Introduction: The audit role and where it fits into corporate governance

Overview of the audit role

Auditing is defined as an assurance service that objectively gathers evidence and communicates it to third parties. Companies that are required to prepare a financial report for a financial year must have their financial report audited and obtain an auditor's report. Thus all large proprietary companies and public companies must appoint an auditor. Small proprietary companies, and small companies limited by guarantee, are not required to prepare a financial report in normal circumstances and hence need not appoint an auditor. However, they must do so in a limited range of circumstances, namely where members holding at least 5 per cent of the votes in a general meeting require preparation of accounts and ask for an auditor.

Broadly, the function of an auditor is to conduct a review and verification of the financial affairs of the company and to ascertain whether the financial report provided by the company complies with relevant legal requirements and accounting principles, and gives a true and fair account in all material respects of the company's financial affairs. The audit role has several objectives. The main one is to provide reasonable assurance that the financial information reported by the company is free from material misstatement. In the process, auditors provide a barrier of protection against careless or dishonest company officers. In order to fulfil this role, the auditor must have suitable skills and expertise, and must be independent of the company.

The main auditing requirement is to provide a report to the members, within the financial report, for a financial year. This is laid before the annual general meeting and lodged with the Australian Securities and Investments Commission (ASIC).

It is important to note that the auditor's role is essentially procedural, not substantive, in nature. More particularly, pursuant to sections 307 and 308 of the Corporations Act 2001 (Cth), the auditor's report to members must set out a number of matters in relation to the financial report for a financial year.

Higher community expectations of directors

Initially low standards of care, skill and diligence expected of directors

Directors’ statutory duties and liability are discussed in greater detail in Chapter 9. It is, however, important to first make a few observations regarding the higher community expectations of directors.

Based on antiquated English precedents, it has been accepted that directors are not liable for a breach in their duty of care, skill and diligence if they merely acted negligently. One of the first indications that more than ordinary negligence was required is found in an English case decided in 1872, where it was held that directors are liable only for a breach of their duty of care, skill and diligence if they acted with crassa negligentia (gross negligence). This rule was confirmed in a later case (1899) by Lord Lindley MR, one of the most famous English commercial Lords:

Introduction

The Australian Securities and Investments Commission (ASIC), as the primary corporate regulator, has had some spectacular successes, as well as failures, in enforcing the civil penalty provisions underpinning breach of directors’ duties under the Corporations Act 2001 (Cth) (Corporations Act). ASIC has played an active role in enforcing civil penalty provisions against directors and officers.

Introduction

One only has to scan the daily newspaper or follow a newsfeed to find plentiful examples of corporations being criticised for unethical conduct. It would take little more time to find businesses or business leaders who have suffered significant reputational damage, enforcement actions or damages claims. Since the 1970s, a considerable academic and practical literature has developed that considers and explores the field of business ethics, drawing on theory, practice and empirical data. Subjects that consider business ethics have become standard within university business courses. There can be no doubt that the conduct of corporations attracts considerable public interest. For a corporation, the consequences of perceived unethical activity can be profound: they include significant penalties for breaches that amount to regulatory infringements. It can also lead to calls for enhanced regulation and broader scrutiny of corporate activity. In this context the management of a corporation's ethical climate and conduct is increasingly seen as critical to its success, and a matter with which the senior management and the board should be deeply concerned. No book on corporate governance would, therefore, be complete without canvassing this topic.

The modern corporation knows few bounds – its widespread use in business and the corporatisation of essential services means that it permeates almost every aspect of our daily lives. It is companies, small and large, that drive economies and that can create economic prosperity for countries. However, all is not bright and shining; companies, especially large multinational public companies, have been the cause of considerable harm to the environment and society generally because of pollution, exploitation of employees and not providing safe working environments. There are too many examples in too many countries to name them all, but as this book originated in Australia, the James Hardie case, where many suffered tremendously because of exposure to asbestos, with little or no respect by the company for those who suffered, is a prime example of why it is of considerable importance that companies are governed properly. We discuss the James Hardie case in detail in Part 2.4.2, as well as in Part 14.2.3 from a business ethics perspective. Principles of corporate governance have a vital role to play in protecting consumers, shareholders, creditors, the environment and society, and in ensuring that companies act responsibly as well as legally.

Since the appearance of the first edition of Principles of Contemporary Corporate Governance in 2005, developments have gained velocity, and the volume of materials on corporate governance has grown exponentially. This made the appearance of a second edition in 2011 inevitable. The global financial crisis that emerged in about 2008 and global financial uncertainties in the European Union (since 2008) made us predict in 2011 (in the Preface to the second edition of this book) that the discipline of corporate governance would retain its prominence in future. That has indeed been the case, and it was a main motivation for us to bring out the third edition and now this fourth edition of Principles of Contemporary Corporate Governance.

Again we looked at the book in its entirely and asked how we could keep it relevant and contemporary. We decided not to simply add more materials to the book and make it a monstrous work. Rather, we decided to stick to our original approach of focusing on the fundamental and contemporary principles of corporate governance. However, we also wanted to include more of the corporate governance themes and issues that have become particularly prominent in recent years.

Introduction

This chapter highlights the roles of and relationship between the twin regulators, the Australian Securities and Investments Commission (ASIC) and the Australian Securities Exchange (ASX) in the Australian corporate governance regime. The exercise of ASIC's powers is reviewed and enforcement patterns are commented upon. The chapter sketches the role of the ASX in corporate governance and concludes with remarks addressing the broad philosophical debate on the role of the regulator in light of the carnage (the widespread corporate collapses or near collapses) arising from the Global Financial Crisis, and the pressure on ASIC to be more proactive and to perform to a higher standard. The reasons for the parliamentary inquiry into ASIC's performance are captured in the following passage:

Introduction

As touched upon in Chapter 1, contemporary commentary on corporate governance can, in general terms, be divided into two main camps: those who consider corporate governance as being about building effective mechanisms and measures to satisfy the expectations of the variety of individuals, groups and entities (collectively, ‘stakeholders’) that inevitably interact with the corporation, and those who focus on it in relation to the narrower expectations of shareholders (shareholder primacy).

This chapter focuses on the first of these objectives, with attention being given to the stakeholders of the company, how the law influences corporations to recognise and protect the interests of these stakeholders, and the relationship between these stakeholders and the underlying objective of companies of achieving and maintaining good corporate governance.

Steve Letza, Xiuping Sun and James Kirkbride explain the difference between the two corporate governance paradigms, ‘shareholding’ and ‘stakeholding’, as follows:

Introduction

As a general rule, directors owe their duties to the company as a whole, not to individual shareholders. Historically, directors’ duties and liability were discussed under general law duties (duties at common law or in equity); more recently, they were added to under statutory duties. Under general law duties, most courts and commentators usually draw a distinction between equitable duties based on loyalty and good faith, with a particular focus on fiduciary duties, and the duty to act with due care and diligence (the duty of care). The duty of care may arise under principles of equity and at common law. Fiduciary duties in Australian law are proscriptive, not prescriptive. That is, the duties prohibit the fiduciary from engaging in particular conduct rather than prescribing what the fiduciary must do in particular situations. The failure to act in a reasonable manner has traditionally fallen within the domain of the duty of care, rather than fiduciary duties in equity. The range of equitable duties that are owed by company directors are generally recognised as follows: