NFRA starts off on the wrong foot

There was much hope when the finance minister announced the setting up of the NFRA on March 1. The Centre’s notification of March 21 regarding its composition has, unfortunately, put paid to that hope.

A brief background

The NFRA was first proposed as an independent regulator of accounting and auditing in the wake of the Satyam scandal which went undetected for many years by the company’s auditors. There was a public outcry and calls for a complete overhaul of the regulation of the accounting and auditing profession in India.

In 2010, the report of the Standing Committee on Finance of the Lok Sabha on the Companies Bill 2009 recommended the creation of a supervisory mechanism with a “mandate not only to set and oversee accounting and auditing standards, but also to monitor the quality of audit undertaken across the corporate sector” (paragraph 37). As a result, the Companies Act 2013 included Section 132 relating to the NFRA.

The Institute of Chartered Accountants of India (ICAI) opposed the creation of the NFRA from the beginning arguing that it was doing a good job of regulating auditors and there was no need for another regulator. While most provisions of the Companies Act 2013 had been notified by 2017, curiously, Section 132 was not.

In 2016, the Standing Committee on Finance of the Lok Sabha on the Companies (Amendment) Bill 2016 recommended that the excising mechanism under the ICAI Act “should be strengthened and streamlined without needlessly adding to regulatory levels” (paragraph 3.21). This could have aborted the NFRA. The committee’s recommendation came in the face of the strong case made for the NFRA by the Company Law Committee and the ministry of corporate affairs (MCA), and the earlier Standing Committee. This speaks volumes about the ICAI’s lobbying power. Fortunately, the MCA stood its ground on the need for the NFRA, though it was not set up.

The scene changed drastically after Prime Minister Narendra Modi gave CAs a rap on the knuckles in his speech on Chartered Accountants’ Day on July 1, 2017. The speech strongly hinted at CAs’ involvement in money-laundering and tax evasion and highlighted the ICAI’s poor record of disciplining its members. Used to being lauded for its efforts in “nation-building”, the CA community was shocked by the Prime Minister’s candour and the threat of severe action against errant CAs. Despite this there was no progress, which is further proof of ICAI’s lobbying skills. This would have been inconceivable in any other country.

The PNB wake-up call

The ₹13,000-crore Punjab National Bank fraud perpetrated by certain companies that surfaced in February has raised questions about the effectiveness of auditing in banks. Public sector banks (PSBs) have a variety of audits done by CAs including statutory, branch, concurrent, and stock audit. The accompanying table shows the amounts paid by banks to external auditors in fiscal years 2017 and 2016.

Despite paying such hefty sums to the auditors, bank frauds continue to take place. The rising non-performing assets of banks have also raised questions about the auditors’ failure to review asset quality carefully and insist on provisions for bad loans. The PNB fraud finally forced the government’s hand on setting up the NFRA.

 

 

1 step forward, 2 steps back

Unfortunately, the composition of the NFRA, which will consist of a chairperson, three full-time members and nine part-time members, suggests that it may not be fully independent.

The part-time members will be one each to represent the MCA, the Comptroller and Auditor-General of India, the Reserve Bank of India, and the Securities and Exchange Board of India, three from the ICAI — president, chairperson of Accounting Standards Board and chairperson, Auditing and Assurance Standards Board — and two experts from the field of accountancy, auditing, finance, or law.

The inclusion of three members from the ICAI’s council is intriguing. The Companies Act 2013 has no such requirement. The government has repeatedly stressed that the NFRA is being set up as an independent regulator and precisely because the ICAI’s self-regulation is conflicted and not working.

Having three members from the ICAI is not the best way to reassure the consumers of the services of auditors about the independence of the audit regulator. Interestingly, the rules require the chairperson and all members to submit a declaration of no conflict of interest or lack of independence.

The members drawn from the ICAI’s council are practising CAs and by virtue of their activities as auditors or advisers to their clients and others they are certain to be conflicted and lack independence. Their presence in the NFRA will raise troubling questions about the body’s neutrality. It is not clear what the ICAI’s council members can do which the other members can’t. The National Advisory Committee on Accounting Standards (NACAS), the predecessor to the NFRA, had one nominee of the ICAI compared to the NFRA’s three. This is anything but progress.

A question of trust

The separation of the regulator from those it regulates is a fundamental principle of good governance. There is no instance of a regulatory body having representatives of those regulated. This is true of the Securities Board of India (SEBI), the Telecom Regulatory Authority of India (TRAI), and the Competition Commission of India (CCI). It would be unthinkable for the US Public Company Accounting Oversight Board (PCAOB), the UK Financial Reporting Council (FRC), the Australian Securities and Investments Commission (ASIC) to include members of the audit industry associations in their countries.

The International Forum of Independent Audit Regulators (IFIAR) stipulates that any regulatory board member active with a professional body or a firm cannot have access to the IFIAR ‘members only’ website, attend IFIAR meetings or receive IFIAR papers and news for members. In other words, the three ICAI council members on the NFRA would not be considered on par with the others.

The IFIAR gave the ICAI the cold shoulder precisely because it is an association of practitioners. In India, the government has indulged the CA community for too long and the consequences are there for all to see. It is time to make the relationship business-like.

Arm’s length relationship between the regulator and the regulated is essential to prevent undue influence on the regulator. Formal independence of the regulator is necessary to maintain trust and public confidence. CAs elect members of the ICAI’s council to represent their interests, and not to protect the interests of investors, creditors, tax authorities, and other stakeholders. Allowing the industry association’s representatives to have a say in the working of the NFRA is like letting the fox guard the hen-house.

The writer is a professor of finance and accounting, Indian Institute of Management-Bangalore. The views are personal

COMMENT NOW