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Project Report
On
Accounting Scams in India in Recent Time:
Lessons for Government of India
SUBMITTED BY
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EXECUTIVE SUMMARY
Corporate entities of all sizes, across the globe, are easily susceptible to frauds at any points of time.
From Enron, WorldCom and Satyam, it appears that corporate accounting fraud is a major problem
that is increasing, both in its frequency and severity. According to ACFE Global Fraud Study 2012,
The typical organization loses 5% of its revenues to fraud each year. Applied to the 2011 Gross
World Product, this figure translates to a potential projected annual fraud loss of more than $3.5
trillion. However, research evidence has shown that growing number of frauds have undermined the
integrity of financial reports, contributed to substantial economic losses, and eroded investors
confidence regarding the usefulness and reliability of financial statements. The increasing rate of
white-collar crimes demands stiff penalties, exemplary punishments, and effective enforcement of
law with the right spirit.
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1. INTRODUCTION
Fraud is a worldwide phenomenon that affects all continents and all sectors of the economy. Fraud
encompasses a wide-range of illicit practices and illegal acts involving intentional deception or
misrepresentation. According to the Association of Certified Fraud Examiners (ACFE, 2010), fraud is
a deception ormisrepresentation that an individual or entity makes knowing that misrepresentation
could result in some unauthorized benefit to the individual or to the entity or some other party. In
other words, mistakes are not fraud. Indeed, in fraud, groups of unscrupulous individuals manipulate,
or influence the activities of a target business with the intention of making money, or obtaining goods
through illegal or unfair means.
Fraud cheats the target organization of its legitimate income and results in a loss of goods, money,
and even goodwill and reputation. Fraud often employs illegal and immoral, or unfair means. It is
essential that organizations build processes, procedures and controls that do not needlessly put
employees in a position to commit fraud and that effectively detect fraudulent activity if it occurs.
Fraud is a deliberated action done by one or more persons from the societys leadership, employees or
third parts, action which involves the use of false pretence in order to obtain an illegal or unjust
advantage. The auditor will be concerned with the fraudulent actions leading to a
significant falsification of financial situations. The fraud involving persons from the leadership level
is known under the name managerial fraud and the one involving only entitys employees
is named fraud by employees association. The IFACs International Audit Standards-240 (2009)defines two types of fraud relevant for the auditor: (a) Falsifications that are caused by the
misrepresentation of the assets; and (b) Falsifications that are caused by the fraudulent financial
reporting, meaning the basic action that has provoked a falsification of the financial situations was
done intentionally or/and unintentionally. Financial statement fraud is also known as fraudulent
financial reporting, and is a type of fraud that causes a material misstatement in the financial
statements. It can include deliberate falsification of accounting records; omission of transactions,
balances or disclosures from the financial statements; or the misapplication of financial reporting
standards. This is often carried out with the intention of presenting the financial statements with a
particular bias, for example concealing liabilities in order to improve
any analysis of liquidity and gearing. The research highlighted the Satyam Computers Limiteds and
Ultra Mega Power Projects accounting scandal by portraying the sequence of events, the aftermath of
events, the key parties involved, and major follow-up actions undertaken in India; and what lesions
can be learned from Satyam scam and Ultra Mega Power Projects scam.
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1.1 MAGNITUDE OF FRAUD
Organizations of all types and sizes are subject to fraud. On a number of occasions over the past few
decades, major public companies have experienced financial reporting fraud, resulting in turmoil in
the U.S. capital markets, a loss of shareholder value, and, in some cases, the bankruptcy of the
company itself. Although it is generally accepted that the Sarbanes-Oxley Act has improved
corporate governance and decreased the incidence of fraud, recent studies and surveys indicate that
investors and management continue to have concerns about financial statement fraud. For example:
The Association of Certified Fraud Examiners (ACFE) 2010 Report to the Nations on
Occupational Fraud and Abuse found that financial statement fraud, while representingless than five
percent of the cases of fraud in its report, was by far the most costly, with a median loss of $1.7
million per incident. Survey participants estimated that the typical organization loses 5% of its
revenues to fraud each year. Applied to the 2011 Gross World Product, this figure translates to a
potential projected annual fraud loss of more than $3.5 trillion. The median loss caused by the
occupational fraud cases in our study was $140,000. More than one-fifth of these cases caused losses
of at least $1 million. The frauds reported to us lasted a median of 18 months before being detected.
Fraudulent Financial Reporting: 19982007, from the Committee of SponsoringOrganizations of
the Treadway Commission (the 2010 COSO Fraud Report), analyzed 347 frauds investigated by the
U.S. Securities and Exchange Commission (SEC) from 1998 to 2007 and found that the median
dollar amount of each instance of fraud had increased three times from the level in a similar 1999
study, from a median of $4.1 million in the 1999 study to $12 million. In addition, the median size of
the company involved in fraudulent financial reporting increased approximately six-fold, from $16
million to $93 million in total assets and from $13 million to $72 million in revenues.
A 2009 KPMG Survey of 204 executives of U.S. companies with annual revenues of $250 million
or more found that 65 percent of the respondents considered fraud to be a significant risk to their
organizations in the next year, and more than one-third of those identified financial reporting fraud as
one of the highest risks.
Fifty-six percent of the approximately 2,100 business professionals surveyed during a Deloitte
Forensic Center webcast about reducing fraud risk predicted that more financial statement fraud
would be uncovered in 2010 and 2011 as compared to the previous three years. Almost half of those
surveyed (46 percent) pointed to the recession as the reason for this increase.
According to Annual Fraud Indicator 2012 conducted by the National Fraud Authority (U.K.),
The scaleof fraud losses in 2012, against all victims in the UK, is in the region of 73 billion per
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terms fraudulent financial reporting and financial statement fraud are interchangeably throughout
this paper. Past research has shown that corporate environment most likely to lead to an accounting
scandal manifests significant growth and accounting practices that are already pushing the envelope
of earnings smoothing (Crutchley et al., 2007). The primary responsibility for the prevention and
detection of frauds and errors belongs to the leadership, as well as, to the management of the
corporation. The accent falls on preventing frauds, and it can determine individuals to not commit
fraud because of the possibility to be discovered and punished. The creation of a culture of the
organization and ethical behavior is necessary in any corporation/society and it must be
communicated and sustained by the persons in charge of leadership (surveillance, control,
management). The active surveillance of those in charge of the leadership means a continuity of the
internal control, the analysis of the financial situations safety, the efficiency and efficacy of
operations, of the conformity with the legislation and regulations in use.
1.2 COMMITS FRAUDS
As Reuber and Fischer (2010) states: Everyday, thereare revelations of organizations behaving in
discreditable ways. Observers of organizations may assume that firms will suffer a loss ofreputation
if they are caught engaging in actions that violate social, moral, or legal codes, such as flaunting
accounting regulations, supporting fraudulent practices, damaging the environment or deploying
discriminatory hiring practices. There are three groups of business people who commit
financial statement frauds. They range from senior management (CEO and CFO); mid- and lower-
level management and organizational criminals (Crumbley, 2003). CEOs and CFOs commit
accounting frauds to conceal true business performance, to preserve personal status and control and to
maintain personal income and wealth. Mid- and lower-level employees falsify financial statements
related to their area of responsibility (subsidiary, division or other unit) to conceal poor performance
and/or to earn performance-based bonuses. Organizational criminals falsify financial statements to
obtain loans or to inflate a stock they plan to sell in a pump-anddumpscheme. Methods of financialstatement schemes range from fictitious or fabricated revenues; altering the times at which revenues
are recognized; improper asset valuations and reporting; concealing liabilities and expenses; and
improper financial statement disclosures (Wells, 2005). Sometimes these actions result in damage to
an organizations reputation.
While many changes in financial audit processes have stemmed from financial fraud or
manipulations, history and related research repeatedly demonstrates that a financial audit simply
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The wave of financial scandals at the turn of the 21st century elevated the awareness of fraud and the
auditors responsibilities for detecting it. The frequency of financial statement fraud has not seemed
to decline since the passage of the Sarbanes-Oxley Act in July 2002 (Hogan et al., 2008). For
example, The 4th Biennial Global Economic Crime Survey (2007) of more than 3,000 corporate
officers in 34 countries conducted by PricewaterhouseCoopers (PwC) reveals that in the post-
Sarbanes-Oxley era, more financial statement frauds have been discovered and reported, as evidenced
by a 140% increase in the discovered number of financial misrepresentations (from 10% of
companies reporting financial misrepresentation in the 2003 survey to 24% in the 2005 survey). The
increase in fraud discoveries may be due to an increase in the amount of fraud being committed
and/or also due to more stringent controls and risk management systems being implemented,
(PricewaterhouseCoopers 2005). The high incidence of fraud is a serious concern
for investors as fraudulent financial reports can have a substantial negative impact on a companys
existence as well as market value. For instance, the lost market capitalization of 30 high-profile
financial scandals caused by fraud from 1997 to 2004 is more than $900 billion, which represents a
loss of 77% of market value for these firms, while recognizing that the initial
market values were likely inflated as a result of the financial statement fraud.
