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CLERP 9 – Audit Reform & Corporate Disclosure

Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure Bill) 2003 was released by the Government in October 2003 having come into effect in 2004. The main reforms looked at:

1   Independence & rotation of auditors

2   Disclosure of fees paid to auditors for non-audit services

3   Retiring auditors seeking positions on the audited body's board

4   Requirement for the CEO and CFO to sign-off on financial statements

5   Disclosure of directors' and senior managers' remuneration in financial reports

6   Dispute resolution on a non-binding basis for financial reporting

7   Infringement notices for continuous disclosure contraventions

8   Proportionate liability for economic loss caused by misleading or deceptive conduct

9   Analyst independence and general advice

10   "Whistle blowing" protection

11   Enhanced shareholder information and participation

12   Disclosure documents

13   Officers, senior managers, and employees

Audit Reform


The Financial Reporting Council's role will expand to include control of the audit standard setting arrangements. All auditing standards issued by the Auditing and Assurance Standards Board will receive legislative support.  


There will be new independence rules imposed on auditors. The provisions regulating independence apply to individual auditors (sole practitioners), audit firms (partnerships), and audit companies who must establish adequate internal control systems to ensure that they will not contravene the independence requirements. The duty to be independent on appointment and to remain so, are the responsibility of the auditor - not the audited body.

Auditors must give the directors of the company a "written declaration" that the auditor and each professional member of the audit team have complied with the auditor independence requirements of the Act and any applicable codes of professional conduct.

The general independence requirement is a prohibition on an auditor (individual, firm, or Audit Company) engaging in audit activity for a company where a "conflict of interest situation" exists. This will exist if there are circumstances that "impair, or might impair, the ability of the auditor, or a professional member of the audit team, to exercise objective and impartial judgment in relation to the conduct of an audit" or "would give a person, with full knowledge of the facts and circumstances, reasonable grounds for concern that the ability of the auditor, or professional member of the audit team, to exercise objective and impartial judgment in relation to the conduct of the audit is, or might be, impaired". The professional relationships between the auditor (and audit firm or audit company) and the company, its directors and senior managers, will have a bearing on these tests of independence.

This general standard of independence has restrictions on specific employment and financial relationships between auditors and their corporate clients. There are prohibited relationships that threaten auditor independence. There are a number of new definitions and phrases, which are crucial to understanding how to comply with the new independence requirements, including "audit company", "audit-critical employee", "engage in audit activity", "investment in a company", "lead auditor", "review auditor", professional employee" and "professional members of the audit team".

These independence requirements have more strength by the imposition of a statutory duty on the auditor to inform ASIC if the auditor is aware of circumstances that 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.  


Retiring auditors who seek to take up senior positions in companies, which they formerly carried out audits, are subject to waiting periods. The length of the waiting period depends upon the extent to which the auditor was directly involved in the audit of the audited body. Direct involvement is measured by whether the person was a "professional member of the audit team.”

A waiting period of four years applies to partners of an audit firm or directors of an audit company who were directly involved in the audit of the audited body, but only a two-year waiting period applies to those who were not directly involved in the audit. A waiting period of four years applies to retiring professional members of the audit team. The waiting periods will operate prospectively, meaning that they will apply to persons who resign or retire on or after 1 July 2004.

There is a prohibition on any more than one former audit partner or director of an audit company, becoming a director or taking up a senior management position with the audited body. This proposed provision will operate prospectively.  


The rationale for auditor rotation assumes that the independence of the auditor diminishes over time. That it may come at the cost of continuity of knowledge is unavoidable. The rules on auditor rotation only apply to listed companies and are determined by whether the subject auditor “played a significant role in the audit.”

The basic rule is that lead and review auditors who have conducted audits on a company for five successive financial years, cannot be re-engaged to play a significant role in the audit of the company for at least another two successive years. To reflect the fact that auditors may not necessarily audit the company in successive years (thus avoiding the prohibition, a secondary rule operates to the effect that a person may not play a significant role as auditor of the company for more than five of any seven successive financial years). ASIC will be given limited power to extend the auditor rotation periods.

The auditor rotation rules will apply from two years following 1 July 2006. So, if the person has conducted three or more successive audits of the company as at 1 July 2004, then the auditor will need to be replaced in respect of the audit based on the financial year commencing 1 July 2006 (since they would have completed audits for five successive years by that time).  


Auditors must retain audit records and working papers for a period of seven years. ASIC may approve the disposal or destruction of audit records within the seven-year period in limited circumstances.  


A company can register as a company auditor known as "authorised audit companies” however, each director must be a registered company auditor; and the company must have adequate and appropriate professional indemnity insurance cover.


The annual directors' report for a listed company must disclose details of the fees paid for all non-audit services (e.g. taxation advice, or assurance-based services) provided by the company's auditor. The directors must state in the directors' report whether they are satisfied that the provision of non-audit services by the auditor is compatible with the standards of auditor independence imposed by the Act and the reasons for being so satisfied.  


