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CORPORATE ACCOUNTING SCANDAL AT SATYAM: A CASE STUDY OF INDIA'S ENRON

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Satyam Fraud: A Case Study of India's Enron

We thank Lori Holder-Webb (editor) and Gregory M. Trompeter (associate editor) for their constructive comments and feedback on earlier versions of the manuscript, as well as those provided by two anonymous reviewers. We are grateful to the undergraduate and graduate students participating in the case, and for their feedback used for case validation purposes. We especially acknowledge Joe Radliff, Jennifer Rampolla, and Jonathan Shertok for allowing portions of their solutions to be incorporated into the suggested solutions for the Satyam case study.

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Veena L. Brown , Brian E. Daugherty , Julie S. Persellin; Satyam Fraud: A Case Study of India's Enron. Issues in Accounting Education 1 August 2014; 29 (3): 419–442. https://doi.org/10.2308/iace-50735

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This case provides students a unique opportunity to examine and reflect on the challenges of auditing in today's global environment. Students examine a real-world billion dollar plus embezzlement and fraud at Satyam Corporation, an international company based in India and previously trading on the New York Stock Exchange. The case focuses on auditors' responsibilities related to obtaining and evaluating audit evidence, particularly as it relates to confirming cash and receivables. It also explores the quality control responsibilities related to audit procedures performed by foreign affiliates of a large international audit firm. The case illustrates the role of culture in performing an audit in accordance with auditing standards issued by the U.S. Public Company Accounting Oversight Board. Additionally, case details provide opportunities for class discussions and foster students' critical thinking skills on other auditing topics such as audit risk and planning, related party transactions, tone-at-the-top, and internal control deficiencies. By using a foreign issuer to explore these issues, the case highlights both the technical and international challenges of performing auditing procedures.

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A business journal from the Wharton School of the University of Pennsylvania

Scandal at Satyam: Truth, Lies and Corporate Governance

January 9, 2009 • 18 min read.

When terrorists attacked Mumbai last November, the media called it "India's 9/11." That tragedy has been succeeded by another that has been dubbed "India's Enron." In one of the biggest frauds in India's corporate history, B. Ramalinga Raju, founder and CEO of Satyam Computers, India's fourth-largest IT services firm, announced on January 7 that his company had been falsifying its accounts for years, overstating revenues and inflating profits by $1 billion. According to experts from Wharton and elsewhere, the Satyam debacle will have an enormous impact on India's business scene over the coming months. The most significant questions, however, will be asked about corporate governance in India, and whether other companies could follow Satyam's Raju in revealing skeletons in their own closets.

• Finance & Accounting

When terrorists attacked Mumbai last November, the media called it “India’s 9/11.” That tragedy has been succeeded by another that has been dubbed “India’s Enron.” In one of the the biggest frauds in India’s corporate history, B. Ramalinga Raju, founder and CEO of Satyam Computers, India’s fourth-largest IT services firm, announced on January 7 that his company had been falsifying its accounts for years, overstating revenues and inflating profits by $1 billion. Ironically, Satyam means “truth” in Sanskrit, but Raju’s admission — accompanied by his resignation — shows the company had been feeding investors, shareholders, clients and employees a steady diet of asatyam (or untruth), at least regarding its financial performance. ( Editor’s note : Satyam is a corporate sponsor of India Knolwedge@Wharton.)

Raju’s departure was followed by the resignation of Srinivas Vadlamani, Satyam’s chief financial officer, and the appointment of Ram Mynampati as the interim CEO. In a press conference held in Hyderabad on January 8, Mynampati told reporters that the company’s cash position was “not encouraging” and that “our only aim at this time is to ensure that the business continues.” A day later, media reports noted that Raju and his brother Rama (also a Satyam co-founder) had been arrested — and the government of India disbanded Satyam’s board. Though control of the company will pass into the hands of a new board, the government stopped short of a bailout — it has not offered Satyam any funds. Meanwhile, a team of auditors from the Securities and Exchange Board of India (SEBI), which regulates Indian public companies, has begun an investigation into the fraud. Since Satyam’s stocks or American Depository Receipts (ADRs) are listed on the Bombay Stock Exchange as well as the New York Stock Exchange, international regulators could swing into action if they believe U.S. laws have been broken. At least two U.S. law firms have filed class-action lawsuits against Satyam, but given the company’s precarious finances, it is unclear how much money investors will be able to recover.

According to experts from Wharton and elsewhere, the Satyam debacle will have an enormous impact on India’s business scene over the coming months. The possible disappearance of a top IT services and outsourcing giant will reshape India’s IT landscape. Satyam could possibly be sold — in fact, it had engaged Merrill Lynch to explore “strategic options,” but the investment bank has withdrawn following the disclosure about the fraud. It is widely believed that rivals such as HCL, Wipro and TCS could cherry pick the best clients and employees, effectively hollowing out Satyam. Another possible impact could be on the trend of outsourcing to India, since India’s IT firms handle sensitive financial information for some of the world’s largest enterprises. The most significant questions, however, will be asked about corporate governance in India, and whether other companies could follow Satyam’s Raju in revealing skeletons in their own closets.

