Review of independent auditing

CAMPBELL, Mr Gavin, Accounting and Financial Advisory Committee Member, Australian Institute of Company Directors

ELLIOTT, Mr Rob, National Policy Manager, Australian Institute of Company Directors

GRANT, Mr Stuart, Accounting and Financial Advisory Committee Member, Australian Institute of Company Directors

CHAIRMAN We have received your submission, for which we thank you. Do you have a brief opening statement before we start to ask our penetrating questions?

Mr Elliott We appreciate the opportunity and we understand the need for brevity in the opening statement; we would like to maximise time for questions. To set the scene very briefly, Stuart Grant and Gavin Campbell are both experienced company directors. Gavin is an exmanaging director of the Australian Stock Exchange. Stuart Grant has experience in a number of capacities, as a chartered accountant and as a senior regulator with ASIC, or ASC as it was at the time.

The Australian Institute of Company Directors is a peak body, organised to look after company directors as individuals not as companies. There are 16,500 of those company directors, large and small. The organisations cover all industries across Australia, large and small, private, public, not-for-profit sectors. Membership is individual not corporate.

Probably the most important thing we would like to introduce is the concept that the AICD is about promoting excellence in director performance and what we are not about is protecting poor director performance. With regard to promoting good practice rather than protecting poor practice in directorship, the institute's education and professional development has developed a number of publications. I understand you already have one of these. I will table the other, which is called Fifty matters to be considered before signing a company's financial statements. The final thing I would like to table is an AICD article published in the Financial Review on 25 June 2002 titled 'The auditing buck must stop with directors'. Having said those things, I would like to maximise the amount of time for questions.

CHAIRMAN Do you have a copy of that article?

Mr Elliott Yes, we will provide one.

CHAIRMAN Thank you for that. I should declare that the four of us here at the moment have no conflict of interest; that is to say we have never been members of your institute.

Mr KING So far as we know.

CHAIRMAN I have not and you said you have not. In your submission, you stated:

A new financial reporting paradigm is needed, which emphasises substance over form and where the detailed approaches selected are based on effectiveness and have regard to the cost of their application.

You go on to support a new, principle based approach. But is it not true that we have in the past had an almost totally principle based approach rather than one that is at all rule based and that what we have today is a rule based approach with an override of 'true and fair'? Are you really saying you want to go back totally to principles and get rid of Australian standards and our movement to international standards?

Mr Elliott The short answer is no, and I will let my colleagues elaborate.

CHAIRMAN A bit more than 'no' might be helpful.

Mr Grant Substance over form really means true and fair view in another form. As to the principles based approach, I think what we have at the moment in accounting standards is a mixture; it is a composite of principles combined with some prescription. The notion of a true and fair view is there but it is not an override - you mentioned an override, Mr Chairman. The predominant requirement is compliance with the rules which is embraced in accounting standards. There is a secondary requirement, which is true and fair view, which we believe is somewhat neglected because of the focus on the specific requirements, because they are so extensive.

The preference of the institute, which has been contained in its submissions for many years, is to revert to the requirement for a true and fair view being paramount - to comply with accounting standards but, nevertheless, to require that there be compliance with a true and fair view. In practice, this will mean additional disclosure, because 'true and fair' typically means more rather than less. The way the regime has moved, however, is that the true and fair view has tended to be only if you do not agree with the standard, so it is a one-sided assessment instead of an all-embracing assessment. As I say, we would like to see the more principles, the more allembracing assessment. May I add that a true and fair view and substance over form are a more onerous test than any compliance with a set of rules.

CHAIRMAN My understanding is that in Australia we have moved to continuous reporting and the Americans have stayed with quarterly reporting on a more detailed prescription. The Europeans vary, sometimes reporting half-yearly as well as yearly and sometimes more often. Would you support continuous audit of continuous reporting?

Mr Grant My reaction is that that would not be desirable. It seems to be too onerous and perhaps too time consuming - too much delay. Furthermore, much of the continuous disclosure announcements, if they are valuable, should be in the form of projections, which are inherently not capable of traditional verification that an audit would normally apply. So we think that the regime of continuous disclosure is very good - the application of it can always be improved - but that an audit of it seems undesirable.

