Case study questions

sameerah2@

SynergybetweenISAandmanualauditingprocessatJainChowdharyCompanyIndia.pdf

Home >Business & Finance homework help >Accounting homework help >Case study questions

Synergy between ISA and manual auditing practises at Jain Chowdhary & Company, India

Meghna Rishi and Anjana Singh

On 19 January 2011, S.C. Jain (Subhash Chand Jain), Chartered Accountant with 38 years

of experience and senior partner of M/s Jain Chowdhary & Company (Mumbai), was driving

towards the Jaipur Chapter of the Institute of Chartered Accountants of India (ICAI) where he

was invited to address a class full of 55 young students, who were undergoing rigorous

training for the completion of their professional degree of Chartered Accountancy. His visit

to this classroom was enthusiastically anticipated by the students because, in 2003, his

company had been appointed, by the Office of the Custodian – Ministry of Finance

(Government of India) under the Special Court TORTS Act (1992), as one of the investigator

CA firm, for the Harshad Mehta Share Scam that happened in the year 1992, in India, where

the main accused – Harshad Mehta, ‘‘single-handedly manufactured a bull market’’

(BBC News, 2001). The students were keen to seek such a senior professional’s insight on

the intricacies involved in complex yet highly responsible duty of auditing. S.C. Jain’s visit to

this class was for the purpose of delivering a lecture on efficient, vigilant and transparent

methods to execute a complex audit (Exhibit 1). This lecture was even more insightful for the

students, because the ICAI had made the implementation of information technology (IT),

mandatory for the execution of audits, in the year 2004-2005. This required all chartered

accountancy firms, practising in India, to have partners within the company, who would have

undergone training of information systems audit (ISA). The students were, hence, keen on

seeking the professional’s inputs on the way his company executed the investigation in an

information system enabled environment. This lecture was thrilling for them also because

they were keen on understanding how Jain, at the age of 55, completed the ISA certification

program, which they, as active students, were finding difficult to even attempt.

Jain on his way, was reading a financial broadsheet to explore the nuances of the financial

irregularity reported at Citibank, which marked the financial year end (2010), in India, with yet

another financial irregularity, that was engineered by the manipulation of IT (The Economic

Times, 2010). He was perplexed because he desired to seek a solution, as central statutory

auditor, towards ensuring policy lead and clean financial practises at some of the leading

public sector banks (PSBs) that his company was auditing. He knew that without the use of

IT, operations management within any organisation was nearly impossible, but his concerns

were deeper. He wanted to offer a strategy to the partners of Jain Chowdhary & Company,

that could ensure the early identification of IT’s misuse. Since his company’s client base

comprised of, both, national and international investors, along-with globally present financial

organisations, he further wanted to devise measures to investigate the lapses in trading of

various stocks and securities to protect investors’ interests. As his phone rang, he voiced

these concerns to Siddharth Jain, his son and partner of the firm:

It is important that all six partners of our firm, who are primarily involved with the auditing

functions, meet and brainstorm on issues around ISA implementation. As statutory auditors,

PriceWatehouse Cooper failed to identify financial irregularity at Satyam Computer Services

Limited, in 2009, which we read extensively about, in Bloomberg Businessweek (2009) and Jain

DOI 10.1108/20450621111176256 VOL. 1 NO. 3 2011, pp. 1-22, Q Emerald Group Publishing Limited, ISSN 2045-0621 j EMERALD EMERGING MARKETS CASE STUDIES j PAGE 1

Meghna Rishi and

Anjana Singh are both

Associate Professors at the

Institute for International

Management and

Technology, Gurgaon,

India.

The authors are extremely thankful to S.C. Jain and Siddharth Jain for indulging in consecutive long discussions and offering key details of their operational activities for the purpose of this academic writing.

Disclaimer. This case is written solely for educational purposes and is not intended to represent successful or unsuccessful managerial decision making. The author/s may have disguised names; financial and other recognizable information to protect confidentiality.

Chowdhary & Company cannot afford to repeat this history, even if it is unintended.

System-generated data eases execution of the audit and saves time, but we all have to

decipher, how prudent is it to rely on such data? (Jain, 2011c).

Jain addressed the students for two hours and his lecture was well received. An excerpt from

his lecture:

Indian economy witnessed the second highest growth rate amongst the major world economies in

2009, during the global financial meltdown, as the GDP of the country grew by 6.5% when

developed nations like the USA and the UK were coping with negative growth of 22.4% and

24.8%, respectively. In light of this fact it is imperative that Indian professionals equip themselves

towards upholding the economy against financial scams like the one at Satyam Computer Services

Limited, in the year 2009. As young Chartered Accountants, who will ensure ethical practises at

leading organisations in an emerging economy like India, it is important for you to understand that,

you will be considered as Complete Business Solution Providers by your clients. This is because

organisations are globally connected, business environment is extremely challenging and

Information Technology has overtaken the simplest activities of any business. Hence, young CA’s

will have to be thoroughly trained in all aspects of accounting, finance and information systems

audit. In India, until the year 2004-05, there had been no formal mandate that required chartered

accountants and auditors to undergo a certification around monitoring, controlling and auditing

information as well as business systems. But today the Institute of Chartered Accountants of India,

offers to all its students and members, the post-qualification course on ISA, which enables

chartered accountants to offer unique, value-added services in an ITequipped environment. This

further, empowers financial professionals to undertake varied responsibilities including

implementation of efficient accounting, offering advice on multifarious issues like foreign

collaborations, mergers and acquisitions, joint ventures and diversification, restructuring

executing feasibility study, generating financial resources and capital structure and planning.

