Law and Financial Frauds

7/28/2019 Law and Financial Frauds

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Financial Frauds

From a Legal Perspective

Nayab Maqsood, Muhammad Hayat Khan, M. Ahsan Raza Khan & Saad Iqbal

3/6/2013


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Financial Frauds 1

CONTENTS

Introduction............................................................................................................................................................................. 2

Corporations and Financial Frauds ............................................................................................................................ 3

Legal Reforms to Prevent Financial Crime in Pakistan .............................................................................. 7

Conclusion................................................................................................................................................................................. 8

References ................................................................................................................................................................................ 9


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INTRODUCTION

Fraud can be defined as a deliberate deception that is committed for personal gain to the person

and hence damages the other individual. The definition of fraud varies with respect to the legal

jurisdiction of a country and is considered both a crime as well as an offense of the civil law. The

common law states that for fraud to occur there must be four basic factors present; firstly the

statement needs to be significantly fabricated, secondly the person providing the statement needs

to know that the knowledge is untruthful when it was made, the third factor states that the victim

to whom the statement has been made relies on it significantly and finally suffers loss or damage

due to trusting on the statement (Wells, 2005). Financial fraud falls under the category of

financial crimes and can be of many types; corporate fraud, bank fraud, securities fraud, theft and

many other. Amongst financial frauds forgery, money laundering, embezzlement, tax evasion

and cheque frauds are the most prominent. Committing fraud does not require the ability to use

many media platforms and so mail, phones and even the internet are becoming basic forums for

assisting people committing frauds. Fraud being considered a white-collar crime can be

considered as the most difficult crimes to deal with considering they are very clean and hence

difficult to unearth (Simpson and Gibbs, 2007). This term was first coined by the sociologist

Edwin Sutherland who was the chief proponent of this social concept of crime. Within the field

of criminology white-collar crime has been defined by Edwin Sutherland as: A crime

committed by a person of respectability and high social status in the course of his occupation.It

deals with criminal acts by public servants, persons in authority or even by persons involved in

commercial organizations. White-collar crime therefore overlaps with corporate crime because

the opportunity for fraud, bribery, insider trading, embezzlement, computer crime and forgery is

more available to white-collar employees.


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Furthermore Tomasic (1994) asserts that financial frauds are commonly committed by

organizations and individuals who have had a large influence or are important in their respective

sector and therefore are backed up with political forces and can be considered invincible. One

problem associated with the legal structure of financial fraud is that the criminal sanctions have

not yet been developed which adapt to the financial misconduct that has occurred. The law has

predominantly not identified practices that would punish those committing fraudulent acts and

therefore this further becomes a problem in eliminating financial frauds.

Leigh (2009) says that mostly when fraudulent acts are committed by large scale organizations

no action is taken as the government considers them a vital asset in the prevalence of the

economy and therefore if they are put under remand the economy might falter as well hence

leaving these financial frauds with more security. The major fraud act committed by BAE

Systems, one of the largest arms dealer in the UK was involved in bribery by providing Saudi

Arabia with nearly seventy Tornado fighter aircrafts for 20 billion whilst the correct price

revolved around 43 billion. Considering the vast nature of the BAE Systems organization and

the dependence of the UK on its production, the organization is still safe and the bribery case has

not yet been settled (Augar, 2009).

CORPORATIONS AND FINANCIAL FRAUDS

Over the past century, there have been numerous frauds in the corporate sector which shook the

world. The frauds were all in billions and some of them caused a drastic effect in the lives of

common people. Among the numerous, we will be discussing major famous frauds which

include the Satyam computers fraud in India, the Daewoo Group fraud in South Korea, and the

Bernie Madoff Investment scandal in NY, America.


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The first fraud case was the Satyam computers scandal. Satyam computers was 3rd largest

software company in India. It was founded in June of 1987 by Mr. B. Rama Raju & B.

Ramalinga Raju. The company from that period to the 20th century slowly made its pace from a

growing firm to a successful corporate firm. However, in the year 2009 all of India including the

employees and Investors in Satyam Computers were shocked to learn that it was involved in a

fraud of worth 7000 crore rupees. The Chairman of Satyam Computers; Ramalinga Raju

confessed that he was guilty of manipulating the balance sheets of the company to show falsified

profits etc. The amount of non-existing cash and assets kept piling up until it reached a point

when the amount could not be rectified any way. The aftermath of the case was that Raju along

with 2 others accused of the scandal were sentenced to Jail with heavy fines imposed on them to

make good some of the amount that they had scandalized. However, Raju told the press that the

scandal was not done for personal profits but it was done to increase the share price which was at

an all-time high of $29.0 in 2008 but fell to $1.80.