Mr Elliott We have written to Senator Campbell with regard to a fundamental review of the continuous disclosure regime and how it works because, whilst we think it is very good and, relative to the rest of the world, excellent, that is not to say it is perfect. We pointed out some particular areas in it which we think needed to be improved and we are pleased to see that CLERP 9 is going to be picking up a number of those issues.

CHAIRMAN Would you mind sending us that information too.

Mr Elliott Sure.

CHAIRMAN I took a bit of exception to your media release that evidently appeared in the Financial Review on 25 June 2002 which started out by saying:

Given the deafening debate on the independence of auditors and the role of audit committees, it is timely to remember that it is the directors of the board …

I would remind you that this committee's brief is far broader than the independence of auditors. We hope and expect to have a very important role to play in whatever position the Australian government ultimately takes on regulation versus self-regulation and recommendations we might make to independent companies and to independent auditors.

Mr Elliott I take your point, Mr Chairman. In fact, the institute's business is in the wider range of corporate governance matters, and we understand that the independence audit, competence audit committee is just one small part of the broader corporate governance regime of Australia. We see that as core business.

CHAIRMAN One of the issues that we debate, and have continuously in these hearings, is the issue of auditor competence and how that might be judged. The Corporations Act requires that an auditor be a natural person, not a corporation. It says so, specifically. Yet, the big four, who deal with a lot of the directors that you represent, are all huge firms. They are not one man audit or accountancy firms with one auditor who happens to be one of the partners. How would you view changing the Corporations Act to require auditors to be corporations rather than natural persons?

Mr Grant We actually discussed that, having read the transcript of earlier hearings of this committee.

Mr Campbell I think the limited liability issue is important and probably can be handled in a number of ways. At this stage, I have no view whether incorporating auditors would be the best way of doing it, but it maybe worth doing - one way or another. As for wider aspects of corporation, I do not know whether they would conflict with the day-to-day duties of an auditor or cause any difficulties or diminish the sense of personal liability that an auditor faces when he brings his pen to sign off on audit. I would have to leave that to my colleague.

CHAIRMAN Would you object if say, regardless of whether it was compulsory or voluntary, an audit firm became a corporation, as I understand some are in some states in the United States? If it became a corporation, and was listed on the exchange, there would of course be a requirement for its financial operations to be audited. Would you be averse in such a situation to the audit firm also having a published performance audit performed on it relating to its independence and the quality of its work?

Mr Grant Some interesting ifs in there. I think it sounds appealing in principle. I am not sure how effective it would be in practice. Also, I am not sure if there are measurable benefits from incorporating, as you are suggesting, as a possibility. The key to audit performance is for the audit partner or the executive group to make the tough calls when required. In my view, all the discussion about competency can be distilled down to that one issue: are they willing and able to make the tough calls? I am not sure about incorporation or peer review because those judgments that the audit team have to make are not capable of being fully documented. There is a high degree of instinct, subjectivity and experience that is brought to bear which, at the end of the day, lead the auditor to say, 'Yes I accept,' or 'No, I do not.' It is very difficult to secondguess that in hindsight.

Mr Elliott It would be fair to say we would not automatically say, no, this is not a bad idea. It is something that we are all need to look at quite closely to ensure that those benefits actually did flow through and it would work practically.

CHAIRMAN You might think about both those issues and come back to us.

Mr Grant Chairman, I should confess our thorough bias. As a former managing director of the Stock Exchange, I ask, 'Why not?' as the question to be answered. But, yes, it is worth looking at.

CHAIRMAN The last respondent to this inquiry, who appeared just before you, has recommended very strongly that it be a requirement of the Corporations Act that the audit firms, not the individual audit partner, be changed every five years. He argues strongly that that would increase the quality of their public reporting, because they would have no fear that they were going to be sacked during that five years. They would make sure they did a better job because they would be reviewed by the new firm that came in after five years. Do you have a view on those views?

Mr Grant Certainly the topic of rotation of audit firms has been the subject of a lot of discussion. I think what has not been fully canvassed is the practical and commercial difficulties that that gives rise to. There is a lot of expertise and a lot of knowledge that goes into an audit. An audit of, say, one of the big banks in Australia might involve 50 staff in that audit at the peak time or for quite a long period of time, and to suddenly say that is going to be removed from that firm, you have to ask: what are you going to do with those people, what are you going to do with that expertise? It is never going to be a neat fit that they are going to get another job that precisely fills the spot. So there are significant commercial difficulties with that. It seems to me that there might be other aspects of the audit role that could be brought to bear that sufficiently
enhance the security of tenure of the auditor without going to a fairly extreme practice of complete withdrawal of one firm from the audit and replacement with another. Just as an aside,
Mr Chairman, rotation of audit firms was introduced in Italy in about 1975 and the Italians got around it by switching the partners from firm to firm.

