TaxTMI 
TaxTMI 
2024 (5) TMI 279
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....9; hereafter). This Order is divided into the following sections: A. Executive Summary B. Introduction and Background C. Major Lapses and Violations D. Findings on the Articles of Charges of Professional Misconduct E. Penalties and Sanctions A. EXECUTIVE SUMMARY 1) Reliance Home Finance Limited (RHFL) is a Non-Banking Finance Company (NBFC) listed on both the Bombay Stock Exchange and the National Stock Exchange. Mis Price Waterhouse & Co Chartered Accountants LLP (PW) was initially appointed as the auditor of RHFL for FY 2018-19. The Director General of Corporate Affairs (DGCoA), Ministry of Corporate Affairs (MCA), Government of India, vide its letter dated 29.05.2020 informed the National Financial Reporting Authority (NFRA) that PW had filed a report to MCA under section 143(12)[ Under section 143(12) of Companies Act, 2013 auditor is required to report any fraud identified in the company] of the Companies Act, 2013 (the Act) on 03.06.2019. PW then resigned from the audit on 11.06.2029, without issuing an audit report for FY 2018- 19. Mis Dhiraj & Dheeraj were appointed by the board of directors of RHFL on 29.06.2019 as statuto....
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....cludes that the Auditor failed to meet the relevant requirements of the SAs and violated the Act, and the Code of Ethics in respect of several significant areas of audit. In the areas of the audit identified in this Order, the Auditor was grossly negligent, failed to apply professional skepticism and due diligence, and did not adequately challenge the management assertions. Major violations proved in this Order are as follows: a) The Auditor did not exercise professional skepticism and perform risk assessment procedures to identify, assess and respond to the Risk of Material Misstatement (ROMM) due to fraud or error in respect of (a) RHFL 's loan disbursal (General Purpose Corporate Loans) to financially weak companies without appropriate business rationale, (b) Funds so disbursed being diverted/siphoned off to other group entities. b) The Auditor did not perform sufficient appropriate audit procedures in respect of verification of the company's assessment of (a) the going concern assumption, and (b) adequacy of the Expected Credit Loss (ECL) of Rs 278 crore on loans at amortised costs of n 6,259 crore, which included Rs 7849 crore of General Purpose Corpo....
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....nd impose penalties for professional or other misconduct of the individual members or firms of chartered accountants. 8) RHFL was required to prepare its Financial Statements for FY 2018-19 under Schedule III and other applicable provisions of the Act and Indian Accounting Standards (Ind AS) notified under the Companies (Accounting Standards) Rules, 2006. 9) We observe that RHFL, despite being a housing finance company regulated by the National Housing Bank (NHB), had advanced loans under the category 'General-Purpose Corporate Loan' (GPCL) to group companies with significant deviations from their lending policy. The outstanding amount of GPCL as of March 31, 2019, amounted to Rs 7,849.89 crore as per the financial statements. These loans were stated as secured by a charge on the current assets of borrowers. The majority of the Company's borrowers had undertaken onward lending transactions and the borrowings from the Company were used, inter a/ia, for repayment of financial obligations by some of the group companies. The previous auditor PW reported issues with the recoverability, end use and business rationale of these loans. Order in the matter of Statutory Audi....
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.... as auditor previously held by another chartered accountant after first communicating with him in writing. 12) The Auditor sought two extensions for submitting their response to the SCN which was granted. The Firm, the EP and the EQCR Partner, on 18.09.2023, submitted their replies to the SCN. The SCN also provided an opportunity for a personal hearing to the EP, EQCR Partner and the Audit Firm which was availed by them on 30.01.2024. The Auditor also made written submissions on 08.02.2024 in addition to the reply to the SCN and the oral submissions. All the written and oral submissions have been examined in detail before issuing this Order. C. MAJOR LAPSES AND VIOLATIONS 13) The major basis for charges in the SCN included client acceptance without complying with requirements of the law, failure to examine the merits of the significant matters reported by the previous auditor, use of management's experts in violation of SA 500 [SA 500, Audit Evidence], failure in the evaluation of the Going Concern and Expected Credit Loss (ECL) on loans, and absence of objective review by the EQCR Partner. 14) Replies of the Auditor to the charges in the SCN are examined and discus....
