Corporate frauds refer to deceptive practices undertaken by companies for personal gain or to mislead stakeholders. In India, corporate frauds have been prevalent for a long time, and fraudulent transactions have been the root cause of many corporate scandals. The most common types of fraudulent transactions include –

1. Related Party Transactions,
2. Excessive Managerial Remuneration,
3. Insider Trading,
4. Inter-Company Transactions,
5. Mergers/Demergers/Acquisitions,
6. IPO Frauds, Ponzi Schemes,
7. Public Deposits, And
8. Transfer Of Shares.

In the following sections, we will discuss these fraudulent transactions with examples.

1. Related party transactions

Related party transactions refer to any transaction between a company and its directors, promoters, or their relatives. These transactions can often be used to divert company funds for personal gain or to manipulate financial statements to present a more favorable picture to investors.

One real-life example of related party transactions being used for fraudulent purposes is the infamous case of Satyam Computers. Satyam’s founder and chairman, Ramalinga Raju, used related party transactions to inflate the company’s revenues and profits. He created fictitious companies and fabricated invoices to make it seem like Satyam had more clients and was earning more revenue than it actually was. Raju also siphoned off company funds through these related party transactions.

Another example is the case of Fortis Healthcare, where the promoters, Malvinder and Shivinder Singh, diverted funds through related party transactions to their other companies. They gave loans to these companies at low interest rates and did not disclose these transactions to the board or shareholders. The Singh brothers also used related party transactions to buy real estate at inflated prices, which resulted in losses for Fortis Healthcare.

To prevent related party transactions from being used for fraudulent purposes, the Companies Act, 2013 in India mandates that such transactions be approved by the board of directors and disclosed to shareholders. However, these regulations have not always been effective in preventing corporate frauds.Excessive managerial Remuneration-

One of the ways in which corporate frauds are conducted in India is through excessive managerial remuneration. This refers to the practice of paying high salaries or bonuses to top executives, directors or key managerial personnel in a company, which can often be unjustified or disproportionate to their performance.

One real-life example of excessive managerial remuneration being used for fraudulent purposes is the case of Kingfisher Airlines. The airline’s former chairman, Vijay Mallya, paid himself and other top executives’ hefty salaries and bonuses even as the company was running huge losses and accumulating debt. In fact, in the year before the airline was grounded, Mallya paid himself a salary of over Rs. 16 crores, while the company was losing over Rs. 1,000 crores annually.

Another example is the case of IL&FS, where the top management and board members paid themselves excessively high salaries and perks, even as the company’s financial health deteriorated. In some cases, the salaries paid to the executives were up to 20 times higher than those of other employees in similar positions.

• Excessive Managerial Remuneration

Excessive managerial remuneration can be used as a tool for corporate frauds by diverting company funds to pay unjustified salaries or bonuses to top executives, which can result in financial losses for the company and its shareholders. To prevent such malpractices, the Companies Act, 2013 in India mandates that the remuneration of top executives and directors be approved by the board and disclosed to shareholders. The act also requires that the remuneration be in proportion to the company’s financial performance, and that excessive remuneration be recovered from the executives in case of fraud or financial mismanagement.

In conclusion, excessive managerial remuneration can be used as a means for corporate frauds in India, and it is important for companies and regulators to ensure that such practices are curbed through effective governance and regulation.

Insider trading is another way in which corporate frauds can be conducted in India. This refers to the practice of buying or selling securities based on non-public information that is not available to the general public. This illegal practice can result in unfair gains for the insider trader, while causing losses to other investors and damaging the integrity of the capital markets.

One real-life example of insider trading in India is the case of Reliance Petroleum Limited (RPL). In 2007, Reliance Industries Limited (RIL) announced a merger between RPL and itself. Prior to the announcement, certain insiders including RIL’s chairman, Mukesh Ambani, had traded in RPL’s shares based on the non-public information of the impending merger. The Securities and Exchange Board of India (SEBI) subsequently conducted an investigation and found them guilty of insider trading. As a result, the insiders were fined and barred from trading in securities for a period of time.

