I'll give you a little
bit of background, the perspective of our work at the NFRA, and why it is so
critical for our country at this stage of development.
So let me give you
some of the figures. We are trying to grow at the rate of 8% GDP in the real
terms. We are already the fifth largest economy in the world. And we aspire to
become the third largest economy very soon. Now, the IMF estimates that by next
decade, India will contribute almost 20% to the global economy. By 2031, India
will be a $ 7 trillion economy.
In the process our per
capita income, which is around $2,500 now will double. We shall be a
middle income country. But more than that, where do we reach by 2047. By the
time we complete 100 years of Independence by then, there are varying estimates
saying that if we continue to grow at around 8% in real terms, then our GDP,
which is about $3.5 trillion, will become somewhere around $27 trillion. And
let us consider this in the perspective that today's US economy is of this
size, $27 trillion. But China is $17 trillion. Of course, by 2047, they also
would have gone much ahead.
Our per capita income
will be around $14,000 to $15,000. So that will become a middle income country.
But then, is just a kind of a hope? Or is it just something that it will just
automatically come? In fact, recently Bain Consulting came out with a report.
It was very interesting. What they have done, they have said that supposing
what happens if India continues to grow at 5%, then what will be the size of
our economy in 2047? It will just be $13 trillion. Very, very far away from $27
trillion, right?
What makes a high
growth rate happen?
So we must grow at
around 8%. Now, how will this happen? It will require a lot of private
investment. It's not the responsibility of the government alone. For instance,
the government's budget today is around Rs 50 trillion. But our GDP is around
Rs 260 trillion, right? So government investment alone is not going to drive
the GDP. So this means we actually require a lot of private investments. And
what we are finding is that, who are the investors? And why would they invest
in companies?
Remember, the
investors, when we were growing up, the investors used to be large, big
industrialists. Only they used to invest. Like the Tatas, Birlas, Dalmiyas,
these are the people who were investing.
Instead during the
last 10, 15, 20 years there is now a kind of a democratization of investors.
One of these is the startups. To finance them are the retail investors, who
through the SIP are putting in money. And to make all this happen seamlessly,
we are quite fortunate that an entire digital revolution has taken place in
India, particularly in the financial sector.
And I feel very
fortunate that I have been associated with many of these things, like Aadhaar,
for example. That actually solved the problem. It is unique. Nowhere in
the world do you have this. You can do your KYC online. You can open a bank
account. You can open a DMAT account, and so on and so forth. All those
things are possible today. And that actually has led to the democratization of
investments.
For the retail
investors these have simplified investments. Everyone says, let me put some
money. Let me have some SIP.
Then, a lot of foreign
FIIs, foreign investors, FDIs, plus domestic institutional investors, all of
them are coming here. And that is where the role of corporate governance, which
I was mentioning in the beginning, that becomes very important.
Because along with good corporate governance comes trust. People should be able to trust the management, trust the board. And that is what is very, very critical.
I remember that in
2018-19, one of the banks called Punjab and Maharashtra Cooperative Bank
failed. DHFL, Yes Bank, and now this New India Cooperative Bank. So whenever
such failure takes place, the people become very wary, saying that, look,
should I put my money there? Will I get my money back? The same thing happens
with the companies.
In Yes Bank, the ATI
Bonds got written off, about 12,000 crore rupees, even though Yes Bank was
revived. But then the people didn't get the money, because the nature of the
bonds was like that. So maybe legally it was correct. You all are LLM
students. You will know the process well.
It has had
repercussions in the bond market reducing the level of confidence. Once the
confidence dips the people go back to buying the same things like land or other
forms of real estate.
These investments are
not that productive. And then finally, people will say that, all right,
I'll put money in the gold, or I'll keep cash. Now, if that is the tendency,
then, , where will the investment take place? And so therefore, it is
absolutely necessary that if India has to grow, it has to have this corporate
governance and trust.
So it is, , I was
mentioning about the rise of retail investors. Some of the figures, , what has
happened in this wake of digitalization, , the total amount of DMAT, number of
DMAT accounts, was 4 crores just about five years back. Can you imagine how
much, how many will it be? It is somewhere around, , 17 crores.
