Saikat Bhattacharya

20171577

2020
Detection of Corporate Frauds

Saikat Bhattacharya
O.P. Jindal Global University
6/17/2020

Electronic copy available at: https://ssrn.com/abstract=3629175

Saikat Bhattacharya
B.B.A. L.L.B. 2017

INTRODUCTION

Corporate fraud is most commonly performed by taking the advantage of the

sensitive & confidential information and also the valuable assets, using them to
maximise the gains. There are many methods that help predict fraud before they
occur. These activities are often hidden behind legitimate business transactions
and exchanges to hide it from the authorities. This paper focuses on various tools
which can be used to detect such activities how they are administered.

Fraud is defined under section 447 of the companies act 2013 which says that
“fraud in relation to affairs of a company or a body corporate, includes any act,
omission, 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”1

But in order to prevent fraud from happening, one must know what it is, what
are its consequences, how they are committed and how can it be prevented. The
information that we obtain from these exercises should be put back into the
system so that the fraud prevention measures can implemented, and monitoring
can be done to prevent a reoccurrence. The detection of them is directly related
to their prevention. There are various methods for detecting fraud and reporting
it to the authorities. Poor corporate governance and internal control are the mains
reasons of frauds occurring, preventing them would ensure a healthy financial
statement. “Inside a business firm, the corporate managers play a primary role for
fraud prevention and detection withing a business firm2 but employees have an
important role to play as well”3. “Effective employee training, thorough screening

1
The Companies act 2013
2
PwC, 2008; Razaee & Riley, 2010
3
Copes et al., 2006

Electronic copy available at: https://ssrn.com/abstract=3629175

Saikat Bhattacharya
B.B.A. L.L.B. 2017

and internal control, board oversight”4. There many ways in which corporate
fraud may be detected. They are, internal audit, external audit, whistle blowing,
forensic assessment etc.

INTERNAL AUDIT

“Internal auditors are the first group of people who have the knowledge of the
business environment and the control of the structure in the company”5. “They
are the ones who are more likely to detect fraud6 and therefore, they are frequently
employed for this by the company”7. “Big organisations are highly dependent on
the internal auditors to detect frauds happening within a company because these
are the people who have been trained to detect unusual activities taking place in
the organization’s financial statements”8

Their methods are designed in such a way that they provide evidence and warning
that the fraud is about to take place or has already happened. Effective methods
are the best way to prevent is mishaps. However effective these procedures are,
sometimes they might not be able to prevent fraud.

In India, according to the section 138 of the companies act 2013, certain
companies are required to appoint an internal auditor. Every listed company,
private company and a few unlisted companies with a few requirements have to
always appoint an internal auditor.

Deloite in 2012 found that out of the total number of cases, 53% of the cases were
found out by the internal auditors only. “It is always advised that they hire internal
auditors permanently rather than outsourcing it to another third party because they
are able to have a better control in the organisation’s environment”9. “More or

4
PwC, 2008
5
Razaee, 2005
6
Coram et al., 2006
7
EY, 2012
8
Burnaby et al., 2011
9
Coram et al.,2006

Electronic copy available at: https://ssrn.com/abstract=3629175

Saikat Bhattacharya
B.B.A. L.L.B. 2017

less, their job is to reduce the chance of fraud happening inside organisation and
their possible impacts10.”

EXTERNAL AUDITING

“One of the most frequently used fraud detecting methods but less effective ones
is external auditing. According to the survey conducted by the ACFE in 2014, the
external auditors were only able to detect fraud in only 3% of the total cases.
Their fraud detection was mostly termed as sheer luck or accidental”11.

There recently has been a wide difference between the opinion of auditors and
the general public about their working. Therefore, there has been a huge gap
between the actual outcome and the expectations from the auditors. To reduce
this gap, ICAI (Institute of Charted accountants of India) made it mandatory for
the external auditors to provide some assurance about the fact that the financial
statement doesn’t have any material misstatement which occurred due to some
fraud or error. They were also required to have a few rigorous sessions in order
to detect any existing fraud risk factors.” Hence, it is very important that the
auditors are given proper training about various tools they can use to detect fraud
because unlike internal auditors, they are not familiar with the environment of the
organisation and should have an eye for a detail in order to catch minute frauds”12.

The Serious Fraud Investigation Office (SFIO) is a statutory external corporate

fraud detecting and investigating agency which set up by resolution that was
adopted on 2nd July 2003 by the Indian Government. It carries out various
investigation within the existing legal parameter of the section 235 to 247 of the
companies act 1956. With time section 211 of the companies act 2013 gave SFIO
a statutory status. It always comes under the jurisdiction of the Ministry of

10
Burnaby et al., 2011
11
Hassinket al., 2010
12
Hassinket al., 2010

Electronic copy available at: https://ssrn.com/abstract=3629175

Saikat Bhattacharya
B.B.A. L.L.B. 2017

Corporate Affairs and are primarily supervised by the officers from various
government services.

Whistle blowing

The company’s employees and outsiders which primarily consist of consumers

and the suppliers are most common and accurate source for raising a voice against
the fraudulent activities that take place inside an organisation. The whistle
blowing policies that has been made motivates them further to report such
activities as it the easiest and cost less to catch such frauds than other methods13.
Such misconducts reported may just not be the activities of the present, they have
had happened in the past or are in early stages of execution which have not yet
been carried out. There are two types of whistle blowing, Internal and external
whistle blowing. Internal, as the name suggests, is an act of reporting fraud by
someone from inside the organisation. External whistle blowing is mostly done
by a law enforcement or the media.

