The corporate frauds within the country are as old as hills. The Audit Committees and the Corporate Boards are concerned about the tightening of Sections 447 and 212 of the Act as well as the addition of fraud to the list of crimes covered by the PMLA.
Corporate Frauds in India has been a persistent issue in India, dating back to the infamous LIC/Mundhra scam in the 1950s. Over the decades, notable frauds like the Harshad Mehta, Ketan Parekh, Sahara, and Satyam scams have continued to plague the corporate landscape. In response to these challenges, the legal framework has evolved, culminating in the Companies Act of 2013, which introduced stringent measures to combat fraud.
This article aims to provide an in-depth understanding of the legal aspects surrounding corporate frauds in India, focusing on the relevant sections of the Companies Act, the role of the Serious Fraud Investigation Office (SFIO), and recent legislative developments.
Key Takeaways
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Evolution of Legal Provisions
Historically, corporate frauds was not explicitly defined in the Companies Act of 1956, as the Indian Penal Code adequately addressed such crimes. However, spurred by the corporate scandals of 2007–2008, legislative changes were proposed. The Companies Act of 2013 introduced Section 447, offering a distinct definition of fraud. Simultaneously, Section 212 established the SFIO to investigate these frauds. Section 447 amalgamated several IPC sections, such as:
- Section 405 on Criminal Breach of Trust
- Section 415 on Cheating
- Section 463 on Forgery
- Section 477A on Falsification of Accounts is combined into Section 447 of the Act.
Understanding Section 447
Section 447 of the Companies Act, 2013, provides a comprehensive definition of fraud. It covers various components such as acts, omissions, concealment of facts, and abuse of position with the intent to mislead, take advantage of, harm, or impair the interests of the company, its shareholders, creditors, or other parties.
The section imposes a maximum sentence of ten years, and the standard of proof required is “beyond a reasonable doubt.”
Conditions for Granting Bail
Section 212(6) of the Act outlines stringent conditions for granting bail to those charged under Section 447. The accused must satisfy twin conditions: the public prosecutor’s approval to contest bail, and the court’s satisfaction that the accused is innocent and unlikely to commit another crime while on bail.
These conditions, reminiscent of those under the Prevention of Money Laundering Act (PMLA), have been criticized for being nearly impossible to meet.
A person charged with an offence covered by Section 447 of the Act is not eligible for release on bail until the following requirements are met, according to Section 212(6) of the Act:
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Impact of Section 447 on Bail
Despite the Supreme Court’s landmark ruling declaring Section 45 of the PMLA unconstitutional, arrests under Section 447 of the Companies Act still occur, and bail is denied using similar twin conditions. Notably, the Supreme Court, in SFIO v. Nitin Johari, emphasized the need to treat economic offenses differently concerning bail.
Disgorgement Orders under Section 212(14A)
The Companies (Amendments) Act of 2019 introduced Section 212(14A), empowering the Central Government to seek disgorgement orders from the National Company Law Tribunal (NCLT) if an SFIO report identifies unauthorized benefits obtained by directors or officers due to fraud. This provision aims to hold individuals personally liable without limitations.
Integration with the Prevention of Money Laundering Act
Section 447 of the Companies Act has been included in the list of scheduled offenses under the PMLA. Consequently, handling the proceeds of corporate frauds is now considered money laundering. The Enforcement Directorate can seize and attach assets defined as “proceeds of crime,” creating unintended consequences for innocent parties.
Auditors’ Reporting Duty
Section 143(12) of the Companies Act mandates auditors to report any fraud committed against a company by its officers or employees. The Institute of Chartered Accountants of India (ICAI) has guided reporting fraud. Failure to report fraud may lead to the auditor’s removal for acting fraudulently.
Recent Regulatory Developments
As of October 8, 2020, the Securities and Exchange Board of India (SEBI) amended the SEBI (LODR) Regulations, 2015. Listed entities must now disclose the initiation of a forensic audit, the entity conducting the audit, and the final report upon receipt. This change, lacking materiality thresholds, poses challenges for Audit Committees and Boards, potentially impacting stock prices and investor sentiment.
With effect from October 8, 2020, SEBI has amended the SEBI (LODR) Regulations, 2015, to provide that if a forensic audit is initiated, listed entities must make the following disclosures to stock exchanges:
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Challenges for Corporate Boards and Auditors
The tightening of Sections 447 and 212, coupled with the inclusion of fraud in the PMLA, has raised concerns among Corporate Boards and Audit Committees. Strict bail conditions, asset forfeiture clauses, clawback provisions, and unlimited personal liability for directors have heightened apprehensions. Regulators and law enforcement agencies are increasingly focusing on criminal prosecution, shifting the landscape of corporate governance.
Conclusion
Corporate frauds remains a critical challenge for India’s corporate sector, necessitating stringent legal measures. Sections 447 and 212 of the Companies Act, along with their integration into the PMLA, reflect a commitment to addressing this issue. However, the impact on bail conditions, asset forfeiture, and personal liability for directors requires careful consideration. As lawmakers and regulators continue to adapt to evolving corporate frauds scenarios, vigilance and adherence to legal frameworks become paramount.
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