Road construction takes place near the IL&FS building in Mumbai. (Photographer: Abhijit Bhatlekar/Bloomberg News)

IL&FS Auditors In The Crosshairs As Report Alleges Fudging Of Accounts

The statutory auditors of Infrastructure Leasing & Financial Services Ltd. acted in a “negligent and fraudulent manner” and prepared incorrect financial statements of the debt-laden conglomerate, alleged the Ministry of Corporate Affairs on the basis of an interim report filed by the Institute of Chartered Accountants of India.

The ICAI report led the MCA to seek reopening of last five years’ financial records of IL&FS group, and its two subsidiaries—IL&FS Financial Services Ltd. and IL&FS Transportation Networks Ltd., said an application filed by Manmohan Juneja, regional director at MCA at the National Company Law Tribunal on Dec. 21. The application further sought re-casting of the financial statements of the three companies by a government-appointed chartered accountant. BloombergQuint has reviewed a copy of the MCA application.

Based on an initial opinion of the audits conducted by Deloitte Haskins & Sells LLP, SRBC & Co. LLP and BSR & Associates LLP on IL&FS and its two subsidiaries, the ICAI report alleged that the condition of the IL&FS group companies was a result of mismanagement reflected upon its statutory auditors.

Here are some key findings of the ICAI interim report. It alleged that the auditors failed to report:

  • That IL&FS did not meet Reserve Bank of India’s regulatory framework for core investment companies.
  • Whether the required approvals were being taken to provide high managerial remuneration.
  • Direct and indirect investments made by the parent IL&FS in its group subsidiaries.
  • The “serious mismatch” between assets and liabilities which indicated liquidity concern on the lender’s balance sheet.
  • Key balance sheet indicators of the beleaguered financier, such as its over-reliance on short-terms borrowings for financing its long-term assets, adverse key financial ratios and deterioration in the value of the assets used to generate cash flows. “In fact the SA (statutory auditors) have mentioned that in view of its (IL&FS) positive net worth, positive cash flows, credit ratings and boards proposals, there is no doubt on the ability of the entity to continues as a going concern,” the report noted.

The report also found irregularities in the books of IL&FS Financial Services, based on which the MCA application to NCLT alleged that,

  • Even though RBI pointed out that the net owned funds of the non-banking lender had turned negative and its balance sheet was over-leveraged, in its 2014-15 annual inspection report and made similar observations later, the auditors failed to state the material facts in their report.
  • Auditors understated the lender’s bad loans and did not point out the inadequate provisioning made against such loans, violating RBI’s circular on “Disclosure in the Notes to Accounts to the Financial Statements – Divergence in Asset Classification and Provisioning”. No reasons were given for increasing liabilities/loans and increasing borrowing costs of the financial services arm, leading to non-disclosure of the consequential impact of insufficient provisioning for debts.
  • Auditors failed to show the diversion of the lender’s funds through its subsidiaries, due to fraud or error.
  • Failed to report that the lender indulged in non-viable financial transactions with its own subsidiaries and did not indicate the risk involved in such transactions.

The report alleged that the its transport subsidiary IL&FS Transportation Networks serviced its debt through fresh borrowings instead of meeting its finance costs from cash flow of operations. The loans were extended to loss-making projects which threatened its long-term viability, the report noted. It further alleged that the auditors “blindly” relied on the Group Companies Statutory Auditors Report, and failed to verify independently whether the company was financially in a position to repay its debt.

Earlier, on Dec. 3, the NCLT had temporarily restrained nine former senior executives of insolvent IL&FS, being probed by the serious frauds office, from selling or pledging their personal assets and securities. The decision was based on revelations of an interim report, submitted by the fraud investigator, which alleged that the senior management formed a separate committee of directors to take all operational decisions regarding credit and investments in subsidiaries and misstated profits to hide the group’s poor financial health in order to obtain higher credit ratings and raise debt.

The slide began four years ago when IL&FS, and its direct subsidiaries—IL&FS Financial Services and IL&FS Transport Networks—borrowed short-term funds from the market and banks, based on window-dressed financials and high credit ratings, according to the white-collar crime investigator. They lent the money for the long term at high interest rates to its project subsidiaries and group companies, which in turn used these funds to pay interest on loans taken in the past from the same set of lenders. That made the parent and its key subsidiaries look financially healthy to borrow more. The cycle continued till it became impossible to sustain, ending in multiple defaults and spooking the credit market.

The new board, led by veteran banker Uday Kotak, found that the group was far more complex with 348 associate firms and subsidiaries and had a total debt of about Rs 91,000 crore. The board has already invited buyers for some of the assets as part of its resolution plan.

Also Read: SEBI Probing How Rating Agencies Missed Stress In IL&FS