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Chronology of Satyam Fraud Month Dec 08 Jan 09 What happened Raju family bid to sell Maytas to Satyam falls

through A whistle blower writes a mail to one of the independent directors exposing the fraud and the independent Director fails to get any response Merryl lynch who are advisors to the Maytas sale also gets wind of some thing being wrong writes to SEBI saying that they smell something fishing Ramaliga Raju becomes incommunicado and does not respond to calls Raju writes to SEBI and to the board admitting that the books of accounts have been cooked and the cash balance as stated in the books does not exist Directors, CFO and Auditors arrested and CBI /Serious fraud office starts investigation

Jan 09

Dec 08/Jan 09 Jan 09

Jan 09

Was it accounting jugglery or Fraud


Raju admits that he along with his brother have cooked the books by inflating revenue, receivables and also by artificial head counts and inflation of expenditure cash and have falsified accounts by submitting fake documents to all people including Auditors who certified the books of accounts Is this fraud or mere window dressing of accounts for share price or even assuming that it was accounting manipulation does it amount to fraud on investors

What is fraud
false representation of a matter of factwhether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosedthat deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury.
Fraud must be proved by showing that the defendant's actions involved five separate elements: (1) a false statement of a material fact,(2) knowledge on the part of the defendant that the statement is untrue, (3) intent on the part of the defendant to deceive the alleged victim, (4) justifiable reliance by the alleged victim on the statement, and (5) injury to the alleged victim as a result

So what happened in Satyam can not be called accounting jugglery and it is a fraud on the investors even if it is accounting fraud

Theories on what actually happened in Satyam The most plausible explanation

The theory as confessed by Raju in the letter may be only partially true
What has been stated is not entirely true , the invoicing part was partially true and the part about diversion of salaries into artificial accounts also appears only to be partially true since the SFO / CBI are yet to trace the identity of all the fake employees Raju and family borrowed heavily from money lenders to buy land in the family members names as well as benami names . The benami names and borrowing from secondary market made it extremely difficult to trace the funds The theory is that the company deposit was used as a collateral for security for the borrowed money and the family also pledged the shares with the lenders. The lenders were the tobacco mafia of Guntur and were possibly issuing threats for immediate repayment

Theories on what actually happened in Satyam The most plausible explanation


He created main accounts along with sub accounts and only the sub accounts were considered for the audit purposes and only he and his brother knew about the main account There was pressure building on him for repayment of the borrowings and since the real estate market was going down and was not liquid enough , Also due to the stock market fall the security against shares was inadequate and hence the pressure on the Satyam deposits which was than used for repayment through borrowing in benami names from the banks and repaid the original lenders Subsequent pressure from the banks on the family to repay the bank loans brought things to head and consequent confession How were the Bank documents fudged Theory no one The documents were falsified in the MDs room Theory two since these related to year ending numbers temp money was arranged in these accounts in the last days and immediately withdrawn after the year closing and partially forged documents were arranged for auditors

Who were involved and who were implicated- other than Raju and Raju
Possible Players Possible involvement

CFO

Says he signed the accounts blindly on the basis of Accounts submitted by Junior staff Extremely difficult to believe such statements obviously in the know Likely They have circumvented processes for giving loans / may also be involved in false documents Did not know as claimed by him .. May be true considering the fact that they are supposed to sign the balance sheet and at most times are not intimately involved in the audit finalization All people claimed that they were unaware .At least some of them should have known ( The treasury and control guys) Again all people claimed they were unaware difficult to believe because departmental MIS is a strong tool for business heads and they will know if their incomes are inflated . More so if wages are inflated If they do not know they are either not telling the truth or are simply incompetent

Bankers

Company Secretary

Other senior accounting staff including direct reports

Other senior people and business heads

Internal Audit team

Who were involved and who were implicated- other than Raju and Raju..contd
Possible Players Audit Committee Possible involvement Possibly never independent or believed that some thing done by PWC should be ok benefit of doubt to them Believed in the management , audit committee, statutory auditors and internal auditors Either extremely nave in accepting any documents received by them and not exercising due checks as normally done or fully involved .--- CBI /SFO seems to think they are involved Possibly had complete faith in the management and saw it as a privilege to be on the board of an illustrious company

