Tightening and twisting arms of Auditors

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Recently, the National Financial Reporting Authority (‘NFRA’) has imposed a penalty of Rs 3 crore on the Audit Firm namely Pathak H.D. & Associates, Rs. 1 crore on Engagement Partner (EP) and Rs 50 Lakh Engagement Quality reviewer (EQR). ?Further NFRA debarred the EP and EQR for 10 year and 5 years, respectively 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.

Background:

Reliance Capital Limited (RCL), (listed company) was engaged in financial services, which was jointly audited by M/s Price Waterhouse & Co LLP (PWC) and M/s Pathak HD & Associates (PHD) for the Financial Year 2018-19. Later PWC had resigned from the audit, without issuing an audit report for FY 2018-19 and reported suspected fraud regarding loans and investments amounting to approximately ?12,571 crore to some group companies since these group companies incurring losses, having negative net-worth and going concern issue was there under section 143(12) to MCA. Further, the audit report for the FY 2018-19 issued by PHD on August 14, 2019, stated that there were no matters attracting Section 143(12) through EOM para in their report after resignation of PWC.

What went wrong for Pathak HD & Associates

On the basis of examination of audit files of PHD related to Reliance capital by NFRA under section 132 (4) of the Companies Act 2013, the following irregularities observed.

1. Despite the reporting of suspected fraud and the resignation by the PWC, the PHD did not perform adequate procedures as required by the Standards on Auditing (SA) for material misstatements in the financial statements due to fraud.
2. While PHD was functioning as a joint auditor, PWC brought some significant matters to PHD’s notice through various communications These matters included potentially irrecoverable loans and investments amounting to approximately ?12,571 crore to group companies portrayed as recoverable. However, PHD failed to carry out any independent procedures on these matters and discharge the responsibilities of a joint auditor in this regard.
3. PHD engaged in self-review by preparing material information for the financial statements of the Company, which subsequently became the subject matter of their audit opinion, and thus violated the Code of Ethics and SAs.
4. PHD used the Emphasis of Matter (EoM) para in its audit report in which it concluded that there were no matters attracting section 143(12). The EoM para was in non-compliance with the SA? 706 and was misleading for the users of the financial statements.
5. ?Failed to identify and respond Risk of Material Misstatement (ROMM) due to Fraud on valuation of investments, the rationale for sanctioning loans and investments to potential non-creditworthy entities and the adequacy of provisions.
6. Failed to identify and respond to the ROMM related to management override of control on loans amounting to Rs. 6,557 crore (net of impairment) which were sanctioned by RCL violating its lending policy.
7. Failed to evaluate the adequacy of the expected credit loss provisions of ? 2,577 crore on loans in accordance with Ind AS 109.

Reliance capital Limited and Its Promoters:

Following governance issues and payment defaults, the Reserve Bank of India (RBI) took over the board in November 2021. Subsequently, on December 2, 2021, the RBI filed a petition with the tribunal to initiate the Corporate Insolvency Resolution Process (CIRP) for RCL.

After the Corporate Insolvency Resolution Process (CIRP), creditors filed claims exceeding?Rs 38,500 crore. IndusInd International Holdings Ltd (IIHL) proposed a resolution plan offering?Rs.9,661 crore for Reliance Capital, supplemented by the company's cash balance of??500 crore.

RCL had outstanding shareholders around 25.41 crore (Numbers) out of which public shareholders were holding around 98.49% stake in RCL and the average share price was approx. Rs 560 in 2017-18. Further, RCL had applied for delisting of its shares on Feb 27, 2024, from BSE. The liquidation value for shareholders was determined to nil. Total loss to the creditors and shareholders turns out to be Rs 28,339 crore and Rs.14,229 crore, respectively. Further, the promoter of RCL, Mr. Anil Ambani is enjoying a lavish life.

Conclusion:

Nowadays, the Audit and assurance field facing many heats, it is heading in the direction of consultancy business due to rapid competition. Considering cumulative experience of mine, i can see that small audit firms lack negotiation power. Further, we are waiting to see whether similar action will be taken on promoters also.

Please let me know your thoughts about this in the comment box.