


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when an individual knows, or has reason to believe that he or she will or may be joining the audit client at some time in the future.61

7.3 Australia and each of the relevant overseas jurisdictions have addressed these concerns by requiring a ‘cooling-off’ period between the partner’s or professional’s departure from the firm and his or her joining the audit client. There are, however, subtle differences between the requirements in each jurisdiction.

Australia

7.4 To deal with the threat to independence when a retired audit partner joins the board of an audit client, the Ramsay report recommended that there be a mandatory period of two years following resignation from the audit firm before a former partner of an audit firm who was directly involved in the audit of a client can become a director of the client.

7.5 The Ramsay report noted that its proposal received the support of a number of key stakeholders who were consulted during the course of the review, including the support of the ‘then’ big five accounting firms. The Ramsay report was very conscious in framing its recommendation, of not wanting to unduly impede employment opportunities for those who want to move from audit firms to companies. It recognised that it can be of benefit to the economy to allow those who have financial expertise to take this expertise to companies by becoming directors or employees of those companies. In that context, the Ramsay report stressed the limited nature of its recommendation which would only restrict a former partner of an audit firm directly involved in the audit of a client becoming a director of the client within a period of two years of resigning as partner of the audit firm.

7.6 The Ramsay report considered that it had struck an appropriate balance between the important objective of putting in place mechanisms to ensure auditor independence while, at the same time, not unduly impeding professionals in audit firms joining companies and bringing with them to those companies financial expertise.

61 APB Ethical Standard 2: Financial, Business, Employment and Personal Relationships: paragraph 41.

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Part 7: Employment restrictions applying to former audit partners and senior audit personnel

7.7 The Ramsay report recommendation has been implemented in sections 324CI and 324CJ of the Corporations Act. The following aspects of the requirement should be noted:

• The restriction applies to:

– a partner of an audit firm or a director of an audit company who was a professional member of the audit team for the audit of the audit client; and

– in the case of an audit company, the lead or review auditor for the audit of the audit client, where the lead or review auditors were not directors of the audit company.

• The restriction applies if the audit firm or the audit company has undertaken, at any time, an audit of the audit client and it is not necessary for the audit firm to be the current auditor of the company.

• The obligation is placed on the retired partner of the firm and the director, lead or review auditor of the audit company rather than placing the obligation on the audit firm or audit company. This is because it would be inappropriate to impose criminal liability on the firm or audit company for actions taken by a person who has departed from the firm or audit company. The penalty for contravention of the offence is 25 penalty units or imprisonment for six months, or both. The criminal offence has been drafted to ensure that there is a real incentive for a person who breaches the requirement to resign from the audit client. A person who contravenes the requirement and is prosecuted and convicted, is liable to be prosecuted again if he or she does not resign because the offence is framed in terms of the person becoming or continuing to be an officer of the audit client.

• The restriction does not apply to a small proprietary company.

• If the audit client is a listed entity (other than a registered scheme), the restriction also applies to a related body of the audit client.

Canada

7.8 ICAO Rule 204.4(16) prohibits a member of the ICAO and the audit firm from performing an audit engagement for an audit client if a person who participated in an audit capacity in an audit of the financial statements of the audit client has accepted employment in a financial reporting oversight role with the audit client, until a period of one year has elapsed from the date that the financial statements were filed with the relevant securities regulator or stock exchange.

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7.9 There are a number of differences between the Australian and Canadian restrictions:

• The Canadian rule prohibits a member of the ICAO and the audit firm from engaging in an audit of the audit client. The Australian restriction imposes the obligation on the audit partner who has resigned from the firm.

• The Australian requirement has been formulated as a criminal offence while the Canadian restriction would be based on the contractual relationship between the ICAO member and the ICAO and the contractual arrangement between the audit firm and CPAB.

