Auditing Profession Bill: Department response to submissions

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Finance Standing Committee

17 October 2005
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FINANCE PORTFOLIO COMMITTEE


18 October 2005
AUDITING PROFESSION BILL: DEPARTMENT RESPONSE TO SUBMISSIONS


Acting Chairperson: Mr K Moloto (ANC)

Relevant documents

 

Auditing Profession Bill [B31-2005]
National Treasury proposed amendments

SUMMARY
The Committee considered the document prepared by National Treasury which contained amendments proposed by the Committee at the previous meeting, as well as input from each submissions received during the hearings. A matrix indicating proposed amendments by the public and the department's response to each would be distributed at the 4 November meeting.

The problematic concept of ‘material loss’ in the definition of "reportable irregularity" was flagged for further discussion. Clause 11 was clarified to ensure that registered auditors were appointed to the Regulatory Board. The Democratic Alliance expressed concern with Clause 19 which allowed the Regulatory Board to revoke any decision taken by its disciplinary committee. Clause 21 was flagged for further discussion as the balance of key stakeholders on the auditor ethics committee was unclear. Clause 24 was amended to make it clear that individuals with significant legal experience must be members of the disciplinary committee.

The amendment to Clause 29 emphasised that the Ministerial representative appointed would attend meetings of the Regulatory Board but would only have observer status and would not be allowed to vote, which ensured the independence of the Regulatory Board. Clause 30 was flagged because it was not clear as to what would happen should the Minister not abide by the decision reached by the Regulatory Board. The use of the phrase "the fairness or the truth or the correctness" in Clause 44 was unclear and was flagged for further discussion. The duty to report on irregularities in Clause 45 was flagged for further discussion because the DA proposed it involved a breach of fiduciary duty, and the DA it imposed a much more onerous reporting standard than Parliament itself prescribed for the Auditor-General. Clause 46 was amended to confine the application of unlimited liability to the statutory audit alone, and also stipulated that the liability for the statutory audit would be incurred both by the firm and the individual.

MINUTES
Mr F Nomvalo, the Accountant General, informed the Committee that the document contained amendments that were proposed by the Committee at the previous meeting, as well as input from each submissions received during the public hearings. He stated that he and his team had worked through the night on the document, and requested the indulgence of the Committee if the document did not yet contain the detailed matrix that indicated proposed amendments by the public and the department's response to each. The detailed matrix document would however be ready by the meeting to be hold on 4 November 2005.

He stated that the document contained many technical and consequential amendments, but only the substantive amendments would be highlighted.

Chapter 1: Interpretation and Objects of Act
Clause 1: Definitions
"accreditation"
Mr Nomvalo explained that National Treasury decided to insert this definition in the Bill, as proposed by the Public Accountants and Auditors’ Board (PAAB) submission.

"audit"
The phrase ‘audit service’ has been removed from the new definition because many of the submissions expressed a problem with it, and any reference to that phrase throughout the Bill had been removed. The new definition of ‘audit’ had been taken from the definition employed by the International Federation of Accountants, and PAAB agreed. The revised definition needed to be amended however by replacing the words "high level of assurance" with "reasonable or limited level of assurance", as proposed by the PAAB.

Mr Y Bhamjee (ANC) asked whether there was a difference between "reasonable" and "limited". Furthermore, he was not in favour of the deference paid to routes followed by international institutions, as the Bill needed to apply specifically to the South African context.

Mr Nomvalo responded that auditors used those terms because they took samples of the voluminous financial statements and financial controls that existed in the organisation they were auditing, to arrive at an opinion as to whether the financial statements had been prepared in accordance with the prescribed framework. They did not go through each and every transaction, and it was for that reason that the term "reasonable and limited assurance" was used. A further reason for the use of that term was that there was an inherent error in each sample taken, it was the nature of the exercise.

Mr Bhamjee sought an indication on the minimum size of the sample used.

Mr Nomvalo replied that it varied according to the complexity of the organisation being audited as well as the controls within the organisation, and was thus a matter of professional judgement.

