NCRDS STERLING INSTITUTE OF MANAGEMENT STUDIES

Subject: Business Ethics and Corporate Governance Topic: Analysis of Satyam Scam

Submitted to: Prof. Navneet Baweja Date: 22nd March 2012

Submitted by: Jeevan Yadav Roll- 95, Div- B

Satyam Scam

NCRDS Sterling Institute of Management Studies

Page 1

INTRODUCTION

Satyam fraud unfolded and so were the inherent weaknesses of Corporate Governance in India. Ramalinga Raju, once a posture boy of Indias growing software sector who could find a seat beside Bill Clinton on the dais, has become a villain in the corporate world for valid reasons. His emotionally charged four and half page letter of startling revelations shook the entire corporate world when he admitted of cooking the account and inflating the figure by Rupees 5040 crore. This scam is being equated with Enron of USA because here also the scam was orchestrated by its Auditor, Arthur Anderson, in Satyam, Price Waterhouse cooper. By the end of the 20th century, Satyam computers had made a name for itself on the globe and had emerged as the 4th largest software in the country. The meteoric rise of the company can be substantiated by the fact that it was established in 1987 as private company and got listed by BSE in 1991. In 2001 its share was listed in NYSE and in 2004 it made its place in European stock market. According to companys statement, its revenue exceeds to 2 bn USD in 2008. Similarly Rajus sons companies also were moving with leaps and bound. Maytas infra got the ambitious Metro projects and bagged many tenders including one of construction of Technology Park.

CORPORATE GOVERNANCE IN INDIA- REALITY AFTER SATYAM SCAM

Interestingly Satyam has bagged Golden Peacock award for best corporate governance by World Council for Corporate Governance only a few years ago. The scam has raised many doubts about the class of corporate governance in India. While speaking at a seminar on corporate governance organized by CII, Ministry of Company affairs and National foundation of corporate governance, C.B.Bhave, the chairman of SEBI said on 6th February, 2009 that the corporate governance is an ongoing process. There is a retrospection everywhere that some concrete steps with respect to it should be done. There are few importance elements of corporate governance namely Auditing, Independent Directors, Regulators and Finally the Board including CEO itself. If we examine these constituents one by one, it would be crystal clear that all the constituents either failed or did not act as was required.

The role of Price water house Coopers (PwC), the Auditing firm of Satyam has been dealt. Institute of Chartered Accountants of India (ICAI) constituted under Charter Accountants Act, 1949 is the regulatory body of all the accounting and auditing firms across the countries. According to a report there is acute shortage of qualified chartered accountants and auditors in India and around the world also. The number of CAs passing every year is hopelessly small. It is apprehended therefore that the auditing firms out source unqualified or semi-qualified commerce graduates of Post graduates to do the auditing in the companies. The prestigious firms get the assignment by virtue of their name and fame which they recklessly sell in the market by out sourcing the auditors at a very low remuneration. In case of Satyam, the man who was supposed to do audit was incidentally executive member in ICAI.

The independent directors have also failed to discharge their duties properly. Section 49 of SEBI Act and section 229 A of Company Act, 1956 provides for appointment of Independent Directors in the Companies for protecting the rights of public at large in general and shareholders in particular. In the case of satyam T.R.Prasad, the retired Cabinet Secretary Govt of India was one of the directors. It speaks a lot about the procedure of appointment of independent directors. What kinds of people are being appointed in the company? Moreover, they are appointed by the Companies themselves and pay hefty salaries and perks for virtually doing nothing. Under this circumstance is it thinkable that these Independent directors would dare to peep into the affairs of the company against the wishes of the CEOs? There are only two possibilities in Satyam with respect to Independent directors. Either they connive with Raju and knew everything that was going on, or they did not know. In both the cases they failed miserably to discharge their duties. What is the need of such Independent Directors if they cannot do anything in this matter? One unpalatable justification is given that the Independent Directors participate in the meeting and are not concerned with autonomy of the company. It should be bone in mind the Enron scam was exposed by Sherron Watkins, a women independent director.

Thirdly, the SEBI and Ministry of Company Affairs too have failed in their assigned jobs. SEBI is the highest regulator and keeps eagle eye on the activities of the capital markets. When the profits of this company were registering abnormal growth, thereby the prices of the shares were soaring, what were these guys doing? There has been a lot of hue and cry with respect to insider

trading; a howl SEBI failed to listen to and it inflicted heavily on Satyam. Raju had pledged almost all his shares so did many of the promoters. The newly appointed CEO Murthy is also said to have sold about 3.14 lakhs shares including 40,000 in December itself belonging to him and his family members. These are the insider trading. Although insider trading per se is not illegal but it is unethical, moreover when Companys high official who were on share selling spree must had the idea of what was going in the company. All such transactions are needed to be probed.

