The chill in the air that's giving auditors the shivers
A series of events has created unprecedented pressure on the audit profession, resulting in a spate of resignations. But it could change corporate governance for the better.
N Sundaresha Subramanian
18 Jun 2018
THE UDAY KOTAK COMMITTEE'S RECOMMENDATIONS, LIKELY TO TAKE EFFECT IN FY19, DEMAND GREATER TRANSPARENCY FROM AUDITORS;
April to June is the time of the year when people in the audit profession burn the midnight oil. These three months keep them extremely busy as annual accounts are finalised, audit reports get written, and company executives prepare for annual general meetings. But this year, the script has changed — auditors are busy running away from the companies they audited.
While a couple of resignations at troubled companies such as Vakrangee and Manpasand Beverages made headlines, there are several others that remained unreported.
According to data from Prime Database, of the 30-odd instances this year of auditors quitting companies, as many as 25 happened in April and May.
Among the big names, auditors from Price Waterhouse (PW) and its affiliates resigned from Vakrangee, Atlanta, and Edelweiss Financial; Deloitte auditors resigned from Manpasand; Sharp & Tannan quit Smart Link Holdings; and Chaturvedi & Shah exited from CG Power.
Several auditor resignations have been reported earlier, but the frequency and the timing this year have unnerved investors. Resigning right before the finalisation of annual accounts, citing little or no reason, has raised concerns for regulators too.
SN Ananthasubramanian, a senior company secretary, whose firm has been a secretarial auditor for several large listed firms, says, "In the case of Vakrangee and Manpasand, the circumstances leading to their resignations do point to many concerns. While resignation per se is the last viable option for the auditors to express themselves, they should have been more explicit in their communication by stating the reasons with better clarity."
Since the board of directors appoints auditors on the recommendation of the audit committee, outgoing auditors are expected to reveal reasons leading to their resignation to the latter. The reason could be unanswered queries, unsatisfactory clarifications, lack of the top management’s attention to the exercise, etc.
The audit committee and the independent directors are expected to exercise their judgement on the matter before they send their recommendation to the board. Recent resignations show the company and auditors differed on the reasons attributed.
Sadly, we are in an era where we need every legislative intent to be reduced to writing for compliance.SN Ananthasubramanian, senior company secretary
Experts say resignation is the culmination of a dissatisfactory or inadequate process in the course of performance of statutory duties by an auditor and should only be resorted to in the most unavoidable situations.
Among the recent cases, Inox Wind is considered bizarre, as the auditor resigned saying it had taken on too many assignments.
Ethical behaviour demands the auditor should not have accepted fresh assignments till the existing ones were completed.
"Sadly, we are in an era where we need every legislative intent to be reduced to writing for compliance," says Ananthasubramanian.
Company insiders and experts feel that while there could be varied reasons for the resignations, a series of events over the past few months has steadily built up the pressure on the profession, and these resignations are just sings of what is happening below the surface.
Tarun Bhatia, managing director of corporate investigation and risk consultancy Kroll, says, "Generally, there is more scrutiny [of the profession]. Auditors are reviewing their portfolio as they are expecting tougher norms being put in place."
ET Prime dug a little deeper and found seven issues that have got the first-level watchkeepers of India Inc shivering.
1. Prime minister’s call for an honest business culture: On October 4, 2017, Narendra Modi delivered a long speech at the golden jubilee celebrations of the Institute of Company Secretaries of India (ICSI).
At the event, held at the national capital’s Vigyan Bhavan, Modi said corruption and black money were the bane of the nation and underlined the issue of shell companies, which were used to subvert the objectives of the November 2016 note ban.
The prime minister asked whether, by 2022, ICSI could achieve the following:
Take responsibility for making the country a high tax-compliant society
Ensure that there won’t be a single shell company in the country
Ensure that every company in the country will honestly pay taxes
Establish an honest business culture in the country by expanding the scope of ICSI’s guidance.
For audit professionals (many company secretaries are chartered accountants, too), already shaken by the raids and arrests that followed the crackdown on shell companies after the note ban, the message was loud and clear — any kind of irregularity or corruption would be met with an iron fist.
