Why not legislate governance principles?

The question of legislating governance principles has been troubling this writer since the Federal Government made public its plans last September to legislate audit principles as embodied in auditing standards.

Why not legislate governance principles?

Disclaimer

The opinions expressed in this article are not AICD policy

• AICD agrees that the process for issuing guidelines in these areas should be transparent, especially in relation to the Australian Stock Exchange Corporate Governance Principles

• AICD does not agree with the suggestion of legislating corporate governance

• AICD urges its members to respond to its surveys on the ASX Corporate Governance Principles on the AICD website

• AICD is also concerned about recent proposals that ASIC be given the power to issue fines and is lobbying government in the context of the continuous disclosure regime

The question of legislating governance principles has been troubling this writer since the Federal Government made public its plans last September to legislate audit principles as embodied in auditing standards.

It would appear odd for a government that likes the notion of self-regulation – and the notion of business taking ownership for governance issues – to pursue the legislating of auditing standards, but this government has taken decided there is virtue to be had in inconsistency.

What is happening is the Australian Stock Exchange's corporate governance council is being allowed free rein to set governance principles whereas the auditors' setter of standards will be placed under the eye – watchful or otherwise – of the Financial Reporting Council.

We are presented with the very picture of inequity from the beginning because there is little difference between the two sets of literature other than the fact the government appears to be giving special attention to the auditing standards board.

One set stipulates the principles which should apply when audits are being planned, evaluated and executed. The other set is quite clearly setting down desirable governance practices which could apply to any number of entities listed on the stock exchange.

A core similarity between the two is that the way they are intended by their authors to be implemented. No single audit, for example, is going to be the same. It is pointless applying rules dealing with the review of the internal controls of banks to an entity that only manufactures widgets.

The auditing literature, in other words, requires judgment to be used by those conducting the audits.

Some corporate governance council guidelines – such as the requirement to have an audit committee as a subcommittee of the full company board – might not be terribly productive in an entity where there are only a handful of directors and the company is at the lower end of the listed market.

The expense of establishing and running such a committee may not be justified, although there is an orthodoxy on matters of governance that appears to have sprung up since the foibles of HIH, Enron, WorldCom, One.Tel, Harris Scarfe and others unfolded in the media in recent times.

Neither is suited to legalistic interpretation although the Federal Government seems to believe the auditing standards are capable of being moulded and reshaped to suit the demands being placed on the legislature by the Australian Securities and Investments Commission.

ASIC is concerned that it has a limited suite of powers to take a company's auditor on through the courts and it would like to have the capacity to pursue fines for, say, not following a specific provision in an auditing standard where the audit of a company was found to be deficient.

These deficiencies usually only come to light when a company is on the skids and closer examinations of the books of the company and the audit firm's files would provide clues to the experienced forensic accountant as to what – if anything – might have gone wrong in the audit process.

A senior audit partner of a major firm once told me that errors in the audit process will occur in circumstances where the client is good and it poses no problems. Those errors that occur in the audit of a so-called "good" client are a matter of audit failure and would ordinarily not be picked up because the client is a "healthy" one.

The only way, therefore, for this legislating of audit standards to actually work is if ASIC was going to walk into practices with investigative teams and rip through random sets of audit work papers to test whether a particular audit partner or team had followed the auditing standards in a proper manner.

Such a program would demand ASIC be adequately tooled up to enter premises and do the required work with competence.

Little imagination is required before one comes to the conclusion that this type of program would require an army of knowledgable investigators and consultants.

There is another problem with the Government's fuzzy logic in seeking to legislate auditing principles and not those so-called governance recommendations that are apparently the work of industry self-regulation.

An auditor is not the owner of the financial statements. An auditor is not the person accountable for the contents of the financial statements.

When a listed company such as Coca-Cola Amatil, BHP Billiton, Brambles or Western Mining Corporation prepares its financial statements they are the accounts of the entity. They are not the accounts of the audit firm, but the accounts of the directors overseeing company operations on behalf of the shareholders and others affected in the community.

The ASX guidelines are arguably just as important – if not more important – than the standards setting down the principles of auditing. There are many more directors in this country than there are registered company auditors and it is probably more critical to capture that greater mass than the auditing professionals who can be dealt with under existing laws.

There are certain advantages in having the corporate governance guidelines such as those issued by the ASX's secretive and less-than-transparent council legislated as disallowable instruments.

Poor practice could be prosecuted by the securities regulator in the same manner as is being advocated of auditing standards and there is a darned good chance the process would be open and the community would get an opportunity to comment on exposure drafts of the governance guidelines.

One of the failings of the closed-door deliberations is the document was not developed in the same structured manner that people come to expect of documents that are effectively treated as de facto legislation by the business community.

The irony in all of this is that the very audit board the Government is trying to constrain by making the auditing standards disallowable instruments actually exposes the documents it issues for public comment. That body meets in public and has done so for several years at the urging of the two professional accounting bodies, the Institute of Chartered Accountants in Australia and CPA Australia.

Why does the Australian Stock Exchange hold its council meetings in private and not deal with these deliberations in an open and frank manner? That alone is a good reason to legislate these principles because a due process that is open, just and fair would be followed instead of the present charade.

The accounting profession that opened up its processes of standard setting long before the Federal Government even had the foresight to force the opening of the Financial Reporting Council's processes to public scrutiny is being victimised.

Basic principles of equity and fairness – the existence of which is obviously not known to the Federal Government – demand that there be parity in the way both sets of guidance are dealt with under incoming legislation.

The very credibility of this Government, its oversight structure and the reputation of this capital market hinges on whether these matters are dealt with properly.

It might also be a good idea for the Government to ensure transparency rules the day in an environment where Treasurer Costello has promised all of the recommendations dealing with independence and audit practice in the report on the collapse of HIH will be implemented.

He should promise the Australian community that all of the institutions that exist with the sole purpose of ensuring the capital market has the confidence of the investing public will be open and transparent.

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The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.