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Summer is here and that can only mean, it is the season for ice creams of varying flavours – vanilla, mango, strawberry or Gadbad – a medley of flavours!. Unfortunately, investors are also being served these flavours by corporate entities. India Inc. is regaling investors with a stream of bad news regarding fraud.

First, the disclosure by IndusInd bank about “errors” and “discrepancies” in its derivative portfolio rattled the stock and the markets. Now, the SEBI Order on Gensol Engineering, a startup company that listed on the BSE SME Platform on October 15, 2019 at Rs 83 per share and subsequently migrated to the main board of BSE and NSE on July 3, 2023 has stunned Dalal Street. Gensol stock touched a lifetime high of Rs 1,1,24.90 per share on the NSE in June 2024. However, in the last ten months, Gensol shares have fallen approximately 90% from its lifetime high.

Predictably, the SEBI Order on Gensol has led to calls for overhaul of corporate governance and has also led to multitude of agencies investigating the Company – Ministry of Corporate Affairs, the Institute of Chartered Accountants of India (ICAI), Enforcement Directorate (ED) and Economic Offences Wing (EOW).

Unlike the Gadbad-flavoured IndusInd scam that involved mark to market accounting of derivatives and hedge positions, the fraud at Gensol is a plain vanilla fraud. According to the SEBI Order, corporate funds were used to defray personal expenses of the promoters, diversion of funds to relatives of the promoters through non-disclosure and misuse of related parties and related party transactions. Misuse of related parties to divert funds is not new to India Inc. and is in fact, a well-trodden and time-tested method to commit fraud.

Gensol has diligently recorded transfers to related parties as evidenced by SEBI’s review of the bank statements of the Company. In essence, the fraud was hidden in plain sight and this begs the question, where were the Board of Directors and the auditors?

Role of Go Auto Private Limited – supplier or money mule?

Go Auto Private Limited, supplier of EV vehicles to Gensol, acted as a money mule and transferred funds between and amongst subsidiaries and Related Parties of Gensol. The SEBI Order outlines the various fund transfers, layering and routing of funds wherein funds were transferred by Gensol to Go Auto, further from Go Auto to Related Parties of Gensol and eventually to fund personal expenses of the promoters. In addition, funds that originated from Go Auto were also circulated multiple times through Gensol and its Related Parties.

Clearly, the Ministry of Corporate Affairs, Serious Fraud Investigation office and Enforcement Directorate must probe Go Auto Private Limited for these dubious circular routing of funds since SEBI has no jurisdiction over Go Auto Private Limited, an unlisted entity.

Audit fraternity: Sleeping on the job?

The nature, extent and quality of audit performed by both the internal and external auditor are questionable in the Gensol case. Both internal and external audit must answer how these transactions were missed? What was the level of audit and review for Related Party Transactions given the volume, frequency and amount of such transactions?

As the SEBI Order demonstrates, an in-depth review of the bank statements of Gensol would have raised sufficient red flags for any auditor – internal or external. Did the auditors fail to identify these Related Party Transactions or did they fail to exercise professional skepticism and chose to accept management explanations for these transactions?

The NFRA’s role in monitoring quality of audits is needed now more than ever since the ICAI’s self-disciplinary mechanism and peer review process is woefully inadequate.

Related party transactions: Hit and miss by the Board

The SEBI Order clearly delineates several Related Party Transactions undertaken by Gensol including routing funds through several Related Parties to the promoters and using Related Parties for layering funds that ultimately were distributed to the promoters.

Gensol’s transactions with Related Parties required approval of the Audit Committee and further, any Related Party Transactions that were not at ‘arm’s length’ or ‘in the ordinary course of business’ required approval of the Board. Finally, Gensol was required to disclose particulars of contracts/arrangements entered into by the Company with Related Parties as part of Board’s Report and in the financial statements.

This is a clear case of failure of the Board given the nature and extent of Related Party Transactions and round tripping of funds through Related Parties. Go Auto Private Limited, supplier of EV vehicles to Gensol acted as a conduit to transfer funds amongst and between Genson and its subsidiaries.

The use of Related Parties for round tripping and layering of funds is not new and in fact, the Satyam fraud (in 2008) highlighted the role of several Related Parties which existed only to receive and transfer funds amongst and between group companies and subsidiaries. Further, the non-performing assets (NPAs) of banks in the last decade has been due to these unsavory practices and the Reserve Bank of India (RBI) has taken significant steps to crack down on such abuse and banks have tightened end use monitoring of funds.

In the Gensol case, either the Board members were negligent in not reviewing the Related Party Transactions or worse, looked the other way. Either way, the Board is culpable and must be held accountable.

It is disheartening that corporate India has not learnt its lessons since 2008 as far as use of Related Parties are concerned despite extensive rules and regulations in this regard.

The SEBI Order concludes that: “What has been witnessed in the present matter is a complete breakdown of internal controls and corporate governance norms in Gensol, a listed company. The promoters were running a listed public company as if it were a proprietary firm. The Company’s funds were routed to related parties and used for unconnected expenses, as if the Company’s funds were promoters’ piggybank.” A damning indictment of those responsible for establishing good governance.

In conclusion, the SEBI mandated forensic audit at Gensol must answer the questions of 5W and 1H (the who, what, when, where, why and how) of fraud at Gensol and in particular, provide answers as to why the Board and auditors failed to do their mandate in establishing good governance at Gensol.

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