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Harshad Mehta was an Indian stockbroker caught in a scandal beginning in 1992. Harshad Shantilal Mehta was born in a Gujarati jain family of modest means. His father was a small businessman. His early childhood was spent in the industrial city of Bombay. Due to indifferent health of Harshad’s father in the humid environs of Bombay, the family shifted their residence in the mid1960s to Raipur, then in Madhya Pradesh and currently the capital of Chattisgarh state. While doing odd jobs he joined Lala Lajpat Rai College for a Bachelor’s degree in Commerce. After completing his graduation, Harshad Mehta started his working life as an employee of the New India Assurance Company. During this period his family relocated to Bombay and his brother Ashwin Mehta started to pursue graduation course in law at Lala Lajpat Rai College. After his graduation Ashwin joined (ICICI) Industrial Credit and Investment Corporation of India. They had rented a small flat in Ghatkopar for living. In the late seventies every evening Harshad and Ashwin started to analyze tips generated from respective offices and from cyclostyled investment letters, which had made their appearance during that time. In the early eighties he quit his job and sought a job with stock broker P. Ambalal affiliated to Bombay Stock Exchange (BSE) before becoming a jobber on BSE for stock broker P.D. Shukla. In 1981 he became a sub-broker for stock brokers J.L. Shah and Nandalal Sheth. After a while he was unable to sustain his overbought positions and decided to pay his dues by selling his house with consent of his mother Rasilaben and brother Ashwin. The next day Harshad went to his brokers and offered the papers of the house as guarantee. The brokers Shah and Sheth were moved by his gesture and gave him sufficient time to overcome his position. After he came out of this big struggle for survival he became stronger and his brother quit his job to team with Harshad to start their venture GrowMore Research and Asset Management Company Limited. While a broker’s card at BSE was being auctioned, the company made a bid for the same with financial assistance from Shah and Sheth, who were Harshad's previous broker mentors. He rose and survived the bear runs, this earned him the nickname of the Big Bull of the trading floor, and his actions, actual or perceived, decided the course of the movement of the Sensex as well as scrip-specific activities. By the end of eighties the media started projecting him as "Stock Market Success", "Story of Rags to Riches" and he
too started to fuel his own publicity. He felt proud of this accomplishments and showed off his success to journalists through his mansion "Madhuli", which included a billiards room, mini theatre and nine hole golf course. His brand new Toyota Lexus and a fleet of cars gave credibility to his show off. This in no time made him the nondescript broker to super star of financial world. During his heyday, in the early 1990s, Harshad Mehta commanded a large resource of funds and finances as well as personal wealth.
WHAT WENT WRONG?
Harshad Mehta was the darling of the stock markets -- a superstar whose popularity had begun to rival that of a matinee star. He was the cover story on several magazines and was being shot by audio-visual newsmagazines symbolically feeding peanuts to bears at the Bombay zoo. The fall In April 1992, the Indian stock market crashed, and Harshad Mehta, the person who was all along considered as the architect of the bull run was blamed for the crash. It transpired that he had manipulated the Indian banking systems to siphon off the funds from the banking system, and used the liquidity to build large positions in a select group of stocks.
In the early 1990s, the banks in India had to maintain a particular amount of their deposits in government bonds. This ratio was called SLR ( Statutory Liquidity Ratio). Each bank had to submit a detailed sheet of its balance at the end of the day and also show that there was a sufficient amount invested in government bonds. Now, the government decided that the banks need not show their details on each day, they need to do it only on Fridays. Also, there was an extra clause that said that the average %age of bond holdings over the week needs to be above the SLR but the daily %age need not be so. That meant that banks would sell bonds in the earlier part of the week and then buy bonds back at the end of the week. The capital freed in the starting of the week could then be invested. Now, at the end of the week many banks would be desperate to buy bonds back. This is where the broker comes in. The broker knew which bank had more bonds (called ‘plus’) and which has less than the required amount (called ‘short’). He then acts as the middleman between the two banks. Harshad Mehta was one such broker. He worked as a middle man between many banks for a long time and gained the trust of the banks’ senior management. Lets say that there are two banks A (short) and B (plus). Now what Harshad Mehta did was that he told the banker at A that he was dealing with many banks and hence did not know who would he deal in the end with. So he said that the bank should write the cheque in his name rather than the other bank (which was forbidden by law), so that he could make the payment to whichever bank was required. Since
he was a trusted broker, the banks agreed. Then, going back to the example of bank A and B, he took the money from A and went to B and said that he would pay the money on the next day to B but he needed the bonds right now (for A). But he offered a 15 % return for bank B for the one day extension. Bank B readily agreed with this since it was getting such a nice return Now since Harshad Mehta was dealing with many banks at the same time he could then keep some capital with him at all times. For eg. He takes money from A on Monday, and tells B that he’ll pay on Tuesday, then he takes money from C on Tuesday and tells D that he’ll pay on Wednesday and the money he gets from C is paid to B and as a result he has some working capital with him at all times if this goes on with other banks throughout the week. The banks at that time were not allowed to invest in the equity markets. Harshad Mehta had very cleverly squeezed some capital out of the banking system. This capital he invested in the stock market and managed to stoke a massive boom. The story began to fall apart with the revelation that Harshad had helped himself to a cool Rs 5 billion from State Bank of India by making a SGL receipt vanish.
