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TMI Blog2023 (8) TMI 260X X X X Extracts X X X X X X X X Extracts X X X X ..... nal Misconduct E. Penalty and Sanctions A. EXECUTIVE SUMMARY 1. This Order is being passed as a result of investigation by the National Financial Reporting Authority (NFRA) into the professional conduct of CA Harish Kumar T K for his role as the Engagement Partner (EP) in the audit of three branches of Dewan Housing Finance Corporation Limited (DHFL). DHFL, a housing finance company listed on both NSE and BSE and operating through a network of branches, was reportedly involved in financial fraud. NFRA took suo motu notice of the matter and carried out an Audit Quality Review (AQR) of the statutory audit of DHFL for FY 2017-18, conducted by Chaturvedi & Shah (CAS), a Mumbai-based Chartered Accountant Firm. During the review, NFRA noticed that 33 Engagement Partners (EP) or branch auditors had signed the "Independent Branch Auditors' Report" for nearly 250 branches. NFRA investigated these EPs under section 132 (4) of the Companies Act, 2013 (the Act), including K. Varghese & Co. (the Audit Firm), which was the "Statutory Branch Auditor" of 17 branches of DHFL for FY 2017-18, and CA Harish Kumar T K, who was the Engagement Partner (EP) for the audit of three of these 17 bran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bound by the duties and responsibilities prescribed in the Act, the rules made thereunder, the Standards on Auditing (SA), including the Standards on Quality Control and the Code of Ethics, the violation of which constitutes professional misconduct, and is punishable with penalty prescribed under Section 132 (4) (c) of the Act. 7. Fallowing media reports regarding the alleged siphoning of public money of around t31000 crore and the Enforcement Directorate's reported action in April 2020 on an alleged banking fraud of about Rs.3700 crore by the promoter/ directors of DHFL, NFRA suo-motu initiated an AQR to probe into the role of the Statutory Auditors of DHFL for the FY 2017-18, the year in which the alleged fraud was primarily stated to have occurred. While examining the Audit Files1 of the statutory audit carried out by CAS, a Mumbai-based CA firm, certain prima facie violations were observed relating to the appointment of Branch Auditors and the conduct of branch audits of DHFL which were relied upon by CAS. Accordingly, NFRA suo motu called for the audit files from EPs who had signed the "Independent Brach Auditors' Report" for nearly 250 branches, under Section 132(4) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2.2023. A "Supplementary Audit File" was also submitted by EP along with the reply to the SCN wherein some additional documents (including the Previous Year's Trial Balance for FY 2016- 17 for branches at Kottayam, Thrissur and Coimbatore; Audit Scope and Plan 2013-14; Cash Verification; and Loan Verification Sheets, etc.) were submitted. The EP did not avail of the offer of a personal hearing. The various charges levied in the SCN and the response of the EP to the charges are discussed in Part C of this Order. C. MAJOR LAPSES AND VIOLATIONS BY THE EP 12. The major lapses for which the EP was issued the SCN primarily relate to (i) accepting the audit engagement issued without a valid authority and thus violating the provisions of the Act and (ii) violations of the Standard of Auditing in conducting the audit. I. Acceptance of audit engagement without valid authorization and without complying with ethical requirements; and issuing an audit report in violation of the Act 13. The EP was charged with acceptance of an audit engagement without complying with ethical requirements and issuing the audit report without a valid appointment as per the Act, as the appointment of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the provisions of Section 139, then there would have been no exemption for auditors for foreign branches either . ... The Form ADT 1 prescribed under Rule 4(2) of Company (Audit and Auditors) Rules 2014, to be filed by a company on appointment of auditors, does not envisage appointment of branch auditors. If the intent of the law was to appoint branch auditors under Section 139, then there would have been provisions in ADT 1 for reporting to the government on appointment of auditors". c. " ... appointment of a branch auditor would depend on the decision of the company auditor. For this reason the tenure of appointment would depend on the inability of the company auditor to do audits of branches on his own......... In view of the above stated multiple reasons embedded in the legal provisions, appointment of branch auditors can only be an administrative matter between the company's auditor and the Board of Directors." d. "A branch auditor is not a company's auditor. Appointment of auditor dealt within Section 139 is only about the company's auditor, and not about branch auditors. Appointment of branch auditors is not required to be done by the members of the compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of "as such" clarifies that the auditor must be appointed specifically as an auditor of the company and that their qualifications