TMI Blog2023 (12) TMI 1250X X X X Extracts X X X X X X X X Extracts X X X X ..... ule of the CA Act, an EP is guilty of professional misconduct if he did not exercise due diligence and was grossly negligent in the conduct of his professional duties - Since the EP compromised his independence and failed to recognize and report the pervasiveness of the deficiencies of the financial statements, his conduct undoubtedly falls into the category of lack of due diligence and gross negligence. Therefore, the charge of professional misconduct on the part of the EP on this account is proved. Internationally also, similar cases of Auditor's conflict of interest with the auditee company has been viewed seriously. In this case the audit done by the EP related to SKNL which was a large public listed company and involved interest of large number of shareholders and other stake holders such as banks, creditors etc. It is critical that the auditor and the EP performed their job with due diligence to give assurance to the investors and stakeholders on true and fairness of the financial statements and thereby protect public interest. Any default on this account impacts and jeopardizes the larger public interest which needs to be considered while determining the quantum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany during relevant period hence comes under NFRA domain. A Show Cause Notice was issued to M/s SMMP Company and CA Shyam Malpani. 4. NFRA's investigations inter alia disclosed that CA Shyam Malpani - the SKNL's Auditor for the FY 2013-14 failed to meet the relevant requirements of the Standards on Auditing ('SA' hereafter); provisions of the Companies Act 2013 and the Companies Act 1956. He also demonstrated serious lapses and absence of due diligence. One of the lapses was that he accepted the Audit Engagement of SKNL for FY 2013-14 despite owning the shares of SKNL through a company which was wholly owned by him and his family members and thereby violated applicable Laws and Standards relating to conflict of interest and independence. Further, he had issued Qualified Audit Opinions on Standalone Financial Statements ('SFS' hereafter) and Consolidated Financial Statements ('CFS' hereafter) with eleven (SFS) and fifteen (CFS) qualifications respectively de spite the fact that the nature and effect of qualifications in the Independent Auditor's Reports were material and pervasive to the financial statements. As per the Standard on Auditi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... made thereunder, the Standards on Auditing ('SA' hereafter), including the Standards on Quality Control ('SQC' hereafter) and the Code of Ethics. Violation of these constitutes professional or other misconduct, and is punishable with penalty prescribed under section 132 (4) (c) of the CA 2013. 8. NFRA suo motu started action under section 132(4) of the CA 2013, after examining the information received from CEIB vide their letter dated 09.09.2022. This information and other information subsequently collected from IDBI Bank show the following major lapses and irregularities in the financial statements ofSK.NL for the FY 2013-14 to 2017-18: a) Financial interest of the Auditor in SKNL; b) Writing off of receivables worth Rs 1044 crores [Amounts have been rounded off to nearest Rs in crores in this Order.] ; c) Revaluation of Stock at a loss of Rs 678 crores; d) Sale of Stock returned at a loss of Rs 1619 crores to the same non-operating parties; e) Potential linkage of non-operating parties with real estate business of promoters relatives; f) Adjustment of Advance for capital assets of Rs 546 crores against trade payables; g) Impairment of inv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rprise in which the auditor has a substantial interest. This charge of misconduct was against CA Shyam Malpani. b) Failure to exercise due diligence and being grossly negligent in the conduct of professional duties. This charge of misconduct was against Mis SMMP Company CA Shyam Malpani - Proprietor of Mis Shyam Malpani Associates. c) Failure to supply the information called for, and non-compliance with the information requisition of NFRA. This charge of misconduct was against Mis SMMP Company and CA Shyam Malpani. 12. The Hon'ble High Court of Bombay disposed of the above Writ Petition (WP no. 1399 of 2023 filed by the Auditors) on 13.06.2023 and directed NFRA to hear the petitioners and decide whether it has jurisdiction to act in respect of matters that preceded its establishment and allowed NFRA to pass a combined order on jurisdiction and merits, in case it holds that it has jurisdiction in the matter. Accordingly, NFRA extended the time period for submission of reply to SCN till 26.07.2023. On the issue of jurisdiction, as directed by the Hon'ble High Court, NFRA heard the Auditors and their counsel on 11.07.2023. They also gave their written submissi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd observed that CA Shyam Malpani had given qualified audit report with eleven (11) qualifications on Standalone Financial Statements (SFS) and fifteen (15) qualifications on Consolidated Financial Statements (CFS), and the effect of these qualifications was material and pervasive as it covered substantial proportion of sales, purchases, trade receivables, trade payables, inventories, provisions, interest on loans, share capital etc. Therefore, the appropriate Audit Opinions in such a case would either be an Adverse Opinion or the Disclaimer of Opinion. Therefore, on 25.08.2023, one more charge was added to the SCN regarding non compliance with SA 705 as Audit Opinions expressed by the Auditors were found to be not appropriate. 