It is truly said that “History repeats itself”. This is said in reference with the Second World War which was solely and sorely an outcome of the Great Depression of 1939.The cause of it may not be as likely as they are for the present situation. But it can be said that the entire world is again being led into the Great Depression, the major cause of it is FRAUD. Due to FRAUD, History is going to repeat itself. Let us analyze how it works and leads us a way back to the situation of 1939…
The monster, as we may term it i.e. FRAUD, the main culprit should be defined first. The Dictionary meaning of FRAUD is “A deception deliberately practiced in order to secure unfair or unlawful gain”. With changing times, even FRAUD has different flavors. Some of them are as follows:
These may be only literal terms used in the dictionary to describe various types of Frauds. And also true to its word, the history is full of examples of them i.e. each and every type of fraud leading to a full page explanation of its meaning and its examples in the dictionary.
But, let’s come back to the present times, where money plays an important part in people’s lives rather than emotions. Therefore, currently we shall discuss the most classic type of fraud which is prevalent and most prominent in present times: CORPORATE SCANDALS. Our History is full of them, but since with growing aspirations day by day, our brains have become smaller and smaller. Therefore, we take up the most recent CORPORATE SCANDAL in the Indian History, i.e. the SATYAM SCAM.
As we have already discussed the dictionary meaning and types of FRAUD, now we shall discuss what leads to a FRAUD, how it initiates itself and like a Virus eats away the whole Corporate, its effect on the economy and most important of all, how it plays with people’s lives who are associated either directly or indirectly with the concerned corporate.
Let us look at a simple diagram which effectively describes a CORPORATE FRAUD:
F: Frustrated investors
R: Recession impending
A: Accountability is crushed
U: Undermining Corporate Governance
D: Depression in the Economy
Looking at the above diagram, one must think of the Herculean efforts taken by the fraudsters to bring about such tsunami waves throughout the economy. Like any other corporate with solid and stable promoters, Satyam Computers had seen its golden days fro nearly two decades, starting from 1987. It was established on 24th June, 1987 by Mr. B. Rama Raju & B. Ramalinga Raju as its Promoters.
In 1991, it was converted to a public Company that is when it started growing, to make a startling impact on Indian Economy. In 1992, it set up a Software Technology Park and divulge into 100% export oriented Software Development through its Public Issue.
By 1996, it had started to spread its tentacles throughout the World by acquiring new Business Partners in USA, Australia, Canada, Japan & Europe. It had also started floating Sister concerns in the name of Satyam Renaissance Consulting Ltd., Satyam Enterprise Solutions Pvt. Ltd. & Satyam Infoway Pvt. Ltd.
With an impending start of the new century, it had a strong hold on Indian economy, starting with the bonus issue of 1:1. After this, every year almost there were a series of Awards in various fields for Satyam, which led into building a strong image of “Corporate India”. Most ironic amongst them were National HRD award – 2000 for outstanding contributions to HRD & being ranked 3rd in Corporate Governance Survey by Global Institutional Investors. When later, due to its scandal, the most aggrieved were the Employees and it had the negative impact of the highest order on the Indian Corporate Governance.
Like an upside journey to a mountain’s peak, beyond that starts a downward dissonance, same was the story here. In spite of its many achievements in the technical field which was recognized worldwide, there was a darker side to it, which not only shocked the nation but the World as well. The whole debacle started with the starting of the new millennium. In order to see the stock prices of the company at its peak, the chairman, the winner of the most acclaimed Corporate Citizen of the year by Asia Business Leader Awards, 2002; Mr. Raju started manipulating the Balance Sheet of the Company by overstating the revenue and undermining the liabilities. The revenue began an upward slide and so did the Stock Prices. The gap began to widen with the advancement in the years leaving a big hole in the company’s Balance Sheet. Every solution was tried in order the remedy this plight but nothing could be done to bring the Company’s Balance Sheet to its true Position.
The last attempt to remedy this debacle was to buy stakes in the Maytas Infra Ltd. And Maytas Properties, which failed. Prior to this, Satyam’s name was smeared black worldwide when it was allegedly accused of theft of World Bank Data and bribing the bank officials in December, 2008. In January, 2009, Mr. Raju admitted to fraud and resigned as chairman. More than 50000 employees were on the brink of unemployment. It came as a shock to the nation.
The doom began with the fall in promoter’s stock on 2nd January, 2009 from 8.64% to 5.13%.the scam was done in the Accounts Balance Sheet totaling to Rs. 7,136 crores. In the quarterly Balance Sheet ending September, 2008, the faked figures included Rs. 5,040 crores of non-existent Cash & Bank Balances as against Rs. 5,361 crores in the Books of Accounts. He admitted to the fraud in his letter addressed to Securities & Exchange Board of India (SEBI) and its Board of Directors. He also confessed in his letter that the money was not used personally, only for taking the Stock price high by showing High Margin. This Scam is compared with the ENRON Scandal in India.
With the above referred Financial Scandal, we would also like to discuss other Scandals which shook the Economy and the Nation. The other Scandals are listed below:
India’s fourth largest software services company Satyam Computer Services Ltd had announced that it planned to acquire Maytas Properties Pvt. Ltd for $1.3 billion, or Rs 6,214 crores, and a 51% stake in Maytas Infra Ltd for $300 million, in a move that was largely going to benefit the Raju family that has promoted all three firms, and which was strongly criticized by analysts and fund managers.
The deal was announced after trading hours in India but on the New York Stock Exchange, the reaction was immediate: Satyam’s American depositary receipts had dropped to $5.64 each, 54.66% lower than their previous close, at 10.04am Eastern Standard Time.
The Raju family directly owned about one-third each in the two companies it planned to acquire and 8.61% in Satyam. Satyam didn’t explain how the deal would be funded. The company had cash of at least Rs 5,300 crores on its books as of 30 September 2009.
The proposed deal of acquisition was difficult to digest. The deal, had it gone through, would have consumed all the surplus cash on the books of Satyam, which is estimated to be $1.1 billion. The acquisitions would have netted the Raju family $570 million (they hold a 35 per cent stake in Maytas Properties and 36 per cent in Maytas Infra), while exhausting Satyam’s cash reserves and leading it to raise $400 million of debt, leave alone the debt that would have added to its books on account of the acquired entities.
The explanation, provided for the said deal was to de-risk the business model of the company, in the light of a bleaker business outlook for the IT services company. But, to diversify so radically at a time when Satyam’s rivals were hoarding cash to weather a global slowdown was disconcerting. A look at the margins of Maytas Infra (financials of Maytas Properties not available) also suggests that the margins of the combined entity would have stood reduced after the deal.
The move, which the company management said would diversify its revenues beyond its core software services business, shocked analysts and investors, who saw little synergies between Satyam’s core software operations and the realty and infrastructure business of the two firms.
The fact that the promoters of Satyam, who held less than 10 per cent stake in the company, went ahead with the deal without the approval of its minority shareholders, just because it was "not required as per regulations", shows that corporate governance was not exercised in "true spirit" and yet again brings to surface, loopholes in the system. This, despite the fact, that it was a related-party transaction and that it would have changed the risk profile of the company. It is also difficult to fathom, why the company did not prefer a three-way stock-based merger of the entities, which would have ensured that the cash would continue to stay in the system. The disclosure on the short listing process and valuations for the two target companies was also not sufficient, which seemed grossly expensive.
As per the deal, Maytas Properties (unlisted) was being valued at Rs 91.47 lakhs per acre (Rs 6,220 crores; land bank of 6,800 acres), despite the fact that bulk of the land was in tier II and III cities such as Vizag, Vijaywada, Kakinada and Nagpur. Analysts said that, on a realistic basis, the per acre price should average at Rs 40-45 lakhs per acre or even less, given the current scenario.
On the other hand, Maytas Infra had been valued at nearly 1.6 times F.Y. ‘08 revenues even as mid-cap construction stocks on an average were trading at less than half their F.Y. ‘08 revenues. Even on a P/E basis, the valuations were high.
LOOKING BEYOND NUMBERS
Rs in crores
The buyout decisions were approved by the acquirer’s board. Satyam did not consider any other realty or infrastructure firm seriously, Chairman B.Ramalinga Raju said in an analyst call. This firmly leads to the conclusion that this acquisition was merely a plan to bailout Satyam.
On the call, Srinivas Vadlamani, Chief Financial Officer of Satyam, was heard saying that the acquisition would add to Satyam’s earnings per share in the second year. Raju was of the opinion that the buyouts were made in an environment of slowdown in tech services.
In the wake of ongoing global economic crisis, Satyam had revised the full year dollar revenue guidance downwards to between $2.55 billion and $2.59 billion, implying a growth of 19-21% over fiscal 2008, lower than a forecast of 24-26% made earlier.
