James McGrath (Queensland, Liberal National Party) Share this | Link to this | Hansard source

On behalf of the Chair of the Parliamentary Joint Committee on Corporations and Financial Services, I present the report of the committee on the regulation of auditing in Australia, together with documents presented to the committee.

James Paterson (Victoria, Liberal Party) Share this | Link to this | Hansard source

I move:

That the Senate take note of the report.

I rise to take note of the Regulation of auditing in Australia report. I'll put the headline up-front: the committee has delivered a final report in addition to its interim report, which was tabled in February. In the intervening period, not much has changed about auditing but everything has changed about our economy, and that reflects the concluding comments that the committee has made today and will be tabled today.

In short, the committee stands by all 10 recommendations which were made in our interim report in February 2020. Those recommendations were made on a bipartisan basis in a unanimous report encompassing all members of the committee. I take the opportunity to place on the record my appreciation for all members of the committee who worked together in a collegiate way on this issue and in this interim report and now final report and, in particular, the deputy chair, Mr Georganas, and Senator O'Neill, who initially referred this inquiry through this chamber to the committee.

Our interim report in February found that although there were widespread concerns among stakeholders about the quality of audit in Australia there wasn't good evidence available to the committee, hard empirical evidence, that there was a systemic problem with audit in Australia. What we did identify was a perception about the problem of audit quality in Australia. Many stakeholders, whether they were shareholders or academics or industry associations or other groups, believed that there were perception issues in the industry that needed to be addressed.

We made 10 recommendations. Some were aimed at the industry, some were aimed at the regulator ASIC, others were aimed at the financial FRC and others were aimed at government in order to address those perception issues. We believe that if those recommendations are faithfully implemented by all those bodies then the reputation of the audit industry in this country will be enhanced and greater confidence will be restored to the industry, because the confidence that investors are able to place into the financial statements made by companies is a crucial part of a free market economy. It allows the efficient allocation of capital. It allows the trust in markets that are essential to this industry, and auditors have a crucial part to play in that.

In our concluding comments tabled today, we stand by all 10 of those recommendations. I won't go through all of them individually and I won't go through them in detail, but there were some which have attracted particular interest and particular comment. Our seventh recommendation in our interim report was to implement a mandatory audit tendering regime, which would require company boards after a 10-year period of using one auditor to either engage in a tender process to potentially choose a new auditor or, if they didn't wish to do so or didn't believe that it was necessary to do so, to explain that decision to their shareholders. That could be in the form of a note in their annual report or another means whereby they demonstrated to their shareholders that they had thought about this issue and they had decided they wanted to stick with their current auditor for whatever reason.

There are good reasons why you might wish to keep an auditor for longer than 10 years. Having an auditor for a long period of time allows them to develop a familiarity and an understanding of your business. It's typical that in the first few years of an audit enormous resources have to be expended to get to understand a company and its operations and that over time the audit process becomes both more efficient and more effective. However, the longer period of time that a company is audited by the same auditor, the greater the risk that the independence of the auditor is compromised and, perhaps in some ways more importantly, the greater the risk of a perception that that auditor's independence has been compromised.

We have seen a few high-profile companies and auditors who have been in audit relationships for many decades. In fact, there was one celebrated case, I think it was 67 years, where the same audit firm audited a company for that time. Of course, the audit committee chair on the board of the company that was audited would have changed many times in those 67 years. The chief financial officer in that company would have changed many times in those 67 years, and the lead audit partner in the audit firm would have changed many times in those 67 years. Nonetheless, it sent a message to the regulated community, to the audience for those audit reports, that a cosy relationship may have been established, and that has undermined confidence in the system.

What that recommendation is asking companies to do is to either undertake a tender every 10 years or to demonstrate to their shareholders why they don't believe that's necessary.

Some have said that a 10-year period is too short, and it would absolutely have been up to the committee to recommend a different period—it could have been 12 years or 15 years. I don't think there's anything hard and fast about the 10-year rule, but it is important that some sort of process is put in place here to demonstrate that boards understand that their relationship with their auditor should not be set and forget and that they should not allow the perception to form among their shareholders or other stakeholders that it has become set and forget. They should demonstrate that they're considering this.

Another recommendation that has attracted some comment and interest is recommendation 9, which is about establishing internal controls for financial reporting. It has been put to the committee that there would be costs involved in implementing this recommendation, which is undoubtedly true, and that in some instances and for some businesses this may not be necessary—for example, a family owned business where the family is both the management of the company and the owner of the company. Who would they be assuring except themselves? That is a good and fair point. It is also true that, even in larger businesses, there would definitely be transition costs in implementing this recommendation.