12.5 For natural justice, an opportunity of personal hearing was also accorded to the Auditors on 15.09.2023. On 31.08.2023, the Auditors requested for rescheduling the personal hearing either on 21 or 22 September, 2023, which was acceded to and the personal hearing was rescheduled for 21.09.2023. The personal hearing was attended by CA Shyam Malpani along with his legal counsels during which they reiterated their written submission and sought time to f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat the Statutory Audit of a company under the Companies Act, 2013 must be conducted in accordance with that law. The Accounting Standards and Standards on Auditing have been de fined in the Companies Act, 2013. Accounting Standards are prescribed by the Central Government under Section 133 of the Companies Act, 2013. Section 143(9) of the Act mandates an auditor to comply with the auditing standards. Auditing Standards are those prescribed by the Central Government under Section 143(10) of the Companies Act, 2013. The Proviso to Section 143(10) states that until the Auditing Standards are prescribed by the Central Government, the Auditing Standards issued by the ICAI will be deemed to be the Auditing Standards under this sub-section. 16. Section 132 of the Companies Act, 2013 that establishes the National Financial Reporting Authority (NFRA) defines its functions and powers. Section 132(4) vests NFRA with the power to investigate into the Professional or Other Misconduct committed by any member or firm of Chartered Accountants, registered under the Chartered Accountants Act, 1949. 17. The Explanation to Section 132(4) further states that for the purposes of this sub-section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f professional or other misconduct against auditors of companies referred to in Rule 3 shall be initiated by Authority and no other institute or body shall initiate any such proceedings against such auditors. Thus, NFRA has exclusive jurisdiction in matters of professional or other misconduct. It could not have been the intent of the legislature to leave a regulatory gap in respect of professional or other misconduct committed prior to the establishment of NFRA. Any subsequent law which enables an authority to investigate into the acts which fell into the category of professional and other misconduct as per the law prevailing at the time when the act was committed cannot be said to be retrospective. Therefore, NFRA has jurisdiction of investigation into misconduct committed in the past as well. Thus, the challenge to the jurisdiction of NFRA with respect to misconduct committed prior to 2018 does not stand. 20. It is also a well settled law that retrospective applicability can either be expressly provided for or can be inferred by necessary implication from the language employed. The Hon'ble Supreme Court in the case of Zille Singh v. State of Haryana, (2004) 8 SCC 1 at Para ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... artered Accountants Act, 1949 (Emphasis supplied). So obviously, the Authority has jurisdiction over misconduct committed in the past. 23. Further, any presumption against retrospective applicability would arise when a vested right is sought to be impaired. The explanation to Section 132(4) would clearly reveal that the subject matter of investigation and penalty under this provision is professional or other misconduct having the same meaning assigned under Section 22 of the Chartered Accountants Act, 1949. No Chartered Accountant can claim to have a vested right to commit professional or other mis conduct, which was already prohibited and subject to disciplinary action albeit under a different regulatory statute, namely, the Chartered Accountants Act, 1949. In view of the above, we are of the considered view that NFRA has jurisdiction in this matter. 24. The Hon'ble National Company Law Appellate Tribunal (NCLAT) vide Order dated 01.12.2023 [Order in the matter of Comp. App. (AT) No. 68, 87, 90 91 of 2023, Judgment dated 01.12.2023] , has also decided that NFRA has retrospective jurisdiction and concluded that: Thus, after taking into consideration the backgro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d, as the SCN has been issued after recording reasons and suo motu recognition of the apparent misconduct by the Auditor. Multiple opportunities for hearing and for submissions have been afforded to the Auditors in compliance with the principles of natural justice. The Auditors have fully availed these opportunities by presenting their submissions in writing as well as making oral submissions by themselves along with their legal counsel. 