Lessons to learn

Lessons to learn

By Kim Sbarcea

Corporate Australia may be somewhat nervous about the onset of new stiffer regulations around corporate governance and record keeping, but at least they have a point of reference.

Kim Sbarcea asks what, if anything, Australia can learn from the US and Sarbanes Oxley when it comes to getting our regulatory houses in order.

Auditor independence became a major issue in the United States following the collapse of Enron and WorldCom. The tightening up of laws and standards governing auditor independence was a primary focus of the Sarbanes-Oxley Act of 2002 enacted by US Congress.

Similar corporate collapses have occurred in Australia over the last few years. High profile companies such as Ansett, Pasminco, One.Tel, Harris Scarfe and HIH Insurance have bitten the dust amidst spectacular accusations of the failure of the auditing profession.

Following Andersen's demise, other audit firms were hit by its shockwave and there was widespread perception that imposing more rules on the accounting profession would prevent further corporate disasters.

While US reformers linked the provision of non-audit services by audit firms with audit failure, Australia's response was to engage Professor Ian Ramsay of the University of Melbourne to conduct a review of auditor independence. His report, commonly referred to as the Ramsay Report, was released in October 2001.

Hot on its heels was the HIH Royal Commission Report of 2003 which pointed the finger not only at auditor independence, but also the poor level of corporate governance within Australian companies.

The response to both the Ramsay Report and the HIH Royal Commission was the recent enactment on July 1, 2004 of the CLERP 9 legislation that outlined major reforms to auditor independence and corporate governance.

So amongst the flurry of tightening regulations and new legislation, what can we say has been the cause of these cascading collapses and what lessons can Australia learn from recent US experience?

Frank Clarke, Emeritus Professor of Accounting at the University of Newcastle and Honorary professor at the University of Sydney, is a leading Australian expert and commentator on corporate structure and regulatory regimes. Clarke, along with Sydney colleagues professors Graeme Dean and Peter Wolnizer, made a lengthy submission to the HIH Royal Commission, so is well placed to comment on the Australian setting.

Clarke questions whether it is too late for lessons. He comments: "Australia has already gone down the corporate governance trail. It is time for sober expectations. There has been incremental corporate governance since the creation of the modern corporation with the enactment of the UK 1844 Companies Act. What has occurred recently is just another chapter in an ongoing process".

Professor Clarke sees Sarbanes-Oxley as mostly a knee-jerk reaction to the sudden collapse of Enron and WorldCom. Against a background of US corporate scandals involving misleading accounting and alleged overall executive failure, damage to market confidence and exposure of dangerous liaisons between security analysts and merchant bankers, Sarbanes-Oxley, in Clarke's view, did not change the general modus operandi of the regulatory framework.

He considers that the US legislation "merely gave the SEC more rules to enforce. So, corporate regulation remains a 'rules and sanctions mechanism' that concentrates on capturing the baddies and penalising them".

There is little impact he believes on an inherently defective system that permits ungovernable corporate group structures and an accounting system that practically guarantees deception even without intent.

So perhaps the cause of the corporate failures has more to do with corporate structure than auditors running amok. Clarke says "the point is, the corporate world will continue much as it has" and he almost sounds despairing when he states that corporate governance measures put into place both in Australia and the US are simply "cosmetic".

The perception is that Australia has a similar corporate structure to the US and can learn from how the US injected their regulatory framework with additional rules in the hope of successful resuscitation.

A lesson for Australia is not to view the US response as a template for how we should respond. Clarke believes that Australia followed the US and pointed the finger too readily at poor corporate governance without establishing causal linkages.

"No convincing evidence has been adduced that a lack of auditor independence, stock options in executive remuneration packages, ex-audit firm partners being on the Board caused the US or Australian failures" he says, causal linkages have been presumed through "drawing heavily on circumstantial scenarios".

Clarke warns that the real imperative for corporate Australia is to work towards having an accounting system that discloses a "true and fair view" of a company's financial performance and its financial position, rather than focusing on slapping the wrists of auditors and executive directors.

He does not believe that the FASB's accounting standards in the US, nor the AASB's accounting standards in Australia, are likely to deliver the holy grail of a healthy accounting system immune to greedy executives or overstatements of corporate wealth and progress. Clarke also says that the International Accounting Standards Board's (IASB) standards to be introduced in 2005 will fail to address the weaknesses of the accounting system.

President Bush's "cleaning up of corporate America" campaign has led to the perception of being back in control. Clarke ironically observes that seventy years ago, President Roosevelt's "truth in securities" campaign, which set up the US Securities & Exchange Commission (SEC), is almost identical to Bush's zeal for corporate clean up campaigns.Clarke explains that Australian companies generally remain unperturbed by CLERP 9.

"Most companies" he says "already had audit committees. The complement of non-executive directors and the enactment of CLERP 9 has left auditors able to continue to provide non-audit services for their clients. Most companies' Board structures complied or could do so with little discomfort".

The major current concern for Australian companies is the adoption of the Australian equivalents of the IASB's International Financial Reporting Standards in January 2005. For many companies, this will entail writing off intangibles and goodwill; adopting a new regime of physical asset valuation; a different accounting for financial instruments; and substituting an 'impairment' regime for the traditional depreciation system.

Clarke stresses that "for those with substantial intangibles -mastheads, trademarks etc-it will entail taking an unwelcome big bath, reported assets and retained earnings will be hit, possibly necessitating re-negotiation of borrowing covenants and the like. Clearly, previously reported financial indicators will change as a result". The irony, Clarke says, is that despite the enthusiasm from those pushing to adopt the IFRS-equivalents, nobody has demonstrated their superiority to what Australia already has. A future lesson to be learnt perhaps!

Has the SEC experienced difficulties in developing procedures for monitoring compliance with Sarbanes-Oxley and can Australia learn anything? Clarke says that the SEC's current major focus is pursuing the actions resulting from corporate collapses, whilst US corporations carry on as usual leaving untouched any major reform of corporate structures.

For Australian regulators, the real lesson should be to improve shareholders' welfare and increase creditor protection. Whilst war may have been declared on non-compliance with accounting standards, Clarke asks "to what extent will a company's affairs be more transparent than they were in the past? What benefit accrues if non-compliant companies incur penalties, when the financials would be equally, perhaps more, misleading were they to be Standards-compliant?"

Clarke points to the current James Hardie affair: "It is sobering to contemplate whether anything in CLERP 9 would have prevented the James Hardie situation. Putting aside how the estimated $2 billion shortfall in the MRCF arose, the element in the Hardie affair that arises frequently is how the corporate group structure is a vehicle by which creditors find their claims with an asset poor subsidiary, and do not have recourse to the assets of the other related companies in the group".

Clarke doubts that CLERP 9 would have come to the rescue of creditors and believes that the corporate group structure, which has played a vital part in the machinations of most company failures over the last 50 years, lives on and remains untouched.

The final lesson that both Sarbanes-Oxley and CLERP 9 leave us with, according to Clarke, is that both pieces of legislation "leave the overall system unchanged. The rules of both are directed at controlling the behaviour of individuals. It is as if the 'system' is in order, but is vandalised by recalcitrant directors, executives, accountants and auditors".

Clarke thinks corporate Australia should contemplate whether Sarbanes-Oxley and CLERP 9, along with other corporate governance regimes, have the correct sources of the problem in their sights.

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