Mr Campbell As you would expect.

CHAIRMAN This committee has heard that some have suggested that perhaps the majority of Australian companies view audit as simply an expense rather than adding value to their operations. Would you care to comment?

Mr Campbell In my particular case I never had that view. I always saw comfort in the auditor and the importance of making sure that the auditor had direct access to the board and to me as a director.

CHAIRMAN Would you then support public performance auditing?

Mr Campbell Of the company or the auditor?

CHAIRMAN Of the company. The earlier question was a performance audit of the auditor, but let us go back to the crux of the question, a performance audit of the company to give a true
and fair view of the company's operations.

Mr Campbell In my personal experience the nearest analogy I can get to is the preparation of a prospectus or an IPO, an initial public offering. I did that when I was a director of Optus - Cable & Wireless Optus as it became. In fact, I was chairman of the due diligence committee. I will just give you some numbers. The cost of the audit in the year prior to that listing year was about $1 million. The estimated cost of preparing the company for listing was put in the prospectus at about $50 million, and that figure did not include some costs met by the two major partners who were pushing this concept and had special considerations, and did not include the opportunity cost of the massive diversion of senior management time from making a buck for the shareholders. I might say it was the third time the company had had a go at this, so probably they got some streamlining in the processes. If that is in broad terms a valid analogy - you can pick holes around the edges, of course - one has to be prepared for a significant increase in costs. I think a lot of the debate is going to concern where the benefit-cost balance lies in what is going to be a diminishing returns curve. Personally, I thought the requirements for an IPO were excessive in terms of the consequential costs and diversion of key people's time, but that is in a climate when you only do it every now and then; you do not do it every year, much less every quarter if it ever comes to that. So I think there is a fair comment that there can be more quality injected with more effort and more money into auditing processes, including possibly expanding them to cover non-traditional areas, but there has to be a cost consequence and cost
balancing.

CHAIRMAN You would understand, Mr Campbell, that this committee, which has a strong role with respect to audit for the Commonwealth, deals almost entirely with performance audits of Commonwealth entities. From time to time, we do take on inquiries which do not, and this is a good example of one where we believe we know more about the audit function than any other committee in the parliament, so we decided to inquire into it publicly rather than privately. You would be aware of our interest in performance audits?

Mr Campbell Yes.

CHAIRMAN I think I can say on behalf of everyone on this committee that we believe very strongly that performance audits add value.

Mr Campbell Yes. Where you do not have the alternative of a market setting its own discipline on performance, I think you may have little alternative, if I may make that point.

CHAIRMAN Okay, we accept your point.

Senator MURRAY These remarks I am about to make result from a six-year tenure which I have had on the Joint Committee on Corporations and Securities, now the Joint Committee on Corporations and Financial Services. That committee has oversight of ASIC. In my capacity as a member of that committee, I have periodically explored the issue of best practice election of directors. Does the institute have a set of guidelines as to the way in which company constitutions should develop the best processes for electing directors and some alternative models for the types of boards which might be seen as providing the best balance of capabilities and skills?

Mr Elliott As you would expect from an organisation that considers its core business to be corporate governance, yes, almost everything we do touches upon corporate governance. Many of those issues that you have asked about are covered in a wide range of products and services that we provide, including the company director course. Over 2,000 members go through this course each year. There are a number of other purpose-built courses, including the role of the chairman, the selection of the board and developing a good corporate governance manual and process within your board. These are specific courses and there are subset modules of larger courses. There is a range of publications which touch on a number of those issues. Probably the most recent one is on the succession, selection and performance of directors, called 'The 21st century board', which we released at the end of last year. There is a wide range of publications and courses that touch on those issues.

Senator MURRAY This committee will plainly have to take a view as to the health, if you like, of directors as a body throughout the publicly listed companies. Could I ask you on notice, firstly, to give us a summary of what your institute considers best practice process within company constitutions for the election of directors; secondly, what you consider to be a range of good models for board structures, depending on size, risk and all those sorts of things; and, thirdly, what balance of skills and abilities your institute believes are ideal for good corporate governance in that sense. All those are best put on notice.

Mr Campbell There could well be a potential conflict between what might be logically and demonstrably best practice and, if you like, the almost sovereign right of shareholders who own a company to pick the directors they want anyway. I think there seems to be at times no end to the silliness of people in charge of companies. But the shareholders who own the company have the right to pick their directors unless there are extremes of criminality or whatever to exclude them.

Senator MURRAY I take that point. The problem that was exposed in an inquiry into this was that the shareholders who often come in after the event are confronted with a constitution and a process which allows for rigging. It is only in a number, a minority perhaps, of companies that that occurs. Really, it is the reform process that I am interested in.

Mr Campbell I accept that, where that is an issue, it should be looked at.

Mr Elliott To make a point on that, when we talk about competency of the audit, we are not just talking about competency of auditors. We are also talking about and are quite concerned about the competency of directors in the process. That is very important. We are in no way saying that this is a one-sided debate. And the point is made in our -

Senator MURRAY I clearly understood that.

Mr Elliott Our role is to try and improve those directors.

Senator MURRAY I am trying to move with some pace because of the time. The second area is audit committees. In those companies with excessive executive or managerial dominance, sometimes combined with excessive control or dominance by a financial interest, it seems to me in those situations that the audit committee of such a board will be the creature of that board and will not be an independent committee. The independence of non-executive directors is an absolutely vital issue and that really relates in part to the last question. In those companies with best practice, I do not think you have to worry about it too much. And HIH and those people are kind of worst practice if you want to make a judgment at this stage. The issue of appointing auditors and making them independent, I believe, requires there to be an independent process of appointment. One model that I have contemplated, which is not mandated - I do not believe it should be mandated - but it is a model that is available is the corporate governance board model, which, as you know, is elected by one vote per shareholder, not one vote per share. It has a very limited remit and does not interfere with main board operation. It is very cheap. It covers constitutional amendments, running meetings, supervising the election of directors, remuneration issues for directors and management, and appointment of key advisers such as auditors and valuers. So it has a very limited remit, a very limited job. Providing it is not mandated, I presume your organisation would have no objection to the view that, if a company wants to set itself up with such a system, with a main operating board doing what it normally does and a corporate governance board, you would have no in-principle objection to that, would you?

Mr Elliott Absolutely not. In fact, it can do that right now and there are some companies that we know about - for example, Mr Shann Turnbull has companies and has in the past set up companies with this structure. There is nothing to stop or prohibit that and the institute sees itself in the governance debate as providing a smorgasbord of opportunities, not mandating any in particular, suggesting what we consider to be best practice, but basically having a debate and being a forum for the debate. As long as it is not mandated, and you made that point.

Senator MURRAY I assumed that would be your response. The reason I raised that was that a previous witness from PricewaterhouseCoopers, when asked the question whether he would oppose an independent non-executive director being elected on the basis of one vote one shareholder, as a concept he said that he thought it was wrong because he thought it would not represent the economic interest - in other words, the controlling shareholders. What is your reaction to that view?

Mr Elliott I think you have two different votes there, don't you? You would have one vote under the existing structure for the board of directors, and no-one is proposing that that change, and your suggested corporate governance advisory board model has a separate vote for that purpose. That would be something which the constitution would have to have built into it to make it quite clear that those are two separate votes under two different voting mechanisms for two different bodies. As long as it is not mandated, if it works for the company at the time, it should be looked at.

Senator MURRAY Thank you.

Mr GRIFFIN I want to take you back to the proposal about five-year rotations of audit companies. First off, I am interested in your concept of 'suddenly', given, in effect, a company would have five years notice of the fact that it would be getting rotated. Do you really consider that to be suddenly, as you said earlier, an issue for change within the company? Following on from that, you seemed to suggest that there was a commercial imperative from a company's point of view, particularly for large audits, with respect to them actually having a commercial relationship which would make it difficult for them if they lost that particular audit. Does that have implications for compromise with respect to their actual operation, which would seem to be the logical suggestion? If there is a commercial concern from the company's point of view, then that could have an implication for them actually performing their duties versus actually maintaining that commercial relationship. I am also interested in your comments regarding Italy and the circumstances there. Has that since been changed, or is it still a situation of playing pass the partner?

