[Pakhi Jain is an Advocate practising in the areas of corporate law and financial regulatory matters]
The interim ex-parte order passed by the Securities and Exchange Board of India (“SEBI“) in the matter of Rajesh Exports Limited (“REL Interim Order“) will be remembered not merely for the magnitude of REL’s alleged financial misstatements, but for the vexed regulatory question it poses. While the REL Interim Order records prima faciefindings of revenue inflated to the tune of approximately INR 15,15,385 crore, it simultaneously exposes an unresolved tension in India’s securities law framework: when does an audit failure cross into professional negligence of the auditor and justify preventive action by SEBI?
Whilst the order raises serious concerns regarding the statutory audit of REL’s financial statements, SEBI falls short of initiating any enforcement action against the auditors, instead directing the National Financial Reporting Authority(“NFRA“) to examine their conduct. This restrained approach reflects the continuing influence of the Securities Appellate Tribunal (“SAT”) decision in Price Waterhouse & Co. v. SEBI (“Price Waterhouse”) where the Tribunal significantly limited SEBI’s ability to impose practice related sanctions on auditors under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 (“PFUTP Regulations”).
This post argues that the REL Interim Order exhibits a regulatory gap in India’s securities law framework. While the distinction between fraud and professional negligence laid down in Price Waterhouse serves an important limiting function, its application may have unduly curtailed SEBI’s preventive jurisdiction over statutory auditors.
REL Saga: A Complete Audit Failure
The significance of the REL Interim Order extends far beyond the alleged financial irregularities of a listed entity. While the REL Interim Order records prima facie findings of revenue inflation and accounting misstatements by REL, its broader importance lies in exposing systemic deficiencies in financial reporting that raise questions regarding the effectiveness of the statutory audit process. These irregularities may broadly be classified into three categories: (i) revenue misstatement through subsidiary accounting; (ii) fictitious related party transactions; and (iii) repeated departures from the applicable Indian Accounting Standards (“Ind AS“).
The first category relates to the accounting treatment adopted by REL and its subsidiaries and step-down subsidiaries, particularly Global Gold Refineries AG (“GGR“) and Valcambi SA. SEBI observed that Valcambi SA recognised only processing charges as revenue, whereas GGR (having no substantial business) recognises the gross value of gold transactions together with processing charges as part of revenue, substantially increasing the group’s reported consolidated revenue. SEBI also noted REL’s failure to disclose the financial statements of its subsidiaries and step-down subsidiaries as mandated under the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”). These findings exhibit that REL’s consolidated financial statements do not present a “true and fair view” as required under the Companies Act, 2013.
The second category concerns unauthorised fund transfers between REL, its promoter and promoter-related entities. As per the REL Interim Order, these transactions were recorded as purchase and sale transactions, resulting in fictitious purchases and sales amounting to thousands of crores. SEBI further records that these transactions lacked the requisite approvals of the Board of Directors and Audit Committee and were not disclosed as related party transactions despite the requirements of the Companies Act, 2013 and the LODR Regulations. These findings reveal not merely disclosure lapses but fundamental deficiencies in internal financial controls, corporate governance and oversight.
The third category relates to departures from the applicable Ind AS governing financial reporting. As per the REL Interim Order, REL recognised foreign exchange differences and interest income as revenue from operations in contravention of Ind AS 21 and offset trade receivables against trade payables without satisfying the disclosure requirements under Ind AS 107. Although these appear to be technical accounting issues, they materially affect the financial indicators upon which investors and market participants rely heavily while evaluating a listed company.
These findings, viewed cumulatively, exhibit a sustained pattern of financial reporting deficiencies rather than isolated accounting errors. Their significance lies not merely in the alleged contraventions of accounting standards but in the widespread concerns they raise concerning the effectiveness of statutory audits as an independent oversight within India’s corporate governance framework.
Importance of the Auditors’ Role
The oft-quoted observation in Re Kingston Cotton Mill Co. (No. 2) that an auditor is “a watchdog, but not a bloodhound” has long shaped the understanding of an auditor’s responsibilities. Although this phrase acknowledges that auditors are not expected to uncover every instance of fraud through exhaustive investigation, it does not dilute their obligation to exercise professional scepticism, due professional care and independent judgment while conducting an audit. The statutory auditors hold a unique position within India’s corporate governance framework. They act as independent gatekeepers entrusted with examining whether the financial statements present a “true and fair view” of the company’s financial position as per requirements prescribed under the Companies Act, 2013, its allied regulations and the applicable Indian Accounting Standards. Their roles extend beyond verifying accounting records mechanically and include exercising professional scepticism, identifying material misstatements, assessing internal financial controls, and obtaining sufficient audit evidence before expressing an independent opinion.
The significance of the auditors role is even greater in the case of listed companies. Investors, creditors, regulators and other market participants rely heavily upon audited financial statements to assess a company’s financial health while making informed investment/economic decisions. Therefore, the statutory audit serves as a critical mechanism for promoting transparency, maintaining market integrity and reinforcing investor confidence.
Recognising this central role, the Committee on Fair Market Conduct constituted by SEBI that SEBI possesses concurrent powers to proceed against auditors who are instrumental in financial statement fraud and may invoke its powers under section 11B of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) to issue preventive directions, including debarring auditors from associating with listed companies, notwithstanding the disciplinary jurisdiction of professional regulators. Accordingly, where material financial irregularities remain undetected over successive financial years, concerns inevitably arise regarding whether the statutory auditors have effectively discharged their role as the first line of independent oversight within the corporate governance framework.