‘Riding a Tiger’

Raju was compelled to admit to the fraud following an aborted attempt to have Satyam invest $1.6 billion in Maytas Properties and Maytas Infrastructure (“Maytas” is Satyam spelled backwards) — two firms promoted and controlled by his family members. On December 16, Satyam’s board cleared the investment, sparking a negative reaction by investors, who pummeled its stock on the New York Stock Exchange and Nasdaq. The board hurriedly reconvened the same day and called off the proposed investment.

The matter didn’t die there, as Raju may have hoped. In the next 48 hours, resignations streamed in from Satyam’s non-executive director and Harvard professor of business administration Krishna Palepu and three independent directors — Mangalam Srinivasan, a management consultant and advisor to Harvard’s Kennedy School of Government; Vinod Dham, called the “father of the Pentium chip” and now executive managing director of NEA Indo-US Ventures in Santa Clara, Calif.; and M. Rammohan Rao, the dean of the Indian School of Business in Hyderabad (ISB). Rao had chaired both December 16 board meetings. On January 8, he resigned his position as the ISB dean. In a letter to the ISB community, he explained: “Unfortunately, yesterday’s shocking revelations, of which I had absolutely no prior knowledge, mean that we are far from seeing the end of the controversy surrounding Satyam Computers. My continued concern and preoccupation with the evolving situation are impacting my role as dean of ISB at a critical time for the school. Given that my term with ISB anyway ends in a few months, I think that this is an appropriate time for me to step down.”

Resigning as Satyam’s chairman and CEO, Raju said in a letter addressed to his board, the stock exchanges and the market regulator Securities & Exchange Board of India (SEBI) that Satyam’s profits were inflated over several years to “unmanageable proportions” and that it was forced to carry more assets and resources than its real operations justified. He took sole responsibility for those acts. “It was like riding a tiger, not knowing how to get off without being eaten,” he said. “The aborted Maytas acquisition was the last attempt to fill the fictitious assets with real ones.”

Specifically, Raju acknowledged that Satyam’s balance sheet included Rs. 7,136 crore (nearly $1.5 billion) in non-existent cash and bank balances, accrued interest and misstatements. It had also inflated its 2008 second quarter revenues by Rs. 588 crore ($122 million) to Rs. 2,700 crore ($563 million), and actual operating margins were less than a tenth of the stated Rs. 649 crore ($135 million).

Satyam’s auditor PricewaterhouseCoopers issued a terse statement: “Over the last two days, there have been media reports with regard to alleged irregularities in the accounts of Satyam…. Price Waterhouse are the statutory auditors of Satyam. The audits were conducted by Price Waterhouse in accordance with applicable auditing standards and were supported by appropriate audit evidence. Given our obligations for client confidentiality, it is not possible for us to comment upon the alleged irregularities. Price Waterhouse will fully meet its obligations to cooperate with the regulators and others.”

Impact on ‘Brand India’

The outrage over Raju’s admission of systematic accounting fraud has broadened to wider concern about the potential damage to India’s appeal for foreign investors and the IT services industry in particular. Immediately following Raju’s confession, Satyam’s shareholders took a direct hit as the company’s share price crashed 77% to Rs. 30 (approximately 60 cents), a far cry from its 52-week high of Rs. 544 ($11.35) last May.

“If there were one or two more such accounting scandals in the next six months, it would make international investors more wary,” says Wharton management professor Michael Useem . “One example would put people on guard; several examples would be enough to tell big investment money managers that they have to be especially careful working in that environment.”

Jitendra Singh , a Wharton management professor who is currently dean of the Nanyang Business School in Singapore, believes Satyam is an “outlier” and that there is no reason to think that “problems of this kind may be much more extensive than one company or a handful of companies.” However, he adds, “foreign investors will look a little more askance at accounting data from India. And that may not be a bad thing.”

Useem also warns against overreacting. “Don’t assume other firms are guilty,” he says. But he considers the situation to be an “alerting call” for investors to check where their money is, and for auditors and independent directors in all major firms to take a look at the books.

Corporate India has tried to contain the damage so far. Rajeev Chandrasekhar, president of the Federation of Indian Chambers of Commerce and Industry, called upon regulators “to move quickly to demonstrate that this is an exceptional case among corporations, and that investors need not worry about Indian corporate governance and accounting standards.” Suresh Surana, founder of RSM Astute Consulting Group, said in a statement that the Satyam development is “a major eye opener and will bring into renewed and critical focus the role of independent directors, auditors, company management, [the] CFO and other key persons involved.”

“When you have companies that are ostensibly growing their top lines at 30%, 40% or 50%, it is possible to paper over things,” Singh says. “Satyam was doing it by boosting sales and profits; Bernie Madoff was doing it by boosting rates of return. When growth rates slow down, you are unable to hide the financial reality of how much cash you actually have. It is possible that during this slowdown period, more scandals will come to light.” (U.S. financier Madoff last month admitted to running a $50 billion Ponzi scheme to keep his hedge fund afloat.)

