TaxTMI 
TaxTMI 
2023 (12) TMI 1250
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Year 2013-14' hereinafter). (The EP and the Firm are collectively called 'Auditors' hereafter). 2. This Order is divided into the following sections: A. Executive Summary B. Introduction & Background C. Issue of jurisdiction and procedures D. Major lapses in the Audit and Charges in the SCN E. Finding on the Articles of Charges of Professional Misconduct by CA Shyam Malpani F. Penalty & Sanctions A. EXECUTIVE SUMMARY 3. Central Economic Intelligence Bureau ('CEIB' hereafter), Ministry of Finance, Government of India vide letter dated 09-09-2022 shared information about irregularities committed by the SKNL and its Auditors. After preliminary examination, NFRA Suo motu initiated investigations into the professional conduct of the statutory auditors of SKNL under Section 132(4) of the Companies Act 2013 ('CA 2013' hereafter). SKNL was a listed company during relevant period hence comes under NFRA domain. A Show Cause Notice was issued to M/s SMMP & Company and CA Shyam Malpani. 4. NFRA's investigations inter alia disclosed that CA Shyam Malpani - the SKNL's Auditor for the FY 2013-14....
X X X X Extracts X X X X
X X X X Extracts X X X X
....tor implementation and enforce compliance of the auditing and accounting standards and to oversee the quality of service of the professions associated with ensuring compliance with such standards. NFRA is empowered under section 132 (4) of the CA 2013 to investigate for the prescribed classes of companies [As defined in Rule 3 of the NFRA Rules 2018] , the professional or other misconduct and impose penalty for proven professional or other mis­ conduct of the individual Chartered Accountants or firms of Chartered Accountants. 7. The Statutory Auditor, whether an individual Chartered Accountants or a firm of Chartered Accountants, is appointed by the members of companies as per the provision of section 139 of the CA 2013. The Statutory Auditors, including the Engagement Partners ('EPs' hereafter) and the Engagement Team that conduct the Audit are bound by the duties and responsibilities prescribed in the CA 2013, the rules made thereunder, the Standards on Auditing ('SA' hereafter), including the Standards on Quality Control ('SQC' hereafter) and the Code of Ethics. Violation of these constitutes professional or other misconduct, and is punishable with....
X X X X Extracts X X X X
X X X X Extracts X X X X
.....2022, they raised legal & procedural issues and requested NFRA to drop the proceedings against them. On 03:01.2023, NFRA again asked them to submit the Audit File within 15 days. On 17.01.2023, the* Auditors again sought 15 days' time citing fairness of justice. On 18.01.2023, Advocate of the Auditors intimated that they had filed a WP in the Hon'ble High Court, Mumbai, hence no action be taken in this matter. On 03.02.2023, NFRA again asked the Auditors to submit Audit File for FY 2013-14, as there was no stay from Mumbai High Court on NFRA's proceedings. Yet the auditors did not submit the audit file. In these circumstances, based on examination of the materials on record including annual financial statement of the company, NFRA issued a Show Cause Notice ('SCN' hereafter) on 23.05.2023 under section 132(4) of the Act, to the Auditors charging them for the following professional misconduct: a) Expression of opinion on financial statements of a business or enterprise in which the auditor has a substantial interest. This charge of misconduct was against CA Shyam Malpani. b) Failure to exercise due diligence and being grossly negligent in the c....
X X X X Extracts X X X X
X X X X Extracts X X X X
....NL for relevant period; and (d) Audit Report including CARO Report issued by the Auditors to the members of SKNL; This request of the Auditors was unusual as the e documents are expected to be available with them being statutory auditors. Yet we went ahead and provided to the Auditor the Annual Report of SKNL containing Audit Report and CARO report. 12.3 So far as the Audit File was concerned, the Auditors did not submit it. It was not very clear from their reply whether they had the audit file. Therefore, on 04.08.2023, we asked them to provide an affidavit about availability of the Audit File and in case it had been destroyed, then the date of destruction of the file was to be provided. On 16.08.2023, the Auditors submitted a consolidated reply to SCN dated 23.05.2023 along with an affidavit by CA Shyam Malpani stating that he neither had the Audit File nor had the exact date of destruction of the Audit File. 12.4 Since the Auditors did not submit the Audit File, we analysed the Audit Reports and Financial Statements available with us and observed that CA Shyam Malpani had given qualified audit report with eleven (11) qualifications on Standalo....