Law on Audit Failure
Over the past few years, SEBI’s jurisdiction over statutory auditors has been the subject of considerable judicial scrutiny. Whilst statutory auditors are primarily regulated under the Companies Act, 2013 and are professionally accountable before the NFRA, where an auditor’s conduct facilitates fraud or threatens the integrity of the securities market, SEBI may exercise its powers under sections 11 and 11B of the SEBI Act. The contours of this jurisdiction, however, remain unsettled.
The REL Interim Order holds significance for what it omits. Despite recording prima facie findings of pervasive accounting irregularities that persisted over several financial years, SEBI refrained from taking enforcement actions against the auditors by exercising its powers. This marks a notable departure from SEBI’s earlier enforcement approach.
This notable departure is particularly striking when viewed together with SEBI’s Order in the matter of Price Waterhouse & Co. SEBI. In that case, SEBI initiated proceedings against Price Waterhouse and other auditors of Satyam under sections 11 and 11B of the SEBI Act read with regulations 3 and 4 of the PFUTP Regulations. SEBI concluded that the auditors had failed to exercise the degree of professional diligence expected of statutory auditors and restrained them from undertaking audit assignments of listed companies and directed the disgorgement of the audit fees earned from Satyam. On appeal, however, SAT held that professional negligence could not by itself constitute fraud under the PFUTP Regulations. Relying on SEBI v. Kanaiyalal Baldevbhai Patel, SAT observed that fraud necessarily requires an element of inducement and, since SEBI failed to establish such inducement against auditors, the restraint directions were set aside, although disgorgement was upheld.
This Order of SAT maintains the distinction between fraud and professional negligence to prevent the overextension of SEBI’s jurisdiction into areas primarily regulated by professional regulators. Nonetheless, its practical consequence has narrowed the scope of SEBI’s preventive jurisdiction under section 11B of SEBI Act. While this approach prevents the overlap between SEBI’s regulatory mandate and the disciplinary jurisdiction of professional regulators, it also limits SEBI’s ability to invoke its preventive powers under section 11B of SEBI Act against auditors whose conduct, although involving serious or persistent audit failures undermining market integrity, falls short of satisfying the threshold of fraudulent conduct under the PFUTP Regulations. In such cases, disciplinary proceedings before NFRA remain the primary regulatory response.
The REL Interim Order illustrates the practical implications of this jurisprudence. Despite recording prima facie findings of extensive accounting irregularities, SEBI confined itself to referring the auditors to NFRA. The REL Interim Order therefore revives the argument as to whether the threshold established in the matter of Price Waterhousecontinues to adequately serve the objectives of investor protection and market integrity. Since SEBI’s appeal in Price Waterhouse remains pending before the Supreme Court, since 2019, wherein the Apex Court, by way of an interim order, has stayed SAT’s broader observation that SEBI lacks the power to debar audit firms from auditing listed companies, the precise scope of SEBI’s preventive jurisdiction over statutory auditors continues to remain unsettled.
Regulatory Failure and Global Response
The statutory approach adopted by some leading jurisdictions illustrates a common understanding that auditor accountability forms an integral component of securities market regulation rather than merely professional discipline. The Public Company Accounting Oversight Board (“PCAOB”), in the United States, possesses broad powers to sanction and investigate auditors for significant departures from auditing standards, irrespective of whether such conduct directly induces investors to trade. Similarly, the United Kingdom has progressively strengthened its audit oversight regime through the Financial Reporting Council (“FRC”) and its proposed successor, the Audit, Reporting and Governance Authority (“ARGA”), reflecting a policy shift towards greater regulatory scrutiny of audit quality and auditor independence.
The collapse of Wirecard AG in Germany and Carillion in the United Kingdom exposed the systemic consequences of prolonged audit failures and prompted significant reforms to strengthen auditor independence, supervisory oversight and the quality of statutory audits. Notably, Germany enacted the Act on Strengthening Financial Market Integrity(“FISG”) in 2021 following the Wirecard scandal, substantially improving its financial reporting oversight and expanding the powers of market regulators over auditors.
Although none of these jurisdictions empowered their securities markets regulators to impose disciplinary sanctions on auditors of public companies, the comparative experience demonstrates that audit failures are increasingly viewed as issues hampering forces of demand and supply in the securities market rather than merely professional discipline. This depicts broader recognition that statutory auditors perform a function of public interest, and persistent failures in discharging that function warrant timely regulatory intervention, along with professional disciplinary proceedings, where such failures threaten investor confidence and market integrity.
Conclusion
With SEBI’s appeal pending before the Supreme Court, there lies an opportunity to clarify the relationship between SEBI’s preventive powers under section 11B of the SEBI Act and NFRA’s disciplinary jurisdiction.
The lessons from jurisdictions like Germany show that corporate failures often require reenactment and reassessment of the regulatory framework governing statutory audits. Whilst India’s institutional framework is different, the present scenario raises an important question of whether the existing framework clearly delineates the respective roles of SEBI and NFRA in dealing with serious audit failures. Greater clarity in this regard would not only reduce regulatory uncertainty but also ensure that timely preventive action and professional discipline operate in a complementary manner, thereby strengthening investor confidence and market integrity.
– Pakhi Jain