Singh adds that companies with “the bluest of blue-chip reputations [such as] Infosys and TCS” could actually gain in the current environment, because of a potential “flight to quality” among client companies. “The third-tier and weaker companies will probably undergo a lot more scrutiny,” he says.

According to Ravi Aron , senior fellow at the Mack Center for Technological Innovation at Wharton, the Satyam fallout could affect India’s IT offshoring and outsourcing firms in several ways. An immediate impact could be skepticism on the part of clients about whether Indian IT firms can be entrusted with sensitive financial information. “Clients could begin to ask, ‘How much do I know about this IT company and its governance?'” says Aron. “Is the IT service provider doing anything that could jeopardize the client’s compliance with FASB, Sarbanes Oxley, Basel II or other financial regulations?”

Aron recommends that before other IT companies get blackballed because of Satyam’s problems, “they should act swiftly to demonstrate that their own operations are squeaky clean.” Indian IT companies have always had exceptionally high standards of accounting, and they should ensure that they do not face any spillover effect, he adds. This has already begun to happen. On the day that Raju came clean, N. R. Narayana Murthy, chief mentor at Infosys, was on Indian television — distancing Infosys and the rest of the IT industry from Satyam’s practices. Similarly, Vineet Nayar, CEO of HCL, e-mailed a personal letter to the company’s clients and associates. Describing Satyam’s disclosures as “unfortunate,” the letter added that Nayar would “reaffirm our commitment that we [will] focus on creating value for our customers with the same passion that we have demonstrated in the past while maintaining the highest ethical and governance standards.”

Mauro Guillen , a Wharton management professor who has studied corporate governance in emerging economies, believes that Indian business has an advantage in arguing that the problem is limited to Satyam and is not systemic. “India is not perceived like Russia — it is neither everyone’s darling nor the plague,” he says. “This works to the country’s advantage because it deflects the blame of such occurrences to the way governance works in emerging economies rather than to India. What regulators in India need to do in response to Satyam is to find out quickly if other companies have been doing similar things. The proper response is to deal with and defuse the problem as soon as possible.”

Guillen notes that what makes Satyam’s case unusual is that it had listed its ADRs on the NYSE. “Companies in emerging economies have trouble raising capital at low costs. The literature shows that is the reason they want to list in the U.S., where they accept a higher level of governance in order to raise capital at a lower cost. The fact that Satyam listed its ADRs in the U.S. but still had such serious governance problems makes this case particularly disturbing.”

Guillen adds, though, that India has several well-regarded IT companies. “If one or two of them don’t make the grade, it should not shake investor confidence. It shows that investing in emerging markets is risky. Investors always balance risks and rewards. If the IT sector in India continues to remain competitive, the Satyam episode will just be a footnote in India’s business story. If the sector becomes uncompetitive, then that would create a serious problem.”

Saikat Chaudhuri , a management professor at Wharton, believes the Satyam episode reveals that the pressure on companies to maintain their financial performance is immense. “Satyam always wanted to keep up with the Big Three of Indian IT companies — TCS, Infosys and Wipro,” he notes. “At a time when the IT industry was booming and companies were growing rapidly, it was easy for Satyam to argue that the company was doing well and that it had good governance.” The involvement of the board, Chaudhuri adds, was at the “strategic level; in companies like Satyam, it is the owner/promoter/founder who runs the show. It has to do with the ownership structure.” In Chaudhuri’s view, auditors such as PricewaterhouseCoopers, who signed off on the bogus accounts at Satyam, have a lot more to answer for than the board of directors. “This is a serious lapse on their part. They should have probed.”

Chaudhuri’s advice to other Indian IT firms is to distance themselves from the Satyam fallout through prompt action. “Honesty and transparency will alleviate investor concerns,” he says. “I don’t believe the sector will come crashing down. Perhaps Indian IT companies will face more scrutiny in the coming months; they may have to answer a few more questions, but India Inc. will pull through.” NASSCOM, the National Association of Software and Services Companies, could play a role in helping communicate that “the Satyam episode, though it shocked everyone, is an isolated instance,” he adds. 

WorldCom and Tyco, Again

Useem says that if one were to take an inference from recent high-profile scandals outside of India, “there would be a redoubled effort [in India] on the part of investors and independent directors at other companies to ensure that nothing like what happened at Satyam happens under their noses.”

Useem draws a parallel between what occurred at Satyam with the scandals at WorldCom and Tyco, rather than at Enron. “At WorldCom, the CFO and the CEO were knowingly misstating the accounting and financials of the firm; at Tyco, the CEO and the CFO were knowingly taking money from the company for personal purposes,” he says. “Satyam’s disaster has a parallel to these acts of malfeasance.”

Useem recalls the CEO and promoter of a Chinese solar panel company who “wanted his company to be extremely well governed” and therefore listed it on the New York Stock Exchange. “He wanted a great board of directors and thus listed the company fully on the NYSE — not as an ADR — for the sole purpose … of forcing himself to be disciplined in the governance policies his company pursues.”

