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Fraud and corporate governance changing paradigm in India 2012


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This report offers a perspective on the bribery landscape across Europe, the Middle East, India and Africa (EMEIA), including enforcement trends, risks for businesses to be aware of and mitigating steps companies may want to consider.

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Fraud and corporate governance changing paradigm in India 2012

  1. 1. Fraud and corporate governance:Changing paradigm in IndiaA report based on India fraud survey 2012
  2. 2. Fraud and corporate governance: Changing paradigm in India2IntroductionIndia is an emerging market, which is witnessing rapid economic growth. But the spate of scamsunearthed in the last few years has raised anxiety in the minds of foreign investors, who are lookingto be part of the Indian growth story, but are wary of fraud, bribery and corruption risks.On looking beyond our borders, we observe that the increasingly multi-directional flow of trade andinvestment has created a polycentric world in which opportunities, capabilities and competitionare spread broadly across multiple spheres of influence.1In addition, there are increasing risks andchallenges, as governments around the world introduce anti-corruption legislation such as the USForeign Corrupt Practices Act (FCPA) 1977 and the UK Bribery Act 2010, which have extra-territorialjurisdiction. Bribery and corruption continues to be the biggest challenge in the corporate world, andthe risk is compounded by increasing enforcement of regulations and stricter penalties.Indian policy makers are taking robust steps to increase the confidence of investors — corporateand public. In the recently concluded Parliamentary sessions, two important bills were introduced— the Prevention of Bribery of Foreign Public Officials Bill and The Anti-Corruption, GrievanceRedressal and Whistle-blower Protection Bill. In addition to this, ratification of the United NationsConvention against Corruption (UNCAC) by the Government this year has helped India demonstrateits commitment to good governance. In another significant development, the Government is workingon the Lokpal Bill, which aims to create stricter regulations and has given more credibility to its fightagainst bribery and corruption. We hope these steps will help the country recover from the setbacksit has faced and that investors with a long-term view will focus on the opportunities being offered inthe domestic market.This year, we have made an attempt to take our study beyond the fraud scenario to understand theprofile of a fraudster. According to the profile created by the majority of the respondents, a typicalfraudster is an internal male employee, who is in his 30s, is far from the age of retirement and is an
  3. 3. Fraud and corporate governance: Changing paradigm in India 31 Winning in a polycentric world: Globalization and the changing world of business, Ernst & Young, 2011Arpinder SinghPartner and National DirectorFraud Investigation & Dispute ServicesErnst & Young Pvt. Ltd.average performer in middle management from the procurement or sales department. This profiledescription does not come as a surprise, with increasing consumerism and the desire for instantgratification driving employees to commit fraud against their companies. However, although insiderthreats are easy to understand, they are hard to detect as compared to external ones.According to our respondents, external perception of their company is very important — more thanhalf of them feel that damage to an organization’s reputation is the greatest collateral damagecaused by fraud. This fear also stems from the fact that damage to a company’s reputation canresult in loss of revenue or destruction of shareholder value, even if it is not found guilty of a crime.One of the possible causes for the increasing trend of fraud being committed by employees could becorporate reluctance to seek legal recourse against employees.Today, we see a number of companies wanting to incorporate proactive fraud risk management intheir companies as compared to a year ago. This is an encouraging sign, which indicates a brighterfuture for corporate governance in India.We hope you gain some useful insights from this report, and it helps you to address challenges andrisks faced by your business.We take this opportunity to express our gratitude to the people and organizations who took timeto respond to our survey. The report and the findings would not have the same value without thesupport of these respondents and all those who made the survey successful.
  4. 4. Fraud and corporate governance: Changing paradigm in India4
  5. 5. Fraud and corporate governance: Changing paradigm in India 1Executive summary.....................................................................................2What lies beneath........................................................................................4Section 1: Fraud scenario in India — ground reality......................................6 Cost of fraud — more than monetary........................................................7 Discovery of fraud — methodical and accidental........................................7 Current practices — inconsistent with globally accepted norms..................8 Growing greed — profile of a fraudster......................................................9Section 2: Areas of concern.......................................................................10 Data and information theft – managing insider threat..............................11 Management’s overriding controls.........................................................11 Supply chain leakage facilitating counterfeiting in consumerproduct industry...................................................................................12 Bribery and corruption – the perpetual challenge....................................13Section 3: Changing regulatory landscape.................................................18Section 4: Tools for fighting fraud.............................................................20 Role of technology................................................................................21 Whistle-blowing....................................................................................23 Fraud response plan..............................................................................24 Third party due diligence.......................................................................24 Independent directors — a strong influence.............................................25About the research....................................................................................26In this report
  6. 6. Fraud and corporate governance: Changing paradigm in India2This study aims to understand how businesses havecoped with increasing fraud and corruption risk lastyear, what the emerging fraud risks in the industry areand the measures taken by various organizations tomitigate these risks.Some key highlights of the study• Increasing incidence of fraudNearly three-fifths of the respondents saidthat their companies have been subjected tofraud during the course of last year. Moreover,with the growing use of technology in businessoperations, instances of technology-led fraudhas also increased significantly. Since most ofthe traditional processes in a company, e.g.,accounting, procurement, etc., are movingto IT-based processes and systems, and mayeventually move to cloud computing, so is fraud inthese areas. This is posing a major challenge fororganizations today2.• Top five fraud risks1. Data or information theft and IP infringement2. Bribery and corruption3. Fraud by senior management and conflictof interest4. Vendor fraud or kickbacks.5. Regulatory non-complianceData or information theft has emerged as a newthreat in the evolving risk landscape due to theproliferation of IT, giving rise to issues relating toprivacy and data protection.• Changing profile of a fraudsterAccording to most survey respondents, “He isan internal employee of a company, who is in his30s and is far from retirement. He is in the middlemanagement cadre, working in the procurementor sales department.” With increasingExecutive summary2 Technology fraud: a changing world, Ernst & Young, 2011consumerism, there is a shift from the “need”to “greed” as a motive for committing fraud.And today we are seeing a trend where youngeremployees are increasingly committing fraud tosupport a lifestyle that is not commensurate withtheir incomes. This appears to be in line with theincreasing consumerism in India.• Lack of action against the fraud perpetratorCompanies are reluctant to take legal recourseagainst employees responsible for committingfraud. Only 35% of the respondents said that theircompany takes any disciplinary action againstunscrupulous employees. One reason for thiscould be that companies fear possible damageto their reputation if news about the fraudulentincidence leaks into the public domain.• Significant impact of fraudLoss of reputation emerged as the biggest andseverest collateral damage caused by fraud.External perception is highly valued by companies,since damage to their reputation can result inloss of revenue or destruction of shareholdervalue, even if they are not found guilty of havingcommitted a crime.• Continuing bribery and corruption riskBribery and corruption continue to be a perpetualchallenge for corporate India.1. Level of awareness: Around 70% of therespondents were aware of the Prevention ofCorruption Act 1988. This is not surprisingin view of recent scams and subsequentmedia and public activism. However, withmore than 75% of the respondents working inmultinational corporations ( MNCs), less than50% are aware of global anti-graft legislationssuch as the US FCPA and the UK Bribery Act.2. Rationale for bribery: Kickbacks are givento win or retain business, to obtain approvalsfrom government agencies and to influencepeople to make favorable decisions.
