Bills Digest no. 134 2011–12

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WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

Margaret Harrison-Smith
Law and Bills Digest Section
24 March 2012

Contents
Purpose
Background
Financial implications
Main issues
Key provisions

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Date introduced:  29 February 2012
House:  House of Representatives
Portfolio:  Treasury

Commencement:  Sections 1 to 3 commence on the day the Act receives the Royal Assent.  Schedule 1 commences on the 28th day after the Act receives the Royal Assent, and Schedule 2 commences on the day the Act receives the Royal Assent.

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill's home page, or through http://www.aph.gov.au/Parliamentary_Business/Bills_Legislation. When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website at http://www.comlaw.gov.au/.

Purpose

The purpose of the Corporations Legislation Amendment (Audit Enhancement) Bill 2012 (the Bill) is to implement a number of reforms directed at enhancing audit quality in Australia, and to bring Australia into line with international best practice in audit regulation.[1]

Background

Treasury consultation paper

In March 2010, the Chairman of the Financial Reporting Council (FRC) released a Treasury consultation paper entitled Audit Quality in Australia: A Strategic Review (consultation paper).[2]

In releasing the consultation paper, the Chairman stated:

High quality financial reporting and an effective audit function are key components of efficient capital markets and are critically important to global financial stability and sound economic growth.[3]

The Chairman referred also to the part the global financial crisis has taken in highlighting ‘the importance of audit quality with a range of additional complexities, risks and uncertainties confronting auditors’.[4]

 A key finding in the consultation paper was:

…that Australia’s audit regulation framework is robust and stable and, as a key driver of audit quality, can be considered to be in line with international best practice.[5]

However, the consultation paper also identified a number of areas where it was considered that improvements could be made to bring Australia into line with international best practice in audit regulation.

Release of exposure draft

On 30 September 2011, the Parliamentary Secretary to the Treasurer released an exposure draft Corporations Legislation Amendment (Audit Enhancement) Bill 2011 (exposure draft).[6]

The intended improvements identified in the consultation paper were reflected in the exposure draft.  They included:

• provision for directors of a listed company or listed registered scheme to extend the current auditor five year rotation period in specified circumstances
• a requirement for larger audit firms to publish an annual transparency report
• streamlining of the respective roles of the FRC and the Australian Securities and Investments Commission (ASIC) and
• empowering ASIC to publish audit deficiency reports on individual audit firms.

Comments were sought on the exposure draft by 28 October 2011. Treasury received 16 submissions in response to the draft, 15 of which were public, and one, confidential.[7] Submitters were supportive of the key reforms proposed in the exposure draft, including the proposal to extend the five year audit rotation period currently provided for in the Corporations
Act 2001 (Corporations Act) for up to two years, and the proposed new functions for the FRC under the Australian Securities and Investments Commission Act 2001 (ASIC Act). 

 

In response to concern at the failure of the Exposure Draft to provide audit firms with a right of response to an audit deficiency report by ASIC, the Bill provides auditors with the right to comment on such a report prior to publication, and to have their comments published by ASIC with its report.  

Basis of policy commitment

The Government has indicated its commitment to implementing the improvements to Australia’s audit regulation framework identified in Treasury’s strategic review of audit quality in Australia.[8]

Committee consideration

On reviewing the Bill, the Senate Standing Committee for the Scrutiny of Bills (Scrutiny of Bills Committee) sought responses from the Treasurer justifying the approach taken on two of the Bill’s proposed provisions.[9]

The first provision, proposed subsection 332B(1), provides that the information to be included in an annual transparency report must contain information to be prescribed by the regulations. Although the explanatory memorandum provides details of the sort of information that would be required[10], it provides no explanation of why delegated legislation is appropriate.

The Scrutiny of Bills Committee considered that at least some of the information requirements could be dealt with in the Bill itself.  The Committee considered that the proposed provision may be considered to delegate legislative powers inappropriately, in breach of Standing Order 24(1)(a)(iv).[11]

In response, the Treasurer has stated:

The reason that this approach has been taken is because this information is a matter of a detailed technical nature. Including the information in the Regulations allows it to be dealt with more efficiently. It also ensures that if practical concerns are raised with the requirements following implementation these concerns can be addressed quickly.[12]

The Treasurer has also noted in his response that ‘the Bill permits information to be omitted from the transparency report where its disclosure is likely to cause unreasonable prejudice to the auditor, despite that it may be required by the Regulations’.[13]

The Committee thanked the Treasurer for his response with respect to this proposed provision.[14]

The second provision, proposed section 332G, provides that an offence that would otherwise be committed by a firm in relation to an annual transparency report is to be taken to have been committed by each member of the firm.  The Committee indicated that, in its view, the imposition of collective responsibility should be strictly justified.

