TaxTMI 
TaxTMI 
2023 (12) TMI 1250
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....P 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 failed to meet the relevant requirements of the Standards on Auditing ('SA' here....
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....ee 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 penalty prescribed under section 132 (4) (c) of the CA 2013. 8. NFRA suo motu started action un....
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....in 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 conduct of professional duties. This charge of misconduct was against Mis SMMP & Company & CA Shyam Malpani - Proprietor of Mis Shyam Malpani & Associates. c) Failure to supply the ....
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....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 Standalone Financial Statements (SFS) and fifteen (15) qualifications on Consolidated Financial Statements (CFS), and the effect of these qualifications was material and pervasive as it covered substantial proportion of sales, purchases, trade receivables, trade payables, inventorie....
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....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 must be conducted in accordance with that law. The Accounting Standards and Standards on Auditing have been de­ fined in the Companies Act, 2013. Accounting Standards are prescribed by the Central Government under Section 133 of the Companies Act, 2013. Section 143(9) of the Act mandates an auditor to comply with the auditing....
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....ination 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 auditors of companies referred to in Rule 3 shall be initiated by Authority and no other institute or body shall initiate any such proceedings against such auditors. Thus, NFRA has exclusive jurisdiction in matters of professional or other misconduct. It could not have been the intent of the legislature to leave a regulatory gap in respect o....
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....tion. 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 supplied). So obviously, the Authority has jurisdiction over misconduct committed in the past. 23. Further, any presumption against retrospective applicability would arise when a vested right is sought to be impaired. The explanation to Section 132(4) would clearly reveal that the subject matter of investigation and penalty under this provisi....
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...., 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 been issued after recording reasons and suo motu recognition of the apparent misconduct by the Auditor. Multiple opportunities for hearing and for submissions have been afforded to the Auditors in compliance with the principles of natural justice. The Auditors have fully availed these opportunities by presenting their submissions in writing as well as making oral submissions b....
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....tting 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. f) In a similar case of CA Narayan Balkrishan Toshniwal, ICAI vide Order dated 7th December 2022, held that it has been explicitly specified in the Code of Ethics published by ICAI that substantial interest would be deemed to exist only if a member has a stake in the equity in business entity exceeding 20% and exonerated the auditor from the charge of professional misconduct falling within the meaning of Item (4) of Part I of the....
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....nt, 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 of the auditee company through NFPL and thereby ran afoul of the Section 226(3)(e) of the CA 1956 as well. 34. Further, by holding equity shares of the auditee company- SKNL, CA Shyam Malpani has com­ promised his independence. It is fundamental for an auditor to maintain his independence as has been provided in SQC 1, SAs and the Code of Ethics mentioned below: Para 18 of SQC 1 states, "The firm should establish policies and procedures designed to provide it with reasonable assurance that the firm, its personnel and, where applicable, others subject to independ....
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.... 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 shares of SKNL; and in turn had direct financial interest in the Auditee company - SKNL. Therefore, in terms of para 290.105 of the Code of Ethics quoted above, he was required to either dispose of direct financial interest in SK.NL or to resign as auditor of SK.NL. The EP did not take any of the above actions as neither shares of SKNL held by NFPL were disposed of, nor did he resign as the statutory auditor of SKNL. 36. An Auditor's Independence from the auditee safeguards the Auditor's ability to form an audit opinion without being affected by influences that might compromise that opinion. Independence enhances the A....
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....een 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 appropriate Audit Opinions in such a case would either be Adverse Opinions or the Disclaimer of Opinions. The Qualified Audit Opinions were not appropriate in this case. Therefore, vide letter dated 25.08.2023, the EP was charged for noncompliance with SA 705. 40. In response to the letter dated 25.08.2023, the main contentions of -the EP are as follows: a) He does not have any documents relating to the audit of SK.NL for FY 2013-14, therefore he is unable to offer a response to this charge. b) The evaluation of financial statements and annual report of SK.NL at a later date, when more information is available, is hindsight bias. He referred the Ju....
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....sp; 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 Receivable 1831 2883 Percentage of Trade receivable to balance sheet size of Rs 3344 crores (SFS) & Rs 5549 crores (CFS) 54.76% 51.95% 4 Inventories 552 1371 Percentage of Inventories to balance sheet size of Rs 3344 crores (SFS) & Rs 5549 crores (CFS) 16.51% 24.71% 5 Trade Payable 166 571 Percentage of Trade Payable to balance sheet size of Rs 3344 crores (SFS) & Rs 5549 crores (CFS) 4.95% 10.29% 6 Non provision of interest on NPA loans 721 981 6 A Percentage of Non provision of interest on NPA loans to balance sheet size of Rs 3344 crores (SFS) & Rs 5549 crores (CFS). (for liability) 21.57 17.68% 6B Percentage of Non provision of interest on NPA loans to loss of Rs.1858 crores (SFS) & Rs.3653 crores (CFS). (for expenses) 38.82%....
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....g 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, Rs 166 crores, Rs 1 crore and Rs 17 crores in respect of Assets, Liabilities, Income and Expenditures respectively (CFS). iv) Sale of pledged shares of promoters worth Rs 127.59 crores (both SFS & CFS) by lender Banks. v) Non provision in respect of long term investment of Rs 178.88 crores in foreign step down subsidiary (both SFS & CFS) and Goodwill of Rs 119.29 crores (CFS), which went into financial reconstruction and consequential impact on investment and loss of SKNL. vi) Non confirmation of balances of banks/financial institutions of Rs 2316.82 crores in SFS and Rs 3961.21 crores in CFS; and Rs 0.28 crore current account balances in CFS. vii) Adjustment of outstanding balances of trade payables with trade receivables (both SFS & CFS). viii) Write down of inventories and impairment of fixed assets was not done and its impact is not quantifiable as physical verification of inventor....
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....k 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 interest with the auditee company has been viewed seriously. The US Audit regulator- Public Company Accounting Oversight Board (PCAOB)- in the matter of Wanen Averett, LLC [PCAOB Release No. 105-2023-022 August 29, 2023] has observed that" Rule 2-01 (b) of the Com­ mission's Regulation S-X provides that an accountant is not independent of an audit client if, at any point during the audit and professional engagement period, "the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement. " In applying this standard, it is appropriate to "look in the first instance to whether a relationship or the provision of a service: creates a mutual or conflicting interest between the accountant and the audit client." In this case, PCAOB imposed a penalty of$ 2,00,000 on....