By now, most people have probably heard about the huge Satyam scandal, where the company’s founder and chairman, Ramalinga Raju, has taken responsibility for massive fraud in reporting the company’s earnings, profits, and cash balance. Satyam, one of India’s largest consulting and IT companies, has admitted it claimed $1 billion in assets that simply did not exist for just one three month period in 2008. The company is now facing the abyss, as its share prices are evaporating, and clients are starting to defect to rivals (including IBM and Accenture). Satyam currently employs 53,000 people.
As background, Reuters has an informative story on the status of Ramalinga Raju as a symbol of Hyderabad as a new IT hub (“Cyberabad”) and the whole, now deeply tarnished “India Shining” mythology.
And that’s not all. Two American legal firms are filing lawsuits against Satyam, claiming fraud. Distressingly, PriceWaterhouse Coopers, the accounting firm that signed off on Satyam’s accounting practices for years, never detected the fraud.
What went wrong? Salil Tripathi has a provocative Op-Ed at the Wall Street Journal, where he addresses the aspects of Indian business culture that enabled this to happen. For Tripathi, one of the key factors in Satyam’s case is the clan-like structure of Satyam’s upper management and Board of Directors, which are heavily populated by relatives and close friends of the chairman:
What distinguishes a listed company from other forms of business is the separation of ownership from management. As in other countries, some Indian companies have boards made up of friends, if not the family, of the entrepreneur who started the firm. Often, senior management positions are also held by members of the family. Transactions between related parties are not at all rare, and when they occur, the information is not disclosed clearly.
All these warning signs were missed in the case of Satyam, which decided to invest in two real-estate companies related to the Raju family. The board, which included Krishna Palepu, a Harvard Business School professor and a corporate governance expert, and Vinod Dham, regarded as one of the minds behind the Pentium chip at Intel, agreed. The deal fell through when institutional investors protested. Credit the greater transparency economic reforms have brought about in India, with external investors asking hard questions, and the media scrutinizing companies thoroughly. Markets did their job quickly; relief from courts would have taken longer. (link)
Despite the probable collusion of members of the Board of Directors and other members of Senior Management at Satyam in the fraud (it seems hard to imagine that Raju did all this without anyone knowing about it), for Tripathi, the solution is not new laws or tighter regulation:
But good governance requires vigilance by the board. India will need more of that. Institutional investors and the media will have to scrutinize companies more deeply. None of that necessarily requires new law. Indian corporate law is mature. India should take a look at what happened in the U.S. after the Sarbanes-Oxley law of 2002 before it decides to bring back some of its old red tape. (link)
Tripathi is referring to the Sarbanes-Oxley Act, which was instituted in the U.S. after the Enron scandal to strengthen the integrity of corporate accounting practices. I am not sure I agree with Tripathi that new regulations are not required (it seems like the problem he’s describing is exactly the kind of thing carefully written regulations can address), though I admittedly don’t know much about the problems Sarbanes-Oxley has created for American businesses.
What do people think? Tripathi’s article is helpful, though I’m a little confused on some points: aren’t there conflict-of-interest types of restrictions for Boards of Directors in western countries? (In the first passage I quoted, Tripathi suggests in-bred management/accounting/governance structures like Satyam’s are not unique to India.) Shouldn’t some such restrictions be there?
We will probably find out more about how this fraud was perpetuated in the coming weeks, which will clarify what legal reforms are necessary. It is probably too early to say, as confidently as Tripathi does here, that nothing is really wrong.
It remains to be seen how PWC will weasel its way out of this one, when it has certified Satyam’s annual reports not just in India, but in the Europe and the US for several years.
The statutory auditors have failed, and very badly, this time, in the case of Satyam. At least in the case of Enron, it involved US based audit firms that had expanded into practice areas (such as consulting) that carry the risk of conflicting with the disinterest that an auditor and the process itself requires. There was even a harebrained request that audit firms take up legal representation as well, by merging with law firms, thankfully that did not happen, because of the experience of Enron. In India the audit profession is very tightly regulated, and rules that may seem archaic, such as the prohibition on marketing, limits on the number of partners per firm, limits on partners holding of directorships, and such like, should have worked some way or the other. That PWC did not qualify the accounts of Satyam even once, usually the indication of a storm to come, reflects very poorly on PWC. It is also interesting that a scam of this sort had to happen in a new-economy company run by a 1st generation business family. There have been times before when the auditor has qualified the accounts and resigned [not offering themselves for reappointment] rather than ignore the managing family’s scams. The case of Raymond Woollen Mills Ltd. and their auditors S.B. Billimoria & Co., in 1984 created a furore that continued even after SBB quit and an “international firm” took its place!
What is mind boggling for me as well is the role of PWC, cash is the first thing to be verified by auditors during an annual audit, with detailed confirmations sent out for all major bank account and physical count of cash on premises. I can’t seem to get my head around the fact how more than 90% of cash and equivalents don’t exist. With regards to board independence, it is a myth, I believe there are committees of the board like compensation and audit here in the US, that have stricter independence requirements. I really don’t think it is an India specific problem, as the oversight by SEBI and other agencies is anything but lax. Partners at PWC India have a lot to answer for as their role definitely doesn’t pass the smell test.
Jyotsana,
Excellent points, qualified audit opinions are routinely never issued, most issues in my experience are almost always dropped at partner/cfo level discussions, that being said, this is is far too blatant.
I have a PDF of Raju’s letter but am not sure how to attach it here, any ideas?
Indian version of Enron and Madoff scandal…Crony capitalism or corruption ?
Umber desi, you can anonymously post files like PDFs on sites like SendSpace.com. I’m sure readers would be curious to see the letter.
if you’re an investor, here’s your problem:
However, that said, while I feel very bad for people who don’t have very much and are losing money now, including employees of Satyam, that international / Indian investors were defrauded instead of untitled agricultural labourers is the only thing that puts this in the news. what would be more interesting to know is why this was revealed now, as opposed to earlier or later.
I can’t access the site at work, hopefully this works.
I think it was disclosed now as it became too big to conceal, same logic as why the Madoff scandal got blown up now. The reason why he wanted to acquire the two real estate companies was to make up for some of the gaps on the Balance Sheet. Most investors will not be able to detect something like this and I don’t think there are any regulatory audits for such companies unlike banks and most people rely on audited financial statements.
what would be more interesting to know is why this was revealed now, as opposed to earlier or later.
As I understand it, what started the collapse was the company’s attempt, last fall, to invest in the real estate company owned by members of Raju’s family. Investors rebelled against the investment, but so did some independent board members. Those events, which were highly publicized, led people to start asking hard questions about what the company was doing.
This is another face of the same Madoff’s Ponzi scheme. The proxy voting in board meetings is also causing rumblings with more corporate regulations in the cards
For heaven’s sake, can someone please run to the nearest kachery and get this Satyam guy an attorney. I pity his criminal defense team. His incriminating statements will kill him in any trial.
Satyam had also received a Golden Peacock award for excellence in corporate governance in 2008.
Look at the parallels…Dubious way to enter Madoff’s inner circle though they were not relatives or friends. –
Membership Has Its Penalties
Jeff,
I saw that the award was taken away, my question is how they got it in the first place.
Bridget,
Madoff was not regulated, I think only his broker dealer arm was. Satyam has been audited by PWC for a number of years and regulated by SEBI in addition I believe they also had to comply with SEC requirements as its ADR trades here.
I thinks more than Satyam, PWC got some ‘splainin’ to do. However terrible Raju’s lies you can at least chalk it up to the profit motive. How does $1,000,000,000 fall through the cracks for an auditing firm though? That’s scary. Kinda subverts the purpose behind the entire system of auditing.
I’m not an expert on accounting, but I know enough to say that it’s not an exact science. There are all kinds of ‘judgment calls’ and ‘rules of thumb’ and ‘when you recognize something’ and ‘is it marked to market or book value’ and ‘what discounting rate do you use’ and ‘how much goodwill do you estimate’ and ‘what is the estimated recoverable amount from your debtors’ and so on and so forth. So the question of how $1 B can fall through the cracks is, that’s how.
