NATIONAL FINANCIAL REPORTING AUTHORITY UNDER THE COMPANIES BILL, 2011

BY CS KRISHAN PAUL DUTT, AEO, ICSI

Legislative Background

Companies Bill, 2011 (Clause 132) Constitution of National Financial Reporting Authority (NFRA) by Central

Govt. by notification, to provide for matters relating to accounting & auditing standards.

Companies Act, 1956 (Section 210 A) (Inserted by Amendment Act of 1999) Earlier called as National Advisory Committee on Accounting Standards

(NACAS). Also called as “Advisory Committee”. Constitution by Central Govt. by issuing notification in Official Gazette, to

advise on formulation & laying down of accounting policies & accounting standards for adoption by companies or class of companies.

Gave recommendations to Central Govt. on such matters of accounting policies & standards & auditing as may be referred to it for advice from time to time.

"accounting standards" means standards of accounting recommended by ICAI, as may be prescribed by Central Govt. in consultation with NACAS.

What is NACAS & its functions

Constituted in 2001, NACAS: is a a body of experts including representatives of

various regulatory bodies & Govt. agencies; has been examining Accounting Standards prepared

by ICAI for use by Indian corporates. Central Govt. prescribes accounting standards in

consultation with & after receiving recommendations of NACAS. In this exercise, it adapts international norms established by International Financial Reporting Standards issued by International Accounting Standards Board.

MEMBERS OF NACAS-COMPANIES ACT, 1956

Chairperson shall be a person of eminence & well versed in accountancy, finance, business administration, business law, economics or similar discipline ;

One member each nominated by ICAI, ICWA, & ICSI; One representative each nominated by Central Govt., RBI,

SEBI & CAG; A person who is or was a professor in accountancy,

finance or business management in any university/ deemed university ;

Chairman of CBDT or his nominee ; Two members to represent Chambers of Commerce &

Industry to be nominated by Central Govt.

Need for Change of Role –From Advisory Body to Independent Oversight Body

Global Environment   Need for regulating audit firms has been felt globally during past years,

especially after Enron-Andersen-dotcom-telecom meltdown around turn of the millennium. Consequently, new regulations like Sarbanes Oxley Act, 2002, Dodd-Frank Act 2010, new auditing standards like Statement on Auditing Standard (SAS) 99 in 2002 & creation of an oversight body like Public Company Accounting Oversight Board (PCAOB) emerged in US to address this growing concern of stakeholders. Sarbanes-Oxley Act authorises PCAOB to inspect registered firms for compliance with applicable laws, rules, & standards in a firm's audit work for clients.

Report of Parliamentary Standing Committee (PSC) on Finance: Guiding Principle of examination of Companies Bill, 2009 by PSC was:

“in the light of recent experiences in corporate mis-governance, setting up of oversight body to set standards & supervise quality of audit be recommended.”

Change of Role –From Advisory Body to Independent Oversight Body

Suggestion made by MCA to Standing Committee: “As of now Companies Act recognizes only accounting standards. Auditing

standards had all along been undertaken only by ICAI. Now we are proposing that auditing standards should also be vetted by NACAAS & later on it can come for formal approval from Ministry. This is very essential keeping in view increasing role of auditors & entire Bill focuses upon tightening role of auditors themselves. So, we cannot leave auditing standards to be decided by a single institute. We thought that there should be an oversight body for this.”

Recommendation of Parliamentary Standing Committee: “While welcoming introduction of auditing standards as a concept in the Bill, it

would like NACAAS to be institutionalized not only as a body for setting up auditing standards but also as a quasi-regulatory body for generally supervising quality of audit undertaken. The Committee would expect Ministry to clearly delineate role & responsibilities of this body accordingly.”

NACAAS be given sufficient mandate not only to set & oversee auditing & accounting standards, but also to monitor quality of audit undertaken across corporate sector. It should, therefore, be manned by professionals. Its role may be expanded depending upon experience gained.

Change of Role- Suggestion of SEBI

INTERNATIONAL REQUIREMENT: SEBI is a member of International Organization of Securities

Commissions (IOSCO) an association of bodies that regulate world's securities & futures markets. The IOSCO had formulated 8 new principles in June 2010 to ensure that systemic risks were reduced & markets functioned fairly, efficiently & transparently.

One of the key principles was that 'auditors should be subject to adequate levels of oversight by an authority that is independent of the audit profession'. SEBI wants to ensure that it does not fall short on meeting any IOSCO requirement.

SEBI wants oversight mechanism created quickly in line with requirements of new global rules.

(SOURCE: ECONOMIC TIMES DATED DECEMBER 06, 2011)

STATEMENT OF OBJECTS & REASONS OF COMPANIES BILL, 2011

National Advisory Committee on Accounting and Auditing Standards (NACAAS) proposed to be renamed as National Financial Reporting Authority (NFRA) with a mandate to ensure monitoring & compliance of accounting & auditing standards & to oversee quality of service of professionals associated with compliance.

