Brief facts of the enquiry

An issue was highlighted in the meeting of Quality Assurance Board (QAB) of ICAP, related to a Sole Proprietorship Firm, which had been in non-compliance with the requirements of the Code of Corporate Governance Regulations, 2017. The observation was as follows:

“During review, it was observed that the firm is auditing the company since the year 2008 (i.e. more than 5 years) which is a non-compliance of clause of 34 (2) of the Listed Companies (Code of Corporate Governance) Regulations, 2017 (“the Code”) and paragraph 290.149 of code of ethics.”

The audit firm also commented that “Please note that clause 34 of the Listed Companies (Code of Corporate Governance) Regulation, 2017 (the Code) which is applicable to the partners of the firm. In our case, the same, is not applicable as our concern is a proprietorship. Furthermore, the amendments made in 2019 are applicable from the date of amendment in the Code and the same cannot be applied retrospectively”.

Based on the above, the QAB evaluated the matter and has requested a written comment from the Technical Services Department that whether the requirements of the Code of Corporate Governance, 2017 were breached and whether the amendments of 2019 meant that the rotation was not required previously in case of sole proprietorship firms?

The Auditing Standards and Ethics Committee’s comments and conclusion

The Committee’s understanding of the submitted fact pattern and its comments on the enquired matter are contained in ensuing sections.

1.The Committee, based on the information provided in the enquiry, noted that a sole proprietor is acting as external auditor of a listed company since 2008.

Based on this basic information, the enquirer has requested for clarification on the following:

a)whether requirements of the Listed Companies (Code of Corporate Governance) Regulations, 2017 (CCG Regulations 2017) relating to the rotation of the external auditor were breached; and

b)whether the amendments of the Listed Companies (Code of Corporate Governance) Regulations, 2019 (CCG Regulations 2019) meant that the rotation of external auditor was not required previously in case of sole a proprietor.

2.The Committee noted that enquired matter relates to the application of provisions of CCG Regulations 2017 and CCG Regulations 2019. The Securities and Exchange Commission of Pakistan (SECP) has issued these regulations.

The Committee, while analysing the matter, considered the relevant requirements of:

•the Corporate governance framework for listed companies;

•the Code of Ethics for Chartered Accountants 2019; and

•the Companies Act 2017.

Corporate Governance Framework

3.The Committee observed the SECP has issued corporate governance frameworks for different types of companies (i.e. listed, insurance, public sector).

A listed company, under the Companies Act 2017, is obligated to consider and comply with the CCG Regulations 2019.

The Committee also observed that SECP over the years has issued and repealed corporate governance frameworks for listed companies. These included:

•Code of Corporate Governance 2002 (Code 2002)

•Code of Corporate Governance 2012 (Code 2012)

•CCG Regulations 2017

4.The Committee noted that the above-noted corporate governance frameworks contained specific provisions relating to the change and rotation of external auditor.

CCG Regulations 2019, compared to previously applicable CCG Regulations 2017, Code 2012 and Code 2002, specifically added a provision relating to the change of the external auditor who is a sole proprietor.

•Relevant part of regulation 34 of CCG Regulations 2019 relating to change and rotation of external auditor is reproduced hereunder:

1) “It is mandatory that all listed companies in the financing sector shall change their external auditors every five years:

2) It is mandatory that all listed companies other than those in the financial sector shall, at the minimum, rotate the engagement partner after every five years:

Provided that in case the audit firm is a sole proprietorship then after completion of five years such audit firm shall be changed.” (Emphasis is ours)

•CCG Regulations 2007, Code 2012 and Code 2002 also contained specific requirements for change and rotation of external auditor. However, those corporate governance frameworks did not contain a specific provision for rotation of external auditor who is a sole proprietor.

For example, regulation 33 of CCG Regulations 2017 stated that:

1) “All listed companies in the financial sector shall change their external auditors every five years.

2) All listed companies other than those in the financial sector shall, at the minimum, rotate the engagement partner after every five years.”

Code 2012 and Code 2002 also contained similar provisions. These are provided in Annexure A to this letter.

5.The Committee observed that the enquired matter emanates from the CCG Regulations, which have been issued by the SECP. The Committee also observed that the enquired matter requires interpretation of the application of the relevant statutory provisions.

