Abrupt auditor resignations: SEBI seeks transparency

By Vinod Kothari & Vinita Nair,

Partner, Vinod Kothari & Co

corplaw@vinodkothari.com

Original: July 19, 2019

Version: October 19, 2019

A SEBI proposal by way of a Consultative Paper[1] dated July 18, 2019 to amend Reg. 33 of SEBI (LODR) Regulations, 2015 (Regulations) sought to lay down in the rule book of listed entities that when auditors want to resign in the middle of an auditing assignment, they cannot be allowed to leave citing reasons such as “pre-occupation”. They must be encouraged and asked to open their heart, and speak out the real reason, or confirm that there is no reason other than the one that they mention while resigning. Also, the auditor must not leave the auditee in the lurch, and complete the on-going audit engagement to the point of completing the audit of the year or limited review of the quarter. The resignation must be discussed with the Audit Committee chairman, and thence, to the Audit Committee, highlighting the concerns, if any. The views of the Audit Committee will be filed before the stock exchanges.

In essence, the proposal of SEBI tried to implement what seems to be the clear intent – that the veil of secrecy behind auditor resignation, where everyone can sense that everything is not alright but does not get to know what exactly it is – should be lifted.

The Consultative Paper was open for public comments till 8^th August, 2019. Accordingly, on 18^th October, 2019, SEBI came out with a Circular[2] implementing the aforesaid proposal. While the Circular does not amend Reg. 33 of Regulations, as proposed, it has laid down the doables for the auditors of the listed entities and material subsidiaries at the time of resignation.

Inspiration of the amendment

The inspiration of the amendment is the recent turmoil in the corporate sector, where, mostly in the midst of worsening financial position, auditors put in papers. There are rumours of auditors’ discomfort with the financial statements; mostly people smell transactions that may involve transfer of assets to connected entities, inflation of profits or hiding of losses. One wonders as to why most of these resignations come only when the financial position of the entity is suddenly worsening – is it that in good times, financial statements are immune from such vulnerable transactions or practices? However, it mostly seems that an impending default will bring the entity into regulatory glare, and the auditor may have to face persecution action.

What has made the auditor fraternity even more jittered is the action of the regulators against auditors of a failed financial entity, seeking to use the very heavy provisions of section 140 (5) of the Companies Act. It is just a matter of time when the country will witness class action suits against auditors, which abound in the Western world.

The instinctive auditor action in such cases is, to try to control the damage by quitting the scene, rather than qualifying the statements which, in the past, have been affirmed by the same auditor. Of course, the reasons cited can be as slippery as “pre-occupation” or lack of bandwidth.

It was reported in 2018 that the Minister of State for Corporate Affairs, P P Chaudhary’s written reply to the Rajya Sabha stated that as per the filings in MCA 21 registry, auditors of 204 listed entities had resigned since January 1, 2018 to July 17, 2018.

ICAI also constituted a Group and the task of developing guidance for the members was entrusted to the Auditing and Assurance Standards Board (AASB). In December 2018, ICAI released ‘Implementation Guide on Resignation/Withdrawal from an Engagement to Perform Audit of Financial Statements’ ^[3] which provides matters to be included in the resignation letter (Para 19) which is similar to the Annex-B of the SEBI Consultative Paper. It additionally required the response from the management or those charged with governance, on the written communication made by the auditor, to be included in the resignation letter.

Is it wrong to resign?

No, as ICAI’s auditing standards (SA-705) provides the situation under which an auditor may resign from the audit. If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive so that a qualification of the opinion would be inadequate to communicate the gravity of the situation, the auditor shall resign from the audit, where practicable and not prohibited by law or regulation.

Is it necessary to cite reason for resignation?

Section 140 (2) of Companies Act, 2013 mandates an auditor to indicate the reason and other facts as regard to its resignation while filing the statement of resignation with the Registrar and the Comptroller and Auditor-General of India, where applicable.

What is the meaning of resignation?

It is important to note that the appointment of an auditor is done for a term of 5 years. Therefore, even if an auditor resigns after completion of the audit for a financial year, within the term of 5 years, it is still a case of resignation.

Provisions of section 139 (9) may be interpreted to mean that the auditor may actually state before a general meeting, within the term of 5 years, that he is not willing to be reappointed. However, is that a case of resignation?