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.... a) The additional letters submitted along with the reply to SCN, did not form part of the Audit File submitted to us on the affidavit [Refer to paragraph on non-compliance with Paragraph 14 of SA 230 & SQC 1 which prescribes a maximum period of 60 days for completion of assembly of Audit File in Chapter on Audit Documentation]. These letters do not contain any acknowledgement from the recipients or proof of delivery. Compounded with this is the fact that the engagement acceptance letter and the two additional letters, submitted in the course of these proceedings, were addressed to different offices, viz, the Board of Directors, Executive Director & CEO, and Chief Financial Officer (CFO) respectively. Thus, these letters lack reliability and evidentiary value. More importantly, being qualified chartered accountants bound by the Code of Ethics and SAs, the Auditor knows very well that the engagement cannot be accepted without first communicating with the previous auditor. b) The following chronology of events makes it clear that the Audit Finn accepted the engagement before communication with the previous auditor and commenced the audit without waiting for a reasonabl....
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....tor should consider the integrity of the client by collecting information from existing and previous providers of professional accountancy services to the client and from other sources. The Audit File[WP "K.9. Client-Engagement Acceptance & continuance checklist"] did not contain evidence of examination of the integrity of the client, particularly, any information obtained, or attempted to be obtained, from the previous auditor. The above actions of the Audit Firm violate its quality policy, contained in the Quality Control Manual prepared as per the requirements of Paragraph 3 of SQC 1. This shows the absence of operating effectiveness of firm-level controls on acceptance of the engagement. 18) Based on the above, the charges in paragraph 15 stand proved. The Audit Firm and the EP are guilty of professional misconduct in terms of Clause 8 of Part-I of the First Schedule to the Chartered Accountants Act, 1949, paragraph 12(b) read with paragraph A21 of SA 300, paragraph 28 & 30 of SQC 1 and the Audit Firm's policy for accepting the Audit Engagement. 19) It is the admitted position [Paragraph B.7.5 of the Reply to the SCN by the Audit Firm] that the EQCR Partner participat....
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....mination of the replies and records, we observe that the Audit File does not contain sufficient evidence of due examination of the matters reported by PW to the Government. There is no documentation of the ADT 4 form filed by PW, that contains the basis for PW's allegations. The EP stated in this regard that ADT 4 was requested from PW, but it was denied by PW citing confidentiality. Hence the Audit Firm obtained from the "management" the "relevant observations" of PW and "evaluation of such observations by the management". We find that this action of the Audit Firm is in disregard of its professional duties and shows the absence of professional skepticism because of the following facts: a) In PW's NOC dated 05.07.2019, received by the Auditor, PW referred to its letter dated 18.04.2023 issued to RHFL. This letter contained the basis for the reporting of fraud by PW. Neither this letter nor a complete examination of the matters covered in this letter is found in the Audit File. b) Also, the management response to the queries raised by PW was not documented in the Audit File. The EP submitted the response of the management along with the replies to the SCN.....
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.... filing of ADT 4 by the previous auditor should not document the issues raised and perform adequate audit procedures on the same. This shows a total absence of professionalism and is gross negligence on the part of the new Auditor. This is discussed in detail in the following paragraphs. c) We also observe from the report of the expert [WP E. Checklists\E.4.Standards on Auditing\E.4.2.SA Working Paper\WP SA 240] appointed by the Audit Firm to examine the matters reported by PW that the expert obtained from RHFL all the communications between the Company and PW, including the ADT 4 form filed by PW and PW's letter dated 18.04.2019. Yet, the Audit Firm's documentation did not contain any reference to these key communications. d) There is no documented discussion amongst the ET members with an emphasis on material misstatement due to fraud, including how fraud might occur.[Paragraph 15 and 44 of SA 240 and Paragraph 10 of SA 315] There is no documentation of the significant decisions reached in this regard [Paragraph 44 of SA 240]. In the limited WP [K.12. Fraud Meeting Discussion] available, nothing is mentioned about the impact of matters reported by PW on ....
