Forensic audit 28 april 2013

INDICATIVE AND NOT AUTHENTIC - NOT FOR CIRCULATION

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FORENSIC AUDIT S VASUDEVAN ex IA&AS

BCOM, FICWA, CS AND CFE

28 APRIL 2013


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Agenda FRAUD AND FINANCIAL

FRAUDS FORENSIC AUDIT TOOLS

AND TECHNIQUES Case studies and

discussions


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MARKET ATTRACTIONS (as on April 23, 2013) INR IN CRORE

COMPANY (FACE VALUE)

NO OF SHARES

PAID UP CAP

DIVIDEND PER SHARE (RS)

MARKET CAP

MKT PRICE PER SHARE

BOOK VALUE / SHARE

TCS (INR 1 ) 195.72 195.72 25 279801 1429 126

ONGC (5) 855.44 4277.24 9.75 279464 326 132

RELIANCE (10)

322.86 32293.30 8.50 259476 803 498

ITC 781.84 781.84 4.50 250803 317 24

COAL INDIA 631.6 6316 10 196786 311 31

HDFC BK (2) 237.94 476 4.30 164087 689 127

INFOSYS (5) 57.42 287 47 129898 2262 518


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ENVIRONMENT – FACILITATORS?

• PRIVATE PLACEMENT • PREFERENTIAL ALLOTMENT • FREE PRICING • ENFOCEMENT – LACUNAE OR

INEFFECTIVENESS • RULES OR PRINCIPLES – DILEMMA • REGISTRAR OF COMPANIES OR REGISTRAR

OF COMPLIANCE?• PROFESSIONAL CODES AND ETHICS


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Definition of fraud Section 17 of Indian Contract Act 1872

Fraud" means and includes any of the following acts committed by a party to a contract, or with his connivance, or by his agent with intent to deceive another party thereto of his agent, or to induce him to enter into the contract:- ◦ (1) the suggestion, as a fact, of that which is not true, by one who does not believe it to be true ; ◦ (2) the active concealment of a fact by one having knowledge or belief of the fact ; ◦ (3) a promise made without any intention of performing it ◦ (4) any other act fitted to deceive ; ◦ (5) any such act or omission as the law specially declares to be fraudulent

Explanation to section 447 of the New Companies Bill 2012 “fraud” in relation to affairs of a company or any body corporate, includes◦ any act, omission, concealment of any fact or abuse of position committed by any◦ person or any other person with the connivance in any manner, with intent to deceive,◦ to gain undue advantage from, or to injure the interests of, the company or its◦ shareholders or its creditors or any other person, whether or not there is any wrongful◦ gain or wrongful loss;

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

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


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DEFINITION: Where a person or entity makes undue gains by inducing the general public to part with their money or money’s worth by knowingly making false or untrue statements and in nature and content it is more than contractual frauds between two or more parties.

RBI COMMITTEE on Banking frauds in 2001 attempted to define financial frauds as scams affecting the general public and economy as a whole. RBI COMMITTEE included the following, amongst others, as illustration of financial frauds:

MARKET MANIPULATIONS BY LEAKING PRICE SENSITIVE INFORMATION BY SOME OFFICIALS OF REGULATORY AGENCIES.

PRICE RIGGING AND MANIPULATIONS IN SECONDARY MARKETS INITIAL PUBLIC OFFER RELATED FRAUDS DEMAT ACCOUNT FRAUDS VANISHING COMPANIES BANKING FRAUDS MISSTATEMENT FRAUDS PONZY SCHEMES FINANCIAL STATEMENT FRAUDS PERSONS OR ENTITIES (LIKE ONE OR MORE INTERRELATED OCB ACTING IN

CONCERT FOR MARKET MANIPULATIONS

FRAUD AND FINANCIAL FRAUDS


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Distinction between financial fraud and contractual fraud

CONTRACT FRAUD FINANCIAL FRAUD

TORTUOUS - INTEREST OF ONLY PARTIES TO THE CONTRACT INVOLVED

INTERST OF THIRD PARTIES AND PUBLIC AFFECTED

ADVERSE RELATIONSHIP AND LEGAL RIGHTS

NOT NECESSARILY SO

MOVE THE COURT FOR RECOVERY OF MONEY LOST

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

Normally does not affect public policy Every instance of financial frauds triggers review of policies for safeguarding the public interest

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


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The Fraud triangle

Opportunity

Incentive/Pressure

Rationalization


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Incentive

(Pressure)Opportunity

Rationalisation High

Risk

The Fraud triangle


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

Did the author of the deceit derive any advantage from it which he could not have had if the truth had been known?”