But as students you, also have to understand that efficient auditing process requires the use of

human intelligence and not mere reliance on artificial intelligence. The day financial professionals

and auditors start to rely on artificial intelligence or system generated data, blindly, scams will be

a natural outcome. And this is a close description of what is happening with some auditors in

developing as well as developed economies. They are excessively dependant on technology and

sometimes, fail to scratch the real meaning out of complex raw data. The crux of efficient auditing

lies in learning from experience and honing your own investigative skills. ISAs require intense

labour and hard work, therefore, complacency has no scope, irrespective of the fact that many

menial tasks get executed through computers. As future auditors you must have the finesse to

use systems prudently, by identifying what has to be fed into the system to get maximum benefit

from computerised procedures. Hence, feeding of informed data and auditor’s intelligence

become the most important components of auditing in the era of ISA. Ignorance of these

elements facilitates culprits in using IT to execute malpractices. In other words, computers and

systems work on a ‘‘Garbage-In-Garbage-Out’’ principle. If the raw data and elementary

information, entered into the system, is not manually checked/authenticated, it leads to financial

irregularities. To carry out audits in ISA environment, all raw data has to be keenly identified and

the auditor has to develop a futuristic thinking where he has the ability to think four steps ahead of

the present circumstances. Key assets of an auditor include patience, diligence, passion for

numbers and farsightedness. In that sense, all auditors can be brilliant chess players.

While talking about the Harshad Mehta Share Scam’s investigation, that Jain Chowdhary &

Company, had executed, amongst other CA firms, Jain said:

Though it was an extremely prestigious opportunity to be one amongst the 16 CA firms in India,

that were selected for carrying out the investigation work, this entire project was like a throne of

barbed wires. This investigation was initiated by the Government of India in the year 2003, almost

years after the actual scam[1] and in the backdrop of missing data, the execution of this task was

successful because of my company and team’s finesse in running the ISA along with their

auditing intellect. ISA and related auditing tools helped us to investigate the flow of funds vide

which the money was siphoned off a financial institution to reflect an artificial increase of shares

and stocks which indirectly resulted in the financial scam. Manual auditing practises alone would

have made the tracing of exact fund flows, extremely tedious and long-drawn, however this, in no

way suggests that manual auditing has become redundant. ITand ISA helped us in reducing the

time to analyse the figures and make tabulations. However, the background of the case history,

digging out missing reports and scrutinising the case history was done manually and was a

painstaking process (Jain, 2011c).

PAGE 2jEMERALD EMERGING MARKETS CASE STUDIESj VOL. 1 NO. 3 2011

Company background

M/s Jain Chowdhary & Company has been a partnership firm of Chartered Accountants with

its Head Office in Mumbai (India). It was established in the year 1976 and the firm today has

national as well as International presence with seven branch offices in India and one office in

Taiwan. The firm has held recognition with various financial regulatory bodies and esteemed

panels of India, including the Reserve Bank of India (RBI), Comptroller and Auditor General of

India, New Delhi, Income Tax Department for Special Audits under Income Tax Act, Insurance

Regulatory and Development Authority, New Delhi, The Registrar for National Co-operative

Societies, New Delhi and the ICAI. Amongst the varied accounting and financial services

offered by Jain Chowdhary & Company, the key functions of the firm have included

management audits, ISA, audits of public sector units (PSUs), banks and corporations

and executing special investigations that get entrusted by the Government of India.

Jain Chowdhary & Company has 12 partners and it was brought into existence, 35 years back,

by S.C. Jain whose areas of passion (expertise) have been in audits, taxation, investigation

work and resolving financial matters. The partners of the firm have unique areas of

specialisation including accounts and taxation, company law, management services, excise

matters, indirect taxation, special investigations, internal audits and management audits.

The seeds of Jain Chowdhary & Company got planted in the year 1976; four years after S.C.

Jain received his CA degree. At that time, he was employed with a leading Chartered

Accountancy firm in Mumbai. In the year 1975, during an intense discussion with his boss,

Jain suggested some path-breaking solution to ship out his employer from a grave Income

Tax crisis. His ideas were eventually implemented and they successfully contributed

towards resolving the issue, at hand. This was a Eureka moment for Jain where he realised

that he has to make it big by starting his own practise and next year, he moved to a tier II city,

Jaipur, to begin his own company. His strategy was to establish himself in a smaller

geographical expanse and then spread the company’s presence to bigger cities. He

established his forte in investigation work for insurance companies and later executed audits

and investigations for companies from various industries, from different cities. In the year

1992, he decided to expand his operations to Mumbai, which is popularly known as the

financial capital of India. He eventually handed the reins of this office to his son Siddharth

Jain, who completed his CA degree in 1998. With the Mumbai office, Jain’s business started

multiplying fast and he added two more partners from the cities, Ahmadabad and Baroda,

respectively, in the year 1997. With four company offices in India, Jain further expanded his

company’s presence to Faridabad and Ajmer, in the year 2000. In the domestic market,

Jain’s company was renowned by now. His expertise in dealing with a plethora of financial

issues faced by companies and individuals in an emerging economy like India induced him

to expand internationally and in the year 2009, one of his partners took the company’s office

to Taiwan (see Exhibit 2 for a diagram of the Organisational Structure at Jain Chowdhary &

Company).