Now imagine 4 crores
to 17 crores in the span of five years. Then look at the mutual fund portfolio
where the asset under management, used to be 10 lakh crore in 2014. Now it is
67 lakh crores.
The SIP used to be
8,000 crores every month. Now it is 24,000 crore every month. The small-town
people, they are investing largely 75% of the equity.
And in the big town,
about 50% equity. So why I'm saying all these figures is that corporate
governance is no more a problem of, , let's say, imagine 30 years, 40 years
back. If a company failed, who would have impacted? Because at that time, , the
rich and other people, , they were investing.
But now it has become
a much wider problem, right? The people from even low income group who have put
their lifelong savings into these are affected. So it is a much bigger problem.
And therefore, the corporate governance and trust becomes absolutely critical.
You'll find that
people in your own family, your uncle, your parents, , they have put their
money into many of these areas, either in the bond or the equity or in the
fixed deposit somewhere.
So that is why it is
absolutely necessary. And if we want that to have a sound investment, people
all over the world, including the domestic investor, if they continue to
invest, then they should be able to trust.
How to improve Trust
How do you create the
trust? Because there is a company. The company publishes annual reports and
quarterly result. But how do that those figures are correct? And you are
not aware that the Companies Act requires, there are certain requirements.
And the accounts have
to be published. And then there are LODR mandated by Sebi. So all those
requirements are there.
But who is certifying
that the accounts are true and fair, in the technical terms, that the accounts
are true and fair? First of all, it is the management’s responsibility.
And then that of the shareholders, they actually appoint the tatutory auditor.
Because the accounts
are so complex that it is not for each of the investors to figure out how do
you recognize the revenue, how much is the profit, how much is the loss, how
much is the items in the balance sheet, how much is the assets. So these things
are not possible for everyone to realize that. So they want some kind of an
assurance from an expert body.
And that is what the
statutory auditor is supposed to do. The law also recognizes that, OK, look,
there could be a conflict between the management. Because management would like
to overstate, paint a rosy picture. But then the shareholders' interest is to
protect its own interests. So the law requires that the shareholder has to
actually appoint the statutory auditor.
So a statutory auditor
is appointed. And then the statutory auditors are supposed to audit
independently. And then they have to certify that the accounts are true and
fair.
Now, does that happen?
You mentioned about Satyam. Satyam had all these distinguished persons in their
board. But it still happened.
If you look at Yes
Bank, you look at DHFL, all of them had some eminent people. In ILFS there were
eminent people. And top notch auditors.
But how does corporate
malfeasance still happen? You have eminent people on the board, knowledgeable
people. Eminent auditors there. But still, off and on, every five, seven years,
some big corporate failure happens. And then, this completely shakes the
confidence of investors in this entire capital market. Why does this happen?
If you examine many of
the episodes of corporate mis-governance in the world, we find people hid their
identities. This is not possible with a system like Aadhaar. So people would
change the name, add qualification, and all kinds of things happened.
Fake inventory, fake
revenue, fake sales. And this is how many episodes went. And these would be
audited by the Big Four. What I'm saying is, even the good auditors, they
also, sometimes, , they fail, right? So that is why, so that happened. So after
seven, eight years, around somewhere around 38, 39, , this whole scam broke.
And that time, then suddenly, what went wrong? Then, , the law was
incorporated, that you have to publish your financial statement.
In your board, you
should have some independent director. And then the shareholder has to approve
the auditor. And also, the inventory has to be physically verified by the
auditor.
So some of these
things came. So independent person, independent director, , again, for the
corporate governance. So these are some of the things that happened.
Then, , thereafter,
then, again, after, off and on, , the scams used to take place, like WorldCom,
then Enron, in our country, Satyam. So it keeps happening. And finally, in
around 2000, 2002, 2003, when Enron things came up, that time, again, thinking
was, after all, who is certifying true and true, true and fair? The auditor.
Who is regulating
them? And they said that, , earlier, the impression used to be, it's a
profession. So therefore, naturally, every profession says that I should be
self-regulated, like doctors, or even the lawyer, for example, right? So the
auditor, in case of an auditor, but then it was felt that, see, the auditor is
not only a profession. You are actually performing a very important public function.
