Tax Management India. Com
                        Law and Practice: A Digital eBook ...

Category of Documents

TMI - Tax Management India. Com
Case Laws Acts Notifications Circulars Classification Forms Manuals SMS News Articles
Highlights
D. Forum
What's New

Share:      

        Home        
 

TMI Blog

Home List
← Previous Next →

2019 (9) TMI 592

..... BI to issue directions in the nature of remedies in the interest of the securities market and investors in securities - whether SEBI as a market regulator could be said to have jurisdiction to pass any of the directions as contained in the SCN? HELD THAT:- The show cause notice was issued on February 14, 2009 and August 26, 2009. The impugned order was passed on January 10, 2018. It took SEBI nine long years to complete the proceedings and the fault lay entirely on SEBI. The request of the appellants to cross examine certain individuals whose statements were relied upon by SEBI was rejected. This Tribunal on June 1, 2011 allowed the appeal and directed SEBI to allow cross examination. SEBI did not do so and took the matter to the Supreme Court and kept it pending for six years. The Supreme Court on January, 2017 held that the stand of SEBI was incorrect and directed that cross examination and inspection should be allowed to the appellants. During the pendency of the proceedings, the appellants were carrying on their business and auditing listed companies to the satisfaction of the shareholders and / or of the investors without any blemish. Over the last decade, the appellants have .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... ot necessary for that person to possess the highest level of expertise in that branch which he practices. WTM found that for this negligence, the auditors and the firms benefitted by way of charging a fee. WTM was of the opinion that this wrongful gain was liable to be disgorged. We find that for this professional lapse, there has been a breach of duty and failure to maintain that standard of care. For this lapse / negligence, we are of the opinion that the appellants were not justified to retain this amount. In our opinion, the WTM was justified in disgorging the said amount along with interest. The power was rightly exercised under Section 11 and 11-B of the SEBI Act to persons who in some way was associated with the securities market as well as under the Companies Act. Order of the WTM of SEBI debarring the PW firms as well as the two auditors from auditing listed Companies cannot be sustained and is quashed. Directions to listed Companies not to engage any audit firm forming part of PW network is also quashed - Appeal No. 6 of 2018 WITH Appeal No. 7 of 2018 WITH Appeal No. 190 of 2018 AND Appeal No. 191 of 2018 - 9-9-2019 - Mr Tarun Agarwala, Presiding Officer And Dr. C. K .G. .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... any audit firm forming part of Price Waterhouse network for issuing any certificate with respect to compliance of statutory obligations which SEBI is competent to administer and enforce, under various laws for a period of two years. 3. Even though, separate appeals have been filed against a common order we have clubbed all these appeals and are being decided together by a common order. 4. Appeal No. 6 of 2018 has been filed by Price Waterhouse & Co. alongwith nine other Chartered Accountant (CA) firms under the banner Price Waterhouse (PW). Appeal No. 7 of 2018 has been filed by Price Waterhouse, Bangalore. Appeal No. 190 of 2018 has been filed by S. Gopalakrishnan and Appeal No. 191 of 2018 has been filed by Srinivas Talluri. 5. The facts leading to the filing of the aforesaid appeals are that PW Bangalore was given the audit for auditing the books of accounts of Satyam Computers Services Limited (hereinafter referred to as SCSL ). The engagement partner for the audit of SCSL for the period 2000-07 was S. Gopalakrishnan and for the financial year 2007-08 which was extended till September 2008, the engagement partner was Srinivas Talluri. 6. SCSL was regarded as one of the top .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... ouse & Company Kolkata, Lovelock & Lewes Hyderabad, S. Gopalakrishnan and Srinivas Talluri directing them to show cause as to why directions under Section 11, 11(4) and 11B of the SEBI Act should not be issued for violation of Sections 12A(a), 12A(b) and 12A(c) of the SEBI Act read with Regulations 3(c), 3(d), 4(1), 4(2)(a), 4(2)(e), 4(2)(f), 4(2)(k) and 4(2)(r) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (hereinafter referred to as, PFUTP Regulations). Subsequently, a supplementary show cause notice dated February 19, 2010 was issued to the above persons/entities alongwith Lovelock & Lewis Mumbai, Price Waterhouse Kolkata, Price Waterhouse New Delhi, Price Waterhouse & Co. Chennai. Another show cause notice dated February 19, 2010 was issued to Dalal & Shah Ahmadabad, and Dalal & Shah Mumbai. 10. The show cause notice is a voluminous document. In a nutshell, the respondent directed the appellants to show cause for : (i) successive failure to exercise even a minimum level of diligence in verifying the accounting systems and internal controls of SCSL, thou .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... ners to use the name Price Waterhouse in India. The auditor s report, balance sheets, Profit & Loss accounts of SCSL were signed by S. Gopalakrishnan, Chartered Accountant for the period from April 2000 to March 2007. S. Gopalakrishnan was a partner in Price Waterhouse Bangalore as well as in Lovelock & Lewes Kolkata. Srinivas Talluri was the Chartered Accountant who signed the auditor s report, etc. of SCSL for the period from April 2007 to March 2008. He was a partner in Price Waterhouse Bangalore and Lovelock & Lewes Kolkata as well as in Price Waterhouse & Co. Kolkata. 12. It was further alleged in the SCN that the 11 firms have common branch offices located in New Delhi, Mumbai, Kolkata, Chennai, Bangalore, Hyderabad, Pune, Gurgaon, Bhuvneshwar & Ahmedabad and there were several common partners in these firms. These firms share resources, manpower, offices, revenues, etc. amongst themselves and, for this purpose, the 11 firms have entered into an agreement in 2000 for resource sharing. It was further stated that the members of the engagement team which worked on the audit of SCSL was on the pay roll of Price Waterhouse Kolkata and Lovelock & Lewes Kolka .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... Act ). It was submitted that under the provisions of the SEBI Act and the Regulations framed thereunder, directions can be issued by SEBI for regulating the securities market, but beyond that, it had no power to issue any such directions. It was contended that the powers of SEBI cannot be construed to cover anybody under its umbrella on the ground of regulating the securities market. The petitioners in Writ Petition No. 5256 of 2010 submitted that the said petitioners had not taken part in any manner in the matter of audit of accounts of the Company and therefore the show cause notice could not be issued against them. It was asserted that the show cause notice could not be issued simply because the petitioners were associated with Price Waterhouse & Company. It was contended that if there was any occasion or request on the part of any Chartered Accountants in the matter of discharging their professional duties, it is only the ICAI which had the power to regulate the profession of the Chartered Accountant (CA) under the CA Act. 16. The contention of SEBI before the High Court was that by issuing notices to CA s and to the audit firms, SEBI was not regulating the profession of CA .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... xistence of which depends jurisdiction of a court, a tribunal or an authority. It is the fact upon which an administrative agency's power to act depends. If the jurisdictional fact does not exist, the court, authority or officer cannot act. If a Court or authority wrongly assumes the existence of such fact, the order can be questioned by a writ of certiorari. The underlying principle is that by erroneously assuming existence of such jurisdictional fact, no authority can confer upon itself jurisdiction which it otherwise does not possess. 