Since Enron, rotation of auditors has often been seen as the panacea for all financial accidents occurring.

The European Union (EU) is considering implementing the recommendations of the Barnier Report, which inter-alia advises that audit firms be required to rotate after a maximum engagement period of six years. A cooling-off period of four years is applicable before the firm can be engaged again by the same client.

The period before which rotation is obligatory, can be extended to nine years if joint audits are performed, i.e., if the entity being audited appoints more than one audit firm to carry out its audit.

The Sarbanes Oxley Act — now proved to be a reaction to Enron than a solution — set the practice of detailing non-audit services that an auditor would be barred from doing.

The Barnier Report continues with this trend, by stating that audit firms would be prohibited from providing some non-audit services to their audit clients if non-audit fees exceed 10 per cent of audit fees. Large audit firms will be obliged to separate audit activities from non-audit activities in order to avoid all risks of conflict of interest, thus creating audit-only firms.

The list of prohibited services has the usual suspects — book-keeping and other such services that could be linked to the audit. Clause 49 of the Listing Agreement repeats these provisions.

Research in the UK is attempting to prove that the heads of finance in large companies tend to prefer those audit firms where they learnt the skills of their trade. That cannot, by any means, be said to be best-in-class governance practices.

Companies Bill

The Companies Bill, which is a step away from becoming law, has many sections dealing with auditors. On their duties, the Bill proposes punishment for auditors who sign financial statements with gay abandon. The punishment clauses begin with a run-of-the-mill fine, which shall not be less than Rs 25,000 but which may extend to Rs 5 lakh.

It gets more serious if an auditor has contravened such provisions with the intention to deceive the company or its shareholders or creditors or any other person concerned or interested in the company. In that case, he would be punishable with imprisonment for a term that may extend to one year and with a fine that shall not be less than Rs 1 lakh and may extend to Rs 25 lakh.

The question to be asked is: How does one prove the intention behind certifying statements that had financial landmines? Can one say that the auditor who signed the financials of, say, a SkyLight Hospitality, did so with an intention to deceive anyone?

Since auditors comment on the financial health of the company and its monies and report to the shareholders, it would not be too difficult for anyone to prove that the intention behind not pointing out a glaring error was to deceive someone. Just to rub salt into the wounds of the bruised auditor, the Bill states that the auditor shall refund the remuneration he received and also pay for damages. Auditors and the insurance industry should be talking to each other soon to think of insurance policies to off-set damage claims.

Rotation

Rotation of auditors has often been seen as the panacea to set right financial accidents in entities.

The Companies Bill mandates that an individual cannot be appointed as an auditor for more than five years and a firm cannot be appointed for more than a decade.

A decade is a long time in the lifetime of an entity and the auditor. If they both want to be partners in crime, they could do so in year one itself, knowing well that they have nine years to cover this up. Even if the company wants to reappoint the auditor who retires after his term, there is a cooling period of five years.

While the original Companies Bill gave an option to companies to decide if the audit partner and his team should be rotated every year, the amendments to the Bill have retained this proviso, but given the option to companies to decide at what time-intervals the rotation should occur.

Annual rotation of partners could at least provide some glimmer of hope that both the parties have attempted their best to be independent. However, independence being primarily a state of mind, there could be quite a few balance-sheets published out there, which contain land-mines that no Act can eradicate.

As long as deterrent laws are in place, one can only hope that such instances are the exceptions rather than the rule.

(The author is a Bangalore-based chartered accountant)

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