CAs have not covered themselves in glory

July 1 is National Doctors’ Day. The country celebrates the birthday of the late Dr BC Roy, legendary physician and former chief minister of West Bengal, who was awarded the Bharat Ratna. By a quirk of fate, July 1 is also Chartered Accountants’ Day marking the date on which the Chartered Accountants Act came into effect in 1949. The day does not mark the birth of any CA who has made a contribution to the people of India in the way BC Roy did.

Prime Minister Narendra Modi addressed the CA Day gathering in Delhi this year. The ICAI (Institute of Chartered Accountants of India) bigwigs probably expected him to praise their contribution to “nation building” and announce new business opportunities for accountants. Startlingly, the Prime Minister chose the occasion to warn accountants of the consequences of their assisting tax evasion, money laundering and fraud. He referred to the rather murky role of CAs during the demonetisation exercise last year. He questioned the creation of shell companies, hinting more than subtly that CAs had a hand in their activities. The speech was a warning to CAs to mend their ways.

Accountants advise their clients on compliance with tax laws. In practice, things work very differently. Instead of highlighting the need to pay taxes on both legal and moral grounds, CAs give dubious advice on tax evasion using shell companies as instruments. They devise aggressive methods of tax planning (often a euphemism for tax avoidance). The Vodafone case is a good example.

To rephrase a well-known quip, behind every successful tax planning scheme, there is an accountant. India is one of the few countries that requires tax audit by external auditors. CAs conducting tax audits have direct responsibility for detecting and reporting tax evasion. Though the practice has been around since 1984, tax audit seems to have failed to check tax evasion and avoidance.

Assurance is the newfangled word for audit. Ironically, audit assures nothing. It is an example of newspeak, George Orwell’s word for confusing language. Audit reports contain so many exclusions, disclaimers and caveats that it is difficult to imagine who benefits from them, except for auditors.

The non-performing assets (NPA) situation illustrates all that is wrong with auditing. Banks are subjected to many types of audit such as the annual financial statement audit, concurrent branch audit, annual branch audit, regular stock audit, and so on. Yet, NPAs are at alarming levels. Also, there are large-scale frauds in the financial statements of some borrowers. But nobody has thought of holding the auditors accountable for their failure. There is hardly any published bank audit report that has highlighted substantial under-provision for NPAs or weak credit appraisal systems. Despite the auditors’ poor record, the ICAI constantly lobbies for expanding audit coverage especially in public sector banks. The standard line of accountants is that auditors are not responsible for the detection of fraud. It is unclear what they are responsible for.

After the Satyam scandal there was a flurry of activity but with no observable improvement. Auditors are now required to report on internal financial controls. These reports read like boilerplate. They seldom mention any internal control weaknesses. Going by them, Indian companies would seem to have the best internal controls in the world. Despite many companies ceasing to function or being unable to carry on without continued external financial support, going concern qualifications are non-existent. These are mere symptoms of serious audit quality problems.

The most bizarre thing is that despite its poor record in protecting investors, creditors and society, the power of the accounting industry has grown by leaps and bounds. The ICAI’s past and serving presidents, vice-presidents and council members are in committees of the ministry of corporate affairs, ministry of finance, RBI, SEBI and other public institutions. These positions give them enormous power to influence the deliberations and outcome of committees in favour of the accounting industry.

The ICAI’s council is reported to have held a “brainstorming session”. Predictably, the ICAI wants more powers to regulate its members. However, this time the Government should not give in and should instead push for radical institutional changes.

First, the Government should set up the National Financial Reporting Authority (NFRA), the body responsible under the Companies Act for the establishment and enforcement of accounting and auditing standards and oversight of the work of auditors. The ICAI has successfully lobbied against the NFRA so far. The quality of the NFRA will depend on the quality of its members and staff. It is important to get persons of high competence and impeccable integrity to help the NFRA achieve its mission. Filling the positions with connections, past or present, to the accounting industry would be the easiest way to hinder its functioning.

Second, the ICAI should be demutualised. Conflict of interest is built into the ICAI’s design as a mutual society. Its governing council is elected by CAs. Elected representatives can hardly be expected to act against the members who elect them. A demutualised ICAI should be run by a professional board with members drawn from the users of financial statements such as individual and institutional investors, banks, insurers, and others with an interest in the efficient functioning of capital markets. The ICAI should be responsible for CAs’ education, training, examination and continuing education. This will free the ICAI from its current preoccupation with establishing standards and disciplining members — matters in which it faces conflict of interest — so that it can work on matters that concern its large membership worldwide. With rapid changes in technology and regulation, there is a lot to do in these areas.

Third, a whole lot of pro forma activity should be dumped. These include tax audit, private company audit, bank branch and concurrent audit, and numerous certificates that require a CA’s rubber stamp. This will also be an important step in improving ease of doing business in India.

Fourth, regulatory bodies such as SEBI and the RBI should strengthen their capacity for monitoring and enforcing compliance with regulations. They should set up specialised divisions to examine accounting and auditing matters. The Securities and Exchange Commission in the US employs high-quality professionals to achieve its objectives. Expecting those who are regulated to improve the standards of regulation is naïve. The regulated have no incentive to improve the system. The push has to come from the regulator.

Finally, shareholder litigation should be made easy, accessible and economical. Nobody would be more interested in a company’s functioning than its shareholders. There is an urgent need to strengthen mechanisms such as arbitration and expert witnessing in order to improve the speed and fairness of redressing shareholders’ complaints against company auditors. Class action rules should be disseminated widely. The fear of litigation contributes in no small measure to doing the right thing.

The Prime Minister asked the CAs: “Who did you work [for] after demonetisation? Client or country?” Clearly, it was a rhetorical question. The accounting community should ponder this question and change its ways. Otherwise, CA Day will be risible. And the Government may launch a surgical strike.

The writer is a professor at IIM-Bangalore. The views are personal

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