The Authority shall consider International Financial Reporting Standards & other internationally accepted accounting & auditing policies & standards while making recommendations on such matters to Central Govt. which will improve competitiveness of our companies with other companies. The Authority is also proposed to be empowered with quasi judicial powers to ensure independent oversight over professionals.

NFRA-Companies Bill, 2011

Objective of NFRA is better monitoring of corporate financial management.

The mandate of NFRA as per clause 132 is to: Make recommendations to Central Govt. on the

formulation & laying down of accounting & auditing policies & standards for adoption by companies or class of companies or their auditors;

Monitor & enforce compliance with accounting & auditing standards recommended by it in prescribed manner;

Oversee quality of service of the professions associated with ensuring compliance with such standards & suggest measures required for improvement in quality of services & other prescribed matters;

Perform other prescribed functions.

Members/Staff/Audit of NFRA

It shall consist of a chairperson, who shall be a person of eminence & having expertise in accountancy, auditing, finance, business administration, business law, economics or similar disciplines, to be nominated by Central Govt, & such other prescribed members not exceeding 15.

Head office shall be at New Delhi & it may, meet at such other places in India as it deems fit.

Central Govt. may appoint secretary & other employees for performance of functions by NFRA.

Its accounts shall be audited by CAG & such accounts as certified by CAG together with audit report shall be forwarded annually to Central Govt.

Role of NFRA Under Companies Bill, 2011

Central Government may: prescribe standards of accounting or auditing or

any addendum thereto, as recommended by ICAI in consultation with & after examination of recommendations made by NFRA;

in consultation with NFRA, by order, direct in respect of such class or description of companies, as may be specified in the order, that auditor’s report shall also include a statement on specified matters.

OVERSIGHT OVER PROFESSIONALS BY NFRA

Notwithstanding anything contained in any other law for the time being in force, NFRA shall— have power to investigate, either suo moto or on a

reference made to it by Central Govt., for prescribed class of bodies corporate or persons & in prescribed manner into matters of professional or other misconduct committed by any member or firm of CA, CMA or CS in practice constituted under CA Act, CWA Act & CS Act, or any other prescribed profession.

No other institute/body shall initiate or continue any proceedings in such matters of misconduct where NFRA has initiated investigation.

NFRA-QUASI JUDICIAL POWERS

It shall have powers of civil court under Code of Civil Procedure, 1908, while trying a suit, in respect of following matters:discovery & production of books of account/other

documents at specified place & time; summoning & enforcing attendance of persons &

examining them on oath; inspection of any books, registers & other

documents of any person referred above at any place;

issuing commissions for examination of witnesses or documents.

POWERS OF NFRA IN CASE OF PROFESSIONAL MISCONDUCT

If professional/other misconduct is proved, NFRA can — impose penalty of not less than Rs. 1 lakh in case of

individuals & not less than Rs. 10 lakh in case of firms; debar member/firm from engaging from practice as

member of Institute for a minimum period of 6 months or for such higher period not exceeding 10 years as it may decide.

Aggrieved persons may make appeal to the Appellate Authority constituted under section 22A of CA Act, CWA Act, & CS Act against any order of NFRA.

“Professional/other misconduct” shall have same meaning respectively assigned to it under section 22 of the CA Act, CWA Act & CS Act.

INTERNATIONAL TREND-USA PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD (PCAOB)

Created by Sarbanes-Oxley Act, 2002, which was passed after Enron & other scams, PCAOB required that auditors of U.S. public companies be subject to external & independent oversight for first time in history. Previously, profession was self-regulated.

It oversees audits of public companies in order to protect investors & public interest by promoting informative, accurate, & independent audit reports.

Powers of PCAOB (Section 101): Register public accounting firms that prepare audit reports for issuers; Set auditing, quality control, ethics, independence & other standards

relating to preparation of audit reports by issuers; Conduct inspections of registered public accounting firms; Conduct investigations & disciplinary proceedings concerning, &

impose appropriate sanctions where justified upon, registered public accounting firms & associated persons of such firms (including fines of up to $100,000 against individual auditors, & $ 2 million against audit firms);

Perform other prescribed duties/functions necessary to promote high professional standards among, & improve quality of audit services offered by registered public accounting firms & their employees.

Fines Imposed by PCAOB It fined Lovelock & Lewes & PWC Bangalore $ 1.5 m for

violations of rules/standards in relation to Satyam audit engagement & imposed significant limitations & undertakings related to firms' audit activities, required appointment of independent monitor & censured firms.

It also fined Ernst & Young (E&Y) $ 2 m over its alleged wrongdoing in 2005 to 2007 relating to Medicis Pharmaceutical Corporation’s financial statements. It punished E&Y together with 4 of its former & current audit partners for violating its rules & failure to comply with its standards.

INDIAN INVESTORS: Though investors across the globe were compensated,

Indian investors were left out, one of the reasons may be that there is no oversight body like PCAOB in India.

INTERNATIONAL TREND-UK

PROFESSIONAL OVERSIGHT BOARD (POB) Set up in 2004 as part of the reformed Financial Reporting Council

(FRC) following Government’s Review of Audit Regulation in 2003 in light of major auditing failures in US at Enron & WorldCom.

