Business Background Research Report Satyam Scandal

Snehal Tiwari, Student Id: 3316645 Assignment 2 Course Code: BUSM 2112

Executive Summary

Satyam was one of the big five IT consulting and services firm in India. At the time of this scandal it reported around USD 2 billion in revenues. Satyam meaning truth in Sanskrit, is today more related to this scandal. The scandal in brief is about how its promoter and chairman resorted to fudging the accounts to overstate earnings (by about 1.5 billion dollars USD, over a long period of time) in order to purportedly retain investor confidence and ostensibly retain control of the company in which he did not have a controlling stake. This scandal was affected (supposedly by a single person) in spite of: y Company having listed in India and USA and hence having to adhere to strict market regulations. i.e. Company Law and SEBI (market regulator) in India & SEC and Sarbanes-Oxley act in USA y One of the biggest names in financial auditing (PWC) in charge of auditing company financial reporting. y Company having a majority representation of independent directors on its Board. y Marquee names in industry and academics were present as independent directors on the Board. y Promoter (the conspirator) though in place as a chairman, was not a majority shareholder. This scam led to financial losses for a large number of small shareholders at the same time eroding the confidence of investors in corporate environment in India. It gave a substantial beating to the clean and responsible image of IT companies in India and abroad. The scam is also a display how two major components, in ensuring authentic financial reporting (auditors) of the company and fiduciary prudence (independent directors) failed to honestly carry out their responsibilities. This report has described the resultant effects of this scam on its promoters, auditors, company as a whole, stock market and IT companies in India. It has also compared this scam with the Enron scam which took place in USA at the start of the century. The report then has given a short brief about corporate social activity of the company. This report concludes that given due diligence and attention to their responsibilities by directors and auditors, this scam could have been avoided. The requirement in Indian context is to have credible checks to balance out the undue promoter/management influence on company board selection and functioning. Accounting practices in India need to be strengthened and laws are needed to make auditors liable for their lapses. Investigations and court cases related to this scandal are still in progress in India.

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Table of Contents

Executive Summary ................................ ................................ ................................ .......................... 1 Introduction ................................ ................................ ................................ ................................ ...... 2 Background ................................ ................................ ................................ ................................ ...... 3 The Scandal ................................ ................................ ................................ ................................ ...... 3 Corporate Governance................................ ................................ ................................ ................... 4 Indicators of impending Disaster ................................ ................................ ................................ ....... 4 Ethics & failure of Oversight ................................ ................................ ................................ ............ 5 Internal and External Auditors ................................ ................................ ................................ ....... 6 Independent Directors ................................ ................................ ................................ ................... 6 Aftermath and Effects ................................ ................................ ................................ ....................... 7 Comparison with Enron ................................ ................................ ................................ .................... 7 Corporate Social Responsibilities ................................ ................................ ................................ ...... 8 Conclusion ................................ ................................ ................................ ................................ ........ 8

The primary purpose of corporate leadership is to create wealth legally and ethically. This translates to high level of satisfaction to five constituencies: - Customers, employees, investors, vendors and society at large. The raison d'etre (reason for existence) of every corporate body is ensuring predictability, sustainability and profitability of revenues year after year. - N. R. Narayana Murthy, Chairman of the Board and Chief Mentor, Infosys (www.infosys.com)

Satyam seems to have transitioned from being acommon noun (meaning truth in Sanskrit) tobecoming a proper noun (the leading company)to a verb, and an adjective representing a fraud of a hugescale. - Sandeep Parekh Professor, Indian Institute of Management, Ahmedabad

Introduction

The company Satyam Computer Services was established in 1987 by B. Ramalinga Raju. In beginning of 2009, it was among the five big IT Companies in India (others being Tata Consultancy, Wipro, Infosys and HCL). It was listed in Indian and US stock exchanges. As per US Securities and Exchange Commission submission (SEC 2008) it reported 2.1 billion US Dollars in revenues. It had over 53000 IT professionals on its payroll working in 67 countries with 20 countries having a Development Centre established. It had 654 global companies amongst its customers, 185 of which were Fortune 500 companies (Mynampati 2007). The company had PriceWaterhouseCoopers (PWC) as their financial auditors.

Snehal Tiwari, Student Id: 3316645

Assignment 2

Course Code: BUSM 2112

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Background

As Jayati (2009) finds in her article about Corporate Governance in India, rules regarding regulations pertaining to registered companies in India is governed by the Companies Act, 1956. After independence in 1947, India as a country adopted socialist policies and all big companies where nationalized and run by bureaucrats. There was a policy change by the government in 1991 where neo-liberal policies were adapted. After this point in time, international trade and investment, initiation of privatization and tax reforms were conducted. This opened up the economy and active participation of masses in private enterprise. As a result, people started investing in companies and share markets emerged. To overlook and further strengthen public confidence in companies further legislation was created by the government in 1992.

