House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Notes on clauses

Clause 1: Short Title

Upon enactment, the Bill will be known as the Australian Securities and Investments Commission Amendment (Audit Inspection) Act 2006 .

Clause 2: Commencement

The covering clauses (Clauses 1, 2 and 3) will commence on the day the Act receives the Royal Assent. The operative provisions of the Act (Schedules 1 and 2) will, in the case of Schedule 1, commence on the day after the Act receives the Royal Assent, and in the case of Schedule 2, at the time set out in the Table of commencement information in Clause 2.

Clause 3: Schedule(s)

The Acts specified in a Schedule to the Bill will be amended or repealed as set out in the applicable items in the Schedules and any other item in a Schedule will have effect according to its terms.

Schedule 1 - Enhancement of ASIC's audit supervision

Background

The US Sarbanes-Oxley Act 2002 (the SOX Act) introduced a rigorous corporate governance scheme which has substantially enhanced the US companies and auditors regulation regime. The SOX Act, and the rules made pursuant to it, creates extensive new obligations for companies that access US capital markets; for auditors of those companies; and for auditors indirectly involved in the preparation of audits for US capital market participants.

ASIC has been approached by a number of major Australian companies seeking to minimise US-Australian regulatory duplication created by the concurrent operation of both the Australian regime (as enhanced by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the CLERP 9 Act) and the US regime. These companies acknowledge the need for US-based capital raising rules to apply to US activities but point to the potential for substantial regulatory duplication between the Australian regime and the US rules as they apply more generally, including to the audit process.

Many of the SOX Act obligations relate not only to the activities directly undertaken in the US, but also to the structure and operation of the activities of the companies and auditors in Australia. This could result in an increased burden for Australian companies that seek to raise capital within US capital markets, or to have their securities listed on US markets. The SOX Act also has extensive ramifications for Australian auditors involved in the audit of entities regulated by SOX Act provisions.

Compliance with the SOX Act subjects public accounting firms, including Australian auditors, to:

mandatory registration, payment of fees and submission of periodic reports to the PCAOB;

compliance and cooperation with the PCAOB's standards, inspections and disciplinary process; and

specific auditor independence requirements.

Discussions between ASIC and the PCAOB have identified potential for significant rationalisation of the two regimes applying to the audit inspection process. ASIC is continuing its discussions with the PCAOB with the aim of securing agreement on a cooperative arrangement relating to joint inspections of Australian audit firms that are subject to both Australian and US audit requirements.

It is proposed that the co-operative arrangement between ASIC and the PCAOB will be governed by a Statement of Protocol agreed by the two bodies. The purpose of the protocol is to set forth the intent of ASIC and the PCAOB in relation to the procedures for co-operating in the oversight of auditors subject to the regulatory jurisdiction of both ASIC and the PCAOB.

The amendments in the Bill are necessary to support the proposed US-Australian Audit Regulation Programme.

Description of principal changes

The proposed new provisions in Schedule 1 of the Bill will provide a legislative framework to support ASIC entering into an agreement or arrangement with a foreign regulatory body in relation to audit regulation and will also provide ASIC with enhanced information-gathering powers in relation to audit inspections.

The proposed principal amendments to the ASIC Act fall into five categories:

the proposed provisions in item 1 of Schedule 1 will empower ASIC to enter into cooperative arrangements with foreign regulatory bodies relating to audit regulation;

the proposed provisions in items 2, 3 and 4 of Schedule 1 will enhance ASIC's powers in relation to the inspection of an auditor's books and in relation to the seeking of information from an auditor about audit-related matters;

the proposed provisions in item 11 will require ASIC to inform an auditor of the details of information obtained by ASIC from the auditor, in the course of an audit inspection process with a foreign regulatory body, which have been given to the foreign regulatory body;

the proposed amendments in items 14 and 15 of Schedule 1 will enable ASIC to provide information to a foreign body which, although not an agency of a foreign country, will assist the foreign body to perform a regulatory function conferred on the body by a law of that foreign country; and

the proposed amendment in item 16 of Schedule 1 will require ASIC to include in its annual report information about the activities it has undertaken during the reporting period in accordance with a co-operative audit regulation arrangement with a foreign regulatory body.

Clause by clause commentary

Australian Securities and Investments Commission Act 2001

Item 1 Subsection 11(9B)

Section 11 of the ASIC Act currently provides for functions and powers to be conferred on ASIC by or under the corporations legislation (defined in section 5 to mean the ASIC Act and the Corporations Act) and for other functions and powers to be conferred on ASIC by the States and Territories.

