Daybreak - What is suddenly sending shivers down the spines of 350,000 CAs?

Episode Date: June 6, 2024

It has been a tough couple of years for India’s Chartered accountants. This was and to some extent still is one of the most sought after jobs in the country. But lately, the amount of risk involved in their work has been amped up considerably. And as a result, CAs have been resigning left, right and centre. The reason this is happening is because the auditing industry has been undergoing a major shake-up. And behind this shakeup is a relatively new, independent audit regulator called the NFRA, or the National Finance Reporting Authority. The NFRA has set all sorts of records in the last two years. Since 2022, it has debarred 78 auditors and imposed close to Rs 20 crore in penalties. Tune in. 

Hi, this is Rohan Dharma Kumar. If you've heard any of the Ken's podcasts, you've probably heard me, my interruptions, my analogies, and my contrarian takes on most topics. And you might rightly be wondering why am I interrupting this episode too. It's for a special announcement. For the last few months, I and Sita Raman Ganeshan, my colleague and the Ken's deputy editor, have been working on an ambitious new podcast. It's called Intermission.

We want to tell the secret sauce stories of India's greatest companies. Stories of how they were born, how they fought to survive, how they build their organizations and culture, how they manage to innovate and thrive over decades, and most importantly, how they're poised today. To do that, Sita and I have been reading books, poring over reports, going through financial statements, digging up archives, and talking to dozens of people. And if that wasn't enough, we also decided to throw in video into the mix. Yes, you heard that right. Intermission has also had to find its footing in the world of multi-camera shoots in professional studios, laborious editing, and extensive post-production.

Sita and I are still reeling from the intensity of our first studio recording. Intermission launches on March 23rd. To get alert, as soon as we release our first video. episode, please follow intermission on Spotify and Apple Podcast or subscribe to the Ken's YouTube channel. You can find all of the links at the ken.com slash I am. With that, back to your episode. It's been a pretty tough couple of years for India's chartered accountants. I mean, this was, and to some extent still is one of the most sought-after jobs in the country. But lately, the amount of risk involved in their work has been amped out.

up considerably. And as a result, CAs have been resigning left right and centre. Now, the reason this is happening is because the auditing industry has been undergoing a major shake-up. And behind the shake-up is a relatively new independent audit regulator called the NFRA, or the National Financial Reporting Authority. Now, the NFRA has set all sorts of records in the last two years. Since 2022, it's DeBard's seven. 78 auditors and imposed close to 20 crore rupees in penalties. That's huge. Just to put that in context, another regulator called the Institute of Chartered Accountants of India or ICAI

that's been around for more than 70 years has only taken action against 25 auditors so far. But the NFRA is meant to be that feisty new kid on the blog. And things are different now that it's in the picture. There is also a reason for that. You see, over the last few years, cases of financial irregularities involving big public and private companies have become pretty frequent.

Think by Jews, ILFS, reliance capital, the list goes on and on. And when allegations of fraud or financial mismanagement are thrown around, very often it's the auditor's neck that's on the line, even before the accused company stop management. And in these situations, the NFRA is almost like the auditing industry's very own ghostbuster. It's coming after all the auditors that somehow missed that the company they were auditing

is carrying out crores worth of financial fraud. But here's the thing. The job of an auditor isn't that straightforward. The nature of the job is actually really, really complicated. And the NFRA doubling down on auditors is only making things more complex. The auditing industry has been shaken up from the inside out. And the people that seem to be losing out the most in the situation are the CAs. Welcome to Daybreak, a business podcast from the Ken.

I'm your host Rahal Philippos and I'll be joining Sniktha every week to bring you one business story that is worth understanding and worth your time. Today is Thursday, the 6th of June. In April this year, something very important happened. The NFRA levied penalties worth well over $4 crore rupees on an auditor called Pathah KDN Associates and two other CAs. This was the highest penalty levied on an auditing agency since 1949. The auditing agencies were being accused of falling short in their audits of the financial services company, Reliance Capital Limited. The sequence of events leading up to this are worth discussing. You see, just before the NFRA came into the picture,

another auditor of Reliance Capital, called Price Waterhouse, had flagged what was suspected to be thousands of crores worth of fraud by the company. And right after that, Price Waterhouse resigned as Reliance Capital's auditor. Now, the obvious question then is, how come Parta KHD and associates couldn't find any fraud? How did they miss it? Now, the NFRA wanted to make an example of the Reliance Capital incident. It wanted it to serve both as a deterrent,

and as a warning to audit and accounting professionals. And that it did. Like one senior associate from Deloitte told the Ken reporter, Vanita Bhattnagar, there's a great deal of risk and fear involved. And frankly, not many people want to take up chartered accountancy anymore. So here's the auditor's argument. They say that it's on the company executives to ensure that their financial statements are accurate. The auditor is only to obtain reasonable assurance and not a guarantee,

that a financial statement is accurate. Some auditors said it's often hard to find failures. Like in the Reliance Capital case, for instance. Imagine how vast the company's books must have been. For a CA, it isn't possible to assess everything, so they usually pick samples from selected markets and assess them. One CA working with an audit firm that was penalized by the NFRA, put it simply. He said that the norm for auditors was to be watchdogs and not bloodhounds.

