Breaking the Business-auditor Nexus Is Key to Financial Clean-up
On 11th June, the ministry of corporate affairs (MCA) moved the national company law tribunal (NCLT) with a 214-page petition to bar Deloitte Haskins & Sells (Deloitte), statutory auditors of IL&FS Financial Services (IFIN) and BSR Associates (a part of the KPMG network in India), for five years for colluding with management to bury serious issues of round-tripping money and ever-greening loans by buying the auditors’ silence through consulting assignments and worse. The complaint is against Deloitte, its chief executive Udayan Sen, partner Kalpesh Mehta and BSR’s partner Sampath Ganesh. 
 
A whistle-blower’s letter, first published in Moneylife on 10th April, was the basis of a quick investigation by the Serious Frauds Investigation Office (SFIO) leading to this petition being filed in record time.
 
The commendable speed with which SFIO has conducted its investigations and followed them up with filing of charge-sheets is a refreshing development that has been missing for the past 30 years, including for major security scams of 1992 (Harshad Mehta) and 2000 (Ketan Parekh).
 
Hopefully, it will lead to far better outcomes than in the past, if the judiciary cooperates and does not allow lawyers to game the system with endless adjournments. 
 
SFIO has, correctly, targeted statutory auditors first. While it is true that the Reserve Bank of India (RBI), lenders (including mutual funds—MFs), rating agencies and others have failed in their responsibilities, statutory auditors are the first watchdogs that failed to bark. The others, to an extent, can hide behind audit reports being a true reflection of the organisation’s finances, to justify their own complicity. 
 
When Ramalinga Raju of Satyam wrote his famous confession in 2009, he also threw the marquee audit firm, Price Waterhouse & Company (PWC) under the bus. But, although PWC was a controversial and repeat offender, the Securities and Exchange Board of India (SEBI), under two chairmen, allowed the investigation to drag on for nine years. It handed a two-year ban and disgorgement order only in June 2018. This order also did not affect its on-going audits. Is it any surprise that Deloitte thought nothing of colluding with the failed IL&FS group until it led to a systemic panic?
 
But this is not the only instance. Quick and decisive action by the MCA is throwing up a lot more dirt, probably because auditors realise that the government is serious this time. I am just putting together revelations in the past few weeks alone, which show how the rotten, business-auditor nexus has attained grotesque proportions and inflicted a massive cost on the financial system. Here are a few examples.
 
1. PWC vs Reliance: On 11th June, the shares of Reliance Capital and Reliance Home Finance, both from the beleaguered Anil Dhirubhai Ambani group (ADAG), which has already been exposed for various collusive deals, collapsed on the news that PWC had refused to sign the accounts and resigned with immediate effect. 
 
The ADAG companies reacted with the usual bluster and threatened legal action against the auditor. PWC’s decision to walk out happened after the REDD exposure about the ‘box system’ used by DHFL and Reliance Capital to circumvent rules and well after the MF industry’s controversial lending to these groups had caused panic among investors. 
 
Reliance has said it will finalise its accounts with the other auditor, Pathak HD & Associates, whose term remains valid. So far, all regulators are silent, while NAVs (net asset values) of some debt schemes went into a vertical fall. Now, in a sensational new development, PWC has written to MCA that it has been threatened and intimidated by Reliance Capital.
 
2. Infibeam Avenues vs SRBC & Co LLP:  On 11th June, while ADAG was hogging the headlines, Infibeam Avenues announced that its decision, to ‘terminate’ SRBC & Co LLP, its joint statutory auditor, was approved by MCA. The audit firm, which is part of the Ernst & Young (E&Y) group, was accused of having leaked unpublished price-sensitive information and had earlier denied the charges. It is not clear if this will lead to further regulatory action, but the allegation reveals another venal side of the business-auditor nexus. Every major corporate development indicates information leakage as evident from stock price movements. Moneylife regulars would have read our many exposés of this problem. 
 
3. Eros International Media Ltd and Hindenburg Research: This case erupted on 6th June when the rating agency CRISIL suddenly downgraded Eros by 10 notches. The agency, apparently, woke up just as Hindenburg Research, a US-based forensic financial research firm, and an admitted short-seller of the stock in the international markets, was getting ready to put out an explosive research report. 
 
