Understanding Corporate Fraud

Understanding Corporate Fraud

Overview 

“Fraus Omnia Vitiate” – Fraud Vitiates Everything 

Corporate fraud is a looming peril in the corporate landscape. In the past few years we have seen a lot of news on corporate frauds taking place not just in India, but also on a global level.  Financial frauds like  Tyco, Satyam, Enron, Sahara, PNB Fraud, ABG Shipyard Scam, etc created havoc for the country’s economy, investors and the company. 

India has a very fast-developing corporate sector, and corporate fraud can destroy this development and the economy of the entire country. Corporate frauds come in many different forms. But the main question is, why does this happen? How to prevent such corporate funds? Does India have enough provisions to prevent damage when corporate fraud takes place? 

Let’s find out!

Understanding the basics of corporate fraud

A fraud (Section 17 of Indian Contracts Act, 1872) is nothing but an intentional deception which is made for a personal benefit or done to damage another entity or person. This kind of deception is criminal in nature and is wrongful. This deception can lead to a personal/financial loss to the other party.

Corporate fraud is an illegal act carried out by a company or people with the aim of financial gain from using deceptive acts or cheating. Such frauds are very difficult to identify, as they are very complex and complicated. Corporate frauds are unethical and illegal activities done by any individual or a whole company for a competitive gain from others in the same industry. Corporate frauds can be of various types, like manipulating financial books, abusing the assets, corruption by employees, etc.

Corporate frauds take a huge toll on the business. It damages the credibility of the industry and the company. In simple words, any activity done which is dishonest in nature (illegal or unethical) in a company for any type of personal gain is known as corporate fraud. For instance, when a CFO intentionally manipulates some financial statement of the company. 

Major types of corporate fraud in India

Different types of corporate fraud in India are:

Type of corporate fraud Explanation  Example
Asset misappropriation Misuse or theft of the company assets is called asset misappropriation. It can be done by any insider of the company, like employees, directors, etc. Assets include intellectual property, movable and immovable assets, funds, goods, etc.  Satyam Computer Services scam
Financial statement fraud When financial records are intentionally  manipulated/misreported in order to cheat the public, investors or regulators.  IL&FS crisis
Corruption and bribery  When someone/company receives, offers, gives something valuable to influence the actions of the other party.  2G spectrum scam
Insider trading  When material and non-public information is used to trade in the company stocks, it is referred to as insider trading. This unethical way gives benefit to the insiders.  Martha Stewart’s insider trading case
Tax evasion When a business or an individual does not pay entire taxes for which they are liable, it is termed ‘tax evasion.’ This is one of the most common corporate frauds.  Panama Papers case 
Cyber fraud  With technology integrating into almost all activities in the companies, there has been an increase in cyber corporate frauds. The data and information are manipulated online, which causes financial loss.  Yahoo data breach case

Legal framework for corporate fraud in India

There are various legal frameworks in India which provide protection and punishment in case of corporate frauds. 

Companies Act, 2013

Companies Act, 2013 is the main legislation which oversees everything related to companies be it registration, insolvency, winding up, etc. 

Section 447 of Companies Act, 2013

This section defines corporate fraud and lays down punishments for the same. A person committing a corporate fraud shall be liable for both imprisonment and a fine. This section includes corporate frauds like embezzlement and financial misreporting along with other fraudulent financial crimes. 

Section 211 of Companies Act, 2013

As per this section, the Serious Fraud Investigation Office (SFIO) which is a specialised agency, was established. SFIO investigates all the complex cases of corporate fraud. 

Section 177 of Companies Act, 2013

As per this section, all the companies are required to set up a committee for audit to ensure all standards are followed and financial integrity is maintained. 

Section 149 of Companies Act, 2013

This section states that independent directors should be appointed compulsorily to make sure there is no bias and to reduce the risk of manipulation and corporate frauds.  

The Insolvency and Bankruptcy Code (IBC), 2016

To ensure that no corporate frauds are carried out when a company is bankrupt or insolvent, the IBC was introduced. This code sets the entire procedure for companies when they are facing bankruptcy or insolvency. This set of rules and regulations ensures no fraud is done by transferring assets. 

Securities and Exchange Board of India (SEBI)

SEBI is the key regulator which oversees the entire securities market. They play a key role when it comes to the prevention of corporate frauds in companies which are listed. 

SEBI (Prohibition of Insider Trading) Regulations, 2015

This prohibits insider trading. All the companies have to mandatorily reveal sensitive information in order to prevent any type of manipulation in the markets. 

SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015

SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, make sure that high standards of transparency and accountability are followed by all the companies which are listed. 

