FRAUD - Motives, Risk Areas,forensic audit


Amrapali Fraud


ICAI to Look into Alleged Financial Misdeed at Fortis

It has been alleged that Fortis founders Malvinder Singh and Shivinder Singh took at least ₹500 crore ($78 million) out of the publicly-traded hospital company they control without board approval about a year ago.
"We are looking into Fortis case. We have to be vigilant about any misconduct by a chartered
accountant," Gupta said. Stock exchanges have issued notice to Fortis following reports of the alleged

ICAI is also hoping the government will consider its demand to be allowed to look into the conduct of firms and not just the chartered accountant in case of a wrong-doing.
The institute had renewed its demand to penalise the erring audit firms following the action by the
Securities Exchange Board of India against Price Waterhouse in the Satyam Computer case.
"We can take action against the member who conducts the audit but the firm should also be held
responsible for misconduct… Government has not denied our request but we are yet to get a final
word," Gupta said.
ICAI has also written to the ministry of corporate affairs to provide two nominees to set up one more
bench of the disciplinary committee for faster disposal of cases.
The institute also plans to have a separate committee for public interest litigations and also start
e-hearing of disciplinary matters to reduce pendency of cases. The pendency of cases against ICAI has
come down to two years from four years in 2016. "We are taking proactive measures to fasten the
processes and reduce pendency," Gupta added.
The institute has disposed four of the five cases of misconduct by CAs referred to it by the Serious
Fraud Investigation Office after the demonetisation exercise



Examples of fraud done by ledger keeper in purchase ledger are:

.  Crediting the account of a supplier on the basis of ficticious invoice, showing that certain supplies have been received from the firm, whereas in fact no goods have been received or on the basis of duplicate invoice from a supplier, the original amount whereof has already been adjusted to the credit of the supplier in the purchase leger, and subsequently misappropriating the payment made against the credit in the supplier’s account.

Suppressing a credit note issued by a supplier in respect of return or an allowance and misappropriating an amount equivalent thereto of the payment made to him. For if a credit note issued by a supplier either in respect of goods returned to him or for an allowance granted by him, is not debited to his account, the balance in his account in the purchase ledger would be larger than the amount actually due to him. The ledger keeper thus will be able to misappropriate the excess amount standing to the supplier’s credit.

.  Crediting an amount due to a supplier not in his account but under a fictitious name and misappropriating the amount paid against the credit balance.


Examples of fraud done by ledger keeper in sales ledger are:

.  Teeming and lading: Amount received from a customer being misappropriated; also to prevent its detection the money received from another customer subsequently being credited to the account of the customer who has paid earlier. Similarly money is received from the customer who has paid thereafter being credited to the account of the second customer and such a practice is continued so that no one account is outstanding for payment for any length of time, which may lead the management to either send out a statement of account to him or communicate with him.

.  Adjusting an authorized credit or fictitious rebate, allowance, discount, etc. in the account with a view to reduce the balance and when payment is received from the debtor, misappropriating an amount equivalent to the credit.

.  Writing off the amount receivable from a customer’s bad debt account and misappropriating the amount received in payment of the debt.


Frauds done by ledger keeper in supplier’s ledger are:

Wrongly allocating income or expenditure.

Understating or overstating stock or prepaid expenses or liabilities

A phylosophical understanding of why fraudsters continue to thrive - in the light of recent scams in india
 Uma Shashikant

Marcus Felson and Lawrence Cohen proposed a theory of crime in 1979, according to which, they framed fraud as a routine activity that would be willingly adopted. They proposed that the presence of three elements—supply of motivated offenders, availability of suitable targets and lack of capable guardians—at the same time and space, would lead to a routine level of criminal activity in society.

They debunked the idea that social factors, such as poverty and inequality, led to crime. If we view what goes on around us through this prism, it offers interesting insights into fraud that we see so commonly around us.

Consider the first element—the willing offender—proposed by Felson and Cohen. What could be the motivation for fraud?

To suggest that someone who is greedy and dishonest is likely to commit fraud might be an oversimplification. The desire to use an opportunity to commit fraud is a personal psychological attribute.

Psychologists point out that motivation could also come from normal social circumstances. The friction arising from lack of finances to match one's desires, the craving for social acceptance, threats to status, power and position are all recorded motivators of fraudulent practices.

E Stotland, writing about white-collar criminals, points out that a sense of mastery and overcoming of challenges pervades the fraudster's mind, leading to ego satisfaction when the crime is completed.

Consider the environment in the dealing rooms of financial institutions and brokers; or the strong desire to be the largest bank, broker, stock exchange, or mutual fund; or the craving for social recognition and media attention. Motivation for fraud need not always be lack of morals, greed or desire for crime.

The second element, namely the suitable target, especially in the financial markets, tends to evoke responses seeking financial literacy and education. It is widely believed that educated and informed investors may be able to effectively defend themselves from offenders. That may be only a part of the story.

Investors may fail to identify persuasive offers as frauds for three important reasons. First, most propositions are designed to create a visceral influence. If it appeals to a basic need, such as hunger, lust or greed, or plays up the victim's emotional needs for status, recognition or exclusivity, the target may not even check the facts or conduct due diligence.

Second, the targets may not identify the fraudster due to the latter's status of power, influence, popularity and acceptance in the media, among peer groups, or such set-ups.

Third, fraudsters may be able to neutralise their criminal behaviour by weakening the restraint of the target and making it look naive and foolish to miss an opportunity. All these situations create suitable targets, which may be vulnerable even if they were financially literate. Investor education remains necessary, but not sufficient.

The Saradha scam ruthlessly dangled assured returns to those who had very low incomes, as a means to get rich. Several spurious companies continue to appeal to the desperate need to get rich. Or, they target senior citizens, who may be searching for a higher return, given their limitations to acquire more wealth.

Most financial product distribution businesses train their staff in 'soft skills'. They are expected to learn how to appeal to the psychological needs of the customer. There are relationship managers, who can get money from customers by walking their dogs and pandering to their egos.

It would be difficult for a cricket-crazy nation to associate one of the sponsors of the national team with a lengthy court battle, wherein the validity of its investor records is questioned and there are allegation of unauthorised mobilisation of money.

Investors in the National Spot Exchange ( NSEL) thought that they belonged to an exclusive club of the privileged who could earn steady returns, and staying out would have been foolish.

These are not cases of lack of financial literacy, but vulnerability arising from factors beyond the cold rationality of decisionmaking. The third element—presence of a capable guardian—is something we sorely lack. A neighbourhood police station will first know that a finance company has set up shop nearby and is mobilising public money.

Under the current law, they are empowered to act, but in capability and willingness, they have been found lacking. The FMC has acted several months after illegal forward trading had been going on in the NSEL.

The ruling of regulators takes time, charges of criminality languish in courts, and efficient implementation is not a skill we seem to possess. The search for the SRO, which would start policing the army of financial advisers, is still on 15 years after the mis-selling of technology funds to retired investors.

Thousands of agents continue to push IPOs, unsecured company deposits, and insurance products without being held responsible for the quality of promises they make, or the harm they cause their targets.

The criminologists who study fraud have shown that neutralisation is a strategy so widely accepted by fraudsters that it no longer seems like a morally depraved activity. There are rationalisations and justifications to make the entire act seem acceptable.

Some producers hold that it was investors' greed and illiteracy that brought them the grief of a poorly performing financial product. In some cases, as has been reported in the NSEL case, the refrain is that the investors were partners in crime, who should have known that the party may not last and, therefore, deserved to lose.

Then there is the overall sense of low ethical standards, where tax evasion, black money, illegitimate wealth, benami holdings, and money laundering, are widely prevalent and well known. Those who do not participate are seen as naive, unfortunate, less privileged, or simply stupid.

We should recognise that this environment of low ethical standards is creating several targets, capable of motivating even the most morally upright entities to become opportunistic criminals.

A respectable bank that is driving a target for acquiring assets and deposits crosses the line. We may not be able to stem the rising criminality in our economy with penalties and delayed punishments.

We have to break the easy confluence of the three elements in the routine activity hypothesis of Felson and Cohen. The teenager who speeds away wickedly when the car keys are left behind by unsuspecting parents is not a hardened criminal with low morals.

The availability of the car and the absence of the parent created an opportunity, motivating him to do so, demonstrating what Felson and Cohen have been saying about crime.

(The author is Managing Director, Centre for Investment Education and Learning.)

Satyam fraud -methodology of inflating sales- revealed
 April, 29th 2009
Indian investigators disclose how computer systems were subverted to generate false invoices
The Central Bureau of Investigation (CBI) of India has revealed details of the fake invoicing system used by Satyam Computer Services Ltd as part of the US$1 billion-plus fraud that has rocked the company.
Documents released to the general public in India showed how the company's standard billing systems were subverted to generate 'false invoices to show inflated sales,' before its former boss Ramalinga Raju admitted his role in India's largest ever corporate scandal.
The CBI said it had used cyberforensics to uncover how in-house computer systems were exploited to generate fake invoices.
Regular Satyam bills were created by a computer application called 'Operational Real Time Management (OPTIMA)', which creates and maintains information on company projects.
The 'Satyam Project Repository (SRP)' system then generates project IDs; there is also an 'Ontime' application for entering the hours worked by Satyam employees; and a 'Project Bill Management System (PBMS)' for billing. An 'Invoice Management System (IMS)' generated the final invoices.
CBI officers have concluded that the scandal involved this system structure being bypassed by the abuse of an emergency 'Excel Porting' system, which allows 'invoices [to] be generated directly in IMS…by porting the data into the IMS.' This system was subverted by the creation of a user ID called 'Super User' with 'the power to hide/unhide the invoices generated in IMS'.
By 'logging in a Super User, the accused were hiding some of the invoices that were generated through Excel Porting. Once an invoice is hidden the same will not be visible to the other divisions within the company but will only be visible to the [company's finance division sales team]' concluded the CBI.
The CBI said their inquiries revealed there are 7,561 invoices found hidden in the invoice management system, worth INDRupees 51 billion (US$1.01 billion).
As a result, 'concerned business circles' would not be aware of the invoices, which were 'also not dispatched to the customers'. The note added: 'Investigation revealed that all the invoices that were hidden using the Super User ID in the IMS server were found to be false and fabricated.' The value of these fake invoices 'were shown as receivables in the books of accounts of [Satyam] thereby dishonestly inflating the revenues of the company.'
And there were a lot of these bills. The CBI said their inquiries revealed there are 7,561 invoices found hidden in the invoice management system, worth INDRupees 51 billion (US$1.01 billion). 'As a result of this analysis, the individuals who have generated and hidden these false and fabricated invoices have been identified,' said the law enforcement agency.

ponzi scheme worth Rs 45,000 crore by Pearls Agrotech

Central Bureau of Investigation (CBI) on Thursday claimed to have recovered documents from the premises of Pearls Agrotech Corporation Ltd (PACL) and Pearls Golden Forest Ltd (PGF) which show the real estate group allegedly used ponzi schemes to cheat nearly five crore investors of Rs 45,000 crore.
The CBI has named PGF director Nirmal Singh Bhangoo and PACL director Sukhdev Singh besides six other directors of the companies in a case of criminal conspiracy and cheating.
"Initial investigation by CBI has revealed an alleged scam to the tune of Rs 45,000 crore in a case relating to an alleged fraud by Delhi-based private company and others through raising investments... through collective investment scheme under the garb of sale and development of agricultural land," a CBI spokesperson said.
The agency said the inquiry was carried out on the orders of the Supreme Court into allegations that the companies had collected crores of rupees through deposits from public at large through their ponzi scheme promising land.
"It was revealed that PGF, on being directed by the High Court of Punjab and Haryana to wind up the scheme and refund the money to the investors, a similar fraudulent scheme was operated under the name of PACL with office at Barakhamba Road," a CBI spokesperson said.
It is alleged that funds collected from new investors of PACL were used to repay the earlier investors of PGF to stave off criminal prosecution. The agency has carried out searches at the offices of PGF and PACL at their offices in New Delhi, Chandigarh, Mohali, Ropar and Jaipur.
Securities and Exchange Board of India (Sebi) had raised concerns over legality of PACL’s operations since it was running a collective investment scheme in the garb of a real estate company. (With PTI inputs)

Forensic Accounting,Forensic Investing, investigative accountants, forensic auditors or fraud auditors

Forensic Accounting

Forensic just means "relating to the application of scientific knowledge to a legal problem" or "usable in a court of law." Most of the crimes, such as homicides, investigated on a show like "CSI" are known as "crimes against the person." Forensic accounting is simply a specialty field within the broader arena of accounting.

They investigate crimes such as fraud and give expert testimony in court trials. They also perform work related to civil disputes. Forensic accountants are also known as fraud investigators, investigative accountants, forensic auditors or fraud auditors.

 It is the practice of utilizing accounting, auditing, Computer Aided Auditing Tools, Data Mining Tools, and investigative skills to detect fraud/ mistakes. Computer Software

Forensic Investing

Forensic investing involves looking beyond the obvious. A normal investor acts like a watchdog, but a forensic investor acts like a bloodhound looking for red flags. Investors must look beyond the numbers on financial statements and dig into the corpse of a company or a mutual fund. The author and creator of Sherlock Holmes [Sir Arthur Conan Doyle] said that "detection is, or ought to be, an exact science, and should be treated in the same cold and unemotional way."

Many investors and creditors are discouraged from using financial statements and the related footnotes because of their complexity. And, indeed, a thorough knowledge of financial statements of a company of any size can required considerable time and effort. But it is possible to glean important information about a company's prospects by spending time looking for specific indications of potential problems or red flags.

But suppose the financial statement is wrong? Some companies use creative accounting techniques to disguise damaging information, to provide a distorted picture of the financial health of the business, to smooth out erratic earnings, or to boost anemic or no earnings. Investors should have a healthy skepticism when reading and evaluating financial reports. Businesses are often clever in hiding these accounting tricks and gimmicks, so investors must be ever alert to the signs of outright financial shenanigans. Investors must attack financial statements and company information the way the fictional Sherlock Holmes approached murder cases.

According to Howard M. Schilit, "financial shenanigans are acts or omissions intended to hide or distort the real financial performance or financialconditions of an entity." Schilit provides seven shenanigans; the first five boost current year earnings, and the last two shifts current-year earnings to the future:

  1. Recording revenue before it is earned
  2. Creating fictitious revenue
  3. Boosting profits with non recurring transactions
  4. Shifting current expenses to a later period
  5. Failing to record or disclose liabilities
  6. Shifting current income to a later period
  7. Shifting future expenses to an earlier period

Red Flags

Clues that a company may be heading for trouble include:

  • Earnings problems. One of the most significant red flags is a downward trend in earnings. Companies are required to disclose earnings for the last three years in the income statement, so don't look just at the "bottom line." The trend in operating income is just as important as the trend in earnings.

  • Reduced cash flow. To a certain extent, management can exploit GAAP to produce the appearance of increased earnings. Some popular shenanigans include booking sales on long-term contracts before the customer has paid up, delaying the recording of expenses, failing to recognize the obsolescence of inventory as an expense, and reducing advertising and research and development expenditures. You can use the cash flow statement to check the reliability of earnings. If net income is moving up while cash flow from operations is drifting downward, something may be wrong.

  • Excessive debt. Crucial to determining whether a company can weather difficult times is the debt factor. Companies burdened by too much debt lack the financial flexibility to respond to crises and to take advantage of opportunities. Small companies with heavy debt are particularly vulnerable in economic downturns. Investment professionals pay special attention to a company's debt-to-equity ratio, the total debt to stockholders' or owners' equity. While the optimum ratio varies from industry to industry, the amount of stockholders' or owners' equity should significantly exceed the amount of debt by a significant amount. This information should be available on the balance sheet, but Enron hid millions of dollars of debt in special purpose entities.

