Auditor Concerns Over NFRA's Fraud Reporting Circular

About Authority
The National Financial Reporting Authority (NFRA) was constituted on 01 October 2018 by the Government of India under Sub Section (1) of section 132 of the Companies Act, 2013.

Its Functions and Duties

As per Sub Section (2) of Section 132 of the Companies Act, 2013, the duties of the NFRA are to:

1. Recommend accounting and auditing policies and standards to be adopted by companies for approval by the Central Government;
2. Monitor and enforce compliance with accounting standards and auditing standards;
3. Oversee the quality of service of the professions associated with ensuring compliance with such standards and suggest measures for improvement in the quality of service;
4. Perform such other functions and duties as may be necessary or incidental to the aforesaid functions and duties.

Subject Matter of Circular 

NFRA has recently issued a Circular on 26.06.2023 on the responsibilities of Statutory Auditors’ in relation to Fraud in a Company.

Need of Circular

NFRA has noticed that auditors are not fulfilling their statutory responsibilities relating to reporting of fraud as mandated under the Companies Act, 2013 (CA 2013) read with the relevant Rules and the applicable Standards on Auditing (SAs).

This has come against the backdrop of instances of corporate fraud and also NFRA taking action in recent months against auditors for various lapses. 

Auditors have mandatory reporting obligations to report fraud or suspected fraud to the Central Government and the Board/Audit Committee.

How do you define-“Fraud”?

Definition of fraud under section 447 of CA 2013 is wide and states that, “fraud” in relation to affairs of a company or anybody corporate, includes any act, omission, 1 Additional matters to be reported in the Auditor’s Report in terms of Order issued by the Central Government in exercise of powers u/s 143 (11) of the CA 2013. concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss”.

Various Provisions Related to Reporting of Fraud

* Reporting Obligations under CA 2013: Section 143 (12) of CA 2013 and related Rules places certain reporting obligations on the auditor, in relation to frauds: 

“Notwithstanding anything contained in this section, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed”

* Additional Reporting Obligations under CARO 2020: Clause (xi) of Companies (Auditor’s Report) Order, 2020 also requires auditors to make statements relating to reporting of fraud in his/her report. Fraud involving amounts of INR 1 crore or more needs to be reported by the auditor to the board or audit committee. 

* Auditor’s Responsibilities under SA 240: The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements elaborately deals with the auditor’s responsibilities relating to fraud in an audit of financial statements. The SA requires the auditor to maintain professional scepticism throughout the audit and states: “In accordance with SA 200, the auditor shall maintain professional scepticism throughout the audit, recognizing the possibility that a material misstatement due to fraud could exist, notwithstanding the auditor’s past experience of the honesty and integrity of the entity’s management and those charged with governance.” 

* The standard also highlights the importance of effective communication. The guidance provided in paras A59-A66 of SA 240, details the reporting of the fraud/suspected fraud to Management, Those Charged with Governance (TCWG) and Regulatory and Enforcement Authorities.

Adverse Consequences on Auditors for Non-Reporting of Fraud:

* In accordance with Section 140(5) of the CA 2013, auditors may face repercussions if they assisted or cooperated in any fraud committed by, or in connection with, the firm, its directors, or officials. In addition to removal and debarment for a five-year period, the auditor is also subject to actions under Section 447 of CA 2013 under the provisions of the section.

* Creates doubt on integrity/ independence of auditors and also portrays connivance with the management, promoters etc.

* Unpleasant impact on Audit Firm’s Goodwill, bad name in the market,  blacklisting/ removal from empanelments by/of various agencies/ authorities and organizations.

Benefits of Reporting of Fraud:

* More transparent reporting to concerned stakeholders.

* Increased true and fair view of the financial statements.

* Demonstrates Auditors’ independence and integrity,

* Compliance of various statutory provisions.

* Benefit to the Nation’s Economy

* Healthy relationship with various stakeholders

* Positive Image building of the auditors firm.

Roles and Responsibilities of Statutory Auditors in this regard:

* Statutory Auditors are strictly required by law to report fraud or suspected fraud if they notice questionable behaviours, transactions, or business practises that give rise to suspicions that the company’s officers or workers are committing or have already committed fraud against it. In this situation, the Statutory Auditor must take the actions outlined in Rule 13 of the Companies (Audit and Auditors) Rules 2014, starting with notifying the board or audit committee as soon as they become aware of the fraud within 2 days.

* Even in situations where the Statutory Auditor is not the first to notice the fraud or suspected fraud, the Statutory Auditor is required to submit Form ADT-4 to the Central Government pursuant to Section 143 (12).

* In the case of reporting of a fraud involving or expected to involve individually an amount of rupees one crore or above, the Statutory Auditor fails to get any reply / observations from the Board/Audit Committee within 45 days, the Auditor shall forward a report in the specified form viz., ADT-4 to Secretary, Ministry of Corporate Affairs, Government of India.

NFRA Clarification on Auditors’ Resignation and Reporting Obligations 

NFRA has very well clarified that there seems to be a misconception among auditors that resigning from an audit engagement absolves them of their reporting obligations under CA Act, 2013 for non-reporting of fraud.

However, a recent judgment by the Hon’ble Supreme Court of India (Union of India and Another versus Deloitte Haskins and Sells LLP & Anr 2022) clarifies that auditors who resign without reporting fraud will still be subject to the consequences outlined in Section 140(5) of the Companies Act, 2013. The court emphasizes that acting fraudulently, directly or indirectly, is a serious misconduct with inevitable consequences and that auditor’s resigning to avoid such consequences cannot be permitted. In short, the act of resigning does not release the Auditor from their legal obligation to report suspected fraud or fraud. 

Upholding Professional Skepticism and Independence

During the entire journey of evaluating/ detecting fraud, auditors must exercise their own professional skepticism. They should not be unnecessarily by legal opinions furnished by the company or its management. It is their duty to diligently assess any potential fraud and fulfill their reporting responsibilities.

Analysis of the Circular

The circular is a welcome step and its spirit is to detect and report frauds. These reporting requirements are very much vital for upholding the integrity and trustworthiness of financial reporting processes.

However, the implementation mechanism of this circular needs more clarity. In my limited view, it is ambiguous in certain aspects and needs some clarifications. Few of the points needing clarification are listed below:

1. Materiality threshold of fraud not defined. To elaborate, will this circular cover all frauds i.e. even petty frauds or only frauds above a certain level only need to be reported?

2. Detection of fraud and its mechanism

3. Types of fraud which are covered in the circular. For e.g. will it cover whistle blower frauds also as whistle blower complaints are subject to thorough verification but are in the nature of potential/ suspected frauds. A whistleblower mechanism provides a channel to employees and Directors to report to the management concerns about unethical behaviour, actual or suspected fraud or violation of the Codes of Conduct or any Policy of the Company.   

4. Study of various provisions reveals that the current regulatory framework requires auditors to report only those fraud instances which have come across to them in the course of performance of their duties and not otherwise, but the Circular seems to have imposed additional responsibilities on the auditors for reporting all frauds irrespective of whether they were identified by them or not. 

All the above points need to be addressed by NFRA to give more clarity to the Statutory Auditors.

The Institute of Chartered Accountants of India and NFRA must engage on this subject to enable the auditors to follow the NFRA guidelines without any ambiguity. The Institute of Chartered Accountants of India will have to come up with robust process notes with respect to implantation of this circular and consequent reporting by the Statutory Auditors.

The author of this Article is a Senior Partner with a renowned CA Firm- M/s Ravi Rajan & Co LLP and has more than 17 years of expertise in various fields such as Insolvency, Valuation, Forensic investigations, Assurance and Advisory.