Will The New Satyam Board Bring Back The Lost Glory?

'Satyam’ in Sanskrit means ‘Truth’, but it is quite ironical that the same word has come to be associated with falsehood, deceit, greed, fraud, chicanery and worse… The promoters of Satyam have turned the sublime and revered word into an object of revile. The enormity of the crime perpetrated by the promoters has shocked and shaken the corporate world and investing community alike even as they watch the skeletons tumbling daily out of the Satyam cupboard with disbelief. So massive is the scale of this fraud that it almost fell the fourth largest IT company in India. The gigantic fraud has not only severely dented the company’s image, it has also dented the morale of its employees and shaken the confidence of its clients and the investor fraternity at large. Now, forget about expecting returns, investors would be hard put to believe that even ‘fundamentally sound companies’ could be trusted for parking their funds.

A controversial event that started more as a corporate governance issue has culminated into one of the biggest frauds that Corporate India has ever seen. Even after foiling management’s first attempt at deception on December 16, 2008, little did the investors know that a much bigger scam was waiting to blow up in their face that would wipe out overnight their years of gains. However, after Ramalinga Raju’s letter became public, all hell broke loose and the Satyam scrip crashed, losing a whopping 87 per cent in just two trading sessions (i.e. January 7 & 9, 2009). While on BSE the scrip touched a low of Rs 11.50, on the NSE it was just Rs 6.30. From its 52-week high of Rs 544 in May 2008, the fall was even worse at around 98 per cent! However, now nobody knows the exact value of the stock. While most investors (both domestic and foreign, retail as well as institutional) in Satyam suffered due to the massive fall, only a few of them were lucky to make an exit. One of them is Sundaram BNP Paribas, whose spokesperson M R Vaidyanathan confirmed that “as of January 5, 2009, Sundaram BNP Paribas Mutual Fund had no exposure in Satyam Computer Services across it schemes and have added to cash.”[PAGE BREAK]

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Raju’s letter was a bombshell which exploded right into the faces of the investors, clients, employees and many others. Did his letter mean that after years of deception his conscience had finally forced him to accept that manipulation did occur in Satyam’s accounts? The letter gives vivid facts and numbers of manipulation, the cash and bank balances that never were and, the best part is that it spells out the corrective steps that can be taken to manage the crisis. It is surprising to see that a person with such a burden on his conscience could write such a structured letter with such finesse. But before we attempt to decode the letter (Read: Decoding of Raju’s letter) we’ll look at the many questions that are begging for answers.

Raju’s confession tip of the iceberg?
The first question that begs answer is: Why did Raju confess? Although some might think that Raju has come clean with his confession, we do not think so. The last one month has already shown that Raju has not been as honest as was believed to be after he tried convincing investors about benefits of the Maytas deal or demanded an apology from World Bank when he knew for sure that he wasn’t right. So Raju’s confession letter doesn’t make him a saint and hence we would rather dig further into his confession rather than taking him at his face value. Firstly, the letter is so well written and properly structured that it clearly shows it wasn’t written in a hurry and that it appears to be a well-thought out strategy of Raju so as to make people believe in his version of the story even while admitting the biggest corporate fraud. Raju is clever enough not to give too many details, apart from revealing some specific numbers from the September quarter. Hence, this letter could be more to divert attention from the fraud than to revealing the true and full dimensions of the fraud which could be much larger. In fact, what Raju has revealed could be just the tip of the iceberg. In fact the Satyam plot only thickens with each passing day as latest reports claim that Satyam’s senior officers have together sold around 60 lakh shares in 2008. Topping that list is previous elected interim CEO and President Ram Mynampati who sold 9.5 lakh shares when Satyam’s scrip price was around Rs 300-500 per share. If this is the case then it is quite clear that Satyam’s senior officers were aware of the fraud, which is in contrast to Raju’s statement that apart from him nobody was aware of the sorry state of Satyam’s accounts.[PAGE BREAK]

