The term ‘Forensic’ comes from the Latin word ‘forensis’, meaning ‘acceptable before the forum’. “Forensic” refers to something that is “qualified for a court of law”. Forensic Audit is an application of accounting, auditing, and investigative skills to examine financial records and transactions in legal contexts. Forensic Auditor serve as financial detectives, often working on cases involving:

1. Fraud investigations (embezzlement, securities fraud, bank fraud, insurance fraud)
2. Financial statement manipulation
3. Asset tracking and recovery
4. Economic damages calculations in litigation
5. Divorce proceedings involving complex financial assets
6. Business valuation disputes
7. Bankruptcy and insolvency cases

What makes forensic audit distinct from traditional audit is its dual focus on financial accuracy and legal admissibility. Forensic Auditor must not only identify financial irregularities but also present their findings in a way that meets evidentiary standards and can withstand cross-examination in court.

The term “Forensic Investigation” got into prominence post the exposure of Satyam Computers Limited financial scam where the investigating agencies required specific accounting standards and parameters to establish the chain and link between the defaulters. The term “Fraud” which has been defined under various Laws as detailed below, which widely means – “a false representation of a matter of fact whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury.”

The term “Fraud” under various legislations are provided in brief below:

Types of Financial Frauds:

1. Bank Frauds – Including ATM frauds and loan-related frauds, with RBI providing regulatory frameworks for detection and reporting under Master Circular on ‘Frauds’- Classification and Reporting dated July 1^st, 2015, and Master Directions on Frauds- Classification and reporting by commercial banks and select FI dated July 3^rd, 2017, which provides framework to banks to enable them to detect and report frauds and take consequent actions such as to report to investigating agencies, so that fraudsters are been charged and effective.
2. Corporate Frauds – Involving dishonest activities by companies or management, including financial misrepresentation, fake valuation to attract potential investors, to commit money laundering, tax evasion etc. In general, the company’s auditor and the board of directors are responsible to raise any concern which may lead to any such situation that may result in fraud. Any failure on the part of auditor and /or directors as prescribed under the Companies Act, 2013 makes them accountable for commission of such fraud.
3. Bribery & Corruption – Unlawful behaviour seeking advantages through illegitimate means. It can be defined as intentional offering, promising or giving any undue pecuniary or other advantage to a public/private officer or decision maker, with an expectation that said person acts or refrains from acting in relation to the performance of their duties. Corruption or bribery schemes can be simple or very complex running across geographies using multiple modus operandi.
4. Cyber Frauds – Technology-based crimes including phishing, ransomware, and crypto scams. Any fraud committed through the use of internet, artificial intelligence or any mode of technology is referred as cyber fraud. Cyber frauds from a financial crime perspective are related to the identity theft or data to perspective financial frauds. Some of the most common cyber fraud schemes include Phishing Scams, Business email compromise, Website spoofing, Ransomware, malware, crypto related scams, etc.
5. Money Laundering – Processing illegal proceeds through placement, layering, and integration stages. The key purpose behind getting involved into the process of laundering or layering is to showcase that money has been acquired through legitimate means and thereby making of multiple layers so as to disguise the original source and show the source to be of genuine nature.
6. Ponzi Schemes – A Ponzi scheme is an investment fraud that pays existing investors with funds collected from next set of investors. It is an investment scam that attracts gullible investors with promise of extremely high returns. It pays such returns to initial investors with the newly deposited funds of new investors. With negligible or no legitimate earnings, Ponzi scheme require a constant flow of new investors to survive. The Ponzi scheme collapses when the perpetrator is no longer able to attract adequate funds from new investors to pay off the funds due to old investors.
7. Tax Frauds/Evasion – Tax fraud or tax evasion is an illegal activity in which a person or an entity deliberately and intentionally avoids paying a genuine tax liability. It generally involves some form of misrepresentation which is deliberate and intentional.

Role of Forensic Audit under the Indian Laws:

What is Forensic Audit?

Forensic audit is a specialized field in accountancy that involves systematic and independent investigation of frauds and analysis of financial information for use in legal proceedings. It has gained prominence due to the increasing number of financial and accounting fraud cases.

Regulatory Framework

The Institute of Chartered Accountants of India (ICAI) issued the Forensic Accounting and Investigation Standards (FAIS) 2023, effective July 1, 2023. These standards are mandatory for all auditors conducting forensic audits and provide guidelines for:

1. Systematic investigation procedures
2. Evidence gathering techniques
3. Identification of fraud symptoms and anomalies

Common Fraud Indicators

Forensic auditors look for various red flags, including:

1. Missing documentation
2. Same parties appearing in both debtor and creditor listings
3. Excessive voids or refunds
4. Multiple technical defaults
5. Purchases exceeding actual needs

Types of Offences Investigated

Forensic auditors typically investigate:

1. Embezzlement
2. Corruption
3. Asset misappropriation
4. Kickbacks
5. Financial statement fraud
6. Fictitious transactions
7. Money laundering

Legal Applications

The forensic audits are utilized to unveil economic offences, committed especially in relation to companies as mentioned below:

1. Companies Act, 2013: The Central Government can investigate company affairs, with SFIO (Serious Fraud Investigation Office) reports serving as starting points for forensic audits.
2. SEBI Act, 1992: Under Section 11, SEBI appoints investigating authorities for securities market violations, often utilizing forensic auditors.
3. Insolvency and Bankruptcy Code, 2016: Sections 43-51 and 66 require investigation of avoidance transactions, including preferential, undervalued, and fraudulent transactions.
4. Prevention of Money Laundering Act (PMLA): Forensic auditors help uncover complex transaction structures designed to hide asset disposals and their impact on going concern status.
5. Bharatiya Sakshya Adhiniyam 2023: Sections 39-45 recognize forensic auditors as expert witnesses, making their reports and opinions admissible in court proceedings.

Role in Legal Proceedings

Forensic auditors serve dual functions:

1. Investigators: They gather evidence and prepare detailed reports for stakeholders and investigation agencies
2. Expert Witnesses: They assist courts in adjudicating financial fraud cases, with their expertise being recognized across various Indian courts, including the Supreme Court

The forensic audit serve as a crucial tool in India’s fight against financial crimes, providing both investigative capabilities and expert testimony for legal proceedings.

Few cases are illustrated below, where Forensic Audit has played a critical role in exposing the financial fraud:

The above stated case studies in this article are been carved out from some of the leading financial fraud happened in last few years for general awareness and information purpose only. To know further details, clarification, assistance or any legal advice on fraudulent transactions, forensic audit, financial fraud or any action committed by the companies to defraud its creditors or any legal issues on insolvency, claims against fraudulent transactions or any disputes among the shareholders/promoters/ investors etc., you may connect with us at admin@equicorplegal.com  / 08448824659 and visit www.equicorplegal.com.