19. On the question of jurisdiction, the Bombay High Court held that it was not open to SEBI to encroach upon the powers vested with the ICAI under the CA Act. The powers available to SEBI under SEBI Act are to be exercised in the interest of investors and interest of securities market. Further, in order to safeguard the interest of investors or interest of securities market, SEBI was entitled to take all ancillary steps and measures to ensure that the interest of the investors were protected. 20. The Bombay High Court held that the jurisdiction of SEBI would depend upon the evidence which is available during such enquiry and if any material wa .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... anner. 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. So far as listed Companies are concerned, the SEBI has all the powers under the Act and the Regulations to take all remedial and protective measures to safeguard the interest of investors and securities market. and further held:- Normally, an investor invests his money by considering the financial health of the Company and in order to find out the same, one will naturally would bank upon the accounts and balance-sheets of the Company. 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. In our view, the SEBI has got inherent powers to take all ancillary steps to safe .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... ebar a Chartered Accountant from practicing as Chartered Accountant but SEBI can definitely take regulatory measures under the SEBI Act in the matter of safeguarding the interest of the investors and securities market and in order to achieve the same, it can take appropriate remedial steps which may include keeping a person including a Chartered Accountant at a safe distance from the securities market. SEBI can always take preventive as well as remedial measures in this behalf. Exercising such powers, therefore, cannot be said to be in any way in conflict with the powers of the Institute under the CA Act. If ultimately any decision is taken by debarring any particular person from auditing the books of a listed company, such direction can always be said to be within the powers of SEBI and that is in the aid of regulating the affairs in connection with the investors interests and the interest of the securities market. By exercising such powers, it cannot be said that the SEBI is trying to regulate the profession of Chartered Accountants in any manner and in that view of the matter, in our view, it can never be said that it is in conflict with Section 24 of the CA Act. The Bombay High .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... and fudge the books of accounts is a matter of investigation and inquiry by the SEBI. Ultimately if any evidence in this behalf is brought on record before the SEBI during the inquiry, appropriate steps can be taken in this behalf as provided for by the SEBI Act. 26. Insofar as the petitioner s of Writ Petition No. 5256 of 2010 were concerned, the Bombay High Court held that SEBI would adjudicate whether a petitioner firm of CA had any role to play and if in a given case, ultimately it was found that there was only omission without any mens rea or connivance with anyone, then on such evidence, SEBI could not issue any further directions. The Bombay High Court, in this regard, held:- SEBI being a quasi-judicial authority, while adjudicating the matter, will look into this aspect and will consider as to whether any particular firm of Chartered Accountants has any role to play or for that reason any of the petitioners had played any role in any manner they may bring the matter to the notice of the SEBI. In a given case, if ultimately it is found that there was only some omission without any mens rea or connivance with anyone in any manner, naturally on the basis of such evidence the S .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... . Vatsala Pant, Advocates for the appellant in Appeal No. 191 of 2018 and Mr. Ravi Kadam, Senior Advocate along with Mr. Kevic Setalvad, Senior Advocate, Mr. Jayesh Ashar, Mr. Mihir Mody, Ms. Shreya Parikh, Mr. Sushant Yadav and Mr. Tabish Mooman, Advocates for the respondent in all the appeals. 29. As per the directions of the Bombay High Court, the scope of enquiry was restricted only to the charge of conspiracy and involvement in the fraud and not to any charge of professional negligence. The charge of conspiracy and involvement in the fraud was required to be established on the basis of material available on the basis of investigation. The Bombay High Court had narrowed the scope of enquiry under the SEBI Act as it was aware that the appellants are Chartered Accountant / Chartered Accountant firms and were not dealing directly in the securities. The Bombay High Court, thus, held that there must be evidence to show that the engagement partners / audit firms had indulged in or were instrumental in the fabrication of the books of account of SCSL and that there was an intention or knowledge in connivance or collusion with the management of the SCSL in fudging the books of account. .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... nce. Black s Law Dictionary 6th Edition defines collusion as an agreement between two or more persons to defraud a person of his rights by the forms of law, or to obtain an object forbidden by law. It implies the existence of fraud of some kind, the employment of fraudulent means, or of lawful means for the accomplishment of an unlawful purpose. Connivance means the secret or indirect consent or permission of one person to the commission of an unlawful or criminal act by another (Black s Law Dictionary 6th Edition). Black s Law Dictionary 8th Edition defines connivance to mean the act of indulging or ignoring another s wrongdoing. Advanced Law Lexicon 5th Edition defines connivance as voluntary blindness to some present act or conduct. Fraudulent means based of fraud; proceeding from or characterized by fraud, tainted by fraud; done, made, or effected; tainted by fraud; done, made or effected with a purpose or design to carry out a fraud. A statement, or claim, or a document, is fraudulent if it was falsely made, or cause to be made with the intent to deceive. To act with intent to fraud means to act willfully, and with the specific intent to deceive or cheat; ordinarily for the pu .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... cation and fabrication of the books of account of SCSL. 33. This leads us to go into the question as to how WTM has arrived at a finding that the appellants were guilty of misconduct and were responsible for the fabrication of the books of account of SCSL. The findings are as follows:- (i) the balance in the current account of SCSL with Bank of Baroda, New York Branch was overstated by ₹ 1731.88 crore as on 30.09.2008. The confirmation did not match with balances as per bank reconciliation statement. (ii) the auditors relied on the bank confirmation purportedly received from Bank of Baroda, New York through SCSL for confirmation of the balances in the current account with Bank of Baroda New York. (iii) the firm failed to seek direct confirmation of bank balance from Bank of Baroda, New York and only sought balance confirmation from other banks having nil or negligible balance. (iv) fixed deposit account of SCSL held in 5 banks were overstated by ₹ 3308.41 crore as on September 30, 2008. These fixed deposits were fabricated documents which the auditors failed to detect. The letters of confirmation addressed to the auditors were received from the Company by the auditors a .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... (bank balances and FDs), reliability of audit evidence, external confirmation and having an attitude of professional skepticism. (xiv) the auditors failed to detect the fabrication of the Invoicing Management System (IMS) of SCSL which were exported manually from the IMS into the Oracle Financials which was the accounting software used by SCSL which resulted in the inflation of the revenues of SCSL. This failure to detect the fake invoices occurred as auditors failed to carry out any reconciliation between invoices in Oracle Financials (OF) and IMS. Failure to detect the fake invoices indicated the quality of audit and thus did not conduct the audit with bonafide intentions. (xv) the alternate procedure as per para 39 of the AAS 30 adopted by the auditors was prone to potential fraud risk and, in any case, did not relieve the auditor from this obligation of conducting a satisfactory confirmation of debtors. (xvi) passive acceptance at face value of information provided by SCSL does not benefit the stature of audit and amounts to gross negligence. (xvii) the carefully laid out scheme of fraud and fabrication of accounts in SCSL by the top management of SCSL was not possible without .