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BW Businessworld

Fall Guys

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Just as most every crime novel has its fall guy and every blood sport its bum-of- the-month, Satyam has spawned not one but two innocent victims of which we looked at independent directors in last month’s Fine Print Too Much Heaven On Their Minds. In the weeks since, it seems auditors are winning the victimisation war by a long shot. For reasons that seem not to be associated with the actual conduct of their duties, two respectable members of the chartered accounting community have been arrested. So far, there has been no public disclosure of any specific wrongdoing for which any auditor appears to be culpable. All we have here is a witch hunt followed by a media trial, neither inspiring much confidence. The bazaar talk is deeply entertaining but insubstantial. There are rumors galore and conjectures worse confounded but the moment you start to scratch at the surface of any story, it doesn’t hold up. Duplicate FDR’s they say? Exactly how did Satyam match that up with TDS returns? False billing they say? How were the cross-border customer remittances matched up with Banks?
It’s hard not to think that wise heads are contriving conspiracy theories after the fact without thinking very much about the scale of the deception. More significantly, no one has asks this question: how come the auditors were more competent to discover this alleged fraud than either the Income Tax Department or the Reserve Bank of India?

Indeed, I would want to know the law, fact, practice, principle or auditing norm by which it is an auditor’s job to discover a fraud. I understand the legal position here is still held by the twenty year old case of Tri-sure India Limited v A.F.Fergusson and Company {[1987]61CompCas548(Bombay)} where the Bombay High Court took the view that: “(it is) directors of a company who are primarily responsible for the preparation of the annual accounts and for the information contained in it… The auditor does not conduct the audit with the objective of discovering all frauds...such an audit would have to involve a detailed and minute examination of all the books, records and other documents of the company, and the cost of doing so would be prohibitive and disproportionate to the benefits which may be derived by the shareholders.

I don’t presume to be able to put the issue in better perspective; or language. What is it that we want our auditors to do? We can expect the auditor to check that adequate internal controls and systems are in place and that they are being followed. To be doubly sure, we can expect the auditor to selectively verify compliance with these internal controls and systems. However, can we expect the auditor to verify compliance in relation to more than a fairly small sample of transactions? And how deep do we want them to go? Let me be really tedious here and deal with specific examples of the sort of creative accounting that is de rigueur in India. First, there is the whole inventory game of inflated quantities of goods enroute to customers and understated warranty returns none of them reconciled. Do we want our auditor to contact his client’s individual customers: after all, a company that can fake sales can fake customer certifications? Then there is the ‘pre-booking’ of sales: do we want the auditor to talk to individual customers and ask them if they placed an order? Then there is bad debits masquerading as receivables: do we want the auditor to chase up people who the company claims will eventually pay? I could go on all day. All these solutions are part of serious forensic work, as tedious as police work and as labor intensive as breaking stones on a road.

Quite apart from the whole antagonism of the process, there is too the question of cost benefit. As a young lawyer, I have done enough forensic due diligences to know how frustratingly difficult and painstaking forensic cross verification can be. Imagine an auditor doing this year after year using an army of lawyers in respect of each of his clients with NO reason to believe that anything is amiss. Have we ever asked our auditor to be this hostile to their own clients? Should we? How do you define paranoia? Let me take the argument a step further within the Satyam context. Even if something amiss could with appropriate precision be found but wasn’t, what is an auditor accused of? In law, a man is not negligent because his conclusion differs from that of another, nor is he negligent because he is not as smart or skilled as another. If this was so, every lawyer of lesser intellectual stature than a leading Supreme Court counsel would be in jail. The true test is only that such a man should have failed in circumstances where an ordinary man proceeding with ordinary diligence would not have failed.

Indeed, in the Tri-sure India case, the Bombay High Court said as much when it observed that: "An auditor, however, is not bound to do more than exercise reasonable care and skill in making inquiries and investigations. He is not an insurer; he does not guarantee that the books do correctly show the true position of the company's affairs; he does not even guarantee that his balance-sheet is accurate according to the books of the company.”

This at last brings us to the heart of the matter: Raju’s incomprehensible confession. I for one do not buy into his ceremonial hara kiri. He had an agenda to pursue which is understood only when we admit that beneath the surface lies a large political storm waiting to go off. Too many contracts have been won and this generally entails too many expenses. E Sreedharan, that rarest of rare being who is both incomparably effective and utterly incorruptible, told us as much in September 2008. So this is the question: is it that Satyam never make money (and inflated its sales to push up share valuations) or is it that it siphoned off the money to bag contracts beyond what it could afford? Raju was facing an investigation and the slammer anyway. He was going to have to explain about the money: did we expect him to admit that he passed the money on to people who control the people who run the jail he was going to? It’s obvious that he would say that he never earned the money in the first place. So as I see it, Satyam is really not about Raju but about the system. In most democracies, one way or another, businesses fund politics through more than direct contributions and if we are going to arrest auditors for that crime, isn’t it self-evident that all your auditors are going to end up in jail? And if this is the inevitable result of our compulsions: then who will secure the little compliance that the system does allow us to have in the first place? Do we really believe in this self-righteous suicide?  

(The author is managing partner of the Gurgaon-based corporate law firm NDLO South and author of the pioneering business book, Winning Legal Wars. He can be contacted at [email protected] )