Catalyzing Corporate Integrity: NFRA’s Transformative Audit Circular
The National Financial Reporting Authority (NFRA), established in 2018 by the Indian Government under Section 132(1) of the Companies Act, 2013, plays a crucial role in ensuring adherence to auditing compliance. In light of the current shortage of Statutory Auditors fulfilling their obligations and the ongoing resignations of auditors from major corporations, the NFRA issued a pivotal circular on June 26, 2023, which has reshaped the landscape of auditing in India.
This circular introduced a set of regulations that auditors of entities must strictly adhere to. According to the new guidelines, auditors are now mandated to report suspicions of fraudulent practices within a company to the Ministry of Corporate Affairs (MCA), Government of India, regardless of whether they themselves discovered these irregularities. The circular emphasizes the imperative need for auditors to practice and promote due diligence and professional skepticism. They must not rely solely on the company’s internal legal assessments but must conduct their independent evaluations and analyses. This aligns with rules such as the Companies (Auditor’s Report) Order, 2020 [CARO 2020], which compels auditors to consider whistleblower allegations. This means that even if such malpractices were not uncovered during their audit procedures but were brought to their attention through a whistleblower or internal reviews, they must report them to the MCA. Additionally, terminating an audit contract does not absolve auditors of their reporting responsibilities.
As per Rule 13 of the Companies (Audit and Auditors) Rules 2014, “If an auditor of a company, in the course of performing their duties as statutory auditor, has reasonable grounds to believe that an offense of fraud involving an amount of one crore rupees or more is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government.”
Thus, until now, auditors were typically required to report fraud above the mentioned threshold to the Department of Corporate Affairs only if they were the first to notice it during the audit procedures.
In accordance with the Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013 (Revised 2016), if the statutory auditor discovered fraud through internal reviews, whistleblower complaints, etc., they were only obligated to report it to the audit committee or the company’s board and had no duty to report it to the Government. However, as per this circular, even transactions not identified by the auditors, exceeding the specified financial limit, must now be reported to the Indian Government.
Indian statutes categorize fraud into two types, civil (Indian Contract Act, 1872) and criminal (Indian Penal Code – ‘fraudulently’). As per Section 447 of the Companies Act, 2013, fraud is comprehensively defined as “fraud in relation to the affairs of a company or any body corporate, includes any act, omission, concealment of any fact, or abuse of position committed by any person, or any other person with connivance, with intent to deceive, to gain undue advantage from, or to injure the interests of the company, its shareholders, its creditors, or any other person, whether or not there is any wrongful gain or wrongful loss.”
The Standard on Auditing (SA)-240 issued by ICAI defines fraud as “an intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage.”
It is evident from these definitions that mens rea or a guilty mind is a crucial element in establishing fraud. This assessment is rather technical, and statutory auditors must now determine if a suspicious transaction has occurred. Not all suspicious transactions are necessarily fraudulent; some may simply result from poor commercial judgments, which auditors, like enforcement authorities such as the Serious Fraud Investigation Office (SFIO), will have to discern.
The NFRA Circular is poised to play a significant role in combating bribery and corruption in India. It mandates auditors to identify potential frauds and undertake independent analysis and evaluations, rather than relying solely on the company’s assessments. The circular has broadened the scope of audit scrutiny, ensuring that all allegations made by whistleblowers are taken into account. This circular promotes transparency and integrity in the corporate world by holding auditors accountable even after their resignation. These measures are expected to have a substantial impact on the fight against bribery and corruption.
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