When Jain had incorporated the company, his vision was clear. He wanted to establish a

Chartered Accountancy Firm that would set new paradigms and stand at par with reputable

giants in the financial market. He notes:

As a young CA, it was my dream to establish a company that would be one amongst the

established CA firms of the country and today, our company features in the top 100 CA firms of

India and is emplaned with the biggest and most prestigious authorities of India. This is a result of

sheer dedication, farsightedness and the strategy to expand business by gaining maximum

geographical spread. Even though we are a compact workforce, I believe that the strong ethical

practises and diligent work procedures, that I established, have led everyone towards emulating

the same, making Jain Chowdhary & Company, an entity which is respected amongst

competitors, and is known for resolving some of the most complicated financial scams of India

(Jain, 2011c).

By 2011, Jain Chowdhary & Company was spread in, both, Tier I and Tier II cities of India

and it was a deliberate move by Jain because he wanted his company to be present at the

geographic locations, from where, maximum business gets generated. By this year, the firm

had gathered an experience of 30 years, in executing the role of statutory auditor of state

VOL. 1 NO. 3 2011 jEMERALD EMERGING MARKETS CASE STUDIESj PAGE 3

and central government undertakings (PSUs); statutory branch auditor of nationalised and

other banks and special audits, inspection and investigation work. The firm has had 20 years

of experience as concurrent auditors/internal auditors for branches of banks and ten years of

experience as central statutory auditors of banks. In its journey, the company rendered it’s

services to public sector undertakings in the sectors including railways, road transport,

banks, infrastructure construction, shipping, insurance, agro industries, tourism, hospitality

and logistics. Other industries which the firm has had clients from include software

and IT, infrastructure, healthcare and pharmaceuticals, real estate and construction,

banking and financial institutions, retail and distribution, manufacturing, travel and tourism,

entertainment, FMCG, co-operative banks, jewellery and diamonds, power sector,

telecommunication, provident funds and foreign companies and their subsidiaries in India.

The firm has been amongst the first few in India to get a certification for executing ISA

through the ICAI and has been able to unearth various financial scams and irregularities,

some to the tune of INR 17.5 billion, with the efficient amalgamation of ISA with manual

auditing practises.

Talking about his company, Siddharth Jain noted:

Our expertise lies in the fact that we have extensive experience and knowledge, about the auditing

function. All 12 of us, are deeply passionate about working with figures and we understand that

technology is just a supporting mechanism, not an element, on which the auditing function can be

left blindly. We have unearthed various financial irregularities and scams, in the past 30 years but

each audit brings with it unique challenges where we have to ideate on exceptional solutions to

thesedifferentproblems.We havepioneeredourselvesbecausewehavedeeplyimbibedwhatour

mentor S.C. Jain told us. He taught us that as an auditor, one cannot point fingers at problems.

Auditors haveto necessarilyfind a solutionand if an auditorcannot finda solution,he does not even

have the right to bring out a problem. Today, when IT is indispensible, the biggest challenge facing

us is to understand that how could we pre-empt a financial irregularity and ensure clean financial

practises.It isanirony thatIT isusedto enhancetheaccuracyofourinvestigations butit isthe same

IT that acts as a facilitator to these financial irregularities and scams (Jain, 2011a).

Financial irregularities resolved by Jain Chowdhary & Company

Financial irregularity at a non-banking financial company (NBFC)

In 1997, one time exercise was carried out in India, wherein the existing NBFCs, were

compulsorily audited by different CA firms all across the country. Non-financial-institutions or

NBFC’s are considered to be an important subset of the total financial system of a country and

these encompass institutions that are ‘‘a loan company, an investment company, a

hire-purchase finance company, an equipment leasing company or a mutual benefit financial

company’’. Typically, NBFC’s in India, fall under the scrutiny of the RBI and are divided in four

categories: ‘‘deposit-taking NBFC’s (NBFC-D), other than residuary non-banking companies;

non-deposit taking NBFC’s (NBFC-ND) and the residuary non-banking companies (RNBCs)’’

(Leeladhar, 2008).

Even though varied NBFC’s differ from each other, based on varied attributes, yet the ability

to offer ‘‘niche financial services’’, in India, characterises them. Their popularity is primarily

dependant on the fact that they can offer personalised financial services and can process

them much faster than other financial institutions and banks (Gurusamy, 2009). During the

auditing process, for NBFC’s, auditors typically ensure whether internal controls have been

appropriately adopted by NBFC’s and also ascertains that these controls are being

rigorously followed (Sasidharan and Mathews, 2008).

The audit, in the year 1997, of existing NBFC’s in India, was primarily to ensure that the

CAMEL guidelines have been mandatorily and diligently followed by such NBFC’s because

NBFC’s earnings: ‘‘come mainly from the interest spread between loans and borrowing.

