INDEPENDENT AUDIT REQUIREMENTS UNDER TURKISH LAW

INDEPENDENT AUDIT REQUIREMENTS UNDER TURKISH LAW AND POSSIBLE SANCTIONS IN CONNECTION WITH THE FAILURE TO FULFILL THESE REQUIREMENTS

I. Independent Audit

Independent audit is a generally accepted method to provide reasonable assurance with respect to the compliance and accuracy of the annual financial statements and other financial information of the companies. Further, it refers to the application of all necessary independent audit techniques prescribed in the independent auditing standards, auditing books, records and documents, evaluating and submitting to a report.

Independent audit is an indispensable necessity for today's companies as it is the only possible way of obtaining transparent, clear and understandable information. Independent auditing is a fundamental tool to provide accurate and reliable information both to the company management, shareholders, employees, lenders, investors and also regulatory institutions and organizations such as Banking Regulation and Supervision Agency, Capital Markets Board of Turkey etc.

Independent audit aims to provide benefit to both the audited company, the public and also the State. It provides accurate information flow to management; helps the management make predictions and analysis regarding financial statements and make sound decisions for the future; shows whether the financial statements reflect the actual data or not; helps business management and employees avoid fraudulent acts. With independent audit, it becomes easier for the companies to find low-cost financing with independently audited financial statements and the rights of all shareholders are well protected.

II. Applicable Laws and Regulations

Independent audit is regulated under the Articles 397 to 406 of the Turkish Commercial Code No. 6102 (“TCC”).  Under Article 397 of the TCC, it is stated that financial statements of joint stock companies and group of companies subject to audit are audited by the auditor in accordance with Turkish Auditing Standards, which are compatible with international auditing standards published by the Public Oversight, Accounting and Auditing Standards Authority to determine whether the financial information included in the annual activity report of the board of directors is consistent with the audited financial statements and whether it reflects the truth. It is also stated that companies subject to audit must clearly state whether their prepared financial statements have been audited and, if so, include the auditor's opinion in the title of the relevant financial statement. This provision also applies to the annual activity report of the board of directors. Although subject to audit, financial statements, and the annual activity report of the board of directors that have not been audited are considered non-existent. Further, under Article 397, sub-paragraph 6 of the TCC, financial statements and annual activity report of the board of directors of those which are subject to audit within the scope of the fifth paragraph but have not been audited, are deemed to be considered void. These provisions are also applicable to the limited liability companies by way of analogy.

Article 398 explains the purpose and scope of the audit as

“Audit of the financial statements of the company and the group and the annual activity report of the board of directors is the audit of inventory, accounting and internal audit to the extent stipulated by Turkish Auditing Standards, the reports given in accordance with Article 378 within the meaning of the provisions of this Chapter and the annual activity report of the board of directors within the framework of the first paragraph of Article 397. This audit also includes examining whether Turkish Accounting Standards, the law and the provisions of the articles of association regarding financial statements are complied with. Auditing is carried out carefully and in accordance with the requirements and ethics of the auditing profession, within the context of the principles determined by the Public Oversight, Accounting and Auditing Standards Authority. The audit is carried out in a way to honestly indicate whether the assets and financial situation of the company and the group are reflected in accordance with the fair presentation principle within the meaning of Article 515, and if the truth is not reflected, the reasons must be stated honestly.”

As per Article 399, the auditor is elected by the general assembly of the company and the group auditor is elected by the general assembly of the parent company. The auditor must be elected before the beginning of the fourth month of the fiscal year of the related company, and in any case before the end of the fiscal year in which the auditor will perform the duties. After the election, the board of directors (managers in limited liability companies) registers with the relevant trade registry which auditor it has assigned the audit duty to, without delay, and announces it in the Turkish Trade Registry Gazette and on the website. If the requirement to appoint an auditor is not duly fulfilled, the companies face the risk of litigation. The board of directors, each board member or any shareholder may request the fulfillment of such requirement before the commercial court at the place of the company’s headquarters.

