Secretarial Audit-Fraud Detection and Reporting – CS Professional Study Material

Chapter 16 Secretarial Audit-Fraud Detection and Reporting – Secretarial Audit Compliance Management and Due Diligence ICSI Study Material is designed strictly as per the latest syllabus and exam pattern.

Secretarial Audit-Fraud Detection and Reporting – Secretarial Audit, Compliance Management and Due Diligence Study Material

Question 1.
Analyse the differences between the following :
Fraud and Non-compliance (Dec 2019, 2.5 marks)
Answer:
Fraud V/S Non Compliance
Fraud : As defined in Explanation to Section 447 of the Companies Act, 2013 tthe “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 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.
In general the fraud can be defined as act or course of deception, an intentional concealment, omission, or perversion of truth, to

  1. gain unlawful or unfair advantage,
  2. induce another to part with some valuable item or surrender a legal right, or
  3. inflict injury in some manner.

Willful fraud is a criminal offense which calls for severe penalties, and its prosecution and punishment. However, incompetence or negligence in managing a business or even a reckless waste of firm’s assets (for example by speculating on the stock market) does not normally constitute a fraud.

Non Compliance: The term non-compliance refers to failure to comply with the laws, rules regulations etc. It is commonly used in regard to a failure to meet the compliance requirements or failure to doing compliance be it the failure in following procedures, filing of information, eligibility conditions, reporting etc.
The relationship between the Fraud and the non-compliance can be constructed as the non-compliance in the company may lead to a fraud however it may also be noted that the fraud can also be made in the compliant company.

Secretarial Audit-Fraud Detection and Reporting - CS Professional Study Material

Question 2.
If the amount of a fraud detected by a Secretarial Auditor during the course of his work in a company is ₹ 50 lakh, explain his duties to report. (June 2019, 3 marks)
Answer:
Reporting of frauds by auditor involving amount less than ₹ 1 crore:
As per the Sub-rule (3) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 in case of fraud involving an amount less than ₹ 1 Crore, the auditor shall report the matter of fraud to the Audit Committee or to the Board within 2 days of his knowledge of the fraud. The report should specify the nature of the fraud with description, approximate amount of the fraud and parties involved in the fraud.
In such case, as per Sub-rule (4), the Board shall disclose in its report (Board’s Report) the nature of fraud with description, approximate amount of the fraud, parties involved in the fraud and remedial action taken. Name of parties should be disclosed only when the Board or Audit Committee has not taken any remedial action against the fraud.
In the given instance, the Secretarial Auditor shall report the same to the Audit Committee or to the Board of the company within 2 days of his knowledge of fraud.

Question 3.
A fraud is punishable offence whereas the non-compliance also attracts the penalties. Differentiate between the two concepts i.e. Fraud and Non-Compliance. (June 2019, 5 marks)
Answer:
Any person who is found to be guilty of fraud shall be punishable with imprisonment and shall also be liable to fine as prescribed under section 447 of the Companies Act, 2013.
The term fraud can be defined as an act or course of deception, an intentional concealment, omission or perversion of truth, to

  • Gain unlawful or unfair advantage,
  • Induce another to part with some valuable item or surrender a legal right, or
  • Inflict injury in same manner.

Non Compliance: The term non-compliance refers to failure to comply with i the laws, rules regulations etc. The term non-compliance is commonly used in regard to a failure to meet the compliance requirements, be it the failure in following procedures, filing of information, eligibility conditions, reporting etc.
The relationship between fraud and the Non-compliance can be constructed as the Non- compliance in the company may lead to a fraud. However the fraud can also be made in the compliant company.

Question 2.
As a Company Secretary, how would you deal with a complaint by the Registrar of Companies (ROC) and the Serious Fraud Investigation Office (SFIO) in a Special Court. (Aug 2022, 5 marks)
Answer:
The Registrar of Companies (ROC) and the SFIO are empowered to file complaint before a Magistrate if they are of an opinion that a particular company has been in default according to Companies Act, 2013 or is pursuing its activities violating the law of the land. They can file a complaint under section 190 of the Criminal Procedure Code, 1973. But the difference lies in how the complaint is treated.

The SFIO has been empowered under the section 212 of the Companies Act to file a complaint. The complaint of SFIO is treated as police report under section 173 of the Criminal Procedure Code, 1973. Whereas, the complaint filed by the Registrar of Companies is not considered as a police report but a private complaint under section 190 of the Criminal Procedure Code, 1973. The complaint by the ROC has to pass through the hurdle of pre-trial evidence on the same platform as that of the complaint of SFIO.