It’s not a question of rules and regulations, because they can always be subverted. It’s a question of ethics, from one end to the other. Enron also had its books audited. How did their stuff happen? If I remember right, it’s auditor lost all its credibility, and had to sink with it, and reopened under a new name.
The problem with traditional financial audits is that they were never meant to be broad enough in scope to provide any sort of assurance against management fraud. The standard unqualified audit report has all kinds of provisions abdicating the auditors of any responsibility.
Auditors do provide some level assurance against unintentional deviations from accepted practices, and against very simple frauds like Ponzi schemes.
Due to legal and economic disincentives against innovation in the audit industry over the past 50 years auditors have failed to incorporate techniques that can detect misinformation resulting from ‘ earnings management‘ (which the vast majority of public companies practice to some extent). One side benefit of the credit crunch is that the resulting insolvency will force a lot of these people out of the woodwork.
Auditing firms today are largely in the business of selling the illusion of secutriy.
Notanacctgpro,
There are clear rules on which assets have to be carried on the balance sheet and what values, trading securities are required to be marked to market. Property etc, is carried at book value less accumulated depreciation. Debtors and cash balances are usually pretty straightforward to verify, Major debtors like major bank account are sent confirmation letter directly from auditors to verify balances as of a particular date and cash in hand has to be physically counted. Debtors in doubt are reserved against.
The question is how PWC didn’t catch any of these items that are straight forward, so how all this fell through cracks is muddier than it seems.
Auditor In Enron’s case, Arthur Andersen ceased to exist, its business was acquired by other audit firms, I believe it was KPMG that took over most of its business in India.
Former PWC auditor,
That is why there is a management rep letter post SOX that is mandatory in the US, that shifts the responsibility from the auditor to the management. I think in this case, PWC didn’t do what they were supposed to.
you know what i thought was cute in this whole unsavory business? “maytas,” the real esate firm acquisition that rocked the boat is the “satyam” spelled backwards. the truth inverted. it seems like a nice little word trick tucked in an overwrought desi novel.
In the case of Raymonds, 25 years ago, it being a manufacturing company, there were tangible assets such as inventories to be verified, where even if valuation of closing stock is a matter of “opinion” absence wasn’t an option. In the case of Satyam, it is receivables – possibly from inflated revenue recognition that seems to be the problem. But converting the same receivables into cash is trickier. The Maytas acquisition would have helped Satyam “adjust” its cash balances and convert them to fixed assets. But that would led to another problem, because if acquired for cash and not consideration other than cash, Maytas would still be due for an audit of its cash holdings prior to merger. As it happens Raju & Co., were merely putting off the problem, and exchanging a slipped disc for a migraine.
The case of Bernie Madoff is more serious. It is wholesale fudging of every transaction – the statements sent to clients had no relation to what was being bought and sold. The Unit Trust of India in the pre-SEBI days was not very different. It had a bunch of funds whose NAV was for all purposes notional. But in the meanwhile, money was being raised for new funds all the time. But in that case the GoI knew what was happening and controlled the entire movement of funds, and that too conservatively. The older “popular funds” notably Units-64 and ULIP paid out the best though not sky-high returns and for many years were used as a year end tax shelter by corporates – assuring predictable cash flows. There isn’t anything wrong with a Ponzi scheme as long as your prediction of cash flows is correct. Governments can do that, private entities cannot.
Amardeep wrote: “and the whole, now deeply tarnished “India Shining†mythology.”
What has this got to do with anything? Scandals were a dime a dozen in the socialist days of yore. Sucheta Dalal waged a lone battle in the 1990s against the lack of transparency of government institutions such as the Unit Trust of India. If you think the private sector in India is bad, the public sector is a disaster.
Even in non-financial govt institutions, cronyism is rampant. In fact, in the 1980s, there was a cover story in the Illustrated Weekly of India on the Indian intelligence agency Research & Analysis Wing (RAW). They had named it the ‘Relatives and Associates Wing”. 🙂
Folks who request more regulation have no clue on how such things work in India. Additional regulations only end up lining the pockets of the regulators. They do not yield better governance.
