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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 ..... a position as auditor previously held by another chartered accountant after first communicating with him in writing - Section 132(4) of the Companies Act 2013 - penalty and sanctions. HELD THAT:- M/s Shridhar Associates and the EP CA Ajay Vastani 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 CA 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 Auditors failed to disclose in their report the material non- compliances the Company. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Auditors failed to conduct the audit in accordance with the SAs but falsely reported in their audit report that the audit was conducted as per SAs. 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 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. It is concluded 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. Penalty and sanctions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ort 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 the FY 2018-19 with an Emphasis of Matter (EOM) paragraph relating to the report filed by ex-Auditors PW, stating that Based on the views of the Company and supported by legal opinions there were no matters attracting the said section . 2) As per the consolidated financial statements, RCFL's total assets were ₹13,504 crore. The external liabilities included debt of over 12,623 crore, consisting of debt securities, borrowings from banks etc. It had a total revenue of around ₹1,780 crore and reported a net loss of ₹ 1,892 crore for FY 2018-19. PW reported suspected fraud regarding 'Work ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r). d) The auditors did not perform the audit procedures to ensure the reasonability of the Expected Credit Loss provision of ₹ 537 crore on loans of ₹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 override of controls, and the business rationale of sanctioning and disbursing loans by the Company. None of these factors was adequately reflected in the Auditor's assessment of risks of material misstatement due to fraud; consequently, the Auditors failed to perform audit procedures that were responsive to the fraud risk. (Details in section C.5 of this Order) 5) Despite the resignation of the previous auditor and a reporting of suspected fraud, the Auditors failed to conduct the audit as per the standards on auditing. The material misstatements in the financial statements due to inadequate provision, unju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 to fill the vacancy caused by the resignation of PW. The examination of the Audit File, annual reports of the Company and other communications by the Audit Firm to NFRA showed a prima facie case of professional misconduct on the part of the Auditor. 10) On satisfaction that a sufficient cause exists to initiate action under Section 132(4) of the Act, an SCN was issued to the Auditors to show cause as to why necessary action for professional misconduct against them should not be taken under Section 132(4)(c) of the Act read with Rule 11 of NFRA Rules 2018 for professional misconduct of: a. Failure to disclose a material fact kn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 communicate with the previous auditor before accepting the position. 15) The Auditors denied the charges. They submitted that the EP had a telephonic discussion on 30.06.2019 with the previous auditor. In this discussion, the previous auditor stated that they would send their no-objection. After the discussion, their acceptance letter to the Company was given on 01.07.2019. The Auditors also submitted that the Clause does not explicitly require the auditor to get a written response before accepting the appointment . It is further submitted that the NOC from the previous auditor was received on 05.07.2019 and On July 10, 2019, we signed an engagement letter dated July 1,2019 which was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 predecessor auditor, in compliance with relevant ethical requirements, prior to starting an initial audit. c. In line with the above requirements, the Audit Firm's quality control manual, prepared under SQC-1, states: The firm shall issue its engagement letter and/or consent to act as an auditor only after performing necessary due diligence procedure, risk assessment procedure and receiving the professional clearance from predecessor auditor . 20) Accordingly, based on the above facts, we conclude that the EP accepted the engagement without first communicating with the previous auditor and without waiting for a reasonable time for a reply. The deviation from the Law and the firm's quality p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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-adjusting event by disclosing that the matter was not reportable under section 143(12). 24) The Auditors denied the charges, except for the submission that [we] agree that there was a typographical miss in stating that the opinion was not modified in respect of this matter . We have examined and discussed in the following paragraphs the detailed replies and evidence in this regard. 25) Paragraphs 7 and 9 of SA 706 (Revised) make it clear that the EoM shall refer only to information appropriately presented or disclosed in the financial statements and indicate that the auditor's opinion is not modified in respect of the matter emphasized. Thus, before providing an EoM, it must be ensured that the subject matter of the E ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 applicable when the auditor has reason to believe and has knowledge that a fraud has occurred or is occurring based on evidence obtained and the professional judgements made. Once it is reported to the MCA, the legal determination of the fraud and admitting or ruling out fraud is a regulatory matter. Neither the Company nor an Auditor is competent to make a conclusive legal determination Refer to Sections 130, 199, 206, 211, 212, 213 etc. of the Act of a Statutory matter reported by the previous Auditor as per his judgement and under the mandate provided in the Act. The normal course of action in this situation for any prudent Company could be initiating an independent investigation into the alleged matters to bring out the truth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 note in the first sentence of their EoM, the Auditors added one sentence stating, Based on the views of the Company and supported