Satyam: A case of worst audit failure

By  Dr Sibichen K Mathew

   Satyam episode, once again raises question mark over the sanctity of the system of audits and the authenticity of the audit reports. After analyzing the series of audit failures reported in the recent years, following article suggests that an Independent Audit Regulatory Authority is the need of the hour. Only an objective and pro-active audit system with investigative bend of mind can function as a corporate watchdog on behalf of millions of stake holders.

   World witnessed audit failures of great magnitudes in the 1990s. The Andersen, which was an honoured name with more than 100 years of reputation, was party in deceiving millions of stakeholders of Enron. Like Andersen, many such audit firms, which were considered as the leading torchbearers of ethical practices left many investors high and dry. That happened in the cases of Worldcom, Sunbeam Corporation, Lucent Technologies, Boston Chicken and many more. In India we had the Mardia Group, CRB, Lloyds, Patheja Group, Parasrampuria, Global Trust bank etc who manipulated their financial statements to hide thousands of crores of liabilities and bad debts. In all these scams, audit firms played disastrous roles.

    Satyam is the most recent and the worst corporate debacle triggered by unethical accounting and audit practice. Corporate audit is the watchdog that every stake holder viz. investor, customer, supplier, employee, government rely on. If it shirks its responsibility for short term revenue interests, there is no one who can protect the stakeholders. In a reasonably regulated economy, all enforcement agencies and stakeholders examine and evaluate the performance of a company exclusively depending on the audited financial statements.

     The corporate scams and scandals happened in the world in the last few years are clear indications of the collusion between auditors and management in accounting frauds. Auditing, though considered as a vital institution has lost the credibility due to the manner in which auditing functions are performed.

Why the torchbearers cover up the dark and dingy?

     While function to ensure that corporates earn good revenues following the right track, audit firms compete among themselves to have their own revenues shoot up. In the run to greedy heights, they are forced to compromise on objectivity. Some examples are over dependence on the client for steady earnings, beneficial interest in the business activities and also of the sister concerns of the client, self-interest situations like re-employment in group concerns, over dependence on non-audit work etc.

     It needs to be studied in detail how much and how long the firm that audited Satyam stretched its hands by providing suggestions and consultancy. It should also be examined how much of the fee received by the audit firm was indeed for non-audit functions.

       Enron had paid Andersen twenty five million dollars for audit and twenty seven million dollars for non-audit services in the year prior to its debacle. In addition Andersen earned another six million dollars from Enron’s sister concerns. The share of management consultancy in the total revenues of the big audit firms in US had gone up from 13% in 1981 to more than 50% by 2000. Similar involvement is evident in respect of many Indian companies as well.

      Most of the multi national audit firms in India engage in consultancy services for their clients apart from their audit functions. Even if the steps are correctional, such advices often compromise on the objective evaluation of the outcomes of such action. Disclosures should not be made ambigous in the guise of maintaining client confidentiality. It is surprising how auditors of Satyam missed certain vital understatements such as non-existent accrued interest of 376 crores, receivables of 490 crores and 588 cores of cash that didn’t exist. All these are figures of just one quarter. Chairman of Satyam has admitted the profits were inflated substantially since last several years. Now it is for the ICAI’s disciplinary committee to examine whether adequate due diligence was ensured by the auditors of satyam.

Do we have enough regulations?

     Sarbanes-Oxley (SOX) Act passed by US was the first ever radical initiative by any country. It was a strong response to popular outrage in the wake of Enron, Worldcom, and other equally lurid failures of law, standards, governance and most importantly audit. As per the SOX Act, all audit and non-audit services (with some exceptions) must be pre-approved by the audit committee of the company, and such approval must be disclosed to the investors. Audit partners must be rotated periodically. It is also stipulated that the audit firms must report to audit committees, the recommended alternative accounting treatments that have been discussed with the management. SOX Act laid down an array of strictures on company directors, especially CEOs and CFOs. Punishments include imprisonment upto 25 years. Companies listed in US may have to face penal action if detected for accounting and audit frauds.