Ms J Ferreira, National Treasury Director: Legal Services, added that the inclusion of the words "reasonable and limited assurance" related to the amendments effected to Clause 46, which dealt with the limitation of liability of auditors. Part (a) of the definition referred to the statutory audit whereas part (b) referred to other evaluations, and Clause 46 confined the unlimited liability to the statutory audit in part (a). The limited liability would be allowed for the non-statutory audit because National Treasury recognised that auditors would have to compete with people who were not registered auditors but who were also providing financial advice.

"improper conduct"
Mr Nomvalo indicated that the words "intentional or negligent" had been removed, as submissions contended that strict non-compliance was the proper standard to be employed.

"management board"
The words "responsible for" have replaced "having control of" because "having control of" referred to ownership or shares in the institution, which could only be held by the shareholders. As the definition referred to management structures, the decision was taken to insert "responsible for". This was proposed by one of the submissions.

"nominated auditor"
The submissions contended that this definition would create confusion, and National Treasury agreed to delete it from the Bill..

"public practice"
The words "for reward" were removed because it made the definition non-sensical, as proposed by one of the NGOs.

"reportable iregularity"
Mr Nomvalo indicated that the phrases "in the conduct of" and "or control" were replaced with "responsible for", for the same reasons provided with regard to ‘management board’ above. The reference to "client" was replaced with "investor", because a submission contended that "client" was far too broad in application. The phrase "or otherwise dishonest" was removed because, as colourfully indicated by the submissions, it would result in very perverse interpretations.

National Treasury believed that the reference to "any unlawful act" which was "likely to cause material financial loss" covered the concerns raised during the public hearings, and did serve government’s policy direction. Concern was also raised with the phrase "under any law applying to the entity", but in the definition it referred specifically to the fiduciary duties of the management of the entity.

Mr I Davidson (DA) stated that he was not convinced that the amendment to the definition put auditors in a position to assess the actual material financial loss caused without knowing the personal circumstances of the person concerned.

Mr Nomvalo responded that the concept of material loss was well known to auditors. The aim of the legislation was to protect the public interest, and it was the shareholders in their capacity as shareholders that needed to be protected. The primary concern in the definition was the extent to which the interests of shareholders were being jeopardised by the actions of management.

Mr Moloto stated that he interpreted the submissions as attempting to restrict the material loss caused to the entity alone. He was however concerned that that approach did not protect the ordinary worker who had, for example, invested his pension fund into the entity.

Mr Davidson stated that he agreed with the submissions that the definition restricted the material loss to the entity, because it the entity suffered loss then the workers, shareholders and members would suffer a loss as well. That loss could be readily assessed by looking at the financial statements of the entity. He argued that the moment the definition moved beyond the material loss caused to the entity it would then have to inquire into the personal circumstances of the shareholder etc. which may bear no relationship to what had happened in the entity. That was the problem. He argued that the loss suffered by all those categories of people was automatically subsumed under the loss suffered by the entity.

Mr T Vezi (IFP) questioned the wisdom in using the term ‘material’, because it appeared to be difficult to define.

Mr B Mnguni (ANC) was of the view that the definition, as proposed in the document, did in fact apply to all the investors as well as the entity.

Mr Nomvalo replied that he did not believe that the auditors were being forthwright in their submissions when they contended that the personal circumstances of the individual would have to be inquired into. The material nature of the loss in relation to an individual shareholder could be ascertained without delving into their personal circumstances, because that was irrelevant as what they had invested into other companies would not necessarily have been lost as a result of that specific transaction. The provisions in the Bill were focused on protecting the interests of the shareholder.

Conversely, there were cases in which there was no loss to the entity but where a loss was in fact suffered by the shareholders. This was the generally accepted practise of share options, simply because shareholders were not given sufficient information by management on the concept, and auditors allowed it to happen. In that example although the company retained its value, when the directors who were offered share options decided to exercise those options, the pool of shares would increase and, consequently, the value of each share would decrease. There would thus be no loss to the company, but the shareholder would suffer a loss as the price of each share would now have dropped. Government was under a duty to protect the shareholders from this misleading management tool.

Mr Davidson contended that that did not cure the problem because the share option would in any event have to be approved by the shareholders themselves. Furthermore, it still did not enable the auditor to assess the materiality of the loss to the shareholder, member, creditor etc.

Mr Moloto stated that he differed with Mr Davidson’s interpretation as he understood the material loss to the shareholder to be assessed in relation to the activities within the entity.