The Committee engaged with SECP with the objective to seek clarification regarding the requirements for rotation of external auditor who is a sole proprietor, under CCG Regulations 2019 and repealed CCG Regulations 2017.

6.In response to the Committee’s request for clarification, SECP clarified that:

“The Listed Companies (Code of Corporate Governance) Regulations, 2017 (now repealed) was silent w.r.t rotation of sole proprietorship audit firm.

Therefore, application of rotation of sole proprietorship firm as envisaged in proviso of sub-regulation (2) of regulation 33 will made after the promulgation of CCG Regulations, 2019.”

7.The Committee concluded that SECP response provided necessary clarification on the matters raised by the enquirer.

Code of Ethics for Chartered Accountants

8.Besides above discussed requirements of the corporate governance framework, the Committee also considered the Code of Ethics for Chartered Accountants (Revised 2019) (ICAP Code of Ethics 2019) requirements related to the rotation of auditor.

ICAP Code of Ethics 2019 requires that, for audits of public-interest entities, the engagement partner should be rotated after a pre-defined period. Part 4A, section 540 (Long Association of Personnel (Including Partner Rotation) With an Audit Client) of ICAP Code of Ethics 2019 specifies the requirements for rotation of auditors of public-interest entities.

Relevant paragraphs R540.5 and R540.9 and definition of engagement partner as provided in the ICAP Code of Ethics 2019 are reproduced hereunder:

Paragraph R540.5

“Subject to paragraphs R540.7 to R540.9, in respect of an audit of a public interest entity, an individual shall not act in any of the following roles, or a combination of such roles, for a period of more than seven cumulative years unless the law prescribes a shorter period (the “time-on” period):

a) The engagement partner;

b) The individual appointed as responsible for the engagement quality control review; or

c) Any other key audit partner role.

After the time-on period, the individual shall serve a “cooling-off” period in accordance with the provisions in paragraphs R540.11 to R540.19.” (Emphasis is ours)

Paragraph R540.9

“When a firm has only a few people with the necessary knowledge and experience to serve as a key audit partner on the audit of a public interest entity, rotation of key audit partners might not be possible. As an exception to paragraph R540.5, if an independent regulatory body in the relevant jurisdiction has provided an exemption from partner rotation in such circumstances, an individual may remain a key audit partner for more than seven years, in accordance with such exemption. This is provided that the independent regulatory body has specified other requirements which are to be applied, such as the length of time that the key audit partner may be exempted from rotation or a regular independent external review.”

ICAP Code of Ethics 2019 defines engagement partner as “the partner or other person in the firm who is responsible for the engagement and its performance, and for the report that is issued on behalf of the firm, and who, where required, has the appropriate authority from a professional, legal or regulatory body.”

While, public-interest entity includes a listed entity and other entities categorized as public-interest by local statutory provisions.

ICAP Code of Ethics 2015 also contained similar requirements for rotation of auditor. Relevant requirements of ICAP Code of Ethics 2015 are reproduced in ‘Annexure B’ to this letter. With issuing and application of ICAP Code of Ethics 2019, ICAP Code of Ethics 2015 was superseded.

Prior to ICAP Code of Ethics 2015, ICAP Code of Ethics 2008 was applied, and it also contained the auditor rotation requirements.

9.The Committee also considered it pertinent to mention that:

•Regulation 32 (2) of the CCG Regulations 2019 requires a listed company to appoint an auditor who is compliant with the Code of Ethics as adopted by the Institute of Chartered Accountants of Pakistan (the Institute).

Previously applicable, CCG Regulations 2017 and Codes of Corporate Governance (now repealed) also contained same the requirement.

•Section 247 3(i) of the Companies Act, 2017, while stating the qualifications and disqualifications of external auditor, specifies that a person who is not eligible to act as auditor under the Code of Ethics as adopted by the Institute, cannot be appointed as external auditor of a company.

10.The Committee, in light of above requirements, noted that for rotation of external auditor, requirements of the applicable Code of Ethics for Chartered Accountants (issued by the Institute) shall also be considered and complied with, together with the requirements of the applicable corporate governance framework.

(Issued in March, 2022)