28. The EP averred through an affidavit dated 16.08.2023 that he does not have the audit file in respect of audit of SKNL for FY 2013-14 and mandatory period of seven years for retention of the audit file has already lapsed. We find that the period of 7 years lapsed on 15.10.2022. The NFRA letter calling for the Audit File was sent 19 days after a lapse of 7 years. Therefore, we would not like to pursue the issue of non-submission of the audit file any further. D. Major Lapses in the Audit and Charges in the SCN Replies of the auditor to the charges in the SCN are examined and discussed in the following paragraphs. I. Acting as statutory auditor of SKNL while holding or controlling shares of SKNL in violation of section 141 of the Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ilar case of CA Narayan Balkrishan Toshniwal, ICAI vide Order dated 7th December 2022, held that it has been explicitly specified in the Code of Ethics published by ICAI that substantial interest would be deemed to exist only if a member has a stake in the equity in business entity exceeding 20% and exonerated the auditor from the charge of professional misconduct falling within the meaning of Item (4) of Part I of the Second Schedule to the Chartered Accountants Act, 1949. g) The EP and his relatives hold shares in NFPL, which in tum holds only 0.16% of total share holding of SKNL, which is not substantial being less than 20% of total shareholding of SKNL. 31. First of all, we do not agree with the contention of the EP that he was governed by CA 1956 and not the CA 2013. The following are the facts related to his appointment as an EP. (i) His appointment was approved in the AGM of SKNL held on 13.07.2015; (ii) He obtained no-objection certificate from the previous auditor on 11.08.2015; and (iii) The EP started the said audit activity after 11.08.2015. 32. In view of the above, the EP's appointment as the Statutory Auditor of SKNL for the period April 2013 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s has been provided in SQC 1, SAs and the Code of Ethics mentioned below: Para 18 of SQC 1 states, The firm should establish policies and procedures designed to provide it with reasonable assurance that the firm, its personnel and, where applicable, others subject to independence requirements (including experts contracted by the firm and network firm personnel), maintain independence where required by the Code . (Emphasis supplied) Para 11 of SA 220 states, The engagement partner shall form a conclusion on compliance with independence requirements that apply to the audit engagement . (Emphasis supplied) Para 290.8 of the Code of Ethics,[The Code of Ethics is issued by ICAI] defines Independence of mind as The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism . Para 290.8 of the Code of Ethics defines Independence of appearance as The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns as neither shares of SKNL held by NFPL were disposed of, nor did he resign as the statutory auditor of SKNL. 36. An Auditor's Independence from the auditee safeguards the Auditor's ability to form an audit opinion without being affected by influences that might compromise that opinion. Independence enhances the Auditor's ability to act with integrity, to be objective and to maintain an attitude of professional skepticism. The auditor should not only perform his audit with independent mind but he should also be seen to be independent and free from any potential conflict of interest. Independence with no conflict of interest is necessary for ensuring transparency, trust, and cred ibility of the audit process. The EP in this case issued the Audit Report to the members of SKNL and at the same time he himself was owning and/or controlling shares of SK.NL through his family owned company NFPL, which impaired or had the potential to impact his independence as statutory auditor of SKNL. Therefore we find that the EP has violated SQC 1, SA 220 and the Code of Ethics. 37. In his reply dated 16.08.2023, the EP has relied on the case of CA Narayan Balkrishan Toshniwal, bef ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions of -the EP are as follows: a) He does not have any documents relating to the audit of SK.NL for FY 2013-14, therefore he is unable to offer a response to this charge. b) The evaluation of financial statements and annual report of SK.NL at a later date, when more information is available, is hindsight bias. He referred the Judicial Pronouncement of Bombay High Court in case of Tri-Sure India Ltd. vs A.F. Ferguson And Co. And Others dated 24 October 1985. c) Besides, under the paragraph Al of SA-705, the criteria determined which effects the type of opinions expressed is his own judgement and, again, it is reiterated that judgement is very subjective and can differ from person to person and it is based on the Respondent's own judgement that the type of opinion was expressed at the relevant time. (sic) d) Utilizing comprehensive professional judgment, and meticulously weighing the materiality of these qualifications, the EP arrived at the decision to offer qualified opinions rather than entirely disclaiming the financial statements. 