UK Government to break up the dominance of the Big Four audit firms

The UK Government has unveiled proposals to reduce the dominance of the Big Four audit firms and scrap the industry regulator Financial Reporting Council (FRC).

The business of auditing companies' accounts, and ensuring they are a fair reflection of their financial health, is dominated by four firms: KPMG, Deloitte, PwC and EY.

The aim is to improve regulatory standards after big corporate failures like Carillion and BHS.

To ensure much more accuracy in accounts directors of companies will have more responsibility or face tougher penalties. The changes would help restore business confidence. A 16-week consultation on the proposals is on the agenda from the middle of March.

There is concern that providing both accountancy and auditing services creates a conflict of interest. We can refer to Sec-144 of Companies Act, 2013 wherein the services which an auditor cannot render has been detailed.

Large companies will now have to use smaller audit firms for their annual audit to dilute the Big Four's dominance.

KPMG, Deloitte, PwC and EY will have to make their audits more rigorous.

They can face a cap on the number of companies they will audit, through FTSE 350 index, if improvements aren’t far reaching.

Almost a third of audits inspected on the FTSE 350 last year were in need of improvement.

The largest private companies in the UK would now face greater scrutiny from the regulators.

The collapse of construction giant Carillion is an example and a consequence of the failure in the audit profession.

The new proposals would help restore trust; similar measures had worked in the US.

The information on which people make their decisions is accurate and honest, and an auditor's role is to ensure that information is truthful.

People want to know three things about a business - how is it performing, is it honestly run, and will it survive. And auditors are the key to answering all three.

It is clear from large-scale collapses like Thomas Cook, Carillion and BHS that Britain's audit profession needs to be modernised with sensible, proportionate reforms.

A new accountancy regulator, Audit, Reporting and Governance Authority (ARGA), will implement the changes and replace Financial Reporting Council (FRC). It will have legal powers to force auditors and companies to resubmit their accounts without court action.

UK companies and directors will face curbs on dividend and bonus payments if there is misconduct, inaccurate accounts, or insufficient cash reserves. Bonus paid to directors of failed firms will be clawed back up to two years to clamp down on rewards for failure.

By providing more transparency over company accounts this will discourage firms facing insolvency from making large scale dividend and bonus payments. They will also be required to produce resilience statements.

Accountancy firms welcomed the proposals. The proposals also won the support of employers' groups.

Conclusion

There are a lot of takeaways and lessons to be learnt from the above and what the British Government is doing for improvisation of the audit profession in the UK vis-à-vis the Big Four.  

Can we, the Chartered Accountants in practice in India, along with our regulators viz, ICAI and NFRA, take ourselves forward a decade ahead is the million dollar question.

Findings of NFRA on Audit of IL&FS by BSR & Associates LLP for 2017-18

Note - BSR & Co, formerly Bharat S Raut, is part of KPMG’s domestic and international network for auditing. KPMG does auditing work in India through BSR an Indian chartered accountant firm that also signs on the balance sheets of Indian companies. KPMG, a network of global firms, cannot conduct audit as per Institute of Chartered Accountants of India (ICAI)’s regulations. Hence it conducts audit through BSR. It is just for signing purposes that such arrangement is made.

1. BSR’s appointment as statutory auditor of IL&FS Financial Services Ltd. (IFIN) for 2017-18 was illegal, since BSR was not eligible to be appointed due to violation of Sec 141(3)(e) (subsisting business relationships on the date of appointment) and Sec 141(3)(i) (provision of non-audit services directly or indirectly) of the Companies Act, 2013. BSR’s continuation as statutory auditor was also violative of Sec 141(4)

2. Notwithstanding such lack of eligibility, and without prejudice to such finding, NFRA has conducted a full Audit Quality Review. The important findings in the AQRR (Audit Quality Review Report) are mentioned below.

3. Failure to comply with Standards of Auditing (SAs) documented in AQRR are of such significance that NFRA concludes BSR did not have justification for issuing the Audit Report asserting that audit was conducted as per SAs.

4. Please refer to ICAI’s Implementation Guide on Reporting Standards. If during a subsequent review of audit process, it is found that audit procedures in SAs were not complied with, it tantamounts to auditor making a deliberately false declaration in the report and consequences for auditor could be very serious indeed.

5. BSR and KPMG network entities de facto use the KPMG Trade Mark and Brand Name for all their audit and non-audit services, making a futile attempt to show a de jure separation from KPMG. This will fail in view of public perception of BSR network entities being part of KPMG global network, and legal agreements between them. Non-audit services provided technically by KPMG labelled network entities are services provided by BSR entities, and result in gross violations of independence requirements for auditors as per Companies Act, and Code of Ethics mandated by Institute of Chartered Accountants of India.

