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Big Threats to Auditor’s independence and their safeguard measures

Every company registered under the Companies Act has to get its accounts audited by a statutory auditor and present his views before the stakeholders every year. Auditors are professionals that are not related or connected to the company’s operations and hence their independent opinion matters to shareholders and other stakeholders.

Here are five threats that could endanger auditor’s independence:

Self-interest threat

It arises when an auditor acts in her own financial or other personal self-interest. It happens in an audit engagement when the audit firm, its partners or team members benefits materially from a financial or other interest in an audit client. For instance, a member of the audit firm might hold shares of a company and discover an irregularity in its financial statement. If she believes that such disclosure will result in a fall in its share price and thereby affect her net worth, she might refrain from making such disclosures.

There are many ways to deal with self-interest threats. One, by ensuring such members (holding shares, for instance) leaves the team or at least disposes of the shares before an engagement. If still it cannot be resolved, consider leaving the engagement altogether.

Intimidation threat

It arises when an auditor is being overtly or covertly coerced by an audit client or by another interested party. For instance, the audit firm might earn more than 30% of its audit income from a client. The client is also aware of this and threatens to discontinue the audit services if it discloses any financial irregularities.

Auditors can avoid being intimidated by sticking to their guns. By doing a thorough background check of new companies before making a pitch, such difficult engagements can be avoided. Databases that provide historical information about litigations and previous auditor’s comments can prove to be a game-changer in this exercise.

Familiarity threat

Long-time association of the auditors with the client, for instance, can create familiarity and the auditor might become sympathetic towards their actions. It could cloud objectivity and ultimately the quality of the audit report.

The Company Law to some extent addresses this issue by stipulating that no company can appoint an audit firm as an auditor for more than two terms of five consecutive years.

At the auditor level, if an audit member has any family or personal relationship with an employee of the client, either he should be removed from the team or audit engagement structured in a way so that they don’t deal directly.

Self-review threat

It refers to the threat of bias arising when an auditor audits his own work or that of his colleague. This typically happens when the auditor has provided other services other than that of audit and review of financial statements to the same client.

For instance, an audit company might provide account preparation services to a client and in the course of the audit discover financial misstatements. Since the audit company is responsible for the misstatement, it might choose to ignore it.

Self-review threat can be avoided by having separate teams for audit and other services. If that is not possible, consider relinquishing the engagement.

Advocacy threat

It arises when an auditor also acts as an advocate for (or against) an audit client’s position or opinion by representing them. For example, a company might hire its auditor to represent them in court for a dispute with a buyer. In this circumstance, the auditor is an advocate for the client and therefore might refrain from disclosing financial misstatements.

Auditors can safeguard against this threat by segregating their team for each task or by choosing between representing or audit engagement.

Takeaway

Having separate teams can solve many threats relating to conflict of interest while a thorough historical background check avoids pitfalls relating to intimidation and other ethical issues.

About Probe42:

  • Probe is an independent Information Services company focused on providing financial information on Unlisted and under-covered companies in India
  • Our Customers have found value in using Probe42.in to enable their decisions involving Identifying prospects, sales preparation, credit and competitor analysis, etc.
  • The Probe42 platform has been extensively used by Banks and Corporates

 

 

What makes for a great valuation analyst?

Valuation analysts on the buy and sell side operate in an extremely competitive environment. While financial prowess and extensive research skills are part of the basic skill sets needed to execute their job, there are certain traits that make them stand out from the rest.

Here are six of them:

  1. Focus

Many of the successful analysts have vast years of experience in a niche area. For instance, some track the oil market or auto industry for decades. In this setup, they typically focus on a small set of companies and their business models. By keeping track of development and trends over a period of time, they eventually gain a deep understanding of the industry and become experts.

Often, there is less time in hand to react – making sharp focus the need of the hour.

  1. Turn data into useful information

It’s the age of information explosion. Every minute, all sorts of news reach you through various sources of media. It is important to filter them and absorb only the relevant ones. Otherwise, there is the risk of analysts gathering all sorts of data and not reaching any conclusion.

Moreover, some critical information can be a game-changer. For instance, access to details about acquisitions of unlisted companies. Being unlisted, information about their financials and business performance is not in the public domain.