The existing subsection 11(9B) will be repealed and proposed subsection 11(10) will empower ASIC, with the written consent of the Minister, to enter into an agreement or arrangement with a regulatory body of a foreign country under which ASIC would assist that regulatory body to ascertain, whether Australian auditors (defined in section 5) comply with audit requirements that are imposed by or under laws of that foreign country or adopted as professional standards in that foreign country.

The requirement that the Minister's consent be obtained in relation to an agreement or arrangement between ASIC and a foreign regulator is an important safeguard that will be built into the legislative framework. Proposed subsection 11(11) expressly provides that the Minister may, in writing, vary or revoke the Minister's consent mentioned in subsection 11(10).

Proposed subsection 11(12) will require ASIC to publish a notice in the Gazette , as soon as practicable after entering into an agreement or arrangement with a regulatory body, in which the notice must:

set out the identifying particulars of the regulatory body (for example, the PCAOB);

give brief particulars of the agreement or arrangement entered into; and

identify the audit requirements to which the agreement or arrangement relates.

The notice published in the Gazette under subsection 11(12) is for information purposes only and is not a legislative instrument for the purposes of section 5 of the Legislative Instruments Act 2003 (see proposed subsection 11(13)).

The scope of the new functions conferred on ASIC in relation to audit regulation agreements or arrangements with a regulatory body of a foreign country are described in proposed subsections 11(10) and (14).

Proposed subsection 11(14) confers on ASIC the function of assisting a foreign regulatory body to examine the policies and working practices of an Australian auditor, so as to help the regulatory body to ascertain compliance with audit requirements to which the agreement or arrangement relates.

Proposed subsection 11(14) also confers on ASIC the function of disclosing to a regulatory body with which it has entered into an agreement or arrangement under subsection 11(10), the information that ASIC has obtained in assisting in such an examination.

Proposed subsection 11(15) makes it clear that in performing a function referred to in paragraph 11(14)(a), ASIC may inquire into policies and working practices of an auditor in general and/or in their application to particular audits.

It is noted that proposed subsections 11(10), (14) and (15) attract the protection against liability for damages for ASIC, an ASIC member, ASIC staff member and other persons referred to in section 246 of the ASIC Act for 'an act done or omitted in good faith in performance or purported performance of any function, or in exercise or purported exercise of any power, conferred or expressed to be conferred by or under the corporations legislation'.

Proposed subsection 11(16) provides that ASIC is not under a duty to perform a function referred to in subsection (14). This provision replicates the position which applies to agreements or arrangements that ASIC enters into with a State or Territory (see subsection 11(9) of the ASIC Act).

Proposed subsection 11(17) replicates the effect of the existing subsection 11(9B) which will be repealed but the new provision also provides that ASIC is not subject to any directions of the Minister in relation to ASIC entering into an agreement or arrangement with a regulatory body of a foreign country referred to in subsection 11(10) or performing functions conferred under subsection 11(14).

Item 2 Division 3 of Part 3 (heading)

Item 2 is a consequential amendment reflecting the inclusion of audit information-gathering powers in this Division.

Item 3 Section 28

Section 28 of the ASIC Act contains a purpose test which limits the circumstances in which ASIC may use its inspection powers contained in Division 3 of Part 3. The proposed amendment in item 3 will exclude ASIC's powers under proposed section 30A from section 28 because proposed subsection 30A(2) will contain its own purpose tests in relation to audit related matters.

Item 4 After section 30

New section 30A Notice to auditors concerning information and books

Item 4 will insert a proposed section 30A which will enhance ASIC's inspection and information-gathering powers in relation to Australian auditors.

At present, under subsection 30(1) of the ASIC Act, ASIC is empowered to seek books (defined in section 5) from an auditor ('an eligible person') in relation to the affairs of a body corporate. ASIC relies on its powers under section 30 for purposes of its enhanced audit enforcement and surveillance responsibilities introduced by the CLERP 9 Act reforms. In addition, ASIC may use subsection 37(9) of the ASIC Act, which gives ASIC the power to require the auditor to explain any matter about the compilation of the books or to which the books relate. The form of these inspection powers under section 30 of the ASIC Act, which pre-date the CLERP 9 Act, are not well adapted to the kind of inspection work now undertaken by ASIC or the inspection work that ASIC would undertake in assisting the PCAOB to undertake an audit inspection. That work involves a general examination of the processes and systems an audit firm has in place to meet its obligations generally, and not just in relation to the affairs of a body corporate. The proposed cooperative arrangement between ASIC and the PCAOB is unlikely to be feasible under ASIC's existing inspection powers.

