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Auditors’ duties to report reportable irregularities: make sure you get it right
In terms of the South African Auditing Profession Act, 2005 (“APA”), registered auditors have a duty to report on reportable irregularities that have taken place or are taking place in a company without delay and to alert the Independent Regulatory Board for Auditors (“IRBA”). Failure to do so can be a very serious offense, so it is important for registered auditors to know exactly what their responsibilities are.
The IRBA’s role
The IRBA is a statutory body established in terms of the APA. At the core of its functions and duties, IRBA must take steps to promote the integrity of the auditing profession and to protect the public in their dealings with registered auditors.
In terms of the APA, the IRBA is entitled to investigate alleged improper conduct on the part of registered auditors, conduct disciplinary proceedings, impose sanctions for improper conduct, and conduct practice reviews or inspections.
What is a reportable irregularity?
A “reportable irregularity” is defined in section 1 of the APA:
“means any unlawful act or omission committed by any person responsible for the management of an entity, which -
(a) has caused or is likely to cause material financial loss to the entity or to any partner, member, shareholder, creditor or investor of the entity in respect of his, her or its dealings with that entity; or
(b) Is fraudulent or amounts to theft; or
(c) represents a material breach of any fiduciary duty owed by such person to the entity or any partner, member, shareholder, creditor or investor of the entity under any law applying to the entity or the conduct or management thereof.” (our emphasis added)
The threshold to be met for an auditor to lodge an reportable irregularity is set out in section 45 of the APA as well as the Revised Guide on Reportable Irregularities issued by the IRBA, dated May 2015 (“the Guide”).
For something to be considered a reportable irregularity, the conduct in question must be perpetrated by management and must be an unlawful act or omission. However, not all unlawful conduct on the part of management qualifies as a reportable irregularity. Section 45 therefore serves a limited and specific purpose.
The auditor’s duties
The auditor only has the duty to report the unlawful act or omission as a reportable irregularity where, based on the professional judgement of the auditor, they have evidence that, on the face of it, causes the auditor to be satisfied or have reason to believe that the unlawful act or omission meets the definition of a reportable irregularity.
The auditor must report the reportable irregularities in good faith based on the information available at their disposal.
The requirements set out in sections 45(2) and (3) of the APA are designed in recognition of the fact that the written report can have serious consequences for the company. There is therefore an expectation that the auditors that make the written report in terms of section 45(1) will give consideration to representations that management may make in terms of section 45(3).
By virtue of sections 45(2) and 45(3), the auditor who has sent the written report referred to in section 45(1) to the IRBA, must send a copy to the management of the relevant entity to which the report relates (“the First Report”). The auditors must take all reasonable measures to discuss the First Report with management and afford management the opportunity to make representations in respect of the First Report.
Thereafter, the auditors must, pursuant to considering the representations from management and within 30 days of issuing its First Report, submit a second report to the IRBA (“the Second Report”) in which the auditors advise IRBA that either:
- no reportable irregularity has taken place or is taking place;
- the suspected reportable irregularity is no longer taking place and that adequate steps have been taken for the prevention or recovery of any loss as a result thereof, if relevant; or
- the reportable irregularity is continuing.
If the reportable irregularity is reported as continuing in the Second Report, the IRBA must notify any appropriate regulator thereof and provide them with a copy of the reports made to the IRBA by the auditor.
It is clear from the definition of reportable irregularity that a distinction is drawn between a material breach of a fiduciary duty owed by those charged with management and other unlawful conduct contemplated in terms of the definition of a reportable irregularity.
The question of what constitutes a fiduciary duty within the context of section 45 has been dealt with in the Guide. It provides that:
- A fiduciary duty is defined as the legal duty of a fiduciary to act in good faith in promoting and protecting the interests of a beneficiary and to avoid a conflict of interest between the fiduciary and the beneficiary.
- In the context of a company, the directors' fiduciary duty is owed to the company.
- The fundamental fiduciary duties owed by directors toward a company under the common law include preventing a conflict of interest, not exceeding the limitations of their power, maintaining an unfettered discretion, exercising their powers for the purpose for which they were conferred and not making a secret profit.
- Whether or not a fiduciary relationship exists in the first instance will depend on the facts of the particular case.
- Similarly, when determining whether there has been a material breach of a fiduciary duty, the auditor must consider all the relevant circumstances and factors.
It is important for auditors to be particularly careful in determining whether there is an obligation to report a reportable irregularity in terms of section 45 or not, because:
- If a report is made, when one is not necessary, it could cause significant harm and damage to a company (particularly, for example, if a reportable irregularity is a trigger for immediate repayment of the full outstanding balance under a facility provided by the company’s bankers as well as having implications in relation to the disclosure of the reportable irregularity in the company’s annual financial statements in certain circumstances); and
- If a report is not made, when one is necessary, the auditor could be guilty of professional negligence.
Auditors therefore need to exercise professional judgement, having regard to all the evidence and factors at their disposal prior to reporting reportable irregularities in terms of section 45 of the APA.
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