  • Overstated inventories and receivables. Look at the ratio of accounts receivable to sales and the ratio of inventory to cost of goods sold. If accounts receivable exceeds 15 percent of annual sales and inventory exceeds 25 percent of cost of goods sold, be careful. If customers aren't paying their bills and/or the company is saddled with aging merchandise, problems will eventually arise. Overstated inventories and receivables are often at the heart of corporate fraud, resulting in future declines in profits. As significant as the ratios are, trends overtime are also important. Although there may be good reasons for a company to have bloated or increasing inventory or receivables, it is important to determine if the condition is a symptom of financial difficulty.

  • Inventory Plugging. Inventory fraud is an easy way to produce instant earnings and improve the balance sheet. Crazy Eddie, an electronic equipment retailer, allegedly recorded sales to other chains as if they were retail sales (rather than wholesale sales)

  • Balancing Act. Inventory, sales, and receivables usually move in tandem, because customers do not pay up front if they can avoid it. Neither inventory or accounts receivable should grow faster than sales. Furthermore, inventory normally moves in tandem with accounts payable, since a healthy company does not often pay cash at the delivery dock as purchases are received.

  • Off-Balance Sheet Items. Enron had more than 2,500 offshore accounts and around 850 special purpose entities.

  • Unconsolidated Entities. Enron did not tell Arthur Anderson that certain limited partnerships did not have enough outside equity and more than $700 million in debt should have been included on Enron's statements.

  • Creative or Strange Accounts. For their 1997 fiscal year, America Online, Inc. showed $385 million in assets on its balance sheet called deferred subscriber acquisition costs.

  • Barter deals. A number of Internet companies used barter transactions (or non-cash transactions) to increase their revenues.

  • Look at revenues. Compare the trend in sales with the trend in net income. For example, from 1999 to 2001, HealthSouth's net income increased nearly 500%, but revenues grew only 5%. On March 19, 2003, the SEC said that HealthSouth faked at least $1.4 billion in profits since 1999 under the auditing eyes of Ernst & Young.

  • Hockey stick pattern. Look for aggressive revenue recognition policies (Qwest Communication, $1.1 billion in 1999-2001) which form a hockey stick pattern.

  • Nonrecurring charges. Beware of the ever-present nonrecurring charges (e.g., Kodak for at least 12 years).

  • Avoid Buying Shares of a Mutual Fund Just Before it Pays  Dividend. Merrill Lynch says to wait until after the fund's record date before making your investment. Otherwise, you'll owe taxes on the dividend, even though that dividend is, in a sense, return of the principal you've just invested. Also, the share price is typically lowered by the amount of the dividend after it is paid. So, by waiting, you may acquire more shares for the same investment amount.

  • Switching of Auditor. Auditor switching and the financial condition of a company are dependent to a limited extent. Firms in the midst of financial distress switch auditors more frequently than healthy companies.

  • Underwriter Broker Basis. The long run performance of initial public stock offerings that are recommended by their underwriters is dramatically worse than the performance of firms recommended by non-underwriters. Roni Michaely and Kent Womack found significant evidence of bias-- and possible conflict of interest -- between the analyst's responsibility to his investing clients and his incentive to market stocks underwritten by his firm. Contrary to the conventional wisdom, they found that the market does not come close to recognizing the full extent of this bias.

  • Hyped Sales. According to court documents, CEO Emanuel Pinez used a form of trickery rarely seen: He hyped sales by using his ample personal fortune to fund purchases. 'Any auditor would have had a hard time catching that,' says William Coyne, an accounting professor at Babson College. Centennial Director John J. Shields, a former CEO of Computervision Corp., says in an affidavit that Pinez admitted to him that he altered inventory tags and recorded sales on products that were never shipped. Pinez' lawyer says he is innocent. (Geoffrey Smith, "Why Didn't Anyone Smell a Rat at Centennial?" Business Week, March 24, 1997, p.190.)

  • Board of Directors. The "Heard on the Street" column in the April 25, 1997 issue of the Wall Street Journal, written by E. S. Browning, discusses red flags that relate to a company's board of directors. Wharton Professors John Core, Robert Holthausen and David Larcker published a study that found six different board characteristics linked to both higher CEO pay and weaker performance of the company's common stock. These factors cause poor governance systems and ultimately lead to poor financial performance by the firm, according to the authors. The characteristics of boards that are danger signals for a company's common stock are the following:

    • Chairman and Chief Executive are the same person
    • Large board
    • Chief Executive himself appoints outside directors
    • Outside directors who have business dealings with company
    • Outside directors over the age of 70
    • "Busy" outside directors who serve on many other boards

7 Signs to tell whether a Company is cooking its Books: "Financial Shenanigans

We all know about one company or the other, which had manipulated its accounts to dupe investors. Instances of management manipulating the books of accounts are not bound by any geography, race, religion or culture. Be it USA (Enron, Worldcom), Europe (Paramalat), India (Satyam) or Japan (Toshiba), each market has its own share of ‘stalwarts’, who instead of genuinely improving the business, decided to cook the books to show better performance.

Now a days, most of the companies offer share price linked incentive schemes to their managers. Such schemes are offered to align the interests of managers and shareholders so that both can benefit by good performance of the company and its stock. However, these schemes have acted as double-edged swords

Share price linked incentives motivate managers to work hard and show good performance. Nevertheless, when times are tough and business is slump, they offer easy incentives to managers for dressing up the accounts to show a good picture to the markets to shore up the share price.

In the hindsight, the analysis of disclosures & exchange filings of such companies has always pointed to clues, which could have helped investors in identifying the red flags. However, the key is to identify such clues before the problems becomes large enough to affect the share price. These clues, if identified at right times, could have guided investors to exit before the nefarious acts of these companies became public and their prices fell like a pack of cards. 

Therefore, it becomes essential that all stock market investors, be it institutional or individual should learn the tools/signs that can indicate, when a company starts deviating from the standard practices and the possibility of an underlying fraud becomes a real possibility. The signs that can tell an investor, whenever something is not right with the presented accounts. An investor can then, analyse the company deeper and rule out whether the company is trying to falsify its books and if so, then can exit the company’s stock at the earliest opportunity.

Recently, I read the book: “Financial Shenanigans: How to Detect Accounting Gimmicks & Frauds in Financial Reports” by Howard M. Schilit and Jeremy Perler. This book provides a comprehensive account of the possible juggleries that managements can play to dress up their financial statements. It helps the readers identify the signs/tools that could have caught these juggleries at an early stage.

The book explains various methods deployed by companies in the past to manipulate their earnings, cash flows and balance sheet metrics. It then, takes the reader through the key parts of their disclosures, which could have directed a discerning reader to the gimmicks played by the management. Finally, the book explains to the reader with calculations, various ways to find out the correct earnings and cash flows from the inflated numbers presented by the companies.

Financial Shenanigans” provides an easy to read and simple to understand explanations of complex circuitous acts of managements to dress up their financials. 

The current article attempts to summarize the comprehensive effort of the authors, Howards Schilit & Jeremy Perler, and presents the gist to investors to sensitize them about the need to learn more about such shenanigans.

Most of the attempts to dress up the accounting books by management are focused on manipulation of earnings (revenue & profit), cash flows and balance sheet to present a better picture of deteriorating financial situation. 

Let us understand these attempts one by one:

A) Manipulation of Earnings: 

Most of the companies attempt to show higher revenue & profits during the current period to meet or exceed market expectations. Higher earnings in current period acts as a strong factor to raise the market price of company’s shares and increase the wealth of promoters/managers who stand to benefit from their stake/stock options in the company. 

However, there have been cases when companies have tried to mask the current good performance and tried to defer revenue/profits to a future period so that they can show sustained performance during upcoming tough times. 

Deferring current good earnings for future periods helps the company to show sustained performance during bad times, thereby, giving the impression of resilient business model to the markets. Stock markets usually assign higher multiples (P/E ratio) to such companies, which show stable performance with low volatility in earnings. Therefore, the management has sufficient incentive to act both ways.

Managements may use the following techniques to inflate their current period earnings:
  • Recording revenue too soon
  • Recording bogus revenue
  • Boosting income by using one time or unsustainable activities
  • Shifting current expenses to a later period
  • Using techniques to hide expenses or losses
Managements may use the following techniques to subdue their current period earnings in an attempt to inflate future period earnings:
  • Shifting current income to a later period
  • Shifting future expenses to an earlier period
All these steps could easily help the management achieve their objectives. However, there are certain checks and balances in place in the system, which often play the spoilsport for such managements:
  • the requirements of disclosures about revenue recognition and other accounting policies and
  • the presence of three financial statement: Balance Sheet, Profit & Loss and Cash Flow Statement, which talk to each other. If the management tinkers with one of these statements, then there is very high probability that investors would find signs of unhealthiness in other two statements.
We would look at the methods to detect earnings manipulation by management in the later part of this article.

B) Manipulation of Cash Flow: 

Most of the corporate frauds in 1990-2000s involved the companies showing super-normal growth in revenues & profits. However, upon analysis of cash flows, it could easily be deciphered that the earnings were not backed by cash flows. Therefore, all the investors started analyzing cash flow statements to see whether the profits are being converted into cash flow from operations to verify the genuineness of earnings. 

Cash flow from operations (CFO) became the key parameter to analyse companies. However, the ever-evolving managements realized this pattern and soon enough devised techniques to manipulate cash flow statements as well, so that they could hide ineligible/bogus revenue practices from investors.

These techniques mainly focused on either shifting investing/financing inflow to operating section or shifting operating outflow to investing section. The book “Financial Shenanigan” classifies such attempts under following headings:
  • Showing financing cash inflow as operating inflow
  • Showing operating cash outflow as investing outflow
  • Using acquisitions or disposals to boost operating cash flow
  • Boosting operating cash flow by using unsustainable activities
However, in these cases as well, the mandatory requirement of reconciliation of three financial statements helped the investors. Reconciliation requires that all the entries of cash inflow or outflow have to be in the cash flow statement and the management can only change their classification from one head to another. Therefore, if an investor uses certain adjustments in her analysis of cash flows then she can easily detect such shenanigans and improve her stock analysis to reflect the true economic reality.

C) Misrepresenting Balance Sheet items:

The book “Financial Shenanigans” describes many ways in which over jealous managements distort the balance sheet presentations to show a rosy picture to investors. Some of these methods are:

a. Distorting account receivables to hide revenue problems: 
 e.g. by selling them, showing them in other receivables than account receivables, changing definitions of DSO (days of sales outstanding or receivables days) etc.

b. Distorting inventory metrics to hide profitability problems: 
By classifying certain inventory as noncurrent saying that it will not be used within one year. Using only in-store inventory and excluding warehouse & transit inventory etc.

c. Distorting financial asset metrics to hide impairment problems: 
mainly applicable for financial institutions, which might use various tricks to hide the actual stress in their loan books.

D) Using non-standard parameters as representative of business performance: 

Many a times, managements create new parameters to describe their business performance. Such parameters are not the standard parameters of profitability or efficiency as described in accounting standards. However, many times, they help investors understand the status of companies of any particular industry in a better fashion. 

Such creative parameters are essential but due to non-standardization, the managements get an opportunity to change their definitions as per their requirements. Some of the examples covered in the book “Financial Shenanigans” are:

a. “Same store sales” for retailers, restaurants:
Managements may alter the vintage/criteria of the eligible stores to be used in calculation of disclosed metric. Companies have been known to show high level of reverse engineering skills to create such eligibility criteria to show desired trend in performance.

b. ARPU (average revenue per user) for telecom, broadband or cable TV companies: 
The key here is what constitutes the revenue and the number of users in ARPU. Management of one company may exclude advertisement revenue and report only subscription revenue whereas management of another company may include advertisement and other certain items as well. Similarly, different companies may use different criteria to select the number of users for calculating ARPU.

c. Subscriber addition for media houses:
Some companies may add up subscribers of unconsolidated entities/JVs as well, while others may not.

d. Order book for contractors:
Some companies may not disclose the details about orders, which might contain cancellation clauses/indemnity clauses and club all orders as if they might be firm sources of revenue in future.

e. Using EBITDA rather than PAT for disclosing business performance:
Some companies may act as if key expenses like depreciation, interest etc., are irrelevant for businesses and investors. For many companies, like rental cars, depreciation is the real cost of inventory & operations. Looking at EBITDA only for such companies is highly misleading.

f. Presenting cash earnings (PAT + Depreciation) or EBITDA instead of CFO to investors as better parameters:
Some managements may stress on cash earnings as if changes in working capital do not matter for businesses.

All the above described methods have been used by one company or the other in past to dress up its books in order to hide their deteriorating financial position from the markets & investors. The book “Financial Shenanigans” provides detail of each of these tools used by different managements with real life examples. 

Financial Shenanigans” delves deeper into regulatory & exchange filings done by these companies and digs out extracts from their disclosures, which if noticed by investors, could have alerted them about things not being right. Then, the investors could have analysed it further to reassess their investment positions.

Financial Shenanigans” also explains various tools and ratios, which if used by investors during analysis, would have helped them, identify the red flags. Some of these tools can be easily calculated from the publically available information and therefore, can be very helpful for all the readers. Let us discuss these tools, which I believe that every stock market investor should learn and use in her stock analysis framework:


1) Cumulative Cash From Operations (cCFO) falling short of cumulative Profit After Tax (cPAT) in the past:

As discussed above, if any company inflates its revenue by either accelerating its revenue recognition or recording false/bogus revenue, then there is high probability that such revenue would not be backed by collection of cash. In such cases, the cumulative CFO would fall behind cumulative PAT.

Therefore, investors should always compare cCFO and cPAT of any company over last 10 years and be wary when cCFO is significantly less than cPAT. Such companies would require enhanced due diligence before the investor commits her hard earned money to them.

(To know more about cCFO vs cPAT read: 5 Simple Steps to Analyze Operating Performance of Companies)
2) Increasing Receivables Days/Days of sales outstanding (DSO): 

Similar to the above point, inflated revenue recognition without backing of cash collections would lead to continuously increasing account receivables/trade receivables/debtors in the balance sheet. The increase in account receivables, if at a faster pace than increase in sales, would increase the Receivables Days/DSO.

(Read more about receivables days calculation and interpretation: 5 Simple Steps to Analyze Operating Performance of Companies)

Many a times, such receivables could be bogus receivables, which might not be realized ever. Therefore, the investor should be wary of investing in companies, which show continuously increasing receivables days.

Similar to the increase in account receivables, a continuous increase in unbilled receivables also reflects an aggressive revenue recognition policy. Investors should be very cautious while analyzing companies with large amount of unbilled receivables like infrastructure companies and EPC contractors.

Moreover, investors should also be concerned when they see a large drop in DSO/receivables days especially after a period of rapid increase in DSO. This is because, such drop in DSO might be due to the management using the tricks to either sell receivables off their books or classify them under any other head in balance sheet.

3) Fast buildup of inventory/decreasing inventory turnover:

Inventory buildup may indicate that the company might be carrying old inventory on its books, which might not be useful anymore. Management may hesitate before writing off such inventory, as it would have to book impairment losses, which would reduce earnings. 
However, such write offs if genuinely needed, then cannot be deferred indefinitely and companies end up recognizing major impairment losses all of a sudden. Such large losses affect the earnings in big way and no doubt that the share price tanks both due to losses and due to management quality concerns.

Therefore, an investor should do extra due diligence when she comes across companies, which have continuously decreasing inventory turnover over the years.

