For Management Students

SATYAM SCAM: Is it failure of Business

Ethics & Corporate Governance ?

By

Prof. Ram Mallar March, 2013. Prof

. Ram

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IPR Unauthorized access to this document by anyone other

than management students of Prof. Ram Mallar is prohibited. If you are not Prof. Ram Mallar’s student, any disclosure, copying, distribution or any action taken or omitted to be taken in reliance on it, is prohibited and may be unlawful. Any opinions or advice contained in this document are subject to the standard terms and conditions of confidentiality.

© 2013 Mallarr Law Associates LLP Email: office@mlallp.com

mlc@mallarlaw.com Website: www.mlallp.com

Blog: rammallar.blogspot.com Phone: +91 22 24328413 2 March, 2013 Prof

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Framework What is Satyam Scam? What is “Corporate Governance”? What is “Business Ethics”? Safeguards built in the Code of Corporate

Governance to prevent such fraud ? Real Reasons for failure of Corporate

Governance in Satyam. Learnings - Suggested Remedies.

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Satyam Scam – India’s Enron

Enron corporation of USA collapsed in 2001.

Collapse of Enron rudely shaken the

confidence of Americans to the rock bottom.

Parking liabilities off Balance-Sheet, fudging Accounts, stock promoting, bloated executive pay packages, massive stock option grants, were some of the malpractices indulged in by Enron.

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What happened in Satyam Computers, One of the best known

IT company?

But in December 2008, we did better in Satyam Computers Ltd than what Enron did.

It’s India’s Enron of more than Rs. 7000 crores fraud. Falsification of Accounts upto Rs. 7000 crores Fraudulent diversion of Funds Money Laundering Foreign Exchange Manipulations Insider trading Criminal Breach of Trust Income Tax violation March, 2013 Prof

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What happened in Satyam? Contd……

Round tripping of ill-gotten wealth More than 10,000 fictitious Employees created. 327 front companies floated by Raju Family to secure

loans for the Promoter family. They borrowed Rs. 1500 Crores from Financial

Institutions, 36 companies claimed that they had lent Rs. 1230 Crores to Satyam and not claimed back.

Raju states that he had understated liabilities and overstated debtors.

Corporatised family holdings as SRSR Holdings Limited which pledged the shares.

Raju forged Fixed Deposit Receipts to show balance that are not existing.

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What happened in Satyam? Contd……

Serious Fraud Investigation Office (SFIO)

investigating the matter.

Class Action Suit in New York in USA – District Court against PWC, for recklessly disregarding multi-layer massive fraud by former management of Satyam.

Also against Satyam, Ramalingam Raju, his brother and PWC by purchasers of ADR.

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What happened in Satyam? Contd……

Raju in his 5 page letter admitted years of

financial deception, that sales and profits were inflated , that Satyam did not actually have the bulk of Rs. 5,300 crores cash which it said it did, that liabilities totaling Rs. 1230 crores were understated.

Receivables are less than earlier stated by atleast Rs. 7000 crores in the Companies books.

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What happened in Satyam? Contd……

Satyam chairman and his brother are already

arrested for non-bailable offences under IPC, including criminal breach of trust, criminal conspiracy, cheating and forgery for fudging Satyam Accounts and misrepresenting facts which could put them behind bars for years.

CBI now found Raju diverted Rs. 154 Crores to totally unconnected foreign companies from 1999 to 2002, which never reflected in Books of Accounts of Satyam.

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CBI also found misappropriation of funds and diversion to Accounts in British Virgin Islands.

Directors were not only given handsome remuneration but also given unjustified stock options at Rs. 2/- per share as against the market price of Rs. 500 per share.

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RBI has now estimated the notional loss suffered by Inverstors on the date scam broke out at Rs 14,162.52 crores. Raju on January 7, 2009 confessed that the Satyam suffered loss of Rs 5040 crores on account of fudging of Accounts by him. Thus the total loss works out to nearly Rs 20,000 crores.

