Governance body opposes structural separation of the big 4

In its submission to Treasury on regulating accounting, auditing, and consulting firms in Australia, the professional association for governance and risk practice said its members do not support requiring structural separation of large, multidisciplinary accounting, auditing, and consulting firms. This mirrored KPMG’s view in its submission.

It argued that the potential costs would outweigh the benefits and could reduce audit quality by limiting access to international audit networks for large clients.

It also warned of high costs and practical implementation challenges, including the complexity of implementing structural separation.

Its submission further argued that achieving operational separation within existing structures could also result in heavy transition costs for auditing services for reporting entities. It added that governance separation alone may not lower a firm’s exposure to commercial pressures.

“The appropriate management of non-audit services is extremely important to clients,” the submission said on the issue of managing structural conflicts of interest in multidisciplinary firms.

“Most large companies have frameworks in place to manage these situations, and the issues are addressed prior to engaging a provider. Given that directors of listed companies are required to make a statement that they are satisfied that the provision of non-audit services has not compromised the audit independence requirements, boards and board audit committees take this issue very seriously.”

It continued that large audit firms use a variety of strategies to manage conflicts of interest, including information barriers (walls), policies, procedures, and remuneration strategies.

“However, as the discussion paper shows, ‘it may be impossible to erect an effective impenetrable wall between departments of the same firm’,” the submission read.

The Governance Institute said that after reviewing Treasury's options paper on this issue, it considers prohibiting reporting entities from engaging their auditor for non-audit services as the most appropriate balance between the potential costs and benefits of the reform.

Treasury’s options paper said this would prevent reporting entities from procuring non-audit services from their audit firm. It would also directly address the key risks to both the real and perceived independence of auditors in multidisciplinary firms, the paper said.

However, the Governance Institute said its support for this option was subject to clarification, including clear definitions of what constitutes audit and non-audit services, including any exemptions from the requirements which may, for example, include other assurance-related services.

On internal governance of audit partnerships, the Governance Institute recommended adopting option 3A in the options paper. Treasury has proposed imposing new governance requirements on large audit firms, including a board for decision-making, strategic direction, and oversight; a minimum number of independent board members; and new, specific, tailored duties for key personnel (similar to directors’ duties in the Corporations Act).

Furthermore, the association has recommended an audit firm governance code that focuses on the culture and governance of large professional services firms. The code would aim to manage conflicts of interest related to commercial objectives and audit quality, improve the accountability of partners and firm leadership, and increase transparency for regulators, investors, and clients.

The audit firm governance code should cover eight areas, including applying across large audit firms irrespective of their legal structure, introducing independent governance oversight, strengthening partner accountability, enhancing transparency of governance and audit quality outcomes, and linking remuneration to quality rather than revenue, the submission proposed.

In addition, it should require governance of AI and emerging technologies, and preserve partnership models while imposing governance expectations equivalent to those expected of large listed entities, it said.

Lastly, the submission continued, the code “should require the chair, managing partner, and the head of audit through an annual governance declaration to certify that the governing body has reasonable grounds to believe that the firm maintains effective governance arrangements, appropriate quality management systems, and a culture that prioritises audit quality, independence and public trust”.

“The governance code should be co-designed with the industry and reflect best practice governance structures,” the submission read.

“The benefit of this option is that it drives transparency and consistency by holding key personnel accountable for decision-making.”

However, the association “strongly cautions against the corporatisation of partnerships and imposing new tailored duties on key personnel in legislation (such as the Corporations Act)”.