Does India’s accounting watchdog NFRA have powers to check past audits?

India’s independent audit regulator National Financial Reporting Authority (NFRA) has knocked on the doors of the Supreme Court to challenge the Telangana High Court’s September interim ruling which stayed its orders against the audit firm P Murali and Co.

The Telangana High Court had ruled in favour of P Murali citing that prima facie NFRA does not have jurisdiction over audits prior to its constitution in October 2018.

The debate whether NFRA has powers to check past audits presumes significance since many of its critical 50-plus orders pertain to the period before it was set up including its very first order dated July 2020 against Deloitte ex-CEO Udayen Sen in the IL&FS fraud case.

Sen, the engagement partner in the statutory audit of the entity’s financial services arm or IL&FS Financial Services for the financial year 2017-18, was barred for seven years from being appointed as an auditor of any company for professional misconduct; Sen thereafter filed a petition and got a stay on the NFRA order. Since then, multiple petitions have been filed across various High Courts in the country and the case is sub judice.

ETCFO discusses the subject with corporate lawyers and industry experts.

Retrospective applicability of law?

Vinati Kastia, Senior Partner, and Ayush Tandon, Partner, at AZB & Partners, say the law does not contemplate any “retrospective operation” of Section 132 of the Companies Act, 2013 which deals with the constitution and powers of the NFRA.

Section 132 (4) of the Companies Act states that: Notwithstanding anything contained in any other law for the time being in force, the National Financial Reporting Authority shall have the power to investigate, either suo motu or on a reference made to it by the Central Government, for such class of bodies corporate or persons, in such manner as may be prescribed into the matters of professional or other misconduct committed by any member or firm of chartered accountants, registered under the Chartered Accountants Act, 1949.

The lawyers also argue that the Chartered Accountants Act was the only prevailing law until October 1, 2018, and that did not stipulate any consequences against a firm of CAs and only individual CAs could be penalised for professional misconduct.

“NFRA exercising retrospective jurisdiction against the firms is in effect making the firm subject to a consequence that did not exist at all before October 2018, which must not be permitted,” the AZB & Partners' lawyers say.

NFRA, though not yet passed orders against the firms, has issued show cause notices to auditors Deloitte and KPMG (Audit arm BSR) in the IL&FS case and EY (SRB and Co LLP) in connection with IL&FS Transportation Network (ITNL) case.

Kamal Aggarwal, Senior Partner, Tax, Singhania & Co, backs the above lawyers’ viewpoint.

In my personal opinion, the legal framework on the date of execution of the audit report should prevail. Whenever an activity is done, one bears in mind not only the consequences but also the investigating agency. So, the NFRA should be looking at the audits conducted after its incorporation.Kamal Aggarwal, Senior Partner, Tax, Singhania & Co.

Telangana High Court cited the same arguments.

“In view of the fact, as borne on record that the respondent was constituted by the Central government on 01.10.2018 under Section 132(1) of the Companies Act, 2013, and Section 132 (4) was enforced with effect from 24.10.2018 and the NFRA rules, 2018, were brought into force on 14.11.2018, this court prima facie is of the opinion that the respondent does not have any jurisdiction or statutory authority to issue any direction or commence any proceedings against the petitioner pertaining to audits conducted prior to its constitution,” the Telangana High Court said.

One partner at a large accounting firm, who does not wish to be named, argues that NFRA examining past audits is “unconstitutional” and “unfair” to the industry.

If you see some of the audit quality review reports of the NFRA for the past years prior to its constitution, the regulator has taken a different approach and interpreted the definition of management services entirely differently from what used to be construed by the profession previously. This is not merely a change in an authority or a forum but a change in the entire set of rules and regulations which is just not fair to the industry. You can’t apply these interpretations retrospectively.A Partner at a large accounting firm , citing anonymity, tells ETCFO.

Management Services is one of the non-audit services prohibited under the regulation for auditors to safeguard their independence otherwise if they provide such services, then they would be conflicted to give a true and fair opinion on the accounts.

In the case of IL&FS' financial services arm IL&FS Fin, the NFRA said in the audit quality review reports that the appointments of its former auditors Deloitte and KPMG (BSR) were illegal, saying they violated auditor independence norms. The NFRA had contended the auditors offered management services.

A similar story played out in the case of IL&FS Transportation Network or ITNL, where the audit firm was EY (SRB and Co LLP).

A CFO’s perspective

MP Vijay Kumar, CFO of Sify Technologies, suggests it would be a good long period for the NFRA to even take up a review of companies post its constitution in October 2018. He says the period from 2018 would be more appropriate for the regulator.

