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Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003

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2002 — 2003

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

HOUSE OF REPRESENTATIVES

 

CORPORATE LAW ECONOMIC REFORM PROGRAM (AUDIT REFORM AND CORPORATE DISCLOSURE) BILL 2003

EXPLANATORY MEMORANDUM

(Circulated by authority of the Treasurer,

the Hon Peter Costello, MP)



 



Table of Contents

Corporate Law Economic Reforem Program (Audit Reform and Corporate Disclosure) Bill 2003        1

Outline ............................................................................................................. 1

Abbreviations ................................................................................................... 4

Financial Impact Statement ............................................................................. 6

Regulation Impact Statement .......................................................................... 8

Notes on Clauses ............................................................................................ 80

 



 

1

CLERP (Audit Reform and Corporate Disclosure) Bill 2003

Outline

1.1     The Corporate Law Economic Reform Program (CLERP) was initiated in 1997 as a vehicle for the ongoing review and reform of Australia’s corporate and business regulation to ensure that it is modern, responsive and promotes business activity.

1.2     The most recent stage in the Government’s reform agenda is CLERP 9.  A discussion paper — Corporate Disclosure:  Strengthening the financial reporting framework — was released in September 2002 and proposed a range of measures designed to enhance audit regulation and the general corporate disclosure framework.  The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003 (the Bill) implements the CLERP 9 measures and recommendations contained in the Ramsay report Independence of Australian Company Auditors (Ramsay report).  The Bill also takes account of the relevant recommendations of the report of the Joint Committee of Public Accounts and Audit’s Report 391 ( Review of Independent Auditing by Registered Company Auditors) .  In addition, the Bill implements a number of recommendations of the HIH and Cole Royal Commissions.

1.3     The Bill was released for public consultation on 8 October 2003 and over 50 submissions were received.  The Business Regulation Advisory Group was consulted on both the policy proposals and the provisions of the Bill.

1.4     The underlying objective of the reforms is to improve the operation of the market by promoting transparency, accountability and shareholder activism.  To this end, the Bill sets up a framework with the following features:

·        Measures designed to improve the reliability and credibility of financial statements through enhanced auditor independence:

-         The role of the Financial Reporting Council (FRC) will be expanded to cover oversight of the audit standard setting process and monitoring and advising on auditor independence.

-         Auditors will be required to meet a general standard of independence and make an annual declaration that they have maintained their independence.

-         Disclosure will be required of certain matters in relation to all non audit services.

-         Restrictions on certain employment and financial relationships will be introduced and/or enhanced.

-         Auditors will be required to rotate after five years (and up to seven years where ASIC relief has been granted).

-         Auditors will be required to attend company Annual General Meetings (AGMs).

-         Australian Securities and Investments Commission (ASIC) will be given a power to impose conditions on auditors’ registration.

·        Improved enforcement arrangements:

-         The operational capacity of the Companies Auditors and Liquidators Disciplinary Board (CALDB) will be enhanced by appointing a deputy chair and facilitating concurrent hearings.  In addition, the majority of members will be non accountants.

-         A Financial Reporting Panel (FRP) will be established to resolve disputes between ASIC and companies regarding the application of accounting standards.

-         Auditing standards will be made legislative instruments in the same way as Australian Accounting Standards Board (AASB) accounting standards.

-         Protection will be available for employees and others who report suspected breaches of the law to ASIC and internally within the company.

-         The obligations for auditors to report suspected breaches of the law to ASIC will be strengthened.

·        Measures to better allocate and manage risk:

-         Auditors will be able to incorporate and a regime of proportionate liability will be introduced.  Incorporation will protect auditors who are not responsible for loss caused by another auditor in the audit firm.  Proportionate liability will ensure that liability rests with all defendants in proportion to their contribution to the plaintiff’s loss.  The proportionate liability reforms are of general application and are not confined to auditors.

·        Better disclosure to shareholders and improved shareholder activism:

-         The presentation of disclosure documents and the operation of the secondary sale provisions are being improved.

-         Disclosure requirements applying to director and executive remuneration will be enhanced and shareholders will be better equipped to hold directors accountable for their decisions regarding remuneration.

-         Shareholders will have greater ability to ask auditors questions regarding the conduct of the audit and the content of the audit report.

-         Mechanisms for shareholders to participate and vote in general meetings will be improved.

·        Better enforcement mechanisms for continuous disclosure:

-         The maximum civil penalty for a contravention of the continuous disclosure (and other financial services civil penalty) provisions by a body corporate will be increased.

-         Persons involved in a contravention of the continuous disclosure regime by a body corporate will be subject to civil penalties.

-         ASIC will be given the power to issue infringement notices specifying payment of a financial penalty in relation to contraventions of the continuous disclosure regime.

·        A specific duty on analysts to manage conflicts of interest.



 

2

Abbreviations

AASB

Australian Accounting Standards Board

AAT

Administrative Appeals Tribunal

AGM

Annual General Meeting

ARWP

Audit Review Working Party

ASIC

Australian Securities and Investments Commission

ASIC Act

Australian Securities and Investments Commission Act 2001

ASX

Australian Stock Exchange Ltd

AUASB

Auditing and Assurance Standards Board

CAB

Corporations Amendment Bill 2002

CAC Act

Commonwealth Authorities and Companies Act 1997

CALDB

Companies Auditors and Liquidators Disciplinary Board

CEO

Chief Executive Officer

CFO

Chief Financial Officer

CLERP 9

Corporate Law Economic Reform Program Paper No.  9 Corporate Disclosure ¾ strengthening the financial reporting framework

Corporations Act

Corporations Act 2001

CPAA

CPA Australia

FRC

Financial Reporting Council

FRP

Financial Reporting Panel

G100

Group of 100 Inc



Abbreviations (continued)

HIHRC

HIH Royal Commission

IAASB

International Auditing and Assurance Standards Board

IASB

International Accounting Standards Board

IASC

International Accounting Standards Committee

ICAA

The Institute of Chartered Accountants in Australia

IFAC

International Federation of Accountants

JCPAA

Joint Statutory Committee of Public Accounts and Audit

NIA

National Institute of Accountants

PDS

Product Disclosure Statement

Ramsay report

Independence of Australian Company Auditors

SEC

Securities and Exchange Commission

Trade Practices Act

Trade Practices Act 1974

 



 

3

Financial Impact Statement

3.1       Implementation of the measures in the Bill will require Commonwealth expenditure on an ongoing basis.

3.2       In the 2003-04 Budget, it was announced that the Australian Securities and Investments Commission (ASIC) would be provided with funding of $12.3 million over four years for its role in the implementation of CLERP 9.  This funding will enable ASIC to conduct surveillance, investigate and take enforcement action in relation to alleged contraventions of the CLERP 9 provisions.  Further funding will be subject to review.

3.3       It was also announced in the 2003-04 Budget that $4 million would be provided over four years to support the expanded role of the Financial Reporting Council, which will include oversight of audit standard setting and auditor independence issues.

3.4       These allocations for ASIC and the Financial Reporting Council total $16.3 million over four years, or $4.1 million per annum.

3.5       Funds will be expended in the establishment of the Financial Reporting Panel (FRP).  There will also be ongoing costs associated with the running of the FRP.  Funding will be administered along similar lines to the arrangements that apply to the Takeovers Panel, which falls within the Treasury portfolio.  The introduction of referral fees will provide a mechanism for some of the running costs to be recouped.

3.6       The Bill will provide a mechanism for ASIC to issue infringement notices for alleged contraventions of the continuous disclosure provisions of the Corporations Act.  These notices would contain a financial penalty which would be payable to the Commonwealth.



3.7       The Bill contains provisions that amend the administrative arrangements for the registration of auditors and the lodgement of documents by auditors.  While fees will be prescribed for these activities, the low number of transactions involved means that there will be negligible effect on Commonwealth revenue.



 

4

Regulation Impact Statement

Background

4.1       The Corporate Law Economic Reform Program (CLERP) was initiated in the mid 1990s as a vehicle for ongoing review and reform of Australia’s corporate and business regulation to ensure that it is modern, responsive and promotes business activity.  Since that time, substantial changes have been made to the Corporations Act and the corporate regulatory framework more generally, particularly in the areas of accounting standards, fundraising, directors’ duties, takeovers and financial services reform.  A policy proposal paper covering cross border insolvency has also been released is in the process of being implemented.

4.2       The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003 (‘the Bill’) is the next stage in the Government’s reform agenda.  It will promote the Government’s broad economic objectives of increasing employment and growth by ensuring that regulatory structures remain strong, modern and flexible without burdening business with unnecessary regulation.  The proposals in the Bill will implement measures that strengthen, as well as build on, the previous CLERP reforms.

CLERP 9 process

4.3       The policy proposals contained in CLERP 9 were developed in consultation with stakeholders and ASIC and build on the recommendations contained in the Ramsay Report (Independence of Australian Company Auditors ) which was released in October 2001 and the 1997 report of the MINCO Working Party ( Review of the Requirements for the Registration and Regulation of Company Auditors ). 

4.4       CLERP 9 was released in September 2002 and over 60 submissions were received by the time the consultation period ended in November.  Since then, the Government has met with a broad range of stakeholders to discuss the proposals.

4.5       The Treasurer released the draft Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003 (the CLERP 9 Bill) for public comment on 8 October 2003.  The period for public comment closed on 10 November 2003.  Over 50 submissions were received from a broad range of stakeholders.

4.6       The Business Regulation Advisory Group (BRAG) was consulted on both the policy proposal paper and the Bill.  BRAG is made up of senior representatives from the business community and was established specifically to advise the Government on proposals arising out of CLERP.

4.7       The Bill also implements recommendations of both the HIH and Cole Royal Commissions and takes account of relevant recommendations of the Joint Committee of Public Accounts and Audit Report 391 ( Review of Independent Auditing by Registered Company Auditors ).

Problem identification and analysis of proposals

Auditor Independence

Problem

4.8       Audited financial statements are an important part of the financial information that is available to the capital markets and an essential element of effective corporate governance.  Auditor independence is fundamental to the credibility and reliability of auditors’ reports and in turn independent audits perform an important function in terms of capital market efficiency.  There has been widespread concern about the efficacy of the audit function, including the independence of auditors, as a result of major corporate collapses in Australia and overseas, including HIH.

4.9       The sound operation of Australia’s financial markets is dependent upon parties such as auditors providing information or services to investors free from any bias, undue influence or conflict of interest.  Auditor independence is concerned with the auditor’s capacity, including the perception of that capacity, to exercise objective and impartial judgment in relation to the conduct of an audit.

4.10     The accounting profession has undergone a substantial transformation and the process of change continues.  There has been a continuing trend in Australia and overseas for audit firms to merge, resulting in increased size, both domestically and internationally.  Accounting firms have established international networks, affiliating under common names.  There has also been a significant increase in non-audit services provided by audit firms to their clients, both in terms of the range of services offered and as a proportion of total firm revenue.  Accounting firms have become multi-disciplinary service entities and have entered into new forms of business relationships with their clients which can potentially compromise independence.

4.11     The impact on investment levels and efficient operation of the market can be detrimental where shareholders and investors lose confidence in the market as a result of the persons that they rely on not acting independently.  Given that a loss of confidence in the market can impact severely on operation of capital markets and the economy more generally, it is essential that broad measures be put in place which will promote independence and ensure that parties operate free from conflicts of interest. 

4.12     Over recent years there have been a number of corporate collapses which have called into question the degree of independence of auditors.  These cases have demonstrated that while a company’s actual financial position may have been poor, the financial statements and the audit report did not reflect the true condition of the company.  This has impaired the ability of shareholders and the market more generally to adequately assess the financial health of their investment.  The proposals to promote independence will improve the quality and reliability of information provided to the market.

Objective

4.13     The Bill looks to address these concerns by putting in place a broad regulatory framework governing audit oversight and independence arrangements.  In doing so, the Bill retains the co-regulatory approach in relation to auditor independence.  Under the current requirements, while the Corporations Act contains some provisions directed at relatively specific employment and financial relationships, the professional rules issued by the professional accounting bodies contain more comprehensive requirements.  The Ramsay report recommendations envisage the inclusion of a comprehensive legislative framework of auditor independence requirements in the Corporations Act which would be supplemented by the auditor independence rules in the professional codes of conduct.  The Bill incorporates the recommendations of the Ramsay report (as refined in the CLERP 9 policy paper) and the relevant recommendations in the HIH Royal Commission (HIHRC) report.  The objective is to establish best practice requirements on auditor independence in Australia.

Proposals promoting auditor independence

4.14     The Bill introduces the following key auditor independence reforms: 

·        A general requirement of auditor independence.

·        A requirement that auditors make an annual declaration that the auditor has complied with the auditor independence requirements of the Corporations Act and of any applicable codes of professional conduct.

·        The introduction of restrictions on specific employment and financial relationships between auditors and their clients.

·        The imposition of mandatory waiting periods before partners of audit firms, directors of audit companies and audit personnel may join an audit client as a director or in a senior management position.

·        A requirement for the compulsory rotation of auditors after a fixed number of years.

·        A requirement for an auditor to attend the AGM of a listed company at which the audit report is tabled and to answer reasonable questions about the audit.

·        A strengthening of the oversight arrangements of an audit firm’s procedures and processes, and the audit standard setting process.  In particular the Financial Reporting Council (FRC) will assume responsibilities for overseeing the audit standard setting process and auditor independence.

·        A requirement for listed companies to disclose in their annual directors’ report the fees paid to the auditor for each non-audit service, as well as a description of each service.  In addition, the annual directors’ report of each listed company must include a statement by directors whether they are satisfied that the provision of non-audit services does not compromise independence.

4.15     Many of these requirements are contained in rules of professional bodies and apply to members of those bodies only.  The majority of the above proposals will apply to all 7075 registered company auditors regardless of membership of professional bodies.  The audit committee requirements will apply to all public companies and the fee disclosure requirements will apply to public companies, registered managed investment schemes and large (and certain small) proprietary companies.

Options and impact analysis

General independence requirement and declaration of independence

4.16     The Bill includes a general requirement of auditor independence which was recommended by the Ramsay report.  The standard is defined by reference to circumstances (a ‘conflict of interest situation’) whereby a an auditor or professional member of the audit team is not capable of exercising objective and impartial judgment in relation to the conduct of the audit.  The standard also includes an objective test whereby a reasonable person with full knowledge of all relevant facts and circumstances, would conclude that the auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body.

4.17     The Bill requires an auditor to give the directors of a company an annual declaration that the auditor has complied with the auditor independence requirements of the Corporations Act and of any applicable codes of professional conduct.

Option 1

4.18     In formulating the general requirement of independence and the declaration of independence consideration was given to whether to maintain the status quo whereby a statement of best practice has been developed and implemented by industry with no legislative sanction attached in the event of non-compliance.  This approach would not give rise to new or additional costs.  However, it would omit a key element of the proposed package of auditor independence reforms which would be contrary to the recommendations of both the Ramsay report and the HIHRC.  In addition current professional requirements apply to members of the professional bodies only and therefore are limited in their application across the profession.

Option 2

4.19     Consideration was also given to introducing the general requirement of independence as a legal obligation.  This would provide consistent coverage of the entire profession and thereby achieve a level playing field.  It would also provide stronger sanctions to address instances of non-compliance.

4.20     The declaration of independence effectively builds on the general statement of principle and is a means of assuring investors, shareholders and the market more generally that the auditor is complying with the general requirement to be independent.

4.21     The legislative measures will apply a consistent and objective standard of conduct across the auditing profession and thereby promote the credibility and reliability of auditing reports and financial statements.  The inclusion of an objective standard in the general auditor independence requirement is critical for enforcement purposes because objectivity, being a state of mind, is not, except in unusual circumstances, subject to direct proof.  The difficulties associated with identifying a compromise of independence are also inherent in the nature of the audit process.  Accordingly, the perception of auditor independence, as demonstrated by external facts and circumstances, under an objective standard, takes on great importance.

4.22     A legislative requirement in many cases will formalise and reinforce conduct which many auditors are, or should as a matter of best practice be complying with.  In this respect the compliance costs that these proposals give rise to are expected to be minimal or at least comparable to costs currently incurred by auditors.

4.23     There are a number of short-term costs that will be incurred by auditors who do not, as a matter of best practice, act independently of their client or who do not follow the rules of the professional bodies.  These costs will primarily be in the nature of administrative costs arising as a result of implementing measures that are necessary to comply with the requirements, such as the establishment of quality control systems to detect and prevent threats to auditor independence. It is expected that compliance with the general requirement and declaration of independence will not give rise to any significant compliance burden in the longer term.

Consultation

4.24     There has been broad support for introducing a general requirement of independence as a legal obligation in the Corporations Act.  This proposal has been the subject of consultation in the context of CLERP 9, the Ramsay report and the HIHRC.

Conclusion

4.25     Option 2 is considered to provide the most assurance to investors of the integrity of audited financial statements.

Restrictions on employment and financial relationships

4.26     The Bill contains a comprehensive range of restrictions on specific employment and financial relationships between an auditor and the audit client.  These restrictions incorporate the recommendations of the Ramsay report which described these restrictions as ‘core circumstances which, if they exist, necessarily mean that the auditor is not independent’.  These ‘core circumstances’ are drawn from key international rules and principles (SEC rules on audit independence, the independence rules of the International Federation of Accountants and the European Union Commission Recommendation on auditor independence).

Option 1

4.27     Consideration was given to leaving the regulation of specific employment and financial restrictions to the professional accounting bodies Professional Statement F.1 on auditor independence.  While this would not involve any additional regulatory compliance costs, this would be contrary to the Ramsay report recommendations that these restrictions should be contained in the Corporations Act as they are fundamental restrictions that are necessary to ensure auditor independence.

Option 2

4.28     In formulating the specific restrictions on employment and financial relationships, consideration was also given to their inclusion in the Corporations Act as legal obligations.  This approach would facilitate their enforcement and is consistent with the approach recommended by the Ramsay report.  While this approach would involve some additional compliance costs, they should not be too onerous given that auditors should already be complying with similar, although less extensive requirements in Professional Statement F.1.

Consultation

4.29     Generally, there is broad support for introducing specific restrictions on employment and financial relationships between auditors and their audit clients.  There are concerns regarding the level of detail that is required to put the provisions into a legislative form and some stakeholders consider that it would be desirable to continue relying on the professional rules.  These proposals have been the subject of consultation in the context of CLERP 9, the Ramsay report and the HIHRC.

Conclusion

4.30     Option 2 has been adopted as a means of strengthening the current restrictions in the professional rules by making the requirements legal obligations within the Corporations Act.  The Bill therefore sets up a legislative framework for auditor independence and audit oversight which is currently only dealt with in a cursory way in the law.  The requirements will improve both actual and the perception of independence and thereby lead to greater confidence in the credibility and reliability of audited financial statements.

Mandatory waiting periods before partners of audit firms etc can join an audit client

4.31     The CLERP 9 Bill imposes a mandatory waiting period on partners of audit firms, directors of an audit company and professional members of the audit team before they can join an audit client as a director or in a senior management position.

4.32     The Ramsay report noted that a particular concern in Australia has been retired audit partners joining the boards of their audit clients.  Where this occurs, it is often seen as a particular threat to the independence of the audit firm.

Option 1

4.33     The CLERP 9 policy paper proposed that partners in an audit firm that were directly involved in the audit of the audit client should be subject to a 2 year waiting period before joining the client company as a director or in a senior management position.

Option 2

4.34     Consideration was also given to the recommendations of the HIHRC which extended the 2 year restriction on partners directly involved in the audit of the client to 4 years and included senior audit personnel in the scope of the restriction.  The HIHRC recommended that partners of audit firms not directly involved in the audit should be subject to a 2 year waiting period.

4.35     The HIHRC also recommended that there should be a prohibition on any more than one former partner of an audit firm, at any time, being a director of or taking up a senior management position with the audit client.

Consultation

4.36     There is general acceptance of the need for a mandatory waiting period for purposes ensuring that there is a perception of independence between the auditor and audit client.  However, concern has been expressed by the accounting profession regarding the 4 year restriction instead of the 2 year waiting period proposed in the CLERP 9 policy paper.

Conclusion

4.37     The underlying policy objective is to strike an appropriate balance between promoting auditor independence and not unduly impeding audit professionals joining companies and bringing with them valuable financial expertise.  Option 1 will achieve that balance.

Provision of non-audit services

4.38     The Bill provides that the annual directors’ report of a listed company must disclose the fees paid for each non-audit service provided by the auditor during the financial year, as well as a description of each service.  In addition, the board of directors (in accordance with advice of the audit committee where applicable) must make a statement as to whether in their opinion the provision of non-audit services provided by the auditor compromise auditor independence, and an explanation of why those non-audit services do not compromise independence.  These provisions are in accordance with recommendations of CLERP 9 and the HIH Royal Commission.

Option 1

4.39     In developing the requirement that audit committees explain why the provision of non-audit services is compatible with independence, consideration was given to whether the provision of non-audit services should be prohibited entirely.

4.40     A blanket prohibition on certain non-audit services would provide the maximum assurance to shareholders and regulators that the auditor and its client are not contracting non-audit services that threaten independence.

4.41     When an audit firm provides non-audit services to a client it is serving two different sets of clients: management in the case of non-audit services; and the audit committee, the shareholders and all those who rely on the audited financial statements in the case of the audit.  In serving these different clients the audit firm is subject to conflicts of interest.

4.42     A rule prohibiting audit firms from providing non-audit services to their clients would be relatively easy to administer and would not preclude an audit firm from providing non-audit services, as long as those services are not provided to audit clients.

4.43     Such an approach would however place Australia out of step with many jurisdictions and would not recognise that the provision of non audit services per se does not compromise independence but rather it is the possibility of dependence on the financial stream flowing from those services.  The HIH Royal Commission report did not propose a blanket prohibition on non-audit services.

4.44     A modification of this approach would be to prohibit only specified non-audit services as in the US.  This may give rise to a culture of adherence to rules rather than the underlying principle of ensuring independence.  It would be almost impossible to draft legislation specific enough to prohibit non-audit services based on the substance of work to be performed.

Option 2

4.45     An alternative to prohibiting some or all non-audit services is to require the disclosure of those services and the fees earned in relation to those services.  This would reduce the potential for conflicts of interest to arise and ensure that any compromise of independence is evident to the market.  As long as there is appropriate disclosure this approach provides flexibility to auditors to perform a range of services that are in the public interest, that do not compromise independence and are beneficial to audit effectiveness.  A disclosure-based approach would provide sufficient information for investors to determine for themselves whether they believe the non-audit services contracted are reasonable.

4.46     In addition, there is no solid evidence of any specific link between audit failures and the provision of non-audit services, and non-audit services have been provided by audit firms to their clients for many years.  A ban should not be imposed in the absence of compelling evidence of a problem.

4.47     Option 2 recognises that audit firms increasingly need specialists to provide critical audit support.  Attracting and retaining these specialists, and motivating them to provide direct audit support, may be hampered if they were to be prohibited from providing non-audit services to clients.  On some occasions it may be advantageous to the company and shareholders for the auditor to provide non-audit services, particularly where that service benefits from an intimate knowledge of the business.  Therefore, an unintended consequence of a prohibition on auditors providing non-audit services to their clients could be to reduce the effectiveness of business advisory services received by the company.

4.48     The mandatory disclosure of non-audit services and the fees attaching to those services will help the market identify the extent of non-audit services provided and the degree of fee dependence.  It is not expected that the requirement will give rise to significant compliance costs as the accounting standards already require companies to disclose fees for audit and non-audit services on an aggregate basis.  To meet the proposed obligation, companies will be required to keep separate records of fees for audit and non-audit services.  It is anticipated that many companies would already keep such records and there would therefore not be any administrative costs in the form of record keeping.  In terms of the actual disclosure, it is expected that compliance costs will be negligible.

Consultation

4.49     Generally stakeholders supported a disclosure based approach to the provision of non-audit services.  Some stakeholders considered that the provision of non-audit services should be banned altogether.  The proposal to require disclosure in relation to all non-audit services was the subject of extensive discussion in the report of the HIH Royal Commission and was consulted upon as part of consultations on the Bill.

Conclusion

4.50     In keeping with the principles based approach underlying CLERP a disclosure-based solution as in option 2 is preferred.  Disclosure of the non-audit services contracted between auditors and their clients is sufficient to enable shareholders to determine whether the amount and nature of those services poses an unreasonable threat to independence whilst providing companies the flexibility to garner maximum benefit from the expertise gained in an audit engagement.

Auditor rotation

4.51     The Bill requires the lead engagement and review partners in an audit engagement team to be rotated after a maximum of five years service on a particular audit client.  A two-year period would need to pass before either partner could be reassigned to the client.  Overall, the lead engagement and review partners would only be allowed to perform any five out of seven successive annual audits.  ASIC will be able to provide relief from the rotation requirements in circumstances where there would be a significant burden on the auditor and/or client were they not allowed the extension.

Option 1

4.52     An audit partner rotation requirement - after seven years rather than five — currently forms part of the Joint Code of Professional Conduct of the ICAA and CPAA.  Although the coverage of these professional bodies captures most auditors, it is necessary to provide for a rotation requirement in legislation in order to ensure its consistent application across the entire profession.

4.53     Audit partner rotation was considered an appropriate measure to promote independence by ensuring that audit partners do not remain with clients for significant periods which allow inappropriate relationships to develop which may compromise independence.  It was considered appropriate that the rotation requirements be limited to the lead engagement and review partners as it is these partners who are responsible for the audit opinion and have the ability to control the work of other members of the engagement team.  It is at this level that independence concerns are greatest.  It was also consider appropriate to require rotation after five years as a means of enhancing the perceived independence of audit partners.

4.54     As a result of the rotation requirements, audit firms may incur costs as new auditors take time to become familiar with the client, its operations and associated risks.  These costs will be present at each new audit engagement however the costs could be minimised through appropriate transitional arrangements between the auditors.  Under the Bill’s transitional arrangements the rotation requirements will not apply until two years after the Bill comes into effect.  This will give auditors and listed companies time to prepare for a change in auditor should one be needed as soon as the requirement takes effect.

Option 2

4.55     Rotation of audit firms was also considered whereby companies would need to select a new audit partnership or firm to undertake its statutory audits after a fixed period of time.  This would entail an entirely new audit firm being employed on the audit which would potential impose significant cost, disruption and loss of experience for companies.

4.56     In addition, given the small market for auditors in Australia, especially at the large end of the market which is characterised by only four suppliers of audit services, it was considered that companies should be free to choose their auditor.

4.57     The marginal benefit of rotating audit firms rather than just partners would be minimal and would not justify the significant compliance costs, in terms of disruption and loss of expertise that it would entail.

Consultation

4.58     A number of submissions commented on the period after which auditors should be required to rotate.  Many submissions raised concerns that rotation after five years could adversely impact on small firms.  To address these concerns, the Bill provides the Australian Securities and Investments Commission with a power to extend the rotation period to seven years in appropriate circumstances.

Conclusion

4.59     Given the characteristics of the Australian market for audit services it is considered appropriate to require the lead engagement and review partners to rotate after no more than five years.  This approach is in keeping with developments overseas and builds on best practice requirements already contained within the rules of the professional bodies.

Attendance by auditors at the company AGM

4.60     The Bill requires auditors of listed companies (or their representatives) to attend company AGMs.

Option 1

4.61     Consideration was given to whether attendance should remain voluntary as is currently the case under the Corporations Act.  This would allow auditors the choice of whether they attend.  Given the importance of the role of external auditors, mechanisms to strengthen accountability were considered desirable especially given that the AGM is the only forum where the auditor and the persons to whom the auditor is accountable can meet on a face to face basis.

Option 2

4.62     A compulsory attendance requirement was considered preferable as it would maximise shareholders’ opportunity to ask questions of the auditor and in this way promote the independence and the accountability of auditors.

4.63     The attendance of the auditor at the AGM may give rise to costs for companies to secure the auditor’s attendance.  It is difficult to quantify such costs as they would be dependent upon individual fees charged by auditors and the length of time the auditor spends at the AGM.  The benefits of improved accountability are however considered to outweigh any additional costs.

Consultation

4.64     This issue was considered in the context of the Audit Review Working Party and CLERP 9.  Generally stakeholders were supportive of compulsory attendance by auditors at AGMs.

Conclusion

4.65     Given the improvements to auditor accountability which will flow from attendance at AGMs, Option 2 is supported.

Submitting questions to auditors prior to the AGM

4.66     The Bill also introduces the right for members of a listed company to submit written questions to the auditor before the AGM.  Where questions are submitted, auditors will be required to consider those questions before the AGM and the listed company would be required to make those questions available for attendees at the AGM.

Option 1

4.67     Consideration was given to maintaining the status quo whereby shareholders are able to ask questions of the auditor regarding the conduct of the audit and the contents of the audit report if they are in attendance at the AGM.  This approach did not however take account of the fact that shareholders for whatever reason may not be able to attend company meetings.  It was considered desirable to facilitate shareholders’ ability to ask questions regardless of whether they are in attendance at the meeting.  This would place all shareholders on a more even footing.

Option 2

4.68     Consideration was given to facilitating written questions to be submitted by shareholders prior to AGMs and requiring auditors to provide answers to written questions and questions asked at the AGM.  This however would place a significant burden on auditors to respond to what could possibly be hundreds of questions. 

Option 3

4.69     This option would allow shareholders to submit written questions and to ask questions from the floor of the AGM but does not include a corresponding obligation on the auditor to answer all questions.  Written questions submitted would serve to highlight to shareholders in attendance at the meeting and to company directors where concerns exist with the audit or the audit report and could promote questions from the floor.  Some costs would be directly incurred by the company in passing the questions to the auditor and costs would be incurred by the auditor in examining the questions and providing a list of questions to be made available at the AGM.  The benefits however of highlighting areas of concern and promoting greater accountability of auditors are considered to outweigh any additional costs. 

Consultation

4.70     Although the proposal to allow questions via e-mail was flagged in the CLERP 9 paper, little comment was received one way or the other on this issue.  Some stakeholders did however suggest that shareholders should be able to submit questions whether by email or other medium.

Conclusion

4.71     On balance, Option 3 is supported as it strikes an appropriate balance between enhancing accountability of auditors and promoting shareholder activism on the one hand and ensuring auditors are not unreasonably burdened with having to provide substantive responses to all questions received.

Oversight of the auditing profession

4.72     Over time there has been a growing recognition that, while the self-regulatory nature of the profession has benefits, the impact of the profession on industry and commerce is so great that some supervision of the profession is needed to ensure its self-regulatory mechanisms are both adequate and appropriate.

4.73     Currently there is minimal oversight of the auditing profession by Government agencies.  Instead, the professional accounting bodies play a large role in overseeing the profession.  Concerns exist that this does not promote independence, nor the perception of independence, as the professional bodies could be expected to champion the interests of their members rather than broader community interests.  There is the added concern that auditors who are not members of the professional accounting bodies are subject only to minimal supervision by ASIC (for example, the requirement to lodge a triennial statement).  As a means of addressing these concerns the following options were considered.

Option 1

4.74     Consideration was given to establishing a new Auditor Independence Supervisory Board (AISB) as proposed in the Ramsay report on the Independence of Australian Company Auditors .

4.75     Under this option the professional bodies would continue to develop ethical and procedural rules dealing with appropriate standards of behaviour for their members and the manner in which accountancy practices are to be conducted. 

4.76     The AISB is a mechanism that could provide that supervisory function and provide an independent analysis of the self-regulatory functions and practices of the profession.

4.77     This option however would see the creation of a separate board with associated costs to the industry of establishing and maintaining the board. 

4.78     In addition AISB would not take on any functions relating to audit standards setting.

Option 2

4.79     This option proposes to expand the current role of the Financial Reporting Council (FRC) to include oversight of auditor independence.  The AISB independence oversight function in addition to its existing role of providing broad oversight of accounting standard setting.

4.80     The benefits of having the FRC monitor auditor independence would be similar to option 1 however the cost burden would be spread over existing FRC stakeholders, being the Government, accounting profession and business. 

4.81     In order to promote greater independence in the auditing profession, responsibility for audit standard setting could be brought within the FRC’s functions and thereby complement the FRC’s current functions in relation to the setting of accounting standards.  This proposal would complement the FRC’s current role and would bring under one umbrella responsibility for standard setting within the financial reporting framework thereby achieving synergies in the administration of accounting and auditing standard setting.

Consultation

4.82     Some submissions argued that the FRC was not the appropriate body to be responsible for the oversight of auditing standards and independence, as it did not have the appropriate membership and experience.  Other submissions supported the proposed role for the FRC.  These concerns have been taken into account in finalising the Bill.

Conclusion

4.83     Option 2 is preferred as it achieves independent oversight of the profession while at the same time building on the existing arrangements.

Proportionate Liability

Problem

4.84     Insurance plays an important role in the Australian economy.  It provides a mechanism for transferring and pooling the risk of financial loss to entities with the expertise to manage the risks involved.

4.85     Professional groups have traditionally dealt with their unlimited liability exposure for professional default through professional indemnity insurance, which insures against loss arising from professional services offered by the insured professional.

4.86     Australia is currently experiencing a ‘hard insurance market’ that is, a market characterised by tougher risk selection by insurers.  While the Australian experience has been exacerbated by the collapse of a major domestic player in HIH (which held around 35 per cent of the professional indemnity market), globally most classes of insurance have moved into a hard market cycle in the last two years drawn especially by a world-wide downturn in investment returns and losses arising from the terrorist attacks on 11 September 2001.  In the case of professional indemnity insurance, this has been compounded by major claims emerging out of the collapse of Enron and other major corporations in the United States of America and elsewhere.

4.87     Specifically, professional groups are reporting that they are experiencing extreme difficulties with the availability and cost of professional indemnity insurance.  This is a result of fewer insurers offering the product, while those insurers that do are severely restricting the scope of services they are prepared to cover.

4.88     Exposing professionals to unlimited personal liability could have significant supply side ramifications if it discourages new entrants and leads to the exit of existing players in these occupations.

4.89     There is evidence to suggest that the lack of professional indemnity insurance is leading to a withdrawal of services provided by some occupational groups.

4.90     For example, the Institute of Chartered Accountants reported in a January 2003 survey of members that over half are considering to cease, or have ceased, offering services, particularly audit, because of rising insurance costs.  The Association of Consulting Engineers Australia also reported in a January 2003 survey that firms are withdrawing services in areas where insurance is unavailable or unaffordable, such as pollution control, asbestos removal and air-conditioning treatment to combat legionnaires disease.

4.91     Such developments, obviously, have broad economic ramifications.

4.92     The inability of professionals to obtain liability insurance on reasonable terms becomes even more problematic in circumstances where Australian governments increasingly are requiring such cover by law.  For example, the Financial Services Reform Act 2001 obliges financial players to have ‘adequate means of compensating’ wronged consumers.  This will, in effect, mean that in a large number of cases, professionals will be required to hold professional indemnity insurance.

4.93     From the data available, it is not possible to determine how many professional service providers are operating without insurance cover for a part or all of their business.  Clearly, it will not be possible for consumers to access appropriate damages in the case of liability if a professional is operating without insurance or sufficient assets.

4.94     Professional groups report that the greatest impact of the lack of professional indemnity insurance is being felt by small to medium sized businesses and businesses in regional areas.  Less impact is being felt by large firms who have sufficient capital to self-insure up to certain levels and insure above these levels on the international reinsurance market.  This will cause an impact on competition where only larger firms can continue to provide professional services.

4.95     The primary concern for Government with the lack of appropriate insurance therefore is threefold.  Firstly, many professionals may be operating without appropriate insurance cover, and divorcing themselves from assets through discretionary trusts and the like, leaving consumers unable to access appropriate damages in the case of negligence.  Secondly, a contraction of supply of professional services is likely to lead to reduced competition.  Finally, the withdrawal of professional services, especially in areas critical to public health and the like, will adversely impact on the wellbeing of the community.

4.96     It is likely, moreover, that most, if not all, of the generally higher costs of professional indemnity insurance will ultimately be passed on to consumers.

4.97     The CLERP 9 paper discussed the accounting profession’s ongoing concerns about the present unlimited liability regime to which auditors are exposed for professional default.  The accounting profession, and other professional groups, have proposed that the current rules of joint and several liability should be replaced with proportionate liability as one of the possible remedial measures to address their concerns about the consequences of unlimited liability.

4.98     The CLERP 9 paper proposed that the Commonwealth should seek the agreement of the States and Territories to introduce proportionate liability for economic loss and property damage on a nationally consistent basis.

4.99     Auditors, and other professional groups, have traditionally dealt with their unlimited liability exposure for professional fault through professional indemnity insurance.  Insurance plays an important role in the Australian economy.  It provides a mechanism for transferring and pooling the risk of financial loss to entities with the expertise to manage the risks involved.  Professional indemnity insurance insures against loss arising from professional services offered by the insured professional.

Objective

4.100   The objective of the proposed action is to:

(a)            Prevent the ‘deep-pocket’ syndrome which is synonymous with professionals.  The ‘deep-pocket’ syndrome occurs when professionals are the targets of negligence actions not because of culpability but because they are insured and have the capacity to pay large damages awards. 

(b)           Allow insurers to more accurately price risk.  Currently under joint and several liability insurers have to price for the negligent actions of third parties.  Proportionate liability enables insurers to insure only against the negligent conduct of the insured. 

(c)            Assist professionals to obtain suitable cover at more reasonable premiums.

(d)           To limit the liability of defendants for the loss suffered by a plaintiff to the extent to which each defendant is responsible for the plaintiff’s loss. 

Options

Option 1:  Maintain the status quo

4.101   The Commonwealth would not directly or indirectly intervene in the professional indemnity insurance market to ensure professionals have adequate insurance cover to pay awards for damages in the event that liability is proved.

Option 2:  Commonwealth to directly subsidise professional indemnity insurance premiums

4.102   The Commonwealth would directly intervene in the market for professional indemnity insurance to subsidise those professions experiencing difficulty in obtaining appropriate, affordable insurance.

Option 3:  Modified standard of care

4.103   The Commonwealth is unable to directly implement this option, but can encourage states and territories to implement this option.

4.104   The Review of the Law of Negligence recommended that in cases involving an allegation of negligence on the part of a person holding himself or herself out as possessing a particular skill, the standard of reasonable care should be determined by reference to:

(a)            What could reasonably be expected of a person professing that skill?

(b)           The relevant circumstances at the date of the alleged negligence and not a later date.

4.105   This rule could, obviously, be applied generally to all professionals.

Option 4:  Amend Commonwealth legislation to support any state or territory that implements professional standards legislation

4.106   New South Wales and Western Australia have enacted professional standards legislation in their Professional Standards Act 1994 (NSW) and Professional Standards Act 1997 (WA).  These Acts focus on minimising claims against professionals by improving professional standards, requiring risk management strategies, compulsory insurance cover, ongoing professional education and appropriate complaints and disciplinary mechanisms, in return for limited liability.

4.107   The Commonwealth could not implement a professional standards legislation scheme, as such.  However, Commonwealth support for such a scheme, by amending the Trade Practices Act 1974 , the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 , is essential to ensuring any state and territory professional standards legislation is not undermined.

4.108   The current New South Wales scheme is most likely to form the basis for any national model of professional standards legislation. 

Option 5:  Implement proportionate liability for economic loss with a consumer carve-out.

4.109   The other option that has been considered in developing a national model for proportionate liability is whether there should be some form of consumer carve out in order to protect small consumer plaintiffs.  The carve-out could operate so that joint and several liability would apply in cases where the plaintiff was a consumer.  Consumer would be defined by reference to the definition of consumer in the Trade Practices Act 1974.    

Option 6:  Implement proportionate liability for economic loss

4.110   The principle objective of implementing proportionate liability for economic loss is to place downward pressure on professional indemnity insurance premiums.

4.111   Proportionate liability will overcome the ‘deep pocket’ syndrome inherent in a joint and several liability regime which often sees one party bearing full responsibility for loss or damage despite the fact that a number of parties may have contributed to the loss.  Proportionate liability means that liability rests with all defendants in proportion to their contribution to the plaintiff’s loss.  This is contrasted against joint and several liability where a defendant can be held liable for the total loss sustained, even if they contributed to the loss in a small way.

Impact Analysis

Groups likely to be affected by the proposed action include:

(a)            purchasers of professional services:

(i)            ‘consumer’ type purchasers; and

(ii)          ‘business’ type purchasers.

(b)     providers of professional services.

Option 1:  Maintain the status quo

4.112   This option might be justified in circumstances where the Government was confident that problems in the professional indemnity insurance market were of a short-term, cyclical nature.  While low investment returns on the global insurance market clearly represent a cyclical element to the current problems in the domestic market, these problems also reflect key structural factors.  These include the demise of Australia’s major domestic provider in this class of insurance, HIH, and the fact that Australian society has become increasingly litigious, to the point of almost being equivalent with the United States of America.

4.113   There is a strong consensus among all Australian jurisdictions that action is needed to address these two structural issues.  In essence, the challenge is to attract a higher proportion of global risk capital back in to the Australian market for liability insurance.

