WHEN WATCHDOGS FAIL

Accountants are the watchdogs of the corporate world. But what happens when they fail to do their duty but collude in fraud? The trust fabric crumbles, investors scuttle away and new investment dries up. But such fraudulent behavior is not typical of India alone. Internationally too there have been similar notorious incidents...

Some of our brightest youth join Chartered Accountancy after passing one of the toughest examinations in the country. Chartered accountants work in all fields of business and finance, including auditing, taxation, financial and general management. Some go for jobs while some do private practice. In India, chartered accountants are members of the Institute of Chartered Accountants of India (ICAI), which is the national professional accounting body of India. It was established on 1st July 1949 as a statutory body under the Chartered Accountants Act enacted by Parliament. A robust accounting system coupled with bold auditing is a must for the growth of the corporate sector and the financial world and this becomes the vital role of a chartered accountant. Auditors are supposed to be watchdogs safeguarding the interest of shareholders of companies. A transparent system of auditing boosts the capital market and brings more investment for the corporate sector.

THE BLACK SHEEP

This noble profession has come into the news recently for the wrong reasons. Some black sheep have brought disrepute to this great profession. The Serious Frauds Investigation Office in the Ministry of Corporate Affairs has alleged criminal fraud and violations of auditing principles against two leading audit firms in the accounts of ILFS which is already under a cloud due to the shadow banking scam. By law, a company’s accounts and profits have to be certified as true and accurate by a qualified auditor. The auditor, as well as the audit firm, are bound by the assessor as to what is going on in the company. They are supposed to report any discrepancy they notice without any fear or favor. ICAI has to take appropriate action against their member chartered accountant in case of any wrongdoing.

The Prime Minister, while giving a speech on the annual day celebration of ICAI in 2017, admonished the CA community for not doing enough against errant members. He further added that the black sheep in this noble profession have to be named and shamed and ICAI should take strict punitive action against them. The government is now in the process of creating a new regulation called the National Financial Reporting Authority (NFRA) with the help of laws to be passed in Parliament which will oversee the work of auditors. However, this may affect the autonomy of ICAI to some extent. A criminal investigation can also be started under the Indian Penal Code against auditors if found guilty of fraud and collusion. The government is planning to amend the Companies’ Law to tighten auditor oversight in view of the alleged role of auditors in the case of the ILFS scam.

A perusal of Income Tax laws reveals that there are many provisions where the certificates issued by the qualified chartered accountants have to be respected. Taxpayers can claim prescribed benefits on the strength of such certificates. The Legislature has reposed full confidence in chartered accountants while legislating tax laws, both direct and indirect. Common experience is that the majority of chartered accountants abide by the law and they do not betray the trust that has been reposed in them. But unfortunately, there are also cases where bogus statutory certificates have been given to claim tax benefits. The fact of rampant tax evasion and piling of black money cannot be denied. Tax evaders thrive with the aid and abetment of tax professionals and accountants. Some corrupt tax officials also shield tax evasion with the help of accountants. The phenomenon of shell companies is one such architecture for creating black money by the process of tax evasion and these shell companies can be created only with the help of expert accountants.

It is in the interest of corporate management that they are made known about the weakness of the company. The weakness should not be hidden by juggling the accounts but they should be faced and corrected

The government is now in the process of creating a new regulation called the National Financial Reporting Authority (NFRA) with the help of laws to be passed in Parliament which will oversee the work of auditors. However, this may affect the autonomy of ICAI to some extent

INTERNATIONAL FRAUD

Cases of accounting frauds are not only common to our country but they keep happening all over the world. The greed for quick money by corporate managements, when duly supported by accountants, give rise to frauds and embezzlements. Some infamous cases noted here:

1. Waste Management Scandal (1998)

The Houston based, publicly-traded Waste Management Inc reported $1.7 billion in fake earnings. The main players were founder/CEO/ Chairman Dean Buntrock with top executives and helped by company auditors, Arthur Andersen. This auditor firm was amongst the top ones in the world. This was done by falsely increasing depreciation time length for their property, plant and equipment. A new CEO caught the scam while going through the books.

