Forensic Accounting PDF

CHAPTER 1 1 BACKGROUND & OVERVIEW LEARNING OUTCOMES After studying this Chapter, you will be able to: -  Get a brief overview and evolution of Forensic Acco...

CHAPTER 1 1 BACKGROUND & OVERVIEW LEARNING OUTCOMES After studying this Chapter, you will be able to: -  Get a brief overview and evolution of Forensic Accounting Profession  Know about some of major global corporate frauds  Have an understanding of increasing Importance of Forensic Accounting Profession  Get a synopsis of legal & regulatory ramifications in Forensic Accounting Profession  Have a glimpse of Opportunities in Forensic Accounting for Chartered Ac- countants ©The Institute of Chartered Accountants of India  1.2 FORENSIC ACCOUNTING CHAPTER OVERVIEW Legal and regulatory ramifications Opportunities for Chartered Accountants Importance of Forensic Accounting Profession Evolution of Forensic Accounting Profession 1.1 BRIEF OVERVIEW & EVOLUTION OF FORENSIC PRFESSION The Forensic word originates from the Latin word “forensis” which translated literally means “of or before the forum”. In Roman times when someone was charged with a crime, the case was presented before a group of public individuals in a “forum”. The accused and the accuser would present their side of the story and show their supporting evidence and the case would get decided based on the compelling arguments presented. This is believed to be the origin of the term forensic which com- bined the two key elements of legal evidence and public presentation. Historically, crimes were solved through forced confessions and witness testimony, both questionable methods to establish guilt or innocence. These methods sometimes allowed criminals to escape punishment due to lack of reliable and compelling evidence. Initial work in this area involved developing methods to gather evidence in a more objective and reliable way. Science provided the required discipline and laid the way to properly establish the nature of the crime (e.g., murder or accident), time of crime, and to link finer aspects (such as finger prints) between the crime and the criminal. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.3 Money plays a big role in many crimes. Money is a big motive behind the crime a number of times. For example, where there is a property dispute, we sometimes see the alleged owners physically hurt or harm the other party resulting in a criminal act. Further, the theft of money in, itself, is a crime as defined in law which protects victims of cheating, deception, fraud etc. In India, Section 420 of Indian Penal Code is a well-publicised example of law provision on “Cheating and dishonestly in- ducing delivery of property”. As handling and recording of money and property became complex and sophisticated, the emer- gence of the accounting profession began to take shape. At the same time, the trustworthiness of the accountants became an important matter. Hence, various checks and balances were introduced and need arose to provide assurance over the reliability of the book-keeping and the reporting of financial matters. From this, emerged the auditing profession and auditor came into picture to pro- vide the much-needed independent assurance. With rise in volume of trade and industry, opportunities grew exponentially for unethical persons to commit frauds.. Along with all this, the profession of Forensic Accounting began to take shape to support the need to gather evidence required to prove financial crimes. Forensic Accounting has now emerged as a highly regarded domain of the Emphasis Accounting Profession, and some would say, a Forensic Profession in its own right. With all the advancements in science and technology, investigations became a lot more methodical and rigorous, allowing for the discovery of evidence which is more reliable and acceptable. The gathering of evidence in this manner has helped to support the discovery of truth and help establish “what” actually happened. Nevertheless, there is also the need to understand “why” the actions took place and so the necessity to support the criminal acts with the motives also became important. This is only possible when the curious mind of a professional investigator is applied to understand the reasons for the criminal act and gather evidence to support such motives. Through a comprehensive investigation, the professional is able to present the complete picture to an independent judge in a court of law to help establish whether or not there has been a criminal act. Therefore, the profes- sional is able to support legal proceedings. Numerous cases of fraud have occurred in spite of laws to deal with such instances. Nevertheless, incidents of fraud continue to affect many organizations, regardless of size, geographic location, or industry. In Great Britain, the passage of the Joint Stock Companies Act in 1844 and its later versions ©The Institute of Chartered Accountants of India  1.4 FORENSIC ACCOUNTING contributed greatly to auditing field in general and to the development of external (independent) auditing. Fraud incidents have helped emergence of related fields such as internal audit. Governments all over the globe have tightened laws and regulations to improve corporate governance. One of the drivers of Forensic Accounting profession is to cater to regulatory requirements to bring culprits of financial crimes to book. Some noteworthy incidents which hit headlines in the past are presented below: S.N. Organisation (Year) Brief Information 1 Enron US$ 74bn investor loss (2001) Jobs of 1000’s employees Huge impact on Customers, Vendors and employees. 2 WorldCom US$ 180bn losses for investors (2002) US$ 11bn due to loss of company Loss of 30,000 jobs 3 Lehman Brothers Caused subprime mortgage meltdown (2008) US$ 600bn (largest) bankruptcy filing 4 Bernie Madoff Largest Ponzi Scheme in history (2008) US$ 64.8bn in losses 5 Satyam Biggest accounting fraud in India (2009) US$ 1.5bn in inflated revenues and assets ENRON – A Synopsis The Background Enron was an energy utility company based in Houston, Texas (US) which ventured into other busi- nesses like energy-trading, etc. It also had operations in India in the form of its investment in Dhabol Power Company, a natural gas-fired power plant generating 2184 MW of power. The company grew in a rapid manner from the year 1996, when it reported Revenues of $13 billion to over $100 billion by year 2000. It quickly became the seventh largest company in the USA. It also became a very popular company in the stock exchange as its share price shot up to a peak high of $90/share. However, Enron was found to be indulging in a major accounting fraud which came to light in 2001 and now it is most famous as a company which perpetrated one of the largest frauds in history through the manipulation of various accounting practices. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.5 The Fraud Enron traded extensively in the energy derivates market where it made huge trading losses. How- ever, by using special purpose vehicles (SPVs, which are separate legal entities), and through var- ious accounting jugglery, it inflated its revenues through “marked-to-market” accounting, hid its huge losses and its massive debt through the SPVs. The executive management used fraudulent means by fabricating its financial records to fool the public, its business partners and employees. The COO oversaw the building of its vast trading operations using complex financial instruments. CFO of En- ron was responsible for the financing and accounting of these complex transactions and manipulated the accounting to avoid giving visibility to these new-age risks being assumed by the company for quick gains. At the height of its operations, the company was executing such trades worth over $2.5 billion per day! The SPVs allowed it to keep these business dealings off the books and hidden from the investing public. However, Enron’s misdeeds were finally exposed in 2001 as one of the Vice President level officials suspected these unethical dealings and blew the whistle by writing to the CEO and things stated to unravel from thereon. From mid-2001, it started to report its losses by which time the early warning signs of the fraud started to unravel the whole situation. By November 2001, the credit rating agen- cies reduced Enron’s credit rating to junk and by December 2001 Enron filed for bankruptcy, with over $60 billion in assets, which at that time was one of the largest such bankruptcies. The Aftermath Post-bankruptcy, Arthur Anderson, the Auditors of Enron were dismissed as they were being ac- cused of shredding and destroying important documents and evidence. They were indicted by the US Department of justice for obstruction of justice, and then eventually went out of business. Various other parties, including the Securities and Exchange Commission (SEC), the investment banks and the rating agencies were all accused of negligence in the Enron saga. The scandal resulted in the US government passing a wave of new laws and regulations to increase the financial oversight over public traded companies. A new draconian legislation, called the Sarbanes- Oxley Act in 2002 was issued to hold public companies and their executives more accountable for the financial affairs and financial statements of their companies. SOURCE: Based on research of various media reports and documents/reports in public domain ©The Institute of Chartered Accountants of India  1.6 FORENSIC ACCOUNTING CASE STUDY - WORLDCOM (An Excerpt) The Hero of the Case No integrity questions can be raised about Cynthia Cooper whose careful detective work as an in- ternal auditor at WorldCom exposed some of the accounting irregularities apparently intended to deceive investors. Originally assigned responsibilities in operational auditing, Cynthia and her col- leagues grew suspicious of a number of peculiar financial transactions and went outside their as- signed responsibilities to investigate. What they found was a series of clever manipulations intended to bury almost $4 billion in misallocated expenses and phony accounting entries. A native of Clinton, Mississippi, where WorldCom's headquarters was located, Ms. Cooper con- ducted her detective work in secret, often late at night to avoid suspicion. The thing that first aroused her curiosity came in March 2002 when a senior line manager complained to her that her boss, CFO Scott Sullivan, had usurped a $400 million reserve account he had set aside as a hedge against anticipated revenue losses. That didn't seem kosher, so Cooper inquired of WorldCom's accounting firm, Arthur Andersen. They brushed her off, and Ms. Cooper decided to press the matter with the board's audit committee. That put her in direct conflict with her boss, Sullivan, who