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Warren Buffet said “Risk comes from not knowing what you are doing”. Auditors, who can lay claim to being in one of the riskiest professions around now, may not agree with the Sage of Omaha since they would invariably believe that they know exactly what they are doing when they sign-off on the financial statements of the auditee.
However, the pursuit of profits by a business many a time involves entering into complicated arrangements which the auditor may not be privy to or which would be documented in so much detail that the essence of the transaction is obliterated.
Pluri Cell E
Pluri Cell E is in the news for its complicated chain of transactions ultimately benefiting the Reliance Group – masquerading as a French couple in the documentation. The Financial Services Authority (FSA) in the United Kingdom focused on the happenings at investment banks and their tendency to cross the line between disclosure and deception at will.
The Securities and Exchange Board of India (SEBI) was conducting its own investigations into the round-tripping of Indian funds through investment vehicles abroad that traded in participatory notes and other derivatives.
The Reliance Group requested for a consent agreement which SEBI agreed to on January 14, 2011 for an amount of Rs 50 crore. The consent order barred the defaulting companies and the implicated individuals from making investments in listed securities in the secondary market restricted participation in the markets.
But one of the most critical conditions mentioned in the consent order was that the Reliance Group implement a policy of rotation of the statutory auditors and therefore the statutory auditors for the year 2009-10 shall not be appointed for a period of three years commencing from 2010-11. Without saying it in as many terms, SEBI appears to have found the auditors' responsible for not reporting the round-tripping.
Companies Bill 2011
The Companies Bill 2011 agrees with SEBI. Apart from rotation of auditors over half a decade or a decade, depending on the constitution of the auditor, the Bill adds a few more clauses on the responsibilities of the auditor. He is expected to report on any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith and whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls.
Other matters connected therewith can include anything and everything a company deals with and can land the auditor in trouble since he is expected to play God and know everything in every rule-book applicable to the company and if the company has followed them. SEBI charged Reliance with violating the SEBI Act, 1992, the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 and the SEBI (Foreign Institutional Investors) Regulations, 1995.
While it is expected that the auditor should know these rules, detecting non-compliance in a web of cross-holdings could prove to be tough. Reporting on internal controls is a direct import from the Sarbanes Oxley Act and does give power to the auditor to say it as it is.
A residual clause specifies that any other matter can also be prescribed to be reported. The Bill further empowers the auditor of a company who- in the course of the performance of his duties as auditor- has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, to report the matter to the Central Government within such time and in such manner as may be prescribed- a sort of a whistle-blowing mechanism for the auditors.
Risk-reward ratio
The provisions in the Companies Bill, 2011 follow the draft recommendations of the Barnier Report in the European Union though the latter focuses on joint audits too apart from mandatory rotation of auditors. As risks and rewards generally go together, the audit community would expect to be adequately rewarded for their work.
This would be all the more pertinent now since in case they are found guilty of negligence, the reward is to be returned in addition to monetary and other liabilities.
The risk-reward ratio would be all the more relevant in the audit of Government companies where the auditors have an additional responsibility - facing off with the team from the Comptroller and Auditor General of India (CAG).
(The author is a Bangalore-based chartered accountant.)
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