3

Auditing the Auditors

 

3.01     Who audits audit? This question has vexed economists as well as corporate governance specialists. Simply put, the auditor performs a critical role in informing the shareholders of the true and fair picture of the state of financial and operational affairs of a company. However, the ability to play this role well depends upon the auditor’s knowledge, skills, independence, professional scepticism and integrity. It has been often argued that there are ought to be ais great  need to credibly regulate auditors effectivelyso as to ensure that they have properly discharged their fiduciary responsibilities.

 

3.02     In most countries, the regulatory role is carried out, to greater or lesser degree, by professional bodies representing certified public accountants. Whilst in some countries the regulator is a re are merely voluntary “non-statutory” self self-regulating organisation, in some others they are creatures of a specific statutes. In IndiaHere, the Institute of Chartered Accountants of India (ICAI) has been set up under the Chartered Accountants Act, 1949, to examine and regulate the profession. Similarly, the Institute of Company Secretaries of India (ICSI) has been set up under the Company Secretaries Act, 1980, to regulate its members. Analogously, and  the cost accountants are regulated by the Institute of Cost and Works Accountants of India (ICWAI)Institute of Cost and Works Accountants of India (ICWAI) regulate the cost accountants. Indeed, these three professional organisations are statutory bodies created by acts of Parliament, and not mere self-regulating organisations.

 

3.03     Until recently, most countries felt no need for any kind of public oversight board acting as  to be an independent apex organisation to regulate the conduct of these fiduciary intermediaries. The US corporate scandals have changed all that. Spurred by the public spectacle of senior auditors claiming little knowledge of the financial skulduggery of top-level executives of Enron and Worldcom, shareholders and corporate governance specialists as well as peoplethe world at large have been are increasingly demanding the setting up of credible public oversight bodies.

 

3.04     The first such move has beenwas initiated by the SOX Act, which has legislated in favour of setting up the Public Company Accounting Oversight Board (PCAOB). Box 3.A synopsises the basic elements of the PCAOB. Its provisions are worth reading in some detail, for it is the most comprehensive legislative intermediation in the history of auditing.

 

3.05     At the time of writing, there are reports that the financial community in the US is up in arms against the severe provisions governing the PCAOB. In fact, expert commentators believe that the rules and regulations governing PCAOB will have to be modified to suit reality. Irrespective of what happens in the US, it is a fact that providing for the PCAOB has raised similar demands in other countries. And, the Committee has been entrusted in its terms of reference to examine this matter. 

 

 

Should India have its Public Accounting Oversight Board?

3.06     The Committee took note of the Statement on Peer Review issued by the ICAI in March, 2002.  According to this statement, the ICAI has decided to aid professional firms in their quest for enhancement of quality of work through peer review, and have recognised that a professional should be always ready to show the quality of his work.

 

3.07     Quality has now come to be defined as the degree to which a set of inherent characteristics (distinguishing features) fulfils requirements, a requirement being the need or expectation that may be stated or generally implied, or obligatory.

 

3.08     The Committee, after some deliberation, came to the conclusion that while the ICAI statement on Peer Review is indeed a good one, it was time to think of a more independent and refined arrangement to ensure the quality of attestation services assignments performed by chartered accountants in relation to the technical standards prescribed for them.

 

3.09     The opinions expressed ofby those who met with the Committee were split along the middle: one set of people fervently advocated the setting up of an independent Public Accounting Oversight Board, while another — most notably, many chartered accountants, argued otherwise. We feel that it is important for the Committee to record both arguments before arriving at a conclusion.

 

3.10     Those who favoured an oversight board based their arguments on the perception of the efficacy and independence of ICAI. According to this school of thought, while the ICAI is legally empowered to carry out most of the regulatory, oversight and disciplinary functions outlined in the SOX Act (barring prosecution and levying of penalties), the public perception is that ICAI mechanisms are very slow and that the Institute seems to be loath to sufficientlyadequately discipline its errant members;. Ttherefore, it was argued, the need for a new, independent body to carry out such critical oversight functions.

 

3.11     Not surprisingly, many chartered accountants and spokespersons for ICAI believe otherwise. According to them, the Chartered Accountants Act, 1949, the regulations framed thereunder, and the organisational structure of ICAI enjoin the Institute to conduct all the necessary disciplining functions. The ICAI did agree that the procedures prescribed under the Chartered Accountants Act and its regulations tend to be slow, and favoured legislative amendments. They, however, contended that speeding up the process accompanied by changes suggested by them, should suffice to strengthen effective oversight over the disciplinary mechanism within the structure of ICAI. Hence, they felt that perhaps there was no need to create yet another legally mandated quasi-independent supervisory institution.