Since NBFCs are financial intermediaries whose business is to borrow and lend, spreads are

one of the important yardsticks (Malhotra, 2000)’’. (CAMEL model was used for evaluating

NBFC where C implied Capital Adequacy; A implied asset quality and asset profile; M

implied management quality of NBFC; E implied earnings and L implied liquidity.)

PAGE 4jEMERALD EMERGING MARKETS CASE STUDIESj VOL. 1 NO. 3 2011

Use of IT by Jain Chowdhary & Company in resolving the financial irregularity

The Chief Finance Officer of the NBFC, which Jain Chowdhary & Company was auditing,

was also one of the major pioneers who was involved with the regulatory body of India, to

form the CAMEL guidelines. The CMD of that NBFC was a very well known face in the Indian

financial markets. This NBFC was, obviously, amongst the top ten in the country and yet

major financial irregularities and indiscipline was discovered during the course of audit.

The auditors were able to decipher the irregularities because they decided to screen

through all the data (which was available or made available after auditors’ request) manually

and further fed it into the computer to execute complex calculations and analysis. Even

though the senior management of the NBFC comprised of extremely influential

professionals, this fact was not treated as an element that could affect the multiple levels

of inspections/analysis that Jain Chowdhary & Company would have done, on any other,

similar institution. Computers and laptops were not widely used in India, in 1997, and

processing speeds were slow. Indian CA firms, largely, were not using IT for auditing

purposes and ISA implementation was minuscule. Jain however, decided to remain

progressive and decided to introduce the use of technology in the execution of this task and

this marked the initiation of IT implementation within Jain Chowdhary & Company. The

company carried out different financial ratios and analysis through computers, without which

such extensive analysis would not have been possible. After Jain submitted the audit report,

to India’s financial regulatory body, within a span of two years, the company had to wind up

its operations and it got merged with a private bank. The risk, which the auditors played, by

introducing computerised systems for auditing procedures, proved fruitful and Jain

Chowdhary & Company was one amongst the three firms in India, which had submitted the

report to the utmost satisfaction of the controlling authority in India. The ripple effect led to

the company being selected as auditors for various eminent financial institutions and PSBs.

Financial irregularity at a co-operative bank

In the year 1999-2000, India faced one of its biggest financial scam that involved a

co-operative bank[4]. Many small depositors lost their money and the financial regulatory

body of India came to the forefront, in order to protect the interests of every individual

account holder. The challenge faced by the regulatory body was that their governing act had

no rule that empowered the body to make provisions in their Balance Sheet to cover the

losses of the co-operative bank.

Jain Chowdhary & Company was appointed as the Central Statutory Auditor of this regulatory

body and the task at hand involved the auditors to devise a strategy where the investors could

beprotectedbutsimultaneously,theirclient,theregulatorybodydoesnotgetundulypenalised.

Night-longbrainstormingsessionswerecarriedoutbutitwasimpossibletooffer thedepositors,

any loss recovery provision, because the act did not include any such regulations. On the other

hand, the regulatory body was under the ethical liability of protecting all investors to keep afloat,

the faith of Indian domestic investors, in their country’s financial institutions.

Use of IT by Jain Chowdhary & Company in resolving the financial irregularity

The balance sheets of the regulatory body were manually made, till that year and the data

which had to be screened through was immense. This tedious process was crucial for

finding a solution to the problem at hand. Siddharth Jain decided to use ISA-related auditing

tools to shape up the final balance sheet of the regulatory body. He says:

At that time, as auditors of the regulatory body itself, we were faced with a big challenge around the

means to make disclosure of the said scam in the balance sheet of the regulatory body. The interest

of the depositors had to be protected but there seemed no way out. We eventually had to suggest

necessary changesin the regulatory body’s act itself so that the whole issue could be legalised. We

also knew that the more data we have, the easier it would be to get these changes implemented.

Hence, we used ISA related auditing tools to screen through immense data, avoid repetitive

checking of entries and by applying some broad parameters to the software to facilitate quick data

sorting. This aided in making disclosures in the balance sheet and the regulatory body was able to

make proper provisions so as to safeguard the interest of thousands of depositors (Jain, 2011b).

VOL. 1 NO. 3 2011 jEMERALD EMERGING MARKETS CASE STUDIESj PAGE 5

Harshad Mehta share scam investigation

Case facts

The Harshad Mehta Share Scam happened in India in the year 1992 and it was the first

‘‘stock market scam’’ that involved the equity market as well as the bond market. The pricing

bubble that came about during this scam resulted in the escalation of the market index by

143 per cent between September 1991 and April 1992 (Fernando, 2009). The scam was

engineered by Harshad Mehta along with other bull operators. Mehta acted as the broker

who facilitated short-term, ‘‘secured interbank lending’’. For the execution of his fraudulent

practises, he used banks that were ready to issue to him, bogus bank receipts (BRs) or BRs

that had no authentication from any government securities. After procuring the fake BRs,