for appointment must meet the requirements set out in the Act. There is no room for any other interpretation or to examine the intention of the law when the plain meaning of the law is sufficiently clear and not contradicting any other parts of the Act. It is also pertinent to refer to A Ramaiya's Guide to The Companies Act, 19th Edition, wherein it is explained that "considering under the Act, the auditor of a company is appointed by shareholders, it follows that the above mentioned2 position would continue and thus the decision whether a branch should be audited by the company's auditor or by any other auditor has to be taken by the shareholders in a general meeting". b. The EP's contention that Form ADT 1, to be filed by the Company on the appointment of statutory auditors, does not cover the appointment of branch auditor and hence the law "does not envisage appointment of branch auditors" is baseless. The contents of a form prescribed under the Act have no impact on the substantive requirements of the Act, which unambiguously provides ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... W) as the Statutory Auditors of the Company to audit the accounts of all the Company's offices including those of its zonal/ regional and branch offices for the financial year 2017-18. No other branch Statutory Auditors were appointed or ratified by the Company in the said meeting. Only CAS was appointed as the Statutory Auditor for the company as well as all its branches. Thus, the shareholders of the company approved only one Statutory Auditor (viz. Chaturvedi & Sah) for the Company and its branches. Therefore, in absence of any valid appointment, EP' s acceptance of the appointment as Statutory Auditor of the branches shows the absence of due diligence. f. Despite the invalid appointment letter issued by DHFL addressing the Audit Firm, the acceptance letter dated 12.09.2017 issued by the Audit Firm and the "Independent Branch Auditor's Report" issued by the EP for the three branches of DHFL, including the report required under CARO 2006 described the engagement as Branch Statutory Audit. 17. Therefore, as explained above, we find that the absence of due diligence and display of gross negligence by the EP run afoul of the provisions of the Chartered Accountants Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ance with SA 210 "Agreeing the Terms of Audit Engagements" 19. The EP was charged with non-compliance with SA 2104 and displaying an absence of professional scepticism and professional judgment in documenting the objective and scope of the audit, thereby violating SA 2005 as well. SA 2106 stipulates that the auditor shall agree to the terms of the audit engagement with management or Those Charged With Governance (TCWG) and that subject to paragraph 11 of the SA, the agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable forms of a written agreement and shall include (a) the objective and scope of the audit of the financial statements; (b) the responsibilities of the auditor; ( c) the responsibilities of management; ( d) identification of the applicable financial reporting framework for the preparation of the financial statements; and ( e) reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content. 20. Responding to the charges, the BP stated that "The audit in question is a "company's branch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 is not a law or regulation that prescribes in sufficient detail the terms of the branch audit engagement. Hence, the contention that the details mentioned in para 10 of SA 210 are not required to be included in the engagement letter is baseless and not acceptable. 23. The EP accepted the appointment letter issued by DHFL and issued the audit report without complying with the requirements of SA 210. Between 2015-16 and 2016-17, there was a significant change in the circumstances relating to the branch audit. In 2015-16 the AGM decided to have a separate branch auditor and company's auditor, while in subsequent years there was only one auditor (CAS) to audit the Company and all its branches. This calls for the application of para 13 of SA 210 as well. EP's negligence of the provisions of SA 210 resulted not only in accepting an illegal appointment and non-compliance with SA 210 but also in the absence of professional skepticism and professional judgment in understanding the objective and scope of the audit, thereby violating SA 200 also. Therefore, the charges in para 19 above stand proven. Non-Compliance with SA 230 "Audit Documentation" 24. The EP was charged with non ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Audit Documentation" i.e. in a manner contemporaneous with the events that are being sought to be documented. b. Apart from SA 230, there are other SAs also that require the documentation of events, data, evidence, opinions and conclusions. SA 230 makes it very clear that reliance can be placed only on the audit file as evidence of what was done. Para AS of SA 230 is explicit: "Oral explanations by the auditor, on their own, do not represent adequate support for the work auditor performed or conclusions the auditor reached, but may be used to