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1
CHAPTER I
SATYAM SCAM - AN EYE OPENER FOR INDIAN
CORPORATE WORLD
Satyam Computer Services was among the top four information technology (IT) majors in the
country. It played a crucial role in the stock market as one of the 30 largest and most actively
traded stocks that determined the Bombay Stock Exchange’s (BSE) value-weighted index,
Sensex. Industry analysts say Satyam promoter B. Ramalinga Raju’s biggest crime was perhaps
in misleading investors completely.
The scam at Satyam Computer Services, the fourth largest company in India’s much showcased
and fiscally pampered information technology (IT) industry, has had an unusual trajectory. It
began with a successful effort on the part of investors to thwart an attempt by the minority-
shareholding promoters to use the firm’s cash reserves to buy out two companies owned by them
— Maytas Properties and Maytas Infra.
That aborted attempt at expansion precipitated a collapse in the price of the company’s stock and
a shocking confession of financial manipulation and fraud from its chairman, B. Ramalinga Raju.
The whole story is now of facts and figures which have been analysed by corporate experts as
well as various economists in India. The certain parties/issues which need to be analysed to
understand the nature of the fraud and its related problems have been highlighted which shall be
elaborated later.
Satyam Company and The Board: The event came to the light when B, Ramalinga Raju,
Chairman of Satyam Computer Services made a confession that took the nation as well as the
world at large1 by surprise and everybody listened with an awed expression as to what one was
1 The company offers information technology (IT) services spanning various sectors, and is listed on the New York Stock Exchange and Euronext.Satyam's network covers 67 countries across six continents. The company employs 40,000 IT professionals across development centers in India, the United States, the United Kingdom, the United Arab Emirates, Canada, Hungary, Singapore, Malaysia, China, Japan, Egypt and Australia. It serves over 654 global companies, 185 of which are Fortune 500 corporations. Satyam has strategic technology and marketing alliances
2
hearing. It is believed that Raju diverted Satyam funds to the companies headed by his sons, B.
Teja Raju (Maytas Infra) and B. Rama Raju Jr. (Maytas Properties), to buy large tracts of land
and win projects. He had chalked out a game plan to acquire the companies and in the process
also reduce the alarming gap in Satyam’s accounts, between actual profit and the figure stated in
the books, and keep the wealth within the family. Much like Satyam, Raju nurtured the two
companies well and had ambitious plans for them, using his clout with the Andhra Pradesh
government, which bent over backwards to patronise Maytas. During the past three years,
Maytas Infra bagged projects worth Rs.30, 074 crore on its own or in joint ventures and became
the “fastest growing infrastructure company” in the State. The projects covered areas such as
irrigation, railways, roads and ports. The “superfast growth” of the company, which recorded a
turnover of Rs.1,600 crore in 2008 as against Rs.100 crore in 2003; the speed and ease with
which it got projects, and the questionable role played by the top political leadership, are all
under the scanner now.
The ‘honest’ confession2 brought many issues to the lime light along with the truth that the fraud
committed by The Chairman was not single-handed and also included other perpetrators. This
with over 50 companies. Apart from Hyderabad, it has development centers in India at Bangalore, Chennai, Pune, Mumbai, Nagpur, Delhi, Kolkata, Bhubaneswar, and Visakhapatnam.2 The letter written by B, Ramalinga Raju, Chairman of Satyam Computer Services to the Satyam Board:
“It is with deep regret and tremendous burden that I am carrying on my conscience, that I would like to bring the
following facts to your notice:
1. The Balance Sheet carries as of September 30, 2008,
a. Inflated (non-existent) cash and bank balances of Rs 5,040 crore (as against Rs 5,361 crore reflected in
the books);
b. An accrued interest of Rs 376 crore, which is non-existent
c. An understated liability of Rs 1,230 crore on account of funds arranged by me;
d. An overstated debtors' position of Rs 490 crore (as against Rs 2,651 reflected in the books);
2. For the September quarter(Q2) we reported a revenue of Rs 2,700 crore and an operating margin of Rs 649
crore(24 per cent of revenue) as against the actual revenues of Rs 2,112 crore and an actual operating
margin of Rs 61 crore (3 per cent of revenues). This has resulted in artificial cash and bank balances going
up by Rs 588 crore in Q2 alone.
The gap in the balance sheet has arisen purely on account of inflated profits over several years (limited only to
Satyam standalone, books of subsidiaries reflecting true performance).
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.
3
issue of corporate fraud as most like to name it as the biggest corporate fraud in Indian Corporate
history contains such players as The Auditors, The Bankers, The Promoters and also the
investors.3
Auditors- Price Waterhouse Coopers: The incident also raised some serious question about well-
named bodies and organisations who were involved in the business of managing the ‘fraudulent’
affairs of the Company. In this context it is also necessary to note the role of the auditors as the
It has attained unmanageable proportions as the size of the company operations grew significantly (annualised
revenue run rate of Rs 11,276 crore in the September quarter, 2008, and official reserves of Rs 8,392 crore).
The differential in the real profits and the one reflected in the books was further accentuated by the fact that the
company had to carry additional resources and assets to justify a higher level of operations thereby significantly
increasing the costs. Every attempt made to eliminate the gap failed. As the promoters held a small percentage of
equity, the concern was tha poor performance would result in the takeover, thereby exposing the gap. It was like
riding a tiger, not knowing how to get off without being eaten.
The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones. Maytas' investors
were convinced that this is a good divestment opportunity and a strategic fit. 3 One Satyam's problem was solved, it was hoped that Maytas' payments can be delayed. But that was not to be.
What followed in the last several days is common knowledge.
1. I would like the board to know:
2. That neither myself, nor the Managing Director (including our spouses) sold any shares in the last eight
years - excepting for a small proportion declared and sold for philanthropic purposes.
3. That in the last two years a net amount of Rs 1,230 crore was arranged to Satyam (not reflected in the
books of Satyam) to keep the operations going by resorting to pledging all the promoter shares and raising
funds from known sources by giving all kinds of assurances (statement enclosed only to the members of the
board).
4. Significant dividend payments, acquisitions, capital expenditure to provide for growth did not help matters.
Every attempt was made to keep the wheel moving and to ensure prompt payment of salaries to the
associates. The last straw was the selling of most of the pledged shares by the lenders on account of margin
triggers.
5. That neither me nor the managing director took even one rupee/dollar from the company and have not
benefited in financial terms on account of the inflated results.
6. None of the board members, past or present, had any knowledge of the situation in which the company is
placed.
7. Even business leaders and senior executives in the company, such as, Ram Mynampati, Subu D, T R
Anand, Keshab Panda, Virender Agarwal, A S Murthy, Hari T, S V Krishnan, Vijay Prasad, Manish Mehta,
4
whole affair was managed by one of the biggest names in the auditing business- Price
Waterhouse Coopers.
According to audited balance sheet figures (if they are to be trusted) available from the CMIE’s
database, the paid-up equity in Satyam Computer Services rose from Rs. 56.24 crore in March
2000 to just Rs. 64.89 crore by March 2006 and further to Rs. 133.44 crore in March 2007.
Overall, the number of shares held by the promoter group fell from 7.16 crore (22.8 per cent) to
Murli V, Shriram Papani, Kiran Kavale, Joe Lagioia, Ravindra Penumetsa, Jayaraman and Prabhakar Gupta
are unaware of the real situation as against the books of accounts. None of my or managing directors'
immediate or extended family members has any idea about these issues.
Having put these facts before you, I leave it to the wisdom of the board to take the matters forward. However, I am
also taking the liberty to recommend the following steps:
1. A task force has been formed in the last few days to address the situation arising out of the failed Maytas
acquisition attempt.
2. This consists of some of the most accomplished leaders of Satyam: Subu D, T.R. Anand, Keshab Panda and
Virendra Agarwal, representing business functions, and A S Murthy, Hari T and Murali V representing
support functions.
3. I suggest that Ram Mynampati be made the chairman of this Task Force to immediately address some of
the operational matters on hand. Ram can also act as an interim CEO reporting to the board.
4. Merrill Lynch can be entrusted with the task of quickly exploring some merger opportunities.
5. You may have a 'restatement of accounts' prepared by the auditors in light of the facts that I have placed
before you.
I have promoted and have been associated with Satyam for well over 20 years now. I have seen it grow from few
people to 53,000 people, with 185 Fortune 500 companies as customers and operations in 66 countries. Satyam has
established an excellent leadership and competency base at all levels.
I sincerely apologise to all Satyamites and stakeholders, who have made Satyam a special organisation, for the
current situation. I am confident they will stand by the company in this hour of crisis.
In light of the above, I fervently appeal to the board to hold together to take some important steps. TR Prasad is well
placed to mobilise a support from the government at this crucial time.
With the hope that members of the Task Force and the financial advisor, Merrill Lynch (now Bank of America), will
stand by the company at this crucial hour, I am marking copies of the statement to them as well.
Under the circumstances, I am tendering the resignation as the chairman of Satyam and shall continue in this
position only till such time the current board is expanded. My continuance is just to ensure enhancement of the
board over the next several days or as early as possible.
