CORPORATE FRAUD- Recent Trends & Remedies

Prepared by:
Ms. MANISHA CHAUDHARY
Advocate

www.ukca.in
 CORPORATE FRAUD-Introduction

• Corporate Fraud is not a new phenomena. It is prevalent in existence in may

forms, shapes and sizes.

• Corporate frauds and Scams in India during the recent years have badly
effected the Indian economy and corporates. According to one of survey
conducted by Economic Intelligence Unit sometime in 2015 and report
published in business today, India has one of the high percentages of
companies where fraud, in particular corruption and bribery, was detected.
The history of corporate frauds and scams in India is not unknown for Indians
as Harshad Mehta scam, Satyam Scam, saradha group financial scandal, 2G
Scam etc. has been widely in news at that time.
 CORPORATE FRAUD-Meaning

• Till the commencement of the Companies Act, 2013, the term fraud has not been
defines in the Indian laws. Even the Indian Penal Code does not touch upon the
fraud directly.

• Generally Corporate Fraud means the activities done by an individual or company

in a dishonest or illegal manner. It is an act of deception, an intentional
concealment, omission or prevention of truth to gain unlawful advantage, induce
another to part with some valuable item or surrender a legal right, or inflict injury
in some manner.

• First time in the Indian Corporate History, the Government of India has provided
the definition of fraud in the Companies Act, 2013.
 CORPORATE FRAUD-Definition

• Pursuant to Explanation (i) to Section 447 of the Companies Act, 2013, fraud, in
relation to affairs of a company or any 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 interest of, the company
or its shareholders or its creditors or any other person, whether or not there is
wrongful gain or wrongful loss.

• Further explanation (ii) to the aforesaid section provides that “wrongful gains”
means of property to which the gaining is not legally entitled. Similarly
“wrongful loss” means the loss by an unlawful means of property to which the
person losing is legally entitled.
 CORPORATE FRAUD-Penalties

• Section 447 of the Companies Act, 2013 provides that without prejudice to any
liability including repayment of any debt under this Act or any other law for the
time being in force, any person who is found to be guilty of fraud, shall be
punishable with imprisonment for a term which shall not be less than six
months but which may extend to ten years and shall also be liable to fine which
shall not be less than amount involved in fraud, but which may extend to three
times the amount involved in the fraud.

• Where the fraud in question involves public interest, the term of imprisonment
shall not be less than 3 years. [proviso to S 447]
 CORPORATE FRAUD- Instances of fraud mentioned
in the Act
• There are various section where certain offence amounts to fraud and hence,
accordingly, person responsible will be liable for actions for fraud. Some such
instances are:

• Incorporation of company based on false or incorrect information, the first

director, first subscriber and professional who made declaration will be liable
for fraud [S. 7(5) and (6)]

• For untrue, misleading statement in prospectus or inclusion or omission of any

matter. [S. 34]

• For fraudulently inducing person to invest money [S. 36]

• For personation for acquisition of securities. [S. 38]

 CORPORATE FRAUD- Instances of fraud mentioned
in the Act

• Acceptance of deposits with intent to defraud depositors or for any fraudulent

purpose. [S. 75]

• Cases where auditor of the Company acts in a fraudulent manner. [S. 147 (5)].

• Where business of the Company is carried on for a fraudulent or unlawful purpose or

with intent to defraud creditors, members or any other person [S. 213]

• For making any application for removal of name. [S. 248, not yet enforced].

• For furnishing any false statement, mutilation, destruction of documents during

inspection, inquiry and investigation. [S. 229]

• For furnishing any false statements etc. [S. 448]

• For giving false evidence. [S. 449]

 CORPORATE FRAUD-Recent cases

• After the commencement of the Companies Act, 2013, no major case on corporate fraud under
section 447 of the Companies Act, 2013 has been witnessed which has been decided by the

judicial authorities in India.

• However, allegation of frauds under the aforesaid section has been mentioned in various

cases filed before various judicial authorities in India.

• Some of the instances where provisions for fraud has been invoked after the commencement
of Companies Act, 2013 are in the case of default in payment of deposits, in cases relating to

oppression and mismanagement, in the matters relating to schemes of compromise and

arrangements etc. However, no person or company has been penalized till date under the

provisions of Companies Act, 2013.

