CORPORATE FRAUDS AND
THE ROLE OF SFIO
(SERIOUS FRAUD INVESTIGATION OFFICE)
Dr. Vikas Sharma1
Contact No.: 8949381828
Contact No.: 8294155259
Institute of Legal Studies & Research, Mangalayatan University, Aligarh-U.P. -202145 1&2
The instances of corporate frauds and the amount of money involved have been found to be increasing over the period of time. Few prominent examples of corporate frauds which had shaken the capital market include Harshad Mehta Scam, Ketan Parekh Scam, Satyam Scam, Mallya’s bank default case, Bhushan Steel bank default case, and many others. For preventing the occurrences of corporate frauds and economic scams the Government of India established SFIO. The purpose of SFIO is to protect the financial interest of the persons who invest capital in a company-such investors may be shareholders, creditors, depositors, etc. SFIO seeks to protect such investors from the corporate frauds committed by the management of the company. SFIO is a multi-disciplinary office consisting of experts having experience in banking, corporate affairs, taxation, auditing, law, information technology, capital market, or in similar other fields. SFIO was first established in the year 2003 by way of government resolution. Therefore, though it was functional during the operation of the previous Companies Act 1956, it did not have statutory basis because of which it could not effectively carry out its function of investing corporate frauds. It neither had the power to arrest the accused, nor the power to file chargesheet, nor to conduct prosecution. In order to enable SFIO to carry out its functions effectively, it was given statutory status under section 211 of Companies Act 2013. In this article the authors attempt to study the instances of corporate frauds, the usual modus operandi of conducting frauds, and the role of SFIO in investigating corporate frauds and carrying out prosecution.
Keywords - Corporate Fraud; SFIO; Serious Fraud Investigation Office; Bank default; Bank Scam; economic fraud, Section 447 Companies Act 2013, Investigation of Fraud.
MEANING OF FRAUD
Fraud is an act of “deceit, trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage”. In a financial fraud the corporate, bank, financial institution, investor, borrower, or any other participant deliberately misleads the other participants in the capital market by furnishing them fabricated, incomplete statements in order to make unlawful gains. A Financial fraud becomes a serious fraud when it attains such magnitude that it jeopardises the economy of the nation or destabilizes the capital market, for example the Satyam Scam (Satyam Computer Services Scandal) in the year 2010 in which a fraud of Rs. 7,800 crores was committed by manipulating the accounts, contracting with clients who did not exist in reality, making fake sales invoices, misstating the facts, showing salary payments in the name of non-existent employees (such amount ultimately going in the hands of the company’s directors), and other deceitful means&. Section 447 of Companies Act 2013 defines fraud in relation to a company (i.e., corporate fraud) as “any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss”. Section 447 of the Act also prescribes punishment for the person who commits the corporate fraud-the punishment being imprisonment ranging from six months to ten years and also fine ranging from the amount of fraud to three times the amount of fraud.
MODUS OPERANDI OF CORPORATE FRAUD INVOLVING BANK DEFAULT
The banking practice generally followed in India is that banks provide loans to a promoter of the company in the ratio of 3:7, which means that a bank asks promoter to contribute 30% of the project cost and thereafter the bank sanction loans of 70% of the project cost. Suppose, in the first cycle, a promoter needed INR 100 Lakhs. He contributed INR 30 Lakhs and the bank sanctioned him a loan of INR 70 Lakhs. The promoter then bought some useless and worthless software, patent or any other intangible property of INR 100 Lakhs from a corporate mafia (usually established in a foreign country) which later refunded INR 99 Lakhs back to the promoter in his personal bank account (usually maintained in any foreign country). The account book of the company showed that the cost of the software/patent/etc. as INR 100 Lakhs. In the second cycle, out of the INR 99 Lakhs wrongfully acquired the promoter then reinvested say INR 45 Lakhs in the company and obtained a loan of INR 105 Lakhs from the bank (bank providing loan in the ratio of 3:7). With the total of INR 150 Lakhs the promoter again bought the useless and worthless intangible property from a corporate mafia who refunded INR 149 Lakhs back to the promoter in his personal account. Out of INR 149 Lakhs the promoter kept paying interest to the bank for a period of time in order to maintain its trust in him. In just two cycles the amount of loan obtained by the promoter from the bank was INR 175 Lakhs (INR 70 Lakhs in the first cycle and INR 105 Lakhs in the second cycle) while the actual amount spent by the promoter on acquiring intangible