The second huge scandal which was witnessed by the world was committed by the Daewoo

Group; mainly its chairman and founder Kim Woo Choong. Daewoo was the second largest

conglomerate in South Korea with projects in nearly 100 countries. Some of its corporations are

Daewoo Electronics, Daewoo Motors, Daewoo Bus Service etc. But like any company at the top

of the hill, the fall does follow. Daewoo's condition deteriorated 1998 due to Asian Financial

Crisis. Even in that condition, Daewoo added 14 more companies to its current lot, in a year

where it had already incurred a loss of around $468 million on sales. In 1999, Daewoo was

officially bankrupt. The major reason of the bankruptcy was found to be the fraud committed by

the founder of Daewoo which amounted to approximately $41.3 billion. Woo also illegally

borrowed money which was around $10 billion and was also found guilty of trafficking money


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of amount $3.2 billion out of the country. Woo fled the country and came back in 2005 to face

the charges. He was sentenced to 10 years of jail and was also liable to restitute $20 billion as a

fine for the fraud committed.

Another major fraud which had a good collateral damage was the famous Bernie Madoff and the

$50 billion heist. Bernie Madoff was the founder of Bernie L. Madoff Investment Securities Inc.

which was founded in the year 1960. It grew slowly but with a promising list of clients and over

the years became one of the biggest trade market in wall street. Madoff started enlisting his

family members into the firm. His brother Peter joined in as the Chief Compliance Officer.

Madoff's sons, Mark and Andrew also enrolled in the firm as traders and Peter's daughter Shana

joined the firm as its lawyer. However, in 2008, the successful investing career of Bernie Madoff

came to an end when after being alerted by his sons, he allegedly confessed of having lost $50

billion of his investors money. The money figure was only an approximate amount as experts

did not account opportunity costs and the taxes that were paid on the profitability of the firm

were also accountable. If all the factors were taken into account, experts said the value of the

fraud could be around $64.2 billion. Madoff was tried on June 29, 2009 and was sentenced to a

maximum prison life of 150 years.

Pakistan has not shied away from financial frauds, Khanani and Kalia committing one of the

major financial frauds in Pakistan. Khanani and Kalia was one of the largest currency exchange

companies in the country, founded in 1983 by Hanif Kalia. Khanani and Kalia claimed to be

Pakistans first ISO 9001 and 27001 certified Exchange company. The directors of the company

were accused of violating the Foreign Exchange Regulations Act, the Prevention of Electronic

Crimes Ordinance and the Pakistan Penal Code by operating a money transfer system based on

personal contacts, known as Hawala. Munaf Kalia and Javed Khanani, directors of Khanani and


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Kalia International (KKI), were arrested by FIA on the charges of money laundering worth 10

billion. Nine officials of the National Database and Registration Authority were also arrested

from various offices in Karachi based on charges of making fake identity cards.

The main charge against them was that they were involved in physical transfer of foreign

currency from Pakistan and ran the illegal Hawala or Hundi businesses. Lahore, Gujranwala,

Karachi and Peshawar were the main cities where the Hundi and Hawla business were being run,

any one could easily transfer large amounts of money from Pakistan to rest of the world without

any paper work or legal requirements. The State Bank of Pakistan suspended the license of

Khanani & Kalia International for 30 days for violation of its rules and regulations. The state

bank of Pakistan also prohibited the exchange company to perform any business activity and

forced to shut down all its franchises during the suspension period. Closure of franchises and

headquarters caused great trouble for people whose payments were in process. Munaf Kalia said

he was not involved in any kind of illegal money transfers or money laundering and would prove

wrong all allegations leveled against him.

Munaf Kalia said that his company was not involved in Hundi or Hawala business, but faisal

owner of Dunya Money exchangers who has taken the franchise of the Khanani & Kalia

Company, was involved. Malik Boston, representative of the Forex Association of Pakistan, said

the association would turn in anyone found involved in illegal transfers. The FAP collects $7

billion foreign exchange annually and gives it to the government. If we are targeted and

harassed, this money will not be received, he said. The sources said investigators had found

many politicians also being involved in money laundering. The prosecution in the case against

Khanani and Kalia, however, was not able to provide any evidence that showed that the

company, its directors or the four bankers were in any way involved in such activity.