 

3.12     After considerable deliberation, the Committee came to the view that there was merit in theto ICAI argument. The reasons are as follows:

• First, the powers that are sought to be vested in the PCAOB of the United States under the SOX Act are today, in India distributed across a plethora of regulatory agencies — the DCA, SEBI, RBI, ICAI, ICSI, ICWAI, the power to proceed under the Information Technology Act, 2000, and residual powers under the Civil Procedure CodeCode of Civil Procedure and the Code of Criminal Procedure. Code.
• Secondly, therefore, if there were to be an Indian version of the PCAOB, then such powers would need to be withdrawn from the existing regulatory agencies and concentrated oin the proposed public oversight board. Without these powers, the board would be yet another toothless agency — maintained for the matter of form, pro formabut without any significant operational content. India, it was argued, had enough such cosmetic agencies, and did not need another one.
• Thirdly, it was argued that the need of the hour was reform of auditing oversight functions — but that such reforms did not necessarily entail circumscribing the powers of existing institutions to create yet another one. Instead, it was necessary to empower the organisations that are on the ground and, if need be, provide additional safeguards to ensure that they can expeditiously achieved their stated objectives.

 

3.13    On balance, the Committee opted in favour of this view, and therefore rejected the idea of setting up yet another new regulatory oversight body. However, it also felt that the ICAI must now show more determination and speed — and so prove that it is an efficient body that can be always entrusted to provide transparent and expeditious auditing oversight in the interest of investors and the general public.

 

3.14     If not a new public oversight board, then what? The Committee considered two major steps. First, recommending legislative and organisational support for the setting up of independent Quality Review Boards to strengthen and extendreform the peer review system   within the ICAI. Secondly, recommending significantly enhanced and expeditious disciplinary action within the framework of the Chartered Accountants Act, 1949 to bring errant auditors to book . The former is discussed in section 3.2, while the latter is examined in section 3.3 below.

 

Independent Quality Review Boards

3.15     Before recommending the setting up of independent Quality Review Boards (QRBs), it should be stated that tThe Committee examined the ICAI’s recently introduced system of peer review of audit firms, which is going to be operational from 1 April 2003. While ICAI’s Peer Review Statement seems to be an adequate, self-contained document that addresses most of the issues regarding ‘who audits the auditors’, it is still necessary to recommend a process of quality review that is publicly perceived to be independent and expeditious. The committee noted that such a system has already been established in Sri Lanka recently.  The committee recommends setting up of independent QRBs — one each for the ICAI, the ICSI and the ICWAI.

 

 

Disciplinary Action foragainst Professional Misconduct

3.16     The areasubject of disciplinary mechanism requires careful consideration. Spurred by revelations of significant audit failures in the US, there have been reports in the Indian media expressing concern over the alleged lack of disciplinary action on auditors who have failed to perform their duties. It has also been stated by many who interacted with the Committee that the ICAI has been unable to adjudicate disciplinary cases within reasonable time. Similar concerns have been expressed for the other two Institutes, even though they have much fewer disciplinary cases.

 

3.17     Under the current legal framework, failure on the part of auditors regarding their civil and/or criminal acts or omissions are dealt with under the respective laws. Auditors are  also liable under the common law of the country. But law proceeds in ponderous ways. And the hallmark of any reputed profession, especially one discharging key fiduciary obligations, is the code of ethics that it imposes on its members, and  the mechanism for reviewing and punishing professional misconduct. In fact, The Chartered Accountants Act, Company Secretaries Act and the Cost and Works Accountants Act do provide for athe framework for taking disciplinary action against the erring members.

 

3.18     As far as chartered accountants are concerned, section 21 of the Chartered Accountants Act provides for disciplinary action against a member of the ICAI for professional and/or other misconduct; while regulations framed under the aAct defines  the framework and procedures by which the disciplinary proceedings must be conducted. The existing mechanism is quite elaborate. However, procedures that were framed in the past have not been able to cope with the changed scenario, which must deal with complex businesses and over 70,000 practicing members.

 

3.19     Not surprisingly, there have been professional as well as public concerns aboutover  the time taken in the disposal of disciplinary proceedings.[2] The existing system suffers from the following limitations :

• Inability of the ICAI to enforce information/documents from the concerned agencies before the prima facie stage.
• Inability to deal with dilatory obstructive practices resulting in delay at every stage of proceeding.
• Inability to adopt a prioritised approach, which can distinguish classify cases according to the severity of misconduct and importance to the public, and deal with the serious ones expeditiously.

 

3.20     Indeed, a note from the ICAI has itself highlighted the problems which occur at each stage of the process. These require some elaboration.