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... legitimately arrived at on a consideration of the totality of the materials, would be permissible and legally justified. …. . 36. Before we deal with the findings given by the WTM and the submission made by the parties it would be appropriate to extract the provisions of Section 12A of the SEBI Act as well as Regulation 2(1)(b), 2(1) (c), 3 & 4 of the PFUTP Regulations which reads as follows:- SEBI Act Prohibition of manipulative and deceptive devices, insider trading and substantial acquisition of securities or control. 12A. No person shall directly or indirectly- (a) use or employ, in connection with the issue, purchase or sale of any securities listed or proposed to be listed on a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of this Act or the rules or the regulations made thereunder; (b) employ any device, scheme or artifice to defraud in connection with issue or dealing in securities which are listed or proposed to be listed on a recognised stock exchange; (c) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person, in connection with the i .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... that affects the market price of the security, resulting in investors being effectively misled even though they did not rely on the statement itself or anything derived from it other than the market price. And fraudulent shall be construed accordingly; Nothing contained in this clause shall apply to any general comments made in good faith in regard to- (a) the economic policy of the Government; (b) the economic situation of the country; (c) trends in the securities market; (d) any other matter of a like nature; whether such comments are made in public or in private; Prohibition of certain dealings in securities 3. No person shall directly or indirectly- (a) ……… (c) employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange; (d) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange in contravention of the provisions of the Act or the rules and the regulations .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... lly empowered to pass appropriate orders to protect the interest of investors in securities and securities market and such orders can be passed by means of interim measure or final order as against all those specified in the abovereferred to provisions, as well as against any person. The purport of the statutory provision is protection of interests of the investors in the securities and the securities market. 79. Along with Section 12-A, when we read Regulation 2(1)(c) of the 2003 Regulations, the act of fraud has been elaborately defined to include any kind of activity which would work against the interest of the investors in securities. Further, such interest of the investors can be better ascertained by making reference to Section 2(h)(iii) of the SCR Act, 1956 which defines security to mean the right or interest in securities. A conspectus reference to Sections 12-A(a), (b) and (c) read along with Regulations 2(1)(b) and (c), as well as Section 2(h)(iii) of the SCR Act, 1956 sufficiently disclose that it would cover any act which will have relevance in protecting the interest of the investors in securities and security market with any person however remotely the same are connec .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... ted impact on the market resulting in the creation of artificiality . 39. Thus, Section 12A of the SEBI Act creates a clear prohibition of manipulative and deceptive devices, insider trading and acquisition of securities. Section 12A(a),(b) & (c) stipulates that no person should directly or indirectly indulge in such manipulative and deceptive devices in connection with the issue, purchase and sale of any securities or use any device or engage in any act which would operate as fraud or deceit on any person while dealing in securities. The emphasis is on the word(s) securities and dealing in securities . The manipulative and deceptive devices which would operate as a fraud or deceit is directly linked to securities and dealing in securities . If a person is not dealing in securities either directly or indirectly then Section 12A would not be applicable. In this regard securities have been defined under Section 2(h) of the Securities Contracts (Regulation) Act, 1956 ( SCRA Act for short) which is extracted hereunder:- (h) securities include- (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated com .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... object and purpose of the 2003 FUTP is to curb market manipulations . Market manipulation is normally regarded as an unwarranted interference in the operation of ordinary market forces of supply and demand and thus undermines the integrity and efficiency of the market. 29. On a comparative analysis of the definition of fraud as existing in the 1995 Regulations and the subsequent amendments in the 2003 Regulations, it can be seen that the original definition of fraud under the FUTP Regulations, 1995 adopts the definition of fraud from the Contract Act, 1872 whereas the subsequent definition in the 2003 Regulations is a variation of the same and does not adopt the strict definition of fraud as present under the Contract Act. It includes many situations which may not be a fraud under the Contract Act or the 1995 Regulations, but nevertheless amounts to a fraud under the 2003 Regulations. 30. The definition of fraud under clause (c) of Regulation 2 has two parts; first part may be termed as catch all provision while the second part includes specific instances which are also included as part and parcel of term fraud . The ingredients of the first part of the definition are: 1. includes .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... se situations and possibilities. Once a conclusion, that fraud has been committed while dealing in securities, is arrived at, all these provisions get attracted in a situation like the one under consideration. We are not inclined to agree with the submission that SEBI should have identified as to which particular provision of the 2003 FUTP Regulations has been violated. A pigeon-hole approach may not be applicable in this case instant. 47. Accordingly, non-intermediary front-running may be brought under the prohibition prescribed under Regulations 3 and 4(1), for being fraudulent or unfair trade practice, provided that the ingredients under those heads are satisfied as discussed above. From the above analysis, it is clear that in order to establish charges against tippee, under Regulations 3(a), (b), (c) and (d) and 4(1) of the 2003 FUTP, one needs to prove that a person who had provided the tip was under a duty to keep the non-public information under confidence, further such breach of duty was known to the tippee and he still trades thereby defrauding the person, whose orders were front-runned, by inducing him to deal at the price he did. 54. The definition of fraud , which is an .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... the legislature inserted every part for a purpose and the legislative intention is that every part of the statute should have effect. While interpreting a provision, the effort must always be made to find out the true intention behind the law. 43. From the aforesaid decisions and on a reading of the provisions of Section 12A of the SEBI Act and Regulation 3 & 4 of PFUTP Regulations, it is apparently clear that the object of Section 12A & PFUTP Regulations is to curb market manipulations . The manipulative and deceptive devices must be in relation to securities and must be by a person dealing in securities . The Supreme Court in Kanaiyalal (supra) has expanded the term person to include a non-intermediary culpable under the PFUTP Regulations as the front runner was found to be dealing with the securities. Further, the charge against the tippee was required to be proved under Regulation 3(a),(b),(c),(d) & 4(1) of the PFUTP Regulations. Further, the use of manipulative device was intended to deceive another person. The Supreme Court thus enlarged the scope of fraud under the PFUTP Regulations to cover an action or omission even without deceit if such act or omission had t .