The Securities and Exchange Board of India (SEBI) was established on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992. The Preamble of the Securities and Exchange Board of India describes the basic functions of the Securities and Exchange Board of India as: ..to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto - http://www.sebi.gov.in/

Jayati (2009) also notes that regulations regarding board independence, financial disclosures and procedures relevant to listed companies have been prescribed by Listing Agreement laid down by SEBI. Clause 49 introduced by SEBI in February 2000 and its subsequent modifications in 2004 & 2008 (post Enron Scandal) laid down stringent guidelines in terms of Companies Board composition and Director independence.

The Scandal

B. Ramalinga Raju (2009), the Chairman of Board of Directors for Satyam Computers Limited, in a letter to the Board of Directors, SEBI Chairman and bankers for the company disclosed to committing a fraud. As per the letter, he mentioned that he had been manipulating the accounting books of the company to the tune of INR 7000 crore (roughly USD 1.5 billion). The cooked balance sheet of September 2008 had inflated cash and bank balances, non-existent accrued interest, understated liability and overstated debtors position. This admission of guilt shocked the shareholders, employees of Satyam, clients, people working in IT industry, regulators, bankers and more or less Indian citizens and all the well-wishers of India. It shook the confidence of shareholders in the corporate governance in India and as a result in ensuing period the 2 prominent indices of Indian share market (BSE & NSE) lost about 11 & 17 percentage points. IT companies were hit even worse where median fall for stocks was 37 percent (Varma 2009).

Snehal Tiwari, Student Id: 3316645

Assignment 2

Course Code: BUSM 2112

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Corporate Governance

Preceding the scandal, Satyam Computer Services had been awarded the Golden Peacock award for excellence in corporate governance in 2008 by The World Council for Corporate Governance (WCFCG), with Dr. Ola Ullsten, the former Prime Minister of Sweden, serving as lead judge (Satyam 2008). This was mainly due to the prestige and composition of Satyams Board. The Satyam Board then comprised of six independent (non-management) directors out of nine (SEC 2008). Four of the independent directors were academics with marquee reputation (one being a Harvard Business School professor specializing in corporate governance). One was a former cabinet secretary of Indian government (bureaucrat) and one was a former chairman/CEO of a technology company (Intel Corporation).

Indicators of impending Disaster

Professor Sandeep Parekh (2009) cites various issues which were an indication that things were not quite right at Satyam.
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In December 2008, Satyam announced an unanimous decision by the Board to buy large stakes in 2 infrastructure companies Maytas Properties and Maytas infrastructure (maytas is satyam spelled backwards) for a price of USD 1.6 billion. These companies were promoted by relatives of executive chairman of Satyam, Ramalinga Raju. These companies were not related to core competencies of Satyam and would have emptied the cash and bank holdings of Satyam. In the world economic situation of recession and property prices taking a nose dive this was an exorbitant valuation for companies which were controlled by relatives of executive chairman. Only 100 acres of the 8600 acres of land holding under development claimed by Maytas Properties could be verified. The promoters of MaytasInfrastruce owned around 85 percent of the company (via surrogates) against 35 percent as claimed by the promoters. A lawsuit against Satyam in US seeking a billion dollars as compensation was not reported to Indian exchanges or to SEC in US. The World Bank, Satyams fourth largest client, had blacklisted Satyam from working with the bank for eight years on charges of providing improper benefits to bank staff. Ramalinga Raju had only 8.5 percent stake in the company, how he could manage to take such a big decision (to acquire companies) without major shareholder approval!

Also Satyams own filing of Form 20 with SEC (2008)

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Satyam did not have anyone on its Audit Committee who had all the attributes required by SEC to server as an Audit Committee Financial Expert. Satyams Board did not have who was financially capable / knowledgeable or experienced in checking the companys financials. Satyam had separated the positions of CEO and Chairman from one person, but both positions were held by people who were members of company management with substantial stakes in the company and were related (brothers). Satyam self-disclosed that the best practice followed by quite a number of companies, i.e. independent directors meeting amongst themselves without the presence of management directors, was not followed at Satyam.