Another example is the case of Satyam Computer Services, where the company’s founder and chairman, Ramalinga Raju, was found guilty of insider trading. Raju had manipulated the company’s financial statements and sold his personal stake in the company before the fraud was exposed. His actions resulted in losses for thousands of investors and employees.

Another classic example of insider trading in India is the case of Rajat Gupta. Gupta, a former board member of Goldman Sachs, leaked insider information to hedge fund manager Raj Rajaratnam, who made millions in profits.

Insider trading can be used as a tool for corporate frauds by allowing insiders to profit from non-public information, which can be used to manipulate the market and deceive investors. To prevent such malpractices, India has strict laws and regulations that prohibit insider trading and mandate disclosure of all material information to the public in a timely manner.

• Inter Company transactions

Inter Company transactions refer to transactions between two or more companies within the same group or related parties. While such transactions can be legitimate, they can also be used as a means for conducting corporate frauds in India.

One common way in which intercompany transactions are used for fraud is by inflating the prices of goods and services exchanged between the companies. This can be done by one company charging a much higher price for the goods or services provided to the other company, resulting in a transfer of profits from one company to the other. This practice is commonly known as transfer pricing and is used to shift profits to low tax jurisdictions.

A real-life example of this practice is the case of Vodafone, which had acquired Hutchison Essar in India. In 2007, Vodafone International Holdings BV (VIHBV), a subsidiary of Vodafone, sold shares of a subsidiary based in Mauritius to another subsidiary based in India, resulting in a capital gain of around Rs. 8600 crores. The Indian tax authorities contended that the transaction was undervalued and that VIHBV should have withheld taxes from the payment made to the subsidiary in Mauritius. The case went all the way to the Supreme Court of India, which eventually ruled in favour of Vodafone.

Another example is the case of Satyam Computer Services, where the company inflated its revenues and profits through intercompany transactions. The company created fictitious invoices and transferred money between its subsidiaries to inflate its profits, leading to a significant loss for investors and employees when the fraud was exposed.

To prevent such malpractices, India has strict regulations and laws that govern intercompany transactions and transfer pricing. Companies are required to disclose all intercompany transactions and the pricing mechanism used for such transactions to ensure that they are conducted on an arm’s length basis.

• Mergers, demergers, and acquisitions

Mergers, demergers, and acquisitions are common corporate transactions that can be used for legitimate purposes, such as expanding business operations or reducing costs. However, these transactions can also be used for fraudulent purposes, such as manipulating stock prices or concealing financial losses.

One way in which mergers and acquisitions can be used for fraudulent purposes is by inflating the value of the target company to attract investors or by undervaluing the company to acquire it at a lower price. This can be achieved by manipulating financial statements or by creating false assets and liabilities. For example, in the case of Satyam Computer Services, the company’s founder, Ramalinga Raju, inflated the company’s profits and assets to attract investors and to increase the value of the company’s shares.

Another way in which mergers and acquisitions can be used for fraudulent purposes is by using shell companies to conceal financial losses or to divert funds. Shell companies are companies that exist only on paper and have no real business operations. They can be used to hide fraudulent activities or to transfer money to offshore accounts. For example, in the case of the Punjab National Bank fraud, the accused used shell companies to issue fake letters of credit and to transfer money to offshore accounts.

Demergers can also be used for fraudulent purposes by transferring assets to related parties or by creating false liabilities. This can result in a transfer of profits from the company to related parties or in a reduction of the company’s assets. For example, in the case of the Sahara India Pariwar fraud, the company created multiple shell companies to invest in real estate and other businesses, resulting in a loss of over Rs. 24,000 crores for investors.

To prevent such fraudulent activities, India has enacted laws and regulations that govern mergers, demergers, and acquisitions. Companies are required to disclose all related party transactions and to obtain approval from regulators before conducting any such transactions. Additionally, companies are required to provide accurate and transparent financial statements to prevent manipulation of financial information.