  7. 7. Fraud and corporate governance: Changing paradigm in India 33. Common mode: Cash and gifts are the mostcommon mode of giving bribes.4. Factors facilitating bribery and corruption:Nearly 40% of the respondents indicatedthat the inherent nature of the industryin which their companies operate isresponsible for encouraging corruption; 34%of the respondents said that this is due toorganizations having a “weak tone atthe top.”5. Lack of enforcement of anti-corruption laws:Around 33% of the respondents said that lackof an effective regulatory and compliancemechanism, and weak law enforcement areequally responsible for facilitating corruption.6. Fight against bribery and corruption:Around 62% of the respondents are in favorof stringent disciplinary procedures and 73%said that companies should adopt a zerotolerance approach to bribery and corruption,e.g., by taking legal action against theperpetrators of fraud.• Weak anti-fraud measuresCompanies still rely on old traditional anti-fraudmeasures. Reliance on internal and externalaudit, and code of conduct is high. This seemssurprising in today’s environment, wherefraudsters are using advanced tools andtechnology to perpetrate frauds.Proactive fraud risk management:Need of the hourBusiness leaders are aware of the need to addressfraud risks, but lack of a comprehensive and integratedapproach to fraud risk management continues to bea concern. Currently, companies take a “check-the-box” approach to fraud risk management, conductingisolated risk assessments, whereas the need of thehour is a cohesive but wider approach, aligned with thestrategic business objectives of organizations.Technology can play a larger role in fraud riskmanagement. Another possible area that should beconsidered by companies in countering fraud risk is awhistle-blowing mechanism.Changing regulatory scenario:Positive changeThere is increased regulatory activism, and existingActs are being amended and updated to address newand complex threats. Regulators are proposing morestringent standards for prevention, detection andreporting of fraud. For instance, the Government hasproposed various measures to counter fraud risk inthe Companies Bill 2011, which is slated to replacethe Companies Act 1956. This is in addition to manycurrent regulations such as Clause 49 of the listingagreement, Companies’ (Auditor’s Report) Order(CARO) 2003, which entrusts the responsibility ofpreventing corporate fraud to the Directors, CEO, CFOand auditors of a company.The fact that around two-thirds of the respondentssaid that scams and corporate frauds were unearthedbecause of legislations such as the Right toInformation Act (RTI) and Public Interest Litigation(PIL) speaks volumes about public awareness in India.Globalization has added to the regulations to whichcompanies need to adhere. Governments around theworld, in an attempt to address bribery and corruptionrisks, have introduced anti-corruption legislation suchas the US FCPA and the UK Bribery Act, which haveextra-territorial jurisdiction.Future outlookMore and more companies are taking cognizanceof the changing regulatory scenario. We are seeingan increased focus on corporate governance. Alsocompanies are increasingly now taking proactivemeasures against fraud, bribery and corruption.
  8. 8. Fraud and corporate governance: Changing paradigm in India4What lies beneath3
  9. 9. Fraud and corporate governance: Changing paradigm in India 5Rapid-growth markets such as India have gainedsignificant momentum due to their rising percapita incomes, favorable demographics and largepopulations. Most have come through the financialcrisis with very little long-term damage and continueto have impressive growth trajectories. With economicgrowth projected to surpass 8% annually and thenumber of people in the Indian middle class set totreble over the next 15 years, domestic demand isexpected to grow at a compound rate of 9.2% peryear between 2010 and 2030. This places India in afavorable position to attract an increasing proportionof global foreign direct investments (FDI).4Although India is on the expansion path of MNCslooking for high growth, recent fraudulent incidentsreported by the media have made foreign investorswary of various hidden risks. They are faced withthe dual challenge of achieving aggressive growthnumbers and ensuring that in the process they arenot violating any regulatory guidelines. The complexbusiness environment, renewed regulatory activismand increasing use of technology have tipped thescale against corporate organizations that arehard-pressed to deliver business results in today’srisk-prone scenario.India struggles with corruption issues, perceived andreal. According to the 2011 Corruption PerceptionIndex (CPI), the country is ranked 95th out of 183countries, and has scored less than in previousyears — 3.1 on a scale of 0 to 10 where 0 stood forhighly corrupt.5Practical issues that companies may face in anemerging market such as India:• Lack of availability of unique identification numberand reliable rating data for entities or individuals3 “What lies beneath? The hidden costs of entering rapid-growth markets, ”Ernst & Young Master CFO Series, 20114 Reaching toward its true potential, Ernst & Young’s 2011 India attractiveness survey.5 Corruption perception Index 2011, Transparency International, December 2011.6 Reaching toward its true potential, Ernst & Young’s 2011 India attractiveness survey.• Facing the challenges of bribery and corruption,particularly while working with local partners,who may have a different approach to conductingbusiness• Extensive use of cash or cheques, rather thanelectronic transfers, with the danger thatthese may be used to facilitate unethicalbusiness practices• “Relatively weak governance” comprising oneof the top challenges companies can face inthe countryDespite the prevalence of bribery and corruption,legal and regulatory intervention, as well as increasedattention being paid to this issue by corporateorganizations, seems to be having a positive effect.The Government recognizes that bribery andcorruption are detrimental for business and companiesare taking corporate governance seriously and aligningtheir business strategies to reflect this. As a result, weare seeing a steady decline in this problem, althoughit is an ongoing process that will require continuousintervention from the Government and the corporatesector to make further progress.Corruption is often cited as one of the mainchallenges faced by india. The Governmenthas taken steps to fight it by offering many ofits services online, thereby reducing avenuesthrough which corrupt officials can demandbribes. However, recent scandals haveunderlined the persistence of this problem.6According to more than three-fourths of the respondents, theincidence of fraud has increased in the country in this last one year.