4.114   Relevant too is that professionals are increasingly being required by law to hold professional indemnity insurance.  For example, the Financial Services Reform Act 2001 obliges financial players to have ‘adequate means of compensating’ wronged consumers.  This will, in effect, mean that in a large number of cases, professionals will be required to hold professional indemnity insurance.  Obviously, this becomes problematic when such insurance is simply unattainable or beyond the financial capacity of professionals.  It seems, in fact, that there is a body of legal opinion which suggests that the law, and the consumer protection it purports to offer, would be nullified in these circumstances.

Option 2:  Commonwealth to directly subsidise professional indemnity insurance premiums

4.115   Although this option would obviously allow professionals to access affordable professional indemnity insurance, there are several factors which argue against the Commonwealth directly subsidising professional indemnity insurance premiums.  In particular, it would represent a potentially inequitable cross-subsidisation between general taxpayers and the providers and users of professional services.

4.116   Government intervention in this form also runs the moral hazard risk that it could lead to rapid, significant increases in premium costs as the normal market constraints to pricing would effectively be removed or relaxed.  Further, such a moral hazard response would negate the potential benefits of the option.

Option 3:  Modified standard of care

4.117   The Commonwealth is unable to directly implement this recommendation.  Many states and territories have implemented this or a similar recommendation, or are considering implementing this or a similar recommendation.

4.118   Implementing this option would re-balance the interests of defendants and plaintiffs, as was the general objective of the Review of the Law of Negligence .

4.119   This option can be viewed as another element in an overall package of required responses.

Option 4:  Amend Commonwealth legislation to support any state or territory that implements professional standards legislation

4.120   The Government has supported the implementation of professional standards legislation.  The Government expects to introduce legislation to give effect to professional standards legislation in the 2003 Spring Sittings. 

4.121   The Insurance Council of Australia has stated that professional standards legislation is one of four pillars to improve the affordability and availability of professional indemnity insurance.  The other three pillars are amendments to section 54 of the Insurance Contracts Act 1984 , implementing proportionate liability for economic loss and amending the Trade Practices Act 1974.

4.122   This option can be viewed as another element in an overall package of required responses.

Option 5:  Implement proportionate liability for economic loss with a consumer carve-out

4.123   The Commonwealth, and several of the States, including New South Wales, do not favour a consumer carve out because this could undermine the benefits of proportionate liability in terms of insurance claims, and would make it more difficult for insurers to price premiums.  A carve out, while offering some consumer protection, could also have an adverse impact on small business defendants.

Option 6:  Implement proportionate liability for economic loss

4.124   Proportionate liability has been under consideration by SCAG and MINCO since 1994.  One of the threshold issues that was required to be addressed was whether proportionate liability could be confined either to the auditing profession or to the professions generally.

4.125   This issue was addressed by the Davis Inquiry into the law of joint and several liability which was established by the then Commonwealth and New South Wales Attorneys-General in February 1994.  The Davis Inquiry concluded that proportionate liability reforms should not be confined to professional activities because this would lead to unnecessary anomalies.  For example where a builder, an architect and a local authority were found to be concurrently liable in relation to a claim for economic loss, only the architect would normally be regarded as engaging in professional activities.  However, the loss caused by the wrongdoing of each is precisely the same, and the Davis Inquiry argued that none should be excluded from consideration simply on the basis of an ill-defined division between professional activities and others.  This position in relation to the scope of the proportionate liability reforms has been accepted in the national model that has been endorsed by all governments in 2003.

4.126   It is accepted that while proportionate liability for economic loss limits the exposure of professionals to those matters for which they are personally responsible, it does not prevent other parties who have contributed to the wrongful act being liable for damages.  As part of the proportionate liability principle, any contributory negligence on the part of a plaintiff is also taken into account in awarding damages.

4.127   Moving to proportionate liability for economic loss better reflects the responsibilities of professionals to their clients.

4.128   The main benefit, from an economic perspective, of implementing proportionate liability for economic loss is that since insurers are insuring only the risk of a particular professional, and not the risk of other professionals, insurers can be more confident in insuring risk.

4.129   Under this proposal, the costs to plaintiffs of the risk of the insolvency or inability to trace defendants may be transferred from co-defendants to the plaintiff.

Consultation

4.130   There is broad support for the proportionate liability reforms, particularly from the professional groups.  The proposals have been the subject of consultation in the context of the CLERP 9 policy paper and the consultations undertaken by the Treasury Ministers with the insurance industry and the professions in relation to insurance issues.  In developing the nationally agreed model, the Commonwealth has also worked in close consultation with the States and Territories.

·        The criticism has been made that proportionate liability for economic loss places an onerous burden on plaintiffs to join all defendants to the action to recover full compensation.  This argument can be countered in two ways. 

·        First, full compensation is a misnomer if defendants are not able to access affordable professional indemnity insurance.  In the current climate, professionals are faced with extremely high premiums some with very high deductibles.  It is this climate which is forcing some professionals to run ‘bare’, that is, without adequate professional indemnity insurance.  Proportionate liability is viewed by the majority of stakeholders as being a fundamental component of the current proposed package aimed at putting downward pressure on professional indemnity insurance premiums. 

·        Second, procedural rules associated with proportionate liability for economic loss are designed to provide the appropriate balance between the interests of plaintiffs and defendants.

·        It operates so that, in applying proportionate liability to a claim, a court should have regard to the responsibility of any potential defendant who is not a party to the proceedings.  Further, it requires defendants to notify a plaintiff in writing of the identity and alleged role of any other potential defendants of whom they are aware would also provide protection to plaintiffs.  Defendants who fail to co-operate would risk being ordered to pay costs.

4.131   Given these procedural protections, it is highly unlikely that consumers will be materially disadvantaged by these reforms.  Fundamentally, they are intended to ensure that professional indemnity insurance can be purchased at reasonable prices and that consumers therefore can have greater confidence that the professionals with whom they deal are in fact covered by such insurance.

4.132   The Commonwealth Department of Prime Minister and Cabinet, Commonwealth Department of Finance and Administration and the Commonwealth Attorney-General’s Department have been consulted. 

Evaluation and Conclusion

4.133   Option 1 would not achieve the stated objectives.  Although this option will have no cost on business, it will not improve the existing problems business is currently facing in obtaining affordable and appropriate insurance cover.  This option could also be expected to exacerbate the problem of some businesses not having appropriate insurance or assets to cover any payment for damages in the case of liability being proved.  This would obviously leave consumers of professional services in a worse position in these circumstances than they would otherwise be.

4.134   Although option 2 would achieve the dual objectives of providing protection to professionals and consumers, this would be at a significant cost to Government due to the potential cross-subsidisation between general taxpayers and the providers and users of professional services.

4.135   The Commonwealth supports the implementation of option 3.  However, the Commonwealth is unable to directly implement this option.  For this reason, the Commonwealth has encouraged the states and territories to implement this, and other, recommendations of the Review of the Law of Negligence .  Once again, this option is viewed as one element of a broader set of measures.

4.136   The Government has endorsed option 4, to support any state or territory that implements professional standards legislation, and expects to introduce legislation to this effect into Parliament in the Spring Sittings 2003.  This option is considered to be only one element in an overall package of reforms.

4.137   The Commonwealth believes that option 5 does not achieve the stated objectives and may in fact undermine the desired effect of proportionate liability for economic loss. 

4.138   On balance, option 6 would appear to achieve the stated objectives better than any of the other options put forward.  It would have no financial cost to business.

4.139   It is considered that the national model for proportionate liability when implemented in all jurisdictions, will contribute to an improvement in the professional indemnity insurance market across Australia.

Incorporation of audit firms

4.140   In addition to proportionate liability, liability of auditors is also being addressed through the incorporation of audit firms.

Options and impact analysis

Option 1

4.141   To address the concerns, it is proposed that the Corporations Act be amended to allow audit firms to incorporate. 

4.142   Incorporation of auditors will address liability concerns arising as a result of accounting firms being structured as partnerships.  The partnership structure means that all partners of the firm can be liable for losses caused by one partner despite the fact that they may have had no involvement in the conduct causing the loss.  Incorporation will help sheet home liability to those who are actually responsible for loss or damage by quarantining the liability of auditors within audit firms to the particular auditor(s) who have caused the loss.  In addition, incorporation will give audit firms a broader range of options in determining how the business is structured and managed.

Option 2

4.143   Consideration was given to introducing a form of limited liability partnership.  However, it is recognised that the regulation of partnerships in Australia is primarily a matter of State and Territory law.

Consultation

4.144   Stakeholders are generally supportive of a mechanism to allow incorporation of auditors.

Conclusion

4.145   Implementation of option 1 is preferred.  It will not be mandatory to incorporate and the legislative requirements will only give rise to compliance costs if audit firms choose to incorporate.  Firms that choose to move from the partnership structure to an incorporated entity will face one off costs associated with the incorporation of a company and obtaining the necessary approvals for the company to operate as an auditor.  In addition, there will be the annual costs associated with operating an incorporated company.

4.146   In terms of the impact on plaintiffs, a plaintiff could no longer make claims on the assets of the firm and then all individual partners of the firm.  The plaintiff in this circumstance would be limited to recovering from the individual negligent auditor and from the assets of the incorporated entity.  On balance it is considered that the benefits of auditor liability reform which the market would receive, outweigh any additional costs that might be borne by plaintiffs.

Management of Conflicts of Interests by Financial Services Licensees

Problem

4.147   Analysts promote the operation of informed and efficient markets by collecting and analysing information about companies and financial products.  The research prepared by analysts helps to filter the wide range of information available to investors about product issuers and investments.

4.148   Analysts may face conflicts of interest that have the potential to undermine their independence and hence the objectivity of research provided to investors.  These conflicts are most acute in conglomerate financial services firms that provide services (such as investment banking) to companies they are analysing.  In these circumstances, an analyst may be influenced to provide positive research reports about client companies.

4.149   However, the potential for conflicts of interest to arise is not limited to analysts.  Financial services licensees and their representatives may also face conflicts of interest that have the potential to undermine their independence, and therefore the objectivity of the service they provide. 

4.150   Market failure can result if financial services licensees and their representatives do not manage their conflicts effectively.  Therefore it is considered that any new provision requiring the management of conflicts of interest should not apply only to analysts.  Rather, it should apply more broadly to financial services licensees, and their representatives.

Objectives

4.151   The key objective is for financial services licensees and their representatives to manage conflicts of interest effectively, including through transparent disclosure of relevant conflicts, so that the market will have confidence in the integrity of the services they provide.  Adequate disclosure of conflicts will assist investors and others in assessing the objectivity of any views provided.  This facilitates informed investment decision-making and encourages confident participation in financial markets.

4.152   Financial services licensees and their representatives are covered by the licensing, conduct and disclosure regime contained in the Corporations Act.  C urrently licensees are obliged to ‘do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly’.  There is no explicit duty in relation to the management of conflicts of interest.  However, certain conflicts must be disclosed in relation to retail clients considering whether to acquire financial services or products or whether to act on personal advice.

Options and impact analysis

Option 1

4.153   This option involves retention of the status quo, whereby guidance on the management and disclosure of conflicts by financial services licensees is primarily provided by industry initiatives.

4.154   This option could benefit consumers and the community by promoting industry awareness of independence issues.  It could also benefit industry, through the flexible and adaptable nature of a voluntary regime, while incurring no additional Government expenditure or regulatory change.

4.155   The main cost of this option is that the standards might not be sufficiently stringent to ensure that investors are adequately protected and have confidence in the advice they receive.  Events such as investigations by United States’ regulators into the impact of investment banking on research have shown that industry self-regulation may not be adequate.  The cost to consumers is that existing industry guidelines are not legally enforceable nor externally monitored for compliance, although compliance costs for industry are lower. 

4.156   ASIC’s research report into analyst independence, released in August 2003, concluded that Australian industry guidelines had not been adopted as uniformly and closely as is appropriate.  Further, ASIC concluded that the industry guidelines are not sufficient to overcome the deficiencies in analyst firm’s management and disclosure of conflicts of interest that it identified in its report.

4.157   A consideration of the costs and benefits suggests that while industry initiatives would continue to play a valuable role, government initiatives might further improve outcomes.

Option 2

4.158   This option involves ASIC providing guidance via a policy statement on the level and manner of disclosure of conflicts required under the general duty to provide financial services ‘efficiently, honestly and fairly’.  This approach was originally proposed in the CLERP 9 paper.

4.159   This option could be expected to result in higher standards than relying on industry initiatives alone.  In addition, ASIC could link its guidance to the general duty to act ‘efficiently, honestly and fairly’.  This could facilitate enforcement action by ASIC under the licensing regime against licensees.  Consumers could benefit from more transparent disclosure of conflicts.  A collaborative approach is also a more flexible and less costly means of influencing business practices than additional prescriptive legislative rules.

4.160   There would be costs associated with ASIC developing and administering further guidance, although consultation with industry would help to minimise these costs.  Principles-based guidance, which is flexible enough to accommodate different operating structures and overseas developments, is unlikely to impose substantial compliance costs on industry.

4.161   ASIC guidance, developed in consultation with stakeholders, would help to ensure an appropriate response to managing conflicts of interest and this would benefit consumers without imposing unnecessary compliance costs on industry.

Option 3

4.162   This option involves introducing in the law an additional duty in relation to the management of conflicts of interest to supplement the general duty to provide financial services ‘efficiently, honestly and fairly’.

4.163   A conflicts management duty would be in addition to the ‘efficiently, honestly and fairly’ duty.  Introducing an additional duty would provide a stronger legislative backing for any guidance issued by ASIC, while being consistent with the Government’s principles-based approach.  This would make it clearer that ASIC could take enforcement action rather than relying on compliance with the general duty.  It could promote certainty by making each licensee’s responsibility for managing conflicts of interest clearer on the face of the legislation.

4.164   It is unlikely to impose additional obligations on most licensees, because licensees are already expected to manage conflicts (either as part of the general duty or a matter of best practice).  Both an additional duty and ASIC guidance may impose a higher cost on licensees not currently managing conflicts of interest adequately.  However, ASIC guidance would be worthwhile in terms of enhanced enforcement and investor confidence.

4.165   On balance, an additional duty would clarify and reinforce the overriding obligation to manage conflicts of interest by supplementing the general duty to act ‘efficiently, honestly and fairly’.

Consultation

4.166   Industry supported a principles-based approach.  The main concerns expressed were that any additional obligations not require the breaking up of conglomerates and not impose detailed prescriptive guidelines on industry.

4.167   The CLERP 9 proposal for further ASIC guidance, in conjunction with effective industry initiatives, received strong support from industry.  This approach involved general duties and guidance rather than a heavily prescriptive approach.  It was considered that stakeholders could actively contribute to ASIC’s consultation process to ensure the guidelines effectively address analyst independence and conflict management issues.

4.168   ASIC supported the addition of a specific licensing obligation to manage conflicts as a means of enhancing its capacity to remedy inadequate conflicts management practices.

Conclusion

4.169   ASIC guidance, supported by a specific licensing obligation in relation to the management of conflicts of interest, will deliver a market-based solution for managing conflicts of interest.  This will benefit consumers by improving industry standards.  An additional duty in relation to the management of conflicts will supplement the general duty to act ‘efficiently, honestly and fairly’ and provide a firmer legislative basis for the development of ASIC guidance.  These initiatives will ensure that conflicts of interests are managed effectively.

4.170   The effectiveness of ASIC guidance should be monitored after there has been some experience with its operation.  This would provide an opportunity to consider whether any further legislative changes are required.

Informed Market

Introduction

4.171   The Government aims to promote an informed market for financial products (such as shares, debentures and managed investment products) through disclosure requirements that apply to the issuers of these products.

4.172   These disclosure requirements are intended to address information asymmetries between product issuers and investors.  In the absence of these requirements, issuers of financial products may withhold adverse information from investors or selectively disclose materially price sensitive information about their products to particular investors.  In addition, the nature of financial products means that investors may be unable to obtain the information that they require to make an informed decision about whether to acquire or dispose of a financial product.  Alternatively, the overall cost to investors of compiling this information may greatly exceed the cost to an issuer of obtaining and disseminating the same information. 

4.173   Disclosure requirements are intended to facilitate confident investor participation in financial markets (especially in relation to so-called ‘retail investors’) by ensuring that investors have equal and timely access to the information necessary to evaluate investment opportunities (as well as to determine whether a particular investment is suited to their needs). 

4.174   Disclosure requirements are also intended to ensure that shareholders are properly informed in relation to their rights to participate in, and exercise voting rights at, company general meetings.  This enables shareholders to influence the direction of companies in which they invest. 

4.175   It is important to ensure that disclosure requirements are not too burdensome for issuers so that they increase the cost of capital.  It is also necessary to ensure that disclosure requirements achieve an appropriate balance between the need to maintain an informed market and the need to safeguard the commercial performance of issuers by allowing them to withhold information whose disclosure might be commercially detrimental. 

4.176   CLERP 9 examined three aspects of disclosure by product issuers:

·        fundraising provisions that generally apply when financial products are first issued to retail investors (as well as in certain secondary sale situations);

·        continuous disclosure provisions (which apply to product issuers that are disclosing entities and require them to disclose materially price sensitive information on an ongoing basis); and

·        shareholder disclosure in relation to company meetings and resolutions. 

Fundraising

Problem

4.177   The Bill addresses three issues in relation to the disclosure requirements governing fundraising. 

·        Difficulties encountered by retail investors in easily comprehending the contents of prospectuses and other disclosure documents. 

·        Additional compliance costs associated with the need for issuers of continuously quoted managed investment products to disclose information that has already been made publicly available and therefore readily available to investors. 

·        Excessive limitations on financial institutions that receive wholesale placements of financial products to on-sell these products to retail investors within 12 months without a disclosure document. 

4.178   It is considered Government legislative action is needed to correct these problems because they relate to requirements set out in the fundraising provisions of the Corporations Act. 

Objectives

4.179   The objective of the fundraising provisions is to facilitate confident investor participation in Australia’s primary securities market without imposing unduly high costs on issuers (thereby increasing the cost of raising equity capital). 

4.180   The fundraising provisions are contained in Chapters 6D and 7 of the Corporations Act and are administered by the Australian Securities and Investments Commission (ASIC).  The provisions of Chapter 6D apply to shares and debentures and, with some exceptions, Part 7.9 applies to all other financial products.

4.181   The fundraising provisions require offers of financial products to retail/unsophisticated clients to be accompanied by a disclosure document that contains information relevant to the offer.  These clients are unsophisticated in financial markets and receive additional protection under the Act, principally through the disclosure of relevant information to enable the client to make an informed choice about the financial product in question.  They specify the information that is required to be contained in disclosure documents and provide penalties and other remedies for inadequate disclosure. 

4.182   The fundraising provisions only apply to offers to retail clients.  They do not apply to offers made to wholesale clients (such as financial institutions) as these persons are deemed to be able to safeguard their own interests without the need for mandatory disclosure. 

4.183   These amendments are intended to improve the practical operation of the fundraising provisions in line with the Government’s intention to ensure investors are fully informed when making investment decisions.

Options

4.184   It was considered that the problems identified in relation to the fundraising regime could only be addressed through legislative amendments. 

Format and presentation of Chapter 6D disclosure documents

4.185   The reforms in the Bill introduce a ‘clear, concise and effective’ presentational requirement that is intended to avoid disclosure documents that are unclear, vague or ambiguous. 

4.186   This amendment mirrors provisions introduced by the Financial Services Reform Act (the FSR Act) into the prospectus regime.  This does not detract from the content of a disclosure document but ensures that it more effectively conveys the required information to the investing public.

Option 1

4.189   Option 1 is to not make amendments to Chapter 6D in line with Chapter 7.

4.190   This approach will have a minimal impact on industry.  However, it will result in investors potentially not receiving effective disclosure.  Disclosure documents have grown increasing complex.  Whilst it is important to disclose the content required under the Act, a tendency to use legally proven or established language has meant that such documents are usually at the expense of clarity and brevity.  Given that a disclosure document’s main aim is to inform unsophisticated investors of relevant information, a document that does not convey such information in a manner that can be readily understood will be of limited effectiveness as an information source.  It is not intended to detract from the content of a disclosure document but ensure it effectively conveys the required information to the investing public.

Option 2

4.191   Option 2 is to insert into Chapter 6D a provision mirroring that in subsection 1013C(3), which requires a PDS to be worded and presented in a ‘clear, concise and effective manner’.  This would bring Chapter 6D wording and presentation of disclosure documents into line with Product Disclosure Statements (PDS) in Chapter 7. 

4.192   This option may involve an increase in compliance costs for product issuers to the extent that new disclosure documents may have to be modified to comply with this requirement.  This could involve extra drafting time to ensure a document meets both the content and presentational requirements of the Act.  That said, industry may benefit though shorter documents that involve less printing costs and easier marketability to the market.

4.193   Further, it is expected that greater understanding of how this presentational requirement works in practice will develop given the application of the ‘clear, concise and effective’ requirement to both Chapters 6D and 7 of the Act.

4.194   Retail investors and the wider investing market will benefit through access to more useful information when making decisions about financial products. 

Contents of a PDS for continuously quoted managed investment products

4.195   The reforms in the Bill provide concessionary disclosure arrangements in relation to further issues of continuously quoted managed investment products. 

4.196   These amendments mirror provisions introduced by the FSR Act into the prospectus regime and reduce the overall cost to managed investment scheme operators of preparing a PDS.

Option 1

4.197   Option 1 is to maintain the current legislative provisions.  These provide that in determining what information needs to be contained in a PDS (the name of the disclosure document required to be prepared under Part 7.9 of the Corporations Act), the issuer (or other responsible person) is simply required to take account of the effect of the enhanced disclosure provisions that apply to disclosing entities. 

4.198   This option would ensure that retail investors continue to receive all relevant information in the PDS accompanying the offer.  However, managed investment scheme operators that issue these products would continue to bear the preparation, printing and distribution costs associated with the provision of information that has already been disclosed to the market. 

Option 2

4.199   Option 2 is to amend Part 7.9 of the Corporations Act to insert provisions modelled on section 713 (that apply in relation to products covered by Chapter 6D).  These provisions would permit issuers of managed investment products that are continuously quoted securities to issue shorter, or transaction specific, PDS (and allow ASIC to deny an issuer access to these arrangements if it has not met its disclosure obligations in the past 12 months).  The PDS would be required to inform investors of their right to obtain free of charge copies of documents lodged with ASIC in relation to the issuer.  These amendments would bring Part 7.9 into line which Chapter 6D (in relation to the framework of disclosure applying to continuously quoted securities). 

4.200   This option would reduce the cost to managed investment scheme operators of preparing a PDS.  Furthermore, that the PDS would inform investors of their right to obtain information that was excluded from the PDS and that retail investors may consider relevant in making a decision to acquire a continuously quoted managed investment product, would reduce the risk that all relevant information may not be accessed before such a decision is made.

Anti-avoidance provisions for secondary sales

4.201   Retail clients are entitled to information through a disclosure document, such as a prospectus, when securities are being issued.  The secondary sale provisions are designed to prevent the avoidance of the fundraising regime through the issue of securities to an intermediary, who then on-sells those shares to retail clients.  These provisions were strengthened through legislative amendments contained in the FSR Act that required a disclosure document to be prepared if either the issuer or the seller intended that the relevant financial products be on-sold within 12 months.

4.202   The Bill proposes to improve the operation of these provisions to ensure the placements market can operate efficiently.  However, these amendments ensure investors are protected by receiving relevant information to make an informed decision.

Option 1

4.203   Option 1 is to revert to the pre-FSR Act position in relation to secondary sales (under which the intention test would apply only to the issuer and not the subsequent seller). 

4.204   This would provide greatest benefit to issuers and financial institutions.  Financial institutions would have few constraints on their capacity to on-sell financial products to retail clients (provided they did not deliberately intend to circumvent the relevant fundraising provisions).  This may reduce the cost of capital to issuers, since financial institutions would not require an additional risk premium in relation to constraints on their capacity to dispose of the financial products.

4.205   However, this option moves away from the Government’s intention in the FSR Act to strengthen the anti-avoidance intent of the secondary sales provision.  Going back to the pre-FSR Act position could mean that retail investors and the wider market do not have access to appropriate information. 

Option 2

4.206   Option 2 is to make no legislative amendments to the anti-avoidance provisions. 

4.207   This option ensures that retail investors receive adequate disclosure in relation to financial products on-sold within 12 months of being issued without a disclosure document.  However, this option relies on ASIC Class Order relief to enable the practical operation of the placements market.  Without relief, the current provisions of the law imposes significant demands on secondary sales as financial institutions accepting share placements would be required to incur the expense of preparing a disclosure document if they wanted to on-sell these securities to retail investors within 12 months of issue.  They would therefore demand an additional risk premium from issuers, thereby increasing the cost of equity capital raising. 

4.208   Even though ASIC relief could apply, introducing legislative change provides greater certainty of both the legal position and the Government’s intention to facilitate the secondary sales market whilst ensuring investors are protected through access to relevant information. 

Option 3

4.209   Option 3 is to build on the post-FSR Act amendments to not require further information in relation to secondary sales of securities where:

·        prospectus-like information has been disclosed to the market; or

·        a prospectus in relation to the same class of securities has been lodged with ASIC.

4.210   This option balances the interests of retail investors on the one hand and those of financial institutions and issuers on the other.  It allows financial institutions to on-sell financial products where retail investors have reasonable access to equivalent information to that which would otherwise have been required to be contained in a disclosure document covering the relevant financial products. 

4.211   Legislative change also provides a basis for additional ASIC relief where appropriate.

Consultation

4.212   There was support for the Bill’s proposal to improve the presentation of disclosure documents through a ‘clear, concise and effective’ requirement.  The Bill recognises that this presentational requirement does not detract from the content of the information required under the Corporations Act.

4.213   There was also support for the Bill’s proposals in relation to continuously quoted securities and secondary sales.  A range of technical queries were raised in submissions and have been largely addressed in the final Bill.

Conclusion

4.214   The Bill extends the existing ‘clear, concise and effective’ presentation requirement for Product Disclosure Statements to disclosure documents to more effectively convey information to the investing public.

4.215   It is considered that the benefits of improved disclosure to retail investors would exceed any potential increase in compliance costs for the issuers of these products. 

4.216   Further, the Bill:

·        allows issuers of continuously quoted managed investment products to issue shorter, or transaction specific,  PDSs (with other information available on request); and  

·        provides an exemption from the anti-avoidance provisions for secondary sales in relation to financial products for which retail investors can gain ready access to relevant information through:

-       prospectus-like information that has been disclosed to the market; or

-       a prospectus in relation to the same class of securities has been lodged with ASIC.

4.217   It is submitted that these two measures will reduce costs for financial institutions through introducing practical reforms to the regime, whilst ensuring that retail investors receive appropriate protection. 

Continuous disclosure

Problem

4.218   The problem consists of inadequate compliance by disclosing entities (especially listed disclosing entities) with their continuous disclosure obligations.  This is reflected in a failure by listed entities to make full and timely disclosure of materially price sensitive information in relation to their listed securities.  Both the ASX and the Australian Securities and Investments Commission (ASIC) have identified a need to create an improved culture of compliance with these provisions amongst listed entities. 

4.219   This problem has a significant impact because continuous disclosure is fundamental to the integrity of Australian securities markets.  It is important that all investors should have equal and timely access to price sensitive information released by disclosing entities.  Inadequate disclosure has the potential to discourage confident investor participation in securities markets.  This in turn could reduce the liquidity of these markets and hence the efficiency of the price discovery process. 

Objectives

4.220   The objectives of the proposed measures are to increase compliance with the continuous disclosure obligations that apply to disclosing entities. 

·        This objective is most significant in relation to the most actively traded listed disclosing entities that feature the largest direct and indirect retail shareholder participation. 

4.221   Responsibility for ensuring that disclosing entities comply with their continuous disclosure obligations is shared between ASIC and the relevant market operator (in relation to entities that are listed on the ASX, the Bendigo Stock Exchange (BSX) and the Stock Exchange of Newcastle (NSX)). 

·        ASX accounts for over 99 per cent of Australia’s listed disclosing entities. 

4.222   The continuous disclosure rules that apply to ASX, BSX and NSX listed entities are contained in the listing rules of the relevant market operator. 

·        In general, listed disclosing entities are required to immediately disclose materially price sensitive information to the relevant market operator so that it can be made available to investors.  Entities are permitted to withhold information from immediate disclosure if it falls into the so-called ‘carve-out’.  This ‘carve-out’ is intended to avoid premature disclosure of potentially misleading or commercially damaging information.  However this information may only be withheld so long as it remains confidential. 

4.223   Market operators have frontline responsibility for monitoring compliance with their continuous disclosure rules and for maintaining an informed market (including requiring listed entities to remedy inadequate disclosure).  They are also responsible for issuing guidance to listed entities in relation to their compliance with these rules. 

4.224   In light of the significance of continuous disclosure for market integrity, the continuous disclosure rules of ASX, BSX and NSX have been given statutory backing in Chapter 6CA of the Corporations Act 2001 (the Corporations Act).  Inadequate disclosure by a listed entity can result in criminal and civil action by ASIC, which administers the Corporations Act. 

·        ASIC currently has primary responsibility for enforcement in relation to inadequate disclosure by listed disclosing entities (including by seeking criminal and civil penalties).  The penalties are intended to function as a deterrent to contraventions.

4.225   The continuous disclosure requirements that apply to listed disclosing entities are therefore based on a combination of ‘quasi-regulation’ by market operators, reinforced by explicit governmental regulation in the form of criminal and civil penalty provisions contained in the Corporations Act. 

4.226   ASIC also has direct responsibility for monitoring and enforcing continuous disclosure by unlisted disclosing entities.  The continuous disclosure rules that apply to these entities are contained solely in the Corporations Act. 

Options and impact analysis

4.227   In the course of developing the policy proposals relating to continuous disclosure that were contained in the CLERP 9 paper, a systematic review was undertaken of all of the major components of the current framework of enforcement. 

4.228   This included an examination of:

·        the division of responsibility between ASIC and market operators (in relation to continuous disclosure by listed disclosing entities);

·        procedures for the dissemination of materially price sensitive information to investors; and

·        the operation of the current enforcement framework. 

4.229   An examination was also undertaken of the operation of the continuous disclosure frameworks of several other jurisdictions, including the United Kingdom, the United States, Canada (Ontario), New Zealand, Hong Kong and Singapore. 

4.230   Four options were considered following examination of the current enforcement framework.  It is necessary to consider the impact of these options on the following persons:  investors in securities issued by disclosing entities, the disclosing entities themselves, market operators (who have front line responsibility for monitoring compliance with their continuous disclosure rules) and ASIC, which has responsibility for administering the provisions of the Corporations Act which provide statutory backing to these rules and impose similar obligations on unlisted disclosing entities. 

Option 1 — Transfer of full enforcement responsibility to ASIC
Description

4.231   Option one is that ASIC should assume direct responsibility for monitoring and enforcing continuous disclosure rules in relation to both listed and unlisted disclosing entities (as opposed to the continuous disclosure framework that applies to listed disclosing entities continuing to consist of both ‘quasi-regulation’ and ‘explicit government regulation’).

·        This option involves adopting the UK approach, in which the Listing Authority of the Financial Services Authority has direct responsibility for enforcing compliance with a single set of continuous disclosure obligations that apply to all listed entities. 

Impact analysis

4.232   Under this option, front line responsibility for enforcing compliance with the continuous disclosure provisions that currently apply to listed entities would be transferred from the relevant market operator to ASIC. 

·        ASIC would have added front line responsibility for monitoring disclosure and disseminating information in relation to listed disclosing entities to its current responsibility for penalising non-compliance. 

4.233   The main benefit of this option would be to address concerns about potential conflicts of interest between the commercial objectives of market operators and their responsibilities for market supervision (especially administration of their listing rules in relation to listed entities that may be commercial partners or rivals). 

4.234   However, this option would involve additional costs for ASIC (including the adoption of more complex arrangements to recover these costs from relevant market operators).  In addition, it is not clear that a body such as ASIC would be as well as equipped as the relevant market operator to perform this function (especially if it lacked responsibility for monitoring trading activity). 

4.235   Finally, it should be noted that market operators are already required to adopt measures to handle conflicts between their commercial and supervisory responsibilities.  There is no evidence that these arrangements are not operating adequately. 

4.236   The likely costs associated with this option appeared to exceed any benefits that could be achieved from increasing ASIC’s responsibilities in this area. 

4.237   As a consequence, it has been decided to retain the current allocation of responsibility between market operators and ASIC.  Market operators are best placed to act as front line regulators because of their responsibility for monitoring trading activity as well as for receiving and disseminating price-sensitive information disclosed by market entities.  Maintaining adequate disclosure by listed entities is also fundamental to the obligation of market licensees to maintain ‘fair, orderly and transparent’ markets for financial products. 

·        ASIC should continue to focus on penalising inadequate disclosure (generally in relation to matters referred to it by the relevant market operator). 

Option 2 — Increased role for market operators
Description

4.238   Option two is to require market operators to play a greater role in penalising contraventions of their continuous disclosure rules by relevant listed entities, especially in relation to less serious contraventions of the regime, which might not be appropriately dealt with through criminal or civil proceedings instituted by ASIC.

·        It is important to distinguish this from market operators relying on their existing operating rules to impose a range of penalties (ranging from censures to substantial fines) against participants in relation to disciplinary action for contraventions of their trading and conduct of business rules. 

Impact analysis

4.239   Under this option, market operators would play a greater role in penalising less serious contraventions of their continuous disclosure rules by listed entities (through the imposition of penalties ranging from censures to fines).  ASIC would have retained responsibility for dealing with serious contraventions. 

4.240   This option would have implications for market operators and for listed entities that had not complied with their continuous disclosure obligations. 

4.241   This option would impose some additional costs on market operators, since they would be required to create mechanisms and tribunals for investigating and penalising less serious instances of inadequate disclosure by listed entities. 

4.242   It would also impose costs on entities that contravened their continuous disclosure obligations (although these costs would be appropriate as a means of deterring contraventions). 

4.243   The main disadvantage of this option is that market operators may not have adequate investigatory powers to punish contraventions.  It could also be argued that a requirement for market operators to penalise less serious contraventions of the regime might detract from their responsibility to provide guidance to listed entities and maintain an informed market by remedying inadequate disclosure. 

·        Market operators argued that they should be responsible for maintaining an informed market and that ASIC should be responsible for penalising breaches. 

4.244   The problem with this option is market operators indicated that they would be unwilling to make the necessary amendments to their operating rules.

4.245   It has been decided, therefore, that ASIC should retain primary responsibility for penalising contraventions of the continuous disclosure regime.

Option 3 — Involvement of a peer review panel
Description

4.246   Option three is for the establishment of some form of peer review involvement to penalise inadequate disclosure by listed entities.  A peer review panel would review alleged contraventions by listed entities to determine whether a penalty should be imposed (either by the panel itself or by the courts on the application of ASIC) and might play a useful role in providing guidance in relation to compliance with continuous disclosure obligations. 

Impact analysis

4.247   The main potential benefit that could be derived from this option would be to ensure that the continuous disclosure provisions are interpreted in accordance with market practice.  It may also have the potential to increase compliance, by providing increased guidance to relevant entities and giving them a sense of ownership in relation to continuous disclosure. 

4.248   However, consultation with market operators and ASIC revealed a number of potential disadvantages associated with this option. 

·        It could involve significant administrative costs (deriving from the need for the Government to establish and maintain a peer review body, either on a stand alone basis or as a separate division of the Takeovers Panel);

·        It would have significant potential to limit the capacity of market operators and ASIC to respond to contraventions;

·        It could lead to inconsistent interpretations of the continuous disclosure obligations of listed entities (which would not assist compliance); and

·        It is not clear that a peer review panel would boost levels of disclosure among listed entities. 

4.249   On the basis of these considerations it has been decided that the introduction of a peer review panel would not benefit investors and was more likely to reduce the effectiveness of enforcement of the continuous disclosure framework. 

4.250   It has also been decided that market operators should be solely responsible for providing guidance to listed entities in relation to complying with their continuous disclosure rules and that the prospect of conflicting interpretations of these requirements was likely to reduce rather than enhance compliance. 

4.251   It was noted that the Takeovers Panel has a remedial rather than a punitive role in relation to takeovers disputes.  In relation to continuous disclosure, it is considered that this remedial role is best performed by market operators. 

Option 4 — Enhance ASIC enforcement powers
Description

4.252   Option four is to leave the current framework largely unchanged but to strengthen the enforcement framework by enhancing ASIC’s capacity to penalise contraventions of the continuous disclosure regime (including alleged contraventions that are referred to ASIC by the relevant market operator). 

4.253   Three measures are proposed: 

·        an increase in the maximum civil penalty that a court may impose on bodies corporate in relation to a contravention of the continuous disclosure regime from $200,000 to $1 million;

·        allowing ASIC to seek civil penalties against individuals directly and knowingly involved in such contraventions; and

·        permitting ASIC to issue infringement notices to bodies corporate in relation to less serious contraventions of the continuous disclosure regime. 

Impact analysis

4.254   This option would have implications for entities that contravene the continuous disclosure provisions (including their directors and shareholders) and ASIC. 

4.255   The main benefit of this option is its potential to provide improved incentives towards compliance with the continuous disclosure framework by increasing the likelihood that contraventions will be penalised.  The proposal for the introduction of an infringement notice mechanism may also benefit ASIC by reducing the costs of pursuing less serious contraventions of the regime.  This benefit would accrue if entities elect to pay the applicable penalty rather than continuing to pursue the matter in the courts. 

4.256   Increased compliance with the regime will benefit investors who rely on timely disclosure of materially price sensitive information by disclosing entities in order to make investment decisions in relation to their securities. 

·        Investors still suffer as a consequence of less serious contraventions. 

4.257   The main costs of this option would fall on disclosing entities that contravene the continuous disclosure regime.  Firstly, they will be exposed to the potential for much higher financial penalties (although a court is only likely to impose the maximum possible penalty in relation to particularly serious contraventions).  In common with all financial penalties imposed on bodies corporate, this would have some adverse implications for shareholders. 

4.258   Costs would also potentially fall on officers of these corporations that are responsible for its disclosure practices and may be knowingly and directly involved in a contravention.  These officers would be exposed to civil penalties in relation to their conduct as well as civil actions for damages by investors (in addition to their current civil and criminal liability). 

4.259   Finally, the proposal to introduce an infringement notice mechanism may also increase administrative costs to the extent that ASIC would be able to pursue an increased number of contraventions than is possible under the current framework (especially less serious contraventions). 

4.260   These proposals would not increase the obligations on disclosing entities.  They will simply strengthen the enforcement mechanism in relation contraventions of the continuous disclosure regime.

4.261   The benefits of these proposed reforms outweigh their costs. 

Consultation

4.262   Generally, there is broad support for increasing the maximum civil penalty, although stakeholders generally did not support the proposals to extend civil liability to individuals involved in a contravention and give ASIC the power to issue infringement notices.

4.263   A number of stakeholders considered that the extension of civil liability to persons involved in a contravention should be accompanied by a due diligence/business judgment defence and confined to officers or senior managers (and not those involved in the decision-making process but who cannot effect disclosure).  However, some submissions supported the initiative.  ASIC, in particular, considered that individuals should have express obligations in the continuous disclosure context and that existing Corporations Act provisions provide adequate safeguards. 

4.264   A number of submissions also expressed concern that the infringement notice power is unnecessary given ASIC’s existing power to bring civil penalty proceedings and that it would result in ASIC acting as the judge, jury and executioner with respect to alleged contraventions.  Some stakeholders argued that the market operator is better placed to assess price sensitivity and pursue continuous disclosure actions.  Some submissions favoured the establishment of an independent review panel or mechanism.  Other submissions, including ASIC and the ASX, however, supported the proposal.

Conclusion

4.265   As proposed in the CLERP 9 policy paper, the CLERP 9 Bill will adopt option 4 and will not adopt options 1 to 3. 

2.266   This conclusion is based on the assumption that the requirements of the current regulatory framework are broadly adequate.  There is no need to require the disclosure of additional information, to reallocate responsibilities between ASIC and market operators or to introduce some form of peer review panel. 

·        Market operators should maintain front line responsibility for providing guidance to listed disclosing entities in relation to their continuous disclosure obligations, for maintaining an informed market and for remedying inadequate disclosure. 

·        ASIC will retain primary responsibility for penalising contraventions of the regime. 

4.267   The main problem in relation to continuous disclosure relates to inadequate compliance with the existing rules and gaps in ASIC’s capacity to penalise less serious contraventions. 

4.268   Option four fills a significant gap in the current enforcement framework. 

4.269   This proposal contains safeguards commensurate with the magnitude of the potential penalties involved. 

·        Before issuing an infringement notice, ASIC would be required to hold a private hearing at which the entity would be given an opportunity to give evidence and make submissions. 

·        Compliance with an infringement notice is not taken as an admission by the entity of liability or a contravention of the Corporations Act.  Furthermore, if it complies, the entity is not subject to court proceedings or further penalties in relation to the matter.

·        If an entity elects not to comply with the infringement notice, ASIC would bear the evidential burden of proving its case in court.  An entity would only become liable to comply with the notice if ASIC is able to satisfy the civil standard of proof.  Only the court would be able to force an entity to comply with the notice. 

·        ASIC may only publish details of an entity’s compliance with an infringement notice.

