ABSTRACT
In this article, the author aims to examine the adequacy of Companies Act, 2013 against corporate frauds through analysing the definition of fraud as per Section 447 of Companies Act, 2013 and the flaws that are present with the reporting duty of auditors and independent directors. The author also tries to highlight that in spite of regulatory mechanisms and procedural laws, because of prevalence of corruption, corporations and their employees manage to effectuate frauds that costs huge losses to the nation. A proper implementation of present mechanisms with the setting up of internal vigilance committee may prevent corporate frauds.
INTRODUCTION
The prevalence of corporate fraud is not new. It is widely used and comes in a variety of shapes, sizes, and forms. Occasionally, it is observed that numerous companies or persons on behalf of the company engage themselves in ways that ultimately prove to be quite fatal. Corporate fraud is the term used to describe such misrepresentations made by any company or person while operating within the corporate culture. When such activities are discovered, the corporation frequently has to deal with very serious repercussions for the wrongdoings that its employees committed.[i] Before Sec. 447 of CA, 2013 was introduced, the instances of fraud used to be dealt with the provisions of Indian Penal Code, 1860, namely Ss. 406, 420, 465, 477-A etc. However, a particular provision was deemed necessary due to the intricacy of corporate frauds, the magnitude of their effects, and the growing need to thoroughly investigate and punish them. Although with the passage of time, the adequacy of even Section 447 is questionable.
ANALYSIS OF DEFINITION OF FRAUD U/S 447
Section 447 of Companies Act, 2013 gives punishment for fraud.[ii]
Upon analyzing the definition, it is to be highlighted that the section does not actually defines fraud. On the contrary, the explanation to the section does. It can be found that it is so much open-ended that there are loopholes which are often utilized by the companies because of two reasons-
- Firstly, the definition given merely illustrates what can be a fraud which makes it an inclusive one and not an exhaustive one. It leaves spaces to include more acts to be qualified as fraud. Now, with this character the question arises as to who will decide what to be included as fraud and what not? That is not the way criminalizing provisions works.
- Secondly, the phrases, “the interests of” and “any other person” are too wide to be interpreted. This is leading to vagueness. It was held in the case of Skilling v. United States[iii], ‘a penal statute must define the criminal offense (1) with sufficient definiteness that ordinary people can understand what conduct is prohibited; and (2) in a manner that does not encourage arbitrary and discriminatory enforcement.’ “Criminal laws that do not specifically and clearly explain which activity or omission results in criminal penalties may be challenged on the grounds that they are invalid due to ambiguity. This is due to the fact that ambiguous statutes can result in arbitrary and prejudiced prosecutions and place an excessive amount of power in the hands of the investigators.”[iv]
Similar to this, the court overturned a legislation that criminalised “goondas” in the case of State of MP vs. Baldeo Prasad[v] on the grounds that it did not adequately define what a “goonda” was. Here, the legislation’s (Central Provinces and Berar Goondas Act, 1946) definition of a “goonda” was broad in nature without including any clear-cut criteria so as to determine a person as a “goonda” or not And, the CA, 2013’s Sec. 447 has a similar issue.[vi]
FLAWS IN REPORTING DUTY OF AUDITORS AND INDEPENDENT DIRECTORS
Within 30 days, auditors must notify the Central Government of material fraud. Immaterial fraud must be disclosed to the board or the company’s audit.
Each public listed firm must have a procedure for the directors and the employees to report any legitimate concerns, according to the audit committee’s mandate. The vigil mechanism must have sufficient protections against victimisation of those who use it. In suitable cases, it shall provide for direct access to the Audit Committee’s chairperson.
Independent directors shall report concerns about fraud, whether it is real or just suspected. Additionally, they must verify and affirm that the corporation has a sufficient and effective vigil mechanism and that anyone using it won’t have their interests prejudicially impacted as a result.
The structure and responsibilities of the board’s audit committee are covered in great detail in Audit Committee Clause 49.[vii] The audit committee’s authority over related party transactions is limited by Clause 49. Its main responsibility has been to make sure linked party transactions are adequately disclosed. This leads to the paradoxical situation where related party transactions can go unnoticed unless they are disclosed on a regular basis in the company’s financial statements.[viii] Given this context, it is necessary for the audit committee to “monitor and approve all related party transactions, including any modification or amendment in any such transaction”, as stated in the Guidelines.[ix] It is a significant step toward establishing checks and balances against insiders, such as controllers, extracting value from the corporation, and it expressly acknowledges that related party transactions should be reviewed by an outside watchdog, the audit committee, rather than just being disclosed.[x] On the other hand, it can be argued that the Guidelines are not sufficiently thorough in protecting minority shareholders from value-diminishing transactions that could benefit controlling owners. Furthermore, related party transactions should be approved by a committee made up of independent directors. However, it is uncertain whether the same outcome will occur if the audit committee, which consists both independent and non-independent directors, is given approval rights.[xi]
The current mechanism for appointing auditors has been criticised for being susceptible to capture by the controlling shareholders, which is similar to the situation with independent directors. As a result, the Guidelines stipulate that the audit committee should serve as the initial point of auditors’ appointment.[xii] The auditors must also prove their independence to the company, just like independent directors.[xiii] The Guidelines mandate that the audit partner and audit firm be switched every three years and every five years, respectively, to maintain independency.[xiv] However, there have been complaints about the formation of audit firms in India, the weak enforcement of current regulations, and the absence of adequate regulation of auditors and audit firms.[xv]
CONCLUSION
After Satyam scam, the market regulator SEBI modified the 2013 Companies Act and Corporate Governance Code, since the case involved more collusion than negligence on the part of the company’s auditors. Rotation of the auditors and to declare shares pledged by the company’s promoters mandatorily, were both introduced in India. [xvi]
Vijay Maliya of Kingfisher owes a total of 9000 Crores to the 17 banks in India. When this became known to the public, he ran away from the nation. The Indian government seized his assets, accounts, and Goa home.[xvii] It was an infamous case of non-performing assets, which resulted in a substantial loss for banks like SBI and IDBI.