Maytas Infra ended the last fiscal with total revenue of Rs 1,660 crores and a net profit of Rs100 crores. The order book of the firm, which holds a 35-year license to run a metro network in Hyderabad, stood at Rs 11,554 crores at the end of quarter ended 30 September.
Vadlamani was in favor of Maytas Properties, as it had a land bank of 6,800 acres with a potential built-up space of 245 million sq. ft. In comparison, “DLF had 10,000 acres of land and was valued at Rs 60,000 crores,” But in comparison to this, the Maytas Properties had acquired the said land bank at Rs6,500 crores. Herein lied the difference which had sorely tempted the shareholders & others to go against the deal.
While privately held Maytas Properties was to be immediately acquired, 31% in Maytas Infra was to be acquired from that company’s promoters at Rs475 per share and an additional 20% would be acquired from the public through an open offer at Rs525 per share.
An undisclosed stake of Maytas Properties was held by Infinite India Investment Management, a realty fund jointly promoted by JM Financial and US-based SRM Investments, which had invested Rs600 crores in the firm in February.
Analysts and experts were outraged at the decision. They thought that it would deplete cash resources. No due diligence was carries out and moreover, the companies considered for acquisition were the companies promoted by the same group.
According to Indian law, free reserves of a company up to 100% can be used for acquisitions without shareholder approval.
Hit by the adverse market reaction, Raju had to call ofF the Deal which would have saved his Dooms Day.
Satyam Computer had tanked as much as 33 per cent and witnessed its 52-week-low level on bourses in early morning trade after the company had called off its $1.6-billion deal to acquire two infrastructure businesses.
We would now like to start our dissection of the case with the exact wordings of the Confession given by Mr. Raju on the 7th Jan 2009. (Also we have attached the scanned copy of the original letter for reference):
The above mentioned letter is the epicenter of the earthquake, which we would like refer as “SATYAM SHIVAM SCANDALAM” that shook the nation. Let us analyze point by point how the Scam was pulled off!
Indian Government and the people were shocked and stunned after the founder-chairman of one of the countries largest IT service companies admitted to years of falsified profits and financial fraud to the extent of 1.5 billion dollars.
This meant that roughly around 1.5 billion US dollars of the firm’s past funds were fictitious or non-existent.
It had been recorded on the books of accounts of the company for the past several years that had been audited by the internationally reputed firm of Auditors, PRICE-WATER-HOUSE-COOPERS
The most alarming aspect of the scam was that the company’s financial records have been fudged for the “LAST SEVERAL YEARS”
True to its description, let us see how the fraud of this magnitude can be pulled off over several year and it’s AFTERMATH!
The first point of the letter acknowledges the Accounting Fraud that is going to be termed as from now onwards the Cooking of the Books of Accounts over a number of years.
This was very difficult to manage but was carried out sufficiently. Listed below are the ways in which fake income can be generated but would have been detected by the Auditors:
In all the above 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 (like we have an opening called “Indian Gambit” in chess, we can refer to this henceforth as “Satyam Gambit”).
It shows the clever manner in which the fraud was crafted by Mr. Raju. It is many a times seen that profit are being inflated by bogus booking of sales which in turn will also inflate the debtors. These debtors will remain sticky/ irrecoverable as no real sales support them. Companies will get rid of such debtors following one of the following three methods,
Such bogus sales, if the quantum is high, will not escape the auditors eyes as they will scrutinize the receivables, seek for confirmation of the balance, will analyze the debtors to see if they are one off customers or frequent buyers etc.
Showing such receivables becomes difficult in the case of a big company like Satyam as they will have a relatively smaller number of customers contributing to significant portion of total revenues of the company. Any bluff will be quickly caught as high profile customers will be quick to respond to balance confirmation requests.
So Mr. Raju did his master stroke. 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.
How can one get actual collections from fictitious companies? No, 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) 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.
Mr. Raju had to however, overcome one more problem. Normally, auditors will ask for confirmation balances for the bank balances shown by the company. 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?
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 how Mr. Raju could convince the auditors? Mr. Raju, most likely did one cleverer thing.
He raised some personal money. He didn’t sell the Satyam shares for this purpose (note that he has told in his confessions that he has not sold any shares in the market). Instead he pledged the shares with the banks and raised cash. That cash, either he sent using illegal route abroad to get back as software sale realizations or simply made book entries for recoveries and went to banks to create deposits in the name of Satyam Computers.
This exercise must have started on a small scale in the beginning. With a favorable bull market, he could have also easily raised the money needed by pledging the shares. (This is how the unaccounted liability of Rs.1,000 odd crores (Rs.10 billion) started to accumulate – personal cash used for making deposits for company will create assets for the company but no liability is created).
But, as the expenses in Satyam ballooned and as the requirement to meet the investor expectations in terms of revenues and profits increased, Mr. Raju might have resorted to this fudging route more often that the inflated bank balances reached the confessed high of Rs.5,040 crores (US $ 1 billion) over a period of several years.
At this manipulation high and falling Satyam stock price, it should have become difficult for Mr. Raju to prove to the auditors the existence of the bank balances. But, as I already told, the auditors would have also become (at least one) nagging wife seeking for confirmation of balances.
So, what how did he over come this problem?
I think, he would have used the limited cash at his disposal (Rs.1,000 crore (Rs.10 billion) is limited cash if you look to plug the gap of Rs.5,000 crore (Rs.50 billion)), to create bank balances for Satyam Computers close to the quarterly reporting dates by creating and closing multiple deposits while keeping the proof of making the deposits to convince the auditors.
The auditors, could have possibly, accepted such proofs and partial confirmations and most likely would have documented accepting such evidence with their reasoning.
This was the most difficult of all, i.e. to manipulate the original receipts received from the bank which was a minute figure and replacing them with the receipts with the magnified amount, and then given to the Accounts department as well as the Auditors, to be verified.
CBI’s investigation of the Computer used by the chairman found that it had been used to print the fake FDRs as well as the accrued interest receipts. These were shown as investments and the accrued interest was accordingly booked on them to inflate the profits from other sources, as discussed earlier.
The fake FDRs showed huge amounts as the interest on these deposits was projected to be over Rs 375 crores as against the actual interest income of Rs 7.42 lakhs only.
When these receipts were taken to the bank for authentication, the officials denied having issued these receipts to Satyam and testified that they were fake. This piece of information led to the CBI to investigate and found the Machine which printed these fake receipts. Guess what? This machine personally belonged to our founder-chairman, Mr. Raju. The CBI claimed to have retrieved the mirror images of the FDRs that were designed in the computer, the sources said.
Also in order to deceive the auditors and his own accounts department, as well, what Mr. Raju did was most shocking of all. He used to request the bank to issue a duplicate FD receipt, giving the reason that, the original receipt has been lost. Once he got the duplicate receipt, within a few days he used to withdraw the FD with that bank and create FD with the same amount with another Bank or perhaps adding some more amount. Then while audit, he used to show the original receipt of FD of the First bank as well as the new receipt of the Second bank. This way the auditors were fooled and they passed on the inflated amount of FDs booked in the Books of accounts.
Indian investigators disclose how computer systems were subverted to generate false invoices, which is highly technical but CBI has revealed that details of the fake invoicing system used by Satyam Computer Services Ltd as part of the US$1 billion-plus fraud that has rocked the company.
Documents released to the general public in India showed how the company’s standard billing systems were subverted to generate ‘false invoices to show inflated sales,’ before Mr. Raju confessed.
The CBI said it had used cyber forensics to uncover how in-house computer systems were exploited to generate fake invoices. Regular Satyam bills were created by a computer application called ‘Operational Real Time Management (OPTIMA)’, which creates and maintains information on company projects.
The ‘Satyam Project Repository (SRP)’ system then generates project IDs; there is also an ‘Online application for entering the hours worked by Satyam employees; and a ‘Project Bill Management System (PBMS)’ for billing. An ‘Invoice Management System (IMS)’ generated the final invoices.
CBI officers have concluded that the scandal involved this system structure being bypassed by the abuse of an emergency ‘Excel Porting’ system, which allows ‘invoices [to] be generated directly in IMS…by porting the data into the IMS.’ This system was subverted by the creation of a user ID called ‘Super User’ with ‘the power to hide/unhide the invoices generated in IMS’.
By ‘logging in a Super User, the accused were hiding some of the invoices that were generated through Excel Porting. Once an invoice is hidden the same will not be visible to the other divisions within the company but will only be visible to the [company’s finance division sales team]‘ concluded the CBI.
The CBI said their inquiries revealed there are 7,561 invoices found hidden in the invoice management system, worth INDIAN Rupees 51 billion (US$1.01 billion).
As a result, ‘concerned business circles’ would not be aware of the invoices, which were ‘also not dispatched to the customers’. The note added: ‘Investigation revealed that all the invoices that were hidden using the Super User ID in the IMS server were found to be false and fabricated.’ The value of these fake invoices ‘were shown as receivables in the books of accounts of [Satyam] thereby dishonestly inflating the revenues of the company.’
