MAFR - PART 2
4. Implementation Date
The implementation date is 1 April 2023. The reason for this can be found in Section 90 (2) of the
Companies Act 2008 (2008Act). To be appointed as an auditor of a company, whether as required
by subsection (1) or as contemplated in section 34(2), a person or firm:
• b i) a director or prescribed officer of the company;
• b ii) an employee or consultant of the company who was or has been engaged for more
than one year in the maintenance of any of the company’s financial records or the
preparation of any of its financial statements;
• b iii) a director, officer or employee of a person appointed as company secretary in terms
of Part B of this Chapter;
• b iv) a person who, alone or with a partner or employees, habitually or regularly performs
the duties of accountant or bookkeeper, or performs related secretarial work, for the
company; and
• b v) a person who, at any time during the five financial years immediately preceding the
date of appointment, was a person contemplated in any of subparagraphs (b i) to (b iv).
As of 25 January 2016 many audit firms are engaged in various consulting engagements would
preclude them from being appointed as auditors until 25 January 2021 (assuming they withdrew
from this consulting work on the 25 January 2016). If the audit firm is given say 2 years to complete
their current consulting engagement then the date MAFR can be implemented is 2023. If the audit
firm is not engaged in any work as contemplated above the audit firm can be appointed
immediately under s 90of the 2008Act. This would obviously benefit those audit firms who are
currently not engaged in consulting work, which in essence will be most small to medium size audit
firms (SME). Nkonki believe that 2023 favours the large audit firms and gives them an unfair
competitive advantage by delaying implementation to 2023. The SMEs are being disadvantaged as
they do not have access to consulting work for listed companies. Only by giving them immediate
access to listed clients will the playing fields become level.
5. Costs
While MAFR has obvious cost implications for audit firms and their clients, proponents argue the
costs of audit failure trump MAFR costs. Morgan Stanley estimates that the increased cost of
[MAFR] would be approximately $1.2 billion per year, versus the $460 billion loss in market
capitalization caused by the failures of Computer Associates, Enron, Quest, Tyco and WorldCom.
The increase was calculated using $10 billion of audit fees in 2000 for the (then) Big Five, a 30
percent increase in audit fees for the first two years, and a rotation period of every five years. The
International Federation of Accountant’s Financial Reporting Supply Chain Report notes: ‘Although
there are concerns about loss of valuable knowledge and experience, long lead times to get-up-to
speed and more expensive audits, many respond that getting fresh eyes on the audit outweighs
cost.’
The purpose of an audit is to enhance the degree of confidence of intended users in the financial
statements. If auditors do not remain independent - impair audit quality. This lessens the
confidence of the financial reporting process. The cost of this loss of confidence will be greater
than any cost of MAFR which in essence is simply a mandatory change of auditors as opposed to a
voluntary one. The appears to be no complaints when auditors in the normal course of events are
replaced. Change of audit firms every five years is standard practice in the public sector and there
appears to be no debate over the costs.
6. Scope
MAFR should be applied to the audits of all PUBLIC INTEREST ENTITIES as defined by the
Independent Regulatory Board for Auditors.
7. International Perspective
Over the years, regulators have expressed concerns about auditor independence and taken actions
to mitigate those concerns. These actions include the passage of the 2002 Sarbanes– Oxley (SOX)
Act, also known as the "Public Company Accounting Reform and Investor Protection Act", which is
US legislation that, among many other requirements, prohibits the auditor (in a US context) from
providing most non-audit services to its clients; imposing a 1- year “cooling-off period” for former
auditors taking employment at their clients; and requiring audit partners to rotate every 5 years.
The US also shifted from a seven-year rotation with a two-year cooling-off period, to a stricter fiveyear
rotation and five-year cooling-off period for audit engagements. More specifically the
requirement is to rotate (1) the partner having primary responsibility for the audit and (2) the
partner responsible for reviewing the audit every five years.
