Statutory auditors are not fulfilling statutory responsibilities on fraud reporting, rues audit regulator NFRA

National Financial Reporting Authority (NFRA), the country’s sole independent audit regulator, has urged the statutory auditors of listed entities and large private entities to exercise “professional scepticism” while evaluating frauds.

Noting that statutory auditors are not fulfilling their statutory responsibilities relating to reporting of frauds, NFRA has advised them not to be influenced by legal opinion provided by the company or its management.

In a circular, NFRA has reiterated the current legal position (post SC judgement of May 2023 in Deloitte, Haskins & Sells matter) which states that resignation does not absolve an auditor of his/her responsibility to report suspected fraud or fraud as mandated by law.

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There is a misconception among some auditors that resigning from an audit engagement absolves them of their reporting obligations relating to fraud and the consequences under Companies Act, 2013 for non reporting of fraud, the NFRA circular highlighted.

It may be recalled that the Companies Act, 2013 mandates a statutory auditor to report frauds directly to the Centre. This is in addition to their existing responsibilities of reporting requirements to the shareholders of the company.

When an auditor observes suspicious activities, transactions or operating circumstances in a company that indicate “reasons to believe” that an offence or fraud is being or has been committed against the company by its officers or employees, then the auditor is duty bound to bring the matter to the board/audit committee within two days of his/her knowledge of the fraud.

If the statutory auditor fails to get a reply from the board/audit committee within 45 days, the auditor then should forward a report in specified form to the MCA Secretary.

Simply put, the current company law had transformed the role of the statutory auditors from being a watchdog to a whistleblower. However, NFRA has noted that the statutory auditors have not been fulfilling their fraud reporting responsibilities.

The latest NFRA circular has also highlighted that Statutory auditor is “duty bound” to submit Form ADT-4 to the Centre u/s 143 (12) of Companies Act 2013 even in cases where the statutory auditor is not the first person to identify the fraud/suspected fraud.

In a landmark ruling in May this year, the Supreme Court had made it clear that legal proceedings under the company law against any fraudulent auditors cannot get terminated on the grounds of their subsequent resignation post the initiation of enquiry.

In its order in the IL&FS Financial Services Limited (IFIN) auditors’ matter, the apex court had also upheld the constitutional validity of Section 140(5) of Companies Act 2013–a provision under which NCLT can suo motu or on application filed by the Centre initiate action against fraudulent auditors—and ruled that this provision is neither discriminatory, arbitrary and/or violative of Article 14, 19(1)(g) of the Constitution of India as alleged.

Amarjit Chopra, former ICAI President, said that Para 4.2 of the circular requires the auditor to report to government frauds already detected and dealt with by a person other than auditor.

“Such a requirement in my opinion is an overreach. Such frauds would require to be reported in CARO2020 in any case in addition to frauds detected by the auditor,” he said.

“To me, the requirement of Sec143(12) is a fraud or a suspected fraud detected by the auditor. Responsibility for reporting frauds detected by others should be of management and for that Companies Act needs to be amended. Needless to say that in case of frauds detected by others and known to auditor, he should expand the scope of his audit in such areas. Also, depending upon the materiality of the fraud he may report the same in his report in addition to reporting requirement under CARO,” Chopra added.

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