Tuesday, August 11, 2015

Changes in the Fraud Reporting Mechanism Under the Companies (Amendment) Act, 2015

[The following guest post is contributed by Suprotik Das, a 4th year law student at the Jindal Global Law School, Sonepat, Haryana.]

The Companies (Amendment) Act, 2015 is a harbinger of positive trends in the ease of doing business for Indian companies. This post is specifically with regard to Section 143 of the Companies Act, 2013 concerning the power and duties of auditors and its amendment thereof. 

Section 143(12) of the 2013 Act previously read:

Notwithstanding anything contained in this section, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government within such time and in such manner as may be prescribed.

Now, Section 13 of the Amended Act states that:

“Notwithstanding anything contained in this section, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed:

Provided that in case of a fraud involving lesser than the specified amount, the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as may be prescribed.”

There are some key points that I would like to highlight with regard to this amendment:

1. Materiality of frauds - The amended section 143(12) speaks of a threshold limit (yet to be notified), wherein fraud involving amounts above the threshold limit will be reported to the Central Government and amounts lower than the threshold limit will be reported to the Audit Committee under S. 177.


With regard to fraud materiality, there has been some development in the United States. In Amgen Inc. v. Connecticut Retirement Plans & Trust Funds,[1] the Supreme Court stated that a plaintiff is not required to prove the materiality of fraud/misrepresentation in order to obtain class certification. Class certification is a process by which a certain set of people are grouped together as a ‘class’ for the purpose of a class action suit under Rule 23 of the Federal Rules of Civil Procedure. This ruling will greatly benefit plaintiffs in the United States.

2. Bifurcation in reporting fraud - Internally to the Audit Committee and externally to the Central Government. However, this is applicable only to auditors.

3. With regard to internal and external whistleblowing by employees:

(a) For an employee in a company, there is still no demarcation as to when they are to report fraud internally and externally. The law still mandates reporting fraud to the Audit Committee with a stringent whistleblower policy in place. However, the execution and implementation of this aspect remains flawed due to the lack of protection to ensure anonymity for employees.

(b) The Ministry of Corporate Affairs (MCA) should ensure that it specifies rules dealing with the instances and threshold limits, which would guide an employee as to when to report fraud via the internal or external route. This procedure should be captured in the company’s whistleblower policy and adequate safeguards should be included to protect and preserve the anonymity of the employee.

(c) This dual procedure of an internal route vis-à-vis an external route of reporting fraud would provide greater clarity as to what exactly constitutes a ‘genuine concern’ under S. 177(9) of the Companies Act.

(d) There should also be safeguards that address conflict of interest issues such as when the internal route is biased, or when a member of the audit committee is being accused of fraud.

Conclusion

The present scenario of whistleblowing in India is quite ambiguous and there exists a number of inconsistencies within the Act. Just as the Parliament has started this dual approach to reporting fraud keeping in mind the materiality and substantiality of the amount involved with regard to Auditors, the MCA should notify rules which guide employees of a company when to report fraud internally and externally.

It will be interesting to see how fraud reporting pans out in India and whether reporting increases of decreases, especially after the new materiality requirement.

- Suprotik Das




[1] No. 11-1085, 2013 WL 691001

1 comment:

vswami said...

OFFHAND
The 'materiality requirement' dwelt upon, whether of auditors (or as-canvassed-for, of whistle blowers)is, prima facie,such an obviously nebulous, highly impracticable concept,as to be expected to make any sense or serve any useful purpose.If were to be probed into,it is bound to be realized that,even if he were an auditor howsoever shrewd or ideally equipped with 'professionalism' of a reasonable order -rarely come-by though, to make a clear apprisal of and come to a definitive conclusion as to what is material or not in a given situation is too difficult , nay well nigh impossible; as viewed, the reason is that,the basic exercise that entails suffers from the malady of , - 'subjectivity' and the inevitable consequence of human trait/tendency to be 'judgmental'.

In short, each one of the related concepts,- crude but being far from foolproof or safe-proof, is amenable to being individualistically understood and interpreted in a sense mutually differing and widely at variance.