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An attempt to wriggle out of the mess?
The second possibility that Raju may have had very limited options left to get out of this mess. This is evident from the fact that Raju sent the letter to the exchanges on January 7, 2009 at 10.53 a.m. mentioning that DSP Merrill Lynch can be trusted with the task of quickly exploring merger opportunities. However, DSP Merrill Lynch (DSPML) in its letter to the BSE had informed that it had terminated its engagement from the Satyam assignment with effect from January 6, 2009 on grounds of ‘material accounting irregularities’ in Satyam’s books. Satyam was also informed about it by DSPML. Thus, since DSPML’s letter had anyway exposed the fraud, Raju might have thought of confessing rather than getting caught. When contacted by us, DSPML declined to comment on the issue. However, in the larger interest of the shareholders, we feel SEBI should direct DSPML to disclose these accounting anomalies to help investigators solve the case quickly.

Where did Rs 5,000 crore go?
IT companies command higher valuation due to their better margins, which leads to higher profits and higher cash from operations. But it’s preposterous when you read that 94 per cent of Satyam’s cash and bank balances did not exist at all. If a 20-year-old IT giant with presence in 60 countries and servicing 185 fortune 500 clients doesn’t earn such money then who will? So was this company showing fake revenues, fake contracts and fake clients all these years? This may have been true partially where the company would have played around with the revenues, it is also true that the company did have income, it did get contracts and it does have Fortune 500 clients. But the problem is with its operating margins, which as on September 2008 quarter, stood at a mere 3 per cent as per Raju’s letter. Thus, the company could be making a loss on the net level. This is just about one quarter and Raju’s letter claims that the fudging of accounts has been going on for years. So, there is a possibility that it was a loss-making company in the previous years as well, which would then explain the inflated or non-existent cash balances. Secondly, what ate into the margins are the increased costs. The letter mentions that to justify the higher level of operations the company had to carry additional resources and assets. Thus Satyam had much higher bench strength than required, which increased its cost unnecessarily thereby leaving its operating margins at mere 3 per cent rather than 24 per cent it had stated previously. The other possibility is that Satyam could have enjoyed higher operating margins of 24 per cent, but profits might have dropped not because of the additional resources, but because the promoters might have siphoned off the money. In fact, Satyam’s CFO Srinivas Vadlamani admitted that he did not pay attention to the[PAGE BREAK]

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Balance Sheet details which was prepared by his assistant Ramakrishna. This clearly indicates negligence on the part of the internal audit team.

Why Balance Sheet was inflated by Rs 7,000 crore?
Investors always like aggressive and progressive companies rather than regressive companies. In a bid to do match up to the numbers of their peers, companies resort to all kinds of manipulations to pump up their numbers. We believe Satyam’s case could be a result of such peer pressure. Call it Raju’s ego, greed for money or the need to keep the stock buzzing, the company has over the seven years continued to inflate its profits to show better results. And they were quite successful at this considering the fact Satyam was considered one among the Big 4 of the Indian IT industry. However, maintaining this rate of growth and margins similar to those of its peers led to further bloating of the Balance Sheet size. This resulted in huge increase in its cash and bank balances, which as on September 2008, stood at whopping Rs 5,361 crore, out of which Rs 5,040 crore never existed! Even the company resorted to over-stating debtors, which also resulted in bloating the Balance Sheet size by more than Rs 7,000 crore.

Satyam dogged by controversies in the past too
This is not the first time that Satyam has found itself mired in controversies. The company’s tryst with controversies goes back as long as nine years. In the year 2000 Satyam through its subsidiary SIFY had acquired an unknown internet company called as India World. India World was a company, which had various web portals such as www.samachar.com, which covered India related news, www.khel.com, which was dedicated to covering sports, while www.khoj.com was the Indian search engine and www.bawarchi.com provided information on Indian recipes, respectively. However, what was shocking about this acquisition was that Satyam paid a whopping $115 million or Rs 500 crore for a company that had revenues of a mere Rs 1 crore with profits of just Rs 25 lakh. It should be noted that during 2,000 dotcom boom, IT companies’ valuations had reached dizzy heights. India World had claimed that it had 13.5 million page views every month and if these numbers were to be believed then Satyam paid around $8.51 or about Rs 425 to acquire each of these page views. However, it was also being said that internet companies including Yahoo and Amazon’s average capital cost that goes into each page view was around $2. If this was true, it’s obvious that Satyam had paid too high a price for this acquisition. Besides, it should be noted that when Satyam exited SIFY it didn’t make money as in 2002-03 it got $119.62 mn or Rs 598 crore for its 52.5 per cent stake in SIFY. [PAGE BREAK]

