Background
The CR Bhansali Scam of 1996 is referred as the biggest scam of that era. Bhansali’s scam is an example of how a lack of ethical boundaries of the director and the auditor could lead to such critical consequences on public money.
Bhansali started his life journey as a middle-class trader and by profession as a Chartered Accountant to conduct one of India’s largest mutual fund scams in the era of 1992 – 1996. He identifies and exploits the loopholes in the NBFC sector by systematically adjusting the weaknesses into opportunities for Fraud.
In 1992, he altered CRB Mutual Fund & CRB share custodial services, along with 133 unlisted companies & subsidiaries. These were the bedrock of his fraudulent transactions. He used the Ponzi schemes to influence people to invest and execute the fraud. The CRB Scam became the first-ever Indian scam on the Ponzi scheme and is considered one of the biggest mutual fund scams in India.
Process
A Mutual Fund is a financial instrument combining capital from multiple sources of investors which is then invested in an assortment of securities, including stocks, equities, debt funds, bonds, and other assets. Skilled fund managers oversee these funds and the fund’s objectives to guide their investment choices to create dividends and capital gain for the investors.
A Mutual Fund can earn in two ways:-
1. Interest/Dividend: – The securities that the Mutual Fund invests the total fund as a sum of income is from the dividends which are based on how the market performs, and remaining interest from the pre-determined interest earnings which are irrespective of market conditions. Investors collect the dividends or the interest earnings from the invested organization and distribute it to public inventor of the mutual fund in proportion.
2. Capital Gain: – The investor also earns as a capital gain when he invests in the mutual fund. The capital gain can also be explained as the amount earned by selling their units at a price higher than the one they paid when buying the units. The gains also depend on the time period or holding period of the investment. If the investment is for less than three years, you get short-term capital gains and if the investment is for more than three years, you get long-term capital gains. The tax on capital gains depends on the type of Mutual Fund scheme.
The Securities and Exchange Commission (SEC) requires mutual funds to report the complete lists of their holdings on a quarterly basis since they are regulated investment companies. Mutual funds use SEC Forms N-Q and N-CSR to disclose their quarterly holdings at the end of each fiscal quarter So that the investor can inspect the investment of mutual funds and examine the growth of such funds. Every mutual fund has a Scheme Information Document readily available on the fund house’s website that can give you all the details about its holdings, fund manager, etc.
What went wrong
What is a Ponzi scheme?
➣ A Ponzi scheme is an investment scam that pays early investors with money taken from later investors to create an illusion of big profits. A Ponzi scheme promises a high rate of return with little risk to the investor. It relies on word-of-mouth, as new investors hear about the big returns earned by early investors. Inevitably, the scheme collapses when the flow of new money slows, making it impossible to keep up the payments of alleged profits.
How the scam was executed
➣ Bhansali established ‘CRB Consultants,’ a private limited company in New Delhi in 1985, and in 1992, the name of the company was changed to CRB Capital Markets (CRB Caps) and it was converted into a public limited company. He then established CRB Mutual Fund (Mutual Fund) in 1994 and CRB Share Custodial Services in 1995. He conducted most of the transactions in the company by establishing 133 unlisted companies and subsidiaries. The Ponzi schemes were fraud schemes that lured investors and paid profits to earlier investors with funds collected from recent investors. The scheme leads victims to believe that profits are coming from genuine business activity, and they remain unaware that other investors are the source of funds for these schemes. The CR Bhansali Scam became the first ever Indian scam based on this type of scheme.
➣ The CRB offers multiple services to the public such as merchant banking, leasing, hire & purchase, bill discounting, asset management fixed deposit, and other multiple services. CRB was also quite active in stock broking at NSE and BSE. Their main business was to collect money from the public through fixed deposits, bonds, and debentures. His company was rated AAA by CARE (Cooperative for Assistance and Relief Everywhere).
➣ Generally, Bhansali bought IPOs of companies at a much lower price than the issue price and hence entered a deal with the company. As per the deals, Bhansali sold the holdings at a higher price, promising to buy them back after a year at a higher price. The money generated thus was shown as profits in the books of CRB Caps or CRB Corporation as profits from the sale of investment. This procedure was repeated over and over again, keeping the books of the companies fluctuated. The huge profits always helped him keep his share price high and also helped him get more money from the public. Since the company managed to get higher credit ratings, it ensured a steady fixed deposit and bank credit inflow. These actions and deeds were made possible with the help of Bhansali’s trusted firms of auditors.
Internal Auditor insights.
Internal auditors could have identified gaps in compliance with regulatory requirements and identified the scam operated throughout the organization. They could have highlighted the lack of oversight from regulatory bodies such as SEBI and pointed out the need for stronger compliance measures to ensure transparency and adherence to trading norms. Internal auditors would have been responsible for verifying the profitability status of subsidiaries, the reliability status of the organization, and the management of funds throughout the organization. They could have raised concerns about discrepancies in profit of non-operating subsidiaries, identify the fake investments and unlawful methods’ used to inflate the valuation of organization in the market. Internal auditors assess the effectiveness of internal controls designed to prevent and detect fraud.
Learning
The case highlights the importance of professional ethics specified by ICAI which needs to be complied by the Chartered Accountant to protect the public interest. Furthermore, there is a need for the government to have some strict policies and compliance to disclose the source and method of operation of such schemes.
Conclusion
The primary reason for the emergence of such scams is a lack of regulation on the organization for transparent reporting. The main cause of such scams is a lack of regulation on the part of our auditors, who come out clean in all such cases. Furthermore, it is clear that the Bhansali group has paid auditors to express the report in favor of the organization where the auditor chose to not comply as per the ethics established by the ICAI, the collusion of the director and the auditor is proportional to the lack of fair and true information to the investors and public.
Authors:
Umesh Vishwakarma |Director
Swapnil Mukati |Associate Consultant
Email: blogs@bilimoriamehta.com
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