  10. 10. Fraud and corporate governance: Changing paradigm in India6Section 1:Fraud scenario in IndiaGround reality
  11. 11. Fraud and corporate governance: Changing paradigm in India 7According to half of the survey respondents,the incidence of fraud has increased in theirindustry. In addition to industries such as banking,Non Banking Financial Companies (NBFC), realestate and telecommunications, which are generallyperceived as being highly fraud prone, around 50%of the respondents from infrastructure, IT/ITeS andconsumer product companies also indicated that fraudincidents have increased in their segments.In the survey, nearly three out five respondents revealed that theircompanies had been subjected to fraud during this last one year.Out of these respondents, around two-third said that it was exposedbecause of whistle-blowing.A respondent from the manufacturingsector said, “The root causesare increased use of technology,power without adequate checks,decentralization of operations, lack ofinternal checks and controls, fallingmoral values, disappointing characterof national leaders, greed, etc.”2%3%3%4%9%9%10%12%13%15%20%0% 5% 10% 15% 20% 25%OthersAsset misappropriationManagement conflict of interestMoney launderingAccounting fraudProcurement fraud, favoritismFraud committed by senior managementVendor fraud, kickbacksBribery and corruptionTheft of data and information, IP infringementRegulatory non-complianceQ: Which of the following types of fraud do you believe can pose the biggest riskto your industry?Figure 1: Fraud riskCost of fraud – more than monetaryIn the wake of recent scams and public activismagainst graft, there is a good chance that adversenews about a company may be blown out ofproportion by the media. At such times, companieswalk on a thin rope and are overtly conscious ofpotential fraud, as it may damage their reputation andmarket capitalization. In addition, they are also fearfulof rating agency judgments on their risk management,which can influence availability and cost of capital.Discovery of fraud – methodicalor accidentalOnly 14% of the respondents attributed detection offraud to automated surveillance systems. It seemscounter-intuitive that we still detect most cases offraud by being tipped off or by accident, even withadvancement in technology and heightened regulatoryactivity. Therefore, now, more than ever, there is aneed to apply advanced analytics to fraud detection.
  12. 12. Fraud and corporate governance: Changing paradigm in India8For companies, public perception can have a dramatic impacton their business. According to more than three-fourth of therespondents, loss of reputation is the most serious collateraldamage (actual or potential) stemming from fraud.Q: Has your company been subjected to any fraudulent incidents during the last year?If so, which one of the following methods of detection were employed?7%9%9%12%14%34%41%62%0% 10% 20% 30% 40% 50% 60% 70%OthersBy accidentExternal auditRotation of duties and personnelAutomated detection and surveillanceProactive fraud risk managementInternal audit andcorporate securityWhistle-blowing mechanismFigure 2: Methods employed to detect fraud77 Some percentages in this report total more than 100%, since executives can make multiple selections.Current practices – inconsistent withglobally accepted normsCompanies still using internal/statutory auditto detect fraudCompanies tend to over-rely on audits. Internal andexternal audit, and code of conduct seem to be themost preferred anti-fraud measures employed bycompanies. However, these methods are not sufficientfor detecting fraud and limiting losses caused by it.There are only a few companies that have put in placeproactive fraud risk management initiatives and have awhistle-blowing mechanism.Corporate reluctance to seek legal recourseCompanies typically prefer to avoid reportingany economic offence to a regulator because of aAround 80% of “enterprise data,” e.g., company documents, presentations, the internet, e-mail, etc., isunstructured, yet most of today’s automated, anti-fraud detection tools and audit techniques focus on 20% ofstructured data.perceived threat to their reputation. They deal withsuch instances in a discreet manner by not lettingeven their employees know about such incidents,fearing that it would tempt others to attemptsomething similar. They are generally interested inrecovering the defrauded money rather than gettingthe culprit punished under Indian laws, since it is notlegally binding on them. Companies also hesitate toreport such matters to the police, apprehending thehardships they may face during the investigation andprolonged judicial trials.Corporate reluctance to seek legal recourse is aground reality, and the reasons for this cannot beunderestimated, but it is imperative to report thewrongdoing, so that the perpetrator is punished andthe company can send out a strong message of zerotolerance for such misdemeanours to its employeesand stakeholders.
  13. 13. Fraud and corporate governance: Changing paradigm in India 9Growing greed – profile of a fraudsterIn the often-quoted fraud triangle of Donald R.Cressey, usually the motive for committing fraud isattributed to financial need, which a fraudster maybe unable to meet with his or her regular income.However, in recent years, we have seen a change inthe motive, as it shifts from “need” to “greed”, withmore and more people committing fraud to supporttheir opulent lifestyles, which are not commensuratewith their incomes. There are many real-lifeexperiences and certain assumptions that form thebasis for the traits of a fraudster, as drawn by therespondents in this study. These include the following:• Young employees, especially in their 30s, whoare at ease with technology, may commit fraud tomake “quick money.”• Image projection in a sluggish economy andthe prospect of accelerated career growth canmotivate employees to bend rules for reasonsbeyond financial need.• An employee working at an offsite location or ina remote satellite office, away from the directcontrol of management, has a greater opportunityto commit fraud.• Sales and procurement are the two departmentsthat have the maximum interaction with externalparties. This offers employees working in thesedepartments the opportunity of colluding withoutsiders to exploit their insider and confidentialknowledge about their companies, without comingin the direct line of suspicion.• Lack of controls in rapidly growing organizations,where fraud may be overlooked as the costof doing business, is another factor that canencourage fraud.Given the high cost of occupational fraud, effectivefraud-prevention measures are critical today.Fraudsters generally show behavioural warning signsof their misdeeds. These red flags, e.g., as livingbeyond their means or displaying control issues,cannot be identified by traditional control methods.Employees should be trained to recognize commonbehavioural signs that indicate that fraud is beingcommitted and be encouraged not to ignore such redflags, since these may be the means of detecting ordeterring fraud.88 “2010 Report to the Nations,” Association of Certified Fraud Examiners (ACFE), 2010.Only 35% of the respondents said that their companies take legalaction against any employee responsible for committing fraud. Mostcompanies do not take any disciplinary action against employeesresponsible for fraud.
