Chit funds, my mother and the Saradha scam

My life centered around the word and world of Chits since my childhood. Whenever I asked my mother to buy any toy or ice cream, the answer would be, ‘No money, we need to pay for the chits’. My sister and me hated chits so much, as most of my mother’s salary was drained as subscription to chits. But later we realized that it was a very good investment strategy. My mother bought every consumer durable of the house like TV, Refrigerator, Water pump, furniture etc. through her chit savings. She renovated the house and invested in jewellery through careful and calculated bidding at chit auctions. In fact, there used to be tacit understanding between her teacher colleagues at the time of chit auction. They would have discussed and decided who was in dire need for funds at that point of time so that others would never jack up the bid. Even today, after several decades, she continues to invest in chits. But she has been wise enough to invest only in the chits promoted by the government companies and co-operative banks. She forces my professor sister and me to subscribe to the chits of the Kerala State Financial Enterprises (KSFE). I agree, but boldly default on the monthly subscriptions. I know, my mum will pay on my behalf promptly! KSFE, which is state-run has a blemish-free record. 

Millions of people use chit funds, a rotating savings and credits association, as an avenue for savings, meeting expenses and for making investments. This is because the chit sector is less sophisticated, more transparent and easily accessible. This is one of the oldest financial sectors, unique to India. However, after the Saradha scam, there is a lot of hue and cry against chit fund companies. Thousands of people from the lower middle class invested their hard earned money in the group and shocked to hear the news that the company has been closed. Incidents of suicides were reported from various parts of West Bengal as many lost their entire life savings.

Why chit companies became cheat companies?

Blame it on our regulatory enforcement. We are very good at making rules. But fail in our enforcement. Apart from the Central Chit FundsAct (1982), most of the state governments have their own chit regulations. For example, Kerala state enacted the regulations as early as in 1914. Thus, there is no dearth of sector specific regulations. The rules and procedures of Registrar of Companies, though not fully equipped to curb proliferation of ‘paper’ companies, are not complied. This has resulted in having multiple companies registered from a single address with all possible permutations and combinations in the names of Directors. Thousands of companies vanish every year after collecting huge sums of money from millions of people.

(phooto source: PTI-New Indian Express)

Where were the auditors of these companies, who were supposed to be the watchdogs? Laugh with me! Most of these auditors are nothing but predators that suck the blood of their clients. None to regulate them, as they are ‘self-regulators’! (See my article). There are a few sincere and committed auditors and audit firms. But they are side-lined by the mighty audit firms, who never want to leave their large clients to whom they are more eager to offer consultations than audit. 

The need for stringent enforcement

In a greedy, unethical and lax environment that nurtures shameless competition to amass wealth adopting any means, the hapless and financially illiterate common people suffer the most. In India, though investigations were conducted on hundreds of fraudulent banking companies, only a microscopic minority of investors have got their money back. Then what is the use of such investigations, when the victims have not been compensated and the scams continue to happen at regular intervals across the country?

 Authorities need to enforce the rules stringently and ensure that every rupee invested by common man is repaid back with interest. No individual or agency should be allowed to engage in chit business without following the procedure. It is true that there are thousands of genuine chit funds, both in private and public sector catering to millions of people. These ventures need to be encouraged as they create the habit of saving and also provide financial security. 

                                                                                (c) Sibichen K Mathew

Views are personal. Comments are welcome. 

Click links below to read other articles in Cyber Diary on related subject

Satyam: A case of worst audit failure

Frauds, Scams and a Corporate Lokpal

Who trusts the Auditors?

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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