Auditing the Auditors
3.01 Who audits audit? This
question has vexed economists as well as corporate governance specialists.
Simply put, the auditor performs a critical role in informing the shareholders
of the true and fair picture of the state of financial and operational affairs
of a company. However, the ability to play this role well depends upon the
skills, independence, professional scepticism and integrity. It has been often
argued that there
are ought to be a need to credibly regulate
auditors so as to ensure that
they have properly discharge d their fiduciary
3.02 In most countries, the
regulatory role is carried out, to greater or lesser degree, by professional
bodies representing certified public accountants. Whilst in some countries
re are merely
voluntary “non-statutory ” self
regulating organisation, in some other they are creatures of specific statute s.
the Institute of Chartered Accountants of India (ICAI) has been set up under the
Act, 1949, to examine and regulate the profession. Similarly, the Institute of
Company Secretaries of India (ICSI) has been set up under the Company
Secretaries Act, 1980, to regulate its members. Analogously, the cost accountants are regulated by
the Institute of Cost and Works Accountants of India (ICWAI). Indeed, these
three professional organisations are statutory bodies created by acts of
Parliament, and not mere self-regulating
3.03 Until recently, most
countries felt no need for any kind of public oversight board
to be an independent apex
organisation to regulate the conduct of these fiduciary intermediaries. The US
corporate scandals have changed all that. Spurred by the public spectacle of
senior auditors claiming little knowledge of the financial skulduggery of
Enron and Worldcom, shareholders and corporate governance specialists as well as
world at large are increasingly
demanding the setting up of credible public oversight bodies.
3.04 The first such move
has been initiated by the SOX Act,
which has legislated in favour of setting up the Public
Company Accounting Oversight Board (PCAOB). Box 3.A synopsises the basic
elements of the PCAOB. Its provisions are worth reading in some detail, for it
is the most comprehensive legislative intermediation in the history of auditing.
3.05 At the time of writing,
there are reports that the financial community in the US is up in arms against
the severe provisions governing the PCAOB. In fact, expert commentators believe
that the rules and regulations governing PCAOB will have to be modified to suit
reality. Irrespective of what happens in the US, it is a fact that providing for
the PCAOB has raised similar demands in other countries. And, the Committee has
been entrusted in its terms of reference to examine this matter.
Box 3.A: Public Company Accounting
Oversight Board of the SOX Act
To oversee the audit of listed companies in order to protect investors’ and
public interest in matters relating to the preparation of audited financial
A non-profit body corporate, and agency or establishment of the US government.
(i) Register all audit firms, (ii) establish and/or adopt rules for auditing,
quality control, ethics, independence and other standards relating to the
preparation of audited financial reports, (iii) conduct periodic inspection of
auditing firms, (iv) conduct investigations and disciplinary proceedings where
justified and, if necessary impose appropriate sanctions and penalties, and (v)
enforce compliance with the SOX Act, securities laws relating to preparation and
issuing of audit reports and the rules of the SEC.
Five full time members, who are prominent individuals of integrity, possess an
understanding of financial disclosures and have a demonstrated commitment to the
interests of investors and the public. While serving on the board, none of the
members can be employed or be engaged in any other professional or business
activity. Only two members out of five may be certified public accountants and
if such a member is the chairperson, then s(he) cannot be practicing certified
public accountant for at least five years prior to his or her appointment to the
The board has powers to (i) sue, be sued, complain and defend, (ii) conduct its
operations, maintain offices and exercise all other rights and powers authorised
by the SOX Act, (iii) appoint employees, accountants, attorneys and others,
define their duties and fix their compensation, and (iv) allocate, assess and
collect support fees from registered public accounting
All public accounting firms have to register with the board within 180 days from
the passing of the Act.
quality control and independence standards and rules:
The board shall establish by rule all auditing, attestation, quality control and
ethics standards that need to be used by audit firms. These standards may be
formulated either by adopting those of professional groups or by recommending
of audit firms:
The board shall have the powers to conduct a continuing programme of inspections
of audit firms to assess their degree of compliance to its rules as well as
those of the SEC. In general the board will annually inspect each audit firm
more than 100
companies, and once in three years those that audit 100 or less
Investigation and disciplinary
proceedings: The board has the powers to conduct investigations of any act
by an auditing firm or its partners that may violate the provisions of SOX Act
and other laws
and rules. Non-cooperation with such investigations can result in suspension and
revoking of the registration or licence of the audit firm. Moreover, the board
has powers to initiate and conduct disciplinary proceedings against any
registered audit firm.
