TMI Blog1955 (8) TMI 18X X X X Extracts X X X X X X X X Extracts X X X X ..... t was a prosecution witness and it appears that not only the records of the bank, but his personal papers as well were seized in the course of the investigation. The criminal proceedings terminated with the appellate judgment of this High Court, given in August, 1952. On the 4th of February, 1954, one Shri B.K. Kaul, Deputy Secretary to the Government of India, Ministry of Finance, Department of Economic Affairs, addressed a letter to the Secretary of the Institute in which he stated that the balance sheets and the profit and loss accounts of the Aryan Bank Limited for the years 1942, 1943 and 1944 did not exhibit a true and correct view of the state of the bank's affairs and he asked that such action as the Institute might deem fit might be taken against the respondent. According to the informant, the bank had resorted to manipulation of accounts on an extensive scale during the period covered by the respondent's audit. As instances, he alleged that in 1943, the bank had purported to allot a prodigious number of shares to certain concerns in which the managing director or his relatives were interested and this it had done not on receipt of any actual payment in cash, but by open ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eas, the respondent also stated that he had been unable to obtain his papers from the courts and the police within the short time given to him and he had, therefore, been compelled to rely entirely on his memory. After the respondent had filed his written statement, the matter was referred by the Institute to the Disciplinary Committee for an enquiry. The Committee treated the complaint as one alleging that the respondent had been grossly negligent in the performance of his professional duties as auditor of the bank in respect of the years mentioned in the complaint. It will be noticed that although the actual items of specific information which the informant had given related only to the years 1943 and 1944, the enquiry covered 1942 as well. At the enquiry, the Disciplinary Committee had to contend against the difficulty that practically none of the records of the bank was made available to them. Besides the balance sheets and the profit and loss accounts for the years in question and two special reports made by the respondent in respect of the years 1942 and 1943, they had before them only the share allotment register for 1943, the articles of association and certain share ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... guilty. In so far as the complaint was based on certain alleged manipulations of the accounts of the bank in respect of loans, overdrafts and fixed deposits, the Committee have pointed out that an audit, particularly a bank audit is concerned with verification and not investigation and that an auditor cannot be expected to deduct deep-laid plots of fraud conceived and carried out by dishonest directors, unless he has some information before him which excites or ought to excite his suspicion. In the case before them, the books and records of the bank were not available and therefore the Committee were not in a position to say whether there was anything in them which ought to have caused some suspicion to the respondent and put him on further enquiry beyond the matters which he had himself admitted in the course of his evidence to be of a doubtful nature. The facts found by the Committee against the respondent may now be stated. The balance sheets in question were consolidated balance sheets for the head office of the bank as also its branches. The reports made by the respondent in respect of the years 1942 and 1943 were in the form of a certificate, merely answering the four quest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o answer was given. Then as regards the year 1943, the special report with regard to that year did not specifically state that the respondent had not audited the accounts of the branches, but it stated that the balance sheet and profit and loss accounts of the branches prepared by the chief accountant of the bank from returns as certified by the respective agents of the branches, had been incorporated in the books of the bank, which implied that the respondent had not personally checked the branch accounts. In fact, the respondent did not check the accounts of the branches for any year, as he admitted in course of his evidence. The balance sheet for the year 1943 showed a cash balance of Rs. 3,85,943-5-2, of which Rs. 3,62,749-6-2 was cash in hand. The special report for the year 1943 did not state specifically that the respondent had not verified the cash, but it stated that the cash balance had been certified by the management. In the course of his evidence, the respondent admitted that he had not actually verified the cash. Then there was a general statement in the special report to the following effect: "The remarks given on the last account generally holds goods for the year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he respondent appears to have replied that he had checked the cash by reference to pass books. When it was pointed out to him that such a thing was impossible, he made no reply. On the above facts the Committee held that in examining the balance sheet it was the duty of the respondent to verify the cash in hand and that by failing to do so in respect of the years 1942 and 1943 he had failed to discharge the duty which lay on him under the law and the approved audit procedure. The fact that he had stated in the special report that he had not personally verified the cash could not absolve him from his statutory liability. The Committee held further that if the respondent felt some doubt as to some of the loans, overdrafts and fixed deposits, as he said he had felt and if he found it necessary to qualify his reports by certain reservations made in the special reports, he should have