‘As a result of this analysis, the individuals who have generated and hidden these false and fabricated invoices have been identified,’ said the law enforcement agency.
As discussed earlier, that in order to pay off the fictitious debtors, he falsely claimed to have either receive the payments and convert them to cash & Bank Balances. In order to do that, he had taken personal loans from small investors and routed the money back to the company using illegal means. Therefore, the debtors were converted to receivables and the liabilities were not at all entered in the books of accounts.
This was done purely to keep the operation going. He confessed that this was done by pledging the shares and raising the funds from known sources by giving all kinds of reassurances.
But, investigators are of the opinion that, illegal means have been used to raise this money and route it to the company.
The next question is why he would want to give money to the company from his own pocket. But the answer to this question is THE MAYTAS DEAL. By going ahead with that acquisition, he would have converted a major portion of the non-existent bank balances as “inflated” investments and also taken away the Rs.10 billion real cash available (funded by him). With inflated acquisition price, this would not have hurt him at all.
But, why the confession now. Two reasons according to the public opinion are:
It is alleged by the Indian investigators that Satyam may have shown an inflated employee count to siphon off money in the name of Salary to Ghost Employees. This is not as easy to pull off as the other above mentioned ingredients. This is because various other procedures are involved such as opening of salary accounts, identity proofs & other records to be maintained.
Thus, we may only predict what may have happened with the Ghost Employees and their existence in the Books of Accounts and other records.
The likely modus operandi would be as follows:
To open a salary account, minimum following documents are required
It is very easy for a company like Satyam to get these records. For example, in a year, it receives about 10 lakhs application for various categories of Jobs in the company. Out of this we assume around 30% i.e. 3 lakhs people are called for interview. It is a general practice to ask for above mentioned documents from the candidates who are selected for the interview. Therefore, a provision is made for documents required.
Now comes the part of opening the salary account with the Bank and maintaining it:
If a genuine person wants to open an account, it requires tremendous efforts, but if a company of the acclaimed stature like Satyam wants to open about 100 salary accounts together, the bank executives will willingly oblige as it would be easy to achieve their as well as the bank’s target of the given selling of the accounts as their main purpose is to do business.
Thus, now for processing of the Salary accounts, the above mentioned documents & an appointment letter from Satyam is required to be given to the bank altogether, which will be opened now without any hitches.
The other question which comes to the mind is that how these accounts would be operated or how the correspondences from the bank would be prevented from going to the real person’s place or address mentioned in the proofs given. The only way out would be that the executives of the company insist on the accounts to be opened across the counter immediately and the addresses given for correspondences would that be of Satyam’s Guest Houses & Hostels, for convenience.
The only question now remains of the Customer’s signature required on various forms while opening the account. The answers which can only be predicted as of now is that at the time of the interview or at a later stage, they may be asked to fill up these forms as a procedure. But, ultimately, they are rejected and not recruited.
Such a stature of deception is not possible by a few number of people, it is predicted that there is more to come than what it seems to be right now.
When the Dog did not bark!
It is often said that auditors are watchdogs of the company and they may act as bloodhounds if they smell something suspicious.
Then the question is how come the watchdogs did not come to know of the biggest corporate fraud of the Century. This leads to the belief that Satyam Scam is not a one-man Show but is alliance between the Board & the Auditors.
A simple fact has to be stated that despite the auditors of the fraud-hit Satyam Computer Services pleading ignorance, the Central Bureau of Investigation (CBI) has accused them of colluding with the company’s erstwhile management.
The fact that their fees increased from a mere 1 crores to almost 4 & odd crores is the factor leading to their slightly modified Gandhian Principles of “not to see, hear or smell anything at all”
“It is revealed that as per the records maintained by the Institute of Chartered Accountants of India, S Gopalakrishnan and Talluri Srinivas are partners in the firm Price Waterhouse Bangalore and not in Price Waterhouse. Both the accused, by affixing their signatures on the audit reports for and on behalf of Price Waterhouse deliberately with the knowledge of its implications and consequences, violated the requirements of Auditing & Assurance Standards (AAS) 28,” the CBI said in its charge sheet.
Satyam had contracted PW chartered accountants as statutory auditors in 2000. S Gopalakrishnan, a partner at the auditing firm, had endorsed the accounts of Satyam from 2001 to 2007. Talluri Srinivas took over Gopalakrishnan’s role in 2007.
Satyam’s ex-CFO Srinivas Vadlamani knew that the auditors were not the representatives of PW, but of Price Waterhouse Bangalore, it said. The auditors were also found to have “deliberately” not verified the information they have about the company’s financial health with the banks and other institutions, the charge sheet said.
This has raised many questions as to the authenticity of the Audit Reports, the presence of the Independent Auditors in the Company, the social responsibilities of the Business, the eminence of Corporate Governance in India, etc.
People, mainly in India are of the opinion that since corporation is not an individual, it has no social responsibilities, but this is not true. Lets see how through Corporate Governance, Corporate can be held socially responsible:
A Corporate pursuit of profit cannot ignore its responsibility towards Society. A company’s independence to make profits ends at that point where it starts affecting other members of society. That is why the various social-control mechanisms to keep corporations in check. But when these systems are obviously not robust enough, and corporate are not self-regulating, they raise issues of ethics and the interest of stakeholders.
As Edward Freeman, who suggested the stakeholder theory, says, “it’s not useful anymore to separate questions of business and questions of ethics.” An integrated way of thinking about business and ethics is via responsibility of action. That is, “businesses and executives are responsible for the effects of their action. They are responsible precisely to those groups and individuals that they can affect or be affected by…”
The Satyam debacle has destroyed in no small measure the stakeholder value, especially that of the shareholder. While their plight is understandable, it must also be realized that they are as much, if not more, responsible for the situation they find themselves in. The very shape and idea of the shareholder has changed. No longer do shareholders come in as providers of capital who will remain invested for reasonably long periods. Now, they are investors aiming to make quick money. This is true also of institutions such as mutual and pension funds. The interest of these ‘investors’, as opposed to ‘shareholders’, is short term. When the average duration of an equity investment by a US mutual fund is 11 months, what would be its long-term interest in the company?
With shareholder value redefined by time, managements are left looking for quick profits. In the effort to retain shareholder interest, managements have become slaves to the stock market. The market is greedy and has an insatiable demand for profits. The practice of quarterly reporting worsens matters as corporate feel obliged to show growth in every reporting period. This is difficult to achieve from core activities, so managements turn to financial re-engineering. While attempts have been made, through incentives, to ensure that managers do not misuse the wealth that is not theirs, they have done just that and repeatedly. This is what led to Enron, WorldCom, Arthur Andersen… The situation is worse when the so-called ‘owners’ (though promoters would be the better term as they usually hold low with little of their own money invested) do the fudging.
The light-touch regulation and the misplaced faith in a self-regulating market have left corporate to their devices. They, in the pursuit of profits, give short-shrift to good governance practices leading to such crisis as that at Satyam. Besides the corporate, the Satyam debacle is a severe indictment of the systems and regulatory practices and, crucially, the auditors.
Some blame must also attach to the media that are perhaps collectively the most influential with the people than any other institution. They aid in information processing by selecting the most relevant information for their set of readers and, more importantly, by cross-checking the veracity of the news. This iterative approach gives the media the watchdog role. But have the media played this role? Not really, because oftentimes journalists simply do not know what is happening even with the companies they track. Journalist may plead, variously, work pressures, lack of expertise, or voluminous and opaque corporate reports. But with a larger informing role, it is incumbent upon journalists to consult experts and do diligent follow-ups.
Also, media have a tendency to quickly lionise seemingly successful businesspersons. A look at scamsters over time would reveal this pattern: Media initially hailing them and promptly throwing them to the wolves once the truth emerges. Media must be more careful in its reporting of corporates and their chieftains. They are, as it were, informal regulators and watchdogs of the corporate governance process.
The Satyam debacle will hopefully bring in changes to the corporate governance framework. Though the outlook appears bleak, there is opportunity too. But there could be changes in the way business is perceived and practiced. One obvious development could be consolidation. But with large corporate seemingly having feet of clay, there could be a shift to disaggregation.
To spread the risk, contracts may be handed out to a number of medium-size companies, rather than one giant. This is especially true of the outsourcing industry where confidence has no doubt taken a beating, post-Satyam. But as confidence returns, there could be a shift towards more small/medium players rather than one large company. This will raise opportunities for system integrators who will have the ability to manage work handed out to diverse players and integrate them for delivery.
Disgraced founder Ramalinga Raju and his brother Rama Raju were sent to judicial custody as the government and regulator SEBI huddled in Delhi to put a new management together to run the IT Company and to think about its bail-out.
Raju, who on 7th January 2009 disclosed a financial fraud in the company running into 7,000 crores over several years, and his brother were produced before the 6th Chief Metropolitan Magistrate who remanded them to judicial custody till January 23, 2009.
