National Financial Reporting Authority (NFRA) vs M/s Pathak H.D. & Associates (FRN 107783W), CA Parimal Kumar Jha & CA Vishal D. Shah | Order under Section 132(4) of the Companies Act, 2013

Facts of the Case

Reliance Capital Limited (RCL), a listed financial services company, was jointly audited for FY 2018-19 by Price Waterhouse & Co LLP (PW) and M/s Pathak H.D. & Associates (PHD).

During the audit process, PW identified serious concerns regarding loans and investments aggregating approximately ₹12,571 crore made to various group companies. PW considered these transactions suspicious and reported suspected fraud under Section 143(12) of the Companies Act, 2013 through Form ADT-4 filed with the Ministry of Corporate Affairs (MCA). Subsequently, PW resigned from the audit engagement without issuing an audit report.

Despite the resignation and fraud reporting by the joint auditor, PHD continued as statutory auditor and issued the audit report dated 14.08.2019, stating that there were no matters attracting Section 143(12) of the Companies Act, 2013.

NFRA examined the audit file and found prima facie evidence of serious violations of auditing standards, professional ethics, and statutory obligations. Consequently, Show Cause Notices were issued to:

1. M/s Pathak H.D. & Associates (Audit Firm)
2. CA Parimal Kumar Jha (Engagement Partner)
3. CA Vishal D. Shah (Engagement Quality Control Review Partner)

Issues Involved

1. Whether the auditors failed to discharge responsibilities as joint auditors under SA 299 (Revised).
2. Whether the auditors failed to perform independent audit procedures regarding concerns raised by the resigning joint auditor.
3. Whether the audit firm engaged in self-review by preparing material information subsequently audited by itself.
4. Whether the Emphasis of Matter paragraph included in the audit report was misleading and contrary to SA 706 (Revised).
5. Whether the auditors failed to exercise professional skepticism and adequately assess fraud risks.
6. Whether the auditors failed to obtain sufficient appropriate audit evidence before concluding that Section 143(12) was not attracted.
7. Whether the auditors failed to evaluate impairment, recoverability of loans, valuation of investments, and adequacy of provisions.
8. Whether the auditors committed professional misconduct under Section 132(4) of the Companies Act, 2013.

Petitioner’s Arguments (NFRA)

NFRA contended that:

• PW had repeatedly communicated concerns regarding potentially irrecoverable loans and investments amounting to approximately ₹12,571 crore.
• PHD failed to perform independent audit procedures despite receiving detailed communications from PW.
• The audit firm ignored significant indicators of fraud risk and credit impairment.
• PHD improperly relied upon management explanations and legal opinions without adequate audit verification.
• The audit firm participated in preparing information that later became part of the financial statements and audit report, resulting in self-review.
• The Emphasis of Matter paragraph wrongly suggested that no matter attracted Section 143(12), thereby misleading users of financial statements.
• Material misstatements relating to loans, investments, provisioning, and recoverability were not identified or reported.
• The auditors failed to maintain professional skepticism, due diligence, and compliance with applicable Standards on Auditing.

Respondents’ Arguments

The Audit Firm, Engagement Partner, and EQCR Partner denied all allegations and submitted that:

• They made repeated attempts to engage with PW but were unsuccessful.
• PW had not shared sufficient basis for its observations.
• The concerns raised by PW were not new and similar matters existed in earlier periods.
• Extensive audit procedures were conducted after receiving the Audit Committee’s mandate.
• Their examination concluded that no circumstances warranted reporting under Section 143(12).
• There was no self-review because examination of the matters formed part of their statutory audit duties.
• The Emphasis of Matter paragraph was appropriately included.
• Their conclusions were supported by audit working papers and management records.

Court Findings / NFRA Findings

NFRA rejected the explanations of the auditors and recorded the following findings:

1. Failure as Joint Auditor

The audit firm failed to comply with SA 299 (Revised).

Although PW had repeatedly communicated serious concerns, PHD did not perform independent audit procedures before PW's resignation and failed to independently evaluate the observations.

NFRA held that this amounted to violation of responsibilities imposed upon joint auditors.

2. Lack of Professional Skepticism

NFRA observed that the auditors accepted management representations without adequate challenge.

The auditors failed to reassess audit risk, fraud risk, materiality, or recoverability despite significant warning signs.

3. Self-Review Threat

NFRA found that PHD effectively prepared material information that later became part of:

• Audit Committee records,
• Board disclosures,
• Financial statement disclosures, and
• Audit report conclusions.

The same information was subsequently audited by PHD itself.

This constituted self-review and violated the Code of Ethics and auditing standards.

4. Misleading Emphasis of Matter (EOM)

NFRA held that the EOM paragraph:

• Was not supported by adequate audit evidence.
• Relied upon legal opinions that did not examine the substantive merits of the transactions.
• Misled users of financial statements.
• Violated SA 706 (Revised).

5. Failure to Assess Fraud Risk

NFRA found that the auditors:

• Failed to identify indicators of fraud.
• Failed to evaluate unusual transactions.
• Failed to investigate end-use of funds.
• Failed to examine management override risks.
• Failed to assess the implications of transactions involving financially distressed entities.

6. Failure to Verify Recoverability of Loans

NFRA observed that:

• Several borrowing entities had negative net worth.
• Many borrowers were loss-making.
• Certain entities had no employees.
• Assets primarily consisted of loans and investments.
• Borrowers demonstrated significant credit impairment.

Despite these indicators, auditors did not conduct sufficient procedures to support recoverability assumptions.

7. Failure to Evaluate Expected Credit Loss (ECL)

NFRA concluded that the auditors failed to adequately evaluate provisions relating to expected credit losses and thereby failed to detect material misstatements in the financial statements.

Important Clarifications

Clarification Regarding Section 143(12)

NFRA clarified that once an auditor reports suspected fraud under Section 143(12), the legal determination of fraud becomes a regulatory matter.

Neither the company nor another auditor can conclusively determine that no fraud exists merely through management explanations or legal opinions.

Clarification on Joint Auditor Responsibilities

Joint auditors are independently responsible for evaluating significant observations communicated by another joint auditor.

Failure to perform independent procedures amounts to non-compliance with SA 299 (Revised).

Clarification on Self-Review

An auditor cannot prepare material information that becomes part of the financial statements and thereafter audit the same information without creating a self-review threat.

Clarification on Emphasis of Matter

An Emphasis of Matter paragraph cannot be used as a substitute for a modified audit opinion where material misstatements exist.

Final Order

NFRA held the Audit Firm, Engagement Partner, and EQCR Partner guilty of professional misconduct under Section 132(4) of the Companies Act, 2013.

Monetary Penalties

Debarment

The debarment prohibits appointment as auditor, internal auditor, or undertaking audit engagements relating to financial statements or internal audits of any company or body corporate.

Sections Involved

Companies Act, 2013

• Section 132(4)
• Section 143(12)
• Section 139
• Section 177
• Section 130
• Section 199
• Section 206
• Section 211
• Section 212
• Section 213

Standards on Auditing

• SA 200
• SA 240
• SA 299 (Revised)
• SA 705 (Revised)
• SA 706 (Revised)

Accounting Standards

• Ind AS 10
• Ind AS 32

Professional Ethics

• ICAI Code of Ethics, 2009

Link to download the order - https://cdnbbsr.s3waas.gov.in/s3e2ad76f2326fbc6b56a45a56c59fafdb/uploads/2024/04/20240413980099888.pdf

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