Monday, 13 July 2015

What was the Satyam scam?

Satyam's case has been widely regarded as the debacle of the Indian Financial System. The case of Satyam is often referred to as "India's Enron"(Enron was a US based company which was inflicted with a similar accounting fraud). It was a 7,136 crore (nearly $1.5 billion) Fraud and it is seen as India's Most Colossal Financial Fraud. The fraud shows how disastrously investors can lose money by simply misstating the figures in the Balance Sheet.  Ironically, Satyam means “truth” in Sanskrit, but Raju’s admission of guilt has given the company, the name "Asatyam"!

There shall be a reasoning to questions such as "What was the need to commit a fraud on such a large scale?","How did Raju manage to cook up his books and what was his actual accounting techniques to manipulate the accounts for a period of eight years?", "Why was Raju forced to blow his own whistle?", "Why wasn't there a stricter punitive action against the auditors of Satyam(PricewaterhouseCoopers)?"

Raju had a fetish for acquiring land and the more land he acquired, the more he orgasmed. But Raju's story is not merely about his rapacious land acquisition, it is also about how he masterminded in siphoning funds off funds from his IT company Satyam and Construction company Maytas Infra by creating a fictitious revenue and profits to satiate his lust.

Raju, a Havard Graduate, had a very impressing disposition, a pleasing temparament and a respectable character in his circle and everybody had the utmost faith in him. The directors of the Board never questioned him about his operations as they were of the view that he could be trusted with everything. But funnily, even Raju, in his wildest of dreams, did not foresee that he could not possibly go undetected forever for cooking up his balance sheets to the tune of thousands of crores. The saga of Raju also exposes how vital the link of politics is with business. Ramalinga Raju could not have become what he did without the aid of Chandrababu Naidu and of Naidu's successor, the late Rajashekara Reddy, whose government awarded him with the massive metro rail project in Hyderabad. But raju would have been a big IT industry man and nothing more if fate had not intervened in the form of Chandrababu Naidu. Determined to make his name as India's most modern Chief Minister, Naidu wanted to showcase Hyderabad as a shining symbol of an emerging India that could dare to take on the developed world. In his endeavour, Naidu sought to use the software Industry to project Hyderabad. That is precisely where Raju's utility to Naidu came in. Naidu was so impressed by Raju that he presented him to the world as the icon of new Hyderabad and chose the occasion of visit to the then US President, Bill Clinton to do so.  Raju was also smart enough to pawn the former President APJ Abdul Kalam in his board for his Emergency Medical Research Institute (EMRI). He had a lot of clout in him that he knew convincingly enough, that he could get away with all his wrongdoings forever!

So how did his greed force him to commit a fraud on such a scale? Greed got the better of him. He used every single cent earned to purchase real estate. Before 1999, land purchases by raju were funded by the dividends he earned from Satyam. But as Hyderabad started to develop further, he stepped up his land purchases. To finance the purchases, he started pledging and selling all of his shares and that of his families. Since the laws of land did not allow the denizens to acquire more than 54-acres of land, Raju began purchasing land through his privately held companies. When law caught him, he had managed to set up 325 companies, owned by his immediate relatives!! And to add to that, major portion was bought as agriculture land, so the rental income was not taxable!

But why did he have to reveal that he had committed a fraud? Was it a guilty conscience ? I guess not. Raju would not have landed in this position if it hadn't been for the recessionary forces that hit the Indian shores in 2008. Recession threw Raju off guard and closed all his options. The market was rife with rumours of Satyam been plagued by hostile takeover threats and in order to stave away such threats, he falsely increased the turnover so that the companies wanting to acquire the company wouldn't as it would be a costly affair for the company making the bid for acquisition. Also, he transferred the funds from Satyam by cooking the books to purchase lands, so now there was a big hole in the balance sheet. But what if he merged his real estate and construction company with Satyam? He could then have possibly concealed the fraud. He gave himself up when he had to abort the merger of Satyam with Mytas Infra since the shareholders weren't consenting and the rumours had spread a lot.

So, how he did he mastermind this maze? Keen to project a perpetually rosy picture of the company to the investors, employees and analysts, Raju manipulated the books so that it appeared a far bigger enterprise than it actually was. To achieve this, they sewed up deals with fictitious clients and had large teams working on these fictitious projects. Note, here two things are done. One, fictitious Debtors i.e money receivable from clients is created and fictitious payroll (a.k.a ghost employees) showing payment of salary to them. He introduced 7000 fake invoices into the company's computer system to record sales that simply did not exist. Obviously, over the years, these ghost debtors never paid their bills leading to a big hole in Satyam's balance sheet meaning only Sales increased, Cash didn't. He further forged the bank statements to draw a mountain of cash balance. This thing, infact was possible that the auditors would not have known at least for a few years because seldom do auditors do the Third Party Confirmation (Whereby the auditors confirm balances not by relying on the client produced documents, but by privately following up with banks for the balance, to increase the test reliability). Atleast in mediocre firms, articles usually oversee this and completely rely on the client produced documents because even their managers or partners do not stress on this fact! What were the Internal Auditors(IA) doing? Although, IA can only"recommend" action to the clients but According to the sources, the IA were assured by the finance team that the accounts had been "Reconcilled"  as in the errors were rectified and Bank statements were reconciled with the financials but I really doubt that!

What happened to PwC? Well, actually nothing happened to PwC as compared to the gross negligence and possible involvement in the fraud. The Institute of Chartered Accountants (ICAI) cancelled the license of the two auditors and imposed a maximum fine of Rs 500,000 on each  auditor and PwC had to pay penalties which were infinitely minuscule in comparison to the fraud The stakeholders have immense trust and faith in the Statutory Auditors and hence given that amount of respect. In the wake of such disasters, the confidence of such users of financial information gets shaken up. Is it because the auditors are let go due to their way of reporting? I think so, yes. Auditors are able to easily claim that since their report says "In our opinion and to the best of our information and according to the explanations given to us..." , and by diverting the entire responsibility to the management, the auditors are able to absolve themselves from the shackles of the legal system. Hence, its in the need of the hour to advocate stronger and stricter action against such firms which show negligence or abet the fraud. What would have happened to PwC if this fraud had happened in a country like USA? Well, in case of enron, the then auditors Arthur Anderson was convicted of obstructing the justice and the CPA licences of the partners were cancelled and the right to practice before the SEC was declined including a hefty penalty, effectively putting it out of business and compelling the firm to go into dissolution. Comparing PwC to that, it has been a cake walk!!
Reference: Case study of India's Enron, KIMEP University.

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