TaxTMI 
TaxTMI 
2019 (9) TMI 592
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....: Mr. Ravi Kadam, Senior Advocate with Mr. Kevic Setalvad, Senior Advocate, Mr. Jayesh Ashar, Mr. Mihir Mody, Ms. Shreya Parikh, Mr. Sushant Yadav and Mr. Tabish Mooman, Advocates i/b K. Ashar & Co., Mr. Ravi Kadam, Senior Advocate with Mr. Kevic Setalvad, Senior Advocate, Mr. Jayesh Ashar, Mr. Mihir Mody, Ms. Shreya Parikh, Mr. Sushant Yadav and Mr. Tabish Mooman, Advocates i/b K. Ashar & Co. JUDGEMENT Per : Justice Tarun Agarwala, Presiding Officer 1. In this group of appeals, the appellants have questioned the legality and veracity of the impugned order passed by the Whole Time Member (hereinafter referred to as, 'WTM') of Securities and Exchange Board of India (hereinafter referred to as, 'SEBI') under Sections 11 and 11B of the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as, 'SEBI Act') which empowers SEBI to issue directions in the nature of remedies in the interest of the securities market and investors in securities. 2. The WTM held that:- (i) Entities / firms practicing as Chartered Accountant (CA) in India under the brand and banner of Price Waterhouse (PW) shall not directly or indirectly issue any certificate of a....
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....ers each year. SCSL had eminent board members with experience and qualifications in diverse fields as Independent Directors. SCSL was very much in the limelight on account of media and Analysts and there were no signs of adverse comments or suspicious remark on its performances or the management came to light. More also PCAOB conducted an oversight inspection on SCSL as a US listed Company in 2006-07 and the inspection team did not find any negative in the performance of SCSL as a whole. 7. In the year 2009, SEBI received an email dated January 7, 2009 from Shri B. Ramalinga Raju, the then Chairman of SCSL stating that the statements of accounts of SCSL were not true and fair. The e-mail basically revealed that there was large scale financial manipulation in the books of accounts of SCSL, namely, that the balance sheet of SCSL as of September 30, 2008 carried inflated / non-existent cash and bank balances. 8. On the basis of this information, SEBI carried out an investigation into the affairs of SCSL. The investigations revealed that the statutory auditor of SCSL was Price Waterhouse Chartered Accountant w.e.f. April 1, 2000. The investigations found that certain directors an....
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....dissemination of spurious and false data in the market albeit certified as true, which distorted the decision of millions of investors and induced them to trade in the securities of SCSL; (iv) these act of omission and commission, singly or jointly, in the discharge of their duties and "regardless of whether any criminal intent preceded such omissions or commissions clearly contained the key ingredients of the definition of fraud as laid down in SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003 ('PFUTP Regulations, 2003' for short). (v) for selectively obtaining direct confirmations in cases of certain bank accounts of SCSL which had nil or negligible balances while failing to obtain the same with respect to the account of Bank of Baroda, New York (BOB, NY) which showed the largest account balance (i.e. approximately 75% of all current account balances of SCSL) going upto Rs. 1731.88 crore in the quarter ending 30th September 2008. (vi) failure to consider the direct confirmations received from banks with respect to the figures of fixed deposits while blindly relying on the indirect confirmations ....
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.... "Price Waterhouse" in India. By judgment dated August 13, 2010, the Bombay High Court dismissed the Writ Petition holding that it cannot be said that SEBI at that stage, had no jurisdiction to issue a SCN simply because the appellants are professional Chartered Accountants. The Bombay High Court, however, set out the scope and extent of SEBI's power under Section 11 and 11B of SEBI Act read with Regulation 11 of the PFUTP Regulations to act against Chartered Accountants and the circumstances under which SEBI could issue direction to Chartered Accountants acting in their professional capacity. The Bombay High Court emphatically held that the jurisdiction of SEBI in the present case would depend upon the evidence which is available during the investigation and that if there was only some omission without any mens rea or connivance with anyone, in any manner, then SEBI could not issue any further direction. 14. The judgment of the Bombay High Court has become final inter se between the parties, as it was not challenged before a higher forum. All the parties thus, acquiesced to the observations / findings / directions given by the Bombay High Court. Much will depend upon the scope ....
