National Seminar on Secretarial Audit 27 th March 2015 Presentation on Main Principles of Audit in relation to Secretarial Audit By: S. C. Vasudeva, Partner S. C. Vasudeva & Co. Chartered Accountants 1
Session Plan : Requirement in relation to Secretarial Audit FAQs issued by Institute of Company Secretaries Main Principals Governing an Audit Reporting by an Auditor of offences involving fraud. 2
Requirement of Secretarial Audit : Section 204 read with rules provides that : every listed company and any other public company having a paid up capital of Rs. 50 crores or more or turn over of Rs. 250 crores or more shall annex with the Board s report, a secretarial audit report given by the Company Secretary in practice, in such form as may be prescribed. The relevant rule prescribes the form of the report in MR-3. 3
Principles of Audit in relation to Secretarial Audit : Section 204 further provides that : All assistance and facilities to be extended to the Company Secretary in practice for auditing the secretarial and related records of the company. Board is required to explain in full, any qualification or observation or other remarks made by the Company Secretary in practice given in his report. Sub-section (4) of the aforesaid section provides penalty for not complying with the above provisions. 4
Audit Report in relation to Secretarial Audit : A perusal of the secretarial audit report as prescribed by the relevant rule indicates that the secretarial auditor is required to state that : Audit was conducted in a manner that provided reasonable basis for evaluating the corporate conducts / statutory compliances and expressing his opinion thereon. Based on verifications of books, papers, minute books, forms and returns filed and other records maintained by the company and also the information provided by the company and its officers, agents and authorized representative during the conduct of secretarial audit, the company during the period covered under audit has complied with the statutory provisions listed in the report and that the company has proper Board processes and compliance-mechanism in place to the extent, in the manner and subject to reporting made hereinafter. 5
Audit Report in relation to Secretarial Audit : The secretarial auditor is required to state that he has examined the books, papers, minutes books, forms and returns filed and other records maintained by the company for the relevant financial year according to the provisions of the Act and other specified Act such as Companies Act 2013 Depository Act 1996, Securities Contracts (Regulation) Act, 1956, Foreign Exchange Management Act 1999, (FDI, Overseas Direct Investment and External Commercial Borrowings) rules, regulations, bye laws under these Act 6
Audit Report in relation to Secretarial Audit : specified regulations and guidelines prescribed under the Securities and Exchange Board of India Act 1992. These include: a) SEBI (Substantial Acquisition of Shares & Takeovers) Regulations 2011 b) SEBI (Prohibition of Insider Trading) Regulation 1992 c) SEBI (Capital and Disclosure Requirements) Regulations 2009 d) SEBI (Employee Stock Option Scheme and Employee Purchase Scheme) Guidelines, 1999. e) SEBI (Issue and Listing of Debt Securities) Regulations 2008 f) SEBI (Registrar to an Issue and Share Transfer Agents) Regulations 1993 7
Audit Report in relation to Secretarial Audit : g) SEBI (Delisting of Equity Shares) Regulations 2009 and h) SEBI (Buy bank of Securities) Regulations 1998 i) Other Laws applicable to the Company 8
Audit Report in relation to Secretarial Audit : The secretarial auditor is also required to state that he has examined the compliance with the applicable clauses of the Secretarial Standards issued by the Institute of Company Secretaries of India and the listing agreement entered into by the company with the stock exchanges, if applicable. 9
Audit Report in relation to Secretarial Audit : The secretarial auditor is also required to state that Constitution of the Board of Directors of the company has a proper balance of executive directors, non-executive directors and independent directors and that changes in the composition of the Board of Directors that took place during the period under review were carried out in compliance with the provisions of the Act. Adequate notice is given to the directors to schedule the Board Meetings, agenda and detailed notes on agenda were sent seven days in advance and a system exists for seeking and obtaining further information and classification on the agenda items before the meeting and for meaningful participation at the meeting. 10
Audit Report in relation to Secretarial Audit : The secretarial auditor is also required to state that there exist adequate systems and processes in the company commensurate with the size and operations of the company to monitor and ensure compliance with applicable laws, rules, regulations and guidelines. The Institute of Company Secretaries has issued FAQs on various provisions of the Act and one of the FAQ dealing with this aspect explains the requirement as to other laws to be looked into by the Secretarial Auditor. The Council of the ICSI at its 226th meeting held on November 21, 2014 decided on the Scope of Secretarial Audit as regards point (vi).( other laws as may be applicable specifically to the company), is discussed in subsequent slides: 11
Q 9. What is the coverage of Point (vi)... (other laws as may be applicable specifically to the company) in Form MR-3? Reporting on compliance of Other laws as may be applicable specifically to the company which shall include all the laws which are applicable to specific industry for example for Banks- all laws applicable to Banking Industry; for insurance company-all laws applicable to insurance industry; 12
