SEBI has initiated action yet another time against auditors of a listed company that was alleged to have carried out massive frauds, made false/fake/duplicate books of accounts, etc. In an earlier case, SEBI had actually debarred an auditor/Chartered Accountant from issuing any certificates under various Securities Laws. This case was discussed earlier in this column in the April, 2016 issue of this Journal. Further, as will also be discussed later herein, the Bombay High Court had held that SEBI did have power to take action against auditors and that such powers were not the exclusive prerogative of the Institute of Chartered Accountants of India. This results in not only SEBI being able to debar auditors but also initiate other actions such as penalties, prosecution, etc. Action under other laws such as the Companies Act, 2013, can also not be ruled out.
This particular case (Order of SEBI dated 16th February 2017 in the matter of Arvind Remedies Limited) has an interesting and perhaps worrisome feature. SEBI has taken a view that the concerned auditors had been negligent in their duties as auditors and failed to maintain requisite professional standards in their work. Based on this, the auditors have been accused of fraud, manipulation, deceit, etc. These allegations are not only more serious but can result in far stricter punishment.
FACTS OF THE CASE
A forensic audit was carried out of the listed company, Arvind Remedies Limited, by a consortium of bankers. Several findings were made by these forensic auditors and also by SEBI’s own subsequent investigation. Some of alleged frauds/manipulation, etc. were as follows:-
1. Maintenance of multiple sets of books of accounts.
2. Recording of bogus sales.
3. Allegedly making fake sales/entries with several companies.
4. Destruction of large amount of inventories which SEBI suspects to be originally non-existent.
5. Reduction of a large amount of tangible assets in a suspicious manner.
And so on.
The turnover of the company had reduced very substantially. The share price on stock exchange too had reduced to a small fraction of the price in preceding period. It was alleged that during the relevant period the Promoters sold a very substantial number of shares and reduced their shareholding from 46.84% to 3.58%. The Promoter Director also had drawn a large amount as commission on sales which SEBI has alleged to be fake.
Around this time, the erstwhile auditors (“the Auditors”) of the Company resigned and a new firm was appointed. The findings by the new firm were similar to findings of SEBI/the forensic auditor.
ACTION BY SEBI AGAINST THE COMPANY AND PROMOTER DIRECTOR
SEBI alleged that the Company and its promoter director were guilty of violation of several provisions of the SEBI Act/SEBI (PFUTP) Regulations relating to manipulations, frauds, etc. It also alleged that the promoter director had drawn a large amount of commission on the basis of bogus sales. Accordingly, it issued the following interim directions:-
1. Debarred the Company and the promoter director from accessing the securities markets, buying/selling shares, etc.
2. Directed the promoter director to impound the commission that he had drawn on basis of allegedly bogus sales.
SEBI also directed the promoter director not to alienate any of his assets till the amount of commission was duly impounded in the manner specified by SEBI.
ACTION AGAINST THE AUDITORS
SEBI had sought a statement from the Auditors on various issues to which replies were given by them. Pursuant to such replies and investigation, SEBI made several observations against the role of the Auditors. SEBI stated: “For negligence in certification of accounts of listed company, failure to maintain professional standards in Audit, the Statutory Auditor and its proprietor were prima facie alleged to have violated – i. Section 12A(a), (b) and (c) of the SEBI Act and Regulation 3(b), (c) and (d) and Regulation 4(1) and 4(2)(a), (e), (f), (k) and (r) of the PFUTP Regulations.” (emphasis supplied).
Again, SEBI pointed out several alleged lapses of the Auditors such as not reporting on certain discrepancies in the accounts. Based on this, SEBI observed, “The irregularities perpetrated by ARL, its Director and Statutory Auditor, discussed hereinabove are prima facie in violation of Sections 12A(a), (b) and (c) of the SEBI Act; Regulations 3(b), (c) and (d) read with Regulations 4(1) and 4(2)(a), (e), (f), (k) and (r) of the PFUTP Regulations. “
Thus, SEBI has alleged that the Auditors have prima facie violated the provisions relating to fraud, manipulation, deceit, etc. as contained in the SEBI Act and the PFUTP Regulations.
These provisions provide for certain fairly serious violations. Section 12A(a) concerns with use of “any manipulative or deceptive device or contrivance” in connection with certain issue/purchase/sale of securities. Section 12A(b) deals with employment of “any device, scheme or artifice to defraud” in connection with issue or dealing of securities. Regulation 4(2)(r) of the PFUTP Regulations deal with “planting false or misleading news which may induce sale or purchase of securities.”
Thus, and to repeat, these are serious violations alleged.
The interim order also operates as a show cause notice to the Auditors asking them to show cause as to why they should to be debarred from giving various certificates for having allegedly committed violations of the provisions relating to fraud, manipulation, deceit, etc.