2. The PW verdict by Sebi: After a nine-year wait, market regulator Sebi on January 10 passed an order against PW in the Satyam scam.
The argument that the PW entities are a 'network' of audit firms in India and do not operate as a corporate multinational or a global partnership or a single firm did not hold water.
Sebi said that having taken into account all the factors relating to the manner in which various firms in India get registered with the Institute of Chartered Accountants of India (ICAI) showing the name PWC (bearing different registration numbers) and the nebulous way in which they are present in various parts of the country, it is difficult not to take note of the loss of faith of the investors in the brand name.
The entire network was banned from a gamut of activities under the sphere of Sebi for two years.
Though the network has challenged the order in the Securities Appellate Tribunal, its business hangs by a thread following a temporary relief.
3. Auditor rotation: The new companies act, which became law in 2013 and came into effect from April 1, 2014, gave listed companies a three-year deadline to rotate their auditors.
Under this provision, auditors who had completed two consecutive terms with a particular company had to be rotated out.
Most rotations happened in the last fiscal. The Big Four’s scamper for market share resulted in aggressive acquisition of new accounts.
JN Gupta, managing director, Stakeholders' Empowerment Services (SES), says, "Rotation has broken many relationships that continued between the auditors and their listed clients for decades. The new auditor is not going to blindly accept the practices it is not comfortable with, and it is not obliged to give a favourable opinion. In the long run, this will make the audit process more independent and transparent."
Dhruv Phophalia, managing director at professional services firm Alvarez & Marsal, says, "As a consequence of the auditor rotation programme, new auditors are independently assessing the information provided by the management. Information previously provided may not be satisfactory for the new auditors, as a result of which they may choose to withdraw from the audit."
According to Prime Database, Vakrangee was one of the few hundreds of firms that rotated their auditor last year.
Rotation has broken many relationships that continued between the auditors and their listed clients for decades.JN Gupta, managing director, SES
4. Forensic audits under insolvency proceedings: Earlier, if a company was unable to repay the loans, it would have gone into corporate debt restructuring or CDR. Under the CDR phase, the auditors would make the restructuring plans.
But things have changed under the Insolvency and Bankruptcy Code (IBC). Restructuring plans are being made by an independent quasi-judiciary authority called the resolution professional (RP). The promoters are losing control, and often the RP is asking, 'Who validated these financial numbers?'
"Auditors may also be taking a harder look and asking more questions to companies that are financially stressed. The introduction of IBC enables an independent search for undervalued transactions, preferences, and other avoidance actions.
"Any significant undervalued transfer of assets or other avoidance transaction or fraud may have a big impact on the numbers and disclosures in the audited financial statements.
"Auditors may be reluctant to sign off on financial statements where the information or explanations from the management are not satisfactory,” says Phophalia of Alvarez & Marsal.
Also, once the National Company Law Tribunal (NCLT) process matures, there will be a derivative impact on auditors of companies that have come under IBC proceedings.
In several NCLT cases, forensic audits initiated by RPs have unearthed irregularities. Jaypee Infratech and Binani Industries are recent examples. In Jaypee, the NCLT has ordered reversal of certain related-party deals.
5. Kotak committee recommendations: The Uday Kotak Committee formed by the Sebi looked into reframing the corporate governance norms for listed companies.
It recommended that auditors have to clearly state specific reasons for not completing audits and must take approval of the audit committee before resignation.
"Auditors are critical gatekeepers of corporate-governance standards. Their role in ensuring that the financial statements of the entity provide a true and fair view of the affairs of the entity makes them critical to the corporate governance agenda.
"The resignation of an auditor before the expiry of the term may be a cause for concern. For the sake of greater transparency, the committee believes that it is important for companies to disclose the reasons for the resignation of its audit firm.
"Moreover, audit firms too must be encouraged to truthfully disclose the reasons for their resignation as audit firms must see this disclosure as part of their fiduciary responsibility towards the shareholders," the Kotak Committee’s report stated.
