Chapter 5Rationalising the regulators for audit and accounting
Introduction
5.1Evidence to the inquiry identified a range of issues with the current regulatory framework for the Australian financial reporting and auditing industry. Some submitters noted that the current regulatory system ‘is a patchwork that has built up over time’, leading to both overlaps and regulatory gaps.
5.2The Treasury has also identified several issues: firstly, the large number of bodies tasked with setting, overseeing and enforcing auditing-related standards; secondly, the limited resources available to the Australian Securities and Investments Commission (ASIC) for audit quality oversight; and thirdly, the shared responsibility for formulating and applying system-wide standards (for quality management and ethics) which may present risks to audit quality.
5.3The role and effectiveness of the Companies Auditors Disciplinary Board (CADB) and its relationship to ASIC was another prominent issue, as were concerns about the potential for the Big Four audit firms (PwC, Deloitte, EY and KPMG) to exert undue influence over the Financial Reporting Council (FRC) and the two standards boards, the Australian Accounting Standards Board (AASB) and the Australian Auditing and Assurance Standards Board (AUASB), by virtue of the numbers of persons sitting on the boards of those bodies that have connections to the Big Four firms.
5.4The current regulatory framework consists of both industry and statutory bodies (see Appendix 6). The various statutory bodies undertake a range of functions including regulatory oversight of the industry, standard setting, oversight of the reporting and standard setting framework, and disciplinary action as follows:
ASIC has regulatory oversight of the Corporations Act 2001;
the AASB sets standards for financial and accounting reporting;
the AUASB sets standards for the conduct of audits;
the FRC oversees the framework for financial reporting and the audit and accounting standards setting; and
CADB conducts disciplinary hearings and makes decisions about registered company auditors.
5.5This chapter begins by considering the evidence on the role and effectiveness of CADB. It then looks at the issue of the independence of the standard setters and the FRC from the Big Four firms. Next it considers proposals for rationalising the statutory bodies. The chapter concludes with the committee views and recommendations.
The Companies Auditors Disciplinary Board
5.6CADB is an independent statutory body that considers disciplinary action against registered company auditors based on referrals by ASIC or the Australian Prudential Regulation Authority (APRA)
Issues that have arisen for the CADB:
5.7CADB’s caseload has been very small over the last decade, often only one or two cases per year, apart from a brief surge in 2020–21 following an uptick in ASIC’s enforcement activity for auditing.
5.8CADB submitted:
Even taking account of periods of increased activity over the last decade, the number of matters that have been considered by CADB is insufficient to fully realise either CADB’s potential to meaningfully impact regulatory settings in relation to auditors or the full scope of its legislative function.
5.9The small CADB caseload has occurred despite significant numbers of audits failing in ASIC surveillance inspections. For example, in ASIC’s 2022 audit inspection report, there was an overall increase in the level of negative findings from 32 per cent to 36 per cent, and only 18 out of 45 audit files inspected had no negative findings, with the number of negative findings increasing by nine per cent for the six largest audit firms. Few of those audit quality failures are being referred to CADB.
5.10However, ASIC argued that its audit surveillance program is not designed to generate referrals to CADB. Rather, the objective ‘is to promote improvement in audit quality’ with the most common findings being ‘the auditor not having obtained sufficient or appropriate audit evidence’.
5.11The evidence shows that 27 auditors subject to potential referrals from ASIC to CADB were able to resign (in 2020–2021) and thereby avoid a CADB disciplinary process.
5.12ASIC confirmed that it could refuse an auditor’s resignation, for example in an instance of serious misconduct, to allow CADB to hear a case. However, ASIC advised that most recent cases were low-risk administrative matters where the cancellation of a registration was a quick and efficient means of achieving the desired outcome.
5.13CADB identified issues around its resourcing and ability to pursue disciplinary processes. CADB argued that the arrangements for resourcing CADB functions through secondments from ASIC have been ineffective due to disagreements between ASIC and CADB.
5.14CADB also suggested that there needs to be greater oversight of the way in which ASIC and APRA refer matters to CADB, as well as potentially expanding the entities that may make applications to CADB regarding registered auditors.
