Establishment of Serious Fraud Investigation Office

Podcast On Establishment Of SFIO

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1.1 Short Introduction

The Companies Act, 2013¹ provides for the powers and procedure of the investigative arm of Central Government, Serious Fraud Investigation Office². Chapter 14 of the said Act outlines the role of SFIO in terms of Investigation, Searches, Seizure and Arrest. SFIO is relatively a new arm of Investigating Agency of the Central Government. It was formulated as recent as the year 2014. The requirement to bring in a new arm of Central Government is highlighted more in Parliamentary Debates than Chapter 14 of the said Act or for that matter the provisions of the said Act.

1.2 “Stock Market Scam” leading to establishment of SFIO

Interestingly, the suggestion of establishment of SFIO was born in the year 2001. The SFIO was already in existence prior to the year 2014. The Stock Market Scam of 2001 was the reason behind strengthening the SFIO. The SFIO was subsequent to the Stock Market Scam set up in the year 2003 under the Ministry of Corporate Affairs. An executive Order was passed to carry out investigations under the Companies Act, 1956. However, with a view to review, revive and strengthen the functioning of SFIO and also to make it more effective, the Central Government constituted an Expert Committee. The responsibility of the Report was given to Shri Vepa Kamesamm who was the former Deputy Governor of Reserve Bank of India.

A Report of the Expert Committee headed by Shri Vepa Kamesam at the instance of Ministry Of Corporate Affairs, New Delhi³ submitted its extensive report on the rise of ‘Corporate Frauds’. One of the core issue it recognized was the distinguishing factor of “corporate frauds” and from the “regular” ones. It observed that generally, frauds had an impact on Indian Stock market, the latest accounting fraud perpetrated by the promoters of Satyam company was a fraud on the company itself as it endangered the very survival of the company. The impact of serious and complex frauds on a large number of stakeholders has intensified the concern for effective regulation of the “corporate world”, the Report noted. This was the seed that lead to the idea of establishment of an Investigative Arm that dealt primarily with “Corporate Frauds”.

1.3 Readings of the Report – a glimpse into the minds of Lawmakers

A glimpse into the said Report would highlight the minds of the Lawmakers about the need to establish another arm of expert Investigators. It highlights the requirement about the reason behind an addition of another Investigating Agency, apart from Directorate of Enforcement and Central Bureau of Investigation. At the time, the other Investigating Agencies did not have the length and breadth to specifically investigate into the “corporate crimes”. The ‘Stock Market Scam of 2001’ was the seed that saw the development and establishment of SFIO. The Report noted that there must be a separate legislative framework to strengthen the investigation by SFIO and to make it more effective. Some of the provisions existed in the Companies Act, 1956 but were not strong enough to counter corporate frauds.

As a result, after deliberation upon various issues relating to investigation of corporate frauds, developments in the Indian and World arena and experiences of SFIO, a framework was suggested in the said Report. The Report also considered the law in several other jurisdictions such as United States of America, United Kingdom and Germany. The Report recognized the following two broad points to strengthen the law to address corporate frauds-

The existence, nature and phenomenon of “corporate frauds” to be recognized separately.
Provision should be made to address the “corporate fraud”
A comprehensive and inclusive definition of the Offence of ‘Fraud’ must be included in the Companies Act.
The jurisdiction of the SFIO must be integrated seamlessly in the Companies Act

The Report primarily wanted recognition, a definition and scope for the offence of ‘fraud’ to be inserted in the Companies Act, 1956⁴. It is worthy to note that the definition of the term ‘fraud’ centered around a similar Companies Act in United Kingdom namely, ‘UK Fraud Act, 2006’. The Report suggests that the expression or the definition of ‘fraud’ must be included in the Companies Act irrespective of the fact that it has features of any offence defined under Indian Penal Code, 1860⁵. Another important aspect the Report suggested is the integration of SFIO into the Companies Act, 1956. It suggested that the jurisdiction and power of SFIO must not be called into question when investigating ‘corporate frauds’.

1.3.1. Absence of procedure for prosecution incase of Fraud committed by Corporate Companies

According to the Report, there was no provision in the then existing Companies Act, 1956⁶ to address a criminal act by a corporate company. There was no provision under which criminal prosecution against a corporate company indulging in fraud could be initiated directly in a Criminal Court. Therefore, the Committee suggested to fill the lacuna. The Report recognized that the act of a corporate fraud stand on a different footing as per Companies Act and Indian Penal Code. Both the Acts may contain overlapping features or ingredients of a particular offence but it cannot be placed on an equal footing. An offence under Indian Penal Code and Companies Act cannot be said to be identical as the contravention of provisions of Companies Act by a Corporate Company would be different than a typical offence under Indian Penal Code.

