Time to start conducting integrity audits?

The YES Bank fiasco, which was brewing for quite some time now, has shaken up the confidence of the financial system. In all fairness, the government and the RBI swung into action promptly, and announced a damage control exercise primarily aimed to protect the interest of the depositors of the beleaguered bank. The questions which naturally arise in this context are: Why is it that these types of failures are not detected earlier by various agencies, including the regulator? The matter is significant, since the YES Bank fiasco has come after the major Il&FS debacle.

In fact, the cries of various stakeholders in IL&FS have not yet died down. The final word on the subject is quite a distance away, and the public at large would like to know how can we prevent one more YES Bank.

Oversight mechanism

Occupying centre-stage of discussion in any corporate or bank failure is the question of the board’s role. The onerous responsibility cast on the board of directors today is of ensuring that the depositors’ interest is protected. How come the board over the last two or three years could not come into grips of the issue, and was probably not even aware of the promoter and his family’s activities.

The legal framework, as designed today, does not seem to cover in its ambit the requirement to probe the promoter/CEO’s family companies unless he/she specifically declares it to the board, mainly in the context of Related Party Transactions. This means the director should first and foremost be aware and demand the list of entities and companies owned and managed by the promoter/CEO.

In effect, the need of the hour is for the board to look beyond the balance sheet and expand its horizon to look into the accounts of the entities owned and controlled by the Promoter/CEO (in this case, 78). A similar issue surfaced in the case of IL&FS, where the company in question had 350-odd group associated entities.

Independent directors are now under fire. The spate of resignations in the last couple of years indicates that they are just not in a position to deal with complex corporate issues. More than anything else, it is not their cup of tea to question continuously the bonafide and the integrity of the Promoter/CEO. Regulatory interventions like creating a database and online proficiency test is only dealing with the problem in a limited way. The real battle lies in directors sitting in meetings and raising uncomfortable questions.

The next issue relates to the audit and audit methodology. Large organisations have multiple audits by different names. They maybe called concurrent audit, internal audit, information technology audit, forensic audit, statutory audit, etc; these are only illustrative and not exhaustive. Despite this, the promoter/CEO is still able to bypass all layers and indulge in frauds and malpractices. A forensic expert indicated that a fraudster can beat any system and the paper trail will be so water-tight that the audit methodology cannot detect the fraud. This brings us to a very fundamental question — how do we undertake integrity audit?

The history of scandals, failures and debacles have clearly established that the promoter/CEO at the helm of affairs by virtue of his greed or otherwise can indulge in wrong-doing for personal gains. This is nothing but an issue of integrity. Moral science is, sadly, a forgotten subject in classrooms. Here lies the starting problem.

Preservation of integrity

Disintegration of the family system has eroded family values, traditions and core values of integrity. The backbone of integrity lies in the preservation of value systems. Every scandal or scam represents the destruction of this value system. It is unfortunate that we now need a psychologist to understand the body language of the promoter/CEO and determine whether he is speaking the truth or not. The regulator is also in the same situation. Merely looking at papers and paper trail is not serving any purpose, and if at all, it only means ticking some boxes.

The crying need of the hour is to arrest integrity deficit and restore good value systems. No other corrective action can eradicate this malaise on a long-term basis.

An integrity audit is the audit of the behavioural pattern of an individual. It is a subject of forensic diligence, and in effect, means behavioural audit. The body language and the response of the promoter/CEO to any question posed throws light on their sincerity and honesty. In the good old days of audit practice, it was said that the moment the response to the question is evasive or delayed, suspect the individual.

While the contours of integrity audit have to be developed before it is too late, the trigger is also occasioned by the Clause 3(xi) in CARO 2020, which requires the auditor to report “whether any fraud by the company and any fraud on the company has been noticed or reported during the year…” The impact of the clause mandates assessment of the promoter/CEO and the senior management teams.

Whatever be the method adopted by the government in undertaking the bailout, it has to be via the taxpayer’s money. The question is how long will 97 per cent of the population bear the brunt and contribute to rescue institutions, which represent 3 per cent of unscrupulous elements. There must be a collective movement to eliminate this 3 per cent element.

The writer is a chartered accountant