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... taken up only by ICAI. 45. The evidence that has been brought on record indicates that certain directors and employees had connived in the fabrication, falsification and misrepresentation in the books of account and financial statements of SCSL. The books of account contained false and inflated current account bank balances, fixed deposit balances, fictitious interest from sales. We find that there is no direct evidence to show that the engagement partners / audit firms / other PW firms were directly involved in the fabrication of the books of account of SCSL. In fact, the Chairman of SCSL has gone on record in so many words that the statutory auditors were kept in the dark and that they had no role to play in the fudging of the books of account. 46. The fraud at SCSL involved deception by way of manipulation, fabrication, alteration of accounting records and supporting documents from which the financial statements were prepared. Apparently, audit team s audit procedures did not reveal SCSL s alleged fraud because there was a devious systematic scheme by the SCSL s Directors, management and employees to circumvent SCSL own corporate governance structure, internal controls and inte .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... ly misconceived and based on surmises and conjectures. In the peculiar facts and circumstances of the case, a finding of guilt cannot be imposed upon the appellants on the basis of preponderance of probabilities. There has to be a specific finding that there was an intention on the part of the engagement partners and/or of the audit firm that they had deliberately with intention and knowledge fabricated the books of accounts of SCSL in connivance with the top management of SCSL. In the instant case, there is overwhelming evidence to show that the fabrication and falsification of books of accounts was done only by the top management of SCSL and that the engagement partners as well as the audit firm had no clue nor had any hand in this fraud. Thus, pinning down the engagement partners and the audit firms on a preponderance of probabilities that they had committed a big fraud in a reckless and careless manner cannot in our view lead to a conclusion that there was any intention or mens rea on their part. The High Court was very clear and categorical that SEBI could only proceed under the SEBI laws only if there was a specific finding of mens rea against the engagement partners and / or .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... s dealing directly or indirectly in securities. It is in this light that the Bombay High Court clearly held that mens rea is required to be proved and that there must be an intention and knowledge that an engagement partner / audit firm connived or colluded with the management in the falsification and fabrication of the books of account. The High Court clearly recorded:- It is further submitted that during inquiry if any evidence is brought to the effect that the Auditors with the connivance and in collusion with Mr. Ramalinga Raju had fabricated the accounts, then naturally SEBI can proceed against the petitioners. In furtherance to the aforesaid, the Bombay High Court further held:- In a given case, if ultimately it is found that there was only some omission without any mens rea or connivance with anyone in any manner, naturally on the basis of such evidence the SEBI cannot give any further directions. 53. Thus, in order to issue any directions under the SEBI Act, SEBI was required to establish with evidence regarding connivance and collusion by the auditors with the management of SCSL in the falsification of the books of accounts. In the present case there is no shred of evidenc .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... panies Act. 57. Auditing and Assurance Standards (AAS) has been framed by ICAI relating to the role and responsibility of an auditor. Under AAS2, the objective of an audit of financial statements, prepared within a framework of recognized accounting policies and practices and relevant statutory requirements, if any, is to enable an auditor to express an opinion on such financial statements. The auditor s opinion helps determination of the true and fair view of the financial position and operating results of an enterprise. The user, however, should not assume that the auditor s opinion is an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which management has conducted the affairs of the enterprise. The auditor s work involves exercise of judgement, for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgements and estimates made by management in preparing the financial statements. Furthermore, much of the evidence available to the auditor can enable him to draw only reasonable conclusions therefrom. Because of these factors, absolute certainty in auditing is rarely attainable. In forming h .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... cial statements will be detected. The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting a material misstatement resulting from error because fraud, generally, involves sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional misrepresentations being made to the auditor. Such attempts at concealment may be even more difficult to detect when accompanied by collusion. Collusion may cause the auditor to believe that evidence is persuasive when it is, in fact, false. The auditor's ability to detect a fraud depends on factors such as the skillfulness of the perpetrator, the frequency and extent of manipulation, the degree of collusion involved, the relative size of individual amounts manipulated, and the seniority of those involved. Audit procedures that are effective for detecting an error may be ineffective for detecting fraud. Furthermore, the risk of the auditor not detecting a material misstatement resulting from management fraud is greater than for employee fraud, because those charged with governance and management are often in a pos .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... rent and control risk, and how the evidence from other planned audit procedures would reduce audit risk to an acceptably low level for the applicable financial statement assertions. The auditor should employ external confirmation procedures in consultation with the management. In deciding the extent to use external confirmations, the auditor is required to consider the characteristics of the environment in which the entity being audited operates and the practice of potential respondents in dealing with requests for direct confirmation. When obtaining evidence for assertions not adequately addressed by confirmations, the auditor considers other audit procedures to complement confirmation procedures or to be used instead of confirmation procedures. 60. Under AAS 28, the report should include a statement that the financial statements are the responsibility of the entity s management and a statement that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. Financial statements are the representations of management. The preparation of such statements requires management to make significant accounting estimates and judgments, as well .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... rous. Their work is responsible and laborious, and the remuneration moderate………… auditors must not be made liable for not tracking out ingenious and carefully laid schemes of fraud when there is nothing to arouse their suspicion, and when those frauds are perpetrated by tried servants of the company and are undetected for years by the directors. So to hold would make the position of an auditor intolerable. The Court further held- On consideration of the authorities cited at the Bar, the principles which can be carved out are as follows: The auditor is required to employ reasonable skill and care, but 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 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 accounts are based, but he is not required to perform the functions o: a detective. What is reasonable care a .