Delhi High Court Upholds NFRA Penalty Of Rs 4.5 Cr On CAs And Audit Firm For Reliance Capital Audit Lapses

According to the consolidated financial statements for 2018-19, Reliance Capital had approximately INR 12,000 crore in loans from banks and around INR 32,000 crore in other external borrowings. These funds were utilized to provide loans and make investments in other group companies.

Brief Facts:

M/s Pathak HD & Associates (PHD), the Audit Firm, CA Parimal Kumar Jha, who served as the Engagement Partner (EP), and CA Vishal D. Shah, the Engagement Quality Control Review (EQCR) Partner (collectively “Petitioners”) were involved in the statutory audit of Reliance Capital Limited (RCL) for the Financial Year 2018-19. They approached the Delhi High Court (“High Court”) contesting an order issued by the National Financial Reporting Authority (NFRA), which debarred CA Parimal Kumar Jha and CA Vishal D. Shah from auditing for 10 years and 5 years respectively. Additionally, NFRA imposed penalties of INR 3 crore on PHD, INR 1 crore on CA Parimal Kumar Jha, and INR 50 lakhs on CA Vishal D. Shah. The Petitioners were also challenging the constitutional validity of Section 132(4) of the Companies Act, 2013, and Rules 10, 11, and 12(4) of the NFRA Rules, 2018.

Reliance Capital was audited jointly by M/s Price Waterhouse & Co LLP (PW) and PHD for FY 2018-19. PW resigned from the audit without issuing an audit report and reported suspected fraud to the Ministry of Corporate Affairs. PHD's audit report reported no irregularities. However, PW had previously sent a letter to Reliance Capital, its Audit Committee, and PHD, highlighting concerns about loans disbursed, investments, and disposal of Compulsory Convertible Debentures of group companies with a cumulative carrying value of approximately INR 12,571 crore. This led NFRA to conduct a suo moto examination of PHD's audit file.

The investigation revealed that Reliance Capital's Consolidated Financial Statements for FY 2018-19 showed loans from banks amounting to approximately INR 12,000 crore and other external borrowings totaling INR 32,000 crores, including debentures, commercial papers, and pass-through certificates. It was alleged that these funds were used by Reliance Capital to extend loans and make investments in other group companies. PW reported suspected fraud concerning loans and investments of around INR 12,571 crore, which were depicted as recoverable. NFRA claimed that despite evidence of irregularities and communications from PW, the Petitioners failed to take necessary actions. Consequently, NFRA concluded that the Petitioners were negligent, did not obtain sufficient audit evidence, and failed to report material misstatements in RCL's financial statements.

Observations by the High Court:

The High Court noted that NFRA's order highlighted significant issues with the audit conducted by PHD and its partners, notably their failure to independently investigate substantial concerns raised by their joint auditor, PW. Both PHD and PW were appointed as joint statutory auditors of Reliance Retail for five years starting from September 2017. PW had repeatedly communicated with PHD about potentially irrecoverable loans and investments totaling approximately ₹12,571 crore made to group companies, but PHD, particularly the Engagement Partner (EP), failed to conduct independent audit procedures on these matters.

The High Court also noted the sequence of events showing that the Audit Committee's conclusions were heavily influenced by the EP's presentation, which ruled out the possibility of fraud without adequate rigor. The audit files lacked evidence of PHD's independent examination or disagreement with PW's observations, further highlighting the deficiencies in their audit process. The EP's failure to respond adequately to the issues raised by PW until prompted by the Audit Committee after PW's resignation was a critical lapse.

Additionally, the NFRA identified a significant issue with RCL's financial disclosures. The management's use of PHD's work as the basis for disclosures in the financial statements resulted in a self-review, where the auditor's own opinions were used to audit the financial statements, which is against the principles of independence and objectivity in auditing.

Considering these detailed findings and the established violations of auditing standards, the High Court found no ground to grant any interim relief to the Petitioners. The applications for such relief were consequently rejected. The High Court stressed that the discrepancies and failures in the audit process, particularly the lack of appropriate responses to fraud risk factors and the self-review issue, were too significant to overlook.

Case Title: Vishal Dhiren Shah Vs Union Of India, Through Ministry Of Corporate Affairs & Anr. And Connected Matters

Citation: 2024 LiveLaw (Del) 620

Case Number: W.P.(C) 5840/2024

Advocate for the Petitioner: Mr. Shri Venkatesh, Mr. Shryesth Ramesh Sharma, Mr. Vineet Kumar, and Mr. Vedant Choudhary, Advs.

Advocate for the Respondent: Mr. Aakash Meena, G.P. for UOI. Mr. Zoheb Hossain, Mr. Vivek Gurnani, Mr. Kartik Sabharwal, Ms. Abhipriya Rai, Ms. Radhika Puri, and Mr. Vivek Gaurav, Advs. for Resp./ NFRA.

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