Author: Aysha Hanan, Cochin University of Science and Technology
INTRODUCTION
India has witnessed several high-profile financial scams over the years, including the Harshad Mehta securities scam in 1992, the Ketan Parekh stock market scam in 2001, and the more recent Punjab National Bank fraud case. These scams have not only caused significant financial losses but also undermined trust in India’s financial institutions and slowed economic growth.
The Satyam scam, which came to light in 2009, is a stark reminder of the devastating impact of corporate fraud on a country’s economy. When Ramalinga Raju, the founder and chairman of Satyam Computer Services, confessed to cooking the company’s books, it sent shockwaves through India’s financial markets and beyond. The scam not only eroded investor confidence and led to a loss of billions of dollars but also highlighted the vulnerabilities in India’s corporate governance and regulatory framework.
This article will delve into the details of the Satyam scam, exploring how it was perpetrated, the factors that enabled it, and the consequences for the company, its stakeholders, and the broader economy.
SATYAM COMPUTER SERVICES LTD.
Satyam Computer Services Ltd. was founded in 1987 by B. Ramalinga Raju and his brother B. Rama Raju in Hyderabad, India. Starting with just 20 employees, the company rapidly expanded to become a global IT services powerhouse, operating in 65 countries worldwide. Under Raju’s leadership, Satyam achieved remarkable success, becoming the fourth largest IT firm in India by 2000. The company made history by being the first Indian firm to list on the New York Stock Exchange. Satyam garnered numerous awards for innovation, governance, and corporate accountability, including the prestigious Global Peacock Award for excellence in corporate accountability in 2008. Ramalinga Raju himself received accolades, such as the Ernst & Young ‘Entrepreneur of the Year’ award in 2007. Nevertheless, this success story took a dramatic turn in 2009 when the company was caught up in a massive accounting fraud scandal, revealing a stark contrast between its boasted governance and the reality of its financial dealings.
PECULIARITIES OF THE SCAM
The Satyam scam stands out as a peculiar case in the annals of Indian corporate history, marked by its sheer magnitude and brazen strategy. Although its modus operandi differs from the Harshad Mehta and Ketan Parekh scams, the basic thought is similar. The scam’s uniqueness lay in its multifaceted nature, involving corporate fraud, accounting fraud, money laundering, and insider trading.
At its core, the Satyam scam employed the classic “pump and dump” scheme. The offenders artificially inflated the company’s stock price by showcasing fake growth, which attracted investors to pump huge amounts to the company and allowed the offenders to sell shares at exorbitant prices. To increase the share price, the fundamentals of the company have to be made strong which would have required significant time and effort, especially for a company from a developing country like India. To circumvent this, the scamsters resorted to accounting frauds, presenting a fake picture of the company’s financial health.
The scam’s architects fabricated information about non-existent customers, generated illegitimate invoices, and inflated revenues. The annual reports were doctored to show a profit 50 times higher than the actual figure. This artificial growth narrative lured in investors, who were then duped into buying shares at inflated prices. As the share price surged, they sold their holdings, reaping enormous profits.
THE SCAM
In 2000, India experienced a real estate boom, particularly in Hyderabad. Ramalinga Raju, the founder of Satyam, aimed to capitalize on this trend by investing in properties, which required significant funds. This led him to concoct a manipulative scheme. By showcasing Satyam’s substantial growth to potential investors, Raju hoped to increase the company’s share value, enabling him to sell shares or use them as collateral for substantial bank loans to finance his real estate ventures.
Raju and his accomplices knew that their accounting manipulation would eventually require them to replenish the funds. To address this, they planned to use profits from their real estate investments to bridge the gap. The accounting fraud involved creating fake invoices, inflating revenue and profits, and fabricating evidence, including forged bank statements, to mislead investors and banks.
At first, the plan seemed to work, as investments poured in and Satyam became the hot stock in market. Raju acquired over 1,000 acres of land in Hyderabad in his name, as well as in the names of his friends, relatives, and 365 companies controlled by them. Between 2000 and 2008, Raju’s stake in Satyam decreased from 25% to 2% due to share sales. In 2006, Satyam’s revenue reached $1 billion, and the company received accolades for its governance, including several awards in 2007.