SEBI UNFLODED THE MYSTERY
It is the astounding story of an irrepressible and ambitious Harshad Mehta attempting to cock a snook at the system, which tried to tie him down in 35odd court cases and re-work his charismatic magic with investors. Fortunately for Indian investors, the comeback died a quick death. Harshad had made his plans carefully. He anticipated the Internet as a powerful tool and launched his own website -- www.harshad.com to dispense stock tips and analyse market trends. A set of media managers then set him up with columns in several leading newspapers. The next step was to convince a set of companies to collaborate with him in ramping up their prices and find several legitimate brokers to put through his trades. Sebi's investigation reveals that a set of brokers was happy to deal with these unknown companies with no financial standing or professional expertise and without taking any security or deposit, only because of their faith in the Harshad Mehta magic. BPL, Videocon and Sterlite were lured by Harshad's sales pitch and by February 1998, the market was buzzing about the return of the Big Bull. Sebi's investigations show that from April to June 4, 1998, BPL, Videocon and Sterlite's scrip prices moved up 137 per cent, 232 per cent and 41 per cent respectively, even while the bellwether BSE Sensex declined 11 per cent due to various domestic and international factors. But April 1998 was very different from April 1992. Harshad had limited access to funds, his trading cards were suspended. More importantly, he needed to create a large network of front companies to do his business. Sebi refers to these as the Damayanti Group. The companies included Damayanti Finvest, CDP Fincap and Leasing, KRN Finvest and Leasing, Rijuta Finvest and
Ikshu Finvest which operated through a set of brokers and sub-brokers who did Harshad's bidding. All these companies had the same address: 1208 Maker Chambers V, Nariman Point, Bombay 400 021 -- once famous as Harshad's nerve centre and the office of Growmore Research & Asset Management Ltd. He also started another set of companies in keeping with his plans. They were Money Television Industries, Esquire International, Starshare Investment and Finanz, Stable Constructions and New Prabhav Finvest. The Damayanti group began to face payment difficulties and papered this over by rolling their positions from one bourse to another and transferring positions among brokers though a system of kaplis or credit notes. (This was a loophole for manipulation, which has since been plugged). Sebi says the Bombay Stock Exchange, which was perfectly aware about Harshad's shenanigans, not only failed to take "effective surveillance measures", but also lowered margins in these scrips and later tried to bail him and his brokers out by arm-twisting companies to cover the payment default. They also opened the trading system in the middle of the night to insert synchronised trades at prices that were completely out of line with the day's trading. When the payment crisis hit the market, it was common knowledge that Harshad had gone broke. Newspapers wrote about it, but Sebi's job was to track his front companies and to link them to him. That was a tough proposition, since Sebi has limited powers of search and seizure. At every stage, Harshad's people fudged their answers, refused to co-operate and tried to cover their tracks. Yet, the 1999 investigation was complete. Sebi found that four persons -- Anil Doshi, Dinesh Doshi, Dilip Shah and Vinod Shah -- were directors of the Damayanti group in various permutations and combinations. The first two were his wife's brothers. The latter two claimed they were just salaried employees and had carried out orders. Pankaj Shah, Sunil Samtani and Atul Parikh, who were co-accused with Mehta in 1992, were also an important part of the front operators. After searches at the Damayanti offices, Sebi established links to Harshad through telephone bills, payment to lawyers, investment details and brokers such as LKP Securities and Digital Leasing. Travel bills found at Harshad's office were key to linking the Mehtas. Though the bills and invoices of the two travel agencies -- Taurus Travels and Bonik Travels -- were fudged to show purchases in the names of company
employees, Sebi managed to verify through the airlines that it was Harshad Mehta, his family and associates who had actually traveled on the tickets. It also found payments to the tune of Rs 1.4 million made from the front companies to Harshad's lawyers Mahesh Jethmalani, S D Jaisinghani, and Chougle & Co when they had sought no legal advice from them. Sebi also tracked telephone calls from the Damayanti group to senior BPL executives such as its director T C Chauhan, who admitted he had made the calls to Harshad at the Damayanti group offices. Sebi hit pay dirt when it found a document from the Damayanti office which listed details of investments of Rs 1.46 billion in BPL, Videocon and Sterlite in the second week of June, which pertained to the BSE and NSE settlements of that period. The document also connected Harshad Mehta's activities to a series of brokers -- El Dorado Guarantee, Dil Vikas Finance, LKP Securities, Madhukar Sheth, Sony Securities and GNH Global Securities. Of these, Madhukar Sheth and LKP have figured prominently in the 2001 debacle too. S S Gulati of LKP Shares and Stockbrokers and Digital Leasing, which had tried to recover money from Harshad Mehta, provided further corroboration. Shrenik Jhaveri and Bharat Khona were two other brokers who informed Sebi that Harshad had delivered a large quantity of BPL shares to them through the front companies in lieu of old liabilities. The key to Mehta's market manipulations were his dealings with BPL, Videocon and Sterlite which were finally barred last week from accessing the capital market for four, three and two years respectively. Sebi discovered that these companies lent Harshad the initial money to build up concentrated position in these counters. The outstanding purchases were particularly heavy at the end of each settlement period in order to provide price benchmarks for the next settlement. In fact, at one stage the brokers operating in BPL for the Damayanti group accounted for 70 per cent of the total outstanding position of the scrip on the BSE -- a clear indicator that the BSE was studiously turning a blind eye to their activities. Interestingly, another set of brokers operating on the NSE took delivery of 70 per cent of the total delivery for BPL in settlement no 22 of 1998 -- indicating how positions were rolled over from on bourse to another. Exactly the same operation was replicated in Videocon and Sterlite as well. Having established that the Damayanti Group was set up by Harshad Mehta, the rest was easy. The three corporate houses did not even cover their
tracks as we show in the next two parts. As Sebi points out, such cornering of shares and price manipulation created an artificial market that ultimately led to the collapse and was detrimental to the interest of investors in general.