X X X X Extracts X X X X
X X X X Extracts X X X X
....iously further decisions will be neither permissible nor necessary. If the NFRA on the other hand holds that it has jurisdiction, then it cannot be expected to stop at that. It must then proceed to decide all other issues and return final findings. 10. We clarify that we do not expect the order on jurisdiction to be passed first unless the Authority finds in favour of the present Petitioners in which case it will be the only order to be passed". It may be mentioned here that SLPs were filed against the above order of the Hon'ble High Court Bombay by other petitioners in the tagged cases, which were dismissed by Hon'ble Supreme Court vide its Order dated 10.07.2023. 14. The Auditors in their submissions contended that they had accepted the appointment as Joint Statutory Auditor of SKNL on 06.08.2013 whereas NFRA was constituted on 01.10.2018 and section 132(4) of the CA 2013 came into effect on 24.10.2018. Therefore, NFRA does not have any retrospective powers to investigate this case. 15. We have carefully gone through the replies submitted by the Auditors. At the outset it is stated that the Statutory Audit of a company under the Companies Act, 2013....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ndatorily complied with from the date of their respective applicability, while conducting statutory audits. Hence, no new obligation is created on the EP by creation of NFRA as these standards were required to be mandatorily followed by the EP even prior to NFRA's establishment. Section 132(4) designates NFRA as the forum for determination of professional misconduct. The setting up of a new forum i.e. NFRA does not impose any new duties or obli­gations on Auditors. NFRA only evaluates their professional work in accordance with the Standards on Auditing and statutory requirements prevailing at the time of the audit. Therefore, there is no bar on NFRA's jurisdiction over the cases of professional or other misconduct committed prior to establishment of NFRA. 19. Section 132(4) of the Companies Act gives exclusive jurisdiction to NFRA in matters of professional or other misconduct. Hence, all cases that fall within the jurisdiction of NFRA will be excluded from the jurisdiction of other bodies. Additionally, Rule 10(3) of the NFRA Rules, 2018, states that on the commencement of the said rules, the action in respect of cases of professional or other misconduct against aud....
X X X X Extracts X X X X
X X X X Extracts X X X X
....sional or other misconduct committed by any member or firm of Chartered Accountants registered under the Chartered Accountants Act, 1949 in such manner as may be prescribed. The proviso to Section 132(4)(a) creates a bar on any other institute to initiate or continue any proceedings where the NFRA has initiated an investigation under this Section. This clearly implies that even for matters of professional or other misconduct committed prior to the coming into force of Section 132(4), NFRA can initiate an investigation, which would disentitle any other institute such as the ICAI from continuing their proceedings in such matters of misconduct. The expression "such matters of misconduct" would clearly mean misconduct which has been committed prior to 24.10.2018 i.e. the date of coming into force of Section 132(4) and qua which proceedings were already underway by the ICAI and with effect from 24.10.2018, the said proceeding would be in the exclusive domain of NFRA. 22. Further, Section 132(4)(a) itself speaks of "matters of professional or other misconduct commit­ ted by any member or firm of chartered accountants, registered under the Chartered Accountants Act, 1949" (Emphasis....
