Thursday, January 8, 2009

Satyam Fraud - The First Look

In one of the darkest days in India’s corporate history, Satyam Computer Services Founder and Chairman B Ramalinga Raju resigned after saying he falsified earnings and assets. 

The revelation comes soon after Raju was forced to reverse a decision to invest almost Rs 8,000 crore in two other promoter-owned infrastructure and property companies mid-December, following strong shareholder protests. The company has been in crisis since, after four independent directors resigned from Satyam’s board as a result of widespread criticism of their role in the decision.

Today’s disclosures, however, prompted a collapse in the stock of India’s fourth-largest software services company. Satyam, whose name means “the truth” in Sanskrit, plunged a record 78 per cent on the Bombay Stock Exchange (BSE), dragging down the Sensitive Index in a scandal described as “horrifying” by Securities and Exchange Board of India (Sebi) Chairman C B Bhave.

The National Stock Exchange has excluded Satyam, which has received several prominent awards for corporate governance in the past, from the Nifty 50 and S&P CNX 500 with effect from January 12.

A BSE spokesman said the bourse will examine whether to remove Satyam from the Sensitive Index, which tumbled 7.3 per cent today. Meanwhile, the New York Stock Exchange (NYSE) today halted trading in Satyam stock. In the pre-market trade, the company’s American Depository Receipt (ADR) had crashed 91 per cent on the NYSE.

Raju’s letter to the company’s board said he tried to sell two promoter-related firms to Satyam last month, in a final attempt to plug Rs 5,500 crore of “fictitious” cash on the company’s balance sheet. Profits have been “inflated for several years,” Raju said.

Of Satyam’s reported cash and bank balances of Rs 5,361 crore on September 30, Rs 5,004 crore was non-existent, Raju said in the letter. Operating margin for the quarter ending September 30 was 3 per cent of revenue, instead of the reported 24 per cent, he said. The company’s revenue was Rs 2,100 crore, 22 per cent less than the inflated figure of Rs 2,700 crore that had been reported.

Raju arranged Rs 1,230 crore “to keep operations going” at Satyam over the last two years by pledging the founders’ shares and raising funds from other sources, he said.

“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,” Raju said. “It was like riding a tiger, not knowing how to get off without being eaten.”

Raju, who was barricaded in his Hyderabad office all day today, said his concern was that poor performance, combined with the fact that promoters held a small stake in the company, would make Satyam an easy target for a takeover, exposing the inflated figures.

B Rama Raju, managing director of the company, also resigned today. Both will, however, continue in the position till the current board is expanded. Ram Mynampati, president (commercial and healthcare business), has been appointed interim CEO.

Meanwhile, the company has formed a SWAT team consisting of senior leaders — many of them Satyam veterans with a minimum experience of 10 years in the company and more than 20 years in the industry — to steer the company through the crisis.

Swift action: After Raju’s disclosure this morning, the government and regulators swung into action quickly. Sebi said a probe team will visit Satyam’s offices in Hyderabad Thursday to inspect the company’s accounts. Meanwhile, the corporate affairs ministry has given the Registrar of Companies (RoC), Hyderabad, time till January 14 to submit a report on the statement sent by Raju. Minister of Corporate Affairs Premchand Gupta said: “No leniency will be shown to those found guilty.”
Satyam’s auditors — PricewaterhouseCoopers — also came under fire, with the Institute of Chartered Accountants saying it will take action after investigations.

Sources familiar with the developments said Raju was forced to make this revelation after DSP Merrill Lynch, which was appointed by Satyam to look for a partner or buyer for the company a week ago, terminated its engagement with the company after it found financial irregularities. Merrill Lynch is also understood to have sent the information and the reason for their termination of the contract to the BSE, Sebi and even the New York Stock Exchange, on which Satyam is listed. This left Raju with no other option but to resign.

Raju said he was “submitting himself to the laws of the land and the consequences thereof” but corporate lawyers said the Companies Act, 1956, provides for imprisonment for up to two years for providing false statements. Section (628) also has provision for a fine. In addition, the government has the power to suspend the entire board in the interest of the shareholders and appoint directors.

The government can either initiate suo motu action against the company, based on reports available so far, or wait for the report from RoC before taking action. The ministry of corporate affairs has a serious fraud office (SFO), which was set up to investigate offences of this nature.

