This article first appeared in Corporate, The Edge Malaysia Weekly, on May 30 - June 5, 2016.

OF the many headlines surrounding 1Malaysia Development Bhd (1MDB), an accounting scandal was not among them. There are those who think it should have been, arguing that 1MDB ran into cash flow issues not too long after being cleared as a going concern.

Others disagree. While none of 1MDB’s audited financial statements issued through March 31, 2014, had a qualified opinion, the Public Accounts Committee’s investigations show that two of its external auditors were replaced over a span of five years for asking too many questions.

And 1MDB’s accounts have thus far gone through three of the so-called “Big Four” audit firms — Ernst & Young, KPMG and Deloitte. (The fourth “Big Four” is PricewaterhouseCoopers, Tesco plc’s auditor of 32 years, which came under the spotlight in 2014 after investigators said the UK supermarket chain had grossly overstated its profits.)

Globally, at least two of the “Big Four” firms have been sued for failing to highlight fraud.

Whether or not there is a mismatch between public expectation on the ability of auditors to detect and expose fraud, the credibility of the accounting profession has again been thrown into question — despite heightened scrutiny by accounting oversight bodies since the likes of Enron and WorldCom imploded over a decade ago. In 2007, Malaysia saw its own mega accounting scandal in Transmile Group Bhd, which counted reputed billionaire businessman Robert Kuok among its shareholders. (Tesco had Warren Buffett as shareholder.)

Nik Mohd Hasyudeen Yusoff, the Audit Oversight Board (AOB) founding board member, recalls the general “frustration of audit not being done properly” in Malaysia in the wake of accounting scandals. An independent audit regulator was sorely needed to establish a base standard for the audit profession and, over time, raise the bar.

The same frustration was felt globally. “If you look around the world, there are now at least 50 countries that have independent audit regulators. Today, it is expected that a good economy must have good independent audit regulator because you need that independence,” says Nik, who was AOB executive chairman until end-March.

Malaysia responded by setting up AOB on April 1, 2010, under the Securities Commission Malaysia Act 1993. This is to provide independent audit oversight over so-called public interest entities (PIEs) and ultimately, restore and strengthen investor confidence in the quality and reliability of audited financial statements.

1MDB, which falls under Minister of Finance Inc, is not among the 1,140 PIEs under the AOB’s purview. Any institution can be added to come under its purview by order of the minister of finance.

Even so, Nik says rebuilding confidence in the system involves a lot more than the act of putting 1MDB or any other entity under AOB’s supervision.

“1MDB is a little bit tricky because it falls under the category of government-owned companies, like Khazanah [Nasional Bhd]. It’s not as simple as [widening coverage, because you will need to have more people to cover other government-linked companies]. We have to be careful. We cannot extend the scope just because of one incident. There will be other unintended consequences,” adds Nik, who was also president of Malaysian Institute of Accountants (MIA) from 2007 to 2009 and a member of the Malaysian Anti-Corruption Commission’s operational review panel for six years through 2015.

Nik acknowledges limitations on AOB’s scope as it “cannot be regulating everybody”. “We were looking at the sectors that need to be regulated. That would be the capital markets, banking and insurance sectors as well as fund management companies and stock brokers. That’s how the mandate of AOB was drafted. It was purely for these sectors,” he says.

According to him, anything outside AOB’s purview automatically falls under MIA, a professional body with regulatory powers that allow it to investigate and punish members for falling short in carrying out their professional duties. (It is worth noting that the Ministry of Finance oversees the Accountant General’s Department, which nominates appointees to MIA’s council, including some audit firm heads.)

Rather than discussing the potential conflict of interest, Nik says AOB and the Securities Commission of Malaysia (SC) have sent a strong signal to the profession on the severity of non-compliance when it comes to upholding audit and professional standards.

Last year, for the very first time, AOB revoked the registration of audit firm Wong Weng Foo & Co and two of its partners for failure to remain fit and proper to audit PIEs. The appeals were pending as at end-2015, according to data on the SC’s website.

At the AOB level, the financial penalty is up to RM500,000 and the board can also prohibit an auditor or audit firm from accepting any PIE or schedule fund as a client for a period of 12 months or permanently.

The SC is also sending out a strong message to auditors when it comes to companies (their clients) making misleading statements by pursuing criminal prosecution. Yue Chi Kin, audit partner of Messrs Roger Yue, Tan & Associates, was fined RM400,000 and sentenced to a year’s imprisonment by the Kuala Lumpur Sessions Court on Oct 21 last year after he was found guilty of abetting United U-Li Corp Bhd in making a misleading statement to Bursa Malaysia in its annual report and financial statements for the year ended Dec 31, 2004.

