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Forensic audit, fraud detectionand Investigation techniquesByBhagwan Lal Soni, IPSADGP cum Director,Rajasthan Police Academy, Jaipur.

WHAT IS FRAUD misrepresentation of facts with intention tomislead someone to believe these facts astrue; parting with some valuable thing ormoneybelonging to someone aftergettinginduced by relying upon suchfacts, Misappropriation of valuable thing ormoney belonging to someone who partedwith it after getting induced bymisrepresented facts causing or likely tocause loss of money and/or valuable thingsto the affected person.

CORPORATE FRAUD - A WORLDWIDE PHENOMENON Enron, World. COM, Daewoo Motors Korea ,Xeroxetc. are some of the world level frauds whichcaused business losses to their Indian affiliates andpublic financial institutions. In India too some big financial frauds have beenwitnessed in the recent past involving huge loss ofpublic money. In the securities scam by HarshadMehta and Ketan Parekh , C.R. Bhansali ,HomeTrade fraud,SatyamScam, failure of non-bankingfinancial institutions, frauds through vanishingcompanies & plantation companies etc. thousands ofcrores of public money has been lost.

FINANCIAL FRAUDS, QUITE COMMONIN CORPORATE SECTORSCausing loss of enormous money to;BanksFinancial institutionsGeneral publicAdversely Affecting the trust in mechanismof trade, finance, and investment Havingdestabilizing effect on commercial institutionsAffecting national progress and putting strainon national resources

Financial frauds PrimaryMarket Frauds Secondary Market Frauds Bank Frauds NPAs- 55000 Cr Import / Export Frauds Public sector frauds Tax frauds Money laundering5

Contd IntellectualProperty Crime/Theft Insurance Frauds Non-Banking Finance Companies(NBFCs Frauds) Fake Currency Fake stamps scam Computer & internet frauds6

HOW COMPANIES ARE USED FORCOMMITTING FRAUDFraudsters use companies as vehicle forcommitting fraud to cheat banks,financial institutions, and generalpublic7

POSSIBLE AREAS WHERE FRAUDS CANBE COMMITTED IN CORPORATE SECTORSmisappropriation of cash by fudging accounts; raising huge amount of term loan from banks andfinancial institutions by means of inflating theproject cost by over invoicing the plant &machinery and components purchased for settingup the project and then diverting of inflatedamount for non business use; raisingof excess working capital loan frombanks by over valuing the inventory and bookingof bogus expenses etc. and diversion of funds forpersonal gains; CONTD8

-Using inter bank transactions for creation of fictitiousentries by rotation of cheques for raising equity capital of acompany without bringing any money in the company.-Fictitious capital raised by the companies in the abovemanner are used showing them as promoters contributionin order to raise loans from banks and financial institutions.-Share certificates issued on the basis of such fictitiouslycreated equity capital are also sold to the public at a highlyjacked-up price for making money in fraudulent mannerfrom share market.-Raising of fictitious bills of sale and purchase by doingcircular trading entries of sale and purchases amonggroup companies without movement of goods and usingsuch bills for discounting with banks for collecting fundsfrom the banks.CONTD.

Falsification of annual accounts of the companies toshow inflated turnover as well as inflated profits and inthis way declaring good working results to stakeholdersas well as banks in order to mislead them for attractingmore investments from public and credit facilities frombanks; Accounts are also falsified to conceal true results ofoperations, or financial position of the company with aview to prevent timely detection of corporate frauds. Floating of many companies/firms on paper withoutany significant business and using various bank accountsopened in the names of these companies tomisappropriate funds diverted to them from the creditfacility availed from banks as well as investmentsreceived from public;CONTD.10

Generally employees of the main company(indulging into fraudulent activities) are shown asdirectors/partners of such companies/firms(used for diverting the funds received from publicand banks) and they do not know any of theaffairs of these companies/firms except signing ofthe cheques issued by these companies/firms; Cheating in foreign exchange transaction byshowing fictitious exports; Misappropriation of the funds provided by bankson discounting of export bills issued in the nameof foreign buyers under disguise.11

