TaxTMI 
TaxTMI 
2023 (8) TMI 358
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....Misconduct E. Penalty and Sanctions A. EXECUTIVE 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 (EP) in the audit of two branches 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 (EP) 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 Sam Varghese, who was the EP for the audit of two of these 17 branches at Koehl and RPU Kochi. 2. NFRA's investigations revealed that th....
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....by 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 Section 132 (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 Branch Auditors' Report" for nearly 250 branches, under Section 132(4) o....
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....he 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 Kochi and RPU Kochi, Audit Scope and Plan for FY 2013-14, Attendance Sheet, Cash Verification, Deposit Details, Stamp Verification, 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 bran....
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.... have been no exemption for 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 Charter....
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....pecifically 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 o....
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.... 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 two Branches 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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....th 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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.... 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 skepticism 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 the natur....
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....umented. 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 A5 of SA 230 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 during....
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.... 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 the additional documents added by the EP in the interest of fairness, and have taken the evidence into consideration wherever it is supporting or corroborating the original audit documentation submitted to NFRA. However, the conclusion is inescapable that 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 timin....
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....echnical 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 in those area....
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.... 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 "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 sub-sections (1) 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 mean that the branch a....
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....absolute disregard to the quality of audit. Moreover, the audit plan now submitted by the EP was not forming part of the Audit File for 2017-18. Such contentions of the EP are against the fundamentals of SA 230 that require the maintenance of an Audit File that can enable an experienced auditor having no connection with the audit to understand the nature, timing and extent of the audit procedures performed to comply with the SAs. To evidence compliance with the requirements of the SAs, it is the fundamental stipulation of SA 230 that the auditor shall assemble the audit documentation in one audit file (and not multiple audit files of different years). b. Non-compliance with para 5, 6 & 11 of SA 31516 and para 1, 5 & 6 of SA 33017 as the audit file lacks any documentation regarding the performance of risk assessment procedures for material misstatements at the financial statement level and assertion level and response to such risks etc. The EP submitted that the "risk of material misstatement, in the Trial Balance, was only with respect to expenses incurred, as no other line item qualified to be tested for risk of material misstatement because of the accounting model of the company....
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....& 9 of SA 50020 in not designing and performing audit procedures to obtain sufficient appropriate audit evidence and not evaluating the reliability of information produced by the company. The EP replied that "it is a matter of judgment for the auditor to design the audit procedure to obtain audit evidences" and stated that SA 500 has complied. The replies are not accepted since there is no evidence in the Audit File of designing and performing audit procedures, such as an audit plan, the substantive procedures performed and the conclusions drawn. f. Non-compliance with para 6 of SA 52021 relating to the design and performance of analytical procedures. The EP submits that SA 520 is not applicable since it is not a financial statement audit. The reply is not accepted since, as explained earlier in this order, the SAs are applicable for the branch statutory audit also. g. Non-compliance with para 4, 6, 7, 8 & 9 of SA 530 relating to the determination of sample design, sample size and required audit procedures. The EP states that the "basis of selection of sample was defined in the appointment letter itself, and the skills of judgment and competence of the auditor were applied to dra....
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.... the Second Schedule to the CAs Act); c) Failure to obtain sufficient information which is necessary for the expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion, because of the lapses and omissions as explained and proved in part C2 above, (As per Section 22 and Clause 8 of part I of the Second Schedule to the CAs Act); and d) Failure to invite attention to material departure from the generally accepted procedures of audit applicable to the circumstances of the audited Company, because the BP certified in the report that the audit was done as per SAs mandated under section 143 of the Act and committed the lapses and omissions as explained and proved in part C2 above (As per Section 22 and Clause 9 of Part I of the Second Schedule to the CAs Act). Thus, we find that BP Sam Varghese committed professional misconduct, as defined in the respective clauses of the CAs Act, the meaning of which is conceived under Section 132 ( 4) of the Companies Act as amounting to professional misconduct. E. PENALTY AND SANCTIONS 39. Section 132(4) of the Companies Act, 2013 provides for penalties in a case where professional misconduct is....
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....violations and principles of proportionality and keeping in mind the deterrence, proportionality, signalling value of the sanctions and time required for improvement in knowledge gaps we, in the exercise of powers under Section 132(4)(c) of the Companies Act, 2013, proceed to order the following sanctions: i. Imposition of a monetary penalty of Rs 100,000 (One Lakh) upon CA Sam Varghese; ii. CA Sam Varghese is debarred for one year 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. 46. This order will become effective after 30 days from the date of issue of this order. --------------- Foot Notes 1 As defined in para 6 of SA 230 2 The general meeting may authorise the Board of Directors to make the appointment in consultation with companies auditor. 3 As per Ministry of Corporate Affairs Circular No. 7/2014, dated 01-04-2014, the equivalent sections of the Companies Act 2013 for the above sections of the Companies Act 1956 are sections 139 and 140. 4 SA 210, Agreeing the Terms of Audit Engagements. 5 Para 15 and 16 of SA....