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2023 (8) TMI 261
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....l Misconduct E. Penalty and Sanctions ACUTIVE SUMMARY 1. This Order is being passed as a result of an investigation by the National Financial Reporting Authority (NFRA) into the professional conduct of CA Mathew Samuel for his role as the Engagement Partner (BP) in the audit of one branch of DHFL. DHFL, a housing finance company listed on both NSE and BSE) and operating through a network of branches, was reportedly involved in financial fraud. NFRA took suo motu notice of the matter and carried out an Audit Quality Review (AQR) of the statutory audit of DHFL for FY 2017-18, conducted by Chaturvedi & Shah (CAS), a Mumbai-based Chartered Accountant Firm. During the review, NFRA noticed that 33 Engagement Partners (BP) or branch auditors had signed the "Independent Branch Auditors' Report" for nearly 250 branches. NFRA investigated these EPs under section 132 (4) of the Companies Act, 2013 (the Act), including K. Varghese & Co. (the Audit Firm), which was the "Statutory Branch Auditor" of 17 branches of DHFL for FY 2017-18, with CA Mathew Samuel, who was the BP for the audit of one of these 17 branches at Trivandrum. 2. NFRA's investigations revealed that the appointment....
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....the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA), including the Standards on Quality Control and the Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty prescribed under Section132 (4) (c) of the Act. 7. Following media reports regarding the alleged siphoning of public money of around Rs.31000 crore and the Enforcement Directorate's reported action in April 2020 on an alleged banking fraud of about Rs.3700 crore by the promoter/ directors of DHFL, NFRA suo-motu initiated an AQR to probe into the role of the Statutory Auditors of DHFL for the FY 2017-18, the year in which the alleged fraud was primarily stated to have occurred. While examining the Audit Files1 of the statutory audit carried out by CAS, a Mumbai-based CA firm, certain prima facie violations were observed relating to the appointment of Branch Auditors and the conduct of branch audits of DHFL which were relied upon by CAS. Accordingly, NFRA suo motu called for the audit files from EPs who had signed the "Independent Brach Auditors' Report" for nearly 250 branches, under Section 132(4) of the A....
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....bmitted by the EP along with the reply to the SCN wherein some additional documents (including the previous year's Trial Balance for FY 2016- 17 for the branch at Trivandrum, Audit Scope and Plan FY 2013-14, Cash Verification, and Loan Verification Sheets, etc.) were submitted. The EP did not avail of the offer of a personal hearing. The various charges levied in the SCN and the response of the EP to the charges are discussed in Part C of this Order. C. MAJOR LAPSES AND VIOLATIONS BY THE EP 12. The major lapses for which the EP was issued the SCN primarily relate to (i) accepting the audit engagement without a valid authority and thus violating the provisions of the Act and (ii) violations of the Standard of Auditing in conducting the audit. I. Acceptance of audit engagement without valid authorization and without complying with ethical requirements; and issuing an audit report in violation of the Act 13. The EP was charged with acceptance of an audit engagement without complying with ethical requirements and issuing the audit report without a valid appointment as per the Act, as the appointment of the Audit Firm as "Statutory Auditor for the branches" of DHFL for FY 2017....
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....auditors for foreign branches either...... The Form ADT 1 prescribed under Rule 4(2) of Company (Audit and Auditors) Rules 2014, to be filed by a company on appointment of auditors, does not envisage appointment of branch auditors. If the intent of the law was to appoint branch auditors under Section 139, then there would have been provisions in ADT 1 for reporting to the government on appointment of auditors". c. " ... appointment of a branch auditor would depend on the decision of the company auditor. For this reason the tenure of appointment would depend on the inability of the company auditor to do audits of branches on his own....... In view of the above stated multiple reasons embedded in the legal provisions, appointment of branch auditors can only be an administrative matter between the company's auditor and the Board of Directors." d. "A branch auditor is not a company's auditor. Appointment of auditor dealt within Section 139 is only about the company's auditor, and not about branch auditors. Appointment of branch auditors is not required to be done by the members of the company." e. "The intent of the Clause (9) is that a Chartered Accountant, before....
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....lly as an auditor of the company and that their qualifications for appointment must meet the requirements set out in the Act. There is no room for any other interpretation or to examine the intention of the law when the plain meaning of the law is sufficiently clear and not contradicting any other parts of the Act. It is also pertinent to refer to A Ramaiya's Guide to The Companies Act, 19th Edition, wherein it is explained that "considering under the Act, the auditor of a company is appointed by shareholders, it follows that the above mentioned2 position would continue and thus the decision whether a branch should be audited by the company 's auditor or by any other auditor has to be taken by the shareholders in a general meeting". b. The EP's contention that Form ADT 1, to be filed by the Company on the appointment of statutory auditors, does not cover the appointment of branch auditor and hence the law "does not envisage appointment of branch auditors" is baseless. The contents of a form prescribed under the Act have no impact on the substantive requirements of the Act, which unambiguously provides for the appointment of the branch auditor under Section 139 of the ....
