Friday 25 November 2011

RE-ENGINEERING THE AUDITOR

We live in frighteningly uncertain times and more than anything else, globalisation is to be blamed for the situation. What started as a process to make this world a more manageable ecosystem gave rise to an unending need for growth. As a result, we have in place a system (not by default, but by design), which renders almost every checkpoint defunct. Billions of dollars are spent every year in organising conferences and round table meeting where thought leaders supposedly have a dialogue on how to fix this recurring mess. But as is evident, nothing happens. In fact, more scams and accounting frauds are unearthed everyday. I think – to start with – it is time that we actually sit up and reengineer the role of auditing firms.

The Madoff Scam would be a good case in point to understand what I’m trying to put forth. In December 2008, Bernard Madoff, the former Chairman of Nasdaq, was charged with fraud. His investment firm was running a Ponzi scheme and the size of the fraud is estimated to be around $64.8 billion. Madoff’s accounting firm – Friehling & Horowitz – had offices in a strip mall and was run by three employees. Given the size of this firm, it is quite obvious why there was no whistle blowing. After all, they had to be in business! But what is not so obvious is the fact that KPMG, PricewaterhouseCoopers, BDO Seidman and McGladrey & Pullen (the auditing firms for institutions that invested in Madoff’s company) also gave a clean chit to the funds that were invested with Madoff.

Not so surprisingly, the scenario in India is not different either. The Indian arm of PwC was fined with $7.5 million by the United States Securities and Exchange Commission on failing to reveal that Satyam Computer Services’ balance sheets were cooked up. If such instances are not enough to reconsider the role of auditing firms, then sample this. In a landmark report released by The Committee of Sponsoring Organizations (COSO) [an independent US body, which provides guidance on governance], it was revealed thus, “79% of companies found to be engaged in frauds were being audited by the Big Four (Ernst & Young, PwC, KPMG and Deloitte) between 1998 and 2007.”

Around 90% of companies in India are privately held. Big and small auditing firms alike are paid by them. The fact is, till the time this transactional relationship exists between corporates and auditing firms, such scams will continue to flourish. Further, auditors are regulated by ICAI guidelines. Most of the auditors survive on a handful of clients. Further, the remuneration they receive is not based on their ability to add to the business but to fill certain documents and add their signature. Therefore, such auditing firms are left with no choice but to help promoters circumvent the law. I feel that auditors must undertake assignments, which they can manage with resources at hand. Moreover, ICAI will have to take a stronger stand on this issue so that the system becomes more rewarding. In fact, in the prevailing system, I see these auditing firms as nothing more than image managers. Most Indian companies bring the likes of PwC and E&Y on board because they hope that such an association would enhance their image before investors. There are two choices from here on. Either turn a blind eye – let the auditors rake in billion of dollars for perpetrating frauds and allow the companies to fool investors – or bring in a regulatory body or make amendments in the Companies Bill to clamp down on these auditing firms. If not, then auditors will continue to act as voluntary puppets instead of the watchdogs they are supposed to be.