Missing the mark

By definition, the Companies Act is a legislation meant to regulate companies. The 1956 version attempted this but in the process became too bulky unwittingly. The twin accounting accidents of Satyam and Sahara jolted the government to bring out a new version in 2013.

While regulating companies, the 2013 version seemed to train its guns on the people who ran the company (directors) and reported on its financial statements (auditors). Auditors who were used to benign terms such as audit reportand qualifications had to get used to harsher ones like imprisonment, internal financial controls and frauds.

A recent Notification from the Ministry of Corporate Affairs details how the statutory, cost and secretarial auditors should report a fraud.

The notification states that where the amount involved in the fraud is ₹1 crore or more, the auditor should alert the Audit Committee within two days, ask for a reply from them within 45 days and report the matter to the Secretary, Ministry of Corporate Affairs, with or without the reply.

In case the fraud involves an amount of less than ₹1 crore, only the Audit Committee or the Board need to be sensitised about it. The notification mandates the Board to report on the details of the fraud and remedial actions taken in their report.

Detecting and reporting a fraud takes time, effort and patience -- none of which a statutory, cost or secretarial auditor have due to the fact that their assignments are post-mortem exercises. At best, these auditors may have hunches or hazy indicators of a fraud. In such instances, the requirements of the notification to report on the nature of the fraud, approximate amounts and parties involved may put off the auditor from reporting it since he will not be able to tick most of the boxes required to be reported.

There is some audit or the other occurring at any given time in a company. Who has the best chance of discovering a fraud in an entity? It should be the Internal Auditor or Concurrent Auditor since he spends more time than any other auditor at the auditees place and knows a thing or two about their internal controls. The notification does not indicate any role for the Internal Auditor in reporting a suspected fraud.

The Companies Act mandates appointment of an Internal Auditor for listed and certain other class of companies. Though the duties of an Internal Auditor are decided between the company and the auditor, the Act should provide the Internal Auditor the freedom to report any fraud that has come to his notice to the other auditors. If they keep mum, he should report it to the government.

Enron showed us that the best bet to get information about possible frauds is to encourage whistleblowers. Most companies in India have whistleblower policies but these can work well only if there is a robust legal system to protect their interests. While the present legal system in the country does inspire some confidence, a couple of eerie decisions that are in the public domain could force whistleblowers to keep mum.

To control the occurrence or recurrence of frauds, what works best is a reward mechanism coupled with legal protection. The notification sets out the process to report a fraud. What it does not do is to provide encouragement to detect it.

The writer is a chartered accountant

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