• The Canadian requirement is wider than the Australian requirement in the sense that it applies to employment in a ‘financial regulatory oversight role’ with the audit client. This term is defined in the ICAO Rules as ‘a position in which a person may or does exercise influence over the contents of the financial statements or anyone who prepares the financial statements’. The Australian restriction relates to the person becoming or continuing to be an officer of the audit client. The definition of ‘officer’ in Section 9 of the Corporations Act covers a director or secretary of the company and a person in a senior management position whose decision making powers affect the whole, or a substantial part of the business of the company.

• The ‘cooling-off’ period in Canada is for one year and runs from the date that the relevant financial statements were filed with the securities regulator or stock exchange. The Australian ‘cooling-off’ period is for two years and runs from the date of the partner’s resignation from the audit firm, regardless as to when the partner’s participation on the audit team occurred.

European Union

7.10 The EU Recommendation on the Independence of the Statutory Auditor states that a Key Audit Partner leaving the audit firm to join the audit client for a Key Management Position would be perceived to cause an unacceptably high level of independence risk. The Recommendation thus provides that a period of at least two years should have elapsed before a Key Audit Partner can take up a Key Management Position.62

7.11 A Key Audit Partner is defined as:

an audit partner of the engagement team (including the engagement partner) who is at group level responsible for reporting on significant matters, such as on

62 The EU Recommendation: Part B: Specific Circumstances: Division 3 — Employment with the Audit Client: paragraph 4.

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significant subsidiaries or divisions of the audit client, or on significant risk factors that relate to the statutory audit of that client.

7.12 A Key Management Position is defined as:

any position at the audit client which involves the responsibility for fundamental management decisions at the audit client, such as the CEO or the CFO. The definition is also framed so that it would cover engagement of the former audit partner under a consultancy arrangement.

7.13 While the EU requirement has been formulated within a principles based framework, the key elements of the restriction are similar to the approach of the Australian requirement.

United Kingdom

7.14 The ‘cooling-off’ restriction in the UK is set forth in paragraph 44 of the APB Ethical Standard 2. The requirement imposes an obligation on the audit firm to resign as the auditor of the audit client and a further obligation not to accept re-appointment as the auditor of the audit client until after a two year period has elapsed. The text of the restriction is set out below:

Where a partner leaves the firm and is appointed as a director (including as a non-executive director) or to a key management position with an audit client, having acted as audit engagement partner (or as an independent partner, key audit partner or a partner in the chain of command) at any time in the two years prior to this appointment, the firm should resign as auditors. The firm should not accept re-appointment as auditors until a two year period, commencing when the former partner ceased to act for the client, has elapsed or the former partner ceases employment with the former client, whichever is the sooner.

– The ‘chain of command’ covers all persons who have direct supervisory, management or other oversight responsibility over either any audit partner of the audit team or over the conduct of audit work in the audit firm. The definition includes all partners, principals and shareholders who may prepare, review or directly influence the performance appraisal of any audit partner of the audit team as a result of their involvement with the audit engagement.

– The definition of ‘Key Management Position’ in the APB Ethical Standards is identical to the corresponding definition in the EU Recommendation (see paragraph 7.12).

7.15 While the UK adopts a two year ‘cooling-off’ period, the period is calculated from the date of the former partner’s appointment at the audit client backwards for a maximum period of two years. Thus if the former partner was the audit engagement

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partner for audit of the audit client three years before his or her appointment at the client, this would not be caught by the restriction. The Australian restriction runs for two years from the resignation date, regardless as to when the former partner was a member of the audit engagement team.

United States

7.16 Section 206 of the SOX Act specifies that an accounting firm cannot perform an audit for a registrant if a chief executive officer, controller, chief financial officer, or any person serving in an equivalent position for the issuer, was employed by the accounting firm and participated in any capacity in the audit of that that issuer during the one year period preceding the date of the initiation of the audit.

• The way in which section 206 has been drafted, it would appear that the ‘cooling-off’ period could be longer than one year because it requires that the person not be a member of the audit engagement team during the year preceding the commencement for the current audit engagement. The SEC has adopted this interpretation because in the commentary to the amendments to its independence rules made on 6 May 2003, the SEC states that ‘under our rules, the prohibition would require that the accounting firm has completed one annual audit subsequent to when an individual was a member of the audit engagement team’.

