National Financial Reporting Authority- India's New Audit And Accounting Regulator

In my previous post I gave a glimpse of the IBC process. In this article I shall try to go in detail of the upcoming chaos creating event- The constitution of the "National Financial Reporting Authority" or simply "NFRA". This article is based on the draft law. The current law is different but the facts would remain the same.

Background: India is a signatory to the Group of 20 (G- 20 Nations). In 2010 India made a commitment to G- 20 that the 'Standard Setting' and 'Oversight' would not be under the same umbrella. Currently in India the Institute Of Chartered Accountants Of India plays both the roles i.e. setting standards through the Accounting and Auditing and Assurance Standards Boards including the National Advisory Committee on Accounting Standards (NACAS) and oversight via the Disciplinary Committee under section 21(D) of the Chartered Accountants' Act, 1949 and its other committees. Developed countries already have an oversight body for example United States of America has the Public Company Accounting Oversight Board -PCAOB, (PCAOB was formed under the Sarbanes-Oxley Act, 2002 better known as "SOX" which was framed after the Enron Scam.) and the United Kingdom has Financial Services Authority (FSA). Consistent to the G- 20 commitment and in line with international practices the Ministry Of Corporate Affairs incorporated section 132 in the Companies Act, 2013 pertaining to NFRA. The section is still not fully notified though draft rules are ready.

About NFRA and how it will work: NFRA typically will be a 2 tier structure,the supreme being, the Authority itself and below the Authority there will be its three committees namely:

1) Committee on Accounting Standards

2) Committee on Auditing Standards

3) Committee on Enforcement

There shall also be an Appellate Authority which will be formed to appeal against the orders of Enforcement Committee. For all the above committees the constitution is mentioned in section 132 of the Companies Act, 2013.

Now the next question coming into your mind would be who would be there in the Authority? Section 132(3) of the Companies Act defines its constitution, it would include:

1) A Chairperson appointed by the Government

2) Member- Accounting (Who would head the Committee on Accounting Standards)

3) Member- Auditing (Who would head Committee On Auditing Standards)

4) Member- Enforcement (Who would head Committee on Enforcement)

5) One representative from Ministry Of Corporate Affairs

6) One Nominee from Reserve Bank Of India

7) One Nominee from Securities And Exchange Board Of India

8) Retired Chief Justice Of High Court or a judge of High Court (experience of minimum 5 Years), nominee of Central Government

9) President of the ICAI (ex- officio)

The Scope Of The Authority: The scope of NFRA is of prime importance. It shall investigate following companies:

1) Listed Companies,

2) Unlisted Companies having a certain net worth or turnover or capital,*

3) Companies having securities listed outside India.

The NFRA has been specially constituted to monitor the Auditors. The Authority shall have direct power to punish or take action against the Auditors in the individual capacity as well as Audit Firm ( Auditors are not allowed to form companies because Indian Constitution as well as the Chartered Accountants' Act, 1949 directs that a person performing attestation functions cannot have limited liability). Even more important is the scope of NFRA to act against Auditors.

It includes auditors who audit either directly or indirectly through network of Firms (i.e. MNC Audit Firms like Big 4 or BDO, GT etc)

1) Audit of 200 companies or more in a year.

2) Audit of 20 or more listed companies.

3) Audit of companies having a certain net worth or turnover or capital.*

The Authority will be a super powerful body as the authority will also have powers to start an investigation suo-moto against ANYONE inter alia above stated persons! To give a glimpse of its powers let me quote sub clause 4 which inter alia states-

" Provided that no other Institute or body shall initiate or "continue" any proceedings in such matters of misconduct where NFRA has initiated an investigation". This shall leave ICAI powerless in its role of oversight for major cases.

Setting Accounting And Auditing Standards: Besides being a disciplinary authority, this powerful body will also regulate the accounting and auditing profession by bringing in and modifying the Accounting and Auditing Standards which will virtually leave the ICAI powerless of its role of a standard setter. Though the ICAI will have a say in the process, as the NFRA is mandated to send the draft rules to ICAI, but the final say will remain with NFRA. Mind you that NFRA will be the only "Oversight Body" in the world which will also be a "Standard Setter". This function shall be carried out through its Accounting and Auditing Committees.

ICAI at loggerheads with the Government: ICAI, time and again, has rejected NFRA in its present concept. Recently the Institute has published " A Position Paper on Regulation of Accountancy Profession and Oversight Mechanism in India" in which ICAI has ripped apart the concept of NFRA.

The Future of ICAI: As per the press release of Ministry Of Corporate Affairs, ICAI shall continue to provide inherent regulatory role as provided in the Chartered Accountants' Act, 1949 in respect of its members, students and specifically audits pertaining to private limited companies and public unlisted companies below the threshold. There is no mention with regards to standards pertaining to Valuations, Internal Audit etc. in the current section 132, therefore it shall continue to remain the domain of ICAI.

NFRA as a concept according to me: It is a very nascent concept in the current stage. The whole idea of framing an oversight body gets demolished when it also becomes a standard setter. The Government has created a parallel body with the same powers as that of current ICAI. It is pertinent to note that the Central Council of ICAI today already has members which are nominated by Central Government. It also is not prudent to include nominees of RBI and SEBI in the "Accounting and Auditing Committees" as it will be a partial representation i.e. only financial services has a representation basically. Also too many cooks will spoil the cake! The formation of NFRA will cause legal dilemma i.e. section 20(2) of the Chartered Accountants' Act, 1949 empowers the Council to remove the member from the profession. If we go as per this, currently only the council has the powers to remove a CA; it is not under any obligation to listen to an outside authority. Consequently an amendment would be required to empower the Council to implement orders of NFRA! Many such more legal tangles are there.

As the Government has signed the G-20 2010 protocol it is bound to form NFRA. But the Institute and Government in their collective wisdom should find out a way.

* for the purpose: Net worth not less than Rs. 500 Crores or

Paid up Capital not less than Rs. 500 Crores or

Annual turnover of not less than Rs. 1,000 Crores as on March 31 of immediately preceding financial year.

(The views expressed in the article are my own and they do not constitute the views of my firm.)