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TMI Blog2025 (3) TMI 341X X X X Extracts X X X X X X X X Extracts X X X X ..... rges of Professional Misconduct E. Penalty and Sanctions A. EXECUTIVE SUMMARY 3. NFRA initiated action under Section 132(4) of the Companies Act, 2013 (the Act) for investigating into professional or other misconduct of the EP for the statutory audit of RFL for the FY 2017-18, and issued a Show Cause Notice (SCN) on 15.05.2024. 4. This Order disposes of the said SCN and finds that the EP failed to meet the relevant requirements of the Act as well as the Standards on Auditing ('SA' hereafter) in respect of several significant areas, reflecting gross negligence and lack of due diligence in performing the audit of RFL for the Financial Year ended 2017-18. These include: i. Failure to comply with Companies (Audit and Auditors) Rules, 2014 in timely reporting of fraud to the Central Government under Section 143(12) of the Companies Act, 2013 in respect of the Corporate Loan Book (CLB) of Rs. 2,036 crores. ii. Failure to appropriately assess the risk of fraud and risk of management override of controls in RFL, ignoring that RBI had raised serious concerns regarding the CLB portfolio of RFL and RFL itself reporting to RBI regarding a fraud pertaining to Strategic Credit C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpanies and impose penalty for professional or other misconduct of the individual members or firms of chartered accountants. 7. The Statutory Auditors, both individual and firm of chartered accountants, are appointed under Section 139 of the Act. The Statutory Auditors, including the Engagement Partners, Engagement Quality Control Reviewer and the Engagement Team that conducts the audit are bound by the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA hereafter), including the Standards on Quality Control and the Code of Ethics, the violation of which constitutes professional or other misconduct, and is punishable with penalties prescribed under Section 132(4)(c) of the Act, 2013. 8. NFRA took up for suo motu examination, under Section 132(4) of the Act, possible violations of the SAs by the EP in the statutory audit of RFL, a company located at Delhi, following receipt of information from Securities and Exchange Board of India (SEBI) vide letter dated 19.06.2020 that its investigations had indicated irregularities in the loan transactions of RFL, a subsidiary of REL. 9. In order to investigate whether the statutory audi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which was held on 27.08.2024 at the office of NFRA, New Delhi and post the hearing, written submissions were submitted on 10.09.2024. The EP was represented by legal counsel Mr. Ajay Bahl and his team of advocates. This Order is based on NFRA's own independent investigation including a review of the Financial Statements of RFL for the FY 2017-18, the audit files, written responses of the EP, submissions made during the personal hearing and written submissions thereafter. Each of the charges in the SCN is analysed and discussed herein below. C. LAPSES IN THE AUDIT C1. Delay in reporting fraud under Section 143(12) of the Companies Act, 2013 12. The EP was charged with delay in filing ADT-4 report relating to fraud. Rule 13 of Companies (Audit and Auditors) Rules, 2014 requires an auditor, if he has reason to believe that an offence of fraud, is being or has been committed against the company by its officers or employees, to report the matter to the Central Government and file ADT-4, if the amount involved is Rupees One crores or above. 13. RBI had issued a letter dated 27.01.2017 to RFL pointing out irregularities in the loans granted by RFL under its CLB portfolio, stating ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent or convincing evidence of fraud when the audit was commenced in October 2017. 16. The EP further added that: i. the ET was enquiring and analysing the details with the management and was in continuous correspondence with RFL, RBI and the banks, however, the flow of information was taking time, and more time was required for having 'reasons to believe' that fraud was committed. The ET received from the management on 18.01.2018, party wise quarterly movement details of the CLB for the period April 2015 to September 2017 and the RBI inspection Report for the F.Y. 2015- 16 and 2016-17 on 09.02.2018. The Financial Statements for the period upto December 2017 were received on 30.03.2018. ii. The RBI inspection reports for 2015-16 and 2016-17 received on 09.02.2018 prohibited further sanction of loans under the CLB portfolio as the roadmap to liquidate the CLB loan Portfolio, as directed by RBI in its letter dated 27.01.2017, was not implemented by RFL. The EP vide letter dated 12.04.2018 requested RBI to provide relevant information regarding certain transactions where, according to RBI the funds disbursed to nine borrowers ultimately came back to group companies of RFL. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Financial Statements of December 2017 were received towards the end of March 2018; that EP had issued a qualified opinion as the RFL had made a provision of 50% only on the CLB portfolio of Rs. 2036.70 crores as on 31.03.2018, while the EP considered the entire loan portfolio as loss asset to be provided @100%; that the EP then wrote to the Audit Committee on 25.05.2018, listing out the items that he had considered for possible reporting under Section 143(12) of the Companies Act; the Audit Committee (which had changed following several resignations), provided its response on 09.07.2018 where they disagreed with his proposal to report the matter under Section 143(12) of the Companies Act. However, after considering the response from the Audit Committee, the EP made the ADT-4 filing on 23.07.2018. 20. We have considered the submissions of the EP. The RBI letter dated 27.01.2017 expressly stated that loans under CLB portfolio were granted to financially weak borrowers, without proper appraisals and end use monitoring, and that funds disbursed by RFL ultimately came back to the group companies of RFL. Based on the same, the predecessor auditor had also qualified his opinion. In this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bstance in the stand of the EP that he was obtaining additional information to confirm his 'reasons to believe' about suspected fraud in the CLB portfolio. The EP's deliberate delay which concealed critical information from the stakeholders exhibits lack of due diligence and gross negligence in performance of his statutory function. We find the EP to be grossly negligent in complying with Rule 13 of Companies (Audit and Auditors) Rules, 2014 and consequently Section 143(12) of the Companies Act, 2013. 23. We also note that the EP signed the Financial Statements for FY 2017-18 on 30.05.2018 and the Annual General Meeting was held on 28.09.2018 (Date of issue of Financial Statements). The EP filed ADT-4 with the Central Government (Ministry of Corporate Affairs) on 23.07.2018 which was an event after the date of the auditor's report but before the date the Financial Statements were issued. The EP was required to carry out specific audit procedures after filing ADT-4 as mentioned in paragraphs 4, 6 and 10 of SA 5604, especially assessing whether the Financial Statements needed amendment and additional disclosures. However, we find no evidence that the EP carried out s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or suspected fraud, or treated the same as an instance of management override. Therefore, pending the RBI's inspection reports for FY 2015-16 and FY 2016- 17 which were due, the risk assessment was appropriate, however, the EP undertook significant investigation after the RBI's Inspection Reports for FY 2015-16 and FY 2016- 17, resulting in identifying and reporting fraud to Central Government. 29. We have reviewed the planning assessment documents prepared by the EP, a screenshot of which is placed below: Exhibit 1 Audit Area Assessed Risk Audit Approach to Assessed Risk 9. Loans and Advances Existence, Rights & obligations, Completeness and Valuation- For these assertions risk has been assessed to be high 1. Verifying the Assignment Deals and Loans Sold during the financial year 2. Ensure write off and revocery of loan is accounted properly and approvals for written off taken or not. 3. Requirement of classification of related party loans as per Schedule III is been fulfilled. 4. Checking the Provision of loan as per RBI norms. 5. Check for dimunition in the valuation of assets acquired in satisfaction of debts 6.Approvals of loan restructured 30. The audit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wal Other engagement team members: Issues Disussed Comments and actions raising Financial statement areas susceptible to fraud Loans and Advances Revenue recognition As per AS 9 Potential for management override Based on the developments related to the group, the audit procedures should take into account potential for management over-ride Exhibit-3 B. Meeting with Management/ Those charged with Governance Present: Date: 12-01-2018 Client: Mr. Sanjay Kumar (AV ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... serious concerns regarding the CLB portfolio in its letter dated 27.01.2017, based on which the predecessor auditor had issued a qualified opinion. 34. Further, sanctioning of loans under CLB to borrowers with weak financial creditworthiness and solely based on relations with the promoter and the Disclaimer of Opinion given in the Internal Control over Financial Reporting (ICOFR) by the auditor of the previous Financial Year, which was known to the EP during the risk assessment exercise and the fact that the EP himself also issued a Disclaimer of Opinion in the ICOFR report which clearly established that there was management override of controls. 