When the scam broke out, he was called upon by the banks and the financial institutions to return the funds, which in turn set into motion a chain reaction, necessitating liquidating and exiting from the positions which he had built in various stocks. The panic reaction ensued, and the stock market reacted and crashed within days. He was arrested on June 5, 1992 for his role in the scam. His favorite stocks included • ACC • Apollo Tyres • Reliance • Tata Iron and Steel Co. (TISCO) • BPL • Sterlite • Videocon. The extent The Harshad Mehta induced security scam, as the media sometimes termed it, adversely affected at least 10 major commercial banks of India, a number of foreign banks operating in India, and the National Housing Bank, a subsidiary of the Reserve Bank of India, which is the central bank of India. As an aftermath of the shockwaves which engulfed the Indian financial sector, a number of people holding key positions in the India's financial sector were adversely affected, which included arrest and sacking
of K. M. Margabandhu, then CMD of the UCO Bank; removal from office of V. Mahadevan, one of the Managing Directors of India’s largest bank, the State Bank of India. The end The Central Bureau of Investigation which is India’s premier investigative agency, was entrusted with the task of deciphering the modus operandi and the ramifications of the scam. Harshad Mehta was arrested and investigations continued for a decade. During his judicial custody, while he was in Thane Prison, Mumbai, he complained of chest pain, and was moved to a hospital, where he died on 31st December 2001. His death remains a mystery. Some believe that he was murdered ruthlessly by an underworld nexus (spanning several South Asian countries including Pakistan). Rumour has it that they suspected that part of the huge wealth that Harshad Mehta commanded at the height of the 1992 scam was still in safe hiding and thought that the only way to extract their share of the 'loot' was to pressurise Harshad's family by threatening his very existence. In this context, it might be noteworthy that a certain criminal allegedly connected with this nexus had inexplicably surrendered just days after Harshad was moved to Thane Jail and landed up in imprisonment in the same jail, in the cell next to Harshad Mehta's. Mumbai: Just as the year 2001 was coming to an end, Harshad Shantilal Mehta, boss of Growmore Research and Asset Management, died of a massive heart attack in a jail in Thane. And thus came to an end the life of a man who is probably the most famous character ever to have emerged from the Indian stock market. In the book, The Great Indian Scam: Story of the missing Rs 4,000 crore, Samir K Barua and Jayanth R Varma explain how Harshad Mehta pulled off one of the most audacious scams in the history of the Indian stock market. Harshad Shantilal Mehta was born in a Gujarati Jain family of modest means. His early childhood was spent in Mumbai where his father was a small-time businessman. Later, the family moved to Raipur in Madhya Pradesh after doctors advised his father to move to a drier place on account of his indifferent health.