The siblings will be treated as ‘C’ class prisoners vastly different from the luxury of their home in the posh Jubilee Hills and will be treated like other prisoners, jail officials said.
Vadlamani Srinivas, Satyam Computer’s Chief Financial Officer, who resigned a day after the fraud came to light and which is yet to be accepted, was first picked up for questioning and was later formally placed under arrest. Srinivas had been arrested on the same charges that have been slapped on the Raju brothers–criminal conspiracy, cheating, use of forged documents, forgery and criminal breach of trust–under the Indian Penal Code, he said.
The other authorities which will be involved to investigate the fraud & slap charges are SEBI & Ministry of corporate affairs.
Consequent to a written confession by Satyam Computer Chairman Ramalinga Raju, admitting to the recent multi crores scam of misrepresenting facts in the Company’s balance sheet to the tune of around Rs. 7000 Crores, has brought the role of auditors and accountants for the company under scrutiny.
The role of PricewaterhouseCoopers- the statutory auditors in “India’s Enron” comes under the spotlight amid allegations that large Indian companies regularly use misleading accounting techniques and bully analysts, accountants and auditors into staying quiet. Given the scandals of the past like Worldcom, Parmalet and Enron, the imminent issue is how effective and trustworthy Auditors really are. An Auditor, first and foremost has to be a Chartered Accountant under the Chartered Accountants Act, 1949. He is the person appointed to examine the books of account and the accounts of a company registered under the Companies Act, and to report upon them to the company’s shareholders. Audit means the examination or assessment of a company’s annual accounts, i.e. a balance sheet, profit and loss account and other financial statements as required by law.
Under the Companies Act, an auditor is required to express an opinion as towhether the annual accounts give a true and fair view of the company’s state of affairs and financial position. To formulate such an opinion, the auditor needs to examine the company’s internal accounting system, inspect its assets, test-check of accounting transactions.
The CBI charged that the auditors had a quid pro quo arrangement with the conspirators for overlooking the facts because of which they were paid exorbitant audit fee. The CBI has also found the letterheads of PW in the computer systems of the other key accused and the company, which were meant to communicate with the banks for seeking the actual information on Satyam independently. The CBI said the letterheads were used by the conspirators for creating statutory records on their own.
There was information coming in from banks about the real financial health of the company, the CBI said.
However, it was Gopalakrishnan who first started ignoring the information to accommodate that given by company officials alone. In fact, Price Waterhouse itself had found deficiencies in Satyam for the first time in 2006-07.
According to the charge sheet, IT general check was carried out for the first time in 2006-07 by head of information systems audit of Price Waterhouse, wherein about 180 deficiencies were found, and was communicated to the audit team with the assertion that the IT systems in Satyam are not fully integrated and are subject to manipulation.
Therefore, due to all these allegations, they have been taken into custody after questioning.
Let’s embark on to the OTHER FINANCIAL SCANDALS STARTING FROM THE 18TH CENTURY:
He was popularly known as the wizard of the Dala Street, also the BIG BULL in the Business Circle
BIG BULL as it was his style of buying huge quantities of particular scrip, and to publicise it adequately, so there would be a large buying of that scrip in the market. He had such an impression in the market that people used to value his opinion. His name was enough for investors to buy that stock. He was a pied piper for many middle class Indian. He dreamt big and made people dream big – The Great Indian dream that is to become rich. His idea was to take the prices of the scrip to such heights that in that process , everyone would make money. But his method was not good. Its not possible for anyone to put unlimited money to keep running up a stock which made him take the wrong path. On his journey from rags to riches, he had made many enemies most of them were bears who envied Harshad’s success. He made frontlines in newspapers with pictures of luxury cars at a time when even big industrialists hardly owned them. Another picture of his in a zoo, where he was feeding peanuts to bears. They were waiting for a chance to trap him. So, when they got the winds that he was drawing money illegally, they hounded on him. This led to his downfall as the money supplied stopped and the market collapsed.
He hailed from Raipur, but had initially moved there from Mumbai. He started working as a dispatch clerk in New India Assurance Company. From there he was fascinated by the Stock Market. He along with his brother started investing in the Stock market and became a stock broker on the Bombay Stock Exchange.
He used to invest heavily in one scrip at a time to shoot up its price and used to give assurance to his clients about that scrip. Soon he came to be known as BIG BULL. With the rise in the price of that particular scrip, he used to give the explanation of Replacement Cost Theory. The theory basically argues that old companies should be valued on the basis of the amount of money, which would be required to create another such company.
On April 23, 1992, journalist Sucheta Dalal in a column in The Times of India, exposed the dubious ways of Harshad Metha. The broker was dipping illegally into the banking system to finance his buying. This was being done through Ready Forward Deal, the mechanism after all his finances. The RF is in essence a secured short-term (typically 15-day) loan from one bank to another. Crudely put, the bank lends against government securities just as a pawnbroker lends against jewellery. The borrowing bank actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher price.” It was through this system, that Mehta used to raise huge finances through the banking system.
The Deal: A typical ready forward deal involved two banks brought together by a broker in lieu of a commission. The broker handles neither the cash nor the Securities. “In this settlement process, deliveries of securities and payments were made through the broker. That is, the seller handed over the securities to the broker, who passed them to the buyer, while the buyer gave the cheque to the broker, who then made the payment to the seller.
In this settlement process, the buyer and the seller might not even know whom they had traded with, either being known only to the broker.”
This the brokers could manage primarily because by now they had become market makers and had started trading on their account. To keep up a semblance of legality, they pretended to be undertaking the transactions on behalf of a bank.
Another instrument used in a big way was the bank receipt (BR). In a ready forward deal, securities were not moved back and forth in actuality. Instead, the borrower, i.e. the seller of securities, gave the buyer of the securities a BR.
It acts as a receipt for the money received by the selling bank. Hence the name – bank receipt. It promises to deliver the securities to the buyer. It also states that in the mean time, the seller holds the securities in trust of the buyer.”
Through these instruments, Mehta wanted to raise money illegally. He needed accomplices in the form of Banks, where they would issue fake receipts or receipts not backed by the Government. Here, the Bank of Karad (BOK) and the Metorpolitan Co-operative Bank (MCB) came into picture. These banks were willing to issue BRs asand when required, for a fee,” the authors point out. Once these fake BRs were issued, they were passed on to other banks and the banks in turn gave money to Mehta, obviously assuming that they were lending against government securities when this was not really the case. This money was used to drive up the prices of stocks in the stock market. When time came to return the money, the shares were sold for a profit and the BR was retired. The money due to the bank was returned.
The game went on as long as the stock prices kept going up, and no one had a clue about Mehta’s modus operandi. Once the scam was exposed, though, a lot of banks were left holding BRs which did not have any value – the banking system had been swindled of a whopping Rs 4,000 crore.
The GOODBYE to the GURU!
Mehta made a brief comeback as a stock market guru, giving tips on his own website as well as a weekly newspaper column. This time around, he was in cahoots with owners of a few companies and recommended only those shares. This game, too, did not last long.
Interestingly, however, by the time he died, Mehta had been convicted in only one of the many cases filed against him.
US-64 was a scheme, just like a modern day mutual fund, attracting a large number of small investors. Since, Government was involved in its handling, the trust was all the more enhanced.
But when the bubble busted, the most affected were the small fishes, as the big fishes were smartly moved away with the help of the caution thrown to the winds by the Fund Managers. The six-month freeze announced by the Unit Trust of India (UTI) on all transactions in its Unit Scheme 1964 (US-64) had come as a bombshell to the millions of its small investors, it had left even the most vocal supporters of liberalisation dumbfounded.
This scheme was just like a modern day mutual fund, wherein the units were to be bought initially at the open of the offer at the face value of Rs. 10/- per unit. That is why it was affordable to the investors, especially the small ones.As the very name of the scheme suggests, small investors used to purchase units from the UTI and sell back to the latter whenever they needed hard cash. In every calendar year, the transactions used to start in July after the UTI declared the sale and repurchase prices of its units. Sale price meant the rate an investor paid to purchase units from the UTI, and repurchase price was the rate at which he could sell his units back to the UTI. These prices used to appreciate month by month, they were duly notified through newspaper ads, and the transactions used to be closed at May-end next year. The month of June was reserved for bookkeeping and calculation exercises within the UTI, after which it used to declare a rate of dividend for its investors.
For example, 10 units are purchased in July @ Rs. 10 per unit. Every month the appreciation in its value was publicized in the newspapers. Therefore say after 3 onths, its price is Rs. 12/- per unit. Now the value of the investment is Rs. 120/- as against its purchase price of Rs. 100/-. Also a dividend was declared towards the end of June which further added to its attraction.
After the end of June every year, the investor had two options before him. He could either get a cheque for the dividend accrued to him in the previous 12 months or he could reinvest the same, that is, get it converted into units and thus increase the number of units in his hand. In the latter case, the amount of dividend due to him automatically increased year after year, till he chose to withdraw money by selling his units back to the UTI.
