Stress on auditors’ accountability is good, but more reforms are needed

Along with rating agencies, statutory auditors have played a central role in the recent string of corporate scandals that have rocked India Inc and undermined public confidence in the financial system. IL&FS and DHFL saw yawning mismatches between assets and liabilities come to light after debt defaults. The PMC Bank failure seems to be the result of concentrated crony lending that blatantly flouted regulatory norms. In many instances, post-mortem forensic audits commissioned by regulators have uncovered evidence of financial fraud and window-dressing on a grand scale, that the statutory auditors apparently failed to detect despite their close acquaintance with the firm’s finances for years. Therefore, the Ministry of Corporate Affairs is quite right to consider measures that will place a greater burden of accountability on the statutory auditors of companies.

The Ministry is said to be working on an overhaul of the Companies Auditor’s Report Order (CARO), additions to the secretarial audit report and a requirement for auditors to digitally file their opinions even before the annual report is published. While these are good moves, it is important that the reform of the audit profession in India doesn’t stop with this. CARO 2016 already prescribes a list of over 16 items on which statutory auditors are required to certify that firms they are auditing are complying with the law. But the fact that corporate frauds have flourished despite this, can only indicate that the auditors have either been woefully negligent or complicit with the management. Therefore, the Ministry would do well to institute stiffer penalties in proven cases where poor audit standards have contributed to fraud. As a firm’s propensity to cook its books shows up in many ways — from aggressive revenue recognition to large related party deals — statutory auditors do have the ability to serve as an early warning system on misdoings. But in the Indian context, this ability is undermined by the auditors’ extreme reluctance to call a spade a spade. Qualified opinions are kept to a bare minimum and vague obfuscations are used to flag critical issues. The newly constituted audit regulator, National Financial Reporting Authority (NFRA), can play a key role in addressing this, both through its audit quality reviews and its penal powers.

The Centre must expedite efforts to the augment the regulatory capacity and resources of the NFRA, to help it effectively fulfil its mandate. It is also important that it doesn’t give in to specious arguments that the NFRA’s powers to impose stiff punishment, such as debarment of erring auditors for upto 10 years, impede ‘ease of doing business’ or ‘ease of living’ in India. Recently, the Company Law Committee, to decriminalise corporate offences, has taken the view that debarment is too extreme a penalty and the Institute of Chartered Accountants of India should ‘ideally’ be the body making these decisions. The ICAI’s lacklustre record in penalising errant members is, after all, the raison d’etre for the NFRA.

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