The Satyam scandal: Causes, consequences and cures

The Satyam scandal has shaken corporate India, and damaged its reputation with investors, domestic and foreign. It turns out that founder and CEO B. Ramalinga Raju invented $1.0 billion in cash, which never existed. How could the auditors miss this fraud?
The Satyam fraud is baffling because it seems to be so transparent that it should have been spotted much earlier, before it grew to a point where it will likely bring down the firm. The auditors just have to be called to account, because checking on cash balances is both a simple and necessary part of their job. How could employees of one of the big four global accounting firms make such a mess of their assignment, year after year?
It's true that the high-profile board of directors and senior officers of the firm should also have smelled a rat. But in a large public corporation, where reputed auditors were certifying the financial statements, their laxness in monitoring might have been understandable. After all, Satyam's performance was not obviously "too good to be true" as measured by the benchmark of industry leaders.
Amazingly, one of Raju's friends, who runs a non-profit funded by Raju, was quoted in the Wall Street Journal as blaming investors for the fraud, because of their 'short-termism' and pressure for growth that they created for Raju. This is utter nonsense and one of the stupidest comments about this case. Investors, in fact, are the biggest victims, because they had no opportunity to independently verify the financials - they had to take the auditors' word, and they were rational in having confidence in a publicly traded company with audited financial results.
The consequences of the Satyam scandal will depend partly on policy responses. The press is pointing out that many Indian companies could have similar hidden problems. If investors get suspicious, this could severely damage the corporate sector and the country's chances of getting back to 9.0 per cent growth. My guess is that Satyam itself will not survive. It already has liquidity problems. It has a large number of corporate customers, who are locked in to Satyam in the short run, but who will each be looking for an alternative: they cannot afford to rely on a firm that may not survive. The only exit strategy here is probably a buyout, which will allow a complete replacement of Satyam's discredited senior management.
The government could play a role by facilitating some sort of acquisition of Satyam so that the company's customers and service systems survive, but its failed financial systems and senior management are replaced. In fact, the latest news is that the government has superseded the interim management and will oversee constituting a new management and board of directors. The government's main policy response should be to strengthen disclosure and monitoring requirements, especially making sure that auditing practice never again fails as blatantly and spectacularly as it did in this case.
Even though weak corporate governance is not the main culprit in the Satyam fiasco, the scandal is highlighting the poor state of India's corporate governance, and provides a political opening to institute some reforms. Industry associations like the Confederation of Indian Industry (CII) should be proactive in this process, and work with the government in this reform process. Failing to strengthen corporate governance will hurt the entire economy. In particular, the structure and functioning of auditing committees is a central issue of concern.
Here is a quote from the K.M. Birla Committee report several years ago: "…when the three main groups responsible for financial reporting - the board, the internal auditor and the outside auditors - form the three-legged stool that supports responsible financial disclosure and active and participatory oversight. The audit committee has an important role to play in this process, since the audit committee is a sub-group of the full board and hence the monitor of the process. Certainly, it is not the role of the audit committee to prepare financial statements or engage in the myriad of decisions relating to the preparation of those statements. The committee's job is clearly one of oversight and monitoring, and in carrying out this job it relies on senior financial management and the outside auditors. However, it is important to ensure that the boards function efficiently for if the boards are dysfunctional, the audit committees will do no better. The Committee believes that the progressive standards of governance applicable to the full board should also be applicable to the audit committee. The Committee therefore recommends that a qualified and independent audit committee should be set up by the board of a company. This would go a long way in enhancing the credibility of the financial disclosures of a company and promoting transparency. This is a mandatory recommendation."
Initial reports suggest that Satyam was violating such existing Indian guidelines, as well as those for US listed firms. This seems to be a common problem - the standards are already in place, but are just not being monitored or enforced. Negligence requires different policy responses than structural institutional deficiencies. Even though the external auditors are the primary defence against fraud, not instituting internal checks and balances as required by law only increases the probability of fraud.  
PRICEWATERHOUSECOOPERS TURNING INTO TANDOORI: Freelance writer Francine McKenna reported in 2009 that  everyone was calling Satyam the Indian Enron. Some said it had more "shades of Madoff". But rest assured, colourful "confession" notwithstanding, no one admits to such a major fraud unless pushed. Now there are new reports that the CEO who broke the story about his own wrongdoing is missing. Francine quoted from the Hindustan Times: The country was rocked by possibly its biggest corporate fraud … as B. Ramalinga Raju, chairman of Satyam Computer Services, resigned after confessing that the company's profits and cash reserves had been doctored for several years. This threatens the image of India's iconic software industry that fuels aspirations for jobs and prosperity among millions of middle-class people.