5.15However, the disciplinary functions for liquidators, as well as financial services and credit, have less independence from ASIC. For example, liquidator disciplinary functions occur through ASIC referring a matter to a committee consisting of ASIC, a registered liquidator chosen by a prescribed body and a person appointed by the Minister.
5.16Similarly, ASIC convenes the Financial Services and Credit Panel to consider suspected misconduct by a financial adviser. Each sitting panel comprises an ASIC staff member and at least two members appointed by ASIC from a pool of people specified as being eligible by the Minister.
Regulatory body independence from the Big Four firms
5.17The committee received evidence expressing concern that numerous members of the FRC, AASB and AUASB have a conflict of interest.
5.18This conflict of interest was set out by Associate Professor Corinne Cortese, who submitted that members of the FRC, AASB and AUASB ‘are entrusted to act in the public interest in the creation of accounting and auditing frameworks and standards at the same time as being employed by firms earning millions of dollars from clients as a result of applying and advising on those same standards’.
5.19Professor Cortese argued that the part-time appointments of FRC and standards board members exacerbate this issue:
40 per cent of the FRC members have ties to the Big Four firms;
50 per cent of the AASB members have ties to the Big Four firms; and
6 of the 11 AUASB members are partners at the Big Four firms.
5.20Such conflicts of interest are associated with the wider ‘revolving door’ problem of staff moving between the public and private sectors, as Dr Kelli Larson explained:
One concern regarding consultancy use in government departments is the so-called ‘revolving door’ where individuals move between public and private jobs, notably between working for the government and then moving to work at a consultancy firm and vice versa. The problem with the revolving door is that it can lead to conflict-of-interest situations, increasing the risk of corruption. Given their decision-making power, access to information and influence, former Ministers and other government members can be great assets for private companies. Governments should ensure that appropriate measures are in place so that former public servants do not misuse their power and influence to benefit their private interests.
5.21Dr Larson suggested the use of cooling-off periods, noting the existing cooling-off period under the Code of Conduct for government ministers. However, DrLarson argued that the cooling-off periods should be longer than 18 months and legally enforceable.
5.22The Australia Institute also supported measures to address the ‘revolving door’ by strengthening the Public Service Code of Conduct:
Post-separation requirements in the Public Service Commission Code of Conduct reportedly rely on the goodwill and ethical behaviour of the individuals involved. A more detailed or strict policy would help address these ambiguities. Worth consideration is whether it should include a mandatory post-separation period for public servants who have who have had direct contact with consulting firms.
5.23Dr Andy Schmulow commented on the importance of ensuring an oversight body is independent of the firms it regulates:
To ensure the independence of such an oversight authority, regulated firms should not be permitted to fill board positions or advise to, or be seconded by, such an authority. Failing which the exercise will simply devolve to one of self-regulation. That in turn will exacerbate conflicts of interest.
5.24To ensure Board independence, Dr Schmulow recommended:
It would be useful to stipulate that the Board of such an oversight authority may only comprise individuals who are at arms-length from the firms to be regulated, and further, should not at any stage in the past have been associated with the regulatees, or have received any benefit from the regulatees (such as political donations).
5.25Professor Cortese recommended that board independence requirements would include staggered terms of not more than five years, full-time appointments, and at least 75 per cent of board members not drawn from the Big Four firms.
5.26As a point of comparison, CADB’s membership comprises the Chairperson, the Deputy Chairperson, six members of Professional Accounting Bodies (PABs) and six business members with experience in business, commerce, financial markets, financial products, financial service, economics or law. The Australian Securities and Investments Commission Act 2001 (ASIC Act) specifies that a person is not eligible for appointment as Chair or Deputy Chair unless they are enrolled as a barrister, solicitor, or legal practitioner of the High Court or any federal court or Supreme Court of a state or territory and has been so enrolled for a period of at least five years.
5.27There are currently very few conditions on the appointments of FRC members by the Minister or by an organisation specified by the Minister.
5.28The Minister appoints the Chairs of the AASB and the AUASB, and the FRC appoints the other members of the AASB and the AUASB.
5.29Answers to questions on notice received from the International Ethics Standards Board for Accountants and the International Auditing and Assurance Standards Board state that from 2025–2026, board membership will be limited to five audit practitioners on a board of 16. This measure is being undertaken to ‘balance the risk of undue influence by the audit profession with the need for relevant technical expertise in setting high-quality standards’.