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... 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 blood-hound 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 must employ reasonable care and skill. What is reasonable care and skill must depend on the circumstances of each ease. 65. In the light of the aforesaid, picking one para of an AAS and thus holding the appellants to be guilty of gross negligence and recklessness in conducting the audit is misplaced. Merely because the auditors failed to seek direct confirmation from the Bank relating to bank balances and fixed deposit does not amount to gross negligence or recklessness. AAS should be read as a whole. No doubt, under AAS-30 there is a responsibility of sending letters seeking external confirmation and, by not seeking external confirmation, the auditors failed to exercise care and prudence. However, it does not mean that there was gross negligence or carelessness or that the auditors had any intention to defraud the shareholders of the invest .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... hat the auditor should proceed with an attitude of professional skepticism. The WTM lost fact that there are other accounting standards apart from AAS-4. 67. Reliance on the decision in United States vs Benjamin 328 F. 2D 854 (1964) of the US Court of Appeals is misplaced. The case was concerned with a securities fraud by an accountant. The Court was examining whether there was sufficient evidence to convict the accountant. In that context, the Court held that the accountant deliberately closed his eyes to facts he had duty to see. The accountant was convicted for conspiring willfully. It was found that the accountant had knowledge of the falsity of his reports and deliberately conspired to defraud investors. In that light the Court observed that the accountant deliberately closed his eyes. No such finding to this extent has been found in the instant case. 68. From the aforesaid decisions, the principles which can be culled out is that the auditor is required to employ reasonable skill and care but the auditor is not required to begin with suspicion or to proceed in the manner of trying to detect a fraud or a lie, unless some information has reached which creates suspicion. What is .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... rensic audit is to catch the perpetrators of the financial theft and fraud which could range from money laundering, tax evasion, false documentation, etc. Auditing the books of account and forensic auditing are two different and distinct areas. The procedures for financial audits are designed to detect material misstatement and not in material frauds. There is no doubt that many of the financial misstatements and frauds could be detected with the use of financial audits which can only be done by a detailed examination of the audit trail as well as the events and activities behind the documents. This procedure is problematic and involves a lot of time. On the other hand, financial audit is dependent on sample documents and reliance on the audit trail coupled with the fact that financial audit has to be completed within a stipulated period. 72. Thus, the auditor must not be made liable for not tracking the carefully laid schemes of fraud when there was nothing to arouse their suspicion especially when the fraud is perpetuated by the top management of the Company and remain undetected for years. The auditor does conduct the audit with the objective of discovering all frauds. When an a .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... ully the events leading up to this methane explosion to ascertain what assessment was made of the methane explosion risk, and why; but it is necessary if the defendants conduct is to be fairly judged, that the making of this detailed retrospective assessment should not of itself have the effect of magnifying the significance of the methane risk as it appeared or should reasonably have appeared to ordinarily competent practical men with a job to do at the time. 75. The aforesaid principle was adopted by the Supreme Court in Jacob Mathew vs State of Punjab and Another (2005) 6 SCC 1. In Re: A Vakil, ILR (1925) 49 Mad, it was held that negligence by itself is not a professional misconduct. It must have the element of moral delinquency. Similar view was adopted by the Supreme Court in Pandurang Dattatraya Khandekar vs. Bar Council of Maharashtra, Bombay and Ors. AIR 1984 SC 110. 76. SEBI under the SEBI Act enjoys wide powers under Section 11, 11A and 11B to protect the interests of the investors in the securities market by taking such measures as it thinks fit. In Securities and Exchange Board of India vs Pan Asia Advisors Limited and Others (2015) 14 SCC 77, the Supreme Court held:- 7 .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... 1 or associated with securities market or to any company in respect of matters specified in Section 11-B in the interest of investors in the securities and the securities market. The paramount duty cast upon the Board, as stated earlier, is protection of interests of the investors in securities and securities market. In exercise of its powers, it can pass orders of restraint to carry out the said purpose by restraining any person. 77. In Sahara India Real Estate Corporation Limited and Others vs Securities and Exchange Board of India and Another (2013) 1 SCC 1, the Supreme Court held the SEBI Act is a special law and a complete code in itself containing elaborate provisions with respect to protection of the interests of the investors. The SEBI Act is a special Act dealing with a specific subject which has to be read in harmony with the provisions of the Companies Act, 1956. The Companies Act and the SEBI Act will have to work in tandem in the interests of the investors. The Supreme Court held:- 303.1. Sub-section (1) of Section 11 of the SEBI Act casts an obligation on SEBI to protect the interest of investors in securities, to promote the development of the securities market, and .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... urisdiction under the SEBI Act and its Regulations. Thus, the role of debarment is beyond the scope and powers under Section 11 and 11B of the SEBI Act. Direction under Section 11 and 11B of the SEBI Act can be issued to a person associated with the securities market. Such directions can only be remedial. If such person is not dealing in securities then only remedial direction could be issued. Preventive directions cannot be issued. In our opinion, debarment is punitive. We may further point out that ICAI had initiated proceedings against the auditors under the CA Act and cancelled their license to practice as CA. Once their license has been cancelled, there was no need for SEBI to issue an order of debarment. In our opinion, it was a redundant exercise in view of Section 226 of the Companies Act which stipulates that only a CA under the CA Act could audit a Company. Once the license of an auditor to practice as a CA has been cancelled by the ICAI, the question of auditing the books of account of any company does not arise. 79. Appeal No. 6 of 2018 has been filed by ten partnership firms of CA comprising several partners having their head office at various places in India. The said .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... e documents, PW network firms in India are linked to each other on the following two fundamental basis: a. the firms comprising the network are either members of or connected with the Price Waterhouse Coopers International Ltd. (PWCIL), a United Kingdom based private company; and b. there are Resource Sharing Agreements with each other. (i) The PW network of audit firms neither operate as a corporate multinational, nor do they act as agent of any other member firm. (ii) Each of the ten firms- (a) is wholly owned by Indian nationals registered as Chartered Accountants with the ICAI (b) is a separate entity (c) does not own stakes in one another (d) is separately registered with ICAI (e) maintains separate books of account (f) accounts for profit and loss as a separate entity (g) pays its personnel from separate budgets (h) has their own PAN and GST Registrations (i) files separate income tax returns 84. The WTM by the impugned order restrained the ten firms from issuing any certificate of audited listed companies under the brand and banner PW and further directed the listed companies and intermediaries registered with SEBI not to engage any one firm forming part of the PW network fo .