As you are aware that Forensic Audit helps to detect fraud, investigate financial crime and to protect organization assets and reputation. Forensic science, also known as criminalistics, is the application of science principles and methods to support legal decision-making in matters of criminal and civil law. During criminal investigation in particular, it is governed by the legal standards of admissible evidence and criminal procedure.
"Forensic" means using scientific methods/tests to find out about a crime or facts of crime.
MEANING OF FORENSIC AUDIT
Forensic audit is, in general, referred to as an examination of evidence regarding an assertion to determine its correspondence to established criteria carried out in a manner suitable to the court.
AS PER THE DEFINITION GIVEN IN INVESTOPEDIA
Forensic Audit is an examination and evaluation of a firm's or individual's financial information for use as evidence in court. A Forensic Audit can be conducted in order to prosecute a party for fraud, embezzlement or other financial claims. In addition, an audit may be conducted to determine negligence or even to determine how much spousal or child support an individual will have to pay.
JACK BOLOGNA AND ROBERT DEFINED FORENSIC AUDIT as the application of financial skills and an investigative mentality to unresolved issues, conducted within the context of the rules of evidence. As a discipline, it encompasses financial expertise, fraud knowledge, and a strong knowledge and understanding of business reality and the working of the legal system.
COLLIN GREENLAND defines that forensic accounting (or auditing) is the integration of accounting, auditing and investigative skills in order to provide an accounting analysis suitable for the resolution of disputes (usually but not exclusively) in the courts.
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 further states that forensic audit is also called forensic accounting.
Forensic accountants utilise accounting, auditing and investigative skills when conducting an investigation. Equally critical is their ability to respond immediately and to communicate financial information clearly and concisely in a courtroom setting. Forensic accountants are trained to look beyond the numbers and deal with the business reality of the situation.
Forensic accountants are multi-disciplinary and have a wide range of experience in the forensic and investigative field. They are frequently called upon to serve as expert witnesses and litigation consultants. Forensic accountants are specialists that integrate accounting, auditing and investigation - all in one.
The merging of all these skills under the forensic hat means that the results are suitable for the courts for discussion, debate and dispute resolution. A forensic accountant is trained to "look beyond the numbers", and should be hired as early as possible in order to achieve ultimate results.
A partnership with a forensic accountant early in the litigation process can yield significant results, and can reduce overall costs. If retained early, a forensic accountant can assist with the identification of additional areas of damages, settlement negotiations, preliminary assessment of the amount of the damages, and the information for discovery. Ideally, a forensic accountant should be retained by counsel; so that the privilege that exists between the client and counsel can be extended to the work of the forensic accountant wherever possible. Attorneys know that partnership with a forensic accountant can help in the matter at hand in terms of strategy, and the final results that will benefit clients.
CURRENT POSITION OF FRAUD IN INDIA
RBI has revealed that in fiscal year 2023, there were frauds exceeding of $ 302.5 billion , equivalent of Rs. 30,000/- Crores. This mark has decreased from Rs. 1.30 Trillion reported in 2021.
Frauds and economic crimes rates remain at record high , impacting more and companies in various diverse ways than even before. The value of bank fraud reported in financial year 2021-22 to the tune of Rs. 60,114 Crores [ RBI's Financial Stability Report dated May 27, 2022].
The RBI report further states that though the amount of frauds was down 56.28% from 1.30 trillion in 2020-21 but in terms of numbers of frauds there was hike of 23.69%. Total number of frauds was 9,103 in 2021-22 , as against 7,359 in 2020-21. Also maximum frauds have occurred in loan portfolios , both in terms of numbers and value. In number of frauds , advances constituted 42.2% and in value terms , it was almost 97% at Rs. 58,328 Crores.
The RBI Report for Fiscal Year 2023-24
The number of online frauds in the country surged 334% year-on-year (YoY) to 29,082 in the financial year 2023-24 (FY24).