5.30Likewise, the United Kingdom Financial Reporting Council informed the committee that it has restrictions on current practitioners sitting on its board:
Current practitioners cannot sit on the FRC Board, we operate a requirement for…[there] to have been a cooling off period of no less than five years before they can be appointed. A board member can be in receipt of a trailing retirement income…
5.31To ensure the independence of the Tax Practitioners Board from tax practitioners, the government response to the review of the Tax Practitioners Board included the Treasury Laws Amendment (2023 Measures No. 1) Act 2023, which amended the Tax Agent Services Act 2009 to require that ‘[b]oard members must be individuals who are representatives of the community rather than representatives of larger registered tax agents or [Business Activity Statement] BAS agents’.
5.32Another aspect of regulatory independence from the Big Four firms is ensuring that regulatory bodies have appropriate codes of conduct and requirements for disclosure of interests.
5.33In February 2024, the current Chair of the FRC, MrAndrew Mills, commented on the requirements for disclosing conflicts of interest:
You need a process to ensure that the matters are declared in the first place and that there are consequences of failure to disclose. I think that’s standard in many places. You then need to manage it to ensure, where situations arise that might give rise to that conflict, that it’s on the table. People may need to absent themselves from discussion or decision-making on that.
5.34The committee previously examined codes of conduct and requirements for disclosure of interests in its report on the 2017–2018 annual reports of bodies established under the ASIC Act. That report considered bodies including the FRC, AASB and AUASB, and found significant weaknesses and wide variations in the codes of conduct and requirements for disclosure of conflicts of interest, including that there was no statutory requirement for the members of the FRC to avoid or disclose conflicts of interest.
5.35At the time, the committee made several recommendations for review by Treasury and legislative change.
5.36The current and former governments provided no substantive response to the committee’s recommendations.
Recent developments—Proposed merger of the FRC and standards boards
5.37In November 2023, the government announced its intention to combine the AASB, AUASB and FRC into a single entity (the new FRC) with a proposed operational date on or after 1 July 2026. The government identified the following advantages of having a single body:
In addition to accounting and auditing standards, this new integrated body will better support the ongoing implementation of climate‑related financial disclosure standards in Australia.
Business, investors and other stakeholders will benefit from engaging with a single entity, helping to increase regulatory consistency, reduce red tape and unnecessary costs and avoid duplication.
5.38Mr Andrew Mills, Chair of the FRC, observed that the government’s proposal is bringing the bodies together within their existing powers and that one advantage may be improved efficiency and flexibility. He also noted that there is no standard regulatory model internationally and each model has its advantages and disadvantages.
5.39Mr Doug Niven, Chair and Chief Executive Officer of AASB, agreed that the government’s motivation for the proposal to integrate the FRC and the standards boards was greater flexibility in responding to new international standards. This could include the ability to set up a new standards-setting board with the right experience and expertise to pick up on international developments and incorporate Australia-specific elements if required.
5.40Mr Niven also noted that it was important that any new structure is adequately resourced to oversee the due process of the boards, while also respecting technical decision-making on the standards. These processes need to be recognised internationally because Australia needs ‘to work with international standards setters and influence the quality of their standards, which ultimately we’re being asked to adopt’.
5.41Finally, Mr Niven noted that the merger would not deal with the enforceability of standards, which is a separate legislative issue.
Proposals to create a new regulatory and enforcement body
5.42The proposals put to the committee to create a new regulatory and enforcement body can be broadly generalised into two categories: firstly, a proposal to expand the current FRC regulatory framework to include oversight of the PABs and be the sole ‘regulatory clearing-house for the accounting profession’; and secondly, a more substantial proposal to create a body like the United States Public Company Accounting Oversight Board (US PCAOB). See Appendix 5 for a comparison of regulatory frameworks in relevant jurisdictions.
5.43The first proposal by the Institute of Public Accountants (IPA) would require the new FRC to have new ‘compulsory information gathering and information sharing powers and a power to sanction non-compliance with information gathering’.
