Dr.

Ram Manohar lohiya National Law University,

Lucknow

CORPORATE FRAUD

Submitted to: -
Submitted By: -

Prof. Prem Kumar Gautam

Ankit Diwan

Faculty in Law
Roll Number – 20,

X
Semester

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Objectives

1. To analyse the corporate fraud and its instances that had taken place in
the corporate world.

3. To study the role of the legislature for the prevention of such crimes.

Hypothesis

1. That fraud in corporates affects not only to corporate world but also
adversely affects

the society and affects the economy of the country at large.

2. That such fraud reduces the interest of the general public into corporate
investment.

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3. That legislature has played a vital role to preserve and protect the
interest of the society.

Research Methodology

This project is a brief doctrinal project which is carried out by the

researcher after a careful research and analysis of the data and which has
been collected with the help of different books, various articles & journals
and number of web references.

TABLE OF CONTENTS

(1) Introduction………………………………………………………………….
(5)

(2) Treatment of fraud under current laws in

India………………………….(7)

(3) Fraud under SEBI

Regulations……………………………………………(10)

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(4) Scope of Corporate
Fraud………………………………………………….(11)

(5) Examples of Corporate

fraud………………………………………………(18)

(6) Existing provisions and regulations dealing with corporate

fraud……..(21)

(7) Recent Changes that is going to be made to combat

corporate fraud…..(30)

(8) Conclusion……………………………………………………………………
(38)

(9) Bibliography…………………………………………………………………
(40)

(1) Introduction

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White Collar Crimes are those, which are committed by respectable
persons, holding enviable positions, either in public or private concern. It is
very hard to detect these crimes. It is defined by the Federal Bureau of
Investigation as “illegal acts characterized by deceit, concealment or
violation of trust, which are not dependent upon the application or threat of
physical force or violence .1” The FBI says that in cases of white collar
crime, “individuals and organizations commit these acts to obtain money,
property or services; to avoid the payment or loss of money or services; or
to secure personal or business advantage.” The phrase “White Collar
Crime” was coined in 1939 during the speech given by Edward Sutherland
to the American Sociologist society. He, in his published research paper on
white collar criminality in the American Sociological Review, defined the
concept as, “a crime committed by persons of respectability and high social
status in course of their occupation.” White collar crimes by their very
nature are such that the injury or damage caused as a result of them is so
widely diffused in the large body of society that their gravity in regard to
individual victim is almost negligible. 2 It is highly difficult to prosecute a
white collar crime because the perpetrators are sophisticated criminals
who conceal their activities through a series of complex transactions.
Today, the focus of white collar crimes has moved from the individual to the
organization, where individuals alone or in collaboration with others commit
acts that are criminal. One of such white collar crimes is the CORPORATE
FRAUDS. Of all white collar crimes, corporate frauds are the most
sophisticated and adversely affect the society. They are the crimes which
are committed by the so called high profile and sophisticated humans of the
society. They reduce the interest and trust in corporate investments and in
turn reduce the confidence on the government as well as society. Corporate
frauds are more dangerous to the society because financial loss to society
from corporate frauds is greater than the financial loss from burglaries,
1
http://www.onlinelawyersource.com/criminal_law/white_collar/recentcases.html.
2
Sutherland E (1941). ‘White collar criminality’, American Sociological Review. Vol-V No.1.
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robberies, larcenies etc. Corporate frauds have become a global
phenomenon with the advancement of commerce and technology. Like any
other country, India is equally in the grip of corporate fraud. The reason for
enormous increase in corporate frauds in recent decades is to be found in
the fast developing economy and industrial growth of this developing
country. According to Oxford dictionary, a fraud is defined as, “the use of
false representations to gain unjust advantage and criminal deception.”
According to the Internal Resources Service (IRS) Department of the US
Department of the treasury, “A corporate fraud is violation of the Internal
Revenue Code (IRC) and related statutes committed by large, publicly
traded corporations, and /or by their senior executives.” 3 A corporate fraud
occurs when a company or organization deliberately changes or conceals
the information in order to make it appear healthy. A company may commit
fraud by manipulating accounting records, hiding debt, or failing to inform
shareholders of loans and bonuses given to its executives. The falsification
of financial information, including false accounting entries, bogus trades
designed to inflate profits or hide losses and false transactions will help the
organization to attract funds from the lenders and investors. The motives of
committing fraud by a company may be many, but the main motive is
making money and creating a false soundness for the company in order to
save its image in the market and to misguide the government departments
to avoid the heavy tax burdens. In India, the Commission on ‘Prevention of
Corruption’ in its report4 observed, “the advancement of technological and
scientific development is contributing to the emergence of mass society
with a large rank in file and a small controlling elite, encouraging the
growth of monopolies, the rise of a managerial class and intricate
institutional mechanisms. Strict adherence to high standard of ethical
behavior is necessary for the even and honest functioning of the new social,
political and economic processes. The inability of all sections of society to
3
http://www.irs.gov/compliance/enforcement/article/.
4
Government of India, Report of the Commission on Prevention of Corruption (1964) Para 2.13, p 11.
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appreciate this need in full results in the emergence and growth of white
collar and economic crimes renders enforcement of the laws, themselves
not sufficiently deterrent, more difficult .”5 The Report of the Vivian Bose
Commission of Inquiry into the affairs of Dalmia-Jain group of companies in
1963 highlights how these big industries indulge in frauds, falsification of
accounts, tampering with records for personal gains and tax evasion 6 etc.
Similar observations were made by Mr. Justice M C Chagla about the big
business magnate Mundra who wanted to build up an industrial empire of
dubious means. There were as many as prosecutions against this business
tycoon and companies owned and controlled by him between 1958 to 1960
and as many as 113 of them resulted into conviction. A careful study of a
number of large corporations and business houses attribute to the highest
degree of criminality to business world which include traders, businessmen
and industrialists. It has been held in the Report of Vivian Bose Commission
of Inquiry7 that Business Communities in India of large and small merchants
are basically a dishonest bunch of crooks. While it is true that the object of
businessmen is to make profit, there are degrees and degrees of making
profit, and nowhere in the world do businessmen get rich as quickly as they
do in India . The most comprehensive survey of attitudes by business
executives towards management and corporate practices showed that the
Business executive tends to ignore the great ethical laws as they apply
immediately to his work. It is also believed that Businessmen would violate
a code of ethics whenever they thought they could avoid detection.

(2) Treatment of fraud under current laws in India

5
Law Commission of India, 29th Report, 1966, p3.
6
Government of India introduced VDIS (Voluntary Disclosure of Income Scheme), 1997 to unearth Black money on
the recommendations of Wanchoo Committee appointed in 1990.
7
Government of India (1963), Report of the Vivian Bose Commission of inquiry.
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It would be relevant also to see how fraud is currently dealt with under the
Indian Penal Code and the Companies Act, 1956 as also some other related
legislations such as the SEBI Act 1992. Indian Penal Code Offences under
the IPC relevant for the purpose are dishonest misappropriation of property,
criminal breach of trust and cheating. These are defined in IPC as under:
Section 403 - Dishonest misappropriation of property. Whoever dishonestly
misappropriates or converts to his own use any movable property, shall be
punished with imprisonment of either description for a term which may
extend to two years, or with fine, or with both.

Section 405 Criminal breach of trust

Whoever, being in any manner entrusted with property, or with any

dominion over property, dishonestly misappropriates or converts to his own
use that property, or dishonestly uses or disposes of that property in
violation of any direction of law prescribing the mode in which such trust is
to be discharged, or of any legal contract, express or implied, which he had
made touching the discharge of such trust, or wilfully suffers any other
person so to do, commits "criminal breach of trust".

Section 415 - Cheating

Whoever, by deceiving any person, fraudulently or dishonestly induces the

person so deceived to deliver any property to any person, or to consent that
any person shall retain any property, on intentionally induces the person so
deceived to do or omit to do anything which he would not do or omit if he
were not so deceived, and which act or omission causes or is likely to cause
damage or harm to that person in body, mind, reputation or property, is said
to "cheat".

Explanation, -- A dishonest concealment of facts is a deception within the

meaning of this section.

Section 420 Cheating and dishonestly inducing delivery ofproperty.

