The new Companies Act requires the Directors’ Responsibility Statement to affirm that the directors have devised proper systems for compliance with all applicable laws and that the systems are operating effectively.
This is an onerous responsibility on the Board. India has State and federal laws and regulations that are amended quite frequently — ensuring compliance will therefore prove a mammoth task. This is especially so in industries such as telecom, FMCG and pharmaceuticals, which operate in complex regulatory environments.
Increased accountability
Even though directors have the responsibility to devise proper systems for compliance, they would also need to look at the various non-compliances by the company, and may face scrutiny from regulatory bodies.
Directors would, therefore, most likely rely on the company’s auditors to not only set up a proper system but also ensure compliance with law. This puts auditors in a tight spot as they have to equip themselves for the task.
The auditor is commonly recognised as a ‘watchdog and not a bloodhound’. However, with the additional task of ensuring compliance with law, the extent of an auditor’s responsibilities becomes unclear.
Risks and penalties
Let us look at a few industries to assess how an operational matter can pose a huge risk to companies and their auditors.
The telecom industry has to comply with the radiation norms promulgated by the Government, and companies have to pay large sums as penalty for non-compliance.
The pharmaceutical industry has to maintain certain standards in new drug trials and ensure minimum hygiene requirements, which are audited by independent agencies. The licence to manufacture medicines is granted after the audit and this is periodically reassessed.
In the manufacturing and mining industry, environmental clearances are needed before starting manufacturing and mining activities.
All of these are purely operational issues, and auditors are generally not required to assess compliances. However, Indian companies have faced penalties running into several million dollars for non-compliances, as also prolonged litigations, and may have going concern issues. Hence, auditors are confronted with a separate set of audit risks, and they have to assess their impact on the audit conclusion. Litigations are on the rise, and companies are likely to face heightened scrutiny from various regulators — which will further step up litigations.
In addition, auditors’ responsibilities are continually increasing due to changes in law, complex business models, increasing use of technology, and so on. Hence, in addition to accountants, the auditor may have to hire experts who understand industry, laws and technology.
Class action suits against auditors by investors are on the rise in various countries, though their numbers have fallen in the US. Such litigations would be possible in India too under the new Companies Act, so auditors will have to safeguard themselves. Such regulatory changes are likely to change the future of the auditing profession. The new Companies Act states that if an auditor is found guilty, his personal assets too can be attached to collect the penalty amount. This is not prescribed even for the directors, who are more involved in the business decision.
Taking all of this into consideration, the question is: Where does the auditor’s responsibility end?
Nilesh Lahoti is Director and Snehali Kulkarni is Manager, Deloitte Haskins & Sells