I am now prepared to subject myself to the laws of the land and face the consequences thereof.
5
5.8 crore (8.6 per cent) between September 2001 and September 2008. This points to a conscious
decision by the promoters to sell shares, which may have been used to acquire assets elsewhere.
The more inflated the share values, the more of such assets could be acquired. It is quite possible
that the assets built up by the eight other Raju family companies under scrutiny, including
Maytas Properties and Maytas Infra, partly came from the resources generated through these
sales. If true, this makes Raju’s confession suspect, since he stated that “neither myself, nor the
Managing Director (including our spouses) sold any shares in the last eight years — excepting
for a small proportion declared and sold for philanthropic purposes.” Price Waterhouse Coopers
has been the statutory auditor for Satyam Computer services for last six years. Auditor‘s
involvement is crystal clear. Satyam had paid twice the amount of what was charged by other
Audit Firms. There was no cash within the company's banks and yet the auditors went ahead and
signed on the balance sheets saying that the money was there. Not just the cash, even they even
signed off on the non-existent interest that accrued on the non-existent cash balance! Auditors do
bank reconciliation to check whether the money has indeed come or not. They check bank
statements and certificates. So was this a total lapse in supervision or were the bank statements
forged? No one knows yet as everyone still awaits the investigation report regarding this issue.
The company officials said they relied on data from the reputed auditors. But
PricewaterhouseCoopers, stung by this insinuation hit back at Satyam.4
Satyam and Corporate Governance: Just three months ago, India's fourth-largest software
services exporter, Satyam Computer Services received a Golden Peacock Global Award from a
group of Indian directors for excellence in corporate governance. Now that Satyam is in turmoil
and its shares have plunged after a botched attempt to buy two infrastructure firms in which
management held stakes, concerns over the conflict of interest and a lack of transparency are
(B Ramalinga Raju)
Copies marked to:
1. Chairman SEBI
2. Stock Exchanges4 Price Waterhouse Coopers to the media: “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."
6
being raised. Ramalinga Raju himself was the recipient of many an award for corporate
governance and transparency, but the fraud has brought to light the fact that in India the
distinction between owners and management is still not very clear. Where the owners are also the
managers, such frauds are always a possibility. In the Satyam case, of course, none is guiltier
than the Rajus. This shows the status of Indian Corporate Governance and how it can easily fall
prey to people like Rajus’.
SEBI and its take on Satyam: The Securities and Exchange Board of India, which says it is
‘horrified at the magnitude of the fraud’ had in December given a clean chit to Satyam saying
that it had not found any violation of norms relating to takeover and corporate governance in its
preliminary surveillance of the deal involving the acquisition of Maytas Infra by Satyam
Computer Services. Analysts say the “market watchdog” lacks the teeth for ensuring compliance
on governance. Now, after so much water has flown under the bridge, Sebi has moved to ‘take
action’ against the company.5
The Satyam episode has brought out the failure of the present corporate governance structure.
The present corporate governance structure hinges on the independent directors, who are
supposed to bring objectivity to the oversight function of the board and improve its effectiveness.
Stakeholders place high expectation on them. But is the expectation misplaced? Perhaps, yes. An
individual independent director cannot play an effective role in isolation. Even if a particular
independent director is highly committed, he can only watch‘ wrong doing and at best initiate a
discussion, but alone she cannot stop a decision even if it is detrimental to the interest of
shareholders or other stakeholders. Neither can she blow the whistle outside the board room (e.g.
to regulators) because board proceedings are considered confidential.6
CHAPTER II
SATYAM SCAM: ROLE OF AUDITORS AND
BANKERS AS TO THEIR INVOLVEMENT5 Infra Chapter III “Satyam Scam and SEBI: Who is to be blamed?”6 www.ndtv.com/convergence/ndtv/story.aspx?id=NEWEN20090079469 - 101k
7
Once the picture becomes clear as how the manipulation of funds were done and as to how the
scam could be caused in spite of so many regulations and statutory restrictions7 present to curb
and check any deviation from the established duties and obligations that are essential and
compulsory on nature.
If one is to blame the Satyam for instigating the corporate down-fall and rise of the questions as
to corporate governance and similar concerns then there are others also involved who may be
said to have played a pivotal role in ‘aiding’ Mr. Raju in pulling off such a fraud and hood
winked even the best in the business to prevent such mishaps.8 Hence, it is bemusing as to how
Satyam could have indulged in accounts fudging without getting detected by the auditors.
Firstly, one needs to speak about Price Waterhouse Coopers the auditors of Satyam Computer
Services who should have caught it as because:
Book sales belonging to the subsequent year in the current year by pre-dating the
invoice. This is like catching the tiger by the tail. Unless the sales improve, the Company
will have to follow the same thing in the subsequent years as well to ensure that the profit
trend is maintained. (The auditors can detect this by matching the dates of invoices,
shipment advises, gate passes, delivery receipts, physical stock verification reports,
debtors’ confirmation etc.)
7 Infra Chapter V, “Satyam Scam & Legal Provisions Under Companies Act, 1956”; Chapter III, “Satyam Scam and
SEBI: Who is to be blamed?”8 www.expressindia.com/latest-news/Satyam-fraud-Not-a-one-man-show/408664/ reports “KPMG, which audits the
accounts of IT majors like Infosys and Wipro, doubted the veracity of the confessional letter written by B Ramalinga
Raju, the founder-chairman of Satyam Computer, saying the financial bungling cannot be done only by the head of
the Hyderabad-based firm. “It defies logic, one is not sure whether there is much more to it than is written in the
letter and whether the letter contains all the facts,” KPMG Chief Operating Officer Richard Rekhy said here on the
sidelines of a CII function. It is too simplistic at the moment to believe that the kind of thing that has happened in
the company is done by Raju alone, he said. “It requires a whole battery of people to advance those accounting
entries and credit those because you have to involve other people as well like bankers to get those certificates,” he
said. When asked whether Raju might have siphoned off funds and he is now admitting to lesser crime, he said it is
quite possible but it could be known only after investigation of group companies”
8
Book bogus sales to inflate profits in one year and show return sales in the subsequent
year. This is again like catching the tiger by the tail as the quantum will have to be
increased each year to compensate for the additional charge coming in the subsequent
year due to return sales. (The auditors can detect this by checking the invoices,
subsequent year sales returns, debtor confirmations, stock tally etc.)
Book bogus other income. This is done to inflate the profits and mostly to as a money
laundering exercise: Unaccounted money is laundered into the books by showing
income for no actual service rendered. (Auditors can detect this by seeing the actual
documents supporting the other income and by comparing with the expertise available in
the company to provide such services)
By not booking purchases or overheads. Companies try to inflate profits by not
booking purchase of material or overheads: This again has to be covered up in the
subsequent year when the creditors are to be paid. (Some of the ways in which the
Auditor can find these include, comparison of the purchases with physical stock,
quantitative tally of stocks and consumption, trend analysis of overheads between two
periods, obtaining creditor’s confirmation, bank reconciliation statements to check for
amounts paid but not accounted in books which will be hanging as a difference between
bank balance as per books and as per the bank statements for a given cut-off date)
In all the cases of inflation of sales in the books, the company will credit the sales account to
increase the sales and pass the debit to a debtor account to show receivables. The problem here
is that the receivables has to be squared off either by reversing the sale or by writing off as most
fraudulent companies do not introduce cash to square of the receivables for bogus sales.
However, Mr. Ramalinga Raju has introduced a new gambit in this fraud committed by him and
his ‘allies’. He booked bogus income, most likely with fictitious companies and cleared off the
debtor balances by showing collections and there by increasing the cash and bank balances. In
order to get actual collections from fictitious companies, he didn’t make any actual collections.
He just got some more book entries made to clear the debtors and transferred the debits to bank
balances. If something remains in debtors, it will raise questions from many quarters, starting
from the auditors to the Board of Directors to the analysts to institutional investors to (at least)
9
some of the intelligent retail investors. If the debtor balance is converted into Bank balances? No
one is going to doubt. In fact, people will become happier to see the swell of cash. The
Company will be valued higher it is sitting on a huge pile of cash.
The problem starts here. Normally, auditors will ask for confirmation balances for the bank
balances shown by the company. But then how did he get away for so many years without
having actual bank balances? Or how did he produce the needed confirmation to the auditors for
these balances? Did the auditors (one of Big Four, mind you) overlook seeking confirmation of
balances? This presumption seems to be impossible. Auditors though by definition are not
“bloodhounds” but are “watchdogs”, they minimum become a nagging wife if confirmation for
significant balances are not received. They will qualify such things in their audit report and also
will draw the attention of lack of confirmations to the Board of Directors and Audit Committee.
So the big question that arises here is “How could Mr. Raju convince the auditors?” 9 There can
9 One has to note that the Auditors Report required under the Indian Companies Act, 1956 is very different from the
Auditors’ certificate as per USA and other country laws.
Under those laws, much of the responsibility on the accounts is shifted to the management. Interestingly, this report
doesn’t specify any such minute details to be followed but simply asks auditors to look at all things that may require
a scrutiny, which is lucid and ‘flexible’.
