2024 (12) TMI 167 - NFRA - Companies Law

Professional misconduct of the statutory auditors of Coffee Day Enterprises Limited under Section 132(4) of the Companies Act 2013 - diversion of funds and evergreening of loans/advances - HELD THAT - After a detailed examination of facts and circumstances, it is observed that the failure in this audit engagement was due to violations of SAs, and 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 delineated in the SAs and SQC -1. Given the fact that the Audit Firm is the legal body appointed as the auditor and EP mandatorily takes responsibility for the individual audits subject to firm-level supervision, both have joint and several responsibilities for the Audit. Section 132 (4) of the Act emanates from this basic premise. However, there is not adequate evidence of effective supervision and oversight by Mis Venkatesh Co. Providing the ET with a quality policy and tools are not good enough to establish effective supervision as envisaged in SQC-1. Had the Audit Firm discharged its supervisory responsibilities timely and effectively such major lapses in the audit could have been avoided. Therefore, Mis Venkatesh Co. is responsible for the misconducts committed by the EP and EQCR. Due to these fraudulent transactions the consolidated financial statements of CDEL were grossly misstated. The Auditors in audit reports issued by the Audit Firm had disclaimed the opinion. Their contention about disclaiming the audit opinion is not logical as an auditor is required to comply with Laws and auditing standards even if he disclaims his opinion. Further, the Auditors were required to comply with section 143(12) of the Act and CARO even in case of Disclaimer of Opinion - The lack of professional skepticism in challenging the management about clearly visible fraud is not expected from an auditor of a listed company. Such omissions and commissions by an experienced audit firm cannot be taken lightly, as these 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 study covers all major jurisdictions in the world, including India and top tier Audit Firms. The Auditors and EQCR have made a series of serious departures from the Standards and the Law, in conduct of the audit of CDEL for FY 2019-20. Based on the above discussion, it is proved that the Auditors and EQCR 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 the Auditors and EQCR 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 (CA Act). Penalty and sanctions - HELD THAT - Section 132(4)(c) of the Companies Act 2013 provides that National Financial Reporting Authority shall, where professional or other misconduct is proved, have the power to make order for (A) imposing penalty of-- (I) not less than one lakh rupees, but which may extend to five times of the fees received, in case of individuals; and (II) not less than five lakh rupees, but which may extend to ten times of the fees received, in case of firms; (B) debarring the member or the firm from-(I) being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate; or (II) performing any valuation as provided under section 247, for a minimum period of six months or such higher period not exceeding ten years as may be determined by the National Financial Reporting Authority. Considering the seriousness of proved professional misconduct and keeping in mind the nature of violations, principles of proportionality and deterrence against future professional misconduct, in exercise of powers under Section 132(4)(c) of the Companies Act, 2013, it is hereby ordered imposition of a monetary penalty of Rs Two crores upon M/s Venkatesh Co.; Rs Ten lakhs upon CA Dasaraty V.; and Rs Five lakhs upon CA Desikan G. In addition, CA Dasaraty V. and CA Desikan G are debarred for a period of Ten years and Five 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. Lapses in the audit of fraudulent diversion of funds and evergreening of loans.
2. Lapses in the audit of compliance with Section 185 of the Companies Act.
3. Lapses in acceptance of the audit engagement.
4. Lapses in forming the audit opinion.
5. Lapses in the Engagement Quality Control Review.
6. Omissions and commissions by the audit firm.
7. Findings on articles of charges of professional misconduct.
8. Penalty and sanctions.

Detailed Analysis:

I. Lapses in the Audit of Fraudulent Diversion of Funds and Evergreening of Loans:

The audit firm and its partners failed to exercise professional skepticism and due diligence in identifying and reporting fraudulent transactions involving the diversion of Rs 3,535 crores to a promoter entity, MACEL, and the evergreening of loans through structured circulation of funds. Despite having access to an investigation report detailing these irregularities, the auditors did not report the fraud to the Central Government as required by Section 143(12) of the Companies Act. The auditors claimed they were only responsible for auditing CDEL and not its subsidiaries, but the NFRA found this defense inadequate, emphasizing the auditors' statutory right to access the records of subsidiaries.

II. Lapses in the Audit of Compliance with Section 185 of the Companies Act:

The auditors failed to report CDEL's non-compliance with Section 185 of the Companies Act regarding loans and guarantees given to subsidiaries without special resolutions or ensuring the funds were used for principal business activities. The auditors incorrectly claimed Section 185 did not apply as the directors had no interest in the subsidiaries, but NFRA highlighted that the Board of CDEL controlled these subsidiaries, making Section 185 applicable.

III. Lapses in Acceptance of the Audit Engagement:

The auditors accepted the audit engagement without performing mandatory procedures, including obtaining a no-objection certificate from the outgoing auditor. The NFRA found that the auditors began audit activities before receiving this certificate, violating the standards on quality control and audit planning.

IV. Lapses in Forming the Audit Opinion:

The auditors were charged with gross negligence in preparing the Independent Auditor's Reports, providing contradictory statements about obtaining sufficient appropriate audit evidence, and improperly including Key Audit Matters and Emphasis of Matter paragraphs in the reports. The NFRA found these actions violated the standards on audit reporting, leading to a misleading impression of the financial statements' credibility.

V. Lapses in the Engagement Quality Control Review:

The Engagement Quality Control Reviewer (EQCR) failed to perform an objective evaluation of significant judgments made by the engagement team. The NFRA found no evidence of review work done by the EQCR, and the review certificate was signed after the audit report, violating the standards on quality control.

VI. Omissions and Commissions by the Audit Firm:

The audit firm, M/s Venkatesh & Co., was held responsible for the misconduct committed by its partners. The NFRA emphasized the firm's duty to establish and maintain a system of quality control to ensure compliance with professional standards and legal requirements. The firm's failure to supervise and oversee the audit process led to significant lapses.

VII. Findings on Articles of Charges of Professional Misconduct:

The NFRA found the auditors and EQCR guilty of professional misconduct under various clauses of the Chartered Accountants Act, including failing to disclose material facts, report material misstatements, exercise due diligence, obtain sufficient information, and communicate with the outgoing auditor.

VIII. Penalty and Sanctions:

The NFRA imposed a monetary penalty of Rs Two crores on M/s Venkatesh & Co., Rs Ten lakhs on CA Dasaraty V., and Rs Five lakhs on CA Desikan G. Additionally, CA Dasaraty V. and CA Desikan G. were debarred from being appointed as auditors for ten and five years, respectively. The order will be effective 30 days from issuance.