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Fraud & Reporting In India
10 Sep 2014

Fraud& Reporting In India

 

Corporate fraud and Fraud Reporting to SFIO is a major problem that is increasing both in its frequency and severity.Research evidence has shown that growing number of frauds have undermined the integrity of financial reports, contributed to substantial economic losses, and eroded investors’ confidence regarding the usefulness and reliability of financial statements. The increasing rate of white-collar crimes demands stiff penalties, exemplary punishments, and effective enforcement of law with the right spirit. Our country has also witnessed several corporate Frauds, few of them being - the 5000 crore rupees Harshad Mehta scam in 1992, 7000 crore rupees Satyam fiasco in 2009, the 27000 crore rupees Sahara fraud case which started in 2010 and is sub-judice in Supreme Court, till date. 

 

Regulatory Legislations

Anti-Fraud Legislations/Regulations/Guidance - Examples

INDIA

USA/EUROPE

Indian Contract Act 1872

Sarbanes Oxley Act

Indian Penal Code

Foreign Corrupt Practices Act

Prevention of Corruption Act

Patriot Act

Prevention of Money Laundering Act

OECD Guidelines

The Companies Act 2013

IIA Guidance

Clause 49 of Listing Agreement

The Fraud Act 2006 of UK

CARO 2003

 

 

Prior to the new Companies Act, 2013 of India fraud was largely seen as a broad legal concept. The term is not new; the old Act already provides punishment for fraud in various sections but the new Act has come with more specific and clear provisions relating to fraud and fraud reporting. The scope and coverage is very wide and unlike Companies Act, 1956 the Companies Act, 2013 provides similar punishment for all type of frauds. The Fraud provision is in force w.e.f. 12th September, 2013 and Fraud Reporting provisions are brought in force w.e.f. 01st April, 2014 under the Companies Act, 2013.

What is Fraud?

Wikipedia describes Fraud is a deception deliberately practiced in order to secure unfair or unlawful gain. As a legal construct, fraud is both a civil wrong (i.e., a fraud victim may sue the fraud perpetrator to avoid the fraud and/or recover monetary compensation) and a criminal wrong (i.e., a fraud perpetrator may be prosecuted and imprisoned by governmental authorities). Defrauding people or organizations of money or valuables is the usual purpose of fraud, but it sometimes instead involves obtaining benefits without actually depriving anyone of money or valuables, such as obtaining a drivers license by way of false statements made in an application for the same.

 

Indian Penal Code, 1860 Section 25 of IPC defines "Fraudulently” as: A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise

 

Fraud is defined in Section 17 of Indian Contract Act, 1872 as follows:

“Fraud”means and includes any of the following acts committed by a party to a contract, or with his connivance, or by his agents, with intent to deceive another party thereto his agent, or to induce him to enter into the contract;

(1)The suggestion as a fact, of that which is not true, by one who does not believe it to be true;

(2)The active concealment of a fact by one having knowledge or belief of the fact;

(3)A promise made without any intention of performing it;

(4)Any other act fitted to deceive;

(5)Any such act or omission as the law specially declares to be fraudulent.

Explanation.—Mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud, unless the circumstances of the case are such that,regard being had to them, it is the duty of the person keeping silence to speak, or unless his silence, is, in itself, equivalent to speech.

 

Comprehensive explanation of term Fraud is given in Explanation to Section 447(1) of The Companies Act, 2013 as follows:

“Fraud”in relation to affairs of a company or anybody corporate, includes

(a)Any act,

(b)Omission,

(c)Concealment of any fact or

(d)Abuse of position committed by any person or any other person with the connivance in any manner, -

i.with intent to deceive,

ii.To gain undue advantage from, or

iii.To injure the interests of,

The company or

Its shareholders or

Its creditors or

Any other person,

Whether or not there is any wrongful gain or wrongful loss; 

 

-“wrongful gain” means the gain by unlawful of property to which the person gaining is not legally entitled; 

-“wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled.

 

Statutory provisions of Fraud and Fraud Reporting under The Companies Act, 2013 

A.Punishment for Fraud in Companies Act, 2013:

Section 447 of the Companies Act, 2013 often now referred as one of the draconian section of the new Act deals with provision relating to punishment for fraud.It reads as: “Without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud:

 

Where the fraud in question involves public interest, the term of imprisonment shall not be less than 3 years” 

The Companies Act, 2013 has provided punishment for fraud as provided under section 447 in around 20 sections of the Act e.g. u/s 7(5), 7(6), 8(11), 34, 36, 38(1),46(5), 56(7), 66(10), 75, 140(5), 206(4), 213, 229, 251(1), 266(1), 339(3), 448 etc. for directors, key managerial personnel, auditors and/or officers of company. Thus, the new Act goes beyond professional liability for fraud and extends to personal liability if a company contravenes such provisions.