The Bernard Madoff scam
Bernard Lawrence "Bernie" Madoff (born April 29, 1938) is an incarcerated former American stock broker, investment adviser, non-executive chairman of the NASDAQ stock market, and the admitted operator of what has been described as the largest Ponzi scheme in history. Madoff was born into a Jewish family, Ralph and Sylvia (née Muntner) Madoff in the New York City borough of Queens, on April 29, 1938. Madoff graduated fromFar Rockaway High School in 1956, attended the University of Alabama for one year, where he became a brother of the Tau Chapter of the Sigma Alpha Mu fraternity, then transferred to and graduated from Hofstra College in 1960 with a B.A. in political science. In 1959, Madoff married Ruth Alpern, who graduated from Queens College and worked in the stock market
in Manhattan. She later worked in Madoff's firm, and founded the Madoff Charitable Foundation
Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960. He was its chairman until his arrest on December 11, 2008. The firm started as a penny stock trader with $5,000 ($36,731 in current dollar terms) that Madoff earned from working as a lifeguard and sprinkler installer. His business grew with the assistance of his father-in-law, accountant Saul Alpern, who referred a circle of friends and their families. Initially, the firm made markets (quoted bid and ask prices) via the National Quotation Bureau's Pink Sheets. In order to compete with firms that were members of the New York Stock Exchange trading on the stock exchange's floor, his firm began using innovative computer information technology to disseminate its quotes. After a trial run, the technology that the firm helped develop became the NASDAQ. The firm functioned as a third-market provider, which bypassed exchange specialist firms, by directly executing orders over the counter from retail brokers. At one point, Madoff Securities was the largest market maker at the NASDAQ and in 2008 was the sixth largest market maker on Wall Street.  The firm also had an investment management and advisory division, which it did not publicize, that was the focus of the fraud investigation. Madoff was "the first prominent practitioner of payment for order flow, in which a dealer pays a broker for the right to execute a customer's order. This has been called a "legal kickbac
HOW IT WORKED
Every great scheme needs a cover story in order to shield it from scrutiny. With something like the Madoff Ponzi scheme however, the cover story is vitally important because of the absolutely ridiculous returns that Madoff was generating through the processes that eventually resulted in the Madoff scandal in 2008. A Ponzi scheme is a type of fraud that is a really simple investing scheme. An investment company or investment manager promises potential clients a high return on their investments with low risk. From 1982 to 1992, Madoff Securities was able to generate a return to its clients of more than 15% per year. That is something that ended up catching the attention of a number of people that in turn started interviewing
him in different media outlets. Madoff deflected attention from this particular story by pointing out that the S&P 500 index actually generated an average return per annum of 16.3% over the course of the same period of time. In the financial world, an arbitrage situation is one wherein a person invests in multiple outcomes with the knowledge that those outcomes allow you to make a profit no matter which way the market turns. They are essentially can’t lose propositions and according to Madoff, he knew about a lot of them and used them in order to generate the returns that he was later able to give back to his clients. It is this ruthless and cold-blooded premeditation with billions of dollars that has made him one of the most hated people in the modern financial world. Because of that, he will also be a person that is talked about quite a bit as time goes on. Madoff pretended he was running a legitimate financial business when in reality he was putting together one of the greatest Ponzi schemes of all time. The investigators that believe he had been in the illegal active ties at least in part since the 1970s, there are grounds to be very worried about how the different parts of the regulatory framework of the financial system within the United States are working. There was a report released in 2007 by the Financial Industry Regulatory Authority that actually pointed out that Madoff Securities had different sections that did not seem to service any customers. At the same point in time, there were various red flags about the way in which Madoff was doing business that did seem to alert many of the other outside agencies as to the fact that fraud of some kind might be going on in his firm. One reason that has been put forward regarding the Madoff scandal being so successful for so long is that a lot of people did not really want to mess with Bernie Madoff. Another thing that people point to is the almost incestuous relationship that Madoff’s family had with Washington. There were multiple instances over the course of time when legislation that would have helped Madoff maintain his veil of secrecy over the operations of his firm was passed. He definitely had a lot of beneficial non-regulation thrown his way. Whether that was because of his family’s relationship to Washington or just coincidental is another point of debate for many people. Many large clients like Union Bancaire Privee and Fairfield Greenwich Group claimed that after taking a close look at his business practices, they did not see anything unusual with the way in which he did his business. By promising modest rather than overwhelming returns to that smaller number of larger clients, Madoff was able to run his Ponzi scheme with a slightly
higher health level since the percentage gain that he was required to pay out to each successive person was a bit smaller.
THE FALL OF THE GIANT
There were ample signs that Madoff's operation was fraudulent. He made his reputation and his millions by delivering solid returns of 1 or 2 percent a month to his investors month in and month out from the day he launched his investment advisory business as an adjunct to his brokerage firm. Wealthy investors and hedge fund operators marveled as Madoff worked his "magic" in bull markets and bear markets alike, regardless of the gyrations on the stock market. It started with an inkling that the downturn in the stock market was on its way. As the economy started to get worse, the Democratic candidate started to go up in the polls. This is relevant because eventually it was Bernie Madoff that ended up becoming the poster boy for the terrible shape in which the regulatory framework of the government was. The returns from the stock market were able to allow Madoff to keep his Ponzi scheme going, but when the stock market started to unravel it became pretty obvious that Madoff was definitely in deep trouble.
His $17 billion investment advisory business was "a giant Ponzi scheme," continue to widen. According to a criminal complaint filed by the FBI and a civil action brought by the Securities and Exchange Commission (SEC), the elderly Madoff estimated that the losses from his fraud exceeded $50 billion. The tally of losses already reported by banks, hedge funds and wealthy investors climbed over the weekend to nearly $20 billion. Banks and hedge funds around the world—in the US, Britain, Italy, Spain, France, Switzerland and Japan—are reporting hundreds of millions and even billions in losses. University endowments, charities and other institutions that entrusted their money to Madoff or to hedge funds that invested in Madoff's company are reeling from the news that their investments are worthless. The largest victim of Madoff’s scheme was probably the Fairfield Greenwich Group, with around $7.3 billion invested in over 15 years. During this entire time, Madoff gave them an annual return which was over the regular interest rates by 4 to 6 percent. HSBC was another big victim of Madoff’s Ponzi scheme, with over $1 billion, which were loaned to clients that wanted to invest with Madoff’s company. Santander, which is a very large European bank, invested around $3.1 billion, while Fortis Bank and Access International invested $1.4 billion each, Union Bancaire Privet put $1.1 billion and Tremont Capital lost a staggering $3.3 billion. Even schools lost money to Madoff, some examples being Bard College, the New York University, the Maimonides School and others. Prominent and wealthy individuals—including J. Ezra Merkin, the chairman of GMAC, Fred Wilpon, the principal owner of the New York Mets, Norman Braman, the former owner of the Philadelphia Eagles professional football team, Frank Lautenberg, the multimillionaire Democratic senator from New Jersey, and Mortimer Zuckerman, the owner of the New York Daily News, Steven Spielberg, actor Kevin Bacon, the owners of the New York Mets, and others. —are among those who have lost millions. Some of Madoff's investors are actually out on the street, living out of cars and RV's. Among the thousands and even tens of thousands of individuals likely to be affected is no small number of retirees of relatively modest means whose life savings were tied into Madoff's operation. The fallout from the Madoff scandal will inevitably result in the failure of other investment firms, impacting thousands more individuals and hundreds more businesses.
The returns from the stock market were able to allow Madoff to keep his Ponzi scheme going, but when the stock market started to unravel it became pretty obvious that Madoff was definitely in deep trouble. Over the days leading up to his arrest, Madoff attempted to get more money from other people and use that money to pay off the existing debts that he had. He was in full damage control mode, but after a period of time it became apparent that he was not going to be able to go very far under the current damage control mode that he was in. When it became obvious to Madoff that he was finished, he actually went into consolidation mode. Forgetting about his investors entirely, Madoff tried to have bonuses paid out to the different company employees in order to secure for his own people the funds that were still remaining in the company. Interestingly enough, it is quite possible that Madoff might have been successful in this scheme were it not for the fact that two unlikely candidates stopped him dead in his tracks. Those two candidates were his sons. Mark Madoff and Andrew Madoff were both employees in the firm and their father came to them with the plan to pay out bonuses to the employees from the $200 million or so that the company still possessed at the time, down from the billions that it had been
worth just a few months earlier. His sons demanded to know how he could have come up with such a bad idea. To them, paying out bonuses to employees of the company when the company did not even have the liquidity available to meet commitments to its investors was the height of irresponsibility. It was at that point that Madoff was forced to admit to them that the asset management wing of his company was nothing more than a Ponzi scheme. Shocked to find that out, his sons immediately reported him to the authorities and they came and arrested Madoff. He was handed a sentence that was worth 150 years in prison. He was also ordered to pay back $170 billion in restitution, money that might be meaningless now given the fact that he really did not have the ability to come up with that amount of money at any point in time. Additionally, since Madoff is already in his seventies, one would think that he might not even get a chance to serve the first 10% of his prison term before he eventually ends up dying in prison. That is something that will definitely happen to him, the only question really is when. The 150 year sentence was far more of a statement than it was anything of practical importance.
THE ENRON SCANDAL
The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron undoubtedly is the biggest audit failure. Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, through the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives were able to mislead Enron's board of
directors and audit committee of high-risk accounting issues as well as pressure Andersen to ignore the issues.
Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enron's auditor, Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U.S. Supreme Court, the firm had lost the majority of its customers and had shut down. Employees and shareholders received limited returns in lawsuits, despite losing billions in pensions and stock prices. As a consequence of the scandal, new regulations and legislation were enacted to expand the reliability of financial reporting for public companies. One piece of legislation, the Sarbanes-Oxley Act, expanded repercussions for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. The act also increased the accountability of auditing firms to remain objective and independent of their clients.
WHAT HAPPENED TO ENRON?
The collapse of Enron caught almost everyone by surprise, from employees and investors to analysts and creditors. But how did the seventh largest company in the Fortune 500 plummet into bankruptcy and implode so quickly? The Enron story comes in three stages • Stage 1: The Company leveraged itself through debt, which it used to grow its non-core wholesale energy operations and service business. Some of this debt was reportable on the company's balance sheet, and some was not. No problem for the company, as long as the stock price held up. • Stage 2: The stock price fell. When that happened, off-balancesheet liabilities put pressure on debt agreements, and eventually led to credit downgrades.
Stage 3: The margins in this business are very thin and lower credit quality increased Enron's cost of borrowing to the point where the whole company fell into a liquidity trap.
Movement of Enron’s share price (USD):
Enron's stock price, which hit a high of US$90 per share in mid-2000, caused shareholders to lose nearly $11 billion when it plummeted to less than $1 by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) began an investigation, and Dynegy offered to purchase the company at a fire sale price. When the deal fell through, Enron filed for bankruptcy on December 2, 2001 under Chapter 11 of the United States Bankruptcy Code, and with assets of $63.4 billion, it was the largest corporate bankruptcy in U.S. history until WorldCom's 2002 bankruptcy.
As the energy markets, and in particular the electrical power markets were deregulated, Enron’s business expanded into brokering and trading electricity and other energy commodities. The deregulation of these markets was a key Enron strategy as it invested time and money in lobbying Congress and state legislatures for access to what traditionally had been publicly provided utility markets. Some of Enron’s top executives became frequently named corporate political patrons of the Republican Party. Enron needed the federal government to allow it to sell energy and other commodities. According to the Center for Responsive Politics, between 1989 and 2001, Enron contributed nearly $6 million to federal parties and candidates It was one of the first amongst energy companies to begin trading through the Internet, offering a free service that attracted a vast amount of customers. But while Enron boasted about the value of products that it bought and sold online – a mind-boggling $880bn in just two years – the company remained silent about whether these trading operations were actually making any money. At about this time, it is believed that Enron began to use sophisticated accounting techniques to keep its share price high, raise investment against it own assets and stock and maintain the impression of a highly successful company. Enron's 2000 annual report reported global revenues of $100bn. Income had raised by 40% in three years. Financial Reporting Enron’s complex business model—reaching across many products, including physical assets and trading operations, and crossing national borders— stretched
the limits of accounting.6 Enron took full advantage of accounting limitations in managing its earnings and balance sheet to portray a rosy picture of its performance. Two sets of issues proved especially problematic. First, its trading business involved complex long-term contracts. Current accounting rules use the present value framework to record these transactions, requiring management to make forecasts of future earnings. This approach, known as mark-to-market accounting, was central to Enron’s income recognition and resulted in its management making forecasts of energy prices and interest rates well into the future. Second, Enron relied extensively on structured . Finance transactions that involved setting up special purpose entities. These transactions shared ownership of specific cash flows and risks with outside investors and lenders. Traditional accounting, which focuses on arms-length transactions between independent entities, faces challenges in dealing with such transactions. Accounting rule-makers have been debating appropriate accounting rules for these transactions for several years. Meanwhile, mechanical conventions have been used to record these transactions, creating a divergence between economic reality and accounting numbers.
Enron’s accounting problems in late 2001 were compounded by its recognition that several new businesses were not performing as well as expected. In October 2001, the company announced a series of asset write-downs, including after tax charges of $287 million for Azurix, the water business acquired in 1998, $180 million for broadband investments and $544 million for other investments. In addition, on October 5, 2001, Enron agreed to sell Portland General Corp., the electric power plant it had acquired in 1997, for
$1.9 billion, at a loss of $1.1 billion over the acquisition price. These writeoffs and losses raised questions about the viability of Enron’s strategy of pursuing its gas trading model in other markets. In summary, Enron’s gas trading idea was probably a reasonable response to the opportunities arising out of deregulation. However, extensions of this idea into other markets and international expansion were unsuccessful. Accounting games allowed the company to hide this reality for several years. Capital markets largely ignored red gas associated with Enron’s spectacular reported performance and aided the company’s pursuit of an awed expansion strategy by providing capital at a remarkably low cost. Investors seemed willing to assume that Enron’s reported growth and pro. Stability would be sustained far into future, despite little economic basis for such a projection. The market response to the announcements of accounting irregularities and business failures was to halve Enron’s stock price and to increase its borrowing costs. For a company that had relied heavily on outside finance to fund its trading businesses and acquisitions, the results were equivalent to a run on the bank. On November 8, 2001, Enron sought to avoid bankruptcy by agreeing to being acquired by a smaller competitor, Dynergy. On November 28, Enron’s public debt was downgraded to junk bond status, and Dynergy withdrew from the acquisition. Finally, with its stock price at only $0.26 on December 2, 2001, Enron led for bankruptcy.
THE CHRONOLOGY OF THE FALL:
20 Feb, 2001 A Fortune story calls Enron a highly impenetrable Co. that is piling on debt while keeping the Wall Street in dark. 14 Aug, 2001 Jeff Skilling resigned as chief executive, citing personal reasons. Kenneth Lay became chief executive once again. 12 Oct, 2001 Arthur Anderson legal counsel instructs workers who audit Enron’s books to destroy all but the most basic documents. 16 Oct, 2001 Enron reports a third quarter loss of $618 million. 24 Oct 2001 CFO Andrew Fastow who ran some of the controversial SPE’s is replaced. 8 Nov 2001
The company took the highly unusual move of restating its profits for the past four years. It admitted accounting errors, inflating income by $586 million since 1997. It effectively admitted that it had inflated its profits by concealing debts in the complicated partnership arrangements. 2Dec,2001 Enron filed for Chapter 11 bankruptcy protection and on the same day hit Dynegy Corp. with a $10 billion breach-of-contract lawsuit. 12 Dec 2001 Anderson CEO Jo Berardino testifies that his firm discovered possible illegal acts committed by Enron. 9 Jan 2002 U.S. Justice department launches criminal investigation. Hence within three months Enron had gone from being a company claiming assets worth almost £62bn to bankruptcy. Its share price collapsed from about $95 to below $1.
