Introduction

The battle against financial fraud and malpractices has significantly intensified over recent years. Globally, governments are establishing stricter regulatory frameworks and compliance standards to combat fraud in commercial transactions. A manifestation of such heightened awareness and regulatory action in India is evident under the provisions in relation to the Serious Fraud Investigation Office (SFIO) introduced under the Companies Act, 2013 (the Act) and Rules thereunder. These provisions bring with them implications for companies, which need to be fully understood and preventative steps taken to avoid any suspicion of fraud and consequent arrests. In the following paragraphs, we have analysed key aspects of the newly introduced Rules and the steps that must be taken by corporates to avoid any adversity under the same.

Under the provisions of the Act, the SFIO has been established by the Central Government as a multi-disciplinary office consisting of experts from diverse fields. The SFIO has been empowered to investigate serious cases of ‘fraud’, as defined under the Act. Furthermore, under the recently notified Companies (Arrests in Connection with Investigation by Serious Fraud Investigation Office) Rules, 2017 (the SFIO Rules or Rules), the SFIO has been empowered to arrest any person if believed to be guilty of fraud. The legislative intent behind these provisions and the wide-ranging powers granted to the SFIO is certainly clear. The power of investigation coupled with the power to arrest any person ‘believed to be guilty of fraud’ indeed equips the SFIO with potent powers to combat the menace of corporate fraud, which is deeply entrenched into and plagues our economy.

The Long – Arm of the SFIO

To fully understand the powers granted to the SFIO, it is important to analyse the key aspects of the legislative provisions. Under Section 447 of the Act, the term ‘fraud’ has been given a rather expansive definition. ‘Fraud’ has been defined to include any act, omission, concealment of any fact or abuse of position by any person with the intent to deceive, gain an undue advantage or injure the interests of the company, its shareholders or creditors, whether or not there is any actual gain or loss.

Furthermore, it is important to note that the definition of fraud under the Act uses the term ‘person’, thereby extending its application to directors, officers, employees or any other person in relation to the affairs of the company. Thus, auditors, advisors, consultants, experts, independent directors or non-executive directors who are not promoters or key managerial personnel, can also be held liable for fraud for acts or omissions which occurred within their knowledge. In fact, even directors who have resigned can be held liable, even after resignation, for offences committed during their tenure.

Implications for those subject to SFIO’s jurisdiction

Given the wide powers granted to the SFIO under the Act and Rules, it is important to understand the implications that it may have for companies in cases where the offence of fraud is committed. More particularly, since the power of arrest has been so overtly granted to the SFIO, it is crucial to understand the inherent rights of every person facing arrest.

As provided under the Rules, all provisions in relation to arrest under the Code of Criminal Procedure. 1973 shall apply mutatis mutandis to arrests made under the Rules. On making an arrest under the Rules, the arresting officer is required to forward a copy of the arrest order, the material in his possession (on the basis of which belief of guilt is formed), personal search memo and all other documents to the Director, SFIO immediately after the arrest is made. These details and particulars of the arrest like time and date, etc. shall be recorded by the Director in a register maintained by him. Furthermore, the arresting officer is also required to inform the arrested person of the grounds for arrest and produce him before a Judicial Magistrate within 24 hours of the arrest.

Moreover, as fraud is a cognizable, non-bailable and non-compoundable offence, bail is permitted only after giving reasonable opportunity to the public prosecutor to oppose it. Further, the court should be satisfied that there are reasonable grounds for believing that he is not guilty of such offence and that he is not likely to commit any offence while on bail.

Prudent anticipatory measures

In view of the stringent laws surrounding actions by the SFIO, it is extremely important for companies to undertake preventive measures and put in place adequate systems of internal controls and processes so as to steer clear of SFIO’s radar. Some important measures that ought to be considered are as follows:

  • Institutionalise specific processes for fraud risk management as a part of a company’s overall risk management strategies.
  • Include adequate internal policies, procedures, tools and mechanisms for prevention, detection and investigation of fraud. Well documented internal policies such as a code of conduct, anti-bribery policy, accounting policy, whistle blower policy, competitor contact policy etc. should be developed, adopted and adequately disseminated to all employees of the company.
  • Conduct periodical mandatory training workshops, seminars and sessions to educate employees and managerial personnel about the provisions concerning the offence of fraud.
  • Establish a specific fraud management committee or identify company executives who are actively involved with auditors in carrying out focused audits.
  • Establish concrete reporting protocols that require reporting and specific monitoring of transactions above a stipulated monetary threshold. Also, generally, the company should establish internal mechanisms for reporting, evaluating, investigating and undertaking remedial actions.