Frauds – RBI Guidelines & Case Studies 1 Ashit Hegde

Classification of Frauds In order to have uniformity in reporting, frauds have been classified as under, based mainly on the provisions of the Indian Penal Code: a)Misappropriation and criminal breach of trust. b) Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property. c) Unauthorized credit facilities extended for reward or for illegal gratification. 2 Ashit Hegde

d ) Negligence and cash shortages. e) Cheating and forgery. f) Irregularities in foreign exchange transactions. g) Any other type of fraud not coming under the specific heads as above. 3 Ashit Hegde

Frauds committed by unscrupulous borrowers i.Fraudulent discount of instruments or kite flying in clearing effects. ii. Fraudulent removal of pledged stocks/disposing of hypothecated stocks without the bank’s knowledge/inflating the value of stocks in the stock statements and drawing excess bank finance. iii. Diversion of funds outside the borrowing units. 4 Ashit Hegde

Reporting of frauds – All cases of frauds involving Rs 1 lakh and above should be reported to the RBI and to the banks boards. FMR 1 On detecting the fraud FMR 2 Quarterly report on frauds outstanding FMR 3 Quarterly progress reports on frauds Report to be sent in soft copy within 15 days. 5 Ashit Hegde

Case Study on Frauds – 1. Fraud involving inland LC 2. Import bills received directly by the importer. 3. Credit facility against collateral of shares. 6 Ashit Hegde

Fraud involving inland LC Part I – Details of the Case 1.On B Bank ltd. opened an inland LC (Usance 60 days) for Rs.195 lacs fvg Perfumes pvt ltd. on behalf of their client Star and Star 2.Perfumes pvt ltd. handed over the documents under LC to FCL (a factoring co.) for discounting. 3.FCL presented the documents to B Bank Ltd. thro their Bankers. 4.B Bank Ltd accepted the documents on and conveyed the same to FCL. 5.FCL discounted the accepted bill and paid Rs.195 lacs to Perfumes pvt ltd. Ashit Hegde 7

6.On , one more LC for Rs.600 lacs was opened by B Bank Ltd. and documents drawn under this LC was accepted by B Bank on Three Demand Drafts dt aggr. Rs.195 lacs issued by B Bank Ltd. were received by FCL under a covering letter from B Bank Ltd. saying the DDs were in settlement of the LC Bill. The drafts were signed by two authorised officials of the bank. 8.The DDs were presented for payment by FCL in clearing on The B Bank ltd dishonored the DDs with remarks ---" Present again tomorrow’’. 10.The DDs were presented again and were again dishonored with remarks " DDs obtained by fraudulent means’’. Ashit Hegde 8

Part II - The Legal Wrangle 1.FCL approached Banking Ombdusman (BO) at Bangalore. Ombdusman tried to persuade B Bank to pay FCL but B Bank did not agree. The BO issued a letter on declining to exercise the authority vested in them. 2.B Bank filed a criminal complaint against all concerned. 3.FCL issued a legal notice to Perfumes pvt ltd saying they have defrauded FCL. 4.FCL filed a summary suit against B Bank Ltd. in Sept 2007.and also started recovery efforts from Perfumes pvt ltd. Ashit Hegde 9

5. Perfumes pvt ltd offered properties with value of about Rs.50 lacs to secure the debt. 6.B Bank appealed to High Court to dismiss the summary suit and demanded a normal trial. 7.High Court dismissed the summary suit application of FCL. 8.FCL went in appeal to Supreme Court. The Apex court upheld High Court order but also ordered the trial court to complete the trial within 6 months. 9.Accordingly, daily trials were held in the Judges chamber every afternoon. Ashit Hegde 10

10.The trial court gave its judgement in favour of FCL. 11.The B Bank has gone in appeal to High Court after depositing Rs.250 lacs in the court as ordered by Trial court. 12.In the meanwhile B Bank also filed case against Perfumes Pvt Ltd and obtained an ABJ (attachment before Judgment) against the property which was offered to FCL. 13.FCL approached high court and brought an injunction on the property so that it could not be sold by B Bank. Ashit Hegde 11

Part III - What went wrong and where? Discuss Ashit Hegde 12