Where a complaint is made against an SCA by a public sector bank, it would be the duty of the RBI to examine such complaint carefully

RBI
LD/60/69
Gupta & Gupta Chartered Accountants Vs. Reserve Bank of India
October 10, 2011 (DEL)
Section 30 of the Banking Regulation Act, 1949 - Audit

Where RBI failed to afford Chartered Accountants an
opportunity of defending itself against Nationalised
Bank’s allegations and also, neither RBI nor Bank had
communicated to Chartered Accountants decision
to discontinue it as an Statutory Central Auditor for
extended review period, it was violative of principles of
natural justice and was, therefore, illegal
The procedure for the appointment of a firm of
auditors as Statutory Central Auditor (SCA) for a public
sector bank envisages a primary role for the RBI, which
acts as such in exercise of its powers under Section
30 (1A) of Banking Regulation Act, 1949 ['the BR Act'].
In terms of Section 10 (1) of the Banking Companies
(Acquisition and Transfer of Undertakings) Act, 1970
['1970 Act'] and the corresponding provision in the
Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1980 ['1980 Act'], the RBI has to
mandatorily grant prior approval to the appointment
of SCAs of twenty-six public sector banks. The RBI
has issued circulars specifying the norms for appointment
of SCAs in public sector banks. Where the total
liabilities and assets of the public sector bank is up
to R50,000 crore the prescribed number of SCAs
is four; where it is between R50,000 crore and up to
R1 lakh crore, the number of SCAs is five and above
R1 lakh crore, the number of SCAs is six. The SCAs
appointed during 2006-07 and thereafter would have
a tenure of four years after which they were to be
rested for two years. Further, the Office of Comptroller
& Auditor General of India ('CAG') is entrusted with the
responsibility of calling for applications from auditors/
audit firms desirous of being appointed as SCAs in
public sector banks every year. After subjecting the
applications to scrutiny in terms of the prescribed
norms, the CAG prepares a list of eligible auditors/
audit firms. That list is then forwarded by the CAG to
the RBI. Finally, the selection of auditors/audit firms
by the RBI is made from amongst the auditors/audit
firms found eligible by CAG.
The discontinuance of an SCA, selected through
such a rigorous process, is likely to have adverse
consequences for its reputation and goodwill if such
discontinuance is as a result of a complaint about
its competence or integrity. For a firm of auditors the
appointment as SCA of a public sector bank is bound
to be seen to be a prestigious one. As a corollary
the discontinuance of a firm of auditors as SCA,
unless for circumstances unconnected with integrity
or competence, is bound to be viewed negatively.
Further, since the number of SCAs of a public sector
bank is unlikely to be more than six, the appointment
and discontinuance of an SCA is likely to be known
immediately to all chartered accountants.
An SCA of a public sector bank discharges
statutory responsibilities traceable to Section 224 (2)
of the Companies Act, 1956, the BR Act, the 1970 Act
and the 1980 Act. In the context of the circulars issued
by the RBI on the charging of interest by public sector
banks, the Supreme Court in Central Bank of India v.
Ravindra [2001] 107 Comp. Cas. 416 explained that
the power conferred on the RBI under Sections 21
and 35A of the BR Act is coupled with the duty to act
fairly and reasonably. The RBI's circulars were held to
be binding on "those who fall within the net of such
directives." By analogy the RBI's circulars as regards
the appointment and continuance of SCAs must be
viewed as binding on public sector banks including the
PNB. RBI discharges a statutory duty when it selects
a firm of auditors to act as an SCA of a public sector
bank. It is a reflection of both the competence as well
as integrity of the firm of auditors. It acknowledges
that the answerability of the public sector bank is as
much as to the law as to the public in general whose
monies it is the custodian of. On their part the SCAs
are expected to discharge their professional duties
in the context of the above statutory obligations and
their answerability to both the RBI and the public in
general. The relationship of an SCA with the public
sector bank whose audit they are engaged to undertake
transcends the usual client-auditor relationship.
The involvement of the RBI in the appointment and
discontinuance of an SCA is meant to ensure a degree
of protection to the SCA which is expected to discharge
its professional duty fearlessly and independently.
