10 years after Satyam, auditors still can't flag a management fraud

Ten years after the financial scam at Satyam Computer Services, audit fraternity says it is still tough to detect fraud perpetrated by the management in collusion with employees of the company in the normal course of the audit. 

Over the years, the regulators have brought in several checks and balances in the audit process to detect and deal with frauds. These include provisions relating to internal controls testing, risk assessment and analytical reviews, besides the presence of an effective audit committee and clear corporate governance policies and practices. “I can unequivocally say that laws and accounting rules play a less significant role in the red-flagging of financial frauds than auditor attitudes and behaviours,” says Albert Aboody, a retired KPMG-US partner, who was the independent monitor overseeing the implementation of the consent orders between PwC India and the US Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) in connection with its audits of Satyam.

Amarjit Chopra, a former ICAI president, too, agrees with this line of thinking. To substantiate, Chopra points out that the huge volume of non-performing assets (NPAs), amounting to more than ~11 trillion, as declared by banks is a testimony to the fact that no early-warning signal is thrown out by the auditors.

An auditor, who has overseen Satyam Computer’s accounts for several years, says it was difficult at that time to state anything to alert on the possible fraud without any adverse comment or concern raised by any of the stakeholders — be it directors, shareholders, employees, customers, analysts, a whistle blower or even the media. “The situation remains the same even now,” he adds.

However, one important change in boardrooms, in the post-Satyam era, say many in the audit fraternity, is the auditor relationship with the audit committee.  

Audit committees have become far more diligent in conducting their oversight responsibilities, say auditors. “The audit committee has a vital role to play in keeping management honest with the help of the auditors. And this is a function it now understands better than ever before,” says Aboody. 

Sanjay Kallapur, a professor of accounting at Indian School of Business, feels the unprecedented two-year ban by the Securities and Exchange Board of India (Sebi) on Price Waterhouse firms auditing listed companies seems to have had a big impact on the audit profession. “During the last year or so we have heard of several auditors resigning because they did not get enough information from client companies,” he adds. Kallapur agrees while it may be impractical to expect statutory auditors to prevent frauds, there is room for improvement in audit quality. “The recent reforms and increases in penalty give hope for improvement in this regard,” he says.

According to Chopra, both bigger and smaller firms have been found wanting in quality of the audit. “So to say that a bigger firm has better audit systems is a myth,” he says.

The exercise of professional scepticism is important for auditors to be effective, say experts. “Auditors must not allow themselves to be intimidated by the client management into conducting audits by conversation,” says Aboody. It is important for auditors to conduct proper interviews and ask probing and searching questions, he says. However, many auditors concede they generally receive little training in such “soft” skills. Aboody, too, agrees that the profession has not adequately responded to the “mindset” requirement of an auditor. “Some inroads have started in the post-Satyam period, he says.

THREE THINGS AUDITORS ARE DOING DIFFERENTLY

Strengthening of external confirmation process

Pressure on companies to ensure direct replies from banks/external authorities 

Focus on fraud risk assessment

A lot more importance is being given to the quality of the management and the board, instead of going simply by their reputation

Strictly following reporting requirement on fraud under Companies Act  

Auditors are insisting on reporting of internal controls over financial reporting