'If not bloodhounds, auditors at least need to be barking dogs'

Amarjit Chopra

Auditors and the auditing industry have been under intense and harsh scrutiny over the last few years as corporate scandals emerged across sectors. Globally too, the largest four audit firms often clubbed under the epithet of the Big Four have been under pressure to show independence from their corporate clients.

Here in the second part of a two-part interview with Shalini S. Dagar, Amarjit Chopra shares his candid views on the auditors and wider corporate governance. Chopra was heading the group that recommended changes for the Companies (Auditor’s Report) Order, CARO 2020 to prevent frauds.

Edited excerpts:

Q: While auditors have been under fire lately, you are well known for saying that it is not the responsibility of the auditor to detect fraud.

A: So far as Standard on Auditing (SA 240) dealing with auditor’s responsibilities relating to fraud in audit of financial statements is concerned, it does not lay down this as the auditor’s responsibility. It only says that if you stumble upon some information where you can see symptoms of fraud, then you need to go deeper into the matter.

Frankly speaking, if you ask me today, and I don’t hesitate to say this now. I am saying this on all forums now… In 1971, when I studied the famous Kingston Cotton case where the jury said that “the auditor is a watchdog, not a bloodhound”. I honestly feel that the auditor may continue to be a watchdog, but he at least has to become a barking dog now. He may not be a bloodhound, he may not be biting every time, but he at least must be a barking dog. There is no doubt about it. He has to send the alarm signals at least. Gone are the days when the auditor could say that this is not within my domain.

The new report that we have brought out in the form of CARO 2020 has ensured that it sends a lot of alert signals.

We have gone to the extent of asking the auditor to comment upon the stock or debtor statements submitted to the bankers are in line with the books of accounts.

Most of the working capital frauds in the banks where a lot of money has been siphoned off have occurred due to the inaccurate statements submitted to the banks. So to that extent we have brought in the alert signals. We have also brought in the signals on the cases where the title deeds are not in the name of the companies, then the auditor should let us know on the number of properties and their value. Some kind of barking will (definitely) will be required.

Q: Other than the auditors which other segments do you think need to be brought to account as well?

A: If you ask me, the promoters have got away completely scot-free. Who prepares the accounts? It is not the auditor, but the company management.

And nobody questions the rating agencies, the valuers or the lawyers.

If they (rating agencies) are providing the rating based just on the audited financial statements then where is the need for them? In the recent case of a large NBFC, why did the banks not look at the overall debt service ratios? Had they asked for the information, they would have known the situation. Even under the Insolvency and Bankruptcy Code has anyone asked them why they need to take such high haircuts? On average it is around 70 percent.

Shouldn’t the enforcement of mortgages be far stricter? Wouldn’t we have recovered more under the IBC then?

What is happening right now is that even in cases where the banks can settle they are pushing those cases too to the IBC. Once the courts tell them to take a haircut they don’t feel threatened.

Banks have provided enhancements or renewals in cases where the letter of credit (LCs) were already devolving. RBI has also given extensions to prevent loans from turning bad. It has also given specific exemptions in specific cases.

You look at the valuers. For example, consider a property which was valued at Rs 10 crore ten years ago, is today being valued at Rs 1 crore or Rs 80 lakh when the borrower comes for a one-time settlement. How is it possible? Either the fraud was committed at that time or it is being committed right now.

These are the pitfalls of the entire system. Blaming only auditors is not desirable.

What about lawyers? How many cases have been filed in case of wrong title search reports? No bank has the guts to file a case against the lawyers. It is atrocious the kind of title search reports that have been given in certain cases and the properties have been found to be missing.

With lawyers, the punishment is only removing them from the panel, whereas in case of chartered accountants the complaints are filed with the police, the Institute (ICAI) is approached and CBI is also approached. This is the factual position.

I am not absolving the auditors, but I say whatever treatment you mete out to the auditors, hand it out to the others too.

Q: One of the major issues is around scrutiny of the independence of the auditor, especially due to the conflict of interest regarding non-audit fees. How do you see that settling?

A: To my mind there are two things which are key to the independence of the auditors. One is the existence of non-audit fees. And the other is the shareholders as appointing authorities.

In case of non-audit services, it need not be the same firm. The conflict exists even in the case of a network firm too. Then there are cases where a firm retires from its auditing responsibilities and then immediately undertakes a non-audit assignment, the value of which is higher than its audit fees. This is not justified. There must be a cooling-off period.

The Financial Reporting Council (FRC) of the UK has already come out with a report that by 2024 these audit firms will have to part company with the non-audit business. That is going to happen without a doubt. If FRC can do it in 2024, then we (in India) should be able to do it in 2025. This should be done.

Q: The Big Four firms dominate the audit business. While there are periodic calls for a more balanced market, what is the way forward in your opinion?

A: Look, I am not anti-Big Four, but I definitely do not want the concentration of work in the hands of a few. I want the growth of the profession on an overall basis. If the government is ready to encourage the top 150-200 firms, the scenario can undergo a change.

There are about 500 firms which are capable of carrying out the central audit of various banks. Indian firms which are carrying out the audits of various large, listed state-owned companies. These firms are being treated as if they are not capable of conducting the audit of similar private companies. How can that be the case?

I can well agree that there could be certain pitfalls with the constitution of firms with the Comptroller and Auditor General (CAG). However, that need not deter us. The empanelment system, weightage and point-based system can be strengthened. To my mind there are at least 150-odd audit firms which can compete with the Big Four if given the opportunity.

The problem is that our entire tendering system is biased towards the Big Four, particularly the government tendering system. The conditions will be such that unless you are a Big Four firm, you cannot even enter the system.

If at all the bigger audit firms have to be created in India, then the government tendering system should undergo a change. I am very confident that in the next five years, you will have the growth of at least 100 Indian firms which will be visible.

Q: Please elaborate.

A: There is a lot to be said about the tendering process, not just from the point of view of eliminating the dominance of the Big Four but also from the point of view of the process itself.

The tender conditions are such that only few firms are able to clear the tender. You cannot have such tailor-made documents. In recent times, we have found the negligence of the bigger firms in various scandals. Can we deny what happened?

Apart from the entry barriers, the reliance on the financial bid for the decision is also questionable. In some cases, the gap between L1 and the next bid can be as large as 10 to 15 times. The whole process is flawed. Ideally, technical parameters should get a maximum (about 80-90%) weightage.

Also a more fundamental question. Do you ever tender for legal services? Do you talk of L1 in the process of engaging a lawyer? Never, so why should there be a tender for accounting and auditing firms? How can you have a tendering process when hiring for a forensic auditor?

Look at how a caucus is getting formed in the case of insolvency professionals. First, these firms are becoming process advisors and then the consulting (assignment) is going to one of the related network firms. This is ridiculous.

The government has to become serious about not allowing the concentration of a handful of these firms. It has to give a boost to the local firms.

Also Read: Fair valuation basis must be adopted universally, even by smaller companies says former ICAI President