Under scrutiny

Auditors need to be reined in, but not through over-regulation

The Reserve Bank of India (RBI) recently announced that it was tightening rules for statutory audits of banks and that it would take action against auditors if they were found responsible for any lapses in financial statements or audit reports of banks. This is only one of several recent developments that have led to auditors in particular, and accountants in general, becoming wary about misstatements in corporate accounts. The establishment of the National Financial Reporting Authority (NFRA) was cleared by the Cabinet in March. This will be the first independent regulator to oversee the accounting profession, which has never been answerable to any regulatory body other than the Institute of Chartered Accountants of India (ICAI). While the ICAI remains the arbiter of accounting standards and will play a valuable advisory role, the NFRA gains its authority from Section 132 of the Companies Act, 2013. The new regulator would oversee the audits of large companies, listed and unlisted. The government could also refer cases for investigation to it, in the public interest. The NFRA is to be formally established within the next two months and the rules have been notified. The regulator would have the powers to penalise any individual CA or any audit firm. It can levy fines of up to 10 times the fee received, and also debar firms from practising.

The Securities and Exchange Board of India (Sebi), too, has started getting tough on auditors. In January it took action against Price Waterhouse by slapping a two-year ban on it for its failure to report fudged invoices a decade ago in the Satyam Computer scandal. Then, in May, the Ministry of Corporate Affairs amended a key section of the Companies Act, which meant that an entire audit firm could now be held accountable for the errors committed by a single partner; in the past, the liability only devolved on the persons responsible for them. Now, Sebi wants auditors and other monitoring agencies to undertake third-party fiduciary assignments. The new rules, once effective, will bring the activities of auditors and CAs, etc. with regard to listed companies under Sebi’s ambit.

In the long term, the effect of all these actions should be positive. It should lead to more trustworthy accounts and hence, to better corporate governance. But in the short run, it has led to confusion and apprehension within the accounting profession, which is still adjusting to the sudden advent of new regulatory norms. At least 30 listed companies have suffered the withdrawal of appointed auditors in the past few months. In some cases, the auditors offered excuses such as “pressure of work” but in a couple of instances, they bluntly said the corporate in question was not providing material information. Clearly, the new regulatory standards have been triggered by high-profile scandals such as fraud in Punjab National Bank and the rising mountain of bad loans in the banking system. But a strict interpretation of the new rules, say, the RBI statement that it would penalise auditors for divergence in asset classification and provisioning, could mean that every major audit firm will be debarred from bank audits. That may be impractical. Also there is some merit in the argument of auditors that over-regulation is not the ideal way to go, which seems to precisely the case now. There will be a considerable regulatory overhang if auditors are regulated by the NFRA, the RBI and Sebi. While it is desirable that India’s auditing standards match the global norms, a prudent approach is called for to make it happen.