An analysis of the Satyam Computers fraud and whether

it could have been prevented

Abstract

This paper describes the $2.9 billion fraud in Satyam Computer Systems Limited, a large

Indian software company. The top management, including the CEO, perpetrated this ‘control

fraud’. The actions of a whistleblower forced the CEO to admit the colossal fraud. Suitable

legislation like the Sarbanes Oxley Act in the US coupled with strong internal control mechanism

and not mere presence of independent directors can create a force against such frauds. PWC,

the auditors and the regulatory agencies ignored the early warnings. The often-overlapping role

and multiplicity of investigating agencies is highlighted. The role of whistleblowers is examined

as a means of detection of crimes of this nature.

Key words

Satyam Computers, control fraud, corporate governance, whistle-blower, independent

directors.
Introduction

This paper describes the accounting fraud, which happened over a period of eight years in

India’s fourth largest software company, Satyam Computer Systems Limited. The top

management, including the CEO of the company, perpetrated the fraud. The nature of fraud and

its subsequent investigation has important lessons for the prevention of such offences in future.

The role of external auditors and how far they can be expected to go in uncovering frauds of this

nature is examined. The omissions on the part of the regulatory agencies, which ignored the early

warnings emanating from Satyam, are also highlighted. The often-overlapping role and

multiplicity of investigating agencies is highlighted. It is important to enact suitable legislation

and increase the awareness about such frauds. Finally, the role of whistleblowers is examined as

an important means of detection of crimes of this nature.

White collar crimes in India

Edwin Sutherland defined white-collar crime as “crimes committed by a person of

respectability and high social status into the course of his occupation”. Prior to Sutherland,

scholars like W. A. Bonger (1916), EA Ross (1907), Sinclair (1906) and Steffens (1903) have

written about misdeeds by businesspersons and elites. Edwin C. Hill had mentioned criminal

behavior of the elites in the American Congress in 1872 in his paper ‘Criminal Capitalists’. Prof.

Hugh Barlow proposed that in addition to Sutherland’s “high status” offenders, the people of

lower strata also committed white-collar crime.

If there is an industry in which India has surpassed the developed west then it is the field

of white-collar crimes. White-collar crimes in India are not entirely based on the theory

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propounded by Sutherland but more on the concept by Prof. Hugh Barlow as “crimes committed

by the people of lower strata in their occupational status”.

In India, white collar crime mostly includes manipulation of funds or in stock exchanges

or misrepresentation in advertising or in financial statements of a corporation or violations of

labor laws, copyright, patent laws etc., which often occur during the course of one’s occupation.

Some examples, which come to mind easily, are adulteration of milk by the milkman, selling

adulterated food by the shopkeeper, selling expired medicine, taking out few pounds of gas from

the cylinder and so on. The Indian Monopolies Inquiry Commission has this to say about

essential commodities—

“There is hardly anybody in India who has not been a victim of the practice of hoarding,

cornering and profiteering. Whenever there is a slight shortage — even temporary — in any

consumer goods for which the demand is urgent and inelastic, almost every trader — it is

perhaps unnecessary to use the qualification ‘almost’ — conceals his stock and blindly tells the

customers that he has not got the commodity in stock...”

Article 39(c) of the Constitution of India states:

“The State shall, in particular, direct its policy towards securing that the ownership and

control of the material resources of the community are so distributed as best to sub serve the

common goods; that the operation of the economic system does not result in the concentration of

wealth and means of production to the common detriment”.

This provision has resulted in the following enactments geared towards controlling white-

collar crimes:

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1. Essential Commodities Act, 1955,

2. Industrial (Development and Regulation) Act, 1957,

3. Import and Export (Control) Act, 1947,

4. Companies Act, 1956,

5. Foreign Exchange (Regulation) Act, 1973,

6. Central Excises and Salt Act, 1944,

7. Income-tax Act, 1961,

8. Customs Act, 1962,

9. The Conservation of Foreign Exchange and Prevention of Smuggling Activities and

Smugglers and Foreign Exchange Manipulators (Forfeiture of Property) Act, 1976

The first major committee set up by the Government of India on white-collar crimes was

the Santhanam committee. It gave a graphic account of the misdeeds of businesspersons and

industrialists in the following words:—

“Corruption can exist only if there is someone willing to corrupt and capable of

corrupting. We regret to say that both these willingness and capacity to corrupt is found in a

large measure in the industrial and the commercial classes...”

