SEBI: Submission highlighting challenges in complying with disclosure requirements in case of initiation of forensic audit on listed companies

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SEBI: Submission highlighting challenges in complying with disclosure requirements in case of initiation of forensic audit on listed companies

Tejasvi

@tejasvi

January 5, 2021

Public Policy

495

As you may be aware, Securities and Exchange Board of India (SEBI) recently issued Frequently Asked Questions (FAQs) to clarify some issues relating to disclosure of information of forensic audit of listed entities due to issue of Notification No. SEBI/LAD-NRO/GN/2020/33 dated October 8, 2020 requiring listed companies to make disclosure to stock exchanges of forensic audits.

Based on inputs received from industry, we have highlighted the following concerns to SEBI:

Issues in disclosure relating to initiation of forensic audit:

The scope of the term ‘forensic audit’ has now been clarified in the FAQs to mean “those audits (by whatever name called), which are initiated with the objective of detecting any mis-statement in financials, mis-appropriation/ siphoning or diversion of funds. It does not seek to cover disclosure of audit of matters such as product quality control practices, manufacturing practices, recruitment practices, supply chain process including procurement and matters that would not require any revision to the financial statements disclosed by the listed entity.”

Thus, scope of the term ‘forensic audit’ has now been narrowed down, leaving out matters that does not involve revision to financial statements. However, there is still a disclosure requirement relating to initiation of forensic audits in cases involving detection of mis-statement in financials, mis-appropriation/ siphoning or diversion of funds.

While we understand that only basic details are required to be disclosed in case of initiation of audits (i.e., fact of initiation of audit, name of entity initiating it and reasons for the same, if available), immediate disclosure of the same to stock exchanges (however immaterial or minor), may be premature and can result in negative market sentiment and speculative trading, leading to price volatility in the scrip.

It could also lead to speculation on the topic by investors and other stakeholders, thereby leading to brand and reputation issues, parallel investigations by other regulatory authorities and can result in obstructions to the ongoing forensic audit.

Many a times forensic audits are done with confidentiality clause and investigations are done without the knowledge of the other party involved. Making such disclosures public, could cause obstacles to the investigation process. Therefore, intimation to stock exchanges / SEBI should be kept in strict confidence till the findings are finalised.

Further, the requirement of disclosure of initiation of audit may not satisfy the test of adequate and material information prescribed by SEBI under Chapter 2 of SEBI (Listing Obligations and Disclosure Requirements) regulations, 2015 (SEBI LODR).

Chapter 2 of SEBI LODR provides that a listed company is obligated to disseminate accurate, adequate and timely information to the investors, and refrain from misleading or misrepresenting to the investors/ stock exchanges.
All events/ information that are ‘deemed to be material’, and enumerated in Schedule III, Part A, Para A of the LODR require disclosure only once a decision has been taken or an outcome has been reached with finality.

Issues in disclosure of forensic audit report:

SEBI require listed companies to disclose final forensic audit report to stock exchanges along with comments of management. The audit report may contain proprietary information such as client information, details of contract, internal policy of the company, legal advice, etc. It may also contain details of witnesses who have provided information and evidence during the course of the audit. While SEBI FAQs specifies that sensitive personal information may be redacted, there is an ambiguity in terms of what portion of information could be expunged by the company.

Further, such redaction may not adequately protect identities of persons and there could always be the fear of inferences being drawn on their identities, resulting in further speculation. This could result in investigations and forensic audits becoming counter-productive to SEBI’s objective. Moreover, disclosing contents of final audit report in the public domain does not serve any meaningful purpose. Instead, the investors/ public should be given a full disclosure of material information.

Once forensic audit report is filed with stock exchanges, the document loses confidentiality and privilege. As a result, the company and its board can be sued by stakeholders for the findings of forensic audit report, even though the audit was instituted by the board to find and fix a problem.

SEBI may also examine the global best practices in this regard. To our understanding, there is no precedent for disclosure of all forensic audit reports for public disclosure in other countries.

Recommendation

Based on the above issues, NASSCOM has made a representation to SEBI requesting for the following:

For disclosure related to initiation of a forensic audit –

The requirement of disclosure should be limited to such audits initiated by the regulatory agencies.
Further, companies should also be allowed to make disclosure of other audits initiated by management or other stakeholders to stock exchanges, provided the same is kept confidential by stock exchanges until conclusion of the audit.

For disclosure of forensic audit report on conclusion of audit –

SEBI should provide guidance on the type of information that should be treated as sensitive, to avoid any ambiguous interpretations.
SEBI should require companies to submit summary of the issue along with the resolution of the same by Board of Directors for the purpose of public disclosure. This will enable company to disclose relevant information while ensuring appropriate treatment of the sensitive and confidential information. The forensics audit report, if it is required to be submitted, should be for SEBI’s internal purposes to verify the appropriateness of management’s public disclosure.
SEBI may consider distinguishing between management related fraud and process related fraud and stringent regulations can be framed for the former as it would have significant impact on the investor community.

We will keep you posted on further developments in this regard.

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Tejasvi