The cardinal principle of company law, as enshrined under Section 129(1) of the Companies Act, 2013 (“Companies Act”), is that the financial statements (“FS”) should give a ‘true and fair view’ of the state of affairs of the company, comply with the accounting standards notified under Section 133, and also be in the form provided for different classes of companies under Schedule III.
Further, Section 134(5) of the Companies Act provides that the Directors’ Responsibility Statement should inter alia state that – (a) in the preparation of the annual accounts, applicable accounting standards had been followed, along with proper explanation relating to material departures; and (b) the directors had selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a ‘true and fair view’ of the state of affairs of the company at the end of the financial year and of the profit and loss for that period.
Although the Companies Act does not define ‘true and fair view’, the Supreme Court of India (“SC”) elucidated in J.K. Industries Ltd. v. Union of India that the term ‘true and fair view’ implies that the FS should convey an overall fair view and should not give any misleading information or impression. All the relevant information should be disclosed in such a manner that the financial position and the working results are shown as they are. There should neither be an overstatement nor an understatement.
Adherence to the ‘true and fair view’ principle and complying with the applicable accounting standards and Schedule III disclosure norms assumes special relevance for listed companies, as minority shareholders and other stakeholders rely heavily on the FS to assess the health of a company, and gain deeper insight over its operations – which is critical for building trust and confidence among all stakeholders.
In this context, it is significant to note that the Explanation to Regulation 4(1) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“FUTP”), that was inserted vide an amendment dated October 19, 2020, provides as under:
“For the removal of doubts, it is clarified that any act of diversion, misutilisation or siphoning off of assets or earnings of a company whose securities are listed or any concealment of such act or any device, scheme or artifice to manipulate the books of accounts or financial statement of such a company that would directly or indirectly manipulate the price of securities of that company shall be and shall always be deemed to have been considered as manipulative, fraudulent and an unfair trade practice in the securities market”.
At the outset, it is instructive to examine the regulatory intent behind introducing this provision, which effectively brings any manipulation of FS within the ambit of an ‘unfair and fraudulent trade practice’ under the FUTP.
The Report of the Committee on Fair Market Conduct (“FMC Report”) stresses on the significance of accurate FS/ financial reports, since they can influence investor decisions to buy/ sell or deal in the securities market. While manipulation of FS is an offence under the Companies Act, it has a higher degree of implication for listed companies, and affects all investors of a listed company, irrespective of whether they traded in the scrip during the manipulation period.
It was accordingly noted that notwithstanding the power of the Ministry of Corporate Affairs (“MCA”) to take action for financial statement fraud, SEBI should concurrently step in to initiate action against a listed company for engaging in manipulation of FS – basis its powers under Section 24 of the Companies Act and Section 11 of the SEBI Act, 1992 (“SEBI Act”) (which highlights that SEBI’s primary role is to protect the interests of investors in the securities market).
SEBI Board Note
It is significant to note that SEBI’s board note dealing with the insertion of the Explanation to Regulation 4(1) of the FUTP (“SEBI Board Note”) states that – ““Artificially inflating a company’s revenue, profits or receivables or hiding diversion of funds will impact the price of the shares of the company and would influence the investment/disinvestment decisions of the investors. In cases relating to diversion of funds or misstatements in disclosures of a listed company and its management, the intention of the perpetrators is to reap the benefit of such diversions or misstatements which has a direct bearing on the interest of the investors as they remain invested or deal in securities without having any information of such diversion. Therefore, such diversion of funds or misstatements in disclosures are unfair trade practices and the element of dealing in securities or the element of inducing others to deal in securities need not be specifically proved in such cases”.
Further, the Explanation clarifies that any manipulation of assets/ earnings, in a manner that would manipulate the price of listed securities, always fell within the prohibitive ambit of the FUTP. Hence, whilst SEBI always had the power to initiate action for FS fraud (the source of this power emanating from Section 11 of the SEBI Act), this has been further crystallised by amending the FUTP.
SEBI Order in the Bombay Dyeing Case – Key Implications
The implications of the Explanation to Regulation 4(1) of the FUTP were tested in SEBI’s recent order in the Bombay Dyeing Case, where the SEBI WTM considered whether non-compliance with ‘true and fair view’ (due to an alleged inflation of revenues) and the accounting standards (by allegedly not classifying an entity as an associate company) would amount to a fraudulent and unfair trade practice under Regulations 3(d) and 4(1) of FUTP.
While holding that the alleged non-compliance with ‘true and fair view’ and the applicable accounting standards was violative of Regulations 3(d) and 4(1) of the FUTP, the SEBI WTM held that the Explanation to Regulation 4(1) only made explicit what was already implicit in Regulation 4(1) – i.e. manipulation of FS (in a manner that would manipulate the price of listed securities) always amounted to a fraudulent and unfair trade practice under the FUTP. In other words, it was held that the Explanation only clarifies, and does not alter the legal position – and could accordingly be applied even for acts/ omissions committed prior to October 20, 2020.
Whilst the SAT has stayed the operation of the SEBI WTM Order during the pendency of the appeal, it is important to note that pursuant to the Explanation to Regulation 4(1) of the FUTP, similar proceedings for non-compliance with the ‘true and fair view’ and/ or applicable accounting standards cannot be ruled out. In this regard, it is also relevant to note that in Oasis Securities Limited v. SEBI, the SAT had previously upheld SEBI’s jurisdiction to initiate action for non-compliance with the applicable accounting standards.
This assumes relevance from the standpoint of approval and adoption of FS by the Board, where all directors may not be well-versed in the nuances and intricacies of the applicable accounting standards – and would in turn rely on the views of the Audit Committee, representations provided by the management, and the certification provided by the auditors.
