Wednesday 31 May 2023 was an important day for the South African auditing profession and its stakeholders, with the Supreme Court of Appeal (SCA) ruling that the mandatory audit firm rotation (MAFR) rule is to be set aside. Following years of debate on the merits of MAFR in South Africa, the judgement was made that the Independent Regulatory Board for Auditors (IRBA) did not have the power to mandate the MAFR rule that was promulgated on 5 June 2017 (with an effective date of 1 April 2023).
The SCA judgement dealt with an appeal by the East Rand Member District of Chartered Accountants on the promulgation of MAFR being ultra vires (beyond legal authority). It may be argued that the SCA judgement was based on a technical issue, which can be addressed by amending the relevant governance powers. The SCA judgement, however, provides a unique opportunity for the South African auditing profession and its stakeholders to reflect on the past and apply the learnings to future decisions on auditor firm tenure concerns in South Africa.
Globally, there has been a tightening of audit regulations in response to the global financial crisis of 2008/2009 and the increased incidence of accounting scandals. Especially, long-term audit engagements have been criticised by the media, public and regulators – as it is perceived to impair auditor independence, therefore negatively affecting audit quality. MAFR limits the maximum duration of the auditor–client relationship and is regarded as the most significant audit reform, because it means that regulators intervene in the free market. The real effect of MAFR on audit quality is, however, not yet known – mainly owing to the limited number of countries applying MAFR. Although some countries introduced MAFR, many of them later abolished it. Italy, however, has implemented MAFR for more than 25 years. In June 2016, the European Union implemented MAFR and South Africa followed suit with the promulgation of MAFR on 5 June 2017.
In 2017, IRBA motivated their rationale on implementing MAFR in South Africa based on the lengthy audit firm tenures observed; the Big 4 audit firm dominance of the audit market; and the high incidence of accounting scandals at the time. Furthermore, the IRBA’s stated objectives with MAFR were to enhance audit independence and to allow for accelerate transformation and deconcentration in the audit profession.
In essence, the MAFR rule in South Africa meant that an auditor of a public interest entity may not serve as the external auditor of a client for more than 10 consecutive years, and that a cooling-off period of 5 years is required before being eligible for reappointment. The MAFR rule should, however, not be misinterpreted as referring to the Companies Act requirement that prohibits an audit partner (within an audit firm) to be the lead auditor on an audit engagement, as defined by the Act, for more than 5 consecutive years, followed by a cooling-off period of 2 years. The SCA ruling of setting aside MAFR does not affect the audit partner rotation rule. Audit partner rotation is accepted as an appropriate measure to address auditor independence in many jurisdictions that do not apply MAFR.
The first application of MAFR was for financial year-ends ending on or after 31 March 2024, therefore most companies had either already replaced their auditors or appointed their successors at the time of the SCA ruling on 31 May 2023. Companies started replacing their auditors as early as 2016, when a new IRBA requirement on the mandatory disclosure of audit firm tenure in audit reports of public interest entities came into effect. Research at Stellenbosch Business School1
shows that audit firm replacements increased significantly since 2016, and that these replacements also significantly increased the dominance of the Big 4 audit firms in the audit market.
Our research shows that JSE-listed companies carried out about 288 audit firm replacements from 2016 to date, with about a further 41 audit firm replacements to be implemented in 2023 to 2025, as announced via the JSE Securities Exchange News Service (SENS). A limited number of JSE-listed companies (about 9%) did not appoint replacement auditors in anticipation of the MAFR rule before 31 May 2023. In IRBA’s response2 to the SCA judgement they therefore indicated that, on a short-term basis, investors do not need to be concerned about the risk of auditor independence threats based on lengthy tenures.
The sheer scale of audit firm replacements since 2016 therefore allows us to ‘take stock’ and reflect on whether MAFR is the most appropriate measure to address auditor independence concerns. As stated in the SCA judgement, the real effect of MAFR will potentially only be known about 10 years from implementation date. The audit replacements affected in South Africa in anticipation of MAFR can therefore provide empirical evidence on the effect of MAFR on audit quality and audit fees. The fact that the disclosure of audit fees is no longer mandated by the new Companies Act of 2008 of South Africa, however, hampers research on audit quality and audit fees – and should be addressed by regulators.
Furthermore, from the SCA judgement we are reminded of the mechanics of MAFR. In essence, the net effect of MAFR is to impose restrictions on appointing the audit firm of choice. Audit committees are mainly responsible to assess the independence, which includes an assessment of audit firm tenure, of the external audit firm and to recommend the appointment for approval to shareholders. If audit committees therefore effectively perform their responsibilities, the restrictive nature of MAFR is to be questioned. Competency and independence of audit committee members are therefore non-negotiable in ensuring audit quality.
The South African auditing profession is currently in a transitional stage. There is ample evidence of audit firm replacements in anticipation of MAFR and regulators now have the choice to reinstate the MAFR ruling by amending the governance powers or to use this period to reflect and plan for the future. The IRBA’s response2
to the SCA judgement reaffirms their position that MAFR is regarded as the appropriate measure to address auditor independence in South Africa and that changing of governance powers to reinstate MAFR is being considered. The IRBA, however, also responds by reiterating the importance of the role of the audit committee in assessing auditor independence, which includes the assessment of audit firm tenure.
South Africa will not be the first country to implement MAFR (albeit for only two months) and then abolish it. Regulators are urged to encourage research and conversations on the real effect of MAFR in South Africa – and not merely reinstate MAFR. With audit firm tenure now transparently disclosed and lengthy audit firm tenure effectively addressed, the South African audit market participants are in an ideal position to contribute to the local and global debate on the effect of audit firm tenure on audit quality.
- Wesson, N. 2021. Will mandatory audit firm rotation reduce audit market concentration in South Africa? South African Journal of Business Management, 52(1):a2426. https://doi.org/10.4102/sajbm.v52i1.2426
- IRBA. 2023. Set aside of MAFR poses little risk to investors since the majority of public interest entity auditors have already rotated. https://www.irba.co.za/news-headlines/press-releases/set-aside-of-mafr-poses-little-risk-to-investors-since-the-majority-of-public-interest-entity-auditors-have-already-rotated