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Part 10 - Enforcement issues

Date

This part discusses a number of enforcement issues, including changes to the Corporations Act penalties regime, an expansion of the duty to report information to ASIC by auditors, protection for company officers who report breaches, and the institutional arrangements and procedures for enforcing discipline against registered company auditors.

Enforcement issues specific to the continuous disclosure regime are covered in Part 8. Enforcement issues specific to the provision of non-audit services and the proposed auditor statement of independence are covered in Part 4.

10.1 Penalties for breaches of the Corporations Act auditing and accounting requirements

10.1.1 Background

The role of ASIC includes enforcing the auditing and accounting disclosure requirements of the Corporations Act.

Under Australia's corporate governance model, it is the responsibility of the board of directors of a company to certify that a company's financial statements comply with accounting standards, and also give a true and fair view. This is consistent with the broader fiduciary responsibilities of directors under the Corporations Act. The role of registered company auditors includes forming an opinion about whether a company's financial statements comply with accounting standards and give a true and fair view.

The United States has recently adopted an approach of requiring chief executive officers to personally vouch for the veracity, timeliness and fairness of their companies' public disclosures, including their financial statements. While the Government does not currently propose any departure from the present corporate governance model, it remains the case that senior company officers can be prosecuted if they engage in any fraudulent activity in relation to the presentation of the company's financial statements.

ASIC enforcement powers

ASIC has substantial enforcement powers relating to financial reporting and audit under the Corporations Act, the ASIC Act, and the various State Crimes Acts.

ASIC's can: make orders to require compliance; institute legal proceedings which can produce outcomes that carry heavy civil and criminal penalties; direct companies to prepare and lodge reports; seek injunctions to restrain contravention of the Corporations Act; and investigate matters where it believes the Corporations Act or other corporate laws have been broken.

ASIC employs a substantial team of accounting qualified staff involved in enforcement matters related to financial reporting. ASIC's enforcement program is resourced from its appropriation, estimated to be $158.4 million in 2002-03. In the 2002-03 Budget, ASIC received new funding totalling $90.8 million over four years. This will equip ASIC to maintain and, where necessary, extend its surveillance and enforcement activities, including in the area of corporate reporting.

ASIC enforcement actions

ASIC has been active in referring matters to the CALDB. Over the past 10 years, ASIC has referred 249 registered company auditors to the CALDB with the result that 146 auditors had their registration cancelled or suspended, 11 auditors received reprimands, and 82 matters were withdrawn - generally after auditors voluntarily surrendered their registrations. Additionally, in 10 cases the CALDB refused to exercise its discretion.

ASIC has also been active in enforcing financial reporting in accordance with accounting standards and the Corporations Act. From 1998-2002, ASIC investigated and resolved financial reporting matters involving accounting irregularities which produced more than $3 billion in restatements in company financial statements.

On 12 July 2002, the ASIC Chairman announced a new accounting surveillance project directed to areas of accounting abuse of the type recently uncovered in the United States. ASIC has assembled a special task force for the project comprising representatives from its Office of Chief Accountant and its Corporate Finance and Enforcement Directorates.

The primary focus of the project is compliance with accounting standards relating to capitalised and deferred expenses; recognition of revenue; and recognition of controlled entities and assets. The surveillance will relate to the full-year financial reports of selected listed companies for the financial year ended 30 June 2002.

In announcing the project, the Chairman noted that ASIC had no reason to believe that abuses such as those recently uncovered in the United States are prevalent in Australia. Nevertheless, ASIC had decided that a targeted surveillance of these issues would assist to maintain confidence in the reliability of public company financial reporting. ASIC expects to report its preliminary findings by 31 December 2002.

10.1.2 Penalties for breaching the accounting and auditing requirements in the Corporations Act

Current Corporations Act penalties

The Corporations Act contains a range of civil and criminal penalties.

The maximum criminal penalties in the Corporations Act for breaches such as insolvent trading and breaches of directors' duties are 2000 penalty units ($220,000) and 5 years gaol. These penalties can be cumulative for multiple breaches.

The Corporations Act also contains a regime of civil penalties, which allow corporate misconduct to be pursued outside the criminal law framework. This system can overcome some of the difficulties in proving matters beyond reasonable doubt (as required by the criminal law, rather than proof on the balance of probabilities required by civil penalty provisions), and permits remedies such as the payment of civil penalties of up to $200,000, payment of compensation, and disqualifying officers from future involvement in corporations.

Some examples of offences which can be pursued by ASIC either as a civil penalty provision or a criminal offence are outlined below.

Offence

Corporations Act reference

Maximum criminal penalty (note: penalty unit = $110)

Failure to exercise powers with care and diligence.

180(1)

2,000 units and/or 5 years

Failure to exercise powers in good faith and for a proper purpose.

181(1)

2,000 units and/or 5 years

Must not misuse position to gain advantage or cause detriment to the company.

182(1)

2,000 units and/or 5 years

Must not misuse information obtained by virtue of their position to gain advantage or cause detriment to the company.

183(1)

2,000 units and/or 5 years

Breach the procedures under Corporations Act when giving a financial benefit to a related party of the company.

209(2)

2,000 units and/or 5 years

Failure to comply with the financial reporting requirements under the Corporations Act.

344(1)

2,000 units and/or 5 years

Breaches the duty not to trade while insolvent.

588G(2)

2,000 units and/or 5 years

Failure to comply with continuous disclosure requirements of a share market.

674(2)

200 units and/or 5 years

Failure to comply with continuous disclosure requirements to ASIC, where a share market does not require it.

675(2)

200 units and/or 5 years

Engage in various forms of market manipulation in relation to financial products.

1041A - 1041G

200 units and/or 5 years

Offences in relation to insider trading.

1043A(1)

2,000 units and/or 5 years

ASIC can also pursue actions under State Crimes Acts for fraudulently appropriating corporate property or making or publishing accounting entries intended to defraud, which can attract penalties of up to 10 years in prison.

Should penalties for breaches of the financial reporting requirements of the Corporations Act be increased?

There is a case for increasing penalties under the Corporations Act. Although changes have been made in specific areas, a general review of these penalties has not been carried out for a considerable period.

An example of a penalty that might be inadequate is for breach of section 1309 of the Corporations Act (misleading an auditor or other officer). Fabricating or 'covering up' the fabrications of others in relation to financial reports can cause significant damage and loss. The two year maximum gaol term imposed for this contravention is unlikely to be in line with comparable crimes of a similar significance.

However, it would be desirable to keep the increase of penalties in relation to financial reporting offences appropriately proportionate to other comparable penalties under the Corporations Act. Accordingly, a revision of penalties will be undertaken covering all of the Corporations Act, focusing on financial reporting and officers' duties. This will encompass civil penalties, especially for bodies corporate,1 and would take into consideration the findings of the Australian Law Reform Commission's report on civil and administrative penalties in Australian federal regulation.2 ASIC has been asked to provide recommendations for this review.

Proposal 32 - Revision of civil and criminal penalties

ASIC will monitor the adequacy of civil and criminal penalties and make such recommendations as are required to ensure consistency and adequacy of penalties under the law.

 

10.2 Auditors duty to disclose information to ASIC

This section discusses the requirements placed on auditors to disclose to ASIC information about breaches of the Corporations Act.

Under section 311 of the Corporations Act, a registered company auditor in the case of an audit of financial reports for a financial year or half-year, or a review of a financial report for a half year, must 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, or 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 the company directors.

To assist the auditor in performing his or her duties, section 1289 of the Corporations Act provides that an auditor shall not, in the absence of malice, be liable to any action in respect of defamation for any statement made in the course of duties as an auditor, whether the statement is made orally or in writing.

