Satyam scam: Audit firms are registered with ICAI; SEBI cannot exercise its power over audit firms nor debar them as they do not deal in the securities market: SAT

Pricewaterhouse (PW) Bangalore was given the audit for auditing the books of accounts of B. Ramalinga Raju owned Satyam Computers Services Limited (Satyam Computers).

In the year 2009, Securities Exchange Board of India (SEBI) received an email from Ramalinga Raju, the then Chairman of Satyam Computers stating that the statements of accounts of Satyam Computers were large scale financial manipulation in the books of accounts of Satyam Computers to the tune of Rs. 5,000-crore. It further stated that the balance sheet of Satyam Computers carried inflated /non-existent cash and bank balances.

On investigation, SEBI found that certain directors and employees of Satyam Computers had connived and collaborated in the overstatement, fabrication, falsification and misrepresentation in the books of account and financial statements of Satyam Computers. The SEBI probe found the scam was much higher at Rs. 7,800 crore. The investigation also noted that the statutory auditors of Satyam Computers had connived with the directors and employees of Satyam Computers in falsifying the financial statements of Satyam Computers.

On the basis of the investigation, a Show Cause Notice (SCN) was issued to Price Waterhouse, Lovelock & Lewes Hyderabad, and the engagement partners for audit of Satyam Computers – S. Gopalakrishnan and Srinivas Talluri directing them to show cause as to why directions under Section 11, 11(4) and 11B of the SEBI Act should not be issued for violation of Sections 12A(a), 12A(b) and 12A(c) of the SEBI Act read with Regulations 3(c), 3(d), 4(1), 4(2)(a), 4(2)(e), 4(2)(f), 4(2)(k) and 4(2)(r) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (PFUTP Regulations).

Two Writ Petitions were filed in July 2010 before the Bombay High Court for the quashing of the SCNs on the ground that SEBI lacked jurisdiction as it was encroaching upon the jurisdiction of Institute of Chartered Accountants of India (ICAI).

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.

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. Despite the fact that the Chartered Accountants Act, 1949 (CA Act) conferred exclusive jurisdiction upon the ICAI to adopt disciplinary misconduct, the Bombay High Court held that in a given case SEBI can pass orders directing CA to keep away from the securities market from auditing listed Companies.

The Bombay High Court had ruled that SEBI had the jurisdiction to enquire and investigate the matter in connection with manipulation and fabricating the books of accounts and balance sheet of the Satyam Computers. The Court further held that the power of SEBI is independent and does not encroach upon the powers of the ICAI under the CA Act.

The question before the Securities Appellate Tribunal (SAT) was as to how did the Whole Time Member (WTM) arrived at a finding that the appellants were guilty of misconduct and were responsible for the fabrication of the books of account of Satyam Computers.

The SAT ruled that from the reading of the provisions of Section 12A of the SEBI Act and Regulation 3 & 4 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 role of debarment is beyond the scope and powers of SEBI under Section 11 and 11B of the SEBI Act.

Further, the applicability of PFUTP Regulations can be extended to persons associated with the securities directly or indirectly. The appellants (Pricewaterhouse) did not deal in the securities either directly or indirectly but are auditors of listed companies. In order to bring them culpable within the four corners of Section 12A and Regulation 3 and 4 of PFUTP Regulations, fraud has to be proved on the basis of evidence.

The SAT held that the fraud at Satyam Computers 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 Satyam Computers’ alleged fraud because there was a devious systematic scheme by the Satyam Computers’ Directors, management and employees to circumvent Satyam Computers own corporate governance structure, internal controls and internal audit as well as the statutory audit process.

According to SAT, the modus operandi of this complex fraud was perpetuated by the management of Satyam Computers 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, etc. and therefore very difficult to detect. The scope of the enquiry as directed by the Bombay High Court was restricted only to the charge of conspiracy and involvement in the fraud and not to any charge of professional negligence.

The order of the Bombay High Court was thus passed in the peculiar facts and circumstances of the given case wherein jurisdiction was conferred upon SEBI only if it proved that on the basis of the material the Chartered Accountant was instrumental in preparing false and fabricated accounts or had connived in the preparation and falsification of the books of accounts.

The SAT further held that in its view, an action against a Chartered Accountant can be taken only in terms of Chartered Accountants Act, 1949. SEBI cannot in the garb of proving conspiracy and connivance on the part of the Chartered Accountant interpret the auditing standard on a standalone basis. The auditing standards can only be related to the professionalism of a Chartered Accountant vis-à-vis its professional misconduct which could only be considered by the ICAI. In the tribunal’s view, banning an audit firm or an auditor from auditing the books of a listed Company or from certifying any report of a listed Company cannot be justified and that such decision is wholly arbitrary and illegal.

According to SAT, on the date of the impugned order passed by SEBI, there were 98 partners in the ten PW firms out of which 70 are new partners who were not partners of the PW firms during the period 2000 to 2009 (the period of the alleged irregularities which were noticed only when B. Ramalinga Raju made a statement in January 2009 with regard to financial manipulation in the books of account of the Satyam Computers). Thus banning them from doing audit work of listed Company merely because they are presently partners in PW firm is in complete violation of Section 31(2) of the Partnership Act.

Justice Tarun Agarwala, the Presiding Officer held that “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.”

The SAT thus quashed the SEBI order debarring the PW firms as well as the two auditors from auditing listed Companies. However, it partly allowed disgorgement of the Rs.13 crore fee from the auditor.

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