The Financial Reporting Council (FRC) in its 2004-05 Report on Auditor Independence recommended that ASIC's powers of inspections in relation to audit firms needed to be clarified. The FRC said in its report that it is aware that some of the audit firms are concerned about the extent of ASIC's powers to review the firms and undertake inspection work. The FRC noted that ASIC clearly has the power to inspect an audit of any reporting entity to test its compliance with the Corporations Act, but queries have been raised about its powers to inspect the firms' processes and systems. Proposed section 30A would remove the uncertainty identified by the FRC as to the extent of ASIC's existing powers.

Proposed subsection 30A(1) will empower ASIC to give an Australian auditor a written notice requiring the auditor to give specified information or to produce specified books to ASIC.

ASIC's powers under subsection 30A(1) to obtain specified information or require production of books may only be exercised if they meet the purpose tests in proposed subsection 30A(2) which are directed specifically at audit related matters. These purpose tests are based on the existing purpose tests contained in section 28 of the ASIC Act but modified to apply to audit-related matters. The purpose tests which, if satisfied, would trigger the enhanced information-gathering powers include:

the performance or exercise of any of ASIC's functions and powers in respect of audit-related matters under Chapter 2M or Part 9.2 or 9.2A of the Corporations Act or under other provisions of that Act that relate to that Chapter or that Part (Corporations Act audit requirements); or

the performance or exercise of any of ASIC's functions and powers related to audit requirements referred to in proposed subsection 11(10) of the ASIC Act (overseas audit requirements); or

ascertaining compliance with Corporations Act audit requirements or overseas audit requirements; or

an alleged or suspected contravention of a law of the Commonwealth, or of a State or Territory in this jurisdiction, being a contravention that relates to an audit matter and that either concerns the management or affairs of a body corporate or involves fraud or dishonesty and relates to a body corporate; or

an investigation under Division 1 of the ASIC Act relating to a contravention of Corporations Act audit requirements.

Proposed subsection 30A(3) clarifies that the scope of ASIC's powers under subsection 30A(1) includes the power to specify information or books that relate to:

the policies relating to audit that the auditor has adopted or proposes to adopt, or the procedures relating to audit that the auditor has put in place or proposes to put in place;

audits the auditor has conducted or proposes to conduct or in which the auditor has participated or proposes to participate; or

any other matter pertaining to audit that is prescribed by the regulations (there are no proposals for regulations at the present time).

A person responding to a notice under subsection 30A(1) will have qualified privilege in respect of the response (see proposed amendment to paragraph 1289(1)(d) of the Corporations Act under item 17 of Schedule 1).

An auditor must comply with a notice given by ASIC under subsection 30(A)(1), even if giving the information or producing the books would result in a breach of any obligation of confidentiality that the auditor owes an audited body (proposed subsection 30A(4)). This will ensure that an auditor could not be sued by a client on the grounds of breaching client confidentiality if the information was disclosed in order to comply with a notice under section 30A of the ASIC Act.

Proposed subsection 30A(5) provides that ASIC may extend the period within which an auditor who received a notice under subsection 30A(A)(1) must give the information or produce the books to which that notice relates.

Application of legal professional privilege and other privileges recognised under Australian and US laws

Australian and US law on legal professional privilege is different. As a result, the ability of ASIC and the PCAOB to require the production of documents that is subject to such privilege may not be the same.

During the consultation period on the proposals relating to the US - Australian Audit Regulation Programme, the major audit firms raised concerns that the firms and their audit clients may be disadvantaged because ASIC would be able to obtain and pass onto the PCAOB documents which the PCAOB would not be able to obtain directly because of the privilege available under US law.

The requirement for the Minister to consent to the arrangement between the PCAOB and ASIC provides a safeguard against such an outcome. It is expected that in deciding whether to approve any arrangement, the Minister would have regard to whether the arrangement makes adequate provision to ensure that neither ASIC nor the PCAOB would be able to obtain through the other body information or documents which it would not be able to obtain under its own laws because of legal professional privilege or any other privilege (for example the privilege against self-incrimination) recognised under its own laws.

In addition, it is noted that the existing statutory privilege in relation to self-incrimination in section 68 of the ASIC Act will apply to proposed section 30A. This is also the case for the statutory privilege conferred on lawyers relating to legal professional privilege by section 69 of the ASIC Act.

Item 5 Section 33

Item 5 is a drafting amendment consequential upon the proposed amendment under item 6 which will add a new subsection 33(2).

Item 6 At the end of section 33

Proposed subsection 33(2) will enable ASIC to serve a notice on a person (other than the auditor) requiring the production of specified books that are in the person's possession and which relate to the question whether an auditor has complied with Corporations Act audit requirements, or overseas audit requirements, within the meaning of proposed subsection 30A(2).

Item 7 Subsection 34(2)

Proposed subsection 34(2) will expand the scope of the existing subsection by enabling ASIC to limit an authorisation under section 34 by reference to the information that may be required to be given by a person. At present, under subsection 34(2) ASIC can only limit an authorisation by reference to the persons of whom a requirement may be made and/or by reference to the production of books.

Item 8 Subsection 34(3)

Item 8 is a consequential amendment to ensure that subsection 34(3) applies to a requirement made under proposed section 30A.

Item 9 Paragraph 34(3)(c)

Item 9 repeals existing paragraph 34(3)(c) and substitutes proposed paragraphs 34(3)(c) and (d). The proposed amendment will take account of the fact that a written notice issued under proposed section 30A relates not only to the production of specified books but also to specified information.

Item 10 Paragraphs 37(5)(b) and (c)

Section 37 outlines the powers that a person authorised by ASIC has over books that are produced to, or seized by, ASIC under Division 3. Subsection 37(5) sets out the purposes that must be satisfied in relation to the retention of those books by ASIC.

Proposed paragraph 37(5)(b) is a consequential amendment that will ensure that the books can be retained for any of the purposes set out in proposed paragraphs 30A(2)(a), (b) and (d).

The existing paragraph 37(5)(c) provides that it is a legitimate purpose to retain books for so long as is necessary for a decision to be made about whether or not a proceeding, to which the books concerned would be relevant, should be instituted. Proposed paragraph 37(5)(c) will make it clear that this purpose does not apply to ASIC's functions and powers relating to compliance with overseas audit requirements for purposes of paragraphs 30A(2)(a)(ii) and (b)(ii) because in those circumstances, it would be the foreign regulatory body and not ASIC that would have to make a decision whether proceedings should be instituted for contravention of the audit requirements of a foreign country.

Item 11 At the end of Division 3 of Part 3

The purpose of proposed section 39B is to place an obligation on ASIC to inform an auditor of the details of the information, obtained by ASIC from the auditor under a joint inspection process, which ASIC has passed to a foreign regulatory body, such as the PCAOB. The audit firms requested that such a transparency requirement should be imposed on ASIC.

The circumstances in which ASIC will be required to provide such information are set out in proposed subsection 39B(1):

where an Australian auditor gives information or produces books because of a requirement made under subsection 30A(1) for purposes relating to overseas audit requirements referred to in subparagraph 30A(2)(a)(ii) or 30A(2)(b)(ii); or

where books in such a requirement are obtained from an Australian auditor under a warrant issued under section 36 of the ASIC Act; or

where a person gives information or produces books that relate to the question whether an auditor has complied with overseas audit requirements within the meaning of subsection 30A(2) because of a requirement made under subsection 33(2); or

where such books are obtained by ASIC from a person under a warrant issued under section 36 of the ASIC Act.

Where ASIC has provided information or books, or copies of the books, to a foreign regulatory body with which it has entered in to an agreement or arrangement under subsection 11(10), proposed subsection 39B(2) requires ASIC, within 14 days of doing so, to notify the Australian auditor or person in writing of the details of the information or books, or copies, given to the foreign regulatory body.

Item 12 Paragraph 63(1)(c)

Subsection 63(1) of the ASIC Act is an offence provision which provides that a person must not intentionally or recklessly fail to comply with specified requirements made under Part 3 of the Act. The penalty for contravention of subsection (1) is 100 penalty units or imprisonment for two years, or both.

The purpose of the amendment to paragraph 63(1)(c) is to ensure that the requirements under proposed section 30A are brought within the scope of subsection 63(1).