227. Powers and duties of auditors: (1) Every auditor of a company shall have a right of access at all times to the
books and accounts and vouchers of the company, whether kept at the head office of the company or elsewhere, and
shall be entitled to require from the officers of the company such information and explanations as the auditor may
think necessary for the performance of his duties as auditor.1[(lA) Without prejudice to the provisions of sub-section (1), the auditor shall inquire-
(a) whether loans and advances made by the company on the basis of security have been properly secured and
whether the terms on which they have been made are not prejudicial to the interest of the company or its members;
(b) whether transactions of the company which are represented merely by book entries are not prejudicial to the
interests of the company;
(c) where the company is not an investment company within the meaning of section 372 or a banking company,
whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at
a price less than that at which they were purchased by the company;
(d) whether loans and advances made by the company have been shown as deposits;
(e) whether personal expenses have been charged to revenue account;
(f) where it is stated in the books and papers of the company that any shares have been allotted for cash, whether
cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether
10
be only speculations as to how he could have hoodwinked his auditors but unless the SEBI or the
administrators frame and deduce something definite in this regard speculations cannot be the
correct answer as to whether there was any involvement between the auditors and the perpetrator
of the fraud, Mr. Raju. Under S. 227 read with S. 233 of the Companies Act, 1956 the auditors are
required to accurately, fairly and diligently review and audit the accounts of the company before
issuing the signed auditors’ report.10 Failure to do so would result in a penalty under S.233 of Rs.
10,000. Under Sections 62 and 63 of the Act, any person issuing a prospectus that contains a false
statement may be punished with up to 2 years imprisonment and fine up to Rs.50, 000.11 This
includes directors, promoters and experts such auditors and investment bankers. Satyam also had an
ADS listing in the US and filed a prospectus with the US SEC. Under Rule 10b-5 issued under
Section 10 of the Securities Act of 1933, it is unlawful for any person to make any untrue statement
the position as stated in the account books and the balance-sheet is correct, regular and not misleading.]
Looking at the provisions of Section 227 (1A) (b) can it be said that the auditors ensured as to whether it is not
the same case with Satyam before certifying their accounts? If yes, how did they ensure?
Difficult questions as the whole baloon of Satyam was blown up only with “book entries”. Instead of acting as
book keepers, the Satyam finance department under instructions and intrusions of Mr. Raju, probably “book
cooked”.
In addition to the above, subsection 3 of the same section 227 warrants the auditor to report this:
(3) The auditor’s report shall also state-
(a) whether he has obtained all the information and explanations which to the best of his knowledge and belief were
necessary for the purposes of his audit;
(b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as
appears from his examination of those books, and proper returns adequate for the purposes of his audit have been
received from branches not visited by him;2[(bb) whether the report on the accounts of any branch office audited under section 228 by a person other than the
company's auditor has been awarded to him as enquired by clause (c) of sub-section (3) of that section and how he
has dealt with the same in preparing the auditor's report;]
(c) whether the company’s balance-sheet and profit and loss account dealt with by the report are in agreement with
the books of account and returns;3[(d) whether, in his opinion, the profit and loss account and balance-sheet comply with the accounting standards
referred to in sub-section (3C) of section 211;]
Then the obvious question arises in the mind of people that whether compliance was done by Satyam? And, if so
done then to what respect?10 See Sec. 233, Companies Act, 195611 See Sec. 63, Companies Act, 1956
11
of a material fact or to omit to state a material fact in connection with the sale of a security. Under
Section 11 of the Securities Act, the persons who signed the registration statement (directors and
officers) are liable in addition to the underwriters, auditors and other experts.
In addition, disciplinary proceedings/enquiries could be initiated by the Institute of Chartered
Accountants of India12 against the audit firm, which would be a very serious implication for the audit
firm, as it could have the immediate effect of disqualifying their eligibility to act as statutory auditors
for several banks and other institutions. Such an event could also result in suspension or debarment
of the audit firm if the ICAI13 concludes that there were serious lapses on the audit firm‘s part.
Secondly and most importantly comes, the issue of independent directors14 and the
shareholders. The role of the company's directors, including independent directors, in the entire
episode too has been exposed after the Satyam episode. Most of them essentially remain
‘nodders’ in the boardroom and agree to whatever the management or the promoters want to
push through.
The Satyam board, including its five independent directors15 had approved the founder's proposal
to buy 51 per cent stake in Maytas Infrastructure and all of Maytas Properties, owned by the
family members of Satyam chairman B Ramalinga Raju. Despite the shareholders not being
taken into confidence, the directors went ahead with the management's decision. The decision of
acquisition was, however, reversed 12 hours later after investors dumped Satyam's stock and
threatened action against the management. By any yardstick, the directors were men of eminence
and learning who should be independent. Clause 49, of the Indian listing agreement deals with
12 ICAI, 194913 ibid14 see Chapter III: “Satyam Scam And Sebi: Is Somebody To Be Blamed.”15 Satyams’ independent directors includes—
Mangalam Srinivasan,
Vinod Dham (Entrepreneur)
Krishna Palepu (Harvard professor)
M. Rammohan Rao (Indian School of Business dean) from CNN-IBN Published on Thu, Jan 08, 2009 at
13:10 , Updated at Thu, Jan 08, 2009 at 17:42
12
the role of independent directors and assumes, that not being related to a promoter or having a
direct economic benefit from a company, makes a director independent.16
In Satyam‘s case, directors may have voted differently if they knew perhaps through such meetings
the views of shareholders on the issue of unrelated diversification of the kind proposed by the
promoters. Shareholders on their part, have a right to know how their directors represent them.
Details of dissenting views, in a board can convey useful information about the various options
considered at a meeting. While detailed views cannot usually be disclosed in the short term, it is
possible to have minutes publicized after two-three years. This will not serve the immediate purpose
of protecting present shareholders, but would impose pressure on independent directors to be seen to
be fulfilling their duty of loyalty. If diligence was exercised at the board then it is to be known as to
how independent directors voted on such issues, perhaps through a statement in the annual report. It
would call in to question, the real independence in a board, if persons of widely varying backgrounds
were to always seem to agree, on every issue. By resigning instead of coming up with an explanation
for what transpired at the board, some of the directors of Satyam, beg the question whether any
meaningful debate took place at all, on this issue. It is not difficult for the regulators to bring the
sunlight of transparency to board discussions, through a few changes in their disclosure guidelines.
Under the SEBI and Companies Act 1956, all directors cannot be held responsible because
institutional directors and independent directors are nominated directors of various financial
institutions or the government nominees. They cannot be held responsible as nominated directors
cannot be held legally liable.
CHAPTER III
SATYAM SCAM AND SEBI: IS SOMEBODY TO
BE BLAMED?
16 Supra note 14
13
The scam or fraud whatever one may term the incident as it caught the Regulatory bodies’ off-
guard and also pointed out the gaping holes existing in the legal framework to prevent such fraud
from happening. The Satyam scam represents a lowering of guard and the throwing of
established practices to the wind by those who were expected to safeguard the interests of small
investors. The auditors imagined the fixed deposit receipts were genuine, the company’s
directors overly trusted Raju, SEBI mistakenly thought it could easily get at Raju with its wide-
ranging powers, while the CID was too protective about sharing information.17
THE Securities and Exchange Board of India (SEBI) may not have foreseen, as experts claim,
the fraud committed in Satyam Computer Services, but there is plenty the market regulator can
do to ensure that another one like this does not occur in the country.
The SEBI wears several hats: it regulates the market; facilitates information flow between the
stock exchange, the listed companies and the investors; and keeps tabs on the operations of listed
companies. Its responsibility towards investors is to ensure that any information regarding listed
companies is placed in the public domain. If fraud exists in a listed company, SEBI’s job is to
probe the matter to protect the investors.
SFIO and SEBI
As soon as Ramalinga Raju admitted to the fraud on January 7, the regulator, empowered by the
provisions of the SEBI Act, 1992, ordered an investigation and sent its officials to Hyderabad to
inspect the books and records. The officials were, however, not allowed access to Raju as he had
already surrendered before the Hyderabad police. It is essential for SEBI to interrogate Raju as
he has insisted that only he was involved in the scam.
A senior official said that perhaps Raju was advised well to get himself arrested in order to stall a
probe by SEBI. A lawyer said the police would not be able to deny SEBI access to Raju as the
regulator is armed with the provisions of the 1992 Act. SEBI moved a Hyderabad court seeking
permission to interrogate Raju and his brother Rama Raju. However, on January 23, the court
rejected the plea and refused to entertain another petition by the Serious Fraud Investigation
17 “Far from the truth” by S. Nagesh Kumar published in ‘the Frontline’ [Volume 26 - Issue 04 :: Feb. 14-27,
2009]
14
Office. It was not until February 4, 2009 that the Supreme Court came to rescue SEBI by giving
it permission to examine them in jail. While the lower court had rejected its petition, while the
Andhra Pradesh High Court asked it to wait for some more time. The interim report of the
Registrar of Companies (RoC) has, according to reports, confirmed falsification of books of
accounts and inflation of the company’s financial position to the extent of over Rs.5,000-6,000
crore by Satyam Computer Services Ltd. The RoC report is the basis for the probe by the Serious
Fraud Investigation Office (SFIO), set up under the Ministry of Corporate Affairs in 2003. As
the probe by the SFIO is the main limb of the multi-pronged investigation into the fraud, a close
look at what the SFIO can achieve under the present legal and regulatory framework needs to be
examined.
