Corporate Laws A/B: hearings

Meeting report

TRADE AND INDUSTRY PORTFOLIO COMMITTEE
29 May 2006
CORPORATE LAWS A/B: HEARINGS

Chairperson: Mr B Martins (ANC)

Documents handed out:
 

Corporate Laws Amendment Bill [B6-2006]
Presentation by Deloitte on the Corporate Laws Amendment Bill
Submissions by Deloitte on the Companies Amendment Bill: Part 1, 2 & 3
Price Waterhouse Coopers presentation, executive summary and submissions on Corporate Laws A/B
Price Waterhouse Coopers submission
KPMG Comments on the Corporate Laws Amendment Bill [B6-2006]
ABASA presentation
Ernst and Young presentation

SUMMARY
The Corporate Laws Amendment Bill [B6-2006] introduces a number of amendments to the Companies Act (No. 61 of 1973) and the Close Corporations Act (No. 69 of 1984), which were required prior to completion of the corporate law reform process currently underway.

Deloitte recommended that Section 275 and 275A be removed, alternatively that "tax advisory services" must be defined. It was suggested that this section perhaps did not correctly reflect SARS’ concerns. The regulatory body should be asked to develop ethics to deal with the situation. Section 269A should include size criteria. Section 300A required a narrower definition and should define questions that an auditor was obliged to answer. Penalties should be included for those misleading auditors. Questions related to the appointment of the Independent Regulatory Board for Auditors, the suggested definition of tax advisory services, the distinction between individuals and firms, penalties and the references to UK and USA legislation. Deloitte agreed to submit suggested redrafted sections to the Committee.

Price Waterhouse Coopers believed that Section 285A imposed differing accounting standards and suggested that the Bill should require public companies to comply with International Financial Reporting Standards, but that limited interest companies should have less onerous, but more clearly defined standards. Section 287A needed redrafting to ensure that nothing permitted a departure from accounting standards. Section 275A was inconsistent in its descriptions in heading and body text. There was no clarity on tax advisory services. The proposed prohibition preempted the role of Independent Regulatory Board for Auditors. The sections referring to tax advisory services should be deleted. Questions related to the composition of the Regulatory Council, financial assistance by companies for purchase of own shares, and rewordings of Section 285A. The terms "auditor" and "designated auditor" were explained. There was discussion on tax advisory services. The questioning at annual general meetings was clarified.

Prof Michael Katz addressed the Committee on the proposed scope of and reasoning behind the revised Section 38. It was intended to give protection to creditors and shareholders in five defined situations. The main amendment removed the prohibition on a company giving finance for the purchase of its own shares. Questions related to further clarification on the purpose and effect. Prof Katz believed the section was well drafted and would be effective.

KPMG was concerned that Section 269A could lead to a reduction in the numbers of members serving on audit committees. Section 270A was supported, but caution sounded that full committees should sanction any delegation of audit committees’ powers. Section 274A made no provision for transitional arrangements. Section 275A contained inconsistent references in heading and main body of the text, in regard to auditors. KPMG favoured a strong, principle-based approach to defining "tax advisory services". KPMG queried whether some references to private companies were intended. Section 285A was problematic as auditors would be forced to qualify reports. Section 290 would have to be amended to avoid conflicting rules. Section 300A could result in sensitive information being released to public and media at AGMs. Section 440U would duplicate the efforts of the Financial Reporting Council. Schedule 4 items should not be included in the Companies Act but under Financial Reporting Standards. Questions related to limited interest companies, disclosure of information at AGMs, the definition of a client, matters that an auditor must report to shareholders, and how amendments would affect audit firms. Specific suggested wording was discussed.

In the afternoon, Ernst and Young and the Association for the Advancement of Black Accountants of Southern Africa provided submissions on the Corporate Laws Amendment Bill with specific reference to the independence of auditors and the role of audit committees. Advisory tax functions and tax advice were outlined. Audit companies had to operate in an independent manner and financial statements should include an audit committee report. The proposed legislation should govern both the private and public sectors in equal measure.

Members asked various questions including the distinction between accountants and auditors, the proportion of non-audit functions within accounting firms, the role of audit committees in providing pre-approval, the ability of smaller firms to audit specialised sectors of the economy, the rotation of firms as opposed to individual auditors, the clear definition of key concepts within the Bill and the lines of communication between the different functions.

Minutes
Submission by Deloitte
Mr P Austin (Deloitte: Reputation and Risk Leader – Audit) reported that the Minister and the Executive had taken positive steps after hearing the concerns on aspects of the Companies and Close Corporations Amendment Act, after publication, but Deloitte wished to address outstanding concerns.