(Read more about inventory turnover calculation and interpretation: 5 Simple Steps to Analyze Operating Performance of Companies)

4) Free Cash Flow: 

Financial Shenanigans” mentions many cases where companies tried to inflate their earning and CFO by capitalizing normal day-to-day operating expenses. By using this trick, the companies derive dual benefits. They improve their profits as they do not deduct these expenses from revenue and at the same time inflate CFO as they show these expenses as cash outflow for investing section rather than in operating section.

Detecting such tricks can be quite challenging for an amateur investor who does not have deep understanding of accounting & finance as well as does not have sufficient spare time to spend in deeply analyzing financial statements. However, the investor can safeguard herself from these management tricks by using a simple method. This method is using the Free Cash Flow (FCF) rather than Cash From Operations (CFO) for her analysis.

FCF is arrived at by deducing capital expenditure (Capex) from CFO and thereby taking care of the operating expenses excluded from P&L and shown as cash outflow from investing section.

FCF = CFO – Capex

Therefore, it is advised that and investor should:
  • focus more on cash flow statement than P&L. 
  • Moreover, she should rely more on FCF than CFO, while analyzing cash flow statement.
The investor should be cautious when she observes declining free cash (FCF) while strong CFO in the cash flow statements.

5) Frequent Acquisitions: 

Acquisitions are a favorite area for over-smart managers to hide a lot of things under the carpet. Analysis of financials become a lot complex when two companies merge with each other and the management presents combined financial statements for the two companies. 

Apart from the book manipulations, acquisitions also provide many legal means (loopholes) for acquiring companies to beautify their books. Improvement in CFO is one such loophole. Let’s see how it works:

Account receivables of the acquired company, when received, flow through the CFO of acquirer, whereas the costs incurred to generate these receivables (inventory bought by the acquired company, salaries paid in past etc.), which ideally should flow through CFO as outflow, now flow through CFI as outflow as acquisition cost for the acquiring company. 

We can see that if any company that tries to grow organically, then it would have to do a lot of cash outflow from operations (inventory purchase, salaries etc.) to generate cash inflow from operations (CFO), whereas in acquisition, the acquiring company gets target’s future cash inflow from operations (outstanding account receivables at time of acquisition) but its related cash outflow (acquisition cost) is recorded as cash outflow from investing. 

Therefore, acquisitions provide a legal method of boosting CFO. No wonder once companies realize this, they become serial acquirers

Financial Shenanigans” provide a tool to counter this inflated CFO position. The authors advise that the investors should use:

CFO - Capex outflow - Cash paid for acquisitions

to mitigate this impact.

6) Abnormal/supernormal performance:

An investor should be cautious while she comes across companies that show deviation from normal trends like:
  • Unexpected stable/smooth earnings during tough volatile times
  • Continuous history of meeting market expectation of earnings
This is not to say that such companies would not have inherent business strength to show exceptional performance. However, there is high probability that management of such companies might be managing their accounts to show such performance. Therefore, it is advised that the investor should do enhanced due diligence while analyzing these companies.

7) Changes in accounting policies/disclosures:

Changes in accounting policies are one of the major methods used by managements to hide financial juggleries. Major policies to be monitored for changes by investors are:
  • Change in revenue recognition policies
  • Change in capitalization of expenses policies
  • Change in accounting years (April-March to July-June to Jan-Dec etc)
  • Change in depreciation assumptions
  • Change in pension, lease assumptions
An investor should always ask herself the question: Why the particular accounting change and why now?

Similarly, investors should focus on variations in disclosures:
  • Be wary when company stops disclosing an important metric.
  • Failing to highlight off balance sheet obligations/contingent liabilities like corporate guarantees given to bank for loans taken by other parties or a lawsuit or claim filed against the company.
  • New disclosures should provide more answers not give rise to many new questions. If reverse is true, then management is hiding something.

These are some of the tools described by “Financial Shenanigans” to help investors recognize accounting manipulations at initial stages and protect their hard earned money.

After reading the book “Financial Shenanigans”, the reader would realize that managements of many of the well-known names in the world have used accounting tricks at some point in time. They have mostly been caught by regulators, penalized, and directed to rectify their books. It indicates that no investor is shielded from accounting juggleries and she can ignore learning about at her own peril. 

The book describes numerous ways of accounting manipulation that have been used by firms and similarly many other ways/indicators, which can highlight the use of nefarious methods in financial statement. However, covering all of them is not possible within one article. However, the investor should be aware that ever evolving financial landscape would provide newer opportunities for over smart managements to use shortcuts to achieve their targets.

Therefore, it becomes essential that every investor should learn about the basic tools to highlight any accounting manipulation and use them regularly in her stock analysis so that she can avoid investments in fraud companies and save her hard earned wealth from erosion.

- See more at:

Wells Fargo Scandal 9th Sep 2016
Everyone hates paying bank fees. But imagine paying fees on a ghost account you didn't even sign up for.
That's exactly what happened to Wells Fargo customers nationwide.
On Thursday, federal regulators said Wells Fargo (WFC) employees secretly created millions of unauthorized bank and credit card accounts -- without their customers knowing it -- since 2011.

The phony accounts earned the bank unwarranted fees and allowed Wells Fargo employees to boost their sales figures and make more money.
"Wells Fargo employees secretly opened unauthorized accounts to hit sales targets and receive bonuses," Richard Cordray, director of the Consumer Financial Protection Bureau, said in a statement.
Wells Fargo confirmed to CNNMoney that it had fired 5,300 employees over the last few years related to the shady behavior. Employees went so far as to create phony PIN numbers and fake email addresses to enroll customers in online banking services, the CFPB said

Capital Market  Frauds

wells fargo scam

professional negligence 

Us law suit

Moody's to pay $864 mn fine to US authorities for pre-2008 crisis ratings

Moody's Corp has agreed to pay nearly $864 million to settle with federal and state authorities over its of risky mortgage securities in the run-up to the 2008 financial crisis, the Department of Justice said on Friday.
The agency reached the deal with the Justice Department, 21 states and the District of Columbia, resolving allegations that the firm contributed to the worst financial since the Great Depression, the department said in a statement.
"Moody's failed to adhere to its own credit-rating standards and fell short on its pledge of transparency in the run-up to the Great Recession," Principal Deputy Associate Attorney General Bill Baer said in the statement.
S&P Global's Standard & Poor's entered into a similar accord in 2015 paying out $1.375 billion. Standard and Poor's is the world's largest rating firm, followed by Moody's.
Moody's said it would pay a $437.5 million penalty to the Justice Department, and the remaining $426.3 million would be split among the states and Washington, D.C.
As part of its settlement, Moody's also agreed to measures designed to ensure the integrity of credit going forward, including keeping analytic employees out of commercial-related discussions.
The rating agency's chief executive also must certify compliance with the measures for at least five years.
Moody's said that it stands behind the integrity of its and noted that the settlement contains no finding of a violation of law or admission of liability.
Moody's said it already has implemented some of the compliance measures in the agreement.
Moody's shares closed at $96.96 on Friday. The stock plummeted more than 5 percent on Oct. 21, the day it disclosed the Justice Department had notified the firm it was planning to sue over the ratings.
Moody's settlement on Friday resolved the Justice Department probe without a federal lawsuit. In the Standard & Poor's case, the resolution was reached after the filed a $5 billion fraud suit.
Connecticut, whose attorney general helped lead negotiations, filed a against Moody's in 2010. Mississippi and South Carolina later sued, and other states had potential claims.
Connecticut's claimed that Moody's were influenced by its desire for fees, despite claims of independence and objectivity. It also accused Moody's of knowingly inflating on toxic mortgage securities.
Moody's were "directly influenced by the demands of the powerful investment banking clients who issued the securities and paid Moody's to rate them," Connecticut Attorney General George Jepsen said in a statement on Friday.

Sudden resignations by the auditors of a couple of companies have triggered a sharp drop in their share prices in recent times. Deloitte Haskins & Sells India quit as auditor of Manpasand Beverages a few days before the declaration of annual results. The stock plunged nearly 50 per cent in five sessions following the announcement. Shares of Atlanta tumbled 20 per cent on Friday after Price Waterhouse chartered accountants resigned as its auditors. Earlier, Vakrangee witnessed a similar development. An auditor is responsible for the reliability of company’s financial statements, as it is entrusted with carefully checking accuracy of business records. An unexpected resignation leaves shareholders as well as lenders in the lurch, as they wonder if there is anything amiss in its books of accounts. Why auditors quit? Auditors have become bold and do not shy away from putting in papers if they find something suspicious in the accounts of a company. Some recent regulatory developments have also made auditors more conscious.
An auditor normally takes an easy way out, if he finds that the company management would not like his opinion, Dinesh Kanabar, CEO, Dhruva Advisors, told ETNOW. He said there were issues earlier with the disciplinary powers of the Institute of Chartered Accountants and they have now been moved to an independent body, which looks at disciplinary cases. Therefore, there is a heightened fear among the auditors.
In a couple of cases, auditors have also been arrested and sent behind bars. No auditor would like to face that ignominy. Therefore, there is a heightened awareness within the profession about the audit role. “If something goes wrong in accounts of the company, there is an awareness that the regulators, be it CBI or SFIO or an institute, would pile on the auditors,” Kanabar said.
Top Red Flags spoke to various market experts to identify early signs that something may be not above board in a company. Arpinder Singh, Partner and Head - India and Emerging Markets, Fraud Investigation & Dispute Services, Ernst & Young, shared five pointers
Skewed business performance
 Organisations exhibiting unusual profitability in saturated markets or in comparison to peers can possibly have trouble brewing within. Another red flag could be organisations with significant changes in financial ratios from previous year to current.
Absence or low implementation of policies or frameworks Most organisations with global operations would need to comply with applicable Indian and foreign laws, which would require instituting policies or frameworks around whistle-blowing, code of conduct, code of ethics, anti-bribery or anti-corruption. Absence or low implementation of these policies can be a serious red flag, raising questions around corporate governance and ethical concerns.
 Unusual related party transactions
 Red flags can also be in the form of unusual related party transactions that would include inadequate disclosure of such transactions, fictitious or circuitous transactions.
Behavioural factors
 Perpetrators of fraud can show certain behavioural signs that may be red flags. These include an apparent change in lifestyle, financial or legal issues, frequent disagreements with the company (compensation/ job rotation) and unusually close association with key vendors or customers. Lack of tone at the top level as well as information or decision making generally restricted to few important individuals and lack of transparency in regular transactions can also be matters of concern. Value investors have a different way of looking for such aberrations. Generally, they try to look for such signs in the books of accounts.
 Frequent fundraising/equity dilution
Normally, one should avoid companies that keep on raising funds by diluting equity. Value investor Ekansh Mittal, who is a Research Analyst at Katalyst Wealth, said, “While it’s not a sureshot sign of trouble brewing in a company, it does tell us the fact that either the company is trying to be too aggressive or the business is not self-sufficient enough to generate funds for expansion. It also tells us that promoters themselves don’t value their equity much in the company and a lot of times such promoters have even siphoned out funds from the company.”
Too many acquisitions
 It’s well known that no matter how much the promoters talk about the synergies from the acquisition, most of the times the acquisitions turn out bad or the price paid turns out to be too high with a subsequent write-off. “An occasional acquisition of a company and that too of a manageable size (with respect to the acquiring company) is understandable; however frequent acquisitions are most definitely a red flag for us,” said Mittal.
Consistently increasing debt
 There have been several examples such as Bhushan Steel, Amtek Auto where the companies’ debt on balance sheets increased with every passing year. The common pattern that market experts have found is sales and profits of such companies grow every year just like their debt, and suddenly one year, they report huge losses and become bankrupt.
While debt is a lifeline for capital-intensive businesses, however, if the company is not taking a breather and consistently expanding by taking on huge debt then some day or the other it will find itself in trouble. Value investor Gaurav Sud, who is Managing Parner at Kanav Capital, said, “Many companies take debt to fund growth. While this strategy works well in good times, when the cycle turns, high debt levels cannot be served by cash flows, resulting in huge problems. While there is no golden rule, but any company where the debt-to-equity ratio is more than 1:1, one should study it carefully to see if it can sustain that debt in the case of a cyclical downturn (eg Jaiprakash Associates, Bhushan Steel, Reliance Communications).” One should also look at debt servicing ratio of a company, Amit Maheshwari, Partner, Ashok Maheshwary & Associates LLP said, “If the debt servicing coverage ratio is decreasing every year. It is being calculated by dividing EBIDTA with interest and loan repayment obligation in a year. If this ratio has come down to less than 1, it means that company has difficulties in repaying its debt and interest obligations. The possibility of converting the account into NPA is very high.”
 Formation of too many subsidiaries
 It has been observed that companies that form too many subsidiaries are generally up to something. “A lot of times, such subsidiaries are formed for the purpose of siphoning off funds. Basically, the modus operandi is that parent company offers loans to such subsidiaries, which then are unable to perform up to the mark or report losses and finally the loans and advances are written off. While there could be genuine cases as well, but a lot of times promoters take out money through such subsidiaries,” said Mittal of Katalyst Wealth.
High receivables
 When you see that the debtors of a company are growing at a rate faster than that of sales then there is a big red flag. Gaurav said, “This implies one of two things - either the company is trying to increase sales by giving more credit in the market or the company is unable to collect money in a timely manner. This could happen due to lack of negotiating power with customers or they have a hard time to give money. At times this reflects outright fraud (Ricoh India).”
No or low tax payment

Sud also highlighted another important issue. “Many a time, there are companies reporting good profits but paying no or very low tax. This can happen because of tax exemptions or because the company is operating in a jurisdiction where there is no tax (eg Dubai / Mauritius). While there could be genuine reasons for paying no taxes, sometimes a company may be showing profits because there is no cost for show increased profits. Satyam Computers is a great example, which showed non-existent profits as there was no tax it for IT companies.”


Mondelez FATCA


Analysis of Bank Frauds
Central Vigilance Commission

Gem & Jewellery Sector

The cases of frauds perpetrated by three companies in this sector have been analysed.  The companies  were  in  business  of  the  Diamonds  &  Jewellery.  The  companies  had  adopted  a business  model  by  which  they  imported  gold/gem  through  foreign  Banks/private  parties against SBLC/LC/ Cash Credit for value addition and production of Jewellery for export to its customers located aboard. The Companies availed credit facilities from the banks under consortium arrangement led by one of the banks.

Modus operandi:

      The  companies  deliberately  inflated  the  valuation  of  diamonds  with  the  malafide intention  to  avail  higher  credit  facilities  from  the  lenders  and  also  to  indicate  the security coverage available with the lenders.

      Export bills which remained unpaid on due date were purchased by the consortium Banks.  Simultaneously,  the  disruption  of  the  cash  flow  led  to  the  devolvement  of SBLCs and outstanding of cash credit remained unpaid.

      The group of the companies informed that as their receivable were not being realized in  time  due  to  financial  difficulties  of  the  foreign  buyers;  they  could  not  meet  the SBLC (Standby Letter of Credit) commitment on time.

      The details of receivable/debtors submitted by the companies to the bank in order to avail credit facilities appeared to be manipulated, false and fabricated.

      The companies acted cleverly to avail entire pre-shipment as Standby Letter of credit instead of packing credit loans, for which consortium succumbed to their innovative funding  ideas.  The  companies  also  resorted  to  availing  post-shipment  finance  by discounting  “Export  Bills”  from  one  of  the  member  banks,  while  pre-shipment finance was obtained from another member bank by way of SBLC, leading to double financing.