by legal opinions there were no matters attracting the said section . The Auditors chose not to state that their audit opinion was not modified in this regard Refer to Appendix 3 and 4 of SA 706 (Revised) for illustrative examples of EoM . This gives a clear impression to the users that the Auditor fully agrees and reiterates the disclosure. This could potentially be seen as the Auditors endorsing the company's legal interpretation and dismissing any suspicions of fraud while the matter was pending with MCA. Thus, the action of the Auditors amounts to non-performance of any procedures and evidence, ruling out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oned 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 of material uncertainty relating to going concern. The Company's ability to meet its obligations is significantly dependent on material uncertain events Interestingly, this presentation before the Audit Committee has been relied upon by the Auditor in his response to SCN. b. The Auditors identified three significant events or conditions that may cast significant doubt on the entity's ability to continue as a going concern. These events were (a) near complete freeze on bank's lending to NBFCs (b) operating loss during the year and (c) temporary liquidity mismatch. c. There is no examination in the Audit File of how the ICA will ensure the going concern status. 30) The above facts show that the Auditors had identified conditions present that may cast ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 the nature and implications of the uncertainty is necessary for the fair presentation of the financial statements. Thus, on noticing the significant events or conditions that may cause material uncertainty, the ET needs to consider: i. the magnitude of potential impact, i.e., will the impact of these events effectively put the entity out of business or what is the worst-case scenario? ii. The likelihood of occurrence, i.e., does the management have a realistic contingency plan or how do they plan to deal with the impact on day-to-day operations? None of the above requirements were considered by the ET. The scenario mapping is essential here and should form part of management's assessment of the going concern, which is absent in this case. c. RCFL had entered into the ICA for th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 details of financing arrangements such as the magnitude, timelines, the availability of refinancing etc. The Company does not disclose the magnitude of financing arrangements, the expiration and the total financing arrangements, or the impact or the availability of refinancing by way of securitization. The Company only describes some adverse situations and planned mitigation measures and then goes on to say that the financial statements have been prepared on a going concern basis. It neither characterizes this situation as a material uncertainty nor rules out material uncertainty. 32) Contrary to Company's disclosure, the Auditors stated in the Independent Auditor's Report that the Company's ability to meet its obligations is significantly dependent on material uncertain events including re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 references WPS - B-30 (pertaining to planning), E-4 (Arithmetical accuracy of ECL computation), E-2.3.1 (List of 29 ADAG group companies and why the loans given to them has been written off mentioned) provided by them in their response to substantiate the work done by them, only reflect verification of the arithmetical accuracy by the Auditors of the ECL computation as done by the management, audit plan for verifying underlying working data used to calculate ECL rates, PD and LGD to ensure the accuracy of working and ECL provision and a list of loans advanced to 29 ADAG group companies and the ECL amount thereon. 37) On perusal of the WPs as referred by the Auditors in their response, we note that the audit file does not contain evidence of the substantive procedures and test of details claimed to have been performed. The reply is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 material weakness on the assessment of 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. In the absence of the test of the design, implementation, and operating effectiveness of internal controls on ECL the opinion on internal financial controls over financial reporting is unreliable. f. We note from the Audit File Work papers on Section -E -Loans and Advances-Critical issues and in work paper on impairment on loans and advances E-2.1, E-2.2, work paper E-10 , that the ET observed that the loan was disbursed to financially unsound borrowers. It is recorded that there are companies which created subservient charges against the loans. On checking the financials, those assets included advances made to the group companies or investment in group ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... luded 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, the EP and the Audit Firm were charged with the following: a. 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. b. Failure to exercise due diligence and professional skepticism and concluding without obtaining sufficient appropriate audit evidence that no reporting is required regarding the matters of suspected fraud reported by the previous auditors to MCA. c. Failure to adequately examine the end-use of loans even after observing that the borrowers had used the funds for onward lending to other group companies which were not creditworthy. On RBI's intervention, the Company wrote off these loans, indicating siphoning of funds from the company. d. Failure to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 indications of financial distress of the borrowers such as no operating revenues, inadequate securities provided by the borrowers, absence of required documents in the borrower's file, negative worth of borrowers since past few years etc. These are indicators of fraudulent transactions to entities such as shell companies. Despite these observations in the WPs, the Auditors did not examine the fraud risk. b) It is evident from the end-use certificate provided by a chartered accountant WP E05 and E5 and E5.1 Pg 10 that the loans were diverted WP E-Critical Issues to other group companies and were not used for the purpose for which it was sanctioned. It is noted that the loans of ₹5,849.43 crores were used for purposes other than operations. They also listed certain borrowers WP E-3 who had ultimately diverted the borrowed funds to financially weak group comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 SA 240. f) Regarding the requirements of paragraph 30 of SA 240 that the auditor shall design and perform further audit procedures whose nature, timing and extent are responsive to the assessed risks of material misstatement due to fraud at the assertion level, the Auditors submitted that they had considered 'valuation' as a relevant assertion and performed procedures to address this assertion. However, we observe that planned procedures WP E1.3 in this regard was not responsive to risks of material misstatement due to fraud. For instance, the planned procedures for assertions of 'Valuation' and Right were as follows. 