While setting aside an order of the Bombay High Court (HC), the Supreme Court clarified that resignation does not mean that proceedings against an auditor before the national company law tribunal (NCLT) under Section 140(5) will end. The HC had quashed a complaint filed by the serious fraud investigation office (SFIO) against Deloitte Haskins and Sells and KPMG unit BSR & Associates, the two auditors of Infrastructure Leasing & Financial Services (IL&FS).
The bench of justice MR Shah and justice MM Sundresh says the HC erred in holding that the resignation of the auditor meant that proceedings against the auditor before NCLT would end. "If such a position is taken, auditors, whenever they face proceedings, will resign and that this could not have been the legislature's intention."
"There must be a final order passed by tribunal irrespective of his resignation to see if he has colluded or acted in a fraudulent manner," the bench says.
The apex court stressed that auditors play a vital role in the affairs of a company and have to act in the larger public interest, adding that an auditor acting in a fraudulent manner, directly or indirectly, is very serious misconduct.
However, the bench says automatic disqualification of auditors and the entire firm, including partners, for five years to become an auditor of any other company is highly disproportionate and it is ultimately for the legislature and Parliament to provide the debarment.
The SC also noted that on the principle of joint and severe liability, the auditors and the entire firm, including partners, shall be liable and, therefore, can be subjected to Section 140(5) and the consequences mentioned in Section 140(5) of the Companies Act.
In
an order in April 2020, the Bombay HC held that when chartered accountants (CAs) defraud a company but have completed their term and left, they could not be charged and, hence, were not amenable to Section 140(5).
"... disqualification stipulated in the second proviso to Section 140(5) cannot be construed as a second punishment for same misconduct & it also does not attract the principle of double jeopardy. As the legislative mandate of disqualification in the second proviso to Section 140(5) is not a punishment either for the misconduct or the offence, obviously, it is added as a measure to achieve a laudable goal stated," the HC had said.
However, the apex court says the intention of the legislature behind Section 140(5) is very clear that, irrespective of the other provisions of the Act, the NCLT is vested with the power to see if the auditor acted in a fraudulent manner. "...Section 140(5) cannot be called to be an excessive or arbitrary use of power by NCLT to determine offences of grave nature and stated that the ample opportunity shall be given by NCLT before passing a final order."
In January 2020, the national company law appellate tribunal (NCLAT) had asked the ministry of corporate affairs (MCA) to clarify whether civil proceedings, as sought by the ministry against the audit firms, can be carried out on the basis of a criminal report.
The ministry has cited the interim report of the SFIO alleging collusion by the auditors with the IFIN management in concealing information, among other charges. The ministry had sought the freezing of the assets of the audit firms based on the report.
Interestingly, in December 2019, the national financial reporting authority (NFRA) had said Deloitte Haskins and Sells did not comply with the standards of auditing in the crisis-ridden IL&FS Financial Services (IFIN).
In its audit quality review (AQR), NFRA said that the quality control systems and processes of Deloitte were found to be 'severely inadequate and ineffective'.
"The AQR has disclosed that DHS (Deloitte) has failed to comply with the requirement of the SAs (standards of auditing). The instances of failure noticed are of such significance that it appears to NFRA that DHS did not have adequate justification for issuing the audit report asserting that the audit was conducted in accordance with the SAs," the report says.