4.270   The proposal should not increase the potential for different interpretations of the continuous disclosure rules as ASIC is already responsible for enforcement in relation to contraventions of these rules and, in deciding whether to issue infringement notices, ASIC would be required to consult with the relevant market operator. 

Shareholder Participation and Information

Problem

4.271   Shareholders can and should play a key role in promoting good corporate governance practices by influencing the management of corporations through participating at general meetings.  The practical opportunities for shareholders, particularly at the retail level, to play this role is restricted because relevant information is not communicated in a form that is useable and timely.

Objectives

4.272   It is sought to increase the practical opportunities for shareholders to assess and influence the performance of the board by effectively participating in general meetings of corporations.

Options and impact analysis

Option 1

4.273   This option looks to maintain the status quo.  To maintain the current position means that many shareholders will continue to be subject to practical hurdles in relation to effective participation in shareholder meetings.  Inadequate shareholder participation has indirect costs because widespread effective participation would lessen the chances that poor corporate governance practices, leading to loss of shareholder value, will be allowed to continue.

Option 2

4.274   This option looks to implement proposals in the original CLERP 9 paper.  These proposals aim to facilitate increased shareholder participation, particularly at the retail level, by:

·        allowing improved presentation of information regarding meetings so it can be more easily understood;

·        facilitating use of electronic communications for meeting information and other reports to shareholders.

4.275   The likely benefits are an increased level of well informed shareholder participation and likely decreases in costs for companies in terms of less printing.  Companies that do not already have website technology would need to invest in it, but the proposals do not make such an investment mandatory.

4.276   CLERP 9 also includes a proposal to require disclosure by directors of additional information concerning other directorships in annual reports.  The proposal is to address a perception that a number of directors take on too many board positions and cannot properly perform their responsibilities.  There are not significant direct or indirect compliance costs on the part of directors or the corporations.  The benefit is that shareholders will be directly informed about the other offices of board members and can, where appropriate, seek to influence the number of positions directors take on.

Option 3

4.277   This option would require companies to provide electronic information distribution, internet voting and similar facilities for shareholders.  This would ensure all shareholders with access to the internet would have the same opportunities to participate in corporate meetings.  However, this could impose significant compliance costs on corporations that do not already have the technology to provide those facilities.  It would be desirable to provide companies with a suitable time period to acquire the technologies and shareholders without access to internet themselves would still not have access. 

4.278   In relation to the disclosure of directorships, it would be possible to provide for a maximum number of directorships.  This would have the benefit that no director would be able to exceed a maximum, but at the cost of flexibility.  Opportunities for some directors to input valuable skills and experience to corporations could be lost by adopting an arbitrary maximum.

Consultation

4.279   The proposals received support from the majority of submissions.  However, in light of submissions it was decided to limit the proposal concerning disclosure of directorships so that it applies only in relation to directorships on the boards of other listed entities. 

Conclusion

4.280   The CLERP 9 proposals, as modified in light of consultation, offer the prospect of substantially meeting the objectives at little cost or disadvantage.  Accordingly, this option is preferred over retaining the status quo or adopting prescriptive requirements.

Enforcement

Problem

4.281   An effective regulatory framework requires strong enforcement mechanisms and timely resolution of disputes.  It is essential that standards that govern conduct in the industry are able to be enforced and that there are strong sanctions in the event of the breach of those standards. 

4.282   Disciplinary bodies operating within the enforcement framework must also have the necessary credibility to perform an effective disciplinary function. 

4.283   Obligations to report misconduct should be clear and comprehensive and those parties such as employees who may be in positions to report misconduct should be able to do so without fear of retribution from employers.

4.284   Some concerns have been raised about the effectiveness of accounting and auditing enforcement mechanisms.  Key standards by which auditors must abide when conducting audits will not, in the event of a breach of the standard, attract any direct penalty.  This differs to the position with accounting standards which are legally enforceable under the Corporations Act.  As a consequence ASIC has a more limited suite of powers available when pursuing enforcement action relating to misconduct of auditors.

4.285   Further, where there is a dispute between ASIC and companies on the application of the accounting standards and true and fair view requirement contained in the Corporations Act, ASIC must initiate legal proceedings in order to resolve the matter.  Judicial proceedings can be costly and slow, resulting in the market being misinformed about a company’s financial situation for prolonged periods.  There are also some concerns about the unfamiliarity of courts with subject matter concerning the application of accounting standards and the true and fair view.

4.286   Concerns also exist with machinery arrangements of the key auditor disciplinary board, the Companies Auditors and Liquidators Disciplinary Board (CALDB).  In particular, the membership base of the Board does not promote the perception that its hearings are independent from the accounting profession.  The CALDB consists of a Chairperson (who must be a barrister, solicitor or legal practitioner) and two other members nominated by the ICAA and CPAA. 

4.287   In addition, some provisions currently contained in the Corporations Act are narrow in scope.  In particular, requirements for auditors to report misconduct to the regulator are not comprehensive and employees, who may be in a position to identify and report on corporate misconduct, are not confident to do so for fear of retribution from their employers.  As a result, conduct that should ordinarily attract some form of sanction, or at least investigation, may go unchecked.

Objectives

4.288   The CLERP 9 measures are designed to create an enforcement regime that provides the right incentives for auditors to maintain their professional independence and to adhere as closely as possible to the best practice standards expected of a professional auditor.  An effective enforcement regime cannot rely solely on tough penalties for those convicted of breaches but must also provide alternatives to court action where possible, and incentives for all parties involved to cooperate with regulators in identifying those who have behaved improperly.  It is important therefore that the enforcement regime be proactive, not solely reactive.

4.289   The institutional arrangements involved in the auditor disciplinary process at all levels should also have credibility in the market in order to achieve the objectives above.

Proposals promoting enforcement

4.290   The Bill contains a number of mechanisms designed to enhance enforcement mechanisms in the law.

Options and impact analysis

Legislative backing of auditing standards

4.291   Auditing standards are currently developed by the Auditing and Assurance Standards Board (AuASB) but are approved by the executive councils of the ICAA and CPAA.  The standards provide guidance and prescribe the minimum criteria for the conduct of audit services.  Compliance with auditing standards, which is mandatory only for members of CPAA and ICAA, is enforced through members’ professional rules.  Members of the ICAA and CPAA can be disciplined by the Companies Auditors and Liquidators Disciplinary Board (CALDB) for failing to follow auditing standards.  In this respect auditors can be deregistered for failing to comply with the standards.  However no specific enforcement action can be taken by the regulator in the event of a breach of the standard.

Option 1

4.292   This option proposes that the Corporations Act be amended to give auditing standards the force of law.  The effect of the proposal would be to require all registered company auditors to use auditing standards when they are performing auditing work in accordance with the requirements of the Corporations Act.

4.293   Auditing standards perform an important role in the financial reporting framework and by giving legislative backing to auditing standards, this role will be reinforced.  In addition, legislative backing will provide a mechanism by which appropriate sanctions and remedies can be imposed for a breach of the standards.  The standards will apply to all auditors regardless of whether they are members of the professional bodies and in this respect the proposal will establish a consistent standard of conduct applying to all auditors across the industry.  In addition, a broader range of sanctions will apply in the event of a breach. 

4.294   Auditors who are members of the professional bodies will already comply with the auditing standards and consequently this proposal will give rise to little, if any, compliance costs for those parties. 

4.295   For others, who are not members of the professional bodies (as noted less than 10 per cent of all company auditors) and who do not comply with auditing standards as a matter of best practice, it is expected that some compliance costs will be incurred in having to conduct audits according to the standards.  These parties may have to put in place revised or additional procedures for performing audits in a manner that complies with the requirements in the standards.  These procedures, which may involve additional checking of transactions and maintaining comprehensive working papers and records of the audit, may lead to increased costs in the short term while the new procedures are being developed and implemented.  It is expected that in the longer term this proposal will result in a small increase in ongoing compliance costs, primarily in respect of the additional test checking that may be required and the need to maintain working papers.  These increased costs for individual auditors will be offset by the benefits that will flow to capital market participants through the knowledge that all audits are conducted in accordance with a common set of rules. 

4.296   This proposal will affect all registered company auditors.  However given that members of the professional bodies already comply with auditing standards the impact of the proposal will be limited to less than 10 per cent of company auditors are not members of the two professional bodies. 

4.297   The proposal will also impact on the Auditing and Assurance Standards Board who will be required to redraft standards into legally enforceable instruments.  A one-off cost will be incurred by the AUASB to perform this task. 

Option 2

4.298   In developing this proposal consideration was given to maintaining the status quo by retaining the standards as professional standards.  This approach was not adopted as it would not guarantee the application of the standards consistently across the entire industry and it would not facilitate enforcement of the standards by the regulator.  Retaining the standards as industry standards would therefore result in a narrower application of the standards and more limited suite of enforcement options.

Consultation

4.299   Stakeholders raised concerns with the proposal to give auditing standards the force of law.  In particular stakeholders considered that the standards set out broad principles that are expressed in terms which are not currently amenable to legislative backing.  Consequently, redrafting of standards will be required which could adversely impact on international harmonisation objectives.  In addition, it was argued that standards are already legally enforceable in an indirect way.  Some submissions did however support this initiative.  In particular ASIC considers that this initiative will reinforce the importance of auditing standards, increase the likelihood that a change in a standard will have an immediate effect across the industry and ensure that breach of the standard will attract appropriate remedies.

4.300   Notwithstanding the reservations expressed in some submissions, giving auditing standards the force of law will result in all key requirements associated with the preparation and audit of company financial statements having direct legal under-pinning.  This, in turn, would strengthen ASIC’s ability to enforce the financial reporting requirements in the Corporations Act and to investigate and prosecute any breaches of those requirements.  It is envisaged that the required redrafting of the standards would result in the standards retaining a principles based approach.

Conclusion

4.301   Option 1 is preferred as it will apply minimum standards of conduct for auditors consistently across the industry and ensure that minimum a breach of those standards is capable of attracting a sanction. 

Establishment of a Financial Reporting Panel

4.302   The Financial Reporting Panel (FRP) is based on a similar body in the United Kingdom which has proven to be an effective alternative dispute resolution body.  It would represent a less expensive method of resolving disputes between ASIC and companies and ensure that disputes are resolved in a timely and efficient way.

Option 1

4.303   Consideration was given to maintaining the status quo so that in circumstances where ASIC and a company were in dispute about the application of accounting standards or the true and fair view, the matter would need to be resolved by pursuing the matter in court.  This situation is disadvantageous for the market, the company and ASIC for a range of reasons.  Judicial proceedings can be slow which means that disputes can go unresolved for a significant length of time leaving the market misinformed about a company’s financial situation for some time.  In addition, judicial proceedings are costly for the company and ASIC and courts may lack the expertise to determine disputes dealing with the application of accounting standards.  The cost and complexity of pursuing matters in court means that financial reporting issues effectively remain unaddressed.  The FRP would provide a mechanism for an independent third party to determine contested issues that avoids these disadvantages. 

Option 2

4.304   This option involves establishing an FRP to serve as an alternative dispute resolution mechanism in circumstances where there is a dispute between ASIC and a company regarding the application of accounting standards or the true and fair view and the matter cannot be resolved through negotiations between the parties.  FRP determinations would not be binding on either ASIC or the company and either party could still decide to pursue the matter in court.  Where a company does not accept an FRP determination and ASIC subsequently initiates court proceedings, the Court may have regard to the findings of the FRP.

4.305   These measures are unlikely to result in any additional compliance burden for participants in the industry as the body would generally be used as an informal and expeditious alternative to court proceedings, and participants would not be encouraged to have legal representation.

4.306   The FRP will be budget funded and an initial establishment cost and ongoing running costs will be incurred.

Consultation

4.307   There is broad stakeholder support for the FRP.

Conclusion

4.308   Given the benefits expected to flow from the establishment of the FRP, option 2 is  preferred.

Disciplinary arrangements

4.309   Registered company auditors who fail to adequately and properly carry out their duties as an auditor, can be disciplined and/or deregistered by the Companies Auditors And Liquidators Disciplinary Board (CALDB).  Matters are brought before CALDB by ASIC and it is up to ASIC to make their case for action against an auditor.  Grounds which may be argued by ASIC may include breach or non-compliance with the requirements of auditing standards.  A breach of auditing standards is not, however, a ground in itself for deregistration of a company auditor.

4.310   It is proposed in CLERP 9 that the arrangements for taking disciplinary action against registered company auditors will be strengthened to:

·        provide for a majority of members of the CALDB, with appropriate skills, who are non-accountants;

·        allow the CALDB to sit in more than one division simultaneously and provide for the appointment of a deputy chairperson for the CALDB; and

·        enable the CALDB to provide information obtained in the course of a disciplinary proceeding to the investigation and disciplinary committees of the ICAA, CPAA and NIA and other prescribed professional bodies as appropriate, to facilitate the disciplinary procedures of those bodies.

4.311   These initiatives will enhance the operation of the CALDB, promote the independence and perceptions of independence, and also facilitate coregulatory arrangements by allowing the CALDB to work more effectively with the professional bodies. 

4.312   These measures are unlikely to result in any compliance burden for participants in the industry as the changes merely look to strengthen the current institutional and machinery arrangements rather than impose new obligations.

4.313   Allowing the CALDB to sit in more than one division simultaneously will give the board greater flexibility in hearing cases.  The proposal will require the membership of the Board to be increased which will give rise to increased operational costs.

4.314   The proposals update the current legislative arrangements for the CALDB and facilitate their operations by increasing their capacity to conduct hearings.  They do not change the policy underlying the role and functions of the Board. 

Consultation

4.315   Stakeholders are generally supportive of this initiative.

Matters auditors must report to ASIC

4.316   It is also proposed that the Corporations Act be amended to expand the matters which auditors must report to ASIC to include any attempt to unduly influence, coerce, manipulate or mislead the auditor.  Currently auditors are required to notify ASIC in writing as soon as possible if the auditor has reasonable grounds to suspect that a contravention of the Corporations Act has occurred.  To date, there has been little use of the current provisions. 

4.317   By clarifying the types of conduct which must be reported by auditors it is anticipated that the provisions will be better utilised and will ensure that instances of wrongful conduct are brought to the attention of the regulator.  The threat of being reported for wrongful conduct will also provide a disincentive for companies to engage in such conduct. 

4.318   The requirements are unlikely to require auditors to undertake any additional monitoring and merely require the exercise of judgement on the part of the auditors.  As the proposals build on the current obligations of auditors it is expected that only minimal, if any, compliance costs will be incurred.

Consultation

4.319   Stakeholders are generally supportive of this initiative.

Protection and qualified privilege for whistleblowers

4.320   It is proposed that employees, officers and subcontractors be provided protection against retaliation from companies for reporting in good faith on reasonable grounds a suspected breach of the corporate law.

4.321   This will encourage company employees, officers and subcontractors who may often be in positions to witness misconduct, to report those breaches.  In addition, the measure will help to identify instances of misconduct and will directly assist ASIC in enforcing the law.

4.322   This measure will not give rise to significant compliance costs on the part of employers.  However, in the event that the provisions are breached, companies and/or their employees may become liable to pay compensation to the victim.  Other legal costs may also be incurred by companies that are prosecuted under the provisions.  Qualified privilege will only be available to employees that report misconduct in good faith and on reasonable grounds.  This will limit the scope for vexatious allegations against employers and in this way will limit the cost that employers may experience in having to deal with reports of misconduct. 

Consultation

4.323   Stakeholders are generally supportive of this initiative.

Conclusion

4.324   In light of the benefits that will flow from better enforcement as a result of the establishment of a Financial Reporting Panel, enhanced disciplinary arrangements, a broader range of issues that must be reported to ASIC and the provision of qualified privilege and protection for whistleblowers, it is proposed that these measures be adopted.

Accountability of parties within the financial reporting framework

Problem

4.325   There are currently a number of areas in which legislative requirements do not effectively promote accountability.

·        Auditors are currently registered by ASIC.  When registering an auditor ASIC takes into account the educational qualifications of the auditor as well as experience.  Auditors are not however required to meet specific competency standards (although the registration process envisages the applicant having the necessary competencies) nor complete any specialist training courses on auditing.  While these requirements may be met through compliance with the rules of the professional bodies, there are no explicit legislative requirements of this nature.  To ensure minimum competencies of participants in the profession and the application of consistent standards across the industry some form of action is required in order to promote the accountability of auditors to their clients. 

·        The senior management of a company is responsible for the preparation and content of financial statements.  While liability may be incurred by management where false representations in relation to the financial statements are made, there is no specific legal requirement for management to certify whether the statements comply with the law and the accounting standards.  There is consequently no incentive to ensure the veracity of information contained in the financial statements beyond ensuring that there are no misleading or false statements.

Objective

4.326   Improving the accountability of parties who are responsible for preparing financial reports as well as those who independently attest to the financial health of the company will promote the reliability and credibility of the regulatory system, instil greater confidence in the market and improve the efficiency of the market for audit services.

Proposals promoting accountability

4.327   CLERP 9 proposes a number of legislative measures be adopted to promote accountability

CEO and CFO sign-off on financial statements

4.328   Currently directors of companies are required to declare whether, in their opinion, the financial statement and notes to the statements comply with the Corporations Act, the accounting standards and give a true and fair view of the financial position of the company.  There is no requirement for CEOs and CFOs to make similar declarations despite the fact that for most listed companies, CEOs and CFOs are responsible for the preparation and content of the financial statements. 

Options and impact analysis

Option 1

4.329   This option proposes thatCEOs and CFOs be required to certify to the board of directors that financial statements are in accordance with the Corporations Act and accounting standards and present a true and fair view of the financial position and performance of the company.  The receipt of such a certificate by the board would be recorded in the board’s minutes, which can be inspected by ASIC.

4.330   The proposal will promote the reliability of financial statements, as well as market confidence and will focus the minds of senior company managers on the need to ensure the accuracy of the content of financial statements.  The proposal will also ensure that those who are responsible for the preparation of financial statements are accountable for their content thereby heightening the accountability of senior management. 

4.331   Given that in most listed corporations, CEOs and CFOs are responsible for the preparation and content of the financial statements they should already be ensuring that financial statements are prepared in accordance with the law and accounting standards despite the absence of a specific legislative requirement for them to do so.  As a matter of best practice, many CEOs and CFOs currently certify to the board of directors the truth and accuracy of the financial statements.  As the legislative changes will effectively formalise what is best practice, the change will not give rise to significant compliance costs for those corporations that already follow such practice.

4.332   For those CEOs and CFOs who do not currently certify to the board, the principal cost would be in terms of the time they and their staff need to devote to making the inquiries required to enable them to certify to the board that the financial statements have been prepared in accordance with the Corporations Act.

Option 2

4.333   Another option was for a requirement that company management sign off on the financial statements to shareholders directly.  This approach was not adopted as it had the potential to blur the lines of responsibility between company directors and company management.  Under the Corporations Act directors are responsible for the presentation and accuracy of the financial statements to shareholders.  

Option 3

4.334   Consideration was given to maintaining the status quo whereby CEOs and CFOs sign off on accounts to the board of directors as a matter of best practice.  In light of the importance of the accuracy of information contained in financial statements and the important role that senior company management plays in developing those statements, it was considered desirable that this practice be formalised in legislation to ensure its application across all companies.  This approach was considered preferable to relying on the broader, more general duties placed on management to ensure the accuracy and completeness of financial statements.

Consultation

4.335   Stakeholders are generally supportive of a requirement for CEOs/CFOs to verify the accuracy of financial statements.

Conclusion

4.336   Option 1, having executive sign off to the board of directors is the preferred option.  This approach will retain the overall responsibility of directors for the financial statements but will at the same time impose a specific requirement on those responsible for preparing the statements to turn their minds to the actual legal requirements and compliance with the accounting standards.

Qualifications and practical experience

4.337   In the case of company auditors, CLERP 9 proposes changes to the education qualifications and practical experience requirements for registration.  Qualifications will be enhanced through the introduction of a new requirement for the completion of a specialist auditing course prior to registration, while the practical experience requirements will be revised to include satisfactory compliance with a competency standard in auditing. 

Options and impact analysis

Option 1

4.338   Currently an auditor will meet the necessary practical experience requirements by demonstrating compliance with the time based criteria specified in the Corporations Regulations.  For processing applications from prospective auditors, ASIC has developed guidelines which attempt to assess the time-based criteria in terms of the breadth of experience an applicant should have.  A particular difficulty with this criteria has been the inability of prospective auditors who are either resident in small regional centres or members of small accounting firms to meet the time-based requirements, notwithstanding that they might otherwise have extensive experience in audit-type work. 

4.339   The law currently requires prospective auditors to have completed a three-year degree course in accountancy from an Australian university, or to have other qualifications and experience which, in the opinion of ASIC, is equivalent to such a degree.  While the legislation does not require any specialist auditor training, the accounting bodies require completion of an advance training course in auditing before full membership of the body can be obtained.  As the majority of prospective auditors are members of one of the accounting bodies, the practical effect is that most company auditors currently registered by ASIC have undertaken specialist training in auditing. 

4.340   Consideration was given to maintaining these current practices.  While this approach would give flexibility to the industry to determine how best to meet the educational requirements, it does not provide for a consistent standard to be applied across the industry.  In addition, the problems faced by prospective auditors in small firms and in regional centres in obtaining the pre-requisite practical experience would not be addressed.

Option 2

4.341   A legislative requirement for auditors to meet competency standard-based practical experience requirements and to complete specialist auditor training will ensure that applicants for registration as company auditors have demonstrated competence in the key skills required to perform the duties of an auditor.  A competency based requirement will promote greater confidence in the auditing profession. 

4.342   Introduction of competency standard based practical experience requirements will result in establishment costs associated with the new arrangements being incurred by the accounting bodies, accounting firms, prospective auditors and ASIC.  Once implemented, ongoing administrative costs associated with the actions needed to comply with the standard are likely to be incurred by accounting firms and prospective auditors.  These costs are off-set by the benefits that will flow to the capital market participants through having auditors who are more uniformly trained in a broad range of audit situations.  In addition, adoption of competency standards can be expected to benefit the accounting bodies, accounting firms, prospective auditors and ASIC by eliminating the appeals and hearing which currently occur when an application for registration as a company auditor is rejected.

4.343   In terms of the specialist training requirements, the requirements of the professional bodies only apply to their members and consequently there do not exist comprehensive requirements which apply across the board to all persons who are performing the function of auditor.  A legislative solution will ensure the application of robust educational standards across the whole of the industry.

4.344   This requirement will not lead to significant compliance costs for many auditors currently operating within the system.  As noted above, the specialist audit training course is equivalent to that currently required by the professional bodies and many auditors would have completed the current courses.  It is expected that those who have completed the current courses would be grandfathered into the new regime and therefore would not incur any compliance costs as a result of this measure.  For those auditors who have not completed the auditing module required by the accounting bodies, some costs associated with meeting the legislative requirements will be incurred. 

Consultation

4.345   The proposal that accountants be required to meet the practical experience requirements through satisfactory compliance with competency standards and to complete specialist training prior to registration was strongly supported in CLERP 9 submissions as well as submissions made in the context of the Ramsay Report on the Independence of Australian Company Auditors.

Conclusion

4.346   Option 2, undertaking an advanced course in auditing and satisfying the practical experience requirements for registration through compliance with a competency standard in auditing, is preferred as it will ensure that  all new applicants for registration as company auditors have the key skills required to perform the duties of an auditor.

Remuneration of directors and executives

Problem

4.347   Under Australia’s corporate regulatory framework, directors and senior company employees exercise control over company resources on behalf of shareholders, who have no direct operational control over the company.  While this relationship is the most efficient approach to operating a company that is owned by hundreds or thousands of different parties, a recognised limitation is that it can give rise to a principal-agent problem.

4.348   The principal-agent problem is characterised by owners or principals (shareholders) of a venture hiring agents (professional managers) to manage the affairs of that venture to achieve the investment objectives of the principal.  Agents are hired because they bring skills and devote time to a venture that the principal is not in a position to provide personally.  In reality agents may not always act in a way that best achieves the objectives of the principal.

4.349   Under the Australian corporate system directors act as representatives of shareholders in guiding management as to the company’s strategic and administrative decisions.  Directors are able to devote time and effort necessary to oversee the management of the company and are often compensated for this role.

4.350   In Australia, shareholders of public companies elect directors by resolution at the annual general meeting (AGM).  Directors must stand for re-election at regular intervals and may be dismissed by a resolution of the shareholders.  As directors represent all shareholders in their role, it is essential that their actions are transparent and that they are accountable to shareholders in discharging their duties.

4.351   Directors are generally paid remuneration as determined by shareholders by resolution at an AGM.  Directors, in turn, appoint senior employees of the company and determine their remuneration.

4.352   Recently, shareholders and other stakeholders in companies have expressed concern at a lack of transparency surrounding company remuneration practices.  In order to ensure that directors are discharging their duties effectively (and hence to make informed decisions of the appropriateness of the board’s actions) shareholders require timely, detailed information on the remuneration packages that provide incentives for key staff to act in accordance with shareholders’ objectives.

4.353   It is essential that directors, as representative shareholders, communicate with shareholders to ensure that they develop and apply an appropriate remuneration policy.

Current disclosure requirements

4.354   The Corporations Act requires disclosure in the annual directors’ report of:

·        board policy for determining the nature and amount of remuneration of directors and senior company executives;

·        the relationship between such policy and company performance; and

·        the nature and amount of each element of the remuneration of each director and each of the 5 most highly remunerated officers.

4.355   In addition, the Corporations Act provides that shareholders holding at least 5 per cent of the votes that may be cast at a general meeting, or at least 100 members entitled to vote at a general meeting, may require disclosure of the remuneration paid to each director of the company or its subsidiaries.  If this occurs, an audited remuneration statement for the last financial year must be sent to all members entitled to vote.

4.356   Current accounting standards contain requirements for the disclosure of directors’ and executives’ remuneration in the notes to the financial statements.  The aggregate remuneration of all directors must be disclosed as well as the number of directors who receive remuneration that falls within successive $10,000 bands.  Aggregate remuneration of executives must be disclosed for those executives who earn more than $100,000 per annum.  In addition, the number of executives whose annual remuneration falls within each successive $10,000 band over $100,000 must be disclosed.

4.357   The Australian Stock Exchange (ASX) Listing Rules require companies to disclose, on a continuous basis, any information that is “materially price sensitive”.  While this requirement includes remuneration agreements entered into by a company, in practice it is likely that few, if any, remuneration contracts would have a material impact on share price.  The ASX has informed companies that it intends to administer the continuous disclosure rules so that, where a company announces the appointment of a Chief Executive Officer, they must also disclose the key terms and conditions of the relevant remuneration agreement.

Objectives

4.358   The Government is committed to the principle of transparency in disclosure of information about remuneration of directors and senior executives.

4.359   In keeping with this objective, the Bill seeks to ensure shareholders are provided with sufficient information about corporate performance to allow them to make informed decisions about the board’s performance in setting remuneration for directors and executives.

4.360   In seeking greater disclosure of information about remuneration, the Bill does not seek to intervene in the market by placing limits on the quantum of director or executive remuneration.  Instead, it recognises that remuneration levels are a matter for directors having regard to the circumstances of the market in which the company operates.

4.361   It is not appropriate for shareholders to play a direct role in determining executive remuneration as under the Australian corporate framework this role is delegated to the board.  The Corporations Act provides that the ultimate sanction available for shareholders where they disagree with the actions of the board is to pass a resolution to remove some or all of the members of the board.

4.362   The measures in the Bill reflect that communication between shareholders and boards is the most effective means of averting more disruptive actions, such as dismissal of board members over operational decisions where such action could be avoided.

Options and impact analysis

4.363   Three options have been identified as viable means of overcoming the problem that has been identified and achieving the Government’s objectives:

·        amending the Corporations Act;

·        enhancing disclosure requirements in accounting standards;  and

·        relying on guidance developed by the market.

Option 1

4.364   As a means of enhancing transparency and facilitating accountability for decisions regarding remuneration, the Corporations Act could be amended to broaden the scope and nature of the disclosures that are currently required.  The Government’s objectives could be achieved by providing more detailed guidance on the matters that need to be disclosed regarding remuneration and applying the disclosure requirements to the entire corporate group in addition to the listed entity.

4.365   Currently 5% of shareholders are able to request that directors prepare a remuneration report and lay it before the company’s AGM.  These provisions could be complemented by requiring companies to include in their annual report a separate section which contains disclosures that need to be made under the law and requiring that shareholders be given an opportunity to comment on the report at the AGM and vote on a non-binding resolution.  This will serve as a channel for shareholders to articulate their views on directors’ decisions regarding remuneration.  The resolution would serve as an advisory opinion to assist the board in assessing the views of shareholders as a whole, rather than relying on comments from the floor of an AGM alone. 

4.366   The Corporations Act already contains provisions that require shareholder approval of payments made to persons who hold board or managerial office.  In particular, the Corporations Act generally requires shareholders to approve retirement benefits.  There are several, significant exemptions to this general requirement.  Shareholder approval is not required if the payment relates to, among other things:

·        Damages for breach of contract.  This includes damages agreed or ‘settled’ between the entity and director.

·        An agreement made between the company and the person before the person became a director, as part of the consideration for the person agreeing to become a director. 

4.367   While it is consistent within the corporate regulatory framework for directors to determine the amount of such payments, given experience in recent times, it is arguable that shareholders should be given an opportunity to have a say in such payments where they are large in relation to the director’s income whilst in office and their length of service.

4.368   There are a number of advantages associated with amending the law to put in place the above initiatives.  In particular, any legislative disclosure requirements would be mandatory and failure to comply would be enforceable by ASIC.

·        In addition, director and executive remuneration is an issue of corporate governance as well as being a financial reporting issue.  As such, it is appropriate for the disclosures to be made in the annual directors’ report. 

4.369   The proposed requirements will not adversely impact on the ability of companies to offer remuneration packages that will attract and retain the best executives.  Boards of directors are faced with a conflict of interest when determining their own remuneration and they must be mindful of the need to justify executives’ remuneration to shareholders.  Enhanced disclosure and greater shareholder activism will potentially give rise to some costs although these are not expected to be onerous.

Option 2

4.370   This option relies on the accounting standards to set requirements for the disclosure of director and executive remuneration in company financial statements. 

4.371   The AASB is currently reviewing relevant standards and has proposed amendments to its standard on Executive, Director and Related Party Transactions (ED 106) to require detailed disclosure in the financial statements of total remuneration paid and owed to all directors and the five most senior non-director executives of an economic entity.  The AASB currently envisages that its revised standard will apply from 1 January 2004. 

4.372   Given that disclosures required by the accounting standards are focussed on financial information it may be argued that accounting standards are the appropriate vehicle for such disclosure requirements.  

4.373   One difficulty in relying on accounting standards to achieve the Government’s disclosure objectives is that the AASB is an independent statutory body and the Government is not able to influence the requirements contained in the standards.

Option 3

4.374   A third approach to the disclosure of remuneration is to rely on industry self regulation and produce its own standards for disclosure.  This would require no action on the part of the Government other than to encourage bodies to develop guidance for companies.

·        The least prescriptive approach that the Government could take would be to leave industry and investor groups to develop their own guidelines for disclosure of executive remuneration.  In particular, the Government could rely on the work of the ASX’s Corporate Governance Council.  The primary advantage of such an approach is that it would give companies the flexibility to tailor their disclosures to the specific needs of their investors.

·        A disadvantage of this approach however is that industry standards are not enforceable by law, which may allow situations to arise where those that chose not to comply are those that have the poorest governance practices more generally and whose shareholders would benefit most from disclosure.

Consultation

4.375   The Government has sought public comments on these proposals.  While there has broad support for many the proposals, concerns have been raised about the impact of disclosure of remuneration on the level of salaries and the potential blurring of responsibility for determining remuneration caused by a non-binding shareholder vote.

Conclusion

4.376   It is proposed that a mix of all three options should be adopted.  To achieve this, the Government will introduce into the Parliament legislative amendments to the existing disclosure requirements along the lines of the proposals in option 1.  It will also support the continued improvement of disclosure requirements in accounting standards, in particular, the Corporations Regulations will refer to accounting standards in prescribing disclosures to be made.  Finally, the Government supports the work of the ASX’s Corporate Governance Council and encourages companies to adopt the recommendations of the Council where they go beyond the requirements of the legislation and accounting standards.

4.377   In terms of the concerns raised in consultations, it is noted that there is only anecdotal evidence that disclosure leads to increases in remuneration.  Concerns regarding the blurring of lines of responsibility have been noted however the Bill ensures that responsibility for determining executive remuneration remains with directors.

Operating and financial review

Problem

4.378   Over time, the form and content of information contained in an entity’s financial report has been expanded to the point where the report can be a long and complex document.

4.379   While detailed financial reports are essential for the purpose of meeting the information needs of sophisticated investors and financial analysts, they can be confusing for smaller investors, many of whom are unaccustomed to reading financial reports.

Objectives

4.380   There is a need to include in either the statutory directors’ report or the annual financial report information to allow the users of those reports to make an assessment of the operations of the entity, its financial position and business strategies.  The reports should be presented in a manner which maximises their usefulness to all users, having particular regard to the needs of people who are unaccustomed to reading financial reports.

4.381   In some jurisdictions, the information needs of capital market participants have been satisfied by either enhancing the statutory directors’ report or introducing an operating and financial review containing management, discussion and analysis-type disclosures.  Providing shareholders with such information is increasingly being accepted in the world’s capital markets as an integral part of good corporate governance and high quality financial reporting.

4.382   In other jurisdictions, the information needs of capital market participants have been addressed through the use of simplified financial reports which - in theory at least - can be more readily understood by the users of the reports.  In such cases, a simplified financial report may be accompanied by expanded explanatory material about the financial results.

4.383   Australia currently uses a mix of these approaches for providing information to capital market participants.

·        The Corporations Act requires the directors of an entity to prepare a directors’ report which contains a range of information about the entity, including the entity’s operations and activities, the names of the entity’s directors, dividends paid or proposed, options over unissued shares and particulars of the remuneration of directors and senior executives.

·        The Australian Stock Exchange (ASX) Listing Rules require companies to include a review of operations and activities for the reporting period in their annual report.  Guidance about the issues to be included in the review has been prepared and published by the Group of 100 Inc (G100).  The Listing Rules also require the inclusion of a commentary on the results for the period to be included in the preliminary final report submitted to the Exchange.

·        Accounting standard AASB 1039, which sets out the requirements for the preparation of a concise financial report, provides that a discussion and analysis of the principal factors affecting the financial performance, financial position and financing and investing activities of the company is to be included in every concise financial report prepared in accordance with the standard.

Options and impact analysis

4.384   Two principal options are available for ensuring capital market participants are provided with the information needed to allow them to make an informed assessment of the operations of an entity, its financial position and business strategies:

·        maintaining the status quo; and

·        amending the Corporations Act to require each listed company to prepare an operating and financial review as part of the directors’ report.

Option 1 — Maintaining the status quo

4.385   This option envisages the continuation of the existing legislative requirements for the preparation of a directors’ report and the requirement in the ASX Listing Rules for the preparation of a review of operations and activities, supplemented by additional discussion and analysis about the financial results where a concise financial report has been prepared.

4.386   Adoption of this option would impose no new obligations on the business community.

4.387   As anecdotal evidence suggests many entities have adopted a ‘minimalist’ approach to compliance with these requirements, capital market participants may not gain any significant benefit from a decision to maintain the status quo unless mechanisms are put in place to encourage, or require, a high level of compliance with the Listing Rules and the requirements of AASB 1039.  In this regard, it should be noted that the introduction of any measures to further enhance the level of compliance with the Listing Rules (assuming that such measures were needed or justified) would be a matter for the ASX.

Option 2 — Legislative requirement for an operating and financial review

4.388   Under this option, the Corporations Act would be amended to require the preparation of an operating and financial review as part of a listed entity’s directors’ report.  The review would require the disclosure of the information members would reasonably require to make an informed assessment of the entity’s operations, its financial position, business strategies and prospects for future financial years.  As with the existing ASX Listing Rules, the legislation does not set out detailed disclosure requirements.  It is expected that, in considering the issues to be addressed in their review, directors will have regard to best practice guidance such as that prepared and published by G100.

4.389   This option builds on the existing requirements, with which directors and their senior executives should already be familiar.  As such, the requirement does not impose a significant new regulatory burden on the entities to which it applies, provided that they are already complying with the existing requirements.

4.390   One significant difference between this option and the existing requirements is that under this option the disclosure requirements will have force of law, with the disclosures being underpinned and/or enforced by the sanctions contained in the Corporations Act.  This is expected to benefit all capital market participants through directors being more diligent in the preparation of the operating and financial review.

Consultation

4.391   The recommendation that directors prepare an operating and financial review is contained in the report of the HIH Royal Commission.  The Government’s decision to require the preparation of a review was announced by the Treasurer on 7 October 2003 and draft provisions to give effect to the decision were included in the draft Bill which was released for public comment on 8 October.

4.392   Comments received to date suggest that there is broad support within the business community for the proposed requirement.  Some commentators have, however, suggested that the status quo should be maintained to give the recommendations of the ASX Corporate Governance Council, which were released in early 2003 and which seek to strengthen the ASX’s existing requirements for the preparation of a review of operations and activities, time to become fully operative.

Conclusion

4.393   Option 2, with its underpinning by Corporations Act sanctions, is considered to be the most appropriate means of ensuring all capital market participants, and in particular those who are unaccustomed to reading financial reports, receive information which enables them to understand, and make an informed assessment about, an entity’s operations, its financial position, business strategies and prospects for future financial years.



 

5

Notes on Clauses

5.1       Clauses 1 to 3 of the Bill provide:

·        that the Bill, when enacted, will be known as the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 (clause 1);

·        when the various amendments contained in the Bill come into operation (clause 2); and

·        that the items contained in the various Schedules to the Bill are to amend the Australian Securities and Investments Commission Act 2001 , the Corporations Act 2001 and (in the case of amendments in Schedule 3 of the Bill) the Trade Practices Act 1974 in the manner indicated in each item (clause 3).

5.2       The Bill specifies the following commencement dates for sections (currently clauses), Schedules and Parts of Schedules:

·        Royal Assent:

-         sections 1 to 3; and

-         Schedule 12;

·        one day after Royal Assent:

-         Parts 2 and 4 of Schedule 4; and

-         Schedules 6 and 7;

·        1 July 2004:

-         Schedules 1 and 2;

-         Parts 1, 3 and 5 of Schedule 4; and

-         Schedules 5, 8, 9 [1] and 11 [2] ;

·        1 January 2005:

-         Schedule 10; and

·        a day to be fixed by proclamation:

-       Schedule 3

5.3       The following paragraphs provide an explanation of the amendments contained in Schedules 1 to 11 of the Bill.  An explanation of the transitional and application provisions in Schedule 12 of the Bill will be found with the substantive provisions to which each transitional/application provision relates.



Schedule 1:  Audit reform

5.4       Schedule 1 of the Bill contains the amendments for the reform of the audit provisions in the Australian Securities and Investments Commission Act 2001 (ASIC Act) and the Corporations Act 2001 .  Within the Schedule the amendments are grouped as follows:

Part 1

Audit oversight

Part 2

Qualifications of auditors

Part 3

Auditor appointment, independence and rotation requirements

Part 4

Registration of authorised audit companies

Part 5

Auditors and AGMs

Part 6

Qualified privilege

Part 7

Expansion of auditors’ duties

Part 8

Companies Auditors and Liquidators Disciplinary Board

Part 1:  Audit oversight

Overview

5.5     The text in this Part of the Commentary is divided into the following topics:

·        new and amended definitions;

·        changes to objects of Part 12;

·        changes to FRC’s functions and powers;

·        AUASB’s establishment, functions, powers, procedures, membership and other administrative matters;

·        auditing standards; and

·        liability for damages.

5.6       The Bill expands the responsibilities of the Financial Reporting Council (FRC), which currently oversees the accounting standard setting process, to oversee auditor independence requirements in Australia and the auditing standard setting arrangements.  To this end, the existing Auditing and Assurance Standards Board (AuASB) [3] will be reconstituted with a Government appointed Chairman under the auspices of the FRC, similar to the Australian Accounting Standards Board (AASB).  Auditing standards will have the force of law on the same basis as AASB standards.

5.7     These arrangements will bring together, under a single oversight body, policy advising, monitoring and technical oversight functions for the key elements of the financial reporting framework.  Having broad policy direction coming from a single overarching body will ensure coherent and effective oversight while at the same time protecting the independence of the two technical boards within the structure.

5.8     Part 1 of Schedule 1 of the Bill amends both the ASIC Act and the Corporations Act to implement the oversight arrangements.  In particular, this Part:

·        sets out new functions for the FRC in relation to auditor independence and oversight of the audit standard setting process;

·        establishes the Auditing and Assurance Standards Board (AUASB) as a statutory body corporate and sets out its functions, powers, membership structure and administrative arrangements;

·        gives the AUASB power to make auditing standards for the purpose of the Corporations Act and to formulate auditing and assurance standards for other purposes; and

·        requires auditors to comply with standards made by the AUASB when conducting Corporations Act audits and provide for the imposition of penalties where auditors fail to comply with such standards.