Mr Grant I am not sure if I can remember all your three questions.

Mr GRIFFIN The first one was define 'suddenly', the second one was commercial versus compromise in respect of relationships of auditors, and the third one was the Italian experience.

Mr Grant On the five-year period sudden cut-off, my feeling, and certainly the view of the Institute of Company Directors, has been that rotation of audit firms is not necessary, as I summarised before. Even if it were to be telegraphed by being a fixed and rigid period, it would still happen that precipitously that knowledge that had been built up would be, in effect, lost. When I mentioned commercial it was not the commercial relationship that I was commenting upon but, rather, the commercial position of the auditor. One of the ingredients of auditor independence is that they are paid reasonably well. The best way to be totally independent, of course, is not to be paid at all, but that is not so practical.

Mr GRIFFIN We tried that with politics a long time ago.

Mr Grant That was really mentioned as an aside; it is not a predominant reason. But the knowledge and skill that an audit team brings to bear develops substantially. Furthermore, there is a significant cost to the company and, therefore, to the shareholders in making that change through just the process of change. Also, the new team of auditors coming in has to be, if you like, retrained on all the company's procedures and so on, which is a significant allocation of company staff time. These are more practical issues than philosophical, as you are probably well aware, but nevertheless they are significant. I believe the case is yet to be presented that really indicates there would be significant benefit in light of the costs. I also have a concern that there might be a temptation to recommend it as a bandaid fix, when in fact it does not deal with the core issues of independence and competence at all. As to Italy, I believe it has changed. I am a little bit out of touch with it, but I believe that in Italy now they do not require - I believe, but I am not absolutely sure.

Mr GRIFFIN If you could check that and get back to the committee, that would be great.

Mr Grant Okay, I will see if I can find that out.

Mr Elliott I think there is also the practicality of the big five becoming the big four. Given that, for large listed companies, there will be a certain size of audit firm which is required and a certain skill base, and conflicts of interest, there are some practicality issues in rotating regularly. We are not saying it is impossible, but there are some issues there.

Mr KING The public interest concerns the failure of auditors to warn the commercial community and shareholders of problems found on file, it seems to me. I was wondering whether or not you wish to comment on that problem in the face of the overmighty executive, and on whether the answer to that problem is a more detailed regulatory regime for auditors, or better education and training for directors, or both.

Mr Elliott Possibly both, but I would probably defer to either of my colleagues who have plenty of first-hand experience of that from both sides - both the auditor and the corporate side. My gut feeling is that -
Mr KING HIH and Enron seem to be pretty good examples.

Mr Elliott Absolutely, and I think you do not have to be a rocket scientist to figure out perception is reality in a lot of these cases. What gets kept and what does not is pretty crucial for confidence and, after all, the markets rely on confidence and integrity.

Mr Grant It is never as simple as it appears after the event. You are right, however, in that I understand that the issues that have become problems in HIH and, let's say, in Enron were known to the audit team at least partially. In practice, it is never typically black and white. In the HIH situation, for example, I believe a significant issue there - and far be it for me to prejudge the outcome, but this is my impression from media reports - was that the auditors were deliberately misled by the withholding of information with side deals. There is no amount of audit that can really detect that until it is too late. When those side agreements start to be called upon they will be identified and, all of a sudden, the auditor will realise that there has been a misrepresentation, but that could be two years later. So while the auditors were aware of the issues they were profoundly misled - to use somebody else's phrase - by withholding of information. Furthermore, in that industry the problems of measurement are enormous. Normally for a corporation the problems of measurement relate to assets, but in an insurance company the issues of measurement relate to liabilities: have you got them all and have you measured them correctly? And there is no right answer. You can flick your assumptions by one decimal point or one percentage point and your outcome could be tens or hundreds of millions different in your assessment of the need for outstanding claims. So there is a huge amount of estimation, a high degree of sophistication and, typically, the company and the industry have more expertise than the auditor does . You would certainly hope they do because they work in it every day, whereas
the auditor does not; so the auditor has, inherently, a degree of hesitation in being adamant when it is a grey area because the industry knowledge contained through the executives is superior to his. He will seek expert advice, of course, but nevertheless he has to be cautious, to make sure he is on firm ground, if he takes a stand. That is a fairly longwinded response, but I am just trying to give you a flavour of the issues not being as simple as they might appear after the event. It now appears that the WorldCom executive who capitalised those costs, which now everybody thinks clearly were expenses, argued passionately and believed he had a good case to argue that they were capital. The CFO from WorldCom - Mr Sullivan, I think his name was - believed that he was doing the right thing. In hindsight, it appears that he was erroneous. We have had this with Southern Cross Airlines: they capitalised training costs for pilots for the new aircraft. Is that right or not? It is highly debatable. The aircraft were not flying yet, so clearly those costs were not attributable to revenue today. They carried them forward. Debate: should they or should they not? Bond Corporation capitalised advertising costs when they owned Swan Brewery.