ultimately backed down. The next day, however, he warned her to stay out of such matters. Undeterred and emboldened by the knowledge that Andersen had been discredited by the Enron case and that the SEC was investigating WorldCom, Cynthia decided to continue her investigation. Along the way, she learned of a WorldCom financial analyst who was fired a year earlier for failing to go along with accounting chicanery. Ultimately, she and her team uncovered a $2 billion accounting entry for capital expenditures that had never been authorized. It appeared that the company was attempting to represent operating costs as capital expenditures in order to make the company look more profitable. To gather further evidence, Cynthia's team began an unauthorized search through WorldCom's computerized ac- counting information system. What they found was evidence that fraud was being committed. When Sullivan heard of the ongoing audit, he asked Cooper to delay her work until the third quarter. She bravely declined. She went to the board's audit committee and in June, Scott Sullivan and two others were terminated. What Ms. Cooper had discovered was the largest accounting fraud in U.S. history. SOURCE: https://www.scu.edu/ethics/focus-areas/business-ethics/resources/worldcom/ All these incidents listed above are actually accounting frauds which were perpetrated by their top management in the hope of cheating investors (and others) to personally gain financially from their acts. As can be seen from the Enron synopsis and the excerpt taken from a Case Study conducted on WorldCom the discovery of the fraud was no mean task. It took a lot of courage and forensic ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.7 accounting type of work for the Whistle blowers and the Internal Audit Head of WorldCom to tena- ciously seek out the fraudulent entries to prove the fraud. Similarly, in India, Satyam was a starting point which triggered a lot of such frauds to surface later on. Needless to say, these incidents have made the government and regulators to tighten the systemic issues which emerged as a root cause for such incidents. Some of the reasons considered to be the reasons for these frauds are as follows (indicative list): (a) Inadequate oversight by the board and those charged with governance; (b) Abuse of power and authority by the promotors and top management; (c) Corruption and collusion between top management and lenders/bankers; (d) Short-term performance pressures from the investing public; and (e) Failure on part of auditor and regulators to identify and report the problems. The governments and regulators have taken many steps to try and prevent the repetition of these incidents. 1.2 INCREASING IMPORTANCE OF FA PROFESSION The most important tool of communicating the financial information to the general public by any publicly traded company is through its quarterly and annual financial statements. It is also the most reliable means of disseminating financial results and state of affairs by the organisation to the in- vesting public, creditors, lenders and of course the shareholders so as to allow them to make their investing and lending decisions. The overall efficiency of the financial markets is, therefore, very much dependent on the quality and reliability of these financial statements. Accounting Standard setting bodies (such as the ICAI) and government authorities (such as the MCA and SEBI) have always taken prompt and decisive actions for ensuring the quality and reliability of financial state- ments. Companies are, therefore, expected to place a lot of emphasis on preparing, reporting and disclosing authentic, accurate and reliable set of financial statements as and when these are re- quired to be issued and reported. Time and again, it has come to light that some (very few) companies have indulged in financial statement distortion or manipulation to hide their misdeeds and in those cases, the audit reports issued along with the statements have not been in accordance with Standards on Auditing. Misdeeds by company managements have been undertaken to either indulge in unethical activities like finan- cial frauds, tax frauds, or to manipulate the stock price for personal enrichment, or in most cases, ©The Institute of Chartered Accountants of India  1.8 FORENSIC ACCOUNTING simply just to mislead investors with the poor financial health of the organisation. As the business and financial environment becomes more complex and challenging, underlying dynamics of navi- gating the business through these challenges also becomes very difficult. Hence, loopholes are exploited by the few unethical parties in the hope that the manipulations are only a temporary solu- tion and once the situation improves, the original “honest” situation would be restored. Of course, this never happens, and before we know, the company has started its journey down the slippery slope which after sometime becomes a situation out of control. These manipulations have a devas- tating impact on the overall viability of the company because the financial statements are built on trust and once this trust is lost, it can never be regained in the original manner. Failure of one com- pany, then, leads to cascading effect on economy. Recently, there has been a significant increase in the importance of the Forensic Accounting (FA) professional all over the world, and more so in India l. In almost all large fraud incidents, especially those presented above (and also others which hit the media headlines around that time), there have been large scale financial irregularities involving huge amounts and large financial implications. In these frauds, to unearth the truth, and to fully understand what actually happened, professionals with financial accounting expertise were used to piece together the required evidence by scrutinising suspicious transactions in great detail. This level of expertise was required to put together the com- plex jigsaw puzzle that is usually left behind in tatters by the financial culprits. Many of these culprits themselves are actually people who understand the “accounting language” very well. In fact, they know the finer financial nuances so well, that they can quickly identify and exploit the loop holes for financial crimes. Not only that, some of the mas- terminds are so smart that they usually go a step further and use their expertise to disguise their “criminal footprints”. In this way, they are able to hide their crime from the eyes of their superiors or even from the auditors! A study of previous financial frauds (Gerald, 2002) has established conclusively that financial information manipulation significantly erodes the trust of the investing public in the financial state- ments issued by the companies. To retain and restore this trust, it’s very important that the govern- ment and the regulators play a proactive role in ensuring that any such incidents are contained well and quickly. This was very much the case in India when the incident of the Satyam fraud came to light. The government machinery moved swiftly to minimize the fallout from the incident and consid- erable effort was made to ensure that there is minimal damage to the investors from the imminent ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.9 implosion of the company. The law enforcement authorities were quick to go after the culprits and a number of forensic investigations were undertaken in a an urgent manner to try and book the guilty as soon as possible. In fact, Satyam fraud has triggered the profession of forensic accounting in India in a significant way. This is because forensic techniques deploy both quantitative and qualita- tive methods to gather evidence and find the truth, thereby helping to solve the cases in a very methodical and reliable manner. With all these frauds increasing at such an alarming rate, the need for professional experts to help the law enforcement agencies to solve these cases has also grown at an exponential rate. Profe- sionals are being called upon by not just the law enforcement agencies but also by the lenders (e.g., the banks) and investors and in some cases even by the top management of the companies them- selves. Professionals with hands on knowledge and expertise in investigating financial crimes using forensic techniques are now in great demand. In India, the accounting profession led by the Institute of Chartered Accountants of India (ICAI) has played a pioneering role in this regard. Most of the professionals operating in this domain are qualified and practising Chartered Accountants. They have made a name for themselves in in providing services for gathering evidence for such “white- collar crimes”. Also, ICAI has been quite active in improving the quality of the work undertaken by the professionals through the issuance of set of “Forensic Accounting and Investigation Standards”, also referred to as the FAIS.. In the WorldCom case, the Internal Auditor required not just basic investigative skills of looking in the right places, but also the technical expertise of computer systems. EXAMPLE This was supported with the tenacity to continue doing the work despite roadblocks coming in the way. Finally, a lot of courage was required to overcome the intimidation by the boss and other superiors! The main reason for the increasing importance of the FA professional is that they come with much more than basic accounting and finance skills. The FA professional is actually a highly skilled, multi- dimensional professional with expertise in many different areas (and not just basic accounting and finance). Law and regulations play a major role in most of these assignments, due to which legal knowledge and expertise becomes critical in such assignments. The other aspect that has now been well recognised is that there are certain industries (e.g., the banking industry) and sectors (e.g., the finance and real estate sectors) which are more prone to financial and accounting frauds. This is partly because the banks, especially the Public Sector Banks (PSB) in India, have been found to be soft targets by some highly influential (and somewhat corrupt) ©The Institute of Chartered Accountants of India  1.10 FORENSIC ACCOUNTING promotors who use their connections to get loans from these banks but never have any intentions to return these loans. 