While there is no longer an obligation on listed and public interest companies to rotate their audit firms after 10 years, they must still appoint a new auditor after five years.

The Companies Act regulates individual audit tenure and prohibits the same individual from serving as the auditor of a company for more than five consecutive financial years.

At the end of May the Supreme Court of Appeal (SCA) struck out the mandatory audit firm rotation rule (MAFR) introduced by the Independent Regulatory Board of Auditors (Irba).

Read: Mandatory audit firm rotation should happen every five years – Cosatu

The SCA findings follow an appeal by the East Rand Member District of Chartered Accountants and its chair Jari Cerny. The group petitioned the SCA to review and set aside the MAFR after its application for a review before the Pretoria High Court was dismissed.

After considering the facts the SCA found that the promulgation of the rule was beyond the legal powers or authority of the Auditing Professions Act and falls to be set aside.

The rule

The rule, besides prohibiting an audit firm, including a network firm, from servicing as the auditor for more than 10 consecutive financial years, also stated that the firm could only become eligible for reappointment after at least five financial years.

The rule was promulgated in 2017, with 1 April 2023 as the effective date for implementation. Legal experts Kim Rew, Ryan Hopkins, and Matt Williams from law firm Webber Wentzel, say the SCA finding is significant for the auditing profession.

They note that one has to be mindful of the distinction between the rotation rule and the Companies Act.

“The unlawfulness and setting aside of the MAFR has no bearing on the tenure of an individual auditor as required by section 92 of the Companies Act,” they say.

Irba CEO Imre Nagy said in response to the judgement that it was based on a technical issue and did not bring into question the value or effectiveness of the MAFR.

Read/listen: Irba responds to court’s dismissal of mandatory auditor rotation

“Therefore we stand by the principle of strengthening independence through regular rotation of firms.” The regulator vowed to work urgently to address the technical issue raised in the judgment.

‘Power-grab’

In a scathing reaction to Irba’s statement, the East Rand Member District of Chartered Accountants said the finding of the court was not based on a “technical legal” issue.

“It goes to the heart of an attempted power-grab by Irba, which sought to regulate the choice of audit firm made by companies and other so-called public interest entities.”

The SCA found the net effect of the rule was that it imposed a broad restriction on companies, audit committees, and their current and future shareholders from appointing an audit firm of their choice. It also prohibits audit firms from accepting appointments even if they are selected by a company.

In his statement Nagy says Irba still believes in the mandatory rotation rule. Audit firms play a “pivotal role” in ensuring that the representations made by companies in annual financial statements are reliable, accurate, and portray a fair and balanced position of a company’s financial affairs.

Cost of doing business

The industry association notes that in terms of the act, Irba regulates auditors and not companies or other entities. It also refers to the reasonableness of the rule and although the SCA did not make any findings on the matter, the association claims it is unreasonable.

It imposes significant costs of doing business on companies and other entities and their auditors with no evidence of any concomitant benefit, the association says.

During the deliberations on the introduction of a mandatory audit firm rotation rule, many argued that the South African pool of auditing firms was too small and that it may have a negative impact on smaller firms.

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The Webber Wentzel team says the irony of the SCA decision is that the rule came into effect on 1 April 2023. This means that many companies would have long since made plans for its implementation.

“Large audits are planned well in advance and, in many cases, the new auditors have already been appointed. It remains to be seen if this matter will now be appealed to the Constitutional Court,” they remark.