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NCLAT upholds NFRA’s power. What does it mean for auditors and larger financial sector

The National Company Law Appellate Tribunal (NCLAT) on Friday ruled that the National Financial Reporting Authority (NFRA) has power to probe cases of professional misconduct that had occurred before the audit regulator was set up in 2018. Banikinkar Pattanayak explains the significance of the verdict for the financial sector.

What is NFRA’s ambit?
The NFRA was established under Section 132 of the Companies Act, 2013, which gives it powers to take action against auditors of all listed and large unlisted public limited companies for professional lapses. Besides, it can take up any audit case referred to it by the government. The NFRA can also recommend accounting and auditing policies and standards to the government for adoption. Before it was set up, the Institute of Chartered Accountants of India (ICAI) had, more or less, exclusive jurisdiction over disciplining the auditors. The Ministry of Corporate Affairs and regulators like Sebi have limited oversight over auditors.

What was the case before the NCLAT?
The NFRA barred four partners of Kerala-based K Varghese & Co from auditing for one year and imposed a penalty of Rs 1 lakh each in March-April 2023 for lapses in auditing 17 branches of the scandal-hit Dewan Housing Finance Corporation Ltd (DHFL) in 2017-18. The auditors filed separate appeals against the NFRA orders in the NCLAT, which were then clubbed together.

What was the auditors’ main argument?
The auditors contended that the 2017-18 audits of DHFL branches for which they were being sought to be punished predated the regulator’s existence. So, the NFRA has essentially exercised retrospective jurisdiction which is bad in law. The ICAI should have regulatory jurisdiction over such audits instead of the NFRA, they argued.

What did the NCLAT say?
Upholding NFRA’s orders against the auditors, the appellate tribunal said a “change in forum” (to the NFRA from the ICAI) due to a change in law has no bar on being implemented with retrospective effect. No new obligation on auditors was created due to the change, as audit standards were to be mandatorily followed even prior to NFRA’s establishment. The NFRA, it validates, has the power to probe professional misconduct of auditors and if it starts investigation in any audit case, no other institution can continue or initiate proceedings in the same case.

How will it impact auditors?
It could bolster NFRA’s stance in its orders against dozens of auditors in large scandals like IL&FS and DHFL and even other cases where the auditors have challenged not just the regulator’s action against them in pre-2018 cases, but also its very constitutional authority. The aggrieved auditors have dragged the NFRA to the Supreme Court and various high courts, including in Delhi, where cases are ongoing, and the NCLAT verdict may have a bearing on such cases.

How will it affect the NFRA and the financial sector?
Subject to the apex court ruling, the latest verdict reinforces NFRA’s authority over auditors of listed and large unlisted public firms and could serve to remove any perceived regulatory grey area that auditors may seek to exploit. The NFRA has been particularly vigorous in its action against errant auditors since last year. The heightened fear of action could force auditors to better adopt the stipulated standards that could eventually lead to greater corporate governance and a more realistic picture of companies’ performance, benefitting various financial sector participants as well as regulators.

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