The NFRA’s first set of audit quality reviews of IFIN raise fundamental questions

It is good to see National Financial Reporting Authority (NFRA) — the super-regulator set up by the Centre in 2018 to oversee the auditing profession in India — not letting the grass grow under its feet. Having initiated a review of the audit procedures and standards followed in the case of the failed IL&FS Financial Services (IFIN), it has now put out two exhaustive audit quality review (AQR) reports analysing threadbare the lacunae in processes of two big-name auditors — Deloitte Haskins & Sells LLP and BSR & Associates LLP — who certified the firm’s accounts just before it went under. It has passed orders debarring three former partners of Deloitte for not exercising adequate due diligence. While the order has been challenged on jurisdiction, the issues flagged in the AQRs set important precedents for the auditing profession.

Three issues raised by the NFRA have fundamental ramifications for the profession. One, the regulator argues that for stakeholders to repose confidence in their reports, statutory auditors, like Caesar’s wife, must be above suspicion. They need to not just ensure independence of mind but also give dispassionate observers no reason to doubt this independence. It alleges that IFIN’s statutory auditors failed in this by virtue of their affiliates pocketing substantial fees from non-audit services to IFIN group entities. Invoking Section 144 of the Companies Act which expressly prohibits such engagements, the NFRA interprets the terms ‘management services’ and ‘business relationships’ in the broadest possible manner, to debar auditors from undertaking services such as employee background checks, evaluating deals or business continuity plans for clients. This view, if upheld, is likely to put paid to the common practice of audit firms supplementing their fee income by providing prospective and past clients with a range of non-audit services that expose them to conflicts of interest. Two, by taking the stringent view that even services provided by affiliates of an audit firm to group entities of an auditee disqualify it from accepting an engagement, the NFRA has also called into question the practice of multinational accounting firms setting up India offices for management consulting (to comply with the letter of the law), while using an informal network of Indian affiliates to take up audit work prohibited to the parent. Three, it has hauled up IFIN’s statutory auditors’ for failing to upbraid the management for its delay in complying with RBI inspection reports, not exercising ‘professional scepticism’ on assurances given by the management and resorting to ‘soft reporting’ instead of qualifying IFIN’s accounts for overstating net worth and capital adequacy ratios.

The NFRA’s observations threaten to upend established ways of doing business for many big-name auditors and their clients in India. It is thus bound to face considerable push-back from vested interests. The Centre also needs to take note of NFRA’s findings to plug loopholes in the regulation of the accounting and auditing profession created by the ambiguous drafting of the Companies Act and Chartered Accountants Act.