No doubt, recent corporate accounting scandals and the resultant outcry for transparency and honesty
in reporting have given rise to two disparate yet logical outcomes. First, forensic accounting skills
have become crucial in untangling the complicated accounting maneuvers that have obfuscated
financial statements. Second, public demand for change and subsequent regulatory action has
transformed corporate governance (henceforth, CG) scenario. Therefore,more and more company
officers and directors are under ethical and legal scrutiny. In fact, both these trends have the
common goal of addressing the investors concerns about the transparentfinancial reporting system.
The failure of the corporate communication structure has made the financial community realize that
there is a great need for skilled professionals that can identify, expose, and prevent structural
weaknesses in three key areas: poor CG, flawed internal controls, and fraudulent financial statements.
Forensic accounting skills are becoming increasingly relied upon within a corporate reporting
system that emphasizes its accountability and responsibility to stakeholders (Bhasin, 2008).
Following the legislative and regulatory reforms of corporate America, resulting from the Sarbanes-
Oxley Act of 2002, reforms were also initiated worldwide.
Largely in response to the Enron and WorldCom scandals, Congress passed the Sarbanes-Oxley Act
(SOX) in July 2002. SOX, in part, sought to provide whistle-blowers greater legal protection. As
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Bowen et al. (2010) states, Notable anecdotal evidence suggests that whistle-blowers can make a
difference. For example, two whistle-blowers, Cynthia Cooper and Sherron Watkins, played
significant roles in exposing accounting frauds at WorldCom and Enron, respectively, and were
named as the 2002 persons of the year by Time magazine.
Given the current state of the economy and recent corporate scandals, fraud is still a top concern for
corporate executives. In fact, the sweeping regulations of Sarbanes-Oxley, designed to help prevent
and detect corporate fraud, have exposed fraudulent practices that previously may have gone
undetected. Additionally, more corporate executives are paying fines and serving prison time than
ever before. No industry is immune to fraudulent situations and the negative publicity that swirls
around them. The implications for management are clear: every organization is vulnerable to fraud,
and managers must know how to detect it, or at least, when to suspect it.
1.4 GLOBAL CASES OF CORPORATE FRAUDS AND ACCOUNTING FAILURES
Financial scandals have plagued our society since before the Industrial Revolution. During the last
few decades, there have been numerous financial frauds and scandals, which were milestones with
historical significance. For instance, in the 1970s, the equity funding scandal was uncovered.
In this context, Pearson et al., (2008) remarked, Equity funding scandal is significant because it is
one of the first major financial scandals, where computers were used to assist in perpetrating a fraud.
The CEO and other conspirators kept track of the phony insurance policies by assigning special
codes to them. The public has witnessed a number of well-known examples of accounting scandals
and bankruptcy involving large and prestigious companies in developedcountries. The media has
reported scandals and bankruptcies in companies, such as, Sunbeam, Kmart, Enron, Global Crossing
(USA), BCCI, Maxwell, Polly Peck (UK) and HIH Insurance (Australia). Besides scandals in
developed countries, which have sophisticated capital markets and regulations, similar cases can be
also seen in developing countries with emerging capital markets. Asian countries have also
experienced similar cases, such as, PT Bank Bali and Sinar Mas Group (Indonesia), Bangkok Bank of
Commerce (Thailand), United Engineers Bhd (Malaysia), Samsung Electronics and Hyundai (Korea).
The corporate collapses of recent times, culminating with massive collapses, such as, those of Enron
in the U.S., HIH in Australia, and Satyam in India, have suggested that there are major systemic
problems facing the way in which corporations and CG operate.
The recent high-profile accounting scandals involving major companies worldwide, such as, Enron,
WorldCom, Parmalat and most recently, Indias Satyam along with recent outcries overthe excessive
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remuneration paid to some CEOs have raised questions about the relationship between ethical
leadership, financial incentives and financial misreporting (Chen, 2010). During
the recent series of corporate fraudulent financial reporting incidents in the U.S., similar corporate
scandals were disclosed in several other countries. Almost all cases of foreign corporate accounting
frauds were committed by entities that conducted their businesses in more than one country, and most
of these entities are also listed on U.S. stock exchanges. The list of corporate financial accounting
scandals in the U.S. is extensive, and each one was the result of one or more creative-accounting
irregularities. Table 2 identifies a sample of U.S. companies that committed such fraud and the nature
of their fraudulent financial reporting activities (Badawi, 2003). Overseas, nine major international
companies, based in eight different countries have also committed financial accounting frauds. Table
3 identifies these nine international companies and the nature of the accounting irregularities they
committed (Taub 2004).
Table 2: A Sample of Cases of Corporate Accounting Frauds in the USA
(Source: Badawi, I. (2003) Global Corporate Accounting Frauds and Action for Reforms, Review
of Business, page 9)
Other frauds of significant interest include ZZZZ Best (1986), Phar-Mor (1992), Cendant (1998),
Waste Management (1998), Sunbeam (2002), Parmalat (2003), along with a host of others. According
to Accounting Scandals, the long list reached a critical mass in 2002 in the U.S. Perhaps no
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financial frauds had a greater impact on accounting and auditing than Enron and WorldCom. In the
case of WorldCom, for example, it can be seen that in 2002 WorldCom filed the largest bankruptcy in
accounting history, revealing that management fraudulently misstated earnings. Arthur Andersen,
WorldComs auditor, failed to notice US$3.85 billion shifting offunds to cover up revenue shortages.
The Enron case also showed a similar pattern of earnings management. Enron had aggressive
earnings targets and entered into numerous complex transactions to achieve those targets. Arthur
Andersen, a well-known accounting firm, let the line between consulting and auditing blur. The
collapse of large companies worldwide (HIH insurance, Enron, WorldCom) have sparked lively
interest in the amount of consultancy fees that external auditors receive in addition to audit fees. In
the Australia environment, HIH insurance paid Andersen A$1.7 million for audit services and A$1.6
million for consultancy services for the 19992000 financial year. As a consequence, it has been
argued that the role of external auditors has been subject to the influence of the board of directors of
the company. As Jennings (2003) concluded, The Enron collapse showed a similar relationship
between Andersen and Enron. In fact, while the Enron/Andersen relationship was extreme, its
individual components provide indications of how a relationship can become so muddled that auditor
independence is sacrificed. The above evidence shows that auditors were not independent and this
can lead to low-quality financial reporting.
In general, it can be claimed that the above accounting scandals occurred because of integrated
factors, such as, lack of auditor independence, weak law enforcement, dishonest management, weak
internal control, and inability of CG mechanism in monitoring management behaviors. Unfortunately,
it is also true that most frauds are perpetrated by people in positions of trust in the accounting,
finance, and IT functions (Carpenter et al., 2011). Consequently, there should be alternative tools to
detect the possibility of financial frauds. Forensic accounting can be seen as one of such tools. As
Pearson et al., (2008) states, An understanding of effective fraud and forensic accounting techniques
can assist forensic accountants in identifying illegal activity and discovering and preserving
evidence. Hence, it is important to understand that the role of a forensic accountant is different from
that of regular auditor. It is widely known that an auditor determines compliance with auditing
standards and considers the possibility of fraud. Some regulators have apparently noticed the need for
forensic accounting. For example, the Sarbanes-
Oxley Act (SOX), the Statement on Auditing Standards-99 (SAS 99), and the Public Company
Accounting Oversight Board (PCAOB) have not removed the pressures on CFOs to manipulate
accounting statements (Gornik et al, 2005). The PCAOB recommends that an auditor should perform
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at least one walkthrough for each major class of transactions. However, SAS 99 does not require the
use of forensic specialists but does recommend brainstorming, increased professional skepticism, and
unpredictable audit tests. Thus, a proactive fraud approach involves a review of internal controls
and the identification of the areas most subject to fraud.