1.3 LEGAL & REGULATORY RAMIFICATIONS One of the main feature of Forensic Accounting profession is that it exists at the intersection between Accounts and Law. The Chartered Accountant pursuing a career in this area needs to have a sound understanding of the legal and regulatory requirements which come into play in this area. This is because in most cases, the forensic or investigation work is focused on identifying violations to certain stipulated laws and regulations. After all, it is not fair to make any accusations of wrongdoing against someone unless these accusations can be proved in a court of law which provides the plat- form for the accused to not only defend himself fairly but also for an impartial judge to make an independent determination of guilt or innocence by reviewing the evidence presented by both parties to support their positions. Each engagement is unique due to its circumstances and the context and, in most cases, subject to relevant applicable statutes. The Professional is expected to understand provisions of not only the general laws, but also the specific requirements which may apply under the circumstances. Without adequate knowledge and appreciation of these provisions, the Professional will not be able to con- duct his work properly, nor will he be able to look for the relevant and suitable evidence to complete the engagement in an effective manner. In any court proceedings, any evidence to be admissible in a court of law has to be in compliance with the provisions of the Indian Evidence Act, 1872. This law defines EXAMPLE the nature of the evidence (e.g., it has to be relevant) and the manner in which the evidence is gathered for presenting in court proceedings. It also gives various illustrations to clarify the provisions and should be studied very thoroughly. It is also important to keep in mind that a FAI engagement may arise either when: the Professional is appointed in accordance with some specific law or regulation (e.g., by a court of law or competent authority) – which may provide both, the mandate and the process, of conducting the engagement; or the Professional is appointed by the client through a contractual arrangement – which may provide the mandate but is subject to the provisions of various laws and regulations and conducts the engagement within the framework of those laws and regulations. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.11 When dealing with laws & regulations in a forensic accounting and investigation EMPHASIS engagement, it’s important to remember that the professional has to not only look for legal and regulatory violations by the accused party, but also conduct his work in line with the provisions which dictate the manner in which such work is to be completed without compromising on the authenticity and reliability of the evidence matter. It needs to be understood that many laws and regulations apply to FAI engagements. These can be categorized into “Direct impact laws” and certain “Engagement specific laws”, explained further be- low: income tax violation - Direct impact or engagemen (a)Direct impact laws: Despite all laws being an integral part of the engagement, certain laws specific are specifically applicable to FAI engagements. These laws form an essential basis for the Professional to conduct the engagement. As an example, there are certain statutes with provisions relating to white collar crime, corruption and money laundering, and certain con- tract or company related laws with specific provisions concerning frauds and irregularities. The Professional is expected to have a basic understanding of these direct impact laws to plan and conduct the engagements. (b) Engagement specific laws: In addition to the directly impacting laws mentioned above, there are certain specific laws which apply when engagements are planned and executed. These engagement specific laws shall govern the overall conduct of the engagements in such situations. As an example, there are certain statutes with provisions concerning the information technology environment, privacy of individuals, some laws concerning insol- vency and bankruptcy which codify the manner in which FAI procedures need to be con- ducted to discover evidence and laws concerning how evidence needs to be admissible in a Court of law. The Professional is expected to have a basic understanding of these en- gagement specific laws for proper conduct of work procedures. A gist of the nature of various laws and regulations which may become relevant to the assignment undertaken by the professional is given below: - (a) Indian Penal Code, 1860: The Indian Penal Code (IPC) is the main and earliest criminal law of the country. It includes all the criminal offences including crimes related to property and theft, etc. Anyone found guilty of a crime is punishable under the IPC. Some of the relevant sections under IPC are as follows:  Section.405: Criminal breach of Trust ©The Institute of Chartered Accountants of India  1.12 FORENSIC ACCOUNTING  Section 420: Cheating and dishonestly inducing delivery of property  Section 463: Forgery  Sec 464: Making a false document (b) The Indian Contract Act, 1872: The Indian Contract Act, 1872 prescribes the law relating to contracts in India and is the key act regulating Indian contract law.  Section 17: defines Fraud in the context of contractual arrangements.  Section 18: defines misrepresentation (c) Indian Evidence Act, 1872: The Indian Evidence Act (IEA) contains a set of rules and related matters covering the admissibility of evidence in the Indian courts of law. This Act is divided into three parts and there are 11 chapters in total under this Act, a summary of these is as follows: ov. applicable 1) IEA Part 1: Deals with the relevancy of facts which form the basis of evidences. r doc. of Chapter 1 introduces the Indian Evidence Act. (an overview) idence cover Chapter 2 deals with the relevancy of the facts. der which act. 2) IEA Part 2: Deals covers the subject of Proofs and matters like oral vs. documentary evi- dence. Chapter 3 deals with facts which need not be proved Chapter 4 deals with matters of oral evidence Chapter 5 deals with documentary evidence, and Chapter 6 deals with matters dealing with exclusion of oral by documentary evi- dence. 3) IEA Part 3: Deals with production and effect of evidence. Chapter 7 deals with the burden of proof Chapter 8 deals with estoppel Chapter 9 deals with witnesses Chapter 10 deals with examination of witnesses, and Chapter 11 deals with improper admission and rejection of evidence. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.13 It would be appropriate to emphasize importance of the Indian Evidence Act,1872 in the profession of Forensic Accounting as practiced in India since this piece of legislation clearly lays out the details of what is considered “acceptable (or unacceptable) in the court of law”. Considering that the work of the professional is based on the quality and reliability of the evidence gathered it is critical that finer nuances of this law are well understood by profes- sional. (d) The Code of Criminal Procedure 1973: The CPC, applicable to all criminal proceedings, creates the required mechanism for apprehending the criminals, investigating the criminal cases, how their trials are to be conducted before the Criminal Courts and the manner of imposition of appropriate punishment to the guilty parties. The CPC also enumerates the hierarchy of criminal courts in which different offences can be tried and also spells out the limits of the sentences which can be passed by the relevant Courts. For the Forensic ac- counting Professional working with the law enforcement agencies, this is an important piece of legislation which needs to be well understood so that the Investigations can be conducted in a proper and compliant manner. (e) Prevention of Corruption Act, 1988: The Prevention of Corruption Act (PCA) was enacted to fight corruption and other malpractices in government and public sector business in India. It is designed to pursue criminal charges against corrupt public servants in order to deter the evil of corruption. Some of the relevant sections under PCA are as follows: Section 7 covers offence relating to public servant being bribed Section 7A Taking undue advantage to influence public servant by corrupt or illegal means or by exercise of personal influence Section 8 Offence relating to bribing of a public servant Section 9 covers offence relating to bribing a public servant by a commercial organi- sation Section 12 Punishment for abetment of offences (f) The Prohibition of Benami Property Transactions Act, 1988: The Prohibition of Benami Property Transactions Act makes it illegal to hold (or conduct transactions) of properties by a benami person (defined as someone who owns a property on paper but where the con- sideration of such property has been paid for by some other person) and gives the govern- ment the right to confiscate such benami property. Some of the relevant sections (§) under this law are as follows: ©The Institute of Chartered Accountants of India  1.14 FORENSIC ACCOUNTING Section 3 relating to prohibition of benami transactions Section 4 deals with prohibition of the right to recover property held benami Section 5 relating to property held benami liable to confiscation (g) The Securities and Exchange Board of India Act, 1992: The Securities and Exchange Board of India (SEBI) Act established a Board to protect the interests of investors in securities and to promote the development of and to regulate, the securities market in India. It has urpose of various Chapters, the important ones being: stb. of Chapter II on the Establishment of SEBI EBI act Chapter IV covers the Powers and Functions of the Board Chapter VA deals with prohibition of manipulative and deceptive devices, insider trad- ing and substantial acquisition of securities or control (h) The Prevention of Money Laundering Act, 2002 (“PMLA”) PMLA was enacted to pre- vent money-laundering and to provide for confiscation of property derived from money- laundering. The PMLA seeks to combat money laundering in India and has three main objectives: To prevent and control money laundering. To confiscate and seize the property obtained from the laundered money; and To deal with any other issue connected with money laundering in India. PMLA and the rules notified there under impose obligation on banking companies, financial institutions and intermediaries to verify identity of clients, maintain records and furnish in- formation in prescribed form. (i) Companies Act, 2013: The Companies Act, 2013) is one of the most important legislations of the nation relating to companies. Some of the important provisions for forensic account- ing professional are: -Section 34 Criminal liability for mis-statements in prospectus Section 36 Punishment for fraudulently inducing persons to invest money Section 210 Investigation into affairs of company Section 211 Establishment of Serious Fraud Investigation Office Section 212 Investigation into affairs of company by Serious Fraud Investigation Of- fice. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.15 Section 213 Investigation into company’s affairs in other cases Section 245 Class action Section 447 Punishment for fraud Section 448 Punishment for false statement In accordance with Section 211 of the Companies Act, 2013, the SFIO was established by the Government of India in 2015. The SFIO is a multi-disciplinary organisation under the Ministry of Corporate Affairs (MCA), consisting of experts in the field of accountancy, forensic accounting, banking, law, information technology, investigation, company law, capital market and taxation etc. for detecting and prosecuting or recommending for prosecution white collar crimes and frauds. Investigation into the affairs of a company is assigned to SFIO, where Government is of the opinion that it is necessary to investigate into the affairs of a company in case of any of the following situations: (a) on receipt of a report of the Registrar or inspector under section 208 of the Companies Act, 2013; (b) on intimation of a special resolution passed by a company that its affairs are required to be investigated; (c) in the public interest; or (d) on request from any department of the Central Government or a State Government. (j) Information Technology Act, 2000: This legislation was enacted to provide legal recog- nition for transactions carried out by means of electronic data interchange and other means of electronic communication, commonly referred to as “electronic commerce”, which involve the use of alternatives to paper-based methods of communication and storage of infor- mation, to facilitate electronic filing of documents with the Government agencies. Gist of some of important provisions of this law are as under: - Section 4 Legal recognition of electronic records Section 43 Penalty and compensation for damage to computer, computer system, etc. Section 43A Compensation for failure to protect data Section 65 Tampering with computer source documents Section 66 Computer related offences ©The Institute of Chartered Accountants of India  1.16 FORENSIC ACCOUNTING Section 66 B Punishment for dishonestly receiving stolen computer resource or com- munication device Foreign Laws relevant in the area of Frauds and Forensics: Many a times, the forensic account- ant has to deal with situations concerning cross border transaction (e.g., buying raw materials or selling products), or they may have to deal with matters having global implications (e.g., transfer pricing). Companies operating in multiple countries have to be in compliance with laws and regula- tions pertaining to not just the country in which they operate but also other countries of their parent entity or countries where they may be registered (e.g., tax havens). All these different jurisdictions have their own laws pertaining to matters concerning the topics listed above under laws concerning India, such as Corruption, Bribery, Money Laundering, etc. given that these are global problems and not problems plaguing the business environment in India alone. A quick snapshot of some of these laws is presented here. Country Legislation Year of Issue USA Foreign Corrupt Practices Act 1977 USA Sarbanes Oxley Act 2002 USA Prevention of Money Laundering Act 2002 USA United States Organizational Sentencing Guidelines 2004 UK United Kingdom Bribery Act 2010 1.4 OPPORTUNITIES IN FORENSIC ACCOUNTING FOR CAs There are opportunities galore for Chartered Accountants (CAs) in area of Forensic Accounting and Investigations. (1) A career in these areas is though challenging, but is quite exciting since a CA who is helping to prevent or detect financial crimes is actually fighting for a bigger cause in society. The ICAI has issued a set of Forensic Accounting and Investigation Standards (FAIS) which are discussed in subsequent chapter. Forensic Accounting and Investigating (FAI) engage- ments can be undertaken for different context or situations. Depending on their nature, the engagement undertaken may include any or all of the following elements: Forensic Accounting Services (2) Investigation Services. (3) Litigation Support Services. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.17 Forensic Accounting Services: An indicative list of services that can be provided by the Profes- sional in this area are as follows: (a) Financial Statement manipulations (b) Fund diversions/Asset tracing which one of the following (c) Anti-Money laundering not cover under forensic (d) Licence Fees/Dues/Tax Evasion accounting services? (e) Related party transactions/valuations (f) Valuations/Estimations of loss/damage (g) Suspicious transactions under IBC (Insolvency and Bankruptcy Code) Investigation Services: An indicative list of services that can be provided by the Professional in this area are as follows: (a) Fraud investigations (including Cyber frauds) (b) Insurance/Personal injury claims (c) Ethical/Code of Conduct violations (d) Whistle-blower complaints (e) Asset theft/Bribery/Corruption (f) Data breach/theft of Intellectual Property Litigation Support Services: An indicative list of services that can be provided by the Professional in this area are as follows: (a) Alternate Dispute Resolution (b) Testimony before Competent Authority These are explained as under: Financial Statement manipulations: When conducting a Forensic Accounting engagement on financial statement manipulations, the primary objective is to identify any fraudulent activities related to the financial statements of the organisation. Here are some specific objectives that may apply to such an exercise: (a) Identify the nature and extent of the manipulation: Determine the specific methods used to manipulate the financial statements, such as falsifying transactions, or altering records, and the extent to which they were used. ©The Institute of Chartered Accountants of India  1.18 FORENSIC ACCOUNTING (b) Determine the impact of the manipulation: Determine the impact that the financial statement manipulation had on the financial performance of the organizations, such as inflating profits or hiding losses. (c) Identify the parties involved: Identify the individuals or groups that are engaged in the fi- nancial statement manipulation, including any external parties. (d) Identify any violations of laws and regulations: Determine whether the financial statement manipulation involved any violations of laws and regulations, such as securities fraud, ac- counting standards, inadequate disclosures as per the Companies Act, 2013, violation of anti-money laundering laws, Insolvency and Bankruptcy Code, 2016, etc. Fund diversions/Asset tracing: The objectives of Forensic Accounting in fund diversions or as- set tracing cases can vary depending on the specific case, but generally, the following objectives may apply: (a) To identify Misutilisation of Funds or assets: The primary objective of Forensic Accounting in fund misutilisation or asset tracing cases is to identify any funds or assets that have been diverted or misappropriated in contravention to the original intentions or agreements. For example, funds received as a loan from the bank to expand production capacity are not used to buy the equipment but diverted to some other businesses, or to buy land for ac- commodation of individuals, unrelated to the business. Hence, the objectives in this case may involve tracing funds through bank accounts or other financial records, or tracing as- sets through ownership records or other documentation. (b) To quantify losses: The objectives may be to quantify the losses suffered as a result of fund misutilisation or asset misappropriations. This may involve calculating the value of diverted funds or misappropriated assets, as well as any financial damages resulting from the di- version or misappropriation. (c) To establish a timeline: The objectives may be to establish a timeline of events relevant to the case. This may involve identifying when funds or assets were transferred, or when financial statements or other documents were altered, or when other irregularities actually took place. (d) To identify the parties involved: The objectives may be to identify the parties involved in the diversion or misappropriation. This may involve tracing financial transactions and ana- lysing financial records to determine the people involved in processing the transactions from the bank or on the books of account. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.19 (e) To assist in asset recovery: The Professional may be called upon to assist in the recovery of diverted funds or misappropriated assets. This may involve working with Law Enforce- ment Agencies or other professionals to recover assets or providing information that can help identify the location of missing funds or assets. Anti-Money laundering: The objective of a FAI engagement in money laundering offence is to trace the properties. The following objectives may apply in these situations: (a) To trace assets allegedly generated by commitment of scheduled offences: The money laundering offence involves the properties generated by commitment of certain scheduled offenses prescribed under the Prevention of Money Laundering Act 2002 (PMLA). The rel- evant Law Enforcement Agencies expect the Professional to trace those properties or to trace the funds and assets. (b) To verify and gather evidences allegedly from laundered assets: The Professional is ex- pected to verify and examine various documents such as accounting records, bank state- ments, property related documents, etc., to trace the properties. These documents are to be evaluated for submission of evidence. Licence Fees/Dues/Tax Evasion: The objectives of Forensic Accounting in license fee or dues or tax evasion cases can vary depending on the specific case, but generally, the following objec- tives may apply: (a) To identify the extent of the evasion: The primary objective of Forensic Accounting in li- cense fee or dues or tax evasion cases is to identify the extent of the evasion. This may involve analysing financial records, reviewing tax returns, or conducting other financial analysis to identify any discrepancies or irregularities. (b) To identify the parties involved: The Professional may be called upon to identify the parties involved in the evasion. This may involve tracing financial transactions and analysing fi- nancial records. (c) To determine the amount owed: The Professional may be called upon to determine the amount owed as a result of the evasion. This may involve calculating the amount of taxes or fees owed, plus any penalties and interest. ©The Institute of Chartered Accountants of India  1.20 FORENSIC ACCOUNTING Since early 2000 the government has been charging telecom operators license and ich one spectrum usage fees using AGR (Adjusted Gross Revenue) methodology. The telecom EXAMPLE operators have been excluding non-telecom revenue from AGR and