Stock market regulator takes a step forward

As the primary market regulator Securities and Exchange Board of India (SEBI) has realised the need to not only lay down broadbased framework and regulations, but also actually go into the next level of detail in creating an architecture for monitoring and clarificatory mechanisms. Two recent steps in this regard raise hope. First, SEBI mandated peer review of certain listed companies. While the results thereof are not known and the system itself requires further refinement, it was an important first step.

Now the SEBI Committee on Disclosures and Accounting Standards (SCODA) has come out with a discussion paper on certain proposals relating to particular aspects of listing agreements. The list of such proposals is by no means comprehensive but nevertheless marks another important step forward.

We examine here the relevance of some of the issues considered.

A critical issue debated was the requirement of a professional qualification for becoming a Chief Financial Officer (CFO). Today with highly developed professional organisations like the Institute of Chartered Accountants, the Institute of Cost Accountants, various management institutes which grant MBA in finance, etc. the ability to define financial literacy and the basic threshold of qualifications for being a CFO, would seem a no brainer. However, I am sure there was push back from many organisations who have old experienced and non-professional hands, as CFOs and perhaps even Government organisations whose CFOs are at times people without any prior financial literacy. Unfortunately, the recommendation, SEBI has come up with on this issue is extremely weak.

It has argued that the advantages of a professional CFO is that major professional organisations can take disciplinary action against him/her, whereas this should have been a minor argument, the more appropriate argument should have been that in this ea of extreme complexity of business corporate and fiscal laws, it is impossible that a non-specialist, however, well intentioned, can discharge the function of a CFO. SEBI has recommended that it would be adequate if the CFO is approved by the audit committee, thereby casting the entire responsibility on the committee to ensure that the CFO has the necessary accounting/related financial management expertise and he possesses experience in financial or other comparable experiences or background (italics mine).

This would lead to larger questions about competence of such audit committees to take such decision and why even six decades after professional institutes have been set up in the country, can it not be specified that only a certified professional can be a CFO? The Companies Act has already specified this for company secretaries.

The SCODA discussion paper also debates the role of the internal auditor of the company and this debate gets focused on whether an in-house internal audit function, is better or whether an external audit firm would provide greater objectivity and independence. Finally, the committee has decided to maintain a status-quo that is to leave it to companies to decide. However, according to me the critical issue is not internal versus external. The pros and cons of both approaches are well known.

The internal person has greater industry knowledge, operational knowledge, business knowledge and familiarity with systems and processes; the external auditor would have comparable best practices knowledge and would be able to introduce "out of the box" thinking since he would not be constrained by having grown up within the organisation. The internal auditor would, however, lose a lot of his inherent advantages since his career continuum would be at the mercy of the people within the organisation, who may make life miserble for him.

To compound these, in many corporates, the internal audit department is staffed by secondees from other operational departments, who have to go back live with and be judged by those superiors they are reporting upon today; sometimes the internal audit department also serves as a dumping ground for inconvenient or incompetent individuals. Both internal and external systems have their merits and in my view what can only operate is a combination of both systems with a core cadre of inhouse internal auditors, doing the risk mapping and laying down a risk based comprehensive program for auditing in coordination with external professionals and then such external professionals executing a bulk of the internal audit.

The in-house internal audit department should deal with the logistics of planning, quality control of external audit reports, training and selection of external auditors and follow up and action taken reporting of all findings whether by the internal audit department themselves or by the external auditors. The internal audit department should also be segregated from the rest of the corporate and their performance should be reviewed against specific benchmarks directly by the Board or the Audit Committee. Being in the internal audit, department should not act as career stopper.

In the two issues discussed above, SEBI has raised a correct question but it is just one foot forward since the answers they have come up with in the discussion paper are disappointing and just perpetuate the status-quo. It is a long journey ahead and SEBI and its SCODA committee must be more assertive and less tentative.