Home >Companies >News >A seismic shift is in the works in disciplining directors and auditors
(Photo: Aniruddha Chowdhury/Mint)
(Photo: Aniruddha Chowdhury/Mint)

A seismic shift is in the works in disciplining directors and auditors

  • A high-level panel that looked into corporate laws has suggested major changes in the way auditors and directors are regulated
  • The regulatory action following the IL&FS crisis on auditors and directors came on top of a crackdown on black money and shell firms in preceding years

New Delhi: In a surprise move, towards the end of September 2018, the government had sacked the board of non-bank lender Infrastructure Leasing and Financial Services Ltd (IL&FS), and appointed a team of handpicked professionals to restore the financial health of the heavily indebted group. In fact, the failure of the group to service debt of about $1 trillion was too hard for policy makers to ignore.

The IL&FS crisis was just the tip of what lay underneath—the massive liquidity crunch faced by non-bank lenders came to the fore. The regulatory action on auditors and directors—two gatekeepers of the corporate world—following the IL&FS crisis came amid the already high-pitched crackdown on black money and shell companies.

A deepening economic slowdown, risk aversion and subdued investor sentiments, which later became very evident, raised questions about how tight the regulatory regime should be. A high-level panel led by corporate affairs secretary Injeti Srinivas finally recommended a fundamental shift in the way auditors and directors should be disciplined. The recommendations tabled in November 2019 sets a precedence: Far too stringent regulations could be counterproductive and may not yield the desired results.

Auditors

Statutory auditors, whose job is to assure that a company’s financial statements reflect the true and fair picture of its health, have for long faced the wrath of regulators worldwide. Regulators try to nail auditors for everything—from negligence and turning a blind eye to improper conduct by company managements, to frauds auditors are completely unaware of and outright connivance with corporate crooks. Whenever previously undetected fraud emerged, auditors claimed that their job was to certify financial statements, not to act like detectives. The Companies Act, 2013, allows debarring auditors, whether an individual or a firm, for five years if the National Company Law Tribunal (NCLT) finds fraudulent conduct, collusion or abetment by the auditor. Audit quality watchdog, the National Financial Reporting Authority (NFRA), too, was empowered to debar auditors under a different section of the law. But there was no way now of limiting the debarment to individual auditors in a firm. The Srinivas panel, which looked into the laws, observed that the right to practice was a core requirement for professionals to exercise their right to livelihood.

(Graphic: Paras Jain/Mint)
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(Graphic: Paras Jain/Mint)

“Debarment of a firm may be an exception rather than a rule. It should only take place in cases where the firm refuses to cooperate in the proceedings in question or if the higher management of the firm is involved in the fraud. Otherwise, debarment even in case of audit firm may be restricted to only those individuals or partners associated with the firm who were actually involved in the fraud," the panel said. It also said debarment should be considered a serious punishment, and should be resorted to in rare circumstances only. Besides, debarment should, in usual course, be executed by Institute of Chartered Accountants of India (ICAI), the self regulator.

“In the case of auditors, banning the firm should take place in rarest of rare occasions, when all or majority of the partners in the audit firm are involved, or have connived or colluded in the fraud, not otherwise," said Amarjit Chopra, former president of ICAI, who was a member of the Srinivas panel.

Directors

Under the existing law, directors on company boards, including independent directors, were liable to be disqualified for reasons relating to their individual failure to comply with the law, as well as in cases where the company concerned failed on certain reporting and financial obligations, including filing financial statements and annual returns and repayment of deposits, payment of interest on deposits and debentures and the declared dividends. Once a director is disqualified, he is not eligible to be on the board of any other company, including those that have not defaulted on its reporting or financial obligations. The panel recommended that the vacation of directorship should be limited to only disqualifications incurred for faults at the individual level.

“For the purpose of ease of doing business, you have to make the life of independent directors much easier than what is presumed to be today," said Chopra.

The existing law allows only six months for new directors hired by defaulting companies to rectify their defaults on financial and reporting obligations before facing a disqualification. Since repayment of debt or paying dividend is not in the hands of directors, the panel recommended that directors joining defaulting companies should be disqualified only if they fail to rectify the reporting default.

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