The
fraud at Satyam may well turn out to be the biggest
of all scams unearthed from the interior of corporate
India. As evidence and speculative narratives from the
ongoing investigations are selectively leaked to the
media, it is clear that there is no single Satyam story.
Through multiple routes involving a large number of
related companies and myriad transactions, the promoters
of Satyam Computer Services, led by the company's Chairman
Ramalinga Raju, are alleged to have siphoned out a huge
quantity of money from the firm. To cover that up, the
accounts were manipulated and documents were forged
to declare nonexistent cash reserves and understate
liabilities.
The money that was taken out may have been used, among
other things, to acquire large quantities of land in
what seems to be a set of speculative real estate ventures
that could enrich the family. The Maytas companies that
had titles that spelt Satyam in reverse were important
conduits in this process, but there were clearly many
more. According to reports, the Registrar of Companies
has found that ''Satyam's annual report reveals several
transactions with subsidiaries and other group companies
by way of investments, purchase of assets and other
receivables'' that point to the concealed transfer of
funds out of the company.
Shockingly, one of the allegations made by the Crime
Investigation Department (CID) of Andhra Pradesh is
that the company had only 40,000 employees on its rolls
as compared with the 53,000 claimed by it and the remaining
13,000 were mere fake salary accounts through which
as much as Rs. 20 crore a month were taken out of the
company over a period of five years. If true, this involves
descent to a level of manipulation and fraud that could
make the story much bigger than it already is.
There are reasons to believe that there is indeed much
more to be revealed, as the effort at separating truth
from lies proceeds. To start with, it now does appear
that the ''confession'' by Ramalinga Raju was aimed
at concealing more than it revealed. In particular,
two claims of the Chairman are now suspect. One is that
the process that led up to the claimed Rs. 7,000 crore-plus
hole in the company's balance sheet was the result of
an unmanageable cumulative process that was triggered
by a small (even if unwarranted) manipulation of the
accounts many years back. This, according to the Chairman
put him in a position where he was ''riding a tiger''.
However, if the information being yielded by the ongoing
investigations is indeed true, it was not a small error
but a planned, audacious and outrageous scam, which
was expanded in scale over time, that led to the company's
near collapse.
The other claim of the Chairman that is obviously untrue
is that neither he ''nor the Managing Director (including
our spouses) sold any shares in the last eight years
- excepting for a small proportion declared and sold
for philanthropic purposes.'' The truth is that the
stake of the promoters has fallen sharply after 2001
when they reportedly held 25.60 per cent of equity in
the company. This fell to 22.26 per cent by the end
of March, 2002, 20.74 per cent in 2003, 17.35 per cent
in 2004, 15.67 per cent in 2005, 14.02 per cent in 2006,
8.79 in 2007, 8.65 at the end of September 2008 and
5.13 per cent in January 2009. While the last of these
declines was due to sales by lenders with whom the promoters'
shares were pledged, earlier declines were partly the
result of sale of shares by promoters. The promoters
are estimated to have sold around four-and- a-half crore
shares in the company over a seven-year period starting
September 2001. It has been alleged that the company's
accounts were manipulated to inflate share values, so
that these sales of shares would have delivered large
receipts to the promoters. According to one estimate,
the promoters could have earned as much as Rs. 2500
crore through the stake sale. Thus, Raju's confession
clearly sought to conceal the dimensions of the scam.
Raju's confession is also suspect because it seems to
substantially understate the actual profit-making capacity
of the company. He claims that the huge difference between
actual and reported profits in the second quarter of
2008-09 was because the ratio of operating margins to
revenues was just 3 per cent rather than the reported
24 per cent. But even if Satyam Computer Services was
cooking its books, it was engaged in activities similar
to that undertaken by other similarly placed IT or ITeS
companies and it too had a fair share of Fortune 500
companies on its client list. It is known that many
of these companies have been showing operating margins
that are closer to the 24 per cent reported by Satyam
than the 3 per cent revealed in Raju;s confession. Thus
in financial year ending March 2008, the ratio of profits
before tax of Infosys was 32.3 per cent of its total
income, that of TCS 23.1 per cent, of Satyam 27.8 per
cent and that of Wipro 19.2 per cent. This suggests
that either Raju is exaggerating the hole in his balance
sheet or that other firms in the industry are also inflating
their revenues and profits. While the Satyam episode
indicates that the latter possibility cannot be ruled
out altogether without an investigation, the difference
between 24 per cent and 3 per cent seems too large to
be the industry standard. It appears that the company's
potential is being discounted to make the scam seem
smaller than it is likely to have been.
A third reason why the investigations may reveal the
Satyam scam to be even bigger than it now seems is the
initial reticence on the part of the industry, government,
politicians and sections of the media to believe that
this was a scam of the kind and of the magnitude that
it now appears to be did slow the proceedings. This
reticence was implicitly justified with the argument
that ''one bad apple'' should not be allowed to affect
the credibility of the industry as a whole. Protecting
the industry's reputation and preempting demands for
greater regulation and state intervention were visible
motivations. It must be recalled, that the spate of
financial scams in the US involving firms like Enron
and WorldCom led to the Sarbanes-Oxley Act which set
new norms and standards for all U.S. public company
boards, management, and public accounting firms, with
stringent penalties in case of violations. This was
what most did not and do not want for the IT industry,
which explains the reticence noted above. Satyam Computer
Services was ranked number four among companies in an
industry that has come to epitomise India's post-liberalisation
success and has been uncritically celebrated by the
government, sections of the media and part of the vocal
elite. It was an industry that was often presented as
one that adheres to modern best practices with regard
to governance, accounting and disclosure and includes
firms (like Satyam) and individuals that had received
awards for entrepreneurship and good governance. A leading
player in that industry could not be easily recognised
as having been involved in massive financial fraud,
without triggering demands for regulatory rethink.