It is important to recognise that since NFRA has come into existence and through its communication particularly in the recent past through circulars, review reports, and orders, the Companies, and Auditors have focused more on the quality of financial reporting. Hence, the period from 2018 would be more appropriate.MP Vijay Kumar, CFO, Sify Technologies

The finance veteran is quick to add that if there are past period cases i.e., prior to 2018, which other regulators like SEBI have referred to NFRA, then the same could be taken up, subject to how legal experts would interpret considering there is no specific grandfathering provision.

It is to be noted that the high-profile IL&FS case was recommended to the NFRA by the central government.

Contrarian views

A government official seeking anonymity argues that even prior to October 2018, auditors were required to audit the accounts properly and that it is not a new offence or a punishment that has been created all of a sudden. He also cites a Bombay High Court July’s ruling which left the decision of the jurisdiction on the regulator NFRA itself.

The law is clear from our side. Professional misconduct was earlier also an offence and now only the forum has changed. That is earlier the power to punish the auditor for wrongdoing was with the ICAI….So, procedural law can be applied retrospectively but the only thing is you can’t create new punishment or a new offense…Also, there is a Bombay High Court order which asked NFRA to decide its jurisdiction, and then against that decision (of the regulator) one can go to the Court.A government official, citing anonymity, tells ETCFO

This Bombay HC ruling was in the matter between NFRA and the auditors of Dewan Housing Finance Corporation, Chaturvedi and Shah; the audit firm had moved the Court seeking to stall the publication of the Audit Quality Review Report of the NFRA which found lapses in its audit for financial year FY17-18.

NFRA’s ex and very first chief R Sridharan backs this official’s view. He says the law has not been altered and that only the adjudicating authority or the forum has changed.

“It is a standard matter that change of forum does not prejudice the rights of the person by whom the offence is committed. There is no option to choose the forum, other than the one notified under the law has the jurisdiction,” Sridharan says.

Gyanendra Kumar, Partner at Cyril Amarchand Mangaldas adds to the debate, walking a similar narrative. He reasons that the power of an investigative body cannot be limited by the date of its constitution, but is defined by the area of its investigation.

So as long as the issue being investigated is within the competence of the NFRA, and is within its limitation, the power of the NFRA would be broad enough to cover that, even if the NFRA was constituted post such an occurrence.Gyanendra Kumar, Partner at Cyril Amarchand Mangaldas

Lawyers who back this view feel that section 132 (4) of the Companies Act, 2013 mentions that if the NFRA has initiated investigation proceedings, then no other regulator can take up the proceedings parallelly, and in that case only the accounting watchdog has jurisdiction.

Section 132 (4) of the Companies Act, 2013 states: “Provided that no other institute or body shall initiate or continue any proceedings in such matters of misconduct where the National Financial Reporting Authority has initiated an investigation under this section.”

Shriram Subramanian, MD, of a proxy advisory firm InGovern, feels the purpose of setting up NFRA was to improve audit quality and enhance auditing standards, and if the watchdog is able to identify weaknesses in auditing in the pre-2018, then it should not be an issue if the regulator examines the past audits.

If the NFRA’s examination of past audits is able to provide inputs and directions for future audits, that would be good.Shriram Subramanian, MD, of a proxy advisory firm InGovern

Ashok Haldia, ex secretary, at the Institute of Chartered Accountants of India concurs saying extending the NFRA's jurisdiction on past audits may not be an issue given the regulator's initiatives in the last few years which he thinks have led to better quality in the audit firms.

The way forward

The matter of NFRA’s jurisdiction debate is listed in the Supreme Court for October 13.

Also, the future cues may come from the Delhi High Court, where a batch of petitions against the regulator’s orders pertaining to the pre-2018 have been clubbed together and the hearings are in the final stages.

The Delhi High Court has finished hearing the arguments of Advocate Kapil Sibal, who represented Deloitte Haskins and Sells LLP in the matter of IL&FS; Sibal contested that NFRA was using the retrospective application of the law. Next in line will be the arguments of the respondent NFRA and other audit firms petitioners including EY. The Delhi HC proceedings will be heard by the Division bench comprising Yashwant Varma and Dharmesh Sharma.

“Any new law requires time to settle down…The NFRA is attending various National Company Law Appellate Tribunals (NCLATs) and High Courts including the Delhi High Court and now it has been challenged before the Supreme Court. We have clarity on our jurisdiction, but for those who are confused, this matter will give them clarity,” the official, earlier cited, signs off.

“Retrospective application of the law does not bode well for the industry and the economy. The lawmakers have not provided for any retrospective application of the law. There needs to be consistency in the NFRA’s approach. The industry is looking for justice from the courts,” the partner, at a big accounting firm, earlier cited, concludes.

A questionnaire to the NFRA, P Murali & Co, Deloitte, and KPMG seeking their comments for this story went unanswered while EY declined to comment on the subject till the time of the publication of this report.