The investor’s benefit, its attraction!:
Any amount of money could be invested, let it be large as in crores or in mere hundreds of Rupees, so attractive to small investors. Rate of earnings were more than investing in a Bank.
Secondly, compared to some other instruments like Kisan Vikas Patras or National Saving Certificates, the US-64 offered its investors the benefit of a very high degree of liquidity. While one’s money was locked in the above instruments for five to six years, a US-64 unit holder could sell his units back to the UTI any time in the year, save in the month of June, at the previously declared repurchase price. In any month, the repurchase price used to be only 15 to 25 paise less than the sale price, and did not mean any loss to the investor. After surrendering his units to the UTI, the investor got a cheque for his money in a week or so.
It was also free of any disadvantages that come alongwith the other investment instruments which were highly speculative. It was safe from the ups & downs of the stock market. Small investor thought that his money was safe in the custody of the "government of India."
It did not bring along forfeiture if the investments were not regular. It depended totally upon the investors capacity to save. This was particularly to the liking of those who had no regular or fixed income.
Under the US-64, an investor was required to purchase a minimum of only 100 units; that meant an investment of only Rs 1500 or so. Thus, even those with modest incomes and savings could become members of the scheme.
Lastly, if a US-64 investor had two options before him, of getting a cheque for the dividend earned by him or of reinvesting the same into more units, the conversion from one option to the other was not difficult in the least and could be effected through simple correspondence. This offered another attraction for the investors.
It was these factors that made the US-64 investments highly attractive for the investor community as a whole. The scheme, on the whole, was a haven for small investors, particularly those working in the private or unorganised sector, who did not have any security of post-retirement or post-retrenchment benefits.
This also explains how the US-64 alone accounted for about 23 per cent of the Rs 60,000 crore plus corpus of the UTI that runs a number of other schemes. In fact, no scheme of the UTI achieved such tremendous success as the US-64 did, making the UTI the biggest mutual fund of the country and one of the biggest in the world.
Liberalisation of the economy immediately led to the liberalisation of the UTI, throwing it to the mercy of the stock market. In 1992, itself the US-64 scheme was changed from a debt-based fund to one linked to equity. In 1992 only 28% of its funds was in equity; today it is over 70%. Further liberalisation was pushed by Chidambram, as the finance minister of the U F government, who, in 1997, removed all government nominees from the board of the UTI. Besides, the US-64 does not come under SEBI regulations, its investment delails are kept secret (ever depositors cannot know where their funds are being parked) and the chairman has arbitrary powers to personally decide an investment upto a huge Rs 40 crores. Such ‘liberalisation’ is tailor-made for frauds. Not surprisingly, within one year of Chidambram’s liberalisation, in 1998, the UTI crashed, and the new BJP-led government organised a large Rs. 3,500 crore bail-out to prevent default.
It was during this crisis that the new chairman, P.S. Subramanyam, was appointed. Subramanyam was a direct appointee of thug Jayalalitha, who had made his selection a condition for her continuing the support of the then NDA government. Later, though Jayalalitha withdrew from the government, Subramanyam developed close links with the Prime Minister’s Office, and corporative big-wigs. Small investor’s funds were used to promote big business houses, shower favours to politicians, and invest huge amounts in junk bonds….all for a fat commission. Subramanyam functioned like a fascist, arbitrarily transferring hundreds of senior staff, in order to cover his tracks. He was a key player in the Ketan Parekh scam.
Huge amount of UTI funds were channelled into the infamous K-10 list of Keten Parekh stock, such as Himachal Futuristic, Zee Telefilims, Global Tele, DSQ, etc. The UTI continued to buy these shares even when their market value began to crash in mid-2000, in order to prop up the share values of these stocks. The Trust saw its Rs. 30,000 portfolio (value of stocks) lose half its value within a year since Feb. 2000.
Besides, the UTI also invested in junk bonds like Pritish Nandy communications (Rs. 1.5 crores), Jain Studios(Rs.5 crores), Sanjay Khan’s Numero Uno International (Rs. 7.5 crores), Malavika Spindles(Rs. 188 crores) etc. This amounted to nothing but handing over people’s money (investments) to the rich and powerful. Thereby thousands of crores were siphoned off to big business and prominent individuals, with the UTI chairman, bureaucrats and politicians taking their cuts.
But this was not all. The fraud continues even further. With knowledge that the UTI was in a state of collapse, the Chairman organised a high profile propaganda campaign promoting UTI (spending crores of rupees on the top advertising company, Rediffusion), while at the same time leaking information to the big corporates to withdraw their funds. The Chairman thereby duped the lakhs of small investors through false propaganda, while allowing windfall profits to the handfull of big corporates who had invesed in UTI.
So, in the two month prior to the freezing of dealings in UTI shares, a gigantic sum of Rs. 4,141 crores was redeemed. Of this Rs.4,000 crores (97%) were corporate investments. What is more, they were re-purchased at the price of Rs. 14.20 per share (face value Rs.10) when in fact its actual value (NAV — net asset value) was not more than Rs. 8. As a result UTI’s small investors lost a further Rs. 1,300 crores to the big corporates.
In fact these huge withdrawals further precipated the crisis. On July 4, 2001 the board of UTI took the unprecedented step of freezing the purchase and sale of all US-64 UTI shares for six months. Simultaneously it declared a pathetic dividend of 7% (10% on face-value), which is even lower than the interests of the banks and post office saving schemes. Such freezing of legally held shares is unheard of — and is like overnight declaring Rs. 100 notes as invalid for some time. In other words the 2 crore shareholders could not re-invest their money elsewhere — and would have to passively see their share price erode from Rs. 14 (at which they would have purchased it) to Rs 8 — and get interest at a mere 7% on their initial investments. Fearing a back-lash, the government/UTI later announced the ability to repurchase UTI shares at Rs. 10 — i.e. at 30 % below the purchase price.
The description of the scene when the scam was unearthed:
May 18, 1997 – when hundreds of investors who had trusted the CRB Group of companies for Investment Advice & channelizing their hard earned money into fruitful means, were gathered outside the Reserve Bank of India’s (RBI) Mumbai headquarters under the scorching sun. They were waiting for Chain Roop Bhansali (Bhansali), the head of the CRB Group of companies to arrive.
Three days earlier the RBI had given Bhansali 72 hours to come up with a plan to repay his liabilities following over 400 complaints from depositors in his company’s financial schemes. Most top officials of CRB, including the head itself were untraceable after the RBI’s demand for an explanation. The Central Bureau of Investigation (CBI) locked and sealed the offices of the CRB Group and arrested six persons, including four directors (two from Bikaner and two from Mumbai) of the satellite companies of the group, a financial controller in Mumbai and a relative and close associate of Bhansali in Delhi. The CBI also conducted simultaneous searches at 16 places in Mumbai, three in New Delhi, one each in Chennai and Ahmedabad and two places each in Calcutta, Jhunjunu, Sujangarh and Bikaner.
The CBI froze the bank accounts of the group companies and seized incriminating files and other documents from the residence of the vice-president of the CRB group in Mumbai. Following rumors that Bhansali had fled India and was hiding in Hong Kong or Canada, the CBI sought Interpol’s assistance to trace his whereabouts. RBI filed a winding-up petition claiming that the continuance of the CRB Group was not in the interest of the public and depositors.
It seems that Bhansali had targeted the buyers of investment companies in particular. This is because he floated dummy investment companies and used to lure the buyers to buy them showing a rosy picture of the future. He capitalized on the 1985 boom in leasing companies to become cash rich.
He had established good contacts in the Registrar of Companies and the Controller of Capital Issues offices. He registered companies with practically no equity and then stage-managed the dummy company’s maiden public issue with a few hundred investors, largely from Calcutta’s close knit Marwari Jain community. Having had a company listed on the stock exchange, Bhansali then sold it for a profit to businessmen who needed dummy public limited companies in a hurry.
Bhansali used his own money to rig share prices in order to raise more money from the markets in two ways. Firstly, he bought his own stock through private finance companies owned by him. Secondly, he used his other public companies to buy into each other as cross-holdings…
In May 1996, CRB Caps opened a current account in SBI’s main Mumbai branch, for payment of interest, dividend and redemption cheques. The payment warrants could be presented at any of the 4,000 SBI branches for payment.
However, Bhansali was granted only a current account facility and did not enjoy any overdraft facility. He was expected to deposit cash upfront into the current account, along with a list of payments that had to be honored. Claming that the logistics of payment were very complex and that it was not possible for every branch to check with the head office before honoring a dividend warrant, the branches gradually began treating these instruments just like a demand draft. For about nine months, the setup worked very well.