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Whoever cheats and thereby dishonestly induces the person deceived to
deliver any property to any person, or to make, alter or destroy the whole or
any part of a valuable security, or anything which is signed or sealed, and
which is capable of being converted into a valuable security, shall be
punished with imprisonment of either description for a term which may
extend to seven years, and shall also be liable to fine. These offences
have `dishonestly' or `fraudulently' as necessary ingredients. These two
expressions are defined in IPC as under:

(a)Section 24 defines "dishonestly" thus: "Whoever does anything with the

intention of causing wrongful gain to one person or wrongful loss to another
person is said to do that thing dishonestly".

(b) "Fraudulently" is defined in section 25 thus: "A person is said to do a

thing fraudulently if he does that thing with intent to defraud but not
otherwise".

As judicially held, the expression "defraud" involves two elements, namely,

deceit and injury to the person deceived. Injury is something other than
economic loss that is, deprivation of property, whether movable or
immovable, or of money, and it will include any harm whatever caused to
any person in body, mind, reputation or such others. In short, it may even be
a non-economic or non-pecuniary loss. A benefit or advantage to the
deceiver will in most cases cause loss or detriment to the deceived. Even in
those rare cases where there is a benefit or advantage to the deceiver, but
no corresponding loss to the deceived, the second condition would be
satisfied. The idea of deceit is a necessary ingredient of fraud, but it does
not exhaust it; an additional element is implicit in the expression. The scope
of that additional element is the subject of many decisions. In Dr. Vimla V.
Delhi Administration8, the Supreme Court held thus: "The word "defraud"
includes an element of deceit. Deceit is not an ingredient of the definition of

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[(1963) Supp. 2 SCR 5851.
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the word "fraudulently". The former involves a pecuniary or economic gain
or loss while the later by construction excludes that element. Further, the
juxtaposition of the two expressions "dishonestly" and "fraudulently" used in
the various sections of the Code indicates their close affinity and therefore
the definition of one may give colour to the other. To illustrate, in the
definition of "dishonestly", wrongful gain or wrongful loss is necessary
enough. So too, if the expression "fraudulently" were to be held to involve
the element of injury to the person or person deceived, it would be
reasonable to assume that the injury should be something other than
pecuniary or economic loss. Though almost always an advantage to one
causes loss to another and vice versa, it need not necessarily be so. Should
we hold that the concept of fraud would include not only deceit but also
some injury to the person deceived, it would be appropriate to hold by
analogy drawn from the definition of "dishonestly" that to satisfy the
definition of "fraudulently" it would be enough if there was a non-economic
advantage to the deceiver or a non-economic loss to the deceived. Both
need not co-exist."

All the acts in relation to a company, even if in breach of the provisions of

the Companies Act requiring discharge of fiduciary responsibilities of
individuals in charge of the company, may not attract the provisions of
criminal law. This may be illustrated with respect to the `breach of trust'
under company law. Breach of trust is both a civil wrong and a criminal
offence. There would, however, be certain situations where is would
predominantly be a civil wrong and may or may not amount to a criminal
offence. For instance company law may require the directors of a company
to discharge their fiduciary duties in good faith and breach of this obligation
may give rise to civil consequences only. To constitute an offence of
criminal breach of trust punishable under IPC, there must be an
entrustment, misappropriation or conversion to one's own use, or use in
violation of legal direction or of any legal contract: and the

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misappropriation or conversion or disposal must be with a dishonest
intention. While several acts, which would contribute to fraud, are
recognized in the IPC, there is no comprehensive definition of fraud. It is
therefore necessary to identify the nature of the act or acts and combine
different provisions of the IPC to deal with a situation of fraud. Specific acts
dealt with under these provisions give rise to criminal liability with
punishment as specified.

(3) Fraud under SEBI Regulations

SEBI also exercises jurisdiction on frauds in the matter of `issue and

transfer' of securities in terms of Section 55A of the Companies Act, 1956.
Therefore, it is useful to look at definition of fraud as it appears in SEBI's
Regulations on Prohibition of Fraudulent & Unfair Trade Practices (2003).
Under Regulation 2(1)(c), fraud includes an act, an expression, or omission
or concealment committed whether in a deceitful manner )r not, by a
person, or by any other person with his connivance, or by his agent, while
Sealing in securities in order to induce another person or his agent to deal
in securities, whether or not there is any wrongful gain or avoidance of any
loss, and shall also include i) a knowing misrepresentation of the truth or
concealment of material fact in order that mother person may act to his
detriment, b) a suggestion as to a fact which is not true by one who does not
believe it to be true, c) an active concealment of a fact by a person :laving
knowledge or belief of the fact. Thus, definition of fraud under SEBI
Regulations is an inclusive definition and seeks to lay down the elements
constituting a fraudulent act. While this definition is included in the
subordinate legislation under the SERI Act, 1992 rather than in the
principal Act itself, it is useful to take into consideration the ingredients of
this definition. In sum and substance, the definition of fraud in the SEBI
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Regulations has suppressio veri and suggestiofalsi as its underlying
elements. The intention behind the action is relevant irrespective of
whether the act committed with such intention actually results in any
wrongful gain or avoidance of loss. The trappings of fraudulent act are
considered as pernicious as its culmination with all its deleterious effects.
The predisposing elements to the fraud, though by themselves may not be
causing loss at that stage, have been included. From the foregoing
discussion, it is observed that the Indian Penal Code defines several
offences, all or any of which, in varying combinations may be ingredients of
fraud. The Code segregates such ingredients rather that dealing with a
separate all inclusive phenomenon of fraud, leaving it to the
stakeholder/prosecution agency to combine his response depending upon
the merits of the situation. The Companies Act, 1956 provides the statutory
code for the structure of a company, its governance and regulation. In doing
so, it recognizes certain situations, which may arise as a result of fraud and
seeks to address them in a manner that is supportive to the main object of
that Act. Each of the two legislations does not debar the application of the
other. Practical difficulties, however, arise since the Companies Act is a
Central Act, to be implemented by the Central Government whereas the
Indian Penal Code is implemented through the State Governments in
exercise of their domain with regard to public order and police functioning.
Special Acts such as the SEBI Act 1992 seek to define fraud both
comprehensively in context of capital market operations. The SEBI
definition, however, is a part of SEBI regulations rather than the main SEBI
Act and consequently would lead to issues with regard to enforcement of
criminal liability.

(4) Scope of Corporate Fraud

Over the years the corporate form has emerged as the preferred mode of
doing business and of mobilizing resources. Companies bring people
together for economic activity and mutual gain, facilitate rising of capital,
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invest resources in viable activity and provide employment to millions of
people. The corporate structure and its governance has evolved over a long
period of time to enable corporate operation with transparency and
accountability and in a manner that harnesses and makes the best use of
individual talent and merit. The need for efficient conduct of its operations
has resulted in the development of business management as a separate
professional discipline. Companies today have spread their operations
across the globe and comprise organizations, governance structures and
employees carrying out their allotted tasks. Components of such corporate
organizations are very unlikely to have knowledge and information about
their organization beyond their immediate area of function and control. The
investors and shareholders are likely to know even less. For this reason the
essential corporate governance requirements are addressed in most
jurisdictions through statute. At the same time, some unscrupulous
elements have also misused the corporate form for carrying out dishonest
acts and transactions by misleading investors, creditors and other
stakeholders, creation of artificial bubbles of expectation and
misappropriation of public funds through what has sometimes been called
"ugly manipulations of companies". Such actions have often been the result
of fraudulent actions on the part of those who are concerned with the
conduct of the affairs of the company. Their impact can be catastrophic,
shaking credibility and faith in business activity, wiping out investments of
tens of thousands of crores of rupees and employment for lakhs of people in
a flash. However, over the same period, laws and regulatory structures have
also emerged, and continually need to develop, that have compelled more
elaborate ways of investigation and bringing the culprits to book and
devising of penalty structures that punish the wrong doer and compensate
the victims of fraud. From time to time different forms and nature of fraud
emerge. The vigil of the regulator therefore, has to take the complexity of
the phenomena in its sweep while remaining dynamic to counter ever-

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changing situations. It is relevant to examine issues relating to corporate
fraud in this context.

Corporate Fraud

When fraud is perpetrated through, or in relation to a company, it is termed

as corporate fraud. In fact, in the case of serious frauds, involving large
volumes of money and resulting in duping of large number of stakeholders,
the company form is often the instrument through which such activities take
shape and effect. In such cases individual culpability may be obscured by
actions taken on behalf of the company and the real perpetrators of may
take shelter behind the corporate veil. Fraud, however, would invariably be
the outcome of actions of and individual or group of individuals. The task in
such cases is to sift through the maze of corporate organization, scanning
the corporate action and the intent behind it with reference to its impact on
the victim of fraudulent action. Fraud can take place in various situations
with regard to a company. Some of these are as discussed below.

