UNIT-III: Major corporate Governance Failures: JUNK Bonds (USA), Arthur Andersen

World wide (USA), Harshad Mehta Scam (India), Satyam Computer Services Ltd (India),
Kingfisher Airlines (India); Common Governance Problems in Various Corporate Failures

 Harshad Mehta was an Indian stockbroker, well known for his wealth and for having
been charged with numerous financial crimes that took place in 1992. Of the 27 criminal
charges brought against him, he was only convicted of four, before his death at age 47 in
2001. It was alleged that Mehta engaged in a massive stock manipulation scheme
financed by worthless bank receipts, which his firm brokered in "ready forward"
transactions between banks. Mehta was convicted by the Bombay High Court and
Supreme Court of India for his part in a financial scandal valued at 4999 Crores which
took place on the Bombay Stock Exchange (BSE). The scandal exposed the loopholes in
the Indian banking system, Bombay Stock Exchange (BSE) transaction system and SEBI
further introduced new rules to cover those loopholes. He was tried for 9 years, until he
died in late 2001.

SCAM DETAILS
Let's say we have three banks A, B and C. And a broker X. And obviously, the government.
Now the banks want to make as much profit as they can by using the money just the way they
want. And the government wants to regulate them by making it compulsory for them to invest
some of the money in Government bonds. So the government puts a simple rule that at the end of
every day, A,B and C have to show them a balance sheet and a minimum amount has to be
invested in bonds.

The banks do it for some time but they ask the government for some kind of relaxation. So a new
rule comes where you need to show the balance sheet only on Fridays. The average amount per
day in the bonds has to be over the fixed amount, however, there is no such limit on the daily
amount now.

Now X comes into the scenario. Since A would sell some bonds to invest elsewhere and B may
buy some bonds as well, the banks will now have different amounts of money invested in bonds
everyday and some will have less while some will have more. But all of them need to have that
minimum amount on Friday, so the banks with lesser amounts, i.e, A in this case, would need to
buy the bonds to keep up with the average.
So what does A do? It contacts X to get it some bonds from either B or C.
X is a trusted broker and all the banks know him pretty well. So X tells A that he'll get the bonds
but right now he isn't sure that from whom will the bonds come, B or C. So instead of making
the cheque on the bank's name, A should sign the cheque for X. (Which was illegal, BTW).
So A does that. Now X goes to B and ask for the bonds and using the power of trust, X tells B
that he'll pay the money the next day to which B agrees because he also offered a good return on
the money. See, bonds are important, money may come later too.
Using this trick, X makes sure he always has some money with him.
Now comes part two. The money he had, he invested heavily in the stock market to create a
turmoil, specifically for a few companies like ACC. The market saw a huge run like never before
and share prices of ACC and some others went over the tops.
Once he knew the market was at a peak, he started profit making and markets crashed. The bank
people who were involved with him in the illegal acts panicked and one of them even committed
suicide.
JUNK BONDS (USA)
a high-yielding high-risk security, typically issued by a company seeking to raise capital quickly
in order to finance a takeover.
Michael Robert Milken (born July 4, 1946) is an American former financier and philanthropist.
He is noted for his role in the development of the market for high-yield bonds ("junk bonds"),
As an executive at investment bank Drexel Burnham Lambert Inc. during the 1980s who used
high-yield junk bonds for corporate financing and mergers and acquisitions. Michael Milken
amassed an enormous personal fortune, but in 1989 he was indicted by a federal grand jury and
eventually spent nearly two years in prison after pleading guilty to charges of securities fraud.
While he is credited with founding the high-yield debt market, he was banned for life from the
securities industry.

