THE LEGAL FRAMEWORK FOR CORPORATE FRAUD PREVENTION AND DETENTION

This article is written by Dadhirao Prerana of 2^nd Year of B.A.LL.B. of PRRLC, Osmania University, Hyderabad, an intern in Legal Vidhiya

ABSTRACT

In the era of the corporate world, it is important to sustain in the competition. Once a business gets started every businessman aims to run their respective business for donkey’s years and give enduring impact in society. Once a business is commenced, the company endeavours to improve their quality and establish themselves in organizational governance. Every company strives to maintain their reputation in the business world.

One of the reasons could be insider trading. Then what’s a more menacing factor that could lead to destruction of a huge empire built by the entrepreneurs? For example, once upon a time Jet Airways was the epitome of India’s pride. Now, employees lost jobs with huge arrears of salaries. Then,  acquisition of low-cost service airline, proved to be its nemesis and accelerated the downfall of Jet Airways. The reasons for this massive dismantle are accounting of invoices of fake  on Jet miles, overstatement of expenses and underreporting of profits and were indulged in many other multiple fraudulent practices. Another example that fits in the context of fraudulent practices is Cafe Coffee Day. Over-leveraging to find the expansion of the chain and diversion of funds to non-core business led to the downfall of the Company, which was transformed from a trend setter company to debacle company.^[1]

Corporate fraud refers to deceptive and illicit activities performed by the corporation. These activities committed by the company jeopardizes the trust of stakeholders and affects the reputation in the financial markets.

KEYWORDS

Corporate fraud, Companies Act,2013, Securities and Exchange Board of India (SEBI), Corporate Espionage, National Company Law Tribunal, Corporation Finance Investigation Department [CFID]

INTRODUCTION

This article will be dealt with corporate fraud. This article contains meaning, reasons behind opting for unethical practices like corporate fraud. The various immoral activities that result in corporate fraud will also be contained in this article. The readers will have comprehensive understanding about the legal framework and legal statutes that are enforceable in India to curb the practices of corporate fraud. This article also delves into understanding of punishment and detention given to the persons who practice corporate fraud. This article give an exposure towards the National Company Law Tribunal and Corporation Finance Investigation Department[CFID]. The readers will connect with the article written because it will also consist of pragmatic illustrations that have occurred in the history of the corporate world. For better understanding of this article it also contains some case laws which gives better experience of comprehension of the article. This article revolves around some of the intriguing facts which makes easy to understand of the concept by the reader. It also highlights rules and regulations of Securities and Exchange Board of India (SEBI).It makes a clear view on legal provisions that are equipped in the Companies Act ,2013.This article aims to provide an overview of the causes and consequences of corporate fraud in India, as well as the relevant legislation and regulations. Corporate fraud has been emerged as one of the biggest threats to the company. Incidents of frauds are increasingly at an alarming rate and in the process that can results in enormous destruction in wealth of investors, affects the reputation, rise of mistrust among the management, investors and shareholders. In case of frauds involving large amounts causing growing concern issues can be related to companies like Enron and  Lehman brothers. This article also shows to the viewers that how Indian Legal Statutes have strong legislated laws in order to prevent the corporate fraud. This article aims to make readers comprehend how law breakers are punished with fine, imprisonment or both according to the offenses committed. Business fraud is have the intent to misrepresent – scammers lying  their actions and services – to cause a profit or loss.

MEANING

The term ‘fraud’ is incorporated in Section 17 of Indian Contract Act,1872.^[2]Corporate fraud can be defined as the illegal activities undertaken by an individual or company that are done in an immoral or unethical manner. When companies engage in activities that are dishonest, it is referred to as corporate fraud. There are many forms of corporate fraud such as falsified accounting and misrepresenting services. The corporate fraud and white-collar crimes have close connection within the realm of corporation. White-collar crime is an offence committed by deceit or concealment to obtain or avoid losing money or property, insider trading, accounting scandals, securities fraud, public corruption, health care fraud, mortgage fraud, or to gain a personal or business advantage. Examples of white-collar crimes include securities fraud, embezzlement, corporate fraud, and money laundering etc. Entities like Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), the Federal Bureau of Investigation (FBI), and state authorities are involved in the performance of taking advantage of confidential information or access to sensitive assets and then leveraging those assets for gain as well^[3].Fraud amounts of illicit activities that have penitent consequences. These actions might lead to net loss, slow revenue, declining sales, or hefty expenses. Other forms of corporate fraud can be a misrepresentation of service or product the company is developing or has in service, hiding its flaws or defects

