Chartered Accountant held guilty of misconduct not detecting fraud in bank concurrent audit with penalty of severe reprimand – Delhi High Court

CA held guilty of misconduct not detecting fraud in bank concurrent audit, served with penalty of severe reprimand – Delhi High Court

ABCAUS Case Law Citation:
983 2016 (08) HC
Date/Month of Judgment: August 2016

The indictment:
It was alleged by the bank that the respondents chartered accountant had not carried out the audit negligently while working as the concurrent auditors in not detecting fraudulent transactions.

Brief Facts of the Case:
CA U.S.Jha, was a partner in a firm of Chartered Accountants which were appointed concurrent auditors to audit the account of the Branch of Punjab and Sindh Bank for the period July 01, 2003 to June 30, 2004.

As per the terms of appointment the audit spanned the entire working of the branch and shortcomings observed to be reported to the Branch Manager in the form of short notes for necessary rectification. If a fraud, fraudulent activity or foul play was noticed or detected it was to be reported to the General Manager (Vigilance) as also to the Zonal Inspectorate and the General Manager as well. Guidelines issued for the concurrent audit required to check the new accounts opened and particularly the current accounts and see whether the operations therein were unusual. To verify that the loans and advances were duly sanctioned as per guidelines of the bank. To verify the securities and documents received and in particular whether they were entered in the register. To check reconciliation of entries in the suspense accounts. To report any noticeable unauthorized use of discretionary powers. To report whether users had been made aware of the confidentiality of passwords.

It was specifically brought to the notice of the auditors that recently a fraud allegedly committed by a staff member had been reported by the branch and a special audit conducted by the bank revealed that the fraudulent activities had continued to take place.

However as alleged, the chartered accountant in charge of the concurrent audit failed to detect the fraud and the Disciplinary Committee of the Institute of Chartered Accountants of India held the respondent chartered accountant guilty of professional misconduct falling within the meaning of clause (5), (6) and (7) of Part I of Second Schedule read with Sections 21 and 22 of the Chartered Accountants Act, 1949.

The findings by the Disciplinary Committee were that the respondent chartered accountant might be right that the manner in which the fraud was committed required an indepth investigation but opined that objective of a concurrent auditor was to keep a check on the general audit and qua the transactions which were carried out in the newly opened accounts the respondent had to be more vigilant because the term of the audit had brought to the notice of the auditors that recently a fraud allegedly committed by a staff member had been detected and that while carrying out the audit newly opened accounts should be kept under strict scrutiny. The committee was of the view that with a little more diligence the concurrent auditors could have unearthed the modus operandi.

However, the Council of the ICAI at its meetings held on January 16 and 17, 2011 had re-appraised the material to conclude that whereas the respondent could not be held guilty of professional misconduct within the meaning of clauses (5) and (6) of Part I of Second Schedule read with Sections 21 and 22 of the Chartered Accountants Act, 1949, he would be guilty of professional misconduct within the meaning of clause (7) thereof.

Contentions of the Respondent(s)
However, the respondent chartered accountant had not appeared in the High Court to defend himself. In their written pleadings, the respondent had denied to have any fraud perpetrated for the period of the audit conducted by them. However, it was pleaded that the purported frauds began in July, 2002 and continued till April, 2005 and and went undetected. 

The respondent also pleaded that a subsequent special audit report which unearthed the fraud had acknowledged that there was no control on the branch by the branch incharge and that the Chief Manager and the Senior Manager perpetrated the fraud in a manner that a normal audit could not detect the same. The respondent also highlighted the observations of the special audit report that vouchers were prepared to falsify certain entries. The respondent also highlighted that the special audit report brought out that most of the fraudulent entries pertained to the period pre and post July 01, 2003 to June 30, 2004. It was pointed out that the periods spanning the fraud was four financial years and neither year routine audit could detect the same.

Observations of the High Court:

The respondent chartered accountant had pleaded that there was no fraud committed for the period covered in the audit and simultaneously it was pleaded that the fraud commenced much prior to the period of the audit and continued a little beyond. The Court observed that from the pleadings it can only gather that the respondent intended to highlight that the frauds were of a kind which could not be detected during routine audits. However, due to non presence of the respondent it can not be considered.

The High Court noted that Misconducts listed in (5), (6) and (7) of Part I of Second Schedule read with Sections 21 and 22 of the Chartered Accountants Act, 1949 are as under:-

“(5) fails to disclose a material fact known to him which is not disclosed in a financial statement, but disclosure of which is necessary to make the financial statement not misleading;

(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;

(7) is grossly negligent in the conduct of his professional duties;” 

It was noted that the misconduct contemplated by clauses (5) and (6) are severe vis-a-vis clause (7) under which the Council of ICAI had held him guilty of professional misconduct.

Held:
Their Lordships upheld the decision of the Council of the ICAI in holding the respondent chartered accountant guilty of misconduct contemplated by clause (7) of Part I of Second Schedule read with Sections 21 and 22 with penalty of severe reprimand contemplated by Section 21(6)(c) of the Chartered Accountants Act, 1949.