Who will police the policemen? That is the million dollar question being asked in corporate circles after Deloitte Haskins & Sells, one of the big-four accounting firms, has been called out in the Infrastructure Leasing & Financial Services Ltd (IL&FS) case for turning a Nelson’s eye to the company’s debt pile. As the government-appointed board of IL&FS peels off the layers of subterfuge, the Ministry of Corporate Affairs is considering penal action, including a long-term ban on Deloitte.
Our regulators and enforcement agencies don’t seem to learn from history. It was not so long ago – January 2009 – when Satyam Computer Services boss B Ramalinga Raju was taken into custody after he manipulated accounts to show excess revenues of over Rs 14,000 crore. It was also revealed that auditors PricewaterhouseCoopers (PwC) were complicit in this huge cover-up.
It took the Securities & Exchange Board of India (SEBI) nine long years to complete investigations and penalise PwC. The final verdict, given in January 2018, was a let-down: a ban on PwC from providing audit services to listed companies for two years and a “disgorgement” of `13 crore.
EVIDENCE PILES UP
In the current IL&FS case, the Serious Fraud Investigation Office has found that in the main IL&FS subsidiaries — IL&FS Financial Services (IFIN), IL&FS Transportation Networks Limited (ITNL) and IL&FS Securities Services Ltd (ISSL) — the basic principles of auditing were given the go by Deloitte though it charged a handsome audit fee of Rs 13-14 crore and an additional `6-8 crore in advisory/consultancy fees.
IL&FS was incorporated in 1987 to promote infrastructure lending. Over the years, it grew into a multi-layered behemoth with over 350 interconnected subsidiaries. By September 2018, the crisis was triggered when IFIN defaulted on its repayments; and there were shock waves when it was found that there may be unpaid loans to the tune of `91,000 crore. The old board has been sacked and a new, government-mandated board headed by Uday Kotak is attempting to put the pieces together.
Central to the current investigations now is the deposition of a whistle-blower, who claims he was part of the senior IL&FS management team. He has alleged that it is not just Deloitte’s failure of due diligence, but its abetment in the fraudulent practices. When audit findings did not show IL&FS in ‘favourable light’, the auditor conveniently relied on ‘management explanations and comfort letters’ and compromised its independent opinion. At times, IL&FS’ top echelons would meet and “coerce Deloitte for a more favourable position or watered down position.” The fact is that Deloitte has, over a decade, never once provided an audit report with adverse findings, even for 2017-18 when the loan crisis of IL&FS had ballooned to unmanageable proportions.
IT HAPPENS IN THE US TOO
An auditor’s job is to assess a company’s financial information and determine if the information is accurate and complete. What we have here is the auditor not only shielding financial wrongdoing, but becoming complicit in the fraud. It does not only happen in India. In case of the US energy major, Enron Corporation, it was found that the company had kept huge debts off the balance sheet and ultimately collapsed in 2001, losing $74 billion of shareholder wealth.
Audit firm Arthur Andersen, known as one of the ‘Big-Five’ was found guilty of having cooked up the accounts and was forced to surrender its license to practice. Though it got a legal reprieve later, Arthur Andersen went into oblivion. Back to IL&FS and India, the government wants to impose severe penalties including a possible five-year ban on Deloitte.
However, if the process of investigation takes a decade, as it did for PricewaterhouseCoopers in the Satyam case, the purpose of deterrent punishment will be defeated. Auditors are the eyes and ears of the financial system. If they become part of the loot, the system will collapse. The government has sweeping powers under Section 140 (5) of the Companies Act to force a company to change its auditors if they are found to be engaged in or abetting fraud. It should make use of it effectively. A ban for two-to-three years is not good enough. They should be kept out for good.
There must have been smoke if there was a fire. The depth of the rot in IL&FS did not have to hit `91,000 crore before it blew up. And didn’t anyone know Deloitte was covering up? As we said, it doesn’t happen only in India. Fortune Magazine had named Enron as ‘America’s most innovative company’ for six years in a row before the s—t hit the ceiling covering up According to the whistle-blower, when audit findings did not show IL&FS in ‘favourable light’, the auditor conveniently relied on “management explanations and comfort letters”.