this has been a bone the of contention for many years since. Therefore, forensic accounting work has been llowing applied in this area by government authorities to unearth non-telecom revenue to augment their fees from telecom operators. not ver Related party transactions/valuations: The objectives of Forensic Accounting in related party der transactions cases can vary depending on the specific case, but generally, the following objectives lated may apply: rty (a) To identify conflicts of interest: The primary objective of Forensic Accounting in related ansaction party transactions cases is to identify potential conflicts of interest. This may involve ana- lysing financial transactions, reviewing contracts, or conducting other financial analysis to determine whether the transactions were conducted at arm's length. (b) To assess the risk of fraud: The Professional may be called upon to assess the risk of fraud in related party transactions. This may involve evaluating the potential for fraudulent activ- ities based on the transaction's characteristics, such as the size, nature, or timing of the transaction. (c) To quantify the impact on financial statements: The Professional may be called upon to quantify the impact of related party transactions on financial statements. This may involve adjusting financial statements to reflect the fair value of the transactions or assessing the impact on financial ratios. (d) To evaluate compliance with laws and regulations: The professionals may be called upon to evaluate there has been any breach in the compliance of related party transactions with ap- plicable laws, regulations, and corporate governance standards, especially those related to anti-corruption and insider trading regulations. Valuations/Estimations of loss/damage: The primary objective of Forensic Accounting in valu- ations or estimations of loss or damages is to provide an independent, objective, and reliable assessment of the financial impact of a particular event or dispute. These events or disputes may include fraud, embezzlement, breach of contract, insurance claims, or any other situation where there is a financial loss or damage. The specific objectives of Forensic Accounting valuations or estimation of loss or damages may vary depending on the nature of the event or dispute. Some of the common objectives include: ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.21 (a) Determining the extent of the financial loss or damages incurred by the affected party: The Professional may be engaged to calculate the amount of financial loss or damages resulting from an event such as fraud, breach of contract or negligence. (b) Identifying the root cause of the financial loss or damages: The Professional may be called upon to investigate and determine the root cause of a financial loss or damages. (c) Evaluating the impact of the loss or damage: The Professional may also assess the impact that a financial loss or damage had on an individual or organisation. This can involve ana- lysing the financial, operational, and reputational impacts of the loss or damage. (d) Assessing the reliability of financial statements: The Professional may be called upon to investigate financial statements, particularly in situations where there is suspicion of fraud or misappropriation of funds. Suspicious transactions under IBC: During the Corporate Insolvency Resolution Process (CIRP), the Resolution Professional (RP) or Liquidator may appoint a Professional for examining specific transactions, viz., Preferential, Undervalued, Fraudulent Trading and Extortionate Credit, which collectively are referred to as PUFE transactions. The objectives of identifying suspicious transactions under IBC through Forensic Accounting are: (a) Fraud detection: Forensic Accounting can help detect fraudulent transactions that may have taken place during the insolvency process. This includes identifying transactions that were made with the intention of deceiving creditors, hiding assets, or inflating liabilities. (b) Identifying preferential and undervalued transactions: Forensic Accounting can help identify transactions that may have given preference to certain creditors over others. This includes transactions that may have taken place before the company was declared insolvent or trans- actions made with related parties. Similarly, Forensic Accounting can be used to determine if any property of the Corporate Debtor has been sold or transferred at an undervalued price by the management during the relevant period. (c) Building evidence for legal proceedings: Forensic Accounting can help build evidence to sup- port legal proceedings against those who may have engaged in fraudulent activity or violated regulations during the insolvency process. ©The Institute of Chartered Accountants of India  1.22 FORENSIC ACCOUNTING Fraud investigations (including Cyber frauds): When conducting a forensic investiga- tion on suspected fraudulent activities, (includ- ing cyber fraud), the following are some specific objectives that may apply: (a) Identify the nature and extent of the sus- pected fraud: The Professional may be called upon to determine whether the fraud has occurred, its scope and sever- ity of the illegal or fraudulent activities that have taken place. (b) Determine the impact of the suspected fraud: The Professional may be called upon to assess the financial, legal, and reputational effects of the fraudulent activity. The Investigation may be required to determine the amount of financial loss caused by the fraud. (c) Identify the parties involved: The Professional may be called upon to identify the individuals or entities responsible for the suspected fraudulent activity. This can include the person or group who perpetrated the fraud, as well as any third-party individuals or organizations that may have enabled the fraud to occur. (d) Identify any violation of laws and regulations: The Professional may be called upon to de- termine whether the suspected fraudulent activities involved any violation of laws and reg- ulations, such as money laundering, bribery and embezzlement. Insurance/Personal injury claims: Many times, there are financial implications of personal inju- ries caused as a result of the negligence of some party. The injured party makes a claim to the negligent party to seek damages or financial claims to help alleviate the burden of the injury. The forensic accountant uses expertise in the area of future earning potential etc., to develop a scien- tific and calculated basis to justify the nature and quantity of the claim amount. When such claims are made in a methodical and reliable basis the insurance companies (who may have to eventually foot the bill) are much more acceptable to reimburse the claim. Ethical/Code of Conduct violations: The objectives of a forensic investigation into ethical or code of conduct violations are to determine if any violation has occurred, identify the extent of the viola- tion, and establish a basis for disciplinary action or legal action, if required. Here are some of the primary objectives of such an Investigation: ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.23 (a) Establish Facts: The objective of a forensic Investigation into ethical or code of conduct violation is to establish the facts. This may involve gathering evidence, interviewing wit- nesses, documents, and analysing data. (b) Identify Violation: The Investigation aims to identify any violation of the ethical or code of conduct policies of the organisation. This may include actions such as discrimination, har- assment, retaliation, conflicts of interest, fraud, or other violation of company policies. (c) Assess the Extent of Violation: The Investigation aims to assess the extent of the violation to determine the impact on the organization and its Stakeholders. This may involve evalu- ating the financial impact, reputational damage, and legal implications of the violation. (d) Determine Accountability: The Investigation aims to identify the individuals or groups re- sponsible for the violation and assess their level of culpability. This may involve evaluating the actions of employees, supervisors, managers, and executives. Whistle-blower complaints: The objectives of a forensic investigation on whistleblower complaints are to identify any incidents of misconduct, assess the severity of the incident, identify the individuals responsible for the misconduct. These could be non-financial matters pointing towards some behav- ioural infraction or violation by individuals. Here are some of the primary objectives of such an in- vestigation: (a) Establish Facts: The objective of a forensic Investigation on whistleblower complaints is to establish the facts and seek out the truth of what actually happened. This may involve gath- ering evidence, interviewing witnesses, reviewing relevant documents, and analysing data to determine if any incident of misconduct or harassment has occurred. (b) Identify the Extent of the Misconduct: The Investigation aims to identify the extent and sever- ity of the misconduct to determine the impact on the organisation and its employees. This may involve evaluating the any financial, legal, or reputational implications for the organisa- tion. (c) Determine Accountability: The Investigation may require the need to identify the individual(s) and assess their level of culpability. This may involve evaluating the actions of senior em- ployees, supervisors, managers, and executives. Asset theft/Bribery/Corruption: The objectives of an Investigation on asset theft, bribery, or cor- ruption are to determine the amount of financial loss or damage caused to the organization from these activities, assess the extent and scope of the wrongdoing, identify (if possible) the individuals ©The Institute of Chartered Accountants of India  1.24 FORENSIC ACCOUNTING or groups involved in the misconduct. Here are some of the primary objectives of such an investiga- tion: (a) Identify the Extent of misconduct: The objective of an Investigation on asset theft, bribery, or corruption is to identify the extent of the misconduct. This may involve gathering evidence, reviewing financial records, interviewing witnesses, and analysing data to determine the scope and severity of the wrongdoing. (b) Determine Accountability: The Investigation may require the need to identify the individuals or groups responsible for the wrongdoing and assess their level of culpability. This may in- volve evaluating the actions of employees, supervisors, managers, and executives. (c) Assess the Financial Impact: The Investigation aims to determine the amount of financial loss or damage caused to the organisation by asset theft, bribery, or corruption. This may involve evaluating the financial records