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Price Waterhouse-SAT case: How Supreme Court ruling will impact SEBI in the long run

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Stock market regulator SEBI’s legal stand on various cases, including market manipulation, is now being relied upon by the Supreme Court in the final verdict in the case involving audit firm Price Waterhouse (PW) , say legal experts.

There was partial relief for SEBI as the Supreme Court on Tuesday gave an interim stay on the SAT ruling, which said that the regulator did not have the power to debar an audit firm dealing with a listed company.

BusinessLine had published a detailed report on September 27 highlighting why SEBI should challenge the SAT order in the PW matter mainly on the question of its jurisdiction on audit firms dealing with listed companies.

Effectively, Tuesday’s interim stay by the Supreme Court means that SEBI has powers and can deal with those who do not directly form ‘components’ of the capital market but are even indirectly linked to it, such as audit firms who deal with preparing the financials of a listed company.

Impact of final SC ruling on SEBI

It includes the regulator’s power in dealing with those indirectly associated with the capital markets and establishment of a ‘mens rea’ or direct proof and not circumstantial evidence against those who are not directly linked to the markets.

“SAT in its ruling had observed that SEBI has punitive powers (under Section 11&11B of the SEBI Act) only against entities dealing in the securities market. But for entities not dealing in the securities market, there can only be remedial action by SEBI. The said observation has been stated by the Supreme Court in its latest order. Although the current order is in favour of SEBI, if the Supreme Court upholds the SAT order in respect of SEBI jurisdiction, the same will have a wide impact on the regulator’s power,” said Deepika Sawhney, Partner, Corporate Professionals.

What needs to be settled now?

“Who are ‘persons associated with securities market’ and hence amenable to SEBI’s jurisdiction, is an important question of law which needs to be decided by the Supreme Court,” said Sumit Agrawal founder, Regstreet Law Advisors, and former SEBI Officer.

Agrawal says that while the Bombay High Court had said that auditors are to be considered associated, the Supreme Court has not decided on the issue so far. “Similarly, what does dealing in securities cover, for SEBI to apply its Fraudulent and Unfair Trade Practices Regulations? Would “audit” or “advice” be covered? This, too, has to be decided,” Agrawal said.

Another key point raised by SAT for rejecting SEBI’s case against PW was that the regulator had failed to prove ‘mens rea,’ meaning establishing intent or direct evidence. SEBI mainly moved to punish PW and other entities for their role in the Satyam Computer scam, based on a trail of ‘convincing evidence.’

But there is a view based on past Supreme Court judgements that a ‘quasi judicial’ regulator such as SEBI can proceed on the basis of ‘convincing proof’ against corporate wrong-doers, rather than trying for evidence similar to proving ‘culpable homicide’, which is key in criminal proceedings. In white collar crimes, it is often next to impossible to get direct evidence, and it is mostly the trail of evidence or pre- ponderance of probablities that is followed by regulators like SEBI that could be ‘convincing enough to a prudent mind,’ to issue strictures, experts said.

Observation of Chief Justice Ranjan Gogoi on ‘mens rea’ in SEBI matter

On September 20, 2017, Justice Gogoi in a judgement involving SEBI versus Kanaiyalala Baldevbhai Patel versus SEBI observed, “Mens rea is not an indispensable requirement and the correct test is one of a preponderance of probabilities. The inferential conclusion from the proved and admitted facts, so long as the same are reasonable and can be legitimately arrived at on a consideration of the totality of the materials, would be permissible and legally justified.”

In another benchmark ruling in a civil case, which was widely quoted in law journals, involving the case of a Chief Income Tax Commissioner versus one Durga Prasad More, Supreme Court judges A Grover and K Hegde with regard to the evidence said, “Science has not yet invented an instrument to test the reliability of the evidence placed before a court or tribunal. Therefore, the Courts and Tribunals have to judge the evidence before them by applying the test of human probabilities. Human minds may differ as to the reliability of a piece of evidence. But in that sphere, the decision of the final fact finding authority is made conclusive by law.”

Why was PW guilty according to SEBI

In the matter involving a network of accounting firms, including Price Waterhouse, were held held guilty by SEBI of gross negligence of duty to follow minimum standards of diligence and care expected from a statutory auditor. In fact, SEBI has gone a step further and even talked about the acquiescence and complicity of Price Waterhouse in the case and stated that several red flags, which were all too obvious for any reasonably professional auditor to miss, failed to engender the necessary professional scepticism in the Price Waterhouse team associated with the Satyam Computer audit.

By accepting the information provided by the company at face value and performing a perfunctory job (despite warnings), the auditor has failed to live up to the expectations of shareholders, SEBI had observed. SEBI had said that a dispassionate analysis of the whole episode spanning a period of at least eight years would reveal that the perpetration of the fraud could not have been made possible without the knowledge and involvement of the statutory auditors.

What did SAT say

SAT’s main contention against SEBI in the PW matter was that SEBI was “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.”