In this article, Parth Sarthy Kaushik discusses whether SEBI should have the power to penalise Auditors or not.

Introduction

Corporate governance refers to the role played by different participants (such as the management, the board of directors, the shareholders and the auditors) entrusted with the supervision, control, and direction of the company. The need for good corporate governance essentially arises from the division between ownership and control of the company. Therefore, corporate governance focuses on running the company in the mutual interest of all stakeholders.

The role of the auditors is pivotal to effective corporate governance as they are in the best position to provide an unbiased analysis of the finances of the company thereby acting as trustees of shareholders and prospective investors. The shareholders of the company place very high trust on the auditor’s report, which apparently shows the true and fair view of the accounts of the company. However, in many cases the auditors fail to perform this role diligently and honestly and are often found to commit fraud in collusion with the management.

Therefore, the need for an effective oversight of the performance, independence and objectivity of the auditor and the quality of the audit cannot be overstated. With a view to enhance the standards of corporate governance of listed companies in India, Uday Kotak Committee on Corporate Governance has recommended, inter alia, an active monitoring of the role of auditors and conferring powers on SEBI to act against auditors in case of an ineffective audit. However, The Institute of Chartered Accountants of India (ICAI) has expressed its dissent on these recommendations as the regulation of chartered accountants is covered under the Chartered Accountants Act, 1949 and disciplinary measures for auditors will come under the National Financial Reporting Authority (NFRA), which is a regulatory agency for auditors proposed to be set up under Section 132 of the Companies Act, 2013.

Thus, these recommendations can give rise to jurisdictional conflict and have wide-ranging implications for companies and their auditors. In the present context, it is very important to examine these recommendations and objection raised in light of the failure of the ICAI to rein in erring auditors.

Rules Governing the Role of Auditors – Present Framework Vis-à-Vis Proposed Framework

Following are some of the key proposals made by the Committee to ensure independence of the auditors and the quality of audit reports:

1. Audit Qualifications

Under Schedule IV, Part-A of the SEBI (Listing Obligations & Disclosure Requirements) Regulations, 2015 (LODR) if the impact of audit qualification is not quantifiable, the management is required to make an estimate which shall be reviewed by the auditor. In case the management is unable to make an estimate, it is required to provide the reasons.

Committee has recommended that the disclosures regarding audit qualifications should be made mandatory. However, there is one exception to this rule i.e. matters of going concern or sub-judice matters. In such cases, the management will be required to provide reasons which will be reviewed by the auditor.

2. External Opinion

Currently, there are no specific provisions in any law which enables an auditor to obtain an independent external opinion in relation to the audit/limited review.

Committee has recommended that Regulation 33 of LODR, which deals with the Financial Results of a listed entity, should be amended to grant auditors a right to independently obtain opinions from external experts, when they do not agree with experts appointed by the listed entity. Also, it has been suggested that any expenditure incurred for obtaining such opinion shall be borne by the listed entity.

3. Resignation of Auditors

Section 140 (2) of the Companies Act, 2013 read with Rule 8 of the Companies (Audit and Auditors) Rules, 2014 provides that, upon the resignation of auditors, reasons for such resignation shall be filed with the company and Registrar of Companies. However, SEBI LODR Regulations does not have any specific provision providing for such disclosure.

To ensure that auditors don’t resign quietly when called upon to take a position on contentious issues, it is very important that detailed reasons for their premature resignations are provided. Therefore, with a view to bring the LODR Regulations in consonance with the provisions of the Companies Act, 2013 the Committee has recommended that it should be mandatory for a listed entity to disclose the reasons for the resignation of its auditors. Furthermore, auditors shall also be required to truthfully disclose the reasons for their resignation.

4. Role of ICAI

At present the Chartered Accountants Act, 1949 regulates the conduct of Chartered Accountants in India which, inter alia, provides for the mechanism of disciplinary action against erring members. Further, Section 147 of the Companies Act, 2013 provides that if an auditor contravenes any of the statutory duties laid down in the Act then –

(a) In case of unintentional contravention, the auditor can be punished with a maximum fine of Rs. 5 Lac; and

(b) In case of wilful contraventions, the fine can be extended upto Rs. 25 Lac. Further, in case where audit of a company is being conducted by an audit firm, the partners of the concerned audit firm and the firm can be made jointly and severally liable. However, it must be emphasised that the enforcement of the provisions of CA, 2013 is through the Ministry of Corporate Affairs and not the ICAI.

As the current mechanism has failed to deter auditors from participating in fraudulent activities in collusion with the company management. The Committee has recommended that ICAI may be given powers to increase the scope of punishment as well as the penalty amount by increasing the upper limit to Rs. 1 crore in case of auditors and Rs. 5 crore in case of repeated violations by an audit firm. In addition, it has been recommended that a separate cell should be formed by ICAI for the enforcement of disciplinary proceedings pertaining to listed entities.

5. Enforcement by SEBI

Section 11 of the SEBI Act, 1992 provides that, in order to protect the interests of investors and to promote the development of the securities market, SEBI can restrain person accessing the securities market a certain time period. However, under the SEBI Act or Regulations framed thereunder, currently there is no specific provision which provides for specific penal powers in relation to auditors.

As SEBI is duty bound to protect the interests of investors in the securities market and regulating listed entities, it is only logical that SEBI should have clearly defined powers to act against auditors with respect to their functions concerning listed entities. The Committee has recommended that the power conferred under Section 11 ought to be extend against the audit firms as well.

ICAI and Auditors – A Mutual Benefit Society?

The infamous Satyam scandal which broke out in January, 2009 showed that no system is fully equipped to prevent greedy and dishonest people from putting their personal interests ahead of the interests of the companies they manage. Today it’s a well-known fact that the auditors were paid to hide the fraud and actively participated in luring the investors by manipulating facts and figures.

This is not a one off instance where auditors were found hand in gloves with the management in perpetrating frauds of unheard proportions. In 2001, the role of the auditors of Global Trust Bank had come to light in the backdrop of Ketan Parekh stock market scam. A lot of noise is made in the regulatory circles, every time there is a new scam exposing the wrongdoings of auditors but the system governing auditors does not witness any observable improvement.

The reforms suggested by Uday Kotak Committee can have far reaching impact on the role of auditors in the corporate governance of listed companies. As expected, ICAI has protested by claiming that the Committee has exceeded its mandate and the recommendations if implemented would cause a conflict of jurisdictions between SEBI and ICAI or proposed National Financial Reporting Authority (NFRA). Considering that ICAI has been successfully lobbying against NFRA and its own track record in taking action against the erring auditors, one may find it baffling to see ICAI making the above argument. But given that the governing council of ICAI is elected by Chartered Accountants, it can hardly be expected that elected representatives will show any diligence in acting against the members who elect them. One such example is the disciplinary proceedings against the auditors of Global trust Bank, which stretched for more than a decade.

It is clear that self-regulation of auditors has resulted in dubious accounting and auditing practices. Therefore, it is imperative that SEBI should be allowed to strengthen its capacity to effectively reduce opportunities for accounting fraud and insure greater accountability of the auditors.

Conclusion

The auditing profession has an important role to play in strengthening the corporate governance mechanism. If the above recommendations are implemented in their letter and spirit then transparency in accounting and auditing practices is sure to increase, which will result in adoption of more ethical practices. In long-term, these reforms will prove out to be instrumental in the evolutionary process of India’s corporate governance mechanism.