6. IFIN didn't comply with Minimum Net Owned Funds and Capital to Risk Assets Ratio as on 31st March, 2018. These were negative, against a minimum positive requirement, and this non-compliance continued since long. Financial Statements (FS) of NBFC have to disclose these numbers. IFIN’s management contested RBI’s computation method and showed positive numbers as per its own definition. BSR was convinced that IFIN management was wrong. But they went along with wrong numbers disclosed in the FS, with only an Emphasis of Matter (EOM) para in Auditor’s Report, when EOM is justified only when the disclosure requirements as per SAs are fulfilled. Thus, BSR failed to highlight a material misstatement of major magnitude and fundamental importance.

7. Unjustified Valuation of a Derivative Asset: Rs 184 cr. Reversal of General Contingency Provision: Rs 225 cr. Non-provision for Impairment in the value of Investments: Rs 200.20 cr. In the above cases, BSR has not obtained sufficient, appropriate audit evidence, as required by SAs, to support the numbers finally reported in the FS. The total of the 3 items led to an inflation of profits of IFIN by Rs 609 cr

8. Numerous other violations of the SAs have been detailed in the AQRR. These deal with the assessment of the use of the Going Concern assumption by the management, the complete absence of the required communication with Those Charged With Governance, inadequate and improper evaluation of the Risk of Material Misstatements, determination of Materiality amounts on the basis of non-relevant factors, etc

9. The Engagement Quality Control Review (EQCR) mechanism was found to be completely inadequate for the intended task.

10. NFRA has also extensively studied the IT processes and platform that are used by BSR for their Audit File documentation. NFRA found that the IT processes/platform have deficiencies that are systemic and structural in nature, and arise substantially from a complete disregard for basic principles of IT security in the software used. This renders the audit documentation completely unfit for the intended purpose.

Deloitte having big problems of auditing professional ethics and quality in China from 2016

There are serious problems at the Beijing office of Deloitte. And Deloitte is just playing by the Chinese audit industry’s unspoken rules. 

A leaked document from a Deloitte employee who remains anonymous at their Beijing office outlined serious problems of auditing professional ethics and quality going back to 2016. It had been sent in a group email to colleagues. The report reveals the unspoken rules of the Chinese audit industry.

This has been communicated to Deloitte management and Deloitte Reputation and Risk Group (RRG) more than 30 times for 2 years since 2018, requesting Deloitte to deal with audit quality reporting issues properly. 

The employee seems to imply that managerial conflicts of interest may have resulted in inaction up till now.

Deloitte has taken no action against the accused individuals, even though the problems were first pointed out in 2018. The accused include two partners and multiple senior managers who are all mentioned by name.

The main accusation is failure to abide by proper auditing protocol. Deloitte took major shortcuts telling their clients that their jobs were thoroughly completed when they were not.

The firms include Sinotrans, a logistics platform of the state-owned transportation conglomerate China Merchants Group, Boqi Environmental, a well known waste management provider and LG CNS China. 

RYB Education — an NYSE-listed company that itself had a scandal in 2017 involving child abuse at a kindergarten — is mentioned as compensating employees with gift cards and paying for their expenses, including those incurred by senior executives’ children overseas, irregularities to which Deloitte has turned a blind eye. 

Deloitte auditors are accused of dilly-dallying on the job, failing to read requisite files, skipping quality control procedures, and even falsifying data. Pictures in the report depicted stacks of papers strewn across floors of windowless rooms.

Response from Deloitte and the regulators 

The China Security Regulatory Commission (CSRC), the main financial regulatory body equivalent to the SEC in the US acknowledged the report’s existence. CSRC now wants to verify and follow up with the relevant institutions.

Deloitte responded on its website saying that Deloitte had started an investigation and no evidence was found that affected the adequacy of their audit work. It said Deloitte reserves the right to take legal action for the spread of false information. 

But the employee had tried to report the malpractice through the appropriate channels, but Deloitte had reacted by suspending their career development. Deloitte also documented a culture of bullying and intimidation tactics.

Deloitte is one of the Big-4 largest accounting firms in the world along with PricewaterhouseCoopers, KPMG and Ernst &Young. In 2020, Deloitte was listed as one of the largest privately owned companies in the US along with Koch Industries and Cargill, the agri business giant. 

If genuine, the document offers a rare window into a lucrative but shadowy arm of the global financial system. Auditors mediate between private institutions and public regulators, making their own work less transparent and less scrutinized relative to the private clients they serve.

Instead, auditing firms rely mostly on internal ethical codes and self-enforcement mechanisms to ensure quality. This makes it difficult to see when they are misbehaving. 

In recent decades, as global financial firms have flourished, business practices and financial instruments have become more complex. Tax auditing, which has grown along with the industry, has developed into its own kind of complex trade, with its unique culture, practices, and vocabulary.

ICAI takes disciplinary action against eight CA’s arrested in invoice fraud.

The government had arrested eight chartered accountants (CAs) in its nationwide drive against fake GST fraud launched since mid-November to nab unscrupulous elements using fake invoices to fraudulently claim input tax credit.

