Audit restrictions in the new Act and changing systems as per

PCAOB guidelinees - Is it doing good in India

Company Law

Submitted by Rohan Dua

Division B 17010224134 BBA.LL. B

2017-22 Symbiosis Law School, NOIDA

Symbiosis International (Deemed University), Pune.

In August,2019

Under the Guidance of Mr. Rajnish Jindal and Ms. Sonakshi Kumar

Faculty of Company Law

C E R T IF IC AT E

The Project entitled “Audit restrictions in the new Act and changing systems as per
PCAOB guidelinees - Is it doing good in India” submitted to Symbiosis Law School, NOIDA
for Company Law as part of Internal assessment is based on my original work carried out under
the guidance of Mr. Rajnish Jindal and Ms. Sonakshi Kumar from July 2019 to August 2019.
The research work has not been submitted elsewhere for award of any degree. The material
borrowed from other sources and incorporated in the thesis has been duly acknowledged. I
understand that I myself could be held responsible and accountable for plagiarism, if any,
detected later on.

Signature of the candidate

Date:
INDEX

A. ABSTRACT
B. INTRODUCTION
C. PROBLEMS IN THE AUDIT PROFESSION
D. AUDIT RESTRICTIONS
E. LEGAL REGIME BEFORE COMPANIES ACT, 2013
F. ADVENT OF NATIONAL FINANCIAL REPORTING
AUTHORITY: POST COMPANIES ACT, 2013

G. IMPACT OF NFRA
 A. ABSTRACT

This paper analyses the various stages of corporate governance reforms in India with respect
to Audit regulation system in India. Deliberations and discussions about the lack of an effective
audit regulation system in India first arose back in 2002 when the Enron scandal in the US first
unravelled itself to the world. Fearing the same situation might end up in India, the government
formulated various committees on corporate governance to find out existing defects present in
accounting management and auditing system in India and look for ways to strengthen the same.
Various proposals were brought forward which included ban on certain non-audit services by
audit firms to tackle conflict of interest, setting up Quality review board post-Enron under
ICAI, an independent audit body to review auditing standards etc,. All these alternatives failed
once the satyam scandal came around. Finally, the Indian government came up with a system
post-satyam to tackle future audit failure issues on the lines of the PCAOB in the US which
was completely independent oversight mechanism set up under the Sarbanes-Oxley Act, 2002.
This was the National Financial Reporting Authority, an independent audit regulator that would
identify audit lapses in large companies based on auditing standards recommended by the ICAI.
This paper analyses the usefulness of a body like NFRA and how its powers are set up under
the companies act, 2013 and how corporate governance laws have strengthened since the
introduction of NFRA.

B. INTRODUCTION

Independent audit regulators are the need of the hour for the Indian stock market. There is a
need for audit regulators because investors have started to realise the inherent weaknesses
present in the self-regulation of auditors and audit firms.

The concept of independent audit regulation started in the United States with the setting up of
the PCAOB(Public Company Accounting Oversight Board) in 2002 as a result of the Sarbanes-
Oxley Act, 2002. This independent body was setup to counter audit failures performed by large
audit firms that have resulted in big accounting and bankruptcy scandal since the start of the
21st century. The most significant of these scandals and the one that aided in the coming to
fruition of the PCAOB was the bankruptcy of the Enron Corporation and its audit failure by
the now defunct Arthur Andersen LL.P. Back in the early 2000s there were only 5 big
accounting firms that managed accounting work for the publicly traded U.S. companies and
they were namely Ernst & Young LL.P, Deloitte, Pricewaterhouse Coopers and Arthur
Andersen. With the demise of Arthur Andersen there still remains the remaining 4 firms that
still continue to be the most sought after firms for auditing and consulting operations. They are
now collectively known as “The Big 4”.

C. PROBLEMS IN THE AUDIT PROFESSION

Since the professional audit market is dominated by the “Big 4” across global jurisdictions,
who in India, perform audits of almost 60% of India’s richest companies which are on the Nifty
500 index, There is a real possibility, which some financial commentators have also pointed
out, of implicit bias and collusion amongst the biggest companies in India and across the world.

