1 CHAPTER I SATYAM SCAM - AN EYE OPENER FOR INDIAN CORPORATE WORLD Satyam Computer Services was among the top four information technology (IT) majors in the country. It played a crucial role in the stock market as one of the 30 largest and most actively traded stocks that determined the Bombay Stock Exchange’s (BSE) value-weighted index, Sensex. Industry analysts say Satyam promoter B. Ramalinga Raju’s biggest crime was perhaps in misleading investors completely. The scam at Satyam Computer Services, the fourth largest company in India’s much showcased and fiscally pampered information technology (IT) industry, has had an unusual trajectory. It began with a successful effort on the part of investors to thwart an attempt by the minority-shareholding promoters to use the firm’s cash reserves to buy out two companies owned by them — Maytas Properties and Maytas Infra. That aborted attempt at expansion precipitated a collapse in the price of the company’s stock and a shocking confession of financial manipulation and fraud from its chairman, B. Ramalinga Raju. The whole story is now of facts and figures which have been
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CHAPTER I
SATYAM SCAM - AN EYE OPENER FOR INDIAN
CORPORATE WORLD
Satyam Computer Services was among the top four information technology (IT) majors in the
country. It played a crucial role in the stock market as one of the 30 largest and most actively
traded stocks that determined the Bombay Stock Exchange’s (BSE) value-weighted index,
Sensex. Industry analysts say Satyam promoter B. Ramalinga Raju’s biggest crime was perhaps
in misleading investors completely.
The scam at Satyam Computer Services, the fourth largest company in India’s much showcased
and fiscally pampered information technology (IT) industry, has had an unusual trajectory. It
began with a successful effort on the part of investors to thwart an attempt by the minority-
shareholding promoters to use the firm’s cash reserves to buy out two companies owned by them
— Maytas Properties and Maytas Infra.
That aborted attempt at expansion precipitated a collapse in the price of the company’s stock and
a shocking confession of financial manipulation and fraud from its chairman, B. Ramalinga Raju.
The whole story is now of facts and figures which have been analysed by corporate experts as
well as various economists in India. The certain parties/issues which need to be analysed to
understand the nature of the fraud and its related problems have been highlighted which shall be
elaborated later.
Satyam Company and The Board: The event came to the light when B, Ramalinga Raju,
Chairman of Satyam Computer Services made a confession that took the nation as well as the
world at large1 by surprise and everybody listened with an awed expression as to what one was
1 The company offers information technology (IT) services spanning various sectors, and is listed on the New York Stock Exchange and Euronext.Satyam's network covers 67 countries across six continents. The company employs 40,000 IT professionals across development centers in India, the United States, the United Kingdom, the United Arab Emirates, Canada, Hungary, Singapore, Malaysia, China, Japan, Egypt and Australia. It serves over 654 global companies, 185 of which are Fortune 500 corporations. Satyam has strategic technology and marketing alliances
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hearing. It is believed that Raju diverted Satyam funds to the companies headed by his sons, B.
Teja Raju (Maytas Infra) and B. Rama Raju Jr. (Maytas Properties), to buy large tracts of land
and win projects. He had chalked out a game plan to acquire the companies and in the process
also reduce the alarming gap in Satyam’s accounts, between actual profit and the figure stated in
the books, and keep the wealth within the family. Much like Satyam, Raju nurtured the two
companies well and had ambitious plans for them, using his clout with the Andhra Pradesh
government, which bent over backwards to patronise Maytas. During the past three years,
Maytas Infra bagged projects worth Rs.30, 074 crore on its own or in joint ventures and became
the “fastest growing infrastructure company” in the State. The projects covered areas such as
irrigation, railways, roads and ports. The “superfast growth” of the company, which recorded a
turnover of Rs.1,600 crore in 2008 as against Rs.100 crore in 2003; the speed and ease with
which it got projects, and the questionable role played by the top political leadership, are all
under the scanner now.
The ‘honest’ confession2 brought many issues to the lime light along with the truth that the fraud
committed by The Chairman was not single-handed and also included other perpetrators. This
with over 50 companies. Apart from Hyderabad, it has development centers in India at Bangalore, Chennai, Pune, Mumbai, Nagpur, Delhi, Kolkata, Bhubaneswar, and Visakhapatnam.2 The letter written by B, Ramalinga Raju, Chairman of Satyam Computer Services to the Satyam Board:
“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;
d. An overstated 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 per cent of revenue) as against the actual revenues of Rs 2,112 crore and an actual operating
margin of Rs 61 crore (3 per cent 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 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.