Snehal Tiwari, Student Id: 3316645

Assignment 2

Course Code: BUSM 2112

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Ethics & failure of Oversight

As per Ramalinga Rajus Letter (2009), atthe roots of this fraud was the case of manipulating the books several years ago to cover a marginal gap in operating profits. This gap grew over time and all efforts to eliminate this failed as the company grew and the complexity increased along with downturn in the global markets. At times he felt like he was riding a tiger and did not know how to get down without getting eaten. It seems that in a corporate race (amongst Indian Companies) and to keep companys image of wellbeing intact in the eyes of market analysts and pundits, he took the process of Earnings Management a bit too far. The fact that Raju did not have a majority holding in the company and was prone to being dislodged from his post if the company did not perform to expectations, might have played a role. Earnings Management is the process where in a company intentionally manipulates their reported earnings to meet a specific monetary goal, often an amount consistent with analyst expectations. One of the motivations behind earnings management is to "smooth" earnings, or to make a company's profits look less volatile and more consistent. - www.abanet.org Managers that always promise to "make the numbers" will at some point be tempted to make up the numbers - Warren Buffett Worlds Leading Investor, Industrialist &Philanthropist (Buffett & Clark p. 43)

Raju maintains that he alone was responsible for this fraud, but it seems highly implausible and also points to complicity or gross negligence of their duties by tree critical roles within and outside the company. It is suspected at this point of time that presence of a substantial stakeholder/s in management roles and their personality has had an adverse impact on work culture and ethics in the company. A mix of individual, organizational and institutional factors are responsible for ethics failure at Satyam.

As a counter argument, Jirapron et al. (2008) mention that though Earnings Management is viewed as detrimental to the company in light of recent scandals (Enron and Worldcom), some argue that Earnings Management may be beneficial because it improves the information value of earnings by conveying private information to shareholders. Also their research reveals that Earnings Management on average is not detrimental to companies.

Snehal Tiwari, Student Id: 3316645

Assignment 2

Course Code: BUSM 2112

Page 6 of 9

Internal and External Auditors

It is the duty of people working in the auditing profession to safeguard investors and shareholders by affirming the essential facts of the business story. Over a long period of time internal auditors of Satyam failed to spot that numbers do not add up in accounts reported by the company to regulatory bodies, clients, associated companies and shareholders. External Auditors (in this case PriceWaterhouseCoopers) who are supposed to judicially and independently access the companys accounts also failed to perform their duties. Institute of Chartered Accountants of India (ICAI)maintains and publishes Indian Accounting Standards in India. A senior member of ICAI stated to Business Standard (dated 8th Jan 2009, <http://www.business-standard.com/india/news/price-waterhouse-faces-icai-probe/11/16/345594/>, viewed 11th Apr 2011) said that Auditors merely audit the documents provided by the company management and give their opinion. It was too early to pass a judgment on external Auditor culpability.

Independent Directors

Independent directors to a company board are supposed to play two important roles that may not be mutually exclusive. On one side, they must act as watchdogs for promoters and management on behalf of all stakeholders and at the same time, they are viewed as reservoirs of strategic advice which the management and promoters can tap into to maximize overall company value. The fact that company CEO often plays and important role in appointment of Independent directors to the company board does not sit well with their monitoring role. In Satyams caseit has been observed that the Independent Directors on the Board failed to carry out their fiduciary responsibility towards the stakeholders. They failed to verify the financials of the company and also did not question the investments as put forth by the management. Also the fact that these directors were given a substantial monetary benefit by the management might have impeded their ability to question management decisions (Parekh 2009). In light of substantial monetary benefits given to the Satyam Independent Directors, the supposed independence of these Directors comes to risk. Quite a number of studies have been conducted to verify and quantify the effect of remuneration given to independent / non-executive Directors. One study done by He et al. (2009) in Australia found that there is positive relationship between earning management and share ownership of non-executive directors. The same study also revealed that there is negative relationship between non-executive director compensation and earning management. On basis of their extensive interviews Khanna and Mathew (2010) state that in India, there is lack of understanding about the role that an Independent Director is expected to play in company affairs. At the same time there is concern about applicability of civil and criminal laws to independent directors. Independent Directors seek these concerns to be addressed in the proposed reform to company legislation in India.

