SATYAMS IMPACT ON CORPORATIONS AND CORPORATE SECURITY

LAWS

Submitted towards partial evaluation of

corporate social security laws

Name of the Student: Nikhila Bodepudi

Roll No: 03
MBA 2014-16

Centre for Management Studies

NALSAR University of Law
Hyderabad
October 2015

CONTENTS
1. ABSTRACT
2. HOW DID SATYAM AFFECT OTHER CORPORATIONS
3. CHALLENGES AND CONTROVERSIES FACED BY CORPORATE
GOVERNANCE
4. ANATOMY OF AN AUDIT AND ACCOUNTING FAILURE
5. ANATOMY OF THE INDEPENDENCE AS A DIRECTOR
6. CONCLUSION

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Abstract
From Enron, WorldCom and Satyam, it appears that corporate accounting fraud is a major
problem that is increasing both in its frequency and severity. Research evidence has shown
that growing number of frauds have undermined the integrity of financial reports,
contributed to substantial economic losses, and eroded investors confidence regarding the
usefulness and reliability of financial statements. The increasing rate of white-collar crimes
demands stiff penalties, exemplary punishments, and effective enforcement of law with the
right spirit. An attempt is made to examine and analyse in-depth the Satyam Computers
creative-accounting scandal, which brought to limelight the importance of ethics and
corporate governance (CG). The fraud committed by the founders of Satyam in 2009, is a
testament to the fact that the science of conduct is swayed in large by human greed,
ambition, and hunger for power, money, fame and glory. Unlike Enron, which sank due to
agency problem, Satyam was brought to its knee due to tunnelling effect. The Satyam
scandal highlights the importance of securities laws and CG in emerging markets. Indeed,
Satyam fraud spurred the government of India to tighten the CG norms to prevent
recurrence of similar frauds in future. Thus, major financial reporting frauds need to be
studied for lessons-learned and strategies-to-follow to reduce the incidents of such
frauds in the future.

HOW DID SATYAM AFFECT OTHER CORPORATIONS

Satyam Computer Services chairman B Ramalinga Raju's admission he had cooked the
company's books has undoubtedly left India's fourth-largest software exporter struggling to
survive the fallout, but his misdeeds may cast a cloud over the squeaky-clean profile of the
entire sector, and by extension, the rest of the Indian corporate sector.
For years, Satyam and larger rivals such as Tata Consultancy Services, Infosys and Wipro
were feted as among the new ambassadors of Indian industry with their corporate
governance practices winning accolades around the world and their strong growth rates
luring investors.
This looks set to change after Mr Raju announced on Wednesday Satyam's famed cash pile
was almost non-existent and its revenues and profits were inflated.
"In the short term, companies will definitely get painted by the same brush and Indian IT
companies could come under a cloud," says L&T Infotech CEO Sudip Banerjee, who till
recently worked with Satyam's larger rival Wipro Technologies.
The impact of Mr Raju's misdeeds was visible on the Indian stock markets investors exited
the stock in a big way. Satyam shares plunged nearly 78%, and dragged down the broader
market. Peers such as HCL Technologies closed 15% lower.
Some experts believe the damage will not be limited to the technology sector. "The impact
is more on India Inc's credibility, rather than brand India IT, as it is a wider problem and not
sector specific," Future Brands CEO Santosh Desai said.
Raman Roy, chairman and managing director of Quatrro BPO Solutions and regarded as
father of Indian outsourcing, said the onus will now be on India's technology sector to prove
it does not have anything wrong in its accounting practices.
That must be frustrating for the sector's top executives, most of whom have spent long
years differentiating India's IT sector from the rest of Indian industry as they built their firms
to take on some of the mightiest in the world. It took a lot of hard work for Indian IT
companies to build reputations that enabled them to stand alongside global names such as
IBM, Accenture, HP, Cap Gemini and Atos Origin.
For an industry born in the late 1980s and gained traction around and after the Y2K
crossover, Satyam's revelations could not have come at a worse time. The global economic
slowdown has slowed growth and forced them to fight harder for business in the $800billion global IT services market.
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Some believe while the $50-billion Indian IT sector could find customers questioning the
quality of their books, it could also perversely be seen as a coming of age of the sector.
While the Satyam episode could temporarily cast a cloud over Indian IT firms, IT in India is
unlikely to be as affected. Large overseas companies will still need to cut costs, and India will
remain a preferred destination for doing so.
In the short term, overseas firms could still go to more familiar global names such as IBM or
Accenture or CSC, all of which have significant operations in India. "The Indian global IT
story, which was built on efficiency and costs not clean books, will not suffer any credibility
issues globally as long as efficiency is not compromised," said Mr Sinha.
"There could be a shift in customer loyalties. The solution for global customers will be
delivered by multinationals if not Indian players," says Avinash Vashistha, CEO of Tholons,
which advises global firms on offshoring.
While the immediate impact on brand India IT could be negative, some experts believe such
things are common around the world and can be easily restored by further strengthening
governance practices in the sector.
"Every country has such incidents. Corporate governance standards of Indian IT, particularly
the non-family owned firms, are very good and I believe brand IT will not suffer in the long
run," added Mr Banerjee of L&T Infotech.
The consequences of the Satyam scandal will depend partly on policy responses. The press
is pointing out that many Indian companies could have similar hidden problems. If investors
get suspicious, this could severely damage the corporate sector and the countrys chances
of getting back to 9 percent growth.

