Wednesday, February 15, 2017

Satyam Scandal- Ethical Model Analysis

Satyam Scandal- Ethical Model Analysis

1.   Introduction and Background
In the year 2009, when the world was already reeling under the impacts of major financial recession, Indian Technology sector was hit by what is termed as the most colossal fraud in corporate history of India, The Satyam Scandal. The fraud often dubbed as the ‘India’s Enron’1 took everyone by surprise as at the time scam was exposed, Satyam was a renowned Indian IT company. However, things turned ugly when on January 07, 2009, the chairman of Satyam Computer Services Ramalinga Raju wrote a letter to Securities and Exchange Board of India admitting to the fraudulent activities and financial irregularities in his company2.Ramalinga acknowledged in his letter that he had been forging company’s accounts by overstating its revenues and inflating its profits for years and that Satyam Balance sheet showed nearly $1.5 billion in non-existent cash and bank balances, accrued interest, and misstatements3.
Before we analyze the factors led to the debacle of Satyam, we briefly discuss the background of the company which was doing well in business before the scam came to light. Satyam, the name which ironically means ‘Truth’, was established in 1987.It was a major IT player which provided services across the globe in fields of healthcare, Bio -Tech, Telecommunication, Banking and Finance4 etc. Prior to 2009, Satyam Computer Services was fourth largest Indian IT Service Provider5 which was generating USD 2.1 billion revenue5. It had 9% of the market share6. There were 530007 employees working in different IT Projects on different IT projects in Satyam’s Development Center across the world. Its clients included 163 Fortune 500Companies. The exports of Satyam accounted for almost 75.9 %9of its total sales revenue with North America being the largest contributor (65%)10Everything was going well with Satyam until the sequence of events unfolded which ultimately led to the disclosure of not only the biggest financial but also the major ethical scam of corporate India
2.   Ethical Framework
Satyam was evidently the case of ethical malpractices of Ramalinga Raju, chairman of the company who admitted his own misconducts. The Serious Fraud Investigation Office (SFIO), investigating arm of Ministry of Corporate Affairs in India investigated the case and submitted its preliminary report on April 13, 200912.  Per the report, Satyam founders, ex-CFO Vadlamani Srinivas, and ex-vice-president (finance) G Ramakrishna, conspired to artificially increase the revenues and profits in the books. The report highlights that the falsification was done by deliberately leaving loopholes in the Computerized Accounting System which uses ERP modules. The high-level application landscape of Satyam internal applications has many links between various systems where either there was no integration or there was weak integration. These loopholes were intentionally left to insert fictitious invoices and bank statements to balance them without being detected13.

