Committee of Experts on regulating audit firms & net- works report: A discussion

Committee of Experts on regulating audit firms and net- works set up by Ministry of Corporate Affairs in response to the issues raised by the Honorable Supreme Court in the judgement of S.Sukumar Vs. Institute of Chartered Accountants of India (February 23, 2018) submitted its report on October 25, 2018. It deals with steps to be taken to strengthen the legal regime of auditors and promote audit as a profession. I am here through this article to express my views on audit profession in India with my vast decades of combined audit experience in India as well as U.S.A.

Committee of Experts on regulating audit firms and net- works report and its consequences

Complete copy of the report was published by Taxguru.in by its article dated 10^th November, 2018 and no attempt will be made to explain its detailed features. Any one can easily read the same for detailed analysis.

In a simpleton’s view, auditor was created to deal with the sudden and monumental failure of stock crash in 1939 in U.S.A. by the federal government to give reassurance to all stake holders like investors, suppliers, federal/state authorities dealing with regulatory functions and even to the principal who was raising capital, applied for loan facilities from banks and other creditors. Essentially, the auditor was heavily relied upon for the financial truth of the accounts which were not prepared by him. He clearly stated in his report that the books of accounts and other papers were supplied by M/S——— and were relied upon him to give his opinion. Yes, similar developments in U.K, Europe or Asia set the tone for evolving audit profession and its supervision.

Committee of Experts (COE) deals with market failures which have arisen even after having the accounts of customers duly audited by authorized auditors who were licensed by regulatory authorities.

 Legal regimes all over the world have developed a range of tools to deal with market failures.

 These legal tools could be broadly classified under the following six categories:

1. 1. Qualification and disqualification requirements: The law could lay down specific qualification requirements for acting as a statutory auditor. It could also disqualify persons from acting as auditor of a particular company for under taking additional duties which may interfere his role as auditor on grounds of conflict of interest. Such a policy may prevent auditors from providing certain non-audit services to audit clients.
2. Disclosure obligations: The law could impose various disclosure obligations on auditors. Such norms could help reveal the conflict of interest that the auditors may face, the sources of funds they receive, and the methodology behind their recommendations. Detailed information on fees earned would throw light on deeper bonds between the auditor and his client.
3. Management of conflict: The law could incorporate rules to mitigate the conflict of interest faced by auditors. The vested interests in the company are the Board, and the professional managers whose role contributes towards the final results. The role of independent directors to become part of audit committee and the real independence earned by audit committee towards the accounts department would form the basis for fair functioning of the company.
4. Regulatory oversight: The law could also enhance the regulatory oversight on auditors, making them more accountable to the principal – the shareholders – and other stakeholders of financial statements of the auditee company.
5. Auditors’ power: The law could increase the power that auditors wield against the audited company, thereby making audit decisions are based on truth. Restriction on fees earned by auditors would enable them to enlarge their clients and their independence as auditors.
6. Liability risk: The law could increase the liability risk of auditors, over and above their reputation risk. This could be achieved by allowing parties who rely on the audited accounts and reports to impose civil liability (damages) on negligent auditors. For instance, the law could increase the litigation risk that auditors could face for negligence. Similarly, criminal liability could be imposed on auditors for false statements in audit reports. Recent arrests of Chartered Accountants in fraud cases or NPAs of delinquent borrowers were some indication of this argument.

The report has shown the development of supervision over an auditor in India over a period of time.

I am quoting directly the following from the report. My observations on these developments would be given at the end.

Year, Developments.

2002 High Level Committee on Corporate Audit and Governance

 2003 ICAI Study Group Report

 2007 Constitution of Quality Review Board (QRB), changes in disciplinary proceedings

 2009 Satyam financial fraud CII Task Force on Corporate Governance

 2010 Parliamentary Standing Committee on Finance on Companies Bill, 2009

 2011 ICAI Study Group Report on operations of MAF

 2013 Notification of Companies Act, 2013

2016 Company Law Committee recommends constitution of NFRA

 2017 Report of MCA’s Expert Group on Audit Firms

 2018 Securities and Exchange Board of India (SEBI) passes order against Price Waterhouse (PW) Supreme Court judgment in S.Sukumar v The Secretary, ICAI

 Cabinet approval on setting up NFRA

My observations

It took the journey from 2003 to 2018 to implement NFRA by setting up the agency and prepare its constitution. Even now one hears rumbling of ICAI about passing on information to NFRA for its enquiry.

