Business

Saturday August 11, 2012

Will audit have its day in court?

Optimistically Cautious
By ERROL OH


Silver Bird may well be the first local listed company to sue its internal and external auditors.

IF ever there were Malaysian parents who had hoped that their kids would go into audit, there's probably quite a bit of serious rethinking going on right now. It looks like the audit profession is in for some harsh scrutiny and painful soul-searching.

On Aug 1, Silver Bird Group Bhd and two wholly-owned subsidiaries filed an action in the Kuala Lumpur High Court in relation to financial irregularities at the three companies. One of the 10 defendants named in the suit was Crowe Horwath, Silver Bird's longtime external auditors.

According to Silver Bird's announcement through Bursa Malaysia, the suit against the accounting firm is premised on alleged negligence and breach of duty of care and/or its duties and responsibilities to the plaintiffs as external auditors.

The bread and confectionery maker links this to Crowe Horwath's “failure to discover and/or detect the financial irregularities”.

It is believed to be the first such legal action by a listed company in Malaysia against its external auditors.

In recent years, it's increasingly common to hear of auditors in the United States, Britain and elsewhere (Japan, India and Hong Kong, for example) being sued for professional negligence because they had failed to spot fraud and warning signs of business collapses.

It's perhaps an indication of the current thinking that when companies go under, certain parties should be held accountable for the huge losses and suffering, and these include the auditors, whose opinion on the companies' financial statements are widely relied upon.

The day after Silver Bird initiated the civil suit, Crowe Horwath issued a press release to deny the allegations in the suit, as laid out in the Silver Bird announcement. The auditors pointed out that they had, in fact, discovered the irregularities and immediately reported these to Silver Bird's audit committee and board of directors.

“We believe that the suit by Silver Bird is frivolous in nature and without basis. We strongly believe that we have fully discharged our duties professionally and will vigorously defend our position in court,” added the firm.

Indeed, as that last line in the press release indicates, right or wrong will be decided before the judge, unless the case doesn't go to trial.

However, there were no such statements from Audex Governance Sdn Bhd and Focus Internal Audit Solutions (FIAS), who are also among the defendants. Both are on the list because they have done internal audit work for Silver Bird, which had outsourced its internal audit function to Audex Governance before switching to FIAS.

Suits against internal auditors appear to be rare overseas and it's almost certain that Silver Bird's civil action against Audex Governance and FIAS is a first for Malaysia.

The Silver Bird case has thrown the spotlight on the roles and responsibilities of internal auditors.

Internal audit became a more visible component of corporate governance in Malaysia when it was made mandatory beginning Jan 31, 2009, for a listed company to have an internal audit function.

Bursa Malaysia's listing rules require that the internal audit function be independent of the activities it audits and that it reports directly to the audit committee.

In addition, the listed company's annual report have to include a statement relating to the internal audit function, informing whether the function is performed in-house or is outsourced, and the costs incurred for the function in respect of the financial year.

Despite these rules, most people tend to underestimate the importance of internal auditors, probably because few people really appreciate what internal auditors do.

In a brochure, The International Institute of Internal Auditors (IIA) reports this lament: “There is a universal lack of understanding of the internal audit profession, how it makes a difference in regard to organisational governance, risk, and internal control; and its value to stakeholders.”

In addition, there's more emphasis on the audit opinion of the external auditors as it's a tangible product of their work.

Also, the external auditors are seen as independent of the management, whereas an in-house internal audit function is undertaken by those on the company's payroll.

The IIA defines internal audit activity as a “department, division, team of consultants, or other practitioner(s) that provides independent, objective assurance and consulting services designed to add value and improve an organisation's operations”.

It adds: “The internal audit activity helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of governance, risk management and control processes.”

On the other hand, as Crowe Horwath puts it in Silver Bird's financial statements for the year ended October 2011, the external auditors are called in primarily to express an opinion on the financial statements “based on our audit in accordance with approved standards on auditing in Malaysia”.

Silver Bird's move to sue the internal auditors tells us that it's time to take a closer look at the internal audit function, whether in-house or outsourced. The regulators and the internal audit profession should be asking some tough questions.

Would it be possible for companies to sue internal auditors for professional negligence if they are employees? Who watches over the outsourcing of the internal audit function and the firms that take on such jobs? What more can be done to ensure the independence and quality of the internal audit function?

When financial irregularities are not picked up by the internal and external auditors, is it possible for one of the auditors to be exonerated while the other is found to be at fault?

The Silver Bird case may or may not lead to answers to these questions, but if the audit profession is truly proactive and dynamic, it wouldn't wait for the case to be resolved before responding to the reality that in Malaysia, resistance to the idea of suing auditors is waning.

> Executive editor Errol Oh hopes he will have the stamina and patience to follow closely the developments in the Silver Bird lawsuit.

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