35. Regarding areas that are prone to fraud, the EP in his risk assessment form has made an assertion that 'the client is highly professional' (exhibit-7) which amounted to exhibiting lack of professional skepticism in an area where he had presumed fraud risk and eventually filed ADT-4. Exhibit-7 S.No Procedures W/P reference Comments 1 Audit Planning: Discussions amongst the engagement team on areas susceptible to misstatements arising from fraud, considering the following factors (Refer to Section 8.4.2 of the Manual) & ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of professional skepticism with particular regard to the risk of fraud etc. In the same case, FRC imposed financial sanction of GBP4,410,000 on Ernst & Young and GBP47,250 on its partner Neil Parker for a different financial year but for similar deficiencies in audit'. C.3. Audit of Loan Book RFL 39. The EP was charged with non-compliance with SA 2008, SA 230⁹ and SA 50010 in the audit of the loan book of RFL for the FY 2017-18, for not performing enhanced procedures in view of the suspected fraud in the CLB portfolio and the SCCPL fraud reported to RBI wherein twelve (12) loan accounts were assigned to SCCPL and subsequently Rs. 793 crores was written off during FY 2016-17 on the direction of RBI. 40. The EP denied the charge and submitted that the Engagement Team had applied higher caution in the evaluation of the loans under the Loan Against Property (LAP) or Loan Against Shares (LAS) verticals of the loan book of RFL, and the audit documentation for the audit of Loans and Advances was sufficient and appropriate as per SA 230. 41. Subsequently, the EP submitted additional documents under an affidavit stating that there was an inadvertent omission of certain workp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 30. 43. FRC in the matter of PricewaterhouseCoopers LLP and Richard Hughes" decided that a financial sanction of GBP1,750,000 is payable by PwC and GBP42,000 by Mr Hughes for deficiencies in audit of BT Group plc. FRC found that Respondents did not act with the requisite professional skepticism; did not obtain sufficient appropriate audit evidence; and did not prepare audit documentation that was sufficient to enable an experienced auditor, having no previous connection with the audit, to understand the nature, timing and extent of the audit procedures performed. C.4 Recognition of Deferred Tax Assets (DTA) 44. The SCN stated that DTA of Rs. 495.63 crores was recognised in the Standalone Financial Statement of RFL as on 31.03.2018 without sufficient appropriate audit evidence that such future taxable income will be available. The EP was charged for non-compliance with SA 200¹², SA 230¹³, SA 50014 and SA 54015 for not exercising professional skepticism and failing to verify whether there was virtual certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised as per the requirement of AS 2216. 4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not the tampering with the audit file. The auditor's reliance on company- provided figures without corroborative analysis, coupled with the presentation of supplementary documents that do not substantiate audit procedures, indicates a significant lapse in the performance of his professional duties, undermining the reliability and transparency of the Financial Statements. We, therefore, conclude that the EP failed to comply with SA 200, SA 230, SA 500, and SA 540 in recognition of DTA of Rs. 495.63 crores which was a material amount. C.5 Audit of Investments 49. The EP was charged with non-compliance with SA 200, SA 240 and SA 500 for his alleged failure to verify the business rationale of the investments made by RFL, obtain sufficient appropriate evidence regarding impairment/diminution of investment and verify the interest income received on the investments. These are discussed below. Investment in Non- Convertible Debentures (NCDs) of OSPL for Rs. 200 crores 50. The EP was charged with non-compliance of AS 1317 regarding accounting for investments. RFL had a current investment of Rs. 200 crores in the non-convertible debentures of OSPL Infradel Private Limited (OSPL). As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was no reason to disagree with that treatment. 54. The reply of the EP is not acceptable for the following reasons: i. During FY 2016-17, OSPL borrowed Rs. 200 crores from RFL via NCDs and invested Rs. 204 crores in the Equity Shares of BRNL. Therefore, OSPL acted as a conduit for transfer of funds from RFL to BRNL. ii. The NCDs were supposed to be repaid by 14.12.2017, however, the same were not repaid till the end of the FY 2017-18. iii. OSPL did not service the interest after June 2017. iv. RFL already had existing exposure of more than Rs. 50 crores (unsecured) towards BRNL under its CLB Portfolio. There was no justification for RFL to accept the security of shares of BRNL as both OSPL and BRNL were SREI group sister companies. 55. Therefore, it is amply clear that RFL funded OSPL's purchase of equity shares of BRNL. The EP did not question the business rationale of making a big investment of Rs. 200 crores in a very small company, with no real business and having net worth of Rs. 1.23 lakhs only. The EP did not show professional skepticism by questioning why RFL routed funds through OSPL and not directly invest in the shares of BRNL, which already owed it Rs. 50 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ancial Statements and a Disclaimer of Opinion on the Internal Financial Control over Financial Reporting (ICOFR) for the FY 2017-18. The Qualified Opinion and the Disclaimer of Opinion did not take into account the impairment needed for investments in the debentures of OSPL Infradel Pvt. Ltd, which amounted to Rs. 200 crores, and the incorrect recognition of DTA of Rs. 495.63 crores, discussed in the foregoing paragraphs. The EP denied the charge by stating that based on his replies given against the charges for recognition of DTA and impairment of investments, there was no reason to modify the opinion. 