Satyam, a word in Sanskrit - an ancient Indian language, means truth. Ironically, a company by the same name has been involved in the largest scandal in the history of Indian corporate world. On Jaunary 7, 2009, B Ramlinga Raju, the chairman of Satyam Computer Services Ltd., wrote a letter to the company board in which he took responsibility for a fraud of about 50 billion Indian rupees (INR). The fraud took the corporate world by surprise, not only because of the gigantic volume, but also because Satyam has been touted as a pioneer of corporate governance practices, winning the Golden Peacock Global Award for Excellence in Corporate Governance given by the World Council for Corporate Governance in 2008, just three months before the scandal. Satyam also won the Golden Peacock National Award for Excellence in Corporate Governance in 2002, and was rated as having the best corporate governance practices by the Investor Relations Global Rankings (IRGR) for 2006 and 2007. Mr Ramlinga Raju in his letter acknowledged that the fraud has been going on for past several years. As the analysts try to understand how a company with best corporate governance practices could keep such a huge fraud under wraps, about 115 independent directors on the boards of listed Indian companies resigned in one month period following the Satyam scandal. Following the scandal, the big question facing the corporate world and the regulators is how to ensure good corporate governance, moving beyond the ceremonial adoption of best practices by firms.
History of Satyam
Satyam Computers Limited (Satyam) is the India's fourth largest software development and IT consulting company based on 2008 figures. Incorporated in 1987 as a private limited company by two brothers - B Rama Raju and B Ramalinga Raju, Satyam's success became synonymous with the success of Indian IT industry for the next 20 years. Satyam converted itself from a private limited company to a public company in August 1991 and issued shares to the public in 1992. The money raised in the stock market was used to build a software technology park and a 100 percent export oriented unit. In the following year, Satyam made its first global foray by entering into a joint venture with Dun and Bradstreet, USA. In 1996 Satyam setup its first foreign office in US, followed by another one in Japan. It also developed new business partnerships in several other countries including Australia, Canada, and some European countries. Meanwhile Satyam continued its growth initiatives in the domestic market, opening new offices and facilities in different parts of India, promoting four subsidiaries - Satyam Spark Solutions, Satyam Renaissance Consulting Ltd., Satyam Enterprise Solutions Pvt. Ltd. and Satyam Infoway Pvt. Ltd., and starting an information technology school - Indian Institute of Information Technology (IIIT). IIITs were a result of public-private partnership, with several of these being promoted by global corporation such as IBM, Microsoft, and Oracle in different parts of India. In 1997, Satyam became the first Indian company to get ITAA certification for Y2K solutions.
To capitalize on the IT boom in late 90s, Satyam made its first green field investment in the US in 1998, opening a software development center in New Jersey, USA, and subsequently opening several such centers all over the world including Singapore, UAE, Australia, Malaysia, China, Egypt and Brazil. In 1999, different subsidiaries of Satyam were merged with the parent firm, and Satyam got listed on NASDAQ. The money raised by NASDAQ listing was used for further growth initiatives including new ventures. Satyam entered into several alliances and long term contracts with global bodies and corporations such as World Bank, Microsoft, Yahoo!, SEEC, Healthaxis, Insur-Enroll Solution, Computer Associates, Saint-Gobain Abrasives, Venture global Engineering, Vignette Corporation, Computer Associates, Emirates, SAS, i2 Technologies, Ford etc. As of 2008, Satyam had a revenue of over two billion USD, more than 51,000 associates of over 60 nationalities, 654 customers which include one-third of the Fortune Global and US 500 companies, a presence in 63 countries, and 31 global solution centers. It is listed on New York Stock Exchange in US, Euronext in Amsterdam and Bombay and National Stock Exchanges in India.
Along with its phenomenal growth, Satyam and its employees also won several national and international awards and recognitions. Satyam was named a 2000 Web Business 50/50 award winner for its corporate intranet. Satyam won the national Human Resource Development (HRD) Award in 2000 for its outstanding HRD efforts. Dataquest, a leading IT magazine named Mr. Ramalinga Raju as IT Man of the Year for 2000. Hong Kong-based Far Eastern Economic Review ranked Satyam as one of the 10 well-regarded companies in India based on a survey conducted in 2000. Satyam also won the Frost & Sullivan market engineering award for Competitive Strategy in 2001 in the application service provider category IBM Lotus award for innovation in 2003. These awards and honors are clear reflection of the prestige and reputation of Satyam amongst its clients, employees and society in general.