However, some specialized databases capture data of such unlisted companies from the registrar of companies. Access to PAS-3 information, in turn, gives details about allotment of shares or securities of an unlisted entity within a month.

A successful analyst digs deeper into such extra information that is relevant and useful in his decision-making.

  1. Independent thinking

Herd mentality abounds in the stock market – perhaps out of fear of someone becoming the odd man (or woman) out. So, seldom there is independent thinking and the analysts play it safe by keeping their view in line with that of the majority.

However, the great analysts work on their conviction which in turn comes from deep insight into the stock or industry trends. With great clarity in their minds, they are willing to stand alone, if need be, in their conclusions. This trait really separates the men from the boys.

  1. Creative

How do you value a company with little historical data of performance or guess the growth trajectory of a new-age industry? Often, there are few data points available to value companies and that’s where right-brain thinking helps. Shrewd analysts search for the closest peer or data trends to connect the dots.

  1. Compelling communication

While incisive analysis makes for a good analyst, equally important is to communicate the findings in a clear and concise way to clients. Jargon-filled reports or complicated graphics can make it difficult to get the message across. So, the need of the hour is to communicate in a simple language sans jargon while being coherent in arguments.

  1. Learning from mistakes

The market is a great teacher. It teaches a lot day in and day out for those willing to learn. For instance, a wrong decision made on impulse costs a fortune while doing nothing often pays off especially if you are in for the long haul.

Similarly, a wrong assumption upsets an entire financial model. Analysts, therefore, need to have the ears to the ground and review past decisions and mistakes. A great analyst is seldom fixated on his views and is a constant learner.

Takeaway

A successful analyst uses relevant and cutting-edge data to his advantage. By being open and flexible, she strives to make decisions purely on data-backed conviction rather than following the herd.

About Probe42:

  • Probe is an independent Information Services company focused on providing financial information on Unlisted and under-covered companies in India
  • Our Customers have found value in using Probe42.in to enable their decisions involving Identifying prospects, sales preparation, credit and competitor analysis, etc.
  • The Probe42 platform has been extensively used by Banks and Corporates

 

 

 

Liabilities and Safeguard tools that every Director should know

Last year, a non-executive director of Modi Xerox was pulled up by the Enforcement Directorate for alleged exchange rate violations by the company. Executive directors of Bundl technologies, which operates e-commerce platform Swiggy, in turn, were threatened to be arrested by the GST officials for alleged wrongful availment of the tax credit.

Both the cases were dismissed by the upper Court – not without causing hardship to the directors concerned.

Duties and liabilities of directors are increasingly coming under focus, especially in the wake of rising corporate scams and many legal proceedings being made against them.

Liabilities of a director in a company can arise under the Companies Act, 2013 as well as under other legislation that apply to the company due to the nature of its business.

Liabilities under Companies Act

Managing directors, CEOs, whole-time directors, executive directors are usually in charge of day-to-day business activities and hence held responsible for any lapse. However, independent directors and non-executive directors can also be held liable for wrongful acts or omissions or if the activity was performed with their consent or connivance.

Director’s liabilities can be classified into the following:

  1. Breach of fiduciary duty – Directors hold the office of trust and fail to exercise their power in the interest of the company.
  2. Ultra-vires Act – Director acts beyond the powers sanctioned under the Companies Act, Memorandum and Articles of Association.
  3. Negligence – Failure to exercise care and caution. The error of judgment however cannot be construed as negligence.
  4. Mala fide acts – Liable for breach of trust if found misusing their powers.

Other Legislations

Then, depending upon their nature of operations, directors are also liable under other legislations.

For instance, a fine might be imposed on failure to deduct TDS, while a deliberate attempt to evade taxes can be punishable with imprisonment that may extend up to 7 years under the Income Tax Act.

Similarly, labour legislations – Building and other construction workers Act, 1996 and contract labour Act, 1970 – make it mandatory to adhere to prescribed working and safety measures. Any offense where the directors are found directly responsible could attract penalties including that of imprisonment.

Then, there are liabilities under exchange control laws, Negotiable instrument Act, environmental laws and so on.