Because the Audit market, in practice, is about Business and profit-making, and it is controlled
by only a few players, the Big 4 in order to maintain their dominant position and keep
increasing profits, form a network of firms with the local firms in India comprising of local
auditors and statutory auditors and in other countries and form a Limited Liability Partnership
with the local firms so as to get a share of the revenue or fees the local firms earn as a result of
the audits of the local companies. This process arose out of the recommendations given by the
Report on Corporate Audit and Governance issued by the Government and the Study Group
report issued by the ICAI on the back of the Enron Scandal.1

These practices lead to various problems, especially when we consider that audits are very
important when someone outside of the market is looking to invest in the market. He will
obviously look at the financial information of the company he is looking to invest in and that
information is corroborated by none other than the auditors. But because there is collusion and
bias and it is only about profit-making for the audit firms and not about finding the truth about
the financial records of a company, there are often instances wherein the investors have lost a
fortune of money because they invested in a company whose numbers looked good only in
form but not in substance.

If the corporate world learnt anything about theses issues, then that was that the auditing
standards had to be governed independently and unbiased without any conflict of interest. This
can only possible if the audit profession’s regulatory model be shifted from a self-regulatory
model to an independent regulatory structure.

1
Anurag Agarwal, Sudhanshu Pandey, Ravinder, COMMITTEE OF EXPERTS ON REGULATING AUDIT
FIRMS AND THE NETWORKS, Ministry of Corporate Affairs, Government of India, (October 25, 2018)
 D. AUDIT RESTRICTIONS

Currently under the companies act, 2013, section 143 provides for the powers and duties of the
auditors and also prescribes the auditing standards which the auditors have to abide by.

Section 141 provides for the eligibility criteria and qualifications of an auditor. The first and
foremost requirement under the section is that the person must be a chartered accountant to be
appointed as an auditor of a company.

Section 147 (2) and 147(3) provide for punishment of an auditor in case of any misconduct a
prescribed in the section. Section 147(2) and (3) have been reproduced below verbatim for
better understanding.

“(2) If an auditor of a company contravenes any of the provisions of section 139,

section 143, section 144 or section 145, the auditor shall be punishable with fine
which shall
not be less than twenty-five thousand rupees but which may extend to five lakh rupees:
Provided that if an auditor has contravened such provisions knowingly or wilfully
with the intention to deceive the company or its shareholders or creditors or tax
authorities,
he shall be punishable with imprisonment for a term which may extend to one year
and with
fine which shall not be less than one lakh rupees but which may extend to twenty-five
lakh
rupees.
(3) Where an auditor has been convicted under sub-section (2), he shall be liable to—
(i) refund the remuneration received by him to the company; and
(ii) pay for damages to the company, statutory bodies or authorities or to any
other persons for loss arising out of incorrect or misleading statements of
particulars
made in his audit report. “2

In 2018, a committee of experts set up by the Ministry of corporate affairs gave certain
proposals on how to further impose restrictions on the audit firms performing audits listed
companies. The committee in their report have recommended that the audit firms should be
disallowed from rendering certain non-audit services like taxation, valuation or restructuring

2
Section 147, The Companies Act, 2013
work of the companies they audit and also that their revenues for non-audit work should not
exceed 50% of fees paid for audit work.3

These restrictions recommended by the committee are in addition to the restrictions already
imposed by section 144 of the Companies act, 2013 which has addressed the issue of conflict
of interest. Section 144 of the new act expressly prohibits eight types non-audit services by
statutory auditor. These restrictions have been imposed in order to ensure that the auditors
focus on what they need to do as auditors rather than look at opportunity to offer other revenue-
generating services to their clients.

E. LEGAL REGIME BEFORE “COMPANIES ACT, 2013”

The ICAI set up an independent regulatory body under the Chartered Accountants Act, 1949
called the Quality Review Board which would examine and evaluate the audit services
provided by the members of the ICAI for publicly listed companies as well as private
companies. The QRB constituted of 11 members, the chairperson and 5 members appointed by
the Central Government and the other 5 members appointed by the ICAI.

E.1. SATYAM SCANDAL

In the aftermath of Enron scandal, the U.S. government enacted the Sarbanes Oxley Act, 2002.
The Supreme Court in S.Sukumar vs The Secretary, Institute of Chartered Accountants of
India, dated February 23, 2018 has referred to this statute to examine the need of an oversight
regulatory body for the audit profession. This law inter alia provided for the setting up of the
Public Company Accounting Oversight Board (PCAOB) as an independent oversight
mechanism to review the audits of public companies. This marked the first big change in the
corporate and audit world away from SRO(Self-Regulatory) model.4

