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TMI Blog2023 (12) TMI 487X X X X Extracts X X X X X X X X Extracts X X X X ..... the Law, in the conduct of the audit of DHFL for FY 2017-18. Based on the discussion, it is proved that EP had issued an unmodified opinion on the Financial Statements without any basis. The poor quality of the audit, incomplete documentation and attempt to mislead through baseless replies further compound the professional misconduct on the part of the EP. He demonstrated a lack of awareness and disregard for the mandatory provisions of the SAS and the law throughout the replies. Based on the discussion and analysis, it is concluded that the EP has committed Professional Misconduct as defined in the Act, as below: a. CA Jignesh Mehta 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 Chartered Accountant 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of an opinion . This charge is proved as 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 as explained in Paras D. 1 to D.8 above. e. CA Jignesh Mehta 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 Chartered Accountant 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 EP failed to conduct the audit in accordance with the SAS as explained in Paras D. 1 , D.3, D.4, D.5 and D.8 above but falsely reported in his 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 aud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not discharged his professional duties in accordance with the Act as well as the Standards on Auditing (SA, hereafter). Consequently, an SCN was issued to the EP asking him to show cause why action under Section 132 (4) of the Act should not be initiated against him for professional misconduct. 2. After examining his detailed written submissions, this Order concludes that the EP failed to meet the relevant requirements of the SAS and violated the Act in respect of several significant areas of audit. In the areas of the audit identified in this Order, the EP was found to be grossly negligent and failed to apply professional skepticism and due diligence sufficiently and adequately to challenge the management assertions. 3. DHFL operates through a network of around 250 branches across various states in India. C S was appointed as the company's statutory auditor, including its zonal/ regional and branch offices, in the 32nd Annual General Meeting (AGM) for five years from FY 201617. The 33rd AGM ratified the said appointment for FY 2017-18. The EP, in his Independent Auditor's Report to the members of DHFL, has, inter alia, stated that the reports on the accounts of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the EP failed to document any evidence in the Audit File to show that there was no material misstatement in the financial statements due to non-compliance with laws and regulations having a direct effect on the disclosures in the financial statements. 7. The EP failed to obtain sufficient appropriate audit evidence regarding the entity's ability to continue as a going concern. The EP ignored clear indications/events that should have raised concerns over the entity's ability to continue as a going concern The EP failed in the discharge of his professional duties by not challenging management's assessment of the going concern assumption, by failing to test the adequacy of the supporting evidence, and by failing to evaluate the risk of management bias. The EP, therefore, did not comply with SA 570 (Revised) [Going Concern.] . 8. In the absence of adequate audit procedures in the identification, assessment and conclusions of Risk of Material Misstatement (RoMM) and documentation as required by Para 32 of SA 315 [Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment] and SA 230 [Audit Documentation] , th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s Order. In light of the judgment of the Hon'ble National Company Law Appellate Tribunal (NCLAT) dated 01.12.2023, we have limited the monetary penalty to Lakh only since the violations relate to FY 2017-18. a. Monetary penalty of Rupees Five Lakh. b. In addition, CA Jignesh Mehta is debarred for 10 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. B. INTRODUCTION AND BACKGROUND 14. This Order is being passed pursuant to an investigation by the National Financial Reporting Authority (NFRA) into the professional conduct of CA Jignesh Mehta for his role as the EP in the audit of DHFL. DHFL is a company listed on both, Bombay Stock Exchange and National Stock Exchange (BSE NSE, hereafter), and was one of India's leading housing finance companies. The DHFL group consisted of around [As provided in the annual report 17-18] 250 branches, three wholly owned subsidiaries, associates and joint ventures as on 31 st March 2018, and was primarily engaged in the housing finance, life insurance and financial ser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g such financial statement, where he is concerned with that financial statement in a professional capacity; b. failure to report material misstatements known to him to appear in a financial statement with which the EP is concerned in a professional capacity; c. failure to exercise due diligence, and being grossly negligent in the conduct of professional duties; d. 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; and e. failure to invite attention to any material departure from the generally accepted procedures to audit applicable to the circumstances. C. PRELIMINARY LEGAL MATTERS 19. The EP has raised objections with regard to the powers and jurisdiction of NFRA under the Act and the process followed by NFRA during this proceeding. 20. The Audit Firm and the EP had filed writ petitions, WP (C) 5326/2022 and 119/2022, in the Hon'ble Bombay High Court challenging NFRA's jurisdiction to issue the SCN. The Hon'ble High Court vide its order dated 13 th June 2023 disposed of the Writ Petition 1399 of 2023 along with Writ Pet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd found that NFRA has the required jurisdiction under Section 132(4)(c) of the Companies Act, 2013, as discussed in paragraphs 23 to 32 below. Jurisdiction of NFRA 23. Section 143 (9) of the Companies Act, 2013 mandates an Auditor to comply with the Auditing Standards. The proviso to Section 143 (10) states that until the Auditing Standards are notified by the Central Government, the Auditing Standards specified by the ICAI would be deemed to be the Standards on Auditing. The notification of NFRA with effect from 01-10-2018, as the body responsible inter alia for investigating professional misconduct and other misconduct, did not alter the Auditor's liability to fully comply with the Standards and the law as it existed before the formation of NFRA. 24. Section 132 (4) of the Companies Act gives exclusive jurisdiction to NFRA in matters of professional or other misconduct of Auditors of entities that fall within the jurisdiction of NFRA, which is evident from the following: a. The Proviso to Section 132 (4) (a) of the Act states - Provided that no other body or institute shall initiate or continue with proceedings in such matters of misconduct where the Nationa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... knowledged evil for the benefit of the community as a whole (ibid., p. 440). This can be achieved by express enactment or by necessary implication from the language employed. If it is a necessary implication from the language employed that the legislature intended a particular section to have a retrospective operation, the courts will give it such an operation. In the absence of a retrospective operation having been expressly given, the courts may be called upon to construe the provisions and answer the question whether the legislature had sufficiently expressed that intention giving the statute retrospectivity. Four factors are suggested as relevant: (1) general scope and purview of the statute; (ii) the remedy sought to be applied; (iii) the former state of the law, and (iv) what it was the legislature contemplated. (p. 388) In the instant case the language used viz other misconduct committed , clearly implies jurisdiction over past conduct i.e. before 24.10.2018, the day when the said section came into force. 29. Further, the presumption against retrospective applicability arises when a vested right is sought to be impaired. The explanation to Section 132 (4) would clearl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... JOR LAPSES IN THE AUDIT 33. Vide letter dated 28.07.2023, the EP was informed about NFRA's decision on the issue of jurisdiction, and he was requested to submit his reply to the SCN. The EP approached Hon'ble NCLAT vide Comp. App. (AT) No. 167 of 2023 wherein the EP raised the issue of non-supply of reasons for arriving at the issue of jurisdiction. The appeal was dismissed as withdrawn vide NCLAT order dated 05.09.2023. 34. The EP was required to submit his reply to the SCN on or before 1st November 2021. After availing multiple extensions of time, the EP submitted his reply to the SCN, vide letter dated 06.09.2023, and requested an opportunity for a personal hearing. The EP was granted an opportunity for a personal hearing along with his legal representative on 05-10-2023. However, on request from the EP, the hearing was rescheduled to 12.10.2023. The EP requested an adjournment of the hearing again and it was rescheduled to 19.10.2023. The EP again requested for adjournment, and he was informed that he should avail of the hearing on 19.10.2023 itself. The EP was repeatedly informed that if he fails to appear, the matter will be decided on merits based on available ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nch Audit Reports issued by the illegally appointed Branch Auditors. In this background, the EP was charged with the following. a. There is no evidence in the Audit File to establish the existence of legal appointment of any branch auditor by the AGM of the Company as required under the Act. There was also no evidence that C S, the legally appointed auditor for the branches, has carried out the audit of the entire company, including all its 250 branches. The EP failed to discharge his statutory duty of completing the branch audits, which was the key requirement in the completion of the audit of the Company's Financial Statements. In the absence of the audit of the branches, the Independent Auditor's opinion on the financial statements of 2017-18 is incomplete and invalid and, therefore, void ab initio. b. Failure to perform the audit procedures required for the Company's branches, failure to meet the requirements of Section 143(3)(b) of the Act, failure to conduct the audit in compliance with the applicable SAS, and issuance of false statements in the Independent Auditors' Report for FY 2017-18. No audit of branches under Section 143 38. The EP in hi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and 139 of the Act. Hence, these branch auditors were not the statutory branch auditors appointed under Section 143(8) of the Act, since the appointment was not made by the shareholders in the AGM as required by section 139. Besides, the shareholders of the Company had already appointed C S as the only Statutory Auditor. All the appointment letters issued to the branch auditors, describing them as statutory branch auditors, were issued in consultation with C S and were also copied to the Audit Firm. The EP documented all these letters in the Audit File, despite knowing the admitted fact that C S was the only statutory auditor for the Company and all its branches. d. The EP did not point out the illegality of the appointment of branch auditors to the Company. Instead, he received the audit reports, along with the specified returns, directly from the branch auditors and used those reports/returns for reporting on the financial statements of the Company, as is evident from the Audit Report issued by him. It is also evident from the following facts, recorded in the Audit File, that C S, DHFL and many of the branch auditors considered this as a valid statutory audit of branches. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd have been properly dealt with by us in preparing this report. (Emphasis added). The Proviso to section 143 (8) states Provided that the branch auditor shall prepare a report on the accounts of the branch examined by him and send it to the auditor of the company who shall deal with it in his report in such manner as he considers necessary. (Emphasis added). This makes it clear that the requirement of 'dealing with' branch auditor reports arises only when the branch auditor and company auditor are different. vii. We examined the work of the so-called branch auditors in a separate proceeding under Section 132(4) of the Act. We issued SCNs to 33 engagement partners representing the illegally appointed branch auditors. In reply to our SCN, the engagement partners of 122 branches stated that they were the statutory branch auditors appointed by the Company in consultation with C S. In all other cases where we issued disciplinary orders, it has been proven that these auditors acted as statutory auditors for the branches without legal authority. However, none of the 250 branch auditors verified the compliance of their appointment with the Companies Act, 2013 . e. The EP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f branches was performed through the ERP system of the company. His stand was that the company had centralised controls, and all branches operated under the same control environment and the transactions in the branches were immaterial. The EP being aware of the provisions of the Act, has thus made false statements in his audit report about the involvement of branch auditors, and all the submissions regarding the pro per conduct of branch audits by the EP are afterthoughts only. This is evidenced by the following: a. None of these submissions are supported by evidence in the Audit File and are thus afterthoughts and rationalisations on his part to justify his conduct. b. Contrary to EP' s submissions, we note that the majority of the loans (which is a material item) are initiated at the branches, loan accounts are created at the branches, accounted for from the branches and are serviced by the branches. The Branches also handle collection, disbursement, and cash balances, which are susceptible to fraud risk. It is recorded in the Audit File [WP -SME_Operations_Manual] that 22 activities, including Data Entry, Appraisal Note, Approval Note, Issuance of Sanction Letter, Ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... andalone and Consolidated Financial Statements (CFS) and under CARO 2016 unambiguously refer to the branch auditor's reports, as explained in the above paragraphs. The audit report nowhere indicates that the EP did not rely on these branch auditors. b. The WP Audit Closure , documented in the Audit File, records that The Company has appointed various Branch Auditors whose scope are pre-defined and on whose report the statutory auditor rely with respect to the areas covered in their respective scope (emphasis added). This is an unequivocal statement by the engagement team evidencing reliance on the work of the illegally appointed branch statutory auditors. c. The EP stated before the Audit Committee on 30-04-2018 [The presentation made by EP, documented in WP 30302 Audit Committee presentation, slide 4 and 19] that We have also considered the reports received from the branch auditors in respect of the financial information of the branches informing our opinion and We have received reports from 250 branch auditors which have been considered and relied upon in forming our opinion. (emphasis added). d. The statements made in reply to the SCN are opposite to what h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ors as a basis for his opinion. Also as explained above, the language used by the EP in his audit report complies with the legal requirements when separate auditors of the Company and branches are legally appointed. However, the EP also admits that there is only one auditor, i.e., C S, for the company and its branches. Due to these contradictions, the replies of the EP lack substance and hence are rejected. Audit of the Branches by EP 43. The EPs next contention is that C S did the audit of all the branches in the manner required by the Act. We observe that these contentions are also not supported by evidence, as explained below. a. The EP enumerated a summary of the branch audit reports in a work paper [WP 29 Branch Audit\Branch Audit Gist FY 17-18.xls.] in the Audit File. The adverse observations noted by the branch auditors were listed against 39 branches out of 250. However, there are no further audit procedures documented regarding how the EP addressed these adverse remarks, what was the materiality of these misstatements and how it was considered in forming an opinion on the financial statements as per SA 700. b. The EP states that the audit of individual br ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the illegally appointed branch auditors nor the legal statutory auditor C S audited the branches as per SAS. This amply proves that the EP who was responsible for the Audit failed to conduct the branch audits as per the Act and SAS and made a false report to the shareholders. In the absence of the branch audit of 250 branches as required by the Act, the Audit Reports on the SFS and CFS of DHFL, dated 30-04-2018 issued by the EP in the capacity of the Statutory Auditor of DHFL are void ab initio. All the charges in Para 37 thus stand proved. D.2. Consolidated Financial Statements 45. On February 13, 2017, DHFL incorporated a wholly-owned subsidiary, DHFL Investments Limited (DIL), by investing around crore towards its equity share capital. On March 31, 2017, DHFL sold its entire stake in DHFL Pramerica Life Insurance Company Limited (DPLI) (representing 50% of the paid-up equity share capital of DPLI) to DIL at a fair market value of Rs.2000.50 crore. This transaction added Rs. 1969.43 crore to DHFL's profits, being the excess fair value over the cost of acquisition. DIL funded the investment through the issue of Compulsorily Convertible Debentures (CCD) of crore to Wadh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... than the legal form. It was also supported by an expert opinion. Hence, according to EP, there was no violation of AS 21. 