The above Act came into operation by publication on 14 December 2007
The notes below provide a summary of the amendments to the
Companies Act 1973 introduced by this new Act insofar as they
are relevant to the functioning of the Audit Committee of
"Widely Held Companies" (i.e. public companies) and
of related issues.
The Act brings the regulation of the Audit Committee partly out of the realms of secondary regulation (JSE listing requirements / King report) into the scope of the primary corporate legislation (the Companies Act, 1973).
The Act does not set out to govern the way in which Audit Committees will undertake their functions. It is limited in its application to:
- The requirement that there should be an Audit Committee.
- The membership of the Audit Committee.
- The limited statutory functions allotted to the Committee in relation to the appointment of external auditors; the liaison with the external auditors and the regulation of non-audit work by them, and the performance of certain limited functions in regard to dealing with complaints and reporting to the members.
The method of operation of Audit Committees will continue to be dealt with by a combination of listing requirements and stock exchange regulation together with foreign statutory requirements as applicable.
The Act has limited impact on the statutory or common law exposure of the members of Audit Committees save to the extent that it defines their role in relation to these limited functions with greater precision and that will impact upon the standards by which they are judged.
Relevant Sections Of The Act
1. Definition section
- "financial report" means financial statements and any financial information in a circular, a prospectus or a provisional announcement of results upon which users may reasonably rely;
- "financial reporting standards" means statements of Generally Accepted Accounting Practice adopted by the Accounting Practices Board prior to the establishment of the Council, and thereafter issued in terms of Section 440U(2);
- "financial statements" means annual financial statements, provisional annual financial statements and interim or preliminary reports and includes, where applicable, group and consolidated financial statements;
- "user" in relation to a financial report, means a shareholder, prospective shareholder, creditor, regulator or any person who relies on information contained in the report;
- See also the definition of "widely held company" in the amended Section 1(6)(a) of the Act (effectively , a public company).
2. Section 269A – Audit Committees for Widely Held Companies
- A Widely Held Company must have an Audit Committee for each financial year.
- If the holding company Audit Committee fulfils that function for subsidiaries then widely held subsidiaries do not need a separate Audit Committee.
- The Minister may dispense with the requirement of an Audit Committee if satisfied that little or no benefit would result from the appointment of such a committee in specific categories of companies.
- The Audit Committee must have at least two members and may consist only of non-executive directors who must act independently.
- Non-executive means that the director:
(i) Is not involved in the day to day management of the business and has not in the past three financial years been a full time salaried employee of the company or its group;
(ii) Is not a member of the immediate family of an individual mentioned in (i) above.
- A director acts independently if that director:
(i) Expresses opinions, exercises judgment and makes decisions impartially;
(ii) Is not related to the company or to any shareholder, supplier, customer or other director of the company in a way that would lead a reasonable and informed third party to conclude that the integrity, impartiality or objectivity of that director is compromised by that relationship.
- This latter test is an objective test (i.e. the reasonable and informed third party). The mere appointment as the nominee of a particular shareholder ought not to be definitive – per Margo J in Fisheries Development v Jorgensen:
"A director is in that capacity not the servant or agent of the shareholder who votes for or otherwise procures his appointment to the board (the position of "nominee", though referred to in the plea, would not seem to have the legal consequences alleged by the defendants). The director's duty is to observe the utmost good faith towards the company, and in discharging that duty he is required to exercise an independent judgment and to take decisions according to the best interests of the company as his principal. He may in fact be representing the interests of the person who nominated him, and he may even be the servant or agent of that person, but, in carrying out his duties and functions as a director, he is in law obliged to serve the interests of the company to the exclusion of the interests of any such nominator, employer or principal. He cannot therefore fetter his vote as a director, save in so far as there may be a contract for the board to vote in that way in the interests of the company, and, as a director, he cannot be subject to the control of any employer or principal other than the company."
