In this blog post, Harpreet Kaur, a blogger at laswschoolnotes, an Advocate at the Punjab and Haryana High Court, describes the responsibility of Auditors of a Company in reporting fraud.
“Doing right things and doing them in the right way is the essence of Corporate Governance”.
-Anonymous[1]
Introduction
“The statutory requirement as regards accounts is that books of accounts must reflect true and fair view of state of affairs of a company and its branches, if any, so that its financial position can be correctly assessed by directors, members, officers, investors and all those who transact business with the company”[2]. Because of this reason it is necessary that the accounts so prepared by company through its directors must be checked and scrutinised by some independent authority so that they can be relied upon by those who are interested in company’s affairs and business[3].
Hence, the role of Auditor/Audit Committee is very significant and their responsibility in corporate governance is to provide assurance that the corporation is in rational compliance with relevant laws and regulations, is conducting its affairs fairly, and is maintaining effective controls against employee conflict of interest and fraud[4]. An audit committee consisting independent directors can have control over management and can act as a sort of assurance to the shareholders that they will have full disclosure of correct information. To have good corporate governance, audit committee needs resource persons to act as independent directors on whose shoulders lay the responsibility to take the company in the right path[5].
Pointing on the importance and auditors, Chakarvati, then C.J. of Calcutta High Court in Deputy Secretary, Government of India, Ministry of Finance v. S.N. Das Gupta[6] observed[7]: “A joint stock company carries on business with capital furnished by persons who buy its shares. The owners of the capital are, however, not in direct control of its application which is left to the executive of the company, composed of the directors or superior officers. The Companies Act, therefore, provides for the employment of an auditor who is servant of the shareholders and whose duty is to examine the affairs of the company on their behalf at the end of a year and report to them what he has found. The examination of an independent agency such as the auditor is practically the only safeguard which the shareholders have against the enterprise being carried on in an unprofessional way or their money being misapplied or misappropriated without their knowing anything about it”.
Appointment of an Auditor
Section 139 of the Companies Act, 2013 deals with the appointment of Auditors. This section corresponds to the section 224 of the Companies Act, 1956[8]. It provides that a company shall appoint an individual or a firm as an auditor at Annual General Meeting (AGM) subject to his written who shall hold office till conclusion of sixth AGM. The manner and procedure of selection committee shall be prescribed by the Central Government. A notice of appointment should be filed with the Registrar. The section provides for rotation of auditors. The Central Government may prescribe the manner in which companies shall rotate their auditors[9].
In case of a Government Company, the auditor will be appointed by the Comptroller and Auditor General of India within 180 days from the commencement of the Financial Year, who shall hold office till the conclusion of the AGM. Even if the auditor is appointed for 5 years, then the members of the Company should ratify such appointment at every AGM[10].
Section 141 of Companies Act, 2013 deals with the eligibility, qualifications and disqualifications of an Auditor. It corresponds to sections 224(1B) and 226 of the Companies Act, 1956[11] and provides that a person shall be eligible for appointment as an auditor of a company only if he is a Chartered Accountant. It also provides for the persons who are not eligible for appointment as an auditor of a company and says that an auditor, who gets disqualified after his appointment as auditor, shall have to vacate office.
Responsibilities of an Auditor
Section 143 of the Companies Act, 2013 contains provisions relating to the powers and duties of auditors. It corresponds to section 227 of the Companies Act, 1957[12]. Main duties of an Auditor are:
- Duty to make certain inquiries
- Duty to make a report to the company on the accounts examined
- Duty to make a proclamation in terms of the provisions set.
- Detection and Prevention of Fraud
- Duty to report fraud
- Duty as to substantial precision[13]
Meaning and Definition of the term Fraud
According to the Association of Certified Fraud Examiners (ACFE), fraud is “a deception or misrepresentation that an individual or entity makes knowing that misrepresentation could result in some unauthorized benefit to the individual or to the entity or some other party”[14].
Explanation to Section 447(1) of Companies Act, 2013 defines fraud as: “fraud in relation to affairs of a company or anybody corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss”. “wrongful gain means the gain by unlawful means of property to which the person gaining is not legally entitled”; “wrongful loss means the loss by unlawful means of property to which the person losing is legally entitled”[15].
Section 17 of Indian Contract Act, 1872 defines fraud as: “Fraud means and includes any of the following acts committed by a party to a contract, or with his connivance, or by his agents, with intent to deceive another party thereto or his agent, or to induce him to enter into the contract:
(1) the suggestion as a fact, of that which is not true, by one who does not believe it to be true;
(2) the active concealment of a fact by one having knowledge or belief of the fact;
(3) a promise made without any intention of performing it;
(4) any other act fitted to deceive;
(5) any such act or omission as the law specially declares to be fraudulent.
Explanation: Mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud, unless the circumstances of the case are such that, regard being had to them, it is the duty of the person keeping silence to speak, or unless his silence is, in itself, equivalent to speech”[16].