and analysing data to determine the extent of financial loss. Sometimes there is a need to seek restitution from the parties involved so as to try and recoup or mitigate the losses. Data breach/theft of Intellectual Property: Data breach is a violation of the security measures in place to protect sensitive or confidential data, and results in the theft of such information by individ- uals who are not authorised to have access to such information. Very often, such breaches are done to steal digital property which has a lot of value, also called intellectual property since it has been created by application of some human intelligence. Incidents of these types are now becoming quite common due to the immense value of these intangible assets, which are also quite easy to steal by smart technical criminals. The forensic accountant has to therefore have an expertise of digital fo- rensic to be able to investigate these types of incidents. Alternate Dispute Resolution: The objectives of Forensic Accounting in Alternate Dispute Resolu- tion can vary depending on the specific case, but generally, the following objectives may apply: (a) To facilitate a settlement agreement: One of the primary objectives of Forensic Accounting in ADR is to facilitate a settlement agreement between the parties. The Professional may be called upon to provide financial information, analysis, or expert opinions that can help the parties reach a mutually acceptable settlement agreement. (b) To identify financial issues: The Professional may be called upon to identify financial issues that are relevant to the dispute. This may involve reviewing financial records, analysing finan- cial statements, or conducting other financial analysis to identify financial discrepancies or irregularities. ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.25 Testimony The Professional may be asked to testify before a Competent Authority with respect to their FAI Report. The following objectives may apply: - (a) To provide factual information: The primary objective of a witness is to provide factual in- formation relevant to the case. In the case of Forensic Accounting, this may involve provid- ing information about financial transactions, accounting practices, or other financial mat- ters. (b) To explain methodology adopted: The Professional may be questioned or cross examined on the methodology adopted in conducting the FAI engagement. (c) To help establish a timeline: A witness may be asked to provide information that helps establish a timeline of events relevant to the case. This may include information about when specific financial transactions occurred or when certain documents were created. TEST YOUR KNOWLEDGE Multiple Choice Questions (MCQs) Choose the most appropriate option: - 1. Out of given below statements, identify statement likely to be true: - (a) A Professional can investigate into whistle-blower complaint against officers of a company as part of a Forensic Accounting & Investigation engagement. (b) A Professional cannot investigate into whistle-blower complaint against officers of a company as part of a Forensic Accounting & Investigation engagement. (c) A Professional can investigate into whistle-blower complaint against officers of a company as part of a Forensic Accounting & Investigation engagement only in cer- tain explicit specified circumstances. (d) A Professional cannot investigate into whistle-blower complaint against officers of a company unless regulator specifically requires to do so. ©The Institute of Chartered Accountants of India  1.26 FORENSIC ACCOUNTING 2. Identify the most appropriate statement: - (a) Alternate Dispute resolution forms part of Forensic Accounting & Investigation ser- vices to be provided by a professional. The objective of alternative dispute resolution is confined to facilitate a settlement agreement between the parties. (b) Alternate Dispute resolution forms part of Forensic Accounting & Investigation ser- vices to be provided by a professional. The objective of alternative dispute resolution may be to facilitate a settlement agreement between the parties and/or to identify financial issues that are relevant to dispute. (c) Alternate Dispute resolution does not form part of Forensic Accounting & Investiga- tion services to be provided by a professional as such services do not involve foren- sic accounting skills. (d) Alternate Dispute resolution does not form part of Forensic Accounting & Investiga- tion services to be provided by a professional as such services do not involve inves- tigative skills. 3. Which of following statements is likely correct description of forensic science? (a) Forensic science involves use of scientific methods for solving a crime which can withstand scrutiny of law. (b) Forensic science involves method of using extensive interviews with suspects to solve a crime. (c) Forensic science involves method of using documentary evidence to solve a crime. (d) Forensic science involves method of using extensive interrogation to solve a crime. 4. Which of the following landmark legislation, which seeks to protect investors from fraudu- lent financial reporting, was passed in USA in aftermath of Enron and some other scandals? This legislation also requires that officers of companies certify in writing that company’s financial statements comply with necessary disclosure requirements. Further, this law also contained provisions for imposing harsh penalties for giving false statements. (a) Foreign Corrupt Practices Act,1977 (b) Prevention of Money Laundering Act,2002 (c) Sarbanes Oxley Act, 2002 (d) Investor Protection Act, 2009 ©The Institute of Chartered Accountants of India  BACKGROUND & OVERVIEW 1.27 5. A FAI engagement can arise in certain situations. Which of following is not such a situation? (a) Professional is appointed by a Court of Law. (b) Professional is appointed by a Regulatory body. (c) Professional is appointed by a client under contractual agreement. (d) Professional, on his or her own, undertakes such engagement to take to logical con- clusion any suspicious activities observed during audit of financial statements. Answers to Multiple Choice Questions: 1. (a) 2. (b) 3. (a) 4. (c) 5. (d) ©The Institute of Chartered Accountants of India CHAPTER 12 INTRODUCTION AND BASIC CONCEPTS LEARNING OUTCOMES After studying this Chapter, you will be able to: -  Understand meaning and concept of Forensics  Know Meaning of Forensic Accounting, Investigations and Fraud  Differentiate among audit, forensic accounting and investigations  Know meaning of Stakeholders in FAI engagement  Gain knowledge of roles and responsibilities of stakeholders  Have overview of Theories and Vulnerabilities of Fraud  Gain an introduction to Forensic Accounting and Investigation Standards (FAIS)  Have a bird’s eye view of matters dealt with by each FAIS ©The Institute of Chartered Accountants of India  2.2 FORENSIC ACCOUNTING CHAPTER OVERVIEW Possibility of Forensic Forensic Fraudulent Accounting Accounting and events or and Investigation suspicious Investigations Standards transactions 2.1 MEANING OF FORENSICS, FORENSIC ACCOUNTING, FRAUD AND INVESTIGATION (a) FORENSICS: Forensics, in general, is quite a broad term. In many ways, it’s the way something is minutely reviewed and analysed so that it can serve the needs of some legal requirements. Dictionary meaning of “Forensics” is scientific methods of solving crimes, that involve examining objects or substances related to a crime. (b) FORENSIC ACCOUNTING: Using Forensics in accounting domain means that the books of accounts and/or accounting transactions and balances are minutely reviewed and analysed to serve the needs of some legal requirements. Hence, this is slightly narrower and focused to accounting and financial matters. The Framework governing Forensic Accounting and Investigations defines forensic accounting as under: - DEFINITION: FORENSIC ACCOUNTING Emphasis Forensic Accounting is gathering and evaluation of evidence by a professional to interpret and report findings before a Competent Authority. The overriding objective of Forensic Accounting is to gather facts and evidence, especially in the area of financial transactions and operational arrangements, to help the Professional report findings, to reach a conclusion (but not to express an opinion) and support legal proceedings. ©The Institute of Chartered Accountants of India  INTRODUCTION AND BASIC CONCEPTS 2.3 (c) FRAUD: Fraud is an act conducted by someone to cause some form of financial harm to another through deception. This act can be a civil or a criminal offence depending on how it has taken place. If one person has acted against another person in a private matter, such as buying and selling property, and one of the persons has tried to unfairly deceive the other person in this act, then it can be assumed to be a civil offence between them due to their personal contractual arrangement. The victim can take the offending individual to court through a civil case. However, if this act is reported to the police as a fraud by the victim, the same act can be tried as a criminal offence in a court of law which will seek to establish the legal violation and also establish the damages. This definition of Fraud, as per Section 17 of the Indian Contract Act, 1872, is as follows: “Fraud” means and includes any of the following acts committed by a party to a contract, or with his connivance, or by his agent, with intent to deceive another party thereto of his agent, or to induce him to enter into the contract: — (1) the suggestion, as a fact, of that which is not true, by one who does not believe it to be true; (2) the active concealment of a fact by one having knowledge or belief of the fact; (3) a promise made without any intention of performing it; which one of the (4) any other act fitted to deceive; following is not a (5) any such act or omission as the law specially declares to be fraudulent fraud The term “Fraud” and its related words like “fraudulently” and “intent to defraud” have been used for a long time in the Indian Penal Code and other Statutes. The courts, and these Statutes have helped to define the key elements of the term (such as deception or intent to deceive) and therefore helped to establish whether or not a fraud has occurred. But its coverage in the corporate setting was very limited. The Companies Act, 2013 has defined term “Fraud” in very broad terms covering almost every conceivable situation. Section 447 of Companies Act, 2013 defines fraud as under: - (i) “Fraud” in relation to affairs of a company or anybody 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 Institute of Chartered Accountants of India  2.4 FORENSIC ACCOUNTING  