Chairman Admits to Fraud

As reported by Bloomberg’s Harichandan Arakali in Satyam Chairman Resigns After Falsifying Accounts
this afternoon:

Satyam Computer Services chairman Satyam Computer Services Ltd. Chairman

Ramalinga Raju resigned after saying he falsified earnings and assets, prompting
a collapse in the stock of India’s fourth-largest software-services provider….
Of Satyam’s reported cash and bank balances of 53.61 billion rupees [over $1
billion) on Sept. 30, 50.4 billion rupees was non- existent, Raju said in [a]
letter sent to the Bombay Stock Exchange [and Satyam’s board]…. 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.

The chairman of Satyam Computer Services, a leading Indian information

technology company that serves numerous Fortune 500 companies, resigned on
Wednesday after disclosing major accounting irregularities, sending Satyam’s
shares down 77 percent, The New York Times’s Heather Timmons and Bettina
Wassener reported.

Recently there were many news articles talking about the stock market issue that happened with Satyam
Computers. Most newspapers were cryptic, either to protect their advertisement interests or because they
did not understand the issue. This blog entry (in tamil) explains what happened in a very simple and clear
manner. The language used by the author hides the fact that he has a good inside understanding of “going
public” movement of the corporates. We have witnessed the negatives of a highly interconnected world
market during this global downturn. This issue is a rare one where international players protected the
interests of Indian stockholders.

Sub: Satyam Computer Services Limited- Issues for consideration

1.0 Objective:
This memorandum seeks to apprise the Board on the various issues that came
up for consideration in the context of Satyam episode.
2.0 Introduction:
The following issues were examined with reference to the provisions of SEBI
Act, Rules and Regulations and the Companies Act, 1956.
• Corporate Governance issues (Clause 49) & Investment in group
companies
• Peer Review of the working papers of the Statutory Auditors.
• Restatement of accounts
• Disclosures re: promoters’ holding vis a vis pledging thereof.
Some of these items were discussed in SEBI Committee on Disclosure and
Accounting Standards as well as Primary Market Advisory Committee. Others
were examined internally. A brief note on the above is given below-:
3.0 Corporate Governance issues (Clause 49) & Investment in group
companies
3.1 Satyam Computer Services Limited (hereinafter referred as ‘Satyam’)
had informed the exchanges on December 16, 2008 that their Board of
Directors in the meeting held on the same date approved the proposals
to acquire 100% stake in Maytas Properties Limited and 51% stake in
Maytas Infrastructure Limited. It was also inter-alia mentioned that the
total outflow of the acquisition is expected to be US$ 1.3 billion for
Maytas Properties and US $ 0.3 billion for 51% stake in Maytas
Infrastructure Limited. It may be noted that Ramalinga Raju group
holds around 8.60% of equity in Satyam and 36.64% of the equity
capital of Maytas Infrastructure Limited whereas Maytas Properties
Limited is an unlisted company belonging to Ramalinga Raju group.
3.2 Several institutional investors and sections of the media questioned the
action of the Board of Satyam regarding the rationale for diversification
of an information technology company into real estate sector and the
rationale for paying huge amount of consideration for acquiring stakes
in the entities owned by the promoter group. Further, there were also
questions regarding the role and the duties of the independent
directors, since the proposed deal was unilaterally approved by the
Board. The adverse feedback from the investing community and the
market participants was reflected in both the Indian markets and the
overseas markets where the Depository Receipts of the company are
listed. The price of the ADRs of Satyam listed in the New York Stock
Exchange (NYSE) fell 55% from its previous day closing.
Subsequently, Satyam made an announcement on Dec 17, 2008
stating that it was not going ahead with its proposed acquisition of
Maytas Properties and Maytas Infrastructure, in the light of the
feedback received from the investing community.

3.3 The key issues which arise in the aforesaid deal which fell through are
the role and responsibilities of the independent directors and whether
the Board of Satyam’s decision to go ahead with the deal without the
approval of the shareholders was in order. In the context of the Indian
regulatory framework, Clause 49 of the Listing Agreement between the
companies and the stock exchanges specifies the broad framework for
certain procedural formalities on Corporate Governance. These include
provisions regarding the composition of the Board including
Independent directors, Board Procedure, Constitution of Audit
committee, Remuneration & Shareholders’ Committees and furnishing
of Management Discussion & Analysis report in the Annual Report to
shareholders to ensure that the basic tenets of the corporate
governance principles like transparency, fairness and accountability
are followed by the companies. The clause specifies the number of
independent directors mandatorily required to be on the Board of the
companies. The companies are expected to appoint person of
necessary qualification and integrity to their board as independent
directors so that they can take decision objectively and independently
and contribute to the value addition in their boards. Satyam had the
requisite number of independent directors.
3.4 Clause 49 has not particularly specified the role and the responsibilities
of the independent directors, probably because the provisions of
Companies Act, 1956, cast a fiduciary duty on all directors, including
the independent directors, towards the shareholders.
3.5 As regards the Board’s decision to invest in group companies without
approval of the shareholders, the investment made by a company in
any body corporate is governed under Section 292 and Section 372A
of the Companies Act, 1956. Section 292 mentions about power of the
Board to invest the funds of the company by means of resolutions
passed at meetings of the Board. Section 372A requires that the
consent of the shareholders is required when the aggregate of any
loans made, or investment made or guarantee given or security
provided by the company exceeded 60% of the aggregate of the paid
up capital and free reserves or 100% of its free reserves, whichever is
more. Further, Sections 292 and 372 A are also not delegated sections
to SEBI under Sec 55A of the Companies Act for administration and its
purview lies with the Ministry of Corporate Affairs (MCA).
3.6 SEBI has written to the independent director who chaired the said
meeting of the Board, seeking certain information in this regard.
4.0 Peer Review of the working papers of the Statutory Auditors.
4.1 In the light of recent developments with respect to Satyam, the SEBI
Committee on Disclosures and Accounting Standards (SCODA) met
on January 9, 2009 to discuss the course of action required to be taken
by the regulatory agencies to boost the investor confidence in the
financial disclosures made by listed entities. SCODA recommended
that a peer review of the working papers (relating to financial
statements of listed entities) of auditors may be conducted in respect
of the companies constituting the NSE – Nifty 50, the BSE Sensex and
some listed companies outside the Sensex and Nifty chosen on a
random basis. It was recommended that such a review would be in
relation to the last quarterly results and the last audited annual
financial results and that for this purpose, a panel of auditors would be
prepared by SEBI. SEBI has accepted the aforesaid recommendation
of the SCODA and vide press release dated January 9, 2009 had also
intimated the same to the market participants.
4.2 Legal provisions for mandating the peer review
It is proposed to mandate the peer review by invoking Section 11(2)(i) of
the SEBI Act, 1992 which empowers SEBI to “call for information from,
undertaking inspection, conducting inquiries and audits of the stock
exchanges, mutual funds, other persons associated with the securities
market intermediaries and self- regulatory organisations in the securities
market”.
The scope, objective and approach of the peer review are proposed to be
as follows:
(a) Scope for the review
The scope for the peer review may be as under:
To independently review the:-
i) Working papers of the audit/limited review relating to the quarterly
financial statements of the company for the quarter ended December
31, 2008.
ii) Working papers of the audited annual financial statements of the
company for the last financial year. For this purpose, working papers
pertaining to the audit of financial statements of the listed entity and
the process of consolidation shall be seen (Working papers of
consolidating entities shall not form part of this exercise).
(b) Objective of the peer review :
The objective of the peer review may be as under:-
i. To ensure that the audit/limited review working papers (including
additional audit working papers requested by the peer reviewer)
provide adequate comfort for placing reliance on the financial
statements filed with the stock exchanges.
ii. To ensure that there are appropriate audit/limited review work
papers to demonstrate that accounting standards notified in the
Companies Accounting Standards Rules are complied with.
iii. All significant accounting and auditing matters have been
appropriately dealt with in the audit report/limited review report.
iv. To ensure that the auditor has considered AAS-4, "The Auditors’
Responsibility to Consider Fraud and Error in an Audit of