While there are exceptions in the proposed provision to collective liability, the defendant bears an evidential onus of proof.  The Committee noted that this is not addressed in the Explanatory Memorandum.[15]  The Committee considered that the proposed provision may be considered to delegate legislative powers inappropriately, in breach of Standing Order 24(1)(a)(i).[16]

The Treasurer has provided the following response:

The imposition of collective responsibility is designed to encourage a 'culture of compliance' across the whole firm. This will ensure that each member of the firm is aware of the firm's responsibilities and takes responsibility for the firm's compliance with the transparency report provisions.

The offence provisions were drafted so that a member of a firm does not commit an offence if they are not aware that the contravention occurred or they have taken reasonable steps to correct the contravention. The burden of proof is placed on defendants because it would be extremely difficult for the prosecution to prove a defendant's knowledge of a contravention and this would act as a disincentive to compliance. The burden of proof on the defendant is lower than that on the prosecution. Section 13.3(3) of the Criminal Code provides for standards of proof required from the prosecution and defendants.

An evidential burden of proof imposed on a defendant requires only evidence that suggests a reasonable possibility that a matter exists or does not exist. In contrast, the legal burden of proof on the prosecution to disprove any matter in which a defendant has discharged an evidential burden of proof must be beyond reasonable doubt.

The imposition of an evidential burden of proof on the defendant is consistent with other offence provisions in the Corporations Act 2001.[17]

The Scrutiny of Bills Committee has left the question of whether the proposed collective responsibility provisions are appropriate to the consideration of the Senate as whole.[18]

The Senate Selection of Bills Committee resolved at its meeting on 15 March 2012 not to refer this Bill to a committee.[19]

Policy position of Coalition

The Bill is supported by the Coalition.  Tony Smith, MP, speaking on behalf of the Shadow Assistant Treasurer, said that:

The bill is an incremental but nevertheless worthwhile improvement to the audit process. It has the widespread support of the audit industry. The legislation is the outcome of a Treasury review of the quality of audits in Australia. This was instigated following the global financial crisis in 2008. This review found that the legal framework was, overall, robust and stable and was in line with international best practice and no fundamental changes were required. This is a tick of approval for the former Howard government's major audit reforms, which were introduced through the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act some eight years ago, in 2004. The issues addressed in this bill are very much tweaking rather than wholesale, for those reasons.

…

We are very happy to support well-reasoned legislation where consultation has been extensive and the industry is in agreement, and this is one rare occasion where that is the case. On behalf of the shadow Treasurer, I commend the bill to the House.[20]

Position of major interest groups

Stakeholders responded positively to the exposure draft released in September 2011.[21]  The key elements of the exposure draft were broadly supported. Criticisms of the exposure draft related more to the detail of the proposed reforms than to the reforms themselves.

The Bill reflects a number of amendments made as a result of the consultations on the exposure draft. For instance, in providing an auditor with the right to comment on a deficiency report prior to the publication of the report, and requiring any comments made to be included by ASIC in the report, proposed section 50E of the ASIC Act, inserted by item 16 of Schedule 2 of the Bill responds to procedural fairness concerns with a proposal in the exposure draft, which were raised by a number of stakeholders. For example, Ernst & Young submitted:

…if ASIC chooses to publish a report, the Firm should be permitted to provide a response and, if the firm does so, ASIC should be required to publish the response together with the report.^[22]

The Bill does not respond to criticism by some stakeholders of the absence from the exposure draft of a right of review of ASIC decisions relating to the publication of an audit deficiency report.

Although supporting the view expressed in the Explanatory Memorandum to the exposure draft^[23] (and repeated in that of the Bill)^[24] that review by the Administrative Appeals Tribunal (AAT) of such decisions would create undue delay, several stakeholders made alternative review suggestions.  For example, Deloitte submitted:

… the Treasury could consider other established review bodies that could more efficiently or expeditiously consider an appeal against the publication of an audit deficiency report, such as the CALDB [Companies Auditors and Liquidators Disciplinary Board] or the Financial Reporting Panel within specified time frames.  We do not believe a fair appeal process would unduly delay the publication of the reports nor be contrary to the public interest.^[25]