Section 275 and 275A
These sections of the Companies Act (the Act), related to the independence of auditors. The Audit Professions Act (APA) sought to regulate the auditing profession, thus Deloitte did not believe that it was appropriate for the Companies Act to include regulation of auditors. The provisions of the Bill detracted from the Independent Regulatory Board for Auditors (IRBA). Deloitte therefore recommended that Section 275A be deleted entirely on the basis that rules relating to audit independence would be published by the Committee for Auditor Ethics (CAE).

If this proposal was not accepted, then Deloitte submitted, as a second alternative, that the section required amendment. For the first time this section now included reference to "tax advisory services", which was sought to be implemented by 14 June. There was no definition of this in the Bill or the Act, and failing such a definition there would be inconsistency in the way it was applied. Deloitte understood that this section was incorporated following a comment from SARS, but it seemed that SARS only intended to address the auditor signing the report, and not the entire firm, and furthermore that SARS comments were based upon a report that dealt only with aggressive tax schemes, and not with day-to-day work. Unintended consequences, if 275A were to be adopted, would include tax partner rotation to the detriment of smaller firms. Multinational companies would view section 275A as hindrance to doing business, as it did not accord with international best practice. A prohibition against providing tax advisory services would make it difficult for auditors to attract and retain tax specialists and would reduce their audit effectiveness. If this provision were to be retained, then the terms must be defined, in terms of the CAE or IRBA legislation and the reference to auditor must be changed to "designated auditor". If this was not met, then at least the reference to "auditor " must be changed to "designated auditor" and the CAE should be required to adopt consistent rules governing the independence of registered auditors.

Section 269A
Deloitte agreed with recommendations on formation of audit committees made up of Independent non-executive directors. They agreed with the definition of public interest entities, and welcomed section 269A permitting the Minister to exempt associations. However, Deloitte believed that additional size criteria should apply, so that any entity above a certain size, plus all public entities and those governed by the Public Finance Management Act (PFMA) or Municipal Finance Management Act (MFMA) should be regarded as public interest companies. No regulation should make the cost of small, medium and micro businesses unsustainable.

Section 300A
Deloitte believed that the requirement in Section 300A that auditors attend annual general meetings (AGMs) to answer questions relating to their financial investigations was too broad, lacked definition and did not carry adequate legal protection. An auditor should not be asked to answer any questions beyond the scope of the audit. Deloitte suggested this section be removed, alternatively, if it were to stay, that further research and consultation be conducted to give clear guidance on the type of questions that an auditor should answer.

Penalties
The question of penalties was one that may be taken up in the reform of the corporate law programme. The current provisions cast very strict penalties upon auditors, including criminal sanctions, but there was no correlating requirement that management make proactive disclosure to the auditors. , Deloitte suggested that civil sanctions and criminal sanctions be included for those misleading auditors.

Section 440AA
Deloitte supported the financial statement investigation process, but suggested that the eighteen days response period was inadequate, as a full Board meeting and Audit Committee meeting would need to be held. Deloitte suggested a period of between two to three months. There should be some guidance on the meaning of "non-compliance"

DiscussionProf Turok (ANC) asked who appointed the IRBA.

Mr Austin replied that the Auditing Professions Act had come into operation on 1 April 2006. This Act was drafted by National Treasury to ensure that independent regulated oversight from Treasury, the Minister of Finance, who called for nominations and appointed six members, controlled Appointments.

Prof Turok asked whether Deloitte had any suggested definition for tax advisory services.

Ms F Mahomed (ANC) asked what exact changes would be made if 275A were not deleted. She queried whether tax advisory services related to re-computing, or merely to checking tax.

Mr Austin referred to his detailed memorandum. Other countries each had their own definition. Most countries permitted audit firms to provide tax advisory services during an audit, provided the audit partner was satisfied that there were no material threats as that the firm had procedures in place to protect against actual or perceived threats to independence. Most were opposed to audit for approval of aggressive tax schemes. In principles, firms that undertook a performance management function, such as a tax valuation, should not audit their own work; the client should perform the calculations and the auditor should review and correct. To separate audit from tax affairs was very difficult. Independence of management could be addressed on the same principle as the five-year rotation. Auditors should not provide management functions to clients. The UK dealt with this on an ethics basis and the USA in short legislation. Deloitte proposed that the Ethics Committee should be able to deal with the matter; it was difficult to define in a piece of legislation.

Mr D Dlali (ANC) asked what period would be appropriate for definitions and transition.

Mr Austin suggested that the US and UK markets had taken between three and nine months for the Regulator to settle a clear definition.

