By Vivek N Gour
It is a pity that Boris Johnson decided not to travel for India’s 72nd Republic Day celebrations. A dilemma, which the Government could have accomplished without the need of. Proposals from UK Government’s Department of Business, Energy and Industrial Strategy (BEIS) on corporate and governance reform can nevertheless help in resolving other dilemmas back dwelling. Given the shared history, India has naturally taken cue from UK in designing its governance, financial and institutional models. From two tier parliamentary program to electrical energy boards (which includes their subsequent reform, nevertheless a work in progress in India) and the shared passion for cricket and curry are all properly identified.
Both economies also share a rather ignominious function – recurring corporate scandals. The current ones in UK contain Carillion, Thomas Cook, Patisserie Valerie amongst other individuals. In India, the list involves IL&FS, Jet Airways, Café Coffee Day, amongst other individuals. There are numerous similarities, apart from the reality that Carillion and IL&FS have been in infrastructure and building, Thomas Cook and Jet in travel and hospitality and Patisserie Valerie and Café Coffee Day operated retail chain of cafes.
Take the instance of Carillion and IL&FS. Carillion, 1 of UK’s biggest building firms collapsed spectacularly in January 2018. It was a sudden fall that jeopardized about 20,000 jobs and place to danger a lot of pensions. It was UK’s biggest insolvency with Carillion’s liabilities exceeding $9 billion. IL&FS’s fall was also sudden, as it went from AAA to junk in much less than six months, with a debt of more than $12 billion.
A report by UK’s two Parliamentary Committees was scathing in criticism of the directors, auditors and regulators. The words used to describe the directors have been “reckless, hubris and greed”, who prioritized individual economic interests more than the organization’s survival. Sandeep Hasurkar, an investment banker, with numerous years in IL&FS’s power vertical utilizes related words in his current book, “Never Too Big to Fail: The Collapse of IL&FS and its Ten Trillion Rupee Maze”. His book claims to provide detailed insights into the grandiose objectives purported by the directors but shallow, flawed choice generating of notable achievements in early years followed by devastating failure of grandstanding hubris and myopic self-interest of systemic blindness and tacit complicity of fiduciary responsibilities and failures of danger management and corporate governance.
The directors of each Carillion and IL&FS have been uniformly criticized and are now below investigation in respective nations. However, UK’s Parliamentary Committee’s strongest criticism was directed to the accountants. The Committee notes that Carillion’s accounts have been systematically manipulated to make optimistic assessments of income. KPMG was paid £29 million to act as Carillion’s auditor for 19 years. However, it under no circumstances certified its opinions to flag the dangers and signed off the numbers developed by directors, which have been progressively bizarre.
A crucial point in the complete Carillion saga relates to the conflict of interest in appointment of auditors and consultants. British MP Heidi contended that PwC’s involvement in numerous elements which includes working for Carillion till late 2016, advising pension fund trustees and Government will seem to the outdoors globe as a huge conflict of interest. This is so due to the fact most of their revenues have been derived from consulting services. For instance, in the UK, they now earn much less than a quarter of their earnings from the auditing small business. Deloitte – the Carillion internal auditor, that “failed in its risk management and financial controls role” – earns only 14% from auditing.
The case of IL&FS auditors is quite related. India’s National Financial Reporting Authority (NFRA), the independent regulator for auditing profession and accounting requirements, not too long ago declared the appointment of Deloitte as the statutory auditor of IL&FS Financial Services as an illegal act. The principal charge relates to ineligibility due to conflict of interest and that Deloitte was not eligible to be appointed as it violated Sec 141(3)(e) (subsisting small business relationships on the date of appointment) and Sec 141(3)(i) (provision of non-audit services straight or indirectly) of the Companies Act, 2013v. This followed a preceding order of NFRA imposing a 7-year ban and a monetary penalty of Rs. 25 lakhs on Deloitte’s former CEO for expert misconduct, especially highlighting that independence of thoughts and look of statutory audit was completely compromised and noting a critical lapse in discharge of duties, intentional recklessness, and collusive behavior to fraudulent presentation of the economic statements. It seems that lessons from Satyam fraud a decade ago are but to be learnt. Mr. Deepak Parekh appointed on the Board of Satyam as element of the crisis management work is on the record stating the negligence of the auditors (Price Waterhouse) in the case. A subsequent investigation by market place regulator SEBI revealed “glaring anomalies” and “systematic problems” in the audit course of action top to a 2 year ban and a disgorgement order.