The SFIO is a non-statutory body and was set up on the basis of the recommendations of the
Naresh Chandra Committee18 on corporate governance in the backdrop of stock market scams,
failure of non-financial banking companies and the phenomena of vanishing companies and
plantation companies. It is a multi-disciplinary organisation with experts on finance, capital
market, accountancy, forensic audit, taxation, law, information technology, company law,
customs and investigation. These experts are drawn from banks, the Securities and Exchange
Board of India (SEBI), the Comptroller and Auditor General’s office and the organisations and
departments concerned of the government.
The SFIO’s mandate is extremely focussed and, to some extent, limited by Sections 235 to 247
of the Companies Act, 1956. Although the Naresh Chandra Committee envisaged a separate
statute to enable the SFIO (along the lines of the SFO in United Kingdom) to investigate all
aspects of fraud and direct the prosecution in appropriate courts, the Central government,
inexplicably, did not find it necessary to simultaneously create a separate legislative framework
for the SFIO to function under. This has, according to observers, seriously compromised the
SFIO’s efficiency and effectiveness.
18 The Naresh Chandra Report (2003) seeks to enforce the guidelines laid down in Kumarmangalam Report (1998)
and also lays stress on “Independent Directors” which are to be characterised in line with:
Independence of judgment.
No material relationship.
No pecuniary relationship
15
SFIO takes up investigations only into those cases of alleged fraud when:
referred to it by the Central government under Section 235/237 of the Companies Act,
1956;19
cases that substantially involve public interest, to be judged by size, either in terms of
monetary misappropriation or in terms of persons affected, or those cases that may lead to a
clear improvement in systems, laws or procedures;
the SFIO may also take up cases on its own without them being referred to it by the
Department of Company Affairs.20
After completing all the formalities for listing its securities, including of entering into listing
agreement, the securities of the company are listed and traded at the concerned stock exchanges.
Before listing, the company enters into a listing agreement with the concerned stock exchanges.
Almost all the stock exchanges have a standard listing agreement (which is amended from time
to time by issuing circulars by each of the stock exchanges). Companies listed on stock
exchanges have many obligations to discharge. These obligations are elaborated in all the
relevant clauses of the Listing Agreement which the company has entered into with the Stock
Exchange(s).
Clause 49 and SEBI
Clause 49 Background: SEBI had constituted a Committee on Corporate Governance under the
chairmanship of N R Narayana Murthy to improve standards of corporate governance in India.
SEBI introduced some major amendments based on the report on this committee on 26th August,
2003, in clause 49 of its listing agreement.
19 These provisions enable the Central government to appoint one or more competent persons as inspectors to
investigate and submit a report on the affairs of a company if, in its opinion, or in the opinion of the RoC or the
Company Law Board, there are circumstances suggesting that the business of a company is being conducted with
the intention to defraud its creditors or members, or for a fraudulent or unlawful purpose.20 In these cases, the SFIO Director has to record the reasons in writing, and the decision will be subject to review by
a coordination committee set up for the purpose. It is to be seen whether these aspects of its functioning have
restricted its autonomy or operational efficiency.
16
Applicability of Clause 49: All companies which were required to comply with the requirement
of the erstwhile Clause 49 i.e. all listed entities having a paid up share capital of Rs 3 crores and
above or net worth of Rs 25 crores or more at any time in the history of the entity, are required to
comply with the requirement of this clause. This clause does not apply to other listed entities,
which are not companies, but body corporates, incorporated under other statutes. Clause 49 will
apply to these institutions as long as it does not violate their respective statutes, guidelines or
directives.
Clause 49 - Corporate Governance The company agrees to comply with the following provisions:
I. Board of Directors
(A) Composition of Board: (i) The Board of directors of the company shall have an optimum
combination of executive21 and non-executive22 directors with not less than fifty percent of the
board of directors comprising of non-executive directors.
(ii) Where the Chairman of the Board is a non-executive director, at least one-third of the Board
should comprise of independent directors and in case he is an executive director, at least half of
the Board should comprise of independent directors.
(iii) For the purpose of the sub-clause (ii), the expression ‘independent director’ shall mean a
non-executive director of the company who:
a. Apart from receiving director‘s remuneration, does not have any material pecuniary
relationships or transactions with the company, its promoters, its directors, its senior
management or its holding company, its subsidiaries and associates which may affect
independence of the director;
21 An executive director is the senior manager or executive officer of an organization, company, or corporation. The
position is comparable to a chief executive officer (CEO) or managing director. An executive director is usually
remunerated for his or her work.22 A non-executive director (NED, also NXD) or outside director is a member of the board of directors of a
company who does not form part of the executive management team. He or she is not an employee of the company
or affiliated with it in any other way
17
b. Is not related to promoters or persons occupying management positions at the board level
or at one level below the board;
c. Has not been an executive of the company in the immediately preceding three financial
years;
d. Is not a partner or an executive or was not partner or an executive during the preceding
three years, of any of the following:
1. The statutory audit firm or the internal audit firm that is associated with
the company, and
2. The legal firm(s) and consulting firm(s) that have a material association
with the company.
e. Is not a material supplier, service provider or customer or a lessor or lessee of the
company, which may affect independence of the director; and
f. Is not a substantial shareholder of the company i.e. owning two percent or more of the
block of voting shares.
There are several distinct benefits in having an independent board of directors which they can
bring to a company, ranging from long-term survival to improved internal controls. Independent
directors in the board can:
Counterbalance management weaknesses in a company.
Ensure legal and ethical behaviour at the company, while strengthening accounting
controls.
Extend the ―reach of a company through contacts, expertise, and access to debt and
equity capital.
Be a source of well-conceived, binding, long-term decisions for a company.
18
Help a company survive, grow, and prosper over time through improved succession
planning through membership in the nomination committee etc.
Corporate Governance principles all over and listing requirements assign tasks that have a
potential for conflict of interest to independent directors, examples of these are integrity of
financial and non-financial reporting, review of related party transactions, nomination of board
members and key executives remuneration.
Satyams‘ independent directors includes:
Mangalam Srinivasan,
Vinod Dham (Entrepreneur)
Krishna Palepu (Harvard professor)
M. Rammohan Rao (Indian School of Business dean)
The company in its corporate governance report for 2007 did not name Palepu as independent
director, perhaps because he received Rs 87 lakh from the company towards consultancy fees.
Each individual director received around Rs 13 lakh for the year 2007 for say 100 hours of work
(a survey in US reveals that independent directors in large companies devote 50-100 hours per
annum to carry out board responsibilities). Keeping in view the compensation levels in India, the
compensation should be considered good. It is not only in Satyam that independent directors
showed lack of commitment. In the case of Enron, WorldCom and other companies in which
corporate governance failed independent directors failed to perform effectively. If an individual
considers certain responsibilities as peripheral and if the chance of failure in performing those
duties coming to light is low, it is likely that he will shirk those responsibilities, because in that
case the cost of failure to the individual is low. Independent directors are human beings and
therefore, we should not expect them to behave differently from a rational human being. If the
regulators fail to assess the performance of the board on regular basis, albeit indirectly through
scrutiny of filings, and if law enforcement agencies fail to penalize errant independent directors,
the present corporate governance structure will remain ineffective.23 However, the solution is not 23 news.outlookindia.com/item.aspx?657476
19
simple. If independent directors are held liable for corporate fraud and severe penalties are
imposed on them, it will be difficult to induct right people as independent directors in the board
and companies will be deprived of the collective wisdom of people who can make a difference in
the performance of companies.24
The shareholders, especially the minority shareholders, also look to independent directors
providing transparency in respect of the disclosures in the working of the company as well as
providing balance towards resolving conflict areas. In evaluating the board‘s or management
decisions in respect of employees, creditors and other suppliers of major service providers,
independent directors have a significant role in protecting the stakeholders interests. One of the
mandatory requirements of audit committee is to look into the reasons for default in payments to
deposit holders, debentures, non-payment of declared dividend and creditors. Further they are
required to review the functioning of the ―Whistle Blower mechanism and related party
transactions. These, essentially, safeguard the interests of the stakeholders. The changes in the
operating environment have raised the stakes on managing business risks. Strong and effective
Corporate Governance is no longer ‘a nice to have’ but ‘a must have’ clause. The shareholders and
the Board should decide as to how many of independent directors would be adequate to have
effective governance for their company. That apart, it has to be appreciated that promoters who have
majority stake in the business and on whose confidence people have subscribed in the company must
have significant representation on the Board. In this perspective, FICCI is of the view that the limit of
independent directors should not be more than 25% including nominee directors. It is to be recalled
that as per the SEBI Regulations, companies will have to comply with the requirements of Clause 49
of the Listing Agreement by December, 2005, which provides for a minimum of 50% independent
directors on the Board. It is, therefore, inevitable that the decision on this aspect expedited to avoid
confusion and uncertainty amongst corporates.