The whistle-blower protection act was formulated in 1989, especially for the
people who work for the federal government who inform about the various illegal
or improper activities that are taking place. It protects them from various
consequences such as termination of employment, demotion, suspension, threat
or harassment14. The world’s most famous case of whistle blowing is that of
Edward Snowden. He was hired by the NSA. As soon as he was employed,
Snowden leaked many classified NSA documents to the media which were
regarding the tactics that the United States government has employed for
surveillance on its citizens.

13
Deloitte, 2012
14
PwC, 2008

Electronic copy available at: https://ssrn.com/abstract=3629175

Saikat Bhattacharya
B.B.A. L.L.B. 2017

The U.S. Securities and Exchange Commission (SEC) has made a special
department for the whistle-blower claims which is known has the Office of
Whistle-blower. They encourage the employees to file claims with the SEC for
any illegal or illicit activities that take place in their organisation and also offer a
choice of being anonymous.

Indian government passed Whistle Blowers Protection Act, 2011, The main aim
of this act will be to promote whistle blowers for reporting against any
wrongdoing. Whistle blowing is also covered under the section 206 to 229 in the
Companies Act 2013 which covers the inspection, inquiry, and investigation part.
The section 208 allows the officers to inspect a company’s record and give
recommendations accordingly for investigations to get conducted. The
government is empowered by the section 210 of the act to conduct an
investigation into the matters of the company.

Forensic accounting.

“In the current times, Auditors have failed to detect and control the increasing
fraud occurrences due to which the demand of forensic accounts has significantly
increased”15. This method drastically increases the auditor’s ability to detect
fraud. It also helps in making accounting analysis which are suitable to be used
in legal proceedings.

The accountants are hired to analyse, interpret, and summarize the financial and
business aspects of the organisation. They are mostly employed by insurance
companies, police forces, banks, government agencies or public accounting firms.
They are supposed to compile financial evidence, develop various sheets and
applications to make sure the information is collected regularly and are
communicated in form of reports and presentations. For investigations inside an

15
Razaee & Burton, 1997

Electronic copy available at: https://ssrn.com/abstract=3629175

Saikat Bhattacharya
B.B.A. L.L.B. 2017

organisation, forensic accounting uses methods of tracing funds, identify assets

recovery of assets and due diligence reviews. “The accountants not just work to
detect fraud all the times, but they also work on non-fraud activities like contract
agreement, finance advisory and mediation, making sure that the internal control
doesn’t come and the financial reports improves”16. Their involvement in the
organisations depends on its size.

Detection of fraud by mistake

There are many cases where the organisation gets to know about the fraud by
accident, a confession, or an uninvited notification from another party. Fraudster
may be intelligent to sneakily do a fraud, but many times they fail to cover their
tracks. These are found by another employee in a form of an irregularity in the
books of the organisation as the employees are rigorously trained to sport
irregularities.

Conclusion

There are numerous ways through which corporate frauds can be detected, but
above-mentioned methods are the most commonly used ones across the Indian
corporate sector as well as globally. The motive of the was to identify the methods
of detecting corporate fraud and it has been achieved.

References: _

16
Modugu & Anyaduba, 2013

Electronic copy available at: https://ssrn.com/abstract=3629175

Saikat Bhattacharya
B.B.A. L.L.B. 2017

1) PricewaterhouseCoopers (PwC) (2008). Fraud a guide to its prevention,

detection and investigation, Price Water House Coopers.
2) Copes, H., Kerley, K. R., Mason, K. A., & Wyk, J. V. (2006), Reporting
behaviour of fraud victims and black’s theory of law: An empirical
assessment. Justice Quarterly, 18 (2), 343-363.
3) Coram, P., Ferguson, C., & Moroney, R. (2006). The value of internal
audit in fraud detection, Retrieved from
http://www.theage.com.au/ed_docs/Fraud_paper.pdf. 1-32.
4) Burnaby, P., Howe, M., & Muehlemann, B. W. (2011). Detecting fraud in
organisation: An internal audit perspective. Journal of Forensic and
Investigative Accounting, 3(1), 195-233.
5) Hassink, H., Meuwissen, R., & Bollen, L. (2010). Fraud detection,
redress and reporting by auditors. Managerial Auditing Journal, 25 (9),
861-881.
6) Deloitte (2012), Indian banking fraud survey-2012 navigating the
challenging environment. Deloitte Touche Tohmastu India Private
Limited. Retrieved May13, 2014, from
http://www.indiafinancebrief.com/best practices/industry/186534/india-
banking-fraud-survey-2012-navigating-the-challenging-environment.
7) PricewaterhouseCoopers (PwC) (2008). Fraud a guide to its prevention,
detection and investigation, PriceWaterHouseCoopers.
8) Razaee, Z., & Burton, E. J. (1997). Forensic accounting education:
Insights from academics and certified fraud examiner practitioners.
Managerial Auditing Journal, 12(9), 479-489.
9) Modugu, K. P., & Anyaduba, J. O. (2013), Forensic accounting and
financial fraud in Nigeria: An empirical approach. International Journal
of Business and Social Science, 4(7), 281-289.
10) The Companies Act 2013

Electronic copy available at: https://ssrn.com/abstract=3629175