The recommendations were cleared by the regulator and are likely to take effect from FY19.
"If these are implemented next year, then you have to be cautious from now," says SES’s Gupta, who was part of the committee.
6. National Financial Reporting Authority: The National Financial Reporting Authority (NFRA) is an independent body proposed under the companies Act for regulation of audit profession.
The existing framework of ICAI was found to be inadequate as processes of disciplinary actions were found to be very time consuming and penalties were meagre.
Critics say ICAI functions more like a political body than a regulatory institution. Not surprisingly, the NFRA move had been long resisted by ICAI, which had wanted the existing arrangement to continue.
However, following the breakout of the Nirav Modi scam in February, the Union Cabinet cleared the formation of NFRA, which will comprise people from outside the profession such as law and finance.
Once this body becomes operational, chartered accountants (CAs) won’t have the luxury of their own ilk watching their back.
The NFRA will have significant powers to impose financial penalties, which could go up to 10 times the fees earned by the firms and debarment up to 10 years. It will have significant power to initiate investigations, summon people, and ask for records.
7. Supreme Court directive: A public interest litigation had raised the issue of multinational accounting firms (MAFs) operating in India in violation of law and various irregularities in the way the profession has organised itself through the network model.
"The MAFs are illegally operating in India and providing accounting, auditing, book-keeping, and taxation services," the petition alleged, adding, "It was noted that the bodies corporates formed for management consultancy services were being used as a vehicle for procuring professional work for sister firms of CAs.
"Members of ICAI were associating with such bodies as directors, managers, etc., to provide an escape route to MAFs. CA functions must be discharged by animate persons and not inanimate bodies."
Investigations by various bodies into the affairs of PW were also part of the PIL.
While the ICAI explained its structure and functions before the court, a report by an expert group formed by the Ministry of Corporate Affairs was also submitted before the court.
The group found that the MAFs were not operating directly, but there was nothing wrong in the way they were organised: "This is a standard practice across jurisdictions. It does not make MAFs subject to the control by the global parent. MAFs cannot be considered as multinational entities as there is no foreign control through ownership or management. Network partners are run, controlled, and managed by Indian nationals."
In its judgement in February, the Supreme Court bench of AK Goel and UU Lalit directed the government to form a three-member committee to look into "whether and to what extent the statutory framework to enforce the letter and spirit of Sections 25 and 29 of the CA Act and the statutory Code of Conduct for the CAs requires revisit so as to appropriately discipline and regulate MAFs."
It also wanted to examine the possibility of an independent regulator, which to some extent has been addressed by the NFRA announcement.
A policy expert close to the affairs of the committee says, "The government has already formed the committee. The mandate of the committee is very broad and it will study every aspect of the profession before giving its final recommendations."
What next?
The government committee was to be formed within two months of the order and it was to submit its recommendations by the end of the third month.
The deadline will end in July. Separately the ICAI council has also has set up its own panel to submit its comments on the issues raised by the Supreme Court. An e-mail seeking comments from ICAI did not elicit any response.
Some suggest strict regimes such as in the US can make things better. "The financial losses of non-compliance or bad practices in the developed markets such as the US are severe. Such losses may include large fines and penalties by regulators or class-action law suits by stakeholders.
"Strong regulatory enforcement and financial penalties can be a huge deterrent for non-compliance and bad behaviour," says Phophalia of Alvarez & Marsal.
In fact, the Supreme Court bench had asked the government committee to consider the need for appropriate legislation in line with the Sarbanes Oxley Act, 2002, and the Dodd Frank Wall Street Reform and Consumer Protection Act, 2010, of the US.
"Auditors are the first gatekeepers of governance. But, they have not been as honest as they should be. What is happening now is a combination of many different factors at play. Once things get better here, other institutions such as independent directors will also follow suit over the next two three years," said Gupta of SES.
Sweeping change seems to be on the anvil. When it comes, the recent auditor resignations will perhaps be seen as the harbinger of the change itself.
(Clarification: The story has been updated with a correction in a quote by the Alvarez & Marsal spokesperson.)