Requiring the disclosure of remuneration of directors and “senior managers” of both the listed entity and the corporate group has strengthened the disclosures in the directors’ report under section 300A. The remuneration disclosures required by section 300A are to be presented "in a separate and clearly identified section of the report" and must be presented under the heading "Remuneration Report.”

A listed company's Remuneration Report must be presented at the company's AGM for discussion and is to be put to the vote of shareholders. The company's chairperson will come under an obligation to allow shareholders as a whole to ask questions about, or comment on, the Remuneration Report. However, the resolution of shareholders about the remuneration report is not binding on the directors.  


The annual directors' report of a listed entity must contain information which, in the opinion of the board, shareholders of the company would reasonably require to make an informed assessment of the entity's operations, financial position, current and future business strategies. This seems to supplement section 299 of the  Corporations Act , which imposes a requirement that the directors' report must contain a review of operations and likely future developments. (Section 299 is not limited to listed entities).


The chief executive officer (CEO) and the chief financial officer (CFO) of a listed entity must certify to the board of directors that the annual financial statements are in accordance with the Corporations Act and the AASB accounting standards, and that they present a true and fair view of the company's financial position and performance. This requirement is based on section 302 Sarbanes-Oxley Act 2002 (US) and Recommendation 4.1 of the ASX's Corporate Governance Best Practice Recommendations.

This certification and sign-off does not diminish the board's ultimate responsibility to ensure that the financial reports comply with the Act. Section 189 permits a director to rely on information provided by others, in certain circumstances, but the "reasonable reliance defence" only operates for the statutory duties in Part 2D.1 (and the equivalent general law duties), and not Chapter 2M. The CEO and CFO sign-off may affect the operation of section 189 if legal proceedings are brought against the directors for negligence in the preparation and publication of the financial reports.  


A Financial Reporting Panel will seek to resolve disputes on a non-binding basis between ASIC and companies about whether the company has complied with the financial reporting requirements of Chapter 2M of the Corporations Act (proposed Part 2M.3 Division 9). The Financial Reporting Panel can be a better alternative to court proceedings, with its membership having particular expertise in the interpretation and application of accounting standards. The Financial Reporting Panel's report must be publicised by ASIC, and a Court may take the Financial Reporting Panel's report into account in the event the dispute between ASIC and the company escalates to legal proceedings. The Financial Reporting Panel's membership, procedures, and operations will be set out in the ASIC Act (proposed Part 13).  


Currently, a civil contravention of the continuous disclosure rules leads to the imposition of penalties on the entity itself, but not the individuals responsible for the contravention. Under the changes, persons ''involved'' in a contravention of the continuous disclosure rules are subject to civil penalties, which aim at directing responsibility to the natural persons making the decisions whether or not to disclose the information, i.e. directors and senior managers.

ASIC can issue infringement notices for continuous disclosure contraventions, which is intended to serve as an alternative to civil penalty proceedings under Part 9.4B, where ASIC has "reasonable grounds to believe" that an entity has breached the continuous disclosure laws.

ASIC must before issuing the infringement notice give the entity its reasons for believing there has been a continuous disclosure contravention and must give the entity the opportunity to express its views at a private hearing. Penalties depend on the company’s market capitalisation and if it has previously contravened the continuous disclosure laws. To comply with the infringement notice, the entity must pay the relevant fine, and remedy any inadequate disclosure. Compliance with an infringement notice is not an admission of contravention or liability. Compliance with the infringement notice will shield the entity from any further civil or criminal liability for the alleged contravention.  


Amendments to the ASIC Act 2001, Corporations Act 2001, and Trade Practices Act 1974 ensure that proportionate liability applies to damages for economic loss for misleading and deceptive conduct. This will affect claims for damages under section 12GF ASIC Act, section 1041I Corporations Act and section 82 Trade Practices Act.

Under a proportionate liability system, the defendants contribute to the plaintiff's loss according to their share of responsibility for the loss or damage. These changes are part of wider government reforms relating to joint and several liabilities and proportionate liability but they exclude intentional torts and claims involving fraud from the application of proportionate liability. The rules do not affect the law of contributory negligence, vicarious liability, the liability of partners under partnership law and the liability of a principal for the acts of an agent.  


CLERP 9 policy paper took the opportunity to review the Australian regulatory framework concerning the management of conflicts of interests of analysts working within large financial conglomerates, which offer a wide range of both advisory and research services. The conflicts of interest largely stem from the way in which analysts are remunerated for their services. If an analyst's salary is linked to other corporate or advisory services of the firm or even to the profitability of the firm as a whole, then their independence or objectivity might be compromised since they have an incentive to provide positive research reports and recommendations on corporate clients who also engage the firm for corporate or advisory work. Similar conflicts may arise where research and broking houses act as underwriters to initial public offer.

