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Auditors cannot be held liable fraud in the absence of collusion

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The Securities Appellate Tribunal in a recent decision has set aside a SEBI order which had imposed monetary penalty on the statutory auditors of a listed company.  

Briefly the facts of the matter are that SEBI had alleged that the appellant had facilitated a scheme of cleaning up of the books of the Company despite being aware of the irregularities and misstatements in the financial statements and had acted against the fiduciary capacity instead of working in the interest of the shareholders of the company.  

SEBI in its order arrived at a finding that the appellant being the statutory auditor despite being aware of the irregularities certified the financial statements of the company as true and fair which therefore shows the appellant’s direct involvement on such misstatements of the Company.  

Based on appreciation of the material on record, the SAT held that the appellant was not aware of the nature of the transactions and consequently could not have examined the same. SAT further held that the scope of inquiry by SEBI in respect of auditors is very limited and is confined only to the charge of conspiracy of involvement of the appellant in the fraud, if any, and to take consequential action if there is connivance or conspiracy with the appellant and its directors. Only then, SEBI could take action under the SEBI Act and the PFUTP Regulations otherwise it is not open to SEBI to inquire into any charge of professional negligence of the auditor since the audit firm is not dealing directly in securities.  

Further, relying upon the decision by the Bombay High Court in the matter of Price Waterhouse & Co. (PwC) which dealt with the jurisdiction of SEBI in respect of Chartered Accountants, the SAT held that once an investigation or a finding in the inquiry comes that the appellant was not involved in the fudging of the books of accounts and that there was no collusion or connivance by the appellant as a statutory auditor with any employee, promoter or director of the Company then the matter has to be dropped and SEBI could not proceed any further.  

Recently, the NCLAT also in a matter relating to the NFRAs authority held that the jurisdiction of SEBI over the conduct of auditors and audit firms is related to their involvement in defrauding investors and thus narrower than that of the ICAI. The NFRA has more flexibility when it comes to imposing penalty on auditors and audit firms and it has a broader mandate than SEBI.  

A copy of the SAT judgement is enclosed herewith.  

Readers are welcome to send their views to Regstreet Law Advisors at info@regstreetlaw.com.

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