(With inputs from Priyanka Salve)
A series of events has created unprecedented pressure on the audit profession, resulting in a spate of resignations. But it could change corporate governance for the better.
N Sundaresha Subramanian
18 Jun 2018
THE UDAY KOTAK COMMITTEE'S RECOMMENDATIONS, LIKELY TO TAKE EFFECT IN FY19, DEMAND GREATER TRANSPARENCY FROM AUDITORS;
April to June is the time of the year when people in the audit profession burn the midnight oil. These three months keep them extremely busy as annual accounts are finalised, audit reports get written, and company executives prepare for annual general meetings. But this year, the script has changed — auditors are busy running away from the companies they audited.
While a couple of resignations at troubled companies such as Vakrangee and Manpasand Beverages made headlines, there are several others that remained unreported.
According to data from Prime Database, of the 30-odd instances this year of auditors quitting companies, as many as 25 happened in April and May.
Among the big names, auditors from Price Waterhouse (PW) and its affiliates resigned from Vakrangee, Atlanta, and Edelweiss Financial; Deloitte auditors resigned from Manpasand; Sharp & Tannan quit Smart Link Holdings; and Chaturvedi & Shah exited from CG Power.
Several auditor resignations have been reported earlier, but the frequency and the timing this year have unnerved investors. Resigning right before the finalisation of annual accounts, citing little or no reason, has raised concerns for regulators too.
SN Ananthasubramanian, a senior company secretary, whose firm has been a secretarial auditor for several large listed firms, says, "In the case of Vakrangee and Manpasand, the circumstances leading to their resignations do point to many concerns. While resignation per se is the last viable option for the auditors to express themselves, they should have been more explicit in their communication by stating the reasons with better clarity."
Since the board of directors appoints auditors on the recommendation of the audit committee, outgoing auditors are expected to reveal reasons leading to their resignation to the latter. The reason could be unanswered queries, unsatisfactory clarifications, lack of the top management’s attention to the exercise, etc.
The audit committee and the independent directors are expected to exercise their judgement on the matter before they send their recommendation to the board. Recent resignations show the company and auditors differed on the reasons attributed.
Sadly, we are in an era where we need every legislative intent to be reduced to writing for compliance.SN Ananthasubramanian, senior company secretary
Experts say resignation is the culmination of a dissatisfactory or inadequate process in the course of performance of statutory duties by an auditor and should only be resorted to in the most unavoidable situations.
Among the recent cases, Inox Wind is considered bizarre, as the auditor resigned saying it had taken on too many assignments.
Ethical behaviour demands the auditor should not have accepted fresh assignments till the existing ones were completed.
"Sadly, we are in an era where we need every legislative intent to be reduced to writing for compliance," says Ananthasubramanian.
Company insiders and experts feel that while there could be varied reasons for the resignations, a series of events over the past few months has steadily built up the pressure on the profession, and these resignations are just sings of what is happening below the surface.
Tarun Bhatia, managing director of corporate investigation and risk consultancy Kroll, says, "Generally, there is more scrutiny [of the profession]. Auditors are reviewing their portfolio as they are expecting tougher norms being put in place."
ET Prime dug a little deeper and found seven issues that have got the first-level watchkeepers of India Inc shivering.
1. Prime minister’s call for an honest business culture: On October 4, 2017, Narendra Modi delivered a long speech at the golden jubilee celebrations of the Institute of Company Secretaries of India (ICSI).
At the event, held at the national capital’s Vigyan Bhavan, Modi said corruption and black money were the bane of the nation and underlined the issue of shell companies, which were used to subvert the objectives of the November 2016 note ban.
The prime minister asked whether, by 2022, ICSI could achieve the following:
Take responsibility for making the country a high tax-compliant society
Ensure that there won’t be a single shell company in the country
Ensure that every company in the country will honestly pay taxes
Establish an honest business culture in the country by expanding the scope of ICSI’s guidance.
For audit professionals (many company secretaries are chartered accountants, too), already shaken by the raids and arrests that followed the crackdown on shell companies after the note ban, the message was loud and clear — any kind of irregularity or corruption would be met with an iron fist.
