Confusion reigns over Sebi's peer review mandate

The compulsory peer reviews of auditors’ notes for Sensex and Nifty companies for Q3 results of the last fiscal and full-year results of 2007-08 have proved a virtual non-starter, owing to confusion over its scope and the appointment of auditors.

Peer reviews were mandated by the Securities and Exchange Board of India (Sebi) on January 9 as an investor confidence-building measure two days after Satyam Computer founder Ramalinga Raju confessed to inflating profits for several years.

The review was to cover the working papers of auditors for companies constituting the National Stock Exchange’s Nifty 50 index and the Bombay Stock Exchange's benchmark 30-share index Sensex and was due to be completed by the end of February 2009. Two months after that deadline, peer reviews are yet to begin or have just started for some companies.

The principal problem is the interpretation of the exercise. At a recent seminar on corporate governance in Delhi, former Sebi chairman M Damodaran said the peer review was being interpreted as a second, detailed audit.

“This is leading to a situation in which if I am tasked to look into what somebody has done, I believe I will be earning my fee only if I find some inadequacies in the previous attempt to audit... The second guy has to be better than the first,” Damodaran said.

As a result, in some cases, managements are being asked questions that appear irrelevant to them. “It’s a duplication of efforts and costs,” said Manish Dugar, CFO, Wipro Ltd. Many of his fellow CFOs shared these concerns at a recent CFO forum.

Arun Gandhi, director at Tata Sons and a leading chartered accountant, said defining the scope of review was important to avoid confusion, since the audit notes of the statutory auditor were being subject to examination by another firm, which could also raise issues of confidentiality. “It’s important to ensure that both firms are on the same plane,” Gandhi added.

The reviewer is expected to examine the working papers (of the first auditor) to determine whether the information needed to conduct a reasonable audit was made available and used. The reviewer also has to establish if the audit was conducted according to the standards laid down by the Institute of Chartered Accountants of India (ICAI), the regulator for the profession.

“An independent assessment of the quality of audit will enhance faith in the system and processes. If some people are looking at it as a second audit, they have grossly misunderstood it,” said Shailesh Haribhakti, chairman of audit firm BDO Haribhakti.

“ It’s a good measure. But we should not flog it to a level that it becomes counter-productive,” Damodaran warned.

The peer review was proposed by ICAI for three years. Right now, it is mandatory for Sensex and Nifty companies, but Sebi will also choose a few listed companies randomly for this exercise.

The review is also running behind schedule because of a delay in appointing the auditors, which entails a long process to ensure there is no conflict of interest.

Sebi first sends a company a list of three audit firms to check for conflict of interest. The company will then write to its statutory auditor to check if it has a conflict of interest with any of the names proposed. If an audit firm has done work for a client of the company concerned or is auditing its competitor, it will be ineligible for the review.

A conflict can also occur if one of the reviewer’s employees has been employed by the original auditor or if the two auditors have had an alliance or jointly bid for some assignment.

“Once the auditor responds, the company reverts to Sebi. This process can take two or three weeks or more. Most companies went through this process in March. Companies have also been trying to finalise their annual accounts,” said Rahul Roy, partner, S R Batliboi and director, E&Y.

This selection criteria have led to problems in many sectors. Take the IT sector. It is difficult to find an audit firm that has not audited another IT company. “Even if you find one, not everyone can understand a complex foreign exchange transaction,” said Jamil Khatri, head of accounting services, KPMG.

Banks face a similar problem. “You have to find an audit firm that has not audited any other bank before. This would leave only the small audit firms, which may not understand the issues. Many firms are getting ‘conflicted out’ because they would have done some tax or advisory work for these companies,” added Khatri.  Zeroing down on the right audit firm is taking time but once the auditors are appointed, Haribhakti thinks the process should not take more than two weeks. Even so, investors should not mind that if they can be reassured of India Inc’s numbers.