Investigation into the Affairs of a Company: Procedural Aspects

“Economic Offences have deep rooted conspiracy & huge loss of public funds, and they pose serious threat to the financial health of a country”

Supreme Court of India

Economic offences are divided into multiple categories and company fraud is one of them. As incorporated entities serve as an efficient mechanism for capital allocation [1], they sometimes become seedbeds for various frauds and financial irregularities of unimaginable value. “If someone delves down the surface of the corporate world they may come across a continuous stream of corporate scams[2]” The survey conducted by Delloite, highlighted that in the opinion of more than 63% of independent directors’ corporate scams would increase in the next two years.[3] As these corporate scams have attained a recurring nature it has become necessary for every person to have knowledge about legal remedies available in case one is aggrieved by the actions of such unscrupulous companies.

What Are Corporate Frauds?

Due to the severity and impact of corporate fraud on the financial health of a country, the government has structured and imposed various rules and legislations governing every aspect of a company from its incorporation to winding up and the investigation of frauds is no exception. The Black’s Law Dictionary defines “fraud” as all acts, omissions & or concealment which involve a breach of legal or equitable duty, trust or confidence justly reposed and are injurious to another or by unconscientious advantage is taken by another. In simpler terms, an intention to deceive any person with the objective of securing an unfair advantage can be termed fraud. The explanation provided under section 447 of The Companies Act, 2013 defines fraud in relation to affairs of a company as “any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss”[4]. The bare perusal of this section makes it clear that prosecution under this section is related to companies at first instance and then against the person who connived in the commission of fraud.[5] It must be noted that whenever an allegation of fraud is raised, the source of such information, details of information and details of fraud must be mentioned in the pleading. As Delhi High Court has opined, any vague allegations in respect of fraud will not be entertained until and unless it has been explicitly stated in pleadings.[6] It is a well-settled principle of law that any complaint of fraud failing to prove a prima facia case is liable to be quashed.

Types of Corporate Frauds

How does the Registrar of Companies (ROC) investigate Corporate Frauds?

Based on the information furnished by the company or by the representation made by a person stating that the business of the company is being carried on in a fraudulent, unlawful manner or in contravention to the provisions of the Companies Act, the ROC firstly will inform the company of the said allegation by written notice and call it to furnish an explanation on the matter thereby providing it with an opportunity of being heard[7]. The ROC also has the power to call for any information, inspect books of accounts of the company and conduct necessary inquiries and if a company fails to furnish the required documents the officers at default are punishable for a fine up to 1 lakh[8]. Further, after conducting necessary inspection and inquiry the ROC will submit a report in writing to Central Government recommending further investigating giving reasons for such recommendation[9]. It must be noted that any aggrieved person can make representation before ROC by filing an application highlighting all the information which prima facia indicates frauds and unlawful activities undertaken by the company and its directors.

Earlier under section 234(7) of the Companies Act, 1956 only a person interested could make representation before the ROC and not any stranger, for instance, a rival company or its director or members as such persons could not be said to have interest in the company but under section 206(4) of the 2013 Act, the Registrar can act on the representation made by “any person”[10]

What are the Powers of Central Government to Investigate Corporate Frauds?

The Central Government has the power to investigate the affairs of the company on-

• Receipt of Report from ROC as mentioned above or;
• When a special resolution is passed by a company, their affairs should be investigated.  or
• In Public Interest [11] or;
• When an order is passed by any court /tribunal in any proceeding that affairs of a company must be investigated [12]and
• On request made by any department of Central Government or State of Government [13]

The central government assigns the investigation to Serious Fraud Investigation Office (SFIO). The SFIO under the direction of the Central Government firstly can submit an interim investigation report thereafter the SFIO is required to file an investigation report after the completion of the investigation [14]. After analyzing the investigation report and considering the legal advice, the central government may order SFIO to initiate prosecution against the company and the officers of the company who are directly or indirectly connected with the affairs of the company. As per the provision of the act, the Central Government can order an investigation into affairs of a company in the public interest, but these powers are discretionary in nature, “In order to exercise this discretion reasonably and lawfully, the Central Government is required to formulate an opinion that an investigation into the affairs of the company is necessary[15]–

Whenever there are serious allegations of misuse of public funds then there is substantial public interest[16] involved for which investigation must be held however, if there is a lack of requisite material to arrive at the requisite opinion or record the necessary satisfaction that there is public interest involved then it is safe for courts to quash and set aside the order of such investigation.[17] In past years SFIO has been entrusted with an investigation where an exorbitant amount of money is collected from the public by such companies in the name of investments, chit funds etc. and the same is siphoned off to offshore accounts.[18]

It must be noted that any person can approach the central government for reporting corporate fraud by filing a serious complaint on the Ministry of Corporate Affairs web portal and such complaints must contain all the details of fraud committed by the concerned company.

How to file a Complaint in NCLT for Initiating Investigation for Corporate Fraud against a Company?

When there are circumstances which prima facia show that the business of the company is being conducted –

• In a fraudulent or unlawful manner or persons concerned with the incorporation of the company are guilty of misfeasance or misconduct.

• OR the members of the company have not disclosed all the information in relation to the affairs of the company which they are legally bound to disclose.