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....able with SEBI and ultimately if it was found that the books of accounts of the Company were manipulated with knowledge and intent, then such manipulation would have a direct bearing on the securities market for which appropriate action could be taken. It was further asserted that if during the enquiry any evidence is brought to the effect that the auditors had connived and were in collusion with B. Ramalinga Raju and had fabricated the accounts then SEBI could proceed against the CAs and the audit firms. It was asserted that if the CAs had violated the norms and standards of accounting prescribed by the CA Act, SEBI had powers to take regulatory measures for protecting the investor's interest by taking appropriate steps against the CAs by preventing the CA from auditing the books of accounts of such listed Companies. It was thus contended that on the basis of prima facie evidence of fudging the books of accounts SEBI had the power and jurisdiction to issue notices and enquire into the matter. 17. The question whether SEBI as a market regulator could be said to have jurisdiction to pass any of the directions as contained in the SCN was considered by the Bombay High Court. Despit....
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....gh Court further held that whether any particular firm of CA had any role to play in any manner and if it was found that there was only some omission without any means rea or connivance with anyone in any manner, then on such evidence, SEBI could not give any further directions. The Bombay High Court was quite specific in holding that the jurisdictional fact would clearly depend upon the evidence that was unearthed during the enquiry. 21. The Bombay High Court held:- "It is true, as argued by the learned counsel for the petitioners, that while exercising powers under the Act, it is not open to the SEBI to encroach upon the powers vested with the Institute under the CA Act. However, it is required to be examined as to whether in substance by initiating the proceedings under the SEBI Act, the SEBI is trying to overreach or encroach upon the powers conferred under the CA Act. and further held:- "In order to safeguard the interest of investors or interest of securities market, SEBI is entitled to take all ancillary steps and measures to see that the interest of the investors is protected. Looking to the provisions of the SEBI Act and the Regulations framed there....
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....entive measures are required to be taken in this behalf." 22. The Bombay High Court held that the role of auditors is very important under the Companies Act and owe a duty to the shareholders and are required to give a correct picture of the financial affairs of the Company. The Bombay High Court observed:- "An investor is likely to be guided by the audited balance-sheet of the Company and would presume that the facts incorporated in the balance-sheet are true and correct. Considering the said aspect, even though the petitioners may not have direct association in the share market activities, yet the statutory duty regarding auditing the accounts of the Company and preparation of balance-sheets may have a direct bearing in connection with the interest of the investors and the stability of the securities market. In our view, the petitioners in their capacity as auditors of the Company Satyam, which was at one point of time considered to be a blue chip company who had a defining influence on the securities market, can be said to be persons associated with the securities market within the meaning of the provisions of the said Act." 23. On the question whether SEBI can re....
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....ular period" 24. The Bombay High Court held that it is open to SEBI to take into consideration the accounting standards prescribed under the CA Act to see if the CA has violated any audit norms then whether such CA should be allowed to function as an auditor of a listed Company if by construing such auditor of a listed Company it may hamper the interest of the investors of such a listed Company. The Bombay High Court however held that it is only the ICAI which is the regulating body to consider the professional norms, but in a given case if there is evidence to show that a CA has fabricated the books of accounts etc., then SEBI can issue directions not to utilize the services of such a CA in the matter of audit of a listed Company. The Bombay High Court further went on to hold:- "However, on conclusion of inquiry, if no evidence is available regarding fabrication and falsification of accounts, etc., then naturally SEBI cannot give any direction in any manner and ultimately its jurisdiction will depend upon the evidence which may be available in the inquiry and SEBI has to decide as to whether any directions can be given on the basis of available evidence on record." ....
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....- (i) On the basis of the allegation in the show cause notice, SEBI can investigate and enquire into the conduct of the CA and the CA firms in order to find out whether the books of accounts and balance sheet have been manipulated and/or fabricated. (ii) The manipulation of the books of accounts and balance sheet by the CA and the CA firms was done with their knowledge and intent. (iii) If during investigation and enquiry, if any evidence is brought on record to show that the auditors had connived and were in collusion with B. Ramalinga Raju and had fabricated the books of accounts of balance sheet, then SEBI can proceed in the matter and take appropriate steps against CA by preventing the CA from auditing the books of accounts of such listed Companies. (iv) SEBI can take into consideration the accounting standards provided under the CA Act to see whether a CA has violated any norms but upon conclusion of enquiry, if no evidence is available regarding fabrication, fabrication or fudging the books of accounts etc. then SEBI cannot issue any direction. (v) SEBI would adjudicate whether other Price Waterhouse firms had any role to play and ....