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....e Company's offices including those of its zonal/ regional and branch offices for the financial year 2017-18. No other branch Statutory Auditors were appointed or ratified by the Company in the said meeting. Only CAS was appointed as the Statutory Auditor for the company as well as all its branches. Thus, the shareholders of the company approved only one Statutory Auditor (viz. Chaturvedi & Sah) for the Company and its branches. Therefore, in absence of any valid appointment, EP's acceptance of the appointment as Statutory Auditor of the branches shows the absence of due diligence. f. Despite the invalid appointment letter issued by DHFL addressing the Audit Firm, the acceptance letter dated 12.09.2017 issued by the Audit Firm and the "Independent Branch Auditor's Report" issued by the EP for the one branch of DHFL, including the report required under CARO 2006 described the engagement as Branch Statutory Audit. 17. Therefore, as explained above, we find that the absence of due diligence and display of gross negligence by the EP run afoul of the provisions of the Chartered Accountants Act, 1949 and resulted in professional misconduct as conceived under Section 22, Cl....
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.... with non-compliance with SA 2104 and displaying an absence of professional scepticism and professional judgment in documenting the objective and scope of the audit, thereby violating SA 2005 as well. SA 2106 stipulates that the auditor shall agree to the terms of the audit engagement with management or Those Charged With Governance (TCWG) and that subject to paragraph 11 of the SA, the agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable forms of a written agreement and shall include (a) the objective and scope of the audit of the financial statements; (b) the responsibilities of the auditor; ( c) the responsibilities of management; ( d) identification of the applicable financial reporting framework for the preparation of the financial statements; and ( e) reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content. 20. Responding to the charges, the EP stated that "The audit in question is a "company's branch audit" falling within the provisions of Section 143(8) of the companies Act 2013 .....
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....e branch audit engagement. Hence, the contention that the details mentioned in para 10 of SA 210 are not required to be included in the engagement letter is baseless and not acceptable. 23. The EP accepted the appointment letter issued by DHFL and issued the audit report without complying with the requirements of SA 210. Between 2015-16 and 2016-17, there was a significant change in the circumstances relating to the branch audit. In 2015-16 the AGM decided to have a separate branch auditor and company's auditor, while in subsequent years there was only one auditor (CAS) to audit the Company and all its branches. This calls for the application of para 13 of SA 210 as well. EP's negligence of the provisions of SA 210 resulted not only in accepting an illegal appointment and non-compliance with SA 210 but also in the absence of professional scepticism and professional judgment in understanding the objective and scope of the audit, thereby violating SA 200 also. Therefore, the charges in para 19 above stand proven. Non-Compliance with SA 230 "Audit Documentation" 24. The EP was charged with non-compliance with SA 230. EP's audit documentation does not give evidence of t....
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....to be documented. b. Apart from SA 230, there are other Sas also that require the documentation of events, data, evidence, opinions and conclusions. SA 230 makes it very clear that reliance can be placed only on the audit file as evidence of what was done. Para AS of SA 23 0 is explicit: "Oral explanations by the auditor, on their own, do not represent adequate support for the work auditor performed or conclusions the auditor reached, but may be used to explain or clarify information contained in the audit documentation". Para 14 mandates that the auditor shall assemble the audit documentation in an audit file and complete the administrative process of assembling the final audit file on a timely basis after the date of the auditor's report. c. SA 230 requires that the auditor shall prepare audit documentation that is sufficient to enable an* experienced auditor, having no previous connection with the audit, to understand (a) The nature, timing, and extent of the audit procedures performed to comply with the SAs and applicable legal and regulatory requirements, (b) The results of the audit procedures performed, and the audit evidence obtained, and (c) Significant matters arising....
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....in this case, is that the EP did not maintain the audit documentation in accordance with the SAs and SQC 1 27. The EP also contended that since it "was not required to audit the financial statements of the branch office of DHFL, there was no straight jacket application of the provisions of SA 230 ", which permitted the EP to adapt the standard as necessary in the circumstances when applied to audits of other historical financial information rather than financial statements. We find that while adaptations of SAs are permitted in certain cases, they should not be taken as a reason for deviating from the fundamental principles of audit documentation as detailed in the preceding paragraphs. 28. Keeping the above in mind, we have examined, in the interest of fairness, the additional documents added by the EP and have taken the evidence into consideration wherever it is supporting or corroborating the original audit documentation submitted to NFRA. However, we find that even the additional documentation submitted to NFRA was deficient in terms of the nature, timing and extent of the audit procedures performed, who prepared and reviewed the audit working papers (WPs) and the timing of t....
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....ot a mere technical and procedural formality but is a serious issue which strikes at the very root of the audit and may defeat the very purpose of the audit itself. Lack of sufficient documentation has been viewed seriously by national and international regulators as well. For example, in the matter of Bharat Parikh & Associates Chartered Accountants, dated 19-03-2019, the US audit regulator PCAOB took a serious view on the lack of sufficient documentation and imposed penalties and sanctions for violations including insufficient documentation. The PCAOB Order states "Audit documentation must contain sufficient information to enable an experienced auditor, having no previous connection with the engagement to (a) understand the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions reached, and (b) determine who performed the work and the date such work was completed as well as the person who reviewed the work and the date of such review ....... the documentation for each of those audits was insufficient to demonstrate the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions reached, including....