Prof Turok commented that SARS and Treasury probably needed to give their input on the tax advisory services clause. He drew the analogy of a building inspector, who, seeing that the job was faulty was limited to calling back the contractor, as he could not repair the work himself. The auditor should surely not attend to the redrawing of accounts or calculations, as this was the responsibility of client. He believed that there was really any distinction between an individual and a firm. If an individual was engaged to do the audit, there was no Chinese wall between him and the firm, and he would be bound to obey the rules of the firm.

Dr P Rabie (DA) asked whether the time frame of two to three months for investigation on non-compliance was an international norm.

Mr Austin replied that no time frame was laid down in United States of America (USA) other than that the Security Exchange Committee required a response within 14-21 days. Deloitte believed a time frame should be specified.

Prof Turok asked if any criminal sanctions were included in the Act at present.

Mr S Njikelana (ANC) asked for further comment on penalties.

Ms D Ramodibe (ANC) asked whether the PFMA did not contain sufficient penalties for misleading auditors.

Mr Austin reported that the APA had introduced criminal sanctions for auditors’ incorrect reporting, with collusion or complicity, being a maximum fine of R10 million and /or ten year imprisonment. Although the PFMA did contain some provisions in relation to those misleading auditors that Act only applied to government-controlled entities. Deloitte would be happy to submit a draft wording to the Department of Trade and Industry (dti), and would do so if dti found this acceptable. No criminal sanctions against those misleading auditors were contained in the Companies Act. Ideally criminal sanctions should rather be included in the APA, similar to USA and UK legislation, as "umbrella legislation", but given the fact that it had only just been passed it was unlikely to be amended in the short term. Because public companies were the largest custodians of public funds, it would then probably be appropriate to put this into the Companies Act.

Mr Njikelana asked why Deloitte had made so much reference to UK and USA legislation, as opposed to other jurisdictions. Mr Austin replied that UK was a major trading partner and Deloitte had taken into consideration that most listed companies were partnered on UK and USA markets. Legislation in Australia was substantially similar. Europe was more complex because the Eighth Directive was only approved late the previous year and the 25 member states had not finalised their processes to adopt their own legislation.

Ms Mahomed asked if Deloitte had any suggestions as to redrafted wording, in the event that the deletions suggested did not occur. Mr Dlali (ANC) asked the same question, referring particularly to comments on attendance and questioning at AGMs, and on strict penalties.

Mr Austin responded that in all cases Deloitte was happy to offer assistance to dti in redrafting.

The Chairperson clarified that because the Portfolio Committee had asked for comment and elaboration, it was not relevant whether dti wished to have assistance. The request had actually come from the Committee, who would interact with the stakeholders.

Mr Austin thanked the Chairperson for this clarity and undertook that drafts would then be forwarded to the Committee clerk.

Hearing on the written submissions of PricewaterhouseCoopers Ltd on the Bill
Mr T Jali, Chairman of PricewaterhouseCoopers, reported that the firm was fully committed to the principles of corporate governance. Consistency in audits could not be over-emphasised. The comments were detailed under headings.

Section 285A
Mr S Kana (Deputy CEO, PricewaterhouseCoopers (PWC)) commented that accounting standards differed. Paragraph 4 of the Objectives of the Bill dealt with the legal backing to accounting standards. It stated that the amendments would impose a uniform standard, to be developed by a Financial Reporting Standards Council (FRSC). This standard would have to comply with the International Accounting Standards Board (IASB) in order to increase investment in South Africa and to minimise duplication. PWC believed that the international standards would be blurred by the South African intervention. International Financial Reporting Standards (IFRS) were developed after consultation with more than 100 countries, and were globally recognized. Any other standards would not be appealing to investors. Already the JSE required listed companies to comply with IFRS. Although it might seem a technicality, a great deal depended upon the standards used. Therefore PWC suggested that the Bill should require all public companies to comply with IFRS, and Section 440S should require the FRSC to adopt the IFRS, and Section 285A(1) should be amended to contain similar provisions.

PWC submitted that this should not apply to limited interest companies, where there was a need for simplified requirements. Here the Bill required compliance with the Accounting Framework for Financial Reporting Standards, and certain disclosures under Schedule 4. However, the Accounting Framework used by IASB contained conceptual guidance only on the preparation and presentation of statements. The lack of guidance would lead companies to set their own standards. Specific guidance was required and PWC suggested that FSRC must develop accounting standards applicable to limited interest companies, and that dti should impose a time limit for development of those standards.

Section 287A
The Bill required fair presentation of financial statements, and non-compliance was an offence in terms of section 287. Section 287A created an offence for false or misleading financial reports, but did not make reference to accounting standards. This had the anomalous result that it allowed departure from standards if it was believed that compliance would result in the financial report being misleading or false. PWC suggested that Section 287A be redrafted to the effect that nothing in that section permitted non-compliance with accounting standards.