  Due diligence report on borrowers were not obtained before submitting the sanction/ renewal  proposal.  While  recommending  the  proposal  for  enhancement  in  limits, quantum  of  export  was  focused  to  get  the  limit  enhanced.  However  comforts  like LC/SBLC  were  not  insisted  to  ensure  timely  payments  of  exports  whereas  imports were on the basis of SBLC.

  The entire group of existing buyers companies was controlled by a single person. No credit assessment was done for these customers. There was no evidence for proof of delivery of the goods to customers. Later on, the investigating agency have raised the issue  regarding  proof  of  delivery  of  sales  of  gold  and  diamond  jeweller  to  foreign companies.

  In  the absence  of any effective  mechanism to  monitor the movement  of discounted Export  bill  proceeds  towards  liquidation  of  SBLCs  across  member  banks,  the companies manipulatively diverted and round tripped the funds to their related/ shell companies.

  Consortium Mechanism under the leadership of lead bank broadly failed to check and monitor  the  transactions.  The  exchange  of  information  was  more  a  ceremonial formality rather than to sift the data. The lead bank did not share the areas of concern. They did not take  note of warning signals mentioned in the business rating reports. The  lead bank did not exchange  the information in meetings to alert  other member banks at early stages.

  It is evident that Bullion Trade and Merchant Trading were not genuine transactions carried out in the ordinary course of the business. The losses were deliberately booked through  related  party  transactions  to  siphon  off/  divert  the  funds  availed  from  the consortium thus committing default in making payment/ repayment thereof. The high value transactions were made without the specific approval of the consortium.

Systemic Improvement:
   There should be control of financers on movement of stocks. Genuineness of buyers should  have  been  verified  to  ascertain  whether  buyer  is  capable  of  such  a  huge buying.

       Banks  should  have  exercised  due  diligence  on  the  buyers  and  have  executed  a tripartite agreement with the buyers & exporters to remit proceeds to bank account of the companies in India. Confidential Report (CR) on all foreign buyers should have been obtained/ analyzed.

   Gem  &  Jewellery  Sector  credit  facilities  to  these  companies  increased  manifold within  a  short  span  of  time  in  an  effort  by  the  banks  to  increase  their  credit dispensation.  There  should  have  been  some  segment  related  limits  on  such  type  of credit exposures.

   There were frequent attempts by fraudsters to fabricate documents and avail finance from   banks.   Heightened   awareness   of   loopholes,   consequences   of   bypassing procedural aspects and  check  points for evaluating genuineness of  various essential documents was very much necessary. These points should be the learning lesson for future.

   It should be ensured that appropriate accountability is fixed in the chain of command including  sanctioning  authority  in  the  event  of  such  frauds  instead  of  fixing  entire responsibility on lower functionaries.

   Investigation should be done to find out the trail of diversion so as to find as to where the money has gone whether any money has been remitted /parked aboard.

   Bank     must     immediately     delist     such     third     party     valuers,     Chartered Accountants/Chartered    Engineers,    Advocates    etc.     who    have    questionable credentials/have been negligent in their professional duties or have caused financial loss to the bank by their willful acts of omission/commission/dishonesty. A periodical review of all empanelled professionals should to be ensured by banks for weeding out undesirable third party service providers.

   In  such  cases  of  frauds  the  concerned  banks  should  get  forensic  audit  done  and concerted efforts should be made by banks to get back the money lost.

   Jewellery sector units may also be asked to furnish a monthly declaration to its lender Banks declaring details of all transactions /financial agreement/ contract entered into by its subsidiaries with their business associates.

Analysis of Bank Frauds
Central Vigilance Commission

Manufacturing Sector

The  cases  of  frauds  perpetrated  by  five  companies  in  this  sector  have  been  analysed.  The companies   were   in   business   of   manufacturing   in   Pharmacy,   Textile,   Ferrous   metals, pharmaceuticals products  and  various ranges of steel products.  The Companies had started availing credit facilities in form of working capital (Fund based & Non fund based) from the banks under consortium arrangement led by one of the banks.

Modus operandi:

      One  of  the  Companies  had  exported  the  goods  against  the  shipping  bills  and  had discounted export bills on different dates. Since the bills were long outstanding, the lead  bank  requested  Commissioner  of  Customs  Duty  to  verify  the  genuineness  of these bills.

       As per Commissioner’s report, out of all  shipping bills,  only a small number were genuine, a few shipping bills pertained  to  ICD, Ludhiana  and  rest  of  shipping bills were not genuine, and were forged.

      The  other  Company  made  purchases  to  the  tune  of  Rs.6740  crore.  Out  of  this, Rs.1679.45 crore was for purchase of fancy shirting.

      On review of purchase invoices and stock records of this item indicated that purchase invoice did not define any code, grade, make etc. It was unable to confirm physical movement of fancy shirting material.

      Mismatches were found in products mentioned in LC invoice documents and products mentioned as per books of the company.

      In case of  another company, the turnover was inflated. There was no actual purchase or movement of stocks as depicted by the borrower company in its books of accounts and financial statements.

      There had been misappropriation of funds by the management of the company. They explored all possible avenues to divert the funds. There was mis-match of accounting data vis-à-vis the banking statements and the non-reporting of the same in the audited financials by the auditors of company.
      The  payment  made  to  the  beneficiaries  of  LCs  was  diverted  to  the  accounts  of  the debtors of the company from where it was finally routed either to the account of the borrower company or to its subsidiaries.
      Another company had  been  importing pharmaceutical products and chemicals from overseas suppliers based at Singapore and were exporting its products to Hong Kong and Singapore having a branch office at Dubai. The exporting company owned by the same proprietor as the supplier company.

    The company was dealing in computers, computer peripherals and other commodities.
There   were   consignment   transactions   of   computers   and   computer   peripherals, whereby the company was sending computers and computer peripherals to its branch office at Dubai by way of Branch transfers.

      The  export  and  import  documents  submitted  to  bank  by  company in  respect  of  the Merchanting Trade transactions purported to be relating to pharmaceutical and allied products appeared to have been falsified.

      The other Company finalized its Balance sheet for the year 2011-12 and got it audited on 30.04.2012 showing profit of Rs.23.74 crores. On the basis of the Balance Sheet, the company got credit facilities from consortium banks. Subsequently, the company revised  its  audited  B/s  for  2011-12  on  05.09.2012  without  informing  any  of  the member Banks. The profit in the revised balance sheet was reduced to Rs.0.34 crore.

      The Company was maintaining current accounts with the Banks, which were not part of  consortium.  The  credit  turnover  in  these  accounts  was  Rs.176.96  crore.  The Company  had  incurred  loss  of  Rs.241.83  crore  during  2012-13  as  against  profit  of Rs.0.34 crore during 2011-12 against  same volume of turnover of Rs.2178 crore in both years.

      The  Company  routed  sales  proceeds  through  account  with  non  consortium  Banks without prior permission of consortium. The Company had not submitted Book Debt statements certified by CA.

      The Companies had defrauded the banking system by unscrupulous activity such as manipulation of books of accounts, removal, depletion & disposing of hypothecated stocks without the bank’s knowledge.


  The Company had submitted forged Bills of Entries/Postal documents to banks and huge amounts of foreign exchange were remitted to various overseas accounts.

  The  status  of  Bill  of  Entry  in  the  ICEGATE  system  under  option  “Bill  of  entry  at ICES” was not checked and “Out of Charge” (OOC) date in the concerned column of OCC was not verified with the print out of exchange control copy of the Bill of Entry submitted by the importer as proof of import.

  The  company  had  generated  entire  set  of  documents  for  exporting  the  goods,  but cancelled  later  on.  Directorate  of  Revenue  Intelligence  had  submitted  details  of  13 shipping Bills.

  It was also found that 35 shipping bills were issued by CFS (container freight station)
and rests of shipping bills were not genuine but were forged.

  Apart from Bank accounts with consortium members, transactions were carried out in other Bank accounts of company. The nature and purpose of these transactions could not be ascertained.

  Incorrect  and  non  existing  debtors  were  included  in  the  debtors’  statement  of  the company.   The   company   resorted   to   circular   transactions   to   report   higher sales/purchases figures, Mismatch were noticed in the stocks/debtors as per the books of the company and as per the stock statement submitted by the company.

  In  circular  transactions,  the  parties  were  related  to  each  other  either  by  way  of common  directorship  in  other  companies  in  individual  capacity  or  through  family members.

  The majority of the transactions reflected in their respective Bank’s statements were in  nature  of  the  same  day  fund  transfers  to  connected  parties.  The  majority  of  LC payments  used  for  circular  rotation  of  money  had  been  made  against  purchase  of Fancy Shirting which was trading product of the company.

  Most  of  the  debtors  were  not  available.  The  debt  confirmation  letters  sent  by  the consortium  leader  by  Regd.  post  were  returned  undelivered  in  most  of  the  cases. Confirmations were received only from 22 debtors, but they denied the dues reported by the borrower company to the consortium lenders.

  Perusal of the statement of bank accounts of beneficiaries of the LCs revealed that the payments  received  were  re-routed  through  various  accounts  and  channelized  back either  to  the  account  of  the  borrower  company  or  one  of  its  subsidiary/  associate concern.

  Out  of  the  12  transport  operators,  two  were  fictitious  and  enquiries  in  the  vicinity revealed  that  no  such  transport  operators  ever  existed  at  these  addresses.  The  two available  transport  companies  informed  that  the  lorry  receipts  attached  with  the invoices were fake which were not issued by them.

  To find out the authenticity of the data of the debtors, the audit company selected 10 top  buyers  of  the  borrower  company  and  found  that  all  the  10  parties  were  not traceable at the given addresses.

  The  company/  firms  to  whom  payments  were  made  by  banks  were  dealing  with products not related to the business of the borrower company.

  The Company had made sale/purchase transactions of the same products with same companies/related   companies.   There   was  no  evidence   of  any  processing  value addition to the products.
  The Company had sold goods to a firm on merchant export basis which was dealing in information and technology, telecommunications, office automation and electrical appliances.  The  company  had  made  purchases  from  a  firm  which  was  engaged  in manufacturing  and  distribution  of computer components,  consumer electronics,  and digital electronics.

  Three  associates/subsidiaries  were  shown  in  the  balance  sheet  of  the  company.
However,  these  companies  virtually  existed  on  papers  without  any  functional  or business activities.

  The bills of lading were wrongly generated by non-existent forwarders. Their Dubai office  responded  that  they  could  not  trace  the  details  of  bills  of  lading.  Four companies were involved in fake merchant trade transactions with the company.

  A  complaint   lodged  by  the  bank  with  CBI  has  revealed  that  the  directors  of  the company in collusion with each other fabricated the records and faked non-existent transactions as genuine transactions and indulged in fabrication of purchases and sales of    the    same    products    from    firms    which    were    actually    dealing    in    IT, telecommunication, electric and electronic products.

  The stock audit was conducted on 20.05.2013 and 21.05.2013. It was observed that Drawing Power comes to Rs.20.64 crore against total sanctioned limit of Rs.465.00 crore  whereas  the  company  submitted  stock  statement  showing  D.P.  of  Rs.467.59 crore in Feb 2013. The company did not submit stock statement after Feb2013.

  The Company had reduced the holding of sundry debtors at the end of March 2013 in the  age  group  of 90  days  from  Rs.  525.76  crore to  Rs.216.04 crore.  The Company could not produce documentary evidence for such reduction.

  From  the  stock  statement,  it  was  observed  that  holding  had  substantially  increased from  Rs.58.74 crore  as on 31.03.2012  to Rs.1216.17 crore  as on  31.03.2013  which represented increase by 114.78% in comparison to previous year.

  No records were maintained for stores & consumables which constituted Rs.47 crore during  2012-13  indicating  lack  of  internal  control  system.  Due  to  lack  of  detailed information the auditors had not commented in respect of end use of funds.

  The  Company  had  not  complied  with  bank’s  instruction  to  submit  Book  Debt statement certified by CA along with VAT returns for the financial year 2011-12 and
2012-13 which implied that Book Debt statement submitted to Bank were inflated.

Systemic Improvement:
   Due  diligence  of  major debtors should  be  carried  out by direct  visit,  direct balance confirmation, engaging agencies and comparing the realization of receivables as per stock/BD  statements  with  routing  of  funds  through  lending  banks  to  ascertain diversion  through non lending banks.

   Meaningful analysis of stock statements should be carried out. Confirmation should be  obtained  from  debtors  at  periodic  intervals.  Regular  monitoring  of the  operative account should be ensured.

   The past track record of the borrower or the length of his satisfactory association with the Bank should be one of the considerations. The status of the customer should be more critically analyzed while renewing the existing facilities.

   The field level functionaries  should be advised to scrutinize the financial statements submitted by the borrowers thoroughly and where ever it is observed that the short term funds are used for long term purposes and vice versa they should be advised to ascertain from the borrower the reasons and purpose of there and record the same in appraisal notes.

   Investigation should be done to find out the trail of diversion of fund so as to where the money has been done and whether any money has been remitted /parked aboard.

   The irregularities arising out of credit transactions should be meticulously looked into to  satisfy  whether  these  were  on  account  of  genuine  trade/business  transactions, market  conditions,  general  state  of  industry  and  economy  or  overflow  of  corporate fraudulent transactions, which were being attempted to or were being concealed.

   Field functionaries should be advised to ensure end use of funds. They should follow the  proper  due  diligence  and  not  to  rely  entirely  on  documents/papers  produced, before them. Documents and disbursement should be cross verified.

Analysis of Bank Frauds

Central Vigilance Commission
Agro Sector:

The cases of frauds perpetrated by three companies in this sector have been analysed.  The companies were in business of processing of basmati Rice, manufacturing of sandal wood oil and  producing  of  castor  oil.  The  Companies  had  started  availing  credit  facilities  from  the banks under consortium arrangement led by one of the banks.

Modus operandi:

      One  of  the  companies  resorted  to  diversion  of  funds  through  group/  associate concerns, inflated level of debtors for availing higher limits/DP, higher cost of capital expenditure.

      Capital   expenditure   advances   were   given   to   3   vendors   without   any   purchase transactions  and  the  same  was  used  for  investment  in  acquiring  shares  of  another company. All these vendors were holding shares of that company.

      The debtors’ levels more than doubled during the last two years while sales turnover had  come  down.  It  was  also  observed  that  the  sale  had  been  made  to  debtors throughout the year without any amount having been realized from them during the year.

      The  Company  had  capitalized  the  warehouse  building,  the  cost  of  construction  of which was shown on a higher side compared to similar type of buildings that were constructed  at  much  lower  cost.  Thus  the  Company  inflated  the  cost  of  capital expenditure.

      Another Company obtained drawing powers in the account from consortium against the book debts outstanding in their books majority of which were found to be non- existent and were based on fake invoices/debtors. In this way, the Company diverted working capital funds.

      The Company did not route proportionate sales with the member Banks. The matter was  taken  up  with  the  company  repeatedly,  but  the  turnover  in  the  accounts maintained with member Banks did not improve.

      The  company  had  shown  debtors  which  were  non-  existent.  The  company  got  the enhanced facilities sanctioned on the  basis of fake  inventories of debtors and funds were siphoned through personal accounts of Directors.

      Packing credit advance had been taken from member Banks, but the company failed to execute export business.

      Another Company initiated an alternate procurement model whereby pre-harvest farm loans were extended to farmers through Village Level Aggregators (VLA) supported by Post Dated Cheque (PDC) as collateral security.

      With  the  introduction  of  pre-harvest  financing,  its  traditional  practices  and  controls failed  resulting  in  embezzlement  of  funds.  Fake  inventories  were  created  through collusion of employees and associates involved in procurement.

