Our Long Time Stand that CAG has Constitutional Mandate to Audit Private Firms has been Vindicated by the Hon’ble Supreme Court says Shashi Kant Sharma CAG is duty bound to Report to Parliament Matters Involving Revenue Sharing : CAG

The recent ruling of the Honorable Supreme Court is a landmark one and has removed, once for all, the doubts on the constitutional mandate to audit private firms by the CAG so far as it relates to revenue sharing with the Government. Our long time stand, that an entity using public resources in its business and sharing revenue with the Government can be audited by the CAG, has been vindicated by the Honorable Supreme Court. This was stated by the Comptroller and Auditor General of India, Shri Shashi Kant Sharma while delivering the inaugural address at the 8th Annual Summit on “Corporate Frauds - Risk and Prevention under Changing Paradigm” here today.

The CAG said that there is no doubt  that the institution of the CAG is duty bound to report to the Parliament in all such matters which involve revenue sharing with Government on country’s natural resources. Shri Sharma disclosed that the work on Telecom audit is already in progress and the first report would be ready before the year end. We would be taking up performance audit of some ongoing PPP projects shortly, the CAG added.

Removing doubts on expertise of the CAG to audit PPPs, Shri Sharma said that PPP Audit is not a new area to the institution of CAG and we have got recognition worldwide and the institution takes pride in it. So nobody should have any doubt on our expertise on this area, he said.

The CAG stated that Indian economy would grow into a mature market economy, which would present opportunities to maximize profits and help the corporates expand across the globe with confidence and credibility. The CAG expressed that the captains of Industry would not want to be known as lynchpins of a crony capitalist economy.

Shri Sharma said that many corporate tycoons in emerging economies are today accused of making fortunes by “rent seeking”. They want to grab a bigger slice of the pie, rather than making the pie bigger. This type of rent seeking is not only unfair but also bad for long term growth, the CAG said.

Stating categorically that audit by CAG will not be taken up in a routine manner, Shri Sharma clarified that the CAG audit is an independent audit which is different from statutory audit or internal audit. Stating that the companies will have to strengthen their internal control mechanism and that would be a step in the right direction, CAG said that there would be protocols to undertake such audits which would be done keeping in view the risk assessment and impact on public interest. The CAG asked, why companies should fear such audit if they have nothing to hide, in a mature market economy, where there is very little scope for manipulations and fudging.

Following is the text of the speech of the CAG :-

“Corporate fraud would remain an undeniable reality of our economy, especially as financial growth picks up pace and provides more avenues for both entrepreneurs and fraudsters.  Fundamentally, both businessmen and fraudsters are tempted to their acts for the same reason: to make money. While honest businessman would try to make money through entrepreneurial ways, the fraudster would try to make money through dishonest criminal acts.  While we need to applaud and support the honest entrepreneur, it is also equally important for us to be on constant vigil against fraudsters.

Fraud should be distinguished from error.  The distinguishing factor between fraud and error is whether the underlying action is intentional or unintentional.

Fraud is an intentional act involving the use of deception to obtain an unjust or illegal advantage.  Fraud, thus, has a legal or criminal connotation. It may involve manipulation, falsification or alteration of record or documents.  Also, it may be by way of misappropriation or misapplication of assets, recording of transactions without substances or misapplication of accounting policies.

Corruption and fraud are not mutually exclusive.  There is, in most cases, a nexus between the two.  When management gets involved in the perpetration of fraud, the activity assumes the proportion or the additional bearing of corruption.

Both fraud and corruption are without proper authority and involve breach of trust and therefore are illegal and irregular. They also involve an element of non-transparent conduct or behaviour.

Examination of system for detection and prevention of fraud and corruption is an integral part of all regularity audits and also of performance audits.  When the evidence is clear, audit teams can come to a conclusion about a suspected fraud and include it in their reports.  Thus, the audit findings can put up red flags which need further investigation by appropriate agencies.

However, in the present economic scenario, where government has gradually withdrawn from several economic activities and handing over those responsibilities to private sector, the very concept of corporate fraud, has to be expanded to understand what we are dealing with.  And why is it so crucial for us to be awake to the complex realities of corporate fraud, be it by a devious individual or by companies that aim to manipulate our regulatory frameworks and market dynamics.

