Case Laws, Case Studies and Practical Aspects – CS Professional Study Material

Chapter 7 Case Laws, Case Studies and Practical Aspects – Forensic Audit ICSI Study Material is designed strictly as per the latest syllabus and exam pattern.

Case Laws, Case Studies and Practical Aspects – CS Professional Forensic Audit Study Material

Question 1.
Anustup Chandra Heavy Electricals Ltd., is a major player in the league of manufacture of heavy industrial boilers and steam turbine. The company had won a major bid for a big project in Colombo for fabrication of 10,000 MW boiler and turbine. The company outsourced some of the activities through a system of open tender and awarded contracts to eight different companies.
The company received complaints from three different bidders that there was a collusive bidding by four entities, to whom different contracts had been awarded by the company. You are appointed to conduct forensic audit to determine whether the complaint made by the three different bidders is having any merit. Your approach be based on :
(a) What will be the indicators/red flags you will look for ? (June 2019, 4 marks)
(b) What will be your line of investigation, to determine whether there has been really any collusive bidding ? (June 2019, 8 marks)
Answer:
(a) The forensic auditor in order to determine the merit of the complaint made by three bidders as to the collusive bidding shall look into following aspects as indicators/red flags:

• Whether the winning bids are low when benchmarked against the company estimates, past experience and industry standards.
• Whether the entities complained against, had very close price range, similar experience tenure, consistent in terms, conditions and technical specifications.
• Whether these entities were operating from same building with just different office/door numbers marked like say 23A, 23B, 23C, etc.
• Whether some of the qualified bidders who failed to make it to short list were internally rated good for performance, based on past experience and their marked reputation.
• Unusual bid patterns (e.g. the bids are exact percentage apart, winning bid is just under thresh hold of acceptable prices, exactly at budget price, too high, too close round numbers, incomplete etc.)
• Conflict of interest angle needs to be looked into i.e. any relationship exists between procurement head and the chosen vendors.

(b) The line of investigation after looking into the indicators/red flags shall consist of:

• Prepare a questionnaire for interviewing the complainants and those who failed but rated good and conduct interview of the complainants and investigate through confidential sources.
• Data collection paper trail: bid documents, requests for bids, bid comparison documents prepared internally, Bill of Quantities (BoQs), comparison line item wise and bid securities.
  ‘Identify physical similarities in the bid documents like paper quality, colour schemes, type, faces, formatting, language, etc.
• Connection between bidders on inter-company connections, common address, contacts details, etc.
• Unusual bidding patterns comparing the financial and quantity data line item wise. Test whether they are exact percentages or value apart.
• Conduct a physical verification check of the addresses given by the bidders in question to see whether they are operating from same building or not. ‘Background check on all the final short listed bidders for finding out common ownership, employees, affiliations or prior involvement in the other collusive bidding schemes.
• Review the bid security details in order to identify whether issued by same bank and branch to group of bidders and, or issued to bidder by the same day in all the cases.
• Most bid documents have a special enquiry audit enabler clause. Exercising that right on the winning bidder is conducted as a routine formality. Instead, a detailed inquiry can be made into the business of the winning bidder.
• Interviewing the winning bidder based on the information collected and from the above processes and as given by them in bid documents. Also have interview of the three complainants and all of the other bidders who have lost the bid to find out the reasons of their failure.

Question 2.
What are the governance problems which lead to the collapse of Satyam Computers.
Answer:
Following are the common governance problems, which have been noticed in the collapse of Satyam:

• Unethical conduct: Founders wanted to make money by avoiding paying taxes, cooking books, and pay offs; revealed some alarming truths that he was concealing for a long period by confessing to a fraud of ₹ 7,800 crores ($1.47 billion) on Satyam’s balance sheet.
• A case of false books and bogus accounting: These figures of accrued interest were shown in balance sheets in order to suppress the detection of such non-existent fixed deposits on account of inflated profits. The investigations also detailed that the company had deliberately paid taxes of about 186.91 crores on account of the non-existent accrued interests of ? 376 crores, which was a considerable loss for the company.
• Unconvinced role of independent Directors: The Satyam episode has brought out the failure of the present corporate governance structure that hinges on the independent directors, who are supposed to bring objectivity to the oversight function of the board and improve its effectiveness. They serve as watchdogs over management, which involves keeping their eyes and ears open at Board deliberations with critical eye raising queries when decisions scent wrong
• Questionable role of Audit Committee: The true role of audit . committee in precis is to ensure transparency in the company, that financial disclosures and financial statements provide a correct, sufficient and creditable picture and that, cases of frauds, irregularities, failure of internal control system within the organization, were minimized, which the committee failed to carry out.
• Dubious Role of Rating Agencies: Credit rating agencies have been consistently accused of their lax attitude in assessing issuers and giving misleading ratings without thorough analysis they failed to warn market participants about the deteriorating condition of company.
• Questionable Role of Banks: While sanctioning short term loans why not the banks posed any question as to why the company which was supposedly cash rich as per the financial statements was taking loans from them.
• Fake Audit: Price water house Coopers (PwC)’s audit firm, Price Waterhouse, was in the auditor for Satyam and have been auditing their accounts since 2000-01. The fraudulent role played by the Price water house Coopers (PwC) in the failure of Satyam matches the role played by Arthur Anderson in the collapse of Enron. Partners of PwC according to the SFIO findings, had admitted they did not come across any case or instance of fraud by the company. However, founder admission of having fudged the accounts for several years put the role of these statutory auditors on the dock.

