Was the SEBI action on PwC justified ?

For once the regulatory action on PwC – one of the Big 4 not only in size but global influence – was resounding both in its significance and punitive intent. It is a tragic comment on our legal system that PwC was able to evade this outcome for 9 long years, and may still do so till the tortuous process ends in the Supreme Court over the next many years.

The fact that PwC has been grossly negligent in following standard auditing practices, and thus guilty of fraudulent misrepresentation of the financial statements, is apparent to most except the firm itself. The core issue is one of the prevalent culture which oscillates between being simply lackadaisical in its approach and a general bravado in its ability to “manage” the implications due to its influence without any damage to its core business. The SEBI action has punctured this notion of infallibility.

Most of us associated with the profession and the corporate world would recollect the alarming regularity with which PwC and its various affiliates have faced severe reprimand over the last 20 years across the world. From the US SEC enforcement actions in 2002 in celebrated cases involving 16 audits of publicly listed clients including Avon and Pinnacle, to SEC’s order in our own Satyam case in 2011, to the UK Financial Reporting Council indicting and penalizing it for GBP 5 mln for “extensive misconduct” in the RSM Tenon group case in 2017 and making accounting “mistakes” of USD 250 mln in Tesco’s 2014 accounts, to being banned by Ukrainian authorities in 2017 when they failed to detect a systematic fund diversion of GBP 5.5 Bln by two oligarchs Gennadiy Bogolyubov and Igor Kolomoisky from their largest financial entity PrivatBank, to the US court case over mortgage fraud of GBP 4.5 mln….the list goes on. Even in India, the RBI had banned them for auditing banks and NBFCs in 2004-5 post the Global Trust Bank collapse where they failed to discover massive under provision of NPAs due to the Bank’s over exposure to capital markets and its consequent erosion of net worth.

A study of the cases would indicate that the pattern has been familiar. They were related to violation of auditor independence rules, improper accounting of costs, violation of federal securities laws with regard to reporting provisions of listed entities, contingent fee arrangements, etc. Interestingly, in most of the cases, these were perpetrated over an extended period of time and PwC was unable to detect them for years. These were not one off cases which could be attributed to the actions of an errant partner or audit executive. More interestingly, in all the international cases PwC readily agreed to consent orders, paid huge fines in miliions of dollars, agreed to systemic remedial actions to prevent recurrence. Despite all this, repeatedly conducting deficient audits and enabling massive accounting fraud continued as we saw in the GTB , Satyam, mortgage fraud in the US and the Ukranian Bank case as late as in 2017.

I am not insinuating their deliberate involvement as I do not have enough evidence : but what should be obvious is the much larger quality control failure rampant throughout the organization. Apart from the lackadaisical culture I alluded to earlier, the grossly inadequate supervisory mechanisms of its loosely held confederate structure is largely to blame in my opinion. The defence PwC has been putting up of their right to rely on management representations, and not being required to be a “detective” in matters of signing off the accounts punctuated with years of accounting fraud ( inflated revenues, fictitious debtors, false cash and cash equivalent balances including Fixed deposits, etc.) of a billion dollars, is simply laughable. What is, however, not laughable is the brazenness with which such firms can do so in our legal system whilst succumbing meekly to exactly the same cases in the US or the UK. The SEC charged, and settled, the same Satyam case and PwC agreed to a settlement with a $ 6 mln fine, along with a censure and a cease and desist order, way back in 2011.

The Institute of Chartered Accountants of India too have been meek observers and would do well to exercise some authority in matters which fall directly within their area of influence. The PwC affiliates in the Satyam case reached a settlement with the Public Company Accounting Oversight Board, US including a censure and a fine of $ 1.5 mln in 2011.

SEBI through its action has reiterated - for the first time in India - that the auditor’s objectivity is critical to the financial reporting process of listed entities and has a direct adverse impact on the public confidence on the integrity of the capital markets : it has further unequivocally decreed that what will be beyond the realms of compromise in India is the most fundamental duty of a public watchdog to comply with established auditing standards and those of auditor independence.

SEBI must be lauded for this…and it is my hope that both SAT and the Courts will support this in the interest of enunciating strong principles of jurisprudence in corporate India.

The edited version appeared in The Economic Times ET-CFO dated Jan 13, 2018 as a Guest Column >Article

(PRABAL BASU ROY)

A Sloan Fellow from the London Business School and a Chartered Accountant, the author presently manages a PE fund, advises start ups and has formerly been a Director and Group CFO in various companies. He is one of LinkedIn's Top Voices ; his views are frequently published in the national media on the intersection of current affairs, leadership and strategy with matters of finance, public policy, financial markets and corporate affairs.

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