Corporate frauds are one of the most secretive and complex white-collar crimes. It aims at gaining an advantage, primarily monetary, by way of deceiving someone. Well, known examples of this are the Punjab National Bank Scam by Nirav Modi and the Satyam Scam by B. R. Raju. These frauds result in heavy monetary losses to the banks, investors, or the organization as the case may be. And when disclosed these result in loss of goodwill and trust in the corporate sector.
The Article deals with the famous corporate frauds and the legislations containing provisions against such frauds. It further discusses the steps taken by the government and various regulatory authorities in this regard, and finally the suggestion to curb the crime of corporate fraud.
Crimes committed by people who hold privileged positions in private or public corporations are known as white-collar crimes. These crimes involve a breach of trust, fraud, deceit, and concealment; and at times are hard to detect. These can be committed by a single individual or even the organization as a whole. One such white-collar crime we are going to discuss here is Corporate Frauds.
It refers to a purposeful misrepresentation of some information, hiding of the truth, or gaining wrongful access to some sensitive data to deceive someone and gain an advantage. This may involve hiding losses, altering accounts, showing a false profit, and giving false information in the prospectus of the company among other things.
It is considered to be the most complex of all white-collar crimes. And once disclosed can lead to loss of jobs and investments, lack of trust in the corporate sector, and even imprisonment to the accused. The reason why it is considered a big crime is that the monetary loss, in this case, is much greater than that in other crimes.
There are many types and forms of corporate fraud such as Misuse of Assets, alteration of accounts, bribery, theft of assets, cash or information, employee count fraud, false expenses, vendor fraud, customer fraud, diversion of money, etc. However, the most common types of fraud namely are corruption, financial fraud, and misuse of assets. Corruption involves taking or giving bribes or some wrongful payment and includes helping and facilitating fraud by others. Financial Fraud means altering or manipulating account book, improper application of accounting guidelines, and wrong representation of such accounts. Likewise, misuse means improper use or theft of information or money by someone whether within or out of the company.
Corporate Frauds: World and India
As per the PWC’s survey on Global Economic Crime and fraud of 2018, as much as 49 % corporate organization admit that they were a victim of fraud. The survey suggests that this is the highest percentage to have been recorded in the past eighteen years, of the level of awareness. The rest 51% as per it is just ignorant of such issues. It confirmed that frauds and crimes committed by actors within the organization have increased to almost 52%, among which the involvement of higher management has increased from 16% to 24% from the year 2016 to 2018. However, fraud and economic crimes are not restricted to actors within the organization. Therefore, the survey explains that customers, vendors, agents, and service providers combined are more than 65% of the external actors committing fraud.
Corporates all over the world are facing issues of fraud and its risk is increasing significantly. And India is no exception to it. As per the report of the Commission on Prevention of Corruption, the progress in technology and science have led to a small group of controlling elites and the rise of the managerial class. For proper working of the new socio-economic and political processes, strict compliance with ethical behavior is necessary, or else economic and white-collar crimes will increase. Later in the Vivian Bose Commission’s report, it was explained how the big business house gets involved in fraud by altering accounts and tax evasions. It also pointed out that nowhere do the businessmen get rich as fast as they do in India.
Lack of control, dependence on external actors, identity frauds, and lack of skilled staff have created such an environment in India that among all the frauds committed in South Asia about three-fourth are committed in India. An industry survey in 2017 suggested that a little less than 90% of the companies in India have been a victim of at least one fraud and almost one-third of them suffered losses of more than 7%.
Harshad Mehta Scam
Harshad Shantilal Mehta was a stockbroker at the Bombay Stock Exchange. He gradually went on to become famous and was known by the name of Big Bull. He used his popularity and name to play fraud against several banks.
He used the system of Ready Forward short term loans, in which one bank lends money to the other bank in exchange for securities for a short period. And at the end of the loan period, the later bank buys back the government exchange from the former bank at a higher price. Generally, in this system, the broker only gets a commission from the two banks for bringing them together. He neither holds the d=security nor the cash in the process. But Harshad took it to another level by taking control of the securities and the cash. That is to say all the government securities and cash between the two parties passed through him and at times the two parties would even not know the other side.
Government securities in this system were not moved but a Bank Receipt was given on its behalf. Therefore, Harshad with the help of two banks managed to get fake Bank Receipts. He gave Bank Receipt to banks and took money from it in the name of transferring it to the other side. He used this money to alter the prices in the stock market. And at the end of the loan period, he sold the shares in profit and paid the money back to the banks.
