May 06, 2022

International Fraud & Asset Tracing 2022 – Trends & Developments (India Chapter)

The Serious Fraud Investigation Office – a Growing Force

The Serious Fraud Investigation Office (SFIO) has been set up as a specialised multidisciplinary organisation to investigate serious cases of corporate fraud by the Ministry of Corporate Affairs (MCA). The Companies Act 2013 (“the Act”) gives the SFIO primacy as an investigating agency. This is evident from the fact that once the SFIO initiates an investigation, other agencies cannot proceed further with their investigations into the same matter till the SFIO finishes its investigation. Further, other agencies are obliged to transfer pertinent documents and material to the SFIO to enable it to investigate the matter being investigated. Upon culmination of the SFIO’s investigation, the SFIO is authorised to share any information/documents available to it with any investigation agency, government or police authority, as well as any tax authority, with respect to any action being undertaken by them for any matter being investigated.

The SFIO was originally formed in 2003 and did not have any special status as an agency under the Companies Act 1956. The absence of any special powers or primacy was largely responsible for the SFIO not being the favoured agency for investigating cases by the MCA, which largely relied upon the Registrar of Companies (ROC) for undertaking such actions. However, this position changed once the Act came into force from April 1 2014. Once the SFIO’s power and status were codified under Sections 211 and 212 of the Act, the MCA started entrusting it with investigating matters of corporate fraud.

The MCA now appoints the SFIO to investigate corporate frauds involving complex transactions that have interdepartmental and multidisciplinary ramifications or substantial impact on public interest. This is supported from data available on the SFIO’s website itself – the SFIO completed investigations in 104 cases in its first ten years, ie, from FY 2003–04 to FY 2012–13, and has completed 186 investigations in the first three years of its powers being codified, ie, from FY 2014–15 to FY 2016–2017. While these numbers have increased in recent years, the SFIO’s website does not have information on completed investigations beyond FY 2016–17. In response to a question on 19 September 2020, the Minister of State for Corporate Affairs informed Parliament that the SFIO was at that time investigating 92 cases. This indicates a substantial increase in reliance on the SFIO for investigations by the MCA.

Under Section 212 of the Act, the SFIO is tasked with preparing a detailed investigation report, which it then presents to the MCA for its examination and sanction. The MCA may direct the SFIO to initiate prosecution after analysing the SFIO’s investigation report. However, the impact of the SFIO’s reports is not limited to criminal prosecution alone. An SFIO’s report may also be used to initiate various other actions, such as an action for removal of the statutory auditor, and an action for oppression, mismanagement and unfair prejudice, either at the behest of the government, the shareholders of a company or in a class action.

Multiple regulators and enforcement agencies have started relying on the SFIO’s findings and initiating action pursuant to those findings. The MCA itself has, in certain cases, taken multiple steps before the investigation report of the SFIO even results in a prosecution by the special courts formed under the Act to examine the same subject of investigation. Our firm analyses the developments in the increasing use of the SFIO’s investigative powers, and reliance on its reports.

Aftermath of an SFIO Report

The SFIO may submit two types of reports to the MCA – (i) an interim report while the investigation is ongoing, or (ii) an investigation report on completion of the investigation. The SFIO’s investigation report is treated at par with a police officer’s report under Indian law, and can be used to initiate prosecution against the accused entity(ies)/individual(s). However, the court has recently held that the SFIO is not required to complete its investigation before initiation of prosecution.

A criminal case can be filed pursuant to the SFIO’s interim report as long as detailed charges are made out against the accused. In the Infrastructure Leasing and Financial Services (IL&FS) scam, where losses were initially quantified at 92,000 crores (USD13 billion), the SFIO was brought in as the sole investigating agency, to the exclusion of all others, to look into the matter. In this case, the SFIO not only investigated the matter but also initiated prosecutions based on their findings in the interim report.

Imprisonment and fines – prosecution by the SFIO

The SFIO’s reports are not merely a tool for preliminary investigation, but also form the basis for penal action and prosecution under the Act and under other laws in India. While the Act provides for investigative powers to the SFIO, prosecutions led by the SFIO to determine the guilt of the accused have steadily increased. Over time, the SFIO has also seen a consistent rise in the number of convictions as a result of this. As per the SFIO’s website, the SFIO had closed 93 convictions with penalty and imprisonment till FY 2018–2019, and the SFIO’s conviction rate had increased from 48% in FY 2013–2014 to 70% in FY 2019–2020.

