It is time to focus on accounting companies (23 January 2001)  

Even after the collapse of the CRB group, there was no action against the accounting firm which audited its accounts. The firm, operating out of the back lanes of Calcutta, is probably busy certifying cooked up accounts of other firms whose annual reports are duly filed with DCA

On January 6, the Securities and Exchange Commission (SEC) of the USA released a report by independent consultant Jesse Fardella, who was appointed by it to investigate violation of independence rules by the accounting firm PricewaterhouseCoopers (PwC). A year earlier, the SEC had censured PwC for such violations on the basis of an on-going investigation and followed this up with Fardella’s appointment to supervise an internal review by PwC.

Under US laws auditors are not allowed to hold securities issued by client firms/companies that are audited by them. These include securities, mutual funds, insurance products and even bank accounts. Apart from insider trading regulations, these “auditor independence rules” are aimed at ensuring that auditors simply cannot buy or short sell scrips of companies audited by them - companies where they have inside information on financial performance.

The results of the PwC investigation were startling. They showed that 86 per cent of PwC’s partners had violated the independence regulations at least once. PwC had attributed the large number of violations (8064) to the merger of Pricewaterhouse with Coopers & Lybrand, but the SEC investigation indicated that it was not a one-time breakdown in compliance because of the merger. The investigation, on the contrary, showed that professional self-regulatory procedures which depended on individual initiative to follow the rules had failed to detect violations. The SEC has now asked the Public Oversight Board to sponsor independent reviews at other firms and figure out ways to improve professional standards.

The SEC findings are interesting for several reasons. At a recent meeting of a committee appointed by the Department of Company Affairs, consumer activist Manubhai Shah had suggested that auditors should not be allowed to buy shares of companies audited by them. There was no mention of extending this to mutual funds or other securities. Yet, everybody in the room agreed that the mere suggestion of such rules would create a furore among accounting professionals in India. If the suggestion seemed so stringent even to non-accounting persons in that meeting, it is because of the low expectations that we have from independent auditors. The PwC independence audit shows that self-regulation does not work even in the US.

Yet, in India we not only condone professional misconduct and dereliction of duty by auditors but leave the supervision and censure of these firms to a self-regulatory body which has distinguished itself only for its inaction against member firms. Accounting firms in India escape responsibility and accountability because they face no pressure from the investing public or investor protection groups. Punitive actions by the Securities and Exchange Board of India (SEBI) and the Department of Company Affairs against individual audit firms are unknown. In fact the only known action against audit firms in the last 10 years was the slap on the wrist delivered by the Reserve Bank of India after the Securities Scam in 1992. It had dropped a firm which audited certain banks from its list of empanelled firms for a couple of years. Otherwise, auditing misdemeanors are good for a couple of news reports and fades away. I am not sure if the Institute of Chartered Accountants even discusses all cases of delinquency, let alone punish firms by scrapping their registration.

Even after the collapse of the CRB group, there was no action against the accounting firm which audited its accounts. The firm, operating out of the back lanes of Calcutta, is probably busy certifying cooked up accounts of other companies whose annual reports are duly filed with the DCA.

It is same with vanishing companies. The Indian Express series on vanishing companies shown that entire groups promoted by the same individuals seem to disappear from the public eye after tapping the capital market for funds. Surely all of them have the same auditors? Again, neither SEBI nor the DCA has targeted these auditors. In fact, the DCA’s website lists vanished companies (provided by SEBI) with their addresses. It would be useful for it to now collate the names of the auditors of these firms and ask the Institute of Chartered Accountants of India (ICAI) to investigate collusion negligence or delinquency by the audit firms and to initiate action against them within a fixed time frame. Otherwise they should initiate action on their own.

All over the world accounting firms are not only more responsible but they even pay a price for failing to do their job. They are sued and have to protect themselves through insurance. For instance in Dubai, the central bank has initiated stern action against the well-known firm Ratan Mama Consultants in the wake of the scandal connected with the failure of HAMCO, a firm of India origins. It is learnt that the firm has been stopped from auditing several categories of companies. Since the firm of Ratan Mama has associates and clients in India, the Central Bureau of Investigation (CBI) is also conducting an investigation, but not a whiff of it has been allowed to leak to the press. This attitude only makes it easier for companies to get away unpunished and with no loss of reputation either.

The same attitude and public apathy marks the devastating disclosures routinely put out by the Comptroller and Auditor General on mismanagement of public funds. Last year alone it reported the excessive employment of teachers at government assisted schools in backward Bihar (a stunning ratio of one teacher for every student), the exorbitant spending by the Telecom Regulatory Authority of India on foreign junkets, misuse of several corporate aircraft by the hugely loss-making public sector behemoth the Steel Authority of India Ltd and finally the diversion of relief funds collected by state governments. None of these reports have provoked any reaction from the elected public representatives or led to any punitive action.

Yes, India is a long way from regulation so stringent that auditors are subject to US style independence regulations, but is it not time to at least ensure that so-called independent auditors are not ensconced within the corporate offices of their large client firms. I can think of at least three large Indian groups, where the auditors operate almost like a subsidiary of the group. As usual, the regulators are unlikely to get tough and demand time bound action from self-regulatory professional bodies or simply drop the charade of self-regulation, unless investor groups step up the demand for such action.