Auditing | Where Sebi can't, NFRA steps in

The NFRA’s jurisdiction is not restricted to listed companies, but extends beyond it

A concern often commonly expressed, and rightly so, when corporate accounting scams are revealed, is ‘what were the auditors doing?’. While well-organised plans are beyond the reach of even auditors, where they were negligent or, as it is said the watchdog sleeping on the job, repercussions should happen.

However, a kind of vacuum was perceived when SEBI's action against auditors in Satyam case was largely struck down. This happened because of a well-reasoned judgment of the Bombay High Court which laid down the clear lines on when SEBI gets jurisdiction to hold them liable and take penal action against them, and when it cannot.

Essentially, the court confirmed that SEBI did have jurisdiction over auditors. However, this is only when the auditors were complicit to the corporate accounting fraud. If it was only a matter of auditors not doing their duty as per the auditors’ standards, SEBI could not act. This precedent was cast in stone. Practically all of SEBI’s action against auditors thereafter were overturned on appeal where SEBI could not prove involvement in fraud. The perception, incorrect of course, was that auditors are getting away as, for one, it was very difficult to prove fraud since that required crossing a higher benchmark of proof. Secondly, if negligence was found, SEBI couldn’t act.

Also Read: Congress wonders if SEBI request for extension in Adani case an attempt to bury the 'scam'

The recent actions by the National Financial Reporting Authority (NFRA) against erring auditors is seen as those which were earlier beyond SEBI’s powers. The NFRA’s recent orders against certain auditors of Cafe Coffee Day group, of the Dewan Housing Finance Limited branches, etc. demonstrate this. Stringent penalties, apart from long periods of debarment (which can often be career destroying) are being handed out. Sure, this seems to be a slow start, but it is a sure start.

Moreover, the NFRA jurisdiction is not restricted to listed companies, but extends beyond too. The NFRA can act against auditors of, apart from listed companies, those companies which either have paid up capital of at least Rs 500 crore or have annual turnover of at least Rs 3,000 crore or have loans/debentures/deposits of at least Rs 500 crore. There are other categories also listed in the NFRA rules to which its power reaches.

The mandate of the NFRA is broad. It not only has power to help make guidelines and standards for accounting and auditing for companies and auditors, but has also power and duty to monitor and enforce their compliance. It has powers to investigate cases either on its own initiative or on a reference made by the Union government.

Where professional or other misconduct is found after due investigation, it can levy penalty and order debarment on the auditors. The penalty, in case of individuals, would be at least Rs 1 lakh (up to five times the fees received). In case of firms, the penalty would be at least Rs 5 lakh (up to 10 times the fees received). The NFRA can also debar the auditor from acting as auditor of companies/body corporates for at latest six months (up to 10 years).

Several recent orders demonstrate the strict action taken by the NFRA. Take the order dated April 12 against the Engagement Team of the audit firm for the audit of Coffee Day Global Limited (CDGL). The alleged scam therein was massive though it also followed with the tragic reported suicide of the group’s founder.

Notably, the proceedings in this case by the NFRA was pursuant to sharing of information by SEBI of its investigation of 2022 regarding diversion of funds of more than Rs 3,500 crore from seven subsidiaries of Coffee Day Enterprises Limited, the listed company. The alleged diversion was to a company controlled by the promoters. The NFRA gave a finding that the auditors ‘failed to meet the relevant requirements of the Standards of Auditing’ and ‘also demonstrated a serious lack of competence’. These were followed by multiple other adverse findings. The 46-page order goes into more details and then levies penalty and orders debarment for various periods on the audit firm and the members of the engagement team of up to five years. There are similar orders against auditors of branches of Dewan Housing Finance Corporation Limited (DHFL) and other companies.

The NFRA, thus, seems to be quickly filling in the perceived gap in law, as confirmed by the high court that SEBI cannot act against auditors for not maintaining professional standards. That said, while there is a good start, time will of course tell how this pace is maintained and even how well these orders stand up in appeal.

That apart, the NFRA’s actions should also clear the broader picture and possible misconceptions on the audit profession. On one side is the fair argument while lakhs of companies and businesses are audited, often a few well-publicised scams stigmatise the auditing profession. On other side is this perception in some circles that audit malaise is more widespread. The NFRA and its actions will tell us, with clear findings in individual cases, what is the more correct version.

(Jayant Thakur is a chartered accountant)

(Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH)