Mumbai: The National Financial Reporting Authority (NFRA), the proposed watchdog for the auditing community, will be effective only if it is kept independent from the Institute of Chartered Accountants in India (ICAI), the existing self-regulatory organization for auditors, said experts.

The Union cabinet on Thursday approved a proposal to establish NFRA as an independent regulator for the auditing profession, in an attempt to tighten regulatory oversight over chartered accountants and plug loopholes. The bill will now be tabled in the coming session of Parliament.

“For the NFRA to be effective, it should consist of independent experts with an impeccable record of integrity. Persons elected to ICAI’s council should be kept out," said R. Narayanaswamy, professor of finance and control at the Indian Institute of Management, Bangalore.

NFRA will replace National Advisory Committee on Accounting Standards (NACAS), which was an extension of the ICAI. ICAI will continue with routine matters and regulating private and public unlisted companies below a particular threshold (the threshold has not been notified). “We do not want to interfere in the professional autonomy of the institute or its functioning," finance minister Arun Jaitley said in a press briefing after the cabinet meeting.

“The NFRA should keep its distance from the ICAI. Otherwise, it will be yet another case of regulatory capture," added Narayanaswamy.

This assessment is based on ICAI’s track record in dealing with economic offences and the role of auditors has been patchy at best.

According to the ministry of corporate affairs’ comments in the Standing Committee report published on December 2016, data was obtained from ICAI on action against auditors for various misdemeanours. Out of the 1972 disciplinary cases taken up by the institute, only in the matter of Satyam Computer Services Ltd was the member permanently removed; in six other cases, members were merely reprimanded. Penalties of one year or more have been imposed on members in only 14 of these cases.

Further, in the majority of the cases where members have been found guilty, they have been merely reprimanded or cautioned. As many as 1,226 cases were closed at prima facie stage by the disciplinary committee. Of these, 117 cases were referred by various government agencies and regulators: 49 of these cases were referred by the corporate affairs ministry and the markets regulator. In all these cases, the auditors were found to be not guilty.

In November 2015, MCA had referred cases of 132 listed companies for examining the role of auditor and possible misconduct. These companies were suspended by Sebi for price manipulation. Even here, according to MCA, preliminary action was not initiated by the ICAI ‘despite several reminders’.

To combat this, the Kotak panel on corporate governance in October last year had proposed that Sebi should be able to take action against auditors in case of possible misconduct in listed companies. While Sebi has not accepted the proposals of the Kotak panel, ICAI had protested the move.

“We have seen several instances where though the companies or banks have been regularly audited, and the auditors did not detect the wrongdoings in the finances of these entities, which they should have, if they followed the auditing standards. It would seem that an independent body was needed to ensure independence of auditors," said Daksha Baxi, executive director, Khaitan & Co, a law firm.

While the 1992 Harshad Mehta securities scam ended the careers of bankers and brokers, nothing happened to the auditors of the banks involved in the fraud. The 27 audit firms that were indicted by the Joint Parliamentary Committee on the scam continue to do business even today.

“Self-regulation has in-built conflict of interest. Members or their elected representatives should not be expected to take action against themselves. It is a bit like asking students to grade their own homework. The ICAI’s loss of ‘self-regulatory’ powers have resulted from years of apathy in taking action against the black sheep in its flock," said Narayanaswamy.

Establishment of NFRA was envisaged under the Companies Act, 2013. But despite two committee reports, assent to the watchdog took nearly five years.

“While NFRA should have come sooner, the body should also look at company secretaries who are currently governed by Institute of Company Secretaries of India (ICSI) as they have an equally important role to play in examining rule compliance," said J.N. Gupta, managing director and co-founder at proxy advisory firm Stakeholder Empowerment Services.

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