Role of Andersen: Arthur Andersen – one of the world's five leading accounting firms - was the auditor to Enron. When the scandal broke. Andersen’s chief auditor for Enron, David Duncan, ordered the shredding of thousands of documents that might prove compromising. Andersen has dismissed Mr Duncan and Andersen’s chief executive at the time of the Enron collapse, Jo Berardino, resigned at the end of March 2002 Besides obstruction of justice, Andersen also faces charges that it improperly approved of Enron's off-balance-sheet partnerships, called "special purpose entities", which the company used illicitly to hide losses from investors. Creative Accounting: The Special Purpose Entities (SPE’s) At the heart of Enron's demise was the creation of partnerships with shell companies, these shell companies, run by Enron executives who profited richly from them, allowed Enron to keep
hundreds of millions of dollars in debt off its books. But once stock analysts and financial journalists heard about these arrangements, investors began to lose confidence in the company's finances. The results: a run on the stock, lowered credit ratings and insolvency. According to claims and counter-claims filed in Delaware court hearings; many of the most prominent names in world finance - including Citigroup, JP Morgan Chase, CIBC, Deutsche Bank and Dresdner Bank - were still involved in the partnership, directly or indirectly, when Enron filed for bankruptcy. Originally, it appears that initially Enron was using SPE's appropriately by placing non energy related business into separate legal entities. What they did wrong was that they apparently tried to manufacture earnings by manipulating the capital structure of the SPEs; hide their losses; did not have independent outside partners that prevented full disclosure and did not disclose the risks in their financial statements. There should be no interlocking management: The managers of the off balance sheet entity cannot be the same as the parent company in order to avoid conflicts of interest. The ownership percentage of the off balance sheet entity should be higher than 3% and the outside investors should not be controlled or affiliated with the parent: This was clearly not the case at Enron. Enron, in order to circumvent the outside ownership rules funneled money through a series of partnerships that appeared to be independent businesses, but which were controlled by Enron management. The scope and importance of the off-balance sheet vehicles were not widely known among investors in Enron stock, but they were no secret to many Wall Street firms. By the end of 1999, according to company estimates, it had moved $27bn of its total $60bn in assets off balance sheet.
Satyam is the fourth largest IT service provider in India and is enlisted in New York Stock Exchange. The company also boasts a clientlist of who-is-who of the industry and has more than 50,000 people on its pay roll. Satyam scandal has cast a shadow over the outsourcing industry of India, and has shook the confidence of the investors in the Indian market. The financial irregularities of such a high level were unheard of in the IT sector until yet but the recent developments in Satyam has raised questions about the management of companies of such a repute.
Ramalinga Raju and his brother Rama Raju, accused of committing a Rs40 billion fraud that threaten to shake the very foundation of Satyam Computers. The Government has further offered financial support to bail out the beleaguered Satyam. The 50,000 odd employees of Satyam find themselves at sea, with some IT majors deciding against hiring displaced Satyam staff. There are fears over the adverse fallouts of the Satyam fraud on the international reputation of the exports-driven Indian IT industry. Byrraju Ramalinga Raju founded Satyam Computers in 1987 and was its Chairman until January 7, 2009 when he resigned from the Satyam board after admitting to cheating six million shareholders, some of whom have lost their entire life savings.. After being held in Hyderabad's Chanchalguda jail on charges including cheating, embezzlement and insider trading, Raju was granted bail on 18 August 2010.
WHAT BASICALLY HAPPENED?
The Satyam Computer Services scandal was publicly announced on 7 January 2009, when Chairman Ramalinga Raju confessed that Satyam's accounts had been falsified.
Chairman Ramalinga Raju resigned after notifying board members and the Securities and Exchange Board of India (SEBI) that Satyam's accounts had been falsified Raju confessed that Satyam's balance sheet of 30 September 2008 contained:
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Inflated figures for cash and bank balances of 5,040 crore (US$ 1.09 billion) as against 5,361 crore (US$ 1.16 billion) crore reflected in the books. An accrued interest of 376 crore (US$ 81.59 million) which was nonexistent. An understated liability of 1,230 crore (US$ 266.91 million) on account of funds was arranged by himself. An overstated debtors' position of 490 crore (US$ 106.33 million) (as against 2,651 crore (US$ 575.27 million) in the books).
Raju claimed in the same letter that neither he nor the managing director had benefited financially from the inflated revenues. He claimed that none of the board members had any knowledge of the situation in which the company was placed.
Following is a copy of his letter To the Board of Directors Satyam Computers Services Ltd. From B. Ramalinga Raju Chairman, Satyam Computer Servcies Ltd
Dear Board Members, 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 balance of Rs 5,040 crore (as against Rs 5361 crore refglected in the books) b) An accured 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 over stated debtor position of Rs 490 crore (as against Rs 2651 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 revenues) as against the actual revenues of Rs 2,112 crore and an actual operating margin of Rs 61 crore (3 per cent of revenue). This has resulted in artificial cash and bank balances going up by Rs 588 crore in Q2 alone. 3. The gap in the balance sheet has arisen purely on account of inflated profits over a period of last several years (limited only to Satyam standalone, books of subsidiaries reflecting true performance). What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of the company operations grew significantly (annualized revenue run rate of Rs 11,276 crore in the September quarter, 2008 and official reserves of Rs 8.392 crore). The differential in the real profits and the one reflected in the books was further accentuated by the fact that the company had to carry additional resources and assets to justify higher level of operations – thereby significantly increasing the costs. Every attempt made to eliminate the gap failed. As the promoters held a small percentage of equity, the concern was the poor performance would result in a takeover, thereby exposing the gap. The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones. It was like riding a tiger, not knowing how to get off without being eaten.
