CRITICAL ANALYSIS OF FRAUDS IN CORPORATE WORLD

This article was written by Shubham Mishra, a student of VIT School of Law, Chennai.

INTRODUCTION

Corporate frauds are of much more significance from investor’s point of view in the corporate world. Fraud can be defined as, an act of deceiving or misrepresenting intentionally in order to obtain benefits in an illicit or unwanted manner. According to association of certified fraud examiners(ACFE) fraud is , deception or misrepresentation that an individual or entity makes knowing that misrepresentation could result in some unauthorized benefits to the individual or to the entity or some other party. Now a days Corporate frauds have become a matter of serious concern, since it affects, entity’s reputation and investor’s faith on the organization. Fraud consists of many unscrupulous activities by individual or company for making large amount of personal benefits. Fraud is an indirect way of attaining huge amount of money, the problem is in order to augment the level of company in corporate world, it indulges itself into unwanted activities, which affects organization to the larger extent as well as the investors loses trust over the company and they beware in future from  these mistakes which take place. Before diving further into the present topic, author would like to highlight the importance of corporate advisory and would recommend anyone associated with such practice (intentionally or otherwise) to consultant their corporate lawyers. One such Corporate Law firm is Edmonton, Canada can reached on freedomlaw.ca.

Coming back to issue in hand, Organizations of all types, whether private or public or any other sector are confronting these fraudulent activities. The major public companies have experienced financial reporting fraud, resulting in turmoil in the capital markets, a loss of shareholder value, and in some cases the bankruptcy of the company itself. There are various mechanisms are being adopted by the companies for keeping an eye on these intentional and harmful activities and now a days investors are taking precautionary measures in order to avoid monetary risks which can take place through various conducts because they want their investments to be safe in the hands of the entity.

The investors are the backbone of the securities market. They actively take part in security market and become conducive in the enhancement of the economy of the nation. The number of investors are increasing in India at large level. every organization needs money for carrying out their functions in secured and well established manner. Therefore investors are taking initiative to indulge themselves in the money market for fulfillment of their needs and become prosperous people through becoming a part of the company. Companies  borrow money from banks, individuals, and many financial institutions through issue of their financial securities like debentures, shares and bonds. Therefore for the betterment of the corporate world, the faith of investors over companies need to be stagnant always because they want benefit from their investments.

CORPORATE FRAUDS

1.Who commits fraud:  Corporate frauds can be committed through many ways. It can be done inside the organization by the employee through manipulation of audit and financial statements of the company for the purpose of attainment of unauthorized benefit. Generally there are 3 groups of people who commit financial statement fraud. First category is people who are at top level of management such as CEO and CFO commit accounting frauds to conceal true business performance, to preserve personal status and benefits, for instance if company is running out of profits and they are not able to repay their debts to creditors, then they start showing their false income for obtaining huge amount of capital from individuals and from financial institutions without the security and it leads to company in wrong way and pushes it into the well of loss so this is all done for getting personal benefits and for maintaining the stagnant position of the company in market.

Mid and Lower level employees falsify financial statements related to the area of their responsibility to conceal poor performance of the company and to earn performance based bonuses. Corporate world criminals falsify financial statements to obtain huge amount of loan from many big firms, individuals, banks and financial institutions, or to inflate they plan to sell in a pump and dump scheme. While many changes in financial in financial audits processes have stemmed from the financial frauds, or manipulations, history and related research repeatedly demonstrates that a financial audit simply can’t be relied upon to detect frauds at any significant level.[1]

So from abovementioned discussion, it can be clearly inferred that fraud can be committed in organization from the top level to lower level of management and just for the sake of attaining certain amount of benefits, they keep image of the company at stake.

2.Consequences of Fraudulent Reporting: Fraudulent reporting in accounts of company creates a chaos in the operation of activities of comapny. It can have significant consequences for the organization and its stakeholders and it affects public confidence in capital market because it hampers share value of company in capital market, moreover the fraudulent financial reporting impacts organization in numerous areas such as, financial, operational activities and psychological and the consequences can be horrible and it can cause company to crumble like commodity because the goodwill, reputation, customer trust over the company will be vanished and obtaining trust might be a herculean task for the company and from future point of view, when extreme need of capital arises, no one will be ready to provide loans to company. these unwanted activities affect on stakeholders, creditors and employees as well who suffer jobs and diminishes position and value and auditors, attorneys, and insurers and even competitors whose reputation suffer by association.[2]

As fraud can be perpetrated by any member of company, therefore there should be proper mechanism and strategical plans for avoiding these harmful activities to take place in the next level itself and proper fraud management department should be separately available in the organization itself which will eyeball on company daily operational activities.

3.Types of Frauds : There are plethora of Corporate Frauds existing at present level in Corporate World,  and feasible solution need to found for avoiding these inevitable and fraudulent activities.