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....redit policy, end use of borrowings, the creditworthiness of borrowers, the high risk and low success rate of some borrowers, cash flow mismatch, absence of business plan for certain borrowers, deviations in approval, and non-monitoring of borrowers accounts. The business rationale for sanctioning such loans [paragraph 32(c) and A47 of SA 240] is not verified in all cases. h) There is no documentation for understanding how those charged with governance (TCWG) exercised oversight of management's processes for identifying and responding to the risks of fraud in the entity and the internal control to mitigate these risks [Paragraph 20 of SA 240]. i) WP SA 530.1 referred by the EP documents that 100% population needs to be tested for non-housing loans (GPCL). Later in the same work paper, the ET took less than three-fourths of the GPCL as the sample. The audit procedure performed is limited to verification of the arithmetical accuracy of the data given by the Company. Similarly, the Auditor contends that the evaluation of credit appraisal, authorization of loan disbursement, verification of end-use of funds, etc. was done on a test basis. However, sufficient subst....
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....isation of the omissions. Further, the above statements are evidence of the absence of professional skepticism, because the whole focus of the EP is on the second part of the statement of PW where PW states the absence of a satisfactory response from RHFL regarding the transactions. However, according to PW, the impact of these transactions, if remained unresolved, would "be significant, material and substantive to the financial statements". It was the professional duty of the Audit Firm to rule out any impact of these transactions on the financial statement assertions before concluding that there was no fraud or error. This required rigorous audit procedures, covering all the significant transactions pointed out by the previous auditor, with a focus on possible fraud factors as prescribed in SA 240, which is absent in this case. Any prudent auditor can understand the indications that the Company has attempted to depict irrecoverable loans as recoverable, thereby materially misstating the financial statements. Also, there were possible instances of siphoning off of money, indicated by irrational business decisions, multiple layers of transactions and borrowers having insufficient r....
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....r Agreement (ICA) for the resolution of its debt. e) Major shift in the primary business of the company from Housing Finance to Non-Housing Finance. 28) Paragraph 16 of SA 570 requires that when the events and conditions are present that may cast significant doubt on the entity's ability to continue as a going concern, the auditor has to obtain sufficient appropriate audit evidence through audit procedures to determine whether a material uncertainty exists. The procedures include the evaluation of management's plan for future actions (paragraph 16 (b) of SA 570) and if a cash flow forecast is prepared by the management, then analysis of this forecast by evaluating the reliability of underlying data and evaluating the adequacy of the underlying assumptions (paragraph 16 (c) of SA 570). 29) The minutes of the meeting with management recorded the management's views that the above events do not cast a material uncertainty. However, there is no further independent examination by the Auditor of these contentions of the management, as required by paragraph 16 of SA 570. Though the ET obtained the cash flow forecast prepared by the management, it did not perform ....
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....may need to consider a wide range of factors relating to current and expected profitability, debt repayment schedules and potential sources of replacement financing before it can satisfy itself that the going concern basis is appropriate. There are no such considerations in this case. 32) Assuming, but not admitting, that there is no material uncertainty as claimed by the EP, then paragraph 20 of SA 570 requires the auditor to evaluate the adequacy of disclosure in the financial statements where events or conditions have been identified that may cast significant doubt on the entity's ability to continue as a going concern. Note No. 17(d) of the Financial Statements contains disclosure on the Company's going concern assumption which does not fully disclose the events or conditions and the mitigation plan. The disclosure made by the Company neither discussed the details of financing arrangements such as the magnitude, timelines, the availability of refinancing etc. The Independent Auditor's Report included an 'Other Matter' paragraph on going concern which stated that the liquidity mismatch was resulting in delayed payment of bank borrowings and the Company'....
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....round 90% of RHFL's balance sheet size. In this regard, the EP and the Audit Firm were charged with failure to notice the deficiencies in the internal controls over ECL on the loans, deficiencies in the ECL model of the Company and material shortfall in ECL provisions. The EP and the Audit Firm were also charged with failure to perform planned audit procedures, despite identifying ECL as a Key Audit Matter (KAM). 37) In their reply, the EP and the Audit Firm referred to WPs at the audit planning stage [WP "K.2 - Audit Programme" and WP "K.5 Overall Audit Strategy"] in which it had noted the planned procedures in respect of ECL. All the WP references provided in the response to SCN primarily reflect the audit plan/strategy relating to ECL. The Auditor failed to show sufficient appropriate evidence to support the assertions in the financial statements relating to ECL. In the absence of adequate evidence, we conclude that the following omissions and commissions, as conveyed in the SCN, contributed to the absence of verification of ECL. a) There is insufficient evidence of substantive procedures performed to verify the ECL model. The WP ["2.ECL MODEL DEVELOPMENT.pdf] av....