Mehta used to pass them on to other banks, which used to then lend him money assuming

that ‘‘they were lending against government securities’’. Mehta used this money to hike the

prices of stock in the Bombay (now Mumbai, India) Stock Market. ‘‘When the time came to

return the money, the shares were sold for a profit, the BRs were retired and the money due to

the bank was returned’’. By the time this scam got exposed, India’s banking system had

been duped of INR 40,000 million (Hull and Basu, 2010). The magnitude of the scam can be

understood from the fact that the ‘‘BSE remained closed for one month’’ after its occurrence

(Pathak, 2011). Siddharth Jain says:

The entire scam is known as Harshad Mehta Share Scam but in reality Mehta did not bring about

the entire scam all alone. It involved different entities who were associated with him in one form or

the other and they all had jointly, in 1991-1992, manipulated the Indian stock market. Mehta

assisted various ordinary investors in gathering unanticipated wealth using ready forward

deals [2] (Jain, 2011a).

In 2003, the Office of the Custodian – Ministry of Finance (Government of India) under the

Special Court TORTS Act (1992), had appointed around 16 Indian CA firms to perform

intense investigation around the various entities involved with the said scam. This

investigation was given to CA firms because departments like police, CBI and taxation

collected data from their respective area of expertise. But the financial position, as on a

particular date, of the accused, had to be established by specialised CA firms who were

given absolute power to contact all parties and make investigations the way they deemed fit.

Each CA firm was given two to three entities to investigate and formulate books of accounts.

Jain Chowdhary & Company’s role in the investigation

Jain Chowdhary & Company, too, was one of the selected firms and they had begun the

investigation work in December 2003, almost 11 years after the actual scam. When they

began the investigation work the information was totally scattered. The firm had to first

gather the information from five primary sources that included the CBI, Income Tax

Department, various banks, the Custodian’s Office and some key defaulting parties.

Procuring information from CBI was a very lengthy and tedious process. The information,

which the firm received, was in the form of papers and the material that CBI had collected at

the time of raids and surveys, on the entity for which Jain Chowdhary & Company was the

investigator. Since the information was sought after a gap of 11 years, many bankers could

not make the requested information available. This was because, either the papers had

already been destroyed or the information was not available at all. The auditors could not

question the bank for destroying relevant papers because legitimately, banks are supposed

to maintain any case records for a period of ten years after which they have the freedom to

legally destroy the same. Similarly, only limited information could be procured from each

source and it meant that investigators had to contact even more sources to collect a pool of

raw data.

Investigation trail undertaken by Jain Chowdhary & Company

Jain and his team had compiled all the information that they had collected from varied

sources and assembled it in chronological fashion so that the scattered data could be

delineated in terms of a definite start and end. All documents were studied manually to

identify details, within each document, about any accounting information. If accounting

PAGE 6jEMERALD EMERGING MARKETS CASE STUDIESj VOL. 1 NO. 3 2011

details could be identified in a document, they were fed into the accounting software so that

the firm could prepare the statement of accounts and position as on a particular date

demarcated by the court of law. In context with this Jain notes:

In order to make the books of accounts and bring out the true picture behind the trail of events, we

had to collect information from as many departments/sources as possible. There was a time when

we felt highly pressurised and de-motivated because the Government of India wanted all reports

within three months and we were finding it impossible to even gather information within the

stipulated time. When investigations began, many entities who were cross confirmed, as being an

important link in the scam, blatantly denied their claims. Many were not cooperative at all and

seeking information again became a tedious task. Throughout the investigation we were working

in a hostile environment. To add to this, authorities were not going to reimburse us for any

expenses till the investigation reached its culmination, which meant that we were running the

investigation, literally from our own pockets. However, these bottlenecks have to be considered

as a part of every investigation and we decided to replicate the same strategy, which we had

applied in 1997 and 1999-2000. We amalgamated human intelligence with ISA’s swiftness to

complete menial/repetitive procedures and through this we ended up reducing the cost of

manpower by almost 60 per cent. The extra time that we had spent on procuring data and

manually feeding it, got compensated because we used ISA-related auditing tools to make

relevant calculations, perform tabulations and perform repetitive checks on data entries (Jain,

2011d).

Based on the study of collected papers, the company had identified at least another 80-90

names who had some sort of transactions with the accused party. To make the accounts fool

proof, information was gathered from these people. Further a list of debtors, from whom the

accused entities had to recover the money, was identified. Such names came up through

corroborative proofs and Jain Chowdhary & Company tried to contact all these people either

through the court of law or the Custodian’s office. The aim was to give these people an

opportunity to prove themselves, thereby making the firm’s case even more transparent.

Money had to be procured back, from these debtors, by the Government of India and hence

establishing proper contact with them was essential. This involved numerous rounds of letter

sending, reminders and following up with the said parties on regular basis. All information

which Jain and his team received from identified sources was further fed into the system and

it was co-related with the raw data, which was procured through papers and hard copies.

Siddharth Jain says:

The use of logic was applied here. We correlated data and established each accounting entry.

Through missing links single account entries were made. The books of accounts that were

procured from the accused parties’ offices were mostly in hard form and were not very easily

legible. Therefore, we had to read them very carefully, understand their implication and only then

could we feed them into the accounting software. Since the process was dreary and long-drawn,

every data was rechecked thrice before we entered it in the digitised format because one error

would have made the entire investigation worthless (Jain, 2011b).

