Regulators shouldn’t only target auditors

Mohan R Lavi | Updated on October 19, 2021

In the Srei Infra case, for instance, the RBI should also have recommended action against the management of the enterprise

The environment around audit firms and regulators in India has been action packed. The action commenced after Satyam and has gained a lot of pace post the IL&FS and PNB episodes. SEBI initiated action against the auditors of Satyam, NFRA (National Financial Reporting Authority) looked into detail at the work done by the auditors of IL&FS and Jaiprakash Associates, the C&AG has given negative reports on the audit work of public sector undertakings done by some audit firms, and the RBI has banned a few firms from doing audit work of banks and financial institutions.

The only regulator that has not taken any action against audit firms appears to be IRDAI. The position of audit firms today can be likened to a situation wherein they are batting in a game of cricket but have to face bowlers who are not on the field and can come on any time to bowl and attempt to get them out.

The most recent action of the RBI against audit firms is rumoured to be for their audit of Srei Infrastructure Finance (SREIF) — rumoured because the RBI does not state names and facts when the announce such bans. Some time back, the RBI had replaced the entire board of SREIF, which is also facing insolvency proceedings under the Insolvency and Bankruptcy Code.

The RBI has maintained a stoic silence on the reason for the ban on the audit firm — all we have is the failure to follow a particular RBI instruction. At a time when the focus is on improving audit quality, the RBI should have stated the specific reason for the ban in order that other audit firms take a cue from this to improve their audit quality.

The audit report of SREIF has a qualification on the ability of the firm to continue as a going concern, six matters on which they have laid an emphasis of matter, and four areas of Key Audit Matters. The financial statements of SREIF typify the issue with firms that are ailing in the infra and real estate spaces — a balance sheet wherein borrowings stand out for their enormity and have to be paid and investments that match borrowings in their enormity but not in their realisable value.

For the year ended March 31, 2021, SREIF took a hit of almost ₹6,000 crore for impairment of some of their financial assets. One wonders what else the audit firm should have mentioned in their report to avoid the RBI ban. The continuing focus on audit firms distracts one from focussing on the management of the enterprise in question and the action being contemplated against them. Surely, the regulators who have taken action against audit firms can take action or recommend action against those who were responsible from the enterprises’ side.

In the case of SREIF, even before the auditor missed the RBI instruction, there was someone in SREIF who had also missed the same instruction. Regulators would need to figure out a way to name and blame everyone responsible instead of taking action only against statutory auditors who invariably come to the table only after all have left.

It is possible that the issues at SREIF came to light because they had to follow Ind AS — the loans on which impairment losses were made were measured at amortised cost and the rest were at fair (market) value. For reasons that are not known, the RBI is yet to mandate banks to adopt Ind AS — the impact on their loan loss provisioning and investments are expected to be significant. If the RBI desires high-quality audits, they should ensure that they prescribe high-quality accounting standards.

Regulating the regulators

When introduced, the Companies Act, 2013 was considered a draconian piece of legislation since it used the word imprisonment 78 times. This Act had a separate Chapter XIV consisting of 24 sections which empowered the Registrar to conduct inspection, inquiry and investigation. Sections 211 and 212 of this Chapter indicated action being taken by the Serious Frauds Investigation Office (SFIO) — yet another regulator. Anyone found guilty of furnishing a false statement under this Chapter could be charged with fraud under Section 447 of the Act.

The SFIO has published information about investigations undertaken and officers held guilty — but the data pertains to the year 2017-18, suggesting that the SFIO has slowed down after NFRA was contemplated. There is not much information in the public domain about action taken under Section 447 of the Companies Act, 2013. There have been calls to have a super-regulator to avoid a multitude of regulators but this may not happen as the existing regulators are well-entrenched in their turf and would not want to let go of their control.

It is important that the multitude of regulators get together and issue a charter as to who will investigate whom and under what circumstances. If possible, the charter should also prevent multiple regulations by different regulators. Each of these regulators should then incorporate this provision in their respective rules so as to ensure that everyone is clear about what to expect and from whom.

The writer is a chartered accountant

Published on October 19, 2021

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