Unlocking value from CSR by mitigating fraud risks

Stakeholders should be given access to an organisation’s whistle-blowing mechanism

In today’s socially conscious society, the role of ethics, corporate governance and transparency has become critical for business success. Organizations with strong ethical values tend to have a positive impact on the economy as their decisions are likely to reflect the best interests of all stakeholders. In India, organizations above a certain threshold are mandated by law to contribute toward corporate social responsibility (CSR) initiatives, give back to the society, uphold their commitment to sustainability, and enable overall welfare.

INDIA’S CSR MISSION

India has been a front-runner in CSR, making it mandatory by law. As per Section 135 (1) of the Companies Act 2013 (the Act), organizations with a net worth of Rs. 500 crore or more, turnover of Rs.1,000 crore or more or net profit of Rs.5 crore or more during the immediately preceding financial year must set up a CSR Committee of the Board. The Act states that the company should annually spend at least 2% of the average net profits made in the three immediately preceding financial years to pursue its CSR policy, and on initiatives prescribed in Schedule VII of the Act.

Recently, the Companies (Amendment) Act, 2019 included punishable provisions for non-compliance with CSR. The guideline prescribed a penalty of Rs.50,000 to Rs. 25 lakh for companies, and jail time of up to three years for company executives, or a fine up to Rs. 5 lakh or both. This move met with a sharp reaction from companies, but their fears were assuaged when the government clarified that any violations would carry civil liability, and not criminal.

The positive impact of CSR

can be far-reaching and truly beneficial. The repercussions of disciplinary action would be adverse for organizations. Decision-making can be hasty, careless or even unethical.

CHALLENGES IN MANAGING CSR PROGRAMMES

CSR committees need to recommend the expenditure to be incurred, institute a transparent monitoring mechanism for the policy and projects, and factor in potential risks.

But committees can face many challenges during the implementation process such as conflict of interest, fraud perpetrated by implementation partners, unethical spending by preferring a particular beneficiary (non-government organisation, trust or institute), diversion of funds or activities to the committee/ board’s relatives or connections, disproportionate budget allocation to derive personal gains or inflated bills.

There may be improper utilization of funds, gaps in monitoring and lack of transparency when dealing with local agencies.

Executives may inadvertently engage with fake NGOs, run by dubious individuals, or contribute toward fictitious projects. For example, a packaged consumer goods company commenced a CSR initiative with the objective of providing specialized training to underprivileged sections of the society. A third party was roped in to set up and run the operations of the training centres across India.

Subsequently, a proactive review was conducted on the company’s CSR initiative which threw up some alarming results. It was discovered that the third party was charging a fee for providing the training, there were inflated records of trainees (enrolled versus attendees), placements were not offered to everyone and there were discrepancies in the locations of the training centres. All these highlighted false claims by the implementation partners which were not commensurate with the company’s directive.

SUSTAINABLE CSR THROUGH FRAUD MITIGATION

At an initial stage, organizations should have details of the committee and key decisionmakers through mandatory disclosures.

This can cover other business activities, investments, directorships held and family details. Implementation partners should undergo robust due diligence before on-boarding, covering general and financial information, and background checks of key employees. Once the implementation partner is shortlisted, organizations should determine adherence to terms of contract, purchase orders and payment processes. They should also conduct periodic audits of books of accounts to identify possible high-risk transactions or payouts, systematic diagnosis of the end utilization of funds, identify trends, assess gaps in implementation and document CSR activities.

All stakeholders should be given access to the organization’s whistle-blowing mechanism. Typically, internal stakeholders are the first line of defence to identify any kind of misconduct. Companies should also examine reports of alleged fraud or illegal activities, embezzlement, corruption that may violate laws, analyse vendor relationships or activities that may be suspicious and conduct surprise visits.

A sound governance structure to oversee the sanctity of CSR initiatives is imperative, with a formal committee or a designated individual entrusted with the responsibility of bringing any issues forward. Annual reports and the corporate website should have a disclosure on the CSR committee’s composition and other compliance measures undertaken. Senior management should also play an active role in supervising and directing the CSR agenda.

A MACRO PERSPECTIVE

Globally, corporate governance legislation overlaps with CSR-related requirements in most countries. CSR is usually a voluntary initiative for which no exclusive legislation has been enacted in most countries except a few.

For instance, Denmark has a legal obligation for reporting CSR initiatives for a certain category of companies.

CSR has transitioned from “good to have” to a necessary requirement in the last decade across the world. Regulations such as the California Transparency in Supply Chains Act 2010, UK Modern Slavery Act 2015, French Duty of Vigilance Law 2017, EU Conflict Minerals Regulation 2017, Netherlands Child Labour Due Diligence Draft bill 2017 and German Human Right Due Diligence Law 2019 are making it a regulatory requirement for organizations to embrace social initiatives as part of their business strategies.

Sustainability reporting is being considered an essential part of CSR.

In the UK, regulations such as the Companies Act 2006 state that directors need to understand the impact of business operations on the environment and community.

Global organizations may face consequences such as fines, imprisonment, reputational damage and debarment from public procurement in case of deviation from applicable laws. The last decade has also witnessed an increase in investigations and litigation related to CSR initiatives, making it imperative for the organizations to comply with laws and guidelines around the subject.

With the amount of CSR spending rising every year, companies need to be cognizant that the contributions made are towards the right and purpose-led initiatives.

The law mandates it, consumers and investors demand it, employees deserve it and the environment needs it. It is imperative to ward off the treacherous consequences of CSR allocations which may camouflage unethical behaviour.