LEGAL UPDATE | SAT OVERTURNS SEBI ORDER AGAINST PWC IN SATYAM CASE

Very recently, the Securities Appellate Tribunal, Mumbai (SAT) in Price Waterhouse & Co v. Securities and Exchange Board of India <http://emaila.mhco.co.in/ltrack?g=0&id=LE4CCQBTBVYDAR4EUVQHVgdbWh0=AQAHVkoMH0ILUBZdEXJZVl9OUgQZUA1Z&client=11511&c=0000> overturned the order of the Securities and Exchange Board of India (SEBI) against Price Waterhouse & Co (PWC) and others in the Satyam Computer Services Limited (Satyam) case. These proceedings arose from the fact that the books of account of Satyam were not true and fair since there was large scale financial manipulation of the balance sheet which carried inflated / non-existent cash and bank balances. This update gives a brief overview of the decision of SAT. 

Decision of SEBI: 

The WTM had inter alia passed the following directions under Sections 11 and 11B of the SEBI Act, 1992 (SEBI Act) against PWC and 10 firms purportedly part of the PWC network and 2 of the partners of PWC for alleged violations of Section 12A of the SEBI Act and Regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations, 2003 (FUTP Regulations) arising from their role as auditors of Satyam: 

* Entities/firms practicing as Chartered Accountants (CA) under the brand PWC shall not directly or indirectly issue any certificate of audit of listed companies, compliance of obligations of listed companies and intermediaries registered with SEBI for a period of 2 (two) years; 

* Individual auditors, Mr S Gopalakrishnan and Mr Srinivas Talluri, shall not issue an audit certificate or any certificate of compliance for a listed company for 3 (three) years; 

* PWC and the individual auditors shall jointly and severally disgorge the wrongful gains of Rs 13,09,01,664/- along with interest of 12% pa from 7 January 2009 till the date of payment. 

Decision of SAT 

Other than the direction to disgorge the wrongful gains, SAT overturned the directions of SEBI based on the following reasoning: 

* PWC and the other appellants had filed two writ petitions in the Bombay High Court against the show cause notices issued by SEBI in the matter. The main argument of the petitioners was that SEBI did not have jurisdiction in the matter which was vested in ICAI since the petitioners were CA / CA firms. The Bombay High Court did not accept this argument since SEBI had the mandate to protect the securities market and investors but the court restricted the scope of SEBI`s authority. As per the directions of the Bombay High Court the scope of enquiry of SEBI 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 from the investigation. 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 Satyam and there was an intention or knowledge in connivance or collusion with the management of Satyam in fudging the books of account. The requirement of men rea and not merely an omission was also posited by the Bombay High Court. The SAT decision was based on these guidelines issued by the Bombay High Court. 

* SEBI held that failure to seek external confirmation of the bank balances and fixed deposits coupled with the failure to detect fake invoices without adopting the rigorous procedure mandated by the accounting standards draws an inference of gross negligence and involvement in the fudging of accounts which amounts to an act of fraud. In SAT`s view this finding was erroneous since: 

* there was no shred of evidence to show that the auditor / audit firm had fabricated or fudged the books of account of Satyam in collusion with its top management.

* an element of inducement must exist which was absent in this case. 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 engagement partners and/or the audit firm to fabricate the books of Satyam in collusion with its top management. This is clearly not the case since the evidence overwhelmingly shows that the fabrication of the books of account was done solely by the top management of Satyam.

* mens rea had not been established as was required by the decision of the Bombay High Court

* An auditor`s duty is to see what the state of the company`s affairs actually is and whether it is truly reflected in the accounts of the company upon which the balance sheet and the profit and loss account are based. But the auditor is not required to perform the functions of a detective. The duty is verification and not detection. Although in performing the duty of verification, the auditor must employ reasonable care and skill. 

* The auditor`s opinion on the financial statements is based n the concept of obtaining reasonable assurance. Hence, in an audit, the auditor does not guarantee that material misstatements, whether from fraud or error, will be detected. The accounting standards must be read as a whole and should not be cherry picked to pin responsibility on the auditors. 

* SEBI as a regulator has no authority under SEBI laws and regulations to look into the quality of audit services performed by auditors. The powers conferred on SEBI under Sections 11 and 11B of the SEBI Act are remedial and not punitive. The action taken by SEBI in the instant case was punitive and not justified. 

* There was no evidence to show that the 10 firms penalised by SEBI belonged to the same network since each firm was separately registered, the network was not registered as such with ICAI and the revenue sharing arrangement clearly postulated that the firms were acting on a principal to principal basis. In any case, even if there is a network of firms, implicating the ten firms on the ground of networking is misconceived and untenable without a specific finding that the 10 firms were in collusion and there was an intention and knowledge to play fraud in the audit of Satyam. 

* Under Section 31(2) of the Partnership Act, 1932 (PA), a partner is liable for the actions of the firm only after he has become partner. He is not liable for pre-existing debts. PWC had 98 partners on the date of the order of the SEBI of which 70 partners were new and were not part of the partnership during the relevant period of 2000 2009. Banning them from doing audit work would violate Section 31(2) of the PA and also impact their fundamental rights under Article 19(1)(g) of the Indian Constitution. 

* 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 amount to negligence. Thus, the order of disgorgement made by the WTM is justified and must be upheld. 

MHCO Comment : SAT`s order must be assessed from the perspective of (i) ICAI having already cancelled the licences of the auditors involved in the Satyam audit; and (ii) the contours of the decision of the Bombay High Court. From this perspective, the SAT order seems justified. However, as a precedent, the SAT order would make it extremely difficult to find auditors culpable for falsified books of account of a company since the burden of proof established by the SAT order is onerous on SEBI. This may allow unscrupulous auditors to escape the regulatory net even though their actions have led to losses to investors in the securities market. This would also diminish the value attached to audit reports. 

This update was released on 21 September 2019.