Regulating the auditors: How NFRA and Sebi could co-exist

The audit fraternity appears a divided lot. This is to do with the securities market regulator’s oversight powers to penalise and bar an audit firm from undertaking assignments of listed entities. The question being hotly debated in the audit fraternity is: “If the Securities and Exchange Board of India (Sebi) has the oversight powers over audit firms of listed firms, what will be the role of the proposed National Financial Reporting Authority (NFRA), the independent regulatory?”

 “Will the NFRA just look at the unlisted entities?” asked a former president of the Institute of Chartered Accountants of India (ICAI), the fraternity’s self-governing body. 

This comes at a time when the institute has been unsuccessfully lobbying with the government for additional powers to debar any errant audit firm. 

The institute, to date, could act against individual members found guilty of professional misconduct. This includes cancelling the licence. 

Most corporate law experts say that Sebi must have oversight powers over audit firms. “Just as the Reserve Bank of India (RBI) has the ability to decide the thresholds audit firms need to meet to be eligible to audit banks, Sebi must have the powers to set such thresholds and hold such audit firms accountable for lapses in audit quality,” said Hetal Dalal, chief operating officer, Institutional Investors Advisory Services.

While the investor protection mandate in Sebi is all-encompassing, the Kotak Committee has also recommended that the market regulator should have clear powers to act against auditors and their firms with respect to their functions concerning listed entities.

The absence of an authority like the NFRA makes a strong case for Sebi’s intervention, points out Sumit Agrawal, ex-Sebi official and author of a book on the Sebi Act. “There is no question of diluting the jurisdiction of the proposed NFRA,” he added.

According to Dalal, the role of an independent regulator should be to set audit standards and measures, conduct inspections, investigations and disciplinary proceedings and impose penalties on audit firms. “These functions will be overarching and will apply across the board to the audit industry,” she added.

Experts point out that having an independent audit regulator will ensure there is a single body that has the powers to impose rules, regulations, reporting structures, disclosure norms and penal actions in a legitimate manner. “Overall, the NFRA’s focus should be to improve audit standards in the country,” said Dalal.

However, Agrawal points out that Sebi’s jurisdiction might become limited after the establishment of the NFRA. Section 132(4)(a) of the Companies Act  says “no other institute or body shall initiate or continue any proceedings in such matters of misconduct where the NFRA has initiated an investigation”.

Experts said the NFRA could penalise auditors and cancel their registration. Sebi could take penal action, such as disgorging profits or debarring auditors from issuing audit certificates to listed companies for a specific period. 

In many foreign jurisdictions there are instances of simultaneous action by the securities market regulator (market manipulation caused due to misconduct) as well as the auditing/accounting regulator (for professional misconduct), said experts. According to Param Pandya, research fellow, Vidhi Centre for Legal Policy, in the US, the Securities and Exchange Commission (SEC) recognises the Financial Accounting Standards Board (FASB) as the designated authority for establishing generally acceptable accounting principles. The Sarbanes-Oxley Act, 2002, created the Public Company Accounting Oversight Board (PCAOB) to oversee the auditing profession for the private sector. 

“The SEC oversees the FASB and PCAOB,” said Pandya.  Similarly, the Financial Reporting Council (FRC), the corporate governance regulator in the UK, has the powers to take action against auditors. 

Pandya is in favour of setting up a coordination mechanism to resolve any potential jurisdictional conflict between the NFRA and Sebi. Agrawal, however, felt that might not be necessary. 

“The NFRA is going to have an enforcement committee to look into all of this,” he said. 

Moreover, the NFRA board could also include a Sebi nominee, he added.