Mr S Asiya (ANC) proposed that the matter be flagged for further discussion during the clause-by-clause deliberations.

Mr Nomvalo proposed that the words "in their dealings with the entity" be inserted at the end of part (a) of the definition, in order to cure Mr Davidson’s concern.

Mr Davidson stated that he approved of the principle being proposed, but requested that the matter be flagged until a proper formulation was devised.

Mr Davidson proposed that a materiality aspect be introduced in part (b) as well, as proposed by the submissions.

Mr Nomvalo disagreed and replied that strict liability would apply here.

Clause 2: Objects of Act
Mr Nomvalo indicated that it was proposed during the public hearings that the words "as a consequence" be inserted in 2(c) so that the provision read better. The amendment was accepted by National Treasury and has been inserted.

Chapter 2: Independent Regulatory Board for Auditors
Part 2: Functions of Regulatory Board
Clause 4: General functions
Mr Nomvalo informed Members that a submission indicated that the provision currently provided that the Regulatory Board "must" provide all the functions listed, whereas it was not under a duty to perform them all. National Treasury had thus split the clause into two, with 4(1) prescribing the functions that the Regulatory Board "must" perform, and 4(2) dealt with functions that the Regulatory Board "may" perform. The new clause also included the power of the Regulatory Board to conduct practice reviews or inspections, as well as the prescription of auditing standards..

Clause 5: Functions with regard to accreditation of professional bodies
Mr Nomvalo stated that the insertion of 6(1)(g) was inserted as proposed by one of the commentators during the public hearings, in order to refer to Clause 39.

Clause 6: Functions with regard to registration of auditors
Mr Nomvalo effected a proposal made during the public hearings that partial accreditation be included.

Clause 7: Functions with regard to education, training and professional development
This clause was also split into two subsections, each dealing with the prescriptive and discretionary powers of the Regulatory Board, as was the case with Clause 4. A new 7(3) was added to accommodate that impact of the withdrawal of recognition of an education institution, as proposed by the submissions.

Clause 8: Functions with regard to fees and charges
Ms Ferreira stated that this clause was also split into two subsections, each dealing with the prescriptive and discretionary powers of the Regulatory Board.

Part 3: Powers of Regulatory Board
Clause 9: General powers
Ms Ferreira indicated that several of the submissions contended that the members of the Regulatory Board should be remunerated for services rendered, which was currently not the case in the Bill. These determinations would be done in consultation with the Minister, to avoid the problems experienced with this issue in similar provisions in other pieces of legislation.

Part 4: Governance of Regulatory Board
Clause 11: Appointment of members of Regulatory Board
Ms Ferreira indicated that the submissions proposed the setting of a minimum number of Regulatory Board members, which was now reflected in the clause. The phrase "with suitable qualifications" was replaced with "competent" in accordance with proposals made during the public hearings, as the former implied that people needed to have specific degrees.

Mr Davidson noted that the submissions raised the concern that the current wording of 11(4) did not stipulate that registered auditors must be members of the Regulatory Board, as it simply stated "may".

Mr Moloto disagreed and contended that the wording required them to be members of the Regulatory Board, and the "40%" threshold merely prescribed the maximum number that would sit on the Regulatory Board..

Mr Mnguni agreed with Mr Moloto that the provision clearly stipulated that registered auditors must be present on the Regulatory Board, as no-one else had those skills.

Mr Davidson responded that the problem was that the Bill did not contain a single provision that expressly stipulated that registered auditors must be appointed to the Regulatory Board. The law cannot be allowed to operate on assumptions. The current 11(4) could, in theory, result in a Regulatory Board that did not contain a single registered auditor.

Mr Nomvalo proposed that 11(2) be amended by the insertion of ", which must include registered auditors" after "persons".

Mr Davidson approved of the proposed amendment.

Clause 12: Term of office of members of Regulatory Board
Ms Ferreira explained that the State Law Advisor had proposed the insertion of the new 12(6) to ensure that the Regulatory Board continued to function pending the appointment of a new Regulatory Board.

Mr Bhamjee stated that a time limit within which the new Regulatory Board would have to be establishment must be included in the clause.

Mr Nomvalo responded that the point was accepted in principle, but a precise formulation would be provided at a later stage.