Section 275A
The heading referred to "designated auditor" whereas the section referred only to "auditor". Firstly, PWC was concerned that the use of "the auditor" broadened the scope of the section, as opposed to the previous reference to "the nominated auditor". PWC understood that SARS had concurred that "the designated auditor" was the intention of the section, therefore should not extend to the other partners and staff of a firm.

Secondly, there was now a prohibition on the rendering of tax advisory services in described circumstances.

PWC submitted that this pre-empted the role of the IRBA. This Board was to establish an Auditor Ethics Committee, which would set a code of conduct, and deal with auditor independence. If the Companies Act were to try to determine the types of non-audit services, this interfered with IRBA’s function. PWC suggested that this section be deleted and that IRBA be permitted to fulfil its statutory duty. If the request to delete was not accepted, then PWC recommended that "designated auditor" or the individual Registered Auditor referred to in Section 27 of the Auditing Profession Act" be used throughout. Furthermore PWC recommended that the reference to "tax advisory services" be deleted. It was internationally accepted that these services did no adversely affect auditor independence.

Discussion
Prof Turok stated that the FRSC was comprised of professionals. He asked if PWC would support greater representivity – for instance by including academics on the panel.

Mr Jali felt that this would be beneficial.

Prof Turok enquired whether auditors obliged to make reports to the Executive should also submit them to Parliament. He enquired whether dti should have the responsibility to monitor compliance.

Mr Jali could see no problem with reports to Parliament.

Prof Turok referred to the question of financial assistance being given by companies to purchase their own shares, to achieve shareholder diversification. He asked whether this would not lead to abuses.

Mr Jali commented that as long as solvency and liquidity were not affected it was held to be permissible for companies to get financial assistance for the purchase of own shares. This was also in line with the Close Corporations Act.

Prof Turok asked for comment upon the wording of Section 269A(4) (Clause 22 of the Bill).

Mr Jali commented that the only restrictions applied to family members. The requirements relating to acting independently were aimed at empowering people to be able to acquire shareholding and materiality of the shareholding should be considered.

Prof Turok commented that the departments consulted in the Bill were National Treasury, FSB, JSE and CIPRIO. He asked whether PWC considered that sufficient.

Mr Jali stated that the draft Bill was issued on the website by National Treasury, and was widely available for comment. He felt that sufficient input had probably been given.

Mr Dlali asked whether PWC had any specific recommended wording for Section 285A, if it were to stand, and any suggestion on time limits for development of standards for limited interest companies. He also asked if IRBA would be in a position to come up with regulations, and the likely time frame.

Mr Jali commented that there was currently a project run by the IASB, considering submissions drawn by the East Africa Society of Chartered Accountants. IFRS would probably be able to draw these within about 12 months; PWC had suggested time limits so that the matter was attended to urgently. IRBA had to establish various committees, including the Audit Ethics Committee. The call for nominations had closed the previous Friday. The Committee should be able to start work at the end of June when it could start to draft the regulations.

Mr Kana referred the Committee to the detailed written submissions of PWC, where some suggested definitions were given.

Ms Mahomed asked for further explanation of the terms "auditor" and "designated auditor".

Mr M Fairbank (National Risk Manager, Tax Services, PWC) commented that "auditor" effectively meant the firm of auditors appointed, or the auditor who was registered in his personal name. "Firm" would mean any partnership, company, or proprietorship registered as a firm, as opposed to an individual. If the reference to "designated" were only to appear in the heading, or if it were not supplemented to read "designated auditor or the individual registered auditor referred to in section 27 of the Auditing Profession Act", then this would exclude the individual auditor registered in his personal name. The section of the Bill defining "designated auditor" applied only in the case of a firm.

Mr Fairbank, with the permission of the Chairperson, elaborated further on the questions asked of Deloitte, on USA and UK legislation. PWC had recently done some research, in comparable developing jurisdictions, on "tax services". India believed that the tax services did not interfere with audit independence, and therefore had no restriction on the service being provided, as long as the non-audit fees did not exceed the annual audit fees. China did not regard it necessary to restrict the auditor’s ability to provide the services. In both countries the rules on auditor independence were set by the equivalent of the IRBA. In Brazil authorities in 2003 decided not to put any restriction on the provision of non-tax services, except in cases of an extremely aggressive tax scheme proposed by the auditors. Although auditors were not prohibited from doing the work, they nonetheless had to obtain a third party legal opinion to support the tax treatment. A draft Bill was put before the Mexican Congress in 2005, proposing restrictions, but this was based upon a very different point as, unlike South Africa, their auditors were obliged to certify tax returns. After public hearings the authorities decided that not to prohibit auditors from providing tax advisory services, but instead to introduce a targeted measure to address aggressive tax schemes of an abusive nature. An objective study published in the Journal of Accounting Research in June 2004 concluded that financial statements tended to be more reliable if the auditors had been used for tax services. Mr Fairbank reiterated that the SARS comment was intended only to deal with abusive tax shelters.

Prof Turok understood that all public entities had to adopt the audit report at their AGM, and that the entity appointed the auditor. He therefore queried why there was sensitivity about the auditor, who acted as an inspector for that entity, being asked to attend and answer questions at the AGM. Mr Kana replied that there was no difficulty provided that the questions related solely to the work done on the audit, and if auditors were given the questions ahead of time, in order to prepare.

Address by Professor Michael Katz on proposed amendments to s38 of the Companies Act (Clause 7 of the Bill)
Professor Katz was asked to address the Committee to clarify the present and proposed wording of Section 38. It was correct that the current Section 38 included an absolute prohibition on companies giving financial assistance for the acquisition of their own shares, or of shares in a holding Company. This was intended to reflect capital maintenance rules, which protected creditors by ensuring that whatever was contributed as capital would not be depleted, otherwise than as prescribed. The objective was sound but the methodology deficient because it did not deal with protection, and the absolute rule caused problems.

The rule of capital maintenance was designed to cover five contexts: share buy-back by a company of its own shares; share buy-ins where a subsidiary company bought shares in the holding company; payouts by way of dividends; redemption of redeemable preference shares; and the prohibition of financial assistance by the company for the purchase of its own shares or those of a holding company. The rules were changed in 1998 to cater for the first three examples, so these options became possible provided that dual tests of solvency and liquidity were passed. In addition to these tests, a Director breaching his fiduciary duties would be personally liable. Redeemable preference shares had their own regime and did not need to be covered. However, this was not extended to financial assistance for the purchase of own shares because of the fear that financial assistance could be used to manipulate control, and that management could use corporate funding to entrench itself.

The proposed new Section 38 was now aimed at shareholder protection. It provided that if a company wanted to give financial assistance, the solvency and liquidity tests would have to be met in order to protect creditors. In addition, and in order to protect shareholders there would have to be a meeting of shareholders, convened on proper notice, at which 75% of shareholders would need to approve the financial assistance. The absolute prohibition, which had been an impediment to many useful transactions, was now removed. Professor Katz believed that this was a well-structured and useful piece of legislation that conformed to the rules on capital maintenance.

The Chairperson asked Professor Katz to submit a written submission and he undertook to do so.

Prof Turok asked whether the previous prohibition had held back progress. Professor Katz stated that even if 100% of shareholders had agreed to a transaction, that would have proven benefits, it was not permitted under the old legislation. Many black economic empowerment (BEE) transactions were hindered in this way.

Prof Turok asked if there was still danger, despite these provisions, of shareholder manipulation. Professor Katz replied that in addition to the protection conferred by the Act, Directors were still bound to comply with their fiduciary duties. If it could be demonstrated that a group of shareholders was oppressed or that the transaction was a poor one, the overriding requirement of Director’s responsibility and appropriate corporate purpose would still apply.

Mr Dlali asked for confirmation that checks and balances added to other forms of transactions. Prof Katz replied that share buy-backs and buy-ins were already addressed in the 1998 amendments, so that only the financial assistance for purchase of own shares still needed to be – and had now been – addressed.

In answer to Mr Njikelana, Prof Katz clarified that the proposed new Section 38 (2A) contained the checks and balances and that 38 (2B) prescribed that when the Directors valued the assets, they must now take into account actual and contingent liabilities, so that extra caution was added.

Professor E Chang (IFP) asked whether the Bill catered for any conflict of interest.

Mr M Netshitenzhe (Director, dti) replied that the common law would deal with this issue.

Mr F Sibanda (Chief Director, Policy and Legislation, dti) commented further that there was an onus on the audit committee to ensure that there were no conflicts of interest, especially when dealing with services provided by an auditor. – such as Clause 24, dealing with Section 270A(5). Ms X Mdludlu (State Law Advisor) confirmed that the Audit Professions Act also catered for this.

Prof Turok posed the question what would happen if a young auditor were sent by a large firm to undertake an audit of a major client, and discovered irregularities – could he be said to have any independence from the firm? A hierarchy of control and management always existed, and the auditing firm was a commercial company, so could true independence ever exist?.

Ms Mdludlu stated that the checks and balances were intended to cover most situations.

Mr Netshitenzhe added that criteria were not exhaustive.

Mr Fairbanks (PWC) added that firstly all auditors were bound to a code of professional ethics, which set out clearly that individuals, both in and outside the profession, had a duty to report. Secondly, the larger firms also had global codes of conduct and ethics and partners could be disciplined for putting undue pressure on individuals. PWC also had a confidential whistleblower line and all calls were referred to the external and independent Chair of the Ethics Committee.

The Chairperson added that all professionals were guided by Codes of Ethics, but one must accept that from time to time infringements did occur and one could not possibly legislate for every situation.

Mr Njikelana asked if the State Law Advisor had come across situations where a transaction was pursued at all costs.

Ms Mdludlu replied that the Audit Profession Act had guidelines on the information that could be sought by the auditor, as also that he should report any suspected irregularities. The Act also specified reportable misconduct.

Prof Turok commented that the language of the Bill needed improvement, such as Clause 8, which contained extremely convoluted wording.

Mr Sibanda said that the corporate law reform process was looking to overhaul all legislation and he would convey these comments.

Prof Turok asked whether this Portfolio Committee should be dealing with the matter alone, or whether they should not also call for input from FSB, Treasury and other committees. The Chairperson confirmed that the committee would consult with colleagues in the Finance Portfolio Committee.

Hearing of submissions by KPMG on the Bill
Mr Moses Kgosana (Chairman, KPMG) reported that KPMG welcomed the process of review as a step towards keeping in line with global trends. KPMG appreciated the opportunity to comment, and comments could be summarized as follows:

Definitions
KPMG agreed with the definition of a public interest company, but believed it important that any restrictions and responsibilities should apply only to listed and public interest companies that were of reasonable size. The Bill had not defined a "public company", and in particular it was unclear if it intended to regulate subsidiaries of listed entities, or those whose shares were available freely. This required clarity.

Section 269A referred to audit committees for public interest companies. Section 269A(3) required the audit committee to consist of at least two members, and only of non-executive directors. KPMG agreed that there should be two members but pointed out that due to the shortage of experience independent non-executive directors many companies would be forced to reduce the size of their existing committees. No transitional arrangements were made, so that when the legislation came into force, many companies would immediately be in breach. KPMG suggested this should be amended.

Section 270A required the audit committee to pre-approve any contract for provision of non-audit services by the external auditor. KPMG agreed that this should not be delegated to management. However KPMG believed that the full committee should not need to approve, provided that it was ratified at the next full meeting.

Section 274A related to rotation of audit partners. KPMG agreed, but pointed out that no transitional arrangements were made.

Section 275A referred in the heading to "designated auditor" but in the body text to "auditor". This led to conflicting possibilities of interpretation and needed to be amended. In regard to non-audit service, KPMG agreed that the auditor should not conduct an audit of his own work. However, both internal and external audits contained a wide range of services and if the Bill did not delete the prohibition, then it should at least defined "tax advisory" and "internal audit" services which it wished to regulate. There was a need to prohibit very few as most of the services would not be subjected to own audit, and since many of the services would in fact occur during the audit function. Auditors had to include a large range of specialist service, and many of these equipped the auditor to do the audit more effectively. Thus a blanket prohibition was ill founded and would harm audit quality. KPMG therefore suggested that the legislation should establish a strong principles-based process to test independence issues as they arose.

Section 275 referred to a "private company", but KPMG wondered if this should have referred to "limited interest" company, consistent with the rest of the Bill.

Section 285A allowed limited interest companies to comply with the accounting framework of financial reporting statements. This did not include any presentation or disclosure criteria. Although the Companies Act would allow the departures, the Auditors would nonetheless not be able to express an unmodified opinion, which would have a negative impact on the perception of the company being reported, as well as on their relationships with their banks.

Section 290 allowed limited purpose companies not to consolidate financial statements. This departed from IFRS, and would result in opposing rules for the same transaction. If this section were to remain it should at the least be amended so that the decision not to consolidate must be taken through majority consent of shareholders. The departure from IFRS should be defined in the limited interest accounting standards.

Section 300A required the auditor to respond to questions at an AGM. This could result in sensitive information being disclosed, and could be beyond the scope of the Access to Information Act and a breach of the auditor’s duty of confidentiality.

Section 440U required the Minister of Trade and Industry to approve the financial reporting standards. KPMG believed that this should not be required. The Financial Reporting Council would be equipped with necessary skills and experience to comment on new and revised IFRS. The standards were updated frequently and would shortly include GRAP standards. There was already a conflict between the requirements for listed entities to report on IFRS whereas the Bill required them to report on standards issued by the FRC.