explain or clarify information contained in the audit documentation". Para 14 mandates that the auditor shall assemble the audit documentation in an audit file and complete the administrative process of assembling the final audit file on a timely basis after the date of the auditor's report. c. SA 230 requires that the auditor shall prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand (a) The nature, timing, and extent of the audit procedures performed to comply with the SAs and applicable legal and regulatory requirements, (b) The results of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he standards and after the prescribed archival period is not acceptable. The inevitable conclusion, in this case, is that the EP did not maintain the audit documentation in accordance with the SAs and SQC 1. 9 Standard on Quality Control (SQC) 1, Quality Control for Finns that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements. 27. The EP also contended that since it "was not required to audit the financial statements of the branch office of DHFL, there was no straight jacket application of the provisions of SA 230 ", which permitted the EP to adapt the standard as necessary in the circumstances when applied to audits of other historical financial information rather than financial statements. We find that while adaptations of SAs are permitted in certain cases, they should not be taken as a reason for deviating from the fundamental principles of audit documentation as detailed in the preceding paragraphs. 28. Keeping the above in mind, we have examined, in the interest of fairness, the additional documents added by the EP and have taken the evidence into consideration wherever it is supporting or corroborating the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ans sanctioned during the year and classification of loans as per regulatory norms (substantive audit procedures); and e. KYC verification, anti-money laundering verification, and security verification (substantive audit procedures). 30. The lack of sufficient documentation in an audit is not a mere technical and procedural fom1ality but is a serious issue which strikes at the very root of the audit and may defeat the very purpose of the audit itself. Lack of sufficient documentation has been viewed seriously by national and international regulators as well. For example, in the matter of Bharat Parikh & Associates Chartered Accountants, dated 19-03-2019, the US audit regulator PCAOB took a serious view on the lack of sufficient documentation and imposed penalties and sanctions for violations including insufficient documentation. The PCAOB Order states "Audit documentation must contain sufficient information to enable an experienced auditor, having no previous connection with the engagement to (a) understand the nature, timing, extent, and results of the procedures performed, evidence obtained, and conclusions reached, and (b) determine who performed the work and the date such wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eport on the financial statements, and therefore was not falling within the scope of SA 700 ". 34. The contentions of the EP, we find, are a flawed interpretation of the law. Para 2 of SA 20012 makes it clear that the SAs are written in the context of an audit of financial statements by an auditor. They are to be adapted as necessary in the circumstances when applied to audits of other historical financial information. Branch auditors appointed under section 143(8) read with Section 139 of the Act are statutorily required to comply with the SAs since section 143(9) requires "every auditor" to comply with the SAs. The interpretation of Rule 12 (1) of Company (Audit and Auditors) Rules 2014 by the EP that ''for the audit of the branches of a company, the responsibility of auditor as provided in Section 143(1)-143(4) are on the company's auditor and not on the branch auditor" is utterly misconceived and irrational reading of the law. The said rule, that states that "For the purposes of sub-section (8) of section 143, the duties and powers of the company's auditor with reference to the audit of the branch and the branch auditor, if any, shall be as contained in subsect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eriality thresholds in the audit file, there is no basis for ruling out the identified misstatements as immaterial. The above instances also indicate control deficiency which EP did not evaluate. In his reply to the SCN, the EP stated that " ... Since the loan was not appearing in the Trial Balance of the Branch, non accounting of the closure of loan would not have resulted in any misstatement of the Branch Trial Balance ... the accounting effect if any for the loan account transaction of Rs 1.15 crores would only have a misstatement effect in the Trial balance of the HO alone because the loan accounts and bank account were in the Trial Balance of the HO. Test of materiality was to be applied at the HO Level ... in the Trial Balance attested by the Respondent it was not a case of unadjusted misstatement ... to give correct treatment in the Financial Statements of the company, the proper course for the Branch Auditor was