The irony of the Satyam scandal is that the system worked. Back in the 70s and 80s, such scandals in family owned companies (especially the infamous marwari companies like the Birlas, Dalmias, Firodias, Bajaj et al) would have never have been uncovered.
Look on the bright side. People with last names that should be first names are known to do a a lot worse. James Earl Ray, Lee Harvey Oswald, Sirhan Sirhan, Anand Jon Alexander. What I’m really saying is someone better keep an eye on Elton John.
Just went back and reread the post. Not to correct Amardeep the English Prof, but didn’t you mean ‘perpetrated’? Or did you actually mean perpetuated, in asking how it lasted so long? Your post gives the impression that the fraud was over a three month period, but I thought it went on for longer, more like three years, based on a cursory reading of Raju’s letter.
24 · settuponnu said
wasn’t it owned my family members? it sounds like a financial arrangement to have separate entitites for some reason rather than anything else. or maybe a shared commitment to the satyam family / business.
Quizman,
You are absolutely right, this has nothing to do with India and happens all the time. Look at this list of scandals here between 2000-2002. There was a year when didn’t pay any taxes due to differences in tax and statutory accounting.
SOX and similar legistlation in other countries doesn’t solve the problem. Signing off on statements just means that management is responsible for management fraud. But doesn’t mean that external auditing firms are going to be better able to detect problems, especially when management is dishonest.
I find it ironic that the audting industry was finacially rewarded for its failures after Enron et al, as the costs of SOX implementation significantly increased the demand for their services.
Former Auditor,
never contended sox is a means to solve the problem, just trying to illustrate how there are means to shift the responsibility from the auditors to the management.
Debashis Basu co-wrote a terrific book on the Harshad Mehta scandal. He has a nice post about the Satyam scandal.
Read somewhere (Times of India?) that the revenue and profit inflation that Raju confesses to in his letter could actually be a cover up of something even worse. The 3% profits that he says was the true figure is too low for an IT co., according to IT experts and even Satyam employees.
I wonder how Reliance would stand up to close scrutiny?
31 should read, there was a year when reliance didn’t pay any taxes.
Glass house both reliance factions have friends in high places, Mukesh is close to the Gandhis and Anil to Mulayam and Amar Singh.
People often forget that in socialist India, the govt of India was often the majority shareholder in large companies. e.g. TISCO. They had a vested interest in keeping things under wraps.
Uber: Reliance is a strong case in point. For years, they not only managed to get over the regulatory framework, but also influenced policy making. This was during the license-raj era, wherein they gained traction with policies favoring them. You would have some inane line item in the budget about tax incentives provided for exporting (or setting up plants) of some arcane petrochemical. It was so blatant.
“tax incentives provided for exporting (or setting up plants) of some arcane petrochemical”
Ramalinga Raju Arrested (or he ‘surrendered’ to the DGP Andhra)
Looks like they’re effectively going to nationalize Satyam. Or it’s going to get ‘bailed out. 53,000 employees. Too Big to Fail. National Reputation. Not too different from what happens in the US!
Amardeep,
Thanks for posting about this topic. Many points to make, I’ll try to be breif:
2.External audits are not designed to identify misstatements where collusion is in place. I predict PWC will be exhonerated.
3.Many people external people have known about this. It just that enough people were benefitting, that they kept quiet.
4.Re: 3% profit in Satyam, once you bid on the contract at a competitive rate, and then hand out kickbacks to all of the people who got you in in the first place, there is no room left for profit. It’s a tough business. Also, Satyam’s “hosptality” doesn’t come free.
I’m sad for all of the 53,000 employees and thier families, thier maidservant’s, drivers, gardeners, nannies, and all of the other dependants who will be out of work, due to one man’s lack of courage and greed.
I’m sad for the people of Hyd and AP who used the example of RR as someone who had “made” it. It gave them the courage and confidence to think that they could too.
Umber desi, jyotsana, and Former PWC auditor, thanks for your comments. It’s increased my understanding of the scope, breadth, and magnitude of this scandal.