3. Section 270A – Functions and funding of Audit Committees
Section 270A sets out the obligatory functions of the Audit Committee, which must:
- Nominate as external auditor a registered auditor who, in the opinion of the Audit Committee, is independent. Criteria for independence are set out in subsection (5) including:
(a) No remuneration outside audit fees;
(b) The extent of any consultancy, advisory or other work undertaken by the auditor;
(c) Whether independence is prejudiced as a result of any previous appointment as auditor;
(d) Such other criteria as may be specified by the Independent Regulatory Board for Auditors (IRBA).
Independence is, accordingly, determined by both the subjective assessment of the Audit Committee ((b) above) and the objective criteria established by the IRBA – as yet unpublished.
- Determine the fees to be paid to the auditor and the auditor's terms of engagement. Members of the Audit Committee will need to:
- Be satisfied that the audit fee negotiated with the independent auditor is fair and reasonable and in accordance with industry norms having regard to the extent of the audit engagement.
- Give proper consideration to the terms of the engagement letter to ensure that it determines the extent of the independent audit obligation adequately and that it contains no provisions which are in conflict with applicable legislative or regulatory stipulations.
- To ensure that the engagement properly defines the nature and extent of non-audit services which the auditor may provide to the company.
- Pre-approve the engagement or any subsequent contract for the provision of non-audit services.
- Insert a report in the financial statements which:
- Describes how the Audit Committee carried out its functions, and
- Confirms that the Audit Committee is satisfied that the auditor was independent of the company in the sense referred to above.
- Receive and "deal appropriately with" any complaints (whether from within or outside the company) relating to either the accounting practices or the internal audit of the company or to the content or auditing of its financial statements or "any related matter". The purpose of this provision is clearly to:
- Provide a vehicle for employees of the company to raise queries or concerns in regard to the financial affairs and reporting of the company through a medium other than management. The Audit Committee ought to establish procedures which will ensure appropriate protection for parties making reports in this regard in good faith.
- Act as a recipient for external queries in relation to the financial affairs and reporting of the company – a role which will be stimulated by the inclusion in the published accounts or reports by the Audit Committee.
- Perform "any other functions determined by the board".
- Recommend the appointment of an independent auditor, but the section recognises the right of the company in general meeting to appoint another auditor but subject to the proviso that the Audit Committee is satisfied as to the independence of the new nominee. By this mechanism the Audit Committee retains a right of veto but limited to circumstances in which any nomination contrary to its own infringes upon the notions of independence as reflected in the Act.
The Act specifically records that the appointment of the Audit Committee does not reduce the functions of the Board of Directors of the company except with respect to the appointment, fees and terms of engagement of the auditor. This is an important stipulation in that it:
- Reaffirms both the right and the obligation of the board to control both the financial affairs and the financial reporting of the company within legislative constraints save for the express functions reserved by this new statute for the Audit Committee; and
- Reaffirms the individual and collective responsibility of members of the Audit Committee as general members of the board of the company in relation to its overall financial administration.
- Confirms that Audit Committee members have at least the same obligations and liabilities that rested upon them before the enactment of this Act, supplemented by the functions now specifically delegated to them by the Act.
Section 27A recognises the obligation of a public interest company to meet all expenses "reasonably incurred" by the Audit Committee which would include the fees of any consultant or specialist engaged by the Audit Committee to assist it in the performance of its duties.
- This is seen, particularly in the US experience, as an important protection for Audit Committee members in the pursuit of the onerous obligations resting on them as "specialist" members of the Board of Directors. By seeking appropriate competent professional advice in relation to legal and accounting issues which are of concern to them, the Audit Committee avoids or reduces the contention that it has acted without due care. The requirement that any such expenses be funded by the company is a recognition of the rights of the Audit Committee to function as an independent unit within the board in regard to matters which fall within its specified functions or which have been delegated to it by the board.
4. Section 274A – Rotation of auditors
The Act now stipulates that the same individual may not function as the individual registered auditor (within the meaning of that term in the Auditing Profession Act, 2005 (APA)) for more than five consecutive financial years. Once such an individual cease to act as auditor after two or more consecutive years then there is a compulsory gap of at least two complete financial years before the individual can be considered for re-appointment.