Snehal Tiwari, Student Id: 3316645

Assignment 2

Course Code: BUSM 2112

Page 7 of 9
Aftermath and Effects

Immediately after the disclosure by Ramalinga Raju, the existing board of Satyam was barred from functioning and the Company Law Board appointed 10 nominal directors to temporarily oversee functioning of the company. Then CEO and brother of Ramalinga Raju (Rama Raju) and Companys CFO were taken in for questioning and later arrested. Their prosecution is still underway in Indian courts. Some of the banks and customers terminated their relationship with Satyam post declaration. Indian Government nominated well known personalities to Satyam board to look over operations and help in investigating the true financials of the company. Via a public auction process, the company was purchased by Mahindra & Mahindra Company, Tech Mahindra. Under the new management Satyam name has been re-branded as Mahindra Satyam. In light of investigations into Satyam scandal, ICAI (accounting regulatory body) recently, has asked the big four accounting firms (PWC, KPMG, Deloitte and Ernst & Young) to desist acquiring Indian Audit Firms and go in for quality control (Indian Express, 27 February 2011, <http://www.indianexpress.com/news/icai-bans-pwc-kpmg-e&y-from-buys/747146/> viewed 11 April 2011). Khanna and Matthew (2010) also noted that there have been a large number of resignations from Company Boards of Independent directors due to fear of reputational damage and risk of facing liability and prosecution due to rogue activities of promoters outside of their knowledge. On other hand Jayati (2009) concludes based on the research that in India 50 percent of companies have executives who serve as board chairman. Also noted was that there was an increasing trend where promoters doubled up as board chairmen. Given the numbers Jayati mentions that possibility of independent directors acting as obedient agents of a powerful CEO is a distinct possibility in India. Reforms in corporate management are also being considered by the relevant authorities in order to reduce the influence of controlling shareholder in selecting their monitor i.e. role of management/promoter in selecting independent director. Another set of law is being considered to enhance liability of auditors, rotating auditors and granting direct access to information to directors. Initial response to these suggestions is not very positive. Experts think that without creating means of enforcing these new and existing laws, carrying out reforms is not going to be much use (Khanna 2009). Also, according to Porus Doctor, who is a partner with Deloitte India, Indian Corporations have taken the role of internal auditing very seriously. While independent auditors now spend considerable more time in audit committee meetings then what they used to pre Satyam. There is also absolute focus on internal audit of the company by independent directors (Seal 2010).
Comparison with Enron

Many perceive Satyam scandal to be similar to Enron scandal and call it Indias Enron. Both scandals involved large amounts of money, were widely publicized and involved gross misstatement of financial performance. But the similarities end there. Enron was not a fraud at one firm, but involved frauds at a number of US firms that shared some similarities. In India, Satyam is only firm which has reported this type of fraud. Also Satyam is a fraud which has been orchestrated by its controlling shareholder overstating profits, whereas Enron involved management trying to camouflage losses incurred due to bad business decisions. Satyam is a case of majority-minority shareholder conflict whereas Enron was more of a manager-shareholder conflict (Khanna 2009).

Snehal Tiwari, Student Id: 3316645

Assignment 2

Course Code: BUSM 2112

Page 8 of 9
Corporate Social Responsibilities

In spite of its failings in corporate management, Satyam has always had a very strong focus on its social responsibilities. Satyam setup and supported Byrraju Foundation (in 2001) in memory of Byrraju Raju, founder of Satyam group of company. It runs various programs in healthcare, education, water, sanitation, environment, agriculture, women empowerment, community leadership, disability and rehabilitation in rural areas in the state of Andhra Pradesh in India (Byrraju Foundation 2011). Byrraju Foundation has adopted about 200 villages in Andhra Pradesh and provides 9 volunteers to each village to provide support to Foundations activities. They have a nodal coordinator for every 15 villages and have regional offices in 3 cities to support the nodal agencies. Post-acquisition by Mahindra & Mahindra, Mahindra Satyam has setup Mahindra Satyam Foundation with a mission to bridge the gap for underprivileged in urban areas. This foundation is the largest corporate volunteering program in the India and has 15000 registered volunteers. These volunteers are organized into teams of 7 and have worked about 850,000 volunteer hours since inception. The foundation is also the largest corporate blood donor in India (Mahindra Satyam 2011). The key programs are aimed towards education, livelihood, health, empowering disabled people and flood relief operations.

