2024 (5) TMI 900 - HC - Companies Law

Professional misconduct - Debarment from being appointed as an auditor or internal auditor or from undertaking any audit - levy of penalty - constitutional validity to Section 132 (4) of the Companies Act, 2013 and Rules 10, 11 and 12(4) of the NFRA Rules, 2018 - negligent and failure to obtain sufficient appropriate audit evidence to support opinion and failure to identify and report material misstatements in the financial statements of RCL. HELD THAT - The Audit Committee s conclusion was based solely on EP s presentation to the Committee in which EP concluded that the PW observations did not attract the provisions of section 143 (12) of the Act. The opinions of the two legal counsels did not examine the merits of the transactions. Nor did the PHD subject the points raised by PW to the rigours of audit examination commensurate with fraud risk to agree or disagree with them and arrive at its own conclusions before the mandate . Ultimately the same conclusion appeared in the Board s Report with acknowledgement of its origin to PHD. It is also disclosed in the Financial Statements in the form of a material assertion. Finally, PHD audited the same disclosure, based on its own opinion, and provided its audit opinion, in the form of an EoM-16, that there was no matter attracting section 143 (12) in the PW observations. The draft note containing the above disclosure was included in the draft financial statements by the management only one day before the signing of the audit report. Thus, it is evident that the disclosure note emanated from information originally prepared by EP. The total balance sheet size of RISL for the FY 2017-18 was only ₹20.7 crore, without the above-said transaction. This is only 3.5% of the loan amount of ₹581 crore. Thus, the balance sheet size is negligible as compared to the loan amount. During the oral hearing, EP submitted that RISL had created a charge on the assets in favour of RCL. Neither the liability towards RCL nor the assets represented by the loan to Reliance Communications appear in the audited balance sheet of the borrower. Yet a charge was created on its assets, and the balance confirmation was provided - Despite the presence of a report under Section 143 (12), these factors did not prompt EP to revise the risk assessment or perform additional procedures to rule out the existence of any material misstatements due to fraud or error, such as the authenticity of the confirmations or validity of the charges in all the cases. Thus, EP ignored the contradictory evidence and did not perform any further procedures to confirm the facts in accordance with the requirements of para 26 of SA 330 and failed to obtain sufficient appropriate audit evidence as required by SA 500 to support the audit opinion. There are no ground to grant any interim relief at this stage - application dismissed.

Summary

Issues Involved:
1. Debarment and penalties imposed by NFRA.
2. Constitutional validity of Section 132(4) of the Companies Act, 2013 and NFRA Rules, 2018.
3. Alleged audit irregularities and negligence by PHD and its partners.
4. Examination of audit procedures and compliance with auditing standards.
5. Interim relief sought by petitioners.

Issue-wise Detailed Analysis:

1. Debarment and Penalties Imposed by NFRA:
The petitioners, M/s Pathak HD & Associates (PHD), CA Parimal Kumar Jha, and CA Vishal D Shah, challenged the NFRA's order dated 12 April 2024. NFRA debarred CA Parimal Kumar Jha and CA Vishal D Shah from being appointed as auditors for 10 years and 5 years respectively, and imposed penalties of INR 3 crores on PHD, INR 1 crore on CA Parimal Kumar Jha, and INR 50 lakhs on CA Vishal D Shah. The petitioners were aggrieved by these sanctions, arguing that they were unjust and excessive.

2. Constitutional Validity of Section 132(4) of the Companies Act, 2013 and NFRA Rules, 2018:
The petitioners also challenged the constitutional validity of Section 132(4) of the Companies Act, 2013, and Rules 10, 11, and 12(4) of the NFRA Rules, 2018. The court noted that these writ petitions were tagged with other pending matters questioning the validity of Section 132(4), and thus, entertained the petitions on these grounds.

3. Alleged Audit Irregularities and Negligence by PHD and Its Partners:
The court examined the facts presented, noting that RCL was jointly audited by PHD and Price Waterhouse & Co LLP (PW) for FY 2018-19. PW resigned without issuing an audit report and reported suspected fraud involving loans and investments amounting to approximately INR 12,571 crore. NFRA's suo moto examination of PHD's audit file led to the issuance of a Show Cause Notice (SCN) dated 25 July 2023. NFRA asserted that despite evidence of documented irregularities and communications by PW, the petitioners failed to take appropriate steps, showing negligence and failure to obtain sufficient appropriate audit evidence.

4. Examination of Audit Procedures and Compliance with Auditing Standards:
The court reviewed the audit procedures and compliance with auditing standards, particularly SA 299 (Revised). It was noted that PHD and PW were jointly responsible for the entire audit work. Despite PW's communications regarding potentially irrecoverable loans and investments, PHD's Engagement Partner (EP) failed to carry out independent procedures as mandated. The court observed that PHD did not perform any audit procedures on these matters until specifically asked by the Audit Committee on 12 June 2019, after PW had resigned and reported fraud. The court found that PHD's actions amounted to self-reviewing the financial statements, confirming the charges of non-compliance with SA 299 (Revised).

5. Interim Relief Sought by Petitioners:
The petitioners sought interim relief against the NFRA's final order. However, the court, upon reviewing the disclosures and conclusions reached by NFRA, found no grounds to grant interim relief at this stage. The applications for interim relief were consequently rejected.

Conclusion:
The court directed the respondents to file a reply within three weeks, with the petitioners to file a rejoinder before the next date fixed. The writ petitions were tagged with W.P.(C) 1065/2021, scheduled for hearing on 29.05.2024. The applications for interim relief were rejected, and the court found substantial grounds to entertain the writ petitions concerning the constitutional validity of Section 132(4) and the NFRA Rules, 2018.