ACCOUNTING FRAUD AT SATYAM COMPUTERS

OVERVIEW OF THE COMPANY

Satyam Computers Services Limited (SCSL) was registered as a PVT Ltd organisation in AP in the year 1987. Soon in the year 1991 it became a Limited Company. It became the fourth largest IT services company in India and in the year 1995 it received a certification for ISO 9001. Satyam computers offered a large no of services and expertise in the fields of Development of software’s , System Embedment , various Engineering Services such as CAD and CAM , ERP management , EAI ,CRM ,SCM,E-Commerce and Consulting.  In the year 2001, the company was given IMC Ramkrishna Bajaj National Award for its contribution in the field of Service.

In the year 2002 company expanded its operations into China. In the same year Satyam was cited as 'Top choice for SAP support' by Giga Research group. In 2003 the Group announced a new business center in Singapore and also launched a Global solution center. Satyam was given the prestigious IBM Lotus award for its innovative knowledge & content management solutions in the year 2003. It was also given an Outsourcing contract by WORLD BANK worth $15 million in 2003. It inaugurated a new development center in Mississauga, Canada in 2004. Satyam also acquired Citisoft Plc a UK based company and Dynamics, a leading data warehousing company in Singapore in the year 2005. In 2006 Satyam received the best performing stock from CNBC and Excellence in cost management from ICWAI. In the year 2007, Satyam acquired Nitor Global Solutions Ltd, a UK based company in a deal worth $5.5 million. In the same year it established a new development centre in Brisbane to support the fields of Local Governance, insurance, mining and Finance. Satyam was the proud winner of Corporate Social Responsibility Award in ASIA under the poverty alleviation category. In the year 2008, Satyam Computers (SCSL) became the first company registered in India to list its American Depository Receipts or Shares (ADR) on NYSE and Euronext in Amsterdam. (I M Pandey-2013)

HOW THINGS TURNED OUT?

SCSL had many fortune 500 companies as clients including Unilever, Nestlé ,Cisco, GE, Sony, World Bank,  GM, United States government etc. in quite a few case SCSL had even a role in the maintenance of its  client companies accounting and finances.

The fraud unveiled at SCSL was India’s largest corporate scandal till date and the first casualty in the wake of Global financial meltdown in 2007-2008. But before the fraud was detected and made public Satyam was always under close scrutiny and watch of concerned agencies for various conflicting reports and seemingly ill directed activities.   

In early October 2008 there was a  report that the company was immediately banned from any further World Bank contracts , when it was reportedly found to have installed spy software’s and cameras in some of the World Banks computers. Saytam denied but late it was confirmed by the Bank In December 2008, Satyam’s shareholders revolted the news that the company has agreed to buy two entities which allegedly had ties to the incumbent Chairman and his Son.  By the end of the year 2008 , the board of directors refused to back the chairman and the CEO on the matter and four Board members resigned by February  2009.

The books of Accounts of Satyam was audited for the last many years by PriceWaterCooper (PwC) and they just overlooked somehow the underlined fraud.

This accounting fraud looked very obvious and basic when the then chairman and Satyam’s founder, Mr Ramalinga Raju admitted (Rishi Mehra -2011) the following facets about the Balance Sheet dated 30th Sept 2008:

(a) About Rs 5040 crores which consisted of almost 95% of the cash at bank as on Sept’08 was fictitious, because of largely inflated profit margins and lots of fictitious Assets.

(b)    There was an item under the heading of Current Assets called accrued interest  to the tune of  Rs. 376 crore which  did not exist and just fabricated.

(c)     There was an understatement of a particular liability to the tune of Rs 1230 crores, which was on account of funds arranged by him and the promoter’s family.

(d)    The balance sheet also showed Debtors position to be in excess by atleast Rs. 490 crore.

It was strange that the extraordinarily large fictitious cash pile of bank deposits claimed by successive Balance sheets were never verified properly and its existence on a long term basis raised enough doubt about the quality of the audit done by internationally known Auditors. At the same time it was also surprising for everybody that the Board of Directors which consisted of very highly skilled and experienced individuals  did nothing substantial to avert the potentially damning situation.

The first level of corporate governance in a company is its board of directors itself and in case of SCSL the board comprised of very big names including Mr Vinod Dham who worked with INTERL corporation, professor Krishna Palepu of HBS and former Cabinet Secretary TR Prasad. It was intriguing that such an assembly of the intellect could not detect the fraud while it was going on .

This scandal also raised questions about the way outsourcing companies are being regulated and particularly audited. The failure of regulatory authority was so complete that it was joked that a blind and deaf man would have easily found it, if he wanted it to.