Question 3.
Discuss the case study of NSEL.
Answer:
Facts

• Creation of NSEL was ideated on concept that it would provide a platform for farmers to sell their produce and on the other hand processors, exporters, traders and investors to buy produce electronically.
• This in theory would help price discovery in efficient way. NSEL was supposed to help the farmers to access the national market and get the best price for their commodities
• It was also envisaged that with the creation of holding capacity, the farmers would be able to raise funds under warehouse receipt financing by the banks.
• Under Forward Contracts Regulation Act, a spot contract shall be settled within 11 days including payment and physical delivery of goods i.e. in T+11 days.
• Spot contracts are out of Forward Market Commission which is the regulatory authority.
• Also as per concerned government departments notification in 2007 the spot contracts were deemed to be out of FMC if settled in T+2 days.
• NSEL somehow managed to ensure ‘sell’ contracts at T+25 / T+35 and ‘buy’ at T+2 providing major players wide window for ‘arbitrage’.
• Eventually, it was found that NSEL could not honor their T+25/35 obligations as it neither had money nor commodities.
• NSEL had also lent money to 24 borrowers without underlying commodity deposited by them – Warehouse receipt financing.
• Exchange allowed trading in stocks without verifying existence of the same.
• FMC found trading in contracts exceeding 11 days which was breach of provisions of FCRA, 1952. This led to unsettled payouts ballooning to ₹ 5400 crore.
• It was found that the commodity stockists where selling warehouse receipts to investors for immediate payments.
• The investors entered into buyback arrangements by selling back the commodity to stockists after 25-35 days without verifying the actual commodity stock.
• These investors latter actually sold commodities without proof of underlying stock.
• The NSEL scam has once again raised doubts over investing opportunities and investment safety.

Red Flags / Questions:

• How did central government allow NSEL to not follow demutualization rule?
• Why there is no regulatory authority or monitoring mechanism for spot contracts in commodities?
• Why were no red flags raised when liquidity was diminishing?
• Why were no red flags raised when only few members of the exchange did the actual business for so many years?

Investigation Process:

• Prepare a questionnaire for interviewing the complainants. Interviewing complainants and confidential sources.
• Data collection paper trail: agreements between NSEL, brokers, stockists, brokers, contract notes, warehouse receipts, financial and non-financial records.
• Data collection IT: email backups, electronic data from the computer device of all the suspects, server data, trade data, etc.
• Connections between brokers, investors, warehouse owners, exchange shareholders on inter-company connections, common address, contact details, etc.
• Data analytics: identify relevant statistics – significant increase in business of certain brokers, investors, warehouse owners, etc.
• Data analytics: correlate the data based on trade time stamps, spurt in volumes, cartel of brokers, investors, warehouse owners., speculators, etc. based on Time-Space Analysis.
• Forensic analysis of financial records of the exchange, its holding company, brokers, investors, warehouse owners and all major traders in the exchange.
• Specific focus on regulatory compliances and filings – both in terms of timely reporting and quality of the information reported.

Question 4.
Write a details note on Bank Fraud.
Answer:
Facts:

