Forensic Audit-Thorough View

FORENSIC AUDIT – MEANING

The term ‘forensic audit’ has not been defined under any statue, therefore for the meaning of the same reliance has been placed on dictionary meaning.

In general, Forensic Audit represents an area of finance that combines detective skills and financial acuity.

Forensic audit also known as forensic accounting is an examination of evidence regarding an assertion to determine its correspondence to established criteria carried out in a manner suitable to the court.

Investopedia

Forensic Audit is an examination and evaluation of a firm’s or individual’s financial information for use as evidence in court. A Forensic Audit can be conducted in order to prosecute a party for fraud, embezzlement or other financial claims. In addition, an audit may be conducted to determine negligence or even to determine how much spousal or child support an individual will have to pay.

Collin Greenland (2001), Demystifying Forensic Accounting, The Weekend Observer, Pg. 5, December 7, 2001

Forensic accounting (or auditing) is the integration of accounting, auditing and investigative skills in order to provide an accounting analysis suitable for the resolution of disputes (usually but not exclusively) in the courts.

Jack Bologna and Robert J. Lindquist (1987), Fraud Auditing and Forensic  Accounting : New Tools and Techniques, by, JohnWiley & Sons, New York

Forensic Audit as the application of financial skills and an investigative mentality to unresolved issues, conducted within the context of the rules of evidence. As a discipline, it encompasses financial expertise, fraud knowledge, and a strong knowledge and understanding of business reality and the working of the legal system.

NEED OF FORENSIC AUDIT

With the increase in the financial frauds popularly known as white collar crimes, forensic auditing and accounting have risen to prominence for ensuring the directed growth of the corporates and inclusive growth of economy.

In the contemporary times, when the Government is looking forward for a robust economy and nation building at par, financial stability is a must in the corporates. Henceforth, Forensic audit submits various recompenses in ensuring commercial health of the companies through aiding in the Prevention, Regulation and Penalization of financial frauds and scams.

In the previous years too, India has witnessed financial frauds which affected the golden growth of India’s economy. The Investigations and risk consulting firm Kroll unearthed in their survey 23 that 69% of companies studied were affected by fraud in Financial Year of 2013, up from 68% in the previous year. The value of fraud, the study found, rose, to 71% from 67%. Insider fraud was particularly rife in India, with 89% of respondents indicating the perpetrator was an insider of some sort — a junior, middle management or senior employee, or an agent.

Indeed, the recent upswing in the financial frauds in India, compelling more management to conduct forensic audits in the interest of our growing economy.

Further, provisions of the Companies Act mean that every company now has to have proactive fraud risk management policies. The Act requires independent directors to increase safeguards against fraud and reminds them of their whistleblowing responsibilities.

The Enforcement Directorate and the Serious Fraud Investigation Office have also emphasized the need for forensic audit following the rise in money laundering and Wilful default cases that are plaguing the banking system.

The above discussion confirms that in order to assist in the paramount growth of Indian economy on the global platform under the realm of good governance, transparency, accountability and uprightness, Forensic Audit has become a need of the hour.

WHY FORENSIC AUDIT IS IMPERATIVE?

Forensic Audit is a strategical approach in detecting the financial frauds in the organizations along with enhancing their financial stability at par. In this context, benefits of Forensic Audit are listed below:

1. Detection and Responsibility of Corruption: It aids in detecting the corruption in the corporates and also determine responsibility of the person liable for the corruption and its practices.

2. Detection of Asset Misappropriation: This is the most common and prevalent form of fraud. Misappropriation of cash, raising fake invoices, payments made to non-existing suppliers or employees, misuse of assets, or theft of Inventory are a few examples.

3. Detection of Financial Statement Fraud: This type of fraud tries to show the company’s financial performance as better than what it actually is. The goal is to improve liquidity, ensure top management continue receiving bonuses, or to deal with pressure for market performance. Some examples are, intentional forgery of accounting records, omitting transactions – either revenue or expenses, non-disclosure of relevant details from the financial statements, or not applying the requisite financial reporting standards.

4. Fraud Identification and Prevention: Fraud is quite common in big organizations where the number of daily financial transactions is huge. In such an environment, an employee can easily undertake fraudulent activities without being caught. Forensic accounting helps in analyzing whether the company’s accounting policies are followed or not, and whether all the transactions are clearly stated in the books of accounts. Any deviation observed in the books of accounts can help in identifying fraud, and necessary measures can be taken to prevent it in the future.

5. Making Sound Investment Decisions: It provides a path for investors to make thoughtful investment decisions. Further, many organizations also apply for loans from various financial institutions. By performing an analysis, such institutions can come to a decision on whether they would like to fund a company or not.

