Till the breaking news hit the ceiling some days back, the perception of the Satyam scam was one of disregard of corporate governance, coupled with the feudal stance of the promoter in investing in his sons’ business. The nonchalance of the directors was criticised, as it did not behove the icons who graced the board. I received several negative reactions to my last column, questioning my pessimistic outlook and naivety in not appreciating that empires cannot be built, if every move and action is monitored minutely. Post the historic confession, I did however receive retractions in writing.
This incident, expectedly, will have far reaching repercussions not just on how corporate frauds are perpetrated and the conduct of the independent auditor — Price Waterhouse in having neither prevented nor detected the frauds — but on the broader issue of role of auditors, scope of their duties, independence, conflict of interest, and how effectively they safeguard stakeholders from corporate dishonesty.
In India Inc’s corporate history, this is perhaps the first time that a reputed audit firm has been so implicated. Though Arthur Anderson made an unceremonious exit, that was the repercussion of a global fallout emanating from the Enron debacle. It’s not if such scenarios have not been contemplated by the government. In the 1960s, Section 227 of the Companies Act (“Act”) was amended to provide for the Central government to provide appropriate instructions to auditors against the backdrop of common practices, such public companies’ Financial Statements showing outstanding loans as paid, making fictitious cash entries for sales and purchases etc.
The Act was further amended in 1999 and 2000 requiring auditors to provide for negative qualifications and highlighting issues having possible adverse effects on the functioning of the Company. The Institute of Chartered Accountants of India (ICAI) on its part issued the Auditing and Assurance Standard — 21 on auditors’ responsibilities, requiring them to identify instances of non-compliance with laws and regulations to be complied with in preparing financial statements, and making enquiries to obtain sufficient evidence.
With the economy liberalised, and the government controls being replaced by self-regulation, there have been several committees constituted to lay down corporate governance norms as amendments to existing laws and regulations. Unfortunately, the only Committee which dealt with statutory auditors and company relationship in detail is the Naresh Chandra Committee. The report, which examined various aspects of the relationship, recommending measures such as random scrutiny of audited accounts, rotation of statutory audit firms and partners, restrictions on auditors rendering non audit services to the same client and most importantly setting up of an independent regulator, similar to the US Public Accounting Oversight Board has been put on the backburner.
As of today, the auditors’ duties are prescribed under the Act, but the misdemeanors are dealt with by ICAI under Sections 21 and 22 of the Chartered Accountants Act and its schedule as professional misconduct, which includes failure to disclose material facts, or report material misstatements which would render financial statements misleading. The provisions do not address the auditors’ duties to the public at large, being confined to the client-consultant relationship Case law however has also not evolved. The only Supreme Court decision in 1968, while holding the auditor guilty of misconduct for not reporting the irregularity of loans made from the Provident Fund Account of the Company, let off the auditor with a reprimand.
For private limited companies, where the shareholders do not have access to the accounts, and internal controls are less sophisticated and stringent, the auditors’ report is the only available document for investment knowledge and protection. In case of public limited companies, where investors are not involved in the management, the auditor is the watch dog. There has been a fair amount of debate on the watch dog role, with the accountant lobby worldwide resisting the pressure to policing on behalf of the business and investor community.
There being no privity of contract between the investors and the auditors it may not be easy for shareholders to sustain any action against them, unless it can be proved that their losses were attributable to the auditors inaction. Ultimately, Price Waterhouse’s fate depends on how Satyam’s management is prosecuted, whether they can be arrayed as abettors and what the investigations yield.
The author is a Partner in Rajinder Narain & Co. and can be reached at
kumkumsen@rnclegal.com
