5/12/2010

The Satyam Fiasco

A Corporate Governance Disaster!
Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

The Satyam Fiasco

A Corporate Governance Disaster!

Abstract:
Corporate Governance is becoming increasingly important for companies across the globe. With the number of companies failing and the increasing frequency by the day, the markets now feel the need for an express code stressing on good corporate governance. Corporate Governance depends on two main aspects, firstly, the commitment of the management towards integrity and good business decision making and secondly, it is up to the monitoring agencies to put in place a set of standard practices to ensure sufficient disclosure, clarity of decisions and ethical decision making for both family managed businesses and professionally managed businesses, likewise.

In this case study, we have taken up Satyam Computer Services Ltd, the fourth largest IT firm in India as a case sample and studied the failures of corporate governance at different layers which led to a collapse of this magnitude. Not only were there failures at the regulatory level, but also at the executive level. With no express code for corporate governance in India, the company failed to follow the industry standard best practices and as a result, collapsed. This study would be useful to students and regulators in identifying the different kind of failures in a family owned business like Satyam and to policy makers in designing and implementing corporate governance frameworks for professionally managed as well as family managed businesses like Satyam.

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500) 1

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

Introduction:
Satyam Computer Services Limited (NYSE: SAY) currently known as Mahindra Satyam is a global information technology (IT) services provider, offering a range of services, including systems design, software development, system integration and application maintenance. The erstwhile company Satyam Computer Services Limited was founded in 1987 and was one of the big four IT Companies in India with a $2.1 billion dollar revenue. It had employed over 53,000 IT Professionals in over 67 countries with development centres in over 20 countries. It serves 654 global companies, 185 of which are Fortune 500 companies (Mynampati, 2007). Multinational clients of Satyam included Nestle, General Motors (GM), and General Electric (GE). Satyam also owned and controlled several subsidiaries including Maytas Infrastructure. Satyam attempted to acquire a stake in this company which led to the collapse of Satyam.

Speaking of the local presence of the company, Satyam has development centres in Brisbane, Canberra, Melbourne and Sydney. The major clients that Satyam served in Australia are Quantas, NAB, ANZ, Telstra, SunCorp and Coles. Most of the Australian clients have stayed with Satyam post-scandal except Telstra. It also had plans to open a campus in Geelong with a total seating capacity of 2000 to serve as an incubator for budding graduate professionals in partnership with Deakin University. This whole project which was expected to contribute a commercial activity of AU $175 million to Victoria has now been scrapped as a result of the company takeover following the accounting scandal.

The company has been currently taken over by Tech Mahindra (a joint venture with British Telecom), 6th largest IT firm in India. The new company formed as a result of this merger is called Mahindra Satyam. Mahindra Satyam as a result of the accounting fraud has current staff strength of 25,000 professionals down from 53,000 professionals and has reported revenue of $1.3 billion in FY09 down from $2.1 billion for FY08 (Satyam, 2008). The company continues to be listed on the NYSE Euronext exchange and has reportedly stabilised its operation after the takeover by the Mahindra Group, a family owned business group too.

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500) 2

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

The Scandal:
Satyams troubles started when the World Bank, one of the biggest clients for Satyam, announced that two of Satyams employees had hacked into their systems and managed to access sensitive information. As a result, the World Bank did not renew the five year contract with Satyam and severed all ties with the company. Satyam however denied all allegations and denied any wrongdoing. To follow this up, the company was jolted again by Ramalinga Rajus (Chairman, Satyam) announcement to influx $ 1.6 billion dollars into the acquisition of Maytas Infrastructure and Maytas Properties. Efforts in this direction were immediately withdrawn under pressure from shareholders. Satyams ADRs (American Depository Receipt) fell by 50% overnight following this incident. If this was not enough, the result of a pending litigation by a former-client Upaid Systems was out. Upaid Systems alleged Satyam of intellectual fraud and forgery and made a claim of $1 billion, adding to the companys woes. After all this drama, hell broke loose when Raju wrote a letter to the board and the SEBI (Securities and Exchange Board of India) explaining the accounting fraud and the over inflated balance sheets.