Table 3: A Sample of Cases of Corporate Accounting Frauds Overseas
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(Source: Badawi, I. (2003) Global Corporate Accounting Frauds and Action for Reforms, Review
of Business, pp. 12-13.)
The corporate scandals of the last few years came as a shock not just because of the enormity of
failures, but also because of the discovery that questionable accounting practice was far more
insidious and widespread than previously envisioned. A definite link between these accounting
failures and poor CG, thus, is beginning to emerge. For instance, Badawi (2003) very aptly observes:
Adelphia, for example, was given a very low 24% rating by Institutional ShareholderServices on its
CG score. In Europe, Parmalat and Royal Ahold were ranked in the bottom quartile of companies in
the index provided by Governance Metrics International. Similarly, theCorporate Library had issued
early failure warnings in respect of both WorldCom and Enron. An increasing number of researchers
now are finding that poor CG is a leading factor in poor performance, manipulated financial reports,
and unhappy stakeholders. Corporations and
regulatory bodies are currently trying to analyze and correct any existing defects in their reporting
system. In addition, discussion on the relevance of forensic accounting in detecting accounting
scandals has emerged in recent year.
The fraud cases described above implies that these corporations have failed to supply accurate
information to their investors, and to provide appropriate disclosures of any transactions that would
impact their financial position and operating results. To quote Razaee (2005), The recentaccounting
scandals have induced a crisis of confidence in financial reporting practice and effectiveness of CG
mechanisms. Accordingly, a number of efforts have been conducted to prevent the possibility of
similar scandals in the forthcoming future.
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2. REVIEW OF LITERATURE
Starting in the late 1990s, a wave of corporate frauds in the United States occurred with Enrons
failure perhaps being the emblematic example. Jeffords (1992) examined 910 cases of frauds
submitted to the Internal Auditor during the nine-year period from 1981 to 1989 to assess the
specific risk factors cited in the Treadway Commission Report. He concluded that approximately 63
percent of the 910 fraud cases are classified under the internal control risks.
Calderon and Green (1994) made an analysis of 114 actual cases of corporate fraud published in
the Internal Auditor during 1986 to 1990. They found that limited separation of duties, false
documentation, and inadequate (or non-existent) control accounted for 60% of the fraud cases.
Moreover, the study found that professional and managerial employees were involved in 45% of
the cases. In addition, Smith (1995) offered a typology of individuals who embezzle. Heindicated
that embezzlers are opportunists type, who quickly detects the lack of weakness in
internal control and seizes the opportunity to use the deficiency to his benefit. To deter
embezzlement, he recommended: (a) institute strong internal control policies, which reduce the
opportunity of crime, and (b) conduct an aggressive and thorough background check prior to
employment.
Bologna and Lindquist (1996) in their study cited the environmental factors that enhance the
probability of embezzlement of funds. However, Ziegenfuss (1996) performed a study to determine
the amount and type of fraud occurring in state and local governments. His studyrevealed that themost frequently occurring types of fraud are misappropriation of assets, theft, false representation;
and false invoice. On the other hand, Haugen and Selin (1999) in their study
discussed the value of internal controls, which depends largely on managements integrity.
Adding to the situation of poor internal controls, the readily available computer technology also
assisted in the crime, and the opportunity to commit fraud becomes a reality.
Sharma and Brahma (2000) have emphasized on bankers responsibility on frauds; bank fraudscould
crop-up in all spheres of banks dealing. Major cause for perpetration offraud is laxity in observance
in laid-down system and procedures by supervising staff. Harris and William (2004),
however, examined the reasons for loan frauds in banks and emphasized on due diligenceprogram.
They indicated that lack of an effective internal audit staff at the company, frequent turnover of
management or directors, appointment of unqualified persons in key audit or finance
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posts, customers reluctance to provide requested information or financial statements andfictitious or
conflicting data provided by the customers are the main reasons for loan frauds. Beirstaker, Brody,
Pacini (2005) in their study proposed numerous fraud protection and detection
techniques. Rezaee (2005), however, finds five interactive factors that explain several highprofile
financial statement frauds. These factors are: cooks, recipes, incentives, monitoring and end results
(CRIME). Moreover, Willison (2006) examined the causes that led to the breakdown of Barring
Bank. The collapse resulted due to the failures in management, financial and operational controls of
Baring Banks.
Choo and Tan (2007) explained corporate fraud by relating the fraud-triangle to the brokentrust
theory and to an American Dream theory, which originates from the sociologicalliterature, while
Schrand and Zechman (2007) relate executive over-confidence to the commitment of fraud. In fact,
research results by Crutchley et al., (2007) have shown that corporate environment most likely to
lead to an accounting scandal manifests significant growth
and accounting practices that are already pushing the envelope of earnings smoothing. Firms
operating in this environment seem more likely to tip over the edge into fraud if there are fewer
outsiders on the audit committee and outside directors appear overcommitted. Moreover, Bhasin
(2008) examined the reasons for check frauds, the magnitude of frauds in Indian banks, and the
manner, in which the expertise of internal auditors can be integrated, in order to detect and prevent
frauds in banks. In addition to considering the common types of fraud signals, auditors can take
several proactive steps to combat frauds.
Chen (2010) in his study examined the proposition that a major cause of the leading financial
accounting scandals that received much publicity around the world was unethical leadership in
the companies and compares the role of unethical leaders in a variety of scenarios. Through the use of
computer simulation models, it shows how a combination of CEOs narcissism, financial incentive,
shareholders expectations and subordinate silence as well as CEOs dishonesty can do
much to explain some of the findings highlighted in recent high-profile financial accounting
scandals. According to a research study performed by Cecchini et al., (2010), the authors provided a
methodology for detecting management fraud using basic financial data based on support vector
machines. A large empirical data set was collected, which included quantitative
financial attributes for fraudulent and non-fraudulent public companies. They concluded that
Support vector machines using the financial kernel correctly labeled 80% of the fraudulent cases and
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90.6% of the non-fraudulent cases on a holdout set. The results also show that the methodology has
predictive value because, using only historical data, it was able to distinguish
fraudulent from non-fraudulent companies in subsequent years.
An examination of prior literature reveals that the likelihood of committing fraud has typically been
investigated using financial and/or governance variables. The moral, ethical, psychological
and sociological aspects of fraud have also been covered by the literature. Moreover, some studies
also suggested that psychological and moral components are important for gaining an understanding
of what causes unethical behavior to occur that could eventually lead to fraud. A large majority of
these studies were performed in developed, Western countries. However, the managers behavior in
fraud commitment has been relatively unexplored so far. Accordingly, the
overarching objective of this paper is to examine managers unethical behaviors in documented
corporate fraud cases on the basis of press articles, which constitute an ex-post evaluation of alleged
or acknowledged fraud cases. Unfortunately, no study has been conducted to examine behavioral
aspects of managers in the perpetuation of corporate frauds in the context of adeveloping economy,
like India. Hence, the present study seeks to fill this gap and contributes to
the literature.
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3. ACCOUNTING SCANDALS
Accounting scandals are political and business scandals which arise with the disclosure of misdeeds
by trusted executives of large public corporations. Such misdeeds typically involve complex methods
for misusing funds, overstating revenues, understating expenses, overstating the value of corporateassets or underreporting the existence of liabilities, sometimes with the cooperation of officials in
other corporations or affiliates.
In public companies, this type of creative accounting can amount to fraud and investigations are
typically launched by government oversight agencies, such as the SEBI (Securities and Exchange
Board of India), RBI (Reserve Bank of India) in India.
Scandals are often only the tip of the iceberg. They represent the visible catastrophic failures. Note
that much abuse can be completely legal or quasi legal.
All accounting scandals are not caused by top executives. Often managers and employees are
pressured or willingly alter financial statements for the personal benefit of the individuals over the
company. Managerial opportunism plays a large role in these scandals. For example: Managers who
would be compensated more for short term results would report inaccurate information since short
term benefits outweigh the long-term ones such as pension, annuity, etc.
Creative accounting means accounting practices that may follow the letter of the rules of standard
accounting practices, but certainly deviate from the spirit of those rules. They are characterised by
excessive complication and the use of novel ways of characterising income, assets or liabilities and
the intent to influence readers towards the interpretations desired by the authors.
Creative accounting is at the root of a number of accounting scandals, and many proposals
for accounting reformusually centering on an updated analysis of capital and factors of
production that would correctly reflect how value is added.