Therefore, the Report suggested that it is paramount to identify the features of ‘fraud’ in all its aspects and dimensions to cover as much ground of the offence as possible in order to deal effectively and efficiently with corporate frauds. Another important aspect the Report noted that it would be futile to attempt to suggested changes to the Indian Penal Code in order to define the term ‘fraud’. A corporate fraud, according to the Report covered complex, multifarious and multi-layered dimensions. The Company suggested that- Since companies are dealt with though a specific legislation, Companies Act, 1956 , and it provides a platform where corporate fraud may be dealt with suitably, the Committee recommends that “comprehensive definition of fraud as an offence along with related offences, be included, with reference to the affairs of a company, as an inclusive definition, including the components defined in the UK Act, along with stringent penalties.

It was the recommendation of the Report that in exclusive jurisdiction ought to be mentioned for the purposes of addressing corporate frauds under the said Old Act. The inclusion of a jurisdiction to address the corporate frauds should be irrespective of whether it has features of the offence under Indian penal code. The changes must be able to deal with the cases of contraventions of the Companies Act and offences committed for non-compliance of the provisions of the Companies Act.

The Report noted that the investigation into offences, particularly economic offences committed by ‘Corporate Companies’, would not necessarily be a function of a police officer. It recognized that the powers of investigation into offences of economic nature are vested in specialized agencies which are set up under that very Special Act. Generally, the statute or the Act defines such an offence, it’s purpose and also mentions the punishment for contravening the provisions of such an Act. The Special Act provides for investigation and prosecution along with a framework of procedure by which such investigation and prosecution harmoniously proceed. The Report suggested establishment of SFIO as a Special Agency under the Special Act, Companies Act.

Another interesting aspect noted by the said Report in support for a separate Legislation for empowering SFIO with investigation and reporting of crime was the consequence of SFIO lodging an First Information Report⁷ with the State Police. The investigation by SFIO as well as State Police would result in duplication of work and problems of coordination. This could have the possibility of causing delays in the investigation and make the procedure for prosecution cumbersome, the said Report noted. It was noted that under the regime of the said Old Act, the SFIO was able to conduct investigations in a fair manner for offences arising out of violations of the Companies Act. Therefore, the Report felt, that instead of drafting a new Legislation, steps must be taken to strengthen the then current said Old Act.

1.3.2. Amendments to the Old Companies Act to strengthen the powers of SFIO

The Report noted that the ultimate object of setting up SFIO was to establish an Agency with multi-disciplinary capacity that had an understanding of the complex layers of a corporate structure and bandwidth to conduct investigations into corporate frauds. The nature and complexity of the ‘corporate frauds’ such that it was difficult to uncover the truth. Therefore, on the basis of experience gained through investigations conducted in the past, the Report noted that the said Old Act provides a framework for investigations by SFIO. The only necessity was to carry out amendments in order make it strong and meaningful. The strengthening of SFIO at the organizational level, co-ordination with other intelligence agencies and specialized skills for investigation was necessary in order to improvement of the functioning of the SFIO.

One of the changes suggested in the said Report to the said Old Act was in relation to the report of Registrar of Companies⁸ which is the basis of the decision by the Central Government to issue Orders for investigation into a company. The provision of the said Old Act was Section 235. The analogous provision in the new Act is Section 212 of the Act. It also empowered the concerned Court to pass directions for investigation into the affairs of a Company. The Report noted that the provisions were appropriate to enable any stake-holder to approach the court and seek directions for investigation. The procedure is time consuming and depends on the report of the ROC, who may not be equipped to comprehend the nature of ‘fraud’ in cases of complex nature. As per Section 234 of the said Old Act, an opportunity was provided to the concerned Company prior to an Order of prospective investigation by the Central Government. The Report noted that the prior hearing may afford an opportunity to persons indulging in corporate fraud to destroy evidence or tamper with the records.

Therefore, the Report suggested a report by ROC should not be the only basis of ordering investigation into the affairs of a Company. It noted that there are several other Agencies, like the SEBI, Enforcement Directorate, Income Tax Department etc. which would also report about a fraud in a corporate company. Information can be gathered or passed between such Agencies in order to seek an investigation by SFIO against corporate frauds. Therefore, being mindful of the effect an investigation may have on the credibility of a Company, the Government was tasked with taking well-reasoned decision for investigation into the affairs of a Company. This would also negate the aspect of destruction of evidence or tampering with records as the Government would not be required to provide a prior-investigation hearing.

Another suggestion of the said Report to provide Statutory recognition to SFIO. The statutory recognition to SFIO would imply investigation suo moto⁹, or by an Order of the Central Government. Another question that the report noted was if it permitted the SFIO to conduct investigation on its own then under what circumstances could it also close the investigation for lack of evidence to avoid abuse of power. The Report was also conscious of the fact that the SFIO should not be burdened and the kind of investigation must be considered to be ‘serious’ before affording SFIO to conduct inquiry.

The seriousness of an investigation may be assessed in terms of the quantum of amount of the funds, the number of stake-holders involved and the complexity of an alleged ‘corporate fraud’. The Report did not provide any formula or hard and fast rules for the guidelines for threshold of investigation. The alleged corporate fraud may be innocuous but it may have an impact on the stake-holders, the markets, the banks, other financial institutions. These were suggested to be important factors to consider a case- ‘serious’.

