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TMI Blog2024 (12) TMI 226X X X X Extracts X X X X X X X X Extracts X X X X ..... ngs on the Articles of Charges of Professional Misconduct E. Penalties and Sanctions A. EXECUTIVE SUMMARY 1) Reliance Commercial Finance Limited (RCFL) is a Non-Banking Finance Company (NBFC) listed on both the Bombay Stock Exchange and the National Stock Exchange. Price Waterhouse & Co Chartered Accountants LLP (PW) was initially appointed as the auditor of RCFL for FY 2018-19. The Director General of Corporate Affairs (DGCoA), Ministry of Corporate Affairs (MCA), Government of India, vide its letter dated 29.05.2020 informed the National Financial Reporting Authority (NFRA) that PW had filed a report to MCA under section 143(12) Under section 143(12) of Companies Act, 2013 auditor is required to report any fraud identified in the company of the Companies Act, 2013 (the Act) on 03.06.2019. PW then resigned from the audit on 11.06.2019, without issuing an audit report for FY 2018- 19. M/s Shridhar & Associates were appointed by the board of directors of RCFL on 28.06.2019 as statutory auditor of RCFL to fill the casual vacancy caused by the resignation of PW. M/s Shridhar & Associates issued its unmodified opinion on the financial statements of the Company on 14.08.2019 for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for a modification of opinion. The audit report gives a clear impression to the users that the auditor fully agrees with and reiterates the inappropriate disclosure by the Company. The auditors also endorsed the company's legal interpretation that there was no fraud and based on that dismissed any suspicions of fraud even while the matter was pending with MCA. (Details in section C.2 of this Order). c) The auditors did not obtain sufficient appropriate evidence to conclude and report that there was no material uncertainty regarding the going concern status of RCFL. (Details in section C.3 of this Order). d) The auditors did not perform the audit procedures to ensure the reasonability of the Expected Credit Loss provision of Rs. 537 crore on loans of Rs.12,224 crore. (Details in section C.4 of this Order). e) Despite being aware of the report of suspected fraud by the previous auditor, the EP stated in the audit report that there were no matters falling under section 143(12). Therefore, the audit report to the members was misleading. The Auditors also failed to adequately examine the end-use of loans, indications of siphoning of funds from the company, management over ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of Ethics, the violation of which constitutes professional misconduct. NFRA has the powers of a civil court and is empowered under Section 132(4) of the Act to investigate the prescribed classes of companies and impose penalties for professional or other misconduct of the individual members or firms of chartered accountants. 8) RCFL was required to prepare its Financial Statements for FY 2018-19 under Schedule III and other applicable provisions of the Act and Indian Accounting Standards (Ind AS) notified under the Companies (Accounting Standards) Rules, 2006. 9) Following the information from DGCOA, as described in the executive summary of this Order, we suo motu decided to examine the audit evidence that led the Audit Firm to issue an unmodified audit opinion. We called for the Audit File Vide NFRA letter dated 24.11.2021 and other information from the Audit Firm on 24.11.2021. After two extensions, the Audit Firm submitted the Audit File and other documents electronically through File Transfer Protocol (FTP) on 07.03.2022. From the Audit File, it was observed that M/s Shridhar & Associates were appointed as statutory auditors by the Board of Directors of RCFL on 28.06.2019 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lure to examine significant matters reported by previous auditors, use of Emphasis of Matter (EOM) in the Audit Report that violates SA 706, use of management experts in violation of SA 500, failure in the evaluation of the appropriateness of the going concern assumption, lapses in the verification of the expected credit loss etc. 13) Replies of the Auditors to the charges in the SCN are examined and discussed under the following broad categories. Only the violations/actions/omissions proved to result in one or more professional misconduct as per the articles of charges in the SCN are covered in this Order. C.1. Acceptance of Audit Engagement C.2. Emphasis of Matter in the Audit Report C.3. Going Concern C.4. Expected Credit Loss C.5 Matters Reported by the Previous Auditor and Violations of SA 240 C.6 Key Audit Matters C.7 Audit Documentation C.8 Role of the Audit Firm C.1 Acceptance of Audit Engagement 14) The Auditors were charged with professional misconduct of accepting an audit engagement without complying with the requirements of Clause 8 of Part 1 of the First Schedule to the Chartered Accountants Act, 1949, which requires an auditor to communica ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hartered Accountants Act, Code of Ethics, SA 300 (SA 300) - Planning an Audit of Financial Statements and the Quality Policy