3.1 Worldcom
WorldCom was one of the big success stories of the 1990s. It was a
symbol of aggressive capitalism. Founded by Bernie Ebbers, one
of the most aggressive acquirers during the US mergers and
acquisitions boom of the 1990s, WorldComs asset value had
soared to $180bn before the US capital market started witnessing a
downtrend.
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WorldCom admitted in March 2002 that it will have to restate its financial results to account for
billions of dollars in improper bookkeeping. An internal audit showed that transfers of about $3.06
billion for 2001 and $797 million for the first quarter of 2002 were not made in accordance with
generally accepted accounting principles.
In August 2002, an internal audit revealed an additional $3.3bn (2.2bn) of improper reported
earningstaking the total to more than $7bn, double the level previously reported. Over $3.3bn
money was from the companys reserves, which was misrepresented as operating income.
As a result of the discovery, WorldCom said that its financial statements for 2000 will have to be
reissued. The company said it may now write off $50.6bn in intangible assets. Former chief financial
officer Scott Sullivan and ex-controller David Myers were arrested, and face seven counts of
securities fraud and filing false statements with the SEC (US Securities and Exchange Commission).
The company filed for Chapter 11 bankruptcy protection on 22 July 2002, a process that protects it
from its creditors while it tries to restructure. It became the largest bankruptcy in US history, listing
$107bn in total assets and $41bn in debts.
In May 2003, WorldCom agreed to pay a record amount to the US financial watchdog. MCI
(formerly WorldCom), while neither admitting nor denying any wrongdoing, came to a settlement
over its massive accountancy scandal. It will pay $500m to SEC, the highest fine ever imposed by
the regulator. The original figure of $1.5bn was scaled down as MCI declared itself bankrupt and so
received favourable treatment.
The settlement sorts out the civil lawsuits that have been filed. But the criminal cases relating
primarily to the actions of former employees at the company are still pending.
Summary
Scandal discovered: March 2002
Charges: Overstated cash flow by booking $3.8 billion in operating expenses as capital expenses.
Company founder Bernard Ebbers received $400 million in off-the-books loans. The company found
another $3.3 billion in improperly booked funds, taking the total misstatement to $7.2 billion, and it
may have to take a goodwill charge of $50 billion.
Outcome: Former CFO Scott Sullivan and ex-controller David Myers have been arrested and
criminally charged, while rumours of Bernie Ebbers impending indictment persist. On 9 March
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2005, four foreign banks agreed to pay $428.4 mn for settling the class action law suit by investors
accusing them of hiding risks at WorldCom before its collapse.
3.2 Enron
In just 15 years, Enron grew from to be Americas seventh largest
company, employing 21,000 staff in more than 40 countries. It
started out as a pipeline company, and transformed into an energy
trader, buying and selling power. Among other businesses, Enron
was engaged in the purchase & sale of natural gas, construction &
ownership of pipelines and power facilities, provision of
telecommunications services, and trading in contracts to buy &
sell various commodities. It expanded into many diverse
industries for which it had no unifying strategies and no expertise.
Fortune magazine named it the most innovative company in America six years in a row, not spotting
that much of the innovation was sleight-of-hand accounting that amounted to fraud. Enron lied about
its profits and used off-the-books partnerships to conceal $1 billion in debt and to inflate profits.
Some tactics used by Enron
Earnings manipulation: From at least 1998 through late 2001, Enrons executives and senior
managers engaged in wide-ranging schemes to deceive the investing public about the true nature and
profitability of Enrons businesses by manipulating Enrons publicly reported financial results and
making false and misleading public representations.
The schemes objectives were:
To produce that reported earnings steadily grew by 15%-20% p.a.
To meet or exceed, without fail, the expectations of investment analysts about Enrons EPS.
To persuade the investing public that Enrons future profitability would continue to grow.
To achieve these objectives, quarterly earnings targets were imposedon each of the companys
business units based on EPS goals and not true forecasts. When the budget targets could not be met,
through results from business operations, they were achieved through the use of fraudulent devices.
The primary purpose was to increase the share price which increased from US$30 per share in 1998
to US$80 in 2001even after a stock split.
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The rising stock prices enriched Enrons senior managers in the form of salary, bonuses, grants of
artificially appreciating stock options, restricted stock, and phantom stock, and prestige within their
professions and communities.
Other methods used were:
Manipulating reserve accounts to maintain the appearance of continual earnings growth and to mask
volatility in earnings by concealing earnings during highly profitable periods and releasing them for
use during less profitable periods
Concealing losses in individual business segments through fraudulent manipulation of "segment
reporting," and deceptive use of reserved earnings to cover losses in one segment with earnings in
another;
Manufacturing earnings through fraudulent inflation of asset values and avoiding losses through the
use of fraudulent devices designed to "hedge," or lock-in, inflated asset values
Structuring of financial transactions using improper accounting techniques in order to achieve
earnings objectives During 2000, Enrons wholesale energy trading business, primarily its Enron
North America business, generated larger profits mostly due to rapidly rising energy prices in the
western United States, especially in California. This growth was more than the smooth, predictable
annual earnings growth of 15% to 20%. Beginning in the first quarter of 2000 and continuing
throughout 2000 and 2001, Enron improperly reserved hundreds of millions of dollars of earnings,
and used large amounts of those reserves to cover-up losses in ENA's "merchant" asset portfolio and
from other business units such as EES. This misuse of reserves was discussed and approved among
Enron's and ENA's senior commercial and accounting managers.
Concealment of uncollectible receivables owed to Enron Energy Services by California utilities
Enron also used reserves to conceal huge receivables (valued in the hundreds of millions of dollars),
accumulated during the California energy crisis, that California public utilities owed to Enron and
that Enron believed it would not collect. The California utilities were refusing to pay these monies,
and they likely were headed for bankruptcy. Enron concluded that it should book a large reserve for
these uncollectible receivables.
Concealment of EES failures by manipulating reporting
In the first quarter of 2001, new EES managers discovered and quantified hundreds of millions of
dollars in inflated valuations of EES contracts that would have to be recorded as losses. This would
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wipe out EES's modest reported profits and reveal it was a badly mismanaged business that was
losing large amounts of money.
Enron's senior management decided to conceal these EES losses from investors by offsetting them
with Enron Wholesale trading profits earned in that quarter, as well as profits improperly reserved in
prior periods. This was accomplished through a "reorganization" of Enron's business segments that
was made effective for the first quarter of 2001, enabling Enron to avoid reporting the losses in the
EES segment. This was explained deceptively to Enron's auditors and investors as meant to improve
"efficiency. This maneuver helped to conceal the hundreds of millions of dollars in reserves booked
within ENA for the uncollectible California receivables owed to EES.
Fraudulent valuation of "merchant" assets
Enron's ENA business unit managed a large "merchant" asset portfolio, which consisted primarily of
ownership stakes in a group of energy and related companies that Enron recorded on its quarterly
financial statements at what it alleged to be "fair value." Senior Enron and ENA commercial and
accounting managers fraudulently generated earnings needed to meet budget targets by artificially
increasing the book value of certain of these assets, many of which were volatile or poorly
performing. Likewise, to avoid recording losses on these assets, Enron's management fraudulently
locked-in these assets' value in improper "hedging" structures.
ENA's largest merchant asset was an oil and gas exploration company known as Mariner Energy
(Mariner), which Enron was required to book at "fair value" every quarter. During the fourth quarter
of 2000, there was a shortfall of approximately $200 million in Enron's quarterly earnings objectives.
Senior Enron and ENA managers decided to increase artificially the value of the Mariner asset by
approximately $100 million in order to close half of this gap.
In the third quarter of 2000, other ENA "merchant" assets were similarly manipulated in value before
being inserted into an elaborate hedging mechanism known as the "Raptors." Enron and ENA
managers instructed ENA managers that Enron had constructed a device that would allow ENA to
lock in approximately $400 million in book value of its assets, thereby protecting them from later
write-downs,
Other manipulative devices used in Enron wholesale
Enron employed other devices fraudulently to manipulate the financial results of Enron Wholesale
and its predecessor ECT. For example, ECT entered into a large contract in 1997 to supply energy to
the Tennessee Valley Authority (TVA) that resulted in an immediate "mark-to-market" earnings gain
to Enron of approximately $50 million dollars. But in mid-1998, when energy prices in the region in
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which the TVA was located sharply increased, Enron's unhedged position in the TVA contract fell
to a loss in the hundreds of millions of dollars , which would have eliminated ECT's earnings at the
end of the then-current reporting period. To avoid this Enrons managers removed the TVA contract
from Enron's "mark-to-market" accounting books by instead applying accrual accounting to the
contract. Enron then did not disclose the loss.