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issue of corporate fraud as most like to name it as the biggest corporate fraud in Indian Corporate
history contains such players as The Auditors, The Bankers, The Promoters and also the
investors.3
Auditors- Price Waterhouse Coopers: The incident also raised some serious question about well-
named bodies and organisations who were involved in the business of managing the ‘fraudulent’
affairs of the Company. In this context it is also necessary to note the role of the auditors as the
It has attained unmanageable proportions as the size of the company operations grew significantly (annualised
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 a 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 tha poor performance would result in the takeover, 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. 3 One Satyam's problem was solved, it was hoped that Maytas' payments can be delayed. But that was not to be.
What followed in the last several days is common knowledge.
1. I would like the board to know:
2. That neither myself, nor the Managing Director (including our spouses) sold any shares in the last eight
years - excepting for a small proportion declared and sold for philanthropic purposes.
3. 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 and raising
funds from known sources by giving all kinds of assurances (statement enclosed only to the members of the
board).
4. 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 shares by the lenders on account of margin
triggers.
5. That neither me nor the managing director took even one rupee/dollar from the company and have not
benefited in financial terms on account of the inflated results.
6. None of the board members, past or present, had any knowledge of the situation in which the company is
placed.
7. 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, S V Krishnan, Vijay Prasad, Manish Mehta,
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whole affair was managed by one of the biggest names in the auditing business- Price
Waterhouse Coopers.
According to audited balance sheet figures (if they are to be trusted) available from the CMIE’s
database, the paid-up equity in Satyam Computer Services rose from Rs. 56.24 crore in March
2000 to just Rs. 64.89 crore by March 2006 and further to Rs. 133.44 crore in March 2007.
Overall, the number of shares held by the promoter group fell from 7.16 crore (22.8 per cent) to
Murli V, Shriram 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 family members 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.
2. This consists of some of the most accomplished leaders of Satyam: Subu D, T.R. Anand, Keshab Panda and
Virendra Agarwal, representing business functions, and A S Murthy, Hari T and Murali V representing
support functions.
3. 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.
4. Merrill Lynch can be entrusted with the task of quickly exploring some merger opportunities.
5. 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 20 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 apologise to all Satyamites and stakeholders, who have made Satyam a special organisation, 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. TR Prasad is well
placed to mobilise a support from the government at this crucial time.
With the hope that members of the Task Force and the financial advisor, Merrill Lynch (now Bank of America), will
stand by the company at this crucial hour, I am marking copies of the statement to them as well.
Under the circumstances, I am tendering the 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 the consequences thereof.
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5.8 crore (8.6 per cent) between September 2001 and September 2008. This points to a conscious
decision by the promoters to sell shares, which may have been used to acquire assets elsewhere.
The more inflated the share values, the more of such assets could be acquired. It is quite possible
that the assets built up by the eight other Raju family companies under scrutiny, including
Maytas Properties and Maytas Infra, partly came from the resources generated through these
sales. If true, this makes Raju’s confession suspect, since he stated that “neither myself, nor the
Managing Director (including our spouses) sold any shares in the last eight years — excepting
for a small proportion declared and sold for philanthropic purposes.” Price Waterhouse Coopers
has been the statutory auditor for Satyam Computer services for last six years. Auditor‘s
involvement is crystal clear. Satyam had paid twice the amount of what was charged by other
Audit Firms. There was no cash within the company's banks and yet the auditors went ahead and
signed on the balance sheets saying that the money was there. Not just the cash, even they even
signed off on the non-existent interest that accrued on the non-existent cash balance! Auditors do
bank reconciliation to check whether the money has indeed come or not. They check bank
statements and certificates. So was this a total lapse in supervision or were the bank statements
forged? No one knows yet as everyone still awaits the investigation report regarding this issue.
