One IL&FS, too many regulators?

A bird flies next to the headquarters building the of IL&FS (Infrastructure Leasing and Financial Services Ltd.) in Mumbai. REUTERS

On October 1, the government announced that the Serious Frauds Investigation Office ( SFIO) will probe into what went wrong at IL&FS. On October 5, it said the SFIO had commenced investigation of five subsidiaries of IL&FS. Six days later, it was announced that the newly-constituted National Financial Reporting Authority (NFRA) — established as per the requirements of the Companies Act, 2013 — have got their first client — IL&FS. An investors’ association has sought a CBI enquiry into IL&FS.

The Securities and Exchange Board of India (SEBI) has revised disclosure norms for credit rating agencies and the Institute of Chartered Accountants of India (ICAI) has formed a group to study the systemic issues in the IL&FS matter and suggest remedial measures. The question is: are there too many regulators looking to fix the same problem? 

Even before the investigation begins, why IL&FS came to this state is crystal-clear: the promoters got into a business area (infrastructure) that needed creation of project-wise subsidiaries, exchange of money between these subsidiaries was rampant, promoters were more interested in minding their own bank balances than those of the subsidiaries, the credit rating agencies and auditors got lost in the maze of transactions between subsidiaries, and the tone of the top management was management by threat instead of management by consensus.

The findings of any investigating agency will invariably revolve around the above issues. In this context, it is worth discussing whether it was appropriate to give NFRA the task of investigating IL&FS instead of leaving it to the SFIO. More importantly, is there a necessity for an NFRA when there are already multiple other regulators.

NFRA Rules

The government notified the NFRA rules on November 13. The notification commences on a fatherly note, stating that NFRA will protect the public interest and the interests of investors, creditors and others associated with companies or bodies corporate. NFRA plans to do so by establishing high-quality accounting and auditing standards (which are already in place) and exercising effective oversight of the accounting functions performed by companies and bodies corporate and auditing functions performed by auditors (by definition, an impossible task as this would mean NFRA teams being present constantly at the company or the auditors’ office). 

The notification goes on to state that NFRA will maintain details of auditors, recommend accounting and auditing standards and monitor and enforce their compliance, oversee quality of the profession and promote awareness about accounting and auditing standards. The role of NFRA appears to be a potpourri of the roles currently being played by SEBI, SFIO and ICAI. The biggest issue is that it could end up doing a bit of everything but not completing a task.

SFIO cases

In its own limited manner, the SFIO has been investigating cases. Reports state that more than 500 cases have been referred to the SFIO over the past decade and it has completed investigations into more than 300. The SFIO has investigated marquee cases such as Satyam, Ranbaxy, Fortis and Deccan Chronicle. It is unfortunate that the investigation reports are not made public — shareholders have a right to know exactly what happened. 

One of the major problems faced by SFIO has been an acute shortage of manpower. SFIO probes would mandate forensic audits. India has limited resources for forensic audits. Appointing a consulting firm would appear to be the way to go but one cannot rule out a conflict of interest.

The NFRA rules do not provide any guidance as to why a manpower shortage should not hit NFRA also. Forensic audits need long hours and continued concentration — anyone prepared for this would come at a price that the SFIO/NFRA cannot afford to pay because it would create some problem in someone else’s pay scale. While notifying NFRA, the government did not dissolve SFIO or fix a sunset date for its removal. Instead of creating another regulator, the government should simply empower and strengthen SFIO further and incentivise its employees to come to work everyday.

ICAI has been in complete control of accounting and auditing standards — these standards in India are right now equal to, if not better than, international norms. The Ministry of Corporate Affairs (MCA) notifies accounting standards suggested by ICAI without many changes.

NFRA is now going to be one more needless conduit between ICAI and MCA. Accounting and auditing standards need to be left to ICAI and MCA. ICAI needs to be blamed a bit for getting itself into this situation because of long delay in disciplining its members. ICAI has a system of peer review which is also working successfully. Which begs the question, why NFRA?

When Enron happened in America, the Securities and Exchange Commission reacted with the Public Company Accounting Oversight Board (PCAOB) which had powers to regulate both companies and auditors. The government wants to make NFRA the Indian version of PCAOB. The PCAOB has been extremely active in its investigations and many of their reports are in the public domain. It is difficult to imagine the NFRA being so active, with so many regulators all over the place already.

Irrespective of who investigates IL&FS, the writing is on the wall: some subsidiaries will be sold off, needless assets will be sold, someone will fund the remaining parts of the company and the entity will continue in a smaller version of its present size. Activist shareholders will demand that action be taken against the persons responsible for bringing it to its current state.

The IL&FS imbroglio provides government an opportunity to score many brownie points — they can take concrete action to inform everyone how bad the problem at IL&FS really is and what action they have taken against those responsible. Once they show this intent, government itself will realise that NFRA would translate to ‘Non-Functioning Regulatory Authority’ and hence is not required. They can then take the SFIO more seriously.

(The writer is a Bengaluru0based tax expert)

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