CHALLENGES AND CONTROVERSIES FACED BY THE CORPORATE GOVERNANCE

It is said that sometimes when a big tree falls, the earth shakes. When the earth shakes,
squirrels fall out of the trees still standing. Those that do not fall are stunned into a state of
disbelief. As the details of one of the biggest accounting frauds in India came to light, heads
began to roll. Ramalinga Raju and his brother were swiftly arrested on various criminal
charges and an investigation was initiated by the CID. Merrill Lynch and Credit Suisse
terminated their engagements with the company.
The New York Stock Exchange halted trading in Satyam stock on the same day. India's
National Stock Exchange has announced that it will remove Satyam from its S&P CNX Nifty
50-share index on January 12. The scrip fell faster than a dive-bomber on steroids and
Satyam investors lost thousands of crores in the ensuing bloodbath. The credibility of
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Satyams statutory auditors, PriceWaterhouse Coopers (PWC) took a severe beating. PWC
partners in charge of the Satyam account were suspended. SEBI initiated an inquiry into its
audit process and threatened cancellation of its India licence. The squirrels had indeed
started falling from the trees while the rest of them looked on in shocked disbelief.
The true extent of the fraud rattles investor confidence across the world. It became clear
that Satyam's balance sheet of 30 September 2008 contained multiple anomalies and some
outright untruths. There were inflated figures for cash and bank balances which stood at Rs
5,040 crore whereas Rs 5,361 crore was reflected in the books. There was an understated
liability of Rs. 1,230 crore on account of funds which were arranged by Ramalinga Raju
himself. A fictitious accrued interest of Rs. 376 crore was also shown in the books. In
addition, the books also showed an overstated debtors' position of Rs. 490 crore as against
Rs. 2,651 crore.
To get to the heart of the Satyam debacle, popularly called Indias Enron one must first
understand how it all came out. As said above, there was a huge gap between actual assets
and what was being shown in the books. This gap according to Ramalinga Raju himself grew
unmanageable over the year as Satyams revenues grew. As the promoters held only a small
percentage of equity, the concern was that poor performance would result in a takeover,
thereby exposing the gap. In order to fill the void and replace the fictitious assets with real
ones, the Satyam brass decided to takeover two Maytas companies which dealt with
infrastructure and real estate. The reason given was that Satyam needed to cover its risks by
diversifying. Shareholder outrage at the decision forced the Satyam board to recant its
decision faster that one can say abort. The aborted Maytas acquisition deal was the last
attempt to fill the fictitious assets with real ones.
Thereafter, the increased scrutiny meant it was game over for Ramalinga Raju and his men.
Ironically, if the Maytas acquisition had gone ahead as planned, Satyams books could
probably have been balanced out and it would have emerged as a stronger company.
Furthermore, Maytas, which has extensive real estate holdings and stakes in the
infrastructure sector had been valued at over Rs 6523 crores by Earnst & Young. Satyam had
been on the verge of acquiring Maytas for a considerably lower sum of Rs 6410 crores. All in
all, it was a good deal for Satyam but unfortunately the means did not justify the end.
The Satyam debacle has striking similarities with the Enron scandal that rocked financial
circles worldwide in 2001. The Enron scandal was a corporate scandal involving the
American energy company Enron Corporation. In addition to being the largest bankruptcy
reorganization in American history, Enron undoubtedly was the biggest audit failure. The
scandal caused the dissolution of Arthur Andersen, which at the time was one of the five
largest accounting firms in the world. Opaque financial reporting combined with a complex
business model helped Enron conceal its true performance through a series of accounting
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and financing maneuvers, and hype its stock to unsustainable levels. This was in spite of
having in place a robust Corporate Governance system.
What shocked financial regulators even further was the fact that Enrons high-risk