For a company in petroleum sector- all laws applicable to petroleum industry; Similarly, for companies in pharmaceutical sector, cement industry etc specific law would need to be checked. 13
Q 10. Whether financial laws need to be examined while conducting secretarial audit? A 10. In case of financial laws like tax laws and Customs Act etc., Secretarial Auditor may rely on the Reports given by Statutory Auditors or other designated professionals. 14
MAIN PRINCIPALS GOVERNING AN AUDIT 15
Main principals governing an audit : Engagement Letter Before starting any audit, the auditor should have an engagement letter depicting full details regarding Scope of work responsibility of management Timing Fee arrangements Limitations of audit Advisable to send two copies of such engagement letter to the client and obtain a confirmed copy of such letter from the client before taking up the assignment. 16
Main principals governing an audit : Integrity, objectivity and independence An auditor is expected to be honest and sincere in his approach to the professional work. He must be fair and not allow prejudice or bias to override his objectivity. He should have an impartial attitude and both be and appear to be free of an interest which might be regarded as being in conflict with the integrity and objectivity. This is an ethical requirement which is a must for any audit assignment. 17
Main principals governing an audit : Confidentiality An auditor should respect the confidentiality of information acquired in the course of his work and should not disclose any such information to a third party without specific authority unless there a legal or professional duty to disclose. 18
Main principals governing an audit : Work performed by others An auditor should carefully supervise and review the work performed by the engagement team. He should obtain reasonable assurance that the work performed by such engagement team is adequate for the purpose giving his report required to be given under the provisions of the Companies Act, 2013. 19
Main principals governing an audit : Planning An auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. Plans should be based on the knowledge of the clients business and activity. Plans should be made to cover among other things the following:- Degree of reliance be placed on internal control with regard to conduct of various processes and maintenance of statutory records. Programming the nature, timing and extent of audit procedures to be adopted. Preparation of an Audit Programme so as to have a checklist of various aspects relating to records to be verified and the manner in which such verification is required to be conducted. Such programme can also include a checklist with regard to the compliance of specified Secretarial Standards. Coordinating the work to be performed. The plans should be developed and revised, if necessary, during the course of the audit. 20
Main principals governing an audit : Audit Evidence The auditor should obtain sufficient appropriate audit evidence through the compliance and substantive procedures to enable him to draw reasonable conclusion therefrom on which to base his opinion on the information to be given in the report. The management is responsible for maintaining the statutory records and other connected books and papers on which the auditor is required to give his report. An auditor has therefore, to reasonably ensure that the systems in operations are adequate and the information which is required to be recorded has in fact being recorded. Internal control, if any in this regard would help an auditor normally to contribute to such an assurance. 21
Main principals governing an audit : Audit Evidence (Cont ) In case the internal controls are sufficiently in place, he may reduce his substantive procedures. Should obtain sufficient appropriate audit evidence regarding compliance with those laws and regulations generally recognized to have a direct effect on working of the company. Should perform audit procedures in such a way as to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw conclusions on which to base the auditor s opinion. 22
Main principals governing an audit : Documentation An auditor should prepare audit documentation that is sufficient to enable an auditor, with no previous connection with the audit, to understand the nature, timing and extent of the audit procedures required to be performed to comply with the applicable legal and regulatory requirements, the results of the audit procedures performed, and the audit evidence obtained. The audit documentation should be prepared on a timely basis. The auditor should include significant matters arising during the audit, conclusions reached, and significant judgments made in reaching the conclusions in the documentation. 23
Main principals governing an audit : 24 Risk Assessment Auditor should assess the risks of material misstatement at the level of various documents made available for audit and if necessary to apply further audit procedures. Auditor should identify and assess the risks of material misstatement of various documents due to fraud and obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement (i) due to fraud, and respond appropriately to fraud or suspected fraud identified during the audit. (ii) due to non-compliance with laws and regulations. Should appropriately respond and address the assessed risk of material misstatement. Identification of such risks should be based on a general understanding of the legal and regulatory framework.