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....e conspiracy and involvement in the fraud and not on professional negligence. 30. In this regard the term / words used consistently by the Bombay High Court in its judgment becomes important and provides an insight to the scope of enquiry. The Bombay High Court in its judgment has consistently used the words "false", "fabricated", "fabrication", "falsification", "concocted" and "fudge" in relation to the books of account of SCSL. The Bombay High Court has also used the words "indulged", "instrumental", "intention", "knowledge", "connived", "collusion", "manipulation", "fraud" and "mens rea" in the fabrication or falsification of the books of account. These words speak volumes of the intent, scope and extent of the enquiry to be conducted under the SEBI laws. 31. Black's Law Dictionary 8th Edition, defines "false" as untrue, deceitful, lying, not genuine. What is false can be so by intent. The term "fabricate" means to invent, forge or devise falsely. To fabricate a story is to create a plausible version of events that is advantageous to the person relating those events. The term is softer than a lie (Black's Law Dictionary 7th Edition). "Falsification" means to counterfeit or....
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....tation of the truth or concealment of a material fact to induce another to act to his or her detriment (Black's Law Dictionary, 7th edition). "Misrepresentation" means any manifestation by words or other conduct by one person to another that, under the circumstances, amounts to assertion not in accordance with the facts; an untrue statement of fact; an incorrect or false representation that which, if accepted, leads the mind to an apprehension of a condition other and different from that which exists. Colloquially, it is understood to mean a statement made to deceive or mislead (Black's Law Dictionary, 6th edition). "Negligence" means the omission to do something which a reasonable man, guided by those ordinary consideratiosns which ordinarily regulate human affairs, would do, or the doing of something which a reasonable and prudent man would not do. Negligence is the failure to use such care as a reasonably prudent and careful person would use under similar circumstances; it is the doing of some act which a person of ordinary prudence would not have done under similar circumstances or failure to do of a person of ordinary prudence would have done under similar circumstances (Black....
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....refore it was left to the statutory auditors to conduct such verification which they failed to do so and they relied upon the balance confirmation letters received through SCSL which were found to be fabricated. (vi) the manner in carrying out the verification of the bank balance and fixed deposits was not in accordance with Auditing and Assurance Standards (AAS) issued by ICAI which was a mandatory requirement. (a) as per AAS 13, the auditors had a duty to obtain direct bank confirmation as a preliminary validation procedure which the appellants failed to do so. (b) as per AAS 30, the responsibility of sending the letters seeking external confirmation was upon the auditor which the firm failed to adhere to the said audit process. (c) as per AAS 30, the auditors were mandated to verify the source of contents of confirmation letters by additional audit procedures viz. telephonic calls, email, etc. which the appellants failed to do so. (vii) having failed to comply with the audit procedures as mandated under AAS, the appellants failed to fulfill these basic professional duties of an auditor. (viii) the auditors have relied upon th....
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....possible without the knowledge and involvement of the statutory auditors. (xviii) there were gaping holes in the auditing process since they did not follow scrupulously the AAS and Guidance Note, which points the needle of suspicion from negligence to one of acquiescence and complicity on the part of the auditors which in turns draws an inference of malafide and involvement on their part. (xix) the accumulated omission on the part of the auditors over eight years is an act of gross negligence and amount to an act of commission of fraud for the purposes of SEBI Act and SEBI PFUTUP Regulations. (xx) mens rea in the criminal sense is not relevant and is not required to be established in a violation alleged under PFUTP Regulations read with the SEBI Act in view of the Supreme Court decision in the case of Securities and Exchange Board of India vs. Shri Kanaiyalal Baldevbhai Patel & Others, (2017) 15 SCC 1. Thus reliance on the judgment of the Bombay High Court by the appellants was unnecessary and misplaced. 34. In a nutshell, the WTM held that failure to seek external confirmation of the bank balances, fixed deposits, failure to detect fake invoices witho....
