Statutory auditors cleared of fraud charges despite gross negligence in inflated sales audit case

SEBI disposed of proceedings against statutory auditors accused of professional misconduct in preparing financial statements showing inflated sales and non-existent transactions. While SEBI found gross negligence and dereliction of duty by the auditors, insufficient evidence existed to prove fraudulent connivance with company management. The auditors had issued qualified reports highlighting irregularities, which supported their defense. SEBI granted benefit of doubt regarding fraud allegations but issued cautionary advice and directed forwarding the order to ICAI and NFRA for appropriate professional disciplinary action.

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Issues Involved:
1. Manipulation of financial statements by ARL.
2. Role of statutory auditors in the manipulation.
3. SEBI's jurisdiction and actions against the statutory auditors.

Summary:

Issue 1: Manipulation of Financial Statements by ARL

SEBI received a forensic audit report from Punjab National Bank highlighting irregularities in ARL's financial statements, showing inflated sales and non-existent purchases. SEBI's preliminary examination revealed that ARL conducted transactions with controlled entities without actual movement of goods, prepared different sets of financial statements for FYs 2011-2013, and posted inflated figures in annual reports. The transactions with controlled entities were circuitous, indicating manipulation of sales and profits. Statutory auditors failed to detect these manipulations, resulting in shareholders being misled.

Issue 2: Role of Statutory Auditors in the Manipulation

The statutory auditors, M/s Doshi, Chatterjee, Bagri & Co. LLP (DCB), and R.K. Bagri, were alleged to have been negligent and failed to maintain professional standards. They did not adhere to the basic auditing procedures, such as sending confirmation letters to debtors, which would have revealed the fictitious nature of the transactions. The auditors were accused of aiding ARL in projecting untrue financial statements. The investigation found that the auditors failed to exercise professional skepticism and did not question the nature of circular transactions, thus facilitating the manipulation of financial statements.

Issue 3: SEBI's Jurisdiction and Actions Against the Statutory Auditors

SEBI issued a show cause notice to the auditors, asking why suitable directions/prohibitions should not be imposed against them. The auditors contended that SEBI lacked jurisdiction and that the delay in proceedings vitiated the case. They argued that forensic audits and statutory audits have different scopes and methodologies. Despite the auditors highlighting certain irregularities in a limited review report for the quarter ending December 31, 2014, SEBI found that the auditors were grossly negligent and derelict in their duties. However, SEBI acknowledged the lack of sufficient evidence to prove connivance or collusion with ARL's management.

Findings and Directions:

SEBI concluded that while there was gross negligence and professional misconduct by the auditors, there was insufficient evidence to prove their collusion with ARL's management. Consequently, SEBI disposed of the proceedings with a cautionary advice to the auditors to be careful while dealing in the securities market. SEBI directed that a certified copy of the order be forwarded to ICAI and NFRA for appropriate action. The order came into immediate effect, and copies were served to relevant parties for compliance.

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