Audit trail: 5 years of NFRA cracking the whip

The regulator has pulled up erring chartered accountants and firms, but is its work having an impact?

In the five years since the National Financial Regulatory Authority (NFRA) was established in 2018, it has ticked off many company auditors, made some of them resign and pushed for reforms. What it has been unable to do is catch the imagination of company board rooms.

The Institute of Chartered Accountants of India (ICAI) is more visible in those circles, despite its perceived lack of zeal to censure chartered accountants for errors. NFRA has passed 22 penal orders on auditors in about 30 months.

“Our role and responsibilities are very distinct which is for standard-setting, investigation and disciplinary matters (on auditors) of listed entities,” says Ajay Bhushan Pandey, NFRA’s chairman. “Just last week, several auditors of large companies had to resign as a consequence of our debarment orders".

NFRA completes the disciplinary arc of bodies covering the corporate sector. The Securities and Exchange Board of India (Sebi) ensures companies play fairly in raising equity or debt; the Insolvency and Bankruptcy Board of India ensures winding up of companies; and the NFRA keeps a tab on auditors.

NFRA derives its power from section 132 of the Companies Act and its function is broadly bucketed into two areas (a) standard-setting, (b) monitoring and enforcing standards and investigation of professional misconduct / disciplinary action against chartered accountants and firms.

NFRA owes its emergence to the need felt worldwide for having independent regulation for the audit profession instead of self-regulation. “Recommend accounting and auditing standards for India and also have oversight and disciplinary authority over those involved in (these) jobs in listed and other large public interest entities” is the role of NFRA, Pandey says.

There are similar bodies in developed economies, with the USA having a crucial difference. The Public Company Accounting Oversight Board (PCAOB) there is housed under the market regulator, the Securities and Exchange Commission. The SEC has oversight authority over the PCAOB, including approving its rules, standards, and budget. The Indian legislation to set up NFRA offers no such mandate to the Sebi.

The UK model is somewhat complicated. The Financial Reporting Council’s six arms, including the Professional Oversight Board, ran the business of inspection of audit and actuarial capacity of firms, but from this month the Audit, Reporting and Governance Authority has replaced this architecture.

NFRA seems to follow the Japanese and the Australian model. Tokyo’s CPAAOB and Canberra’s ASIC are independent bodies in their own right.

Who audits

Stakeholders globally are concerned that auditors of companies are often unable to or unwilling to act as whistleblowers. The remedies suggested show an interesting cultural difference and in most countries, those recruited to audit watchdogs are from the same profession.

In Japan, the chairman of the CPAOOB is a former professor of “professional accountancy” at Aoyama Gakuin University. The heads of the US and the UK bodies come from the same profession. But just like at other Indian financial regulators, NFRA’s leadership too is packed with government officers, mostly IAS. In a significant departure last year, Madhabi Puri Buch became the first non-IAS chairperson of Sebi.

Writing about this issue, MS Sahoo, a former regulator and now a distinguished professor at National Law School in Delhi, said: “It is advisable, therefore, that the Governing Body does not have any nominee from the government, particularly when the latter is empowered to give directions to the regulator on matters of policy and even supersede the (body). Ideally, a regulator may not have any nominee at all”.

The government followed this principle in an amendment to the role of chartered accountants. In the Chartered Accountants, The Cost And Works Accountants and The Company Secretaries (Amendment) Act, 2022, the role of their respective governing councils, especially to discipline their members, has been clipped. Parliament passed the Act in 2022. The government has more or less run on the principle that only civil servants may run regulatory organisations.

This does not mean the NFRA has not stuck to its job as the data shows ( see interview). In April, it recently passed strong orders for alleged audition lapses at the Cafe Coffee day chain. A set of auditor firms were barred for two years from taking up any audit role in any firm and asked to pay financial penalties.

Gaps in auditing regulation remain. The NFRA cannot examine the role of external auditors of public sector banks. The role vis a vis NBFCs is also not yet clear.

Yet as Pandey points out “since the formation of NFRA in 2018, we have reviewed and recommended 40 proposals on amendments to Ind AS and issuance of new standards on leases Ind AS 116. (Both accounting standards) All these recommendations have been notified by the central government. Just a few days back, NFRA reviewed and approved a proposal on new Ind AS on Insurance Contracts viz. Ind AS 117 which is again based on the newly implemented IFRS Standard”.

He also feels that “the logic behind moving from hitherto self-regulation  to  independent regulation and assigning NFRA jurisdiction to listed and large companies  is based on the need to protect a large number of  their public shareholders and other stakeholders such as banks, creditors etc”.