The company officials said they relied on data from the reputed auditors. But
PricewaterhouseCoopers, stung by this insinuation hit back at Satyam.4
Satyam and Corporate Governance: Just three months ago, India's fourth-largest software
services exporter, Satyam Computer Services received a Golden Peacock Global Award from a
group of Indian directors for excellence in corporate governance. Now that Satyam is in turmoil
and its shares have plunged after a botched attempt to buy two infrastructure firms in which
management held stakes, concerns over the conflict of interest and a lack of transparency are
(B Ramalinga Raju)
Copies marked to:
1. Chairman SEBI
2. Stock Exchanges4 Price Waterhouse Coopers to the media: “The audits were conducted by Price Waterhouse in accordance with
applicable auditing standards and were supported by appropriate audit evidence. Given our obligations for client
confidentiality, it is not possible for us to comment upon the alleged irregularities. Price Waterhouse will fully meet
its obligations to cooperate with the regulators and others."
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being raised. Ramalinga Raju himself was the recipient of many an award for corporate
governance and transparency, but the fraud has brought to light the fact that in India the
distinction between owners and management is still not very clear. Where the owners are also the
managers, such frauds are always a possibility. In the Satyam case, of course, none is guiltier
than the Rajus. This shows the status of Indian Corporate Governance and how it can easily fall
prey to people like Rajus’.
SEBI and its take on Satyam: The Securities and Exchange Board of India, which says it is
‘horrified at the magnitude of the fraud’ had in December given a clean chit to Satyam saying
that it had not found any violation of norms relating to takeover and corporate governance in its
preliminary surveillance of the deal involving the acquisition of Maytas Infra by Satyam
Computer Services. Analysts say the “market watchdog” lacks the teeth for ensuring compliance
on governance. Now, after so much water has flown under the bridge, Sebi has moved to ‘take
action’ against the company.5
The Satyam episode has brought out the failure of the present corporate governance structure.
The present corporate governance structure hinges on the independent directors, who are
supposed to bring objectivity to the oversight function of the board and improve its effectiveness.
Stakeholders place high expectation on them. But is the expectation misplaced? Perhaps, yes. An
individual independent director cannot play an effective role in isolation. Even if a particular
independent director is highly committed, he can only watch‘ wrong doing and at best initiate a
discussion, but alone she cannot stop a decision even if it is detrimental to the interest of
shareholders or other stakeholders. Neither can she blow the whistle outside the board room (e.g.
to regulators) because board proceedings are considered confidential.6
CHAPTER II
SATYAM SCAM: ROLE OF AUDITORS AND
BANKERS AS TO THEIR INVOLVEMENT5 Infra Chapter III “Satyam Scam and SEBI: Who is to be blamed?”6 www.ndtv.com/convergence/ndtv/story.aspx?id=NEWEN20090079469 - 101k
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Once the picture becomes clear as how the manipulation of funds were done and as to how the
scam could be caused in spite of so many regulations and statutory restrictions7 present to curb
and check any deviation from the established duties and obligations that are essential and
compulsory on nature.
If one is to blame the Satyam for instigating the corporate down-fall and rise of the questions as
to corporate governance and similar concerns then there are others also involved who may be
said to have played a pivotal role in ‘aiding’ Mr. Raju in pulling off such a fraud and hood
winked even the best in the business to prevent such mishaps.8 Hence, it is bemusing as to how
Satyam could have indulged in accounts fudging without getting detected by the auditors.
Firstly, one needs to speak about Price Waterhouse Coopers the auditors of Satyam Computer
Services who should have caught it as because:
Book sales belonging to the subsequent year in the current year by pre-dating the
invoice. This is like catching the tiger by the tail. Unless the sales improve, the Company
will have to follow the same thing in the subsequent years as well to ensure that the profit
trend is maintained. (The auditors can detect this by matching the dates of invoices,
7 Infra Chapter V, “Satyam Scam & Legal Provisions Under Companies Act, 1956”; Chapter III, “Satyam Scam and
SEBI: Who is to be blamed?”8 www.expressindia.com/latest-news/Satyam-fraud-Not-a-one-man-show/408664/ reports “KPMG, which audits the
accounts of IT majors like Infosys and Wipro, doubted the veracity of the confessional letter written by B Ramalinga
Raju, the founder-chairman of Satyam Computer, saying the financial bungling cannot be done only by the head of
the Hyderabad-based firm. “It defies logic, one is not sure whether there is much more to it than is written in the
letter and whether the letter contains all the facts,” KPMG Chief Operating Officer Richard Rekhy said here on the
sidelines of a CII function. It is too simplistic at the moment to believe that the kind of thing that has happened in
the company is done by Raju alone, he said. “It requires a whole battery of people to advance those accounting
entries and credit those because you have to involve other people as well like bankers to get those certificates,” he
said. When asked whether Raju might have siphoned off funds and he is now admitting to lesser crime, he said it is
quite possible but it could be known only after investigation of group companies”
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Book bogus sales to inflate profits in one year and show return sales in the subsequent
year. This is again like catching the tiger by the tail as the quantum will have to be
increased each year to compensate for the additional charge coming in the subsequent
year due to return sales. (The auditors can detect this by checking the invoices,
subsequent year sales returns, debtor confirmations, stock tally etc.)
