By JAYANT M. THAKUR
Chartered Accountant
SEBI has proposed regulations that prescribe specific duties
of Chartered Accountants/auditors, cost accountants valuers, etc. (termed as
“fiduciaries”). These duties will have to be performed whilst carrying out
assignments for listed companies and other entities associated with the
securities markets. The “fiduciaries” will face a range of penal actions if
they do not comply with these provisions.
A question is often raised whether Chartered Accountants,
should be subjected to action by SEBI and other regulators, when they are
already regulated by the ICAI. The issue is: whether fiduciaries should face
action from multiple regulators for the same default?
SEBI has, in the past, taken action against auditors.
However, in the Price Waterhouse/Satyam case, the matter had reached the Bombay
High Court which laid down certain limits to the powers of SEBI. The Kotak
Committee in its report of 2017 on `corporate governance’ has recommended
broader powers for SEBI. However, the
proposed regulations circulated by SEBI through a consultation paper dated 13th
July 2018 appear to go beyond Kotak Committee’s recommendations. Hence, the
need to review these recommendations to understand their implications.
Nature of Amendments Proposed
Over the years of its existence, SEBI has formulated several
Regulations to regulate intermediaries like stock-brokers, etc., and regulate
transactions in the securities markets. There exist regulations relating to
stock brokers, investment advisors, merchant bankers, etc. Then there are
regulations relating to issue of shares, insider trading, frauds, etc. Many of
these regulations require the services of auditors, company secretaries,
valuers, etc., to provide certificates, reports, etc. Clearly, defaults by
these fiduciaries in carrying out their duties can have repercussions for
investors and capital market who rely on their reports/certificates. Through
the consultation paper, SEBI has proposed amendments to 31 regulations to
provide for duties of fiduciaries and for penal action in case of
non-compliance.
Who are These Fiduciaries Covered?
The following fiduciaries are specifically covered:
1. Chartered
Accountants including a statutory auditor
2. Company
Secretary
3. Valuers
4. Monitoring
agency
5. Cost
Accountants
6. Appraising
or appraisal agency
The fiduciary could be an individual, firm, LLP or a
corporate entity. Relevant to this is the concept of `engagement partner’. Hence, the term
“engagement partner” has been defined as:
“Engagement partner” means the partner or any other person
in the firm or limited liability partnership, who is responsible for the
engagement or assignment and its performance, and for the report or the
certificate, as the case may be, that is issued on behalf of the firm or
limited liability partnership, and who, has the appropriate authority from a
professional body, if required;
What is the nature of activities by fiduciaries covered?
The regulators cover submission or issue of any report or
certificate by any such fiduciary under the applicable Regulations. Each of the
Regulations provide for an indicative list of such reports/certificates that a
fiduciary may issue under that Regulations. These reports/certificates include
auditors report, compliance report, net worth certificate, valuation report,
etc.
What are the obligations of the fiduciaries in relation to
such reports/certificates?
The fiduciary whilst issuing a certificate/report is required
to:
“(a) exercise due care, skill and diligence and ensure
proper care with respect to all processes involved in the issuance of a
certificate or report;
(b) ensure that such a certificate or report issued by it
is true in all material respect; and
(c) report in writing to the Audit Committee of the listed
company, any material violation of securities laws, noticed while undertaking
such an assignment.”
The requirements of individual regulations vary a little. For
example, in (c) above, the report relating to violation of securities laws may
be made to the other relevant party such as merchant banker or compliance
officer, etc.
This requirement also underlines the importance of working
papers to establish that ‘due care etc.’, has been exercised in the preparation
of the certificate / report.
What are consequences of
non-compliance by the fiduciaries?
If the fiduciary issues any false report/certificate or which
does not comply with any requirement of the applicable Regulations, SEBI would
take “appropriate action” under the general provisions of the securities laws.
Hence, the action that can be taken could include:
- Disgorgement of fees earned by the
fiduciary.
- Debarment of the fiduciary from carrying out
any assignment in relation to listed companies and other entities associated
with securities markets.
Action may be taken against whom?
In case of violation of the regulations in terms of
submission of false reports/certificates, not carrying out the work in the
manner prescribed, etc., the action would be taken “against the fiduciary, its
engagement partner or director, as the case may be.”.
The Bombay High Court decision
in case of Price Waterhouse/Satyam fraud
To understand the origin of this consultation paper, the
PwC/Satyam case may be recollected briefly. SEBI had issued a show cause notice
against Price Waterhouse and associate firms in relation to the audit, etc.,
carried out relating to Satyam scam. Price Waterhouse raised several questions
as to jurisdiction of SEBI. One of the objections was whether SEBI had any
jurisdiction to act against Chartered Accountants who are otherwise regulated by the Institute of Chartered Accountants of India.
