India: 'Satyam Scam Tip of Corporate Fraud Iceberg'
Three weeks after the Satyam Computer Services promoter-chairman B. Ramalinga Raju confessed that he had cooked the information technology (IT) company's books, the scam continues to send shock-waves through Indian business and industry.
As more facts come to light, it becomes clear that Raju and his family have been spiriting cash out of the company since 2001, if not earlier, through an elaborate, well-ramified set of arrangements and manoeuvres, including forgery, inflating expenses, stripping assets, and manipulating income, inventory value and profits.
The disclosures have tarnished the image of India's IT industry, which has enjoyed a remarkable growth of 25 to 30 percent a year, generally attributed to hard work and inventiveness.
They have shattered the myth that the 'free market' policies launched in 1991, including liberalisation and deregulation, have promoted genuine competition and a clean relationship between business and government.
Most importantly, the 1.5 billion US dollars scandal shows up enormous cracks in India's corporate governance and regulatory systems
Satyam, based in Hyderabad in the southern state of Andhra Pradesh, is India's fourth largest IT company, with a turnover of 2.1 billion dollars and 690 clients in 20 industry groups in more than 65 countries.
The clients include 185 Fortune-500 corporations. Satyam specialised in engineering and product development, supply chain management, business process quality, business intelligence, enterprise integration, and infrastructure management.
The World Bank was also a Satyam customer until September last year, when it blacklisted it for making 'improper payments' (read, offering bribes) to its employees. Since then, the Bank has blacklisted two other Indian IT companies, including the third largest, Wipro.
'It seems unlikely that Satyam is a unique exception, a one-off case, as is being claimed by many industrialists and chambers of commerce,' says Jay Bhattacharjee, a highly experienced Delhi-based capital markets analyst. 'Corporate malfeasance and outright fraud is widely prevalent in Indian industry.'
Adds Bhattacharjee: 'Satyam may be an exception because of the sheer magnitude of the amount of defalcation, which is two-and-a-half times the sum involved in the Enron scandal. But the fact remains that all the supervisory and regulatory agencies failed to detect and prevent the Satyam scam, and that this failure is structural and pervasive.'
These agencies include the statutory auditor (Price Waterhouse, the Indian subsidiary of PriceWaterhouseCoopers), Satyam's independent directors, the Ministry of Corporate Affairs, the Registrar of Companies, the Company Law Board, the Institute of Chartered Accountants of India, the Securities and Exchange Board of India (SEBI), and the Quality Review Board (QRB), a high-powered 11-member committee appointed by the Indian government for chartered accountants.
Many of the agencies did not perform their assigned oversight functions, ignored complaints and warnings, or actively covered up the fraud.
Price Waterhouse, which has been Satyam's auditor since 1991, blindly certified its account-books to be correct and accurate without verifying their authenticity. It failed to detect huge transfers of funds, of the order of over one billion dollars, according to Raju's own confession.
Two of accounting company's directors have since been arrested. They failed to verify the authenticity of the bank documents pertaining to cash reserves and balances presented to them by Satyam's management.
It is likely that there was collusion between Satyam and its auditor. According to Deepak Parekh, the chairman of a reputed private bank who was appointed to the Satyam board after the scandal broke out, these documents were 'obvious forgeries' and would have been visible as such to anyone.
One of the biggest sources of defalcation at Satyam was the inflation of the number of employees. Raju claimed that the company has 53,000 people on its payroll. But according to the Criminal Investigation Department of the Andhra Pradesh police, the real number was just over 40,000. This closely matches the number of Satyam employees registered for provident fund payments, a little over 43,000.
The fictitious number could be conjured up only because payment to the remaining 10,000 employees was faked year after year - an operation that evidently involved the creation of bogus companies with a large number of employees. Yet, no one detected this massive fraud.
Similarly, going by Raju's account, Satyam's operating margin was as low as three percent. But India's top-ranking IT companies have margins of 20 to 30 percent. If Satyam's margin was indeed higher, then hundreds of millions of dollars were spirited out of the company, without detection.
