CS Divyanshu Sahni
The financial/ corporate frauds and scams which have taken place in India, required the attention of the Law makers. It was high time to evaluate the high standards in corporate governance and implement stringent provisions to tackle corporate Fraud. The problem was on the rise both in its frequency and severity. The increasing rate of white-collar crimes demanded stiff penalties, exemplary punishments and effective enforcement of law with the right spirit.
Our country has witnessed several corporate Frauds, till date e.g. Rs. 5,000 crore Harshad Mehta scam in 1992, Rs. 7,000 crore Satyam fiasco in 2009, the Rs. 27,000 crore Sahara fraud case which started in 2010 and is sub-judice at the Supreme Court currently.
The notification issued on the 15th of December, 2015, by the Ministry of Corporate Affairs (MCA), has made the provisions of section 13 of the Companies (Amendment) Act, 2015 (21 of 2015) effective from the December 14, 2015.
Section 13 of the aforementioned Act pertains to sub-section (12) of section 143 of the Companies Act, 2013 (the Act), which deals with reporting of fraud by the auditor.
Section 143 (12) states that –
“Notwithstanding anything contained in this section, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed:
Provided that in case of a fraud involving lesser than the specified amount, the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as may be prescribed:
Provided further that the companies, whose auditors have reported frauds under this sub-section to the audit committee or the Board but not reported to the Central Government, he shall disclose the details about such frauds in the Board’s report in such manner as may be prescribed.”
Section 143 (13) of the Act states that–
“No duty to which an auditor of a company may be subject to shall be regarded as having been contravened by reason of his reporting the matter referred to in sub-section (12) if it is done in good faith.”
From the reading of the above provisions, one can deduce that the auditor ought to report, if he has reason to believe, any offence involving fraud being committed in the company. This reporting of fraud will be construed to have been done in the best interests of the company without prejudice to the other obligations and duties of the auditor.
What is fraud?
At this juncture we need to understand what constitutes the term “fraud”. Though the word “fraud” is subjective and might take in its ambit any degree, types or acts as fraud, it is important for us to have a distinct view on the same.
Although Section 143 of Act, 2013 does not give any basis for determining an act or deed as
‘Fraud, we may refer to Section 447 which states the penal consequences for fraud.
Explanation (i) to section 447 introduces a definition, reproduced herein below –
“fraud” in relation to affairs of a company or anybody 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
However, since the above definition is restricted to prosecution and for understanding the notion of ‘fraud’ under Section 143, we certainly have to look for an independent rendition and cannot read it restricting ourselves to the provisions of Section 447.
An extensive definition of ‘fraud’ can be drawn from section 17 of the Indian Contract Act,
1872, which states –
“Fraud” means and includes any of the following acts committed by a party to a contract, or with his connivance, or by his agents, with intent to deceive another party thereto his agent, or to induce him to enter into the contract;
This indicates that to identify an act to be fraudulent, the following points have to be proved –
i. the suggestion as a fact, of that which is not true, by one who does not believe it to be true;
ii. the active concealment of a fact by one having knowledge or belief of the fact;
iii. the suggestion should be found to have been made with intent either to deceive or to induce the other party to enter into contract in question. The course of action
EXPLANATION TO THIS DEFINITION
In order to amount to Fraud, an act must be confined to acts committed by a party to contract with an intention to deceive another party or his agent or to induce him to enter into a contact.
Fraud, which vitiates the contract, must have a nexus with the acts of the parties entering into the contract.
This definition highlights the precondition to prove the intention of the person who has committed Fraud. If that person has willingly committed a Fraud, then he will be punished. Here the person means himself or his agent. The acts which include fraud are wrong suggestions or concealment of facts or false promises or any fraudulent act to deceive others.
