Satyam Fraud; Failure Of Corporate Governance

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ATYAM FRAUD; A FAILURE OF CORPORATE GOVERNANCE OM PRAKASH YADAV

MONOLITH STATUE OF BUDHA AT HYDERABAD, THE HQ OF SATYAM

Satyam

fraud is unfolding and so are the inherent weaknesses of Corporate Governance in India. Ramalinga Raju, once a posture boy of India’s growing software sector who could find a seat beside Bill Clinton 1

on the dais, has become a villain in the corporate world for valid reasons. His emotionally charged four and half page letter of startling revelations shook the entire corporate world when he admitted of cooking the account and inflating the figure by Rupees 5040 crores. He committed this fraud and tried to hush up it by an abortive bid to purchase Maytas infra, a company created by him and run by his son Teja Raju. The move was opposed by some of the directors and thus last attempt of Raju to cover up the scam was thwarted. This is the story in brief which all of us know. This scam is being equated with Enron of USA because here also the scam was orchestrated by its Auditor, Arthur Anderson, in Satyam, Price Waterhouse cooper. WHY DID RAJU UNFOLD THE SCAM HIMSELFThere are two sets of serious questions which still desperately require answers. Why did Raju, the mastermind of the entire fraud, accept the guilt? Why did he choose to surrender before Police and not run away from India, which he could have easily done? Why was this fudging done and for what? Secondly, what were regulators and watch dogs like SEBI, ICAI, and independent directors doing? The question remained unanswered that whether this fraud shook the conscience of Raju and he unravelled the truth out of sagacity, or he was simply unable to hush up the matter which was increasing day by day assuming insurmountable proportions? 2

No, simply not. It was a well calculated, well strategized blended with legal opinion and well thought move to unfold the story and surrender before the police. Mahabharata, the Great War was caused due to Dhritarastra’s obsession for his son Duryodhana. The lust of kingdom and its geographical expansion had led many wars across the world. Like many fathers, Raju too wanted to create two separate empires for his sons, Teja Raju and Rama Raju jr. He subsequently formed Maytas infra and Maytas info for Teja and Rama respectively. By the end of the 20th century, Satyam computers had made a name for itself on the globe and had emerged as the 4th largest software in the country. The meteoric rise of the company can be substantiated by the fact that it was established in 1987 as private company and got listed by BSE in 1991. In 2001 its share was listed in NYSE and in 2004 it made its place in European stock market. According to company’s statement, its revenue exceeds to 2 bn USD in 2008. Similarly Raju’s son’s companies also were moving with leaps and bound. Maytas infra got the ambitious Metro projects and bagged many tenders including one of construction of Technology Park. It is in this perspective, the question that everyone is willing to ask is that when everything was fit and fine then why did Raju fudge the account of the company and commit countries biggest fraud. The fudging of account had started when the Maytas were formed. Raju started diverting the cash from 3

Satyam into Maytas and many other companies which he had formed either in his own name or benami like Godavari bio, Godavari agro etc. In fact such practices are very common and prevalent in many Indian companies and it would not be a matter of surprise it similar frauds are unravelled more in future. They do it for simple reasons, to help establish their kiths and kin. This ‘drain of wealth theory’ is substantiated by the fact that the share of Promoters in the company which was 25.6% in 2001, diminished to 3.6% in January, 2009. Similarly by 2008 Raju had pledged almost all his shares and had thus siphoned off most of his shares. In fact according to information retrieved from NSE, not only Raju but CFO V.Srinivas, A.S.Murthy, V. Murli etc has sold shares of 3,6500, 3,14,000, 1,83,000 respectively. Raju inflated the account for increasing the price of shares so that he and his accomplices get maximum profits, in which he succeeded also. The day this news broke, the Satyam’s share was soaring. He wanted to hush up the matter in December, 2008, when he made a desperate but unsuccessful bid to purchase his son’s Maytas. It was vehemently opposed by one of the independent directors Mangalam Srinivas, he subsequently resigned. Thus the entire game plan of Raju was shattered. He, by now had come to know that he is not going to succeed in his plan. He therefore, wrote an emotional letter and confessed him fraud. How did he do it? - As per the accounting practise, the Bank accounts are presented before the Auditors of the company by the CFO after its verification. It seems that the fraud was initially connived by Raju and CFO 4