• The fraudster posed as banker’s representative to various PSUs and Corporates for making fixed deposits with the bank.
• PSUs and Corporates believed that they would be anyhow be dealing with the Bank and transactions would happen via regular banking channels, hence remain unsuspecting and trusting.
• The fraudster would change his role when he visited the Banks and offered to bring huge deposits from companies. He acted as representative of PSUs and Corporates.
• In the Bank Fraud Case, upon transfer of ₹ 110 cr. by ABC Private Company to the Bank for creating of FD, the fraudster asked the banker to immediately transfer the amount to his accomplice’s account KBP International via a FAX communication.
• Immediately, that transfer was followed by another trench of ₹ 70 cr. for FD creation.
• The Bank again received instructions to transfer the amount to the accomplice’s account via FAX message.
• Meanwhile, ABC Private Company directly contacted Bank to enquire why FD Receipts were not yet delivered to the company. It was then, they and Bankers realized that fraud has been perpetrated on them.
• The last trench of transfer was saved, but the earlier transfer of money is yet to be recovered.
• In another Bank Fraud case, the Bank received bulk deposits from Corporates and PSUs between 30 January 2017 and 5 May 2017.
• The modus operandi was similar.
• The fraudster represented organizations and as banker to the other.
• Fraudster convinced the organizations to create FD with the Bank and collected the KYC documents, obtaining signatures on forms, filled them and helped them through the entire process.
• Fraudster then submitted forged documents with the Bank and obtained FDRs of ₹ 256.69 cr.
• The originals were collected by the fraudster as representative of the organizations.
• The FDRs were subsequently pledged with the Bank by the ‘same signatories’ against which overdraft facilities of ₹ 223.25 crore were obtained.
•  The funds were then surreptitiously transferred out of bank.
• The Banks also lost their stocks by 5% and stock lost 3.5% upon these revelations.
• Bank FD scam gets bigger, 9 FIRs filed, estimated fraud at least ₹ 700 cr.
• Preliminary inquiry by EOW has been initiated in another 10 cases.
• Finance Ministry has ordered a forensic audit in these PSU Banks.
• Both the banks have complained to the CBI, which has also looking into the matter.

Red Flags

• Middle man
• Audience participation and
• Another involvements

Investigation Process
In addition to the usual,

• Document forensics: Paper and ink analysis, handwriting analysis, signature analysis.
• Following regulatory channels, analyzing the email and telephone call data records.
• Establishing the linkages between the fraudster’s location while perpetrating fraud, communications with people within the organization and banks, etc.
• Mapping the procedural role of banking officials and the PSUs-Corporates officials with their job description and the standard operating practices/rules governing their duties.

Question 5.
Write a details note on Corruption and Bribe Case.
Answer:
Facts:

• HR department observed that a certain officer in the Purchase department was resented by his colleagues and juniors as being arrogant and asocial.
• Upon enquiries it was revealed that in last few years, some vendors with whom business was low were delivering to this particular officer sweets and gifts and sometimes for the entire department. Few of such suppliers were not in approved list with the company.
• At annual HR review the employee was generally asked about his life and family where he proudly stated that his daughter stood first in her class. Interestingly the school he revealed was one of the expensive international schools in the city. Lifestyle improvements were also observed i.e. use of branded products, travel by radio taxi on daily basis for commuting, etc.
• An inquiry into the matter was sought when at the annual Departmental Head meeting, the HR and Purchase Heads accidently discussed the employee in question at tea break, which was then escalated for approval by the management.

Red Flag Indicators

• Disproportionate increase in wealth of the procurement official.
• Frequent receipt of gifts
• Non-competitive selection of a contractor, unjustified favoritism.

Investigation Process

• Data collection IT: email backups, company mobile devices as per the company policy and applicable law, electronic data from the computer device of the suspect.
• Data collection paper based: suppliers documentation since pre-vendor creation stage, quotes, bids, invoices, payments, delivery acknowledgements, revisions to contracts, etc. for the alleged suspects tenure with the company.
• Data collection paper based: suppliers documentation since pre-vendor creation stage, quotes, bids, invoices, payments, delivery acknowledgements, revisions to contracts, etc. for the alleged suspects tenure with the company.
• Data analytics will help identify relevant statistics: significant increase in business. Significant increase indicate most likely vendors who could have received business by paying kickbacks.
• Reviewing transactions thoroughly including bidding documents, order placements, contractual agreements, per unit prices, quality of goods and services, etc.
• Background search on suspect vendors for their location, publicly available financial information via MCA or Financial database software’s like Prowess or Capital line, litigations against them, ownership structure, and overall market reputation.
• Background search on suspect vendors for their location, publicly available financial information via MCA or Financial database software’s like Prowess or Capital line, litigations against them, ownership structure, and overall market reputation.
• Background search on the suspected procurement officer about his reputation in the department, increase in his assets, changes in his lifestyle, etc.
• If significant indicators point towards fraud by the employee, asset trace investigation can be conducted to help recover the loss.
• From data analytics, identification of vendors whose business has suddenly decreased or were removed from the approved list during this tenure needs to be identified. Informal discussions and discrete inquires can be made with them. It is very likely that concrete information can come from such disgruntled vendors.
• Combined analysis of data analytics, background checks, document reviews, discrete enquiries with vendors no longer being favored will give a good understanding of situation as to what is going on and who is involved.