2.1         Unethical Conduct – Ramalinga Raju
Satyam’s chairman Ramalinga Raju’s way of conducting the business is the classical example of unethical practices in the industry. He was solely driven by the greed of money and acquiring lands. He wanted to compete with the top three IT companies of India (Infosys, TCS and WIPRO). Raju chose the easiest yet the most immoral ways to achieve his goals. He forged the accounting books for nine years, avoided taxes, and diverted the money received from shareholders, created fake clients, account salaries and invoices. Ramalinga Raju showed his company in very good financial health and attracted money from shareholders to buy lands. Ironically, he had bagged golden peacock global award in 200814 for good corporate governance. Also,+ world Bank in December, 2008 barred Satyam from business for eight years for providing Bank staff with “improper benefits”. Ethical standards thus in the company were poor15.
2.2         Insider Trading
The promoters indulged in insider trading of the company’s shares to raise money. The funds collected by the former chairman B.  Ramalinga Raju, his brother Rama Raju and their relatives were used to purchase lands in the names of 330 companies Promoters of Satyam and their family members during April 2000 to January 7, 2009 sold almost 3.9 crore shares collecting in Rs 3029.67 crore16. The promoters based on the inflated books thus projected a very good financial position of the company and used the shareholders’ money deceitfully for their personal gains.
2.3         False Books & Accounting
According to the findings of SFIO, Satyam’s balance sheet as on September 7, 2008 carried an accrued interest of Rs. 376 crore, which was non-existent. The company had created a false impression about its fixed deposits summing to be about Rs 3318.37 crore while they held FDRs of just about Rs 9.96 crores17.
One of the biggest sources of forgery at Satyam was the inflation of the number of employees. While founder chairman Raju claimed that the company had 53,000 employees on its payroll but in real number was just over 40,000.  The fictitious number  could  be fabricated only because payment to the remaining 10,000 employees was faked year after year - an operation  that  evidently  involved  the  creation  of  bogus  companies  with  a  large  number  of employees18.
2.4         Negligent Board of Directors
The directors at the Satyam Board never questioned the actions of their Chairman. They did not raise objections when the management decided to invest 1.6 billion dollars to acquire a 100 percent stake in the two real estate firms promoted by Raju's sons19 which was in gross violation of the Companies Act 1956, under which no company is allowed without shareholder’s approval to acquire directly or indirectly any other corporate entity that is valued at over 60 percent of its paid-up capital.
2.5         Dubious role of Independent directors
Six of the nine directors on Satyams Board werindependent directors including US academician Mangalam Srinivasan (the independent director since 1991), Vinod KDham (famously known as father of the Pentium and an ex Intel employee), M Ram Mohan Rao (Dean of Indian School of Business), US Raju (former director of IIT Delhi), T.R. Prasad (former Cabinet Secretary) and Krishna Palepu (professor at Harvard Business School)20. They all were men of good reputation. But the fact that seven out of nine of these directors were present when Maytas deals were unanimously finalized, raises questions about their integrity. It indicated that they were aware of the malpractices and kept silent about them.
2.6         Dubious role of rating agencies
Credit rating agencies based their ratings of Satyam based on the falsified documents and never did any due diligence in their coverage and assessment21. They seemed conveniently unaware of the deteriorating financial condition of Satyam and therefore could not warn investors in advance.
2.7         Questionable role of Banks
 Banks did not raise any doubt while sanctioning the short-term loans to Satyam which was supposedly a cash rich company. The behavior of banks is unscrupulous in this regard22.
2.8         Unscrupulous role of Auditors
Price Waterhouse, was the auditor for Satyam and have been auditing their accounts since 2000-0123. The auditors compromised on standards by not using the PwC standard testing tools rather they relied on Satyam for that. Auditors, in connivance with perpetrators, did not report the possibility of fraud and control deficiencies in Information Systems to shareholders. The Statutory auditors also failed in discharging their duty when it came to independently verifying cash and bank balances, both current account and fixed deposits. There needs to be a physical verification of assets owned by the company rather than simply relying on the books prepared by the company.
Satyam ownership model was flawed from the perspective of good corporate governance24.
1.   As a publicly owned company, it was under pressure to overstate profits to keep the company’s bonds and equities in high esteem.
2.   Mr. B. Ramalinga Raju, diluted his holding from 25.6 % in 2001 to 3.6 % in 2009. He could overstate profits with the objective of influencing other shareholders. The overstatement never hurt him as his own share was small.
3.   Satyam would not have overstated its revenues and profits if it had to back both with real cash. A big part of the blame for the colossal fraud thus belongs to India’s trade and fiscal policy makers.
·       Deontology: is the study of that which an “obligation of duty”25 and consequent action based on moral judgment determine whether the person, business or any actor has complied to.
Ramalinga Raju actions were ethically in contrast with what is expected from the leader of any organization. He put his greed and ambitions before his duties towards his company, employers and stakeholders and did not hesitate from falsifying the accounting books for years ignoring all moral obligations towards them.