SYMPTOMS OF FRAUDDelayed submission of returnsinformation etc.; Delayed remittances into Bank; Delay or non preparation of Bankreconciliation statements; Lifestyle of promoters/directors and keyemployees ; Continued internal control lapses and notfollowing norms of corporate governance 12

SYMPTOMS OF FRAUD( Contd.)INTERNAL INDICATORS Delay in finalisation of accounts; Frequent changes in Accounting Policies; Continuing Losses; Over drawl of loans or advances; Higher cost per unit of production; High amount of losses or wastage shown inbooks Vs Norms; High investment in group companies Profit not supported by increased cashavailability13

MODUS-OPERANDI Loans& Advances Fake CA Certificates/Financial Statements Bogus Invoices/quotations/bills Fraudulent removal of stocks charged Inflated valuations of securities Forged property documents Fake/Wrong search reports Diversion of funds through bogus/sister concerns

MODUS-OPERANDI (Contd ) Deposits/Miscellaneous areas Un-authorized loans against deposits/NRI deposits ATM Frauds by stealing PINs/interception of cards Encashment of stolen/forged financial instrumentsthrough fictitious accounts Misuse of other’s passwords formisappropriation of funds15

MODUS-OPERANDI (Contd .) Import / export Business Fake LCs/Confirmation not obtained by thebanker Fake export orders for obtaining Packing Credit Forged shipping documents16

WHY DO FRAUDS OCCURGross negligence: non-compliance with establishedprudent procedures and practices/time tested safe-guards Excessive trust on customers / clients Willing complicity: Willful violation ofsystems & procedures by bank staff Failure of internal control mechanism Delaysin re-conciliation of inter-branchaccounts Laxity in custody of security stationery Non-compliance of computer security policies Access to bank’s records to outsiders

METHODOLOGY TO DETECTFRAUDAll the relevant documents and bank accountsof a company suspected to be involved infraudulent activities are to be collected from thecompany directly These documents are examined to trace out theutilization of various funds of the companycollected from the public, banks and financialinstitutions and to examine whether that hasbeen done as per the declared objectives of thecompany, CONTD.18

METHODOLOGY TO DETECTFRAUD(Contd.) After these examinations, patterns andconnections of financial transactions arediscovered which may be prejudicial tothe interest of the company and itsstakeholdersbutbenefitinganyparticular promoter or employee of thecompany or its related concerns.19

METHODOLOGY TO DETECTFRAUD (Contd.) fraudulent activities of a company can also betraced by collecting information from diversesources such as capital market, statements ofbank accounts of the company, its relatedbusiness concerns, promoters, directors andemployees of the company obtained from banks,various records of companies available withdifferent Government agencies i.e. Income tax,Customs & Central Excise, Director General ofRevenue Intelligence (DGRI) etc.20

METHODOLOGY TO DETECTFRAUD (Contd.) Disgruntled employees and tradingpartners can be very good source forgathering intelligence and collectingevidence. Pattern of deterioratingfinancial condition of the company andflourishing economic condition ofpromoters, employees, directors andrelated concerns of the company can beanalysed to detect possible fraud.21

STEPS INVOLVED IN FRAUDINVESTIGATION Fraud investigation mainly involvesforensic auditing of accounts anddocuments,examinationofbankstatements and various records andstatements etc filed by the company withdifferent Govt. Agencies. Sometimesforensic examination ofdocuments is also required to be done toverify the signature, handwriting etc.FSLGEQD22

STEPS INVOLVED IN FRAUDINVESTIGATION Findings of documents are corroboratedby oral examination of persons involvedin preparation of the documents andrunning the affairs of the company. Based on these documentary &oralevidence as well as expert opnionproceedings are initiated in Court oflaw/competent authorities23

FORENSIC AUDITING Forensic auditing is a technique to legallydetermine whether accounting transactions arein consonance with various accounting, auditingand legal requirements and eventually determinewhether any fraud has taken place. Forensicauditing is a blend of accounting, auditing andinvestigative skills. In doing so, the veil of corporate entity ispierced to establish the intentions of person(s)behind such transaction(s).24

Forensic Auditinvestigation of a fraud or presumptivefraud with a view to gathering evidencethat could be presented in a court of law.However, there is an increasing use ofauditing skills to prevent fraud byidentifying and rectifying situations whichcould lead to frauds being perpetrated (i.e.risks). It might be useful, therefore, todiscuss forensic auditing as being either’Reactive’ or ‘Proactive.25

