09 January 2009

Satyam - lessons for India Inc.

Here is a piece I wrote for the Financial Times Op-Ed stating why we should not believe the confession letter. More importantly, I think this event will impact the reputation of corporate India. India Inc needs to clean up its intestines to remain trustworthy.

Here are excerpts:
"The first thing I did, when I saw the now famous letter of B. Ramalinga Raju of Satyam Computer Services confessing to carrying out a $1bn fraud, was to compare the initials on the letter with his signature in the 2008 Annual report. They don’t tally even remotely. I was reminded of the paradox of the statement ‘I always lie’.

Raju claims that he had inflated profits and cash while understating liabilities and became addicted to the lies to keep up with analysts’ expectations. While most of the media has taken the confession letter as containing the broad truth, after all a voluntary disclosure of fraud can’t be so unbelievable, it clearly hides more than it reveals. The only thing certain is that Raju has made at least this much money vanish from the once venerable quartet of India’s software giants. How he did this and with whose complicity is not clear, though he claims in the letter that he was alone in this fraud.

A quick back of the envelope analysis shows that - if his letter is to be believed - in the second quarter of 2008 Satyam made an operating profit of Rs.610m ($12.5m); given 53,000 employees, each employee would have earned an operating profit of $3.75 per day. This number stretches credulity by a wide margin.

In short, we have not even begun to uncover the nature and quantum of the fraud.

One of the scourges of India’s corporate landscape is the existence of related party transactions and private investment holding companies. These will need to be reduced if not eliminated in the larger companies, for them to gain the trust of increasingly suspicious international investors. It is common for control persons to own shares of listed companies through private companies and trusts.

Also, the system by which independent directors are appointed and compensated will have to be examined carefully so that they are neither fiduciaries of the promoters nor so cosy with the management that they sleep through board meetings. The audit committee which has an important task of asking the right questions from the internal/external auditors and the chief financial officer, free from the presence of management will need to be held accountable. The mythical creatures called independent directors will also need to face music if they are unable to demonstrate independence. This can best be ensured if the minutes of the board meetings and audit committee meetings are released in full detail.

The utopian time of raising equity at any price named by companies has gone. In these difficult times for companies to raise capital, or even hold on to existing shareholders, the companies must comply with ethical processes to remain relevant. After all the pain, the Satyam episode may be a blessing in disguise and a wake up call for corporate India to come clean and build on a more solid foundation."

1 comment:

sdd said...

Even after the recent developments, officials of SEBI do not appear to have learnt much.

There are numerous legal flaws in the order dated 7th Jan of P K Nagpal, Executive Director, SEBI, authorizing investigation into the Satyam affair. This can severely curtail SEBI’s ability to take enforcement action later.

In this case, the matters to be investigated mainly are cooking of books (violation of clause 49 of listing agreement) and Off market transfer of shares (through pledge etc). Both these violations fall under Securities Contracts (Regulation) Act, 1956/ Rules, 1957(Section 23, Rule 19 and Section 13 / section 18 of SCRA).

The investigation order of 7th Jan (as available on SEBI website) issued by Mr P K Nagpal, Executive Director, has following glaring mistakes:

1) It invokes powers under SEBI (Merchant Bankers) Rules. These Rules are no more in existence and were rescinded vide notification 1455 of 07/09/2006.

2) The order signed by Mr. P K Nagpal, mentions Securities Contract (Regulation) Act, 1956 as having been notified (made) under SEBI Act, 1992

3) For appointing the investigating authority, the order invokes Regulation 7 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Markets) Regulations, 2003; and Regulation 29(1) of the SEBI (Merchant Bankers) Regulations, 1992. Mr Nagpal should know that Regulation 5 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities market) Regulations, 2003 deals with the appointment of “Investigating authority” and not regulation 7. Further, Regulation 29(1) of SEBI (Merchant Bankers) Regulations, 1992 refers to the appointment of “Inspecting Authority” and not “Investigating Authority”, whereas vide the said order and under said Regulation 29(1) SEBI has appointed an “Investigating Authority”.

4) There is no order to investigate violations of SCRA. Therefore, there is no power vested with the Investigating Authority to inquire into all major aspects of the Satyam case, which prima facie mainly involves SCRA violations. The investigating authority is, thus, empowered with a defective order.

All of this points towards lack of application of mind. Later, Satyam may argue on these basic defects in the order of Nagpal and get relief. One can only hope that SEBI wakes up now