Satyam Systems

5/27/2018 Satyam Systems

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Satyam Systems, a global IT company based in India, has just been

added to a notorious list of companies involved in fraudulent financial

activities, one that includes such names as Enron, WorldCom, Societe

General, Parmalat, Ahold, Allied Irish, Bearings and Kidder Peabody.Satyams CEO, Ramalingam Raju, took responsibility for broad

accounting improprieties that overstated the companys revenues and

profits and reported a cash holding of approximately $1.04 billion that

simply did not exist.

This leads one to ask a simple question: How does this keep happening?

At the Columbia Business School, we teach a course called Performance

Measurement in which we study some of the dynamics that lead to this

type of accounting scandal. In our course, we study the fraud committed

at WorldCom and Kidder Peabody in detail. In our studies, a distinct

pattern emerges.

It starts small. Typically, executives do not wake up one morning and

say, I feel like adding 5 billion rupees to our revenue today. They

usually start by fudging the number a littleand then it grows.

It is usually a response to competitive pressures. Companies have

targets that they need to reach every month, quarter and year. These

targets can come from their internal budgets or from the expectations of

their shareholders and stock market analysts.

The fiddle is easy to rationalize at first. Managers typically have

confidence in their skills and believe that their company is

fundamentally sound. Given that, its easy to rationalize that while were

just a little short on the numbersnow, we will make it up in the future,

and nobody will know.

It gets out of control. When the company is unable to make up the gap, a

larger distortion is needed to cover it up. This in turn creates pressure to

deliver even better resultswhich leads to bigger cover-ups, and so on.

In his letter to his board, Satyams Raju shows the markers of this

pathology. He states that, What started as a marginal gap between


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actual operating profits and ones reflected in the books of accounts

continued to grow over the years. It has attained unmanageable

proportions. Later, he describes the process as like riding a tiger,

not knowing how to get off without being eaten.

Can anything be done?

Unfortunately, it appears that several of the mechanisms we rely upon

today have not gone far enough. When management has the wrong

incentives, we need other mechanisms to hold those incentives in check.

Typically, we rely on corporate governance, audit and legal

consequences.

Historically, several characteristics have been considered importantingredients of excellent corporate governance. These include outsider

representation on the board, boards that arent too large, boards that

meet often, etc. Unfortunately, these characteristics dont seem

sufficient. Satyam, for example, had a reputation of excellent corporate

governance. In fact, the World Council for Corporate Governance

awarded Satyam its Golden Peacock Award for Corporate Governance in

2008. This suggests that we need to fundamentally rethink the criteria

that we require in order for boards to provide effective governance.

When an accounting fraud involves reporting cash that is not there, it is

typically the result of adding fraudulent transactions, such as cash sales,

to customers that never happened. These types of transactions should

have been audited to assure their legitimacy. In the case of Satyam, the

auditors signed off on the financial reports, raising concerns that even

the increased auditing standards imposed by Sarbanes-Oxley may not

be sufficient.

Finally, we also need stiffer penalties. Simply put, white collar crime

cannot be viewed as less of an evil than any other form of crime.

The fact that white collar crime continues to occur, and seemingly at an

increasing rate, suggests that the expected costs do not outweigh the

expected benefits from cheating. Stronger penalties are needed.


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Despite my calls for improvements in governance, audit and legal

penalties, Im left with the nagging concernthat whatever we do may be

insufficient. At the end of the day, the actions at Satyam were

perpetrated by one or two individuals who simply may not have realized

that the small distortions they created in the past would lead to massiveproblems today. Hopefully, creating an awareness of the large

consequences of small lies may help some to avoid this trap.

Actions such as those of Satyam are being observed all over the world,

and their effects are not simply localized to their executives, employees

or even their countries. Whether it is accounting fraud, excessive trading

risks, a Ponzi scheme or making loans to those who cant pay, many are

hurt by corporate improprieties. These types of actions affect the global

economy. In other words, they affect us all. If there isnt sufficient belief

in the notion that business will act in good faith, then the capitalist

system is itself at risk.