Nicknamed "The Junk Bond King" in the 1980s, Milken earned between $200 million and $550
million a year at the height of his success.
Junk bonds have survived a dramatic rise and fall in popularity, as well as heated controversy.
Before the 1980s, few companies issued junk bonds. The only ones available were from
established companies that had fallen on hard times. That changed in the late 1970s when young
companies with no credit began issuing bonds that started out as "junk" in order to get off the
ground. Junk bonds became a common investment tool by the early 1980s, setting the stage for
the ambitious trader Michael Milken, who later became known as the "Junk Bond King."
Milken in 1988 before he went to prison (and before he was named one of the world's richest
people in 2006)
One of Milken's more successful and controversial tactics had to do with using junk bonds to
finance hostile takeovers of companies; that is, attempting to buy them against their will. With
junk bonds, the acquiring company could borrow serious cash with little or no assets and use it to
bid on another unwilling company, or target. Believing that a change in management would
make these targets more profitable, the acquiring company would then use the target's newly
acquired assets to repay the debt it incurred to fund the takeover.
  The Satyam Computer Services, scandal was a corporate scandal affecting
India-based company Satyam Computer Services in 2009, in which chairman Ramalinga
Raju confessed that the company's accounts had been falsified

What is the Satyam scam about?

It is about corporate governance and fraudulent auditing practices allegedly in connivance with
auditors and chartered accountants. The company misrepresented its accounts both to its board,
stock exchanges, regulators, investors and all other stakeholders.
It is a fraud, which misled the market and other stakeholders by lying about the company’s
financial health. Even basic facts such as revenues, operating profits, interest liabilities and cash
balances were grossly inflated to show the company in good health.
What: The scandal broke in 2009 when founder-chairman of Satyam Computers Ramalinga
Raju confessed that the company’s accounts were tampered with. He disclosed a Rs.7,000-crore
accounting fraud in the balance sheets.
Who: The 10 people found guilty in the case are: B. Ramalinga Raju; his brother and Satyam's
former managing Director B. Rama Raju; former chief financial officer Vadlamani Srinivas;
former PwC auditors Subramani Gopalakrishnan and T Srinivas; Raju's another brother B
Suryanarayana Raju; former employees G. Ramakrishna, D. Venkatpathi Raju and Ch Srisailam;
and Satyam's former internal chief auditor V.S. Prabhakar Gupta.
When: The timeline of the scam
January 7, 2009: Ramalinga Raju dropped a letter-bomb on unsuspecting investors, employees
and the government confessing to a Rs.7,136-crore fraud committed by him and his close circle
of relatives and employees at the company. Ramalinga Raju resigns. > Read more

 January 8, 2009: Citibank freezes Satyam's 30 accounts.

 January 9, 2009: Ramalinga Raju and his younger brother B. Rama Raju arreste. Central
govt disbands Satyam’s board, to appoint its own 10 directors. >Read more
 Jan 9, 2009: Satyam removed from Sensex, Nifty. >Read more
 Jan 10, 2009: Satyam’s former CFO Srinivas Vadlamani arrested. >Read more
 Jan 11, 2009: Government appoints Deepak Parekh, Kiran Karnik and C. Achuthan to
Satyam board.
 February 2009: CBI takes over investigation, goes on to file three chargesheets.
 Mar 6, 2009: Gets SEBI nod for bidding process to select investor.
 April 22, 2009: Tech Mahindra makes open offer to Satyam shareholders at Rs. 58/share,
offer to close June 9.
 June 22, 2009: Mahindra unveils new brand identity for Satyam, Mahindra Satyam.
>Read more
 2010: Raju says charges levelled by CBI are false.
 November 2, 2011: Supreme Court grants bail to Raju since CBI failed to file
chargesheet on time.
 October 28, 2013: Enforcement Directorate files a criminal complaint against 47 persons
and 166 corporate entities headed by Ramalinga Raju.
 December 8, 2014: Ramalinga Raju and three others given six months jail term by SFIO.
 December 23, 2014: Judge postpones verdict citing voluminous documents.
 March 9, 2015: Special court defers verdict till April 9.
 April 9, 2015: All 10 accused found guilty.
  Vijay Mallya - KINGFISHER
Wilful defaulters can be individuals, juristic persons (groups of individuals, such as corporations,
which are treated by law as though they are persons) and all forms of business enterprises.
With the increased focus, over the past few weeks, on the huge pile of bad loans — The Indian
Express published a multi-part investigation last month on the Rs 1.14 lakh crore of debts written
off by 29 state-owned banks between 2013 and 2015 — Indian banks have declared a few
promoters including Vijay Mallya, director of Kingfisher Airlines who is now believed to be in
the UK, a “wilful defaulter”.
But as lenders and investigative agencies mount pressure to recover the Rs 7,000 crore lent to
Kingfisher Airlines, Mallya has claimed that he and his companies are being labeled wilful
defaulters only on “technical grounds”.
So, what constitutes a wilful default
According to a Reserve Bank of India circular of July 1, 2014, and a subsequent amendment of
January 7, 2015, a default — not meeting loan repayment obligations — is wilful when it fulfils
one of the following four conditions:
* A borrower (or an entity) does not pay up even when it has the capacity to pay,
* a borrower has not used the loan for the purpose borrowed and diverted the money elsewhere,
* a borrower has siphoned off the funds and the money is not available with it in the form of
other assets, and,
* a borrower sells assets given as security against the loan without informing lenders.

