The contention of ICAI, that there exists an overlap between it and NFRA, runs contrary to international best practices, which show a distinct shift from self-regulation to an independent oversight of auditors, accounting for about 80% of global stock market capitalisation.
Historically, the role of an auditor has been that of a financial ‘gatekeeper’, which makes it imperative for the auditor to be independent and free from any conflict of interest, both in fact and in appearance. This becomes even more important with regard to public companies with hundreds of thousands of investors, who suffer from severe information asymmetry.
While the Enron episode led to the enactment of Sarbanes Oxley Act, 2002, and the establishment of the Public Company Accounting Oversight Board (PCAOB) in the US, the Satyam episode brought about a shift from a self-regulatory framework to an independent regulatory framework with the constitution of the National Financial Reporting Authority (NFRA) under the Companies Act, 2013, in India. The primary objective of NFRA is to have an independent oversight body to oversee the quality of accounting and auditing services with respect to listed companies as well as unlisted public companies above a prescribed threshold. Of course, the Centre is empowered to refer any other class or classes of companies to NFRA in public interest.
The Institute of Chartered Accountants of India (ICAI) has been up in arms against the constitution of NFRA, contending that it would affect their disciplinary power vis-à-vis their members and create a regulatory overlap. However, the contention of ICAI runs contrary to international best practices, which show a distinct shift from self-regulation to an independent oversight of auditors, accounting for about 80% of global stock market capitalisation. The Financial Reporting Council (FRC) of the United Kingdom regulates auditors of public companies and delegates certain tasks related to auditors of private companies to five recognised self-regulatory organisations (SROs), which it can revoke anytime. The FRC can also impose penalties on the SROs if they fail to perform their duties properly. In the United States, the PCAOB regulates auditors of public companies whereas professional bodies continue to regulate auditors of private entities. However, unlike India, where the disciplinary body consists of elected practicing chartered accountants (CAs), the professional bodies in the United States consist of appointed members,who are independent of practicing CAs to prevent conflict of interest. In China, there are three regulators of the audit profession, namely, the ministry of finance, the Chinese Institute of Certified Public Accountants and the Chinese Securities Regulatory Commission.
The regulatory shift in India has been an outcome of major financial scams that led have to a huge trust deficit in self-regulation of the audit profession. The inherent conflict of interest in an SRO that is supposed to discipline the members of the same profession who constitute it, has made it untenable as an independent regulator. The entire debate on the need of NFRA, particularly the objections raised by ICAI, was considered by the Companies Law Committee (CLC), constituted in 2016, to suggest amendments to the Companies Act, 2013, and it was concluded that an independent body to oversee the audit profession in India was essential in the light of the inherent conflict of interest in the SRO model and to align India with international best practices.
With the constitution of NFRA, India is now eligible to become a member of the International Forum of Independent Audit Regulators (IFIAR), which was denied until now for want of an independent audit oversight body in the country. Under section 132 of the Companies Act, 2013, NFRA is responsible for recommending accounting and auditing policies and standards in the country, undertaking investigations, and imposing sanctions against defaulting auditors and audit firms in the form of monetary penalties and debarment from practice for up to 10 years. The ICAI will continue with its core business of conducting CA exams, registering qualified CAs, issuing certificates of practice (including withdrawing and suspending them), specifying codes of conduct for members, entering into memorandums of understanding and mutual recognition agreements with its counterpart bodies in other countries, and regulating auditors of private companies (which form 95% of the 1.2 million companies in the country). Further, given that public companies would normally engage relatively bigger firms, not more than 500 audit firms (out of around 43,000 audit firms in the country) are likely to be regulated by NFRA. There is no contradiction or overlap between NFRA and ICAI, as each of them has their exclusive jurisdiction. Hence, both should meaningfully co-exist and harness mutual synergies and complementarities. Finally, ICAI should accept the reality that NFRA has come to stay.
By Injeti Srinivas. Writer is a civil servant. Views are personal