Senior Enron and ECT managers devised a plan to avoid later disclosure of most of the loss from
TVA by investing hundreds of millions of dollarsin the purchase of power-plant turbines and the
construction of "peaker" power plants that Enron otherwise would not have purchased. This
mechanism ultimately resulted, in a later reporting period, in a recorded loss to Enron from the TVA
contract that was hundreds of millions of dollars less than the actual loss incurred in 1998. Enron did
not reveal this.
During 1999, Enron attempted unsuccessfully to shed itself of this costly investment in turbines and
"peaker" plants. Unable to sell the assets at a profit to satisfy budget targets, Enron devised and
executed a scheme to manufacture current earnings by agreeing to entering into back-to-back trades
with Merrill Lynch & Co., Inc. which to sell and then repurchase energy generated by Enron's
"peaker" plants. These trades with Merrill Lynch, which virtually mirrored each other, ensured that
ENA satisfied budget targets for the fourth quarter of 1999.
Apart from this many of Enrons senior managers were charged with insider tradingand indicted.
Enron was also accused of creating phantom shortagesin Californias unregulated electricity market
to fleece ratepayers of an estimated $30 billion during the 2001 energy crisis.
Outcome:
Enron filed for Chapter 11 bankruptcy, allowing it to reorganise while protected from
creditors.
Enron has sought to salvage its business by spinning off various assets.
Enron's core business, the energy trading arm, has been tied up in a complex deal with UBS
Warburg. The bank has not paid for the trading unit, but will share some of the profits with
Enron.
Centrica, part of the former British Gas, has bought Enron's European retail arm for 96.4m.
Dynegy, a smaller rival, has won a key pipeline in the US after merger talks fell through. The
pipeline was then resold to Warren Buffet.
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Summary
When scandal was discovered: October 2001
Charges: Boosted profits and hid debts totaling over $1 billion by improperly using off-the-books
partnerships; manipulated the Texas power market; bribed foreign governments to win contracts
abroad; manipulated California energy market
Latest developments:Ex-Enron executive Michael Kopper pled guilty to two felony charges; acting
CEO Stephen Cooper said Enron may face $100 billion in claims and liabilities; company filed
Chapter 11; its auditor Andersen was convicted of obstruction of justice for destroying Enron
documents.
ARTHUR ANDERSEN
Energy giant Enron went from being America's seventh biggest company to being biggest bankruptcy
in US corporate history. Enron's success had been based on artificially inflated profits and on
accounting practices that had kept hundreds of millions of dollars in debt off its books.
Andersens role
Arthur Andersen's job was to check Enron's accounts and to make sure they were an accurate
reflection of the state of the business. The auditor would have been expected to spot large scale fraud
or deception. The company also carried out consultancy work for Enron, leading to accusations of a
conflict of interest.
When the energy giant's business began to unravel, staff at Arthur Andersen destroyed thousands of
Enron-related documents and e-mails. This happened both before and after US stock market
regulators had asked for more information about the energy giant's accounts.
Charges:
Arthur Anderson was in trouble with the SEC in June 2001 over action related to its audit work for
Waste Management Corporation, paying a record $7 million fine. Again in July the SEC filed an
amended complaint against five officers of Sunbeam Corporation and the lead Andersen partner who
worked on the Sunbeam audit, contending that Sunbeam's financial statements were materially false
or misleading. Thus Anderson was familiar with SEC enforcement proceedings and anxious to avoid
any further sanction or censure.
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Andersen audited the publicly-filed financial statements of Enron, a sophisticated trading and
investment conglomerate with a global energy trading business. Enron employed accounting practices
that were highly aggressive, stretching Generally Accepted Accounting Principles (GAAP) to their
outermost limits. Although the firm knew of Enron's accounting practices, Andersen bent over
backward to accommodate Enron, its largest domestic client, whom the firm billed approximately $58
million in 2000.
Andersons management uncovered serious accounting problems in Enron in late 2001 that caused it
to anticipate imminent SEC action and civil litigation. First, in September 2001, Andersen personnel
discovered that its Enron engagement team had approved the use of an improper accounting
technique for four Raptors, a group of special purpose entities (SPEs) that Enron used to engage in
"off balance sheet" activities. To conceal the losses due to Raptors had experienced sharp losses, they
allowed Enron to aggregate the four entities even though petitioner's own accounting experts
deemed that it as a violation of GAAP. Second, it was also found that Enron and petitioner had made
a separate $1.2 billion accounting errorin Enron's favor which would require that Enron reduce its
outstanding shareholder equity by $1.2 billion in its quarterly SEC filing,
After Jeffrey Skilling, Enron's CEO, resigned unexpectedly it caused widespread speculation about
financial problems at Enron and after a Wall Street Journal article suggested improprieties at Enron,
the SEC opened an informal investigation of the company. The firm began to prepare for legal action
(including SEC document requests) relating to Enron. By September 28, 2001, in-house attorney
Nancy Temple held near-daily meetings or conference calls with an Enron crisis-response group
composed of high-level Andersen partners. It was understood by the firm that investigation was
"highly probable and there was a "reasonable possibility [that this] will force a restatement";
It was then decided to use the firm's widely ignored document policyto purge harmful material from
its files. In broad outline, petitioner's document policy required that only information necessary to
support the firm's final audit opinion be maintained in the audit "workpapers." All other information
(including draft documents and handwritten notes) was to be permanently destroyed upon conclusion
of an audit.
Andersen personnel (including many members of the Enron engagement team) were urged to comply
with the document policy. It was explained that "if it's destroyed in the course of the normal policy
and litigation is filed the next day, that's great... we've followed our own policy, and whatever there
was that might have been of interest to somebody is gone and irretrievable." When this was not
complied with, Temple requested them to comply with the policy even though it actually provided
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that "in cases of threatened litigation, no related information will be destroyed" and identified
"regulatory agency investigations (e.g., by the SEC)" as situations where "material in our files cannot
be altered or deleted."
After Ken Lay, Enron's CEO, mentioned that Enron was reducing "shareholder equity" by
approximately $1.2 billion, the SEC notified Enron by letter of its existing investigation and
requested various accounting information and documents. Temple again ordered compliance with the
firm's document policy which led the Professional Standards Group accountants to delete
hundreds of Enron-related e-mails.Duncan and the other Enron engagement partners also decided
that compliance with the previously ignored document policy was imperative inspite of knowing that
the SEC had already requested documents from Enron, and he acted out of concern that "extraneous
material" in petitioner's files could be used against it in civil lawsuits and the SEC investigation.
The firm's Enron auditors were instructed to make compliance with the document policy a priority
despite the mounting time pressure they faced in dealing with Enron's accounting problems. As a
result, the Enron engagement team made an unprecedented effort to destroy non-workpaper
documents. Documents were shredded on-site and also were shipped to petitioner's main office for
bulk shredding. There was an extraordinary spike in physical document destructionthat coincided
with petitioner's discovery of the SEC inquiry. In addition to the destruction of hard copies of
documents, tens of thousands of e-mails and other electronic documents were deleted,
representing at least a three-fold increase over usual activity.
The shredding continued notwithstanding the following:
Firm's discovery of two additional major accounting problems-one involving suspected
fraud by Enron relating to an entity named "Chewco" and the other a large accounting error by
Anderson itself;
Decision by Enron's Board of Directors to form a special committee to investigate Enron's
accounting;
Efforts of Andersen partners to help Enron's Board formulate strategy for dealing with the
SEC and restating its finances;
Filing of numerous shareholder lawsuits;
And petitioner's receipt of a subpoena for Enron documents from a private plaintiff.
Only after the SEC served a subpoena for its Enron documents, and Enron announced its
intent to file a restatement did Duncan's assistant send an e-mail to "Stop the Shredding".
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Trial: Andersen went on trial in Houston, Texas, after allegations that employees had illegally
destroyed thousands of documents and computer records relating to its scandal-hit client. The firm's
lawyers had argued that the shredding of documents had been routine housekeeping, but the jury
decided it was an attempt to thwart federal regulators investigating Enron.
The prosecution's star witness was former Andersen partner David Duncan, who was in charge of the
Enron audit team. He admitted obstructing justice in April and told jurors that he had signed an
agreement with Andersen to present a united front, claiming that neither had done anything wrong.