Fraud in relation to the formation or promotion of a company

Corporate fraud may be in relation to the formation or promotion of the

company. This may be done to disguise the real intention and identity of the
promoters and first directors and may involve false representations with
regard to the information relevant to the identity of the company, its control
and management and its intended operations. The Companies Act has
provisions providing for offences arising `in relation to the formation or
promotion' of the company. Section 203 disqualifies a person from being a
director if he is convicted of any offence in connection with the promotion,
formation or management of a company. Section 455 (2) enables the Official
Liquidator to file a report before the Tribunal, stating the manner in which
the company was promoted or formed and whether in his opinion any fraud

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had been committed by any person in its promotion or formation. Section
478 permits public examination of persons where any person in the
promotion or formation of the company has committed a fraud.

Fraud through the Company

A company may also be used as a `vehicle' to commit the fraud. Here,

the company is a mere cloak or a sham and the fraudster operates through
the entity to conduct his deceitful activities. The fraud is not `by the
company' for which it can be indicted. Rather its structure is used to
project an image based on statute and to make certain representations and
projections to persons dealing with it that disguise the real intentions of the
promoters. The reality behind the corporate veil is quite different.

In Skipper Construction Company (Private) Limited, the Supreme Court

noted that the concept of corporate entity was evolved to encourage and
promote trade and commerce but not to commit illegalities or to defraud
people. Where, therefore, the corporate character is employed for the
purpose of committing illegality or for defrauding others, the Court would
ignore the corporate character and will look at the reality behind the
corporate veil so as to enable it to pass appropriate orders to do justice
between the parties concerned. Further, the fact that Promoters and
members of his family had created several corporate bodies did not prevent
the Court from treating all of them as one entity belonging to and controlled
by the promoter and/or members of his family and arriving at the conclusion
that the device of incorporation was really a ploy adopted for committing
illegalities and/or to defraud people.

Fraud or offences in relation to the affairs of the company.

Similarly, there are provisions which use the expression fraud or

offences in relation to the affairs of the company. There may be cases of
fraud where the corporate form is used to deceive, but without involving or

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siphoning of the company's assets. In a case where equity capital is falsely
shown by mere circulation of funds through the bank accounts of the
company and its associate companies without having any funds, genuinely
contributed as equity in those accounts, no corporate assets may appear to
be siphoned of, as the funds received towards the so-called equity cannot be
said to belong to the company. However such equity is used to reflect a
certain image of the financial position of the company that is not true and
fair, to lenders, investors etc. and is very much a component of fraud. Same
position may result from turnover of a company built up through fictitious
invoicing.

Where the method used for raising or receiving the funds is itself
fraudulent since the corporate form is used for raising or receiving the
funds, it ought to be covered by corporate fraud' even though no siphoning
of the Company's assets has take place. A few persons in the company may
practice such fraud surreptitiously, without the knowledge of others-or by
the comprehensive involve of the structure of governance of the Company.
In the former situation, the Company itself is inert and is merely used as a
vehicle. In the second case issue of liability of the company itself, in addition
of theose charged with its governance may arise.

Fraud by the company

As the very expression suggests, "corporate fraud" is an act in relation to,

or involving a company. The fraudulent act at times may be attributed to the
company itself. In such case it may be termed as a fraudulent act `by the
company'. It is well settled that a company can be `punished' for such an
offence, even though mens rea [guilty mind] is an essential requisite of such
offence. The question is under what circumstances may fraud be attributed
to the company as a corporate person as distinct from physical person in
control of its affairs.

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It is well established that the courts will not allow the corporate form to be
used for the purposes of fraud, or as a device to evade a contractual or
other legal obligation. For certain purposes, the courts, while respecting the
separate legal personality of a company, have treated the conduct or
characteristics of its directors, managers or members as attributed to the
company itself. Attribution of mens rea to a company for the acts
committed by its representatives for the purposes of criminal or civil
liability is an illustration of this principle.
A company is a 'person' under Section I1 of the Indian Penal Code, and can
be prosecuted as such. It is now the settled position that a company may, in
an appropriate case, be indicted by the corporate name. A company is
indictable for criminal acts of its directors, or authorized agents or servants,
whether, they involve mens rea or not, provided they have acted or have
purported to act under authority of the company or in pursuance of its aims
and objects. The question whether a company should or should not be liable
for criminal action resulting from the acts of some individual depends on
the nature of the offence disclosed by the allegations in the complaint, the
relative position of the officer or agent vis-a-vis the company and the other
relevant facts and circumstances which could show that the company, as
such, meant or intended to commit that act. Any director who is a party to
the fraud is personally liable. This is on the principle that whoever commits
a wrong is liable for it himself. The company may also be liable but that
does not exonerate the director. One situation where a company itself may
be liable for fraud may be arise out of t h e manner it deals with its
contractual obligations. Another, where the undertaking or the business of
the company is itself subordinated to fraudulent purpose or where the
company lends itself to be used as such. Yet another situation may be where
the governance structure of the Company - its board, key management
personnel or managers and officers are knowingly involved in fraudulent
act.

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Fraud on the company
In a `corporate fraud', the company itself may be the victim of the fraud.
The fraud may be committed 'on the company' itself. The company may have
no role in the commission of the fraud. The fraudulent act causing damage
to the company may be committed by an outsider or an insider. Status of
the fraudster is not a necessary ingredient of the fraud committed `on the
company', or `in relation to the company'. Such acts or transactions may
be of a nature that falsifies the accounts or
financial statements of a company. A few individuals acting secretly, without
the knowledge of other employees or even other persons involved in the
governance of the company who may believe the information so created to
be true. Such false projection of the state of affairs of the company may be
used to create false expectations in the stock market and inflate its scrip
value through manipulation, or to generate resources, which may be
siphoned away through a maze of connected/associate companies. A
company can also be made anaemic through suppression of its true financial
position or actual drain of its financial and other resources through
siphoning. That affects the interests not only of the shareholders, but also
other stakeholders. The objective may be to suppress its valuation
artificially and to squeeze out minority shareholders with low compensation.
Or to arrange its takeover by another with part of the consideration being
paid in a manner that deprives the real or minority shareholders of fair
value while enriching a few through compensation paid outside the
company. In other cases the undertaking of the company may be transferred
to the benefit of shareholders, with the company itself being deprived of the
same.