If the board finds that there have been violations, it is allowed to impose
sanctions such as (i) temporary suspension, (ii) permanent suspension and
revocation of licence, (iii) fines ranging from $50,000 to $100,000 for a
natural person for each such violation, and between $2 million and $15 million
for each violation committed by any other person.
These provisions will apply to non-US auditing firms that prepare audited
financial statements for US publicly listed companies.
India have its Public Accounting Oversight Board?
The Committee took note of
the Statement on Peer Review issued by the ICAI in March, 2002. According to this statement, the ICAI
has decided to aid professional firms in their quest for enhancement of quality
of work through peer review, and have recognised that a professional should be
always ready to show the quality of his work.
3.07 Quality has now come to
be defined as the degree to which a set of inherent characteristics
(distinguishing features) fulfils requirements, a requirement being the need or
expectation that may be stated or generally implied, or
3.08 The Committee, after
some deliberation, came to the conclusion that while the ICAI statement on Peer
Review is indeed a good one, it was time to think of a more independent and
refined arrangement to ensure the quality of attestation services assignments
performed by chartered accountants in relation to the technical standards
3.09 The opinions
of those who met with the Committee were split along the
middle: one set of people fervently advocated the setting up of an
independent Public Accounting Oversight Board, while another — most notably,
many chartered accountants, argued otherwise. We feel that it is important for
the Committee to record both arguments before arriving at a conclusion.
3.10 Those who favoured an
oversight board based their arguments on the perception of the efficacy and
independence of ICAI. According to this school of thought, while the ICAI is
legally empowered to carry out most of the regulatory, oversight and
disciplinary functions outlined in the SOX Act (barring prosecution and levying
of penalties), the public perception is that ICAI mechanisms are
slow and that the Institute seems to be loath to sufficiently discipline its
errant members .
Therefore, it was argued, the
need for a new, independent body to carry out such critical oversight functions.
3.11 Not surprisingly, many
chartered accountants and spokespersons for ICAI believe otherwise. According to
them, the Chartered Accountants Act, 1949, the regulations framed thereunder,
and the organisational structure of ICAI enjoin the Institute to conduct all the
necessary disciplining functions. The ICAI did agree that the procedures
prescribed under the Chartered Accountants Act and its regulations tend to be
slow, and favoured legislative amendments. They, however, contended that
speeding up the process accompanied by changes suggested by them, should suffice
to strengthen effective oversight over the disciplinary mechanism within the
structure of ICAI. Hence, they felt that perhaps there was no need to create yet
legally mandated quasi-independent supervisory
3.12 After considerable
deliberation, the Committee came to the view that there was merit
to ICAI argument. The
reasons are as follows:
the powers that are sought to be vested in the PCAOB of the United States
under the SOX Act are today, in India distributed across a plethora of
regulatory agencies — the DCA, SEBI, RBI, ICAI, ICSI, ICWAI, the power to
proceed under the Information Technology Act, 2000, and residual powers under
Procedure Code and the Criminal
therefore, if there were to be an Indian version
of the PCAOB, then such powers would need to be withdrawn from the existing
regulatory agencies and concentrated on the proposed public
oversight board. Without these powers, the board would be yet another
toothless agency — maintained for the matter of form,
but without any significant operational content.
was argued, had enough such cosmetic agencies, and did not need another
it was argued that the need of the hour was reform of auditing oversight
functions — but that such reforms did not necessarily entail circumscribing
the powers of existing institutions to create yet another one. Instead, it was
necessary to empower the organisations that are on the ground and, if need be,
provide additional safeguards to ensure that they expeditiously
d their stated objectives.
3.13 On balance, the Committee
opted in favour of this view, and therefore rejected the idea of setting up yet
another new regulatory oversight body. However, it also felt that the ICAI must
now show more determination and speed — and so prove that it is an efficient
body that can be always entrusted to provide transparent and expeditious
auditing oversight in the interest of investors and the general public.
