The results of our survey into Audit Quality, working to fill the gaps in understanding and the expectations about what audits deliver - 20 May 2019
It’s important to remind people of the key role we believe audit plays in contributing to market integrity and informed, investor decision-making. That’s what our legislative mandate directs us to and audit quality sits at the heart of that. It speaks to investor confidence, efficient markets and to governance and culture, both within the auditors themselves and the firms commissioning audit reviews.
If we want to develop participation in our markets and a thriving financial services sector then investors, large and small, professionals and mums and dads, should be able to rely on audited information. Not surprisingly we are also focused on the quality of the oversight regime as we are responsible for supervising the supervisors. Our role is to improve the quality and integrity of the audit profession.
So that’s the aspiration and the value we consider audit can bring, but the reason we did a survey of stakeholders’ perception is because – and none of this should be a surprise to you - auditors and their reputations are taking a pasting in other jurisdictions.
Because of some of our concerns around those issues abroad and the sense of complacency here in NZ about a low perception of audit value, we commissioned a survey to test our own views. The research that we shared with you in the industry last week, clearly shows the expectation gap between what investors want, as the end users of audit services and what they believe the industry is delivering. So I’ll come to the results in more detail in a moment, but here’s the headline.
What we’ll be saying in our public interaction is that overall confidence in the sector is ok, but serious expectation gaps exist among stakeholders with what is being delivered, and investors are not connected to the value that auditors can bring. The good news is we are in better health than overseas. But we still need a concerted effort from the industry to fill these gaps.
Context and events overseas where we’ve seen confidence in auditors collapse.
One word seems to have fallen from the lexicon when it comes to audit work. Assurance. And all that entails. Particularly when you think about how much assurance contributes to investor confidence in our financial markets.
A shareholder group in the UK was quoted recently in the FT as saying
“Previously votes against auditors were based on whether they were seen as being independent of the company. We are now at a stage where demonstrable failure by some firms is becoming a reason to oppose their appointment. Bad audit firms should fail.”
And the reason the investor groups are so hacked off? This is how the Carillion affair was recently reported in the UK press.
“The auditors earning around £1.5m a year for vouching that Carillion’s accounts gave a “true and fair view” of its business, were in fact rubber-stamping figures that “misrepresented the reality of the business”. In March 2017, the firm expressed no concern over reported profits of £150m even though just four months later these proved to be illusory.”
Over there, historic indifference between auditors and the shareholders has turned to a crisis in investor mistrust. But the UK is not alone, the US has seen the same horror shows, and in Australia faith and confidence in audit is also shaken. The various reports in the UK, such as the Kingman Review into the role of the regulator, CMA review into competition among audit firms and the Brydon review into the future of auditing have indicated a huge shake-up of the audit profession as a whole.
As with the conduct and culture review of our big banks and insurers, these issues overseas could threaten to become major issues here.
We see a clear opportunity here for the industry to get ahead of the crisis, examine the issues, and demonstrate leadership with stakeholders and investors. Before there is a major loss of confidence and faith in the industry in New Zealand too.
I’m not here to criticise the industry but instead to lay down a challenge. The gap in expectations demonstrated in our research is yours to fulfil. The solution to the low confidence and trust and lack of understanding is yours to own. We can help promote awareness and understanding, but it’s not our job to promote what should be your own interest in the confidence in your profession. You can build that bridge with investors and the wider public. It’s not broken yet but it needs urgent attention.
Results of the survey.
So the people we asked the agency to survey were
- Retail investors
- Institutional investors
- Directors and members of Audit Risk Committees
- Managers of reporting entities
- Auditors themselves
What did we want to test?
- Test the level of trust and respect for the audit profession
- Are the current oversight regime and regulation system well understood
So what did we find?
- Overall a reasonable level of confidence with auditors. There is a good basis on which we can work.
- A clear expectation gap between investors and audit firms. Events such as company collapses and restatements of accounts/valuations in large listed entities has had a clear negative impact on the results
- Just over half of investors said they trusted audit, while less than half thought the quality of auditors in NZ was of a high standard.
- As far as the gap in trust is concerned. Directors are somewhere in the middle, with auditors marking themselves pretty well. As one of the participants in the detailed interviews suggested, that’s logical – the closer you are to something, the more likely you are to have faith in it.
- Many investors question the value of auditors, while half find the information provided difficult to read. Many investors think regulation on auditors should increase.