Cross border fraud

Extent and reach of fraud committed through corporate entities are not
restricted to entities within the country only. Experience has shown that in
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many frauds of serious and complex dimensions, actions extend beyond
national boundaries involving overseas corporate bodies to set up a
complicated web of transactions and front companies/entities. Many
companies also have their operations and subsidiaries abroad with transfer
of funds arising out of business operations taking place in and out of the
country. Proceeds of frauds are also siphoned off to entities outside the
country and parked there. In many cases perpetrators of fraud skip the
country so as to be outside the reach of local law enforcing agencies. The
situation is made complex by the presence of tax havens that have secrecy
laws making obtaining information or carrying out investigation more
difficult. Such inter-linkages also have security linkages in addition to being
used as a means to move or launder proceeds of crime.
Fraud and the public dimension Corporate assets are represented by capital
which is contributed by the members of the public; or public deposits or
loans from public raised through issue of securities; or loans from banks
and financial institutions, which being drawn from public institutions, also
possess the attributes of public funds. When the assets are misappropriated
and are lost to the company, the real loss falls on the shareholders,
depositors, other security holders, or the credit institutions. A fraud causing
loss by misappropriation of such funds drawn from public sources, even
within a corporate setting, amounts to a public fraud. Fraud may be
caused in raising of funds from public by
misrepresentations/falsehoods in prospectus, statements, etc. as to the
financial statements or financial or other affairs of the company or its
intentions/future plans or as to promoter's contribution on the basis of
fictitious entries etc. Frauds may also be caused in raising of funds from
public sources through loans from banks/financial institutions. Term loans
may be obtained by inflating project costs; overvaluation of inventory,
booking bogus transactions, expenses; by misrepresentation with regard to
equity promoters contribution, inventories, turnover etc. The methods
used for raising the funds and the treatment of funds thereafter would seem
19
to have direct relevance to the definition of `corporate fraud'. Following
aspects need to be taken into account in this regard. Funds may be raised
in fraudulent manner for the use of the company, money raised may also be
accounted for in the company's books, and is may also be actually used
towards the company's objects as permitted by its memorandum.; b.
Company funds may be misappropriated/siphoned off The method used for
raising the funds may not be fraudulent, but money raised is not accounted
in the company's books and hence does not form part of the company's
assets. The method used for raising the funds is not fraudulent, money
raised is also accounted in the company's books and hence forms part of
the company's assets, but is thereafter it is siphoned off. The Company and
its management: In Raja Narayanlal Bansilal vs. Manech Phiroz Mistry and
anr, the Registrar of Companies issued notices to petitioners for conducting
investigation against them on allegations of fraud in conduct of business.
Confirming the Registrar's decision the High Court held that that
investigation against person in charge of management making profit at cost
of interest of company and other parties was distinct from ordinary breach
of trust and misappropriation. "Persons in charge of management are
distinct from other citizens. -----citizen can protect his interest but financial
interest of large number of persons depends upon person in charge of
management ---- it is legitimate to treat these companies and their
managers as distinct class to provide safeguard against abuse of power
vested in them." Considering these persons as separate class, conducting
investigation into their affairs was held not violative of Article 14. Further,
"Directors are regarded as trustees of company's property which is in their
hands or under their control. The primary consequence of this principle of
trusteeship is that a director is answerable as a trustee for any
misapplication of the company's property in which he participated and
which he knew or ought to have known to be a misapplication. A
misapplication in this context means any disposition of the company's
property which by virtue of any provision of the company's constitution or
20
any statutory provisions or any rule of general law the company or board is
forbidden or incompetent or unauthorized to make, or which is carried out
by the directors otherwise than in accordance with their duty to act bona
fide in the interests of the company and for the proper purposes. This
second limb covers not only misappropriations of the company's property
but also dispositions in favour of third parties which do not satisfy the test
of bona fides.9" There is a need to review and strengthen regulatory
response to fraud comprising of effective powers of the Central Government
for timely detection of corporate fraud including by intelligence gathering,
ordering and conduct of investigation through experts to unravel the
nature scope and impact of fraud, quick unravelling of the fraud or scam, an
effective prosecution mechanism leading to speedy justice, maximum
recovery of illegally acquired gains from frauds, restoration of such assets
and money to their rightful owners. The beginning however must be made
by a clear appreciation of fraud, in particular corporate fraud. The Fraud in
a corporate framework has its own dimension and involves actions by
perpetrators within the confines of, or in relation to the affairs of a virtual
person, the Company, in a structure that is complex in itself. Besides the
statutory framework that is designed to reward risk while dispersing and
mitigating its negative consequences can well be subverted to mobilize
funds through false pretences and to channel or siphon away the benefits
for personal gain of a few, away from those who genuinely deserve them. All
this is done with movement of funds at high speed through scores of
entities, elaborate organizational and financial structures, behind the
corporate veil that clouds liability and behind a veneer of apparent
compliance. Very often the sharpest and the best minds devise the detailed
elaborate and complex structures behind which corporate frauds take place.
These cannot be unravelled except by expert teams having multidisciplinary
expertise. Therefore corporate fraud is a phenomenon that is distinct in
itself and needs to be treated separately in law.
9
[Boyle & Birds' Company Law, 3r" ed., page 456].
21
 (5) Examples of Corporate Fraud in India

Stayam Scam

The biggest corporate scam in India has come from one of the respected
business family .Satyam -Fourth largest Indian IT Company listed in India &
US. .Over US $ 2 billion annual revenue size co. Established in mid 1980s,
grown to 53,000 employees. 600 plus customers including 185 fortune 500
Cos. Operations in 66 countries across the globe. Financial advisor: Merrill
Lynch (now Bank of America). Auditors was Price Water House Coopers.
Bankers were Citi bank; BNP Paribas, HSBC & HDFC. On January 7, 2009,
Chairman Raju resigned after publicly announcing his involvement in an
accounting fraud. Causes behind Satyam scam were :-Fudging of Accounts,
Over stated Assets of Rs. 490 crore, Fake cash balances over Rs. 5,000
crore in the Balance Sheet, Interest component of Rs. 376 crore which
never flowed into the company’s coffers, Understated Liabilities of Rs. 1,230
crore. Aftermath effect were Investors-Panicked as Stock plummeted,
Employees -stranded in many ways-morally, financially, legally and socially,
the incident resulted in immeasurable and unjustifiable damage to Brand
India and Brand IT in particular, Chairman, MD and CEO, CFO, Key
associates arrested, partners of Audit Firm were also arrested, people lost a
staggering Rs 100 billion in Satyam in market capitalisation as investors
reacted sharply and dumped shares, pushing down the scrip by 78 per cent
to Rs. 39.95 on BSE.

Harshat Mehta Scam

Harshad Shantilal Mehta was born in a Gujarati Jain family of modest

means. His early childhood was spent in Mumbai where his father was a
small-time businessman. Harshad Mehta slowly and gradually arose to
become a stock broker in the Bombay Stock Exchange. He was making
waves in the stock market. He had been buying shares heavily since the
beginning of 1990. The shares which attracted attention were those of
22
Associated Cement Company (ACC). The price of ACC was bid up to Rs
10,000. For those who asked, Mehta had the replacement cost theory as an
explanation. The theory basically argues that old companies should be
valued on the basis of the amount of money which would be required to
create another such company. Through the second half of 1991, Mehta was
the darling of the business media and earned the sobriquet of the ‘Big Bull’,
who was said to have started the bull run. He promised the ultimate rags to
riches story10. On April 23, 1992, journalist Suchita Dalal in a columnin The
Times of India, exposed the dubious ways of Harshad Metha. The broker
was dipping illegally into the banking system to finance his buying. “In
1992, when I broke the story about the Rs 600 crore that he had swiped
from the State of Bank, it was his visits to the bank’s headquarters in a
flashy Toyota Lexus that was the tip-off. Those days, the Lexus had just been
launched in the international market and importing it cost a neat package,”
Dalal wrote in one of her columns later. The authors explain: “The crucial
mechanism through which the scam was effected was the ready forward
(RF) deal. The RF is in essence a secured short-term (typically 15-day) loan
from one bank to another. Crudely put, the bank lends against government
securities just as a pawnbroker lends against jewellery…. The borrowing
bank actually sells the securities to the lending bank and buys them back at
the end of the period of the loan, typically at a slightly higher price.” It was
this ready forward deal that Harshad Mehta and his cronies used with great
success to channel money from the banking system. A typical ready forward
deal involved two banks brought together by a broker in lieu of a
commission. The broker handles neither the cash nor the securities, though
that wasn’t the case in the lead-up to the scam. In this settlement process,
deliveries of securities and payments were made through the broker. That
is, the seller handed over the securities to the broker, who passed them to
the buyer, while the buyer gave the cheque to the broker, who then made

10
Sucheta Dalal, ‘Harshad Mehta: From Pied Piper of the markets to India's best-known scamster’ December 31,
2001 http://www.rediff.com/money/2001/dec/31dalal.htm
23
the payment to the seller. In this settlement process, the buyer and the
seller might not even know whom they had traded with, either being know
only to the broker. This the brokers could manage primarily because by now
they had become market makers and had started trading on their account.
To keep up a semblance of legality, they pretended to be undertaking the
transactions on behalf of a bank. Another instrument used in a big way was
the bank receipt (BR). In a ready forward deal, securities were not moved
back and forth in actuality. Instead, the borrower, i.e. the seller of
securities, gave the buyer of the securities a BR. As the authors write, a BR
“confirms the sale of securities. It acts as a receipt for the money received
by the selling bank. It promises to deliver the securities to the buyer. It also
states that in the mean time, the seller holds the securities in trust of the
buyer.” Having figured this out, Mehtha needed banks, which could issue
fake BRs, or BRs not backed by any government securities. “Two small and
little known banks - the Bank of Karad (BOK) and the Metorpolitan Co-
operative Bank (MCB) - came in handy for this purpose. These banks were
willing to issue BRs as and when required, for a fee,” the authors point out.
Once these fake BRs were issued, they were passed on to other banks and
the banks in turn gave money to Mehta, obviously assuming that they were
lending against government securities when this was not really the case.
This money was used to drive up the prices of stocks in the stock market.
When time came to return the money, the shares were sold for a profit and
the BR was retired. The money due to the bank was returned. The game
went on as long as the stock prices kept going up, and no one had a clue
about Mehta’s modus operandi. When the bubble burst after fictitious
trading rings came to light, the banks found themselves cheated of $1.4
billion and were left holding BRs which did not have any value. Mehta made
a brief comeback as a stock market guru in 1997, giving tips on his own
website as well as a weekly newspaper column 11. This time around, he was

11
Sucheta Dalal, ‘Harshad Mehta: From Pied Piper of the markets to India's best-known scamster’ December 31,
2001 http://www.rediff.com/money/2001/dec/31dalal.htm
24
in cahoots with owners of a few companies and recommended only those
shares. This game, too, did not last long 12. Interestingly, by the time he
died13, Mehta had been convicted in only one of the many cases filed against
him. Till now, it is still unknown what was the real story behind the entire
scam.