• Initial Public Offering (IPO)

Initial Public Offering (IPO) is a significant event for companies looking to raise capital by offering shares to the public for the first time. It is also an area where corporate fraud can occur. In India, companies have been involved in IPO frauds in various ways.

One of the most common types of IPO fraud is the practice of artificially inflating the share price. This is often achieved through collusion between company insiders and brokers, who work together to create false demand for the shares. This can be done by placing large buy orders for the shares or creating fictitious buyers.

Another way companies commit IPO fraud is by misrepresenting their financials to potential investors. This can include overstating revenues, understating expenses, or hiding debts. Companies may also fail to disclose important information that could affect the price of their shares.

For example, in 2006, the Securities and Exchange Board of India (SEBI) banned 24 entities, including brokers and investors, for their involvement in IPO fraud in the case of Yes Bank. It was found that the entities had manipulated the share price of Yes Bank during its IPO.

In 2018, the SEBI banned four entities, including a former executive director of Punjab National Bank, for their involvement in the IPO scam of PNB Housing Finance. It was found that the entities had manipulated the financials of the company in order to inflate the share price during the IPO.

In conclusion, IPO frauds can have a significant impact on investors and the economy as a whole. Companies must be transparent in their disclosures and follow ethical practices to avoid any fraudulent activities.

• Ponzi Schemes-

A Ponzi scheme is a fraudulent investment scheme where returns are paid to earlier investors using the capital invested by newer investors. The scheme eventually collapses when there are not enough new investors to pay returns to earlier investors. In India, Ponzi schemes have been a significant source of corporate fraud, leading to large-scale losses for investors.

One example of a Ponzi scheme in India is the case of the Saradha Group. The Saradha Group was a consortium of over 200 companies that ran various businesses, including chit funds, real estate, and media. It was found that the group had collected over Rs. 2,500 crores from investors in West Bengal, Assam, and Odisha through chit funds, promising high returns.

The Saradha Group operated as a typical Ponzi scheme, using the money collected from new investors to pay returns to older investors. The group also used a multi-level marketing strategy to attract new investors, promising high commissions to agents who brought in new investors. However, when the group was unable to find enough new investors, the scheme collapsed, and investors lost their money.

Another example is the case of the Pearls Group. The Pearls Group was a real estate company that ran various investment schemes, promising high returns to investors. The group collected over Rs. 45,000 crores from investors in various schemes, including the Pearls Agrotech Corporation Limited (PACL).

It was found that the Pearls Group was operating a Ponzi scheme, using the money collected from new investors to pay returns to older investors. The group also used a multi-level marketing strategy to attract new investors. However, the scheme eventually collapsed, and investors lost their money.

• Public Deposits-

Public deposits refer to the amount of money deposited by the public in companies for a fixed period with a promise of interest on the same. Companies often use this mode of financing to raise funds for their businesses. However, this mode of financing has also been used as a tool for corporate frauds in India.

Companies often lure the public by offering higher interest rates than the market standard, with promises of guaranteed returns. In some cases, companies even use fake credentials and false promises to attract unsuspecting investors. They may also use the funds for their personal gains or to cover up losses or debts.

One of the most notable examples of corporate fraud involving public deposits is the case of the Saradha Group, which was a conglomerate of over 200 companies operating across various sectors. The group collected public deposits promising high returns but eventually turned out to be a Ponzi scheme, where the returns of earlier investors were paid from the investments of newer investors. The company’s founder and chairman, Sudipta Sen, was arrested in 2013 and the group’s assets were seized by the government.

Another example is the case of the Sahara Group, which raised funds from the public through its two companies, Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited. The group collected over Rs. 24,000 crore (approx. USD 3.2 billion) from the public but failed to repay the amount. The founder and chairman of the Sahara Group, Subrata Roy, was arrested in 2014 and the group’s assets were seized by the government.

In both these cases, the companies used public deposits to run Ponzi schemes and eventually failed to repay the amount to the investors. This not only led to huge losses for the investors but also tarnished the reputation of the companies involved.