X X X X Extracts X X X X
X X X X Extracts X X X X
....r is not relevant to the present case due to following reasons : * The above case pertains to Rule 12 of Chartered Accountants (Procedure of Investigations of Professional and Other Misconduct and Conduct of Cases) Rules 2007, which empowers Director ICAI to refuse to entertain a complaint made after more than seven years from the date of alleged misconduct, if Director ICAI is satisfied that there would be difficulty in securing evidence. We note that there is no blanket provision in the above rules that no com­ plaint shall be entertained after seven years; and there is also no such provision in the case of proceeding before NFRA under the CA, 2013. Moreover, in the present case, the evidence is otherwise available to support charges against the Auditors. Therefore, the case of Wholesale Trading is not applicable. * Moreover, in the case of Wholesale Trading the High Court had held that the complainant, being a private individual, had no cause of action, whereas in the present case public interest is involved. 27. Regarding the issue of procedure raised by the auditors, the required process under Section 132 of the Act has been followed, as the SCN has be....
X X X X Extracts X X X X
X X X X Extracts X X X X
....he postal address and email address of NFPL are the same as that of the EP. This indicates that the EP has a financial interest in SKNL through NFPL. As such, he was not eligible for appointment as statutory auditor of SKNL. 30. The EP's replies are summarized hereunder: a) He accepted the appointment of statutory auditor of SKNL on 06.08.2013 and started the audit activity after getting a no-objection certificate dated 11.08.2015 from previous auditor. b) His appointment as auditor of SKNL is covered under section 226 of the Companies Act 1956 (CA 1956) and he did not violate CA 1956 as he did not have voting rights in SKNL. c) The grounds for ineligibility of appointment as an Auditor were substantially and significantly widened in the Companies Act, 2013 (CA 2013), which came into effect from 01.04.2014. d) His appointment as auditor of SKNL was governed by CA 1956 and not by CA 2013, and the provisions of section 141(3)(d) of the CA 2013 have not been violated as he himself did not have any shares/securities/interest in SKNL. e) His qualified report stands as an unequivocal affirmation of the auditor's independence. ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... (iii) ... ; (e) ... ; (f) .. ; (g) .. ; (h) ..; (i) .. ". In this case, the EP and his relatives were having interest in the company by holding 476474 equity shares of SKNL through their family owned company NFPL, which had same address as that of the EP. In NFPL, the EP, his wife and two sons have equal shareholding i.e., 25% each. The EP performed audit of SKNL while having interest in the company and therefore violated Section 141(3)(d)(i) of the Companies Act 2013. 33. Further, for the sake of argument, even if we accept the contention of EP that he is governed by CA 1956, the relevant Section 226(3)(e) of the CA 1956 too disqualifies a person from being appointed as an auditor of a company if he holds security of the company. Security has further been defined as an instrument with voting rights. The EP and his family had voting rights by virtue of holding 476,474 equity shares of SKNL through NFPL. Since there is nothing in wording of the Section 226(3)(e) of the CA 1956 which restricts itself to only direct holding of securities, the only inescapable conclusion that can be drawn is that he owned the securities ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... member of the assurance team; or (c) Remove the member of the assurance team from the assurance engagement The clause (n) of the Definitions in the Code of Ethics defines Financial Interest as "An interest in an equity or other security, debenture, loan or other debt instrument of an entity, including rights and obligations to acquire such an interest and derivatives directly related to such interest". The clause (n) of the Definitions in the Code of Ethics defines Direct Financial Interest as "Owned directly by and under the control of an individual or entity (including those managed on a discretionary basis by others)". Para 290.104 of the Code of Ethics states inter alia that "In evaluating the significance of any threat to independence, it is important to consider the degree of control or influence that can be exercised over the intermediary, the financial interest held, or its investment strategy. When control exists, the financial interest should be considered direct. " In the instant case, CA Shyam Malpani was holding equity shares of the auditee company (SK.NL) through a family owned private company, thus he had the control over the ownership of equity....