(6) Existing provisions and regulations dealing with corporate

fraud

In order to address corporate fraud, it is important to look the provisions of

the Companies Act 1956 and the manner in which they address situations
involving fraud with relation to the affairs of a company. The Act deals with
actions by the directors, officers and managers of the companies rather
than by the companies as such. It also deals with investigation of fraud, the
manner of appointment of persons to investigate fraud and their powers,
prosecution for offences against the provisions of the Act and the associated
punishments.

Nature of Offences under the Companies Act, 1956

The Companies Act contains several provisions, which specify the

compliance requirements by companies and offences arising out of
contravention, violation or noncompliance. In this regard, it is necessary at
the outset to notice the objects of the Act. As observed by the Madras High
Court in the case of Indian Express 14

12
“Sebi Debars Harshad Mehta from securities dealing: BPL, Videocon, stelite restricted” April 19, 2001.
http://www.rediff.com/money/2001/apr/19sebil.htm.
13
“Big Bull' Harshad Mehta dead Tuesday”. 01 Jan 2002

<http://www.thehindubusinessline.com/bline/2002/01/01/stories/2002010102180100.htm>
14
[44 CC 106 Mad].
25
 "The whole scheme of the Companies Act is to ensure proper
conduct of the affairs of companies in public interest, and the preservation
of the image of the company in the eyes of the public, and in the interests of
the members of the company and also the creditors to ensure that the
affairs of the company are conducted in a proper manner and its
transactions are above suspicion. It is to ensure this that the various
provisions under the Companies Act have been devised and returns have
been prescribed for the purpose of enabling a close watch to be kept in
regard to the transactions of the company and in regard to the manner in
which its affairs are conducted." Statutory contraventions/offences or non-
compliance may or may not involve criminal intention. Non-compliance may
be inadvertent and unintentional in many cases. The Companies act
recognizes this and provides for consequences accordingly. Some
procedural non-compliance is dealt with by monetary penalties which may
be in the form of an escalating fee structure linked to the period of default.
Some acts or omissions may give rise to civil liability. In other cases
contravention or non-compliance may lead to criminal liability. This
distinction has been recognized by the courts. The Supreme Court
judgment in Guljag Industries vs Commercial Taxes Officer considered
15

this issue in the context of the Rajasthan Sales Tax Act. Section 78 (5) of
that Act provides for penalty in certain situations. The following extracts
from the judgment are relevant: "We are concerned with the goods in
movement being carried without supporting declaration forms. The object
behind enactment of Section 78(5), which gives no discretion to, the
competent authority in the matter of quantum of penalty fixed at 30 per
cent of the estimated value is to provide to the State a remedy for the loss
of evenue. The object behind enactment of Section 78(5) is to emphasize
loss of revenue and to provide a remedy for such loss. It is not the object of
the said Section to punish the offender for having committed an economic
offence and to deter him from committing such offences. The penalty
15
(2007)7SCC269.
26
imposed under the said Section 78(5) is a civil liability. Willful consignment
is not an essential ingredient for attracting the civil liability as in the case of
prosecution. Section 78(2) is a mandatory provision. If the declaration Form
18A/I8C does not support the goods in movement because it is left blank
then in that event Section 78(5) provides for imposition of monetary penalty
for non-compliance. Default or failure to comply with Section 78(2) is the
failure/default of statutory civil obligation and proceedings under Section
78(5) is neither criminal nor quasi-criminal in nature. The penalty is for
statutory offence. Therefore, there is no question of proving of intention or
of mens rea as the same is excluded from the category of essential element
for imposing penalty. Penalty under Section 78(5) is attracted as soon as
there is contravention of statutory obligations. Intention of parties
committing such violation is wholly irrelevant. For the afore stated reasons,
we hold that Section 78(5) of the RST Act 1994 (Section 22A(7) of the RST
Act 1954) is the section enacted to provide remedy for loss of revenue and
it is not enacted to punish the offender for committing economic offence
and, therefore, mens rea is not an essential ingredient for contravention of
Section 78(2) of the RST Act 1994." Having regard to this position, non-
compliance with the statutory requirements under the Companies Act
which provide for a penalty specific to the non-compliance or other civil
consequences would not, in itself, lead to criminal liability. There are also
offences defined under the Companies Act, which result in criminal liability
and imposition of punishment accordingly. These offences may result in
imposition of punishment or fine or fine or imprisonment or both or fine and
imprisonment. The quantum of punishment is defined in the provisions of
the Companies Act. However, in a corporate setting, acts of non-compliance
resulting in penalties or civil consequences only, if committed with
fraudulent intention they may result in a fraud, which is a criminal act,
which, while. not defined in the Companies Act is recognized in respect to
several situations arising out of corporate structure and functioning. There
are several provisions in the Companies Act, which use the expressions
27
`fraud' or `fraudulent'. It is necessary to appreciate that the provisions in
which these expressions are used have a distinct purpose, and they have to
be understood in the context of the underlying objects of those provisions
and objects and scheme of the Companies Act. Keeping in view the main
objectives of the Companies Act, these provisions are supplemental to those
objects. There is no specific offence of fraud defined under the Companies
Act as a punishable offence. Where the ingredients of an offence defining it
as an offence punishable under IPC are present, prosecution under the IPC
is also feasible. The provisions of the Companies Act do not bar prosecution
under IPC with application of Criminal Procedure Code. It can be seen that
nothing in the provisions of the Companies Act which would even by
implication bar a recourse to the laying of the information before the police
for the purpose of investigation and action under the Code of Criminal
Procedure when there are reasonable grounds for believing that cognizable
offences under the Indian Penal Code had been committed in relation to the
affairs of the company. It cannot be said that the Companies Act is
exhaustive even in the matter of investigation into cognizable offences
under the Indian Penal Code committed in relation to the affairs of a
company. In fact, the Act does not touch that aspect at all." 16 Thus, the
provisions of the Companies Act do not exclude invoking the provisions of
the Criminal Procedure Code by laying of information before the police or
filing a private complaint in regard to offences under the Indian Penal Code
where such offences are committed in relation to the affairs of a company.

At the same time, the provisions of the Companies Act are inter-linked.
Monitoring of those provisions and particularly, the non-compliance with the
provisions has to be viewed carefully, having regard to the corporate
settings. The experience shows that a seemingly minor or technical non-
compliance with a `insignificant' provision may be symptomatic of a

16
Indian Express 44 CC 106 Mad.
28
systemic infraction and may even turn out to be a foundation of a serious
`corporate fraud'.

The Existing provisions, which address fraudulent conduct with regard to

affairs of companies, are discussed as under.-

Specification of Offences, Prosecution and Penalties

The provisions of the Companies Act addressing fraudulent actions by

directors or officers of companies through its provisions comprising of
sections 203, 3885 to 388E ,Sections 397/398 read with sections 401,406
(read with provisions of section 539 to section 542 of schedule XI of the
Act), 408 and Sections 539 to 542. Section 203 company . However, this
applies where a person is convicted of any offence in provides powers to
restraint fraudulent persons from managing connection with the
promotion, formation and management of a company or during the course
of a winding up of a company, it appears that the guilty of an offence for
which he is punishable under section 542, or is otherwise guilty of any
fraud or misfeasance in relation to the company etc. Sections 388B to 388E
provide power to the Central Government to remove any managerial
personnel from the office on the recommendation of CLB and also debar
him from holding any position in any company on finding him guilty of
fraud, misfeasance, persistent negligence or default in carrying out his
obligations and functions under the law, or breach of trust. However, for
such violations, there is no provision for his punishment with imprisonment
and monetary fine as such violations are not dealt in these provisions as
criminal offences. The provisions of Sections 397 /398 read with section
401 enable any member of the company or Central Government itself to file
complaint with the Company Law Board (CLB) against such affairs of a
company which are conducted in a manner prejudicial to public interest or
in a manner oppressive to any member or members of the company. These
provisions empower CLB to pass such orders, which may ensure the

29
running of the affairs of a company in proper manner. Central Government
is also empowered in such circumstances to appoint directors as per the
order of CLB to run the affairs of the company in proper manner. These
provisions, however, do not specifically define any criminal offence of the
nature of financial fraud and do not provide for punishment to the directors
or managers found guilty of running the affairs of the company in fraudulent
manner.