When a complaint is received by the Magistrate, the power to take cognizance on the basis of such complaint is provided under Section 190 of Criminal Procedure Code, 1973. However, further action on such complaint has to be taken under Sections 200- 204 of Criminal Procedure Code, 1973.

Under Section 200 Criminal Procedure Code, 1973, the Magistrate has to record the statement of the complainant on oath, and also of other witnesses, if any. As the large number of complaints are filed by private individuals, many of which may be frivolous complaints. Therefore, it is considered necessary to verify the details of such complaints by examining the complainant on oath under Section 200 of Criminal Procedure Code, 1973. In certain “complaint” cases, action may have to be taken by the Magistrate under the provisions of Section 202 Criminal Procedure Code, 1973, i.e., an inquiry by the Magistrate himself or an investigation by police, etc. After these steps, if the Magistrate does not find sufficient ground or finds no prima facie case to proceed further, he may dismiss the complaint under Section 203 of Criminal Procedure Code, 1973; on the other hand, if he finds sufficient ground to proceed, he may issue process under Section 204 of Criminal Procedure Code, 1973.

The complaint filed by SFIO does not have to pass through the process of section 200 to 203 as mentioned above. After a complaint has been filed by the SFIO, it is treated as police report and it directly proceeds to the section 204 and the next stage of trial that is issuing of summons or warrants. Whereas the complaint filed by the ROC has to pass through the procedure mentioned under section 200 to 203 which causes a delay in the prosecution initiated by the ROC.

Secretarial Audit-Fraud Detection and Reporting - CS Professional Study Material

Question 3.
Define Speculation. How Suspicion is different from Speculation? (Aug 2021, 3 marks)
Answer:
Speculation:
The term Speculation is defined as act of trading in an asset or conducting a financial transaction that has a significant risk of losing most or all of the initial outlay with the expectation of a substantial gain. With speculation, the risk of loss is more than offset by the possibility of a huge gain, otherwise there would be very little motivation to speculate. It may sometimes be difficult to distinguish between speculation and investment, and whether an activity qualifies as speculative or investing can depend on a number of factors, including the nature of the asset, the expected duration of the holding period, and the amount of leverage.

Such as the Foreign Exchange Market, Bond Market, Stock Market and Specially the derivatives segment which comprises of futures and options contracts which is typically used by brokerages and high net worth individuals to bet on the direction of the markets. Due to this the Indian capital markets have tilted towards speculative instruments having implications of a high level of speculative trading activity compared to investment activity.

Suspicion:
On the other hand, the term Suspicion is the positive tendency to doubt the trustworthiness of appearances and therefore to believe that one has detected possibilities of something unreliable, unfavorable.

Question 4.
What are the circumstances that calls for the Investigation by Serious Fraud Investigation Office (SFIO)? (Dec 2021, 5 marks)
Answer:
As per Section-212 (1) of the Companies Act, 2013, Investigation into the affairs of a company is assigned to Serious Fraud Investigation Office (SFIO), where Government is of the opinion that it is necessary to investigate into the affairs of a company

  1. on receipt of a report of the registrar or inspector under section 208 of the Companies Act, 2013;
  2. on intimation of a special resolution passed by a company that its affairs are required to be investigated;
  3. in the public interest; or
  4. on request from any department of the Central Government or a State Government

Question 5.
You are appointed as a Secretarial Auditor for audit of Group Companies comprising of 20 plus companies. There are numerous transaction between the group companies and lot of Inter Company Transfer of funds had taken place during audit period besides frequent resignations of Directors and change in shareholders. During the audit you suspect something is wrong. List out at least six transactions that could be suspicious in your opinion to investigate during audit. (Dec 2021, 5 marks)
Answer:
Suspicion is the positive tendency to doubt the trustworthiness of appearances and therefore to believe that one has detected possibilities of something unreliable, unfavorable.
The following transactions relating to company formation and management may be considered as the suspicious transactions which may or may not be with the group companies, where the detailed audit is need to be performed are:

  • subsidiaries which have no apparent purpose;
  • companies which continuously make substantial losses;
  • complex group structures without cause;
  • uneconomic group structures for tax purposes;
  • frequent changes in shareholders and directors;
  • unexplained transfers of significant sums through several bank accounts;
  • use of bank accounts in several currencies without reason;
  • purchase of companies which have no obvious commercial purpose;
  • sales invoice totals exceeding known value of goods;
  • makes unusually large cash payments in relation to business activities which would normally be paid by cheques, banker’s drafts etc; and
  • transferring large sums of money to or from overseas locations with instructions for payment in cash.