expressed himself unequivocally on the suspected items instead of making cryptic statements which might mean anything or nothing. It was further held that his duty was to give information and not merely means of information. The Committee also held that the alleged verification of the cash in hand at the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in that regard he had failed to perform his duty. On behalf of the Institute, Mr. Meyer contended that the findings arrived at by the Disciplinary Committee and confirmed by the Council of the Institute were clearly right and his further submission was that inasmuch as the misconduct found was of a kind which the Act itself had named as misconduct which would render a Chartered Accountant unfit to be a member of the Institute, this Court could only direct the removal of the respondent's name from the rolls. On behalf of the respondent, Mr. Sen did not dispute the factual part of the findings, but he contended on various grounds that they did not establish negligence. He submitted further that, in any event, the court was not. bound to impose the maximum penalty of removal from the rolls, but might pass any other order. Before considering whether the respondent has been guilty of negligence in the discharge of his duties as auditor, it is necessary to see what the duties of a statutory auditor are. The statute, which in this case is the Indian Companies Act, offers little guidance. All that section 145(2), so far as is material, says is: (2) "The auditors shall make a report t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f we remember the place of an auditor in the scheme of the Companies Act. A joint stock company carries on business with capital furnished by persons who buy its shares. The owners of the capital are, however, not in direct control of its application which is left to the executive of the company, composed of the directors and the superior officers. It is true that the directors are chosen by the shareholders, but once chosen they move away to the eminence and isolation of the Board and are left to carry on the administration of the company according to their discretion and without any reference to the shareholders. In those circumstances, some arrangement is obviously called for by which those who provide the capital may know periodically what is being done with their money, how the affairs of the company stand and what the present value of their investments is. The Companies Act, therefore, provides for the employment of an auditor who is the servant of the shareholders and whose duty it is to examine the affairs of the company on their behalf at the end of a year and report to them what he has found. That examination by an independent agency such as the auditor is practically the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fairs. (See Halsbury's Laws of England, Hailsham Edition, Vol. 5, page 285). Next as to the method the auditor must follow. He must of course examine the books of the company to see what they contain, but he must also ask for further information and for explanations when such are required. In performing that function, he is required on the one hand to employ reasonable skill and care, but on the other hand, he is not required to do more. He is not required to begin with suspicion and to proceed in the manner of trying to detect a fraud or a lie, unless some information has reached him which excites suspicion or ought to excite suspicion in a professional man of reasonable competence. An auditor's duty is to see what the state of the company's affairs actually is and whether it is reflected truly in the accounts of the company upon which the balance sheet and the profit and loss account are based, but he is not required to perform the functions of a detective. As has been said, he is a watch-dog but not a bloodhound and, as the same thing has been said without the aid of a metaphor, his duty is verification and not detection, although in performing the duty of verification, he mus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te, either as to the true position of the affairs of the company or as to the correctness of the balance sheet in relation to the books. He is, as has been said, not an insurer and does not guarantee the absolute accuracy of what he certifies. But if he does not take reasonable care and skill before he comes to believe that what he certifies is true or even when he generally displays the highest degree of care and skill but falls short of the strict duty of an auditor even in one instance, he must be held to have been negligent, if not worse. The audit with which we are concerned in the present case is the audit of a banking company. Such an audit has been called a balance sheet audit, meaning thereby that it is primarily confined to the verification of the existence of assets shown in the balance sheet, because on account of the multitudinous character of the transactions of a bank, it is not ordinarily possible to examine everyone of them, nor is it usually done except with reference to matters, if any, which provoke enquiry. But the existence of the assets must be strictly verified, cash in hand by actual counting, cash in banks by reference to the pass book or letters of conf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, if disclosed, they would show the balance sheet in a different light, those facts must be conveyed to the shareholders. They cannot be suppressed, nor can doubt or dissent be expressed, but the reasons therefor withheld. In India, the Act deals with the last matter in subsection (2A) of section 145 which says that where any of the matters referred to in sub-section (2) is answered in the negative or with a qualification, the report shall state the reasons for such answer. Vis-a-vis the shareholders, the auditor holds a position of trust and it is his bounden duty to honour that trust by being candid with