  14. 14. Fraud and corporate governance: Changing paradigm in India10Section 2:Areas of concern
  15. 15. Fraud and corporate governance: Changing paradigm in India 11Data and information theft — managinginsider threatTill recently, India was the most sought after andpreferred destination for companies looking tooffshore their IT and back-office functions. However,some recent incidents of stolen data and fraudhave raised concerns relating to privacy anddata protection.Some key risk prone areas:• Increased vulnerability due to anytime andanywhere accessibility• Leakage of company and customer’s confidentialinformation by current or ex-employees• Loss of confidential data due to externalvulnerability• Manipulation of procurement, accounting or otherIT-based process or systemAlthough insider threats are easy to understand,they are hard to detect as compared to externalones. Employee perpetrating fraud are generallyallowed or authorized to access sensitive informationor data to execute their routine jobs. To identify anindividual who is misusing information is like lookingfor a needle in a haystack blindfolded. It is even moredifficult than detecting the unauthorized access of anexternal hacker or intruder.A respondent from the IT/ITeSindustry said, “In the nature ofour industry, fraud takes placemore often due to false claims inemployees’ profiles with regardto their work experience, andalso due to data violations suchas unauthorized downloadingof software, leading to seriousintellectual property rightviolation issues.”Management’s overriding controlsPublic capital is the key driver of the growth ofcompanies. Moreover, accessing markets is thepreferred mode of raising capital in the case of manypromoter-driven companies. However, this comeswith strings attached, e.g., the expectation of andresponsibility to shareholders and creditors, additionalstatutory compliance requirements and associatedcosts. The pressure on management to deliver resultsand manage expectations, irrespective of marketconditions, is also very high.A company usually has to walk the fine line betweencompliance and business efficiency, and erringon either carries a high penalty. Therefore, itsmanagement is expected to act as its guardian andimplement suitable risk-based control structures tomanage compliance and business requirements.It has been observed that the tighter control acompany has over its audit functions, the more likelyit is that at some point this will become ineffective.In difficult market conditions, its managementmembers may succumb to the pressure of “keeping upappearances” and ignore the controls they are meantto safeguard.According to 15% of the respondents, management conflict ofinterest poses the highest fraud risk.According to a respondent,“Fraud occurs in any area andis not restricted to sales, andalso not to middle or seniormanagement, but is essentiallyperpetrated by people in position,who have the power to influencedecisions and by those who arenormally trusted.”
  16. 16. Fraud and corporate governance: Changing paradigm in India12Supply chain leakage facilitatingcounterfeiting in consumerproduct industryThe consumer product supply chain is complex innature, and the industry witnesses tough competition,which pushes companies to be highly cost-efficient.This necessitates that large FMCG companies primarilydepend on third-party (3P) vendors for their supplyof raw materials, packaging as well for contractmanufacturing. High-growth pressures and aggressiveexpansion plans tend to make the management ofsuch companies frequently overlook the importanceof setting up proper controls over and monitoringmechanisms for their third-party vendors. The supplychain is especially vulnerable to leakages at the nodalpoint of third-party vendors, as compared to othernodes such as company- managed plants, warehouses,distribution centers and retail stores. What makesfraudulent incidences even more difficult to detectand to distinguish fake products from genuine onesis the fact that the material used by counterfeiters tomanufacture spurious products often seems genuine.This is a problem that is clearly crying for redressal.Counterfeiting leads to loss of revenue, attrition ofcustomer satisfaction, damaged brand integrity, pricedistortions and the development of a gray marketfor goods. Quite often, the original material is usedto manufacture counterfeit products. Counterfeitersgenerally manage to infiltrate a company’s supplychain and encompass third-party vendors, warehousesand 2P vendors that siphon of material. Once theyhave access to original material, it is easy for themto assemble counterfeit products with a minimalinvestment, e.g., in a cottage industry.Probable leakage points in the supply chain:• Scrap channel: Sometimes a stock of unusedmaterial is scrapped without it being destroyed.Material discarded in this manner can be easilyused to assemble spurious products• A parallel supply chain: Counterfeiters caninfringe a company’s original supply chain andsource genuine material from it.• Improper disposal of obsolete and expiredstock: In some cases, companies fail to controldisposal of their obsolete and expired stock, andcounterfeiters obtain these products from thecompanies’ managed units.• Leakage from company warehouses: Finishedproducts are stolen from the warehousesand plants of companies, and are sold atdiscounted rates.
