Fraud Reporting under Companies Act vis-à-vis Whistleblower Mechanism

April 19, 2024
fraud companies

By Rupin Chopra and Apalka Bareja

Ensuring trust and transparency in the corporate world is critical for a healthy economy and integrity for sustainable growth to maintain the trust amongst the stakeholders. Unfortunately, the potential for fraud and other forms of misconduct can undermine investor confidence and stifle growth. In India, the Companies Act, 2013 takes a proactive stance against such malfeasance by establishing a comprehensive framework for fraud reporting. This framework operates in close synergy with a dedicated whistleblower mechanism, creating a powerful two-pronged attack on corporate wrongdoing. This article explores how these provisions work together to safeguard the integrity of Indian businesses.

Fraud Reporting under Companies Act

Fraud Reporting by Auditors-

Section 143(12) of the act puts an obligation on auditors to report the matter to the central government, if he has a reason to believe that a fraud has been or is being committed against the company by its officers or employees, within such time and manner prescribed.

Rule 13 of the Companies (Audit and Auditors) Rules, 2014, provides for steps which are to be followed by the auditor if he has sufficient reason to believe that a fraud is being committed against the company by its officers or employees. As per the rule, if the auditor is of the opinion that a fraud of an amount of Rs. 1 crore or more is being or has been committed against the company by its officers or employees, then he is required to report the matter to the board or the audit committee, seeking their reply or observation within 45 days.

After receiving such reply or observation, the auditor is required to forward his report along with the reply or observation of the board or the audit committee, along with his comments to the central government within 15 days. In case, the auditor fails to receive any reply or observation from the board or audit committee within the stipulated time, then he shall forward his report to the central government along with a note. The report to the central government shall be in the form of a statement as specified in Form ADT-4.

Where a fraud of an amount less than Rs. 1 crore has been committed, the auditor is required to report the matter to the audit committee or to the board.

Vigil Mechanism/Whistleblower Mechanism under the Companies Act

The act requires a certain category of companies to establish a vigil mechanism vis-à-vis whistleblower mechanism, ensuring adequate protection for whistleblowers. Section 177 (9) & 177 (10) of the act, read with Rule 7 of the Companies (Meetings of Boards and its Powers) Rules, 2014, requires the following companies to establish a vigil mechanism[1] :

  • All listed companies
  • Companies that accept deposits from the public; and
  • Companies that have borrowed money from banks and public financial institutions in excess of Indian Rupees 500 million.

Furthermore, the companies that are mandated to form an audit committee must supervise the vigil mechanism via said committee. In case of other companies, a director shall be nominated from among the board of directors who shall play the role of audit committee to whom other director or employees may report. The vigil mechanism has been designed to protect the employees and directors who use it. They can directly reach out to the chairperson of the audit committee or the designated director for the purpose of vigil mechanism, in exceptional cases.

Working in Tandem

These two systems complement each other. Auditors, through audits and review procedures, may uncover potential fraud. Employees with firsthand knowledge can utilize the whistleblower mechanism to report such activities. The reported information can then be investigated by the company or relevant authorities.

Key Differences

  1. Initiation: Fraud reporting by auditors is triggered by suspicion detected during audits. Whistleblower reports can be based on any information the employee possesses.
  2. Focus: Auditors typically focus on financial irregularities. Whistleblower reports can encompass a wider range of misconduct, including ethical violations.
  3. Anonymity: While whistleblower mechanisms aim for anonymity, the identity of the reporting auditor may be known.

National Financial Regulatory Authority (NFRA) June 26, 2023 Circular

[2]As per the guidance note on reporting frauds issued by the Institute of Chartered Accountants of India (ICAI), statutory auditors werenot obligated to report a fraud to the central government if they weren’t the first to discover it during their duties as auditors, regardless of whether it exceeded the monetary threshold specified.

Therefore, if a fraud was discovered through whistleblower mechanism and was being addressed by the management, and if the statutory auditory was informed of such a case, then, provided certain conditions outlined therein were met (failure to meet which could still require reporting to the central government), the statutory auditor was not required to report it to the central government since they did not identify the fraud themselves.

The National Financial Regulatory Authority (NRFA) has recently issued a circular dated June 26, 2023, whereby it has stated that even if the statutory auditor is not the first person to identify the fraud, it is obligated to submit Form ADT – 4 to the central government under section 143(12) of the act.

Moreover, the circular states that even if the auditor has resigned he would not be relieved from the responsibility to report fraud or suspected fraud as mandated by the law.

Conclusion

In conclusion, The Companies Act’s fraud reporting and whistleblower provisions provide a robust framework for detecting and deterring corporate fraud. By encouraging reporting from both internal and external stakeholders, the Act promotes transparency and accountability within Indian companies thereby showcasing a significant stride towards combating fraud and promoting ethical practices in the corporate world. By empowering individuals to report fraudulent activities without fear of attack, this mechanism encourages transparency and accountability within the organizations. However, successful implementation requires not only legislative support but also a strong system, which includes clear reporting channels and safeguarding the interest of the whistleblowers.

Ritvik Kashyap, Intern at S.S. Rana & Co. has assisted in the research of this Article.

[1] https://www.mca.gov.in/Ministry/pdf/NCARules_Chapter12.pdf

[2] https://files.caclub.in/wp-content/uploads/nfra-circular-dated-26-06-2023-corporate-frauds-reporting-oblidations-of-auditors.pdf

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