The last few years have seen a rise of advisory and consulting services at today’s largest audit firms. However, despite the trusted status of these firms, such activity may pose risks to audit quality and investor protection in days to come.
This issue should be a worry to the corporate governance community, boards, audit committees, and their counsels, bearing in mind that high level audits and auditor independence are so core to the integrity of South Africa’s economy.
Take, for example, the catastrophic investor losses in the US that were a result of Enron and WorldCom, among others. Major accounting firms were implicated in a host of accounting irregularities during these scandals.
These events saw the introduction of The Sarbanes-Oxley Act (SOX) of 2002, which was passed by the US Congress in order to protect investors from the possibility of fraudulent accounting activities by corporations. SOX was passed by huge majorities in the US Senate and the House, and the legislation founded the Public Company Accounting Oversight Board, a private-sector, non-profit corporation to oversee the audits of public companies and other issuers to protect investors’ interests.
The scandals of the early 2000s and the subsequent act can only lead us to the conclusion that independent audits are crucial to the integrity of our capital markets. Without an independent audit, the markets cannot hope to be open and free. However, if the companies responsible for the audits are themselves providing consulting services, at which point is there a conflict of interest?
Many of the large name firms have increasingly been providing IT consulting services to their clients, creating divisions dedicated to delivering the specialist expertise required to manage and maintain their technology infrastructure, and utilise it for innovation and growth.
Many investors are worried that auditors’ interest in developing or maintaining a non-audit services relationship with their customers could overtake their interest in the primary audit relationship. In addition, investors are concerned that various non-audit services, when given to an audit client, create core conflicts that go totally against auditor objectivity.
This is why the rise of the advisory and consulting services within accounting firms is raising red flags. The growth in these services could pose a threat to auditor independence and quality. Investors have a right to be concerned that the firms may not maintain the utter independence that ensures integrity.
Because of these concerns, many countries have put legislation in place to minimise the potential for conflicts of interest. In America, accounting firms are not allowed to provide non-audit services to companies for which they perform audits; in Britain, the rules are not as strict, allowing auditors to perform “internal audits” and provide advice to companies they audit.
The only system we have in South Africa to provide red flags within the auditing sphere is based on tips, making it hard to delineate what is or isn’t ethical or allowed
Until recently, the law was not as strict in South Africa. That may change — pending a new law that has been tabled, which makes provision for mandatory audit firm rotation, forcing companies to change auditors every few years. This system has long been used in Europe, where auditors must be changed every 10 years. However, these “Chinese walls” are very unlikely to provide true protection.
Five years is a long time in which audit firms can establish consulting-type relationships with their clients, even if they don’t strictly provide audit services. Corporate governance expert Mervyn King recently said that there are more than enough safeguards in South Africa’s existing rules to ensure auditors are independent, including the requirement that the partner in charge of auditing a company’s financials is changed every five years, and the fact that the Companies Act stipulates that shareholders must appoint the audit committee, which then must ensure that auditors are independent.
Yet we still see audit firms going outside of their traditional mandate and there is enough of a grey area to allow these companies to continue providing consulting services without breaking any laws. The only system we have in South Africa to provide red flags within the auditing sphere is based on tips, making it hard to delineate what is or isn’t ethical or allowed.
There is also the concern that an increased focus on growing the advisory services business may detract the leaders of the firm from the core audit business. This could result in lesser investments being made in the audit practice. This could include smaller spend on training, technology, innovation and, of course, the hiring of skilled professionals.
Accounting firm heads need to address the possible threats that arise from a growing advisory and consulting practice. In addition, they should make sure that they continue to invest in the audit business, including hiring top staff, implementing best-in-class technology and ensuring adequate training is given. Most importantly, as firms boost their advisory practices and turn into multidisciplinary service providers, firm heads must never forget the principle of total independence.
- Richard Firth is CEO of Johannesburg-based software development firm MIP Holdings
