Understanding the SEBI Order in the Matter of PwC

Understanding the SEBI Order in the Matter of PwC.

[Udyan Arya]

The author is a fourth-year student at National Law Institute University, Bhopal.

On January 10, 2018, the Securities and Exchange Board of India (“SEBI”) passed an order against accounting firms practicing under the brand Price Waterhouse (“PwC”). The order bars PwC from issuing audit and compliance certificates to listed companies for a period of two years and imposes a penalty of Rs. 13.09 crores with interest.

The genesis of the present order can be traced back to the 2010 Bombay High Court judgment in the case of Price Waterhouse & Co. v. SEBI,[1] wherein the Court ruled that SEBI possessed the necessary powers to initiate investigations against an auditor of a listed company for alleged wrongdoing. PwC’s challenge to this ruling, by way of a special leave petition in the Supreme Court, was dismissed in 2013.[2]

Background

SEBI issued Show Cause Notices (“SCNs”) to PwC pertaining to PwC’s audit of Satyam Computer Services Limited (“Satyam”). SEBI, in its investigation, had found false and inflated current account bank balances, fixed deposit balances, fictitious interest income revenue from sales and debtors’ figures in the books of account and the financial statements of Satyam for several years. The SCNs alleged that the statutory auditors of Satyam had connived with the directors and employees in falsifying the financial statements of Satyam. The SCNs sought to initiate action against PwC under Sections 11, 11(4), and 11B of the SEBI Act, 1992 and Regulation 11 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003.

The Bombay High Court Judgment

PwC filed a writ petition before the Bombay High Court challenging the SCNs claiming that SEBI did not have jurisdiction to initiate action against auditors discharging their duties as Chartered Accountants (“CAs”). Only the Institute of Chartered Accountants of India (“ICAI”) established under the Chartered Accountants Act, 1949 could impose restrictions on CAs and determine if there has been a violation of the applicable auditing norms. SEBI, therefore, was encroaching upon the powers of ICAI by issuing the impugned SCNs.

The Court observed that SEBI’s powers under the SEBI Act were of wide amplitude and could take within its sweep a CA if his activities are detrimental to the interests of the investors or the securities market,[3] and that taking remedial measures to protect the securities market could not be equated with regulating the accounting profession.[4] Since investors are guided by the audited balance sheets of the company, the auditor’s statutory duties may have a direct bearing on the interests of the investors and the stability of the securities market.[5]

The Court, however, asked SEBI to confine the exercise of its jurisdiction to the object of protecting the interests of investors and regulating the securities market and, ultimately, its jurisdiction over CAs would depend upon the evidence which it could adduce during the course of inquiry.[6] If the evidence showed that there were no intentional or wilful omissions or lapses by the auditors, SEBI could not pass directions. The Supreme Court, on appeal, upheld the decision.

The SEBI Order

Jurisdiction of SEBI

Taking note of the decision of the Bombay High Court, SEBI held that if the evidence sufficiently indicates the possibility of there being a role of the auditors in the alleged fraud, then SEBI, as a securities market regulator, is empowered to protect the interests of the investors and could proceed to pass appropriate directions as proposed in the SCNs.

Duties of Auditors

The order has extensively dwelled upon the duties of auditors under the regulatory framework in India and whether the auditors in question had discharged their professional duties in accordance with the principles that regulate the undertaking of an independent audit.[7] The auditor’s conduct was checked against the applicable accounting standards and principles, and significant departures were found in the audit.

It was noted that 70 percent of the Satyam’s assets comprised of bank balances, which, being a high-risk asset prone to fraud and misappropriation, warranted significant audit attention. However, the auditors failed to maintain essential control over the process of external confirmations and verifications, as mandated under the Audit & Accounting Standards of ICAI.

The role of independent auditors in a public company was emphasized.[8] Since the certifications issued by auditors have a definite influence on the minds of the investors, it was held that the auditors owe an obligation to the shareholders of a company to report the true and correct facts about its financials since they are appointed by the shareholders themselves.

Findings

Finding PwC grossly lacking in fulfilling their duties as statutory auditors, SEBI noted that the acts of the auditor induced the public to trade consistently in the shares of the company. It was noted that the auditors made material representations in the certifications without any supporting document, pointing towards gross negligence and fraudulent misrepresentation.