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. (ii) “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled; (iii) “wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled. The Framework governing Forensic Accounting and Investigations defines fraud as under: - Emphasis DEFINITION: FRAUD Fraud is any intentional or deliberate act to deprive another of property or money through deception or other unfair means. (d) INVESTIGATION: Investigation is generally referred to a set of specific activities undertaken to gather the evidence required with a set purpose in mind. The specific activities can be in the nature of forensic accounting when the matter involves finance and accounting or the activities can be in form of observations or interviews for non-financial matters. The specific objectives can be anything where truth has to be established and presented with the facts, for example it could be fund diversion in a case of financial frauds. The Framework governing Forensic Accounting and Investigations defines Investigation as under: - audit vs investigation Emphasis DEFINITION: INVESTIGATION Investigation is the systematic and critical examination of facts, records and documents for a specific purpose. Investigation is a critical examination of evidences, documents, facts and witness statements with respect to an alleged legal, ethical or contractual violation. The examination would involve an evaluation of the facts for alleged violation with an expectation that the matter might be brought to a Court of law or a regulatory body. Some examples of each of the key terms defined above is presented below to clarify and appreciate the terms better. ©The Institute of Chartered Accountants of India  INTRODUCTION AND BASIC CONCEPTS 2.5 EXAMPLES – Frauds Some instances of Frauds in the Companies Act, 2013 (which attract Sec. 447 punishment): ♦ Sec. 34: For untrue, misleading statement in prospectus or inclusion or omission of any matter; ♦ Sec.36: For fraudulently inducing persons to invest money; ♦ Sec.38: For personation for acquisition of securities etc.; ♦ Sec.75: Acceptance of deposits with intent to defraud depositors or for any fraudulent purpose; ♦ Sec.147: Cases where auditor acts in a fraudulent manner or abets or colludes in any fraud; ♦ Sec.213: When business of the Company is carried on for a fraudulent or unlawful purposes or with intent to defraud creditors, members or any other persons; ♦ Sec.229: For furnishing of false statement, mutilation, destruction of documents during inspection, inquiry or investigation; and ♦ Sec.251: For making fraudulent application for removal of name. EXAMPLES – Investigations An internal investigation is sometimes initiated by the audit committee based upon its own concerns. More often, investigations are triggered by external factors, circumstances, or events. Common subjects of audit committee investigations include: ♦ Improper accounting for business activities (e.g., manipulation of earnings), falsified books and records, stock option grant irregularities, etc. ♦ Illegal payments to obtain business (e.g., government contracts, FCPA issues, and commercial bribery) ♦ Occupational misconduct, such as embezzlement or employee theft ♦ Conflict-of-interest or related-party transactions ©The Institute of Chartered Accountants of India  2.6 FORENSIC ACCOUNTING EXAMPLE – Forensics The Company received an anonymous hand written letter through the mail in which there were serious death threats against the CEO and his family. The letter alluded to the fact that bodily harm may be inflicted on the children of the CEO unless he took some specific action to send a specific amount of cash in currency notes within a specified time period in such a manner where the identity of the receiver was to remain unknown. The CEO immediately informed the police who took the letter, and the envelope it came in, for “forensic analysis". The lab undertaking the forensic work examined the paper used, the possibility of capturing some finger prints on the letter and envelope, scrutinise the manner in which the writing was done, such as the ink used to find out the nature of the writing implement, deployed the expertise of a handwriting expert to decipher the possibility of the writer etc. The police also undertook an investigation of the possible suspects and collected various samples of hand-writings of suspects to allow the forensic experts to match the handwritings and shortlist the most likely suspect. All the above-mentioned techniques deployed to analyse the only clue available (letter and envelope) are generally referred to as forensic work. EXAMPLE – Forensic Accounting The management of a pharma company suspects pilferage in its inventory and it appoints a Professional to seek help to confirm or rule out this suspicion. It wants review of its accounting records and their reconciliation with physical quantities to confirm or rule out suspicion. The management also wants to initiate legal proceedings against perpetrators in case fraud is confirmed. The Professional meticulously reviewed accounting records. To identify the reason of the variance, he undertook a review of the quantities of some of the large inventory items to see if he could identify the variance in kilogram weight terms. He noticed that some large expensive raw material inventory items receipts could neither be located in the store room or the factory production floor. He tried to trace these receipts to specific production runs to see if they had been used for making the medicines sold Finally, he reviewed the wastage records to see if these had been discarded due to quality control purposes. When he received no plausible explanation, he came to the conclusion that there is a serious possibility of pilferage of these expensive raw materials and asked the security head to investigate the matter during and after the time of receipt. This investigation led the security people to review the CCTV footage and records during delivery to identify a few instances of short delivery by the inward people. This detailed analysis by Professional is an example of some Forensic Accounting techniques used to identify a case of fraud. ©The Institute of Chartered Accountants of India  INTRODUCTION AND BASIC CONCEPTS 2.7 2.2 DIFFERENCES BETWEEN AUDIT, FORENSICS AND INVESTIGATIONS Media constantly uses the term “Forensic Audit”, and no day goes by where some news or another is not splashed on printed pages referring to some forensic work or another underway! The media (and some others) have coined this new term called “Forensic Audit” to indicate a fraud investigation. Strictly speaking, “Forensic Audit” is a misnomer – a misleading term, because either one can have a Forensic Accounting exercise or an audit, never the two together. As Forensics becomes a new buzzword in this era of high-profile frauds, it keeps getting much publicity these days (as shown above). In fact, it has now become more of a generic term to Example of the indicate a particular type of misuse of the “detailed audit” designed to term “Forensic Audit” by the unearth fraudulent activity. media! This stems primarily from the fact that forensics is seen as an extension of a typical audit and Chartered Accountants (CAs) are generally best placed to also undertake Forensic Accounting and Investigation work. However, it is mandated clearly in Forensic Accounting and Investigation Standards need to avoid any reference to the term “Forensic Audit”. This is to prevent any confusion between a FAI engagement with an audit engagement, where the Auditor is expected to express an independent opinion based on work performed in accordance with Standards on Auditing. The FAIS, therefore, do not apply to auditors, but to other Professionals undertaking FAI engagements, irrespective of the Stakeholders. In many cases, the stakeholders could include a Competent Authority and other government agencies, such as a Regulatory Body (e.g., RBI, SEBI etc.). In fact, some of these bodies mandate FAI type of engagements, at times referring to them as “Forensic Audits”. Hence, wherever the Professional is undertaking an engagement which is being referred to as a “Forensic ©The Institute of Chartered Accountants of India  2.8 FORENSIC ACCOUNTING Audit” (or any name whatsoever) and it complies with the mandate which is in the nature of either a Forensic Accounting engagement or an Investigation engagement (or a combination of the two), the FAIS would be applicable to such an engagement. It is expected from the Professional to recognise the nature of the engagement by understanding the mandate received from the Primary Stakeholder. The requirements are expected to be implemented through an understanding of the various unique features which define the requirements in the mandate. These unique features cover various elements like objective, approach, focus, required skill set and also the typical outcomes, etc. 2.2.1 We are familiar with meaning of audit. An audit is an independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon. The outcome of an audit is written audit report in which auditor expresses an opinion. The objectives of audit vary in nature. Statutory Audit is undertaken to express an independent opinion over the truth and fairness of financial statements. Internal audits are designed to strengthen internal controls with a focus on system and process improvement and thereby mitigate risks. These audit activities can, at best, identify red flags or fraud indicators, which may act as the starting points for a FAI engagement. 