CORPORATE FRAUDS, THE RECENT MCA NOTIFICATION ON ‘REPORTING OF FRAUD’ AND MECHANISMS TO COMBAT THEM

“CORPORATE FRAUDS, THE RECENT MCA NOTIFICATION ON ‘REPORTING OF FRAUD’ AND MECHANISMS TO COMBAT THEM”

By Priya Agarwal

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’s 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’s 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’s 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’s own report to the Central Government within 15 days. In case of no response from the Board or Audit Committee, the auditor’s 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’s Report. Contents of the auditor’s 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’s Report should also mention Remedial actionstaken 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.

HOW MANAGEMENT ENCOURAGES FRAUD

If authority, responsibility and accountability is not defined or documented 

Goals and objectives are neither established nor monitored

No written policies or procedures of internal control exist along with inadequate physical security for assets and records

Inconsistent application of policies or procedures resulting in unfair treatment of employees, favoritism and low morale