If it survives, Satyam may be able to redeem itself with new management and governance codes, Useem says. He recalls working as a consultant a couple of years ago with Tyco, where the company’s new CEO Ed Breen systematically went about cleaning up after the departure of disgraced CEO Dennis Kozlowski, instituting strong corporate governance practices. Tyco is one of the best examples of a corporate governance turnaround, Useem notes.

Singh adds that the Satyam scandal doesn’t necessarily warrant more regulation. “There is no need to strengthen corporate governance regulations [in India],” he says. “The issue is really more one of leadership at the board level. The tone gets set by the chairman of the board; it’s much more a matter of culture within the board room, of the group dynamics within the board.”

Truth in Numbers

Notwithstanding Raju’s confession, the Satyam episode has brought into sharp relief the role and efficacy of independent directors. SEBI requires Indian publicly held companies to ensure that independent directors make up at least half their board strength.

The knowledge available to independent directors and even audit committee members is inherently limited to prevent willful withholding of crucial information, Singh notes. “The reality is, at the end of the day, even as an audit committee member or as an independent director, I would have to rely on what the management was presenting to me,” he says, drawing upon his experience as an independent director and audit committee member at Fedders, a publicly held company in the U.S. that filed for bankruptcy last year. “It is the auditors’ job to see if the numbers presented are accurate.”

Singh says he drew “a level of confidence” from the accounting rigor and governance mechanisms at Infosys, where he was an independent director from 2000 to 2003. He recalls how T.V. Mohandas Pai, the company’s then-chief financial officer (now a director overseeing human resources) “would take so much time going into accounting details.”

Even if outside directors were unaware of the true state of Satyam’s finances, some red flags should have been obvious. According to Aron, Satyam is one of the world’s largest implementers of SAP systems. In an effort to compete against Satyam, HCL recently acquired Axon, an SAP consulting firm, at a cost of $800 million. ( Editor’s note : See interview with HCL CEO Vineet Nayar .) Aron notes that any Satyam director should have been puzzled that the company was proposing to invest $1.6 billion in real estate at a time when a competitor as formidable as HCL was gunning for one of its most lucrative markets. “IT is a highly capital-intensive business, especially in India,” says Aron. “What on earth would compel Satyam to invest $1.6 billion in real estate at a time when competition with HCL was about to grow more intense? That is what the directors should have been asking.” Instead, he adds, like the dog that didn’t bark in the Sherlock Holmes story, the matter was allowed to slide.

How effective independent directors can be is mainly a factor of the “dynamics inside the board room once the doors are closed,” according to Singh. “There is an attitude in some Indian companies that the board members actually work for the people who have brought them onto the board. This is a completely misguided attitude. It looks like this may have been a problem at Satyam…. The real strength of a healthy board is when a consensus gets overturned by a dissenting view.”

Even if the proposed investment in the two Maytas firms appeared to be ethical on first sight, Singh notes that he would have expected the independent directors to be extra careful. “Given the fact that there is a family connection involved, as an independent board member I would be looking very hard at whether this is the right decision for the company,” he says. “Also, quite aside from issues of governance, everything we know about unrelated diversification [deals] from management literature is that, as a general matter, they are not a good idea; they don’t seem to make strategic sense.”

Independent Defectors

Useem wonders if the Satyam directors who resigned actually did the right thing. “The leadership dictum is that you need to stay the course, stay in the game, face the problem and solve the problem,” he says. “Did the four directors who resigned have an option of banding together, staying on the board and changing governance?” Useem adds that “it is often very hard to stay the course. I am empathetic with people who have difficulty [making that decision].”

Media reports quoted former independent director Srinivasan as saying she accepted “moral responsibility” for failing to cast a dissenting vote on the Maytas proposal. Some of the other directors who resigned have cited difficulties in attending frequent board meetings. Useem says it can indeed prove challenging for independent directors to go through reams of documents and attend frequent board meetings that companies in distress typically have.

In a written response to Knowledge at Wharton, Palepu, Satyam’s former non-executive director, stated that he was not present at the board meetings where the Maytas investment proposals were discussed. “As a result, under Indian law, I was not eligible to vote on the proposals,” he said. Palepu earned nearly Rs. 1 crore (about $200,000) from Satyam in 2007, according to regulatory filings, most of it for rendering “professional services.” He declined comment, but those services were essentially leadership development and consulting for Satyam’s top management, according to Archana Muthappa, the company’s head of media relations.

SEBI and India’s registrar of companies have launched an investigation into Satyam. Citing the Indian Securities Contract Regulation Act of 1956, a report in The Economic Times says SEBI is empowered to award penalties of up to Rs. 25 crore and imprisonment of up to 10 years to directors and management executives “for violating the listing agreement by making false and inaccurate disclosures in the company’s quarterly and annual results.”

Singh says it is important to remember who the ultimate victims are in cases like Satyam. “This is a real tragedy; the people who will be left holding the bag will be the shareholders.”

Even as Raju is widely blamed for unleashing “India’s Enron,” Chaudhuri points to a major difference between Enron and Satyam. “At Enron, the CEO stonewalled, while whistle-blowers came out with the truth,” he says. “At Satyam, there were no whistle-blowers. The CEO blew the whistle on himself.” In that sense, Raju did — ultimately — tell the truth and perhaps live up to the “Satyam” name. Unfortunately for him, the company, and India’s IT industry, by then it was much too late.

