Culture of Accountability: Directors, Auditors, and the ED in RAAG

I. Introduction

The recent raids conducted by the Enforcement Directorate (ED) on the Reliance Anil Ambani Group (RAAG), connected to banking frauds and irregularities involving Yes Bank, have shed light on the issues of corporate governance in India. The scale of the fraud is unprecedented and involves around ₹17,000 crore as non-performing asset (NPA) loans to three key RAAG entities. It also involves a separate fake bank guarantee involving Reliance Nu BESS Ltd., in relation to which the ED summoned Anil Ambani.

This piece discusses the critical shortcomings in the corporate governance structure in India and seeks to resolve these shortcomings through novel approaches. It also compares how corporate governance is dealt with in other jurisdictions.

II. The Scale of the Fraud as Revealed by the ED

The investigation and questioning carried out by the ED have revealed certain critical deficiencies in corporate governance and accountability, showcasing a failure of board oversight over actions that included failures in loan approval and in the independence of the independent directors (IDs). The investigations revealed the use of shell companies, undisclosed accounts, some digital directors, and even dummy directors.

Furthermore, the ED has alleged that there was an illegal diversion of ₹3,000 crore granted by Yes Bank to RAAG between 2017 and 2019. It is alleged by the ED that the loans were given in exchange for a bribe, wherein Rana Kapoor, along with his family members and entities connected to him, received ₹285 crore before the disbursement of the loan. The scale of the fraud involves 20 private and public sector banks whose exposures later turned out to be NPAs.

The investigation carried out by the ED sheds light on the severe failure of corporate governance in RAAG. These include failure in the loan approval process, a failure of board oversight, ineffectiveness and lack of integrity among independent directors, and weakness in internal control. Investors have pulled out of RAAG due to the erosion of the integrity of its governance structure.

III. Failure of Corporate Governance

The ED revealed that there were discrepancies regarding the loan approvals, as proper due diligence was not done and backdated credit approval memoranda were used, which were directly against the credit policies of the bank. The investigation also unearthed red flags that indicate the failure of corporate governance: books of accounts and shareholders’ registers were not present at the registered office of the company; dummy directors were found signing fake documents; and seven undisclosed bank accounts of the company were found, holding proceeds of crime amounting to crores of rupees.

IV. Role of the ED in Combating Financial Crimes

The ED investigated RAAG based on the findings by regulatory bodies such as the Securities and Exchange Board of India, the National Financial Reporting Authority, and Bank of Baroda. The findings prompted the ED to initiate the investigation under Section 17 of the PMLA. The PMLA provides severe punishments for reporting entities found guilty of the offence of money laundering. The punishments include fines, imprisonment, and confiscation of property that contains the proceeds of crime.

Furthermore, the Companies (Significant Beneficial Owners) Rules were amended by the Ministry of Corporate Affairs, which expanded the scope of money laundering and imposed strict compliance requirements on reporting entities. This includes the threshold for beneficial ownership, reduced from 25% to 10%, which makes it tougher to use shell companies to conceal ownership and control. Banks and financial institutions are required to collect information from senior management, partners and beneficiaries, which will now address the issues related to dummy directors and undisclosed accounts, and help in understanding the individuals controlling the company. Furthermore, cryptocurrency and virtual digital assets have been included under the purview of the money laundering laws, which helps in tackling money laundering done through digital assets.

V. Role of Independent Directors and the Audit Committee in Preventing Fraud

An independent director (ID) is an unrelated person who becomes a part of the board to keep oversight over the affairs and decisions of the company and to provide an unbiased opinion on those decisions. Section 149 of the Companies Act mandates that a listed company shall have at least one-third of its members as IDs. The IDs must report any discrepancies and act as whistleblowers.

SEBI’s LODR Regulation 18(1) mandates that there shall be an Audit Committee with a minimum of three directors, headed by an ID. The LODR also mandates that the members of the Audit Committee shall be “financially literate” and that the head of the committee shall be a financial expert.

Furthermore, SEBI has delineated the role and responsibilities of the Audit Committee in the precedent of the LEEL Electricals case. The Audit Committee is headed by an independent director to ensure corporate oversight. Sections 177(9) and 177(10) of the Act mandate that the Audit Committee shall report any sort of fraud occurring in the company. The Supreme Court in the N. Narayanan case noted that the role of the Audit Committee is that of a watchdog of the company, as its members have to sign the financial reports and verify every transaction.

It is, however, noted in the RAAG case that the Audit Committee failed to conduct its duty with due diligence and integrity, as a fraud on such a large scale would not have gone unnoticed by either the Audit Committee or the IDs. There was not even a single whistleblower in the RAAG case, and the Audit Committee did not raise a single shred of doubt while signing financial records. This raises serious doubts about whether the corporate governance structure is adequate.

VI. Comparative Analysis

The RAAG scam has highlighted critical deficiencies in the corporate regulatory structure and requires the incorporation of certain best corporate practices adapted to India’s own regulatory context.

