The Delhi High Court has quashed 11 show-cause notices and four final orders issued by the National Financial Reporting Authority (NFRA) against multiple Chartered Accountants and audit firms for professional misconduct. The court ruled that the audit regulator’s procedure “clearly lacked neutrality and dispassionate appraisal.”
The notices, issued between January 2020 and January 2023, targeted among others the partners of Deloitte Haskins & Sells LLP and S R B C & Co LLP over alleged professional misconduct during the audit of certain IL&FS entities nearly six years ago.
The violation
In a 476-page order disposing of a batch of writ petitions, the Bench of Justice Yashwant Varma and Justice Dharmesh Sharma held that the NFRA had violated legal provisions requiring a separation of functions. The Companies Act and NFRA Rules mandate distinct roles within the regulator to ensure impartiality in disciplinary proceedings.
The court emphasised the need for a clear “division” of authority within the NFRA. It ruled that the same unit cannot both investigate alleged misconduct and determine the need for disciplinary action, as this compromises fairness.
“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 these reports (AQRR). The procedure which NFRA chose to follow in these cases clearly lacked attributes of neutrality and a dispassionate appraisal,” the court stated.
The decision on whether disciplinary action should proceed must be made independently by NFRA members unconnected to the audit review process and the preparation of Audit Quality Review Reports (AQRRs), the order added.
Dual role
The petitioners had argued that the NFRA had assumed the dual role of both prosecutor and judge by preparing the reports and initiating disciplinary proceedings based on them.
However, the court has allowed NFRA the option of initiating fresh proceedings through new notices—provided it establishes a proper separation of authority within its structure.
Additionally, the Delhi High Court upheld the constitutional validity of Section 132(4) of the Companies Act, 2013, rejecting the petitioners’ challenge.
“We uphold the validity of Section 132 and the NFRA Rules. We find no merit in the challenge based on the arguments of vicarious liability, retroactive operation, and violation of Article 20(1) of the Constitution,” the order stated.
The petitioners had sought to strike down Section 132(4) and NFRA Rules 3, 8, 10, and 11, arguing that they violated due process rights. However, the court found no grounds to declare them unconstitutional.