Safeguarding tools

Directors can use the following safeguard measures to ensure they don’t fall on the wrong side of the law:

Ensure compliance

Director’s liability can be mitigated if it can be demonstrated that a director has exercised due diligence in ensuring compliance with requirements of applicable laws and that the offense was committed without his knowledge, consent or connivance.

Directors, therefore, need to be on top of data flow and monitoring systems related to their area of operations. While tracking their company in greater detail, they also need to keep a tab of peer performance and market trends.

Indemnification

Any activity or step which they feel is violative should be brought forward in the board meeting and ensure such dissent is recorded in the minutes of the meeting. Furthermore, the directors can insist on an indemnification clause in the shareholder’s agreement or in the employment agreement, which will safeguard them from any claims arising from third parties on account of their bonafide actions in the company.

Director’s insurance

They can also insist that the company obtain Directors and Officers Liability insurance. It hedges against any pecuniary liability arising out of actual or alleged breach of duty, neglect, misstatements or errors in the director’s managerial capacity.

Legal intelligence

Independent directors need to be aware beforehand of company’s legal cases that are pending in the Court. Likewise, of the legal status of the industry they operate in. For instance, there is the rising number of cases being initiated against directors in the fintech and cryptocurrency industry.

Conclusion

By exercising due diligence and by adhering to best practices in the areas of employment, taxation, environment and corporate governance, directors can mitigate liability-related risks.

 

About Probe42:

  • Probe is an independent Information Services company focused on providing financial information on Unlisted and under-covered companies in India
  • Our Customers have found value in using Probe42.in to enable their decisions involving Identifying prospects, sales preparation, credit and competitor analysis, etc.
  • The Probe42 platform has been extensively used by Banks and Corporates

 

 

A modern CFO’s role in bringing Corporate Makeover

Economic uncertainty, tighter regulations and greater investor scrutiny have put the CFOs in the spotlight today. The historical ‘bean counter’ accounting function, CFOs previously had, is history. They are now becoming bean growers, playing a critical role in giving organizations a  direction, while also acting as catalysts instilling a financial mindset throughout the business units.

Here are the important roles that the CFOs are playing in the business world:

Strategic Leadership

In the popular management book – Good to Great, author Jim Collins underscores the need to understand the brutal facts confronting an organization if it is to be successful. CFO with his or her numerical prowess brings in hard data and empirical mindset to the table. Analysis of statistics relating to market trends, competitive position and supplier’s finances amongst others facilitates strategic planning.

While CFOs are already financial leaders, the modern ones are expanding their role by lending their support in forecasting trends and by building strategic capabilities.

Risk management

Companies are today exposed to a complex array of risks and uncertainties than ever before. Emerging technologies such as Blockchain, the Internet of Things, Artificial Intelligence and then cybersecurity threats and data privacy concerns to grapple with on the technology front.

Often, businesses have more data than they perceive. For instance, if it needs to evaluate the risk of hiring a supplier, specialized data sources do allow checking its credit quality and financial situation which in turn facilitate their onboarding. Similarly, due diligence helps evaluate the creditworthiness of customers. CFOs with their financial prowess are best placed to analyze all such critical data (internal as well as external) and turn it into insights for risk mitigation and monitoring.

Financial strategy and control

CFOs also play a vital role in establishing a clear financial baseline for business transformations to happen. At the simpler level, last year’s financials become the baseline for making forecasts and allocating budgets. But business is much more complicated and therefore the need to adjust data with necessary one-time events or market aberrations. For instance, forecasting a sales target without reflecting on the decline in market prices and demand as compared to a year before could result in unrealistically set transformation targets.

Organizational initiatives like reducing costs also need a balance between control and empowerment. Too much of financial control, for instance, by drastically reducing the threshold for purchase approval, could hurt productivity and employee morale. CFO plays a vital part here by resorting to fine balancing.

Value creation

In the traditional business setting, the CEO champions organizational transformation while the COO assumes operational control and individual business heads take the lead for their own performance. CFO in turn is left on the sidelines providing auditing and transactional support.

The new-age CFO today however becomes an important line of defense in a high-pressure transformation environment.            For instance, overemphasis on accounting quarterly profits in a high-pressure work environment could result in a negative effect on cash flow. CFO being numerically savvy can raise the flag, while also highlighting if incremental profit has come on the back of a drop in credit quality. By comparing the creditworthiness of customers as well as that of its competitors, one gets an insight into it, which in turn could avoid probable NPA and losses in the long run.