It all started with Ramalinga Raju, the founder and Chairman, Satyam sending across a letter to the Board of Directors along with SEBI. In this letter, he outlined that the companys ba lance sheet for the quarter ending on 30 September 2007 had inflated cash and bank balances of upto 50.4 billion rupees (AU $ 1.44 billion). With a quoted cash reserve of 53,610, the actual cash reserves stood at 3,210 million which is just about 5% of the declared value. The letter also stated that the financial statements consist of understated liabilities worth 12,300 million rupees and non-existent accrued income of 3,760 million rupees. All in all, with an actual profit margin of 610 million rupees, the company submitted an externally audited and approved statement of 6,490 million rupees. PricewaterhouseCoopers (PwC) the external auditor for Satyam, approved and oversighted the inflated figures on the balance sheets year on year without suspecting any fraud. Either PwC has participated in the conspiracy or has demonstrated utter negligence on its part. The Chairman (Satyam) has claimed that none of the board members or the family members were aware of the accounting scam (Raju, 2009).

In December 2008, Raju masterminded a plan to fix the gap ($ 1.6 billion) between the actual figures and the reported figures, by showcasing an investment of $ 1.6 billion dollars into the acquisition of Maytas Properties and Maytas Infrastructure and actually pay the two companies post acquisition once surplus revenues are generated. Investors questioned Satyams investment in two companies which are both unrelated to Satyam and its core competencies. Raju justified the investment saying that the board is acting in the best interest of the shareholders by doing so and is trying to diversify the companys investment to enable the company to mitigate the risk of revenue concentration and thereby, position itself in a better position in times of turbulence and revenue uncertainty by spreading out its portfolio. At this time, even though the investors were not aware of the over inflated figures (was revealed on Jan 7,

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2009), they started smelling something fishy and the investor confidence levels in the company started dropping. The widespread anger forced the board to call off the deal.

An important point to ponder upon at this point is, how did the board comprising of independent directors approve the Maytas acquisition deal? Both the Maytas companies belonged to Rajus sons and by the arms length principle (ALP) this was no normal acquisition. The amount of money to be spent on this deal was an extra ordinary sum too. Going by the books, $ 1.6 billion would have reduced the well performing company into a debt-ridden company. The board could by no means have taken such a huge decision without discussing it and taking a shareholder approval. There was now a huge crisis of public confidence in the business, auditors, directors, lawmakers and executing agencies. By any yardstick, these are men of eminence and learning who should be independent. Yet this fiasco took place on their watch. One can well imagine the Securities and Exchange Board of India and the US Securities Exchange Commission wondering, if a board so exalted could not protect the interests of minority shareholders, what can one hope for governance at all? (Behan, 2009)

One more question raised at this point is, is the position of an independent director justified? After all, how independent is an independent director? In the very first place, an independent director is appointed with a CEO approval. So all factors like the selection of an independent director to the remuneration of the independent director depend on the CEO to some extent. Given these facts, if an independent director is not able to protect the interests of the shareholders, the whole purpose of appointing an independent director is beaten! This Satyam Scandal also raises alarms over the authenticity and reliability of external auditors and the certified financial statements. If a top auditing firm like PwC managed to oversee figures inflated to this extent and certified their financial statements over so many years, it leaves little hope for investors and shareholders to trust external auditing firms. The Satyam scam was a total failure across all levels starting from agency issues in the family managed business to failure at the executive and expert external auditors levels. And if this wasnt enough, Satyam was awarded the Golden Peacock Award for Excellence in Corporate Governance by The World Council for Corporate Governance (WCFCG).

Having discussed the background of this scandal, let us summarize the failures in Corporate Governance at Satyam: - Decision of Maytas acquisition was announced without shareholder approval. - Ramalinga Raju had only 8.5% stake in the company. How could he manage to take such a big decision without the approval of distributed shareholding with a total stake of 91.5%? - Besides, Maytas was a company in which he and his sons had a major stake. So his interests in that company were known to the board. Transferring $1.6 billion from Satyams books to Maytas was like transferring money from the company to own pockets (because Raju and Family had only 8.5 % stake in Satyam whereas the stake in both the Maytas companies was 30% +). This is a serious failure as per the Arms Length Principle (ALP). How did the board approve the deal?