For companies that are required to comply with the Ind AS accounting standards (“Ind AS”), these issues may get exacerbated. In addition to the technicalities involved, many of the Ind AS are founded on the management’s ‘judgments’ and ‘reasonable estimates’. Now, by virtue of Regulation 4(1), even a technical violation of any Ind AS may be regarded as a FUTP violation. To illustrate this with a classic example, if an actual liability is shown in the books as a contingent liability, this could, in a given factual context, potentially be regarded as a FUTP violation.
For such an FUTP violation, Section 15HA of the SEBI Act provides for a stringent penalty that can range from INR 5 Lakh to INR 25 Crore, or three times the amount of profits made out of such practices, whichever is higher. Further, along with being restrained from accessing the securities market for a specified period, the possibility of initiation of criminal proceedings under Section 24 of the SEBI Act cannot be ruled out.
Precautions to be observed by the Audit Committee/ Board
While preparation and finalisation of FS falls within the domain of the CEO, CFO and the management team, a director would be required to exercise independent judgment and reasonable care, skill and diligence – to satisfy himself that the FS reflect the ‘true and fair view’ and comply with Schedule III and the applicable accounting standards.
As noted by the SC in its celebrated decision in the P.A. Tendolkar case, a director “cannot shut his eyes to what must be obvious to everyone who examines the affairs of the Company even superficially”. Further, as held in N. Narayanan v. SEBI – “The overriding obligation of the Directors is to approve the accounts only if they are satisfied that they give a true and fair view of the profits or loss for the relevant period and the correct financial position of the company”.
While there may be limits on the extent of due diligence that can be undertaken by a director before approving the FS, he cannot wilfully shut his eyes to something that is obvious. Further, the directors should exercise ‘professional scepticism’ and closely scrutinise the disclosures made (i) in the ‘notes to accounts’; and (ii) with regard to identification and classification of persons/entities as related parties/ associates/ subsidiaries, etc. Given that Schedule III of the Companies Act has now been significantly revamped to cover a wider gamut of disclosures in the ‘notes to accounts’ – it is also essential to evaluate whether all the Schedule III disclosure norms are adhered to in letter and spirit.
Another aspect that assumes relevance in this regard is the precautions that need to be taken by the Audit Committee and Board members, if the auditor’s report on the draft FS is qualified. In such situations, directors should insist that the management addresses the qualifications raised by the auditors before the FS are adopted by the Audit Committee and the Board. If a director is still uncomfortable, he should write a dissent note, and ensure that his dissent is accurately recorded in the minutes of the Audit Committee/ Board meeting.
Given that the disclosures made in the FS influence the decisions of investors, and keeping in mind SEBI’s primary role of safeguarding minority shareholders’ interest, the insertion of the Explanation to Regulation 4(1) of the FUTP is a step in the right direction – and could set the foundation for a body of jurisprudence on the standards for review of FS by the Audit Committee and the Board.
To safeguard minority shareholders’ interest, regulators are likely to insist on a spirit-based compliance (as opposed to a mere technical adherence) with the principle of ‘true and fair view’, applicable accounting standards, and the recently introduced Schedule III disclosure norms. Even a minor technical non-compliance with Ind AS could potentially be regarded as a FUTP violation, leaving directors vulnerable to liability consequences for ‘glossing over’ the draft FS.
While the process for approval and adoption of the draft FS may inherently be based on reliance and representations (where the Board relies on the audit committee, the audit committee relies on the auditor, and the auditor in turn relies on management representations), it is now all the more essential for directors to exercise ‘professional scepticism’, independently satisfy themselves on the integrity of the FS – and ensure that they do not ‘wilfully shut their eyes’ on early warning signals and red flags.
 J.K. Industries, (2007) 13 SCC 673.
 For a detailed analysis of the concept of ‘true and fair view’, interested readers may refer to our earlier blog, available at – How True is ‘True and Fair’ View? | India Corporate Law (cyrilamarchandblogs.com)
 Inserted vide the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) (Second Amendment) Regulations, 2020 w.e.f. October 19, 2020.
 Report of the Committee on Fair Market Conduct, chaired by Dr. T.K. Viswanathan, dated August 08, 2018.
 SEBI Board Note, Amendments to provide for clarification in the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.
 SEBI WTM Order in the matter of The Bombay Dyeing and Manufacturing Company Ltd, bearing reference number, WTM/AB/CFID/CFID_1/20686/2022-23, dated October 21, 2022.
 The Bombay Dyeing and Manufacturing Company Limited and Anr v. the Securities and Exchange Board of India, Misc. Application No. 1353 of 2022 and Misc. Application No. 1354 of 2022 and Appeal No. 838 of 2022, SAT Order dated November 10, 2022.
 SAT Order dated March 17, 2020, in Misc. Application No. 649 of 2019 and Appeal No. 316 of 2018.
 To this effect, it may also be noted that Regulation 48 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 provides that a listed entity shall comply with all the applicable and notified accounting standards from time to time.
 Section 15HA of the SEBI Act provides that – “If any person indulges in fraudulent and unfair trade practices relating to securities, he shall be liable to a penalty which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of such practices, whichever is higher”.
 Section 24(1) of the SEBI Act provides that – “Without prejudice to any award of penalty by the adjudicating officer or the Board under this Act, if any person contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of any rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may extend to ten years, or with fine, which may extend to twenty-five crore rupees or with both.
 Official Liquidator, Supreme Bank Ltd. v. P.A. Tendolkar, (1973) 1 SCC 602.
 (2013) 12 SCC 152.
 Schedule III of the Companies Act has been revamped vide MCA Notification dated March 24, 2021.