An application can be filed with the National Company Law Tribunal with all the necessary documents and information necessary to support the allegation and provide a good reason for initiating an investigation into the affairs of the company. It must be noted that a complaint to NCLT under section 213 can only be made

• In a company having share capital by more than 100 members or members holding not less than 1/10 of voting powers

• In a company with no share capital by not less than 1/5 of members of total members on the register of the company [19]

But as per the prevailing provision of the companies act, the NCLT on receipt of such application or complaint on being satisfied that there are circumstances suggesting that defraud etc. has been committed the NCLT can only refer the matter to the central government for investigation they are not competent to straight away direct any investigation to be conducted by SFIO.[20]

How are Accounting Frauds Investigated by National Financial Reporting Authority (NFRA) ?

The central government has already structured and prescribed accounting standards to be followed by companies and NEFRA being the government body which is set up under the companies act is entrusted with the duty to establish a high quality of accounting and auditing standards and supervise the accounting functions of companies. The authority is vested with the power to investigate matters of professional or other misconduct committed by any members or firms of Chartered accountants registered under the Chartered Accountants Act, 1949. The authority can initiate an investigation –

• When directed by Central Government
• Authority decides to undertake investigation due to irregularities in yearly compliance by company
• Suo Motu after recording reasons in writing[21]

After investigating, if the authority is of the view that there has been a contravention on part of the company, the authority refers the matter to the concerned division and show cause notices would be issued by it thereby providing them with a fair opportunity to be heard. The division must dispose of the show cause notices within a period of 90 days by commencing a summary procedure. The order of disposing of can result into the following situations-

1. No action
2. Caution
3. The penalty [22] can be imposed-
4. Fine of Rs. 1,00,000/- extendable up to 5 times the fee received in case of individual
5. Fine of Rs. 10,00,000/- extendable up to 10 times of fee received in case of firms
6. Debarment of the individual or firm

Any person or firm aggrieved from the penalty imposed by the division can appeal against the order in Appellate Tribunal constituted by the central government i.e. NCLAT.[23]

How is an investigation initiated by the Enforcement Directorate in Cases of Corporate Fraud?

The Enforcement Directorate (ED) generally deals with the offences under The Prevention of Money Laundering Act, 2002 which cover all the persons who are directly or indirectly and knowingly assist in concealment, possession, acquisition, or use of proceeds of crime. But in the case of the Enforcement Directorate public cannot make complaints directly to the agency they can either file an F.I.R which can be forwarded to ED or the Director of ED can Suo Motu on basis of material available to him is of opinion that there is a cause of action can file F.I.R and initiate investigation against the accused.

How is Investigation Initiated by CVC or CBI in Cases of Corporate Frauds?

The Prevention of Corruption Act is the principal act governing the laws relating to corruption the act focuses on the offence of bribery or misconduct committed by a public servant, but sections 9 and section 10 of the act also cover the circumstances when bribery is committed by a commercial organisation. Section 9 and 10 specifically state that when an offence under this act is committed by a commercial organisation such organisation will be punishable with a fine whereas if it is proved that such offence was committed with consent or connivance of any directors, manager, or any officer of organisation then they shall be individually punishable with imprisonment for a term of 3 years extendable up to 7 years with fine. It must be noted at this stage that-

• These agencies do not entertain anonymous and pseudonymous complaints;
• The Commission does not entertain complaints which are against private persons, State Government officials, Members of Parliament or State Legislature, elected representatives of other bodies, members of judiciary or officials of private organisations. The Commission does not have jurisdiction over them[24]

Therefore, in order to initiate investigation in such cases the complainant must include the name of the public servant to whom the bribe was given by the concerned commercial organisation otherwise the concerned authorities do not have jurisdiction over the private commercial organisations.

If any person has a reason to believe that a commercial organisation or any directors of such organisation have committed the offences under the prevention of corruption act, they may file a complaint either with- 

• Central Bureau of Investigation
• Central Vigilance Commission
• State Vigilance Commission

As “Corruption cases are of that category where preliminary inquiry may be conducted” [25] The agencies initiate preliminary inquiries, it must be well understood that preliminary inquiry is not conducted to verify the veracity of the information but only to ascertain whether any cognizable offence is revealed or not. Then The First Information Report is filed, and an investigation is initiated by the concerned agencies.[26]

If during the investigation process the Central Government due to any reasons mentioned above has assigned the case to SFIO then CBI, ED, CVC or SVC cannot proceed with the investigation instead the concerned agency has to transfer all the relevant documents and records in respect of such offences to SFIO which will be responsible for all further investigation.[27]  

Conclusion

Corporate Frauds are usually overly complex in nature and require special expertise for understanding and investigating them. Any person aggrieved by the actions of such unscrupulous companies may approach any of these agencies as per the procedure and seek remedy. These above-mentioned procedures and special agencies have facilitated the investigative process to a great extent, but any investor should not forget that the mere creation of a regulatory framework cannot eradicate corporate fraud. There is a further need for proper implementation of a code of ethics, corporate code of conduct, a comprehensive procedure for reporting unethical practices and the development of anti-corruption and anti-bribery policies within an organisation.[28]