Fraud and the law

THE Satyam fraud has exposed the inadequacies in Indias legal and regulatory systems to tackle corporate wrongdoing of such unprecedented dimensions. The interim report of the Registrar of Companies (RoC) has, according to reports, confirmed falsification of books of accounts and inflation of the companys financial position to the extent of over Rs.5,000-6,000 crore by Satyam Computer Services Ltd. The RoC report is the basis for the probe by the Serious Fraud Investigation Office (SFIO), set up under the Ministry of Corporate Affairs in 2003. As the probe by the SFIO is the main limb of the multi-pronged investigation into the fraud, a close look at what the SFIO can achieve under the present legal and regulatory framework needs to be examined.

The SFIO is a non-statutory body and was set up on the basis of the recommendations of the Naresh Chandra Committee on corporate governance in the backdrop of stock market scams, failure of non-financial banking companies and the phenomena of vanishing companies and plantation companies. It is a multi-disciplinary organisation with experts on finance, capital market, accountancy, forensic audit, taxation, law, information technology, company law, customs and investigation. These experts are drawn from banks, the Securities and Exchange Board of India (SEBI), the Comptroller and Auditor Generals office and the organisations and departments concerned of the government.

The SFIOs mandate is extremely focussed and, to some extent, limited by Sections 235 to 247 of the Companies Act, 1956. Although the Naresh Chandra Committee envisaged a separate statute to enable the SFIO (along the lines of the SFO in United Kingdom) to investigate all aspects of fraud and direct the prosecution in appropriate courts, the Central government, inexplicably, did not find it necessary to simultaneously create a separate legislative framework for the SFIO to function under. This has, according to observers, seriously compromised the SFIOs efficiency and effectiveness.

The SFIO, therefore, takes up investigations only into those cases of alleged fraud referred to it by the Central government under Section 235/237 of the Companies Act, 1956. Both these provisions enable the Central government to appoint one or more competent persons as inspectors to investigate and submit a report on the affairs of a company if, in its opinion, or in the opinion of the RoC or the Company Law Board, there are circumstances suggesting that the business of a company is being conducted with the intention to defraud its creditors or members, or for a fraudulent or unlawful purpose.

Not all cases of corporate fraud get referred to the SFIO. Only cases that are complex, and have inter-departmental and multi-disciplinary ramifications, are taken up for investigation. Cases that substantially involve public interest, to be judged by size, either in terms of monetary misappropriation or in terms of persons affected, or those cases that may lead to a clear improvement in systems, laws or procedures, can also be referred to the SFIO.

According to the charter, the SFIO may also take up cases on its own without they being referred to it by the Department of Company Affairs. In such cases, the SFIO Director has to record the reasons in writing, and the decision will be subject to review by a coordination committee set up for the purpose. It is to be seen whether these aspects of its functioning have restricted its autonomy or operational efficiency.

In the case of the Satyam fraud, for example, the SFIO has been asked to submit its report to the Central government within three months. While sources in the SFIO have been reported to be sceptical about completing the task in three months with the available staff strength, the SFIOs Charter leaves no room for an extension. It says the investigation must be completed within the time frame assigned by the Central government; the subject-specific groups of officers who assist the investigating officer have to examine the issues involved within a given time frame and give the requisite inputs to the investigating officer.

This is bound to raise the question whether the Satyam fraud, to be unravelled in such a short time, is a complex matter. A case is considered to be complex if the company involved is already closed and its promoters are already absconding neither of which is true in the case of Satyam. Therefore, Chief Justice of India K.G. Balakrishnans view as reported in the media that the Satyam affair is not a complex one and that the judiciary is fully equipped to establish the guilt of those accused of fraud makes sense. The sheer scale of the Satyam fraud if not the complexity appears to have convinced the Central government that the case merits investigation by the SFIO.

Having said that, however, one has to admit that the record of the SFIO in prosecuting corporate frauds hardly inspires confidence. Its website reveals that it has filed 756 cases against 30 companies, after obtaining sanction for prosecution, on the basis of its investigation reports. Twenty-eight cases are pending against three companies in the High Courts for the purpose of obtaining sanction for investigation, as these companies are under liquidation. Besides, it filed four cases of oppression and mismanagement in the Company Law Board when its investigation revealed fraudulent acts committed by management.

The lengthy legal processes have raised a question mark about the SFIOs effectiveness in bringing the prosecution of any corporate fraud to its logical conclusion. That the SFIO has not got a single court verdict in the cases it has filed since 2003 is a telling commentary on the constraints it faces. According to SFIO insiders, these constraints include inadequate manpower, the involvement of multiple agencies in the investigation of the same case, and dependence on ordinary courts for the trial of those accused of corporate fraud. In the case of the Satyam fraud, apart from the SFIO, SEBI and the Institute of Chartered Accountants of India are also investigating different dimensions of the scam, which are bound to overlap with one another.

Therefore, the prosecution of the perpetrators of the Satyam fraud is not going to be easy. A perceptive observer of Indian corporate law, V. Umakanth, observed after Ramalinga Rajus confession: What is baffling is that the company was not only listed on Indias leading stock exchanges, but even had its American depository receipts [ADRs] listed on the New York Stock Exchange [NYSE]; for this reason it had seemingly complied with all the onerous requirements of corporate governance imposed by the Indian regulations [clause 49 of the SEBIs listing agreement] as well as the oft-feared Sarbanes-Oxley Act of 2002 of the U.S. enacted after the Enron scam. Clearly, this has been a case of compliance of corporate governance norms in form, but utter breach in spirit.

Another leading business journalist, Sucheta Dalal, noted in one of her columns: From 1992 to 2000 and beyond, no corporate house has been punished despite their deep involvement in financial scandals. It is only brokers and bank officials who end up as scapegoats.

The Satyam scam also raises the question whether the fraud could have been detected earlier had the government undertaken appropriate reforms in time. One such reform was recommended by the committee chaired by a former Chief Justice of India, Justice M.H. Kania, in 2005, with regard to amending Section 15A of the SEBI Act, 1992. Under this provision, failing to furnish information or any document as required in the regulations would invite penalty.

However, while deciding a case in 2005, SEBI interpreted this provision to mean that filing of false information or material could not be penalised as it could not be equated with non-filing. The Kania Committee recommended the amendment of this provision as to empower SEBI to initiate adjudication proceedings for furnishing false information knowingly.

Jayant Thakur, a chartered accountant, observed in 2005 in his column on rediff.com: Numerous SEBI provisions require the filing of information. This information is used by SEBI to keep track of developments, check law compliance, ensure protection of investors interests and so on. Obviously, if false information is filed, the purpose will be defeated. Thus, a wrongdoer may file false information to avoid detection. Even if the false information is not filed intentionally, the objective of filing the information will not be achieved. Thakur added in his recent post on the Indian Corporate Law blog after the Satyam fraud that this recommendation has not been acted upon even today. Among other things, SEBI is now perhaps anxious to know whether Satyam had filed false information with it, misrepresenting its financial health. Making a false document or a false electronic record is an offence under Section 464 of the Indian Penal Code.

SEBI monitors and regulates corporate governance of listed companies in India through Clause 49. This clause is incorporated in the listing agreement of stock exchanges with companies and it is compulsory for them to comply with it. An amendment of this provision in 2005 laid down stricter qualifications for independent directors on the board of a company. In the context of the so-called independent directors of the Satyam board failing to detect the fraud in time, this provision probably requires further tightening.

Thus, there is much to be said in favour of creating an effective legal and regulatory environment for successful prevention and prosecution of corporate frauds.