The audit committee is required to ensure that the requisite rotation actually takes place. In the
European Union (EU) regulations have recently changed significantly. The European Parliament in
2014 voted in favor of new rules to force European companies to hire new audit firms at 10- to 24-
year intervals, depending on certain criteria, bringing mandatory audit firm rotation into one of
the world’s most significant economic regions. More specifically, public interest entities have to
appoint a new firm of auditors every 10 years. However, member states have the option to extend
this maximum period to 20 years (24 if there is a joint audit) provided the audit is subject to a
public tendering carried out after 10 years.
These new rules require European-listed companies, banks and financial institutions to appoint a
new audit firm every 10 years, though this can be extended if companies put their audit contract
up for bid at the decade mark or appoint another audit firm to do a joint-audit. It would also
prohibit certain non-audit consulting services and cap the amount of additional fees auditors can
charge their clients (to 70%). The laws are expected to apply from mid- June 2016.
It is expected that the United Kingdom “UK” will implement mandatory firm rotation as well in the
near future. Currently UK companies are required to re-tender or explain why not every 10 years.
There has recently been large scale change in UK regulations in this regard. In 2012, the Financial
Reporting Council (‘FRC’) introduced a provision in the UK Corporate Governance Code for FTSE
350 companies to consider tendering their audit appointment every 10 years, on a comply or
explain basis. The Competition and Markets Authority (‘CMA’) finished its long running
investigation of the UK large company statutory audit market in October 2013 and concluded that
tendering of the audit appointment should be mandatory for FTSE 350 companies at least every
10 years. The ruling will come into force on the 1st of January 2016. In addition to the mandatory
tender after 10 years, it is expected that UK companies will have to appoint a new auditor every
20 years.
As can be seen in the comparison between the US regulations of auditor rotation and the recently
adopted EU and the UK audit firm rotation regulations, there is a difference between auditor
rotation (i.e. audit engagement partner) and audit firm rotation, although sometimes the terms
are used too loosely and the distinction is lost. Auditor rotation, as in the US and South Africa,
refers to the mandatory rotation of the engagement audit partner after a prescribed number of
years (5 years in the US and in South Africa).
Under auditor rotation the audit firm retains the client, providing a different audit partner to the
engagement. There is then a “cooling-off” period (5 years in the US, 2 years in South Africa)
whereby the rotated audit partner must wait until being allowed to be appointed again as
engagement partner on that client. However, audit firm rotation, as is now being adopted in 2016
by the EU, is a step further than this. This requires a change of the audit firm, not simply the audit
partner. The audit firm effectively loses the business of the audit client, regardless of the partners
in the firm being capable of performing the audit. The EU has adopted this in an attempt to further
mitigate the threats (particularly familiarity) to independence.
8. Why MAFR?
In its policy document South African Company Law for the 21st Century: Guidelines for Corporate
Law Reform10it was posited that: ‘The mobility of international capital has highlighted the need
for domestic laws to be investor friendly and competitive with international trends.’
There are obvious risks for Listed Companies in having the same statutory auditors or audit firms
for 50 or 100 years as happens today. Such a long professional relationship may undermine the
statutory auditor's independence and negatively impact on its professional scepticism. Rotation of
the key audit partner within an audit firm is insufficient because the main focus of the audit firm
remains client retention. A new partner would be under pressure to retain a long-standing client
of the firm.
Mandatory audit firm rotation will help reduce excessive familiarity between the statutory auditor
and its clients, limit the risks of carrying over repeated inaccuracies, and encourage fresh thinking,
thus strengthening the conditions for genuine professional scepticism. Mandatory rotation will
hence contribute to a better audit quality.
In order to facilitate the smooth transition to the new statutory auditor or audit firm, the new rules
require that the former auditor transfer a handover file with the relevant information to the
incoming statutory auditor. Mid-tier audit firms (i.e. those who are not members of the largest
networks) will benefit from the reform as new market opportunities emerge. Mandatory rotation,
together with the incentives for joint audit and tendering, as well as the prohibition of certain nonaudit
services to audit clients - requiring de facto that another audit firm provides these services -
are examples of measures that should make the market more dynamic and ultimately less
concentrated.
