Part 1 - Introduction

1.1 Background to review

In a joint press statement on 27 June 2002, the Treasurer and the Parliamentary Secretary to the Treasurer announced a process for achieving further improvement in audit regulation and the wider corporate disclosure framework as the next phase in the Government's Corporate Law Economic Reform Program (CLERP).

This policy paper is an important step in that process, aimed at seeking stakeholder comment on specific Government proposals. As announced in the joint press statement, the paper includes a Government response to the Ramsay report on the Independence of Australian Company Auditors. The paper reviews:

• the effectiveness of accounting standards and a proposal that Australia adopt international accounting standards by 2005;
• the regulation of accounting standards and practices;
• the audit function in Australia, including:
  • the market for audit and non-audit services;
  • the institutional framework for setting auditing standards and whether they should be given the force of law;
  • the rules and practices governing the audit engagement including appointment and removal of auditors and related corporate governance arrangements;
  • auditor independence issues canvassed in the Ramsay report;
  • the structures for oversight of the profession, including disciplinary powers, ethical rules, external quality assurance, educational requirements, professional development, competency standards etc; and
  • liability issues, drawing on current work in the context of public liability and medical indemnity insurance, including the question of incorporation of auditors;
• the present continuous disclosure regime;
• conflicts of interest in relation to the provision of financial product advice;
• the current disclosure requirements for shares and debentures; and
• ways to encourage investors to become more active in the companies they invest in.

The final implementation of reforms will need to take account of any relevant recommendations of the HIH Royal Commission, work being undertaken by the Joint Committee of Public Accounts and Audit (JCPAA), and developments overseas. The United States has recently introduced significant legislative reform in the area of corporate disclosure in response to the Enron collapse and the overstatement of earnings by WorldCom and certain other large corporations.

The globalisation of markets means that, in adjusting its regulatory framework, Australia must have regard to developments in major economies. Australian companies will face a cost of capital premium if our framework is perceived to be less rigorous than elsewhere, and they will pay a compliance cost penalty for over-regulation or poorly conceived regulation. In either case, their international competitiveness may be impaired. The objective must be for Australia's regulatory framework to remain in line with or ahead of world's best practice.

The Government believes that Australia starts from a position of strength in terms of the robustness of our institutional framework (including a highly skilled accounting profession) and corporate governance practices.

These practices were substantially strengthened in the 1990s through the Government's CLERP program, changes to the Australian Stock Exchange's Listing Rules, and actions by companies, business peak bodies and regulators to define and adopt industry best practice.

Australia is in line with or ahead of overseas practice in key areas of corporate disclosure. For example:

• as a result of the Government's CLERP 1 reforms, we have an effective accounting standard setting process with broad stakeholder oversight of an independent and well-funded standard setter, the Australian Accounting Standards Board (AASB);
• our accounting standards emphasise economic substance over form;
• there is an effective continuous disclosure regime requiring provision of timely and relevant information to shareholders;
• arguably, as a matter of 'culture' and practice, the actions of our market participants are less conditioned by short-term earnings results than those of their United States counterparts;
• Australia has an effective and well-resourced corporate regulator, the Australian Securities and Investments Commission, with appropriate enforcement powers; and
• severe penalties are already in place for corporate fraud.

The history of business compliance with disclosure rules is generally good. Most audits are conducted professionally and competently, with full regard to the interests of shareholders, the need for independence, and professional ethical rules.

Had Australia experienced the same speculative 'bubble' seen recently in the United States, it is likely we would have been better able to avoid disclosure problems on an equivalent scale. At the same time, our disclosure framework probably helped avoid the build-up of speculative pressures (for example, by ensuring that the cash positions of high technology start-up companies were disclosed). Nevertheless, Australia cannot afford to be complacent. It is timely to review Australia's corporate disclosure framework in view of developments overseas - in the United States in particular - and in view of lessons learned from recent corporate collapses in Australia.

This is not to say that Australia should match the United States point for point. The recent US legislative response tends to be prescriptive and rules-based. In addressing corporate governance issues, Australia has traditionally relied on a principles-based approach, employing a mix of regulation, co-regulation and encouragement of industry best practice. This approach has worked well in Australia and the Government supports its continuation.

More specifically, the Government has taken the view that legislation is appropriate where it delineates broad parameters for the conduct of business, removes uncertainty in the operation of the law, and clarifies the rights, duties and responsibilities of stakeholders. Beyond this, however, the Government has been reluctant to legislate without evidence of a clear failure of market-based incentives or sanctions to produce appropriate outcomes.

It is difficult to legislate against fraudulent behaviour by a few market participants. Moreover, it is impossible to legislate against corporate failure, which is inherent in a competitive economy where market participants seek to balance risk and reward. Attempts to do either risk imposing excessive regulatory burdens that could adversely affect innovation and wealth-creation.

Accountability of management, transparency of financial and other information, and the protection of shareholder rights are fundamental to the integrity and efficiency of markets and to investor confidence. The package of proposals in this paper continues the corporate law improvement begun in 1996 under the Government's CLERP initiative. Its aim is to ensure that Australia has an effective disclosure framework that helps define world's best practice and provides the structures and incentives for a fully informed market.

Since 1996, the Internet has become a powerful and widely used communications tool and information source. CLERP 9 recognises that this development has changed the environment for disclosure. It seeks to empower shareholders through Internet based technologies which give them more real time information about their companies and the ability to become more involved in their companies' affairs.

1.2 Key economic principles

The objective of CLERP is to ensure that business regulation is consistent with promoting a strong and vibrant economy and provides a framework that helps business adapt to change.

As with previous reform proposals underpinning CLERP, the policy proposals in this paper are, where possible, assessed against the following key principles:

• cost/benef
  it analysis of proposed changes;
• the development of a regulatory and legislative framework that is consistent, flexible, adaptable and cost effective;
• the reduction of transaction costs for firms and other market participants;
• an appropriate balance between government regulation and industry regulation;
• the removal of barriers to entry for service providers; and
• improved harmonisation between Australia's regulatory framework with those applying in major world financial markets.