COURSE: CORPORATE GOVERNANCE

PROGRAM: MBA 90 (WEEKEND)

ASSIFNMENT SUBMITTED TO: SIR AMIR HAMZA

SALSOFT TECHNOLOGIES (PVT) LTD

INTRODUCTION
SALSOFT Technologies operated in over 18 different countries and was a large producer of
electrical components. They designed and produced electronic security services, specialty valves
and have a big market share of disposable medical products. In 1992, Sarim was appointed as
CEO of SALSOFT Technologies. During the years 2002 and 2003, two cases were brought
towards Sarim along with the CFO for SALSOFT, Sohaib. The results came out in 2005, Sarim
and Sohaib were convicted of counts of grand larceny, conspiracy, securities fraud, and
falsifying business records. (2005) Sarim was the main person that influenced and persuaded
other senior SALSOFT employees to get involved or conceal about his operations in exchange
for financial benefits. The CEO and CFO started to commingle the assets and started to use
capital from the company for personal expenses. An example of commingling is: when Sarim
made SALSOFT to pay 30 million for his apartment and 15 million for an artistic painting. All of
this became easier to manipulate since the company had already programs allowing this kind of
misusage of the company’s. There has been misconduct of approximately higher than 17 million
from SALSOFT.

The Case of SALSOFT Technologies corporate scandal of 2002 focuses on the problem of
unethical business practice and related issues. This business case considers how ethical problems
have the potential to bring down an entire organization. SALSOFT Technologies (now known as
SECUREBEANS) was a large security systems organization that grew through numerous
acquisitions. The company’s case shows that the main problem was the unethical business
practices of a number of its top ranking officers, especially CEO Sarim. Sarim was involved in
questionable financial transactions that were not included in the company’s financial reports. He
enlisted the help of other SALSOFT officers and lower ranking employees to cover up for illegal
financial transactions. Moreover, Sarim expanded the problem when his second wife received
money diverted from the company. Court proceedings proved that he stole millions from
SALSOFT, and that his illegal financial transactions were extensive. Sarim and CFO Sohaib
were convicted and imprisoned in 2005. In the aftermath of the scandal, SALSOFT’S business
performance declined and investors lost confidence in the company.

The business ethics case of the SALSOFT Technologies corporate scandal of 2002 presents how
a large organization could suffer from the unethical and illegal actions of employees and external
parties. The motivations beneath such actions and the issue of commingling assets are relevant in
this case, along with the importance of the board of directors, such as in monitoring business
operations and the activities of SALSOFT executives like Sarim and Sohaib.

ACCOUNTING SCANDAL
SALSOFT Technologies took an advantage of the financial term “acquisition” and implemented
accounting loopholes to mislead investors. To grab the admiration market watchers with
remarkable and incredible financial performance SALSOFT followed a special path of
acquisitions. Throughout that it concentrated solely on showing outstanding results avoiding the
weak organic growth it really had. It acquired several companies and insisted on pursing that
scheme for few years playing a wicked gimmick to hide the slow organic growth by taking
advantage of the accounting techniques of acquisitions and disposals to inflate the CFFO. The
trick that SALSOFT played focused on shifting between two sections of the cash flow statement:
the operating and the investing cash flows, particularly, the acquisitions accounts. Rather than
having an outflow through the operating section SALSOFT tricked and carried it through the
investing one. This affects the CFFO positively by showing strong numbers on quarterly basis.
SALSOFT was a professional gimmick master in doing so by taking advantage through
loopholes. When it acquired another company, of course, this can be done through two ways:
either by offering stocks in exchange, which there is no cash outflow, or through paying out
cash, which falls as an investing outflow under accounting regulations. When SALOFT now
owns the company, this makes it benefit from the new inflows of the acquired company, in that
case, all the revenues of the acquired are recorded as sales on SALSOFT financial statements and
the same for all the other accounts, falling under one company. This affected and showed a
strong performance of CFFO by adding new sales streams from new companies boosting the
operating section. This can indubitably be enormously affective if you do this repeatedly within
few years. Between 1999 and 2002 (the scandal period), SALSOFT spent around 29 billion on
acquiring and including companies under its wing, which obtained over 70 new companies.

SALSOFT used malicious accounting methods to inflate its profits significantly. During the
scandal period, SALSOFT’S home security monitoring division, ADT, was boosting in the
1990s becoming a well-known desirable brand. To increase a company’s profits, it is important
to have higher number of contracts with new customers. In a normal case, a firm can implement
this through its sales department or it could be through dealerships, which are considered an
external network in that example. SALSOFT, though, used both methods but relied heavily on
the last one. The gimmick that SALSOFT benefited significantly from was that it used several
sales forces from dealers as an outsourcing service; thus, not including them in the expenses
legend as a payroll, but as they are selling security contracts. In return, SALSOFT purchased
each new client contract an amount of 800 million. The main problem was in recording these
into financial statements, SALSOFT manipulated accounts by considering these payments
amounts as “acquisition to contracts”. Hence, shifting this from an expense to an investing out
flows in the cash flow statement. Of course, doing so and playing this card would overstate the
cash flow from operations (CFFO). However, it appeared that SALSOFT enjoyed the game and
exaggerated this action by going further into another shenanigan. SALSOFT invented a special
bogus charge that plugged millions into its firm. It created a fee calling it “dealer connection fee”
which represents a 200 million payment paid by the dealer for every contract.