Book bogus other income. This is done to inflate the profits and mostly to as a money
laundering exercise: Unaccounted money is laundered into the books by showing
income for no actual service rendered. (Auditors can detect this by seeing the actual
documents supporting the other income and by comparing with the expertise available in
the company to provide such services)
By not booking purchases or overheads. Companies try to inflate profits by not
booking purchase of material or overheads: This again has to be covered up in the
subsequent year when the creditors are to be paid. (Some of the ways in which the
Auditor can find these include, comparison of the purchases with physical stock,
quantitative tally of stocks and consumption, trend analysis of overheads between two
periods, obtaining creditor’s confirmation, bank reconciliation statements to check for
amounts paid but not accounted in books which will be hanging as a difference between
bank balance as per books and as per the bank statements for a given cut-off date)
In all the 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 fraud committed by him and
his ‘allies’. 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. In
order to get actual collections from fictitious companies, 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)
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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.
The problem starts here. Normally, auditors will ask for confirmation balances for the bank
balances shown by the company. But then 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? This presumption seems to be impossible. 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 the big question that arises here is “How could Mr. Raju convince the auditors?” 9 There can
9 One has to note that the Auditors Report required under the Indian Companies Act, 1956 is very different from the
Auditors’ certificate as per USA and other country laws.
Under those laws, much of the responsibility on the accounts is shifted to the management. Interestingly, this report
doesn’t specify any such minute details to be followed but simply asks auditors to look at all things that may require
a scrutiny, which is lucid and ‘flexible’.
227. Powers and duties of auditors: (1) Every auditor of a company shall have a right of access at all times to the
books and accounts and vouchers of the company, whether kept at the head office of the company or elsewhere, and
shall be entitled to require from the officers of the company such information and explanations as the auditor may
think necessary for the performance of his duties as auditor.1[(lA) Without prejudice to the provisions of sub-section (1), the auditor shall inquire-
(a) whether loans and advances made by the company on the basis of security have been properly secured and
whether the terms on which they have been made are not prejudicial to the interest of the company or its members;
(b) whether transactions of the company which are represented merely by book entries are not prejudicial to the
interests of the company;
(c) where the company is not an investment company within the meaning of section 372 or a banking company,
whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at
a price less than that at which they were purchased by the company;
(d) whether loans and advances made by the company have been shown as deposits;
(e) whether personal expenses have been charged to revenue account;
(f) where it is stated in the books and papers of the company that any shares have been allotted for cash, whether
cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether
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be only speculations as to how he could have hoodwinked his auditors but unless the SEBI or the
administrators frame and deduce something definite in this regard speculations cannot be the
correct answer as to whether there was any involvement between the auditors and the perpetrator
of the fraud, Mr. Raju. Under S. 227 read with S. 233 of the Companies Act, 1956 the auditors are
required to accurately, fairly and diligently review and audit the accounts of the company before
issuing the signed auditors’ report.10 Failure to do so would result in a penalty under S.233 of Rs.
10,000. Under Sections 62 and 63 of the Act, any person issuing a prospectus that contains a false
statement may be punished with up to 2 years imprisonment and fine up to Rs.50, 000.11 This
includes directors, promoters and experts such auditors and investment bankers. Satyam also had an
ADS listing in the US and filed a prospectus with the US SEC. Under Rule 10b-5 issued under
Section 10 of the Securities Act of 1933, it is unlawful for any person to make any untrue statement
the position as stated in the account books and the balance-sheet is correct, regular and not misleading.]
