Satyam Fraud - Ethical/Moral Crisis

In my previous post I had covered my analysis of the Satyam fraud. In case you haven't read it here's the link. In this blog I will be covering some of my thoughts on what led to this crisis and what can we do to prevent this in future.

How did we get here?

I read couple of interesting posts in the net that the world is going through not just economic crisis but also ethical crisis with the mis-management of banks & financial institutions, Ponzi schemes, Corporate frauds, Bribes etc. This is very true. While we can have rules, compliance procedures, multiple levels of cross-checks etc, end of the day if someone wants to cheat he very well can find his way around the system. All our systems and processes are built on the basis of trust & ethics. When these fundamental qualities of an individual/organization fails the whole systems comes crashing down.

What happened in Satyam's case is precisely that. It was a breakdown of trust and ethics. Satyam was bound by SEC, GAAP, SOX regulations, they have independent third party audits etc and still managed to get away with their fraud that too for around 7+ yrs (This came from Raju's statements during enquiry). The current society is becoming more and more materialistic and power, greed, fame, market/peer pressure etc are taking over and some of the basic human values are forgotten. As history has shown us repeatedly those who don't operate in a moral and ethical manner will eventually fail as in the case of Satyam/Raju.

What can we do to prevent this?

In the near-term as an outcome from investigations/analysis Govt will come up with more rules, regulations and compliance procedures. These are more like patchwork and will address some of the outcomes of this fraud and add more overheads to the system (similar to SOX regulations in US where businesses spend millions/billions of $'s). However putting more regulations will not address the root-cause of this issue. This whole episode will keep repeating itself time and again till we reach a stage where our rules and regulations become more of an impediment to our businesses instead of enabling them and defining boundaries/acceptable norms. I'm not saying that we don't need rules & regulations just that rules and compliance alone can never be sufficient.

For us to fix this issue each of us need to look within and ask ourselves if we are doing the right thing. Just like there are rules & regulations for the society, each of us need to operate under the boundaries of personal ethics and values. We as a society need to encourage moral values like honesty, integrity, ethics etc and reward people who follow them. The value system needs to imbibed into the future generations through our education systems and by parents setting an example to their children. While this may sound very philosophical it is essential that we fix this as failure of personal ethics and values is root cause of this issue.

We as individuals need to take ownership and drive this change both in us and in our societies. Lets start with ourselves and kick-off this change one at a time!

Sathyam Fraud - An Analysis

In my earlier post i had covered my thoughts on the Maytas debacle. For those who haven't read it here is the link. I will be covering about my analysis of the Satyam corporate scandal/fraud in this blog.


Overview

Satyam has been topping the media charts for the last few weeks and have been rattled by a series of shocks. The whole mayhem started with the announcement & subsequent cancellation of Maytas acquisition, it was followed by World Bank contract termination & allegation of bribery by Satyam and then came the resignation of 4 independent directors from its board. Today Ramalinga Raju delivered the coup-de-grace when he made a press release that Satyam's books were fudged; that they have been reporting inflated revenue/margins for the last few years and the stated cash reserves of $1.2B are non-existent. The overall revenue impact of this fraud was a whopping Rs.8000 Crores ($1.66 Billion). This is the biggest corporate scandal in Indian history. This whole episode has not only impacted Satyam but this has created lot of negative publicity for Indian IT and Industry as a whole and impacted its corporate reputation.

Here's a summary of the misreported amounts as claimed by Raju in his letter to Satyam Board:

1. The Balance Sheet carries as of September 30, 2008

• Inflated (non-existent) cash and bank balances of Rs.5,040 crore (as against Rs. 5361 crore reflected in the books)
• An accrued interest of Rs. 376 crore which is non-existent
• An understated liability of Rs. 1,230 crore on account of funds arranged by me
• An over stated debtors position of Rs. 490 crore (as against Rs. 2651 [cr.] reflected in the books)

2. For the September quarter (02) we reported a revenue of Rs.2,700 crore and an operating margin of Rs. 649 crore (24% Of revenues) as against the actual revenues of Rs. 2,112 crore and an actual operating margin of Rs. 61 Crore ( 3% of revenues). This has resulted in artificial, cash and bank balances going up by Rs. 588 crore in Q2 alone.

Pls check out the complete draft of Raju’s mail in this link.


What beats me about this whole incident is how can a company with $2B revenue get away with $1B+ mis-reporting/fraud. Here are some glaring questions that pop-out of this episode:

• Satyam is a publicly listed company in both India and US and are bound by Indian/US (GAAP) accounting standards. I don’t know much about comprehensiveness of Indian accounting standards, However US GAAP standards and SoX regulations are very stringent(especially post-Enron scenario). They need to go through mandatory 3rd party audits as well. Given this how can Satyam fudge their books?

• This whole mis-reporting has been going on for a few years now. How can the external auditing company(PWC) make a mistake and not find this out all these years. If it has been consistently missing all these quarters then its an 'incident' not an 'accident'.

• I guess most of these inflated amounts have been reported in terms of inflated revenues(both top line & bottom line) for each of the quarters. Auditors are required to validate the customer invoice amounts, receivables, outstanding amounts, bank statements etc and tally them with each other? How can a gap of tens of millions dollars each quarter not be noticed by the auditors?

• If a company claims to have $1.2B of cash reserves they need to report and provide proofs of how the amount is invested/maintained to Auditors and also provide it as part of their regulatory filings. How can a company conceal a whopping $1B cash surplus without showing proofs of investment?

• The additional revenue reported will attract Income tax. It will be interesting to see if Satyam paid tax on inflated amounts. Wouldn’t IT department/RBI scrutinize their bank accounts, Forex transactions, annual/quarterly reports to validate the tax collections?

Based on the above thoughts I feel that the auditing firm has received some kick-backs and is involved in the whole fudging exercise. There is no way this could have been pulled off without involvement of Auditor. I wouldn’t also be surprised if Satyam provided falsified proof for some of these claimed investments (Auditor could infact have guided Satyam on the same so that their bases are covered).

Next I am trying to explore what could be the possible motive behind this whole fraud. The obvious fact is that numbers were inflated to drive up the stock price. It’s a no brainer that it is just a matter of time before this is exposed and when it does get exposed the stock will have a freefall and might even lead to dissolution of company(as its happening now and as it happened in the case of Enron). I am sure Raju is smart enough to understand this. If so why would he try to take this undue risk especially when he is not planning to sell any shares when the market was high (as he has mentioned in his letter)? This leads me to believe that there is a more deep underlying cause than just propping up stock price. I am not sure what it could be, this needs further investigation. There is definitely more to it than meets the eye.

The whole story around pledging stocks to financial institutions and using that money to run the company (as stated in his letter) sounds very fishy to me. I have a feeling that he took that route to realize the value for stocks without selling them in the open market and panicking the investors (The other advantage also being that since these were mortgaged when the market was high he would have got higher amounts based on prevailing stock price at that time). I doubt if that mortgaged money made its way into Satyam operations. I’m fairly certain that at least a sizeable portion of that is stacked away safely most likely outside India. Here again the question that comes to my mind is when an individual is pledging stocks and borrowing upwards of Rs.1,200 crores($250M+) how did it not come under IT purview? There is a distinct possibility that IT dept/political big-wigs could have a hand in this.


To be continued.. Pls post your comments/feedback/thoughts on the same.