2023 (12) TMI 1250 - NFRA - Companies Law

Professional misconduct - Auditor's conflict of interest with the auditee company - Acting as statutory auditor of SKNL while holding or controlling shares of SKNL in violation of section 141 of the Companies Act 2013 section 226(3)(e) of the Companies Act 1956 resulting in failure to maintain independence of auditor - Non-compliance with para 7 to 9 of Standard on Auditing (SA) 705 - penalties and sanctions - HELD THAT - It is clear that CA Shyam Malpani had violated the Companies Act 1956, the Companies Act 2013, SQC1, SA 220 and SA 705 by performing this audit despite having serious conflict of interest and in not giving appropriate audit opinions. It is therefore concluded 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 - 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, the charge of professional misconduct on the part of the EP on this account is proved. Internationally also, similar cases of Auditor's conflict of interest with the auditee company has been viewed seriously. In this case the audit done by the EP related to SKNL which was a large public listed company and involved interest of large number of shareholders and other stake holders such as banks, creditors etc. It is critical that the auditor and the EP performed their job with due diligence to give assurance to the investors and stakeholders on true and fairness of the financial statements and thereby protect public interest. Any default on this account impacts and jeopardizes the larger public interest which needs to be considered while determining the quantum of punishment. Considering the nature and seriousness of violations and principles of proportionality, in the exercise of powers under Section 132 (4) (c) of the Companies Act, 2013, the sanctions ordered - a monetary penalty of Rupees Five Lakh imposed upon CA Shyam Malpani. In addition, CA Shyam Malpani is debarred for a period of Five years 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. Application disposed off.

Summary

Issues Involved:
1. Jurisdiction and Procedures
2. Major Lapses in the Audit and Charges in the Show Cause Notice (SCN)
3. Professional Misconduct by CA Shyam Malpani
4. Penalty & Sanctions

Summary:

1. Jurisdiction and Procedures:
The Hon'ble High Court of Bombay directed NFRA to first decide its jurisdiction regarding matters preceding its establishment. NFRA concluded it had jurisdiction over the professional misconduct committed before its establishment as per Section 132(4) of the Companies Act 2013, which allows NFRA to investigate misconduct by Chartered Accountants. The retrospective jurisdiction was affirmed by the NCLAT, emphasizing NFRA's authority to investigate past misconduct without creating new obligations. The court also noted that there is no statutory time limit for NFRA to initiate such actions.

2. Major Lapses in the Audit and Charges in the SCN:
The SCN highlighted several charges against the auditors, including:
- Conflict of Interest: CA Shyam Malpani held shares in the audited company SKNL through a family-owned entity, violating Section 141(3)(d)(i) of the Companies Act 2013 and Section 226(3)(e) of the Companies Act 1956, compromising his independence.
- Non-compliance with SA 705: The auditor issued qualified opinions despite pervasive and material effects on the financial statements, which warranted either an adverse opinion or a disclaimer of opinion. The qualifications covered substantial portions of sales, purchases, trade receivables, trade payables, inventories, and more, indicating gross negligence and lack of due diligence.

3. Professional Misconduct by CA Shyam Malpani:
NFRA found CA Shyam Malpani guilty of professional misconduct for:
- Accepting the audit engagement despite a conflict of interest.
- Failing to issue appropriate audit opinions as required by SA 705.
- Violating the independence requirement as per SQC 1, SA 220, and the Code of Ethics.
The auditor's actions compromised the integrity, objectivity, and professional skepticism expected in an audit, thus breaching the standards and laws governing the profession.

4. Penalty & Sanctions:
Considering the seriousness of the violations and the principles of proportionality, NFRA imposed a monetary penalty of Rs 5 Lakh on CA Shyam Malpani and debarred him for five years from being appointed as an auditor or internal auditor or from undertaking any audit in respect of financial statements or internal audit of any company or body corporate. These sanctions will take effect 30 days from the issuance of the order.