Sections 539 to 542 of the Act also deal with the punishment for fraudulent
conduct of business but these provisions are applicable only during winding
up proceedings of a company. Punishments are provided in Section 539 to
542 of Schedule XI, of imprisonment up to two years for defrauding
creditors or any other person and up to seven years for falsification or
destruction of documents. However, prosecution for such punishment can
be filed in the Court, only after it is established during proceeding before
CLB, that business of the company was carried on with intent to defraud
creditors of the company or any other person or for any fraudulent purpose.
Such proceedings before CLB are a long drawn process and could result in
considerable delay in filing of criminal prosecution in Courts. Besides, the
punishment of imprisonment for two or seven years provided presently may
also be inadequate, considering the extent, gravity and impact of financial
frauds taking place today.

Apart from the provisions of sections 397/398 and 539 to 542, there are
certain other sections in the Companies Act at present, such as Section
58A, 63, 68, 628 etc that provide for punishment of certain actions by a
company. Section 58A deals with the provisions relating to collection of
fixed deposits by the company from public and provides for punishment, if
fixed deposits are collected in wrongful manner. Section 63 provides for
punishment for including any untrue statement in a prospectus issued by a
company. Section 68 provides for punishment for fraudulently inducing
persons to invest money in a company. Section 628 deals with the provisions
30
for providing punishment for falsification of reports and records of the
company.

Section 58A provides punishment only for collection of deposit in

wrongful manner. In case the company does not return deposits collected by
them to the public, there is no provision for punishing the company and its
officers as in the case of criminal offence. In such circumstances, CLB may
pass orders for repayment of the deposit amount by the company. Officers of
the company are also punishable by three years imprisonment in case of
non-compliance of order of CLB. However the proceedings before CLB are
long and cumbersome. Many defaulting companies keep on prolonging the
proceedings before CLB or thereafter in the courts, and in some cases even
become untraceable. Section 63 provides for punishment for any
misstatement in prospectus for up to two years. There is no provision in the
Companies Act for punishment of officers of the company, if they raise
money from public or private institutions or banks in wrongful and deceitful
manner and thereafter use this fund for their personal gain, causing
financial loss to the entities concerned. Section 68 deals with situations
resulting from collection of funds by fraudulently inducing general public to
invest in shares of a company and provides for punishment of up to five
years imprisonment

From the foregoing, it is seen that while the possibility of fraud in

companies is recognized in the Companies Act and several provisions have
been included to situations resulting from fraud, the Companies Act
provisions could however result in protracted litigation since the definition
of offences is diffuse and several extenuating circumstances are provided
which could make it difficult to fully establish criminal intent Besides civil
consequences of fraud are not adequately addressed. Therefore these
provisions need to be more focused to provide a clear framework for action,
providing for both civil and criminal remedies, in cases of fraud.

31
Investigation of corporate fraud

At present, the company, which is suspected to be indulging in fraud, is

being ordered for investigation by an officer of SFIO either u/s 235 or 237 of
the Companies Act.

As envisaged in the above two provisions, investigation into the affairs

of the company can be ordered only after fulfilling of either of the following
statutory requirements:-

(i) Receipt of report from Registrar of Companies (ROC) u/s 234(6)

(ii) Passing of an order by Company Law Board (CLB) or Court

At present, officers of SFIO exercise powers as given in the provisions of

239, 240 and 240A. Section 239 provides for power of Inspectors appointed
u/s 235/237 to carry out investigation into affairs of related companies,
either subsidiaries or companies under common management. Section 240
provides power to enforce production of document and evidence either in
writing or orally and Section 240A provides for power of search and seizure
of documents by Inspectors.

From the last two decades India too has seen several corporate fraud
experiences involving thousands of Crores of public money. These frauds hit
the Indian industry as well as country’s financial system so severely that it
has no other go except to bring changes in the policies of regulatory
authorities like RBI, SEBI etc. To bring the drastic changes in the corporate
sector and to formulate the corporate governance policy, the Indian
government initiated three high-level committees. The Naresh Chandra
Committee was appointed by the Union government to look into the role of
audit committees focusing primarily on independent directors. The Kumara
Mangalam Birla Committee and Narayana Murthy Committee were
appointed by SEBI to look into the various aspects of corporate governance.
These committees concluded: Appointment of independent Directors in the
32
Audit committees of the listed companies. Certification of CEOs, COOs on
the Annual Audit Accounts.Setting up an independent quality review board
to periodically examine and review the quality of audit, secretarial and cost
accounting firms, and pass judgment and comments on the quality and
sufficiency of systems, infrastructure and practices. Setting up of a
corporate serious fraud office (CSFO) in the Department of Company
Affairs. Strengthening of ROC offices to ensure better compliance.
Outsourcing of non-statutory work, and tightening the law regarding lapses
in sectorial compliance, by inserting a section analogous to section 233A to
allow the government to special compliance audits. Inclusion of clause 49
in the listing Agreement between the companies and SEBI by giving
emphasis on the disclose practices and inclusion of independent directors
on the board of a listed company, who would be responsible for upholding
the corporate ethical culture.

Clause 49 (Listing Agreement) – SEBI Guidelines

The recommendations of the Narayan Murthy Committee have been

accepted by SEBI and included in clause 49 of Listing Agreement of every
Indian stock exchange. Clause 49 is all about the provisions of listing
agreement between companies and SEBI. It not only frames the code
conduct to be followed by the companies, but also deal with many other
aspects like board of directors, non executive directors, audit committees
and related aspects. The listed Companies are now bringing about a slew
reforms to clause 49 in the areas such as committee composition, board
practices and compensation policies – the core of corporate governance.
The formulation of Audit Committee is mandated to oversee the financial
reporting process which is the prime source of corporate frauds. The
following are the provisions in relation to fraud prevention.

Audit Committee

33
 Composition of Audit Committee: A qualified and independent audit
committee shall be formed with a minimum three directors as members, out
of which two-thirds of members must be independent directors. All the
members must be financial literates. An independent director must be the
chairman of audit committee, who will answer the queries of shareholders.
A Company Secretary will act as secretary to the committee.

Powers of Audit Committee: the audit Committee shall powers,

which should include the following:

To investigate any activity within its terms of reference, to seek

information from any employee, to obtain outside legal or other professional
advice, to secure attendance of outsiders with relevant expertise, if it
considers necessary.

Role of Audit Committee: The role of the audit Committee shall include the
following: Oversight of the company’s financial reporting process and
disclosure of its financial information to ensure that the financial statement
is correct, sufficient and credible, recommending to the Board, the
appointment, re-appointment and, if required, the replacement or removal
of the statutory auditor and the fixation of audit fees, approval of payment
to statutory auditors for any other services rendered by the statutory
auditors, reviewing, with the management, the annual financial statements
before submission to the board for approval, with particular reference to:

a) Matters required being included in the Director’s Responsibility

statement to be included in the board’s report in terms of clause 2AA of S
217 of the Companies Act, 1956.

b) Changes in accounting policies and practices for the same

c) Major accounting entries involving estimates based on the exercise of

judgment by management.

34
d) Significant adjustments made in the financial statements arising out of
audit findings.

e) Compliance with listing and other legal requirements relating to financial

statements.

f) Disclosure of any related party transactions.

g) Qualifications in the draft audit report.

Reviewing, with the management, the quarterly financial statements before

submission to the board for approval. Reviewing, with the management,
performance of statutory and internal auditors, adequacy of the internal
control systems. Reviewing the adequacy of internal audit function, if any,
including the structure of the internal audit department, staffing and
seniority of the official heading the department, reporting structure
coverage and frequency of internal audit. Discussion with internal auditors
and significant findings and follow up there on. Reviewing the findings of
any internal investigations by internal auditors into the matters where there
is suspected fraud or irregularity or a failure of internal control systems of a
material nature and reporting the matter to the board. Discussion with the
statutory auditors before the audit commences, about the nature and scope
of audit as well as post-audit discussion to ascertain any area of concern To
look into the reasons for substantial defaults in the payment to the
depositors, debenture holders, shareholders and creditors. To review the
functioning of the Whistle Blower mechanism, in case the same is exists.
Carrying out any other function as is mentioned in the terms of reference of
the Audit Committee.

Report on Corporate Governance

There shall be a separate section on corporate governance in the Annual

Reports of company, with a detailed compliance report on corporate
governance. Non-compliance of any mandatory requirments of this clause
35
with reasons thereof and the extent to which the non mandatory requirment
of this clause with reasons thereof and the extent to which the non
mandatory requriments have been adopted should be specifically
highlighted. The information to be place before Board of Directors are:

Annual operating plans and budets and any updates. Quaterly results for
the company and its operating divisions or business segments. Minutes of
meetings of audit Committee and other Committees of the Board The
information on recruitment and remuneration of senior officers just below
the board level, including appointment or removal of chief financial officer
and the company secretary. Show cause, demand, prosecution notices and
penalty notces which are materially important. Fatal or serious accidents,
dangerous occurences, any material effluent or pollution problems. Any
material default in financial obligations to and by the company, or
substantial nonpayment for goods sold by the company. Any issue, which
involves possible public or product liablity claims of substantial nature,
including any judgment or order which, may have passed strictures on the
conduct of the company or taken an adverse view regarding another
enterprise that can have negative implications on the company. Details of
any joint venture or collaboration agreement. Transactions that involve
substantial payment towards goodwill, brand equity, or intellectual property.
Significant labor problems and their proposed solutions.Any significant
development in human Resources / industrial Relations front like signing of
wage agreement, implementation of Voluntary Retirement Scheme etc. Sale
of material nature, of investments, subsidiaries, assets, which which is not
in normal course of business. Quaterly details of foreign exchange
exposures and the steps taken by management to limit the risks of adverse
exchange rate movement, if material. Non-compliance of any regulatory,
statutory or listing requirements and shareholders service such as non-
payment of dividend, delay in share transer etc

(7) Recent Changes that is made to combat corporate fraud

36
Following are the changes made by the New Companies Bill 2011-:

Provision relating to vigil mechanism

corporate fraud is rarely the result of actions of only one person acting
alone. It is most likely to be the result of a group of persons who may have
the knowledge of fraud being committed but may not wish to get involved,
or may even be intimidated in remaining silent. Yet such person can shed
light on whether and in what manner fraud is taking place in a company. It
is important to incentivize such persons to cooperate and collaborate with
the investigators. Therefore, Provisions in respect of vigil mechanism
(whistle blowing) proposed in the new Companies bill 2011 to enable a
company to evolve a process to encourage ethical corporate behaviour,
while rewarding employees for their integrity and for providing valuable
information to the management on deviant practices.

Provisions relating to the auditors

These changes come in the background of the Irani Committee report, and
more importantly the

Ramalinga Raju saga where the statutory auditors of a large public

company like Satyam Computer

Services Limited were found to have abetted the fudging of the company's
accounts. The proposed

changes are not coming a day too soon as accounting malpractices in

corporate sector in India are

known to abound. Under the Company Law, the statutory auditor is

primarily responsible to the

shareholders of the company in ensuring that their money invested in the

company is being used by

the directors prudently and lawfully. To this end Section 143 of the new bill
requires the auditor to

37
report to the members of the company that the financial statements and
accounts of the company to

be laid in the annual general meeting give a true and fair view of the state
of affairs of the company,

taking into account the accounting and auditing standards etc. The bill
proposes to create National

Financial Reporting Authority which will lay down auditing standards. The
audit has to be carried

out in accordance with these standards. In the audit report the auditor has
to specifically report on

following points -

Whether the auditor has sought and obtained all information and
explanations necessary for the

purpose of audit. If not, the details thereof and the effect of such
information on the financial

statements;

Whether in the opinion of the auditor, proper books of account have been
kept by the company

including its branches;

Whether the company's balance sheet and profit and loss account are in
agreement with the books

of account and returns;

Whether in the opinion of the auditor the financial statements comply with
the accounting

standards;

Any observations on financial transactions or matters which have any

adverse effect on the

functioning of the company;

38
Any qualification, reservation or adverse remark relating to the
maintenance of accounts and other

matters connected therewith;

Whether the company has implemented adequate internal financial controls

and whether these are

effective.

In case the answer to any of the above matters is in the negative or is

qualified, the auditor will have

to give full reasons for the same.

In cases where a company has branch office(s) whether in India or outside,

the accounts of such

office(s) are required to be audited either by the same auditor or by any

other person qualified as an

auditor. The branch auditor has to submit report on the accounts of the
branch to the auditor of the

company.

Responsibility on auditors to report fraud

An important new provision is proposed in Clause (12) of Section 143 of the

bill. This says that "if

an auditor of a company, in the course of the performance of his duties as

auditor, has reason to

believe that an offence involving fraud is being or has been committed

against the company by

officers or employees of the company, he shall immediately report the

matter to the Central

Government within such time and in such manner as may be prescribed."

This places an onerous

39
personal responsibility on the auditor. The term 'fraud' has not been defined
under this bill. It would

take its definition from the Indian Penal Code. To my mind this will include
tax fraud (as distinct

from mere tax planning or tax avoidance). This provision is being extended
to Company Secretaries

and to Cost Accountants also in respect of companies where cost audit is

mandated by the company

law. Further, its violation is to be visited by a monetary penalty as Section

143(15) of the bill

provides that "If any auditor, cost accountant or company secretary in

practice do not comply with

the provisions of sub-section (12), he shall be punishable with fine which

shall not be less than one

lakh rupees but which may extend to twenty-five lakh rupees."

Empowering auditors

In order to enable the auditors to effectively discharge these duties Clause

(1) of Section 143 of the

bill confers on the auditors a right of access to the books of account and
vouchers of the company,

whether kept at the registered office or at any other place. The auditor shall
also be entitled to

require from the officers of the company such information and explanation
as he may consider

necessary for the performance of his duties including –

Whether loans and advances made by the company on the basis of security
have been properly

secured and whether the terms on which they have been made are
prejudicial to the interests of the
40
company or its members;

Whether transactions of the company which are represented merely by book

entries are prejudicial

to the interests of the company;

Where the company not being an investment company or a banking

company, whether so much of

the assets of the company as consist of shares, debentures and other

securities have been sold at a

price less than that at which they were purchased by the company;

Whether loans and advances made by the company have been shown as
deposits;

Whether personal expenses have been charged to revenue account;

Where it is stated in the books and documents of the company that any
shares have been allotted for

cash, whether cash has actually been received in respect of such allotment,
and if no cash has

actually been so received, whether the position as stated in the account

books and the balance sheet

is correct, regular and not misleading.

These appear to be salutary principles designed to break the cozy

relationship between auditors and

the companies whose accounts they audit.

Criminal liability on companies and auditors

The bill provides that if any of these provisions is contravened, the

company shall be punishable

with fine ranging from twenty-five thousand rupees to five lakh rupees; and
every officer of the

41
company who is in default shall be punishable with imprisonment for a term
which may extend to

one year or with fine ranging from ten thousand rupees to one lakh rupees,
or with both. The bill

next provides that if the auditor contravenes any of the above provisions he
shall be punishable with

fine ranging from twenty-five thousand rupees to five lakh rupees. And, if
the auditor does so with

intention to deceive the company or its shareholders or creditors or any

other person interested in

the company, he shall be punishable with imprisonment for a term which

may extend to one year

and with fine ranging from one lakh rupees to twenty-five lakh rupees. In
case the audit is

conducted by a firm of auditors, and it is proved that the partner or

partners of the audit firm have

acted in a fraudulent manner or abetted in any fraud by the company or its

directors such partner or

partners of the audit firm as also the firm shall be jointly and severally
liable for these

contraventions.

These provisions in the new Companies Bill reflect a substantive move

towards professionalisation

of the affairs of companies, and should go a long way in improving the

corporate governance in the

country. If that happens the 'aam' shareholder should stand to benefit.

You can't appoint your employee as auditor.