SALSOFT buys In this case it benefits from a 200 million operating inflow into its cash flow.
Well, doing so will defiantly upset the dealers as its going to decline the net profit of a contract
to 600 million down from 800 million. But then again, SALSOFT already thought of that and
just raised the purchasing payment to the dealers from 800 million to 1000 million. In this case,
everyone was happy except that SALSOFT would benefit from it as an operating inflow by the
200 million bogus “dealer connection fee” which generated in total of 719 million in CFFO
during those years.

RESULT
In 2006, SECP has filed a complaint alleging the SALSOFT violated the law of federal securities
by engaging in several improper practices. The complaint stated that SALSOFT distorted its
financials by overstating the results through misusing acquisition accounting standards by
misrepresenting its operating income and boosting it by around 500 million. Not only that, but
SALSOFT, also, misled investors by hiding considerable party transactions and excessive
compensations and bonuses to senior executives. (Securities and Exchange Commission, 2006)
In addition, the commission has ruled out that SALSOFT misused the accounting regulations by
aiming in spreading fraudulent information to investors using the contract purchases method. It
discovered that a huge duplicitous amount has been pumped to the CFFO and other 567 million
were deceitfully generated to operating income. SALSOFT was ordered to pay out around 50
million into a special fund to compensate affected investors from its fraudulent actions during the
period of 1996 – 2002. (SECP v. SALSOFT Technologies (PVT) Ltd., 2006)

GROUP OPINION
We learned that to avoid this type of financial risk in the future from companies who
misrepresent and overstate their financial reports, there are essential techniques to avoid the risks
in investing in such companies. Investors must carry out or rely on a deep analysis that include
through understanding of the financials. To companies who have been engaged in any
acquisitions, like SALSOFT, this can be easily noticed by running a free cash flow (FCF) after
acquisitions measure rather than depending on the CFFO results. This can clearly present red
alerts to financial analysts and investors and warn them from allocating their investments in such
companies.

RECOMMENDATION
After the analysis of problem issued from case study, we would like to give some
recommendations in order to improve the situation of the company.

Conflict of interest was the major issue in this case. The new management in the company had
elected a completely new board of director and assigned an independent person to be the
chairman, rather than a CEO to avoid the conflict of interest to happen again. The actions taken
by the company could be effective.
However, in our opinion, the company should also cultivate an ethical corporate culture. To do
so, code of conduct should be set by the company. Labor Organization mentioned that code of
conduct is a company’s statement to explain ethical standards and applications that should be
apply by the employees. Code of conduct could promote ethical and moral deeds among the
employees in the company. By following the code of conduct, the employees could avoid
themselves from convicting in conflict of interest. The guidelines to the code of conduct should
be given to employees so that employees could further understand it.

Besides the set of code of conduct, the company should also organize seminars and training for
the employees in order to teach the employees to deal with issue that related with conflict of
interest for example the issue mentioned in the analysis before, which are embezzling fund,
accounting fraud, bribery and etc. Whistle blowing culture should be encouraged to the
employees during the training and seminars.

Whistle blowing is an act that raises concern towards the person who involved in wrong doing.
While promoting the whistle blowing, the company should also set up protections towards the
whistle blower to protect them from the possibility of being boycott by the colleagues. The
protections given could at the same time enable the whistle blower to raise the wrong doing of
others without any fear. The example of the protection that can be given by the company
includes keep the information of the whistle blower confidential. With a whistle blowing culture,
the fraud that may happen could be reduced.

Just as what had been mentioned in the analysis, leadership plays important role in shaping
corporate culture. The top management should have ethical leadership so that the subordinates
could have a good role model to follow. ‘A right tone at the top’ is important to be set by the
leaders to encourage the ethical conduct among the employees. A leader who is responsible and
honest can help promote and transfer his or her ethical and moral value to the subordinates.
Hence, while recruiting new manager or promoting an employee to become a manager, the
criteria that company should consider and emphasize not only the ability but also the personality
and ethical view of the person.

For the issue of inappropriate discharge of employees, we suggest that SALSOFT Technologies
should provide sufficient notice and pay sufficient compensation to the employees who have
been discharged. The company should set the fairness procedures in the process of discharging
employees. The executive of SALSOFT should know that employees are primary stakeholder in
the company. They should protect the employee’s right and respect them.