Duty: Auditors have a legal obligation to convey a reportable irregularity to the correct authority.
African Bank’s recent colossal collapse and JD Group’s mammoth increase in provisions for bad debt have raised questions about why issues were not picked up by a number of regulatory bodies in both these sectors, but in particular by their auditors.
The frustration for many investors is that there are a number of avenues auditors may take to raise the alarm, and legislation to guide them, and the public is not always alerted when auditors who have erred are punished.
KPMG director Steven Louw said auditors have a legal obligation to convey a reportable irregularity to the Independent Regulatory Board of Auditors (Irba), including where management has been involved in fraud or suspected fraud, has failed to comply with fiduciary duties, or has not complied with an Act and incurred material losses.
Louw adds a new standard on audit reports is expected to be released by the International Auditing and Assurance Standards Board, which should be effective by the end of 2014, and will require auditors to disclose more in their audit reports. This will allow for increased flexibility for reporting what an auditor feels is important to communicate with shareholders for a particular financial year.
Louw, however, believes that auditors generally fulfil their duties, and very few examples exist in the local market of where auditors have “gotten it horribly wrong. The audit process is not an exact science and requires much judgement”. This, he says, makes it difficult to pinpoint whether auditors have gotten it wrong or whether there are other factors at play, such as information not being fully disclosed.
Louw notes that if an auditor gets an audit opinion wrong, the auditor and all his or her partners can be sued since there is unlimited liability, provided that the auditor is proven to be negligent. If an auditor knowingly or recklessly expresses an opinion or fails to report a reportable irregularity, they face a fine or 10 years in jail, he adds.
Jeremy Klerck, the director at Herold Gie Attorneys, believes that it is important for there to be co-operation and communication between internal auditors. Internal auditors should examine relevant strategic, business and operational risks and their significance, while external audit is empowered by legislation to evaluate companies’ internal control procedures and financial reporting.
Irba chief executive Bernard Agulhas said auditors do report weaknesses in internal controls, adding the association receives about 800 reportable incident reports a year, which are then investigated by the relevant regulators.
He said companies’ governance structures, such as audit committees, the board and those charged with governance, along with management who are responsible for preventing business failures, not auditors.
“If they did not respond to the auditor’s communications, then they should be held accountable,” he said.
Agulhas notes governance issues relating to companies that should be raised include: absence of oversight in implementing internal controls and controls for the prevention of fraud; risks that could impact on the business not being identified; poor oversight and controls over management reporting; and ineffectiveness of governance structures such as audit committees.
The issues also include absence of oversight to prevent fraudulent financial reporting; management not exercising fiduciary duties; policies and procedures not being complied with; poor IT governance; laws as well as regulations not being complied with.
Agulhas said auditors do alert shareholders to issues through the audit report. They also have a direct line to audit committees or oversight authorities, and the Irba will alert relevant stakeholders about reportable incidents.
Shareholder activist Theo Botha said in the case of African Bank and the JD Group, investors should have received more warning.
Auditors “can play a fantastic role”, he said, but complacency is a risk. He believes auditors should be rotated every seven to 10 years so they do not fall into this trap. He believes, too, that internal auditors, who take their direction from management, should be in better communication with companies’ external auditors.
Botha said auditors should also be issuing reports to shareholders when they find concerning issues, such as qualified audits.
He said it is hard for a company to act as a “whistle-blower” against a client. “I’ve never seen an auditor alert anybody to anything, honestly,” he said.