Similarly, by setting formal budget commitments, CFOs can facilitate organizational transformation and ensure turnaround initiatives actually get to the bottom line.

Takeaway

Modern CFOs go beyond the usual financial responsibilities by playing a larger role in organizational transformation. By bringing hard data and empirical mindset to the table, they are assisting strategic planning.

About Probe42:

  • Probe is an independent Information Services company focused on providing financial information on Unlisted and under-covered companies in India
  • Our Customers have found value in using Probe42.in to enable their decisions involving Identifying prospects, sales preparation, credit and competitor analysis, etc.
  • The Probe42 platform has been extensively used by Banks and Corporates

 

 

 

Important Roles of Independent Director in the Boardroom

Independent Directors’ (ID) act as a mentor, coach and guide to a company. With their knowledge, experience and skill, they guide the Board in risk management while also striving to improve corporate credibility and accountability. Through their presence in various corporate committees, amongst other things, they also ensure good corporate conduct and governance practices.

Let’s understand the main roles of an ID in an Indian context:

  1. Hold ethical standards of integrity and probity

While the management conducts its operations, the independent directors focus on stewardship and oversight. The evolution of corporate scandals in India (Satyam, for instance) and elsewhere in the world have resulted in the mandatory appointment of IDs in the company’s board.

The business disruption caused by the pandemic has further underscored the need to be vigilant and strengthen governance frameworks. An October 2021 Deloitte report titled ‘Corporate fraud and misconduct: Role of independent directors’ finds that 63 percent of IDs surveyed expect the current business environment induced by the pandemic to spur fraud over the next two years. Large-scale remote working and cash flow crunch acting as the main triggers for frauds. Good governance is easily among the top priorities of ID today.

  1. Objective evaluation of the performance of the board and management

The fact that the directors are independent also implies that unwittingly they have limited information about the company and industry. That’s where the quality of the flow of information becomes critical.

The directors are usually provided with materials to equip them to effectively deal with various agendas. For instance, quarterly financial information could be supplemented with budgets, management forecasts and analyst expectations to give a holistic financial perspective to IDs.

However, in order to truly provide an objective view, such information needs to be supplemented by market intelligence. ID need to undertake their own due diligence, to learn about the company from the public record. It will help in a better way of scrutinizing, monitoring and evaluating management’s performance vis-à-vis its agreed goal and objectives. An informed director is the first step to becoming a useful director who could exercise business judgment and common sense.

  1. Safeguard the interests of all stakeholders, particularly the minority shareholders

Safeguarding the interest of all stakeholders – promoters, investors, employees and customers – and especially that of minority shareholders and balancing the conflicting interest among them are two key responsibilities of IDs. A true litmus test of the above criteria is how their decisions enhance the sustainability of the company.

We are increasingly living in a VUCA world – Volatility, Uncertainty, Complexity and Ambiguity – thanks to new laws, policies and new kinds of businesses. Having adequate knowledge about the company and the external environment in which it operates could prove to be a game-changer.

  1. Play a vital role in Risk Management

IDs cannot and ideally should not be involved in actual day-to-day risk management. Instead, through their risk oversight role, they should satisfy themselves that the risk management policies and procedures designed and implemented by the company’s senior executives and risk managers are consistent with the company’s strategy and risk appetite. And that the systems of risk management are robust and defensible.

Moreover, ensure necessary steps are being taken to foster an enterprise-wide culture that supports risk awareness and behaviours that are consistent with the risk management strategy.

It often calls for checking on the integrity of financial information and assessing the quality, quantity and timeliness of the flow of information between the management and the board.

Takeaway

While management’s job is to operate business, the independent directors are the roving ambassadors of the company. They focus on stewardship and oversight with the help of appropriate, useful and timely information that often might not flow from the company.

About Probe42:

  • Probe is an independent Information Services company focused on providing financial information on Unlisted and under-covered companies in India
  • Our Customers have found value in using Probe42.in to enable their decisions involving Identifying prospects, sales preparation, credit and competitor analysis, etc.
  • The Probe42 platform has been extensively used by Banks and Corporates