Related Party Fraud: Detection Techniques & Companies Act Compliance

The Indian Related Party Landscape — Why Fraud Risk Is Elevated

Indian corporate structures present unique related party fraud risks that differ significantly from Western corporate environments. The promoter-driven model — where a family or individual holds controlling interest across multiple entities — creates an extensive web of related party relationships that can be exploited for value extraction.

In our forensic accounting practice, we observe that related party fraud typically involves three characteristics: (1) the transaction appears commercially legitimate on its face; (2) the pricing or terms are manipulated to transfer value from the company (usually a listed entity or one with minority shareholders) to a promoter-controlled entity; and (3) the related party nature of the transaction is either not disclosed or is disclosed but the non-arm’s length nature is concealed.

Common Related Party Fraud Schemes

Scheme 1 — Transfer pricing manipulation: The company sells goods or services to a promoter-controlled entity at below-market prices, or purchases from such entities at above-market prices. The margin differential is effectively extracted from the company. This is particularly common in group structures where raw materials flow from one entity to another.

Scheme 2 — Consultancy and management fee siphoning: Promoter-controlled entities provide vaguely defined “consultancy services,” “management fees,” or “brand usage fees” to the company. The services are either non-existent or grossly overvalued. These arrangements are structured as ongoing contracts making them difficult to challenge on a transaction-by-transaction basis.

Scheme 3 — Loans and advances without commercial substance: The company advances funds to promoter-controlled entities as inter-corporate deposits (ICDs), loans, or advances against supply. These amounts remain outstanding for extended periods, are rolled over repeatedly, and may carry below-market interest rates or no interest at all.

Scheme 4 — Property and asset transactions: The company purchases property from promoter-related entities at inflated valuations, or sells company property to such entities at below-market values. Valuation manipulation is the key tool, and our valuation practice frequently encounters such cases.

Scheme 5 — Circular trading revenue inflation: Goods are circulated between group entities to inflate revenue figures without genuine economic activity. This is particularly prevalent in commodities, chemicals, and textile sectors. Our guide on revenue recognition fraud covers this in detail.

Scheme 6 — Undisclosed related party arrangements: The most insidious form — where the related party nature of the transaction is deliberately concealed through layered corporate structures, benami arrangements, or use of family members’ associates who fall outside the statutory definition of related parties.

Legal Framework — Companies Act 2013

Section 184 — Disclosure of Interest by Director

Every director must disclose their interest in any entity — as director, partner, member, or otherwise — at the first board meeting of each financial year and whenever there is a change. This disclosure forms the basis of the related party register.

Key requirements:

• Disclosure must be made in Form MBP-1 at the first board meeting of each financial year
• Any change in interest must be disclosed at the first board meeting after the change
• An interested director must not participate in board discussions or vote on matters where they have an interest (Section 184(2))
• Contravention carries imprisonment up to one year and/or fine from Rs 50,000 to Rs 1 lakh (Section 184(4))

Fraud risk in Section 184: Directors may provide incomplete MBP-1 disclosures, omitting entities where they have beneficial (as opposed to legal) interest. Shell companies, trusts, and entities held through associates may be deliberately excluded. Forensic investigation must go beyond the MBP-1 register to identify undisclosed interests.

Section 188 — Related Party Transactions

Section 188 mandates specific approval processes for prescribed categories of related party transactions:

Transaction Type	Board Approval Required	Shareholder Approval Required
Sale/purchase/supply of goods or materials	All transactions	Exceeding 10% of turnover or Rs 100 crore (whichever is lower)
Selling/disposing of or buying property	All transactions	Exceeding 10% of net worth or Rs 100 crore (whichever is lower)
Leasing of property	All transactions	Exceeding 10% of turnover or Rs 100 crore (whichever is lower)
Availing or rendering services	All transactions	Exceeding 10% of turnover or Rs 50 crore (whichever is lower)
Appointment to office or place of profit	All appointments	Monthly remuneration exceeding Rs 2.5 lakh
Remuneration for underwriting	All transactions	Exceeding 1% of net worth

Critical compliance points: Related party transactions must be on arm’s length basis and in the ordinary course of business. Where shareholder approval is required, the related party must not vote on the resolution. For listed companies, SEBI LODR Regulation 23 imposes additional requirements including prior approval of the audit committee for all RPTs.