1. Rights obligation: To verify that the entity holds or controls the rights to assets of the entity The rights of the Assets is verified by the agreements sanction letters for the loan granted to the customers 4. Valuation: Objective: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oning 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. C.6 Key Audit Matters 46) The Auditors were charged with failure to communicate the Key Audit Matter (KAM) with Those Charged with Governance (TCWG) as required by paragraph 17 of SA 701 SA 701, Communicating Key Audit Matters in the Independent Auditor's Report and failure to document the rationale behind the Auditor's determination of KAM, as required by paragraph 18 of SA 701. 47) The Auditors denied the charges. However, in the absence of any evidence produced by the auditors to show compliance with the mandatory requirements of paragraph 18 of SA 701, we deem the charges as proved. C.7 Audit Documentation 48) The Auditors were charged with non-compliance with Paragraph 9 of SA 230 which requires the auditor to document who performed the audit work, the date such work was completed, who reviewed the audit work performed, date and extent of such review. There are severa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en 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 of SQC-1, to state that The Engagement Partner is responsible for forming an audit opinion on the financial statements.... To facilitate the function of the Engagement Partner in performing his duties, the Noticee No. 1 (The Audit Firm) provided him with adequate staff and provided training to staff members involved in audit and accounting topics .... Professional Judgement is followed by the engagement partner and the same is consulted with the quality review partner. Noticee No.1 (The Audit Firm) has provided adequate resources and support to the engagement partner for facilitating him in fulfilling its responsibilities . 53) We do not agree with any of the contentions of Shridhar Associates in this regard. Audit Firm is the legal entity appointed under Section 139 of the Act as the auditor of RCFL. Hence the report issued by the legal entity, signed by EP, is the primary responsibility of the legal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ropriate 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 they are assigned by the firm as per its policies. 55) When a firm is appointed as an auditor under Section 139, all the responsibilities cast under the Act are primarily on the firm. As mandated by Section 132, the responsibility of overseeing the quality of service of the professions associated with ensuring compliance with auditing standards rests with NFRA. Monitoring and enforcing compliance with standards of auditing (SA) is another statutory duty cast on NFRA. 56) Taking the above cardinal factors into account, Section 132 (4) of the Act empowers NFRA to investigate the matters of professional or other misconduct committed by any member or firm of chartered accountants, registered under the Chartered Accountants Act, 1949. Violation of the Act, SAS or SQC 1 is one of the key ingredients of professional misconduct, as envisaged by the Act. 57) Thus, after a detailed examination of facts and circumstances, we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing 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-related-attachments.pdf?sfvrsn=e362f3a_3 Order in the matter of Statutory Audit of Reliance Commercial Finance Ltd for FY 2018-19 , 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, including India, in the world and top tier Audit Firms. The study reveals that many metrics can be applied at both the engagement and firm level and some metrics may only be reported at either the engagement level or the firm level. (Refer to Page 5 of the report). The report lists key Audit Quality Indicators reported by 9 leading audit firms Various reports issued by nine firms were reviewed to identify firm level metrics disclosed in public reports. These firms are BDO USA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 does not exercise due diligence or is grossly negligent in the conduct of his professional duties . This charge is proved as the Auditors, conducted the Audit of a Public Interest Entity in total disregard of their 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 C.1 to C.8 above. d) 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 8 of Part I of the Second Schedule of the Chartered Accountants Act, 1949 (No. 38 of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... roved 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 13,504 crore and total external liabilities were around ₹12,623 crore as of 31.03.2019. The external liabilities included a debt of over 10,284 crore, in the form of debt securities and borrowings from banks, commercial papers etc. Given the high degree of public interest in this listed entity, it was the duty of the Auditors to conduct the audit with the highest level of professional skepticism and due diligence and report their opinion in an unbiased manner. Despite the resignation of the previous auditor and a reporting of suspected fraud, the Auditors failed to conduct the audit as per standards on auditing. The major lapses started from the acceptance of the initial appointment of Shridhar Associates as statutory auditors and continued throughout the risk assessment, audit of loans, evaluation of going concern and reporting. The material misstatements in the financial statements due to inadequate provision, unjustified valuation of loans and irrational business practices were concur ..... X X X X Extracts X X X X X X X X Extracts X X X X
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