under SQC-1 were violated by the Auditor: a. Clause 8 of Part-1 of the First Schedule to the Chartered Accountants Act, 1949 states that a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct if he accepts a position as auditor previously held by another chartered accountant without first communicating with him in writing. The Code of Ethics 2009 makes it clear that "the object of the incoming auditor, in communicating with the retiring auditor is to ascertain from him whether there are any circumstances which warrant him not to accept the appointment". This objective will be met only upon receiving the return communication from the previous auditor. The Code also states that in case there is a delay in receiving the reply from the outgoing auditor "the auditor appointed can act, after waiting for a reasonable time for a reply". This requirement on the Code is also reflected in various decisions of the Disciplinary Council of the ICAI. b. Paragraph 12 of SA 300 requires that the auditor shall communicate with the prede ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ial statements referring to filing of Form ADT-4 under Section 143(12) of the Companies Act, 2013 to the Ministry of Corporate Affairs (MCA) by the previous auditor. Based on the views of the Company and supported by legal opinions there were no matters attracting the said section." 23) In this regard, the Auditors were charged with: a) Issuing an EoM on a disclosure which was not fit for referring in an EOM, since the subject matter was not properly presented or disclosed in the financial statements and was factually incorrect. The Auditors were also charged with using EoM for giving an opinion on the subject matter of the disclosure. b) Failure to state that the audit opinion is not modified in this respect, as required by SA 706 (Revised). c) Failure to challenge the management about non-disclosure of adjusting or non- adjusting events as envisaged by Ind AS 10 (Ind AS 10), Events after Reporting Period as a fraud report under section 143(12) of the Act has been filed by the previous auditor after the financial reporting date and hence it falls under the purview of Ind AS 10. The reporting of fraud is an adjusting event. However, the Company has treated it as a non-adju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ance cost, loss of goodwill, action by lenders etc. There is no disclosure in the financial statements of an estimate of such financial impact nor is there a statement that such an estimate cannot be made. There is no evidence in the Audit File of EP's examination of any of the above-mentioned matters. b. Section 143(12) mandates that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government. Further, Rule 13 of the Companies (Audit and Auditors) Amendment Rules, 2015 and Form ADT - 4 provide the manner of reporting and SA 240 provides the basic requirements while auditing. These provide that the auditor reporting the suspected fraud will first take it up with the Audit Committee and the Board seeking their views within 45 days and then file the report in the form ADT-4. All these stipulations when read together make it clear that the reporting on fraud in the course of performance of duties as an auditor is app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the legal opinion because it endorses the examination by legal experts appointed by the Company. However, the EP submitted in his reply to the SCN that he did not rely on the legal opinion. This is contrary to his EoM and noting in the Audit File which reads as ".... In light of that, we have relied on the legal opinion and concluded that 143(12) is not attracted". Such a reliance, placed on the legal opinion at the time of the audit, was not in compliance with the requirements of SA 500, Paragraph 8, which require that when audit evidence has been prepared using the work of a management expert, the auditor shall obtain an understanding of the work of that expert along with evaluation of the appropriateness of that expert's work as audit evidence for the relevant assertion. No such evaluations were carried out by the auditors. Therefore, the Auditors did not have an adequate basis for issuing the EoM. f. Further, the EoM does not state that the auditor's opinion is not modified in respect of the matter emphasized. Such an omission in one of the most significant parts of the audit report cannot be ruled out as a typographical error. g. After describing the disclosure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... related to going concern.". Despite this, the Auditors denied the charges and submitted that "... there is an error in our documentation in WP A 42-1 where we have documented that "The company's ability to meet its obligations is significantly dependent on material uncertain events....... due to above significant event, we have given material uncertainty para related to going concern. The facts are that there were no material uncertain events since the Company had already initiated Intercreditor Agreement (ICA) for the resolution of its debt which proposal was accepted by more than 75% of the lenders of RCFL..." 29) The above submission of the Auditors are