One of the greatest roadblocks on the path of sustainable and collective economic growth is the abuse of economic power and the collection of wealth through illicit means. To curb this menace, companies appoint auditors to pore through their books of accounts, transactions, and internal practices, and investigative agencies are empowered to take action against alleged offenders.
However, recently, auditors have been on the receiving end of a considerable amount of flak for their roles in assisting and enabling massive corporate accounting scandals. Globally, auditors have been found guilty of fudging accounts for the benefit of the large organisations that they were meant to keep in check. The fall of one of the erstwhile "Big 5", Arthur Andersen, was a result of their complicity in a fraud that caused a loss of $74 billion to shareholders. Andersen was also found to have carried out faulty audits of WorldCom, whose inflated assets caused a loss of $180 billion to investors, and was finally uncovered by WorldCom's internal auditing department. Though the obstruction of justice conviction against Arthur Andersen was eventually overturned by the United States Supreme Court, the damage to the accounting firm had been done.
In the aftermath of Arthur Andersen's demise, a number of corporate accounting scandals were brought to light, and the Sarbanes-Oxley Act of 2002, also known as the Corporate and Auditing Accountability, Responsibility, and Transparency Act, was enacted on 30th July , 2002. Among other objectives, the Sarbanes-Oxley Act prevented auditing firms from providing non-audit services to companies whose audits were being conducted by such auditing firms. Similarly, the Dodd Frank Wall Street Reform and Consumer Protection Act, 2010 (Dodd Frank Act) was enacted in the US following the 2008 financial crisis, and overhauled financial regulation to prevent a repeat of the global economic disaster caused by an abuse of financial products. The subsequent rollback of the Dodd Frank Act by the enactment of the Economic Growth, Regulatory Relief and Consumer Protection Act on 24th May, 2018, is characteristic of the trend of increased regulation after a crisis to deregulation during an economic boom, and a longer conversation best left for another day.
Closer to home, while deciding whether Multinational Accounting Firms (MAFs) were operating in India illegally with the help of Indian Chartered Accountancy Firms (ICAFs), the Hon'ble Supreme Court of India, vide its judgment dated 23rd February, 2018 in S. Sukumar vs the Secretary, Institute of Chartered Accountants of India , acknowledged the importance of the auditing profession to the economy and the need for an equivalent framework to the Sarbanes-Oxley Act and the Dodd Frank Act in India. The Hon'ble Supreme Court directed the Union of India to constitute a three member Committee of experts to look into whether the statutory framework in place to enforce Sections 25 and 29 of the Chartered Accountants Act, 1949 and the statutory Code of Conduct for Chartered Accountants needs to be restructured or revisited. One vital question put to the Committee was whether on account of conflict of interest of auditors with consultants, the auditors' profession may need an exclusive oversight body.
In its findings, with "a focus to strengthen the legal regime of auditors and promote development of the audit profession in the country", the Committee called for the formation of the National Financial Regulatory Authority (NFRA), provided for by Section 132 of the Companies Act, 2013, and noted that, "adoption of NFRA will be in tune with the internationally accepted global best practices in this regard".
The Committee further took cognizance of the opposition to the formation of the NFRA. To wit, "However, the continued opposition to the establishment of NFRA has delayed the implementation of this critical reform. ... Once NFRA becomes fully operational, it will be adequately equipped to handle the contemporary challenges in relation to auditors, audit firms and networks operating in India." The formation of the NFRA would also make India eligible for membership in the International Forum of Independent Audit Regulators (IFIAR), a global organization of independent national audit regulators, whose membership has grown from 18 at inception to over 50 countries today. On 1st March, 2018, the Union Cabinet approved the establishment of the NFRA as an independent regulator for the auditing profession .
