Supreme Court seeks govt response on NFRA's 'division of functions'

The Supreme Court on Monday sought a response from the Ministry of Corporate Affairs and others on an appeal by the National Financial Reporting Authority (NFRA) challenging a Delhi High Court (HC) order.

 

The HC order of February 7 quashed show-cause notices issued by the auditing standards watchdog to audit firms, including Deloitte Haskins & Sells LLP and SRBC & Co LLP, as well as prominent chartered accountants (CAs), for certain procedural violations in initiating disciplinary proceedings.

 

A bench of Chief Justice of India Sanjiv Khanna and Justice Sanjay Kumar on Monday did not stay the HC ruling and observed that NFRA should have separate divisions for investigating financial auditors and chartered accountants, and for adjudicating penalties and disciplinary actions under the Companies Act.

 

“Under the Customs and Excise Act, the same position emerges. The show-cause notice is by one authority, and assessment proceedings are carried out by a different authority… you can also have these proceedings conducted by different persons,” the bench told Solicitor General Tushar Mehta, appearing for NFRA.

 

The Delhi High Court, while upholding the constitutional validity of NFRA and its retrospective authority, had stated that it is obliged to maintain a division of functions between the review of an audit and the formation of an opinion to initiate disciplinary proceedings.

 

Mehta on Monday argued against the need for separate divisions before the apex court, saying that NFRA has only three members and lacks the capacity for distinct investigative and adjudicatory functions.

 

“The impugned judgment has wide ramifications… We (NFRA) are a composite body and cannot work in divisions in a strict sense. The law only stipulates three members in NFRA,” he said.

 

Earlier, the Delhi HC had upheld the validity of Section 132 of the Companies Act and said that NFRA acted contrary to legislative intent, which required it to ensure separation of its unit that undertook assessment of circumstances needing an enquiry, from the one that drew up the audit quality review report.

 

Section 132 of the Companies Act, 2013, establishes NFRA as the regulator of auditors.

 

“Since the unit within NFRA that was responsible for the audit quality review report and the one that issued the show-cause notice was the same, the Delhi HC held that there was a reasonable apprehension of bias. Therefore, the impugned show-cause notices and final orders passed thereto were set aside,” Manmeet Singh, partner at law firm Cyril Amarchand Mangaldas, said.

 

Alay Razvi, managing partner of law firm Accord Juris, said the Delhi HC’s judgment will have implications for NFRA and its earlier orders.

 

“In this judgment, the court’s (HC) concern was over NFRA’s internal processes, wherein NFRA had not adequately separated its functions between audit quality and disciplinary actions. This lack of division could lead to potential biases, as the same team might act as both investigator and adjudicator,” he said.

 

“The Delhi High Court’s judgment does not diminish NFRA’s necessary role but refines its boundaries and operational framework, ensuring that its powers are executed with the highest degree of integrity and adherence to justice,” Sonal Alagh, partner at law firm Alagh & Kapoor Law Offices, said.

 

Some other experts, however, think that the Delhi HC ruling could mark a turning point in financial regulation, compelling NFRA to reconsider its approach and potentially leading to a wave of litigation against its past decisions.

 

“If courts across the country begin applying the Delhi High Court’s reasoning, NFRA may find its previous enforcement actions unravelling one by one, forcing it to reissue notices, conduct fresh hearings, or abandon certain cases altogether,” said Tushar Kumar, an advocate practising in the Supreme Court of India.

 

With the ruling of the HC challenged, a clarification may be expected. “Although the High Court did not make the ruling applicable retrospectively (explicitly) to past orders by NFRA, it is expected that such orders would be susceptible to challenge in light of the order,” said Shiv Sapra, partner at law firm Kochhar & Co.