In a significant judgment for the auditing profession, the Supreme Court of Appeal has ruled that the Independent Regulatory Board for Auditors did not have the power to mandate audit firm rotation.

On Wednesday (31 May 2023), the Supreme Court of Appeal (SCA) handed down judgment in East Rand Member District of Accountants v Independent Regulatory Board for Auditors – finding that the promulgation was beyond the legal power or authority of the act (ultra vires) and “falls to be set aside”.

According to law firm Webber Wentzel, the case concerned the lawfulness of promulgating the Mandatory Audit Firm Rotation Rule (MAFR) by the Independent Regulatory Board for Auditors (IRBA).

Webber Wentzel noted that the rule’s promulgation came as the auditing industry had been historically implicated in domestic and international corporate wrongdoing.

“The IRBA attributes this, among other things, to the long tenure of audit firms. It issued the MAFR to strengthen auditor independence and enhance audit quality,” the firm added.

The rule, promulgated in 2017, obliged listed and public interest companies to appoint a new audit firm after a tenure of 10 years. After that, the audit firm would only be eligible for reappointment after the expiry of at least five financial years, the firm said.

The IRBA was established under the Auditing Profession Act 26 of 2005 (the APA), which confers powers upon the IRBA. The IRBA can only exercise public authority, such as the promulgation of MAFR, to the extent that that power is conferred upon it by law, such as IRBA’s founding legislation (the APA).

According to law firm Webber Wentzel, in this regard, section 10(1)(a), read with section 4 of the APA, empowers the IRBA to prescribe rules on standards for professional competence, ethics and conduct of auditors as well as auditing standards.

The IRBA submitted that these provisions were the source of its powers to promulgate MAFR.

However, the Supreme Court found that section 4 of the APA confines the IRBA’s rule-making powers to “the prescription of standards” in defined functional areas, and the MAFR did not constitute a “standard” of professional competence or a professional standard as required by section 4 of the APA.

The SCA held that the net effect of MAFR is to impose broad restrictions on audit committees, companies and shareholders from appointing an audit firm of their choice, said Webber Wentzel.

The firm added that, at the same time, it prohibits audit firms from accepting appointments even if a company selects them.

“The IRBA did not have the power to promulgate MAFR and, therefore, the SCA held that MAFR was ultra vires the APA, unlawful and should be set aside,” said the SCA in its judgment.

This effectively means there is no more mandatory rotation of audit firms in South Africa.

“This is a significant decision for the auditing profession. It is, however, important to be mindful of the distinction between MAFR and section 92 of the Companies Act 71 of 2008,” said Webber Wentzel.

“Section 92 of the Companies Act, among other things, regulates individual audit tenure and prohibits the same individual (not audit firm) from serving as the auditor of a company for more than five consecutive financial years,” the firm added.

The irony of the decision is that the rule came into effect on 1 April 2023, which means that many companies would have long since made plans for its implementation. Large audits are planned well in advance, and the new auditors have already been appointed in many cases, noted the firm.

It remains to be seen if this matter will now be appealed to the Constitutional Court.