Flawed audit oversight system in Pakistan

The Audit Oversight Board (AOB), a watchdog on auditing firms, needs to be dissolved forthwith as it altogether lacks independence and in its place an autonomous a ‘Financial Reporting Council (FRC) should be established in line with international practices and standards. It seems a formidable task for AOB to recognise itself as an independent entity with its flawed structure and composition, dominated by members of only one professional accounting body, ie, ICAP, whereby altogether ignoring ICMA Pakistan, another statutory professional accounting body formed through an act of parliament.

The existing audit oversight board compromises autonomy which is the hallmark of any independent regulatory body. It would be in the fitness of things and in consonance with global practices to replace the AOB with an independent FRC having diversified representations from all segments of society viz accounting, auditing, law, academia, trade bodies, corporate and the public sector with authorisation to nominate their representatives on its board so as to institutionalise the oversight body.

The very concept of appointing members of an oversight board on recommendation of a ‘nominating committee’ is unfathomable as such kind of un-institutionalised nominating structure is unnoticeable in oversight models followed by other countries. The SECP (Amendment) Act, 2016 mentions the members of ‘nominating committee’ as finance secretary; the SECP chairman; the SBP governor; the ICAP president and one member to be co-opted by ex-officio members. Almost all of them are government servants and most likely to follow public policy.

The oversight board seems to tilt towards the regulator as not only the selected head of AOB is former chairman of SECP but two other members had also served the SECP as commissioners. One member is a former controller general of accountants whereas other three members have experience in corporate and legal consultancy, audit practice and stock exchange. Obviously, with a majority of members hailing from the government, this form of composition seems to be inclined towards a bureaucratic-style of thinking and therefore the accounting profession cannot expect any value addition in adoption of global standards and restoring investor confidence.

By profession, most of the members of the Audit Oversight Board are chartered accountants which in itself is a conflict of interest. Quite obviously, they would have an inclination and lenient approach towards a specific professional body which would influence their decision making role. The pre-dominance of CAs on the board also signifies bias and is tantamount to giving monopolistic rights to one profession.

The CMAs qualified from ICMA Pakistan — a statutory professional body enacted through an act of parliament — has been altogether ignored in the composition of the AOB. CMAs with their vast insight and exposure in areas of financial and cost audits can be a useful asset in the regulatory role. Under Section 247 of the Companies Act of 2017 they are already doing audit of accounts of companies having paid-up capital of less than Rs3 million.

The diversified composition of FRC model would bring on board the people having vision about the changing requirements in accounting profession unlike the present composition of AOB which consists of a select group of retired professionals and bureaucrats with discretionary powers which goes against the norms of justice. This would not, in any way, help in strengthening reliability and effectiveness of audits of public interest companies.

Who to regulate public interest companies?

The SECP being a regulator has been given discretionary powers to identify which company falls under the category of a ‘Public Interest Company (PIC)’ or otherwise. The SECP (Amendment) Act of 2016 says that a public interest company means ‘a company or body corporate as may be notified by the Commission’.

The Third Schedule to the Companies Act of 2017 describes the criteria of Public Interest Companies (PIC) which include Listed Company and Non-Listed Company which may either be a public sector company; a public utility company; or a company holding assets in a fiduciary capacity for a broad group of outsiders such as a bank, insurance company, securities broker, pension fund, mutual fund or an investment banking entity etc. These PICs are required to comply with the disclosures and reporting requirements as framed by the SECP.

The fact of the matter is that the authority of classifying any company as a PIC should not rest with the SECP; rather it should be the mandate of the independent Financial Reporting body. It is worth mentioning that one of the functions of Financial Reporting Council of the UK is to directly monitor the auditors of public interest entities (PIEs) and large AIM quoted companies. Similarly, the Financial Reporting Council of Mauritius is responsible for monitoring and developing the quality and integrity of financial reporting and disclosure of public interest entities (PIEs). In Sri Lanka, the oversight board ensures quality audits especially on public interest companies. It reviews audits of large public and private companies dealing with public funds. Further, it protects the public from deviations in share price and ensures that company directors are putting in robust control mechanisms.

What is expected from the regulator, ie, the SECP is that it must elicit input from all relevant stakeholders, including professional accounting bodies, financial experts, legal practitioners and corporate sector representative bodies like the FPCCI, on the modus operandi of the proposed Financial Reporting Council (FRC). In case of AOB, the SECP’s role was quite isolated and it resorted to only forming a 6-member joint committee of SECP and ICAP, rather engaging all stakeholders, including the ICMA Pakistan. Quite obliviously, the vested interests within the regulator did not allow public debate on this issue so as to keep the discretion of twisting the proposed law in their hands.

A startling fact revealed from press reports is that the Joint Committee presumably studied the Japanese model of ‘CPA Audit Oversight Board (CPAAOB)’ ignoring altogether other global matured oversight models such as ‘Public Company Accounting Oversight Board (PCAOB) of the US. What is important to note is that the Japanese model of CPAAOB does not have any concept of a ‘Nominating Committee’, as proposed in Pakistani oversight model, rather its’ board members are appointed by the Prime Minister of Japan with the consent of Diet (both Houses). Unlike Pakistani oversight model, the full-time Chairperson of CPAAOB is, by profession, a Professor Emeritus of a renowned University in Japan. He is being assisted by a full-time Commissioner who is a former Professor of Graduate School of Professional Accountancy in a Japanese University. There are eight more part-time Commissioners of CPAAOB, out of which six members represent the academia, outside corporate auditors and directors, whereas only two members are Partners in Chartered Accountant firms (KPMG and Deloitte).

On the basis of this writer’s own research, it is suggested that the government must follow the US model of PCAOB which is the most matured oversight body in the world. It was created by the US Congress in 2002 soon after the famous bankruptcy scandals of Enron, WorldCom, etc. To prevent capture by accounting professionals and to ensure independence, the US Congress made it a legally binding that only two out of five members of the board should be CPAs. At present, the chairman and two other members of the PCAOB are lawyers by training and profession. This audit oversight model of the US was followed by the European Union and other advanced and emerging countries with some modifications. However, all of them share certain common attributes, prominent among which is that they are all government agencies or bodies that are independent of the audit profession.

(To be continued next week) 

Published in The Express Tribune, September 10^th, 2017.

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