Financial Statements".
v. To ensure that there is no material misstatement of assets and
liabilities as at the reporting date.
(c) Approach to peer review
The approach to the peer review may be as under:-
(i) The focus of this peer review is to obtain comfort and confidence on
the entity's financial statements submitted to the stock exchanges.
(ii) The approach set out in the Peer Review Manual issued by "The
Institute of Chartered Accountants of India" may be followed to the
extent applicable.
(iii) The peer review may include working papers in the ‘permanent audit
file’ and ‘current file’ as defined under SA 230 on ‘Documentation’.
(iv) It is not intended that the peer review should amount to a re-audit or
investigation. However, the peer review may require the auditor to
perform additional procedures or obtain additional documentation to
evidence the accuracy of the financial statements. In cases, where the
documentation is significantly inadequate to arrive at a conclusion as
to the truth and fairness of the financial statements submitted to the
stock exchanges, the peer review should be immediately discontinued
and the matter should be brought to SEBI’s immediate attention.
4.3 The panel of auditors including the eligibility norms of the peer
reviewer and the terms of reference of the peer review are being
worked out.
5.0 Restatement of accounts
5.1 It appears that there are no clear provisions in the Companies Act
regarding restatement of accounts when necessitated. However, under
Notes in the Guide to Companies Act of Ramaiya, circular dated 13th
January, 2003 of Ministry of Corporate Affairs is reproduced; the
operative portion of the circular is given below:
5.2 “Recently it has come to notice of the department that insurance
companies, pursuant to directions for revision of accounts by
Insurance Regulatory and Development Authority (IRDA) are required
to reopen their accounts.”
5.3 “It is hereby clarified that a company could reopen and revise its
accounts even after their adoption in the annual general meeting and
filing with the Registrar of Companies in order to comply with technical
requirements of any other law to achieve the object of exhibiting true
and fair view. The revised annual accounts would be required to be
adopted either in the extraordinary general meeting or in the
subsequent annual general meeting and filed with the Registrar of
Companies.”
5.4 It is understood that IRDA had on an occasion directed a life insurer to
restate the accounts when the apportionment of premia amount was
not reflected in the balance sheet properly leading to the direction.
6.0 Disclosures re: promoters’ holding vis a vis pledging thereof.
6.1 The members of both the advisory committees unanimously agreed
that there is need to have disclosures of pledge of shares held in listed
entities by promoters, either to enable the company to raise funds
(shares are pledged as collateral) or to raise funds for their own
purpose (where shares are pledged as main security), since the
“pledged shares” per-se signifies likelihood of the sale of such shares
by pledgee upon default.
6.2 The following has been recommended by the committees
o SEBI may provide for “event based” as well as “periodic disclosures”
of this information.
o The periodic disclosure can be made part of the format of the
shareholding pattern filed with stock exchanges on quarterly basis
under clause 35 as well as clause 41 of the Listing agreement. Under
Clause 41, after disclosure re: public shareholding, a line item will be
added to include promoters holding (total) with bifurcation into (i)
unencumbered holdings and (ii) encumbered holdings. Under Clause
35, the format which gives promoters holding as well as disclosure
about 1% holding may clearly indicate unencumbered holdings and
encumbered holdings”. Under these sub-categories, number of
shares as well as % of shares held by promoters shall be indicated.
o As regards, event-based disclosure, SEBI may provide that the
promoters shall inform details of pledge on the shares of listed
company, if any, to the company and the company shall in turn inform
the same to the public through the Stock Exchanges. Similarly, it may
also be obligated to inform the details of sale of “pledged shares”, if
any, to the company for the purpose of public dissemination. Such
disclosure would be on the lines of what is mandated under Insider
Trading / Takeover Regulations.
7.0 Proposal :
The Board is requested to take note of the memorandum and consider the
proposals contained therein and authorize the Chairman to take such action as
may be deemed necessary.

The Crisis Exposes All The Flaws

Warren Buffett once said, "It's only when the tide goes out that you realize who has been swimming naked."
Well, it's ebb tide for the global economy, and high-flying companies are being caught in the buff. The
latest hapless swimmer? Ramalinga Raju, CEO and founder of Satyam Computers, India's fourth-largest
tech firm. Satyam worked with more than a third of the Fortune 500, and claimed good financial health. But
last week Raju resigned after confessing to inflating the company's profits for years. Satyam's shares
plummeted, dragging India's stock market down.

The scandal stunned the country's corporate titans, who now fear foreign investors will pull back.
Meanwhile, the public was left to wonder how regulators could have missed so large a fraud, and how many
other nude swimmers might still be in the sea.