accounting practices were not hidden from the Board of directors. In fact, the Board not
only knew of them but also made possible such activities by Board resolutions. As a direct
result, the US Congress passed the Sarbanes Oxley Act which tightened regulations
relating to corporate governance and financial reporting.
The Satyam affair as one can call it must therefore be analyzed under the twin sets of
accounting/audit failure and failure of the Board of Directors. However one must first keep
in mind the Corporate Governance situation in India as well as regulations which mandate
financial reporting. In 1998, the Confederation of Indian Industries ( CII ), came out with a
Code of Corporate Governance for listed companies which acted as a guide for corporates
to voluntarily adopt principles of good governance. Acknowledging the fact that in a
globalized world where flows of goods, services and capital are worldwide, a company
which does not promote a culture of strong independent oversight risks its very stability and
future health, the Securities and Exchange Board of India (SE I) constituted a committee
under the Chairmanship of Kumar Mangalam Birla in 1999 to suggest and lay down certain
norms of Corporate Governance.
Many of its recommendations dealing with composition of the Board of Directors,
constitution of Audit Committees, more comprehensive disclosure etc were incorporated
into the Standard Listing Agreement in the form of a new Clause 49 in 2000. Furthermore,
the Companies Act was amended in 2000 incorporating many provisions dealing with
Corporate Governance like additional grounds of disqualifications for Directors, formation of
the Audit Committees etc.
In 2002, following the passing of the Sarbanes-Oxley Act by the US Congress after the
collapse of global giants like Enron in 2001, the Government of India appointed a committee
under the Chairmanship of Naresh Chandra, former Cabinet Secretary, to suggest changes in
the law with respect to certain fundamental aspects of Corporate Governance like auditorclient relationships, auditor independence, role of independent directors etc. At around the
same time in 2002, SEBI constituted a Committee under the Chairmanship of N.R Narayana
Murthy to review Corporate Governance in India and make recommendations to further the
same. Observing that Corporate Governance is beyond the realm of law; it stems from the
culture and mindset and cannot be regulated by legislation alone, the Committee fine
tuned the recommendations of the Naresh Chandra Committee in addition to presenting its
own recommendations. In August 2003, SEBI revised Clause 49 of the Listing Agreement by
incorporating many of the recommendations made by the aforesaid committees.

In addition to Clause 49, the Indian Companies Act contains various provisions dealing with
the concept of Corporate Governance. Sec 299 of the Act requires every director of a
company to make disclosure, at the Board meeting, of the nature of his concern or interest
in a contract or arrangement (present or proposed) entered by or on behalf of the company.
Sec 292A of the Act requires every public having paid up capital of Rs 5 crores or more to
constitute a committee of the board called the Audit Committee. Sec 309(1) of the Act
requires that the remuneration payable both to the executive as well as non-executive
directors is required to be determined by the board in accordance with and subject to the
provisions of Sec 198 either by the articles of the company or by resolution or if the articles
so require, by a special resolution, passed by the company in a general meeting.
Further, Schedule VI of the Act requires disclosure of Directors remuneration and
computation of net profits for that purpose. To pave way for introduction of real corporate
democracy, Sec 192A of the Act and the Companies (Passing of Resolution by Postal Ballot),
Rules provides for certain resolutions to be approved and passed by the shareholders
through postal ballots. Clause 49 has often been called the cornerstone of Corporate
Governance in India. The recommendations made by the Kumar Mangalam Birla Committee
in 1999 were incorporated in 2000 by SEBI into the Standard Listing Agreement as Clause 49
dealing with Corporate Governance for implementation by all Stock Exchanges for all listed
companies within 3 years. This clause mandates all listed companies to implement and
comply with its requirements relating to good Corporate Governance practices.