Its deep audit of this New York-listed Indian company exposed how the audit committee of Eros as well as its statutory auditors have ‘failed to raise the red flags’, despite enough holes in the company's functioning. It also says that Eros’s “bankers seemed more interested in generating fees through debt & equity offerings than in performing credible underwriting” and that the “complex international structure made it too challenging for regulators to enforce.” The Indian auditor of Eros International is Chaturvedi & Shah, which has an association with the Reliance group since the 1980s. Mukesh Ambani controls a 5% stake in Eros.
 
Eros’s advances had surged 207% and receivables shot up 66% in 2017-18. When Hindenburg Research examined Eros’s claim about not being able to collect trade receivables (largely unsecured), it found that these receivables, largely, did not exist. The forensic investigation also went deep into its subsidiary companies to expose how it used a web of shell companies to round-trip money to promoters.  The auditors clearly looked the other way, despite years of warning signs.
 
“We think Eros’s collapse is an egregious failure of its auditors, Grant Thornton, to apply even basic scrutiny to the company’s financial condition,” it says in a scathing indictment. This is a stunning because Grant Thornton did a terrific forensic audit for IFIN (of the IL&FS) group in what is called Project Icarus. Its findings have helped SFIO in that investigation. So far, no regulator has reacted to this.
 
The Hindenburg investigation has, finally, proved long-standing rumours that Indian companies have been using small and unknown auditors to sign off on subsidiaries and shell companies that were used to route and round-trip money for promoters. Hindenburg Research exposed, with photographs, how Eros Television India Pvt Ltd’s audit firm was housed in a slum rehabilitation building with barely one table space. 
 
The report concludes, “Eros's unravelling is like the obvious ending to a cliché movie.” I would say that Eros is just one of the scenes in this movie; the dirt that has spilled out in June alone suggests that it is the audit industry’s credibility that is unravelling even more rapidly. 
 
The question then is: Where are we headed from here? Remember, RBI has already barred SR Batliboi & Company from handling audits of commercial banks for one year. This seems like a slap on the wrist, but actually causes a major upheaval for the firm, since clients forced to move on for lapses in statutory audit may not, necessarily, return after a year.  
 
With PWC, Deloitte, Grant Thornton, SR Batliboi (of the Ernst & Young group) and BSR (part of the KPMG group) under a cloud, all the big global names of the audit world have been hauled up for serious lapses. It has already triggered media reports projecting a gloom & doom scenario for India, if all major audit firms face punitive action. 
 
This is a fake fear-scenario propagated by the big four and their powerful lobbying machinery working through mainstream media. Every major upheaval creates an opportunity for growth. Remember, the Deloitte whistle-blower was an insider. Such People need an opportunity to become independent and grow. 
 
In 1992, several lawyers told me how their business quadrupled after the central bureau of investigation (CBI) and banks went on a spree of filing litigation, because the government failed to separate civil issues from criminal fraud and settle the former out of court. Today, many of them are considered marquee law firms. 
 
Companies will be governed dramatically better if managements fear statutory auditors. The government failed to send a strong signal to multinational audit firms after the Satyam scandal. It would have ensured a clean-up long before our bad loans ballooned to Rs10 lakh crore and several major companies went bust. 
 
The timing is just right again because several disparate events have converged simultaneously. Fortunately, MCA has acted firmly, decisively and quickly with IFIN. Let’s hope the momentum continues.
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COMMENTS

R P SHIVKUMAR

1 day ago

excellent atricle , There is a lot of scope for disclosure systems in companies and better quality auditors. Also the press has to report on in more detail about the collapse of mid cap companies like zicom, rolta mcleod russell in detail and let investors know more about their investments and not just the top few

Sadanand Patwardhan

1 day ago

Regulator: Auditor, you should maintain strict neutrality, independence of judgment, due diligence to bring out accurate & material picture of the business and it's compliance (or not) with statutory obligations. Any deviations must be reported without favour or fear.

Auditor: Yes sir, err.. you are right; but how can we bite that hands that feed us. We will be out of business.

ICAI is merely sitting on it's haunches and has let rot set in.

