Latest development in the Forensic Accounting & Investigation Norms

Latest Norms on the Forensic Accounting and Investigation :

The recent reports suggest that India will have very soon the norms on the Forensic Accounting Investigation, the report recently published in the Economic Times daily suggest on this. Before going in to that for the purpose of the basic understanding on this article I would like to explain various definitions and meaning of the Forensic Accounting & Audit :-

What is Forensic Accounting & Audit?

The definition of Forensic Audit which is also known as Forensic Accounting process refers to the "application of accounting methods for the detection and gathering evidence of Frauds, Embezzlement or any other such white-collar crime" (Definition as per the Industry professionals). Some day it is the application of accounting skills to legal questions. It is also an evidence gathering to prove a financial crime by adopting the accounting methods, which will prove that a transaction or set of transactions were not according to the standard accounting procedures, and were with the intention of committing a fraud. Such procedure or process also will give some answer to the legal questions or about the illegality of a transaction, with regards to what went wrong in the past.

According to some experts "Forensic Accountancy or Financial Forensics is the specialty practice area of accounting that describes engagement that result from actual or anticipated disputes or litigation. The author of this article is an Associate Member of the Certified Fraud Examiners, ACFE, USA. According to me it is the profession of the Financial Crime Investigators or Detective who detects, and prevents the financial crimes in the financial transactions. ACFE is very proactive in creating the experts or Forensic Auditors fraternity in the industry in the world. This certification is a widely accepted qualification for the Forensic Auditors and creating the group of professionals in the world. Any victim of a fraud also have a legal remedy. These experts therefore help the organisation to acquire the evidences for taking legal action against the perpetrators of the financial crime. They adopt some process which will help to detect the crime and gather the evidences requires for legally proving the financial crime. Forensic accounting, forensic accountancy or "financial forensics is the specialty practice area of accounting that describes engagements that result from actual or anticipated disputes or litigation". (Reference : Industry Experts).

According to some other industry experts a "A forensic audit is an examination and evaluation of a firms's or individual's financial records to derive evidence that can be used in a court of law or legal proceedings" [Definition of Industry experts]. Further according to some experts "Forensic auditing is a specialization within the field of accounting, and most large accounting firms have a forensic auditing department. Forensic audits require the expertise accounting and auditing procedures as well as expert knowledge about the legal frame work of such an audit". [Definition by Industry experts].

Investigative activities are the part of the Forensic Audit. It is not within the definition of the Investigation under the Criminal Procedure Code 1973 which allows only a Police Officer to conduct an investigation after filing an FIR under Section 154 of the Cr PC. The power of the Police Officer to investigate a crime defined in Section 156 (1) of the Cr PC. Procedure of Investigation also defined under Section 157(1) of the Cr PC and the Investigation defined in Section 157 (2) of the Code of Criminal Procedures 1973. Here the investigation is authorized by the Magistrate of Judicial Court and therefore any other process cannot be technically defined as Investigation. A Police after completion of the Investigation process, forward his report to the Judicial Court where the FIR is pending U/s. 173(5) of the Cr PC. [Chapter XII - The Code of Criminal Procedure 1973]. In other words the Investigation conducted by the Forensic Auditor or Investigator cannot be legally called as "Investigation" may be we can technically called as "Verification" since the Law is very clear on the jurisdiction of the term "Investigation".

However from the professional perspective we can say that similar investigation or verification activities or process in wide range is involved in the forensic audit. It may be conducted for collection of evidence to prove the wrong doing and therefore finally help as evidence in prosecuting a party or person who has perpetrated a fraud, embezzlement or other financial crimes. It also involves other issues like ; disputes related to bankruptcy filing, business closures and divorces. The Forensic Auditor finally become a witness in the case as an expert to depose before the Court during prosecution process or in any Civil proceedings to recover the loss. In the case of the Insolvency cases also before reaching in to conclusion the authority may decide for a Forensic Audit / Investigation before taking a decision. Reference: Industry experts]. [Insolvency Act].

Why people or Business organisations conduct Forensic Audit?

It can uncover or confirm or proves occurrence of some illegal activities happened in the past. Companies conduct Internal and Statutory Audit as a part of the check and balances of the system to ascertain the accuracy or true state of affairs of an organisation or firm. But Forensic Audit is usually chosen when somebody doubt or anticipate some sort of crime or evidence collected would be used in the judicial courts in the future.

Fraud in the Corporate:

In a Forensic Audit, the Auditor will be looking various aspects to prove the irregularity if any occurred or not. Th following aspects usually are the points they look for :-

1. Conflict of Interest : This is one of the area an Auditor during the Forensic Audit look for, which the fraudster whether used his influence for his personal unlawful gains to the detriment of the Company. For example somebody willfully allows an expenditure which is not justified as per the Company rules, but since the person who sanction it for example is the relative of the beneficiary or a friend of the beneficiary employee, then there is a conflict of interest. Other examples are like a contract is awarded to the relative of the Project Head who himself approves a Quotation for relatively higher price for the work, even though cheap options are available. In another example the Head of the Project allowed a contractor to put high rate which is otherwise given for Quality - A work instead given this rate for the Quality - B work, then there is a conflict of interest.