“This is a clear criminal breach of trust,” said Somasekhar Sundaresan, partner of J Sagar Associates, adding that the company violated Sebi (Prohibition of Fradulent and Unfair Trade Practices relating to the Securities Market) Regulations, 2003, under which “making a statement or purveying information by a person which he does not believe to be true is an offence”.

Assessing the damage: “This quarter will be tumultuous for us,” interim CEO Ram Mynampati said in an emailed statement to Satyam’s employees. “Rumours will abound and it would be fair to assume that competition will try to leverage it to their advantage.”
Mynampati, who has been mandated by the board to steer the company through this crisis, expressed “shock” at the disclosures. “We recognise that our associates have committed a significant part of their careers to build Satyam. We will pursue all avenues to secure their future in the company,” Mynampati added.

Satyam will hold a press conference at its headquarters in Hyderabad in the next 24 hours.

Employees confused: However, Satyam’s over 53,000 employees are not impressed. “We have been trying to get in touch with our seniors but they have simply vanished,” said a mid-managerial level employee. The top management, said employees, have been “avoiding talks with junior and mid-level employees”.

They maintain that the management didn’t bother clarifying matters when independent directors resigned from Satyam, nor were they forthcoming about Raju’s resignation.

Most Satyam employees were shocked to see Raju owning up to fraud. An employee, who has been working in Satyam for seven months, said, “He was our hero and we felt privileged to be a part of the Satyam family. But now, we can only worry about what our position will be if another company takes over.”

Future tense: Satyam may also lose clients, and become an unattractive proposition — both for investors and outsourcing companies, analysts said. Sudin Apte of Forrester asserts that “30 to 50 per cent of Satyam’s clients will review their deals”. These, he explained, are primarily the 100-odd clients that have deals of around $1 million or less. He added that “Satyam’s attraction as a company has decreased, and this also result in a slightly lower enthusiasm to buy from Indian players”. But will India’s outsourcing/offshoring image also take a hit? Nasscom president Som Mittal, said: “We are shocked with the disclosure of both the magnitude and content of fraud. The IT-BPO industry has high sets of corporate governance and this is an isolated case of governance failure. We are closely working with the Task Force set up by Satyam and our priority at this point is the 50,000 employees and customers of the company.”

Commenting on whether the software body will take any action against Satyam, Mittal said, “There are enough provisions in the law and we are not taking any action. The company will remain on Nasscom’s list. Also, the blame for such an isolated incident should not be put on the entire country or industry because such incidents have taken place in Europe and more recently, in the US.”

Funds exit: Some of the big institutional shareholders have already started exiting the company. On the BSE and NSE today, these shareholders sold 8.62 per cent of their combined holdings. Abardeen, one of the largest shareholders, sold the entire 5.6 per cent stake it had in Satyam, and Swiss Finance also exited. Stock Exchange data showed huge sales by Morgan Stanley and Fidelity as well.

Shock & dismay: The reaction from India Inc was one of shock and dismay. Infosys, India’s second-largest software company, called the incident “deplorable,” R C Bhargava, Chairman, Maruti Suzuki (and an independent director on many boards) admitted that “the Satyam episode has tarnished the image of independent directors at Satyam.” He wondered how the internal audit committee (mostly populated by independent directors) could have missed the irregularities.

JJ Irani, Chairman of expert committee to draft the new Companies Act, Director of Tata Sons, said, “This is a lesson for corporate houses and they should wake up to reality. In the new companies Act, we proposed to give more powers to independent directors. They are completely in the dark. They should be well informed and kept active.”

Rajeev Chandrasekhar, MP and President, Ficci, said, “This fraud on the investors and employees of the company shows a systemic breakdown in the audit and board oversight of the company. Questions will need to be asked about how this happened and who caused it to happen,” he added.

CII Director General Chandrajit Banerjee said the developments at Satyam need to be seen as exceptions to the rule because standards of corporate governance in India are among the highest in the world today.

Brokerage houses, on their part, were blunt. Hitesh Agrawal, Head (Research), Angel Broking, said: “This has shaken the confidence of investors — both domestic and global — the repercussions of which could be felt over the medium-term”.

In its note to its investors on Wednesday, CLSA, a brokerage house covering the Asia-Pacific markets, said: “In this scenario, the January 10 board meeting of Satyam now becomes irrelevant. When there is no cash, how can there be a buyback? And where did the cash go? Only an investigation can tell.”

A Credit Suisse statement, too, said the Satyam episode “clearly indicates that the current financials of Satyam cannot be relied upon. As such, we are unable to issue any further investment advice on Satyam and suspend our coverage of the stock”.

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