Main principals governing an audit : Skills and Competence An auditor should be performed and the report prepared with due professional care by persons who have adequate training, experience and competence. Such specialized skills and competence would be acquired through a combination of general education, technical knowledge obtained through study and formal qualifying examination recognized for this purpose. 25
Main principals governing an audit : Confirmation procedure from the Company s legal Counsel An auditor should confirm with the legal counsels of the company about the outstanding litigations in the specialized area or the legal cases they are representing. Such independent information will ensure that all the legal cases have been reviewed by the auditor for the purpose of reporting compliance in his report. 26
Main principals governing an audit : Representation letter An auditor should also obtain detailed representation letter in respect of the compliance procedures and deviations, if any, noted by the management. Also, auditor should obtain representation in writing for any instance of fraud against the company, noticed by the management of the Company. 27
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Section 143 of the Companies Act 2013 (the Act ) deals with the powers and duties of the auditors and auditing standards. Sub sections (12) and (13) of section 143 of the Act, dealing with reporting on frauds, state as under: (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 involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government within such time and in such manner as may be prescribed. (13) 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. 28
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Proposed amended sub-section: (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 29
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Provided, that in case of a fraud involving lesser than specified amount, auditor shall report that matter to the Audit Committee constituted under Section 177 or to the Board of Directors 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, need not report to the Central Government and Board shall disclose in detail about such frauds in the Board Report in such manner as may be prescribed. 30
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Section 143(12) deals with offences involving fraud whether committed or being committed against the company by officers or employees of the company, that are to be reported to the Govt. within the time prescribed, attention is also drawn to section 447 of the Act, which (while dealing with punishment for fraud for the purpose of that Section), defines fraud {in Explanation (i)}, having certain ingredients: 31
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Explanation. For the purposes of this section i. fraud in relation to affairs of a company or any body 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; ii. wrongful gain means the gain by unlawful means of property towhich the person gaining is not legally entitled; iii. wrongful loss means the loss by unlawful means of property to which the person losing is legally entitled. 32
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Analysis of the above. will make it clear that: a. It must be, in relation to the affairs of the Company or any body corporate, b. It includes any act, omission, concealment of any fact or abuse ofposition c. It must be committed by any person or any other person with the connivance in any manner, 33
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 d. It must be with intent to deceive, to gain undue advantage from, orto injure the interests of, the company or its shareholders or its creditors or any other person, e. There may or not be any wrongful gain {defined in clause (ii)} or wrongful loss{defined in clause (iii)}. 34
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Since offence of fraud under the Companies Act, 2013 is in relation to affairs of a company, fraudulent acts committed by any other person amount to fraud under the Act if such acts are in relation to the affairs of the company. 35
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Section 143(12) deals with the duty of the auditor to report to the Central Govt., only offences involving fraud only against the Company and those relating to officers and employees. Other offences need not be reported within the strict interpretation of that section, though such offences, if proven as frauds, within the meaning of section 447 {say by abetment/connivance as per the definition of fraud - see ( c) above}), would be subject to punishment under section 447 of the Act. It needs to be reiterated that there is punitive action on the auditor concerned for non reporting to the Central Govt., of the offence involving fraud as per section 143(15) of the Act, and punishment on the professional for non compliance can involve a fine which shall not be less than one lakh rupees but which may extend to twenty-five lakh rupees. 36
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Sections 448 and 449 respectively deal with punishment for false statement and for false evidence. If in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of the Act or the rules made thereunder, any person makes a statement, a. which is false in any material particulars, knowing it to be false; or b. which omits any material fact, knowing it to be material, he shall be liable under section 447. 37
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 If any person intentionally gives false evidence: a. upon any examination on oath or solemn affirmation, authorised under the Act; or b. in any affidavit, deposition or solemn affirmation, in or about the winding up of any company under the Act, or otherwise in or about any matter arising under the Act, he shall be punishable with imprisonment for a term which shall not be less than three years but which may extend to seven years and with fine which may extend to ten lakh rupees. 38
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 It will be observed from the definition of fraud contained in the Explanation to section 447 of the Act, that a person shall be treated as guilty of an offence involving fraud under the Act, if the following is involved: a. Furnishing false information or suppressing material fact in documents or declaration filed for incorporation of a company - section 7(5); b. Misstatements in prospectus section 34; c. Fraudulent inducements to invest, making false promises, forecasts or statements section 36(1); d. Presentation for acquisition of securities, or making multiple applications for acquiring securities section 38; 39