SEBI and PWC:
The Bombay High Court issued its judgment in the case of Price Waterhouse & Co.(PWC) v.
Securities and Exchange Board of India25 where the court ruled that SEBI possesses necessary
24 newsx.com/tag/satyam-scam25 http://indiacorplaw.blogspot.com/2010/08/sebis-domain-over-auditors-of-listed.html
20
powers to initiate investigations against an auditor of a listed company for alleged wrongdoing.
In this case the contention was filed by the PWC and its partners and affiliates challenging a
show cause notice issued to them by SEBI pertaining to audit of Satyam Computers and their
alleged failure to detect financial wrongdoing within the company of significant magnitude that
in turn resulted in severe losses to Satyam shareholders. The financial wrongdoing included
overstatement of cash and bank balances, non-existent accrued interest, overstated debtor
position and the like. SEBI’s show cause notice sought to initiate action against PWC under
Sections 11, 11B and 11(4) of the SEBI Act and Regulation 11 of the SEBI (Prohibition of
Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003.
Although PWC raise objections regarding jurisdiction of SEBI before its member, no order was
passed on jurisdiction, which then prompted PWC to file the writ petition before the Bombay
High Court for quashing the pending proceedings before SEBI.
The key questions before the court were:
i. whether the show cause notice issued by SEBI was without jurisdiction so as to require
quashing of such proceedings; and
ii. whether the proceedings initiated by SEBI amount to an encroachment of the powers of
the ICAI under the Chartered Accountants Act.
The court analyzed the powers of SEBI under various provisions of the SEBI Act. It found
various measures were available to SEBI that could be employed in regulating the securities
markets. Those powers were of wide amplitude which would “take within its sweep a chartered
accountant if his activities are detrimental to the interest of the investors or the securities
market”. The court found that by taking remedial measures to protect the securities markets, it
cannot be said that SEBI is regulating the accounting profession. SEBI’s general domain extends
to protecting investors of listed companies and the securities markets. In exercise of such powers,
there is no reason why SEBI cannot prevent any person from auditing a public listed company.
Even though the auditors are not directly involved in the securities markets, the court found that
21
since investors rely heavily on the audited accounts of the company, the statutory duty of the
auditors and discharge thereof “may have a direct bearing in connection with the interest of the
investors and the stability of the securities markets”. The court finally ruled that the powers of
SEBI are independent of those held by the ICAI and hence SEBI cannot be said to encroach
upon the powers of the ICAI under the Chartered Accountants Act.26
The judgment is important as:
it establishes the regulatory domain of SEBI over auditors of listed companies. The court
largely arrives at its conclusions based on an analysis of SEBI’s powers to regulate the
securities market, which is then contrasted with ICAI’s powers to regulate the accounting
profession.
it establishes the role of an auditor to be closely linked with the functioning of the
securities markets. Inherent in this analysis is the fact that proper performance of audit
role in listed companies is a prerequisite for investor protection which is crucial to
maintain robust securities markets. If audit and investor protection are said to be
interconnected, it then takes us to a fundamental legal question: do auditors owe a duty to
shareholders/investors? The Bombay High Court, in this case, appears to answer in the
affirmative.
The last word is yet to be spoken in the matter, since the judgment itself indicates that PWC has
sought to file a special leave petition before the Supreme Court but the affirmation given by the
Bombay High Court clearly shows that even the Indian Judiciary is also willing to take strict
actions against those who may have had any correspondence with the Satyam as they are also not
outside the scope of judicial as well as ‘quasi-judicial’ scrutiny so that what is seeming to be a
bottom-less trench, at least the depth and what is the nature of the issue lying in that trench can
be grasped.
26 ibid
22
CHAPTER IV
SATYAM SCAM & LEGAL PROVISIONS UNDER
COMPANIES ACT, 1956
Section 291 of Companies Act, 1956 provides for general powers of the Board of directors. It
mandates that the Board is entitled to exercise all such powers and do all such acts and things,
subject to the provisions of the Companies Act, as the company is authorized to exercise and do.
However, the Board shall not exercise any power and do any act or things which is required
whether by the Act or by the memorandum or articles of the company or otherwise to be
exercised or done by the company in general meeting.
As to power of the individual directors, unless the Act or the articles otherwise provide, the
decisions of the Board are required to be the majority decisions only. Individual directors do not
have any general powers. They shall have only such powers as are vested in them by the
Memorandum and Articles.
Section 292(1) of the Companies Act, 1956 provides that the Board of directors of a
company shall exercise the following powers on behalf of the company and it shall do so
only by means of resolution passed at meeting of the Board:
1. The power to make calls on shareholders in respect of money unpaid on their
shares;
2. The power to authorize the buy-back referred to in the first proviso to clause (b)
of sub-section (2) of section 77A;
3. The power to issue debentures;
23
4. The power to borrow moneys otherwise than on debentures;
5. The power to invest funds of the company; and
6. The power to make loan.
DUTIES
1. Statutory Duties:
a. To file return of allotment: Section 75 of the Companies Act, 1956 requires a company
to file with the Registrar, within a period of 30 days, a return of the allotments stating the
specified particulars. Failure to file such return shall make the directors liable as .officer
in default. A fine up to Rs. 5000/- per day till the default continues may be levied.
b. Not to issue irredeemable preference share or shares or share redeemable after 20
years: Section 80, as amended by Amendment Act, 1996, forbids a company to issue
irredeemable preference shares or preference shares redeemable beyond 20 years.
Directors making any such issue may be held liable as .officer in default. And may be
subject to fine up to Rs. 10,000/-.
c. To disclose interest (Section 299-300): In respect of contracts with director, Section 299
casts an obligation on a director to disclose the nature of his concern or interest (direct or
indirect), if any, at a meeting of the Board of directors. The said Section provides that in
case of a proposed contract or arrangement, the required disclosure shall be made at the
meeting of the Board at which the question of entering into the contract or agreement is
first taken into consideration. In the case of any other contract or arrangement, the
disclosure shall be made at the first meeting of the Board held after the director become
interested in the contract or arrangement. Every director who fails to comply with the
aforesaid requirements as to disclosure of concern or interest shall be punishable with
fine, which may extend to Rs. 50,000/-.
d. To disclose receipt from transfer of property (sec. 319): Any money received by the
directors from the transferee in connection with the transfer of the company property or
24
undertaking must be disclosed to the members of the company and approved by the
company in general meeting. Otherwise, the amount shall be held by the directors in trust
for the company. This money may be in the nature of compensation for loss of office but
in essence may be on account of transfer of control of the company. But if it is bona fide
payment of damages for the breach of contract, then it is protected by Section 321(3).
Even no director other than the managing director or whole time director can receive any
such payment from the company itself.
e. To disclose receipt of compensation from transferee of shares (Sec.320): If the loss of
office results from the transfer (under certain conditions) of all or any of the shares of the
company, its directors would not receive any compensation from the transferee unless the
same has been approved by the company in general meeting before the transfer takes
place. If the approval is not sought or the proposal is not approved, any money received
by the directors shall be held in trust for the shareholders, who have sold their shares.
Any such director, who fails to take reasonable steps as aforesaid, shall be punishable
with fine, which may extend up to Rs. 2500/-.
f. Duty to attend Board meetings [Section 283(1) (g)]: A number of powers of the
company are exercised by the Board of directors in their meetings held from time to time.
Although a director may not be able to attend all the meetings but if he fails to attend
three consecutive meetings or all meetings for a period of three months whichever is
longer, without permission of the Board, his office shall automatically fall vacant.
g. To convene statutory, Annual General meeting (AGM) and also extraordinary
general meetings [Section 165,166 &169]: It is the duty of every company to hold a
statutory meeting27 and also forward a report28 at least 21 days before the meeting is to be
held which shall contain all the details as to the issued shares and their valuation along
27 S. 165 (1): Every company limited by shares, and every company limited by guarantee and having a share capital,
shall, within a period of not less than one month nor more than six months from the date which is the company is
entitled to commence business, hold a general meeting of the members of the company, which shall be called “the
statutory meeting”.28 S. 165 (2): “the statutory report” means that which the Board of directors shall, at least twenty-one days before
the day on which the meeting is held, forward to every member of the company
25
with the details of the issuer i.e. the directors, the auditors, and the promoters and such
other managerial persons involved in the issue of those shares and raising the capital of
the company. The details of the above-mentioned persons shall also be incorporated in
the report. The report is to be signed by at least two directors of the company and at least
one should be a managing director. Any contravention to this provision may also lead to a
penalty of fine being imposed up to five thousand rupees upon the director or such other
officers of the company.
h. To prepare and place at the AGM along with the balance sheet and profit & loss
account a report on the company‘s affairs including the report of the Board of Directors
(Section 173, 210 & 217).
i. To authenticate and approve annual financial statement (Section 215): Every balance
sheet and every profit and loss account of a company shall be signed on behalf of the
Board of directors either by the people mentioned in the sub-section (2) of section 29 of
the Banking Companies Act, 1949 (in case of banking companies) or by the manager or
secretary along with not less than 2/3rd of the directors present of whom one should be a
managing director if present (in any company other than a banking company).
j. To appoint first auditor of the company (Section 224), to appoint cost auditor of the
company (Section 233B), to make a declaration of solvency in the case of Members
and voluntary winding up (Section 488) are also some of the provisions that bestow
certain duties upon the directors and the officers of the company.
