In a major upset for audit firms Deloitte Haskins and Sells LLP and BSR and Associates LLP, an Indian affiliate of KPMG, the Supreme Court has held that an enquiry initiated against an auditor cannot stand terminated just because he has resigned. The ruling comes on a criminal complaint filed by the Serious Fraud Investigation Office against the erstwhile auditors of Infrastructure Leasing and Financial Services Ltd.
In allowing the investigation to continue, the apex court has overturned a ruling by the Bombay High Court. The high court had held that upon the resignation of auditors, no enquiry could be maintained against them. While upholding the constitutional validity of Section 140(5) of the Companies Act, the high court said that the provision applies only to existing auditors. The provision allows the National Company Law Tribunal to examine the role of an auditor.
The apex court disagreed with the high court and held that even if an auditor has resigned during an enquiry, there must be a final order on whether it has directly or indirectly acted in a fraudulent manner.
The court said that an enquiry must go to its logical end, and the subsequent resignation and/or discontinuance of an auditor shall not terminate the enquiry.
Elaborating on the reasons for its ruling, the apex court stated that auditors play a very important role in the affairs of a company and that they have to act in the larger public interest. Therefore, the enquiry initiated against them cannot be said to be discriminatory or violative of Article 14 of the Constitution of India.
"Acting in a fraudulent manner, directly or indirectly, by an auditor is a very serious misconduct, and therefore the necessary consequence of indulging into such a fraudulent act shall follow," the Supreme Court said.\
The apex court pointed out that if the interpretation of the high court is upheld, the auditor would simply resign, which could not have been the intention of the legislature.
The case pertains to a series of defaults by the IL&FS Group companies, which had an aggregate debt of more than Rs. 91,000 crore in 2018. This had threatened to collapse the money markets in India, added pressure to corporate bond yields, and sparked a sell-off in the stock market.
Subsequently, a petition was filed by the Ministry of Corporate Affairs before the NCLT, requesting to re-open the books of accounts of IL&FS Group companies on the ground that the affairs of the group had been mismanaged, casting doubt on the reliability of the financial accounts. The petition was accepted, and books of accounts were ordered to be reopened.
The ministry sought to remove the auditors, Deloitte and BSR, and impose a five-year ban for their alleged participation in masking the defaults. The plea was allowed by the NCLT but was subsequently struck down by the high court on the ground that the audit firms had resigned during the enquiry.
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