- Directors and members of audit risk committees were more positive – but it is notable that only a little over half agreed with the idea that auditors challenge management sufficiently. Under half felt they got good value from an audit, with some saying that fees are too high.
- Auditors rated themselves as close to 100% when it comes to ethics, acting independently and the question of whether there is sufficient oversight. Only 56% of investors agreed.
It’s research of two halves
More broadly if you look at the research in two halves – the survey gives very broad brush strokes around issues within the industry, while the detailed interviews with 15 participants painted a more complex, nuanced picture. Both provided incredibly useful perspectives.
And we know that in New Zealand confidence has also been dented by issues at major businesses such as Fonterra, Fletcher Building, the collapse of businesses like CBL and Wynyard, while acknowledging all the very different circumstances in these cases. It is noticeable that we saw businesses underperform and go under in this time – the likes of Pumpkin Patch – but this was not a shock to investors, because investors knew and understood the risks they were exposed to.
But as one auditor director told us in the survey:
“What grandma investor reads in the newspaper are all the business failures, but that’s got nothing to do with the integrity of the audit.” Well, that may be true in some cases, but that might also just be the rose-tinted view of the audit profession itself.
Our survey shows a serious gap opening between investors and the professions when it comes to confidence in quality and trust in audit.
The expectation gap that we are going to discuss in the next session is writ large in all the verbatim responses and in-depth interviews. The end users of your product - shareholders and investors – do not see the value you bring.
The stark divergence of trust was mercifully qualified in the in-depth interviews. But let’s not draw a veil too quickly over this immediate sense that investors neither understand nor appreciate what you do.
The mitigating factors are bound up in the fact that the industry also noted it does a poor job in promoting itself, the value it brings and the extent to which it undergoes robust supervision and oversight of its functions and processes.
We need to demonstrate joined up leadership between the regulator, and the oversight bodies, talking to their role, their disciplinary functions or the overall issues.
According to the survey, auditors have failed to communicate. The research highlighted that investors, – professional and retail, are looking for more from auditors, particularly in having a presence and communicating issues and findings at the Annual General Meetings.
For the FMA there is a key point to demonstrate again to investors and the broader public, the level of oversight we currently have over auditors in our annual review process, and our ongoing dialogue with the oversight bodies in referring matters of concern to them.
An interesting point was raised in the research which we’re happy to answer around naming of auditors in our individual file reviews. We can see why that would lead to less optimal outcomes with our engagement with auditors if they were to fight every point with us to mitigate the possibility of an unfavourable review naming the auditor. So we feel comfortable at the moment with our thematic approach.
Returning to conclude on the lessons from overseas and how we might prevent them here
In Australia’s Royal Commission it was said that the fraud and misconduct that happened in the big firms was the kind of behaviour that can go unnoticed while no-one was looking….
Isn’t that one of the roles of the audit assurance - a word that needs to be gold-plated and returned to the top of audit priorities? Aren’t you supposed to be looking? In fact some were, and, according to some records, misconduct and poor governance around risk had been noted by auditors sometime before the ARC kicked off. But firms failed to listen and auditors failed to pursue it.
So a narrow view of audit limited to the review of financial statements doesn’t get us there. Relying on the information in audited accounts means trusting that some level of assurance has been provided that the figures, valuations, estimates, liabilities are all more than reasonable and appropriate - they are backed up with some solid evidence and board assurance that directors and the Audit and Risk Committee have done the work.
In the US the auditors, particularly the big 4 firm, have paid a heavy price in penalties for a lack of rigour in their work - but is that enough to stave off regulators imposing business models and separating functional operation of auditors?
We can’t solve these questions overnight - competition and rotation issues are complex... But we need to ask hard questions about the values we tested in the survey:
- Professional scepticism
- Independence
- Reliability and clarity
- Robust selection
And not overlooking the role of oversight and regulation. We need to avoid inadvertently forcing a tick-box approach to running audits and failing to encourage the use of judgement where appropriate.
These are all ingredients that will build trust – if they are applied explained and modelled by a profession that wants the confidence of investors – not just the rewards from its clients.
More recently, the tide has turned quickly in NZ where gaps in the financial markets regulation have been identified. Since our report into banks last November, gaps are being plugged this year. The Government is reacting where issues threaten broader public confidence.
As I said earlier, our message is that overall confidence in the sector is ok, but serious expectation gaps exist among stakeholders with what is being delivered, and investors are not connected to the value that auditors can bring. We need a concerted effort from the industry to fill these gaps.
Thank you.
Speech as delivered may have differed from these notes.
