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Too Many Related Party Transactions At MCX: PwC

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According to Multi Commodity Exchange, the now-maligned commodity exchange built into a billion dollar enterprise by Jignesh Shah, 235 parties the company did business with were 'related parties'. However, according to a forensic audit by PriceWaterhouse Coopers, there are another 676 additional parties the companies engaged with, who they suspect to be 'related parties'. A 'related party' is, in essence, anybody (or entity) connected with the promoter or management of a company. Often 'related party' transactions are entered into for justifiable commercial reasons. For example, one of MCX’s related parties is its parent company Financial Technologies, which provides the software support the exchange uses. Some of these transactions, as PwC claims to have discovered, are not so kosher though.
 
The presumption, under rules for auditors, is that transactions with 'related parties' are at terms that are prejudicial to the company, because those who sign off on these transactions (that is, the management) also have a direct interest in them. However, an auditor is not expected to investigate which of the transactions were with related parties. He is allowed to rely on the list the management provides. It is now easy to see how a company’s management could hoodwink an auditor, and by extension the outside world.
 
PwC’s report, goes on to highlight many deficiencies in the transactions of MCX, under scrutiny by the commodities regulator Forward Markets Commission after a serious payment problem arose in group company National Spot Exchange of India. The amounts involved are, to be fair, not substantial for an exchange that reported a profit of Rs 300 crore in 2012-13. (The larger payments mentioned in the report, like the Rs 649 crore paid to FT for use of technology, are disclosed in the annual report) But the charges levelled, nevertheless, reek of malfeasance in the way the exchange was being run. The report alleges that agreements were entered into retrospectively to cover transactions that were already past, vendors to whom the company made payments could not be traced, payments were made to related parties without receiving the service it was meant for, and so on. The bogus payments could cumulatively exceed Rs 100 crore, it says.
 
A total of 15,131 instances of circular trading took place -- if the authors of the report are to be believed -- involving a turnover of Rs 1,856 crore, while in 1,565 cases, the buyers and sellers on the exchange were from the same group, contributing to Rs 1,181 crore in turnover. Some of the names mentioned in the report were blanked out in the copy filed with the Bombay Stock Exchange. MCX did not comment on this story, but in a press release, it questioned the timing of the report's release, coming as it does when the promoters are looking to exit their shareholding in the exchange.
 
But the question naturally arises, why the statutory auditors of the company, Deloitte, didn’t spot these issues in the course of their audit last year. Deloitte’s audit report gives hardly any reason to suspect any problem whatsoever at the exchange. But veteran auditors are not willing to put the blame on Deloitte yet. 
 
“As an auditor my duty is to ensure that all transactions are reported. Only if I suspect fraud, then I must go a few steps further to investigate,” says Mumbai-based Chartered Accountant BK Vatsaraj. In a sense, this highlights the ‘tick the box’ approach that auditors have begun to adopt, especially the larger firms. A typical audit report consists of so many disclaimers that nobody can really rely on one. Plus, often, an auditor is compelled by the pressures of the market (he is appointed by the management – so re-appointment can be a bait) to take the view that is most favoured by the management. And then there is the pressure of time. All listed company audits must be completed and signed by the end of May, leaving auditors with hardly two months to do all substantive procedures, says Vatsaraj. It is easy to see why they choose not to investigate too deeply. Deloitte did not come on record for this story, but an executive of the firm  points out that none of the transactions individually were large enough for an auditor to highlight in their report. Deloitte did mention in their report (as PwC also states) that in some of the cases, competitive bids were not called for.
 
Much of the flaws in today's audits will get rectified in the new Companies Act, effective April 1. Auditors will be liable to even go to jail if they are found to be colluding with fraudulent management. Negligence,  (as is more likely a scenario) could result in huge fines, arising out of Class Action Suits from shareholders. That should keep them on their toes. Again, rotation of auditors, introduced in the Act, will keep them vigilant, as no auditor will want to be called errant by a rival who takes over But just as well, companies could do with having a sweeping forensic audit on a periodic basis, lets say,  every five years. Forensic Audits are akin to an investigation, where these chinks in the governance armour get exposed. To be sure, such audits can be prohibitively expensive, at least at the moment. But better prevention than cure, as the wise men say.