EXPLANATORY STATEMENT

Select Legislative Instrument 2006 No. 126

Issued by the authority of the Parliamentary Secretary to the Treasurer

Corporations Act 2001

                        Corporations Amendment Regulations 2006 (No. 4)

Subsection 1364(1) of the Corporations Act 2001 (the Act) provides that the Governor‑General may make regulations prescribing matters required or permitted by the Act to be prescribed by regulations, or necessary or convenient to be prescribed by such regulations for carrying out or giving effect to the Act.

Section 343 of the Act provides that the regulations may modify the operation of Chapter 2M in relation to a specified company, registered scheme or disclosing entity; or all companies, registered schemes or disclosing entities of a specified kind.

Chapter 2M of the Act imposes the obligation for all companies to keep financial records and requires some to prepare financial reports.

The purpose of the Regulations is to update accounting standard references relating to remuneration disclosures; extend transitional provisions to provide the former professional auditing standards with the force of law until 29 June 2007; and address a number of anomalies and unintended consequences in relation to the auditor independence requirements in the Act.

An outline of the Regulations is at Attachment A and details of the Regulations are set out in Attachment B.

Under the Corporations Agreement 2002, the State and Territory Governments referred their constitutional powers with respect to corporate regulation to the Commonwealth.  Under subclauses 506(1) and 507(2) of the Corporations Agreement 2002, the Commonwealth is required to consult with and receive the approval of at least three State and Territory Ministers of the Ministerial Council for Corporations (the Council) before making a regulation under the national law.  The Commonwealth has received approval of the Council for the Regulations.  In addition, under subclause 511(3), the Commonwealth is required to consult with the Council as to whether regulations should be exposed for public comment for between one and three months.  The Commonwealth has received the approval of the Council to waive the public disclosure period for the Regulations.

The Regulations are a legislative instrument for the purposes of the Legislative Instruments Act 2003.

The Regulations commence on the day after they are registered.

ATTACHMENT A

Remuneration disclosures

Regulation 2M.3.03 in the Corporations Regulations 2001 (the Corporations Regulations) refers to accounting standard AASB 1046 Director and Executive Disclosures by Disclosing Entities.  Regulation 2M.6.04 in the Corporations Regulations refers to Schedule 5B of the Act, which also makes reference to AASB 1046.

The Australian Accounting Standards Board (AASB) recently decided to withdraw the requirements of AASB 1046 and move its requirements into AASB 124 Related Party Disclosures.  This resulted in the regulations becoming inoperative or ineffective.  The amendments replaced references to AASB 1046 with references to AASB 124.

The amendments ensure that the regulations concerning remuneration disclosures remain effective for the preparation of financial reports for financial periods ending on or after 30 June 2006.  The amendments do not modify the substance of the Corporations Regulations.

Auditing standards

Regulation 10.5.01 in the Corporations Regulations lists the auditing standards made by the Australian accounting profession prior to 1 July 2004 that are to be treated as if they had been made by the Auditing and Assurance Standards Board (AUASB) for the purposes of the Act.  Regulation 10.5.01 refers to 1 July 2004 because section 1455 of the Act gives auditing standards made by the accounting profession before 1 July 2004 interim legal backing from that date.  Section 1455 of the Act limits the life of these standards by providing that they cease to have effect in relation to financial reports for periods ending after 30 June 2006.

The AUASB has announced that the new auditing standards it has made for the purposes of the Act will apply to financial periods ending on or after 30 June 2007.  As a result, there will be no auditing standards with the force of law applicable to audits of financial reports for periods ending after 30 June 2006 and before 30 June 2007.  The amendment ensures that the former professional auditing standards continue to have effect until the new standards made by the AUASB are in force.

Auditor Independence

The Regulations relating to auditor independence modify the operation of the auditor independence requirements in the following manner to address three unintended consequences:

•                the introduction of an ordinary course of business exemption in relation to the prohibition on an audit firm owing more than $5,000 to an audit client;

•                clarification that cheques and savings accounts are not intended to be covered by the prohibition on loans by an audit firm to the audit client; and

•                giving the Australian Securities and Investment Commission (ASIC) the power to extend the period within which an auditor is required to resolve a conflict of interest situation beyond the existing 21 days under subsections 327(2A), 327(2B) and 327(2C) of the Act.

Attachment B

Details of the Corporations Amendment Regulations 2006 (No. 4)

Regulation 1 – Name of Regulations

This regulation provides that the title of the Regulations is the Corporations Amendment Regulations 2006 (No. 4).

Regulation 2 ‑ Commencement

This regulation provides for the Regulations to commence on the day after they are registered.

Regulation 3 – Amendment of Corporations Regulations 2001

This regulation provides that the Corporations Regulations 2001 (the Principal Regulations) are amended as set out in Schedule 1.

Schedule 1 - Amendment

Item [1] – Paragraph 2M.3.03(1)(d)

Regulation 2M.3.03 details the prescribed information on director and executive remuneration that listed companies must disclose in the directors’ report.  Regulation 2M.3.03 makes reference to Accounting Standard AASB 1046 Director and Executive Disclosures by Disclosing Entities on executive and director remuneration disclosures.  In December 2005, the Australian Accounting Standards Board decided to withdraw AASB 1046 and move the substance of its requirements into AASB 124 Related Party Disclosures.

The amendments in items 1 to 5 of Schedule 1 merely update the references to AASB 1046 paragraphs and terminology in the Principal Regulations to the equivalent references in AASB 124.

This item replaces the reference to paragraph 7.1 of AASB 1046 with paragraph Aus25.4 of AASB 124.

Item [2] – Paragraph 2M.3.03(2)(b)

This item replaces references to paragraph 7.5(d)(iv) and paragraph 7.6 of AASB 1046 with references to paragraph Aus25.5(d)(iv) and Aus25.6 of AASB 124.

Item [3] – Paragraph 2M.3.03(2)(c)

This item replaces the reference to paragraph 7.5 of AASB 1046 with Aus25.5 of AASB 124.

Item [4] – Subparagraph 2M.3.03(2)(c)(iv)

This item replaces the reference to section 6 of AASB 1046 with a reference to applicable accounting standards.

Item [5] – Subregulation 2M.3.03(4), definition of accounting standard

Subregulation 2M.3.03(4) defines accounting standard as Accounting Standard AASB 1046 Director and Executive Disclosures by Disclosing Entities.

This item redefines accounting standard to mean Accounting Standard AASB 124 Related Party Disclosures.

Item [6] – Regulation 2M.6.05

Item 6 inserts regulation 2M.6.05.  Regulation 2M.6.05 modifies the operation of Chapter 2M of the Corporations Act 2001 (the Act) in relation to all companies, registered schemes and disclosing entities as set out in Schedule 5C.  Refer to item 14 below.

Item [7] – Subregulation 10.5.01(3)

The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the CLERP 9 Act) amended the Australian Securities and Investments Commission Act 2001 (ASIC Act) to provide for the reconstitution of the accounting profession’s Auditing and Assurance Standards Board as a Government body and the Act to provide that standards made by the accounting profession’s Board have force of law for the purposes of the Act.

To facilitate the transition from a regime in which the accounting profession made the auditing standards to the new arrangements under the oversight of the Financial Reporting Council, section 1455 of the Act provides a mechanism under which certain auditing standards made by the accounting profession prior to 1 July 2004 are to be treated as if they had been made by the Government’s Auditing and Assurance Board (AUASB) under section 336 of the Act.

•                To be brought within the scope of this arrangement, a professional standard must be specified in regulations made pursuant to subsection 1455(1) of the Act.

–               Subregulation 10.5.01(1) of the Principal Regulations lists the auditing standards that are to be treated as if they had been made by the AUASB under section 336 of the Act.

•                Paragraph 1455(5)(a) of the Act provides that these standards cease to have effect in relation to financial reports for periods ending after 30 June 2006, although paragraph 1455(5)(b) provides for the period to be extended by regulations made under subsection 1455(1).

