SEBI’s Domain Over Auditors of Listed Companies

Earlier this month, the Bombay High Court issued its judgment in the case of Price Waterhouse & Co. v. Securities and Exchange Board of India. The court ruled that SEBI possesses necessary powers to initiate investigations against an auditor of a listed company for alleged wrongdoing.

Facts: A writ petition was filed before the Bombay High Court by Price Waterhouse & Co. (PWC) and some of its partners and affiliates challenging a show cause notice issued to them by SEBI. This pertains to PWC’s audit of Satyam Computers and their alleged failure to detect financial wrongdoing within the company of significant magnitude that in turn resulted in severe losses to Satyam shareholders. The financial wrongdoing included overstatement of cash and bank balances, non-existent accrued interest, overstated debtor position and the like. SEBI’s show cause notice sought to initiate action against PWC under Sections 11, 11B and 11(4) of the SEBI Act and Regulation 11 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003. Although PWC raise objections regarding jurisdiction of SEBI before its member, no order was passed on jurisdiction, which then prompted PWC to file the writ petition before the Bombay High Court for quashing the pending proceedings before SEBI.

Arguments: The principal arguments raised by PWC are that SEBI does not have the requisite jurisdiction to initiate action against auditors who are discharging their duties as professionals. SEBI can only regulate the securities markets and that auditors can never be considered to be associated directly with the securities markets. Moreover, PWC argued that there is already an established legal regime in the form of the Chartered Accountants Act, 1949 (and the Institute of Chartered Accountants of India (ICAI) established therein) that governs the accounting profession and hence any restrictions on the practice of that profession can be imposed only by the ICAI. Only the ICAI can determine whether there has been a violation of applicable auditing norms. Failing this, SEBI would be seen as encroaching upon the powers of the ICAI.

On the other hand, SEBI argued that the investigation pertains to a corporate scam that had a cascading effect on the price of Satyam’s shares and consequently on the securities markets as a whole. Since the auditor’s role is to certify the books of accounts of the company, persons dealing in the securities markets are likely to place reliance upon those accounts while making investment decisions. Consequently, it is argued that SEBI has jurisdiction to take appropriate steps in relation to auditors of listed companies.

Issues: The key questions before the court were (i) whether the show cause notice issued by SEBI was without jurisdiction so as to require quashing of such proceedings; and (ii) whether the proceedings initiated by SEBI amount to an encroachment of the powers of the ICAI under the Chartered Accountants Act.

Decision: The court analyzed the powers of SEBI under various provisions of the SEBI Act. It found various measures were available to SEBI that could be employed in regulating the securities markets. Those powers were of wide amplitude which would “take within its sweep a chartered accountant if his activities are detrimental to the interest of the investors or the securities market”. The court found that by taking remedial measures to protect the securities markets, it cannot be said that SEBI is regulating the accounting profession. SEBI’s general domain extends to protecting investors of listed companies and the securities markets. In exercise of such powers, there is no reason why SEBI cannot prevent any person from auditing a public listed company. Even though the auditors are not directly involved in the securities markets, the court found that since investors rely heavily on the audited accounts of the company, the statutory duty of the auditors and discharge thereof “may have a direct bearing in connection with the interest of the investors and the stability of the securities markets”. The court finally ruled that the powers of SEBI are independent of those held by the ICAI and hence SEBI cannot be said to encroach upon the powers of the ICAI under the Chartered Accountants Act.

Analysis: The judgment is important as it establishes the regulatory domain of SEBI over auditors of listed companies. The court largely arrives at its conclusions based on an analysis of SEBI’s powers to regulate the securities market, which is then contrasted with ICAI’s powers to regulate the accounting profession.

A greater significance of this judgment is that it establishes the role of an auditor to be closely linked with the functioning of the securities markets. Inherent in this analysis is the fact that proper performance of audit role in listed companies is a prerequisite for investor protection which is crucial to maintain robust securities markets. If audit and investor protection are said to be interconnected, it then takes us to a fundamental legal question: do auditors owe a duty to shareholders/investors? The Bombay High Court, in this case, appears to answer in the affirmative: “The auditors in the company are functioning as statutory auditors. They have been appointed by the shareholders by majority. They owe a duty to the shareholders and are required to give a correct picture of the financial affairs of the company.” [emphasis added]. Although the court cites to Institute of Chartered Accountants of India v. P.K. Mukherjee to state that auditors owe duties to shareholders in a company, that case had largely to do with a provident fund and its beneficiaries and it is not clear whether the ruling has any direct application to the present situation.