- Stephen’s “History of the Criminal Law of England”

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

- John W. Hill

A person “becomes criminal because of an excess of definitions favorable to violation of the law over definitions unfavorable to violation of the law”

- Edwin H. Sutherland“Principles of Criminology”

Greed Opportunity NeedsExpectancy of being caught is

low

G O N E

Ingredients of a fraud…


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GreedIngredients of fraud - Greed

• What began with a few pencils and paperclips...


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Common comments regarding fraud

Our staff cannot / would not commit fraud

Fraud does not happen in stable organizations, as we have robust internal control systems and processes

We would know if fraud occurred

Fraud can be discovered / detected quickly and loss will not be significant

Our internal controls will take care of fraud related issues


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Types of frauds • All frauds arise out of contracts and hence

known as white collar crime. However financial frauds impact public also.

• Capital market frauds – primary and secondary market • Off market frauds • Financial statements and accounting manipulations -

incentive and performance oriented (corporate frauds)• Tax frauds • Banking frauds • Others – like foreign exchange, derivatives, etc • Employee frauds • External frauds (by outside entities)


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CAPITAL MARKET FRAUDS • PRIMARY MARKET

• FRAUDULENT PROJECTIONS IN OFFER DOCUMENTS • UNDERWRITING AND SUBSCRIPTION THROUGH THIRD PARTIES • PROMOTERS CONTRIBUTION THROUGH ROTATION OF

CHEQUES AND BOOK ENTRIES • OFF MARKET DEALS FOR THRESHOLD SUBSCRIPTION

• SECONDARY MARKET • INSIDER TRADING • PRIVATE PLACEMENT • PRICE RIGGING

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


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TYPICAL BANKING FRAUDS • (a) opening of new fictitious deposits accounts by persons not properly identified by the bank

followed by deposit of fake/stolen/forged instruments in such accounts and immediate withdrawals of the proceeds,

• (b) submission of false stock/financial statements to avail of finance, • (c) clandestine removal of goods hypothecated and siphoning of sale proceeds,• (d) acceptance of deposits both Resident and Non-Resident through middlemen and thereafter

allowing/availing of overdraft against fraudulent discharge of these deposits receipts by forgoing power of attorney and loan documents of third parties who were also not properly identified,

• (e) raising of accommodation bills,• (f) kite flying,• (g) manipulation in outward/inward clearing, • (h) raising unauthorised debits on nominal heads of account,• (i) manipulating and tampering with the books of accounts by passing unauthorised entries, • (j) sanction of one time ad hoc credit facility to non-clients, • (k) issue of letter of Credit, Bank Guarantees without recording in the branch books,• (l) issue of pay orders/demand drafts without consideration, • (m) fake documentation, etc.


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RBI On instances of banking frauds

• Loans / advances against hypothecation of stocks

• Housing loan cases • Submission of forged documents including

letters of credit, forged FDRs, etc • Valuation related• Invoice manipulations for availing credit facilities

Source: RBI circular dated May 31, 2011 on Findings of Forensic scrutiny – Guidelines for prevention of frauds


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TYPICAL FINANCIAL STATEMENT FRAUDS

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


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FORENSIC AUDIT TOOLS AND TECHNIQUES


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Fraud consists of….

Corruption

Fraudulent StatementsAsset Misappropriation


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Categories of Financial Statement Frauds – some examples

Fraudulent financial reporting, e.g., fraud arising from improper revenue recognition, overstatement of assets or understatement of liabilities

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

Misappropriation of assets, e.g., embezzlement, payroll fraud, external theft, procurement fraud, counterfeiting or product diversion

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

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

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


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What is forensic accounting?• Forensic Accounting is a tool for determining the adequacy of

evidence for testing compliance with applicable legal and accounting standards.

• Forensic accounting is the application of a specialized knowledge and specific skills to stumble upon the evidence of economic transactions.

• The job demands reporting, where the accountability of the fraud is established and the report is considered as evidence in the court of law or in the administrative proceeding.

• Forensic accounting is both proactive and reactive in nature. When proactive it is applied for legal review, offering the highest level of assurance, and including the now generally accepted connotation of having been arrived at in a scientific fashion.

• Forensic audit is extension of Forensic Accounting techniques for investigation and fraud risk assessment.


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Forensic audit

Forensic audit is extension of Forensic accounting concepts to audit- no formal definition of Forensic Audit.