As the AUASB has announced that the first standards it has made will apply to financial reports for full-year periods ending on or after 30 June 2007, there will be no auditing standards with force of law applicable to audits of financial reports for periods ending after 30 June 2006 and before 30 June 2007.

The amendment in item 7 remedies this situation by inserting a new subregulation 10.5.01(3) which provides that the professional standards listed in subregulation 10.5.01(1) will cease to have effect in relation to a financial reporting period that ends after 29 June 2007.

Item [8] – Schedule 5B, clause 1, definition of AASB 1046

Regulation 2M.6.04 provides that Chapter 2M of the Act is modified in the way specified in Schedule 5B ‘Annual Financial Reports — Listed Companies’ to the Principal Regulations.  The modifications in Schedule 5B allow listed companies not to make executive and director remuneration disclosures in the financial report if they make the disclosures in the directors’ report.

Regulation 2M.6.04 makes references to Accounting Standard AASB 1046 Director and Executive Disclosures by Disclosing Entities on executive and director remuneration disclosures.  At its 7-8 December 2005 meeting, the AASB decided to withdraw AASB 1046 and move the substance of its requirements into AASB 124 Related Party Disclosures.

The amendments in items 8 to 13 of Schedule 1 merely update the references to AASB 1046 paragraphs and terminology in the Principal Regulations to the equivalent references in AASB 124.

This item replaces the reference to AASB 1046 in Schedule 5B, clause 1 with a reference to AASB 124 Related Party Disclosures.

Item [9] – Schedule 5B, clause 3

This item replaces the reference to AASB 1046 in Schedule 5B, clause 3 with references to paragraphs Aus25.4 to Aus25.7.2 of AASB 124.

Item [10] – Schedule 5B, paragraph 4(b)

The AASB has also decided to remove the definitions of specified director and specified executive in AASB 1046 and rely solely on the definition of key management personnel in AASB 124.

This item replaces the reference to a specified executive within the meaning of AASB 1046 with a reference to the definition of key management personnel in AASB 124.

Item [11] – Schedule 5B, paragraph 4(c)

This item replaces references to AASB 1046 with references to AASB 124.

Item [12] – Schedule 5B, subparagraph 4(d)(iv)

This item replaces a reference to paragraph 7.5 of AASB 1046 with a reference to paragraph Aus25.5 of AASB 124.

Item [13] – Schedule 5B, sub-subparagraph 4(d)(iv)(D)

This item replaces a reference to section 6 of AASB 1046 with a reference to ‘applicable accounting standards’.

Item [14] – Schedule 5C

This item inserts a new Schedule 5C to the Principal Regulations.

The CLERP 9 Act established a comprehensive regime on auditor independence, implementing recommendations of the report on Independence of Australian Company Auditors (the Ramsay report) and relevant recommendations of the HIH Royal Commission.

The legislative framework of the auditor independence requirements in the CLERP 9 Act includes:

•                a general requirement for auditor independence;

•                specific auditor independence requirements which contain restrictions on an extensive range of specific employment and financial relationships between an auditor, and other persons connected to the auditor, and the audit client.  The Ramsay report described these specific restrictions as involving ‘core circumstances which, if they exist, necessarily mean that the auditor is not independent’; and

•                a number of additional requirements relating to other auditor independence issues, such as audit partner rotation.

Schedule 5C, clause 1: Money owed — debt

Item 15 of the table in subsection 324CH(1) of the Act prohibits an individual auditor, an audit firm or an audit company (and various other persons specified in the tables in subsections 324CE(5), 324CF(5) and 324CG(9) of the Act) from owing an amount of more than $5000 to:

•                the audited body; or

•                a related body corporate; or

•                an entity that the audited body controls.

This restriction existed in the auditor independence requirements in the Act which pre-dated the CLERP 9 Act.  This restriction was included in the CLERP 9 Act auditor independence requirements in accordance with a recommendation in the Ramsay report.

During the implementation of the CLERP 9 auditor independence requirements, concerns have been raised that this restriction is catching ‘ordinary course of business’ transactions between an auditor and an audit client.  An example is where an audit firm that audited an airline, such as Qantas, would not be able to fly with Qantas unless it paid cash rather than operating an account on normal credit terms.