the shareholders and telling them frankly and fully everything with regard to the affairs of the company which has come to his knowledge and which it is material for the shareholders to know. It is only fair to add that there may be circumstances in which it will not be to the interest of the shareholders themselves that all the information regarding the company should be included in a public and printed document like the auditor's report. To give an instance, a foreign company may invade the market so long occupied by the products of a home company and may suffer loss in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the respondent stated in his special report that he had not verified the cash, he had absolved himself from liability. I am afraid the argument was entirely misconceived. The respondent is not being proceeded against under the criminal law, nor for misfeasance; and the particular finding does not relate to his failure to give information to the shareholders or to concealment of anything, but to his failure to perform one of the essential duties of an auditor. The fact that he did not conceal the omission from the shareholders is not therefore material. If an auditor does not do what it is his duty to do, it is not defence for him to say in a disciplinary proceeding started under the Chartered Accountants Act that he had told the shareholders that he had not done it. The lapse is constituted by his failure to perform a duty without which an audit is meaningless and it is not excused by giving information of the omission to the shareholders. The reason is that the object of the Act is to ensure in public interest that those who practise the profession of auditors shall perform in their actual practice at least the essential duties of an audit and shall bring to bear on their work at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ( No. 2 ) [1896] 2 Ch. 279 in aid of his contention that the respondent had not been negligent in the discharge of his duties by accepting the certificate of the management. I do not think that the case is of any assistance to him. It was a case where the stock-in-trade of a Cotton Mill Company, as shown in the balance sheet, had been accepted by the auditors on the certificate of the manager and they had stated in their balance sheet that they were accepting the figure "as per manager's certificate." The stock-in-trade was shown not by quantity but in value and the actual fact was that the manager who had, up to the time of the audit, been regarded as a man of acknowledged competence and a high degree of integrity, had systematically manipulated the accounts and overstated the value of the stock-in-trade. The auditors had taken the figure from a stock journal which contained several accounts, each one of which showed the stock-in-trade in that account and the total of such accounts was taken as the resultant stock-in-trade which was shown in the balance sheet. The auditors had checked whether the sum total of the figures shown under each of the contributory accounts agreed with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... found that although, in that case, an amount which was not cash in hand was described in the balance sheet as such, the auditors made all the requisite enquiries which would be appropriate to the case of money held by a third party, as in fact the amount in question really was, but even then the court did not say without qualification that the conduct of the auditors did not amount to negligence. That case also, in my view, would not support a claim that an auditor can omit to verify cash actually in hand and accept instead a certificate from the management. In my view, the first item of negligence found by the Council is amply established. Proceeding to the next second item, I have already pointed out that it is inconsistent with the first and the third and that the negligence which can be properly charged against the respondent is not that he failed to inform the shareholders of the weakness of the bank's position, but that he failed to inform them clearly and directly of his doubts and the facts by which those doubts had been caused. As to this item of negligence, little need be said. In respect of the year 1942, the auditor admittedly felt some doubt as to some of the loans ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tory report which they originally prepared, they used the following language: "The value of the assets as shown on the balance sheet is dependent upon realisation. And on this point we have reported specifically to the board." Ultimately they were persuaded by the chairman of the board of directors of the company to omit the last sentence and the report went only with the statement that "the value of the assets as shown on the balance sheet was dependent upon realisation." With reference to the charge that the auditors had failed give full information to the shareholders, Lindley, L. J. observed that if the auditors had laid before the shareholders the balance sheet and profit and loss account, accompanied by a certificate in the form in which they first prepared it, they would perhaps have done enough under the peculiar circumstances of that case. The learned Lord Justice proceeded to utter a warning that if, even in such circumstances, an auditor chose to give means of information rather than information, he would do so at his own risk, because he might be held judicially to have failed to discharge his duty. But the fact remains that in the opinion of the learned Lord Justice, a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reached when he signed the report for 1944 in anticipation of letters of confirmation from the banks in respect of the cash said to be lying with them. Mr. Sen contended that the amounts lying in current accounts might be checked from the pass books and amounts lying in fixed deposit might be checked from the fixed deposit receipts. But