One of the most important suggestion in the said Report was the procedure of ordering of investigation by the Central Government under section 235 of the said Old Act solely on the basis of the report of the ROC. It was considered to be in adequate and needed to be modified. The Report urged that the Central Government’s opinion as to the necessity for an investigation into the affairs of a company should also take into consideration at the time of decision-making, reports of a prima facie occurrence of ‘fraud’ from other agencies like Central Bureau of Investigation, SEBI Directorate of Intelligence, Income Tax etc. The Report also urged that the Order by the Government should be a speaking one, indication application of mind like the charges against the company reasons for Order investigation and justification in due public interest. A suitable amendment to Companies Act must reflect this, as per the said Report.

1.3.3. Wider net of the said Old Act to include Individuals and Firms

The said Report emphatically suggested to widen the net of the said Old Act in order to include firms, associations, trusts, individuals and societies. The underlying logic was that such entities may also be involved in fraudulent activities or take part in facilitation of fraud. Section 239 of the said Old Act¹⁰ provided for the circumstances under which investigation may extend to other entities. One or more entities may be related to each other through a host of inter-connected transactions which would be outside of the list of cases provided under Section 239 of the said Old Act. There could be a situation that promotors of entities not mentioned under the said Old Act and more specifically Section 239, could be the beneficiaries of the fraud committed by the Companies. In such a scenario, the said Report suggested that the new of the penal consequences must be extended in order to include sole proprietorships, partnerships, trusts etc. There were further suggestions to improve, strengthen and enhance the workings of SFIO. For the purposes of understanding the Law surrounding Corporate Frauds, the basic outline of suggestions have been mentioned. It has no bearing largely on the prevalent and current law of said Act.

¹⁰ 239. Preservation of books and papers of amalgamated companies.—The books and papers of a company which has been amalgamated with, or whose shares have been acquired by, another company under this Chapter shall not be disposed of without the prior permission of the Central Government and before granting such permission, that Government may appoint a person to examine the books and papers or any of them for the purpose of ascertaining whether they contain any evidence of the commission of an offence in connection with the promotion or formation, or the management of the affairs, of the transferor company or its amalgamation or the acquisition of its shares.

1.4 Establishment of SFIO under Companies Act, 2013

Section 211 of the said Act¹¹ deals with –‘Establishment of Serious Fraud Investigation Office’. It is divided into 5 sub-sections, dealing primarily with the composition and the power of Central Government to establish SFIO. Sub-Section (2) of Section 211 of interesting to note as it outlines the type of officers comprising of the SFIO. Sub-section (2) of Section 211 clearly lays down that the SFIO should include experts from various fields. The experts from such fields will be appointed by the Central Government. The sub-section (2) lists the fields, from which the experts can be chosen. Some of them are – (i) banking, (ii) corporate affairs, (iii) taxation, (iv) forensic audit etc. Sub-section (2) of Section 211 makes it clear that the type of investigation the SFIO will carry out. The experts are from various fields of ‘corporate finance’. Thus, it gives us a glimpse of the nature of investigation SFIO will carry out.

¹ Herein after referred to as “Act”

² Herein after referred to as “SFIO” for short

³ Dated April 2009; Herein after referred to as “Report”

⁴ Prior to Companies Act, 2013, Companies Act 1956 was the governing Law.

⁵ Indian Penal Code, 1860 carves out offences of various kinds like murder, cheating etc.

⁶ Herein after referred to as “Old Act”

⁷ First Information Report is the ‘first information’ of an alleged crime to be reported to a police station. The procedure for registration of First Information Report is provided under Criminal Procedure Code, 1973.

⁸ Herein after referred to as the “ROC”

⁹ Suo Moto implies- on it’s own.

¹¹ 211. 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 sub- section (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 2nd July, 2003 shall be deemed to be the Serious Fraud Investigation Office for the purpose of this section. (2) 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, - (i) banking; (ii) corporate affairs; (iii) taxation; (iv) forensic audit; (v) capital market; (vi) information technology; (vii) law; or (viii) such other fields as may be prescribed. (3) 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. (4) 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. (5) 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.

Establishment of Serious Fraud Investigation Office, Companies Act 2013

FAQ: Establishment of Serious Fraud Investigation Office (SFIO)

What led to the establishment of the SFIO?

The SFIO was established in response to the 2001 Stock Market Scam in India. This scam highlighted the need for a specialized agency to investigate complex corporate frauds. While the SFIO was initially set up in 2003 under the Ministry of Corporate Affairs, it was later strengthened and given statutory recognition under the Companies Act, 2013.

What were the key recommendations of the Vepa Kamesam Committee Report?

How does the SFIO differ from other investigating agencies?

What are the powers of the SFIO?

How does the SFIO receive information about potential corporate frauds?

Why was it necessary to amend the Companies Act, 1956 to strengthen the SFIO?

What is the composition of the SFIO?

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