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

- Raju justified the investment of company resources into his sons companies by calling it diversification of investment. If it was genuinely diversification, why was a novice company like Maytas chosen instead of the several other reliable options available in the market? - Besides, this was the time when the credit crunch hit the market and most companies tried to enahnce their cash reserves. Why did Satyam want to make such a huge acquisition of a barely known company at such a time? Especially when this purchase had the potential of making the cash rich company into a debt ridden company? The WCFCG conferred Satyam with the Golden Peacock Award, the highest honour in Corporate Governance and cited Satyam as one of the Global Leaders in Corporate Governance. On revelations by Raju, the WCFCG was quick to distance itself by stripping Satyam of the award and by stating that the award was achieved by the company by non-disclosure of material facts. Beverly Behan from Bloomberg BusinessWeek has pointed out to some material facts that the jury should have known before conferring the award to Satyam: - As per Item 16A of Form 20 - F submitted by Satyam in August 2008, Satyam has admitted to the Securities and Exchange Commission (SEC) that they do not have anyone on the audit committee (AC) who has all the attributes as required by the SEC to be serving the committee as an Audit Committee Financial Expert (Satyam, 2008). - Satyam had a board consisting of six non-management directors out of which four were academicians and one was a former Cabinet Secretary of the Indian Government. Only Vinod K. Dham had previously served as a Chairman/ CEO of a technical company i.e. Vice President, Microprocessing Products Group, Intel Corp. - Besides, two of the independent directors including Vinod K. Dham and T. R. Prasad were noted to be serving on 8 other boards each, apart from Satyam. - The board consists of no one who is financially capable or experienced in checking the companys financials. Vinod K. Dham has the experience of being the CEO of Intel Corp but then, he too comes from a technical background. - Satyam has showcased a board composition which would not qualify for a well-rounded board as expected in case of such a big company which has earned so many accolades. - Speaking of the board independence, the Satyam board had separated the positions of CEO and Chairman but both positions were occupied by brothers and had a major interest in the company and were members of the management. The board had no independent board leadership. - The jury who conferred the Golden peacock award to Satyam consisted of several judges who were British by origin. These Britain based members of the council were expected to know this basic best practice that at least one independent non-executive director should be appointed to be a senior independent director. - A best practice to be followed by all companies listed on the U.S. exchanges is that, the board should meet regularly without the management directors. This practice has been widely adopted here in Australasia too, with 60% of the companies following it. However, Satyam in its Form 20-F filed in August

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2008 has clearly claimed that their non-management directors do not meet without the presence of the management directors at regular intervals. - One more divergence from the global governance practices is the Satyam Boards declaration in their Form 20-F that they lack a Corporate Governance Committee. A failure of this magnitude could have possibly been averted with a corporate governance committee in place. - Interestingly though, they had a separate committee called the Investors Grievance Committee which definitely would have had a lot of activity to deal with after all the trauma the company and its investors had to go through post-2008.

With all the unethical activities of the board and the misdeeds of the chairman, it would have been difficult for any external auditing agency or watch dog to realise the flaws in corporate governance of the company. However, it is beyond my comprehension, as to how the WCFCG awarded a company of this order a global recognition for excellence in corporate governance when it could barely manage to implement the industry standard best practices for corporate governance? The failures in the board composition and independence were glaring. Some of the most modest publicly traded companies are following governance practices far more laudable than those being followed by this global honouree (Behan, 2009). Organisations like the WCFCG should be careful while conferring such recognition. It is such certifications and recognitions, on which the investors and minority shareholders trust on, to get an insight into a company before investing in them.