Santhanam committee found that during 1958-1962; nearly 700 firms wrongfully utilized

licenses valued at millions of rupees through misrepresentation, forgery or through other

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violations of the Export/Import control regulations. This led to enactment and/or amendment of

the following legislations:

1. Anti-Corruption Laws (Amendment) Act, 1964;

2. Foreign Exchange (Amendment) Act, 1964;

3. Prevention of Food Adulteration Act, 1954,

4. Wealth Tax (Amendment) Act, 1964

These Acts provide for more powers to the investigating officers and Magistrates for

conducting the proceedings of the summary trials and to better investigate and try white-collar

crimes.

However, the seventh biennial fraud survey, conducted by audit and consulting firm

KPMG India in 2008, reveals that 60% of the companies in India experienced fraud, while 42%

experienced fraud committed by top management officials such as board members, directors and

even managing directors. The findings of the report suggest that the inherent responsibilities and

trust associated with senior positions and their ability to access classified company information

create the risk of fraudulent acts.

The number of white-collar crimes has risen dramatically, as per the report of KPMG.

The last survey, carried out in 2006, had found 39% of firms complaining on this count. The

survey, carried out by KPMG’s forensic wing in India, covered leading Indian firms from the

public and private sectors. The respondents included chief executive officers, chief financial

officers, internal auditors, chief compliance officers and other senior management officials.

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 Indian companies, according to the study, remain highly vulnerable to fraud in the

absence of “effective internal control mechanism” that can identify and deal with such crimes.

The report suggests that 75% cases of fraud remain undetected and that more than 60% of Indian

firms have inadequate anti-fraud measures.

The frauds covered in the survey also include anti-bribery compliance. Almost 84% of

the companies strongly believed that businesses in India pay bribes to facilitate work. India

scores poorly on corruption and bribe payments in the list of organizations such as Transparency

International, which ranks countries based on corruption and propensity to demand bribe. India’s

corruption perception index score was 3.5 in 2007 on a scale of 0-10, and the bribe-payers index

score was the lowest.

The rise of Satyam

B. Ramalinga Raju and his brother-in-law D.V.S. Raju established Satyam Computer

Services Limited (SCSL) in 1987 and it was incorporated as a public limited company in 1991. It

became a global consulting IT company in a few years and became India’s fourth largest IT firm

in India after Infosys, TCS and Wipro. Among its large number of subsidiary companies, Satyam

Info Way (Sify) became the first Indian internet company to be listed on the NASDAQ. With a

presence in 55 countries Satyam expanded rapidly in the 1990’s acquiring many businesses like

Singapore based Knowledge dynamics and London based Citisoft Plc. It had strategic

partnerships with leading international players like Microsoft, Emirates, TRW, i2 technologies

and Ford. At its peak, Satyam served 44 Fortune 500 companies and over 390 multinational

corporations.

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 Satyam served as the back office for some of the largest banks, manufacturers, health

care and media companies in the world, handling everything from computer systems to customer

service. Clients have included General Electric, General Motors, Nestlé, World Bank and the

United States government. In some cases, Satyam was even responsible for clients’ finances and

accounting.

Satyam had a significant corporate social responsibility (CSR) initiative in the Satyam

Foundation and Emergency Management and Research Institute (EMRI). The foundation

provided Service Initiative, which saved thousands of lives through its emergency ambulance

services in eight Indian States. Satyam gave $ 10 million in cash and $ 20 million worth of

property for these two programs.

Satyam had about 300,000 shareholders, over 53,000 employees and 650 clients in over

60 countries. In September 2008, the World Council for Corporate Governance awarded Satyam

with the "Global Peacock Award" for global excellence in corporate accountability. In 2007,

Ernst & Young awarded Mr. Raju with the Entrepreneur of the Year award. Ramalinga Raju

was the Dataquest IT Man of the Year in 2000, and the winner of CNBC’s Asian Business

Leader - Corporate Citizen of the Year award in 2002.

The nature of the fraud

According to investigation reports, the falsification of the company’s accounts started in

2001, after an informal meeting between Ramalinga Raju and his brother Rama Raju. The scope

of falsification was $47 million in 2002, $1 billion in 2007 and $1.47 billion by the end of

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September 2008. After unearthing several hidden records, the Central Bureau of Investigations

(CBI) has put the figure at about $2.9 billion, in the additional charge sheet.

The company essentially showed inflated sales by creating false invoices. The CBI, using

cyber forensics found 7,561 invoices worth $ 1.04 billion hidden in the Invoice Management

System (IMS). The CBI analyzed the computer logs relating to both IMS and the computer

network of SCSL. This study was matched with the company’s “access control swipe card” data.