2. The PW verdict by Sebi: After a nine-year wait, market regulator Sebi on January 10 passed an order against PW in the Satyam scam.
The argument that the PW entities are a 'network' of audit firms in India and do not operate as a corporate multinational or a global partnership or a single firm did not hold water.
Sebi said that having taken into account all the factors relating to the manner in which various firms in India get registered with the Institute of Chartered Accountants of India (ICAI) showing the name PWC (bearing different registration numbers) and the nebulous way in which they are present in various parts of the country, it is difficult not to take note of the loss of faith of the investors in the brand name.
The entire network was banned from a gamut of activities under the sphere of Sebi for two years.
Though the network has challenged the order in the Securities Appellate Tribunal, its business hangs by a thread following a temporary relief.
3. Auditor rotation: The new companies act, which became law in 2013 and came into effect from April 1, 2014, gave listed companies a three-year deadline to rotate their auditors.
Under this provision, auditors who had completed two consecutive terms with a particular company had to be rotated out.
Most rotations happened in the last fiscal. The Big Four’s scamper for market share resulted in aggressive acquisition of new accounts.
JN Gupta, managing director, Stakeholders' Empowerment Services (SES), says, "Rotation has broken many relationships that continued between the auditors and their listed clients for decades. The new auditor is not going to blindly accept the practices it is not comfortable with, and it is not obliged to give a favourable opinion. In the long run, this will make the audit process more independent and transparent."
Dhruv Phophalia, managing director at professional services firm Alvarez & Marsal, says, "As a consequence of the auditor rotation programme, new auditors are independently assessing the information provided by the management. Information previously provided may not be satisfactory for the new auditors, as a result of which they may choose to withdraw from the audit."
According to Prime Database, Vakrangee was one of the few hundreds of firms that rotated their auditor last year.
Rotation has broken many relationships that continued between the auditors and their listed clients for decades.JN Gupta, managing director, SES
4. Forensic audits under insolvency proceedings: Earlier, if a company was unable to repay the loans, it would have gone into corporate debt restructuring or CDR. Under the CDR phase, the auditors would make the restructuring plans.
But things have changed under the Insolvency and Bankruptcy Code (IBC). Restructuring plans are being made by an independent quasi-judiciary authority called the resolution professional (RP). The promoters are losing control, and often the RP is asking, 'Who validated these financial numbers?'
"Auditors may also be taking a harder look and asking more questions to companies that are financially stressed. The introduction of IBC enables an independent search for undervalued transactions, preferences, and other avoidance actions.
"Any significant undervalued transfer of assets or other avoidance transaction or fraud may have a big impact on the numbers and disclosures in the audited financial statements.
"Auditors may be reluctant to sign off on financial statements where the information or explanations from the management are not satisfactory,” says Phophalia of Alvarez & Marsal.
Also, once the National Company Law Tribunal (NCLT) process matures, there will be a derivative impact on auditors of companies that have come under IBC proceedings.
In several NCLT cases, forensic audits initiated by RPs have unearthed irregularities. Jaypee Infratech and Binani Industries are recent examples. In Jaypee, the NCLT has ordered reversal of certain related-party deals.
5. Kotak committee recommendations: The Uday Kotak Committee formed by the Sebi looked into reframing the corporate governance norms for listed companies.
It recommended that auditors have to clearly state specific reasons for not completing audits and must take approval of the audit committee before resignation.
"Auditors are critical gatekeepers of corporate-governance standards. Their role in ensuring that the financial statements of the entity provide a true and fair view of the affairs of the entity makes them critical to the corporate governance agenda.
"The resignation of an auditor before the expiry of the term may be a cause for concern. For the sake of greater transparency, the committee believes that it is important for companies to disclose the reasons for the resignation of its audit firm.
"Moreover, audit firms too must be encouraged to truthfully disclose the reasons for their resignation as audit firms must see this disclosure as part of their fiduciary responsibility towards the shareholders," the Kotak Committee’s report stated.
The recommendations were cleared by the regulator and are likely to take effect from FY19.
