On October 18, the Financial Services Commission (the "FSC") announced plans to improve the designated auditor system under the Act on External Audit of Stock Companies, Etc. (the "External Audit Act").

Pursuant to Article 11 (2) of the External Audit Act and Article 15 of the Enforcement Decree of the External Audit Act, which took effect as of October 2018, if any of the following companies appoints an external auditor for six consecutive fiscal years pursuant to Article 10 (1) of the External Audit Act, the Securities and Futures Commission (the "Commission") may request that the company appoint an accounting firm designated by the Commission in accordance with the standards and procedures prescribed by the Presidential Decree.

1. Stock-listed companies (excluding companies listed on the KONEX market)

2. A company whose total assets are at least KRW 100 billion and at least 50% of the total number of issued and outstanding shares (excluding non-voting shares) are held by a large shareholder and his/her specially-related persons under Article 43 (8) of the Enforcement Decree of the Corporate Tax Act, and whose representative director is the large shareholder or his/her specially-related person

Article 8 of the Addenda to the External Audit Act provides that the amended provisions of Article 11 (2) of the External Audit Act shall apply from the business year that begins after the first anniversary of the effective date of the External Audit Act.  In such case, the calculation of six consecutive business years shall include the business years before the first application of the amended provisions of Article 11 (2).

According to the above regulation, half of all listed companies are expected to be designated with external auditors this year.  As the supervisory authority designates the external auditor, there are matters to be noted with respect to the execution of the auditor appointment agreement with the company after the designation by the Commission and consultation with the external auditor during the external audit process, which would not be an issue with an external auditor appointed by a company itself.  In this regard, the key contents of the press release announced to improve the designated external auditor system are as follows:

1.   Establishment of Best Practice Guidelines for Designated Audits

The FSC has announced the "Best Practice Guidelines for Designated Audits" covering the supervision on designated audits.

The key contents of the Best Practice Guidelines for Designated Audits are as follows:

1. Mandatory consultation between designated auditors and companies regarding audit engagement-related matters such as audit personnel, time and remuneration; and mandatory composition of an audit team in consideration of the characteristics of the company

2. Restrictions on acts, such as making unreasonable information requests or third party certification, by abusing the status of a designated auditor

3. Stipulation of the requirements for the designated auditor's request for digital forensics (investigation of accounting fraud)

4. Specific procedures for resolving disagreements between the respective auditors for the financial statements of the previous and current fiscal years

5. Clarification of regulations prohibiting external auditors from supporting the preparation of financial statements

2.   Clarification of Legal Nature of Standard Audit Hours

Article 16-2 (1) of the External Audit Act prescribes that the Korean Institute of Certified Public Accountants may determine the standard audit hours to be spent by an auditor to improve the quality of audit and to protect stakeholders of the company, including investors.  The FSC announced its plan to issue a clear authoritative ruling on the legal nature of the standard audit hours and the reason for designating the auditor.  In addition, the FSC explained that there was a misunderstanding that if the audit hours fell short of the standard audit hours, an accounting firm would be subject to disciplinary action by the Korean Institute of Certified Public Accountants and that an auditor would be newly designated to the company.  Instead, sanctions would be imposed only if audit hours were unreasonably low compared to that of other companies or the audit of the previous year for the company.

The Best Practice Guidelines for Designated Audits also stipulate “the designated auditor (candidate) shall consider the standard audit hours to calculate the audit hours to be applied to the company, but shall not propose the audit hours to the company based solely on the standard audit hours.”
 

In consideration of the growing controversy over companies and external auditors as the number of companies subject to the designation of auditor continues to increase after the implementation of the periodic auditor designation system, this improvement plan is noteworthy in that it prepares integrated guidelines on the performance of audit work by designated auditors and clarifies the legal nature of the standard audit hours.  In addition, the amendment includes improvement of the dispute resolution system through the council for settlement of disagreement between the respective auditors for the previous year and the current year if the former auditor and the current auditor disagree on the financial statements for the previous year.  Please note the details of the final version of the Best Practice Guidelines for Designated Audits and the authoritative ruling by the FSC on the legal nature of “standard audit hours” and the reason for designating an auditor are to be confirmed. 

[Korean version]