LIABILITY
a. Prospectus: Failure to state any particulars as per the requirement of the section 56 and
Schedule II of the act or mis-statement of facts in prospectus renders a director personally
liable for damages to the third party. Section 62 provides that a director shall be liable to
pay compensation to every person who subscribes for any shares or debentures on the
faith of the prospectus for any loss or damage he may have sustained by reason of any
untrue or misleading statement included therein.
26
b. With regard to allotment: Directors may also incur personal liability for:
i. Irregular allotment, i.e., allotment before minimum subscription is received
(Section 69), or without filing a copy of the statement in lieu of prospectus
(Section 70) - [Section 71(3)] - Under section 71(3), if any director of a company
knowing contravenes or willfully authorizes or permits the contravention of any
of the provisions of section 69 or 70 with respect to all allotment, he shall be
liable to compensate the company and the allottee respectively for any loss,
damages or costs which the company or the allottee may have sustained or
incurred thereby.
ii. For failure to repay application monies in case of minimum subscription having
not been received within 120 days of the opening of the issue: Under section
69(5) read with SEBI guidelines, in case moneys are not repaid within 130 days
from the date of the issue of the prospectus, the directors of the company shall be
jointly and severally liable to repay that money with interest at the rate of 6 % per
annum on the expiry of 130th day. However, a director shall not be liable if he
proves that the default in repayment of money was not due to any misconduct or
negligence on his part.
iii. Failure to repay application monies when application for listing of securities are
not made or is refused: Under section 73(2). where the permission for listing of
the shares of the company has not been applied or such permission having been
applied for, has not been granted, the company shall forthwith repay without
interest all monies received from the applicants in pursuance of the prospectus,
and, if any such money is not repaid within eight days after the company becomes
liable to repay, the company and every director of the company who is an officer
in default shall, on and from the expiry of the eighth day, be jointly and severely
liable to repay that money with interest at such rate, not less than four per cent and
not more than fifteen per cent, as may be prescribed, having regard to the length of
the period of delay in making the repayment of such money.
27
c. Unlimited liability: Directors will also be held personally liable to the third parties
where their liability is made unlimited in pursuance of section 322 (i.e., vide
Memorandum) or section 323 (i.e., vide alterations of Memorandum by passing special
resolution). By virtue of section 322, the Memorandum of a company may make the
liability of any or all directors, or manager unlimited. In that case, the directors,
manager and the member who proposes a person for appointment as director or manager
must add to the proposal for appointment as a statement that the liability of the person
holding the office will be unlimited. Notice in writing to the effect that the liability of
the person will be unlimited must be given to him by the following or one of the
following people, namely: the promoters, the directors, manager and officers of the
company before he accept the appointment. Further, in case of limited liability
Company, the company may, if authorized by the articles, by passing resolution alter its
Memorandum so as to render the liability of its directors or of any director or manager
unlimited. But the alteration making the liability of director or directors or manager
unlimited will be effective only if the concerned officer consents to his liability being
made unlimited. This alteration also, unless specifically consent to by any or all
directors will not have any effect until expiry of the current term of office.
d. Fraudulent trading: Directors may also be made personally liable for the debts or
liabilities of a company by an order of the court under section 542. Such an order shall be
made by the court where the directors have been found guilty of fraudulent trading. Section
542(1), in this regard, provides that if in the course of the winding up of a company, it
appears that any business of the company has been carried on, with intent to defraud
creditors of the company or any other person, or for any fraudulent purpose, the court, on
the application of the Official Liquidator, or the liquidator or any creditor or contributory of
the company may if it thinks it proper so to do, declare that any persons who were
knowingly parties to the carrying on business in the manner aforesaid shall be personally
responsible without any limitation of liability, for all or any of the debts or other liabilities
of the company as the court may direct. Further, section 542(3) provides that every person
who was knowingly a party to the carrying on of the business in the manner aforesaid, shall
28
be punishable with imprisonment for a term which may extend to two years, or with fine
which may extend to fifty thousand rupees, or with both.
LIABILITY OF RAMALINGA RAJU AS A DIRECTOR
Criminal Charges against Raju: Satyam founder Ramalinga Raju and his brother Rama Raju
were arrested as part of the crackdown by state authorities and the central government, which
disbanded the tainted IT firm‘s board on a day of fast-paced developments. Raju was arrested
and has been booked in a case of financial irregularities, Additional Director General of CB-CID
A.S. Shivnarayan said minutes after the police action. ― both are in our custody. A case has
been registered and we will produce them before the court within 24 hours, Kaumudi told
reporters outside the office Director General of Police, Andhra Pradesh.
The 54-year-old Raju, who stepped down as chairman after admitting to the fraud and Rama
Raju, who resigned as CEO and MD of the company, were arrested under five sections of the
Indian Penal Code—section 120B for criminal conspiracy, section 420 for cheating, section 409 for
criminal breach of trust, section 468 for forgery and also section 471 for falsification of records. All
the charges are non-bailable offences.29
In addition, under the Companies Act, Depositories Act and the Listing Agreement, SEBI will have a
cause of action for violation of mailing a false annual report to the shareholders. As Satyam’s ADSs
are listed on the New York Stock Exchange, action may also be taken in the US, including by the
SEC. The company may face a class action lawsuit by its US shareholders.7 Mr. Raju and his brother
could be proceeded against under the various provisions under the Companies Act, 1956 and the
Indian Penal Code for fraud, falsification of accounts and breach of fiduciary duties as a director. In
addition, they could also be proceeded against for having violated the rules, regulations, laws and
bye- laws of the stock exchanges and SEBI - in particular, the Listing Agreement. Since Satyam is
listed on the New York Stock Exchange, they could also be prosecuted under applicable law of the
United States of America. In addition to the above, there could also be criminal proceedings and civil
shareholder lawsuits that could be brought against him and his brother in India and in the US.
Further, the news reports seem to suggest that the Government is considering referring the matter to
29 http://www.livemint.com/2009/01/09225139/Satyam8217s-Raju-brothers-a.html
29
the Serious Frauds Investigation Office and also mulling a concerted series of actions involving the
SEBI, stock exchanges, Company Law Board etc.30
Mr. Raju and his brother could be prosecuted under S. 477A of the Indian Penal Code, 1860 for
falsification of accounts and under S. 418 and S.420 of the Indian Penal Code, 1860 for cheating
with knowledge that wrongful loss may ensue to person whose interest offender is bound to
protect. In addition to the above-mentioned provisions, certain other provisions of the Companies
Act to provide for imprisonment for violations by the directors and officers in default may be
attracted. In addition, they could also possibly be prosecuted under Section 406 of the IPC for
criminal breach of trust.
Under Section 621 of the Act, violations of the sections of the Act are cognizable offenses and
are therefore bailable. However, the offenses may be compounded which may lead to more
serious charges.
The offence under S. 477A of the IPC carries a maximum punishment of 7 years imprisonment
and/ or fine and is non- bailable. The offence under S. 418 of the IPC carries a maximum
punishment of 3 years imprisonment and/ or fine and is bailable. The offence under S. 406
carries a maximum punishment of 3 years imprisonment and is a non-bailable offence. The sons
do not seem to be directly implicated since they are involved with Maytas and not with Satyam.
Raju in his letter states that none of his immediate family members had any knowledge of the
fraud.
The entire board of Satyam will share liability. Although Raju in his letter states that the other
board members were not aware of the fraud, the independent directors will still face liability
questions because they will have to prove that they were not in breach of fiduciary duty. The
independent directors also owe a duty of care and a fiduciary duty to the shareholders of the
Company. Unless the facts on record indicate that they were aware of the fraud or that they were
blatantly and grossly negligent in their duties, it may not be possible to bring any proceedings
against the independent directors. If they had not been aware of the falsification of the financial
30 http://satyamscam.in/2009/01/satyam-scam-and-its-legal-implications/
30
records of the company, one could not hold them responsible for relying on the genuineness of
the accounts as provided to them, as they had been audited by a reputed accounting firm.
CHAPTER V
SATYAM SCAM: LEADING THE PATH FOR
MORE SUCH FRAUDS
In India the Satyam scam may be grabbing the headlines, but corporate frauds are likely to be
uncovered in many countries. In the leading capitalist economy, the United States, such
corporate frauds have been rising sharply in recent years, according to data from the official
investigating agency, as the accompanying chart shows. Between 2001 and 2007, the number of
corporate fraud cases that were opened by the FBI (covering both corporate fraud per se and
securities and commodities fraud) increased by 43.7 per cent, even though convictions barely
increased. And in 2008, the number of scandals that has come to light, and the sheer extent and
audacity of several of them, almost defy description.
A quick look Enron case can help one understand how these frauds have started to occur or
happen.
