Will The NFRA Eclipse The ICAI?

Ten years ago the Enron scam prompted the Sarbanes Oxley Act with measures to improve governance standards in corporate America and so was born the Public Company Accounting Oversight Board. PCAOB oversees the audits of public companies, has 2363 accounting firms registered with it, a staff of 766 and a budget of 245 million dollars.

A similar chain of events has occurred in India – where the Satyam scam has led to stronger governance measures in the Companies Act 2013, which in turn creates the National Financial Reporting Authority. the NFRA is tasked with  standard setting, overseeing compliance and quality and enforcement. Headed by a Chairman - it can have upto 15 members including 3 full time members for Accounting, Auditing And Enforcement, each of whom will head individual committees. In cases of professional misconduct the NFRA can impose substantial

penalties and also debar indivduals and firms. So far the ICAI was doing the same job. So will the NFRA eclipse the ICAI? and will it do a better job of audit regulation?

NEW AUDIT REGULATOR
NFRA: Selection Committee

Draft Rules
• CJI or his nominee
• MCA Secretary
• Ministry of Law & Justice Secretary
• Reputed CA
• Selection Committee: One year term

NEW AUDIT REGULATOR
NFRA: Composition

Companies Act, 2013
• Chairperson + Upto 15 part-time/full-time members
• Chairperson & members to be independent
• Chairperson & full-time members cannot be associated with audit/consultancy firm during membership + 2 years after

NEW AUDIT REGULATOR
NFRA: Composition

Draft Rules
• Chairperson                                      
• Accounting Member
• Auditing Member
• Enforcement Member
• Representatives from MCA, RBI, SEBI
• Retired High Court Chief Justice or Judge of minimum 5 years
• ICAI President

NEW AUDIT REGULATOR
NFRA: Powers

Companies Act, 2013:   In case of professional misconduct
• Impose penalty of Rs 1lakh to 5 times fees received by individual
• Impose penalty of Rs 10 lakhs to 10 times fees received by firm
• Debar member/firm for 6 months – 10 years

To answer that I have with me Former ICAI President Amarjeet Chopra, Deloitte Audit Head P R Ramesh and Former Auditor now well known Independent Director Nawshir Mirza.

Doshi: Will the NFRA eclipse the ICAI and I premise that question by telling you that setting of accounting standards has moved from National Advisory Committee on Accounting Standards (NACAS) to NFRA, setting of auditing standards has moved from ICAI to NFRA, enforcement has moved from ICAI to NFRA. Given this shift in powers and responsibilities, it seems clear now that the NFRA will eclipse the ICAI?

NEW AUDIT REGULATOR
NFRA: Functions

Companies Act, 2013
• Make reccos on accounting & auditing standards
• Monitor & enforce compliance with accounting & auditing standards
• Oversee quality of service
 
Chopra: There is no question of eclipsing the ICAI. I can only tell you one thing, institutions are far greater. The difference which has come in and I think all through we have opposed that- there is no doubt about it - and that was that auditing standard should continue to be formulated and of course notified by the Institute. Can you ever think of a situation that the doctors will be told how to conduct an operation? I think this is absolutely ridiculous if somebody says that auditing standards will be the domain of the NFRA and even if you look at it today very minutely, we are going to be asked what auditing standards are to be pronounced and it is ultimately the Institute which will prepare these standards…(Interrupted by Anchor)

Doshi: You will be consulted Sir. The ICAI would be consulted. The NFRA will have the final word.

Chopra: No, I think this is a wrong presumption. All through it is very clear that these standards will be prepared by the Institute, will be given to NFRA and NFRA will have a look at it. The committee of auditing, which is being proposed to be constituted, they will have a look at it and then if they are disagree to anything, they will send it back to ICAI to be relooked.

Doshi: Which means their word is the last word; not yours. Given the powers that the NFRA has- based on the Act and the draft rules that were put out- most of the functions that the ICAI used to carry out with regards to standard setting and enforcement has moved to the NFRA. Give me specific reasons for why you disagree? 
 
Chopra: You are looking at the corporate world. Our accounting standards will continue to be there for the non-corporate also for that matter. 
 
Doshi: To carry on the point that Mr Chopra made, the NFRA functions include- according to the draft rules- quality review of audits of listed companies, large unlisted companies listed abroad. That pretty much covers the universe of companies with the exception of small private companies in that sense. The NFRA functions include investigating auditors that audit more than 200 companies in a year, more than 20 listed companies in a year, any auditor who audits a large company, any auditor who audits a company listed abroad - that pretty much covers all the large audit firms and auditors in this country. The scope of the powers and the functions of the NFRA eclipse the ICAI, the power is clearly shifting- would you not agree with that?