properties was merely INR 2 Lakhs (INR 1 Lakh in the first cycle and INR 1 Lakh in the second cycle) while. Further suppose that the promoter paid INR 20 Lakhs as interest to the bank over a period of time. The money wrongfully acquired by the promoter be defrauding the bank was INR 150 Lakhs (175 Lakhs-2 Lakhs-20 Lakhs) in just two cycles. The cycle continued and the quantum of money wrongfully acquired by the promoter also multiplied to billions. When the promoter started defaulting on loan the bank seized the properties of the company for auctioning it in order to recover its loan amount. However, since the properties were useless and worthless intangible properties the bank could not find any buyer. The bank could not even recover the amount from the personal bank account of the promoter since it was maintained in a foreign country. The bank faced difficulty in prosecuting the corporate mafia and the promoter since the corporate mafia was established in foreign country and the promoter also fled to any foreign country-extradition of fugitives being quite a complicated process. (Even if the promoter instead of acquiring intangible properties, acquires any tangible property such as land, building, etc. he acquires it from any of his relatives at a highly inflated cost. When bank tries to sell such property, the amount recovered does not match the amount of loan that the bank had sanctioned)
INSTANCES OF CORPORATE FRAUD
According to the data published by Reserve bank of India, 53,314 cases of bank frauds have been detected between the Financial Years 2008-09 and 2018-19. The aggregate amount involved in those frauds was INR 2.05 lakhs crores (USD 28.72 billion). The amount involved in the fraud committed during this 11 years period was so huge that it almost equalled one year GDP of Nepal (for the Financial Year 2018-19) and more than 10% of the one-year GDP of Pakistan (for the Financial Year 2018-19). Moreover, the instances of bank frauds and the amount of money involved have been found to be increasing over the period of time.
Financial Year (FY)
Number of Bank Fraud Cases
Amount of Money Involved
Rs. 41,167 crores
Rs. 71,500 crores
Source: Based on Above Data
Few prominent examples of corporate frauds include Mallya’s bank default of INR 9,091crores; Bhushan Steel bank default case of INR 45,818 crores; IL&FS bank default of INR 90,000 crores. In Mallya’s Bank Default case, Vijay Mallya was the promoter of the now defunct Kingfisher Airlines (KFA)- “The King of Good Times”. The KFA, which was founded in 2003, was one of the best airlines in India but over a period of time it made several bad business decision such as acquisition of loss making Air Deccan by KFA; entering into international flight market in which it could not survive the competition from Emirates and Etihad airlines which dominated the international market; in the domestic operation it had entered the market in the premium category catering the business executives but later it shifted to budget category which was dominated by SpiceJet and other domestic airlines. Because of the series of bad business decisions, the KFA went into heavy losses. Consequently, KFA had to ground several of its fleet; it failed to pay salary to its employees because which they went on strike; it deducted TDS from its employees but failed to deposit it with Income Tax Department because of which the tax department attached the bank accounts of KFA. On 1st October 2012 KFA had to cancel all its flights because of the strike by its employees and on 20th October 2012 the operating licence of KFA got cancelled. KFA owed INR 7,000 crores plus interest to the public sector banks which nearly aggregated to INR 9,000 crores. It was not that Mallya did not have means to repay the money he owed to the banks. For obtaining loans he had given his personal guarantee to the banks. Additionally, he was also the promoter of USL (United Spirits Limited). Karnataka High Court had directed Mallya not to sell his shares in USL. However, despite of the High Court’s direction he sold his USL shares to Diageo (a London based MNC and a global leader in alcohol beverages) for which Diageo paid him millions of dollars in his foreign account. Therefore, Mallya was indeed capable to repay the loans; if not the entire loan, then definitely a significant portion of it; to the public sector banks but he wilfully defaulted. By the time the banks took action against Mallya, he escaped to England.
SFIO AND INVESTIGATION OF CORPORATE FRAUDS
The Purpose of SFIO- The purpose of SFIO is to protect the financial interest of the persons who invest capital in a company-such investors may be shareholders, creditors, depositors, etc. SFIO seeks to protect such investors from the corporate frauds committed by the management of the company including the board of directors. The duty of SFIO is to detect the cases of serious corporate frauds and to prosecute or to recommend the prosecution of the corporate officers in default who commit serious corporate frauds by abusing their powers for making wrongful gains.
