CS Ambika Mehrotra
Frauds have become quite a common occurrence in the corporate sector. From the medieval crimes such as robbery, arson and other crude forms of crime, present-day use of technology has given rise to skilfully crafted and conducted frauds. Corporates are, at times, victims of fraud, as culprits. While the latter case may not be the subject matter for immediate discussion, the former has become quite common.
Fraud may be painful; the consequential reporting requirements may only increase the pain. Here is a guide to fraud reporting under Companies Act and RBI Regulations in case of NBFCs:
Q.1 What is fraud in terms of Companies Act, 2013?
Ans: As per Explanation (i) to section 447, “fraud” in relation to affairs of a company or any body corporate, includes
any act, or
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.
Q.2 What is the common law meaning of fraud?
Ans: The term fraud draws its inference from Section 17 of the Indian Contract Act, 1872 as “the acts committed by a party to a contract, or with his connivance, or by his agents , with intent to deceive another party thereto or his agent, or to induce him to enter into the contract-
(1) the suggestion, as a fact, of that which is not true, by one who does not believe it to be true;
(2) the active concealment of a fact by one having knowledge or belief of the fact;
(3) a promise made without any intention of performing it;
(4) any other act fitted to deceive;
(5) any such act or omission as the law specially declares to be fraudulent.”
The above termisalso defined under Regulation 2 (1)(c )of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.
a. State Of Maharashtra vs Dr. BudhikotaSubharao, 1993 SCC,
The Supreme Court in the above matter held that ,“’Fraud’ is false representation by one who is aware that it was untrue with an intention to mislead the other who may act upon it to his prejudice and to the advantage of therepresentor.”
b. Kamlaben Punjabhai Solanki v/s High Court of Gujarat,
“Fraud means an intrinsic, collateral act, and fraud of an egregious nature would vitiate the most solemn proceedings of court of justice. Fraud is an act of deliberate deception with a design to secure something, which is otherwise not true. The expression fraud involves two elements, deceit and injury to the person deceived. It is a cheating intended to get an advantage.”
c. Vimla (Dr.) vs. Delhi Administration, AIR 1963
“whenever the words “fraud” or intent to defraud” or “fraudulently” occur in the definition of a crime two elements at least are essential to the commission of the crime : namely, first, deceit or an intention to deceive or in some cases mere secrecy ; and secondly, either actual injury or possible injury or to a risk of possible ‘injury by means of that deceit or secrecy.”
d. In Haycraft v. Creasy (1) LeBlanc, observed (1) (1801) 2 East 92
“by fraud is meant an intention to deceive; whether it be from any expectation of advantage to the party himself or from the ill-will towards the other is immaterial.”
In essence, it is not important that the fraudster should be standing to gain by virtue of the fraud.
Q.3 What are the elements of frauds?
Ans: The United States, common law generally identifies nine elements needed to establish fraud:
a. a representation of fact;
b. its falsity;
c. its materiality;
d. the representer’s knowledge of its falsity or ignorance of its truth;
e. the representer’s intent that it should be acted upon by the person in the manner reasonably contemplated;
f. the injured party’s ignorance of its falsity;
g. the injured party’s reliance on its truth;
h. the injured party’s right to rely thereon; and
i. the injured party’s consequent and proximate injury.
Q.4 What can be the possible instances for occurrence of fraud?
Ans: The common element behind any fraud is the intent to deceive.. Some the instances for the same can be as represented below:-
a. Manipulation of accounts
b. Misrepresentation or omission of facts
c. Misapplication of accounting principles
d. Misue of information
e. Corruption, bribes or kickbacks
f. Theft/ misuse in assets
g. Improper payments/ false expenses
In furtherance to the above, frauds have been classified as under in Chapter III of NBFCs (Reserve Bank) Directions, 2016 mainly based on the provisions of the Indian Penal Code:
a. Misappropriation and criminal breach of trust
b. Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property
c. Unauthorized credit facilities extended for reward or for illegal gratification.
d. Negligence and cash shortages
e. Cheating and forgery
f. Irregularities in foreign exchange transactions
g. Any other type of fraud not coming under the specific heads as above.
Q.5 Who can detect frauds?
Ans: Apart from those persons in every organization who are responsible for ensuring the adequacy of compliances or scrutinizing the events which occurred, any person may act like a whistleblower in detecting frauds and bringing the same to light.
Following are the persons most likely to detect the occurrence of any fraud :-
a. Audit Committee
b. Risk Management Committee
d. Auditors (Internal and External)
f. External Authorities
g. Business Partners
h. Other stakeholders
Q.6 What if the fraud is detected by the auditor?