Looking at the provisions of Section 227 (1A) (b) can it be said that the auditors ensured as to whether it is not
the same case with Satyam before certifying their accounts? If yes, how did they ensure?
Difficult questions as the whole baloon of Satyam was blown up only with “book entries”. Instead of acting as
book keepers, the Satyam finance department under instructions and intrusions of Mr. Raju, probably “book
cooked”.
In addition to the above, subsection 3 of the same section 227 warrants the auditor to report this:
(3) The auditor’s report shall also state-
(a) whether he has obtained all the information and explanations which to the best of his knowledge and belief were
necessary for the purposes of his audit;
(b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as
appears from his examination of those books, and proper returns adequate for the purposes of his audit have been
received from branches not visited by him;2[(bb) whether the report on the accounts of any branch office audited under section 228 by a person other than the
company's auditor has been awarded to him as enquired by clause (c) of sub-section (3) of that section and how he
has dealt with the same in preparing the auditor's report;]
(c) whether the company’s balance-sheet and profit and loss account dealt with by the report are in agreement with
the books of account and returns;3[(d) whether, in his opinion, the profit and loss account and balance-sheet comply with the accounting standards
referred to in sub-section (3C) of section 211;]
Then the obvious question arises in the mind of people that whether compliance was done by Satyam? And, if so
done then to what respect?10 See Sec. 233, Companies Act, 195611 See Sec. 63, Companies Act, 1956
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of a material fact or to omit to state a material fact in connection with the sale of a security. Under
Section 11 of the Securities Act, the persons who signed the registration statement (directors and
officers) are liable in addition to the underwriters, auditors and other experts.
In addition, disciplinary proceedings/enquiries could be initiated by the Institute of Chartered
Accountants of India12 against the audit firm, which would be a very serious implication for the audit
firm, as it could have the immediate effect of disqualifying their eligibility to act as statutory auditors
for several banks and other institutions. Such an event could also result in suspension or debarment
of the audit firm if the ICAI13 concludes that there were serious lapses on the audit firm‘s part.
Secondly and most importantly comes, the issue of independent directors14 and the
shareholders. The role of the company's directors, including independent directors, in the entire
episode too has been exposed after the Satyam episode. Most of them essentially remain
‘nodders’ in the boardroom and agree to whatever the management or the promoters want to
push through.
The Satyam board, including its five independent directors15 had approved the founder's proposal
to buy 51 per cent stake in Maytas Infrastructure and all of Maytas Properties, owned by the
family members of Satyam chairman B Ramalinga Raju. Despite the shareholders not being
taken into confidence, the directors went ahead with the management's decision. The decision of
acquisition was, however, reversed 12 hours later after investors dumped Satyam's stock and
threatened action against the management. By any yardstick, the directors were men of eminence
and learning who should be independent. Clause 49, of the Indian listing agreement deals with
12 ICAI, 194913 ibid14 see Chapter III: “Satyam Scam And Sebi: Is Somebody To Be Blamed.”15 Satyams’ independent directors includes—
Mangalam Srinivasan,
Vinod Dham (Entrepreneur)
Krishna Palepu (Harvard professor)
M. Rammohan Rao (Indian School of Business dean) from CNN-IBN Published on Thu, Jan 08, 2009 at
13:10 , Updated at Thu, Jan 08, 2009 at 17:42
12
the role of independent directors and assumes, that not being related to a promoter or having a
direct economic benefit from a company, makes a director independent.16
In Satyam‘s case, directors may have voted differently if they knew perhaps through such meetings
the views of shareholders on the issue of unrelated diversification of the kind proposed by the
promoters. Shareholders on their part, have a right to know how their directors represent them.
Details of dissenting views, in a board can convey useful information about the various options
considered at a meeting. While detailed views cannot usually be disclosed in the short term, it is
possible to have minutes publicized after two-three years. This will not serve the immediate purpose
of protecting present shareholders, but would impose pressure on independent directors to be seen to
be fulfilling their duty of loyalty. If diligence was exercised at the board then it is to be known as to
how independent directors voted on such issues, perhaps through a statement in the annual report. It
would call in to question, the real independence in a board, if persons of widely varying backgrounds
were to always seem to agree, on every issue. By resigning instead of coming up with an explanation
for what transpired at the board, some of the directors of Satyam, beg the question whether any
meaningful debate took place at all, on this issue. It is not difficult for the regulators to bring the
sunlight of transparency to board discussions, through a few changes in their disclosure guidelines.