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....A 705.2"] where the standard conditions were waived, eligibility was not as per norms, loan amount exceeded the maximum permitted, return on investments was below norms, no credit ratings, no ESCROW accounts and no cashflows/income. The ET also noted that "GPCL has been sanctioned to Newly Formed Entities (formed in 2018-19) without having Credit/business assessment/project report". Many borrowers did not have the financial strength to get such loans but the loans were disbursed. Therefore, all such loans disbursed during the year met the definition of Purchased or Originated Credit Impaired asset (POCI). However, the company did not recognise these loan assets as POCI thereby violating provisions of lnd AS 109 and Ind AS 107. Such loans were originated credit impaired and hence were required to account with a carrying value reflecting the lifetime expected credit losses as per Ind AS 109. A few instances noticed, to gauge the extent of misstatements, are given below. i) RHFL sanctioned loans of Rs. 50 crore to Hirma Power Ltd, and ~55 crore to Tulip Advisors Private Ltd in FY 18-19. The total exposure of these two Companies was shown as Rs 444.67 crore as per the ECL work....
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.... are also absent in this WP. The KAM also mentions the engagement of specialists to test the ECL model. However, no such experts were engaged as per SA 620. There is also no documentation in the Audit File regarding the skills and competencies of the ET members who were conversant with ECL calculations. This is in contravention of paragraph 14 of SA 540 as well. f) In the Audit Report on internal financial controls over financial reporting, a qualified opinion is provided stating that the company's internal financial control system over financial reporting was not operating effectively for "General Purpose Corporate Loan Product" due to weak credit appraisal and loan sanctioning mechanism. However, there is no assessment of the consequences of this material weakness on ECL calculations. There is also no separate test of the design, implementation, and operating effectiveness of internal controls on ECL as required by SA 540 and SA 315. g) The Company provided the percentages of average Probability of Default (PD) rates, Loss Given Default (LGD) rates, and the ECL amount. However, other than checking the arithmetical accuracy of the calculations [WP 4.14, 4.2, ....
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....US audit regulator PCAOB imposed sanctions on an auditor for failure to appropriately evaluate the reasonableness of a discount rate used in developing the valuation estimate. The sanctions included revocation of registration of the firm, restrictions in acting as EP and a civil money penalty of $30,000. In the matter of Martin Lundie, CPA [PCAOB Release No. 105-2022-040 December 22, 2022] (Partner, EY Canada), PCAOB imposed sanctions for failing to sufficiently test the assumptions underlying the estimate and by failing to sufficiently test the accuracy and completeness of data on which that estimate was based. Sanctions included debarring from being an associated person of a registered public accounting firm and a civil money penalty of $65,000. C.5. Modification of the Audit Opinion on the Financial Statements 40) The Auditor issued a qualified opinion on the basis that sufficient appropriate audit evidence was not available to ascertain the recoverability of principal and interest, including the time frame of recovery, of overdue amounting to Rs 566.30 crore of General Purpose Corporate Loans as on March 31, 2019. In this regard, the EP and the Audit Firm were charged wit....
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....ualification) was Rs 107 crore. This ECL of no? crore is not a subject matter of qualification. However, there is no basis for the accuracy of ECL, which should be a forward-looking estimate, when the ET was unable to obtain evidence on the recoverability of the loan balances. d) The Audit File[WP 'SA 705.2 Significant Deviation.pdf and WP "WP SA 705.2 Observations on GPCL"] lists significant deviations from the lending policy, while sanctioning loans to 45 borrowers whose outstanding GPCL amounted to Rs 7490 crore. These borrowers were evidently credit impaired. The listed deviations also included factors such as not registering the charges, sanction of loans to new entities without any business assessment, irregularities/deviations in the approval process, discrepancies in credit appraisal, no recovery steps despite defaults in repayment, non-monitoring of borrower accounts post-disbursal, etc. The management has failed to provide any explanations regarding the recoverability of the entire outstanding balance. So, there is not enough basis for the ET to conclude that the absence of sufficient evidence is limited only to the principal and interest outstanding on some ....
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....addition to the legal experts (management's expert) mentioned above the Audit Firm also appointed a legal expert (auditor's expert) to examine the same matter. In this regard, The EP and Audit Firm were charged with failure to comply with the requirements of SA 500 [SA 500, Audit Evidence] and SA 620 [SA 620, Using the Work of an Auditor's Expert] regarding using the work of the management's expert and auditor's expert respectively. Consequently, they were also charged with failure to exercise due diligence and the required professional skepticism as mandated by SA 200. 45) The EP and the Audit Firm submitted that they did not consider any of the legal opinions as the basis for concluding the matter of fraud and hence compliance with the requirements of SA 500 and SA 620 does not arise. We observe that the submissions are contradictory to the facts, as explained hereafter. a) Note 54 discloses a material matter that has a pervasive effect on the financial statements. The Auditor concurred with this note explicitly in their audit report as explained in the previous paragraphs of this Order. As per note 54 quoted above, the basis for ruling out fraud, ....
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....btained by the Auditor's expert were not even seen by the ET. There is no documentation evaluating the adequacy of the expert's work or their findings' relevance and reasonableness. No audit procedures as required by SA 620 [Paragraph 9 to 13 of SA 620] were documented in the Audit File. 46) In light of the above, it is clear that the Auditor has failed to carry out adequate audit procedures. Its purported independent examination of the matters was significantly deficient in arriving at a reasonable conclusion on the matter of suspected fraud. The Auditor's said opinion is neither supported by the works of the management's expert nor the auditor's expert. Consequently, we conclude that the Audit Firm issued a misleading audit report. Hence, the charges in paragraph 44 above are proved. C.7. Engagement Quality Control Review (EQCR) 47) The EQCR Partner and the Audit Firm were charged with failure to ensure compliance with SA 220 [SA 220, Quality Control for an Audit of Financial Statements] and SQC-1 because of the EQCR Partner's failure to objectively evaluate the significant judgments and conclusions of the ET. The EQCR Partner failed to conduc....
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....explained in the previous paragraphs of this Order, the cryptic documentation of the EQCR Partner did not evidence compliance with all the requirements of SA 220 and the Audit Firm's responsibilities as per SQC 1. 50) In light of the above, it is proved that the EQCR Partner has failed to exercise due diligence and carry out adequate audit procedures as required by SA 220 and SQC 1. The Audit Firm did not supervise the work of the EQCR adequately, leading to the serious omissions of the ET remaining unquestioned. Hence the charges in paragraph 4 7 above regarding non-compliance with SA 220 and SQC-1 stand proved. 51) We also observe that such lapses have been viewed seriously by international regulators as well. For example, PCAOB [PCAOB release no 105 2015 001 dated 12.01.2015], the US Regulator, charged Grant L. Hardy (CPA) for his failure in connection with his role as Engagement Quality Reviewer ('EQR' hereafter) in the audit of financial statements of some of the issuer clients and noted that "Hardy violated PCAOB Auditing Standard No. 7, Engagement Quality Review ("AS 7") by providing his concurring approval of issuance without performing with due profession....
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....mination of sanctions, given the admission and commitment by the Auditor. D. FINDINGS ON THE ARTICLES OF CHARGES OF PROFESSIONAL MISCONDUCT 55) As discussed, the Auditor has made a series of departures from the Standards and the Law, in conduct of the audit of Reliance Home Finance Limited for FY 2018-19. Based on the above discussion, it is proved that the Audit Firm issued an audit opinion on the Financial Statements without adequate supporting evidence. Based on the discussion and analysis, we conclude that the EP, EQCR Partner and the Audit Firm have committed Professional Misconduct as defined in the Act, as below: a) The Audit Firm Mis Dhiraj & Dheeraj and the EP CA Piyush Patni 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 i....
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....iciently material to negate the expression of an opinion". This charge is proved as the Auditor 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 as explained in paragraphs C.1 to C. 7 above. e) Mis Dhiraj & Dheeraj and CA Piyush Patni 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 a CA 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 Auditor failed to conduct the audit in accordance with the SAs as explained in paragraphs C.1 to C. 7 above but falsely reported in their audit report that the audit was conducted as per SAs. f) Mis Dhiraj & Dheeraj, CA Piyush Patni and CA Pawan Kumar Gupta committed professional misconduct ....