The Delhi High Court has set aside show cause notices and orders issued by the National Financial Reporting Authority (NFRA) against auditors of companies in the IL&FS group, raising apprehensions about whether the NFRA’s wings as a regulator of the auditing profession have been clipped. That, however, would amount to a misreading of the order, as there are many positive takeaways for the six-year old organisation.
The High Court has upheld the constitutional validity of Section 132 of the Companies Act, which gives NFRA the power to monitor and enforce compliance with accounting standards in public companies, and to oversee the functioning of auditors. The Court has also brushed aside the argument about NFRA not having the power to investigate audits done before it was formed. It is also worth noting that the Court has not objected to the audit quality reviews issued by the NFRA, or with its content. It has struck down the contention that the procedures followed by NFRA suffer from the “vice of manifest arbitrariness and deprivation of a fair procedure”. The orders issued in the IL&FS case were among the first major orders of the NFRA, and the Court order can be viewed as a vindication of its investigative processes.
But the grounds on which the Court has set aside these particular orders need to be addressed exigently. The High Court has pointed out that the regulator did not follow the law, which required that it “shall perform its functions through such divisions as may be prescribed.” Since the same divisions performed the investigation and issued the orders in the IL&FS case, these orders were not considered neutral. Factors such as paucity of adequate staff in initial years and delay by the government in issuing notification regarding formation of divisions in the organisation, could have led to this lapse. But the NFRA can take comfort in the leeway provided by the Court, in asking the regulator to start the proceedings afresh with a new set of members. The way forward should be to firewall the divisions which investigate a case and those that take disciplinary action, so that there is no conflict of interest. A leaf can be taken from the system in the Competition Commission of India where the Director General’s office acts as the investigative wing and the CCI is the adjudicating authority. The DG does the investigation and submits report to the CCI. But the recommendations of the DG are not binding on the CCI.
The NFRA was set up with the intention of improving the accounting and auditing standards in India, on the lines of the Public Company Accounting Oversight Board in the US and Financial Reporting Council in the UK. The AQRs issued in the IL&FS case show serious professional misconduct and auditing lapses by large auditing firms such as Deloitte Haskins & Sells, BSR and SRBC. A process should be in place to enforce the NFRA’s orders in a time-bound manner. That would go a long way in lifting the quality of auditing.
