External auditors are only the last line of defence
Reliable financial statements start from within a company and that’s why whistle-blowers are valuable
Steinhoff, EOH and Tongaat Hulett have all recently been accused of financial mismanagement and misstatement of information, illustrating the challenges the corporate world has faced in the past few years in delivering a “clean” record that investors can rely on regarding compliant financial statements and good governance.
Listed corporates are required to have several checks and balances in place in terms of law and governance best practice. This makes it tough to understand exactly how financial mismanagement on such a scale can go undetected, sometimes for long periods.
Mistrust in the external auditing fraternity in SA has grown with each new corporate scandal that has surfaced in the past few years. However, auditors insist that they can only work with the financial information provided to them by companies, and that uncovering financial mismanagement is not their responsibility. If not the auditors, then whose responsibility is it?
There are three important roleplayers regarding assuring the veracity of audited financial statements: the audit committee, an internal audit function and the external auditors. All three of these functions should work together to ensure good governance of audit practices. If there is a weak link in the chain, opportunity is created for financial mismanagement. As seen with the recent examples of Steinhoff and Tongaat, the implications are enormous.
Did the Tongaat internal audit function and its audit committee do enough when the discrepancies first emerged?
The audit committee is a subcommittee of the company’s board. The committee will elevate issues or concerns to the board, but its primary task is to guard the auditing practices of the company and finalise a company’s financial statements, with the head of the audit committee assuming responsibility for signing off the financial statements.
The internal audit function acts as another line of defence and ought to report directly to the audit committee on material internal audit findings. The external auditor has to take a view on whether the financial information of a specific financial year is correct and unqualified.
Regarding the Tongaat case, it appears as if the combined audit function did its job properly when it picked up financial irregularities within the company, but it could take some time to determine what (and if) fraudulent activity actually took place, to what extent and for how long. However, the question remains: did the Tongaat internal audit function and its audit committee do enough when the discrepancies first emerged?
Steinhoff, by comparison, had an audit committee comprising seasoned and experienced individuals who maintain that all the fraudulent activity that came to the fore emerged out of the blue, and they knew of nothing beforehand. Yet the implicated transactions orchestrated by Markus Jooste and certain executives continued for almost 10 years. Can we assume they managed to hoodwink experienced and well-respected members of the combined audit function throughout that time?
Entrenched board members
Given the calibre of the audit committee members, it is hard to comprehend how this happened. This raises the question of whether the board members applied their minds appropriately when they saw the financial results. Or did they just blindly accept that the information was correct? This highlights the critical role a board plays in interrogating financial statements, and the correct use of the internal audit function.
Both companies had entrenched and long-serving board members and CEOs, which could have affected the independence of the board.
Financial mismanagement has been going on in corporates for years, locally and globally. In SA a culture of unethical political leadership has developed, and if that is how elements of the country’s leadership operate, financial mismanagement will definitely find its way into the private sector.
Greed is already an enormous problem in the corporate world. Cunning fraudsters believe they can continue to get away with this kind of activity, but the tide is turning. Companies and individuals are increasingly being exposed for poor governance practices and irregular financial activity.
To support this ongoing fightback against corporate corruption there is an urgent need to protect whistle-blowers within organisations. The establishment of whistle-blowing mechanisms should be encouraged. As an organisation we continue to champion the protection of whistle-blowers in our market.
• Lewenson is head of environmental, social and corporate governance engagement at Old Mutual Investment Group.