3.14 If not a new public
oversight board, then what? The Committee considered two major steps. First,
recommending legislative and organisational support for the setting up of
independent Quality Review Boards to strengthen and
extend the peer review
system within the ICAI.
Secondly, recommending significantly enhanced and expeditious disciplinary
action within the framework of the Chartered Accountants Act, 1949 to bring
errant auditors to book . The former is discussed in section 3.2, while the
latter is examined in section 3.3 below.
Independent Quality Review Boards
Bef ore recommending
the setting up of independent Quality Review Boards (QRBs) , it should be stated that
Committee examined the ICAI’s recently introduced system of peer review of audit
firms, which is going to be operational from 1 April 2003. While ICAI’s Peer
Review Statement seems to be an adequate, self-contained document that addresses
most of the issues regarding ‘who audits the auditors’, it is still necessary to
recommend a process of quality review that is publicly perceived to be
independent and expeditious. The committee noted that such a system has already been established in Sri Lanka. The committee recommends setting up of
independent QRBs — one each for the ICAI, the ICSI and the ICWAI.
Setting up of independent Quality Review Board
There should be established, with
appropriate legislative support, three independent Quality Review Boards (QRB),
one each for the ICAI, the ICSI and ICWAI, to periodically examine and review
the quality of audit, secretarial and cost accounting firms, and pass judgement
and comments on the quality and sufficiency of systems, infrastructure and
the interest of realism, the QRBs should, for the initial five years, focus
their audit quality reviews to the audit firms, which have conducted the audit
for the top 150 listed companies, ranked according to market capitalisation as
on 31 March.
This should give investors the comfort that the audited
financial and secretarial reports of all important listed companies are being
reviewed. Depending upon the record of success of such reviews, the
DCA may subsequently consider altering the sample size or criterion.
Composition of ICAI’s QRB: The board shall consist of 11
members, including the chairman. The chairman shall be nominated by the DCA, in
consultation with, but not necessarily from, the ICAI. Five members of the
board, excluding the chairman, shall be nominated by the DCA who will be people
of eminence, professional reputation and integrity including, but not limited
to, nominees of the Comptroller and Auditor
General of India, RBI, SEBI, members or
office-bearers of the Bombay Stock Exchange or the National Stock Exchange, the
three apex trade and industry associations (CII, FICCI and ASSOCHAM), reputed
educational and research
bankers, economists, former public officials and business executives. The
remaining five members of the Board will be nominated by the Council of the
Composition of ICSI’s QRB: A five-member board, including
the chairman. The chairman shall be nominated by the DCA, in consultation with,
but not necessarily from, the ICSI. Two
members, excluding the chairman, shall be nominated by the DCA, who will
have the same attributes suggested for ICAI’s QRB above. The remaining two
members will be nominated by the Council of the ICSI.
Composition of ICWAI’s QRB: A five-member board, including
the chairman. The chairman shall be nominated by the DCA, in consultation with,
but not necessarily from, the ICWAI. Two
members, excluding the chairman, shall be nominated by the DCA, who will
have the same attributes suggested for ICAI’s QRB above. The remaining two
members will be nominated by the Council of the ICWAI.
Funding: Each of these QRBs will be funded by their
respective institutes in a manner that
each sees fit.
Appellate forum: In the instance of a dispute between the
findings of the QRBs and reviewees, the matter should be referred to an
appropriate appellate forum. This appellate forum should be the same as that
suggested for disciplinary matters, which is discussed in Recommendation 3.2
DCA should adopt transparent
procedures while nominating people of eminence to the
for Professional Misconduct
area of disciplinary mechanism requires careful
consideration. Spurred by revelations of significant audit failures in the US,
there have been reports in Indian media expressing concern over the alleged lack of disciplinary
action on auditors who have failed to perform their duties. It has also
been stated by many who interacted with the Committee that the ICAI has been
unable to adjudicate disciplinary cases within reasonable time. Similar concerns
have been expressed for the other two Institutes, even though they have much
fewer disciplinary cases.