Ind AS 24 — Related Party Disclosures

Ind AS 24 governs the identification and disclosure of related party relationships and transactions in financial statements. Key aspects relevant to fraud detection:

Broader definition: Ind AS 24 captures relationships that Section 2(76) may miss — including entities with joint control, KMPs of the parent company, close family members (not limited to “relatives” as defined in the Companies Act), and entities controlled or jointly controlled by any of these persons.

Disclosure requirements: Entities must disclose the nature of the related party relationship, transaction amounts by category, outstanding balances, terms and conditions, provisions for doubtful debts on outstanding balances, and expense recognised for bad or doubtful debts. These disclosures enable financial statement users (and forensic investigators) to assess the extent and impact of related party transactions.

Arm’s length disclosure: Ind AS 24 para 23 specifically states that a claim of arm’s length terms should be made only if such terms can be substantiated. This is a critical provision — many companies routinely claim arm’s length without supporting documentation.

Forensic Detection Techniques for Related Party Fraud

Technique 1 — Complete Related Party Universe Mapping

The first step in any related party fraud investigation is to map the complete related party universe — going far beyond the statutory register:

MCA filing analysis: We extract directorship data from MCA portal for all directors and KMPs to identify all entities where they hold directorships, past and present. We then map the directorship networks to identify common directorships, family member directorships, and layered structures.

Beneficial ownership tracing: Statutory filings may show nominee directors while actual control rests with the promoter family. We trace beneficial ownership through shareholder registers, trust deeds, partnership agreements, and LLP designated partner details.

Family relationship mapping: The Companies Act definition of “relative” under Section 2(77) read with Rule 4 covers a specific set of relationships. However, fraud may be perpetrated through persons who fall outside this statutory definition but have close personal or business relationships with directors. Forensic investigation must look beyond the legal definition.

Corporate structure mapping: We create a visual corporate structure map showing all entities in the group, their shareholding patterns, inter-entity relationships (supplier, customer, lender, borrower), and the flow of funds between entities. This map often reveals structures designed to obscure the ultimate beneficiary of transactions.

Technique 2 — Data Analytics for Undisclosed Relationships

Address and contact matching: We run matching algorithms on the vendor/customer master database against the employee/director database to identify shared addresses, phone numbers, email domains, and PAN numbers. Common registered office addresses between vendor entities and promoter entities are a strong indicator of undisclosed relationships.

Bank account analysis: Shared bank accounts, common authorised signatories, and fund flows between the company and vendor entities that circle back to director or promoter accounts are forensic indicators. We use bank statement analysis to trace the ultimate destination of payments to suspected related parties.

Vendor creation pattern analysis: New vendor entities created shortly before large transactions, vendor entities with limited operating history, vendors with a single customer (the subject company), and vendors whose registration date post-dates the purchase order date are all red flags.

Pricing anomaly detection: Statistical analysis comparing pricing of transactions with suspected related parties against arm’s length benchmarks. We examine whether the same goods or services are procured from unrelated parties at different prices, and whether pricing patterns with specific vendors diverge from market trends.

Technique 3 — Fund Flow Tracing

In related party fraud, the ultimate question is: where did the money go? Fund flow tracing involves:

Inter-entity fund flow mapping: We trace all fund movements between group entities — loans, advances, investments, trade payables/receivables — to identify circular flows, round-tripping, and net value extraction. Often, a transaction that appears bilateral is actually part of a multilateral circular arrangement.

Cash trail analysis: Following the money from the company through intermediary entities to the ultimate beneficiary. This requires bank statement analysis, payment instrument examination, and in some cases, co-operation from banking institutions.