However, in March 1997, SBI realized that the account had been overdrawn to the extent of a few crores. Bhansali was called to the SBI office and asked to remit the difference immediately, which he promptly did…
The collapse of the CRB group seemed to be a fraud allowed by supervisors despite the regulations in place. The lack of clear communication channels between the banks, RBI and the government seemed to have worked to Bhansali’s advantage to a great extent.
Frequent clashes occurred between RBI and SEBI in the media, with both of them trying to prove how the other was responsible for not acting early enough. The RBI claimed that it had no powers to examine the asset quality of the CRB group and thereby was not in a position to pass any judgment on the character of asset generation or deployment of the funds raised by the group.
The bank further claimed that the powers were granted only in March 1997, when the RBI Act of 1934 was amended to include specific provisions for the purpose. The bank also stated that it had begun to examine the liabilities and not the assets. However, media reports were quick to refute RBI’s claims…
The CRB scam took the whole nation by storm. At one point, the Union finance ministry held a meeting everyday to get to the brasstacks of the CRB fiasco. In a meeting with SEBI, the finance minister criticized the regulator severely.
The government asked the RBI to prepare a panel of auditors asking to explore the possibility of making auditing of NBFCs a prerequisite to registration. In October 1998, the SEBI appointed an administrator for CRB’s Arihant scheme finalized a scheme for payment to the unitholders.
Under the scheme, the investors were prematurely paid Rs 4.95 per unit, which was its NAV as of 31 March 1998. When the administrator had taken over, the assets of the scheme comprised the fund’s frozen bank accounts worth Rs 81 lakh, plus some dividends from investments. Besides, there were a large number of listed (but thinly traded) and unlisted shares amounting to Rs 17.5 crores…
The 176-point1 Sensex2 crash on March 1, 2001 came as a major shock for the Government of India, the stock markets and the investors alike. More so, as the Union budget tabled a day earlier had been acclaimed for its growth initiatives and had prompted a 177-point increase in the Sensex. This sudden crash in the stock markets prompted the Securities Exchange Board of India (SEBI) to launch immediate investigations into the volatility of stock markets. SEBI also decided to inspect the books of several brokers who were suspected of triggering the crash.
Meanwhile, the Reserve Bank of India (RBI) ordered some banks to furnish data related to their capital market exposure. This was after media reports appeared regarding a private sector bank3 having exceeded its prudential norms of capital exposure, thereby contributing to the stock market volatility. The panic run on the bourses continued and the Bombay Stock Exchange (BSE) President Anand Rathi’s (Rathi) resignation added to the downfall. Rathi had to resign following allegations that he had used some privileged information, which contributed to the crash. The scam shook the investor’s confidence in the overall functioning of the stock markets. It led to the controversy on lending of funds by the bank for funding capital market operations as well as against collateral securities. It also raised questions about the validity of dual control of co-operative banks4. (Analysts pointed out that RBI was inspecting the accounts once in two years, which created ample scope for violation of rules.)
The main culprit behind the Scam, the noted Bull Ketan Parekh (herein after referred to as KP) who kept a very low profile, was arrested by CBI on 30th march, 2001. Unaware, that they have caught the biggest fish of all, the investigations revealed that this scam was caused by him single handedly. He was charged with defrauding Bank of India (BoI) of about $30 million among other charges.
KP was a chartered accountant by profession and used to manage a family business, NH Securities started by his father. Over the years, KP built a network of companies, mainly in Mumbai, involved in stock market operations.
The rise of ICE (Information, Communications, and Entertainment) stocks all over the world in early 1999 led to a rise of the Indian stock markets as well. The dotcom boom7 contributed to the Bull Run8 led by an upward trend in the NASDAQ9.
The companies in which KP held stakes included Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips and Pritish Nandy Communications. He also had stakes in HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics KP selected these companies for investment with help from his research team, which listed high growth companies with a small capital base.
KP took advantage of low liquidity in these stocks, which eventually came to be known as the ‘K-10’ stocks. Since due to his heavy investments in theses stocks led to their price increase, brokers and fund managers started investing heavily in K-10 stocks. Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks, and saw their net asset value soaring. By January 2000, K-10 stocks regularly featured in the top five traded stocks in the exchanges. As such huge amounts of money were being pumped into the markets, it became tough for KP to control the movements of the scripts. Also, it was reported that the volumes got too big for him to handle.
According to market sources, though KP was a successful broker, he did not have the money to buy large stakes. According to a report11, 12 lakhs shares of Global in July 1999 would have cost KP around Rs 200 million. The stake in Aftek Infosys would have cost him Rs 50 million, while the Zee and HFCL stakes would have cost Rs 250 million each. Analysts claimed that KP borrowed from various companies and banks for this purpose. His financing methods were fairly simple. He bought shares when they were trading at low prices and saw the prices go up in the bull market while continuously trading. When the price was high enough, he pledged the shares with banks as collateral for funds. He also borrowed from companies like HFCL.
Similar to the Harshad Mehta Scam, it was not a one men show without any accomplice. A small Ahmedabad-based bank, Madhavapura Mercantile Cooperative Bank (MMCB) was KP’s main ally in the scam. KP and his associates started tapping the MMCB for funds in early 2000. In December 2000, when KP faced liquidity problems in settlements he used MMCB in two different ways. First was the pay order12 route, wherein KP issued cheques drawn on BoI to MMCB, against which MMCB issued pay orders. The pay orders were discounted at BoI. It was alleged that MMCB issued funds to KP without proper collateral security and even crossed its capital market exposure limits. As per a RBI inspection report, MMCB’s loans to stock markets were around Rs 10 billion of which over Rs 8 billion were lent to KP and his firms.
The second route was borrowing from a MMCB branch at Mandvi (Mumbai), where different companies owned by KP and his associates had accounts. KP used around 16 such accounts, either directly or through other broker firms, to obtain funds. Apart from direct borrowings by KP-owned finance companies, a few brokers were also believed to have taken loans on his behalf. It was alleged that Madhur Capital, a company run by Vinit Parikh, the son of MMCB Chairman Ramesh Parikh, had acted on behalf of KP to borrow funds. KP reportedly used his BoI accounts to discount 248 pay orders worth about Rs 24 billion between January and March 2001. BoI’s losses eventually amounted to well above Rs 1.2 billion. The MMCB pay order issue hit several public sector banks very hard. These included big names such as the State Bank of India, Bank of India and the Punjab National Bank, all of whom lost huge amounts in the scam. It was also alleged that Global Trust Bank (GTB) issued loans to KP and its exposure to the capital markets was above the prescribed limits. According to media reports, KP and his associates held around 4-10% stake in the bank. There were also allegations that KP, with the support of GTB’s former CMD Ramesh Gelli, rigged the prices of the GTB scrip for a favorable swap ratio13 before its proposed merger with UTI Bank.
He used to raise funds by offering the shares which he had bought at a lower rate (but the current market price was souring than the purchase price due to heavy investments zeroed in on that particular stock), as a collateral security to the bank. This continued till there was rise in the Stock Market. The crash, which was led by a fall in the NASDAQ, saw the K-10 stocks also declining. KP was asked to either pledge more shares as collateral or return some of the borrowed money. In either case, it put pressure on his financials. By April 2000, mutual funds substantially reduced their exposure in the K-10 stocks. In the next two months, while the Sensex declined by 23% and the NASDAQ by 35.9%, the K-10 stocks declined by an alarming 67%. However, with improvements in the global technology stock markets, the K-10 stocks began picking up again in May 2000. HFCL nearly doubled from Rs 790 to Rs 1,353 by July 2000, while Global shot up to Rs 1,153. Aftek Infosys was also trading at above Rs 1000.
In December 2000, the NASDAQ crashed again and technology stocks took the hardest beating ever in the US. Led by doubts regarding the future of technology stocks, prices started falling across the globe and mutual funds and brokers began selling them. KP began to have liquidity problems and lost a lot of money during that period.
It was alleged that ‘bear hammering’ of KP’s stocks eventually led to payment problems in the markets. The Calcutta Stock Exchange’s (CSE) payment crisis was one of the biggest setbacks for KP. The CSE was critical for KP’s operation due to three reasons. One, the lack of regulations and surveillance on the bourse allowed a highly illegal and volatile badla business. Two, the exchange had the third-highest volumes in the country after NSE and BSE. Three, CSE helped KP to cover his operations from his rivals in Mumbai. Brokers at CSE used to buy shares at KP’s behest.
Though officially the scrips were in the brokers’ names, unofficially KP held them. KP used to cover any losses that occurred due to price shortfall of the scrips and paid a 2.5% weekly interest to the brokers. By February 2001, the Scrips held by KP’s brokers at CSE were reduced to an estimated Rs 6-7 billion from their initial worth of Rs 12 billion. The situation worsened as KP’s badla payments of Rs 5-6 billion were not honored on time for the settlement and about 70 CSE brokers, including the top three brokers of the CSE (Dinesh Singhania, Sanjay Khemani and Ashok Podar) defaulted on their payments.
