All about Forensic Audit of a Company in India

Ramanan Murali

03 Apr, 2020

In today’s world, increasing white-collar crimes has led to the need for bringing in the forensics to save a business from any mishap. Crimes that are taking place using deceptive practices for financial gains are often tricky to prosecute, as the executioner takes sophisticated and calculated steps to ensure that their illegal activities are difficult to detect.

With the introduction of the definition of fraud in the Companies Act 2013, the concept of Forensic Audit in India as a practice and methodology has gained colossal importance and relevance in addition to the regular auditing techniques already in place.

What is a Forensic Audit in India?

A forensic audit is the inspection of a company’s financial records to gather evidence for use in legal proceedings regarding any accounting frauds. The corporate veil is lifted while identifying the fraud and the persons involved. Audit skills have to be applied to determine legally if fraud has taken place. The steps of an investigation process include planning, review, and a report. In the planning stage, objectives such as – identification of fraud committed, since when is the scam happening, who is involved, how much is the financial loss, fraud prevention measures, etc. are set.

Audit Engagement is one of the essential blueprints to be designed with the help of business owners and Audit Experts. It helps in finding the key areas which need to be focused and further work for excellent results. However, the forensic auditing is not the same as financial audit or secretarial audit; in aspects of objective and procedure as both differ long way. To support the success of the Indian economy on the global platform under the realm of good governance, transparency, accountability, and uprightness, the Forensic Audit has become the main indulgence in the corporate world.

Forensic audit in India extensively has a crucial role in supporting the business enterprise for concentrating on efficiency. On the larger parameters, Forensic audit as tool-mix of accounting and investigation is serving all the five E’s of good governance and make the corporates to grow and develop on the parameters of being Effective, Efficient, Easy, Empower, and Equity.

Who can conduct Forensic Audit?

Forensic auditors do not differ from other legal professionals; They investigate accounting and different reliable settings by combining their knowledge of accounts, law, finance, and investigating skills to find evidence of corruption or financial crimes. The professional goes beyond looking into the financial statements, which includes examination and investigation, bringing out evidence, writing reports, understanding the legal scope of the evidence, and ways to prove it in court. Starting from collecting evidence to examining the shreds of evidence, later zeroing the culprit behind the fraud to appearing in the court for submitted the testimony, a forensic auditor plays a vital role as a part of his responsibility.

Process of conducting Forensic Audit

The evidence gathered is in a manner that is usable in court. A report is then produced with the findings of the investigation. Such findings may also be presented in court. Process of conducting a forensic audit is outlined below:

Understanding Forensic Audit in India Through Nirav Modi Scam

Forensic reports deliver findings and recommendations of the forensic investigation conducted. Details regarding the causes, circumstances, illegal or potentially fraudulent activities. The Forensic audit was used wisely and significantly to reach the core of the fraudulent transaction. We will understand with the help of Nirav Modi and Punjab National Bank Scam. (A detailed analysis)

How did the scam begin?

• In 2011, LOU (Letter of undertaking) was opened at the Mumbai branch of PNB Punjab National Bank) by the Nirav Modi Group- with an LOU, a bank can agree to repay the principal and interest on a loan by its client, without any conditions.
• Two employees of PNB used SWIFT to raise money and move funds out of the bank by bypassing CBS (Core Banking Solution).
• The software system named FINACLE was misused to issue overseas credit as these were issued without authorizing into the bank’s CBS
• Fake LOUs were issued by the employees on which loans were given to PNB by foreign branches of Axis Bank and Allahabad bank.
• PNB’s Nostro accounts were fund by these foreign currency loans, which were moved to overseas parties.
• The SWIFT network was misused, and the bank’s management was kept in the dark regarding such transactions for a long time.
• The fraud was eight times the bank’s 2016-17 profit of ₹ 1325 Cr. and one-third of PNB’s market capital of ₹ 35300 Cr.
• Similar modus operandi was seen in Mehul Choksi’s companies while issuing LOUs/LCs. Transactions were initially rooted via CBS but subsequently changed by increasing the amount transmitted through SWIFT without reporting through the CBS.

What happened further after the Fraud was detected?

The present findings of the investigation are-

• On 16th January 2018, Diamond R US, M/s Solar Exports and M/s Stellar Diamonds approached Punjab National Bank requesting for LOUs to pay their overseas suppliers.
• When the bank demanded their cash margin, suspicion on the issuance of fraudulent LOUs in the past came into light as no such records were found.
• PNB reached out to the CBI to file a complaint on 29th January 2018, alleging that Nirav Modi, Ami Modi, Nishal Modi and Mehul Choksi, partners of the said firms have colluded with two bank officials and cheated PNB thereby causing a wrongful loss.
• The complaint stated that at the Brady House branch of PNB, two employees, Gokulnath Shetty, retired Deputy Manager and another bank official Manoj Kharat issued fraudulent LOUs to the overseas creditors on behalf of the said firms.
• The FIR filed by CBI state that, “The public servants committed an abuse of official position to cause pecuniary advantage to Diamonds R US, Solar Exports and Stellar Diamonds and wrongful loss of Rs 280.70 crore to PNB during 2017.”
• As on 18th May 2018, it was found that the scam involved ₹14,356.84 crores (US$2.1 billion) and Nirav Modi is said to be in hiding.
• The CBI approached the Interpol to issue a Red Corner Notice against the accused on 13th June 2018.
• The government dismissed Usha Ananth Subramanian as she was the MD of PNB between August 2015 and May 2017 and had also been its executive director. She was granted bail by Special CBI court on a surety bond of rupees one lakh.
• One of the accused in the fraud, Nitin Shahi filed an application on 7th September in special CBI court to book PNB also as an accused in the case as there is prima facie evidence against the bank.
• An asset appropriation case was registered by the CBI against Gokulnath Shetty, retired deputy manager of PNB for allegedly amassing 200% more wealth than the recognized income sources.

How the scam could have been avoided

• Implementation of blockchain technology for accounting and transactions may help in the detection and prevention of frauds. It records the movement of an asset and tracks its journey from point-to-point.
• Full integration and reconciliation of SWIFT transactions with the core banking solution software
• Following the general practices of banking companies or Companies Act. For example, the rotation of employees of banks every three years.
• There should be a regular review of the critical systems and processes by the banks and following ethical banking practices.
• Regular disclosures to SEBI, RBI and other regulatory entities and All LOUs should be mandatorily SWIFT-CBS linked
• The audit reports should be disclosed on time to the government auditors and have to be regularly examined by RBI.
• The bank staff should be trained on new and upgraded techniques of banking with awareness on the possible ways of banking frauds
• Any suspicious entries that may or may not be frauds should be flagged so that proper authorities can pay attention and an enquiry can be conducted.

Regulatory Viewpoint on Forensic Audit

The Reserve Bank of India has looked upon the deteriorating quality of assets and contrived forensic audit obligatory for large advances and re-structuring of accounts. The Enforcement Directorate (ED) and the Serious Fraud Investigation Office (SFIO) also stress upon the need for forensic audit pertaining to the rise in money laundering and willful default cases that is bothering the banking system.

Conclusion