Corporate Frauds – Recent MCA Notification on ‘Reporting of Fraud’ And Mechanisms To Combat.

Corporate Frauds – Recent MCA Notification on ‘Reporting of Fraud And Mechanisms To Combat.

A fraud is an intentional deception made for personal gain or damage to another person/entity. It can have civil or criminal implications. The Indian Contract Act defines Fraud to mean and 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 a contract while the Indian Penal Code defines Fraudulently as- A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise. The Regulations for prevention of corporate frauds include the Companies Act, Clause 49 of Listing Agreement, Prevention of Money Laundering Act, the Prevention of Corruption Act and Companies (Auditor Report) Order-CARO, 2016.

THE MCA NOTIFICATION

The Ministry of Corporate Affairs (MCA) gave a notification regarding reporting of frauds embodied in Rule 13 to the Companies (Audit and Auditors) Amendment Rules, 2015. The notification indicates the acceptable threshold value of fraud loss from a reporting standpoint which had been left to the company discretion for a long time. This has been introduced as a part of the warning system that is being put in place by the government to prevent recurrence of a Satyam like accounting scam.
According to the notification, if an auditor has reason to believe that fraud, which involves or could potentially involve individually an amount of Rs. 1 crore or above, is being or has been committed against the company, the auditor needs to report the matter to the Central Government within 60 days of his or her knowledge of such a fraud. The process includes reporting the matter to the company Board or the Audit Committee within 2 days of knowing about the fraud, seeking a response from the Board or Audit Committee on the matter within 45 days, and forwarding this response along with the auditor own report to the Central Government within 15 days. In case of no response from the Board or Audit Committee, the auditor report along with the communication sent to the Board should be forwarded to the Central Government.
In case of a fraud involving amounts less than Rs. 1 crore, the auditor needs to report the matter to the Audit Committee or the Board within 2 days of coming to know about the fraud. To ensure further transparency, the MCA requires each of such frauds to be disclosed in the Board Report. Contents of the auditor report should include nature of the fraud and a brief description, approximate amount involved in the fraud and potential parties involved. In addition to this, the Board Report should also mention Remedial actions taken for it.

CONCERNS IN THE NOTIFICATION

The issues in the implementation of this include the legal unawareness of an auditor regarding the commission of frauds as per Section 447 of the Companies Act, 2013. The time limit of 45 days is too tight and investigation may not be possible so soon according to the nature of the fraud. Further, frauds of 1 crore or more individually are to be reported to the Central Government and not if they collectively add to the amount which is a lacuna in the process and a determination of the amount involved can be difficult at such an initial level.

MECHANISMS FOR PREVENTING AND COMBATING FRAUDS

1. The key lies in building strong ethics and governance by responsible leaders, an environment encouraging reporting of unethical practices and whistleblowers protection
2. Establishment of reliable Internal Controls, training on the technology like sophisticated spreadsheets and database application being employed to implement these controls along-with special controls for those recruited to monitor this
3. Arrange for reference checks on new employees and a code of sanction for Suppliers/ Contractors to ensure right appointment while Banks should undertake customer due diligence to prevent landing into controversies
4. Empowering Shareholder committees, Remuneration committees and so on with a watch list to ensure no corrupt individuals make it to important posts
5. Identifying risks by using algorithms and development of detailed anti-corruption and bribery policies (Vigil Mechanism) and their implementation, continuous monitoring and giving assurance of the effectiveness of these efforts.
6. Employ data mining techniques to identify suspicious transactions, E-discovery solution to bring to light the suspects and email tracing to identify the origin of data
7. Computer Assisted Audit Tools and Techniques refers to the use of any computerized tool or technique which increases the efficiency and effectiveness of the audit function
8. Understanding cyber threats and developing specific measures to address those assigning roles to the Board and senior management in mitigating cyber threats by providing a checklist to tackle cyber threats.
9. Manage disputes that arise in the process of addressing frauds and as organizations gear up for growth
10. Like the concept of plea bargaining, a person concerned with the fraud directly or indirectly should be pardoned or dealt with leniency if he makes a full and true disclosure of all facts in his knowledge

By Priya Agarwal