7.17 The key elements of the relevant SEC rule can be paraphrased as follows:

• An accountant is not independent if the accountant has an employment relationship with an audit client, such as employment at the audit client of a former employee of the accounting firm where:

– the former partner, principal, shareholder or professional employee of the firm is in a financial reporting oversight role at the audit client unless the person employed by the audit client was not a member of the audit engagement team during the one year period preceding the date that audit procedures commenced for the fiscal period that included the date of initial employment of the person by the audit client.

– persons, other than the lead partner or the review partner, who provided ten or fewer hours of audit services during the relevant period are not considered part of the audit engagement team.

7.18 The US requirement is wider than the Australian restriction to the extent that it applies to any person who participated in ‘any capacity in the audit’ of the audit client. The Australian requirement is restricted to a partner of a firm or a director of an audit company who were members of the audit team and the lead or review partner in an audit company. On the other hand, the US requirement is less restrictive than the Australian requirement as it does not extend back beyond the period of one year preceding the current audit engagement. The Australian requirement applies provided

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the audit firm has been ‘at any time’ before the date of the partner’s resignation, the auditor of the audit client.

Overall conclusions

7.19 The comparative review of the ‘cooling-off’ period restrictions raise a number of issues for consideration:

• The two year ‘cooling-off’ period in Australia is generally in line with the periods adopted in all the relevant overseas jurisdictions (noting that Canada has adopted a one year period).

– The HIH Royal Commission recommended that the CLERP 9 proposal for a two year ‘cooling-off’ period should be extended to four years, but this would have taken Australia well outside the approach adopted in overseas jurisdictions.63

• The Australian two year ‘cooling-off’ period applies to a former partner who was a member of the audit team, regardless of when the partner participated as a member of the audit team.

• However, the scope of the Australian requirement only applies to a partner or director of an authorised audit company who has been a professional member of the audit team. The UK requirement extends beyond membership of the audit team to other partners in the ‘chain of command’. The US requirement is even more extensive and applies to any person who participated ‘in any capacity’ in the audit.

MULTIPLE FORMER PARTNER OF AUDIT FIRM/AUDIT COMPANY DIRECTOR RESTRICTION

Australia

7.20 Section 324CK of the Corporations Act implements the recommendation of the HIH Royal Commission that a prohibition be introduced preventing more than one former partner of an audit firm, or director of an audit company, at any time being a director of, or taking up a senior management position in, the audit client.64

7.21 The following extracts from the HIH Report explain the rationale underlying the recommendation:

63 HIH Royal Commission: Vol 1: page 176, paragraph 7.2.3. 64 HIH Royal Commission: Vol 1: Recommendation 11: page 177.

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Three former partners of Andersen were appointed to the board of HIH. One was appointed as the chair of the board and appointed to the audit committee 17 months after his retirement from Andersen. Another joined HIH as the chief financial officer the day after he resigned from Andersen, where he had been the engagement partner on the HIH audit. A third former partner was appointed to the board of HIH approximately five months after his retirement from Andersen, where he had played a significant role in the audit of HIH for twenty-five years … I consider that those circumstances resulted in the perception that Andersen were not independent of HIH. One of the primary reasons for my conclusion was that the cumulative effect of three former partners on the HIH board affected the perception that Andersen’s independence had been compromised more than the presence of one former partner would have done.65

7.22 The accounting profession raised concerns about the proposed restriction in its submissions on the exposure draft of the CLERP 9 Bill. The profession said that the restriction had the potential to impact negatively on the employment market and recruiting practices of accounting firms especially in light of the size of the Australian market. In particular, concerns were expressed that potential employees of firms would be reluctant to join firms if they were restricted in their ability to move from firms to audited bodies at a later date.

7.23 The Report of the Taskforce on Reducing Regulatory Burdens on Business has recommended that the Australian Government should review the multiple audit partner restriction.66 The Australian Government has announced that it will review the multiple former audit firm partner restriction by the end of 2006.

