Scams hit India Inc: Corporate governance to blame?

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Scams hit India Inc: Corporate governance to blame?

There has been a whiff of suspicion in the market since quite some time now leaving very little belief in corporate governance at the micro and macro level. So how much of these fears are real and how much of this is an over-reaction; Sandeep Parekh of Finsec Law Advisors and Ashvin Parekh of Ernst & Young discuss.

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There has been a whiff of suspicion in the market since quite some time now leaving very little belief in corporate governance at the micro and macro level. So how much of these fears are real and how much of this is an over-reaction; Sandeep Parekh founder of Finsec Law Advisors and Ashvin Parekh partner and global leader of financial services at Ernst & Young discuss.

Sandeep Parekh tells CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee that the focus on softer corporate governance issue is a positive sign as he sees huge improvement in reporting standards since the Satyam scam. However, he continues to feel that consent orders need more disclosures from regulators. "Also, accountability in public sector undertakings is quite low," he adds.

However, according to Ashvin Parekh of E&Y, accounting irregularities have been overblown due to rumours.

Below is a verbatim transcript of their interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.

Q: At a micro level, last few days we have had a SEBI order against one of the country's largest groups suggesting that some part of their numbers were falsely added to. We have had an issue where these Comptroller and Auditor General (CAG) has pulled up a large public sector company BEML saying they overstated sales. How sanguine are Indian income statements, which is the basis on which global investors invest in stocks in India?

S Parekh: I think they are becoming a lot more skeptical which is probably a good sign as investors. So, I would see it as a positive that people are taking notice of smaller things including therefore the fact that the Reliance order we don't know any facts, we just know that SEBI has passed a consent order, in which they have asked for auditor rotation.

So, we don't know whether there was some misrepresentation in the accounts. So, given that and people have kind of taken that with the kind of fistful of salt, so I would say that I would see that as a positive sign that we becoming a lot more sophisticated. We are taking softer issues into account rather than just big picture fraud and major problem areas.

Q: The last time this issue was top of mind was post the Satyam scam, since then to now though, do you think any headway has been made on this basic issue of reporting accounting standards and that being checked adequately?

S Parekh: I think we have come some way. I don't think we have come a long way. Satyam, I think, had met all the checkbox requirements of corporate governance. They had marquee independent directors, majority of them independent big for audit company. So, they had pretty much all the tickbox items checked, but still scam as big as that happened.

Compared to that, we are seeing in the Reliance case, I think consent order where there is very little information, people have drawn adverse inference. People have said that look, if you don't tell us what is wrong with you, people will assume that the worst has happened. So, I think it is a good sign from the investors' perspective and the markets perspective, it is becoming a lot more sophisticated. It is not just looking at independent directors and the numbers of independent directors, but looking at softer issues such as what wrong have you done. Unless you tell us, we are going to assume that you have done something drastically bad.

Q: In that SEBI consent order, there are mentions of things like RNRL , Reliance Infra misrepresented investments in yield management certificates and misrepresented profit and loss accounts, those seems quite specific in terms of allegations.

S Parekh: Yes, they are specific, but that is all they say. They don't specify exactly what happened behind the scenes. The fact is that it is not a penalty, which has been imposed. In two to two and a half pages, they have all these very stringent penalty or settlement charges and bar from the market etc.

So, I think there is very little information, infact vast majority of the valuation is not connected to misrepresentation in the financial reporting. It is something to do with foreign exchange and round-tripping which again nobody knows because the consent order is quite salience. But coming back to financial reporting, I think it is good that people are taking those one-and-a-half to two lines, which we just mentioned, a lot more skeptically than they would have taken it five years back.

Q: There is talk of auditor rotation in some of these group companies, which has been sought by SEBI. There are some unconfirmed reports that some auditors have approached the government saying that you must protect us because we are being coerced. Can you just take us through what is going on between large companies and auditors and whether there is probably the suggestion of some kind of pressure being borne on them to misrepresent facts or to overlook facts?

A Parekh: There are two parts to it. One is this rotation, for example, that is being talked about of the auditors. How really do you want to implement that rotation, what are the various aspects of that rotation? The approach that can be taken perhaps is that if you change the audit team, for example, or the partners who are associated with a certain audit very regularly, for example, within the same firm then that could be one of the approaches that can be taken in regards the change of the rotation of the auditors.

By merely changing the firms, what you are doing is in the process is that the knowledge and the evidence that the auditors would have collected on the corporate working in various different areas, particularly in those areas where the business risks are higher, what you are doing is you are asking someone to look at them completely afresh. So, there are pros and cons associated with both the types of rotations which are being talked about.

Somewhere along we will have to take a view in regard saying, are we accepting the principle, the principle being that the team associated with the audit, which works very closely with the management and with the boards of these corporate bodies, should that be changed or should the firm itself be changed. So, this is one of the important aspects, which has been doing rounds for a little while.

There is a good debate in the Indian context in terms of saying the auditors and the ability of the auditors to examine the business risk associated with various businesses. It is very important that the regulators, the auditors themselves should be well trained, well experienced to be in a position to examine that. There are specific sectors like insurance, for example, will you not agree that a good understanding of the actuarial working and valuations is very critical for any auditor who is going to take up let us say complex sectors such as those. So, the whole process has to be well understood in regards what is going to come out of this rotation that is being talked about.