The individuals who generated and hid these invoices were identified. The computer server

where these incriminating records were stored was identified and records retrieved.

The investigations showed that a software program called Satyam Project Repository

(SPR) generated the project ID, another software, called Ontime, was used to record the number

of hours put in by employees. Another software called Project Bill Management System (PBMS)

generated the billing advice from the data received from Ontime and from the rates agreed upon

with the customer. However, apart from this regular flow, SCSL had another method of

generating invoices directly in IMS bypassing the regular application flow. This was done by

transferring the data directly into the IMS using Excel Porting.

Raju and his associates also forged board resolutions and obtained unauthorized loans

and advances to the tune of $247 million, as per the CBI report. The company books did not

show any entries relating to these loans and advances. Another $249 million has been shown to

be infused into SCSL by promoters of 37 front companies floated by Raju. No records of this

were found in the respective account books. Raju also inflated prices pertaining to the acquisition

of shares of Nipuna Services Ltd., the Information Technology Enabled Services (ITeS) arm of

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Satyam. A sum of $47 million was generated as dividends from the inflated profits of Nipuna

services.

Apart from the above Raju and the company’s global head of internal audit used some

more techniques to perpetrate the fraud. Using his personal computer Raju created numerous

bank statements to inflate the balance sheets with profits, which did not exist. He also created

about 6,000 fake salary accounts over past several years and appropriated the salary after the

company deposited it. The money raised through American Depository Receipts (ADR’s)

apparently never made it to the balance sheets. .

Where did the money go

Raju initially claimed that he did not divert the money to his personal accounts. He was

simply inflating the profits to keep up with expectations. However, in later interrogations he

revealed that he diverted the money to other firms that he and his relatives owned. He was doing

this since 2004, or about 4 years until he was caught. The charge sheet filed by the CBI revealed

that Raju siphoned off around $ 253 Million dollars at the rate of $4 million every month for

several years.

Ramalinga Raju had an obsession for building assets through purchase of land. He

acquired vast stretches of land in Hyderabad, a major commercial center and capital of Andhra

Pradesh. Raju had floated two companies Maytas Infra and Maytas Properties where his sons

were the major shareholders. All land holdings acquired by Raju are with Maytas (Satyam

spelled backwards) and none with Satyam. In fact, with so much land in Raju’s family name,

most offices of SCSL are either on lease property or rental agreement. About $70 million out of

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the funds, which were siphoned out by Raju, were poured in buying land in and around

Hyderabad as per the following table.

Land Purchased 6000 acres

Housing Plots 40,000 sq yds

Built up area 900,000 sq feet

No. of land deals 1065

Most of these properties were in Rangareddy, a neighboring district of Hyderabad and a

total of 1065 land deals were struck to this effect. Most deals were struck through Akula Rajaiah,

a well-known real estate broker of Rangareddy.

Satyam scandal as a ‘control fraud’

The fraud perpetrated by the persons who control the company such as the promoter(s),

CEO and top management has been called “control fraud” (Black, 2005). Control frauds consist

of rational choices by the offenders. They are most prominent in case of failing firms. The CEO

typically will inflate profits and hide losses. This allows the CEO to delay the ultimate failure

and loot the firm in the interim. This becomes easier if the firm has no assets with readily

ascertainable market value, such as real estate or software. If the firm can get the auditors to

“bless it”, it can declare seemingly legitimate dividends year after year. The savings and loans

debacle has been described as a wave of control frauds (Black, 2005).

Control frauds that loot use accounting fraud as their weapon of choice (Akerlof &

Romer, 1993). This process produces fake profits and thus attracts investors who naturally want

to invest in profitable ventures. The CEO diverts this money outside of the firm, to be collected

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later. The CEO uses normal corporate mechanisms (stock options, dividend, growth in value of

the stock) to convert creditors funds to his personal use.

Control frauds use one of the two ways to commit the crime. In the first, they deceive

customers. They sell substandard goods to the customers who know little about the quality of the

product. The seller exploits this information advantage to misrepresent the quality of goods.

George Akerlof has shown that this can produce short term supra normal profits for the firm.

Enron engaged in this kind of fraud for some time. It took off electrical generating capacity off-

line during periods of high demand. This created capacity overloads in the electric transmission.

The fraud caused extraordinary increases in electrical energy costs in California, bankrupted two

major utilities and caused several blackouts (FERC, 2003)..

The second kind of control fraud comes from CEO’s who misuse their dominant position

to loot the firm, its shareholders and creditors. They create artificial profits by faking accounts,

even though the firm is actually making losses.