2. Enron Scandal (2011)

It was again a Houston based company dealing in commodities, energy and services. Shareholders lost $74 billion and thousands of employees and investors lost their retirement accounts. The company was also seen indulging in immoral ways to get business. The company was committing fraud by keeping huge debts off the balance sheet. The matter got caught with the help of a whistleblower and due to suspicion caused by a sudden rise in the stock price. The main players were CEO Jeff Skilling and former CEO Ken Lay who were duly helped by Arthur Andersen (auditors). CEO Skilling was sent to prison for 24 years while former CEO Lay died before going to jail. The auditors were found guilty of fudging the accounts. Before the scam was brought to light, Fortune magazine had named Enron as America’s most innovative company six years in a row.

3. Worldcom Scandal (2002)

It was a telecommunication company which inflated assets by as much as $11 billion and the same resulted in loss to investors to the tune of $180 billion. The main player was CEO Bernie Ebbers. The scam was carried out by inflated revenues with fake accounting entries. The matter got caught by internal accounting. The CFO was found complicit and got fired. The CEO was sentenced to 25 years in jail. The company filed for bankruptcy.

4. Toyo Scandal (2002)

It was the case of New Jersey-based blue chip Swiss security systems company where the CEO and CFO stole $150 million while inflating the income of the company by $500 million. This was done by siphoning money through unapproved loans and fraudulent stock and benefits. They got caught due to the investigation by the SEC. The culprits were sent to jail for 8-25 years and the company had to pay $2.95 billion to investors.

5. Health South Scandal (2003)

This was the case of the largest publicly traded health care company in the US which inflated its earnings figure by $1.4 billion to meet the expectations of shareholders. The fraud was detected when there was a sudden sale of stock of $75 million, just a day before posting a huge loss.

6. Freddie Mac Scandal (2003)

It was the case of a mortgage financing giant which misstated its earnings by $5 billion. The main players were CEO David Glenn and CFO Vaughn. Investigation by the SEC exposed the fraud.

7. American Insurance Group Scandal (2003)

Massive accounting fraud of $3.9 billion was perpetuated in this multinational insurance corporation together with bid-rigging and stock price manipulation. The modus-operandi was to book loans as revenue. The fraud was detected due to an SEC investigation.

8. Lehman Brothers Scandal (2008)

This was an international fraud by a very reputed global financial services firm. Loans of $50 billion were hidden as sales. The main players were Ernst & Young (auditors) with top executives of the firm. They did it by selling toxic assets to Cayman Island banks with the understanding that they would be brought back eventually. They got caught when the company became bankrupt. It became the largest bankruptcy case in the US. However, people could not be sent to jail for the lack of punishable evidence.

9. Bernie Madoff Scandal (2008)

It was a Wall Street investment firm. It tricked investors of $64.8 billion through the largest Ponzi scheme ever. The main players were Bernie Madoff and his accountant David Friehling. They ran the scheme by paying investors out of their own money and not out of any profit. The matter came to light as Madoff told his sons about the scheme and they reported it to the SEC. Madoff was awarded a prison term of 150 years. Accountant Friehling was also sent to prison.

10. Satyam Scandal (2009)

Satyam was a very respected IT service and back-office accounting firm in India. The main player was founder/Chairman Ramalinga Raju. The company falsely boosted revenue by $1.5 billion by falsifying revenues, margins and cash balances. Criminal proceedings were started against Raju Bros. Even the auditor who audited the books was found guilty of negligence by ICAI.

As good doctors are essential for the upkeep of our physical health, good auditors are necessary for maintaining corporate and economic health. An auditor need not be an investor but it is important that he is not negligent and that he is honest and bold. Lord Justice Topes says, “The auditor is a watchdog and not a blood-hound.” It is in the interest of corporate management that they are made known about the weakness of the company. The weakness should not be hidden by juggling the accounts but they should be faced and corrected. Now when the Insolvency and Bankruptcy Code (IBC) comes into full operation, the management of a financially weak company may lose ownership.

We have a huge problem of non-performing assets (NPA) of banks and they have been caused by weak accounting, amongst many other reasons. We have to endeavour that the black sheep in our accounting and auditing community are purged.