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Who audits the auditors?

Shyamal Majumdar

Warren E Buffet is known for his blunt statements. Three years ago, when he described auditors as those "whose bread I eat, his song I sing," the furious chartered accountant fraternity found many sympathisers.

Buffet, however, stood firm in his opinion that instead of regarding the investing public as their clients, auditors tend to kowtow to managers who choose them and dole out the fees that pay their salaries.

Three years on, many more people are suddenly willing to believe Buffet. The avalanche of America Inc's murky financial deals - led by Enron's $100-billion bankruptcy story and the rather dubious role played by its auditors, Andersen - have ensured that accountancy professionals will have to get used to many more potshots.

The US has, however, acted swiftly to control the damage. A new corporate reform legislation was unveiled last week that sharply increases penalties for fraud and beefs up oversight of accountants - until now a self-regulated profession.

The Bill, expected to be signed by President Bush soon, creates a new oversight board for accounting and has quadrupled jail time for wire and mail fraud, statutes that are often used to prosecute white-collar crimes, to 20 years.

The US's rapid action damage control should encourage the Indian government to shake off its lethargy and take some concerted action.

For, with US auditors facing the heat, their counterparts in India can't be too far behind. Never before in its 50-year history has the Institute of Chartered Accountants of India, the Delhi-based apex body that governs all audit practices in India, come under so much pressure.

What are the options before the government? While the suggestions come thick and fast, the department of company affairs under whom ICAI comes, must take some urgent steps to restore confidence in auditors.

One possible way could be to take a cue from an interesting suggestion made in the US to end the cosy relationship between companies and auditors that Buffet hints at.

To improve audit accountability, the cost of auditing should be borne by the stock exchanges rather than the companies since they (the former) have a larger interest in getting credible numbers from companies.

The government should also revive an earlier proposal to strip ICAI of its regulatory powers and set up a statutory authority comprising members from the RBI, Sebi, the Central Board of Direct Taxes, the Comptroller General of India, and, of course, the ICAI.

The model could be the Financial Reporting Council in the UK which has two subsidiaries - the Accounting Standard Board and the Financial Reporting Review Panel. While the Board issues and withdraws standards, the Panel enforces them and has statutory powers to force companies to correct deviation from accounting standards.

It would be an excellent idea to have corporate members in the statutory body too. Analysts say the ICAI could play the role of the Accounting Standard Board, but the penal powers should be separate as self-regulation hasn't really succeeded in India and several other countries.

ICAI says that the framework governing the regulation of the corporate sector and the auditing profession in the US is very different from the one in India and is, in fact, a "move towards the position that exists in India."

The institute also says it would be able to exercise oversight through a Peer Review Board set up by the institute. The board comprises 11 members, where one of the government nominees on the Council of the ICAI is the chairman of the Board.

In addition, five members on the Board are drawn from the government and regulatory bodies.

Besides, the institute has already suggested several measures to improve corporate governance. These include introduction of a system of joint auditors, fixing the auditor's remuneration, following certain parameters to be stipulated in the Act instead of fixation by the "management" as at present, non-acceptance of qualified audit report by the Registrar of Companies, Sebi and other regulators.

Although ICAI is vehemently opposed to the idea of a separate regulatory body, the numbers are certainly not on its side.

True, India Inc has not witnessed any major accountancy scams - yet - but over the years, the credibility of the numbers dished out by companies has taken a few hard knocks.

On July 12, a Crisil report made the damning disclosure that corporate India is window-dressing its books of accounts through unethical, though legal, accounting practices.

Besides, consider the department of company affairs report to the joint parliamentary committee, which charged as many as 73 companies of funds diversion, deliberate de-subsidiarisation to avoid disclosures and misleading reports on utilisation of funds/cash flows in annual reports and offer documents, inadequate disclosure of information in balance sheets and violation of accounting standards.

"Auditors have a greater responsibility and if they themselves become part of the malaise, the financial checks and balances would collapse," the JPC draft report said.

The reason JPC is upset is the fact that ICAI has failed to complete disciplinary proceedings against 23 of the 27 audit firms who were named by the earlier JPC looking into 1992 scam.

What is more, three of these firms were allowed to function as statutory auditors of various private sector and foreign banks. This, says the draft report, shows a complete lack of urgency and disregard of the promises on the JPC's recommendations by the ICAI and the government.

ICAI officials, however, claim that the institute has the best self-regulatory mechanism in the past 50 years - 1,650 cases have been sent to the high courts and an equal number would have been punished by the institute. On the poor progress of the disciplinary proceedings, the officials say that though the JPC inquiring into the 1992 scam made the observation that ICAI should investigate, none of the regulators bothered to give any information to ICAI till 1998.

The officials also cite inadequate powers as the main stumbling block. For example, the institute doesn't even have the authority to call for an annual report from companies.

Nineteen years back, ICAI had recommended a revamp of the ICAI Act, 1949. That the Act is hopelessly dated is evident from the fact that it prescribes a princely sum of Rs 500 as fine in case of impersonation as a chartered accountant.

ICAI officials say that the government sat on the recommendation for 10 years and wrote back to ICAI in 1993, asking whether the suggestions made in 1983 were still relevant.

ICAI then wrote to the government in early 1994, suggesting some more amendments. Again, the government could not find time to get back to the institute which recently sent a fresh set of recommendations.

The government seems to be suffering from selective bouts of amnesia, officials say.

ICAI has a point. For example, it had suggested that due to the increased membership of the institute and the likelihood of more complaints coming in, it needs to change the way disciplinary committees function.

The institute wanted to set up regional benches, which would take up cases, study them, and give punishments. These benches would also have some outsiders like retired judges on them. The proposal is gathering dust.

DCA has a counter-point. "Given its track record, it's doubtful whether more powers to ICAI would serve any purpose. There are enough legal provisions already to discipline errant auditors and the institute should have been much more aggressive in completing its disciplinary proceedings and refer the cases to DCA."

For example, under Section 62, an auditor can be held liable to compensate every person who subscribes for any shares or debentures of a company on the basis of a prospectus containing an untrue statement made by him as an expert.

And, under Section 543, a court may assess damages against delinquent directors and other officers of the company - including the auditor - if found guilty of neglect of duty or misfeasance so as to cause a loss to the company in any way.

The accusation against ICAI is that it has not been proactive enough in putting its house in order. Rather, some of the standard practices it had adopted gives rise to a perception that it only encourages accountants who may choose to play truant.

Example: one of the standards says "due to the inherent limitations of an audit, there is a possibility that material mis-statements of the financial information resulting from fraud and, to a lesser extent, error may not be detected. The subsequent discovery of material mis-statement of the financial information resulting from fraud or error existing during the period covered by the auditor's report does not, in itself, indicate that the auditor has failed to adhere to the basic principles governing an audit."

The moot point is ICAI cannot and should not be allowed to remain a self-regulated organisation anymore as it hasn't really covered itself in glory.

While its track record on punishing errant auditors has been extremely casual, the way it has gone about formulating a flurry of accounting standards also exposes it poor planning.

For example, till 1999, ICAI had only 15 standards. Over the last three years, it suddenly issued as many as 13 more, the speed baffling its own members.

Reform is clearly long overdue. After all, the accountancy profession in India wouldn't like to be the butt of Buffet jokes, would it?

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