It is clear that The Ministry of Corporate Affairs (MCA) is annoyed with a few audit firms. On May 5, the Secretary to the Ministry of Corporate Affairs said that they are not expecting auditors to find a needle in a haystack but they should certainly be able to find an elephant in the room.

On June 10, the MCA moved the NCLT to ban a couple of audit firms for a period of five years for not doing their job properly during the audit of IL&FS Financial Services (IFIN). The MCA has also filed a caveat (right to be heard) in both the High Court and the NCLT just in case the audit firms in question cross-file a case against the NCLT.

Companies Act

The application to ban the auditors was moved under Section 140(5) of the Companies Act. The Section says that if the tribunal, either suo motu or because of an application moved by the government or any person concerned, is satisfied that an auditor of a company has acted fraudulently or abetted/colluded in any fraud, it may, by order, direct the company to change its auditors.

In case the tribunal passes an order barring the auditors for five years, the MCA has made the Institute of Chartered Accountants of India, the Reserve Bank of India and the Securities and Exchange Board of India respondents in the case, so that they can execute the order swiftly.

Charges

In its complaint, the SFIO has alleged that the auditors were aware that IFIN was lending to defaulting borrowers through group companies so that they could suppress their non-performing assets (NPAs) and not provide for the bad debt. Moreover, it alleged that the auditors failed to verify the end-use of bank finances and money raised through non-convertible debentures (NCDs) despite it being mandatory to do so.

The complaint goes on to say that the auditors falsified books of accounts and financial statements of the company from FY14 to FY18 and did not report the negative net owned funds, as well as its negative capital to risk (weighted) assets ratio (CRAR) resulting in loss to those who had invested in the company’s NCDs.

The audit committee members colluded with the management and overlooked the many impairment indicators in contravention of the accounting standards and principals of prudence.

Undoubtedly, the proposed ban will have a significant impact on the audits of listed companies. These firms operate through a complex network of firms and at first blush it appears that not all the firms in the network are proposed to be banned. It remains to be seen if SEBI permits other firms in the network to audit entities whose auditor has been banned — though, as things stand, this appears to be a remote possibility.

Since too few firms handle the audit of too many listed entities, the temporary exit of two of these is bound to put pressure on the remaining firms to handle many more audits in compressed timeframes.

The ban provides an opportunity for mid-size Indian firms to bid for some of the audits that are up for grabs.

There has been a concern expressed in some quarters that if smaller firms get the audit of big entities, audit quality would suffer resulting in further fatal accounting accidents.

Going forward, this should not be a concern at all because the proposed ban sends out a loud and clear message to the auditing fraternity — shape up or ship out.

The writer is a chartered accountant

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