The disclosures were part of the Reserve Bank of India's (RBI) annual report for the fiscal year ended March 2024 and covered instances involving cards and the internet.
In contrast, online frauds in the country stood at 6,699 in FY23.
As per the report, the amount involved in these cases surged to INR 1,457 Cr in FY24 from INR 227 Cr in the previous year.
"Frauds have occurred predominantly in the category of digital payments (card/internet), in terms of number. In terms of value, frauds have been reported primarily in the loan portfolio (advances category). While small value card/internet frauds contributed the maximum to the number of frauds reported by the private sector banks, the frauds in public sector banks were mainly in loan portfolios," the report stated.
The report also outlined that fraud cases in the banking sector skyrocketed nearly 166% YoY to 36,075 in the year ended March 2024 from 13,564 in FY23.
Meanwhile, these frauds accounted for a cumulative sum of INR 13,930 Cr during the period under review, down 46.7% from FY23's INR 26,127 Cr.
The number of online frauds in the country surged 334% year-on-year (YoY) to 29,082 in the financial year 2023-24 (FY24).
PWC's Global Economic Crime and Fraud Survey 2022, published on May 11, 2023 has found that organisations perimeters are vulnerable , and external fraudsters are becoming a bigger threat on attacks increase and become more sophiscated, they are inventing more and more ways and techniques of cheating. They are equipped with knowledge and technology so that there on step ahead of all organisation security programmes.
The survey of 1296 businesses from 53 countries found that customer fraud and assets misappropriation were the most common crimes experienced by organisations, regardless of revenue.
HISTORY OF FORENSIC AUDIT
Forensic accounting has a rich history that dates back to ancient civilizations, where individuals used accounting methods to uncover fraud and corruption. The practice continued to evolve through the Middle Ages, with early forensic accountants serving as financial advisors and investigators for monarchs and nobles. In modern times, forensic accounting has transformed into a specialized field of accounting, used to detect and investigate financial fraud and other white-collar crimes. Its growth has been fuelled by a series of high-profile financial scandals, such as Enron and WorldCom, which have highlighted the importance of forensic accounting in protecting companies and individuals from financial fraud.
Until 1817 forensic accounting was very little known , when the first recorded case of accounting testifying as an expert witness is noted in the history book. In the late 20th century, the complexity in accounting rules and financial transactions raised demand for forensic auditors, especially following discovery of high profile accounting scandals, such as- Enron, in 2001, Worldcom in 2002, Tyco-in 2002, Lehman Brothers -2008, Satyam Computers-2008, Kingfisher Airlines, Jet Airlines, Bhushan Steel, PNB, ILFS, PMC Bank, YES Bank, Café Cofee Day, Spot Exchange of India are some of the corporate frauds in India in recent times, which shocked the investors and disestablished market confidence. The frauds have given rise for the niche field of Forensic Audit.
Financial Statements of entities are based on Accounting Standards and Generally Accepted Accounting Principals issued by Accounting Bodies /Boards all over the world. These standards and principals provides some flexibility to apply these principals and standards. Consequently, they allow discretion to preparers to apply Accounting Principles stipulated in AS.
In order to apply AS to all segments of companies, discretion is essential but might be misused by the managers. Generally this discretion are used and Generally Accepted Principles are formulated for private benefits by these managers and financial statement prepares at the cost of Shareholders ,Creditors and other stakeholders. These types of discretion in AS and GAAPs lead to hide true economic condition of the company and using window-dressing to depict untrue and unfair picture before other stakeholders for the benefits of persons in control of the company.
Here Forensic Audit, plays and important role in accounting, investigation and inspection to find out true culprit behind the fraud and present true economic condition of the company before stakeholders.
AMENDMENT IN COMPANIES ACT, 2013
The Companies Act, 2013 has opened the doors of opportunities for the Forensic Auditors.
SECTION 245 OF THE COMPANIES ACT, 2013.
