SFIO – Super Regulator for Financial Sector Frauds?

In the last decade India witnessed financial sector frauds of huge magnitude, which severely dented the financial sector. Non-Performing Assets rose to dangerous levels of USD 120.6 billion causing serious stress on the banking and non-banking financial sectors. While billions of dollars are involved in such frauds; investigation, tracing, and recovery of the same has been painfully slow and ineffective. Historically, only small fractions of sum involved in such frauds have been traced and that too after long and arduous investigations. Restitution of the same is another story as it happens only after successful prosecution. Scams of such magnitude severely affect the economy and can potentially disrupt sectors by setting-off chain reactions. Most such corporate frauds gravely jeopardize interests of the public shareholders as well as lenders since most large corporates are public listed companies where promoters conduct business with funds from banks, financial institutions and general public.

The modus operandi in most cases has been the promoters and management siphoning corporate funds through structured transactions which are seemingly legitimate but are really parts of a larger conspiracy. The illegality is only revealed when various layers are peeled, and the transactions are seen together to reveal the actual effect. A classic ploy has been companies transacting business with entities which on paper appear legitimate third parties but are either de facto controlled by the promoters or the management or are acting in concert with them.

Myriad of such ostensibly legitimate transactions are executed to create a smokescreen and conceal the ultimate beneficiaries. In this quagmire the money often disappears. Often there is an offshore leg of such transactions, ensuring that monies are routed through foreign tax havens which makes investigation and tracing extremely difficult. It is but obvious that such transactions cannot be conceived, structured or executed without the help of sophisticated professionals.

The rise in sophisticated crimes in the financial sector requires a well-equipped specialized agency to investigate and prosecute such crimes. While most state police forces have a separate ‘Economic Offences Wing’, the said department is found inept in investigating and prosecuting complex financial crimes. A major hurdle in investigating complex financial crimes across the globe has been jurisdictional overlap between investigative agencies which have differing agendas and consequently, end up with divergent findings / conclusions.

CII Recommendations for 2021-22 Budget

The Confederation of Indian Industry1 (‘CII’) in their recommendations presented to the Government of India for the budget year 2021 – 22 called for various financial sector reforms. Amongst the various reforms suggested, it specifically called for a single specialized agency with the requisite expertise to deal with financial sector frauds. CII further recommended creation of market intelligence units within the Ministry of Finance, Government of India to identify early signs of financial sector fraud which would eventually help in preventing deep-rooted financial fraud. CII also called for Financial Stability and Development Council to play a bigger role in protecting investors, especially small investors by ensuring seamless coordination between various agencies.

Interestingly, the CII, as an alternative suggested reworking the existing framework to ensure better coordination between investigative agencies and enhancing their capabilities. It is clear from the recommendations that there is concern in the industry regarding financial sector fraud and the need for better coordination between the investigating agencies. Undoubtedly, keeping in mind the current scenario, strong coordination for enforcement is required. While the present regime has proved to be ineffective, leading to calls for a specialized agency, the way forward may be found in the present law itself in the form of the Serious Fraud Investigation Office (‘SFIO’) established under the Companies Act, 20132 (‘Companies Act’).

SFIO under the Naresh Chandra Committee

The SFIO was established pursuant to recommendations of the Naresh Chandra Committee (‘Report’). The agenda was simple – create a multi-disciplinary body which could single-handedly tackle the rising menace caused by complex corporate frauds which the pre-existing agencies, given their resources, were unequipped to handle3. SFIO was modelled along the lines of the Serious Fraud Office (‘SFO’) in the UK and the Corporate Task Force in the US and was envisaged as the single agency which would direct and supervise investigations and prosecutions under various economic legislations.

Initially, the SFIO was established by way of a government resolution (‘Resolution’) within the Department of Company Affairs (‘DCA’) to take up investigation of frauds characterised by:

  1. complexity and having inter-departmental and multidisciplinary ramifications;
  2. substantial involvement of public interest in terms of monetary misappropriation or in terms of number of persons affected; and
  3. the possibility of investigations leading to, or contributing towards a clear improvement in systems, laws of procedures4.

