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SYNOPSIS -
Definition of Fraud
Definition of Corporate Frauds
Corporate frauds under companies act, 2013
Types of Corporate Scandals
Causes of Corporate Fraud
Landmark Cases of breach of Corporate Governance
Definition of Fraud -
Section 17 of the Indian Contract Act, 1872 defines “Fraud” as “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 a contract.”
Definition of Corporate Frauds -
Corporate fraud is defined as “one that occurs within an organization or by its
owners or managers and involves deliberate dishonesty to deceive the public, investors
or lending companies, usually resulting in a financial gain to the individuals or
organization.” Most of the corporate frauds fall under the categories of asset
misappropriation, money laundering, accounting frauds, frauds committed by senior
management, bribery and corruption and regulatory non-compliance. It is practices such as
these that are denting the image of our financial system. It is remarkable to note that the total
number of frauds reported by the commercial banks as on March 31, 2013, was INR 1.69 lacs
involving an amount to the tune of INR 29910 crores. Reportedly, the public sector banks
cumulatively lost INR 22743 crores because of frauds from 2010-2013. The organizations,
therefore, must be attentive to these challenges and adopt proactive anti-fraud measures
rather than being reactive. Otherwise, organizations and entire societies have to bear the risk
of fraud and its consequences, which will become more devastating.
Section 17 of the Indian Contract Act defines “Fraud” as
"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 a contract.
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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.
Corporate frauds under companies act, 2013
The Companies Act, 2013, is the legislation which focuses on issues related to corporate
frauds. Fraud in relation to affairs of a company or any corporate body as defined in S.447 of
the Companies Act 2013, includes any act, omission, concealment of any fact or abuse of
position committed by any person or any other person with the connivance in any manner,
with intent to deceive, to gain undue advantage from, or 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.
In order to amount to Fraud, an act must be confined to acts committed by a party to contract
with an intention to deceive another party or his agent or to induce him to enter into a
contract. Fraud, which vitiates the contract, must have a nexus with the acts of the parties
entering into the contract. This definition highlights the precondition to prove the intention of
the person who has committed fraud. If that person has willingly committed a fraud, then he
will be punished. Here the person means himself or his agent. The acts which include fraud
are wrong suggestions or concealment of facts or false promises or any fraudulent act to
deceive others.
Types of Corporate Scandals -
Corporate frauds are those activities undertaken by an individual or company that are done in
a dishonest or illegal manner, and are designed to give an advantage to the perpetrating
individual or company. There are various Corporate Frauds such as;
1. Falsification of Accounts Term falsification of accounts means to manipulate the
account of an enterprise in such a manner that will not give the true financial position
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of the company. Some enterprises manipulate the accounts to get the desirable profit
out of misleading information (or the accounts and financial statement do not present
a true and fair picture of the Company’s financial health). Many international
accounting and Audit Firms had been indulged in falsification of accounts.
Some of the methods usually adopted to falsify accounts are as follows:
a) Showing fake and excessive expenses in the books of account.
b) Making bogus entries in the books of account with some ultimate motive.
c) Undervaluation or overvaluation of stock.
d) Charging excessively low or high depreciation in order to inflate or reduce projects.
e) Over valuation or under valuation of assets
f) Over valuation or under valuation of liabilities.
g) Making fictitious entries of loans from promoters or directors to route black money.
2. Under Invoicing Importers are required to pay custom duty on imported goods
generally according to the value of imports. Importers ask the exporters to show low
prices of goods in the invoice so as to minimize custom duty payment. The difference
between actual prices and prices shown in invoice is remitted to exporters through
illegal means. In such cases, customs officials are also bribed to -get clearance of
imported goods.
3. Over Invoicing Exporters get cash and other incentives from the Government as
mean of export promotion. Exporters make change in the invoice to claim greater
amount of incentive. They compensate foreign buyers for difference in prices by
illegal means. Thus, under-invoicing and over-invoicing are scandals adopted by
companies engaged in international trade.
4. Tax Evasion Many business firms suppress their sales turnover and net profits so as
to reduce their tax liability. Bribes are paid to tax officials for assessing lower
turnover and projects. Tax evasion is more common in case of income tax, sales tax,
excise duty and stamp duty.
5. Misappropriation of Assets Misappropriation of assets, often called defalcation or
employee fraud, occurs when an employee steals company's asset, whether those
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assets are of monetary or physical nature. Typically, assets stolen are cash or cash
equivalents and company data or intellectual property. However, misappropriation of
assets also includes taking inventory out of a facility or using company assets for
personal purpose without authorization.
6. Fraudulent Financial Reporting Fraudulent financial reporting means an intentional
manipulation of accounting policies or accounting estimates to improve financial
statements. Public and Private Enterprises commit fraudulent financial reporting to
secure investor interest or obtain bank approvals for financing, as justifications for
bonuses or increased salaries or to meet expectations of shareholders. The corporate
fraud at Stock exchange occurred due to the above reason.
Causes of Corporate Fraud -
Corporate Fraud is committed mostly by the promoters and founders of the Company
(includes the majority shareholder). It ruins the reputation of the company as well the
economic health of the nation. There are various causes that led to Corporate Fraud; some of
these are as follows:
a) A weak internal control is an opportunity for fraudster.
b) Lack of transparency in financial transactions is an ideal method to hide a fraud.
c) Poor management information where a company's management system does not produce
results that is timely, accurate, sufficiently detailed and relevant.
d) Lack of an independent audit department within the company is also a sign of weak
internal control. Poor accounting practice is also part of a weak internal control.
e) An example of poor accounting practice is failure to make monthly reconciliation of bank
account.
f) Top managers tend to share price to make a company an easier takeover target. When the
company gets bought out (or taken private) at a dramatically lower price the takeover artist
gains a windfall from the former top executive's actions to surreptitiously reduce share price.
Not all accounting scandals are caused by top executives. Often managers and employees of
the firms are pressurized or sometimes willingly alter financial statements for the pecuniary
and personal benefit. Managerial opportunism plays a large role in these scandals. For
example, managers who would be compensated more for short-term results would report
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inaccurate information, since short-term benefits outweigh the long-term ones such as
pension obligations.
Landmark Cases of breach of Corporate Governance -
1. Ricoh Case
The saga at Ricoh India demonstrates that the radiance of good governance that is
automatically ascribed to MNCs is not ensured the result. In spite of administrative
interference after the Satyam scam and legislative amendments to tighten the governance
framework [Companies Act, 2013, SEBI (Listing Obligations and Disclosure
Requirements) Regulations, etc.] the Ricoh scene was almost a replica of the Satyam
episode in terms of accounting fraud and resultant fraud of stock prices interestingly without
any promoter being in the saddle.
2. ICICI Bank Scam Case
It was the role of the Board in hurriedly giving a clean chit to its CEO without the results of
an independent investigation released in the public domain in an apparent case of alleged
nepotism, and its refusal to take any questions on the matter.
3. Kingfisher Airlines and United Spirits Case
Mainly regarding illegal internal corporate funding to parties, falsifying accounts. It was
entirely evident that assets had been transferred from United Spirits Ltd. (USL) to subsidise
Kingfisher, that United Breweries (UB) Holdings was utilised as a channel for raising loans
and giving them to his group, that intercorporate credits were given to related groups without
the Board’s approval, accounts were inappropriately expressed, reviews were stage overseen,
etc. during the period Mr Vijay Mallya was responsible for USL.