Fraud Reporting under the Companies Act, 2013
Section 143(12) to 143(15) of the Companies Act, 2013 contains provisions relating to reporting of fraud. Section 143(12) reads:
“(12) Notwithstanding anything contained in this section, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed:
Provided that in case of a fraud involving lesser than the specified amount, the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as may be prescribed:
Provided further that the companies, whose auditors have reported frauds under this sub-section to the audit committee or the Board but not reported to the Central Government, shall disclose the details about such frauds in the Board’s report in such manner as may be prescribed”[17].
The term “sufficient reason to believe” has been defined[18] as: “To have knowledge of facts which, although not amounting to direct knowledge, would cause a reasonable person, knowing the same facts, to reasonably conclude the same thing”.
The reporting requirement under Section 143(12) is for the statutory auditors of the company and also equally applies to the cost accountant in practice, conducting cost audit under Section 148 of the Act; and to the company secretary in practice, conducting secretarial audit under Section 204 of the Act. However, the provisions of Section 143(12) do not apply to other professionals who are rendering other services to the company[19].
Also, “it may be noted that Section 143(12) includes only fraud by officers or employees of the company and does not include fraud by third parties such as vendors and customers”[20].
However, exception has been provided for acts done in good faith in Section 143(13) which provides that: “No duty to which an auditor of a company may be subject to shall be regarded as having been contravened by reason of his reporting the matter referred to in sub-section (12) if it is done in good faith”[21].
Moreover, similar provision is applicable to Cost Auditor and Secretarial Auditor as it has been provided in Section 143(14) which reads as: “The provisions of this section shall mutatis mutandis apply to- (a) the cost accountant in practice conducting cost audit under section 148; or (b) the company secretary in practice conducting secretarial audit under section 204”[22].
Manner of Reporting
The Companies (Audit and Auditors) Amendment Rules, 2015, issued by the Ministry of Corporate Affairs, on 14th December 2015, amended Rule 13 of the Companies (Audit and Auditors) Rules, 2014[23]. As per the amended Rule 13, if an auditor of a company, in the course of performance of his duties as statutory auditor, has reason to believe[24] that an offence of fraud, which involves or is expected to involve individually an amount of rupees one crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government[25].
“The amended Rule 13 provides the following manner of reporting to the Central Government:
(a) The auditor shall report to the Board or the Audit Committee, as the case may be, immediately but not later than two days of his knowledge of the fraud, seeking their reply or observations within forty-five days;
(b) On receipt of such reply or observations the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within fifteen days from the date of receipt of such reply or observations;
(c) In case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of forty-five days, he shall forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he has not received any reply or observations;
(d) The report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed post followed by an e-mail in confirmation of the same.
(e) The report shall be on the letter-head of the auditor containing postal address, e-mail address and contact telephone number or mobile number and be signed by the auditor with his seal and shall indicate his Membership Number; and
(f) The report shall be in the form of a statement as specified in Form ADT-4”[26].
Auditor shall report the matter to Audit Committee constituted under Section 177 of the Companies Act, 2013 or to the Board immediately but not later than two days of his knowledge of the fraud and he shall report the matter specifying the following[27]:
- a) Nature of Fraud with description;
- b) Approximate amount involved; and
- c) Parties involved.
Punishment for default has been provided under Section 143(15) which provides that: “If any auditor, cost accountant or company secretary in practice does not comply with the provisions of sub-section (12), he shall be punishable with fine which shall not be less than 1 lakh rupees but which may extend to 25 lakh rupees”[28].
Punishment for Fraud
The Companies Act, 2013 has provided punishment for fraud under Section 447 of Companies Act, 2013 which provides that “Without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud:
Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years”[29].
The following table mentions some sections that attract liability u/s 447[30]:
| SECTION | FRAUD WITH RESPECT TO | WHO WILL BE PENALISED |
| 7(5) | Registration of a company | A person furnishing false information or suppressing any material information of which he or she is aware. |
| 36 | Inducing persons to invest money | The person doing so. |
| 75(1) | Acceptance of deposit with intent to defraud depositors or for any fraudulent purpose | Every officer of the company who accepted the deposit. |
| 206(4) | Conducting business of a company for a fraudulent or unlawful purpose | Every officer of the company who is in default. |
| 213 | Other cases:
Company withholding information from members with respect to its affairs, which they may reasonably expect |
Every officer of the company who is in default and the person(s) concerned in the formation of the company or management of its affairs. |
| 229 | Furnishing false statement or mutilation or destruction of documents | Person required to provide an explanation or make a statement during the course of inspection, inquiry or investigation, or the officer or other employees, as required. |
| 251(1) | Application for removal of name from register with the object of evading liabilities/intent to deceive | Persons in charge of management of the company. |
| 339(3) | Conducting business of company with intent to defraud its creditors, any other persons or for any fraudulent purpose | Every person who was knowingly a party to the business in the aforesaid manner. |
| 448 | Making a false statement in any return, report, certificate, financial statement, prospectus, statement or other document required by or for the purpose of any of the provisions of this Act or the rules made thereunder | Person making such a statement etc. |
Conclusion
The new law i.e. Amended Companies Act, 2013 read with Amended Companies (Audit and Auditors) Rules, 2014 will plug most loopholes of the old regime. It will improve corporate governance, protect the interest of minority shareholders and make it tougher for companies to hide illegal transactions or commit fraud[31]. Considering the number of corporate frauds that are surfacing in the country today, the old Act was evidently inadequate. Hence, it is anticipated that the new provisions of the Companies Act, 2013 would bridge the gulf between increasing corporate frauds and the statutory regime. “The new company law envisages the metamorphosis of the statutory auditors from being a watchdog to a whistle blower”[32].