      The company suppressed the facts regarding depletion of stocks and did not inform the misappropriation of stocks by their employees to the consortium. It was reported that their employees had embezzled the stocks.

      The   management   of   the   company   had   misrepresented   the   performance   of   the company to the consortium lenders at various occasions.

Loopholes / Lapses :

  Proportionate sales transactions were not routed through working capital limits with consortium  member  banks.  Round-tripping  of  funds  was  resorted  between  various working capital limits with member banks.

  The percentage of working capital loan vis-a vis Sales turnover of the Company was on higher side sometime, even crossing 100%. This ratio was not commensurate with its peers in the industry.

  There was no system of preparing sales order. In majority of the cases, the companies did not maintain the supporting documents except for invoices.

  The Companies resorted to round-tripping of funds between various working capital limits with member Banks for diverting the funds raised from various Banks.

  Purchase was mainly confined to two suppliers and sales to three buyers only. The units of buyers were found inoperative.

  Commodities  were  not  exported  in  the  case  of  export  finance  availed  from  the consortium  member  Banks.  Working  capital  fund  was  diverted  to  another  entity controlled  by  a  company  and  various  other  accounts  including  current  accounts  of promoters of the company.

  The  funds  were  diverted  on  a  large  scale  which  establishes  the  fact  that  fraudulent activities were undertaken.

  Alternate  procurement  model  was  initiated  by  which  pre-harvest  farm  loans  were extended  to  farmers  through  Village  Level  Aggregators  (VLA)  supported  by  Post Dated Cheque (PDC) as collateral security.

  Fake inventories were created through collusion of employees and associates involved in  procurement. With the  introduction of pre-harvest  financing,  traditional practices and controls failed resulting in embezzlement of funds.

  Facts  regarding  depletion  of  stocks  were  suppressed  and  were  not  intimated  to consortium. The management of the companies had misrepresented their performance to the consortium lenders at various occasions.

Systemic Improvement:

   Assessment of working capital limit should be done as per Bank guidelines/procedure.
While  assessing  working  capital  limit,  the  scale  of  operations  as  reflected  in  VAT returns, stock records and sales register etc should be examined properly. This process should also be followed at the time of further enhancing the limit.

   Any  enhancement  by  the  member  Bank  should  be  first  discussed  in  consortium meeting to maintain maximum permissible Bank finance and to ascertain the position of advance taken from other members of consortium.

   A  proper  scrutiny  with  respect  to  the  number  of  debtors  and  the  amount  due  from each  debtor  be  done  with  reference  to  the  records  maintained  by  the  firm  and  the debtors.

   There  are  frequent  attempts  by  fraudsters  to  fabricate  documents  and  avail  finance from   Banks.   Creating   awareness   about   loopholes,   consequences   of   bypassing procedural aspects and  check-points for evaluating genuineness of  various essential documents become necessary.

   Investigation should be done to find out the trail of diversion so as to find as to where the money has gone and whether any money has been remitted /parked aboard.

   Immediately  after  filing  the  case  with  CBI,  all  the  accounts  of  the  promoters  be confiscated   and   bank   should   take   adequate   measures   like   appointment   of administrator /receiver to take stock of all the accounts.

   CBI files the charge sheet in the trail court for criminal action without investigating the trail of money on account of fraud. Therefore, CBI should also investigate the trail of money so that action could be taken for recovery of money lost.

   Bank must immediately delist such third valuers, Chartered Accountants/ Chartered engineers, Advocates etc. who have questionable credentials/ have been negligent in their professional duties or have caused financial loss to the bank by their willful acts of   omission/   commission/dishonesty.   A   periodical   review   of   all   empanelled professionals  should  be  ensured  by  banks  for  weeding  out  undesirable  third  party service providers.

   The Banks should pay the required attention to the area of internal control system and the  fraud  prevention measures  to  ensure  compliance  of  instructions  issued  by them from  time  to  time.  The  controlling  offices  should  play  their  role  of  overseeing  the functioning of branches effectively.

   The irregularities arising out of credit transactions should be meticulously looked into to satisfy whether these are on account of genuine trade/business transactions, market conditions, general state of industry and economy or overflow of corporate fraudulent transactions, which are being attempted to or are being concealed.

   Field functionaries should be advised to ensure end use of funds. They should follow proper  due  diligence  and  not  to  rely  entirely on  documents/papers  produced  before them. Documents and disbursement should be cross verified.

   It may be ensured that proportionate accountability is fixed in the chain of command including   sanctioning   authority   in   the   event   of   fraud   instead   of   fixing   entire responsibly on lower functionaries.
Analysis of Bank Frauds
Central Vigilance Commission

Media Sector:

The  cases  of  frauds  perpetrated  by  two  companies  in  this  sector  have  been  analysed.  The companies were in business of broadcasting on television channels, printing and publishing news paper and periodicals. Their projects were financed by banks under  consortium led by one of the banks and the company also availed other credit facilities from various banks.

Modus operandi:

      The  funds  disbursed were  got  transferred from no  lien account  to  various suppliers and  group  accounts  by way  of  DDs  or  RTGS.  The  funds  credited  in  suppliers  a/cs were  transferred  to  other  companies  where  promoters  were  Directors  or  authorized signatories.

      Funds were diverted through suppliers’ accounts which were the associates/connected accounts of the borrowing companies. Further, there was huge  difference in cost of equipments as per investigation report and the invoices submitted by the party.

      The  Companies  had  submitted  inflated  and  fabricated  invoices  which  amounted  to misrepresentation of facts to the Banks for securing higher limits and misutilisation of the same.

      One  of  the  Companies  had  submitted  a  certificate  from  CA  regarding  infusion  of capital.  The  Chartered  Accountant  had  in  writing  denied  having  issued  the  said certificate. Hence, the company had submitted fabricated certificate to avail loans.

      Fraud  element  had  been  apprehended  due  to  the  fact  that  one  of  the  suppliers  was non-existent and in case of 3 major suppliers, the promoters had managerial interest by virtue of being on board of the supplier companies at different times.

      Funds were thus siphoned off and re-routed into the accounts of the promoters and their group companies which were further misused.

      One of the Companies raised loans from various Bank/ FIs through its two balance sheet  periods  by  concealing  the  information/  details  of  its  borrowers/  names  of  the lenders.

      The  balance  sheet  figures  were  fudged/  fabricated  with  particular  reference  to  the outside  borrowings  from  Banks/  FIs.  The  company  did  not  give  the  details  of  the lender wise exposure in the schedules of the audited balance sheets.

      The Company effectively prevented the lenders from insisting on NOC/ Confidential opinion from other lenders which otherwise would have revealed the true picture of total borrowings of the company.

      The funds were diverted to their accounts with other banks and were not utilized for the purpose for which these were given and the company misrepresented the facts and cheated the bank.

      The  Company produced  end  use certificate  issued by an  auditor other than  the  one who  audited  company’s  balance  sheet.  The  company  concealed  the  information  on existence of prior charge on one of the machineries offered as collateral security to the bank.

  Public  money  availed  from  banks  in  the  form  of  loans,  had  been  diverted  through shell companies. The loans were granted at the highest level by most of the banks.

  Bank financed one of the companies overseas and end use was not ensured. Instead, the  funds  were  remitted  to  various  other  companies  not  connected  with  the  related activities of the company.

  Banks,  which  were  not  members  of  consortium  had  allowed  the  company  to  open account and transferred the money to siphon it off.

  No  appraisal  and  due  diligence  was  exercised  by  member  Banks  independently  as they depended entirely on the lead bank for this purpose.

  Operations  in  cash  credit  account  were  neither  monitored  nor  scrutinized/analysed properly. No enquiry was made to ascertain sources of funds brought by the company to build-up/ increase in tangible net worth.

  There were also a large number of credits in the accounts from group companies. The terms   of   sanction   clearly   stipulated   that   funds   should   not   be   diverted   to sister/group/associates concerns.

  There was lack of competence & skills to appraise technical aspects of a project for finance from banks & invariably banks accepted whatever was stated by the borrower.

  There was no mechanism to verify & counter check the antecedents of suppliers of equipments regarding their capacity, life of equipments, maintenance etc.

  The objective of forming different companies for similar activities was not enquired.
No action was taken by the banks to ensure segregation of securities.

  The other Company did not publish its audited balance sheet for the relevant period.
The  company  made  the  lenders  to  forcibly  fall  back  on  the  immediately  previous audited balance sheet for appraising the loan proposals.

  The Company had committed the purported fraud with the connivance of Chartered Accountant  of  the  agency  responsible  for  due  diligence.  The  balance  sheet  of  the company does not reveal true picture of the financial position of the company.

  The Company had also got the valuation of the securities manipulated by reporting inflated value in connivance with the valuers.

Systemic Improvement:

   The  main  company  had  formed  further  companies  which  were  engaged  in  similar business   of   post   production   activities   and   were   actually   working   in   close clusters/premises.   Banks   should   scrutinize   the   objective   of   forming   different companies for similar activities.

   At the time of carrying out the review, the past track record of the borrower or the length   of   his   satisfactory   association   with   the   bank   should   be   one   of   the considerations. The status of the borrower should be more critically analysed.

   The field functionaries should find out the kite flying operations from the nature of transactions and their respective character.

   The field level functionaries  should be advised to scrutinize the financial statements submitted by the borrowers thoroughly and where ever it is observed that the short term funds are used for long term purposes and vice versa, they should be advised to ascertain from the borrower the reasons and purpose of the same and record the same in appraisal notes.

   Due diligence of suppliers of machinery equipment should be done by the branches even when it is not specified in the sanction letter. In some cases no efforts were made by the branch to enquire whether the supplier is a manufacture or a trader.

   Branches  should  read  and  study  the  Audited  balance  Sheet  of  the  borrower  as expected.   Adverse   observations   by   the   auditors   should   be   read   and   critical observations be discussed in the credit appraisal.

   Field functionaries should be advised to ensure end use of funds. They should follow the proper due diligence and not to rely entirely on documents/papers produced before them. Documents and disbursement should be cross verified.

   The Banks should pay the required attention to the area of internal control system and the  fraud  prevention measures  to  ensure  compliance  of  instructions  issued  by them from  time  to  time.  The  controlling  offices  should  play  their  role  of  overseeing  the functioning of branches effectively.

   Any enhancement by a member Bank should be first discussed in consortium meeting to  maintain  maximum  permissible  bank  finance  and  to  ascertain  the  position  of advance taken from other members of consortium.

   Immediately  after  filing  the  case  with  CBI,  all  the  accounts  of  the  promoters  be confiscated and bank should take adequate  major like appointment  of administrator
/receiver to take stock of all the accounts.

   The  Bank  should  adopt  coordinated  approach  in  expeditiously  taking  the  issues  in hand instead of adopting compartmentalized approach.

   CBI files the charge sheet in the trail court for criminal action without investigating the trail of money on account of fraud. Therefore, CBI should also investigate the trail of money so that action could be taken for recovery of money loss.

Analysis of Bank Frauds
Central Vigilance Commission

Aviation Sector:

The case of frauds perpetrated by a company in this sector has been analysed. The company commenced  its  commercial  operations  in  this  sector  in  May  2005.  The  company  was  a leading Airlines company of India with a market share of 21% in domestic operations. The company was promoted by another group which had presence in several countries.

The company was one of the domestic companies offering service on international routes and operated in both segment of the market, i.e.  low-cost segment and full serve segment. The company availed credit facilities from the banks under consortium arrangement led by one of the bank.

Modus operandi:
      The Company cheated the bank by suppressing facts in the financial statements and diverting  the  funds  to  related  entities  for  the  purpose  other  than  those  for  which finance was made.

      The Company ran its operations mostly on leased aircraft for which an overseas entity (vendor) was created which in turn had created fictitious invoices with inflated bills. The  money  was  transferred  to  it  through  legal  means.  Whatever  the  money  the company owed to the leasing company would be disbursed and rest parked with the entity.

      The  entire  transaction  carried  out  was legal  as  it  was  done  through  proper  banking channels.  The  vendor  had  submitted  invoices and  created  intermediaries which  had nothing  to  do  with  the  leasing  of  aircraft.  Therefore,  funds  received  by  the  vendor were illegal.

       The Company willfully cheated the banks with an intention to siphon off funds. The money apparently was diverted to several shell companies in seven countries.

       The  Company’s  promoter  willfully  and  malafide  intension  did  not  pay  the  dues covered  by  his  personal  and  corporate  guarantees.  Despite  restraining  orders  from High  Court,  the  promoter  entered  into  an  arrangement  with  overseas  company  to receive a big amount for stepping down from his office and position as Director and Chairman of group.

Loopholes/Lapses :
  The  lapses  with  respect  to  loans  extended  to  the  defunct  airline  which  was  under scanner.  The  company’s  balance  sheet  was  never  strong  and  its  credit  rating  was lower than what was required for sanctioning loans.

  All   Banks   under   consortium   financed   the   company   on   the   basis   of   brand capitalization. Valuation got done through a private company which was much higher than what was valued by other valuers.

  There was alleged conflict of interest of at least three independent Directors on the board  of  the  airline.  SFIO  had  alleged  that  certain  private  companies  and  three independent  board  Directors  of  company  had  a  commercial  relation-ship  with  the airlines.

Systemic Improvement:

   Advances/credit facilities were sanctioned to the company on the basis of Brand name which does not form any tangible security for the purpose of recovery. The practice should be discontinued in future.

   The  Company  submitted  brand  evaluation  done  by  private  entities.  Banks  blindly accepted the higher one. Bank considered report of only one valuers for the valuation of brand and based on that loans were given to the carrier. Regulations issued by RBI require  that  at  least  two  different  valuation  reports  should  be  considered  before deciding  credit  facility  on  the  basis  of  brand  in  case  the  brand  name  is  to  be considered as security.

   The past track record of the borrower or the length of his satisfactory association with the bank should be one of the considerations. The status of the customer should be more critically analyzed while renewing the existing facilities.

   Managing fraud risk in large value advances need a comprehensive approach. There has  to  be  changes in  mindsets,  fine  tuning of  work processes  and  human  resources skills. There has to be better information sharing among banks. There has to be more effective fraud management systems. There has to be better support from enforcement agencies and there has to be legislative.

   Multiple  banking arrangements  in  large  value  financing have  done more harm  than good to banks. This type of arrangement enabled corporate to secure multiple finances from  various  banks  far  in  excess  of  their  requirements.  Funds  raised  were  easily diverted through company’s accounts with various banks in the absence of effective exchange of information between the banks.

   Banks  do  not  have  a  fool-proof  system  of  checking  and  confirming  whether  the company  has  actually  working  on  the  contracts  and  whether  the  contracts  were genuinely business based.

   The Government should consider examining the role of third parties such as Chartered Accountants, Advocates, Auditors and rating agencies that figure in accounts related to bank frauds and put in place strict punitive measures for future deterrence.

Analysis of Bank Frauds

Central Vigilance Commission

Service/Project Sector

The cases of frauds perpetrated by three companies in this sector have been analysed.  The companies   were   in   business   of   providing   corporate   logistic   services,   Industrial   and engineering  projects,  plants  &  machineries,  equipments  etc  under  lease  agreement.  The Companies  were  enjoying  working  capital/  term  loans  from  the  banks  under  consortium arrangement led by one of the banks.

Modus operandi:

      One  of  the  companies  induced  the  bank  to  sanction  and  disburse  loans  for  2804 vehicle to the company and its’ employees/drivers on the basis of false assurances and tampered/forged vehicle registration documents.

