Research on Early Warning Signals of Corporate Frauds

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CA Mayur Joshi
CA Mayur Joshi
CA Mayur Joshi is a Forensic Accounting evangelist in India. He is the co-founder of Indiaforensic and is author of 7 books on forensic accounting, fraud investigations and money laundering.

Early warning signals of corporate frauds 

Indiaforensic Center of Studies commenced the research on Early Warning Signals of Corporate Frauds. The project was commenced in early 2008 to identify a set of exceptional transactions, under the leadership of CA Mayur Joshi to setup the benchmark for the industry.

What is Corporate fraud ?

Corporate fraud refers to activities undertaken by an individual or company done in unethical manner. Often, this kind of securities fraud is designed to give an advantage to the perpetrating individual or company. Corporate fraud goes beyond the scope of an employee’s stated position and are marked by their complexity and economic impact on the business, other employees, and outside parties.

This report aimed to help the board of directors of the listed companies in reducing the losses caused to the organization by the financially fraudulent activities. Further this project was aimed to create awareness about the opportunities pertaining to forensic accounting and to prevent the frauds by understanding the early signs and thereby taking the appropriate action.

At the time of this research forensic accounting in India was in a nascent stage. However, in the United States, former telecommunications company, Worldcom, was the victim of long-term accounting fraud by the company’s CEO.

Bernie Ebbers was able to inflate the company’s assets by more than $11 billion by capitalizing certain line costs, rather than appropriately recording them as expenses and inflating revenue through fake loans.  The internal audit team at Worldcom uncovered the massive fraud. Ebbers sentence was 25 years in prison, and the Sarbanes-Oxley Act was subsequently passed as a result of the massive scandal. 

India witnessed its first accounting fraud in the year January 2009. Stock Prices of erstwhile Satyam Computers collapsed, investors lost millions of dollars. Internal Auditors failed in detecting the frauds as the bank account statements of the company were forged. Just six months after the research on early warning signals of corporate frauds was completed.

On 29th August’2008 we have made available the study on Early warning signals of the corporate frauds. More than 300 professional Chartered Accountants from India and other countries participated in this and results of this survey are available in public domain.

There are two primary types of corporate frauds in India.

  • Frauds committed against the business
  • Frauds committed for the business

Certified Forensic Accounting Professional Syllabus is designed on the basis of this research. This research address symptoms of various fraud schemes, which can be sub classified under the above mentioned two schemes.

This research has a national significance and the excerpts of the Economic Times article are provided here for the kind reference.

“According to the initial concept, if the early warning system detects evidences or any trends indicating frauds or cheating, the ministry will have the right to initiate an inspection under provisions of Companies Act, 1956. The data on frauds will also be passed over to various Central government agencies dealing with money laundering, auditing and other financial frauds.

According to Mayur Joshi, Founder of Indiaforensic Center of Studies, a Pune-based education organization engaged in fraud examination and forensic accounting, the early warning signals are divided in two parts globally – warning signals of the frauds done for the company and indicators of the frauds done against the company.

“Frauds broadly covers financial statement frauds like recognizing the revenues too early in the balance sheet in order to meet the analyst expectations or in case of the SME’s the frauds which are committed to evade the taxes. Frauds against the company affects the bottom line of the company, for instance traveling claims inflation, embezzlement of funds and payroll frauds,” he explained.”

Impact of Research

This research had a significant impact on Indian society. In the next few years this research there were significant activities. Indicative list of the activities associated with the research on Early Warning signals of corporate frauds is elaborated below

  • M R Mayya former Executive Director of Bombay Stock Exchange supported this research report in Public and wrote article in Business Standard about the genuineness of this research. He also contributed to the Economic Times under the heading of “Do Multiple Agencies Harm market regulation?
  • While writing about the Satyam accounting scandal, in Jan’2009, Geeta Nair of Financial Express stated that it was predicted by Indiaforensic in the year 2008. This was the first and massive accounting fraud in India.
  • Thomas Wheelen and J David Hunger in their book on Management written in 2011, quoted the research to prove their point
  • Examination papers set by the Institute of Company Secretaries had the examination question on the research conducted by Indiaforensic
  • Study on Corporate Governance in India by Amit Kashyap referred this research as one of the references. This research is published by the Gujrat National Law University.
  • Dr. Gaddam Naresh Reddy of Osmania University published a research report on fraudulent financial reporting. This was created for Universities Grant Commission to understand the importance of the fraudulent financial reporting where Indiaforensic Research was mentioned as the base.

White collar corporate frauds are always expensive, investors have lost huge money in these frauds.

Satyam was a $ 2 billion fraud. Tyco was $ 500 million fraud.

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