And therefore, is
self-regulation sufficient. And then Sarbanes and Oxley Act came in the US. And
then they said that, no, we'll move from self-regulation to an independent
regulation.
And PCAOB was set up
in the US. And then the other countries followed the FRC in Canada, and so on
and so forth. And then, India, we were kind of behind.
And then, , the Satyam
came. Then, 2013, this New Companies Act came. And then, New Companies Act, ,
the provisions for this NFRA, National Financial Reporting Authority, was
there.
But again, even after
the, I'm just imagining that even after, let's say, the parliament has passed
and said that there shall be an NFRA, Section 132 of Companies Act, the entire
Companies Act has more than 450 sections. But only one section was not
notified. And you all are background of law.
Even if the law is
passed by the parliament, unless and until it is notified by the government,
that doesn't take effect. So out of all more than 400 sections, this one
section was not notified. Therefore, even after the parliament has passed, ,
this NFRA, that provision was put on hold.
Then about 2017, our
prime minister went to one of the functions of the chartered accountant and
spoke his mind. And then thereafter, 17, 18, a lot of these scams came up,
right? Like ILFS, and many of these things came, Punjab National Bank, for
example. Because what people were wondering, saying that if all these bad
things were happening within the company, then why it didn't come to notice at
all? Because they all had very, very eminent people.
And then the eminent
audit firm, then why it was not being pointed out? So then it was realized
that, look, because no scam can happen, no big things can happen overnight. It
slowly builds up over the years, four, five, six years. So what would have
happened, let's say, in the first year itself, or second year itself? , these
things were pointed out.
And if they were
pointed out, maybe in ILFS, 70, 80,000 people had to lose. They had to take a
haircut, bankruptcy, or maybe just bank, or maybe DHFL. So the retail, as well
as the institutional investor, or the banks, wouldn't have had to take so much
of losses.
This wouldn't have
happened. The whole idea was that, why it's not being pointed out? And that is
where it was thought that in India also, we want an independent regulation for
the auditor side. And that is how this, that's the genesis of the NFRA.
Now, if the, so
essentially, when we talk about the corporate governance, I say that there are
five lines of defense. And the five lines of defense, one is, of course, the
management. Because the primary responsibility to prepare accounts and present
it to the server is of the management.
The CFO, the CEO, is
there. Then the second line of defense is of the audit committee, and then the
board. Third line of defense is the auditors.
So what we have seen
is, and auditors, and then the fourth line of defense is the shareholders. So
in all these failures, corporate failures, whether in India or abroad, all
these four lines of defense have failed. The four lines of defense in the sense
that the management pointed out, didn't bring out true and fair.
Then audit committee
didn't look into this. Independent directors didn't look into this. Failed, or
it escaped their notice.
Then the statutory auditor
also didn't point them out. And then shareholders also, because if the
statutory auditor doesn't point them out, how will the shareholders know? So
all four, there was a failure. And that is why, finally, when it becomes
public, then everybody comes to know.
So these are the four
lines of defense. And now the fifth line of defense has been added, that is, of
the regulator like us or SEBI. So we are working on the auditor side.
SEBI works on the
company side, board of directors side. So this is the fifth line of defense. So
in order to ensure, because many times I hear that the people try to pass
bucks, saying that, look, is it our responsibility? Because any failure takes
place, then the people start playing ping pong, saying that you are responsible.
I'm not responsible.
But actually, everyone is in the lines of defense. Tomorrow we are going to
also be held responsible if there is a major something in the queue.
What did happen as a
regulator? So therefore, it is absolutely critical that all five lines of
defense should work. These five lines of defense, in order that five lines of
defense work, then of course, and that is where the role and how we have
started working and what we have found, some of the things, because I must say
that the NFRA has been very, very, that we're a very new organization. We were
set up in late 2018, then two, three years, COVID.
And we actually
started working in the real sense from 2021, 22 onwards, so around three years.
In three years, we have passed around 100 orders. Each of our orders is
published on our website.
And the reason for
publishing in the website is, of course, to know everyone, that this is what is
happening. We also publish in the order itself one or two-page summary,
exclusive summary. So I think it will be a good reading for all of you.