Clause 49 lays down various requirements to be implemented by a company. The

mandatory requirements leave the company with no choice but the implementation of the
non mandatory ones is at their discretion. The mandatory requirements are laid out under 6
heads, namely Board of Directors, Audit Committees, Disclosures, CEO/CFO certification and
Compliance Certificate from Auditors or PCS ( practicing company secretaries).The nonmandatory requirements deal with a variety of topics such as remuneration for directors,
the companys whistleblowers policy, shareholders rights, audit qualifications, training of
board members etc. Thus it can be said that at least on paper, that India has one of the
most comprehensive codes of corporate governance in the world.
The question then arises that how did the Satyam incident take place? How could such a
huge accounting fraud spanning years in time and over thousands of crores in monetary
value remain hidden from its auditors? The answers lies in the nature of the failures
themselves as well as the nature of the law that governs various aspects of corporate
Governance like auditing & accounting practices as well as the responsibilities and liabilities
of Directors. One can analyse the aforesaid independently.

ANATOMY OF AN AUDIT AND ACCOUNTING FAILURE

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Ramalinga Rajus confessional statement on the 7th of January, 2009 uncovered the one of
the biggest accounting scandals till date in India. Thousands of crores of fake assets had
been reported in the books. What was even more disconcerting that Satyams statutory
auditors PriceWaterhouse Coopers had no clue the books were being fudged. Together with
allegations of negligence and collusion on part of PWC, the episode also raised questions
about the role of the auditor. Before one gets into the endoskeleton of what exactly caused
the audit failure in the Satyam case, it would be prudent to examine what exactly is the role
of the Auditor.
The complete scope of who an auditor is and what he does is laid down by many sections of
the Companies Act. Sec 209 of the Act lays down that not should a company maintain
proper books of accounts; such books should also give a true and fair view of the state of
affairs of the company. Sec 211 of the Act, inter alia, requires that every balance sheet of
the company should give a true and fair view of the state of affairs of the company at the
end of the financial year and that every profit and loss account should give a true and fair
view of the of the profit and loss of the company and they should comply with accounting
standards.
Therefore, to ensure that all aspects of the Act in this regard are complied with, the books
represent the true and fair state of affairs and that the financial statements are in
agreement with the books of accounts, an auditor is appointed. The powers and duties of
the auditor are laid down in Sec 227 of the Act. He has the right to call for information and
explanations as well as have access to the books of account. The auditor owes the
shareholders a duty to safeguard their rights. The examination by an independent agency
such as the Auditor is practically the only safeguard the shareholders have against the
enterprise being carried on in an unbusinesslike way or their money being misapplied
(Deputy Secretary to the Government of India, Ministry of Finance v. S.N Das Gupta, (1955)
25 Com Cases 423 )
An audit, as defined in the landmark case of Frankston and Hastings Corpn. v. Cohen,
(1960)102 CLR 607, comprises of three main objects

To certify to the correctness of the financial position as shown in the balance sheet,
and the accompanying financial statements.
The detection of errors.
The detection of fraud. The detection of fraud is of primary importance.