60. As discussed in the above paragraphs the recognition of DTA and investments in NCDs of OSPL were not in accordance with the relevant accounting standards and therefore were misstatements accounting for 5.07% of the Standalone Balance Sheet as on 31.03.2018. The combined impact of these two items, along with the suspected fraud in CLB, as discussed in charge C.1 above was Rs. 2,672.33 crores, which was 21.32% of the Standalone Balance Sheet as on 31.03.2018 which was material and pervasive. The breakup is shown below: i. The suspected fraud in the loans given under the CLB por ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly, the minority interest was the same as in previous year in terms of percentage. The Minority Interest was calculated by applying the said percentage to the shareholders' fund i.e. 12.50% of Rs. 197.77 crores which comes to Rs. 24.72 crores as stated in the Consolidated Financial Statements. The EP stated that while submitting the Audit Files to NFRA, the working papers for appropriateness, valuation and completeness of the Minority Interest were inadvertently missed out and submitted an email containing attachments showing the calculation of the minority interest and the elimination entries for the purpose of preparation of the Consolidated Financial Statements of RFL as on 31.03.2018. 65. We note that the EP had submitted an affidavit dated 23.11.2022 at the time of submission of the Audit Files solemnly affirming that the Audit Files submitted were as defined as per Para 6(b) of SA 230 and were true and complete in all respects, and that nothing had been concealed. The SCN explicitly stated that the responses should be based only upon documents available in the Audit Files {as defined in Para 6 (b) of SA 230}; and that in case of any difference between the documents avail ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r failing to test the accuracy and completeness of the amounts presented by the company for the purpose of consolidation of its subsidiaries. D. ARTICLES OF CHARGES OF PROFESSIONAL MISCONDUCT 68. Based on the foregoing discussion and analysis, we conclude that the EP has committed professional misconduct as defined in Section 132(4) of the Companies Act, read with Section 22 the Chartered Accountants Act 1949 (the CA Act), as amended from time to time, as detailed below: i. The Auditors committed professional misconduct of failure to report a material misstatement known to them to appear in a financial statement with which they are concerned in a professional capacity. (Refer Clause 6 of Part I of the Second Schedule of the CA Act). This charge is proved as explained in Section C.4 and C.5 above. ii. The Auditors committed professional misconduct by failing 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. (Refer Clause 8 of Part I of the Second Schedule of the CA Act). This charge is proved as explained in Section C.1 to C.7 above. iii. The Auditors committed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of CA Neeraj Bansal establish his professional misconduct. The lack of documented evidence in the original Audit File severely compromises the credibility of the audit and the reliability of the Financial Statements. Moreover, the submission of supplementary work papers, without substantiated audit procedures, appears to be an attempt to cover up significant audit deficiencies. Despite being a qualified professional, CA Neeraj Bansal has not adhered to the Standards and has thus not discharged the duty cast upon him. This conduct not only violates the SAs but also signifies a disregard for the principles of transparency and accountability in the audit profession. Had the auditor exercised due diligence, care, and attention in performing his duties, and had he raised appropriate red flags in a timely manner through his audit report, many of the serious lapses such as fund diversion, which led to irreparable losses for shareholders and creditors could potentially have been prevented. While assessing the auditor's work, we have been fully mindful that a statutory auditor is not a forensic auditor and does not have the benefit of hindsight. However, auditing standards mandate tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an Audit of Financial Statements 4Standards on Auditing (SA) 560, Subsequent Events 5Standards on Auditing (SA) 315, Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment 6SA 330, The Auditor's Responses to Assessed Risks 7https://www.frc.org.uk/news-and-events/news/2024/05/sanctions-against-three-audit-firms-over-the-audits-of-london-capital-finance-plc/ 8SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing ⁹SA 230, Audit Documentation 10SA 500, Audit Evidence 11https://media.frc.org.uk/documents/Final_Decision_Notice_against_Pricewat rhouseCoop rs LLP_PwC_and_Richard_Hughes.pdf 12Standards on Auditing (SA) 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing 13Standards on Auditing (SA) 230, Audit Documentation 14Standards on Auditing (SA) 500, Audit Evidence 15Standards on Auditing (SA) 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures 16Accounting Standard (AS) 22 Accounting for Taxes on Income ..... 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