unacceptable and an afterthought due to the following reasons: a. Apart from the above mentioned documentation in the Audit File, regarding going concern the EP in his presentation Submitted along with the reply to SCN, not forming part of the Audit File. The date of the Audit Committee meeting is mentioned in paragraph 7.2.1 (17) of the reply to SCN to the Audit Committee on August 14, 2019 (the date of signing the Audit Report) stated that "These events or conditions, along with other matters indicate the existence o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ve Bank of India on Prudential Framework for Resolution of Stressed Assets. Majority of our lenders have already entered into the ICA. The Company is confident of implementing its Resolution Plan during Financial Year 2019-20. In view of the steps taken by the Company, the accounts of the Company have been prepared on "Going Concern" basis." There is no evidence of independent examination of these contentions of the management, as required by Para 16 of SA 570 (Revised). Though the ET obtained the cash flow forecast prepared by the management, it did not perform any audit procedure to evaluate the reliability of the underlying data and adequacy of the assumptions. The ET neither obtained nor analysed any detailed maturity profile (fortnightly and monthly) of assets and liabilities over the next 12 months to support the forecast given by the company nor did they examine the probability of a positive outcome of restructuring of loans and the ICA (para 16(b) of SA 570(Revised)). b. As per Paragraph 18 of SA 570, a material uncertainty exists when the magnitude of its potential impact and likelihood of occurrence is such that, in the auditor's judgment, appropriate disclosure of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has the potential to affect the going concern of the Company since its continued existence was contingent on meeting the CRAR requirements. The regulatory proceedings consequent to the reporting of suspected fraud by the previous auditor was another event affecting the going concern. These events were neither disclosed in the notes to the financial statements on the going concern nor assessed by the Auditors in perspective. e. Thus, the requirements of SA 570 (Revised), as stated above, were not met by the Auditor. 31) We further observe that note no. 55 of the Financial Statements on the going concern assumption does not fully disclose the events or conditions and the mitigation plan. The disclosure note does not list all the significant events or conditions that may cast significant doubt on the entity's ability to continue as a going concern. The breach of capital adequacy regulatory norms, which has the potential to affect the going concern is absent in the disclosure. How the company will be able to infuse the required capital to meet the RBI requirement of minimum CRAR of 15%, is also absent in the disclosure. The disclosure made by the Company did not discuss the d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 35) The value of 'Loans given to borrowers' shown in the financial statements of RCFL as on 31st March 2019 amounts to 12,223.86 crores in the balance sheet which constitutes around 90% of its balance sheet size. The Auditors were charged with the following regarding the verification of ECL on these loans. a. Failure to obtain sufficient appropriate audit evidence to verify whether the ECL estimate and its related disclosures in the financial statements were reasonable and whether the financial statements were materially misstated. b. Failure to report the absence of adequate provision for originated credit-impaired loans as per Ind AS 109. c. Failure to exercise professional skepticism in accordance with the requirements of SA 200 in auditing complex accounting estimates of ECL. d. Failure in assessing and documenting the impact of material weakness in internal control on ECL. There is no separate test of the design, implementation and operating effectiveness of internal controls on ECL as required by SA 540 and SA 315. 36) The Auditors denied the charges and stated that all the required procedures were performed, and the evidence was obtained. The WP referen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... credit risk' criteria underlined by Ind AS 109. c. Whether the management's decisions on the range of scenarios and scenario weightings captured the appropriate extent of ECL required by Ind AS 109, including the effect of possible economic conditions. d. There is no evidence of the challenge of the ECL model and the underlying data sources. Given the high-risk factors and complexity of the ECL estimates the Auditors were required Para 14 of SA 540 to assess the need for employing experts in verifying ECL. However, there is no documentation in the Audit File regarding the skills and competencies of the ET members who were conversant with ECL calculations. There is no evidence of the involvement of any auditor's expert or management expert. e. In the audit report on internal financial controls over financial reporting, the Auditors issued a qualified opinion stating that the Company's internal financial