Pay the Piper, Don't Call the Tune: Independence of Audit Firms

Last month, one of the topmost global audit firms KPMG was fined by the British financial regulator for its close connections with the top-end fashion retailer Ted Baker. KPMG pleaded guilty and settled with the regulator to pay the fine of more than £ 2 million. Early this year, PricewaterhouseCoopers was banned from auditing clients in India for two years for its role in the Satyam scandal about 10 years ago. At the turn of the century, Arthur Andersen simply vanished from the scene due to revelations made regarding Enron and WorldCom. Deloitte is in trouble because of the British software company Autonomy audit. Among others Ernst & Young has been facing the problem regarding Dubai gold refinery scandal as it failed to point out the irregularities of the Kaloti group of companies, which sometime back controlled half of the Dubai gold refining business.

There are a number of stories regarding the auditing firms and their extremely close relationship – too close for comfort – with their clients, and we have just mentioned the global top four auditing firms. It has always been a murky, sinister, confusing situation about the auditing firms being paid by the clients themselves, who are audited by these firms. Extremely high levels of professionalism, which according to the British financial regulator's recent comment have slowly been diluted to the extent of being unacceptable at least in the case of KPMG – other auditing firms are not very different – demand that the right hand should not know what the left hand is doing, and the fact that the client is footing the bill should not have any implication on the quality of work being done. This may be true in an ideal situation, however, in a practical realistic world things do not work in this fashion.

There has been expansion of the work done by these firms in the nature of consulting work, advisory, even transgressing into the legal services domain, and so on and so forth. Besides the global brand-name, there's hardly any homogeneity in the quality of services provided all over the world, and there is no standardisation of the work being done in different jurisdictions. Typically, the business model is to take the services of local accounting and audit firms, by providing them training and orientation for the global outlook, polishing them particularly in soft skills, and then bringing them under their respective trade name umbrellas. Due to this style of working, they can only be indirect and subtle control from a central controlling unit, may be known as the global headquarters, or from the regional head offices.

In an attention-grabbing case – S. Sukumar v. Secretary, ICAI – which had been decided by the Supreme Court in February this year regarding the services provided by multi-national accounting firms (MAFs) in a covert manner along with the Indian Chartered Accountancy Firms (ICAFs), an 8-member committee was formed to examine the relationship. The draft review report released late last month – final report is expected in a week or so – makes it mandatory for ICAFs to declare upfront their relationship and dealings with MAFs. This is the least one expects for self-regulation by the controlling body lest the financial regulator and the judiciary impose strict and onerous restrictions.

The stakes usually are so high, and the discretion accorded to the auditors is almost unbridled that the combination of both often makes things go wild and crazy. With one stroke of the pen millions can be taking care of as is being investigated in the case of KPMG accepting family wedding expenses as company expenses for the Gupta family in South Africa. This is, of course, too glaring and requires no evidence for proving that the auditors were lying cosily in the client's pockets.

Professional service firms, as the name suggests, are manned by professionals. Ethical standards for professionals have to be maintained at a very high level and moral flexibility has no place in the dealings.

Paying the piper doesn't mean one can call the tune. The piper must play the tune he ought to play.

The author is a professor at IIM-A, akagarwal@iima.ac.in