By Jayant M. Thakur
Chartered Accountant
BACKGROUND
Recently, on 9th September, 2019,
the Securities Appellate Tribunal (SAT) overturned the SEBI order banning 11
firms of chartered accountants of the ‘Price Waterhouse group’ (PW) for two
years. The ban was on carrying out audits, certification, etc. of listed
companies / intermediaries associated with the capital markets. It was in
connection with the audit by one such firm in the Satyam Computer Services
Limited (Satyam) case where massive frauds were found consequent to a
confession by Satyam’s Chairman. The SEBI order disgorging the fees earned by
PW from the audit of Satyam of about Rs. 13 crores plus interest was, however,
upheld. Essentially, what SAT held was that PW did not participate knowingly in
the fraud though there was negligence involved to an extent. Several other
conclusions were drawn. Whether, when and to what extent are auditors subject
to the jurisdiction of SEBI was something analysed in great detail. Two
important aspects were particularly discussed. Whether SEBI can ban auditors if
they are negligent in their professional duties, or whether this is the domain
of the Institute of Chartered Accountants of India? In case of alleged fraud /
connivance in fraud by auditors, does SEBI have to provide direct evidence or
will it be enough to show this by ‘preponderance of probabilities’, as the
Supreme Court has held in certain cases?
Needless to say, this decision will have
far-reaching implications for auditors of listed companies / intermediaries /
entities associated with the capital markets. Many auditors have been banned in
the past and this decision creates a path-breaking precedent for a modified
viewpoint over future cases. It is also possible that SEBI may, apart from
possibly appealing to the Supreme Court against this SAT order, seek amendments
to the law to seek wider jurisdiction over auditors.
Some major conclusions and observations by
SAT are discussed in this article.
Quick summary and background of matter
leading to this decision
Readers may recollect that the Chairman of
Satyam, Mr. B. Ramalinga Raju, had, in January, 2009, sent a ‘confession email’
to SEBI of massive frauds in Satyam. This had resulted in its bank balances /
fixed deposits with banks, revenues, debtors, profits, etc. being overstated.
The amount involved was in thousands of crores of rupees. Several criminal and
other proceedings were initiated against the Chairman, directors and certain
officers, the signing partners of the auditors and the Price Waterhouse group.
However, for purposes of this article, the focus is on the proceedings against
the PW group by SEBI. Against these proceedings, PW petitioned the Bombay High
Court claiming, inter alia, that SEBI did not have any jurisdiction over
auditors who are chartered accountants and over whom only the Institute of
Chartered Accountants of India (ICAI) has jurisdiction. The High Court rejected
this contention and upheld SEBI’s jurisdiction over auditors albeit with
certain conditions. Thereafter, SEBI issued an order on 10th
January, 2018 banning the PW group of 11 firms for two years from performing
certain audit / certification work in relation to listed companies, etc. It
made a finding that PW had committed / connived in fraud and was negligent. It
also ordered that the fees earned by it be disgorged – with interest @ 12% pa.
Now, SAT has partially overturned this order.
BOMBAY HIGH COURT’S DECISION
PW had filed a petition before the Bombay
High Court claiming that SEBI had no jurisdiction over auditors who, being
chartered accountants, were subject to action only by the ICAI. The Court (Price
Waterhouse & Co. vs. SEBI [2010] 103 SCL 96 [Bom.]) rejected this
contention but with certain riders which can be summarised as follows: It said
that auditors in general were primarily subject to ICAI. If the auditors were
negligent in their duties, it is the ICAI that can take action against them.
However, SEBI is a body that has been formed for the protection of investors
and safeguarding the integrity of capital markets. Auditors perform an
important role of attestation of financial statements that are relied on by
shareholders. If they themselves carry out a fraud or participate / connive in
fraud in the entity they audit, SEBI does have a role – to take action.
However, this has to be established by evidence by SEBI. If the auditor has
been negligent in performance of his duties but it cannot be shown that he has
committed or connived in fraud, SEBI does not have jurisdiction. It is these
comments by the Court that became the core point on which SAT rendered its
decision.
What are the tests by which SEBI can
prove a person is guilty of fraud in securities markets?
This was an important aspect discussed in
the decision and indeed was the turning point. SEBI had charged PW with fraud
under multiple provisions of the SEBI Act and Regulations. But what were the
valid criteria that were sufficient to establish fraud under these provisions?
SEBI applied the more liberal criterion of ‘preponderance of probabilities’. It
stated that PW was negligent on so many counts and over so many years, that it
was far more likely than not that it had connived in the fraud.