The added regulatory oversight received a mixed response from auditors (see accompanying story). AOB and Nik himself (at the time of writing, a new AOB executive chairman had yet to be appointed since Nik left in end-March) had come under fire for arguably being “too punitive”. Some auditors argue that AOB reprimands could tarnish their image and reputation.

Nik is unfazed, though. “I don’t think this is a problem of us taking action, but more of a problem of auditors not doing their job. In fact, we didn’t start taking any action until a few years ago. If the facts suggest that the breach is beyond our tolerance and makes us worry, we have to take action,” he says.

While it is a company’s responsibility to prepare a good financial statement, he says it is the auditors’ job to audit it properly.

“We don’t have a view on whether there are too many or too few [reprimands] … [but] we have to be objective. If the standard is not there, the standard is not there. It’s not fair for the market to be supplied with work [that is not up to par with auditing standards],” Nik says, adding that AOB is always “objective and fair”, with firms given a chance to explain their case before action is taken.

“[They’re given] three chances to be heard … it’s a fair process. In fact, if they want to appeal to the SC, they have another chance, but most of them don’t challenge.

“We just do our work and stick to the facts. It’s not about us winning or the firm winning, but standards have to go up. Of course, there are people who have different ideas about how we should be doing our work … they are welcome to challenge us,” he says, adding that AOB never takes challenges personally.

But beyond wielding the stick, Nik is convinced good audit is good for business and hopes the industry will share this view instead of being afraid of losing clients for raising audit standards. Firms determined to maintain audit quality and professional standards “are not worse off economically compared with their peers and in certain market segments, are more competitive” because good businesses want to be associated with credible audit firms.

“There is a commercial element in what we do. We highlight something from an independent point of view, so many firms actually see that as a positive way of dealing,” Nik says.

“It makes good business sense for audit firms to maintain quality work. It’s not like ‘Don’t go to this firm, its standards are high’. It doesn’t work like that. There are companies that want to be associated with such firms ... it is a positive thing. I’m quite happy with where we are today.”

There is always room for improvement, even among the “Big Four + two (BDO Binder and Crowe Horwath)”. They lead the pack of eight firms with “more than 10 partners”, which collectively (with 191 auditors) audit 922 PIEs covering 95.64% of the market capitalisation of public-listed companies and 872 schedule funds covering 99.3% of the fund size in Malaysia.

“The workload means each partner, on average, viewed and signed 217 audit reports last year, which could range up to 24 PIEs, 288 entities related to PIEs, or 1,330 non-PIEs per partner,” AOB says in its 2015 annual report, flagging that “unreasonable workload contributes towards inconsistency of engagement performance, which ultimately affects audit quality”.

Nik also says the complexities that come with globalisation and a fast-changing business environment mean auditors have to understand a client’s business in order to perform a good audit.

“Today, banks are driven by technology, so the auditors must have the ability to look at IT audit. Conglomerates are involved in different industries and they are everywhere in the world, so it’s not as easy as last time,” he says.

Nik also warns against having a false sense of security when auditing companies they are familiar with and to always obtain evidence to support their judgement, because circumstances and context can change over time. “One of the threats is when the auditors don’t bother to check — ‘I’m familiar with the company. I’ve seen it before, so it must be the same thing’. That’s where they get caught.” 

He also reckons that an audit firm should not accept a client if its people are not confident in doing a good job.

Nik adds that audit firms have become more proactive in highlighting audit issues and audit quality in Malaysia in recent years following AOB’s engagement with auditors.

“Things still happen, yes, but we have to look at what led to those incidents. Last time, there were companies that suddenly collapsed. So the company may fail first, only then do people realise that it was an audit issue.

“But today, these incidents are more driven by the audit firms. They refuse to sign [off the accounts], they alert the market, they issue a disclaimer. In that respect, they have done what they are supposed to do, although we still find some audit issues today. What is more important is, we expect the auditors to perform their duties honestly and diligently,” he says.

AOB’s 2015 annual report, released on May 10, also noted “instances of change in audit opinion subsequent to its regulatory activities”, mainly in the area highlighted in AOB’s inspection findings. AOB also observed instances of changes in audit composition and audit procedures to obtain more reliable audit evidence. It did not provide specific statistics on the number of cases or how substantial the changes were.

To be sure, there is no perfect system. What is certain, though, is that there is a need to safeguard investor confidence with regard to the reliability of financial statements because a breakdown of trust would mean a higher risk premium and higher costs for companies seeking funds from the market.

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