The revenue figures inflated to keep share prices high and package a shaky business as rosy, revealed a hole well above Rs 70 billion and reminded many of the Enron case in the US that led to the conviction of key executives. The fraud rattled thousands of employees in the information-technology sector and investors already smarting under the impact of a global financial meltdown and a local slowdown. Key investors - including the biggest shareholder Aberdeen-dumped shares as truth became a casualty in the company named Satyam. The company's share plunged nearly 80 per cent to Rs 40 in India, and 90 per cent in the US, where it is listed on the New York Stock Exchange.
Raju faced a government-led probe after coming clean in what he said was an act of conscience. In a letter addressed to the company's board, Raju admitted that the balance sheet, riddled with fictitious assets and non-existent cash, contained a big hole that could no longer be concealed….There were reports that Satyam had been hunting for a buyer for a while. These same reports cited Tech Mahindra and HCL as possible suitors. HT learnt that these companies raised serious questions about the authenticity of Satyam's books and sought clarifications. This may have forced Raju's hands.
Actually, Merrill Lynch was hired not too long ago to advise on alternatives to a recent failed acquisition of a firm called Maytas. But as Dennis Howlett reports, they may have known what's up. They resigned the engagement, prior to the CEO's stunning disclosure.
According to The Times of India: "There's intense speculation as to what finally triggered Raju's confession of wrongdoing. It's clearly more than coincidence that it came hot on the heels of investment banker DSP Merrill Lynch's letter to the company … terminating its days-old agreement with Satyam to advise it on strategic options because of "material accounting irregularities.'' It was the only one that did not mention PricewaterhouseCoopers (PwC), Satyam's long-term auditors. Every other report did, often with enormous venom and pre-emptive accusations, and significant speculation about how they could have missed the US $1.0 billion cash hole, amongst other lies and prestidigitation.
Unlike the Madoff scandal in the U.S., Satyam was audited by a Big Four firm - PwC. However, if fraud is involved in the Satyam affair, there may be an argument that the audit firm was defrauded as well.
Mohammed Hadi, in The Wall Street Journal, wrote: "The whole affair-already being dubbed India's Enron-throws India's corporate governance into sharp relief. That Mr. Raju thought it appropriate to spend $1.6 billion on two firms so unrelated to Satyam's business and in which he had a financial interest, without seeking shareholder approval, speaks volumes about his sense of what his shareholders would tolerate."
Shailesh Haribhakti, executive chairman at BDO Haribhakti, a Mumbai management services firm, told Reuters that there was little risk of similar problems at other companies in India. "There is no need to extrapolate Satyam to any other enterprise in the country-it's just not possible that this level of misstatement will be there in a widespread manner."
In a similar vein, LiveMint.com said that corporate leaders were confident that the scandal wouldn't damage India's business image or the IT sector. "These kind of things do not do any good, but I don't think this will affect the image of India Inc. totally," said Maruti Suzuki India (MRTI.BO) Chairman R.C. Bhargava. "A fraud could happen in any sector."
The Economic Times questioned the role of the company's auditors in the fraud: "The image of Satyam's statutory auditors, PricewaterhouseCoopers, has been tarnished as voices are being raised at the possibility that the auditors were hand-in-glove with the conspirators in the…scam."
COMPUTER ACCOUNTING FRAUD: With all the 10 people involved in the multi-million accounting fraud in the erstwhile Satyam Computer Services Ltd (SCSL) found guilty by a special Central Bureau of Investigation court in Hyderabad, the six-year-old case has reached its logical conclusion. The 10 people named in the case are B Ramalinga Raju, who was the founder-chairman of the company, his brother and Satyam's former Managing Director B Rama Raju, former chief financial officer Vadlamani Srinivas, former PwC auditors Subramani Gopalakrishnan and T Srinivas, Raju's another brother B Suryanarayana Raju, former employees G Ramakrishna, D Venkatpathi Raju and Ch Srisailam and Satyam's former internal chief auditor VS Prabhakar Gupta. B Ramalinga Raju was arrested by Andhra Pradesh Police's Crime Investigation Department along with his brother Rama Raju and others on January 11. All the 10 accused in the case are currently out on bail. Around 3,000 documents were marked and 226 witnesses examined during the trial that began nearly six years ago.
SATYAM SCAM UNTANGLED: 2003-2008: False clients, projects and invoices created to boost companies profile; 2009: Satyam reports Rs 52 billion sales vs real sales of Rs 41 billion;  2009: Satyam reports 24 per cent profits vs real profits of 3 per cent; Damages calculated at Rs 79 billion.
SATYAM SCAM PROBE: Concurrent probe by CBI, ED, SEBI; 53,000 employees, millions of investors impacted; accused charged with cheating, forgery, faking accounts and IT violations;  the letter allegedly sent by Raju to board was a hoax;  3000 documents; 223 witnesses examined; and verdict postponed twice.

Jamaluddin Ahmed PhD FCA is former President, Institute of Chartered Accountants of Bangladesh (2010) and General Secretary, Bangladesh Economic Association.
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