And here's the thing. Generally, auditors work in a pretty conflicted environment. They're not just working for the client. They're also accountable to the larger public. They're supposed to be independent entities keeping a check on clients and flagging mistakes and only once everything is in order are they meant to sign off the balance sheets.

And they have to do all of this while still getting paid by their client. And that's exactly where the problem lies. Because this, as you would imagine, is a pretty skewed dynamic. Like one lawyer pointed out to Van Dita, the CAs are expected to be skeptical and ask tough questions from their clients,

but the client would obviously prefer auditors who tow the line. And of course, the auditor will want to stay on the right side of their clients so they can get more work from them and win newer clients through recommendations. That's just how it works. So you see how things can go south very fast for auditors. And with the NFRA in the picture, auditors have to always remain on guard, which is good in a way

because one way to look at it is that there's a lot more accountability. But in cases of fraud and financial mismanagement, should it be entirely on them? More on that in the next segment. Now, more than ever, Indian CAs and auditing firms are worried about the consequences

of the NFRA's penalties. Let's go back to the case of Reliance Capital. When Price Waterhouse raised that red flag, Reliance Capital filed a defamation case against it. Now, this was a defamation suit of 10,000 crore rupees. Luckily, PWC happens to be part of the Big Four, which means it's one of the biggest auditing firms in the world. Another auditing firm, especially a smaller one, would not have been as lucky.

Very often, their revenue is far less than 10 crore rupees. So, between the NFRA's penalties and possible litigation from companies, they're likely to be wiped off in no time. In fact, during a recent press conference, NFRA chairperson Ajay Bhushan Pandey had a word of advice for these auditing firms. He hinted that they should hike their fees to accommodate risks associated with audits rather than compromise on their quality.

So given all of this, it isn't really surprising that resigning seems to be the safest bet for many auditing professionals across the country. In fact, instances of CA's resigning from auditing firms seem to have shot up over four times in six years until March 2022. Many auditors said they felt blindsided by the NFRA's sudden over-enthusiasm, like it came out of nowhere. But a Ministry of Corporate Affairs official told Vanita that this wasn't really the case.

It was clear that India needed an independent regulatory body, much like in the US and Singapore. Particularly after high-profile cases of financial mismanagement, like with ILFS and by Jews. The reason the 70-year-old Institute of Chartered Accountants of India or ICAI just didn't cut it was because it did not have jurisdiction over CA firms. It could only take action against an individual accountant for professional misconduct. It couldn't penalize a whole organization.

But the NFRA can and has been doing just that. The regulator also seems to have very little patience for auditor's concerns. They believe finding fraud is a very, very important part of an auditor's job and that there's no two ways about it. Here's what one NFRA member said on the matter. We are not asking auditors to investigate, nor are we asking them to expend lots of resources to go out and get specialists. All we urge is when you see things of concern,

don't just unsee them, rather flag them. Basically, trust but verify should be the auditor's motto, is what the NFRA is saying. Now, the NFRA is also all about transparency. It has actually instructed auditors from the top thousand listed companies to submit annual transparency reports, along with the financial statements for the year

ended March 2020. The NFRA wants these reports to cover everything that the auditor is doing to ensure high-quality audits. Now, all of this is very out of the ordinary for India's auditing industry. In fact, once CA, from Deloitte said raising red flags

while looking at a company's financials was never the norm. Remember, until now, their job was auditing financial statements and providing financial guidance to businesses. But raising red flags is exactly what the NFRA expects. So one thing is clear.

Things are changing and they are changing fast. But India's CAs seem to be struggling to catch up. Daybreak is produced from the newsroom of the Kent India's first subscriber-focused business news platform. What you're listening to is just a small sample of our subscriber-only offerings. A full subscription unlocks daily long-form feature stories, newsletters and podcast extras. Head to the ken.com and click on the red subscribe button on the top of the website.

Today's episode was hosted by Rahil Filippo's, produced by me Snigda Sharma and edited by Rajiv Sien.