 CORPORATE FRAUD-Recent cases

• One of the big and well known case is manipulating the financial

statements case of ‘Satyam Computers’. In ‘Satyam Computers’ case, where

profits were increased, liabilities were hidden and related party

transactions were carried on against the interest of public shareholders. The

Satyam Computer Services scandal was a corporate scandal affecting India-

based company Satyam Computer Services in 2009, in which chairman

Raymalinga Raju confessed that the company's accounts had been falsified.
 CORPORATE FRAUD-Recent cases

• The Satyam Computers Case is about corporate governance failure

and fraudulent auditing practices allegedly in connivance with

auditors and chartered accountants. The company misrepresented its

accounts both to its board, stock exchanges, regulators, investors and

all other stakeholders. It is a fraud, which misled the market and

other stakeholders by lying about the company’s financial health.

Even basic facts such as revenues, operating profits, interest

liabilities and cash balances were grossly inflated to show the

company in good health.

 CORPORATE FRAUD-Recent cases

•The mastermind behind the scam was Satyam Founder- B Ramalinga Raju.
•He falsified the records of the Company. Raju maintained thorough details of the
Satyam's accounts and minutes of meetings since 2002.

•Fake invoices and bills were created using software applications such as 'On time'
that was used for calculating hours put in by an employee.

•A secret programme was allegedly planted in the source code of the official invoice
management system creating a user id 'Super User' with the power to hide or show

the invoices in the system.

•A web of 356 investment companies was used to allegedly divert funds from

Satyam.
 CORPORATE FRAUD-Recent cases

• These companies had several transactions in the form of inter-corporate investments,

advances and loans within and among them.

• The cash so raised was used to purchase several thousands of acres of land across Andhra

Pradesh to ride a booming realty market.

• The role of external third party auditors, who were tasked to ensure that no financial

bungling is undertaken to carry out promoters’ interest or hide facts, have also been

brought to question.

• Every attempt made to eliminate the gap failed. As Raju put it, "it was like riding a tiger,

not knowing how to get off without being eaten."

 CORPORATE FRAUD-Recent cases

• Cashing out by selling Maytas Infrastructure and Maytas Properties to Satyam for an
estimated Rs 7,800 crore was the last straw. The attempt failed and Raju made the stunning
confessions three weeks later.

• On 7 January 2009, the chairman of Satyam, Ramalinga Raju, resigned, confessing that he
had manipulated the accounts by US$1.47-Billion. The global corporate community was
said to be shocked and scandalised.

• In February 2009, CBI took over the investigation and filed three partial charge sheets
(dated 7 April 2009, 24 November 2009, and 7 January 2010), over the course of the year. All
charges arising from the discovery phase were later merged into a single charge sheet.
 CORPORATE FRAUD-Recent cases

• Pearls Group Scam of Rs. 45,000 crore is one of the biggest scam
reported in Real Estate Sector in India, recently. According to

news published in various newspapers, Pearls group collected

money from investors through its various agents across India,

who approached people to put their saving into scheme run by

two of Pearls group company namely Pearls Agrotech

Corporation Ltd (PACL) and Pearls Golden Forests Ltd (PGF).

 CORPORATE FRAUD-Recent cases

• The collective schemes were offered to people for booking a plot which was
decided by PACL. The company then used the money to book properties in
various parts of the country, on which investors were offered 12.5% annual
return as well. In ponzi schemes, returns are given to investors from the money
collected from other depositors in a pyramid-like structure. Recently, CBI
arrested chairman-cum-managing director of PACL and PGF Nirmal Singh
Bhangoo and three other top officials in connection with Rs 45,000-crore pozi
scam case. It is estimated that close to 5.5 crore investors were duped by the
investment scheme.
 CORPORATE FRAUD-Recent cases

• No list of corporate screw-ups would be complete without a good old-fashioned

accounting scandal. In September, electronics conglomerate Toshiba admitted that

it had overstated its earnings by nearly $2 billion over seven years, more than four

times its initial estimate in April. CEO and President Hisao Tanaka resigned from

the firm, and an independent investigators found that “Toshiba had a corporate

culture in which management decisions could not be challenged” and “Employees

were pressured into inappropriate accounting by postponing loss reports or

moving certain costs into later years.” [As reported by Fortune- The 5 Biggest

Corporate Scandals of 2015]

 CORPORATE FRAUD-Recent cases

• The other fraud reported by the Fortune was about Valeant, a

famous drug company in USA. In October, short seller Andrew Left

accused drug company Valeant of using a specialty pharmacy

company Philidor to artificially inflate its sales. Valeant denied the

charges. But the fact that Valeant had never discussed its close ties

to Philidor raised questions about Valeant's, and Philidor's, sales

practices. It also shook investors' confidence in the acquisitive drug

company, which had racked up debt as it did deals.