Definitions

5.9       The Bill contains a number of new and amended definitions which are inserted into subsection 5(1) of the ASIC Act (see items 2 to 7) and section 9 of the Corporations Act (see items 37, 38 and 39).  Particular definitions to note are:

·        ‘AUASB’ is an abbreviation for the Auditing and Assurance Standards Board that is used in both the ASIC and Corporations Acts (items 2 and 37);

·        ‘auditing standard’ is defined to mean either a standard in force under proposed section 336 or a provision (paragraph) of such a standard (item 38);

·        ‘auditor independence requirements’, which is defined to mean the independence requirements contained in the Corporations Act and the codes of professional conduct, has been included in the legislation to facilitate the drafting of proposed subsections 225(1) and (2B) (item 3);

·        ‘Australian auditor’, which is defined to mean an individual auditor, an audit firm or an audit company that is conducting, or has conducted, Corporations Act audits, has been included in the legislation to facilitate the drafting of proposed amendments to Part 12 of the ASIC Act (item 4);

·        ‘international auditing standards’, means standards made by the International Auditing and Assurance Standards Board (IAASB) (a body established by the International Federation of Accountants) (paragraph (a) of the definition) or another body specified in the regulations (paragraph (b) of the definition).  Paragraph (b) has been included principally to provide flexibility in the event that another overseas body/standard setter takes over the role of the IAASB in developing a set of internationally accepted auditing standards (compared with, definition of ‘international accounting standards’) (item 5);

·        ‘member’ means, in relation to the AUASB, a member of that body (item 6);

·        ‘professional accounting body’ means a body prescribed by the regulations for the purposes of the definition.  It is envisaged that Australia’s three main accounting bodies will be prescribed: CPA Australia, The Institute of Chartered Accountants in Australia and the National Institute of Accountants (items 7 and 39).

Changes to objects of Part 12 of ASIC Act

5.10     Items 11 and 12 amend section 224 (Main objects of this part) to reflect the CLERP 9 decision to reconstitute the AUASB as a statutory body and to give auditing standards the force of law.

5.11     Item 11 inserts proposed paragraph 224(aa), which provides that one of the objects of Part 12 is to facilitate the development of auditing and assurance standards and related guidance materials that:

·        provide auditors with relevant and comprehensive guidance in forming an opinion about, and reporting on, financial reports; and

·        require the preparation of auditors’ reports that are reliable and readily understandable by the users of the financial reports to which they relate.

Changes to FRC’s functions and powers

Oversight of AUASB

5.12     Items 14, 15 and 16 of the Bill amend section 225 of the ASIC Act (Functions and powers of the Financial Reporting Council) to reflect that the FRC will be responsible for overseeing both the AASB and the AUASB.

5.13     Provisions relating to the FRC’s oversight of the AUASB are modelled on the current AASB/FRC arrangements (see proposed subsection 225(2A)).

5.14     One area in which the FRC’s oversight functions for the AUASB differs slightly in terms of wording, but significantly in terms of outcome, from its existing functions in respect of the AASB concerns promoting the adoption of international best practice standards in Australia.  As the AUASB already has a policy of adopting international best practice auditing standards, the FRC’s function refers to ‘promoting the continued adoption’ of such standards (see proposed paragraph 225(2A)(g)) to reflect the current state of affairs.  As the AASB is now also in the process of adopting international best practice accounting standards, an equivalent amendment is being made to the FRC’s functions in respect of that body (see proposed paragraph 225(2)(g)).

Monitoring auditor independence

5.15     Item 14 of the Bill also amends section 225 of the ASIC Act to specify the FRC’s functions in relation to auditor independence.

5.16     Proposed subsection 225(2B) provides that the FRC’s auditor independence functions include:

·        monitoring and assessing the nature and overall adequacy of:

-         the systems and processes used by:

Australian auditors to ensure compliance with auditor independence requirements; and

professional accounting bodies for planning and performing quality assurance reviews of audit work to the extent to which those reviews relate to auditor independence requirements; and

-         the action taken by the professional bodies, and the auditors who were subject to review, in response to recommendations contained in review reports ; and

-         the investigation and disciplinary procedures of the professional accounting bodies;

·        monitoring the overall compliance by companies and other entities with audit-related disclosure requirements, such as disclosure in the financial report of fees paid to the auditor for the provision of non-audit services and the inclusion in the directors’ report of a copy of the auditor’s independence declaration;

·        giving the Minister and professional accounting bodies reports and advice about the above matters;

·        monitoring international developments in auditor independence, assessing the adequacy of Australian requirements in light of those developments and giving the Minister and professional accounting bodies reports and advice on any additional measures needed to enhance Australian requirements; and

·        promoting the teaching of professional and business ethics by, or on behalf of, the professional accounting bodies to the extent to which those subjects relate to auditor independence.

5.17     It is important to note that, notwithstanding the FRC’s extensive functions on auditor independence, its role is purely one of monitoring activities and/or developments and providing appropriate advice to Ministers or the accounting bodies.  Enforcement of auditor independence requirements is the responsibility of either ASIC or the accounting bodies, depending on whether the independence requirement is contained in the Corporations Act or a code of professional conduct of one of the bodies.

Information gathering powers

5.18     To assist the FRC in the performance of its auditor independence functions, proposed section 225A (item 17) gives the FRC power to obtain from each professional accounting body: information about, or documents relating to:

·        its code or proposed code of professional conduct and proposed amendments to that code;

·        its planning and performance of quality assurance reviews, to the extent that those reviews apply to audit work undertaken by Australian auditors; and

·        its investigation and disciplinary procedures, to the extent that those procedures apply to Australian auditors (proposed subsections 225A(1) and (2)).

5.19     An accounting body will have qualified privilege in respect of a disclosure it is required to make to the FRC.  Similarly, a person who makes, on behalf of an accounting body, a disclosure that the body is required to make to the FRC also has qualified privilege (proposed subsections 225A(3) and (4)).

5.20     The FRC may also give written notice to an Australian auditor for the purpose of obtaining information about, or documents (including audit working papers) relating to, one or more audits conducted by the auditor and the measures adopted, or the procedures put in place, to ensure the auditor was, and continues to be, independent of the audited body (proposed subsection 225A(5)).

5.21     An auditor must comply with a notice to provide such information, even it results in a breach of any obligation of confidentiality between the auditor and the audited body.  Where the FRC requires a copy of a document to be given to it, it may require the document to be certified by a particular person or a person holding a particular position or office (proposed subsection 225A(6)).

5.22     The purpose of these subsections is to enable the FRC to obtain information about the systems and processes that have been put in place by auditors and to assess, by reference to material about individual audits, whether those systems and processes are being followed by the auditor when it conducts an audit.  Proposed subsections 225A(9) and (10) provide that a person who fails to comply with a notice commits a strict liability offence that attracts a penalty of 10 penalty units.  However, a member of an audit firm does not commit an offence if, at the time the failure to comply with the notice occurred, the member did not know the notice had been given to the firm and the member took all reasonable steps to ensure compliance with the notice as soon as possible after the member became aware that a notice had been given to the firm (proposed subsection 225A(13)).

5.23     To facilitate the FRC’s function of monitoring auditor independence, amendments are proposed to sections 127, 213 and 237 (see items 8, 9 and 32) to allow ASIC and the CALDB to provide information to the FRC and for the FRC to provide information to the CALDB and the professional accounting bodies.  Paragraph 237(2)(d) already enables the FRC to provide information to ASIC.

Audit papers

5.24     As a means of assisting the FRC monitor auditor independence, and as a mechanism to facilitate ASIC’s enforcement role, item 40 amends the Corporations Act by inserting proposed section 307B which requires auditors to retain all audit working papers for a period of seven years after the date of the audit report.  The provision provides that where the working papers are kept in an electronic format, they must be convertible into hard copy.

5.25     The legislation will allow ASIC to approve the destruction of the audit working papers before the end of the seven year period where an individual auditor dies or resigns their registration, an audit firm is dissolved or an authorised audit company is wound up or ceases to be authorised to conduct audits.  However, before approving the destruction of any working papers ASIC is required to consider whether:

·        it is investigating any matters concerning the auditor or audited body to which the papers relate;

·        a professional accounting body has an investigation or disciplinary action pending in relation to the auditor;

·        there are civil or criminal proceedings in relation to the audit or the contents of the financial report to which the papers relate have commenced or are about to commence.

5.26     Failure to retain the working papers will be a strict liability offence attracting a penalty of 50 penalty units.  However, a member of an audit firm does not commit an offence if, at the time the contravention occurred, the member did not know of the matter and the member took all reasonable steps to correct the contravention as soon as possible after the member became aware of the matter.

Transitional arrangements

5.27     Proposed section 1454 of the Corporations Act (inserted by item 2 of Schedule 12) provides that proposed section 307B applies in respect of a financial year that begins on or after 1 July 2004.

Reporting to Ministers

5.28     Item 25 inserts section 235BA, which requires the FRC to report annually to the Minister on its audit independence functions, including the findings and conclusions that it reached in performing those functions and the actions that it took in relation to those findings and conclusions.

5.29     The report, which may be included in the FRC’s annual report under section 235B or prepared separately, must be tabled in Parliament. 

AUASB’s establishment, functions, powers, procedures, membership and other administrative matters

5.30     Amendments to the ASIC Act to establish the AUASB, set out its functions and powers, require it to have regard to the views of the FRC, specify its meeting procedures and provide for its membership arrangements are contained in items 18, 22 and 28 to 34.

5.31     Except where noted, these provisions mirror the equivalent AASB provisions.

Establishment, functions and powers

5.32     Item 18 of the Bill amends the ASIC Act to establish the AUASB (proposed section 227A) and set out its functions and powers (proposed section 227B). 

5.33     Section 227A establishes the AUASB as a body corporate thereby allowing it to employ staff and acquire property in its own right.  This means the AUASB will be a Commonwealth authority for the purposes of the Commonwealth Authorities and Companies Act 1997 (CAC Act).  This Act sets out the reporting, financial and other requirements with which Commonwealth authorities must comply.

5.34     As with the AASB, it is envisaged that the AUASB’s reporting obligations under the CAC Act will be covered by the report that the FRC prepares in accordance with section 235B and the AUASB will not be required to prepare a separate report specifically for the purposes of the CAC Act.  To this end, the Bill amends section 235B of the ASIC Act (see items 23 and 24) to require the FRC’s annual report to contain:

·        disclosures about the operations of the AUASB and its committees, advisory panels and consultative groups (proposed subparagraph 235B(1)(a)(iii)); and

·        details of any change to the AUASB’s priorities or business plan that was made as a result of action taken by the FRC (proposed subsection 235B(2A)).

5.35     Under proposed section 227B, the significant functions of the AUASB will be to:

·        make auditing standards for the purposes of the Corporations Act;

·        formulate auditing and assurance standards for purposes other than those of the Corporations Act (for example, non-financial audits such as performance or efficiency audits);

·        formulate guidance on auditing and assurance matters; and

·        participate in the formulation of international auditing standards so as to influence their content towards the achievement of the objectives set out in section 224.

5.36     For the purpose of performing these functions, the AUASB will have power to engage staff and consultants, establish committees, advisory panels and consultative groups, and receive money contributed towards its operating costs.

5.37     The AUASB will be empowered to make an Australian auditing standard by issuing the text of an international standard with any minimum modification to ensure that the standard operates effectively having regard to the existing Australian legislative framework and institutional regulatory arrangements.  The AUASB may make such a standard regardless of the fact that the international standard does not reflect the views of the AUASB when it provided comments on the exposure draft of the standard or when the AUASB participated in any deliberations during the standard’s development.  The rationale for this is that it may be considered in Australia’s best interests to adopt an international standard with minimum modification because it represents the results of many deliberations and compromises necessary to achieve international acceptance.

5.38     The provisions dealing with auditing standards refer to the AUASB ‘making’ and ‘formulating’ auditing standards.  The word ‘making’ is used when the AUASB issues a standard for the purposes of the Corporations Act while the word ‘formulated’ is used when the standard is for other purposes (for example, non-financial audits).

AUASB to have regard to FRC views

5.39     Item 22 inserts proposed section 234C which provides that, when it is performing its functions, the AUASB must have regard to the FRC’s views concerning the broad strategic direction of the standard setter, follow the general policy directions given to the standard setter by the FRC and take into account the advice and feedback provided by the FRC on matters of general policy.

5.40     The FRC does not have a power to direct the AUASB in relation to the development, or making, of a particular standard (see proposed subsection 225(7)).

AUASB ¾ general provisions

5.41     Item 28, which inserts ‘Subdivision BA ¾ The Auditing and Assurance Standards Board’ into Part 12 of the ASIC Act, contains provisions which set out the procedural requirements for the conduct of AUASB meetings and provisions concerning AUASB membership.

Meeting procedures

5.42     Proposed section 236E (Procedures) contains a number of procedural requirements relating to the conduct of AUASB meetings.  As with the AASB, a meeting, or part of a meeting, concerned with the content of an auditing standard must be held in public.

Appointment, resignation and termination of members of the AUASB

5.43     Proposed section 236F (Appointment of members of the AUASB) sets out the procedures for appointing the Chair and other members of the AUASB.  These requirements mirror requirements currently applying to the AASB.

5.44     Proposed section 236G (Resignation and termination of appointment) deals with the manner in which the Chair or another member of the AUASB may either resign or have their appointment terminated.  The independence of the AUASB is preserved by strictly limiting the grounds upon which an appointment can be terminated.

5.45     In the case of resignation, the Chair is required to provide a written resignation to the Minister, while other members are required to provide a written resignation to the Chair of the FRC (proposed subsection 236G(1)).

5.46     The Minister may terminate the appointment of the Chair for misbehaviour or physical or mental incapacity.  The Minister must terminate the appointment of the Chair if the Chair:

·        becomes bankrupt;

·        applies to take the benefit of any law for the relief of bankrupt or insolvent debtors;

·        compounds with their creditors;

·        makes an assignment of his or her remuneration for the benefit of their creditors; or

·        contravenes section 237 (proposed subsections 236G(3) and (4)).

5.47     Proposed subsections 236G(6) and (7) deal with the circumstances in which the FRC may or must terminate the appointment of a member of the AUASB (other than the Chair).  These subsections are expressed in terms similar to proposed subsections 236G(3) and (4) and give the FRC the same powers in respect of AUASB members as the Minister has in respect of the AUASB’s Chair.

5.48     Under proposed section 236H (Acting appointments), the Minister will be able to appoint a person to act as Chair of the AUASB during any vacancy in the office of Chair or at any time when the Chair is absent from duty (proposed subsection 236H(1)).  Similarly, the members of the AUASB will also have the ability to appoint one of their number to act as Deputy Chair during any vacancy in the office of Deputy Chair or at any time when the Deputy Chair is absent from duty (proposed subsection 236H(2)).  The FRC will also be able to appoint a person to act as a member of the AUASB (other than Chair) during any vacancy in the office of member or at any time when a member is absent from duty (proposed subsection 236H(3)).

5.49     Subsection 236H(1) is primarily intended to ensure that any delegations, functions or powers that can only be exercised by the Chair of the AUASB can continue to be dealt with during any period in which there is either no Chair (for example, because of death, resignation or expiration of appointment) or the Chair is absent (for example, because of overseas representational requirements, recreation leave or illness).  The other provisions are intended to ensure that the AUASB retains the structure and the number of members needed to operate effectively and efficiently.

Confidentiality requirements

5.50     Items 29 to 31 amend section 237 of the ASIC Act (Confidentiality) to make the AUASB subject to the same confidentiality requirements that are currently applicable to the FRC and AASB.

5.51     The practical effects of these amendments are that the AUASB:

·        will be required to protect from unauthorised use or disclosure information that is given to it in confidence;

·        may disclose information where such disclosure is allowed by a law of the Commonwealth, is made to enable an authority or a person in a jurisdiction outside Australia to perform or exercise a function or power that corresponds to any of the functions or powers of the AUASB, or is made to a body that sets international auditing standards; and

·        may disclose information to ASIC to facilitate ASIC’s performance of its functions under the corporations legislation (other than the excluded provisions [4] ).

5.52     As a result of a separate amendment to subsection 237(2) (see item 32), which is primarily designed to allow the FRC to provide information to the CALDB and the professional accounting bodies, the AASB and AUASB will also be authorised to provide information to the CALDB and the accounting bodies to the extent that it facilitates the performance of their respective functions.

Moneys of AASB and AUASB

5.53     Items 33 and 34 amend section 238 (Application of money) to include provisions concerning the moneys of the AUASB.  The moneys of the AUASB may only be applied:

·        in payment or discharge of the costs, expenses and other obligations incurred by the AUASB in the performance of its functions or the exercise of its powers;

·        in paying or discharging, or reimbursing someone for, the costs, expenses and other obligations incurred in connection with the performance by the FRC of its functions and the exercise of its powers;

·        in meeting the administrative expenses of the committees and advisory groups the FRC establishes;

·        in payment of any remuneration and allowances payable to any person appointed to the FRC or the AUASB; and

·        in making payments to the AASB (proposed subsection 238(2)).

5.54   Equivalent amendments are proposed to the provision dealing with the moneys of the AASB (currently section 238).

5.55   The provisions have been structured so that either the AASB or AUASB may:

·        pay or discharge the costs, expenses and other obligations incurred by the FRC; and

·        pay the remuneration and allowances payable to any person appointed to the FRC.

5.56   The objective of these provisions is to enable the expenses of the FRC to be shared by the AASB and AUASB in accordance with decisions made by the FRC.  The ability of the AASB and AUASB to make payments to each other is also intended to:

·        facilitate payment of FRC expenses where one body makes the payments and the other body reimburses the first body (for example, the AASB pays all of the FRC’s expenses and is reimbursed by the AUASB); and

·        allow the sharing of contributions made by government, the accounting profession and business towards the cost of the standard setting arrangements where the payment is made to one body but is intended to be for the three bodies.

Auditing standards

Procedural matters

5.57     Item 22, which inserts Division 2A into Part 12 of the ASIC Act, contains provisions dealing with:

·        the interpretation of auditing standards;

·        some of the powers of the AUASB to make standards;

·        requirements with which the AUASB must comply when making standards; and

·        the ability of the FRC and the Minister to give directions to the AUASB.

5.58     The provisions of this Division are based on the equivalent accounting standards requirements in Division 2 of Part 12.  The principal difference is the omission of requirements equivalent to:

·        section 230, which provides that accounting standards for the preparation of financial reports for a period may require the inclusion of comparative amounts for earlier periods; and

·        section 231, which requires the AASB to carry out a cost/benefit analysis of the impact of a proposed Australian or international accounting standard.

5.59     Notwithstanding the omission of a provision equivalent to section 231, the AUASB will still be obliged to prepare a cost/benefit analysis of a proposed Australian auditing standard, or a significant amendment to such as standard.  The Government’s requirements for the preparation of Regulation Impact Statements (RIS), which are applicable to the AUASB, includes a requirement for an analysis of costs and benefits.

5.60     Major features of Division 2A are:

·        Proposed section 234A provides that auditing standards are to be interpreted in a manner that promotes the objects of Part 12 of the ASIC Act.  In addition, the proposed section provides that each auditing standard made by the AUASB is to be interpreted in a manner that promotes the purpose or objective of that auditing standard, provided that that purpose or objective is not contrary to the purpose or objective of Part 12 of the ASIC Act.

·        Proposed section 234B provides that auditing standards may be of general application (that is, apply to all audits) or limited application (that is, apply to different types of audit and specified industries or entities). 

·        Proposed section 234D provides that the Minister may give the AUASB a direction about the role of international auditing standards in the Australian auditing standard setting system.  However, prior to giving a direction to the FRC, the Minister must obtain and consider a report from the FRC about the desirability of giving the direction.

5.61     This provision is intended to provide a mechanism for the Minister, upon the advice of the FRC, to require the AUASB to move towards greater adoption of international standards if it is considered appropriate and the AUASB has not moved in that direction of its own accord.

5.62     It is noted that the AUASB is already working towards convergence of Australian auditing standards with international standards.  In addition, the AUASB is currently considering the appropriateness of adoption of international auditing standards as Australian standards.

·        Should the AUASB, through error or oversight, fail to follow all the procedures associated with the making of auditing standards when it makes or formulates a particular standard (for example, fails to have regard to the views of the FRC), the error or oversight will not affect the validity of the standard made as a result of those defective procedures (proposed section 234E).

Making auditing standards

5.63     Proposed section 336 of the Corporations Act, which is inserted by item 44, provides that the AUASB may make auditing standards for the purposes of that Act.  A standard, which must be in writing and must not be inconsistent with either the Corporations Act or the Corporations Regulations, is a disallowable instrument for the purposes of section 46A of the Acts Interpretation Act 1901 .  This means each standard made by the AUASB has to be tabled in each House of the Australian Parliament within 15 sitting days after the day on which the standard is made (proposed subsections 336(1) and (2)).

5.64     Auditing standards made by the AUASB are expressed to apply to financial reports in respect of particular financial periods.  The Bill provides that, in the absence of a specific commencement date in a standard, the standard applies to each financial period ending after the commencement of the standard.  The AUASB may, however, specify a later commencement date and provide that the standard is to apply to all financial periods either ending or starting on or after that date (proposed subsection 336(3)).

5.65     Proposed subsection 336(4) allows auditors to adopt an auditing standard before the commencement date specified in the standard, provided the standard does not expressly preclude early adoption.  Where an auditor adopts a standard prior to its commencement date, the auditor’s decision must be recorded in the audit report.

Transitional arrangements

5.66     Proposed section 1455 of the Corporations Act, which is inserted by item 2 of Schedule 12, is designed to give interim legal backing to some or all of the auditing standards made by the AUASB, as currently constituted, and issued by the Australian Accounting Research Foundation (AARF) on behalf of The Institute of Chartered Accountants in Australia and CPA Australia.  The primary objective of the transitional provision is to ensure there is, and continues to be, a comprehensive body of standards available to provide guidance to auditors who are appointed to conduct audits under the Corporations Act.

5.67     The auditing standards to be given interim legal backing will be listed in regulations made for the purpose of proposed subsection 1455(1) and will have effect as if they were made by the AUASB under proposed section 336 on the day specified in the regulations.  Table 1 lists existing auditing standards.  All standards that are relevant to Corporations Act audits will be prescribed in the regulations.

5.68     Auditing standards that are given interim legal backing cease to have effect on 1 July 2006, although provision is made for the regulations to extend the period.  During the two-year period (or such longer period as may be allowed by the regulations) it is proposed that the AUASB should review the standards and remake them in accordance with proposed section 336.

5.69     As a means of facilitating a smooth transition to legal backing, proposed subsection 1455(5) provides that a person will not contravene proposed section 307A or 989CA or proposed subsection 308(3A) or 309(5A) by failing to conduct an audit in accordance with standards that have been given interim legal backing, or include information in an audit report prepared in accordance with such standards, if the contravention occurs before 1 July 2006.  This gives the Board time to review the existing professional standards.  However, it should be noted that where a person fails to use a standard that has been given interim legal backing disciplinary action could still be taken against the person by either the CALDB or a professional accounting body (see note, proposed subsection 1455(5)).  As standards are remade by AUASB, the relief provided under subsection 1455(5) will cease.



Table 1:  Australian Auditing Standards as at 1 October 2003

Reference

Title

Date issued or revised

AUS 102

Foreword to Australian Auditing and Assurance Standards and Guidance Statements

January 2002

AUS 104

Glossary of Terms

July 2002

AUS 106

Explanatory Framework for Standards on Audit and Audit Related Services

November 2001

AUS 108

Assurance Engagements

October 2001

AUS 202

Objective and General Principles Governing an Audit of a Financial Report

July 2002

AUS 204

Terms of Audit Engagements

June 2000

AUS 206

Quality Control for Audit Work

July 2002

AUS 208

Documentation

July 2002

AUS 210

The Auditor’s Responsibility to Consider Fraud and Error in an Audit of a Financial Report

January 2002

AUS 212

Other Information in Documents Containing Audited Financial Reports

October 1995

AUS 214

Auditing in a CIS Environment

October 1995

AUS 218

Consideration of Laws and Regulations in an Audit of a Financial Report

January 2002

AUS 302

Planning

October 1995

AUS 304

Knowledge of the Business

July 2002

AUS 306

Materiality and Audit Adjustments

May 2001

AUS 402

Risk Assessments and Internal Controls

July 2002

AUS 404

Audit Implications Relating to Entities Using a Service Entity

July 2002

AUS 502

Audit Evidence

October 1995

AUS 504

External Confirmations

July 2002

AUS 506

Existence and Valuation of Inventory

July 2002

AUS 508

Inquiry Regarding Litigation and Claims

July 2002

AUS 510

Initial Engagements ¾ Opening Balances

July 2002



 



Reference

Title

Date issued or revised

AUS 512

Analytical Procedures

October 1995

AUS 514

Audit Sampling and Other Selective Testing Procedures

April 1998

AUS 516

Auditing of Accounting Estimates

October 1995

AUS 518

Related Parties

July 2002

AUS 520

Management Representations

July 2002

AUS 522

Audit Evidence Implications of Externally Managed Assets of Superannuation, Provident or Similar Funds

October 1995

AUS 524

The Auditor’s Use of the Work of the Actuary and the Actuary’s Use of the Work of the Auditor in Connection with the Preparation and Audit of a Financial Report

July 2002

AUS 526

Auditing Fair Value Measurements and Disclosures

September 2002

AUS 602

Using the Work of Another Auditor

July 2002

AUS 604

Considering the Work of Internal Auditing

October 1995

AUS 606

Using the Work of an Expert

July 2002

AUS 702

The Audit Report on a General Purpose Financial Report

March 2002

AUS 704

Comparatives

July 2002

AUS 706

Subsequent Events

October 1995

AUS 708

Going Concern

July 2002

AUS 710

Communications with Management on Matters Arising from an Audit

May 1999

AUS 802

The Audit Report on Financial Information Other than a General Purpose Financial Report

May 2002

AUS 804

The Audit of Prospective Financial Information

July 2002

AUS 806

Performance Auditing

July 2002



 



Reference

Title

Date issued or revised

AUS 808

Planning Performance Audits

October 1995

AUS 810

Special Purpose Reports on the Effectiveness of Control Procedures

July 2002

AUS 902

Review of Financial Reports

July 2002

AUS 904

Engagements to Perform Agreed-upon Procedures

July 2002

 

The use of auditing standards

5.70     Proposed section 307A of the Corporations Act, which is inserted by item 40, requires audits of a financial report for a financial year and audits or reviews of a financial report for a half-year to be conducted in accordance with auditing standards.

5.71     Items 41 and 42 amend sections 308 (Auditor’s report on annual financial report) and 309 (Auditor’s report on half-year financial report) by inserting proposed subsections 308(3A) and 309(5A).  The proposed subsections require an auditor to include in their report any statements or disclosures required by the auditing standards.

5.72     Item 45 inserts a requirement dealing with the audit of financial statements of financial services licensees (see proposed section 989CA).

Transitional arrangements

5.73     Proposed section 1454 of the Corporations Act (inserted by item 2 of Schedule 12) provides that proposed sections 307A and 989CA apply in respect of a financial year that begins on or after 1 July 2004.

Liability for damages

5.74   Items 35 and 36 amend section 246 of the ASIC Act, which lists the people who are not liable to an action or other proceeding for damages in relation to an act done in good faith in performance of any function conferred by the corporations legislation.

5.75     The Bill extends the protection to the following:

·        members of staff, or consultants, of the AASB and AUASB (proposed paragraphs 246(i) and (j)); and

·        officers or employees of an Agency (within the meaning of the Public Service Act 1999 ) or an authority of the Commonwealth whose services are made available to the FRC or Companies Auditors and Liquidators Disciplinary Board (CALDB) (proposed paragraph 246(k)); and

·        a person engaged by an Agency (within the meaning of the Public Service Act 1999 ) or an authority of the Commonwealth, to provide services to the FRC in connection with the performance or  exercise of the FRC’s functions or powers (proposed paragraph 246(1)(l)).  This provision is intended to facilitate the FRC in the performance of its functions by providing protection to persons acting on behalf of the FRC.

5.76   In addition, the Bill provides that the following are taken to be appointments for the purposes of the ASIC Act:

·        members of the CALDB;

·        members of the FRC or committees or advisory groups established by the FRC;

·        members of the AASB and AUASB or committees, advisory panels or consultative groups established by those bodies (proposed subsection 246(2)).

Part 2:  Qualifications of auditors

Overview

5.77     The Bill will update and enhance the qualification requirements applying to accountants who seek registration as company auditors.

5.78     The amendments to the Corporations Act contained in Part 2 of Schedule 1 of the Bill:

·        provide that the practical experience requirements for registration may be satisfied by completion of all the components of a competency standard in auditing;

·        revise the education requirements for registration to include completion of a specialist course in auditing;

·        make an auditor’s continued registration subject to compliance with any conditions that may be imposed by ASIC in accordance with the regulations;

·        replace the requirement for auditors to lodge a triennial statement with a new requirement to lodge an annual statement;

·        revise the matters that may be referred to the CALDB; and

·        permit Commonwealth, State and Territory Auditors-General to delegate to senior members of their staff responsibility for Corporations Act audits.

Registration of auditors

Practical experience

5.79     Items 50 to 53 amend section 1280 (Registration of auditors), which sets out the educational and practical experience requirements for registration as a company auditor.

5.80     Proposed paragraph 1280(2)(b) provides two ways in which the requirements can be met:

·        by satisfying all the components of an auditing competency standard that has been approved by ASIC under section 1280A (for further details, see the comments on proposed section 1280A below); or

·        by having the practical experience in auditing that is prescribed in the regulations.  Regulation 9.2.04 (Practical experience in auditing) currently provides that the prescribed practical experience in auditing is work in auditing under the direction of a registered company auditor for a period of not less than three years and at least one continuous year during the five years immediately before the date of the application spent supervising audits of companies.

Education requirements

5.81     In addition to the practical experience requirements, persons seeking registration as a company auditor will be required to meet certain educational requirements and have completed a specialist course in auditing.

5.82     Proposed subsection 1280(2A), which is based on existing subparagraph 1280(2)(a)(ii), continues to require applicants for registration to have a degree, diploma or certificate from a university or another institution.  As at present, the course must include study in accountancy (including auditing) of not less than three years’ duration and commercial law (including company law) of not less than two years’ duration.  The universities and other institutions at which the degree, diploma or certificate may be obtained, and the courses in auditing which may be undertaken, are to be prescribed in the regulations.

·        The universities and other institutions to be prescribed are expected to be based on those prescribed for the purposes of the existing subparagraph 1280(2)(a)(ii) (see regulations 9.2.02 and 9.2.03), subject to amendments to reflect changes in the names and/or status of any of the bodies.

5.83     In addition, applicants will be required to have completed a specialist course in auditing.

·        These courses will be prescribed in the regulations and are expected to be those courses that are conducted by, or on behalf of, the professional accounting bodies.

5.84     Existing subparagraph 1280(2)(a)(i), which provides that membership of The Institute of Chartered Accountants in Australia (ICAA), CPA Australia (CPAA) or any other accounting body prescribed in the regulations satisfies the educational pre-requisites for registration, will be omitted.  The original reason for having this provision was to deal with the situation in which a member of the ICAA or CPAA obtained his or her qualifications through the satisfactory completion of the body’s own examinations.  As a university degree or equivalent has been a pre-requisite for membership of both the ICAA and the CPAA for more than 20 years, few, if any, applications for registration are now received from individuals who are not graduates.

5.85     Proposed subsection 1280(2B) provides that an applicant satisfies the educational requirements where, in ASIC’s opinion, they have qualifications or experience equivalent to that specified in subsection 1280(2A).  This provision, which is equivalent to the existing subparagraph 1280(2)(a)(iii), would, for example, enable ASIC to process applications from persons who are members of an overseas accounting body or who have a degree from an overseas university.  In either case, it would be necessary for ASIC to consider whether the course of study undertaken by the person to obtain the membership or their degree is equivalent to the requirements set out in subsection 1280(2A).

Approval of auditing competency standard

5.86     Item 54 inserts proposed section 1280A, which sets out the method of approving a competency standard to be used for the purposes of proposed paragraph 1280(2)(b), the manner in which the standard may be amended and the circumstances in which the approval may be revoked.  The proposed section also sets out the basic content requirements for a competency standard.

5.87     Any person may make application for the approval of a competency standard (proposed subsection 1280A(1)).  However, an application for either the variation of a competency standard or the revocation of an approval may only be made by the person who sought the original approval for the standard (proposed subsections 1280A(2) and (4)).  All approvals of new standards, approvals of variations or revocations of approvals made by ASIC must be in writing.

5.88     While it is envisaged that the three main professional accounting bodies will be the groups most likely to seek approval of a competency standard, the provisions have been framed to allow other professional associations, individual accounting firms or groups of accounting firms to seek approval of their own competency standards.  However, whether such associations or firms seek such an approval will be a matter for each association or firm to decide, as a competency standard approved on the application of another body will be available for use by any person seeking registration as a company auditor (see the note to proposed subsection 1280A(1)).

5.89     Proposed subsection 1280A(3) provides that ASIC must not approve a competency standard, or a variation to a standard, unless it is satisfied that the standard:

·        requires a person’s performance against each component of the standard to be verified by a person who is a registered company auditor and who has sufficient knowledge of the person’s work to be able to give that verification;

·        is not inconsistent with the Corporations Act or any other Commonwealth law under which ASIC has regulatory responsibilities;

·        adequately addresses the level of practical experience needed for registration as a company auditor; and

·        is harmonised as much as possible with other approved competency standards.

5.90     Proposed subsection 1280A(4) provides, in part, that ASIC may revoke the approval of a competency standard where it is no longer satisfied that the standard complies with the requirements of subsection 1280A(3).

5.91     An example of the matters that might be included in a competency standard may be viewed on the ICAA’s website (www.ic a a.org.au under technical resources/auditing/draft audit competency guidelines).

Transitional arrangements: registration using auditing competency standard

5.92     Proposed section 1456 of the Corporations Act (inserted by item 2 of Schedule 12) provides that applications for registration as a company auditor that are made prior to 1 July 2004 will be processed in accordance with the requirements in force at the time the application was lodged.

5.93     It should be noted that, while the legislation is silent about whether a competency standard may have regard to audit work and other experience gained prior to the commencement of the new requirements, any application made shortly after the commencement of the new requirements and based on such prior experience should be extensively documented to allay any concerns the regulator might have about the authenticity of the claims made in support of the application.

Conditions on registration of auditors

5.94     Item 59 inserts new Division 2A of Part 9.2, which gives ASIC the ability to impose conditions on the registration of an auditor (see proposed section 1289A).  The purpose of this amendment is  to provide ASIC with enhanced post-registration supervision of registered auditors (for example, where a person is not a member of a professional accounting body it might impose conditions such as a requirement to undertake continuing professional development and to participate in a quality assurance program).

5.95     Key features of ASIC’s power to impose conditions on registration include:

·        the conditions may only be of a kind specified in the regulations; and

·        where it is proposed that a condition be imposed by ASIC after a person has been registered, the condition must not be imposed unless ASIC has first given the person the opportunity to appear before, or be represented at, a private hearing held by ASIC and to make submissions in relation to the matter (however, it should be noted that the requirement for a hearing does not apply where the condition is being imposed at the request of the registered auditor).  A decision by ASIC concerning the imposition of a condition may be the subject of an appeal to the Administrative Appeals Tribunal in accordance with Part 9.4A of the Corporations Act.

Transitional arrangements

5.96     Proposed section 1458 of the Corporations Act (inserted by item 2 of Schedule 12) makes it clear that ASIC may impose a condition on a person’s registration as an auditor, even if the registration took place prior to 1 July 2004.  However, where ASIC seeks to impose a condition in such circumstances, the auditor is entitled to a hearing in accordance with proposed subsection 1289A(4).  In addition, any decision taken by ASIC following such a hearing could be the subject of a review by the Administrative Appeals Tribunal.

Annual statements by auditors

5.97     Although the triennial statement that each registered company auditor has to lodge with ASIC under section 1288 of the Corporations Act is intended to allow ASIC to monitor the registered company auditor’s audit activities, the Audit Review Working Party noted that there are widely held views that the statement fails to achieve this objective.  Perceived deficiencies of the statement include that it does not provide up to date information for surveillance purposes, that it requires the disclosure of information that has already been provided to ASIC, and that the particulars of audits conducted during the period give no indication of the size or complexity of those audits.  The Working Party concluded that many of these concerns could be overcome by the adoption of an annual reporting requirement and the provision of revised information to ASIC.  The Ramsay report endorsed the move to an annual statement.

5.98     Item 56 inserts proposed section 1287A, which replaces the existing requirement for auditors to lodge a triennial statement with a new requirement for the lodgment of an annual statement.  Under the proposed amendment, every person who is a registered company auditor at the end of a calendar year is required to lodge a statement by 31 January in the following calendar year (proposed subsection 1287A(1)), although an application may be made to ASIC for an extension of the period in which the statement has to be lodged (proposed subsection 1287A(2)).

5.99     The content of the annual statement will be prescribed in the regulations.  It is envisaged that the information to be prescribed will include:

·        the auditor’s personal particulars (serving the purpose of confirming or updating ASIC’s records);

·        details of the nature and complexity of major audit work undertaken by the auditor; and

·        details concerning compliance with any conditions that may be imposed on the auditor’s registration.

5.100   Items 50, 57, 58 and 64 contain technical amendments to sections 1274 (Registers), 1288 (Triennial statements by registered auditors and liquidators) and 1298 (Effect of suspension) associated with the introduction of a requirement for auditors to lodge an annual statement.  The items amend:

·        subparagraph 1274(2)(a)(ii) to include an annual statement lodged by an auditor in the list of documents that may be searched by the public;

·        subsections 1288(3) and (4) to omit references to registered company auditor (when amended, section 1288 will require only liquidators to lodge a triennial statement); and

·        section 1298 to provide that, where a person’s registration as an auditor is suspended, the person is still required to lodge an annual statement.

Transitional arrangements

5.101   Proposed section 1457 of the Corporations Act (inserted by item 2 of Schedule 12) provides that the annual statement requirements for auditors will apply from the calendar year ending on 31 December 2004.  This means that all registered company auditors will be required to lodge an annual statement for 2004 by no later than 31 January 2005.

5.102   The information to be included in the first annual statement will cover the period from either the end of the period covered by the last triennial statement or the date of the person’s registration, whichever is the later.

Powers of CALDB in relation to auditors

5.103   Items 60 to 63 amend subsection 1292(1), which sets out the matters in respect of which the Companies Auditors and Liquidators Disciplinary Board (CALDB) may cancel or suspend a person’s registration as an auditor.  As a result of the amendments made elsewhere in this Part of the Bill, the matters that may be referred to the CALDB have been revised to include:

·        failing to lodge an annual statement in accordance with proposed section 1287A (this replaces the existing matter concerning the failure by an auditor to lodge a triennial statement);

·        failing to comply with a condition of the person’s registration; and

·        ceasing to have the practical experience necessary for carrying out audits, as demonstrated by a failure to perform any audit work, or any significant audit work, during a continuous period of five years.  The first year for the purpose of this requirement will be the calendar year commencing on 1 January 2005 (see proposed section 1459, inserted by item 2 of Schedule 12).

5.104   For the purpose of deciding whether the audit work performed by a person is significant, proposed subsection 1292(1A) provides that regard is to be had to the following matters:

·        the nature of the audit;

·        the extent to which the person was involved in the audit; and

·        the level of responsibility the person assumed in relation to the audit.

Delegations by Auditors-General

5.105   Item 55 will amend section 1281 (Auditor-General taken to be registered as auditor) to provide that where an auditor-general delegates to a person the function of conducting an audit, or the power to conduct an audit, that person is also taken to be a registered company auditor under Part 9.2.  With the increasing number of government business enterprises being formed or reconstituted as Corporations Act companies, Auditors-General are experiencing a significant increase in the number of audit reports they have to sign.  By allowing Auditors-General to delegate responsibility for signing Corporations Act audits to senior staff, the amendment will facilitate Auditors-General in the performance of their functions.

Part 3:  Auditor appointment,  independence and rotation requirements

Overview

5.106   The text in this part of the explanatory memorandum is divided into the following key topics:

·        independence requirements for auditors;

·        rotation of auditors; and

·        non-audit services.

·        Current section 324 of the Corporations Act contains provisions relating to:

·        the appointment of individuals and firms as an auditor of a company;

·        the effect of appointing a firm as auditor including the reconstitution of a firm;

·        the requirements for appointment of an individual and a firm as auditor; and

·        auditor independence requirements in relation to an individual auditor and an audit firm.

5.107   In light of the CLERP 9 proposals which significantly expand the auditor independence requirements and the need to include authorised audit companies in the legislative framework, the matters dealt with in current section 324 are contained in three separate Divisions of Schedule 1, Part 3:

·        Division 1 ¾ Entities that may be appointed as an auditor for a company or registered scheme.

-       Division 1 broadly replicates the effect of existing provisions in section 324 which recognise the status of an individual and a firm for appointment as an auditor of a company as well as provisions relating to the effect of the appointment of a firm as an auditor, including the reconstitution of an audit firm.  Division 1 now also extends those provisions to authorised audit companies. 