The lack of literacy among investors and innocent individuals who have no interest in learning about the business complexity taking place behind the corporate veil is one of the factors contributing to the fraud rate’s steady growth. Additionally, as a result of technological advancements, international boundaries have been broken and spam fraud has become quite simple. The Companies Amendment Act of 2013 and the Insolvency Code of 2016 were both introduced, and the market regulators SEBI and RBI frequently passed rules and policies in an attempt to prevent and stop frauds. However, each time, it is the human trait of greed that fuels corporate corruption, as major scams in India have demonstrated.[xviii]
One more fallacy is, while the Guidelines do a good job of recognising the significance of related party transaction approval by a supposedly independent committee, they miss the chance to set up adequate checks and balances that may prevent value extraction from minority shareholders through such transactions, which are found to be widespread in countries like India where companies with controlling shareholders predominate.[xix]
It is unclear whether the Guidelines will continue in their current form in the future or if they will become more formal and mandatory. The rules may become obligatory in the upcoming years, according to the government.[xx]
SUGGESTIONS:
- India should devise stricter measures to punish those responsible for scams so as to protect legitimate investors and the hard-earned money of the common citizen.
- There exists enough rules, regulations and guidelines, the agencies should work on their proper implementation.
- Prevalence of corruption is one of the very major reasons of fraud which must be eradicated through setting up of a Vigilance Committee internally in a company.
[i] Adv. Sakshi Shairwal, Corporate Fraud – an Understanding, Lexology, www.lexology.com/library/detail.aspx?g=f14e4ac0-4ead-409e-a7f5-74d596bb9b26 (last visited April 11, 2023).
[ii] The Companies Act (2013), § 447.
[iii] 2010 SCC OnLine US SC 82 : 177 L Ed 2d 619 : 561 US 358, 402-403 (2010).
[iv] Bharat Chugh, Definition of “Fraud” under the Companies Act: A case of a blurred signpost to criminality,
https://www.scconline.com/blog/post/2021/02/08/definition-of-fraud-under-the-companies-act-a-case-of-a-blurred-signpost-to-criminality/ (last visited April 11, 2023).
[v] AIR 1961 SC 293.
[vi] Supra Note, 4.
[vii] Varottil, Umakanth, “India’s Corporate Governance Voluntary Guidelines 2009: Rhetoric or Reality?”, NLSIR 22, no. 2 (2010): 1–28, https://repository.nls.ac.in/cgi/viewcontent.cgi?article=1105&context=nlsir (accessed April 11, 2023).
[viii] Sharma, Seema, “Corporate Social Responsibility in India- The Emerging Discourse & Concerns”, IJIR 48, no. 4 (2013): 582–596, http://www.publishingindia.com/ijir/22/corporate-social-responsibility-in-india-the-emerging-discourse-concerns/286/2096/ (accessed April 11, 2023).
[ix] Ministry of Corporate Affairs, Corporate Governance Voluntary Guidelines, § III.C.ii (2009).
[x] Paying the Price: Satyam ‘s Auditors Face Plenty of Questions, Knowledge at Wharton Staff, https://knowledge.wharton.upenn.edu/article/paying-the-price-satyams-auditors-face-plenty-of-questions/ (last visited April 11, 2023).
[xi] Sood, Ashima, “Urban Multiplicities: Governing India’s Megacities”, Review of Urban Affairs 48, no. 13, (2013): 95–101, https://www.epw.in/journal/2013/13/review-urban-affairs-review-issues/urban-multiplicities.html (accessed April 11, 2023).
[xii] Ministry of Corporate Affairs, Corporate Governance Voluntary Guidelines, § IV.A.
[xiii] Ministry of Corporate Affairs, Corporate Governance Voluntary Guidelines, §IV.B.
[xiv] Ministry of Corporate Affairs, Corporate Governance Voluntary Guidelines, § IV.C.
[xv] Supra Note, 10.
[xvi] Ministry of Corporate Affairs, Companies (Audit and Auditors) Rules, § 6 (2014).
[xvii] MARYAM HUSSAIN, CORPORATE FRAUD THE HUMAN FACTOR (Bloomsbury USA, 2014).
[xviii] ROBIN BANERJEE, WHO CHEATS AND HOW? SCAMS, FRAUD AND THE DARK SIDE OF THE CORPORATE WORLD (SAGE Publications, 2015).
[xix] Frank Yu & Xiaoyun Yu, “Corporate Lobbying and Fraud Detection”, The Journal of Financial and Quantitative Analysis 46, no. 6 (2011): 1865–1891, https://www.cambridge.org/core/journals/journal-of-financial-and-quantitative-analysis/article/abs/corporate-lobbying-and-fraud-detection/3A409C91901654D06A9567BE53C8AE3F (accessed March 7, 2023).
[xx] “7 Voluntary Norms May Be Mandatory”, THE TRIBUNE (April 30, 2010), http://www.tribuneindia.com/2010/20100501 (accessed March 7, 2023).
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By Yashika Soni, 3rd Year Student, Dharmashastra National Law University, Jabalpur
Author Bio