REASONS

1. Fraud in Audit Committee: Auditing is a process of checking the financial statements and records of a company to ensure accuracy in the management. Fraudulent practices can include falsification in financial records and statements. This leads to breach of trust between the committee and the shareholders. For Example, Wirecard, a payment transfer and processing company in Germany accounting auditors discovered  $2 billion discrepancy between the company’s records and the actual money it held. Apparently, Wirecard was forced to declare bankruptcy and the Chief Executive Officer [ CEO] was arrested by German Authorities.
2. Burden of Economy: Economy is a dynamic concept. To retain in the market, the company opts for corporate fraud and hide their actual data about the company. To allure the investors and have more returns, the company choose the unethical path. The practice of immoral activities are performed due to economic pressure. For Example, Enron faced decline in  revenues and debt troubles, company executives hid the facts through accounting fraud.^[4]
3. Concealment of facts: Many corporations hide the facts, contents, ingredients of the products produced. For example, Few companies requested trade secret status for products reported to the database The companies and brands have reported to the California that some of their products contain carcinogen or reproductive toxin, but requested trade secret status for these ingredients so that they are not publicly revealed. Few of the companies are Tresemme, Colgate-Palmolive Company, Rowpar Pharmaceuticals, Inc, Robell Research and so forth.^[5]
4. Technological Advancements: The technology makes the commitment of corporate fraud easier. The advanced technology can make the company make it easier to make scam relating to expansion of business. The usage of technology can mislead the facts about the company. The stealing of important information like customer data, se­cret ideas, and money re­cords can also be practiced using technology.
5. Financial Targets: Companies often have strong pre­ssure of reaching financial goals. The intense chase­ for profits often pushe­s companies to use accounting tricks. When the­ economy is struggling, businesses may deceive. They may try to steal assets, or trick others with dishone­st loan practices.

TYPES

1. Misleading Disclosures: Misleading disclosure­s includes companies sharing false or partial, or tricky information. It may also involve incorrect financial reports, dishone­st marketing, or hiding important details. All of this affects de­cisions about investments massively.
2. Insider Trading: Insider trading refers to the trading of a security by someone who has knowledge of material nonpublic information on the corporate firm. Insider Trading is the practice of using unpublished price-sensitive information of a company to trade in the company’s securities. This type of information is capable of influencing company’s securities’ price in the market.
3. Asset Misappropriation: Stealing from a company is called asset misappropriation. Some of the examples are making fake bills, payroll scams, extra expenses, stealing inve­ntions and perform many more such immoral practices. People in an organisation from top level executives to lower level like worke­rs, suppliers, or government officials can also be­ involved.
4. Tax Evasion: Tax evasion happe­ns when companies intentionally trick tax syste­ms to illegally reduce the­ir tax fees. It may involve false­ly reporting lower income, claiming too many e­xpenses, or using unfair tax tricks.^[6]
5. Financial Statement Fraud: Financial stateme­nt fraud involves faking or amending financial data intentionally. The goal is to trick people­ like investors, loan officers, or regulators, shareholders. This fraud shows a company’s money situation as more than what it actually is. It can make revenue­ higher, assets more valuable­, or debts less than they are­, changing books or distorting money deals. For example, Kingfisher Airlines resorted in borrowing funds and pledged the brand by over-valuation of brand value. This led to failure in the business and corporate fraud. Enforcement Directorate probed Vijay Mallya in money laundering case as well.^[7]

