Let’s say you’re a company that wants to commit an elaborate fraud. What is the most egregious fraud that you can think of?
Maybe let’s not start with egregious. Let’s start with something simple! Here’s something that’s reasonably common:
- Pay people to buy your product (or like give them huge discounts or whatever). Inflate your revenue. Lie about your actual customers.
- Hype your company up. Do an IPO, take your company public. Sell some of your own stock.
- Slowly try fixing your numbers. If you happen to succeed, that’s great! You win. If you don’t succeed, you still win? You’ve done your IPO and sold some stock. That’s a lot of money.
This is the simple kind of fraud, which also makes it difficult to identify. You might have to talk to the company’s customers, read the fine print in its disclosures, do sanity checks of its financials, that sort of stuff. It’s tough to catch the simple kind of fraud, which is also why so much of it exists in the form of whispers and rumours without ever getting proven.
Now let’s go egregious:
- Why pay people to buy your product? Hell, why even have a product? Just manifest in your imagination that there are hundreds of thousands of people buying whatever you’re selling and write it down.
- Hype your company up! Do an IPO, sell some stock. This part remains the same.
- Don’t bother fixing your numbers. Instead, keep publishing imaginary revenue figures. Keep selling stock to public investors. Publish your financials every quarter with whatever numbers you like.
If you do this, there’s only so far you can go. Eventually, your hype will attract attention and someone might figure out that both your customers and product were creative imagination.
Here’s a SEBI order from late in April about Manpasand Beverages. Manpasand used to be a beverages company based in Gujarat. In 2019 the company shut down because it got caught in a bunch of frauds. It’s only now that SEBI published the details of what was happening. Probably best summarised by fund manager Amit Mantri: [1]
Fake it till you make it (or don’t)
Manpasand faked its revenue (of course). It also faked its expenses, customers, vendors, tax liabilities, etc. How did it get away with doing this stuff? I don’t know, someone’s gotta ask Deloitte. They were Manpasand’s auditor for eight years, resigning only in 2018. The company’s fraud came out officially in 2019—Deloitte, whose job was to make sure the books were right and also had access to all the inside information, figured that something was off only a year earlier!
Anyway, SEBI appointed its own auditor to figure out what was wrong with Manpasand’s accounts and the auditor came back with a bunch of stuff. [2]
Here’s the bit about Manpasand inflating its revenue. From SEBI’s order:
… CGST vide letter dated July 07, 2019, inter alia, informed that Manpasand had shown inflated sales figure in its balance sheet by way of receipt/ supply of fake invoices without actual receipt/ supply of goods. It was further informed in the said letter that Manpasand had floated 38 bogus/paper firms to inflate its turnover and that inward and outward transactions made with such bogus firms amount to Rs.188.48 Crore and Rs. 691.30 Crore, respectively.
Manpasand created 38 different companies and it both “sold” its products to those companies as well as “bought” stuff from some of them. Basically, Manpasand created real companies to play the role of its customers and vendors.
… it was observed that the parties with whom transactions amounting to Rs.29.84 Crore were entered into, were not registered for dealing in the said goods/products being manufactured by the Company. Further, there was non-receipt of sale considerations and debtors balance were adjusted by passing journal entries
Manpasand was a beverages company that was selling stuff to its customers. Traditionally a company like Manpasand might have distributors as customers but Manpasand’s customers were registered as something else entirely (I do wonder what, the order doesn’t mention it). These are fake customers that Manpasand created out of thin air. Establishing companies is quite a bit of effort! Why half-ass the part where you select the “business type”? I sort of understand though. I’ve done it too. Put so much effort into something that you’re bored by the end that you muck it up.
I’m kidding! The real reason is probably that Manpasand wouldn’t have actually created these fake companies itself. There would be a middleman who would have them made in advance, all ready to go whenever needed to do fraud.
Manpasand propped up its sales as well as its expenses by pretty much just funnelling money around from one entity to the other. In some instances, it wouldn’t even move real money around. It would just note down that it had to pay one company, and had to also collect payments from another company, and then cancel each other out. Manpasand was running its accounts on Splitwise.
In general, there is nothing wrong with a company having such set-off arrangements. If you know your creditor owes money to your debtor, sure, cancel those transactions out. But how likely is it that a company’s suppliers and distributors know each other? And transact with each other?
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All except death and taxes
If you’re planning to do some accounting fraud, here’s something to keep in mind. I mean, I’m not not recommending that you do fraud, but if you do have your mind made up I might as well pass this along. Fake your sales, that’s fine. Fake your expenses, that’s fine too. But don’t fake your taxes, those guys will come after you.
In 2019 right before Manpasand shut down, GST officials raided its offices and arrested the CEO, CFO and a director. If you think about it, one of the reasons Manpasand got away with its fraud for as long as it did was that its accounts looked reasonably realistic. Deloitte made sure of that! Manpasand didn’t just arbitrarily put in fake numbers, oh no. It showed transactions to back them up with actual companies.
But any sales or purchases bring with it a cute goods and services tax, and the GST folks don’t care all that much about the fact that your sales are real. They’d like their share anyway. And not the GST you owe them, but because of how GST works, they would also want the GST your vendors (and your vendors’ vendors) might owe them.