CLASS ACTION
(1) Such number of member or members, depositor or depositors or any class of them, as the case may be, as are indicated in sub-section (2) may, if they are of the opinion that the management or conduct of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or depositors, file an application before the Tribunal on behalf of the members or depositors for seeking all or any of the following orders, namely:-
(a) to restrain the company from committing an act which is ultra vires the articles or memorandum of the company;
(b) to restrain the company from committing breach of any provision of the company's memorandum or articles;
(c) to declare a resolution altering the memorandum or articles of the company as void if the resolution was passed by suppression of material facts or obtained by misstatement to the members or depositors;
(d) to restrain the company and its directors from acting on such resolution;
(e) to restrain the company from doing an act which is contrary to the provisions of this Act or any other law for the time being in force;
(f) to restrain the company from taking action contrary to any resolution passed by the members;
(g) to claim damages or compensation or demand any other suitable action from or against-
(i) the company or its directors for any fraudulent, unlawful or wrongful act or omission or conduct or any likely act or omission or conduct on its or their part;
(ii) the auditor including audit firm of the company for any improper or misleading statement of particulars made in his audit report or for any fraudulent, unlawful or wrongful act or conduct; or
(iii) any expert or advisor or consultant or any other person for any incorrect or misleading statement made to the company or for any fraudulent, unlawful or wrongful act or conduct or any likely act or conduct on his part;
(h) to seek any other remedy as the Tribunal may deem fit.
(2) Where the members or depositors seek any damages or compensation or demand any other suitable action from or against an audit firm, the liability shall be of the firm as well as of each partner who was involved in making any improper or misleading statement of particulars in the audit report or who acted in a fraudulent, unlawful or wrongful manner.
(3) (i) The requisite number of members provided in sub-section (1) shall be as under:-
(a) in the case of a company having a share capital, not less than one hundred members of the company or not less than such percentage of the total number of its members as may be prescribed, whichever is less, or any member or members holding not less than such percentage of the issued share capital of the company as may be prescribed, subject to the condition that the applicant or applicants has or have paid all calls and other sums due on his or their shares;
(b) in the case of a company not having a share capital, not less than one-fifth of the total number of its members.
(ii) The requisite number of depositors provided in sub-section (1) shall not be less than one hundred depositors or not less than such percentage of the total number of depositors as may be prescribed, whichever is less, or any depositor or depositors to whom the company owes such percentage of total deposits of the company as may be prescribed.
(4) In considering an application
under sub-section (1), the Tribunal shall take into account, in particular-
(a) whether the member or depositor is acting in good faith in making the application for seeking an order;
(b) any evidence before it as to the involvement of any person other than directors or officers of the company on any of the matters provided in clauses (a) to (f) of subsection(1);
(c) whether the cause of action is one which the member or depositor could pursue in his own right rather than through an order under this section;
(d) any evidence before it as to the views of the members or depositors of the company who have no personal interest, direct or indirect, in the matter being proceeded under this section;
(e) where the cause of action is an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be-
(i) authorised by the company before it occurs; or
(ii) ratified by the company after it occurs;
(f) where the cause of action is an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company.
(5) If an application filed under sub-section (1) is admitted, then the Tribunal shall have regard to the following, namely:-
(a) public notice shall be served on admission of the application to all the members or depositors of the class in such manner as may be prescribed;
(b) all similar applications prevalent in any jurisdiction should be consolidated into a single application and the class members or depositors should be allowed to choose the lead applicant and in the event the members or depositors of the class are unable to come to a consensus, the Tribunal shall have the power to appoint a lead applicant, who shall be in charge of the proceedings from the applicant's side;
(c) two class action applications for the same cause of action shall not be allowed;
(d) the cost or expenses connected with the application for class action shall be defrayed by the company or any other person responsible for any oppressive act.
(6) Any order passed by the Tribunal shall be binding on the company and all its members, depositors and auditor including audit firm or expert or consultant or advisor or any other person associated with the company.
