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Self-regulation is not enough to maintain standards

Feb-11 - 17, 2002

Capital market experts and regulators are of the unanimous view that the objectives of the reforms in the financial sector cannot be fully achieved without reforming the accountancy profession, implementation of International Accounting Standards and reliably conducted audits of industrial and business companies. It is commonly believed that financial frauds and bunglings can be effectively checked only by ensuring that the chartered accountants performed their job diligently and honestly.

There is almost a consensus in the concerned circle that the Institute of Chartered Accountants (ICAP), which has been acting as a self-regulatory authority for the accounting profession, has failed to improve or regulate the conduct of its members. It is increasingly being argued that self-regulation is not enough to maintain standards. It is felt that the profession must be regulated by a tough statutorily independent body. The recent collapse of energy giant Enron in the United States and consequent criticism of some big accountancy firms for conniving with the management and conceding vital information from stakeholders has reaffirmed the prevailing view and added urgency to the matter.

The Securities and Exchange Commission of Pakistan (SEC), which has emerged as an effective watchdog of the capital market, is closely monitoring the functioning of listed companies with the main objective of protecting the interest of minority shareholders. During its minute scrutiny and evaluation of the accounts of such companies, the SEC has detected a number of outright frauds and financial bunglings which the management could not commit without the active connivance of chartered accountant firms responsible for preparation of profit and loss accounts, balance sheets and conducting the audits of the companies' accounts. According to press reports, SEC has, besides taking action against the management of such companies, also imposed fines on the firms of chartered accountants responsible for concealing the facts, as it is mandatory for them to disclose all such wrong doings in their annual accounting reports. Under the prevailing law, SEC can only impose a nominal fine of Rs. 2000 for such lapses on the part of accounting and auditing firms. The Commission has been promptly reporting such cases to ICAP for taking disciplinary action against their members for professional misconduct.

ICAP has, however, hardly ever moved effectively against any of their members for professional misconduct, leading authorities to the conclusion that self-regulation is not enough to maintain professional standard and for enforcing strict compliance of International Accounting Standards, to create desired level of credibility amongst foreign investors and fund managers.

Recently, the SEC chairman, while addressing a big gathering of professional accountants at an ICAP function plainly told them, "There has been no shortage of accounting scandals and failures in recent years, both within Pakistan and internationally. After the recent Enron affair and certain inherent problems with the profession this has highlighted it is high time the profession gears up and takes decisive steps to visibly enhance its quality as well as image. I do not have to tell you that there is considerable intellectual ferment that is calling for major reform in several areas: First, it is increasingly being argued that self-regulation is not enough to maintain standards. It is felt that the profession must be regulated by a tough, statutorily independent body under the direct aegis of the Securities Commission (or a part of it) the agency must have teeth to fine or ban erring auditors. Secondly, conflicts of interest in accounting firms need to be properly addressed. It is simply inappropriate for an auditor to also provide consulting services. Even if there isn't any conflict, the perception of it is enough to undermine investor confidence."

Continuing he said, "I might tell you that this is a very important area for Pakistan to effectively to tackle if we are to engender investor confidence and attract investment. Everything else is coming together and the circumstances for the country are most propitious. The stars appear to be in alignment for Pakistan! All macroeconomic factors are improving, geo-politically we are in a most advantageous position, we are internationally acceptable and receiving a lot of economic assistance, the regulatory framework of the capital market is of international standard, we have an independent, no-nonsense regulator, and the capital market is offering phenomenal values. We should, if we play our cards right, attract substantial capital. One thing, however, still remains outstanding we need to put our accountancy house in order! And if you don't do it, then I will!"

That it is not just rhetoric is conformed by some background interviews with some of the concerned officials of the SEC. The Commission seems determined to play its role in reforming this sector as well, in order to have a transparent and reliable corporate sector, inspiring confidence, both among the domestic and foreign investors. In this context, a number of amendments are being proposed in the Companies Ordinance l984, to have stringent laws for improving the corporate governance including streamlining of the much criticized role of chartered accountant firms in Islamabad. The draft law is repeatedly being sent to the Ministries of Finance and Law and Justice, for necessary vetting.

One of the proposed recommendations is that chartered accountant firms found guilty of professional misconduct, besides fine, should be blacklisted and debarred from serving any listed company for a period of 3 years. To ensure honest and fair performance of the auditors and their impartiality, it is being suggested that companies should engage them on non-renewable yearly contracts. The idea is that auditors should not gain anything by producing overly favorable audit reports.