In 1992, when the fraud was disclosed the banks realized that they had lost a lot of money and were left with Bank Receipts of no value. Some cases were filed against him but he was convicted in only one.
Satyam Computer Services Ltd. was a Consultation and Information Technology services company listed on the National and Bombay Stock Exchange as well as the New York Stock Exchange. In the year 2008, it was awarded the Golden Peacock Award for Corporate Governance under Risk Management and Compliance Issues. But later in January 2009, its founder B. Ramalinga Raju disclosed that the company’s profits were falsified and overstated. He confessed that the balance sheet of the company showed inflated cash and bank balances, lesser liabilities, non existing accrued interest, and enhanced debtors position. He stated that the financial gap and alterations in the balance sheet were going on for several years and increased significantly with time.
B. Ramalinga Raju was arrested and charged with offenses such as forgery, breach of trust, and criminal conspiracy. This scam was termed as India’s very own Enron Scam and the New York Stock Exchange stopped trading with the company. Steps were also taken by the National Stock Exchange. Companies share fell from more than Rs. 500 to less than Rs. 12 immediately. It was later disclosed that the company showed additional 13,000 employees that did not exist and withdrew about Rs. 20 crores to pay them every month.
A UK based mobile payment company also sued the company for fraud, breach of contract, and forgery. And the World Bank banned it for doing business with them for some time because of the improper payment to its staff.
Ponzi Schemes scam
The Speak Asia scam of 2011 and the Sarada Chit fund Scam of 2013 are an example of Ponzi schemes. In the former case, a survey related business firm took more than Rs. 2000 crores from its investors, promising them to increase their money four-folds within a year in exchange for filling surveys. A criminal case was filed against it and the firm was shut down.
The later is said to be the biggest Ponzi scheme in Bengal, which took more than Rs. 2000 crores form the investors, promising them to increase their money and a holiday trip. But it collapsed leading to default. A case of misappropriation of funds was created by Enforcement Directorate and the Serious Fraud Investigation Office.
Vijay Mallya Scam
Vijay Mallya is a businessman and former chairman of United Breweries Holdings Ltd. The company produces beer under the brand name ‘Kingfisher’. Under Mallya’s chairmanship, the company’s turnover grew rapidly and he diversified the company’s business by acquiring other companies. On these lines, he started Kingfisher Airlines which became popular soon but failed to get permission to fly internationally. Therefore, he bought Deccan Air to merge it with his Airlines but the idea resulted in heavy losses.
To keep running this business he took loans from several banks but was unable to pay back later. This case was filed against him but before any action could be taken he flew away to the United Kingdom. The C.B.I, S.E.B.I, Serious Fraud Investigation Office and the Enforcement Directorate are investigating the Kingfisher Airlines for the loan avoidance of about Rs. 10,000 crores. Mallya faces charges of money laundering, criminal conspiracy, cheating, and diversion of funds.
He has been accused of concealing hiding and using the proceeds of crime and for not disclosing his assets properly while taking the loan for Kingfisher Airlines. He is also said to have diverted a lot of money from Kingfisher Airlines to his Formula one team and IPL team. He has been charged under the Prevention of Money Laundering Act by the Enforcement Directorate.
Similarly, C.B.I has charged him of cheating and criminal conspiracy under the IPC. And S.E.B.I has banned him for some time. Also, the court has declared him a fugitive economic offender under the relevant act.
Punjab National Bank scam
Nirav Modi is a jeweler, designer, and the chairman of the Firestar international. He along with his wife, brother, and uncle Mehul Chowski is accused of fraud with the Punjab National Bank. Two employees of the bank, involved in the fraud, at its branch office in Mumbai issued a fraudulent Letter of Undertakings to make payments to Modi’s overseas suppliers. These LOU’s were made in favor of branches of various Indian Banks overseas.
The first fraudulent guarantee was received by Modis in 2011, and since then they managed to get more than a thousand such guarantees within six years. This fraud has made PNB liable for more than Rs. 11,000 crores. The scam unfolded when PNB began to check its transaction history with Modi’s firms. It is being investigated by Enforcement Directorate and Central Bureau of Investigation currently.
Nirav Modi is charged with cheating, corruption, breach of trust, money laundering, and criminal conspiracy among other things.
PMC Bank Scam
Punjab and Maharastra Cooperative Bank is the youngest bank to have received the status of Scheduled Bank by the RBI. It was also one of the top ten cooperative banks in the country, with branches in several states.