Under the SEBI and Companies Act 1956, all directors cannot be held responsible because
institutional directors and independent directors are nominated directors of various financial
institutions or the government nominees. They cannot be held responsible as nominated directors
cannot be held legally liable.
CHAPTER III
SATYAM SCAM AND SEBI: IS SOMEBODY TO
BE BLAMED?
16 Supra note 14
13
The scam or fraud whatever one may term the incident as it caught the Regulatory bodies’ off-
guard and also pointed out the gaping holes existing in the legal framework to prevent such fraud
from happening. The Satyam scam represents a lowering of guard and the throwing of
established practices to the wind by those who were expected to safeguard the interests of small
investors. The auditors imagined the fixed deposit receipts were genuine, the company’s
directors overly trusted Raju, SEBI mistakenly thought it could easily get at Raju with its wide-
ranging powers, while the CID was too protective about sharing information.17
THE Securities and Exchange Board of India (SEBI) may not have foreseen, as experts claim,
the fraud committed in Satyam Computer Services, but there is plenty the market regulator can
do to ensure that another one like this does not occur in the country.
The SEBI wears several hats: it regulates the market; facilitates information flow between the
stock exchange, the listed companies and the investors; and keeps tabs on the operations of listed
companies. Its responsibility towards investors is to ensure that any information regarding listed
companies is placed in the public domain. If fraud exists in a listed company, SEBI’s job is to
probe the matter to protect the investors.
SFIO and SEBI
As soon as Ramalinga Raju admitted to the fraud on January 7, the regulator, empowered by the
provisions of the SEBI Act, 1992, ordered an investigation and sent its officials to Hyderabad to
inspect the books and records. The officials were, however, not allowed access to Raju as he had
already surrendered before the Hyderabad police. It is essential for SEBI to interrogate Raju as
he has insisted that only he was involved in the scam.
A senior official said that perhaps Raju was advised well to get himself arrested in order to stall a
probe by SEBI. A lawyer said the police would not be able to deny SEBI access to Raju as the
regulator is armed with the provisions of the 1992 Act. SEBI moved a Hyderabad court seeking
permission to interrogate Raju and his brother Rama Raju. However, on January 23, the court
rejected the plea and refused to entertain another petition by the Serious Fraud Investigation
17 “Far from the truth” by S. Nagesh Kumar published in ‘the Frontline’ [Volume 26 - Issue 04 :: Feb. 14-27,
2009]
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Office. It was not until February 4, 2009 that the Supreme Court came to rescue SEBI by giving
it permission to examine them in jail. While the lower court had rejected its petition, while the
Andhra Pradesh High Court asked it to wait for some more time. The interim report of the
Registrar of Companies (RoC) has, according to reports, confirmed falsification of books of
accounts and inflation of the company’s financial position to the extent of over Rs.5,000-6,000
crore by Satyam Computer Services Ltd. The RoC report is the basis for the probe by the Serious
Fraud Investigation Office (SFIO), set up under the Ministry of Corporate Affairs in 2003. As
the probe by the SFIO is the main limb of the multi-pronged investigation into the fraud, a close
look at what the SFIO can achieve under the present legal and regulatory framework needs to be
examined.
The SFIO is a non-statutory body and was set up on the basis of the recommendations of the
Naresh Chandra Committee18 on corporate governance in the backdrop of stock market scams,
failure of non-financial banking companies and the phenomena of vanishing companies and
plantation companies. It is a multi-disciplinary organisation with experts on finance, capital
market, accountancy, forensic audit, taxation, law, information technology, company law,
customs and investigation. These experts are drawn from banks, the Securities and Exchange
Board of India (SEBI), the Comptroller and Auditor General’s office and the organisations and
departments concerned of the government.