An additional obligation under section 912A applies to financial services licensees generally, to "have in place adequate arrangements for the management of conflicts of interest"  


A new framework to encourage employees, officers and contractors engaged by a company to report suspected breaches of the corporations’ legislation to ASIC. Persons will qualify for "whistle blowing" protection if they have reasonable grounds to suspect a contravention and the person makes the disclosure to ASIC in good faith. The "good faith" requirement will not operate in the same way that the "absence of malice" requirement operates for qualified privilege in other areas of the Act. The good faith requirement is "intended to raise the threshold for obtaining qualified privilege.” A person having a malicious or secondary purpose in making the whistle blowing disclosure is not acting in good faith. A "whistle-blower" will have protection against criminal and civil liability, the enforcement of contractual remedies (e.g. confidentiality clauses), liability for defamation and termination of contract. The Act will prohibit whistle-blowers from being victimised.  


There is a range of measures to ensure that shareholders have adequately information about the exercise of shareholder rights, particularly on voting rights. Notices of meetings must be "worded and presented in a clear, concise, and effective manner.” A general statement, but we suggest that Attachment A of the ASX's Principles of Good Corporate Governance and Best Practice Recommendations is more instructive and useful as to what this requirement entails in practice. The provisions relating to the distribution of notices of meetings via email and other electronic means is broadened. Annual reports may be sent by electronic means, e.g. by email or making them available on the company's website and notifying the shareholder that they are available for download.

A body corporate will be able to be appointed as proxy, which will be able to appoint a representative to exercise the powers that the body corporate may exercise as the member's proxy. Regulations provide for the electronic authentication of proxy appointments (i.e. permissible types of "electronic signatures").

The annual directors' report for a listed company must disclose all directorships held by the director at any time in the immediate preceding three years, including the period for which the directorship was held.

Disclosure Documents


Product Disclosure Statements, which must be used for offers of interests in managed funds, insurance and superannuation, among others - are subject to a comprehensibility requirement in section 1013C(3). However, the law governing prospectuses - used for offers of shares and debentures - contains no such requirement. A comprehensibility rule for prospectuses was raised in "Fundraising: CLERP Paper No 2", but not followed through in the final enactment of Chapter 6D, on the grounds that the anticipated compliance costs would exceed any commensurate gain for investors, and the inherently subjective interpretation of what amounts to "clear, concise and effective" presentation (see pages 18-20).

Chapter 6D will require that prospectuses be clear, concise, and effective way, bringing it into alignment with the rules for Product Disclosure Statements. This change is "intended to improve how the content of a disclosure document is presented and its meaning is conveyed.” 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".  


The legislation will align the disclosure requirements in Part 7.9 (Product Disclosure Statements) and Chapter 6D (prospectuses) in relation to continuously quoted securities and other types of continuously quoted financial products. Listed schemes, which will be the main beneficiary of the new provisions, will be able to issue transaction-specific Product Disclosure Statements.  


The changes intend to improve the practical operation of the secondary sales provisions. The proposed changes purport to address concerns that the width of the secondary sales provisions has a significant and detrimental impact on underwriting arrangements and the ability of institutional investors, who have taken share placements without a prospectus, to dispose of their shareholdings.

The need for disclosure does not trigger if the share placement is part of a class of securities that are quoted and have been subject to the continuous disclosure provisions without exemption for at least 12 months prior to the on-sale. To take advantage of the secondary sale exemptions, a notice must by lodged with the stock exchange by the issuer of the securities. The issuer, not the on-seller, is responsible for preparing and providing the notice. This is because it is the issuer, which did not provide disclosure at the time of making the placement, and it is best placed to provide prospectus-like disclosure to the market. The notice must verify to the market that the issuer has complied with its continuous disclosure and reporting obligations and must provide the market with information which is excluded from continuous disclosure to ensure investors (potential purchasers of the securities being on-sold) receive prospectus-like disclosure. It is a matter for negotiation between the institutional investor (who has taken the share placement) and the issuer to arrange to ensure a valid notice is in place, in order to allow the institutional investor to on-sell its holdings within 12 months of the issue of the securities.

Similar rules will apply about the secondary sale provisions relating to Product Disclosure Statements.  


Currently, the  Corporations Act  has some anomalies about the definitions "officer" and "executive officer.” Definitions of "officer" are in both sections 9 and 82A of the Act, which could lead to confusion in relation to the application of the statutory duties in Part 2D.1 of the Act.

The definitions are not identical. For example, the section 82A definition includes an employee (whilst the section 9 definition does not) and by repealing the section 82A definition of "officer” will remedy these anomalies. Where a provision in the  Corporations Act  intends to apply to employees, the provision will clearly, state that that is to be the case.

The definition of "executive officer" is set out in section 9 and distinguishes between officers who take part in the management of the company (executive officers) and ordinary employees. The term “senior manager’ will replace and repeal the term "executive officer.”

The term "senior manager" will mean a person who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation, or who has the capacity to affect significantly the corporation's financial standing. (The term is defined with reference to a partnership, trust, and joint venture). This definition is identical to the definitions of "officer" in current subparagraphs (a) (i) and (ii) of the section 9 definition of "officer.” Therefore, senior managers will be "officers" for the purposes of the statutory duties in Part 2D.1 of the Act.

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