A hidden risk is lurking in New Zealand’s top companies, with too many of them turning a blind eye to the lessons of Wirecard and Enron bankruptcies.
Right now, 30 NZX50 companies have had the same audit firm for at least the last decade, including 18 that have had the same audit firm for at least the last 20 years (potentially longer but this is where we drew the line on trawling through historical annual reports).
While these audit firms might be doing their jobs well (but perhaps not), the lack of fresh perspective flies in the face of global best practice and poses an unnecessary risk for investors.
The risk of staying too cozy
Auditors, along with management, the audit committee, board, and regulators, all have a vital role in ensuring high-quality, reliable financial reporting.
However, when an audit firm has been with a company for a long time, there is a danger they might get too comfortable and compromise their independence. They might start overlooking details or not dig as deep as they should. Over time, this coziness can lead to serious oversight issues or even outright fraud.
Lessons from history
Unfortunately, history has provided us numerous examples of accounting scandals which could have been averted had there been a system in place to ensure regular rotation of auditors.
The bankruptcies of Wirecard (2020) and Enron (2001) spring to mind. These were not just small mishaps; they were colossal multi-billion-dollar failures that rattled financial markets and destroyed investor capital and trust. One of the key issues being that their auditors missed – or ignored – significant red flags.
Global best practice
As a result of devastating accounting scandals, other parts of the world have moved to making audit firm rotation mandatory. The European Union requires companies to change their audit firms every 10 years, with a possible extension to 20 years under strict conditions. In India, rotation is mandatory every 10 years. Even the United States has been debating similar measures, recognising the need for fresh scrutiny to keep financial reporting honest and accurate.
Where not regulated, there is increasing acceptance that audit firm rotation is best practice. A somewhat ironic example of this was the November 2023 announcement from Westpac Banking Corp and Westpac New Zealand Limited of its decision to tender its external audit services, “reflect[ing] best practices for audit firm rotation,” while subsequently acknowledging that its current external auditor, PwC, was appointed by shareholders in 2002, and individuals who were partners of PwC or its antecedent firms had been their external auditors since 1968! Better late than never!
Why audit firm rotation works
The idea behind audit firm rotation is simple: bring in a new set of eyes every so often to look at the books. New auditors are more likely to ask tough questions and spot potential issues. They do not have the same long-standing relationships that might cloud their judgment. This fresh perspective helps maintain the integrity of financial reporting and boosts investor confidence.
Ryman is righting its ship, but has alerted us to concerns with the wider market
New Zealand market participants have raised concerns with Ryman Healthcare’s aggressive accounting treatment for many years now. However, as part of its latest result in May Ryman investors were shocked to learn that in March 2022, the company switched away from independent valuations in favour of director valuations, which assumed the use of 30% deferred management fees (DMFs) instead of the 20% currently charged to residents. Resorting back to independent valuations resulted in a $398m impairment in value.
This and other unexpected (or underappreciated) instances of historical poor judgement detracted from the result on the day but is what prompted us to dig deeper into the audit hygiene of the wider NZX50 companies.
Despite (or in response to) Ryman’s troubles over recent years, the changes made to policies and practises by Ryman’s recently revised board and management team have seen Ryman leapfrog many other NZ corporates in terms of improving audit hygiene. These improvements include the publication of their External Auditor Independence Policy Statement (which requires the tendering and formal assessment of the external auditor at least every 10 years) and recent recommendation for the appointment of PwC as external auditor, replacing Deloitte who has been in the seat since Ryman’s listing in 1999!
Time to protect NZ investors and learn from the mistakes of others
In NZ, the NZX Listing Rules require that the key audit partner is rotated at least every five years but there is no requirement to rotate audit firm.
Organisations such as the New Zealand Shareholders’ Association advocate for audit firm rotations at least every 10 years. We support this position.
But frankly, we are surprised so little attention has been given to the current state of audit firm tenure in NZ. With so many top companies sticking with the same auditors for over a decade, the risk of oversight and complacency is real.
The time has come to call quits the typical Kiwi “she’ll be right” attitude - it does not have a place when it comes to financial reporting, the health of our financial markets and the potential risk it poses to investors hard-earned money.
But equally, let’s not wait around for a change to be debated and maybe mandated.
Instead, as investors we need to actively demand that NZ companies follow global best practice, which means broadly retendering external audit firms at least every 10 years, and disclosing audit firm tenure annually.
By making this standard practice in New Zealand, investors should have better protection against the kind of corporate scandals that have caused so much damage globally in the past.
This article originally appeared in the NBR on 16 July 2024 (paywalled).
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