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This Briefing Paper will provide an analysis of the Indian accounting scandal that analysts have called "India's Enron." Section I of the paper will provide a corporate history of Satyam. Section II will provide insight into how the $2.7 billion scandal evaded regulators, investors, and the board of directors. This Section will also provide a discussion of who was responsible for the fraud along with corporate structural issues in India that create unique obstacles to Indian corporate governance. Section III explains the scandal's effect in India and the implications for dealing with future obstacles. Finally, Section IV discusses regulatory reform following Satyam and the current status of Indian securities markets. The Satyam scandal highlights the importance of securities laws and corporate governance in emerging markets. Mounting evidence suggests that weak corporate governance slows economic development. The Satyam scandal provides insight into the problems that emerging markets face when they transition from locally controlled corporations to globally traded corporations. There is a broad consensus that emerging market countries must strive to create a regulatory environment in their securities markets that fosters effective corporate governance. India has managed its transition into a global economy well, and although it suffers from corporate governance issues, it is not alone as both developed countries and emerging countries experience accounting and corporate governance scandals.
A. History of Satyam
In 1987, B. Ramalinga Raju ("Mr. Raju") formed Satyam in Hyderabad, India with fewer than 20 employees. Ironically, Satyam means "truth" in the ancient Indian language Sanskrit. The company specializes in information technology, business services, computer software, and is a leading outsourcing company in India. Satyam immediately experienced success after it issued an initial public offering on the Bombay Stock Exchange in 1991. The company grew quickly during the 1990s and 2000s as more and more companies around the world looked to India for outsourcing solutions. It eventually became the fourth largest outsourcing company in India. Satyam provides solutions to approximately 185 Fortune 500 companies throughout the world. The business community recognized Satyam as a global leader in information technology outsourcing. At the peak of its business, Satyam employed nearly 50,000 employees and operated in 67 countries. Satyam was as an example of India's growing success. Satyam won numerous awards for innovation, governance, and corporate accountability. In 2007, Ernst & Young awarded Mr. Raju with the Entrepreneur of the Year award. On April 14, 2008, Satyam won awards from MZ Consult's for being a leader in India in corporate governance and accountability. Satyam's CFO issued a press release noting the award and stating, "These awards recognize this commitment to keeping the market and our investors informed, having our financial information be clearly and easily understood by stakeholders, and complying with increasingly strict regulatory environments." "Additionally, our high rankings show that we are committed to being a responsible corporate citizen that leverages best practices wherever possible." In September 2008, the World Council for Corporate Governance awarded Satyam with the "Global Peacock Award" for global excellence in corporate accountability. Unfortunately, less than five months after winning the Global Peacock Award, Satyam became the centerpiece of a massive accounting fraud.
B. Fraud Is Uncovered
The discussion below will first show how problems started to appear and how the CEO eventually disclosed the fraud. The discussion will also identify the roles that various parties had in the fraud.
the economic crisis. In October 2008, Satyam reported net income of $132.3 million, an increase of 28 percent from the same quarter the previous year. Saytam asserted that, despite the challenging environment, it continued to find opportunities for growth. The first crack in the company's reputation occurred during October, when the World Bank fired Satyam and issued an eight-year ban against the company. The World Bank accused Satyam of installing spy systems on its computers and stealing assets from the World Bank. In addition, during an October conference call reporting earnings, one stock analyst drew attention to large cash balances in non-interest bearing bank accounts. The analyst expressed concern about the large balances and expressed reservations about the accuracy of the numbers. Investors ignored the analyst's comment and the stock price rose with the reports of positive earnings and revenue growth. In December 2008, Satyam's Board of Directors unanimously approved the purchase of Maytas Properties and Maytas Infrastructure, two companies unrelated to the information technology field. At the time, Mr. Raju stated that he and the Board anticipated that the market would "be delighted" by the two transactions as it would provide Satyam with greater diversification. However, investors were outraged over the transactions because Mr. Raju's family held a larger stake in Maytas Properties and Maytas Infrastructure than it did in Satyam. Shareholders viewed the transactions as an attempt to siphon money out of Satyam into the hands of the Raju family. Satyam quickly aborted the transactions, but the incident still caused significant damage to Satyam's reputation as a well-managed company. After the incident, chaos ensued. Analysts immediately soured on the company and put sell recommendations on its stock. Satyam's shares dropped nearly 10 percent and four of the five independent directors resigned. On December 30, analysts with Forrester Research advised clients to stop doing business with Satyam because of the fear of widespread fraud. Satyam hired Merrill Lynch to advise it on ways to increase shareholder value. By January 5, 2009, rumors circulated about several potential mergers between Satyam and competitors. On January 7, just hours before Mr. Raju disclosed the fraud, Merrill Lynch sent a letter to the stock exchange indicating that it was withdrawing from its engagement with Satyam because during the course of its representation it learned of material accounting irregularities. The Board called an emergency meeting for January 10 to address the company's rapidly deteriorating reputation.
