By Jayant M. Thakur
Chartered Accountant
BACKGROUND
Auditors have been the focus of several
regulators, each of whom seek independent and wide powers to take action
against them when they perceive that auditors have not discharged their duties
properly. SEBI has taken action against several auditors of listed companies
where SEBI felt that auditors were negligent, did not discharge duties mandated
by law and / or where there is connivance with the management in fraud, etc.
However,
whether and to what extent SEBI has powers to act directly against the
auditors has been controversial. There are several SEBI orders, a report of
consultation committee of SEBI, a detailed decision of the Bombay High Court,
etc., that have differing views. Some of the decisions of SEBI/SAT are under
appeal. SEBI has recently proposed amendments to regulations to prescribe
duties of auditors and the action SEBI can take in the event the prescribed
duties are not discharged. The powers SEBI is seeking may be questioned before
courts particularly on the issue whether the provisions SEBI Act are wide
enough to provide for powers merely by amending the Regulations. Thus, the
coming years will see several developments before a clearer picture emerges.
In the meantime, SEBI has passed yet another
order debarring a firm of auditors for 5 years from carrying out any
certification work for any listed company or any intermediary associated with
the capital markets. In the case of C. V. Pabari & Co., (“the Auditors”)
SEBI has passed order No : WTM/MPB/ISD-FAC/57/2018, dated 31st
October 2018 relating to audit of Parekh Aluminex Limited. There are several
findings of erroneous accounting and presentation in financial statements, in
addition to diversion of funds, over valuation, etc., and violations of
provisions of the Companies Act.
The Order also debars for 5 years the
Wholetime Executive Director, who was also earlier the Chairman of Audit
Committee. However, this article focuses on the action taken against the
auditors, on the facts and the reasons provided by SEBI for debarring the
auditors for five years.
BROAD BACKGROUND AND SUMMARY OF THE ORDER.
Parekh Aluminex Limited was a company listed
on Bombay stock exchanges. During the period under question (FY 2009-10 to
2010-12), it was alleged that there was wrongful accounting and disclosure in
financial statements, diversion of funds, over valuation of certain assets,
etc. Some time after this period, the main promoter and Chairman/Managing
Director of the Company also passed away. The share price of the Company
plunged from some Rs. 300 to Rs. 10 and the shares were eventually delisted
from the Bombay Stock Exchange.
The Auditors who conducted audit of the
accounts during this period resigned. Other firms of auditors were appointed
who too resigned giving reasons such as non-availability of information. It
appears, however, they did submit some reports. A firm was also appointed to
conduct a forensic audit. Based on the interim forensic audit report and other
preliminary findings, SEBI passed an interim order and also served a show cause
notice to the Whole time Director and the Auditors. They were given a hearing
before passing the final order.
Let us consider some of the major
allegations made, the defenses given by the Auditors and the order of SEBI and
its reasons.
WHETHER SEBI HAS JURISDICTION TO ACT AGAINST THE AUDITORS?
An oft made defense by the auditors is that
SEBI does not have any jurisdiction to act against them in respect of their
services to a listed company. However, SEBI rightly cited the decision of the
Bombay High Court in case of Price Waterhouse & Co. vs. SEBI ((2010) 103
SCL 96 (Bom.)). The Court had held, under certain circumstances
particularly where it can be held that the auditors had connived with the
management in fraud, SEBI could take action against the auditors.
However, interestingly, SEBI observed that
even if the financial statements have not been drawn up in accordance with the
mandated accounting standards, SEBI could act against the auditors. It
observed, “…if the financial statements have been drawn up without following
the norms and standards of accounting, SEBI has jurisdiction to take regulatory
measures for protecting the investors interest by taking appropriate steps
against the Auditor.”. I submit that this view is not supported by the
decision of the Bombay High Court.
ALLEGATION – LOANS / ADVANCES WERE NETTED OFF AGAINST BORROWINGS
It was alleged that loans/advances given to
several persons were adjusted against bank loans in the financial statements.
This resulted in loans given and borrowings both being shown lower by more than
Rs. 1000 crores.
SEBI sought explanation from the Auditors as
to why such a disclosure was made and whether this was in consonance with
applicable accounting standards.