Governance at Satyam
Satyam had relatively small promoter holding for a traditional family run firm in India (Exhibit 1). In fact promoter's ownership share has steadily declined over the years. Foreign institutional holders had the maximum holding varying between 40 and 50 percent. Other important groups of investors included Indian public, banks and financial institutions, and mutual funds. With a relatively high ownership in the hands of domestic and foreign institutional investors, it was important for Satyam to have a 'good' corporate board to gain legitimacy amongst its different stakeholders.
As of December 2008, Satyam had five independent and four internal members on its board (Exhibit 2). Ramalinga Raju and Rama Raju, the two founder brothers, were the only relatives on the board. Ramlinga Raju was also the chairman of the board. The other two internal directors included Ram Mynampati, an internal employee and Krishna Palepu, a Harvard Business School professor, who was listed as an internal director as he also worked as consultant for Satyam. The independent directors included the M Rammohan Rao, the dean of Indian School of Business, Vinod Dham, a former senior manager of Intel, Mangalam Srinivasan, a senior academic with experience of working in several US universities, T R Prasad, a former cabinet secretary in the government of India, and V S Raju, a former director of Indian Institute of Technology, Delhi. The audit and compensation committees had four members each, who were all independent directors. The audit committee met eight times during in the preceding year, while compensation committee met three times.
The composition of the board and different committees was in total compliance with the prescribed rules and regulations. In addition, Satyam seemed to follow the governance standards beyond what was prescribed by law, as is evident from the company's philosophy on corporate governance, stated in the governance reports that Satyam submitted to regulatory authorities:
"Corporate Governance assumes a great deal of importance in the business life of Satyam ("the Company"). The driving forces of Corporate Governance at Satyam are its core values-Associate Delight, Investor Delight, Customer Delight and the Pursuit of Excellence. The Company's goal is to find creative and productive ways of delighting its stakeholders, i.e., Investors, Customers, Associates and Society, thereby fulfilling the role of a responsible corporate representative committed to best practices.
Satyam believes that sound Corporate Governance practices provide an important framework to assist the Board in fulfilling its responsibilities. The Board of directors is elected by shareholders with a responsibility to set strategic objectives to the management and to ensure that the long term interests of all stakeholders are served by adhering to and enforcing the principles of sound Corporate Governance. Thus, the management is responsible to establish and implement policies, procedures and systems to enhance long-term value of the Company and delight all its stakeholders (Associates, Investors, Customers and Society)." (Satyam Corporate Governance Report: March 31, 2007)
The balance sheet of Satyam (Exhibit XX) shows all the signs of a healthy company. In the eight years from 2001 to 2008, Satyam's turnover increased from INR 14.12 billion to INR 84.73 billion. The profit after tax also showed a consistent gain with the net profit margin increasing from 10 percent to 20 percent in eight years during 2001-2008. Satyam expected revenue of about 2.70 billion US dollars in the financial year 2009 (as stated in their form 10k for the financial year 2008). This meant a growth rate of 24.0 percent to 26.0 percent over the revenue for 2008. Basic earnings per American Depository Receipts (ADS) for 2009 were expected to be between US$ 1.44 and US$ 1.47, implying a growth rate of 15.2 percent - 17.6 percent over the previous year. The Earning per Share (EPS) for 2009 was expected to be between INR 29.54 to INR 30.04, with a growth rate of 17 percent to 19 percent over the previous year.
The financial health was based on a robust profile of customers. Satyam's top 100 customers accounted for 85 percent of the revenue. Satyam had two customers with an annual run-rate greater than USD 100 million, while 50 customers exceeded an annual run-rate of USD 10 million. There were 230 customers with an annual run rate of US$1 million. Satyam was the first Indian Company to post its audited results for financial year 2008 in accordance with the International Financial Reporting Standards (IFRS). The Company's CFO, Srinivas Vadlamani remarked in the published statements:
"We see considerable value in adopting IFRS. As a global standard, it enables comparison and comprehension of financials, regardless of a company's location. And, since Satyam has adopted the standards, our operational reporting can be understood, without reconciliation, by more than 100 countries that already permit or require IFRS reporting. Further, the move provides clarity and consistency to Satyam's investors in Europe, where our company is growing quickly."
The unfolding of the crises
On Dec 16, 2008, Satyam's board approved an acquisition of 51 percent stake in Maytas Infra, a listed company in Bombay Stock Exchange for USD 1.3 billion and a 100 percent stake in Maytas Properties, an unlisted firm for USD 300 million. Both these firms are in the construction and real estate business and are promoted by Satyam's chairman Ramalinga Raju's two sons. Ramalinga Raju's immediate family and friends held 36 percent stake in Maytas Infra and 35 percent stake in Maytas properties. The successful completion of the acquisition required a borrowing of USD 300 million to add to the USD 1.2 billion of cash that Satyam claimed to have. Satyam justified the diversification into the real estate and property business on the grounds that real estate is a sunrise industry in India and diversification was essential given the sluggish growth of IT business in the key markets such as the US and Europe.