 

The following table includes some sections that attract liability u/s 447. These are cognizable offences and a person accused of any such offence under the sections shall not be released on bail or bond, unless subject to the exceptions provided u/s 212(6) of the Act: 

 

Section

 

Fraud

Who will be penalised

 

7(5)

 

Registration of a company

 

A person furnishing false information or suppressing any material information of which he or she is aware.

36

 

Inducing persons to invest money

The person doing so.

 

45

Issuing of duplicate certificate

Every officer of the company eligible to make certificate.

75(1)

 

Acceptance of deposit with intent to defraud depositors or for any fraudulent purpose

Every officer of the company who accepted the deposit

206(4)

 

Conducting business of a company for a fraudulent or unlawful purpose

 

Every officer of the company who is in default.

 

213

 

Other cases:

a. Business of a company being conducted with intent to defraud its creditors

b. Fraud, misfeasance or other misconduct of the company or any of its members

c. Company withholding information from members with respect to its affairs, which they may reasonably expect

 

Every officer of the company who is in default and the person(s) concerned in the formation of the company or management of its affairs.

 

229

 

Furnishing false statement or mutilation or destruction of documents

 

Person required to provide an explanation or make a statement during the course of inspection, inquiry or investigation, or the officer or other employees, as required.

251(1)

 

Application for removal of name from register with the object of evading liabilities/intent to deceive

Persons in charge of management of the company.

339(3)

 

Conducting business of company with intent to defraud its creditors, any other persons or for any fraudulent purpose

Every person who was knowingly a party to the business in the aforesaid manner.

448

 

Making a false statement in any return, report, certificate, financial statement, prospectus, statement or other document required by or for the purpose of any of the provisions of this Act or the rules made there under

Person making such a statement etc.

 

 

B.Reporting of Fraud in Companies Act, 2013:

The new act casts onerous responsibility on the part of statutory auditor/cost auditor/secretarial auditor to report fraud to Board and Central Government. It would mean that even for a small fraud involving say Rs. 1000 in a large multi-locational enterprise would cast reporting fraud responsibility on the part of CA/CMA/CS.This provision has mandated a CA/CMA/CS appointed by company under section 139/148/204 to do direct reporting of frauds (to the Central Government) in addition to their existing responsibilities of reporting requirement to the shareholder/Board of company.

Section 143(12) to 143(15) of the Act contains provisions relating to reporting of fraud.

Fraud Reporting:

Section 143(12) Notwithstanding anything contained in this section, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government within such time and in such manner as may be prescribed.

 

Action of Fraud Reporting in good faith:

Section 143 (13) No duty to which an auditor of a company may be subject to shall be regarded as having been contravened by reason of his reporting the matter referred to in sub-section (12) if it is done in good faith.

Similar Provisions applicable to Cost Auditor and Secretarial Auditor: 

Section 143(14) the provisions of this section shall mutatis mutandis apply to—

(a)The cost accountant in practice conducting cost audit under section 148; or

(b)The company secretary in practice conducting secretarial audit under section 204.

 

Punishment for default:

Section 143 (15) If any auditor, cost accountant or company secretary in practice do not comply with the provisions of sub-section (12), he shall be punishable with fine which shall not be less than 1(one) lakh rupees but which may extend to 25(twenty-five) lakh rupees.

Rule 13 of The Companies (Audit and Auditors) Rules, 2014 contains the operational procedure of Reporting of Fraud prescribed in Section 143(12) of the Act.

Reporting of fraud by auditor:

Rule 13(1) For the purpose of sub-section 12 of Section 143, in case the auditor has sufficient reason to believe that an offence involving fraud, is being or has been committed against the company by officers or employees of the company, he shall report the matter to the Central Government immediately but not later than 60 days of his knowledge and after

Followingthe procedure indicated herein below:

FirstFraud Report to Board/Audit Committee:

(i)Auditor shall forward his report to the Board or the Audit Committee, as the case may be, immediately after he comes to knowledge of the fraud, seeking their reply or observations within 45 days;

Final Fraud Report to Central Government on receipt of First Fraud Report:

(ii)On receipt of such reply or observations the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within 15 days of receipt of such reply or observations;

Final Fraud Report to Central Government on failure of receipt of First Fraud Report:

(iii)in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of 45 days, he shall forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he failed to receive any reply or observations within the stipulated time.