Starting in the financial year 2006, Mr B Ramalinga Raju raised money by hypothecating or pledging his family’s shareholding in the company which was little over 8% to outside lenders to secure collateral loans. He then reinvested the money so garnered back into the company to cover up the shortfall of revenue and profits.  Then the Global financial meltdown happened, share prices  fell by more than 40% and thus Lenders became jittery and began selling the collateral . This aggravated the already grim situation and at this juncture B Ramalinga Raju tried to buy two other companies promoted by the family into Satyam’s fold for a reported $1.6 billion. This could have wiped the fictitious assets such as cash and had the potential to bring more assets into the fold but the scheme could not go through because of staunch resistance from lenders as well as other investors (particularly institutional investors).

Indian Stock market Regulator (SEBI) launched an investigation into the fraud in December 2008 .At the same time US Authorities raised objections and concerns with the statutory Auditor Price Waterhouse, whose parent company was listed in US , regarding its audit of Satyam,after their visit to the company headquarters in early 2009.

According to Mr B Ramalinga Raju, the cover-up was started as an attempt to keep under disguise the poor Quarterly results of the company. In a letter to the Board of Directors of the company in Early January 2009 he clearly admitted to inflating the latest quarterly result that the company came out with in SEPTEMBER 2008. He admitted that in that Quarter the company reported a revenue of 2700 crores and an operating profit (EBIT) of 649 crores amounting to almost 24% margin where as the actual results were a revenue of 2217 crores and an operating profit (EBIT) of 61  crores only which amounted to only 3% margin. This resulted in an artificial cash inflow of almost 588 crores in the Q2 of 2008-2009 FY.

Fabricated Balance Sheet and Income (P/L Account) Statement of Satyam: As of September 30, 2008

                                                (Rs. in crore)

 Actual       Reported    Difference

Cash and Bank Balances               321           5,361        5,040

Accrued Interest on bank FDs        Nil             376.5        376

Understated Liability                    1,230        None         1,230

Overstated Debtors                      2,161        2,651        490

Total                                         Nil             Nil             7,136

Revenues (Q2 FY 2009)                2,112        2,700        588

Operating Profits                        61             649           588

When further audit were done later it was found out that only the operations of SCSL was continued to be exaggerated and not the same was done with any of the subsidiaries. Over a period of last one year alone revenues were shown in excess by 3,000 crores (Actual  8,392 crores and shown as 11,276 crores) and reserves were inflated as well.

Because of the staggering amount of difference between these two figures , the company had to carry some additional resources and various other non operational assets to justify the exaggerated amount of operations in case there is a probe and thus the operating costs got bigger by the day and accentuated the matter further.

Every attempt was made to reduce and even completely eliminate the gap. But they failed. Because the promoters only held 8% of the stock , they feared the failure to increase revenue will lead to the company being taken over and thus they tried in a last ditch attempt to infuse more assets and slush out the nonexistent cash by bringing in some from outside. That’s when they tried to buy the family owned Maytas infrastructure to its fold and infuse cash. Once Satyams problem was solved they can settle for cash to paid to Maytas, and more importantly the can be made much later without burdening the cash flows. But others resisted.

Immediately after the confessions made by Raju the shares of the plunged  by 80%  from a high of Rs 544 in may 208 to Rs 11.50 in January 2009. In NYSE , Satyam’s  shares was selling at $29.10 in july 2008 but by contrast in March 2009 they drastically fell to US $1.80. This amounted to investors losing more than $2.82 billion in investment.(BBC News, 2009).

WHO WAS IMPLICATED?

a. B. Ramalinga Raju (chairman): He claimed in his letter to the Board that nobody else was aware of the fraud and particularly BOARD was innocent.

b. Audit Firm PwC.

This Audit firm audited Satyam’s books starting from the year 2000 till 2009. Several experts criticized the auditors in very harsh words  for failing to detect the fraud particularly the existing non-interest-bearing deposits of more than $1 billion.

According to many professionals, any worthwhile auditing firm would have discovered and questioned the logic behind having such an enormous amount in non-interest bearing assets.  This should have been seen as a red flag by PWC and it failed to do so. Further, it was apparent that the  auditors did not independently try to verify for a few years with the banks in which the management of Satyam claimed to have these deposits” (Blakely, 2009).

c. DSP Merrill Lynch: This US company advised Satyam for the last ten years regarding issue of new shares and reportedly helped the company’s listing in US.

WHO THE SCANDAL AFFECTED?

Immediately following the declaration by Raju of the fraud, Merrill Lynch terminated its contract  with SCSL , Credit Suisse relegated SCSL to third tier and the license of PWC to operate in India was revoked. All the awards given bestowed on SCSL was stripped off (Agarwal and Sharma, 2009).

Some of the parties affected by the scam, according to Manoharan (2011), were:

• More than 60,000 Employees of Satyam dealt with nightmares, non payment of salaries, the spectrum of losing their jobs.

• Clients of Satyam seemed to lost their Trust in SCSL. Many fortune 500 clients like  Cisco, Telstra and World Bank cancelled their contracts with immediate effect.

• Shareholders who lost their investments lost faith in the system.

• Bankers and lenders were on tenterhooks for the timely recovery of their claims and a possible financial and non-financial exposure.

HOW IT COULD HAVE BEEN AVOIDED?

