The Punjab National Bank Fraud Case relates to the fraudulent letters of undertaking worth ₹11,356.84 crore (US$1.4 billion) issued by the Punjab National Bank at its Brady House branch in Mumbai making Punjab National Bank liable for the amount. The fraud was allegedly organized by jeweler and designer Nirav Modi.

THE FIRST DISCLOSURE

• On May 31, 2017, Gokulnath Shetty who was allegedly involved in fraudulent LoUs, retired from PNB, having worked at the Brady House branch for nearly seven years, despite RBI’s guidelines stating that staff should rotate every three years.

• In January 2018, the fraud was unearthed when Modi's firm requested further LOUs for paying the overseas suppliers. On this, the bank officials refused on the ground that Modi's firm need to keep 100% collateral for the same.

• The Modi's firm argued that no such money was kept 'on margin' in the past either. Following this, the bank officials scanned the records only to discover that there was no trace of any such transaction. This implies that the guarantees/ undertakings were issued by bypassing the rules in collusion with some PNB employees.

• The violation of banking rules as mentioned above was too glaring a blunder to ignore. Hence, Punjab National Bank filed a criminal complaint with the CBI on January 29 accusing Nirav Modi and others of defrauding the bank and causing it a loss of ₹ 280 crores ($43.8 million). The complaint was filed against three companies and four people, including Nirav Modi and Mehul Choksi, managing director of Gitanjali Gems.

THE EXTENT OF THE FRAUD

• Letter of Undertaking (LoUs), were found to be at the center of the scam. Nirav Modi had obtained the letters by bypassing bank regulations.

• PNB disclosed the scam. After PNB, it was the State Bank Of India (Rs 405 crore), Oriental Bank Of Commerce (Rs 289 crore), Punjab & Sind Bank (Rs 44.10 crore), and the BoI (Rs 175 crore) that were impacted by this fraud.

BACKGROUND

• There were two types of fraud that took place at PNB. In the first type, Nirav Modi, Mehul Choksi, and their companies secured LoUs without proper authorization and without collateral colluded with officials from PNB’s Brady House branch in Mumbai in the issuance of fraudulent LoUs. In the second type, FLCs were issued to importers (Nirav Modi and Mehul Choksi) for importing diamonds. The value of these FLCs was later modified and recorded in SWIFT and in FLC documents at a higher value than the actual amount posted in PNB’s CBS.

• These LoUs and FLCs were used to obtain loans abroad ostensibly to pay for imports. According to investigators, the two submitted forged papers related to imported jewelry. Once the funds were released to suppliers overseas, the suppliers, believed to be fronts for Nirav Modi and Choksi group firms, promptly sent the money back to India into accounts of shell firms owned by the duo through fictitious transactions.

REVELATION FROM THE INVESTIGATIONS POST DISCLOSURE

• Former PNB deputy manager Gokulnath Shetty has confessed before the ED that he issued the first LoU to Nirav Modi in 2010 and that since then all LoUs worth Rs 13,700 crore were issued by him. However, he blamed Rajesh Jindal, who was GM of PNB's Brady House branch between August 2009 and May 2011, for directing the fraud, and prime accused Nirav Modi and his partner Mehul Choksi for blackmailing him from 2010 to 2017, confirmed ED sources.

• According to ED sources, both businessmen had allegedly blackmailed him after his first misconduct. He said he feared that Modi and Choksi would blackmail him further, which is why he kept issuing the LoUs from 2010 to 2017. During the questioning, Shetty also alleged he feared he might lose his job as they both threatened to expose him by making public all LoUs he issued without any collaterals and securities.

• The Forensic Auditors, after investigations, learned that as many as 1,561 Letters of Undertakings (LoUs), worth Rs 28,000 crore, were issued to the Nirav Modi group. Of those, the auditor described 1,381 LoUs valued at Rs 25,000 as being “fraudulently issued”.

• According to the audit report, 21 of 23 exporters in whose names the LoUs were issued were “controlled” by Modi. LoUs worth 6,000 crores were also “mis-utilized” by Modi’s companies for making payments to the bank, the forensic report said.

• The forensic audit has also detected potential fake employee entries and inflated employee costs. The number of people given salaries is almost double the number of people on the attendance lists.

• The Forensic Audit team found that Choksi's diamond companies made "high-value sales and purchases" through 'potentially non-existent partners' (bogus companies), using the same invoice for making multiple imports.

• The Forensic Audit delved deeper to detect that a lion's share - 87 percent - of the Letters of Undertaking (LoU) pertained to only two companies - 4Cs Diamond and Shanyao Gong Si Ltd, both in Hong Kong.

AUDITORS’ ROLE

• The Institute of Chartered Accountants of India (ICAI) commenced an investigation of the integrity of PNB’s auditors

• One of the areas of reporting in the LFAR (Long Form Audit Report) is bank reconciliations and Nostro balances. It is highly unlikely that external auditors missed this important area during the course of their audit which mandates that they specifically report on it.

• Internal audits overlooked reconciliation of SWIFT transactions involving FLC and LoU guarantees with the transactions recorded in the bank’s CBS. No red flag was ever raised by IT auditors for the non-integration of SWIFT and the CBS.

Sources: Wikipedia, News articles and “Gem of the Indian Banking Fraud: A Case of Systemic Control Failures at Punjab National Bank Gagan Kukreja Sanjay Gupa” from Journal of Forensic and Investigative Accounting

Link: http://s3.amazonaws.com/web.nacva.com/JFIA/Issues/JFIA-2019-No2-9.pdf

In the next part of this series, we would cover the fraud related to Infrastructure Leasing & Financial Services (IL&FS) Scam. Stay tuned for more!

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