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... us in law and the directions given by the Bombay High Court was totally disregarded. The impugned order is stated to have been passed under Section 11 and 11B of the SEBI Act which empowers SEBI to issue directions in the nature of remedies in the interest of the securities market and investors in securities. It was urged that the action taken in the impugned order is not remedial but punitive in nature. It was contended that the alleged irregularities from 2000 to 2009 was only noticed when B. Ramalinga Raju made a statement in January 2009 with regard to financial manipulation in the books of account of the SCSL. The impugned order was passed on January 10, 2018 after nine years from the date of issuance of the SCN. It was thus urged, that no remedial action could be taken after nine years. The action had become stale and the delay caused, at the instance of SEBI, was not curable. 86. It was urged that the ban imposed is on the CA firms and not on the partners. It was contended that as on the date of the impugned order there were 98 partners in the ten firms out of which 70 are new partners who were not partners of the firms during the period 2000 to 2009 and thus banning them fr .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... r was wholly illegal and in violation of Article 14 & 19(1)(g) of the Constitution of India. 93. The stand of SEBI before us is the same. The learned senior counsel submitted that the findings given by the WTM does not suffer from any error of law. It was contended that under the SEBI Act, especially under Section 11 & 11B of the Act, SEBI enjoys wide and extensive power to issue any measures in the interest of investors and to promote the development of, and regulate the securities market. It was urged that one of the powers which SEBI can exercise is to issue a direction of debarment against persons associated with the securities market. 94. It was contended that the SCSL scam had a direct and adverse impact in the share market. The prices of SCSL scrip fell drastically. Millions of investors lost their hard earned money on account of abject failure on the part of the statutory auditor of SCSL in failing to comply with its duty to the shareholders of ensuring fairness and accuracy in the audited accounts. It was urged that failure to comply with the basic auditing standards constituted fraud and thus it was vital to uphold the directions in the impugned order against all .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... market. These firms are auditors registered with ICAI. They are independent bodies and have their own budget, maintain separate books of account and are assessed separately as a separate entity by the Income Tax Authority. These firms have no stakes in one another. These ten firms were not the statutory auditors of SCSL and were not involved in the auditing of the books of account of SCSL. There is no evidence of revenue sharing between the PW firms. 99. There is no evidence to indicate that the ten firms had any role to play in the audit of SCSL. These ten firms had nothing to do with the audit of SCSL. They had no knowledge of the day to day affairs of SCSL either directly or indirectly. There is not even a whisper of a finding in the impugned order against the ten firms about any connivance or collusion or intention or knowledge on their part in the audit of SCSL. The entire basis of debarring the ten firms is the resource sharing agreement, the brand PW and the networking of PW as a brand. In our opinion, the approach adopted by the WTM is patently erroneous and is flawed. 100. In the absence of any finding of connivance or collusion or intention or knowledge on the part of th .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... responsible and liable for the delivery of services to clients and for all consequences relating to the professional assignments executed by such firm regardless of whether any of the shares resources have been deployed in the provision of services relating to the respective assignments. F. Nothing contained in the agreement shall constitute an authority in favour of any of the Firms to represent, commit or engage on behalf of the other Firms merely by reason of the sharing of resources or any other act pursuant to the agreement. Nothing contained in the agreement shall constitute a partnership or an agency or donation of a power of attorney in fact or in law to represent, bind or liaise in favour of any Firm on behalf of any of the Firms. The sharing of resources pursuant to this agreement shall be purely on a principal-toprincipal basis alone. G. Any dispute or difference in relation to this agreement shall be resolved by binding arbitration by a sole arbitrator to be appointed by mutual consent in accordance with the Arbitration and Conciliation Act, 1996 IN WITNESS whereof this agreement has been duly executed the day and year abovewritten. 102. The resource sharing agreement .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... n is also a director are also penalized. Thus, if Srinivas Talluri and S. Gopalakrishnan are partners in a CA firm, a fault committed by them in that firm would not affect their liability in other CA firms. 105. ICAI has formulated Rules of Network amongst the firms registered with the ICAI. These Rules enable the practice of CA firms as a Network on a sharing of resources basis. In order to appreciate as to what in fact is a network, it would be relevant to extract a few provisions of the Rule:- RULES OF NETWORK 1. These Rules are called Rules for Network amongst the firms Registered with. The Institute of Cost Accountants of India. 2. Definition. (i) Network - Network amongst two or more firms means an arrangement to facilitate the better function of the affiliate member firms in the interest of the profession and not for acquisition of any gain Such Network shall include the formal Network to use collective resources such as turnover, infrastructures manpower location for execution of Professional services of one or more type. [Explanation - 1. An affiliation as referred to above shall also include: (i) Having an association with an accounting entity within or outside India such .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... cept the internal audit or book‐keeping or such other professional assignments which are prohibited for the statutory auditor firm. 6. Consent of Client: The network shall obtain consent of the client to engage affiliate in discharging the professional assignment. 8. Object of Network: The Network itself will not carry on any business for acquisition of gain for itself and only act as a facilitator for its members/constituents Members firms to pursue their professional jobs. 10. Issuing Reports: Only the firm(s)/Member(s) forming network are eligible to issue/sign/attest any certificate/Report/professional document/assignment 11. Violation of Act: In case of alleged violation of the provisions of the Act Regulations framed there under guidelines/directions laid down by the Council from time to time and Code of Ethics by the Network firm, the proprietary/partnership firms(s)/Individual Member constituting the Network would be answerable. 106. From the aforesaid, it is clear that the Rules of Network provide that two or more firms can form a network. Such network share includes the formal network to use the collective resources such as turnover, infrastructure, manpower, etc. F .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... under the name PW but that by itself does not make them responsible for the alleged irregularities in the audit of SCSL. The network Rules does not, in our opinion, shows that ICAI perceives a network of firms as a single unit . For the purpose of avoidance of conflict of interest, the clause relating to ethical compliance providing that if one firm of the network is a statutory auditor of an entity, then an associate firm of the same network cannot accept internal audit of the same Company does not amount nor can it lead to an inference that the PW network is working as one consolidated unit. So long as these ten firms are separately registered and are assessed separately under the Income Tax Act, SEBI cannot hold them to be one large unit / entity. 