The Delhi High Court has quashed the show cause notice (SCN) issued by the National Financial Reporting Authority (NFRA) for disciplinary action against CAs and auditing firms over misconduct.
The bench of Justice Yashwant Varma and Justice Dharmesh Sharma has observed that uphold the validity of Section 132 of the Companies Act and the NFRA Rules.
The bench noted that the prescription of a summary procedure for trial of disciplinary matters neither obviates nor relieves the NFRA from adhering to a procedure which is in consonance with the principles of fairness and natural justice.
The bench stated that the NFRA clearly acted contrary to the command of the legislation which obliged it to bear in mind the division of functions and which clearly mandates a separation of roles that the authority is called upon to discharge under the Companies Act and the NFRA Rules. The assessment of whether circumstances warranted a disciplinary enquiry being initiated was statutorily liable to be undertaken by a unit of the NFRA separated from the one which drew up those reports. The procedure which NFRA chose to follow in these cases clearly lacked attributes of neutrality and a dispassionate appraisal.
The writ petitions instituted by individual Chartered Accountants as well as auditing firms assailled the validity of Section 132(4) of the Companies Act, 2013. A challenge is additionally raised to Rules 3, 8, 10 and 11 of the National Financial Reporting Authority Rules, 2018.
The petitioners in this batch have individually challenged the notices issued by the National Financial Regulatory Authority in terms of which proceedings were sought to be initiated by the respondent for commencement of disciplinary action in respect of perceived acts of ‘professional or other misconduct’ and for consequential imposition of penalties.
In some of the writ petitions, final orders of punishment including that of debarment had also come to be passed and which too have been challenged in the writ petitions.
The challenge on the basis of constitutional invalidity is founded on a retroactive operation of Section 132 of the Companies Act and which is viewed as empowering the NFRA to initiate disciplinary proceedings not just against individual partners and CAs’ but also auditing firms in respect of any audit that may have been conducted including those commenced and concluded prior to the introduction of that provision in the Companies Act.
Section 132 came to be incorporated in the Companies Act by virtue of Act 18 of 2013 and came to be operationalized in terms of a notification issued on 01 October 2018. In terms of that notification, the Union Government designated the said date as the point of commencement as well as the date of constitution of the NFRA.
It is in the backdrop that the petitioners contend that Section 132 and its retrospective operation would be rendered unconstitutional and invalid since it contemplates the imposition of penalties as well as disciplinary action in terms which were not contemplated by the statute prior to 01 October 2018.
The challenge to Section 132 also proceeds on the ground of an alleged lack of procedural due process as well as the deprivation of rights and safeguards which were conferred upon a CA or a firm while facing disciplinary action under the Chartered Accountants Act, 1949 read along with the Chartered Accountants Regulations, 1988 and (Procedure of Investigations of the Chartered Professional Accountants and Other Misconduct and Conduct of Cases) Rules, 2007.
The action of the respondents which stands impugned in this batch is also based on the various provisions contained in Section 132 itself as well as the NFRA Rules. This facet of the challenge is based on the petitioners arguing that in terms of the statutory provisions aforenoted, the NFRA is envisaged to discharge its functions and duties through various independent and separate “divisions”.
According to the writ petitioners, the statute itself envisages the functions of monitoring and enforcement of accounting standards, overseeing quality of service, suggesting measures, the power to investigate as well as to undertake disciplinary action is contemplated to be discharged by separate divisions of the NFRA.
According to the writ petitioners, in the facts of these cases it is apparent that the body which oversaw the audits in question was the same which came to the conclusion that there was a failure to comply with accounting standards itself and initiated proceedings for taking disciplinary action.
They thus contend that the very same body that had drawn a report on the basis of which the disciplinary proceedings are sought to be initiated and undertaken has essentially donned the role of both prosecutor and judge. This, according to the petitioners, is sufficient to hold the initiation of action as being in clear violation of fair and due process and in breach of Article 14 of the Constitution.
Court’s Observation
The court held that the NFRA Rules oblige the authority to make available to the charged CA or firm a detail of the allegations that are laid together with the evidence in support thereof as well as an appropriate disclosure with respect to the provisions of the Act, Rules or the SAs which are found to have been allegedly violated. It enjoins the SCN to broadly indicate the action that NFRA proposes to take or the directions that it may be constrained to frame if the allegations were to be ultimately established.
The authority is also statutorily obliged to enclose all copies of documents relied upon as well as to make available the extracts of reports of investigation or other records which are proposed to used for proving the allegation levelled. The SCN must be served upon the auditor as well as the firm dependent upon the action which the authority proposes to initiate. The statute thus adopts and incorporates appropriate measures and safeguards to ensure that the procedure that it adopts is in accord with the principles of fair play and natural justice.
The court opined that the proceedings which the NFRA would undertake are not liable to conform to the requirement of guilt being proved beyond reasonable doubt and which is a test which primarily applies to criminal trials. The proceedings under Section 132(4) are essentially disciplinary proceedings and which are governed and guided by the well- accepted principle of the charge being liable to be proved on the basis of preponderance of probabilities.
A body must not only be fair and impartial, but it should also not be burdened by a predisposition or a predetermined state of mind. This aspect assumes significance insofar as we are concerned in light of a common complement of persons having rendered findings of alleged professional misconduct and thereafter sitting upon that very opinion to consider commencement of disciplinary action.
The court left it open to the NFRA to draw proceedings afresh if so chosen and advised from the stage of issuance of fresh notices based on the findings that have come to be recorded in the AQRRs’. The findings and conclusions appearing in the AQRRs’ would be liable to viewed as merely being the expression of a prima facie opinion as opposed to definitive conclusions. Those findings and conclusions may be evaluated afresh for the purposes of formation of opinion whether disciplinary action is liable to be initiated.
Case Details
Case Title: Deloitte Haskins & Sells LLP Versus Union Of India
Case No.: W.P.(C) 1065/2021 & CM APPL. 9896/2021
Date: 07 February, 2025
Counsel For Appellant: Sr. Adv. Kapil Sibal
Counsel For Respondent: Shiva Lakshmi