Proactive forensic auditing Statutory Audit RegulatoryCompliance Diagnostic Tool Investigation of allegations26

Reactive Forensic Auditing-to investigate cases of suspected fraud so as toprove or disprove the suspicions, and if thesuspicions are proven, to identify the personsinvolved, support the findings by evidence and topresent the evidence in an acceptable format in anysubsequent disciplinary or criminal proceedings. Itinvolves working relations with the investigating andprosecuting agencies authorisation and control of the audit investigation documentationof relevant information andsafeguarding all prime records pertaining to the case27

on of records confidentiality evaluation of the evidence to assesswhether the case is sustainable legal advice where appropriate reporting the findings in a manner thatmeets legal requirements. 28

STEPS INVOLVED INFORENSIC AUDITING Detailed examination of financialstatements and books of accounts. Examination of related party transactionsand Inter-corporate Deposits as disclosedin the financial statements Auditing of off Balance sheet items.29

EXAMINATION OF FINANCIAL STATEMENTSAND BOOKS OF ACCOUNTSExamination of : TRADING ACCOUNTMANUFACTURING ACCOUNTPROFIT & LOSS ACCOUNTBALANCE SHEETDIRECTORS’/AUDITOR’S REPORTSCOMPARATIVE ANALYSIS OFFINANCIAL STATEMENTS COST AUDIT30

esproblemFounded by Mayur Joshi in 2005, IndiaforensicConsultancy Services (ICS) is a dedicatedprovider of forensic accounting and fraudinvestigation solutions in India. ICS delivers solutions in two verticals viz. IT andBanking. ICS provides a range of consulting servicesincluding training and education in both theverticals. won the Global award for“Outstanding Performance” for the year 2006given by Association of Certified FraudExaminers. 31

What sets us apart? We, at ICS have Thought-leadership, deep domain expertise andhighly respected amongst the peer-community in thefield of forensic accounting and fraud investigations Developed original and unique intellectual propertyin this field Award winners at the IIM A in business planningcompetition Have the right blend of technology and accountingprofessionals Owners of industry’s most exhaustive resource –Fraud TodayAbove as claimed by IndiaForensics32

Web Presence ICS Webportal www.indiaforensic.com is anexhaustive resource on the frauds in India Ranked #1 by Google,Yahoo and MSN for searchterms Forensic Accounting in India and BPO Frauds.Publications Black Cards Forensics – Research on ATM andCredit Card Frauds Combating the peril of Money Laundering – Thebook explaining the Indian scenario of MoneyLaundering Occupational Frauds and Money Laundering –published by Snow-white publishers

List last updated: 6 January 2014. Forensic Control are IT / computerforensic investigators based in London. Publishing the whole or part ofthis list is licensed under the terms of the Creative Commons –Attribution Non-Commercial 3.0 license. Updates to this page will beannounced on our Twitter feed at twitter.com/ForensicControl Disk tools and data capture Email analysis General tools File and data analysis Mac OS tools Mobile devices File viewers Internet analysis Registry analysis Application analysis Abandonware Copyright 2013 Forensic Control Limited. Registered office: 27 OldGloucester Street, London, WC1N 3AX. Web design by Brandspankin'34

Investigation into corporate fraudsSteps in conducting investigation:1. Develop the theory of the case,2. Identify sources of information,3. Procure documents and data,4. Interrogate key persons,5. Assess the evidence,6. Determine violation of law.35

INVESTIGATION – AN UPHILL TASK Toestablish mens-rea on the part of officials isdifficult Cases complex in nature, documents based, lackof professional competence among IOs Establishing trail of funds difficult Offenders are mostly rich people, take advantageof systemic loopholes Investigation spread over to many states, manybanks and sometimes foreign countries Fixing responsibility of Directors of accusedcompany extremely difficult Modern technology providing enhancedanonymity to fraudsters

INVESTIGATION – SOME KEYISSUES Drafting of FIRPreparation of Plan of Action Teamapproach Collection of documents Funds flow – Bank’s funds to be starting poi