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.... of business which operates or would operate as fraud or deceit upon any person, in connection with the issue, dealing in securities which are listed or proposed to be listed on a recognised stock exchange, in contravention of the provisions of this Act or the rules or the regulations made thereunder; (d) engage in insider trading; (e) deal in securities while in possession of material or non-public information or communicate such material or non-public information to any other person, in a manner which is in contravention of the provisions of this Act or the rules or the regulations made thereunder; (f) acquire control of any company or securities more than the percentage of equity share capital of a company whose securities are listed or proposed to be listed on a recognised stock exchange in contravention of the regulations made under this Act." "PFUTP Regulations "Definitions 2.(1) In these regulations, unless the context otherwise requires,- ................. (b) "dealing in securities" includes an act of buying, selling or subscribing pursuant to any issue of any security or agreeing to buy, sell or subsc....
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....ge 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 made there under. 4. Prohibition of manipulative, fraudulent and unfair trade practices (1) Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities. (2) Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud and may include all or any of the following, namely:- (a) indulging in an act which creates false or misleading appearance of trading in the securities market; .............. (e) any act or omission amounting to manipulation of the price of a security; (f) publishing or causing to publish or reporting or causing to report by a person dealing in securities any information which is not true or which he does not believe to be true prior to or in the course of dealing in securit....
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....nterest 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 connected with such securities, in the event of such an act working against the interest of investors in securities and securities market by way of fraud which has been elaborately defined under Regulation 2(i)(c) of the 2003 Regulations. 90. Under Section 12-A, it is specifically provided to prohibit any manipulative and deceptive devices, insider trading and substantial acquisition of securities or control by ANY PERSON either directly or indirectly. If SEBI's allegation listed out earlier as well as all the other allegations fall under Sections 12-A(a), (b) and (c), there will be no escape for the respondents from satisfactorily explaining before the Tribunal as to how these allegations would not result in fully establishing the guilt as prescribed under sub-clauses (a), (b) and (c) of Section 12-A.....
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.... 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 company or other body corporate; (ia) derivative; (ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes; (ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; (id) units or any other such instrument issued to the investors under any mutual fund scheme; (ii) Government securities; (iia) such other instruments as may be declared by the Central Government to be securities; and (iii) rights or interest in securities;" 40. "Dealing in securities" have been defined under Regulation 2(1)(b) of PFUTP Regulations, 2003 which ....
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....s 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 an act, expression, omission or concealment whether in a deceitful manner or not; 2. by a person or by any other person with his connivance or his agent while dealing in securities; 3. so that the same induces another person or his agent to deal in securities; 4. whether or not there is any wrongful gain or avoidance of any loss. The second part of the definition includes specific instances: (1) a knowing misrepresentation of the truth or concealment of material fact in order that another person may act to his detriment; (2) a suggesti....
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....7. 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 inclusive definition and, therefore, has to be understood to be broad and expansive, contemplates even an action or omission, as may be committed, even without any deceit if such act or omission has the effect of inducing another person to deal in securities. Certainly, the definition expands beyond what can be normally understood to be a "fraudulent act" or a conduct amounting to "fraud". The emphasis is on the act of inducem....
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....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 the effect of inducing another person to deal in securities. Thus, more than "reckless or careless", "inducement" becomes more significant where 'fraud' is required to be proved. The Supreme Court held that mens rea is not an indispensible requirement and fraud can be inferred on a preponderance of probabilities. However, the inferential conclusion must be arrived a....
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....es, 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 internal audit as well as the statutory audit process. The modus operandi of this complex fraud was perpetuated by the management of SCSL which deceived the naked eye of the auditors. The fake sale invoices as in the case of genuine sale invoices had a perfect document trail like purchase orders, time sheets, master software, service agreements, e....
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....dit 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 the audit firm. 51. The contention that the term "mens rea" should be broadly construed and recklessness should be equated to be a part of the term "mens rea" is erroneous. On this issue, reliance by the respondents in the case of Naresh Giri vs. State of M.P. (2008) 1 SCC 791 is misplaced as it was dealing with Sec. 304A of ....
