What do judges understand by auditor independence?

What do judges understand by auditor independence?  In this post, we will analyze the cases in which the auditor’s independence is endangered. In addition to the possible tools available to us to resolve these situations. Let’s see.

1. Should my company’s accounts be audited?

In general, all companies must have their annual accounts audited. This obligation is legally required. However, 90% of Spanish companies do not have the obligation to audit. Although the general rule is as described, the cost and effort of auditing for an SME exempts it from this need to audit. Therefore, the standard establishes the following exceptions to the general rule. These must be repeated for at least two financial years:

1.       The total sum of the company’s assets does not reach 2,850,000 euros.

2.       The annual net turnover must be less than 5,700,000 euros.

3.       The average number of employees of the company during the year does not exceed 50.

There is an additional “exception”. If your company is in its first fiscal year after its incorporation, merger or transformation, it is exempt from this obligation. As long as, again, you meet two of these three circumstances at the end of the fiscal year.

• Who should appoint the auditor? The General Meeting? The directors?

This is a power of the General Meeting. The appointment does not necessarily have to be made to a single individual or legal entity; there may be several persons acting jointly. However, in the case of individuals, both regular and alternative auditors must be appointed. Finally, if no auditor is appointed within the deadline, the auditors or any partner may request the appointment of an auditor. This request must be made to the commercial registrar of the company’s registered office.

2. The need for auditor independence.

The independence of the auditor has been repeatedly analyzed by the Courts. The essential activity of the auditor is the review and subsequent verification of the financial statements. For this work to be carried out correctly, the auditor must be completely independent. Yes, the audit is a service that must be contracted by the company whose accounts are to be audited. But its work affects not only the company in question, but also partners and third parties. Therefore, objectivity and transparency are essential when auditing the annual accounts. Therefore, the auditor cannot belong to the company to be audited. This professional must be totally independent.

• How can I be sure that the auditor is independent?

Current legislation provides certain mechanisms to help ensure the auditor’s independence. Our own jurisprudence has also reiterated their validity. And the fact is that we are dealing with precepts of recent creation and imposed by the European Union. Some of the main characteristics that help to ensure this independence are as follows:

1. The duration of their services: The auditor shall be hired for a minimum period of 3 years, and a maximum of 9 years.
2. The company may not remove the auditor without fair cause. In other words, the Board must allege fair cause for this revocation. This ensures that the auditor can make the corresponding reports without concern about a possible revocation. However, we will analyze this scenario in more detail later.
3. The auditor’s remuneration is agreed as soon as he/she is appointed and for the duration of his/her term of office. It is also forbidden for the auditor to receive any other remuneration from the audited company.

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Annual Financial Statements: Does the Auditor’s “disclaimer of opinion” in his report violate the requirement to audit them?

By regulation, companies are obliged to audit their annual accounts. The auditor for his part has the duty to issue a report collecting his opinion on these.

• When is the auditor’s independence compromised?

The auditor should refrain from conducting an audit when his or her independence is compromised. The existence of financial, commercial or labor relations, directly or indirectly, between the auditor and the audited entity, calls into question such independence. More specifically, the law regulates specific cases of incompatibility that oblige auditors to abstain. It distinguishes between personal circumstances and circumstances arising from the services rendered.

1. Personal situation: They cover a wide variety of cases. Having a position within the audited company (administrator, proxy, etc.) is one of them. Also, having a direct interest in this company derived from a contract, asset or right. As well as carrying out transactions with financial instruments of this company, or requesting gifts or favors.
2. Services rendered: Having rendered accounting services, as well as valuation services, with exceptions. Also included are the rendering of internal auditing services, or the rendering of legal services simultaneously. Finally, the provision of financial information control and management services.

• How can my company remove an auditor from office?

As we have seen above, our legislation requires the concurrence of fair cause. This provision is expressly intended to protect the auditor’s independence. However, there is no definition of what is considered fair cause. Likewise, our Courts have not assessed the cases that can be subsumed under this concept. They have, however, stated that this lack of independence of the auditor is just cause for revocation. However, in all other cases, a case-by-case analysis is necessary to determine when there is just cause.

At this point, we must mention the regulations governing our commercial register. It establishes an enlightening statement regarding this matter: it is only necessary, for the registration of this revocation, to state that there has been just cause. That is to say, it does not appear to be necessary to express the concrete reasons that lead to this just cause. This makes possible the early revocation of the auditor by the Board with fair cause, without the need to state a specific reason.

• Can I challenge the resolution of the Meeting that appoints the auditor?

Our jurisprudence coincides in the positive answer to this question. Yes, it is possible to challenge this agreement when the auditor is not independent. The basis for this is that this agreement is contrary to the law, as it does not respect the aforementioned legal provisions.

• Can I challenge the resolution of the Meeting that approves the annual accounts for lack of independence of the auditor?

Again, the answer to this question is affirmative. Jurisprudence has already taken a favorable position in this situation. Therefore, we have seen judgments in which the action to challenge such corporate resolution has been upheld. The basis for this estimation, again, was the lack of independence of the auditor.

3. Conclusion.

As we can see, the auditor’s independence is a fundamental pillar in the exercise of his functions. Not only does it constitute an insurmountable line that must prevent the auditor from accepting the position that calls into question his independence. It is also considered by our Courts as fair cause for the early removal of the auditor from office. These consequences derive from an initial ground: the auditor must perform his work in an objective and transparent manner. His decisions do not only affect the audited company. They also affect the shareholders and third parties.

If this article has been of interest, we also suggest you to read the following article published on our website:  Director´s Liability for failing to deposit the Annual Accounts (or Financial Statements).