Role of ISA-related auditing tools in the investigation

ISA-related auditing tools had been used by the investigators to interpret and hence

analyse, each accounting entry. Extensive investigation trails had been maintained through

technology supported tools and this had helped Jain and his team to ascertain that the data

is authentic, fault-free and is not redundant. Accurate ‘‘audit trails’’ or ‘‘audit logs’’ had

helped in executing, the otherwise tedious task of preparing electronic records for the

sequence of events. Such logs had enabled them to discern sufficient information to

restructure or verify the entire chain of events and judge them under auditing standards.

Interpretations and analysis lead to the formulation of voluminous reports that also included

evidences for each declaration that Jain Chowdhary & Company made:

As auditors, we were asked to give evidence in the court of law repeatedly because the

investigation was being done for the Government of India. As the senior partner of the firm, I had

to be present at the court many times. Sometimes government pleaders would request me, to

offer an explanation in the court of law, instead of them, about the current situation because my

firm has the actual picture around the financial nuances of the case, says Jain.

VOL. 1 NO. 3 2011 jEMERALD EMERGING MARKETS CASE STUDIESj PAGE 7

He further adds:

If I have to express the entire investigation in a few words I would say it began with collecting all

papers, transforming them in digital form and preparing computerised accounts. These

accounting entries were then traced with banking transactions and attention was paid on how

money had travelled from one to the other entity, to identify who is the final recipient. This trail

revealed that all money was in disguise, passing through different entities and it was finally

reaching Harshad Mehta. This confirmed that the money was siphoned (Jain, 2011d).

Unearthing of financial irregularities in a PSB

Case facts

In the year 2009-2010, Jain Chowdhary & Company had continued to be the Central

Statutory auditors, for consecutively third year, for one of the most reputed PSB in India. The

audit at this bank was a classic example of how inappropriate checks, of the transactions

that happen within a financial organisation’s IT infrastructure, could lead to non-detection of

major financial irregularities.

The bank had held an account of a prominent business group that had its operations in

multifaceted business areas. The accused group had taken bank guarantee facility (non-fund

based finance) for INR 17.5 billion, in total, from 25 financial institutions across India, of which

almost 17-18 were PSBs. The PSB of which Jain Chowdhary & Company were auditors, also

had an exposure to the said accused. The exposure was worth INR 770 million.

The case background had revealed that the accused group had approached the bankers

and had suggested to them that that it would be carrying out infrastructural projects outside

India and it was seeking bank guarantees from Indian banks to offer comfort to it is various

International suppliers. This meant that the PSB’s had been issuing bank guarantees to

parties who were based outside India. After a period of two years the owner of this group,

through his vendors outside India, had started recalling all the bank guarantees, one after

the other. As a chain reaction, within a span of 12 months, this money (INR 17.5 billion) had

gone totally outside India. The PSB’s involved had been well aware that this money will not be

repaid by the accused party and yet the banks did not have any mechanism to stop this flow

of funds. This was because as per the RBI norms, if a bank guarantee is issued by a bank in

India, and if that is being recalled it has to honoured at any given cost, irrespective of the

circumstances.

Jain pointed out:

The accused was well aware of this fact that once a bank guarantee gets issued, irrespective of

the situation, the bankers would have to remit the money outside India, once the bank guarantee

is recalled.

At the time of recalling the guarantees, the accused group had paid the bankers, the

stipulated commission of 1.5 per cent as an official bank guarantee fee. The group’s money

outflow, hence was only INR 420 million but the money which the group got was INR 17.5

billion and since it was issued to a foreign party, its value increased because the money got

converted in foreign currency. Therefore, on the day of currency conversion the overall

liability had come to be around INR 22.5 billion.

The trail of events at the bankers’ end, had been rather odd. Once the payment was made,

the banks had continued to show it as a standard advance. On the other hand they had not

accounted for any interest income, on accrual basis over this advance. Hence, they had not

charged any income but they were showing the money as standard advance. The PSB’s had

been doing this because the bankers had been clearly aware that the money had become

bad and if they charged an interest over such amount then it would tantamount to be

fictitious income.

Jain Chowdhary & Company’s role in the investigation

During the rigorous auditing procedure, Jain Chowdhary & Company had identified all these

elements at the PSB (of which they were statutory auditors). Jain (2011a) said:

PAGE 8jEMERALD EMERGING MARKETS CASE STUDIESj VOL. 1 NO. 3 2011

I realised, on that day that, as an auditor, relying on computers completely, is a blasphemy.

The systems, at such leading Public Sector Banks, should have been extremely prompt. If the

income was not being charged on any standard advance, then that advance should have been

classified by the system as substandard advance (NPA-Non Performing Account), automatically.

But the system obviously did not do so.

On careful scrutiny of the data available, Jain Chowdhary & Company highlighted this

financial irregularity and went on to seek an explanation from the bank.

The management at the PSB, of which Jain Chowdhary & Company were auditors, had

counter argued that since the accused group had availed the bank guarantee facility from

other banks also, the leader bank (which had an exposure INR 4.5 billion) along with few

PSBs, who had bigger exposures, must take the initiative to classify this group’s account as

NPA (substandard account).