The Financial Reporting Council Taskforce also agreed that ‘the AAT is probably not appropriate as the review body given the delay before a hearing could be held and the lack of specialist financial reporting and audit expertise within the AAT’.^[26] However, while considering whether a reconstituted Financial Reporting Panel or CALDB might be more appropriate, it pointed to the resource implications of these options, the need for legislative change and that ‘any third party review would inevitably delay the process having regard to the fact that ASIC already must allow for a six month period before it can publish an audit deficiency report’.^[27]

KPMG submitted:

 

…the potential commercial, legal and reputational consequences of publication, coupled with the [ASIC’s] broad regulatory discretion … merit the protection afforded by a confidential appeals process, particularly when these measures are only intended to be used in exceptional cases.[28]

 

A similar point is made by the Australian Public Policy Committee:

 

Rights of appeal or similar dispute resolution proceedings should be established. Such processes should be concluded before ASIC may publish an audit deficiency report. There are serious reputational issues at stake for auditors that are the subject of audit deficiency reports and the power to publish such reports must be accompanied by due process.[29]

Financial implications

The Explanatory Memorandum states that the proposed amendments would have no financial implications.[30]

Main issues

In view of stakeholder concerns about procedural fairness, there is an issue as to whether the exercise by ASIC of its decision making powers with respect to audit deficiencies, should be the subject of ongoing review.

Key provisions

Schedule 1—Amendments to the Corporations Act

Auditor rotation requirements

Subsection 324DA(1) of the Corporations Act provides that if an auditor plays a significant role in the audit of a listed company or listed registered scheme for five successive financial years, they are not eligible to play such a role for a later financial year unless they have not done so for at least two successive financial years commencing after the end of the five financial year period and ending before the beginning of the later financial year.  Item 7 of Schedule 1 of the Bill inserts into the Corporations Act proposed section 324DAA, which permits the directors of a listed company or listed registered scheme to approve an individual playing a significant role in the audit of the company or scheme for not more than two successive financial years beyond the five year period provided for in subsection 324DA(1) of the Corporations Act. The extension must be granted prior to the end of that five year period (proposed subsection 324DAA(2)).

The approval can be for one or two additional successive financial years (proposed subsection 324DAA(3)).  The directors can extend a one year extension for a further successive financial year by resolution prior to the end of the first extension year (proposed subsection 324DAA(4)).

An individual to whom an extension is granted must comply with the requirements of existing subsection 324DA(1) as if the extension were granted to them under that provision (proposed subsections 324DAA(3) and (5)).

Proposed subsection 324DAB(1) provides that where a listed company or the responsible entity of a listed registered scheme has an audit committee, an approval to extend the auditor’s eligibility term must not be given under proposed section 324DAA unless it is in accordance with the audit committee’s recommendation. This means that the approval must be in accordance with the committee’s recommendation; it must be endorsed by a resolution passed by the members of the audit committee and it must be in writing and signed by a member of the committee and given to the directors of the company or scheme (proposed paragraphs 324DAB(2)(a) to (c)).

Additionally, proposed paragraph 324DAB(2)(d) requires the audit committee’s recommendation to state that the committee is satisfied that the approval is consistent with maintaining the quality of the audit provided to the company or scheme, and that it would not give rise to a conflict of interest situation as defined in existing section 324CD.[31] The reasons why the committee is satisfied must be set out by the directors in their resolution granting approval of the extension (proposed paragraph 324DAB(1)(b)).

Where a company or scheme does not have an audit committee, it is the directors who must be satisfied of these matters, and who must set out their reasons for being so satisfied in their resolution granting the approval (proposed subsection 324DAB(3)).

An approval cannot be granted for an extension unless the auditor to whom the extension relates agrees to the extension (proposed subsection 324DAB(4)).

Proposed section 324DAC requires a copy of the resolution granting the approval to extend an auditor’s eligibility term under proposed section 324DAA to be lodged with ASIC within 14 days of the approval, and for a copy to be provided to the auditor to whom the extension relates.

Proposed section 324DAD provides that an approval will be ineffective unless sections 324DAA, 324DAB and 324DAC are complied with.

Annual transparency reports

Item 18 of Schedule 1 of the Bill inserts new Part 2M.4A into the Corporations Act, which sets out requirements for annual transparency reports for auditors.  New Part 2M.4A commences with proposed section 332, which requires an individual auditor, audit firm or authorised audit company (collectively referred to as a ‘transparency reporting auditor’: proposed subsection 332(1)) to publish a transparency report for each year in which the auditor conducts audits under Part 2M.3 of the Corporations Act, of 10 or more specified types of bodies (proposed subsection 332A(1)).[32]

An auditor will be required to publish the annual transparency report on its website within four months of the end of the year to which it relates.  A copy must also be lodged with ASIC on or before the day it is placed on the website (proposed subsection 332A(3)).

