Fraud investigations gone wrong

Failures in fraud investigations can hinder the pursuit of justice and the deterrence of fraudulent activities. The author examines two case studies that illustrate the immense impact that botched investigations can have on individuals, organizations and society.

When conducted properly, fraud investigations are critical to uncovering illicit activities that can have significant consequences for individuals, organizations and society. The Association of Certified Fraud Examiners’ (ACFE) Code of Ethics requires Certified Fraud Examiners (CFEs) to exercise diligence and professionalism during investigations. A poorly conducted investigation not only erodes public trust in investigative bodies and the justice system, but it can also embolden fraudsters to continue their illegal activities. (See “Code of Professional Ethics,” ACFE.)

People wrongfully accused of fraud or implicated in fraud investigations can face significant personal and professional upheaval. They endure reputational damage, loss of employment, financial strain and even incarceration.

For organizations, a poorly conducted investigation can undermine their credibility and viability, resulting in reputational damage, financial losses and erosion of public trust. The resources that organizations expend in defending themselves against unfounded allegations (legal fees, investigative costs, internal restructuring) can strain finances and efficiency.

High-profile cases of flawed investigations may shake public confidence in law enforcement agencies, judicial institutions and the broader legal framework. The failure to hold accountable those responsible for investigative misconduct or miscarriages of justice can undermine public faith in the accountability mechanisms designed to safeguard against abuses of power. This column examines two instances of fraud investigations gone wrong and what could’ve been done differently.

Satyam Computer Services: Massive accounting fraud

Satyam Computer Services, a prominent information technology (IT) services company based in India, was embroiled in controversy in 2009 after the company’s leadership artificially inflated its revenue by $1.5 billion, catapulting it into one of the largest accounting scandals in history. An investigation led by India’s Central Bureau of Investigation (CBI) revealed that Ramalinga Raju, the company’s founder and chairman, deliberately manipulated financial records, including revenues, margins and cash balances. Raju’s admission of guilt in a letter to the company’s board of directors further cemented the severity of the fraud.

Because Satyam’s American depository shares traded on the New York Stock Exchange, the U.S. Securities and Exchange Commission (SEC) charged the company with fraud in 2011. The SEC alleged that Satyam falsified invoices and forged bank statements to inflate the company’s cash balances. The scheme entailed crafting and using 6,000 fake invoices in the company’s general ledger and financial statements. Employees would then show payment of the false invoices by producing phony bank statements, according to the SEC. (See “U.S. Securities and Exchange Commission v. Satyam Computer Services Limited d/b/a Mahindra Satyam,” SEC.gov, April 5, 2011.) The ruse added up to more than $1 billion in fictitious cash and cash-related balances — half the company’s total assets. To settle with the SEC, Satyam agreed to pay a $10 million penalty, require training of officers and employees in securities laws and accounting principles, and improve its internal audit functions. To evaluate the company’s internal controls, Satyam also agreed to hire an independent consultant. (See “Satyam Computer Services Limited d/b/a Mahindra Satyam,” U.S. Securities and Exchange Commission press release, April 5, 2011.)

In India, Raju and his brother, Rama Raju, faced charges of breach of trust, conspiracy, fraud and falsification of records. The Raju brothers temporarily evaded prosecution due to a procedural lapse: CBI didn’t file charges within the stipulated time frame. The Raju brothers were eventually convicted and sentenced to seven years in prison in 2015. Because CBI was late to file charges, India’s Supreme Court granted bail to the accused, which contributed to the erosion of public trust, a significant loss of investment and a severe blow to market reputation. The Securities and Exchange Board of India banned consulting firm PwC from auditing listed companies in India for two years, accusing the firm of failing to uncover fraud in its audits of Satyam. (See “Satyam Scam – Case Study of India’s Biggest Corporate Fraud!” by Aron Almeida, Trade Brains, July 11, 2024; “Creative Accounting Practices at Satyam Computers Limited: A Case Study of India’s Enron,” by Madan Lal Bhasin, International Journal of Business and Social Research, Volume 06, Issue 06, June 27, 2016; and “PwC slapped with two-year ban in India over Satyam fraud,” by Rosemary Marandi, Nikkei Asia, Jan. 11, 2018.)

The case also resulted in major legislative reform in India. The government responded to the case by abolishing the Companies Act of 1956 and replacing it with the Companies Act of 2013. Under the new law, corporate fraud is a criminal offense, and auditors, cost accountants and corporate secretaries have a legal obligation to disclose fraud. (See “Companies Act, 2013: Key highlights and analysis,” PricewaterhouseCoopers, Nov. 30, 2013, and “Satyam Scam,” 5paisa, June 28, 2023.)