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Satyam Financial Statement Fraud (A)

• By: Sanjay Kumar Mishra & Beenish Hussain
• Publisher: SAGE Publications: SAGE Business Cases Originals
• Publication year: 2022
• Online pub date: January 03, 2022
• Discipline: Financial Reporting , Management Control Systems , Corporate Governance
• DOI: https:// doi. org/10.4135/9781529797602
• Keywords: accounting , auditing , auditors , committees , control systems , corporate governance , financial fraud , financial reports , financial statement , internal audit Show all Show less
• Contains: Teaching Notes Length: 4,734 words Region: Southern Asia Country: India Industry: Information and communication Type: Direct case info Organization: Satyam Computers Limited Organization Size: Large info Online ISBN: 9781529797602 Copyright: © Sanjay Kumar Mishra and Beenish Hussain 2022 More information Less information

Teaching Notes

In 2009, the then chairman of Satyam Computer Services Limited, India, confessed to financial irregularities, which led to a series of grave felonies, including massive financial and securities fraud. In his statement, he confessed that the irregularities in the company financial statements had arisen on account of inflated profit over a period of years. Later, the investigation into the financial reporting process at Satyam and the effectiveness of internal control over financial reporting highlighted that the weakness of the governance system and ineffective control over financial reporting allowed promoters of Satyam to propagate the financial statement fraud. Students will be asked to assess the culpability of the board governing performance and examine the factors that resulted in financial statement fraud at Satyam.

Learning Outcomes

By the end of the case study, student should be able to:

• Explain the role of an audit committee and an auditor in governing and communicating corporate performance.
• Discuss the relationship of the effectiveness of internal and external corporate governance to the quality of financial reporting in a company.
• Assess the impact of the failure of control oversight of financial reporting on company.

Introduction

The System Process Audit Team of Satyam Computer Services Limited (hereafter Satyam), in its assessment of the company’s IT control system during its system process audit, concluded that the Satyam IT control system cannot be relied on, the deficiencies identified during the audit process were significant, and that these deficiencies had the ability to affect the genuineness of the financial reporting and communication, including the financial statements (Sukumar, 2009). Price Waterhouse, the statutory auditor for the company at the time of the assessment, which had conducted its own review, termed the assessment of the System Process Audit Team related to the system control deficiency as ‘insignificant’ and decided not to raise the issue with the audit committee (Sukumar, 2009). In its audit report for the financial year ending 31 March 2008, Price Waterhouse expressed unqualified opinion about the effectiveness of internal control over financial reporting as of 31 March 2008 (Satyam Computer Services Limited, 2008).

Eighteen months later, in September 2008, Ramalingham Raju, erstwhile chairman of Satyam, made the shocking revelation to the Satyam board of directors that he had perpetrated financial misappropriation at Satyam. Raju confessed to financial irregularities leading to a series of grave felonies that constituted financial and securities fraud of massive proportion. In his statement he confessed that the company’s balance sheet as of 30 September 2008 carried inflated cash and bank balances, non-existent accrued interest, understated liability, and overstated debtor’s position. The misstatement in the company’s balance sheet was a consequence of inflated profits during the previous several years. Raju made this confession through a letter written on 7 December 2009 to the board of directors of the company.

Later, Venturebay Consultants Private Limited, a wholly owned subsidiary of Tech Mahindra Limited, conducted an assessment of the effectiveness of internal control over financial reporting. Venturebay found several deficiencies in the internal control over financial reporting, including complex accounting and financial reporting framework coupled with multiple non-integrated financial systems with no mechanism for reconciliation among those systems and an absence of a policy on access to critical IT systems (Satyam Computer Services Annual Report, 2008–9, 2009–10). These shortcomings made Satyam’s financial reporting system vulnerable to perpetration of financial irregularities.

Overview of Satyam Computer Services

Satyam was incorporated by two brothers, B. Rama Raju and B. Ramalinga Raju, on 24 June 1987 in Hyderabad, Andhra Pradesh, India, as a private limited company. The objective of the company was to provide a comprehensive range of information technology services to its customers. In 1991, the company became public and made its initial public offering, which was oversubscribed by a factor of approximately 17x (Shirur, 2011). Satyam was listed in Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) in India.

Satyam grew rapidly as a global IT firm and was selected as one of the most remarkable and rapidly growing entrepreneurial companies in India by Switzerland-based World Economic Forum and World Link Magazine . Satyam benefitted from the growth in global IT spending and the company increased from 20 employees during its early years to 50,570 employees as of 31 March 2008.

In 2000, B. Ramalinga Raju was awarded the IT Man of the Year by Dataquest. By 2001, the revenue of the company surpassed USD 1 billion (Shirur, 2011). In the same year, the company began listing its American Depository Receipts on the New York Stock Exchange under the ticker symbol SAY. In 2005, Satyam was ranked third in the Corporate Governance Survey by Global Institutional Investors. Satyam showed impressive financial performance quarter after quarter. Table 1 summarizes the quarterly financial performance of Satyam Computer Services from March 2005 to September 2008.