The committee understand that, and, in light of the changed economic climate that we're in, our recommendation is that government consider all of the recommendations, but, in particular, recommendation 9, on the basis of, firstly, the time lines for implementation—we should consider very carefully the appropriate time lines—and, secondly, the thresholds for implementation. At which level is it appropriate, whether that is by revenue or by some other measure, to implement them? We urge the government to carefully consider that, because at the moment, quite rightly, businesses and their partners—whether their auditors or other service providers—are solely focused on trying to save their businesses, to save as many jobs as possible and to grow on the other side of this crisis. The committee certainly does not want to distract them from that important task or to impose costs on them at a time when they're focused on that task. They absolutely should be focused on that crucial task. But we believe that, with appropriate time lines and by appropriately staggering the implementation of these recommendations, all 10 could be adopted—and adopted successfully—both on the audit side and on the company side, to enhance the reputation and quality of audit in this country.

I will just conclude by revisiting one of the recommendations in the interim report which most attracted my interest and enthusiasm, and that was recommendation 10, about the introduction of digital reporting. I believe there are huge gains for auditors, for the businesses that they audit and also for other market participants from digitising our financial reporting. It is amazing to me, as I discovered through this inquiry, that in 2020 there are still companies and auditors who engage in a fairly manual process of data entry to extract data from companies for the purposes of financial reporting—that it isn't automated and that it isn't more efficient. Other jurisdictions, including the European Union and the United States, have successfully implemented digital financial reporting. It has lowered the cost of audits and lowered the costs for other market participants in assessing the quality of audits. And it allows much more independent third-party verification of those numbers. It allows those numbers to be used in a lot of other ways that enhance the confidence that all market participants have in this process.

There is little more to add to the concluding comments, which are relatively brief, except to say that, compared to February, when the interim report was handed down, we are in a different world. Certainly, the committee recognises that. It hasn't changed the substance of any of the recommendations that we have made but it does change the posture, I guess, that we've taken on this. Our final recommendation to government in the concluding comments is that the government should carefully consider both appropriate time lines and thresholds for the implementation of these recommendations, taking into consideration the new and very different economic climate that we're now in, thanks to COVID-19, and of course the necessary government responses to COVID-19, which have had an enormous impact on our economy.

Deborah O'Neill (NSW, Australian Labor Party) Share this | Link to this | Hansard source

I rise today to speak about the final report of the Parliamentary Joint Committee on Corporations and Financial Services inquiry into the regulation of auditing in Australia.

This is a landmark report, and it offers a timely, bipartisan and credible road map to ensure our auditing industry is accountable, transparent and appropriately regulated. I'm reminded every time I turn a page of this report—and, indeed, by the concluding remarks that have been tabled here—that this inquiry was desperately needed and that the issues the inquiry uncovered needed to be seen in the clear light of day. I'm also reminded of the high-stakes nature of this issue. If the audit concerns revealed by this inquiry remain unresolved, they could shake our already rocky economy to its core.

Auditing underpins the stock market and the economy and, with more and more Australians depending on superannuation to provide for their retirement, the quality of audit is a matter that materially effects the financial wellbeing of every Australian and their family. The big firms that Australia knows—PwC, KPMG, EY and Deloitte—are at the core of the auditing profession. This report is about what we found when we investigated them, and other entities in the field as well, over the course of most of 2018. This inquiry exposed what journalist Adele Ferguson rightly described as an 'opaque and conflicted industry'. ASIC, although under a cloud at this time, has been vocal over years in calling for an investigation into the quality of audit due to escalating concern following their annual reviews revealing that audit quality was dropping.

The elaborate and systemic exploitation of ordinary Australians by major financial institutions revealed in the Hayne royal commission into banking was a wake-up call to many of us that something was deeply wrong in so many areas of our financial services industry. The conflicts of interests between the consultancy and the auditing businesses of many of Australia's largest professional firms deeply troubled me in that context. The evidence put on the public record in the course of this inquiry about how terribly corrupting financial incentives can be for far too many people and businesses, especially the biggest banks and corporates in the country, is not of the same scale in the audit industry, but we need to be mindful of the power of financial incentives to corrupt.

This report is an achievement. It's an achievement for my colleagues on the committee, who listened to many hours of evidence, read dozens of submissions and contributed in ways big and small. It is an achievement also for all the whistleblowers who bravely stood up and revealed practices and attitudes in the major Australian auditing companies that compromise any commonly understood definition of ethical business behaviour, integrity and professional audit scepticism. Their insight and generosity in sharing their knowledge with me on behalf of their fellow citizens marks them out as genuine servants of our democracy. Truth must be told. Companies that don't hear internal whistleblowers are short-sighted. I hope that more civic-minded Australians see that their truth-telling to parliament can make a profound difference that benefits millions of us. I thank them.