Oh yes one more thing:
scandalwatcher,
With regards to you point number 2, I agree but in this case based on the facts contained in Mr. Raju’s letter, I can’t understand how an auditor can miss such obvious indicators.
I believe foreign private issuers are required to file forms 20-f and 6-k with the SEC and have to comply with with some governance requirements of the stock exchange. Here is what I found on Satyam’s website where it compares the NYSE governance requirements to practices in place.
Truth is all profits of SATYAM were directed to MAYTAS in past 5-7 years..and MAYTAS is owned by Raju’s son..they own real estate etc.. now Satyam is going down… with all profits and assets… so is MAYTAS….but MAYTAS will still survive as it is separate entity… SEBI as well as Government will do the inquiry… But Raju is a smart guy … he has already planned everything…he already knew worst come worst he will go to jail as he already said in his letter only him and MD of company knew everything so rest of the family don’t have to face any criminal charges .. and SATYAM will be bankrupt but his family members will laugh there way to home… only employees will suffer.
Latest form 20-f
44 has it right. This story is as much about India’s real estate bubble as it is about accounting scandal. Perhaps satyam is lying again. Satyam siphoned off money from the company and invested in Maytas. There is no way Satyam would have 3% operating margin. With RE bust, the merger is an attempt at keeping the game going.
Maytas infra is a publicly listed company with seprate auditors one of the firms is Billimoria, which is large local firm with accounts including Tatas so for something like 44 to work, there have to be collusion amongst various levels.
sorry the auditors for maytas infra are batliboi and company.
not just this, satyam was recently dropped as a contractor by the world bank because their employees installed viruses and trojans on world bank computers during a project.
seems like a lovely company all around. as umber desi said, after enron, dynegy etc., cash flow auditing became much stricter, so it is really concerning that pwc let this slide and signed off on their earnings for many years, all over the world.
44 · Abhi (not the SM one) said
Great I am having getting lessons on financial wizardy-101…This above trick seems to be called feeder profits to divert your money just as feeder funds below…
While many other boutique brokerage firms sold out to larger firms, Madoff Securities stayed a family business. Madoff for years ran the firm with his brother Peter. More recently, much of the market-making division was headed by Madoff’s two sons, Andrew and Mark. In the 1990s, Madoff used his success as a market maker to help launch an asset-management firm. Madoff raised money for his fund by exploiting his social network, often courting investors at country clubs where he or family members belonged
27 · quizman said
yes, there is still the gaping hole of sahara, which came out of mysterious origins, and it seems equally mysterious what that group’s earnings are. and after a few flashy years with those amazingly grand weddings, subroto roy is much more reclusive these days – with some rumors of terminal illness, but that group seems like some sort of shell too.
53 · Jef Costello said
irony.
Did someone say Billimoria? SB Billimoria & Co., is India’s oldest indigenous accounting firm, and celebrated its 100th anniversary last year. It is a very difficult firm to work with and believes that it owes its clients nothing more than a timely audit report. The firm has a long record of qualifying accounts and walking away from clients with questionable practices. Debashis Basu is a Chartered Accountant himself and has spent almost his entire career as a business journalist. Also note the scandalous preferential allotment that Satyam made in 2000 to a member of the family when it acquired a group company. This too has a shady precedent, when during Narasimha Rao’s premiership, his finance minister, one Manmohan Singh, did nothing when a number of foreign owned companies made a preferential allotment to their foriegn principals. Then, the government repealed a 1977 law termed the FERA, that limited foreign ownership in public listed companies to 40%. Following the repeal of FERA foreign principals scrambled to increase their stake in their Indian subsidiaries, and finding the shares valued too high, made preferential allotments at throw away prices. After a lot of noise nothing much happened. And then promptly a number of Indian promoters followed suit!
53 · Jef Costello said
I think he refers to the family’s philanthropic foundation: http://www.byrrajufoundation.org/
I had an opportunity to visit the sprawling and very impressive foundation last summer – a real tragedy if all that has to be wrapped up.