 CORPORATE FRAUD-Recent cases

• Valeant VRX -21.12% could still be on the hook if Philidor broke any laws. Valeant employees appear to have

worked at Philidor under aliases to hide their identities. And Valeant had paid $100 million for an an undisclosed

option to acquire Philidor for no additional dollars whenever it wanted, essentially giving Valeant ownership of the

company.

• Valeant has appointed a special committee of its board, and an outside investigator, to look into the company's ties
to Philidor, but it has yet to report its findings. Valeant said that Philidor sales never amounted to more than 7% of

its total sales. Valeant's shares fell 75% in the wake of these revelations, to just over $70 from a high of $260.

• Many well known hedge funders, including Bill Ackman, who has defended the company, suffered big losses
on Valeant stock in the wake of the scandal.
 CORPORATE FRAUD-Recent cases

• On June 29, 2016, in Newark, New Jersey, John Y. Lee, a/k/a “Yong Kook Lee,” of West
New York, was sentenced to 75 months in prison, three years of supervised release and
ordered to pay restitution to Samsung America Inc. of $1,693,271. Lee previously pleaded
guilty to wire fraud and subscribing to false individual income tax returns. According to
court documents, Lee was involved in an elaborate scheme to embezzle funds from
Samsung America, a Ridgefield Park-based global trading and investment company and
American subsidiary of the Korean conglomerate Samsung Corp.
 CORPORATE FRAUD-Recent cases

• In September 2000, Lee created a fictitious entity that he called the Engelhard Supple (sic)
Co. to make it appear as though that entity was actually Engelhard Corp., a provider of
metal refining services. Lee created numerous false financial documents to make it appear
that Samsung Corning Precision Glass Ltd., a joint venture involving the Samsung
Corporation and Corning Inc., had ordered services from Engelhard when in fact, no real
services had been ordered or provided. Lee induced Samsung America to wire money
directly into a bank account Lee controlled. The loss to the company was between $1
million and $2.5 million. Lee also signed and filed a 2006 Individual Income Tax Return
that failed to include $339,138 he had embezzled from Samsung America in 2006.
 CORPORATE FRAUD-Recent cases

• On April 19, 2016, in Charlotte, North Carolina, Jerry Wayne Overcash, of Charlotte, and John
Bernard Thigpen, of Rock Hill, South Carolina, were sentenced to 46 months and 21 months in
prison, respectively. Each were also sentenced to two years of supervised release and ordered to pay
$1.3 million in restitution. Both previously pleaded guilty to wire fraud charges. According to court
documents, Thigpen, a certified public accountant, was the CFO, and Overcash was a co-founder of
CenterCede Services Inc. (CenterCede), a payroll services company. Contrary to their representations
to clients, Overcash and Thigpen did not pay the clients’ federal taxes in appropriate amounts and
by the applicable deadlines. Instead, they diverted the funds to pay their own exorbitant salaries and
to cover growing liabilities, including the tax liabilities of other CenterCede clients. Thigpen,
Overcash and another individual defrauded CenterCede’s payroll clients of more than $2 million
dollars.
 CORPORATE FRAUD-Recent cases

• On April 6, 2016, in Oklahoma City, Oklahoma, Helen Rose Dewey was sentenced to 37
months in prison, three years of supervised release and ordered to pay $974,034 in
restitution to the public works authority and $233,674 in restitution to the IRS. Dewey
pleaded guilty on Nov. 12, 2015, to wire fraud and tax fraud. According to court
documents, in 2010, Dewey became the executive assistant to the director of a waste water
treatment plant which was owned and operated by a public works authority. As part of her
duties, Dewey was authorized to use the public works authority credit cards to make
purchases for the wastewater treatment plant. Beginning in January 2008 and continuing to
August 2013, Dewey embezzled from the authority by using the credit cards to make
unauthorized purchases. In addition, during 2012 and 2013, Dewey embezzled money from
the petty cash fund. To conceal her activity, Dewey altered purchase orders and blocked
out itemized purchases listed on receipts and falsified claims for approval and payment by
the authority. Dewey also falsified her federal tax return for 2012 by grossly under-
reporting her income.
 CORPORATE FRAUD-Recent cases