To prevent such frauds, the government of India has introduced various regulations and guidelines for companies collecting public deposits. Companies are required to provide complete information about their financial standing, including their profits, losses, and debt, to the public. They are also required to obtain credit ratings from credit rating agencies to ensure transparency and credibility. The government has also set a maximum limit on the amount of public deposits that can be collected by companies.

• Transfer of Shares-

Corporate frauds in India are often carried out through various types of transactions, and one of them is the transfer of shares. Share transfer fraud is one of the most common types of corporate fraud in India. Share transfer fraud is a type of fraud where the shares of a company are transferred from one person to another without the knowledge or consent of the shareholder.

The most common way in which this fraud is carried out is by using forged or fake documents. The fraudsters create fake documents and signatures of the shareholders and transfer the shares to their own name or to the name of a third party. This way, they gain control of the company and can carry out fraudulent activities.

Another way in which this fraud is carried out is by using insider information. The fraudsters use their position within the company to gain insider information about the company and its shareholders. They use this information to transfer shares and gain control of the company.

A real-life example of this type of fraud is the case of the Satyam scandal. Satyam was one of the leading IT companies in India, and its founder and chairman, Ramalinga Raju, was found guilty of one of the biggest corporate frauds in India’s history. Raju had transferred shares from his family members to himself and then to a few other companies that he controlled, without the knowledge or consent of the shareholders. This way, he had gained control of the company and had carried out fraudulent activities.

• Accounting Frauds

Accounting fraud is a type of corporate fraud that involves manipulating financial statements to deceive investors and other stakeholders about a company’s financial health. In India, accounting fraud is a common form of corporate fraud that has resulted in significant financial losses for investors.

One example of accounting fraud in India is the case of Satyam Computer Services Limited. In 2009, the company’s founder and chairman, Ramalinga Raju, admitted to falsifying the company’s financial statements to the tune of nearly $2 billion. Raju inflated the company’s revenue, profits, and cash balances over several years, creating an illusion of growth and profitability.

Raju’s fraud came to light when he attempted to acquire two construction companies using Satyam’s funds. The companies’ shareholders and regulators were suspicious of the deal and launched an investigation that uncovered the accounting fraud.

Another example of accounting fraud in India is the case of Kingfisher Airlines Limited. The company, which was founded by the flamboyant businessman Vijay Mallya, defaulted on its loans and went bankrupt in 2012. Investigations revealed that the company had inflated its revenue and understated its losses to obtain loans from banks.

Mallya and other executives at Kingfisher Airlines were charged with fraud and money laundering in connection with the company’s collapse. Mallya fled to the UK to avoid prosecution, where he is currently fighting extradition to India.

1. Illegal Pyramid Schemes-

An illegal pyramid scheme is a fraudulent business model that lures investors with promises of high returns in a short period of time. These schemes operate by recruiting new members who are required to make an initial investment and then earn commissions by recruiting even more members. The pyramid continues to grow until it eventually collapses, leaving the majority of investors with significant losses.

In India, there have been several cases of illegal pyramid schemes, such as the Saradha chit fund scam and the Speak Asia online survey scam. In both of these cases, individuals were promised high returns on their investments in exchange for recruiting new members into the scheme.

The Saradha chit fund scam involved a group of companies that collected money from investors under the guise of a chit fund, promising high returns. However, the money was siphoned off and used for personal gain, leading to a loss of over Rs. 2,500 crore for the investors.

The Speak Asia online survey scam was a similar scheme that promised investors high returns for filling out online surveys. The company collected a large sum of money from investors and then shut down their operations, leaving investors with no returns on their investment.

In both of these cases, the operators of the schemes were found to have committed fraud and were arrested. Investors suffered huge losses, and the scams served as a reminder of the dangers of getting involved in illegal pyramid schemes.

Difference between Pyramid Schemes and Ponzi Schemes-

Here are the differences between pyramid schemes and Ponzi schemes in bullet points:

Pyramid Schemes:

• Participants in a pyramid scheme recruit others to join the scheme and make money by receiving a portion of the fees paid by the new recruits.
• The scheme is structured like a pyramid with the person at the top receiving the most money and those at the bottom receiving the least.
• As the pyramid grows, it becomes more difficult to recruit new members, and those at the bottom of the pyramid are unlikely to make any money.
• Pyramid schemes are illegal in many countries.

