NCRDS STERLING INSTITUTE OF MANAGEMENT STUDIES Subject: Business Ethics and Corporate Governance Topic: Analysis of Satyam Scam

Submitted to: Prof. Navneet Baweja Date: 22nd March 2012 Submitted by: Jeevan Yadav Roll- 95, Div- B Satyam Scam NCRDS Sterling Institute of Management Studies Page 1

INTRODUCTION Satyam fraud unfolded and so were the inherent weaknesses of Corporate Governanc e in India. Ramalinga Raju, once a posture boy of Indias growing software sector who could find a seat beside Bill Clinton on the dais, has become a villain in t he corporate world for valid reasons. His emotionally charged four and half page letter of startling revelations shook the entire corporate world when he admitt ed of cooking the account and inflating the figure by Rupees 5040 crore. This sc am is being equated with Enron of USA because here also the scam was orchestrate d by its Auditor, Arthur Anderson, in Satyam, Price Waterhouse cooper. By the en d of the 20th century, Satyam computers had made a name for itself on the globe and had emerged as the 4th largest software in the country. The meteoric rise of the company can be substantiated by the fact that it was established in 1987 as private company and got listed by BSE in 1991. In 2001 its share was listed in NYSE and in 2004 it made its place in European stock market. According to compan ys statement, its revenue exceeds to 2 bn USD in 2008. Similarly Rajus sons compani es also were moving with leaps and bound. Maytas infra got the ambitious Metro p rojects and bagged many tenders including one of construction of Technology Park . CORPORATE GOVERNANCE IN INDIA- REALITY AFTER SATYAM SCAM Interestingly Satyam has bagged Golden Peacock award for best corporate governan ce by World Council for Corporate Governance only a few years ago. The scam has raised many doubts about the class of corporate governance in India. While speak ing at a seminar on corporate governance organized by CII, Ministry of Company a ffairs and National foundation of corporate governance, C.B.Bhave, the chairman of SEBI said on 6th February, 2009 that the corporate governance is an ongoing p rocess. There is a retrospection everywhere that some concrete steps with respec t to it should be done. There are few importance elements of corporate governanc e namely Auditing, Independent Directors, Regulators and Finally the Board inclu ding CEO itself. If we examine these constituents one by one, it would be crysta l clear that all the constituents either failed or did not act as was required.

The role of Price water house Coopers (PwC), the Auditing firm of Satyam has bee n dealt. Institute of Chartered Accountants of India (ICAI) constituted under Ch arter Accountants Act, 1949 is the regulatory body of all the accounting and aud iting firms across the countries. According to a report there is acute shortage of qualified chartered accountants and auditors in India and around the world al so. The number of CAs passing every year is hopelessly small. It is apprehended therefore that the auditing firms out source unqualified or semi-qualified comme rce graduates of Post graduates to do the auditing in the companies. The prestig ious firms get the assignment by virtue of their name and fame which they reckle ssly sell in the market by out sourcing the auditors at a very low remuneration. In case of Satyam, the man who was supposed to do audit was incidentally execut ive member in ICAI. The independent directors have also failed to discharge their duties properly. S ection 49 of SEBI Act and section 229 A of Company Act, 1956 provides for appoin tment of Independent Directors in the Companies for protecting the rights of pub lic at large in general and shareholders in particular. In the case of satyam T. R.Prasad, the retired Cabinet Secretary Govt of India was one of the directors. It speaks a lot about the procedure of appointment of independent directors. Wha t kinds of people are being appointed in the company? Moreover, they are appoint ed by the Companies themselves and pay hefty salaries and perks for virtually do ing nothing. Under this circumstance is it thinkable that these Independent dire ctors would dare to peep into the affairs of the company against the wishes of t he CEOs? There are only two possibilities in Satyam with respect to Independent directors. Either they connive with Raju and knew everything that was going on, or they did not know. In both the cases they failed miserably to discharge their duties. What is the need of such Independent Directors if they cannot do anythi ng in this matter? One unpalatable justification is given that the Independent D irectors participate in the meeting and are not concerned with autonomy of the c ompany. It should be bone in mind the Enron scam was exposed by Sherron Watkins, a women independent director. Thirdly, the SEBI and Ministry of Company Affairs too have failed in their assig ned jobs. SEBI is the highest regulator and keeps eagle eye on the activities of the capital markets. When the profits of this company were registering abnormal growth, thereby the prices of the shares were soaring, what were these guys doi ng? There has been a lot of hue and cry with respect to insider