He had reneged on the agreement after much "soul searching". The trial heard how one Andersen
executive said on a training video that if documents were shredded and then the investigators arrived,
that would be good.The accountancy firm was found guilty of obstructing justice by shredding
documents relating to the failed energy giant Enron. The firm was sentenced to five years of
probation, fined $500,000, and ordered to pay a special assessment of $400.
Andersen lost much of its business, and two-thirds of its once 28,000 strong US workforce.
Following the conviction, multi-million dollar lawsuits brought by Enron investors and shareholders
demanding compensation are likely to follow, and could bankrupt the firm.
Summary
Scandal discovered:November 2001
Charges: Shredding documents related to audit client Enron after the SEC launched an inquiry into
Enron.
Latest Developments:Andersen was convicted of obstruction of justice in June 2002 and to cease
auditing public firms by Aug. 31. Most of the international arms of Andersen Worldwide have split
from the US side of the business and were taken up by rivals.
3.3 XEROX
In 2002, Xerox Corp announced that it will
restate its revenues by as much as $2 billion
over a five year period from 1997 to 2001
because of an accounting error.
An audit showed that Xerox improperly posted
revenues before they were actually made. The
company described the accounting problems uncovered by an audit as a "timing and allocation issue,"
saying the revenues that were posted early would be shown to have actually been collected later. An
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audit found that Xerox improperly booked far more revenue over a five- year period than the
Securities and Exchange Commission estimated in an April settlement with the company over its
accounting procedures. The SEC had estimated in April the overstatement was $3 billion for the four
years from 1997 through 2000.
The mispostings of revenue could total up to $6 billion. The company disputed that and said the
restatement for that period will be "no more than $2 billion" which is about 2% of revenue for that
period. Subsequently, the company announced that the extent of overstatement of revenues for a five-
year period was even greater, at more than $6.4 billion. Once again the auditors at Xerox, as usual
one of the international "Big Five", had apparently not noticed the discrepancies for all these years.
Summary
Scandal discovered: June 2000
Charges: Falsifying financial results for five years, boosting income by $6.4 billion
Outcome: Xerox agreed to pay a $10 million and to restate its financials dating back to 1997.
PARMALAT
Investors become concerned about the group's accounts in March 2003 when the company failed to
place bonds worth up to EUR500m with investors.
In December 2003 the company missed a bond payment it was disclosed that Bonlat, a Parmalat
subsidiary in the Cayman Islands, did not have accounts worth almost EUR4bn at Bank of America.
A scanning machine had been used to forge BoA documents, which were then sent to auditors who
certified the accounts. Cayman seems to provide a key link in the network of missing funds. Italian
investigators reportedly believe EUR250m, raised in a EUR500m bond issue in Brazil in 2001, ended
up in Malta via a Cayman Islands unit of Spain's Santander Central Hispano.
The total sum of bogus operations uncovered at the firm as of 30 June 2003 amount to $10bn,
including $1.4bn in obligations by other companies in which Parmalat invested. An Italian newspaper
claims that Parmalat had not bought their obligations at all, but had merely copied their names from
the internet.
The Italian government, which had initially promised to bail out Parmalat, but later put some distance
between itself and the fallout by enacting emergency bankruptcy legislation. The decree allows a
company with at least 1,000 employees and debts of more than EUR1bn to apply for immediate but
temporary protection from creditors. This allows the bankrupt firm to continue trading without
government aid.
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Auditors
Deloitte, acted as Parmalat's group auditor from 1999, while Grant Thornton, which had been the
group auditor, carried on as auditor at many of the company's subsidiaries. The sub-Big Four
accounting firm, which audited up to 49% of Parmalat's assets, disassociated itself from its Italian
operations claiming that "Grant Thornton (Italy) has been unable to provide sufficient assurances or
access to the appropriate information and people in an acceptable timeframe."
Deloitte denied acting negligently or being complicit in this massive fraud. Its relationship with Grant
Thornton came under strain when ,in October, Deloitte declined to authenticate the value of
Bonlat's mutual fundin Cayman and also refused to approve a gain on a derivatives contract held by
the fund.
From 1999 to 2001, it qualified the accounts of Parmalat Soparfi SA, a Luxembourg subsidiary, on
the book value of a participation in Parmalat Paraguay. There was also a qualification on the book
value in Parmalat Food Industries South Africa Ltd. Deloitte treated Parmalat with suspicion,
learning from The Enron case which led to collapse of its auditor Anderson too. Deloitte excluded
these assets from its valuation of the subsidiary. However, Deloitte failed to do checks on those big
bank accountssupposedly held by Bonlat at BoA.
In spite of the qualified accounts, Parmalat Soparfi SA was able to raise EUR246.4m in an equity-
linked bond issue with Morgan Stanley acting as manager. The banks which helped Parmalat to
raise moneywere JP Morgan Chase, UniCredito Italiano, Merrill Lynch, Morgan Stanley, Barclays
Capital, Deutsche Bank, Citigroup, Santander Central Hispano, Bank of America and UBS. Citigroup
and Bank of America held exposures of up to $1bn in Parmalat. Together, the banks sold about
EUR8bn in Parmalat bonds between 1997 and 2002.
Outcome
The Italian financial police, the Manhattan District Attorney and the SEC have launched a probe of a
different nature, looking into how the dairy group perpetrated one of the biggest financial scams ever,
and whether any of the banks involved knowingly played a role in it. The banks could find
themselves in trouble with SEC simply for having acted negligently by selling Parmalat bonds.
Italy's market regulator, Consob, has asked a Parma court to annul Parmalat's 2002 accounts, which
showed net profits of EUR252m, due to the company's failure to comply with accounting standards.
According to latest estimates, Parmalat lost EUR1.4bn between 2000 and 2003. A company that had
claimed to have cash balances of EUR4.2bn now appears to be missing assets worth at least
EUR8bn. In December 2003, a fraud investigation was launched, Parmalat went into administration
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and, at the end of December, Tonna, former chairman and chief executive Calisto Tanzi and other
senior executives were arrested by Italian police. Tanzi has also admitted to diverting some
EUR500m from the publicly quoted company into family owned firms.
The rating agencies, auditors and banks involved all claim they were misled or the victims of lies or
fraud.
Developments:
Italian prosecutors have stated that the black hole at Parmalat could be bottomless, as the Tanzi
family's other financial interests like a football club Parma, tourism business Parmatour and others.
Key dates
9 December 2003: Parmalat misses EUR150m bond payment
15 December: Tanzi resigns as chairman and CEO
19 December: Bank of America claims a document showing EUR3.9bn on deposit in Cayman
Islands is a forgery
20 December: Fraud investigation launched
24 December: Parmalat goes into administration
27 December: Tanzi arrested
30 December: Tanzi admits EUR8bn hole in accounts. Claims managers acted of own accord
31 December: Tonna, Del Soldato and others arrested
8 January 2004: Grant Thornton International expels Italian partner firm; Italian officials
investigate Deloitte
Summary
Scandal discovered: December 2003
Charges: Financial fraud to the extent of EUR10bn
Latest developments: Investigation launched by The Italian financial police, the Manhattan District
Attorney and SEC.
http://www.indiainfoline.com/Markets/News/Some-of-the-biggest-accounting-scandals/5504117311
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4. OBJECTIVES OF STUDY
The main objectives of this study was to:
(1) identify the prominent American and foreign companies involved in fraudulent financial reporting
practices and the nature of accounting irregularities they committed;
(2) highlight the Satyam Computers Limitedsand Ultra Mega Power Projects accounting scandal by
portraying the sequence of events, the aftermath of events, the key parties involved, and major
follow-up actions undertaken in India; and
(3) what lesions can be learned from Satyam scam and Ultra Mega Power Projects scam?
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5. RESEARCH METHODOLOGY
Research is defined as a scientific &systematic search for pertinent information on a specific topic.
Research is an art of scientific investigation. Research is a systemized effort to gain new knowledge.
It is a careful inquiry especially through search for new facts in any branch of knowledge. The search
for knowledge through objective and systematic method of finding solution to a problem is a
research.
Financial reporting practice can be developed by reference to a particular setting in which it is
embedded. Therefore, qualitative research could be seen useful to explore and describe fraudulent
financial reporting practice. Here, two issues are crucial. First, to understand why and
how a specific company is committed to fraudulent financial reporting practice an appropriate
interpretive research approach is needed. Second, case study conducted as part of this study, looked
specifically at the fraud case in India, involving Satyam Computer Services (Satyam) and Ultra Mega
Power Projects.