Outstanding balance analysis: Chronic outstanding balances with related parties — particularly inter-corporate deposits that are perpetually rolled over, trade receivables that are never collected, and advances that are never adjusted — indicate value extraction. We examine the ageing, interest provisions, and impairment assessment for these balances.

Technique 4 — Arm’s Length Price Verification

Verifying that related party transaction prices are at arm’s length requires:

Comparable uncontrolled price (CUP) method: Comparing the related party transaction price with prices charged in comparable transactions between unrelated parties. This requires identifying comparable transactions, adjusting for differences in quantity, quality, geography, and timing.

Resale price method: For distribution arrangements, comparing the margin earned by the related party distributor with margins earned by independent distributors in the same industry.

Cost plus method: For service transactions, verifying that the cost base is legitimate and the markup is comparable to arm’s length markups in similar service arrangements.

Independent valuation: For property transactions and complex arrangements, independent valuation by a registered valuer is essential. At our valuation practice, we frequently provide independent valuations in the context of related party fraud investigations.

Technique 5 — Board Minutes and Approval Process Review

We examine the governance process to identify procedural irregularities:

• Whether interested directors abstained from voting on related party resolutions
• Whether the board was provided with adequate information (pricing benchmarks, comparable data) to make informed decisions
• Whether omnibus approvals were used to circumvent transaction-by-transaction scrutiny
• Whether the audit committee conducted independent assessment of material RPTs
• Whether shareholder resolutions were obtained where required, and whether the related party’s votes were excluded

SEBI LODR Regulation 23 — Enhanced Framework for Listed Companies

For listed companies, SEBI has imposed significantly more stringent requirements than the Companies Act:

Prior audit committee approval: All related party transactions require prior approval of the audit committee, regardless of materiality. The audit committee must consider the justification for the transaction, the benefit to the company, the arm’s length basis, and whether the company would have entered into such transaction with an unrelated party.

Material RPT definition: Transactions exceeding Rs 1,000 crore or 10% of the annual consolidated turnover (whichever is lower) require shareholder approval through ordinary resolution with related parties excluded from voting.

RPT policy: Every listed entity must formulate an RPT policy covering the materialiy threshold, approval mechanisms, and review procedures. The policy must be disclosed on the company’s website.

Half-yearly disclosure: Listed entities must disclose details of all RPTs entered into during each half-year on their website and to the stock exchanges.

Red Flags in Related Party Transactions

From our forensic practice, we have identified the following red flags that indicate potential related party fraud. These should trigger a detailed forensic investigation, as discussed in our forensic audit methodology guide:

Transaction-level red flags:

• Transactions at prices significantly different from market rates without documented justification
• Unusually favourable payment terms (immediate payment to related party vendors vs 60-90 day terms for others)
• Transactions with entities that have no or minimal operating history, employees, or physical presence
• Sudden large transactions with a related party near the end of a financial reporting period
• Related party transactions that are reversed or modified shortly after the reporting period
• Recurring waivers or write-offs of amounts due from related parties

Structural red flags:

• Complex corporate structures with multiple layers that appear designed to obscure ownership
• Frequent changes in the corporate structure — new entities created, existing entities wound up
• Entities incorporated in jurisdictions with limited disclosure requirements
• Director/KMP families holding interests in entities that are vendors to or customers of the company
• Same professional advisors (auditors, lawyers) shared between the company and related entities

Governance red flags:

• Interested directors participating in board discussions on related party matters despite Section 184(2) prohibition
• Audit committee approving RPTs without independent price benchmarking
• Omnibus approvals for broad categories of RPTs without transaction-level scrutiny
• Incomplete or delayed MBP-1 disclosures by directors
• Whistleblower complaints regarding related party dealings that are not adequately investigated

Case Study Patterns From Forensic Practice

Pattern 1 — The hidden vendor: A manufacturing company procured a significant proportion of raw materials from a vendor entity that appeared independent. Forensic investigation revealed that the vendor was owned by the son-in-law of the managing director through a trust structure. The vendor’s purchase price was 12-15% above market rates, resulting in annual value extraction of approximately Rs 4 crore. The relationship was not disclosed in MBP-1 as sons-in-law were not within the statutory definition of “relative” at the time (this has since been expanded).

