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AUDITER AS A TRUSTEE: AN IDEPENDENCE DILEMMA

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The objective of this article is to assist audit practitioners with respect to the relationship an auditor has to a trust in two specific cases where:

• the audit of the trust is carried out by Tick and Bash Auditors and one of the trustees of the trust is a partner of Tick and Bash Auditors; or
• the trustee of a trust is a partner of Tick and Bash Auditors and the trust owns greater than 50% of the shares in a company that is audited by Tick and Bash Auditors.

During the auditor’s audit training sessions throughout South Africa, the question has been raised by audit practitioners as to what are Tick and Bash Auditors’ duties and responsibilities in terms of the IRBA and IFACs code of ethics for professional accountants? This issue is a cause for serious concern. It is a very critical and vital question that needs a solution as many auditors in South Africa act as trustees for quite a few of their clients, who in some form are assurance clients.
Principles
1. In Whitehead v EST Adamson 1952 2 SA 139 (N) 143 H – The trustees, even if not the owners, are entitled to the possession and control of the trust property in order to ensure its proper administration and disposal.

2. In Goolam Ally Family Trust v Textile, Curtain and Trimming 1989 4 SA 985 – Whether or not the majority principle applies as a matter of internal administration, it is clear that, provisions of the trust deed apart, trustees must act jointly in their dealings with outside parties if they intend to bind the trust estate.

The trust assets are possessed and owned by the trustees in their capacity as such, and the trustees are obliged to administer the trust assets for the benefit of the beneficiaries in accordance with the trust deed. Control and management of the trust and its assets vest in the trustees.

3. As a firm of auditors has to be registered with the Independent Regulatory Board for Auditors (IRBA), there can be no distinction between each partner/director in the firm. A partner/director cannot carry out an act that would be forbidden to a fellow partner/director. This is important in the context of the audit of trusts and the assets owned by the trust.

Where the audit of the trust is carried out by Tick and Bash Auditors, and one of the trustees of the trust is a partner of Tick and Bash Auditors
P 290.149 of the SAICA Code of Professional Conduct states that, if a partner or employee of the firm or network firm serves as an officer or as a director on the board of an assurance client, the self-review threats created would be so significant that no safeguard could reduce those threats to an acceptable level. Consequently, if such an individual were to accept such a position, the only course of action is to refuse to perform or to withdraw from the assurance engagement.

The question that arises is whether the term officer includes a trustee? The Code defines an officer as “those charged with the governance of an entity”. In most common law legal systems, a trust is an arrangement whereby money or property is owned and managed by one person (or persons, or organisations) for the benefit of another. A trust is created by a settlor, who entrusts some or all of his property to people of his choice (the trustees). The trustees are the legal owners of the trust property (or trust corpus), but they are obliged to hold the property for the benefit of one or more individuals or organisations (the beneficiary), usually specified by the settlor. The trustees owe a fiduciary duty to the beneficiaries, who are the “beneficial” owners of the trust property.
As a result of the above, Tick and Bash Auditors cannot be the auditor of a trust whilst one of the directors/partners – be it the engagement partner or another partner – is a trustee of the trust being audited. Either Tick and Bash Auditors would have to withdraw from the audit or the partner would have to resign as a trustee.

Where the trustee of a trust is a partner of Tick and Bash Auditors and the trust owns a greater than 50% of the shares in a company that is audited by Tick and Bash Auditors:

Situation
Mr. A is a partner of Tick and Bash Auditors. He is appointed as a trustee of XX Trust. XX Trust is not required to be audited. XX Trust owns/acquires (greater than 50%) shares in ZZ (Pty) Limited. ZZ (Pty) Limited is audited by Mr. A.

290.109 of the IFACs code of ethics for professional accountants states that, when a firm or a member of the assurance team holds a direct financial interest or a material indirect financial interest in the assurance client as a trustee, a self-interest threat may be created by the possible influence of the trust over the assurance client.

It is important to note that 290.109 should be read as: as a result of being a trustee Mr. A holds a direct material financial interest or an indirect material financial interest in the assurance client (ZZ). It is argued that Mr. A. does not in fact own any of the shares in ZZ, as all the shares are owned by the trust; therefore Mr. A. could not possibly hold a direct material financial interest or an indirect material financial interest in the assurance client (ZZ). Therefore this section would not apply.

