2019 (9) TMI 592 - AT - SEBI

Legality and veracity of the order passed by the Whole Time Member ( WTM ) of SEBI under Sections 11 and 11B of the Securities and Exchange Board of India Act, 1992 which empowers SEBI 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 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. 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. There is no doubt that there has been a professional lapse on the part of the auditors in conducting the audit especially their failure to seek direct confirmation from the Bank relating to Bank Balances and fixed deposits. These lapses amounted to negligence. Action has already been taken by ICAI against the auditors. Negligence is the breach of duty caused by omission to do something which a reasonable man is guided by these considerations to do something which a prudent and reasonable man would not do so. Negligence becomes actionable on account of a lapse or omission amounting to negligence. In the concept of negligence amounting to an offence, the element of mens rea must be shown to exist, but under Torts, negligence becomes actionable on account of lapse or omission. Once you breach your duty, negligence becomes actionable as there has been a failure to attain that standard of care. A professional such as an auditor comes under a category of persons professing some special skill. Any task which is required to be performed with a special skill would generally be undertaken to be performed only if the person possesses the requisite skill for performing that task. The only assurance which such professional can give is, that he is possessed of the requisite skill in that branch of profession which he is practicing and that he would be exercising his skill with reasonable competence. This is what a person / Company approaching the professional can expect. A professional may be held negligent if he is not possessed of the requisite skill which he professed to have possessed or he did not exercise with reasonable competence. The standard to be applied for judging whether the person charged has been negligent or not, would be that of an ordinary competent person exercising ordinary skill in that profession. It is not 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

Summary

Issues Involved:
1. Jurisdiction of SEBI over Chartered Accountants (CAs) and CA firms.
2. Conspiracy and involvement of auditors in the fraud at Satyam Computer Services Limited (SCSL).
3. Professional negligence versus fraudulent conduct.
4. Liability of CA firms under the Price Waterhouse (PW) network.
5. Validity of SEBI’s punitive measures against CA firms and auditors.
6. Disgorgement of wrongful gains by the auditors and CA firms.

Detailed Analysis:

1. Jurisdiction of SEBI over Chartered Accountants (CAs) and CA firms:
The Bombay High Court clarified that SEBI could investigate and take action against CAs and CA firms if there was evidence of their involvement in preparing false and fabricated accounts with knowledge and intent. SEBI’s jurisdiction was limited to cases where there was clear evidence of connivance and collusion with the management of a listed company in falsifying accounts.

2. Conspiracy and involvement of auditors in the fraud at Satyam Computer Services Limited (SCSL):
The investigation revealed that SCSL’s financial statements were manipulated, but there was no direct evidence showing that the auditors from Price Waterhouse (PW) firms were involved in the fabrication of accounts. The auditors were found to have relied on the documents provided by SCSL, which turned out to be falsified by the company’s management. The Tribunal concluded that the auditors did not have any intention or knowledge of the fraud perpetrated by SCSL’s management.

3. Professional negligence versus fraudulent conduct:
The Tribunal differentiated between professional negligence and fraudulent conduct. It held that the auditors’ failure to seek direct confirmation of bank balances and fixed deposits amounted to negligence but did not constitute fraud. The auditors’ actions were seen as lapses in professional duty rather than intentional misconduct. The Tribunal emphasized that negligence alone does not equate to fraud unless there is evidence of intent and collusion.

4. Liability of CA firms under the Price Waterhouse (PW) network:
The Tribunal found that the ten PW firms were independent entities with separate legal and financial identities, despite sharing resources under a network agreement. There was no evidence that these firms were involved in the audit of SCSL or had any knowledge of the fraud. The Tribunal rejected the notion that the entire PW network could be held liable for the actions of one firm, emphasizing that liability cannot be transferred across independent entities within a network.

5. Validity of SEBI’s punitive measures against CA firms and auditors:
The Tribunal held that SEBI’s order debarring the PW firms and auditors from auditing listed companies was punitive and not remedial. It was found to be in violation of Article 19(1)(g) of the Constitution, which guarantees the right to practice any profession. The Tribunal stated that SEBI’s powers under Sections 11 and 11B of the SEBI Act are intended to be remedial and preventive, not punitive. The Tribunal quashed the debarment order, noting that the appropriate body to address professional negligence is the Institute of Chartered Accountants of India (ICAI).

6. Disgorgement of wrongful gains by the auditors and CA firms:
The Tribunal upheld SEBI’s order for the disgorgement of ?13,09,01,664 along with interest, concluding that the auditors and their firms should not retain the fee earned from the audit of SCSL due to the professional lapses. The Tribunal found that the auditors’ negligence justified the disgorgement order under Sections 11 and 11B of the SEBI Act.

Conclusion:
The Tribunal quashed SEBI’s order debarring the PW firms and auditors from auditing listed companies, emphasizing that SEBI’s jurisdiction is limited to cases of proven fraud involving intent and collusion. The Tribunal upheld the disgorgement order, recognizing the auditors’ professional negligence but distinguishing it from fraudulent conduct. The decision underscored the importance of maintaining the distinction between professional lapses and intentional fraud, and the appropriate jurisdiction of regulatory bodies.