The role of audit committee and auditors in current scenario has become very crucial. Stakeholders expect loyalty and trust from auditor and auditing committee while resolving financial facts and exposing at all fraud and fault in organization. If a company has an active and strong audit committee only then independent auditors’ working will be supported[33] and then transparency is bound to increase which would have a domino effect on corporate governance[34].
[1] Prof. Hetal Pandya/Vyas, Corporate Governance: Role of auditor and auditing committee, IPASJ International Journal of Management (IIJM), Volume 1, Issue 2, July 2013, available at http://ipasj.org/IIJM/Volume1Issue2/IIJM-2013-07-08-001.pdf
[2] Dr. N.V. Pranjape, The New Company Law, Central Law Agency, Allahabad, 6th edition, 2014, p.368
[3] Ibid, at p. 381.
[4] Supra note 1.
[5] Ibid.
[6] AIR 1956 Cal. 414
[7] Dr. N.V. Pranjape, The New Company Law, Central Law Agency, Allahabad, 6th edition, 2014, p. 382
[8] Ed: Ravi Puliani and Mahesh Puliani, Companies Act, 2013, Bharat Law House Pvt. Ltd., New Delhi, 20th edition, 2014, p. 141
[9] Analysis of Companies Act, 2013, Published by Wolters Kluwers (India) Pvt. Ltd., New Delhi, ISBN-13: 978-93-5129-066-7, p. 363
[10] Prof Hetal Pandya/Vyas, Corporate Governance: Role of auditor and auditing committee, IPASJ International Journal of Management (IIJM), Volume 1, Issue 2, July 2013, available at http://ipasj.org/IIJM/Volume1Issue2/IIJM-2013-07-08-001.pdf
[11] Ed: Ravi Puliani and Mahesh Puliani, Companies Act, 2013, Bharat Law House Pvt. Ltd., New Delhi, 20th edition, 2014, p. 145
[12] Ibid at p. 149
[13] Supra note 10.
[14] Madan Lal Bhasin, Corporate Accounting Fraud: A Case Study of Satyam Computers Limited, Open Journal of Accounting, 2013, page 26-38 available at http://file.scirp.org/pdf/OJAcct_2013042509481787.pdf
[15] http://corporatelawreporter.com/companies_act/section-447-of-companies-act-2013-punishment-for-fraud/
[16] Bare provision is available at http://www.lawtimes.org.in/section-17-fraud-defined-indian-contract-act-ica-y1872-s-17.html
[17] Bare Act is available at http://www.indiacode.nic.in/acts-in-pdf/2015/201521.pdf
[18] Source: http://www.lectlaw.com/def2/q015.htm
[19] Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013 (Revised 2016), The Institute of Chartered Accountants of India, Second Edition: February, 2016, ISBN No: 978-81-8441-741-8, available at http://www.ca-online.in/Media/Uploaded/41297aasb-gn-fraud-revised.pdf
[20] Ibid.
[21] Bare provision is available at http://www.mca.gov.in/SearchableActs/Section143.htm
[22] Ibid.
[23] Supra note 19.
[24] See note 18.
[25] Supra note 19.
[26] Supra note 19.
[27] Ibid.
[28] Ibid.
[29] Bare provision is available at http://www.mca.gov.in/SearchableActs/Section447.htm
[30] CA. Amit G. Chandani, Companies Act, 2013 : Fraud and Fraud Reporting, available at http://taxguru.in/company-law/companies-act-2013-fraud-fraud-reporting.html
[31] CA. Amit G. Chandani, Companies Act, 2013 : Fraud and Fraud Reporting, available at http://taxguru.in/company-law/companies-act-2013-fraud-fraud-reporting.html
[32] Ibid.
[33] Prof Hetal Pandya/Vyas, Corporate Governance: Role of auditor and auditing committee, IPASJ International Journal of Management (IIJM), Volume 1, Issue 2, July 2013, available at http://ipasj.org/IIJM/Volume1Issue2/IIJM-2013-07-08-001.pdf
[34] Navajyoti Samanta and Tirthankar Das, Role of auditors in Corporate Governance, 11 October, 2009 available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1487050
The main responsibility always remains with the company Directors of course.
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