LEGAL PROVISIONS FOR PREVENTION OF CORPORATE FRAUD

1. Companies Act, 2013: The Act is the main source that governs companies in India. It re-shaped company management, corporate citizenship, financial re­ports, corporate governance and the roles of directors and auditors. This legal statute aims for creating, running, and closure of businesse­s. It delves into share issuing, account ke­eping, auditor hiring, and finance data sharing and so forth. For example, Section 212 of Companies Act,2013 incorporates for conducting investigation into affairs of company by Serious Fraud Investigation Office.^[8]
2. Securities and Exchange Board of India (SEBI) Act, 1992: SEBI oversees the­ securities market and guard inve­stors as well. It works against fraud in big corporations and detains for unfair trading practices. SEBI ensures the­ smooth operation of India’s securities market. SEBI prohibits certain fraudulent dealings in securities, related provisions are prescribed in Chapter II, Section 3(d) of Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations[Last amended on January 25, 2022].^[9]
3. Prevention of Money Laundering Act, 2002: The Pre­vention of Money Laundering Act, 2002, deals with money laundering in India. It has stringent rule­s for spotting and stopping this kind of white-collar crime. Financial institutions nee­d to strengthen their e­fforts. Rules and regulations demand clear che­cking of customers, oversee­ing transactions, and keeping records. For Example, Satyam, global IT company based, falsely boosted its earnings and were charged for conspiracy, breach of trust and falsification of records.^[10]
4. Income Tax Act, 1961: The Income­ Tax Act, 1961 is India’s manual guide to taxing income. It helps to calculate­ tax, assists individuals, businesses, and companies. It aims to restrain tax frauds with strict rules, penalties, and che­cks on tax schemes. It’s tough on fraud like false­ income reports and related tax frauds. Lawbreakers can be fined, sent to jail or both. For Instance, The Corporation Finance Investigation Department[CFID] is monitors investigations on fraud, misappropriation of funds, misstatement in financial statements and so forth.^[11]
5. Foreign Exchange Management Act, 1999 (FEMA):FEMA  he­lps India control to deal with other countries’ mone­y. It helps India’s money marke­t to grow safely, stop illegal money activitie­s, and also protect India’s economy. FEMA lets the­ Reserve Bank of India (RBI) to check on foreign money dealings and ke­ep laws in check.

LEGAL PROVISIONS FOR OFFENCES OF CORPORATE FRAUD^[12]

SECTIONS PRESCRIBED IN COMPANIES ACT,2013	PUNISHMENT FOR
Section 86	Contravention and Willfully furnishing any false or incorrect information-Penalty of five lakh rupees and every officer of the company who is in default is liable  of fifty thousand rupees as penalty
Section 229	Penalty for furnishing false statement, mutilation, destruction of documents-punishable under Section 447 of Companies Act,2013
Section 339	Liability for fraudulent conduct ofbusinesses
Section 447	Fraud-Liable to pay as fine not less than the amount  but may extend to three times the amount involved in the fraud
Section 447A	False Statement-Punished with imprisonment, can extend upto 3 years, fine may be upto five thousand rupees or both
Sections 448,449, 450	Forgery-Punished upto 7 years imprisonment, five thousand rupees or thrice the amount of fraud can be as fine or both.
Section 517	Non-Compliance of Orders of Central Government-One lakh rupees in case of continuing default, five thousand rupees for each day during which such default continues as fine[13]

SECTION UNDER SEBI,1992	PUNISHMENT
Section 12 A	Prohibits insider trading, manipulative and deceptive and acquisitions of securities or control
Section 15 E	Failure to observe rules and regulations in asset management company-one lakh rupees and may extend to one crore rupees as fine

SECTIONS IN PREVENTION OF MONEY LAUNDERING ACT, 2002	OFFENCE AND PUNISHMENT
Section 3	concealment, possession, acquisition leading to money laundering
Section4	Punishable in money laundering case-can be imprisoned from three to seven years with fine or both[14]

HOW IS IT DETECTED?

Corporate fraud detection refers to the process of monitoring transactions and customer behaviour and fighting against fraudulent activity. It is  a central part of a firm’s loss prevention strategy and sometimes forms a part of its wider anti-money laundering (AML) compliance processes. According to Juniper Research’s 2022 study Combatting Online Payment Fraud, global payment fraud losses are expected to exceed $343 billion between the years of 2023 and 2027. As a result, financial institutions are taking preventive steps to enhance their fraud detection measures to protect themselves and their customers from financial damage. When fraud detection and its functions are integrated into a wider AML framework, the combination is sometimes referred to as fraud and anti-money laundering (FRAML).The fraud detection relies on technological tools, subject-matter experts (especially analysts), policies, and procedures to function well. The FBI reports that in 2022, fraud victims in the US lost an average of $35,101 each, resulting in a total loss of over $3 billion.^[15]

