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The enemy within

The fastest expanding business in the Indian accounting fraternity revolves around fraud. Fraud is ballooning so fast in corporate India that audit firms cannot keep pace.

The fastest expanding business in the Indian accounting fraternity revolves around fraud. Fraud is ballooning so fast in corporate India that audit firms cannot keep pace. The forensic practice of KPMG has some 500 people, doubling over the last two years. At rival Ernst & Young, revenues from the fraud investigation business are expected to double this year and the next, after growing at 50 per cent last year.

As the number of frauds is growing, so is their complexity. Says Arpinder Singh, E&Y's Partner for the service: "If five years ago a typical case would be that of a simple kickback paid to a particular vendor, today it is much more complex, involving data theft, intellectual property issues or complicated bribery cases where tracing money movement can be a challenge."

The sensitivity of companies to such frauds is also increasing. After the Satyam Computer scandal, where Chairman B. Ramalinga Raju cooked the books to report fictitious revenues in excess of Rs 7,000 crore, "tolerance for frauds is veering towards zero in performance-driven companies," says Deepankar Sanwalka, Head of KPMG India's Risk and Compliance Group.

This is a big change from the last decade when the focus at most corporates was on revenue expansion with little thought for controls over the risks that come with unbridled growth. At a given point, KPMG is investigating one or two cases of financial statement fraud with the average size of the transgression being about Rs 50 crore. In fact, Sanwalka believes that, if the slowdown had continued, more Satyam-like skeletons would have tumbled out of India Inc.'s cupboard.


Red flags


  • Results consistently in line with budget
  • Unclear costs, often accompanied by failure to perform reconciliations
  • Profi t and loss items based on judgements rather than hard data
  • Too many manual journals and accruals without automatic adjustment
  • Unusual fl uctuations in sales or forward purchase orders, particularly at the year-end
  • Profits not converted into cash
  • Undue concern about audit visits

    Source: KPMG
A survey of 200 companies in India by KPMG in August this year indicated that weak support for whistle-blowers, regulations with gaping loopholes, and lax board and senior managements were the main reasons behind a spurt in reported incidents of corporate frauds in recent years. Bribery and corruption were seen as an inevitable aspect of doing business in India. And, while supply chain, bribery and corruption continue to be the most common frauds, intellectual property and electronic crime are emerging concerns, the survey found.

Jamshed J. Irani, Director at Tata Sons, the holding company at the Tata group, believes that the key to foiling corporate fraud is a vigilant board rather than regulations. "We have enough laws in the country to deal with any malpractice," he insists, pointing to a new Companies Act that empowers independent directors.

He says the classic case was that of Tata Finance 10 years ago, where the board got involved and the then chief executive Dilip Pendse, was brought to book and jailed. More recently, last year, a case of accounting misrepresentation was reported at a division of TRF, a company with businesses in automotive undergear and material handling in which the Tata Group holds a 34.30 per cent stake. Irani, who chairs the TRF board, declined to discuss the case because investigation is on. But, those who have tracked the developments say TRF was swift in taking action even though, as a Mumbaibased analyst pointed out, "it was not a case of fraud but of wrong calculation of estimates".

The wrong costs and the consequential revenues recorded in the previous years have been reversed in the current year and the previous year by the company.
The figures were to the tune of about Rs 2.4 crore for the year to March 31, 2010, and Rs 13.32 crore in the previous financial year.

Still, about five senior people of a TRF division have been suspended and asked to go on long leave, pending an inquiry. Perhaps a better choice, some would say, than firing the people and losing control over them. To Irani, the importance of an investigation is its deterrent value and not the actual punishment that can follow. If people know that things will get investigated, that in itself would be a big deterrent.

Deterrence works
Such a deterrent would have worked in an instance that the E&Y team dealt with recently. Some employees of a company had floated their own firms to divert cash from their employer. The losses bloated to Rs 100 crore before they were caught. If TRF is an instance of a proactive board, at HDFC Asset Management Company it was the stock markets regulator that stepped in to seek corrective action. In June, following a case of alleged front running by Nilesh Kapadia, Assistant Vice President for Equities at HDFC AMC, the Securities and Exchange Board of India or SEBI asked the company to overhaul its internal controls and get an inquiry done by the trustees of HDFC Mutual Fund. SEBI also barred Kapadia from trading activities done on behalf of HDFC AMC.

SEBI investigations found that Kapadia had tipped off an associate, Rajiv Ramniklal Sanghvi, before placing the purchase or sell orders for HDFC AMC. Sanghvi, in turn, traded based on such tips, making substantial gains. In his order, K.M. Abraham, a member of SEBI, directed the fund's trustees "to identify whether (Kapadia) had indulged in similar front running activities on other occasions". The trustees had been given six months for the investigation, which means SEBI should be hearing from the company in December.

And it is not just the private sector. Cut to Navi Mumbai. In recent years, a government-owned petroleum products company, Hindustan Petroleum Corp Ltd or HPCL, had to deal with instances of alleged corruption and abuse of official position by some of its employees.

The Central Bureau of Investigation has filed a chargesheet against former Oil Sector Officers Association President Ashok Singh and another HPCL executive for alleged irregularities in a retail outlet under his watch. Singh, who was then Chief Regional Manager at HPCL's Vashi regional office, has since been dismissed from the services of the company.

The issues being looked into apparently include manipulation of record of stocks, fictitious swiping of cards and alleged extending of unauthorised credit. HPCL'S Executive Director for Retail, M.S. Damle, declined to discuss this case. But, he says the company was prepared for instances of malpractice. "There are plenty of mechanisms and the moment some irregularity is noticed and proven, action is taken against the people concerned."

According to consultancy firm Grant Thornton, some instances of fraud have surfaced before the Company Law Board that involve foreign acquirers. Some foreign investors, after buying out a company, appoint its former promoters as top managers to run it, says Anil Roy, the partner responsible for forensic investigation services. This can be a big risk since the managers know the operations well enough to exploit it but do not carry the responsibility of owners.

"You can put controls and processes but they remain static," says Roy, a certified fraud examiner. "People and systems are dynamic and evolve constantly." While making pitches, Roy often runs into companies that believe they are immune to fraud. But those very companies turn clients when a routine test throws up a fraud or weakness. There are systemic weaknesses, too, which India is trying to fix.

Thirteen banks, including the State Bank of India, ICICI Bank and Union Bank of India have floated a company called Loss Data Consortium, or Cordex, to collect data related to frauds.

Still, there remain huge gaps: the absence of a whistleblower protection law being one. Globally, most high-profile frauds have been unearthed through whistle-blowing by employees. Under the Sarbanes-Oxley Act in the United States, for one, it is mandatory for companies to report whistle-blowing incidents and audit committees of the board are required to monitor them. India does not have a parallel stipulation, yet.

Clause 49 of the Listing Agreement for Indian stock exchanges makes it mandatory to report fraud, but businesses avoid disclosing as much as they can to avoid loss to reputation. Says Grant Thornton's Roy, "We handled a case pertaining to fraud causing a loss of Rs 50 crore in a high profile Indian company. But the group localised it in an unlisted subsidiary to avoid disclosure." The dark truth is that most instances of frauds remain just that: under wraps.