As stated above, the provisions regarding the audit of a joint stock company also apply to a limited liability company. In short, it is envisaged that limited liability companies will be audited by independent auditors who are certified public accountants or sworn-in certified public accountants; and issues regarding the responsibilities of board members in joint stock companies and regulations regarding board of directors’ reports will be applicable for the board of managers in limited liability companies.

III. Legal Entities that are Subject to Independent Audit

Legal entities subject to independent audit in accordance with the TCC, the Presidential Decree on the Determination of Companies Subject to Independent Audit (Decision No. 6434) and Decision on Determination of Companies Subject to Independent Audit no. 2018/11597 dated 26/03/2018 are listed as follow:

i. General criteria for being subject to independent audit:

Companies that exceed the thresholds for at least two of the following three criteria in two consecutive accounting periods, other than the mentioned in the rest of the circular, are subject to independent audit:

• Companies having total assets with the value of 500 million Turkish Liras;

• Companies having annual net sales revenue with the value of 1 billion Turkish Liras;

• Companies employing staff more than 150.

ii. Special criteria for being subject to independent audit:

Companies that are listed in the annex to the relevant decree are directly subject to independent audit without any asset, net sales avenue or employing staff limits.

IV. Legal Consequences of Not Having an Independent Audit Process Carried Out

The general rule regarding the appointment of the independent auditor is that the appointment is made by the general assembly and this is considered among the inalienable powers of the General Assembly of Shareholders in accordance with Article 408/2-c of the TCC.

Companies that are subject to independent auditing but have not been duly audited might face financial and legal consequences as follows:

• Invalidity

As stated in the second paragraph of Article 397 of the TCC, companies that are subject to audit must clearly state whether their prepared financial statements have been audited and, if so, include the auditor's opinion in the title of the relevant financial statement. This provision shall be applied within the annual activity report of the board of directors/managers. Unaudited financial statements, although subject to audit, will be considered null and void, and the board of directors'/managers’ activity report will also be considered as non-existent. In theory, tables of this nature cannot be reviewed by the general assembly and therefore cannot be subject to discussions or be the basis of a proper release. In this situation, the general assembly cannot carry out certain functions, such as distributing profits, increasing, or decreasing the capital.

The board of directos/managers may be held responsible for any loss or damages that may be incurred by the Company. If any loss occurs for this reason, the board of directors/managers that had not fulfilled its obligation to appoint an auditor would be responsible for the said damages.

• Administrative Finse

Regulations within the scope of independent audit include the TCC, Insurance Law, Private Pension Savings and Investment System Law and Capital Markets Law. For companies operating in any regulatory markets, such as insurance or capital markets etc., sanctions are regulated in detail.

Under Article 562 of the TCC, with reference to Article 1524 of the TCC, it is stated that the members of the Board of Directors/Managers that do not fulfill the obligation to create a website stipulated in the said Article will be punished with a judicial fine of 100 days to 300 days. Administrative fines will be imposed on companies that do not fulfill this obligation, as they are required to announce the independent auditor chosen by the company. If the obligation to select and announce an auditor is not fulfilled, a judicial fine of 20-300 TL per day will be imposed in accordance with the aforementioned Article. These fines are subject to change annually.

• Dissolution of the Company

The decision to dissolve may be one of the most severe penalties for companies that do not have an independent audit process carried out. If company shareholders who have not received an independent audit activity report argue that they do not have access to information and that the principle of transparency has been violated, they may request the dissolution of the company because of the violation of the right to information.

As stated under the Article 437 of TCC, financial statements, consolidated financial statements, annual activity report of the board of directors, audit reports and profit distribution proposal of the board of directors shall be made available for review by the shareholders at the headquarters and branches of the company at least fifteen days before the general assembly meeting. Accordingly, shareholders can request the dissolution of the company if and when they are not provided with access to information. In order to avoid any loss as a result of the company management’s not having an independent audit in place, shareholders will be able to request the dissolution of the company, for which the management will be held responsible.