A similar incident followed in India which was the Satyam scandal which was a real wake up
call for the Indian corporate governance regime audit regulation system. In 2008, satyam’s
auditors, PriceWaterhouse, an Indian subsidiary of Pwc was held guilty of fraudulently
inflating the financial numbers of Satyam computer services limited. Additionally, they were
also held guilty of gross negligence of duty to follow minimum standards of diligence and care

3
Supra note 1
4
S Sukumar v Institute of Chartered Accountant of India & Ors (Civil Appeal No 2422 of 2018) [47].
expected from a statutory auditor by SEBI.5 The parent company was subsequently fined $6
million by the SEC (US Securities and Exchange Commission) for not following the code of
conduct and auditing standards in the performance of its duties related to the auditing of the
accounts of Satyam Computer Services.6 Finally in 2018 , SEBI (Securities and Exchange
Board of India) barred Price Waterhouse from auditing any listed company in India for 2 years,
saying that the firm was complicit with the main perpetrators of the Satyam fraud and did not
comply with auditing standards.7

Various changes were proposed post the Satyam scandal, and the considerations for those
proposals further informed the policy reforms in the next phase of corporate governance in
India.

F. ADVENT OF NATIONAL FINANCIAL REPORTING

AUTHORITY: POST COMPANIES ACT, 2013:
The Supreme Court of India in S.Sukumar case, ordered the central government to examine
the audit profession in India and give recommendations to better safeguard and strengthen the
audit system in India. This was done by way of a committee constituted by the Ministry of
Corporate affairs in April 2018. The Committee was tasked with looking into the aspect of
regulation of audit firms and give findings and recommendations to strengthen the legal regime
of auditors and promote development of audit profession in the country. The Committee
presented its final report on 25th October 2018.8 The parliament had already framed the
provisions of the NFRA when it enforce the new Companies Act, 2013 under section 132 but
left the enforcement of the section in the hands of the government. The government finally
notified the rules of NFRA and brought about its implementation on 13th November 2018
effectively removing the regulatory powers of ICAI’s Ouality Review Board and becoming the
sole independent body on audit regulation in India, much like the PCAOB in the US.9

5
Palak Shah, Satyam Scam: PW’s Saga of ignored red flags, TheHINDUBusinessLine, (January 11, 2018),
https://www.thehindubusinessline.com/markets/stock-markets/satyam-scam-pws-saga-of-ignored-red-
flags/article10027012.ece
6
SEC Charges India-based affiliates of PWC for Role in Satyam Accounting Fraud, Securities and Excahnge
Commission, (April 5, 2011), https://www.sec.gov/news/press/2011/2011-82.htm
7 Jayashree Upadhyay, Sebi bars Price Waterhouse: What is the firm’s role in the Satyam
scam?,HindustanTimes, (January 11, 2018), https://www.hindustantimes.com/business-news/satyam-scam-all-
you-need-to-know-about-the-case-against-price-waterhouse-and-sebi-decision/story-
Ot1RbPuEyn6FoYVPQDxH9M.html
8
id
9 Saumya Bhargava, Birth of Independent Audit regulation in India: An Analysis with US Perspectives, The
Oxford Business Law Blog, (October 26, 2018), https://www.law.ox.ac.uk/business-law-
blog/blog/2018/10/birth-independent-audit-regulation-india-analysis-us-perspectives
The major function of the Authority is to protect the public interest and the interests of
investors, creditors, etc. by establishing high quality standards of accounting and auditing and
exercising effective oversight of accounting functions performed by the companies and bodies
corporate and auditing functions performed by auditors.10

The NFRA has become the all-powerful body for disciplining auditors and overseeing the
quality of service rendered by chartered accountants at large entities. 11 NFRA will now have
the power to monitor and enforce compliance with accounting standards and auditing
standards, oversee the quality of service and undertake investigation of the auditors of listed
entities; unlisted entities with paid-up capital of not less than ₹500 crore or annual turnover of
over ₹1,000 crore or those having aggregate loans, debentures or deposits of not less than ₹500
crore as of March 31 of the preceding financial year.12 The NFRA will also have oversight
over auditors of banks, insurers, electricity firms and also those body corporates referred to it
by the centre. NFRA has the powers to penalize individual auditors and firms, under the
Companies Act, 2013, a provision that is missing in the Chartered Accountants Act. The
penalty for an individual auditor is ₹1 lakh /to five times the audit fee. For firms, it is ₹10 lakh
to 10 times the audit fee. The NFRA can also debar an individual or a firm for six months to
10 year and this has become the biggest source of concern for audit firms. However, debarment,
or any penalty, would first need to pass the MCA’s smell test. After the MCA’s approval, the
proposed penalty would need to be approved by the National Company Law Tribunal.13