This introduced statutory independent oversight over regulation of auditors by recognised professional bodies & marked a significant shift, from what had been essentially self-regulation, to a mixed system, in which both POB & professional bodies have major responsibilities.

FRC is UK’s independent regulator responsible for promoting high quality corporate governance & reporting to foster investment & it: Fixes high standards of corporate governance through UK Corporate

Governance Code & sets standards for corporate reporting & actuarial practice & monitor & enforce accounting & auditing standards.

Oversees regulatory activities of actuarial & professional accountancy bodies & operate independent disciplinary arrangements for public interest cases involving accountants/ actuaries.

UK-PROFESSIONAL OVERSIGHT BOARD

POB reviews through Audit Inspection Unit (AIU), quality of audits of

listed & other major public interest entities; is Independent Supervisor of Auditors General (CAG & other

Auditor Generals) under UK Companies Act, 2006. It contributes to achievement of FRC's fundamental aim of supporting

investor, market & public confidence in financial & governance stewardship of listed & other entities by providing: independent oversight of regulation of auditing profession by

recognised supervisory & qualifying bodies; monitoring the quality of auditing function in relation to economically

significant entities/major audits; independent oversight of regulation of accountancy/actuarial

profession by professional accountancy/actuarial bodies; international regulatory responsibilities.

UK-PROESSIONAL OVERSIGHT BOARD UK Companies Act, 2006:

Requires independent inspection of auditors undertaking statutory audits of listed companies & other entities “in whose financial condition there is considered to be major public interest”. This latter category is determined from time to time by POB.

Provides that in case of listed companies both outgoing auditor & company must notify “appropriate audit authority” about reasons for change of auditors. POB is the audit authority for “major audits”.

Defines “major audit” as a statutory audit conducted in respect of—

a company whose securities have been admitted to official list under Financial Services and Markets Act 2000, or

any other person in whose financial condition there is a major public interest.

UK-PROESSIONAL OVERSIGHT BOARD

Major Audit [Section 525 (3)] POB is the body which may issue guidance on what is meant by “major

audit” for notification purposes.  Audits of following companies is considered as “major audits” for inspections by Audit Inspection Unit : All UK incorporated companies with equity/debt securities admitted to

official list under Financial Services & Markets Act, 2000; All UK incorporated listed companies with a market capitalisation in

excess of £100 million;  Unlisted companies, which have either group turnover in excess of

£500million; or group & long term debt in excess of £ 250 million & turnover in  excess of £100 million;

Unlisted companies or groups which are subsidiaries of foreign parent companies where turnover of UK group or company is in excess of £1,000 million;  

Charitable companies with income exceeding £100 million; Subsidiary companies of the above.

UK-PROFESSIONAL OVERSIGHT BOARD

It provides assurance that professional accountancy bodies are properly setting standards & enforcing discipline for their members, in accordance with Companies Act 2006/other statutory requirements.

It carries out inspections on behalf of FRC, but if any shortcomings are found, sanctions can only be imposed by professional bodies. However, if professional body breaches significantly its own standard procedures in handling a complaint about its member, it will normally seek comments of the body & look at papers relating to the case. It will then write to complainant informing outcome of their consideration of the matter & whether the body proposes to take any action based on their comments. It does not have power to overturn any decision which body has made in a case or to direct how the body should handle a case.

Audit Inspection Unit oversees auditing organizations & makes recommendations for appropriate regulatory actions by governmental & professional authorities.

In 2011, it published information for first time about shortcomings in self-regulation by particular institutes .

Cooperative Agreement between PCAOB & POB

On January 10, 2011, US Public Company Accounting Oversight Board entered into a cooperative agreement with Professional Oversight Board in UK to facilitate cooperation in oversight of auditors & public accounting firms that practice in two regulators’ respective jurisdictions.

The agreement provides a basis for inspection by PCAOB of registered accounting firms that are located in UK & audit, or participate in audits, of companies whose securities trade in U.S. markets.

PCAOB oversees & periodically inspect all accounting firms that regularly audit companies whose securities trade in U.S. markets. More than 890 audit firms currently registered with PCAOB are located outside US, spanning 87 countries. There are 59 registered firms located in UK.

Conclusion Surely, the NFRA will dilute/ clash with the powers of the

professional bodies as it has quasi judicial powers, power to debar members or levy penalties.

No body can institute or start proceedings in any case in which NFRA has initiated. Only appeal shall lie to the appellate authority under CS, CA & CWA Acts against order of NFRA.

However there may be possibility of a mix system as NFRA may consist of members of professional bodies along with other members while handling disciplinary cases/overseeing quality of professionals. Also at present Central Govt. does not have any mechanism to handle professional misconduct/oversee quality.

Further to begin with this provision may be introduced for listed companies or companies having prescribed net worth/ turnover/market capitilsation/paid up capital etc like UK.

Only time will tell how effective the NFRA will be.

THANK YOU

Disclaimer Clause: Views expressed in this presentation views of the author do not necessary reflect those of the Institute.