Authority and Mode/Format of dispatching Final Fraud Report to Central Government: 

Rule 13(2) the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed post followed by an e-mail in confirmation of the same.

Rule 13(3) the report shall be on the letter-head of the auditor containing postal address, e-mail address and contact number and be signed by the auditor with his seal and shall indicate his Membership Number.

Rule13(4) the report shall be in the form of a statement as specified in FormADT-4. This Form of Report is available as an annexure to The Companies (Auditand Auditors) Rules, 2014.

Similar Provisions of Fraud Reporting applicable to Cost Auditor and Secretarial Auditor:

Rule 13(5) the provision of this rule shall also apply, mutatis mutandis, to a cost auditor and a secretarial auditor during the performance of his duties under section 148 and section 204 respectively.

The new law has also bestowed legal status on the Serious Fraud Investigation Officer,According to section 2 (83) “Serious Fraud Investigation Office” means the office referred to inspection 211,a probe agency under the Ministry of Corporate Affairs. SERIOUS FRAUD INVESTIGATION OFFICE (SFIO) is established by Central Government to investigate frauds relating to a company. Until such SFIO is established, the Serious Fraud Investigation Office set-up by the Central Government in terms of the Government of India Resolution No. 45011/16/2003-Adm-I, dated the 2nd July, 2003.

SFIO shall be deemed to be the Serious Fraud Investigation Office for this purpose (Section 211 of the Companies Act, 2013) and the procedure to appoint SFIO is:

  • The Serious Fraud Investigation Office shall be headed by a Director and consist of such number of experts from the following fields to be appointed by the Central Government from amongst persons of ability, integrity and experience in,—

(i) Banking;

(ii) Corporate affairs;

(iii) Taxation;

(iv) Forensic audit;

(v) Capital market;

(vi) Information technology;

(vii) Law; or

(viii) Such other fields as may be prescribed.

  • The Central Government shall, by notification, appoint a Director in the Serious Fraud Investigation Office, who shall be an officer not below the rank of a Joint Secretary to the Government of India having knowledge and experience in dealing with matters relating to corporate affairs.
  • The Central Government may appoint such experts and other officers and employees in the Serious Fraud Investigation Office as it considers necessary for the efficient discharge of its functions under this Act.
  • The terms and conditions of service of Director, experts, and other officers and employees of the Serious Fraud Investigation Office shall be such as may be prescribed.

 

About SFIO

The SFIO is a multi-disciplinary organization under Ministry of Corporate Affairs, consisting of experts in the field of accountancy, forensic auditing, law, information technology, investigation,company law, capital market and taxation for detecting and prosecuting or recommending for prosecution white-collar crimes/frauds. The SFIO will normally take up for investigation only such cases, which are characterized by

  • complexity and having inter-departmental and multi-disciplinary ramifications ;
  • substantial involvement of public interest to be judged by size, either in terms of monetary misappropriation or in terms of persons affected, and; 
  • The possibility of investigation leading to or contributing towards a clear improvement in systems, laws or procedures. The SFIO shall investigate serious cases of fraud received from Department of company Affairs ;
  • Headquarter is located at New Delhi and Regional Office is at Mumbai;
  • Fraud reporting to the address:- The Director ,Serious Fraud Investigation Office 2nd floor, Paryavaran Bhawan, CGO Complex, Lodhi Road, New Delhi-110003 Or through e-mail : inf.sfio@nic.in

 

Conclusion: 

Overall, the new law will plug most loopholes of the old regime. Corporate fraud and Fraud Reporting to SFIO  will improve corporate governance, protect the interest of minority shareholders and make it tougher for companies to hide illegal transactions or commit fraud. Considering the number of corporate frauds that are surfacing in the country today, the old Act was evidently inadequate. Hence, it is anticipated that the new provisions of the Companies Act, 2013 would bridge the gulf between increasing corporate frauds and the statutory regime. The new Act is the welcome improvement if the same is implemented appropriately. The new company law envisages the metamorphosis of the statutory auditors from being a watchdog to a whistle blower. The Auditing and Assurance Standards Board of The Institute of Chartered Accountants of India considering the priority and importance of Fraud and Fraud Reporting under the Companies Act, 2013 has already constituted an expert group to develop a guidance note at the earliest on ‘Fraud Reporting’.

 

Prepared and complied by: Mr. Nikunj Khandelwal- HPACS team

 

 For any further clarification you may raise your query at: hemant@hpacs.com   or click on the contact tab of the website:  www.hpacs.com