Corporate Governance

Failure @
SATY M
Circumstances Under Which The
Satyam Scam Was Exposed
16 December 2008: The board approved a 51% stake acquisition
of MAYTAS INFRA and 100% stake in MAYTAS PROPERTIES. Both
firms were in construction & real estate business.

The deal required borrowing of US$300 million in addition to
US$ 1.2 billion of cash that Satyam claimed to possess.

There was stiff resistance from the Investors.

Even though Satyam called off this deal, it raised questions about
its corporate governance practices.

23 December 2008: World Bank suspended Satyam for 8 years
from doing any business with itself.





On December 26- Mangalam Srinivasan, an independent director resigned.

IL&FS sold 4.41 million shares of Satyam in open market and hence Rajus and
his familys stake diluted to 5.13%.

According to Investors Protection and Redressal Forum, Investment bank DSP
Merrill Lynch, which was appointed by Satyam to look for a partner or buyer for
the company, ultimately blew the whistle and terminated its engagement with
the company soon after it found financial irregularities

A former senior executive in Satyam wrote an anonymous email about the
financial irregularities & fraud to one of the board members.

On January 7,2009 B. Ramalinga Raju wrote a resignation letter to the SEBI
where he admitted that he falsified the financial statements.


Reasons For The Fraud
1. Weak corporate governance:
The mechanism for monitoring the actions, policies and decisions
made in Satyam was proved to be weak.

2. Dubious role of independent directors:
It is hard to believe the independent directors could not discover
the well-planned massive fraud and manipulations.
They should have questioned how and why the company was sitting
on such a huge pile of cash.

3. Failure at all 3 levels of auditing:
Financial irregularities were ignored by the internal & external auditors.
Internal audit headed by the CFO
External audit by PwC
Boards audit committee headed by independent directors


If a company claims it has huge cash on its
hand, then auditors should check whether
that cash in hand is available or not.
There needs to be a physical verification of
assets owned by the company.
But PwC did not perform this for even a
large sum of Rs. 5040 crore.
External audit
by PwC
Board had to ensure that transparency in
the company, that financial disclosures and
financial statements provided a true picture
That no kind of fraud existed in the
company.
But the audit committee of Satyam failed to
detect any manipulation in the accounts.
Boards audit
committee
headed by
independent
directors:
Reasons Of The Fraud (Contd.)

4. Greed

5. Ambitious corporate growth

6. Stock market expectations

7. Whistle blower policy not being effective


Prevention of Fraud
Board
1. Must monitor the ethical practices and
the way they are implemented in the
company
2. Accountable for the financial information
being projected
3. No to inactive board members
4. Authority to independent board of
directors
5. Clear understanding of responsibility
between the board and the next level of
employees
6. Qualified board members
Government Regulation, Policies and
Intervention
1. Play an active role in company affairs
because company runs with public money
2. Frequently check the companys
performance in the market and take
necessary steps in curtailing any
malpractices or falsifications
3. Government intervention must be
increased in the auditors work to have a
foolproof mechanism in the company policy
matters
Accounting Standards
1. To check the fairness and trueness of
the financial statements by involving
proper audit tools
2. Freedom for auditors
3. Reputation of auditing firm/individual
cant avoid scandals
4. Most of the companies involved in
mega scandals were audited by reputed
auditing firms

Ethics of individual/company, defining
and implementing code of conduct
1. Search or Nominations Committee
2. Proper code of conduct updated on a
regular basis should be implemented
3. Every company should have fraud
detection mechanism
4. Good corporate governance
5. Good educational practices doesnt
always mean individual has good ethics
6. Whistle-blowing practices
Corporate Governance at Satyam
Composition of the board & committees was in total compliance
with rules & regulations (It had 5 independent and 4 Internal
members.)

Satyam followed governance standards beyond what was
prescribed by law.

The board of directors was elected by shareholders to set objectives
& to ensure the long term interests of all stakeholders are served by
enforcing the principles.