The offender uses the firm as both a weapon and victim of the fraud. Diamond (1997)

calls the super predators as pathogens, in the context of zoology. They infect their victims and

use them as a weapon to spread the disease. Wheeler and Rothman (1982) have also referred to

the corporation as a weapon and shield in case of white-collar crimes. The chairman of Satyam

used the company as a weapon to earn illegitimate profits. He used the audit mechanism as a

shield to hide the accounting fraud. For many, the idea that the CEO himself would loot the

company looks silly. However, this modus operandi is certainly possible. The former savings

and loan commissioner of California, William Crawford, explained: "The best way to rob a bank

is to own one" (U.S. Congress, 1988: 34).

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 Several companies have engaged in control frauds. The failure of Vernon savings has

also been described as a control fraud. Vernon carefully manipulated its accounting process to

escape the recognition of the regulatory mechanism to hide its fraud and losses (Mayer 1990;

Black 1998; O'Shea 1991). The Harshad Mehta Share scam in 1992, in India, was a massive such

fraud, which eventually led the government to create the Securities and Exchange Board of India

(SEBI). Harshad used many fraudulent methods, one of which was to inflate profits of Apollo

Tires Ltd. When the stock price reached dizzy heights, he sold off his holdings in one go. This

led to a collapse of the stock market. Investigations showed he had indulged in an amazing

variety of fraudulent practices, which were not monitored, due to the weak regulatory and

monitoring environment in India.

How was the Satyam fraud detected

In January 2009, Mr. Raju wrote a letter to the Board of directors that he had prepared

fake accounts for a number of years. He said, “I was riding a tiger and did not know how to get

off it without being eaten”. He said that he showed a profit margin of 25%, whereas actually it

was 3%. The accrued interest of US$ 81.59 million was non – existent. He also confessed to

understate liability to the tune of $ 266.91 million. The debtors’ position was overstated to $

106.33 million as against 575.27 million in the books. The cash at hand was shown to be about $

1 billion, whereas it was only $120 million in reality. Raju claimed that he was the only person

responsible for the fraud. However, Indian authorities later arrested and charge sheeted the CFO,

a managing director, the company’s global head of internal audit, Raju’s brother, officials of

Price Water House Coopers, the auditors and some others.

The role of whistle blowers

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 The fraud at Satyam continued for nearly seven years. The internal controls, regulatory

agencies and law were all there, but could not or did not want to detect the fraud. A whistle

blower finally blew the lid off. An analysis of the 14,000-page report of the Serious Fraud

Investigation Office (SFIO) reveals that a person by the name of Jose Abraham had sent a mail

on December 18, 2008, to Krishna G Palepu, one of the company’s directors that Satyam did not

have any liquid assets. This fact could be verified from the banks. Palepu circulated this mail to

other board members and to S Gopalakrishna of PWC, Satyam’s statutory auditor. This mail was

also forwarded to Ramalinga Raju, who failed to respond to it. The SFIO report says that Raju

discussed this issue with the company’s CFO and vice president between 25 December 2008 and

7 January 2009 in order to discuss ways to hide the colossal fraud. The board members and other

senior officials were constantly approaching Raju for answers. When Raju could no longer hide,

he was left with no alternative but to admit the fraud.

The role of whistle blowers has come further under the spotlight in another recent case.

The murder of Mahender Kumar Sharma on February 16, 2012, in Lakhimpur, India, raises

questions about the role and security of whistleblowers in the $1.14 billion health care fraud in

Uttar Pradesh (UP), the most populous state of India. Perhaps if there were sufficient protection

to whistle blowers many of the frauds would not have reached the massive proportions that they

did.

Sharma worked as a clerk in the Mitauli primary health centre of Lakhimpur, UP, when

he reportedly tried to expose graft in the department about the National Rural Health Mission

(NRHM). The department transferred him thrice in quick succession and then blocked his salary.

The Lakhimpur health department has figured among the top 10 districts where NRHM funds

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were misused in a big way. Ever since, the department has been under the scanner of the Central

Bureau of Investigations (CBI).

In India, the legal protection to whistleblowers has only recently caught the attention of

lawmakers. The Parliament recently passed the Public Interest Disclosure and Protection of

Persons Making the Disclosures Act, 2010. The protection it provides is far from adequate as it

addresses only institutional retaliation (termination or delayed promotion etc.). It is important to

expand the protection to include confidentiality and make it more broad based.