In this situation it is necessary to apply the principles as discussed above.

P 290.109 of the IFAC Code discusses the situation where a member of the assurance team (and here ‘firm’ is also included) holds material a direct financial interest or a material indirect financial interest in the assurance client as a trustee. In the author’s this does not mean only a legal financial interest. In other words, the trustee legally owns the shares in his/her own name. One has to take into account that the trustee has a material direct/indirect financial interest in the shares owned by the trust by the fact that the person is a trustee and trustees have complete control over the assets owned by the trust even though they do not legally own them.

P 290.105 of the IFAC Code states that, when evaluating this type of financial interest, consideration should be given to the fact that financial interests range from those where the individual has no control over the investment vehicle or the financial interest held (e.g. mutual fund, unit trust or similar intermediary vehicle) to those where the individual has control over the financial interest (e.g. as a trustee) or is able to influence decisions. In evaluating the significance of any threat to independence, it is important to consider the degree of control or influence that can be exercised over the intermediary, the financial interest held or its investment strategy. When control exists, the financial interest should be considered direct. Conversely when the holder of the financial interest has no ability to exercise such control the financial interest should be considered indirect.

In this context, where the engagement partner as a trustee could have significant influence over any investment decisions involving a financial interest in the assurance client. In other words, as a trustee does the engagement partner have significant influence over decisions made on behalf of the trust by the trustees? A trustee must not delegate his or her power or his or her decision-making powers to his or her fellow trustees. All trustees must participate in the decision-making process. This raises the question as to whether one trustee can significantly influence the other trustees. Hence the concept of a minority trustee. A minority trustee would in essence be the trustee that did not vote in line with the majority of the trustees. Whether the minority trustee likes it or not, he/she must participate in the implementation of the decisions of the trust. In other words, the minority trustee cannot refuse to “play” just because he/she did not approve or vote for a particular decision. So, for example, if a trust whose trust deed allows for majority decisions, properly passes a resolution to, say, sell its investment shareholding, and the resolution is passed five in favour, two against, the two minority trustees cannot refuse to sign the necessary sale documents on the grounds that they disagree with the decision.

Clearly, here the minority trustee cannot exert significant influence. However, there will come a time when the minority trustee becomes a majority trustee and as a result of the trustee being in the majority probably had significant influence over the decision made. It would then be ludicrous to say that the engagement partner as a trustee is independent when he is in the minority and not independent when he is in the majority. Clearly, the engagement partner as a trustee has an independence problem. It is quite clear from the above: “where the individual has control over the financial interest (e.g. as a trustee)”, the trustee of a trust has a “direct financial interest”.

Therefore, after taking everything written herein into account, it is not possible for Tick and Bash Auditors to do an audit where the shareholder is a trust and one of the partners of Tick and Bash Auditors is a trustee.

Misunderstanding and Misconception
IRBA Code P 7.5 states “Where the practitioner is requested to be a trustee, he/she should be a minority trustee”.

Many audit practitioners use the concept of a minority trustee to argue that there are no independence issues in accepting the appointment as trustee either in Case 1 or 2. As discussed above there is surely no such concept as a minority trustee.

Recommendations
It’s not all doom and gloom. The author is of the opinion that, if the following safeguard is implemented then, where the engagement partner is a trustee of the trust and the trust owns shares in a company that is a client of the engagement partner, Case 2 would be allowed as follows:

The engagement partner should appoint an engagement quality control reviewer as required by ISQC 1. An engagement quality control review will provide an objective evaluation of the significant judgments made by the engagement team and the conclusions reached in formulating the report. The author advises that the engagement quality control reviewer must be from a different office, or even a different firm. The engament quality control reviewer will support the independence in appearance issue that could easily be questioned by any reasonable person.

Dr Steven Firer CA(SA), BCom, BCompt (Hons), MBA, DBA, IFRS DIP (ACCA), is a Registered Auditor and IFRS Advisor with the JSE.