Establishment of SFIO- On 21st August 2002 the Government of India constituted a High-Level Committee under Shri Naresh Chandra, the former Cabinet Secretary for recommending measures for preventing the occurrences of corporate frauds and economic scams which had shaken the capital market such as Harshad Mehta Scam (1992), Ketan Parekh Scam (2001), Dinesh Dalmia Scam (2001). In the very same year 2022 the Naresh Chandra Committee submitted its report in which it recommended for establishment of CSFO (Corporate Serious Fraud Office) under Department of Company Affairs for the purpose of detecting serious corporate frauds and also to direct prosecution of the corporate officers guilty of such fraud. The Committee further suggested that CSFO should be a multi-disciplinary office consisting of specialists drawn from various fields such as tax authority, accountancy, information technology, etc. Based on the recommendations of that Committee the Government established the office of SFIO in the year 2003.
The office of SFIO was first established by the Government of India in the year 2003 not under any statute but by way of resolution. Therefore, though SFIO was functional when the previous company legislation “Companies Act 1956” was in force, SFIO did not have any statutory status. SFIO used to investigate corporate frauds without any statutory authority. It neither had the power to arrest the accused, nor to file chargesheet, nor to conduct prosecution.
Thereafter, the Government of India appointed an Expert Committee under Shri Vepa Kamesam- the former Deputy Governor of RBI, for recommending measures on how to make SFIO more effective. The Kamesam Committee in its report dated 29th April 2009 suggested the Government to confer statutory status to SFIO and it also suggested certain administrative and organization changes in order to enable SFIO to carry out its purpose more effectively.
Thereafter, in Companies Act 2013, which replaced Companies Act 1956, statutory status was given to SFIO. Section 211(1) of Companies Act 2013 obligated the Government of India to establish SFIO. Accordingly, the Government exercising its power under Section 211(1) of Companies Act 2013 re-established SFIO in the year 2015 by way Notification.
Composition of SFIO- SFIO is a multi-disciplinary office functioning under Ministry of Corporate Affairs. Sections 211(2) & (3) of Companies Act 2013 says that the office is headed by a director who would be an officer not below the rank of Joint Secretary to the Government of India and having adequate experience in corporate matters. Besides director, the office consists of members who would be experts having experience in banking, corporate affairs, taxation, auditing, law, information technology, capital market, or in similar other fields. The director and the members are appointed by the Central Government.
Investigation by SFIO- SFIO investigates cases of frauds committed by companies and not cases of fraud or crime of individual nature. Section 212(1) of Companies Act 2013 says that SFIO investigates into those cases of corporate frauds which are assigned to it by the Central Government (CG). It is only on the direction of the CG that SFIO investigates into the affairs of a company. The CG issues such direction to SFIO when the Registrar of Companies, or the inspector who inspects the books of accounts of a company under section 208 of the Act, recommends to the CG that the affairs of the company needs to be investigated; or when company passes special resolution approving investigation into the company’s affairs and intimates the CG about the same; or when the CG thinks that an investigation into company’s affairs is necessary in public interest; or when the CG receives requests from any state government or government department for the investigation into company’s affairs.
When a case is assigned to SFIO then for such offences which fall under Companies Act 2013 no other investigating agency can proceed with the investigation. If any investigating agency had already initiated proceeding before the case was transferred to SFIO then the former needs to transfer all records of that case to SFIO. The director of SFIO appoints an investigating officer for investigating the affairs of the assigned company. The company has the obligation to furnish all documents and information to the investigating officer. After investigation the SFIO then submits the report of investigation to the Central Government. based on the report the Central Government may direct SFIO to initiate prosecution against the company and the company’s officers in default. The investigation report filed by SFIO in the Special Court established under Companies Act 2013 is deemed to be a report filed by police officer under section 173 of Criminal Procedure Code, 1973 and charges are framed based on that report.
Instances of Directors Convicted by SFIO
SFIO has been conferred with the power to investigate as well as the power to arrest, and obtaining bail by accused has also been made more difficult. Section 212(8) of Companies Act 2013 says that any officer of SFIO of the rank Assistant Director and above would have power to arrest any person if he has reasons to believe that the person has committed any offence to which section 447 of the Act applies. The critiques often point out that the power to arrest given to SFIO is wide and discretionary. However, such criticism is not justified because the power of arrest conferred on SFIO is in line with the constitutional rights of the arrestee, for example section 212(8) requires that the officer arresting an accused shall inform the arrestee as soon as may be about the ground of his arrest- this provision is in line with Article 22(1) of the Constitution; section 212(10) requires the arrestee to be produced before Special Court, Judicial Magistrate or Metropolitan Magistrate within 24 hours from the time of arrest-this provision is in line with Article 22(2) of the Constitution.