Clause 13: Disqualification from membership and vacation of office
Mr Nomvalo noted one of the commentators highlighted the fact that the current 13(1)(a) was confusing as it suggested that a person would be a member of the Regulatory Board is he was not a South African citizen and if he was not resident in South Africa. It was for that reason that the new formulation reflects a splitting into two separate portions of the former 13(1)(a) for clarity, and now stipulated the person must be a South African citizen and must be resident with South Africa.

Clause 15: Meetings
Ms Ferreira stated that concerns were raised regarding the frequency with which the Regulatory Board met, and the amendment stipulated that the Regulatory Board would now meet at least four times every year.

Mr Nomvalo added that this was the accepted standard within South African corporate governance practices.

Clause 17: Duties of members
Ms Ferreira indicated that the amendment gave effect to the PAAB concern that the provision did not ensure that the Regulatory Board dealt in good faith with the categories of persons omitted from 17(d).

Clause 19: Delegations
Ms Ferreira explained that the amendment was taken from the Municipal Finance Management Act and allowed the Regulatory Board to delegate powers to deal with minor disciplinary matters. This additional power was inserted as the new 19(1)(b).

Mr Nomvalo added that National Treasury believed that the amendment would address the concern raised during the public hearings that the current disciplinary procedure was both onerous and overloaded.

Mr Davidson proposed that 19(3) meant that the Regulatory Board could revoke any decision taken by one of its committees, which could include a disciplinary committee. This was problematic.

Mr Nomvalo replied that the Regulatory Board would be revoke decisions lightly. The key issue was that the principle of corporate governance must be carried out properly, which meant that in the final analysis it was the Regulatory Board that was accountable to the Minister, not the various committees. The Regulatory Board must have the power to make the ultimate decision.

Part 5: Committees of Regulatory Board
Clause 20: Establishment of committees
Ms Ferreira noted that the amendment clarified those committees that the Regulatory Board must establish, and the new 20(2)(d) introduced the inspection committee as proposed by PAAB. The amendment to 20(3) gave effect to the call during the public hearings that the power of the Regulatory Board to terminate the membership of a member be clarified.

Mr B Johnson (ANC) sought clarity on the meaning of the term "unsatisfactory" in the proposed 20(3)(c)(i), and how it would be assessed.

Mr Nomvalo responded that the general practice was that the committees would have terms of reference and charters that defined its operations, and one of the conditions was usually a self-evaluation by the board members of their performance. This was the intention of the amendment.

Mr Johnson proposed that the provision refer expressly to the unsatisfactory performance of the specific Committee, and not the Regulatory Board.

Mr Nomvalo agreed.

Clause 21: Committee for auditor ethics
Mr Bhamjee asked whether the balance of key stakeholders on the Clause 21 committee was satisfactory.

Mr Nomvalo replied that 21(1) specifically stipulated that the committee must consist of "at least" the categories of persons listed, which made it clear that at least those specific stakeholders would be present on the Regulatory Board. The Regulatory Board could however decide on additional stakeholders. He reminded Members that the committees were in the final analysis accountable to the Regulatory Board, and thus the composition of the Regulatory Board itself was a check on the balance struck with regard to stakeholder representation on its committees.

The Chair ruled that the matter be flagged for further discussion at a later stage.

Clause 24: Disciplinary committee
Ms Ferreira indicated that the proposed amendment now required "individuals with significant legal experience" to be members of the disciplinary committee. This was necessitated by result disciplinary hearing outcomes which illustrated that there was a lack of appropriate legal representation, which might have resulted in a different outcome. The amendment proposed to 21(2)(a) inserted a "retired judge" yet the State Law Advisor opposed the insertion because a judge remained a judge for life, even after vacating office. The difficulty however was that the general perception was that "judge" referred to a person currently practicing as a judicial officer. The reference to "retired judge" was thus retained for clarity.

She stated that further that whereas the previous position was that the decision of the disciplinary committee was final, the Bill now allowed the Regulatory Board to overturn that decision because that disciplinary committee in any event derived its power via delegation from the Regulatory Board itself.

Mr L Gabela (ANC) questioned whether the words "suitably qualified" in the proposed 24(2)(c) should not be replaced with "competent", as was the argument in Clause 11 above.

