Who is my regulator?: On RBI’s recent actions against auditors

Synopsis: RBI’s recent actions against auditors highlight the need for role clarity as well as coordination among regulators

Introduction

Recently, the RBI had issued an order debarring a firm of chartered accountants from undertaking any type of audit assignment in any RBI regulated entity for a period of two years.

This action has been taken, on account of the failure of the audit firm to comply with a specific direction issued by the RBI.

The direction was related to its statutory audit of a systemically important non-banking financial company.

Similarly, in the past, SEBI has also banned a CA firm for their involvement in the accounting scam in a large listed company. These orders are now in appeal before the Supreme Court (SC).

What are the roles and responsibilities of Institute of Chartered Accountants of India (ICAI)?

Objective: The Institute of Chartered Accountants of India (ICAI) is a body established by The Chartered Accountants Act, 1949, for regulating the profession of chartered accountancy.

Composition: The ICAI is managed by a council of 40 members of whom 32 are elected by chartered accountants and the remaining eight are nominated by various public authorities.

Core functions of the ICAI:

– Regulating the profession of accountancy,

– Formulation of accounting standards

– Prescription of standard auditing procedures

– Disciplining and taking action on misconduct by auditors

The ICAI, like other regulators of “professions”, is thus structured as a self-regulatory organisation (SRO).

While ICAI has the power to Discipline and take action on misconduct by auditors, why RBI and SEBI needs to intervene?

Over the years, ICAI’s record in disciplining errant members has not been noteworthy. As a consequence, there has been a growing tendency among sectoral regulators to discipline the auditors.

Why National Financial Reporting Authority (NFRA) was constituted?

In the wake of some large corporate accounting and auditing scandals in the late 1990s, many OECD countries established bodies to oversee the audits of public companies.

This was aimed to protect investors and further the public interest in the preparation of informative, accurate, and independent audit reports.

In line with this global development, the National Financial Reporting Authority (NFRA) was constituted by the Government of India on October 1, 2018, under the new Companies Act of 2013.

What are the powers given to National Financial Reporting Authority (NFRA)?

Broadly, the NFRA has the power to

– Monitor and enforce compliance with accounting and auditing standards,

– Oversee the quality of service

– Undertake investigation of the auditors of a class of companies.

These include companies whose securities are listed on any stock exchange in India or outside. Large unlisted public companies with a paid-up capital or annual turnover or debt above prescribed thresholds, all insurance & banking companies are within the NFRA’s jurisdiction.

For the balance class of companies, the ICAI continues to be the regulator of the profession.

How the accounting and auditing fraternity responded after the constitution of NFRA?

It was unhappy with the dilution of its self-regulatory role. In November 2018, the Northern India CA Federation had challenged the constitutional validity of powers given to the NFRA. A similar petition has been filed by another CA which is pending before the Madras High Court.

What is the way forward?

The present situation offers an opportunity to put in place a clear regulatory framework and machinery for the conduct of the accounting and auditing profession.

First, If the twin regulatory model continues, this should ideally be in one consolidated legislation with clarity on the respective roles of ICAI and NFRA.

Second, the disciplining arm of the ICAI will need to be restructured and strengthened to improve its effectiveness and credibility.

Third, both ICAI and NFRA have representatives of sectoral regulators on their key decision-making bodies. These will need to be fully energised to become robust mechanisms for sectoral inputs as well as operational regulatory coordination and co-operation.

Finally, as the economy becomes more complex, India will need to strengthen the regulatory frameworks in other similar cross-cutting domains like data protection and competition.

Source: This post is based on the following articles “Who is my regulator? “ published in Business Standard on 29th Oct 2021.