Item 13 After paragraph 80(1)(a)

Section 80 of the ASIC Act provides for the admissibility in evidence of copies of, or extracts from, certain books. The amendment in item 13 will ensure that a copy of, or an extract from a book relating to an audit-related matter referred to in proposed subparagraph 30A(2)(a)(i) will be admissible in evidence in a proceeding in court or other proceeding (as defined in section 5).

Item 14 After paragraph 127(4)(c)

Paragraph 127(4)(c) of the ASIC Act authorises ASIC to disclose information to a government or an agency of a foreign country. This provision would not empower ASIC to pass information to a regulatory body such as the PCAOB because the status of the PCAOB is expressly described in the SOX Act as not being 'an agency or establishment of the United States Government'. The SOX Act refers to the PCAOB as a body corporate operating as a non-profit corporation.

Proposed paragraph 127(4)(ca) will authorise ASIC to furnish information to a foreign body which will enable or assist the foreign body, although not an agency of a foreign country , to perform a regulatory function, or to exercise a related power, conferred on the body by or under a law in force in that foreign country. The PCAOB would fall within the ambit of proposed paragraph 127(4)(ca).

The PCAOB is subject to stringent confidentiality requirements under subsection 105(5) of the SOX Act which are comparable to the strong confidentiality protections which apply to documents and information that are provided to ASIC.

Item 15 Subsection 127(4)

Item 15 is a drafting amendment consequential on the insertion of proposed paragraph 127(4)(ca).

Item 16 After subsection 138(2)

Section 138 of the ASIC Act sets out the additional matters that ASIC must include in its annual report for the purposes of section 9 of the Commonwealth Authorities and Companies Act 1997 .

Proposed subsection 138(3) will require ASIC to include in its annual report information about the activities that ASIC has undertaken during the reporting period in accordance with each agreement or arrangement that ASIC has entered into with a foreign regulatory body in relation to audit regulation.

Corporations Act 2001

Item 17 Paragraph 1289(1)(d)

Section 1289 of the Corporations Act sets out the circumstances where an auditor and other persons enjoy qualified privilege.

The proposed amendment to paragraph 1289(1)(d) will ensure that an Australian auditor who responds to a notice under proposed subsection 30A(1) of the ASIC Act has qualified privilege in respect of the response.

Schedule 2 - Technical amendment to auditing standard provisions

Background

Subsection 1455(5) of the Corporations Act provides relief from criminal penalties where an audit is not conducted in accordance with auditing standards and the contravention occurs prior to 1 July 2006.

The relief under subsection 1455(5) was granted because the auditing standards prior to 1 July 2006 were made by the professional accounting bodies, rather than the Auditing and Assurance Standards Board (AUASB) and as a consequence the drafting is not as precise as that usually contained in an instrument intended to have force of law.

While the life of the auditing standards made by the professional accounting bodies was originally limited under section 1455 by providing that they ceased to have effect in relation to financial reports for periods ending after 30 June 2006, regulations were subsequently made under section 1455 to provide that the professional standards listed in Regulation 10.5.01 of the Corporations Regulations 2001 cease to have effect in relation to financial reports for periods ending after 29 June 2007 (instead of 30 June 2006).

The extension of the life of the auditing standards made by the professional accounting bodies was necessary because the new auditing standards made by the AUASB for purposes of the Corporations Act, would only apply to periods ending on or after 30 June 2007, and if the life of the standards made by the professional accounting bodies had not been extended, there would be no auditing standards with force of law applicable to audits of financial reports for periods ending after 30 June 2006 and on or before 29 June 2007.

The purpose of the technical amendment is to ensure that the current immunity against criminal liability under subsection 1455(5) is extended to cover all financial reports for periods ending on or before 29 June 2007 that are audited using those standards made by the professional accounting bodies.

Description of principal changes

The proposed amendment to subsection 1455(5) would extend the current immunity against contravention of an auditing standard listed in sub-regulation 10.5.01 of the Corporations Regulations 2001 beyond 30 June 2006 to cover all financial reports for periods ending on or before 29 June 2007 that are audited using those standards.

Clause by clause commentary

Corporations Act 2001

Item 1 Subsection 1455(5)

The effect of the proposed amendment to subsection 1455(5) is to extend the application of the period of relief from criminal liability beyond 1 July 2006 until the standards made by the professional accounting bodies cease to have effect as an auditing standard. The standards made by the professional accounting bodies cease to have effect for purpose of the Corporations Act on 29 June 2007.