Ans: Pursuant to the provisions of Section 143 (12) of the Companies Act, 2013, where the auditor has a reason to believe that an offence of fraud involving such amount as prescribed in Rule 13 of the Companies (Audit and Auditors) Rules,2014 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 the specified timeline and as per the manner prescribed in the above rules.
Further, in the cases where the fraud involves any amount lesser than the specified amount, the auditor shall report the matter to the audit committee constituted, if any or to the Board in other cases within the timeline and the manner prescribed in the above rules. In cases where auditors have reported frauds to the audit committee or the Board but not reported to the Central Government, the board shall disclose the details about such frauds in the Board’s report.
Also, as per Para A of Part C under Schedule II of SEBI LODR, 2015, in case the fraud is disclosed by the internal auditors, the Audit Committee shall review their findings if there is suspected fraud of material nature and shall report the matter to the board.
Q.7 What if the fraud is detected by any employee of the company?
Ans: A fraud as understood from its meaning can be detected by any person working in an organization. Listed Companies and other companies as prescribed under section 177 are required to constitute a vigil mechanism for the directors and employees to report genuine concerns. The reporting is to be done in the manner prescribed under Rule 7 of the Companies (Meetings of Board and its Powers) Rules, 2014.
Q.8 Is there a role of whistleblower policy relevant for fraud detection?
Ans: The vigil/whistleblower mechanism in a company is for the employees to report genuine concerns inter aliaincluding frauds. Also, Regulation 4(2)(d)(iv) read with Regulation 22 of SEBI LODR, 2015 provides listed entities to devise an effective whistle blower mechanism enabling stakeholders, including individual employees, directors and their representative bodies, to freely communicate to the management their concerns about illegal or unethicalpracticesThe mechanism makes provision for direct access to the chairperson of the Audit Committee in appropriate cases. It also provides for adequate safeguards against victimization of employees and directors who avail of the same. Thus, the whistle blower policy may also be a means for identifying frauds by those persons covered in itand the manner of dealing with such information as and when it comes across.
9. What are the compliances on occurrence of frauds?
Ans: Lack of effective corporate governance undermines any fraud risk management policies or controls functioning in an organization. It is only through meticulous and ongoing effort by an organization through which it can protect itself against significant acts of fraud.
Considering the provisions of Companies Act and SEBI Listing Regulations, 2015 following shall be the actionables in the event of occurrence and detection of frauds:
a. Regulation 30 read with Schedule III
b. Regulation 30(8)
c. Para A of Part C under Schedule II
d. Section 134(3) read with Section 143(12)
e. Regulation 17 (8) read with Schedule II
10. What are the reporting requirements for NBFCs?
Ans: All systemically important and deposit taking non-banking financial companies are required to comply with the requirements provided under Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016in order to put in place a reporting system for recording frauds. Chapter IV of the abovementioned master directions deal with the Reporting of Frauds to Reserve Bank of India.
The reporting requirements are specified hereunder:-
|Instances for reporting||Reporting Requirements||Format Prescribed|
|Frauds involving ₹ 1 lakh and above||a. reports in the prescribed format shall be sent within three weeks from the date of detection of the fraud to ‘Central Fraud Monitoring Cell’ of RBI; and
b. to the Regional Office of the Department of Non Banking Supervision of the Bank under whose jurisdiction the Registered Office of the applicable NBFC falls.
c. case-wise quarterly progress reports on frauds involving ₹ 1 lakh to be submitted to the Regional Office of RBI, Department of Non-Banking Supervision under whose jurisdiction the Registered Office of the applicable NBFC falls within 15 days of the end of the quarter to which it relates.
|Where the amount involved in fraud is less than ₹ 1 crore, reporting to be done in the format given in FMR – 1
Format in FMR-3 only
|Frauds committed by unscrupulous borrowers||In respect of frauds in borrowal accounts, additional information as prescribed under Part B of FMR – 1 should be furnished|
|Frauds involving ₹ 1 crore and above||In addition to the requirements given above, applicable NBFCs shall report the fraud by means of a D.O. letter addressed to the Chief General Manager-in-charge of the Department of Banking Supervision, Reserve Bank of India, within a week of such frauds coming to the notice
A copy of the D.O. letter should be endorsed to the Regional Office of RBI
|The letter shall contain brief particulars of the fraud such as:-
a. amount involved, nature of fraud,
b. modus operandi in brief,
c. name of the branch/office,
d. names of parties involved (if they are proprietorship/ partnership concerns or private limited companies, the names of proprietors, partners and directors),
e. names of officials involved, and
f. whether the complaint has been lodged with the Police
|Cases of attempted fraud involving ₹ 25 lakh or more||The report on the such cases to be placed before the Audit Committee||The report shall contain:-
a. The modus operandi of the attempted fraud;
b. How the attempt did not materialize in the fraud or how the attempt failed / was foiled;
c. The measures taken by the applicable NBFC to strengthen the existing systems and controls;
d. New systems and controls put in place in the area where fraud was attempted;
e. In addition to the above, yearly consolidated review of such cases detected during the year containing such information as prescribed, within three months of the end of the relative year.
