Auditors’ duty is to verify, not detect

Lokeshwarri SK | Updated on September 12, 2019

The SAT’s verdict in the Satyam case brings about some rationality in the manner in which the auditing profession is viewed

In the ongoing battle between the market regulator, the Securities and Exchange Board of India, and auditors, this round has gone to the latter. The Securities and Appellate Tribunal has not only reversed a large part of the order delivered by SEBI’s Whole Time Member against the auditors of Satyam Computers, it has also rapped the regulator on the knuckles for regulatory over-reach.

The Satyam saga that began on January 7, 2009, with the famous email sent by Ramalinga Raju to SEBI, has had a far-reaching impact on the audit profession. The dramatic mail, besides comparing Raju’s predicament to ‘riding a tiger’, had stated that the accounts of the company were not true and fair. SEBI’s investigations into the affair revealed that the published books of accounts, as on September 30, 2008, contained false and inflated bank and fixed deposit balances, fictitious interest income, revenue and debtors’ figures.

Based on these findings, SEBI had issued an order against firms practising under the brand and banner of Price Waterhouse and the partners involved in the audit of Satyam, restricting them from auditing any listed companies for a period of two years. SEBI had also ordered disgorgement of the audit fee of ₹13.09 crore along with interest at 12 per cent per annum from January 2009.

In a balanced and well-argued ruling, the Securities Appellate Tribunal (SAT) has quashed the SEBI order barring the firms from auditing listed companies, while retaining the disgorgement ruling. Besides this, there are other interesting takeaways from the SAT order, which will be music to the ears of the auditors.

SEBI’s jurisdiction

The important contention in the auditors’ appeal against the SEBI order was with regard to the market regulator’s power to rule against auditors who were governed by the Institute of Chartered Accountants of India. It needs to be noted that the ICAI had already passed an order in 2015 against the chartered accountants involved in the case — S Gopalakrishnan and S Talluri, P Siva Prasad, C Ravindernath, V Srinivasu and VS Prabhakara Gupta.

The ICAI had found them guilty of professional misconduct and awarded the maximum punishment of removal of their names from the Register of Members permanently and had also imposed a fine of ₹5 lakh each on them.

In order the address the issue of extent of SEBI’s powers, SAT relied on a Bombay High Court order pertaining to the Satyam case.

The Court had held that the jurisdiction of SEBI to rule against the auditors of Satyam Computers would depend on the evidence unearthed during the SEBI investigation and that if there was only some omission without any ‘mens rea’ or connivance with anyone, then SEBI could not issue any further direction.

Based on the above, the Tribunal has held that SEBI does not have the power to pass an order restraining the auditors because, while accounts have been falsified, there is no direct evidence that the auditors were involved in the falsification. In fact, the chairman of SCSL (Satyam Computer Services Ltd) has gone on record to state that the statutory auditors were kept in the dark and that they had no role to play in the fudging of the books of account.

The negligence and recklessness in adhering to the AAS (Auditing and Assurance Standards) in the course of auditing the accounts of Satyam, points towards professional negligence which needs to be addressed by the ICAI and does not fall within the purview of SEBI.

This ruling can provide some relief to auditors. In instances where the company’s management intentionally falsifies accounting statement, auditors need not worry if they have conducted their work in accordance with auditing standards. Only if they have connived in falsifying the financial statements of a listed company, will SEBI get the power to pass a preventive and remedial order, restraining them from future audits of listed companies.

Watchdogs not bloodhounds

With rising instances of corporate frauds — an ICAI study shows that 2 per cent of accounting statements are likely to have been misstated — it is common to point fingers at internal and statutory auditors for not detecting the falsification of statements. SAT has batted for the auditing profession in this order by pointing out that the auditor is required to employ reasonable skill and care but the auditor is not required to begin with suspicion or to proceed in the manner of trying to detect a fraud or a lie, unless some information has reached which creates suspicion.

The auditor is not required to perform the functions of a detective. “The auditor is a watchdog and not a bloodhound. The duty of an auditor is verification and not detection,” says the order. The Tribunal has also pointed out that forensic audit is different from a statutory audit wherein verification is done by selective sampling alone.

Governing auditors

A lot of water has flowed under the bridge over the last decade, since the Satyam episode first came to light and the audit profession has also seen numerous changes that increase transparency and decrease the possibility of auditor connivance with the management.

Yet, the recent instance of the role of auditors in IL&FS Financial Services, revealed in the SFIO report shows that the regulatory bodies cannot let their guard down in supervising the conduct of the auditors. With investors as well as all external stakeholders relying on the audited numbers in decision-making, it is critical that sufficient care is taken to ensure that the reported numbers are true and fair.

But converting regulatory supervision into a witch-hunt is also not a solution as it can have adverse impact — as seen in the slew of auditor resignations in recent times.

Clearly, audit profession is an old one and the rules are, for most part, in place. If audit committees which have a majority of independent directors do their work diligently, it can ensure that auditors are truly independent and carry out their duties effectively.

With the National Financial Reporting Authority set up last year, taking on the role of a supervisor to ensure compliance with accounting and auditing standards or undertaking investigations, auditing outcomes could get better. Providing sufficient resources to this institution will be important for establishing an additional level of check on the auditors.

Published on September 11, 2019

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