Board Audit Committee – Boon or Bane?, ETCFO
When I read about the two recent high-profile corporate governance mishaps, my first thought was – what was the Audit Committee doing? Of course, the next question that cropped up was – whether the Auditors were sleeping?
It is alleged that IndusInd Bank has committed accounting irregularities, including fraud and insider trading, in its microfinance portfolio and balance sheet disclosures. The issues involve discrepancies in accounting for derivative transactions, particularly those related to foreign currency borrowings, as well as misreporting of income.
Another recent instance of poor governance was that of Gensol Engineering, the solar and EV car-making company. SEBI, the market regulator, has castigated the company promoters, stating that they were running the ‘listed public company’ as if it were a ‘proprietary’ firm. The allegations involve the misutilization and diversion of the company’s funds by its promoter directors.
Audit Committee and red flags
The key question in both cases is: Shouldn’t the Audit Committee have identified the red flags before the matter became public? In the case of Gensol Engineering, there were frequent changes in CFOs, reduction of promoter shareholding, resignations of independent directors, delayed financial results, default in bank payments, false data to credit rating agencies, and the list is unending.
In the Indusind Bank’s case, there were internal control system weaknesses, usage of complex instruments like derivatives, misuse of the technology platform, repeated accounting lapses, rising NPAs, and falling CASA (Current and Savings Account deposits). Especially in a bank, it is expected that the audit committee, along with the internal and external auditors, will examine valuation and accounting practices.
In both cases, there were enough indications that something was a miss!
Audit Committee and Law
Section 177 of the Companies Act and Schedule II Part C of LODR define the role of Audit Committees. Every ‘listed’ company must have an audit committee, consisting of a minimum of three directors, with Independent Directors forming the majority.
The Audit Committee has a reasonably significant role to play. These include – examination of the financial statement; prior approval of related party transactions; scrutiny of inter-corporate loans and investments; evaluation of internal financial controls; and monitoring the end use of funds raised through public offers.
In short, the Audit Committee has an all-encompassing power to check, investigate and seek clarifications on almost all important matters of corporate governance, including ensuring the preparation of reliable financial statements and sniffing out potential fraud.
The biggest question remains – do most Audit Committees play their role as envisaged in the statute books? Unfortunately, this query remains a question mark in many cases.
Audit Committee – who can be part of it?
All members of the Audit Committee shall be ‘financially literate’ (i.e. possessing the ability to understand financial statements).
In addition, at least one member shall have accounting or related ‘financial management expertise’ (i.e., possessing finance or accounting experience or an accounting professional qualification like CA, CMA or CS).
This means that the Audit Committee cannot have board members who cannot read Balance Sheets. Unfortunately, in several instances, the reverse is true – doctors, scientists and engineers are audit committee members.
Audit Committee failures
Over time, audit committee infractions have been brought up and penalties levied.
In a recent instance, it was found that the Audit Committee members lacked financial literacy. LEEL Electricals Ltd appointed two members to the Audit Committee, one of whom was a retired Air Force Marshall and the other, a physical therapist by profession. SEBI fined the two Independent Directors Rs 10 lakhs.
The Audit Committee has the added responsibility to monitor the end use of the funds that are raised from public. This was not done in the case of Southern Ispat and Energy Ltd., where GDRs raised were deposited in an overseas bank, against which SIEL had created a pledge in favour of loans issued by another company owned by one of the directors. It was a clear case of diversion of funds raised.
SEBI has started adopting a stringent stance on the accountability of independent directors for fulfilling their audit committee roles.
Can the Audit Committee blame Auditors?
A company’s audit committee cannot shirk its responsibility towards ensuring accurate financial statements of listed firms merely because the auditors have failed in their duty.
In many cases, the Audit Committee’s meetings with the Auditors are brief. Usually, they take place just before the Board Meetings, where the accounts will be presented for acceptance. Two-way interactions are missing in many cases. No wonder that in the case of poor governance findings, the audit committee is left gasping. Timely and meaningful interactions with the auditors help the Audit Committee identify potential red flags.
The Accounting Regulator – NFRA chief has repeatedly expounded that the Audit Committee’s lackadaisical approach can’t escape blame by citing auditors’ failure. The audit panel members may note this.
What should the Audit Committee members do?
The following quick ‘to-do list’ could prove helpful:
* Accounting number understanding: Members need to possess the ability to read and comprehend financial statements and must be vigilant with the financial affairs of the company.
*Ensure audit is not a farce: Make sure that the internal and statutory audits of the company are carried out independently and efficiently.
* Prompt actions: Do not go by the assurances of the company top management that things will be set right in the future. Prompt remedial actions are the only solution. Don’t defer corrective action.
* Be vigilant: Keep your eyes and ears open for red flags. Remember, there is no smoke without fire.
Audit Committee members are getting involved in the levy of penalties. The earlier view of a lack of knowledge and understanding is no longer holding water when it comes to Audit Committee members.
Last few words
The famous saying is, you can fool some people some of the time, but not all people all of the time. Gone are the days when companies can keep hoodwinking investors and lenders by promising things that are not meant to be fulfilled.
The Audit Committee and the Auditors, being the fulcrum of good corporate governance, are now being increasingly exposed to questioning whenever things go wrong.
An Audit Committee could be a boon for correcting governance tremors, or a bane for ignoring red flags. The choice is now up to the Board Audit Committees of listed companies to decide what they wish to be portrayed as!
About the Author: Robin Banerjee is the Chairman of Nucleon Pvt Ltd, a global clinical research company. Earlier, he served as the Managing Director of Caprihans India Ltd. Robin has authored 3 bestselling business non fiction book : (i) Who Cheats and and How; (ii) Who Blunders and How; and (iii) Corporate Frauds: Bigger, Broader, Bolder.
Disclaimer: The views expressed are solely of the authors and ETCFO.com does not necessarily subscribe to it. ETCFO.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.