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 e. Issue of duplicate shares with intent to defraud section 46(5); f. Transfer of shares with intent to defraud section 56(7); g. Reduction of capital- concealing name of creditor or misrepresenting amount or nature of debt - section 66(10); h. Auditor acting in fraudulent manner or in fraud by or in relation to a company section 140(5); i. Carrying on of business of Company for a fraudulent or unlawful purpose section 206(4); j. Business of the company carried on with intent to defraud creditors, members or any other person or otherwise for fraudulent or unlawful purpose - Section 213; 40
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 k. Furnishing false statement, mutilation, destruction of documents, falsification of documents during the course of inspection/inquiry/ investigation- Section 229; l. Fraudulent application for removal of name - section 251(1); m. In the course of winding-up it appears that business of the company has been carried with intent to defraud creditors or any other persons or for any fraudulent purpose section 339(1); and n. False statement in any return, statement, prospectus or other document for purposes of any provision of the Act section 448. 41
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 As per the provisions of section 212(6) of the Act, the above offences are cognizable offences and no person accused of any offence under above sections can be released on bail without giving opportunity to be heard to the Public Prosecutor. There is provision of establishment of Special Courts to try the offences under the Act and pending such establishment, the offences are to be tried by a Court of Session exercising jurisdiction over the area (refer Section 440 of the Act ). 42
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Serious Fraud Investigation Office (SFIO): The Act also provides for establishment of Serious Fraud Investigation Office (SFIO) and till it is established under Section 211(1), the present SFIO established under administrative orders, referred to in the Proviso to section 211(1) shall be deemed to besfio for the purpose of Section 211. TheCentral Government can assign investigation into affairs ofany company to SFIO and if there is any offence under investigation by SFIO no other investigation authority including the State Police, can continue or commence investigation. Under the Companies Act, 2013, the SFIO has been given a statutory status and powers of investigation under the Code of Criminal Procedure, 1973 have been vested in SFIO sub section (17) of Section 212 makes a specific provision for sharing of any information or documents available with any other investigating authority or income-tax authorities with SFIO and likewise SFIO can share information or documents available with it, with any other investigating authority or income-tax authorities. 43
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Rules relevant to reporting by the auditor, in terms of Section 143(12) of the Act Rule 13 of the Companies (Audit and Auditors) Rules, 2014 that requires Reporting of frauds by auditor, states as under: (1) For the purpose of sub- section (12) of section 143, in case the auditor has sufficient reason to believe that an offence involving fraud, is being or has been committed against the company by officers or employees of the company, he shall report the matter to the Central Government immediately but not later than sixty days of his knowledge and after following the procedure indicated herein below: 44
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 i. auditor shall forward his report to the Board or the Audit Committee, as the case may be, immediately after he comes to knowledge of the fraud, seeking their reply or observations within forty-five days; ii. 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 alongwith his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within fifteen days of receipt of such reply or observations; 45
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 iii. 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 alongwith a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he failed to receive any reply or observations within the stipulated time. 2. 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. 46
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 3. The report shall be on the letter-head of the auditor containing postal address, e-mail address and contact number and be signed by the auditor with his seal and shall indicate his Membership Number. 4. The report shall be in the form of a statement as specified in Form ADT-4 5. The provision of this rule shall also apply, mutatis mutandis, to a cost auditor and a secretarial auditor during the performance of his duties under section 148and section 204respectively. 47
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Form prescribed (ADT-4 ), for reporting fraud or suspected fraud has, amongst other, the following requirements, that are relevant: 5) Address of the office or location where the suspected offence is believed to have been or is being committed 6) Full details of the suspected offence involving fraud (attach documents in support) 7) Particulars of the officers or employees who are suspected to be involved in the commission of the offence, if any: a) Name(s) : b) Designation c) If Director, his DIN d) PAN 8) Basis on which fraud is suspected 9) Period during which the suspected fraud has occurred 13) Estimated amount involved in the suspected fraud 48
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Rules and form ADT-4 are not in harmony with Section 143(12). Section requires an auditor to report on fraud when he has Reason to Believe. Rules requires reporting of fraud when auditor has Sufficient reason to believe. The addition of the word Sufficient in the rule, mandates an auditor to have concrete evidence in possession before reporting on fraud. Contrary to this, act requires an auditor to exercise his judgment, for such reporting. 49
REPORTING BY AUDITOR OF OFFENCES INVOLVING FRAUDS UUNDER THE COMPANIES ACT, 2013 Form ADT-4 also requires; (8) Basis onwhich fraud is suspected (13) Estimated amount involved in suspected fraud Without sufficient reason, it will not be possible to give Basis of fraud as well as Estimated Amount of fraud. Because of this contradiction the Rules require change to be consistent with forms and rules. 50
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