Moreover, this is an industry which has not only received
tax and other concessions from the government but built
close relationships with politicians and successive
governments, which bestowed recognition and access to
leading actors of a kind that was not afforded to successful
industrialists in the past. There is therefore an element
of complicity of the state in the acts of the industry,
which can be justified when the industry delivers growth
and employment but is an embarrassment when events such
as the Satyam fraud occur. This seems to have resulted
in a lack of alacrity on the part of state- and central-level
investigation and regulatory agencies to set about the
task of unravelling the scam.
But given the scale of the scam at Satyam, what is surprising
is that the transactions did not raise suspicion much
earlier. This does suggest that the system of corporate
governance that has been in place after liberalization
does not work. It should be obvious that in a private
enterprise system filled with joint stock companies,
there could emerge a difference in the interests of
the managers or managing promoters, on the one hand,
and shareholders and other stakeholders on the other.
In the event, there is the danger that managers and/or
promoters may function in ways that financially benefit
them at the expense of the returns earned by the shareholders
or the security of other stakeholders.
Governance structures are meant to prevent this. One
way in which this is done is through the capital market
which is seen as a monitoring and disciplining mechanism
because it serves as a market for corporate control.
Bad managements trigger stock price declines leading
to their replacement due to pressure from existing shareholders
or from new shareholders who exploit the lower share
values to acquire an influential stake in the company.
In practice, this kind of monitoring rarely works either
because incumbent managements reveal partial or incomplete
information or because minority shareholders would find
it difficult and costly to fully monitor and discipline
managers who put the company's revenues and profits
at risk.
Moreover, shareholders are beguiled by high stock prices,
since they buy into the idea that high and rising stock
prices are a sign of both good performance and good
management. If accounts are manipulated and revenues
and profits inflated, the stock market performance of
the company improves, and that improvement serves to
conceal the fraud that is under way.
Advocates of regulatory forbearance under a reformed
and liberalised capitalism argue, however, that the
system has fashioned a governance structure that is
explicitly aimed at ensuring compliance and disclosure.
That structure is multilayered, consisting of boards
of directors which include independent directors expected
to represent the interests of the minority shareholders
and society at large, auditors who are expected to ensure
that the books which provide the information on the
performance of the managers and the financial health
of the company are in order, regulators who ensure that
guidelines with regard to accounting standards, disclosure
and good management practices are followed and agencies
that can investigate and prosecute in case fraud of
any kind is suspected. This combined with international
accounting standards and disclosure norms that are ostensibly
followed by IT companies (since they serve international
clients and are listed in international markets) was
seen as insuring against fraud.
What has shocked observers is that the decision of the
promoters of Satyam Computer Services to manipulate
accounts, defrauding its investors in the process, was
neither sensed nor detected at all of levels of governance.
There are a number of factors that seem to underlie
this overall failure. To start with there was total
failure at the level of the board and the auditors.
This huge fraud which occurred over many years and ostensibly
left a hole of more than Rs. 7,000 crore was completely
missed by a high profile board, which even agreed to
allow the promoters to use its non-existent reserves
to buy up two unrelated companies in which the promoters
have a major stake. The board included independent directors
who are respectable professionals and academics. In
addition, the firm's auditors, PwC, one of the big four,
failed to detect manipulation of this magnitude, despite
the fact that it included claims of huge cash reserves
that did not exist. As many have rightly argued, even
a minimum of diligence would have proved this claim
regarding reserves to be false leading to a detection
of the scam.
The question that arises is whether self-regulation
failed because these individuals and entities were paid
by the company to undertake their role. A similar issue
came up after the sub-prime mortgage crisis when observers
asked whether the fact that the rating agencies such
as Moody's and Standard and Poor, which were to serve
as monitors of risk, discounted risk and gave high ratings
because they were paid by the firms whose securities
they rated. According to reports, independent directors
in Satyam Computer Services were being paid huge fees
for their professional services, varying from Rs. 12.4
lakh to Rs. 99.48 lakh in 2006-07, in the form of commission,
sitting fees and professional fees (''Satyam directors'
remuneration'', Business Line 30 December, 2008). This
gives rise to the criticism that the practice of managements
paying independent directors (and paying them well)
could lead them to take a soft view of matters and not
take their monitoring and correcting role seriously.
Further, lack of adequate caps on revenues obtained
by auditors from their clients also creates a problem.
The search for large fee incomes and competition between
auditors to increase market share, does encourage auditors
to take the claims of their large clients and the documents
they produce at face value, dropping the minimal checks
which would possibly have revealed the Satyam fraud.
Here again the fact that the monitor is paid by the
monitored seems to be a major source of the problem.
In the event the system of self-regulation designed
by the ''reformers'', on the grounds that bureaucratic
intervention is inimical to innovation and ''efficiency'',
ceases to work. That system operates with the belief
that boards, auditors, shareholders and norms and guidelines
are enough to ensure that managements adopt good practices,
and regulators should come in principally when fraud
is detected, to investigate and penalize so as to set
an example. Experience across the world has shown that
such optimism is not warranted.
Thus, the Satyam episode is not just the result of individual
greed. It is also the product of the celebration of
profit making irrespective of magnitude, of the belief
in markets and the discipline they impose, and of regulatory
dilution and regulatory failure. It is this which raises
the possibility that Satyam may not be an isolated bad
apple, but an instance of something that could recur.
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