The investors however reacted very negatively to this news, resulting in 55 percent plunge in Satyam's American Depository Receipts (ADRs). Following stiff resistance from investors in general and institutional investors in particular, Satyam called off the acquisition On Dec 17, 2008. The calling off of acquisition, however, did not pacify the negative sentiments and share prices fell by 30 percent on the Indian bourses. Given the huge related party transactions involved, investors and media also started raising doubts over the corporate governance practices at Satyam. To restore investor confidence, Satyam scheduled a board meeting for Dec 29, 2008 to consider a share buyback. On Dec 23, World Bank suspended Satyam for eight years from doing any business with itself, on the grounds that Satyam was offering bribes to World Bank staff for obtaining lucrative contracts. While Satyam vehemently refused the allegation, its share prices continued to fall. On Dec 26, Mangalam Srinivasan, who has been an independent director since 1991 resigned, taking the moral responsibility for not opposing the acquisition decision in writing. On Dec 28, Satyam postponed the board meeting scheduled for Dec 29. On the same day IL&FS Trust sold 4.41 million Satyam shares at INR 139.83 in the open market. Raju and his family had pledged these shares in lieu of the loans obtained from IL&FS Trust. As a result, Raju and his family's stake in Satyam diluted to 5.13 percent on December 08, from a high of 8.65 percent in September 08. Satyam's market capitalization eroded by 40 percent in just two weeks in the later half of December 08.
Meanwhile, someone with a pseudonym of Jose Abraham, claiming himself to be a former senior executive in Satyam, wrote an anonymous email to one of the board members. The email had details about financial irregularities and fraud at Satyam, including that Satyam did not have enough liquid assets which could be confirmed with its bankers. The email was forwarded to all the board members along with the CEO, Mr B. Ramlinga Raju. It is speculated that this letter ultimately became the basis of the uncovering of the financial fraud. Facing the heat from the market and criticism from the analysts, three more independent directors, Rammohan Rao, who headed the board meeting that approved the acquisition, Krishna Palepu, and Vinod Dham resigned from the board. In his resignation letter, Prof Palepu stated that Satyam's new project needed his physical presence, which his teaching commitments at the Harvard Business School prohibited him from fulfilling. Mr Dham stated that he was not given full and relevant information related to Maytas deal.
On Jan 7, 2009, Mr. B Ramlinga Raju wrote a resignation letter to the Securities and Exchange Board of India (SEBI), which is the market regulator in India. In his resignation letter (Appendix XX), Mr Raju admitted that he cooked the financial statements to the tune of INR 71.36 billion. The cooked amount of INR 71.36 billion included INR 50.46 billion in non-existing cash and bank balances. Mr Raju confessed that he overstated the profits as the profit margins were as low as three percent. He also stated that the financial gap in actual and stated profits was known to senior officials including the Chief Operating Officer and the Chief Financial Officer. Mr Raju stated that he was forced to overstate the profits to maintain the share price level, which was important to make sure that Satyam is not subjected to a hostile takeover. Mr Raju further stated that he never profited from the high market prices of Satyam shares as he never sold any of his shares, but only pledged them with family and others to raise loans to bridge the gap between fake and real assets. Mr Raju stated "It was like riding a tiger, not knowing how to get off without being eaten."
To meet the cash commitments of Satyam Computers, Raju had to take loans from his friends, family and others by pledging his shares. His ownership stake declined from 20.74 percent in 2003 to 8.74 percent in 2008. Justyfing his actions Mr Raju stated in the letter that in his last attempt to save Satyam from a hostile takeover, and to bridge the gap between actual and stated cash, he tried the Maytas deal that failed, and consequently he chose to resign. Mr Raju was probably hoping that he could swap the fictitious cash reserves of Satyam with the assets of Maytas, which was owned by his Sons, and thus bridge the burgeoning gap in the actual and stated cash reserves.
Raju was arrested and put behind the bars. Shares of Satyam fell to INR 39.95 on Bombay Stock Exchange from a 52 week high of INR 544. DSP Merrill Lynch terminated its engagement with the company. Raju's brother Rama a co-founder of Satyam had also been arrested. A special team of auditors from the Securities and Exchange Board of India (SEBI) started the investigations into the fraud. Several law suits were filed in different courts including in the U.S. The Govt. of India disbanded the Satyam board and appointed new directors and an interim CEO.