In the United States, the Sarbanes-Oxley Act, 2002, promotes whistle blowing and

employees are encouraged to file complaints anonymously. Several laws, for example,  Safe

Drinking Water Act (1974), Resource Conservation and Recovery Act (1976), Toxic Substances

Control Act of 1976 and Energy Reorganization Act of 1974 include employee protection

provisions. The Office of Whistleblower Protection Program investigates any retaliation against

the whistleblower. Federal employees also benefit from the Whistleblower Protection Act. There

is also a No FEAR Act, which makes individual agencies responsible for the economic sanctions

of retaliation.

Whether it was failure of Audit

Auditing is the process by which a competent independent person objectively evaluates

evidence regarding assertions of an economic activity. The audit process enables an auditor to

express an opinion on financial statements that are prepared within a framework of recognized

accounting policies and practice. An auditor is a representative of the shareholders, forming a

link between the government agencies, stockholders, investors and creditors.

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 In India, companies have to send the annual report to shareholders, stock exchanges,

DCA (Department of Company Affairs) and ROC (Registrar of Companies). The content of the

annual report is monitored by law and the quality of financial disclosure is judged by DCA,

SEBI and ICAI (Institute of Chartered Accountants of India). In India, non-compliance towards

Corporate Governance practices, if observed, by any director or manager, has to be revealed to

the Chairman, BOD or the audit Committee (Confederation of Indian Industries, 1998). Insider

trading and self-dealing of abusive nature is prohibited by the Corporate Governance code and is

regulated by the Prohibition of Insider Trading Regulations, 1992. An insider here is described as

someone possessing information, which is price sensitive, not in public domain and uses this

information to trade stock of the company (cited in World Bank, 2004).

Mr. Ramakrishna, former Chairman SEBI, said that the Securities and Exchange

Commission (SEC) of the U.S. had found Price Waterhouse guilty on several occasions in the

past. PWC had paid fines of $770 million in the last five years. In Satyam’s case, the CBI

arrested S. Gopalakrishnan and Talluri Srinivas, partners in PWC India, the statutory auditors of

the company for their alleged involvement in fudging and manipulation of financial statements.

According to T.V. Mohandas Pai, member of the Infosys Board, the Satyam fiasco should be

looked at more as an audit process failure and not as an accounting failure. He further said, “The

auditing process says very clearly that you must ask for an independent confirmation of bank

balances from the banks. To me it looks as if it has not been done”.

On the other hand, according to Samuel A. Di Piazza Jr., CEO of Price Waterhouse

coopers: “Generally audits are not designed to detect fraud. They merely asses the financial

position of a company. While doing that we look carefully to see if there are things that appear

14
unusual and yes, at times we may uncover fraud. Material fraud like you had in WorldCom, I

agree, generally surface in an audit.”

There is a famous 19th century English case, which defines the approach of auditors. An

auditor is seen as a watchdog and not a bloodhound. In that case, the judge held, ‘He is justified

in believing the tried servants of the company in whom confidence is placed by the company.’

This approach holds true even today.

The excess amount of cash without being used in any investment should have been a

concern for the auditors and should have raised an alarm for further verification. Many

accounting professionals believe that companies or their management, who keep enormous cash

funds, have suspect strategies. Keeping excessive cash reserves destroys the fund value (Basu,

2003). Not only did PWC not verify the cash statements independently from the banks, but was

unable to identify the reason of these nonexistent reserves. Satyam paid twice the amount to its

auditors as compared to other similar firms like Wipro, TCS and other large IT companies

(Gopalan and Mishra, 2009). It seems that some of the figures were customized and auditors

were involved with the Company in perpetrating the scam.

The United States has established the Public Company Accounting Oversight Board,

which monitors annually, the standards and procedures of auditing of public companies falling

under securities law. The Board guards investors' and well as public interest. The board checks

the audit work papers of last 7 years and verifies the auditor's extent of checking internal systems

of control. Further the board identifies the firm's adherence to standards of quality control while

issuance of audit papers. The firm stands a risk of getting the registration suspended, in case of

non-cooperation with the investigations. Quarterly and annual financial reports have to include

15
disclosures of "all material off-balance sheet transactions" and other provisions or commitments

that might have an impact on the firm's financial condition.

Victims of fraud

Employees of Satyam: They faced non-payments of salaries, layoffs, project cancellations and

bleak prospects of outside employment.

Clients: A loss of trust caused many to cancel their contracts and preferred to go with other

competitors. Cisco, Telstra and World Bank cancelled contracts with Satyam.