U.K. Post Office scandal: Miscarriage of justice

Perhaps the most high-profile example of the far-reaching implications of botched investigations is the U.K.’s Post Office scandal, also known as the Horizon scandal, named for the faulty accounting software that created false shortfalls in the accounts of sub-postmasters from 1999 to 2015. Upon being notified of the reported shortfalls — often amounting to many thousands of pounds — affected sub-postmasters sounded the alarm about a glitch in the software, a product of Japanese IT services company Fujitsu. Post Office officials dismissed their concerns. The Post Office’s reliance on the faulty software led to the investigation and prosecution of hundreds of sub-postmasters. Their wrongful convictions of false accounting, theft and fraud are widely considered one of the most extensive miscarriages of justice in U.K. history. (See “What is Britain’s Post Office scandal?” by Sachin Ravikumar, Reuters, Jan. 10, 2024.)

The Post Office faced legal backlash for the scandal in 2017 when a group of 555 sub-postmasters filed a lawsuit. Two years later, the Post Office agreed to pay them 58 million pounds. Among the wrongly convicted sub-postmasters, only 102 convictions had been overturned as of March 2024. Despite the legal and financial strife surrounding the use of Horizon accounting software, the U.K. Post Office continues to use it. (See “Post Office Horizon scandal: Why hundreds were wrongly prosecuted,” BBC, May 24, 2024.)

In an unprecedented twist, the Metropolitan Police opened investigations into potential fraud offenses committed by the Post Office, stemming from the wrongful prosecutions. According to the Metropolitan Police, potential offenses might be connected to “monies recovered from sub-postmasters as a result of prosecutions or civil actions.” Prior to this, the Metropolitan Police had been investigating instances of perjury and obstruction of justice concerning the Post Office’s conduct in its investigations. (See “Post Office scandal: Met Police investigate potential fraud offences,” by Vishala Sri-Pathma and Emma Simpson, BBC News, Jan. 6, 2024.)

Negligence in fraud investigations

Negligence can contribute to investigative failures, as highlighted in a 2020 study on fraud detection. (See “Investigations: Negligence,” by Thomas Shea, Encyclopedia of Security and Emergency Management, Feb. 10, 2020.) Failure to comply with standards (auditors’ guidelines, accounting standards, etc.) can serve as evidence of professional negligence, indicating a lack of due diligence in fraud detection efforts. Overlooking crucial evidence, misinterpreting data or inadequately scrutinizing financial records can all result from negligence. Robust oversight mechanisms — comprehensive quality assurance processes, independent review panels and internal audit functions — are critical to prevent and detect instances of negligence within fraud investigations.

Principles of ethical fraud investigations

To ensure that investigations yield credible outcomes, organizations and law enforcement agencies must prioritize the enforcement of stringent ethical standards throughout the investigative process. This entails establishing clear codes of conduct and guidelines for investigators, emphasizing objectivity, impartiality and transparency. By fostering ethical conduct and accountability within investigative teams, organizations can mitigate the risk of biases, conflicts of interest and unethical practices. To reinforce ethical behavior and promote adherence to best practices, fraud investigators should have access to regular ethics training and professional development programs.

Along with ethical standards, adequate training and resources are essential to equip fraud investigators with the necessary expertise, knowledge and tools to conduct thorough investigations. Specialized training programs should cover fraud detection, evidence collection, forensic analysis and legal procedures tailored to the specific needs and challenges of fraud investigations. Organizations must invest in technology and investigative resources, including digital forensic tools, data analytics software and expert consultancy services.

Organizations should conduct regular audits and evaluations to assess the effectiveness of investigative procedures, identify areas for improvement and promptly address any deficiencies or irregularities. External oversight bodies, such as regulatory agencies or independent watchdog groups, can play a vital role in ensuring accountability and transparency in fraud investigations by conducting impartial reviews and investigations into allegations of misconduct or malpractice. By promoting accountability and continuous improvement, organizations and law enforcement agencies can uphold public trust, safeguard against abuses of power and deliver credible outcomes in fraud investigations.

Investigative failures have profound, multifaceted ramifications that affect individuals, organizations and society. To mitigate these risks, stakeholders must uphold stringent ethical standards, provide adequate training and resources for investigators, and implement strong oversight mechanisms. By nurturing a culture of accountability, transparency and continuous improvement, organizations and law enforcement agencies can enhance the integrity of fraud investigations and uphold the principles of justice and fairness in combating fraudulent activities.

Adesola Osuji, LLM, CFE, CISA, is head of Internal Audit at Save the Children UK. Contact her at adesolaosuji@gmail.com.