ONE-DAY INTERNATIONAL CONFERENCE

FOR
ACCOUNTING RESEARCHERS AND EDUCATORS

(20th December, 2019)

(ICARE–2019)

Organized by

Department of Accountancy
Faculty of Commerce and Management Science
UNIVERSITY OF KELANIYA (UoK)

Title of the Paper

Forensic Audit and its Procedure:

Role of Company Secretaries in Indian Legal Regime
By
*Prof. A. SURYANARAYANA
**Dr. NAGUNURI SRINIVAS

*Former Dean, Faculty of Management

Osmania University
HYDERABAD-500 007 (Telangana State)
Email: [email protected]
Mobile: 0-9848563756

**Associate Professor & Placement Officer

Department of Business Management
St. Joseph’s Degree & P.G. College
Email: [email protected]
Mobile: 0-9949550576

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 FORENSIC AUDIT AND ITS PROCEDURE:
ROLE OF COMPANY SECRETARIES IN INDIAN LEGAL REGIME

ABSTRACT

India is powering its way towards attainment of economic growth, progress, and all-round
development and is being globally recognized as one of the fastest growing economies of the
contemporary world. Undoubtedly, emerging face of India captures the spirited government’s
reform and initiatives under the realm of Good Governance. However, corporate governance
revolves around five ‘E’s viz., ‘Effective, Efficient, Easy, Empower, and Equity’. In this
direction, as true professionals, Company Secretaries are adopting a highly collaborative
approach and addressing daunting challenges like fraud, deceit, financial misplacement, etc., that
are hindering the inclusive growth of India. In this background, Forensic Audit is considered as
the need of the hour for making the corporate culture of India robust, rich, and resilient. This
concept Paper aims to give glimpses into the practical and applied aspects and procedure of
Forensic Audit and gist of some of the relevant leading Indian Case Laws related to it.
[150 Words]

Key Words: Forensic Audit; Company Secretaries; Good Governance; Fraud; Red Flag
Indicators; and Forensic Audit Investigation.

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 FORENSIC AUDIT AND ITS PROCEDURE:
ROLE OF COMPANY SECRETARIES IN INDIAN LEGAL REGIME

INTRODUCTION
Good Governance in India calls for an accountable, transparent, and developed image of a
globally recognized welfare state in the current era.
Detecting, preventing, and regulating the menace of fraud in the larger interest of the nation has
become a priority and an imperative need for all the growing economies including India. As one
of the gnawing aches, fraud of any kind and magnitude not only cripples companies where it
takes place but has the potential to rattle the entire economy with highly adverse concomitant
consequences—either temporary or permanent. Timely detection, prevention, and regulation of
corporate fraud and reference to due investigation are very critical for Company Secretaries. In
this daunting task, Forensic Audit assumes an imperative role in assisting companies for
maintaining efficiency and merit. On the larger parameters, Forensic Audit acts as a tool-mix of
accounting and investigation to serve all the five E’s of good governance. It helps in making
companies to grow and develop on the five parameters: Effectiveness, Efficiency, Ease,
Empowerment, and Equity.

It is here that Company Secretaries are expected to play varied roles in the field of Forensic
Audit. Further, the present day progressive changes in the Forensic Audit are expanding the
gateway of opportunities for the professionals to guide, advice, operationalize, and appear in the
matters related to Forensic Audit. The domain of forensic audit is vast and requires an integrated
approach to provide a wide perspective and in-depth knowledge to get solid grounding in the
legislative framework, practice, and procedure thereof and to develop specialized skills in the
corpus and complexities of the different aspects of the subject besides meeting the requirement
of a future career in the area. Forensic Audit requires a 360-degree rounded set of learning and
professionals in the domain need to get themselves apprised with the advanced changes in the
arena and their directed implementation.