Firm rotation may also help to prevent large-scale corporate collapses. Firm rotation can help
restore confidence in the regulatory system, which was found to be the case in Italy. Further, if a
client seeks a new auditor, auditors will compete with other audit firms to win the tender and
differentiate themselves in terms of service, improving audit quality. Despite the increased startup
costs which are involved with introducing a new auditor, supporters of audit firm rotation
propose that the costs of corporate collapses, which may not have occurred had audit quality been
higher, outweigh the increase in audit costs involved when introducing a new auditor. From this
perspective, a new auditor brings in more objectivity as they are not familiar with the client,
potentially improving the quality of the audit. Mandatory rotation imposing a time limit on tenure
would directly address the perception of an institutional familiarity threat. An auditor may be more
focused on quality because their files will be reviewed by a successor auditor.
Although there are several thousand-audit firms existing in South Africa, only a few audit firms are
appointed to audit listed companies. Moreover, these companies rarely switch from one audit firm
to another so that audit firms have few opportunities to gain clients. Due to the organisational
structure and the international reach of the Big Four, capital markets are effectively dependent on
them to supply the required statutory audits for multinational companies with subsidiaries. The
market has become significantly more concentrated over the last ten years. Specifically the merger
between the second-largest audit firm (Coopers & Lybrand) and the fourth largest audit firm (Price
Waterhouse) in 1998 reduced the then Big Six audit firms to the Big Five. Subsequently, the demise
of Arthur Andersen in 2002 (following bankruptcy of the energy company Enron in the United
States of America) reduced the number of global networks to the current Big Four.
According to the impact assessment accompanying document to the Commission
Recommendation concerning the limitation of the civil liability of statutory auditors and audit firms
the limited number of players might shrink further for different reasons. The Big Four assert that
a catastrophic claim could lead to the collapse of one of them.
The implementation date is 1 April 2023. The reason for this can be found in Section 90 (2) of the
Companies Act 2008 (2008Act). To be appointed as an auditor of a company, whether as required
by subsection (1) or as contemplated in section 34(2), a person or firm:
• b i) a director or prescribed officer of the company;
• b ii) an employee or consultant of the company who was or has been engaged for more
than one year in the maintenance of any of the company’s financial records or the
preparation of any of its financial statements;
• b iii) a director, officer or employee of a person appointed as company secretary in terms
of Part B of this Chapter;
• b iv) a person who, alone or with a partner or employees, habitually or regularly performs
the duties of accountant or bookkeeper, or performs related secretarial work, for the
company; and
• b v) a person who, at any time during the five financial years immediately preceding the
date of appointment, was a person contemplated in any of subparagraphs (b i) to (b iv).
As of 25 January 2016 many audit firms are engaged in various consulting engagements would
preclude them from being appointed as auditors until 25 January 2021 (assuming they withdrew
from this consulting work on the 25 January 2016). If the audit firm is given say 2 years to complete
their current consulting engagement then the date MAFR can be implemented is 2023. If the audit
firm is not engaged in any work as contemplated above the audit firm can be appointed
immediately under s 90of the 2008Act. This would obviously benefit those audit firms who are
currently not engaged in consulting work, which in essence will be most small to medium size audit
firms (SME). Nkonki believe that 2023 favours the large audit firms and gives them an unfair
competitive advantage by delaying implementation to 2023. The SMEs are being disadvantaged as
they do not have access to consulting work for listed companies. Only by giving them immediate
access to listed clients will the playing fields become level.
5. Costs
While MAFR has obvious cost implications for audit firms and their clients, proponents argue the
costs of audit failure trump MAFR costs. Morgan Stanley estimates that the increased cost of
[MAFR] would be approximately $1.2 billion per year, versus the $460 billion loss in market
capitalization caused by the failures of Computer Associates, Enron, Quest, Tyco and WorldCom.