6. Formulation of Economic Policies: Various cases of fraud that becomes evident after forensic analysis act as a reference for the government to formulate improved economic policies that would be able to curb such fraudulent activities in the future. So, the government can strengthen the economy and prevent such illegal activities in the country.

7. Rewarding Career Opportunity: As a career, forensic auditing is extremely rewarding, as it not only involves regular auditing and accounting activities, but also involves identification, analysis, and reporting of the findings during an audit. The acceptance of reports generated by a forensic auditors by the court of law, gives them an upper hand as compared to other accountants.

TYPES OF FRAUDS

Fraud in legal parlance could be categorized in two categories, which includes:

1. Fraud as a Civil Wrong, is a tort. While the precise definitions and requirements of proof vary among jurisdictions, the requisite elements of fraud as a tort generally are the intentional misrepresentation or concealment of an important fact upon which the victim is meant to rely, and in fact does rely, to the harm of the victim. victim to prove fraud by clear and convincing evidence.

2. Fraud as a Criminal offence, takes many different forms, some general (e.g., theft by false pretense) and some specific to particular categories of victims or misconduct (e.g., bank fraud, insurance fraud, forgery). The elements of fraud as a crime similarly vary. The requisite elements of perhaps the most general form of criminal fraud, theft by false pretense, are the intentional deception of a victim by false representation or pretense with the intent of persuading the victim to part with property and with the victim parting with property in reliance on the representation or pretense and with the perpetrator intending to keep the property from the victim.

Kinds of Fraud in specific to Economy and Financial Transactions

In specific to the impact on economy and financial transactions, frauds could be categorized as below:

1) Bank frauds

2) Corporate frauds

3) Insurance frauds

4) Cyber frauds

5) Securities frauds

1. Bank Frauds: Bank fraud is a big business in today’s world. The number of bank frauds in India is substantial. It is in increasing with the passage of time in all the major operational areas in banking. There is different area in Bank Deposits, loan, inter branch, accounting, transaction etc.

2. Corporate Frauds: In India, Corporate Frauds from leading Indian business are shaking the economy time and again. From Satyam Computers stunned the national financial world in 2009, when Satyam’s Founder B. Ramalingan Raju declared he had inflated profit and jacked up the company’s Balance Sheet by more than one billion dollars to the recent incident of PNB Fraud in year 2017, Frauds are apparent in the corporates. This needs to be checked strictly to ensure financial stability and emerging economy.

3. Insurance Frauds: There is different type of frauds in insurance sectors. E.g. health insurance, claims fraud, false claims, insurance speculations, application frauds etc.

4. Cyber Frauds: Cyber Frauds are the frauds done with the help of the internet targeting the unauthorized use of digital instruments like credit card, ATM card, cyber equipment’s at home etc.

5. Securities Frauds : Apart from Corporate Frauds, Frauds in the Securities and Securities Market are also affecting many people time and again. From the perspective of frauds in securities, investor community could not forget the under truncate Rs. 4000 crore of Harshad Metha scam and over Rs. 1000 Crore of Ketan Parekh scams which duped the shareholder with the loss of their wealth in the big markets. In addition to this, the instances of Insider trading are also considered securities fraud in many circumstances.

LIVE CASES

Forensic Audit on PNB Scam:

Punjab National Bank conducted forensic audit of jeweller Nirav Modi’s companies, according to people directly briefed on the matter.

The bank issued a formal appointment letter to the Belgium-headquartered audit firm on February 27, 2018 to conduct a forensic audit in the scam wherein Modi, his uncle Mehul Choksi and their companies have been accused of defrauding the bank of as much as Rs 12,700 crore.

In the starting of January, 2018, PNB informed the BSE (Bombay Stock Exchange) that it has detected some “fraudulent and unauthorized transactions” in one of its branches in Mumbai to the tune of $ 1771.69 million (approx.). Following the announcement, the share price of the state-owned bank plunged 10%

Meanwhile, the Central Bureau of Investigation (CBI) received two complaints from PNB against billionaire diamantaire Nirav Modi and Jewellery Company alleging fraudulent transactions worth about Rs. 11, 400 crores, the Press Trust of India reported. This is in addition to the Rs. 280 crore fraud case that he is already under investigation for, again filed by PNB.