      In  respect  of  the  loans  availed  by  giving  false  assurance  of  getting  the  vehicles transferred to the drivers/ employees by clearing past dues of the existing lenders, the Directors of the company deliberately and with intent to cheat, willfully neglected to transfer  the  ownership  to  the  said  drivers/employees  as  a  result  of  which  amount disbursed by bank towards finance of vehicles became overdue.

      The loans availed for purchase of new trucks was willfully diverted by the accused Directors and the trucks were never purchased. The funds for transfer of old vehicles to the drivers were also diverted for other purposes. In most of the instances, even the registration  documents  were  not  submitted  to  the  bank  whereas  in  several  other instances old vehicles were passed off as new.

      Another  Company got  issued  performance  cum  mobilization  advance  guarantees in favour  of  aggregators.  The  mobilization  advance  should  have  been  utilized  for execution   of   contracts   against   which   the   advances   had   been   remitted   by   the beneficiary.

      A  part  of  the  funds  was  utilized  for  giving  margin/charges  to  the  banks  instead  of providing such margin by the promoters from their equity. The Company also partly remitted  the  fund  back  to  the  mobilization  advance  received  from  the  Aggregator which was not comprehensible and was highly questionable.

      The Banks sanctioned enhancement in bank guarantee limits for more than 10 years based  on  such  information  as  provided  by  the  Company.  The  guarantees  were eventually invoked. Defaulted guarantees account was debited and after adjusting the cash  margins  available  with  Banks  amount  was  paid  to  overseas  Banks.  It  was dishonesty  on  the  part  of  the  Company  to  avail the  facility  by misrepresenting and concealment of facts.

      Another company did not have loan policy approved by board as envisaged for Non- Banking Financial Companies (NBFC). The company had not fixed prudential

       limits  as  part  of  Assets  Liability  Management  (ALM)  for  individual  gaps  and cumulative mismatches as envisaged by RBI.

      Thereafter, the company was reclassified from Deposit taking NBFC to Non-deposit taking NBFC. After an inspection of the company’s accounts for a particular period, RBI  directed  that  until  further  orders,  the  company  would  not  sell,  transfer,  create charge or mortgage or deal in any matter with its property and assets without prior permission from RBI.

     As per report of the forensic auditors, the fraud was perpetrated by camouflaging the
Balance Sheet in collusion with Statutory/Internal Auditors to avoid detection.

      It  was  identified  that  the  methodology  followed  by  the  company  was  for  window dressing. It was found that the company had inflated income and assets by creating falsified entries.

      The  financial  accounting  and  loan  assets  data  of  the  company  were  maintained  in Oracle data-base. This software being a proprietary one, lacked security controls.  The company’s  top  management,   senior  executives  and   employees  manipulated   the records by using this software.


  The  signatures  of  applicants/  borrowers  were  not  obtained  in  person.  Bank  handed over  the  documents  to  the  officials  of  the  company  for  getting  them  executed. Therefore, there was no base document with the specimen signature of the borrower which  could  be  relied  upon  to  conclude  that  the  documents  were  signed  by  the respective borrowers only.

  The  company  transferred  only  227  vehicles  in  the  name  of  drivers  as  against  1652 vehicles financed by the bank for the purchase of second hand vehicles. The company had failed to transfer the vehicles although it had received sale consideration from the bank and thus it had defrauded the bank in respect of second hand trucks.

  Bank had sanctioned the loans for purchase of new vehicles to drivers of the company but  the  vehicles  were  not  transferred  /registered  in  the  name  of  drivers.  Thus  the company had defrauded the Bank in respect of new trucks.

  There was inter-relationship between the buyer, vehicle dealer and body building unit.
The  Proforma  invoices  issued  for  body  building  /trailer  were  inflated.  There  was diversion of funds/ round tripping of funds.

  Business model  of  the  company  including  the  existence  of  Master  Agreement  with Aggregators/ Agreement between the company and its vendors, were not disclosed to bank/consortium.   Thus,   it   concealed   the   existence   of   the   said   agreement   and misrepresented its lenders with  regard to it business model.  It  was  found  that there were a number of clauses which were exclusively in favour of the Aggregators which were not informed to the bank.

  The  Company  did  not  utilize  the  funds  for  the  purpose  i.e.  for  execution  of  the contracts. 30-35% of the funds were utilized for giving margin/charges to the banks from  the  mobilization  advance  as  against  the  normal  practice  of  providing  such margin by the promoters from their equity.

  The  Company  had  not  provided  the  bankers  any  evidence  of  having  utilized  the mobilization advance for execution of the contracts for which these guarantees were issued  which  in  normal  case  should  have  been  remitted  to  its  vendors  for  the execution of the specific contracts.

  The Company had not utilized the mobilization advances received under BGs/SBLCs for execution of the projects for which BG/SBLCs had been issued. Further, reports of various consultants appointed by the Consortium indicated lapses on the part of the company with regard to compliance of FEMA regulations, ROC regulations etc.

  It  was  also  revealed  that  the  overseas  beneficiaries  had  discounted  the  BG/SBLCs with  banks  in  Europe  and  remitted  the  funds  back  to  the  company  as  mobilization advance. However, the company had not utilized the funds for execution of projects; but instead diverted the same and utilized as margin for the guarantees issued on their behalf.

  The  Company  had  submitted  end  use  verification  certificate  issued  by  Chartered Accountants stating that the loan had been utilized by the company for its working capital requirement and general corporate purpose which was not correct.

  The facts of the case reveal that the fraud occurred due to dishonesty on the part of company  who  got  the  limit  sanctioned  by  misrepresenting  &  concealment  of  facts coupled with lapses in pre-sanction appraisal and post sanction follow up.

  The  stocks  on  hire  under  hire  purchase  agreement  were  calculated  as  per  the agreement  value  less  the  installments  received  from  the  corporate  and  net  of  un- matured financial charges.

  The Company availed finance from the banks against the value of stock on hire under hire purchase agreement. The company had financed other companies in the form of corporate loans and was refinancing hire purchase loans for purchasing of old assets.

  The promoter of the company and statutory auditors of the company engineered the fraud  in  a  systematic  way  against  the  bank  by  flouting  the  relevant  provisions  of Companies Act, incorrect filing of returns under service Tax, VAT and income Tax.

  Various lease transactions were pre closed, but the assets were not written off and the same were continuing in the books of account of the company. Part of the amounts received through pre closure was directly booked as income and part amount was kept in debtor suspense account. The lease rentals as per the original tenure were continued and income was recognized.

  The   Company  formed  satellite  companies  with  employees  of  the  company  as directors.    The  satellite  companies  were  formed  mainly  to  acquire  share  of  the company and to transfer the NPA of the company to these satellite companies.

  The  satellite  companies  were  granted  loans  by  the  company  through  bogus  loan agreement  for  acquiring  NPA  accounts  of  the  company.  With  this  NPA  provisions were reduced and profit of the company boosted.

Systemic Improvement:

   Genuineness of  quotations  should be  verified through  visits  and  direct  contact  with dealers.  In  case  of  vehicle  loans  visit  to  the  dealer  must  be  performed  to  check genuineness  of  dealership.  The  credentials,  genuineness,  capability  to  supply  of vehicle  and  line  of  trade  of  the  dealers  should  be  verified  through  documents  and personal visits before sanction of loan.

   Bank may issue supply orders in consultation with dealer on the basis of quotations or contract  agreement  between  supplier  and  borrower  duly  considered  by  Bank  in  the proposal /sanction instead of direct payment to the supplier before supply. This will ensure generation of bills/invoices and facilitate delivery of goods in proper custody before payment.

   Field functionaries should be advised to ensure end use of funds. They should follow the proper due diligence and not to rely entirely on documents/papers produced before them. Documents and disbursement should be cross verified.

   The contractual obligations between the parties need to be verified from the point of view of onerous clauses by legal advisor. Banks should take extra care when advance payments under BGs are received and ensure end use as being done in the fund based limits.

   While considering/sanctioning such limits in future, it may be stipulated that amount received as mobilization advance be credited to an Escrow account and its end use be monitored.

   There  are  frequent  attempts  by  fraudsters  to  fabricate  documents  and  avail  finance from   banks.   Heightened   awareness   of   loopholes,   consequences   of   bypassing procedural aspects and  check-points for evaluating genuineness of  various essential documents become necessary.

   The  Banks  should  clearly  outline  requirement  of  field  visits  by  the  controllers  and also stock inspection of large borrowal accounts above a cut-off point by an external agency. This would be in addition to the regular inspection/filed visits by the line staff and  the  controller.  Observations  of  the  visiting  officers/stock/  credit  Auditors  must necessarily find place in every review/enhancement proposal of the borrower.

   The Banks should pay the required attention to internal control and fraud prevention measures in addition to instructions issued by them from time to time. The controlling offices should play their role of overseeing the functioning of branches effectively.

   The loan asset management should require to be prudentially monitored with a view to ensure that no potential fraud in the garb of temporary irregularity, liquidity crunch etc  is allowed  to  go  undetected for  an  unduly  long period.  The  appraisal,  sanction, monitoring,  review  and  renewal  of  borrowal  accounts  should  be  objective  and discretion free.

   The irregularities arising out of credit transactions should be meticulously looked into to satisfy whether these are on account of genuine trade/business transactions, market conditions, general state of industry and economy or overflow of corporate fraudulent transactions, which are being attempted to or are being concealed.

   The system of credit audit should ensure that all the credit decisions beyond a cut-off point would be scrutinized to ensure that the norms of appraisal, review and renewal have been duly complied.


Analysis of Bank Frauds
Central Vigilance Commission
Discounting of Cheques & other issues:

The  case  of fraud  perpetrated  by  a  Chartered  Accountant  &  others  in  this  sector  has  been analysed.   A  firm  was  empanelled  for  conducting  concurrent  audit  of  the  bank  branch.  A qualified CA who was a sleeping partner in the firm had gone through the nitty-gritty of the CBS system while conducting audit of the branch. The CA had created several fake and false documents  pertaining  to  his  clients.  Misusing  this  information,  CA  committed  a  mind boggling fraud against the bank.

Modus operandi:

      The CA accessed the Pan and Voter ID cards, business details, financial statements and IT returns etc pertaining to his client who was required for opening of accounts and availing of bank loans.

      The  CA  had  created  several  fake  and  false  documents  for  his  own  manufacturing factory at a location. He had forged signatures in various documents.

      The officials of the Banks at branches in the different cities and also at controlling office  of  bank  colluded  with  a  group  of  customers  and  defrauded  the  bank  by purchasing/  discounting  fake/fraudulent  cheques,  discounting  of  fake  inland  bills, arranging overdraft/loan limits against non- existent LIC policies and also arranging housing Loan /Loan against property without proper title/security or through dummy borrowers. The CA was the main person behind all the fraudulent transactions.

      The fraudulent transactions had been taking place since 2011.These transactions were nullified with proceeds of new fraudulent transactions to avoid deduction.

      There  was  inter-link  between  transactions  in  three  branches  with  many  customers having accounts at all the three branches. The fraudulent transactions were carried out mainly  through  the  discounting  of  cheques,  discounting  of  fake  bills  and  overdraft against LIC policies.

      The  surrender  values  of  the  policies  were  unusually  high,  often  not  found  in  such numbers. Verification of policies with LIC of India revealed that these policies were issued in the name of different LIC offices, for different terms and sum assured.

      There  were  number  of  accounts  involving  a  huge  amount  under  the  Housing  loan category which had either a commonality of the name and/or had some linkage to the audit trail of the fraudulent transactions. In most of the cases security/ assets were not created.

  The accounts were opened without complying with KYC guidelines. The customers would not come to the branch for opening the accounts. No personal interaction took

place.  Their credentials were  never cross  verified  with  the  original/through  net  and there  was  no  practice  of  independent  verification  of  addresses  provided  in  the application.

  The  accounts  were  opened  with  an  intention  to  allow  discounting  of  cheques  on  a continuous basis to selected parties which were related to each other either by blood or bondage or through financial considerations.

  No standard operating procedures ; may it be purchase/discounting of cheques/bills, sanctioning  of  loans/overdrafts  against     LIC  policies  and  /or  sanctioning  loan/ overdrafts for acquiring house/commercial properties were  followed.

  The system in the bank did not furnish any alert when the account was opened with the same officially valid documents of a person already having account with the bank. As  a  result,  accounts  of  the  borrowers  were  opened  at  three  branches  to  facilitate fraudulent transactions.

  The  concurrent  auditors  failed  to  take  note  of  such  fake  transactions.  The  Internal Inspectors also failed to detect and comment about unabated purchase and discounting business,  KYC  norms,  non  compliance  of  systems  and  processes  and  the  bogus/ fictitious documents produced by the branch officials while compiling the reports.

  The officials of the controlling office of the bank ignored the alerts communicated by off-site monitoring cell (OMC), HO, and communicated their full satisfaction about the genuineness of the transactions.

  The  Regional  Office  of the  bank  failed  to  take  notice  of  the  way  the  business  was being  conducted  in  these  branches.  The  branches  discounted  cheques  beyond  their delegated powers on several occasions without obtaining permission/ approval from the Regional Office of the bank.

  All  the  discounted  cheques  were  serially  numbered  and  all  were  for  round  figures which were the characteristics for accommodation purpose. The wrong practice which was going on in the branches of bank was well within the knowledge of officials of the bank.

Systemic Improvement :

   Bank should set up centralized processing centers for opening of accounts. This will be  an  additional  tier  for  online  cross  verification  of  KYC  documents  like  PAN, Aadhar  etc.  These  measures  would  minimize  the  incidence  of  fraudulent  KYC documents. Bank should also introduce alerts in the system while opening the account on  the  basis  of  same  KYC  (i.e.  Pan  Card,  Aadhar  etc.)  document  in  different branches.

   Bank should set up centralized loan processing hubs which will help in streamlining the selection of borrowers with enhanced due diligence, assessment of proposal etc, thus delinking the sanction process from the business owner i.e. branch heads.

   The monitoring system should be strengthened to detect the frauds. Offsite monitoring by the offsite monitoring cell at Head Office and respective Regional Offices should also be strengthened.

   Spurt in advances should be periodically monitored and such identified branches shall be subjected to detailed verification of loan portfolio. Retired officers for assisting in the internal audit of the Bank should be empanelled.

  Integrity, honesty and administrative skills be yard stick for selecting Branch Heads, Regional  Heads,  Zonal  Heads  and  inspection  and  monitoring  officials.  Training system  should  be  reviewed  and  issues  pertaining  to  vigilance  should  be  made mandatory in the training system. It will help understand the participative, preventive and detective methodology, particularly for those who have newly joined the bank.

   Inspection  system  should  not  be  for  name  sake  and  it  should  be  manned  by knowledgeable and experienced persons to prevent, detect and report malpractices in the  bank  to  the  top  management.  Selection  of  Concurrent  Auditors  &  Statutory Auditors should be appointed in consultation of Institute of Chartered Accountants of India (ICAI). Advocates and Architects (valuers) should be appointed in consultation with respective associations.

   LIC policies should be checked through online to verify the surrender value. Advance against LIC policies be entertain through CIBIL. Secrecy of password be maintained at all levels.

Analysis of Bank Frauds

Central Vigilance Commission
Trading Sector

The cases of frauds perpetrated by three companies in this sector have been analysed.  The companies were in business of trading in coal, pulses and agro commodities, and aluminum foil rolls. The companies had adopted a business model by which they imported goods from foreign banks/private parties against SBLC/LC/ Cash Credit for trading in domestic market. The Companies availed credit facilities from the banks under consortium arrangement led by one of the banks.