In 2008, a series of cyber-intrusions at the World Bank raised concerns about the security of

international financial data held at the institution. The Banks chief vendor for cyber-

security, Satyam Computer Services, Ltd. of India, came under scrutiny as the IT system the

company had designed appeared vulnerable. The facts that emerged about the scandal

subsequently included a massive accounting fraud, an ineffective World Bank response to the

emergency and persistent questions about the integrity of the Bank and its actions. Satyam, abillion-dollar IT outsourcing corporation collapsed under the weight of the fraud in January

2009, and is now known as Indias Enron.

Background

In the spring and summer of 2008, the information system of the World Bank suffered a

series of cyber intrusions. An e-mail obtained by Fox News showed that a minimum of 18

World Bank servers had been breached, and that of those, five contained sensitive data.

The Banks IT services had attracted concern before. For years, the Department of

Institutional Integrity (INT), the Banks anti-corruption unit, had been investigating therelationship between Mohamed Muhsin, Chief Information Officer at the World Bank until

2005, and Satyam, the Banks strategic partner in IT systems. In 2005, Muhsin retired

under a cloud, as well as under investigation for receiving improper benefits from Satyam.

Satyam was Indias fourth largest IT company and operated in 65 countries around the

world. The company, at that point, claimed to employ 52,865 workers and serve 690


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companies, including 185 Fortune 500 firms. Work in the U.S. accounted for 62 percent of

Satyams revenues, and the company was headquartered in Hyderabad, India. Under

Muhsin, Satyam had become deeply embedded as a back office IT services provider at the

World Bank, and in 2005, the company registered as a potential vendor with the UN.

After the cyber breaches at the World Bank came to light, Satyam was immediately suspected

by both internal and external observers. Nonetheless, the Bank repeatedly denied that the

company was at fault. In December 2008, the World Bank admitted to GAP that Satyam had

been suspended from consideration for future contracts by the Bank in February 2008, and

debarred for eight years in September 2008. The debarment, Bank officials told GAP, was a

penalty for giving improper benefits to staff members at the Bank and for collecting on

undocumented invoices. Muhsin, it turned out, had been debarred from future work at the

Bank permanently. Given what the Bank knew about high-level corruption at Satyam, the

confidence expressed by Bank management that the company was not behind the cyber-

attacks seemed oddly misplaced.

As Satyams status at the World Bank eroded in 2008, the company undertook to re-register

its services through subsidiaries with new vendor numbers at UN funds and programs. Over

the course of 2008, Satyam re-registered and became an approved vendor through its Swiss

and U.S. operations in August and September. At a number of funds and programs, Satyams

registration was approved with notable alacrity in the same day. For reasons unknown, the

World Bank apparently had not flagged Satyam as a risky vendor prone to corruption with

the Inter-agency Procurement Working Group at the United Nations.

The Confession and the World BanksOpaqueness

On January 7, 2009, Raju confessed that he had cooked the Satyam books, and that $1

billion in claimed cash assets did not exist. As a consequence, the government of India

expressed shock which did not seem entirely genuine sacked the Satyam board and

began efforts to salvage the remains of the company. At the time, Raju claimed that the fraud

began as an effort to obscure minor losses by the company and grew over the years to a gap

between real and actual revenues that he could no longer conceal. He flatly denied stealing

from the company to benefit himself and his family, and he denied that any other officials

related to Satyam or its clients were involved. In light of more recent disclosures, these

claims are dubious. (Months later, it was discovered that a whistleblowers internal

disclosures prompted Rajus confession, and not his own conscience).

Then, on January 11, 2009, the World Bank announced that two other India-based IT

companies had also been debarred from direct future work: Wipro Technologies and

Megasoft Consultants, Ltd.