NEW AUDIT REGULATOR
NFRA: Functions

Draft Rules:  Quality Review of Audits of  
• Listed companies
• Large unlisted companies (Turnover > Rs 1000 cr)
• Companies listed abroad

NEW AUDIT REGULATOR
NFRA: Functions

Draft Rules:  Investigate Auditors that
• Audit > 200 companies in a year
• Audit > 20 listed companies in a year
• Large companies (Turnover > Rs 1000 cr)
• Companies listed abroad

Ramesh: There is a short-term, there is a medium-term, there is a long-term and I don’t want to use the word eclipse. The reality is NFRA is moving in the direction of how independent audit regulators are across the world and if that is so, clearly public interest entities and those who audit public interest entities will be covered by NFRA and as this Section 132 itself says, whatever is taken up by NFRA will not be taken up by the Institute including investigation…(Interrupted by Anchor).

Doshi: Is a case of professional misconduct that the Institute is investigating, if the NFRA starts investigating it, the Institute’s investigation comes to a halt.

Ramesh: There will be a role for the Institute and there will be a role for NFRA but clearly wherever there is public interest…(Interrupted by Anchor).

Doshi: Can I argue that the role for the Institute gets reduced to issues which are very intrinsic to the profession. For instance, one of the rules that CAs have to abide by is that you cannot advertise. Now if a CA is caught advertising, I doubt that the NFRA will step in on issues of professional misconduct; that will stay with the ICAI but everything else which is connected to audits of public listed companies, public companies, large companies has moved?

Ramesh: There are two things there. One is quality of financial reporting and quality of assurance – the quality of financial reporting and the quality of that has functioned is what NFRA would focus on; not the other matters.

Doshi: What you are saying in kind words is the bulk of the responsibility has moved.

Mirza: I would agree with what you are saying even though my two colleagues on this programme are sort of hedging their position. I would agree that the more important functions of the Institute are being taken away by the NFRA. The Institute still has functions without a doubt but the more important ones are being taken away and that is because the Institute has often dragged its heels in doing things it should have done. Let me give you one example- take auditing standards- most of the auditing standards that have been promulgated are ones which have been copied from the international standards but take one very important standard, the standard which is right now the topic of much debate because of the way this profession in India is structured. The Institute still doesn’t have or they still permits joint audits and branch audits to be done for which the principal auditor is not responsible whatsoever. We have the situation of Gujarat NRE Coke where 80 percent of the financial statements were audited in Australia but the auditor in India was not familiar with that.

Doshi: This story we have covered, all our viewers know about it.

Mirza: So now this is the Standard long ago the Institute should have come out with that the principal auditor must take responsibility for the full financial statements.

Chopra: I fully disagree with it. If you look at the entire Standard on reporting- from where it has been taken, it has been taken from the international and even in the international scenario, whatever you have not audited, you say that you have not audited. So where is the question of ICAI dragging its feet?

Doshi: What Mr Mirza used was an illustration for why he thought that the ICAI has not been able to fulfill its responsibilities.

Chopra: I am not denying that but at the same time, we must also look at it from a bigger and broader perspective. Unfortunately, everybody comments on Satyam. Let somebody sit in the shoes of the President of the Institute. If the courts of the country keep on giving stay after stay, what can the President or the Vice President do?

Doshi: Answer the question this way. What is now left for the ICAI to do if issues of gross negligence or professional misconduct, if the overviewing or supervision of audits and financial statements is going to lie with the NFRA; then what is left for the ICAI to do outside of its other core function which is education and training?

Chopra: It only goes on to say that whatever has been undertaken by the NFRA - so far as the investigation or discipline is concerned- that will not be undertaken by the Institute. There is no doubt about it. But you please look at the Rules itself. What does the Rule say? In which case NFRA is going to act against the firms- only where the firm has got 200 company audits, where the firm has got 20 listed companies audits or where they are doing certain audits which are in respect of the foreign entities etc. You tell me, if a scandal occurs in the case of a company and there is a firm, whereby the firm does not have 20 listed companies, the firm does not have 200 companies, the firm does not have a company which has a turnover of more than 1,000 crore or a paid up capital of 500 crore or a networth of 500 crore, can NFRA step in? My answer is no.

Ramesh: Surely, NFRA can step in because it is very clear that on any matter referred by any of the agencies in government and other regulators including if SEBI refers, NFRA can undertake an investigation suo moto.

Doshi: It can do so suo moto, it can do so based on complaints, it can do so based on reference from any other regulator.