Solution?
Audit the auditors, regulate the regulators, watch the watch dogs.
But then who will monitor these 2nd order creatures.
Rot is systemic. More bureaucracy will only mean more painful burden on the citizenry.

REPLY

Aditya G

In Reply to Sadanand Patwardhan 1 day ago

Absolutely. Honestly, there's no solution for auditors. I can only feel their plight.

They're in a catch-22 situation. I've known a lot of CAs who have dropped out of practice because it's:

a) not lucrative enough
b) the reputational risk is just too high
c) Monotony (well, this is nearly universal everywhere...but nowhere is it more pronounced in auditing profession...)

The ICAI has royally screwed up the profession. An entry level IT techie out of engineering college earns more than a CA. So, I'm not sure what the exact problem is. It's definitely an ethics problem, but not anymore important than feeding your family. The economic and professional incentives are skewed against auditors IMHO. This has to change.

vj

2 days ago

Similar investigation/action is also needed in case of business-corporate advocates nexus...all professionals who are discharging statutory duties must bear obligations and accountability in equal proportions so that they act in public interest and not only in the interest of their clients and employers. Otherwise they are always tempted to abuse the monopoly given to them by the statute.

REPLY

vj

In Reply to vj 2 days ago

In short such professionals be treated as Public Servant and be regulated accordingly.

Shankar g

3 days ago

Not only barring by judiciary and Govt is enough but should also make those BIG 4 accountable & recover the money lost by the individuals/ companies/ Banks & Govt . ex-chequer

Mohan Krishnan

3 days ago

Especially in the case of IL&FS where even Armed Forces Pension Funds were not spared (Financial Pulwama attack), all the related entities should be booked under Prevention of Terrorism Act.

IL&FS case: Rating agencies faked IFIN ratings to dupe investors
Credit rating agencies played major villain in the IL&FS crisis as they adjudged positive and impressive ratings on a regular basis to commercial papers and non-convertible debentures (NCDs) of IL&FS Financial Services (IFIN) despite unhealthy financial condition of the company, revealed an investigation report submitted by the Serious Fraud Investigation Office (SFIO) to the Ministry of Corporate Affairs.
 
The document shows that several investors who subscribed to the IL&FS' financial arm's NCDs and commercial papers, attributed their decision to invest on the high ratings accorded by the rating agencies.
 
Anurag Jain, Chief Investment Office at Canara HSBC OBC Life Insurance Company, which invested around Rs 30 crore in commercial papers and around Rs 10 crore in NCDs of IFIN, said their decision to invest was primarily influenced by the credit ratings provided by CARE and ICRA.
 
"The investment in the IL&FS/IFIN papers was done primarily on the basis of the rating of the companies as provided by the rating agencies CARE and ICRA, which are the highest rated in their categories," the SFIO document quoted Jain as saying.
 
During the period between 2013 and 2018, the agencies which gave ratings to the financial instruments of IFIN were CARE Ratings, ICRA Ltd, India Ratings & Resarch and Brickwork Rating India, according to the document.
 
With an investment of around Rs 115 crore in IFIN's NCDs, the Oriental Insurance Company was also apparently duped by the ratings accorded to IFIN.
 
"The basis of selection of debt securities are based on the financials, credit ratings and best yields available in the market. IFIN is an NBFC and based on the financial, credit ratings and better yields available, some funds have been allocated periodically based on the constant AAA ratings assigned by two rating agencies, CARE and India Ratings," said Dushyant Kumar Bagoti, DGM at Oriental Insurance Company.
 
Further, manager at the New Indian Assurance Company, Gyan Ranjan, recorded on oath said: "If rating is AA or above then there should not be any issue on the repayment."
 
New India Assurance Company had invested Rs 62 crore in IFIN NCDs.
 
Implicating the rating agencies, the SFIO said in the document: "From the above it is clear that the investor in NCDs were induced to investment based on the heavy financials and credit rating assigned to the company.
 
"The investors of the NCDs of the company were induced by the management by deliberately concealing the material facts pertaining to the true and fair view of the affairs of the company and the observation of the RBI with respect to NOF, CRAR etc, which had major adverse effect on the company's capacity to continue as going concern."
 
