This presentation is an overview of Fraud Risk Management in Indian companies and the role of the Board of Directors in the context of the newly enacted Companies Act, 2013.

1. Understanding & Managing Fraud Risk
ENHANCING BOARD PERFORMANCE
November 16th 2013, Kolkata
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2. Corporate fraud – a working definition
Corporate fraud occurs when:
• An employee violates his/her fiduciary duties
towards the organization.
• Is done in secret and is concealed.
• Is done for a direct or indirect benefit to the
perpetrator.
• Costs the organization, its assets, revenue, or
opportunities.
…………….. also referred to as Occupational fraud or
Internal fraud.
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3. Classification* of fraud in organizations
*adapted from ACFE 2012 Report to the Nations on Occupational Fraud and Abuse.
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4. How Occupational Fraud is Committed
Occupational Frauds by Category — Frequency
Source : ACFE 2012 Report to the Nations on Occupational Fraud and Abuse.
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5. How Occupational Fraud is Committed
Occupational Frauds by Category — Median Loss
Source : ACFE 2012 Report to the Nations on Occupational Fraud and Abuse.
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6. Why frauds take place-the Fraud Triangle
Pressure
Medical bills, expensive tastes, addiction
problems to Commit fraud
Rationalization (Attitude)
Every one does it. Simply borrow the money
Opportunity
due to weak and override of controls
Trusted persons become trust violators when they conceive of themselves as having a financial problem which is nonshareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to
apply to their own conduct in that situation, verbalizations which enable them to adjust their conceptions of
themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.1
1Donald
R. Cressey, Other People's Money (Montclair: Patterson Smith, 1973) p. 3
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7. The Fraud Triangle……..contd.
PRESSURE: This is what causes a person to commit fraud. This includes medical
bills, expensive tastes, addiction problems, significant financial needs etc. Often
this need/problem is non-discloseable in the eyes of the fraudster. That is, the
person believes, for whatever reason, that their problem must be solved in
secret.
OPPORTUNITY: Opportunity is the ability to commit fraud. Because fraudsters
don’t wish to be caught, they must also believe that their activities will not be
detected. Opportunity is created by weak internal controls, poor management
oversight, and through abuse of power.
RATIONALIZATION: It occurs when the individual develops a justification for their
fraudulent activities. The rationalization varies by case and individual. Some
examples include:
– “I really need this money and I’ll pay it back when I get my salary”
– “Other people are doing it”
– “I didn’t get a raise. The Company owes me.”
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8. The Fraud Triangle…..….contd.
Breaking the Fraud Triangle is the key to fraud
deterrence. Breaking the Fraud Triangle entails
removing one of the elements in the fraud
triangle in order to reduce the likelihood of
fraudulent activities.
Of the three elements, removal of opportunity is
most directly affected by the system of internal
controls and generally provides the most
actionable route to deterrence of fraud.
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9. Detection of Fraud Schemes
Initial Detection of Occupational Frauds
Source : ACFE 2012 Report to the Nations on Occupational Fraud and Abuse.
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10. Dimensions of fraud in India Inc.
•The occurrence of fraud is almost equally poised between public and
private limited companies
• Most of the companies have medium scale of operations with the
average revenue size of less than Rs 200 crores.
• Further, in 80% of the cases, the size of the fraud was less than Rs
200 crores. However, the average revenue size of these companies has
increased 7.25 times in the period after 2009, exposing larger number of
stakeholders to risks of corporate failure
• Fraud risk is pervasive across all the industry sectors with manufacturing
sector accounting for one out of three cases highlighting the need for appropriate
fraud policies across all the sectors
•Significant spurt not only in the number of fraud cases but also in their size after
2009 with an average size of fraud almost doubling since 2009.
Source: Thought Arbitrage Research institute, New Delhi ,Understanding the Demand and Supply Equations of
Corruption and Fraud (an in-depth analysis of 100 major corporate frauds that occurred over the last 15 years),
2012.
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11. Dimensions of fraud in India Inc…contd.
• Most fraudulent transactions were designed to either siphon of the
companies funds by promoters or top management or to
defraud government/ investors/ lenders. One of the key
contributing factors for corporate fraud in India is the control and
concentration of promoters, whether families or MNC’s, at the helm of
affairs. Such controls over all aspects of business are often abused for
personal gains at the cost of other stakeholders
• Fraud techniques used in last 15 years have not undergone much
sophistication. Most of frauds in the study perpetrated through
recording of assets at a value higher than their fair value or alternatively
by a web of book entries through related party accounts to embezzle. This
also points towards existence of control weaknesses that give perpetrators
of the fraud an ‘opportunity’ to commit such a fraud
Source: Thought Arbitrage Research institute, New Delhi ,Understanding the Demand and Supply Equations of Corruption
and Fraud (an in-depth analysis of 100 major corporate frauds that occurred over the last 15 years), 2012.