The bank continuously gave huge loans to the financially burdened Housing Development and Infrastructure Ltd. group. And despite the inability of HDIL to pay back the loans, it did not classify them as non-performing advances. The bank is said to have transferred 73% of all its advances to HDIL.
More than 21,000 accounts were opened in fictitious names to hide the loan accounts and the bank system also tampered. It also altered its account books and reports to hide these loans and collusion with HDIL.
The fraud came into light when some female employees of the bank informed RBI about the fictitious accounts.
A case of money laundering was filed by Enforcement Directorate against the bank. And RBI restricted the bank’s activities for some time.
Legislations against Corporate Frauds
Several anti-fraud regulatory legislation and guidelines exist in India. Namely, the Companies Act 2013, Indian Penal Code 1860, Prevention of Money Laundering Act 2002, Indian Contract Act 1872, Prevention of Corruption Act 1988, Clause 49 of Listing Agreement S.E.B.I, I.T Act 2000, Whistle-blowers Protection Act 2011 and R.T.I Act 2005 and so on.
The Companies Act, 2013 is the primary legislation that deals with Corporate Fraud. As per Section 447 of the Act, fraud refers to any act, omission, abuse of power, or hiding of facts to deceive to gain wrongful advantage or injure anyone’s interest. The Act requires the companies to ensure the implementation of procedures that make sure the safety of its assets, detection, and prevention of fraud, the accuracy of account books, and compliance with its policies. The amendment made in 2017, promotes stricter rules for the reduction in cases of fraud. It provides for greater accountability of auditing professionals and directors and in some cases even makes them personally liable.
From Section 447 to 454 the Act provides punishment for fraud, false statements, false evidence, repeated defaults, etc. As many as 20 sections of the Act talk about frauds committed by auditors, directors, officers, etc. It also has provisions regarding giving false statements in the prospectus, wrongfully inducing people to invest and issuance of a false certificate of shares, etc. A person guilty of fraud under the Act is liable for an imprisonment of 6 months extendable to 10 years and a fine with a minimum limit of the amount involved in the fraud and maximum up to 3 times.
Another regulation to curb fraud in corporations is Clause 49 of the Listing Agreement. It is a recommendation given by the Narayan Murthy Committee and agreed to by S.E.B.I. It provides for provisions of listing agreements between S.E.B.I and various companies. To check the financial reporting process, setting up an Audit Committee is also made mandatory. This committee should have an independent director as its chairman and a Company Secretary as its Secretary. The powers of the committee include seeking information from employees, investigating activities, seeking professional help, etc.
The committee is required to be set up to ensure the correctness and credibility of the companies disclosed financial information, reviewing financial statements before submission to board, recommending the appointment, and removal of statutory auditors, reviewing the working of the Whistle Blower Mechanism, searching for reasons of default, etc.
Similarly, corruption and bribery are among the most common types of Frauds. The Prevention of Corruption Act is also essential legislation to curb corporate frauds. The Act consolidates provisions related to corruption in various criminal laws and provides for criminal liability of the guilty.
The Prevention of Money Laundering Act aims at curbing the activity of Money laundering in India. Money laundering is an activity of converting black money to white. It is involved in almost every case of fraud since the monetary gain by the individual or corporation has to converted into white money to be used publicly. A person convicted under the Act is liable for imprisonment ranging up to seven years and fine.
Provisions of Fraud are also included in the Indian Penal Code and the Indian Contract Act among other legislations.
Steps were taken to curb Corporate Frauds
Several steps have been taken by the government for reducing the cases of corporate fraud in the sector. One such step was the appointment of Narayana Murthy Committee and Kumar Mangalam Birla Committees by S.E.B.I to make policies for corporate governance. Recommendations by these committees have paved a way for controlling the crime.
The Government has also cited certain mechanisms under the Companies Act, 2013, and made amendments to it, for preventing economic crimes. The government through these amendments has focused on strict execution and an increase in penalties for offenses under the Act.
The Central Government has also created a Serious Fraud Investigation Office to investigate in the matter relating to frauds in or by the companies. It has the power to arrest a person is based on the materials possessed, they believe him to be guilty. On the receipt of a report of the registrar, the Central Government can order an investigation of the affairs of a company.