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If we keenly observe, successful businessmen Sahara Group Chairman Subrata Roy and Vijay
Mallya had a lot in common. Both had a passion for sports and also had their own IPL teams,
Sahara Pune Warriors and Royal Challengers Bangalore respectively albeit the fact that after
resigning as the Chief of UB Group, Mallya is technically not the owner of RCB. In fact, the duo
jointly owns the Sahara Force India Formula-1 Team. Sahara Group was accused of failing to
refund over Rs. 20,000 Cr, which it collected through two unlisted companies of Sahara, to its
more than 30 million small investors. In 2011, SEBI ordered Sahara to refund this amount with
interest to the investors as the public issue was not in compliance with the requirements
applicable to the public offerings of securities. Roy was arrested on 28th February 2014 and
remained behind bars as an under-trial. His proposal for a settlement of the matter was rejected
by both the Court and SEBI.
IDENTIFICATION OF GOVERNANCE PROBLEMS USING SELECT CASE STUDIES
 Satyam Computers Case
B. Ramalinga Raju, the founder of Satyam Computers, got into trouble after he admitted to
inflating the company revenue, profit, and profit margins for every single quarter over a period
of five years—from 2003 to 2008. The amount misappropriated in this case is estimated to be
around Rs. 7, 200 Cr. In April 2015, Ramalinga Raju and his brothers were fined Rs. 5.5 Cr and
sentenced to seven years in jail.
Following are the common governance problems, which have been noticed in the collapse of
Satyam:

 Unethical conduct—Founders wanted to make money by avoiding paying taxes, cooking

books, and pay offs; founder revealed some alarming truths that he was concealing for a
long period by confessing to a fraud of Rs 7,800 Cr ($1.47 billion) on Satyam’s Balance
Sheet.
 A Case of false books and bogus accounting—Huge amounts of accrued interest were
shown in balance sheets in order to suppress the detection of non-existent fixed deposits
on account of inflated profits. The investigations also detailed that the company had
deliberately paid taxes of about 186.91 Cr on account of the non-existent accrued
interests of Rs 376 Cr, which was a considerable loss for the company.
 Unconvincing role of Independent Directors—The Satyam episode has brought to the
fore the failure of the present corporate governance structure that hinges on the
independent directors, who are supposed to bring objectivity to the oversight function of
the board and improve its effectiveness. They serve as watchdogs over management,
which involves keeping their eyes and ears open at Board deliberations with a critical eye
raising queries when decisions taken scent wrong.
 Questionable role of Audit Committee—The true role of Audit Committee in précis is to
ensure transparency in the company that financial disclosures and financial statements
provide a correct, sufficient, and creditable picture and that, cases of frauds, irregularities,
and failure of internal control system within the organization, were minimized. However,
the committee failed miserably to carry them out
 Dubious Role of Rating Agencies—Credit rating agencies have been consistently
accused of their lax attitude in assessing issuers and giving misleading ratings. But

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 without any thorough analysis, they failed to warn market participants about the
deteriorating condition of the company.
 Questionable Role of Banks—While sanctioning short-term loans banks never raised any
question as to why a cah-rich company rich as per the financial statements was taking
loans from them.
 Fake Audit—PricewaterhouseCoopers (PwC)’s Audit Firm, Price Waterhouse, was the
auditor for Satyam and had been auditing their accounts since 2000-01. The fraudulent
role played by PwC in the failure of Satyam certainly matches the role played by Arthur
Anderson in the collapse of Enron. According to the SFIO findings, partners of PwC had
admitted that they did not come across any case or instance of fraud by the company.
However, founder’s admission of having fudged the accounts for several years put the
role of these statutory auditors on the dock.