However, the SAT made an important
distinction. It analysed the relevant decisions of the Supreme Court on frauds
under the securities laws. It held that the criteria were different for persons
who dealt in securities and those who did not. In respect of persons who dealt
in securities, the test of preponderance of probabilities applied. However, PW
could not be said to have dealt in securities and hence this test could not be
used to prove fraud. Hence, for such persons direct evidence was needed that
they connived in fraud and that such fraud induced others to deal in
securities. SAT held that SEBI had not provided any such evidence. Negligence,
even if on repeated counts, did not become fraud once this test and standard
was applied.
Thus, the SAT held that SEBI had not
provided evidence that PW had committed fraud. The order of banning the PW
group failed on this ground.
Whether SEBI can ban 11 firms en masse in the PW group?
SEBI had banned 11 firms which according to
it were operating under the Price Waterhouse banner. SEBI also showed several
direct and indirect associations amongst the firms operating under this banner.
There was, for example, sharing of resources, there were common partners
amongst some firms and so on.
The SAT
analysed the relations in context of the law relating to partnerships and LLPs,
the relevant guidelines of ICAI, the fact that there were several partners
among those who joined as such much after this event / audit, etc. It also
noted that it was a ‘signing partner’ who certified the audit of companies. SAT
held that in these circumstances, it could not hold the whole group liable for
fraud in Satyam. A blanket ban on the group was thus not warranted.
Important concepts like negligence, role of
management / auditors, etc. discussed
SAT discussed extensively on what
constituted negligence and also discussed the role of management and the
auditors. In particular, it highlighted the role of the auditor to display
professional scepticism, to act as watchdog and not a bloodhound, to not be
aggressively looking for fraud all the time which is really the role of a
forensic auditor. It also emphasised that an audit cannot guarantee absence of
all fraud as long as the auditor utilises a process that demonstrates a
reasonable professional skill and approach to the audit. SAT also discussed
various applicable auditing standards. Finally, and above all, it stated that
cleverly designed and implemented fraud cannot necessarily be uncovered by an
auditor. The audit cannot be so extensive and detailed, considering the time
and cost constraints, to uncover all frauds; and the scope for such
sophisticated frauds by persons high in management has to be considered.
Remedial orders vs. preventive orders
vs. orders to ban amounting to penalising a person
An order
banning a person from being associated with the securities markets can be for
one or more reasons. The SEBI Act permits directions by SEBI to debar a person
from being associated with the capital markets for preventive or remedial
reasons. Banning a person to punish him for wrongs done by him is, however, a
punitive action.
SAT held that debarring a person can, of
course, be for remedial / preventive reasons. If a person has committed such a
wrong that has harmed investors it may be better to keep him away from the
stock markets for a time (or even permanently in appropriate cases) so that
others (more people) are not harmed.
On the facts of
the case, SAT held that debarring PW served neither a preventive nor a remedial
purpose. It was seen that more than a decade had passed since the uncovering of
the fraud. PW had continued to serve other entities in the securities market
without any complaints. It had, to the satisfaction of even US authorities who
had initiated proceedings against it, taken necessary corrective actions to
prevent such things from happening again. To prohibit PW now from being
associated with the capital markets did not serve any preventive or remedial
purpose.
This is again a relevant test which would
apply to proceedings in other cases against auditors where there may be similar
facts.
Disgorgement of fees
As noted earlier, negligence in performance
of professional work by auditors does not by itself amount to fraud under
securities laws. For holding an auditor guilty of having committed such fraud
direct evidence has to be provided. However, SAT affirmed that the auditors
were negligent in performance of their duties as auditors on certain counts. It
thus upheld the direction of SEBI to disgorge the fees earned by PW from the
performance of the audit of Satyam.
CONCLUSION
Clearly, the order has far-reaching effects
on auditors and even other persons associated with the capital markets. The
order is of course on the facts of the case which SAT took pains to mention and
repeat. But the circumstances and criteria under which auditors can be
proceeded against are now far clearer than before. The decision of the Bombay
High Court which upheld the jurisdiction of SEBI against auditors was
reconciled with decisions of the Supreme Court and it was shown that SEBI had
power and jurisdiction which was narrower. In these times, when auditors face
multiple regulators, it is a relief that there is clarity on who plays what
role and of what nature.
This order will also be relevant for others
who are not directly associated with the capital markets and who do not deal in
securities. These may include independent directors and directors in general,
company secretaries, lawyers, etc. While each group will have to examine how
this decision is relevant for them, there is still some guidance available. For
example, for holding them liable for fraud, direct evidence has to be shown.
Partners of firms of auditors will also have
less cause for worry if, despite reasonable efforts and systems, their partners
are negligent and / or commit fraud. The other partners of such firms will not
be held liable and acted against merely for the faults of one partner.