"If these are implemented next year, then you have to be cautious from now," says SES’s Gupta, who was part of the committee.
6. National Financial Reporting Authority: The National Financial Reporting Authority (NFRA) is an independent body proposed under the companies Act for regulation of audit profession.
The existing framework of ICAI was found to be inadequate as processes of disciplinary actions were found to be very time consuming and penalties were meagre.
Critics say ICAI functions more like a political body than a regulatory institution. Not surprisingly, the NFRA move had been long resisted by ICAI, which had wanted the existing arrangement to continue.
However, following the breakout of the Nirav Modi scam in February, the Union Cabinet cleared the formation of NFRA, which will comprise people from outside the profession such as law and finance.
Once this body becomes operational, chartered accountants (CAs) won’t have the luxury of their own ilk watching their back.
The NFRA will have significant powers to impose financial penalties, which could go up to 10 times the fees earned by the firms and debarment up to 10 years. It will have significant power to initiate investigations, summon people, and ask for records.
7. Supreme Court directive: A public interest litigation had raised the issue of multinational accounting firms (MAFs) operating in India in violation of law and various irregularities in the way the profession has organised itself through the network model.
"The MAFs are illegally operating in India and providing accounting, auditing, book-keeping, and taxation services," the petition alleged, adding, "It was noted that the bodies corporates formed for management consultancy services were being used as a vehicle for procuring professional work for sister firms of CAs.
"Members of ICAI were associating with such bodies as directors, managers, etc., to provide an escape route to MAFs. CA functions must be discharged by animate persons and not inanimate bodies."
Investigations by various bodies into the affairs of PW were also part of the PIL.
While the ICAI explained its structure and functions before the court, a report by an expert group formed by the Ministry of Corporate Affairs was also submitted before the court.
The group found that the MAFs were not operating directly, but there was nothing wrong in the way they were organised: "This is a standard practice across jurisdictions. It does not make MAFs subject to the control by the global parent. MAFs cannot be considered as multinational entities as there is no foreign control through ownership or management. Network partners are run, controlled, and managed by Indian nationals."
In its judgement in February, the Supreme Court bench of AK Goel and UU Lalit directed the government to form a three-member committee to look into "whether and to what extent the statutory framework to enforce the letter and spirit of Sections 25 and 29 of the CA Act and the statutory Code of Conduct for the CAs requires revisit so as to appropriately discipline and regulate MAFs."
It also wanted to examine the possibility of an independent regulator, which to some extent has been addressed by the NFRA announcement.
A policy expert close to the affairs of the committee says, "The government has already formed the committee. The mandate of the committee is very broad and it will study every aspect of the profession before giving its final recommendations."
What next?
The government committee was to be formed within two months of the order and it was to submit its recommendations by the end of the third month.
The deadline will end in July. Separately the ICAI council has also has set up its own panel to submit its comments on the issues raised by the Supreme Court. An e-mail seeking comments from ICAI did not elicit any response.
Some suggest strict regimes such as in the US can make things better. "The financial losses of non-compliance or bad practices in the developed markets such as the US are severe. Such losses may include large fines and penalties by regulators or class-action law suits by stakeholders.
"Strong regulatory enforcement and financial penalties can be a huge deterrent for non-compliance and bad behaviour," says Phophalia of Alvarez & Marsal.
In fact, the Supreme Court bench had asked the government committee to consider the need for appropriate legislation in line with the Sarbanes Oxley Act, 2002, and the Dodd Frank Wall Street Reform and Consumer Protection Act, 2010, of the US.
"Auditors are the first gatekeepers of governance. But, they have not been as honest as they should be. What is happening now is a combination of many different factors at play. Once things get better here, other institutions such as independent directors will also follow suit over the next two three years," said Gupta of SES.
Sweeping change seems to be on the anvil. When it comes, the recent auditor resignations will perhaps be seen as the harbinger of the change itself.
(Clarification: The story has been updated with a correction in a quote by the Alvarez & Marsal spokesperson.)
(With inputs from Priyanka Salve)
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