Sources of data:
The sources of data means from where we have to get data. There are mainly two sources of data.
These are:
Primary data:The Primary data are those which are collected a fresh and for the first time and thus
happens to be original in character.Secondary data: The secondary data are those data which have already been collected by someone
else and which have already been passed through statistics process. We get published data as
maintained by finance departments of a concern or other publications like Annual report, Magazines
etc.
In my research only secondary type of data was collected.
Data sources:
Secondary sources of data:
Annual reports of the company
Internet
Finance books
This also included going through researches prepared by other students.
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6. ANALYSIS
4.1 SATYAM COMPUTERS LIMITED
Ironically, Satyam means truth in the ancient Indian language Sanskrit (Basilico et al., 2012).
Satyam won the Golden Peacock Award for the best governed company in 2007 and in 2009. From
being Indias IT crown jewel and the countrys fourth largest company with highprofile
customers, the outsourcing firm Satyam Computers has become embroiled in the nations biggest
corporate scam in living memory (Ahmad, et al., 2010). Mr. Ramalinga Raju (Chairman and Founder
of Satyam; henceforth called Raju), who has been arrested and has confessed to a $1.47 billion (or
Rs. 7,800 crore) fraud, admitted that he had made up profits for years. According to reports, Raju and
his brother, B. Rama Raju, who was the Managing Director, hid thedeception from the companys
board, senior managers, and auditors. The case of Satyams accounting fraud has been dubbed as
Indias Enron. In order to evaluate and understand theseverity of Satyams fraud, it is important to
understand factors that contributed to the unethicaldecisions made by the companys executives.
First, it is necessary to detail the rise of Satyam as a competitor within the global IT services market-
place. Second, it is helpful to evaluate the driving-forces behind Satyams decisions: Ramalinga Raju.
Finally, attempt to learn some lessons from Satyam fraud for the future.
EMERGENCE OF SATYAM COMPUTER SERVICES
Satyam Computer Services Limited was a rising-star in the Indian outsourced IT-services
industry. The company was formed in 1987 in Hyderabad (India) by Mr. Ramalinga Raju. The firm
began with 20 employees and grew rapidly as a global business. It offered IT and businessprocess
outsourcing (BPO) services spanning various sectors. Satyam was as an example of Indias growing
success. Satyam won numerous awards for innovation, governance, andcorporate accountability. As
Agrawal and Sharma (2009) states, In 2007, Ernst & Young awarded Mr. Raju with the
Entrepreneur of the Year award. On April 14, 2008, Satyam won awards from MZ Consults for
being a leader in India in CG and accountability. In September 2008, the World Council forCorporate Governance awarded Satyam with the Global Peacock Award for global excellence in
corporate accountability. Unfortunately, less than five months after winning the Global Peacock
Award, Satyam became the centerpiece of a massiveaccounting fraud.
By 2003, Satyams IT services businesses included 13,120 technical associates servicing over 300
customers worldwide. At that time, the world-wide IT services market was estimated at nearly $400
billion, with an estimated annual compound growth rate of 6.4%. The markets majordrivers at that
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point in time were the increased importance of IT services to businesses worldwide; the impact of the
Internet on eBusiness; the emergence of a highquality IT services industry in India and their
methodologies; and, the growing need of IT services providers who could provide a range of
services. (Caraballo, 2010) To effectively compete, both against domestic and global competitors,
the company embarked on a variety of multipronged business
growth strategies.
From 2003-2008, in nearly all financial metrics of interest to investors, the company grew
measurably. Satyam generated USD $467 million in total sales. By March 2008, the company had
grown to USD $2.1 billion. The company demonstrated an annual compound growth rate of
35% over that period. Operating profits averaged 21%. Earnings per share similarly grew, from
$0.12 to $0.62, at a compound annual growth rate of 40%. Over the same period (20032009), the
company was trading at an average trailing EBITDA multiple of 15.36. Finally, beginning in
January 2003, at a share price of 138.08 INR, Satyams stock would peak at 526.25 INRa 300%
improvement in share price after nearly five years (www.capitaliq.com). Satyam clearly generated
significant corporate growth and shareholder value. The company was a leading star and a
recognizable namein a global IT marketplace. The external environment in which Satyam operated
was indeed beneficial to the companys growth. But, the numbers did not represent thefull picture.
Exhibit 1 lists some of the critical events for Satyam between 1987 and 2009. The case of Satyam
accounting fraud has been dubbed as Indias Enron.
Exhibit 1: Satyam Timeline
June 24, 1987: Satyam Computers is launched in Hyderabad
1991: Debuts in Bombay Stock Exchange with an IPO over-subscribed 17 times.
2001: Gets listed on NYSE: Revenue crosses $1 billion.
2008: Revenue crosses $2 billion.
December 16, 2008: Satyam Computers announces buying of a 100 per cent stake in two companies
owned by the Chairman Ramalinga Rajus sonsMaytas Properties and Maytas Infra.
The proposed $1.6 billion deal is aborted seven-hours later due to a revolt by investors, who oppose
the takeover. But Satyam shares plunge 55% in trading on the New York Stock Exchange.
December 23: The World Bank bars Satyam from doing business with the banks direct contracts for
a period of 8 years in one of the most severe penalties by a client against an Indian outsourcing
company. In a statement, the bank says: Satyam was declared ineligible forcontracts for providing
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improper benefits to Bank staff and for failing to maintain documentation to support fees charged for
its subcontractors. On the day the stock drops a further 13.6%, it is lowest in more than four-and-a-
half years.
December 25: Satyam demands an apology and a full explanation from the World Bank for the
statements, which damaged investor confidence, according to the outsourcer. Interestingly, Satyam
does not question the company being barred from contracts, or ask for the revocation of the bar, but
instead objects to statements made by bank representatives. It also does not address the charges under
which the World Bank said it was making Satyam ineligible for future contracts.
December 26: Mangalam Srinivasan, an independent director at Satyam, resigns following the World
Banks critical statements.
December 28: Three more directors quit. Satyam postpones a board meeting, where it is expected to
announce a management shakeup, from December 29 to January 10. The move aims
to give the group more time to mull options beyond just a possible share buyback. Satyam also
appoints Merrill Lynch to review strategic options to enhance shareholder value.
January 2, 2009: Promoters stake falls from 8.64% to 5.13% as institutions with whom thestake
was pledged, dump the shares.
January 6, 2009: Promoters stake falls to 3.6%.
January 7, 2009: Ramalinga Raju resigns, admitting that the company inflated its financial results.
He says the companys cash and bank shown in balance sheet have been inflated and fudged to the
tune of INR 50,400 million. Other Indian outsourcers rush to assure credibility to clients and
investors. The Indian IT industry body, National Association of Software and ServiceCompanies,
jumps to defend the reputation of the Indian IT industry as a whole.
January 8: Satyam attempts to placate customers and investors that it can keep the company afloat,
after its former CEO admitted to Indias biggest-ever financial scam. But law firms Izard Nobel and
Vianale & Vianale file class-action suits on behalf of US shareholders, in the first
legal actions taken against the management of Satyam in the wake of the fraud.
January 11: The Indian government steps into the Satyam outsourcing scandal and installs three
people to a new board in a bid to salvage the firm. The board is comprised of Deepak S Parekh, the
Executive Chairman of home-loan lender, Housing Development Finance Corporation (HDFC), C.
Achuthan, Director at the countrys National Stock Exchange, and former memberof the Securities
and Exchange Board of India, and Kiran Karnik, Former President of NASSCOM.
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January 12: The new board at Satyam holds a press conference, where it discloses that it is looking
at ways to raise funds for the company and keep it afloat during the crisis. One such method to raise
cash could be to ask many of its Triple A-rated clients to make advance payments for services.
