2024 (8) TMI 1111 - NFRA - Companies Law

Professional Misconduct by the Auditors - alleged diversion of funds - Lapses in the audit of fraudulent diversion of funds to MACEL, understatement of such diverted funds and evergreening of loans through circulation of funds - Fraudulent understatements of loans and advances given to MACEL and evergreening of loans and advances - Lapses in audit of suspected diversion of funds by CDGL to M/S Classic Coffee Curing Works - Lapse in performing risk assessment procedure in respect of Interest Income of TDL - Omission and Commission by the Audit Firm - Penalty Sanctions. HELD THAT - The failure in this audit engagement was due to violations of SAS, failure in the implementation of Standards on Quality Control and relevant provisions of the Act. Hence the role of the Audit Firm, whose responsibilities are mandated by the Act, is equally important as that of EP and EQCR Partners, whose responsibilities are prescribed in the SAS and SQC -1. Given the fact that the Audit Firm is the appointed auditor under the Act and that the EP remains mandatorily responsible for the individual audits subject to firm-level supervision, both the Audit Firm and the EP have joint and several responsibilities for the Audit. Section 132 (4) that provides for sanctions against both the chartered accountants and the firm of chartered accountants emanates from this basic premise. There is not adequate evidence of effective supervision and oversight of this audit by M/S BSR Associates LLP. Had the Audit Firm discharged its supervisory responsibilities timely and effectively such major lapses in the audit as discussed in the foregoing paragraphs could have been avoided. Further, in this case, the Firm's policies and procedures with respect to audit documentation have also been found to be non-compliant with SQC I and SA 230. Due to these fraudulent transactions the consolidated financial statements of CDEL were grossly misstated and, therefore, did not present a true and fair view of the company's affairs. As a result, the unmodified audit report issued by the Audit Firm was false and misleading for the users of these financial statements. Had the Auditors properly discussed the audit procedures with the component auditors in response to the identified risks, advised them accordingly, and exercised due professional skepticism throughout the audit, (as required by SA 200), they could have identified the material and pervasive misstatements in the CFS - The lack of professional skepticism in challenging both the management and the component auditors and the failure to address contradictory evidence was apparent in significant areas of the audit. Such omissions and commissions by an experienced audit firm cannot be taken lightly, as they are detrimental to the public interest. The Firm and Engagement Performance Metrics published by PCAOB on October 12, 2022, provides a detailed study of engagement level and firm-level quality matrices. Engagement level metrics provide information about a particular engagement of the firm, and firm-level metrics address an audit firm's overall strategy in complementing the engagement-level matrices - The report lists key Audit Quality Indicators reported by 9 leading audit firms (refer to page 14 of the report). This Audit Quality Indicators make it clear that in, actual practice across the world, the Audit Firm has an equally important role as that of EP to ensure overall quality in any audit undertaken by the Firm. Thus, it is proved that they had failed to report fraudulent diversion of funds to related parties and failed to exercise due diligence in performance of audit. Based on the foregoing discussion and analysis, it is concluded that they have 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. The Firm and the EP committed professional misconduct as defined by clause 5 of Part I of the Second Schedule of the CA Act, which states that an auditor 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 the Firm and the EP failed to disclose in their report the material non-compliances by the Company. The Firm and the EP committed professional misconduct as defined by clause 6 of Part I of the Second Schedule of the CA Act, which states that a chartered accountant in practice 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 the Firm and the EP failed to disclose in the audit report the material misstatements made by the Company. The Firm, the EP and the EQCR committed professional misconduct as defined by clause 7 of Part I of the Second Schedule of the CA Act, which states that a chartered accountant in practice 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 the Firm, the EP and the EQCR failed to conduct the audit in accordance with the SAS and applicable regulations, failed to report the material misstatements in the financial statements arising from diversion of tilllds circulation of funds and failed to report non-compliances made by the Company. The Firm and the EP committed professional misconduct as defined by clause 8 of Part I of the Second Schedule of the CA Act, which states that a chartered accountant in practice is guilty of professional misconduct when he fails io 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 as the Firm and the EP failed to conduct the audit in accordance with the SAS and applicable regulations as well as due to his total failure to report the material misstatements and non-compliances made by the Company in the financial statements. The Firm and the EP committed professional misconduct as defined by clause 9 of Part I of the Second Schedule of the CA Act, which states that a chartered accountant in practice 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 Firm and the EP failed to conduct the audit in accordance with the SAS and related Quality Control Standards and Code of Ethics. Penalties and Sanctions - 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 - the infraction of the law and non-adherence to the standards of Audit, Quality Control Standards and Code of Ethics by the Auditors of a listed company viz., CDEL. The Auditors did not report fraudulent diversion of funds despite having enough evidence that public money was moved to a promoters' entity which had no business connection with the listed company. Considering the proved professional misconduct and keeping in mind the nature of violations, principles of proportionality and deterrence against future professional misconduct, we, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, hereby order imposition of monetary penalty of Rs ten crores upon M/S BSR Associates LLP; Rs fifty lakhs upon CA Aravind Maiya; and Rs twenty five lakhs upon CA Amit Somani. In addition, CA Aravind Maiya is debarred for a period of ten years and CA Amit Somani 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.