      Indian laws are not without any provision to tackle offences by the auditors. The Company’s act 2008 provides for certain situations in which the auditors can be held responsible for negligence, incorrect statements etc. As per section 628 of the Company’s Act, if an auditor in any report, certificate, balance sheet, prospectus, statement or other document required under the Act, makes a statement which is false, knowing it to be false or omits any material fact knowingly, it is punishable with imprisonment. Though Indian auditors claim that India has a foolproof legislation in place and the SOX Act is redundant in India, it is necessary to examine why then such audit failures of horrifying magnitude happens, as witnessed in Satyam. Naresh Chandra Committee Report on Corporate Audit and Governance, Report of the SEBI committee on Corporate Governance headed by Kumaramangalam Birla and many other reports have dwelled deep into the issues of corporate governance and had recommended several measures to prevent audit failure. What is clear from the current Satyam episode is not lack of regulations but lack of compliance to the same.

More crucial questions

      Satyam revelations have pointed out the larger regulatory failure which are linked to audits. What was the role played by the Audit Committee, which is mandatory as per clause 49 of the listing agreement. It is often alleged that Audit Committees of most of the companies are only in paper. It is the duty of the audit committee to effectively analyze the operations at all levels of the company in a coordinated manner. One needs to examine not only the financial literacy of the members of the Audit Committees of the companies, but also their capability to effectively fulfill their responsibilities. The members of the audit committees need to review internal audit processes, have detailed discussions with the auditors and CFO and ensure compliance with financial, accounting and stock exchange standards every quarter, as recommended by the Naresh Chandra Committee.

    The role of independent directors in ensuring financial discipline is well recognized. Independent directors are compulsory in the Audit committee. The question is how independent are the independent directors. How couldn’t the independent directors smell the rat in Satyam’s financial results, though the manipulations were very apparent and repeated year after year? Independent directors are supposed to provide objective oversight on the financial activities of the company. It is astonishing to note that they have ignored even the actions of the World Bank against the company by not attempting to find out what exactly is happening within the management of the company. Surprisingly all so called independent directors in Satyam were academicians and retired bureaucrats of international reputes and achievers in their respective fields.

       Public need answers to several questions. Whether what Ramalinga Raju revealed is complete? Whether more such skeletons are hidden in the financial statements and also with respect to its other group concerns? Similarly, if a front runner company like Satyam was sitting on such accounting and audit frauds, what would be the real corporate scenario? Whether similar frauds are happening elsewhere that are neither revealed nor detected?. In the light of information coming in, it is imminent to have a thorough surveillance, inspection and review of the compliance to corporate governance norms by the companies.



Need for an Independent Audit Regulatory Authority

       Time is ripe to think of an independent audit regulatory authority to effectively regulate and enforce the audit system in India. The authority should be responsible for formulating and amending the accounting and auditing standards with the technical assistance of ICAI. It should have an oversight board that reviews the audit work and shall conduct inspections. The possibility of introducing centralized empanelment of auditors and random allocation to various corporates on rotation based on the specialization and need has to be explored. Such an independent auditor general assisted by a well represented audit board should be the disciplinary authority with functions for grievance settlement and adjudication ingrained within them. A national audit fund can be set up to raise resources through various means such as annual fee from companies, and contribution from the listing fee and also a fee on a percentage of the turnover and share capital. A small percentage can be deducted for the fund from the investors at the time of transactions.

Auditors need to be pro-active

     PwC has almost washed its hands stating that its judgment of Satyam was based on what was produced before them. Similar conditional authentication is given by many auditors while furnishing statement of particulars of financial activities of the clients before authorities. Audit firms should understand that such certificates be submitted only after examining the transactions reflected in the relevant books of accounts with supporting evidences. It is the duty of the statutory auditor to check the transactions at random and to provide a critical analysis of the reports and statements prepared by the internal auditors before putting their stamp. Audit as an institution can regain its sanctity only by being pro-active and vigilant. Practices such as periodic rotation of audit firms and audit firm partners, regular peer review, evaluation of action taken reports of audits, transparent corrective actions and clarity in reports can definitely ensure public faith in the audit system as a watchdog.

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As Satyam episode unravelled another corporate scam, and series of investigations are on, let us cross our fingers ..........‘

"First Enron, then Tyco and now WorldCom. How come all these companies are off billions in their accounting and nothing ever happens to them? If you bounce a $15 check at the Quickmart, the feds are at your door!" —Jay Leno