108. SEBI produced a compilation of documents which included engagement letters, balance sheets signed by auditors, correspondence issued by auditors, minutes of board meetings, in order to make a point that the firms were holding out to the market as one entity and that the various letters and balance sheets showed that they were being signed in the name Price Waterhouse and not any particular firm like the appellant in Appeal No. 7 .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... a company, in which case any partner so practicing may act in the name of the firm . Therefore, the stress on the words We , our etc in the audit opinion means that it represents the PW network is absolutely erroneous in as much as the representation was only by the concerned firm which conducted the audit. 111. SCSL and shareholders knew that they were appointing a firm and not a brand or a PW network. Further, SCSL and its shareholders knew that the specific partner alone would carry out the audit and not entire Firm. Audit can only be performed by a partner on behalf of a Firm and thus, the audit opinions have been signed by the concerned engagement partners of SCSL responsible for the audit. Section 229 of the Companies Act is a complete answer to the aforesaid. It provides:- 229. SIGNATURE OF AUDIT REPORT, ETC. Only the person appointed as auditor of the company, or where a firm is so appointed in pursuance of the proviso to sub-section (1) of section 226, only a partner in the firm practising in India, may sign the auditor's report, or sign or authenticate any other document of the company required by law to be signed or authenticated by the auditor. 112. The definition .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... untancy firms Maintenance of branch offices: where a chartered accountant in practice or a firm of chartered accountants has more than one office in India, each one of the offices shall be in separate charge of a member of the institute. This clearly explains signing of the letter by the Shivaji Park branch of the appellant in Appeal No. 7 by one of its partner. 115. Thus the mere fact that the webpage of PWC India describes that they have offices at various places in India does not mean that they refer to the offices of the ten firms in question. The webpage of PWC global may describe PWC as a brand but it does not mean that it includes the brand PW which is operational in India. In any case, even if there is a network of PW firms, implicating the ten firms on the ground of networking as PW firms is misconceived and untenable. There has to be a specific finding that the ten firms were in collusion and that there was intention and knowledge to play fraud in the audit of SCSL. 116. The webpage of PWC or PWC global does not identify that PW entities are working closely with each other under the same brand and identify themselves with the said brand. Even if the PW brand is being used .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... here had been gross violations of the auditing standards in the SCSL audit. 119. The WTM has relied upon certain observations made in these orders, some of which are extracted hereunder:- 4. The failures in the confirmation process on the Satyam audit were not limited to that engagement, but were indicative of a quality control failure throughout PW India. During the relevant period, PW India s quality control system failed to detect that engagement teams throughout PW India routinely relinquished control of the delivery and receipt of cash confirmations to their audit clients and rarely, if ever, questioned the integrity of the confirmation responses they received from the clients. Despite annual quality reviews, PW India did not recognize this compliance failure until after January 2009.... 11. Lovelock, PW Bangalore, PW Co. Bangalore, PW Co. Calcutta, and PW Calcutta are member firms of PricewaterhouseCoopers International Limited, a United Kingdom-based private company. 12. PW India, along with five other India-based PwC network Firms, operate as a domestic Indian network of related audit firms. As such, these firms share common audit and other assurance and assurance risk mana .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... nd Price Waterhouse & Co., Calcutta did not participate in the audits of SCSL. 121. In our view the observations made in SEC & PCAOB orders that failure in the confirmation process in the SCSL audit were not limited to that engagement but were indicative of a quality control failure throughout PW India or the observations that there had been gross violations of the auditing standards in the SCSL audit cannot be utilized. The WTM, in order to implicate the PW firms was then required to go into the individual accounting standards adopted by each firm in relation to their audit engagement with their listed Company and then arrive at a finding that the accounting standards were not a per the standards prescribed by the ICAI. Resource sharing agreement would not in our view lead to a conclusion that each firm was adopting the same accounting standards as adopted by the audit firm which audited SCSL. Thus, reliance by the WTM on the SEC & PCAOB orders does not prove connivance or collusion, nor leads to a conclusion that these firms do not meet with the prescribed accounting standards as per ICAI. 122. The decision in S. Sukumar vs. Secretary, Institute of Chartered Accountan .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... the firm is not distinguishable from the persons from time to time composing it; and when a new member is admitted he becomes one of the firm for the future, but not as from the past, and this present connection with the firm is no evidence that he ever expressly or impliedly authorized what may have been done prior to his admission. This is wholly consistent with the fact that after the admission of a new member, a new partnership is constituted, and thus special circumstances are required to be shown before the debts and liabilities of the old partnership are treated as having been undertaken by the new partnership. 127. From the aforesaid, it is apparently clear that every time there is a change in the partnership, the firm is treated to have been reconstituted and appropriate filings are done as per Regulation 190(4) and 190(7) of CA Regulations, 1988. 128. In this regard the appellants have taken a specific plea in paragraphs 6.20 and 6.24 of the memo of appeal, namely, that a majority of the current partners of the ten firms became partners only after 2009. This fact has not been denied by the respondent. As on the date of the impugned order there were 98 partners in the ten .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... a partnership agreement. A partnership agreement is the source of a partnership; it also gives expression to the other ingredients defining the partnership, specifying the business agreed to be carried on, the persons who will actually carry on the business, the shares in which the profits will be divided, and the several other considerations which constitute such an organic relationship. It is permissible to say that a partnership agreement creates and defines the relation of partnership and therefore identifies the firm. If that conclusion be right, it is only a further step to hold that each partnership agreement may constitute a distinct and separate partnership and therefore distinct and separate firm. That is not to say that a firm is a corporate entity or enjoys a juristic personality in that sense. The firm name is only a collective name for the individual partners. But each partnership is a distinct relationship. The partners may be different and yet the nature of the business may be the same, the business may be different and yet the partners may be the same. An agreement between the partners to carry on a business and share its profits may be followed by a separate agre .....