GST has this magical thing called “input tax credit” which is basically the GST council giving you magic points every time you pay GST as a customer. Say, you buy some glass to make some marbles. You pay GST when you buy that glass, and you get some magic points. When you sell your freshly manufactured marbles, you collect GST from your customers and can redeem those magic points which you got earlier to reduce the GST you actually pay. (This isn’t tax advice so don’t come after me if you mess up your taxes because of anything you read here.)
These points are nice because they help save tax. But a basic requirement to use these points is that the company you bought your glass from has to have paid their fair share of GST in the first place! You only get the points if they’ve paid their tax! In Manpasand’s case the vendors it was dealing with existed solely for the purpose of enabling accounting fraud. Of course they weren’t going to be paying any tax. And yet Manpasand was claiming the magic points and reducing the GST it paid. These fake magic points is how the GST people figured out that there was something very wrong happening.
If the GST raid hadn’t happened, would Manpasand have survived as a company? Absolutely not. But would it have survived longer than it did? Probably.
Roll over, it’s a takeover
Things have already been a bit bizarre but what follows next is absolutely basket case. Here’s a section of Manpasand’s response to SEBI. From SEBI’s order:
The Company is a victim of a pre-planned, fraudulent scheme and conspiracy perpetrated by Finquest Financial Solutions Pvt Ltd (FINQUEST) wherein under the garb of promise to provide working capital worth Rs.100 Crores, six documents were executed by and between MBL & FINQUEST. Within a span of two and a half months, it was clear that this entire so called transaction of providing working capital loan was nothing but a mere play to gain the entire control of MBL which is having asset base of around Rs.625 Crores…
Finquest is an NBFC that lent money to Manpasand right after the GST raid happened and its officials were all in jail. Manpasand is claiming that Finquest’s goal wasn’t to just lend to the company and earn an interest income out of it, but to take over the company itself. Manpasand claims that Finquest defrauded it and even calls whatever they did a “hostile takeover”.
Let’s humour this idea for a bit. If you’re a listed company worried about a hostile takeover, you’d look at who’s buying your stock. That’s the normal way for hostile takeovers to work. You wake up one day to realise that Elon owns 9% of your and immediately fall into a state of panic. If you don’t own enough of your company, Elon just might.
Another hostile takeover could be by a distressed debt investor. You may have taken a loan from some banks or whoever some time back. The banks would’ve sold your loans to outside investors. But then because you’re in tough times, the investors would want to rid themselves of your loans at a discount. This distressed debt is then caught by investors trained in the art of recovering dollars from pennies. If you can’t repay your loans to these guys, they would be more than happy to squeeze it out of you.
This is what happened with Byju’s US unit. But really, hostile takeovers aren’t common with distressed debt investors. They don’t want to run your company! They want their money back with some (a lot) of interest. [3]
Finquest lent to Manpasand, it didn’t buy its stock. So maybe this was the second kind of hostile takeover, the distressed debt kind? Well, here’s Abhishek Singh, then director of Manpasand in an interview with Business Today back in 2019:
Business Today: Dhirendra Singh [the CEO] has accused Finquest of a hostile takeover bid, while Finquest claims that it was always mentioned in the term-sheet that the company will be managed by a professional team until its money was parked with you. It will be nice to get your side of the story.
Singh: Whatever amount has been transferred by the Finquest in the bank account of MBL was done in the new account opened by FFSPL’s representatives in the name of MBL. The control of this new bank account lies with FFSPL’s representatives. FFSPL was allowed operational access to business of MBL and not financial access, as per the term sheet dated July 3, 2019.
…As per the term sheet dated July 3, 2019, FFSPL had right to nominate two directors on the Board of Directors of MBL, which shall constitute minimum one-third strength of the Board. Pursuant to this clause, FFSPL appointed three directors instead of two. The total strength of the board became six directors, one-third of this comes to two. Thus, one more director being a nominee of FFSPL was appointed.
… What? Manpasand borrowed money from Finquest but the bank account where the money came in was controlled by Finquest? And Finquest got “operational access” (whatever that means) as well as a third of Manpasand’s board seats? This isn’t a hostile takeover! It’s a lamblike takeover.
Honestly, I get it. Manpasand’s CEO and others were in jail. The company needed money. The only lender willing to lend to a shady company whose executives are in jail would be a shady lender. And that shady lender was Finquest—which, by the way, had done something similar before—but Manpasand took what it got.
If there’s a second “don’t do this if you’re doing fraud” lesson in this, it’s this. Don’t borrow from a loan shark!
Footnotes
[1] A nice factoid is that Amit Mantri was the first to point out that Manpasand was manipulating its numbers all the way back in 2016. They did some really good on-ground research!
[2] The auditor that SEBI assigned to do this, Chokshi & Chokshi, came back with 12 findings from Manpasand’s accounts. But I think I found a couple of mistakes? It wouldn’t in any way affect SEBI’s conclusion on Manpasand, but I find it funny that a story which is essentially about an auditor’s massive failure to do its job also has an auditor that probably wasn’t too careful themselves? I’ll probably write about this in a future post.
[3] A distressed debt investor would prefer to take over a company to be able to put it into bankruptcy so that it can sell the company’s assets and recover its money. That’s very different from what the kind of takeover that Elon did of Twitter.