 Saradha Chit Fund Case

Saradha Group which ran a Chit Fund in West Bengal had collected around ₹200 to 300 billion
from investors with a promise of high returns for their investments. The company that enjoyed
strong political backings collapsed in April 2013. The amount investors lost is estimated to be
between Rs. 2060 to 2400 Cr.
 Ketan Parekh Scam Case
Parekh was involved in circular trading and stock manipulation through 1999-2001 in a host of
companies. He borrowed from banks such as Global Trust Bank and Madhavpura Mercantile
Co-operative bank, and manipulated a host of stocks popularly known as K-10 stocks.
Among others, PNB and Satyam are clear audit failures. In Satyam case, direct confirmation
from bank was not sought despite the materiality of the same. In PNB, serial number-wise Swift
Messages should have traced to the transaction entry in the General Ledger even on a test check
basis and the scam would have come to light automatically much earlier.

Case Study—I: Collusive Bidding by Contractors

 Facts of the Case
A major infrastructure company had been awarded a road construction contract by the
Government under the Public Private Partnership (PPP) Model. For execution of the project, the
company had sub-divided the geographies as well as execution areas and invited bids for the sub-
contracting. The company had publicized a Whistle Blower Policy and received a complaint
from one of the bidders about possible collusion between certain bidders. The matter was sought
to be investigated by the management of the company.

The Red Flag Indicators in this case are as follows:

 Winning the bids too low when benchmarked against the company estimates, past
experience, and industry standards.

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  Six out of ten bids shortlisted had very close price range, similar experience tenure, and
are also consistent in terms, conditions, and technical specifications.
 Five of these six operated from same commercial complex building with adjoining office
numbers.
 Some of the qualified bidders who failed to get shortlisted were internally rated as good
for performance, based on past experience and their marked reputation.
Any Forensic Audit Investigation should have been on the following lines in this particular
case:

 Preparing a questionnaire for interviewing the complainants and those who failed but
were rated good
 Interviewing complainants and confidential sources
 Data collection of paper trail through Bid documents, requests for bids, bid comparison
documents prepared internally, Bill of Quantities (BoQs) comparison line item wise and
bid securities
 Identification of physical similarities in the bid documents like paper quality, color
schemes, type, faces, formatting, language, etc.
 Examining and establishing the connection between bidders on inter-company
connections, common address, contact details, etc.
 Unusual bidding patterns by comparing the financial and quantity data line item-wise to
test whether they are exact percentages or values apart.
 Conducting background check on all the final shortlisted bidders to check for common
ownership, employees, affiliations, or prior involvement in the other collusive bidding
schemes
 Reviewing the bid security details—whether issued by same bank branch to group of
bidders, or issued to bidders by bank on same day
 Interviewing the complainants and the likely bidders whoever lost in the bidding process
 Conducting a detailed inquiry into the business of the winning bidder as against
exercising the right of special enquiry/audit enabler clause—that most bid documents
generally have—on the winning bidder as a routine formality
 Interviewing the winning bidder based on the information collected and collated from the
above processes.

Case Study – II: NSEL—FTIL Case1

 Facts of the Case
Creation of National Stock Exchange Limited (NSEL) was ideated on the concept that it would
provide a platform (i) for farmers to sell their produce and on the other hand (ii) for processors,
exporters, traders, and investors to buy produce electronically. This, in theory, would help price
discovery in efficient way. NSEL was supposed to help the farmers to access the national market
and get the best price for their commodities. It was also envisaged that with the creation of
holding capacity, the farmers would be able to raise funds under Warehouse Receipt Financing
by the banks. Under Forward Contracts Regulation Act, a ‘spot contract’ shall be settled within
11 days including payment and physical delivery of goods i.e., in T+11 days. Spot contracts
come under the purview of Forward Market Commission (FMC), which is the regulatory

