Friday, January 09, 2009

Satyam: Crisis in Governance

The confession, a couple of days ago, by the Chairman of one of India’s leading software companies, to commission of financial irregularities of unimaginable magnitude is shocking. In his statement, sent to the Satyam board of directors, its Chairman Ramalinga Raju narrates several instances of misrepresentation of financial statements over the last few years. What is baffling is that the company was not only listed on India’s leading stock exchanges, but even had its American depository receipts (ADRs) listed on the New York Stock Exchange (NYSE); for this reason it had seemingly complied with all the onerous requirements of corporate governance imposed by the Indian regulations (clause 49 of the listing agreement) as well as the oft-feared Sarbanes-Oxley Act of 2002. Clearly, this has been a case of compliance of corporate governance norms in form, but utter breach in spirit.

At this stage, it would be premature - events are still unfolding as you read this - to attempt a detailed analysis of what went wrong. That will have to await the availability of relevant facts. However, this does give rise to several issues for consideration, especially on the questions of whether there has been a failure of the existing regulations on corporate governance (that enabled the insiders within Satyam to suppress information of this magnitude and hoodwink investors, regulators and the public for a sustained period of time), whether there was a lapse on the part of regulators such as the Registrar of Companies, the stock exchanges and SEBI in probing further for any red flags, and more importantly, whether the ‘gatekeepers’ such as the independent directors and auditors were truly oblivious of the wrongdoings by the top management (or whether they bore a duty to investigate and seek further information). All these questions will hopefully find some answers in the near future. But, for the present purposes, it would be useful to refer to the array of issues raised by my co-contributor Mr. Jayant Thakur on the Indian Corporate Law Blog.

This episode has invoked strong reactions from the industry, media and the regulators. On the regulatory front, several regulators have already registered their objections or initiated investigations. The Registrar of Companies and SEBI have already initiated investigations, while the Institute of Chartered Accountants of India has announced that it would examine the role of the auditor, Price Waterhouse Coopers, as regards the misstatements in Satyam’s accounts. We can perhaps even expect special commissions or committees to be appointed by the Government to look into the case. The findings, of course, are unlikely to be forthcoming in the near future, especially in a complex case such as this.

At a more general level, this episode is likely to tangentially result in wide-ranging changes to Indian corporate governance norms. After all, such instances shatter investor trust in Indian companies, and more so in the software sector, which is a flag-bearer of Indian industry. The media has termed this India’s Enron, and we all know only too well that the regulatory outcome from the Enron crisis was the enactment of the Sarbanes-Oxley Act in the US. In India, the Minister for Company Affairs has already announced that the Companies Bill, 2008 (which is pending in Parliament) will be reviewed to strengthen the corporate governance regime in the light of recent developments. While Satyam’s case is unfortunate as it severely hurts the interests of all its stakeholders (investors, creditors, employees), it serves as a wake-up call to the Indian industry in general that imbibing corporate governance principles in “spirit” is of utmost importance.

1 comment:

K.V.DHANANJAY said...

I think we already have too many laws in India to deal with the situation unfolding at Satyam. But, these developments at Satyam speak more to the efficiency (or absence of it) of the audit systems in place than to the culpability suspected of insiders in that organization.

Laws mandate an outside ‘audit’ precisely because law treats too much trust in insiders as a peril to shareholders. Take one look at our Companies Act and you will see this lack of trust writ large everywhere.

Comparisons to say, Enron or Worldcom are totally misplaced here. At some form, Enron worked like this:

A sells a product to B, an entity non-related to A. As part of extending credit to B to defer the payment to a future date, A asks B to furnish some security as collateral. However, A directs B to furnish such security as collateral, on A’s behalf, to C. Now C is purely a creation of A. A and C enter into elaborate set of agreements whereby C creates a fiction of a receipt from B and a debt to A. A then treats the due by ‘C’ as a real due, in addition to that owed by ‘B’. This is nothing but a ‘fraud’. However, the accountants at Enron did disclose this scheme of accounting and expressed no opinion as to the legality or otherwise of such treatment.

What we see at Satyam is quite different. I do not know of any other episode where an insider confesses to have hid from his own auditor, massive deficits in cash and bank balances on this scale. Cash and bank balances are the most easily verifiable items on the Balance sheet of an entity subject to an OUTSIDE audit. Yet, if the easiest part of an auditor’s job leads to the presentation of a totally fraudulent and misleading ‘statement of affairs’ at that entity, one must wonder about the true function of the ‘auditor’ really.

And, the confessions are cryptic and fail to disclose satisfactorily, whether, the reference date in that letter is to 30-Sep-2008 or to a recent one. ‘Non-existent’ cash balance means ‘Non-existent’ when really ? In fact, the confessions are very ambiguously worded and hide several things.

If cash accounted for in the books is real but only higher in relation to that in custody, there is an obvious case of embezzlement or pilferage. If cash accounted is itself higher than that legally/contractually receivable, then a disclosure of a higher sum in books is fraudulent . Embezzlement or pilferage more readily attract the penal provisions contained in the Indian Penal Code while accounting fraud is well addressed by the securities laws and regulations in place.

I wonder if that individual, Ramalinga Raju knows a bit more about the laws he is supposed to have breached than an average criminal or securities or corporate attorney does! I look forward to see if this episode offers any lessons that we forgot to remember.