I will recommend that
you must read and see that what exactly has failed. Where exactly the
management or this, they failed. So you will get an idea.
For example, many of
these cases, Cafe Coffee Day, this is one example. This company, I told that in
India, it kind of almost revolutionized the way the people have. Because
earlier, when we were growing up, and supposing if you wanted to meet some
people, some friends were coming home, where do you go? I mean, you wouldn't go
to some, and have a cup of tea or coffee.
The only place that
you will assemble is in some chowdah or somewhere on the roadside for the tea.
That's why, in your muhalla or somewhere. Because if you go to a five-star
hotel, then 500 rupees, something like that.
So the Cafe Coffee Day
on the Starbucks, the kind of format, they started this. And they're supposed
to do very well. But what happened? And we investigated that case, and it is
published on our website.
3,500 crores of
rupees. So one is the listed company. So our domain is only the listed company.
3,500 crores, and then
eight or nine subsidiaries were formed. Those subsidiaries were not the listed
companies. So 3,500 crores in some company, 200, 300 crores were diverted.
Either for showing
some purchase or advance or something. From there, entire money went to a
private account. A company, private company, where the 99% share was held by
the father of the main promoter of Cafe Coffee Day.
And from there, the
money disappeared. So we questioned, what were all these auditors doing? 3,500
crores rupees taken away. And then afterwards, the companies don't have
personal money.
It is the people's
money, investors' money, the bank's money, everything. So you find this
consistent pattern. Same thing happened in the reliance capital.
Again, the orders are
there publicly available. Reliance capital, the people put the many of these
state public sector undertaking, they have appropriate fund money. So they need
to invest.
And they get a little
more interest. So they purchase their bonds. And because they were AAA, and
then, again, the money got transferred to the various.And do you know the
number of subsidiaries? 200 subsidiaries. And then, the money gets routed so
that it becomes a complicated maze.
That it's not easy for
anyone to find out. And that is exactly what the auditors are supposed to be
doing. So, when we look at recent cases in Indias they often seem a rerun of
older cases, globally. There is no difference.
So, even if 100 years
have passed, the modus operandi remains the same. So, is that a good thing or
bad thing? The Good thing is that, we know the modus operandi.
Right? A bad thing is
that, our entire system has not been able to prevent that. So, I say that, the
people always find new ways of, committing offenses. But here, they have not
even graduated to the new ways. And therefore, I say that, the good thing
is that, they are sticking to the old, and therefore, it is very easy to
control. And this is exactly what we have started.
And in a little bit
while, I'll tell you what we are doing to stamp these out. One example is Cafe
Coffee Day. There were many branches of the company which were non-existent.
Now, imagine, can you have a bank branch, which is non-existent and non-existent
home loans. Old formula you will say.
The next stage
Through our own
analysis, analytics, using digital technology, etc we figure out these are the
early signs of failure. Then, we do point these out to the auditors as red
flags they should have raised.
Till some years
ago in India, there was no independent regulator, till the NFRA was set
up. At NFRA we find that many of the auditing standards are of 2002
vintage. That was prior to Enron.
So, after 2002, , a
lot of waters have flown in the river. A lot of amendments had come. But here,
because the primary task of framing the accounting and auditing standards were
of the Chartered Accounting Institute and because there was no independent
regulator, so they continued to do that. This is no surprise that if you have
to regulate yourself, you will always try to avoid, many, new things, because
you are used to working in the older way. So, our auditing standards were not
updated.
And one of the things
was, the dispute over the new yardstick SA-600. I mean, it has been widely
debated in every newspaper. What does it do?
It says that for the listed company, the principal auditor is the auditor of the group too. So, he has to take responsibility, because supposing if the listed company has, 50 subsidiaries, each subsidiary will have its own auditor. So, we call them component auditors.
But then the primary
responsibility is of the principal auditor, because the principal auditor has
to ensure that the component auditor has done properly. Whereas the 2002
vintage of the SA-600 was that the, the primary auditor will rely upon the work
done by the component auditor. Now imagine, if that is the legal standards you
are not going to question and take the responsibility for the audit of the
subsidiaries.