Independent Directors

Statutory Auditors

Other board members

What are the questions that this scam raises


Questions on Control process

Were there adequate controls in place in the company for revenue recognition in the company and were standard recognition policies followed ? Was there internal controls in place to reconcile head count with salary pay out ? Was there a process for bank account verification and reconciliation at the company level or a process of cash flow planning considering the number of bank accounts that a company is required to have more than 500 accounts ? Was the process of board resolutions related to bank accounts done seriously at board meeting or were simply added as minutes in the BM ? Was an MIS in place which is based on project wise profitability and was the manpower utilization linked to the MIS ? Were the internal control process reviewed by the internal auditors Were the Internal controls and accounting policies reviewed by Statutory auditors as is legally required?

Some specific examples in the following slides where manipulations or simply not following processes could lead to problems

Questions that the scam raises


Were there adequate controls in place in the company for revenue recognition in the company and accounting processes followed ? Normally there are defined process and policies for revenue recognition based on defined revenue recognition rules especially in service industry and can be easily manipulated ( Few illustrations) Manufacturing book sales directly through dealers / direct sales and reverse later especially dealer sales can be difficult to verify Cash business effectively can be used for lowering or increasing income as the case may be Service income for a manufacturing company Xerox copy volume income on an accrual basis Any volume can be assumed and reversed in subsequent year

Questions that this scam raises


Income from software contracts on completion method can be manipulated easily . The revenue is based on certification from prject managers and verification is difficult Normally there is a process of regular certification o work done and invoicing Further fake revenue can be done to parties overesas and remittance can also be managed by body shopping professionals taking travel advance and remitting from overseas advantage all round? Education services can be accounted on due basis /cash basis rather than accrual basis Real estate companies using contract accounting can manipulate based on certification of work done billed /unbilled

The issue is there are defined controls and processes but get accrual system of accounting can be easily manipulated in service industry and can not be easily verifiable

Questions that this scam raises

What are the possible ways in which payroll can be manipulated


False head counts Easy especially when there are huge head counts located across the globe where employees regularly are interchanged between holding companies and their subsidiaries and between projects and continued payments to resigned employees ERP Vs physical count difference This is a serious issue inspite of the same system running both packages Manipulation of resigned employees by HR department False names introduced in the salary sheets False totaling of Bank credit sheets Excess shown as payment through cash higher receipts for lower payments very common amongst manufacturing companies

Huge manipulation of payroll is possible and exists amongst companies across sectors

Questions---contd
Was there a process for bank account verification and reconciliation at the company level considering the number of bank accounts that a company is required to have more than 500 accounts ?- Various possible reasons leading to lack of controls
There are large number of bank accounts created for various purposes in companies and monitoring could be very difficult Possibility of promoters borrowing against company deposits in their personal names /sister companies without informing the company and marking lien Guarantees against company bank accounts for promoters to borrow Software companies opening overseas accounts on the basis of one account for one project and can manipulate these accounts for money transfers / laundering / also sub accounts is a major issue when not represented properly Special purpose vehicles created for real estate projects and some may have direct cash deposits without the company being informed . This is used for land payments Using remittance in transit /cheques in hand is another tool for manipulation

The presence of large numbers results in non conformance of rules related to verification of these accounts, Regular verification of BRS and regular confirmations from the banks which is a normal process

What does the CFO do Problems and Solutions

Some problems and possible solutions Detailed in the next few slides
Revenue Recognition policies and processes Reliance on teams Vs Self Check Given the time constraints and multiple role of the CFO Role of Automation Importance of MIS Internal Audits and CFO approach to the internal audit process Balancing prudence with pressure from top management where to draw the line

Expected role of statutory auditor expected role of


CFO

Prevention of Frauds /Role of CFO- Revenue Recognition Issue


Revenue Recognition- Lack of Processes /Intentional manipulation of processes of revenue

Solution
Clear processes inline with revenue of the industry based on accounting policies must be established Data capturing process for revenue and invoicing should is a necessity Robust collection process and reporting process MIS should be used for detecting any possible deviations Top management needs to be educated on the fact that the manipulation can only lead to temp repair and can lead to long term problems

Possible Role of CFO /Balance


The CFO must be clearly involved in the framing the process and should use regular checks to ensure that there is no serious deviations in trends (Month on month , previous year same period etc) Monitor DSOs, Debt levels on a regular basis to see disturbing trends sudden jump in DSO .debt levels MIS gives maximum guidance margins , productivity . Deviations from budgets /similar periods must be used by the CFO One at best can only adjust revenues to the extent that they can be managed in the subsequent period. ??????. Beyond this the board/audit committee/auditors should be informed /???