3. Responsible Parties
Mr. Raju was the primary individual responsible for the fraud. Indian authorities accused Mr. Raju, and subsidiary players such as the CFO, a managing director, the company's global head of internal audit, and Mr. Raju's brother, with responsibility for the fraud and filed charges against them. Additionally, Satyam's auditors and Board of Directors bear some responsibility for the fraud because of their failure to detect it. Finally, the ownership structure of Indian businesses contributed to the Satyam scandal. a. Mr. Raju and Company Insiders' Role Mr. Raju claimed that he overstated assets on Satyam's balance sheet by $1.47 billion. Nearly $1.04 billion in bank loans and cash that the company claimed to own was nonexistent. Satyam also underreported liabilities on its balance sheet. Satyam overstated income nearly every quarter over the course of several years in order to meet analyst expectations. For example, the results announced on October 17, 2009 overstated quarterly revenues by 75 percent and profits by 97 percent. Mr. Raju and the company's global head of internal audit used a number of different techniques to perpetrate the fraud. Using his personal computer, Mr. Raju created numerous bank statements to advance the fraud. Mr. Raju falsified the bank accounts to inflate the balance sheet with balances that did not exist. He inflated the income statement by claiming interest income from the fake bank accounts. Mr. Raju also revealed that he created 6,000 fake salary accounts over the past few years
and appropriated the money after the company deposited it. The company's global head of internal audit created fake customer identities and generated fake invoices against their names to inflate revenue. The global head of internal audit also forged board resolutions and illegally obtained loans for the company. It also appeared that the cash that the company raised through American Depository Receipts ("ADRs")[1] in the United States never made it to the balance sheets. Mr. Raju initially asserted that he did not divert any of the money to his personal accounts and that the company was not as profitable as it had reported; however, during later interrogations, Mr. Raju revealed that he had diverted a large amount of cash to other firms that he owned and that he had been doing this since 2004. Mr. Raju also initially asserted that he acted alone in perpetrating the fraud. However, as noted above, Indian authorities also charged Mr. Raju's brother, the company's CFO, the company's global head of internal audit and one of the company's managing directors. b. Auditors Role Global auditing firm Price Waterhouse Coopers ("PWC") audited Satyam's books from June 2000 until the discovery of the fraud. Several commentators criticized PWC harshly for failing to detect the fraud. PWC signed Satyam's financial statements and was responsible for the numbers under Indian law. One particularly troubling item concerned the $1.04 billion that Satyam claimed to have on its balance sheet in non-interest bearing deposits. According to accounting professionals, a reasonable company would have either invested the money into an interest bearing account or returned the excess cash to the shareholders. The large amount of cash thus should have been a red flag for the auditors that further verification and testing was necessary. Furthermore, it appears that the auditors did not independently verify with the banks in which Satyam claimed to have deposits. Additionally, the fraud went on for a number of years and involved both the manipulation of balance sheets and income statements. Whenever Satyam needed more income to meet analyst estimates, it simply created fictitious sources and it did so numerous times without the auditors ever discovering the fraud. Suspiciously, Satyam also paid PWC twice what other firms would charge for the audit, which raises questions about whether PWC was complicit in the fraud. Furthermore, PWC audited the company for nearly 9 years and did not uncover the fraud, whereas Merrill Lynch discovered the fraud as part of its due diligence in merely 10 days. Missing these red flags implied either that the auditors were grossly inept or in collusion with the company in committing the fraud. PWC initially asserted that it performed all of the company's audits in accordance with applicable auditing standards. c. Board of Directors Role Satyam's Board of Directors consisted of nine members. Five members of the Board were independent as required by Indian listing standards. In its regulatory filings with the SEC, Saytam revealed that it did not have a financial expert on the board during 2008. Further concerns later developed surrounding the Board of Directors lack of independence. The Board contained