Deloitte Haskins and Sells Llp, the auditor of struggling IL&FS Financial Services Ltd (IFIN), may have to disgorge the audit fees it had received from the lender with penalty if a probe finds that the auditing firm had overlooked irregularities or colluded with the non-bank’s management, a person familiar with the investigation said.

Deloitte may also face class action suits from bondholders and shareholders of IFIN, the person said on condition of anonymity.

The Serious Fraud Investigation Office (SFIO), which comes under the corporate affairs ministry, has also extended its probe to BSR and Associates Llp, which came in as the joint auditor of IFIN for the year ended 31 March 2018.

If the ongoing probe finds any shortcoming in the audit of the company, which reported a spike in its bad loans to 90% in the December quarter from 5% in the March 2018 quarter, the government may take action against the individual audit teams assigned to IFIN or Deloitte itself.

The government last year sacked the board members of IFIN’s parent, Infrastructure Leasing and Financial Services Ltd (IL&FS), and some of them are now being probed for negligence, diversion of funds and the company’s inability to manage risks. IL&FS’s payment defaults triggered a liquidity crisis in the non-bank financial sector, which has affected the real estate industry as well as small and medium enterprises.

SFIO is examining if the auditors took the explanations given by the company management at face value or whether they adequately corroborated the genuineness of transactions.

An industry executive familiar with the IFIN audit process said on condition of anonymity that the scope of a statutory audit is narrower than that of a forensic audit, which can track transactions in much greater detail.

“That is not a tenable argument… If the auditors are to accept every claim of the management, what is the need for an auditor?" said the first person cited earlier. “There should be punishment commensurate with the audit lapses to ensure accountability and to prevent such future occurrence. It will have a demonstrative effect."

The regulatory action will depend on the conclusions at the end of the probe. SFIO is examining the firm’s transactions and how the auditors treated them. It is also examining whether individual auditors or the audit firm itself are liable for any lapse.

The second person cited earlier said liability would rest with the audit firm only if it failed to put in place systems that ensured standard audit practices by its professionals.

A spokesperson for Deloitte said the company was fully cooperating with the ongoing investigations relating to IFIN. “We reaffirm that we have conducted our audits in accordance with the standards on auditing and the applicable laws and regulations," added the spokesperson.

The second person said Deloitte had made important observations about IFIN’s dealings in its notes, although it has not qualified the auditor’s report. “During the period Deloitte audited the company, there was no financial trouble. It is hard to predict the future value of a security. Besides, the Piramal Group had expressed interest to buy a stake in IL&FS in 2015-16 at a price above its market capitalization, which reflected the company’s financial health," said the person. Deloitte was IL&FS’s auditor then.

BSR and Co. said in a statement to Mint that it remains committed to the highest standards of ethics and audit quality and that it came into the audit of IFIN as joint auditors only in FY18. “We are not the auditors for IL&FS or any other material subsidiary of IL&FS. We stand by our audit, which was performed in line with the applicable auditing standards and regulations, and are fully committed to cooperating with the regulatory authorities on their inquiries," BSR said.

The exchanges between BSR and SFIO and the National Financial Reporting Authority were at an early stage and no substantial issue had been discussed yet, a third person privy to the development said on condition of anonymity.

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