Saturday, July 13, 2024

Corporate failures: Auditors are soft targets for blame

California-based Silicon Valley Bank (SVB) collapsed last month, making it the biggest lender to go down after the global crisis of 2007-08. The speed at which a bank with assets of over $200 billion went down is alarming and raises several questions, including about flaws in the US’s banking architecture. 

Among other things, the risk management practices in vogue at SVB are a critical aspect that must be considered seriously. Were these practices so poor that they could not anticipate impending trouble? Equally critical is the response of the bank’s board of directors, which was found wanting. When one is in a fiduciary business like SVB had been, it becomes all the more important to be ever ready with a crisis-resolution plans in place, which has been a big failure in this particular case.

SVB collapse has once again spotlighted the question of who should be held responsible in the event of a corporate failure. In such cases, statutory auditors are easy targets, as they are the ones who sign off on a company’s accounts and are required to give an appraisal of the firm’s ability to survive the year ahead. Any large corporate failure has a big economic effect, especially when it is a surprise, with little to indicate impending failure beforehand. With multiple participants overseeing different aspects of financial reporting, including the company’s management, internal auditors, the board and its committees, and also statutory auditors, whose responsibility should it be? Or can such failures safely be attributed to a weak regulatory framework?

When such failures happen, revisiting and redefining each participant’s distinct roles in the financial reporting ecosystem, like the management, audit committee and independent auditor, becomes critical. The management is responsible for preparing financial statements, establishing and maintaining adequate internal control over financial reporting, evaluating its effectiveness and efficiently running the company’s affairs.

According to data by TransUnion CIBIL, India had 15,778 wilful default accounts worth $41.3 billion as of December 2022, compared with 14,206 accounts involving $34.1 billion a year earlier. The top 50 wilful defaulters owed a total of 92,570 crore to Indian banks as of 31 March 2022. While the audit committee is an integral part of this financial ecosystem, its primary function is to oversee financial reporting and related internal controls. The independent auditor is responsible for expressing an opinion on the fairness with which the financial statements present, in all material respects, the financial position, results of operations and cash flows in conformity with defined accounting principles.

There is a need to better define the responsibility and accountability of the audit committee as well as the auditors, and, of course, that of the management. With multiple stakeholders involved in financial reporting, auditors alone cannot be held responsible for challenges that may be faced. There is an imminent need to explore and find ways and means to improve the role played by the audit committee. For instance, audit committees need to get more involved and responsible by expanding their role beyond post-facto analysis and firefighting, which is the case now. Moreover, corporate boards need strong leadership from these audit committees to navigate these complex financial reporting environments, provide independent reassurance, and keep the company on a solid path backed by a robust regulatory framework.

India’s macro-economic environment is creating multiple challenges for the country’s audit industry. This is aggravated by a narrative built up around the audit profession. It’s well accepted that the availability of trustworthy financial information on the performance of companies is important to the proper functioning of any market economy. In present times, wherein questions get raised over the integrity of auditors in carrying out their duties, such scepticism has the potential of taking down the whole system. The fallout of this is evident in other professionals opting to apply for audit roles, citing instances of auditors being subject to harsh criminal proceedings initiated in several cases in the recent past. Add to it the social and professional stigma that gets attached to individuals in the audit profession, as they often end up as the focal point of blame games. A clear understanding of roles and responsibilities at all levels can change this; else, the cause of assigning accountability will continue to slide.

Independent audits are also fundamental to taking informed and correct investment decisions. This requires corporate managements and boards to prepare and present reliable financial statements. For this, it is critical that each key element that is part of this ecosystem is both empowered and accountable.

To foster a business-friendly environment for corporations and professionals in India, participants in the financial reporting ecosystem must interact with one another in the process. Also, our laws and regulations on professional services should keep pace with changing market dynamics.

The liability mechanism for auditors needs to be addressed. A failure to address this could keep high-quality talent away from the profession and result in an atmosphere of fear among auditors, who may want to exit the profession, all of which would compromise rule-compliance further and impact investors adversely.

Bikash Narayan Mishra is an adviser to the Indian Banks Association and a former banker.

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