Another example is where a firm, a member of the firm or other persons covered by the restriction might be prevented from buying whitegoods on store credit provided by an audit client.

As a general rule, debts incurred in the ordinary course of business and on normal terms and conditions would not constitute a threat to auditor independence.

Item 15 of the table in subsection 324CH(1) applies to both ‘loan’ and ‘non-loan’ debt.  This presents difficulties for the auditors of major credit card providers as the loan debt prohibition would encompass outstanding balances on a credit card.  The prohibition would require cancellation of credit cards with an audit client if the outstanding balance exceeded $5000.  It is doubted whether credit card balances would present a threat to auditor independence where the credit arrangement is on normal terms and conditions and would be used for the personal use of the person or firm or in the ordinary course of business of the person or firm.

Subclause 1(1) of Schedule 5C provides that subclause 1(2) applies to audit activity in relation to a financial year that ends on or after the commencement of Schedule 5C.  The meaning of ‘audit activity’ is defined in section 9 of the Act.

Subclause 1(2) provides that the operation of Chapter 2M of the Act is modified by omitting subsection 324CH(5) of the Act and substituting the revised subheading and subsection set out in subclause 1(2).

The existing subsection 324CH(5) provides for a housing loan exception for the purposes of item 15 of the table in subsection 324CH(1).  As the revised subsection 324CH(5) will also apply to debts arising in the ordinary course of business, the subheading will be changed to ‘ordinary course of business exception’.

The new paragraph 324CH(5)(a) replicates the existing housing loan exception in subsection 324CH(5).

The new paragraph 324CH(5)(b) provides that for the purposes of item 15 of the table in subsection 324CH(1) a debt owed by the person or firm to a body corporate or entity should be disregarded if:

•                the debt is on normal terms and conditions, and arises from the acquisition of goods or services on normal trading terms from:

–               the audited body; or

–               an entity that the audited body controls; or

–               a related body corporate; and

•                the goods or services will be used by the person or firm:

–               for the personal use of the person or firm; or

–               in the ordinary course of business of the person or firm.

The new paragraph 324CH(5)(b) will apply to both a loan and a non-loan debt.  The references to ‘the person’ in new paragraph 324CH(5)(b) relates to all the relevant individuals and entities identified in the tables in subsections 324CE(5), 324CF(5) and 324CG(9).  In this context, it is noted that paragraph 22(1)(a) of the Acts Interpretation Act 1901 provides that unless the contrary intention appears, expressions used to denote persons generally, such as ‘person’, include a body politic or corporate as well as an individual.

Schedule 5C, clause 2: Money owed — deposit account

Item 16 of the table in subsection 324CH(1) of the Act prohibits amounts owing to an audit firm (and various other persons and entities specified in the tables in subsections 324CE(5), 324CF(5) and 324CG(9)) by the audited body under a loan.

While amounts owing by a bank under a cheque or savings account may not be regarded as a loan in a commercial sense, the legal interpretation of a loan includes deposit accounts with a bank.

This presents a considerable burden for auditors of banks and other financial institutions that offer cheque and savings account facilities to their customers.  It involves the closing of all the savings and cheque accounts held by the audit firm and individual members of the audit team with the bank or financial institution.

The imposition of a regulatory requirement should not be disproportionate to the risk of potential damage or harm.  In the context of cheque and savings accounts, the potential threat to auditor independence is perceived to be low, particularly if the cheque or savings account facility is arranged in the ordinary course of the audit client’s business and made under normal lending procedures, terms and conditions.

Subclause 2(1) of Schedule 5C provides that subclause 1(2) applies in relation to audit activity in relation to a final year that ends on or after the commencement of Schedule 5C.

Subclause 2(2) provides that the operation of Chapter 2M of the Act is modified by omitting subsection 324CH(6) of the Act and substituting the new subheading and subsection set out in subclause 2(2).

