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The spotlight is back on audit firms

Checking the regulatory oversight of multinational accounting firms

The simple solution for the problem is to empower ICAI to proactively identify and blacklist MAFs or their “partner firms” operating in India and to enable it to restrict its members from joining these firms.

Akhil Arora

The integration of the world economy saw big accounting firms—the Big Four—spreading their global outreach. Backed by financial muscle and Ivy League recruitments, they quickly entrenched themselves at the expense of smaller accountancy companies. It suited MNCs to engage these Big Four types since a common accountancy practice was required for their operations across US, Europe, Asia, etc. The Big Four operations encompassed accountancy, law, technology, and these one-stop services suited MNCs.

Since the turn of the century, hardly a year has gone by when one or the other multinational accounting firm (MAF) has not been in the news in relation to a major accounting scandal. While hardy anyone needs to be reminded of the role played by one such MAF in helping Lehman Brothers deceive investors in the years leading up to its collapse in 2008, what is worrisome is the large number of scandals that have broken out in subsequent years, which give no comfort about the sense of propriety in the operations of MAFs. In the past decade, MAFs have been found guilty of serious misconduct on accounts such as overstating of profits and income, outright falsification of accounts, failure to perform basic due diligence to detect Ponzi schemes, etc.

In India, too, the acts of omission and commission of these accountancy firms have come under adverse scrutiny of both the regulators and judiciary. In January this year, SEBI banned PwC from auditing any listed entity for two years due to its failure to highlight accounting irregularities at Satyam. The firm was directed to disgorge Rs 13 crore of wrongful gains made by it. Investigation is also under way for possible FEMA violations by some MAFs on account of infusion of foreign investment in capital in their Indian subsidiaries without RBI’s approval. However, the latest salvo has come in the form of a judgment of the Supreme Court where the issue at hand was whether MAFs were providing accounting, auditing, bookkeeping and taxation services (i.e. services ordinarily provided by a CA registered with ICAI) within India in a clandestine manner without any regulatory oversight?

Under the prevailing regulatory regime, no company, whether incorporated in India or aboard, can practice as a CA. Also, the Chartered Accountants’ Code of Conduct prohibits advertising or marketing of services or sharing of fees with non-members. In the matter before the apex court, MAFs claimed they are incorporated outside India and are a parent entity in a network comprising of firms around the world, including India, all of which are separate legal entities. The network partners in Indian firms were all Indians and they, along with the partner firm, were both registered with ICAI. MAFs claimed the only services they provided in India were to their network partners, and these too are merely in the nature of developing superior service standards. MAFs contended that fee received from network partners in India was either licence fee for using the global brand name or fee charged to cover expenses incurred in developing global standards. Therefore, there was no violation of the restriction imposed by ICAI on sharing professional fee with a non-member.

The Supreme Court, in arriving at prima facie findings on the issue (in the absence of conclusive investigations by ICAI on account of submission of redacted agreements with parent entities by several MAFs), rejected the arguments put forth by MAFs, lifted the corporate veil, and held that compliance requirements by MAFs were only in form and not in substance. By registering identically sounding partnership firms with their Indian partners, the real beneficiaries of transacting the business of chartered accountancy were the corporates behind foreign accountancy firms. The partnership firms are merely a subterfuge to defy/evade existing laws. In light of these findings, the apex court directed ICAI, Income Tax, Enforcement Directorate, Registrar of Companies and RBI to expedite their investigations to identify specific defaulters. However, the court refrained from opining on whether, as a policy, MAFs should be allowed to operate in India and directed the government to constitute a committee to revisit the statutory framework and Chartered Accountants’ Code of Conduct to facilitate disciplining these MAFs. The court went a step further and encouraged the committee to consider the need for a new mechanism for oversight over all Indian auditors.

The simple solution for the problem is to empower ICAI to proactively identify and blacklist MAFs or their “partner firms” operating in India and to enable it to restrict its members from joining these firms. While the stated objective of MAFs is to set uniform high-quality standards, accounting scandals relating to Satyam, Kingfisher and Global Trust Bank seem to indicate that. The only apprehension is whether an ICAI clean-up will prove a witch hunt to eliminate competition or provide solutions for harmonious existence? The Big Four have brought in good practices and the baby should not be thrown out with the bathwater.

It’s not just the Big Four who were found wanting in best practices. As things are panning out, question marks are hanging on Indian firms who assisted in perpetuating asset stripping by delinquent promoters. The lust for lucre can blind anyone. Even so, ICAI supervisory control over Indian CAs ensures the rotten are weeded out. In addition, ICAI ensures regular upgrade of knowledge and skills. The study material and certification of CAs is an onerous task and is done splendidly by ICAI.

At a time when more and more retail investors are investing their savings in equity markets, the last thing one would want is another scandal with an MAF at the helm. The quality of advisory services provided by these firms is also questionable, considering that the Supreme Court has not ruled out the likelihood of FEMA violations by some of these firms in their own financial transactions. Also, the clandestine presence of MAFs in India is reducing the bargaining power of ICAI in negotiating for reciprocity for Indian accountants internationally.

The government has taken the right step by mandating that overseas auditors will have to undertake joint audit if an international investor insists on audit by a global firm or Indian affiliate. This measure will ensure joint participation of standalone Indian audit firms as MAFs, being direct competitors, are unlikely to collaborate. However, there is an urgent need to tighten the noose on the operations of MAFs in India and simultaneously encourage Indian firms to become global brands. India was one of the least impacted countries during the last financial crisis mainly on account of its prudent banking norms and audit practices. At a time when the Indian economy is a lot of more integrated with the global economy, and massive regulatory, political and economic changes are taking place across the world, it is even more important for these watchdogs of capitalism not to be found wanting and turn the current bonfire into a blaze. In case of push backs on regulatory oversight, it would be in national interest to remove this weed from the root.

The Author is Master of Laws from University of Chicago Law School

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