·        Division 2 ¾ Registration requirements

-       Division 2 replicates the effect of the provisions in section 324 relating to registration requirements for appointment of an individual and a firm as auditor of a company.  Division 2 extends these requirements to an authorised audit company.  Division 2 also replicates the effect of the current exception in section 324 from the registration requirement for a proprietary company which applies in certain circumstances.

·        Division 3 ¾ Auditor independence

-       These provisions are considered in detail below (as well as the auditor’s independence declaration which is contained in proposed section 307C).

5.108   Current sections 327 and 328, which deal with the appointment and nomination of auditors, have been broadly replicated in

5.109   Division 4 deals with the issue of the deliberate disqualification of an auditor and broadly replicates the effect of existing subsection 324(16). 

5.110   New requirements in relation to auditor rotation for listed companies are included in Division 5. 

5.111   Division 6, Subdivision A.  The impact of an auditor ceasing to hold office as a result of a breach of the registration and independence requirements is outlined in section 327B. 

5.112   Current sections dealing with the appointment of registered scheme auditors (section 331AA and 331AB) are broadly replicated in Division 7.

Definitions

5.113   Items 65 ¾ 86 of the Bill amend section 9 of the Corporations Act by inserting a number of key definitions relevant to the independence requirements.  In particular, the following definitions should be noted:

·        a ssociated entity (see also item 87):

-       this definition is based on the concepts contained in the definition of related entity in Professional Statement F.1 and the Ramsay report;

·        audit;

·        audit company;

·        audit-critical employee;

·        engage in audit activity;

·        immediate family member:

-       the definition is based on the corresponding definition in Professional Statement F.1 and means:

:         the person’s spouse or de facto spouse; or

:         a person who is wholly or partly dependent on the person for financial support.

·        investment in a company;

·        investment in a registered scheme;

·        lead and review auditors;

·        professional employee;

·        professional members of the audit team (see also proposed section 324AE):

-       the definition has drawn on the definition of the audit engagement team in the Ramsay report, Professional Statement F.1, and the SEC’s rule on auditor independence in the US.  The approach in the draft Bill is designed to cover the people in an audit firm or audit company who are most directly in a position to influence the audit.

·        senior manager.

Auditor independence

5.114   Auditor independence is fundamental to the credibility and reliability of auditors’ reports.  Division 3 implements recommendations of the Ramsay report as refined in CLERP 9.  In addition, the Bill implements a number of recommendations, and the overall policy direction, of the HIH Royal Commission Report (the HIHRC report).

5.115   The Bill looks to promote the following functions of an independent audit in relation to capital market efficiency:

·        adding value to financial statements by improving their reliability;

·        adding value to capital markets by enhancing the credibility of financial statements;

·        enhancing the effectiveness of capital markets in allocating valuable resources by improving the decisions of users of financial statements; and

·        assisting to lower the cost of capital to those using audited financial statements by reducing information risk.

5.116   The HIHRC report noted that an independent audit also contributes to capital market efficiency by enhancing the consistency and comparability of reported financial information in Australia.

5.117   The Bill establishes a framework for auditor independence comprising a general standard of independence, an annual declaration that the auditor has maintained independence, restrictions on employment and financial relationships, cooling off periods, auditor rotation, and non-audit services.

Auditor independence rules and the liability framework

5.118   `The general framework for the liability of auditors that has been adopted in the Bill in relation to the auditor independence requirements is as follows:

·        In each of the key provisions establishing auditor independence, an individual auditor, a member of an audit firm, an audit company, and a director of an audit company are subject to both:

-       a fault based offence; and

-       a strict liability offence.

·        Under the fault based offences, the prosecution has to prove each of the elements that constitute the offence.  The fault based offences carry a higher criminal penalty than the strict liability offences.

·        The strict liability offence is coupled with a defence which applies where the relevant person (the defendant) had reasonable grounds to believe that the individual auditor, audit firm or audit company (as the case may be) had in place a quality control system that provided reasonable assurance (taking into account the size and nature of the audit practice) that the auditor had complied with the independence requirements.

5.119   The strict liability defence is designed to encourage a “culture of compliance” by auditors.

5.120   This general framework has also been applied in provisions, outside the auditor independence requirements, in Schedule 1 Part 3.   These provisions generally provide a defence to strict liability where the person (the defendant):

·        did not know of the circumstances that constitute the contravention; or

·        knows of those circumstances but takes all reasonable steps to correct the contravention as soon as possible after the person becomes aware of those circumstances.

General requirement for auditor independence

5.121   Proposed sections 324CA to 324CD establish a general requirement for auditor independence in the Corporations Act which is based on the proposals in CLERP 9 and the Ramsay report. 

5.122   Proposed subsection 324CA(1) provides that an individual auditor (sole proprietor) or audit company contravenes this subsection if:

·        The individual auditor or audit company engages in audit activity in relation to an audited body at a particular time; and

·        A conflict of interest situation (see section 324CD) exists in relation to the audited body at that time; and

·        At that time the individual auditor or audit company is aware that the conflict of interest situation exists but does not take reasonable steps to ensure that the conflict of interest situation ceases to exist.

5.123   A contravention of subsection 324CA(1) is a “fault based” offence within the liability framework.  The prosecution would be required to prove each of the separate elements of the offence to secure a conviction.  The maximum penalty for the offence if 25 penalty units and/or 6 months imprisonment or both.

5.124   The general standard of independence is not met where a conflict of interest situation exists as defined in subsection 324CD(1):

·        The auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body; or

·        A reasonable person, with full knowledge of all relevant facts and circumstances, would conclude that the auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body.

5.125   The test in section 324CD(1) reflects the general standard of independence as proposed in the CLERP 9 paper.  The CLERP 9 test, with one relatively minor modification, adopted the Ramsay report recommendation which in turn closely followed the general independence standard adopted in the SEC auditor independence rules.

5.126   Subsection 324CA(2) provides for a strict liability offence  in relation to an individual auditor or audit company coupled with a defence based on the person having reasonable grounds to believe that the individual auditor or audit company would have had adequate quality control systems in place.

5.127   Subsection 324CA(6) provides that the obligations in section 324CA are in addition to, and do not derogate from, any obligation imposed by another provision in the Corporations legislation or a code of professional conduct.

5.128   Proposed section 324CB sets out the general requirement for auditor independence in relation to a member of an audit firm.  The provision contains the same liability framework as applied to an individual auditor and an audit company in section 324CA but applies the contraventions to a member of the audit firm.

5.129   Proposed section 324CC sets out the general requirement for auditor independence in relation to a director of an audit company.  The provision contains the same liability framework as applied to an individual auditor and an audit company in section 324CA but applies the contraventions to a director of the audit company.

Employment and financial relationships

5.130   Current section 324 of the Corporations Act specifies limited restrictions on employment and financial relationships.  CLERP 9 proposed that the current restrictions be significantly expanded in line with the recommendations in the Ramsay report, in addition to the introduction of the proposed general standard of auditor independence.  The new independence requirements have also been applied to authorised audit companies and registered schemes.

5.131   The specific independence requirements are contained in:

·        proposed section 324CE:  an individual auditor.

·        proposed section 324CF:  an audit firm.

·        proposed section 324CG:  an audit company.

5.132   Each of these sections contains a table for the purpose of identifying the specific auditor independence requirements applying to each of the persons or entities listed in the table.  The impermissible relationships are determined by applying the relevant relationships set out in proposed subsection 324CH(1) to the persons or entities listed in each of the tables in sections 324CE, 324CF and 324CG.

Specific requirements for individual auditor

5.133   Proposed subsection 324CE(1) provides that an individual auditor contravenes this subsection if:

·        The individual auditor engages in audit activity at a particular time; and

·        A relevant item of the table in subsection 324CH applies at that time to a person or entity covered by subsection 324CE(5); and

·        The individual auditor is or becomes aware of those circumstances; and

·        The auditor does not, as soon as possible after becoming aware of those circumstances, take all reasonable steps to ensure that the audit activity in those circumstances is not engaged in.

5.134   The prosecution is required to prove each of the elements of this offence to secure a conviction.

5.135   Proposed subsection 324CE(2) establishes a strict liability offence in circumstances where an individual auditor engages in audit activity at a particular time and a relevant item of the table applies at that time to a person or entity covered by subsection 324CE(5).  Proposed subsection 324CE(4) provides a defence  where the auditor has reasonable grounds to believe that there was a quality control system in place that provided reasonable assurance (taking into account the size and nature of the audit practice of the individual auditor) that the auditor and the auditor’s employees complied with the requirements of Subdivision B.

5.136   The following information about the particular items in the table in proposed subsection 324CE(1) should be noted:

·        Item 2: a service company or trust or other entity acting for, or on behalf of, the individual auditor.

5.137   The purpose of this item is to subject a service company or trust arrangement to the independence requirements to prevent these structures being used to avoid the provisions.

·        Item 5: a person who is a non-audit services provider and who does not satisfy the maximum hours test in proposed subsection 324CE(6).

5.138   This requirement implements a CLERP 9 proposal based on a recommendation in the Ramsay report that such a person should not have certain investments in the audited body because of the threat posed to the independence of the auditor.  The purpose of the maximum hours test in proposed subsection 324CE(6) is to exclude such a person from the restriction where the number of hours for which non-audit services are provided during the relevant period does not exceed 10 hours.  The period of 10 hours has been adopted from the corresponding restriction in the US SEC auditor independence rules.  A similar restriction applies to an immediate family member of a non-audit services provider under item 6 of the table.

·        I tem 9: a person who is a former professional employee of the auditor and who does not satisfy the independence test in proposed subsection 324CE(7).

5.139   This item is based on a recommendation in the Ramsay report to address the threat to auditor independence when a former professional employee of an auditor becomes an officer or audit critical employee of an audited body.  The independence test in proposed subsection 324CE(7) will exclude former professional employees from the restriction where they no longer influence the operations and financial policies of the audit practice and have no financial arrangements in relation to the accounting and audit practice other than arrangements relating to payments of a fixed pre-determined dollar amount which are not dependent on the revenues, profits or earnings of the auditor.  The person is also prevented from having a financial arrangement with the auditor to receive a commission or similar payment in certain circumstances.

5.140   In applying subsection 324CE(7) any rights that the person has against the auditor by way of an indemnity for, or contribution in relation to, liabilities incurred by the person when the person was an employee of the auditor are to be disregarded.

·        Item 10 is similar to item 9 but applies the requirement to an individual who is a former owner of the individual auditor’s practice.

·        Items 9 and 10 only apply to a person who ceases to be a professional employee of the individual or who ceases to own the business of the individual auditor after the proposed commencement of these provisions on 1 July 2004.

Specific requirements for audit firms and authorised audit companies

5.141   Similar processes and requirements apply to members of an audit firm (see proposed sections 324CF and 324CH) and an audit company and directors of an audit company (see proposed sections 324CG and 324CH). 

Relevant relationships

5.142   Proposed subsection 324CH(1) contains a table which lists the impermissible relationships that are relevant for the purposes of the specific employment and financial independence requirements contained in proposed sections 324CE, 324CF and 324CG.

5.143   The relationships listed in the table are based on the proposals in CLERP 9 and the Ramsay report.

5.144   Items 1 to 9 relate to the employment relationships identified in the Ramsay report which threaten an auditor’s independence.  Items 10 to 19 list the financial relationships which the Ramsay report recommended should be dealt with in the Corporations Act.  The Ramsay report referred to the specific employment and financial restrictions as “a list of what can be regarded as core circumstances which, if they exist, necessarily mean that the auditor is not independent”.

5.145   The Ramsay report recommendations in relation to employment and financial relationships drew on the current requirements in the Corporations Act, the auditor independence rules formulated by the International Federation of Accountants (IFAC) and  relevant SEC auditor independence rules in the US.  The IFAC rules have been adopted in Australia by the Institute of Chartered Accountants in Australia and CPA Australia and are contained in Professional Statement F.1.

5.146   The following background commentary on each of the items is noted:

·        Items 1 to 6:

5.147   These items are based on the Ramsay report recommendation relating to the restrictions on the employment by the audited body of a current auditor or employee of the auditor.  The restrictions are based on existing subsections 324(1) and (2) of the Corporations Act.  Drawing on corresponding requirements in the IFAC and SEC rules, the Ramsay report recommended that the existing requirements should be extended beyond current partners of an audit firm to cover the professional employees of the audit firm and should also extend to an immediate family member of the audit engagement team.

5.148   The recommendations in the Ramsay report have been implemented and expanded (as a result of the application of the requirements in sections 324CE, 324CF and 324CG to the table of relationships in section 324CH):

5.149   The requirements have been applied to an individual auditor, an audit firm and an audit company.

5.150   In this context, the term ‘a professional employee’ of the auditor referred to in the Ramsay report is applied to a professional member of an audit team (this definition should not be confused with another new definition in section 9 of professional employee which is used in the case of a former professional employee of an auditor joining an audited body).

5.151   The service company or trust arrangement has been expressly covered.

5.152   In addition to the existing case of an officer of the audited body , items 2, 3, 4 , 5, and 6 also refer to an audit critical employee (which is defined in section 9 of the Corporations Act).  The objective is to cover employees who are in a position to affect the conduct or efficacy of the audit but who would not be caught by the definition of officer in section 9.  An audit critical employee is limited to an employee who is able, because of the position in which the person is employed, to exercise significant influence over:

.1       A material aspect of the contents of the financial report being audited; or

.2       The conduct or efficacy of the audit.

·        Item 7 is based on the existing paragraph 324(2)(h) of the Corporations Act with the following changes:

5.153   The relationship is applied to an individual auditor and to an audit company, in addition to an audit firm as reflected in the current provision.

5.154   In line with the CLERP 9 proposal, the restriction applies to any consultancy and is not limited, as in the current provision, to a consultancy on accounting or auditing matters.

5.155   Consistent with the approach adopted in items 2 to 6, the scope of the restriction has been extended beyond an officer of the audited body to also cover an audit-critical employee of an audited body .

·        Item 9 implements the recommendation in the Ramsay report in relation to employment by an audit firm (also applying to an individual auditor and to an audit company) of a former employee of an audited body.  The restriction will apply, in addition to the period to which the audit relates, to:

-       the 12 months immediately preceding the beginning of the period to which the audit relates; and

-       the period during which the audit is being conducted or the audit report is being prepared.

·        Items 10 to 14 implement the recommendations in the Ramsay report relating to investments in audited bodies.  The Ramsay report noted that these financial relationships are prohibited under the IFAC and SEC rules.

·        Item 15 is based on the current paragraphs 324(1)(e) and 324(2)(f) of the Corporations Act.  In accordance with the Ramsay report recommendation the current prohibition has been extended to include an entity that the client controls.  The prohibition does not apply to:

-       a debt owed under a housing loan (see proposed subsection 324CH(5)); or

-       a loan which would be prohibited under item 18 but for the exception in proposed subsection 324CH(7) (which relates to loans made in the ordinary course of business etc).

·        Items 16 to 19 implement the recommendations in the Ramsay report relating to :

-       loans to and from audited bodies; and

-       loan guarantees involving the auditor and audited body.

5.156   For purposes of item 16 loans by immediate family members in ordinary business dealings with the audited body are to be disregarded.

5.157   Proposed subsections 324CH(7) and (8) provide for exceptions in relation to loans and guarantees made in the ordinary course of business etc.  under items 18 and 19 respectively.

5.158   CLERP 9 endorsed the Ramsay report recommendation that the restrictions on employment relationships should not apply to small proprietary companies as defined in section 45A.  This has been implemented in relation to each of the employment relationships contained in items 1 to 9 of the table.

Retiring partners of audit firms and retiring directors of authorised audit companies

5.159   Proposed section 324CI requires a two year cooling off period before a member of an audit firm or a director of an audit company can become, or continue to be an officer of an audited body where:

·        At any time before the person ceases to be a member of the firm or director of the audit company, the audit firm or audit company has engaged in an audit of an audited body; and

·        The member or the director was a professional member of the audit team for the audit

5.160   Proposed subsection 1462(11) provides that section 324CI applies only if the relevant departure time for the purposes of that section occurs on or after the proposed commencement date of 1 July 2004.

5.161   Proposed paragraph 324CI(1)(e) contains a small proprietary company carve out.

5.162   It is noted that proposed paragraph 300(1)(ca) (item 89) provides that the director’s report must include the name of each officer of the company, registered scheme or disclosing entity who was a partner in an audit firm or director of an audit company that is an auditor of the company, registered scheme or disclosing entity and whether the officer was a member or director when the audit firm or audit company undertook an audit of the company, disclosing entity or registered scheme.

Retiring professional member of audit company

5.163   Proposed section 324CJ requires a two year cooling off period before a professional employee of the audit company can become, or continue to be an officer of an audited body where:

·        At any time before the person ceases to be a professional employee of the audit company, the company has engaged in an audit of an audited body; and

·        The person was a lead auditor or review auditor for the audit.

Multiple former audit firm partners or audit company directors

5.164   Proposed section 324CK implements a recommendation of the HIHRC that the Corporations Act contain a prohibition on any more than one former partner of an audit firm, at any time, being a director of or taking a senior management position with the audited body.

5.165   Proposed section 324CK also extends the prohibition to a director of an audit company.

5.166   The prohibition applies where an audit firm or audit company is an auditor of an audited body for a financial year and the person has at any time been a member of the audit firm or a director of the audit company.

5.167   The prohibition will operate prospectively and will apply to a person who:

·        Is, or who becomes, on or after 1 July 2004 a member of the firm or a director of the audit company; and

·        Becomes an officer of the audited body concerned on or after 1 July 2004.

5.168   Proposed paragraph 324CK(e) contains a small proprietary company carve out.

Auditor’s independence declaration

5.169   Subsection 307C applies to an individual auditor and requires the auditor to give to the directors of a company, registered scheme or disclosing entity either an unqualified declaration or a qualified declaration that there have been no contraventions of the auditor independence requirements of the Corporations legislation or any applicable code of professional conduct.  Where a qualified declaration is given to the directors, the individual auditor is required to set out details of the contraventions in the declaration.

5.170   Similar requirements apply to an audit firm or an audit company under proposed subsection 307C where the lead auditor for the audit must give the unqualified or qualified declaration.

5.171   Failure to give the declaration is a strict liability offence.  While the person giving the declaration is not excused from giving a declaration on the ground that doing so might incriminate the individual, subsection 307C(7) provide use and derivative use indemnity safeguards.

5.172   Proposed paragraph 298(1)(c) (item 88) provides that the annual directors’ report must include a copy of the auditor’s independence declaration made under proposed section 307C.  Proposed subsection 306(2) (item 92) contains similar provisions in relation to the directors’ half-year report.

Transitional arrangements for auditor independence amendments

5.173   Proposed section 1462 (item 2, Schedule 12) lists the transitional arrangements for the auditor independence requirements contained in Schedule 1.

People who are regarded as officers of a company for the purposes of this Division

5.174   Division 4 of Schedule 1, Part 3 (proposed section 324CL) is based on current subsections 324(4), (5) and (6).

Deliberately disqualifying auditor

5.175   Proposed subsections 324CM(1) and (2) replicate the effect of the current subsection 324(16) in relation to an individual auditor and an audit firm.

5.176   A similar requirement is imposed on a director of an audit company under proposed subsection 324CM (3).

Rotation requirements for auditors

5.177   Division 5 sets out the framework for auditor rotation in circumstances where either an individual auditor, an audit firm or authorised audit company has been appointed as auditor of a listed company or registered scheme.  The provisions in this Division implement recommendations of both CLERP 9 and the Ramsay report.

5.178   The provisions rely on the concept of an auditor having ‘played a significant role’ in the audit which is defined in section 9 of the Corporations Act (see item 82 of Schedule 1, Part 3).  Generally the persons to whom the rotation obligations apply are the lead and review auditors.  Where an individual plays a significant role in the audit of a listed company for five successive financial years, the individual cannot play a significant role in the audit of that company for at least another two successive financial years (see proposed section 324DA). 

5.179   Proposed subsection 324DA(2) further provides that a person may not play a significant role as auditor for more than five out of any seven successive financial years.  This approach recognises that auditors may not necessarily audit a body in consecutive years however the relationship between the auditor and the audited body can still give rise to a threat to independence.  In these circumstances rotation should still be required.  In addition this approach prevents an auditor from avoiding the rotation obligation specified in proposed section 324DA, for example, in circumstances where an auditor plays a significant role for four successive years, resigns from the audit for only one year and then resumes a significant role for another four successive years. 

5.180   ASIC will be able to provide relief from the rotation requirements in certain circumstances (see below).

Individual auditor’s rotation obligation

5.181   Proposed section 324DB provides that an individual who does not comply with the rotation requirements of the Act contravenes the Act. 

Audit firm’s rotation obligation

5.182   Proposed section 324DC operates in circumstances where an audit firm is appointed as a listed company’s or listed scheme’s auditor.  The section recognises that individuals will act on behalf of the firm and therefore places the rotation obligation on both the lead and review auditors (see proposed section 324AF for the definition of the lead and review auditors).

5.183   Liability for a breach of the rotation obligations is directed at members of a firm.  Where an individual plays a significant role in an audit of a listed company or scheme, and is not eligible to do so due to the rotation requirements, a member of the firm will commit an offence where:

·        the member becomes aware that the individual is not eligible to play that role; and

·        the member fails to take the necessary steps as soon as possible to ensure that either:

-       the audit firm resigns as auditor of the company or

-       the individual ceases to act on behalf of the audit firm as a lead or review auditor.

5.184   Proposed subsection 324DC(2)provides that a member of an audit firm will commit a strict liability offence where an individual acts as lead or review auditor when the individual is not eligible to play a significant role in the audit of the company for that financial year.  Proposed subsection 324DC(4) provides a defence where the member of the firm has reasonable grounds to believe that the audit firm had in place at that time, a quality control system that provided reasonable assurance (taking into account the size and nature of the audit practice of the audit firm) that the audit firm and its employees complied with the requirements of Division 5.

Authorised audit company’s rotation obligation

5.185   Proposed section 324DD contains the same liability framework in relation to a contravention of the rotation requirements by an audit company or a director of the audit company. 

ASIC’s power to modify the rotation requirements

5.186   The Bill recognises that in some circumstances, the rotation obligations could place a burden on particular audit firms or listed companies.  To this end, the Bill provides ASIC with a power to provide relief from the rotation requirements.

5.187   Proposed section 342A gives ASIC the power to extend the period before rotation of an auditor is required.  Where an auditor has performed an audit for five successive years, paragraph 342A(1)(a) allows the period before rotation will be required to be extended to six or seven years.  After this time, the auditor must not undertake the audit of that listed company for the next two years. 

5.188   Paragraph 342A(1)(b) provides for ASIC relief in cases where an audit has not been undertaken in consecutive years.  In these circumstances, ASIC can extend the period before rotation will be required from any five out of seven successive years to any six out of seven successive years.  These provisions would apply for example, where an auditor conducts four successive audits, resigns from the audit for one year and returns to the audit in year six and further seeks to perform the audit in year seven.  Under subsection 324DA(2), the auditor would not be able to perform the audit in year seven unless relief had been provided under paragraph 342A(1)(b). 

5.189   ASIC will only be able to extend the period in response to a written application by the individual auditor or the audit firm or authorised audit company for whom the auditor works.  Proposed subsection 342A(6) requires ASIC to be satisfied that to refuse the extension would cause an unreasonable burden on the auditor, the audit firm or authorised audit company, or the listed company subject to the audit.  Proposed subsection 342A(7) requires ASIC, when considering whether an unreasonable burden would be placed on any of these parties, to take into account the nature of the listed company being audited and the degree of specialist knowledge an auditor might need to undertake an effective audit.  ASIC will also be able to take into account the availability of alternative auditors capable of providing a satisfactory level of audit services to the relevant companies.  This might for example be an issue in the case of auditors operating in rural or remote areas, or in the case of small audit firms where the number of available audit partners able to conduct the audit is limited.

5.190   ASIC’s use of the relief power will be monitored to ensure it is achieving its intended objectives.

Auditor to notify company or registered scheme of ASIC relief

5.191   Proposed section 342B requires an auditor who remains significantly involved in the preparation of an audit pursuant to an ASIC order under proposed section 342A to give the listed company, or the responsible entity of the listed scheme, written notice that the ASIC order has been provided.  This notice should be provided to the company as soon as practicable, if the company’s auditor for the relevant financial year has already been appointed.  If the auditor has not been appointed, the notice must be forwarded before the appointment is made.  Where an auditor remains significantly involved in the audit pursuant to an ASIC order under proposed section 342A, the company should advise shareholders of the details in its annual financial or directors’ report.

Transitional arrangements

5.192   Schedule 12 of the Bill contains the transitional arrangements applying to the rotation obligations.

5.193   Proposed section 1463 provides that the auditor rotation provisions are to apply to the audit of financial years that commence on or after 1 July 2006.  This will give publicly listed companies and audit firms sufficient time to implement the rotation requirements under the Act. 

5.194   It should be noted that rotation will remain a requirement under Professional Standard F.1 with which auditors, not just those of listed companies, should comply. 

Non-audit services

Disclosure of non-audit services

5.195   The Bill requires the board of directors of a listed company to provide a statement in the annual report that identifies all non-audit services provided by the audit firm and the fees applicable to each item of non-audit service (see item 91, subsection 300(11B)).  In addition, the report must include a statement by the directors that they are satisfied that the provision of non-audit services is compatible with the general standard of independence and an explanation of why those non-audit services do not compromise audit independence (see item 91, subsection 300(11B)).  Where a company has an audit committee, this statement must be made in accordance with advice provided by that committee (see item 91, subsection 300(11D)).

5.196   The Bill does not contain a definition of non-audit services.  Consistent with the terms of the Ramsay report, it is intended that non-audit services will encompass any services provided by the auditor which are not included in the terms of the audit engagement.

5.197   The provisions of the Bill implement recommendations of the HIH Royal Commission.

Accounting standards

5.198   Currently Australian accounting standards require disclosure of the aggregate amount of fees paid to the auditor for the audit and related services and for non-audit services.  This requirement applies to all entities required to prepare financial reports in accordance with accounting standards.  The Bill does not relieve entities from the requirements of the accounting standards.

Transitional provisions

5.199   Companies must comply with the requirements in the Bill in relation to directors’ reports that relate to financial years beginning on or after 1 July 2004 (see Schedule 12, proposed section 1460).

Part 4:  Authorised audit companies

5.200   The Corporations Act currently does not allow a company to be registered as a company auditor.  Schedule 1, Part 4 of the Bill establishes a framework for incorporation of audit firms.

5.201   Allowing auditors to incorporate will address some of the concerns relating to the professional liability of auditors.  Incorporation will also provide accounting firms with an additional option in terms of how they structure their operations. 

Application for registration as authorised audit company

5.202   Proposed section 1299A provides that a company may apply to ASIC for registration as an authorised audit company.  An application must be in writing as prescribed and must contain such information as is prescribed.

Eligibility for registration as an authorised audit company

5.203   Proposed section 1299B provides that a company is only eligible to be registered as an authorised audit company if:

·        each of the directors of the company is a registered company auditor and is not disqualified from managing a corporation under Part 2D.6; and

·        each share in the company is held and beneficially owned by a person who is an individual or the legal representative of an individual; and

·        a majority of the votes that may be cast at a general meeting of the company attach to shares in the company that are held and beneficially owned by individuals who are registered company auditors; and

·        ASIC is satisfied that the company has adequate and appropriate professional indemnity insurance; and

·        the company is not an externally administered body corporate.

Registration as authorised audit company

5.204   Proposed section 1299C sets out the requirements relating to ASIC’s granting or refusal of the application and the requirements in relation to the registration of the company as an authorised audit company.

Registration may be subject to conditions

5.205   Proposed section 1299D provides that the company’s registration as an authorised audit company is subject to the provisions of Part 9.2A, any conditions or restrictions specified in the regulations and any other conditions or restrictions determined by ASIC. 

Register of authorised audit companies

5.206   Proposed section 1299E requires ASIC to keep a Register of Authorised Audit Companies and sets out the matters that ASIC must enter in the Register in relation to each authorised audit company.

Notification of certain matters

5.207   Proposed subsection 1299F(1) provides that an authorised audit company must notify ASIC if a condition or restriction to which the company’s registration is subject is contravened.

5.208   An authorised audit company is also required under proposed subsection 1299F(3) to notify ASIC if a change occurs in the details of a matter that is required to be entered in the Register of Authorised Audit Companies.

Annual statements by authorised audit companies

5.209   Proposed section 1299G requires an authorised audit company to lodge at the end of a calendar year, on or before the next 31 January, an annual statement with ASIC.

Cancellation or suspension of registration

5.210   Proposed section 1299H provides that ASIC may cancel a company’s registration as an authorised audit company if the company requests ASIC to cancel the registration.  ASIC’s decision to cancel the company’s registration comes into effect as soon as practicable on the making of the decision.

5.211   Proposed section 1299I provides that ASIC may cancel or suspend a company’s registration as an authorised audit company if the company ceases to be eligible to be registered as an authorised audit company or the company fails to meet conditions or observe restrictions imposed on the company’s registration as an authorised audit company.

5.212   Proposed section 1299J requires ASIC to give a company a written notice setting out ASIC’s decision to cancel or suspend the company’s registration within 14 days after the decision.  ASIC is also required to publish written notice of the decision in the Gazette.

5.213   Proposed subsection 1299K(1) provides that subject to subsection (2) and to sections 41 and 44A of the Administrative Appeals Tribunal Act 1975 a decision by ASIC to cancel or suspend a company’s registration as an authorised audit company comes into effect at the end of the day on which the company is given notice of the decision under paragraph 1299J(1)(a).

5.214   Proposed subsection 1299K(2) provides that ASIC may, in order to enable an application to be made to the Tribunal for review of the decision to cancel or suspend the registration, determine that the decision is not to come into effect until a specified time or the happening of a specified event.

Effect of suspension

5.215   Proposed section 1299L provides that a company whose registration is suspended is, except for the purposes of subsection 1299E(4), sections 1299F and 1299G and Division 2, taken not to be registered as an authorised audit company so long as the registration is suspended.

Effect of cancellation

5.216   Proposed section 1299M provides that if a company’s registration as an authorised audit company is cancelled, each appointment of the company as auditor for a company or registered scheme that is in force on the day on which the cancellation takes effect is terminated at the end of that day.

Authority to sign on behalf of authorised audit company

5.217   Proposed section 324AD provides that a report or notice that purports to be made or given by an audit company appointed as auditor of a company or registered scheme must be signed by a director of the audit company or the lead auditor or review auditor for the audit both in the company’s name and in his or her own name.  Proposed section 324AD recognises that under a corporate structure it may not be practicable or desirable for all the former partners of a large accounting firm to be appointed as directors of the audit company.

Part 5:  Auditors and AGMs

Overview

5.218   The amendments contained in this Part of the Bill are designed to facilitate shareholder participation at Annual General Meetings (AGMs) and improve auditor accountability by:

·        allowing shareholders to ask questions of the company auditor, in writing before the AGM as well as orally at the AGM; and

·        requiring company auditors to attend the AGM.

5.219   Since the Company Law Review Act 1998 came into effect, members of a company have been entitled to ask questions of the auditor concerning the conduct of the audit and the contents of the audit report.  This however only applies in relation to shareholders who attend the AGM and in circumstances where the auditor is in attendance at the meeting. 

5.220   The Bill extends these provisions by requiring the auditor of a listed company (or their representative) to attend the AGM, and by providing an alternative mechanism by which all members ¾ not just those in attendance ¾ can ask questions of the auditor.  For unlisted companies, there is no change to auditor attendance requirements brought about by this Bill.  Auditors of unlisted companies will not be compelled to attend the AGM, but if they do attend, members of the company will be entitled to ask them questions.

5.221   CLERP 9 recommended that shareholders be able to submit questions by e-mail and that questions be posted on the company web site.  The provisions in the Bill are medium neutral and will allow questions to be submitted by members in writing in all forms.  Companies will be required to make the questions available to members attending the AGM.  Companies may choose to post the questions on their website, however this will not be a requirement of the legislation.

5.222   By facilitating shareholder participation in this way, these provisions will strengthen the accountability of auditors to shareholders.  The direct questioning of auditors will improve the ability of shareholders to assess both the quality of the audit, and the performance of the company management.

Questions submitted by members of listed company before AGM

5.223   Item 115 in Schedule 1 of the Bill inserts proposed section 250PA which allows a member of a listed company to submit questions to the auditor about the contents of the audit report or the conduct of the audit.  Questions must be submitted no later than 5 business days before the AGM.

5.224   Proposed subsection 250PA(3) requires the company to forward all questions it has received to the auditor as soon as practicable, so as to give the auditor maximum time to consider the issues raised.

5.225   The auditor is required to prepare a list of questions submitted and, following any filtering, provide that list to the company far enough in advance of the AGM so as to allow the company to make it available to members attending the AGM.  Proposed subsection 250PA(4) assigns responsibility for this to an individual auditor, while proposed subsection 250PA(6) assigns responsibility for this to the lead auditor acting on behalf of an audit firm or company.  The offence of not providing the list to the company shall be one of strict liability.

5.226   The auditor is permitted to filter questions on the basis of relevance to the audit report or conduct of the audit.  It is considered appropriate that the auditor determine relevance rather than the company.  The company could however, express an opinion to the auditor regarding the relevance of individual questions.  The auditor may also exclude questions that are the same in substance as other questions, and questions that were not passed to the auditor in reasonable time for the auditor to assess their suitability for inclusion in the list (see proposed subsection 250PA(8)). 

5.227   Proposed subsection 250PA(9) requires the company to make the list of questions provided by the auditor reasonably available to members attending the AGM.  This may not necessarily require that printed copies be distributed to each attending member, although this would satisfy the requirement in most cases.  The list could be made available by other means. 

5.228   The main purpose of making the list available at the AGM is to highlight to shareholders where there may be areas of concern with the conduct of the audit and the audit report, and to prompt members attending the AGM of possible issues that could be raised with the auditor.

5.229   Item 117 in Schedule 1 of the Bill extends subsection 250T(1) to give the auditor or their representative a reasonable opportunity to answer written questions submitted under proposed section 250PA (see proposed paragraph 250T(1)(b)).  Members already have a reasonable opportunity to ask the auditor questions at the AGM relevant to the conduct of the audit or the audit report under existing section 250T(1), which becomes section 250T(1)(a).

Answering questions

5.230   There is no requirement in the Bill for the auditors to provide answers to written questions either at the AGM or following the meeting.  Such a requirement would raise the issue as to whether the extra burden on auditors would lead to more useful information being disclosed.  In addition, to require written questions to be answered would effectively elevate their status above questions asked orally at the AGM.  As noted above, however, auditors will be given a reasonable opportunity to answer written questions at the AGM if they choose to do so.

Auditor’s attendance at the AGM

5.231   Item 116 in Schedule 1 of the Bill inserts proposed section 250RA which requires the auditor of a listed company to attend the AGM of that company where the audit report is to be considered.  The auditor can arrange to be represented by a member of the audit team who is suitably qualified, and is in a position to answer questions about the audit (see paragraph 250RA(1)(b)).  Where an auditor is an audit firm or company, the lead auditor would normally be expected to attend the AGM.  However, the Bill is not prescriptive on this matter and any suitable member of the audit team may attend. 

5.232   In the case of audit firms and companies, the responsibility to ensure attendance at the AGM lies with the lead auditor (see proposed subsection 250RA(3)).  Where the auditor is not represented at the AGM it will be an offence of strict liability.

5.233   Schedule 12 of the Bill  inserts proposed section 1464 which contains the transitional arrangements to the auditor attendance at AGM provisions.  The provisions will apply to AGMs at which financial reports for financial years that commence on or after 1 July 2004 are considered.

Qualified privilege

5.234   Both auditors and their representatives will have qualified privilege in relation to answering questions at the AGM (see Schedule 1, item 122, proposed subsections 1289(3) and (4)).  This is explained further under Part 6 below.

Part 6:  Qualified privilege

5.235   Proposed section 990L (item 121) will replace the existing section 990L in relation to qualified privilege of auditors of financial services licensees.  The proposed section extends the qualified privilege provisions from individual auditors to registered company auditors acting on behalf of audit companies

5.236   Proposed section 1289 (item 122) will replace the existing section 1289 in relation to qualified privilege of auditors.  The proposed section extends the qualified privilege provisions from individual auditors to registered company auditors acting on behalf of audit companies. 

5.237   As the auditors of listed companies will be required to attend company AGMs under proposed section 250RA, proposed subsection 1289(3) makes it clear that qualified privilege is extended to apply to answers to questions asked before (as provided by proposed section 250PA) or during a company AGM.  Proposed subsection 1289(4) will also extend qualified privilege to a person representing the auditor at the AGM. 

5.238   Qualified privilege also applies to auditors in respect of disclosures made in response to requests for information given to the auditor by the Financial Reporting Council.  This provision is set out in relation to individual auditors, audit firms and companies in respect of financial services licensees and listed companies at proposed paragraphs 990L(1)(d), 990L(2)(d), 1289(1)(d) and 1289(2)(d).

5.239   A note indicating that qualified privilege applies in relation to responses to requests from the Financial Reporting Council has also been inserted into  proposed subsection 225A(5) of the ASIC Act, which provides for the chair of the FRC to make such requests, by item 17 in Schedule 1 of the Bill.

Part 7:  Expansion of auditors’ duties

Overview

5.240   The provisions in this part put in place requirements relating to the reporting of suspected contraventions of the law to ASIC.  Under current subsection 311(1) of the Corporations Act, a registered company auditor conducting an audit must notify ASIC in writing as soon as possible if the auditor has reasonable grounds to suspect that a contravention of the Act has occurred, and believes that the contravention has not been or will not be adequately dealt with by comment in the auditor’s report or by bringing it to the attention of company directors. 

5.241   As a result of the discretion of auditors to deal with any breaches in their report or by raising them with directors, there are concerns that the provision has not been used as effectively as it could have otherwise been. 

5.242   The amendments to sections 311 (and 601HG which contains similar requirements to section 311) balance the need to ensure the profession is able to conduct its business in a flexible way, but at the same time recognise the important role that auditors play as the principal external check on the veracity of companies’ financial statements.  As such, auditors are in a unique position to determine whether there has been a contravention of the law.  The provisions harness the role of auditors by encouraging the timely disclosure of possible breaches of the law.

Reporting contraventions to ASIC

5.243   Item 123 replaces the existing section 311.  Proposed subsection 311(1) provides that an individual auditor who conducts an audit (which includes a review of a half-year financial report) must notify ASIC in writing where the auditor has reasonable grounds to suspect a significant contravention of the Corporations Act.  The auditor must do so as soon as practicable but in any case within 28 days.  Subsections 311(2) and (3) contain similar requirements in relation to audit companies and lead auditors. 

5.244   The effect of these subsections is that, in the case of a breach which is not significant, where the auditor believes that the matter could be adequately dealt with by comment in the auditor’s report or by raising it with directors, the auditor need not report the matter to ASIC.  If, however, the auditor does not believe that a breach would be adequately dealt with in this way, it must be reported. 

5.245   In determining whether a breach is significant, the auditor should consider the penalty applying in the event of a contravention and the affect of the contravention on, or the adequacy of information available about, the financial standing of the company (subsection 311(4)).  Issues which could be considered in determining whether a contravention is significant include: 

·        insolvent trading by the company;

·        a breach of accounting standards or the true and fair view requirement ;

·        a breach of Division 2 Part 2 of the ASIC Act;

·        suspected dishonest or misleading and deceptive conduct; and

·        a breach that may cause a significant loss to any person or class of persons.

5.246   The auditor must also report circumstances which amount to an attempt:

·        in relation to the audit, by any person to unduly influence, coerce, manipulate or mislead a person involved in the conduct of the audit; or

·        by any person, to otherwise interfere with the proper conduct of the audit.

5.247   A person is taken to be ‘involved in the conduct of the audit’ where they are the auditor, the lead or review auditor, a professional member of the audit team or any other person involved in the conduct of the audit (subsection 311(6)). 

5.248   To enhance compliance with proposed subsections 311(1), (2) and (3) and subsections 601HG(4), (4A) and (4B), the maximum penalty for breaching these requirements has been increased to 50 penalty units and/or 12 months imprisonment.  In light of the increased penalty and comments received from industry, the application of strict liability to these provisions has been removed.

5.249   Corresponding amendments to section 601HG are contained in item 124.  Item 127 amends existing subsection 990K(2) by adding a requirement that an auditor must give a report to ASIC in relation to any matter that, in the opinion of the auditor, constitutes an attempt to unduly influence, coerce, manipulate or mislead the auditor in the conduct of the audit (paragraph 990K(2)(c)).

Commencement

5.250   The commencement date for the amended provisions in sections 311, 601HG and 990K is 1 July 2004.

Part 8:  Companies Auditors and Liquidators Disciplinary Board

Overview

5.251   The Companies Auditors and Liquidators Disciplinary Board (CALDB) is a disciplinary body which receives and reviews applications made to it by ASIC or APRA in respect of the conduct of either registered company auditors or liquidators.  Under the existing structure of the CALDB, there are concerns about its operational capacity and its perceived independence from the accounting profession.  Schedule 1, Part 8 of the Bill amends the current provisions governing the CALDB (see Part 11 of the ASIC Act) to address these concerns.  In addition, the amendments facilitate the exchange of information between the CALDB and the professional accounting bodies for the purpose of assisting in the performance of their disciplinary functions.

