House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Parliamentary Secretary to the Treasurer, the Hon David Bradbury MP)

Annual transparency reports

Outline of chapter

2.1 Part 2 of Schedule 1 of the Bill will insert a Part 2M.4A into the Corporations Act containing requirements for the publication of a transparency report by firms conducting audits of ten or more Australian entities of the following categories: listed companies, listed registered schemes, authorised deposit-taking institutions (ADIs) and insurance companies.

2.2 The broad objective of the requirement is to improve audit quality by enhancing the transparency of audit firms. As Australia's larger audit firms are usually structured as partnerships, minimal information about their ownership, governance, business structure and activities is publicly available. Requiring audit firms to publish a transparency report will assist in addressing this situation by ensuring factual information about firms performing significant audits is available to existing and potential clients.

2.3 Introduction of a requirement for Australian audit firms to publish transparency reports will assist in bringing Australia into line with developments in Europe and North America in relation to the publication of transparency reports by such firms.

Context of amendments

2.4 During the last decade, there has been a move in a number of overseas jurisdictions to require larger audit firms to produce a public annual report.

2.5 In Europe, Article 40 of the EU's Statutory Audit Directive ^[1] requires statutory auditors and audit firms to publish on their websites, within three months of the end of each financial year, annual transparency reports that contain a range of information about the firm, including:

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a description of the legal structure, ownership and governance structure of the audit firm;

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a description of the internal quality control system of the audit firm;

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an indication of when the last quality assurance review of the audit firm took place; and

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a list of 'public interest entities' for which the audit firm has carried out statutory audits during the preceding financial year.

2.6 In the United States (US), a US Treasury Committee report issued in October 2008 made the following recommendation in relation to increased transparency by audit firms:

Urge the PCAOB to require that, beginning in 2010, larger auditing firms produce a public annual report incorporating (a) information required by the EU's Eighth Directive, Article 40 Transparency Report deemed appropriate by the PCAOB, and (b) such key indicators of audit quality and effectiveness as determined by the PCAOB in accordance with Recommendation 3 in Chapter VIII of the Report. Further, encourage the PCAOB to require that, beginning in 2011, the larger auditing firms file with the PCAOB on a confidential basis audited financial statements.

2.7 In framing its recommendation, the US Treasury Committee:

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noted that auditing firms and investors have expressed support for requiring US auditing firms to publish reports similar to the EU's Article 40 Transparency Report;

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believed that information about audit quality indicators could improve audit quality by enhancing the transparency of auditing firms and noted that some foreign affiliates of US auditing firms provide such indicators in public reports in other jurisdictions; and

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noted that auditing firms in the UK now publish annual reports containing audited financial statements pursuant to limited liability partnership disclosure requirements as well as a discussion of those statements, a statement on corporate governance, performance metrics, and other useful information.

2.8 In Australia, there is no statutory requirement under the Corporations Act for auditors to publish information on their websites similar to that required under the EU transparency report. However, in November 2010, one of the major audit firms voluntarily published a transparency report in relation to its Australian practice.

Summary of new law

2.9 The amendments will require an individual auditor, an audit firm or an authorised audit company conducting audits of ten or more entities of any of the types referred to below to publish a transparency report. The types of audits that trigger the reporting requirements are those of listed companies, listed registered schemes, authorised deposit taking institutions (ADIs) and insurance companies.

2.10 The disclosures to be made in the report will be prescribed in the Corporations Regulations. Disclosure of any information that is likely to result in unreasonable prejudice to the auditor may be omitted from the report (although in these circumstances the report must say that material has been omitted). The amendments also provide that ASIC may relieve the auditor from compliance with all or specified requirements concerning the preparation of the transparency report.

2.11 The report is to be published on the auditor's website within four months after the end of the year to which the report relates and a copy of the report is to be lodged with ASIC on or before the day on which it is published. The amendments will allow ASIC to extend the period in which the report must be published.

Comparison of key features of new law and current law

Detailed explanation of new law

2.12 The new Part 2M.4A of the Corporations Act will require an individual auditor, audit firm or authorised audit company (collectively referred to in the amending legislation as a 'transparency reporting auditor') [ Schedule 1, Part 2, item 12, section 332(1 )] to publish a transparency report for each year in which the auditor conducts audits, under Division 3 of Part 2M.3, of 10 or more bodies of any of the following kinds: listed companies, listed registered schemes, authorised deposit-taking institutions within the meaning of the Banking Act 1959 and insurance companies. The amendments also permit the Corporations Regulations to be used to add additional kinds of body to the list of bodies that will trigger the transparency reporting obligation. [ Schedule 1, Part 2, item 12, subsection 332A(1 )]

2.13 An auditor will be required to publish their transparency report on their website within four months of the end of the year to which it relates. In addition, an auditor will be required to lodge a copy of the report with ASIC on or before the day on which it is published on the auditor's website. [ Schedule 1, Part 2, item 12, subsections 332A(2 ) and ( 3 )]