control system over financial reporting was not operating effectively with respect to the corporate loan book segment due to weak credit appraisal and loan sanctioning mechanism. However, the Auditors did not assess and document the consequences of the above ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt and absence of professional skepticism are viewed seriously by audit regulators across the world. In the matter of K.R. Margetson Ltd. and Keith R. Margetson PCAOB Release No. 105-2023-023 September 12, 2023, the US audit regulator PCAOB imposed sanctions on an auditor for failure to appropriately evaluate the reasonableness of a discount rate used in developing the valuation estimate. The sanctions included revocation of registration of the firm, restrictions in acting as EP and a civil money penalty of $30,000. In the matter of Martin Lundie, CPA PCAOB Release No. 105-2022-040 December 22, 2022 (Partner, EY Canada), PCAOB imposed sanctions for failing to sufficiently test the assumptions underlying the estimate and by failing to sufficiently test the accuracy and completeness of data on which that estimate was based. Sanctions included debarring from being an associated person of a registered public accounting firm and a civil money penalty of $65,000. C.5 Matters Reported by the Previous Auditor and Violations of SA 240 40) The previous auditors, before resigning, filed a report under section 143(12) of the Companies Act, indicating suspected fraud in RCFL. In this regard, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r was under MCA's purview. The action of the auditors amounts to agreeing with RCFL's irregular legal determination and ruling out suspected fraud, and hence inappropriate reporting since the matter was not concluded by the regulator, i.e., MCA. Thus, we do not accept the Auditor's submission that they have only drawn attention to the fact and have not concluded on the matter. Had it been the case, the audit report should have been qualified, instead of mention in the EoM, since the impact of fraud, if any, could not be ascertained by the Auditor, before it was concluded by MCA. 43) We also note that the Auditors, under their statutory responsibilities, have to verify independently and report that the financial statements are free from material misstatements and present a true and fair view of the affairs of the Company. Without prejudice to our observations regarding the EoM, we observe that the audit opinion was not based on sufficient appropriate audit evidence regarding the significant matters reported by the previous auditor, as explained in the following paragraphs. a) The Auditors specifically noted in the Audit File WP E-2.1, WP E-2.2, WP E-2.3, several indic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apital term loan increased from approximately Rs. 2900 crore as of 31.03.2018 to Rs.8600 crore as of 28.02.2019. However, the Auditors failed to assess and document the impact of such material weakness on the related financial statement assertions. There is no evidence that the potential risks of misstatements on financial statement assertions were ruled out based on substantive procedures. Paragraph 17 of SA 330 Also, Paragraph 33 of SA 240 requires the Auditors to perform audit procedures to respond to the identified risk of management override of controls, which the Auditors did not do. e) The Auditors submitted that they had considered revenue as 'fraud risk' as required by SA 240. However, on perusal of the WP WP B-30, Page 4, it is seen that revenue has been identified as a 'medium risk' without any basis. There is no rebuttal in the WP as to why revenue is not considered a 'fraud risk'. At the time of the appointment itself, the Auditors were aware of the reporting of suspected fraud by the previous auditor. Despite this, the auditors did not consider revenue as a presumptive fraud risk and did not appropriately rebut it as required by para 26 of S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s management's assertions and any information that contradicts such assertions. In forming an opinion, the Auditor shall consider all relevant audit evidence, regardless of whether it appears to corroborate or contradict the assertions in the financial statements Paragraph 26 of SA 330. On perusal of the reply and WPs in this regard, we note that the Auditors ignored several pieces of evidence that contradict the management assertions regarding the suspected fraud. Despite being aware of the report of suspected fraud by the previous auditor, the EP stated in the audit report that there were no matters falling under section 143(12). Therefore, the audit report to the members was misleading. The Auditors also failed to adequately examine the end-use of loans, indications of siphoning of funds from the company, management override of controls, and the business rationale of sanctioning and disbursing loans by the Company. None of these factors was adequately reflected in their assessment of risks of material misstatement due to fraud and consequently failed to perform audit procedures responsive to the fraud risk. 45) Based on the above, all the charges in paragraph 40 are proved. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... results of the procedures performed, evidence obtained, and conclusions reached, and (b) determine who performed the work and the date such work was completed as well as the person who reviewed the work and the date of such review... ... the documentation for each of those audits was insufficient to demonstrate the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions 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". C.8 Role of the Audit Firm 52) M/s Shridhar & Associates in their written submission (made after oral hearing) dated 15.02.2024 submitted that the Firm had provided the EP with adequate staff and provided training to staff members involved in audit and accounting of technical topics. The Firm has also given their responsibility under the respective areas o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... those charged with governance, engagement of Auditor's expert, evaluating the adequacy of internal audit function of the Company, and general quality aspects and SAs, which are subordinate legislations, lay down the following in clear terms: a. Responsibility for the overall quality of all the audit engagements, by ensuring that the firm's personnel comply with applicable laws, SAs and ethical requirements and issues reports appropriate to the situation, rests with the firm SQC- lays down these core principles a Firm must adhere to ensure minimum required quality in any audits undertaken at the firm level. It emphasises that "3. The firm should establish a system of quality control designed to provide it with reasonable assurance that the firm and its personnel comply with professional standards and regulatory and legal requirements, and that reports issued by the firm or engagement partner(s) are appropriate in the circumstances". SQC-1 then mandates in detail the stipulations at the firm level. b. Within the above framework, the individual engagement partners are personally responsible Paragraphs 3, 4 and 8 of SA 220 for the quality of specific engagements to which t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... related to the audit of financial statements of Medicis Pharmaceutical Corporation and subsidiaries, imposed civil money penalties of $2,000,000 to the firm Ernst & Young LLP, $50,000 to Jeffrey S. Anderson, the Partner with final responsibility of the subject matter audit engagement, $25,000 to Robert H. Thibault, the independent review partner, and $25,000 to Ronald Butler, the second partner, supervised by Anderson. The partners were also barred from being associated with a registered public accounting firm. In another case, the PCAOB In the Matter of KPMG Assurance and Consulting Services LLP and Sagar Pravin Lakhani, PCAOB Release No. 105- 2022-033 December 6, 2022 imposed civil money penalties of $1,000,000 on KPMG India and $75,000 on its partner Lakhani for lapses in audit documentation by the partner, who was an ET member. PCAOB also suspended Lakhani from being an associated person of a registered public accounting firm for a period of one year. 59) The "Firm and Engagement Performance Metrics" published by PCAOB on October 12,2022 https://assets.pcaobus.org/pcaob-dev/docs/default-source/about/advisory/documents/iag-october-2022/firm-and-engagement-performancemetrics-and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng such financial statement where he is concerned with that financial statement in a professional capacity". This charge is proved as the Auditors failed to disclose in their report the material non- compliances the Company made as explained in sections C.2 to C.5 and C.8 above. b) M/s Shridhar & Associates and CA Ajay Vastani 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 an Auditor 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 Auditors failed to disclose in their report the material misstatements made by the Company as explained in Paras C.2 to C.5 and C.8 above. c) M/s Shridhar & Associates and CA Ajay Vastani 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 Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection 132 (4) of the Companies Act, 2013, read with Section 22 and Clause 8 of Part I of the First Schedule of the Chartered Accountants Act, 1949 (No. 38 of 1949) as amended from time to time, which states that an Auditor is guilty of professional misconduct when he "fails to communicate with outgoing Auditor". This charge is proved since the Auditors failed to accept the audit in accordance with the law as explained in Para C.1 and C.8 above. 61) Therefore, we conclude that the charges of professional misconduct in the SCN, as detailed above, are established based on the evidence in the Audit File, the audit reports on the financial statements for the FY 2018-19 dated 14th August 2019 and the submissions made by the Auditors, and the Annual Report of Reliance Commercial Finance Limited for the FY 2018-19. E. PENALTY AND SANCTIONS 62) 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. 63) As per the financial statements, RCFL's total assets were 13,50 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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