India is world’s third-highest in corporate fraud

With one of the highest frequencies of corruption, regulatory breach and internet protocol theft cases globally, the problem of corporate fraud is on a rise in India, says a survey by US-based Kroll, a corporate investigations and risk consulting firm

As much as 80 per cent of the respondents from corporate India surveyed by Kroll reported prevalence of frauds this year as against 69 per cent in 2013-14. India is third on the list compared with Colombia's 83 per cent and Sub-Saharan Africa's 84 per cent.

''India also has the highest national incidence of corruption (25 per cent of firms), regulatory breach (20 per cent) and IP theft (15 per cent). It also ties for the highest national level of money laundering (8 per cent),'' the Kroll Global Fraud report for 2015-16 said.

The outlook for the future is also worrying: 92 per cent of Indian respondents reported that their firms had seen exposure to fraud increase in the past year.

For every fraud covered in the survey, respondents from India are more likely than average to report that their firms are highly or moderately vulnerable. In particular, they have the highest proportion reporting this level of exposure to vendor or procurement fraud (77 per cent), corruption and bribery (73 per cent) and regulatory or compliance breach (67 per cent).

While companies in India are willing to spend to improve their level of anti-fraud protection, it appears that such funds are not being invested appropriately. For respondents that had identified the perpetrator, 59 per cent indicated that junior employees were leading players in at least one such crime.

''Despite these vulnerabilities and the high proportion of fraud perpetrated by insiders, only 28 per cent of companies in India invest in staff background screening and only 55 per cent invest in vendor due diligence. Greater attention to employees and reputation-focused due diligence might significantly bolster other fraud efforts at firms in India,'' the report said.

Over $500 million worth of private equity (PE) investments in India are embroiled in legal disputes, according to Kroll.

''In our work supporting PE investors in such disputes, even the most seasoned PE investors who understand the Indian business environment have executed deals where they are unable to maximise the potential of their investments due, in part, to a dispute with the portfolio company,'' it said.

''Most disputes are triggered when PE investors suspect fraud in a portfolio company. The majority of deals in India are minority investments where promoters continue to control the business and the flow of financial information after a PE investment. Additionally, corporate governance standards in India are still evolving, especially in regards to small and mid-sized companies,'' said Reshmi Khurana, managing director and head of Kroll's India office. As a result, promoters may be following certain business practices which may not necessarily be aligned with the interests of the PE investor, such as related party transactions and diversion of funds for other businesses.

In such situations, it becomes difficult for a minority PE investor to understand the true performance of the portfolio company, Khurana said. ''While investigating fraud in portfolio companies, we see that the greatest erosion of value in a portfolio company occurs within the first 18 to 24 months of the PE fund's making the investment,'' she said.

Whether promoters are diverting funds out of the company (through illegal cash kickbacks from vendors) or manipulating financial data, Kroll experience suggests that fraud occurs soon after the investment, the report said.

While a forensic review of the financial data of an investment target can identify red flags, it cannot necessarily be relied upon to uncover fraud. Perpetrators often cover their tracks with false documentation and transactions that appear genuine and do not raise alarms in the pre-investment review.

''PE investors can avoid surprises and disputes by conducting in-depth and independent due diligence on the target company. This means fully investigating red flags or other symptoms of poor performance that are identified pre-investment,'' the report said.