• On March 29, 2016, in Greensboro, North Carolina, Kenneth Dale Stainback, of Burlington,
and Stephen Ray Smith, of Mebane, were sentenced to 14 months and six months in prison,
respectively. Both defendants were also sentenced to three years of supervised release and
ordered to pay $158,530 in restitution to the IRS for the corporate tax loss and $8,000 in
fines. Both were also ordered to pay restitution to the IRS for their individual tax loss.
According to court documents, Stainback, the secretary of McClure Funeral Service
(McClure), and his business partner, Smith, president of McClure and former president of
the North Carolina Board of Funeral Service, conspired to defraud the United States by
filing false corporate tax returns for McClure. Stainback, Smith and another co-conspirator
bought McClure in 2004 and began diverting gross receipts from the business and omitting
that income from the corporation’s tax returns. The co-conspirators opened checking
accounts to divert funds from McClure, pocketed cash payments and deleted and altered
invoices in the business’s accounting system. During the 2009 through 2012 fiscal years,
Stainback, Smith and the other co-conspirator diverted more than $419,000 from McClure.
 CORPORATE FRAUD-Recent cases

• On Jan. 21, 2016, in Sacramento, California, Brent Lee Newbold, of Granite Bay, was sentenced to 51
months in prison and ordered to pay more than $2.9 million in restitution. On Sept. 3, 2015, Newbold
pleaded guilty to a scheme to defraud investors that ran from October 2007 to January 2010. Newbold
was the chief executive officer of Holy Cow, a business that produced a “green” cleaning product.
According to court documents, Newbold made a variety of misrepresentations to investors about the
financial health of the company, including the company’s debt levels and how invested funds would
be used. Between July 2008 and January 2010, Newbold solicited 13 individual investors and falsely
claimed that he was authorized to act on behalf of Holy Cow; that he owned Holy Cow; that he owned
the majority of Holy Cow stock; and that Holy Cow was financially sound, stable and profitable. In
some cases, Newbold provided his individual investors with false Holy Cow stock certificates, false
Holy Cow purchase order reports, and corporate promissory notes. In fact, Holy Cow bore a
significant amount of debt, and Newbold continued to take additional debt related to Holy Cow.
Newbold used investor funds for nonbusiness purposes, diverting it to himself and his wife, paying
his mortgage, and paying previous investors. By December 2009, Spence Enterprises put Holy Cow
into bankruptcy as a result of the unauthorized and undisclosed debt. The loss amount was over $2.9
million.
 CORPORATE FRAUD-Remedies

• It is well said that prevention is better than cure. Accordingly, before entering into any

transaction with any company, the stakeholders should make full enquiry into the affairs of

the company. They should take adequate advise from professionals for the same. They

should go through full documents of the scheme in question before entering into that.

• The corporate should have adequate number of independent directors on its board that

have expertise in the filed of finance, corporate, securities laws etc. Further there should be

adequate Whistle Blower Machanism, vigil mechanism. Compliance of all laws can be

ensured through appointment of team of compliance officer which includes professionals

having knowledge of different laws applicable on the company.

 CORPORATE FRAUD-Remedies

• Further in case of Fraud happen in any corporate under Companies Act,

2013, the victim may approach the appropriate judicial authorities under
the Companies Act, 2013.

• According to section 435 (1) of the Companies Act, 2013, Special Courts
may try an offence punishable under this Act with imprisonment of 2 years
or more. Any other offence shall be tried, as the case may be, by a
Metropolitan Magistrate or a Judicial Magistrate of First Class having
jurisdiction to try any offence under this Act or under any previous
company law.
 CORPORATE FRAUD-Remedies

• Further pursuant to Section 206(1) of the Companies Act, 2013, any person may
file an application to ROC for investigation of affairs of the company. Upon
receiving of such information, ROC, if thinks fit, may order for inspection and
investigation of the affairs of the company. If during such investigation and
inspection, it is found that business of the Company has been or is been
conducted for a fraudulent purpose, then suitable actions under section 447 of
the Companies Act, 2013 may be taken [S. 206(5)]. Further pursuant to section
212 (1) of the Companies Act, 2013, If the Central Government forms the opinion
that investigation into the affairs of the company shall be conducted by Serious
Fraud Investigation Officer (SFIO), then investigation may be assigned to SFIO.
 CORPORATE FRAUD-Remedies

• Similarly, NCLT may try the offence during the course of winding up of the company
under Section 337 (Penalty for frauds by officers), Section 338 (Liability where proper
books accounts not kept), Section 339 (Liability for fraudulent conduct of business) and
340 (Power of the tribunal to assess damages against delinquent directors, etc.)

• It is pertinent to be noted that provisions of Section 337 to 341 shall apply mutatis
mutandis, in relation to an application made to NCLT under section 241 (oppression and
mismanagement) and section 245 (Class Action Suit).
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