In order to ensure independence of the statutory auditors, Section 141 of

the bill says a company
42
cannot appoint an officer or employee of the company as auditor. Apart from
this, the Section lays

down a long list of persons who cannot be appointed as auditors, namely:

A person who is a partner, or who is in the employment of an officer or

employee of the company;

A person who, or his relative or partner -

Is holding any interest in the company or its subsidiary, or of its holding or

associate company or a

subsidiary of such holding company:

Is indebted to the company, or its subsidiary, or its holding or associate

company or a subsidiary of

such holding company;

Has given a guarantee on behalf of any third person to the company, or its
subsidiary, or its holding

or associate company or a subsidiary of such holding company;

A person or a firm who, whether directly or indirectly, has business

relationship with the company,

or its subsidiary, or its holding or associate company or subsidiary of such

holding company or

associate company of such nature as may be prescribed;

A person whose relative is a director or is in the employment of the

company as a director or key

managerial personnel;

A person who has been convicted by a court of an offence involving fraud

and a period of ten years

has not elapsed from the date of such conviction;

Any person whose subsidiary or associate company or any other form of

entity, is engaged as on the
43
date of appointment in consulting and specialised services.

Further, a person appointed as statutory auditor cannot provide the

company or its holding

company or subsidiary company or associate company, services relating to

accounting and book

keeping; internal audit; design and implementation of any financial

information system; actuarial

services; investment advisory services; investment banking services;

outsourced financial services;

management services etc whether directly or indirectly. The idea is to

ensure that the statutory

auditor remains independent and functions in a professional manner at an

arm's length from the

company17.

More power to government18

The new Companies Bill proposes more powers to the government in

launching a probe, stiffer

punishments and a dual-track judicial set-up.

The Bill proposes to grant powers to the government to directly order an

investigation in ‘public

interest’ against any firm. At present the government should have a court
order or a Company Law

17
http://www.moneymantra.co.in/detailsPage.php?id=3317&title=Columnist&wrt=SS%20khan.

18
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44
Board order, or a Registrar of Companies’ report or plea from the
company’s members to launch a

probe. There are other provisions in the Bill that strengthens the
Government’s powers. To speed

up the probe, it is proposed that inspectors need not get a Magistrate’s

order to search and seize a

company’s documents and books. The Companies Act, 1956 stipulates a

Magistrate’s order in this

regard. Those found not cooperating with the inspectors would be

sentenced to a six month jail-

term and monetary penalty. Falsification or mutilation of documents or

evidence is also made a

non-compoundable offence. The other offences newly made non-

compoundable are mis-statements

in prospectus and fraudulently inducing people to invest in a company. The

Bill has special

provision on freezing assets of a company under probe through the

proposed National Company

Law Tribunal’s (NCLT) order.

Two track judicial set up

The Bill has proposed a two track judicial set-up — Special Courts for
criminal offences regarding

the Companies Act, and NCLT for matters regarding mergers and
acquisitions, capital reduction,

restructuring as well as removal of directors and managing directors of a

company.19

19
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45
Statutory recognition to Special fraud investigating officers

In Companie act 1956 there is no separate provision under which Criminal

prosecution against a company indulging in fraud could be launched
directly in a criminal court. Therefore, SFIO is filing complaints under
Section 190 of Cr.P.C., if any fraud is detected by it during investigation.
Section 242 of the Companies Act talks about criminal liability of a person
found guilty during investigation of the affairs of a company but these
provisions are not very [ear as to whether they can empower SFIO to file
criminal prosecution under the provisions of IPC in a court for the offence of
fraud investigated by it. Statutory status to SFIO proposed. Investigation
report of SFIO filed with the Court for framing of charges shall be treated
as a report filed by a Police Officer. SFIO shall have power to arrest in
respect of certain offences of the Bill which attract the punishment for
fraud. Those offences shall be cognizable and the person accused of any
such offence shall be released on bail subject to certain conditions provided
in the relevant clause of the Bill In new companies bill 2011, This is a new
clause and seeks to provide that the Central Government shall constitute
Serious Fraud Investigation Office (SFIO). The SFIO will be headed by a
director and will consist of experts from various disciplines. The Central
Government shall also appoint a Director in the SFIO not below the rank of
Joint Secretary and may also appoint such experts and other officers as it
considers necessary for efficient discharge of functions.

46
 (8) Conclusion

A corporation is a congregation of various stakeholders, namely, customers,

employees, investors, vendor partners, government and society. A
corporation should be fair and transparent to its stakeholders in all its
transactions. This has become imperative in today’s globalized business
world where corporations need to access global pools of capital, need to
attract and retain the best human capital from various parts of the world,
need to partner with vendors on mega collaborations and need to live in
47
harmony with the community. Unless a corporation embraces and
demonstrates ethical conduct, it will not be able to succeed. As there is a
saying ‘As the Ruler, so the rule’ , it does not take much time for the
wrongdoing to spread down the hiearchy. People who come to know of the
wrongdoings of management or those who have themselevs assisted the
management in commmitting the fraud also tend to resort to fraud,
eventually. But, there are proved instances that during the course of time,
some of the persons assisted will become whistleblowers and disclose the
scam to the public. As a result some people become victims of corporate
fraud. These victims can be persons either outside or inside the company.
Insiders who are possible victims include directors, managers, and
employees who may suffer a loss of position, reputation or standing. Outside
victims include investors, creditors, partners, customers, suppliers,
underwriters, attorneys and independent auditors. Corporate governance is
about ethical conduct in business. Ethics is concerned with the code of
values and principles that enables a person to choose between right and
wrong, and therefore, select from alternative courses of action. Good
corporate governance is good business because it inspires investor
confidence, which is so essential to attracting capital. All the confidence
however, that the good companies build, and the good work that they do
over time can be largely undone by a a few unscrupulous businessmen, and
fly-by-night operators. Such exceptions require to be handed out deterrent
punishments. Though many Acts have been created for the security of the
people’s money, there could be no positive outcome from the owner’s side.
Their main goal is to earn as much as possible money from the public
through inviting them to invest, and building their personal empires. It is
the easiest way to earn mass money at a single attempt. Sometimes it seems
that the efforts to build the business empires are just to attract the common
public to invest in their companies and make themselves at the enjoying
posititon. In India, there is a common phenomenon in every citizen that
their own money means hard-earned money and public or others money is
48
the easily-earned money. So, there shall be strict rules and punishments
applied on the directors who gamble with the public money. Any relaxation
towards the guilty will encourage the fraudsters to continue their
fraudulent activities, affecting adversely not just the process of price
formation on stock exchanges, but also the very basis of the functioning of
the corporate world. Though complete prevention is impossible, prevention
of frauds would be a desirable outcome for corporate governance programs.
Implementing better corporate governance measures by the corporates
themseleves and application of laws strictly by the regulatory bodies by
awarding stronger punishment to the fraud makers can prevent these fraud
practices. A better awareness is required among the public while investing
in the corporates. Also, a corporate accountability should be developed in
the corporates since the money invested by the public is to be gainfully
utilized and serve the interests of public at large. Thus what is required is
the good governement based on effective representative democracy with a
strong oppostition drawing its substence from working people, which is
wellinformed and does not confine itself only to rhetorics. This will reduce
the instance so of corporate frauds to a substantial extent. Thus white collar
crimes can be avoided by the promotion of good corporate governance ,
with reasonable transparent processes within the corporation, to detect
improper activities of its executives.

49
 BIBLIOGRAPHY

Acts

1 The Companies act, 1956.

2. The Companies Bill, 2011.

3. The Indian Penal Code, 1860.

Books:

1. Avtar Singh, Company Law, (Eastern Book Company, Lucknow, 15th

edn.)

2. Mishra Girish, Pandey Braj Kumar (1998). White-collar Crimes, New

Delhi: Gyan

Publishing House.

3. Paranjape N V (2007). Criminology and Penology, Allahabad: Central Law

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4. Qadari Afzal S M (2005). Criminology: Problems & Perspectives,

Lucknow: Eastern

Book Company

5. Ramaiya, Guide to the Companies Act, (Wadhwa & Co., Nagpur, Part 1,
16th edn., 2004) p.

6. Sri Valli Naga K (2007). White Collar Crimes-A debate, Hyderabad: The
ICFAI

University Press.

Reports:

50
1. Government of India (1964). Report of the Commission on Prevention of Corruption,

2. Government of India (1960). Annual Report on the Working of Indian Companies Act,
1956

3. Government of India (1983). Report of the SEBI Committee on Corporate Governance.

4. 29th Report of the Law Commission of India

5. Government of India (1963). Report of the Vivian Bose Commission of inquiry

6. Government of India (2009). Report of Vepa Kamesam on Serious Fraud Investigation Office.

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