The SFIO’s mandate is extremely focussed and, to some extent, limited by Sections 235 to 247
of the Companies Act, 1956. Although the Naresh Chandra Committee envisaged a separate
statute to enable the SFIO (along the lines of the SFO in United Kingdom) to investigate all
aspects of fraud and direct the prosecution in appropriate courts, the Central government,
inexplicably, did not find it necessary to simultaneously create a separate legislative framework
for the SFIO to function under. This has, according to observers, seriously compromised the
SFIO’s efficiency and effectiveness.
18 The Naresh Chandra Report (2003) seeks to enforce the guidelines laid down in Kumarmangalam Report (1998)
and also lays stress on “Independent Directors” which are to be characterised in line with:
Independence of judgment.
No material relationship.
No pecuniary relationship
15
SFIO takes up investigations only into those cases of alleged fraud when:
referred to it by the Central government under Section 235/237 of the Companies Act,
1956;19
cases that substantially involve public interest, to be judged by size, either in terms of
monetary misappropriation or in terms of persons affected, or those cases that may lead to a
clear improvement in systems, laws or procedures;
the SFIO may also take up cases on its own without them being referred to it by the
Department of Company Affairs.20
After completing all the formalities for listing its securities, including of entering into listing
agreement, the securities of the company are listed and traded at the concerned stock exchanges.
Before listing, the company enters into a listing agreement with the concerned stock exchanges.
Almost all the stock exchanges have a standard listing agreement (which is amended from time
to time by issuing circulars by each of the stock exchanges). Companies listed on stock
exchanges have many obligations to discharge. These obligations are elaborated in all the
relevant clauses of the Listing Agreement which the company has entered into with the Stock
Exchange(s).
Clause 49 and SEBI
Clause 49 Background: SEBI had constituted a Committee on Corporate Governance under the
chairmanship of N R Narayana Murthy to improve standards of corporate governance in India.
SEBI introduced some major amendments based on the report on this committee on 26th August,
2003, in clause 49 of its listing agreement.
19 These provisions enable the Central government to appoint one or more competent persons as inspectors to
investigate and submit a report on the affairs of a company if, in its opinion, or in the opinion of the RoC or the
Company Law Board, there are circumstances suggesting that the business of a company is being conducted with
the intention to defraud its creditors or members, or for a fraudulent or unlawful purpose.20 In these cases, the SFIO Director has to record the reasons in writing, and the decision will be subject to review by
a coordination committee set up for the purpose. It is to be seen whether these aspects of its functioning have
restricted its autonomy or operational efficiency.
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Applicability of Clause 49: All companies which were required to comply with the requirement
of the erstwhile Clause 49 i.e. all listed entities having a paid up share capital of Rs 3 crores and
above or net worth of Rs 25 crores or more at any time in the history of the entity, are required to
comply with the requirement of this clause. This clause does not apply to other listed entities,
which are not companies, but body corporates, incorporated under other statutes. Clause 49 will
apply to these institutions as long as it does not violate their respective statutes, guidelines or
directives.
Clause 49 - Corporate Governance The company agrees to comply with the following provisions:
I. Board of Directors
(A) Composition of Board: (i) The Board of directors of the company shall have an optimum
combination of executive21 and non-executive22 directors with not less than fifty percent of the
board of directors comprising of non-executive directors.
(ii) Where the Chairman of the Board is a non-executive director, at least one-third of the Board
should comprise of independent directors and in case he is an executive director, at least half of
the Board should comprise of independent directors.
(iii) For the purpose of the sub-clause (ii), the expression ‘independent director’ shall mean a
non-executive director of the company who:
a. Apart from receiving director‘s remuneration, does not have any material pecuniary
relationships or transactions with the company, its promoters, its directors, its senior
management or its holding company, its subsidiaries and associates which may affect
independence of the director;
21 An executive director is the senior manager or executive officer of an organization, company, or corporation. The
position is comparable to a chief executive officer (CEO) or managing director. An executive director is usually
remunerated for his or her work.22 A non-executive director (NED, also NXD) or outside director is a member of the board of directors of a
company who does not form part of the executive management team. He or she is not an employee of the company
or affiliated with it in any other way
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b. Is not related to promoters or persons occupying management positions at the board level
or at one level below the board;
c. Has not been an executive of the company in the immediately preceding three financial
years;
d. Is not a partner or an executive or was not partner or an executive during the preceding
three years, of any of the following:
1. The statutory audit firm or the internal audit firm that is associated with
the company, and
2. The legal firm(s) and consulting firm(s) that have a material association
with the company.
e. Is not a material supplier, service provider or customer or a lessor or lessee of the
company, which may affect independence of the director; and
f. Is not a substantial shareholder of the company i.e. owning two percent or more of the
block of voting shares.