More importantly, the fact that auditors owe duties to shareholders seems to move away from conventional wisdom. In cases involving civil liability, the general position appears to be that the duty of reasonable care in carrying out audit of the company’s accounts is owed to the company in the interests of its shareholders, and that no duty is owed directly to individual shareholders. This has been solidified ever since the House of Lords pronounced its decision in Caparo Industries Plc v. Dickman [1990] 2 A.C. 605 (H.L.). The Bombay High Court’s judgment in the PWC steers clear of any detailed discussion regarding this jurisprudence. At one level, it may be argued that this discussion is not necessary in view of SEBI’s wide powers under the SEBI Act, but since those powers are derived from the investor protection mandate of SEBI, those powers may not be available if auditors do not have duties to individual shareholders in the first place. It is not clear if the discussion of auditors’ civil liability to individual shareholders can be divorced from auditors’ subjection to powers of a securities regulator acting to protect the investor community.

Although the judgment is confined to auditors, it remains to be seen whether third parties such as other advisors involved in securities markets activity (generally referred to as “gatekeepers”) could be drawn into the ambit of SEBI’s powers. Even here, courts in other jurisdictions have been slow to impose civil liability on such third parties. E.g. the U.S. Supreme Court decision in Stoneridge v. Scientific Atlanta. As far as certain gatekeepers such as investment/bankers and credit rating agencies are concerned, they are subject to SEBI’s domain by virtue of registration under relevant SEBI regulations that apply to them.

The last word is yet to be spoken in the matter, since the judgment itself indicates that PWC has sought to file a special leave petition before the Supreme Court.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.


  • Aren't bankers (investments/ merchant) and credit rating agencies already under SEBI's jurisdiction?

    In any case, SEBI's powers, like its jurisdiction, are pretty wide, and in cases like these, not without reason.

  • @Anonymous. Thanks – yes, merchant bankers and credit rating agencies would fall within SEBI's domain in view of their registration with SEBI under the respective regulations. To that extent, their position is different from other gatekeepers such as accountants who are not expressly subject to SEBI's regulatory purview.

  • A commercial bank (as opposed to a merchant banker) is outside SEBI's regulatory reviews. But no commercial bank can undertake issue related business (banker to an issue for instance) unless it is registered with SEBI. Similarly SEBI should first have made it mandatory for auditors desirous of undertaking audit and assurance works of listed companies or companies that propose to get listed. Regulating such auditors then would not have raised many eyebrows.

  • This decision is totally absurd. When there are well established channels of professional investigation, why should SEBI come into picture. I am totally against the views or Mr.Sacha Singh. ICAI maintains the register of CAs , why should you once again get registered with SEBI. Further how will SEBI know whether there has been any professional misconduct without professional assistance. Some thing should always be left with the professionals. How many times will be same issue be investigated and adjudicated. Once by ICAI and again by SEBI ?

  • In the context of UK capital market transactions, a discussion of auditor liability invites discussion of the Bannerman case. In RBS v Bannerman Johnstone Maclay the Scottish Court of Session ruled that since the auditor prepared the audited accounts when they were (or should have been) aware that the accounts would be provided to RBS (a creditor bank) for the purpose for which the accounts were actually provided to RBS and RBS did rely on (even though this purpose was different from the statutory purpose for which the accounts were prepared) established a duty of care to RBS. The position of law in the UK, despite the case, I think remains fluid. I havent as yet read the case law in India to see if there is mention of Bannerman. This issue is of course slightly different from what we have discussed here so far, in that Bannerman (when extended) talks of liability of auditors to purchasers of securities being offered on the basis of an offering memorandum which includes the audit report.

  • This judgment of SEBI brings under its ambit the auditors and auditing firms and hence empowers SEBI to regulate and scrutinize their actions despite the fact that there exists an authority i.e. ICAI which has been statutorily empowered under the Chartered Accountants Act to do the same.
    Can any of the learned friends, from above and around, may provide me with any points or case laws which go against this judgment of SEBI? In the event of the auditing firm filing an SLP before the SC what could be the plausible arguments and case laws it could cite so as to revert the order of the High Court?

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