Although mandated by section 311 of the Act, there has been almost a total absence of reports made to ASIC by auditors under this provision.

To enhance the effectiveness of the provision, it is proposed that section 311 be amended such that an auditor must also report to ASIC if any officer or director of a company attempted to influence, coerce, manipulate or mislead the auditor during the performance of the audit.

Proposal 33 - Auditors' duties under the law will be expanded

The Government will amend the law to expand matters which auditors must report to ASIC to include any attempt to influence, coerce, manipulate or mislead the auditor.

 

10.3 Disciplinary procedures for auditors

Background

The report of the Audit Review Working Party contains a series of recommendations for streamlining the institutional arrangements for taking any disciplinary action against registered company auditors and the procedures for dealing with the disciplinary matters themselves. The Ramsay report provides an overview of the Working Party's proposals and examines whether it would be appropriate to implement those recommendations.

The Audit Review Working Party examined the following aspects of the requirements for disciplining auditors as part of its review:

  • whether the existing institutional arrangements for dealing with disciplinary matters operate in an efficient and effective manner;
  • whether the matters that may be dealt with by the CALDB are appropriate;
  • whether the penalties that may be imposed by the CALDB are appropriate; and
  • whether the CALDB and/or ASIC should be authorised to exchange information with the accounting bodies for the purpose of disciplinary proceedings.

The Working Party, following consultation with stakeholders, put forward a total of 17 recommendations designed to achieve three basic objectives:

  • relieving the CALDB of the task of dealing with disciplinary matters of an administrative nature, thus enabling it to devote its resources to dealing with the more substantive conduct matters;
  • broadening the membership base of the CALDB in order to increase the perception that it is independent of the accounting profession; and
  • increasing publicity associated with disciplinary matters for the purpose of acting as a deterrent to others.

The Ramsay report noted that at the time the Working Party's report was released there was general support for most of its recommendations except the following:

  • the proposal that the chair of the Board need not be a legal practitioner;
  • the recommendation that the CALDB be relieved of the task of dealing with disciplinary matters of an administrative nature was not supported by either CALDB or ASIC on a number of grounds including that it is desirable that disciplinary action which affects the right of an auditor or liquidator to practise should be centralised in one body; and
  • in addition, one other recommendation, that the CALDB should have the ability to impose fines, is no longer possible because the corporate regulation scheme is now based on Commonwealth constitutional powers and there are constitutional limitations on Commonwealth bodies imposing fines.

The Ramsay review's consultation with the CALDB indicates that there is still a high level of support for the Working Party's recommendations, other than those referred to in the preceding paragraph. The CALDB's principal concerns are with proposed changes to its composition. In this regard, the Board has formed the view that, in light of the very technical issues coming before it, t
he composition of the CALDB should not be expanded by the inclusion of nominees from outside the legal and accounting professions.

Nevertheless, as a result of difficulties recently experienced by the CALDB in forming a quorum for an important hearing, the Ramsay report concluded that some changes are needed to the CALDB's membership structure. The CALDB, for its part, has proposed that its membership be expanded through the appointment of reserve members for both the ICAA and CPAA. The CALDB envisages that reserve members would be used when neither the member nor deputy for a particular body is available for a hearing. It has also proposed that, when making future appointments, an effort should be made to include in the appointments some members, deputies or reserves who are current or former insolvency practitioners.

Ramsay formed the view that it would be appropriate to proceed with the Working Party's recommendations, subject to the retention of the existing requirement that the chair have legal qualifications; omitting the proposals opposed by the CALDB and ASIC; and giving effect to the CALDB's proposal for the appointment of additional accounting and insolvency members in place of the Working Party's proposal for the appointment of people with other experience.