Why have Mallya, Kingfisher and United Breweries (Holdings) been named wilful
defaulters?
State Bank of India has alleged that funds were diverted several times from Kingfisher Airlines
to various UB Group companies and other firms. It said as much in an August 2014 notice sent
to Mallya, Kingfisher, United Breweries, and its directors, and filed in the Bombay High Court.
The notice also alleged that United Breweries (Holdings), the parent company, had been
“deliberately avoiding payment to lenders”.

The SBI notice was based on the findings of a forensic audit of Kingfisher Airlines. However,
Mallya has claimed that all inquiries have failed to find any evidence of misappropriation of
funds by him and Kingfisher Airlines. He and United Breweries have challenged the SBI order,
and the case is now pending in the Bombay High Court. Apart from SBI, United Bank of India
and Punjab National Bank have declared Kingfisher and Mallya wilful defaulters.
Who are India’s other prominent wilful defaulters? How much do wilful defaulters owe
Indian banks?
Mallya’s Kingfisher is among the top five wilful defaulters in the country, the others being
Winsome Diamonds and Jewellery, Zoom Developers, Suryavinayak Industries and Deccan
Chronicle Holdings.
Wilful defaulters owe state-owned banks at least Rs 64,335 crore, according to a February 2016
report of the Standing Committee on Finance. That is about 21 per cent of the total non-
performing assets or bad loans of Rs 3.06 lakh crore. At the end of September 2015, State Bank
of India had the most wilful defaulters — 1,160 — who owed it Rs 11,700 crore. Punjab
National Bank had 904 wilful defaulters, who owed it Rs 10,869 crore at the end of December
2015.

So what lies ahead?

Banks' chances of getting their money back from Mallya are very less since Kingfisher hardly
has any assets left for banks. Even if banks go ahead and sell Kingfisher assets such as the
Kingfisher House in Mumbai, it will fetch only a fraction of what is at stake. The only hope for
banks is if Mallya himself have a change of mind and decides to pay back banks from his
personal wealth (Mallya has shares worth Rs7000 crore in various companies and lot more in
fixed assets).

"But, all that will happen if he returns to the country and say he will pay back,” the banker said,
adding that bankers are more irked by Mallya flaunting his wealth publicly even now when
thousands of crores are at stake. According to reports Mallya already received $40 million of his
severance pay from Diageo before he flew to UK. Can the final battle between banks, led by
SBI, and Mallya in Supreme Court and Bangalore DRT result in lenders getting their money
back. Chances are less.
  Andersen Worldwide Société Coopérative (AWSC) was a Swiss-based entity
which managed the global offices of accounting firm Arthur Andersen. It was also the
parent corporation of Andersen Consulting (now called Accenture) before its split in
2000.

Arthur Andersen LLP, based in Chicago, is an American holding company and formerly one of
the "Big Five" accounting firms among PricewaterhouseCoopers, Deloitte Touche Tohmatsu,
Ernst & Young and KPMG, providing auditing, tax, and consulting services to large
corporations. In 2002, the firm voluntarily surrendered its licenses to practice as Certified
Public Accountants in the United States after being found guilty of criminal charges relating to
the firm's handling of the auditing of Enron, an energy corporation based in Texas, which had
filed for bankruptcy in 2001.

The former consultancy and outsourcing arm of the firm, now known as Accenture, which had
separated from the accountancy side in 1987 and renamed themselves after splitting from
Andersen Worldwide in 2000, continues to operate and had become one of the largest
multinational corporations in the world until 2002.

