The time has come to take another look at the disclosure policy for auditors

Recently, two listed companies saw the resignation of their auditors. That auditors get changed is not new. However, in this case, the outgoing auditors were among the big four auditing firms and they gave no reason for resigning suddenly — it made news straightaway.

The stock prices of these companies got into the negative, in one case eroding 80 per cent of the market value over a period of time and in the other going down more than 50 per cent in just one week. The managements of these companies reacted to the departures in the expected way. They claimed that nothing was wrong with their books of accounts and it was just that the auditors had asked for some information, which was taking time and during that period, for reasons not known to the managements, the auditors resigned. For their part, the auditors have barely met the statutory requirement of informing the ministry of corporate affairs about the specific sections under which they had resigned. The sections are so wide that little can be gleaned from what they have said.

In short, besides the company managements and auditors concerned, no other party — minority shareholder, government or regulator — has an inkling of what provoked the high profile resignations. Auditors are citing client confidentiality agreement for non disclosure of the reason. Essentially, both managements and auditors have been able to take refuge under one or the other provision of the law.

No matter in a listed company can be a private affair between two parties — even if those involved are the company board and auditor. With public money at stake, the matter concerns shareholder wealth and company debt raised from banks. If the books of account have been cooked, banks that have lent money to the companies are at risk of losing money.

The time has come to take another look at the disclosure policy for auditors. If auditors find an issue with the books of a company they should disclose information not only to the company board concerned but also market regulator, Sebi, which in turn should analyse future course of action accordingly.

If Sebi reaches the conclusion that the auditor’s observations are not material in nature and yet the auditor is insistent on resigning then, along with the news of the auditor’s resignation, should come the advisory from Sebi that the matter has been looked into. This will ensure that there is no panic on the Street.

In the last two cases, if a few months down the line it becomes clear that the auditors had been extra cautious and resigned as a matter of abundant caution, who would be responsible for the panic selling of the stocks of the two companies. This kind of situation opens up the possibility of insider trading. If a group of investors learn beforehand that there was nothing substantive in what auditor were saying, they are likely to pick up stock at extremely low valuation and sell it when the panic subsides — and make a killing at the cost of small retail shareholders.

Another change which is required is that when a new auditor joins a company, which was the case with two auditors being discussed, it should be made compulsory for the incoming auditors to clarify their stand on issues raised by the outgoing auditors. This will ensure that the managements are not able to go auditor shopping to select a pliable auditor. Given the fact that following the implementation of GST, the whole system of how companies manage their sales and dodge the tax authorities with regard to indirect taxes is undergoing a sea change. Going forward, there are likely to be cases where managements will be reluctant to share information with their auditors because comparative gaps of previous years have the prospect of tumbling out. So, policy makers need be adaptive enough to change the laws in a dynamic environment so that transparency levels are not compromised.