Question

Fraud is an intentional act to misappropriate (steal) assets or to misstate financial statements. There are many documented high-profile collapses of companies due to fraud. As the Enron and WorldCom scandals unfolded, many people asked, “How can these things happen? If such large companies that we have trusted commit such acts, how can we trust any company to be telling the truth in its financial statements? Where were the auditors?”

These scandals caused the creation of the Sarbanes-Oxley Act in the US (NI52-109 Canadian Equivalent) requiring companies to maintain adequate internal controls and for senior officers to sign-off on the company financial statements, among other things.

Discuss one company which has committed an accounting scandal. Provide details on the fraud committed and preventative measures which could have been taken by the company, tying in textbook knowledge where appropriate

Answer 1

  Nirav Modi and The $1.77-Billion PNB Fraud

Punjab National Bank (PNB), India's second-largest public sector lender, is now in the middle of a ?11,400 crore transaction fraud case.

On Feb 14, 2018, PNB informed the Bombay Stock Exchange that it has detected some "fraudulent and unauthorised transactions" in one of its branches in Mumbai to the tune of $1771.69 million (approx).

The Central Bureau of Investigation (CBI) received two complaints from PNB against billionaire diamantaire Nirav Modi and a jewellery company alleging fraudulent transactions worth about ?11,400 crore. This is in addition to the ?280 crore fraud case that he is already under investigation for, again filed by PNB.

Who is Nirav Modi ?

Nirav Modi, the billionaire in the middle of this controversy, is a luxury diamond jewellery designer who was ranked #57 in the Forbes list of India's billionaires in 2017. He is the founder and creative director of the Nirav Modi chain of diamond jewellery retail stores, and is the Chairman of Firestar International, the parent of the Nirav Modi chain, which has stores in key markets across the globe. His designs have been worn to the Oscars by 'Hidden Figures' star Taraji P. Henson and to the Golden Globes by Dakota Johnson, among others. Actor Priyanka Chopra is the brand ambassador.

How The Fraud is detected ?

According to the complaint filed by PNB with the CBI on January 28, the fraudulent issuance of Letters of Undertakings (LOU) was detected at the Mid Corporate Branch, Brady House in Mumbai.

A set of partnership firms -- Diamond R US, Solar Exports and Stellar Diamonds -- approached the bank on January 16 with a set of import documents and requested for Buyer's Credit to make payments to overseas suppliers. The firms have Nirav Modi, his brother Nishal Modi, Mr. Nirav's wife Ami Nirav Modi, and Mehul Chinubhai Chokshi as partners.

Buyers Credit is, typically, a short-term loan facility extended to an importer by a bank to finance goods and services. It is a common mode of transaction in international trade where a bank extends credit to the importer and a finance agency based in the exporter's country guarantees the loan.

As there was no sanctioned limit in the name of the firms, the branch officials requested the firms to furnish 100% cash margin for issuing the LOU for raising the Buyer's Credit. At this, the firms contested that they have been availing this facility in the past; but the branch records do not corroborate this.

On digging further, the bank officials discovered that two of its employees had fraudulently issued LOUs in the past without following prescribed procedures and approvals. The employees had then transmitted SWIFT instructions to the overseas branches of Indian banks for raising Buyer's Credit without making entries in banking system to avoid detection.

The complaint also said that the funds so raised for the payment of the Import Bills have not been utilised for such purposes in many cases.

As per the FIR, five of the SWIFT messages (SWIFT is a messaging network used by financial institutions to securely transmit instruction) were issued to Allahabad Bank in Hong Kong and three to Axis Bank in Hong Kong.

Exclusive details after IT Investigation

Investigations related to the Rs 11,400 crore Punjab National Bank fraud just got bigger as a preliminary report by the Income Tax Department,revealed some startling facts. From striking details about Nirav Modi's limited exposure in his companies to how his uncle and business partner Mehul Choksi used to sell fake diamonds, here is a compilation of 10 shocking facts revealed today:

1) The I-T prelim report said the amount of fraud could exceed Rs 20,000 crore, as against the previously declared amount of Rs 11,400 crore. This is a big revelation considering the fact that much this banking fraud is twice as big as any other in the country.  

2) It has been learnt that before the entire PNB fraud, Nirav's relative and business partner Mehul Choksi used 'ponzi' scheme to restart his diamond empire after almost facing bankruptcy in 2013. Three FIRs filed by separate investors indicate that Choksi duped them of large sums of money, and even conned customers by selling fake diamonds.  

3) The I-T note hints that top authorities, including the RBI, had a rough idea of the mushrooming scam way back in 2014, but no concrete action was taken back then. In fact, several other whistleblowers had also raised red flags, but to no avail.  

4) One of the most shocking points that came to the fore after today is that Nirav Modi owns just 3-4 percent stake in all three companies mainly involved in the scam- Diamond R US, Solar Exports, and Stellar Diamonds. What this essentially means is that despite Modi owning the companies on face-value, the liability due to the loan fraud would not fall upon him.  

5) 'Dummy' companies were used by Nirav Modi and Mehul Choksi to route money - this is another startling revelation that was mentioned in the I-T report.  

6) It may be noted that despite Nirav Modi's exposure being limited in these companies, his name was being used to secure LoUs. Besides, the Income Tax report clearly indicated that the money would be "very hard" to recover, contradicting Punjab National Bank MD and CEO Sunil Mehta's assurance that the money is recoverable.  

7) The investigative agencies are seeking the "hidden" partners who own majority stakes in all of Modi's companies, to find out more information related to the multi-billion fraud. While action has been taken against bank officials, there is very little that has been done to nab other people who colluded with Modi to carry out the fraud. Another point that was raised by the IT department in the report indicates that most partners in Modi's group of companies sold off their share capital in 2017-18.

8) At a time when the government has set goals to recapitalise banks, the PNB fraud case comes as a huge jolt to the Indian banking sector and the government. However, PNB is still apprehensive about paying off the Rs 11,400 crore liability, but other lenders want RBI to mediate in the matter.  

9) In the last five years Punjab National Bank has proved to be a soft target for Jewellers. In the last five years Punjab National Bank (PNB) has been rattled by monumental frauds by jewellers — including two of the biggest by Winsome Diamonds and Shree Ganesh Jewellers — where exactly the same modus operandi was used as in the case of Nirav Modi. Though the losers in about Rs 7,000 crore Winsome case were a consortium of banks — the biggest hit was Delhi-based PNB.

10) The investigative agencies today removed the seal on the Brady Road Branch of PNB, after completing its investigations. It has questioned at least 11 PNB officials including CFOs of Fire Star Diamond and Nirav Modi companies. More names are expected to come out of the investigation in upcoming days, but the incident has revealed how there is a need of major internal reforms at all banks spread across the country.  

This is what we know so far.