Source : http://www.moneycontrol.com

In 2007, Ernst & Young presented B. Ramalinga Raju with the Entrepreneur of the Year award. Satyam’s revenue grew from INR 25,604.9 million in the financial year 2004 to INR 64,850.8 million in the financial year 2007, representing an approximate compound annual growth rate of 36%. During the same period, the net income of the company grew from INR 5,263 million to INR 14,046.2 million, a compound annual growth rate of 38.7%. Satyam was twice awarded the Golden Peacock award for corporate governance excellence, the last being in 2008, by the UK-based World Council for Corporate Governance (Agarwal & Sharma, 2009).

Fuelled by the impressive quarter-by-quarter financial performance of Satyam and its reputation as a well-governed company, the market share price of Satyam continued to appreciate and was trading in the range of INR 390.65–499.50 per share in April 2008. As of 31 March 2008, Satyam was the fourth-largest Indian IT service company on the basis of amount of export revenue generated by the company during the financial year 2007–8.

Satyam offered a range of IT services, including application development and maintenance services, consulting and enterprise business solutions, and infrastructure management services. Satyam also offered business process outsourcing (BPO) service through its wholly owned subsidiary Satyam BOP. The competitors of Satyam included consulting firms, such as Accenture, Bearing Point, Capgemini, and Deloitte Consulting, and the inhouse division of large multinational technology companies such as Hewett Packard and IBM. Other competitors included IT outsourcing firms such as Computer Science Corporation, Electronic Data Systems, IBM Global Services; off-shore IT services firms such as Infosys Technologies Limited, Tata Consulting Services Limited, and Wipro Limited; and software firms such as Oracle and SAP service group (Satyam Computer Services Limited, 2008).

In December 2008, Satyam announced it was going to acquire 100% stake in two companies, namely Maytas Properties and Maytas Infrastructure. The latter was owned by the promoter’s son. The Maytas deal was criticized on the grounds that there was no due diligence performed before announcing the deal and that the acquisition of Maytas would only benefit the promoter family, which would result in transfer of wealth from minority shareholders to majority shareholders. Given the opposition to the deal by selected minority shareholders, the company had to abort the acquisition within seven hours of its announcement.

During the same month, the World Bank barred Satyam from conducting business with the bank. Satyam was accused of (a) providing improper benefits to the World Bank staff and (b) its inability to maintain the necessary documentation related to the fees charged by its subcontractor. The World Bank declared Satyam to be ‘ineligible to do business’ and barred it for a period of eight years. This penalty was one of the most severe sanctions against any outsourcing company levied by the World Bank and adversely impacted the confidence of investors in Satyam. On the same day, the share price of Satyam Computer Services fell by 13.6% in the stock exchange. Satyam opposed the decision of the World Bank and sought an apology, but the damage was already done.

The World Bank episode adversely impacted investor confidence, which led to the depletion in the wealth of the Satyam shareholders within a month. That is, the company share price fell from the range of INR 218.60–319 in November 2008 to the range of INR 114.65–251 in December 2008. Table 2 summarizes the monthly share price of Satyam in Bombay Stock Exchange from April 2008 to May 2009.

Source : Satyam Computer Services Annual Report, 2008–9, 2009–10

This series of events led to the resignation from the board of four independent directors. At the end of December 2008, Satyam Computer Services appointed Merrill Lynch as an advisory firm to explore the possible strategic options that the company should exercise in order to enhance shareholder value. However, the market had already lost confidence, which resulted in further deterioration in its share price. Faced with the inability of the promoters to meet the margin calls on the shares pledged by them with institutional investors, the investors sold the shares of promoters in the market, which resulted in the decrease of promoters holding from an already low of 8.64% to 3.6%.

On 7 January 2009, Ramalinga Raju, the chairman of the company, resigned, confessing to the financial irregularities that led to a series of grave felonies, including massive financial and securities fraud. Through his letter to the board of directors, the promoter-chairman confessed improprieties and explained that what started as a marginal discrepancy in the actual and stated operating profit continued to grow over the period and translated into financial misstatement of massive proportions spread across multiple heads. Furthermore, the promoter justified his actions on account of low proportion of equity shareholding by the promoter and the concern that the poor operating performance and adverse movement in the share price might result in forced takeover of the company. In his confessional statement, Raju also stated that all attempts were made to eliminate the gap in the books of account and the aborted takeover of the Maytas companies was the last attempt. Finally, he rationalized his action by claiming that the decisions taken were in the interest of the company and that he and other members of management had not benefitted from the inflated financial results.

‘It is like riding a tiger, not knowing how to get off without being eaten’—Ramalinga Raju in his confessional letter to the Satyam board, 7 January 2009

Corporate Governance System of Satyam Computer Services

In India, the Companies Act 1956, 1 Chapter II and clause 49 of the listing agreement of the Securities and Exchange Board of India (SEBI) formed the basis of the corporate governance system of Satyam. Satyam, also being listed on the New York Stock Exchange, was also governed by the listing agreement of the U.S. Security Exchange Commission (SEC) Sarbanes-Oxley Act 2002.