Ensure following of process the most vital necessity

Important requirement is that defined processes need to be followed and the process must be regularly audited

Prevention of Fraud Role / Intent/ Time of a CFO


Issue
Given the multiple role that the CFO has and the time constraint how does the CFO control /detect prevent frauds

Possible Solutions
The CFO must spend a lot of time on the processes and ensure that the processes run independent of resources and interchange of roles can also help ( The old logic of nationalized banks) The CFO must do test verification of vouchers if he is not signing them and also must do a ledger scrutiny on a test basis . Supplier ledgers / debtor ledgers /bank verification should be done at frequent intervals surprise checks . Must do enquiry while signing cheques on a test basis Automation is an extremely important tool . Given the large number of transactions especially in the service industry . CFO must ensure a robust process Would again emphasize on the importance of the MIS MIS in line with accounts / Ratios/ Productivity /Large deviations are a very important guide to detect and prevent fraunds k

CFO needs to spend good time in establishing the process

Prevention of Fraud Role of Automation


Problem Is Automation a guarantee against frauds Solution A Powerful single ERP well designed with both front end and back end connectivity could be very useful While implementing the ERP one needs to be very clear of inputs and expected output and controls Gigo concept The levels of checks and access rights for various levels of employees is vital for success of the ERP and good documentation The most vital thing is to follow the rights Giving the junior the password and allowing him/her to operate the system is a prescription for the disaster- especially pricing and policies part Rectification entries/ master creation / monthly closing controls must be with senior person /cfo Regular process audited

Automation will only succeed if properly planned , implemented with discipline

Prevention of Fraud How important is MIS


Problem Possible Solution

Can Frauds be detected and prevented by using the MIS ?

Good MIS is a must and CFO must spend good time on it with an Eagle eye

MIS is at best a tool for detection of possible frauds and possible prevention of frauds IT is a post mortem tool at best A good budgeting process is a must for a necessity for a good MIS The MIS should not be significantly different from the accounts and preferably derived from the accounts Good MIS can be very useful to detect any possible deviations - Revenue comparison to previous periods/ budgets -Expenditure ratios / unusual items can be useful guides - Productivity is a useful tool -Balance sheet MIS for cash /receivables/ liabilities

Checking and Preventing Frauds- Role of Internal Auditor


Problem Possible Solution

The Internal Auditor is considered a pain for Internal audit process is a serious affair . Effective audit teams have succeeded in the CFO and some kind of a villain or not helping in a lot of fraud prevention ( CAG considered serious enough level of involvement would be the best) Internal team especially when there are Audit must be precise , complex system and/or large volume of independent and timely and transactions Process and system audit is also vital must be taken seriously CFO bonus / profit center audit bonus Best medicine to detect and should depend on audit ratings Audit team must report to audit committee possibly prevent fraud and MD The report must be timely and recommend specific actions if frauds or deviations are noticed The CFO must present an action taken report and relies on the report to the CEO./Audit Committee

Detection and Prevention of Frauds CFO Vs Senior Management


Problem The CFO is often pressured by the CEO and other persons to manipulate accounts Show profits and losses according to the whims and fancies CFOs own enthusiasm to manipulate to earn browny points/ bonuses World Com and Tesco Possible Solution The accounts should under normal circumstances should not be adjusted If forced it should be only done to the extent that it is not a fraud and to the extent it is controllable and explainable in the next period . Manipulation for tax avoidance must be avoided . Smart tax planning with clear legal opinion however is a smart option The possible option is to make the senior management that the continuous adjustments is a one way street to disaster and would hit you a later date If still there is force one must report to the auditors / audit committee/independent directors and refuse to sign the balance sheet personal opinion let us discuss ?? CFO should not indulge on his own

A line /limit has to be drawn on the manipulation either ways ( inflation /suppression ) and disown the accounts if it is beyond limits which would be difficult to manage and explain to other stake holders