Sebi's order of 10 January 2018 places a 2-year ban on PricewaterhouseCoopers (PwC) in India. This has come exactly 9 years after the confession of B Ramalinga Raju, Chairman of Satyam Computer Services Limited (whose accounts were audited by PwC), to massive financial manipulation. Auditors are the most visible and reliable gatekeepers of accounts. It is expected that their role in the matter (of manipulation) would be closely scrutinised. However, such a ban (plus disgorgement of fees) of the 11 firms in the PwC network is not merely unexpected and unprecedented, but far-reaching too.
Two years may not sound like a life sentence, but for a professional firm that relies on professional skilled personnel and knowledge, infrastructure, clients, etc., it could cause a lot of harm.
Can Sebi act against auditors -- this contention was upheld by the Bombay High Court in 2010 in the PwC case itself. It rejected the argument that Sebi has no jurisdiction to take action against auditors who participate in frauds in listed companies. Using general powers available to it under law and armed further by this decision, Sebi has already passed orders on auditors earlier. But this order is much more detailed and has wider ramifications.
Any professional – not just a Chartered Accountant, but even doctors, lawyers, etc. – is concerned that his work would be minutely scrutinised with the benefit of hindsight by regulators, courts and errors would be found. However, in this case, had the issue been merely of faulty/negligent work, Sebi may not have been able to take action. The question here was not whether the work was faulty but that it involved knowing participation in a fraud. Sebi not only found serious faults in the conduct of the audit of Satyam by PwC but also that these amount to complicity in the fraud.
Sebi found, for example, that PwC did not do its job well while verifying the huge bank balances/fixed deposits that Satyam supposedly held but actually did not. Sebi highlighted that these constituted nearly 70 percent of the total assets, yet PwC did not provide the necessary 'professional skepticism' in verifying them. Instead of verifying these balances directly from the bankers themselves, PwC largely relied on confirmations obtained through Satyam. This was not only against norms prescribed by the parent body of Chartered Accountants – the Institute of Chartered Accountants of India – but against their own internal manual for conduct of audit.
PwC, Sebi further said, did not detect huge amounts of sales fraudulently recorded in the accounts. Sebi said thousands of fake sales invoices were recorded in a out-of-the-routine course. This should have normally come up in an audit if proper procedures were followed. There were other findings too. However, the question that arises is – even if assuming that all these were faults - did they amount to PwC being complicit in the fraud? Sebi can take action only if it can show complicity to fraud.
Sebi said that to prove complicity in frauds, the standards of proof are lower than in criminal cases. The standard applicable is it is more than likely that PwC was complicit in the fraud. Sebi said that this fraud was perpetrated over several years and if certain basic and prudent audit procedures were not followed, it is more than probable that there was complicity of PwC in the fraud.
The Order said, “There can be only two reasons for such a casual approach to statutory audit – either complacency or complicity”. Thus, it held that PwC was guilty of complicity in the fraud.
The question is, who should be acted against here? Are the persons directly responsible for the audit to be acted against or should the order cover the whole PwC group in India including persons and firms distant to the whole matter? Interestingly, Section 147 (5) of the Companies Act, 2013 clarifies that in case of a firm of auditors, it is the firm and the partners who committed the fraud or colluded therein who are liable for fraud. The Companies Act 2017 (provisions not yet notified) adds a proviso that says that in case of criminal liability other than fine, only the partners involved in the fraud would be liable.
Sebi however noted several aspects here. It found close connection between several member firms of PwC including sharing of resources. It referred to settlement orders of SEC, USA in this matter. It also noted that the firm name was used in the audits and the brand thus served an important purpose and stamp of credibility. Thus, it ordered that the ban should apply to the whole group. This will have far-reaching implications as a precedent.
It is almost certain that the Order will be appealed against. How it turns out will matter not just to listed companies and their shareholders, auditors and professionals generally, but also to other stakeholders in the capital market.
(The writer is a Mumbai-based Chartered Accountant)
Updated Date: Jan 13, 2018 17:39 PM