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authority. Also as per notification of the Government Departments concerned in 2007, the spot
contracts were deemed to be out of FMC if settled in T+2 days. NSEL somehow managed to
ensure ‘sell’ contracts at T+25/T+35 and ‘buy’ at T+2 thereby providing the major players a
wide window for ‘arbitrage’. Eventually, it was found that NSEL could not honor their T+25/35
obligations as it had neither the money nor the commodities.
NSEL had also lent money to 24 borrowers without underlying commodity deposited by
them—Warehouse Receipt Financing. The ‘Exchange’ also allowed trading in stocks without
verifying existence of the same. FMC found trading in contracts exceeding 11 days that is
tantamount to breach of provisions of FCRA, 1952. This led to unsettled payouts ballooning to
Rs. 5400 Cr. It was found that the commodity stockists where selling warehouse receipts to
investors for immediate payments. The investors entered into buyback arrangements by selling
back the commodity to stockists after 25-35 days without verifying the actual commodity stock.
Later on, these investors actually sold commodities without proof of underlying stock. Thus, the
NSEL scam has once again raised doubts over investing opportunities and investment safety.
Red Flags/Questions to be raised in this Case are:

 How did Central Government allow NSEL not to follow demutualization rule?
 Why isn’t there any regulatory authority or monitoring mechanism for spot contracts in
commodities?
 Why weren’t red flags raised when liquidity was diminishing or when only few members
of the exchange did the actual business for so many years?
Forensic Audit Investigation should have been on the following lines in this particular case:

 Preparing a questionnaire for interviewing the complainants. Interviewing complainants

and confidential sources.
 Have a ‘Data Collection Paper Trail’ of the agreements between NSEL, Brokers,
Stockists, Brokers, Contract Notes, Warehouse Receipts, Financial and Non-financial
records.
 IT Data collection through all the email backups, electronic data from the computer
device of all the suspects, server data, trade data, etc.
 Examining and establishing the connections between brokers, investors, warehouse
owners, exchange shareholders on inter-company connections, common address, contact
details, etc.
 Identification of relevant statistics using Data Analytics— significant increase in business
of certain brokers, investors, warehouse owners, etc.
 Using Data Analytics for correlating the data based on trade time stamps, spurt in
volumes, cartel of brokers, investors, warehouse owners, speculators, etc., and based on
Time-Space Analysis.
 Conducting a thorough Forensic Analysis of financial records of the exchange, its
holding company, brokers, investors, warehouse owners, and all major traders in the
exchange.
 Specific focus on regulatory compliances and filings—both in terms of timely reporting
and quality of the information reported.

Case Study—III: Bank Fraud Case

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Facts
The fraudster initially posed as Banker’s representative to various PSUs and Companies for
making fixed deposits with the bank. PSUs and Companies believed that they would be anyhow
be dealing with the Bank and transactions would happen via regular banking channels, hence
remained unsuspecting and trusting. The fraudster would change his role when he visited the
Banks and offered to bring huge deposits from companies ostensibly acting as representative of
PSUs and Companies. In the Bank Fraud Case, upon transfer of Rs. 110 Cr by ABC Private
Company to the Bank for creation of FD, the fraudster asked the banker to immediately transfer
the amount to his accomplice’s account KBP International via a FAX communication.
Immediately, that transfer was followed by another tranche of Rs. 70 Cr for FD creation. The
Bank again received instructions to transfer the amount to the accomplice’s account via FAX
message. Meanwhile, ABC Private Company directly contacted Bank to enquire why FD
Receipts were not yet delivered to the company. It was at that instance they along with Bankers
realized that fraud has been perpetrated on them. The last tranche of transfer was saved, but the
earlier transfer of money is yet to be recovered.
In another Bank Fraud case, the Bank received bulk deposits from Companies and PSUs
between 30th January 2017 and 5th May 2017. The modus operandi was similar. The fraudster
represented organizations and as banker to the other. Fraudster convinced the organizations to
create FD with the Bank and collected the KYC documents, obtaining signatures on forms, filled
them, and helped them through the entire process. Later, fraudster submitted forged documents
with the Bank and obtained FDRs of Rs. 256.69 cr. The originals were collected by the fraudster
as representative of the organizations. The FDRs were subsequently pledged with the Bank by
the ‘same signatories’ and using the same FDRs, overdraft facilities of Rs. 223.25 Cr were
obtained. The funds were then surreptitiously transferred out of bank. The Banks also lost their
stocks by 5% and the stock further lost 3.5% upon these revelations. Bank FD scam got bigger as
many as nine FIRs were filed with an estimated fraud of at least Rs. 700 Cr. Preliminary inquiry
by EOW has been initiated in another 10 cases. Finance Ministry has ordered a ‘forensic audit’
in these PSU Banks. Both the banks have complained to the CBI, which has also looking into the
matter.
 Red Flags in this Case are:
Middle man; Audience participation, and Involvement by others