48. We have examined the replies, the Audit File and the Financial Statements. We observe that the contentions of the EP are not supported by evidence. The EP did not document sufficient appropriate audit evidence and conclusions that the exclusion of DIL from consolidation was in accordance with AS 21. The submissions of the EP echo the management's views and some afterthoughts. Without prejudice, we examined these submissions on merits and observe as follows. a. Paragraph 9 of AS 21 requires consolidation in the CFS of all subsidiaries of the parent. The contention of the EP, that DHFL does not control DIL, is not true to the facts. Because 100% of the share capital of the subsidiary DIL was held and controlled by DHFL [AS 21 Para 5.2 A subsidiary is an enterprise that is controlled by another enterprise (known as the parent) . Para 5.1 Control: (a) the ownership, directly or indirectly through subsidiary(ies), of more than one-half of the voting power of an enterprise; or (b) control of the composition of the board of directors in the cas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cannot be interpreted to mean more than 12 months in the normal course, as explained ['Near Future' is considered as not more than twelve months from the acquisition of relevant investments unless a longer period can be justified on the basis of facts and circumstances of the case. (Explanation (b) to Paragraph 11 of AS 21)] in AS 21. In the present case, the subsidiary DIL could be disposed of only after 100 months, i.e. over 8 years, post-conversion of CCDs. The arrangements allowed dilution of the stake of DHFL in DIL only in the event of the conversion of CCDs being subscribed by WGC. Thus, at the time of investment, there was nothing to indicate the management's intention to dispose of the subsidiary in the near future. In fact, the terms indicate possible disposal after 8 years while the standard indicates the term 'near future' to be construed as a period of not more than 12 months (Explanation (b) to Paragraph 1 1 of AS 21). e. The EP contends that in substance the control had already been transferred to WGC because of the condition in the tripartite agreement that DHFL cannot change the composition of the Board of DIL without the consent of WGC. H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re pledged by WGC for external borrowings. The Opinion also ignores the fact that DIL was a subsidiary of DHFL as well as WGC.] and echoes the same conclusion as that advanced by the EP in his replies to the SON. We observe that while referring to section 129(5) of the Act, the expert recommends that adequate disclosure would, of course, be required of the departure from the standard [AS 21], the reasons for the departure and consequences of such departure . Section 129(5) is applicable only when the financial statements of a company do not comply with the accounting standards. Hence this comment indirectly acknowledges the departure from the standard and talks of adequate disclosures to be given. However, in the immediately preceding paragraph of the opinion, the expert recommends that in accordance with the Accounting Standards [AS 21], the accounts of DIL should not be consolidated in the accounts of DHFL . If the expert believed that the recommended accounting treatment was in accordance with AS 21, then how did the question of departure from the same standard arise at all? The EP's reliance on such an evidently erroneous expert opinion for furnishing a reply to an SCN s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... btain sufficient appropriate audit evidence regarding compliance with those laws and regulations generally recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements. ii. to perform specified audit procedures to help identify instances of noncompliance with other laws and regulations that may have a material effect on the financial statements; and iii. to respond appropriately to non-compliance or suspected non-compliance with laws and regulations identified during the audit. b. From the above provisions of the SAS the responsibilities of identifying the relevant laws, understanding the nature of those laws vis- -vis the material amounts and disclosures in the financial statements and responding appropriately to suspected or identified non-compliance lies with the auditor, The EP lists some WPs where it is claimed that compliance with applicable laws is documented. However, many WPs relied upon by the EP, in fact, copy the disclosures made in the financial statements by the management. The understanding of the EP regarding the applicable provisions of the laws, his conclusions regarding compliance with the releva ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that Management clarifications seemed to be reasonable and therefore these loans were treated as standard assets and accordingly provisioning norms on standard assets as per direction [HFC(NHB) Directions 2010] have been applied for . No efforts were made to check compliance with the directions of the NHB on asset classification and provisioning of restructured loans [HFC NHB Directions 2010 Para 2 clause (zc) states that restructured loans are sub-standard assets] . g. The possible effect of short provisioning due to wrong asset classification of rescheduled/ restructured loans amounting to 093.07 crore could have been significant. The EP should have performed other appropriate audit procedures as prescribed in SA 250. Since the possible impact could be above the materiality threshold decided by the EP, it had a direct impact on the audit report in accordance with SA 705(Revised) read with Para 25 of SA 250. The casual approach of the EP demonstrates the absence of due diligence and professional skepticism in this regard. h. The EP's claim, that he examined the reply of the Company to NHB, is unsubstantiated. The reply letter of DHFL was dated 02-05-2018, i.e., after ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t. It is not documented on what basis the EP could presume that, NHB would not recommend provisioning in the final report. l. The EP stated that he checked the accounting for the items of the inspection report for which the DHFL had agreed to make provision. For those not agreed to by DHFL, the EP also agreed with DHFL. Thus, in both cases, the EP blindly agreed with the management without an independent examination of facts, which is unbecoming of an auditor. 