It was in 2008, that the global recession impacted the real estate market, and Raju struggled to fill the accounting gap, which had grown to ₹7,000 crore. In the financial year 2008-2009, Satyam’s actual profit was ₹60 crore, but Raju reported ₹600 crore to outsiders and banks, while the actual bank balance was ₹300 crore, inflated to ₹5,000 crore – a 10- to 50-fold difference. Realizing he couldn’t bridge the gap with real estate profits, Raju conceived a final plan, the master stroke. He proposed acquiring Maytas Infrastructure and Maytas Properties, intending to distort the ₹7,000 crore gap as an acquisition cost in the financial statements.
The Satyam board approved this proposal in December 2008 without shareholder consent. When shareholders discovered the plan, they began selling shares, causing the company’s stock price to plummet. US investors, primarily institutional investors, filed lawsuits against Satyam, leading to a severe backlash that ultimately thwarted Raju’s final plan.
Reluctantly, Raju made his confession to the board through a letter on 7th January, 2009. Raju revealed that he inflated cash and bank balances by Rs. 5,040 crore, falsely reported accrued interest of Rs. 376 crore, and understated liabilities by Rs. 1,230 crore, while also overstating debtors’ position by Rs. 490 crore. Raju manipulated revenue and operating margins, reporting Rs. 2,700 crore in revenue and Rs. 649 crore in operating margin, when actual numbers were Rs. 2,112 crore and Rs. 61 crore, respectively. He used funds arranged by him (Rs. 1,230 crore) to keep operations going, without reflecting this in Satyam’s books of accounts, and pledged promoter shares to raise funds from known sources. Raju made significant dividend payments, acquisitions, and capital expenditures to maintain the illusion of growth, and attempted to fill the fictitious assets with real ones through the aborted Maytas acquisition deal. His actions ultimately led to a massive gap in the balance sheet, which he tried to bridge through various means, but failed, leading to the collapse of the scam and his resignation. The share prices dropped to persistently in a day resulting to a loss of ₹10,00,00,000 for investors.
As a separate legal entity, the company operated independently of its management and board, with a substantial client base and autonomous activities. Following the fraud scandal, the government took control of the company due to its listed status. The existing board of directors was dismissed by the Company Law Board, and a new board was appointed to oversee the transition. In 2009, the company was put up for public auction, where Tech Mahindra acquired a 51% stake and subsequently renamed it Tech Mahindra.
INVESTIGATION AND VERDICT
The Satyam scandal exposed the complexity of India’s regulatory system when dealing with serious offenses by listed companies. Following the fraud’s revelation, multiple investigations led to charges against various individuals and groups associated with Satyam. The Ministry of Corporate Affairs initiated its investigation through the Serious Fraud Investigation Office. Indian authorities arrested and charged Raju and his brother, B. Ramu Raju, former Managing Director Srinivas Vdlamani, head of Internal Audit and the CFO with criminal fraud. The Institute of Chartered Accountants of India found the CFO and auditor guilty of professional misconduct. The CBI is Investigating the CEO’s overseas assets. In the US, Satyam faced civil charges from ADR holders. The investigation also implicated Indian politicians. Both civil and criminal cases continue in India, and civil litigation persists in the US.
The accused, including Ramalinga Raju, faced charges of cheating, conspiracy, forgery, and violating income tax laws. After a six-year investigation, a special CBI court sentenced Raju and nine others to seven years in prison on April 9, 2015. The court also fined Raju and his brother Rama Raju Rs. 5 crore each, and the remaining accused Rs. 20-25 lakh each. Those found guilty included Raju’s brothers, former executives, auditors, and employees. The investigation involved over 3,000 documents and 250 witnesses, culminating in a massive 55,000-page charge sheet. SEBI suspended Raju for 14 years from securities market in India and PricewaterhouseCoopers for 2 years from auditing Indian companies.