In addition to the usual, Forensic Audit Investigation should have been on the following lines
in the above mentioned Cases:

 Document Forensics using Paper and Ink analysis, Handwriting Analysis, and Signature
analysis
 Analyzing the email and telephone call data records following the regulatory channels
 Establishing the linkages between the fraudster’s location while perpetrating fraud,
communications with people within the organization and banks, etc.
 Mapping the procedural role of banking officials and the PSUs—Company officials with
their job description and the Standard Operating Practices (SoPs) /Rules governing their
duties.

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Case Study—IV: Corruption and Bribe Case
 Facts of the Case
HR department observed that a certain officer in the Purchase Department was resented by his
colleagues and juniors as being arrogant and asocial. Upon enquiries, it was revealed that in the
last few years, some vendors with whom business volume was low were delivering to this
particular officer sweets and gifts and sometimes even for the entire department. Few of such
suppliers were not in approved list with the company. At Annual HR Review, the employee was
generally asked about his life and family where he proudly stated that his daughter stood first in
her class. Interestingly the school whose name he revealed was one of the expensive
international schools in the city. Lifestyle improvements were also observed i.e., use of branded
products, travel by radio taxi on daily basis for commuting, etc. An inquiry into the matter was
sought when at the Annual Departmental Head meeting, the HR and Purchase Heads accidently
discussed the employee in question at tea break, which was then escalated for approval by the
management.

Red Flag Indicators in this Case are:

 Disproportionate increase in wealth of the procurement official.

 Frequent receipt of gifts
 Non-competitive selection of contractor, and
 Unjustified favoritism

Forensic Audit Investigation should have been on the following lines in the above Case:

 IT data collection by using email backups, company mobile devices as per the company
policy and applicable law, and electronic data from the computer device of the suspect
 Paper-based Data collection covering documentation of suppliers from the pre-vendor
creation stage, quotes, bids, invoices, payments, delivery acknowledgements, revisions to
contracts, etc., for the entire tenure of the alleged suspects with the company.
 Using Data Analytics will help identify relevant statistics such as any significant increase
in business to indicate most likely vendors who could have received business by paying
kickbacks.
 Reviewing transactions thoroughly including bidding documents, order placements,
contractual agreements, per unit prices, quality of goods and services, etc.
 A thorough background search on suspect vendors is needed for their location, publicly
available financial information via MCA, or Financial database software like Prowess or
Capitalline, any litigations against them, ownership structure, and overall market
reputation.
 A detailed background search on the suspected Procurement Officer about his reputation
in the department, increase in his assets, changes in his lifestyle, etc.
 If significant indicators point towards fraud by the employee, asset trace investigation can
be conducted to help recover the loss.

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  From data analytics, identification of vendors whose business volume had suddenly
decreased or were removed from the approved list during this tenure needs to be
identified.
 It is very likely that concrete information can come from disgruntled vendors through
informal discussions and discrete inquiries
 Combined analysis of data analytics, background checks, document reviews, and discrete
enquiries with vendors who are no longer being favored will give a good understanding
of situation as to what is going on and who is involved.

[Note: 1Case Study is available at IOSR Journal of Business and Management, IES MCRC
International Case Study Conference.]

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