Over the past several years, audit quality has been a focus of a prolonged parliamentary enquiry in Australia and the subject of heightened regulatory concern.
Recently, those concerns transformed into significant enforcement action against an audit firm and senior audit practitioner, for the negligent conduct of an audit and failure to comply with applicable audit standards, resulting in criminal convictions, fines and the cancellation of the auditor’s registration as a registered company auditor.
This enforcement action should be of significant concern to auditors and their insurers for at least four reasons.
First, the prosecution is the first of its kind in Australia and could represent the start of a trend of increased enforcement activity by the Australian Securities and Investments Commission (ASIC) and the Commonwealth Department of Public Prosecution (CDPP).
Second, the Companies Auditor Disciplinary Board (CADB) took decisive action in cancelling the individual practitioner’s registration.
Third, Australia’s economic outlook poses significant risks for auditors and their clients, particularly at a time when auditors are under increasing pressure to expand their roles in examining fraud risks and company management’s ‘going concern’ assessments.
Fourth, ASIC has identified reviews of audit quality as a number one priority for the next several years, in line with its vision to promote a ‘fair, strong and efficient financial system for all Australians’. Critical to realising ASIC’s vision will be using regulatory tools to act against misconduct to maintain trust and integrity in the financial system and enforcement actions to protect vulnerable customers and investors.
Increased regulatory focus
Many of the recommendations made by the Joint Committee on Corporations and Financial Services in their recent enquiry into audit quality focussed on the role of ASIC in carrying out audit inspections.
ASIC had already raised serious concerns about the quality of auditing in Australia following findings in recent audit inspections that the Big 4 firms had failed to obtain sufficient assurance in up to 32 per cent of key audit areas. The Joint Committee’s recommendations included urging ASIC to ramp up its audit inspection regime.
Conducting reviews of audits of listed entities and other public interest entities has been identified as a top priority in ASIC’s Corporate Plan for 2021-2025. ASIC have flagged they are conducting multiple investigations into poor‑quality auditing by accounting firms, and their surveillance and inspection activities will not change in response to the COVID-19 pandemic. While ASIC have signalled their focus will be on Australia’s top six audit firms, no audit firms can assume they will be immune from adverse action.
Which brings us to the 2018 collapse of Halifax Investment Services, a Sydney based provider of share broking and investment services.
Halifax went into administration in November 2018 and shortly afterwards the administrators lodged a report with ASIC estimating a deficiency in client funds of some AUD19.7 million. ASIC investigated the audit work of Halifax’s audit firm, EC Audit, and its lead auditor, Robert Evett, and referred them both to the CDPP and referred Mr Evett to the CADB.
In the criminal proceeding, EC Audit and Mr Evett pleaded guilty and were each convicted of criminal charges for failing to conduct audits of Halifax in accordance with the applicable Australian auditing standards, contrary to ss 989CA(1) and (2) of the Corporations Act 2001 (Cth). The firm was fined AUD40,000 and the lead auditor AUD10,000. In addition, ASIC sought recovery of some AUD250,000 in legal costs from the defendants, which they did not contest.
In a separate proceeding, the CADB found that Mr Evett was not a fit and proper person to continue practising and cancelled his registration as a registered company auditor, effectively ending his career as an auditor and chartered accountant. In essence, the CADB concluded that Mr Evett had failed to exercise appropriate levels of professional scepticism and professional judgement in his role as Lead Auditor, Engagement Partner and Lead Assurance Partner.
These conclusions were based on multiple adverse findings, including that Mr Evett failed to exercise appropriate direction and supervision of audits conducted over several years, between 2016 and 2018. He was unfamiliar with key audit documentation and the nature of Halifax’s business operations. He displayed an absence of understanding in relation to Halifax’s trading platforms, revenue processes, bank accounts and client liabilities. The audit process lacked a basic framework of procedures, and the audit team carried out a “tick the box” exercise that lacked rigour.
“One of the most challenging reporting periods ever experienced”
So it has been said about the 2019/2020 financial reporting period, which was marked by unprecedented disruption and uncertainty, and substantial changes to, and closures of, many business entities.
The 2020/2021 financial reporting period is likely to be no less challenging. The risks for audit firms and individual auditors posed by increased regulatory scrutiny are likely to be amplified by continuing pandemic related challenges to audit firms’ ability to complete audit assignments, including skills shortages, travel restrictions, remote work, social distancing and changing circumstances across different reporting periods.
There are concerns that Australia is suffering from a chronic shortage of skilled workers in the audit space, which is stretching the capacity of practitioners with the required knowledge and ability to perform audits to the appropriate standard. Such capacity shortages may impact adversely on the quality of audits, which may in turn lead to more audit failings.
Further, financial reporting for financial periods from 31 March 2020 is likely to become more difficult for pandemic related reasons, with auditors grappling with complex issues in multiple key audit areas, such as:
- recognition and measurement of values of assets and liabilities;
- disclosures, including sources of estimation uncertainty, key assumptions, sensitivity analysis, and explanations of results, risks, strategies and future prospects;
- accounting for types of support and assistance received from government, lenders, landlords and others;
- ‘going concern’ assessments, solvency statements and ‘subsequent event’ statements.
Implications for auditors and insurers
While the fines levied on EC Audit and Mr Evett may seem relatively modest, the “first-of-its-kind” prosecution has wider implications, and the cancellation of the lead auditor’s registration by the CADB should be of concern to individual auditors.
So too, recent comments from ASIC’s Commissioner, Cathie Armour, to the effect that the criminal prosecution should act as a deterrent against auditor misconduct and ASIC will continue to prosecute serious failures to comply with applicable audit standards.
Those comments suggest a potentially tougher regulatory regime for audit firms, with more severe consequences for firms and individual auditors who are found to have committed serious audit failings.
In a continuing COVID-19 affected climate, that may have at least the following implications:
- an increase in the cost to the industry of defending and settling claims;
- higher insurance premiums and/or tougher terms and conditions;
- increases in audit fees;
- smaller audit firms suffering disproportionately in a tougher regulatory environment;
- fewer accounting firms with the appetite to carry out audits, reducing competition in the market; and
- reduced underwriting appetite among insurers.
In summary, tough times ahead for Australian audit firms.