The discontinuance of an SCA cannot be
brought about by the public sector bank acting by
itself. Just as there can be no appointment of an SCA
without the intervention of the RBI, there can be no
discontinuance of an SCA without the RBI taking a
decision in that regard. The greater the power to appoint
and remove an SCA, the higher the responsibility on
the RBI as the holder of such power to exercise it in
a fair and reasonable manner after following a just
procedure which comports with the principles of
natural justice.
Where a complaint is made against an SCA by a
public sector bank, it would be the duty of the RBI to
examine such complaint carefully. In the audit of large
public sector banks, there are bound to be queries
raised by the SCAs about the accounts of the large
account holders of the bank. If there are complaints
by the bank, like in the present case, that the audit
is getting delayed on account of the bank having to
answer such queries, the RBI will have to examine the
tenability of such claim after seeking an explanation
from the SCA.
The Petitioner, a firm of chartered accountants,
is aggrieved by a decision of Reserve Bank of India
('RBI'), communicated to Punjab National Bank ('PNB'),
advising that the PNB may carry out the quarterly review
for the quarter ending 30th June 2009 with the five
existing statutory central auditors ('SCAs'), excluding
the Petitioner firm in view of the circumstances
mentioned in the PNB's letter dated 27th May 2009
addressed to the RBI.
The High Court of Delhi held that the PNB first
wrote to the RBI on 24th April 2009 blaming the
Petitioner for the delay in the finalization of the accounts.
The Petitioner's comments on the said letter
were sought by the RBI. The Petitioner then submitted
a reply dated 7th May 2009 explaining that there was no
delay on its part. This reply was furnished to the PNB
by the RBI for its response. In response thereto, on 27th
May 2009 the PNB made several allegations questioning
the Petitioner's professional competence and
integrity. In other words, the tenor of the allegations by
PNB against the Petitioner in the letter dated 27th May
2009 was not confined to the issue of delay. Specifically,
PNB alleged that the intention of the Petitioner was "to
malign the reputation and image of the bank"; that the
Petitioner was "abrasive ab initio and uncooperative in
their approach right from the first audit and are lacking
in professionalism."; that they have been "putting
the entire system to undue stress and holding the
bank to ransom"; "their objective has been to
embarrass the bank and harass its officers. The
behaviour and attitude is indicative of cynicism and
sadism." Then came the impugned decision of the
RBI communicated in its letter dated 24th June 2009
permitting PNB to discontinue the Petitioner as SCA
for the limited extended review for the quarter ending
30th June 2009.
It is not as if the letter dated 24th June 2009
simply states that the Petitioner will be discontinued.
It refers to the PNB's letter dated 27th May 2009 and
states that the Petitioner could be discontinued as
SCA "in view of the circumstances cited in the above
letter." It is therefore not possible to view the said
discontinuance as being innocuous and routine and
not casting a stigma on the Petitioner. The RBI could
not have arrived at the decision without some kind
of an inquiry. The RBI was performing an important
and sensitive task. Allegations concerning the
competence and integrity of an SCA, selected by
the RBI through a fairly rigorous process, cannot be
permitted to be made lightly and equally accepted on
face value without some probe by the RBI. Otherwise
it might be easy for a bank to have an inconvenient
SCA discontinued. Considering that the accounts of
public sector banks are to be audited by employing
the best possible standards, the RBI was under a
statutory obligation to ensure that the discontinuance
of the Petitioner, on a complaint about its professional
competence, was preceded by a proper procedure
comporting with the principles of natural justice.
Admittedly, even a copy of PNB's letter dated 27th May
2009 was not sent to the Petitioner for its comments
although it contained serious allegations about the
Petitioner's conduct and professional competence.
Thereby RBI failed to afford the Petitioner an opportunity
of defending itself against PNB's allegations.
Also, neither the RBI nor PNB communicated to the
Petitioner the decision to discontinue it as an SCA for
the extended review period.
Therefore, the impugned decision of the RBI, as
communicated in its letter dated 24th June 2009 to the
PNB, to discontinue the Petitioner as an SCA, even
for the limited extended period ending 30th June
2009, was violative of the principles of natural justice
and was, therefore, illegal. However, since the period
in question is over no consequential relief can be
granted except to clarify that the said decision of the
RBI, will not come in the way of the Petitioner being
hereafter appointed as an SCA in accordance with the
norms devised by the RBI.
--
*CA. Mukesh Saran
M.Com.,FCA, ISA-ICAI