• Bribery : This is one of the main evil happens invariably in many of the contracts. In most of the cases the Vendor is compelled to bribe otherwise his will Bill not be passed or his work will not be done. Being a former government servant I have an impression that bribery is generally in government services, but to my surprise I have seen that in the Private sector also there is always bribe paid more often in the name of Speed-up money. Offering money to get things done or influence a situation in one's favor is called Bribery technically.
• Extortion : It is the definition for wrongful use of actual or coercion or threat or using force or violence or intimidation to gain money or unlawful gain of money or property from an individual or an organisation / entity is called extortion. The reports of extortion in early Nineties in big cities like Mumbai, India paid by the Real Estate Builders or Property dealers to the organised criminals or "Underworld extortionists" or "Mafia" are the example of extortion. Recent cases or complaints of Political parties extorting money from the big business people for their Political campaigns in India and other parts of the world also make this a very shoddy or gray subject. There were reports of corrupt politicians in the Latin American countries using enforcement agencies like Police and Army against Narcotic "Cartels" who are engaged in the Narcotic business, for funding during elections are also the examples of extortion done openly by the Politicians to gain power in the country highest office elections. [Various references].
• The Fraud referred in the above paragraphs could be uncovered by investigating the intrapersonal relationships involved and exposing a conflict of interest or Extortion. Forensic Auditor cum Investigator during the audit finds such illegal activity in the transactions which can help the organisation to take suitable legal action against the perpetrators of such white collar crimes.

Asset Misappropriation : This is the most popular form of fraud. For example a Manager who is dealing with the sale of scrap in which payments were received in cash failed to deposit huge amounts in the treasury but started a parallel money lending business. In another case investigated by the author of this article found some official of the Company submitting bogus Invoices, in which material never came in a project. By managing the Stores and Security Department, by influencing and abusing the official position of being a senior management official, the subject recommended for making payments to the non-existent suppliers. I am sure this fraud is very common in the projects. Creating Bogus Letter of Credits for fictitious purchases, and diverting funds. In many of the Corporate organisations the transactions are in high volume and therefore such activities are very difficult to detect. Capital items purchased for the projects are highly vulnerable for the frauds by the authorized persons / officials of the companies. Other way of fraud is less quantity of material actually coming in physically but more quantity is ordered and paid. Physical verification of the stock in the ERP and its issues to various projects are also vulnerable areas of these type of frauds commonly seen in India. In the case of consumable and semi Capital goods, it difficult find out where the material is issued and used.

Financial Statement Fraud:

I have got an opportunity to investigate bank frauds in which a usual form of fraud is to take loans from the banks on the basis of manipulated Financial Statements and then divert the funds for other purposes resulting in the cheating of the banks. In many cases Companies produce manipulated Statement of Affairs or Non-audited Balance Sheet, showing a rosy picture of the state of affairs of the Company or in another words Statement showing financial performance better than it actually is. The idea is to get more exposure of fund based or non fund based finance from the banks and improve the liquidity of the Company. Finally the account of the Company with the Bank become bad and NPA due to the default of repayment. [Industry sources and Bank Fraud cases in India].

Important Points or Key Takeaways :

• A Forensic Audit is an examination and evaluation of the Company's or individual's financial records to derive evidence that can be used in legal proceedings.
• It may be conducted to prosecute a party of fraud, embezzlement or another criminal misconduct suspected or reported.
• It is conducted as a part of the due diligence before investing some huge amount in certain venture or project.
• It can also conducted on a random basis by many organisations, who do it not on the basis of a suspicion or complaint but as part of the Internal Audit process.

How it works?

The process of forensic audit is similar to the financial audit conducted ; planning, collecting evidence, preparation of reports, incriminating the findings proved for a future court evidence while taking a legal action. As part of the mitigation of risk it is necessary that the fact may need to be proved before the Court of Law.

Planning the Investigation:

During the planning stage, the forensic auditor and team will plan their investigation to achieve objectives, such as ;-

• Identifying what fraud, if any, is being carried out
• Determining the period during which the fraud occurred
• Discovering how the fraud was concealed
• Naming the perpetrators of the fraud
• Quantifying the loss suffered as a result of the fraud
• Gathering relevant evidence that is admissible in court
• Suggesting measures to prevent such frauds from occurring in the future

Collecting Evidence:

The evidence collected should be adequate enough to prove the identity of the fraudster(s) in court, reveal the details of the fraud scheme, and document the financial loss suffered and the parties affected by the fraud.

A logical flow of evidence will help the court in understanding the fraud and the evidence presented. Forensic auditors are required to take precautions to ensure that documents and other evidence collected are not damaged or altered by anyone.