“a concentrated audit to find out the correctness of recording of the transactions from propriety, value for money and legal perception and to report whether or not a fraud has taken place and any financial benefit has been enjoyed by presenting an untrue picture”

Objectives: to test compliance with applicable accounting and auditing standards to determine whether a transaction will stand legal scrutiny in ordinary course to find out the real person(s) / beneficiaries behind the transaction – piercing corporate veil in case

of company accounts to establish the channels through which the transaction passed through (beyond entity concept) to obtain understanding of modus operandi of the fraud.


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Forensic AuditProactive forensic auditingForensic auditing in this sense could be viewed from different aspects depending on its application, some of which are discussed below:

Statutory AuditInternal controls should be studied and evaluated in respect of safeguarding assets and resources when performing regularity and financial audits, and in respect of assisting management in complying with laws and regulations when performing compliance audits.

Forensic audit methodologies can be used to obtain a more detailed understanding of the entity and its activities to identify areas of risk both in determining the direction of the audit and in expressing an opinion.


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Forensic Audit

Regulatory Compliance

Government Departments/Agencies could themselves use the techniques of Forensic auditing to

assess compliance with regulations governing payments of grants /subsidies. Performance auditors

could also use these techniques while auditing such governmental programs. Techniques may be

used in major audits of large government programs such as ‘ Integrated Child Development

Scheme’, Public Distribution Scheme (for foodgrains), to Customs duty drawbacks and export

subsidies.

Diagnostic Tool

Forensic auditing can be used either by management or by auditors to carry out general reviews of

activities to highlight risks arising either out of fraud or from any other source with the purpose of

initiating focused reviews of particular areas, targeting specific threats to the organisation.


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Forensic AuditReactive Forensic Auditing

The objective in case of reactive forensic audit is to investigate cases of suspected fraud so as to prove or disprove the suspicions, and if the suspicions are proven, to identify the persons involved, support the findings by evidence and to present the evidence in an acceptable format in any subsequent disciplinary or criminal proceedings. In such cases it is important to keep in view the following:

working relations with the investigating and prosecuting agencies authorisation and control of the audit investigation documentation of relevant information and safeguarding all prime records pertaining to the

case rules of evidence governing admissibility/authentication of records confidentiality evaluation of the evidence to assess whether the case is sustainable legal advice where appropriate reporting the findings in a manner that meets legal requirements.


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Forensic Audit


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TOOLS AND TECHNIQUES – 360*

• CRITICAL PATH AUDIT• CRISIS AUDIT • DATA ANALYTICS / DATA MINING • EVIDENCE COLLECTION / RECORDING • VALUE FOR MONEY AUDIT • REGULARITY & COMPLAINCE AUDIT • VERTICAL & HORIZONTAL REVIEWS • EXTERNAL EVIDENCE


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

NAME OF THE ENTITY BRIEF MODUS OPERANDI IMPACT

HARSHAD MEHTA SCAM MONETISED THE FLOAT AVAILABLE WITH THE BANKS FOR MARKET MANIPULATION

CAPITAL MARKET COLLAPSED

C R BANSALI PROMISED HIGH RETURNS FOR INVESTMENTS IN HIS 100+ COMPANIES.

PUBLIC TRUST IN NBFC

UTI SCAM DIVERSION OF FUNDS FOR OTHER PURPOSES

GOVT BAILED OUT OF TAX PAYERS MONEY - 3500 CR

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

PUBLIC LOST MONEY – RS 300 CRORE

KETAN PAREKH SCAM FACILITATED PRICE RIGGING CAP MKT COLLAPSED


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

NAME OF THE ENTITY BRIEF MODUS OPERANDI IMPACT

GLOBAL TRUST BANK AGGRESSIVE LENDING. CAPITAL MARKET COLLAPSED

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

WEAKNESS IN DEMAT SYSTEM – STILL EXISTS

SATYAM CREATION OF NON EXISTANT CASH SURPLUS AND FUDGING OF ACCOUNTS

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

2G, CG, KG G GOES ON JI!!!!!!! PUBLIC

CHIT FUNDS TRADITIONAL METHODS GREEDINESS?????????


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CASE STUDIES NON BANKING

FINANCIAL COMPANY BANKING FRAUD –

INTRA DAY TEMPORARY OVERDRAFT

SWAPPING OF SHARES

REVALUATION RESERVE

AND SO ON..

FRAUD

Forensic audit 28 april 2013

Documents

contractual frauds

wrongful gain

ethics indicative

unlawful means of property

indian contract act

market manipulations

general public

includesany act