Even as the global economy continues facing challenges, corporate fraud is on the rise. It's no different in India. A dynamic business environment, competitive pressures, expectations of stable growth from stakeholders, and the changing social structures and value systems are some of the reasons seen as contributing to the rise in fraud. Businesses are at risk of losing large sums of money, and commercial disadvantage and irreparable damage to reputation are among the other likely fallouts of corporate fraud.

A spurt in corporate fraud

Dr Donald Cressey, celebrated criminologist, analysed the occurrence of fraud using a model called ‘Fraud Triangle'. He explained the occurrence of fraud in terms of three existing conditions — namely incentive/ pressure, opportunity and rationalisation. In the Indian context, businesses are struggling to meet the expectations of investors and stakeholders owing to the economic downturn. The flexibility needed to navigate through the challenging business environment and cost control at times led to weaknesses in internal controls, thereby providing an opening to fraudsters. Under pressure to meet the revenue and earnings target, questionable business practices, aggressive accounting methods are resorted to. The curb on salary costs and promotions in general, and a decrease in performance-based pay coupled with a changing social structure and increasing aspirations provide employees with a rationalisation for fraudulent behaviour.

Widespread impact of fraud

According to the Global Fraud Survey conducted by the Association of Certified Fraud Examiners in 2012, a typical organisation loses 5 per cent of its revenues to fraud each year. Another survey by the Economic Intelligence Unit found that 85 per cent of the Indian companies reported exposure to fraud. Internal financial frauds and financial mismanagement frauds together constituted 45 per cent of the frauds reported by Indian organisations.

According to the India Bank Fraud Survey 2012, 93 per cent of the respondents indicated there was an increase in the number of frauds in the Indian banking industry last year; the average loss per incident for more than half of the respondents was Rs 10 lakh. The respondents also reported that banks in India are able to recover less than 25 per cent of the losses in more than half of the fraud cases. The ACFE report showed that financial statement fraud is the costliest form of occupational fraud, causing a median loss of $1 million.

In India, there are numerous instances of systematic manipulation of financial statements by borrowers, leading to severe losses for the financial institutions. The Indian experience shows that large-scale manipulation of financial statements can threaten the very existence of the victim organisation.

In fact, the impact goes beyond the victim organisation. It affects not only the employees, investors and business associates of the organisation but also market capitalisation in general. Such frauds result in ‘trust deficit', often damaging the business environment and casting a shadow of doubt on the functioning of the entire industry. Very often, an intense regulatory scrutiny follows the discovery of such frauds, culminating in changes in rules and regulation to strengthen corporate governance.

Use of Forensic Accounting

Effective and efficient investigation of fraud minimises the adverse impact on the credibility and future profitability of the victim organisation. However, there are numerous challenges in the form of delayed detection, well laid-out fraud schemes, use of technology, complexity of frauds and lack of preparedness. The perpetrator is often a trusted, intelligent employee or business associate who knows the organisation's systems and processes well enough to effectively abuse them and conceal the evidence.

Forensic accounting is increasingly used to address these challenges in fraud investigation. The American institute of Certified Public Accountants has defined forensic accounting as “the application of accounting principles, theories and discipline to facts or hypothesis at issue in a legal dispute and encompasses every branch of accounting knowledge”.

It uses accounting/ auditing, investigative skills and data mining for fact finding. It includes

combining accounting, document and transaction analysis with witness and third-party evidence, to provide factual findings;

reconstruction of transactions or financial records;

collecting information, reviewing and interpreting data, and explaining complex financial transactions.

Various surveys indicate that the growing trend of corporate frauds is expected to continue. Implementation of a well-planned and effective fraud control framework helps organisations minimise the damage. However, fraud risk cannot be eliminated. Organisations should necessarily be prepared to effectively respond to any eventuality of corporate fraud. Use of forensic accounting helps organisations minimise profit erosion and damage to reputation.

Neeta Potnis is Senior Director, Deloitte Touche Tohmatsu India Pvt Ltd.

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