Mr Nomvalo replied that the problem was that the registered auditors were really insistent that they be allowed to sit on the disciplinary committee. The principle underlying the provision was that a judge or advocate would have to oversee the process, but the majority of the members would consist of non-auditors in order to avoid any conflict of interests. This would however be balanced with the need to have auditors represented on the committee for those cases in which very technical and complex auditing issues were at stake. . He stated that he would consider the matter further.

Mr Davidson stated that the term "non-registered auditors" was not defined in the Bill, and proposed be replaced with "people who were not registered auditors".

Mr Nomvalo agreed with the proposed amendment.

Part 7: National government oversight and executive authority
Clause 29: Ministerial representatives
Ms Ferreira emphasised that the Ministerial representative appointed would sit in on the meetings of the Regulatory Board but would only have observer status and thus, although he would be able to participate in the proceedings, would not be allowed to vote. The independence of the Regulatory Board was thus assured by avoiding that conflict of interests..

Clause 30: Investigations and directives
Mr Nomvalo explained that the concern raised by Members during a previous meeting regarding the directive issued by the Minister was now resolved by the addition of 30(2), which required the Minister to first consult the Regulatory Board before issuing the directive. This retained the independence of the Regulatory Board.

Mr Bhamjee asked what the situation would be should the Minister not abide by the decision reached by the Regulatory Board in 30(2)(b).

Mr Nomvalo replied that 30(2) allowed the Minister to request the Regulatory Board to furnish him with reasons for its decision, should he be unclear, and he would then consider those reasons. If the Minister was still not satisfied he could issue the directive which would require the Regulatory Board to address the matter. The Regulatory Board would then have no choice but to abide by the Minister’s directive.

Mr Davidson stated that it was merely a consultative process that allowed the Regulatory Board to comment on the directive before the Minister in fact issued it.

Mr Moloto stated that the nature of the directive was important. He was not sure what the status of the directive would be if it was found to be inconsistent with the Bill. He proposed that the matter be flagged for discussion at a later stage.

Part 2: Registration of individual auditors and firms
Clause 37: Application for registration of individuals as registered auditors
Ms Ferreira noted that the heading of the provision was amended. The current 37(2)(b), (c) and (f) would be deleted because they were already dealt with in the prescribed education, training and competency requirements. The new 30(2)(c) was inserted to give effect to the PAAB proposal.

Clauses 38-40
Ms Ferreira indicated that these clauses would be renumbered, as reflected in the document. This was consistent with the PAAB proposal. The new 39(4) provided for the lapsing of registration of a partnership, sole proprietor or company, and was in line with the provision already in the Bill that dealt with individuals. Clause 40 now included a reference to re-registration, as proposed in the submissions, as the Bill initially did not allow for re-registration.

Mr Nomvalo explained that 40(3) reflected the retention of the status quo with regard to the multi-disciplinary approach, as has been discussed by the Committee.

Chapter 4: Conduct by and Liability of Registered Auditors
Clause 44: General obligation in relation to audit services

Ms Ferreira stated that 44(1) was inserted in lieu of the term 'nominated auditor', which was deleted from the Bill because its definition was problematic and unclear.

Mr Davidson stated that the Deloitte and Touche submission raised concern with the phrase "the fairness or the truth or the correctness" in 44(3)(g), as those terms were not internationally defined. They proposed the use of "fairly present only in relation to suitable criteria" instead, which was defined.

Mr Nomvalo replied that National Treasury believed that "truthfulness" might have to be removed because it placed too high a burden on the auditor, who was merely relying on the information presented to him by the management of the audited company. He assured Members that the Bill will not be changing the auditing standards.

Mr Moloto flagged the issue for further discussion.

Ms Ferreira stated that the "two year look back period" in the old 44(5) had been deleted, and the entire provision was replaced with a new 44(6).

Clause 45: Duty to report on irregularities
Mr Nomvalo informed Members that the initial reporting procedure was retained in this clause. The concenrs raised that the process was cumbersome were unfounded because the Regulatory Board did not have to take any active steps once it received the report. It thus served the very important purpose of ensuring that every single material reportable matter was indeed reported to the Regulatory Board, as the statistics provided during the Nel Commission indicated that out of a total of 2058 cases only about 57 cases had been reported.