At Satyam, the board of directors was the highest-level decision-making body. Satyam had a distinguished board consisting of nine directors, with six of those being independent directors. Among the independent directors, four were current or former professors, one a former Indian Administrative Service officer, and one an industry expert from the IT domain. Among the managing directors were the two founding brothers, B. Ramalinga Raju as chairman and B. Rama Raju as managing director and CEO of the company. The board of directors was assisted in performing its duties by the board committees, which consisted of audit committee, compensation committee, and investor grievance committee.

Among the key functions of the board was the governance and communication of the corporate performance to its stakeholders through its financial reporting system. The audit committee assisted the board in performing this function. Under Section 292A of Companies Act 1956, India, Satyam was required to have an audit committee. The audit committee of the board was directly responsible for the appointment, compensation, and oversight over the independent auditor; assisting the board by maintaining oversight on the integrity and quality of the financial reporting system, including financial statements; ensuring independence in the performance of company internal audit function; describing, reviewing, and ensuring compliance of the company’s internal quality control procedure through periodic discussion with independent auditors; and reviewing the half-yearly and annual financial statements before their submission to the board (as per the Companies Act 1956). The audit committee of Satyam consisted of four independent members from the board. None of the members of the audit committee had ‘financial expertise’ 2 within the definition of rule 10A-3 of the U.S. Security Exchange Act (Satyam Computer Services Limited, 2008). The members of the audit committee also had limited meetings without the presence of directors.

Internal Control Over Financial Reporting

In India, SEBI listing agreement clause 49 V makes company CEOs and CFOs directly responsible for the establishment and maintenance of internal control over financial reporting. CEOs and CFOs are also responsible for certifying that the financial statement represents a true and fair view of a company’s affairs and is in compliance with the accounting standards. As at 31 March 2008, in its report on the effectiveness of internal control over financial reporting of Satyam, management found the internal control to be effective (Form 20-F filing, FY ending March 31 2008).

Under Section 292A (6) of the Companies Act 1956 and SEBI listing agreement clause 49, 5D (1), the Satyam audit committee was responsible for maintaining oversight over the company’s financial reporting process through periodic assessment of its internal control system. Aside from its independent assessment, the audit committee also relied on the review of management letter, letter of internal control weakness issued by statutory auditor, and internal audit report related to internal control weakness (SEBI listing agreement clause 49, 5E (4)). As well as the above, the audit committee was supposed to periodically discuss the internal control system with the auditor. Price Waterhouse, a leading auditing firm, was the statutory auditor of the company until 9 December 2009. In its report on the consolidated financial statement of Satyam Computer Services for the financial year 2007–8, Price Waterhouse opined that the internal control over financial reporting at Satyam did not have any material weakness (MW) and that in all material respects the company maintained effective internal control over financial reporting as at 31 March 2008 (Satyam Computer Services Limited, 2008).

Later, evidence was found that the auditor ignored the warning of the System Process Audit Team assessment with respect to IT system control at Satyam Computer Services. The team found that the company’s IT control system could not be relied upon, since the deficiencies identified during the audit process were significant in nature and had the ability to affect the genuineness of the financial statements of the company (Sukumar, 2009). The auditor failed to inform the audit committee of the findings of the System Process Audit Team and instead termed the above system control deficiency as ‘insignificant’ (Sukumar, 2009).

While conducting an assessment of the prevailing financial reporting system at Satyam Computer Services by the new acquirer of controlling interest over Satyam, Venturebay Consultants Private Limited, during the period in which the financial statement fraud was propagated, the following drawbacks were found in the internal financial control system of Satyam:

• 1. The company did not maintain an effective control environment at the entity level.
• 2. There was a lack of commitment and effective approach from senior management to perform entity-wide risk assessment. According to the Serious Fraud Investigating Agency report, Satyam founders B. Ramalinga Raju, B. Rama Raju, ex-CFO Vadlamani Srinivas, and ex-vice president (finance) G. Ramakrishna conspired collaboratively to use various fraud schemes to perpetrate financial irregularities. The report also highlighted that these schemes were perpetrated by deliberately leaving loopholes in the computerized accounting system, which used an enterprise resource planning (ERP) module. The internal controls over financial reporting were circumvented by collusion between the key management persons. This also resulted in lack of coordination in the risk oversight functions and other deficiencies in the internal control system over financial reporting, which included (a) deficiencies in internal audit, and (b) ineffective IT general and application control, allowing unrestricted access to critical IT systems and folders, among others.
• 3. Satyam had a complex accounting and financial reporting framework, which, coupled with multiple non-integrated financial systems, enabled perpetration of financial irregularities (Satyam Computer Services Annual Report, 2008–9, 2009–10). Furthermore, there was no process of reconciliation between various systems, including payroll systems.
• 4. The company did not maintain an effective, timely, and accurate financial closing and reporting process.
• 5. There was deficiency in the process of revenue recognition and receivables management. Satyam’s main source of revenue was IT service contracts, which were either time-and-material contracts or fixed price contracts. Significant accounting policies of Satyam revealed that for time-and-material contracts, the revenue was recognized when the service was performed. For fixed price contracts, the revenue was recognized using proportional performance basis, which reflected the pattern in which the obligations to the customers were fulfilled. Satyam used an input-based approach and claimed to have established direct relationship between the units of input and productivity. Satyam revenue recognition principles were consistent with other peer IT companies. However, a forensic investigation of the books of account for the period 1 April 2002 to 30 September 2008 revealed that at Satyam, the fictitious revenue was recorded by creation of false invoices by circumventing the normal revenue recognition cycle. The transactions were recorded using the financial system in a manner that allowed the irregularity to be camouflaged. After creating the fictitious revenue, fictitious cash collections were shown as collections from customers. In order to substantiate these fictitious collections, forged bank statements and fixed deposit receipts were also prepared.
• 6. Satyam’s prevailing system lacked an effective mechanism for customer confirmation, bank balance confirmation, and bank reconciliation procedures by the company. Later evidence was found of the external auditor’s non-adherence to auditing standards and protocol with respect to the above (Sukumar, 2009).
• 7. Physical verification of assets was not conducted at regular intervals and the fixed assets register was not updated. Further, the capitalization of fixed assets was done without evidence of approval by respective departments.