  17. 17. Fraud and corporate governance: Changing paradigm in India 139 Some percentages in this report total more than 100%, since executives make multiple selections.Bribery and corruption – theperpetual challengeBribery and corruption are undoubtedly the mostfrequently discussed topics in the business worldtoday. The world has been witnessing multimilliondollar scams and India is not far behind. Bribery andcorruption may be as old as mankind, but the key issuefaced by India today is not petty bribery, but high-levelcorruption, which has had a significant impact on thecountry, its people and its image.Increased awareness of local laws, but lowawareness of global onesAfter the recent scams, there seems to be anincreased awareness of anti-graft laws, and nearlythree-fourth of the respondents indicated that theywere aware of anti-corruption legislation in India — thePrevention of Corruption Act. However, althoughthree-fourth of the respondents represented MNCs,less than half of them were aware of important anti-graft legislation such as the US FCPA and the UKBribery Act, both of which have extraterritorial reach.A respondent from a multinational company, in responseto a question on anti-graft legislations, said, “There is nolevel playing field for multinational companies in India. Theenforcement environment is strict in MNCs (as comparedto Indian companies) due to FCPA regulations. This isespecially true of the interaction of such companies withgovernment agencies, poses challenges for them and placesthem at a competitive disadvantage as compared to theirIndian peers.”Q: Are you familiar with the following acts or regulations?Figure 3: Increased awareness of anti-corruption laws932%35%49%70%83%0% 20% 40% 60% 80% 100%OECD regulationsUK Bribery Act (UKBA)Foreign Corrupt Practices Act (FCPA)Prevention of Corruption ActIndian Penal Code
  18. 18. Fraud and corporate governance: Changing paradigm in India14Cash seems to be the most popular mode of paying bribes. More thanhalf of the respondents selected it from the long list of possible modes.In India, where it is the customary and accepted practice for people,even corporate organizations, to exchange gifts, 21% of the respondentsselected this as the second most common mode of paying bribes.According to Transparency International, corruptpoliticians and government officials in developing andtransition economies receive bribes totaling betweenUS$20 billion and US$40 billion every year, whichis equivalent to between 20% and 40% of all officialdevelopment assistance provided.1110 “Doing business in a more transparent world: economic profile of India,” World Bank and International FinanceCorporation report, 2012.11 “What lies beneath? The hidden costs of entering rapid-growth markets, ”Ernst & Young Master CFOSeries, 2011.The rationale for bribery varies across industries.We have received diverse responses for differentindustries, for instance, the majority of therespondents from the telecom sector indicatedthat bribery is often used to win business, whereasrespondents from the consumer products sectorreported that it is frequently used to obtain routineadministrative approval. The most blatant reports ofbribery and corruption were from the respondents ofthe real estate segment, with 100% of them sayingthat bribery was a real bottleneck in the path ofprocurement of routine administrative approval inthe sector.Some companies in India take the easy way out andadopt various strategies of paying bribes. Appointingthird parties and paying them, without availing of theirservices, is the most common methodology fordoing this.However, in our experience, we have seen that somecompanies appoint compliance officers to deal withgovernment and related matters. They strictly refuseto pay bribes and follow the difficult path. Theyalso try to imbibe this culture in their employees,suppliers and intermediaries. Accordingly we believethat with the right anti-bribery framework (includingpolicy, procedures and monitoring) it is possible to dobusiness in India with limited exposure to FCPA, UKBribery Act or any other local statute.Rationale for briberyNearly one-third of the respondents said that thepractice of giving “kickbacks to win or retain business”is prevalent; one-fourth of respondents indicated thatthis practice was followed ‘to get routine approvalsfrom government agencies” and “influence people inmaking favorable decisions.”The responses given above are supported by theresults of the Ease of Doing Business Index10of theWorld Bank, in which India is ranked 132nd out of183 economies. This highlights the various delaysand difficulties faced by investors or companies insetting up businesses and attempting to obtain routinelicenses and permits in the country.Unfortunately, corruption is frequently perceived asthe way of doing business in India, and many peoplebelieve it is an acceptable practice to expedite routinegovernmental action, e.g., obtaining approval, byemploying corrupt means such as giving bribes. Aninvestor or a company may be exposed to briberyand corruption risk at various stages of its setting upbusiness, beginning from its corporate incorporationto its setting up a manufacturing facility, fromimporting raw materials to exporting finished productsand from multi-location expansion to obtaining foreignfunding. It is therefore essential for it to be cognizantof these risks.
  19. 19. Fraud and corporate governance: Changing paradigm in India 154%16%23%25%30%33%33%34%35%0% 5% 10% 15% 20% 25% 30% 35% 40%OthersLack of awareness among employeesPoor internal policies and proceduresNo due diligence conducted on third partiesConsidered as acceptable behaviorLack of effective regulatory and compliance mechanismWeak law enforcementWeak tone at the topInherent nature of the industry in which your company operatesQ: Which of the following are the main factors facilitating corruption?Figure 4: Factors facilitating bribery and corruption12Nearly 40% of the respondents indicated that the inherent nature ofthe industries in which their companies operated was responsible forfacilitating corruption; 34% respondents said that it was due to the“weak tone at the top.”12 Some percentages in this report total to more than 100%, since executives can make multiple selections.Factors facilitating bribery and corruptionA respondent from a Private Equity (PE) firm said, “Government-facing industries witness the highest incidenceof corrupt practices.”Many industries in India have historically been dominated by government-owned entities, since the regulatoryenvironment in India is wide enough to control many private companies or the companies directly or indirectlysupply to state-owned entities. It is because of this that certain industries and companies in India face a high riskof bribery and corruption.
  20. 20. Fraud and corporate governance: Changing paradigm in India16Fight against bribery and corruptionCompanies can proactively take the first step againstcorruption by training their employees, implementingtransparent policies and setting the tone at the top.The good news is that a number of companies,irrespective of their country of domicile, are payingheed to the risk of bribery and corruption. Thecorporate world is changing and is proactively settingup an anti-bribery and corruption framework that isbeing increasingly implemented.Around 62% of the respondents were in favor of stringent disciplinaryprocedures and 73% said that their companies should adopt a zerotolerance approach to bribery and corruption, e.g., by taking legalaction against perpetrators of fraud.Q: In your opinion, how can your industry fight bribery and corruption?Figure 5: Steps to mitigate bribery and corruption risk131%18%24%40%42%54%62%73%0% 10% 20% 30% 40% 50% 60% 70% 80%Others3P due diligenceBribery and corruption reviews and due diligenceTransparent disclosures about company policies onbribery and corruptionTrainingBy improving the tone at the topStringent disciplinary proceduresZero tolerance approach to bribery and corruption such as takinglegal action against the perpetratorA respondent from a consumer productscompany said, “Corruption is widely prevalentin the country and the private sector is nottotally immune to it. Strict compliance with therule of law and ethics, setting of high internalstandards and transparent behavior will help toreduce incidences of fraud.1113 Some percentages in this report total more than 100%, since executives can make multiple selections.