Current Corporate Governance Scenario in India, the reason for such scandals:
Poor corporate governance in companies has a potential to bring down the entire company and India has seen a lot of such cases happening in the past. A Mumbai based brokerage house named First Global has estimated that the Indian shareholders have lost close to $2 billion since 2003 prior to the Satyam Scandal due to issues stemming out of Corporate Governance failures. Despite all the international trade and exposure in India, and the fact that a lot of Indian companies are listed and traded in a lot of foreign exchanges, corporate ethics and accounting standards in India have been traditionally poor. Howe ver, family owned companies have set very high standards of corporate ethics and compliance. Family owned businesses like the Tata Group, Aditya Birla Group and the Mahindra Group of companies have time and again demonstrated the highest level of ethics and corporate governance. Speaking about the Tata group, a century old memorandum of Tata referred to Corporate Social Responsibility (Sapovadia, 2009). In spite of not having any express code for corporate governance till recent times, there havent been any failures of corporate governance in these business houses. However, there are firms like the Birla Group (Priyamvada Birla and Lodha), Reliance Group, India Bulls, Satyam Computers and Ranbaxy Laboratories which are known for their notorious transactions and are under the public scanner for

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Manoj Shivanna (22124500) observing improper corporate governance practices. 6

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

In India, two-thirds of businesses are family owned businesses. The biggest businesses until 1980 are without doubt family based businesses. As per Indian corporate laws, there are no mandatory provisions for corporate governance practices be it a family owned businesses or a professionally managed business. It is practiced on a voluntary basis and has been very well recognised and implemented in most family owned businesses. In the year 2007, the Central Government issued guidelines for corporate governance for central public enterprises. However these policies have no binding on the privately owned businesses. Similarly clause 49 of the SEBI listing agreement applies to listed companies only. It has no bearing on the unlisted companies, no matter how big the company is. Company act provides provisions for corporate governance in case there is a conflict of interest in the board or the top management regarding the interest of the company. However, if the company is listed in any of the stock exchanges then it has to follow clause 49 of the SEBI listing agreement in addition to the Company Act. At this point, there are a series of legislations available but there are no watch dogs or monitoring agencies like the ASIC in Australia. There are a series of provisions in the Company Act, 1956 which can be used to punish and penalize the negligent and poorly performing directors and executives. The provisions are available and if properly implemented, will lead to good corporate governance. However, there is corruption and malpractices at every layer leading to misuse and abuse of these provisions. These provisions are seldom used for their original intent but to make excuses and to find loop holes in other provisions. In the rare scenario that the provisions are used and the directors and executives are found to be liable, the process takes too long. It is a time consuming process which would take ages to finish. By the time the guilty are prosecuted, the witnesses become either invalid or would have weakened and the in the worst case, witnesses go missing. There is several times that by the time the guilty have been prosecuted; he/she would have expired. Due to the long and cumbersome procedures, the process loses its deterrent effect and the executives are not much hesitant in engaging into such activities. They have enough time to find another loop hole and beat the law. In the worst case, even if they are prosecuted and found gu ilty, the penalties are negligible and very small compared to the gravity of the offence. By the time the executives are penalised, they would have already reaped the benefits of the offence. To sum it up, there are provisions in the Indian laws to penalise the guilty, but the loop holes and the amount of time available to the guilty along with the meagre punishment that they receive if at all prosecuted; have little or no deterrent effect on the executives, thereby leading to such scandals.

Recommendations from the Satyam Scandal:

1) Regulatory authorities like the SEBI and the CBL need to be pro-active in their approach and should monitor companies more aggressively. 2) Regulators and executives should be held accountable for malpractices and speedy actio n should be initiated against such personnel. 3) Vigilance officers should be appointed and should be trained to check on frauds and wrong doings of these types. 4) The penalties and punishment should be substantial enough to have a deterrent effect on the individuals and the company.