However, instead of being the premier investigative agency as it was touted to be, SFIO remained a paper tiger looking into violations/offences under the old company law (Companies Act, 1956). Shockingly, the SFIO at that stage did not even have the power to arrest an accused, a power which was vested with the SFIO as late as in August 20175, i.e., almost 14 years after its establishment. There were multiple problems which led to dismal performance of the SFIO.

New Law

Undoubtedly, the biggest hurdle before the SFIO was the lack of legislative backing. However, that situation was sought to be remedied when the SFIO was given statutory recognition by virtue of the new company law, i.e., Section 211 of the Companies Act and was given more teeth. Amongst other powers, the SFIO could now arrest accused persons. Further, the threshold for obtaining bail by a person arrested by the SFIO was made incredibly high. However, the issue whether the SFIO could exclusively investigate and prosecute offences related to corporate frauds but punishable under other statutes remained unaddressed.

While Section 212 of the Companies Act hints at exclusive jurisdiction of the SFIO, it muddies the waters more than clearing them up. Section 212 ostensibly puts a bar on other investigative agencies from investigating offences being looked into by the SFIO, but the use of the phrase “…under this Act” in Section 212(2) suggests that other agencies would not investigate offences under the Companies Act which are being investigated by the SFIO. This however is absurd since other agencies in any event do not have the jurisdiction to investigate offences under the Companies Act. The literal interpretation of Section 212(2) makes the provision otiose and nuggatory.

Further doubt has been created by the fact that the SFIO has been granted recognition through the Companies Act and not a separate statute like the Criminal Justice Act, 1987 in the UK. This has led to many believing that SFIO is only responsible for offences punishable under the Companies Act and not other statutes. Pertinently, in India, specific agencies have been established under special legislation to investigate offences arising under those legislations. Therefore, even today, multiple law enforcement agencies continue to conduct investigations into the same financial crimes.

However, the law as it exists today points to legislative intent of conferring primary jurisdiction on the SFIO for cases involving, inter alia, corporate fraud.

Statutory Scheme and Purposive Interpretation

The Companies Act defines ‘Fraud’6 in the broadest possible terms. Transactions which amount to ‘Fraud’ under the Companies Act would often lead to offences under other statutes, especially under the general criminal law, i.e., Indian Penal Code, 1860 (‘Penal Code’). In such cases, purposive interpretation ought to be adopted to ensure that the SFIO investigates the transaction amounting to offence under the Companies Act as well as the general criminal law. However, in case the transaction also leads to offences under the special statutes wherein specific agencies have been entrusted with investigation, SFIO ought to be the primary investigating agency, which would coordinate the investigation and prosecution with other special agencies. This becomes clear from the statutory scheme of the Companies Act.

Firstly, the Report which forms the basis of establishment of SFIO envisioned as a new “super agency” to tackle intricate frauds which could only be unravelled by a multi-disciplinary task force. This goal could only be fulfilled if SFIO were to move beyond the scope of Companies Act and work in tandem with other agencies by supervising them and assisting them with the investigation (as is the case of SFO). Thus, for SFIO to fetch the desired results, it must either look into investigations alone or at least act as a supervising agency.

Secondly, by virtue of Section 212 (2) of the Companies Act, once the SFIO investigation commences investigations by other agencies are to be transferred to the SFIO7. Even the Resolution contemplated that SFIO investigate cases of corporate fraud and later, maybe, transfer investigation reports to the respective agencies for prosecution and/or other appropriate action.8

Thirdly, Section 212(17)(a)9 of the Companies Act directs other investigative agencies including the Police to provide all the information/ documents available with them to the SFIO; with an overall agenda of avoiding duplication of work and wastage of resources.

Fourthly, by mutual reading of Section 435 and Section 447 of the Companies Act, it may be concluded that special courts enjoy exclusive jurisdiction to try offences (including fraud) punishable under the Companies Act. Thus, no other court can take cognizance if the offence is such that is punishable under Companies Act.

From a combined reading of the aforesaid, it is evident that once SFIO is investigating a case for corporate fraud, it may by necessary implication also investigate offences punishable under the general law, but arising from the same transaction, which may then be tried by the special court established under the Companies Act. Interestingly, in certain cases the SFIO has already filed investigation reports in special courts for offences under the general law in addition to the Companies Act.