UK has considering the fact that initiated a series of measures which includes a detailed inquiry titled “Delivering Audit Reform”. This has been a work in progress below the Chair Darren Jones of BEIS with numerous rounds of consultations completed. He commented in the final meeting “that it was vitally important that investors and other stakeholders have confidence in audits. Confidence has been shaken in recent years by a series of audit scandals. The Government and the regulator now need to step up and help improve corporate governance, boost audit quality and tackle competition in the audit market by pressing ahead with the practical measures recommended by a series of reviews”. BEIS is anticipated to provide more than one hundred suggestions early in 2021. These are probably to contain creation of Audit, Reporting and Governance Authority (ARGA), break-up of audit and consulting small business, amongst other individuals.
Building trust in governance systems and the private sector is even more important for India, which according to Arvind Subramanian (ex-Chief Economic Advisor) has been facing the curse of “stigmatized capital”. Similar theme was also echoed in the Economic Survey 2020, stating “…India’s aspiration to become a $5 trillion economy depends critically on strengthening the invisible hand of markets together with the hand of trust that can support markets…”. Given the current history of numerous audit, finance and governance failures such as Yes Bank, PMC Bank, DHFL amongst other individuals, time is ripe for India to graduate to the next level of corporate governance.
We can draw inspiration from our personal wealthy history. Kautilya, also identified as Acharya, recognized the value of accounting techniques and that a appropriate measurement was crucial for effective allocation of sources. Prof. Balbir S Sihag, an emeritus Professor at MIT notes that Kautilya created bookkeeping guidelines to record and classify financial information, emphasized the important function of independent periodic audits and proposed the establishment of two vital but separate offices – the Treasurer and Comptroller-Auditor, to enhance accountability, specialization, and above all to minimize the scope for conflicts of interest.
We need to have to take into account numerous actions, which includes reform in functioning of the Boards, function of the management and appointment of auditors, amongst other individuals. The Board of Directors, with each other with the Management are accountable for the governance, approach, and operations. Therefore, governance reform requirements to begin with appointment of actually independent, competent and respected directors. Equally vital is the course of action of an sincere evaluation of their efficiency and subsequent coaching and certification. Expertise, autonomy and transparency at the Board can minimize the agency expense. In professionally managed firms with weak boards the agency expense can be inflated as management can wring out unjustifiable compensation for themselves, use company’s sources for individual added benefits or collude to report doctored final results. Many of these challenges have been trigger of downfall of Carillion, IL&FS, Yes Bank and other firms. The Uday Kotak Expert Committee, established by SEBI, created a series of suggestions. While numerous have been accepted, a lot of stay unimplemented and other individuals need to have cross-agency co-ordination.
Even more relevant actions are required to modify the behavior of auditors and credit rating firms. Early in 2020 the Ministry of Corporate Affairs published a Consultation Paper to examine the current provisions of law and make appropriate amendments therein to boost audit independence and accountability. It highlighted that time and once again, audit independence has been questioned and named for a critique due to the fact the auditor’s economic or other interest in client’s small business inappropriately influence his judgement or behavior and a conflict of interest generally exists. Implementation of these provisions will probably call for an amendment to the Companies Act. Similar challenges mar the credit rating market, provided the possibility of adverse choice or “rating shopping” by managements. SEBI tightened regulations relating to rating agencies in 2019 to an extent, but additional actions to benchmark to international ideal practices are preferred. BEIS report anticipated in close to future could have some relevant lessons for India.
Marie von Ebner-Eschenbach, renowned Austrian author, as soon as stated, “In youth we learn; in age we understand”. Economic failures create new understandings and lessons, irrespective of geographies and sectors. There are lessons for all. UK is mastering theirs. We need to have to find out ours.
(Vivek N Gour is an independent director with 17+ years of encounter as a Board Member of huge operating firms. He serves on the Board at IndiaMART, Affle India, Cyient and ASK Investment Managers as the Chair of the Audit Committee. Views expressed are the author’s personal.)