Senator MURRAY - Start-up costs are another one.

Mr Grant That is right. Many mining companies and the like capitalise those sorts of startup costs, or removal of overburden: it does not generate revenue in itself but it is necessary to get to the revenue product.

Senator MURRAY And then you depreciate it over 15 years.

Mr Grant That is right. But the fundamental issue in all accounting is: what is a today cost versus what is a tomorrow cost which you incurred today, and that is going to be never ending.

Mr Campbell I add one bit of more upbeat news, which I am sure the committee is already aware of, and that is that under Australian law and accounting practice some of Enron's techniques of getting doubtful things off the balance sheet would not be law and I am sure would not have got past their auditors.

Mr Grant Yes, would not have been permitted.

Mr KING I was very impressed with your comments about the issues about ethics and training, and Simon Longstaff has been talking about this a little bit too. The cri de coeur from some members of the commercial community has been to suggest that audits have proved worthless to the commercial community but very expensive to the companies involved. I would suggest that one solution would be to make them optional and leave it up to people to judge for themselves.

Mr Grant I think there is some merit in that. I would never invest in a company that was not audited.

Mr KING Yes, that is the point.

Mr Elliott Getting back to some of the points about wider governance, good corporate governance is a jigsaw puzzle. It is about a whole range of things as well as disclosure. The market is actually pretty good at working these things out as long as it is a well-informed market and it has the will and the power to act. I would not count it out but I know where I would put my money; it would be in an audited company.

Mr KING Yes.

CHAIRMAN I would like to follow up on what Mr Grant had to say about this reporting process. It has been put to us that, under the current Australian accounting standards, something like 90 per cent of leases in the corporate sector are publicly reported as finance leases - therefore, they are off the balance sheet - when in fact probably the majority of them are operating leases. You could sell off your capital, sell all your buildings, sell a big swag of your assets, move all that off balance sheet as lease costs and show a good profit every year until all of a sudden the whole Taj Mahal came tumbling down. It is not a very good example, is it, Mr Grant?

Mr Grant I think you had it around the wrong way: finance leases are on the balance sheet and operating leases are off - but that is by the way. I do think your comment would not in fact be the case. For example, Qantas might have a leverage lease for a jumbo. If it is a finance lease, the aircraft will be on its balance sheet and it will be charging depreciation and interest but if it is an operating lease then it will just be a lease cost, which is also based on depreciation and interest. The fundamental profit and loss cost is not much different whether you are accounting for a finance lease or an operating lease; it is the presentation of your indebtedness that is the difference. You could be highly geared if you had a finance lease; if you did not record it, it would not be so readily revealed that you were highly geared. I think the concern is more in the balance sheet focus.

Mr CIOBO I have two questions I would like you to take on notice and get back to the committee on, if you could. The first is your views on whether or not CEOs or CFOs should be personally liable for the financial statements that they make. The second question refers to comments attributed to your Queensland branch president, John Massey, in the Australian on 2 May 2002. He stated that he felt some directors were taking on too many directorships and, as a consequence, were perhaps not 'giving the value to shareholders that they should'. I would be keen for your comments on that, on notice. We have received testimony that has indicated that one of the principal drivers diminishing the quality of an audit and the scope and role of an audit flows from, as has been phrased by other members of this committee, the mighty executive having undue influence and perhaps putting audits out for tender. What is the AICD's view of directors seeking to cover up bad news, and what is your view as to whether or not this is one of the key drivers? Should there be
jail terms if this is an ongoing problem - which many have testified it is - as some sort of disincentive to prevent it in the future?

