The recent raids conducted by the Enforcement Directorate (ED)of the Reliance Anil Ambani Group (RAAG) connected to the 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 rupees as non-performing assets (NPA) loans to three key RAAG entities. It also involves a separate INR 68 lakhs crores fake bank guarantee involving Reliance Nu Bess Ltd., wherein ED summoned Anil Ambani.

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

The scale of Fraud as revealed by ED.

The investigation and questioning carried out by ED have revealed that there are certain critical deficiencies in Corporate Governance (CG) and Accountability, showcasing failure of board oversight on the actions that included failure in loan approval, independence of the Independent directors (ID). The investigations revealed the use of shell companies, undisclosed accounts, some digital directors, and even Dummy Directors.

Furthermore, the ED has also alleged that there is an illegal diversion of INR 3000 crore, which was granted by Yes Bank to the 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 as well as any entities connected to him, received INR 285 crores before the disbursement of the loan. The scale of the fraud involves 20 private and public sector banks that later turned out to be NPA.

The Investigation carried out by ED sheds light on the severe failure of Corporate Governance in the RAAG. These include the failure in the loan approval process, a failure of Board of Directors oversight, ineffectiveness and integrity of Independent directors, and weakness in the internal control. The investors have pulled out of the RAAG due to the erosion of the integrity of the governance structure of the RAAG. The scale of this fraud amounts to INR 17000 crores, which is a huge amount.

Failure of Corporate Governance.

ED revealed that there were discrepancies regarding the loan approvals, as proper due diligence was not done, and backdated credit approval memorandums 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, such as Books of accounts and shareholders’ registers were not present in the registered office of the Company, and Dummy directors were found signing the fake documents, and seven bank accounts of the company, which were not disclosed and the same proceed of crime amounting to crores of rupees were found.

Role of ED in Combating Financial Crimes

The ED investigated the RAAG based on the findings by the regulatory bodies like the Securities and Exchange Board of India, National Financial Reporting Authority, and Bank of Baroda. The findings prompted the ED to initiate the investigation under Section 17 of the PMLA. PMLA provides severe punishments for the reporting entities that are 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 ownership) rules were amended by the Ministry of Corporate Affairs, which expanded the scope of Money laundering and imposed strict compliance requirements for the reporting entities. The same includes the threshold for the beneficial ownership, which has been reduced from 25% to 10% which makes it tough to use shell companies to conceal ownership and control. Banks and financial institutions are required to collect information from senior management, partners, as well as beneficiaries, which will now address the issues related to the dummy directors, 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 and help in tackling the money laundering done by digital assets.

Role of Independent Directors and Audit Committee in Preventing Fraud

The 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 provide an unbiased opinion on the decisions of the company. Section 149 of the Companies Act mandates that a listed company shall have at least one-third members as ID holders. The IDs must report any discrepancies and act as whistleblowers.

The Securities and Exchange Board LODR Regulation 18(1) mandates that there should be an Audit Committee that shall have a minimum of 3 directors and shall be headed by an ID. The LODR has also mandated that the members of the AC shall be “financially literate” and the head of the AC shall be a financial expert.

Furthermore, SEBI India has delineated the role and responsibilities of the Audit Committee as in the precedent of the LEEL Electrical case. The Audit Committee is headed by an Independent director to ensure corporate oversight. Section 177(9) and 177(10) of the act mandate that the Audit Committee shall report any sort of fraud happening in the company. The SC in the N Narayan Case noted that the role of the AC is that of a watchdog of the company, as they have to sign the financial reports as well as 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 ID. There was not even a single whistleblower in the RAAG case, and the AC in this case did not even raise a single shred of doubt while signing financial records. This raises serious doubts about whether the corporate governance structure is adequate or not.

COMPARATIVE ANALYSIS

The RAAG scam has highlighted critical deficiencies in the corporate regulatory structure and requires the incorporation of certain best corporate practices that cater to its own regulatory context.

United States of America

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

Furthermore, Section 404 of the SOX empowers ACs 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 power to the AC to commission external forensic audits in case of red flags. This would ensure that the AC acts as a true watchdog on the corporate functioning and would also ensure that there remains neutrality in the report.

United Kingdom

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

Moreover, provision 21 also mandates that the board’s performance needs to be thoroughly evaluated every year. The performance shall be evaluated by an external facilitator.

G20/ OECD Principles of Corporate Governance (2015)

OECD principles on Corporate Governance 2015, Chapter VI, mention the responsibilities of the Board. These principles provide standards for corporate governance, which can be incorporated into the Domestic law framework. These principles outline that the

Suggestions

This section suggests the changes made to the Corporate Governance structure and governing laws in order to prevent such fraud from happening in the future.

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

2. Comply or Explain method.
Similar to the method followed in the UK, the comply and explain method can be enforced in India, wherein the regulators can evaluate the 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 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 gets rewarded for his good work, and it incentivises other whistleblowers to do their work diligently. This model can also be implemented in India, along with strengthening whistleblower protection.

4. Compliance with the OECD Principles
Section VI of the Organisation for Economic Co-operation and Development (OECD) 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 that has members from SEBI, RBI, NFRA, and ED for real-time intelligence sharing.

5. Accountability and Training of Directors
The SOX of the USA mandated that the CFO/CEO shall certify the statements that are being filed by the company. Post obtaining the certification, the CEO and CFO shall be criminally liable for the false disclosures as well as misrepresentations. This can be done in India as well; the Senior Executives of the company signing off the financial statements made by the company shall be liable for the same in case of false disclosures and/or misrepresentation.

6. External Audit Committee to act as Watchdogs
The SOX has also empowered the Audit Committee to engage with external auditors and mandates that the external auditor shall disclose their Independence as well. These AC can be empowered to conduct audits whenever there is a red flag and give their dissenting opinions. Additionally, ID shall be liable for fraud with disqualification under Section 447 of the Companies Act for signing fraudulent accounts without conducting proper due diligence.

Conclusion

The RAAG case has illustrated the shortcomings of the Indian Corporate Governance system. IDs have become an ornament rather than being independent. ACs are acting as rubber stamps instead of acting as watchdogs. These failures will further lead to erosion of the investor’s trust. The ED plays an important role, as in the RAAG case, the ED’s investigations revealed a lot of underlying corporate governance failures. The ED, working in consonance with the other regulatory bodies, would ensure the prevention of such frauds. However, it is still not enough to ensure that the corporate 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 shall ensure that the accountability of the directors empowers AC as genuine watchdogs and incentivise the whistleblowers to do their duties diligently.

To conclude, corporate governance is not just about the presence of laws but also needs an active enforcement and the integrity of the regulatory bodies implementing them. The Directors, ID, and AC need to fulfil their duty diligently, along with the enforcement and regulatory bodies, maintaining regular oversight over their work. The RAAG fraud shall not be treated as a mere episode of fraud, as a point for government and regulatory bodies to rebuild trust in the corporate governance structure, which would ensure independence, transparency, and accountability.