• Prima facie opinion on whether or not a member is guilty is required to be formed at the level of the full Council. The Council of ICAI consists of 30 members, and can only meet eight to nine times a year. This leadscauses to delays at the very first stage of the disciplinary  proceedings.
• Under section 21 of the Chartered Accountants Act, all cases where ICAI’s Council has held the respondent prima facie guilty have to be taken up for enquiry by the Disciplinary Committee, which consists of five members, with no provision for benches. This worked when ICAI had far fewer practising members. It can no longer adequately handle over 300 complaints received every year — a number which is expected to increase in the future.
• The Council must then deliberate on the reports of the Disciplinary Committee. In doing so, a Supreme Court judgement has determined that it must give hearing to the complainant and respondent. This entails further delays and, at times the process has been misused by one or both of the concerned parties.
• If a member is held guilty, the Council either awards punishment or recommends punishment to the High Court. Where the recommendation on the award of punishment is not required to be sent to the High Court, the procedure requires giving yet another opportunity to the respondent. Moreover, according to the rules, the report and recommendation of punishment cannot be considered in the same meeting. Therefore, the punishment part must necessarily await another meeting of the Council.
• In cases where the case is forwarded to the High Court, it takes even more time for the Court to confirm the Council’s award of punishment under section 21(5 and 6)under sub-sections (5) and (6) of section 21.

 

3.21     The Committee believes that such delays just have to be avoided. The confidence of the investing public, especially small investors, cannot be nurtured unless disciplinary cases are dealt with more expeditiously and transparently.

 

3.22     The Committee has been given to understand that in its various representations to government, the ICAI has suggested changes in the processprocedure. Some of these changes are:

·        Merging the two existing two schedules of the Chartered Accountants Act, that describe professional misconduct, into a composite schedule, and clear categorisation of offences. According to ICAI, this ought to help focus on cases having larger public interest and also relate the quantum of punishment to the gravity of offence.

• Constitution of a new Standing Committee (Screening Committee) for forming prima facie opinion.
• Broad-basing the Disciplinary Committee with more representation for nominees of Central Government, and empowering it to function through regional benches.
• The Council, Screening Committee and benches of the Disciplinary Committee should be given powers similar to those vested in a Civil Court regarding matters like discovery and production of documents.
• The benches of the Disciplinary Committee should also recommend punishment in its report submitted to the Council. 
• The Council must consider the report and, in cases where it upholds the punishment recommendation of the bench, simultaneously award punishment.
• The Council must may be empowered to award all types of punishment for all eachtypes of the offences.
• Provision for withdrawal of specified type(s) of complaint case(s) up to a specified stage. Provision for summary disposal, in the event of respondent pleading guilty up to a specified stage.

 

3.23     While the Committee appreciated the changes suggested by the ICAI, it felt that the need of the hour was something more. Shareholders, investors and other stakeholders of companies rely on the audited financial statements for making investments and other major decisions. The auditing profession, therefore, needs to respond to the confidence reposed in them, and has to be seen to be responsive.

 

3.24      Moreover, in most instances, disciplining the auditors need not be a matter requiring consideration of High Courts. For one, there are significant delays whenever a case is recommended by ICAI to the High Court. For another, the High Courts have enough on their plate to be further burdened by ICAI cases. Hence, there is a need not only to have more expeditious disciplinary processes within the ICAI, but also to have a quasi-judicial appellate body outside the High Courts to hear most of the appeals.

 

3.25     The existing disciplinary cases fall under two specific categories: ‘complaint’ and ‘information’ cases. While this categorisation may continue, the procedures to be followed need significant changes not only to overcome the bottlenecks but also to ensure effective and expeditious delivery of justice. Accordingly, the Committee has recommended an entirely new disciplinary procedure which, while keeping the process within the framework of the ICAI and The Chartered Accountants Act, will bring about greater  speed whileand ensuring independence and fair play.

 

3.26     After considering the matter at some length, the Committee arrived at the conclusion that the right to appeal to the High Court or making certain penalties subject to confirmation by the High Court was not strictly necessary.  The Committee noted that such a provision was not there in the Advocates Act. Given the nature of cases involved, it would be more appropriate to establish a high-powered Appellate Body comprising two senior chartered accountants, two eminent persons having qualifications similar to the ones prescribed for independent members of the Disciplinary Committee but of a higher standard and experience and a Presiding Officer who should be a retired Judge of the Supreme Court or a retired Chief Justice of High Court.

 

 

3.27      Independent disciplinary mechanisms may be designed on similar lines in respect of Company Secretaries and Cost Accountants. The Committee believes that the mechanism outlined above is realistic and should work, given adequate funding and determination. This should bring to bear a transparent and expeditious disciplinary procedure that could contribute to enhancing the prestige and public trust that the Institutes have today.