KP again turned to MMCB to get loans. The outflow of funds from MMCB had increased considerably form January 2001. Also, while the earlier loans to KP were against proper collateral and with adequate documentation, it was alleged that this time KP was allowed to borrow without any security.
By now, SEBI was implementing several measures to control the damage. An additional 10% deposit margin was imposed on outstanding net sales in the stock markets. Also, the limit for application of the additional volatility margins was lowered from 80% to 60%. To revive the markets, SEBI imposed restriction on short sales14 and ordered that the sale of shares had to be followed by deliveries. It suspended all the broker member directors of BSE’s governing board. SEBI also banned trading by all stock exchange presidents, vice-presidents and treasurers.
A historical decision to ban the badla system in the country was taken, effective from July 2001, and a rolling settlement system for 200 Group A shares15 was introduced on the BSE.
The small investors who lost their life’s savings felt that all parties in the functioning of the market were responsible for the scams. They opined that the broker-banker-promoter nexus, which was deemed to have the acceptance of the SEBI itself, was the main reason for the scams in the Indian stock markets.
SEBI’s measures were widely criticized as being reactive rather than proactive.
A market watcher said,16 "When prices moved up, SEBI watched these as ‘normal’ market movements. It ignored the large positions built up by some operators.
Many exchanges were not happy with the decision of banning the badla system as they felt it would rig the liquidity in the market. Analysts who opposed the ban argued that the ban on badla without a suitable alternative for all the scripts, which were being moved to rolling settlement, would rig the volatility in the markets. They argued that the lack of finances for all players in the market would enable the few persons who were able to get funds from the banking system – including co-operative banks or promoters – to have an undue influence on the markets.
In October 1997, the Reserve Bank of India (RBI) banned all non-banking financial companies (NBFCs) of the JVG Group of companies – JVG Finance, JVG Leasing and JVG Securities – from accepting deposits from the public. This was after an investigation revealed that these companies had been accepting deposits in excess of their stipulated limits. Soon after, JVG downed the shutters of several of its offices in small towns. The closing of the offices created a panic among the depositors and strong voices were raised against the group in the media.
In November 1997, JVG hurriedly rented an office in Gurgaon (Haryana) to accommodate irate investors. Hundreds of investors and agents camped on the grounds of the office. The agents (or the field-workers), who raised deposits from investors on behalf of JVG, were extremely worried. They said they could not go back to their local offices without collecting the dues fearing the wrath of the investors.
At this point, JVG Chairman V.K.Sharma (Sharma) dropped another bombshell on the investors. He claimed that a majority of the certificates were fake and hence they would not be paid back. For many depositors who had invested as little as Rs 500 and who could not even dream of taking the dispute to court, it meant kissing their investments goodbye. Analysts remarked that the investors and agents had themselves to blame for the loss – because the activities of the JVG Group had always been looked at with suspicion by the industry.
From being a small-time contractor earning less than Rs 2500 a month, Sharma went on to run a group, which on paper had an annual turnover of Rs 1000 crores, in just seven years. Sharma had grand plans for making JVG a Rs 12000 crores empire by 2000. He announced that he would invest over Rs 4000 crores in diverse areas such as power, cement, hotels, steel, textiles and aviation. JVG went ahead with its plans.
However, most part of the JVG Empire was created largely from public fixed deposits. In the early 1990s, Sharma opened branches of his finance companies in various towns and villages. He followed it up with heavy advertising on the interest rates, which were as high as 30%. Investors flocked to buy the company’s schemes and the deposit base soon crossed Rs 1000 crores.
The JVG group’s turnover increased from Rs 102 crores in 1994-95 to Rs 700 crores in 1995-96. JVG had acquired Orkay’s polyester yarn plant and a part of its office space in Mumbai in March 1997 through a tripartite agreement with financial institutions led by IDBI and the Mehras who controlled Orkay. As per the agreement, JVG agreed to pay the Mehras Rs 98 crores in cash and take on the Rs 130 crores liability to the various FIs. JVG paid off Rs 14 crores to the Mehras in March 1997. According to the schedule worked out by the FIs, JVG agreed to pay the second installment in the first week of September 1997. Although JVG could not meet the deadline, it was allowed to run the plant on job-work basis from September 1997. The understanding was that JVG would pay up by the end of September. However, JVG failed to meet the end-September deadline as well and Orkay sought the intervention of IDBI to take possession of the plant. Production at the plant was suspended in October 1997. Following this, the agreement between the Mehras, JVG and the FIs became null and void.
In September 1997, post-dated cheques issued for principal as well as interest on JVG’s deposits bounced. Investors then complained to the civil courts, consumer courts, Company Law Board and criminal courts under the Negotiable Instruments Act upon which legal proceedings were initiated against the group.
JVG’s troubles started in June 1997, after the Securities and Exchange Board of India (SEBI) asked JVG Finance to refund the Rs 45 crores it had raised from a public issue in March 1997. A day after the issue had opened; RBI issued a show-cause notice asking why JVG Finance should not be barred from accepting deposits as the group companies had already exceeded their deposit limits. By the time RBI conditionally cleared the issue after assurances from Sharma, the 70-day stipulated period for listing the shares had passed.
Because of the time-lapse, SEBI intervened and ordered the refund of the public’s money according to the allotment rules. Sharma refused to refund the money to the investors and appealed against the order to the Finance ministry. He admitted that JVG had exceeded its limits while accepting deposits but claimed that since December 1996 (much before the RBI ban) it had stopped accepting deposits on its own and had even given RBI an undertaking. RBI did not accept the argument and barred the group from accepting any more public deposits.
RBI alleged that the company had accepted deposits worth Rs 88.82 crores which was 756.68% of its net owned fund. This was much higher than the permissible limit of 25%2. Similarly, JVG Leasing had received deposits worth Rs 19.28 crores which was 147.58% of its net owned fund. The RBI complaint also said that the deposit forms issued by the JVG Group did not contain any information regarding premature withdrawals, which was necessary as per RBI provisions.
The companies had not provided any information about the rate of interest to the investors on the receipts issued to them. Further, the companies failed to submit their audited balance sheets for the period ending March 31, 1994 and 1995 15 days after their annual general meeting (AGM) and did not inform the RBI about the changes in the composition of the board of directors.
RBI’s petition also stated that the company had not maintained liquid assets as required by section 45IB of the RBI Act, 1934. RBI further contended that JVG Securities accepted public deposits through JVG Leasing Ltd. and had illegally credited it to the account of JVG Finance Ltd. Thus, JVG Securities facilitated collection of further deposits by JVG Finance Ltd., a company which had already accepted public deposits beyond the permissible limit in spite of the warning from RBI not to accept any further deposits.
Meanwhile, JVG, fearing a withdrawal rush on its deposits, asked all its depositors to send their certificates to the Delhi office for scrutiny and also issued notices in the dailies assuring investors that all deposits which had matured would be redeemed immediately.
Sharma revealed that all genuine matured amounts had been repaid and only Rs 30 crores was to be paid to depositors of JVG Finance by January 1998 and another Rs 100 crores to JVG Leasing depositors between July 1998 and June 1999. He also admitted that it was impossible for him to repay all his depositors, including those whose deposits had not matured. Sharma’s allegation that his agents had issued fake certificates to depositors for more than Rs 100 crores was seen as a ploy to wash his hands off the responsibility to pay them. Analysts remarked that if the certificates were issued by agents who were handpicked by Sharma himself, he could not disown them. There was suspicion as to the dubious nature of the investments Sharma had made with the money, which had not yielded the returns he had expected. As a result, he serviced the interest on the old deposits out of fresh deposits.
The JVG companies were delisted and barred permanently from indulging in NBFC activities in the future. However, JVG’s demise and Sharma’s stint in jail would perhaps never replace the dreams and hopes of the investors whose hard-earned money had vanished forever.
Let’s analyze what Mr. Raju did from a bird’s eye point of view. The system was in place, there were the Auditors of the highest esteem i.e. one of the big Fours in place, and there were several authorities to report to, still the biggest Corporate Fraud of the Century took place!
The question is why so! Where is the system lacking. There are Accounting Standards, Auditing Standards, Business Ethics, and Corporate Governance & Procedures to be followed in reporting. But, to hell with all this, here is Mr. Raju in his own grandeur, violating everything the system imposes and carrying on the Fraud!
Here is the definition of various roles which were kept in place in order to avoid this scam:
As we have discussed earlier, how the fraud was carried out in detail. We may also not that it was not possible without either the negligence in duties or the whole hearted support of the Auditors.
The Auditing & Assurance Standards are in place, but when a company like Satyam with its Herculean size operations is required to be audited, these standards are applied, but only to a small percentage of the operations. It is not within the Auditors power to detect Fraud, if prime facie, every thing appears to be genuine. We stress this point because since we have listed the fraud in detail, we may conclude that if fake receipts & invoices were printed and shown to the Auditors, they were not in a position to detect the Fraud.
