Compliance Officer Not Liable for Promoter Fraud - Key Ruling by SAT

Compliance officer not liable for fraudulent accounts unless proven that he was Party

V. Shankar vs. SEBI Order by the Securities Appellate Tribunal, Mumbai Bench, May 5, 2025

The Securities Appellate Tribunal (SAT), Mumbai bench, on May 5, 2025, delivered a significant order in the case of V. Shankar vs. Securities and Exchange Board of India (SEBI). This order pertains to an appeal filed by V. Shankar against an order passed by the Adjudicating Officer (AO) of SEBI on March 22, 2022. The AO's order had imposed a penalty of ₹10 lakhs on V. Shankar under Section 15HA of the SEBI Act, 1992, for alleged violations of Sections 68 and 77A of the Companies Act, 1956, read with Regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (PFUTP Regulations), and Section 12A of the SEBI Act, in connection with a buyback of shares by Deccan Chronicle Holdings Limited (DCHL). The matter dates back to 2011 when DCHL had came with a buyback offer, whose public announcement was signed by Mr V. Shankar as Company Secretary and Compliance Officer.

The crux of the matter revolves around the role and responsibility of a Company Secretary in ensuring the accuracy and compliance of financial statements and public announcements made by a company, particularly concerning a share buyback. The primary issue before the SAT was whether V. Shankar, being the Company Secretary of DCHL at the relevant time, could be held liable for the alleged misstatements and non-compliance in the buyback offer made by the company?

Background of the Case

SEBI's investigation into DCHL revealed irregularities in the company's annual financial statements, including the understatement of outstanding loans and interest. SEBI also found that DCHL had carried out a buyback of its equity shares exceeding the permissible limit of 25% of the total paid-up capital during the financial year 2011-2012 without possessing adequate free reserves. SEBI concluded that this action misled investors and shareholders about the company's valuation and financial health.

Based on these findings, SEBI held that DCHL and its directors and promoters had violated the aforementioned provisions of the Companies Act and SEBI regulations. SEBI vide same order concluded that the statutory auditor of DCHL was not at fault and left statutory auditor of DCHL without penalty. The AO further held V. Shankar, as the Company Secretary who authenticated and signed the buyback offer document, responsible for exercising due diligence and verifying the accuracy and legal compliance of the document.

Submissions by Mr V. Shankar, in his appeal before the SAT, stated that

• He had no role in the preparation of the financial statements of DCHL and therefore could not be held liable for any misstatement in the accounts or the overstatement of free reserves in the public announcement for the buyback.
• There was no allegation or finding that he was involved in the fraudulent overstatement of profits or the preparation of the books of accounts. The show cause notice and the impugned order did not state that he had knowledge of the alleged fraud when he signed the accounts. He further stated SEBI had vide its adjudication order had conclusively held promoter and director liable for fraud and misstatements.
• He was entitled to rely on the multiple tiers of oversight over the financial statements by competent bodies entrusted under the Listing Agreement, including the Audit Committee, the Board of Directors, the statutory auditors, and the CEO/CFO.
• SEBI had not charged the merchant banker involved in the buyback process with any failure to comply with regulations regarding the overstatement of free reserves in the public announcement, implying that SEBI did not expect the merchant banker (or by extension, the Company Secretary in a similar authenticating role) to assume the role of a statutory auditor.
• His role as Company Secretary, in the context of signing the financial statements as per Section 134 of the Companies Act, was on behalf of the Board of Directors and not in his personal capacity.
• The duties of a compliance officer do not extend to verifying the authenticity and correctness of accounts. At the relevant time, DCHL had an Executive Director (Finance) responsible for the company's finances, apart from the Managing Director and Whole-Time Director.

In this regard SEBI contended before SAT that:

• As a Company Secretary and a "statutory official" of DCHL, V. Shankar had a responsibility to exercise utmost due diligence and check the veracity of the buyback offer documents and its legal compliances before authenticating and signing the public announcement.
• The buyback was carried out without adequate free reserves, misleading investors, and V. Shankar, by signing the offer document, facilitated this violation. He was an "officer in default" under the Companies Act and therefore liable for the company's non-compliance. SEBI further stated that V. Shankar should have exercised basic due diligence before signing the offer document for buyback. SEBI highlighted that DCHL had issued debentures for taking the loan. The promoters had pledged their shareholdings in DCHL for same. It was duty of compliance officer to have a basic check on the register of debentures atleast in order to verify whether the amount of debentures issued/ loan amount matches with the balance sheet.
• Regulation 19(3) of the SEBI (Buyback of Securities) Regulations, 1998, requires the company to nominate a compliance officer to ensure compliance with the buyback regulations and to redress the grievances of investors, and as the Company Secretary, V. Shankar held this responsibility. So, it was responsibility of V. Shankar to ensure that buyback process is undertaken in accordance with provisions of law. It also means that the audited accounts submitted for the buyback process were in accordance with applicable accounting standards.

SAT's held as follows

SAT's Final Order (May 5, 2025)

In its order dated May 5, 2025, passed after the Supreme Court's remand, the SAT, while acknowledging the Supreme Court's observations, allowed the appeal filed by V. Shankar and set aside the penalty imposed by the SEBI AO.