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

5) The entire legal procedure of prosecution and conviction should be speedy enough to not allow the guilty to find loop holes and tamper witnesses. 6) There should be provisions to recover the losses that the company makes due to the wrongful acts of the individual from the profits or benefits generated by the individual as a result of the wrong doing. 7) Considering that the family based businesses have a different power structure in the company, there should be special provisions for family based businesses. These provisions should make the family owned businesses more just, transparent and accountable for their actions. 8) Whistle blowers should be granted security and income protection and be encouraged to pro mote the best interests of the company and the shareholders. 9) Clause 49 of should provide wider powers to the audit committee and have penal provisions in case of failures. 10) Management should take into consideration shareholders opinion before making any unrelated diversification and should clearly explain the context and reason for the unrelated diversification. 11) Auditors should be more detail oriented and should be accountable for all certified work. After all, it is such agencies and their ratings on whose basis, the shareholders entrust their investments in the audited companies.

Having said all this, Satyam has demonstrated the fact that its corporate governance standards have been far from that of a global leader. However, now that the Satyam board has been dissolved and the company has been taken over by the Mahindra Group, a family owned business group reputed to have managed businesses with utmost care and best ethical and corporate governance practices. Under the able leadership of the Mahindra group Mahindra Satyam has revived from the crisis state in the last one year and has started securing new contracts again. The latest being the contract for Official IT Partner for FIFA 2010. Looking at this, we can only hope that from the ashes of Satyams Golden Peacock rises a phoenix of far superior governance that can not only salvage the company but set a truly worthwhile example of how a world class company should be governed! (Behan, 2009)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

Bibliography:

ASX. 2007. Corporate Governance Principles and Recommendations [Online]. Available: http://asx.ice4.interactiveinvestor.com.au/ASX0701/Corporate%20Governance%20Principles/EN/body . aspx?z=1&p=-1&v=1&uid= [Accessed May 12, 2010]. BEHAN, B. 2009. Governance Lessons from India's Satyam [Online]. Available: http://www.businessweek.com/managing/content/jan2009/ca20090116_465633.htm?chan=top%20n e ws_top%20news%20index%20-%20temp_managing [Accessed May 10, 2010]. KAUR, G. & MISHRA, R. 2009. A Comparative Study of Male Female Academician s Perception of Reasons for Failure of Corporate Governance [Online]. SSRN. Available: http://ssrn.com/paper=1474664 [Accessed May 05, 2010]. KRIPALANI, I. B. C., BUSINESSWEEK. 2009. India's Madoff? Satyam Scandal Rocks Outsourcing Industry [Online]. Bloomberg BusinessWeek. Available: http://www.businessweek.com/globalbiz/content/jan2009/gb2009017_807784_page_2.htm [Accessed 12 May 2010]. MYNAMPATI, R. 2007. Globalization of Services: Satyams Experience [Online]. Stanford University. Available: http://iis-db.stanford.edu/docs/208/1._Satyam_PPT.pdf [Accessed May 01, 2010]. RAJU, R. 2009. Letter to Satyam Board [Online]. Available: http://trak.in/tags/business/2009/01/06/satyam-head-raju-admits-fraud-letter-boarddirectors/ [Accessed May 10, 2010]. SAPOVADIA, V. K. & PATEL, K. 2009. Is Blood Thicker than Water? Appraising Adequacy of Indian Corporate Governance for Family Based Companies: A Case Study of Satyam Computers [Online]. SSRN. Available: http://ssrn.com/paper=1347868 [Accessed May 10, 2010]. SATYAM. 2008. SEC Filing - Form 20-F [Online]. Available: http://www.sec.gov/Archives/edgar/data/1106056/000114554908001441/0001145549-08001441- index.htm [Accessed May 10, 2010]. SATYAM. 2008. Satyam Revenues (FY08) - Press Release [Online]. Available: http://www.mahindrasatyam.com/media/pr7apr08.asp [Accessed May 09, 2010]. SEBI. 2000. Clause 49, SEBI Listing Requirements [Online]. Mumbai. Available: www.acgaasia.org/public/files/IndiaClause49.doc [Accessed May 08, 2010]. TRIVEDI, M. 2010. Corporate Ethics and Good Governance [Online]. SSRN. Available: http://ssrn.com/paper=1549574 [Accessed May 08, 2010].

2010 Monash University. All Rights Reserved.

Manoj Shivanna (22124500)

Manoj Shivanna (22124500)

2010 Monash University. All Rights Reserved.