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Effect of Scam in Stock Market:

Satyam stock price per share In May 2008 Rs. 500.00 In December 2008 Rs. 265.00 After collapse Rs. 11.50 Later recovered in February 2009 Rs. 50.00

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What is “Corporate Governance”?

It is a set of Methods / Practices by which business is carried on, directed and controlled in a corporate form of business organization for promotion and protection of interest of various stakeholders which should be: Fair to all stakeholders Transparent and Make Board of Directors/ Management accountable.

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Aims and Objectives of Good Corporate Governance

Enhancement of long-term shareholder value, and

To protect interests of other stake-holders like: (a) Customers (b) Suppliers (c) Creditors

(d) Depositors (e) Employees

(f) Government, (g) Society and

(h) Environment

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What is Business Ethics? It is the study of what is good & bad, right

& wrong, just & unjust, fair & unfair for the business.

Code of Conduct for businessman for carrying on business consistent with what is in the best interest of the business.

Different from Personal Ethics, which is based on what he considers good and bad for his personal life.

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Objectives of Business Ethics Check malpractices - rapid business growth

threw up many unethical practices – lust for money and economic power breaded many evils, which harmed society.

Prevent exploitation of market, society and consumers.

Drive home social responsibility to gain confidence of consumer/ public.

Forge cordial relation with the society.

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Codified Corporate Governance & Business Ethics

Safeguards

What are the safeguards we have in the Code of Corporate Governance to prevent corporate fraud in Companies Act and clause 49 of the Listing Agreement?

1. Board of Directs The Board is responsible for the effectiveness of

the ongoing system of internal control including minimizing risk of fraud and report the same to the shareholders.

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Safeguards Contd……

The shareholders are entitled to ask why was a wealth destroying event not anticipated and acted upon by the management.

Credibility and Trust is everything in business because of Satyam that trust has evaporated.

Promoters of Satyam by their money power influenced the guardians of corporate governance, the impression is that Satyam paid the cop on his beat to take a nap.

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2. Independent Directors

The Board should comprise 50% Independent Directors if the Board has executive chairman like Satyam (Ramalingam Raju).

Independent Director is the one who does not have any “material pecuniary relationship” with the company (Satyam had 6 out of 10).

Independent Directors required to review periodically legal compliance reports and also detailed prescribed financial information including investments in subsidiaries or other body corporate.

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Board of Directors Contd……

It is obligatory on the Board to lay down Code of Conduct for all Board Members and Management which is to be posted on the website of the company and they should affirm compliance in the Annual Report.

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3. Audit Committee of the Board

Composition:

All the members to be Non-executive Directors with a majority of independent Director with at least one member: Financial/ Management expert, Chairman to be independent Director to be present at AGM.

Meet atleast thrice a year, once before finalization of Annual Accounts.

Quorum: minimum 2 Independent Directors.

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Audit Committee Contd…..

Power of Audit Committee Power of Audit Committee to investigate any

activity, seek information from any employee, seek outside professional / legal advice , secure attendance of outsiders with relevant expertise if required.

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Audit Committee Contd…..

Role of Audit Committee includes the following:

1. Oversight of the company's financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible.

2. Recommending the appointment and removal of

external auditor, fixation of audit fee and also approval for payment for any other services.

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Role of Audit committee contd…..

3. Reviewing with Management the annual financial statements before submission to the Board.

4. Reviewing with the Management, external

and internal auditors, the adequacy of internal control systems.

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Review of information by Audit Committee The Audit Committee shall mandatorily review

the following information:

1.Financial statements and draft audit report, including quarterly / half-yearly financial information;

2.Management discussion and analysis of financial condition and results of operations;

3.Reports relating to compliance with laws and the risk management;

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Review of information by Audit Committee cont…..