5.44The IPA suggested the new FRC ‘could then delegate complaint handling to each of the professional accounting bodies’. This could occur ‘either in compliance with their individual by-laws’ or through ‘a joint approach or joint framework’.
5.45The Australian Shareholders’ Association considered the proposal had merit but warned that ‘proper oversight and periodic review of its effectiveness, as well as mature whistle-blower protections and obligations on market participants’ were essential to avoid ‘the risk of the FRC being seen as comprised of insiders’ and ‘overly influenced by the industry’.
5.46The second proposal would require more substantial changes to create a body like the United States Public Company Accounting Oversight Board (US PCAOB) with responsibility for:
registering public accounting and audit firms;
establishing audit, quality control, ethics, independence and other standards relating to audits of public companies;
conducting surveillance (inspections), investigations and disciplinary proceedings of registered accounting firms; and
enforcing compliance with the Corporations Act 2001.
5.47Professor George Tanewski and Professor Peter Carey suggested that the FRC be upgraded to be like overseas regulators such as the US PCAOB. They proposed that the new body work independently of ASIC and be ‘funded by ASIC’s current levies on the business community’.
5.48The FRC itself, in its review of the oversight of audit quality in Australia, suggested the government consider two options: to increase ASIC’s funding so that it has more resources to conduct its current oversight and enforcement relating to both auditing and financial statements; or to establish a new independent body with a broader remit to include surveillance of financial reporting and auditing, as well as the disciplinary and enforcement processes currently performed by ASIC and the PABs.
5.49However, ASIC pointed out that several factors need to be borne in mind when comparing ASIC’s enforcement outcomes with the admittedly significant enforcement actions and sanctions achieved by the US PCAOB and the United States Securities Exchange Commission against the Big Four firms.
5.50Firstly, the sanctions achieved in the US would not be possible under current Australian laws because ‘ASIC can only act against a lead audit partner for non-compliance with an auditing standard in the conduct of an individual audit’ rather than sanctioning the audit firm.
5.51Secondly, the US PCAOB has a specific legislative mandate to conduct audit inspections and surveillance whereas ASIC does not.
5.52Thirdly, the US PCAOB has 460 employees on its audit inspection program, compared to 16 at ASIC. The number of relevant listed entities that are audited is only three times larger for the US PCAOB than ASIC. Additionally, the US PCAOB has clear targets for the scope and frequency of audit firm reviews, whereas ASIC does not.
5.53The committee also heard evidence on these issues from the current Chair of the FRC, Mr Andrew Mills. He warned that moving some functions out of ASIC and into a new body could reduce the synergies that presently exist in ASIC because ASIC conducts the enforcement of both financial reporting and auditing.
Committee view
5.54The committee view covers three related topics: integration of some of the roles within the current regulatory framework, ensuring the effectiveness of the disciplinary function, and ensuring the independence of the standard setting and oversight bodies.
Integrating some of the current functions of the regulators and standard setters
5.55Evidence presented to the committee indicated that Australia’s regulatory oversight arrangements in relation to auditing differ significantly from overseas jurisdictions.
5.56Firstly, jurisdictions such as the US, UK, and New Zealand have fewer bodies covering a more comprehensive range of regulatory functions for auditing.
5.57Secondly, establishing audit standards for quality control, ethics and independence in Australia is an industry self-regulatory function, whereas it is government-regulated in the other jurisdictions such as the US, UK, and New Zealand.
5.58Thirdly, the Australian FRC currently has a minimal role overseeing the accounting and auditing standard setters, while overseas peers in the US, UK, and New Zealand have a broader role.
5.59Evidence to the inquiry supported some rationalisation of Australia’s arrangements for standard setting for financial reporting, assurance and auditing. To that end, the committee supports the government’s proposal to integrate the FRC, AASB and AUASB into a single body (the new FRC).
5.60Noting the views of the current FRC Chair, Mr Andrew Mills, the committee is particularly mindful of the value in retaining the synergies that currently exist within ASIC as performs enforcement for both financial reporting and auditing.
5.61The first option for reform would involve giving greater priority and increased funding and resourcing for ASIC’s financial reporting and auditing surveillance and enforcement program.