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If that wasn’t enough, the Department of Company Affairs had also received several investors’ complaints way back in 2002 on the accounting irregularities, while the shareholders had also accused Satyam of holding back material facts. This happened when Satyam went ahead with merger of Satyam Enterprise Solutions (SESL), Satyam Renaissance Consulting (SRCL) and Satyam Spark Solutions (SSSL) with itself. Here SESL made a right issue of 12 lakh shares at par of which 4 lakh where bought by Satyam, while the rest 8 lakh went to the then Director C. Srinivasa Raju of SESL. Thus, while SESL shareholders were given shares of Satyam in the ratio of 1:1, it resulted in Srinivasa Raju getting 8 lakh shares of Satyam at price of just Rs 10 per share when the shares were trading at Rs 1,600! That apart, Republican Party of India MP Ramdas Athawale had written a letter to the then SEBI Chairman G.N. Bajpai claiming that an IT investigation had discovered a host of benami bank accounts with Rs 20 crore traced to the Satyam promoters. Athawale had also raised the issue in the summer session of the parliament in 2003. It is due to these controversies that Satyam lost its premium in the market and continued to trade at a discount to its industry peers.

PWC is not clean either
PriceWaterhouseCoopers’ (PWC) official statement read, “The audits were conducted by the company in accordance with applicable auditing standards and were supported by appropriate audit evidence.” But how can one believe that a large and renowned audit firm such as PWC failed to find such a huge anomaly of non-existent cash balance of Rs 5,000 crore? A strategic advisor such as DSP ML was able to find out these material accounting irregularities within a matter of eight days after being appointed on December 29, 2008. This certainly raises questions about the integrity of PWC’s audit of Satyam over the years. It also shows that this isn’t just the handiwork of Raju alone and there is collusion or deliberate negligence of PWC as well in the fraud.

But considering PWC’s involvement in the Global Trust Bank (GTB) case, it’s clear that PWC’s past is not clean either. PWC was the auditor of GTB. Ved Jain, President, ICAI, says, “PWC officials were also involved in GTB case and the Council of the Institute has completed its investigation and held the PWC partners guilty for that fiasco. That matter has been finalized now and the case is in a concluding stage.” In fact, RBI had barred PWC in December 2005 from conducting banking audit when it found that the firm under-provided for non-performing assets of Global Trust Bank. Serious Fraud Investigation Office (SFIO) of the Ministry of Corporate Affairs had also found Lovelock & Lewes, an auditing entity of PriceWaterhouseCoopers (PWC), guilty of manipulating accounts of DSQ Software. Lovelock & Lewes was the auditor of DSQ Software. In fact, there are as many as 86 companies where Price WaterhouseCoopers is an auditor (Refer list attached), who might now be having second thoughts about PWC. While some of these refrained to comment on the issue, HCL Technologies[PAGE BREAK]

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sources said “We are waiting for the events to unfold and we are clear that if there was a point of negligence, proved by the auditors we would take a call, as it’s a very sensitive issue”. Thus, PWC being part of the Satyam fiasco, the PWC partner who signed the Balance Sheet if proved guilty could be banned for life, while PWC could face stern action by the government. Jitesh Kosla, Joint Secretary, Ministry of Corporate Affairs, says, “There will be lot of thinking on the rotation of audit partners, but not on the rotation of auditors as such. There are so many things attached to it and alternative means available to manage this issue. For example, in firms like Arthur Anderson, auditors were proceeded against directly. So ministry and all bodies concerned will have to look on all those means.” However, Akil Hirani, Managing Partner, Majmudar & Co., puts forward a different argument and says, “There are cases where courts have absolved auditors from liabilities for falsification of accounts. For instance, in Tri-Sure versus A. F. Ferguson, the Bombay High Court held that the “auditor is required to employ reasonable skill and care but is not required to begin with suspicion and to proceed in the manner of trying to detect a fraud or a lie.” (1987) 61 Com Cases 548, (Bom HC), This case too involved falsification of the company’s accounts.” 