Whether negligence/lower professional standards in audit can be treated as fraud, deceit, etc.
In the earlier order in the case of Shashi Bhushan discussed in an earlier article in this column, the auditor concerned was specifically alleged to have committed the violations relating to fraud, etc. In other words, the allegation was that he was party to such things.
In the present case, the order, though not wholly clear/consistent, seems to be on a different footing. The Auditors are not specifically alleged to be party to such fraud, etc. The allegation against them is that they have been negligent in their audit and/or they have applied lower professional standards in their audit. However, whether such negligent work can amount to fraud, manipulation, etc.? The latter are allegations that can result in severe consequences of debarment, penalty, prosecution and perhaps more.
The Order/Show Cause notice further states that “The Statutory Auditor therefore, enabled ARL and its Director to perpetrate manipulation/fraud on genuine investors in the securities market.” Thus, it appears that the allegation is that the alleged actions/defaults of the Company/director were a consequence of such alleged negligence, etc.
It will be interesting to read the final order of SEBI on the matter and how it bridges what I see as a gap between alleging negligence/low professional standards in audit and an active fraud/manipulation/deceit. Negligence/low professional standards in audit is surely a default that ought to be acted upon but allegation of fraud, manipulation, etc. are different and serious defaults. Negligence, it is submitted, does not amount to committing fraud which requires mens rea and a conscious and active participation to commit such an act.
WHETHER SEBI HAS POWERS TO ACT AGAINST AUDITORS
To consider whether SEBI has powers to act against auditors of a listed company, the decision of the Bombay High Court in Price Waterhouse & Co. vs. SEBI (2010) 103 SCL 96) is relevant. The Court had observed therein:-
“25. ….The powers available to the SEBI under the Act are to be exercised in the interest of investors and interest of securities market. In order to safeguard the interest of investors or interest of securities market, SEBI is entitled to take all ancillary steps and measures to see that the interest of the investors is protected. Looking to the provisions of the SEBI Act and the Regulations framed thereunder, in our view, it cannot be said that in a given case if there is material against any Chartered Accountant to the effect that he was instrumental in preparing false and fabricated accounts, the SEBI has absolutely no power to take any remedial or preventive measures in such a case. It cannot be said that the SEBI cannot give appropriate directions in safeguarding the interest of the investors of a listed Company. Whether such directions and orders are required to be issued or not is a matter of inquiry. In our view, the jurisdiction of SEBI would also depend upon the evidence which is available during such inquiry. It is true, as argued by the learned counsel for the petitioners, that the SEBI cannot regulate the profession of Chartered Accountants. This proposition cannot be disputed in any manner. It is required to be noted that by taking remedial and preventive measures in the interest of investors and for regulating the securities market, if any steps are taken by the SEBI, it can never be said that it is regulating the profession of the Chartered Accountants.
….
With a view to safeguard the interests of such investors, in our view, it is the duty of the SEBI to see that maximum care is required to be taken to protect the interest of such investors so that they may not be subjected to any fraud or cheating in the matter of their investments in the securities market. In our view, the SEBI has got inherent powers to take all ancillary steps to safeguard the interest of investors and securities market.”
The Court thus has held that where a Chartered Accountant is “instrumental in preparing false and fabricated accounts”, SEBI does have jurisdiction to act in interests of investors/markets. The Court further observed:-
“If it is unearthed during inquiry before SEBI that a particular Chartered Accountant in connivance and in collusion with the Officers/Directors of the Company has concocted false accounts, in our view, there is no reason as to why to protect the interests of investors and regulate the securities market, such a person cannot be prevented from dealing with the auditing of such a public listed Company.”
It is clear thus that SEBI does have power/jurisdiction to take action against a Chartered Accountant who connives/colludes with the management of the company to concoct false accounts.
However, the questions that this particular case presents are two. Whether negligence/applying lower professional standards in auditing by itself amount to fraud. Secondly, whether such negligence, etc. itself are actionable
by SEBI.
IMPLICATIONS ON OTHER PROFESSIONALS AND GENERALLY THROUGH OTHER LAWS
Action by SEBI against the Chartered Accountant does not rule out action by the Institute of Chartered Accountants of India for defaults of professional negligence, misconduct, etc. Further, action is also conceivable under other laws such as the Companies Act, 2013, etc.
Adverse action is also possible in appropriate cases against other professionals such as Company Secretaries, lawyers, etc.
It will be of interest whether and to what extent the defence of double jeopardy (under Article 20(2) of the Constitution of India) of double punishment for the same offence would be available.
CONCLUSION
The liability of auditors of entities to which Securities Laws apply have only increased over the years. Apart from increasingly complex laws and wider requirements/scope of audit and other work, there are multiple regulators who end up regulating the same work. The auditors would have thus to be prepared to defend their work against action by different regulators/forums and also be subject to multiple forms of adverse action for the same work.
