RBI’s recent actions against auditors highlight the need for role clarity as well as coordination among regulators
The Reserve Bank of India (RBI) governor drew our attention earlier this week to the importance of accurate financial information for resource allocation, market confidence and financial stability. Establishment and enforcement of accounting and audit standards and the regulation of the profession which practices this occupation is therefore crucial for financial markets and the economy.
Earlier in the month, the RBI issued an order debarring a firm of chartered accountants from undertaking any type of audit assignment in any RBI regulated entity for a period of two years. This action has been taken, according to the RBI press release, on account of the failure on the part of the audit firm to comply with a specific direction (reportedly on classification and provisioning for some loans) issued by the RBI with respect to its statutory audit of a systemically important non-banking financial company. After this order, it will be a very brave or a foolhardy company —whether RBI regulated or otherwise— that will engage the debarred CA firm as its auditor.
In January 2018, the Securities and Exchange Board of India (Sebi) had issued an order under the Sebi Act, banning another CA firm and a couple of its auditors from providing audit services to listed companies and market intermediaries for a specified period for their involvement in the accounting scam in a large listed company. In addition, Sebi ordered disgorgement of “wrongful gains” of over Rs 13 crore — the estimated fees of that particular engagement. These orders are now in appeal before the Supreme Court (SC).
While we await the final orders of the SC, it is clear that the RBI and Sebi have effectively become the regulator and disciplinary authority for the subset of chartered accountants in the domains regulated by them.
The Institute of Chartered Accountants of India (ICAI) is a body established by The Chartered Accountants Act, 1949, for regulating the profession of chartered accountancy. The ICAI is managed by a council of 40 members of whom 32 are elected by chartered accountants and the remaining eight are nominated by various public authorities. Regulating the profession of accountancy, formulation of accounting standards and prescription of standard auditing procedures and disciplining and taking action on misconduct by auditors are the core functions of the ICAI.
The ICAI, like other regulators of “professions”, is thus structured as a self-regulatory organisation (SRO). Over the years, its record in disciplining errant members has not been noteworthy. As a consequence, there has been a growing tendency among sectoral regulators to discipline the auditors. Unfortunately, this has other serious consequences. An additional negative fallout of this could be the gradual withdrawal of good firms from the audit of public interested entities. Already, the audit business is taking a back seat with growing remuneration from non-audit services.
At least in part response to this, the ICAI instituted a new disciplinary mechanism in 2007. The website of the ICAI reports that since then it has registered a large number of disciplinary cases. Despite a few tough orders like the ban on the Sebi indicted chartered accountants referred to above, the findings of guilt, though better than before, are still a very low percentage of cases initiated.
In parallel, in the wake of some large corporate accounting and auditing scandals in the late 1990s, many OECD countries established bodies to oversee the audits of public companies in order to protect investors and further the public interest in the preparation of informative, accurate, and independent audit reports. In line with this global development, the National Financial Reporting Authority (NFRA) was constituted by the Government of India on October 1, 2018, under the new Companies Act of 2013.
Broadly, the NFRA has the power to monitor and enforce compliance with accounting and auditing standards, oversee the quality of service and undertake investigation of the auditors of a class of companies. These include companies whose securities are listed on any stock exchange in India or outside. Large unlisted public companies with a paid-up capital or annual turnover or debt above prescribed thresholds, all insurance & banking companies are within the NFRA’s jurisdiction. For the balance class of companies, the ICAI continues to be the regulator of the profession.
The accounting and auditing fraternity is, expectedly, unhappy with the dilution of its self-regulatory role. In November 2018, the Northern India CA Federation had challenged the constitutional validity of powers given to the NFRA. The Delhi High Court disposed of this case because the petitioner failed to argue the matter. A similar petition has been filed by another CA which is pending before the Madras High Court. In the IL&FS case, the NFRA debarred three senior partners of the Big Four firms from practice for a certain number of years. As a result, all of them have challenged the constitutional validity of powers given to the NFRA.
While we wait for the final orders of the courts on these pending matters, the present situation offers an opportunity to put in place a clear regulatory framework and machinery for the conduct of the accounting and auditing profession. If the twin regulatory model continues, this should ideally be in one consolidated legislation with clarity on the respective roles of ICAI and NFRA. Given the incentives of a peer group elected SRO, the disciplining arm of the ICAI will need to be restructured and strengthened to improve its effectiveness and credibility. Both ICAI and NFRA have representatives of sectoral regulators on their key decision-making bodies. These will need to be fully energised to become robust mechanisms for sectoral inputs as well as operational regulatory coordination and co-operation.
As the economy becomes more complex, India will need to strengthen the regulatory frameworks in other similar cross-cutting domains like data protection and competition. Is financial data protection a financial sector issue or a data protection regulatory issue? Likewise, competition in banking straddles two regulatory domains. Resolving these issues will increasingly call for establishing coordination mechanisms for sectoral and domain regulators to cooperate without dilution of their respective responsibilities. The restructured accounting and auditing regulatory and supervisory mechanism can show the way for the future.The writer is professor NCAER, member of a few for-profit and not-for- profit boards and former civil servant