41. We have considered the reply of the EP. For better appreciation of the matter, it is important to evaluate the nature, mater ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Percentage of purchases amount qualified to total purchases of Rs 4225 crores (SFS) Rs 6357 crores (CFS) 98.91% 97.19% 3 Trade Receivable 1831 2883 Percentage of Trade receivable to balance sheet size of Rs 3344 crores (SFS) Rs 5549 crores (CFS) 54.76% 51.95% 4 Inventories 552 1371 Percentage of Inventories to balance sheet size of Rs 3344 crores (SFS) Rs 5549 crores (CFS) 16.51% 24.71% 5 Trade Payable 166 571 Percentage of Trade Payable to balance sheet size of Rs 3344 crores (SFS) Rs 5549 crores (CFS) 4.95% 10.29% 6 Non provision of interest on NPA loans 721 981 6 A Percentage of Non pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or the period ending 30.06.2014 and five subsidiaries' financial statements were for the period ending 31.03.2014. These financial statements reflected total assets of Rs 349 crores, total revenue of Rs 246 crores and cash inflow of Rs 15 crores. The information with respect to disclosures to be made in the Notes to Financial Statements as required under various statues/Accounting Standards in relation to these subsidiaries were not available (CFS). iii) Inability to verify and comment on the existence, valuation and recoverability of assets, accurate quantification and reporting of liabilities, accuracy and correctness of income and expenditures of Rs 32 crores, Rs 166 crores, Rs 1 crore and Rs 17 crores in respect of Assets, Liabilities, Income and Expenditures respectively (CFS). iv) Sale of pledged shares of promoters worth Rs 127.59 crores (both SFS CFS) by lender Banks. v) Non provision in respect of long term investment of Rs 178.88 crores in foreign step down subsidiary (both SFS CFS) and Goodwill of Rs 119.29 crores (CFS), which went into financial reconstruction and consequential impact on investment and loss of SKNL. vi) Non confirmation of balance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ointment as auditor of SKNL despite having ownership interest in the shares of the auditee company i.e. SKNL and failed to form audit opinions in accordance with the SA 705, as explained in Section - D above. Since the EP compromised his independence and failed to recognize and report the pervasiveness of the deficiencies of the financial statements, his conduct undoubtedly falls into the category of lack of due diligence and gross negligence. Therefore, we hold that the charge of professional misconduct on the part of the EP on this account is proved. 44. Internationally also, similar cases of Auditor's conflict of interest with the auditee company has been viewed seriously. The US Audit regulator- Public Company Accounting Oversight Board (PCAOB)- in the matter of Wanen Averett, LLC [PCAOB Release No. 105-2023-022 August 29, 2023] has observed that Rule 2-01 (b) of the Com mission's Regulation S-X provides that an accountant is not independent of an audit client if, at any point during the audit and professional engagement period, the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accounta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t on this account impacts and jeopardizes the larger public interest which needs to be considered while determining the quantum of punishment. 48. The professional misconduct has been detailed and proven on various counts in the body of this Order. Considering the nature and seriousness of violations and principles of proportionality, we, in the exercise of powers under Section 132 (4) (c) of the Companies Act, 2013, order the sanctions detailed below. In light of the judgment of the Hon'ble National Company Law Appellate Tribunal (NCLAT) dated 01.12.2023, [Order in the matter of Comp. App. (AT) No. 68, 87, 90 91 of 2023, Judgment dated 01.12.2023, page 92, that states regarding retrospective jurisdiction of NFRA, that We also take into consideration the fact that neither any new misconduct has been created in law, which NFRA can investigate and levy penalty, if required nor NFRA can levy penalty greater than the quantum of penalty envisaged under the Chartered Accountants Act, 1949] we have limited the monetary penalty to {5 Lakh only since the violations relate to the period April 2013 to September 2014. We impose of a monetary penalty of Rupees Five Lakh upon CA Shy ..... X X X X Extracts X X X X X X X X Extracts X X X X
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