Enron:
The scandal of Enron was the gigantic scam that has unfortunately set the bar for all the
other scandals that have followed since 2001. This was a financial scandal that could
occur because energy sector liberalisation and financial deregulation in the US allowed
for trading in electricity and natural gas futures, partly because of intense lobbying by
Enron and similar firms. While the resulting energy price volatility adversely affected
consumers, it delivered high speculative profits to what was originally a power
generation firm but rapidly became dominantly an energy trading firm. Enron then
created as number of offshore subsidiaries, which provided ownership and management
31
with full freedom of currency movement. This also allowed any losses in such trading to
be kept off the balance sheets. As a result, Enron appeared to be much more profitable
than it actually was. Naturally its share price also zoomed, allowing the managers to
benefit from the capital gains that they received from their employee-stock options and
performance-related bonuses. It is easy to see how this created a dangerous spiral: those
handling the finances had major incentives (and then increasingly felt extreme pressure)
to cook the books so as to show growing profits, even as the company was actually losing
money.
As the dotcom boom in the US finally went bust in 2000, it became even harder for
Enron’s managers to carry own with this creative accounting, until at last it became
impossible to keep up the pretence. Ultimately the company could not even be
restructured but had to be liquidated. Thousands of Enron employees lost not only their
jobs, but also their savings and pensions, which were tied up in company stock. Fourteen
of the company’s managers were accused, faced trial and sentenced on various charges of
fraud, misleading the public, insider trading and other malfeasance.
The role of the auditing company – Arthur Andersen, one of the then Big-Five
accounting companies – obviously came under scrutiny. Remarkably, however, it was
found that it could not be held legally responsible for what was clearly criminal
negligence and dereliction of duty over a prolonged period. Instead, the only charge that
could be brought against it was obstruction of justice, for shredding documents related to
its audit of Enron. And even that was overturned by the Supreme Court in 2005 on
grounds of flaws in the instructions to the jury! However, because the US Securities and
Exchange Commission did not allow it to audit public companies, it could not retain
viable business and the company collapsed.
Adelphia Communications Company:
Another scandal of that period that has even more similarities to the Satyam case is that
of Adelphia Communications Company, which was earlier celebrated as a rags-to-riches
story of two brothers (John and Timothy Rigas) who had originally founded the company
32
on the basis of a $300 cable license. When the company declared bankruptcy in 2003
because it was forced to disclose more than $2 billion in off-balance-sheet debt, it
emerged that the Rigas brothers had used complex financial and cash management
practices to transfer money to various other family-owned entities. In addition, federal
prosecutors successfully accused them of salting away at least $100 million personally.31
Refco:
Similarly, the Refco case related to what would earlier be called straightforward
embezzlement but is now seen as a complex system of sophisticated financial
irregularities. Refco, a finance company that specialised in commodities and futures
contracts, was a private company that went public in the August 2005. Its share prices
immediately rose by more than 25 per cent because of its apparent history of high
profitability. In October 2005, just before its collapse, it was the largest broker on the
Chicago Mercantile Exchange. Refco’s downfall came about when it emerged that its
Chief Executive Officer, Richard Bennett, had hidden about $430 million of bad debts
from both the rest of the company’s board and its auditors. He was able to do this through
the simple and ridiculous expedient of buying bad debts from Refco, so as to prevent the
company from having to write them off, and then paying for these bad loans with money
borrowed by the company itself!
What is most extraordinary about the Refco case is that this fraud was revealed only a
few months after the company had made its first initial public offering (IPO) of shares.
Before such a public listing, due diligence and detailed examination of accounts are
required of the investment banks that manage the IPO. In Refco’s case, the IPO was
handled by the top names in banking: Goldman Sachs, Credit Suisse First Boston, and
Bank of America. Yet none of them had uncovered this huge hole of $430 million in bad
debt that the CEO declared within a couple of months, nor had they even noticed the
peculiar practice that the CEO had used to cover it up. So in this instance it was not just
the auditors (the smaller accounting company Grant Thornton) that were found to be lax
31 http://www.networkideas.org/news/feb2009/news02_Corporate_Frauds.htm
33
and inadequate to the task. While Richard Bennett was sentenced to 16 years in prison in
2008, no action was taken against any of the others involved who had been at best very
derelict in their duty.
Various examples of past and present show that there are bright chances of the corporate fraud
even after Satyam incident as they are neither new nor they are going to become new because the
procedure may be different from time to time but it is the investors who to bear the brunt.
Comverse Technology :
In 2006, Comverse's founder and former Chairman and CEO, Jacob “Kobi” Alexander
and two other former executives, former chief financial officer David Kreinberg and
lawyer William Sorin reported manipulated stock options for their personal gain and
operated slush funds. As part of the scheme, the former executives misguided investors
about New York-based Comverse's stock option grants. The result, Comverse, a maker of
software, systems and related services for multimedia communication and information
processing applications overstated its net income and earnings per share between 1991
and at least 2002.
The three former executives allegedly earned millions of dollars and face multiple
charges of conspiracy, securities fraud, wire fraud, mail fraud, money laundering and
making false filings to the Securities and Exchange Commission (SEC).32 Back dating of
stock options is reported to have victimised Comverse shareholders and prospective
investors.
Alexander, an Israeli citizen, was arrested in Namibia in September 2006. He is free on
bail while the US awaits his extradition to try him on account of 35 criminal counts
related to securities fraud, including stock-option backdating. Alexander reportedly plans
to plead not guilty to these charges. He recently won a Namibian court bid to postpone an
extradition hearing until March 4, 2009.
32 http://sec.gov/news/press/2006/2006-137.htm
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Siemens:
In 2006, Reinhard Siekaczek, a former senior manager of the German group Siemens
received a two-year suspended prison sentence and was fined $128,349 for creating slush
funds and companies to acquire contracts abroad. Siemens accepted that the scandal
involved nearly $1.8 billion described as unclear payments. Siekaczek admitted to his
crime and told the court that although he tried to stop the organised bribery, top managers
did not take action. The judge said it was not clear whether those executives were also
involved or had received the payments. Heinrich von Pierer, the former chairman, and
Klaus Kleinfeld, who took office as chief executive, lost their jobs following the scandal,
which surfaced in November 2006. However, they denied any involvement and were not
charged with any misappropriation.
Computer Associates:
In 2004, Sanjay Kumar, former CEO of Computer Associates was found guilty of being
part of a $2.2 billion accounting scandal. He was tried for charges including conspiracy,
securities fraud and hindering justice. Kumar was accused of developing a company
practice called the “35-day month”, in which the sales people were asked to complete the
deals after the quarter and take out the timestamp from papers. This was done with the
intention of inflating the company’s software sales figures to meet analyst expectations.
According to charges against Kumar, he also encouraged the company’s employees to
misinform the prosecutors and the SEC lawyers when the government began the
investigations in 2002. Kumar was sentenced to 12 years and was fined $8 million for
false reporting software licence revenues and for lying to investors. Five other former
executives of the company also pleaded guilty to charges of fraud. Computer Associates
entered into a deal between Computer Associates and government investigators to protect
the company against prosecution.
WorldCom:
The former CEO of WorldCom, Bernard Ebbers, was found guilty of the $11 billion
scam that led to the fall of the company in 2002. This is considered the biggest corporate
fraud and bankruptcy in the history of the US. Ebbers was blamed for being over-
35
enthusiastic about maintaining the company’s share price high. According to the US
government, Ebbers instructed chief financial officer Scott Sullivan to conceal billions of
dollars in unmanageable expenses and recognize illegal revenue from 2000 to mid-2002.
Ebbers faces charges of securities fraud, conspiracy and charges of making false filings to
the SEC, which can bring imprisonment of up to 85 years.
Interestingly, the Satyam saga is similar to the Global Trust Bank, whose rise and fall
was a story in itself.33 The edifice of GTB was built on falsified accounts in an attempt to
shore up valuations. The scandal surfaced when its then head Ramesh Gelli tried to
diversify into insurance by making an honourable exit from the bank. But that did not
happen and GTB was ultimately merged with the Oriental Bank of Commerce.
Even in the Global Trust Bank case, the auditors were none other than
PricewaterhouseCoopers and the Reserve Bank of India had then imposed a ban on their
auditing bank accounts.
What Ramalinga Raju attempted and failed is exactly the same. Whatever be his public
pronouncements, the promoters tried to maintain a high valuation for the company and to
ensure this the books were fudged. Just as Gelli tried, he sought to wriggle himself out by
moving into real estate and infrastructure by buying the two Maytas companies. When
the deal was stalled, his fate was sealed. The other interesting element in the story is that
both these shares – GTB and Satyam – figured among the 10 scrips that were operated by
Ketan Parekh (named as KP 10) in the infamous stock market scandal years ago.
According to a KPMG survey, India Fraud Survey 2008, the trend of corporate fraud and
misconduct is likely to continue. The respondents of the survey believed that the maximum
potential of committing fraud existed within the organizations including the senior management
and the employees. According to the survey, the inherent responsibilities and trust associated
with senior positions, ability to override internal controls, internal knowledge and access to
confidential company information that came with managerial position created a risk that of fraud.
The survey found that the most prevalent form of theft would be IP or frauds related to e-
commerce and IT.
