This article is written by Aayush Raj. Aayush is a Research Associate at Confederation of Indian Industry.

Bi-halter control syndrome: Do we aim to promote governance or legal quagmire?

Committee on Corporate Governance set up by SEBI has recommended that auditors come under the regulatory purview of SEBI. Is this step worth the call?

Introduction

“Given SEBI’s mandate to protect the interests of investors in the securities market and regulating listed entities, the Committee recommends that SEBI should have clear powers to act against auditors and other third-party fiduciaries with statutory duties under securities law (as defined under SEBI LODR Regulations), subject to appropriate safeguards. – Report submitted by the Committee on Corporate Governance”

Auditors have an important role to play in a business organisation, and their (in)abilities were deftly portrayed during the Satyam fiasco[1]. Though various factors influence business operations, continuously generating financial resources form the focal point, and it can be easily discerned that auditors have a crucial role to play.

In the contemporary context, business organisations are not mere profit-making enterprises. They have social objectives to fulfill. Furthermore, the companies today are run by publicly funded money (in the form of market investments) and therefore misappropriation may negatively affect the economy of the country writ large. Today, the fact if companies are operating in a responsible manner can be gauged only on the basis of various reports and documents published by it, whether statutorily mandated or not. Financial reports mirror a company’s performance and compliance with the laws reflects its statutory commitments. However, the ineffectiveness of description(s) in these documents and statements was denuded in the Satyam scandal, which surfaced within a mere gap of six months of the company being awarded Golden Peacock Award for excellence in corporate governance. It was a dent not only to the corporate governance standards nationally but globally. Though the perpetrators continue to suffer their due, the fait accompli was ruinous. Few thousands of lives were at stake and the documents still unequivocally presented a compliant company.

This manifests in itself the role which auditors can play. In light of such unsettling disruptions, it is only a matter of time that the corporate governance mechanism is overhauled in the country. The recent recommendation by the committee on corporate governance to vest SEBI with the power to overview auditors reflects the commitment of the country and the government towards improving corporate governance standards in India. But with the already existing system, is the step worth the call. This paper analyses the pros and cons of the step and finally makes certain recommendations based on good corporate governance and auditor regulatory practices globally.

International Scenario

The United Kingdom provides a unique insight with respect to regulation of accountants in the country. In the UK the chartered accountants may be members of organisations affiliating chartered accountants in their home country and hold membership of the Institute of Chartered Accountants in England and Wales. However, they are subject to regulation by the Financial Reporting Council which is also responsible for setting UK’s Corporate Governance and Stewardship Codes[2].

In the US, in wake of emerging scandals, a new quasi-governmental regulator for auditors of public companies, the Public Company Accounting Oversight Board (PCAOB) was constituted in the year 2002[3]. It primarily regulates audit firms centring on investor protection (somewhat resembling the role played by SEBI in India).

Other countries have established independent audit regulatory bodies such as Canadian Public Accountability Board (CPAB) of Canada, High Council for Statutory Audit of France, Auditor Oversight Body (AOB) of Germany, Certified Public Accountants & Auditing Oversight Board (CPAAOB) of Japan, Audit Oversight Board Securities Commission Malaysia of Malaysia, Federal Audit Oversight Authority (FAOA) of Switzerland, etc.

Indian regulation of public company auditors:

In India statutes, rules therein, and regulations issued by regulatory agencies regulate auditors, both firm, and individual. A deeper insight into these proactive measures is not within the ambit of this thematic paper. Here we provide a general overview of regulations which deal with the misconduct by individuals.

Chartered Accountant Act, 1949

Definition of professional misconduct – “the expression “professional or other misconduct” shall be deemed to include any act or omission provided in any of the Schedules[4]”

The definition and explanation provided for in the schedule are wide enough to include professional misconduct which has a material effect over the interest(s) of investors in a company. On being found guilty of professional misconduct, the name of such a member can be removed from the register, thereby disabling him/ her from continuing practice as CA.

Apart from this statutory provision, the decision[5] of the Bombay High Court conferring the right to the SEBI, for initiating action against CAs involved in the cooking of the books suo moto, is of extreme relevance.

Analysis of the recommendation

Pros

The external oversight by SEBI on auditors stand justified and a step to foster good corporate governance on various fronts. First, one of the principles of natural justice is ‘nemo judex in causa sua’ which means that no person should be a judge in its own case. If an inference is drawn from this principle (and some might argue this to be a far-fetched extension of the principle), ushering SEBI to exercise oversight over auditors might appear an effective idea. This view is further invigorated by the recent shift towards good governance which lays emphasis on external review of organisational operations. A group of certain members might not jeopardise interest(s) of other member(s) of the group due to common interest(s). However, an independent body does not owe such an allegiance and thus stands justified to a large extent in driving efficient organisational system.

Second, ICAI has been reprimanded by the government of its inefficiency in dealing with cases of professional misconduct. Though, in this context, the government is inclined to formulate a new authority, the National Financial Reporting Authority. However, the vesting of powers in SEBI may help mitigate/ invigorate the in/efficiencies of the present regulator.