Now comes in the question whether all kinds of frauds irrespective of the magnitude ought to be reported. In a company numerous kinds of fraud may occur. These may be in any department done by any individual. This indicates that fraud reporting is nothing less than entering a maze. Hence there should be some guidance on the basis of which the auditors decide upon which frauds to report about. Rule 13 (1) of the Companies (Audit and Auditors) Amendment Rules, 2015 specifies the amount of Rupees One Crore and above, individually, against the company.
Few guiding factors which may be taken into consideration are:-
1. The concept of materiality has to be comprehensive in nature, both quantitative and qualitative.
2. Being a disclosure requirement, the quantitative substantiality of the error should be a deciding factor.
3. The intent behind the fraud committed and the extent of the after-effects should also be taken into consideration
This has been inferred from the International Accounting Standards Committee (IASC) (1989) where information has been considered as material, on the basis of quantum and the intent to effect the decision making of the concerned stakeholders –
“Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement…” (Emphasis supplied)
New highlight: – With the previous rule 13 of the Companies (Audit and Auditors) Rules, 2014 being substituted, auditors have a quantum defined on the basis of which he has to report. If the amount of fraud is rupees One Crore or above the auditor shall report to the Central Government and if the amount of fraud involved is less then, the auditor shall report the matter to Audit Committee constituted under section 177 or to the Board immediately but not later than two days of his knowledge of the fraud.
Manner of reporting
The manner of reporting under Section 143(12) read with Rule 13 of the Companies (Audit and Auditors) Rules, 2014, is explained further –
i. Immediately on detection of the fraud, even if he has sufficient reason to believe the committing of a fraud, the Auditor shall forward his report to the Board or the Audit Committee, as the case may be, seeking their replies /observations within 45 days from such intimation.
ii. In case replies/observations are received in due time, the Auditor shall forward his report along with his comments on the Board/Audit Committee’s replies/observations to the
Central Government within 15 days of receipt of such replies/observations;
iii. In case no replies/observations are received within the stipulated time of 45 days, the Auditor shall forward his report to the Central Government, along with a note stating that the report, earlier forwarded to the Board/Audit Committee, has failed to receive any reply/observation on it.
iv. The report (in the format of ADT-4) should be sent to the Secretary, Ministry of Corporate Affairs, in a sealed cover by Registered Post with Acknowledgement Due or by Speed post followed by an e-mail in confirmation of the same.
v. These shall apply to both the cost as well as the secretarial auditor.
In case of a fraud involving lesser than the amount specified in sub-rule (l), the reporting will be in the following manner-
i. The auditor shall report the matter to Audit Committee constituted under section 177 or to the Board immediately but not later than two days of his knowledge of the fraud and
ii. he shall report the matter specifying the following:-
(a) Nature of Fraud with description;
(b) Approximate amount involved: and
(c) Parties involved.
The following details of each of the fraud reported to the Audit Committee or the Board during the year shalt be disclosed in the Board s Report:-
(a) Nature of Fraud with description;
(b) Approximate Amount involved;
(c) Parties involved, if immediate action is not taken: and
(d) Remedial actions taken.
Penal provisions in case of non-compliance of section 143 sub-section 12
The reporting of fraud has been taken as a serious duty of any genre of auditor. If the auditor fails to report the fraud, as required under section 143 sub-section 12, he has to face penal provisions stated under sub-section 15 of section 143.
Section 143 (15) states 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.
It also takes into its ambit the company secretary along with cost accountant and auditor. Hence compliance must be strictly done so as to avoid the penalty and also for the best interests of the company.
Fraud is unavoidable, and for those in business, it is an occupational hazard. The costs and long-term effects of fraud are many. Organisation that are victims of fraud not only bear the cost of the fraud itself but also the costs of investigating the fraud, of clearing up the problem and of ensuring there is no reoccurrence. Fraud is on the rise and it is therefore necessary to fight against fraudulent activities and financial misconduct. Fighting fraud through education, prevention, detection and, ultimately, the prosecution and punishment of fraudsters should be seriously considered by every organization’s management team and it should be incorporated into the organization’s strategy.