2024 (12) TMI 226 - NFRA - Companies Law

NFRA penalizes auditing firm Rs. 2 crore and auditor Rs. 50 lakhs for professional misconduct under Section 132(4)

In the matter of Reliance Commercial Finance Ltd for FY 2018-19 against M/s Shridhar & Associates and CA Ajay Vastani

NFRA found auditing firm and chartered accountant guilty of professional misconduct under Section 132(4) of Companies Act 2013 for failing to disclose ... Professional Misconduct - Failure to disclose a material fact known to him which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement where the statutory auditors are concerned with that financial statement in a professional capacity - Failure to report a material misstatement known to appear in a financial statement with which the EP is concerned in a professional capacity - Failure to exercise due diligence and being grossly negligent in the conduct of professional duties - Failure to obtain sufficient information which is necessary for the expression of an opinion, or its exceptions are sufficiently material to negate the expressions of an opinion - Failure to invite attention to any material departure from the generally accepted procedures of audit applicable to the circumstances - Failure to accept a position as auditor previously held by another chartered accountant after first communicating with him in writing - Section 132(4) of the Companies Act 2013 - penalty and sanctions. HELD THAT:- M/s Shridhar & Associates and the EP CA Ajay Vastani committed professional misconduct as defined by Section 132(4) of the Companies Act, 2013, read with Section 22 and Clause 5 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that a CA is guilty of professional misconduct when he “fails to disclose a material fact known to him which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement where he is concerned with that financial statement in a professional capacity' - This charge is proved as the Auditors failed to disclose in their report the material non- compliances the Company. M/s Shridhar & Associates and CA Ajay Vastani committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 6 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he 'fails to report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity' - This charge is proved as the Auditors failed to disclose in their report the material misstatements made by the Company. M/s Shridhar & Associates and CA Ajay Vastani committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 7 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he “does not exercise due diligence or is grossly negligent in the conduct of his professional duties' - This charge is proved as the Auditors, conducted the Audit of a Public Interest Entity in total disregard of their statutory duties, evidenced by multiple critical omissions and violations of the standards. The instances of failure to conduct the audit in accordance with the SAs and applicable regulations, and failure to report the material misstatements in the financial statements and non-compliances made by the Company. M/s Shridhar & Associates and CA Ajay Vastani committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 8 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he 'fails to obtain sufficient information which is necessary for expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion' - This charge is proved as the Auditors failed to conduct the audit in accordance with the SAs and applicable regulations as well as due to their total failure to report the material misstatements and non-compliances made by the Company in the financial statements. M/s Shridhar & Associates and CA Ajay Vastani committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 9 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he 'fails to invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances' - This charge is proved since the Auditors failed to conduct the audit in accordance with the SAs but falsely reported in their audit report that the audit was conducted as per SAs. M/s Shridhar & Associates and CA Ajay Vastani committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 8 of Part I of the First Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he “fails to communicate with outgoing Auditor” - This charge is proved since the Auditors failed to accept the audit in accordance with the law. It is concluded that the charges of professional misconduct in the SCN, as detailed above, are established based on the evidence in the Audit File, the audit reports on the financial statements for the FY 2018-19 dated 14th August 2019 and the submissions made by the Auditors, and the Annual Report of Reliance Commercial Finance Limited for the FY 2018-19. Penalty and sanctions - HELD THAT:- Section 132 (4) of the Companies Act, 2013 provides for penalties in a case where professional misconduct is proved. The seriousness with which proved cases of professional misconduct are viewed is evident from the fact that a minimum