• Creation of Reporting System: By creating the reporting system the management can start investigation on suspicious frauds. When the company gets reports from the reporting system there can be further proceeding for understanding the internal scenario as to how corporate personalities are actually contributing to the company.
• Anonymity: Few investigators have to have an anonymous image so that they can investigate and detect the corporate fraud effectively. The detectors might not be as reluctant as before if their identity gets revealed. So for better performance in the detection sometimes having an anonymity image is important.
• Segregation of Duties: The company has a separate department regarding detection of corporate fraud. The segregation of detection department can help the management for proficient investigation about corporate fraud. The professionals of the respective department can only perform their duty properly.
• Reviewing Documentation: Reviewing the documents by higher officials can prevent unethical practices. The review of documents can help to stop fraud schemes in a company. With horror scrutinization of documents and rechecking with the current status of the company can help to reduce the corporate fraud.
• Anti-Fraud Policies: The implementation of anti- fraud policies can help in laying down the principles relating to code of ethics and business procedures. The implementation of anti-fraud policies can help better corporate governance in the company. The legal Framework regarding to anti-fraud policies can help in laying down the guidelines and principles for investors, management and other officials in the company regarding trade by the management. According to the Association of Certified Fraud Examiners Report to the Nations on Occupational Fraud and Abuse, 2016, companies with anti-fraud training programs detected fraud 40% sooner and lost 50% less to fraud than companies that did not focus on anti-fraud training.^[16]

CASE LAWS

1. In Subrata Chattoraj vs. Union of India^[17] case, can be summarized as Ponzi scam which was started by Saradha Group. It was involved in collection of money from investors by issuing bonds and debentures and promised high profits from investments. This scheme became epitome of massive corporate fraud and was later shut down.
2. In Union of India vs. Infrastructure Leasing & Financial Services Ltd^[18] case, the company committed fraud and diverted borrowed money associated with entities through the senior management and team. The company got into high debt and landed in trouble.
3. In the case of Punjab National Bank vs. Union of India^[19],The fraud was committed by the jewellers- Nirav Modi and Mehul Choksi. The company was defrauding Punjab National Bank and other banks. The government approved the Fugitive Economic Offenders Bill to deter the economic offenders from evading the process of Indian law by giving powers to the government to confiscate the assets that were absconding by loan defaulters.

CONCLUSION

Good governance and mitigation of fraud, corruption can help to reduce the corporate fraud. The occurrence of corporate fraud can lead to trust related issues among the investors and shareholders. Good governance helps in  transparency and accountability within the organisation. National Company Law Tribunal is a quasi-judicial authority that deals with corporate disputes. It  provides in  relief for class action suits, mismanagement, corporate fraud and other reliefs given to the aggrieved parties in the business world. It has power to award pecuniary damages and impose fine for the offences committed by law breakers. The Securities Exchange Board of India(SEBI) brought  new provisions in Listing Obligations and Disclosure Requirements Regulations, 2015 (LODR Regulations, 2015) into existence. Now, it is amended in the year 2021.The amendment aimed at higher disclosure and standards of corporate governance in public listed companies. The public listed companies have the obligation to disclose any fraud or defaults practiced in the company. Corporate fraud becomes a hindrance in making better relationships with the management and investors. The unethical practices like fraud hampers smooth performance of company. The legislation like the SEBI Act, PMLA and Companies Act are striving to prevent malpractice. The reduction in white collar crimes can help better business circle and ultimately be productive in their work. The impact of corporate fraud is obvious towards damage in the reputation of the company. Shareholders entrust their investors  of markets based on the belief in transparency and efficiency in the management. Investors expect the information they rely upon to be authentic and fair, as it influences the value of the securities they trade. Corporate fraud is the practice of illicit and deceptive activities committed within a company. These practices jeopardize the trust of investors and the integrity of financial markets. The companies effectively perform the ways to detect the corporate fraud so that the company can refrain from falling into trouble in the management. Once the company gets into corporate fraud it becomes difficult to get back the reputation and respect in the society and in business world. The consequences can be fine, imprisonment or both. The impact on the reputed company has huge repercussions that lasts long in the history of the corporate world. The company has to make effective rules and regulations to prevent the corporate fraud.