there must have been some reason why, in spite of those materials being available to him, if they were available, the respondent asked for letters of confirmation. Why, having felt the necessity of confirmation and asked for it, he should have hurried to certify the balance sheet before the confirmation was received, was not explained. In my view, the third item of negligence has also been established. Before we proceed to consider what order we ought to make, I desire to refer to one matter. Admittedly, the respondent did not examine the accounts of any of the branches in any of the years and he accepted the certificates of the different branch managers or balance sheets and profit and loss accounts prepared by the chief accountant at the head office from the returns made by the branch managers. The Indian Companies Act provides in section 145(3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2 Comp. Cas. 179 . In the case of J . K. Ghose [1954l 24 Comp. Cas. 235 to which Mr. Meyer referred, the present point was not decided. The question for decision in that case was whether the Act at all contemplated misconduct less than misconduct rendering a chartered accountant unfit to be a member of the Institute and whether for such misconduct, the High Court could impose a penalty of lesser gravity than removal of the offender's name from the Membership Register. Incidentally, certain observations as to the scope of certain sections were made, but the present point was not decided. That decision, therefore, does not conclude the matter. The decisions of the Bombay, Madras and Nagpur High Courts relied on by Mr. Sen, certainly support his contention, but with great respect, I have not found much assistance in the reasons given by them in overcoming the difficulty which, to my mind, is created by certain sections of the Act. The draftsmanship of the sections which deal with misconduct and disciplinary action is extremely clumsy. It would appear that before adopting the words "conduct which will render a person unfit to be a member of the Institute", the Legislature did ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e guilty of conduct rendering him unfit to be a member of the Institute, if he " Then follows an enumeration of the acts or omissions contemplated. The result is that by the words of section 22 and the opening words of the schedule, the Act enjoins that if a chartered accountant does any of the acts or be gulity of any of the omissions mentioned in the Schedule, he must be deemed to have rendered himself unfit to be a member of the Institute. In the light of these provisions, section 21(3) assumes a somewhat strange hue. It says that after the finding of the Council has been forwarded to the High Court and after the High Court has given an opportunity to the Council, the member concerned and the Central Government to be heard, it ''may pass such final orders on the case as it thinks fit, if it does not refer it back to the Council for further enquiry. Therefore, even where the Council finds that a member has been guilty of one or more of the acts or omissions enumerated in the schedule and even where the High Court accepts such findings, the High Court may make any order it deems fit and not necessarily an order for the removal of the member's name from the rolls. The language of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... duct which renders him unfit to be a member of the Institute." If the words "conduct which renders him unfit to be a member of the Institute" be taken in the sense of the definition sections, it must follow that once the High Court has found that a chartered accountant has been guilty of one of the enumerated acts or omissions, the Council must remove his name from the register. It is to be noticed that section 20(2) does not say "if the High Court holds him to be unfit to be a member of the Institute," or "if the High Court directs his name to be struck out", but says if he "has been found by the High Court to have been guilty of conduct which renders him unfit to be a member of the Institute." As I have said, if one takes the language of this sub-section in the sense which the definition sections give to it, it is impossible to come to any other conclusion than this, that the moment any of the specified acts or omissions is found against a chartered accountant, his name can no longer remain on the rolls. No room is left for the High Court, after it has found one or more of such acts or omissions to exercise any discretion with respect to the penalty. But the words of section 21 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and, their intergrity and the care and skill which, it is assumed, they will bring to bear on their work, are almost the only guarantees which the shareholders have that they will be kept informed periodically of the true state of the affairs of the company in which they have invested their money. An auditor who pays more regard to his fees or patronage from the directors than to his duty to the shareholders or who construes his duty to the shareholders too narrowly, does a positive disservice, not only to the shareholders who employed him, but to the cause of joint stock enterprise in the country in general. He does so, because by not bringing to the notice of the shareholders matters which it is material for them to know and leaving the directors free to deal with the funds and the business of the company as they choose, he makes it possible for them to bring the company to ruin and thereby he contributes to the destruction of public confidence in joint stock enterprise. It is, therefore, not possible to regard the lapse of the respondent too lightly. We have given this matter our careful consideration and we think that, in all the circumstances of the case, the ends, of justice ..... X X X X Extracts X X X X X X X X Extracts X X X X
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