Analysing the NFRA Rules – Compliance, Penalties & Procedures

Introduction

The Ministry of Corporate Affairs vide its notification¹ dated 13.11.2018 notified the National Financial Reporting Authority Rules, 2018 (“NFRA Rules“) with an objective of strengthening the audit of companies by constituting an independent regulator namely the National Financial Reporting Authority (“Authority”). The Authority has the power to monitor and enforce compliance with accounting standards and auditing standards, oversee the quality of service or undertake investigation of auditors of certain class of companies and bodies corporate.

Applicability

In pursuant of Rule 3 (1) of the NFRA Rules, the class of companies or bodies corporate that will be governed by the NFRA Rules are:

1) listed companies i.e., all the companies whose securities are listed on any stock exchange in India or outside India;

2) unlisted public companies having paid-up capital of not less than INR 500 Crore or having Annual Turnover of not less than INR 1,000 Crore or having, in aggregate, outstanding loans, debentures and deposits of not less than INR 500 Crores as on the 31st March of immediately preceding financial year;

3) insurance companies, banking companies, companies engaged in the generation or supply of electricity, companies governed by any special Act etc;

4) any body corporate or company or person, or any class of bodies corporate or companies or persons, on a reference made to the Authority by the Central Government in public interest; and

5) Body Corporate incorporated or registered outside India, which is a subsidiary company or associate company of the company or body corporate registered in India as referred in point (1) to (4) above; if the income or net worth of such subsidiary or associate company exceeds twenty per cent. of the consolidated income or consolidated net worth of such company or the body corporate, as the case may be, referred to in clauses (a) to (d)Income or net worth of such body corporate exceeds 20% of the consolidated income or consolidated net worth of such company or the body corporate.

Accordingly, the companies which are exempted from the applicability of the NFRA Rules are:

1) Private Companies (unless referred by Central Government to the Authority in public interest); and

2) Unlisted public companies with paid-up capital or turnover or aggregate of loans, debentures and deposits below the limit stated under Rule 3(1).

Compliance requirements

On perusal of the provisions of the Rule 3(2) and 3(3) of the NFRA Rules, the compliances under the NFRA Rules are as under:

1) Every existing Body Corporate other than a company governed by the NFRA Rules, shall, within 30 days from the date of commencement of the Rules, inform the Authority in Form NFRA-1 about the particulars of the auditors as on the date of commencement of the NFRA Rules.;

2) Every Body Corporate other than Indian Companies shall within 15 days of appointment of an auditor, inform the Authority in Form NFRA-1, about the particulars of the auditors appointed by the body corporate under Section 139(1) of the Companies Act, 2013.

Further, in accordance with Rule 5 of the NFRA Rules, every auditor referred in Rule 3(2) and 3(3) of the NFRA Rules as above, has to file a return with the Authority on or before 30th April of every year in such form as may be specified by the Central Government.

Functions , duties and powers of the Authority

The major function of the Authority is to protect the public interest and the interests of investors, creditors, etc. by establishing high quality standards of accounting and auditing and exercising effective oversight of accounting functions performed by the companies and bodies corporate and auditing functions performed by auditors. However, the other functions and duties of the Authority may be summarized as below:

