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FORENSIC AUDIT S VASUDEVAN ex IA&AS BCOM, FICWA, CS AND CFE 28 APRIL 2013


Agenda  FRAUD AND FINANCIAL FRAUDS  FORENSIC AUDIT TOOLS AND TECHNIQUES  Case studies and discussions


MARKET ATTRACTIONS (as on April 23, 2013)

COMPANY (FACE VALUE)

NO OF SHARES

PAID UP CAP

INR IN CRORE

DIVIDEND PER SHARE (RS)

MARKET CAP

MKT PRICE PER SHARE

BOOK VALUE / SHARE

TCS (INR 1 )

195.72

195.72

25

279801

1429

126

ONGC (5)

855.44

4277.24

9.75

279464

326

132

RELIANCE (10)

322.86

32293.30

8.50

259476

803

498

ITC

781.84

781.84

4.50

250803

317

24

COAL INDIA

631.6

6316

10

196786

311

31

HDFC BK (2)

237.94

476

4.30

164087

689

127

INFOSYS (5)

57.42

287

47

129898

2262

518


ENVIRONMENT – FACILITATORS? • PRIVATE PLACEMENT • PREFERENTIAL ALLOTMENT • FREE PRICING • ENFOCEMENT – LACUNAE OR INEFFECTIVENESS • RULES OR PRINCIPLES – DILEMMA • REGISTRAR OF COMPANIES OR REGISTRAR OF COMPLIANCE? • PROFESSIONAL CODES AND ETHICS


Definition of fraud 

Section 17 of Indian Contract Act 1872

Fraud" means and includes any of the following acts committed by a party to a contract, or with his connivance, or by his agent with intent to deceive another party thereto of his agent, or to induce him to enter into the contract:◦ (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

Explanation to section 447 of the New Companies Bill 2012 “fraud” in relation to affairs of a company or any body corporate, 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;

(ii) “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled;

(iii) “wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled.


FRAUD AND FINANCIAL FRAUDS DEFINITION: Where a person or entity makes undue gains by inducing the general public to part with their money or money’s worth by knowingly making false or untrue statements and in nature and content it is more than contractual frauds between two or more parties. RBI COMMITTEE on Banking frauds in 2001 attempted to define financial frauds as scams affecting the general public and economy as a whole. RBI COMMITTEE included the following, amongst others, as illustration of financial frauds: Market manipulations by leaking price sensitive information by some officials of Regulatory agencies. Price rigging and manipulations in secondary markets Initial public offer related frauds Demat account frauds V a n i s h i n g c o m p a n i e s B a n k i n g f r a u d s M i s s t a t e m e n t f r a u d s P o n z y s c h e m e s F i n a n c i a l s t a t e m e n t f r a u d s P e r s o n s o r e n t i t i e s ( l i k e o n e o r m o r e i n t e r r e l a t e d o c b a c t i n g i n c o n c e r t f o r m a r k e t manipulations


Distinction between financial fraud and contractual fraud CONTRACT FRAUD

FINANCIAL FRAUD

TORTUOUS - INTEREST OF ONLY PARTIES TO THE CONTRACT INVOLVED

INTERST OF THIRD PARTIES AND PUBLIC AFFECTED

ADVERSE RELATIONSHIP AND LEGAL RIGHTS

NOT NECESSARILY SO

MOVE THE COURT FOR RECOVERY OF MONEY LOST

NOT SO AS IT AFFECTS ALL THE STAKEHOLDERS – DIRECT AND INDIRECT.

Normally does not affect public policy

Every instance of financial frauds triggers review of policies for safeguarding the public interest

Affects the concerned parties .

Affects economy and livelihood of general public. Gives raise to serious financial fraud and calls for action by regulatory agencies.


The Fraud triangle Incentive/Pressure

Opportunity

Rationalization


The Fraud triangle

Incentive

Opportunity

(Pressure)

Rationalisation

High Risk


What are the key ingredients for fraud? “A practically conclusive test as to the fraudulent character of a deception for criminal purposes is this:

Ingredients of a fraud…

Greed

Opportunity

Needs

Expectancy of being caught is low

Did the author of the deceit derive any advantage from it which he could not have had if the truth had been known?” - Stephen’s “History of the Criminal Law of England”

“The antidote for crime should be administered in childhood, by the parents. The problem is not fundamentally that of the improper child so much as it is that of the improper home.” - John W. Hill

G

O

N

E

A person “becomes criminal because of an excess of definitions favorable to violation of the law over definitions unfavorable to violation of the law” - Edwin H. Sutherland “Principles of Criminology”


Ingredients of fraud - Greed •

G

r

e

ed

What began with a few pencils and paperclips...