Forensic Audit on Dena Bank:

The Finance Ministry ordered forensic audit of Dena Bank and Oriental Bank of Commerce after some of their Mumbai-based branches allegedly misappropriated funds worth Rs. 437 crores, mobilised through fixed deposits. Professional services firm KPMG in India has been given the mandate to undertake forensic investigations. In the case of Dena Bank, the misappropriation was to the tune of Rs. 257 crore and related to funds mobilised from seven corporate. In Oriental Bank’s case, it related to misappropriation of funds amounting to Rs. 180 crore, reportedly belonging to the Jawaharlal Nehru Port Trust. The Central Bureau of Investigation is already looking into the alleged fraud. The developments are disparate ones and took place at different times. The incidents have again brought to the fore the weak risk management systems in public sector banks.

DIFFERENCE BETWEEN AUDIT AND FORENSIC AUDIT

ROLE OF COMPANY SECRETARY

It is reiterated time and again that Good Governance is paramount for the inclusive growth of the country while promoting the community confidence, their participation, transparency, accountability, lead for the better decisions embarking the welfare of the masses and supporting the ethical decision making, which all in consolidation call for the emergent and bright future of the nation at global platform. In the similar context, India has opted to Reform, Perform, Transform under vision New India, 2022, adhering to the best practices of good governance. In this direction, we are witnessing various legal reforms like GST, RERA, IBC, and initiation of amendments in Prevention of Money-laundering Act, 2002 through Finance Act, 2018 and alike.

When talking the all compassing growth, economic growth is one of the significant spheres to be adhered with the premium practices of good governance and henceforth the glitches bugging the emerging growth of economy are tackled by the government at priority.

In this context among other things, Corporate Frauds are considered as one of the major challenges which is obstructing the growth of corporates as well as of economy as a whole.

The role of company secretaries is expending in the era of forensic audit wherein they are crucially assisting in preventing, regulating and penalizing the instance of corporate frauds. Right from conducting forensic audit to examining the evidences, from finding the culprit behind the fraud to appearing in the court for submitted the testimony, a Company Secretary is apt in serving his professional excellence as a forensic auditor.

To summarize, where forensic audit is a detailed engagement which requires the expertise of not only accounting and auditing procedures but also expert knowledge regarding the legal framework, and a forensic auditor is required to have an understanding of various frauds that can be carried out and of how evidence needs to be collected.

In this context, Company Secretary is a Catalyst in Upholding Good Governance via Forensic Audit. His role in specific to Forensic audit is discussed as below.

PROCEDURE

A forensic auditor is required to have special training in forensic audit techniques and in the legalities of accounting issues. A forensic audit has additional steps that need to be performed in addition to regular audit procedures. Forensic Audit could be done with the adoption of the procedure detailed as below:

Step 1 – Accepting the Investigation

A forensic audit is always assigned to an independent firm/group of investigators in order to conduct an unbiased and truthful audit and investigation. Thus, when such a firm receives an invitation to conduct an audit, their first step is to determine whether or not they have the necessary tools, skills and expertise to go forward with such an investigation. They need to do an assessment of their own training and knowledge of fraud detection and legal framework. Only when they are satisfied with such considerations, can they go ahead and accept the investigation.

Step 2 – Planning the Investigation

Planning the investigation is the key step in a forensic audit. The auditor(s) must carefully ascertain the goal of the audit so being conducted, and to carefully determine the procedure to achieve it, through the use of effective tools and techniques. Before planning the investigation, they should be clear on the final categories of the report, which are as follows,

• Identifying the type of fraud that has been operating, how long it has been operating for, and how the fraud has been concealed.
• Identifying the fraudster(s) involved.
• Quantifying the financial loss suffered by the client.
• Gathering evidence to be used in court proceedings.
• Providing advice to prevent the recurrence of the fraud.

Fraud Triangle and Fraud Risk

A fraud triangle is a tool used in forensic auditing that explains three interrelated elements that assist the commission of fraud- Pressure (motive), opportunity (ability to carry out the fraud) and rationalization (justification of dishonest intentions). Fraud risk is the vulnerability, a company/organization has towards those who are capable of overcoming the three elements in the fraud triangle. Fraud risk assessment is the identification of fraud risks that exist in the company/organization. The planning involves the formulation of techniques and procedures that align with the fraud risk and fraud risk management.

Planning also includes the identification of the best way/mode to gather evidence. Thus, it is necessary that ample research is done regarding certain investigative, analytical, and technology-based techniques, and also related legal process, with regard to the outcome of such investigation.

Step 3 – Gathering Evidence

In forensic auditing specific procedures are carried out in order to produce evidence. Audit techniques and procedures are used to identify and to gather evidence to prove, for example, how long have fraudulent activities existed and carried out in the organization, and how it was conducted and concealed by the perpetrators. In order to continue, it is pertinent that the planning stage has been thoroughly understood by the investigating team, who are skilled in collecting the necessary evidence. Techniques such as computer-assisted audit techniques, discussions and interviews with employees, reconciliations, cash counts and reviews of documentation, forensic data analysis, electronic and physical surveillance etc. can be used.