Because as a shareholder
or investor, you are relying upon true and fair. But he's saying that I'm
giving you true and fair based on the work done by the component auditor, who
is not, who has not been appointed by the shareholder. It is by the promoter,
because subsidiaries are often unlisted.
So, that became a
very, very easy modus operandi to divert the money from the main company, take
it to the subsidiary, and do whatever you want to do that. And then, you have
an auditor of your choice to certify it.
And then, you get a
certificate of true and fair audit by the principal auditor. This is exactly
the plea that was taken in case of Cafe Coffee Day, or the ILFS, and the
various cases that we have dealt with. So, we said no to that. We have
take the step. Naturally, it met some resistance.
Naturally, SEBI, RBI,
CAG, because they all are there in our board, they too have all supported the
upgrade. And then, finally, I think, the recommendation has been made to the
government, and the government will be soon expected to notify them.
So, this is one area.
Similarly, about the joint audit. They said that there should be a joint audit.
But then, in the joint
audit, also, what has happened is that a real stipulation was that the audit
will be split. Somebody will check the revenue. Somebody will check the
expenses.
And then, each one
will be responsible for its own part. How is it possible? Somebody has to take
the full responsibility, right? Somebody has to take the responsibility. As law
students you do understand the concept of joint and several liabilities.
But, here while it was
called joint, but there was no joint responsibility, right? So this too we plan
to examine.
So, some of these
things are extremely important and critical.
Independence of auditors
Similarly, the
independence of the auditors.
Because the auditors
have to have no conflict of interest. What we were finding is that in many of
these companies which they audit, they are also providing consultancy
services, either through their subsidiaries or providing a consultancy to the
subsidiaries of the group companies. So, if you are doing that, then how are
you maintaining the independence? For example, in NFRA, we are prohibited from
accepting any private employment while we are in the service.
And when I retire from
here, then for two years, I cannot work in any of these, the audit firms or
with the auditors, right? So, there is a two years cooling off, right? So, this
is how you maintain independence. But I find that many of my colleagues are on
boards of private companies as independent directors or in the audit
committees, right? So, imagine the board meeting takes place, let's say, four
or five times a year, quarterly, right? Now, imagine a complex company, a big
company like say, Hindustan Lever? Now, can anyone understand the full accounts
in just four meetings of a few hours? Impossible. But then, this is how it is.
So, then what happens? They become kind of a rubber stamp. Because I see that,
, my own colleagues, for example, retired as secretaries of government of
India, but how many of them will have an in-depth knowledge of, let's say, the
balance sheet, profit and loss statement, cash flow statement, they may not.
The system is this,
The auditing standards requires that there has to be a two-way effective
communication, between the auditor and those charged with the governance, the
corporate governance. Which is the TCWG? It's audit committee or the board of
directors.
So, we ask the
auditor, what is the communication with the TCWG? They say that, all right, we
attended the meeting, we told them. So, we ask the next question, that how
much, how long this meeting lasts? Audit committee meeting lasts, they say,
barely half an hour. I say that, look, when you are explaining to us, when we
ask them some questions, they ask for a month’s time to revert.
So the obvious
question is How did you, , convince or update or brief the audit committee
members in just half an hour? So, there is the question, right? So, if there is
a half an hour concept that why it didn't come to the notice of the Satyam's
board? So, we have started addressing that problem from the audit angle while
Sebi, which regulates board has begun addressing the other angle.
In this way we might
detect something early enough, and then, we can avoid a colossal corporate
failures of the likes which has happened in the past.
The next stage is
there has to be some training, and I was mentioning just before I came here
that, I'm also doubling up my role as a DG or the CEO of IIC, Indian Institute
of Corporate Affairs. So we have launched some special courses for the
independent directors or the audit committee members, four-month or a
six-month course. What is required is a the multi-pronged approach. In the past
three or four years, I have started getting a feedback from, people who are on
the other side, particularly in the board, that they are very happy about the
training.
And therefore, now
that things are improving in that direction. And this is the direction we
should be going ahead. And as I said in the beginning, that, all these things
actually help build, corporate governance, transparency, and finally the trust.
And trust is the key.
If India has to develop, the corporate governance is the must. So I will end
here and am open for discussion on these issues.
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