Liability for fraudulent conduct of business

Section 339 of the Act provides that where, in the course of winding up, it appears that any business of a company has been carried on with an intent to defraud creditors of the company or any other persons or for any fraudulent purpose, the National Company Law Tribunal (“the Tribunal”) may declare the persons who were knowingly parties to the carrying on of the business of the company as personally liable. Such liability is without limitation towards all or any of the debts/liabilities of the company. Every person party to the carrying on of the business, who had the knowledge of such fraud, may be punishable. The liability of a party to the fraud may also include creation and enforcement of a charge on any debt or obligation due from the company to such person, or on any mortgage or charge or any interest in any mortgage or charge on any assets of the company held by or vested in such person, or any person on his behalf, or any person claiming as assignee from or through the person liable or any person acting on his behalf.

The principle of attribution and responsibility, without any limitation of liability, is not just limited to actions pertaining to Section 339 of the Act alone and transfers undertaken to defeat creditors. The said principle has also been extended to oppression, mismanagement and unfair prejudice cases filed before the Tribunal on account of Section 246 of the Act. In the event such application is made before the Tribunal, it can take necessary actions for recovery of undue gains, including disgorgement of assets.

In recent times, the MCA has exercised its rights under Section 241(2) of the Act to initiate an action of oppression and mismanagement in cases where the SFIO has issued an interim report or an investigation report. In such cases, the SFIO’s report has been considered as evidence to admit such an action by the MCA. The Tribunal has passed directions for safeguarding the stakeholders’ interests based on the findings in the SFIO’s report. The MCA has leaned heavily on such findings to obtain various pre-emptory orders, including orders of attachment before a judgment, and dissolution and takeover of recalcitrant boards of directors.

Claw-back based on the SFIO’s reports – disgorgement of assets

Another recent impactful addition to the effect of an SFIO report is the ability to use it as a basis to seek appropriate orders with regards to disgorgement of assets from such directors, key managerial personnel, other officers or any other person liable personally for the fraud committed upon the company. In terms of Section 212(14A), the central government now has the authority to initiate proceedings before the Tribunal seeking disgorgement of assets based on the SFIO’s findings of fraud. The action for disgorgement of assets can be initiated pursuant to the SFIO’s interim report or final report. Such action can be pursued against any person to claw back unjust enrichment obtained through fraud without any limitation on liability.

This may provide the Tribunal with an opportunity to directly consider findings set out in the SFIO’s reports as the foundation to trace the assets acquired through fraud, and consequently direct disgorgement of such assets. Jurisprudence on the reliance placed by the Tribunal on the SFIO’s findings to direct disgorgement of assets under Section 212(14A), and the extent to which the SFIO’s findings can be relied upon for directing disgorgement, is a matter that is yet to be tested before courts. However, a recent ruling observed that disgorgement of assets based on the SFIO’s reports must be for public interest since such claw-backs are in the nature of equitable relief designed to prevent a wrongdoer from unjustly enriching themselves.

This recent addition of permitting use of the SFIO’s reports is far-reaching. This considerably increases the weight of a report, as well as the reliance upon it. This is because an SFIO’s report can now effectively be a basis for deprivation of property even before trial by the Special Court where the report can be tested.

Re-casting of accounts

The accounts of a company may be reopened and re-cast if it is established that the accounts were (i) prepared in a fraudulent manner, or (ii) the reliability of financial statements is in doubt due to mismanagement of the affairs of the company. The MCA has in the recent past relied upon the SFIO’s findings to show that accounts were prepared in a fraudulent manner, and consequently to reopen past accounts and re-cast them. Since the SFIO’s investigations cover financial fraud and mismanagement, such investigation extensively evaluates the financials of the company under investigation. Enforcement actions based on an SFIO’s investigation and findings is longer limited to prosecution, asset tracing and recovery, but now also includes correction of financial statements.

The interplay between the SFIO’s findings and re-casting of financial statements has been tested before the Supreme Court. For instance, the MCA had obtained permission to reopen and re-cast the accounts of three entities linked to the IL&FS group of companies for five years from FY 2012–2013 to FY 2017–2018. The order permitting re-casting of accounts was challenged all the way to the Supreme Court in appeal. The Supreme Court affirmed the reliance placed on findings of mismanagement/fraud in the SFIO’s reports. Consequently, independent chartered accountants were directed to re-cast the accounts and revise the balance sheets of the three entities.

Use of an SFIO’s report by other regulators

There is always an interaction between different regulators in cases of corporate fraud due to the innovative and widespread nature of wrongdoings. This activates the jurisdictions of multiple regulators and law enforcement agencies due to potential violations of different laws. While other law enforcement agencies cannot proceed with their investigations on fraud once a case is assigned to the SFIO, several other sectoral regulators are free to rely upon the SFIO’s reports to determine the wrongdoing under their respective domains.

