NFRA Rules, 2018 – A Critical Analysis

In February 2018, it was discovered that the failure of the auditors of publically traded Fortis Healthcare Services Limited, to report their suspicions of fraud, had facilitated the siphoning of billions of rupees. Shortly thereafter, the shocking negligence of the auditors of Punjab National Bank also came to light. Audit failures led to the unchecked issuance of fraudulent letters of undertaking by the bank, inappropriately guaranteeing buyers’ credit offered by certain overseas financial institutions to various firms, in sheer violation of banking standards. This finally prompted the Indian Government to establish the NFRA by implementing the statutory provisions relating to its establishment, which were already framed by the Indian Parliament when enacting the Companies Act 2013, and a colossal fudging of accounts aimed to artificially inflate the stock price of Satyam Computer Services Limited, which shockingly escaped the scrutiny of its auditors

Thus in India, the three major audit scandals have led to the creation of the National Financial Reporting Authority (the “NFRA”). Thus NFRA is supposed to help the transition in India from self-regulation of ICAI as auditor regulator of listed companies to segregation of duties of internal and external regulation of large listed companies, following along the lines of control.

Which Companies Will Be Covered By NFRA?

The Authority shall have power to monitor and enforce compliance with accounting standards and auditing standards, oversee the quality of service or undertake investigation of the auditors of the following class of companies and bodies corporate, namely:-

1. All Listed Companies/ Listed Body Corporate;
2. Unlisted Companies with Paid up Capital of Rs. 500 Cr. or More; OR Turnover is Rs. 1000 Cr. or More; OR
3. AGGREGATE of Outstanding Loan, Debentures and Deposit is500 Cr. or More.
4. All Banks/ Insurance/ Electricity Companies;
5. Any Company or Person (Auditor), on a reference made to the Authority by the Central Government in public interest;
6. Foreign Subsidiary/Associate Company of Any Indian Company as mentioned in above 4 points if Income/Net worth of such Foreign Subsidiary/Associate company exceeds 20% of consolidated Income/Net worth of above mentioned Indian companies.

Will ICAI Still Have Its Power?

Proprietorship concerns, Firms, LLPs, Charitable Trust, AOP/BOI, Societies, etc. along with Private Companies and Unlisted Public Companies) would still be governed by ICAI and ICAI would have the sole discretionary power to provide rules and regulation for them.

Due to notification of NFRA, India is now eligible for membership of International Forum of Independent Audit Regulators (IFIAR) Institute of Chartered Accountants of India (ICAI) however, is not open to the establishment of such an authority as it fears reduction in its own powers

The NFRA will include representatives of the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI-the central bank), and the Institute of Chartered Accountants of India(ICAI). Unfortunately, situations of conflict of interest might arise since THESE agencies are responsible for prosecution for violation of various statutes and also discharge regulatory functions, whereas their representatives in the NFRA will act in quasi-judicial capacity.

The appointment of chartered accountants to the NFRA should be restrictedthus, to two members, similar to the PCAOB board. It is critical that the NFRA’s composition ensures objectivity.

The NFRA may conduct investigations suemotto by reference to the Indian Government in case of professional or other misconduct., the NFRA may impose fines or suspend errant audit firms, which powers were never available to the Institute of Chartered Accountants of India. The NFRA’s powers should be expanded so it has the power to even debar an individual’s association with registered audit firms.

Conclusion

The ICAI will continue to retain its regulatory powers in respect of private companies and unlisted public companies below the above-prescribed threshold. Also, the Quality Review Board (QRB) will also be there to continue conducting quality audits in respect of private limited companies, unlisted public companies and such other audit of companies that are delegated by the NFRA.