52. Based on the above discussion and facts all the charges in para 50 stand proved. Apart from the above, the following charges in the SCN are also proved in the absence of proper explanations and evidence in the Audit File. a. In his report, as per the provisions of Housing Finance Companies Auditor's Report (National Housing Bank) Directions 2016, the EP stated that Based upon the audit procedures performed for the purpose of reporting the true and fair view of the financial statements and to the best of information and according to the explanations given to us, we state that the Company has complied with the prudential norms with respect to loan to value ratio, exposure to capital market and concentration ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o be supported by a management philosophy that clearly specifies the risk policies and tolerance limits. The EP did not examine the Company's IT system for generating automated MIS as part of internal control testing nor did he understand the risk policies and tolerance limits if any. The violations of the ALM guidelines are further explained in this Order in the subsequent section on Going concern . c. The EP did not inquire with the management whether DHFL had any prudential limits approved by the Board in terms of Earnings at Risk (EaR) or Net Interest Margin (NIM) in place [As per para 14.5 of the Guidelines in footnote 27 above read with Note 38.14 wf SFS] . Even though the prudential liquidity gap limits for negative gaps up to one year as per NHB Guidelines was 15% of the cumulative cash outflows for that period, no steps were taken by DHFL to rectify the breach of limits as seen from the disclosure of maturity pattern of assets and liabilities at end of the year 2018. 53. The above discussion establishes the materiality of the amounts involved and the failure of the EP to comply with SA 250 and its objectives, thus making the Auditor's report baseless. D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quired to be followed as per Section 143 (9) of the Act. The requirements of the SAS denoted by the word shall are unconditionally mandatory and need to be documented invariably as per SA 230. b. As evident from the Audit File and replies of the EP, the management did not perform a preliminary assessment of the entity's ability to continue as a going concern. In such a scenario, the EP was required by Para 10(b) of SA 570 (Revised) to discuss with management the basis for the intended use of the going concern basis of accounting and inquire of management whether events or conditions exist that, individually or collectively, may cast significant doubt on the entity's ability to continue as a going concern. This procedure is part of risk assessment procedures as per SA 315. However, no such discussions are documented by the EP at the risk assessment stage or even thereafter. c. Section 134(5) of the Act requires the Board to state specifically in its report that the annual accounts are prepared on a going concern basis. Hence, the EP was required to obtain the basis for such an assessment by the management and to evaluate the entity's ability to continue as a goin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elines stipulates that the negative gap (i.e. where outflows exceed inflows) up to 30/31 days time buckets should not exceed the prudential limit of 15 per cent of outflows of each time-bucket and the cumulative gap up to the period should not exceed of the cumulative cash outflows up to one year period. In case these limits are exceeded, the measures proposed for bringing the gaps within the limit should be shown by a footnote in the relative statement.. In DHFL's case, the cumulative gap was 37%, much above the regulatory limit. Thus, there was a regulatory breach which remained unchecked by the EP. As per para 10 read with para A3-A6 of SA 570 (Revised), non-compliance with capital or other statutory requirements is one of the indicators of events or conditions that may cast significant doubt on the entity's ability to continue as a going concern. The Audit File is silent on this aspect. iii. There was a 46% to 55% gap in three-time buckets from 2 months to 12 months. The Audit Report was signed on 30th April 2018. By that date, the actual assets realized and liabilities discharged in the 30/31 days bucket would have been known. Despite the liquidity mismatch in the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d funds to carry out its lending activities. Coupled with the negative operating cash flows (increased by 50% compared to the previous year), such practices could hamper the operating capability of the Company. The EP failed to examine these indicators [AS 3 states, The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise ] . e. The basic analysis of going concern includes regulatory aspects and liquidity aspects [Para A3 of SA 570 (Revised)] The EP's purported examination of going concern does not even touch upon any such aspects. Thus, the EP ignored the documented information available to him when doing his perfunctory assessment of the going concern assumption. f. Paras 16 to 25 of SA 570 (Revised) become applicable only if the EP had complied with the basic requirements in Paras 10 to 15. As none of these requirements was complied with by the EP, there is no basis in contending that he complied with the rest of the SA. 58. Based on the above-noted facts we conclude that the EP did not evaluate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gned and performed, all the audit evidence obtained and the results of all such audit procedures to demonstrate compliance with the SAS and sufficient and appropriate record of the basis for the auditor's report. Para 8 (c) of SA 230 requires documentation of significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions, Moreover, SAS are