3.17 Under the current legal
framework, failure on the part of auditors regarding their civil and/or criminal
acts or omissions are dealt with under the respective law. Auditors are also liable under the common law of the
country. But law proceeds in ponderous ways. And the hallmark of any reputed
profession, especially one discharging key fiduciary obligations, is the code of
ethics that it imposes on its members, and
the mechanism for reviewing professional misconduct. In fact, The
Chartered Accountants Act, Company Secretaries Act and the Cost and Works
Accountants Act do provide for
a framework for taking
disciplinary action against the erring members.
3.18 As far as chartered
accountants are concerned, section 21 of the Chartered Accountants Act provides
for disciplinary action against a member of the ICAI for professional and/or
other misconduct; while regulations framed under the
act defines the framework and procedures by which
the disciplinary proceedings must be conducted. The existing mechanism is quite
elaborate. However, procedures that were framed in the past have not been able
to cope with the changed scenario, which must deal with complex businesses and
over 70,000 practicing members.
3.19 Not surprisingly, there
have been professional as well as public concerns
about the time taken in the
disposal of disciplinary proceedings.
The existing system suffers from the following limitations
- Inability of the ICAI to enforce
information/documents from the concerned agencies before the prima facie stage.
- Inability to deal with
practices resulting in delay at every stage of
- Inability to adopt a prioritised
approach, which can
distinguish cases according to the severity of misconduct
and importance to the public, and deal with the serious ones expeditiously.
3.20 Indeed, a note from the
ICAI has highlighted the problems which occur at each stage of the process. These
require some elaboration.
- Prima facie opinion on whether or not a member is guilty
is required to be formed at the level of the full Council. The Council of ICAI
consists of 30 members, and can only meet eight to nine times a year. This
leads to delay s
at the very first stage of the disciplinary proceedings.
- Under section 21 of the Chartered
Accountants Act, all cases where ICAI’s Council has held the respondent prima facie guilty have to be taken up
for enquiry by the Disciplinary Committee, which consists of five members,
with no provision for benches. This worked when ICAI had far fewer practising
members. It can no longer adequately handle over 300 complaints received every
year — a number which is expected to increase in the future.
- The Council must then deliberate on
the reports of the Disciplinary Committee. In doing so, a Supreme Court
judgement has determined that it must give hearing to the complainant and
respondent. This entails further delays and, at times the process has been
misused by one or both of the concerned parties.
- If a member is held guilty, the
Council either awards punishment or recommends punishment to the High Court.
Where the recommendation on the award of punishment is not required to be sent
to the High Court, the procedure requires giving yet another opportunity to
the respondent. Moreover, according to the rules, the report and
recommendation of punishment cannot be considered in the same meeting.
Therefore, the punishment part must necessarily await another meeting of the
- In cases where the case is
forwarded to the High Court, it takes even more time for the Court to confirm
the Council’s award of punishment
under section 21(5 and
3.21 The Committee believes
that such delays just have to be avoided. The confidence of the investing
public, especially small investors, cannot be nurtured unless disciplinary cases
are dealt with more expeditiously and transparently.
3.22 The Committee has been
given to understand that in its various representations to government, the ICAI
has suggested changes in the
process. Some of these changes
schedules of the Chartered Accountants Act that describe professional misconduct into a composite schedule,
and clear categorisation of offences. According to ICAI, this ought to help
focus on cases having larger public interest and also relate the quantum of
punishment to the gravity of offence.
- Constitution of a
new Standing Committee (Screening Committee) for forming prima facie opinion.
- Broad-basing the
Disciplinary Committee with more representation for nominees of Central
Government, and empowering it to function through benches.
Council, Screening Committee and benches of the Disciplinary Committee should
be given powers similar to those vested in a Civil Court regarding matters
like discovery and production of documents.
benches of the Disciplinary Committee should also recommend punishment in its
report submitted to the Council.
Council must consider the report and, in cases where it upholds the punishment
recommendation of the bench, simultaneously award
must be empowered to award all types of punishment for
types of offences.
for withdrawal of specified type(s) of complaint case(s) up to a specified
stage. Provision for summary disposal, in the event of respondent pleading
guilt up to a
3.23 While the Committee
appreciated the changes suggested by ICAI, it felt that the need of the hour was something
investors and other stakeholders of companies rely on the audited financial
statements for making investments and other major decisions. The auditing
profession, therefore, needs to respond to the confidence reposed in them, and
has to be seen to be responsive.
