NFRA Finds Serious Lapses In BSR’s Audit Of IL&FS Financial Services

BSR and Associates wasn’t eligible to be appointed as statutory auditor of IL&FS Financial Services and it failed to highlight material misstatement of a “major magnitude” in its audit of the non-bank lender during 2017-18, according to the National Financial Regulatory Authority.

The authority made these observations in its audit quality review report—a regulatory assessment which involves evaluation of quality control, documentation, testing of audit and supervisory control procedures, among others.

NFRA has pointed out that BSR, an affiliate of KPMG, didn’t have adequate justification for issuing a report that said the audit complied with the applicable standards. It also violated auditor independence norms as some non-audit services were technically provided to IFIN by certain KPMG labelled entities, the regulator has said.

Since its inception about two years ago, the NFRA has initiated stringent action against errant auditors. Till now, it has debarred Udayan Sen, Rukshad Daruwala and Shrenik Baid—Deloitte Haskin’s audit partners and also concluded that the firm was non compliant with the applicable auditing standards during its audit of IFIN.

NFRA’s Findings

After a twenty-month-long process involving review of BSR’s statements and reports on analytical procedures, materiality, investments, internal controls and charge creation system, the audit regulator has found serious lapses by the KPMG affiliate during the audit of the non-bank lender.

The major findings of the audit regulator include:

Auditor Independence

The Companies Act, 2013, prescribes prohibited services that an auditor cannot directly or indirectly provide to its clients, including provision of management services. The audit regulator called for a list of services provided by BSR as well as other KPMG group entities. After an analysis, the NFRA concluded that BSR violated audit independence requirements because:

• Documents filed by BSR indicated that it’s an affiliate of KPMG India. The firm’s filings with the U.S. audit regulator also stated that it’s affiliated with the global KPMG brand.
• BSR provided several non-audit services directly or indirectly during its tenure as an auditor of IL&FS either on or after the day of its engagement. This included provision of prohibited management services without approval of the audit committee.
• The presence of such services rendered BSR’s appointment void ab initio—which means illegal from the start—since it violated section 144 of the Companies Act.
• BSR’s compliance with code of ethics was threatened by its self interest.
• And so, the audit firm, its engagement as well as audit quality review partner are guilty of professional misconduct arising out of gross violations of law.

Communications With “Those Charged With Governance”

“Those charged with governance” is a term used in auditing standards to describe persons who oversee the strategic direction and have obligations related to the accountability of an entity.

NFRA alleged in its communications that BSR failed to communicate its audit plan to the TWCG Group and failed to comply with standards for audit documentation. To this, BSR contended that it was compliant with the applicable standards and was appointed in November, which required certain preliminary work.

Dismissing the auditor’s representations, the NFRA has observed that BSR violated SA 260 and 300—standards governing communication and planning of audit. The auditor showed very poor judgment and was grossly negligent in discharge of its professional duties, it said. Similarly documents were modified after completion of audit casting a doubt on their integrity, the audit regulator has said.

Inspection Of Net Owned Funds And CRAR

Hidden and under-reported bad loans and misreporting of capital adequacy norms were one of the main reasons behind the collapse of IL&FS group in 2018. A special audit by the RBI indicated that IL&FS had a negative net worth during 2017-18. NFRA alleged in its communication with BSR that the auditor failed to disclose material facts, and material misstatements.

While denying the allegations, BSR argued that Deloitte Haskins—IL&FS’s joint auditor—didn’t bring certain facts to its notice.

Dismissing these contentions, NFRA observed that:

• BSR failed to obtain sufficient and appropriate audit evidence, relied on the stand taken by the IL&FS management without any questioning and did a soft reporting of a very serious matter.
• It failed to evaluate reliability and accuracy of audit evidence in a manner contrary to the applicable standards.

Other Findings

NFRA has listed several lapses by BSR in connection with audit of IFIN’s internal controls, materiality, investment and creation of charges. The observations include:

• BSR failed to disclose a material fact known to it and was thus a colluding party to the fraudulent presentation of the financial statements. It described the non-performing assets identified by the RBI as standard assets.
• It failed to give adequate importance to RBI inspection reports as well as reporting of non-performing assets.
• Utter confusion prevailed in its assessment of the risk of material misstatement by IFIN. BSR completely relied on management representations on certain crucial matters.
• And lastly, the auditor failed to carry out proper ratio and trend analysis, investigate material variances and identify misstatements by the company.

Auditor Reaction

A spokesperson for BSR told BloombergQuint over email that it’s concerned to note the conclusions by NFRA in the audit quality review as they don’t give due consideration to all the facts and circumstances that were transparently shared with NFRA during their review.

“We’re reviewing the report in detail and will determine our response in due course,” the audit firm was quoted as saying in a statement. “Audit quality remains the cornerstone of our profession and we recognise the challenges that lie ahead to improve audit quality across the profession in India and remain committed to support NFRA’s efforts in this regard.”