The passing of the Fugitive Offenders Act, 2018 is another step by the government in this regard. The Act contains provisions to stops the fugitive offenders from avoiding the process of law by absconding out of the jurisdiction of courts in India. The Act is a major step considering the recent cases of Vijaya Mallya and Nirav Modi, who absconded to the United Kingdom after committing fraud in India.
In 2015, S.E.B.I issued directives requiring the listed companies to disclose information relating to frauds within twenty-four hours of its occurrence. In 2018, the R.B.I removed certain banking instruments such as Letter of Comfort and Letter of Understanding to remove loopholes in the Banking Sector. In 2019, S.E.B.I announced monetary rewards up to Rs. 1 crore to encourage the whistleblowers.
The Minister of State for Finance and Corporate Affairs, Mr. Anurag Thakur has stated that frauds in banks reduced from more than Rs. 24,000 crores in 2017, to about Rs. 5,000 crores in the year 2019. The reporting mechanism and the steps taken by the government to check bank frauds have resulted in the waning of such frauds. And the setting up of the Central Fraud Registry has resulted in timely identification and reduction of frauds.
Conclusion and Suggestions
The fraud always brings disgrace and regret to its doer. Still a lot of people commit it with the hope of never being caught. Corporate frauds are generally well planned and are therefore hard to notice. But when disclosed, these frauds lead to loss of trust and investments in the corporate sector. And affect a company’s goodwill, reliability, and subsequently its performance in the market.
Therefore, there is a need to prevent fraud by taking more necessary steps and finding solutions in this regard.
To find solutions to this problem, it is necessary to first understand the Fraud Triangle. It explains the factors that encourage someone to commit fraud. The three factors are pressure, opportunity, and rationalization. Pressure refers to the urgent financial need, which can not be fulfilled through lawful means so the person starts searching for unlawful means. When looking for an unlawful means a person gets a chance to misuse his power and position this is known as an opportunity. Rationalization means not considering the step taken by one to be wrong or justifying it.
So, to curb fraud, it is necessary to remove one of the factors from the triangle. The factor that can be affected easily is an opportunity. So, the company should aim at taking measures to reduce such opportunities for fraud. This can be done by making proper policies and reporting mechanisms.
Other suggestions for reducing frauds are:
- Creation of a fraud response plan
- Strict rules against unethical practices
- Development of a detailed anti-corruption and bribery policy
- Conducting fraud and economic crimes risk assessment
- Use of technology and scientific methods such as Statistical analysis and data mining
- Developing an internal control and reporting mechanism
- Maintaining transparency of accounts and finance
- Creating a Fraud Prevention Policy with the help of an experienced professional
Though these suggestions might not reduce the frauds significantly, these will surely make a company lesser prone to 0such corporate frauds from the criminals.
Frequently Asked Questions
- What are Corporate Fraud and its common types?
- Name some famous corporate frauds in India?
- Which legislation contains provisions against this Crime?
- What are the steps taken by the government and regulatory authorities to curb Corporate Fraud?
- What more can a Company do to reduce cases of Corporate Frauds?
-  Manish Lamba, ‘Corporate Frauds’ (2011) ICSI, available at https://www.icsi.edu/media/portals/70/6jan11.pdf
-  Michael Volkov, ‘The growing problem of Corporate Fraud’ (2018) Corporate Compliance Insights, available at https://www.corporatecomplianceinsights.com/the-growing-problem-of-corporate-fraud/
- Varsha Rajora, ‘Corporate Frauds in the world of Corporate Sector’ (2010) SSRN, available at https://poseidon01.ssrn.com/delivery.php?ID=649017121009107030090115105092022069032034022058026059113005071074031087099121000112103042027101022023115111116124112066009021046051062093060072101085080023125121099059046014126074114027025003068088088095086082113095125087123083020112106023025082122097&EXT=pdf
-  Rohini Singh, ‘Internal Controls, Anti-fraud strategies for companies in India’ (2018) India Briefing, available at https://www.india-briefing.com/news/internal-controls-anti-fraud-strategies-companies-india-17148.html/
-  –, ‘Suspect Corporate Fraud: Inform SEBI and earns Rs 1 crore’ (2019) Business Today, available at https://www.businesstoday.in/current/economy-politics/suspect-corporate-fraud-inform-sebi-and-earn-rs-1-crore/story/374298.html
-  FE Online, ‘PSU bank fraud fall sharply, thanks to these steps taken by the government’ (2020) Financial Express, available at https://www.financialexpress.com/industry/banking-finance/psu-bank-fraud-fall-sharply-thanks-to-these-steps-taken-by-government/1856600/