Corporate Fraud and How to Prevent It?

Introduction: Understanding Corporate Fraud

In simple words corporate fraud refers to an illegal activity undertaken by an individual or a corporate body which is unethical in nature or violates public interest.

According to Section 447 of the Companies Act 2013 "fraud" in relation to company or any corporate body, includes any act, omission, concealment of any fact or abuse of position commited 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 interest of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or any wrongful loss.

Here "wrongful gain" refers to the gain by unlawful means of property to which the person gaining is not legally entitled.

Here "wrongful loss" means the loss by unlawful means of property to which the person is entitled.

Corporate fraud is very common in the modern day businesses. According to a study by Experian.com atleast 46% of small business loans application showed signs of first party fraud. It poses a serious threat to India's business growth and has the potential to cause major damage.

Types of Corporate Fraud

Corporate fraud is a broad and diverse term comprising of many kinds. The various kinds of corporate frauds which undermine the integrity of India's business sector are as follows:-

Financial fraud: It involves faking the financial statement of the company to trick the potential investors. The ruse is to alter the documents showing the revenue more than it actually is, assets more valuable, debts lesser than actual reality etc.

Asset Misappropriation: Asset misappropriation involves unauthorized use of company assets in the form of embezzlement, billing schemes, personal expenses etc.

Corruption and Bribery: It refers to asking for money illegally through misuse of authority for personal expenses. From front line employees to high ranking government officials anyone can be involved in it.

Insider trading: People with inside knowledge of the company buy the most profitable stocks, gaining advantage in the stock market. This is referred to as Insider trading. Usually the bosses or directors get involved in this.

False or Misleading Information: It refers to companies publishing false or misleading information about the company, making it seem as the most ideal place for investment. It can include fake financial statements, false marketing by publishing false statements or omitting important information intentionally.

Tax Evasions and Fraud: It means to trick the tax systems to reduce the taxes to be paid by the corporate entity. It is achieved by showing less revenue generation, more expenses hiding assets overseas etc.

Cyber frauds and Data Breaches: It means breach of important data like customer information, new ideas, monetary details etc., through cyber-attacks etc. It impacts the reputation of the company resulting in many losses sometimes eventually leading to dissolution.

Money Laundering: Money laundering refers to disguising the source of your financial assets into a legal source to be able to use it freely without any detection or penalties.

Legal Provisions regarding Corporate Fraud in India

Indian legal system has released many provisions and acts including various punishments in order to prevent corporate frauds from happening. Some of these acts are as follows:-

The Companies Act 2013

In Companies Act 2013, Section 447, 448, 449, and 450 tell us about the various means of corporate fraud and their punishments. These punishments act as preventive measures, in order to stop such potential violators from committing such crimes.

This Act stipulates that a person involved in the fraud of atleast 10 lakh rupees or one percent turnover(whichever is lower) of the company shall be liable for imprisonment of six months sometimes extending to ten years, and a fine of the same amount involved in the fraud, sometimes extending to three times the said amount.

If the fraud involves matters of public interest then the term of imprisonment will extend up to three years. It also tells us about false statements made by the company. It states that if an individual releases false statements in any document like financial statements, prospectus etc., or any document required under this act, then they shall be subject to an imprisonment term of two years along with fine of fifty thousand rupees which may extend to five lakh rupees.

The statement should be regarding any material particulars knowing it to be false, or omitting any material facts knowing it to be material. This act also deals with punishments for false evidences. It states that any person intentionally giving false evidence under this act during an oath or solemn affirmation, or in the affidavit regarding the winding up of the company, or any similar matter under this Act, he shall be punishable with imprisonment of not less than three years, which may extend to seven years and a fine up to ten lakh rupees. These penalties, imposed by our legal systems helps to protect the general public, investors, stakeholders etc., from any deception. The punishments for repeated offenders, highlights the seriousness of the legal system regarding such offences, emphasising on the ethical conduct of corporate affairs.

Prevention of Money Laundering Act, 2002

The Prevention of Money Laundering Act, 2002 (PMLA) is an important part of Indian legislation combating such illegal activities. The provisions of this act mainly deals with money laundering, but it also tells us about the combative measures for the different kinds of frauds.

Money laundering as defined under this act refers to, concealing the origins of illegally obtained money by a series of banking transactions, in order to hide its illegitimate origins. People responsible for such illegal activities under this act are punishable with imprisonment for a term of 3 to 7 years. The Authorized officers under this act, can conduct searches, seizures and retain the property with a limitation of 180 days. The offences mentioned under this act are cognizable offences, and bail will only be granted only if specific conditions are satisfied, and only if the bail is granted by the special court.

Prevention of Corruption Act, 1988

This act serves as a crucial legal framework combating corruption across various sectors of India including business sectors, consequently dealing with corporate fraud. By maintaining transparency, and holding the officials accountable for their actions, this act emphasises on maintaining the ethical integrity of India's corporate sector.

The PCA includes provisions for prevention and detection of corruption, and empowers the anti-corruption agencies to conduct investigation on such cases, conduct raids and take the necessary action accordingly. It also provides protection to whistle-blowers, who come forward with such instances, to not fear any retaliation and report freely. Corporate entities can be held vicariously liable, if it is proved that the illegal activity was done to benefit the company either directly or indirectly.

The Indian Penal Code, 1860

IPC illegalizes Corporate Fraud and includes sections like Section 420 which deals with Cheating and Dishonesty. It is now Section 318 ofBNS (Bhartiya Nyaya Sanhita). IPC also consists of Section 463 which deals with Forgery.