Naturally, the ICAI had also expressed its opposition to the overlap of powers between the NFRA and itself. In the 37th report of the Standing Committee on Finance (2016-17), the ICAI's concerns against the constitution of the NFRA were set aside by the Standing Committee, who, by a majority view, recommended that the NFRA be established early. The powers of the NFRA and the Institute of Chartered Accountants of India (ICAI) were also brought into question in the Rajya Sabha . To summarise, the Ministry of Corporate Affairs (MCA) answered that the NFRA would make recommendations on framing accounting and auditing policies/standards, monitoring and enforcing compliance, overseeing quality of service of auditing profession, and investigating and ordering action against professional and other misconduct by auditors. Though the ICAI would continue to maintain the list of chartered accountants and carry out examinations, the NFRA would have the power of debarring the member or firm from practicing as member of the ICAI. The MCA concluded by stating that, "The provisions of section 132 of the Act have provided for suitable clarity and flexibility to ensure that harmony and coordination is maintained in the role and powers of NFRA and Institute of Chartered Accountants of India."
The National Financial Reporting Authority Rules, 2018 (NFRA Rules) were published in the official gazette on 14th November, 2018. As per Rule 3 (1), the NFRA shall have the power to monitor and enforce compliance with accounting standards and auditing standards, oversee the quality of service or investigate the auditors of the following classes of companies:
Rule 3(1) -
- companies whose securities are listed on any stock exchange in India or outside India;
- unlisted public companies having paid-up capital of not less than rupees five hundred crores or having annual turnover of not less than rupees one thousand crores or having, in aggregate, outstanding loans, debentures and deposits of not less than rupees five hundred crores as on the 31st March of immediately preceding financial year;
- insurance companies, banking companies, companies engaged in the generation or supply of electricity, companies governed by any special Act for the time being in force or bodies corporate incorporated by an Act in accordance with clauses (b), (c), (d), (e) and (f) of sub-section (4) of section 1 of the Act;
- any body corporate or company or person, or any class of bodies corporate or companies or persons, on a reference made to the Authority by the Central Government in public interest; and
- a body corporate incorporated or registered outside India, which is a subsidiary or associate company of any company or body corporate incorporated or registered in India as referred to in clauses (a) to (d), if the income or net worth of such subsidiary or associate company exceeds twenty per cent of the consolidated income or consolidated net worth of such company or the body corporate, as the case may be, referred to in clauses (a) to (d).
Interestingly, the ICAI will continue to regulate auditors of private companies and unlisted public companies below the threshold limits under Rule 3 (1)(b). Similarly, the Quality Review Board (QRB) will continue to oversee the quality of services of auditors of such private companies and unlisted public companies.
However, such private companies and unlisted public companies are still required to inform the NFRA of the particulars of their auditors, as per Rules 3 (2) and 3 (3). This will enable the NFRA to notify companies when their auditors are penalised or debarred in disciplinary proceedings by the NFRA. Additionally, the NFRA is empowered to refer cases to the QRB relating to the quality of services of auditors of companies which are specified under Rule 3 (1).
On 1st July, 2019, the MCA issued a notification requiring all body corporates not governed by the NFRA Rules to fill Form NFRA-1 regarding the particulars of the auditor appointed by such body corporates. The last date for such a filing is 31st July, 2019.
A crucial distinction is found in the major function of the NFRA, which is to protect the public interest and the interests of investors, creditors and others associated with the companies or bodies corporate governed under Rule 3 (1) (supra) by establishing high quality standards of accounting and auditing and exercising effective oversight of accounting functions performed by the companies and bodies corporate and auditing functions performed by auditors.
While Rule 6 of the NFRA Rules provides that ICAI shall give recommendations to the NFRA in relation to accounting and auditing standards, it appears that the NFRA is expected to relieve ICAI of its powers of regulating and establishing standards for accounting and auditing in India.
If the auditing profession is expected to return to the position of integrity on which it was built, the NFRA and the ICAI must work together towards regulating the profession and establishing high standards in line with global expectations.
Dinesh Kanabar, while speaking on the state of the auditing profession in India, was quoted as saying, "The institute [ICAI] has to think deeply on the current issues. Where is the profession headed in India? Has the institute been just a tool at the hands of small accounting firms? Has it discharged its obligations in taking disciplinary actions? Has it been forward looking on the global developments? Has it participated adequately on the broader theme of corporate governance and how it can contribute to the debate?"
2. https://sci.gov.in/supremecourt/2013/35041/35041_2013 _Judgement_23-Feb-2018.pdf / (2018) 14 SCC 360
5. See page 47 onwards, at:- http://188.8.131.52/lsscommittee/Finance/16_Finance_37.pdf
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