to report ... Respondent had duly discharged this duty too". The reply of the EP cannot be accepted since it is apparent from the Trial Balance certified by the EP that the loans were primarily appearing in the branch's Trial Balance and then transferred to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39;s contentions that since the audit fee is low, the "Audit plan and strategy in such cases are not required to be complex that necessitate detailed documentation" and the audit plan is not required since the scope of work is "well defined" have no basis in the SAs and show the EP's absolute disregard to the quality of audit. Moreover, the audit plan now submitted by the EP was not forming part of the Audit File for 2017-18. Such contentions of the EP are against the fundamentals of SA 230 that require the maintenance of an Audit File that can enable an experienced auditor having no connection with the audit to understand the nature, timing and extent of the audit procedures performed to comply with the SAs. To evidence compliance with the requirements of the SAs, it is the fundamental stipulation of SA 23 0 that the auditor shall assemble the audit documentation in one audit file (and not multiple audit files of different years). b. Non-compliance with para 5, 6 & 11 of SA 31516 and para 1, 5 & 6 of SA 33017 as the audit file lacks any documentation regarding the performance of risk assessment procedures for material misstatements at the financial statement level and assert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ments and material misstatements and hence SA 450 is not applicable. The reply of the EP is not acceptable in the absence of any documentation or conclusions in the audit file in this regard. e. Non-compliance with para 6 & 9 of SA 50020 in not designing and performing audit procedures to obtain sufficient appropriate audit evidence and not evaluating the reliability of information produced by the company. The EP replied that "it is a matter of judgment for the auditor to design the audit procedure to obtain audit evidences" and stated that SA 500 has complied. The replies are not accepted since there is no evidence in the Audit File of designing and performing audit procedures, such as an audit plan, the substantive procedures performed and the conclusions drawn. f. Non-compliance with para 6 of SA 52021 relating to the design and performance of analytical procedures. The EP submits that SA 520 is not applicable since it is not a financial statement audit. The reply is not accepted since, as explained earlier in this order, the SAs are applicable for the branch statutory audit also. g. Non-compliance with para 4, 6, 7, 8 & 9 of SA 530 relating to the determination of sample ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... b) Failure to exercise due diligence and being grossly negligent in the conduct of professional duties, because of the lapses and omissions as explained and proved in parts Cl and C2 above (As per Section 22 and Clause 7 of part I of the Second Schedule to the CAs Act); c) Failure to obtain sufficient information which is necessary for the expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion, because of the lapses and omissions as explained and proved in part C2 above, (As per Section 22 and Clause 8 of part I of the Second Schedule to the CAs Act); and d) Failure to invite attention to material departure from the generally accepted procedures of audit applicable to the circumstances of the audited Company, because the EP certified in his report that the audit was done as per SAs mandated under section 143 of the Act and committed the lapses and omissions as explained and proved in part C2 above (As per Section 22 and Clause 9 of Part I of the Second Schedule to the CAs Act). Thus, we find that EP Harish Kumar T K committed professional misconduct, as defined in the respective clauses of the CAs Act, the meaning of which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relevant training on SAs to improve proficiency in this area. By doing so, CA Harish Kumar T K will be better equipped to provide high-quality audit services. 46. Considering the fact that professional misconducts have been proved and considering the nature of violations and principles of proportionality and keeping in mind the deterrence, proportionality, signalling value of the sanctions and time required for improvement in knowledge gaps we, in the exercise of powers under Section 132(4)(c) of the Companies Act, 2013, proceed to order the following sanctions: i. Imposition of a monetary penalty of Rs.100,000 (One Lakh) upon CA Harish Kumar T K; ii. CA Harish Kumar T K is debarred for one year from being appointed as an auditor or internal auditor or from undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate. 47. This order will become effective after 30 days from the date of issue of this order. --------------- Foot Notes 1 As defined in para 6 of SA 230 2 The general meeting may authorise the Board of Directors to make the appointment in consultation with companies auditor. 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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