Step 4 – Reporting

The reporting stage is the most obvious element in a forensic audit. After investigating and gathering evidence, the investigating team is expected to give a report of the findings of the investigation, and also the summary of the evidence and conclusion about the loss suffered due to the fraud. It should also include the plan of the fraud itself, and how it unfolded, basically the whole trail of events, and suggestions to prevent such fraud in the future.

Step 5 – Court Proceedings

The last stage expands over those audits that lead to legal proceedings. Here the auditors will give litigation support as mentioned above. The auditors are called to Court, and also included in the advocacy process. The understanding here is that they are called in because of their skill and expertise in commercial issues and their legal process. It is important that they lay down the facts and findings in an understandable and objective manner for everyone to comprehend so that the desired action can be taken up. They need to simplify the complex accounting processes and issues for others to understand the evidence and its implications

RED FLAGS

√ Red flags are nothing but symptoms or indicator of situation of fraud.

√ A red flag is a set of circumstances that are unusual in nature or vary from the normal activity.

√ It is a signal that something is out of the ordinary and may need to be investigated further.

Note: Red Flags aids the Auditor’s Responsibility to Consider Fraud & Error. It is effective for all audits relating to accounting periods commencing on or after 1st April 2009.

Common Types of Red flags

The most common types of Red Flags and fraudulent activity can be categorized as:

1. Employee Red Flags are like, employee lifestyle changes, expensive cars, jewellery, homes, Significant personal debt and credit problems, behavioural changes (these may be an indication of drugs, alcohol, gambling)

2. Management Red Flags are like, reluctance to provide information to auditors, Managers engage in frequent disputes with auditors, Management decisions are dominated by an individual or small group, Managers display significant disrespect for regulatory bodies , weak internal control environment, Accounting personnel are lax or inexperienced in their duties, Significant downsizing in a healthy market Continuous rollover of loans, Unexpected overdrafts or declines in cash balances Frequent changes in banking accounts, Frequent changes in external auditors etc.

GREEN FLAGS

Above discussion on Red Flags says that red flags are symptoms or indicators of fraud, white collar crime or something detrimental to the interest of the organization. To the contrary there are other signals which could also imply the existence of fraud but do not activate alarm bells. Rather they may even lead to a greater sense of assurance and comfort in a scenario which may be potentially infused with fraud. These signals are referred as ‘green flags’.

The instance of Green Flags could b heelpful in identifying are unusual signs or inconsistencies, but apparently harmless or perhaps even helpful.

LEGAL FRAMEWORK

The position of Laws and Regulations dealing with Corporate Fraud and also aids in achieving forensic audit would be discussed under the following heads:

1. Companies Act, 2013

2. Indian Penal Code

3. Prevention of Corruption Act, 1988

4. Information and Technology Act, 2000

5. SEBI Act, 1992

6. ICSI Anti Bribery Code.

CASE LAWS

Sahara Group Scam

Sahara Group chairman Subrata Roy and Vijay Mallya had a lot in common. Both successful businessmen had a passion for sports. The two also had their own IPL teams, Sahara Pune Warriors and Royal Challengers Bangalore (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 one team.

Sahara Group was accused of failing to refund over Rs. 20,000 crores to its more than 30 million small investors which it collected through two unlisted companies of Sahara.

In 2011, SEBI ordered Sahara to refund this amount with interest to the investors, as the 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 to settlement of the matter was rejected by the court and SEBI.

Satyam Computers

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 5 years, from 2003-2008. The amount misappropriated in this case is estimated to be around Rs. 7,200 crore.

In April 2015, Ramalinga Raju and his brothers were sentenced to 7 years in jail, and fined Rs. 5.5 crore.

Some governance problems, which have been noticed in the collapse of Satyam are unethical conduct, avoiding tax payment, false books and bogus accounting, Unconvinced role of independent Directors, Questionable role of Audit Committee, Dubious Role of Rating Agencies, Fake Audit.

Saradha Chit Fund

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 which enjoyed strong political backings collapsed in April 2013. The amount investors lost is estimated to be between Rs. 2060 – 2400 crores.

Ketan Parekh Scam

Parekh was involved in circular trading and stock manipulation through 1999­2001 in a host of companies. He borrowed from banks like 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 direct confirmation from bank was not sought despite the materiality of the same. IN PNB, Swift messages serial number wise should have traced to the transaction entry in the general ledger at least on test check basis and the scam would have come to light automatically much earlier.

The Author may be reached at [email protected] or at 9675899911.