Following the 2001 scandal in which energy giant Enron was found to have reported $100bn in
revenue through institutional and systematic accounting fraud, Andersen's performance and
alleged complicity as an auditor came under intense scrutiny. The Powers Committee (appointed
by Enron's board to look into the firm's accounting in October 2001) came to the following
assessment:

"The evidence available to us suggests that Andersen did not fulfill its professional
responsibilities in connection with its audits of Enron's financial statements, or its obligation
to bring to the attention of Enron's Board (or the Audit and Compliance Committee) concerns
about Enron's internal contracts over the related-party transactions".

The Enron scandal in early 2001 forever changed the face of business. Enron, the once high
flying energy trading company, was exposed as being little more than a slowly unraveling multi-
billion dollar financial scheme. Eventually Enron cost employees and investors billions of dollars
after the company was exposed and forced to go into bankruptcy.

But what made the Enron scandal so compelling was the fact that it brought down accounting
giant Arthur Andersen too. It was a truly amazing situation, a conflation of corporate
wrongdoing which would change the accounting world forever.

Arthur Andersen’s Role in the Enron Scandal

Due to the sometimes complex nature of financial matters, many may not be familiar with the
details of Enron case or Arthur Andersen’s role. While Arthur Andersen was not implicated in
directly assisting Enron in cooking its books, the company was found to have been woefully
negligent in its role of overseeing and auditing Enron’s financials.

Additionally, Andersen was found guilty of obstruction of justice because it shredded documents
related to its audits of Enron. When the scandal broke, the world was shocked that not only could
a Fortune 500 company pull off such massive fraud, but one of the world’s largest accounting
firms looked the other way during the audacious crimes.

Sarbanes Oxley and Management Responsibility

In July 2002 the U.S. Congress enacted the Public Company Accounting Reform and Investor
Protection Act, also known as Sarbanes Oxley. By that point there had been a stunning number
of corporate accounting scandals, including Enron, WorldCom, and a developing scandal
involving Tyco.
Because many top managers of these companies claimed they had been unaware of the
accounting discrepancies, Sarbanes Oxley required corporate leaders to personally certify the
accuracy of their company’s financials.

Other Important Components of Sarbanes Oxley

To address the potential conflicts of interest which can arise, Sarbanes Oxley established a
variety of requirements which govern auditing and accounting firms. Some of the notable
requirements include auditor reporting duties and a restriction which prohibits auditing firms
from providing non-audit related services to companies which they audit. Provisions were also
put in place to prevent corporate analysts from benefiting from conflicts of interest, including the
public disclosure of any potential conflicts of interest.

The Legacy of a Scandal

The legacy of Enron and Arthur Andersen will live long after the public has forgotten about the
scandal. Especially in light of the 2007-2009 financial crisis, lawmakers are likely to continue to
keep companies on a relatively short leash. And in the case that enforcement becomes lax, and
the public forgets the lessons learned, there will surely be another giant corporate scandal to
remind us all to remain vigilant.
  Various reasons for failure of Corporate Governance, Corporate
Governance conists of, various examples of Corporate Governance Failures like Enron,
Satyam, Cadbury, Wal-Mart, Xerox and why Corporate Governance failed in such big
organizations.
A critical factor in many corporate failures was:
 Poorly designed rewards package
 Including excessive use of share options (that distorted executive behaviour towards the
short term)
 The use of stock options, or rewards linked to short-term share price performance (led to
Aggressive earnings management to achieve target share prices)
 Trading did not deliver the earnings targets, aggressive or even fraudulent accounting
tended to occur. This was very apparent in the cases of Ahold, Enron, WorldCom and
Xerox (IFAC, 2003).
In terms of corporate governance issues, Ahold, Enron and WorldCom all suffered from
1. Questionable ethics
2. Behaviour at the top
3. Aggressive earnings management
4. Weak internal control
5. Risk management
6. Shortcomings in accounting and reporting
E.g: Corporate Governance failure at Satyam
It is one of Corporate India's worst unfolding chapters, What could be the reason behind such a
huge collapse? The top level management failed to estimate the intensity of the gangrene in the
organization. Questions also arise on the role of the auditors,and how such a magnitude of
financial fraud could have gone unnoticed. Corporate governance is a field which constantly
investigates how to secure and motivate efficient management of corporations. It has began as a
corporate governance issue back in December has now turned into a major financial scandal for
the ages in India. The shares of Satyam Computer Services has plummeted more than 90% in
trading at the NYSE today, a stark reminder that investors must always cover their backs or else
get racked even by the big names in the industry. NYSE today halted trading in Satyam
Computer at its bourses in the US as well as in Europe after the Chairman disclosed financial
bungling at the Indian IT major.
A business will always have two sides, its not necessary to gain profits everytime, but to sustain
in the market the integrity is vital. Every day in some or the other place there is a merger or an
acquisition happening, but due to the projected image the co-players in the market are dropping
out their plans of taking over Satyam.
Undoubtedly there will be intense focus directed at the other Indian IT Services companies as
well.The Satyam corporate governance failure may also make its competitors bolder in terms of
acquiring market share created by its fallout, provided the indutsry can regain the trust of the
same investors that Satyam has deceived.