Another source of fraud was the Satyam board's decision last December to invest 1.6 billion dollars to acquire a 100 percent stake in Maytas Properties and in 51 percent stake in Maytas Infrastructure. Both of these real estate firms were promoted by Raju's sons. They also floated 21 other companies under the Maytas brand.
This investment decision was in gross violation of the Companies Act 1956, under which no company is allowed without shareholders' approval to acquire directly or indirectly any other corporate entity that is valued at over 60 percent of its paid-up capital.
Yet, Satyam's independent directors went along with the decision, raising only technical and procedural questions about SEBI's guidelines and the valuation of the Maytas companies.
They did not even refer to the conflict of interest in buying companies in a completely unrelated business, floated by the chairman's relatives. Indeed, one of the independent directors, Krishna Palepu, a professor at Harvard Business School, praised the merits of real estate investment on Satyam's part.
'Palepu was earlier an independent director on the Global Trust Bank, which collapsed in 2003,' recalls former union revenue secretary E.A.S. Sarma, a public-spirited civil servant of high integrity.
Sarma recently warned SEBI and the Prime Minister's office about malfeasance in Satyam, but was ignored.
SEBI's failure was even more stark. Irregularities were repeatedly reported to it in Price Waterhouse's handling of Satyam accounts in 2001 and 2002. But mysteriously, it failed to conduct an investigation. Similarly, a complaint was filed with SEBI by a Member of Parliament in 2003. But under political pressure, this was not pursued.
Last December, SEBI also approved the Maytas investments. The investment decision were eventually reversed because of shareholder protests, not because of the regulatory authorities' actions.
After Ramalinga Raju made his 'voluntary confession' on Jan. 7, SEBI wasted precious time and did not move to interrogate him or to seize Satyam's papers until after he had surrendered to the state police. The police have still not allowed SEBI to question him.
Similarly, other official agencies, including those under the Ministry of Corporate Affairs, did not discharge their obligations or were prevented from doing so.
The Income Tax Department unearthed several cases of illegal transfers by Satyam as early as 2002. But the concerned official was transferred and the investigation suppressed.
Equally striking is the failure of the Institute of Chartered Accounts of India (ICAI) to take punitive action against Price Waterhouse, which it is empowered to do. Ironically, Price Waterhouse has two members in the ICAI disciplinary council!. The council met earlier this month, but failed to take action against PwC.
Says Bhattacharjee: 'ICAI is a closed professional guild. Like the Bar Council or Medical Association of India, it shields even the most errant of its members. To the best of my knowledge, not a single auditor in India has ever faced punitive action by ICAI or been convicted and sentenced under the Companies Act and other laws.'
One reason for this is the laxity of Indian laws. If an auditor fails in his duty in India, he faces a ridiculous penalty of Rs 10,000 (under 200 dollars) and maximum imprisonment of two years. In contrast the U.S. Sarbanes-Oxley Act, passed after the Enron and WorldCom scandals, awards imprisonment for 20 years.
The U.S. and many other countries have greatly improved fraud detection by reforming audit methods and offering incentives to whistle-blowers. India is yet to do any of this.
India lacks adequate corporate regulation. And its enforcement is appalling. For instance, as many as 1,228 of the Bombay Stock Exchange's 4,995 listed companies have failed to submit reports required by the Listing Agreement, including information on their boards' composition, audit committees, CEO certification of accounts, and related-party transactions and subsidiary companies.
'Unless we urgently take corrective measures, corporate fraud will continue, cheating shareholders and milking the public exchequer,'' says Sarma.
''Statutory auditors aren't enough. We need a Board of Audit, which is authorised to conduct surprise audit on its own or on whistle-blower complaints,'' Sarma said. ''Only then will the conviction rate in corporate frauds, which is currently under five percent in India, improve.'
Among other measures being suggested are compulsory rotation of auditors every three years, the creation by the government of a pool of independent directors from amongst citizens of high integrity, and their appointment by impartial authorities, as well as tighter enforcement and stiffer penalties.
However, the government seems to be preoccupied with rescuing Satyam rather than radically reforming the system of corporate governance and regulation.