Because of its close relationship to Satyam, Megasoft attracted attention when identified as a

debarred firm by the Bank. FoxNews reported that as early as 2003, Megasofts founder-


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chairman, Ravindra Sannareddy, was running a software services division in the U.S. for

Satyam Group. In 2004, Satyam co-founder Srini Raju, Ramalinga Rajus brother, merged

one of his private companies into Megasoft, which began to bid successfully for World Bank

contracts soon afterward.

At the time it announced the three debarments, the Bank also stated that, in the future, it

would disclose the names of its own direct contractors who had been debarred. The step

brought corporate procurement regulations closer to the disclosure policies in effect for

debarments associated with projects and loans in borrowing countries.

But already much damage has been done. The World Bank had information in 2006 that

high-level Satyam management had improperly influenced Muhsin, but management did not

reveal this either to the SEC in the United States or the Securities Exchange Board of India

(where Satyam is publicly traded). Nor was the UN Inter-Agency Procurement Working

Group informed, although its purpose is to share information across the UN system about

vendors in order to contract services most efficiently. Further, sources say that the World

Bank and the UN Working Group met in June, but apparently the Satyam issue was neither

mentioned nor considered. After Satyam was suspended by the World Bank in February last

year, the UN contracted the company for $6 million plus, just five months later.

On January 20, 2009, prosecutors in India revealed that about 10,000 Satyam employees

may not have ever existed, and the funds paid to them as salaries may have been deposited in

Raju-related bank accounts instead. In the US, the SEC announced an investigation and, to

date, at numerous class action investors lawsuits have been filed against Satyam.

On January 14, 2009, GAP wrote a detailedletter to World Bank Managing Director

Juan Jos Daboubasking whether the Bank would cooperate in the SEC and SEBI

investigations of Satyam, among other things, or whether the Bank will invoke its

immunities. In response, Daboub replied with a short paragraph that failed to answer any

inquiries. His note rejected transparency at a time when the Bank was under fire for

concealing allegations of corruption involving an IT firm that solicited contracts throughout

the UN system, even as the World Bank banned it from future work.

Further Developments

Months later, in April 2009, a company named Tech Mahindra won the bidding to control

Satyam. The sale process, however, was plagued with transparency problems and conflicts ofinterest. The new Satyam board, appointed by the Government of India, promised to execute

the sale transparently, but for reasons unknown did not consult with shareholders when

designing the terms of the bidding process.

Later on in April, the complexity of the Satyam fraud deepened when details emerged from

the Indian Criminal Bureau of Investigation (CBI), describing an elaborate system of

generating false invoices to inflate the companys revenues on a grand scale. Based on an
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artificially profitable picture of the company, the Raju family then apparently offloaded

Satyam stock through a complex array of companies that hid the identities of the

beneficiaries of the sales.

In May 2009, it was discovered that the World Banks Administrative Tribunal (AT) found a

former senior manager guilty that previous March of accepting improper benefits from

institutional IT vendors among them, Satyam. The decision was peculiar for many reasons.

In November 2009, new charges were filed by the CBI alleging that the fraud involved

approximately $1 billion more than Satyam CEO Ramalinga Raju originally admitted. New

evidence showed that the missing Satyam assets may not have been simply invented to

inflate the value of the company the money trail suggested the inflated assets were stolen in

a complicated confidence scam involving Rajus relatives.

GAP continues to monitor the developments in the Satyam case. In November 2008 GAP

filed aFreedom of Information Act (FOIA)request with the Justice Department to

learn what the Bank and U.S. government knew about corruption at the highest levels of

Satyam management, and when they knew it. In December 2009, after three FOIA requests

and two responses from the DOJ asserting that it had no information from the World Bank

concerning corruption at Satyam,GAP received four documents in full and one in

part from the Department.The remaining 13 documents were withheld in full. GAP is

currently pursuing a lawsuit against the DOJ in which we contest the decision to withhold

these documents. DOJ also failed to account for crucial documents that GAP asserts are in

the possession of the Criminal Division. In addition, the DOJ consistently missed statuary

deadlines in responding to our requests and APPEALS.
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Documents

Satyam Systems