The answer of the Auditors was that the
adjustment and disclosure was made in the financial statements presented to the
Audit Committee and the Board and the final statements were approved by both
without any objections. The Auditor also pointed out that independent audits
were conducted by banks who had not objected to this adjustment. Further, the
banks extended additional loans. It appears, however, they could not provide
any explanation regarding compliance with accounting standards.
SEBI rejected the explanations. It stated
that auditors were expected to conduct an independent audit and could not rely
merely on approvals by Audit Committee/Board and ‘rubber stamp’ the accounts.
SEBI, reiterated that the Auditors could also not rely on bank audits as they
are mandated to conduct audit independent of other agencies. Further Auditors
failure to explain how such a practice was in compliance with accounting
standards was also noted.
DIVERSION OF FUNDS TO NON- CORE ACTIVITIES
The next allegation was that funds of the
company were diverted for non-core activities. It has been alleged that loans
and advances were given for the purposes of real estate which “…is a non-core
activity of the company”. Similarly, it was alleged that “…the company had
transferred money to companies trading in bullion which is diversion of fund as
the company is engaged in the manufacture of aluminum foil related products.”
Other similar diversion of funds was also alleged. In view of this, SEBI
concluded :
u that the company has
misrepresented its business operations to its shareholders and to the public in
general.”.
u that PAL has misstated its
accounts in respect of set off of such loans/advances and “diversion” of funds.
?
?
OBSERVATIONS OF SEBI ON ROLE OF AUDITORS
While dealing with the defenses offered by
the auditors and generally examining what had happened in the present case,
SEBI made several observations on role of auditors and what acts or omissions
can be held to be actionable:
(a) Auditors are experts in the field of accounts
and finance and should rely on their own expertise and judgment instead of
relying on and accepting accounting treatment by the management. Else, the
whole purpose of certification by them is defeated.
(b) The auditors could not present a due paper
trail for the work they claim to have done in respect of verifying the loan
documents. Hence, their defense on this aspect was rejected.
(c) Auditors should not merely be “rubber
stamping the accounts” and in doing this failed to follow the “minimum
standards of diligence and care as expected of a statutory auditor”.
Auditors thus showed “lack of professional skepticism in auditing the accounts
of the company”.
(d) Considering that in case of listed companies,
public at large, financial institutions (government and private), etc., rely on
report of auditors, “..the duty and obligation of being absolutely diligent
is multiplied manifold and the auditor cannot take such an obligation
casually”.
(e) The investing public relies on the financial
results to make informed decisions. False accounts have direct impact on
securities markets.
(f) Such alleged large-scale falsification,
following dubious accounting practices for manipulating financial results,
etc., could not happen without “…its statutory Auditor being part of the
manipulative and deceptive device. Even otherwise, by making representations in
a reckless and careless manner whether it is true or false, tantamount to
fraud”. ?
Making such observations, SEBI held that
there have been violations of the provisions of the Act and the Regulations
relating to fraud, manipulation etc., and accordingly gave various directions
as mentioned earlier against the auditors.
CONCLUSION AND WAY FORWARD
This is just one of several orders passed
against auditors for their alleged participation or connivance in fraud. Most
of the cases are about fraud, the observations and basis for passing of orders
vary and cover a wide area. It needs to be noted that where the auditors have
participated in or ignored fraud/falsification, the provisions in the SEBI
Act/Regulations relating to fraud would get attracted. This area is sought to
be extended to cover cases of negligence, failure to follow accounting
standards, or proper procedures of audit, and lack of professional skepticism.
The proposed Regulations by SEBI seeking to
prescribe extend the duties of auditors (and other specified professionals)
discussed earlier will thus need closer attention. These proposed amendments
require auditors to observe the proposed prescribed duties while rendering
services to listed companies and other specified entities associated with the
capital markets. Failure to do so would result in adverse action against them
by SEBI. Thus, SEBI would be able to, if these proposed amendments are made
law, take action against auditors even under situations even where there is no
fraud but there is lack of care, diligence, etc. The issue is : should auditors
face proceedings before multiple regulators and be subject to multiple and
overlapping consequences. It is time that a holistic assessment of the whole
issue is made and action against the auditors is through a single regulator,
under clear pre-defined and rational guidelines.