Proposed subsection 332A(4) makes offences relating to the failure by auditors to comply with the annual transparency reporting requirements strict liability offences.  The Explanatory Memorandum states that this:

…is designed to provide an incentive across the firm or audit company to foster an effective culture of compliance.[33]

Although the Scrutiny of Bills Committee notes that it would prefer a more detailed explanation, and for more attention to be paid to the principles stated in the Guide to Framing Commonwealth Offences, Infringement Notices and Enforcement Powers Guide to Framing Commonwealth Offences[34], it observes that the applicable penalties are within the limits set out in the Guide.[35]

Proposed subsection 332B(1) requires annual transparency reports to contain the information prescribed by the regulations.  Where the inclusion of the information is likely to result in unreasonable prejudice to the transparency reporting auditor, the material may be omitted, but the report must say so (proposed subsection 332B(2)).

As stated earlier in this Bills Digest, although details of the sorts of information that might be prescribed under proposed section 332B are set out in a lengthy list in the Explanatory Memorandum, the Scrutiny of Bills Committee considers that at least some of this information could be included in the Bill itself.

Proposed subsection 332C(1) provides that, on application by a transparency reporting auditor, ASIC may make an order, with or without conditions (proposed section 332C(2)) extending the period within which the auditor must publish an annual transparency report.  Proposed subsection 332C(3) sets out the form and contents of the application, and proposed subsection 332C(4) requires ASIC to give the auditor written notice of the order.

Proposed subsection 332D(1) provides that, on application by a transparency reporting auditor, ASIC may make an order in writing, with or without conditions and for a limited or indefinite period (proposed section 332D(2)), relieving the auditor from compliance with all or elements of proposed sections 332A and 332B. Proposed subsection 332D(3) sets out the form and contents of the application, and proposed subsection 332D(4) requires ASIC to give the auditor written notice of the order.

Proposed section 332E empowers ASIC, by legislative instrument, to make an order, with or without conditions and for a limited or indefinite period (proposed section 332E(2)), relieving a specified class of transparency reporting auditor from all or specified requirements of proposed sections 332A and 332B.

Proposed section 332F sets out criteria with respect to which ASIC must be satisfied when making an order under proposed section 332D or 332E.

Proposed section 332G provides that an offence relating to an annual transparency report that would otherwise be committed by a firm, is taken to have been committed by each member of the firm.  Proposed subsection 332G(4) provides for exceptions, if the firm member does not know of the circumstances that constitute the contravention or knows of the circumstances but takes reasonable steps to correct the contravention as soon as possible.  The evidential burden rests with the defendant in this regard.

As stated earlier in this Bills Digest, the Scrutiny of Bills Committee had concerns with this provision.[36]  The Committee said as follows:

… the imposition of collective responsibility should be strictly justified. In addition, the necessity to impose an evidential burden on defendants to establish the exceptions is not addressed in the explanatory memorandum. Although the question of whether steps have been taken to correct a contravention about which a person has knowledge is matter which is peculiarly within the knowledge of the defendant, it is less clear that it is appropriate to require that the defendant bear an evidential burden in relation to the question of whether or not they know of the circumstances that constitute a contravention of the provision concerned. Although the defendant’s lack of knowledge of a matter may obviously be said to be something peculiarly within their knowledge, it may not always be apparent what evidence may readily be available to demonstrate a lack of knowledge by the defendant.[37]

Notwithstanding the Treasurer’s response to these concerns, the Scrutiny of Bills Committee has left the question of whether the proposed collective responsibility provisions are appropriate to the consideration of the Senate as whole.[38]

 

Proposed section 1537 of the Corporations Act, inserted by item 20 of Schedule 1 of the Bill, provides that the proposed annual transparency reporting amendments apply to annual transparency reports for the first transparency reporting year that ends after the commencement of the Act, even if part of that year occurs before the commencement, and to all later transparency reporting years.

Schedule 2—Amendments of the ASIC Act

Auditor independence functions for FRC

Subsection 225(2B) sets out a range of specific auditor independence functions currently pertaining to the FRC.  Item 5 of Schedule 2 of the Bill inserts into the ASIC Act proposed new subsection 225(2B), which replaces the FRC’s auditor independence functions with the function of giving strategic policy advice and reports to the Minister, and professional accounting bodies, in relation to the quality of audits conducted by Australian auditors.  Without limiting the scope of this proposed subsection, proposed subsection 225(2C) expands on the types of functions to be undertaken by the FRC.