trading; a howl SEBI failed to listen to and it inflicted heavily on Satyam. Raj u had pledged almost all his shares so did many of the promoters. The newly appo inted CEO Murthy is also said to have sold about 3.14 lakhs shares including 40, 000 in December itself belonging to him and his family members. These are the in sider trading. Although insider trading per se is not illegal but it is unethica l, moreover when Companys high official who were on share selling spree must had the idea of what was going in the company. All such transactions are needed to b e probed. As a matter of fact the tax holidays for the IT-BPO companies also needs to be s aid goodbye. Had Raju to pay the Income Tax according to the profits shown in th e accounts, he would not have fudged it to this scale. The ministry of Finance m ust deliberate upon the entire gamut of issues related to tax heaven provisions. RECOMMENDATIONS: Taxonomy It is important to lay out the taxonomy of corporate frauds and governance failures. In jurisdictions such as the US and UK, managers (such as the CEO, CFO and other senior executives) are compensated through stoc k options and equity and hence there is a strong incentive to inflate earnings. On the other hand, in countries such as India where there is concentrated shareh olding, the critical actor is not the senior management but the controlling shar eholder (a.k.a. the promoter). In such a scenario, where fraud is involved, it u sually does not result in an inflation of earnings, but in related party transac tions whereby assets of a company are siphoned out to other companies owned by t he controlling shareholder. In that sense, and in drawing international parallel s, although the media has called Satyam Indias Enron, this case is more akin to the Parmalat case which also involved affiliated transactions and misstatement of f inancials. The regulatory response in terms of reforms will have to take into ac count the differences in the systems where diffused shareholding is the norm (US and UK) and where concentrated shareholding is the norm (e.g. India).

Audit Process There is clearly a case for reforms in the audit system. - The appointment of auditors ought to be shifted from the purview of the contro lling shareholders to the independent audit committee so that auditors do not ow e any allegiance whatsoever to the controlling shareholders, and that the proces s of appointment and removal of auditors is effected in a manner that is truly i ndependent of controlling shareholder influence. - There is a case for the estab lishment of a body such as the Public Company Accounting Oversight Board (PCAOB) (that was established in the U.S. a few years ago), as that body would review t he intensity and the integrity of audits by auditors on an annual basis. - There is need for auditor rotation as it prevents creation of any affinity between au ditors and controlling shareholders, and avoids capture of the audit process by in siders in companies. - Auditor liability is currently an unresolved question, an d the affixation of liability for malfeasance needs to be clearly defined. In so me countries, the public regulatory authorities (such as the securities regulato r) could directly initiate action against auditors and the merits of such an app roach require careful consideration. - Other precautionary processes may help as well. This could include meetings between audit committee members and auditors without the presence of management. Independent Directors Independent directors tend to be in an unenviable position. Unless there are any red flags or warnings in a companys operations, it is difficult to pinpoint boar d failure per se. For example, a board that receives false information, without any other warnings, is in a tough spot. Further, in controlling shareholder situ ations, the independent directors are often appointed by the controlling shareho lders, and may hence owe a sense of responsibility to those shareholders. Having said that, the current norms on corporate governance in India do not go far eno ugh to deal with independence of the board in controlling shareholder situations . Some of the possible reforms are as follows:

- Making nomination committees mandatory for Indian companies. Currently, there is no requirement to have nomination committees, although several companies have established such committees voluntarily. When independent directors are chosen by an independent nomination committee and without the influence of controlling shareholders, there is a sense that it would instill greater independence of suc h directors from the controlling shareholders - Other processes relating to the functioning of independent directors may induc e greater credibility in board decision making. These include: -The requirements of lead independent directors - Executive sessions among indep endent directors without the presence of management - Appointment of advisors (s uch as lawyers and accountants) by independent directors to advise them on signi ficant transactions involving a company. Such advice would be provided independe nt of the management or controlling shareholders. - More fundamentally, there ne eds to be a re-evaluation of who appoints independent directors. Under the curre nt system, they are appointed by the shareholder body as a whole, which is often considerably influenced by the controlling shareholder. What is required is a r eform to consider other methods of appointing independent directors. For instanc e, they can be appointed by a majority of the minority shareholders, whereby the controlling shareholders do not have a say on the matter. Alternatively, there may be proportionate representation on boards of listed company where all shareh olders have some level of say in appointment of directors and that the board is not dominated by controlling shareholder nominees. For example, in such a system , the minority shareholders obtain the right to elect such number of directors i n proportion to the percentage holding of such minority shareholders. [Note: The system of proportional representation is already available under the Companies Act, in Section 265, but is only optional] - Moving from a regulatory perspectiv e into standards of conduct and ethics, perhaps it would be useful for industry bodies such as the Confederation of Indian Industry (CII) to draw up guidance fo r directors that would help independent directors clearly determine what is expe cted of them in the boardroom.

Investor Activism There is greater need for activism on the part of the investor s directly. Often, that is not possible because of the lack of coordination amon g various investors, referred to as the collective action problem. One method by which this has been resolved in the U.S. is through the existence of proxy cons ultants such as Institutional Shareholder Services or Risk Metrics who knit toge ther coalitions of investors to actively play a role in significant decisions in volving a company. Similarly, an active business press would also play an import ant role in enhancing governance practices. These are some of the key recommenda tions emanating from the panel discussion. Clearly, there is recognition that no ne of these systems will be failsafe. However, the solution in these circumstanc es is that if a number of such systems are put in place, it would reduce the sta tistical likelihood of things turning sour from a governance standpoint.