Conclusion

Considering the facts on hand, it can be assumed that the dupery at Satyam by its promoter Ramalinga Raju could have been averted if auditors and members on board of directors performed their duties in form and spirit rather than doing just lip service. Ramalinga Raju in public life was an ideal tale of success from rags to riches by hard work. Meteoric Rise of Satyam along Indian liberalization and boom in IT industry, along with CSR initiatives by Satyam and contacts led to a goodwill halo around its chairman and promoter Raju. At the moment is not clear as to absolute motives behind the financial fraud. Some speculate that it is not just a case of misquoting profits (to keep reputation intact and keep a hold on the company), but money has been siphoned away from the company. But by the admission of guilt and wrong doing by the Raju had definitely shattered the halo built around him. It must also have hurt badly to thousands of employees and people impacted by the CSR initiatives, which have been widely applauded by observers. The scam has also left people and specially investors to look beyond the faade presented to them by the management of corporations in India. Although it has been reported that these days there is vigorous auditing and attention to financials by responsible persons in a company (Seal 2010), it is only a matter of time Satyam will be repeated again. The fact still remains, as determined by Jayati (2009), that a large portion of corporate companies in India have a strong influence and representation of management and promoters in the Board room. What is required is affective means to implement and verify that the policies and checks (existing and whatever new are enacted) on corporation are functioning.

Snehal Tiwari, Student Id: 3316645

Assignment 2

Course Code: BUSM 2112

Page 9 of 9 References
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Buffett, M & Clark, D 2009, Warren Buffett's Management Secrets: Proven Tools for Personal and Business Success, Scribner, USA Byrraju Foundation, 2011,Community FAQ, Byrraju Foundation, India, 12th April 2011, <http://www.byrrajufoundation.org/html/media.php?cat=m6> He, L, Wright, S, Evans, E & Crowe S 2009, what makes a board independent? australian evidence, Accounting Research Journal, April, vol. 22, issue 2, pp.144 166, viewed on 11th April 2011, Emerald Jayati, S 2009, Board independence & corporate governance in India: recent trends & challenges ahead, Indian Journal of Industrial Relations, April, vol. 44, issue 4, pp576-592, viewed 10th April 2011, Social Science Research Network Jiraporn, P, Miller, G, Yoon, SS & Kim, YS 2008, is earnings management opportunistic or beneficial? an agency theory perspective, International Review of Financial Analysis, October, vol 17, pp 622-634, viewed 11th April 2011, Social Science Research Network Khanna, V 2009, corporate governance in india: past, present and future?, Jindal Global Law Review, September, rev. 171, viewed 11th April 2011, LexisNexis Khanna, VS & Mathew, SJ 2010, the role of independent directors in controlled firms in india: preliminary interview evidence, National Law School of India Review, October, Vol. 22, p 35, U of Michigan Law & Econ, Empirical Legal Studies Center Paper No. 10-025, viewed 11th April 2011, Social Science Research Network Parekh, SP 2009, satyam a wakeup call for indiainc.,Vikalpa:The Journal for Decision Makers, vol. 34, issue 1, pp 85-88, viewed 10th April 2011, EBSCO Mahindra Satyam, 2011, Corporate Social Responsibility, Mahindra Satyam, India, viewed 12th April 2011, <http://www.mahindrasatyam.com/society/index.asp> Mahindra Satyam, 2011, Annual Rerport 2008-09 & 2009-10, Mahindra Satyam, India, viewed 12th April 2011, <http://www.mahindrasatyam.com/investors/annualreports.asp> Murthy, NRN, Infosys, viewed 10th April 2011, <http://www.infosys.com/investors/corporategovernance/Pages/index.aspx> Mynampati, R 2007, Globalization of Services: Satyams Experience, Stanford University, December 7 2007, Stanford University, <http://iis-db.stanford.edu/docs/208/1._Satyam_PPT.pdf> Raju BR, 2009, Letter to Satyam Board Members and Securities and Exchange Board of India (SEBI), Jan 7 2009, viewed 9th April 2011, <http://trak.in/tags/business/2009/01/06/satyam-headraju-admits-fraud-letter-board-directors/> SEC 2008, Form 20-F submission by Satyam Computer Services Limited, SEC, USA, viewed 10th April 2011, <http://www.sec.gov/Archives/edgar/data/1106056/000114554908001441/u9 3288e20vf.htm#103> Satyam 2008, Satyam Receives Golden Peacock Global Award for Excellence in Corporate Governance, Satyam, September 22 2008, viewed 11th April 2011, <http://www.mahindrasatyam.com/media/pr6sep08.asp> Seal, V 2010, Internal controls have improved since Satyam fiasco came to light, Daily News and Analysis, viewed 12th April 2011, <http://www.dnaindia.com/money/report_internal-controls-haveimproved-since-satyam-fiasco-came-to-light_1329886> Varma, JR 2009, satyam fraud: the regulatory response,Vikalpa:The Journal for Decision Makers, vol. 34, issue 1, pp 75-78, viewed 10th April 2011, EBSCO Assignment 2 Course Code: BUSM 2112

Snehal Tiwari, Student Id: 3316645