mandatorily required to be followed as per Section 143 (9) of the Act. The requirements of the SAS denoted by the word shall are unconditionally mandatory and need to be documented invariably to evidence compliance with the requirements of the law. 64. SA 230 underlines the documentation requirement of all audit procedures and evidence obtained to support the opinion as further emphasised in other provisions of SA 230, such as the purposes served by the audit documentation, the requirement of timely preparation of Audit Documentation, mandatory requirements for documenting the significant matters, conclusions, and significant professional judgements made in reaching those conclusions. In this process, addressing contradictory evidence appropriately ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evant WPs [Mainly, WP Audit Planning Memorandum.pdf, WP Understanding the Entity and its Environment , WP Overall Strategies Memorandum , WP SA 315.pdf?, WP Engagement Summary Memorandum.pdf, WP Fraud Risk.pdf ] in this regard nowhere identify the significant classes of transactions, account balances and disclosures that are related to the identified factors of the entity and its environment. In the case of business risks, the WP lists 4 risk factors (without any basis documented), but there is no documentation on how these business risks result in ROMM and which classes of transactions or account balances are affected. e. The documentation is silent about how the key factors such as understanding of the IT environment, key estimates, litigation and claims, regulatory communications, fraud risk factors and entity-level controls are factored into risk assessment. The documentation nowhere identifies any accounting assertions that are susceptible to ROMM. The risk classification, as required by Para 27 of SA 315, of significant account balances, class of transactions and disclosures are absent. In his reply to the charges on compliance with reporting under Section 143 (3) (i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essed and identified ROMM at account and assertion level . The statement itself proves the fallacy of the whole contentions around ROMM. The WP lists Area of audit , Examples of Risks Assessed' and Examples of steps taken to mitigate the (sic). Listing 'examples' cannot be accepted as compliance with the requirements of SAS in practice. Admittedly, this document lists 40 audit risks in relation to 21 items of financial statements . However, the financial statements of DHFL contain more than 60 major account captions and several disclosures. The accounting assertions relating to these items are manifold. The basis for arriving at 21 captions, which include captions not available on the financial statements of DHFL, is nowhere documented. Evidently, a template containing examples copied from some unknown sources [The list contains area of audit not featured in the financial statements of DHFI. Ega Secured Loan from FII and Insurance Control Accounts ] . cannot contain the actual financial statement captions of DHFL. As a requirement of Paras 27 and 28 of SA 315, having failed to identify and classify risks due to fraud or error, the EP has neither been able t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... instance, there were various deficiencies identified [As documented in the Audit Committee Presentations] by the internal auditor in almost all quarters of 2017-18 like inadequate security creation, non-adherence to product norms, sanction conditions, inadequate approvals, document execution etc. Therefore, a discussion with the internal auditor at the risk assessment stage makes more sense rather than just a formal exercise to comply with the SAS. Even though the glaring indicators of fraud risks were available to the EP, he failed to exercise professional skepticism since no evidence of enquiries at the relevant level is present in the Audit File. k. Thus, it can be seen from the above facts that the purported assessment of ROMM by the EP is an eyewash and served no purpose. 66. Before the conclusion of the audit, the EP was required [Para 25 of SA 330.] to evaluate whether the assessments of the risks of material misstatement at the assertion level remain appropriate. This is because information may come to the auditor's attention that differs significantly from the information on which the risk assessment was based. Though the EP submits that the assessment of ROM ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reached, including in those areas of the audits involving significant risks. For the FY 2016 and 2017 Issuer A audits, the documentation also failed to demonstrate who performed the work and the date such work was completed. Additionally, in each of the Issuer A and Issuer B audits, the audit documentation was insufficient to demonstrate which aspects of the audit and which audit documentation Bharat Parikh reviewed. D.6. Internal control relating to the appraisal of loans Controls on appraisal and sanction of loans 70. The EP was charged with failure to identify the deficiencies in internal control relating to the appraisal and sanction of loans at the head office level and branch level. Needless to say, this is the case of an NBFC where loans are its core function. The revenue, liquidity and asset quality are all dependent on the loan portfolio and hence the verification of this item was a significant matter and material to the financial statements. 71. The EP replied that he complied with all the requirements. He described the loan appraisal process followed by the Company. However, we observe that the EP failed to perform the audit procedures required of him ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arges in para 70 regarding failure to examine controls over loan appraisal and sanction stand proved. Management override of controls 76. The EP was charged with failure to design and perform audit procedures to minimise the risk of material misstatement due to management override of controls [As required by Para 31 of SA 240] in the loan appraisal process of the Company. The EP was also charged with failure to verify the Internal Controls over ensuring end-use in accordance with the sanction terms. 