A case study on the ‘Satyam Scam’ accounting scandal: When the recession of 2008 hit the world, India was not only going through a financial crisis, but also an ethical crisis. Imagine a hypothetical scenario in the stock market in which the basic finances provided to you by a company are manipulated. This is what happened with Satyam Computer Services.
The Satyam scam was finally exposed in early 2009. Analysts dubbed the scam India’s own Enron. Today, we take a look at the scandal that hit the nation in the midst of a recession that took place, its effects, and how it was managed.
The flawless public facade
Satyam Computer Services Ltd was founded in 1987 in Hyderabad by brothers Rama Raju and Ramalinga Raju (hereinafter Raju). The name in the ancient Indian language Sanskrit meant “Truth”. The firm started with 20 employees offering IT and BPO services in various sectors.
The initial success of the company soon led it to go public and opt for an IPO on EEB in 1991. After this, the company soon obtained its first Fortune 500 client: Deere and Co. This allowed the company to rapidly grow to become in one. of the best players on the market.
Satyam soon became the industry’s fourth largest IT software exporter after TCS, Wipro, and Infosys.
At the peak of his success, Satyam employed more than 50,000 employees and operated in more than 60 countries. Satyam was now seen as the best example of an Indian success story. His finances were also perfect. The company was worth $ 1 billion in 2003. Satyam soon crossed the $ 2 billion mark in 2008.
During this period, the company had a 40% CAGR, Operating profit averages 21% with a 300% increase in its share price. Satyam was now an example for other companies as well. It was showered with praise from MZ Consult for being a ‘Leader in Corporate Governance and Responsibility from India, the’ Golden Peacock Award ‘for Corporate Responsibility in 2008.
Raju was also revered in the industry for his business acumen and received the Ernest and Young Entrepreneur of the Year Award in 2008.
At the end of 2008, the Satyam board decided to acquire Maytas, a real estate company owned by Mr. Raju. This did not sit well with shareholders, leading to the decision being reversed within 12 hours, which affected the share price. On December 23, the World Bank prohibited Satyam from doing business with any of the banks’ direct contacts for a period of 8 years.
This was one of the most severe sanctions imposed by the World Bank against an Indian outsourcing company. The World Bank had alleged that Satyam had failed to maintain documentation to support the fees charged to its subcontractors and the company also provided improper benefits to bank staff.
But were these accusations true? At this point, Satyam was the jewel in the crown of India! Just 2 days later, Satyam responded and demanded that the World Bank explain itself and also apologize, as its actions had damaged the confidence of Satyam’s investors.
Satyam scam: What was behind the curtains?
As investors were still grappling with the failed Maytas acquisition and the World Bank accusations on January 7, 2009, the markets received Mr. Raju’s resignation and along with it a confession that he had tampered with the accounts of Rs. 7 billion rupees. Investors and customers around the world were shocked. This just couldn’t be happening!
To understand the scam, we would have to go back to 1999. Mr. Raju had started to inflate quarterly earnings to meet analyst expectations. For example, the results announced on October 17, 2009, exaggerated quarterly revenue by 75% and profits by 97%. Raju had done this together with the company’s global head of internal audit.
Mr. Raju used his personal computer to create a series of bank statements in order to inflate the balance with cash that simply did not exist. The company’s global head of internal audit created fake customer identities and fake invoices to inflate revenue.
This, in turn, would allow the company to easily access the loans and the impression of its success led to an increase in the share price. Furthermore, the cash the company had raised in the US markets did not even make it to the balance sheets. But this was not enough for Raju, he went on to create fake employee records and would withdraw wages on his behalf.
The rising share price led Raju to ditch as many shares as possible and keep just enough to be part of the company. This allowed Raju to make a profit from his sales at high prices. He also retired $ 3 million every month as salaries on behalf of employees that did not exist.
But where did all this money go? Although Raju had started a large IT company, he was also interested in the real estate business. The real estate business in the early 2000s was booming in Hyderabad. It was also rumored that Raju was aware of the plan (route) of a subway to be built in Hyderabad.
