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A Gordian knot in the rise of India Inc. Fraud Factor

Updated: May 1, 2010 1:41 pm

Corporate India or India Inc has traditionally found more friends here in the society than foes. For every success story that corporate India spawned, there has been a loud cheer for the vision and the sheer execution with which Indian companies have sought to raise the bar and aim to conquer the world. Indeed, some of these companies have established global benchmarks, and set leadership examples not just in achieving profitability but also in unrivalled corporate governance standards. But for every successful story, there are a few rotten apples too.

            Not long ago India woke reluctantly and in utter disbelief to the horror of Satyam scam. The eternal optimists though argued that Satyam was the exception rather than the rule. A study now by KPMG has thrown fresh light on the need to bring in adequate checks and balances in the way corporate India conducted its business. The study brings up front the curse of rising frauds in corporate India raising an alarm bell. This is a critical area for all relevant stakeholders to attend to urgently, failing which the rigorous hard work over the years in building brand India Inc in the global arena might go all waste. The KPMG report says with fraud on the rise, corporate India needs to change its outlook pointing out that 75 per cent of survey respondents state that fraud in corporate India is on the rise; stakeholders view financial statement frauds as a major concern; e-commerce and computer-related fraud to be a source of major concern in the coming years and procurement and sales & distribution now being among the most vulnerable areas.

            M Damodaran, former SEBI chief and now advisory board member, KPMG, said, “India has had its share of frauds and their incidence has often significantly impacted investor confidence. In an atmosphere of doubt and disbelief financial statements are often viewed with skepticism. This has also led to erosion of confidence and reduced trust among participants in the financial system.” He added, “It is time that India Inc. sits up and ends its tolerance of unethical behaviour, bribery and corruption. Managements of companies have not only to act ethically but also to intensify their efforts to protect their companies from fraud. They should develop pro-active risk management mechanisms that can anticipate, prevent, understand, detect and respond to fraud.”

           Richard Rekhy, head of advisory, KPMG India, said, “The investor community and stakeholders now expect company boards and audit committees to take the onus of proactively monitoring their companies’ efforts to understand and mitigate fraud risks. Non-executive directors are expected to play a major role in challenging management on the adequacy of their fraud risk identification and mitigation plans. In such a scenario, it is useful to analyse the extant and extent of fraud and fraud risk management practices in corporate India.” KPMG’s forensic practice published an e-survey in Jan 2010 and sent out to close to 1000 leading organisations in India.

            The survey respondents included chairman/ managing directors, chief financial officers, heads of internal audit and compliance, fraud risk managers and other senior management personnel across various industry segments. KPMG fraud report said, “There is a rise in the incidence of fraud ineffective control systems and diminishing ethical values are key contributors to this trend. An overwhelming majority of the respondents indicated that the incidence of fraud, overall and specifically within their industry and company, is rising thereby indicating that India Inc needs to deal with fraud risks firmly. Supply chain fraud (procurement, distribution and revenue leakage) is the single-most exposed area. Weak internal control systems, eroding ethical values and a reluctance on the part of the line managers to take decisive action against the perpetrators are cited as the most vital underlying reasons for frauds being on the rise.”

            The survey found that stakeholders view financial statement frauds as one of the major concerns in India. Stakeholders in India continue to perceive financial statement fraud as a major area of concern. A desire to achieve/exceed targets and earnings of senior executives linked to financial performance are the reasons for senior management’s involvement in such frauds. Ineffective whistle-blowing systems, lack of objective and independent internal audit functions with forensic skills, inadequate oversight of senior management activities by the audit committee and weak regulatory environment are the reasons for growing worries in respect of financial statement fraud, the report added. An alarming 81 per cent found that financial statement fraud was a major issue.

            As regards fraud risk management not prevailing in India Inc, the survey found that Indian companies have a reactive approach to dealing with fraud. Even amongst those that do undertake a fraud risk assessment, the focus is more on financial frauds rather than a holistic assessment. The usage of data analysis tools to analyse critical patterns and trends in data and understanding scenarios of potential fraud which should be inter-woven into the fraud risk assessment process is still in progress. Respondents suggest that a fraud risk management programme should be a shared responsibility across the company board, senior management, internal audit and risk functions. About 41 per cent respondents felt that there was no formal fraud risk management structure in the country.

            The report said the enemy within continues to pose the biggest threat. Committing frauds is not confined to a select few, both junior and senior employees are perpetrators of frauds. The quantum of frauds in value terms is also increasing. The encouraging sign is that fraud detection mechanisms have improved with a majority of frauds being detected through internal audits and whistle-blower mechanisms rather than by accident (as indicated in 2008 Fraud Survey). However, the incidence of legal action against fraudsters is low with a majority of the frauds being investigated and dealt with internally. Around 75 per cent felt that employees perpetrated all frauds except IPR frauds.

            Bribery and corruption continue to remain a challenge in conducting business, the report said, adding that bribery and corruption are viewed as an inevitable aspect of doing business in India. Bribery and corruption are most rampant in seeking routine regulatory approvals and to win new businesses from prospective clients. Despite the presence of anti-corruption laws, weak regulatory enforcement has contributed to the current impasse. With Indian companies going global, we see an increasing trend of Indian companies pro-actively taking measures to adhere to international anti-bribery laws/regulations (e.g.: Foreign Corrupt Practices Act) and strengthening their code of business ethics at the board and senior management levels to regulate dealings with external stakeholders.

            The report said the intellectual property, computer-related fraud, bribery and corruption and supply chain fraud are going to be the risk areas in coming years. Whilst supply chain and bribery and corruption will continue to dominate the frauds horizon, intellectual property and e-crimes are emerging as the new dimensions and organisations in India seem ill equipped to fight these threats. Strong enforcement of intellectual property and anti-piracy laws, the right to audit within third party contractual arrangements, vendor compliance/performance reviews and technology preparedness through document management and retrieval systems are important focus areas if organisations have to successfully counter these new types of fraud threats, the report added.

By K Anjna

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