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January 8, 2009

Financial Scandal at Outsourcing Company Rattles a

Developing Country
By HEATHER TIMMONS

NEW DELHI Ramalinga Raju was contrite, sort of.

In an emotionally charged four-and-a-half page letter, Mr. Raju, the chairman and co-founder of one of
Indias largest outsourcing companies, described to his board on Wednesday how a small discrepancy had
mushroomed into one of the biggest scandals in Indian corporate history.

What started as a marginal gap between actual operating profit and the one reflected in the books of
accounts continued to grow over the years. It has attained unmanageable proportions as the size of
company operations grew, he wrote. It was like riding a tiger, not knowing how to get off without being
eaten.

In the end, the scandal threatened to gobble up not just Mr. Raju, who resigned, but his company, Satyam
Computer Services. Far beyond Satyam, it raised fears that similar problems might lurk in other Indian
companies, particularly in its vaunted outsourcing industry.

One only hopes that with the kind of scrutiny and the kind of focus this brings, everybody doesnt end up
being painted with the same brush, said Lakshminarayana, the chief strategy officer for Wipro
Technologies, which competes with Satyam.

The long-running fraud, which is being called Indias Enron, also raised questions about the vigilance of
regulators in India and the United States.

Satyam serves as the back office for one-third of the Fortune 500, including some of the largest banks,
manufacturers, health care and media companies in the world handling things like computer systems
and customer service for companies that include General Electric, Nestl, Ford Motor, Cisco and the United
States government.

In some cases, Satyam even acted as clients outsourced finance and accounting departments.

The fraud will make people even more nervous about investing in India and other developing markets,
said Jacob Rees-Mogg, the lead manager with Somerset Capital Management, a fund that specializes in
emerging markets.

India needs foreign investment more than ever. Though it has enjoyed 9 percent growth a year recently,
that is expected to slow to 7 percent, at best, as the global economy cools. Housing prices are down, the
countrys major stock index, the Sensex, is half what it was a year ago. And Indias government has little
financial leeway for giant stimulus packages like those in China and the United States.

Outsourcing and information technology are crucial parts of the Indian economy. They provided local
companies with $64 billion in revenues in 2008 and employed more than two million people directly, and
millions more indirectly.

Mr. Raju said he had regularly falsified Satyams accounts as the company expanded from a small family-
run firm into a back office giant with 53,000 workers in 66 countries.

Some of Indias biggest conglomerates started out as family-run companies, and analysts fear the taint of
corruption from Satyam poor governance, lax accounting controls and a lack of transparency could
sully any of those big companies for investors and customers.

Relatives often hold crucial management positions and sizable stakes in the companies. Foreign investors
have begun to push for more outside representation on boards, and for families to give up controlling
stakes they hold.

A huge piece of Satyams finances was a fantasy. Of the 53.6 billion rupees in cash and bank balances the
company listed as assets at the end of its second quarter, 50.4 billion rupees ($1 billion), were nonexistent,
according to Mr. Rajus letter. Revenues for the quarter ended Sept. 30 were actually 20 percent lower than
the 27 billion rupees reported, and the companys profit for the quarter was just 10 percent of what it
reported at the time.

Many analysts said it was unthinkable that Mr. Raju had acted without accomplices, and regulators in
India, Europe and the United States were likely to take action against Satyam for false accounting. In
addition to being listed in India, its shares have traded on the New York Stock Exchange since May 2001,
and on Euronext since January 2008.

Satyams auditor, PricewaterhouseCoopers, which has audited the company since its NYSE listing, said it
was examining Mr. Rajus statement and could not comment further.

Many Satyam clients said they were studying the situation. Cisco said it did not expect any material
impact.

The revelations could lead to a major shake-up in Indias outsourcing industry, as a nearly cashless Satyam
struggles to meet payroll and other expenses. Satyam may be shut down, sold off in its entirety or broken
into pieces, they say.

John C. McCarthy, an analyst with Forrester Research in New York, said Satyams clients were scrambling
to find out whether the fraud is intermingled with their operations, and what their liabilities are.

This happens like clockwork in the high-tech business, he said. Every three to four years theres some
financial scandal. It is because high-tech has traditionally been viewed by the financial analysts as a growth
industry. There are huge pressures to maintain that growth, and not all companies have the management
wherewithal to survive under those pressures. In the short term, many Satyam clients will migrate to
competition like Infosys and TCS, said analysts with Religare Hichens Harrison.

News of the scandal sent the Sensex index down 7 percent on Wednesday. Shares in Satyam fell about 78
percent. Trading in Satyam on the NYSE was suspended until further notice.

Though Mr. Rajus announcement shocked most of the world, there had been signs for months that
something was wrong at the top of Satyam.

The company came under close scrutiny after an October report on Fox News that it had been banned from
World Bank contracts when spy software was installed on some computers. Satyam denied the accusation,
but in December the World Bank confirmed it had been banned for giving improper benefits to bank staff,
and for not accounting for all its fees.

In December, Satyam investors revolted after the company proposed buying two firms with ties to Mr.
Rajus sons.

On Dec. 30, analysts with Forrester Research warned that corporations that relied on Satyam might
ultimately need to stop doing business with the company.

Firms should take the initial steps of reviewing the exit clauses in their current Satyam contracts, in case
management or direction of the company changes, Forrester said.

Four of the companys directors resigned recently and the company hired Merrill Lynch for strategic advice,
a move that is generally a precursor to a sale.

On Wednesday, Merrill Lynch sent a letter to Indias stock exchanges, saying it had terminated its
relationship with Satyam after the bank came to understand that there were material accounting
irregularities at the company. Merrill Lynch officials declined to comment further.

Mr. Raju wrote in his confessional letter that neither he nor the managing director (his brother B. Rama
Raju) had taken one rupee/dollar from the company. He said the board, his brother and their families
had no knowledge of the situation, seeming to leave open the possibility that someone else did.

SEBI, Indias securities regulator, said it would investigate trading in Satyams shares. Mr. Raju could face
up to 10 years in jail and fines of $5 million in India for the accounting fraud.

Claire Cain Miller contributed reporting from San Francisco.

Copyright 2009 The New York Times Company

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