Relevant overseas jurisdictions

7.24 Treasury is unaware of any equivalent requirements in the relevant overseas jurisdictions included in the comparative review.

65 HIH Royal Commission: Vol 1: page 176. 66 Rethinking Regulation: Report of the Taskforce on Reducing Regulatory Burdens on

Business: January 2006: Recommendation 5.26, page 106.

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Part 8: Auditor rotation

INTRODUCTION

8.1 The IFAC Code notes that using the same senior audit personnel on an audit engagement over a long period of time may create a familiarity threat.67 One of the safeguards that IFAC recommends to address this threat is to rotate senior audit personnel off the assurance team.

8.2 The UK Co-ordinating Group on Audit and Accounting Issues in its July 2002 Interim Report to the Secretary of State for Trade and Industry described rotation of senior audit partners as a way of ‘preventing too cosy a relationship to develop between executive management and auditors’.68

8.3 The HIH Royal Commission noted that one aspect of the question of Andersen’s independence of HIH was the length and closeness of their relationship — Andersen had been HIH’s auditor since 1971. The Royal Commission described the familiarity threat in the following terms:

The length of a relationship between auditor or audit firm and client presents clear risks with respect to audit independence. An auditor must not become subject to potential compromise of their objective and impartial judgment by reason of a long-standing relationship with management or a tendency to prefer a particular accounting position because of a previous commitment to that position.69

8.4 The following policy questions need to be addressed in formulating an audit partner rotation model:

• Who should be subject to the rotation requirements — should the requirements be applied beyond the lead audit engagement partner?

• How long should a partner be allowed to remain on an audit engagement before being required to rotate?

• What is the appropriate ‘time-out’ period before a ‘rotated’ partner should be allowed to resume involvement with the same audit client?

• Do the rotation requirements achieve the appropriate balance with the need to maintain continuity and audit quality?

67 IFAC Code paragraph 290.153. 68 Paragraph 3.25 of the Interim Report. 69 HIH Royal Commission Report Vol 1: page 179.

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• Should more stringent rules be applied to listed companies?

• Should special consideration be given to small audit firms?

AUSTRALIA

The Corporations Act rotation requirements

8.5 The auditor rotation requirements are contained in Division 5 of Part 2M.4 of the Corporations Act and were introduced as part of the CLERP 9 Act auditor independence reforms.

8.6 The rotation requirements only apply to audits of listed companies and listed schemes.

8.7 There are two basic auditor rotation requirements :

• the ‘time-out’ rule in subsection 324DA(1); and

• the ‘5/7 rule’ in subsection 324DA(2).

8.8 The time-out rule provides that an individual who has played a significant role in the audit of a particular client for five successive financial years is not eligible to continue to play a significant role unless the individual has not played such a role for at least two successive financial years. This rule means that:

• where an individual auditor has been appointed as the auditor of the listed company or listed scheme, that individual and the review auditor (if any) must rotate;

• where an audit firm or authorised audit company (AAC) has been appointed as the auditor of the company or scheme, only the lead auditor and the review auditor (if any) must rotate.70

8.9 The 5/7 rule provides that an individual may not play a significant role in the audit of a particular audit client for more than five out of seven successive financial years. The 5/7 rule prevents an individual from avoiding the ‘time-out’ rule, for example, in circumstances where an individual plays a significant role for four

70 It should be noted that Auditing Standard ASA 220 Quality Control for Audits of Historical Financial Information requires that there be an engagement quality control reviewer for each listed audit entity who does not need to be a partner of the firm, and can be an employee or a person external to the firm. The definition of an engagement quality control reviewer is set out in footnote 72.

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successive years, resigns from the audit for only one year and then resumes playing a significant role for another four successive years.