3.(1):Payment Fraud: This type of fraud involves falsely creating or diverting payments and for example, creating fake records and bank accounts which enable fradulent payments to be made,Other examples can be generating false payments, making fradulent payments to oneself, intercepting and altering payee details.

3.(2):Pyramid or Ponzi Schemes Fraud: In this category of fraud, investments of later investors are used to pay earlier investors and it often appears at the time of recession when investors want to remove their money from scheme and it is done for giving positive impression that the investments of the initial participants have increased in value in short amount of time.

3.(3):Long and Short Fraud: This  type of fraud occurs when legitimate business is established with the intention to make fool to its customers,creditors and suppliers. This type of fraud may take place after attaining good reputation or when apparent business is operative only for few months and when the huge amount of money is grabbed through various investments, business is shut down and huge profit is attained.[3]

3.(4):Insolvency and Bankruptcy related fraud: Insolvency related fraud occurs when company is aware of its fradulent conduct and it majorly takes place prior to the  anticipated insolvency of company.In order to avoid debts and liabilities, directors establishes phonix comapnies just prior or after the insolvency of the company and they transfer all the assets of from the first comapny to newly established company, so that they get exempted from paying its debts.

CRITICAL ANALYSIS OF SATYAM FRAUD

Satyam Computers was one of the leading star industries in IT Sectors and it secured phenomenal growth at global level and the services of this company were spreaded at every corner of the world and it has won many leading entrepreneurship awards for appreciating growth and became a part in augmentation of an Indian Economy.

Satyam Scandal has been dubbed as India’s Enron and it shook the entire country and IT Market in India because it had immense contribution in Indian Economy. The Factual situation was, On January 7, 2009, Mr. Raju disclosed in a letter to the board of directors about an entire fraudulent activities which were taking place at firm. He expressed that he had been manipulating the company’s accounts numbers for years .Mr. Raju claimed that he overstated the assets on Satyam’s Balance sheet by $1.47bn.Nearly$1.04bn in bank loans and cash that the company claims to own was non-existent.Satyam also underreported liabilities on its balance sheet. Satyam overstated income nearly every quarter over the course of several yeras in order to meet analysts expectations that company is doing well. Mr.Raju and company’s global head of internal audit used a number of different techniques to perpetrate the fraud and Raju created many bank statements to advance the fraud. Mr. Raju falsified the bank accounts to inflate the balance sheet with balances that didn’t exist at all. He inflated the income statement by claiming interest income from fake bank accounts. Mr. Raju also revealed that he created 6000 fake salary accounts over the past few years and appropriated the money after the company deposited it. The global head of internal audit created fake customer identities and generated fake invoices against their names to inflate revenue and he also forged board resolutions and illegaly obtained loans for the company.

Immediately after the revelation of fraud, Merrill Lynch terminated its engagement with Stayam and PwC came under intense scrutiny and its license to operate was revoked. Satyam shares value came down to the lowest level. Satyam shares fell to 11.50 rupees on January 10,2009, their lowest level since march 1998, compared to a high of 544 rupees in 2008.In new york stock exchange, satyam shares peaked in 2008 at US $29.10, BY march 2009, they were trading around US $1.80.Thus Investor lost $2.82 bn in satyam .Many Criminal Charges were brought against, Criminal Conspiracy, breach of trust and forgery and he violated the rules of corporate governance. After revelation, the new board members wanted to save the firm  and they started working towards the feasible solution for bringing company on track and preclude the falling down of firm. Indian officials acted quickly to try to save satyam from the same fate that met Enron and Worldcom. The Indian government immediately started an investigation for the sell of company. To devise a plan of sale, the board met with the bankers, accountants, lawyers and government officials immediately. Several IT field had gained enough confidence in Satyam’s operation to participate in an auction process for Satyam. The SEBI appointed Justice Bharucha, to oversee the process and instill confidence in the transaction. The winning bidder was Tech Mahindra, bought Satyam for $1.13 per share. The stock of the company has again been stabilized  from its fall on November 26,2009 and as a part of Tech Mahindra, Satyam is once again on its track.

INVESTOR PROTECTION

Every Organization needs capital for operation of their daily activities in smooth and perfect manner since finance is the lifeline of all corporate sectors and here the Investors Contribution comes into play for the establishment of admiring and confident image in the eyes of investors. Investors are considered as backbone of the securities market because they contribute heavily in Security market as well as in enhancement of an Indian economy, therefore their invested money need to be safeguarded through effective rules and regulations. The number of investors are taking part in security market but due to several fraudulent scams which have taken place over a period of time has diminished the confidence of investors in capital market. Therefore, this confidence need to be maintained for existence of capital market or else the consequences will be outrageous and horrible which is beyond  fantasy of laymen point of view.

The concept of investors protection need to looked from different angles by looking into aspirations and requirements of different category of investors.

(I)Investors in Equity

(II)Large institutional investors

(III) Investors in Debentures

(IV)Foreign investors and small investors and depositors.

So for the clear understanding of the aforesaid concepts, it is mandatory to know the term investors in elaborative manner.