Raju had appointed a task force to address the Maytas situation in the last few days before revealing the news of the accounting fraud. After the scandal broke, the then-board members elected Ram Mynampati to be Satyam's interim CEO. Mynampati's statement on Satyam's website said: "We are obviously shocked by the contents of the letter. The senior leaders of Satyam stand united in their commitment to customers, associates, suppliers and all shareholders. We have gathered together at Hyderabad to strategize the way forward in light of this startling revelation." On 10 January 2009, the Company Law Board decided to bar the current board of Satyam from functioning and appoint 10 nominal directors. "The current board has failed to do what they are supposed to do. The credibility of the IT industry should not be allowed to suffer." said Corporate Affairs Minister Prem Chand Gupta. Chartered accountants regulator ICAI issued show-cause notice to Satyam's auditor PricewaterhouseCoopers (PwC) on the accounts fudging. "We have asked PwC to reply within 21 days," ICAI President Ved Jain said. On the same day, the Crime Investigation Department (CID) team picked up Vadlamani Srinivas, Satyam's then-CFO, for questioning. He was arrested later and kept in judicial custody. On 11 January 2009, the government nominated noted banker Deepak Parekh, former NASSCOM chief Kiran Karnik and former SEBI member C Achuthan to Satyam's board. Analysts in India have termed the Satyam scandal India's own Enron scandal. Some social commentators see it more as a part of a broader problem relating to India's caste-based, family-owned corporate environment Immediately following the news, Merrill Lynch now a part of Bank of America and State Farm Insurance terminated its engagement with the company. Also, Credit Suisse suspended its coverage of Satyam.. It was also reported that Satyam's auditing firm PricewaterhouseCoopers will be scrutinized for complicity in this scandal. SEBI, the stock market regulator, also said that, if found guilty, its license to work in India may be revoked. Satyam was the 2008 winner of the coveted Golden Peacock Award for Corporate Governance under Risk Management and Compliance Issues, which was stripped from them in the aftermath of the scandal. The New York
Stock Exchange has halted trading in Satyam stock as of 7 January 2009. India's National Stock Exchange has announced that it will remove Satyam from its S&P CNX Nifty 50-share index on 12 January. The founder of Satyam was arrested two days after he admitted to falsifying the firm's accounts. Ramalinga Raju is charged with several offences, including criminal conspiracy, breach of trust, and forgery. Satyam's shares fell to 11.50 rupees on 10 January 2009, their lowest level since March 1998, compared to a high of 544 rupees in 2008. In New York Stock Exchange Satyam shares peaked in 2008 at US$ 29.10; by March 2009 they were trading around US $1.80. The Indian Government has stated that it may provide temporary direct or indirect liquidity support to the company. However, whether employment will continue at pre-crisis levels, particularly for new recruits, is questionable. On 14 January 2009, Price Waterhouse, the Indian division of PricewaterhouseCoopers, announced that its reliance on potentially false information provided by the management of Satyam may have rendered its audit reports "inaccurate and unreliable”. On 22 January 2009, CID told in court that the actual number of employees is only 40,000 and not 53,000 as reported earlier and that Mr. Raju had been allegedly withdrawing INR 20 crore rupees every month for paying these 13,000 non-existent employees.
ROOTS Prof. Sapovadia, in his study, shows that in spite of there being a strong corporate governance framework and strong legislation in India, top management sometimes violates governance norms either to favour family members or because of jealousy among siblings. He finds that there is a lack of regulatory supervision and inefficiency in prosecuting violators. He investigates in detail the recent governance failure at India's 4th largest IT firm, Satyam Computers Services Limited, and considers possible reasons underlying such large failures of oversight.
NEW CEO AND SPECIAL ADVISORS On 5 February 2009, the six-member board appointed by the Government of India named A. S. Murthy as the new CEO of the firm with immediate effect. Murthy, an electrical engineer, has been with Satyam since January 1994 and
was heading the Global Delivery Section before being appointed as CEO of the company. The two-day-long board meeting also appointed Homi Khusrokhan (formerly with Tata Chemicals) and Partho Datta, a Chartered Accountant as special advisors
MAHINDRA SATYAM Mahindra Satyam (formerly known as Satyam Computer Services Ltd) was founded in 1987 by B Ramalinga Raju. The company offers consulting and information technology (IT) services spanning various sectors, and is listed on the New York Stock Exchange, the National Stock Exchange (India) and Bombay Stock Exchange (India). In June 2009, the company unveiled its new brand identity “Mahindra Satyam” subsequent to its takeover by the Mahindra Group’s IT arm, Tech Mahindra. In 2008, Satyam attempted to acquire Maytas Infrastructure and Maytas Properties founded by family relations of company founder Ramalinga Raju for $1.6 billion, despite concerns raised by independent board directors. Both companies are owned by Raju's sons. This eventually led to a review of the deal by the government, a veiled criticism by the vice president of India and Satyam's clients re-evaluating their relationship with the company. Satyam's investors lost about INR 3,400 crore in the related panic selling.