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