The basis for the metro’s plans was laid in 2003. Raju soon diverted all the money into real estate in the hopes of making a good profit once the metro was up and running. He also created a real estate company called Maytas.
But unfortunately, like any other sector, real estate was also badly affected during the 2008 recession. By then, nearly a decade of financial statement manipulation had resulted in grossly overstated assets and underrepresented liabilities. Nearly $ 1.04 billion in bank loans and cash on the books was non-existent. The gap was simply too big to fill!
At this point, attempts to report wrongdoing were also beginning to emerge. The director of the company, Krishna Palepu, received anonymous emails from the alias Joseph Abraham. The mail exposed the fraud. Palepu referred it to another director and to S. Gopalkrishnan, a PwC partner, his auditor.
Gopalkrishnan assured Palepu that there were no truths in the mail and that a presentation would be made to the audit committee to assure him on December 29. Subsequently, the date was revised to January 10, 2009.
Despite this, Raju had a last resort. The plan included an acquisition of Maytas by Satyam that would close the gap that had built up over the years. The new finances would justify that the cash had been used to buy Maytas. But this plan was thwarted after opposition from shareholders.
This forced Raju to put himself at the mercy of the law. Raju later mentioned that it was like riding a tiger, not knowing how to get off without being eaten.
Satyam scam: How could Raju get away with the scandal?
The next big question when looking at this huge scandal is how could Ramalinga Raju get away with the Satyam scam at a company with more than 50,000 employees?
The answer to this lies in the miserable failure of PriceWaterhouseCoopers (PwC), its auditor. PwC was the external auditor of the company and it was his duty to examine the financial records and ensure that they were accurate. It is amazing how they did not notice 7,561 false invoices after auditing Satyam for almost 9 years.
There were multiple red flags that the auditors might have picked up on. First, a simple check with the banks would have revealed that the invoices were invalid and that the cash balances were exaggerated. Second, any company with cash reserves as large as Satyam would at least invest them in an interest-bearing account.
But that was not the case here. Despite these obvious signs, PwC seemed to be looking the other way. Suspicion of PwC was later increased when it was discovered that they were being paid double the fees for their services.
PwC was unable to detect fraud for almost 9 years, but Merrill Lynch discovered fraud as part of its due diligence in just 10 days.
The aftermath of exposure to the Satyam scam
Two days after the confession was made, Raju was arrested and charged with criminal conspiracy, breach of trust and forgery. The shares fell to 11.50 rupees that day compared to the heights of 544 rupees in 2008. The CBI raided the home of Raju’s younger brother, where 112 deeds of sale of different land purchases were found. The CBI also found 13,000 fake employees records created on Satyam and claimed that the scam amounted to more than Rs. 7 billion rupees.
PwC initially claimed that their failure to detect fraud was due to their reliance on information provided by management. PwC was found guilty and her license was temporarily revoked for 2 years. Investors also became different from other companies audited by PwC. This resulted in the The share prices of these companies fall between 5% and 15%. News of the scam led to Sensex falls 7.3%
The Indian stock markets were now in crisis. The Indian government, realizing the impact this could have on equity markets and future FDI, immediately jumped into action. They began to investigate and quickly appointed a new board for Satyam. The board’s goal was to sell the company in the next 100 days.
To this end, the board appointed Goldman Sachs and Avendus Capital to help accelerate the sale. SEBI appointed retired South Carolina judge Barucha to oversee the transaction in order to instill confidence. Several companies submitted bids on April 13, 2009. The winning bid was placed by Tech Mahindra, who went on to buy Satyam for 1/3 of its value before the fraud is revealed.
On November 4, 2011, Raju and two other defendants were released on bail. In 2015, Raju, his 2 brothers and 7 other people were sentenced to 7 years in prison.
There have been no scams that affected the CA and audit firms like Satyam Scam. The growing nature of these scams has made reliance on these professionals much more crucial, highlighting the importance of ethics and QA in their roles.
White collar crimes like these not only make the company look bad, but also the industry and the country.