An investor is a person who is an individual or legal entity who invests his earned money in different ventures without indulging himself or itself into activities of that venture. Investor is always ignorant about the going on procedures within internal management of the organization and they never become part of any decision making process. Normally an investor is a blind person who doesn’t possess any idea about working environment of the corporation itself. The chance of taking part into business activity comes into picture when investors trade among themselves in secondary market, where they buy and sell shares among investors themselves and here no interjection by the companies take place. Investors invest their money in belief that, they will get sufficient amount of return from their money and it will help them to execute their other planned schemes in future and sometimes investors are not aware about the procedure of security market and they invest money without due diligence and proper care which cause them a huge loss in future, since they can’t predict about happenings with their money by the utilizers. An investor has mainly 3 objectives, which he expects to be fulfilled from his investments, firstly the safety of invested money, secondly liquidity position of invested money, and return on investment in selected securities. Therefore for the fulfillment of those three objectives, precautionary measures need to be adopted for prevention of these unwanted activities which hampers company’s reputation as well as confidence of shareholders and other investors.[4]

There are 5 established legislations which governs security markets.

(a)The Security and Exchange Board of India Act, 1992

(b)The Companies Act, 1956, which sets of the code of consuct for the corporate  sector in relation to issuance, allotment, and transfer of securities, and disclosures to be made in public issues.

(c)The Securities Contracts Act,1956, which provides for the regulation of transaction in securities through control over stock exchanges.

(d) The Depositories Act, 1996 which provides for electronic maintenance and transfer of ownership of  demat shares.

(e) The Prevention of Money Laundering Act,2002.

These legislations governs the entire security market scandals and fraud and it works as protective measures of money of investors and helps in establishments of confidence of investors in security market because their participation is necessary for the betterment of economy of country and investors prosperity.

CONCLUSION

The number of Corporate scandals related with primary and secondary market affects the whole entity in many ways such as, financial, psychological and reputation of the company gets hampered and whoever was involved in company’s various operational activities becomes prey of one negligent and greedy decision which drowns the entire firm. The ramifications of scams are easily predictable, therefore for avoidance of these decisions from being taken by employees at all level of entity should carefully indulge into proper decision making process because obtaining money by following wrong direction leads to devastation and collapse of the entire community  and affects economy as whole.

Investors should always be careful and due diligence need to be adopted by them before they indulge into investment process. There is different category of investors and thier knowledge differs in field of security market, therfore those investors who don’t possess knowledge about working procedure of capital market, they should always take consultation with appointed financial brokers by SEBI and every organization should have properly established fraud department which keeps an eye on day to day transactional activities therefore the security market system need to be transparent and trustworthy since the confidence of investors should always be given priority because capital market can’t stand without contribution and full support of investors.

India has enacted various legislation for safeguard of investors’ money because they can’t predict the intention of utilizers of that money and it can be used in many wrong ways, but proper implementation of these laws are necessary for resisting scams in corporate world. These 2 concepts corporate fraud and more of significant value to make sure about protection of investors money because they have certain objectives from these investments which must be fulfilled at any cost and if all goes well, the relationship between investors and conglomerates will increase and it will be condusive for the Indian security market.

1. “Corporate Accounting Fraud: A Case Study of Satyam Computers Limited by Madan Lal Bhasin: SSRN,” October 20, 2015, accessed October 29, 2016, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2676467.
2. Bibliography: Bhasin and Madan Lal. “Corporate Accounting Fraud: A Case Study of Satyam Computers Limited by Madan Lal Bhasin: SSRN.” October 20, 2015. Accessed October 29, 2016. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2676467

[2] Bibliography:Bhasin and Madan Lal. “Corporate Accounting Fraud: A Case Study of Satyam Computers Limited by Madan Lal Bhasin: SSRN.” October 20, 2015. Accessed October 29, 2016. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2676467.

Footnote:“Corporate Accounting Fraud: A Case Study of Satyam Computers Limited by Madan Lal Bhasin: SSRN,” October 20, 2015, accessed October 29, 2016, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2676467.

[3] Bibliography:“Different Types of Corporate Fraud Explained – Solicitors – London.” 2006. Accessed October 29, 2016. http://www.franciswilksandjones.co.uk/site/fwjsays/faq_booklets/tips_different_types_of_corporate_fraud_uf.html.

Footnote:“Different Types of Corporate Fraud Explained – Solicitors – London,” 2006, accessed October 29, 2016, http://www.franciswilksandjones.co.uk/site/fwjsays/faq_booklets/tips_different_types_of_corporate_fraud_uf.html.

[4] Bibliography:“Print Article: Protection of the Interest of the Investor.” Accessed October 29, 2016. http://www.legalservicesindia.com/article/print.php?art_id=1560.

Footnote:“Print Article: Protection of the Interest of the Investor,” accessed October 29, 2016, http://www.legalservicesindia.com/article/print.php?art_id=1560.