Schedule 4 items requiring disclosure were already included by IFRS or GAAP. As standards change, so there would have to be an amendment to the Companies Act. KPMG agreed that some items would remain part of the disclosure required by the Companies Act if they were not dealt with in IRFRS, but these should then rather be included in the Financial Reporting Standards.

Discussion
Dr Rabie asked if KPMG believed that the references to private companies should be amended to limited interest companies.

Mr S Rasmeni (ANC) asked for further clarification on limited interest companies.

Ms L Engelbrecht (Partner, KPMG) stated that KPMG had seen some confusion in the use of "public interest" and "limited interest" companies as it was not clear whether there terms referred to the public/private distinction. Whatever definition was chosen should be clarified and consistent.

Prof Turok asked for further clarification on the disclosure of information at AGMs, since the shareholders were entitled to receive any information, sensitive or otherwise.

Ms L Engelbrecht replied that auditors signed a confidentiality agreement with the client, so that information would not be made available to the general public or the media. The shareholders were indeed entitled to information. The point was that a question might not strictly be audit-related, or might be phrased by a disgruntled shareholder to try to obtain information that was confidential. The auditor could have answered in good faith, but still be accused by the client of a breach of confidentiality.

Prof Turok commented that a CEO might wish to hide something from his own shareholders, and claim that he was the client.

Ms Engelbrecht confirmed that the shareholders appointed the auditor. The position where a CEO might wish to hide something was dealt with in section 45 of the Audit Professions Act, which stated that any irregularities must be reported to the IRBA. Auditors could also modify their audit opinions to the shareholders if they found irregularities. Those provisions were robust enough to deal with suspected irregularities. KPMG was concerned about the fact that anything said in the public forum of the AGM could be debated and pulled out of context. Section 45 of APA seemed a far more appropriate vehicle.

Prof Turok asked what proportion of KPMG’s work was non-audit related, and asked what the impact of the amendments would be if there was a prohibition on performing non-audit services.

Mr Kgosana responded that KPMG supported the principle that an auditor should not audit his own work. KPMG’s non-audit services comprised about 40% of their total fees. An audit of a large company could be very complex and could require input from forensic investigators, IT specialists and the like – although this might be regarded as directly related to the audit. The smaller firms would be most likely to be badly affected as they did not have enough multi-disciplinary experts to supply services to help them to supply a quality audit.

Prof Turok repeated his analogy of an auditor being in a similar position to a building inspector.

Ms Mohamed asked how KPMG suggested that the accounting framework should be worded. Ms Engelbrecht suggested that the FRC should establish a framework for limited interest companies as soon as possible, but certainly before enactment of the Bill, otherwise limited interest companies would receive modified reports from their auditors. Schedule 4 did not allow for consistent evaluation so that the company auditor could not express an unqualified opinion.

Mr Dlali commented that in certain instances KPMG had not made concrete proposals for reform.

Ms Engelbrecht replied that in respect of non-compliance, the Bill should give 12 months from the date of enactment for companies to establish audit committees. The transitional arrangement for audit rotation should be prospective, and not retrospective, and Section 53(3) should be worded to this effect.

Mr Njikelana queried the risk of reducing the number of members in the audit committee under Section 269.

Ms Engelbrecht confirmed that at the moment King II asked for the majority to be independent non-executive directors. The current composition of most Boards was 3-5 and if the Act were to stipulate that all members of the audit committee should be non-executive directors, many companies would be forced to cut down the numbers of serving members to two. It would be preferable if the Act were to ask for "a majority" of non-executive directors, in line with King II.

Mr Njikelana stated that all decisions of the audit committee were in any event ratified by the Board, so he queried why there should be any comment upon delegation of the functions of the audit committee.

Ms Engelbrecht clarified that KPMG had no problems in principle with this section but were concerned that it should not be the function of the audit committee to perform any appointment.

Ms Mohamed asked for KPMG’s opinion whether South Africa was on track in creating a workable regulatory framework.

Ms Engelbrecht believed that it was. The Companies Amendment Bill contained sound practical changes to achieve the objectives set out. The Auditors Profession Act went far to regulate the profession, to offer public protection and to warn shareholders of irregularities. However, she warned that one should guard against over-regulation.

Afternoon session
Ernst and Young presentation
Adv D Clegg (Partner-Tax Division) presented information on the proposed section 275A of the Companies Act regarding the independence of auditors. The basic principle was that auditors should not audit their own work. Detail was provided on tax advisory services. Different opinions existed in terms of certain provisions of the Income Tax Act. Advisory tax functions were outlined. A company would benefit if its auditor was allowed to provide tax advisory services in relation to tax significant events. A company’s audit committee could provide permission to the auditor to render tax advisory services.