The Ramsay report recommendations

The Ramsay report recommended that:

  • The ASIC Act be amended to:
    • provide for the appointment of a deputy chairperson for the CALDB;
    • allow the CALDB to sit in more than one Division simultaneously;
    • provide that a Division of the CALDB be constituted by:
      • the chairperson or deputy chairperson;
      • a member, deputy of the member or a reserve member nominated by the ICAA; and
      • a member, deputy of the member or a reserve member nominated by CPAA; and
    • provide for the ICAA and CPAA to each submit a panel of not less than seven and not more than ten names from which the Minister will appoint:
      • one ICAA member, a deputy of the ICAA member, and up to two ICAA reserve members; and
      • one CPAA member, a deputy of the CPAA member, and up to two CPAA reserve members.
  • In making the appointments, the Minister should have regard to the need to ensure that included in the appointments are some members, deputies or reserves who are current or former insolvency practitioners.
  • The ASIC Act or the Corporations Act, as appropriate, be amended to:
    • enable the CALDB to enforce orders made during the pre-hearing period;
    • provide that, in respect of each disciplinary proceeding, the nature of the matter, the decision and the reasons for the decision should be published; and
    • enable the CALDB to provide information obtained by it during the course of a disciplinary proceeding to the investigation and disciplinary committees of the ICAA, CPAA and NIA, to facilitate the disciplinary procedures of those bodies.

Stakeholder response

There is broad support for the implementation of the Audit Review Working Party's recommendations as modified by the Ramsay report.

It is noted that the proposal by CPAA for a new financial reporting framework envisages a new umbrella body which would have responsibility for standard setting, monitoring and investigation and discipline. The new separate arm of the proposed umbrella body responsible for discipline would bring together the existing functions of CALDB and the separate disciplinary processes of CPAA and the ICAA. While the CPAA proposal calls for structural reform, it would necessarily impact on the existing disciplinary powers of CALDB.

Proposal

The Government agrees with the Ramsay recommendations in this area, with one exception. Consistent with the view of the Audit Review Working Party, the Government believes that, to enhance perceptions of independence of the disciplinary process, a majority of CALDB members should be non-accountants, with non-accountants comprising a majority of members for each hearing.

Proposal 34 - Streamline auditor discipline arrangements

The institutional arrangements for taking disciplinary action against registered company auditors will be strengthened to:

  • provide 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 chairman of 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 to facilitate the disciplinary procedures of those bodies.

 

10.4 Reporting of breaches to ASIC

To improve reporting of breaches of the corporate law, it is proposed that the law be amended so that any company employee who reports a suspected breach of the law to ASIC receives qualified privilege and protection against retaliation in employment.

This should directly assist ASIC in its enforcement of the law and in ensuring that the market receives corrected information where misstatements have been made. It should also help deter those who might otherwise be tempted to break the law.

There is a risk that protection for company employees could lead to some false reports about financial misconduct being made, tying up valuable resources of the regulator and the company. The provision would therefore protect company employees reporting suspected breaches of the corporate law to ASIC in good faith on reasonable grounds.

In the United States, the Sarbanes-Oxley Act contains penalties of fines or imprisonment for up to 10 years for employers who knowingly, with the intent to retaliate, take action against an informant, including interference with his or her employment or livelihood, for providing truthful information to a law enforcement officer about matters relating to the commission or possible commission or a federal offence. There is also a provision that allows civil action for compensation to be taken by employees if they have been victimised by their employer due to their lawful activities in assisting investigators with corporate fraud.

Proposal 35 - Reporting of breaches to ASIC

The Government will amend the law to provide qualified privilege and protection against retaliation in employment for any company employee reporting to ASIC, in good faith on reasonable grounds, a suspected breach of the law.

 


1 The potential inadequacy of the $200,000 maximum civil penalty for bodies corporate that breach continuous disclosure and other financial services civil penalty provisions was highlighted in Chapter 8. It is proposed to increase the maximum civil penalty payable by bodies corporate in breach of those civil penalty provisions to $1 million.

2 See Australian Law Reform Commission, Discussion Paper 65, Administrative Penalties in Australian Federal Regulation, April 2002.