Common comments regarding fraud  Our staff cannot / would not commit fraud  Fraud does not happen in stable organizations, as we have robust internal control systems and processes  We would know if fraud occurred  Fraud can be discovered / detected quickly and loss will not be significant  Our internal controls will take care of fraud related issues


Types of frauds • All frauds arise out of contracts and hence known as white collar crime. However financial frauds impact public also. –

Capital market frauds – primary and secondary market

Off market frauds

Financial statements and accounting manipulations - incentive and performance oriented (corporate frauds)

Tax frauds

Banking frauds

Others – like foreign exchange, derivatives, etc

Employee frauds

External frauds (by outside entities)


CAPITAL MARKET FRAUDS • PRIMARY MARKET –

FRAUDULENT PROJECTIONS IN OFFER DOCUMENTS

UNDERWRITING AND SUBSCRIPTION THROUGH THIRD PARTIES

PROMOTERS CONTRIBUTION THROUGH ROTATION OF CHEQUES AND BOOK ENTRIES

OFF MARKET DEALS FOR THRESHOLD SUBSCRIPTION

• SECONDARY MARKET –

INSIDER TRADING

PRIVATE PLACEMENT

PRICE RIGGING

• OFF MARKET – PRIVATE PLACEMENT, BONUS ISSUES, DEMAT ACCOUNT MANIPULATION, ETC.


TYPICAL BANKING FRAUDS • (a) opening of new fictitious deposits accounts by persons not properly identified by the bank followed by deposit of fake/stolen/forged instruments in such accounts and immediate withdrawals of the proceeds, • (b) submission of false stock/financial statements to avail of finance, • (c) clandestine removal of goods hypothecated and siphoning of sale proceeds, • (d) acceptance of deposits both Resident and Non-Resident through middlemen and thereafter allowing/availing of overdraft against fraudulent discharge of these deposits receipts by forgoing power of attorney and loan documents of third parties who were also not properly identified, • (e) raising of accommodation bills, • (f) kite flying, • (g) manipulation in outward/inward clearing, • (h) raising unauthorised debits on nominal heads of account, • (i) manipulating and tampering with the books of accounts by passing unauthorised entries, • (j) sanction of one time ad hoc credit facility to non-clients, • (k) issue of letter of Credit, Bank Guarantees without recording in the branch books, • (l) issue of pay orders/demand drafts without consideration, • (m) fake documentation, etc.


RBI On instances of banking frauds • Loans / advances against hypothecation of stocks • Housing loan cases • Submission of forged documents including letters of credit, forged FDRs, etc • Valuation related • Invoice manipulations for availing credit facilities Source: RBI circular dated May 31, 2011 on Findings of Forensic scrutiny – Guidelines for prevention of frauds


TYPICAL FINANCIAL STATEMENT FRAUDS • REVENUE RECOGNITION • VALUATION • PROVISIONING • HEAVY RELATED PARTY TRANSACTIONS • OFF BALANCE SHEET TXN • ICDs • CROSS INVESTMENTS


18

FORENSIC AUDIT TOOLS AND TECHNIQUES

INDICATIVE AND NOT AUTHENTIC -


Fraud consists of‌. Corruption

Asset Misappropriation

Fraudulent Statements


Categories of Financial Statement Frauds – some examples Fraudulent financial reporting, e.g., fraud arising from improper revenue recognition, overstatement of assets or understatement of liabilities Misappropriation of assets, e.g., embezzlement, payroll fraud, external theft, procurement fraud, counterfeiting or product diversion

Improper expenditures or liabilities, e.g., commercial and public bribery

Fraudulent acquisition of revenues or assets, e.g., over billing or product substitution against third parties, employer fraud against employees

Fraudulent avoidance of expenses, e.g., tax fraud, booking revenue offshore to avoid taxes

Financial misconduct by senior management – includes misconduct of any magnitude as required by PCAOB Auditing Standard No. 5


What is forensic accounting? • Forensic Accounting is a tool for determining the adequacy of evidence for testing compliance with applicable legal and accounting standards. • Forensic accounting is the application of a specialized knowledge and specific skills to stumble upon the evidence of economic transactions. • The job demands reporting, where the accountability of the fraud is established and the report is considered as evidence in the court of law or in the administrative proceeding. • Forensic accounting is both proactive and reactive in nature. When proactive it is applied for legal review, offering the highest level of assurance, and including the now generally accepted connotation of having been arrived at in a scientific fashion. • Forensic audit is extension of Forensic Accounting techniques for investigation and fraud risk assessment.


Forensic audit Forensic audit is extension of Forensic accounting concepts to audit- no formal definition of Forensic Audit. “a concentrated audit to find out the correctness of recording of the transactions from propriety, value for money and legal perception and to report whether or not a fraud has taken place and any financial benefit has been enjoyed by presenting an untrue picture”

Objectives: ● ● ●

● ●

to test compliance with applicable accounting and auditing standards to determine whether a transaction will stand legal scrutiny in ordinary course to find out the real person(s) / beneficiaries behind the transaction – piercing corporate veil in case of company accounts to establish the channels through which the transaction passed through (beyond entity concept) to obtain understanding of modus operandi of the fraud.