Modus operandi:

      The company had diverted a substantial amount of fund to related parties/ associate concerns.  The  creditors  had  not  been  deducted  for  the  purpose  of  calculation  of drawing  power.  The  scrutiny  of  purchases  and  sales  of  the  company  revealed  that there were many cases where the same party was the customer as well as the supplier.

    The Company violated accounting principles and misutilised funds for other purposes.
Funds were utilized towards purchase of real estate in the name of the director and his relatives.

      The other Company submitted the documents with the bills drawn under the letters of credit  issued/opened  on  behalf  of  the  borrowers  which  were  fabricated  and  the underlying transactions were not real merchant trade transactions. The letter of credit mechanism/ RTGS facility for kite flying transactions involving unconnected parties were grossly misused by the borrowers.

      When  the  bills  drawn  under  the  letters  of  Credit  (LC),  opened  on  behalf  of  the company, started devolving, the bills were met by creating overdrafts in the accounts as fund was not provided by the company.

      In  case  of  another  company,  the  credit  facilities  were  given  by  the  banks  to  the borrower for the purpose of manufacturing and exporting of aluminum foil containers, its lids and covers. However, the company instead of utilizing the funds for which the credit were granted, utilized the same for granting loans for the other entities without any security or documents and that too in the sectors which were not even remotely related to the core business activity of the company.

      The Company resorted to falsification of the account by manipulating the position of LCs/ Buyers credit outstanding in the monthly stock statement thereby overstating the drawing power in the cash credit account.

      The  company’s  debts  increased  substantially  during  a  particular  period.  The  funds were  utilized  for investments  mainly  by  way  of  loans  and  advances,  the  returns  of which were not immediately forthcoming.

      During  Investigation,  some  unusual  transactions  were  observed  in  the  account  of another company.  Funds were  diverted  to finance  various sister concerns/associates dealing in various areas of business ranging from real estate development to gambling business (breeding price bulls and race horses).


  The   Company  dealt  with  many  related   parties  including  subsidiaries/associates including their key management. The gross amount receivable from the related parties was much higher while amount payable was much less.

  The  bills  which  remained  unrealized  from  the  associate  concerns  reflected  funds which  had  already  gone  out  of  working  capital  cycle  for long since  in  many  cases there were cross transactions of sales and purchases from the same party i.e the same party was the buyer as well as the supplier on different occasions.

  The  Company  had  not  made  transactions  in  accordance  with  RBI  guidelines  on merchant trade. In the case of LC opened, it was noticed that major transactions had taken  place  in  a  bank  with  2  parties  with  same  address  where  they  had  acted  as customers as well as suppliers.

  The Company had routed transactions from banks outside the consortium to keep the business going as devolvement had taken place in majority of banks. The 60% sale of the company had such cases where records of delivery/ movement of goods had not been maintained.

  The   promoters   in  connivance   with   their  Chartered  Accountants  had   submitted doctored  financial  papers  for  getting  finance  from  different  banks.  The  Chartered Accountants  wrongly  certified  the  balance  sheets  for  three  years  from  2007-08  to
2009-10 overstating the profits /understating the losses.

  The bills drawn under LCs opened by the bank were suspected to be accommodation bills for the purpose of raising finance.  The method adopted by the company revealed that  the  underlying transactions  were  not  real  merchant  trade  transactions and  were only kite flying transactions.

  During investigation, it was observed that there were major diversion of funds from the borrower company’s cash credit account to personal SB and CD accounts of the promoter directors and other unrelated accounts.

  The company was consistently showing inflated sales, stock holding levels and trade debtors. Book debts statement was given with assumed and artificial figures. Names of debtors were not mentioned by the company.

  Out of loans & advances sanctioned, a substantial amount of loan was free of interest by  the  company  extended  to  various  entities.  Loans  were  extended  in  accounts, wherein no movement of receipt or payment was observed during a particular period.

  The Company had advanced loans various companies engaged in trading of bullion.
Out of these advances, a large amount had been adjusted against expenses not directly attributable to company’s business.

  On  review  of  stock  statement  submitted  to  the  lead  bank,  it  was  observed  that  the scrap  was  included  as  stock  in  monthly  statements.  Hence,  stock  statements  were inflated.

  As  per  the  monthly  stock  &  statement  submitted  to  the  Bank,  it  was observed  that creditors  had  substantially  decreased  as  compared  to  creditors  as  reported  in  the previous month.

Systemic Improvement:

   End use of fund disbursed should be monitored and due diligence procedures should be applied to identify instances of utilization of funds for purposes not related to the business of the client.

   Even in the cases where the funds were disbursed for the purpose of working capital, its end use should be verified so as to avoid diversion of funds. Confirmation may be obtained from the customer on the utilization of funds.

   Periodic  balance  confirmation  from  top  five  suppliers/  buyers  (creditors/  debtors) should be obtained/ ensured in stock audits and should be analyzed as a part of stock statement.

   Banks  should  have  a  fool-proof  system  of  checking  and  confirming  whether  the company is actually working on the contracts and whether the contracts are genuinely business based.

   Corporate governance in banks in the present form is a matter of concern and has to be strengthened. Housekeeping and internal control of banks have to be strengthened.

   Multiple banking arrangements in large value financing have done more harm than good  to  banks.  This  type  of  arrangement  enabled  corporate  to  secure  multiple finances  from  various  banks  far  in  excess  of  their  requirements.  Funds  raised  are easily  diverted  through  company’s  accounts  with  various  banks  in  the  absence  of effective exchange of information between the banks. There is a need to review the multiple banking arrangements.

   Realization of receivables and payment to creditors are required to be monitored. In case transactions routed through the accounts with consortium members do not tally with corresponding movement reflected in the stock statements, Concurrent Auditors
to monitor the transactions need to be appointed by the member banks.

   The debtors’ position of the borrowers should be closely monitored. It should be a part of the Stock Audit and Inspection and audit report. Controller should critically go  into  on  the  quality  of  business  booked  by  branches  and  sudden  spurt,  if  any, observed in business growth should be thoroughly investigated.

   Operating  officials  are  being  equipped  with  inputs  on  Forensic  Audit  areas  and  to understand the complex business models especially transactions through Associates concerns/ wholly owned joint ventures.

   Bank  must  immediately  delist  such  as  third  party  valuers,  Chartered  Accountants/ Chartered  engineers,  Advocates  etc.  who  have  questionable  credentials  have  been negligent  in  their  professional  duties  or  have  caused  financial  loss  to  the  bank  by their  willful  acts  of  omission/commission/dishonesty.  A  periodical  review  of  all empanelled professionals should to be ensured by banks for weeding out undesirable third party service providers.


Analysis of Bank Frauds
Central Vigilance Commission

Information Technology (IT) Sector

The cases of frauds perpetrated by three companies in this sector have been analysed.  The companies were engaged in assembling of computer peripherals, system integration/solution, data center activity,  software  solution &  consultancy,  integration  &  other hardware  related products  and  networking.  The  Companies  availed  credit  facilities  from  the  banks  under consortium arrangement led by one of the banks.

Modus operandi:

      One of the companies did not take off the project of two organizations as planned for various reasons including the company not agreeing to certain terms and condition of both the projects.

      Earnest   Money Deposit (EMD) in the form of a  Bank Guarantee issued by a bank in favour  of  one  organisation  was  invoked  on  account  of  non-  agreement  on  certain terms  and  conditions  of  Letter  of  Intent  by  the  company.  The  project  of  the  other organization  was  also  cancelled  in  June  2013,  as  the  other  bank  did  not  issue performance Guarantee of Rs.69 crore.

      After  the  disappearance  of  CMD  of  the  company,  it  emerged  that  the  employees’ salaries had not been paid. Thereafter, the business operations of the company came to standstill.

      As per Annual Balance Sheet of the company as on 31.03.2013, stock and book-debts were shown at Rs.204.75 crore and Rs.587.97 crore respectively. The account became NPA on 29.05.2013 with bank. After 01.04.2014, there was negligible turnover in the accounts with banks. As per audit report, stock as on date was Rs.30 to 35 crore and book-debtors  were  Rs.7  to  15  crore.  Sudden  decline  in  value  of  stock/book  debt without corresponding credits in the accounts aroused suspicion.

      It  appeared  that  the  company  had  fudged  the  figures  in  the  balance  sheet  and  had represented  wrong/inflated  financials  to  avail  credit  facilities  from  all  members  of banks  in  the  consortium.  Further,  the  debtors  did  not  acknowledge  the  debts  when banks wrote to them.

    Another company availed credit facilities to implement   ISP services in three states.
The  promoter  of  the  company  obtained  loan  from  the  banks  by  making  false  and misleading disclosure with an intention to cheat the banks.

      The Company did not create assets out of bank’s fund and diverted funds through fake companies floated for the purpose. The company had created 3 fly by night operator companies  in  a  state  as  vendors  for  raising  fake  bills  who  never  supplied  any software/ hardware.

      Where about of these India based suppliers were not known. RTGS were sent to the accounts  of  these  companies  with  private  Banks  on  disbursement  of  term  loan. Thereafter,  money  from  these  accounts  was  transferred  to  company’s  accounts  of interested parties maintained with these Banks.

      SEBI in its order, based on the preliminary investigation into the matter of violation of SEBI Act, observed that the company had diverted the loan funds for playing in stock  market  through  entities.  These  entities  played  with  the  scrip  of  the  company presumably to jack up its price.

      Another  Company  had  submitted  debtor’s  statement  as  on  29.06.2013  for  availing Drawing power. Accordingly 34 major debtors were selected and job of verification of debtors was distributed among the member banks of the consortium.

      Three member banks informed that the list of debtors provided by the company was false having no outstanding in the books of debtors.

      Drawing Power (DP) calculation could not be justified as the basis for calculation of DP  was  not  provided  such  as  valuation  of  work  in  progress,  debtors  position  etc. Moreover,  the  damaged  goods  and  or  obsolete  goods  were  included  in  the  stock statement.

      The  Company  had  submitted  a  statement  of  fake  receivable  to  the  consortium  for availing DP. Loans from other financial institutions were availed without permission of consortium.

      One  of  the  member  banks  had  disbursed  limits on  the  basis  of  the  allocation  letter purportedly issued by the lead bank which had denied having issued such allocation letter. It was revealed that the company had produced forged letter and got the limit disbursed.

  It  appeared  that  CMD  of  the  company,  in  connivance  with  other  directors,  had provided false book debts/ stock statements and had inflated the profit & loss account.

  There  was  transfer  of  funds  including  siphoning  off  funds,  diversion  of term  loans disbursed by the banks for creation of Data Centre Racks by the company. There was an involvement of group companies in misappropriation of funds.

  Finance was made on the basis of stock statement. The company did not co-operate for conducting stock audit. The auditors expressed their inability to carry out audit.

  Majority of receivable were non-existing. Information from debtors of the company was sought. The replies of debtors pointed to suppression of facts and falsification of financial statements.

  The   Company   created   hypothecation   over   stock,   book-debts/receivable   through hypothecation  agreement.  However,  it  conspired  against  the  banks and  siphoned  of funds by disposing of hypothecated goods.

  Loans  availed  from  two  banks  were  not  reflected  in  the  financial  statement  as  on
31.12.2012. Similarly, loan availed from L & T finance was not reflected in the books of  account  in  spite  of  creating  charge  in  its  favour.  The  liabilities  with  four  other banks were shown as other current liabilities which were apparently borrowings.

  Verification  of  invoices revealed raising  of multiple  invoices.  With  reference  to all contracts entered into with customers, though the work was supposedly executed in India or controlled from India and the invoices were raised from India, there was no direct remittance through Indian Banking channel from the customers.

  The funds  released  under Packing Credit were seen directly transferred  to  the bank accounts of the company in USA and utilized for US operations, which was a clear indication of diversion of funds. Book debts were hypothecated to the bank as floating charge and no registered power of attorney was there so the bank could not realize the dues directly from the debtors.

  The stock position was not satisfactory/encouraging in view of outstanding level of debt  and fast  obsolescence  of  computer  items.  All  the  debtors  were  more  than  180 days and chances of recovery were bleak.

  The Company had not furnished clarification regarding non-confirmation of debts by some  of  the  debtors.  This  indicates  the  fraudulent  intention  of  the  company  &  its promoters. The Company did not route sales proceeds through accounts of any bank in the consortium.

  The  investigation  revealed  that  the  borrowers/promoters had  indulged  in fraud  with another financial institution which was being investigated by EOW, Delhi police.

  Risk Based Internal Auditor revealed certain irregularities such as CA certified age wise statement of book debt, credit report of overseas parties were not obtained.

  Monitoring of the time schedule of supply as per the order was not done by lead bank which   resulted   in   non-   realization   of   debtors   and   liquidity   crunch.   During investigation, it was revealed that the lead bank had failed in discharging its duty as the DP communicated to the members was not properly calculated.

Systemic Improvement:

   Adequacy  of  credit  monitoring  measures.  It  must  be  ensured  that  all  the  required safeguards  in  disbursement  of  loan  and  ensuring  intended  end  use  of  funds  are  in place.

   Advising the operating offices that all term loans details of major suppliers/vendors should be finalized at the time of sanction of term loan and disbursements made to the specified parties directly.

   In consortium banking arrangement, any new bank entering into the consortium must take credit opinion report at least from the lead bank if not from all the existing banks and must take written consent from the lead bank before release of funds.


   The  business  model,  especially  in  an  IT  company  needs  to  be  understood  in  its entirety.  Highly  technical/complex  projects  need  to  be  subjected  to  independent verification by subject expert, invariably.

   Meaningful  analysis  of  stock  statements  to  be  carried  out.  Confirmation  to  be obtained from debtors at periodical intervals. D & B Report/Opinion Report on major debtors  to  be  obtained.  Also  regular  monitoring  of  the  operative  account  to  be ensured. Scrutiny of large withdrawal/transfer to be made.

   The debtors position of the borrowers to be closely monitored. It has been made a part of the stock audit and Inspection & Audit Reports.

   A member bank under consortium released the limits based on the allegedly forged letters purportedly issued by Leader Bank. The lead bank must send intimation to the other     members     about     the     drawing     limits     released     by     it     and     seek confirmation/acknowledgement of the same.

   Bank   must   immediately   delist   such   third   party   valuers,   Advocates/   Chartered Accountants/  Chartered engineers  etc.  who  have  questionable  credentials/have  been negligent in their professional duties or have caused financial loss to the bank by their willful acts of omission/commission/dishonesty. A fair transparent procedure needs to be devised in appointing such professionals.

   The Government should consider examining the role of third parties such as Chartered Accountants, Advocates, Auditors and rating agencies that figure in accounts related to bank frauds and put in place strict punitive measures such as cancellation of the registration by respective regulatory authorities for future deterrence.

   There should be no deviation from Bank’s extent operating instructions in handling discounting of bills  drawn  under LCs.  Suitable briefing to  stock auditors and using stocks & receivable audit as an effective tool for control and supervision of advances.


Analysis of Bank Frauds
Central Vigilance Commission
Export Business Sector

The  cases  of  frauds  perpetrated  by  four  companies  in  this  sector  have  been analysed.  The companies were engaged in exporting cotton bales, cotton & synthetic yarn, agro/engineering goods  and  readymade  garments  to  China,  Dubai,  Singapore  and  other  countries.  The Companies availed credit facilities from the banks under consortium arrangement led by one of the banks.

Modus operandi:

      Bank was discounting the export bills of the company against LCs from prime banks of  the  buyer.  The  payment/acceptance  of  bills  was  delayed.  On  the  request  of  the company bank had extended the due date of bills.