From this necessarily brief review of the evidence, and particularly of the sources of failure in
financial firms, draw some tentative conclusions. It is important to recognise, however, the
evidence base for firm recommendations on corporate governance in financial institutions is
thinner than one would like, and certainly not robust enough to offer a standardised set of
recommendations valid at all times and in all places.
Principal conclusions are:

 First, that people are more important than processes. Many of the failed firms, or near
failed firms which we have encountered, had Boards with the prescribed mix of
executives and non-executives, with socially acceptable levels of diversity, with directors
appointed through impeccably independent processes, yet where the individuals
concerned were either not skilled enough for, or not temperamentally suited to, the
challenge role that came to be required when the business ran into difficulty.

 Secondly, and in spite of first conclusion, there are some good practice processes worth
having. Properly constituted audit committees, and Board risk committees can play an
important role, as long as they are prepared to listen carefully to sources of advice from
outside the firm.

 Third, and this is a foundation stone of the FSA's approach, a regulatory regime built on
senior management responsibilities is absolutely essential. In some of the cases we have
wrestled with, senior management did not consider themselves to be responsible for the
control environment and indeed, in the old pre FSA regime, were able successfully to
claim that they were not responsible even if the business failed. So our regulation is built
on a carefully articulated set of responsibilities up and down the business. It is important
that they are not unrealistic. We do not expect the CEO to check in the bottom drawers of
 each of his traders for unbooked deal tickets. But we do expect the CEO to ensure that
there is a risk management structure and a control framework throughout the business
which ought to identify aberrant behaviour, or at least prevent it going on unchecked for
any length of time.

 One consequence of this senior management regime, fourth point, is that regulators must
focus attention on the top level of management in the firm. For the major firms we
regulate we insist that our supervisors have direct access to the Board, and that they
present to the Board their own unvarnished view of the risks the firm is running, and of
how good the control systems are by comparison with the best of breed in their sector.
Unfortunately, we find some resistance to this approach. The management of some of our
firms want to negotiate the regulators assessment, so that when it reaches the Board it is
an agreed paper and sufficiently bland to cause no debate. Well-structured Board, and a
confident management, should welcome an independent view, even expressed at the
Board level, which they may challenge and contest if they wish. And non-executive
directors should find it helpful to see a knowledgeable view of the institution which does
not come from or through its own senior management.

 Fifth and penultimate point may not be a popular one. Boards should take more interest in
the nature of the incentive structure within the organisation. I am not talking solely about
the pay of the CEO, important though that is to get right - as some firms in Britain have
recently discovered. Talking about ensuring that the incentives within the firm, and pay is
a very powerful one, are aligned with its risk appetite. A number of our most problematic
cases have their roots in a misalignment of incentives.

 Lastly, no corporate governance system will work well unless there is some engagement
on the part of shareholders. Boards are responsible to shareholders. That is the received
wisdom in Anglo-American capitalism, at least. But if those shareholders are not
prepared to vote their shares, and show little interest in business strategy, then that
accountability is somewhat notional, and unlikely to be effective. Certainly regulators
cannot hope to substitute for concerned and challenging shareholders, though in some
senses they may complement them.