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LEGAL REFORMS TO PREVENT FINANCIAL CRIME IN PAKISTAN

In Pakistan the SEC or Securities and Exchange Commission of Pakistan is considered as the

main body that regulates the financial activities of those performing in the corporate sector as

well as the non-bank financial sector. The SEC examines the entire financial statements of all

organizations that are listed in SEC and make sure that their activities are compliant to the rules

and regulations of the SEC and there are no unauthorized transactions that take place.

Furthermore the body implies corporate governance; a method that makes sure that all the

financial activities of companies remain accountable and visible for the SEC to take note of. The

SEC implemented the Code of Corporate Governance which further requires listed organizations

to follow guidelines whilst publishing their financial statements and making sure that all their

activities are transparent for the auditors to review (Hassan, 2005).

Apart from that for people who have committed financial frauds or corruption in Pakistan then

the person who commits the offence of corruption and corrupt practices would be punishable

with imprisonment for a term which may extend to 14 years, or with fine, or with both, and such

of the assets and property of such person which is found to be disproportionate to the known

sources of his income or which is acquired by money obtained through corruption and corrupt

practices whether in his name or in the name of any of his dependents will be liable to be

forfeited to the appropriate Government. Furthermore if the court finds out that a person has

committed a financial fraud then they order the freezing of his property, movable or immovable,

or part thereof, whether in his possession or in the possession of any relative, associate or person

on his behalf. Furthermore the Accountability Court has an exclusive jurisdiction to entertain and

adjudicate upon all claims or objections against the freezing of any property under Sec. 12 and

such claims or objections shall be made before the Accountability Court within 14 days from the


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date of the order, freezing such property. Also the court requires all banks and financial

institutions to take prompt and immediate notice of all unusual or large transactions with context

to the account which have no apparently genuine economic or lawful purpose and hence upon

the professional judgment of the Bank suspicion that such transactions could constitute or be

related to illegal or illicit activities where there are reasonable grounds to believe that the assets

of a person or any part thereof were acquired through corruption or corrupt practices, and there

was no other likely source of acquiring such assets or part thereof, it shall be presumed, unless

proved to the contrary by the accused person, that such assets or part thereof were acquired,

generated or obtained through corruption and corrupt practices.

CONCLUSION

Financial frauds have taken their toll on the world. Many stock exchanges have fallen because of

financial frauds and share prices have diluted causing large scale losses to shareholders. That

being stated financial fraud is considered the crime of the elite and hence stated as a white-collar

crime. When discussing law although there are legal regulations that deter the applicability of

such financial frauds in the world and also in Pakistan there isnt much on the sanctions arena.

There have still not been correct legal sanctions against those who have committed such crimes

and the legal structure in many areas around the world is still devoid of giving a correct and

persistent sanction to everyone who commits financial frauds. Some are asked to pay their fines

whereas some are sentenced to jail; the timespan again shifts accordance to the degree of the

fraud committed. The importance and often public image of those that commit financial frauds

are high hence even government bodies fail to acknowledge the issue of them committing

financial fraud as they find these people vital to the success of the economy and stock exchange


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therefore they are provided with immunity and there fraud is mostly covered. There needs to be

the development of a stable regulation against financial fraud so everyone who commits the

crime is given the same punishment as law is based on the element of equality.

REFERENCES

Augar, P. (2009) Insiders cannot provide answers on finance. The Financial Times, 20, pp.13.

Hassan. T. (2005) ICAP; Corporate Fraud-Responsibilities of the Board, Management and

Auditors to Prevent and Deter Financial Crime.

Leigh, D. (2009) Austria set to sue over BAE arms sales", The Guardian, No.20 June, pp.18.

Simpson, G. and Gibbs, C. 2007. Corporate Crime, Ashgate, Aldershort, .

Tomasic, R. (1994) Corporate crime in a civil law culture", Current Issues in Criminal Justice, 5

pp.244-55.

Wells, R. (2005). Senate hearing probes tax abuse by charity groups. Wall Street Journal,

245/67, p. 2.

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