All these are being portrayed as audit failures. But these are basically what Professor Stephen Zeff terms ‘systemic failures’: directors, auditors, audit committee and legal advisors all fell short of what was required of them. However, there are some, like the President of the Institute of Chartered Accountants of Scotland (ICAS), who believe that audit firms are disproportionately targeted, and that the spate of litigation against auditors denotes a situation where apparently the audit profession is regarded by many as a source of insurance. While not suggesting that auditors avoid their legal liability, he questions the reasonableness of making the auditor the prime target.
The Company Law Review Steering Group in the UK has in its final report recommended an extended duty of directors and company employees to assist auditors, and in the event of any breach of duty (whether negligent or fraudulent) a fairer attribution of fault and responsibility to the company, directors and employees. While welcoming the steps proposed, the ICAS feels they do not go far enough.
What is required in their view is proportional liability, whereby the courts award only what should be due from individual defendants, supported by a requirement on directors (of at least listed companies) to have substantial indemnity insurance cover. Until a proportional liability approach is adopted, asserts the ICAS, auditors will continue to be put at an unfair risks and suggests that the sooner it is accepted by all that the auditor does not provide insurance, but only reasonable and not absolute assurance, the more likely it is that an efficient and workable regime that benefits all stakeholders in the economy can be established. Auditors, even bad ones, don’t bring down companies nor do non-executive directors. Yet the system of corporate governance that we have evolved depends heavily on both— auditors and non-executive directors. The question now being asked is whether either can really do what is being asked of them.
Is it fair to make non-executive directors share the burden of corporate failures? In Pakistan, many non-executive directors, especially in the public sector companies, sit on boards in an ex-officio capacity. So the boards of some of the largest listed companies in Pakistan —in the telecommunication, gas, electricity sectors - are peopled by directors appointed because of their government posts rather than any knowledge or experience of the company’s activities. Moreover, they are directors of so many companies that even if they wanted to gain insight into the workings of these companies, their core duties just do not allow them the time and opportunity to do so.
The other breed of the ubiquitous directors is the state-owned financial institution employee. The NIT used to have the right and the privilege of picking up 20 per cent of the shares on offer in all new public issues. It invariably exercised this right, which bestowed upon it the additional privilege of a seat on the board of directors. So we have the spectacle of a single NIT employee serving on the boards of scores of companies. It is just not humanly possible for these directors to attend even a fraction of the Board meetings convened by these companies, let alone make any meaningful contribution to their management. At the same time their own work suffers.
The employees of ICP’, Bankers Equity Limited, the NDFC and the IDBP were in a similar position though perhaps not to the extent of NIT employees. Is it merely accidental that all these financial institutions are in such dire straits? Some of them have actually folded up. So how can persons who could not save their own employers from going under contribute in any meaningful way to the companies on whose board of directors they represent NIT and all the other financial institutions?
What is needed in addition to a limit on the number of directorships held by an individual is the selection of technocrats as nominee directors by the government and the financial institutions. Such persons should be compensated adequately for watching, protecting and promoting the interests of the nominating shareholder. This will go a long way towards averting corporate failure resulting from poor governance.