Audit deficiency notifications and reports

Item 16 of Schedule 2 of the Bill inserts proposed new Division 5A into Part 3 of the ASIC Act. Proposed section 50A explains that proposed new Division 5A applies to an audit deficiency identified by ASIC while exercising its powers and functions in relation to audit-related matters under Chapters 2M or 5C, or Parts 7.8,  9.2 or  9.2A of the Corporations Act, or under other provisions of that Act that relate to those chapters or Parts.

Proposed new Division 5A also applies to an alleged or suspected contravention of a law of the Commonwealth, or of a State or Territory in this jurisdiction, being a contravention that relates to an audit matter and that either concerns the management or affairs of a body corporate or involves fraud or dishonesty and relates to a body corporate, and for the purposes of an investigation under Division 1 of Part 2 of the ASIC Act relating to such an alleged or suspected contravention.

An ‘audit deficiency’ is a failure by the auditor to comply with:

• the auditing standards
• the Corporations Act auditor independence standards
• any applicable code of professional conduct or
•  the provisions of the Corporations Act dealing with the conduct of audits

which ASIC reasonably believes indicates a significant weakness in the Australian auditor’s quality control system, or in the conduct of the audit and may be detrimental to the overall quality of the audit.

Proposed section 50B of the ASIC Act provides that ASIC may notify the auditor of the identified deficiency. The matters to be included in the notice are set out in proposed paragraph 50B(2)(a). ASIC must invite a written submission from the auditor, within six months, about the deficiency and any remedial action taken, or proposed to be taken, to remedy the deficiency (proposed paragraph 50B(2)(b)).

Proposed subsection 50C(1) of the ASIC Act provides that at any time after the end of the six month period referred to in section 50B, ASIC may prepare an ‘audit deficiency report’ if it is satisfied that the auditor has not taken appropriate remedial action. Details of what the report must contain are set out in proposed subsection 50C(2).  The report must take into account any submission received from the auditor in response to the invitation under proposed paragraph 50(2)(b), and whether or not the auditor has taken any remedial action.

If it considers it appropriate, ASIC may publish the report on its website (proposed subsection 50D(1)), but not before providing the auditor to whom it relates with a copy, and inviting their comments within 21 days.  If the auditor makes comments, the comments must also be included on the website (proposed section 50E).

If the audit was conducted by an audit firm or company, the report on the website can disclose indentifying particulars of the firm, but not of any professional member of the audit team involved in the audit (proposed paragraph 50D(2)(a)). If the audit was conducted by an individual auditor, not on behalf of an audit firm or company, identifying particulars of the auditor may be revealed, but not of other professional members of the audit team involved in the audit (proposed paragraph 50D(2)(b)).  Particulars of the audited body must not be disclosed (proposed paragraph 50D(2)(c)). The term ‘identifying particulars’ is defined in proposed subsection 50D(3).

The proposed audit deficiency report provisions would apply to deficiencies identified by ASIC after the Act’s commencement (proposed subsection 294(1) of the ASIC Act, inserted by item 18 of Schedule 2 of the Bill).

Communications with corporations, registered schemes and disclosing entities

Item 17 of Schedule 2 of the Bill inserts proposed subsection 127(2D) into the ASIC Act, to allow certain information to be communicated to the directors, the audit committee or a senior manager of a company, responsible entity or disclosing entity if the ASIC Chairperson is satisfied that the information: had been obtained by ASIC while exercising its audit functions and powers; is about how an audit of a company was conducted by an Australian auditor, or about the company’s, scheme’s or entity’s compliance with Chapter 2M or sections 674 or 675 of the Corporations Act; and should be disclosed to assist the company, scheme or entity to properly manage its affairs.

The circumstances that must satisfy the ASIC Chairperson related to information obtained by ASIC are specified in proposed subsection 127(2E).

The proposed communications with corporations, registered schemes and disclosing entities amendments apply to information obtained by ASIC after the Act’s commencement (proposed subsection 294(2) of the ASIC Act, inserted by item 18 of Schedule 2 of the Bill).

Members, Senators and Parliamentary staff can obtain further information from the Parliamentary Library on (02) 6277 2500.

For copyright reasons some linked items are only available to members of Parliament.

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