2024 (4) TMI 728 - NFRA - Companies Law

Professional Misconduct by CA - Failure 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 the statutory auditors are concerned with that financial statement in a professional capacity - Failure to report a material misstatement known to him to appear in a financial statement with which EP is concerned in a professional capacity - Failure to exercise due diligence and being grossly negligent in the conduct of professional duties - Failure to obtain sufficient information which is necessary for the expression of an opinion, or its exceptions are sufficiently material to negate the expressions of an opinion - Failure to invite attention to any material departure from the generally accepted procedures to audit applicable to the circumstances - sanctions and penalties. HELD THAT - EP and PHD 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 is concerned with that financial statement in a professional capacity - This charge is proved as PHD and EP failed to disclose in their report the material noncompliances the Company made. EP and PHD committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 6 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 report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity - This charge is proved as EP and PHD failed to disclose in their report the material misstatements made by the Company. EP, EQCR Partner and PHD committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 7 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 does not exercise due diligence or is grossly negligent in the conduct of his professional duties - This charge is proved as EP, EQCR Partner and PHD conducted the Audit of a Public Interest Entity in total disregard of their statutory duties, evidenced by multiple critical omissions and violations of the standards. The instances of failure to conduct the audit in accordance with the SAs and applicable regulations, and failure to report the material misstatements in the financial statements and non-compliances made by the Company. EP, EQCR Partner and PHD committed professional misconduct as defined by Section 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 8 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 obtain sufficient information which is necessary for expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion - This charge is proved since EP, EQCR Partner and PHD failed to conduct the audit in accordance with the SAs and applicable regulations as well as due to their total failure to obtain sufficient appropriate audit evidence to support their opinion on the financial statements. EP and PHD 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 EP and PHD failed to conduct the audit in accordance with the SAs as explained in Paras C1 to C7 above but falsely reported in their audit report that the audit was conducted as per SAs. Thus it is concluded that the charges of professional misconduct in the SCN, as detailed above, stand proved based on the evidence in the Audit File, the audit reports on the standalone financial statements and consolidated financial statements for the FY 2018-19, the submissions made by EP, EQCR Partner and PHD and the Annual Report of RCL for the FY 2018-19. Sanctions and penalties - HELD THAT - Section 132 (4) of the Companies Act, 2013 provides for penalties in a case where professional misconduct is proved. The seriousness with which proved cases of professional misconduct are viewed is evident from the fact that a minimum punishment is laid down by the law. Because professional misconduct has been proved and considering the nature of violations and principles of proportionality, in the exercise of powers under Section 132 (4) (c) of the Companies Act, 2013, it is ordered a. Imposition of a monetary penalty of ₹3 crore (Rupees Three Crore) on the Audit Firm M/s Pathak H.D. Associates. b. Imposition of monetary penalties of ₹1 crore (Rupees One Crore) and ₹50 Lakh (Rupees Fifty Lakh) respectively on EP CA Parimal Kumar Jha and EQCR Partner CA Vishal D Shah. c. In addition, EP and EQCR partners are debarred for 10 years and 5 years respectively 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.

Summary

Issues Involved:

1. Reporting under Section 143(12) of the Companies Act, 2013.
2. Use of Emphasis of Matter (EoM) paragraph.
3. Impact on Financial Statements of Matters Arising out of the Observations of the Resigned Auditor.
4. Verification of Lending Policy.
5. Direct Confirmation.
6. Assessment of Risk of Material Misstatement (ROMM) due to Fraud.
7. Verification of Expected Credit Loss (ECL) on Financial Assets in Compliance with Ind AS 109.
8. Omissions and Commissions in Engagement Quality Control Review (EQCR).
9. Role of the Audit Firm.

Summary:

1. Reporting under Section 143(12) of the Companies Act, 2013:

The judgment examines the auditors' handling of material information in the notes to the financial statements, which included a self-review. The auditors relied on a legal opinion obtained after concluding that the matter did not merit reporting u/s 143(12). The Audit Committee and the Board's views were based solely on the auditors' conclusions, leading to a self-review situation. The sequence of events confirms that the disclosure note was based on the auditors' conclusion, violating the statutory duty of independent examination.

2. Use of Emphasis of Matter (EoM) paragraph:

The auditors included an EoM paragraph in their report stating that the report filed by the resigned joint auditor did not attract section 143(12). The judgment finds this representation misleading and unprofessional, as the determination was made by the auditors before obtaining the legal opinion. The EoM was not in accordance with SA 706 (Revised) and was based on matters inadequately disclosed in the financial statements.

3. Impact on Financial Statements of Matters Arising out of the Observations of the Resigned Auditor:

The auditors failed to exercise professional skepticism and did not adequately assess the impact of the transactions on the Risk of Material Misstatements (ROMM) due to fraud. They did not perform sufficient audit procedures to verify the recoverability of loans and relied on management representations without independent verification. The financial statements were materially misstated, and the auditors' opinion was without adequate basis.

4. Verification of Lending Policy:

The auditors failed to obtain sufficient appropriate audit evidence regarding compliance with the Lending Policy, despite observing marked deviations. The disbursements were not in line with the policy, indicating weaknesses in internal controls and potential management override of controls. The auditors' limited testing and reliance on a qualified opinion under ICFR showed gross negligence and lack of professional skepticism.

5. Direct Confirmation:

The auditors failed to analyze contradictory audit evidence regarding an ICD not reflected in the borrower's books. The borrower's balance sheet size was negligible compared to the loan amount, and the auditors accepted an illegal accounting treatment. This indicated gross negligence and failure to perform additional procedures to confirm the facts.

6. Assessment of Risk of Material Misstatement (ROMM) due to Fraud:

The auditors failed to identify and respond appropriately to fraud risks in revenue and management override of controls. They ignored contradictory evidence and did not perform adequate audit procedures. The judgment highlights instances of rationalization by the management and the auditors' failure to challenge unusual transactions, indicating gross negligence and lack of professional skepticism.

7. Verification of Expected Credit Loss (ECL) on Financial Assets in Compliance with Ind AS 109:

The auditors failed to obtain sufficient appropriate audit evidence regarding the reasonableness of the ECL estimate. They relied on a valuation report without verifying its relevance to ECL. The auditors did not test the completeness, accuracy, and relevance of inputs or assess the reasonableness of assumptions used by the management. The classification of loans was not as per Ind AS 109, leading to material misstatements.

8. Omissions and Commissions in Engagement Quality Control Review (EQCR):

The EQCR partner failed to exercise due diligence and objectively evaluate the significant judgments of the engagement team. The documentation lacked evidence of objective evaluation, and the EQCR partner's replies indicated a lack of understanding of the requirements. The EQCR partner's failure to document discussions and procedures showed gross negligence.

9. Role of the Audit Firm:

The audit firm, PHD, failed to ensure the overall quality of the audit engagement. The judgment emphasizes that the firm is responsible for setting policies and ensuring compliance with applicable laws and standards. The firm's failure to supervise and oversee the engagement effectively contributed to the audit lapses. The judgment highlights the global practice of holding audit firms accountable for audit quality.

Sanctions and Penalties:

The judgment imposes monetary penalties on the audit firm, EP, and EQCR partner. The EP and EQCR partner are debarred from being appointed as auditors for 10 and 5 years, respectively. The judgment underscores the seriousness of professional misconduct and the necessity of strict sanctions to uphold audit quality and public interest.