Ramesh: Whether in reality it does is a different matter depending on…(Interrupted by Anchor)

Doshi: The parameters that you are referring to are those two sets of responsibilities have to do with quality control of some fashion. They don’t have to do with limiting enforcement.

Chopra: The Rules talk of investigation in all those cases- it is talking of investigation and unfortunately the entire NFRA rules are talking of investigation; they don’t talk of quality review in detail. That is the most unfortunate part.

Doshi: This is where my next question comes- if some powers are shifting and Mr Chopra has a point here - then who does what? If there is an auditor who is responsible for auditing just one listed company and if there is a fraud in that listed company, that auditor will be taken to task by the ICAI or NFRA, who is going to decide that and in these gaps, are we going to end up with two regulators and no regulation?

Ramesh: First let me explain one thing. What is in the law is significantly cast in stone. The Rules are the beginning and the Rules will change as the NFRA evolves. NFRA has to fall in line with the international forum of independent audit regulator otherwise you will have every regulator from outside India coming and inspecting in India as they currently do. Having said that, there is quality of financial reporting and quality control function. Quality of financial reporting today is looked at by FRRB in the institute, by the ROC mechanism and NFRA…(Interrupted by Anchor)

Doshi: You are not answering my question. If these Rules become the final Rules and if there are companies that fall between these gaps, who will take care of that?

Ramesh: If it is a small entity, initially NFRA will not focus because that will be left to the ICAI.

Doshi: Is this the recipe for confusion, two regulators and no regulation?

Mirza: It depends – most of these things are triggered by a complaint being filed. To the extent that it is a complaint which should go to the NFRA - as per the definitions here, the complainant would be told to go to the NFRA but if there are complaints which are not in the NFRA’s domain but nevertheless the complainant goes to the NFRA and says, I don’t have confidence in the ICAI, I am going to the NFRA, it is up to the NFRA to take it up or not take it up.

Doshi: Or pass it back to the ICAI.

Ramesh: But in reality what will happen is NFRA will not dilute its bandwidth by focusing on small and medium enterprises or entities for all your firms even if they are listed; it is an issue of size. It should not also because the NFRA will have limited capacity.

Doshi: You mentioned the issue of capacity. There are several pages that dwell on the design of the NFRA, who mans it etc. Then you have got three other full time members which include an audit member, an accounting member, an enforcement member and it says that the Chairman will be paid Rs 3 lakh a month, no house, no car and that the other full-time members will be paid Rs 2.5 lakh a month no house, no car. I just want to know which right thinking professional who has the experience and the intellect to do this job well is going to want to work for the NFRA at that kind of fee. Add to that the fact that none of these full time members can be attached to any firm or to any company. In fact I think that extends to part time members as well. Interestingly for part time members not only can they not be attached to any firm or any company during their time at the NFRA, they get paid only Rs 10000 per sitting, that is per meeting that they attend. Who in their right mind is going to take on this job? You are not going to get quality people to do this Mr Ramesh?

NEW AUDIT REGULATOR
NFRA: Remuneration

Draft Rules
• Chairperson: Rs 3 lakh per month
• Full-time Member: Rs 2.5 lakh per month
• No entitlement to house/car

NEW AUDIT REGULATOR
NFRA: Eligibility

Draft Rules
• Full-time Member:   20 years experience
• Accounting Member:  Auditor/CFO of large listed company
• Auditing Member:  Auditor of large listed company
• Enforcement Member:  High Court Judge

NEW AUDIT REGULATOR
NFRA: Eligibility
Draft Rules:  Member cannot be
• Associated with audit/consultancy firm
• Employee/ED of company
• ICAI official

NEW AUDIT REGULATOR
NFRA: Composition
Companies Act, 2013
-          Chairperson + Upto 15 part-time/full-time members
-          Chairperson & members to be independent
-          Chairperson & full-time members cannot be associated with audit/consultancy firm during membership + 2 years after

Ramesh: Who are part time members? Those who are involved at the apex level which is the board of NFRA or those who are involved in the individual committees not on a full time basis.

Doshi: Part time members are representatives from MCA, RBI, SEBI- let's assume they don’t get paid; that is fine. Retired High Court Chief Justice or Judge of minimum 5 years…. (Interrupted by Guest)

Ramesh: Say he attends a meeting of the committee on audit or the committee on accounting or the committee on enforcement…(Interrupted)

Chopra: When it comes to the Act, it very clearly differentiates between the full time and the part time. It very clearly says that the Chairman and the full time members should not be engaged with any of the firms. However when it comes to the Rules, it says none of the members of the authority can have any relationship with the auditing firm. This is absolutely contrary to the Act itself.