The increase was calculated using $10 billion of audit fees in 2000 for the (then) Big Five, a 30
percent increase in audit fees for the first two years, and a rotation period of every five years. The
International Federation of Accountant’s Financial Reporting Supply Chain Report notes: ‘Although
there are concerns about loss of valuable knowledge and experience, long lead times to get-up-to
speed and more expensive audits, many respond that getting fresh eyes on the audit outweighs
cost.’
The purpose of an audit is to enhance the degree of confidence of intended users in the financial
statements. If auditors do not remain independent - impair audit quality. This lessens the
confidence of the financial reporting process. The cost of this loss of confidence will be greater
than any cost of MAFR which in essence is simply a mandatory change of auditors as opposed to a
voluntary one. The appears to be no complaints when auditors in the normal course of events are
replaced. Change of audit firms every five years is standard practice in the public sector and there
appears to be no debate over the costs.
6. Scope
MAFR should be applied to the audits of all PUBLIC INTEREST ENTITIES as defined by the
Independent Regulatory Board for Auditors.
7. International Perspective
Over the years, regulators have expressed concerns about auditor independence and taken actions
to mitigate those concerns. These actions include the passage of the 2002 Sarbanes– Oxley (SOX)
Act, also known as the "Public Company Accounting Reform and Investor Protection Act", which is
US legislation that, among many other requirements, prohibits the auditor (in a US context) from
providing most non-audit services to its clients; imposing a 1- year “cooling-off period” for former
auditors taking employment at their clients; and requiring audit partners to rotate every 5 years.
The US also shifted from a seven-year rotation with a two-year cooling-off period, to a stricter fiveyear
rotation and five-year cooling-off period for audit engagements. More specifically the
requirement is to rotate (1) the partner having primary responsibility for the audit and (2) the
partner responsible for reviewing the audit every five years.
The audit committee is required to ensure that the requisite rotation actually takes place. In the
European Union (EU) regulations have recently changed significantly. The European Parliament in
2014 voted in favor of new rules to force European companies to hire new audit firms at 10- to 24-
year intervals, depending on certain criteria, bringing mandatory audit firm rotation into one of
the world’s most significant economic regions. More specifically, public interest entities have to
appoint a new firm of auditors every 10 years. However, member states have the option to extend
this maximum period to 20 years (24 if there is a joint audit) provided the audit is subject to a
public tendering carried out after 10 years.
These new rules require European-listed companies, banks and financial institutions to appoint a
new audit firm every 10 years, though this can be extended if companies put their audit contract
up for bid at the decade mark or appoint another audit firm to do a joint-audit. It would also
prohibit certain non-audit consulting services and cap the amount of additional fees auditors can
charge their clients (to 70%). The laws are expected to apply from mid- June 2016.
It is expected that the United Kingdom “UK” will implement mandatory firm rotation as well in the
near future. Currently UK companies are required to re-tender or explain why not every 10 years.
There has recently been large scale change in UK regulations in this regard. In 2012, the Financial
Reporting Council (‘FRC’) introduced a provision in the UK Corporate Governance Code for FTSE
350 companies to consider tendering their audit appointment every 10 years, on a comply or
explain basis. The Competition and Markets Authority (‘CMA’) finished its long running
investigation of the UK large company statutory audit market in October 2013 and concluded that
tendering of the audit appointment should be mandatory for FTSE 350 companies at least every
10 years. The ruling will come into force on the 1st of January 2016. In addition to the mandatory
tender after 10 years, it is expected that UK companies will have to appoint a new auditor every
20 years.
As can be seen in the comparison between the US regulations of auditor rotation and the recently
adopted EU and the UK audit firm rotation regulations, there is a difference between auditor
rotation (i.e. audit engagement partner) and audit firm rotation, although sometimes the terms
are used too loosely and the distinction is lost. Auditor rotation, as in the US and South Africa,
refers to the mandatory rotation of the engagement audit partner after a prescribed number of
years (5 years in the US and in South Africa).