Pattern 2 — The consultancy arrangement: A listed company paid annual consultancy fees of Rs 8 crore to an entity controlled by the promoter family. The consultancy agreement described services as “strategic advisory, business development, and management support.” Our forensic investigation found no evidence of deliverables — no reports, no presentations, no documented advice. The arrangement was essentially a mechanism for fund extraction, approved by the board without independent assessment of the services’ fair value.

Pattern 3 — Circular trading: A group of companies in the textile sector engaged in circular trading — Company A sold fabric to Company B (related party), which sold to Company C (related party), which sold back to Company A with a markup at each stage. The circular flow inflated revenue for all three entities while the net economic activity was minimal. Our data analytics detected the circular pattern through invoice trail analysis and shipment verification.

Investigation Methodology

When we are engaged to investigate suspected related party fraud, we follow the ACFE investigation methodology adapted for the Indian regulatory context:

Phase 1 — Predication: Establishing the basis for investigation — the specific allegations, the available evidence, and the scope of investigation. We never undertake fraud investigation without adequate predication.

Phase 2 — Evidence collection: Gathering financial records, corporate filings, board minutes, contracts, bank statements, communication records, and system data. All evidence is collected and preserved following forensic standards to ensure legal admissibility.

Phase 3 — Analysis: Applying the detection techniques described above — entity mapping, data analytics, fund flow tracing, pricing analysis, and governance review.

Phase 4 — Interviews: Structured interviews with relevant persons using ACFE interview methodology — from general to specific, non-accusatory to accusatory, with proper documentation.

Phase 5 — Reporting: Forensic report structured for legal admissibility — findings, evidence references, quantification of loss, and conclusions. The report may be used in NCLT proceedings, civil litigation, criminal complaints, or regulatory proceedings.

Frequently Asked Questions

What constitutes a related party transaction under Companies Act?

Under Section 2(76) of the Companies Act 2013, related parties include directors and KMPs, their relatives (as defined under Section 2(77)), firms/companies in which directors or their relatives are partners/directors/members, holding companies, subsidiaries, associate companies, and companies under common control. Any contract or arrangement with these parties for sale/purchase of goods, leasing, availing/rendering services, appointment to office, or remuneration requires compliance with Section 188.

How does Ind AS 24 differ from Companies Act related party provisions?

Ind AS 24 has a broader definition encompassing entities with joint control, KMPs of the parent, close family members of KMPs (broader than “relatives” under the Companies Act), and post-employment benefit plans. While the Companies Act focuses on approval processes (board and shareholder approvals), Ind AS 24 focuses on disclosure in financial statements. Companies must comply with both — a transaction may have proper Section 188 approvals but still require comprehensive Ind AS 24 disclosure.

What is the arm’s length basis requirement for RPTs?

Section 188 requires that related party transactions be at arm’s length basis — meaning the pricing and terms should be comparable to what would be agreed between unrelated parties in a comparable transaction. The burden of establishing arm’s length is on the company. Under Ind AS 24 para 23, a disclosure that terms are equivalent to arm’s length should only be made if it can be substantiated with evidence.

Can a forensic accountant serve as expert witness in RPT disputes?

Yes. Under the Indian Evidence Act Section 45, expert opinions on matters requiring specialised knowledge are admissible. Forensic accountants with CFE credentials regularly provide expert witness testimony before NCLT, civil courts, and arbitration tribunals in related party fraud disputes. Our guide on expert witness testimony covers this in detail.

What should minority shareholders do if they suspect related party fraud?

Minority shareholders can: (1) file complaints with the audit committee through the vigil mechanism; (2) raise concerns at general meetings; (3) file applications before NCLT under Sections 241-242 (oppression and mismanagement); (4) file complaints with SEBI (for listed companies) or with the Registrar of Companies; (5) engage forensic accountants to gather evidence for NCLT proceedings. Contact Virtual Auditor for assistance.