Opinion | Disclosure norms on forensic audit – will they serve intended purpose4 min read . Updated: 14 Oct 2020, 02:15 PM IST
- Requirement of pre-intimation of forensic audit and sharing of report on conclusion of the audit is unprecedented and not recommended under any major regulatory regime. This could be viewed as dilution of independence companies’ boards
The Securities and Exchange Board of India (Sebi) issued a press release on 29 September, after its board meeting, announcing, among other matters, that listed companies shall make disclosures on initiation of forensic audit. This was followed by consequential amendments to the Sebi Listing Regulations on 8 October. A new sub-clause (17) has been inserted in Schedule III of listing regulations, which provides that in case of initiation of forensic audit--by whatever name called--disclosures shall be made to stock exchanges by listed entities about the initiation of forensic audit along with the name of entity initiating the audit and reasons for the same, if available; and the final forensic audit report (other than for forensic audit initiated by regulatory / enforcement agencies) on receipt by the listed entity along with comments of the management, if any.
This amendment has triggered debate in corporate circles on its intent, and the unintended consequences, for more than one reason.
Firstly, the requirement of pre-intimation of forensic audit, and sharing the report on conclusion of the audit, is unprecedented and not recommended under any major regulatory regime.
Secondly, this requirement could be viewed as dilution of the independent conduct of company’s boards, and their inability to discharge their duties under the law.
Thirdly, premature disclosure may lead to significant erosion of shareholders’ value, and adverse impact on the company’s reputation, more so, when the investigation finally concludes that there was no wrong-doing. As a matter of fact, such disclosure may be counter-productive to the interest of minority shareholders, whose interest is sought to be protected by this disclosure requirement. Needless to mention, a premature disclosure of initiation of forensic audit, without waiting for conclusion thereof, will mislead investors and may cause undesirable fluctuation in a company's stock price.
Also, the requirement of sharing the forensic audit report may result in compromising the witness testimonies and confidential deliberations during the audit process. This could have an adverse effect on the trust the employees and other stakeholders have on forensic audit process, which is an effective tool for detecting misconduct and/or potential violation.
Besides all these, forensic audits typically cover wide ranging issues, which are either financial or non-financial or both. The requirement to disclose relevant information during the course of audit may tempt any person to collude with a competitor to make an unsubstantiated whistle-blower complaint, and exploit such pre-mature information to the detriment of company’s interest. Thus, this mandate could render itself for misuse.
It is also important to examine the need for forensic audit for reasons other than investigating alleged wrong doing.
Forensic audit as a specialised skill, within the larger area of audit and assurance, is of recent origin. Coupled with the fact that both managements and boards now have a larger role and responsibility for establishing and reviewing internal controls, forensics has become an adjunct to the internal audit process. Its role is no longer curative, it is preventive as well. Many companies, either through trained internal resources, or by appointing a third party, conduct forensic audit to stress-test the existence, relevance, compliance and effectiveness of their internal processes, systems and controls. Others sometime subject large transactions to an internal forensic investigation--maybe through external service providers--to establish the thoroughness and propriety within their own organisation, and thereby send out a salutary signal. Thus, forensic investigation has an important positive aspect too, which is overlooked by the current amendment. On the contrary, it will discourage such good and forward looking practices.
This discussion leads us to suggest alternative ways to achieve the real intent of Sebi to promptly disseminate information regarding material adverse developments in a company, which if not disclosed, may create a false market of the securities of the company. The report of forensic audit may be disclosed to public at large only in case it is instituted pursuant to an order passed by a regulatory/enforcement agency, and in such a case, the event may be considered as UPSI requiring closure of the trading window for insiders/designated persons. In other cases, it is suggested that Sebi may direct companies to disclose summary of the report of forensic audit upon conclusion of the audit, only in case any material wrong doing(s) are noticed as a result of the said exercise (otherwise, even minor infractions will be a reportable event). Ideally, such disclosure should be filed in strict confidence with Sebi only, for its intended use as an early warning alarm to protect the interest of various stakeholders of the company in case of any wrong-doing in the company. The disclosure obligations should not apply to internal investigations initiated by the company itself.
The ongoing debate calls forth a relook at this disclosure requirement as in the pursuit to keep handful of errant companies under leash, it would cause harm to well-governed companies which are more in number. The suggested measures together with existing disclosure obligations under Sebi regulations would adequately cover the concerns in this regard.
Tridib Barat is a Company Secretary. The views expressed here are personal.