Corporate-auditor relationship needs to change

Updated: Feb 14 2002, 05:30am hrs
The Enron controversy has snowballed over the last few weeks and brought into sharp focus the grave dangers faced by the investing community on account of the cosy relationship between companies and their auditors. Enron, one of the largest and fastest growing companies in the global energy space, shocked one and all by filing for bankruptcy in the US. It was obvious that investors, lenders and regulators had been kept in the dark about the murky financial affairs of the company. And it is also being alleged by the US authorities that Andersen, one of the leading audit firms of the world and the auditor to Enron had destroyed evidence before government inspectors stepped in. Enron may be only a tip of the iceberg and in fact, it is becoming clear all over the world that the amiable relationship between auditors and companies is likely to open many more cans of worms.

The audited financial statement of a company is for all intents and purposes the document that is used by investors, analysts and lenders to assess the financial health of a company. This report is prepared by the auditors of the company and approved by shareholders. This being so, one need not emphasise how important it is that these statements are drawn up with utmost impartiality bearing in mind the interests of all the parties who deal with the company. Unfortunately, it is becoming clear that the auditors are getting increasingly susceptible to pressures from the managements and falling in line with their needs.

The law has recognised the need to maintain the independence of auditors; that is the reason they are appointed by the shareholders and not by the board. But in actual practice, rarely do the shareholders apply their mind to this nor are they given a choice of auditors. Since these are highly lucrative assignments auditors are keen that the management is kept happy. The man who pays the piper calls the tune and so we find auditors normally in total agreement with managements on financial matters.

This is clearly not a good state of affairs and becomes even more scary when one considers that many of these audit firms have large management consultancy outfits that also depend on the same clients for their fees. Over the years, accountancy firms have been going in a big way into the business of management consultancy and their first port of call are the same clients to whom they give audit support. What has now happened is the audit firms have become even more dependent on these large companies for their survival.

In India, the situation is no different. There are thousands of companies which have gone sick and whose assets are totally unrealisable but audit reports routinely make drab statements that the assets are good. Companies enter into major contingent liabilities, which do not get adequately reported. What eventually happens is a sudden statement that a company has gone bust and its assets are not worth anything.

It is of utmost importance that the Indian authorities take steps so that we do not get the Enron-type of situation in India. Actually, the audit system is based on self-regulation. What that means is accountants themselves, have as a group, formed their own associations and governing councils. These are recognised by the authorities and have vast powers and very little interference takes place with their working. They are expected to ensure that their members retain highest standards of integrity so that outside agencies are protected. If the members do not display the integrity, they are supposed to be penalised on a self-regulation basis. Unfortunately, the hard facts are that there are extremely few cases where auditors have been punished by their own kith and kin.

Self-regulation obviously is not working. One suggestion is that it did not work in the stock exchanges and these became a playground for stockbrokers who were both regulators and players. That has now been totally changed and today stock brokers have no control whatsoever over the day to day functioning of the stock exchanges. The same system can be adopted for Institutes of Chartered Accountants, Company Secretaries and Cost and Works Accountants. Just like the boards of directors of stock exchanges are filled with knowledgeable and public spirited people representing various constituencies, these bodies can also be filled with such persons with an executive director to oversee the day to day management. That will ensure that there are no conflicts of interest and be successful like in the stock markets in the last few months.

There are several other suggestions which are also being thrown around. One is to have government appointing all auditors. This may sound very good in theory, but we know the level of nepotism that is likely to ensure where the government doles out audit assignments. Government is also not really in a position to gauge the capability and skills for specific tasks. Of course this will go against the spirit of moving government out of business which is the sign of the times.

Another suggestion is to put a ceiling on management consultancy that audit firms can do for their clients. This is in my view a very naive solution and can be easily circumvented by these firms. If a company is providing both audit and consultancy business to the same group, it is a simple pricing issue how both these can be costed. Hence, this is not a desirable solution at all. A better adaptation of this is to clearly enunciate that where a company has appointed an internal auditor, any firm which is part of that group should not be involved in any other contracts.

There is an urgent need for a public debate on this issue. Many new ideas may come out of this and is bound to improve the system. The last thing we want from the government today is doing nothing on the pretext that we do not have any problem here in India. That would be an ostrich-like attitude. These professional groups should not mind losing some of their hold on themselves. After all, stockbrokers, bankers and most of the intermediaries have an outside regulator but still make a lot of money. It is time we did this for these professions also.

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