The National Financial Reporting Authority (NFRA) has recently identified a concerning issue: auditors are not fulfilling their statutory responsibilities when it comes to reporting fraud in companies. This article aims to highlight the mandatory obligations of auditors and the consequences they may face for failing to report fraud. Here we will discuss the relevant sections of the Companies Act, 2013, the Companies (Audit and Auditors) Rules 2014 and the Standards on Auditing (SAs) that outline auditors’ reporting obligations and the actions to be taken in cases of fraud or suspected fraud, as reiterated by NFRA in it’s Circular dated 26th June 2023.
NFRA Circular dated 26/06/2023: Statutory Auditors’ Responsibilities in relation to Fraud Reporting in a NFRA Regulated Company/Entity
The NFRA has observed that auditors are not fulfilling their responsibilities to report corporate frauds as required by the Companies Act, 2013 and the relevant rules and auditing standards. Auditors have mandatory reporting obligations to report fraud or suspected fraud to the Central Government and the Board/Audit Committee. Detailed steps and forms are provided for reporting fraud under the Companies (Audit and Auditors) Rules 2014 and the Companies (Auditor’s Report) Order, 2020. If auditors are found to have acted fraudulently or colluded in fraud, they may face legal consequences, including removal and debarment for five years.
Reporting Obligations under CA 2013
According to Section 143(12) of the Companies Act, 2013, auditors are required to report any instance of fraud involving a prescribed amount committed by the company’s officers or employees. Rule 13 of the Companies (Audit and Auditors) Rules 2014 provides detailed steps that auditors must follow if they have reason to believe that fraud has been or is being committed against the company. This includes reporting the matter to the Board or Audit Committee and submitting a statement, as specified in Form ADT-4, to the Central Government.
Additional Reporting Obligations under CARO 2020
In addition to the Companies Act, auditors must also comply with the Companies (Auditor’s Report) Order, 2020. Clause (xi) of this order stipulates that auditors must include statements regarding the reporting of fraud in their reports. This requirement is outlined in exercise of powers under Section 143(11) of the Companies Act, 2013.
Auditor’s Responsibilities under SA 240
SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements” provides comprehensive guidelines for auditors. Professional skepticism is a key principle emphasized in this standard, reminding auditors to remain vigilant throughout the audit process and recognize the possibility of material misstatements due to fraud, regardless of their past experience with the honesty and integrity of the company’s management and those charged with governance.
The standard also highlights the importance of effective communication. Paras A59-A66 of SA 240 offer guidance on reporting fraud or suspected fraud to management, those charged with governance and regulatory and enforcement authorities.
Consequences for Auditors
Section 140(5) of the Companies Act, 2013, specifies the consequences for auditors who have acted fraudulently, directly or indirectly, or have abetted or colluded in any fraud related to the company or its directors/officers. Apart from potential removal and debarment for a period of five years, auditors may also be liable for action under Section 447 of the Companies Act, 2013. It is crucial to note that the definition of fraud under Section 447 is extensive, encompassing acts, omissions, concealment of facts and abuse of position committed with the intent to deceive, gain undue advantage or harm the company’s interests, shareholders, creditors or any other person.
NFRA Clarification on Auditors’ Resignation and Reporting Obligations
The NFRA has clarified that there seems to be a misconception among some auditors that resigning from an audit engagement relieves them of their reporting obligations regarding 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.
Compliance with Reporting Requirements
In light of these findings and legal interpretations, NFRA has reiterated the crucial provisions of the Companies Act, relevant rules and auditing standards related to reporting fraud and its consequences. Statutory auditors bear a mandatory obligation to report any fraud or suspected fraud if they come across suspicious activities, transactions or operating circumstances within the company. Rule 13 of the Companies (Audit and Auditors) Rules 2014 outlines the necessary steps for auditors to follow, starting with reporting the matter to the Board/Audit Committee within two days of becoming aware of the fraud.
If the reported fraud involves an individual amount of one crore rupees or more, and the auditor does not receive any response or observations from the Board/Audit Committee within 45 days, Form ADT-4 should be forwarded to the Secretary, Ministry of Corporate Affairs, Government of India. Even if the Statutory Auditor is not the first to detect fraud or suspected fraud, they are still obligated under Section 143(12) to submit Form ADT-4 to the Central Government.
Upholding Professional Skepticism and Independence
Throughout the entire process of evaluating fraud, auditors must exercise their own professional skepticism. They should not be unduly influenced by legal opinions provided by the company or its management. It is their duty to diligently assess any potential fraud and fulfill their reporting obligations in accordance with the law.
The reporting of fraud by auditors is an essential aspect of maintaining transparency and accountability in companies. By following the provisions outlined in the Companies Act, relevant rules and auditing standards, auditors can play a crucial role in safeguarding the interests of the company, its stakeholders, and the broader financial ecosystem. It is imperative for auditors to understand their responsibilities and the potential consequences they may face for failing to report fraud or suspected fraud. The crux of the NFRA Circular is that compliance with these reporting requirements is vital for upholding the integrity and trustworthiness of financial reporting processes.