Having said that, it is also paramount to state that the auditor is a watch-dog, not a
bloodhound, as said by LOPES LJ. This means that his job is verification and not detection.
When suspicion is aroused, it is his duty to probe the issue to the bottom but in case there is
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no material to arouse suspicion, he is not bound to go sniffing around with the intention of
uncovering financial anomalies. He is not concerned with the policy of the company and
does not sit in judgment on management decisions.
If one takes the specific case of the Satyam audit failure, it shows that though there is
evidence of negligence at many levels, there is none with respect to collusion or criminal
conspiracy on part of the auditors. PWC relied on the documents provided by the company
to do the audit. The charges of negligence have been heaped on them because they did not
go to every bank to independently verify that the cash deposits as shown in the books really
existed. Though ideally, an auditor is supposed to do this, it is a fact that very few actually
do. In fact when a firm like PWC is dealing with a company like Satyam (which won the
prestigious Golden Peacock Award for Corporate Governance in 2008) it generally takes the
company at its word that the statements provided are true and represent the true state of
affairs.
In the case of Satyam, the company allegedly went a step further and even submitted
forged documents from banks confirming the presence of the said deposits. In such a
scenario, where none of the documents show even the slightest hint of a financial anomaly,
the auditor would generally not go behind the scenes with the motive of uncovering any
dirt. Though this is not how an audit is supposed to be done ideally, time and convenience
coupled with the name & reputation of the company generally means that the auditor does
not bother. However, since the Satyam scandal came to light, auditors have begun to ask for
independent verifications from banks with respects to deposits etc.
Another aspect of auditing that was questioned after the Satyam scandal was that of the
internal auditor. Internal auditing activity is primarily directed at improving internal control.
The internal auditor forms the companys own level of checks and balances. Under Indian
law, a company must have an adequate internal control procedure commensurate with the
size of the company and the nature of its business. The internal auditors are the constituent
entities of this control. The external auditor is supposed to provide over-watch over the
functions of the internal auditor. The reporting requirement under Section 227(4A) of the
Companies Act, 1956 mandates the statutory auditor to make an affirmation on the quality
of internal audit of the company if it is of certain size.
However, if one looks closely at the internal audit scenario in Indian companies, one is liable
to open a large can of worms. There are instances where the statutory auditors have been
the de facto internal auditors as well, though professional ethics prohibits this. This is
brought into effect by the simple ruse of floating another company where a sizable number
of partners are not from the firm doing the statutory audit. While this complies with the law
in letter, its highly questionable if it does the same in spirit. Then, to compound it all, the
statutory auditor goes on to attest to what the internal auditor has been doing saying that
that the internal audit system is indeed commensurate with the size and nature of business
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of the company. It would be obvious that nothing could be farther from the truth.
In the case of Satyam, the internal auditors have been alleged to have been actively
colluding with the management to perpetuate the fraud. In such a situation, one may argue
that even the statutory auditor may find no material to arouse any suspicions. Keeping in
mind the fact that an auditor is only a verifier, not an investigator, it would thus be
erroneous to say that in PWC should have definitely come to know that Mr Raju was
perpetrating. That there has been negligence in not independently verifying the bank
accounts is obvious, whether PWC was an active partner in the conspiracy is highly suspect.

ANATOMY OF THE INDEPENDENCE AS A DIRECTOR

Another vital issue of Corporate Governance the Satyam scandal brought to light was the
role of the independent director. Their role was highlighted in the wake of Satyams aborted
takeover of the two Maytas infrastructure companies. When Satyam attempted to take over
the two companies, the official explanation was that Satyam wanted to diversify to cover its
risks. Several questions went unanswered. Why was it trying to take over an infrastructure
company when its peers in the IT market were acquiring companies with similar profiles as
themselves? If it was seeking to diversify, why did it choose infrastructure which typically
has long term gains and requires heavy capital investment?
It is had decided on infrastructure, why did it not choose to go after Unitech, which was
available for a similar price and whose portfolio was more balanced? These unanswered
questions created such shareholder outrage that the Satyam board completely recanted its
decision within a matter of days. This had two repercussions. The first one was that the
credibility of the board was lost. Questions were raised as to the speed at which a
unanimous decision of the Board was overturned by itself. The second question raised was
that given the state of affairs, how independent were the independent directors.
To seek answers to the above questions, one must necessarily look into that facts of the
case as well as the law that mandates independent directors in India. The list of
independent directors on the Satyam board is an extremely impressive one and comprised
of distinguished academics like Prof Ramamohan Rao, Dean of the Indian school of Business
who was also incidentally the head of Satyams Audit Committee, Professor Krishna Palepu (
professor at the Harvard Business School ),Prof. V.S Raju ( former Director of two IITs), Mr
Vinod Dham ( father of the Pentium Chip) as well as eminent persons like Mr T.R Prasad ( a
former Union Cabinet Secretary ) .
When the Satyam management proposed the acquisition of the two Maytas companies,
concerns were raised by the Board on several issues. There was concern about the
unrelated diversification and whether there would be synergy between the companies
especially since infrastructure involves long term growth. There was also the concern of
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needless diversification from the companys core competency. However the fact that due
diligence of the companies had been completed coupled with the fact that Satyam was
going to pay significantly less that the firms valuation by Earnst & Young led to the board
giving the go-ahead. Even the fact that the target companies Maytas Properties and
Maytas Infra were led by the two sons of Mr Ramalinga Raju did not seem very relevant.
Shortly thereafter, the reaction from the markets forced the Satyam board to recant the
decision completely.
The concept of independent directors first took shape in 2004, when SEBI revised its
corporate governance norms on the recommendations of the Narayana Murthy Committee.
A key suggestion of this panel was to increase the number of independent directors on the
board of a company. Currently it is mandatory that at least one-third of a companys board
of directors are independent, if the chairman of the board is a non-executive member. In
other cases, independent directors should constitute a minimum of 50 per cent of the
board. In addition, Clause 49 of Listing Agreement framed by SEBI incorporates many key
features of the Sarbanes-Oxley Act, enacted after a series of accounting scandals in the US
like the one that forced Enron into bankruptcy. The question then arises as to what the
problem with independence of directors in India is. The answer to this question reveals an
interesting scenario in India where one part of the law undoes the effect of the other. This is
explained as under.
The role of an independent director is not day-to-day management of the company. That is
the job of the Executive Directors. The role of the independent directors in administration is
therefore limited. In the context of their independence, three very interesting points come
out. Firstly, independent directors are mandated under law i.e. Clause 49 of the Listing
Agreement to have no pecuniary relationship with the company. They must have no
material association with the company. They should not be related to the promoters or
anyone in senior management position from one level below the board. They should not
have been an executive of the company or of its audit, consulting or legal firms in the past
three financial years.
Besides, owning 2 per cent or more of the block of voting shares or being a service provider
to the company, would disqualify one from taking up an Independent Directorship in a listed
company. Their decisions should be independent of those who have controlling stake in the
company and in the overall interest of the company and its stakeholders. However, these
Directors still have to be nominated to the Board. This is done de jure by the shareholders
but de facto by the other Directors. The shareholders merely confirm the nomination. This
makes it possible for people who are known to the Directors to get elected. Their
independence thus becomes suspect at the very beginning.
Secondly, there is the remuneration factor. By law, the independent directors in a public
company are prohibited from getting a salary. An independent director is supposed be
compensated by sitting fees and commissions. However, it is argued that where the
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commission is linked to the companys performance, the very objective of prohibiting such
directors from accepting a salary is defeated. Also, the law mandates that directors have to
hold a minimum number of shares in the company. Once compensation is linked to a
companys profit or share price performance, it is arguable whether this creates a vested
interest in ensuring that the companys reported numbers are good since even a hint of
financial troubles may cause a fall in the share price resulting in the fall in value of a
Directors holdings.
Therefore, even as the law on one hand wants to keep up the independent nature of the
director, other provisions weaken this very stand.

CONCLUSION
The Satyam incident, though unfortunate, exposed some big loopholes in the system. Just as
the United States needed the Enrol Scandal to clean up its act, perhaps India needed the
Satyam fiasco to introduce sweeping changes in its own financial reporting system. It cannot
be denied that the Satyam episode was a stark failure of the code of Corporate Governance
in India. Corporate Governance is not something which can be enforced by mere legislation;
it is a way of life and has to imbibe itself into the very business culture the company
operates in. Ultimately, following practices of good governance leads to all round benefits
for all the parties concerned. The companys reputation is boosted, the shareholders and
creditors are empowered due to the transparency Corporate Governance brings in, the
employees enjoy the improved systems of management and the community at large enjoys
the fruits of better economic growth in a responsible way.

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