Perpetration of Financial Statement Fraud

In the report published by the Serious Fraud Investigating Agency of India (Satyam Computer Services Annual Report, 2008–9, 2009–10), based on the agency’s investigation, the report authors concluded that the confession made by Ramalinga Raju was not out of call of conscience. According to the report, Satyam founders B. Ramalinga Raju, B. Rama Raju, ex-CFO Vadlamani Srinivas, and ex-vice president (finance) G. Ramakrishna conspired collaboratively to use various fraud schemes to perpetrate financial irregularities. The report also highlighted the deficiency in the internal control over financial reporting. The forensic investigation focused on the period 1 April 2002 to 30 September 2008 revealed that Satyam Computer Services had a complex accounting and financial reporting framework, which, coupled with multiple non-integrated financial systems, enabled perpetration of financial irregularities (Satyam Computer Services Annual Report, 2008–9, 2009–10).

Table 3 summarizes the specifics of the financial irregularity, which was substantial in scope and amount, was perpetrated across multiple financial years, and affected various heads of the balance sheet and income statement of Satyam Computer Services. The nature of those financial irregularities may be broadly classified into two categories: (a) fictitious entries recorded in the accounting records through recognition of fictitious revenue and interest income, which resulted in creation of fictitious cash and bank balance and accounts receivables (inclusive fraud scheme); and (b) omitting the recording of real transactions (exclusive fraud scheme) (Satyam Computer Services Annual Report, 2008–9, 2009–10). The overall impact of those inclusive and exclusive frauds to the extent determined by the forensic investigator was INR 67,631 million, including cash and bank balance of INR 52,947 million on the balance sheet as of 30 September 2008 (Satyam Computer Services Annual Report, 2008–9, 2009–10).

Source : Satyam Computer Services Annual Report, 2008–-09, 2009–-10, Schedule -18, Notes of Accounts 3.3, pp. 227–2-28., Retrieved on February 10, 2014 from http://www.techmahindra.com

The Satyam episode raised questions on the conventional measures of the effectiveness of corporate governance and the governance over measuring and communicating corporate performance to the shareholders of the company, which led to significant loss to the shareholders and loss of trust in the financial market.

Discussion Questions

• 1. What was the assessment of the System Process Audit Team? How was it relevant with respect to control over financial reporting at Satyam? How should the auditor have responded?
• 2. What type of fraud scheme was used by the promoter to propagate financial statement fraud at Satyam? What were its overall implications for the financial statement of Satyam?
• 3. What were the factors that resulted in the material weakness in the internal control over financial reporting at Satyam, which allowed the promoter to propagate financial statement fraud?
• 4. Who should be held responsible for the failure of internal control over financial reporting at Satyam?
• 5. If you were the chairman of the audit committee, how would you have assessed whether there was a material weakness in the internal control over financial reporting at Satyam? What follow-up action would you have taken?

1. In India, the Companies Act 2013 has replaced the previous act (i.e. Companies Act 1956).

2. As per the U.S. SEC Sarbanes-Oxley Act Section 407, a company is required to disclose any audit committee members that the company chooses to designate as ‘financial expert’. According to Section 407, individuals with (a) accounting experience, (b) supervisory experience of the financial reporting function, such as CEO and/or CFO, and (c) users of financial reports in a professional capacity, such as financial analyst or venture capitalist, could fulfil this role of ‘financial expert’ (U.S. SEC Sarbanes-Oxley Act Section 407).

Further Reading

Research papers, relevant websites.

• Institute of Chartered Accountants of India. https://www.icai.org
• Ministry of Corporate Affairs, Government of India. https://www.mca.gov.in
• Public Company Accounting Oversight Board. https://www.pcaobus.org
• Securities and Exchange Board of India. https://www.sebi.gov.in
• U.S. Securities and Exchange Commission. https://www.sec.gov

This case was prepared for inclusion in Sage Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes.

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