5.62Further, the committee notes that in the previous chapter, it recommended that ASIC be given the legislative power to act against an audit firm rather than just an individual auditor. Should this recommendation be implemented, ASIC would then have many of the surveillance, investigation, and enforcement powers of the US PCAOB. These reforms could be made without major structural change.
5.63The second option for reform, as proposed by some inquiry participants, would be to establish a body like the US PCAOB in Australia, with responsibilities including registering auditors and firms, setting standards, conducting surveillance and investigation, and undertaking enforcement and disciplinary action.
5.64The committee observes that such a proposal would require moving some functions, such as registration, surveillance, investigation and enforcement, out of ASIC. There may be significant implications of such a substantial change that would need to be carefully worked through.
5.65The integrated nature of a proposed Australian PCAOB would remove barriers in the processes that presently exist in Australia between inspections done by ASIC and disciplinary action for individuals by CADB.
5.66However, as the committee notes in the next section, folding the disciplinary functions of CADB into ASIC would achieve the same outcome within an existing structure.
5.67The committee recommends that:
the Australian Government adopt a phased approach and proceed with its proposal to integrate the accounting and audit standards boards with the Financial Reporting Council; and
the Australian Government then establish an organisation in Australia equivalent to the United States Public Company Accounting Oversight Board.
The role and effectiveness of CADB
5.68CADB is not presently an efficient or effective part of the regulatory framework for auditing.
5.69Despite ongoing issues with audit quality, few cases are referred to CADB. The committee notes that ASIC maintains that most instances it uncovers result in low-risk administrative findings where the most cost effective and efficient method is to allow an auditor to resign. Further, ASIC has discretion over whether to refer such matters to CADB for a disciplinary process.
5.70The committee notes that Australia appears to be unique in having an organisation solely devoted to auditor disciplinary proceedings. Further, the arrangements for seconding staff from ASIC to CADB have been subject to disagreement.
5.71Sufficient time has elapsed since the liquidator disciplinary functions were moved out of the former Companies Auditors and Liquidators Disciplinary Board (leaving the resultant CADB) to consider whether the current arrangements are satisfactory.
5.72In this regard, the disciplinary functions for liquidators and financial advisers achieve independence through committees and panels, which include ASIC but have a majority of independent members. Similarly, the US PCAOB appears to be able to impose sanctions on auditors, without reference to a separate body.
5.73Therefore, the committee is of the view that, while the government is making other changes to address regulatory overlaps and gaps in the auditing sector, there is scope to consider the efficiency and effectiveness of auditor disciplinary functions and CADB.
5.74Given that many of the findings against an individual auditor may be administrative, the committee suggests that the government consider:
whether the disciplinary functions of the CADB should be folded into ASIC with arrangements established similar to those for the liquidator and financial advisor disciplinary functions;
whether a different body could better perform the auditor disciplinary functions;
different arrangements for staffing and resourcing auditor disciplinary functions;
whether more clarity should be provided on what cases are to be referred to CADB;
whether it is appropriate for ASIC to have discretion over whether auditors can avoid a disciplinary process by resigning;
whether it is appropriate for the ASIC audit surveillance program to continue to operate without the intention and actions to generate referrals to CADB and whether the findings of ASIC audit surveillance reports should be automatically referred to CADB; and
whether CADB should be given the power to make own-motion investigations, in addition to receiving referrals from ASIC or APRA.
5.75The committee recommends that the Australian Government reform the Companies Auditors Disciplinary Board (CADB) to improve its efficiency and effectiveness by:
implementing improved, more stable and transparent arrangements for staffing and resourcing auditor disciplinary functions;
providing more clarity around what cases trigger referral to CADB;
removing the Australian Security and Investments Commission’s (ASIC’s) discretion over whether auditors can avoid a disciplinary process by resigning;
compelling the findings of ASIC audit surveillance reports to be automatically referred to CADB; and
giving CADB the power to make own-motion investigations, in addition to receiving referrals from ASIC or the Australian Prudential Regulation Authority.
Independence of the regulators and standard setters from the Big Four firms
5.76A tension exists in the make-up of regulators and standards boards between having access to relevant skills and experience, often drawn from the industry to be overseen, and the ability to act independently of the industry which they oversee.