(7) Any company which fails to comply with an order passed by the Tribunal under this section shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years and with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees.
(8) Where any application filed before the Tribunal is found to be frivolous or vexatious, it shall, for reasons to be recorded in writing, reject the application and make an order that the applicant shall pay to the opposite party such cost, not exceeding one lakh rupees, as may be specified in the order.
(9) Nothing contained in this section shall apply to a banking company.
(10) Subject to the compliance of this section, an application may be filed or any other action may be taken under this section by any person, group of persons or any association of persons representing the persons affected by any act or omission, specified in sub-section (1).
SECTION 245(1g)- provides that depositors and members of the company can claim damages, from auditors, management and other consultants -for the wrongdoings by the company and its management.
SECTION 140(5)OF THE COMPANIES ACT, 2013
Without prejudice to any action under the provisions of this Act or any other law for the time being in force, the Tribunal either suo motu or on an application made to it by the Central Government or by any person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers , it may, by order, direct the company to change its auditors:
Provided that if the application is made by the Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place:
Provided further that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable for action under section 447.
Explanation I - It is hereby clarified that the case of a firm, the liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its director or officers.
Explanation II - For the purposes of this Chapter the word "auditor" includes a firm of auditors.
SECTION 149(12) OF THE COMPANIES ACT, 2013
Notwithstanding anything contained in this Act,-
(i) an independent director;
(ii) a non-executive director not being a promoter or key managerial personnel, shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.
SECTION 149(12)- independent directors would be held liable for the frauds in their knowledge and it is expected that there would be a number of independent directors who could be looking to understand the techniques of fraud investigations by way of training and certifications.
SECTION 177(4) OF THE COMPANIES ACT, 2013
Every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board which shall, inter alia, include,-
(i) the recommendation for appointment, remuneration and terms of appointment of auditors of the company;
(ii) review and monitor the auditor's independence and performance, and effectiveness of audit process;
(iii) examination of the financial statement and the auditors' report thereon;
(iv) approval or any subsequent modification of transactions of the company with related party ;
Provided that the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed;
Provided further that in case of transactions, other than transactions referred to in section 188, and where Audit Committee does not approve the transaction, it shall make its recommendations to the Board:
Provided also that in case any transaction involving any amount not exceeding one crore rupees is entered into by a director or officer of the company without obtaining the approval of the Audit Committee and it is not ratified by the Audit Committee within three months from the date of the transaction, such transaction shall be voidable at the option of the Audit Committee and if the transaction is with the related party to any director or is authorised by any other director, the director concerned shall indemnify the company against any loss incurred by it:
Provided also that the provisions of this clause shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company.
(v) scrutiny of inter-corporate loans and investments;
(vi) valuation of undertakings or assets of the company, wherever it is necessary;
(vii) evaluation of internal financial controls and risk management systems;
(viii) monitoring the end use of funds raised through public offers and related matters.
SECTION 177- provides that Audit Committee has power to investigate and to obtain professional advice from external sources and have full access of information and records of the companies.
SERIOUS FRAUD INVESTIGATION OFFICE
Serious Fraud Investigation Office (SFIO) is a fraud-investigating agency set up to investigate corporate frauds of very serious and complex nature. The authorisation of SFIO is limited to investigating frauds related to a company under the Companies Act. The investigation done by SFIO is considered separate from other normal investigation into the affairs of the company.
SFIO falls under the jurisdiction of the Ministry of Corporate Affairs. The SFIO is involved in major fraud probes. It coordinates with the Income Tax Department and the Central Bureau of Investigation (CBI) for fraud investigation.
The government has recently constituted a 12-membered high-level panel recently set up to prepare an investigation manual for Serious Fraud Investigation Office (SFIO).