In economies like that of India, we are witnessing several new avenues of interaction between private enterprises and the government.  These have gone beyond the conventional interactions in terms of taxes and regulations.  These are now strewn across various categories.  The most important is the right given to private parties to manage public resources such as spectrum, coal and other natural resources.  A second type of activity is where the government, or its commercial arms, have formed joint ventures with private enterprises for public utilities.  The third type is where the private enterprises have been permitted by the government, under agreement, to build public roads, or such facilities, and collect toll.  There may be a few more categories where private enterprises have expanded their activity to take over functions that governments would have discharged in a state controlled economy.

 Indian economy is, thus, witnessing expansion of private sector role in managing public resources and utilities. It is a matter of record that numerous Indian and foreign companies have carried out these activities with high standards of transparency and accountability.  That is what they are expected to do in an open market economy.  However, I am going to focus on the issues in the new economic scenario that CAG auditors have been flagging over the years, and in the context of recent land mark judgments of the Delhi High Court and the Supreme Court.

Be it in the audit of the 2 G spectrum allocation or coal block allocation, be it the construction  and management of Delhi airport, be it related to exploitation of gas and oil fields, we have found very distinct trends that must be of concern to all of us.  In many of our audits involving private parties we have found evidences that fall into a pattern – of private players trying to distort competition, upset free market fairness, and, cause loss to both public exchequer and competitors.

In the coming days, as our economy further picks up, as more and more people join work force, as governments reduce their presence in the market place, and as technological breakthroughs permit exploitation of natural resources in new areas, avenues for private enterprises would further open up and public interest and fairness would be on test.  I urge the captains of industry to appreciate the fact that Indian economy has to grow into a mature market economy, which would present opportunities to maximize your profits and help you expand across the globe with confidence and credibility.  I am certain that you wouldn’t want to be known as lynchpins of a crony capitalist economy.

Emerging markets throughout the globe are experiencing, what America saw in the late 19th century.  Rent seeking tycoons accumulated vast fortunes.  But between 1900 and 1945, America began to regulate big business and build a social safety net.  A new middle class started flexing its muscles.  People wanted politicians who don’t fill up their pockets, and business tycoons who compete without favours.

Many of the corporate tycoons, throughout the emerging economies, are today accused of making fortunes by “rent seeking”.  They want to grab a bigger slice of the pie rather than making the pie bigger.  This is easier in industries that are vulnerable to monopoly, or that involve licensing or heavy state involvement.  Some of the common example are: Banking, mines, telecom spectrum, utilities, oil and gas, public infrastructure etc.

Capitalism based on rent seeking is not just unfair, but also bad for long term growth.  In such an environment, resources are mis-allocated, competition is repressed and dynamic new firms are stifled by better connected players.  And if linked to the financing of politics, rent heavy capitalism sets a tone at the top that can also let petty corruption flourish.

There is evidence to suggest that countries that do well to counter crony capitalism generally have better institutions.  Governments must aim to improve regulation and boost competition. Further, rules are to be enforced rigoursly so that they are ignored less freely.

As private public interface grow I am reasonably certain that the role of CAG and regulators would also expand. Accountability of the Executive as well as that of private enterprise will require to be defined and strengthened through sound and effective institutions which ought to be independent as well as credible.

Institution of CAG enforces such accountability through Parliament as far as public money and resources are concerned.  The Constitutional mandate of CAG is very well defined and the institution is capable of meeting the new challenges presented by the emerging economy.  We do not want to cross our boundaries.  However, the onus is on all of us to ensure that no one upsets the public trust and everyone gets a fair chance.

The recent ruling of the Hon’ble Supreme Court, which upheld the January 2014 judgement of the Hon’ble  High Court, Delhi, is a land mark one as  it has, once for all, removed the doubts on the constitutional mandate so far as it relates to CAG audit of revenue sharing.  An entity that may be using public resources in its business and sharing revenue with the Government can be audited by the CAG.  Our stand has been the same since long.