Mr Grant On the tender side of it: needless to say, in the present market economy it would be a bit difficult to imagine that there should not be an entitlement for a company to put its audit out to tender. I am using those words because I think it has some dangerously concerning aspects. In practice, my experience with audit tenders is that it is somewhat demeaning for the auditor, because the auditor is there to protect the shareholders' interests, not the company's, and yet the company is seeking a fashion parade from these auditors to be seduced as to who is going to be the best for the company and not necessarily for the shareholder. There is also an inevitable tendency to look to the cost. Once again, as a shareholder, my inclination would be to pick the highest price, not the lowest, because I would be more comfortable about getting a quality audit. That is not consistent with the objective of a corporation to keep its costs to a minimum, though, so you have a bit of a dichotomy. As I say, there are some concerns with the tender process.

Mr CIOBO And what about the role that directors play? What was put to the committee was that there was a reluctance by auditors to qualify an audit opinion, for example, if it meant that it was a loss of a revenue stream for them and that that was a power that directors had over an audit firm. From this committee's perspective, what is your response to whether or not directors partake in such activity? Obviously you cannot speak for each and every director. I accept that, but as a general observation what are your comments in response to that testimony?

Mr Grant In another role I have been an auditor for many years too and my experience in 30 years of auditing was that I never experienced that. Sure, you have debate; sure, you have vigorous debate. People get snaky. I have been physically threatened in my role as an auditor. So it is not all beer and skittles. In fact, my partners had knocks on the door at midnight on one occasion with physical threats to their wellbeing. I am pleased to say that that seldom occurs, but it has occurred.

Senator MURRAY Are they still in business?

Mr Grant Have you heard of Nugan Hand?

Senator MURRAY Okay

Mr Grant It can always happen; it is always a possibility if you have got directors who are not ideal. Another observation, just touching on tenders, is that I have a hypothesis that there can be a little bit of a nexus between a company seeking an audit tender and its subsequent difficulties or failure. Qintex, Bond Corporation, Westmex and OT Lempriere changed auditors and went broke within a year or two. Southern Cross Airlines is another. I have a concern about the tender process because to my mind it seems to focusing on the wrong issues. They tend to be trying to squeeze down the audit fee, which represents less than one-tenth of 1 per cent of the revenues of the organisation, when they should be focusing on strategic issues that are much more important. In other words, they are focusing on the petty cash.

Mr Campbell One thing the Enron disaster has shown the world and emphasised is the disaster to an auditor that can come out of loss of credibility, if you like. My observation is that auditors have always been acutely aware of exactly that point, that their credibility in the marketplace is their biggest single asset.

Mr KING Wasn't that the result of an overweening confidence amongst those who audited and those who governed the company rather than any consciousness of their obligations?

Mr Campbell I was not a member of the jury that decided part of that issue, but I think it was a lot more than just confidence.

CHAIRMAN Senator Murray has a question he would like to put on notice to you. We have to take a break now or we do not get to eat.

Senator MURRAY I am a supporter of compulsory voting in the democratic system. I do not think you can apply that in the shareholder system. However, because I am talking about maximising shareholder participation, I want to ask you on notice if you could give some thought to this proposition. Should sophisticated investors - namely, those who manage and control unit trusts on behalf of other shareholders, those sorts of people - be obliged to vote in all company voting situations and should they be prohibited from giving proxies? In other words, should they have to make a decision about the matters, as a duty of care for the investors?

Mr Elliott There is a style of approach to that.

Senator MURRAY I would be obliged if you could give us a response on notice.

Mr Grant I would like to add a short comment. This is a little anecdote following Mr Ciobo's comments or questions. My observation in the last decade since we had the excesses of the 1980s and so-called creative accounting is that directors have been far more diligent and far more independent in their actions than they were before. An example of that is that I was talking to a partner in a second tier firm that does a number of public company audits that have tended to be smaller ones. He related the story that on four occasions they had had disagreements with management over an accounting issue. They went to the board and on four out of four the board agreed with the audit firm and said to management, 'Fix it.' They took the stand and they overrode the management view after due consideration. I think that is an anecdote worth noting, just to demonstrate that I think boards today are much more rigorous and much more independent minded than they were a decade ago.

CHAIRMAN Gentlemen, thank you very much once again for your submission and for coming here. We look forward to receipt of the further information that you have promised.

Proceedings suspended from 1.10 p.m. to 2.00 p.m.