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No clarity on legal action against auditors
January, 10th 2009

Angry shareholders of Satyam may be miffed with the statutory auditors who have come in for sharp criticism following the dramatic revelations of accounting fraud in what is being billed as the country's Enron. But there is not much clarity on the kind of action shareholders can take against the auditors Pricewaterhouse Coopers under the laws.

"The contract that the auditor has with the company is not a contract the shareholders or other stakeholders are privy to. Hence, under Indian law it would be difficult for the shareholders to take any action against the auditors under the law of contract," according to Namrata Mehta, corporate lawyer, Economic Laws Practice, a law firm.

"It is a ticklish issue. Since the statutory auditors are appointed by shareholders they are entitled to take legal action. But investors have to prove that they suffered huge losses," said V Murali, central council member, Institute of Chartered Accountants of India (ICAI).

The shareholders must establish that they relied upon the auditors and that they suffered actual losses. If these conditions are satisfied the claim could well lie against auditors.

Though the books of accounts are prepared by the company and looked in detail by internal auditors appointed by the management, statutory auditors cannot absolve themselves of their responsibilities, Murali noted.

"Action in law has generally been taken either in contract or in tort," Namrata stated. Tort is a wrongful act done willfully in circumstances involving strict liability for which a civil suit can be brought. To establish a claim in tort, the shareholders have to satisfy the court that auditors owe a duty of care to shareholders and that there was a breach of such duty.

Even if the company takes action against the auditors under contract it would be limited by the terms of the contract. Many accountancy firms limit their liability usually to an extent of the fees they receive from the company, Namrata said. "How the court will view the liability of the auditors of Satyam will depend upon the extent to which the court is convinced about a claim for negligence."

Meanwhile, the ICAI has taken up the issue 'suo motu' and has referred it to its financial reporting review board. "We would look at the sampling techniques adopted by the auditors and as to why the normal checks by auditors did not bring out the facts," Murali said.

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