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An open response to SGX's open consultation

An open response to SGX's open consultation

Source: Business Times
Article Date: 10 Feb 2020
Author: Ben Paul

I plan to submit a response to the Singapore Exchange Regulation's consultation paper on its proposed enhancements to the regulatory regime for property valuation and auditors. Please let me know what you think.

This week, I plan to submit a response to the Singapore Exchange Regulation's consultation paper on its proposed enhancements to the regulatory regime for property valuation and auditors.

My purpose in doing so is to add the perspective of a small-time investor to the consultation process. And, by outlining my thoughts in this column beforehand, I am hoping to elicit helpful comments and suggestions from readers as well as inspire others to respond to the consultation.

The segment of the Jan16 consultation paper that has generated the most interest relates to its proposals for auditors engaged by listed companies. In particular, SGX RegCo wants to be able to require listed companies to appoint an additional auditor under certain circumstances to provide a second independent opinion on their financial statements.

SGX RegCo explains in the consultation paper that the objective of the second audit opinion is to address uncertainties in the market in a timely manner. It adds that it might also demand the appointment of second auditor when it has concerns about a listed company's upcoming audits but the listed company wants to continue with the appointment of an incumbent auditor.

SGX RegCo asks respondents to the consultation whether they agree with its proposal that listed companies must appoint an auditor registered with Accounting and Corporate Regulatory Authority (Acra). SGX RegCo also asks whether respondents agree with the proposed circumstances under which SGX may require the appointment of a second auditor.

For the first question, SGX RegCo notes in its consultation paper that efforts are under way to empower Acra to conduct "firm-level inspections" and mete out sanctions on errant auditors. With the anticipation that Acra will have the power and inclination to properly supervise auditors within its fold, requiring listed companies to engage auditors registered with Acra should have the effect of boosting investor confidence in the local market.

The proposal related to SGX RegCo requiring the appointment of a second auditor is more controversial. Certainly, it is potentially troublesome for auditors and the boards that appoint them. Some critics also assert that it isn't in the interest of investors, citing the cost of a second audit and the possibility of the second audit failing to uncover any lapses.

Yet, I intend to express support for this proposal when I respond to the SGX RegCo consultation. The way I see it, the real value of this initiative is that it may be a catalyst for change in the auditing field. Auditors and their regulators are under fire around the world essentially because they are not meeting the expectations of the market. The threat of their clients being required to engage a second auditor, especially if that threat is occasionally carried out, could motivate them to engage investors more closely and rethink their purpose and methods.

Principles of governance

Independent audits of financial statements, along with properly constituted boards, are among the crucial legal protections investors rely on to overcome the risks related to the separation of ownership and control.

Shareholders of companies need to have confidence that their wealth will not be expropriated or wasted, and that decisions about capital spending and acquisitions are in their economic interest and are not acts of empire building by their managers. Shareholders also need assurance that financial statements produced by their managers reflect the true state of affairs.

These protections have failed from time to time. One high profile example was the collapse of Enron in 2001. The company, which was once one of the largest sellers of natural gas in North America, is said to have adopted aggressive mark-to-market accounting for its long-term supply contracts and used special purpose vehicles to keep debt off its balance sheet.

Enron ended up restating its earnings for previous years, filing for bankruptcy, and sparking a criminal investigation. The scandal also sank Enron's auditor Arthur Andersen, which had been found to have shredded documents related to its audits of the company just as investigations intensified.

More recently, and closer to home, Noble Group is now the subject of an investigation in Singapore for, among other things, suspected breaches of accounting standards at a subsidiary. There were concerns in the market about Noble since early 2015. Yet, the authorities didn't announce a full-fledged investigation until November 2018, by which time Noble's market value had almost completely collapsed.

My understanding is that the investigations did not begin earlier because Noble's auditors had not raised any concerns. It remains to be seen if the authorities actually find any evidence of wrongdoing at Noble, and whether its auditor EY played any role in the whole debacle.

In the meantime, SGX RegCo's proposal to require listed companies to appoint a second auditor under certain circumstances could be an insurance policy against the next Noble case not being addressed quickly enough. It could also provide a signalling mechanism of sorts for boards and shareholders when selecting auditors. Clearly, an auditor with a track record of having its work second-guessed by its peers should not be at the top their list of potential candidates.

More importantly, this proposal could have the effect of making auditors more concerned about what is being said about their clients in the market, and prompt them to adopt a sharper and more investor-centric sense of professional scepticism. That, in turn, could mark the beginning of investors taking the work of auditors more seriously.

So, returning to the consultation exercise, under what circumstances should SGX RegCo demand the appointment of a second auditor?

My view is such a move would be warranted in the face of a credible news report or whistleblower testimony that a company's financial statements do not reflect reality.

One caveat on valuers

SGX RegCo asks three other questions in its consultation, all related to whether respondents agree with its proposals for the valuation of real estate held by listed companies.

Specifically, SGX RegCo has called for real estate valuers appointed by listed companies to have at least five years of relevant experience; be members of the Singapore Institute of Surveyors and Valuers; be independent of the companies that engage them; and not be a sole practitioner or have an adverse compliance track record. SGX RegCo also wants listed companies to comply with standards set by SISV.

Most investors are unlikely to have any objections to these proposals, though some sophisticated ones may raise technical issues. In fact, requiring that valuers be properly qualified, suitably experienced, unencumbered by conflicts of interest, answerable to a local regulator, and prepared to adhere to appropriate standards in their work is what the boards of listed companies ought to be doing anyway. Making these standards clear leaves no room for excuses in the future.

While I intend to say that I agree with SGX RegCo's proposals for valuers and the work they do, I might include one caveat.

The problem with instituting minimum standards is that listed companies might attempt to use those standards as a shield against valid criticism or questions. SGX RegCo should not allow listed companies to cite the excuse of having complied with the requisite qualification standards of valuers, or having complied with SISV valuation standards, to avoid addressing questions from the market.

Please let me know what you think of my proposed responses to SGX RegCo. Better yet, let me know what you plan to say in your responses to the public consultation. SGX RegCo requests that all comments reach it by Feb 14.

Source: Business Times © Singapore Press Holdings Ltd. Permission required for reproduction.

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