But they should have gone for Debtors & Bank Confirmation – this would be the normal course of action for any auditor in place. It was done till some extent, but even the negligence of duty on the part of the Auditor was evident. Whereas in support of this, the Raju family had floated enough small companies to act as their debtors and money was siphoned off illegally to be deposited in the bank to confirm the bank balances.
What with the independence of the Auditor: It is a very serious question in these changing times. This is because; auditors are engaged and paid by the same managers who may be responsible for misreporting. They have the incentives to comply with these managers to protect their fees.
Here another concept comes into picture called the “Revolving Door” wherein the individual conducting the audit in actually in the employment of the client personnel. So he is given incentive to conduct poor Audit. Therefore, it should be mandatory to rotate the audit firm over a period of time to avoid this.
Let us look into the role of the Auditor, prescribed:
The statutory duties of the auditor basically entail the following:
The auditor has a duty to inquire into certain matters and seek any information required for the audit, from the company. This could be in relation to security on loans and advances made by the company, any transactions entered into by the company and whether they are prejudicial to the interests of the company, whether personal expenses are recorded and charged to proper accounts, any transaction with respect to sale of shares and whether the position depicted in the books and balance sheet is correct, honest and proper. If there are any suspicious circumstances or unusual transactions like unavailability of original documents, or sudden increase or decrease in shareholdings or debt, employees given the liberty to access unauthorized documents etc., then the auditor is under a clear duty to “probe into these transactions” and ensure that they are proper and legal. At all times, auditor has to act with care and skill of a professional of reasonable competence. The degree of care and skill required however, varies from case to case.
Management fraud – This involves the senior management, as they are basically involved in manipulating the financial statements and deceiving the readers of the financial statements with misrepresenting the real picture, or theft or improper use of company resources.
Employee fraud – This involves non-senior employee theft or improper Use of company resources and carrying out of practices and transactions under the table.
External fraud – This involves theft or improper use of resources by people who are neither management, nor employees of the firm7. Internal audit staff and external auditors have to perform an essential function of fraud prevention and deterrence as they are up to speed, experienced and trained in the same and can see to it that the loopholes in the system and the risk areas are identified and investigated. Once they are identified, quick action has to be taken to address and rectify them. The internal processes and programs have to be tested at regular intervals to test their effectiveness.
In order to do this, the auditor needs to ensure that effective anti fraud programs are in place, which not only prevents fraud but also assists in its detection and cure.
This can be done by
Some of the factors that indicate the existence of fraud are unavailability of original documents, unusual relationships, unauthorized transactions, and unexplained items in the accounts, sudden increase or decrease in trends, employees given liberty to access system and records, disparities in accounts and spur of the moment adjustments in the books.
Once the fraud is detected, the auditor can investigate it further by authentication of original documents, impromptu tests and location visits, contacting major customers and suppliers, interviewing the personnel and testing the veracity of computer records.
The obvious course of action is to report anything out of the ordinary to the Directors or the Management. But this cannot be possible, if they themselves are involved. This is because the possibility of detection is a lot less in such cases. However, then the auditor can either approach a third party or consider legal counsel. The auditor is at all times, required to act with reasonable care and skill, but he is not required to always be on the lookout for fraud or a lie, unless he comes across such information or situation which is unusual and instigates him to act with suspicion of a professional man of reasonable competence. An auditor’s main function is to assess the financial position of the company and depict the same in the accounts i.e. the balance sheet and profit and loss account. There is no hard and fast rule for defining reasonable skill and care and that varies from case to case. If there are suspicious and unusual transactions and features in the accounts or other prima facie reasons, reasonable skill and care has to be exercised.
The unfolding of Mr. Raju’s story has resulted in the Satyam being stripped of the Golden Peacock Award given by the UK based World Council for Corporate Governance for its noted excellence in Corporate Governance.
This means that the picture which seemed to be rosy was full of thorns from the aspect of Corporate Governance. Even the role of Independent Auditors was in jeopardy after the scam.
What is Corporate Governance? It is the system by which the companies are regulated, directed & controlled. There is the Companies Act to regulate the companies, legally. But to make them socially responsible, there is Corporate Governance. It provides an architecture for accountability – the structure and processes to ensure that the company is managed in the interest of it’s owners.
The above mentioned issues involved lead to the prominence of the fact that Satyam’s fraud is a blot on India’s corporate image despite the fact that India continues to rank high in its capabilities and competence in IT sector. The scandal has rocked India Inc and shaken the confidence of thousands of retail investors in India and abroad.
It is a collective failure of directors, auditors and regulatory agencies in ensuring transparency and accountability. The responsibility for preventing fraudulent activities lies with the Board of directors. Their acts and conduct impact the reputation of India and, therefore, they must ensure that the highest standards of corporate governance are set.
Realizing that if Satyam story is not repeated henceforth, efforts are being taken now by different Authorities, they now demanding stricter reporting & accountability from the corporate. The Quality Review Board (‘QRB’), an independent body set up under the MCA, is looking into the standards of audit for chartered accountancy firms with a view to redefine new stringent norms for audit firms. It may ask the SEBI and MCA to mandate listed companies to rotate their auditors to prevent Satyam-type frauds – practice being followed in public sector companies.
Now, in next topic we will discuss about the present legal systems and provisions of other’s countries to deal with such frauds, an attempt is made to suggest the possible measures which can fill the gaps: –
For good corporate governance, Different countries have their own legal mechanism to act, but the fraud and corruption practices act 1977 of United States raised widespread anxiety and concern over world for such corporate frauds. The detailed structure of the act is given as: –
The FCPA is unique. Throughout history, governments have had laws making it illegal for governmental officials to take a bribe. One basic provision of the FCPA is that it prohibits U.S. partnerships, companies, and organizations from not only giving payments but also offering or authorizing payments to foreign officials or political parties with the objective of encouraging or assuring business relationships.
There are two types of bribery provisions. The first prohibits any bribes made directly by the U.S. Company. The second prohibits any organization from knowingly arranging for a bribe through an intermediary. Many thought that the FCPA would place U.S. companies at a disadvantage in the international marketplace since they could no longer influence foreign governments, officials, political parties, or candidates through gifts or payments. There has been no conclusive evidence that this has actually happened.
The FCPA includes record-keeping provisions for companies not involved in criminal conduct. These provisions were an amendment to the Securities and Exchange Act of 1934. The FCPA amendment requires all firms under SEC jurisdiction to maintain an adequate system of internal control whether or not they have foreign operations. This provision of the act applies to issuers of registered securities and issuers required to file periodic reports with the SEC.
Accounting Provisions : – The accounting provisions require companies to "keep books and records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets". The purpose of this accounting provision is to make it difficult for organizations to "cook the books" or use slush funds to hide any corrupt payments. Representative means for transfer of corrupt payments included: Overpayments, Missing records ("No receipt"), Unrecorded transactions, Misclassification of costs (bribes recorded as consulting fees or commissions), Re transcription of records, The accounting provisions include a requirement that companies design and maintain adequate systems of internal accounting controls that provide reasonable assurance that:
Transactions are executed in accordance with management’s authorization, Transactions are recorded as necessary, and Access to assets is permitted only in accordance with management’s authorization
Any internal document that misrepresents the actual nature of a financial transaction could be used as the basis for a charge that the "books and records" section of the FCPA has been violated.
Penalties: – The FCPA provides penalties for violations. Criminal penalties for bribery violations include fines of up to $2 million for firms; fines of up to $100,000 and imprisonment of up to five years for officers, directors, and stockholders; and fines of up to $100,000 for employees and agents (fines imposed on individuals cannot to be paid by companies). The SEC or attorney general may also bring actions that lead to civil penalties. Also, the act’s penalties do not supersede penalties or fines levied under the provisions of other statutes. A violation of the bribery provisions of the FCPA may give rise to a private cause of action for treble damages under RICO (Racketeer Influenced and Corrupt Organizations Act).
The penalties can have long-term ramifications for companies. For example, a company found guilty of violating the FCPA may be barred from doing any business with the federal government. A company indicted for an FCPA violation may not be eligible to obtain various export licenses.
In most corporations, accountants and auditors have responsibility to prevent, detect, and report errors and irregularities. The Corporate Sentencing Guidelines are legislation to deter white-collar crime. The guidelines’ major objective is requiring organizations to monitor business activities to detect criminal conduct within their own ranks. The guidelines allow organizations to use mitigating factors to reduce their exposure to fines. One mitigating factor is maintaining a corporate compliance program. The corporate compliance program is to be the responsibility of an officer or high-level employee.
Post Satyam Scam, the Brand “India Inc.” has suffered a great deal, but looking at above mentioned Acts being enforced in other countries, we hope that Indian Authorities have the good sense to come up with something like this to prevent “SATYAM….. NOW AND FOREVER”
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