There are several distinct benefits in having an independent board of directors which they can
bring to a company, ranging from long-term survival to improved internal controls. Independent
directors in the board can:
Counterbalance management weaknesses in a company.
Ensure legal and ethical behaviour at the company, while strengthening accounting
controls.
Extend the ―reach of a company through contacts, expertise, and access to debt and
equity capital.
Be a source of well-conceived, binding, long-term decisions for a company.
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Help a company survive, grow, and prosper over time through improved succession
planning through membership in the nomination committee etc.
Corporate Governance principles all over and listing requirements assign tasks that have a
potential for conflict of interest to independent directors, examples of these are integrity of
financial and non-financial reporting, review of related party transactions, nomination of board
members and key executives remuneration.
Satyams‘ independent directors includes:
Mangalam Srinivasan,
Vinod Dham (Entrepreneur)
Krishna Palepu (Harvard professor)
M. Rammohan Rao (Indian School of Business dean)
The company in its corporate governance report for 2007 did not name Palepu as independent
director, perhaps because he received Rs 87 lakh from the company towards consultancy fees.
Each individual director received around Rs 13 lakh for the year 2007 for say 100 hours of work
(a survey in US reveals that independent directors in large companies devote 50-100 hours per
annum to carry out board responsibilities). Keeping in view the compensation levels in India, the
compensation should be considered good. It is not only in Satyam that independent directors
showed lack of commitment. In the case of Enron, WorldCom and other companies in which
corporate governance failed independent directors failed to perform effectively. If an individual
considers certain responsibilities as peripheral and if the chance of failure in performing those
duties coming to light is low, it is likely that he will shirk those responsibilities, because in that
case the cost of failure to the individual is low. Independent directors are human beings and
therefore, we should not expect them to behave differently from a rational human being. If the
regulators fail to assess the performance of the board on regular basis, albeit indirectly through
scrutiny of filings, and if law enforcement agencies fail to penalize errant independent directors,
the present corporate governance structure will remain ineffective.23 However, the solution is not 23 news.outlookindia.com/item.aspx?657476
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simple. If independent directors are held liable for corporate fraud and severe penalties are
imposed on them, it will be difficult to induct right people as independent directors in the board
and companies will be deprived of the collective wisdom of people who can make a difference in
the performance of companies.24
The shareholders, especially the minority shareholders, also look to independent directors
providing transparency in respect of the disclosures in the working of the company as well as
providing balance towards resolving conflict areas. In evaluating the board‘s or management
decisions in respect of employees, creditors and other suppliers of major service providers,
independent directors have a significant role in protecting the stakeholders interests. One of the
mandatory requirements of audit committee is to look into the reasons for default in payments to
deposit holders, debentures, non-payment of declared dividend and creditors. Further they are
required to review the functioning of the ―Whistle Blower mechanism and related party
transactions. These, essentially, safeguard the interests of the stakeholders. The changes in the
operating environment have raised the stakes on managing business risks. Strong and effective
Corporate Governance is no longer ‘a nice to have’ but ‘a must have’ clause. The shareholders and
the Board should decide as to how many of independent directors would be adequate to have
effective governance for their company. That apart, it has to be appreciated that promoters who have
majority stake in the business and on whose confidence people have subscribed in the company must
have significant representation on the Board. In this perspective, FICCI is of the view that the limit of
independent directors should not be more than 25% including nominee directors. It is to be recalled
that as per the SEBI Regulations, companies will have to comply with the requirements of Clause 49
of the Listing Agreement by December, 2005, which provides for a minimum of 50% independent
directors on the Board. It is, therefore, inevitable that the decision on this aspect expedited to avoid
confusion and uncertainty amongst corporates.
SEBI and PWC:
The Bombay High Court issued its judgment in the case of Price Waterhouse & Co.(PWC) v.
Securities and Exchange Board of India25 where the court ruled that SEBI possesses necessary