Q.11 Which returns are required to be filed as per above master directions on frauds?
Ans: Chapter V of the Master Directions deals with the quarterly returns to be filed wrt the frauds.
The returns to be filed are as follows:-
|Purpose of reporting||Requirements||Formats Prescribed|
|Report on Frauds Outstanding||Applicable NBFCs shall submit:-
a. copy of the Quarterly Report on Frauds Outstanding to be submitted to the Regional Office of the RBI, within 15 days of the end of the quarter to which it relates
b. a certificate, as part of the above report, to the effect that all individual fraud cases of ₹ 1 lakh and above reported to RBI in FMR – 1 during the quarter have also been put up to the applicable NBFC’s Board and have been incorporated in Part – A (columns 4 and 5) and Parts B and C of FMR – 2
The total number and amount of fraud cases reported during the quarter as shown in Parts B and C should tally with the totals of columns 4 and 5 in Part – A of the report.
|Progress Report on Frauds||a. furnish case-wise quarterly progress reports on frauds involving ₹ 1 lakh and above (where the amount involved in fraud is ₹ 1 crore and above ) to the Central Office of the Department of Banking Supervision of RBI, and
b. to Regional Office of the, Department of Non-Banking Supervision of the Bank under whose jurisdiction the Registered Office of the applicable NBFC falls where the fraud amount involved in fraud is less than ₹ 1 crore within 15 days of the end of the quarter to which it relates
c. In the case of frauds where there are no developments during a quarter, a list of such cases with a brief description including name of branch and date of reporting shall be furnished
|FMR – 3|
Q.12 Which instances are required to be intimated to the police by the NBFCs?
Ans: The following cases should invariably be referred to the State Police:
a. Where fraud committed by outsider: Cases of fraud involving an amount of Rs. 1lakh and above, committed by outsiders on their own and/ or with the connivance of NBFCs staff/ officers;
b. Where fraud committed by insider: Cases of fraud committed by employees of NBFCs, when it involves the NBFCs funds exceeding Rs. 10,000/-
Q.13 What is the impact of frauds on the internal financial controls of a company?
Ans: As per the explanation provided under Section 134 (4) “internal financial controls” means “the policies and procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.”
As enumerated under Sec 134(5) of Companies Act, 2013(“Act”) , the Directors Responsibility Statement shall include a declaration from Director that internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively. Also, as per Rule 8(4) of the Companies (Accounts) Rules, 2014 ,“the details in respect of adequacy of internal financial controls with reference to the Financial Statements” are required to be included in the board’s report. Accordingly, any occurrence of fraud in the organization is a reflection of the inadequacy or a weak internal control systems existing in an organization. Therefore, the details of such fraud shall be disclosed in the Board’s Report.
Q.14 Is there impact on the IFC reporting earlier done ?
Ans: As mentioned above, all the companiesare required to confirm with the requirements internal financial controls. However, despite of having such system, the occurrence of frauds depictssome gap / lack of system / practice in the way they are working. Accordingly, this puts a question on the reporting done previously. In general practice, the companies disclose such inadequacy which related to the financial statements under the specified headin the directors report for the year in which the fraud has been detected. However, in case the investigation/ detection of fraud reveals dome gap which actually existed in the past, the same should form a part of the declaration made by the directors in this regard under the Directors Responsibility Statement in the Board’s Report.
Q.15 What are the penalties wrt frauds?
Ans: Different statutes concerning frauds prescribe different set of punishment for the persons guilty for the same. Section 447 of Companies Act 2013 specifically prescribes that the person who is guilty of fraud involving an amount of at least 10 lakh rupees or 1% of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term not less than 6 months and up to 10 years and fine, which shall not be less than the amount involved in the fraud and may extend to thrice of such amount. However, if the fraud involves public interest, the minimum imprisonment to be awarded shall be 3 years.
In case the fraud involves an amount less than 10 lakh rupees or 1% per cent. of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to 5 years or with fine which may extend to 50 lakh rupees or with both
(Author is associated with Vinod Kothari & Company and can be reached at email@example.com)