NFRA’s new guidelines: Auditors mandated to proactively report corporate fraud

The Government wants to tackle the menace of corporate fraud head-on and there could be more such measures on their way soon

The dark underbelly of the otherwise vibrant corporate world comes to the forefront whenever allegations or investigations of financial irregularities, fraud, or corporate governance issues make headlines. The infamous Satyam scandal is a prime example, which sent shockwaves through India Inc. and reminded us that even the most successful companies can be brought down in a blink of the eye due to allegations pertaining to corporate fraud.

In recent years, shareholders and creditors have increasingly blamed professional statutory auditors for their failures to detect and prevent financial fraud. As a result, quite often, statutory auditors may be targeted by multiple stakeholders (creditors, employees, customers, shareholders’, etc.) who may be at the suffering end due to the corporate fraud. The general expectation of these stakeholders is that the statutory auditors will exercise a high degree of care, diligence, and professionalism in their work as well as raise any alarms about an impending corporate crisis.

This means that statutory auditors must be competent, thorough, and objective in their audits. When allegations of financial fraud arise, statutory auditors are often targeted because they are seen as being responsible for detecting and preventing such fraud.

Corporate fraud is an ever-evolving concept and can be of various types and include forms of embezzlement, misappropriation of funds, conflict of interest issues, kickbacks, etc and therefore the task before the auditors is a challenging one.

Especially, in recent times, auditors have found themselves in the spotlight for corporate governance issues pertaining to listed companies and even coveted start-ups. With listed companies, the resignation of an auditor is seen as a clear red flag and may even send tremors across the stock market.

The NFRA Circular

Considering the recent spate of corporate fraud cases, the government and regulators have shown a clear commitment to establish a robust framework for reporting such frauds. Keeping this spirit in mind, in October 2020, the SEBI amended the SEBI (LODR) Regulations, 2015 which now, inter-alia, mandates listed businesses to disclose forensic audit initiation to stock exchanges.

Recently, on 26th June 2023, the National Financial Reporting Authority (“NFRA”), an authority constituted under the Companies Act, 2013 issued instructions/clarifications for statutory auditors in relation to fraud.
To provide a brief background, auditors are required to report fraud and/or suspected fraud to the board/audit committee of the company or to the Central Government (in certain cases) pursuant to, inter-alia, the Companies Act, 2013, the Companies (Audit and Auditors) Rules, 2014 and the Companies (Auditor’s Report) Order, 2020.

The NFRA has now provided the following clarifications:

(i) it has now been clarified beyond an iota of doubt that even in cases where the statutory auditor is not the first person to identify the fraud/suspected fraud, the duty to report to the board and/or Central Government (as the case maybe) will still affix on the statutory auditor;

(ii) relying on the principals of the judgment of the Hon’ble Supreme Court of India in Union of India and Another versus Deloitte Haskin and Sells LLP & Anr (Criminal Appeal number 2305-2307 of 2022), the NFRA has also clarified that resignation does not absolve the auditor from its duty to report fraud or suspected fraud;

(iii) the statutory auditor must rely on its professional skepticism while evaluating fraud-related issues and cannot rely on legal opinion provided by the company and/or its management. This resonates with ‘SA-240 – The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements’ which similarly requires auditors to maintain professional skepticism throughout the audit, keeping in mind that there may be a possibility for a material misstatement due to fraud.

What next

The NFRA has now clarified its stand pertaining to fraud reporting by auditors, which requires auditors to proactively report corporate fraud.

India has some of the best auditing entities bringing in the best global practices and yet, in recent times, there has been a lot of scrutiny on such auditing entities. Therefore, the NFRA has put the need for greater corporate governance at the forefront, which may now require these audit firms to create/bolster their standard operating procedures and ways of working while dealing with fraud and “suspected” fraud.

It appears that there are mixed views in the market in the aftermath of this circular, especially since auditors might feel some of the obligations imposed would be onerous for them. However, it will be interesting to see how the NFRA enforces this circular and how auditors re-think their ways of working. What is very clear is that the Government wants to tackle the menace of corporate fraud head-on and there could be more such measures on their way soon.

(This article is written by Kartik Jain, Partner and Debottam Chattopadhyay, Senior Associate of JSA)

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of ET Edge Insights, its management, or its members

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