The auditors failed to show any evidence to the effect that they had done their job in consonance with the standards of professional duty and care as required and they were well aware of the consequences of their omissions which made them liable for commission of fraud for the purposes of the SEBI Act and the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.[9]

Liability of the PwC Network

The SCNs sought to impugn liability on all firms operating under the banner of PwC in India. The PwC network firms were found to be linked to each other on the basis of the following facts:

  • The firms forming part of the network are either members of or connected with Price Waterhouse Coopers International Ltd. (“PwCIL”), a UK-based private company;
  • The said firms entered into Resource Sharing Agreements with each other.
  • The webpage of PwC global (https://www.PwC.com/gx/en/about/corporategovernance/ network-structure.html), showed PwC as “the brand under which the member firms of PricewaterhouseCoopers International Limited (PwCIL) operate and provide professional services.” Member firms of PwCIL were given the benefit of using the name of PwC and of utilising the resources of the PwC network, in return for which member firms were obligated “to abide by certain common policies and to maintain the standards of the PwC network as put forward by PwCIL.”
  • The engagement letter, entered into by Satyam with PwC, was signed only as “Price Waterhouse”, without providing for the name of the relevant auditor or the specific audit partnership firm.
  • The omnipresence of the network could be clearly witnessed in the instant case. The partners and the individual firms, in a way, represented to the public that they constituted a single consolidated network of firms under the name of PwC.

The SEBI order also stated that “[a]ny enforcement measure taken by SEBI with a preventive and remedial object, as envisaged under section 11B of the SEBI Act, would not serve the purpose unless the directions bring within its fold the PW Network operating in India. The objective of insulating the securities market from such fraudulent accounting practices perpetrated by an international firm of repute will be ineffective if the directions do not bring within its sweep, the brand name PW. The network structure of operations adopted by the international accounting firm should not be used as a shield to avoid legal implications arising out of the certifications issued under the brand name of the network.”

Directions against PwC

In view of the above, SEBI ordered that entities/firms practicing as CAs in India under the brand and banner of PwC would be barred from issuing any certificate of audit to listed companies for a period of two years. Further, listed companies and intermediaries registered with SEBI would be prevented from engaging any audit firm forming part of the PwC network for the purpose of issuing any certificate of compliance of statutory obligations for the said period of two years.

SEC & PCAOB orders against PwC

The SEBI order also made a reference to the settlement order of the Securities and Exchange Commission, US (“SEC”) dated April 05, 2011 imposing sanctions against member firms of the PwC network in the context of the fraud at Satyam. The SEC order was directed against the 5 Indian firms that were registered with the Public Company Accounting Oversight Board (“PCAOB”) in the US, and which had given audit certifications to Satyam in connection with issuance of Satyam’s securities in the US.

The SEC found that the audit reports issued by PwC Bangalore in connection with Satyam were inaccurate and caused Satyam to issue materially false and misleading financial statements, resulting in violations of US federal securities laws.[10] Similarly, the PCAOB order found PwC India firms in violation of the PCAOB standards on auditing.[11]

Aftermath

PwC appealed against the SEBI order in the Securities Appellate Tribunal. However, the SAT by order dated 19.01.2018, refused to grant a stay on the SEBI order.[12]

However, the SAT bench observed that the SEBI order “shall not come in the way of audit assignments undertaken by PwC and its network firms for fiscal 2017-18″ and clarified that the audit assignments already undertaken by PwC for clients who follow the financial year beginning on January 1, 2018 would not be impacted by the SEBI order.[13]

[1]  Price Waterhouse & Co. v. SEBI, [2010] 103 SC L96 (Bom).

[2]  Talluri Srinivas v. SEBI, [2013] 121 SCL 93 (SC).

[3]  Supra note 1, at ¶ 17

[4]  Id. at ¶ 25

[5]  Id. at ¶ 27

[6]  Id. at ¶ 40.

[7]  In respect of: M/s. Price Waterhouse, Bangalore & Ors., SEBI order dt. 10.01.2018, ¶ 24 to ¶ 172.

[8]   The order relied on Registrar of Companies, Bombay v. P M Hegde, AIR 1954 Mad 1080 and ICAI v. Mukesh Gang (AP HC).

[9]  SEBI order at ¶ 180.

[10]  SEC order dt. 05.04.2011.

[11]  PCAOB Release No. 105-2011-002 dt. 05.04.2011.

[12]  The order has not been uploaded on the SAT website to date.

[13]  SAT refuses to lift SEBI ban on Price Waterhouse, The Hindu Business Line (January 19, 2018).