The companies which are exempted from the applicability of the NFRA Rules are:

1) Private Companies (unless referred by Central Government to the Authority in public

interest); and

2) Unlisted public companies with paid-up capital or turnover or aggregate of loans, debentures
and deposits below the limit stated under Rule 3(1).14

10 Kumar Deep and Richa Soni, National Financial Reporting Authority Rules, 2018 – An Overview,
Mondaq(January 15, 2019),
http://www.mondaq.com/india/x/772178/Accounting+Standards/National+Financial+Reporting+Authority+Rul
es+2018+An+Overview
11 K.R. Srivats, NFRA Rules Notified, ICAI Wings clipped, TheHinduBusinessLine, (November 15, 2018),
https://www.thehindubusinessline.com/money-and-banking/nfra-rules-notified-icai-powers-
clipped/article25508419.ece
12
id
13
Jayashree Upadhyay, Inside the Audit Lapses that led to IL&FS Crisis, LiveMint, (May 21 , 2019),
https://www.livemint.com/companies/news/inside-the-audit-lapses-that-led-to-il-fs-crisis-1558456079750.html
14
Supra note 9
 G. IMPACT OF NFRA

The NFRA, since coming into effect has already started its work and performing its functions
and MCA has assigned to it the task of probing the IL&FS crisis that has shocked the corporate
governance regime in India. In september 2018, IL&FS had defaulted on its debt obligations,
triggering a liquidity crisis in the financial services market. This new found role of NFRA has
already resulted in a feud with the Institute of Chartered Accountants of India since ICAI’s
Quality review board was the first body that was asked to initiate a probe into checking the
quality of the audits of IL&FS group, and to ascertain whether any of the audit partners or the
firms were negligent or were in connivance with IL&FS and its board members. But the MCA
has confirmed that the NFRA is the final authority that will now conduct the probe of IL&FS
auditors.
BIBLIOGRAPHY
1. Anurag Agarwal, Sudhanshu Pandey, Ravinder, COMMITTEE OF EXPERTS ON
REGULATING AUDIT FIRMS AND THE NETWORKS, Ministry of Corporate Affairs,
Government of India, (October 25, 2018)
2. Palak Shah, Satyam Scam: PW’s Saga of ignored red flags, TheHINDUBusinessLine,
(January 11, 2018), https://www.thehindubusinessline.com/markets/stock-markets/satyam-
scam-pws-saga-of-ignored-red-flags/article10027012.ece
3. SEC Charges India-based affiliates of PWC for Role in Satyam Accounting Fraud, Securities
and Excahnge Commission, (April 5, 2011), https://www.sec.gov/news/press/2011/2011-
82.htm
4. Jayashree Upadhyay, Sebi bars Price Waterhouse: What is the firm’s role in the Satyam
scam?,HindustanTimes, (January 11, 2018), https://www.hindustantimes.com/business-
news/satyam-scam-all-you-need-to-know-about-the-case-against-price-waterhouse-and-sebi-
decision/story-Ot1RbPuEyn6FoYVPQDxH9M.html
5. Saumya Bhargava, Birth of Independent Audit regulation in India: An Analysis with US
Perspectives, The Oxford Business Law Blog, (October 26, 2018),
https://www.law.ox.ac.uk/business-law-blog/blog/2018/10/birth-independent-audit-
regulation-india-analysis-us-perspectives
6. Kumar Deep and Richa Soni, National Financial Reporting Authority Rules, 2018 – An
Overview, Mondaq(January 15, 2019),
http://www.mondaq.com/india/x/772178/Accounting+Standards/National+Financial+Reporti
ng+Authority+Rules+2018+An+Overview
7. K.R. Srivats, NFRA Rules Notified, ICAI Wings clipped, TheHinduBusinessLine,
(November 15, 2018), https://www.thehindubusinessline.com/money-and-banking/nfra-rules-
notified-icai-powers-clipped/article25508419.ece
8. Jayashree Upadhyay, Inside the Audit Lapses that led to IL&FS Crisis, LiveMint, (May 21 ,
2019), https://www.livemint.com/companies/news/inside-the-audit-lapses-that-led-to-il-fs-
crisis-1558456079750.html