While dismissing an order of Securities and Exchange Commission of Pakistan (SECP) against statutory auditors of an international Islamic insurance company, the Appellant Bench SECP observed that it is correct that the auditor should maintain his professional skepticism during audit, but it is very difficult for an auditor to detect fraud when the management of the company itself is involved.
In this regard, the SECP Appellant Bench has set aside the order of the SECP insurance Division which was issued against statutory auditors of an international Islamic insurance company.
Among six top lawyers of chartered accountant firm (statutory auditors), Rahat Kaunain Hassan, former Chairperson Competition Commission of Pakistan (CCP), effectively pleaded the case (appeal No 90 of 2016) before the SECP Appellant Bench.
"The management of the company has defrauded not only the Board of Directors of the Company but also the Appellants (CA firm/statuary auditors) through organized scheme of forgery, intentional misrepresentations and failure to record transactions. The management fraud was committed in such a sophisticated manner that it had remained undetected even in the SECP's onsite/offsite monitoring", SECP Appellant Bench added.
According to the order of the SECP Appellant Bench, Insurance Division of the Commission during the review of the audited accounts of Islamic insurance company observed restatement of comparatives. It was disclosed in the audited accounts for year ended on 31/12/14 that management identified various instances in the current year and previous years where liability for the claims was deliberately understated and endorsements were issued without documents to delay the provisioning requirements against outstanding contributions, policies being issued without adequate documentation. Resultantly, contributions, receivables, and related heads were overstated and claim liabilities and related accounts were understated. It transpired that the audited financial statements and the regulatory returns of the company along with statements of assets and liabilities of the company for the years ended on 31/12/12 and 31/12/13 filed with the Commission under section 51 of the Insurance Ordinance, 2000 (Insurance Ordinance) were materially misstated. A top CA firm (Appellant No 1) acted as statutory auditors of the company for the years 2012, 2013 and 2014.
The SECP Appellant Bench is of the view that while it is correct that the auditor should maintain his professional skepticism throughout the audit, the primary responsibility for the prevention of fraud rests with those charged with governance and it is very difficult for an auditor to detect fraud when the management of the company itself is involved. The management's responsibilities include the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies, and the safeguarding of the assets of the entity. The audit of the financial statements does not relieve the management of its responsibilities.
The SECP Appellant Bench observed that the auditor does not conduct the audit with the objective of discovering all frauds, because in the first place it would take a considerable amount of time and it would not be possible to complete the audit within the time-limit prescribed by law for the presentation of accounts to the shareholders. Further, such an audit would have to involve a detailed and minute examination of all the books, records and other documents of the company, and the cost of doing so would be prohibitive and disproportionate to the benefits which may be derived by the shareholders. Finally, even if such examinations were to be conducted, there will be no assurance that all types of frauds, omissions and forgery, etc, would be discovered...The auditor is required to employ reasonable skill and care, but he is not required to begin with suspicion and to proceed in the manner of trying to detect a fraud or a lie, unless some information has reached which excites suspicion or ought to excite suspicion in a professional man of reasonable competence. An auditor's duty is to see what the state of the company's affairs actually is, and whether it is reflected truly in the accounts of the company, upon which the balance sheet and the profit and loss accounts are based, but he is not required to perform the functions of a detective, the SECP said.
In the instant case, the bench has no reason to believe that the audit conducted by the appellants was not properly planned or performed in accordance with the requirements of the International Standards on Auditing (ISA)-merely on the ground that they failed to detect management's material misstatements due to fraud. Moreover, it is established and recognized by ISA that the risk of not detecting material misstatement by the auditor in case of management fraud is more likely. In the instant case, the management has defrauded not only the board of directors of the company but also the appellants through organized scheme of forgery, intentional misrepresentations and failure to record transactions. It is also important to note that this management fraud was committed in such a sophisticated manner that it had remained undetected even in the SECP's onsite/offsite monitoring.
Bench has heard the parties ie appellants (statuary auditors) and the respondent (SECP). The appellants have stated that they carried out the audit in accordance with the requirements of ISA. Furthermore, the appellants (CA firm/statutory auditors) argued that the SECP has failed to recognize the inherent limitations of audit and, therefore, collision and carefully organized schemes may cause the auditor to believe that the audit evidence is persuasive; however, the primary responsibility to detect any fraud rests with those governing the entity. The SECP has rebutted the arguments of the appellants (CA firm/statutory auditors) by stating that the misreporting by the management was primarily carried out in the areas of underwriting and claims and the risks highlighted in the management letters were significant, therefore, in view of the high risks already identified, the appellants should have remained professional and skeptical throughout the audit, recognizing the possibility that a material misstatement may occur.