A. United States of America

The Sarbanes-Oxley Act of 2002 (SOX) was introduced after the Enron and WorldCom scandals. Section 302 of SOX introduced certification of the annual statements by the Chief Executive Officer (CEO) or Chief Financial Officer (CFO). The CEO/CFO would be criminally liable in cases where the reports are false or inaccurate. Section 806 of SOX also protects whistleblowers by criminalising any sort of retaliation against them.

Furthermore, Section 404 of SOX empowers audit committees to hire external auditors directly, which requires the disclosure of the auditor’s independence. In the Indian context, the statutes can be amended to give the Audit Committee the power to commission external forensic audits in case of red flags. This would ensure that the committee acts as a true watchdog on corporate functioning and that neutrality remains in the report.

B. United Kingdom

The UK Corporate Governance Code (2018) requires officials of listed companies to either “comply or explain”, which requires the company, in its annual report, to state whether it has complied with the provisions of the code or else explain publicly why it cannot. Provision 11 of the Code states that at least half of the board shall comprise non-executive IDs. Provision 10 mandates that the company, in its annual report, must identify the non-executive directors and list certain circumstances that can impair their independence.

Moreover, Provision 21 mandates that the board’s performance be thoroughly evaluated every year, with the evaluation conducted by an external facilitator.

C. G20/OECD Principles of Corporate Governance (2015)

Chapter VI of the OECD Principles on Corporate Governance 2015 sets out the responsibilities of the board. These principles provide standards for corporate governance which can be incorporated into the domestic law framework.

VII. Suggestions

This section suggests changes to the corporate governance structure and governing laws in order to prevent such fraud from happening in the future.

1. Strengthening the Role of Independent Directors

In the UK, the Corporate Governance Code mandates that half of the board shall comprise IDs, and their independence shall be evaluated every year through external evaluations. It is suggested that India can implement third-party evaluators. The role of these evaluators would be to ensure independence checks of the IDs, and to consider reappointment in case an ID is considered disqualified.

2. Comply or Explain Method

Similar to the method followed in the UK, the comply-or-explain method can be enforced in India, wherein the regulators can evaluate a company’s non-compliance with certain regulations and ask them to either comply or publicly explain their actions. This would create a deterrence preventing future fraud.

3. Whistleblower Empowerment

The Securities Whistleblower Incentives and Protection provision, Section 78u-6, mandates that the Securities and Exchange Commission shall pay the whistleblower 10–30% of the monetary penalty imposed. This ensures that the whistleblower is rewarded for their work, and it incentivises other whistleblowers to act diligently. This model can also be implemented in India, along with strengthening whistleblower protection.

4. Compliance with the OECD Principles

Section VI of the OECD Principles mentions the responsibility of the board, which states that the corporation needs to be compliant with the applicable laws. Building on this, India can have a joint regulatory task force with members from SEBI, RBI, NFRA and the ED for real-time intelligence sharing.

5. Accountability and Training of Directors

SOX mandated that the CEO/CFO shall certify the statements filed by the company. Post certification, the CEO and CFO shall be criminally liable for false disclosures as well as misrepresentations. This can be done in India as well: the senior executives of the company signing off on the financial statements shall be liable in case of false disclosure and/or misrepresentation.

6. External Audit Committee to Act as Watchdogs

SOX has also empowered the Audit Committee to engage external auditors and mandates that the external auditor shall disclose their independence. Audit Committees can be empowered to conduct audits whenever there is a red flag and to give dissenting opinions. Additionally, IDs shall be liable for fraud with disqualification under Section 447 of the Companies Act for signing fraudulent accounts without conducting proper due diligence.

VIII. Conclusion

The RAAG case has illustrated the shortcomings of the Indian corporate governance system. IDs have become an ornament rather than being independent. Audit Committees are acting as rubber stamps instead of acting as watchdogs. These failures will further lead to erosion of investors’ trust. The ED plays an important role: in the RAAG case, its investigations revealed a great deal of underlying corporate governance failure. The ED, working in consonance with other regulatory bodies, would help ensure the prevention of such frauds. However, that alone is still not enough to ensure that the corporation functions smoothly.

Aligning with the best global practices, India can incorporate certain structural and legal changes in the regulation of corporate governance. The adoption of these practices in the Indian regulatory framework would ensure a genuine culture of accountability. These practices would ensure the accountability of directors, empower Audit Committees as genuine watchdogs, and incentivise whistleblowers to do their duties diligently.

To conclude, corporate governance is not just about the presence of laws but also needs active enforcement and the integrity of the regulatory bodies implementing them. The directors, IDs and Audit Committees need to fulfil their duty diligently, along with enforcement and regulatory bodies maintaining regular oversight over their work. The RAAG fraud should not be treated as a mere episode of fraud, but as a point from which government and regulatory bodies can rebuild trust in the corporate governance structure, ensuring independence, transparency and accountability.