77. Though the EP explained certain processes instituted by the management in this regard, in the absence of any evidence of testing on the part of EP the charges are established. Moreover, from the Audit File [WP, Housing Loan Policy DHFLCredit_Policy_Ver_1.3.pdf , Project Guidelines Project Finance July 2017.Pdf and SME_Operations_Manual.pdf] it is found that the end-use monitoring clause is present only in the case of housing loans granted to individuals. In other loan cases, specifically in project loans, which are high-value corporate loans, such end-use monitoring was not part of the respective policies. Hence, for high-value corporate loan cases, there is no s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ii. Identify significant entity-level controls as part of the Company's control environment and controls over management override. iii. Identify significant account balances and disclosure items and their relevant assertions. iv. Determine the flow of transactions relevant to these assertions, to show the initiation, authorization, process and recording of these transactions. v. Perform audit procedures, such as walkthroughs, on significant flow of transactions to identify areas where control is missing or not appropriately designed. b. However, we observe that the EP's work is grossly inadequate and does not comply with the above basic requirements of SAS and the Guidance Note referred to by the EP. In section D.5 we have proved that the EP failed to identify ROMM appropriately. In this regard, the EP has placed reliance on WP 'SA315.pdf', which lists down certain examples . Its lack of evidentiary value is already explained in Section D.S. We also proved in the said section that the EP did not identify the significant account balances and disclosure items and their relevant assertions, mapped to the ROMM. The EP's contention in this regard is t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... results thereof. Where the auditor identifies risks of material misstatement that management failed to identify, the auditor shall evaluate whether there was an underlying risk of a kind that the auditor expects would have been identified by the entity's risk assessment process. However, there is no such examination done by the EP, neither documented in the Audit File nor claimed to have been done. The EP proceeded to his purported test of the controls on the basis of the data provided by the Company without examining it with professional skepticism. This is the reason why the risks noted therein do not have any connection to the EP's audit plan and risk assessment. f. The RCM provided by the management does not cover branch operations. It is also evident from the WP '6ACM 30APR 2018. pdf' that the development of the Risk Control Matrix (RCM) basis the assurance framework was in Progress during FY 17-18. As per this WP, a draft RCM was prepared for Regional, Branch and Service Center audits and RCM for other functions were in progress. g. Regarding the tests performed by the EP on the data provided by the Company, we observe that there is no evidence of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... procedures through various audit procedures. There is also no evidence of testing that the designed control operated as prescribed by persons possessing the necessary authority and competence to perform the control activity and can effectively prevent or detect errors or fraud. i. Apart from the above fundamental deficiencies, we observe the following further deviations from SAS or the Guidance Note that render the audit opinion on ICFR baseless. i. Entity Level Controls: Entity-level controls, as described in Para 90 of the Guidance Note, are controls that have a pervasive effect on a Company's internal control. The process of identifying relevant entity-level controls could begin with discussions between the auditor and appropriate management personnel to obtain a preliminary understanding of each component of internal financial controls. Other than relying on the policy documents provided by the management, the ET did not document any discussion with the management and/or the ET's conclusions on the operation of such controls. The availability of the Company's policies is no indication of whether these had been adhered to in practice. The ET claims to have und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... EP is unaware of how an audit procedure, such as a walkthrough, is to be conducted for control testing. If we go by the EP's example, it is observed that the control was not operating as designed. iv. The gross inadequacy of the testing is further evidenced by the reply of the EP to our observation in the SCN that there is no documentation of the management's assessment of the adequacy and effectiveness of internal controls. To evidence the management assessment, the EP cites a presentation documented in the Audit File, claiming to be made by the management in the audit committee meeting on 9th April 2018. The EP then claims in his reply that Without carrying out a thorough assessment and evaluations, the management would not have designed the Risk Control Matrix, which had 266 controls, and also, subsequently, made a presentation before the audit committee . v. In this regard, we note that Section 134 (5) of the Act requires the directors' responsibility statement to state that the directors, in the case of a listed company, had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and operati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns at the head office and branches. Read with the above facts, we observe that the EP failed to obtain sufficient information which is necessary for the expression of an opinion on ICFR and issued a baseless audit report under Section 143(3)(i) of the Act. By ignoring even, the basics of the audit of ICFR, the EP demonstrated the absence of professional skepticism, professional competence, and due care as required by SA 200 [SA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing] In view of these facts, the charges in para 80 stand proved. 