The National Financial Reporting Authority (“NFRA”) issued a circular dated 26th June 2023, to the auditors of the entities regulated by NFRA reiterating the statutory auditors’ responsibilities in relation to fraud in a Company.
In the circular, NFRA states that auditors are not fulfilling their statutory responsibilities to report fraud as mandated under the Companies Act, 2013 (“the Act”) read with the relevant Standards of Auditing (“SA”). The circular therefore reiterates the legal position i.e., the statutory responsibility cast on the auditors to report fraud and the consequences that will fall upon the auditors if they fail in discharging such obligations and clarifies certain misconceptions in this regard.
Statutory responsibility on auditors to report fraud under the Companies Act, 2013
The circular reiterates the following statutory responsibilities and consequences under the Act on the auditors in relation to reporting of fraud. Section 143(12) of the Act states that during the course of an audit if the auditor has reason to believe that offence of fraud is being committed in the company by its officers or employees, they shall report the fraud to the Central Government. The procedure for reporting the fraud is prescribed in Rule 13 of the Companies (Audit and Auditors), Rules, 2014 and the procedure is summarized below:
Where the amount of fraud is more than Rs. 1 crore:
The auditor shall report the fraud to the Board or Audit Committee within 2 days of their knowledge.
On receipt of a reply from the Board or Audit Committee, the auditor shall forward their report and reply received to the Secretary, Ministry of Corporate Affairs. In case no reply is received within 45 days, the auditor is required to forward his report to the Secretary.
The auditor’s report shall be on this letterhead and include the prescribed details of the auditor. The report shall be in the form of a statement as specified in Form ADT-4.
Where the amount of fraud is less than Rs. 1 crore:
In case of fraud involving an amount less than Rs. 1 crore, the auditor is required to report the matter to the Audit Committee or Board within 2 days of his knowledge of the fraud.
Further, the auditor must ensure that details of each fraud are disclosed in the Directors Report.
Clause (xi) of Companies (Auditor’s Report) Order, 2020 also requires the auditors to make statements relating to reporting of fraud.
Section 140(5) of the Act further provides that if the auditor has acted in a fraudulent manner or colluded in any fraud, the said auditor will himself be liable for fraud u/s 447 of the Act apart from removal as the auditor of the company and debarment for a period of 5 years.
The circular also refers to SA-240 which requires auditors to maintain professional skepticism throughout the audit irrespective of their experience with the honesty and integrity of the entity’s management and those charged with governance. The circular also reiterates the guidance provided in SA-240 regarding communication with management, those charged with governance and regulatory and enforcement authorities regarding reporting of fraud/suspected fraud.
Specific issues addressed by NFRA.
Firstly, the circular highlights that the consequences for non-reporting of fraud would apply even if an auditor has resigned from their audit engagements without reporting fraud or suspected fraud. NFRA has specifically clarified this in the circular, referring to the recent decision of the Honourable Supreme Court in the case of UOI v Deloitte Haskins and Sells LLP ( Criminal Appeal nos.2305-2307 of 2022.)
Secondly, the circular clarifies that the auditors are required to report the fraud as per the Act and corresponding rules even if the auditor is not the first person to identify the fraud or suspected fraud.
Lastly, the circular cautions auditors to exercise professional skepticism while evaluating fraud and not be influenced solely by the legal opinion provided by the Company or Management.
Conclusion
The circular issued by the NFRA serves as a crucial reminder to auditors regarding the importance of diligently reporting fraud in accordance with the prescribed guidelines. It emphasizes that compliance with the reporting requirements is not only a matter of formalities but should be approached with utmost seriousness. The circular also underscores the severe consequences that auditors may face if they fail to fulfil their obligations in reporting fraud. It signals a heightened level of scrutiny on the role of auditors in fraud cases and indicates that necessary actions will be taken under the Act if auditors are found to have neglected their responsibilities or acted unprofessionally. Auditors should take note of this circular and ensure that they carry out their audit obligations with integrity and professionalism to maintain the trust and confidence of stakeholders.
Authored by Shivam Mishra, Associate at Metalegal Advocates. The views are personal and do not constitute legal opinion.
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