IMPACT
The Satyam scandal led to a call for stronger regulations in India’s securities markets. In response, the Securities and Exchange Board of India (SEBI) overhauled corporate governance requirements and financial reporting standards for publicly traded companies. SEBI also adopted International Financial Reporting Standards (IFRS). Additionally, the Ministry of Corporate Affairs created a new Corporate Code and considered changes to securities laws to facilitate class-action lawsuits.
One of the key reforms introduced was the mandatory appointment of independent directors on company boards, ensuring that at least one-third of the board comprises of independent directors for public companies, preventing domination in the decision-making process. The government introduced auditor rotation of 5yrs for auditors and 10 years for audit firms. The National Financial Reporting Authority (NFRA) was also established to oversee the auditing profession. The government also made it mandatory for listed companies to establish a vigilance mechanism, allowing directors and employees to report concerns about unethical behavior or fraud. This move aimed to encourage whistleblowing and prevent fraud.
The Securities and Exchange Board of India (SEBI) tightened corporate governance norms and introduced guidelines for stricter enforcement and quicker redressal of investor complaints. Disclosure requirements for companies, including directors’ interests and financial statements was increased.
Provisions for class action suits were introduced, allowing shareholders and depositors to claim damages or demand action against companies for fraudulent or unlawful acts.
Satyam’s failure to follow CG rules led to poor relationships with shareholders and employees. The scandal highlighted the need for clear roles, separation of CEO and chairman duties, fair executive compensation, and protection of shareholder rights.
The Satyam fraud prompted the Indian government to tighten corporate governance norms to prevent similar frauds. The government took swift action to protect investors’ interests and maintain India’s credibility globally by introducing the Companies Act, 2013. This led to significant changes in law-making, emphasizing the importance of ethical conduct and strong regulations.
CONCLUSION
The Satyam scam, one of India’s largest corporate frauds, exposed severe weaknesses in the country’s corporate governance and auditing frameworks. The scandal highlighted the importance of robust internal controls, independent auditing, and effective regulatory oversight. Despite its devastating consequences, the Satyam scam led to significant reforms and improvements in India’s corporate governance landscape.
The case study demonstrates that even the most seemingly successful and reputable companies can be vulnerable to fraud and deception. It emphasizes the need for eternal vigilance, skepticism, and rigorous scrutiny from auditors, regulators, and stakeholders.
The Satyam scam’s peculiarities highlight the dangers of unchecked corporate ambition and the importance of stringent regulatory oversight. The fact that such a massive fraud went undetected for so long raises concerns about the efficacy of India’s corporate governance mechanisms. The Satyam scam serves as a cautionary tale, underscoring the need for transparency, accountability, and robust regulatory frameworks to prevent such financial debacles in the future.
The reforms made after it demonstrate the government’s commitment to strengthening regulations, protecting investors, and maintaining India’s global credibility. The Satyam scandal highlighted the need for robust ethics and regulations, prompting swift government action to prevent similar frauds from occurring in the future
REFERENCE
Ahmad, T., Malawat, T., Kochar, Y. & Roy, A. (2010), Satyam Scam in the Contemporary corporate world: A case study in Indian Perspective, IUP Journal. Available at SSRN, 1-48.
https://www.academia.edu/10971389/SATYAM_SCANDAL_A_case_study_
https://www.firstpost.com/business/full-text-this-letter-ramalinga-raju-wrote-uncovered-the-rs-4676-cr-satyam-scam-2190559.html
FAQs
Q: Why did the auditors failed to detect the Satyam scam, despite their supposed role as independent watchdogs?
Answer: The auditors of Satyam was Pricewaterhouse Coopers (PwC) which was one of the largest auditing firms in the world. They had a long-standing relationship with Satyam, which may have compromised their objectivity. The Indian partners of PwC was also sentenced to imprisonment and PwC was suspended from dealing with public limited companies in India for 2 years.
Q: What were some of the key reforms introduced by the government in response to the Satyam scandal?
Answer: Some of the key reforms introduced by the government included:
– Mandatory appointment of independent directors on company boards
– Auditor rotation and oversight by the National Financial Reporting Authority (NFRA)
– Stricter corporate governance norms and disclosure requirements
– Provisions for class action suits