Government did what it had to do
With the Satyam issue getting out of hand, the government had no other option but to take control of the crumbling IT giant. This could be one of the first instances where the government intervened directly in the affairs of a big private entity and superceded the Board and appointed its nominees. This move attains huge significance as it is being done in larger interest of over 50,000 employees, its international clients spread in over 60 countries and, last but not the least, the shareholders. The government has appointed Deepak Parekh, Chairman, HDFC, Kiran Karnik, Former President, NASSCOM, and C. Achuthan, Former Chairman of the Securities Appellate Tribunal, on the Satyam board. In fact, Mr Parekh’s appointment would ensure that Satyam gets funds to keep itself running, while Karnik’s appointment would help restore clients’ trust in the company, while Achuthan’s presence will help in addressing shareholder and regulatory issues. One thing is quite sure, the government doesn’t want Satyam to sink. The Commerce and Industry Minister Kamal Nath said that the government could give Satyam financial support, if needed. The new directors too have wasted no time and have already appointed new auditors KPMG and Deloitte and have listed out some of their priorities, including appointment of new Chief Executive Officer, Chief Financial Officer, restating the company accounts, seeking extension for Q3FY09 results, preponing payments from clients to improve liquidity and address working capital needs.[PAGE BREAK]

The Satyam episode came as a rude shock to everyone. We believe the regulators would now get stricter as far corporate governance is concerned. In fact, media reports suggest that SEBI would be inspecting the books of Sensex and Nifty-based companies. However, though we appreciate regulators being more proactive henceforward, inspecting books of Sensex and Nifty companies would actually send wrong signals to the market, which has already shed its gains. Besides, such a move will also raise suspicion among the FII investors who would become more cautious while investing in Indian markets. Instead, we would urge the regulators to bring in more stringent norms for Indian corporates, which would help restore investors’ faith once again. In fact, UK-based research firm Noble Group has estimated that at least a fifth of India’s top 500 companies’ practice ‘creative accounting’.

That apart, regulators should now focus more on the IPO market where the maximum number of accounting anomalies takes place. In their bid to get a better price, it is observed that companies inflate their numbers to give a much better picture. However, after listing, these companies’ financial performance either does not match up or even deteriorates. On the other hand, some companies run into corporate governance issues before their IPO itself. DLF is one such company which was sued by minority shareholders regarding the advantages taken by the board against the conversion of convertible debentures. Around 1.91 crore equity shares were issued to the promoters just before the IPO. There are other companies which try to take investors for a ride.

Kolar Biotech was one company which was banned by SEBI against the massive fraud committed by the promoters. Kolar Biotech along with its two subsidiary companies (Soundcraft Industries and Adam Comsof) jacked up the prices by announcing bonus issues, which was followed by huge offloading of shares by promoters through subsidiary companies. What was shocking is that the company used the same address for all the three companies as their registered office and also issued a notice for board meeting at the same place although it was sealed. Even Indian companies listed on international bourses have also stayed in the news for wrong reasons. AIM listed Hiranandani Group’s Hirco made it to the newspapers after one of the US-based hedge funds opposed merger resolution of its two subsidiaries proposed by the Hiranandanis. Hirco’s proposed merger would give it direct control over the Hiranandani real estate projects and Hirco Developments. Shareholders believe these resolutions were economically damaging to shareholders as these will dilute shareholder voting power and may remove the company from regulatory oversight. The fund also believes the resolutions are favourable to the company’s management and the Hiranandanis who will have a financial windfall and voting control of the company. Currently, the merger has been put on hold. As far as IT is concerned, the Satyam episode is of course a big jolt to the sector, but we believe with the government intervention Satyam would be revived. The next few months will reveal the extent of damage and value of the fraud. If Satyam doesn’t really have the scale of operations it has been showing over the years, then there could be downsizing and rationalisation of resources leading to job cuts. That apart, India still remain a preferred outsourcing destination, but the clients would henceforth conduct more due diligence before signing contracts with Indian companies.