MR. RAMALINGA RAJU AND THE SATYAM SCANDAL
On January 7, 2009, Mr. Raju disclosed in a letter, as shown in Exhibit 2, to Satyam Computers
Limited Board of Directors that he had been manipulating the companys accounting numbers for
years. Mr. Raju claimed thathe overstated assets on Satyams balance sheet by $1.47 billion.Nearly
$1.04 billion in bank loans and cash that the company claimed to own was non-existent. Satyam also
underreported liabilities on its balance sheet. Satyam overstated income nearly every quarter over the
course of several years in order to meet analyst expectations. For example, the results announced on
October 17, 2009 overstated quarterly revenues by 75 percent and profits by 97 percent. Mr. Raju and
the companys global head of internal audit used a number of different techniques to perpetrate the
fraud. As Ramachandran (2009) pointed out, Using his personal computer, Mr. Raju created
numerous bank statements to advance the fraud. Mr. Raju falsified the bank accounts to inflate the
balance sheet with balances that did not exist. He inflated the income statement by claiming interest
income from the fake bank accounts. Mr. Raju also revealed that he created 6,000 fake salary
accounts over the past few years and appropriated the money after the company deposited it. The
companys global head of internal audit created fakecustomer identities and generated fake invoices
against their names to inflate revenue. The global head of internal audit also forged board resolutions
and illegally obtained loans for the company.It also appeared that the cash that the company raised
through American Depository Receipts in the United States never made it to the balance sheets
(www.outlookindia.com).
Exhibit 2: Satyams Founder, Chairman and CEO, Mr. Rajus Letter to his Board of Directors
To The Board of Directors,
Satyam Computer Services Ltd.
From: B. Ramalinga Raju
Chairman, Satyam Computer Services Ltd.
January 7, 2009
Dear Board Members,
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It is with deep regret, and tremendous burden that I am carrying on my conscience, that I would like
to bring the following facts to your notice:
1. The Balance Sheet carries as of September 30, 2008:
(a) Inflated (non-existent) cash and bank balances of Rs.5,040 crore (as against Rs. 5,361 crore
reflected in the books); (b) An accrued interest of Rs. 376 crore which is non-existent; (c) An
understated liability of Rs. 1,230 crore on account of funds arranged by me; and (d) An over stated
debtors position of Rs. 490 crore (as against Rs. 2,651 reflected in the books).
2. For the September quarter (Q2), we reported a revenue of Rs.2,700 crore and an operating margin
of Rs. 649 crore (24% of revenues) as against the actual revenues of Rs. 2,112 crore and an actual
operating margin of Rs. 61 Crore (3% of revenues). This has resulted in artificial cash and bank
balances going up by Rs. 588 crore in Q2 alone.
The gap in the Balance Sheet has arisen purely on account of inflated profits over a period of last
several years (limited only to Satyam standalone, books of subsidiaries reflecting true performance).
What started as a marginal gap between actual operating profit and the one reflected in the books of
accounts continued to grow over the years. It has attained unmanageable
proportions as the size of company operations grew significantly (annualized revenue run rate of Rs.
11,276 crore in the September quarter, 2008 and official reserves of Rs. 8,392 crore). The differential
in the real profits and the one reflected in the books was further accentuated by the fact that the
company had to carry additional resources and assets to justify higher level of operations thereby
significantly increasing the costs.
Every attempt made to eliminate the gap failed. As the promoters held a small percentage of equity,
the concern was that poor performance would result in a take-over, thereby exposing the gap. It was
like riding a tiger, not knowing how to get off without being eaten.
The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones.
Maytas investors were convinced that this is a good divestment opportunity and a strategic fit. Once
Satyams problem was solved, it was hoped that Maytas payments can be delayed. But thatwas not
to be. What followed in the last several days is common knowledge.
I would like the Board to know:
1. That neither myself, nor the Managing Director (including our spouses) sold any shares in the last
eight yearsexcepting for a small proportion declared and sold for philanthropic purposes.
2. That in the last two years a net amount of Rs. 1,230 crore was arranged to Satyam (not reflected in
the books of Satyam) to keep the operations going by resorting to pledging all the promoter shares
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and raising funds from known sources by giving all kinds of assurances (Statement enclosed, only to
the members of the board). Significant dividend payments, acquisitions, capital expenditure to
provide for growth did not help matters. Every attempt was made to keep the wheel moving and to
ensure prompt payment of salaries to the associates. The last straw was the selling of most of the
pledged share by the lenders on account of margin triggers.
3. That neither me, nor the Managing Director took even one rupee/dollar from the company and
have not benefitted in financial terms on account of the inflated results.
4. None of the board members, past or present, had any knowledge of the situation in which the
company is placed. Even business leaders and senior executives in the company, such as, Ram
Mynampati, Subu D, T.R. Anand, Keshab Panda, Virender Agarwal, A.S. Murthy, Hari T, SV
Krishnan, Vijay Prasad, Manish Mehta, Murali V, Sriram Papani, Kiran Kavale, Joe Lagioia,
Ravindra Penumetsa, Jayaraman and Prabhakar Gupta are unaware of the real situation as against the
books of accounts. None of my or Managing Directors immediate or extended familymembers has
any idea about these issues.
Having put these facts before you, I leave it to the wisdom of the board to take the matters forward.
However, I am also taking the liberty to recommend the following steps:
1. A Task Force has been formed in the last few days to address the situation arising out of the failed
Maytas acquisition attempt. This consists of some of the most accomplished leaders of Satyam:
Subu D, T.R. Anand, Keshab Panda and Virender Agarwal, representing business functions, and
A.S. Murthy, Hari T and Murali V representing support functions. I suggest that Ram Mynampati be
made the Chairman of this Task Force to immediately address some of the operational matters on
hand. Ram can also act as an interim CEO reporting to the board.
2. Merrill Lynch can be entrusted with the task of quickly exploring some Merger opportunities.
3. You may have a restatement of accounts prepared by the auditors in light of the facts that I have
placed before you. I have promoted and have been associated with Satyam for well over twenty years
now. I have seen it grow from few people to 53,000 people, with 185 Fortune 500
companies as customers and operations in 66 countries. Satyam has established an excellent
leadership and competency base at all levels. I sincerely apologize to all Satyamites and stakeholders,
who have made Satyam a special organization, for the current situation. I am confident they will
stand by the company in this hour of crisis. In light of the above, I fervently appeal to the board to
hold together to take some important steps. Mr. T.R. Prasad is well placed to mobilize support from
the government at this crucial time. With the hope that members of the Task Force and the financial
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advisor, Merrill Lynch (now Bank of America) will stand by the company at this crucial hour, I am
marking copies of this statement to them as well.
Under the circumstances, I am tendering my resignation as the chairman of Satyam and shall continue
in this position only till such time the current board is expanded. My continuance is just to ensure
enhancement of the board over the next several days or as early as possible.
I am now prepared to subject myself to the laws of the land and face consequences thereof. Signature
(B. Ramalinga Raju)
(Source: Bombay Security Exchange ,and Security and Exchange Board of India, available at
www.sebi.gov.in)
Greed for money, power, competition, success and prestige compelled Mr. Raju to ride the tiger,
which led to violation of all duties imposed on them as fiduciariesthe duty of care, the duty of
negligence, the duty of loyalty, the duty of disclosure towards the stakeholders. According to
Damodaran (2012), The Satyam scandal is a classic case of negligence of fiduciary duties, total
collapse of ethical standards, and a lack of corporate social responsibility. It is human greed and
desire that led to fraud. This type of behavior can be traced to: greed overshadowing the
responsibility to meet fiduciary duties; fierce competition and the need to impress stakeholders
especially investors, analysts, shareholders, and the stock market; low ethical and moral standards by
top management; and, greater emphasis on shortterm performance.
According to CBI, the Indian crime investigation agency, the fraud activity dates back from April
1999, when the company embarked on a road to doubledigit annual growth. As of December 2008,
Satyam had a total market capitalization of $3.2 billion dollars.
Satyam planned to acquire a 51% stake in Maytas Infrastructure Limited, a leading infrastructure
development, construction and project management company, for $300 million. Here, the Rajuss had
a 37% stake. The total turnover was $350 million and a net profit of $20 million. Rajus alsohad a
35% share in Maytas Properties, another real-estate investment firm. Satyam revenues exceeded $1
billion in 2006. In April, 2008 Satyam became the first Indian company to publish IFRS audited
financials. On December 16, 2008, the Satyam board, including its five independent directors had
approved the founders proposal to buy the stake in Maytas Infrastructure and all of Maytas
Properties, which were owned by family members of Satyams Chairman, Ramalinga Raju, as fully
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owned subsidiary for $1.6 billion. Without shareholder approval, the directors went ahead with the
managements decision. The decision of acquisition was, however, reversed twelve hours after
investors sold Satyams stock and threatened action against the management. This was followed by
the law-suits filed in the U.S. contesting Maytas deal. The World Bank banned Satyam from
conducting business for 8 years due to inappropriate payments to staff and inability to provide
information sought on invoic