Satyam : The End of Innocence

The saber rattling between India and Pakistan has been intense these last two
months, with Indian diplomatic coercion finally looking like itll crack open
the forces across the border. The Indian media has proved to be a strong ally to
this diplomatic offensive, ensuring that Pakistan-bashing (totally justified)
features prominently in prime time viewing or in newspaper headlines. In such
extraordinary times, and considering the gravity of the situation, it would have
needed a news of extremely serious magnitude and gravity to share the same
space. And this is what precisely the January 7 confessions of Byrraju
Ramalinga Raju and the subsequent Satyam fiasco has done.

After all, this was an extraordinary situation: while the debates on whether
the confessions pertaining to getting on to a tiger and not knowing how to
get off were indeed the result of conscience could go on, more important is to
assess the implications and set about trying to rectify the situation. While
Dataquest has analyzed threadbare both the long-term and short-term implications
for Indias much vaunted software services sector as well as the possible fate
of the 53,000 existing employees (the numbers are doubtful like most other
figures emanating from the Satyam stables), there are still a few more critical
issues that need highlighting, and possible rectification measures discussed.

Regulatory Fiasco?

While most analysts rule out mass scale withdrawal of businesses from Indian
IT services companies, what is likely to happen is that the evaluation process
of Indian providers will be expanded now to include a higher level of financial
scrutiny. This is something which Indian companies (especially the larger firms)
have not been subjected to so far, and they need to be prepared to respond to
this scrutiny. The Wipro-World Bank fiasco could be an example of this; the moot
point here is that even if a top notch company like Wipro could be affected, the
tier-2 and -3 services firms must gird their loins much more tightly for this
eventuality.

The impact on investor confidence will be much more significant than the
impact on client confidence. Ask any global business or financial analyst and
the answer is clear: I would think twice now about buying India, Inc shares. I
would not think twice about engaging an Indian service provider, though I would
probably ask more detailed financial health and viability questions. As
expected, all players have already begun to reassure customers and investors.
Many feel that client confidence will not be materially affected, provided our
regulatory bodies like SEBI or for that matter the Ministry of Company Affairs
respond maturely and expeditiously. Nonetheless, at least in the immediate term,
every provider will be scrutinized much more closely. Partly as a result of this
closer scrutiny, the general industry image and credibility will be maintained,
although international competition will certainly feel encouraged.

Thankfully, a positive start has been made by the government with the
formation of a three member board consisting of HDFC chairman Deepak Parekh, ex-Nasscom
president Kiran Karnik and ex-SEBI member C Achuthan, men of impeccable
integrity and reputation. This board will select ten members as well as pick the
new CEO and CFO for beleaguered Satyam. However, critics point out that the
board will find it difficult to select people of necessary credentials, because
any competent person would now hesitate to associate himself or herself with the
Hyderabad company. And the alleged attempt by the government to include people
like Narayana Murthy or Azim Premji or Ramadorai has been ruled out owing to
conflicts of interests.

Many observers are even skeptical about the regulatory turn of events likely
to take place. For one, this is an unusual challenge, where the Indian and US
regulators will simultaneously try an Indian company. The pitfall of this could
be the fact that if the objectives of investigations in both countries are
different, outcomes could also turn out to be different, and that might signal
not just a corporate tangle but more serious diplomatic jostling. The fact that
in India an amendment of the 1956 Companies Law has been languishing for ten
years could trigger this situation. The amendments permit greater responsible
self regulation by companies, which the government now feels should be removed.
But the new law would also give Indian shareholders more rights such as
permission to sue auditors, Price Waterhouse in this case. While the auditor
issue itself needs much greater scrutiny, the fact is that with class action
suits already instituted against Satyam in the US, what will happen if Raju
receives different sentences: will we open a proverbial Pandoras box with
issues like extradition? Or, in a more likely scenario, a US court sentencing
him while the trial in India is still going on.

The role that SEBI would have, is still divided under two schools of thought.
For some, there is not a possibly major role for SEBIs side, which has been
keeping a close eye on Satyam recently owing to the financial irregularities.
Notably, SEBI has termed the disclosures as an event of horrifying magnitude.
Capital market experts point out that though empowered to govern market-related
manipulations, the ball would rather be in the court of the Ministry of Company
Affairs or ICAI rather than SEBI in the case of Satyam. This case will probably
invoke laws of fraudulent practices and is more of accounting manipulation. The
role hence would be of company regulators as SEBI is related to only disclosure
norms pertaining to the market. However, there could be scope of broad
contraventions with regards to section 49 of the SEBI Act, which, in particular,
talks of corporate governance and has to be strictly followed by all companies
listed on Stock Exchanges.

R Ramalinga Raju: the beleaguered Satyam chief

Et Tu, PwC?

And while the moral turpitude of Raju and other top honchos of Satyam like
CFO Vadlamani are regularly debated, the role of the auditors, Price Waterhouse,
have rightly come under the scanner. A serious crackdown on auditors is very
much on the cards. Questions like how could the auditors possibly not have seen
the quarter-by-quarter fraud are on everyones lips. The same question is put
forth by most legal experts. What were the auditors doing, more so in the case
of a misappropriation of this proportion? Hopefully, the IRFS or International
Finance Reporting Standards that is due in India in 2011, and has been met with
pleas of extension and exceptions on grounds of its being a costly affair, would
get a renewed boost now.

But in the more short term one needs to investigate the role of Price
Waterhouse. Whatever official statements they might give out, most auditors
concur that it would be impossible for an auditing firm of PwCs reputation to
overlook the important step of ratifying cash positions against bank statements.
And when, going by Rajus confessions, there has been a discrepancy of over Rs
300 crore in the closing and opening balances of bank statements. Price
Waterhouses playing it safe now by claiming it followed applicable auditing
standards do not cut much ice and there is bound to be questions of a total
failure of professional ethics.

If Price Waterhouses collusion is proved, the ICAI could even suspend the
firm. Unfortunately, this could be a serious possibility, since it is unlikely
that a fraud of this scale could only have been done by Raju alone: there are
4-5 items mentioned in Rajus letter that would require at least 200-250 entries
in the books, and how this could pass muster is the moot question. If Price
Waterhouse deliberately ignored them, thats serious enough, but even if it
could not catch Satyams doctoring of bank accounts or did not cross-check
statements with due diligence, that also throws bad light on their competency.
The fall of Enron took Arthur Anderson along with it; Satyam is definitely a
disaster of Enron-esque proportions; will PwC go the Arthur Andersen way?

The situation indeed looks similar on many counts, especially after Price
Waterhouse has now shot off a letter to BSE and addressed to the new Satyam
board, stressing that their audit reports for the audit period June 2000 to
September 2008, should not be relied upon. Now just mentioning that they have
made a mistake after all the damage is done does not absolve PwC of its
responsibility. The firm has handed over the blame to the then Satyam
management, saying that it placed reliance on management controls over financial
reporting, and the information and explanations provided by the management, as
also the verbal and written representations made to them during the course of
their audits. If a reputed firm of global auditors take everything at face value
and do not even bother to do simple cross-checks it does raise serious
questions. No wonder then that its not just Raju, the noose seems to be
tightening around PwC too.

Rajneesh De

rajneeshd@cybermedia.co.in