Mirza: No. In the Act, they also say they shall be independent. So, in the Rules they have defined independence.

Chopra: You cannot say that if I am a partner in one firm, I am not independent with regards to any other firm in the world. I think that is never the definition. That cannot be the definition.

Mirza: My bigger issue on this whole thing is, I have got two issues; one is the issue you raised – what kind of people will come? I am really concerned about that because the risk is that you will get people who have been failed accountants as it were in the profession and industry and who will to some degree vent their frustration in this role when they get into it. My second concern is retired people. 9 positions have already been identified- who are these 9? There are two retired judges, three bureaucrats and the President of the Institute. Now only the President of the Institute and the accounting member and the auditing member are chartered accountants, all the others are not chartered accountants so they don’t … (Interrupted by Anchor)  

Doshi: But the chairperson has to be someone who understands finance, law, accounting all of that.

Mirza: Okay fair, now the thing is that especially on the Enforcement Committee if they have people from SEBI, RBI, and for some strange reason the Serious Frauds Office, my concern is that these are prosecuting authorities when something has gone wrong. To put them on a Tribunal which will decide whether something has gone wrong when at the same time they are also prosecuting perhaps that fraud or that misdemeanor under their own jurisdictions, there is a issue of conflict of interest or position or whatever and you call it. You can't have these people on these Committees; they shouldn’t be there.

Doshi: So, we have counted several important but smaller things. My bigger question in all of this is, if your job as the NFRA is to do a quality review of audits of all listed companies, large unlisted companies, companies listed abroad where are you going to get the manpower to do this? You need hundreds of people to this in any effective fashion unless you are going to piggy back on the ICAI infrastructure.

PCAOB
Founded in 2003

To oversee the audits of public companies
2363 accounting firms registered
Budget: $245 mn
Staff: 766

Ramesh: You don’t need hundreds of people. If you even see equivalent institutions outside of India inspection of an audit firm takes two weeks with about five persons.

Doshi: But you need some people, let me scale it down, you need tens of people?

Ramesh: You will need tens of people and you will have those people. People will leave accounting firms and join NFRA.

Chopra: You look at the Quality Review Board. Last two years, we have been struggling to find reviewers – top class quality reviewers. When we have to get a review conducted of a big four- to get reviewer of that kind we are not able to get and it is not that we are not paying well.

Ramesh: That is because in the Quality Review Board, you are looking only at practicing accountants. You are missing the entire Comptroller and Auditor General cadre which is there. There are people who are trained to do audits of public sector undertakings; they may move in.

Chopra: I am fully with Nawshir on certain points that whatever is being looked at and the kind of people who may come in probably they may not be audit oriented at all and they may not be accounting standard oriented at all at the end of the day. So, what we need to do is we need to do lot of rethinking. I personally feel that these two committees which are there - auditing committee and accounting committees and the third committee being enforcement committee and what we are talking of the committee which will set these standards will also try to ensure the compliance thereof. It is a maker and checker concept and that defies logic under any circumstances. We should have had another committee which should have been called the quality assurance committee for that matter.

Doshi: You made the case in the beginning that the ICAI is rightfully losing some of its roles and responsibilities. Technically the powers may exist under the Act but this is shifting to the NFRA. Do you think the way the NFRA design shows up in the draft rules gives you confidence that the NFRA will be able to do what the ICAI has not?

Mirza: I have my gravest doubts about that it will be any improvement on the current situation. In fact to some degree my fear is things may get even worse because you are going to have a whole bureaucracy out there, there is a secretariat - anyone who has gone to offices in Delhi knows the kind of situation you have out there. So, my genuine concern is that this is not going to result in an improvement.

Chopra: I can tell you the way the Rules have been drafted, these are far more confusing and we are presuming that there will be complaints from banks, there will be complaints from individuals whereas the Act does not provide for it. The Rules in certain cases are contradictory to the law itself and that cannot happen. I fully agree with what Nawshir has said, not that I am supporting any part of the Institute from that angle but I have the gravest of the doubts that NFRA in the present form can really succeed.

Doshi: The rumour is that you have drafted or scripted a large part of the draft rules. So, I will give you the last word to defend may be what is your creation. But principally do you think that the NFRA is going to do a better job than what the ICAI did given this design?

Ramesh: Let me just make two statements here. One is the quality of the design is very good. You may be concerned about the quality of the construction and maintenance, if I may say so, but the quality of the design is very good. Second I would like to close by saying success depends not on the choices we make but what we make of the choices and that is what is important.