NFRA's order reveal multiple lapses by Pathak HD & Associates in Reliance Capital audit; debars audit partners

India's audit regulator, the National Financial Reporting Authority (NFRA), has taken decisive action against Pathak HD & Associates, the joint auditors of Reliance Capital, following a series of failures flagged by the former auditor, Price Waterhouse (PW), which resigned amidst suspicion of fraud amounting to Rs 12,571 crore by the company.

NFRA's thorough investigation unearthed numerous deficiencies attributed to Pathak HD & Associates (PHD), alongside its engagement partner Parimal Kumar Jha and engagement quality control review partner Vishal D Shah. Consequently, the two chartered accountants have been banned from conducting audit work for durations of 10 years and five years, respectively. Additionally, the firm faces a penalty of Rs 3 crore, with the two CAs individually directed to pay fines of Rs 1 crore and Rs 50 lakh.

The culpability of the firm and its partners lies in their failure to fulfill the obligations of statutory auditors, breaching provisions outlined in the Companies Act and the code of ethics. Moreover, they were found to be "grossly negligent" and negligent in reporting "material mis-statements" within Reliance Capital's books, despite the red flags raised by PW. These flags included potentially irrecoverable loans of Rs 12,571 crore being misrepresented as recoverable, as well as violations of lending practices while disbursing loans totaling Rs 6,557 crore.

During the fiscal year 2018-19, Reliance Capital, a core investment company primarily invested in group companies, held significant bank loans totaling approximately Rs 12,700 crore and other external borrowings amounting to around Rs 32,400 crore. PW's reports indicated severe credit impairment among many of these group companies, which utilized funds to invest in or lend to other entities within the group, despite similar credit challenges. NFRA emphasized that the auditors failed to provide a comprehensive assessment of the business rationale and recoverability of these loans, despite being obligated to do so.

NFRA's investigation further revealed that PHD dismissed fraud concerns based on a limited examination of company data and their interpretation of the law, responding only to inquiries from the audit committee. Moreover, NFRA highlighted the audit committee's failure to address PW's concerns within the statutory 45-day limit, leading to the incorporation of PHD's findings, lacking adequate rigor, into the financial statements.

Additionally, the auditors were faulted for inadequately verifying PW's observation that 11 out of 13 borrowers had incurred losses and negative net worth. They relied solely on comfort letters provided by promoter group entities, without proper documentation of the borrowers' business activities to confirm the legitimate utilization of sanctioned loans. Furthermore, there was a glaring failure to examine bank statements to rule out the possibility of loan evergreening, despite PW's indications of circular transactions.