Summary

Issues Involved:
1. Lapses in the Audit of Consolidated Financial Statements (CFS)
2. Lapse in the Audit of Standalone Financial Statements (SFS)
3. Violations of SQC 1 and SA 230 - Lapses in Audit Documentation
4. Omission and Commission by the Audit Firm
5. Findings on the Articles of Charges of Professional Misconduct by the Auditors
6. Penalty & Sanctions

Detailed Analysis:

1. Lapses in the Audit of Consolidated Financial Statements (CFS):

The National Financial Reporting Authority (NFRA) found that M/S BSR & Associates LLP, CA Aravind Maiya, and CA Amit Somani failed to meet the requirements of the Standards on Auditing (SA), Standards on Quality Control (SQC), and the Companies Act, 2013 during their audit of Coffee Day Enterprises Limited (CDEL) for FY 2018-19. Specifically, they did not perform appropriate additional audit procedures to obtain sufficient appropriate audit evidence, especially regarding loans and advances to MACEL, a promoter-controlled entity. The auditors were grossly negligent in verifying the business rationale of loans amounting to Rs 2,226 crores and failed to evaluate the recoverability of Rs 842.49 crores from MACEL. They also did not identify and report the misrepresentation of financial statements, which included fraudulent understatement of loans by Rs 1,706 crores and evergreening of loans through circular fund transfers.

2. Lapse in the Audit of Standalone Financial Statements (SFS):

The auditors failed to perform audit procedures to verify the end use of substantial loans and guarantees provided by CDEL to its subsidiaries, amounting to Rs 1,055.73 crores and Rs 1,015 crores respectively. They did not ensure compliance with the Companies (Auditors' Report) Order 2016 and section 185 of the Companies Act. The auditors were negligent in assessing the risk of material misstatement and failed to report non-compliance with section 185 of the Act.

3. Violations of SQC 1 and SA 230 - Lapses in Audit Documentation:

The audit documentation maintained by the Firm was not compliant with the requirements of SQC 1 and SA 230. The application used allowed unauthorized modifications of audit work papers without recording the name and date of modifications. This led to the creation and modification of audit work papers after the signing of the audit report, indicating that sufficient appropriate audit evidence was not obtained on or before the date of the auditor's report.

4. Omission and Commission by the Audit Firm:

The Firm, M/S BSR & Associates LLP, was found responsible for the misconduct committed by the Engagement Partner (EP) and the Engagement Quality Control Reviewer (EQCR). The Firm failed to ensure that its personnel complied with professional standards and regulatory requirements. Despite providing tools and safeguards, the Firm did not ensure effective supervision and oversight of the audit, leading to significant lapses.

5. Findings on the Articles of Charges of Professional Misconduct by the Auditors:

The NFRA concluded that the Firm, the EP, and the EQCR committed professional misconduct under various clauses of the Chartered Accountants Act, 1949. They failed to disclose material facts, report material misstatements, exercise due diligence, obtain sufficient information, and invite attention to material departures from generally accepted audit procedures. The auditors' actions resulted in the issuance of a false and misleading audit report.

6. Penalty & Sanctions:

Considering the seriousness of the violations, the NFRA imposed the following penalties:
- A monetary penalty of Rs ten crores on M/S BSR & Associates LLP.
- A monetary penalty of Rs fifty lakhs on CA Aravind Maiya.
- A monetary penalty of Rs twenty-five lakhs on CA Amit Somani.
- CA Aravind Maiya was debarred for ten years, and CA Amit Somani 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 the functions and activities of any company or body corporate.

The order will be effective 30 days from its issuance.