As a matter of fact the tax holidays for the IT-BPO companies also needs to be said goodbye. Had Raju to pay the Income Tax according to the profits shown in the accounts, he would not have fudged it to this scale. The ministry of Finance must deliberate upon the entire gamut of issues related to tax heaven provisions. RECOMMENDATIONS: Taxonomy It is important to lay out the taxonomy of corporate frauds and governance failures. In jurisdictions such as the US and UK, managers (such as the CEO, CFO and other senior executives) are compensated through stock options and equity and hence there is a strong incentive to inflate earnings. On the other hand, in countries such as India where there is concentrated shareholding, the critical actor is not the senior management but the controlling shareholder (a.k.a. the promoter). In such a scenario, where fraud is involved, it usually does not result in an inflation of earnings, but in related party transactions whereby assets of a company are siphoned out to other companies owned by the controlling shareholder. In that sense, and in drawing international parallels, although the media has called Satyam Indias Enron, this case is more akin to the Parmalat case which also involved affiliated transactions and misstatement of financials. The regulatory response in terms of reforms will have to take into account the differences in the systems where diffused shareholding is the norm (US and UK) and where concentrated shareholding is the norm (e.g. India).

Audit Process

There is clearly a case for reforms in the audit system.

- The appointment of auditors ought to be shifted from the purview of the controlling shareholders to the independent audit committee so that auditors do not owe any allegiance whatsoever to the controlling shareholders, and that the process of appointment and removal of auditors is effected in a manner that is truly independent of controlling shareholder influence. - There is a case for the establishment of a body such as the Public Company Accounting Oversight Board (PCAOB) (that was established in the U.S. a few years ago), as that body would review the intensity and the integrity of audits by auditors on an annual basis. - There is need for auditor rotation as it prevents creation of any affinity between auditors and controlling shareholders, and avoids capture of the audit process by insiders in companies. - Auditor liability is currently an unresolved question, and the affixation of liability for malfeasance needs to be clearly defined. In some countries, the public regulatory authorities (such as the securities regulator) could directly initiate action against auditors and the merits of such an approach require careful consideration. - Other precautionary processes may help as well. This could include meetings between audit committee members and auditors without the presence of management.

Independent Directors

Independent directors tend to be in an unenviable position. Unless there are any red flags or warnings in a companys operations, it is difficult to pinpoint board failure per se. For example, a board that receives false information, without any other warnings, is in a tough spot. Further, in controlling shareholder situations, the independent directors are often appointed by the controlling shareholders, and may hence owe a sense of responsibility to those shareholders. Having said that, the current norms on corporate governance in India do not go far enough to deal with independence of the board in controlling shareholder situations. Some of the possible reforms are as follows:

- Making nomination committees mandatory for Indian companies. Currently, there is no requirement to have nomination committees, although several companies have established such committees voluntarily. When independent directors are chosen by an independent nomination committee and without the influence of controlling shareholders, there is a sense that it would instill greater independence of such directors from the controlling shareholders

- Other processes relating to the functioning of independent directors may induce greater credibility in board decision making. These include:

-The requirements of lead independent directors - Executive sessions among independent directors without the presence of management - Appointment of advisors (such as lawyers and accountants) by independent directors to advise them on significant transactions involving a company. Such advice would be provided independent of the management or controlling shareholders. - More fundamentally, there needs to be a re-evaluation of who appoints independent directors. Under the current system, they are appointed by the shareholder body as a whole, which is often considerably influenced by the controlling shareholder. What is required is a reform to consider other methods of appointing independent directors. For instance, they can be appointed by a majority of the minority shareholders, whereby the controlling shareholders do not have a say on the matter. Alternatively, there may be proportionate representation on boards of listed company where all shareholders have some level of say in appointment of directors and that the board is not dominated by controlling shareholder nominees. For example, in such a system, the minority shareholders obtain the right to elect such number of directors in proportion to the percentage holding of such minority shareholders. [Note: The system of proportional representation is already available under the Companies Act, in Section 265, but is only optional] - Moving from a regulatory perspective into standards of conduct and ethics, perhaps it would be useful for industry bodies such as the Confederation of Indian Industry (CII) to draw up guidance for directors that would help independent directors clearly determine what is expected of them in the boardroom.

Investor Activism There is greater need for activism on the part of the investors directly. Often, that is not possible because of the lack of coordination among various investors, referred to as the collective action problem. One method by which this has been resolved in the U.S. is through the existence of proxy consultants such as Institutional Shareholder Services or Risk Metrics who knit together coalitions of investors to actively play a role in significant decisions involving a company. Similarly, an active business press would also play an important role in enhancing governance practices. These are some of the key recommendations emanating from the panel discussion. Clearly, there is recognition that none of these systems will be failsafe. However, the solution in these circumstances is that if a number of such systems are put in place, it would reduce the statistical likelihood of things turning sour from a governance standpoint.