2.14 The year to which the transparency report relates is the period of 12 months starting on 1 July (referred to in the amending legislation as a 'transparency reporting year'). However, if an auditor has a financial year that does not commence on 1 July, the auditor could make an application under the proposed section 332D seeking relief from this requirement. Any relief provided by ASIC is likely to be subject to a condition that the auditor prepares a transparency report in relation to the financial year adopted by the auditor. [ Schedule 1, Part 2, item 12, subsection 332(2 )]

2.15 The disclosures to be made in the transparency report will be prescribed by the regulations. It is envisaged that these disclosures will include the following:

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information about the auditor's legal structure and ownership;

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where the auditor belongs to a network, information about the network and the legal and structural arrangements in the network;

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information about the auditor's governance structure;

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information about the internal quality control system of the auditor and a statement by the administrative or management body of the auditor on the effectiveness of its functioning;

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details of when the last reviews of the auditor took place, showing separately:

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audit inspections by ASIC; and

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quality assurance reviews by each of the professional accounting bodies;

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the names of entities of the kinds listed in proposed subsection 332A(1) for which the auditor conducted audits under Division 3 of Part 2M.3 during the preceding calendar year;

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information about the auditor's independence practices, including details of the last internal review of independence compliance that was conducted;

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the policy followed by the auditor concerning the minimum amount and nature of continuing or other professional education that must be undertaken by professional members of the audit team;

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summary financial information for the auditor, showing total revenue, fees for Corporations Act audits and fees received from audit clients for other assurance services and other non-audit services; and

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a statement of the principles used by the auditor for determining:

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in the case of an audit firm - partners' remuneration;

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in the case of an audit company - directors' remuneration. [ Schedule 1, Part 2, subsection 332B(1 )]

2.16 The amending legislation provides that information may be omitted from the transparency report where its disclosure is likely to cause unreasonable prejudice to the auditor preparing the report. However, in these circumstances the report will have to indicate material has been omitted. [ Schedule 1, Part 2, item 12, subsection 332B(2 )]

2.17 ASIC will be empowered to extend the period within which an auditor must publish a transparency report and to relieve auditors, or a specified class of auditors, from all or specified requirements of proposed sections 332A and 332B relating to such reports. A relief order made by ASIC may be expressed to be subject to conditions. ASIC may take action to revoke a relief order if an auditor fails to comply with the conditions. [ Schedule 1, Part 2, item 12, sections 332C, 332D and 332E ]

2.18 The legislation provides that where ASIC is considering an application from an auditor for relief from the requirements of proposed sections 332A and 332B, it must be satisfied that complying with the requirements of those provisions would be inappropriate in the circumstances associated with the preparation of the transparency report or would impose unreasonable burdens on the auditor. For the purpose of deciding whether the preparation of the report would impose an unreasonable burden on the auditor, ASIC is required to have regard to a range of factors, including the expected costs of compliance with the requirements, the expected benefits of that compliance and practical difficulties the auditor would face in complying effectively with the requirements. [ Schedule 1, Part 2, item 12, section 332F ]

2.19 In conjunction with the introduction of the requirements for the preparation of a transparency report, offence provisions will apply for a failure by an auditor to:

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publish the transparency report; and [ Schedule 1, Part 2, item 12, subsection 332A(2 )]

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lodge a copy of the report with ASIC [ Schedule 1, Part 2, item 12, subsection 332A(3 )].

2.20 Each of these offences will be one of strict liability, attracting a penalty of 10 penalty units ^[2] [ Schedule 1, Part 2, item 13, Schedule 3 ( table items 116NC - and 116ND )]. The strict offence provision is designed to provide an incentive across the firm or audit company to foster an effective culture of compliance.

2.21 Where the auditor preparing the transparency report is an audit firm, proposed section 332G imposes a form of collective liability which is designed to encourage a 'culture of compliance' across the whole firm. The section provides that the requirements of Part 2M.4A of the Corporations Act are to apply to the firm as if it were a person, but with the following modifications:

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an obligation that would otherwise be imposed on the firm is imposed on each member of the firm instead, but may be discharged by any of the members; and

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an offence that would otherwise be committed by the firm is taken to have been committed by each member of the firm. [ Schedule 1, Part 2, item 12, section 332G ]

2.22 Under proposed section 332G, a member of the firm does not commit an offence under a provision of Part 2M.4A of the Corporations Act if the member:

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does not know of the circumstances that constitute the contravention of the provision concerned; or

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knows of the circumstances but takes all reasonable steps to correct the contravention as soon as possible after the member becomes aware of those circumstances. [ Schedule 1, Part 2, item 12, section 332G ]

Application and transitional provisions

2.23 The Bill provides that the transparency reporting requirements will apply in respect of the transparency reporting year that ends after the commencement of Schedule 1 of the Bill and each subsequent calendar year. For example, if Schedule 1 commenced on 1 June 2012, the requirements would first apply to the year ending on 30 June 2012. However, if Schedule 1 commenced on 30 June 2012, the requirements would first apply to the year ending on 30 June 2013. [ Schedule 1, Part 3, item 14, section 1527 ]

Consequential amendments

2.24 There are no consequential amendments for the provisions in Part 2 of Schedule 1.