External auditors, who works towards the interest of the stakeholders, play a very crucial role in the corporate governance framework of a company. In the recent years, there have been many instances of resignations by the auditors of companies post the observations of Securities and Exchange Board of India’s (“SEBI”) in their order in the landmark case of Satyam in 2009.
Post the Satyam saga, the Standing Committee on Finance, constituted under Rule 331C of the Rules of Procedure and Conduct of Business in Lok Sabha proposed the concept of the National Financial Reporting Authority (“NFRA”) which was formally constituted on October 1, 2018 by the Government of India under Sub Section (1) of section 132 of the Companies Act, 2013 (“Act”). The purpose of NFRA is to recommend accounting and auditing policies and standards in the country, undertaking investigations, and imposing sanctions against defaulting auditors and audit firms in the form of monetary penalties and debarment from practice. After the constitution of NFRA, tighter norms were set with respect to the audit functions, which has streamlined the abrupt resignations of auditors.
During 2018, IL&FS Financial Services Limited (‘IL&FS’) and its group companies defaulted on debt repayments aggregating to a sum in excess of ₹900 billion. Deloitte Haskins and Sells LLP (‘Deloitte’) was the statutory auditor of IL&FS from 2008 to 2018 and BSR & Associates LLP (‘BSR’) was appointed as the joint statutory auditor in 2017. BSR resigned from their role in July 2019. In June 2019, the Serious Fraud Investigation Office (‘SFIO’) carried out investigation on IL&FS. Basis the investigation, SFIO prepared a report and on the basis of the same, proceedings were initiated against Deloitte and BSR, among others, under Section 140(5) of the Act. The matter was heard by the Supreme Court of India (‘Supreme Court’) against the decision of the High Court at Bombay. The Supreme Court held that merely by resigning from the company, an auditor cannot avoid the consequences where they have acted fraudulently.
In 2020, Pricewaterhouse Coopers, Chartered Accountants (‘PwC’), resigned from GVK Power and Infrastructure Limited (‘GVK’) followed after the enforcement agencies i.e. Enforcement Directorate and Central Bureau of Investigation, had launched a probe against GVK in connection with money laundering.
It may be noted that the obligation for stating the reason of resignation and filing the necessary form with the Registrar of Companies within thirty days from the date of resignation has been specified under Section 140 of the Act. Further, in case of companies referred to in Section 139 (5) of the Act an auditor shall also file such statement with the Comptroller and Auditor-General of India indicating the reasons and other facts as may be relevant with regard to resignation. It may also be noted that Regulation 30 and Regulation 51 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended, also states that the detailed reasons for resignation of auditor shall be disclosed by the listed entities to the stock exchanges as soon as possible but not later than twenty-four hours of receipt of such reasons from the auditor.
In terms of Section 143(12) of the Act, if an auditor in the course of his appointment as an auditor of any company has a reason to believe that there is an offence of fraud in the company of ₹1,00,00,000 or above, and is committed against the company by its officers or employees, then the auditor shall report the matter to the Central Government.
Failure on the part of the auditors to comply with the applicable provisions will lead to imposition of penalty of ₹50,000/- or an amount equal to the remuneration of the auditor, whichever is less, and in case of continuing failure, with further penalty of ₹500/- for each day after the first during which such failure continues, subject to a maximum of ₹2,00,000/-.
While there is no such restriction on the resignation by the auditors, however, when the auditors are resigning, they should clearly state the circumstances connected with their resignation which they consider should be brought to the attention of the various stakeholders of the company.
It has been observed many times that when an auditor during the course of their audit suspects fraud or mismanagement or siphoning of funds in the company, they immediately resign from the Company without clearly flagging such key issues before the stakeholders or the authorities. Such an act of the auditor is in clear violation of the duties and the responsibility casted on them due to which they are held liable under the applicable provisions of the Act. The manner in which the auditors resign from companies before completion of their prescribed tenure have a significant impact on the companies in a negative way and also on the market value and reputation of companies in the market.
There may be cases that the auditors of the Company may resign on various grounds such as discovery of illegal acts or fraudulent activities carried out by the Company, compromising on their ethical standards laid down or due to any other problems between the auditor and the Company. In such cases, auditor should first attempt to highlight the same before the stakeholders, management and the audit committee of the Company for implementing appropriate measures within a definitive timeline by making appropriate qualifications/disclosures in their audit report. In case the same is not adhered by the stakeholders, management and the audit committee of the Company in spite of such reporting or disclosure, then the same shall be reported to the authorities /regulators.
To overcome the untimely and unpleasant exits of the auditors and to ensure that the market value and goodwill of the Companies do not erode, the companies will also have the responsibility to fully co-operate with the auditors and provide the necessary information for the audit. One needs to bear in mind that if one auditor resigns without signing a financial statement of the Company, such financial statement will be ultimately signed by another auditor, only after taking necessary measures and steps to complete the audit engagement in accordance with the prescribed standards and ethical framework. Therefore, prior to exercising the right to resign, an auditor should explore the possibility of:
Engaging in discussion with the management, stakeholders and members of the audit committee and those charged with governance so as to secure their support and cooperation for the smooth conduct of the audit without compromising on independence and ethics; and
Giving a modified report with a qualified opinion or adverse opinion or disclaimer of opinion.
Soumyajit Mitra is Partner and Kawaljeet Kaur is Senior Associate at SNG & Partners