vadalamani srinivas. Later this nexus might have widened after possible inclusion of auditors and the Bankers. The continuous inflating and cooking of accounts, that too on such a big scale was going unnoticed and unchecked by the auditors and the Bankers sounds absurd, therefore, the possibility of a connivance of bankers and the auditors cannot be ruled out. CID has claimed that Raju had inflated the numbers of the employees also, if it goes true, the involvement of Banks would be proved beyond a shadow of doubt. WHY DID RAJU SURRENDER AND NOT ESCAPE?- a very pertinent question arises but surprisingly a very few is asking as to if Raju was aware of the magnitude of his crime as well as quantum of its punishment then why did he not escape and choose to surrender before the police. Reasons are not far to search. The crime he has committed would attract sections 406,409,420,465,471, etc of IPC and section 628 of Company Act, 1956 and can undergo imprisonment up to more than 7 years. He was fully aware of it but at the same time he also knew that he would be sued in USA under provisions of Security and Exchange Commission Regulation rule 10-5 B. These suits are called Class law suits and the compensation awarded under this is huge. Raju knew it and thought that his entire earnings and his family would be taken away and would be left with naught. One the other hand, he fully understood the loopholes in the Indian Criminal Justice system which hardly punishes white collar criminals. Ketan Parikh 5

scam still is sub-Judice and is expected to go years and years. It is this scam which ruined hundreds of Cooperative Banks across Nation and plummeted Unit64 a popular mutual fund scheme of the UTI, India’s largest mutual fund company. Harshad Mehta died without being finally convicted. Global trust Bank scam is still under the labyrinth of law. Examples are many, results are same. He therefore preferred to surrender than to face class law suits in USA. IS CORPORATE GOVERNANCE IN INDIA NOT WORLD CLASS? - Interestingly Satyam has bagged Golden Peacock award for best corporate governance by World Council for Corporate Governance only a few years ago. The scam has raised many doubts about the class of corporate governance in India. While speaking at a seminar on corporate governance organised by CII, Ministry of Company affairs and National foundation of corporate governance, C.B.Bhave, the chairman of SEBI said on 6th February, 2009 that the corporate governance is an ongoing process. There is a retrospection everywhere that some concrete steps with respect to it should be done. There are few importance elements of corporate governance namely Auditing, Independent Directors, Regulators and Finally the Board including CEO itself. If we examine these constituents one by one, it would be crystal clear that all the constituents either failed or did not act as was required. The role of Price waterhouse Coopers(PwC), the Auditing firm of Satyam has been dealt. Institute of Chartered Accountants of India (ICAI) constituted under 6

Charter Accountants Act, 1949 is the regulatory body of all the accounting and auditing firms across the countries. According to a report there is acute shortage of qualified chartered accountants and auditors in India and around the world also. The number of CAs passing every year is hopelessly small. It is apprehended therefore that the auditing firms out source unqualified or semi-qualified commerce graduates of Post graduates to do the auditing in the companies. The prestigious firms get the assignment by virtue of their name and fame which they recklessly sell in the market by out sourcing the auditors at a very low remuneration. In case of Satyam, the man who was supposed to do audit was incidentally executive member in ICAI. In a startling revelation, the auditors say that they approved the accounts because of Raju’s ‘towering presence’ suggests how ridiculously the auditing was being done. Thus if Scam occurred, the onus would undoubtedly go on the firm. The kind of attitude which is adopted here in India in doing auditing is certainly not in congruent with the standard of world class corporate governance.In fact if we look at the functioning of institutions like ICAI, we would come to know that they are in a way hijacked by a group of people. They have the vast statutory powers but without any responsibilities. Over a period of time so many extra constitutional authorities have come up in India and have taken up the State’s role and act as per their own framed regulations. This needs to be changed. This is the need of hour. Secondly, the independent directors have also failed to discharge their duties properly. Section 49 of SEBI Act and section 229 A of Company Act, 1956 7

provides for appointment of Independent Directors in the Companies for protecting the rights of public at large in general and shareholders in particular. In the case of satyam T.R.Prasad, the retired Cabinet Secretary Govt of India was one of the directors. It speaks a lot about the procedure of appointment of independent directors. What kinds of people are being appointed in the company? Moreover, they are appointed by the Companies themselves and pay hefty salaries and perks for virtually doing nothing. Under this circumstance is it thinkable that these Independent directors would dare to peep into the affairs of the company against the wishes of the CEOs? There are only two possibilities in Satyam with respect to Independent directors. Either they connive with Raju and knew everything that was going on, or they did not know. In both the cases they failed miserably to discharge their duties. What is the need of such Independent Directors if they cannot do anything in this matter? One unpalatable justification is given that the Independent Directors participate in the meeting and are not concerned with autonomy of the company. It should be bone in mind the Enron scam was exposed by Sherron Watkins, a women independent director. Thirdly, the SEBI and Ministry of Company Affairs too have failed in their assigned jobs. SEBI is the highest regulator and keeps eagle eye on the activities of the capital markets. When the profits of this company were registering abnormal growth, thereby the prices of the shares were soaring, what were these guys doing? There has been a lot of hue and cry with respect to insider trading; a howl SEBI failed to listen to and it inflicted heavily on Satyam. Raju had pledged almost all his shares so did many of the promoters. The newly appointed CEO Murthy is also said to have sold about 8

