RBI Governor's Plainspeak to CAs
ADDRESSING a meeting of the Western India Regional Council of the Institute of Chartered Accountants of India (ICAI), the RBI Governor Dr. Subba Rao said,
The profession has shied away from the responsibility for prevention and early detection of fraud. The need for such a service exists and if the profession does not fulfill that need, other agencies, which can provide this service, will displace auditors and deprive them of a potentially expanding opportunity.
The case of Enron, which took down along with it the audit firm Arthur Andersen, comes to mind. The sudden collapse of Enron, an energy trading and distributing company, ranked seventh in the Fortune 500, raised a number of questions about the accounting and auditing practices followed by the company. The company used creative accounting to shift losses and debts off the company's balance sheet into special purpose entities (SPEs) thereby concealing the extent of its indebtedness. The company was also reported to have withheld information about SPEs which could have led auditors to insist on their consolidation in the balance sheet. Enron's accounting transgressions misled investors to believe that the company was more profitable and less leveraged than it really was.
Andersen audited Enron for all sixteen years since the company's formation. On top of pure audit, it also sold internal-audit and consulting services. Despite this privileged insight, Andersen did not discover that Enron was publishing incorrect financial statements leading to the term “Enronisation of financial statements”. This raises an important question of conflict of interest. Is it the case that the extensive consultancy work done by Arthur Andersen for Enron compromised its independence leading to its failure to detect erosion of accounting standards? It also subsequently came to light that some members of the Audit Committee faced financial conflicts of interest, generated in part by the company's donations to charities to which they were connected. Could this conflict have been prevented? Let me turn to the sensitive and important issue of a value system. Recent months have witnessed an agitation across the country about erosion of values in the public domain. The norms of a society are determined by the dominant sections of that society, and the accounting profession is certainly a dominant section of society. The value system you practice in your professional conduct influences the value system of the society. Sadly, we see several transgressions.
The case of Satyam Computer Services here in India - The company's chairman confessed to more than a billion dollar fraud on its balance sheet which was hidden from the company's Board, its senior managers and of course the auditors for several years. The truth followed a now familiar pattern - overstating profits, understating liabilities, and overstating cash causing a big hole in the balance sheet.
With so much accounting misconduct in big corporations, stakeholders wonder why books are not being reviewed on the default assumption that there could be fraud afoot. Accounting experts explain that the kind of forensic auditing that reconstructs fraud is so time-consuming and expensive that it could bring an honest business to its knees. However, I strongly believe that a robust system of audits, a corporate culture in which ethical conduct is encouraged and exemplified and an active and independent Board of Directors can make such frauds harder to perpetrate, easier to detect and help restore public confidence in published results.