SFIO also noted that largely all the four agencies had given the highest rating to the long-term and short-term instruments of IFIN on the strength of its parentage and management linkages with the Infrastructure Leasing & Financial Services Limited (IL&FS).
 
The probe into the role of credit rating agencies with regard to IFIN needs to be taken further in the ongoing investigation of IL&FS, it said.
 
With the testimonials and evidences going against the rating agencies, they might be next in the line of fire after the auditors of IL&FS, which the government wants to bar from auditing operations in the country.
 
The operations of rating agencies are already under close watch of the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) and both the regulatory bodies are looking into the business model of these agencies.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.
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COMMENTS

R Balakrishnan

3 days ago

The investment managers are just passing the buck. Where was their due diligence or analysis? The managers are more guilty than the rating agencies. The whole industry knows about the rating agencies...

REPLY

Nagaraju Bommanahalli

In Reply to R Balakrishnan 3 days ago

ED is doing drama ICICI Bank chandakochar is well known to all she done huge fraud in ICICI Bank, this drama of enquire is doing from past one year, but still she is not arrested, reasons In this icici bank scam all SEBI auditors ED RBI central government rating agencies big leaders of all parties involved.central government making all efforts to avoid arrest these fellows,if arrested all all foreign country become knows most of the Indian companies running on bogus and take away all foreign investment,then India become bankruptcy.This is well known by central government hence avoiding all efforts to arrest directors of icici bank chandakochar DHFL jetairways Videocon kingfisher airline PNB bank head [email protected] etc . wait in few months most of the common people investment in icici bank NBFC PSU banks equity NCD mutul funds become Zero

SC raps petitioner for defective plea against Indiabulls
The Supreme Court on Wednesday pulled up for filing a defective application a petitioner, Abhay Yadav, who has alleged that Indiabulls Housing Finance Ltd (IHFL) misappropriated Rs 98,000 crore of public money.
 
Earlier on Wednesday, IHFL senior counsel A.M. Singhvi urged the vacation bench comprising Justices Indira Banerjee and Ajay Rastogi to list the matter for hearing urgently, as frivolous allegations have been made against the company in the petition, which has been deliberately leaked to the media. 
 
The company counsel represented that as a consequence of these acts, IHFL's market capitalisation has been eroded by Rs 8,000 crore in the two days since filing of the petition, causing losses to lakhs of shareholders.
 
The court observed that while the petitioner has sought directions against respondent numbers six and seven, but, surprisingly, no identities have been assigned against them in the writ petition.
 
Singhvi said that the petitioner had deliberately filed the plea in the vacation bench and created circumstances for the press to discuss it.
 
"A petition has been filed against Indiabulls, but the company has not been included in the list of respondents", he said, raising an objection to the petition.
 
The court rapped the petitioner, asking him to rectify the defects and said the matter will be taken up in July.
 
Singhvi said the company is already facing a huge loss in share value arising from the press reports following a plea filed by a milk vendor, who holds a total of only four shares. 
 
The company alleged it is being blackmailed through the use of a novel technique.
 
According to IHFL, Yadav became its shareholder after purchasing the shares from the stock exchange on May 9. 
 
In a statement earlier, IHFL has described the allegations against its Chairman Sameer Gehlaut and other directors as "bizzare" and designed to malign the reputation of the company.
 
The statement came after a plea was filed in the apex court on Monday seeking legal action against Indiabulls, Gehlaut and the other directors for alleged misappropriation of public money. It said thousands of crores had been siphoned off by Gehlaut and the directors of the firm for their personal use.
 
"The total loans on the books of Indiabulls Housing are approx Rs 90,000 crore. The allegation of siphoning-off Rs 98,000 crores is bizarre," the company said in a regulatory filing.
 
The company said that a racket of blackmailers has been trying to extort money from Indiabulls over the last two months threatening to write complaints to various government departments alleging siphoning off Rs 55,000 crore if Rs 10 crore was not paid to them, following which the company filed an FIR on June 4.
 
It further said that one of the people involved in the blackmail was arrested on June 7. Following the arrest, the group of people involved floated another complaint enhancing the amount in question to Rs 98,000 crore.
 
IHFL said the writ petition is a "desperate attempt" to malign its reputation.
 
The statement also said that the petitioner had bought four shares in the company a month back.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.

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