5.77In the audit sector, the committee notes the make-up of the FRC, AASB and AUASB draws heavily on members with ties to the Big Four audit firms. The committee acknowledges the need for these bodies to have sufficient access to relevant skills and experience. However, the committee also considers it very important that such these bodies can act independently of the Big Four firms. The current arrangements create a risk that an appropriate level of independence is not achieved.
5.78The committee is also concerned about the ‘revolving door’ associated with the movement of staff between the public and private sectors. At some level there are benefits from such movements, however, it can also lead to conflicts of interests.
5.79The committee notes that any restriction on membership may limit access to the relevant technical expertise. However, the committee observes that the International Ethics Standards Board for Accountants is currently implementing restrictions on the numbers of audit practitioners able to sit on its board. The committee therefore considers it feasible to apply a similar approach to Australia’s domestic standards boards for the accounting and auditing sectors.
5.80The committee considers that the government’s proposal to integrate the FRC, AASB and AUASB into a single organisation will provide an opportunity to review the independence, qualifications and other conditions for appointment to the new organisation.
5.81If the government does not proceed with the integration of the three bodies, the committee considers that it should take separate action to address their independence from the Big Four.
5.82In addition to ensuring that the Big Four firms do not unduly influence regulatory bodies, the committee considers it timely to address other matters.
5.83For example, Treasury officers currently staff the FRC secretariat. While such an arrangement may provide efficiencies, the committee is concerned that there is insufficient separation between the FRC and Treasury. In contrast, the secretariat for the AASB and AUASB is independent of Treasury.
5.84When the government implements the integration of the FRC, AASB and AUASB, it will have to choose one approach. The committee is of the view that it is appropriate for the new FRC to have an independent secretariat.
5.85The committee recommends that the Australian Government consider additional mechanisms to ensure the Financial Reporting Council and any related standards boards, the Companies Auditors Disciplinary Board, the Australian Securities and Investments Commission, the Tax Practitioners Board, and the Australian Taxation Office and other government regulatory bodies are independent and are seen to be independent, including by ensuring that the bodies do not include individuals with a current financial interest in entities under the direct governance of the body. This may include revision of internal governance structures, independent review or audit of decision making and internal governance structures by an external third party, such as a government department or parliamentary committee or appropriate expert to ensure that the revolving door between the public and private sectors does not lead to perceived or actual conflicts of interest.
5.86The committee recommends that the Australian Government ensure that the new Financial Reporting Council has structural, governance and administrative arrangements which are independent from Treasury, including by ensuring that the new Financial Reporting Council do not include individuals with a current financial interest in entities under the direct governance of the body.
5.87In addition to ensuring that persons from the Big Four firms do not dominate regulatory bodies, the committee considers that appropriate mechanisms must be in place to monitor the influence of board members through codes of conduct and requirements for disclosure of conflicts of interests.
5.88In 2019, the committee identified significant gaps and inconsistencies in the codes of conduct and requirements for disclosure of conflicts of interest for bodies established under the ASIC Act, including the FRC, AASB, and AUASB. There is no statutory requirement for the members of the FRC to avoid or disclose conflicts of interest. The committee therefore made recommendations to enhance and harmonise the codes of conduct and requirements for disclosure of conflicts of interest.
5.89Since 2019, there have been developments internationally to ensure the structural avoidance of conflicts of interest on industry and standards boards. The committee welcomes these developments as evidence that matters the committee identified in 2019 are still relevant and merit serious consideration. Consequently, the committee does not agree with the government’s view that a substantive response to its 2019 recommendations is no longer appropriate.
5.90Rather, the committee urges the government to reconsider its position on enhancing and harmonising codes of conduct and requirements for disclosure of conflicts of interest for the new FRC and other bodies established under the ASIC Act. At a time when the government is making significant regulatory changes to address governance issues within the Big Four, it is of the utmost importance that government bodies set the benchmark for codes of conduct, including a rigorous approach to the disclosure of conflicts of interest.
5.91The committee recommends that the Australian Government enhance and harmonise codes of conduct and requirements for disclosure of conflicts of interest for all bodies established under the Australian Securities and Investments Commission Act 2001, including the new Financial Reporting Council.