FORENSIC ACCOUNTING AND INVESTIGATION STANDARDS
ICAI is leading the FAIS by being the first accounting body in the world to introduce the FAIS. As of now, 20 standards have been classified, and numbered in a series format, as follows:
- 100 series - Standards on Key Concepts (4 standards)
- 200 series - Standards on Engagement Management (5 standards)
- 300 series - Standards on Executing Assignment (6 standards)
- 400 series - Standards on Specialized Areas (3 standards)
- 500 series - Standards on Reporting (1 standard)
- 600 series - Standards on Quality control (1 standard)
APPLICABILITY AND ITS STAKEHOLDERS
FAIS are mandatorily applicable w.e.f. 1 July 2023 for every member of ICAI (but are incumbent on other professionals to voluntarily comply with the FAIS) and shall be effective for every new engagement executed on and after 1 July 2023.
However, the guidance note has not specifically stated whether the date of execution of the Engagement letter or date of initiation of engagement has to be considered for applicability of FAIS but considering the FAIS 220 "Engagement acceptance and Appointment", understanding about the Engagement Letter has been provided hence applicability may be considered from the date of execution of Engagement Letter.
The external stakeholders to FAIS are Banks, Financial Institutions, MHA, MCA, RBI, SEBI, CAG, CBI, NCLT, IBBI, IRDA, CBDT, CBIC, ICMAI, ICSI, NABARD, TRAI, ED, EOW, SFIO, CERT, NSE, BSE, IBA and few more.
The implication of any non-compliance to the FAIS could, if deemed appropriate, trigger the disciplinary process on the ICAI member. It is also possible that, in the absence of any other such Standards on the topic, the government and regulatory bodies may choose to apply these Standards to all Professionals (including non-ICAI members) and therefore use them as a basis for their own disciplinary process.
COMPANY SECRETARIES AS FORENSIC AUDITOR
Forensic Audit represents an area of finance that combines detective skills and financial acuity. The forensic audit professionals dig deep into financial reports, locate financial transactions and figure out what really happened at various companies and who is the real culprit behind any fraud that has taken place in the company.
THEY COVER AREAS SUCH AS
1. Frauds Finding.
2. Fraud detection and prevention techniques.
3. Fraud-related auditing.
4. Investigation and analysis of financial evidence.
5. Development of computerized applications to assist in the analysis and presentation of financial evidence.
6. Communication of findings in the form of reports, exhibits and collections of documents; and
7. Assistance in legal proceedings, including testifying in court as expert witness and preparing visual aids to support trial evidence, etc.
Further, Forensic Auditing is used in a number of ways and for a number of purposes and not just for criminal activity detection. Firms that do "turn-arounds" or takeovers of businesses, for example, need to have an in-depth understanding of their target's finances. In that scenario, Forensic Audit provides a clear understanding of the financial position along with the connection of the communications related to that.
Forensic audit is becoming increasingly frequent for top leadership searches as stringent corporate governance norms and increasing stakes are prompting Indian and multinational companies to make sure that the people, they take on board have no blotches on their track record. This realizes the significance of Forensic Audit in the contemporary time for the corporates to rationalize premier principles of Good Governance.
A Forensic Auditor is engaged for analysing, interpreting, summarising and presenting complex financial and business-related issues in such a manner it is both understandable and presentable in court of law as an evidence. An Auditor is a person who has deep understanding of various applicable laws, business practices and a sharp and investigative mind so to find out irregularities not apparent and discoverable from simple audit procedures.
A Company Secretary is an eligible professional to be a Forensic Auditor, having good knowledge and command on applicable laws, business practices, people and environment of working of an entity.
ROLE OF COMPANY SECRETARY AS A FORENSIC AUDITOR
1. Criminal Investigations: A Company Secretary should use his/her investigative accounting skills to examine the documentary and other available evidence to give his/her expert opinion on the matter. Their services could also be required by Government departments, the Revenue Commissioners, the Fire Brigade, etc. for investigative purposes. Practicing forensic accountants could be called upon by the police to assist them in criminal investigations which could either relate to individuals or corporate bodies.