5.252   The amendments will result in a change to the existing structure of the Board.  The CALDB is currently comprised of three members, including the Chairperson, a member selected by the Minister from a Panel of five nominees put forward by the ICAA and a member selected by the Minister from a Panel of five nominees put forward by CPA Australia (the CPAA).  It is the Board itself that currently hears matters coming before the CALDB.

5.253   As a result of the amendments contained in the Bill, the new Board of the CALDB will consist of fourteen people instead of three.  The overall Board may meet to determine procedural issues and to conduct the business of the Board.  However, the Board itself will no longer conduct hearings.  Instead, up to two Panels will sit under the Board and will be constituted to hear matters.  Members of each Panel will be chosen from the overall membership of the Board. 

5.254   Currently, accountants form the majority of the Board of the CALDB.  The importance of retaining accounting expertise on the Board to assist in the determination of particular disciplinary matters is recognised.  At the same time, to enhance the perceived independence of the Board, its composition will be changed to allow for a majority of non-accountants to hear matters coming before each Panel. 

5.255   This expanded membership will allow two Panels of the Board to sit at any given time and thereby hear and determine matters more expeditiously. 

5.256   A Panel will normally consist of five persons including: the Chairperson or Deputy Chairperson (who must have legal qualifications), one member from each of the prescribed professional accounting bodies (the CPAA and ICAA), and two members from the business community.  On certain occasions (such as in the case of purely administrative matters) the Chairperson may consider it more cost efficient and appropriate to constitute a Panel with three members.  A three person Panel would consist of the Chairperson or Deputy Chairperson, one accounting member and one business member.

Changes to membership of the Board of the CALDB

5.257   Currently, the practical effect of section 203 of the ASIC Act is that the majority of the Board are accountants.  Items 135 to 137 amend section 203 to provide for a reconstitution of the membership of the CALDB.  These amendments provide for additional members to be appointed to the Board who are not members of the professional accounting bodies.

5.258   The Minister will be responsible for appointing six representatives from the business community who must have qualifications, knowledge or experience in business or commerce, the administration of companies, financial markets, financial products and services, economics or law.

5.259   The number of accountants appointed to the Board will also be increased.  Three members must be chosen from seven nominees put forward by the ICAA, along with three members chosen from seven nominees put forward by the CPAA.  The business and accounting appointees must be resident in Australia.

5.260   The overall Board membership will also consist of a Chairperson, and a new position will be created for a Deputy Chairperson.  The appointment of a Deputy Chairperson will allow the CALDB to hold more than one hearing simultaneously.  The Deputy Chairperson must be a legal practitioner enrolled to practice in a Supreme Court of a State or Territory, or a court of higher jurisdiction, for not less than five years.

5.261   Due to the revised constitution of the CALDB and the appointment of additional members, it will no longer be necessary to appoint deputy members generally.  Therefore, item 145 repeals section 209 and item 153 repeals subsection 212(1).

Terms and conditions of appointment

5.262   Items 138 to 143 provide for the terms of appointment of the Chairperson, Deputy Chairperson and members, including the basis on which: they are appointed, they may resign, or their appointment may be terminated.

Provisions for Acting Chairperson and Acting Deputy Chairperson

5.263   Item 144 replaces existing section 208 of the ASIC Act with proposed sections 208 and 208A.  These sections provide for acting arrangements where there is a vacancy in the position of the Chairperson or Deputy Chairperson.

5.264   Proposed section 208 provides that during either the Chairperson’s absence or a vacancy in the office of Chairperson or when for any reason the Chairperson cannot perform their functions, the Deputy Chairperson would normally fill the Chairperson’s position.  If the Deputy Chairperson is unavailable when a replacement is required, the Minister may appoint another eligible person to act as Chairperson.

5.265   Proposed section 208A provides that the Minister may appoint a person who is eligible for appointment as Deputy Chairperson to act in that position:

·        during the absence of the Deputy Chairperson;

·        during a vacancy in the office; or

·        when the Deputy Chairperson is acting as Chairperson under proposed subsection 208(1).

Meetings of the Board of the CALDB

5.266   Items 146 and 147amend existing section 210 to provide for the conduct of meetings involving the overall Board of the CALDB.  Item 146 inserts subsection 210(1A) which precludes any of the rules in section 210 from applying to a meeting of a constituted Panel.  Item 147 amends subsection 210(3) to provide that at a meeting of the Board, the Chairperson plus five other members will comprise a quorum.

The Constitution of a Panel and Panel Meetings

5.267   Item 148 inserts into the ASIC Act proposed section 210A, which sets out how a Panel is to be constituted to deal with an application made to the CALDB under section 1292 or 1295 of the Corporations Act.

5.268   Proposed subsection 210A(2) provides that the Chairperson is to determine in writing which members are to form a particular Panel.  The provision gives the Chairperson flexibility as to the convening of a Panel.  In some circumstances the Chairperson may wish to convene the Panel relatively quickly, such as in routine matters.  In other circumstances, the Chairperson may wish to give further consideration to a Panel’s composition to ensure that any conflicts of interest are avoided.  It is also recognised that to ensure the availability of the part-time members, it may be necessary to constitute a Panel as close as possible to the date of the hearing.

5.269   Pursuant to subsections 210A(3), (4) and (5), while the Chairperson has discretion as to how they constitute a panel, wherever possible, the Chairperson should constitute a five member panel comprised of:

·        the Chairperson or Deputy Chairperson;

·        one member of the ICAA;

·        one member of the CPAA; and

·        two members of the business community.

5.270   Constituting a five person Panel may not be practicable or appropriate in certain circumstances, particularly in the case of more routine matters such as where a respondent has failed to lodge an annual statement, or in the case of similar matters of an administrative nature.  In such circumstances, the Chairperson may choose to constitute a three person panel comprised of:

·        the Chairperson or Deputy Chairperson;

·        one member of the ICAA or the CPAA; and

·        one member of the business community.

5.271   Where, after a hearing has commenced, a member of the Panel becomes permanently unavailable, the matter must be reheard by a new Panel determined by the Chairperson unless the parties consent to the matter continuing (proposed subsections 210A(6) and (7)).  If the Panel is reconstituted, it is to consist of the original members of the Panel, plus a replacement member.  To avoid duplication of proceedings, the reconstituted panel may have regard to any record of the previous Panel’s proceedings (proposed subsection 210A(8)).

5.272   Since the members will be part-time, it is recognised that on occasions a Panel member may be temporarily unavailable to attend a meeting of a Panel.  To provide for a Panel meeting to proceed where these circumstances arise, proposed subsections 210B(2) and (3) provide for a quorum of the Panel.

5.273   The quorum for a five person Panel is three persons, comprising the Chairperson or Deputy Chairperson, one member from either the ICAA or the CPAA, and one member from the business community.  The quorum for a three person panel is two persons, comprising the Chairperson or Deputy Chairperson and the accounting member.  The quorum provisions are not intended to be used to allow a panel to continue operating where a panel member becomes permanently unavailable.  In these circumstances, the Panel should be reconstituted or the consent of the parties should be obtained, pursuant to proposed subsection 210A(7).

Disclosure of interests

5.274   Items 149 to 152 amend existing section 211 to require the Chairperson, Deputy Chairperson and other members to disclose any interest in a matter that is to be considered by the Board of the CALDB or by a Panel of the CALDB.  The disclosure shall be recorded in the minutes and the relevant member may not normally be present during deliberation of the matter, or take part in any decision by the CALDB or by a Panel on the matter.

Sharing of information

5.275   Items 154 and 155 amend current section 213 to provide that information given to a Panel is to be treated with the same confidentiality as if it were provided to the CALDB.  However, to aid the accounting bodies in their disciplinary activities, disclosure of relevant information will be authorised where it is to assist a professional accounting body or other prescribed professional body to perform its disciplinary function.  This will also allow scope for the CALDB to share information with other disciplinary bodies (for instance, a legal professional body or an insolvency body) as appropriate.

Panel powers and responsibilities

5.276   Items 157 to 163 amend existing section 216.  The changes reflect the distinction made in the Bill between the Board itself and the Panels convened to hear particular matters.

5.277   Where the Board decides to take disciplinary action against an individual, under subsection 1296(1) of the Corporations Act, a notice setting out the decision must be lodged with ASIC and published in the Gazette.  Item 177 provides that, where relevant, the notice should also identify the company or firm to which the individual belongs.

Miscellaneous Amendments

5.278   Items 164 to 175 make technical amendments to existing sections 217 to 221 and 223 of the ASIC Act so as to refer to the Panel Chairperson or Panel where appropriate (rather than to the Chairperson or Disciplinary Board).

5.279   Item 176 corrects cross-referencing anomalies in existing section 1292 of the Corporations Act.

5.280   Item 178 amends existing subsection 1317B(2) of the Corporations Act to include APRA as a party whose interests may be affected by a decision of the CALDB.  This reflects that APRA is a party that may make an application to the CALDB under section 1292 of the Corporations Act. 

Transitional arrangements

5.281   Proposed subsection 287(5) of the ASIC Act (see item 1 of Schedule 12) provides that the relevant changes to the CALDB made by the amendments contained in Schedule 1 of the Bill apply to applications made to the CALDB on or after 1 July 2004.

5.282   Proposed subsection 287(4) of the ASIC Act (see item 1 of Schedule 12) allows for a deputy member who is involved in a matter which begins before 1 July 2004 and extends beyond that date — to retain their position until the matter has concluded.  This transitional provision has been included because the Bill generally abolishes the positions of deputy members.



Schedule 2:  Financial reporting

5.283   Schedule 2 of the Bill contains the following amendments:

Part 1

CEO and CFO declarations in relation to listed entity’s financial report

Part 2

Content of directors’ report for listed public companies

Part 3

Financial Reporting Panel

 

Part 1:  CEO and CFO signoff

Overview

5.284   The Corporations Act requires directors to declare whether, in their opinion, the financial statements and notes are in accordance with the Act (including the accounting standards) and with the requirement that the financial statements and notes give a true and fair view of the company’s financial position.  However, the Act is silent on what inquiries, or other action, should be taken by the directors prior to making their declaration.

5.285   In practice, many Chief Executive Officers (CEOs) of listed companies are executive members of the board and must sign off on the accounts as directors.  In addition, companies will often require the CEO and/or Chief Financial Officer (CFO) to sign off to the board as a matter of best practice.

5.286   In the United States, the Sarbanes-Oxley Act, which was enacted by the US Congress largely in response to a number of major corporate and accounting scandals, introduced a requirement under which the CEO and CFO of an issuer have to certify that periodic financial statements filed with the Securities and Exchange Commission (SEC) fairly present the operations and financial condition of the issuer.

5.287   The JCPAA’s Report 391 ( Review of Independent Auditing by Registered Company Auditors ) recommended that the Corporations Act be amended to require the CEO and CFO of a company to sign a statutory declaration that the company’s financial reports comply with the Corporations Act and are materially truthful and complete.  The report further recommended that the declaration be attached to the company’s financial reports when they are lodged with Australian Securities and Investments Commission (ASIC) and provided to the company’s members and the market operator pursuant to the Corporations Act.

5.288   Following consideration of overseas developments, the JCPAA’s recommendation and comments in a number of public submissions on CLERP 9 recommending the adoption of a CEO/CFO sign off requirement, the Corporations Act will be amended to require CEOs/CFOs to certify to the directors of a listed entity that:

·        the annual financial statements are in accordance with the Corporations Act and accounting standards; and

·        the statements present a true and fair view.

5.289   The sign-off requirement will not derogate in any way from the directors’ responsibilities in relation to the financial report.

Directors’ declaration

5.290   Item 1 amends subsection 295(4) by adding a requirement for directors of a listed entity to state, in the declaration they are required to make pursuant to subsection 295(4), that they have been given a declaration by the CEO and CFO in relation to the entity’s financial statements.

Declaration by CEO and CFO

5.291   Item 2 inserts section 295A which sets out the requirements for the declaration that is to be made by the CEO and CFO.

5.292   The directors of a listed entity are not to make the directors’ declaration under subsection 295(4) until they receive declarations from both the CEO and CFO saying whether, in the opinion of the person making each declaration:

·        the financial records of the entity for the financial year have been properly maintained in accordance with section 286;

·        the financial statements, and the notes referred to in paragraph 295(3)(b), for the financial year comply with the accounting standards; and

·        the financial statements and notes for the financial year give a true and fair view (proposed subsections 295A(1) and (2)).

5.293   Proposed paragraph 295A(2)(d) provides that the regulations may prescribe additional matters that need to be covered in the declarations by the CEO and CFO.  This requirement is intended to add long-term flexibility to the provision.  There is no current intention to prescribe any matters.

5.294   Each declaration made by a CEO and CFO must be in writing, specify the date on which it was made, the capacity in which the person is making the declaration and be signed by the person making it.  Where a person performs the duties of both CEO and CFO, they are only required to make one declaration (proposed subsection 295A(3)).

5.295   To facilitate the drafting of proposed section 295A, the terms ‘chief executive function’ and ‘chief financial officer function’ have been developed (see proposed subsections 295A(4) and (6)).

5.296   Where no one person performs either the chief executive function or the chief financial officer function, but a number of people together perform one or both of those functions, each of those people is required to make a declaration (proposed subsections 295A(5) and (7)).

5.297   Proposed subsection 295A(8) is designed to ensure that the declarations made by the CEO and CFO do not derogate from the primary responsibility of directors to ensure that the financial statements comply with the Corporations Act.

Transitional arrangements

5.298   Proposed subsection 1465(1) of the Corporations Act (see item 2 of Schedule 12) provides that the amendments in Part 1 of Schedule 2 apply in respect of financial years that commence on or after 1 July 2004.

Part 2:  Content of directors’ report for listed public companies

Overview

5.299   Recommendation 13 of the HIH Royal Commission (HIHRC) proposed, among other things, that the Corporations Act be amended to require the inclusion of an operating and financial review as part of an annual report and that the disclosures be the subject of audit.

5.300   In Australia, discussion and analysis-type disclosures are contained in the Australian Stock Exchange (ASX) Listing Rules and accounting standard AASB 1039 Concise Financial Reports .

5.301   The only Corporations Act provision currently dealing with the preparation of information similar to that normally contained in a discussion and analysis-type commentary is subsection 299(1), which requires the inclusion of a range of general information (including a review of operations, details of any significant changes in the entity’s state of affairs and the entity’s principal activities and any significant changes in the nature of those activities) in the annual directors’ report.

5.302   The Bill requires the preparation of an operating and financial review.  However, as such disclosures are usually of a descriptive nature and reflect directors’ views about the past, present and future performance of a company or group of companies, they not do readily lend themselves to audit.  Accordingly, the Bill will not require that the review be subject to audit.

Operating and financial review

5.303   Proposed section 299A, which is included in the Corporations Act by item 6, sets out the requirements for the operating and financial review.

5.304   Proposed subsection 299A(1) provides that the directors’ report must contain information that members of a company would reasonably require to make an informed assessment of:

·        the operations of the entity;

·        the financial position of the entity; and

·        the entity’s business strategies and its prospects for future financial years.

5.305   The preparation of an operating and financial review is increasingly being accepted in the world’s capital markets as an integral part of good corporate governance and high quality financial reporting.  As such, it is a means of providing users of financial statements with an analysis of a company’s business as seen through the eyes of the directors.

5.306   The content requirements for the review have been expressed in broad terms.  The purpose of this is:

·        to enable directors to make their own assessment of the information needs of members of the company and tailor their disclosures accordingly; and

·        to provide flexibility in form and content of the disclosures as the information needs of shareholders, and the wider capital market, evolve over time.

5.307   It is expected that, in considering the issues to be addressed in their review, directors will have regard to best practice guidance such as that prepared and published by the Group of 100 Inc (G100).  As noted earlier, use of the G100 guidance material is already supported by the ASX for the purpose of complying with listing rule 4.10.17.  The G100 guidance may be used for the purpose of satisfying the legislative requirements.

5.308   On the basis of the G100 guidance material, the issues that could be discussed and analysed in the report include:

·        corporate overview and strategy;

·        review of operations;

·        investments for future performance; and

·        review of financial condition.

5.309   While the requirements for the operating and financial review are in addition to the existing directors’ report disclosure requirements, it is envisaged that, in practice, the existing requirements will be addressed as part of the review rather than being presented as a separate report.

5.310   Proposed subsection 299A(2) provides that the requirements are applicable to:

·        an individual company or disclosing entity that is a listed public company when consolidated financial statements are not required; and

·        the consolidated entity if consolidated financial statements are required.

5.311   Proposed subsection 299A(3) provides that information about the entity’s business strategies for the future and its prospects for future financial years may be omitted from the report if the material would result in unreasonable prejudice to the company or disclosing entity.  However, where material is omitted from the report, that fact must be disclosed.  This provision is based on subsection 299(3), which permits certain information to be omitted from the annual directors’ report.

Other amendments

5.312   Items 3 to 5 and 7 to 9 make technical amendments to sections 285, 298, 300 and 314 of the Corporations Act by inserting cross-references to proposed section 299A (items 3 and 4) and existing section 300A (items 3, 5 and 7 to 9).

Transitional arrangements

5.313   Proposed subsection 1465(2) of the Corporations Act (see item 2 of Schedule 12) provides that the amendments in Part 2 of Schedule 2 apply in respect of financial years that commence on or after 1 July 2004.

Part 3:  Financial reporting panel

Overview

5.314   Currently where there is a dispute between ASIC and companies on the application of accounting standards and the true and fair view requirement contained in the Corporations Act, ASIC must initiate legal proceedings in order to resolve the matter.  The Bill establishes a Financial Reporting Panel (FRP) to resolve disputes between ASIC and companies concerning accounting treatments in financial reports.  The FRP represents a less expensive method of resolving these disputes and allows matters to be heard by persons with particular expertise.  This will overcome concerns about the unfamiliarity of courts with subject matter concerning the application of accounting standards and the true and fair view.

5.315   The FRP’s hearings are intended to be expeditious and informal and the parties will not require legal representation.  Following a hearing, if the FRP considers it warranted, it will encourage companies to voluntarily restate their financial reports in a manner that is considered consistent with the accounting standards and the true and fair view.  Such consensual agreements with companies would overcome existing concerns with judicial proceedings, which can be costly and slow, resulting in the market being misinformed about a company’s financial situation for prolonged periods.

5.316   The FRP’s findings will not be binding on either ASIC or the company and the dispute may ultimately be pursued in the Court.  ASIC in its enforcement role would be able to institute legal proceedings against the company at any time.  Where a company does not accept an FRP determination and ASIC subsequently initiates court proceedings, the Court may have regard to the findings of the FRP.

Establishment and membership of the FRP

5.317   Schedule 2, Part 3 of the Bill relates to the Financial Reporting Panel.  Item 10 amends paragraph 1(1)(d) of the ASIC Act to include the FRP in the list of bodies established under the ASIC Act.  Item 11 inserts a new Part, ‘Part 13  ¾ Financial Reporting Panel’ into the ASIC Act after existing Part 12.  Proposed Division 1 of Part 13 deals with general issues regarding the FRP.  Proposed section 239AA establishes the Financial Reporting Panel.

5.318   The FRP will consist of at least five members who may be part-time or full-time, and who will be appointed by the Minister (see proposed subsections 239AB(1) to (3)).  Although it is envisaged that the FRP would comprise around 30 part-time experts, there is no maximum limit placed on the amount of members who may be appointed.  This is to ensure that there is a wide enough pool from which to draw a panel of three members without any conflicts of interest to hear a particular matter.  To allow for flexibility in appointments, provision has been made for the appointment of full-time members.  The members must have experience or knowledge in accounting, auditing, business, the administration of companies, or law (proposed subsection 239AB(4)).  The Chairperson, appointed by the Minister, is to be a member of the FRP (proposed section 239AC).

5.319   Proposed sections 239AE to 239AL provide for terms of appointment of the Chairperson and members, resignation and termination, remuneration, leave of absence and acting arrangements for the Chairperson.

5.320   By 31 October each year, the FRP must prepare a report describing its operations for that financial year and give a copy to the Minister.  The Minister must table the report (proposed section 239AM).

Constitution of a particular panel of the FRP

5.321   Proposed Division 2 of Part 13 sets out how the FRP’s business will be conducted.  A Panel which is constituted to hear a particular matter will consist of a Chairperson, Deputy Chairperson and a third member.  The Chairperson may give directions as to which members are to sit on a Panel (see proposed subsections 239BA(1) to (3)).  If a member chosen for a particular Panel is no longer available (such as where a conflict of interest has arisen or where the member is unable to attend the hearing), before the proceedings are determined, the Chairperson may revoke their original directions and reconstitute the Panel by giving new directions (proposed subsection 239BA(4)).

Disclosure of interests

5.322   The members of a Panel which is to be constituted for a particular matter must disclose any conflicts of interest to the Chairperson and the parties involved.  A member with a conflict of interest must not take part in the Panel’s hearings or deliberations except with the Chairperson’s consent.  Such consent may only be given if the interest is immaterial or indirect and it will not prevent the member from acting impartially (proposed subsections 239BB(1) and (2)).

Confidentiality

5.323   The confidentiality requirements contained in section 127 of the ASIC Act will apply to the FRP (proposed section 239BC).

Interpretation

5.324   Proposed Division 3 of Part 13 has effect as if a reference to the FRP refers to the Panel as constituted for a particular matter.  Further, references to the Chairperson or Deputy Chairperson refer to the persons holding those positions on a Panel as constituted for the particular matter (proposed subsection 239CA(1)).

FRP Proceedings

5.325   Proposed section 239CB allows a Panel to conduct proceedings to exercise the FRP’s functions and powers.  The proceedings must be conducted in private unless a company that is a party to the proceedings elects for the hearing to take place in public (proposed subsections 239CC(1) and (2)).  If the company has chosen public proceedings, the Panel may require part of those proceedings to be private in order to protect another person’s interests or the confidentiality of certain evidence.  The Panel may give directions as to the persons who will be entitled to be present at private proceedings (see proposed subsections 239CC(3) to (5)).  ASIC is entitled to have a representative at the proceedings (proposed subsection 239CC(7)). 

5.326   To preserve confidentiality or the public interest, or to avoid unfair prejudice to a person’s reputation, the Panel may choose to prevent or restrict the publication of evidence or documents given to the Panel (see proposed section 239CD).

5.327   Pursuant to proposed subsections 239CE(1) and (2), a person may be summoned to appear at proceedings to give evidence and produce documents referred to in the summons.  For the purposes of giving evidence a person may be required to take an oath or make an affirmation (proposed subsection 239CE(3)).  A failure to comply with the requirements of proposed subsections 239CE(3) and (5) is an offence under proposed section 239CJ ().  Proposed section 239CL further provides that where a person fails to comply with the provisions of proposed section 239CE, the Panel may certify the failure to the Court and the Court may order the person to comply with matters specified in the Court order.  The FRP may pay witness expenses (proposed subsection 239CE(6)).

5.328   As a means of promoting the informal and expeditious nature of Panel proceedings, it is intended that parties to proceedings not be legally represented.  However, legal representation will be possible where leave is granted by the Panel (proposed section 239CG).  The provisions of proposed section 239CG are not meant to preclude an employee of a party who holds legal qualifications from attending the proceedings as a general representative.

5.329   In Panel proceedings, two members will form a quorum (proposed section 239CF).  Proposed sections 239CI and 239CK provide protections for Panel members, as well as prohibiting a person from acting in contempt of the Panel.  A breach of section 239CK will be punishable by up to 50 penalty units and/or imprisonment for 1 year.

5.330   As a way of ensuring that the FRP is able to achieve consistency in the conduct of Panel proceedings, it will be able to determine the procedural rules to be followed in proceedings (proposed subsection 239CH(1)).  The Panel is to observe the rules of procedural fairness to the extent that they are not inconsistent with the provisions of the Act or the regulations (see proposed subsection 239CH(4)).

Reference of a financial report to the FRP by ASIC

5.331   Item 14 inserts proposed new Division 9, dealing with the reference of a financial report to the FRP, at the end of Part 2M.3.  Under the Corporations Act, a company’s financial report must comply with accounting standards (existing section 296) and the financial statements and notes must present a true and fair view of the company’s financial position (existing section 297).  Existing sections 304 and 305 replicate these requirements in relation to half-yearly reports.  Where a company’s financial report does not comply with these provisions and ASIC wishes to refer the financial report to the FRP under section 323EC, ASIC must follow the notification and referral procedures set out in sections 323ED and 323EF.  

5.332   Before the referral, ASIC must notify the company in writing of its intention to refer the matter, identify and explain how the report fails to comply with the relevant financial reporting requirement(s), and outline the changes necessary to achieve compliance.  ASIC must also include a statement setting out the effect of section 323EC, which provides that ASIC may refer a financial report to the FRP in certain instances.  (See proposed section 323ED).

5.333   Within 14 days of receiving this notice, the company must respond and indicate what action, if any, it proposes to take (proposed subsection 323EE(1)).  A breach of this provision is a strict liability offence (subsection 323EE(1A) and is punishable by up to 25 penalty units.  Generally, the information contained in the company’s response cannot be used in evidence against the company if the matter later proceeds to court (proposed subsection 323EE(2)).

5.334   Following receipt of the company’s response, ASIC has 14 days in which to refer the matter to the FRP for its consideration (proposed paragraph 323EF(1)(d)). 

Reference of a financial report to the FRP by the Company

5.335   If ASIC has informed a company that the financial report does not comply with the financial reporting requirements, the company may, with ASIC’s consent, refer the matter to the FRP (pursuant to section 323EG).  The legislation does not prescribe a mechanism for ASIC to notify the company.  This will provide some flexibility as to how companies may be notified by ASIC.  The requirement for ASIC’s consent is intended to ensure that a referral by a company is not made at a point in time when ASIC is merely at an information gathering stage.  It should be noted that a decision by ASIC to refuse consent is not reviewable by the Administrative Appeals Tribunal.  The company may be charged a fee for making a referral to the FRP.  The Corporations (Fees) Amendment Bill 2003 specifies that a referral of a matter to the FRP is a chargeable matter under section 4 of the Corporations (Fees) Act 2001 .

5.336   Under section 323EH(1), the company must apply to ASIC in writing to obtain ASIC’s consent to a referral.  The application must identify the financial reporting requirements which are being disputed with ASIC and outline how the company’s report complies with the relevant requirements (subsection 323EH(2)).

5.337   If ASIC consents to a referral to the FRP, ASIC must give the company a statement containing ASIC’s reasons for believing that the financial report does not comply with each of the relevant financial reporting requirements (section 323EH(3)).  It is contemplated that ASIC’s consent to the company’s referral would be evidenced by this statement.

Referral to the FRP

5.338   All referrals must be in the prescribed form.  A referral to the FRP by ASIC must comply with section 323EF while a company’s referral must comply with section 323EI.  A copy of the referral must be provided to the other party on the day on which the referral is made (subsections 323EF(3) and 323EI(3) respectively).  Within seven days after a financial report is referred to the FRP, the FRP must notify ASIC and the company of the cut-off date by which written submissions must be made (section 323EJ(1)).  The cut-off date must be at least 14 days after the date of the notice (proposed section 323EJ(2)).  It is intended that, wherever possible, the Panel will resolve the matter on the basis of the written submissions.

FRP to consider the financial report

5.339   The Panel must prepare a report that states whether the financial report complies with the relevant reporting requirement(s) (section 323EK(1)).  If ASIC has referred the matter and the financial report does not comply, the Panel must indicate what changes are necessary in order for the financial report to comply with the reporting requirements in the Corporations Act.  This is mandated because where the regulator has referred the matter, it is essential that the company be informed of the specific changes necessary to achieve compliance.  If the company has referred the matter and the report does not comply, the Panel may choose to indicate the changes necessary to bring about compliance.  The Panel’s report must not include any confidential commercial information obtained in the Panel proceedings (proposed subsection 323EK(1C)). 

5.340   The Panel’s report must be provided to ASIC and to the company within 60 days from when the matter was referred to the FRP.  If the Panel gives notice to ASIC and the company within 60 days of the referral, the Panel may provide its report within 90 days (proposed subsection 323EK(3)).  In the case of publicly listed companies, the Panel must also give a copy of its report to the relevant market operator (proposed paragraph 323EK(2)(c)).

5.341   Where the company is publicly listed, once the Panel’s report is lodged with the market operator, the market operator must take reasonable steps to make the information available to the market (proposed subsection 323EK(5)).  This will ensure that users of the market are informed of the Panel’s findings regarding the company’s application of accounting standards in its financial report.  In addition, ASIC must take reasonable steps to publicise the report and the company’s response to the Panel’s findings (proposed subsection 323EK(4)).  If the company amends its financial report, there is provision for it to re-lodge the documents under existing section 322 of the Corporations Act.

5.342   In the case of unlisted companies, the Panel’s report will only be given to ASIC and the company (proposed subsection 323EK(2)(a) and (b)).  Once ASIC has received the Panel’s report, it must take reasonable steps to publicise the report, along with information concerning whether the company has made any recommended changes to its financial report (proposed subsection 323EK(4)).

5.343   ASIC’s obligation in relation to publicising the report may involve the relevant information being made available on the internet (proposed subsection 323EK(4)). 

Court may have regard to an FRP report

5.344   In the event that ASIC refers the matter to the Court for its consideration, the Court or a tribunal of fact may have regard to the Panel’s report in determining whether a company’s financial report complied with the relevant financial reporting requirements (proposed section 323EM).

Transitional arrangements

5.345   The commencement date for these provisions is 1 July 2004.  However, proposed subsection 1465(3) of the Corporations Act (see item 2 of Schedule 12) provides that the amendments in Part 3 of Schedule 2 apply to all financial reports (including financial reports for periods that started before 1 July 2004).



Schedule 3:  Proportionate liability

Overview

5.346   The Bill will amend the ASIC Act, the Corporations Act and the Trade Practices Act 1974 (Trade Practices Act) to ensure that proportionate liability applies to claims for damages for economic loss or property damage arising from misleading or deceptive conduct. 

5.347   Professionals in every jurisdiction in Australia are currently facing difficulty in obtaining affordable professional indemnity insurance.  It is essential that professionals be able to access this insurance to ensure that consumers can recover damages suffered in the event of negligently provided professional services.

5.348   The introduction of proportionate liability is one of the key measures on which all governments in Australia have agreed in order to improve the availability and affordability of professional indemnity insurance.

5.349   Proportionate liability involves a defendant being liable only for that portion of the damage for which the defendant is judged to be responsible.  Under proportionate liability, a plaintiff can only recover from a particular defendant that proportion of the loss for which the defendant is responsible.

5.350   One of the major criticisms of the current system of joint and several liability is that it leads to plaintiffs targeting “deep pocket” defendants, such as professional service providers and public authorities.  This leads to increased liability insurance premiums for these potential defendants.  Proportionate liability ensures that professionals, such as auditors, who hold professional indemnity insurance do not bear a disproportionate burden of claims where their co-defendants are uninsured.

5.351   Commonwealth, State and Territory governments have agreed to introduce proportionate liability for economic loss and property damage so that it operates, as far as possible, on a nationally consistent basis.  The Commonwealth has agreed to amend the ASIC Act, the Corporations Act and the Trade Practices Act to ensure that proportionate liability for economic loss or property damage applies in both State and Federal jurisdictions.

5.352   The Commonwealth, State and Territory Governments have endorsed the following key features of a model of proportionate liability:

·        in applying proportionate liability to a claim, a Court will be able to have regard to the comparative responsibility of any wrongdoer who is not a party to the proceedings;

·        a defendant to a claim to which proportionate liability can apply, will be obliged to notify the plaintiff in writing, at the earliest possible time, of the identity and alleged role of any other person(s) of whom the defendant is aware, who could be held liable for the plaintiff’s loss or any part of it;

·        where a defendant fails to discharge the disclosure obligation proposed, the Court will have a discretion to order that the defendant pay any or all of the plaintiff’s costs, on an indemnity basis or otherwise; and

·        intentional torts and claims involving fraud will be excluded from the application of proportionate liability, and the law governing  vicarious liability, the liability of partners in a partnership and the liability of a principal for acts of an agent within the scope of the agent’s commission, will not be affected.

5.353   Under the agreed model, the law governing contributory negligence in the States and Territories will also not be affected.  To ensure that the Commonwealth provisions on proportionate liability operate consistently with the State and Territory proportionate liability systems, the Bill includes provisions to ensure that a plaintiff’s contributory negligence is taken into account in apportioning liability for the loss or damage (see proposed subsection 12GF(1B) of the ASIC Act, proposed subsection 1041I(1B) of the Corporations Act and proposed subsection 82(1B) of the Trade Practices Act).

5.354   Schedule 3 of the Bill implements the agreed model in relation to the relevant Commonwealth legislation by making corresponding amendments to the ASIC Act, the Corporations Act and the Trade Practices Act.

5.355   The Bill applies the proportionate liability regime to claims for damages for economic loss or property damage in respect of a contravention of the misleading and deceptive conduct provisions contained in the ASIC Act (subsection 12GF(1)), the Corporations Act (subsection 1041I(1)) and the Trade Practices Act (section 52) (see items 1 to 6). 

Amendments to the ASIC Act

Claims to which proportionate liability applies

5.356   The new rules for determining the proportionate liability of concurrent wrongdoers will only apply to apportionable claims.  An apportionable claim is a claim is made under section 12GF for economic loss or damage to property caused by conduct that was done in a contravention of section 12DA.

5.357   Proposed subsection 12GP(2) provides that there is a single apportionable claim in proceedings in respect of the same loss or damage even if the claim for the loss or damage is based on more than one cause of action.

5.358   Proposed subsection 12GP(3) defines the term ‘concurrent wrongdoer’.  A concurrent wrongdoer, in relation to a claim, is a person who is one of two or more persons whose acts or omissions, independently of each other or jointly, caused the damage or loss that is subject to the claim.

5.359   Proposed subsection 12GP(4) provides that for the purposes of this Subdivision, apportionable claims are limited to those claims specified in subsection (1).

5.360   Proposed subsection 12GP(5) provides that for the purposes of this Subdivision, it does not matter that a concurrent wrongdoer is insolvent, is being wound up or has ceased to exist or died.

Certain concurrent wrongdoers not to have benefit of apportionment

5.361   Proposed section 12GQ makes it clear that certain concurrent wrongdoers in proceedings involving an apportionable claim will not have their liability limited by the new apportionment provisions.  The concurrent wrongdoers who will be excluded are:

·        concurrent wrongdoers who intended to cause the economic loss or damage to property that is the subject of the claim; and

·        concurrent wrongdoers who fraudulently caused the economic loss or damage to property that is the subject of the claim.

5.362   Proposed section 12GQ will ensure that such excluded concurrent wrongdoers will have their liability determined in accordance with any relevant legal rules (apart from those in proposed Subdivision GA.  However, the liability of any other non-excluded concurrent wrongdoer will continue to be limited by the apportionment provisions.

Proportionate liability for apportionable claims

5.363   Proposed subsection 12GR(1) provides that the liability of a defendant who is a concurrent wrongdoer in proceedings involving an apportionable claim is to be limited to an amount reflecting that proportion of the damage or loss claimed that the court considers just having regard to the extent of the defendant’s responsibility for the damage or loss.

5.364   Proposed subsection 12GR(2) provides that if proceedings involve both an apportionable claim and some other claim, then only the apportionable claim is to be determined in accordance with the proposed Subdivision GA.  Existing law will continue to apply to the non-apportionable claim.

5.365   Proposed subsection 12GR(3) provides that in apportioning responsibility between defendants in the proceedings:

·        the court is to exclude that proportion of the loss attributable to a plaintiff’s contributory negligence under any relevant law; and

·        the court may have regard to the comparative responsibility of any concurrent wrongdoer who is not a party to the proceedings.

5.366   Proposed subsection 12GR(4) provides that the section applies in proceedings involving an apportionable claim whether or not all concurrent wrongdoers are parties to the proceedings.

5.367   Proposed subsection 12GR(5) provides that a reference in this Subdivision to a defendant in proceedings includes any person joined as a defendant or other party in the proceedings (except as a plaintiff) whether joined under this Subdivision, under rules of court or otherwise.

Defendant to notify plaintiff of concurrent wrongdoer of whom defendant aware

5.368   Proposed section 12GS provides that where a defendant who has reasonable grounds to believe that a particular person may be a concurrent wrongdoer in relation to the claim, fails to give the plaintiff, as soon as practicable, written notice about the identity of the person, then the court may order the defendant to pay all of the costs in the proceedings which the plaintiff has unnecessarily incurred.  The costs order may be made on an indemnity basis or on some other basis.

Contribution not recoverable from defendant

5.369   Proposed section 12GT provides that a defendant against whom judgment is given under this Subdivision cannot be required to contribute to any damages or contribution recovered from another wrongdoer in respect of the apportionable claim and cannot be required to indemnify any such wrongdoer.

Subsequent actions

5.370   Proposed section 12GU enables a plaintiff to bring an action against a concurrent wrongdoer even though the plaintiff has previously brought an action against another concurrent wrongdoer in respect of the same damage or loss.  However, in such subsequent proceedings the plaintiff cannot recover damages that would result in the plaintiff receiving compensation greater than the loss or damage actually sustained by the plaintiff.

Joining non-party concurrent wrongdoer in the action

5.371   Proposed section 12GV enables the court to join any one or more persons as defendants in proceedings involving an apportionable claim, unless a person was a party to any previously concluded proceedings in respect of the apportionable claim.

Application of Subdivision

5.372   Proposed section 12GW provides that certain matters are not affected by the proposed Subdivision.  In particular:

·        a person can still be held vicariously liable for a proportion of any apportionable claim;

·        a partner can still be held severally liable with another partner for the proportion of an apportionable claim for which the other partner is liable; and

·        any other statutory provisions imposing several liability will not be affected.

Amendments to the Corporations Act and the Trade Practices Act

5.373   Items 3 and 4 replicate the amendments described above in the context of the Corporations Act.  Items 5 and 6 replicate the amendments described above in the context of the Trade Practices Act. 

Transitional

5.374   Proposed section 1466 provides that the proportionate liability provisions contained in Schedule 3 apply to causes of action that arise on or after the day on which the Schedule commences.



Schedule 4:  Enforcement

5.375   Schedule 4 of the Bill contains amendments to the enforcement provisions in the Corporations Act.  Within the Schedule the amendments are grouped as follows:

Part 1

Revision of criminal penalties

Part 2

Protection for employees reporting breaches to ASIC

Part 3

Disqualification of directors

Part 4

Civil penalty provisions

Part 5

Other amendments

 

Part 1:  Revision of criminal penalties

Overview

5.376   Schedule 4, Part 1 of the Bill contains changes to the penalties attaching to breaches of section 1308 and 1309 of the Corporations Act.

5.377   Under subsection 1308(2), it is an offence to knowingly provide false or misleading information.  The penalty for a contravention of this provision is 100 penalty units and/or 2 years’ imprisonment.

5.378   Similarly, subsection 1309(1) prohibits an officer of a corporation from giving or making available false or misleading information to key corporate officers, auditors, and financial market operators.  Section 1309 has a penalty of 100 penalty units and/or 2 years’ imprisonment for intentional conduct and 50 penalty units and/or 1 year imprisonment for a negligent breach. 

5.379   The penalties attaching to these provisions have been increased as a means of reflecting the importance of the obligations that they contain.  In addition, the penalties have been amended to bring them into line with penalties for similar obligations contained in section 1041E (false information affecting the decision of others to acquire or dispose of financial products, or affecting the market price), section 1041G (engaging in dishonest conduct in relation to a financial service or product) and section 728(3) (the provision of misleading statements in an offer document that is materially adverse to an investor).

5.380   The penalty attaching to a breach of section 1308(2) and 1309(1) has been increased to 200 penalty units and/or 5 years’ imprisonment.  The penalty attaching to a breach of subsection 1309(2) has been increased to 100 penalty units and/or 2 years’ imprisonment.

Part 2:  Protection for employees reporting breaches to ASIC

Overview

5.381   Item 1 inserts a proposed new Part into the Corporations Act, ‘Part 9.4AAA ¾ Protection for whistleblowers’, after Part 9.4.  The provisions in this Part establish a framework which is designed to encourage employees, officers and subcontractors engaged by a company to report suspected breaches of the corporations law to either ASIC or internally within the company.  The provisions will prohibit employers from victimising employees, officers or subcontractors when they report a suspected breach in good faith and on reasonable grounds.  Further, the provisions provide the relevant employee, officer or subcontractor with qualified privilege in relation to a protected disclosure of information. 

Protection for disclosures of information

5.382   A disclosure of information regarding a suspected breach of the corporations legislation will be protected if the conditions outlined in proposed section 1317AA are met.  This provision applies to a person who:

·        is an officer of a company;

·        is an employee of a company;

·        has a contract for services with the company; or

·        is an employee of a person who has a contract for services with the company.