8.10 The rotation requirements do not require that the audit firm or AAC rotate.

ASIC’s relief power

8.11 ASIC has a limited power under section 342A of the Corporations Act to modify the rotation requirements. The relief power allows ASIC to:

• declare that the time-out rule applies to an individual as if the references to five successive years were reference to six or seven successive years; or

• declare that the 5/7 rule applies to an individual as if the references to five out seven successive financial years were references to six out of seven successive financial years.

8.12 ASIC may only use its relief power if it is satisfied that, without modification, the rotation requirements would impose an unreasonable burden on:

• the individual registered company auditor (the lead auditor or review auditor in the case where an audit firm or AAC has been appointed the auditor of an audit client);

• the audit firm or AAC on whose behalf the lead auditor or review partner acts in relation to the audit; or

• the audit client.

8.13 ASIC sought comment in April 2006 on a policy proposal paper regarding ASIC’s power to give relief from the auditor rotation requirements in the Corporations Act.

Code of Ethics for Professional Accountants

8.14 The Code of Ethics for Professional Accountants APES 110 has adopted the same time periods in relation to the rotation requirements for audit clients that are listed entities, as apply under the Corporations Act, namely rotation required where five financial years have been served within a seven year period.71

71 APES 110 paragraph 290.154.

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8.15 The Code applies the rotation requirements to the lead engagement partner, audit review partner (if any) and the engagement quality control reviewer’. 72

CANADA

Introduction

8.16 The auditor independence rules applying under the CPAB audit regulatory framework are the auditor independence standards contained in the Rules of Professional Conduct adopted by the various provincial Institutes of Chartered Accountants.

The ICAO auditor rotation rules

8.17 As a general rule, the professional conduct rules of the various provincial Institutes of Chartered Accountants have followed the IFAC Code auditor rotation approach. However, in relation to auditor rotation, the provincial rules have been informed by the basic requirements applying in the US under the SOX Act and the relevant SEC Rules.

8.18 Rule 204.4(20)(a) of the ICAO Rules of Professional Conduct provide that a member of the Institute ‘shall not continue as the lead engagement partner or the engagement quality control reviewer on an audit engagement of a reporting issuer for more than five years in total, and shall not thereafter resume or assume either such role until a further five years have elapsed’.

8.19 ICAO Rule 204.4(20)(b) imposes a rotation obligation on any other audit partner of the audit engagement who, during the engagement period provides more than ten hours of assurance services in connection with the annual financial statements, after seven years and a time-out period thereafter of two years.

72 An engagement quality control reviewer is defined in APES 110 as ‘a partner, other person in the assurance practice, suitably qualified external person, or a team made up of such individuals, with sufficient and appropriate experience and authority to objectively evaluate before the report is issued, the significant judgments the engagement team made and the conclusions they reached in formulating the report’.

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EUROPEAN UNION

Commission recommendation on statutory auditors’ independence

8.20 Paragraph 10 of the Recommendation requires the statutory auditor, as a minimum, to replace the Key Audit Partners73 of the engagement team (including the engagement partner) within seven years of appointment to the engagement team. The replaced Key Audit Partners should not be allowed to return to the audit client engagement until at least a two year period has elapsed since the date of their replacement.

EU directive on statutory audit of annual accounts

8.21 The Directive establishes the principle that in order to reinforce the independence of auditors of public interest entities, the key audit partners auditing such entities should rotate. The Directive provides that the audit firm does not require to be rotated.74 The Directive does not provide detailed time periods within which rotation must occur. Presumably, Member States would have regard to the requirements in the Commission Recommendation in deciding how to implement the Directive.

UNITED KINGDOM

Auditing Practices Board’s ethical standards

8.22 Members of the ICAEW and the other Recognised Supervisory Bodies (RSBs) are required to comply with the Auditing Practices Board’s (APB’s) Ethical Standards when conducting audit engagements in the UK.

73 Defined as ‘an audit partner of the engagement team’. 74 Paragraph 20(c) of the Directive.

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APB Ethical Standard 3

8.23 APB Ethical Standard 3 — Long Association with the Audit Engagement sets forth the auditor rotation requirements in the UK. A summary of the requirements applying to audits of listed companies is as follows:

• An audit engagement partner and an ‘independent partner’ should not act for a continuous period longer than five years.