punishment is laid down by the law. Because professional misconduct has been proved and considering the nature of violations and principles of proportionality, in the exercise of powers under Section 132 (4) (c) of the Companies Act, 2013, it is ordered as follows: a. Imposition of a monetary penalty of Rupees Two Crore upon M/s Shridhar & Associates. b. Imposition of a monetary penalty of Rupees Fifty Lakhs upon CA Ajay Vastani and in addition, CA Ajay Vastani is debarred for 5 years from being appointed as an auditor or internal auditor or from undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate. Issues Involved:1. Acceptance of Audit Engagement2. Emphasis of Matter in the Audit Report3. Going Concern4. Expected Credit Loss5. Matters Reported by the Previous Auditor and Violations of SA 2406. Key Audit Matters7. Audit Documentation8. Role of the Audit FirmDetailed Analysis:1. Acceptance of Audit Engagement:The auditors were charged with professional misconduct for accepting an audit engagement without communicating with the previous auditor, a requirement under the Chartered Accountants Act, 1949. Despite their claim of a telephonic discussion, the evidence showed the engagement was accepted before receiving a No Objection Certificate (NOC) from the previous auditor. This violated Clause 8 of Part-1 of the First Schedule to the Chartered Accountants Act, 1949, SA 300, and the firm's quality control policy under SQC-1. The auditors failed to exercise due diligence and controls on client acceptance, proving professional misconduct.2. Emphasis of Matter in the Audit Report:The auditors misused the Emphasis of Matter (EoM) section in their report, failing to appropriately disclose the suspected fraud reported by the previous auditor. The EoM was based on incorrect disclosures and did not state that the audit opinion was unmodified, violating SA 706 (Revised). The auditors relied on a legal opinion without adequate evaluation, contrary to SA 500. Their actions gave the impression of endorsing the company's interpretation, dismissing suspicions of fraud, proving non-compliance with auditing standards.3. Going Concern:The auditors failed to obtain sufficient evidence to conclude there was no material uncertainty regarding RCFL's going concern status. Despite identifying significant events casting doubt on the company's ability to continue as a going concern, the auditors did not perform necessary procedures to evaluate management's plans or cash flow forecasts, violating SA 570 (Revised). The auditors' report was inconsistent with the company's disclosure, rendering the audit opinion misleading.4. Expected Credit Loss (ECL):The auditors did not obtain sufficient audit evidence to verify the reasonableness of the ECL estimate on loans, failing to assess management's assumptions or test internal controls, contrary to SA 540 and SA 315. The audit file lacked evidence of substantive procedures and independent verification of the ECL model, indicating a failure to exercise professional skepticism. The auditors' actions resulted in an understatement of ECL, proving professional misconduct.5. Matters Reported by the Previous Auditor and Violations of SA 240:Despite being aware of suspected fraud reported by the previous auditor, the auditors failed to exercise due diligence and professional skepticism, issuing a misleading audit report. They did not adequately examine the end-use of loans or assess fraud risks, violating SA 240. The auditors' failure to respond to risks of material misstatement due to fraud and management override of controls further proved professional misconduct.6. Key Audit Matters:The auditors failed to communicate Key Audit Matters (KAM) with Those Charged with Governance and did not document the rationale behind the determination of KAM, violating SA 701. In the absence of evidence of compliance, the charges were deemed proved.7. Audit Documentation:The auditors did not comply with SA 230, as several work papers lacked details on who performed and reviewed the audit work. Proper documentation is crucial for audit quality, and the lack of it was viewed as a serious issue, proving non-compliance.8. Role of the Audit Firm:The audit firm, as the legal entity appointed under Section 139 of the Act, was responsible for the audit report. The firm's failure to ensure compliance with auditing standards and effective supervision contributed to the audit's deficiencies. The firm's role was equally important as that of the Engagement Partner (EP), and both were held jointly responsible for the audit failures.Findings and Penalties:The auditors committed professional misconduct by failing to disclose material facts, report material misstatements, exercise due diligence, and obtain sufficient information necessary for expressing an opinion. The audit firm was fined Rupees Two Crore, while CA Ajay Vastani was fined Rupees Fifty Lakhs and debarred for five years from auditing roles. The order takes effect 30 days from its issuance.