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12. Dimensions of fraud in India Inc…contd.
•
No significant cases came to light where the auditors have
been able to detect such fraud in the course of their audits,
reflecting poorly on the watchdogs (i.e. internal, statutory and tax
auditors) who take their cues from the gatekeepers i.e. regulators. The
auditors should have been the first ones pointing out most of these frauds
in the financial statements because the schemes for committing fraud do
not seem to be too sophisticated or complex
•
Number of frauds in the our study are equally distributed among
firms audited by the Big 4 and Non-Big 4 auditors indicating that
detection of fraud is hard even for large auditing firms
• Presence of earnings management can be construed to be a
potential indicator of presence of financial statement fraud
Source: Thought Arbitrage Research institute, New Delhi ,Understanding the Demand and Supply Equations of Corruption
and Fraud (an in-depth analysis of 100 major corporate frauds that occurred over the last 15 years), 2012.
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13. Dimensions of fraud in India Inc…contd.
• Majority of the companies involved in fraud have either been
liquidated or their business has been discontinued or are
continuing at reduced levels with market valuations
drastically reduced
•
The study did not comment conclusively on the adequacy or
otherwise of the penalties/fines imposed due to lack of adequate
public information. There seems to be an inadequate enforcement
of laws and deterrence for committing frauds. These frauds seem to
be carried out with impunity as the chances of getting caught are
minimal and the quantum of fine and punishment is not a valid
deterrence ensuring them to retain the spoils of the fraud as
personal wealth.
• Effectiveness of Clause 49 of Listing Agreement (corporate
governance code for all for public listed companies) covenants on
fraud occurrence, detection and prevention is very limited
Source: Thought Arbitrage Research institute, New Delhi ,Understanding the Demand and Supply Equations of Corruption
and Fraud (an in-depth analysis of 100 major corporate frauds that occurred over the last 15 years), 2012.
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14. Fraud and Corruption: Mechanics and Perspectives
• Various ways through which transfer of funds takes place during fraud and
corruption includes: loan transactions, related party transactions,
especially structured transactions, payments made through
agents/ distributors, payments made to trusts, transfer of
assets at value other fair market value.
• From MCA perspective, SFIO points that four different types of frauds:
financial statement fraud, capital market fraud, fraud in
project funding, fraud through fake invoices and bills.
• From tax regulator perspective, CBDT observes that black money is
generated either through manipulation of accounts or through out
of book transactions.
• From the US securities market regulator – SEC perspective corporate
frauds mainly takes place through improper revenue
recognition, overstatement of existing assets, and
capitalization of expenses.
Source: Thought Arbitrage Research institute, New Delhi ,Understanding the Demand and Supply Equations of Corruption
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and Fraud (an in-depth analysis of 100 major corporate frauds that occurred over the last 15 years), 2012

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17. Perpetrators of Fraud in India
Source: Ernst & Young, India Fraud Indicator 2012.
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18. Mode of detection of Fraud in India Inc.
1. Whistle Blower/Ethic hotline.
2. Internal Audit review.
3. Data Analytics.
4. IT Controls.
5. Anonymous letter/call/tip off.
6. Business Partner/vendor/Third party complaint.
7. Statutory Audit.
8. By Accident
Ranks are based on total score- Rank 1 is most effective.
Source: KPMG, India Fraud Survey, 2012.
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19. Role of the directors in preventing fraud
The directors on the board of scam-tainted Satyam
Computer acted as "rubber stamps" and "not even
a single dissent note was recorded" during the
board meetings, a CBI official said on Saturday.
"Meetings were conducted in a perfunctory
manner. The promoters were always present to
influence the decision. There were no open
discussions," RBI General Manager, currently on
deputation with the CBI, J L Negi said at a CBI
Workshop here*.
*http://articles.economictimes.indiatimes.com/2010-07-10/news/27599841_1_satyam-directors-rubber-stamp-g-ramakrishna
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20. Foundation for Fraud Risk Management
To ensure a proper foundation for the organization’s fraud risk
management activities, the board should work closely with
management to clearly define and formally record the following
in the organization’s antifraud policy or fraud risk management
policy:
• The board’s expectations of management in managing
fraud risks
• The specific responsibilities of both the board and
management for fraud risk management
• The ownership of risks at the executive, senior manager,
and business-unit manager levels
• The overarching objectives of the fraud risk management
program
Source : The Conference Board, The Role of the Board in Fraud Risk Management, October 2011.
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21. Role of the Board in Fraud management
The Board has the responsibility to ensure that management designs
effective fraud risk management documentation to encourage ethical
behavior and to empower employees, customers and vendors to insist
those standards are met every day.
The Board should;
• Understand fraud risk
•Maintain oversight of the fraud risk assessment by ensuring that
fraud risk has been considered as a part of the organization’s risk and
strategic plans. This responsibility should be considered under a
periodic agenda item at board meetings when general risks to the
organization are reviewed.