Well-known Corporate Fraud Cases in India

M/S Satyam Computer Services Vs. Directorate of Enforcement (2011)

This was the first case of corporate fraud India faced consequently bringing significant changes in India's legal system regarding corporate governance in India. The company was showing large financial statements in their records but were being inconsistent with the companies who are dealing in similar business model. The separate team working on the scam issued fake bank statements convincing the auditors during cessation by giving false evidence. Total of USD 1 billion was involved. Since Satyam had a good business model with many international clients, government took the initiative to revamp the company by hiring professionals and removing the board of directors. Later, the company was sold to the Mahindra group and is now a major part of their successful technology business.

Kingfisher Airlines Ltd Vs. Union of India (2015)

This scam is also one of the important cases of corporate fraud, in relation with airlines industry, leading to the fall of the mighty Kingfisher Empire. The empire was famous for its drinks and beverages, and soon established one of the most luxurious airways in the country owned by the businessman Vijay Mallya. His company was the second highest in market share after Jet Airways. This company fell into bad debts and Vijay Mallya had to sell his private properties to satisfy it. This case reflects the much greater problem of corporate governance, emphasising on the role of Judiciary in enforcing strict legislations. INR 9000 crores of debt was issued by a union of banks.

Given below is a table showing the amount of loans taken by Vijay Mallya from multiple banks:-

Punjab National Bank Vs. Union of India (2022)

This is a landmark case of our nation relating to banking fraud. It was committed by two famous jewellers of our country Nirav Modi and Meghul Chowksi. Both of them were engaged in polished diamond business in India having connections with many international agencies. Their company, after some time started defrauding Punjab National Bank in the name of funding, involving INR 16000 crore. After this scam the government took strict measures and approved the Fugitive Economic Offenders Bill. This prevented the economic violators to evade Indian law and allowed the government to confiscate their assets, benami properties etc. The above mentioned bill covers a large number of economic violations, including loan defaulters, black money, corruption, etc.

Online Fraud The Need of the Hour

In India the instances of modern-day online fraud has been on the rise. To prevent or curb this our government has brought many preventive measures and legal provisions.

Bodies like the National Cyber Crime Reporting Portal and the National Cyber Crime Helpline (1930), have been established for reporting such activities and requesting assistance. The National Cyber Crime Reporting Portal, helps you to lodge complain online while the helpline helps you to file complaints immediately, according to Press Information Bureau, (PIB).

There are also some other remedies available to individuals if the suspect online fraud. Some of those are as follows:

Intimate your Bank

In case of suspecting fraudulent transactions an individual should report to your respective banks immediately.

• Seek support from financial institutions: Contact the financial institutions directly such as SBI General Insurance etc., if the fraud is related to them.
• Online reporting platforms: Many financial institutions have the provision of online portals, for people to report such illegal activities.
• Zero FIR: The new e- Zero FIR system, is a significant step allowing digital reporting of cybercrime complaints.

Common Challenges in Enforcement

Regulatory delays or backlogs can dilute deterrence and show the judicial system as weak.

Law-enforcing bodies are very limited e.g., SEBI.

In some situations political interference in such matters, can pose as a hindrance in the matters of strict governance and justice.

Some Possible Preventive Measures

Preventing Corporate Fraud is not an easy task, especially in large enterprises where efficient management is often a difficult thing to accomplish. Even then, if the owners of the company decide to take some preventive measures such illegal activities can be prevented. Some of the measures which can be incorporated in such corporate settings are as follows:-

• Conducting Audits: Conducting regular audits in any organization can help us understand the financial statement of any organization, independently without any tampering with the data. Through this we can also understand about the areas which require improvement and work on it accordingly.
• Assess your Employees: Knowing or assessing your employees is a very crucial aspect of any business. Owners or directors of any organization, must assess their employees carefully in order to identify any potential risks. Often it is the employee you least expect, who will commit a fraud. That's why it's essential to hear their grievances, on a regular basis.
• Corporate Governance: Corporate governance must be enhanced and stricter, emphasising on the need of transparency and taking bona fide decisions, keeping in mind the best interest of the stakeholders.
• Protection for Whistle-blowers: The corporate organizations must have protection measures installed for the employees daring to come forward to report such illegal activities. If they wish to maintain their anonymity, it should be done accordingly.
• Divide the work: Any important work, such as maintaining the balance sheet, updating the financial records etc., must be divided equally among the employees. At times rotating the employees and giving them new task on a regular basis is also advised as it will allow the new employee to check the work of the previous employee. This way the processes will be transparent for everyone and will be scrutinized accordingly.
• Maintain positive work environment: In the corporate or organizational settings positive work environment must be maintained. Employees must be properly appreciated for their work, and must be recognized for their hard work. Underappreciated employees are at high risk of being potential fraudsters. The owners must set examples, and hold the employees accountable for their actions, regardless of their positions.
• Generate Awareness: Employees must be trained and awareness must be created among them regarding the different types of frauds which can happen in the positions they hold. They must be trained to up hold transparency when it comes to their work, and they must be answerable to the respective CEOs. Their training must include case based scenarios, and practical analysis to make them understand how to respond to such frauds, and the actions to be taken.

Conclusion

Despite the various legal provisions, and so many preventive measures taken by our Indian legal system Corporate Fraud still continues to act like a menace. Preventing or curbing them might be difficult but by following the above mentioned procedures and by making employees aware about the various repercussions of their actions. By proper training of the employees, installing the necessary policies in place, making employees aware about the associated risks etc., might help to prevent it to some extent. Even if we can't stop all corporate fraud, we can reduce the risk by strengthening systems, training people and staying alert.