Not just judges: It's time to reform appointments of auditors too

Ever since the Supreme Court gave itself the absolute power to appoint judges by making what was arguably a colourable interpretation of the constitutional mandate in this regard, there has been a clamour for defanging the judiciary, as it were. The result - the Constitution Amendment Bill moved in the Parliament last week to provide for appointment by a panel comprising people from executive as well as judiciary in order to make judicial appointments as impartial as possible. But it is not as if judges alone have been displaying the proclivity to self-appoint and self-regulate.

Audit is a function that caters to a cross section of stakeholders - shareholders, lenders, suppliers, investors, tax authorities and who have you. All of them rely on audited accounts as gospel though the discerning ones have always had the sneaking suspicion that auditing was a farce given the system of appointment of auditors.

It is de rigueur for auditors to be appointed by company managements themselves in what constitutes the worst act of incest. Indian company law says auditors have to be appointed by shareholders at the annual general meeting but then everybody knows they simply rubber stamp the decision already taken by the promoter group. The result is once the auditor always the auditor because the management and the auditor develop a cozy relationship of mutual back-scratching.

The Companies Act, 2013 has not made any substantive change in the matter of appointment of auditors except that an individual cannot hold office continuously for more than five years after which he can be appointed again only after a cooling off period of five years. A firm or LLP of auditors can serve for ten consecutive years and can be reappointed only after a cooling off period of five years. All that companies have to do in the new milieu is to have two firms of pliable auditors each doing terms for ten years and cooling their heels for ten years thus going beyond the statutory cooling off period of five years. This is no big deal, leave alone a paradigm shift from the past.

What is needed is a roots and branches reform of appointment of auditors - appointment through blind referencing, as it were. Answer sheets are sent to examiners sans the name of the candidate. Research papers are sent to experts for evaluation sans the paper writer's name. Likewise, a company should not know who is going to audit its accounts. There should be an element of secrecy and surprise.

This is already the case with public sector companies' auditors, who are appointed at random from out of a panel of chartered accountants registered with the CAG. Auditors of public sector companies are appointed for five years. With the result the companies do not know who their next auditors are going to be and the auditors do not know what their next assignment is going to be. This is as it should be. There is no reason why the market regulator the SEBI cannot do this function for listed companies in India.

Supreme Court has a high visibility. Hence a reform in appointment of judges has gotten the top billing of the new government. But then appointment of auditors too has been crying for reforms. It has not got the kind of attention it deserves because the matter relates to the private sector and auditing is a relatively esoteric subject.

No auditor would bite the hands that feed him until he is guaranteed his existence and remuneration. The CAG like dispensation ensures that an auditor can give a fearless and damning report and yet fear no reprisal. The Companies Act, 2013 indeed makes the auditor the prime whistleblower and saddles him with heavy penalty for being remiss in performing this role.

While this is fine, auditors would continue to cozy up to managements and wink at their shenanigans in return for giant pay offs unless their appointment is delinked from the incumbent management whose actions or inactions he is going to examine and comment upon. It is idle to expect free and frank report from an auditor who is beholden to the management for his appointment.

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Updated Date: Aug 17, 2014 12:37:20 IST