Reliance Capital: NFRA Slaps Rs4.50 Crore Penalty on Pathak HD & Associates, 2 CAs for Professional Misconduct, Biased Auditing for FY18-19
Moneylife Digital Team 15 April 2024
Holding an audit firm and two chartered accountants (CAs) guilty of professional misconduct, the national financial reporting authority (NFRA) imposed a penalty of Rs4.50 crore on them for showing negligence in the audit of Reliance Capital Ltd (RCL) for FY18-19, despite red-flags issued by the other auditor firm. NFRA slapped a penalty of Rs3 crore on Pathak HD & Associates (PHD), the audit firm, Rs1 crore on CA Parimal Kumar Jha, the engagement partner (EP) and Rs50 lakh on CA Vishal D Shah, who was the engagement quality control review (EQCR) partner, for the statutory audit of Reliance Capital. The other auditor, Price Waterhouse & Co LLP (PW), had reported suspected fraud regarding loans and investments amounting to about Rs12,571 crore to some group companies of Reliance Capital. 
 
In an order last week, the NFRA bench of Dr Ajay Bhushan Prasad Pandey (chairperson)], Praveen Kumar Tiwari and Smita Jhingran (full-time members) say, "Given the high degree of public interest in this listed entity, it was the duty of the auditors to conduct the audit with the highest level of professional scepticism and due diligence and report their opinion in an unbiased manner. Despite the resignation of the joint auditor and the reporting of suspected fraud, PHD, the EP, and the EQCR partner failed to conduct the audit as per the standards of auditing. The material misstatements in the financial statements due to inadequate provision, unjustified valuation of loans and irrational business practices were concurred by the auditors in disregard of their responsibilities under the Companies Act and standards of auditing (SAs). The auditors also demonstrated recklessness and unprofessionalism by rationalising the actions of RCL, inappropriately evaluating the work of the resigned auditor, and ignoring the fundamentals of accounting and auditing. Such actions of the auditors necessitate stricter sanctions and penalties taking into account the letter and spirit of the law."
 
"PHD failed to notice that the loans amounting to Rs6,557 crore (net of impairment) were sanctioned by RCL, violating its lending policy and also failed to examine the fraud risk factors. It failed to identify and respond appropriately to the risk of material misstatement due to fraud in  management override of controls and revenue. PHD failed to evaluate the adequacy of the expected credit loss provisions of Rs2,577 crore on loans. This has resulted in the non-reporting of material misstatements in the financial statements," the authority says in the order. 
 
NFRA also barred CA Jha, the EP and CA Shah, the EQCR partner, for 10 years and five years, respectively, from being appointed as 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.
 
As per the consolidated financial statements for FY18-19, RCL had loans from banks of around Rs12,000 crore and other external borrowings of around Rs32,000 crore, consisting of debentures, commercial papers and pass-through certificates. RCL was a core investment company (CIC) investing primarily in its group companies. RCL used these loans and borrowing to extend loans and investments to other group companies. PW reported suspected fraud regarding loans and investments amounting to around Rs12,571 crore to some group companies. 
 
On 29 May 2020, the director general of corporate affairs (DGCoA) in the Union ministry of corporate affairs (MCA) informed NFRA that PW had resigned from the audit without issuing an audit report for FY18-19 and filed a report under Section 143(12)1 of the Companies Act.
 
On examination of the matter, NFRA found that while the ex-auditor PW had filed form ADT-4 with MCA, reporting suspected fraud in RCL, the audit report for the FY18-19 issued by PHD on 14 August 2019 stated that there were no matters attracting Section 143(12). 
 
"Hence, we suo motu examined the audit file of PHD also, under section 132 of the Act, and observed prima facie that there are certain non-compliances with the Act, the SA and the code of ethics issued by ICAI," NFRA says. It then issued show-cause notices (SCNs) to the audit firm, EP and ECQR partners.
 
The authority found that while functioning as a joint auditor, PW brought some significant matters to PHD's notice through various communications starting from the letter dated 24 April 2019. These matters included potentially irrecoverable loans and investments amounting to about Rs12,571 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."   
 
According to NFRA, PHD indulged in self-review by preparing material information for the company's financial statements, which subsequently became the subject matter of their audit opinion, and thus violated the code of ethics and SAs. 
 
"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 SAs and was misleading for the users of the financial statements," it says.
 
PHD concluded without any regard to the merits of the transactions that there were no matters attracting section 143(12), NFRA says, adding, "Despite the evidence of documented irregularities in RCL, the EP did not question the management. In the absence of tests and evidence, the recoverability of the loans of Rs6,557 crore (net of impairment) disclosed in the financial statements was doubtful. Hence, the management's assertions of the value and rights of these loans were materially misstated in the financial statements, which PHD failed to report." 
 
Also, the actual valuation of investments, the rationale for sanctioning loans and investments to potential non-creditworthy entities and the adequacy of provisions remained unverified in all cases. These factors cumulatively contributed to the risk of material misstatement (ROMM) due to fraud which PHD ruled out without adequate audit procedure, the authority concluded.
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