83. Lapses in the audit of ICFR are viewed seriously by audit regulators across the world. In the matter of James R. Waggoner, CPA [PCAOB Release No. 105-2012-003 May 22, 2012] the US audit regulator PCAOB barred the CPA for three years from being an associated person of a registered public accounting firm. The disciplinary order, inter alia, observed Waggoner authorized BSP's issuance of an audit report containing an unqualified opinion on the effectiveness of North American Gaming's ICFR as of December 31, 2008, despite knowing that North American Gaming could no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not identified. Not conducted in the normal course of businesses Response to Audit Risk ; Review of Related Patties based on declaration in MBP I by Directors. Review of Compliances of Provisions of Section 177 and 188 of Companies Act. b. The EP in his reply to SCN, stated that the ET reviewed declarations by directors in form MBP I , reviewed minutes of the audit committee and the Board, scrutinised ledger transactions and obtained written representations to ensure compliance with Sections 177 and 188 of the Act. However, we observe no procedures and evidence of review of related parties, other than written representations and verification of declarations by the directors documented in the Audit File. The verification of MBP-I can only evidence a part of the related parties, as declared by the Directors. In this regard, the EP was required [Para 11 of SA 550] to perform audit procedures and related activities set out in paragraphs 1217 of SA 550. c. We observe that the Audit File contains Form MBP 1 for 7 directors. Out of the 7 forms, the date of signature and date of declaration is not mentioned in 2 forms. Further in all the forms it is clearly mentioned that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inancial Services Limited was of 77.36 crore. Apparently, there is an excess investment beyond the approval of the Audit Committee.] evidence of approval of the audit committee for investment for an amount not exceeding Rs. 50 Crore in Avanse Financial Services Limited ' [WP -DHFL Gist of Secretarial Records 2017-18, notes the minutes of 78th meeting of audit committee held on 22nd January, 2018,] and a trademark fee transaction with another related party. Even, these two approvals are also partial since the amounts of the transactions are not clearly available in the approval. There is no other documentation evidencing the RPT details and the amounts approved by the Audit Committee. Given the fact that as per Sections 177 and 188 of the Act, all the RPTs require Audit Committee approval or recommendation, it was the duty of the EP to ensure compliance by ensuring proper controls over RPT approvals and through substantive procedures. The documentation of EP does not evidence such compliance by the Company. Out of RPTs with 21 parties mentioned in Note 36B of Standalone Financial Statements 2017-18, a partial approval is seen documented only for one party as explained above. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent appropriate audit evidence in respect of RPTs has been viewed seriously by the International Regulators as well. For example, PCAOB, in the matter of Cheryl L. Gore, CPA and Stanley R. Langston, CPA (Respondents) [PCAOB Release No. 105-2021 -020] , barred the respondents from being associated with a registered public accounting firm and imposed a monetary penalty of $30,000 collectively for their failure inter alia to obtain sufficient appropriate audit evidence with respect to related party transactions. 89. In another case, PCAOB, in the matter of Yichien Yeh, CPA (Firm) and Yichien Yeh (Respondent ) [PCAOB Release No. 105-2021-011] , revoked the firm's registration and barred the respondents from being associated with a registered public accounting firm and imposed a monetary penalty of $10,000 collectively for their failure inter alia to obtain sufficient appropriate audit evidence with respect to related party transactions. E. Articles of Charges of Professional Misconduct 90, As discussed, the EP has made a series of serious departures from the Standards and the Law, in the conduct of the audit of DHFL for FY 2017-18. Based on the above discussion, it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rofessional 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 EP, conducted the Audit of a Public Interest Entity in total disregard of his 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 are as explained in Paras D. 1 to D.8 above. d. CA Jignesh Mehta 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 Chartered Accountant 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 as the EP failed to conduct the audit in accordance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d confidence of investors and the public at large if the auditors do not perform their job with professional skepticism and due diligence and adhere to the standards. 95. The EP in the present case was required to ensure compliance with SAS to achieve the necessary audit quality and lend credibility to Financial Statements to facilitate its users. As detailed in this Order, substantial deficiencies in audit, abdication of responsibility and inappropriate conclusions on the part of CA Jignesh Mehta establish his professional misconduct. The replies of the EP showed his absolute disregard for challenging the management assertions, documenting the audit procedures, documenting evidence and conclusions, lack of understanding of the mandatory nature of SAS, lack of understanding of the basic audit procedures and absence of required professional skepticism. There was no proper audit of the 250 branches, where neither the EP nor the illegally appointed branch auditors followed SAS. C S were the sole Statutory Auditors of the Company including all its branches. Therefore, the EP's report under section 143 of the Companies Act 2013 and the report under CARO 2016, both referring to an ..... X X X X Extracts X X X X X X X X Extracts X X X X
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