5. Section 275A - Certain non-audit services not open to current auditor of public interest companies
- This is the section which gives statutory recognition to the category of non-audit services which may be excluded by the IRBA through the mechanism of the professional code of conduct which it is authorised to formulate under the APA.
- The section specifically recognises that the Audit Committee may further limit services which the independent auditor may render.
- Audit Committees of companies subject to foreign legislative or regulatory enactments may be required to apply any supplementary restrictions which are contained in those foreign enactments.
6. Section 285A - General requirements for financial statements
- This section now gives statutory force to the financial reporting standards as formulated by the newly established Financial Reporting Standards Council.
7. Section 287
- Section 287 establishes criminal responsibility on the part of every director or officer who is a party to the issue of financial statements which are incomplete or do not comply with the requirements of the Act.
8. Section 287A
- Section 287A establishes a new category of criminal liability for "false or misleading reports". In terms of this provision any person "who is a party to the preparation, approval, publication, issue or supply" of a false or misleading report and who "knows or ought reasonably to suspect" that it is deficient, is guilty of an offence. The section further sets out that a person shall be regarded as a party to the preparation of a report if the report includes or is based upon a scheme, structure or form of words devised, prepared or recommended by that person or if it is of such a nature that the person knew or ought reasonably to have suspected that its inclusion would cause the report to be false or misleading.
- There is a potential exposure under this section for parties who recommend schemes or wording which are adopted in any financial report regardless of whether they are officers of the company – this would, presumably, include external financial and legal or tax advisors.
9. Section 300A
- Section 300A deals with "attendance of auditors" and requires the external auditor to meet with the Audit Committee of a public interest company not more than a month before the board meets to approve the financial statements in order to consider any matter which appears to the auditor or the Audit Committee to be of importance and relevance to the proposed financial statements and to the affairs of the company generally.
- Whilst expressed as an obligation resting on the external auditor to call for such meeting, the section implicitly recognises the role of the Audit Committee in providing its own reaction to the matters identified. It cannot be suggested that this section implies that it is the Audit Committee which has the delegated function to approve financial statements and the provisions of Section 270A(iii) expressly record that the appointment of the Audit Committee does not reduce the functions of the Board of Directors in this regard. Nonetheless by including this requirement the legislature gives recognition to stipulations in the codes of practice suggesting that the responsibilities of the Audit Committee include a review of the financial statements prior to board approval and the adequate interrogation of the external auditors in regard to matters which committee members, in the proper exercise of their functions, consider appropriate or require clarification.
- The Companies Act does not in itself dramatically widen the obligations and liabilities of Audit Committee members.
- It does, by its formal statutory recognition of their status and by the compulsory requirement for the appointment of such a committee, entrench the status of Audit Committee members as important functionaries within the corporate governance structure.
- The existing role and responsibility of Audit Committees set out in the King Reports and relevant foreign legislation will inevitability set standards for the role and responsibilities of committee members by which their performance will be measured.
- The implied recognition of the role to be played by the Audit Committee in raising matters of "importance and relevance to the financial statements and the affairs of the company generally" prior to the submission of proposed financial statements to the board for approval suggests a wider role and responsibility than has been expressly recognised.
- US reaction to the definition of the role of the audit committee has been to suggest that this will inevitably give rise to an extension both of the criteria for liability and the potential group of third parties who may contend for reliance upon the proper fulfilment by a audit committee of their defined role and function. Suggested protective measures to be taken by US audit committee members include:
- Contracting out of responsibility in states where that is feasible – not a possibility in South Africa by virtue of the strict provisions of Section 247 of the Companies Act which expressly precludes any contractual disclaimer of liability.
- Appropriate and adequate use of the authority given to Audit Committee members to seek independent advice in matters where uncertainty exists as to the nature or extent of any duty – readily capable of being pursued in the South African context.
- Ensuring that there is appropriate and adequate directors and officers indemnity insurance available to protect Audit Committee members against the consequences of bona fide breach of duty – again readily available in South Africa.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.