Secretarial Audit-Fraud Detection and Reporting - CS Professional Study Material

Question 6.
S Ltd. appointed M & Co., Chartered Accountants, as statutory auditors for the financial year 2021-22. During the audit, the statutory auditors have noticed fake and duplicate expenses reimbursement of ₹ 1.10 crore to the directors of the company.
In this situation, explain the procedure to be adopted by the auditors for reporting of fraud. (June 2022, 5 marks)

Question 7.
Write a short note on “Types of Fraud”.
Answer:
Fraud against a company can be committed either internally by employees, managers, officers, or owners of the company, or externally by customers, vendors, and other parties. Accordingly, the fraud consists of some deceitful practice or willful device, resorted to with intent to deprive another of his right, or in some manner to do him an injury.

The financial and accounting fraud include the fraud relating to the financial statement by Overstating revenue, earnings and assets-along with understating liabilities (or just plain concealing them) are the most common activities found with this type of fraud. The asset misappropriation is also a most susceptible fraud in the companies which are closely held. Further the tampering, accounts receivable skimming, fake billing schemes, payroll schemes, fake or duplicate expense reimbursement schemes and inventory schemes are also the part of the financial and accounting fraud. Also the misuse of company assets is one of the problematic and serious kinds of fraud, as the unauthorized use of company assets, significant open up the company to liability. Also under the growing technology and easy exchange of information and technology, the chances of the theft of intellectual property and trade secrets are increased and such fraud damage the position of the company in the market and the Research activities.

In case of the Non-financial fraud, the fraud includes the false or misleading information, inadequate disclosure produced by the Company to the public or regulatory bodies, false reporting of governance norms and doing business surpassing the regulatory requirement and approvals from the shareholders.

Question 8.
Write a short note on “Fraud v/s Non Compliance”.
Answer:
The term fraud can be defined as act or course of deception, an intentional concealment, omission, or perversion of truth, to

  • gain unlawful or unfair advantage,
  • induce another to part with some valuable item or surrender a legal right, or
  • inflict injury in some manner.

Willful fraud is a criminal offense which calls for severe penalties, and its prosecution and punishment. However, incompetence or negligence in managing a business or even a reckless waste of firm’s assets (for example by speculating on the stock market) does not normally constitute a fraud.

Non Compliance: the term non-compliance refers to failure to comply with the laws, rules regulations etc., the term non-compliance is commonly used in regard to a failure to meet the compliance requirements or failure to doing compliance be it the failure in following procedures, filing of information, eligibility conditions, reporting etc.
The relationship between the Fraud and the non-compliance can be constructed as the non- compliance in the company may lead to a fraud however it may also be noted that the fraud can also be made in the compliant company.

Secretarial Audit-Fraud Detection and Reporting - CS Professional Study Material

Question 9.
Write a short note on “Suspicion”.
Answer:
Suspicion is the positive tendency to doubt the trustworthiness of appearances and therefore to believe that one has detected possibilities of something unreliable, unfavorable.
By a Secretarial Auditor, the following transactions relating to Company Formation and Management may be considered as the suspicious transactions which may or may hot be with the group companies, where the detailed audit is need to be performed are

  • subsidiaries which have no apparent purpose;
  • companies which continuously make substantial losses;
  • complex group structures without cause;
  • uneconomic group structures for tax purposes;
  • frequent changes in shareholders and directors;
  • unexplained transfers of significant sums through several bank accounts;
  • use of bank accounts in several currencies without reason;
  • purchase of companies which have no obvious commercial purpose;
  • sales invoice totals exceeding known value of goods;
  • makes unusually large cash payments in relation to business activities’ which would normally be paid by cheques, banker’s drafts etc; and
  • transferring large sums of money to or from overseas locations with instructions for payment in cash.