One would like to know whether ICAI is so supreme that it would take for ever to investigate the working of Chartered Accountants working under various functions like licensing, renewal of licenses, providing Continuous Professional Education and initiate disciplinary proceedings against errant members. One would like to know whether obtaining a membership is the end of the professional career and whether a member may collide with borrowers, bankers, anti- social elements or in some cases against anti national elements and work against the basic ethics on which the profession of auditing was formed. Can he corrupt or help fraudsters by using his powers as auditor?

Does the institute take steps to strictly implement peer review of the audit of firms? I do hope, with the separation of big firms from ICAI, it would concentrate on disposing of pending disciplinary cases against its members. Some of the members are not treating its trainees as per the rules and do not even pay the stipends on time.

I have heard cases of trainees facing enormous difficulties in finding the firms to train them, work as mentors or give assignments to learn the rudiments of auditing, taxation or other accounting functions. If a complaint is lodged today against any firm, can ICAI indicate the time frame for its completion?

Do the members have a fear of ICAI for non- cooperation, feeling of punishment which may land up to even cancellation or suspension of licenses or other punishments for activities prohibited by ICAI rules?

One is aware of the poor payments by Public Sector Banks which are inadequate to even pay the trainee CAs to undertake the work of concurrent auditor functions or other types of audits. Recent actions initiated against CA firms for having failed to identify the NPAs provision on timely basis in Statutory audits speak by themselves the irrelevant function of Statutory audits and the way they are conducted.

Now to speak of the audit of big companies by reputed big 4 or other firms, the recent  frauds committed on investors, statutory authorities, suppliers or any stake holder of big companies lead us to believe that time has arisen to get NFRA activated and take timely action against giant firms whether located in India or getting their powers from foreign connections who indulgently non-implement the established rules and regulations based on Companies Act, 2013 , instructions issued by ICAI or other statutory organizations.

Can a big 4 audit firm not even verify the cash kept in companies at various places or even verify the fixed deposits kept with themselves or placed with banks at least on real time basis?

I was once talking to some auditors who were leaders in the profession and threw light on the modus operandi in Satyam fraud and the failed audit in that account. I learnt that even total duplicate accounting system was maintained to cheat every one. Recent fraud cases in leading nationalized banks with Nirav Modi and other notorious accounts also indicated that letters issued outside the banking systems were the culprits and bank managers were misled by the letters produced by borrowers.

Have the forensic experts, audit gurus or financial wizards enabled the concerned agencies like ICAI, RBI, banking sector or very big (too big to fail) companies or other financial companies to develop even academic papers which could have been circulated among all to arrive at some solution.

Conclusion  

I am finding many regulatory agencies like SEBI, RBI, NFRA, regulatory agencies in insurance, financial services or state governments/central government initiating necessary steps to save all stake holders whose definition does include themselves also.

Senior honest retired bankers/senior retired officials from regulatory agencies, highly respected lawyers, academicians or bureaucrats who have done yeoman service to the nation must visit or be invited by educational institutions to deliver lectures and involve the young to learn the values of ethics and the real benefit of following ethics which was defined as gaining an internal happiness and also doing a good thing as once explained by our former Honorable Prime Minister Morarji Desai, a symbol of Indian purity and emblem of honesty in real life.

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 Reference

1. Original report from MCA website

https://taxguru.in/wp-content/uploads/2018/10/COE-Report-on-regulating-Audit-firms-and-Network.pdf

2. Tax guru article dated 10^th November, 2018

https://taxguru.in/chartered-accountant/strengthen-operation-nfra-committee-experts-regulating-audit-firms.html