SC underlines need for separation of investigation and adjudication in NFRA proceedings
New Delhi, Feb 17, 2025
The Supreme Court on Monday underscored the necessity of separating investigative and adjudicatory functions within the National Financial Reporting Authority (NFRA) to uphold regulatory impartiality, even as it admitted an appeal by NFRA against the Delhi high court’s verdict that quashed show cause notices issued to auditing firms Deloitte Haskins & Sells LLP and SRBC & Co LLP in the IL&FS case.
A bench comprising Chief Justice of India Sanjiv Khanna and justice Sanjay Kumar issued notice on NFRA’s appeal but declined to stay the high court’s February 7 ruling. The bench also 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 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, who represented NFRA.
The court’s observations echoed concerns raised by the Delhi high court, which struck down 11 show cause notices issued by NFRA citing violations of the separation of functions principle. The high court had ruled that a lack of such bifurcation risked regulatory bias and compromised the credibility of audit reviews.
Mehta, however, argued against the need for separate divisions, stating 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 only three members in NFRA,” he added.
But the bench retorted: “These are the rules framed by your own ministry and they seem to provide for such divisions.”
Supporting the bench, senior counsel Kapil Sibal and CA Sundaram, representing the auditors, stressed that NFRA’s own rules mandate separate divisions, and the regulator must comply with its framework.
In its interim order, the court allowed NFRA to proceed afresh in cases where no audit quality review (AQR) was prepared and was subsequently quashed by the high court. However, the court clarified that NFRA cannot give effect to final orders already passed in other cases.
“The Supreme Court has established a crucial principle that one cannot simultaneously act as both prosecutor and judge in the same case. This age-old principle of natural justice provides relief not only to Deloitte Haskins & Sells LLP and SRBC & Co LLP but also to thousands of chartered accountants who feel aggrieved by the NFRA’s practice of prosecuting and judging them on lapses. Bodies and associations like ICAI are likely closely observing this case,” Dinesh Jotwani, co-managing partner, Jotwani Associates, said.
The legal dispute stems from the collapse of IL&FS, a non-banking financial company (NBFC) that defaulted on loans in 2018, prompting the government to overhaul its board. NFRA, which was established the same year as India’s independent audit regulator, conducted an investigation into alleged lapses in the audit of IL&FS Transportation Networks Ltd (ITNL) and IL&FS Financial Services Ltd (IFIN). The regulator issued multiple show cause notices to Deloitte Haskins & Sells LLP and SRBC & Co. LLP, the auditors of the IL&FS group entities, alleging professional misconduct.
The Delhi high court’s ruling quashing these notices was based on the absence of a clear separation between NFRA’s investigative and disciplinary functions. The high court likened this scenario to the “useless formality theory,” where lack of procedural fairness raises concerns about impartiality. However, the high court had upheld NFRA’s constitutional validity and its authority under Section 132 of the Companies Act to regulate auditors and auditing firms.
NFRA’s appeal in the Supreme Court has broad implications for audit regulation and financial oversight in India. The case raises key questions about balancing regulatory efficiency with fairness. While the NFRA maintains that its executive body, led by the chairperson and two additional members, is empowered to impose penalties and take disciplinary action, the high court verdict has brought the spotlight on structural reforms within the regulator to ascertain impartial penalty proceedings against audit firms and financial professionals in the country’s evolving regulatory landscape.
[The Hindustan Times]