2. Personal Injury Claims: Where losses arise as a result of personal injury, insurance companies sometimes seek expert opinion from forensic auditors before deciding whether the claim is valid and how much to pay.
3. Fraud Investigations: A Company Secretary might be called upon to assist in business investigations which could involve funds tracing, asset identification and recovery, forensic intelligence gathering and due diligence review. In cases involving fraud perpetrated by an employee, the forensic auditors will be required to give his/her expert opinion about the nature and extent of fraud and the likely individual or group of individuals who have committed the crime. The forensic expert undertakes a detailed review of the available documentary evidence and forms his/ her opinion based on the information gathered during the course of that review.
4. Investigation and Inspection: Company Secretary may help the Police, ACB and other investigating authorities in collecting evidence and for other investigation purposes.
For example, section 157 Cr.P.C, 1973;
- Sections 17 and, 18 of the Prevention of Corruption Act, 1988;
- Section 6 of The Bankers Books Evidence Act, 1891;
- Section 78 of Information Technology Act, 2000;
Section 447 of the Companies Act, 2013 wherein the Court or Police may require the skills of forensic auditors while inspecting any books in so far as related to the accounts of an accused.
5. Expert Opinion: Company Secretaries see and carefully examine the accounts and balance sheets and use his skills to find out whether there is any fraud committed or any anomaly associated with it by giving his expert opinion. He can also be called as an expert under section 45 of the Indian Evidence Act, 1872.
6. Professional Negligence: The forensic auditor might be approached in a professional negligence matter to investigate whether professional negligence has taken place and to quantify the loss which has resulted from the negligence. A matter such as this could arise between any professional and their client. The professional might be an accountant, a lawyer, company secretary etc. The forensic expert uses his / her investigative skills to provide the services required for this assignment.
7. Expert Witness Cases: Company Secretary as Forensic Auditor often attend court proceedings to testify in civil and criminal court hearings, as an expert witnesses. In such cases, they attend to present investigative evidence to the court so as to assist the presiding judge in deciding the outcome of the case. He can also be called as an expert under section 45 of the Indian Evidence Act, 1872.
8. Mediation and Arbitration: Some forensic auditors because of the specialist training they would have received in legal mediation and arbitration, have extended their forensic auditing practices to include providing Alternative Dispute Resolution (ADR) services, in absence of which a matter could be expensive and time-consuming for individuals or businesses involved in commercial disputes with a third party. [Section 89 of the Civil Procedure Code, 1908]
9. Litigation Consultancy: Company Secretaries are eligible to be engaged in litigation and assisting with evidence, strategy and case preparation.
10. Computer Forensics: A Company Secretary is trained to assist in electronic data recovery and enforcement of IP rights etc. The Company Secretary plays an important role in mitigating Corporate Frauds.
CONCLUSION
Forensic auditing refers to the process of examination of both financial and non-financial data to find indications of fraud, corruption, or other illegal activity with the aim of establishing the facts and presenting evidence that can be used in court in legal proceedings.
Company secretaries play an important role in forensic audits, particularly in terms of:
- Ensuring the compliance of companies with relevant laws and regulations
- Advising on corporate governance, risk management, and legal compliance
- Assisting companies prevent and detect fraud and other illegal activities
- Assisting in the planning and scoping of the audit
- Reviewing internal controls and procedures
- Providing expert advice on legal and regulatory compliance
- Supporting the investigation process
- Communicating the findings of the audit
Company secretaries' major responsibility in forensic audits is to provide crucial assistance and knowledge to ensure the process integrity and to assist businesses in adhering to applicable rules and regulations. For businesses aiming to avoid and identify fraud and other criminal actions, as well as to keep the confidence of their stakeholders, company secretaries are an invaluable resource.
DISCLAIMER: The article presented here is only for sharing information and knowledge with readers. The views expressed here are personal views of the author, shall not be taken as professional advice. In case of necessity do consult with professionals for more clarity and understanding on subject matter.
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