The management was responsible to establish & implement policies,
procedures to enhance long term value of the company & delight all
its stakeholders.
Driving forces of Corporate Governance at Satyam:
Associate Delight
Investor Delight
Customer Delight
The pursuit of Excellence

Goal:
The companys goal was to find creative & productive ways of
delighting its stakeholders, (i.e. Investors, customers Associates &
society)

Accounting Practices:
U.S. GAAP (Generally Accepted Accounting Principles)
IFRS
Complied with Indian Accounting Standards

Financial Fraud Prediction Models And Ratios
1. Z-Score Fraud Prediction Model (Beneish 1999; updated
by Basilico and Grove 2008)
2. F-Score Fraud Prediction Model (Dechow et al. 2007)
3. Sloan Accrual Measure (Sloan 1996; updated by Robinson
2007)
4. Quality of Earnings Ratio (Schilit 2003)
5. Quality of Revenues Ratio (Schilit 2003)


Satyam won the Golden Peacock Award for Excellence in Corporate
Governance from the Institute of Directors in New Delhi in 2002.
Investor Relations Global Rankings (IRGR) rated Satyam as the
company with Best Corporate Governance Practices & risk
management for 2006 and 2007


Responsibility of the Auditors
One lesson from the failure of the watchdogs at Satyam
is that continuing with procedures that depend heavily
on trust and good faith rather than putting matters
beyond any doubt by verification will leave the door
open to frauds.
Did the watchdogs at Satyam fail to alert the outside
world because the perpetrator of the scam was a familiar
figure they trusted?
In accounting scams like Satyam, coming from the top, internal controls are
easily overridden
Only the external checks in the form of independent directors and external
auditors can provide real assurance to shareholders and investors if they work as
envisaged.
The external checks failed to work as they should have to prevent a fraud of such
major proportions that continued for at least seven years in a seemingly well run
and well regulated company meeting the standards of both (SEBI) and SEC.
In Satyams case auditors failed at all 3 levels of audit
Where they
failed?
The directors, especially the independent directors should have no hesitation in
asking tough questions and should not be satisfied with evasive or vague replies.
Independent directors are supposed to keep a watch on the management and
safeguard the interests of the shareholders.
While the board including the independent directors approved the Maytas deal
as making sound business sense, investors revolted, sending share prices
plunging
They can look for inconsistencies in the information and for trends and
operations that do not make business sense and raise the red flag.
What
should have
done?
The critical role of Internal Auditors
The critical role of Price Waterhouse
PwC affiliates had been accused of repeatedly conducting
deficient audits of Satyam's financial statements for several
years.
Satyam paid them a huge fee and it was suspected that PwC
allowed irregularities.
PW India violated its most fundamental duty as a public
watchdog by failing to comply with some of the most
elementary auditing standards and procedures in conducting
the Satyam audits.
The result of this failure was very harmful to Satyam
shareholders, employees and vendors
Fake bank balances and cash of Rs. 5,040 crore in this case
should be easy to detect.
The auditors are required to verify the companys bank balances
but Indian practice allows them to accept certificates from the
bank handed to them by the company.
It is questionable if an auditor should place such trust in the
management when he is supposed to watch over its handling of
finances on behalf of the shareholders, the regulator and the
general public.
It becomes easy to forge bank certificates and hand them to the
auditor.
What Should be Done?

Auditors brought in by the top management develop a cozy
relationship which has led them to get comfortable with even
fraudulent accounting practices found time and again in a company
Requiring confirmation of bank balances and the rotation of
auditors for listed companies.
For very large companies auditors could even be appointed by
SEBI.
Good auditing practice requires the auditor to confirm the balances
directly with the bank or by confirming with the banks the
statements provided by the management.
Evaluation of the Letter
Ramalinga Raju stated most of the facts about the financial
fraud including the amount to which certain components of the
balance sheet were inflated

Never mentioned the role of the financial auditors' in the scam

The letter shows that the intent of the entire fraud was to just
stay ahead in the competition but not for personal gains