·       Consequentialism26: is the judgment on right or wrong based on the consequences of action taken or conduct of individual, company et al.
It is quite evident from Ramalinga Raju’s letter that when he started to show inflated numbers in his Account books, he miscalculated the consequences of his unlawful actions in long term. Since company was doing well in terms of business (on papers) stakeholders were happy, Raju chose to conveniently overlook the approaching disaster. In his own words “It was like riding a tiger without knowing how to get off without being eaten” (source 7: Economic Times (New Delhi), January 8, 2009, p1.). After his last attempt to fill the fictitious asset with real ones failed, he had to come face to face with the disastrous consequences of his unethical actions.
·       Graham Tucker’s 5 Questions27: The actions of Ramalinga Raju’s can be analyzed based on following questions:
o   Is decision profitable?  -  In short term, Yes. In long term, No. Due to manipulation in accounts, Satyam established its good reputation in the global IT market that helped it attract many investors and gain confidence of clients. The share prices rose due to fictitiously inflated numbers in accounting books but as soon as the truth came out the Satyam shares crashed 77% directly hitting the shareholders28 So in long run Ramalinga Raju’s unethical actions did not yield any profit to anyone.
o  Is decision legal? – No. Raju flouted all the corporate governance rules. He projected the bank balance which did not exist and created fake salary accounts, invoices and illegally diverted money to purchase lands.
o   Is decision fair? -  No, the decision was not taken based on fairness and accountability. The balance sheet and other financial statement should reflect the correct picture of the organization however, in Satyam’s case all the financial statements were unfair and manipulated.
o   Is the decision, right?  -  No, the decision made by Raju reflects his greed and hunger for power and money. As a decision maker, Raju should have considered the negative impacts of his decision on the Indian IT industry. He was rather focused on improving his company’s profits by manipulating the accounts and statements bringing the trust factor on Indian IT companies.
o   Is the decision going to further sustainable development?  - No, the decision in fact had negatively impacted the company’s sustainable development. The decision’s scope was not limited only to Satyam but led to the crash of entire Indian stock market.
·       Virtue Ethics29: Satyam prescribed itself to some great virtues and principles, though their conduct is completely opposite of what they claim to be. Ramalinga Raju flouted every rule in the book of corporate governance to fulfill his hunger and greed for power and money. If the conduct was ethical it would act parallel to the virtues expected by stakeholders. Out here virtues like Sustainability, Honesty and Integrity were only preached but not practiced. The act is based more on greed of making profits at the cost of shareholder’s money.
As soon as the news of Ramalinga Raju’s letter to SEBI (Securities and Exchange Board of India) broke out, the Satyam shares plunged 77%, the future of 40000 employees became uncertain, and the trust on Indian IT sector was shattered. Government of India promptly intervened to save interests of shareholders and, employees as well reinstate the faith in India Inc at global level. Legal cases were filed as per law of land of India against all accused including Ramalinga Raju, his brothers and PWC auditors. Government appointed six-member board to contain the damages in the aftermath. The boarselected Tech Mahindra through the global competitive bidding process. Consequently, Tech Mahindra (holding 31% stake in Satyam) bought Satyam renaming it on June 21, 2009, as MahindrSatyam and replaced its executive Board and Auditors30. Though the steps taken by Government ensured that Satyam did not collapse, however there were multiple financial, legal and customer challenges for new “Mahindra Satyam”In the first few months after the takeover, the new management in Mahindra Satyam spent its energy on traveling, meeting key customers, and reassuring them that it was  business  as  usual. A few customers like State Farm Insurance had moved to rivals even before the new owner and management came on board. Others, shaken by the scam, decided to de-risk and move. One of the most high-profile losses was that of British Petroleum’s $1-billion contract31. A few big names such as GE, a top customer, and GSK stayed on but extracted their pound of flesh. They asked for 15-20% rate cuts across the vendor base, and Mahindra Satyam was no exception32.
4.1         Ramifications in Corporate Governance Strategies in India
The Satyam fiasco led government of India to introduce the new measures in corporate governance to prevent reoccurrence of such frauds in future33. These are:
Ø  The voluntary adoption of international financial reporting standards;
Ø  The appointment of chief financial officers by audit committees based on qualifications, experience, and background.
Ø  The rotation of auditors every five years so that familiarity does not lead to corporate malpractice and mismanagement34.
Ø  Independent Directors are not entitled to receive remuneration for their services, except for reimbursement. At least one-third of the Board of a company should consist of independent Directors35.
Ø  Audit committee has to accommodate a majority of independent Directors.
Ø  Additional disclosure norms are – providing for the formal evaluation of the performance of the Board of Directors, filing returns with the Registrar of Companies with respect to any change in the shareholding positions36.

15.  The World Bank is now having a relook at the ban imposed on the Mahindra Satyam when it was under the Rajus family. Mahindra Satyam requested for lifting the ban. (Economic Times, New Delhi, May 06, 2010, Page 21).