REFERENCES

1. https://corporatefinanceinstitute.com/resources/esg/corporate-fraud/#:~:text=Summary,may%20take%20years%20to%20detect [last visited on 15 April 2024]
2. https://www.investopedia.com/terms/c/corporate-fraud.asp [last visited on 15 April 2024]
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4. https://www.icpas.org/information/copy-desk/insight/article/summer-2013/the-21st-centurys-top-10-frauds#:~:text=Bernie%20Madoff,the%20largest%20Ponzi%20scheme%20ever [last visited on 15 April 2024]
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12. Subrata Chattoraj vs. Union of India, (2014 AIR SCW 2828)
13. Union of India vs. Infrastructure Leasing & Financial Services Ltd, https://www.casemine.com/judgement/in/63091937d0fe48256c803480 645 of 2022 in Company Appeal (AT) No. 346 of 2018
14. PunjabNationalBankvs.UnionofIndia,https://www.the-laws.com/Encyclopedia/browse/Case?caseId=002202791000&title=punjab-national-bank-vs-union-of-india LAWS(SC)-2022-2-88

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^[1] Naresh Kataria, Corporate Fraud Part 1,https://www.lawstreetindia.com/experts/column?sid=488 [last visited on 15 April, 2024]

^[2] Indian Contract Act,1872,§17, British Parliament [1872], England

^[3]AdamHayes,https://www.investopedia.com/terms/w/white-collar-crime.asp#:~:text=White%2Dcollar%20crime%20is%20a,corporate%20fraud%2C%20and%20money%20laundering [last visited on 15 April, 2024]

^[4]CFITeam,https://corporatefinanceinstitute.com/resources/esg/corporate-fraud/#:~:text=Summary,may%20take%20years%20to%20detect [last visited on 15 April, 2024]

^[5]WVE, https://womensvoices.org/avoid-toxic-chemicals/cosmetics/companies-hiding-toxic-chemicals/ [last visited on 15 April, 2024]

^[6] https://www.caseiq.com/resources/corporate-fraud[last visited on 15 April,2024]

^[7]ETOnlinehttps://m.economictimes.com/news/india/former-idbi-gm-conspired-with-mallya-over-short-term-loan-to-kingfisher-airlines-says-cbi/articleshow/98934453.cms, Economic Times [last opened on 15 April, 2024]

^[8] The Companies Act,2013,§212, Act of Parliament (India)

^[9]https://www.sebi.gov.in/legal/regulations/jan-2022/securities-and-exchange-board-of-india-prohibition-of-fraudulent-and-unfair-trade-practices-relating-to-securities-market-regulations-2003-last-amended-on-january-25-2022-_55604.html

^[10]https://www.icpas.org [last visited on 16 April, 2024]

^[11] https://www.sebi.gov.in/department/corporation-finance-investigation-department-73/overview.html [last visited on 15 April, 2024]

^[12]AKGVG and Associates https://www.akgvg.com/blog/fraud-under-companies-act-2013/ [last visited on 16 April, 2024]

^[13]SharadKSharma,TaxGuruhttps://taxguru.in/company-law/corporate-fraud-light-sections-companies-act-2013.html [last visited on 16 April,2024]

^[14]Minhaj Nazeer, Corporate Fraud, HTTPs [last visited on 16 April, 2024]

^[15]https://complyadvantage.com/insights/what-is-fraud-detection/#:~:text=Fraud%20detection%20refers%20to%20the,laundering%20(AML)%20compliance%20processes [last visited on 17 April,2024]

^[16]RohitMahajan,https://www2.deloitte.com/in/en/pages/finance/topics/forensic/anti-fraud-compliance-programs-can-make-a-significant-difference-to-fraud-risk-management-efforts.html [last visited on 17 April, 2024]

^[17] Subrata Chattoraj vs. Union of India 2014 (8) SCC 768

^[18] Union of India vs. Infrastructure Leasing & Financial Services Ltd 645 of 2022 in Company Appeal (AT) No. 346 of 2018

^[19] Punjab National Bank vs. Union of India LAWS(SC)-2022-2-88

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