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....tor. They are to be adapted as necessary in the circumstances when applied to audits of other historical financial information. Branch auditors appointed under section 143(8) read with Section 139 of the Act are statutorily required to comply with the SAs since section 143(9) requires "every auditor" to comply with the SAs. The interpretation of Rule 12 (1) of Company (Audit and Auditors) Rules 2014 by the EP that ''for the audit of the branches of a company, the responsibility of auditor as provided in Section 143(1)- 143(4) are on the company's auditor and not on the branch auditor" is utterly misconceived and irrational reading of the law. The said rule, that states that "For the purposes of sub-section (8) of section 143, the duties and powers of the company's auditor with reference to the audit of the branch and the branch auditor, if any, shall be as contained in subsections (]) to (4) of section 143", only specifies that the company auditor and branch auditor (if there is one) must perform their duties and exercise their powers in accordance with sub-sections ( 1) to ( 4) of section 143, as outlined in the Act. It is perverse to interpret this provision to me....
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....of misstatements and the test of controls and based on the above contradictory evidence available, we observe that the unmodified opinion issued by the EP does not comply with SA 700. Hence, the charges in para 32 above stand proven. Non-Compliance with other SAs 38. The EP was charged with non-compliance with other SAs which include a. Non-compliance with para 6, 7, 8, 9 & 10 of SA 30013 as the EP failed in establishing an overall audit strategy and development of audit plan etc. in accordance with SA 300. The EP submitted an audit plan made for the year 2013-14 and stated that he" ..... had a properly documented audit plan available in the audit file for previous years. Therefore, documentation displaying an overall audit strategy and development of an audit plan for FY 2017-18 was felt not necessary, in view of the fact that it was not an audit of financial statements, and because there was room for the audit documentation to be adapted as necessary in the circumstances, as per SA 230". The replies are not acceptable since SA 300 requires the auditor to include in the audit plan the timing14 of the audit and to update and change the overall audit strategy and the audit plan....
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....emonstrated by documents included within the audit file" the EP states that the "audit file on record sufficiently demonstrates the process adopted by the Respondent". The replies show EP's disregard for professional standards and absence of professional behaviour on EP's part. Proper determination, application and revision of materiality are very basic to an audit. Para 5 of SA 320 makes it clear that "The concept of materiality is applied by the auditor both in planning and performing the audit and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor's report". Mandatory documentation requirements of SA 320 include the factors considered in the determination of materiality and materiality for the financial statements as a whole, the materiality level or levels for particular classes of transactions, account balances or disclosures, performance materiality and any revision of the materiality amounts as the audit progress. The audit documentation in the present case did not contain any of these details and hence the replies of the EP are not accep....
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....sample testing. In the absence of any evidence to show compliance with the determination of sample design, sample size and audit procedures performed on it, the contentions of the EP are not accepted. D. ARTICLES OF CHARGES OF PROFESSIONAL MISCONDUCT BY THE EP 39. Given the above-mentioned actions of commissions and omissions, it is established that CA Mathew Samuel did not comply with the stipulations in the Chartered Accountants Act, 1949 regarding the acceptance of the statutory audit engagement and showed gross negligence and absence of due diligence while accepting the appointment as an auditor that was legally invalid. In addition to accepting a legally invalid appointment, the EP also did not ensure the audit quality and was grossly negligent in performing his professional duties by not adhering to the requirements laid down by the relevant SAs. This led to the issuance of the audit report that displayed the absence of a sound basis and quality in the audit work. Specifically, the following failures on the part of EP CA Mathew Samuel as contained under the Articles of Charges in the SCN are established. a) Failure to ascertain from the audited Company whether the requir....
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....onclusion of the audit, there were substantial deficiencies in the Audit and abdication of responsibility on the part of EP, CA Mathew Samuel, which establishes the professional misconduct. Despite being a qualified professional, we find that the EP, CA Mathew Samuel has not adhered to the Standards of Audit. On the contrary, the EP has tried to cover up the deficiencies by resorting to arguments not supported by law or evidence. 44. The EP's flawed interpretation of the law, evident in the EP's convoluted logic and reading of the standards, shows a lack of understanding of legal principles and a tendency to undermine their proper application. This unprofessional attitude, particularly in the context of the audit of public interest entities, if allowed to persist, will cause severe harm to the interests of the users of the financial statements. Under the circumstances, we proceed to impose the sanctions keeping in mind the deterrence, proportionality, and signalling value of these sanctions. 45. As demonstrated by the discussions above, there are gaps in EP's understanding of SAs that need to be addressed. To enhance CA Mathew Samuel's skills as an auditor capable....