The SAT, in its reasoned order, reiterated that while the Company Secretary has a role in ensuring compliance, this role, particularly concerning the verification of the substantive accuracy of financial information in a buyback offer document approved by the Board, is different from the primary responsibility of the directors and other experts. The tribunal emphasized that holding the Company Secretary liable in this case, where there was no evidence of their direct involvement in the financial misstatements or fraudulent intent, would be an overreach of their statutory duties, especially when other competent bodies were entrusted with the responsibility of verifying the financial health and compliance of the company.

The SAT clarified that the Company Secretary's authentication of the buyback offer document was a procedural requirement following the Board's approval and did not automatically imply a personal responsibility to independently verify the intricate financial details, which are primarily the domain of the company's management, finance department, and statutory auditors.

The tribunal, therefore, concluded that the penalty imposed on V. Shankar was unsustainable, considering his role and the absence of evidence indicating his direct involvement in the fraudulent activities or his failure to perform the duties specifically and directly assigned to a Company Secretary in such matters, beyond the act of authentication following the Board's decision.

The Securities Appellate Tribunal, after hearing both sides and considering the evidence on record, made the following key observations and findings:

• Role of the Company Secretary: The SAT emphasized that once the offer document and the balance sheet are approved by the Board of Directors, the Company Secretary's duty is primarily to authenticate the contents indicated therein. The tribunal opined that the Company Secretary is not necessarily required to delve into the veracity of the buyback offer document and its legal compliances before authentication, especially when multiple layers of oversight are in place, including the Board, auditors, and other professionals like merchant bankers.
• No Involvement in Financial Preparation: The SAT noted that there was no finding in the AO's order that V. Shankar was involved in the preparation of the financial statements or had knowledge of the alleged fraudulent overstatement of profits.
• Reliance on Oversight Mechanisms: The tribunal acknowledged that V. Shankar was entitled to rely on the due diligence expected from other competent bodies responsible for reviewing and approving the financial statements.
• Interpretation of Buyback Regulations: The SAT disagreed with SEBI's interpretation of Regulation 19(3) of the SEBI (Buyback of Securities) Regulations, 1998. The tribunal held that while the Company Secretary, being the Compliance Officer, is responsible for redressing investor grievances, this does not automatically extend to a duty to verify the substantive accuracy and legal compliance of the buyback offer document ab initio, especially after it has been approved by the Board.
• Distinction from Directors' Responsibility: The SAT implicitly distinguished the responsibilities of the Board of Directors, who are primarily responsible for the company's strategic decisions and the accuracy of financial disclosures, from the authenticating role of the Company Secretary.
• Supreme Court Remand: It is crucial to note that the SAT's initial order in this matter (passed earlier, against which SEBI had appealed) was set aside by the Supreme Court, which remanded the matter back to the SAT for a fresh decision. The Supreme Court, in its order, specifically pointed out that the SAT had erred in confining the role of the Company Secretary solely to redressing investor grievances under Regulation 19(3) and had failed to consider the broader obligation of ensuring compliance with the buyback regulations. The Supreme Court directed the SAT to consider both aspects of the Company Secretary's role.

Implications of the Order

The SAT's order in V. Shankar vs. SEBI has significant implications for the understanding of the roles and responsibilities of Company Secretaries in India, particularly in the context of corporate actions like share buybacks and the authentication of related documents. The order suggests that:

• Authentication vs. Verification: There is a distinction between the act of authenticating documents as a Company Secretary (a procedural duty) and the responsibility for independently verifying the substantive accuracy of the financial information contained therein (primarily the responsibility of the Board, management, and auditors).
• Reliance on Board Decisions: Company Secretaries can reasonably rely on the decisions and approvals of the Board of Directors regarding the accuracy and compliance of financial matters, unless there is clear evidence of their direct involvement in fraud or willful negligence of their specific duties.
• Scope of Compliance Officer Role: While the Company Secretary, as a Compliance Officer, is responsible for ensuring regulatory compliance and addressing investor grievances, this role needs to be interpreted in the context of their specific duties and the overall corporate governance framework, which involves multiple layers of responsibility.

Conclusion and Learnings from the SAT order

However, it is crucial to remember that this order is specific to the facts and circumstances of this particular case, especially concerning the regulatory framework and the role of Company Secretaries under the Companies Act, 1956. The Companies Act, 2013, has further defined the role and responsibilities of Key Managerial Personnel (KMPs), including Company Secretaries, and future cases will likely be evaluated under this new framework.

The Supreme Court's initial intervention highlights the importance of considering the Company Secretary's broader compliance responsibilities. While the SAT ultimately ruled in favor of V. Shankar, the case underscores the need for Company Secretaries to be diligent in their duties, understand the implications of the documents they sign, and raise concerns if they have reason to believe that the information provided to them by the management or the Board is inaccurate or misleading.

In conclusion, the SAT's order in V. Shankar vs. SEBI provides a nuanced understanding of the liability of a Company Secretary in the context of a share buyback and emphasizes the importance of distinguishing between the procedural duty of authentication and the primary responsibility for the substantive accuracy of financial disclosures, which rests with the Board and the management. The order suggests a balanced approach, holding Company Secretaries accountable for their specific duties without imposing liability for matters that fall primarily within the purview of other corporate bodies, absent evidence of their direct involvement or knowledge of wrongdoing

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.