X X X X X X X

Full Text of the Document

X X X X X X X

..... cross examination. SEBI did not do so and took the matter to the Supreme Court and kept it pending for six years. The Supreme Court on January, 2017 held that the stand of SEBI was incorrect and directed that cross examination and inspection should be allowed to the appellants. 134. During the pendency of the proceedings, the appellants were carrying on their business and auditing listed companies to the satisfaction of the shareholders and / or of the investors without any blemish. Over the last decade, the appellants have adopted extensive remedial measures as per SEC / PCAOB settlement orders. The independent monitors appointed by SEC / PCAOB have certified that remedial measures have been successfully implemented, meaning thereby that the audit quality met with the requisite standards. Thus looking from this angle also, the order of debarment was not the appropriate choice. 135. Thus, considering the aforesaid we are of the view that the order of WTM debarring the PW firms to audit listed company on the ground of PW network or projecting it as a PW brand cannot be sustained. 136. There is no doubt that there has been a professional lapse on the part of the auditors in conductin .....

X X X X X X X

Full Text of the Document

X X X X X X X

 

 

← Previous Next →

 

 

|| Home || About us || Feedback || Contact us || Disclaimer || Terms of Use || Privacy Policy || Database || Members || Refer Us ||

© Taxmanagementindia.com [A unit of MS Knowledge Processing Pvt. Ltd.] All rights reserved.
|| Blog || Site Map - Recent || Site Map ||