3.24 Moreover, in most
instances, disciplining the auditors need not be a matter requiring
consideration of High Courts. For one, there are significant delays whenever a
case is recommended by ICAI to the High Court. For another, the High Courts have
enough on their plate to be further burdened by ICAI cases. Hence, there is a
need not only to have more expeditious disciplinary processes within the ICAI,
but also to have a quasi-judicial appellate body outside the High Courts to hear
most of the appeals.
3.25 The existing
disciplinary cases fall under two specific categories: ‘complaint’ and
‘information’ cases. While this categorisation may continue, the procedures to
be followed need significant changes not only to overcome the bottlenecks but
also to ensure effective and expeditious delivery of justice. Accordingly, the
Committee has recommended an entirely new disciplinary procedure which, while
keeping the process within the framework of the ICAI and The Chartered
Accountants Act, will bring about greater
ensuring independence and fair play.
3.26 After considering the
matter at some length, the Committee arrived at the conclusion that the right to
appeal to the High Court or making certain penalties subject to confirmation by
the High Court was not strictly necessary.
The Committee noted that such a provision was not there in the Advocates
Act. Given the nature of cases involved, it would be more appropriate to
establish a high-powered Appellate Body comprising two senior chartered
accountants, two eminent persons having qualifications similar to the ones
prescribed for independent members of the Disciplinary Committee but of a higher
standard and experience and a Presiding Officer who should be a retired Judge of
the Supreme Court or a retired Chief Justice of High Court.
3.2: Proposed disciplinary mechanism for
offences and merging of schedules: At present there
are two schedules of offences and misconduct — with the second schedule
requiring action by High Courts. These two schedules need to be merged, so that
the Council is empowered to award all types of punishment for all types of
offences. Further, offences need to be categorised according to the severity of
misconduct, so that processes can be designed, and punishments awarded,
according to the severity of the offence.
Directorate: An independent
permanent directorate within the structure of ICAI shall be created, which shall
act as the Prosecution Directorate. This office will exclusively deal with all
disciplinary cases and, hence, expedite the process of enquiry and
decision-making by fully devoting its time and energy towards processing these
cases. The office should be headed by a person of the level of Director, and
should be one with a legal background and conversant with the provisions of The
Chartered Accountants Act and its regulations. He and his office shall be
independent of the electoral process of ICAI. Suitable regulations need to be
framed to uphold the independence of this office. The Prosecution Directorate
shall have the same powers as are vested in a civil court under the Code of
Civil Procedure, 1908, regarding (i) the discovery and production of any
document; and (ii) receiving evidence on affidavit.
dealing with complaint cases
received in the appropriate form, manner, and complete in all respects, shall be
registered by the Prosecution Directorate, and sent to the member or firm within
15 days of registration of such a complaint.
Depending on the
category of the complaint, the Prosecution Directorate shall ask for and obtain
necessary documents such as written statements, rejoinders, comments, and other
evidence from the complainant as well as the respondent. The time frame for this
should be, under normal circumstances, no more than 60 days. Not submitting such
documents within the prescribed time shall be treated as an offence, risking the
initiation of additional obstruction of justice
On receipt of the
relevant documents, the complaint, along with the views, if any, of the
Prosecution Directorate, will be placed before the Disciplinary Committee. This
has to be done within 20 days of receiving all relevant accompanying
dealing with information cases
received shall be examined by the Prosecution Directorate. After forming his
views, the Director of the Prosecution Directorate will place the matter before
the Secretary of ICAI.
If the Secretary
agrees with the view expressed by the Director, then the information case will
be placed before the Disciplinary Committee.
In the event of the
Secretary differing with the views of the Director, the matter would be placed
before the President of ICAI and, thereafter, it would be discussed at a meeting
between the President, Secretary and the Director. If in this meeting, it is
decided to refer the matter to the Disciplinary Committee, then reference be
made accordingly. Upon such referral, the Prosecution Directorate shall argue
the case before the Disciplinary Committee. If, however, the Secretary and
President of ICAI decide that the information should be filed and closed, then
the Director of the Prosecution Directorate will have the choice to either
follow the majority opinion, or dissent and refer such a case to the
Disciplinary Committee, with his as well as the Secretary’s and President’s
opinion. In such instances, however, the President shall not function as the
Presiding Officer of the Disciplinary Committee. Further, if the Director Prosecution
does not feel that a reference to the Disciplinary Committee is warranted, the
Institute would still be free to take such cases to the Committee if it feels
there is a need to do so.
the ‘information’ case, the procedure outlined for the complaint case may be
followed mutatis mutandis.
relation to misconduct of members shall be held by the Disciplinary Committee.