Accounting frauds are related to manipulative financial reporting with intentional misstatement, missing correct figures knowingly and failing to disclose information correctly and with the sole intention of deceiving the end users. The world has seen its share of accounting frauds but they can be avoided with the help of following precautions:

1.  People in charge must understand in general why employees or managerial personnel create fraudulent behaviour and take part in financial frauds. People commit some because they are under pressure or they do it to relieve pressure without getting caught and have justification to make a fraud. Better internal controls and fine leadership will mitigate the problem.

2. Internal control and audit: 

Internal audits are a constant operation to contain frauds and helps evaluating the processes more precisely and thus assessing the procedures to see whether the control systems in place are adequate or not. If necessary they bring to light the needs of revision and solutions.

3.  Whistleblower Program or internal Watch

In every organisation employees must be encouraged to voice their opinion to a designated committee or seniors. And at the same time it shall be ensured that the grievances are heard and dealt with. If somebody brings up or notices an unethical behaviour , he/she must not be punished. That way internal watch works.

4. Independent Audit

Frauds made by low level employees can be detected through internal audits and higher management checks. But it’s difficult catch the big guns by internal audit alone. Thus there is a need to have independent auditors to check senior management and tricky transactions. 

5. Minimize cash transactions: 

This thing is of utmost importance. Each company shall demarcate the policy by which employees are allowed to handle cash themselves. If the amount exceeds the denoted one then they must get seniors  approval to do it. And in case of directors and others a disclosure to the BOARD of DIRECTORS is a must. At no instance a person disbursing cash shall be from the person in charge of Accounts.

6. Reconcile various Accounts regularly: the Auditors must audit and make reconciliation of statements of cash and bank balances physically and must make sure there is no discrepancy in them. All the bank accounts and credit transactions be reconciled and reported. 

7. Surprise Audits and checks:  Audit committees and independent Auditors must conduct surprise audits of Books of Accounts and transactions which occur more discretely. Surprise checks shall also be conducted for Different branches and offices regularly to keep fraudsters under check.

In more instances internal Employees and officers are the ones who indulge in frauds. This happens because of the oversights on the part of the management and auditors and also because of the lack of internal controls in place.

CONCLUSIONS

The management culture at Satyam, when it was dominated by one man , that of their chairman , symbolized an unethical corporate culture. He not only disregarded but also manipulated the BOD. There was urge on his part to impress the investor and thus compelled him to fudge the results. He was under pressure. But at the same time the independent experts sitting at the Board turned a blind eye to what’s happening around them and did not have a clue.  The board almost connived with his actions and turned itself to a blind spectator, where as they shall have seen the real picture and rectified or advised the true sense into it; the lure of big and fat salary and other form of compensations further encouraged such behaviour. In the end they allowed their behaviour to have destroyed the trust of the investors and the image of nation as well.

Michael Useem, management professor at Wharton noted that Satyam case was little bit unusual in a way that it is listed in NYSE. It’s difficult to get funding at low cost in India thus there was this necessity to issue ADRS in US Market. By entering into the US market Satyam accepted the possibility of greater scrutiny and higher amount ethical governance yet the scandal happened at the company. According to his opinion the issue was indeed disturbing.

But Indian IT sector has come a long way since and overcome the inadvertent situation tactically by being more transparent.

In the month of June ,2009, the company named itself Mahindra Satyam after it was taken over after a SEBI led well rounded bidding process by the MAHINDRA GROUP in the month of April ,2009.Finally the company merged into the flagship MAHINDRA company TECH MAHINDRA in 2013. The eventual merger was much delayed due to a pending income tax claim of  Rs 2700 crores . When merged the new entity created India’s fifth largest technology company with annual revenue of over $3billion.  

REFERENCES  

1.Rishi Mehra ( financial case studies) 2011.(kapoor publications,newdelhi) (TEXT BOOK)

2. FINANCIAL MANAGEMENT BY I M PANDEY -2013 (TEXT BOOK)

3. Agrawal, S. and Sharma, R. (2009). Beat this: Satyam won awards for corporate governance, internal audit. VCCircle. Available at www.vccircle.com/news.

4. Black, W. K. 2010. Epidemics of “Control Fraud” lead to Recurrent, Intensifying Bubbles and Crises, working paper, University of Missouri-Kansas City, SSRN-id 1590447.

5. Ahmad, T., Malawat, T., Kochar, Y. and Roy, A. (2010), “Satyam Scam in the Contemporary corporate world: A case study in Indian Perspective,” IUP Journal. Available at SSRN,pp. 1-48

6. Badawi, I. (2003) “Global Corporate Accounting Frauds and Action for Reforms,” Review of Business, pp. 8-14.

7. Bhasin, M. L. (2008), “Corporate Governance and Role of the Forensic Accountant, The Chartered Secretary Journal, Volume XXXVIII, No. 10, October 2008, published by The Institute of Company Secretaries of India, New Delhi, pp. 1361-1368.