• Where an independent partner becomes the audit engagement partner, the combined period of service in these positions should not exceed five years.

• Where an audit engagement partner or the independent partner have acted for a particular audit client for a period of five years, they should not hold any position of responsibility in relation to the audit engagement until a further five years has elapsed.

• A Key Audit Partner should not act for a continuous period longer than seven years and should not hold any position of responsibility in relation to the audit engagement until a further two years has elapsed.

• Where a partner has been responsible for significant affiliates (but not as a key audit partner) or where senior audit staff have acted for a continuous period longer than seven years, the audit engagement partner should review the safeguards put in place to address the threats to their objectivity and independence and discuss those situations with the independent partner.

8.24 APB Ethical Standard 1 — Integrity, Objectivity and Independence discusses the requirement for review by an independent partner where the audit client is a listed company. ISA (UK and Ireland) 220 Quality control for audits of historical financial information, requires the audit engagement partner to appoint an engagement quality control reviewer for all audits of listed entities. The engagement quality control review involves consideration of the engagement team’s evaluation of the independence of the firm. Paragraph 41 of APB Ethical Standard provides that the independent partner should:

• consider the audit firm’s compliance with APB Ethical Standards in relation to the audit engagement;

• form an independent opinion as to the appropriateness and adequacy of the safeguards applied; and

• consider the adequacy of the documentation of the audit engagement partner’s consideration of the auditors’ objectivity and independence.

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UNITED STATES

Sarbanes-Oxley Act

8.25 The SOX Act requires rotation of certain audit partners on a five year basis in order to continue to provide audit services for an audit client. Section 203 of the SOX Act specifies that:

It shall be unlawful for a registered public accounting firm to provide audit services to an issuer if the lead (or coordinating) audit partner (having primary responsibility for the audit), or the audit partner responsible for reviewing the audit, has performed audit services for that issuer in each of the five previous fiscal years of that issuer.

8.26 The SOX Act is silent in relation to the time-out period that should apply once the lead or review partner has been compulsorily rotated after five years. This issue is addressed by the SEC Rules.

SEC Rules

8.27 The SEC adopted a number of amendments in May 2003 to enhance its existing auditor independence rules, including new rules in relation to auditor rotation, in the light of the auditor independence reforms in the SOX Act.

8.28 The SEC has adopted auditor rotation rules which can be summarised as follows:

• The lead and review partners (concurring partner) are required to rotate after five years and, upon rotation, are subject to a five year ‘time-out’ period.

• Other audit engagement partners who provide more than ten hours of audit or serve as the ‘lead partner’ in connection with the audit of a subsidiary of the audit client whose assets or revenue constitute 20 per cent or more of the assets or revenues of the audit client’s consolidated assets or revenues are subject to a seven year rotation requirement with a two year ‘time-out’ period.

• Audit firms with fewer than five audit clients who are ‘issuers’ for purposes of the securities laws and which have less than ten partners, are exempt from the rotation rules provided the PCAOB conducts a review at least once every three years of each of the firm’s audit client engagements.

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CONCLUDING COMMENTS

8.29 The approach taken in each jurisdiction can be summarised as follows:

• The auditor rotation requirements in each jurisdiction extend to the lead engagement auditor and the review auditor.

• Australia, Canada, the UK and the SEC rules require rotation after five successive years. Australia has an additional requirement that a lead or review auditor must not audit a particular audit client for more than five out of seven successive years. The EU requires rotation after seven years.

• Australia and the EU have adopted a two year time-out period before a ‘rotated’ auditor is allowed to resume involvement with the same audit client. Canada, the UK and the SEC have adopted a five year time-out period.

• The SEC rules provide an exemption from the rotation requirements for smaller audit firms (fewer than five audit clients and less than ten audit partners) provided the PCAOB conducts a review at least once every three years of each of the firm’s audit client engagements.

• None of the jurisdictions require audit firm rotation.

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