Sebi has put forth a cogent, well reasoned and articulated argument why the entire PwC network needs to be penalised for the misdemeanour of two partners in one of the arms for the Satyam case.
The Securities and Exchange Board of India (Sebi) late Wednesday, roiled the small world of auditors and auditing firms in India and across the globe with its two-year ban against the entities and firms associated with the Price Waterhouse (PW) network.
The order pertains to the nine-year-old Satyam Computer Services case where in January 2009, the Chairman Ramalinga Raju in an email to the stock exchanges confessed to a $1.1 billion fraud by booking non-existent revenue. An arm of PwC was the statutory auditor for Satyam.
Soon after the Sebi order was made public late Wednesday, PwC very bravely put forth that it is confident of getting a stay. "As we have said since 2009, there has been no intentional wrongdoing by PW firms in the unprecedented management perpetrated fraud at Satyam, nor have we seen any material evidence to the contrary. We believe that the order is also not in line with the directions of the Hon'ble Bombay High Court order of 2010 and so we are confident of getting a stay."
However, a careful reading of the 108-page order by the markets regulator shows that considerable effort and pages have been expended in putting forth why Sebi is bound to put the entire PW network in the dock for the misdemeanours of two partners in Satyam.
The order addresses each of the possible objections. At one place, G. Mahalingam, wholetime director, who passed the order says, "I find that the objections are aimed at restricting the enforcement actions or directions of SEBI to those firms or persons who have been actually responsible for the alleged violations."
The criticism that has come for the order is based on the belief that the SEBI order uses a broad brush to paint the entire firm black. The argument is that since audit partnership firms of these kind function on the principle of individual entrepreneurship under the overall umbrella of a brand, it is just the errant partners who should be held accountable for their misdeeds.
The market regulator, however, has taken a rather 30,000-feet view of the entire case and seems to have chosen this case to signal a change in overall environment. "The network is omnipresent and identifiable by its name," the order says.
Sebi makes its cases by taking the support of the clauses of the Sebi Act and the regulations of the Sebi (Prevention of Unfair and Fraudulent Trade Practices Act) 2003. The order also cites a Supreme Court direction to the Sebi in 2013 case to bolster its argument. It also cites the US regulators' (SEC and PCAOB) orders on the same case in April 2011.
"The objective of insulating the securities market from such fraudulent accounting practices perpetrated by an international firm of repute will be ineffective if the directions do not bring within its sweep, the brand name PW. The network structure of operations adopted by the international accounting firm should not be used as a shield to avoid legal implications arising out of the certifications issued under the brand name of the network,"
Here is gist of of the point-counterpoint reasoning that Sebi uses to scotch potential objections against its punitive order.
Point: The standards of duty expected from an auditor is different from that expected from the audit firm. Given that the firm comprises of several other partners, all of them cannot be held liable for the actions of two auditors who may have committed fraud or negligence.
Counterpoint: "The assurance of high standards amongst all the entities in the PW Network is not balanced by corresponding liabilities cast on them for wanton disregard of such standards by any firm in the network."
Point: Prohibiting individual partners of PW Bangalore, from issuing any certificate of audit of listed companies would violate their fundamental rights since the individual partners had nothing to do with the audit of Satyam (SCSL). Merely because a person is a partner in a firm, he cannot be liable for the criminal acts of another partner unless he in some way connived with them.
Counterpoint: "I find that the objections are aimed at restricting the enforcement actions or directions of SEBI to those firms or persons who have been actually responsible for the alleged violations."
"The noticee firms (PwC arms) have essentially distanced themselves from the violations of PW Bangalore and its partners by claiming a separate legal existence, with its liabilities being distinct from other firms, even though they formed part of a common network."
Point: The firms exist as separate legal entities with separate books of accounts, separate P&L and separate budgets, separate registrations and separate tax returns.
Counterpoint: The order points out that the US Securities Exchange Commission and the PCAOB orders of April 2011 look at the entire network as a de facto single unit.
The Indian regulator ICAI's rules too point to the same reality, especially for the purposes of avoidance of conflict of interest as well as for the purpose of compliance with regulatory prescriptions.
"The noticee firms (arms of PwC) have essentially distanced themselves from the violations of PW Bangalore and its partners by claiming a separate legal existence, with its liabilities being distinct from other firms, even though they formed part of a common network."
"The network is omnipresent and identifiable by its name. The partners and the individual firms have ostensibly held out to the public to be a single consolidated network of firms under the name PW."
Point: There is no concept of agency in the commission of a wrong.
Counterpoint: "It is but obvious that this global brand recall of PWC carried its own value and influenced the investors to believe in their audit quality of judgment and correctness of the financial statements certified by them."
The Sebi member, G. Mahalingam then concludes that "having taken into account, all the factors relating to the manner in which various firms in India get registered with ICAI showing the name PW (bearing different registration numbers) and the nebulous way in which they are present in various parts of the country, it becomes difficult for me not to take note of the loss of faith of the investors in the brand name."
And therefore, the action against all firms under the brand name.