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....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 evidence of any connivance or collusion nor there is any finding of actual collusion or connivance by the engagement partners and / or by the audit firm with the management of SCSL. 54. In this regard Section 11(4)(b) of the SEBI Act provides that the Board may by an order for rea....
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....actices 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 his opinion on the financial statements, the auditor follows procedures designed to satisfy himself that the financial statements reflect a true and fair view of the financial position and operating results of the enterprise. The auditor recognizes that because o....
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....ganized 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 position that assumes their integrity and enables them to override the formally established control procedures. Certain levels of management may be in a position to override control procedures designed to prevent similar frauds by other employees, for example....
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....ernal 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 as to determine the appropriate accounting principles and methods used in preparation of the financial statements. This determination will be made in the context of the financial reporting framework that mana....
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.... 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 and skill must depend upon the circumstances of each case. 62. In Re Kingston Cotton Mill Company, 1896 2 Ch 279 the Court of Appeals examined the r....
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....s 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 investors especially when alternate procedure as per para 39 of AAS-30 was adopted and no fault was found in ....
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....here 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 reasonable care and skill must depend upon the circumstance of each case. The auditor is not ....
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.... 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 action is taken against the auditor, one has to look at ....
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....ethane 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:- "75. On a reading of....
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....11 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 securiti....
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....er whom SEBI has direct jurisdiction 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 vario....
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....aterhouse, Kolkata and Lovelock and Lewes, Kolkata. 83. As per available 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 aud....
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....evant auditor nor the audit partnership firm has been recorded explicitly thereby leading the stakeholders to believe that the audit was done by the international network of PWC. 85. It was contended that the impugned order is manifestly erroneous 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 fi....
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....as totally farfetched which cannot be sustained under any provision of law. It was contended that each of the ten firms is a separate entity registered separately with the ICAI and is assessed separately under the Income Tax Act. 92. It was urged that the ban order 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 comp....
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....network to maintain common standards in auditing and other services and therefore functioned as one consolidated unit. 98. In the light of the aforesaid, the admitted fact that is culled out on which there is no dispute is, that the ten firms are not dealing in the securities 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 ....
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....ng part of each firm. D. The agreement shall have effect from 1st April, 2000. Any Party may terminate the above arrangement at any point by giving prior written notice of at least 90 days to that effect to the other Party. Such termination shall be without prejudice to the rights and obligations accruing prior to the termination taking effect. E. Each Firm shall be 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 sh....
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....o or more firms, then it is permissible for that person to become partners in more than one firm. Misconduct committed by a partner in one firm will not make the second firm liable. Under the Companies Act it is permissible for a person to be a director in many Companies. If one director of a Company commits a violation of any SEBI laws and is penalized it does not mean that other Companies in which the said person 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 faci....
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....n: (i) A Formal network is required to be registered with the Institute in a prescribed From 'B'(enclosed). 5. Ethical Compliance : Once the relationship of network arises, whether registered or not with the Institute, it with be necessary for such a network to comply with all applicable ethical requirements prescribed by the Institute from time to time in general and the following requirements in particular. (a) If one firm of the network is the statutory of an entity then the associates (including the networked firm(s)) or the said firm directly/indirectly should not accept 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....
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....e are of the opinion that mere admission on the part of the ten firms that there is a network of PW firms would not make all the ten firms guilty of fraud or manipulation of the books of accounts of SCSL. The approach of the WTM in aiming the network responsible for the fraud in SCSL is farfetched, and cannot be sustained. If ICAI allows independent firms to pool their resources it does not make these firms as one big unit. There is no shred of evidence to show that there was revenue sharing between the ten firms. We are further of the opinion that being members or connected with PW Cooper International Ltd., a UK based private limited company, may make them a network of firms 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 n....
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....ich conducted the audit namely "Price Waterhouse". The ICAI registration number of this auditing firm is 07568S. 110. SEBI's argument that the audit opinions were signed by the network of Price Waterhouse is legally untenable and contrary to the applicable law. Section 226(1) of the Companies Act, 1956 provides that- "226. QUALIFICATIONS AND DISQUALIFICATIONS OF AUDITORS. 1. A person shall not be qualified for appointment as auditor of Company unless he is a chartered accountant within the meaning of the Chartered Accountants Act, 1449 (38 of 1949): Provided that a firm whereof all the partners practicing in India are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of 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 kne....