Question 10.
Who is considered as an Auditor for Fraud Reporting?
Answer:
The Auditor includes the

  • Statutory Auditors of the company appointed under Section 139 of the Companies Act, 2013, Company Secretary in practice conducting Secretarial Audit under Section 204 of the Companies Act, 2013.
  • Cost Accountant in practice conducting cost audit under Section 148 of the Companies Act, 2013 and
  • Branch Auditors appointed under Section 139 of the Companies Act.2013.
    However the Internal Auditor or such other professionals appointed under any other statutes rendering other services to the company such as a tax auditor appointed under Income tax act, GST auditors appointed under the respective GST legislations are not covered under Section 143 of the Companies Act, 2013.

Question 11.
Describe the transaction which may involve the fraud.
Answer:
In the past ‘‘Fraud” has been noticed in many cases of scams in the following kinds of transactions:
Related Party Transactions:

  • Excessive Managerial remuneration
  • Insider Trading

Inter Company Transactions:

  • Mergers/demergers/acquisitions
  • IPO frauds

Other means of Corporate fraud are the Inadequate Disclosures, false or misleading information, theft of assets, false expenses, corruption, theft in formation, fraudulent applications, misuse of assets, dishonest business partners, Fraudulent billing.

Secretarial Audit-Fraud Detection and Reporting - CS Professional Study Material

Question 3.
What is the procedure for reporting of fraud?
Answer:
Procedure for Reporting of Fraud
1. Reporting of frauds by auditor involving amount more than ₹ 1 crore
If an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of rupees one crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government. Auditor should report such frauds as soon as possible but not later than 62 days of his knowledge about the frauds:

STEP-1 – Report to Board & Audit Committee
Auditor shall forward his report to the Board of Directors or the Audit Committee, as the case maybe, within 2 days of his knowledge of the fraud, seeking their reply or observations within 45 (forty-five) days. STEP-II – Report to Central Government after reply of board On receipt of such reply or observations the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within 15 fifteen days of receipt of such reply or observations.

STEP-IIA – Report to Central Government if no reply received In case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of 45(forty-five days), he shall forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he failed to receive any reply or observations within the stipulated time. Other Points to be kept in mind: The report shall be on the letter-head of the auditor containing

  • Postal Address:
  • e-mail address;
  • contact number (telephone/mobile);
  • signed by the auditor with his seal;
  • indicate his Membership Number;
  • Report shall be in the form of a statement as specified in Form ADT-4.

(ii) Reporting of frauds by auditor involving amount less than ₹ 1 crore
As per the Sub-rule (3) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 in case of fraud involving an amount less than ₹ 1 Crore, the auditor shall report the matter of fraud to the Audit Committee or to the Board within 2 days of his knowledge of the fraud.
The report should specify the nature of the fraud with description, approximate amount of the fraud and parties involved in the fraud.
In such case, as per Sub-rule (4), the Board shall disclose in its report (Board’s Report) the nature of fraud with description, approximate amount of the fraud, parties involved in the fraud and remedial action taken. Name of parties should be disclosed only when the Board or Audit Committee has not taken any remedial action against the fraud.

Secretarial Audit-Fraud Detection and Reporting Notes

Speculation:
The term Speculation is defined as act of trading in an asset or conducting a financial transaction that has a significant risk of losing most or all of the initial outlay with the expectation of a substantial gain. With speculation, the risk of loss is more than offset by the possibility of a huge gain, otherwise there would be very little motivation to speculate. It may sometimes be difficult to distinguish between speculation and investment, and whether an . activity qualifies as speculative or investing can depend on a number of factors, including the nature of the asset, the expected duration of the holding period, and the amount of leverage.

Suspicion:
Suspicion is the positive tendency to doubt the trustworthiness of appearances and therefore to believe that one has detected possibilities of something unreliable, unfavorable.

Serious Fraud Investigation Office (SFIO):
Serious Fraud Investigation Office (SFIO) has been established through the Government of India. It is a multi- disciplinary organization under the Ministry of Corporate Affairs, of experts in the field of accountancy, forensic auditing, law, information technology, investigation, company law, capital market and taxation etc. for detecting and prosecuting or recommending for prosecution while collar crimes/frauds.

Secretarial Audit-Fraud Detection and Reporting - CS Professional Study Material

Early Warning Signals (EWS):
Early Warning Signals (EWS) are the caution for the auditor, which provide an alert that there is some wrong doing in the company.

“Wrongful Gain”:
“wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled.

“Wrongful Loss”:
“wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled.

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