They were operating multiple non-existent firms and fake entities to dupe the exchequer with fraudulent ITC utilisation in connivance with fraudsters and fly-by-night operators.

The CA Institute (ICAI) has initiated disciplinary proceedings against the eight chartered accountants who have been arrested in the nationwide drive against fake GST invoice frauds in the last two and half months since November 2020.

The Revenue Department’s letter formed the basis for initiation of disciplinary proceedings against these eight Chartered Accountants.

The eighth Chartered Accountant was arrested along with his four business accomplices in Jaipur for operating 25 fake firms to fraudulently avail and pass on Input Tax Credit (ITC) through bogus invoices without actual supplies of goods/services.

Deepak Kochhar threatened to ruin my name says Venugopal Dhoot

Videocon Industries promoter Venugopal Dhoot told the Enforcement Directorate (ED) that Deepak Kochhar had threatened to declare his loans as non-performing assets (NPAs) prematurely and ruin him. Fearing it happen, he transferred the South Mumbai flat shares to Quality Advisors, showing loss in the books of QTAPL of over Rs 3.5 cr.

The ED probe in a money laundering case registered against Deepak Kochhar, his wife and former CEO of ICICI Bank, Chanda Kochhar and Dhoot has revealed the money trail on the suspected quid pro quo between Kochhars and Dhoot for the loans sanctioned to the latter.

Dhoot has revealed that Rs 64 cr were transferred to Deepak Kochhar's company Nupower Renewable Private Limited (NPRL) for sanction of loans from ICICI Bank in 2009.

The ED filed the first charge sheet in Nov-2020 and Dhoot’s statement says that he was forced by Chanda Kochhar to invest in her husband's firm before sanctioning the loan to Videocon group.

Chanda Kochhar was part of the committee which heard the proposals of Videocon for loan.

Videocon Group had made 28 proposals to ICICI Bank and eight were sanctioned. Chanda Kochhar was part of the sanctioning and recommending committee in four such proposals.

Dhoot's statement was recorded thrice by ED officials this year. He alleged that Deepak Kochhar asked him to invest funds in his wind power project and while he required a loan, Deepak Kochhar asked him to meet his wife Chanda Kochhar.

Chanda Kochhar asked him to help Deepak Kochhar in his wind power project and invest in NRPL and when the loan of Rs 300 cr was sanctioned, he transferred Rs 64 cr to NRPL.

If he didn't transfer funds to Deepak Kochhar and accept Chanda Kochhar's deal, the proposal for loan to ICICI Bank would be kept on hold indefinitely. The transfer only happened when ICICI Bank disbursed Rs 300 cr to Videocon Industries.

ICICI Bank sanctioned loans worth Rs 1,875 cr to Videocon Group and the companies associated with it between 2009 and 2011. Most of these loans were in complete violation of banking regulations and ICICI Bank policies.

Chanda Kochhar was the CEO and Managing Director of the ICICI Bank then.

Dhoot's statement mentions that it was a well-devised scheme of Chanda Kochhar as per which, Deepak Kochhar's company received Rs 64 cr of the Rs 300 cr loan from ICICI Bank. The transfer of the Rs 64 cr happened from the Videocon group to NRPL just a day after the disbursement of Rs 300 cr loan from ICICI Bank in 2009.

ED had registered a case on the issue in Jan-2019. An investigation against Deepak Kochhar, Chanda Kochhar, Dhoot and their related companies began following the case registered by Central Bureau of Investigation (CBI) in Jan- 2019.

ED found that loans sanctioned to Videocon group were kept alive by evergreen IMG or refinancing of loans worth around Rs 1,730 cr which turned into NPA in June 2017.

Chanda Kochhar's Suspicious South Mumbai Flat Deal

ED, during its investigation, found that Videocon group had transferred ownership of the flat which was valued Rs 5.25 cr in 2016, to Quality Advisors for just Rs 11 lakh which is a family trust of Chanda Kochhar.

Dhoot, while being questioned by the ED, said it was Deepak Kochhar who had asked him to retain the flat. Deepak Kochhar had threatened to make his loans declared as NPAs prematurely and ruining him.

Fearing the same, he transferred the flat shares to QTAPL to Quality Advisors, showing a loss in books of QTAPL of over Rs 3.5 cr.

The ED has provisionally attached movable and immovable assets worth Rs 78.15 cr consisting of a flat, plot, cash, and machinery of wind farms in Tamil Nadu and Maharashtra belonging to Deepak and Chanda Kochhar.

The proceeds of crime as per ED is around Rs 78.15 cr, which includes Rs 74.54 cr held in the name of NRPL, flat in Mumbai valued at Rs 3.5 cr and an amount of Rs 10.50 lakh seized from a firm of Deepak Kochhar. He is presently in judicial custody.

Dhoot was found equally responsible for the money laundering and siphoning of the funds from the ICICI Bank in name of loans.