Confirming compliance

Forensic audit of fund houses will boost confidence

The Securities and Exchange Board of India (Sebi) appears to be gearing up for a forensic audit covering the entire mutual fund industry, including funds, asset management companies (AMCs), and trustees. The regulator released a consultation paper on February 9 that reviewed the roles and obligations of mutual fund trustees. On February 10, it proposed to mandate a unit holder protection committee to be constituted by the board of the AMC for the purpose of creating an independent review mechanism. On February 11, it followed up with an expression of interest seeking the empanelment of forensic auditors for the purpose of auditing mutual funds, AMCs, and trustees.

It is thus reasonable to assume that Sebi intends to carry out an extensive forensic audit of most or all these entities, and, indeed, the fund industry is bracing for an industry-wide audit. It is presumed that this exercise is being undertaken to help shore up investor confidence in the absence of news about any specific issues. A forensic audit involves a deep examination of all sorts of records within an organisation to identify possible unethical or criminal behaviour, and the object of this exercise is to obtain evidence that is legally admissible. As such, the normal reasons for conducting a forensic audit could range from a potential conflict of interest, or some incidence of corruption or bribe-taking, to misrepresenting financial statements or misappropriating assets.
 

The regulator has conducted forensic audits of fund houses in the past but only when there has been any information of specific wrongdoing. It is unusual to carry out forensic audits at scale across an entire industry in a scattershot fashion, without a specific target. Such audits are always expensive, time-consuming exercises. They tie up large human resources, and while such an exercise is in progress, it can bring normal functioning to a near-standstill in the targeted organisation. To do this purely as a confidence-building exercise might be an overkill. However, it is true that the fund industry has grown at breakneck pace and a close examination of the checks and balances across the industry may be a useful one-time exercise. Assets under management of the industry have jumped from Rs 8.6 trillion in January 2013 to Rs 39.6 trillion in January 2023 — a compound annual growth rate of 16.5 per cent. Individual investors own over 57 per cent of those assets, and there are over 142 million folios in existence, with around 114 million of these estimated to be held by retail investors.

Given the size of the industry and its importance to the economy, it is understandable the regulator wishes to examine processes and practices across the industry. On paper, the rules and regulations governing funds are quite stringent but ensuring that 40 funds and their respective AMCs and trustees are complying strictly is a difficult task. A wide-ranging forensic audit thus should be able to uncover lapses in processes even if no wrongdoing is discovered. Given that the industry is the most efficient way to funnel household savings into productive investments, it is imperative that investors can repose complete trust in these institutions. While it could be counter-productive to expend such resources on a regular basis, a one-time exercise followed perhaps by random periodic audits could help ensure compliance.