NFRA imposes 25 lakhs penalty and debars CA for 7 years for professional misconduct

NFRA imposes penalty of Rs. 25 lakhs and debars CA for 7 years for professional misconduct in statutory audit of ILFS Financial Services Ltd

ABCAUS Case Law Citation:
ABCAUS 3338 (2020) (07) NFRA

The National Financial Reporting Authority (NFRA / Authority) helds CA guilty of professional misconduct for performance as Engagement Partner in statutory audit of ILFS Financial Services Ltd (IFIN) for the year 2017-18.

The CA was charged with professional misconduct in terms of Sec 132(4) of the Companies Act, 2013 and in terms of the following clauses in Part I of the Second Schedule to the CAs Act as under:

Clause Charges
1.  5 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
2. 6 fails to report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity
3. 7 does not exercise due diligence, or is grossly negligent in the conduct of his professional duties
4. 8 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
5. 9 fails to invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances

However, in terms of the order passed by the Hon’ble Delhi High Court in pursuance of Writ Petition filed by the CA challenging the constitutional validity of Section 132(4) of the Companies Act 2013, the jurisdiction of NFRA, etc., the order passed by NFRA shall not be given effect till 31st July, 2020.

In the instant case NFRA proceeded with the proceedings in pursuance of its show cause notice (SCN) as it had provided considerable time to the CA to file its replies and no stay was granted by the Hon’ble High Court.

All the charges against the CA was primarily on account of violations of the Standards on Auditing (SAs) issued by ICAI and consequent violations of the Companies Act, 2013, and Code of Ethics.

The NFRA inter alia extensively relied upon the SAs ( SA 200, SA 230, SA 240, SA 250, SA 260, SA 315, SA 570, SA 580 and SA 700 ) and stated that there is a clear set of positive duties that are cast upon the auditor by the SAs and which need to be complied with to claim that “due diligence” has been delivered.

The CA had argued that the words “Gross Negligence” have not been defined in the Chartered Accountants Act. However, the NFRA noted that the commentary on Clause 7 of Part I of the Second Schedule published by ICAI states that negligence per se does not constitute gross negligence, and thus does not amount to professional misconduct. Any professional accountant would be liable for misconduct only if his actions amounts to culpable negligence, which would justify holding him guilty for gross negligence”.

The NFRA opined that every auditor would, as a matter of prudence, should comply with the SAs. Failure to do so would certainly, therefore, amount to culpable negligence,

One of the argument of the CA was that he had delegated the key tasks to his partner CA but no documents in the Audit File showed such a delegation and the nature and extent of duties delegated by the CA partner. None of the record showed that the CA charged was the engagement partner, though he had signed the Audit Report on behalf of the Audit Firm which according to the NFRA was in violation of SA 220 and SQC-1.

NFRA held the charges of professional misconduct framed against the CA as proved.

The decideing the amount of penalty, NFRA considered the following:

Loss of Independence of the Statutory Auditor

It was clearly visible that the independence in mind and independence in appearance of the statutory auditor had been totally compromised. As Engagement Partner, it was the duty of CA charged to take necessary preventive action to ensure that his, and his Firm’s, independence was not affected. He had been Managing Partner and CEO of Deloitte India for several years. His position in the Audit Firm, his standing in the profession, and his long experience, required him to be especially conscious of, and sensitive to, anything that could detract from his, and his firm’s, independence. This background makes the violation of independence that has been proved even more serious than it would have been in the case of any other partner. This was a serious lapse in the discharge of his duty as CA.

Compliance with SAs and Maintenance of Audit Quality

Given the position, stature, and experience of the CA in question, to insist that there could be more than one Engagement Partner for an engagement was to bypass the SAs entirely. This certainly was one of the main reasons for the disastrous failure in audit quality. The CA failed to do what was expected from him as the Engagement Partner. A critical, questioning attitude, an unwillingness to be satisfied by merely superficial explanations, not concluding on material matters without rigorous verification from more than one angle, diligent and methodical cross verification, proper planning and the meticulous execution of the audit plan etc are fundamental to audit quality. Not only should the Engagement Partner have exhibited these qualities in the required measure, he should also have ensured the same in the rest of the Engagement Team as well.

Promotion of Public and Investor confidence and Effectiveness in Deterring Auditors and Audit Firms from violating the applicable Accounting and Auditing Standards

As expert professionals, auditors are expected to judge the significance of the operations of the entity they audit for the larger financial and economic sectors and accordingly calibrate their approach and procedures. The misconduct of the type and scale that have now been proved would be severely damaging to Public and Investor Confidence. It is, therefore, essential that the penalty imposed has a suitable deterrent effect on other auditors and, at the same time, sends out a message to the Public and the Investor Community that such misconduct will not be allowed to escape lightly

Intentional Reckless Behaviour

The CA was not unaware of the Requirements of the SAs. He should have reasonably foreseen that the likely or actual consequences of his actions or inaction would amount to non-compliance with the SAs. This makes the professional misconduct very serious.

Deterrence to Fraud and Collusive Behaviour

Professional misconduct becomes very serious when the CA has gone along with the Management of the company in agreeing to misstatements/omissions so as to commit a fraud on the users of the financial statements. In this case, it is seen clearly that the company had actually incurred losses in the year 2017-18. It was only through such unacceptable/impermissible stratagems as the imputation of a value of Rs 184 crores to the Put Option on the TTSL shares that the actual incurred loss was turned into a reported profit. Besides, the fact that the company had ceased to comply with the stipulated NOF/CRAR norms was deliberately misstated. The CA went along with this attempt at fraudulent presentation of the financial statements. Hence, this would necessitate the imposition of a severe penalty.

Accordingly, the NFRA made the following order:

  • A monetary penalty of Rs Twenty Five lakhs
  • In addition, the CA was debarred for a period of seven years from being appointed as an auditor or internal auditor or undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body

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