Sniffing out corporate fraud

MOHAN R. LAVI | Updated on August 13, 2011

The indirect role of the corporate sector in the Bellary mining scam came to light during a scrutiny of the bank accounts of a small mining firm.

A specific clause in CARO could give the auditor the fillip to report transactions that he thinks are circuitous and difficult to trail.

The exhaustive report of the Karnataka Lokayukta on illegal mining in certain tracts of mineral reserve areas in Karnataka and the consequent loss of revenue to the State Government dwarfs the amounts the organisers played around with in the Commonwealth Games.

While the report focuses on the methodologies used for illegal mining — erroneous licences, overloading of transport vehicles et al, it also mentions about a couple of entities in the corporate sector that either by intent or design got themselves involved in the process.

At a time when strategies to bring in the funds lying in the parallel economy are being thought of, the report highlights that a scrupulous scrutiny of bank accounts can unravel many a mystery.

As an illustration, the report highlights the existence of a bank account with large balances in the name of a hardware merchant who was clueless about the facts that the account belonged to an iron-ore exporter and millions were being transacted in that account.

In another instance, the bank account provided to the tax department had miniscule balances while the operative account which the department did not have had large amounts of mining proceeds.

Bank accounts

It was while scrutinising the bank accounts of an entity called South-West Mining Company Limited (SWML) that the indirect and discreet role of the corporate sector came to light. SWML and other corporate entities had applied to the State Government for grant of mining licences in certain areas.

Later, the Union Ministry of Mines got involved stating that there were certain complaints against these applications with the Supreme Court pending disposal. It appeared that these entities were attempting to influence the State Government to get the Ministry to clear the pending licences in their favour.

The bank account of SWML recorded a payment of Rs 10 crore to an education trust. As SWML did not have a million-dollar bank account (the bank account invariably showed an overdraft position), the funds had come in from a steel major operating in the same area which had a million-dollar balance-sheet. A verification of mining transactions between the two companies during this period yielded a blank. It is apparent that the steel major has not recorded this amount as a donation since its financial statements for the year reflect only an amount of Rs 3-odd crore as contributions and donations.

Iffy documents

Yet another occasion when the overdraft status of the account turned positive was when SWML paid double the amount paid to the education trust for purchase of an acre of land at a premier IT park in the capital of the State. The land-purchase agreements were iffy with blanks in critical places and the amounts agreed upon were way beyond industry benchmarks. Unsurprisingly, the Lokayukta found that the funds had come in from the steel major which in turn had got it from an associate entity that supplied gas to the steel major. The circuitous route and the trail of transfers from other entities provided enough evidence to the Lokayukta to conclude that the payments were of gratuitous nature, and not for business purposes.

CARO Report

Implementing the powers provided by Section 227(4A) of the Companies Act, the Central Government has issued the Companies (Auditors Report) 2003 (CARO) wherein the auditor is expected to comment on an eclectic variety of issues. One of the requirements is to tabulate the dues of statutory taxes and duties that have not been paid due to disputes. The coverage of this clause could be expanded to include all legal disputes for or by the company — normally mentioned in the notes on accounts which, however, are not owned by the auditor. CARO contains a clause wherein defaults in the payments of dues to banks and financial institutions are to be reported.

Though unusual and abnormal transactions in bank accounts are assumed to have been clarified and disposed off during the audit, a specific clause in CARO could give the auditor the fillip to report these transactions in case he is of the opinion that the transactions and the explanations of the management are circuitous and difficult to trail.

This becomes all the more critical due to the lack of a residual clause under CARO wherein the auditor is given a free hand to highlight issues not specifically mentioned. Though there is a clause on there being no material fraud on or by the company during the year, constraints on audit time and the difficulty in instantly ascertaining whether a particular transaction can be classified as a fraud make asserting a positive statement about a fraud a remote possibility.

(The author is a Bangalore-based chartered accountant.

Published on August 03, 2011

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