It has been a month since the most bewildering corporate fraud admission by Satyam promoter went public, revealing skeletons which refuse to stop as I am penning my thoughts. The accounting scandal has shaken the confidence of foreign investors and lenders, besides discrediting governance in Indian landscape. Its too naïve to conclude that Satyam is an isolated case; a view espoused to downplay the crisis.
Whilst regulatory agencies in India and in the US grapple to fathom the depth of the crisis, inevitable parallels are being drawn, with events that rocked North America following Enron filing for Chapter 11.To add insult to injury, several US-listed companies post Enron fiasco filed for restatement of financials in anticipation of avoiding the regulators wrath. Undeniably, the Satyam saga is not close in terms of enormity of felony charges and funds stashed; it is the first of its kind on Indian soil and would force us to relook at our regulatory and legislative framework.
Legislative overhaul – history has precedence!
The immediate outcome of accounting debacle in the US led to immediate incarnation of Sarbanes-Oxley Act, 2002 (SARBOX); a stricter accounting reporting control and risk legislation, legislative change to financial reporting practice and corporate governance. The mission statement of SARBOX is to ‘protect investors by improving the accuracy and reliability of disclosures, pursuant to the securities laws’. SARBOX covers a multitude of issues on auditor independence, internal control assessment, enhanced financial disclosure, analysis of conflicts of interest, besides making the CEO and CFO personally liable for white collar crimes.
For effective implementation and compliance, SARBOX established a quasi-public agency, the Public Company Accounting Oversight Board (PCAOB) to regulate and discipline accounting firms in their roles as auditors. PCAOB undertakes periodic review of the inspection findings of the US accounting firms with focus on improvement in the audits and quality control systems.
SARBOX was further strengthened by the US Securities Exchange Commission (SEC) Office of Chief Accountant monitoring the activities of the accounting profession, particularly the Financial Accounting Standards Board (FASB); a body responsible for formulation of generally accepted accounting principles (GAAP).
With the advent of SARBOX, the US has not since witnessed repeat of 2002 accounting scandals attributed to an effectively administered regulatory framework and stricter punitive action.
Temptation for over-regulation
The SARBOX regulations did result in an era of paranoia for CFO’s and CEO’s, besides imposing an onerous task on the audit function. Though the rigors of SARBOX were later diluted, arguably, the new legislation ushered in a ‘phobia of overregulation’, impacting the US companies’ competitive edge in foreign financial markets as the cost of compliances shot up. Besides, several transnational corporations preferred non-US listing to avoid being subjected to a difficult compliance regime. Further, M&A activity witnessed a drop due to delay in closure of deals as a result of longer diligence process.
What must India pitch for?
Are our laws adequate enough to tackle a white collar crime of this magnitude? For illustration, under Indian Penal Code, if proven, the Satyam promoters could be booked upto a maximum imprisonment of 7 years. Similarly, under the SEBI Act, it is 10 years and/or Rs 250 million penalty. Compare this to 24 years of imprisonment Enron’s CFO was sentenced to or 25 years for Worldcom’s CEO and trial in less than 5 years. In India, it takes years for a case to go to trial and with absence of single agency to tackle and coordinate investigations, the task is insurmountable.
Obviously, the law makers need to debate and comprehensively overhaul the framework of corporate governance. Some of the key challenges which could determine the shape of corporate governance regulations include:
Amending Clause 49 — to tighten conditions for appointment of independent directors including divesting promoters from such appointment decisions, stricter conditions on conflicts of interest and enhancement of penalty for white collar crimes could be some measures on capital market regulators’ agenda.
Independence of audit committee — Amend the Companies Act to build safeguards for transparent functioning of board committees including audit committee and public disclosure of the committee’s findings. It could also mean separation of role of Auditors by either imposing embargo on availing specified non-audit services and/or seeking audit committee approval for certain services; a la SARBOX regulation.
Empower Sebi — Reserving participation of SEBI or having a veto power in formulating and monitoring accounting standards for listed companies will enable transparency in disclosure of financial information to stakeholders. This will require coordination with Ministry of Company Affairs and ICAI; the professional body overseeing the accounting profession and setting accounting standards.
India’s PCAOB — Appointment of a quasi-public agency in line with the US’s PCAOB to oversee and inspect the auditors’ functioning and reporting procedure. A periodic independent review of the accounting firms’ opinion of public companies’ financial health.
Strengthen Serious Fraud Investigation Office — The recent disclosure of startling frauds has driven a point (for the legislators) to give sharper tooth to the Serious Frauds office for expediting investigation sans support from state police and set daunting deterrents for similar frauds.
Align to IFRS — Scientific graduation to international standards of financial reporting and compliances. With timeline for alignment of Indian accounting standards with IFRS pegged to 2010-11, it is an opportune time for the Accounting Profession, regulator and law makers to define and set the transition process for ensuring highest degree of transparency.
I must emphasise that the ‘proof of the pudding’ lies in making institutions, regulators and laws functional, not by merely replicating what other countries have done, but by tough administration. This can be achieved by fixing accountability for all stakeholders. More than ordinary caution is required to keep inevitable fallouts of complex regulation and stifling compliances at bay, as over-regulation could clip the fledging Indian multi-national corporations. It could well mean over compliance and an expensive audit function! Not to forget, stricter diligence for Indian businesses seeking offshore listings.
While the lawmakers have a daunting task, I would anxiously watch to see if India can retain, if not improve its ranking (third out of 11 Asian countries) in Asia Corporate Governance Association’s corporate governance ranking!!
The author is a Partner with BMR Advisors and views are entirely personal