• Rule 6 elaborates on the function of recommending accounting and auditing standards. It states that the Authority shall receive recommendations from the ICAI for new standards and amendments to existing standards. It may seek additional information from the ICAI on such recommendations. It then considers such recommendations before making them to the Central Government.
• Rule 7 and Rule 8 elaborate on the function of monitoring and enforcing compliance with accounting standards and auditing standards respectively, which is done by the Authority by reviewing the financial statements of a company or body corporate and directing such entity or its auditor by written notice to provide further information. It may also require personal presence of the officers of such entity for seeking additional information. It then publishes such findings relating to non-compliances on its website and in any other manner as it considers fit. It may decide on the further course of investigation if it finds that any accounting standard has or may have been violated by such entity.
• Rule 9 elaborates on the function of overseeing the quality of service and suggesting measures for improvement. On the basis of review in abovementioned rule, the Authority has the power to direct an auditor to take measures for improvement of audit quality and such direction bears as a duty upon the auditor and send a report to the Authority about the compliance. With regards to this function, the Authority may refer cases to Quality Review Board constituted under Chartered Accountants Act, 1949 or call for any report or information in respect of such auditors or entity.
• Rule 10 elaborates on the power of the Authority to investigate into any matter of professional or other misconduct under Section 132(4) of the Companies Act, 2013: 1. Upon reference by Central Government; 2. In furtherance of its compliance or oversight activities; or 3. Suo moto after recording reasons in writing. It then forwards such matter to its Division dealing with enforcement for carrying out investigation. If the Authority finds a matter which involves or may involve fraud amounting to rupees one crore or more, it shall report its findings to the Central Government. Upon the commencement of the Rules, only the Authority (and no other institute or body) shall be entitled to initiate proceedings/action against abovementioned misconduct by such auditors.
• It is embodied with the duties inter alia, to maintain details of auditors appointed by companies and bodies corporate; recommend accounting and auditing standards for approval by the Central Government; monitor and enforce compliance; oversee the quality of service; promote awareness in relation to compliance, etc.
• Rule 17 states that the Authority and all persons and organizations associated with it shall maintain complete confidentiality and it may enter into contractual arrangements to achieve the same.
• Rule 18 imposes on the Authority a duty to not enter into any contract, agreement or relationship, etc. which may or is likely to be perceived to interfere with its ability to perform its functions and duties in an effective, fair and reasonable manner.

Specific Powers to initiate disciplinary proceedings and penalize defaulters

In addition to the general powers as stipulated under Rule 10, the NFRA Rules provides certain specific powers to the Authority under Rule 11 which may be summarized as under:

• The Authority has been empowered under the Rules to initiate disciplinary proceedings if it believes that sufficient cause exists to take actions permissible under sub-section (4) of Section 132 of the Companies Act, 2013.
• The concerned division begins the proceedings by issuing show cause notice to the auditor. The show-cause notice shall be in writing and detailed; shall enclose copies of documents relied upon; shall be served upon the auditor to his/its address provided to ICAI by registered post or electronic mail.
• The concerned Division shall dispose of the show-cause notice within a period of 90 days of the assignment through a summary procedure, while adhering to the principles of natural justice.
• The order passed by the Division shall not become effective until 30 days have elapsed from the date of issue of the order.
• The afore-mentioned order is to be forwarded in all cases to – the Central Government, ICAI, Comptroller and Auditor General of India (in cases of sub-section (5) of Section 139 companies), SEBI, RBI, IRDA and to the concerned regulator in case the auditor is resident outside India.
• The auditor who has been penalized with a monetary penalty shall deposit such amount with the Authority within 30 days of the order, provided if auditor prefers appeal, 10 percent of such amount shall be deposited.
• If the auditor does neither of the aforementioned, the Authority shall inform about such non-compliance to each and every entity the auditor is functioning as auditor.
• Wherein a company or its officer or an auditor or any other person contravenes the provisions of these rules, such shall be punishable as per Section 450 of the Companies Act, 2013.

Miscellaneous

• The Rules provide for role of Chairperson and full-time members acting through one of the Divisions; advisory committees, study groups and task forces.
• The Authority shall conduct training, workshops, conferences as a mean of suitable measures for the promotion of awareness and significance inter alia of accounting standards, auditing standards, auditors’ responsibilities, etc.
• In addition to this, the Authority may choose to become a member of and provide/receive assistance to/from regional or international associations of independent audit regulators and standard-setters as it deems fit.

Footnote

1 http://www.mca.gov.in/Ministry/pdf/NFRARules2018_13112018.pdf