Not putting auditors into the regulatory role has made it clear to Parliament and the general public that there is independence in the process of investigation of audit lapses. But despite the slew of orders the perceived lack of domain knowledge may have also diluted its role, somewhat. “Company board rooms apparently lay more stores by the standards as prescribed by ICAI. The measures taken by NFRA impact to the extent of noting who are the auditors blackballed,” says R Gopalan, former economic affairs secretary and now on the board of more than one listed company.

One way to reconcile between auditors auditing themselves and civil servants with no particular knowledge of the sector do so is to prescribe qualifying exams to serve in NFRA investigation teams. Sahoo says that exams to qualify as insolvency and resolution professionals were rolled out in the very first year of the formation of the Insolvency and Bankruptcy Board of India. It has now become a regular feature that has added to the comfort level of banks and other creditors about the role of these professionals in assuring a sound order.

Auditing issues we flag 'should ring alarm' bells in ecosystem: NFRA chief

The National Financial Reporting Authority (NFRA) recommends accounting and auditing standards in India and it has oversight and disciplinary authority over those involved in accounting and auditing. NFRA chairman Ajay Bhushan Pandey explains his organisation’s work in an interview.

What is the progress in NFRA’s suggestion about putting in place accounting and auditing policies and standards to be adopted by companies for approval by the central government?

NFRA is the independent regulator of accounting and auditing profession in India like PCAOB in USA or FRC in UK and others. Worldwide, the need for having an independent regulation instead of self-regulation for the profession was felt in the aftermath of Enron corporate failure where Arthur Andersen was the statutory auditor. India too witnessed during the last few decades several corporate failures such as Satyam, ILFS, etc where, apart from the management, the role of the statutory auditors also came under intense scrutiny. It is in that context that NFRA was set up in 2018 whose task is to recommend accounting and auditing standards for India and also have oversight and disciplinary authority over those involved in accounting and auditing jobs in listed and other large public interest entities.

We have also started issuing circulars on non-compliance of standards by the companies and auditors to drive systemic change. We are emphasizing that companies are required to comply with the provisions of Ind AS Rules and cannot dilute the rigour of those by treating those as subordinate legislation.

The governing body of chartered accountants, the ICAI, is also responsible for overseeing these professionals. Is this a case of duplication of regulatory standards with NFRA?

There isn’t really any duplication. NFRA’s role and responsibilities are very distinct. Under section 132 of the Companies Act our function can be broadly bucketed into two areas (1) Standard-setting, (2) Monitoring and Enforcing standards and Investigation of Professional Misconduct / Disciplinary Action against the Chartered Accountants and firms. Auditors of remaining smaller companies continue to be under the disciplinary purview of ICAI. The logic behind moving from hitherto self-regulation to independent regulation and assigning NFRA jurisdiction to listed and large companies is based on the need to protect a large number of their public shareholders and other stakeholders such as banks, creditors etc.

Are the financial penalties imposed on the CA firms adequate in terms of their perceived lapses?

Section 132 of the Companies Act prescribes the maximum financial penalty of five/ ten times the fees received and debarment of the chartered accountant and the firm for a period of maximum 10 years. Both financial penalty as well as debarment in combination act as significant deterrents and will be catalyst for prevention of recurrence of such misconducts. During the recent few months, we have issued several disciplinary orders and imposed a penalty up to a crore of rupees and debarment up to 10 years. Just last week, several auditors of large companies had to resign as a consequence of our debarment orders. Also all our orders are required to be published on our website. Though our order pertains to a specific auditor or his firm, we expect that the issues flagged therein should ring the alarm bells in the ecosystem to make other people also cautious and watchful in their audits and companies as well.

We have started publishing executive summaries of our orders too. Our disciplinary orders and executive summaries are written in such a manner that not only the accounting and auditing professionals but also independent and other directors and even public shareholders at large can also understand them so that they can ensure that such wrong-doings do not occur in their companies. Also, just to set a perspective and also to ensure that our disciplinary expectations are at par with the international standards, we have started quoting in our orders how seriously other international regulators such as PCAOB, FRC etc. have viewed certain violations and what kind of punishment they are imposing.

Will NFRA have the mandate to investigate firms that do bank audit?

If a bank is (a) company, then the company and its auditor would come under the regulatory purview of NFRA. Banks not incorporated as companies such as public sector banks are currently not under our jurisdiction. However, the Central government can assign a case of any entity including a public sector bank  to us for investigation by NFRA.