I personally ran into some strong headwinds when I initially moved to establish this inquiry. Indeed, I had to advance it and put it to a vote on the floor of the Senate. I'm happy to say it was carried that day on the voices, but I thank Senator Whish-Wilson and his team, Senator Lambie, Senator Griff, Senator Hanson, Senator Patrick and Senator Roberts for their commitment to supporting my motion, which enabled this committee to do its work. Without their initial support, I don't think the work of the committee that's been reported today would have been undertaken at all. I particularly thank my Labor colleagues, my own wonderful staff and the committee staff for their vital role in bringing forward this report. I also thank the chair of our committee, Senator James Paterson, and the other Liberal members of the committee for their endeavours as well.

Once the direction of the Senate for establishment of the committee was achieved, Senator Paterson approached the inquiry with a calm and steady hand during all of our hearings, private meetings and other deliberations, always happy to reach across the aisle when in the interests of the nation. It's a credit to Senator Paterson that he's worked carefully and collaboratively throughout this inquiry. I listened to his contribution this afternoon and I accord with him in his assessment of where we are. I note in particular his comments around the necessary changes to the implementation of recommendations 7 and 9, which are impacted by practical realities at this time. The report goes out under Senator Paterson's signature, and I hope he will be just as zealous as I will be in ensuring that the recommendations in this report are taken seriously by this government and that implementation occurs as soon as is practicable.

It's fair to say there were significant variations of practices by each of the big four, but the report reveals the necessity of the inquiry, the need to reform outdated and potentially dangerous conflicts of interest, the need to establish more oversight of the practices in the profession and the need to change the perverse and reckless behaviour that we saw in some of the big auditing firms.

This inquiry also found a deeply troubling culture at many of the auditing giants, including evidence of ineffective management of conflicts of interest. I also received in-confidence reports of sexual harassment across the entire sector. It also uncovered that Westpac's anticrime provisions were inadequate and that the board, having known about that failure for years, should have acted much sooner on the reports provided by their auditors. Westpac was subsequently investigated by AUSTRAC over 23 million breaches of the Anti-Money Laundering and Counter-Terrorism Financing Act.

I remain concerned about the use of the CPS 220 reports, which are provided by auditors, about perceived and real conflicts of interest which auditors determine by their own reckoning. Their professional right to undertake work as both an internal auditor and an external provider of assurance services was something I simply couldn't believe they were saying on the record. There might be some technical alchemy of magic words that, with a wand and some swift hand movements, can be employed to continue to justify such practices, but decent, straight-talking Australians know what the word 'independent' really means. You can't be an outsider and an insider at the same time. It's time the sector accepted that fact and fixed the problem, and changed the perceptions as well.

This report has some key recommendations that I would like to speak to briefly: recommendations 3, 4 and 5. In my view, they go to the heart of why I brought this inquiry to bear. I was worried that auditors were too close to their clients and that information barriers declared in internal policy documents were in fact non-existent or severely compromised by lax consideration. It became clear that auditors were auditing their own firm's work. That is just beyond the pale. It cannot happen—not if we're going to have the integrity of financial reporting that we need in this country. I remain concerned, despite denials, that audits are being employed in some instances as loss leaders for far more lucrative consulting work.

The pandemic has shown that we cannot always take for granted that traditions will hold and that inertia and ennui will carry us safely into the future. We need to ensure that ethical practices and culture are not only assumed to be in place but also subject to critical review and, where necessary, regulated and carefully overseen. In Australia, we cannot risk an Enron style auditing failure, and this inquiry, I believe, has brought us back from the brink. Our economic prosperity cannot be rebuilt on falsehoods, on foundations made of sand, and an unreformed and unrepentant auditing industry will put all we seek to achieve here at risk.

I commend the report to the Senate and I give very strong voice to encouraging the government to get on with the job. I know that Senator Paterson will be sharing in my delight as it is implemented. I think we'll all get the benefit of that.

Andrew Bragg (NSW, Liberal Party) Share this | Link to this | Hansard source

It's a really great pleasure to rise to speak to the PJC on Corporations and Financial Services' final report on the regulation of auditing, which of course follows the interim report. I started my career, for better or worse, as an internal auditor at Ernst & Young and got some good skills for life there. Learning how a risk and control framework can do great things for an entity is a good skill. I would say in relation to this inquiry—which, as Senator O'Neill reminded the chamber, was initially referred by her to the committee chaired by my colleague Senator Paterson—that this report has landed 10 quite good recommendations, which are bipartisan and, I think, really could improve the quality of auditing in Australia.