  21. 21. Fraud and corporate governance: Changing paradigm in India 17Table 1:From top to bottom: how management can embed a zero tolerance approach to briberyand corruption14These are several largely commonsense measures that will give employees a reason to care aboutcomplying with anti-bribery and anti-corruption regulations by effectively linking these with their work andcareer advancement. The leadership of an organization needs to incorporate the following in the company:• Make ethical behavior a priority for the business and demonstrate its commitment to achievingthis objective• Conduct a fraud, bribery and corruption risk assessment and identify any gaps in the company’scurrent policies and procedures• Where necessary, implement changes in these procedures, paying particular attention to training• Ensure that training is tailor-made and relevant, reflects the issues and day-to-day problems employeesare likely to encounter and guides them effectively on addressing them• Take a risk-focused approach to those who should be trained, on what, how and how often• Ensure that integrity is reflected in the company’s appraisal system14 “What lies beneath? The hidden costs of entering rapid-growth markets, ”Ernst & Young Master CFO Series, 2011.
  22. 22. Fraud and corporate governance: Changing paradigm in India18Section 3:Changing regulatorylandscape
  23. 23. Fraud and corporate governance: Changing paradigm in India 19Table 2: Changing regulations in IndiaIn recent times, several changes have been made in various laws and regulations relating to fraud, briberyand corruption, and others are being proposed. Some of these acts and proposed bills, with their changes andsalient features, are summarized below:15Bill/Law Salient featuresThe Public Interest Disclosure (Protectionof Informers) Bill, 201016• Expected to encourage disclosure of information in public interest, butthe private sector is excluded• Provides limited protection to whistleblower• Investigation not time boundThe Prevention of Bribery of ForeignPublic Officials (FPO) and Officials of PublicInternational Organisations (OPIO) Bill201117(India’s FCPA equivalent)• Criminalizes acceptance or solicitation of bribes by FPOs and OPIOs• Criminalizes offers or promises to give bribes to FPOs and OPIOs forobtaining or retaining businessThe Prevention of Corruption AmendmentAct, 2011(proposed amendment to the PCA, 1988)• Includes new sections that empower the Act to deal separately theoffence of violating the norms of the Constitution, for using undueinfluence on public servants, misusing official powers and causing loss tothe government exchequer• Empowered to seize, attach and confiscate the property of convictedpersons, who have amassed ill-gotten moneyCompanies Bill 201118• Serious Fraud Investigation Office (SFIO): has powers to probe companiessuspected of fraud• SFIO’s report filed in a court for framing charges to be equivalent to apolice report under the Code of Criminal Procedure, 1973• To have the power to arrest persons for suspected fraud; SFIO tocoordinate its operations with those of other investigating agencies suchas the Central Bureau Of Investigation or Enforcement DirectorateData privacy laws19• To prevent use or gathering of personal information without theknowledge of the concerned persons• To protect personal information, financial information such as bankaccounts, credit or debit card or other payment instrument detailsThe Competition Act20• Anti-competitive agreements• Abuse of dominant position.• Regulation relating to combination15 This information is intended to only provide a general outline of the subjects covered. It should neither be regarded ascomprehensive nor sufficient for making decisions, nor should it be used in place of professional advice.16 Bill No. 97 of 2010, The Public Interest Disclosure and Protection to persons making the Disclosures Bill, 2010; asintroduced in the Lok Sabha on 26 August 201.017 Bill No. 26 of 2011, The Prevention of Bribery of Foreign Public Officials and Officials of Public InternationalOrganizations Bill, 2011.18 Bill No. 121 of 2011, The Companies Bill, 2011.19 “Ministry Of Communications and Information Technology”,, 11th April, 2011.20 No.12 of 2003, The Competition Act, 2002; as amended by The Competition(Amendment) Act, 2007.
  24. 24. Fraud and corporate governance: Changing paradigm in India20Section 5:Tools for fighting fraud
  25. 25. Fraud and corporate governance: Changing paradigm in India 21Almost all companies, irrespective of their sector,are exposed to fraud, bribery and corruption risks,although the degree and complexity may wary.Business leaders are aware of the need to addressthese risks, but lack of a comprehensive andintegrated approach to fraud risk managementcontinues to be a concern. Currently, companies’take the “check-the-box” approach to fraud riskmanagement with isolated risk assessments, whereasthe need of the hour is a cohesive but wider approach,aligned with their strategic business objectives.The increasing number of frauds and the growingdegree of risk necessitates that companies regularlyreview their policies, build in checks and use newand advanced technology to avoid such issues.Furthermore, although no system can be foolproof, aproactive and dynamic approach can make a companyready to counter fraudsters and gain an edge overits competitors.A respondent from the automotive sector said aboutfraud risk management, “Fraud cannot be completelyavoided, but can be limited to a minimum witheffective internal control, cross-functional teams toensure verification, sound whistle-blower policies,commitment of top management and zero toleranceof fraud.”Role of technologyLess than 50% of the respondents are aware offraud-prevention and detection tools. Moreover, inspite of the current popularity of social media, onlyone-fourth of the respondents were aware of IT-basedtools that can be employed to identify unethicalbehavior, based on a social network analysis.Q: Is your company familiar with any of the following fraud-prevention and detection tools?Figure 6: IT tools for fraud prevention or detection2138%26%34%43%46%0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%Cannot sayIT-based tools for identification of unethical behaviorbased on social network analysisSoftware for continuous monitoring of business communications, (i.e.,key words within emails to addresses external to the company)IT-based tools for retrospective identification of fraudulentpayments or other such activitySoftware for continuous monitoring of business transactions21 Some percentages in this report total more than 100%, since executives can make multiple selections.22 Technology fraud: a changing world, Ernst & Young, 2011.An alarming number of respondents (61%) revealed that theircompanies rely on basic spreadsheet software for their IT fraudinvestigations.22
  26. 26. Fraud and corporate governance: Changing paradigm in India22A respondent from the banking sector said,“The vigilance committees in branches andadministrative offices are merely ritual andneed to be effective to conduct real-timemonitoring.”23 Technology fraud: a changing world, Ernst & Young, 2011.24 Working group on information security, electronic banking, technology risk management and cyber fraud report andrecommendations, Reserve Bank of India, January 2011.One-third of the respondents were unaware of the IT Act 2000 andits amendments. We also observed minimal awareness of the IndianEvidence Act and the new data privacy law.23Some areas of their business in whichentities can use technology to preventand detect fraud:• Using varied applications, with multitudes ofdatabases in the background storing companydata in a structured manner — such data beingautomatically and proactively analyzed to identifyduplicate procurements, related parties doingbusiness, ghost vendors, split purchase orders,inflated expense statements, etc.• Restricting access to the function of copyingand transferring data to prevent employeesfrom gaining access to the company’s and itscustomer’s confidential and sensitive information• Monitoring access to information to identify anydeviation in pattern of usage that can help toidentify at a later date “who accessed whatand when”• Classifying employee roles into “informationroles,” describing their need and right to accessrelevant information• Text-based information, when analyzed ratherthan read, providing valuable insight into the“who, what and when” of fraud, especially sincethis relates to the third element of the fraudtriangle — rationalizationRegulator’s approach to technologyThe banking sector is highly prone to fraud and leadsall the other sectors when it comes to proactive fraudrisk management. The possible reason for this isthe active role played by the banking regulator, theReserve Bank of India (RBI).A significant step taken bythe regulator in 2009 was its issuance of the circularon a fraud risk management system for banks; whichmade a bank’s CEO, its audit committee and specialcommittee accountable and responsible for thesystemic failure of controls, or the absence ofkey controls or severe weaknesses in existingcontrols, which facilitated exceptionally large-valuefraudulent incidencesIn addition to the earlier guidelines given by theRBI, the regulator has recently released its report,“Working Group on information security, electronicbanking, technology risk management andcyber fraud.”24Some of the key recommendations of the WorkingGroup include:• A risk-based transaction-monitoring orsurveillance process• Quick fraud-detection capability to reduce lossesand also serve as deterrent for fraudsters• Banks to set up a transaction-monitoring unitwithin the fraud risk management groupWith the help of forensic technology, a bank can turnrisk management into a competitive advantage andalso improve its business performance, but for thisto become a reality, the commitment of its seniormanagement is a prerequisite. Oversight from the topis essential for making the system effective.
