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Auditors Face Scrutiny as 'Cooling-Off' Bill Targets Conflicts of Interest
A draft Indian bill mandates a three-year 'cooling-off' period for auditors to prevent conflicts of interest between auditors & their clients. The legislation, introduced in Parliament, would bar auditors from providing non-audit services to clients.
Auditing Industry Faces Regulatory Headwinds
A legislative proposal in India is set to impose a three-year 'cooling-off' period on auditors, a measure designed to mitigate conflicts of interest between auditing firms and their clients. This draft bill, introduced in Parliament, would prevent auditors from offering non-audit services to companies they audit during a five-year engagement period, followed by an additional three years after the audit concludes. The proposed rule mandates that if a company pays for audit services, it cannot engage the same firm for non-audit services. Similarly, a firm providing non-audit services cannot undertake the audit for the same client for eight years—five years during the service and three years post-service.
The Ministry of Corporate Affairs (MCA) indicated its intent to implement these changes, signaling a broader push for governance reforms under the Companies Act. The objective is to foster audit independence and prevent situations where non-audit service revenue might influence audit objectivity. This move comes amid ongoing discussions about auditor independence, particularly in the context of the Big Four accounting firms.
NFRA Findings and Industry Concerns
In March, the National Financial Reporting Authority (NFRA) found Walter Chandgiok & Co. non-compliant with independence requirements related to Grant Thornton. The NFRA noted that Grant Thornton's network did not maintain strict separation between audit and non-audit services, accepting work that should have been declined due to conflicts of interest. The NFRA has also taken a stance against Deloitte Haskins & Sells, prohibiting non-audit services by its network firms due to potential violations when engaged with client groups.
Deloitte responded to the NFRA's position by stating that its network firms comply with Section 144 of the Companies Act, which restricts non-audit services. Walker Chandgiok maintained that its independence policies align with all applicable laws and standards. Section 144 mandates auditor independence by prohibiting auditors from offering non-audit services to their client companies, holding companies, or subsidiaries.
Similar independence-related concerns have emerged from other NFRA inspection reports, highlighting areas for improvement in audit quality and independence. Critics argue that while the intent of improving audit quality is valid, the proposed measures might disproportionately affect smaller firms. The European Union, Singapore, Australia, and the UK have already implemented some form of cooling-off periods or restrictions on non-audit services.
Impact on MSMEs and the Audit Landscape
Smaller firms are particularly apprehensive about the proposed cooling-off period. Amendments to Section 139 of the Companies Act 2013 would grant the Central Government the authority to exempt certain classes of companies from 'mandatory statutory audit'. This raises concerns about the potential for further erosion of the audit market for smaller firms.
Kallbhushan Sharma of CA firm KPRS and Associates noted that the extensive conflicts of interest in the audit profession are rare. He highlighted that issues related to interest conflicts, particularly involving IL&FS financial services, were uncovered in a 2019 NFRA review of Deloitte Haskins & Sells. The firm was found to be non-compliant with standards of auditing and independence by providing prohibited non-audit services for substantial fees in 2009. Satyam scandal raised similar concerns regarding PriceWaterhouseCoopers (PwC).
PW India, Deloitte Haskins & Sells, and other firms that announced their non-audit services withdrawal from the Indian market in 2020 are already working towards compliance. Exempting smaller companies from mandatory audits could further reduce compliance work, potentially handled by smaller firms. Experts suggest that the proposed reforms might make it challenging for smaller firms to specialize and offer advisory practices.
Industry Perspectives and Talent Crunch
The proposed amendments from the Reserve Bank of India also advocate for a single auditor for banks, with a cooling-off period. This would prevent 'maharatna' major profit-making public sector companies from engaging a second audit firm for four years. The amendment aims to prevent restructuring of audit firms into complex groups to circumvent regulations, potentially driving up business for smaller firms.
Ranjeet Kumar Agarwal, former president of ICAI, stated that the current ease of doing business makes it easier for companies to get statutory audits completed. He also noted that many MSMEs, which need audited accounts for bank financing, may not find sufficient audit talent due to the new regulations. Agarwal estimated that 150,000 CAs are practicing in India, with 67% of insolvency professionals coming from the pool of CAs. An estimated 5,000 USD valuation for an audit is insufficient given the market demand.
A partner at one of the Big Four firms suggested that 100-125 of their employees transition annually from the audit department. The NFRA requires the audit partner to avoid serving the same client for more than 10 years to minimize conflict of interest. The final bill, once passed, is expected to outline the regulatory safeguards and operational flexibility for audit firms.
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