The situation became more complicated when it was found out that the accused group had

intelligently approached the Corporate Restructuring Cell of India, to get the account

restructuredsoastoavoidtheaccountbeingclassifiedasNPA.Itwasevidentthatthegroupdid

not wish to loose the privileges that a standard account gets from the bank. On the other hand

the banks too, were highly reluctant to do anything about this account because the quantum of

moneyinvolvedwasveryhigh.ClassifyingsuchanaccountasNPAwouldhavedirectlyaffected

the profitability and bottom lines.Further, mandate had demanded that disclosuresabout gross

NPA’s held have to be made in the balance and such a big jump, of the NPA level, would have

exposed the bank towards public scrutiny, media’s questions and loss of goodwill.

Taking this plea, immense pressure was put on S.C. Jain, to let go of this account for some

more time. Jain (2011c) noted:

Banks, instead of accepting the facts that a major blunder had been done, went to the point of

arguing that this account has gone for restructuring and some more time must be given to the

bank. I decided to not succumb to the pressure because clearly, I was on the right side of the law.

Jain involved the then President, Vice President and othereminent members of the ICAI, in this

case, to seek their advice about resolving this matter. He had also discussed extensively, the

case details with the central statutory auditors of the leader bank as well as auditors of other

leading banks. When the matter was escalated at this level, the general opinion amongst all

auditors and professionals was that Jain was absolutely correct in his argument and that all

involved banks had conducted a blunder. It was unanimously suggested that all banks must

classify thisaccountasNPA.As on31March2010,concurring to theviews ofJain, sixbanks at

a stroke, classified this account as NPA including the leader bank.

Jain Chowdhary & Company’s opinion on IT implementation and ISA

Jain (2011a) observed:

This financial irregularity proved that IT is not fool proof. A financial irregularity could precipitate

because there was no mechanism to check the manipulation (of the account) being done by the

bankers. This is clearly, the misuse of technology. All banks today use highly advanced systems

for working yet such malpractices occur. This is a lesson for auditors to keep their eyes, ears and

brains wide open, all the time because in today’s IT led business environment we need to be

equipped with advanced auditing strategies that are capable of evaluating the authenticity of the

offline as well as online environment simultaneously.

Jain (2011c) added that:

ISA has now become an integral part of our auditing procedures because IS auditing helps us in

judging the reliability and validity of the information/data which computers generate. Since it is

our prime responsibility, as an auditor, to offer a report that assures that an organisation’s internal

control are reliable we have adopted ISA extensively. It helps us decipher whether systems

adhere to accepted standards; the data which they generate is authentic and that systems are

designed such that they safeguard assets by simultaneously sustaining data integrity. However,

the situation is complicated because information technology can either be manipulated to suit the

wishes of fraudulent entities or it could lead to non-detection of financial irregularities because of

over-reliance on the authenticity of system-generated-data.

VOL. 1 NO. 3 2011 jEMERALD EMERGING MARKETS CASE STUDIESj PAGE 9

Conference room at Jain Chowdhary & Company (Jaipur Office)

On 23 January, 2011 six partners of Jain Chowdhary & Company, had met at the Jaipur

office, for a meeting which was called by Jain. He wanted to brainstorm with his core auditing

team, to identify ways that could pre-empt a financial irregularity or an irregularity in private

as well as PSBs. This was clearly, a spill-over effect of the financial irregularity at the Indian

Citibank (2010) and the fact that Jain was the central statutory auditors of some key Indian

banks.

An excerpt of Jain’s (2011d) address to his partners:

The responsibility of the auditor has increased manifold today. One of our key responsibilities is to

verify specific financial transactions, which are a resultant of the greed of common investors to

maximize their wealth by relying on false assurances of financial professionals who engage in

executing such hoax Financial Transactions. Eventually regulatory bodies will question the

auditors that how they could let such transactions happen and allow the execution of a financial

irregularity and/or scam. All of you will agree with me that such scams and financial irregularities

are now very common and are taking place not only in India but in other countries too. Recently,

an incident of financial irregularity is observed in the case of a senior – Citibank’s Relationship

Manager, who was posted in the Gurgaon branch. He gained the trust of good accounts of the

bank and induced them to make investments in the portfolios managed by Religare Securities

Ltd, Bonanza Portfolio Ltd and Infoline Traders Terminal, which at the end resulted in losses, of

INR 3.5 billion, for investors (who were attached with these accounts). This happened because of

fraudulent transactions carried out by the senior relationship manager (Citibank) in connivance

with high powered officials who belonged to big corporations. Some co-accused in this financial

irregularity involved, the associate VP Hero Corporate Services, managers, some working at PSU

banks and others at private banks[3]. It is alarming that the financial irregularity at Citibank did not

get detected for almost one year. Could this have happened if stringent measure of Continuous

Auditing would have been followed? We know that technology eases the process of continuous

auditing but whenever a financial irregularity happens, largely technology has been used to

precipitate malpractices. We are central statutory auditors of eminent banks and it is imperative

that we equip ourselves with the understanding of various computer assisted auditing tools and

techniques and simultaneously stay rooted to our auditing intelligence. I understand that we have

to have a different strategy for ever organisation, yet I thought it is best to revisit some key

principles that we all must stick by. The financial instability in the US, because of housing loans

irregularities, is also known to us all and this list today, is endless. What should, now be the

approach of us as auditors who are involved with the attestation function? Increased use of

computer system in business deals, global transactions and the transferring of funds through

online banking have made it extremely important to inspect the total trail of transactions so that

siphoning of funds does not take place. All of you will also appreciate that the computerisation

system has its own abuses and the focus of an auditor should be on means to plug all such gaps.