      As  per  information  gathered  from  Custom  authorities,  export  had  not  taken  place against most of the bills. Goods produced for exports against packing credit (PC) were also  not  available.  It  appeared  that  either  goods  were  not  produced  against  PC  or disposed off locally and funds were siphoned off.

      The Customs authorities had informed that exports did not take place in 200 cases out of the pending 203 bills, as these consignments did not relate to any exports.

      Another   company   availed   multiple   loans  from   different  banks/   institutions  for acquisition of the same set of equipments from the same suppliers at almost similar estimated cost.

      Completion of projects was confirmed to respective banks/institutions by submitting false/  fabricated  certificates  from  Chartered  Accountants  and  false  status  reports. Term loans were not accounted for in the year of their receipt/payment.

      The cash inflows and out flows were dealt with outside the books of accounts and not reflected in the audited balance sheets of the company during respective years.

      One other company had given the same export orders to various banks in consortium and availed packing credit facility. The company did not submit the export documents to the same bank from whom the packing credit was availed.

      The Company submitted contract documents to member bank for availing the credit facilities. The company had obtained export packing credit disbursement from another bank against the same contract document.

      The list of book debtors submitted by the party showed that most of the debtors were foreign buyers. In the backdrop of payment received from third parties and the bills


getting returned, earlier the company had stated that the goods were sold to alternate buyers   as   the   original   buyers   were   renegotiating   the   price   after   dispatch   of consignments.

      In  respect  of  the  creditors  for  suppliers,  full  details  of  such  suppliers  were  not available.  The  investigating  officer  stated  that  the  creditors  for  the  supply  were fabricated in order to artificially boost the purchase, sale and receivable.

      The borrower companies cheated the bank by submitting fake and forged export bills for purchase/discount which were drawn in nonexistent overseas buyers.

  The bank had discounted the bills against the terms of the sanction without ensuring acceptance of bills and confirmation of due date for payment from LC issuing bank. The  bank  did  not  obtain  GR  form  of  shipping  bills  verified/issued  by  custom authorities.

  There  were  several  apparent  major  discrepancies  in  set  of  bills  submitted  for discounting which should have aroused suspicion about genuineness of bills. Due date of bills extended at the request of the company without ensuring acceptance of bills, analyzing reasons for non acceptance of bills and delay in acceptance of bills.

  The  Chartered  Accountants  including  Statutory  Auditors  tended  to  collude  and conspired  to  be  a  party  in  submitting  false,  fabricated  and  misleading  financial statements and certificate to the institutions/banks with the only intention of obtaining disbursement of the financial assistance.

  The company had managed affair of the company based on false and fabricated books of accounts to ensure easy and smooth flow of credit without any restraint by way of term loan from financial institutions for funding cash losses.

  The proceeds of packing credits & FBPs credited to the account were withdrawn on the same day in clearing suggesting improper end use and diversion of loan proceeds.

  The export transaction undertaken by the company was suspect considering the fact that within a span of less than 3 months the utilization of the limit was to the brim under PC and negotiation of bills under LC.

  Realization proceeds of export bills credited to current account of the company which was   subsequently   withdrawn   by   the   company   when   bank   packing   credit   was outstanding.

  Credit report of all associates/ sister concerns was not obtained from their banker as per terms of sanction. Periodical inspection for packing credit disbursement to ensure end use was not carried out.

Systemic Improvement:
   Monitoring of systems and MIS generation has to be strengthened. Housekeeping and internal control of banks also have to be strengthened.

   There are lacunae in bank’s credit and risk management policies. Proper mechanism to  be  devised  for  review  of  the  policies  of  the  bank  and  to  keep  it  updated  as  per change of environments.

   Multiple  banking arrangements  in  large  value  financing have  done more harm  than good to banks. This type of arrangement enabled corporate to secure multiple finances from  various  banks  far  in  excess  of  their  requirements.  Funds  raised  are  easily diverted through company’s accounts with various banks in the absence of effective exchange of information between the banks. There is a need to review the multiple banking arrangements.

   There should be no over confidence on the borrowers based on their stature. Bank’s top  management  should  take  considered  decision  on  the  merits  of  the  proposal irrespective of the reputation of the company.

   Fraud monitoring in financial services should be a specialized area and a specialized cadre may be created to monitor and investigate such cases. The skill gaps in banks should be addressed through proper training.

   Management of fraud risk in large value advances need a comprehensive approach. It requires being changes in mindsets, fine tuning of work progress and human resources skills. Banks need to have a system of real time information sharing among them. To deal the fraud effectively, there has to be better support from enforcement agencies coupled with strong legislative.


Analysis of Bank Frauds
Central Vigilance Commission

Fixed Deposit Fraud

The miscreant pretended to the  Govt Organizations/Corporates as representative of a Bank and  to  the  Bank  as  financial  advisor  of  these  Organizations/  Corporates,  brought  bulk deposits to the branch of different Banks. He kept the original TDRs issued by the branches with them and submitted fake copies to the depositors.

Thereafter  the  miscreant  opened  loan/overdraft  accounts  in  the  name  of  depositors  by submitting fabricated documents along with original TDRs to the branch.  They had siphoned off the money through RTGS in his various associate accounts with different banks.

Modus Operandi:

      The deposits were canvassed by the branch manager through a private person and  mobilized  bulk  deposits  of  about  Rs.604.33  crore  through  the  private person from the seven Government Organizations/Corporates.

      Term  deposits  accounts  were  opened  at  the  branch  after  obtaining  KYC documents  from  the  concerned  organization.  The  KYC  documents  were received  through  the  private  person.  Term  deposit  receipts  (TDR)  were delivered on the basis of the Organizations/Corporate authority letters.

      Later on the private person submitted application for loan, purportedly made by Organization/Corporate holding deposits with branch for loan / overdraft against TDR.

      The   loan   applications   accompanied   with   original   TDR   receipt,   duly discharged by the signatories who had signed the documents earlier submitted to  the  branch.  The  sanctioning  authority,  after  completing  the  necessary formalities, sanctioned the loan/overdraft.

      The fraudsters acted as representatives of the organizations, created a forged fixed   deposit   receipt   and   handed   over   the   same   to   the   beneficiaries. Subsequently,  the  original  deposit  receipt  was  utilized  by  the  fraudsters for availing loan against the deposit without the knowledge of the organization.

      While  disbursing  the  loan  amount,  letters  of  request  for  RTGS  transfer  to parties  or  cheques  duly  signed  by  the  authorized  signatories  were  received from the Organizations/Corporates.



  The  private  persons  with  assistance  of  other  unknown  persons  falsely  represented themselves  to  the  Government  Organizations/Corporates  as  representative  of  bank and to the bank as financial advisors of the Organization/Corporates.

  While   collecting   the   KYC   documents   from   the   Organizations/   Corporates, presumably retained the original documents with them and generated fake documents of  KYC,  signatures,  stamps,  letter  heads  etc,  purported  to  have  been  prepared  by concerned Organizations/ Corporates and handed over to the banks.

  After collecting the original TDR receipts from the banks, private persons presumably retained   them   and   handed   over   photocopies   to   the   concerned   Organizations/ Corporates.

  To  avail  a  loan  against  original  TDR  retained  by  them,  they  presumably  created fabricated  documents on  the  basis of  the  documents submitted  to  the  banks earlier. Original  TDR  duly  discharged  by  the  authorized  signatories  accompanied  the  loan applications.

  The branch managers without assessing the genuineness of these apparently looking genuine documents acted on the mandate and recommended/sanctioned loan against TDRs  and also remitted  the  money  to  various  accounts  in  several banks as  per the mandate.

  RTGS for opening TDR accounts were sent by the Organizations/Corporates to the banks  but  they  declined  having  ever  applied  for  loan/  overdraft  availed.  It  also transpired  that  the  private  persons  presented  themselves  as  representatives  of  bank and collected various papers/documents from Organizations/Corporates.

  It is also suspected that current accounts were also opened at the branches in the name of  Organizations/Corporates  where  funds  by  way  of  RTGS  were  received  and disbursed by RTGS transfer to various other banks.

Systemic Improvement:

   Proper due diligence and precautions should be taken by the branches while dealing with the bulk deposit accounts opened in the names of organizations, corporates and public  sector  undertaking  etc.  The  bank’s  systems  and  procedures  should  not  be diluted.

   Branches, on receipt of bulk term deposits of Rs.1.00 crore and above should report the  complete  details  of  such  deposits  to  Treasury  Management  Department.  In  the said report branch should also confirm that KYC guidelines have been complied with.

   Controller should critically go into on the quality of business booked by branches and sudden spurt, if any, observed in business growth should be thoroughly investigated.

   Branch manager should enquire about customers’ requirement and brief them about the  details  of  Loan/overdraft  schemes  such  as  rate  of  interest,  maximum  eligible amount of loan, requirement of signatures, KYC documents etc.

   For  limited  companies,  trusts,  associations,  co-operative,  it  should  be  ascertained whether the company /director/trustees/office  bearers  having borrowing  powers and the  extent  of  these  powers.  The  copy  of  the  necessary  resolution  passed  by  the borrowing  organization  for  borrowing  against  the  fixed  deposit  receipts  should  be obtained.

   Bank should not depend on private person for accepting the bulk deposits. Officers to verify  details  of  Organization/Corporate  and  verify  the  signature  of  all  the  joint holders as per bank record.

   Bank officer should obtain requisite documents executed in person from the applicant and enter the proposal in loan sanction register along with original TDR.

Analysis of Bank Frauds
Central Vigilance Commission

Fraud Committed by Staff member
(Demand loan)

The fraud perpetrated by a staff member of PSU bank by way of sanctioning of unauthorized Demand loans, unauthorized entries in Demand loan accounts, Saving Bank accounts, funds transfer accounts etc.

Nine  fraudulent  Demand  loans  aggregating  to  Rs.252.34  crores  had  been  sanctioned  by branch  manager  against  the  deposits  of  a  Development  Authority  without  the  request
/authorization from the depositor. No documents were available. The transactions had been carried out by then senior manager of the branch.

Modus operandi:

      Fraudulent   demand   loans   were   sanctioned   purportedly   against   deposits   of   the Development   Authority.   It   was   reported   that   nine   fraudulent   Demand   Loans aggregating  to  Rs.252.34  crores  had  been  sanctioned  against  the  deposits  of  the Development Authority without request/ authorization from the depositor.

      The loans had been sanctioned in the name of the Development Authority and loan proceeds were credited to various accounts of different persons. While few credits had been affected directly from demand loan, few credits had been routed through three fictitious Saving Bank accounts of the Development Authority.

      No  documents  were  available  in  the  branch.  The  entire  accounts  stood  closed.  The transactions   had   been   carried   out   by   then   Senior   Manager   of   the   branch. Indiscriminate   credits   and   debits   without   any   authorization,   outward   RTGS remittances,  opening  and  closure  of  loan  accounts  etc  had  been  indulged  by  then Senior  Manager  of  the  branch  and  other  officials  had  passed  the  transactions  in  a routine manner.

      The said three saving bank accounts were used for parking the proceeds of fraudulent demand loans raised by then Senior Manager of the branch and also for transmission of  money  to  various  accounts  for  accommodation  purpose.  All  the  transactions  in those three saving bank accounts were fraudulent.

      The  Development  Authority  had  confirmed  that  no  request  was  made  by  them  for opening   the   said   three   saving   bank   accounts.   Transactions   circumventing   the provisions of Anti- money laundering approved by then Senior Manager were noticed.

  Fictitious demand Loans were allowed to be opened by the branch manager and the proceeds were misutilised to accommodate few constituents.

  Anti – Money laundering provisions had not been adhered to. Reporting was not  done.  Irregular  transactions  pertaining  to  interest  charged  /paid  were passed.

  Three  fictitious  saving  bank  accounts  in  the  name  of  the  Development Authority  were  opened  and  fraudulent  transactions  were  put  through  by  the staff member.

  Branch officials failed to alert controlling office regarding fictitious demand loans.  Vouchers  were  posted/  approved  without  proper  verification  of  its regularity and genuineness of underlying transactions.

  Outstation   cheques   were   debited   to   the   branch   funds   transfer   account.
Fictitious    cheque    numbers    were    entered    and    passed.    Transactions disproportionate to the known sources of income and large value transactions were permitted.

  Transactions disproportionate to their known source of income were allowed.

Systemic Improvement:

   Controlling  offices  should  critically  go  into  the  quality  of  business  booked  by  the branch  and  sudden  spurt,  if  any  observed  in  business  growth  should  be  thoroughly investigated.

   Monitoring of systems and MIS generation has to be strengthened. Housekeeping and internal control of banks has to be strengthened.

   Controlling Offices have to receive the details of all the loans sanctioned under power of the branch along with related account wise Appraisal notes through credit appraisal form every month. The return should be critically scrutinized and adverse conditions, if any, should be taken up with the concerned branch for rectification without delay.

   Due  diligence  for  sanctioning  of  loans  and  observations  of  Bank’s  system  and procedures should not be diluted.

Analysis of Bank Frauds
Central Vigilance Commission
Fraud Committed by Staff member :
(Letter of Comfort)

The  fraud  was  perpetrated  by  staff  member  of  a  bank  in  buyers’  credit  transactions.  The matter  came  to  light  when  the  main  branch  of  bank  received  intimation  from  overseas branches of the bank that payment towards buyers’ credit was not received by them.

When  branch  records  were  verified,  it  came  to  light  that  no  such  buyers’  credit  had  been raised from  those  banks.  It  was further observed  that  several  other buyers’ credit  had  also been  raised  from  those  banks  through  fake  Letters  of  Comfort  (LOC)  via  SWIFT  which became due for payment from 01.07.2016 onwards. It was reported that the branch had issued
20 buyers credit for Rs.429.33 crore due for payments upto January 2017.

Modus Operandi:

      The   Letters   of   Comfort   were   fraudulently   conveyed   through   SWIFT messages  which  emanated  from  the  main  branch  of  bank  where  there  was involvement of staff member.

       On 25.07.2016, the main branch received a message from overseas branches of PSU bank that payments towards buyers’ credit were not received by them. On verification, it was observed that no such buyers’ credit had been raised from these banks.

       It was reported that the branch had issued 20 buyers’ Credit for Rs.429.33 crore due for payments upto January 2017.

      On  verification,  it  was  found  that  there  were  no  documents  and  sanction letters of credit facilities for such transactions. Further, the transactions were not  routed through  the  bank’s Nostro Account as  per prescribed guidelines. The SWIFT messages sent were reportedly fraudulent.

Loopholes/ Lapses:

  SWIFT transactions were not linked to the Core Banking Solution (CBS) of the bank, which contain transaction histories and other data of the customers.

  The  transmission  of  the  messages  is  usually  a  three  layer  process  that  did  not  take place either at the branch or its office.

  SWIFT  transactions  were  therefore  automatically  recorded  and  were  not  seen  by officials of the controlling offices.

  In  SWIFT  system  one  bank  official  is  designated  as  a  maker,  another  verifier  and third as authorizer. All have different logins and passwords and work independently of each other. But in the case all functions were performed by a single person.

Systemic Improvement:

   CBS-Finacle  should  be  integrated  with  SWIFT  (STP-Straight  Through  Processing)
for all payment messages.

   Each   and   every   login   into   SWIFT   system   would   be   only   through   biometric authentication thereby virtually preventing any unauthorized login through password compromise.

   SMS  alert  feature  should  be  introduced  wherein  all  SWIFT  users  will  get  an  alert message in their mobile phones for every login into the SWIFT with their roll number and password including failed login attempt.

   The access to SWIFT connect should be restricted based on IP address-only 2 PCs per branch should be permitted.