Read with section 140 (2), even an unwillingness to be reappointed becomes a case of resignation. This is so because the appointment is done for 5 years, and the ratification of the appointment at the annual general meeting, every year during the 5 year term, has been done way with by the Companies (Amendment) Act, 2017 w.e.f. May 7, 2018.

Therefore, the following are some examples of what may be construed as a case of resignation:

(a) The auditor was appointed in the AGM of Year 1, for completing the audit for FY 1 to FY 5, until the conclusion of the AGM for year 5. At the end of Year 2, after completing the audit of year 2, auditor gives a letter to the management that the auditor is not willing to audit for year 3.

(b) Same case as above, however, instead of the auditor indicating unwillingness to be reappointed, the audit committee while evaluating the performance of the auditor does not recommend continuation of appointment.

(c) Same case as (a), however, the auditor becomes ineligible to continue.

Case (a) is a case of resignation; (b) is a case of removal and (c) is a case of vacation of office resulting in casual vacancy.

SEBI’s prescription: Reveal the truth

The resigning auditor shall reveal all the reasons for resignation in the resignation letter along with the efforts made by the auditor prior to resignation. Whom the concern was raised? In relation to what the concern was raised? Why the concern was not addressed – due to a management-imposed limitation or circumstances beyond the control of the management. The auditor is expected to pour his heart out in the resignation letter, which is in line with the prescription made in ICAI’s implementation guide.

Role of Audit Committee

There are recourse available with the auditors of the listed entity/ material subsidiary as follows:

1. In case, the listed entity/ material subsidiary does not co-operate or they do not provide information as required by the auditors, which may hamper the audit process, the Auditors may approach the Chairman of the Audit Committee and the Chairman shall receive such concern directly without waiting for the quarterly meetings.
2. In case, the auditor proposes to resign, all concerns with respect to the resignation, along with the relevant documents shall be brought to the notice of the Audit Committee. In cases, where the proposed resignation is due to non-receipt of information / explanation from the company, the auditor shall inform the Audit Committee of the details of information / explanation sought and not provided by the management, as applicable.
3. The auditor can provide an appropriate disclaimer in the audit report in accordance with the ICAI/ NFRA if the requisite information is not provided to the auditor as sought.

After the auditor approaches the Chairman/ Audit Committee, the Audit Committee has to communicate its views to the management and the auditor, which is also required to be disclosed to the stock exchange within 24 hours after the date of such Audit committee meeting.

As per the Regulations, the Audit Committee is responsible for the appointment, performance evaluation, ensuring independence of the auditors, finalising the audit plan and reviewing and monitoring effectiveness of the audit process. In view of the Circular, the companies shall now be required to modify the letter of appointment of the existing auditors. Further, the Audit Committee is also required to mandatorily review management letters / letters of internal control weaknesses issued by the statutory auditors.

Auditor’s duty to complete pending assignments

While the language of the Consultative Paper seemed unclear, the  Circular has clarified that the auditor shall be required to complete the audit in the following manner before resigning:

1. If the resignation of the auditor is tendered within 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter.
2. If the resignation of the auditor is tendered after 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter as well as the next quarter.
3. If the auditor has signed the limited review/ audit report for the first 3 quarters- the auditor shall, before such resignation, issue the limited review/ audit report for the last quarter of such financial year as well as the audit report for such financial year.

A comparison between the Consultation Paper and the Circular

A quick snapshot of the major highlights of the Circular along with a comparison with what was proposed in the Consultation Paper is given below:

Concluding remarks

Thankfully, for all Indians, one can relate most tricky situations in life to a Bollywood song, and that really helps to dismiss the gravity of the matter. When it comes to something like auditor’s resignations (judaai), or auditors’ silence (khamoshi), there will a large number of songs or flicks on such situations, evidently the popular themes for Bollywood. Therefore, without claiming to be the best for the situation, here is one that may possibly help to lighten the pain that SEBI and investors may be having:

कभी ऐसा लगता है

दिल में एक राज़ है

जिसे कहना चाहूँ, पर मैं कह पाऊँ ना

आँखों ही आँखों में कह जाती है जो ये

खामोशियों की ये कैसी ज़ुबां

मैंने सुना जो ना उसने कहा

[1] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/jul-2019/1563449963980.pdf#page=1&zoom=auto,-15,842

[2] https://www.sebi.gov.in/legal/circulars/oct-2019/resignation-of-statutory-auditors-from-listed-entities-and-their-material-subsidiaries_44703.html

[3] https://resource.cdn.icai.org/52929aasbicai-igr.pdf