However, on one hand the conditions for obtaining bail by an accused arrested by SFIO have been made very rigorous. Sub-sections (6) & (7) under Section 212 of Companies Act 2013 imposes certain restrictions on obtaining bail and those restrictions supersede the provisions of Criminal Procedure Code, 1973. These sub-sections say that an accused arrested by SFIO cannot obtain bail unless the public prosecutor has been given the opportunity to oppose the bail and prima facie it appears to the court that the accused has not committed the offence; and such restriction is in addition to the restrictions on bail imposed under Criminal Procedure Code, 1973. Such restriction has not found much favours with the courts. In Bhushan Steel Case the Delhi High Court granted interim bail Singhal-the accused and remarked that the provision of bail under section 212(6) & (7) of Companies Act 2013 cannot completely exclude the provision of bail under Criminal Procedure Code, 1973. And, on the other hand sub-section (6) under section 212 of the Act allowing the Special Court to give lenient treatment to women accused in obtaining bail has resulted in women accused easily obtaining bail, for example Aarti Singhal, the former director in Bhushan Power and Steel Limited was easily granted bail despite of the fact that she was accused of fraud of INR 5,500 crores and the advocate representing SFIO kept on pleading that she, if released on bail, might influence the witnesses and destroy the evidences. &  Therefore, it is suggested that the provision of obtaining bail by accused arrested by SFIO should be in tune with the provision of bail under Criminal Procedure Code, 1973.
 https://www.dictionary.com/browse/fraud (Accessed on 2nd Sept. 2022)
 https://en.wikipedia.org/wiki/Satyam_scandal (Accessed on 2nd Sept. 2022)
 https://tradebrains.in/satyam-scam/ (Accessed on 2nd Sept. 2022)
 Promoter means a person who conceives the idea of business; arranges men, money and material for the company to be incorporated; and perform legal compliances for the incorporation of a company.
 Smarak Swain, The Great Indian Fraud: Serious Frauds Which Shook The Economy 13-14 (Bloomsbury, New Delhi, 2020)
 Smarak Swain, The Great Indian Fraud: Serious Frauds Which Shook The Economy 10 (Bloomsbury, New Delhi, 2020)
 Infrastructure Leasing and Financial Services
 https://www.thinkwithniche.com/blogs/details (Accessed on 6th September 2022)
 Tax Deducted at Source
 Arvind Kumar Gupta, Serious Fraud Investigation Office-Law & Practice 1-2 (Bharat Law House, New Delhi, 1st edn., 2020)
 Resolution No. 45011/16/2003-Admn.-1 dated 2nd July 2003.
 Section 211 of Companies Act 2013-Establishment of Serious Fraud Investigation Office— (1) The Central Government shall, by notification, establish an office to be called the Serious Fraud Investigation Office to investigate frauds relating to a company]
 Notification No. S.O.2005(E) dated 21.07.2015.
 D.P. Mittal, Law & Practice relating to SFIO and Inspection, Investigation & Fraud 78 (Bharat Law House, New Delhi, 1st edn., 2020)
 Accessed on 8th September 2022
 Pairvi Officers-They are officers appointed by CBI (Central Bureau of Investigation) for carrying out investigation. Generally retired police officers of the rank inspector and above are appointed as pairvi officers.
 Article 22(1) of Constitution of India- No person who is arrested shall be detained in custody without being informed, as soon as may be, of the grounds for such arrest nor shall he be denied the right to consult, and to be defended by, a legal practitioner of his choice.
 Article 22(2) of Constitution of India- Every person who is arrested and detained in custody shall be produced before the nearest magistrate within a period of twenty-four hours of such arrest excluding the time necessary for the journey from the place of arrest to the court of the magistrate and no such person shall be detained in custody beyond the said period without the authority of a magistrate
 www.businesstoday.in/magazine/corporate/story (Accessed on 9th September 2022)
 www.business-standard.com/article/current-affairs/bhushan-steel-case (Accessed on 9th September 2022)