Mr Davidson proposed that this matter be flagged for further discussion, because the breach of fiduciary duty involved here had not even been explored. The second concern was that the Bill imposed a much more onerous reporting standard than Parliament itself prescribed for the Auditor-General. The Auditor-General.was not required to first inform Parliament of a reportable irregularity and then produce his report, as he simply provided Parliament with a report of the irregularity once he had completed the entire audit.

Mr Nomvalo responded that the standards for public auditors might have to be changed, and the Committee could effected that via this Bill. The breach of fiduciary duty scenario raised by the Ernst and Young submission was unfounded, because the Companies Act dealt with that scenario. The provision should be retained as is because it put in place a mandatory reporting mechanism that would cure the industry-wide problem of failure to report irregularities, as the Nel Commission.statistic illustrated.

Mr Moloto ruled that the matter would have to be discussed further at a later stage.

Clause 46: Limitation of liability
Ms Ferreira indicated that this clause elicited many responses during the public hearings. As explained under the definition of 'audit' in Clause 1 above, part (a) of the definition referred to the statutory audit whereas part (b) referred to other evaluations, and Clause 46 confined the unlimited liability to the statutory audit in part (a). She provided two possible formulations in the document, for consideration by the Committee. The proposed 46(1)(b) stipulated that the liability for the statutory audit would be incurred both by the firm and the individual.

Mr Johnson asked whether the proposed 46(1)(b) was wise, as the submissions had raised concerns with such a proposal.

Mr Nomvalo replied that the Bill marked a shift in thinking in that it now affected both the individual and the firm. This shift was important to give effect to the Regal case in which the audit firm was found to be at fault and consequently had a negative effect on public interest. However, because the current legislative framework at the time did not apportion any liability to firm, only the individual was held responsible. The submissions received from the private sector audit firms were thus aimed at maintaining the status quo whichw oudl serve their own interests, but which would have a detrimental effect on the public interest. The aim of the provision was to ensure the auditor was not able to restrict his liability theough a contract, when conducting a statutory audit.

Mr Moloto approved of the rationale behind the clause.

Mr Davidson asked whether the committing of mistakes by the auditor or the apportionment of damages was accommodated, as queried by the submissions.

Mr Nomvalo responded that the issue as to whether there were other factors beyond the auditor's control at play would be considered in due course by the presiding officer. If the auditor simply made a mistake and did not act fraudulently or maliciously, there was sufficient case law on the matter. Both the Ministerial Panel Review report and the views gained from industry prior to the tabling of the Bill indicated that the issue of apportionment needed to be addressed, but in another more appropriate piece of legislation. Nationa Treasury was currently putting forward proposals to the Companies Act Amendment legislation in this regard, so that the directors could be held liable. This Bill must however dealt with registered auditors alone.

Chapter 5: Accountability of Registered Auditors
Clause 47: Inspections
Ms Ferreira indicated that 47(5)(b) was deleted because, as noted by the submissions, it meant the same as 47(5)(a). The new 47(5)(e) was inserted to give effect to the PAAB proposal for a reciprocity arrangement with an international regulator..

Clause 50: Disciplinary hearing
Mr Johnson sought clarity on the implications and meaning of the proposed 50(8)(b).

Ms Nomvalo replied that it allowed the person to admit to his wrongdoing at any stage during the disciplinary process, should he realise that he had no ooption but to admit to his wrongdoing. This was a common provision in other pieces of legislation.

Ms Ferreira added that the person had the right to choose whether he wanted to be present at the hearing or not.

The State Law Advisor explained that the provision was in line with Section 220 of the Criminal Procedure Act, as it expedites the proceedings.

Clause 51: Proceedings after hearing
Ms Ferreira noted that, as proposed by the PAAB submission, the period of imprisonment was now extended to five years. She stated that she would provide information on the fee penalty at the meeting to be held on 4 November.

Concluding remarks
Mr Nomvalo thanked all who provided input into the tabled version of the Bill, the State Law Advisor and the input of the Committee.

Mr Moloto thanked National Treasury for its commendable efforts in consolidating all the views of the stakeholders that appeared during the public hearings.

The meeting was adjourned.

 

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