DHS LLPs statement on allegation relating to the IL&FS situation

Recently, there have been reports in the media about a petition seeking review of the judgement pronounced by the Hon’ble Supreme Court on May 3, 2023. The judgment was of a technical nature and dealt with the interpretation of certain provisions of the law. The Hon’ble Supreme Court’s ruling did not address or opine on the merits of the allegations.

In the past, there have been reports in the media about certain regulatory authorities examining allegations concerning the IL&FS Group, including the role of the management and directors of IL&FS, the duties performed by the past and present auditors to the company, and the credit ratings agencies. With respect to the auditors of IL&FS Financial Services Limited (“IFIN”), the matter is under consideration by the regulatory authorities; as of today there is no sanction or order on Deloitte Haskins & Sells LLP (“DHS LLP” or “Firm”) that would impact its ability to provide professional services.

DHS LLP remains committed to high standards of audit quality and ethical conduct in its professional practice. The Firm is presenting their position, which is supported by the facts and necessary context, to the relevant authorities. DHS LLP has faith in the regulatory and judicial processes and will continue to cooperate fully with the authorities.

The former auditor has approached SC seeking a review of its May judgment that allowed the Serious Fraud Investigation Office (SFIO) to resume criminal proceedings against it. Deloitte in its review petition told the SC that the May decision had omitted to consider the distinction between a firm that that ceased to be an auditor by operation of law (companies act) and an auditor who has subsequently resigned. Deloitte had rotated out one year prior to the filing. It also failed to consider the provisions of the limited liability partnership (LLP) Act which says no vicarious liability can be fastened on the other partners in the case of alleged fraudulent acts.

The NFRA report has again put a spotlight on the confusion on what services can be provided by an auditor to its audit clients. There is confusion on the definition of ‘management services’. Currently, ICAI is working on a definition. Also what’s bothering the auditors is NFRA’s firm position that if courts do not grant a stay on the proceedings initiated by it, even if the matter is sub-judice, it will go ahead with its orders.

In a major relief to the former auditors of IL&FS Financial Services (IFIN), the Bombay High Court (HC) quashed the criminal complaint against Deloitte Haskins & Sells and BSR Associates, an affiliate of KPMG, filed by the Serious Fraud Investigation Office (SFIO) terming it unsustainable. However, the court upheld the constitutionality of Section 140 (5) of the Companies Act, 2013, but said it is not applicable to auditors who have resigned. BSR & Associates resigned in June 2019, while Deloitte’s term ended in 2018. The National Company Law Tribunal (NCLT) cannot ban Deloitte and BSR for five years under the said Section.

IL&FS failure is a system failure. It cannot be termed as the failure of one entity, i.e. auditors in this case.

We need to realistically look at the entire ecosystem of auditors, independent directors, audit committees, finance managers, system of justice, whistle-blowers, rating agencies, banks and regulators to minimise the occurrence of frauds in corporate India, and not focus exclusively on auditors.

There also appears to be a confusion between what constitutes ‘business failure’ and ‘financial reporting failure’. Given the credibility gap and crisis of confidence in the financial reporting system, if issues are to be addressed, merely focusing on audit quality will not suffice. Corrective steps are needed in all components of the financial reporting ecosystem, thereby addressing the expectation gap, which investors and regulators have on the audit function.

Auditors being gate-keepers and not privy to every action of the management, should not be fastened with criminal charges for a mere failure to report management acts of negligence, which is perhaps too overwhelming and disproportionate. This is where the committee highlights the principle of proportionality and, in my view, constitutional protection against “double jeopardy".

Audit has become highly onerous and extremely risky with stringent professional, civil and criminal liability. The audit liability conundrum needs immediate solution if quality of auditors and audit is to be maintained in public interest.

The auditor is not required to perform the functions of a detective. “The auditor is a watchdog and not a bloodhound. The duty of an auditor is verification and not detection”.

One of the most prosaic messages is the absence of a bankable model for infrastructure in India. If we don’t have long-term funds to finance long gestation projects like roads, ports and airports, and as long as infrastructure companies borrow and continuously roll over cheaper short-term borrowings to build large projects, it will remain a touch-and-go for them.

Rather than blaming auditors for lapses, it may be worth shifting focus to improving regulation and conduct in the field.

The Big Four represent a large pool of talent in India, today employing perhaps 2,00,000 people. These firms have trained a large proportion of India’s financial talent, spanning the corporate, banking and investment sectors. Auditors should not be made to accept what, essentially, is the main responsibility of the management and the board. The Big Four have led the way by investing in technologies and training to increase the quality of audit services. The reputation they have built should be acknowledged as an asset to India.

Penalising audit firms in the absence of conclusive proof of malfeasance is unfair. The job of audit firms is to ask enough questions and ensure that the financial statements give a true and fair view of the company. They should be punished for lapses. But audit firms must also be heard so that they have a chance to explain the alleged omissions and commissions.

IL&FS’s troubles not only create a significant hole in India’s landscape for long-term capital; official calls to ban auditors which stand accused with IL&FS could deter global investors as they depend on the Big Four for diligence and protection of investments in India.

High-quality financial reporting and audits are a collective responsibility. Experience from developed countries shows that the best results are achieved when each stakeholder in the ecosystem plays her part. Rather than expecting any one stakeholder such as the auditors to achieve this single-handedly, India needs to take a similar holistic approach if it seeks to achieve the desired outcome.

If distrust of those in the assurance business remains high, there will be chaos all around.

‘Scapegoating’ firms will hit investor sentiment. An irrational and hostile environment enervating investor confidence in due process under law can dial back foreign investment commitments, causing loss of investment and jobs

Whipping the auditor because of its failure to meet the regulators' and public expectations will not improve the audit quality.

There is a distinction between audit negligence and criminality. The government and the leaders in the auditing profession must have a clear dialogue.

The best way to deal with audit failures is a stiff fine, and/or a censure or restriction on the specific people who muffed an audit. Banning the entire firm makes little sense, when the lapses may have been one of inadequate supervision of the personnel directly dealing with a company’s books.

India is hurting itself with clumsy oversight of the Big Four. New Delhi on Monday sought a five-year audit ban on Deloitte Haskins & Sells and KPMG's local affiliate for alleged failings at IL&FS Group, an infrastructure lending group seized by the government last year after it was crushed by some $14 billion of debt. The process will rattle local and multinational companies.

The Indian audit industry is staring at an upheaval if the National Company Law Tribunal (NCLT) accedes to the government’s demand to ban Deloitte Haskins & Sells and BSR & Co, part of the KPMG network, for their alleged role in concealing bad loans at IL&FS.

Auditors can’t be put in the same category as independent directors and senior management, they argued.

Section 140(5) of the Companies Act does not apply if the auditors are no longer with a company. The said section deals with resignation of auditors. Section 140(5) is only applicable to existing auditors. Deloitte had retired due to rotational laws in FY18.