3.14 lakhs shares including 40,000 in December itself belonging to him and his family members. These are the insider trading. Although insider trading per se is not illegal but it is unethical, moreover when Company’s high official who were on share selling spree must had the idea of what was going in the company. All such transactions are needed to be probed. As a matter of fact the tax holidays for the IT-BPO companies also needs to be said goodbye. Had Raju to pay the I.Tax according to the profits shown in the accounts, he would not have fudged it to this scale. The ministry of Finance must deliberate upon the entire gamut of issues related to tax heaven provisions. INVESTIGATIONS, THE TASK AHEAD- the breaking of news lead to reflexes in all the concerned, the SEBI, ROC, State government and above all MOC. The Ministry of Company Affairs (MOC) came into action and asked ROC in Hyderabad to conduct preliminary inquiry. SEBI and state govt all jumped in the fray. The state govt ordered CB CID inquiry and filed an FIR against Raju and others by themselves as no one came to file a formal complaint against this fraud. After receiving the inquiry report from ROC, MOC order inquiry by Serious Fraud Investigation Office (SFIO). Raju was remanded to judicial custody in Chachalguda Jail and formal inquiry set in. INQUIRY BY CID-CID made some commendable headway and arrested CFO and others. They made a startling revelation by saying that Raju had about 13000 ghost employees and had been drawing their salaries for years. If it is true, the involvement of Banks in the entire gamut of scam is beyond any doubt. It has also identified many Bank accounts of Raju as well as CFO and other accused. Large amount of wealth in terms of Bank account, real estates, false companies 9

etc have been traced. The investigation is still going on. Well the investigation is limited to the provisions of IPC only. The CID must also look into the possible nexus of Raju and politicians and bureaucrats, because the kind of meteoric rise that Maytas made smacks of existence of such nexus. The bagging of Metro project by Maytas infra must be brought to the ambit of investigation because this project was awarded to Maytas in spite of Sreedharan’s opposition, a man of impeccable reputation and whose knowledge about Metro is simply unparallel. SFIO AND SEBI- both of them have started the probe in their own style. The SFIO has later been asked to cover as many as 325 public and private sector companies and 25 individuals under its enquiry by the MOC. SFIO have seized some computers, documents and software of the company in order to find out the roots of the scam. But due to the widening of its inquiry, the result of this, probe is likely to be delayed by few more months. Till date SFIO has not been able to procure remand from the court to grill Raju. SEBI on the other hand has come out with a series of new and so called stiffer guidelines for the listed companies. The promoters will have to inform to it and the share market within 7 days about its pledging of shares. Strict vigil is sought to be kept to check inside trading. But it seems that still it has not understood the symptom of the disease. Experts in this field enlist symptoms and prescribe prescriptions. There is, of course, no denying the fact that prescription in retrospection is easy, but at the same time ‘prevention is better than cure’. It is said that if a company suddenly changes the field and diversify in a completely different are; it is harbinger of tragedy, as it 10

happened in Satyam. No one could foresee that why a premiere software company started diversification in real estate (Maytas infra is a real estate company). Similarly, when a company’s growth is meteoric in terms of profits, it should smell some rat. This is done in order to increase the value of share and once it is achieved, the inside trading takes place. SEBI has rightly formulated that peers accounting shall be done, it would minimise the chances of fudging the accounts. SEBI must concentrate on the modalities of this scam so that the offenders are brought to book and at the same time corrective measures are taken. Many experts suggest that if there is a sudden spurt in insider trading in any company, the regulator should sound alarm bell. In this case the SEBI failed to discharge this job and could not trace when it was going in Satyam. PROBLEMS IN INVESTIGATION AND COVICTIONThe inquiry and investigation are being conducted by a number of agencies; it therefore, is always a possibility of conflicting and intermingling of actions. To avoid this there is need to evolve a mechanism so that a more coordinated and concerted actions are taken and this investigation reaches to a logical conclusion. With respect to the preparation and submission of charge sheet against the culprits including Raju u/s 173 of CrPC, utmost caution is required to be taken. We should not forget that Raju has amassed huge wealth through this scam and the investigating agencies have so far been unable to unearth his treasures. He is capable of hiring the best legal brains available in the world that can tatter the prosecution’s case due to a slightest loop holes. 11

The simplest theory in the criminal justice system is that the crimes including white collar crimes are inherent part of the society, but the quantum of punishments and pace of dispensation of justice are very important and serves as deterrents. USA enacted SARBANES OXLEY ACT, 2002, one of the toughest penal laws with respect Corporate and Capital market crimes after Enron scam. Chapter IX and SECTION 901. of this Act SHORT TITLED ‘‘White-Collar Crime Penalty Enhancement Act of 2002’’ provides for the penalty for such crimes. In fact section 906 of this Act provides for 20 years of imprisonment, whereas in India, the Company’s Act, Section 628 provides for 2 years imprisonment only. It is perhaps due to this fact that sufficient deterrent is conspicuously absent in India and fraud after fraud are taking place. The govt will have to come up with a harsh legislation in this regard so that the culprits are severely punished.

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