The Role Of Forensic Auditing – Case Studies

Business Dictionary defines Forensic Audit as the application of accounting methods to the tracking and collection of forensic evidence, usually for investigation and prosecution of criminal acts such as embezzlement or fraud. It involves:

1. 1. Diligent set of skills
   2. Tools for detecting Fraud through transactions outside the system reflecting fraud
   3.  Analyzing the Financial statements and circumstantial evidences in order to identify fraudulent disclosure
   4. Finding the real culprit behind the Fraud

Serious Fraud Investigation Office

In order to locate and pinpoint where the irregularities exists, Serious Fraud Investigation Office (SFIO) has been established by the Government of India.

Section 211 of the Companies Act, 2013, empowers the Central Government to establish an office called Serious Fraud Investigation Office (SFIO) to investigate frauds relating to companies. No other investigating agency shall proceed with investigation in a case in respect of any offence under the Act, once the case has been assigned to SFIO. The SFIO has power to arrest individuals if it has reason to believe that he is guilty based on the material in possession.

Financial Intelligence Unit – India (FIU-IND) works as a central national agency responsible for receiving, processing, analyzing and disseminating information relating to suspect financial transactions.

Frauds could be categorized as below:

1. 1. Bank frauds
   2. Corporate frauds
   3. Insurance frauds
   4. Cyber frauds
   5. Securities frauds

Let’s see some of the case studies on how forensic auditing facilitate in finding the financial irregularities in frauds.

PUNJAB NATIONAL BANK SCAM CASE

PNB was born on May 19, 1894. The founding board was drawn from different parts of India professing different faiths and a varied back-ground with, however, the common objective of providing country with a truly national bank which would further the economic interest of the country.

In 1951, the Bank took over the assets and liabilities of Bharat Bank Ltd. and became the second largest bank in the private sector.

The bank has been nationalized on 19^th July, 1969. From then on, till now the bank has played a vital role in the banking industry.

The bank rolled out the news about India’s one of the biggest bank scam case on 14 February,2018.

It revealed a scam of Rs.11,000 crore directed by one of the richest diamond businessmen, Nirav Modi. He is 85th on Forbes’s 2017 list of the India’s richest people. Nirav Modi had directed and executed the scam with the support of the Deputy Manager of the PNB Mumbai branch named Gokul Nath Shetty and clerk Manoj Karat.

Nirav Modi and his Uncle Mehul Choksi schemed with these two bank employers. They had facilitated the issuance of unauthorized Letters of Undertaking (LOU) to Modi and his company without following the procedure.

The LOU is an instrument used to meet the short-term credit requirements of a customer of the bank. Under the LOU ban, PNB has not followed the prescribed procedure for the issuance of LOU to its customer.

How Forensic auditing helped in finding the loophole in the system?

The loans were taken in 8 different ways during the period of six years starting from the year 2011 to 2017. Other banks such as Allahabad Bank, Union Bank of India and Axis Bank were also included in providing loans.

The banking system of any transaction with a foreign bank is done through the SWIFT system. In this case, SWIFT was not directly linked with the Core banking system.

Society for Worldwide Interbank Financial Telecommunications (SWIFT) system serves as a network to send and receive information such as money transfer instructions. Core banking system which was the central system of any bank equally important similar to proper functioning of the brain to a human being. It is essential for maintaining compliance with regulations.

During the investigation, it was found that the employees of the PNB took advantage and issued a false LOU copy to the overseas bank. This was evenly going through until January 2018 when the companies of Nirav Modi again approached the PNB for buyer’s credit.

The officer in charge asked for collateral security against the buyer’s credit. The company refused to give any collateral security and thus disclosed that they have been taking the credit for the past 6 years without any collateral security Nirav Modi.

SATYAM COMPUTERS SCAM:

Satyam computers, once India’s fourth largest software exporter, which had been renowned for the financial irregularities in the exaggeration of Sales and earnings figure of the company in 2009. The company that had received Peacock Award for it best corporate governance in 2008, the shares of them has started falling down in January, 2009.

This incident took place after the Chairman has acquired 100% stake in Maytas Properties and Maytas Infra, two firms owned by Chairman Ramalinga Raju’s sons. The chairman justified those acquisition as a measure to benefit the investors. Unfortunately, the shares ditched them. World Bank forbidden the Satyam for data manipulation and corrupting the employees. Independent directors were resigned subsequently leaving an indication about the nation’s biggest scam. Later, the accused persons were sentenced to jail along with the fine of Rs.5.5 crore and the company was taken by Tech Mahindra.

With the role of forensic auditing, the following have been noticed in Satyam scam case,

• Manipulation in Accounting: Showing non-existent fixed deposits and accounted accrued interest for the same in order to show inflated figures in the balance sheets. As a result of the inflated profits having booked in the accounts, it has paid about RS.187crore as tax to the government
• Lack of Corporate Governance: Independent directors who were supposed to be the watchdogs of an organization become a silent spectator.
• Role of Audit Committee: The audit committee failed to highlight the irregularities taken place in the financial disclosures and financial statements.
• Role of Banks: Banks have failed to question as to why the company which is possessing enormous cash was applying for short term loans.
• Dubious role of Rating agencies: Credit rating agencies issued misleading ratings without thorough analysis of the market participants and their true condition in the market.

To put it simply, the role of forensic auditing is to question the roles and functioning of the respective people and the system in order to ensure the compliance of good governance.