33 http://www.bullrider.in/satyam-scam-raju-pwc/
36
With the overall incidence of frauds rising in corporate India, there is a need for India Inc to deal
with fraud risks firmly. “The overall incidence of fraud is rising in corporate India in the last two
years,” the KPMG Fraud Survey Report 2010 said. Survey responses, specifically from the
financial services and consumer markets industry segments, see a higher level of fraudulent
activities within their industry.
The survey indicates ‘procurement’ and ‘sales and distribution’ as the most vulnerable areas
across industries susceptible to fraud risk. “The need of the hour is for organisations to realise
the importance of putting effective internal control mechanisms in place, so as to manage risks,”
KPMG Forensic Head, Deepankar Sanwalka, said. “Accountability is no longer restricted to a
company as a whole but also streams down to each and every individual. It has become
imperative for companies to be vigilant and aware and not just act when fraudulent situations
arise,” he said.
Financial statement fraud emerges as a major issue for investors. An overwhelming 81 per cent
of the respondents of the survey perceive financial statement fraud as a major issue in India.
Ineffective whistle-blowing systems, inadequate oversight of senior management activities by
the audit committee and weak regulatory oversight mechanisms are the reasons for the growing
worries as well as the increase in the number of frauds that one can see in the industry today, the
report said.
“Managing the risk of fraud is essentially no different to managing any other type of business
risk. All that it requires is resilience to combat that fraud,” KPMG Forensic Executive Director,
Rohit Mahajan, said.
Bribery and corruption have come to be viewed as an inevitable aspect of doing business in India
by many Indian companies, the report said. Almost 38 per cent of the respondents believe that
bribery is an integral feature of industry practises and is most rampant in seeking routine
regulatory approvals and to win new business from prospective clients, it revealed. According to
53 per cent of the respondent companies, e-commerce and computer-related fraud will be a
source of major concern in the coming years with supply-chain fraud, a close second followed by
bribery and corruption and intellectual property fraud, the report said. However, whatever be the
37
type of fraud, 75 per cent of the respondents indicate that, except intellectual property (IP) fraud,
fraudulent activities were perpetrated by employees, reaffirming that the enemy within poses the
highest risk, it said.
These events in history show a deceitful tendency spurred by excessive pressure to meet “analyst
expectations”. The question is whether the Satyam episode will make other executives focus on
productivity rather than resorting to such malpractices, or whether stringent regulations are
required to protect investors.
PART D
SATYAM SCAM: Concluding Remarks on
‘REFORMS’ OR ‘NO REFORMS’?
Companies Bill, 2008 points to a new era when maybe it will be easier to tackle frauds like
Satyam as the crux of the Proposed Bill is to strengthen the position of ‘Independent Directors’
and at the same time also enforce stringent norms for corporate governance issues. In this respect
certain key areas of the Bill have been highlighted below:
The Bill requires public listed companies above a prescribed size to reserve a third of all
seats on the board for independent directors. It requires that independent directors (or
their relatives) not do business with the company which amounts to more than 10% of the
turnover of the company in the past two years. Permitting financial transactions with the
company up to this point creates a potential conflict of interest. The listing agreement
under the SEBI Act prohibits independent directors from a material financial relationship
with company but does not define the term ‘material’.
Unlike the 1956 Act, the Bill limits the number of directors on the board of a company to
twelve, excluding the nominees of lending institutions. Specifying a cap goes against the
38
stated objective to “provide a framework for responsible self-regulation” by allowing
decisions to be left to shareholders.
The Bill prohibits auditors from providing certain services, such as accounting and
financial services; to companies they audit in order to prevent conflict of interest. While
prohibiting the same range of services as specified in the Bill, the 2003 Amendment Bill
(now withdrawn) also allowed the government to add to the list of prohibited services.
The 2008 Bill does not give the government the flexibility to notify other prohibited
services.
The 1956 Act restricts transactions between a company and its directors, and certain other
entities, on the grounds of possible conflict of interest. Government approval is required
in most cases. The Bill restricts such transactions only for public companies but broadens
the definition of a related party to include managers of the company. The approval of
shareholders, rather than the government is now required which means that share-holders
have more say in these matters now.
The Bill does not require that the partners of a firm which audit the company be rotated
on a periodic basis. The Naresh Chandra Committee had recommended compulsory
rotation of audit partners of a company every five years. The Irani Committee, however,
had suggested that such decisions be left to shareholders of the company34
The Bill requires all listed companies above a prescribed size to reserve a third of all
seats on the board for independent directors. Clause 49 of the listing agreement under the
SEBI Act, which companies sign with stock exchanges, require those companies with a
non-executive chairman to reserve one third of all seats on the board for independent
directors. Those companies with an executive chairman must reserve half of all seats on
the board for independent directors
Thus, it can be seen that the government is also striving hard to maintain status-quo in the market
of India and at the same time protect the interest of the investors but not at the cost of placing
unreasonable restrictions upon the Board and its members except to the extent of placing only
34 Clause 127 of Companies Bill 2009
39
certain restrictions which are necessary. In comparison with developed countries that impose
stringent penal and criminal consequences for poor corporate governance, penalty levels in India
are considered to be inadequate to enforce good governance. 71 percent of the respondents
considered penalty levels to discipline poor and unethical governance to be low. 22 percent of
the respondents were either undecided or did not know if the penalty levels are low.35 These
statistics reflect the minds and thoughts of the legislators and the need of the hour to bring some
new laws to effectively curb these economic offences.
The Satyam scam may be grabbing the headlines in India, but corporate frauds are likely to be
uncovered in many countries. In the leading capitalist economy, the United States, such
corporate frauds have been rising sharply in recent years, according to data from the official
investigating agency, as the accompanying chart shows. Between 2001 and 2007, the number of
corporate fraud cases that were opened by the Federal Bureau of Investigation (covering both
corporate fraud per se and securities and commodities fraud) increased by 43.7 per cent, even
though convictions barely increased. And in 2008, the number of scandals that have come to
light and the sheer extent and audacity of several of them almost defy description. This is
remarkable because after the huge corporate accounting scandals of the early part of the decade,
exemplified by the Enron scandal and the subsequent exposure of significant firms such as
WorldCom, Adelphia and Peregrine Systems, the U.S. government took steps to enact legislation
that would regulate corporate markets specifically to prevent such frauds.
The Sarbanes-Oxley Act, which was passed by the U.S. Congress in 2002 and is officially
known as the Public Company Accounting Reform and Investor Protection Act of 2002, was
meant to strengthen and tighten corporate accounting procedures. It established a new quasi-
public agency to oversee, regulate, inspect and discipline accounting firms in their roles as
auditors of public companies. It also specified tighter rules for corporate governance, including
internal control assessments and enhanced financial disclosure.
All this, it could be supposed, would operate to prevent any Enron-type scandals from occurring
at all. Indeed, those who opposed the Act argued that it created a complex, over-regulated
environment for U.S. companies and that it reduced their competitive edge over foreign firms. It
35 “The State of Corporate Governance in India: 2008” Report available at “in.kpmg.com”
40
now turns out that far from being too restrictive, if anything the Sarbanes-Oxley Act was not
effective enough. After the spate of corporate financial scandals that actually resulted in the
collapse of several companies in the early part of the decade, corporate fraud has apparently
continued almost unabated even in the U.S. One reason for this may have been in the design and
implementation of the law, which did not take into account the crucial features of such scams,
and the structure of incentives that both allowed and encouraged such malpractices to occur. 36 It
may be also thus concluded that looking for a solution in line with the laws of the developed
countries may not be truly fruitful in nature as it might not lead to the desired result or even
prevent such corporate frauds.
Financial crimes are no less heinous than the crimes dealt with by the Code of Criminal
Procedure. Need a new law to tackle such financial crimes is inevitable. It is a sad fact of life that
the Economic Offences Courts, set up with much fanfare two decades back, have proved a damp
squib. The ICAI has been dormant for several decades as can be seen from the fact that in the
first two decades of the formation of the accounting standards board, the ICAI issued only 15
accounting standards; it woke up in the past two years and rushed with 12 more standards and
more are in the offing.
Whereas these standards were not mandatory in the initial years SEBI has made it compulsory
for the entire corporate sector to fall in line and comply with these accounting standards. It is in
this context that the need for internalising our accounting standards arises. One can also emulate
the US example (though their scenario is also writ with numerous scams and frauds) and
establish a permanent Public Accountability Board. It is also necessary that SEBI is vested with
powers similar to those enjoyed by the SEC in the US.
36 “While corporate fraud can impose significant costs on the economy when left unchecked, the evidence shows that
market mechanisms discipline much bad behaviour while the criminalisation of corporate behaviour, coupled with
bringing highly complex cases before juries that can neither understand the issues nor their instructions, imposes
significant costs on the economy by deterring socially efficient risk-taking behaviour by corporations and their
executives.... The result is harm to the general public, whose members depend on a dynamic, competitive economy
for their welfare.” (Howard H. Chang and David S. Evans, “Has the pendulum swung too far?” Regulation, Volume
30, No. 4, Winter 2007-2008.) available at Frontline “Hall of shame international” by Jayati Ghosh [Volume 26 -
Issue 03 :: Jan. 31-Feb. 13, 2009]
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