The SFIO has the obligation to share its findings with other regulators, investigating agencies, and tax authorities to enable them to take appropriate actions in accordance with their statutory powers for any contraventions made on the basis of such findings. These regulators rely on the findings in the SFIO’s reports to build their case, since the fraud investigated by the SFIO is at times the bedrock to other violations. Regulators such as the National Financial Reporting Authority (NFRA), the Reserve Bank of India (RBI), the ROC, and the Securities and Exchange Board of India (SEBI) are known to rely on findings in the SFIO’s reports to initiate proceedings for violations under their respective regulatory domain.

The NFRA is tasked with investigating the quality of audits and taking disciplinary action against auditors and audit firms. The NFRA has the power to impose sanctions such as monetary penalty or prohibition from practising if an auditor or audit firm’s audit fails to meet the prescribed standards. The NFRA is a relatively new creation aimed at improving regulatory oversight on audit and other accountancy-based financial services. In the IL&FS scam, the SFIO’s investigation cast aspersion on the role of the statutory auditors of IL&FS Financial Services Limited (IFIN). Consequently, the NFRA reviewed the statutory audit and financial statements of IFIN for the past ten years and released Audit Quality Review Reports alleging IFIN’s statutory auditors failed to discharge their duty. The NFRA, in the case of certain individual auditors, has even imposed a fine and barred them from being appointed as an auditor or internal auditor of any company for five to seven years. The NFRA’s authority to review IFIN’s audit has been challenged, and it will be interesting to see how Indian courts define the NFRA’s powers and authority.

The RBI also relied on the SFIO’s report in the IL&FS scam. IFIN, a key subsidiary of IL&FS, was a licensed non-banking finance company regulated by the RBI. The SFIO’s report flagged ever-greening of loans, violation of norms related to adequate provisioning, credit concentration, and net owned funds. Taking notice of these violations, the RBI instituted its own proceedings to penalise and cancel IFIN’s licence.

In the case of National Spot Exchange Limited (NSEL), the SEBI relied on the SFIO’s report in its proceedings to cancel NSEL’s registration as a commodity derivates broker. The SEBI has also initiated an investigation into the IL&FS group companies pursuant to the SFIO’s interim report, and relied on the SFIO’s findings to initiate proceedings against intermediaries associated with such companies.

Courts on the SFIO’s Authority and Conduct of Investigation

Time limits for investigation

The MCA has the power to set time limits on the SFIO’s investigations. However, the Supreme Court held that the timelines set by the MCA are not mandatory in nature since the Act does not set any time limit on the SFIO to prepare its investigation report. The SFIO’s authority to investigate a matter does not end in the case that the SFIO is unable to adhere to the time limit set by the MCA.

Interim reports and investigation reports carry equal evidentiary value

The Bombay High Court examined whether prosecution could be initiated on the basis of an SFIO’s interim report where the SFIO had initiated prosecution while its investigation was still ongoing. The Bombay High Court held that prosecution can be initiated on the basis of an interim report even if investigation into the affairs of connected companies or cross-linkages is still ongoing. The status and evidentiary value of an interim report is to be determined on the strength of the SFIO’s findings and not the nomenclature of the report.

The SFIO can engage independent technical experts to speed up its investigation

The Supreme Court has permitted the SFIO to engage external independent technical experts, such as chartered accountants and valuers, in its investigations – for instance, in the SFIO’s investigation into the affairs of the Heera Gold Exim group. The relative speed of the SFIO’s investigations is likely to increase in addition to more nuanced findings if this is repeated in future investigations.

Strict criteria for bail in economic offences

Recently, the government and courts have started viewing economic offences causing huge loss to public funds very seriously. Courts have considered economic offences as a separate class requiring greater scrutiny and restraint while considering cases arising from them, such as whether to grant bail to the accused while the investigation or prosecution is ongoing. The Supreme Court has repeatedly refused bail in SFIO matters, observing that such offences are grave offences that pose serious threat to the financial health of the country.

The SFIO – The Dominant Fraud Investigating Agency in the Future

The SFIO has in recent years brought investigation of corporate fraud to the forefront. It is given a priority amongst investigating authorities for investigations into corporate fraud, and no other investigating authority can proceed with its investigation once the SFIO is given the mandate to investigate a matter. The SFIO has increasingly conducted more investigations and achieved more convictions, becoming the preferred authority for the central government to investigate cases of fraud.

The SFIO’s role has changed from a mere investigating authority to a one-stop authority for the resolution of fraud. An example of the increasing mandate of the SFIO is the Heera Gold Exim case, where the SFIO was directed to assist investors in realising their claims against the accused by collating all claims and distributing the appropriate amounts. This increasing reliance on, and authority of, the SFIO will define investigations into corporate fraud and asset tracing in the coming years.





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