Forensic Audit Proactive forensic auditing Forensic auditing in this sense could be viewed from different aspects depending on its application, some of which are discussed below: Statutory Audit Internal controls should be studied and evaluated in respect of safeguarding assets and resources when performing regularity and financial audits, and in respect of assisting management in complying with laws and regulations when performing compliance audits. Forensic audit methodologies can be used to obtain a more detailed understanding of the entity and its activities to identify areas of risk both in determining the direction of the audit and in expressing an opinion.


Forensic Audit Regulatory Compliance Government Departments/Agencies could themselves use the techniques of Forensic auditing to assess compliance with regulations governing payments of grants /subsidies. Performance auditors could also use these techniques while auditing such governmental programs. Techniques may be used in major audits of large government programs such as ‘ Integrated Child Development Scheme’, Public Distribution Scheme (for foodgrains), to Customs duty drawbacks and export subsidies. Diagnostic Tool Forensic auditing can be used either by management or by auditors to carry out general reviews of activities to highlight risks arising either out of fraud or from any other source with the purpose of initiating focused reviews of particular areas, targeting specific threats to the organisation.


Forensic Audit Reactive Forensic Auditing The objective in case of reactive forensic audit is to investigate cases of suspected fraud so as to prove or disprove the suspicions, and if the suspicions are proven, to identify the persons involved, support the findings by evidence and to present the evidence in an acceptable format in any subsequent disciplinary or criminal proceedings. In such cases it is important to keep in view the following:  working relations with the investigating and prosecuting agencies  authorisation and control of the audit investigation  documentation of relevant information and safeguarding all prime records pertaining to the case  rules of evidence governing admissibility/authentication of records  confidentiality  evaluation of the evidence to assess whether the case is sustainable  legal advice where appropriate  reporting the findings in a manner that meets legal requirements.


Forensic Audit


TOOLS AND TECHNIQUES – 360* • CRITICAL PATH AUDIT • CRISIS AUDIT • DATA ANALYTICS / DATA MINING • EVIDENCE COLLECTION / RECORDING • VALUE FOR MONEY AUDIT • REGULARITY & COMPLAINCE AUDIT • VERTICAL & HORIZONTAL REVIEWS • EXTERNAL EVIDENCE


SOME OF THE LARGEST FINANCIAL FRAUDS / SCAMS (1993-2012) NAME OF THE ENTITY

BRIEF MODUS OPERANDI

IMPACT

HARSHAD MEHTA SCAM

MONETISED THE FLOAT AVAILABLE WITH THE BANKS FOR MARKET MANIPULATION

CAPITAL MARKET COLLAPSED

C R BANSALI

PROMISED HIGH RETURNS FOR INVESTMENTS IN HIS 100+ COMPANIES.

PUBLIC TRUST IN NBFC

UTI SCAM

DIVERSION OF FUNDS FOR OTHER PURPOSES

GOVT BAILED OUT OF TAX PAYERS MONEY - 3500 CR

HOME TRADE

MOBILISED FUNDS BY PROJECTING TO DEAL IN GILT SECURITIES. RBI TOOK ACTION

PUBLIC LOST MONEY – RS 300 CRORE

KETAN PAREKH SCAM

FACILITATED PRICE RIGGING CAP MKT COLLAPSED


SOME OF THE LARGEST FINANCIAL FRAUDS / SCAMS (1993-2012) NAME OF THE ENTITY

BRIEF MODUS OPERANDI

IMPACT

GLOBAL TRUST BANK

AGGRESSIVE LENDING.

CAPITAL MARKET COLLAPSED

DSQ SOFTWARE

SHARES WERE ISSUED, DEMATTED AND TRADED WITHOUT LISTING ON ANY EXCHANGE AND ACCOUNTING FOR ISSUE

WEAKNESS IN DEMAT SYSTEM – STILL EXISTS

SATYAM

CREATION OF NON EXISTANT CASH SURPLUS AND FUDGING OF ACCOUNTS

MARKET COLLAPSED. CONFIDENCE IN INDIAN COMPANIES TOOK HIT. ECONOMY SLOWED DOWN.

2G, CG, KG

G

GOES ON JI!!!!!!! PUBLIC

CHIT FUNDS

TRADITIONAL METHODS

GREEDINESS?????????


CASE STUDIES  NON BANKING

FINANCIAL COMPANY

 BANKING FRAUD – INTRA

DAY TEMPORARY OVERDRAFT

 SWAPPING OF SHARES  REVALUATION RESERVE  AND SO ON..

FRAUD


Forensic audit 28 april 2013