  27. 27. Fraud and corporate governance: Changing paradigm in India 23Whistle-blowing is at a nascent stage in India, and most Indiancompanies do not use it as an effective tool against fraud. Nearly ahalf of the respondents representing Indian companies revealed thattheir organizations do not have a whistle-blowing mechanism, whilea large number of respondents (three out of every four) from IndianMNCs claimed to have one.25 is recommended under Clause 49of the listing agreement25(SEBI’s guidelines oncorporate governance) and most Indian companies donot consider it necessary to implement it. They relymore on informal channels of communication, whichthey feel their employees will be comfortable using.Furthermore, they have apprehensions relating tomisuse of the whistle-blowing mechanism forpersonal vendetta.What makes whistle-blowing ineffective inIndian companies?Most Indian companies that have a whistle-blowingpolicy use it as a “good to comply with” measure underClause 49 recommendations. A look at the policies inpractised by companies, however, reveals that theirimplementation of this policy can at best be describedas rudimentary. The common features of the policy,which frequently render it ineffective, include:• Reporting employee faces risk of exposure: Inthe absence of anonymity, employees are nevercomfortable about reporting fraud. They maybe more at ease making a call than putting theirnames on a physical or digital document (email orwebsite link).• Absence of a telephone (hotline) as reportingmedium: Less than half of the respondentsreported that their companies have a telephone(hotline) for whistle-blowing. This is particularlyimportant, given that global experience indicatesthat the majority of whistle-blowing tips arecommunicated through hotlines.• Operating hotline internally: Around 90% of therespondents, who reported that their companieshad a whistle-blowing mechanism, revealed thatthese hotlines are operated internally. Giventhe fact that employees who decide to reporta concern at the work place usually have toovercome an internal dilemma to report on their“colleagues,” they may not be in a state of mindto write adequately comprehensive report, butare able to explain the concern when asked theright questions by a professional on the call.Furthermore, it is far more convenient to make acall and express a concern rather articulate itin writing.• Lack of awareness: For effective implementationof a whistle-blowing mechanism, it is imperativeto make employees aware about this medium forreporting fraud or misconduct. They should besensitized to the fact that the mechanism is tobe only used in exceptional cases when all otheroptions of reporting have been exhausted. If anadequate awareness campaign is not rolled out,the mechanism tends to be misused for reasonsthat do not necessarily come under the purviewof whistle-blowing. This may be the reason why71% of the respondents said that only 10% ofthe complaints received through the mechanismrequire further investigation.• Process of categorizing and filtering complaints:Another reason for the low number of complaints,which requires further investigation, is theprobable absence of a process in organizationsthat can categorize and filter complaints. Ameticulously drafted fraud response plan canhelp such organizations to opt for the correctaction to be taken against complaints which areappropriately categorized and filtered. This alsohelps in weeding out “frivolous” complaints.
  28. 28. Fraud and corporate governance: Changing paradigm in India24Fraud response planCompanies struggle to determine exactly who shouldbe the people responsible for making a proactive andreactive response to reporting of fraud within theirorganizations, in order to ensure that they can preventan inefficient response to such reports. The goodnews is that many companies now realize that suchchallenges need to be addressed. The bad news isthat these very companies may not be able toovercome inconsistencies, duplicative efforts and alack of communication within their companiesbecause those responsible for anti-fraud effortsoften operate independently of each other and notin a coordinated manner.Fraud may still occur although the management hasput in place the proper process, trained the company’semployees on spotting problems, exe¬cuted a robustfraud risk assessment initiative and designed internalcontrols to prevent and detect fraud. Therefore,it is essential for companies to formulate reactiveelements for an effective anti-fraud program.Well-documented and consistent fraudresponse planThe cornerstone of a reactive element in an anti-fraud program is a competent team and its timelyresponse to suspected fraud. It is essential toestablish, review, approve and maintain policies andprocedures relating to the company’s response tofraudulent activities. Its fraud response plan shouldencompass investigations, remediation and uniformdisciplinary processes. For an effective fraud responseplan to work, it also has to com¬municate those whowork on specific tasks from the moment an allegationis made till the point at which the results are reported.To execute a fraud response plan effectively, it isnecessary to establish an investigation protocolframework for a company’s management. Theprotocols should state that all suspected fraud,regardless of the source, needs to be reviewed andinves¬tigated. A designated team should determinethe person who will lead the investigation if externalassistance is needed, e.g., external forensic assistancewith fraud, and the results of the investigationcommunicated to the audit committee in atimely manner.Third-party due diligenceThird parties such as business associates,intermediaries, partners and vendors play a criticalrole in the success of a company. However, thisassociation is tagged with a range of risks, the keyamong them being fraud, reputation and regulatoryrisks. Therefore, it is important that companieseffectively assess the potential risk of conductingbusiness with and develop appropriate riskmanagement strategies in relation to third partiesbefore engaging them.While it is impossible to ensure that improper conductwill never occur, an appropriate level of due diligencecan assist companies to proactively identify andmanage risks arising from their association with thirdparties. Such due diligence can help them identify awrong ethical “fit,” legacy issues relating to fraud,regulatory non-compliance issues, unethical practises,misrepresentations, and questionable reputationand credentials.Some of the risks that can be mitigated include:Effective due diligence includes enquiries relating tobusiness references and other customers helping acompany understand the past track record of thirdparties in its commercial dealings.Many government policies and an increase in lawenforcement regulations have exerted increasedpressure on companies to put in place appropriatethird-party due diligence programs. Furthermore, insome recent regulatory developments, there has beena specific reference to third-party due diligence inActs/policies/guidance on anti-corruption complianceprograms. These include references to OECD’s 2010Good Practices Guidance on Internal Controls, Ethicsand Compliance, the UK Bribery Act and the FederalSentencing Guidelines.According to 63% of the respondents, their companies havewell-defined roles within their internal audit, compliance, risk andlegal functions in the event of investigations, and 55% said that theircompanies had in place a clear procedure for reporting incidents, butonly 32% have documented response plans.
