NFRA can investigate audit misconduct that occurred before its formation, has superior powers over ICAI: NCLAT

The National Company Appellate Law Tribunal (NCLAT) at Delhi on Friday ruled that the National Financial Reporting Authority (NFRA) has retrospective powers to investigate allegations of misconduct by financial auditors.

A coram of Judicial Member Rakesh Kumar Jain and Technical Member Naresh Salecha added that while Institute of Chartered Accountants of India (ICAI) has concurrent disciplinary powers to deal with allegations of professional misconduct by Chartered Accountants or auditors, the NFRA has overriding and superior powers in certain respects as laid down in Section 132 (4) of the Companies Act, 2013.

“NFRA has superior and overriding powers in matters relating to professional misconduct of the Chartered Accountants in terms of Section 132 of Companies Act, 2013 … We may conclude NFRA has been consciously and deliberately given superior authority over ICAI on oversight of auditors and in disciplinary matters as stipulated in Section 132 of Companies Act, 2013 … After taking into consideration the background for forming NFRA, the judgment of the Apex Court, proven scams, need to restore shaken confidence of public and investors at large and prevent any adverse impact on Indian economy, we hold that NFRA has clear and required retrospective jurisdiction over the alleged offences by delinquent Chartered Accountants for period prior to formation of NFRA or prior to coming into effect relevant portion of Section 132 of Companies Act, 2013,” the December 1 judgment stated.

The decision was passed while dismissing a batch of four appeals by chartered accountants who had challenged penalties imposed on them by the NFRA for lapses in conducting branch audits for Dewan Housing Finance Ltd (DHFL) at seventeen of the public company’s branches.

The NFRA had issued show cause notices to the four chartered accountants after news broke that the promoters and directors of DHFL were accused of siphoning ₹31,000 crores of public money and that the Enforcement Directorate (ED) reported a banking fraud of about ₹3,700 crores.

The NFRA, therefore, initiated an Audit Quality Review, following which four chartered accountants (CAs) who had been engaged to conduct branch audits in various locations were also asked to answer to allegations of lapses in complying with Standards of Auditing.

In focus was the branch audits conducted during the financial year 2017-18, which is when various transactions related to the DHFL scam were alleged to have occurred.

Earlier this year, the NFRA concluded that the four CAs had failed to adhere to various auditing standards and that they had accepted their engagement to conduct the branch audit without complying with legal requirements under the Companies Act, 2013.

As penalty, the four branch auditors were asked to pay ₹1 lakh fine and debarred from performing audit functions for a year. The four orders passed by the NFRA against these auditors were then challenged by the affected CAs before the NCLAT.

On December 1, the NCLAT passed a 156-page order by which it dismissed all four appeals and upheld the NFRA’s decision. In doing so, the NCLAT also arrived at the following findings:

1. On the role of NFRA versus ICAI on disciplinary matters of Chartered Accountants

The role of ICAI cannot be underestimated since it still exclusively deals with checks on auditors engaged by private companies.

95.95 percent of total registered companies in India as on March 31, 2022, are private companies and the auditors of such large number of companies are still regulated by ICAI exclusively.

However, on a careful reading of the provisions of the Companies Act, 2013 and the ICAI Act, “the NFRA has superior and overriding powers in matters relating to professional misconduct of the Chartered Accountants in terms of Section 132 of Companies Act, 2013,” the NCLAT held.

2. NFRA has retrospective powers

One of the arguments by the appellants was that since the alleged misconduct occurred in 2017-18, which was before the NFRA’s constitution was notified in October 2018, the NFRA could not launch an investigation into the same.  

The NCLAT rejected the submission and held that with effect from October 24, 2018, all proceedings concerning professional misconduct by auditors (in public companies to which the NFRA jurisdiction is made applicable) would lie in the exclusive domain of the NFRA. The NCLAT reasoned that no new offence or liability has been created and that it is simply a case where the forum has shifted from the ICAI to the NFRA.

“Change in forum due to change in law has no bar on being implemented with retrospective effect. The litigant has vested right in action but does not have any vested right on forum. Retrospective application in such procedural law and change in forum is barred only if express provision is made in new law,” the NCLAT explained.

3. There was no violation of natural justice simply because the NFRA investigation and adjudication was not conducted by a “division”

The NCLAT agreed with the NFRA that there was little that the financial audit watchdog could do when the legislature has not prescribed any division. The NCLAT added that such matters cannot be allowed to be avoided only on pure technicalities.

4. The NCLAT rejected an argument by the appellant-branch auditors that they should have minimum responsibility, which is confined only to the branch that they audited. The NCLAT opined that the branch auditor’s role is also critical to the overall audit of a company.

“Auditors of the Branch cannot absolve his responsibilities. We cannot overlook the fact that the allegations of fraud involving Rs. 31,000 Crores by the DHFL including banking fraud of about 3,700 Crores by Directors of DHFL happened and the Auditors clearly failed in their duties,” the NCLAT held.

5. Standards of Auditing (SA) are mandatory and not advisory or a guidance note to auditors.

6. There is no bar on the ICAI or NFRA to restrict its investigations only to “professional misconduct” as defined under Section 22 of the Chartered Accountants Act, 1949.

“The powers are far more and wider and any conduct which makes auditor of unbecoming of such profession will make him liable for suitable investigation and if found guilty may face punishment as per law,” the NCLAT held.

The tribunal added that the “NFRA has far more powers and authority for professional misconduct of members of ICAI in comparison to powers and authority of ICAI itself.”

On a factual analysis, the NCLAT also concluded that the appellants had fallen short of complying with various Standards of Auditing and the Code of Ethics issued by the ICAI and upheld the NFRA’s findings on these aspects.

The NCLAT went on to hold that the penalty imposed by the NFRA for such lapses cannot be termed as “excessive”, particularly considering the enormity of the DHFL scam.

“We consider the penalty as imposed by NFRA on all four Appellants were imposed as deterrent, perhaps keeping in mind all facts, including limited role as branch auditors. This cannot be considered excessive after all; it is fact that there has been fraud in DHFL of Rs. 31,000 Crores and Auditors can’t pretend to be ignorant of what was happening,” the NCLAT held.

Therefore, the appellate tribunal dismissed the appeals and upheld the NFRA’s decisions.

On a parting note, the NCLAT added,

“We feel that it is of utmost importance that Auditors realise their responsibilities which is necessary not only to the company but also to the public … Any deviation to this will only result is catastrophic effect on economy of the nation and cause immense prejudice and harm to the public, shareholders and various stakeholders such as banks, lenders, and creditors.”

Senior Advocate PH Arvindh Pandian with Advocates Goutham Shivshankar, Sharamya Sinha, and Adit Shah, and Advocates CA CV Sajan and Rishi Singhal appeared for the appellants. Advocates Zoheb Hossain, Vivek Gurnani, Farheen Penwale and Kvaish Garach represented the NFRA.