However, in one such case, the High Court of Bombay formed a prima facie view at the interim stage that investigation by the SFIO regarding offences under the Penal Code was a transgression into the domain of other investigative agencies and the legislature could not have intended so.10

While forming such a view, however, the High Court overlooked the aforesaid scheme of the Companies Act as well as the recommendations contained in the Report. In the given scheme of things, purposive interpretation of the statute would point towards exclusive jurisdiction of SFIO regarding transactions which give rise to corporate fraud or at the very least primacy of SFIO investigation.

Specialised Personnel

By not allowing the SFIO to be the primary agency, to investigate cases of corporate fraud, one overlooks a crucial aspect of the agency, i.e., the involvement of experts in the organisation. The Companies Act11 clearly lays down the fields from which members may be appointed within the SFIO which includes persons having expertise in the fields of investigations, cyber forensics, financial accounting, management accounting, cost accounting, etc. This has been further elucidated in rules framed under the Companies Act for investigation and inquiries by the SFIO,12 making it the befitting agency to investigate complicated financial frauds.

By ignoring the obvious benefits of a single agency looking into cases of corporate / financial fraud, the situation as it exists today is one of jurisdictional overlap which could derail investigations and prosecutions. A major drawback of not giving SFIO the stature it deserves is that it leads to prolonged litigation, thereby undermining the very objective of establishing the agency. Considering the rising number of cases of corporate fraud in the financial sector, it is imperative to judiciously utilize the expertise of the SFIO and make it an all-encompassing investigative agency that it was meant to be.

Footnotes

1. CII is an industry association in India. The primary goal of the association is to develop the Indian industry by partnering with the government on various national and international issues.

2. 211. Establishment of Serious Fraud Investigation Office

    1. The Central Government shall, by notification, establish an office to be called the Serious Fraud Investigation Office to investigate frauds relating to a company:

 

Provided that until the Serious Fraud Investigation Office is established under subsection (1), the Serious Fraud Investigation Office set-up by the Central Government in terms of the Government of India Resolution No. 45011/16/2003-Adm-I, dated the 2nd July, 2003 shall be deemed to be the Serious Fraud Investigation Office for the purpose of this section.

    1. The Serious Fraud Investigation Office shall be headed by a director and consist of such number of experts from the following fields to be appointed by the Central Government from amongst persons of ability, integrity and experience in,—

 

    1. banking;
    2. corporate affairs;
    3. taxation;
    4. forensic audit;
    5. capital market;
    6. information technology;
    7. law; or
    8. such other fields as may be prescribed.
  1. The Central Government shall, by notification, appoint a director in the Serious Fraud Investigation Office, who shall be an officer not below the rank of a Joint Secretary to the Government of India having knowledge and experience in dealing with matters relating to corporate affairs.
  2. The Central Government may appoint such experts and other officers and employees in the Serious Fraud Investigation Office as it considers necessary for the efficient discharge of its functions under this Act.
  3. The terms and conditions of service of Director, experts, and other officers and employees of the Serious Fraud Investigation Office shall be such as may be prescribed.

3. Available at: https://www.finmin.nic.in/sites/default/files/chandra.pdf at Page No. 21

4. Resolution No. 45011/16/2003-Adm-I dated 02.07.2003

5. Companies (Arrests in connection with Investigation by Serious Fraud Investigation Office) Rules, 2017, notified on 24.08.2017

6. 447. Punishment for fraud – Without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud involving an amount of at least ten lakh rupees or one per cent. of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud:

Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.

Provided further that where the fraud involves an amount less than ten lakh rupees or one per cent. of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to five years or with fine which may extend to fifty lakh rupees or with both.

Explanation.—For the purposes of this section—

  1. “fraud” in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss;
  2. “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled;
  3. “wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled.

7. Section 212 (2) of the Companies Act, infra note 2

8. Available at: https://sfio.nic.in/about_history_sfio

9. Section 212 (17)(a) – In case Serious Fraud Investigation Office has been investigating any offence under this Act, any other investigating agency, State Government, police authority, income-tax authorities having any information or documents in respect of such offence shall provide all such information or documents available with it to the Serious Fraud Investigation Office

10. Manish Rangari vs. Union of India [Criminal Application No. 94 of 2020]

11. Section 211(2) of the Companies Act

12. Rule 3 of the Companies (Inspection, Investigation and Inquiry) Rules, 2014