Reporting:

A forensic audit requires a written report about the fraud to be presented to the client so that they can proceed to file a legal case if they so desire. At a minimum, the report should include

• The findings of the investigation
• A summary of the evidence collected
• An explanation of how the fraud was perpetrated
• Suggestions for preventing similar frauds in the future—such as improving internal controls

Court Proceedings:

The forensic auditor needs to be present during court proceedings to explain the evidence collected and how the team identified the suspect(s). He or she should simplify any complex accounting issues and explain the case in a layperson’s language so that people who have no understanding of legal or accounting terms can understand the fraud clearly. Understanding of a wrong doing in simple language or under legal terms in the court of law is very essential to prove the frauds.

 LATEST DEVELOPMENTS IN THE FORENSIC ACCOUNTING & AUDIT PRACTICE IN INDIA:

Recent report suggest that Indian professionals will soon come up with Forensic Accounting and Investigation Standards (FAIS), which going to set the basic parameters of Forensic Audits and Accounts. The Institute of Chartered Accountants of India (ICAI) has reportedly constituted a committee to deliberate on the FAIS. The objective of the FAIS is learned to be to codify best practices in the twin domains of Forensics and Investigations, set basic quality benchmarks for conducting assignments in the areas. This move according to experts will make India the first country in the world to release a set of forensic accounting and investigations standards. [Reference : Experts of ICAI]

It is learned that FAIS will include 30 standards covering all aspects in the subject. The idea is to improve the forensic quality of the reports, and their admissibility in the Courts of Laws like any other forensic experts' opinion in the cases. The Judicial courts in India started accepting the expert opinion of various Forensic experts for proving the cases. Until and unless standard is created no Court will take such Financial Forensic Audit experts opinion as Scientific experts' opinion for proving a case. This move is expected to benefit corporate, Regulators and Enforcement Agencies like the Serious Fraud Investigation Office, Economic Offences Wing, Banks and Reserve Bank of India. Other agencies like ED, CBI, Directorate Revenue Intelligence (Ministry of Finance) are having powers governed by the respective Statutes / Acts and the penal sections for conducting investigations and prosecuting the accused or perpetrators of the financial crime. [Industry Reference].

The RBI of India has reportedly mandated a Forensic Audit for transactions of the Corporate over Rs. 200 Crores (About 27 Million USD) while lenders or Companies individually call for the Forensic Audits or Investigations if some fraud is suspected. [Economic Times & Banking Industry Experts]. Experts suggest that when a huge amount is involved in the Corporate transactions, particularly Public Ltd. Company or organisation dealing with the public money, due diligence is required, to assess the Credit or Financial Risk and such process can be done by conducting Forensic Accounting / Audit or financial viability study. The Company Amendment Act 20013 and 2019 creates lot of responsibility and obligation for the promoters / Directors of the Public Limited Company since they are doing business with the public funds. [Industry experts Reference].

Conformed reports indicate that ICAI is planning to consult interested parties like stake holders, Corporate Affairs Ministry, Reserve Bank of India, SEBI, and Comptroller and Auditor General of India (CAG) while taking decision on the mandatory Forensic Audit. It is also learned that a Draft Standards will be released by them soon and may entertain Public Comments or opinion on the subject. Once it is published it will become mandatory and the Forensic Audit and Investigating fraternity will enforce this, and violation of this will be resulting in action against the Corporate. Possibility of a Bill in the Parliament of India on this line also cannot be ruled out. This also going to have lot of opportunity for the Forensic Audit and Investigation practitioners in the coming days. [ICAI, ET & Industry Expert reference].

During my visit to attend an International Conference in Dubai, UAE in January 2020, the author of this Article have got opportunity to interact with the Risk and Finance Heads of various corporate in UAE. Many of the Companies does not have a dedicated Forensic Auditor or Fraud Investigation Heads in their roll but depending on the Audit Firms like (Big 4 Audit firms) or other Forensic Audit Consultants who are practicing on the subject in different parts of the world.

CONCLUSION:

Mandatory Forensic Audit / Investigation as part of the Due diligence process or in the event of a suspected Fraud will have more legal sanctity in the future because of the initiative by the professional body like the Institute of Chartered Accountants of India. We will be setting up a global standards by bringing this process as mandatory. This will also help for evidence gathering without its destruction in the Court cases. Further it is going to open opportunity for the practitioners of the Forensic Audit and Investigation like the Chartered Accountants, Former Federal Police Officers / Officers of Investigating agencies like CBI, ED and DRI. Financial Fraud investigation is a very highly specialized area and few people are available in this field. Professionals with the Police investigation background will be more required for this profession. Organisations like Association of Certified Fraud Examiner (ACFE) are going to have important role in making this opportunity very effective.

[The author of the article is the former Investigating Officer of the Central Bureau of Investigation, Bank Securities & Frauds Cell, EOW-IV, Bangalore and have adequate experience in investigation of the Economic Offences and Financial Crimes including the Bank Frauds].