[By Ridhi Arora and Hitoishi Sarkar]
The authors are both students at Gujarat National Law University.
On 22 July 2020 the former head of Deloitte Haskins and Sells LLP, Udayan Sen was banned from being appointed as an auditor or internal auditor for any company for a period of seven years in an order passed by the National Financial Regulatory Authority (“NFRA”) The NFRA found him guilty of professional misconduct in his audit of the fraud-ridden IL&FS Financial Services Ltd (“IFIN”) and also imposed a monetary liability of Rs 25 lakhs. Interestingly, Mr. Udayan Sen had challenged the constitutionality of the NFRA vide Writ Petition W.P (C) no. 1524/2020 before the Delhi High Court. Despite the same being sub judice before the Delhi High Court, the NFRA went ahead with its proceedings and passed an order dated 22 July, 2020.
This post seeks to analyse the constitutional issues surrounding the NFRA, while also analysing it vis-à-vis the provisions of the Chartered Accountants Act, 1949 (“CA Act”) and the Supreme Court jurisprudence.
The NFRA is established under Section 132 of the Companies Act, 2013. The NFRA aims to regulate the conduct of chartered accountants in the country and draws heavily from section 22 of the CA Act, which conclusively lays down the definition of what constitutes professional misconduct. Evidently, the NFRA comes in direct conflict with the Institute of Chartered Accountants of India (“ICAI”), which grants licenses to the Chartered Accountants and is the regulator for the profession of chartered accountants in India.
The ICAI had expressed their reservations over the constitution of NFRA and the same was noted by the Standing Committee On Finance in its 37th Report as follows:
“a) Multiple Regulatory Bodies: Creating NFRA would result in two regulatory bodies (ICAI and NFRA) governing the same audit profession. This would result in duplication of efforts, added huge costs with no significant incremental benefits. This would also change the self-regulated profession to an externally regulated body.
b) The ICAI Context: NFRA might seem necessary to ensure that standard-setting and enforcement are not carried out by the same body (ICAI). However, it would be pertinent to mention that the ICAI, has been created by an Act of Parliament for this specific dual role (like SEBI). The constitution of NFRA needs to be re-examined in the mentioned contexts where relevant mechanisms and units have been enabled by and/or within the ICAI organization to deliver the twin objectives of robust policy-making and unbiased enforcement in a timely manner.
c) Relevance of NFRA in the context of the Companies Act 2013: The objective of NFRA is to regulate audit quality and protect the public interest. These, in any case, are also the main objectives of ICAI which strives to be a world-class regulator.”
Interestingly, the Committee opined in its Report that the CA Act should be streamlined and strengthened without needlessly adding to regulatory levels and the Centre could simply amend the CA Act to grant it more power if the need arose. However, the Ministry of Corporate affairs went ahead with the constitution of NFRA.
Demystifying the Constitutionality
The NFRA presents a significant challenge from the standpoint of constitutionality when looked at through the prism of several fundamental rights such as the freedom of profession, guaranteed under Article 19 (1) (g) of the constitution. An authority which has not issued the license to practice to an individual should not exercise the power to investigate a person for professional misconduct. The law on this point has been well settled by a Five Judge Bench of the Supreme Court in Supreme Court Bar Assn. v. Union of India & Anr., when it ruled that “since the jurisdiction to grant a licence to a law graduate to practice as an advocate vests exclusively in the Bar Council of the State concerned, the jurisdiction to suspend his license for a specified term or to revoke it also vests in the same body.” [i] Juxtaposing the aforementioned judgment with the functions of the NFRA, it seems that the authority operates in contradiction to principles of law laid down by the Court.
The notion of the unconstitutionality of the NFRA further stems from its considerable overlap with the CA Act. This is due to the Supreme Court’s generally broad interpretation of the CA Act. For instance, in Council of the Institute of Chartered Accountants v. B. Mukherjea, a Three-Judge Bench of the Supreme Court held that “any violations by a Chartered Accountant even as a liquidator will also be dealt with under the CA Act because the legislation is aimed at regulating the CA profession in totality.” [ii] Furthermore, the regulatory tussle between the ICAI and the NFRA will be unavoidable considering that section 22 of the CA Act clearly lays down grounds of misconduct for the CAs. Thus, the operation of both the ICAI and the NFRA will add to the already labyrinthine Indian regulatory framework.
It is no longer res integra post the Supreme Court’s ruling in Ashoka Marketing Ltd. v. Punjab National Bank and Ors., that “when general enactment covers a situation for which specific provision is made by another enactment contained in an earlier Act, it is presumed that the situation was intended to continue to be dealt with by the specific provision rather than the later general one.” [iii] Thus, considering that the CA Act is a special act to regulate the conduct of Chartered Accountants, even after the enactment of the later general enactment i.e , section 132 of the Companies Act, 2013 the specific provisions of the CA Act are likely to prevail.
The Supreme Court has in its ruling in Maganlal Chhaganlal (P) Ltd. v. Municipal Corpn. of Greater Bombay frowned upon such a practice and opined that “where there are two procedures for determination and enforcement of liability, be it civil or criminal or revenue, one of which is substantially more drastic and prejudicial than the other, and they operate in the same field, without any guiding policy or principle available from the legislation as to when one or the other procedure shall be followed, the law providing for the more drastic and prejudicial procedure would be liable to be condemned as discriminatory and void.” [iv] Thus, the lack of legislative clarity regarding the operation of both the liability enforcement regimes i.e, under the CA Act and section 132 of the Companies Act, 2013 puts the constitution of the NFRA in conflict with several decisions of the Supreme Court.
The proviso to section 132 (4) of the Companies Act clearly states that “no other body or authority is competent to investigate or initiate any proceedings against misconduct once the NFRA has initiated proceedings for misconduct.” In light of Maganlal Chhaganlal, there must be legislative clarity as to when the powers conferred on the ICAI and the NFRA can be invoked, and which authority will be competent to deal with cases of professional misconduct. The two presently exist parallelly, and both have the power to regulate the professional conduct of chartered accountants.
While there is wide acknowledgment amongst scholars of the need to revamp auditing and accounting standards in India, the same could have been done without complicating the regulatory framework any further. A more prudent way would have been to pay heed to the Standing Committee On Finance’s suggestion to amend the CA Act to further streamline and strengthen the previously existing regulatory framework. Numerous challenges to the constitutionality of the NFRA are pending across the Delhi and Madras High Court and it will indeed be interesting to see what the Courts rule and if the Apex Court will be called upon to adjudicate on the constitutionality of section 132.
[i] Supreme Court Bar Assn. v. Union Of India & Anr, (1981) 1 SCC 436.
[ii] The Council of The Institute Of Chartered Accountants v. B. Mukherjea, 1958 AIR 72.
[iii] Ashoka Marketing Ltd. v. Punjab National Bank & Ors., 1991 AIR 855.
[iv] Maganlal Chhagganlal (P) Ltd v. Municipal Corpn. Of Greater Bombay, 1974 AIR 2009.