Discussion
Prof B Turok (ANC) asked whether chartered accountants did not perform bookkeeping and accounting services as a normal function. The Bill indicated that accountants should not perform such a role. An auditor should not provide tax advisory services. The distinction between accounting and auditing should not be blurred as the two functions were different. He asked what proportion of an accounting firm’s daily activity was devoted to non-audit services.

Mr Dlali sought clarity on the envisaged additional costs for companies if tax advisory services were not conducted correctly. The need for pre-approval for tax advice from an audit committee for an auditor could create a conflict of interest.

Mr Rasmeni referred to the danger of qualified audit reports to a company’s financial status. The involvement of one company as opposed to various entities could be a more cost-effective approach and avoid a lengthy process.

Ms Mahomed asked whether accounting firms recognised the distinction between tax advisors, auditors and accountants and whether clear lines of communication existed between them.

Adv Clegg noted that auditing firms have accounting and bookkeeping divisions. An established rule was that a firm could not engage in bookkeeping while conducting auditing services. However, bookkeeping and accounting services could be provided for non-audited firms. Ernst and Young had 350 staff members in Cape Town of which 170 were audit professionals, approximately 30 specialised in tax advice, 30 focused on business consultancy and the remainder concentrated on bookkeeping and related services. A certain multi-national company had an annual audit fee of R11 million of which R700 000 was expended for the tax element of the audit. Tax advisors had to understand the particular context of a business in order to grasp the tax deductability of purchased assets. A lack of understanding of a certain context could lengthen the auditing process and generate additional costs in terms of differences of opinion. The appointment of an external tax advisor could serve as replication and duplicate the cost factor. The use of more than one advisor by a company was not uncommon due to the need for specialisation in certain fields. SARS could also be consulted if need be to acquire important information. The taxpayer had to decide which path to follow. Audit companies contained external individuals determined to render an unbiased view of the company and monitor activity. The intention of the committee was to keep the company clean. Costly conflict could be avoided at a later stage if proper consultation was conducted ab initio. Correct advice could prevent the likelihood of a qualified audit in future. A distinction existed between tax advisors and the audit tax division within a firm. However, both functions were directed towards the same purpose, namely, to identify the correct tax liability. Experienced auditors were needed to conduct an audit and identify a significant audit material amount.

Association for the Advancement of Black Accountants of Southern Africa (ABASA)
Mr V Sekese (Management Board) provided background on the organisation that strove to transform the accounting profession. Certain provisions of King 2 should be incorporated into the corporate law framework. Comment was provided on the role of audit committees that had to act independently. All companies should be subject to the audit committee stipulations. Financial statements should include an audit committee report. The committee should comment on the effectiveness of the system of internal controls. Audit partners should be rotated every seven years to ensure independence. The proposed legislation should govern both the public and private sectors in equal measure. The rotation of accounting firms could open up opportunities for smaller firms to acquire experience. More clarity is required in the bill between public interest and limited interest companies in terms of financial reporting requirements. Auditors should have right of access to key role-players within a company.

Discussion
Dr P Rabie (DA) noted the dominance of the big four auditing firms and asked whether smaller firms would have the necessary expertise to conduct audits of clients with specialised needs.

Ms Mahomed asked whether ABASA was proposing that firms be rotated on a seven-year basis and asked how this proposal could be implemented and included in the Bill.

Prof Turok sought clarity on the rotation of the firm as opposed to the individual. Alleged inconsistencies within the public sector should be brought to the attention of the Committee so that oversight could be conducted. He asserted that the distinction between auditing, tax advice and tax-related accounting activities had to be clearly identified in the Bill. Certain key concepts should be clearly defined in the Bill.

Mr Dlali referred to section 22 of the Bill on the role of the audit committee and its composition and sought clarity on the presenter’s proposal in relation to the particular clause.

Mr Sekese replied that a large proportion of the economy was not specialised and smaller companies could be productively employed to engage in audit activities. Opportunities should be provided to new audit firms. Collaboration between experienced and new auditing firms resulted in skills transfer. Many emerging firms could also become experts in certain economic sectors. Regulations should determine the appropriate timeframe for the rotation of auditing firms. Audit firms would need to recover set-up costs over an appropriate period of time. The rotation of individual partners within one firm could create an independence dilemma due to the commercial interest of the firm in maintaining the contract. The rotation of firms would generate a higher level of independence and should occur in both the private and public sectors. No research had been conducted to support allegations of inconsistencies within the public sector in terms of compliance and use of auditing firms. A standard approach was needed to maintain sustainability. Auditors should be allowed to provide assurance-type services after receiving permission from the audit committee. Tax advisory services should be viewed as separate to the auditing function. The King 2 report set out clear standards for the independence of auditors.

The meeting was adjourned.