X X X X Extracts X X X X
X X X X Extracts X X X X
....g opinion in Independent Auditor's Report dated 06.10.2015 - Standalone Financial Statements (SFS) and Independent Auditor's Report dated 15.10.2015 - Consolidated Financial Statements (CFS) 39. After the EP filed an affidavit to the effect that he does not have the Audit File, the Financial Statements and Independent Auditor's Reports is were analysed by NFRA to assess the appropriateness of the Audit Opinions expressed by the EP in the Independent Auditor's Reports. It was prime facie observed that CA Shyam Malpani did not comply with SA 705 as he had given qualified audit reports with eleven qualifications on SFS and fifteen qualifications on CFS. The qualification can be given only if the effect of such qualification is material but not pervasive. However, a perusal of the qualifications in the Audit Reports and the information available in the Financial Statements of SK.NL for relevant period indicates that the effect of qualifications in the Audit Reports was material and pervasive as it covered substantial portion of sales, purchases, trade receivables, trade payables, inventories, provisions, interest on loans, share capital etc. Therefore, the appropriat....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... in SFS & CFS) pertains to understatement of loss of SKNL and other current liability due to non-accounting of interest of Rs 721 crores (SFS) and Rs 981 crores (CFS) on loans classified by lenders as Non-Performing Assets. B) In order to bring home the materiality and pervasiveness of these items mentioned in the above-mentioned qualifications, the qualified amounts and their relative percentage are mentioned in the Table 1 below: Table-1 Rs in crores Sr No. Particulars Amount in qualified opinion and its relative percentage STANDALONE FINANCIAL STATEMENTS CONSOLIDATED FINANCIAL STATEMENTS 1 Sales 5133 6867 Less: Sales Return 1411 2355 Net sales 3722 4512 Percentage of sales amount qualified to total sales of Rs 3727 crores (SFS) & Rs 5014 crores (CFS) 99.87% 89.98% 2 Purchase 4180 6384 Less: Purchase Return No qualification 206 Net Purchase 4180 6179 Percentage of purchases amount qualified to total purchases of Rs 4225 crores (SFS) & Rs 6357 crores (CFS) 98.91% 97.19% 3 Trade Re....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ed opinion on following matters:- i) Non-inclusion of financial statements of 14 out of 20 overseas subsidiaries in the CFS, in view of liquidation of these subsidiaries and consequential inability of auditor to as­ certain its financial impact on the loss, assets and liabilities of CFS. ii) Inclusion of unaudited financial statements of seven subsidiaries as approved by the Board of Directors of respective companies, out of which two subsidiaries' financial statements were for the period ending 30.06.2014 and five subsidiaries' financial statements were for the period ending 31.03.2014. These financial statements reflected total assets of Rs 349 crores, total revenue of Rs 246 crores and cash inflow of Rs 15 crores. The information with respect to disclosures to be made in the Notes to Financial Statements as required under various statues/Accounting Standards in relation to these subsidiaries were not available (CFS). iii) Inability to verify and comment on the existence, valuation and recoverability of assets, accurate quantification and reporting of liabilities, accuracy and correctness of income and expenditures of Rs 32 crores, ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....g serious conflict of interest and in not giving appropriate audit opinions. We therefore conclude that CA Shyam Malpani has committed Professional Misconduct as defined under Section 132 (4) of the Companies Act 2013 in terms of section 22 of the Chartered Accountants Act 1949 (CA Act). As per the clause 7 of Part I of the Second Schedule of the CA Act, an EP is guilty of professional misconduct if he "did not exercise due diligence and was grossly negligent in the conduct of his professional duties". It has been established that CA Shyam Malpani accepted the appointment as auditor of SKNL despite having ownership interest in the shares of the auditee company i.e. SKNL and failed to form audit opinions in accordance with the SA 705, as explained in Section - D above. Since the EP compromised his independence and failed to recognize and report the pervasiveness of the deficiencies of the financial statements, his conduct undoubtedly falls into the category of lack of due diligence and gross negligence. Therefore, we hold that the charge of professional misconduct on the part of the EP on this account is proved. 44. Internationally also, similar cases of Auditor's conflict of....