Certainly, there is a sense in some quarters that there is too close a proximity between auditors and audit clients, and perhaps this is a consequence of there being these four large auditing firms and then a second tier of much smaller audit organisations. I would say from my own experience of working mainly in internal auditing that there were certainly instances where their proximity was too close and there were audit partners that I don't think had the independence required to perform an external or internal audit.

These recommendations, which appear in the interim report and have been endorsed in this final report that's being tabled by my colleague Senator Paterson today, are effectively a way to shore up and improve the existing system. My reading of these recommendations is that they are designed to ensure that there is more confidence in the system. I'll look at a few of these recommendations in detail.

Recommendation 4 deals with the question of a more detailed declaration. That does address the comment I made about where an external auditor providing advisory services to an entity can give rise to a conflict of interest. In many cases, there's been a price war to win the auditing contract. That is almost a bit of a loss leader. Advisory services are where the audit firm or the professional services firm can make a considerable amount of money—which is all good; I have no problem with people making money. But the audit function is so important to our corporate governance structure in Australia that, where there are conflicts, where there are misaligned incentives, they really ought to be stamped out, given the importance of having an audit that reflects the true and fair position of a company's financial accounts. Just as important, I would say, is the role that internal auditors play. I don't just say that as a former internal auditor. Genuinely, there is a greater appreciation of the importance of having a proper risk and control framework.

One of the great disappointments in the last few weeks has been that the corporate regulator has failed to comply with its own risk and control framework. The corporate regulator appeared at Senate estimates two weeks ago, I think it was. It's very embarrassing that the corporate regulator has a risk and control framework, has a control on remuneration, and was unable to comply with that control. That sends a very bad signal. It shows how important it is that internal auditing—a lot of this is about professional services firms winning the contract for the external auditing and providing advisory services which then distort or conflict with the sort of audit you would expect of a public company. In my time, I saw it happen.

Recommendation 4, which provides more fulsome confidence to the market that there will be a full disclosure of services provided, is an important one. Equally, recommendation 5 gives a safeguard that there are no secret commissions or additional payments happening in the background. Recommendation 6 deals with tenure. I think tenure is very important. I'm not certain there is a case for people to be the audit partner for more than a decade. Generally speaking, 10 years is what the ASX Corporate Governance Council would say is a period in which someone can be an independent director on a company board, and after 10 years they lose the right to call themselves independent.

APRA has said that it should be, I think, eight years for people to be on a superannuation board. Like many things APRA does, this has not been enforced. In fact, there are people who are currently sitting on superannuation boards who have been on a board for 26 or 27 years. I'm 36 years of age. That's a long time. That's a good deal—27 years on a board. I do think that tenure is important. If all the other transparency arrangements are in place and the market can make a judgement about the capacity and the appropriateness of a long-term audit tenure, then I think that is okay. The question is: what about the individuals? I think that's what recommendation 6 really asks the government and, ultimately, the parliament or its delegated authorities to put more detail around.

The other recommendation that I want to touch on in the time that I have remaining is recommendation 9. It is a good reminder of how important the control frameworks are and that anything we can do to improve confidence in these control frameworks so that, when people invest in a public company, whether it's a large or small public company, they feel that the accounts are a true and fair position and there is no funny business going on.

Finally, recommendation 10—I'm always interested in all things digital. We have a problem in this country of still doing too many things on paper. The Corporations Act, which was written in 2001, still requires paper delivery of documents and doesn't provide for technology neutrality. This has been a real drag on our productivity and efficiency. I've had many representations from listed companies that have had to chase around small retail shareholders at their last known address for seven years after they were last able to contact them, and send them, effectively, phonebook style correspondence for seven years. We have a plan to try and digitise and modernise the Corporations Act, or many of its provisions. In future, the more that we can provide for technology neutral delivery in a digital age, the more it will enhance our productivity and efficiency. Certainly, the next time we write a Corporations Act we should provide for that form of technology neutrality. I understand that some people will always want to have paper documents and when you have retail shareholders who want a particular form of paperwork there should be a protection so that can be supplied. But, in the main, my sense is that digital accounts will be the way to go and that recommendation 10 is another good contribution.

I congratulate everyone who was involved with this committee report, particularly Senator O'Neill and Senator Paterson.

Deborah O'Neill (NSW, Australian Labor Party) Share this | Link to this | Hansard source

On indulgence, can I acknowledge the secretariat, Dr Patrick Hodder and Dr Jon Bell, for their outstanding work in the context of the report. I seek leave to continue my remarks later.

Leave granted; debate adjourned.