Regulator doesn’t have the authority to bar audit firms, says appeals court
Criticizing Sebi, the appeals court order said the markets regulator cannot invoke laws in a ’cavalier fashion’
An appeals court on Monday quashed a ban on an Indian affiliate of PricewaterhouseCoopers and struck down charges that the auditor colluded with the management of Satyam Computer Services Ltd in what was termed India’s largest accounting scandal.
The order will have far-reaching implications on the way the country’s auditors are regulated, with the tribunal making it clear that Sebi does not have the authority to bar audit firms.
“Regulatory overlaps have been a contentious issue in India. This order will weed out those issues and make it very clear to both Sebi and RBI that their powers are clearly limited to regulating the core operational part of companies and banks," said Sandeep Parekh, co-founder and chief executive of Finsec Law Advisors. “Ultimately, the Supreme Court has to decide that auditors have a separate regulatory body and financial regulators cannot decide anything without working together with such bodies. This will come as a relief for all audit firms in India."
Criticizing Sebi, the SAT order said the markets regulator cannot invoke laws in a “cavalier fashion".
“Detecting fraud is difficult, especially involving material financial statement, misstatements, which occur in about 2% of all financial statements. Normally, the documents supporting omitted transactions are not kept in company files. False documentation is often created or legitimate documents are altered to support fictitious documents," the order said.
“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... financial audit is dependent on sample documents. 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 remained undetected for years," the SAT order said.
In January 2009, Satyam Computer chairman B. Ramalinga Raju confessed to fudging the information technology services company’s accounts over several years. A Sebi probe later revealed fraud amounting to at least ₹7,800 crore in Satyam’s books when PW was the auditor.
SAT also criticized Sebi for taking nine years to complete its proceedings.
The appellate tribunal, however, said that since PW was supposed to carry out its audit duty more diligently, ₹13.09 crore, which was taken by PW from Satyam as the audit fee, can be taken back with interest.
SAT found that Sebi has no evidence againstPW to prove that it has colluded with Satyam’s management. It ruled that an entity’s negligence cannot be construed as misconduct and processes employed in an audit firm can only be judged under the Chartered Accountants Act.
“Fraud has to be proven. There is no evidence of guilt and the engagement partners, audit firms had no clue or knowledge of the fraud. Professional scepticism does not mean the auditor has to sniff like a bloodhound," said a person familiar with the case.
Over the past year, several audit firms have been pulled up for alleged misconduct.
In June, the Reserve Bank of India imposed a one-year ban on SR Batliboi and Co. (the Indian affiliate of EY) after it found several lapses in the audit report of private lender Yes Bank Ltd.
BSR and Associates Llp (an affiliate of KPMG) and Deloitte Haskins and Sells are being scrutinized by six authorities for alleged breach of audit standards in failing to identify financial discrepancies at Infrastructure Leasing and Financial Services Ltd.
The agencies probing Deloitte and BSR include the Serious Fraud Investigation Office, National Financial Regulatory Authority, ICAI, Sebi and Enforcement Directorate.