Shareholders: The erosion of value of Satyam’s share price from $29 to $ 1.5 after the scam left

the shareholders burnt. The investors lost $2.82 billion in Satyam.

Bankers: They were concerned about recovery of loans and no financial exposure and recalled

facilities.

Government: The fraud could affect the FDI inflows into India. The image of corporate India has

been mauled by the scandal. Its regulatory agencies failed to detect the fraud in time. A major

rethink into what went wrong and why the regulatory framework could not detect it would be

required.

Corporate Governance

Corporate Governance is the concept, which fosters honesty and visibility in corporations

(Martin, 2009). Its norms offer guidelines to organizations to not only set up but also implement

ethical goals. When corporate governance is adhered to, it leads to higher economic growth not

only at the organizational but also at the national level (Millstein, 2005). It received heightened

attention all over the world after scandals at Enron Corporation (USA), the BCCI Bank (UK) and

16
the Harshad Mehta Share Scam (India). The lack of ensuring appropriate corporate governance

norms probably led to the turmoil at Lehman Brothers, Morgan Stanley, Goldman Sachs, etc.

The recognition of companies following best corporate governance practices by national

and international bodies has come under shadow after the Satyam scandal. There is no doubt that

Satyam is a classic case of failure of corporate governance. It is noteworthy that Ramalinga Raju,

the then Chairman of SCSL was awarded the “Entrepreneur of the year” in 2007 by Ernst and

Young. He was awarded for “Excellence in Corporate Governance and Accounting Practices”.

The world council, based in London honored him with the Golden Peacock Award for best

practices in Corporate Governance, which was later withdrawn after Raju resigned from Satyam

and accepted falsification charges.

In USA, Sarbanes- Oxley Act, 2002 lays down guidelines for transparent financial

reporting, efficient internal controls and corporate governance. It emphasizes strong boards,

strong rights of shareholders and disclosures being crystal clear (McKinsey and Co, 2002). The

nomination of shareholders in the Board of Directors is based on the shareholders huge holdings

(Gedajlovic and Shapiro, 1998). The Public Company Accounting Board has been established in

the USA, which monitors the standards and procedures of auditing of public companies falling

under securities law. The board acts, as a guardian of the interest of investors’ as well as the

public. A firm that does not cooperate in investigations stands a risk of getting its registration

suspended. Falsification of documents with the intention of manipulating any investigation can

lead to 20 years imprisonment.

The Harshad Mehta share scam in 1992, and other causes led to the establishment of

Securities and Exchange Board of India (SEBI). The chief aim of SEBI is to regulate the stock

17
market and to protect the interests of investors. SEBI has played an important role in placing

systems and conduct for the corporate in India. It has powers of a civil court and can inspect

journals, registers and other related credentials, if required (Fernando, 2010). SEBI requires

compliance of all mandatory regulations, including a report on corporate governance.

Confederation of Indian Industries (CII) took the first notable initiative in 1998 by

establishing a code for corporate governance. The code has a list of recommendations for the

Board of Directors, highlighting the importance of disclosure of information, creditors’ rights,

and capital market issues. The Ministry of Finance and Company Affairs appointed the Naresh

Chandra committee to suggest changes in the code of corporate governance. The Narayana

Murthy committee was set up by SEBI in 2005 to review Clause 49 of the Listing Agreement of

the Stock Exchange and it proposed actions to improve corporate governance principles

including risk management, auditing standards, compensation of directors and auditing

standards.

The annual reports of companies have to be sent to shareholders, stock exchanges,

Department of company affairs (DCA) and Registrar of Companies (ROC). The content of the

annual report is examined by DCA, SEBI and ICAI (Institute of Chartered Accountants of India).

Though the corporate governance principles in developed countries like the USA and emergent

economies like India are similar, the difference lies in enforcement (Berglof and Classens, 2004,

cited in Chakrabarty, 2005). Many Indian companies are family owned businesses. This leads to

minimal representation of independent directors and lack of transparency in decision-making.

The Role of Independent Directors

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 The role of independent directors has been much emphasized in all corporate governance

codes. In case of Satyam, the company did have the required number of independent directors as

required by the Companies Act, 1956 as well as SEBI guidelines. However, the independent

directors failed to do their duty. Let us analyze why this happened.

As per former chairperson SEBI, M. Damodaran, independent directors “must be

competent, knowledgeable and bring fresh perspective and business acumen”. There are no clear

requirements for selection and appointment of independent directors in the present SEBI Act.

