Why Corporate Frauds in India Continue to Rise In Spite of Extensive Vigilance?
Infosys has come in the eye of the storm when a “whistleblower staffer” on October 22, 2019, revealed unsavory accounting dressing information in a letter to the board of directors of the company along with the US markets regulator, the Securities and Exchange Commission (SEC).The stock fell 16% in a single day – one of the steepest falls in recent times. This forced us to think again, why this exponential rise of corporate frauds in India continue to rise?
The letter has alleged that the focus of the company under the stewardship of the current CEO, Salil Parekh has been to window dress the revenues in the shortest time possible. The necessary approvals have been ignored especially for large deals. The so-called large deals of the last few quarters have zero margin – including with companies like Verizon, joint ventures in Japan, Intel and ABN AMRO acquisition. This clearly states the negligence in accountability which the company has started to investigate independently.
A Larger Malaise?
Repeated violation of accounting norms in India and its impact on the markets
So what is it with Indian companies that make them take this path towards dressing up so they end up feeling the dressing down from the stakeholders? Let us look at the most famous scandals and their impact on the markets.
This saw the biggest accounting scam in India with Satyam when the IT offshoring industry was at its peak and Satyam had become the bell-weather for revenues for the sector. The members of the board including the founder – B. Ramalinga Raju were found guilty of inflating the profit numbers for a number of years adding to $1.15 billion. The scam had been going on for nine years bringing to question the role of auditors like Price Waterhouse.
The owners had benefited from $400 million illegal inflation of stock prices. The scandal was closed with Raju and nine others found guilty in 2015. SEBI banned Price Waterhouse network entities from issuing any audit certification for two years to any listed company in India. However, investors have lost $2.7 billion in today’s money terms on account of their collusion.
The home loan financier misused the funds beyond its permissible limits due to the strain of profits. It had extended loans and advances to parties related to the promoters as interconnected entities. These were to the tune of Rs 24,594 crore to 65 entities which were companies with no real operations and minimal documentation. It was in short systematic siphoning off money meant for lending people for houses, leading to one of the most shocking corporate frauds in India.
The “shadow banker” to the commercial banks was a giant infrastructure lender in the economy. The fact that its liquidity issues were not flagged by its auditors became a talking point and serious lapses and collusion of the auditors were found with the promoters to hide the cash crunch. The company had a debt of 94000 crores and is likely to default, leading to massive number of stocks crashing in 2018.
Why corporate frauds in India continue unchecked?
The intention to avoid taxes and siphon off extra profits to offshore investment destinations makes it a lucrative prospect for companies to inflate balance sheets, show lesser profitability and avoid taxes. High corporate taxes, shady deals between companies, auditors and financial institutions have made it extremely difficult to track such cases. The case of Infosys or DHFL has affected millions of investors and has plummeted the Indian stock market by about 4-5%. Easing of rules by the government to initiate payment banks, cooperatives, finance banks have further added on to the probability of financial frauds. Fraudulent companies continue to transfer money to foreign destinations which are tax-free.
In dealing with this, the recent announcement by the government to cut down corporate tax to 22% is a good initiative. This is simply because the shareholders of a company would like to have greater dividends nice the company makes sufficient profits. Taxing this amount kills the very idea of a competitive business model, and investors become reluctant to spend more on growth and expansion. Keeping this in mind, long term capital gains should be taxed at the lowest possible levels to encourage business activities. As profitability grows the intent to transfer windfall gains to offshore banks will drastically reduce.
Tackling with the Issue of Auditor Corporate Nexus
All four big audit firms are under the scanner in India for covering up the trails on alleged losses, related -party transactions letting promoters get away with the diversion of funds, and even insider information leaking. The Satyam case fallout is still awaiting a verdict for Price Waterhouse from the Securities Appellate Tribunal (SAT).
BSR and Co. have recently resigned as auditors of two of Anil Ambani Reliance group companies over transparency issues in related party concerns. The noose around audit firms’ necks has tightened over the last few years with over 48 resignations of auditors from companies in 2018 and 17 listed companies in 2019. The DHFL fiasco saw resign as one of the auditors from the housing finance company.
With Deloitte and BSR seeing their accounts being frozen in India for five years for their alleged role in there has been a serious consideration on steps that can be taken to put an end to such misdemeanor in the future. Securities & Exchanges Board of India (SEBI) has come out with a consultation paper which lays down strict measures for auditors such as –
- Providing reasons for resignation from a firm
- No mid-review resignation till the full year of the audit is complete if they have signed over the quarterly audits
While the All India Chartered Accountants’ Society (AICAS) has opposed these moves on grounds that there is insufficient accounting disclosure and audit information is not enough to file in the statements, such rules will complicate matters.
Importance of Whistleblowers: Their role in exposing corporate frauds in India and why the state must protect its identity
The Whistle Blowers Protection Act, 2014 in India aims to provide a structure of protection and objective investigation to the allegations proposed. It is an important corporate tool to allow the spirit of transparency and openness alive. Most good companies have a whistleblower policy in place to ensure effective corporate governance in place. Reporting acts of wrongdoing is important to keep the strength of the company and invested capital be used responsibly.
Sometimes executives misuse powers vested by their positions and sometimes its a collusion to avoid graver issues where investors and employees can lose everything. Thus, ensuring the safety and giving seriousness to whistleblower calls is important to any company as it is answerable not just to the regulatory authority but society at large with various stakeholders. It will help in maintaining accountability and improve the ethical accounting policies of the corporates.