5.383   Where a person who falls within one of these categories has reasonable grounds to suspect that a company, a company officer or employee has breached a provision of the corporations legislation and discloses this in good faith, that disclosure will be subject to the protections outlined in section 1317AB.  The disclosure may be made to ASIC or an auditor, director, secretary or senior manager of a company, or to a person authorised by the company to receive such disclosures (proposed paragraph 1317AA(1)(b)).  Before disclosing the information however, the person must provide their name and the disclosure cannot therefore be made anonymously (proposed paragraph 1317AA(1)(c)).

5.384   It should be noted that any protected information provided to ASIC will attract the application of the confidentiality requirements contained in existing section 127 of the ASIC Act.

5.385   The protections which will be afforded to a person reporting a breach include protection against:

·        criminal and civil liability;

·        the enforcement of contractual remedies;

·        liability for defamation; and

·        termination of contract.

5.386   Importantly, proposed section 1317AB does not protect a person from liability for any illegal act or wrongdoing in which they have been involved.  While that person could not be subjected to victimisation (proposed section 1317AC), nor to criminal or civil liability for actually making the disclosure, a person who had previously broken the law could still be  the subject of a prosecution or civil proceedings in relation to that matter.

5.387   A person who knowingly provides false or misleading information to ASIC may be guilty of an offence, pursuant to Division 137 of the Criminal Code Act 1995. 

5.388   The Bill also prohibits any actual or threatened detriment being levelled against a person because of their disclosure (proposed subsections 1317AC(1) and (2)).  The type of detriment contemplated would include the termination of employment, a reduction in a person’s terms and conditions of employment, demotion, or unfair or unequal treatment in the workplace.  Where such detriment has occurred, it would be open to a Court to order a suitable remedy to address the detriment suffered.

5.389   Where a person contravenes either proposed subsection 1317AC(1), (2) or (3) they will commit an offence and may be subjected to a penalty of up to 25 penalty units and/or 6 months imprisonment.  Also, where damage is suffered by the victim as a result of the contravention, compensation may be available under proposed section 1317AD. 

5.390   The protection provided under Part 9.4AAA extends to disclosures regarding suspected breaches of the current and previous provisions of the Corporations Act, ASIC Act and regulations made pursuant to these Acts.  The application of the Criminal Code will also extend the protection afforded under the Part to disclosures made in relation to attempts, incitement or conspiracy to breach the law (proposed subsection 1317AA(2)).

5.391   It should be noted that the application of Part 9.4AAA relies on the disclosure being made in good faith.  This differs to requirements currently contained in section 89 of the Corporations Act which provide qualified privilege in circumstances where there is an ‘absence of malice’ in making the disclosure.  The use of ‘good faith’ is intended to raise the threshold for obtaining qualified privilege.  This is considered appropriate given the need to discourage malicious or unfounded disclosures being made and ensure the integrity of these provisions of the Bill.  Where a person has a malicious or secondary purpose in making a disclosure, it is considered that the good faith requirement would not be met.

Commencement

5.392   The proposed provisions in Part 9.4AAA of the Corporations Act will commence on the day after Royal Assent.

Part 3:  Disqualification of directors

Increase of maximum period of disqualification in section 206D

5.393   The Cole Royal Commission into the Building and Construction Industry made a number of recommendations concerning fraudulent phoenix company activity.  In particular it recommended that the periods of disqualification for directors contained in Part 2D.6 of the Corporations Act be increased.

5.394   Section 206D of the Corporations Act currently gives the Court power to disqualify persons from managing corporations for insolvency and non-payment of debts for a maximum period of 10 years.  Item 5 of Schedule 4 increases the maximum period of disqualification in section 206D from 10 to 20 years. 

Extending the period of automatic disqualification

5.395   Section 206B of the Act provides for an automatic five year disqualification period from managing corporations for persons convicted of an offence specified in that provision.  In addition to the amendments above, the Bill inserts proposed section 206BA which will allow Courts to disqualify persons for up to a further 15 years on application by ASIC (Item 4).  The additional potential disqualification period will apply only to disqualifications under section 206B that occur after 1 July 2004, being the proposed section 206BA commences operation (Schedule 12, Item 2).

5.396   ASIC must apply for an extended disqualification period prior to expiration of the first year of the automatic disqualification. 

Clarification of the disqualified persons register

5.397   Item 6 proposes to clarify the required content of ASIC’s register of banned and disqualified directors.

Part 4:  Civil penalty provisions

Overview

5.398   The amendments to the Corporations Act contained in this Part of the Bill will:

·        amend the maximum pecuniary penalty payable by a body corporate in relation to a contravention of a financial services civil penalty provision;

·        clarify that an application for a compensation order can be made in relation to contraventions of the civil penalty provisions regardless of whether a declaration of contravention has been made;

·        encompass references to compensation orders in relation to financial services civil penalty provisions in existing references to compensation orders relating to corporation/scheme civil penalty provisions; and

·        make a technical amendment.

Maximum financial services civil penalty

5.399   The maximum pecuniary penalty payable in relation to a contravention of a financial services civil penalty provision is currently $200,000 (for individuals and bodies corporate)(section 1317G).  While the maximum for an individual will remain $200,000, the maximum for a body corporate will be altered to $1 million (items 12 and 13). 

Declarations of contravention and compensation orders

5.400   Amendments to sections 1317H, 1317HA and 1317J will ensure that persons and bodies corporate can apply for a compensation order in relation to contraventions of the civil penalty provisions, and such compensation orders to be made, regardless of whether a declaration of contravention in relation to those civil penalty provisions has been made (items 14, 15, 16 and 17).  Applicants for a compensation order under sections 1317H and 1317HA will still have to prove a contravention and that damage resulted from it.

References to compensation orders

5.401   The existing reference to a ‘compensation order’ in the definition of a ‘civil penalty order’ (in section 9) will be amended to include a compensation order with respect to a contravention of a financial services civil penalty provision (item 8).  The existing reference is to a compensation order with respect to a contravention of a corporations/scheme civil penalty provision only.

5.402   To reflect the amended reference to a ‘compensation order’ and definition of a ‘civil penalty order’, items 9, 10, 11 and 18 amend:

·        the list of circumstances in which a company shall not indemnity an officer (paragraph 199A(2)(b) and subsection 199A(3)(note 1)); and

·        the circumstances in which a court may relieve a person from liability (paragraph 1044A(2)(a) and subsection 1317S(1)).

5.403   The purpose of these amendments is to ensure that the Corporations Act is clear and internally consistent.  They do not indicate a change of policy.

Technical amendment

5.404   A technical amendment to correct an erroneous cross-reference in the definition of a ‘civil penalty order’ in section 9 will be made (item 7).

Transitional arrangements

5.405   Proposed subsection 1467(3) of the Corporations Act (see item 2 of Schedule 12) provides that the amendments in Part 4 of Schedule 4 apply in relation to a contravention of a financial services civil penalty provision that occurs on or after the commencement day.

Part 5:  Other amendments

5.406   This Part of the Bill deals with the penalties that will be applicable to breaches of sections 308 and 309 of the Corporations Act.

5.407   At present, a contravention of subsection 308(1) is an offence of strict liability which attracts a penalty of 50 penalty units, imprisonment for 1 year or both (see table item 104 in Schedule 3 of the Corporations Act).  No penalty is currently specified in Schedule 3 of the Act for contraventions of any of the other requirements in sections 308 or 309.

5.408   To clarify the situation, contraventions of the requirements in each section will attract a penalty of 50 penalty units while contraventions of all requirements except those in subsections 308(2) and 309(2) will be offences of strict liability. 

5.409   Items 19 and 20 amend section 308 to provide that subsections 308(1), (3), (3A) and (4) are offences of strict liability (proposed subsection 308(5)) while item 21 makes the necessary amendments in respect of subsections 309(1), (3), (4), (5), (5A) and (6) (see proposed subsection 309(7)).

5.410   The penalties of 50 penalty units will be imposed by proposed table items 104 and 104A in Schedule 3 of the Corporations Act (see items 47 and 48 in Schedule 1 of the Bill).



Schedule 5:  Remuneration of directors and executives

Overview

5.411   Schedule 5 of the Bill contains amendments to:

·        sections 300 and 300A of the Corporations Act regarding the disclosure of director and executive remuneration; and

·        Division 2, Part 2D.2 governing the payment of termination benefits to directors.

5.412   These amendments are designed to strengthen the current provisions of the Corporations Act and address concerns surrounding disclosure of payments made to directors and executives. 

5.413   The Bill recognises that it is generally the function of members to approve the remuneration of directors and the function of directors to determine the remuneration of executives.  In performing their function, boards need to be accountable for their decisions and shareholders need to be in a position to exercise their rights in an active and informed way.  The provisions of the Bill are designed to achieve these objectives by promoting transparency and improving the accountability of those parties who determine remuneration. 

5.414   The Bill builds on measures proposed in the Corporations Amendment Bill 2002 (CAB), which was released for consultation at the end of 2002.  The CAB sought to clarify the current disclosure requirements in sections 300 and 300A of the Corporations Act.  These provisions have been incorporated into the CLERP 9 Bill and are being advanced as part of the broader changes proposed by the Government to the disclosure requirements (see items 9 and 11).

5.415   The amendments in this Bill seek to enhance the existing regulatory framework by:

·        extending the application of the disclosure requirements beyond the listed company to include the corporate group;

·        allowing the specific disclosures that must be made to be prescribed in regulations;

·        giving shareholders greater capacity to hold directors accountable for their decisions regarding remuneration; and

·        providing shareholders with greater say in relation to directors’ termination payments. 

5.416   As part of implementing the HIHRC recommendations, the Bill will rationalise definitions of ‘officer’ and ‘executive officer’.  A new definition will be inserted into the Corporations Act ¾ ‘senior manager’ ¾ which effectively covers paragraph (b) of the current section 9 definition of ‘officer’ (see Schedule 1, item 86 and Schedule 9).  The term ‘senior manager’ will be applied to the section 300A disclosure requirements.

5.417   The Bill also makes technical amendments to the definition of ‘remuneration’ in section 9 of the Corporations Act, to reflect anticipated changes in the accounting standards on which the definition is based.  The Bill removes the reference to the accounting standard dealing with related party transactions and instead refers to an accounting standard dealing with directors’ remuneration.

5.418   The reference to directors’ remuneration reflects the definition of remuneration in the Act, which is based on remuneration of an officer or employee, if had it been received by a director, would be remuneration for the purposes of an accounting standard.

Remuneration information to be on a group basis

5.419   Currently section 300A requires disclosure of the remuneration of directors and executives of a listed company.  The disclosures that are required by section 300A are part of the broader financial reporting framework in Part 2M.3 of the Corporations Act.  Other obligations in this Part require reporting on a consolidated basis.  For example, subsection 299(2) requires listed companies to prepare their annual directors’ report on a consolidated basis if they are required to prepare consolidated financial statements.

5.420   The Bill amends section 300A of the Corporations Act to require disclosure of the remuneration of directors and senior managers in relation to both the listed company and consolidated entity (items 11 and 12, proposed paragraphs 300A(1)(a) and 300A(1)(c)).  The intent of these provisions is to provide a better picture of remuneration practices across the corporate group and to prevent corporate structures being used as a way of circumventing the reporting requirements.

5.421   The effect of the amendments will be to retain the current requirement for the disclosure of remuneration in relation to the five most highly remunerated senior managers and all the directors of the listed company.  The provisions extend the disclosure requirements to the top five senior managers in the consolidated entity, where they differ from those in the listed company (item 12, proposed paragraph 300A(1)(c)(iii)).

5.422   In some circumstances the requirements may lead to the disclosure of the remuneration of up to 10 senior managers.  In other circumstances it may be less, for example where one or more of the senior managers is within the top five in the listed company and also in the top five within the corporate group.  In these circumstances the disclosure of that person’s remuneration need only be made once (item 12, paragraph 300A(1)(c)).  In determining this person’s remuneration, all sources of their remuneration from within the group must be taken into account (item 14, proposed subsection 300A(4)).

Specific content of the remuneration section of the annual directors’ report

5.423   The Bill provides that the details of remuneration to be disclosed will be prescribed in regulations (item 12, proposed paragraph 300A(1)(c)).  This will provide greater flexibility in tailoring the disclosure requirements. 

5.424   In making disclosures about director and executive remuneration companies should approach their obligation from the starting point of providing shareholders with comprehensive disclosure.  Shareholders should be placed in a position where they can understand the nature of the remuneration including any performance hurdles or contingencies on which the payment is based.

5.425   This will ensure shareholders are informed about the framework and main components of remuneration and understand the relationship between performance and remuneration.  In addition the disclosure framework will limit the element of surprise in the event of a payment being made especially where that payment accrued over a number of years.

5.426   In framing their disclosures, companies should also have regard to the guidance in the ASX Corporate Governance Council’s best practice recommendations.

5.427   The Bill requires the remuneration disclosures to be made in a clearly dedicated section of the annual directors’ report (item 10, proposed subsection 300A(1)). 

Specific disclosures

5.428   The Act will retain the current requirements in paragraphs 300A(1)(a) and 300A(1)(b) relating to the discussion of board policy and the relationship between remuneration and company performance.  The language of paragraph 300A(1)(a) has, however, been modified to reflect amendments originally proposed in the CAB and to extend the application of the provision to corporate groups.

5.429   Disclosures under proposed paragraph 300A(1)(a) and paragraph 300A(1)(b) should explain the basis on which remuneration packages are structured and how this relates to corporate performance.  To assist in meeting this obligation, the regulations will require disclosure of information such as performance hurdles to which the payment of options or long term incentives of directors and executives are subject; why such performance hurdles are appropriate and the methods used to determine whether performance hurdles are met.

5.430   The provisions of the Bill also allow the regulations to specify the disclosures that are to be made under proposed paragraph 300A(1)(c).  This section primarily relates to the quantitative elements of remuneration, although disclosure of the basis on which an individual’s remuneration is determined will also be required.  The regulations will require disclosure of the nature and amount of each element of the remuneration of the persons named in proposed paragraph 300A(1)(c) (item 12).

5.431   It is intended that the information to be disclosed in relation to remuneration paid or payable will be the same as that proposed to be disclosed under the accounting standards (see AASB ED 106 Director, Executive and Related Party Disclosures ).  The regulations may build on these requirements in relation to the basis on which remuneration is determined.

5.432   In the absence of an accounting standard, as a minimum, the following information will need to be disclosed:

·        primary benefits including cash and other incentive and base remuneration;

·        post-employment benefits, including retirement benefits and contributions by, or changes in the liability of, the entity to pension or superannuation plans and other arrangements to benefit employees following cessation of employment;

·        equity compensation; and

·        other compensation benefits not disclosed under the above categories. 

5.433   Prior to the commencement of the Bill, the progress of ED 106 will be monitored to determine how the actual regulations will be framed.  The AASB’s work program indicates that the standard is intended to be finalised in time for commencement of the provisions.

Discussion of remuneration disclosures at company AGMs

5.434   The Bill requires the chair of the AGM to allow reasonable opportunity for discussion by shareholders of the remuneration section of the directors’ report at the AGM (item 8, proposed section 250SA).  In addition, the directors must put, and allow shareholders to vote on, a non-binding resolution as to whether the members adopt the remuneration report (item 7, proposed subsection 250R(2)).  The notice of meeting must inform members that the resolution on the remuneration report will be voted upon (item 6, proposed subsection 249L(2)).

5.435   While the resolution will not be binding, the process provides an avenue for shareholders to collectively express their opinion on the remuneration paid to directors and senior managers and the board’s policy on remuneration.  This will facilitate more active involvement by shareholders and improve the accountability of directors for decisions regarding remuneration. 

5.436   The Bill expressly provides that the vote is advisory only and does not bind the directors or the company (item 7, proposed subsection 250R(3)).  The Bill is not intended to detract from the responsibility of directors to determine executive remuneration.

Shareholder approval of termination payments

5.437   Division 2, Part 2D.2 of the Corporations Act governs the circumstances in which shareholder approval is required before a benefit may be given to a person in connection with their retirement from ‘board or managerial office’.  ‘Board or managerial office’ effectively applies the provisions to company directors in all capacities in which they act within the company. 

5.438   Subsection 200B(1) prevents a payment being made in connection with retirement from board or managerial office unless shareholder approval is first obtained.  Sections 200F, 200G and 200H provide exceptions to this rule.  The Bill will modify the operation of two exemptions contained in section 200F.

5.439   Currently subparagraphs 200F(a)(ii) and (iii) allow a termination benefit to be paid to a director or former director without shareholder approval where that payment is:

·        a genuine payment by way of damages for breach of contract; or

·        given to that person under an agreement made before the person became a holder of that office as a part of the consideration for that person agreeing to hold the office.

5.440   The Bill will retain these exemptions but will limit the scope of their operation (item 5, proposed subsection 200F(2)).  Where a payment is made pursuant to one of these exemptions, shareholder approval will be required where the payment exceeds an amount calculated in accordance with the formula specified in subsection 200F(3) of the Bill or exceeds the value of one year’s remuneration, which ever is the greatest.  This approach is designed to address concerns that the operation of the formula would necessitate shareholder approval of relatively small payments in the event that a person’s employment is only for a limited period.  This is a result of the formula being based on average remuneration over the previous three years.  Payments that do not exceed either amount will not require shareholder approval. 

5.441   Remuneration for the purposes of this provision is determined by reference to an office holder’s entitlements during their most recent 12 months in office.  Where the office holder has been in office for less than 12 months a reasonable estimate of their remuneration, had they been in office for 12 months, must be made (item 5, proposed subsection 200F(4)).

5.442   It is envisaged that a reasonable estimate would be equal to the office holders’ actual and potential entitlements under their current remuneration agreement over the 12 months from the beginning of their time in office.

5.443   The provisions are intended to ensure that payments made to directors upon their retirement from office are subject to shareholder scrutiny where they may be large relative to the length of time in office or overall remuneration practices of the company.

5.444   These requirements will apply prospectively and will not impact on payments made under agreements existing at the time of commencement of these provisions (Section 1468, Schedule 12).



Schedule 6:  Continuous disclosure

5.445   Schedule 6 of the Bill contains amendments to the Corporations Act provisions dealing with continuous disclosure.  Within the Schedule the amendments are grouped as follows:

Part 1

General

Part 2

Infringement notices

 

Part 1:  General

Overview

5.446   The amendments to the Corporations Act contained in this Part of the Bill will extend civil liability for contraventions of the continuous disclosure provisions of the Corporations Act by disclosing entities to any other persons involved in a contravention.  They will enable ASIC to seek a pecuniary penalty order against an individual involved in a contravention by a disclosing entity, whereas previously such a penalty could only be sought against the entity itself.

5.447   The amendments are intended to apply to individuals with real involvement in a contravention of the continuous disclosure provisions, including individuals who: aided, abetted, counselled or procured the contravention; were knowingly concerned in, or party to, the contravention; and conspired to effect the contravention.  Involvement in a contravention therefore requires some form of intentional participation and actual knowledge of the essential elements of the contravention.  Furthermore, an individual involved in a contravention only faces a pecuniary penalty if the contravention is serious (section 1317G). 

5.448   Although participants in the decision-making process or those who have the capacity to effect disclosure (such as directors, executives and senior managers, for example) are most likely to possess such intention and knowledge, the amendments are not necessarily limited to this class of individuals.  For instance, involvement in a contravention may extend to staff or advisers that knowingly withhold from their superiors or clients, respectively, relevant information that leads to a contravention of the continuous disclosure provisions. 

5.449   The amendments are not intended to apply to individuals with less than real involvement in a contravention of the continuous disclosure provisions.  For example, individuals who pass on information produced elsewhere in the disclosing entity, such as those responsible for communication with the market operator in relation to listing rule matters, would not be taken to be involved in a contravention of the continuous disclosure provisions.  Furthermore, relief from liability is available if the individual acted honestly and in the circumstances ought fairly to be excused (section 1317S).

5.450   The prospect of financial penalties being imposed on individuals is expected to operate as a more credible and effective deterrent than the prospect of financial penalties being imposed on a body corporate alone.

Specific amendments

5.451   Sections 674 (Continuous disclosure  ¾ listed disclosing entity bound by a disclosure requirement in market listing rules) and 675 (Continuous disclosure  ¾ other disclosing entities) will be amended by inserting proposed subsections 674(2A) and 675(2A) (items 1 and 2).  The proposed subsections will extend civil liability for contraventions of the continuous disclosure regime by disclosing entities to any other persons involved in a contravention.

5.452   Section 1317E will be amended by broadening the list of continuous disclosure civil penalty provisions to include the provisions (subsections 674(2A) and 675(2A)) dealing with persons involved in a contravention of the continuous disclosure regime (item 3).

Transitional arrangements

5.453   Proposed subsection 1469(1) of the Corporations Act (see item 2 of Schedule 12) provides that the amendments in Part 1 of Schedule 6 apply in relation to a contravention of subsection 674(2) or 675(2) that occurs on or after the commencement day.

Part 2:  Infringement notices

5.454   The amendments to the Corporations Act contained in this Part of the Bill will provide a mechanism for ASIC to issue an infringement notice containing a financial penalty to a disclosing entity for an alleged contravention of the continuous disclosure provisions of the Corporations Act.

Overview

5.456   The mechanism operates in the following way:

·        If ASIC considers that an entity has contravened the continuous disclosure regime, ASIC notifies the entity in writing of the nature of the case against it. 

·        ASIC then holds a hearing, at which the entity is permitted to give evidence and make submissions.

·        If, following the hearing, ASIC forms an opinion that a contravention has occurred, it may issue an infringement notice notifying the entity of its opinion and indicating that the breach may be addressed through compliance with the infringement notice. 

·        Compliance with the infringement notice entails payment of the financial penalty and remedying any inadequate disclosure as specified in the notice.  The notice also states the effect of complying and failing to comply with the infringement notice within a certain period of time.

·        The financial penalty, which must be specified in the infringement notice, is either $33,000, $66,000 or $100,000, depending on whether the entity is a listed or unlisted disclosing entity and whether the entity had previously contravened the continuous disclosure provisions.  If the entity is listed, the financial penalty will depend on the entity’s market capitalisation.

-       These penalties are substantially less than the $1 million maximum civil penalty for a contravention of the continuous disclosure provisions by a body corporate (see Part 4 of Schedule 4 of the Commentary above). 

·        Compliance with an infringement notice is not taken as an admission by the entity of liability or a contravention of the Corporations Act.  Furthermore, if it complies, the entity is not subject to existing or further civil or criminal proceedings in relation to the alleged contravention, subject to certain exceptions. 

·        The use of publicity by ASIC in conjunction with infringement notices is strictly limited to compliance with a notice.  ASIC may only publish a copy of the notice and/or an accurate summary of the notice if such publicity includes express statements that compliance is not an admission of guilt or liability on the part of the entity and that the entity is not regarded as having contravened the provisions.  ASIC may not publish that a notice has been issued, or that an entity has failed to comply with a notice.

·        If the entity fails to comply with the infringement notice within the period of time specified in the infringement notice, ASIC cannot enforce the infringement notice. 

5.457   Instead, ASIC may bring civil proceedings against the entity in relation to the same alleged contravention.  If the court is satisfied that the entity contravened the continuous disclosure provisions, it must make a declaration of contravention (and, if ASIC has sought one, the court has discretion to make an order to disclose information or publish advertisements) against the entity.  The court must also impose a pecuniary penalty against the entity.

·        It is intended that the proposed infringement notice mechanism only be used in relation to less serious contraventions of the continuous disclosure regime.  However, if an entity fails to comply with an infringement notice and a court subsequently determines that a contravention has occurred, the maximum pecuniary penalty that the court can impose upon the entity is $1 million.

·        If an entity fails to comply with an infringement notice and ASIC is unable to satisfy the burden of proof in subsequent civil proceedings, ASIC cannot issue another infringement notice in relation to the alleged contravention. 

·        ASIC has the power to both issue and withdraw an infringement notice.  Prior to compliance with the infringement notice, and whether or not the entity makes representations seeking the withdrawal, ASIC may withdraw an infringement notice if it considers it appropriate.  In this case, the entity may be subject to civil or criminal proceedings in relation to the alleged contravention.

5.458   The mechanism supplements existing criminal and civil court procedures.  It remedies a significant gap in the current enforcement framework by facilitating the imposition of a relatively small financial penalty and requiring information disclosure in relation to relatively minor contraventions of the continuous disclosure provisions of the Corporations Act that would not otherwise be pursued through the courts.  The capacity to issue an infringement notice also allows ASIC to signal its views concerning appropriate disclosure practices to listed entities more effectively than through court action alone.

5.459   The process is not intended to amount to the imposition of a financial penalty by ASIC.  It is intended, instead, to provide a mechanism through which an entity that in ASIC’s opinion has contravened the regime may forestall an application to the courts by ASIC for the imposition of a financial penalty and the disclosure of specified information in relation to the contravention.

5.460   The proposed new mechanism strikes an appropriate balance between enhancing ASIC’s capacity to deal with relatively minor contraventions of the continuous disclosure provisions and ensuring that there are adequate procedural safeguards.

5.461   However, there may be concerns about a process under which ASIC investigates an alleged contravention and then holds a hearing to determine whether it should form an opinion that a contravention had occurred (and that an infringement notice should be issued).

5.462   In this regard, it is relevant to note that ASIC currently performs a similar role in relation to certain licences granted under the Corporations Act and directors involved in multiple insolvent companies.  ASIC decisions to suspend or cancel a financial services licence (which may have far more adverse implications for an entity than the imposition of a financial penalty) are made as a result of an administrative process.  The division of responsibility within ASIC between investigation and hearings in relation to determining whether an infringement notice should be issued will be comparable to that adopted in relation to financial services.

5.463   The imposition of financial penalties through administrative procedures is also common in overseas jurisdictions.  For example, the United Kingdom (UK) Listing Authority (UKLA) is able to impose financial penalties on listed entities (as well as their directors) in relation to contraventions of the UK listing rules, subject to the right of reconsideration by an independent tribunal.  Under the UK approach, the entity (or person) being investigated bears the onus of referring the matter to a hearing before the tribunal.  If the entity (or person) chooses not to refer the matter to the tribunal, or the tribunal finds in favour of the UKLA, then the UKLA’s action becomes enforceable.  Under the proposed new mechanism, however, ASIC cannot enforce the infringement notice if the entity elects not to comply with it, but must decide whether or not to take court action in relation to the same alleged contravention. 

5.464   Furthermore, the financial penalty specified in an infringement notice is substantially lower than the maximum financial penalty that could be sought through civil court proceedings.  If ASIC elected to pursue a contravention using the infringement notice process, it would not be able to commence or resume any other court action in relation to the matter (aside from enforcing any penalty that was eventually imposed by the court).  Finally, compliance with an infringement notice would not be taken as a contravention of the law by an entity for any other purpose.

5.465   The limitation on the size of the financial penalty nominated in the notice and restrictions preventing ASIC from taking other action in relation to conduct dealt with using this mechanism are intended to ensure that it is not used for more serious contraventions as an alternative to existing court processes.

Exclusion from AAT review

5.466   Item 8 of the Bill will amend section 1317C to provide that ASIC decisions in relation to the issuance and withdrawal of an infringement notice are excluded from review by the Administrative Appeals Tribunal (AAT).  AAT merits review of these decisions is inappropriate because there is no obligation on an entity to comply with the notice and non-compliance with the notice leaves ASIC with the decision whether or not to initiate court proceedings to enforce the continuous disclosure requirements. 

Definitions

5.467   Items 4 and 5 will amend section 9 of the Corporations Act by inserting definitions of the following terms that are used outside proposed Part 9.4AA of the Corporations Act:

·        ‘compliance period’ (for an infringement notice).  In practice, the phrase is defined in proposed section 1317DAH, which is described below in paragraph 0.

·        ‘infringement notice’.  In practice, the phrase means an infringement notice issued under proposed section 1317DAC, which is described below in paragraphs 0-0.

5.468   Items 6 and 7 will amend subsections 674(2) and 675(2) by inserting in each a note stating that an infringement notice may be issued for an alleged contravention of these subsections.

5.469   Item 9 will insert a new part, ‘Part 9.4AA Infringement notices for alleged contraventions of continuous disclosure provisions’, after Part 9.4 of Chapter 9.  Proposed Part 9.4AA contains provisions providing a mechanism for ASIC to issue an infringement notice containing a financial penalty to a disclosing entity for an alleged contravention of the continuous disclosure provisions.

5.470   For the purposes of Part 9.4AA, proposed subsection 1317DAA(1) includes definitions of:

·        ‘compliance period’ and ‘infringement notice’ (which have the same practical meaning as the definitional amendments made by Items 4 and 5);

·        various proceedings relating, or relevant, to the effect of an entity’s compliance, or failure to comply, with an infringement notice.  These proceedings include:

-       ‘compensation proceedings’.  This phrase refers to proceedings for compensation for loss or damages including in relation to:

-       a contravention of a financial services civil penalty provision; or

-       conduct in relation to financial services that is misleading and deceptive;

-       ‘contravention proceedings’.  This phrase refers to proceedings in relation to a contravention of the operating or compensation rules of a licensed market;

-       ‘enforcement proceedings’.  This phrase refers to proceedings in relation to the enforcement of a licensed market’s operating rules against the entity;

-       ‘penalty and disclosure proceedings’.  This phrase refers to proceedings to which the entity is liable if the entity elects not to comply with the infringement notice; and

-       ‘public interest proceedings’.  This phrase refers to proceedings that ASIC can bring on a person’s behalf for the recovery of the person’s property or the recovery of damages for fraud, negligence, default, breach of duty or any other misconduct.

5.471   Subsections 674(2) and 675(2) impose continuous disclosure obligations on disclosing entities.  If the disclosing entity is a registered scheme, subsections 674(3) and 675(3) impose the same obligations on the responsible entity for the registered scheme.  For the purposes of similarly applying Part 9.4AA to a disclosing entity that is a registered scheme, proposed subsection 1317DAA(2) clarifies relevant references.  For example, references to:

·        the disclosing entity are taken to be references to the responsible entity for the registered scheme; and

·        the disclosing entity’s securities are taken to be references to interests in the registered scheme.

5.472   Proposed section 1317DAB outlines the function of Part 9.4AA:

·        to provide a mechanism for ASIC to issue an infringement notice to a disclosing entity for an alleged contravention of the continuous disclosure provisions, as an alternative to civil court proceedings (proposed subsection 1317DAB(1)).

5.473   This proposed section also provides that:

·        ASIC is not obliged to issue an infringement notice;

·        the liability of an entity to court proceedings is unaffected if an infringement notice is either not issued or withdrawn; and

·        if an entity fails to comply with the infringement notice (and ASIC commences court proceedings), a court can impose a higher penalty than the infringement notice penalty (proposed subsection 1317DAB(2)).

Issue of an infringement notice

5.474   Proposed section 1317DAC provides for ASIC to issue an infringement notice to an entity that ASIC has reasonable grounds to believe has contravened the continuous disclosure provisions (proposed subsection 1317DAC(1)).

5.475   An infringement notice can only be issued once for the same alleged contravention.  It must be served on the entity.  It has no effect if it either is issued more than 12 months after the contravention allegedly occurred or relates to more than one alleged contravention (proposed subsections 1317DAC(2), (3) and (5)).

5.476   ASIC is required to take into account the relevant market operator’s guidelines to the listing rules regarding continuous disclosure and any other relevant matter in deciding whether to issue an infringement notice to a listed disclosing entity (proposed subsection 1317DAC(4)).  Guidelines to listing rules do not have the same status as listing rules under the Corporations Act ¾ they are not lodged with ASIC or subject to possible disallowance by the Minister and are not enforceable by statutory means.  The proposed subsection makes it clear that, while ASIC is required to take the guidelines into account, it is not bound by them.

5.477   Proposed section 1317DAD provides that before ASIC makes a decision whether or not to issue an infringement notice to an entity, the entity must be provided with a written statement containing ASIC’s basis for issuing an infringement notice for an alleged contravention.  An entity’s representative must be given an opportunity to give evidence and make submissions at a private hearing before ASIC in response to this statement (proposed subsection 1317DAD(1)).  The hearing before ASIC is conducted in accordance with the ASIC Act, which, for example, requires ASIC to observe the rules of natural justice and allows persons to be represented legally.

5.478   In addition to its obligation under proposed subsection 1317DAC(4) in relation to a listed disclosing entity, ASIC is required to consult with the relevant market operator for the entity before providing the entity with a written statement (proposed subsection 1317DAD(2)).  In cases where the entity is the market operator or is in competition with the market operator, consultation is not required (proposed subsection 1317DAD(3)).  Providing that ASIC is not required to consult with the market operator in these circumstances is intended to avoid conflicts of interest and is consistent with ASIC making decisions and taking action in relation to a self-listed market operator that would otherwise be taken by that market operator (subsection 798C(4) of the Corporations Act). 

5.479   The purpose of proposed subsections 1317DAD(1) — (3) is to allow ASIC to determine whether it should form an opinion that the entity has contravened the continuous disclosure provisions.  These provisions recognise and reinforce the role of the market operator as front-line regulator in relation to continuous disclosure by entities listed on its market, and do not change the balance of responsibilities between the market operator as front-line regulator and ASIC as statutory regulator.  They seek to ensure a consistent interpretation by the market operator and by ASIC of what constitutes a contravention of the continuous disclosure provisions.  Continued cooperation between market operators and ASIC is needed to ensure the effectiveness of the infringement notice mechanism.

5.480   Evidence given, and submissions made, by the entity’s representative at the private hearing before ASIC are inadmissible in evidence in subsequent court proceedings against either the entity or its representative, except criminal proceedings against the entity’s representative for giving false or misleading evidence or information (proposed subsection 1317DAD(4)).  The purpose of the provision is to ensure that if ASIC decides to issue an infringement notice with which the entity fails to comply, and ASIC commences court proceedings, the entity is not unfairly disadvantaged in those proceedings by the evidence and information that it has volunteered at the hearing.

5.481   Proposed section 1317DAE lists various matters that the infringement notice either must or may include.  In addition to the formal and administrative requirements in proposed paragraphs 1317DAE(1)(a)-(c), (h) and (m), the infringement notice must:

·        inform the entity of the nature of ASIC’s case against it in relation to the alleged contravention (proposed paragraph 1317DAE(1)(e));

·        specify the penalty payable (proposed paragraph 1317DAE(1)(g));

·        explain the consequences for the entity if it complies or fails to comply with the infringement notice within the compliance period (proposed paragraph 1317DAE(1)(k));

·        inform the entity that it may write to ASIC seeking the withdrawal of the infringement notice (proposed paragraph 1317DAE(1)(l));

·        inform the entity of the maximum pecuniary penalty that a court may impose (if ASIC commences proceedings against the entity following the entity’s decision not to comply with the infringement notice) (proposed paragraph 1317DAE(1)(f));

·        this Bill proposes to amend the civil penalty provisions to provide for a $1 million maximum civil penalty for a contravention of the continuous disclosure provisions by a body corporate ¾ see Part 4 of Schedule 4 of the Commentary above; and

·        inform the entity that compliance with the infringement notice may result in ASIC publishing details of compliance with the notice by publishing a copy of the notice in the Gazette and/or issuing a statement about the compliance (proposed paragraph 1317DAE(1)(d)).

5.482   The infringement notice may also require the entity to disclose specified information to either ASIC or the relevant market operator (proposed paragraphs 1317DAE(1)(i) and (j)).

Penalties specified in the infringement notice

5.483   For an alleged contravention of subsection 674(2), the penalty specified in the infringement notice is:

·        $100,000 if the entity’s market capitalisation on the relevant day exceeds $1,000 million;

·        $66,000 if the entity’s market capitalisation on the relevant day is between $100 million and $1,000 million; and

·        $33,000 if the entity’s market capitalisation on the relevant day is less than $100 million or it is not possible to work out its market capitalisation because a relevant financial report has not been lodged with ASIC (see paragraphs 0 and 0 below) (proposed subsection 1317DAE(2) and paragraph 1317DAE(6)(a)).

5.484   If the entity has at any time:

·        been convicted of an offence based on,

·        had a civil penalty order made against it in relation to a contravention of, or

·        breached an enforceable undertaking given to ASIC in relation to,

-       subsection 674(2) or 675(2), then the penalty specified in the infringement notice is $100,000 and $66,000 where the penalty specified would otherwise have been $66,000 and $33,000, respectively (proposed subsection 1317DAE(3)).

5.485   The relevant day on which an entity’s market capitalisation is calculated for the purposes of determining the financial penalty is the last day of the financial year of the latest financial report lodged by the entity with ASIC before the infringement notice is issued (proposed paragraph 1317DAE(6)(b)).

5.486   An entity’s market capitalisation on the relevant day is calculated by the following method:

·        For each of the entity’s class of quoted security (excluding options), the relevant day’s closing price for securities in that class is multiplied by the number of securities in that class on issue on the relevant day (as specified in the financial report for the period ending on the relevant day); and

·        Adding up those amounts (proposed subsection 1317DAE(7)).

5.487   The continuous disclosure of relevant, material price sensitive information by listed disclosing entities ensures an informed, efficient market, reduces volatility and minimises the opportunity for insider trading.  The purpose of basing the financial penalty on an entity’s market capitalisation is because the potential damage that results from an ill-informed market is proportional to both the amount of an entity’s securities that can be traded and the value of those securities.  Furthermore, ASIC has not been given discretion to set the financial penalty because flexible penalties for infringement notices are inconsistent with Commonwealth policy and could lead to legal problems.

5.488   For an alleged contravention of subsection 675(2), the penalty specified in the infringement notice is $33,000, or $66,000 if any of the three factors in paragraph 0 above apply to the entity (proposed subsections 1317DAE(4) and (5)).

Effect of compliance with an infringement notice

5.489   Proposed section 1317DAF explains the effect of an entity complying with an infringement notice.  Proposed subsections 1317DAF(1)-(3) provide that proposed subsections 1317DAF(4)-(7) apply if:

·        the compliance period has not ended, the infringement notice is not withdrawn and the entity has not paid the infringement notice penalty and (if required by the infringement notice) disclosed specified information to either ASIC or the relevant market operator; or

·        the entity complies with the infringement notice - ie, the entity, within the compliance period, pays the penalty specified in the infringement notice and if required by the infringement notice discloses specified information to either ASIC or the relevant market operator (in which case ASIC must not withdraw the infringement notice).

5.490   If either of the two scenarios in paragraph 0 above are satisfied:

·        the entity is not taken as having contravened the Corporations Act for any other purpose (proposed subsection 1317DAF(4)); and

·        new or existing proceedings in relation to the alleged contravention cannot be commenced or continued by ASIC on its own behalf against the entity, except for proceedings by ASIC to enforce an order for the recovery of expenses of an investigation related to the alleged contravention (proposed subsections 1317DAF(5) and (7)).

5.491   Compliance with an infringement notice brings the process for enforcing the alleged contravention to an end after its administrative phase (proposed subsections 1317DAF(4) and (5)).  This reflects the intention behind the infringement notice mechanism of providing a process through which the entity may forestall court proceedings by ASIC in relation to the alleged contravention.

5.492   Compliance with an infringement notice by the entity does not, however, forestall civil proceedings brought by ASIC against persons involved in an alleged contravention by the entity of the continuous disclosure provisions.  The reason behind this is that the infringement notice is issued to the entity and not to its officers.

5.493   Despite the entity’s compliance with the infringement notice neither constituting an admission of contravention nor making the entity liable to further civil or criminal proceedings instituted by ASIC on its own behalf, the conduct that constituted the alleged contravention may have resulted in adverse consequences for shareholders, other bodies corporate, market licensees and/or other persons.  The purpose of proposed subsection 1317DAF(6) is to allow these classes of persons to commence or continue compensation proceedings, contravention proceedings, enforcement proceedings and public interest proceedings to seek redress (see paragraph 0 above for explanation of these proceedings).

5.494   Individuals adversely affected by the entity’s conduct should have the right to compensation and redress in accordance with the law whether or not an infringement notice has been issued or complied with, or whether ASIC had commenced civil penalty or criminal proceedings in relation to the alleged contravention.  It would be inappropriate to deny such individuals’ rights of action because ASIC chose to enforce the continuous disclosure obligations by issuing an infringement notice.  Furthermore, the law as it now stands involves the possibility of parallel compensation proceedings where there is a contravention of the corporation/registered scheme or financial services civil penalty provisions.

5.495   The exception in proposed subsection 1317DAF(6) also extends to:

·        proceedings to enforce orders, including proceedings in respect of a breach of an enforcement order; and

·        appeals against decisions or orders,

-       (including costs orders, except in relation to public interest proceedings) made in relation to compensation proceedings, contravention proceedings, enforcement proceedings and public interest proceedings.

Effect of failure to comply with an infringement notice

5.496   Proposed section 1317DAG explains the effect of an entity failing to comply with an infringement notice.  It is structured in a similar manner as proposed subsection 1317DAF and provides that proposed subsections 1317DAG(2)-(5) apply if an infringement notice is not withdrawn (proposed subsection 1317DAG(1)).