In the wake of the recent judgment, there was an intense debate in the media mostly well informed but on some points, not so informed.  The most argued objection was that it would have far reaching consequences as the ruling would extend the scope of CAG audit to other areas like power, mining, ports, airports, oil exploration etc.  It would also apply to all PPP projects.  Some commentators raised doubt on the expertise of CAG for conducting audit of PPPs.  A question is raised that a mandatory audit of all such contracts as also multiple audits of private firms will involve waste of management time.  Also, the very idea of audit by CAG raises doubt on veracity of audit done by statutory auditors. It is also argued that opening of books of account of private firms to the CAG can lead to dampening of investors’ sentiment.

I would attempt to reply, in brief, to some of these points.  As to the issue of extending the scope of CAG audit, the interpretation of the constitutional mandate was long overdue and the imperatives of changing scenario in the economy, which I discussed earlier, makes it quite obvious that accountability through Parliament must be enforced on utilization of resources that normally belong to people.  I will quote the observation of the Hon’ble Supreme Court, to place the issue in perspective:-

 “CAG’s Examination of the accounts of the service providers in a revenue sharing contract is extremely important to ascertain whether there is an unlawful gain to the service provider and an unlawful loss to the union of India, because the revenue generated out of that has to be credited to the Consolidated Fund of India.  The subject matter, with which we are concerned, as already indicated, is “spectrum”, a natural resource, which belongs to the people, therefore, people of this country, through Parliament should know how its natural resources have been dealt with by the Union, State or its instrumentalities or even by UAS license holders.  Instances are not rare where even the Executive, at times, acts hand in glove with license holders, who deal with the natural resources, hence, necessity of proper parliamentary control over the resources.”

Let there be no doubt that the principle which is applicable to spectrum, applies to all natural resources which belong to public  and where revenue is to be shared with Government; and CAG is duty bound to report to the Parliament in all such matters. In fact, work on telecom audit is already in progress and I am hopeful that our first report would be ready before the year end.  Similarly, a report on gas and oil exploration will be presented to the Parliament soon.  We will be taking up performance audit of some ongoing PPP projects shortly.  None of this is aimed to harass the private firms, but to uphold the constituti7onal scheme of accountability.

As to the doubt on the expertise of CAG to carry out such audit, I can only put such doubts to rest by informing that PPP audit is not a new area to the institution of CAG.  CAG has expertise in various domains including gas, electricity, transport, infrastructure etc. Our institutional competence is well recognized, even in international audits, and the institution takes pride in that.  As to the waste of management’s time on account of multiplicity of audits, let me clarify that CAG audit is an independent audit which is different from statutory audit or internal audit. The companies will have to strengthen their internal control mechanism and that would be a step in the right direction.  As you know, the new changes in the Company Act also enjoin additional responsibilities on the companies to improve their accountability mechanism.  I may, however, like to state very categorically that the audit by CAG will not be taken up in a routine manner.  There would be protocols for undertaking such audits where the audit objective and scope will be clearly defined. Further, the mandate does not mean taking up audit in all cases.  It would be done keeping in view the risk assessment as well as impact on public interest.

It may also be necessary for the Government to make sensible and simplified changes in the design of contracts so that incentives to fudge revenue are systematically removed.  If better and sound contracting architecture is put in place and the accountability mechanism is well defined, transparent and fair, I am sure that audit will not lead to any discouragement to the investors.  Finally, in a mature market economy, where there is very little scope for manipulations and fudging, why should companies fear such audit if they have nothing to hide.

To fight corporate fraud in the 360 degree meaning of it, we will have to further strengthen our regulatory and law enforcement agencies, and step up awareness and sensitize all stakeholders.  Regulators will have to devise better norms and simpler procedures in avenues for private sector participation.  This would ensure healthier competition and better participation.  Law enforcement agencies will have to adopt quicker and more sophisticated investigation methods so that allegations are sorted out quickly, and they are not prolonged unnecessarily hindering normal activities.

Above all, Indian corporate will have to appreciate the realities of the emerging landscape.  We are a young nation, with a median age just above 25 years.  We are a restless nation, where surging youth and deprived sections are angry about corruption and what seems to be repeated collusions between sections of government and select private players. We must ensure that corruption and fraud doesn’t spill out into becoming an issue that would unsettle the growth of the nation.  We must remember that the economic progress that has created a class of “rent seekers” has also created its nemesis, a new, educated, urban, taxpaying middle class that is aware of its rights and role, and pushing for a change for the good of the nation”.