2.2.2 The indicative features of terms “forensic accounting” and “investigations” are summarised in infographics presented below: - Key elements of Forensic Accounting are presented here: ©The Institute of Chartered Accountants of India  INTRODUCTION AND BASIC CONCEPTS 2.9 Key elements of an Investigation are presented here: Forensic Accounting aims to highlight any accounting or legal violations, regulatory deviations or contractual breaches through ascertainment of facts and gathering of evidences admissible before a Competent Authority. The focus area is critical examination of transactions, funds and balances in the books of account or with third parties. However, the purpose of the Investigation is to examine facts and circumstances and gather evidence to prove or disprove hypotheses formulated regarding alleged legal violations, unethical conduct or the possibility of a fraud by suspected individuals. The Professional can make a determination of the nature of the engagement by looking at the proposed mandate by the Primary Stakeholder (the party seeking Professional help and appointing the Professional). (a) In most cases, the mandate does not specify any procedures which would immediately direct the Professional to decide the nature of engagement. In fact, the Primary Stakeholder may not know enough to help in this matter and would rely on the regular jargons like “Forensic Audit” or “Investigation” without even knowing enough about the distinction between the two. (b) The mandate received from the Primary Stakeholders mostly define the purpose of the engagement, which eventually will define its nature. This mandate will rightly define the expected outcome. For example, the Professional is informed that the management suspects that there is inventory pilferage from the plant and unpacked finished product is probably being stolen. The purpose in calling the Professional is to seek help to confirm or ©The Institute of Chartered Accountants of India  2.10 FORENSIC ACCOUNTING rule out this suspicion. This therefore becomes the mandate, which in most cases would point towards a Forensic Accounting engagement. The Professional may consider asking some of the following indicative questions while determining the nature of the engagement: (a) Does the engagement require gathering of evidence regarding alleged legal, ethical or contractual violations? (b) Will the findings be reported to a Competent Authority to make a legal or contractual determination? (c) Does the engagement require provision of testimony or assistance to arbitration, mediation or other alternative dispute resolution mechanisms on financial or non- financial matters? The answers to these, and similar questions provide greater clarity to help the Professional make an informed determination. It’s very important that the Chartered Accountants are themselves familiar with the EMPHASIS finer nuances of each of the above terms (Audit, Forensic Accounting and Investigation) and the mandate they define, therefore use the right terms themselves and correct others when they notice the wrong usage. 2.3 ROLES & RESPONSIBILITIES OF STAKEHOLDERS 2.3.1 Meaning of Stakeholders The Professional has to deal with a number of Stakeholders. They can be primary stakeholders or other stakeholders. The appointing authority is the Primary Stakeholder, who is also referred to as “the Client” in some cases. The appointing authority can be identified from the content of the engagement or the appointment letter and their signatory(ies) The Primary Stakeholder could either be a section of the entity’s executive management or the governing body of an organisation (e.g., the Board of Directors or the Audit Committee), or a competent authority (such as a court of law, an adjudicating authority or any other quasi-judicial body) empowered under law to act as such. ©The Institute of Chartered Accountants of India  INTRODUCTION AND BASIC CONCEPTS 2.11 All Stakeholders other than Primary Stakeholders are considered as Other Stakeholders and includes third parties (e.g., lenders, customers, suppliers, business partners, consumers, current or past employees, etc.) 2.3.2 Role & Responsibilities of Stakeholders In case of corporates, so far as frauds are concerned, the Board of Directors are expected to take a pro-active role in their prevention and detection. The Board needs to implement and strengthen the governance processes consisting of anti-fraud measures so that there is a culture of compliance and the people within the organisation (and also those from the outside who deal with the officers of the organisation) have impeccable integrity and would think twice before indulging in any unethical activity. On the detection side, they should seek to implement strong controls and a speak-up culture through whistle-blowing mechanisms which encourage people to highlight any instances of violations which can be investigated and concluded in a rapid manner. Certain classes of companies are required to constitute an audit committee under provisions of Companies Act, 2013. The audit committee performs many important functions like making recommendations for appointment of auditors of company, reviewing and monitoring auditor’s independence, performance and effectiveness of audit process, examination of financial statements & auditor’s report thereon, evaluation of internal financial controls and risk management systems and monitoring end use of funds raised through public offers and related matters. Audit committee, thus, helps in ensuring better standards of corporate governance. The regulators have taken an uncompromising approach to instances of fraudulent activity and over a short period of time, implemented robust regulations and strict compliance reporting requirements. The Reserve Bank of India, for instance has come down very hard on the banks which have been reporting large NPAs The Stock Exchange Board of India has also issued strict strictures on the actions the companies need to take in strengthening their anti-fraud measures and it also undertakes investigations in accordance with law. 2.4 THEORIES AND VULNERABILITIES OF FRAUD Due to the prevalent incidents of frauds , Fraud Risk is now considered to be one of the most important risks being faced by most organisations. In addition, most of the work in the area of Forensic Accounting and Investigations involves, in some form or another, something to do with fraud. So, the obvious question which comes to mind is the most basic question as to “why do frauds take place?” The answer to this million-dollar question will also help us to make sure that all our efforts in the prevention and detection area can be more effective if we are able to identify ©The Institute of Chartered Accountants of India  2.12 FORENSIC ACCOUNTING the real root-cause of this menace. In this regard, its pertinent to mention two key points in the FAIS. FAIS 120, on “Fraud Risk” states as under:- Forensic Accounting and Investigation (FAI) engagements generally involve the possibility of fraudulent events or suspicious transactions. Typical characteristics of a “Fraud” involve an incentive or pressure to commit fraud, a EXAMPLE perceived opportunity to do so, and some rationalization of the act. Therefore, the question of intent becomes critical as part of the engagement objectives. The concept of “Risk” is defined as the possibility of an unfavourable event or outcome, such as the presence of a fraud. Other Stakeholders: Stakeholders other than Primary Stakeholders are considered as other stakeholders and would include third parties (e.g., lenders, customers, suppliers, business partners, consumers, current or past employees, etc.). The above points seem to indicate the real reasons for why frauds happen. If we were to analyse any fraud in detail and look for the cause-effect, we would find that each of the frauds has these three essential ingredients – a motive (incentive), an opportunity (the enabler) and the rationalisation (justification in the mind). These three elements are essential for a fraud to be perpetrated and is presented as “Fraud Triangle Theory”. There are some other theories as well, but they are merely a modified extension of this Fraud Triangle Theory. 2.4.1 FRAUD TRIANGLE Donald Cressey, a sociologist and criminologist in the 1940s, was one of the first persons to specialize in the field of understanding fraudsters and why they do what they do. From his research, Cressey developed "The Fraud Triangle” which was a model he used to explain what caused some people to become fraudsters by analysing the circumstances in which the subjects of his research were drawn into fraud. 2.4.1.1 The fraud triangle, developed by Donald Cressey, is a model for explaining the factors that cause someone to commit occupational fraud. It consists of three characteristics which, together, lead to fraudulent behaviour: (a) The Motive or Perceived Pressure (b) Opportunity or the enablers ©The Institute of Chartered Accountants of India  INTRODUCTION AND BASIC CONCEPTS 2.13 (c) Rationalization or the Justification 2.4.1.2 A pictorial depiction of the Fraud Triangle is as follows: We will now discuss each of these three characteristics. (a) Motive or Perceived Pressure: Management or other employees may find themselves offered incentives or placed under pressure to commit fraud. When, for example, remuneration or advancement is significantly affected by individual, divisional, or company performance, individuals may have an incentive to manipulate results or to put pressure on others to do so. Pressure may also come from the unrealistic expectations of investors, banks, or other sources of finance. Certain risk factors are usefully considered in the evaluation of whether or not the organization is at a greater or lesser degree of risk, owing to incentives or pressures that could potentially lead to material misstatements caused by frauds. Determining the presence and degree of these pressures or incentives is part of the goal in evaluating the risk that misstatements due to fraud may have occurred. Certain risk factors are usefully considered in the evaluation of whether or not the organization is at a greater or lesser degree of risk, owing to incentives or pressures that could potentially lead to material misstatements caused by frauds. Some examples are as follows:  Financial stability or profitability is threatened by economic, industry, or entity operating conditions.  Excessive pressure exists for management to meet debt requirements.  Personal net worth is materially threatened. ©The Institute of Chartered Accountants of India  2.14 FORENSIC ACCOUNTING (b) Opportunity or the enablers: Circumstances may exist that create opportunities for management or other staff to commit fraud. When such opportunities arise, those who might not otherwise be inclined to behave dishonestly may be tempted to do so. Even individuals under pressure and susceptible to incentives to perpetrate a fraud are not a grave threat to an organization unless an opportunity exists for them to act on their need. An opportun ity must exist to commit fraud, and the fraudster must believe the fraud can be committed with impunity. Opportunities may also be inherent in the nature, size, or structure of the business. Certain types of transactions lend themselves more than others to falsification or manipulation, as do certain kinds of balances or accounts.  There is a presence of large amounts of cash on hand or inventory items.  There is an inadequate internal control over assets.  Inadequate segregation of duties.  Absence of mandatory job rotation and vacations (c) Rationalization or the Justification: Some individuals are more prone than others to commit fraud. Other things being equal, the propensity to commit fraud depends on people’s ethical values as well as on their personal circumstances. Ethical behaviour is motivated both by a person’s character and by external factors. External factors may include job insecurity, such as during a downsizing, or a work environment that inspire