5.497   As mentioned above, compliance with an infringement notice involves payment of the specified penalty and the disclosure of specified information (if required by the infringement notice).  The table in proposed subsection 1317DAG(2) outlines the proceedings brought by ASIC to which the entity is liable for failing to comply with the infringement notice.  If, within the compliance period the entity fails to:

·        pay the specified penalty, then the entity is liable to proceedings for a declaration of contravention and a pecuniary penalty order.  (This Bill proposes to amend the civil penalty provisions to provide for a $1 million maximum civil penalty for a contravention of the continuous disclosure provisions by a body corporate  ¾ see Part 4 of Schedule 4 of the Commentary above); and

·        disclose the specified information, then the entity is liable to proceedings for an order to disclose information or publish advertisements.

5.498   The civil proceedings and other action (see paragraph 0 below) brought by ASIC to which the entity is liable for failing to comply with the infringement notice are limited because the infringement notice mechanism is intended for use only in relation to relatively minor contraventions.

5.499   If the entity does not comply with the infringement notice and the notice is not withdrawn, new or existing proceedings in relation to the alleged contravention cannot be commenced or continued by ASIC on its own behalf against the entity, but can be commenced or continued by other classes of persons (proposed subsections 1317DAG(3) and (4)).  This is for the same reason as proposed subsections 1317DAF(5) and (6) (see paragraphs 0 and 0 above).  Shareholders, other bodies corporate, market licensees and/or other persons adversely affected by the conduct that constituted the alleged contravention can commence or continue compensation proceedings, contravention proceedings, enforcement proceedings and public interest proceedings against the entity to seek redress (see paragraph 0 above for explanation of these proceedings).

5.500   The exception in proposed subsection 1317DAG(4) also extends to:

·        proceedings to enforce orders, including:

-       proceedings in respect of a breach of an enforcement order;

-       orders made in relation to proceedings to which the entity is liable if it fails to comply with the infringement notice; and

·        appeals against decisions or orders, including those in relation to proceedings to which the entity is liable if it fails to comply with the infringement notice.

-       (including costs orders, except in relation to public interest proceedings) made in relation to the compensation proceedings, contravention proceedings, enforcement proceedings and public interest proceedings.

5.501   ASIC is also permitted to:

·        make a determination denying the entity exemption from the secondary sales provisions and access to concessionary arrangements in relation to further issues of continuously quoted securities if the entity has contravened the continuous disclosure provisions (or other relevant disclosure provisions) in the previous 12 months;

·        make an order for the recovery of expenses of an investigation related to the alleged contravention;

·        accept an enforceable undertaking; and

·        bring proceedings to enforce the determinations, orders or undertaking (proposed subsection 1317DAG(5)).

Compliance period for infringement notice

5.502   Once an infringement notice is issued, an entity has 28 days in which to comply with the notice (proposed section 1317DAH).  The compliance period may be extended by ASIC only once for up to 28 days by written notice to the entity.  A failure to notify the entity in writing does not invalidate the extension.  Reference to ‘compliance period’ in the Corporations Act includes the extended compliance period.

Withdrawal of an infringement notice

5.503   ASIC may withdraw an infringement notice by written notice to the entity if it has not been complied with (proposed section 1317DAI).  The entity may write to ASIC seeking the withdrawal of the infringement notice and ASIC may withdraw it regardless of whether the entity has sought its withdrawal (proposed subsections 1317DAI(1), (3)-(5)).  Evidence or information given by the entity’s representative in the course of seeking the withdrawal of the notice is inadmissible in evidence in subsequent court proceedings against either the entity or its representative, except criminal proceedings against the entity’s representative for giving false or misleading evidence or information (proposed subsection 1317DAI(2)).  This provision is equivalent to proposed subsection 1317DAD(2)  ¾  see paragraph 0 above). 

5.504   Proposed subsection 1317DAI(6) lists various matters that the withdrawal notice must include.  In addition to the formal and administrative requirements in proposed paragraphs 1317DAI(6)(a)-(c), the withdrawal notice must inform the entity that it is liable to civil and/or criminal proceedings in relation to the alleged contravention (proposed paragraphs 1317DAI(6)(d)-(e)).  ASIC may withdraw the infringement notice with the intention of not pursuing the alleged contravention, in which case ASIC would not commence proceedings against the entity.  Alternatively, the rationale behind the withdrawal may be that ASIC considers that the alleged contravention is more serious that ASIC initially believed and warrants proceedings unavailable under the infringement notice mechanism.

5.505   As mentioned above, compliance with an infringement notice involves payment of the specified penalty and possibly the disclosure of specified information.  If the infringement notice specifies both a penalty and information required to be disclosed and ASIC withdraws the notice following payment of the penalty but before the disclosure of the information specified, ASIC must refund the penalty paid by the entity (proposed subsection 1317DAI(7)).

Publication of notice of compliance

5.506   If an entity complies with an infringement notice, proposed section 1317DAJ allows ASIC to publish details of the entity’s compliance (proposed subsection 1317DAJ(1)).  ASIC may only publish a copy of the notice in the Gazette and/or an accurate summary of the notice if such publicity includes express statements that compliance is not an admission of guilt or liability on the part of the entity and that the entity is not regarded as having contravened the continuous disclosure provisions (proposed subsections 1317DAJ(2) and (3)).  The aim of these subsections is to induce entities to comply with their continuous disclosure obligations.  Publicity will send a signal to the market that ASIC is taking prompt action to deal with inadequate disclosure.

5.507   Proposed subsection 1317DAJ(4) restricts ASIC to publishing details of an entity’s compliance with an infringement notice and provides that ASIC must not publish any other details in relation to the infringement notice (including the issue of, or failure to comply with, such a notice).  The purpose of this provision is to ensure that no adverse conclusions are drawn or so-called trials by media take place in relation to the issue of a notice.  However, this provision does not prevent ASIC from publishing the use of infringement notices on an aggregate and anonymous basis including, for example, the number of notices issued and the number resulting in fines or civil penalty proceedings in a given period.

Commencement of criminal proceedings

5.508   Items 10 and 11 will amend section 1317P (Criminal proceeding after civil proceedings) to prevent ASIC from commencing criminal proceedings against an entity to which an infringement notice has been issued and not withdrawn.  Criminal proceedings will not be able to be commenced against such an entity for conduct that constitutes a contravention of subsection 674(2) or 675(2), regardless of whether:

·        a declaration of contravention or a pecuniary penalty order has been made against the entity (in proceedings following an entity’s failure to comply with the infringement notice); or

·        a compensation order has been made against the entity (in proceedings following an entity’s compliance or failure to comply with the infringement notice).

5.509   The reason for limiting an entity’s liability to civil proceedings is because the infringement notice mechanism is intended:

·        for use only in relation to relatively minor contraventions; and

·        to bring the process for enforcing the alleged contravention to an end upon compliance with the infringement notice.

Transitional arrangements

5.510   Proposed subsection 1469(2) of the Corporations Act (see item 2 of Schedule 12) provides that the amendments in Part 2 of Schedule 6 apply in relation to a failure by a disclosing entity to comply with subsection 674(2) or 675(2) that occurs on or after the commencement day.



Schedule 7:  Disclosure rules

5.511   Schedule 7 of the Bill contains amendments to the Corporations Act provisions dealing with disclosure rules.  Within the Schedule the amendments are grouped as follows:

Part 1

Presentation of disclosure documents

Part 2

Product Disclosure Statements for continuously quoted securities

Part 3

Exemptions from disclosure requirements

 

Part 1:  Presentation of disclosure documents

Presenting disclosure documents in a clear, concise and effective manner

5.512   Disclosure documents (defined in section 9 as prospectuses, profile statements and offer information statements) contained in Chapter 6D are integral elements of the fundraising provisions, as they provide investors and their advisers with appropriate information to make an informed investment decision.  While the content of a disclosure document (such as a prospectus) is important, the effectiveness of this document as an information source can be impaired if that information is presented in a manner that ambiguous, vague or unclear.

5.513   Section 715A provides that the content of a disclosure document must be presented in a clear, concise and effective way.  This amendment is intended to improve the effectiveness of documents such as prospectuses as a useful information source for investors and is consistent with requirements for a Product Disclosure Statement (PDS) under subsection 1013C(3).  It is intended to improve the comprehensibility and readability of disclosure documents.

5.514   That said, this requirement sits alongside and does not detract from the content requirements for the relevant disclosure document, such as for a prospectus under sections 710 and 711.  The intention is not to alter compliance with the content requirements, by:

·        limiting the amount of information provided; or

·        reducing the quality of information contained in a prospectus; or

·        forcing material, such as technical terms, to be oversimplified.

5.515   There may be concerns that the parameters of clear, concise and effective could be subjective.  Given that each disclosure document is different, determining if a document is clear, concise and effective will necessarily be decided on a case by case basis.  This amendment is intended to improve how the content of a disclosure document is presented and its meaning is conveyed.  It is also expected that industry understanding of this concept will develop as this phrase is increasingly applied in practice under both Chapter 7 and now in Chapter 6D of the Corporations Act. 

Breach of the presentational requirement

5.516   A breach of this requirement is not an offence.  Instead, if ASIC is satisfied the requirement for clear, concise and effective presentation has not been met, ASIC will be able to issue a stop order.  It is also intended that the stop order provisions in subsections 739(2) to (4), which relate to hearings and interim orders will also apply. 

5.517   It is noted that under ASIC Policy Statement 152: Lodgment of disclosure documents, ASIC will attempt to resolve prima facie disclosure concerns it is aware of with the issuer after lodgment. 

5.518   Section 719(1A) provides the opportunity for a person to lodge a replacement document if they become aware the information in the document may not be presented in a clear, concise and effective manner.  The consequences of lodging a replacement document is found in subsections 719(4) or (5).

Commencement of the provisions

5.519   Under section 1470, this amendment only applies to disclosure documents for an offer of securities lodged with ASIC after the commencement of the legislation.

Part 2:  Product Disclosure Statements for continuously quoted securities

Overview

5.520   The amendments to the Corporations Act contained in this Part of the Bill will:

·        permit issuers of managed investment products that are continuously quoted securities to issue shorter, or transaction specific, Product Disclosure Statements (PDS); and

·        allow ASIC to deny access to these arrangements in relation to issuers that have contravened relevant provisions of the Corporations Act in the past 12 months.

5.521   As a consequence of the commencement of the Financial Services Reform Act 2001 , the disclosure framework governing securities and debentures is found in Chapter 6D of the Corporations Act, and the analogous regime regulating managed investment products is found in Part 7.9.  Chapter 6D refers to prospectuses and Part 7.9 refers to PDS.

5.522   Chapter 6D provides concessionary arrangements in relation to further issues of continuously quoted securities by listed disclosing entities.  Section 713 of the Corporations Act provides that these securities can be issued to retail investors through a transaction specific prospectus (rather than a full prospectus of the type that would ordinarily be required under section 710 of the Act).  It requires that the prospectus address a modified range of matters and requires that it refer to other information that has been disclosed by the entity, including under the continuous disclosure provisions.  Subsection 713(6) allows ASIC to deny a disclosing entity access to these arrangements if the entity has contravened the continuous disclosure provisions (or other relevant disclosure provisions) in the previous 12 months.

5.523   Part 7.9 (section 1013F) simply provides that in determining what information needs to be contained in a PDS, an issuer’s status as a disclosing entity is one of the factors that a responsible person may take into account.  No distinction is made between a PDS for continuously quoted (CQ) securities or non-continuously quoted (NCQ) securities and no further guidance is provided.  Furthermore, there is no provision similar to subsection 713(6).

5.524   The purpose of these amendments therefore is to align, in terms of practical operation, the framework of disclosure in Part 7.9 of the Corporations Act with the framework in Chapter 6D as they apply to CQ securities.  The amendments are modelled largely on section 713 in Chapter 6D, but do not replicate that section.  The reason for not replicating section 713 is that the content rules for prospectuses differ from those for PDS in Part 7.9.

Specific amendments

5.525   Items 4, 5 and 6 will amend sections 111AQA, 1013D and 1013E, respectively, to clarify that a disclosing entity’s continuous disclosure obligations are relevant in deciding what information should be included in a PDS for either CQ or NCQ securities.  These items reflect the amendments made by items 7 and 8.

5.526   Items 7 and 8 will create a distinction between a PDS for a CQ security and a NCQ security, and provide for differential treatment of CQ and NCQ securities for the purpose of limiting the extent to which information is required to be included in a PDS.

5.527   Section 1013F (General limitations on extent to which information is required to be included) provides that an issuer’s status as a disclosing entity is one of the factors that a reasonable person may take into account in determining what information needs to be contained in a PDS.  This provision currently makes no distinction between a PDS for a CQ or a NCQ security.  Item 7 will amend section 1013F to provide that this factor now only applies to a PDS for a CQ security.

5.528   Item 8 will insert section 1013FA, which provides that information contained in an issuer’s recent financial reports and continuous disclosure notices is not required to be included in a PDS for a CQ security (proposed subsection 1013FA(1) and paragraph 1013FA(2)(a)).  Proposed paragraph 1013FA(2)(b), modelled on subsections 713(3) and (4) in Chapter 6D, requires the PDS to inform investors of the issuer’s reporting and disclosure obligations, and their right to obtain a free copy of the documents containing information excluded from the PDS.

5.529   Proposed subsections 1013FA(3) and (4), modelled on subsection 713(6) in Chapter 6D, will allow ASIC to deny access to the arrangements in subsection 1013FA(2) if the issuer of the CQ securities or a person responsible for the PDS contravened relevant provisions of the Corporations Act in the past 12 months.

Transitional arrangements

5.530   Proposed subsection 1470(2) of the Corporations Act (see item 2 of Schedule 12) provides that the amendments in Part 2 of Schedule 7 apply to a Product Disclosure Statement that is required to be given on or after the commencement day.

Part 3:  Exemptions from disclosure requirements

Secondary sales where no disclosure document has been prepared

5.531   Section 708A is an exemption from the on-sale provision in subsection 707(3).  These amendments are intended to improve the practical operation of the placement market and the secondary sale provisions in the Corporations Act.

5.532   The basis of the proposed amendments is that no further disclosure is required where investors have the benefit of information that is comparable to that otherwise available in a prospectus.  Information can be made available to investors through:

·        a notice to the market that the issuing entity has provided a full release of information to the market; or

·        a prospectus for a retail issue that is more or less contemporaneous with an institutional placement. 

Notice to the market

5.533   A notice under subsection 708A(5) is available if the placement is:

·        part of a class of securities that is listed; and

·        subject to the continuous disclosure requirements of sections 674 and 675 without exemption for at least 12 months prior to the issue. 

5.534   This provides the market with a body of information about those securities that are being on-sold.

5.535   No on-sale can occur until a notice that complies with subsection 708A(6) is provided to the relevant market operator.  This notice is a one-off and contains current information as at the date when it is lodged with the market operator. 

5.536   The issuer, rather than the on-seller, is tasked with providing the notice given it did not provide disclosure through a prospectus when making the placement and is best placed to provide the relevant information to the market.  The issuer of the securities has up to five days after the placement to provide the notice to the relevant market operator, allowing the issuer flexibility on when to disclose information to the market. 

5.537   Given the responsibility for the notice rests with the issuer, the proposed subsection 727(5) makes it clear that an on-seller relying on a notice that actually does not comply with subsection 708A(6) is not in breach of the law.

5.538   The notice:

·        verifies to the market that the issuer has compiled with its continuous disclosure and reporting obligations; and

·        provides the market with information that is excluded from continuous disclosure to ensure investors receive prospectus-like disclosure.

5.539   The additional information in the notice is beyond that required under continuous disclosure.  The information required under continuous disclosure is not a complete substitute for the information provided in a prospectus.  Principally, continuous disclosure does not include certain confidential information that must be included in a prospectus, which may be critical in making an investment decision.  This ensures that investors are provided with material information to make an informed investment decision.

5.540   This requirement is not intended to force companies to respond to rumours but rather to inform investors and the market through providing information of a kind that would otherwise be found in a prospectus.  The proposed content of the subsection 708A(6) notice is consistent with special prospectus content rules in section 713.

5.541   To provide certainty to the market, an issuer cannot withdraw the notice.  Instead, the issuer has an obligation to correct the notice under subsection 708A(9).  This is not intended to be an update of all the information in the notice as at the time a defect is discovered but merely a correction of the defect in the original notice and no more.

Contemporaneous Prospectus

5.542   The proposed subsection 708A(10) recognises that investors may also receive relevant information through a prospectus that while not issued pursuant to the placement, contains current information that relates to the same class of securities as the placement.

5.543   The proposed subsection 708A(11) grants similar relief to securities placed with underwriters or a person nominated by the underwriter in an underwriting agreement.

Anti-avoidance intent of the law remains

5.544   This provision does not reduce the primary anti-avoidance intent of subsection 707(3).  Under paragraph 708A(1)(b), a prospectus must accompany the issue of securities where the issuer has the purpose of those securities being on-sold.  It is not considered that merely an intention to list securities amounts to a purpose of securities being on-sold.  Further, subject to the exemption in section 708A, the anti-avoidance provisions of subsections 707(3) and (4) continue to operate.

The role of ASIC — future relief and determinations

5.545   This amendment will not inhibit ASIC’s ability to provide relief under its existing exemption and modification powers, such as section 741.

5.546   As this is an exemption from the disclosure provisions, the relief will not apply if ASIC has issued a determination under subsection 708A(2) that the issuer has contravened relevant provisions of the Corporations Act in the 12 months prior to the placement. 

5.547   ASIC’s determination powers under subsection 713(6) and 1013FA(3) also incorporate breaches of the proposed relief from the secondary sale provisions.  The determination powers are intended to prevent issuers accessing relief where there have been breaches of the law and provides an incentive from a reputation standpoint to ensure the notice is correct.

Application of Chapter 2L to debentures

5.548   The amendment to subsection 283AA(1) ensures that even due to the section 708A exemption from disclosure, a body offering debentures must meet the requirements of Chapter 2L of the Act and enter into a trust deed and appoint a trustee.

Similar relief from Chapter 7 secondary sale provisions

5.549   Section 1012DA is an exception from the on-sale provision in subsection 1012C(6).  Section 1012DA and associated provisions mirror the relief proposed in section 708A and its associated provisions, taking into account the different disclosure regime for PDS under Part 7.9 compared with the prospectus regime under Chapter 6D.  For example, the obligation applies to regulated persons.

Remedies

5.550   There is an obligation to correct a defect in a notice under subsections 708A(9) and 1012DA(9).  Failure to do so within a reasonable time will incur a penalty of 25 penalty units or 6 months imprisonment or both.

5.551   Given the similarity of the subsection 708A(5) and 1012DA(5) notice to a continuous disclosure notice, the liability provisions for continuous disclosure under sections 1308 and 1309 will apply.  Reliance on existing provisions of the Corporations Act reduces uncertainty through not introducing a new offence regime.  The use of section 1308 and 1309 ensures there are remedies for a notice that is false or misleading.  For avoidance of doubt, subsections 1308(9) and 1309(9) will make it clear that sections 1308 and 1309 are available where information is left out of a notice. 

Commencement of the provisions

5.552   Under section 1470:

·        The amendment to subsection 283AA(1) applies to an offer of debentures that is made on or after commencement of the legislation.

·        Section 708A applies to an offer of securities for sale that is made on or after the commencement of the legislation.

5.553   Section 1012DA applies to a recommendation and sale situation that occurs on or after commencement of the legislation.



Schedule 8:  Shareholder participation and information

Overview

5.554   Schedule 8 of the Bill contains amendments that are intended to facilitate the exercise by members of companies of shareholder rights to be informed, to participate and to vote in general meetings.  It contains proposed amendments to the Corporations Act that are designed to:

·        encourage shorter, more comprehensible notices of meetings;

·        facilitate distribution of notices of meeting and annual reports by electronic means;

·        improve access to general meetings by facilitating voting by proxy; and

·        require disclosure by directors of listed companies of other directorships held. 

Notices of meetings

Content and presentation

5.555   Section 249L contains rules about the content of notices of general meetings.  It is proposed to include a new subsection 249L(3) to also require that notices are worded and presented in a clear, concise and effective manner (Item 5). 

5.556   It would be open to ASIC or affected persons to pursue a remedy for an alleged breach of the new requirement under section 1324.  That section permits a court to make orders, including injunctions and orders to pay damages, in relation to breaches of the Corporations Act.  Section 1322 would operate so that a deficiency in the notice would not ordinarily result in the invalidity of a meeting or any proceeding at a meeting unless substantial injustice was caused that could not be remedied by an alternative order.

5.557   Proposed new section 249LA (Item 6) would permit regulations to be made that identify certain kinds of information that need not be included in a notice of meeting if conditions are met.  Regulations under the proposed new section might, for example, permit some types of information to be incorporated in the notice ‘by reference’.  Such regulations could expressly allow notices of meeting to exclude complex descriptions of a possible transaction for which member approval is sought, on condition that the full details are clearly referred to and made readily available to members who wish to examine them. 

Electronic distribution

5.558   Section 249J of the Corporations Act contains requirements for distribution of notices of general meetings to members and directors.  Subsection 249J(3) already permits members to request notices are sent to them by fax or e-mail.

5.559   It is proposed to amend section 249J by including a new subsection 249J(3A) (Item 3).  Under the new subsection, companies would be able to offer members the option of accessing notices by a wider range of electronic facilities.  Members would be able to nominate an electronic ‘notification’ and also an electronic ‘access means’, which a company could use to distribute notices as an alternative to traditional forms of distribution.  Under this facility, companies would be able to distribute a notice of meeting by, example, sending a short e-mail to a member advising that a notice of general meeting is available for viewing or download from the company website.  Item 2 adds appropriate new paragraphs to subsection 249J(3), which deals with how notice of a meeting is given to a member. 

5.560   A proposed new subsection 249J(5) (Item 4) will include a replaceable rule stating that a notice given under the new facility is taken to be given on the business day after the notice is made available.  This is consistent with the current rule for fax or e-mail distributions in subsection 249J(4), which may also be replaced by an alternative rule in the company’s own constitution (Item 1 includes the new subsection 249J(5) in the table of replaceable rules in section 141). 

5.561   Subsection 1322(2) deals with the consequences of non-receipt of a notice by a person, and provides that ordinarily it would not result in the invalidity of meeting proceedings.  Proposed new subsection 1322(3AA) contains an equivalent rule in relation to the new distribution facility (Item 17). 

Electronic distribution of annual reports

5.562   Section 314 requires companies and certain other entities, to send annual reports to members.  It is proposed to include new subsections 314(4) and (5), which will permit members to receive distribution of annual reports in the same manner as proposed in relation to notices of meetings for companies (Item 16).  If the facility is offered, members would be able to nominate an electronic ‘notification means’ (for example, e-mail) by which they would be advised a report is available, and an electronic ‘access means’ (for example access via website) by which they would access the report following notification.

5.563   The availability of the new facility will not affect the rules regarding full or concise reports. 

Proxy voting

Appointing bodies corporate as proxies

5.564   Proposed new subsection 249X(1A) will permit a member to appoint an individual or a body corporate as a proxy (Item 7).

5.565   Under proposed new paragraph 250D(1)(d), a body corporate appointed as a proxy for a member will be able to nominate an individual to exercise its powers at meetings (Item 14).

Electronic authentication of proxy appointments

5.566   Proposed new subsection 250A(1A) will permit regulations to prescribe authentication mechanisms for authentication of proxy appointments other than signature (Item 9).  A consequential amendment to subsection 250A(1) will be made to recognise other authentication methods (Item 8).

Electronic submission of proxy forms

5.567   It is proposed to replace subsections 250B(3), which deals with the receipt of proxy documents, with a revised subsection that will permit companies to offer a facility for electronic submission of proxy appointment forms and related appointment authorities (Item 11).  An appointment authority is a document such as a power of attorney by which a member has authorised another person to appoint a proxy on the member’s behalf.  Consequential amendments to paragraph 250B(1)(b) will be made to recognise other authentication methods (Items 10 and 11).

5.568   Subsection 250BA(1), dealing with the requirements for listed companies to specify how proxy documents are to be submitted, is proposed to be replaced to recognise the availability of the new facility (Item 13).

Listed companies ¾ notification of directorships

5.569   Subsection 300(11) includes special rules for listed companies regarding the inclusion of information in annual reports.  It is proposed to include a new paragraph 300(11)(e) that will require, in respect of each director of a listed company, details of directorships of other listed companies held by the director in the three years before the end of the financial year to which the report relates (Item 15).

Timing of application of new rules

5.570   It is proposed the new rules would apply as follows (see Schedule 12, Item 2):

New rule

Application

Notices of meeting

Three months after new rule commences

Proxy appointments

Appointments made on or after new rule commences

Distribution of reports

Financial years starting on or after new rule commences

Disclosure of directorships

Financial years starting on or after new rule commences



Schedule 9:  Officers, senior managers and employees

Overview

5.571   Recommendation 2 of the HIHRC report identified some anomalies in the Corporations Act and the ASIC Act that has led to doubt about the application of provisions as they affect certain persons.  The proposed amendments in Schedule 9 of the Bill are designed to clarify the classes of personnel who have duties and obligations under the Act.  The amendments will ensure clear and consistent use of various terms by:

·        correcting current anomalies in relation to the definition of ‘officer’;

·        removing the definition of ‘executive officer’ and replacing it with ‘senior manager’ (‘senior managers’ will be a sub-class of ‘officer’);

·        removing the definition of ‘examinable officer’; and

·        making consequential changes as required to clearly specify the persons that are to be covered by particular provisions.

Definition of ‘officer’

5.572   There are two overlapping definitions of the term ‘officer’ found in sections 9 and 82A of the Corporations Act respectively.  Schedule 9 of the Bill will address the potentially confusing operation of these provisions by repealing the section 82A definition of ‘officer’ (see Item 11) and leaving the section 9 definition.  Item 43 removes an express reference to section 82A from section 530A of the Corporations Act (which relates to officers helping liquidators).

5.573   Definitions of ‘officer’ for specific purposes appearing other than in section 9 are to be removed where possible (Items 11, 20, 25, 78 and 88; Item 31 contains a replacement definition for use in subsection 448C(1)).

5.574   In cases where particular provisions of the Corporations Act dealing with personnel are intended to extend to employees, this will be expressly stated (see ‘Employees’ discussion below). 

5.575   The current section 9 definition of ‘officer’ applies to ‘corporations’ (which includes ‘bodies corporate’ ¾ see section 57A).  Existing section 82A (to be removed) applies its definition to ‘bodies corporate’ and ‘entities’.  Section 64A defines the term ‘entity’ to include bodies corporate, partnerships, individuals, and trusts (including trustees).  An ‘entity’ is also defined in section 9 for the sole purpose of Chapter 2E (Related party transactions) to include also an ‘unincorporated body’. 

5.576   As there are provisions in the Corporations Act that regulate officers of ‘entities’ other than corporations, it is desirable to include a specific definition of ‘officer of an entity’ in the Act.  Item 9 inserts a definition of ‘officer’ into section 9 specifically for entities other than individuals or corporations (such as partnerships and unincorporated associations).  As a consequence of including the definition, the term ‘officer’ has been substituted for ‘office holder’ in some provisions in the ASIC Act dealing with unincorporated associations (Items 4 and 6).  However, Item 10 substitutes ‘office holder’ for ‘officer’ of an unincorporated body within the meaning of a ‘corporation’ as set out in section 57A of the Corporations Act to avoid the occurrence of circular references. 

5.577   Due to changes to the definitions, consequential amendments are proposed to ensure that the range of persons to whom the particular provisions apply is maintained.

‘Employees’

5.578   A large number of provisions of the Corporations Act and ASIC Act impose duties and obligations on ‘officers’.  The section 82A definition of ‘officer’ (to be removed) includes an ‘employee’.  The existing section 9 definition of ‘officer’ generally covers persons who have a degree of influence or potential influence over the general conduct of the entity, through the office they hold or otherwise.  Although some employees fall within the section 9 definition, a large number would not.

5.579   The dual definitions sometimes give rise to doubt about whether provisions that impose duties and obligations on an ‘officer’ apply to an ordinary employee or not.  In many cases, it is not appropriate to extend the provision to such persons.  Removing section 82A of the Corporations Act and leaving the section 9 definition of ‘officer’ as proposed will satisfactorily address those cases.  There are, however, some existing uses of the term ‘officer’ in provisions that should apply to employees.  The following items will insert the term ‘employee’ into those provisions so there is no doubt that employees fall within their scope:

·        Items 3 to 6; 12 to 19; 21; 22; 26 to 30; 32; 34 to 42; 45 to 50; 53 to 56; 61; 69 to 77; and 79 to 87.

‘Executive officer’ and ‘senior manager’

5.580   The need for the term ‘executive officer’ was based on the section 82A definition of ‘officer’, which included ‘employees’.  ‘Executive officer’ distinguished between officers who took part in management of the company and ordinary employees.  Item 8 removes the definition of this term.

5.581   If uses of the term ‘executive officer’ were simply replaced with ‘officer’, this could undesirably widen the scope of the provisions.  This is due to paragraphs (c) to (e) of the section 9 definition which identify certain persons such as receivers and liquidators as ‘officers’. 

5.582   Item 86 of Schedule 1, Part 3 of the Bill will define a new sub-class of ‘officer’ called a ‘senior manager’.  The sections that currently rely on ‘executive officer’ will, under the proposed amendments, use the new term ‘senior manager’. 

5.583   The term ‘senior manager’ is also utilised in Schedule 1, Part 3 ( Auditor appointment, registration, independence and rotation requirements ) and Schedule 5 ( Remuneration of directors and executives ) of the Bill.  The construction of ‘senior manager’ allows the definition to be applied in relation to partnerships, trusts and joint ventures (as well as corporations) for the purposes of applying section 300A to related entities of corporations.  Amendments to section 300A are discussed further in Chapter 5. 

5.584   The following items replace the term ‘executive officer’ with ‘senior manager’:

·        Items 2; 51; 52; 59; 60; and 62 to 68.

5.585   The following items also include the term ‘senior manager’ rather than ‘officer’ to avoid undesirable results from the use of the wider term ‘officer’:

·        Items 12 to 19; and 29 to 31.

‘Provisional liquidator’

5.586   The section 9 definition of ‘officer’ does not include a ‘provisional liquidator’.  Certain sections of the Corporations Act currently redefine ‘officer’ to include a ‘provisional liquidator’ for the purposes of those sections.  The following items preserve the intention that a ‘provisional liquidator’ be included within the ambit of the appropriate provisions:

·        Items 1 (in relation to the ASIC Act); 23; 24; 57; and 58.

‘Examinable officer’

5.587   The term ‘examinable officer’ as defined in section 9 is sufficiently covered by the section 9 definition of ‘officer’ (apart from its inclusion of a ‘provisional liquidator’), so separately defining this term will be unnecessary.  In the interests of simplification and clarity, Item 7 removes the definition of ‘examinable officer’ and Item 57 removes the only instance of the term ‘examinable officer’, found in section 596A, by amending it to refer to ‘officer or provisional liquidator’.

The ASIC Act

5.588   Section 5 of the ASIC Act also contains a definition of ‘officer’, which has elements of both the section 9 and section 82A definition contained in the Corporations Act.  This is to be amended to achieve consistency with the revised Corporations Act.

5.589   Item 1 substitutes a definition for ‘officer’ that explicitly directs interpretation of the term as it is defined in the Corporations Act, but includes also a ‘provisional liquidator’ to preserve the intention that an ‘officer’ in the ASIC Act include a ‘provisional liquidator’ (see ‘ Provisional liquidator’ above).

5.590   Items 2-6 reflect the consequential amendments concerning ‘employees and ‘executive officers’ required to achieve consistency with the amendments set out above. 

5.591   Note also that existing subsections 5(2) and 5(3) of the ASIC Act deal with interpretation of terms used in the ASIC Act.



Schedule 10:  Management of conflicts of interest by financial services licensees

Overview

5.592   Developments in the global financial services industry have given rise to conglomerate firms ¾ which may achieve cost efficiencies by providing a full range of services, and using employees in different capacities across the firm.  In seeking these cost efficiencies, it was widely acknowledged by the financial services industry that scope existed for conflicts of interest to arise.  Firms responded to these concerns by developing policies and procedures (for example, the establishment of Chinese Walls between different areas of their financial services business) for managing these potential conflicts of interest.

5.593   International experience with conflicts of interest ¾ particularly that of the United States (US) in 2002 with respect to analysts ¾ led the Australian Government to consider its own regulatory framework for managing conflicts of interest.

5.594   In August 2003 ASIC completed its Research Report into Analyst Independence.  The Report concluded that while ASIC did not identify any actual contraventions of the Corporations Act 2001, there was in its view, an unacceptable level of reliance, in some entities, on staff integrity to avoid and manage conflicts of interest.  This, together with international experience, confirms a general unease in Australia about analyst independence and the management of conflicts of interest when providing financial services.

5.595   Under the current regulatory regime financial services licensees are required to ensure that financial services covered by their licence are provided ‘efficiently, honestly, and fairly’.  While industry has widely accepted that this would include managing conflicts of interest, the duty was not express in its application to conflicts of interest.

5.596   It was considered that any new provision should not be limited in application to analysts, but should also provide for financial services licensees more generally, as the potential for conflicts of interest to arise are not limited in application.

5.597   Consequently, under proposed paragraph 912A(1)(aa), financial services licensees will be subject to an additional licensing obligation, which specifically requires them to have adequate arrangements for managing conflicts of interest.  This will include ensuring that there is adequate disclosure of conflicts to investors, who can then consider their impact before making investment decisions.  It will require internal policies and procedures for preventing and addressing potential conflicts of interest that are robust and effective.  The obligation will apply to all conflicts of interest, other than those that occur wholly outside the financial services business of the licensee or its representative.

5.598   The additional licensing obligation will supplement the existing general duty in paragraph 912A(1)(a) to provide financial services ‘efficiently, honestly and fairly’.  It will provide a strong legislative basis for the Australian Securities and Investments Commission (ASIC) to develop guidance and take enforcement action, while being consistent with a principles-based approach.  ASIC guidance on the management of conflicts of interest will assist licensees to comply with their legal obligations.  ASIC’s policy proposal in this regard was released for comment on 29 October 2003.

Types of conflicts of interest that must be managed

5.599   There are three main types of conflicts of interest:

·        conflicts within the financial services business (Category 1);

-       examples are conflicts within one area of the financial services business, such as dealing on behalf of various clients, or across different areas of the business, such as between publishing research in a client newsletter and market making;

·        conflicts between something within the financial services business and something outside the financial services business (Category 2);

-       examples are where outside factors give rise to conflicts within the financial services business, such as a conflict of interest between the financial services licensee lending (as principal) to a particular enterprise and the financial services licensee underwriting a public offer for the same enterprise.  Alternatively, a conflict may arise where the objectivity of research is compromised by the analyst’s personal interests or relationships;

·        conflicts outside the financial services business (Category 3);

-       where a factor outside the financial services business gives rise to a conflict with another factor outside the same financial services business.  Examples include where those conflicts might arise between two non-financial services businesses of a merchant bank (for example; corporate lending and dealing on the bank’s own behalf).  Such conflicts are unrelated to the financial services business.

5.600   The purpose of proposed paragraph 912A(1)(aa) is to specifically require licensees to have adequate arrangements for managing Category 1 and Category 2 conflicts of interest.  Licensees will not be obliged under the Corporations Act to manage Category 3 conflicts of interest, which occur wholly outside their financial services business.  They may have other obligations to manage such conflicts.  The Corporations Act already includes a definition of financial services (see Division 4 of Part 7.1).



Schedule 11:  Miscellaneous amendments

5.601   Schedule 11 of the Bill contains a series of miscellaneous amendments to provisions in the ASIC and Corporations Acts.

Corporations Legislation Amendment Act 2003 ¾ technical amendments

5.602   The Corporations Legislation Amendment Act 2003 (Act No 24 of 2003) which, among other things, replaced the requirement for companies to lodge an annual return with ASIC with a range of less-burdensome reporting requirements, came into operation on 1 July 2003.

5.603   Following enactment of the legislation, a number of minor drafting and technical matters have been noted which require correction or clarification.  Items 4 to 7, 13 and 14 of the Schedule, which are described below, make the necessary amendments to the Corporations Act.

·        item 4 will replace the reference to ‘14 days’ in subsection 143(3) with a reference to ‘28 days’.  This will reflect the amendment of subsection 142(2) by the Corporations Legislation Amendment Act in relation to the timeframe for notifying ASIC of a change of address of a company’s registered office.

·        item 5 will amend paragraph 188(2)(a) to make it clear that each director of a proprietary company which does not have a company secretary contravenes subsection 188(2) if the company contravenes a provision set out in subsection 188(1).  Subsection 188(1) of the Act sets out the responsibilities of company secretaries under the Act to update ASIC information about the company.

·        item 6 will replace the reference to ‘14 days’ in section 201L with a reference to ‘28 days’.  In addition, item 7 will replace the reference to ‘14 days’ in Note 1 to section 204D with a reference to ‘28 days’.  These changes reflect the amendment of section 205B in relation to the timeframe for notifying ASIC of changes relating to or details of office holders of a company.

·        item 13 will replace the reference to an ‘extract of particulars’ in subsection 348D(4) with a reference to a ‘return of particulars’.  Subsection 348D(4) deals generally with the requirements for responding to a return of particulars issued by ASIC.

·        item 14 will replace the references to ‘the Corporations Legislation Amendment Act 2002 ’ appearing in section 1448 (including in the heading to the section) with references to ‘the Corporations Legislation Amendment Act 2003 ’.

Directors’ declaration on financial statements

5.604   Subsections 295(4) and 303(4) of the Corporations Act, which, respectively, set out the contents of the directors’ declaration on the annual and half-year financial statements, contain slightly different requirements for the two declarations.  These requirements will be brought into line with each other.

5.605   Subsection 295(4) requires, among other things, directors to make a declaration:

·        that the financial statements, and the notes required by the accounting standards, comply with the accounting standards (paragraph 295(4)(a));

·        that the financial statements and notes give a true and fair view of a company’s or, where consolidated financial statements are required, the consolidated entity’s financial position and performance (paragraph 295(4)(b)); and

·        whether, in the directors’ opinion, the financial statements and notes are in accordance with the Corporations Act, including:

-       section 296 (which requires the financial report to comply with the accounting standards); and

-       section 297 (which requires the financial statements and notes to give a true and fair view of a company’s or, where consolidated financial statements are required, the consolidated entity’s financial position and performance) (paragraph 295(4)(d)).

5.606   Although paragraphs 295(4)(a) and (b), which require directors to make a specific declaration about compliance with sections 296 and 297, differ from paragraph 295(4)(d) [5] , which requires directors to express their opinion about compliance with those sections, the similarity of the requirements has been an ongoing source of confusion for many companies and their professional advisers since the legislation was amended in 1998.

5.607   Item 9 repeals paragraphs 295(4)(a) and (b).  In deciding to repeal these paragraphs, rather than paragraph 295(4)(d), it was noted that paragraphs 295(4)(a) and (b) impose a higher compliance burden on companies and their directors in that they must be satisfied that the financial statements and notes meet the requirements of sections 296 and 297.  There may be circumstances in which directors cannot be totally certain that these requirements have been satisfied, but would be able to legitimately form an opinion that the financial statements and notes comply with the requirements of the Corporations Act, including sections 296 and 297.

5.608   Items 10 and 11 amend subsection 303(4) (directors’ declaration on the half-year financial statements) to bring its requirements into line with those in subsection 295(4).

Other minor and technical amendments

5.609   During the preparation of drafting instructions, and the drafting of provisions, to give effect to the CLERP 9 proposals, a number of minor technical matters were noted in the ASIC and Corporations Acts which require correction or clarification.  Items 1 to 3, 8, and 12 contain the necessary amendments to the Acts.  The more significant changes are described below.

·        item 1 amends the definition of ‘international accounting standards’ in section 5 of the ASIC Act by inserting the formal name of the body responsible for setting international accounting standards: ‘International Accounting Standards Board’.

·        item 3 amends section 111AO of the Corporations Act to make it clear that the financial reporting and audit requirements in Chapter 2M apply only to disclosing entities incorporated or formed in Australia.

·        item 8 amends section 285 of the Corporations Act to correct the reference to disclosing entities that have to comply with the Chapter 2M requirements.

·        item 12 amends section 306 of the Corporations Act by inserting requirements concerning the making and signing of the half-year directors’ report (proposed subsection 306(3)).  The amendment brings the making and signing requirements for the half-year report into line with those for the annual directors’ report.

 




[1]    In the Bill, Schedules 8 and 9 are expressed to commence immediately after the commencement of Schedule 5.

[2]    In the Bill, Schedule 11 is expressed to commence immediately after the commencement of Schedules 1 and 2.

[3]     The AuASB currently exists as a board of the Australian Accounting Research Foundation, an unincorporated body jointly controlled and funded by The Institute of Chartered Accountants in Australia and CPA Australia.

[4]    The excluded provisions are section 12A (other functions and powers) and Division 2 of Part 2  (unconscionable conduct and consumer protection in relation to financial services) of the ASIC Act. 

[5]     Paragraph 295(4)(d) is the result of an amendment to the Company Law Review Bill moved by Senator Andrew Murray ¾ see page 4013 of the Senate Hansard for 24 June 199 8.