Under auditor rotation the audit firm retains the client, providing a different audit partner to the
engagement. There is then a “cooling-off” period (5 years in the US, 2 years in South Africa)
whereby the rotated audit partner must wait until being allowed to be appointed again as
engagement partner on that client. However, audit firm rotation, as is now being adopted in 2016
by the EU, is a step further than this. This requires a change of the audit firm, not simply the audit
partner. The audit firm effectively loses the business of the audit client, regardless of the partners
in the firm being capable of performing the audit. The EU has adopted this in an attempt to further
mitigate the threats (particularly familiarity) to independence.
8. Why MAFR?
In its policy document South African Company Law for the 21st Century: Guidelines for Corporate
Law Reform10it was posited that: ‘The mobility of international capital has highlighted the need
for domestic laws to be investor friendly and competitive with international trends.’
There are obvious risks for Listed Companies in having the same statutory auditors or audit firms
for 50 or 100 years as happens today. Such a long professional relationship may undermine the
statutory auditor's independence and negatively impact on its professional scepticism. Rotation of
the key audit partner within an audit firm is insufficient because the main focus of the audit firm
remains client retention. A new partner would be under pressure to retain a long-standing client
of the firm.
Mandatory audit firm rotation will help reduce excessive familiarity between the statutory auditor
and its clients, limit the risks of carrying over repeated inaccuracies, and encourage fresh thinking,
thus strengthening the conditions for genuine professional scepticism. Mandatory rotation will
hence contribute to a better audit quality.
In order to facilitate the smooth transition to the new statutory auditor or audit firm, the new rules
require that the former auditor transfer a handover file with the relevant information to the
incoming statutory auditor. Mid-tier audit firms (i.e. those who are not members of the largest
networks) will benefit from the reform as new market opportunities emerge. Mandatory rotation,
together with the incentives for joint audit and tendering, as well as the prohibition of certain nonaudit
services to audit clients - requiring de facto that another audit firm provides these services -
are examples of measures that should make the market more dynamic and ultimately less
concentrated.
Firm rotation may also help to prevent large-scale corporate collapses. Firm rotation can help
restore confidence in the regulatory system, which was found to be the case in Italy. Further, if a
client seeks a new auditor, auditors will compete with other audit firms to win the tender and
differentiate themselves in terms of service, improving audit quality. Despite the increased startup
costs which are involved with introducing a new auditor, supporters of audit firm rotation
propose that the costs of corporate collapses, which may not have occurred had audit quality been
higher, outweigh the increase in audit costs involved when introducing a new auditor. From this
perspective, a new auditor brings in more objectivity as they are not familiar with the client,
potentially improving the quality of the audit. Mandatory rotation imposing a time limit on tenure
would directly address the perception of an institutional familiarity threat. An auditor may be more
focused on quality because their files will be reviewed by a successor auditor.
Although there are several thousand-audit firms existing in South Africa, only a few audit firms are
appointed to audit listed companies. Moreover, these companies rarely switch from one audit firm
to another so that audit firms have few opportunities to gain clients. Due to the organisational
structure and the international reach of the Big Four, capital markets are effectively dependent on
them to supply the required statutory audits for multinational companies with subsidiaries. The
market has become significantly more concentrated over the last ten years. Specifically the merger
between the second-largest audit firm (Coopers & Lybrand) and the fourth largest audit firm (Price
Waterhouse) in 1998 reduced the then Big Six audit firms to the Big Five. Subsequently, the demise
of Arthur Andersen in 2002 (following bankruptcy of the energy company Enron in the United
States of America) reduced the number of global networks to the current Big Four.
According to the impact assessment accompanying document to the Commission
Recommendation concerning the limitation of the civil liability of statutory auditors and audit firms
the limited number of players might shrink further for different reasons. The Big Four assert that
a catastrophic claim could lead to the collapse of one of them.
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