Moreover, the management and promoters control the process of appointment. The Board of

directors of Satyam consisted of five independent directors out of nine as required by law. One

of the independent directors in case of Satyam was Krishna Palepu, the Ross Graham Walker

Professor of Business Administration and Senior Associate Dean for International Development,

at the Harvard Business School. He is a specialist in corporate governance and an advocate of

tougher auditing. Another independent director was Rommohan Rao, the Dean of Indian School

of Business, Hyderabad, a top league B school of India. Vinod Dham, the co inventor of the

Pentium processor was also on the Board of Satyam.

The Board first came under fire when it approved Satyam’s purchase of real estate

companies Maytas Infra, in which Mr. Raju owned a huge stake. After a revolt by the

shareholders, the Board was forced to rescind its approval. Palepu, Rommohan Rao and Vinod

Dham all resigned from the Board within two days of the failed Maytas deal. The Board also did

not catch any red flag all the years the scam was brewing. Raju systematically decreased his

holding from 15.67% in 2005 to 2.3% in 2009. Strangely, this fact also escaped notice of the

independent directors.

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 In fact, the independent director of Satyam, were independent only in name. They were

given stock options at ridiculously low prices. In addition, they also received huge commissions

in various forms. For example, Harvard Professor Palepu accepted more than $200,000

compensation for conducting training of Satyam’s employees on corporate governance principles

and their compliance.

Thus, mere compliance of SEBI’s rule of the minimum number of independent directors

does not guarantee ethical practices. The concept of independent directors was suggested in

1940s in the USA to protect mutual fund investors, does not seem to have achieved its aim.

Instances, such as Enron, which had 80 per cent of its Board consisting of independent directors,

Tyco, with 65 per cent and WorldCom with 45 per cent suggest that there is no relationship

between the number of independent directors and the board independence and financial

performance of companies.

In fact, Palepu and Rammohan pleaded that the lawsuits in the USA be dismissed since

there was no specific allegation against them and they fail to allege intent to defraud as required

by the US securities law. Companies listed on the Bombay Stock Exchange have to submit

reports required by Clause 49 of the Listing Agreement, including corporate governance

information on their boards’ composition, audit committees, CEO/CFO certification of accounts,

and related-party transactions and subsidiary companies. It seems that BSE has not paid adequate

attention to its enforcement. Only 1,228 companies out of the listed 4995 have submitted the

required reports.

Insider Trading

Investigations by Andhra Pradesh police and Central agencies have confirmed that the

promoters indulged in insider trading of the company’s funds for purchasing land. The funds

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thus obtained were used to buy land in the names of 330 companies and about 30 individuals.

The inflated profits meant higher share prices. The top management sold their shares and

invested the proceeds in land or elsewhere. They were offloading shares in the weeks and months

preceding the surfacing of the scam. The CFO of the company, Srinivas Vadlamani, offloaded

92,358 shares in two installments in Sept 2008. Ram Mynampati, President of Satyam and a

member of the board also offloaded 80,000 shares in three installments in May and June 2008.

Most senior officials including the chief information officer were selling shares during later part

of 2008. Several institutional investors dumped Satyam shares up to two days before Ramalinga

Raju confessed his misdeeds. Most sales seem to have taken place after the failed bid to acquire

Maytas Infra and Maytas Properties. It is widely suspected that the top management knew that

the ‘end’ was near and that is why they resorted to selling the artificially high priced shares.

Red Flags

The confession by Raju was not the first sign of the rot in Satyam. There were warning

signs as early as 2002-3. The relevant authorities overlooked these indicators. Ramdas Athale, a

Member of Parliament (MP) filed a complaint against Satyam with SEBI in 2003. Political

pressure could have been the reason why no action was taken on that.

Ramesh Gelli, the Chairman of Global Trust Bank (GTB) was a close friend of Raju. He

had a dubious relationship with scamster Ketan Parekh and was banned by SEBI on the charge of

price rigging in 2002. Both GTB and SCSL had the same auditor: PWC. When GTB failed, the

role of PWC was under a scanner. This should have been a cause for concern.

The Securities and Exchange Commission (SEC) of the US had placed fines to the tune

of $ 770 million in the last five years after it found PWC guilty on several counts. Hiring of an

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auditor with this record of accomplishment and not monitoring it by the board of directors

proved to be a costly mistake.

Regulatory Structure in India

The Directorate of Enforcement (DOE) functions under the Ministry of Finance,

Government of India. It develops intelligence and is responsible for enforcing the provisions of

the Foreign Exchange Management Act, 1999 and Prevention of Money Laundering Act, 2002.