The existing subsection 324CH(6) provides an exception for loans by immediate family members of a professional member of the audit team conducting the audit of the audited body or of a non-audit services provider for the purposes of item 16 of the table in subsection 324CH(1).  As the new subsection 324CH(6) also applies to amounts on call, the subheading has been changed to ‘loans by immediate family members and amounts on call’.

The new paragraph 324CH(6)(a) replicates the exception in relation to loans by immediate family members in the existing subsection 324CH(6).

The new paragraph 324CH(6)(b) provides that for the purposes of item 16 of the table in subsection 324CH(1), a debt owed to the person or firm by the audited body, a related body corporate or an entity that the audited body controls should be disregarded if:

•                the body, body corporate or entity is an Australian ADI; and

•                the amount is in a basic deposit product (which is defined in section 761A of the Act) provided by the body, body corporate or entity; and

•                the amount was deposited in the ordinary course of the business of the audited body, body corporate or entity, and on the terms and conditions that normally apply to basic deposit products provided by the body, body corporate or entity.

The reference to ‘the person’ in new paragraph 324CH(6)(b) applies to all the relevant individuals and entities identified in the tables in subsections 324CE(5), 324CF(5) and 324CG(9).

Section 9 of the Act defines an Australian ADI as:

•                an authorised deposit-taking institution within the meaning of the Banking Act 1959; and

•                a person who carries on State banking within the meaning of paragraph 51(xiii) of the Constitution.

Schedule 5C, clause 3: Public company auditor (annual appointments at AGMs to fill vacancies)

The audit reforms in the CLERP 9 Act introduced notification procedures to ensure that there was a staged procedure in place before an auditor’s appointment was terminated on the grounds of the auditor’s failure to address an auditor independence conflict of interest situation.  The staged procedure involves the following steps:

•                An audit firm is required to notify the Australian Securities and Investment Commission (ASIC) within seven days if it becomes aware that it has a conflict of interest situation that has not been resolved (subsection 324CF(1A) of the Act).  Similar requirements apply to an individual auditor under subsection 324CE(1A) and to an audit company under subsection 324CG(1A) of the Act.  No notification is required if the conflict is resolved before the end of the seven-day period.  ASIC is required to give a copy of the notice to the audit client so that the company is put on notice that its auditor has an independence issue that needs to be resolved.

•                After the firm has notified ASIC, the firm has a further 21 days (the remedial period) to resolve the conflict of interest situation (subsection 327B(2B).  Similar requirements apply to an individual auditor under subsection 327B(2A) and to an audit company under subsection 327B(2C) of the Act.

•                An audit firm thus has a maximum period of 28 days after it becomes aware of a conflict of interest situation to rectify the conflict (the initial seven-day period plus the 21‑day remedial period).

•                If the conflict of interest situation is not resolved at the end of the 21 day remedial period, the audit firm’s appointment as auditor of the particular audit client automatically terminates (subsection 327B(2B).  Similar requirements apply to an individual auditor under subsection 327B(2A) and an audit company under subsection 327B(2C) of the Act.

When the CLERP 9 Act was drafted, the maximum period of 28 days was considered to give an auditor sufficient time to rectify a conflict of interest situation.  However, concerns have been raised that complex circumstances do arise that would not be able to be resolved with 28 days.  ASIC does not at present have the power to extend this period.

An example where 28 days may not be sufficient to resolve a conflict of interest situation, is where a member of the audit firm acquires a beneficial interest in shares of the audited body through a deceased estate.  The partner’s interest in the shares may not be able to be disposed of until the probate in relation to the deceased estate has been finalised, which may take months or years.

The purpose of the new clause 3 of Schedule 5C is to give ASIC the power to extend the remedial period of 21 days referred to in section 327B of the Act, in appropriate circumstances.

Subclause 3(1) provides that subclause 3(2) applies to all companies, all registered schemes and all disclosing entities, only in relation to an audit activity that is conducted on or after the commencement of Schedule 5C.

Subclause 3(2) provides that the operation of Chapter 2M of the Act is modified by omitting from subsections 327B(2A), (2B) and (2C) of the Act the words ‘21 days’ and inserting ‘21 days, or such longer period as ASIC allows’.