Third, if seen from the investor perspective, SEBI stands at a better pedestal than any other agency to deal with the issue(s) [without many allusions, SEBI has its own limitations] related to investor protection. The primary need of an independent regulator emerges for protecting the interest of investors. Punishing the wrong-doer is only a deterrent step, which might be of little value to an investor, though not completely irrelevant. Safeguarding their interest is SEBI’s prerogative and thus SEBI befits the market demands.

Cons

First, SEBI is already burdened with the complex web of issues related to improving the standards of corporate governance across the nation. Adding a new burden does not appear an appealing idea. This might dilute the effectiveness of SEBI as an agency for implementing corporate governance standards in the country.

Second, With the NFRA being mooted at the national level, ICAI existent for over six decades, powers being conferred upon SEBI, might be a concrete manifestation of justice being delayed. The confusion around jurisdiction may find firm roots, in turn, triggering legal quagmire between national agencies competing with each other for jurisdiction. This would hamper investor interests exponentially.

Third, unlike the UK in India membership with the national chartered accountant authority is a pre-requisite of practicing as a CA. Therefore, the powers that be cannot unilaterally shift the burden of oversight onto a regulatory agency like Securities and Exchange Board of India. Let me illustrate this in a better way: Let us assume that a businessman appoints two-drivers, one for the domestic and another for business purposes. Both are vested with the powers to drive the same horse-cart. Now, until the two drivers are independently exercising the powers vested in them within their respective domain, no conflict arises. But let us further assume that a cross-road between domestic and business purpose occurs and the businessman calls for the service of both the drivers simultaneously. It would be a situation of bi-halter control; rendering either the horse(s) too confused or the cart ending up in an accident. The powers that be need to decide at the outset how it would disengage call for such situation while conferring regulatory oversight to SEBI.

Recommendations

In order to propose any recommendation with respect to regulating the conduct of accountants, which the government can implement, it is important to identify the existing gaps/ inefficiencies in the Act of 1949. As stated above the Act deals with various forms of misconduct by an accountant and provides for disciplinary action against them. However, the Act only deals with the after-effect of misconduct that is it adopts a post-risk mitigation approach. This approach has an adversarial effect on the interests of investors because, by the time, the fraud is detected the investors’ money is already gone. This does not create a deterrent effect on fraudsters.

We have other agencies that work towards this end of fostering good corporate governance. The Serious Fraud Investigation Office is a statutory office for detecting and prosecuting or recommending for prosecution for white-collar crimes/frauds. However, its effectiveness may be gauged in future because the body is a recent development in India.

It is a matter of fact widely accepted that in India laws are tigers on the paper, the effective implementation of which is the prime concern. Therefore, we need to develop a two-fold strategy in order deal with the broader ambit of corporate frauds, of which regulating accountants is a part. On the one hand the government should make a move to identify risks of corporate frauds, and on the other hand the implementation of existing laws should be strengthened to concretise a deterrent effect in minds of fraudsters.

The first recommendation that we propose is the use of pre-risk identification technique. In order to facilitate this, it is important that various regulatory agencies such as SEBI, SFIO, CBI, ICAI, etc. work in collaboration. In addition to the agencies mentioned, the government should establish an independent authority at the pan-India level to collect information from and protect the interests of whistleblowers. Information collected from whistleblowers should be properly investigated whether for governmental organisations or publicly listed companies. The protection provided for by the Whistleblower Protection Act should be safeguarded. This is only vouched and invigorated by the fact that whistleblower allegations with respect to corporate frauds are found to be true generally[6]. This is aligned with our recommendation of risk-identification approach to inhibiting corporate frauds. Accountants may be of immense help in fraud identification.

The second recommendation is to clearly define the ambit of the jurisdiction of various regulatory agencies and their powers. If the power to review auditors is proposed to be vested with the SEBI, it should not oust the ICAI of its current authority in toto. An approach to make the review process independent should be adopted, as proposed. Though the power to bring an action or initiate an action may be vested in an authority characterised by the harmony between various regulators. Conferring powers of arrest to the SFIO is an exemplary step to promote corporate governance and strengthening the regulatory agency in the country.

The third recommendation is collaboration/ case-study/ research with the International Forum of Independent Audit Regulators (IFIAR) for proper development of modus operandi of SEBI as a regulator of auditors. Recommendations can also be garnered from independent auditor institutes in other countries and indigenous model developed thereafter.

The corporate governance regulation in India has come a long way but is still in its developing stage. The government should focus on developing strengthened regulatory agencies aimed at minimum interference by the judiciary. This would promote the overall investor confidence in the market and thereby boost the Indian economy achieving the ends of inclusive development in India.

[1] Satyam Scandal: Who, what and when, The Hindu, April 09, 2015

[2] About the Financial Reporting Council

[3] About the Public Company Accounting Oversight Board

[4] Section 22, Chartered Accountant Act, 1949

[5] Writ Petition No. 5249 of 2010, Bombay High Court

[6] http://www.moneylife.in/article/nse-admits-that-whistleblowers-allegations-have-been-found-to-be-true-by-an-independent-agency/49307.html