Source: The Institute of internal Auditors, American Institute of Certified Public Accountants and
Association of Certified Fraud Examiners, Managing the Business risk of Fraud: A practical guide,
2006.
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22. Role of the Board in Fraud management….contd.
• Monitor management’s reports on fraud risks, policies and control
activities which include obtaining assurances that the controls are
effective. The Board should also establish mechanisms to ensure it
is receiving accurate and timely information from management,
employees, internal and external auditors and other stakeholders
regarding potential fraud occurrence.
• Oversee the internal controls established by the management.
• Set the appropriate tone at the top by CEO job description, hiring,
evaluation and succession planning processes.
• Have the ability to retain and pay outside experts whenever needed.
• Provide external auditors with evidence regarding the board's active
involvement and concern about fraud risk management.
Source: The Institute of internal Auditors, American Institute of Certified Public Accountants and
Association of Certified Fraud Examiners, Managing the Business risk of Fraud: A practical guide,
2006.
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23. Fraud & the Companies Act, 2013
• “Fraud” and “Wrongful gain” have been defined for the first time, apart
•
•
from penalties; punishment for fraud involving imprisonment, which is now
introduced in many cases.
The Act makes companies and its officers more accountable and brings new
concepts to better regulate companies. From shareholders’ rights (class action
suits) to greater duties of independent directors in scrutiny of related party
transactions and its disclosures (Board now has to justify them), from rotation of
auditors (with maximum tenure of five years for an auditor) to mandatory
formation of vigil mechanism (whistle blowing mechanism), by listed companies
and introduction of stringent penal provisions for fraud or wrongful acts or
contravention of any provisions in the law are some of the highlights of the Act.
Auditors (including, Cost Accountants for Cost Audit and Company Secretary in
Practice for Secretarial Audit), during the course of performance of its duties, are
required to immediately report to the Central Government, any offence
involving fraud that is being or has been committed against the company by its
•
officers or employees.
The legislation also grants statutory powers to SFIO to tackle corporate
frauds. The SFIO will get a big fillip, now that the Act has come into force.
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24. Detecting Fraud and Corruption:
Challenges and Way Forward Perspectives
• The Government of India initiatives, such as RTI Act 2005 and on egovernance, constructive role played by the CAG of India, and greater
judicial involvement have been some of the steps towards coping with
widespread corruption prevalent in the last century in India. However,
challenges still persist.
• In India, multiple regulators, such as SEBI, MCA, and RBI exist with
overlapping domains.
• Significant challenges prevail in the Indian legal and regulatory system:
– enforcement of contracts and delay in the judicial system, low conviction rate
of corrupt people, multiplicity of regulators and investigating agencies and
– lack of skilled resource person.
• The way forward to deal with corruption – leveraging technology, more
skilled resources for investigating agencies, better co-operation and
coordination between multiple agencies, greater efficiency of the judicial
system.
Source: Thought Arbitrage Research institute, New Delhi ,Understanding the Demand and Supply Equations of Corruption
and Fraud (an in-depth analysis of 100 major corporate frauds that occurred over the last 15 years), 2012.
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25. Further reading
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Understanding the Demand and Supply Equations of Corruption and Fraud -An insight into the
Corruption and Fraud by the private sector in India, Thought Arbitrage Research Institute, New
Delhi, 2012, available at
http://www.tari.co.in/public/report/1372144861Understanding%20the%20demand%20&%20suppl
y%20equations%20of%20corruption%20&%20fraud%20-%20final.pdf
India Fraud Indicator 2012 -Increasing magnitude of fraud , A study by Ernst & Young’s Fraud
Investigation & Dispute Services, available at
http://www.ey.com/IN/en/Services/Assurance/Fraud-Investigation---Dispute-Services/India-FraudIndicator-2012.
India Fraud Survey, 2012, KPMG available at
http://www.kpmg.com/IN/en/IssuesAndInsights/ArticlesPublications/Pages/FraudSurvey12.aspx
Report to the Nations on Occupational Fraud and Abuse -2012 Global Fraud Survey, Association of
Certified Fraud Examiners, available at
http://www.acfe.com/uploadedFiles/ACFE_Website/Content/rttn/2012-report-to-nations.pdf.
Corporate Resiliency: Managing the growing risk of fraud and corruption -A holistic approach,
Deloitte Forensic India in collaboration with FICCI, available at
http://www.ficci.com/spdocument/20310/FICCI-Deloitte.pdf.
The Role of the Board in Fraud Risk Management –Director’s Notes, The Conference Board,
available at
http://www.conference-board.org/retrievefile.cfm?filename=TCB-DN-V3N2125
111.pdf&type=subsite

26. Please visit my Author’s page at
http://ssrn.com/author=1714442 for
access to my papers and research on
Corporate Governance with specific
reference to India.
Comments and views are welcome at
spande@nihilent.com
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27. THANK YOU
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