PW-Satyam Case: Tribunal Has Put Unreasonable Burden Of Proof On SEBI, Experts Say
The headquarters of the Securities and Exchange Board of India in Mumbai, India. (Photographer: Adeel Halim/Bloomberg News)

PW-Satyam Case: Tribunal Has Put Unreasonable Burden Of Proof On SEBI, Experts Say

In a major reprieve for Price Waterhouse and its network firms, the Securities Appellate Tribunal has concluded that the audit firm’s role in the Satyam scam can at best amount to professional negligence and not fraud. In saying so, SAT set aside SEBI's 2018 order that had barred not just the specific PW firm that audited Satyam but the entire network of 10 PW audit network firms in India and two individual auditors from auditing the accounts of listed companies for two and three years respectively.

The SAT relied on a Bombay High Court decision in this matter, which defined the scope of SEBI's jurisdiction to investigate PW's role in the Satyam scam. The high court had laid down that SEBI's jurisdiction would depend on the evidence—if SEBI concludes only some omission without any mens rea, or connivance, it cannot give any directions to the audit firms.

Keeping that in mind, SAT said:

  • SEBI failed to prove fraud against the audit firms and the two auditors—there is no evidence to show that these entities fabricated, falsified or fudged Satyam's books in collusion with the company's management.
  • SEBI's regulations on prevention of fraud and unfair trade practices can only apply to persons directly or indirectly dealing in securities—an audit firm cannot be said to be dealing in securities.
  • For an entity not dealing in securities, SEBI's directions can only be remedial in nature. Preventive directions cannot be issued. And debarment, as per SAT, is punitive.

Experts BloombergQuint spoke with said that SAT has laid down an unreasonable burden of proof on the regulator to conclude guilt for market entities that cannot be strictly categorised as "dealing in securities".

SAT’s conclusion on directions that the market regulator can or cannot give to entities that don’t fall under this category should be contested by SEBI before the Supreme Court, they added.

SAT’s Insistence On Proof Of Fraud

As per SEBI’s arguments, Satyam’s auditors were well aware of the consequences of their omissions. And their aggregated acts of gross negligence scaled up to fraud.

This was challenged by PW before the Bombay High Court on grounds of lack of SEBI’s jurisdiction to pass directions against auditors. That rested solely with the Institute of Chartered Accountants of India, PW had argued. But the high court recognised SEBI’s jurisdiction with the caveat that only if the regulator proves connivance, can it issue any directions against the PW network firms and the two auditors.

SEBI’s hands in this investigation were tied to begin with, Umakanth Varottil, associate professor of law at National University of Singapore said.

SEBI’s jurisdiction was circumscribed by the orders of the Bombay High Court where it had clearly held that SEBI’s power will arise only if there are jurisdictional facts. SEBI’s powers were intrinsically tied up with the facts in the case.
Umakanth Varottil, Associate Professor of Law, National University of Singapore

The SAT outcome isn’t surprising since the burden on SEBI was unduly high, Varrotil added. But this lowers the standard for auditors in terms of the role they play in the securities market because SAT is telling us that fraud has to be positively and extensively proved for SEBI to pass preventive orders, he said.

While examining the issue of PW’s connivance with the management, SAT didn’t agree with SEBI’s argument that gross negligence amounts to fraud. It stated that evidence to prove fraud must be direct and apparent and not based on preponderance of probabilities. The regulator also failed to produce any evidence which showed elements of inducement by PW, it held.

But Tushad Cooper, an advocate at the Bombay High Court argued that the definition of fraud under SEBI regulations is broad enough to cover gross negligence.

The definition of fraud in SEBI Regulations is similar to that under section 17 of the Indian Contract Act. If reckless statements would constitute fraud actionable under the Contract Act, there is no reason to exclude such conduct from the purview of fraud under SEBI regulations. 
Tushad Cooper, Advocate, Bombay High Court

While the high court and SAT have expressly held that auditors do perform a role which has a nexus with the securities market, SAT proceeded on the footing that omissions or negligence, howsoever gross, would not tantamount to auditors conniving and colluding with the company, Cooper said.

‘I don’t agree that mens rea is a necessary pre-requisite for fraud as defined in the SEBI regulations,’ he added.

Preventive vs Remedial Directions

Since SEBI failed to prove fraud, the nature of directions it could issue to Satyam’s auditors are also limited, SAT said. In the absence of proof of fraud, the regulator can only give remedial directions. Preventive direction of debarment can be issued only if connivance is proved, the appellate tribunal concluded.

Further, SEBI’s regulations on fraud can only be applied to those entities that are dealing in securities and auditors do not fall under this category, SAT said. Entities like auditors fall in the category of people associated with the securities market and in such cases, SEBI can only pass remedial directions, SAT laid down. And so, it dismissed SEBI’s directions to debar the auditors and the audit firm but upheld the Rs 13 crore penalty on them for a professional lapse.

“A remedial action is to correct a wrong, or a defect. Preventive measure can be issued in a given case of unfair trade practice or where fraud is proved. To a person not dealing in securities, only remedial direction could be issued. Preventive directions cannot be issued. In our opinion, debarment is punitive.” - SAT

The order would have a wide impact as there are entities in the management of a company or independent directors which won’t strictly qualify as persons dealing in securities, Advocate PR Ramesh pointed out.

If you’re saying that fraud must be conclusively proven for everyone that doesn’t fall in the category of persons dealing in securities and the standard of preponderance of probabilities will not suffice, then SEBI will face the same problem with not just auditors but with independent directors etc as well. 
PR Ramesh, Advocate, Bombay High Court

The Supreme Court has extended the scope of SEBI’s regulations to entities like non-intermediaries as well - and this should be one of the grounds that SEBI should contest SAT’s decision on, Ramesh added.

The second argument, if SEBI decides to appeal this order before the Supreme Court, should be the distinction between preventive and remedial directions which SAT has laid down, Varottil said.

The Supreme Court has laid down that SEBI proceedings are civil and not criminal in nature, and so it is not necessary to prove guilt beyond reasonable doubt- in securities market, it will often be onerous. And so, the standard of preponderance of probabilities should be sufficient, Varottil added.

There is no precedence so far on the distinction- remedial versus preventive directions- front. This is the outcome of SAT distinguishing between persons dealing is securities versus those associated with the securities market. This distinction is too technical and misses the bigger picture.
Umakanth Varottil, Associate Professor of law, National University of Singapore

An auditor is never someone who deals in the market. If you take such an interpretation, SEBI will almost never be able to discharge this burden of proof vis-à-vis auditors, Varottil added.

PW Network Cannot Be Held Liable

In dismissing allegations of fraud, SAT also limited the liability to the PW network firm that conducted Satyam’s audit and the signing partners. Professional misconduct committed by a partner in one firm will not make the second firm liable, it held.

“The liability for acts or omissions is certified to individual firms and cannot be passed on to the network firms using PW brand.” - SAT

The appellate tribunal relied on the Resource Sharing Agreement between the firms using the PW brand to say that liability arising from any professional assignment would belong to the firm which executes such assignment.

Cooper and Varottil agreed with this conclusion of SAT.

The concept of network in audit firms is now well understood in India- these entities are clearly separate legal entities and a common alliance in itself is not sufficient to prove charges against all the firms, Varottil opined.

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