India needs to take a judicious view while banning audit firms

Audit firms in India are increasingly facing the threat of debarment by the audit regulator, besides the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI), generating a debate on the liability of auditors, audit firms and their partners. The Company Law Committee, in its report, has suggested against the debarment of audit firms, as opposed to debarment of audit partners. The committee has suggested to limit the debarment of firm to non-cooperation of firm (in investigation) or, and, if the higher management of a firm is involved in the fraud.

This is interesting, considering that in the past, the government, Sebi and the RBI have been highly critical of the Institute of Chartered Accountants of India (ICAI) for not acting against erring firms, which led to enabling provisions under the Companies Act, 2013, for debarment of audit firms.

Distancing the firm from the audit partner (individuals) for debarment may not stand the test of accountability, given that audit is performed by audit teams comprising individuals. Quality audit, however, rests in the audit firm’s auditing tools, standards and control systems and procedures, which the team is required to follow. Together, the leadership takes the responsibility for capacity-building and setting the tone for ethical conduct at the firm, audit team and individual levels.

Under such circumstances, the role and responsibility of an audit firm in ensuring quality audit is as significant as individuals who carry out the audit. If a firm is appointed as an auditor based on its reputation, then it is but logical that it is also equally held liable for an audit failure. This is also the position of regulations governing the auditors world over.

The firms should however be debarred only in the rarest of rare cases, when their conduct has been exceptionally reckless, negligent or fraudulent. Debarment is like a death penalty for an audit firm. Further, debarment is generally limited to class/es of audit and for a quarantine period. It serves both punitive and reformative objectives of the regulations. Regulators, particularly in the US, UK and Europe, have also been conscious of oligopolistic structure of the audit market while considering debarment. Debarment of firm/s in India in recent times in isolated cases should not be the reason to circumscribe the extant law to exclude audit firms from debarment. The need is to remain judicious and pragmatic while banning a firm. However, liability of auditors calls for major reforms and one hopes that the government will bring out a white paper on the subject.

Auditors in India are the first in the line of fire for any and every financial scam in a company. They are liable jointly and severally, and are now faced with class action suits under multiple laws and multiple regulators. Frauds are normally perpetrated through an ingenious design of those who are part of the management. The auditor should not be held liable for the consequences of other people’s actions. It has to be understood that auditors provide assurance on financial statements, and they do not insure related financial risks of stakeholders.

It is high time that the liability of auditors is rationalized by exploring alternatives like mandating proportionate liability, capping the liability, recognising limited liability agreements, mandating professional indemnity insurance (client’s cost) and settlement through deferred persecution agreements.

Audit has become highly onerous and extremely risky with stringent professional, civil and criminal liability. The audit liability conundrum needs immediate solution if quality of auditors and audit is to be maintained in public interest.

Ashok Haldia is former secretary of ICAI, and former MD and CEO of PTC India Financial Services Ltd.