several prominent figures in the business world, a fact that likely contributed to the lack of scrutiny that Satyam received. Members of the Board included Krishna Palepu who is a Harvard Professor and corporate governance expert, Rommohan Rao, the Dean of the Indian School of Business, and Vinod Dham, coinventor of the Pentium Processor. The Board first came under fire on December 16, 2008 when it approved Satyam's purchase of real estate companies in which Mr. Raju owned a large stake. The Board rescinded the approval after shareholders led a revolt of the deal. Krishna Palepu, Rommohan Rao, and Vinod Dham all resigned from the Board within two days of the rescission of the transaction. The botched transaction provided the investors with the impression that the Board was not actively monitoring Satyam. Furthermore, the Board should have caught some of the same red flags that the auditor, PWC, missed. Additionally, the Board of Directors should have been concerned with the knowledge that Mr. Raju decreased his holdings of Satyam significantly over the three years leading up the disclosure of the fraud. Mr. Raju's holdings fell from 15.67 percent in 2005-2006 to 2.3 percent in 2009.
C. Aftermath
The Indian stock market fell dramatically upon the disclosure of the Satyam scandal. Indian authorities quickly started an investigation and pursued criminal actions that ensnarled Satyam's executives, auditors, and Indian politicians. Satyam successfully emerged from the crisis through an asset sale during the spring of 2009. The authorities' swift actions also restored confidence in the Indian securities markets.
3. Satyam Post-Crisis
Immediately after Mr. Raju's revelation of the fraud, new board members were appointed and started working towards a solution that would prevent the total collapse of the firm. Indian officials acted quickly to try to save Satyam from the same fate that met Enron and WorldCom when they experienced large accounting scandals. Both Enron and WorldCom filed for bankruptcycreating a large upheaval in the capital markets, as well as an increase in unemployment as the employees working at those firms lost their jobs. The Indian government immediately started an investigation while at the same time limiting its direct participation with Satyam because it did not want to appear like it was responsible for the fraud or attempting to cover up the fraud. The government appointed a new board of directors for Satyam to try to save the company. The Board's goal was to sell the company within 100 days. To devise a plan of sale, the board met with bankers, accountants, lawyers, and government officials immediately. It worked diligently to bring stability and confidence back to the company to ensure the sale of the company within the 100-day time frame. To accomplish the sale, the board hired Goldman Sachs and Avendus Capital and charged them with selling the company in the shortest time possible. By mid-March, several major players in the IT field had gained enough confidence in Satyam's operations to participate in an auction process for Satyam. The Securities and Exchange Board of India ("SEBI") appointed a retired Supreme Court Justice, Justice Bharucha, to oversee the process and instill confidence in the transaction. Several companies bid on Satyam on April 13, 2009. The winning bidder, Tech Mahindra, bought Satyam for $1.13 per shareless than a third of its stock market value before Mr. Raju revealed the fraudand salvaged its operations. The acquisition has experienced a few problems. On November 26, 2009, shares tumbled 10 percent amid further revelations that the fraud was almost $1 billion larger than initially thought. Furthermore, the Indian courts brought criminal charges against one of the investigators for accepting a bribe related to the investigation, calling into question whether further investigations were necessary. Both Tech Mahindra and the SEBI are now fully aware of the full extent of the fraud and India will not pursue further investigations. The stock has again stabilized from its fall on November 26, 2009 and, as part of Tech Mahindra, Saytam is once again on its way toward a bright future.
1. Governance Reform
The Satyam scandal reinforced the Indian regulators' commitment to continue the process of corporate governance reform. Even before the Satyam scandal broke, India was in the process of updating its 1956 Companies Act, which sets out key Indian corporate governance rules.
E. Conclusion
In the aftermath of Satyam, India's markets recovered and Satyam now lives on. Tech Mahindra purchased 51 percent of Satyam on April 16, 2009, successfully saving the firm from a complete collapse. With the right changes, India can minimize the rate and size of accounting fraud in the Indian capital markets.