Came out with a
confession letter so as to
minimise the effect of
damage that could have
been even more had it
been discovered in a later
time
The attempts that were
made by him to cover the
inflated cash balances.
He also recommended three
steps to minimise the loss in
view of the well being of the
employees as well as the
investors.
His gain from the fraud
that he was indulged in.
Responsibilities of Board of Directors
Towards Investors
Act in good faith in
order to promote
the objects of the
company for the
benefit of its
stakeholders.
Ensuring that there
is no conflict of
interest
To keep a check on
the financial
reporting system
Towards Company
Maintaining
appropriate
relationship with the
companys auditors.
Independent
Directors should
have challenging,
skilled who have
time to devote to
the business.
Setting up of sound
internal control
system
Exercise
independent
judgment in the
company
Rules & Regulations
Declare his interest
in acquiring or
selling of any new
company or
subsidiaries.
Proper reporting and
communication after
detecting any fraud
and taking necessary
actions as soon as
possible.
Act in accordance
with the articles of
the company
Can Regulatory Changes
Prevent Frauds
H
a
r
s
h
a
d

M
e
h
t
a

S
c
a
m

(
1
9
9
2
)

SEBI(Securities &
Exchange Board Of India)
was formed on 1988,but
powers were confined to
C.C.I.
After Harshad Mehta
scam Government passed
SEBI act in 1992.
Now SEBI is the regulator
of stock markets in India.
Rolling settlement was
made compulsory.
Suspended brokers acting
as directors and other
office bearers of BSE for
alleged insider trading
E
n
r
o
n

S
c
a
m

(
2
0
0
2
)

Sarbanes-Oxley act came
into existence in July
30,2002 after Enron scam.
The provisions in the law
are exactly the Enrons
corporate governance
failings.
The provisions of the act
includes Public Company
Accounting oversight
Board(PCAOB) to develop
standards for the
preparation of audit
reports.
On February 13,2002 due
to instances of accounting
violations and corporate
irregularities SEC
recommended changes of
the stock exchanges
regulations.
K
e
t
a
n

P
a
r
e
k
h

S
c
a
m

(
2
0
0
1
)

Withdrew broker control
over stock exchange
Trading cycle was cut short
from week to day
Carry forward system in
stock trading called BADLA
was banned
Introduced forward trading
through exchange traded
derivatives
Laws Enacted After Different Scams
Repetition Of History
There appears to be some similarity between Harshad Mehta
scam and current scam involving NSEL(National Spot
exchange Ltd).
In Harshad Mehta scam fake BR8(Bank receipts) were issued
in NSEL case fake WR(Warehousing Receipts) were issued.
Still FMC has limited powers as compared to SEBI.
The matter appears as a combination of Harshad Mehta &
Ketan Parekh scam.
From Harshad Mehta scam to current NSEL scam, it is seen
that culprits have taken the benefits of the loopholes in the
system.

By designing stringent laws government can prevent scam. It can
pluck loopholes in the current system.
This is not the only remedy. Avoiding unethical things is related to
the conscience of individuals.
There have been laws against bribery but, we have not been able
to exterminate it completely.
In Satyams case it is implied that it bribed PWC (Price WaterHouse
Cooper) to neglect the fraud.
It derailed from the path of ethics to stay in the market and gain
an edge over individuals .
Ethics is nothing but finding the difference between what you
have right to do and what is right to do.



An institution of mechanism for whistle blowers with an effective
whistle blower policy in place.
Central Governments power to direct special audit in certain
cases
To re-appoint independent directors after expiry of a term of
five consecutive years
Blacklisting of Chartered Accountants by ICAI for indulging
in fraudulent accounting practices
Suggestions
Use of investigative audit techniques & Forensic auditors
New Auditing regulations must be cost effective for the companies
Setting up of a separate risk management team by Government
to detect, respond and prevent frauds and their after effects
Lesser Government control over internal corporate processes
Promotion of shareholders democracy with protection of rights of
minority shareholders
Lessons Learned
Compelled Govt. to rewrite Corporate Governance rules, and tighten the
norms for Chartered Accountants
Responsible self-regulation with adequate disclosure and accountability
Criteria for remuneration to key personnel and strengthening quality review
should be there in place
Voluntary corporate governance code should be adopted
Promoters should be prohibited from interfering in the recruitment of
independent directors.
Company should build sustainable competitive advantage through ethics,
values, excellence, quality, social responsibility and human development.
Whistleblowers play an important role in letting others know about the
fraud.
Proper training on ethical values
Thank You