  29. 29. Fraud and corporate governance: Changing paradigm in India 25Nearly two-third of the respondents said that their companiesconduct due diligence on ethics and integrity for third parties. Thispositively reinforces the fact that globalization and the regulatory“push” is driving companies to proactively manage their fraud risk.Being more vigilant in managing third-party relations is anothercrucial step that needs to be taken in this direction.However, the quantum of information that shouldbe collected is dependent on several factors such asfinancial exposure, the criticality of the third partyto a company’s business, the nature of the activityto be performed, the extent of information alreadyknown, etc. Red flags resulting from such third-partydue diligence can assist a company in developingappropriate risk management strategies, including itsdecision on whether it should associate with a specificthird party.Independent directors — astrong influenceIn the past, it was common for directors to notspecifically address fraud as a particular risk totheir organizations. Also, there was no pressureon implementation of specific policies, proceduresand controls for prevention and detection of fraud.However, the recent surge in incidences of fraud andthe resultant confusion over the role of independentdirectors has put this issue on the top of directors’corporate agendas.In the last few months, we have seen independentdirectors taking a direct interest in reviewing thefraud risk management framework put in place bytheir organizations to mitigate the risk of fraud.With the introduction of new corporate governancerequirements, which makes directors responsible forprevention and detection of fraud, directors havebegun exercising adequate oversight on managementof fraud risk worldwide. Non-compliance withthese regulations or guidelines can have seriousrepercussions for all, including loss of reputation andpersonal liabilities.While the management of a company is primarilyresponsible for implementing policies, procedures andcontrols for prevention and detection of fraud, thoseentrusted with governance, i.e., the Board of Directorsor Audit Committee, have also been made responsiblefor prevention and detection of fraud.
  30. 30. Fraud and corporate governance: Changing paradigm in India26About the researchErnst & Young Pvt. Ltd. was assisted by a marketresearch agency while conducting interviews.Thesurvey was carried out online and in all we received114 completed responses. The principal respondentsincluded CXOs (42%), heads of internal audit,compliance and fraud prevention (14%), directors(9%) and mid/senior management (14%). A smallminority (18%) report to these four main stakeholders.Respondents represented a sound mix of domesticcompanies and MNCs, with 45% foreign-based MNCsand 32% represented Indian MNCs. The remaining 23%included Indian companies with domestic operations.The place of origin of the majority of foreign-basedMNCs was the US (41%), followed by UK, Japan andSweden (each 9%).The respondents represented a wide range ofindustries and included the participation of banks andNBFCs, IT/ITeS and manufacturing companies, andPrivate Equity firms.
  31. 31. Fraud and corporate governance: Changing paradigm in India 27About Ernst & Young’sFraud Investigation &Dispute ServicesDealing with complex issues of fraud, regulatorycompliance and business disputes can distract youfrom your effort to achieve your company’s potential.Better management of fraud risk and complianceexposure has become a critical business necessity forcompanies today, regardless of the industry sectors inwhich they operate. With our more than 1,400 fraudinvestigation and dispute professionals across theglobe, we assemble the right multi-disciplinary andculturally aligned teams to work with our clients andtheir legal advisors, to give them the benefit of ourbroad sector experience, deep knowledgeof relevant subjects and pertinent insights fromour work worldwide. This is how Ernst & Youngmakes a difference.FIDS India• Deep competencies: Our FIDS team hasspecific domain knowledge, along with wideindustry experience.• Forensic technology: We use sophisticated toolsand established forensic techniques to provide therequisite services to address individualclient challenges.• Global exposure: Our team members have beentrained on international engagements to obtainglobal exposure on fraud scenarios.• Market intelligence: We have dedicated fieldprofessionals, who are specifically experiencedand trained in corporate intelligence, andare capable of conducting extensive marketintelligence and background studies on varioussubjects, industries, companies and people.• Thought leadership: We serve a variety of leadingclients, which gives us a deep insight into awide range of issues affecting our clients andbusiness globally.• Qualified professionals: We have a qualifiedand experienced mix of chartered accountants,certified fraud examiners, lawyers, CIAs,CISAs, engineers, MBAs and computerforensic professionals.Our services• Anti-fraud and fraud risk assessment• Fraud investigation• Dispute advisory services• Forensic technology and discovery services• Regulatory compliance• Brand protection and IP risk• Forensic business intelligence• Anti-bribery program• Third-party due diligence/Vendor due diligenceFor more information please contact:Arpinder SinghPartner and National DirectorDirect: 91 22 6192 0160Email: arpinder.singh@in.ey.comSandeep BaldavaPartnerDirect: + 91 40 6736 2121Email: sandeep.baldava@in.ey.comVivek AggarwalPartnerDirect: + 91 12 4464 4551Email:
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