It can conduct searches, imposes and realizes penalties and prosecutes persons involved in

money laundering.

The Central Bureau of Investigations (CBI) is an important national agency to investigate

criminal cases involving national or inter-state ramifications. It derives its statutory powers from

the Delhi Special Police Establishment Act, 1946. It investigates cases involving corruption in

high places, serious fraud, cheating and embezzlement and social crime, particularly of hoarding,

black-marketing and profiteering in essential commodities.

The Government of India set up an independent office, Serious Fraud Investigating

Office (SFIO) under the Department of Company Affairs in 2003. The SFIO can investigate

cases when the Government of India, under section 235 of the Company’s Act, 1956, authorizes

it. The SFIO submits the report to the government, which can then take up prosecution as per the

report of SFIO. The SFIO is a multi disciplinary organization consisting of experts in the fields

of accountancy, forensic auditing, law, information technology, investigation, company law,

capital market and taxation for detecting and prosecuting or recommending for prosecution of

white-collar crimes/ frauds. The SFIO will normally take up for investigation only such cases,

which are characterized by complexity and having inter-departmental and multi-disciplinary

22
ramifications. It has powers to search and seize any documents, financial papers of group

companies and entities related to thereto.

A money laundering case was registered against the founder Chairman, B Ramalinga

Raju by the Enforcement Directorate (ED) of the Income Tax Department. The ED has found

evidence confirming the violation of the Prevention of Money Laundering Act. The CBI has also

filed a charge sheet under various sections of the Indian Penal Code (IPC). These include section

120-B (criminal conspiracy), 420 (Cheating), 419 (Cheating by impersonation), 467 (forgery of

valuable security), 471 (forgery for the purpose of cheating), 477-A (using a forged document as

genuine) and 201 (destruction of evidence). The CBI charge sheet confirms money laundering by

Raju and his cohorts. They diverted the funds obtained by manipulating accounts to tax havens

abroad and later brought them back to India through front companies to buy lands.

Regulators and Credit Rating Agencies

There was no immediate probe or action taken by SEBI, regarding the World Bank

declaring Satyam ineligible to receive any direct contracts for eight years. The reasons stated by

the World Bank, for their decision were improper benefits to staff, improper documentation and

malicious attacks on Bank’s information system. The reasons were quite indicative of the

allegations of poor corporate governance (Ribeiro, 2008). Post the scandal, the Insurance

Regulatory Development Authority, IRDA’s chairman Mr. J. Harinarayan, raised a finger on the

authenticity of the rating agencies and questioned the reason to have the audited balance sheet as

the only criteria for corporate. It is evident that there has to be a diligent process to toughen

methodologies and standards of quality/transparency assurance as rating agencies gave Satyam

Computers a Triple A (AAA) rating (Economic Times, 2009). Ratings need to be, hence,

23
evaluated more deeply and apart from the balance sheet other parameters like market

information, external auditors etc. should also be considered.

Conclusion

Though Satyam was not the first large scale fraud of corporate India, its enormity and

nature is an eye-opener for those fighting white-collar crime. The perpetrators of the fraud

merrily carried on with illegal activities for about seven years. There must have looked with

disdain at the vast army of professional managers, internal auditors, “independent-directors

dominated” board of directors, the market regulator SEBI, the Company Law Board, the

Department of Corporate Affairs, BSE, ICAI and other regulating and monitoring agencies. Why

these agencies chose not to respond to the red flags appearing regularly needs to be investigated.

Specific legislations, such as those protecting whistle blowers, are required to be enacted

in India. The enforcement of current laws and regulations needs to be monitored strictly by the

concerned regulating agencies. Internal control mechanism is required to be strengthened to

prevent such frauds in the future. Stricter norms for auditors and independent directors are

required. Market regulators such as SEBI and BSE have to formulate regulations which address

these concerns. The ICAI also needs to look up its audit management process in the country and

bring it in line with international practices.

The penalties for offences of this category are too lenient in India. For example, if an

auditor fails to comply with mandatory requirements, he faces a fine of $ 200 and a maximum

imprisonment of two years. The Sarbanes-Oxley Act, of the USA, prescribes imprisonment of 20

years for similar offences. In case of India, the penalties prescribed for offences under which

Satyam was prosecuted are in the region of two to seven years. The US law offers incentives to

24
whistle blowers and provides protection to them. This has improved fraud detection. India could

learn from this experience not to trust CEOs and Board of Directors blindly.

Finally, awareness at all levels has to be generated against such frauds. An informed

society is the best prevention for white-collar crimes of this nature.

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