To expedite decision-making, the Council of ICAI shall be empowered to
constitute one or more bench of the Disciplinary Committees in cities where
there are regional headquarters of ICAI.
bench should consist of five members. The President or the Vice-President of
ICAI will be the Presiding Officer. However, in
“information ” cases put before the
Committee by the Prosecution Director after disagree with the views of the
President and the Secretary, the President shall not act as the Presiding
Officer. In such cases, the Vice-President will perform this role. Two of the
other four members will be nominees of ICAI’s Council, while the remaining two
will be nominees of the DCA viz. people of eminence, professional reputation and
integrity such as, retired judges, bankers, professionals, educationists,
economists, business executives, former members of regulatory authorities and
former public officials. As far as practicable, members of the Disciplinary
Committee should be from the regions other than the one in which it is being
It needs to be
stated that in terms of the existing requirement, a nominee of the Central
Government is required to be nominated to the Disciplinary Committee. Until very
recently, such a nominee was an official of the DCA. However, DCA officials have
rarely had the time to attend the meetings of the Disciplinary Committee. Hence, the Committee recommends that, given
paucity of time, sitting government official should not be nominated to
the Disciplinary Committee s.
It is pointed out
that for each stage in the process, strict time lines should be prescribed. This is especially important in respect
of scrutiny of
“information cases ”.
of the five members.
Co-terminus with the duration of the ICAI Council.
Disciplinary Committees shall hear the complaint and information cases referred
by the Prosecution Directorate and record their decisions and conclusions in a
report. This report shall also record the punishment to be awarded, if any, to
the member, which can
constitute (i) reprimand, (ii) removing
the name of the member either permanently or for such a period as thought fit,
(iii) monetary penalty, and/or (iv) a combination of any
submitted by the Disciplinary Committee should normally be considered by the
Council within 45 days from the date of the report. It shall be the duty of the
Council of ICAI to act upon the decisions of the Disciplinary Committee. While
performing such a duty, the Council can:
the decisions of the Disciplinary Committee, and implement
any case back to the Disciplinary Committee for further enquiry, when it
finds that certain issues
need further enquiry. However, in doing so, the Council will have to frame the
to place the case before the Appellate Body, in the event of the Council
deciding to appeal against the decisions of the Disciplinary
in New Delhi, the Appellate Body shall consist of a Presiding Officer and four
other members. The Presiding Officer shall be a retired judge of the Supreme
Court or a retired Chief Justice of a High Court. Two members shall be Past
Presidents of ICAI, nominated by the Council. The remaining two shall be persons
of eminence nominated by the DCA (but excluding any officer of the Department or
member of the Council). The quorum shall be three.
of decisions of the Disciplinary Committee
publicity shall be given by the Prosecution Directorate about the punishment
ultimately awarded, through periodicals, newsletters, website and any other
means considered appropriate. However, no decision taken by the Disciplinary
Committee be published unless and until the punishment is endorsed and
implemented by the Council.
Body: Required funding arrangements should be made by the Central Government.
This is essential for ensuring independence, and on the ground that the High
Court stage can be said to have been always funded by the Government.
Committee: The expenses shall be borne by ICAI’s Council, which shall also fix
the emoluments, sitting fees, allowances, and other expenses of the
All expenses will be borne by the Council of ICAI.
complaint, other than a complaint made
by or on behalf of the Central or any State Government shall be
accompanied by a fee Rs.5,000, which will be returned as soon as the
Committee recommends that case is not frivolous. Fees not refunded for frivolous
cases will be used to partly defray the cost of investigation.
disciplinary mechanisms may be designed on similar lines in respect of Company
Secretaries and Cost Accountants. The Committee believes that the mechanism
outlined above is realistic and should work, given adequate funding and
determination. This should bring to bear a transparent and expeditious
disciplinary procedure that could contribute to enhancing the prestige and
public trust that the Institutes have today.