AN INSIGHT INTO CORPORATE FRAUDS
What can Kingfisher Airlines possibly have in common with Yes Bank or a jewelry brand Gitanjali or a financial institution ILFS or Videocon or IT giant Satyam? The answer isn’t most certainly common ownership. They have all been in the news or are still in the news for the wrong reasons. The answer is Corporate Frauds. All of these companies have defrauded the investors in various ways and have looted crores of rupees worsening the woes of already despondent financial institutions. Desperate calls have been made by the backbone of the economy to see them through the crisis, most of which have been in vain.
Answering the desperate calls for help of the backbones of the economy, the Narendra Modi government introduced regulations such as Insolvency and Bankruptcy Code, Prohibition of Economic Offenders Order Act, all of which aim to help the financial sector recover their money. However, this has yielded little results, opening up room for a debate on whether the lacunae lie somewhere else.
This brings into question what the role of an auditor is. With fairly stringent rules in place to conduct regular audits, how is it that these companies are getting away with frauds they commit. Some might uphold the judgement passed in Kingston Cotton Mills co and correctly point out “The auditor is a watchdog and not a bloodhound”, meaning an auditor’s duty is to verify the transactions so stated and not detect frauds while others might also state that “The responsibility of preparation and presentation of the financial statements lies with the management of the company”. While all of these arguments have reasonable weights, they all overlook the problem at the roots.
UNDERSTANDING SECTION 139
Section 139 of the Companies Act 2013, lays down the manner in which an auditor shall be appointed. The section divides the companies on the basis of ownership, i.e Government Companies and Non-government companies.
As per this section:
- First Auditor of a Government Company [Section 139(7)] shall be appointed by the CAG within 60 days from the date of incorporation. In case the CAG fails to do so, such shall be appointed by the Board within the next 30 days and in case they fail to appoint the auditor, the members shall within the next 60 days appoint the auditor through a meeting conducted under Section 100.
- Subsequent Auditors of a Government Company [Section 139(5)] shall be appointed by the CAG within 180 days from the start of the financial year.
- First Auditor of a Non-government Company [Section 139(6)] shall be appointed by the Board within 30 days from the date of incorporation. In case they fail to appoint, the members shall so appoint the auditors within the next 60 days.
- Subsequent Auditor of a Non-government Company [Section 139(1)] shall be appointed by the Board of Directors.
Further Section 139(2) of the Companies Act, 2013 provides for rotation of the auditors the manner of which is laid down in Rule 6 of the Companies (Audit and Auditors Rules) 2014. This is however applicable to a certain class of companies as laid down in Rule 5 of Companies (Audit and Auditors Rules), the cap of which are as follows:
- All unlisted public companies having paid up share capital of 10 crore or more
- All unlisted public companies having paid up share capital of 20 crores or more
- All companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees fifty crores or more.
Further the section states that a firm shall not be appointed as auditors for more than 2 consecutive terms of 5 years each, while an individual shall not be appointed for more than 1 term of 5 years. There is a cooling period of 5 years which follows. A harmonious construction of this section with Rule 9 of Companies (Audit and Auditors Rules) 2014, reveals that a firm having a common partner with a firm whose tenure as auditors has just expired, shall also not be eligible to be appointed as auditors of the company.
A BRIEF COMMENTARY OF SECTION 139
Section 139 of the Companies Act, 2013 was adopted from it’s previous version of Section 224 of the Companies Act, 1956, with a number of significant modifications from it’s previous version.
The newly introduced Section 139(2), brought in to ensure the rotation of auditors was intended to reduce the chances of frauds. The commentary of the section along with a harmonious construction of Rule 9 of Companies (Audit and Auditors Rules) 2014, reveals that the intention of the council was to curb the possibilities of the management of the company tying up with it’s auditors and indulge in fraudulent activities. A continuous rotation of auditors would ensure that the management does not get enough time to develop a relationship with the auditor and pass off their wrongdoings through an unqualified report.
Further, through an amendment brought in recently, the need for ratification of auditors at the General Meeting was removed, essentially giving the directors the power to appoint the auditors of their choice, subject to the recommendations of the Audit Committee constituted under Section 177 of the Act. The commentary states that the intention was to reduce the burden of compliance on the companies viz-a-viz empowering the Board to make decisions.
THE LACUNAE IN SECTION 139
Although these amendments and improvisations have been brought in to empower the auditor and with the expectation of keeping the frauds in check, they somehow seem to be not as effective as they are expected to be. Is there a problem in the implementation of such or does the problem lie with the Act itself?
The question can be answered by a very simple thought. Should a student evaluate his own answers after taking a test? The answer is most certainly no. What are the odds that the student will be awarding himself or herself full marks? Similarly, allowing companies to appoint their own auditors is the equivalent as allowing a student to appoint his own evaluator.
The harsh reality is, when companies are allowed to appoint their own auditors, they can easily influence the auditor in molding the audit report as per the requirements of the company. Either they abide by the management or they are not re-appointed as the auditors of the company the next time.
The chartered accountant faces a dilemma. Should he give in to the demands of the management or should he uphold the dignity of the profession and the responsibilities conferred on him by the shareholders of the company. At the end of the day, they have to fill their pockets as well and most therefore give in to the demands of the client. The select few who choose the other way, the road less travelled, end up being removed from the position. Further, in most firms the pressure of meeting business targets pressurize the partners to give in, simply because of the fact, they have a family to feed back home.
THE WAY OUT: A SOLUTION
Is there a way out, or do we accept this and treat it as a part and parcel of life?
There is a way out. A simple solution would be for a third party to play the role of a mediator and appoint an auditor on behalf of the company. A proposal is to institutionalize a government authority who should be responsible for appointing auditors of company beyond a certain threshold. This institution so formed would look into the performance of the auditors and grade them on various parameters.
Shifting the responsibility of appointment of the auditors to a third party makes them truly independent. Since they will now have reduced pressure from the management, acting in an independent capacity will ensure that they put down a “true and fair” audit report. Moreover, since their appointment and lucrative offers now depend on how fairly they report to their stakeholders, there will be an increased incentive to work independently.
Another solution, which should be initiated in line with this is to amend Section 142 and allow the appointing authority to decide the remuneration of the auditors. This will further remove the problem of incentives, as it will completely depend on the appointing authority now.
Is this a foolproof solution? Will this completely eradicate the problem? Maybe not! There will be people within the appointing authority corrupt enough to accept money under the table and give away appointments as per the will of the company and the auditors. But there will also be people who would be honest enough to uphold the dignity of their position.
After all, there is some good in every evil.