Ponzi Schemes:

• In a Ponzi scheme, investors are promised high returns on their investments and the money of new investors is used to pay off earlier investors.
• The scheme is named after Charles Ponzi, who famously ran such a scheme in the early 20th century.
• The scheme relies on a constant flow of new investors to pay off earlier investors, and it collapses when there are not enough new investors to pay the promised returns.
• Ponzi schemes are also illegal in many countries.

Role of Secretarial Auditors

The role of secretarial auditors in preventing corporate frauds in India is crucial. Secretarial auditors are responsible for ensuring that a company complies with legal and regulatory requirements related to corporate governance, disclosures, and filings. They also review the processes and systems in place to detect and prevent fraudulent activities.

One way that secretarial auditors can help prevent corporate frauds is by conducting a thorough review of a company’s internal controls and procedures. This can help identify weaknesses or vulnerabilities that could be exploited by fraudsters. The auditor can then provide recommendations to strengthen those controls and prevent fraud.

In addition, secretarial auditors can help ensure that a company’s disclosures are accurate and transparent. This can include reviewing the accuracy of financial statements and ensuring that important information is disclosed in a timely and appropriate manner. By providing independent verification of the company’s disclosures, secretarial auditors can help reduce the risk of fraud.

Another important role of secretarial auditors is to provide early warning of potential frauds. By conducting regular audits and staying up-to-date on the latest trends and techniques used by fraudsters, secretarial auditors can help identify red flags or warning signs of fraudulent activities. They can then report these findings to the company’s management or board of directors, who can take appropriate action to prevent or investigate potential frauds.

Overall, the role of secretarial auditors in preventing corporate frauds in India is critical. By providing independent verification and recommendations for improving internal controls, ensuring accurate disclosures, and providing early warning of potential frauds, secretarial auditors can help reduce the risk of fraud and promote corporate governance and transparency.

Role of Statutory Auditors

The role of statutory auditors in preventing corporate frauds in India is also very important. Statutory auditors are responsible for auditing a company’s financial statements and providing an opinion on whether they are true and fair. They are appointed by the company’s shareholders and are independent of the company’s management.

One way that statutory auditors can help prevent corporate frauds is by conducting a thorough review of a company’s financial records and transactions. This can help identify any irregularities or inconsistencies that may indicate fraudulent activity. They can also examine the company’s internal controls and procedures to determine their effectiveness in preventing fraud.

Statutory auditors can also help prevent corporate frauds by providing recommendations for improving internal controls and risk management systems. They can identify areas where the company’s controls may be weak and suggest improvements to strengthen them.

In addition, statutory auditors are required to report any fraud or suspected fraud to the company’s management and board of directors. They are also required to report any material misstatements in the financial statements to the relevant authorities. By reporting any suspected fraud or material misstatements, statutory auditors can help ensure that appropriate action is taken to investigate and prevent further fraud.

Conclusion

So, it is clear that these types of frauds are a widespread problem in the country. Several factors contribute to this, including weak regulatory oversight, a lack of corporate transparency, and a culture of corruption.

One common tactic used in corporate frauds in India is insider trading. This involves individuals with privileged information about a company’s performance using that information to make trades in the company’s stock, resulting in personal gain at the expense of other investors.

Another common form of corporate fraud in India is financial statement fraud, where companies manipulate their financial statements to appear more profitable or financially stable than they actually are. This can involve inflating revenue, understating expenses, and hiding liabilities.

The article also highlights the role of auditors and regulators in preventing and detecting corporate frauds. However, as seen in the examples provided, even when frauds are detected, the legal process can be slow and ineffective, leading to few consequences for those involved.

In conclusion, corporate frauds are a significant issue in India, and efforts must be made to strengthen regulatory oversight, promote transparency in corporate practices, and hold those responsible for fraud accountable for their actions.