NFRA weighs options after Delhi HC junks notices to auditors in IL&FS audit case

New Delhi: National Financial Reporting Authority (NFRA) is weighing its options after the Delhi High Court last week quashed notices issued to auditors of some of the IL&FS group entities including Deloitte Haskins & Sells LLP, and SRBC & Co. LLP on “technical grounds,” according to two persons aware of the development.

The high court order endorsed NFRA’s powers to review audits done before the regulator’s creation in 2018 as well as its practices like relying on the audit files to prove professional misconduct and not granting any cross-examination of witnesses. It, however, quashed the notices demanding explanations issued to 11 persons and entities citing lack of division in the regulator’s functions carrying out quality reviews and disciplinary enquiry.

“NFRA is weighing the options, one of which is an appeal specifically against part of the order on this technical aspect of division of functions. The other findings of the high court in this case are favourable to NFRA,” said the first of the two persons cited earlier, both of whom spoke on the condition of anonymity.

Scope for fresh action

The court left it open to the regulator to initiate fresh proceedings, but any disciplinary action must be taken by NFRA members who were not involved in preparing the audit quality review report, the court said. The petitioners, which include individual auditors too, had argued that there must be a division of functions between those reviewing an audit and those forming an opinion to initiate disciplinary proceedings, arguing that ‘prosecutor and the judge’ cannot be the same.

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The alleged failures in audit of IL&FS entities—IL&FS Transportation Networks Limited (ITNL) and IL&FS Financial Services Ltd (IFIN) for FY18—has been a priority case for NFRA, which in its quality review reports critiqued the affiliations as well as the business model of large audit firms in the country.

NFRA has been paying special attention to how auditors exercise their mandate, especially, whether they showed professional scepticism in evaluating managements’ assertions, communicate with the audit committees in companies regularly, thoroughly look into transactions such as inter-corporate loans that are prone to fund diversion, and whether audit firms have been religiously observing the firewall meant to prevent getting into prohibited non-audit services that could compromise their independence.

Queries emailed to NFRA, Deloitte and SRBC on Saturday after the court order became public remained unanswered till press time.

The first person quoted above said that the high court quashing NFRA’s notices and orders in 11 instances, primarily in the IL&FS cases, was on a matter of technicality, not on merit. As per the court order, the regulator did not act through properly constituted divisions as mandated under the Companies Act, the person said. That is, the quashing was on account of issues around procedural correctness, not the legal soundness of the regulatory finding.

The person said the National Company Law Appellate Tribunal (NCLAT) had in December 2023 held that NFRA used the ‘divisions’ as specified in law, a view later confirmed by the Supreme Court which dismissed appeals against the NCLAT judgment.

A third person, who also spoke on condition of not being named, however, said high courts have broader Constitutional powers, while the NCLAT is a specialized appellate body with limited jurisdiction.

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