Jain (2011b) pitched in:

I think many of our counterparts sometimes fail to understand the value of their professional

certification. It is important that our fraternity explores the variety of financial decisions that our

counterparts, all across the globe take, based on their certifications. The documents or entities

certified by us are believed to be authentic by all the involved stakeholders. Therefore, while

performing our attestation function, we have to be honest and see that we are really applying

ourselves to the job.

Assignment questions

Question. Discuss the challenges and misuse of IT implementation for knowledge and data

management at organisations, in the light of the Citibank Scam – 2010 (India). What can be

the auditors’ role to ensure policy lead and clean financial practises?

Question. IT has initiated online trading and enabled globally connected stock markets.

Foreign institutional investors are also making investments in stocks and securities in

different countries. In the light of this backdrop, along with the Harshad Mehta Scam-1992

(India), how can auditors keep themselves updated so that they could investigate the lapses

in trading of various stocks and securities to protect investors’ interests?

PAGE 10jEMERALD EMERGING MARKETS CASE STUDIESj VOL. 1 NO. 3 2011

Notes

1. Further cited in Goyal (2006).

2. Quoted by Jain, Siddharth and also cited in Business Standard (2011).

3. Further cited in The Economic Times (2010).

4. To maintain confidentiality and to protect the interest of the financial institutions involved, the identity

of any person or institution has not been revealed/discussed in this case study.

Keywords:

Auditing,

Information systems audit,

Information technology,

Chartered accountant,

Finance,

Accountancy,

Investors

References

BBC News (2001), ‘‘Tragic toll of stocks turmoil’’, available at: http://news.bbc.co.uk/2/hi/business/

1400804.stm (accessed 18 January 2011).

Bloomberg Businessweek (2009), ‘‘PwC Liability maybe limited in Satyam case’’, available at: www.

businessweek.com/globalbiz/content/jan2009/gb2009019_069317.htm (accessed 9 July 2011).

Business Standard (2011), ‘‘SEBI moves SC in KNA securities penalty case’’, available at: www.

business-standard.com/india/news/sebi-moves-sc-in-kna-securities-penalty-case/140657/on

(accessed 9 July 2011).

Fernando, A.C. (2009), Business Ethics: An Indian Perspective, Pearson Education, New Delhi, p. 365.

Goyal,A.(2006), ‘‘Regulation and de-regulation ofthe stock marketinIndia’’, inRamesh,M. and Howlett, M.

(Eds), Deregulation and Its Discontents: Rewriting the Rules in Asia, Edward Elgar, Cheltenham, p. 191.

Gurusamy, S. (2009), Indian Financial System, 2nd ed., Tata McGraw-Hill, New Delhi.

Hull,J.C.andBasu,S.(2010),Options,FuturesandOtherDerivates,7thed.,PearsonEducation,NewDelhi,

p. 15.

ICAI (2010), Information Systems Control and Audit: Final (New) Course, Board of Studies, The Institute

of Chartered Accountants of India, New Delhi.

Jain, S. (2011a), ‘‘Discussion on the implementation of information systems audit’’, Interview, Personal

(Face-to-face) Communication on 23 January.

Jain, S. (2011b), ‘‘Discussion on the implementation of information systems audit’’, Interview, Personal

(Face-to-face) Communication on 26 January.

Jain, S.C. (2011c), ‘‘Discussion on the implementation of information systems audit’’, Telephone

Conversation, Communication on 19 January.

Jain, S.C. (2011d), ‘‘Discussion on the implementation of information systems audit’’, Telephone

Conversation, Communication on 21 January.

Kausek, J. (2006), The Management System Auditor’s Handbook, Dorling Kindersley India, New Delhi,

p. 92.

Leeladhar, V. (2008), ‘‘Consolidation in the Indian financial sectors’’, in Kaplia, R. and Kapila, U. (Eds),

Economic Developments in India, Vol. 125, Academic Foundation, New Delhi, p. 118.

Malhotra, M. (2000), ‘‘Evaluating NBFC strengths’’, Expressindia.com, available at: www.expressindia.

com/fe/daily/20000714/ffe11092.html (accessed 26 March 2011).

Pathak, B. (2011), The Indian Financial Systems: Markets, Institutions and Services, Pearson Education,

New Delhi, p. 105.

Sasidharan, K. and Mathews, A.K. (2008), Financial Services and System, Tata Mc-Graw Hill, New Delhi.

The Economic Times (2010), ‘‘Citibank Fraud: Rs 400 crores allegedly siphoned off’’, available at: http://

articles.economictimes.indiatimes.com/2010-12-28/news/27586771_1_gurgaon-branch-citibank-

fraud-bank-employee (accessed 9 July 2011).