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.... No. 7. 114. The WTM referred to certain letters to show that the letters were being addressed in the name of "Price Waterhouse" from the Shivaji Park office in Mumbai. It was thus urged that it was that PW network that was auditing the accounts of SCSL. The submission of the respondent is untenable for the same reasons that the said letters were issued by the appellant in Appeal No. 7 and not by the network firms. The Shivaji Park address is the branch office of the appellant in Appeal No. 7. It was signed by a partner of the appellant in Appeal No. 7. This does not in any way show any acceptance of responsibility by the network of appellant firms as alleged by SEBI. Section 27 of the Chartered Accountants Act, 1949 permits maintenance of branch offices for Chartered Accountancy 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 P....
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....ewes, Kolkata, Price Waterhouse & Co. Bangalore, PW, Kolkata and Price Waterhouse & Co. Kolkata (Appellant Nos. 1, 5 and 2 in Appeal No. 6 of 2018). These proceedings were instituted pursuant to the relevant provisions of the Securities Act which, inter alia, dealt with an auditor lacking in character or integrity or found to have engaged in unethical or improper professional conduct or willfully violated or aided or abetted the violation of the securities laws. The consenting PW entities anticipated the institution of these proceedings and submitted 'an offer of settlement' which was accepted by the SEC and PCAOB. In the light of the said offers of settlement, consent orders were passed by both, SEC and PCAOB dated 5th April 2011. In the order dated 5th April 2011, the SEC observed that there 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 perio....
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.... acted upon by the appellants. In our view, the settlement orders have no precedential value in SEBI proceedings. If SEC and PCOAB are to be relied upon by SEBI, then they should have also issued similar measures and further allowing PW firms to continue with the existing audit arrangement instead of debarring them from auditing listed Companies. The appellants have denied the findings and observations in these orders and in our opinion are entitled to deny these findings in any other legal or regulatory proceedings. Whereas, SEC & PCAOB had jurisdiction over auditors of US listed Companies, the same is not the case with SEBI. We may point out that PCAOB in its order acknowledged at multiple places that PW Bangalore served as SCSL's auditor. The PCAOB also recorded that Price Waterhouse & Co., Bangalore, Price Waterhouse, Calcutta and 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 vio....
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....firm takes over the business, then it will be a case of succession governed by Section 188 of the Income Tax Act as held by a Full Bench of the Allahabad High Court in Dahi Laxmi Dal Factory vs. Income Tax Officer, Sitapur, 1974 All LJ 883. 125. Thus, the liability of a new partner commences from the date of his admission as a partner in the firm. He is not liable for the preexisting debts. Unless there is an agreement to show that the incoming partner is liable for the pre-existing debts, a new partner cannot be made liable to honour the liabilities of the old firm before he became a partner. 126. In this regard, reliance is placed on the judgment of Sharad Vasant Kotak and Ors vs Ramnik Lal Mohanlal Chawda and Anr. [(1998) 2 SCC 171]. Paragraph 16 of the judgment states:- "Each partner is, it is true, the agent of the firm; but as pointed out before, 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....
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....ulam vs. M/s. K. Kelukutty, (1985) 4 SCC 35 explained partnership as- "The Indian Partnership Act, 1932 has, by Section 4, defined a "partnership" as "the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all". The section declares further that the persons who have entered into partnership with one another are called individually "partners" and collectively "a firm". The components of the definition of "partnership", and therefore of "a firm" consist of (a) persons, (b) a business carried on by all of them or any of them acting for all, and (c) an agreement between those persons to carry on such business and to share its profits. It is the relationship between those persons which constitutes the partnership. The relation is founded in the agreement between them. The foundation of a partnership and, therefore, of a firm is 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 prof....
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....of ten years which, in our opinion, is impermissible in law as the Regulations were not attracted." 132. The said principle is squarely applicable in the instant case. If the appellants have violated the provisions of the Companies Act they can be prosecuted there under but the respondent cannot invoke the SEBI laws in this cavalier fashion which violates the appellants' fundamental right to carry on business as envisaged under Article 19(1)(g) of the Constitution of India. 133. There is yet another aspect. 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 ....