The Bombay High Court (Price Waterhouse & Co. vs.
SEBI ((2010) 103 SCL 96 (Bom.)) partially upheld the jurisdiction of
SEBI. It elaborated on the wide range of powers of SEBI in relation to the
securities market. It also held that SEBI does not and cannot regulate the
profession of Chartered Accountants. For example, it cannot prohibit a
Chartered Accountant from practicing, even if found to be at fault. However,
SEBI could, if facts show a default, debar an auditor from issuing
reports/certificates in relation to listed companies, etc. The Court stated
that SEBI could take action only if the auditor is complicit in the fraud.
Hence, if the auditor is not a party to the fraud, SEBI cannot take action. The
proposed regulations have also to be seen in light of this decision.
Kotak Committee on Corporate Governance
The more immediate source of the consultation paper is the
Kotak Committee report on corporate governance submitted in October 2017. In
the report, the Committee had recommended that SEBI should have specific powers
to take action against auditors and other fiduciaries not just in cases of
fraud/connivance, but also in cases of gross negligence. It observed:
“Given SEBI’s mandate to protect the interests of
investors in the securities market and regulating listed entities, the
Committee recommends that SEBI should have clear powers to act against auditors
and other third party fiduciaries with statutory duties under securities law
(as defined under SEBI LODR Regulations), subject to appropriate safeguards.
This power ought to extend to act against the impugned individual(s), as well
as against the firm in question with respect to their functions concerning
listed entities. This power should be provided in case of gross negligence
as well, and not just in case of fraud/connivance. This recommendation may be
implemented after due consultation with the relevant stakeholders, including
the relevant professional services regulators/ institutions.” (emphasis
supplied)
Two points need to be particularly considered. Firstly, the
recommendation was to extend the powers to cover instances of gross negligence.
Secondly, it appears that the action would require concurrence of the relevant
regulator. In view of these two issues
the consultation paper goes beyond gross negligence/fraud.
Lesser burden of proof to levy
penalty on Auditors
Supreme Court has laid down principles for levy of penalty in
civil proceedings. In SEBI vs. Kishore R. Ajmera ([2016] 66 taxmann.com 288
(SC)), the Supreme Court had held that the bar for taking adverse action is
much lower as compared to criminal proceedings. The Supreme Court observed, “The test, in our considered view, is one of
preponderance of probabilities so far as adjudication of civil liability arising
out of violation of the Act or the provisions of the Regulations. Prosecution
under Section 24 of the Act for violation of the provisions of any of the
Regulations, of course, has to be on the basis of proof beyond reasonable
doubt.”
(emphasis supplied).
The test of ?preponderance of probabilities’ was
applied by SEBI in the case of Price Waterhouse (order dated 10th
January 2018). Accordingly, SEBI ordered disgorgement of fees earned with
interest and also debarment from taking up assignments in specified matters
relating to capital markets.
Thus, while prosecution would need proof beyond reasonable
doubt, actions such as levy of penalty, disgorgement of fees and debarment
could arguably be taken with a lower bar of `preponderance of probabilities’.
This is also to be seen in the light that the new
requirements now do not require that the fiduciaries should have themselves
engaged in or been complicit in fraud. For taking action it is enough if the
`fiduciary’ has not discharged the prescribed duties in the manner required by
the proposed new regulations.
Other implications and concerns
The scope of the proposed regulations is limited to
assignments carried out by ‘fiduciaries’ for entities operating in capital
markets. The regulations are broadly framed and comprehensive. Arguably, action
can be taken even in cases that do not involve gross negligence. Thus, it is
likely that action could be taken even in cases where otherwise action may not be attracted by the concerned regulator.
Needless to emphasise, parallel proceedings by several
regulators/authorities and double/multiple penal consequences may also be the
consequence.
Despite the fact that the ‘fiduciaries’ are experts
specialised in certain fields, the proposed regulations also do not give
guidance on how it would be determined whether the fiduciary has committed
violations. It is not provided, for example, that, in case of auditors, the
guidance and pronouncements of the Institute of Chartered Accountants of India
will be considered to test whether the work has been properly performed. Also,
the person who will decide whether the work has been properly done may not be a
peer or an expert in the field, but will be a SEBI member and / or officer.
Thus, fiduciaries would enter a whole new mine field/unexplored territory where
they would be uncertain as to how and who would determine whether they have
discharged their duties correctly or not.
It is likely that fiduciaries would feel
discouraged in carrying out assignments for matters covered under the proposed
regulations. At the very least, costs/professional fees for such work will rise
and will be borne by investors.