Prevention of Money Laundering Act (PMLA), 2002

The main aim of introducing this act was to end money laundering. Money laundering is one of the main reasons why corporate fraud is carried out many times. There are severe penalties under this PMLA for the people or businesses who are engaged in money laundering. 

Whistleblower Protection Act, 2014

Whistleblowers are the ones who expose corporate fraud to the world, authorities of the company and agencies in the country. This act protects the whistleblowers and people are encouraged to expose corporate frauds without any fear. 

Consequences of committing corporate fraud

Type of Crime Provision for punishment  Punishment 


Fraud

Section 447 of the Companies Act, 2013 		 Imprisonment – 6 months to 10 years along with a fine. 
If the same fraud is repeated then three times the amount in fraud. 


Fraudulently asking to invest money

Section 36 of the Companies Act, 2013		 Imprisonment – 6 months to 10 years along with fine. 
If the same fraud is repeated then three times the amount in fraud. 
Money laundering  Prevention of Money Laundering Act, 2012 Imprisonment – 3 to 7 years along with fine which can be up to five lakh rupees. 


Insider trading

Section 15-G of the Securities and Exchange Board of India Act, 1992		 A fine which shall not be less than ten lakh rupees and can extend up to twenty-five crores or 3 times the profit amount made by insider trading whichever is high. 
Corruption  Prevention of Corruption Act 2013 Imprisonment for 3-7 years along with fine. 

Regulatory bodies tackling corporate fraud in India

There are many regulatory bodies in India which tackle the problem of corporate frauds. As we already know how damaging these corporate frauds are to the economy it is very vital to have watchdogs keeping an eye on businesses. 

Ministry of Corporate Affairs (MCA)

The MCA is the key regulatory body which ensures that all the businesses are in compliance with the Companies Act, 2013. MCA oversees all the majority activities of the companies like financial filing, registrations, incomes taxes etc. It also reports any discrepancies to investigating agencies. 

Comptroller and Auditor General of India (CAG)

The CAG’s main point of focus is auditing the accounts of the government. It keeps a check on the public enterprises by auditing them to detect corporate frauds in the companies where the government holds a significant part. 

Enforcement Directorate (ED)

The main responsibility of ED is to investigate the cases of money laundering in the country. They have the power to investigate and seize assets which are gained by corporate frauds. 

Serious Fraud Investigation Office (SFIO)

The SFIO is a special agency created for corporate frauds. SFIO looks into the matters which can impact the people, cause huge financial losses or financial scams. They can take actions on the referrals made by the MCA or suo moto. 

Reserve Bank of India (RBI)

RBI looks into the matters related to corporate frauds in banking sectors. They oversee whether all the banks are following the rules and regulations or not. They also oversee money laundering matters and investigate banking crimes. 

Securities and Exchange Board of India (SEBI)

SEBI governs the securities market in India and ensures that all the listed companies are acting within the law. SEBI is empowered to look into matters on insider trading, frauds related to shares and securities, manipulation in markets etc. 

How to prevent and detect corporate fraud

Corporate frauds can be detected and prevented by:

  • Having an effective audit system and auditors.
  • Strengthening corporate governance.
  • Use of technology to find and keep a check for fraud detection.
  • Whistleblower mechanism.
  • Compliance and ethics workshops.
  • Data analytics and forensic accounting.

Biggest scandals surrounding corporate fraud

Cases Particulars 
Serious Fraud Investigation Office vs Rahul Modi (2019) Fraud investigation under Section 212(1) of Companies Act, 2013.
Satyam scam Inflating the revenue of the company and making profit out of that. 
PNB and Nirav Modi Scam Financial fraud case, where fraudulent Letter of Undertakings were secured. 
Neeraj Singal vs. Union Of India And Ors(2018) Misappropriation of funds
Sunair Hotels Ltd. vs. Union of India & Anr. (2019) Investigation under Section 212(1) of Companies Act, 2013.
IL&FS Financial Scandal (2018) Inability of the company to meet obligations related to debts. 
Vikas Agarwal vs. Serious Fraud Investigation Office Section 447 

Lessons learned

Corporate frauds pose great societal challenges. Despite having solid rules and regulations, frauds still continue to haunt the economy of the country. The companies exploit technological advancement and rapid industry growth. Corporate accountability is very vital despite having the central government introducing new and updated legislation to prevent and tackle corporate frauds. 

Frequently Asked Questions (FAQs)

What are the indicators of corporate fraud?

There are certain indicators which can help in identifying corporate frauds such as sudden wealth, unexplained financial benefits, expensive purchases etc. 

What are the reasons for corporate fraud?

Corporate frauds can take place due to non stringent management in financial reporting, lack of transparency, lack of accountability, weak corporate governance etc. 

References 

https://autrj.com/wp-content/uploads/2024/04/1-AUT-APRIL-2024-4699.pdf

 

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