The Central Bureau of Investigation (CBI) was asked to initiate an inquiry into the financial fraud at Satyam. According to the CBI, the amount of manipulated profits was more than INR 96 billion. Other findings were also different from what Mr Raju stated in his letter. The biggest puzzle for the shareholders, investigators and the general public was that how could Mr. Raju hide the evidence of fake assets from various regulators like Income Tax authorities, SEBI, and Reserve Bank of India for seven years? Further, what was the role played by internal governance mechanisms such as the board and internal as well as external auditors, whose main job is to make sure that such firms do not indulge in such irregularities. The general perception in the business press was that not only Mr Raju cooked the accounting books but also siphoned the money over the years. Mr Raju's claim that Satyam was earning only three percent net profits is hard to believe given that other competitors made 20-25 percent net profits during the same years. Such a massive fraud without an intention to make private gains is difficult to be true.
A closer look at the business dealings by Mr Raju and his family raises further suspicions about his intentions and actions. Mr Raju and his family have a total of three hundred and twenty seven companies registered in their names, with family members being common directors in these companies. Since these firms are not registered in the stock markets, they are not required to follow standard governance practices or publicize the details of their business dealings. It was surprising how these and other facts could be hidden from multiple layers of audit that a firm goes through.
Typically, there are three levels of auditing that happens in any company. First is the internal audit by the team headed by the Chief Financial Officer. This is followed by the external auditors, which was PwC in Satyam's case. Finally, the board has the audit committee, headed by an independent board member. In the case of Satyam, there was a failure at all the three levels.
Satyam contracted Price Waterhouse Coopers (PwC) as its statutory auditors since 2000. During the five year period from 2003-2008, PwC's audit fee tripled to INR 430 million. The audit fee Satyam paid was about twice as much as what its peers in IT industry paid to their auditors. For example, three other leading IT companies in India, WIPRO, Infosys and TCS paid INR 280 million, INR 153 million and INR 277 million respectively. All these companies are listed in domestic and foreign stock exchanges and have to comply with international accounting regulations similar to Satyam. The auditors from Pricewaterhouse Coopers issued a brief statement:
"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."
Given the relatively higher fees that Satyam paid to PwC, it is suspected that the external auditors allowed various accounting irregularities such as improper verification of cash and bank balances. Audit of cash is one of the easiest; as auditors only need to have a written confirmation from the bank that so much money exists. If the bank does not allow verifying the cash, then auditor cannot give an opinion of true and fair view. Initially, the bankers of Satyam declined to comment on the Company's accounts, citing client confidentiality. Later, however, the bankers were also pulled into the investigation to verify huge amount of money shown as bank balance in the financial statements.
Mr Raju admitted that Satyam's fixed deposits which supposedly grew from INR 33.2 millions in 1998-99 to a massive INR 33.20 billion in 2007-08 were all fake. The auditors are supposed to have an independent bank confirmation of such things in the form of a bank statement. Under Indian law, banks have to deduct tax at source for any interest income that exceeds US $200 a year. This money has to be paid directly to the government. It is speculated that either Satyam internally created fake documents verifying the cash in the banks or the bankers issued false TDS certificates for the interest payments.
There were other indications of potential financial irregularities at Satyam that were ignored by the internal and external auditors. For example, Satyam closed the financial year 2007-08 with a debt of INR 2.36 billion, even after having an enormous amount of INR 44.62 billion lying unused in its current account. This amount was neither distributed among shareholders in the form of dividend, nor was it used to earn valuable interest, as it is usually done. As such, the auditor can escape the responsibility only if he or she can demonstrate that there was no gross negligence in conduct of the audit. Following the unearthing of the scandal, PwC's audit head in India resigned, and the two partners, who signed on Satyam's balance sheet - S Gopalakrishnan and Srinivas Talluri - were suspended and imprisoned.
Cremation of Satyam
The fraud resulted in a decline of more than 78 percent in the market capitalization. The immediate challenge for the government appointed board was to protect the interests of shareholders and employees by making sure that the firm survives. In February 2008, the market regulator (SEBI) gave a green signal for sale of 51 percent of the stake of Satyam through a global bidding process. Investors with more than $150 million in net assets were invited to bid. The bidding involved two steps. In the first step, the successful bidder had to acquire equity shares representing 31 percent of Satyam's share capital; in the second phase, the bidding firm had to make a public offer to buy a minimum of 20 percent more. In case the bidding firm failed to acquire 51 percent even after the close of the open offer, it would be eligible to subscribe to additional equity shares. Tech Mahindra, a Mahindra and Mahindra group company, won the bid for Satyam at INR 58 per share. Tech Mahindra paid INR 17.57 billion for a 31 per cent stake in Satyam. Tech Mahindra planned to run Satyam as an independent company with separate liabilities.