4. Records of related party transactions

5.The appointment, removal and terms of remuneration of the Chief Internal Auditor shall be subject to review by the Audit Committee

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4. Whistle Blower Policy to help Audit Committee

Audit Committee has access to Internal Policy :

• Personnel who observe an unethical or improper practice (not necessarily a violation of law) shall be able to approach the Audit Committee without necessarily informing their supervisors.

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5. Management Discussion Report As part of the Directors' Report or as an addition hereto, the Management Discussion and Analysis Report should form part of the Annual Report to the shareholders. This Report should include discussion on the following matters:

1. Risks and concerns. 2. Internal control systems and their adequacy. 3. Management shall make disclosures to the Board

relating to all material financial and commercial transactions, where they have personal interest, that may have a potential conflict with the interest of the company at large.

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6. CEO/CFO certification CEO (either the Executive Chairman or the Managing Director) and the CFO (whole-time Finance Director or other person discharging this function) shall certify that, to the best of their knowledge and belief: i. They have reviewed the Balance Sheet and Profit &

Loss Account and all its schedules and notes on accounts.

ii. These statements do not contain any materially untrue statement nor do they contain statements that might be misleading.

iii. These statements together present a true and fair view of the company, and are in compliance with the existing accounting standards.

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7. Report on Corporate Governance

There shall be a separate section on Corporate Governance in the Annual Reports of company, with a detailed compliance report on Corporate Governance.

8. Periodical Reports to Stock Exchange

The companies shall submit a quarterly compliance report to the Stock Exchanges within 15 days from the close of quarter as per prescribed format.

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Real Reasons for failure of Corporate

Governance in Satyam

1. The model of Management followed in Satyam, and

2. Human failure- Typical Indian Psyche. 3. There is no failure of mechanism of

codified Corporate Governance under Clause 49 or provisions of Companies Act.

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Different models of Management followed in India

1. Family Owned Business (FOB) 2. Family Controlled Business (FCB) 3. Family Managed Business (FMB) 4. Professionally Managed Business

(PMB)

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Family Owned Business (FOB)

Family / Promoter only own the business, they do not attempt to control or manage and leave it to the professionals to run and manage.

It is easier to introduce the Good Corporate Governance.

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Family Controlled Business (FCB)

The Business is normally managed by the professionals, but with the remote control of the Family / Promoter.

Good Corporate Governance is always influenced by the Promoter and also remotely controlled.

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Family Managed Business (FMB)

Like Satyam, the Business totally managed by the Family / Promoters. Business Ethics has the flavor of his Personal Ethics.

Good Corporate Governance is at the mercy and at the pleasure of Promoter.

Family Managed Business will always run the risk of failure of Good Corporate Governance . Satyam is the shining example.

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Professionally Managed Business (PMB)

This is the most ideal type of management of the Business, whoever owns it. There is total separation of Ownership from the Management.

It is best suited for the introduction of good and sustainable Corporate Governance.

There cannot be a Satyam Scandal.

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Objects of Good Corporate Governance

Attempt of the codified Corporate Governance in Companies Act 1956 and SEBI Regulations is to professionalize the management of the business for promoting interest of various stakeholders and eliminate management by family.

Examples of PMB are L&T, Infosys, Tata, ICICI etc.

Unfortunately Family controlled and managed businesses dominate Indian corporate business: Important examples: Mukesh and Anil Ambani and Saytam etc.

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Objects of Good Corporate Governance Contd……

In FMB Business, how far corporate governance is ethical or good, totally depends on Personal Ethics of the promoter or family.

Satyam is FMB and the scandal is totally due to personal ethics of the promoter i.e. Ramalinga Raju. He is a simple looter , a cheat with uncontrolled greed and lust for money.

This can happen in any family managed business, please look out !

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Second Reason is: Human Failure - Indian psyche Indians are good human beings, kind, hospitable,

very helping, emotional and sentimental but many times and many, lack moral courage to tell the truth.

We are not tough individuals, can’t say difficult “No” where the only answer should be “No”

We can’t disappoint a person who has done favor to us. We suffer from favoritism, may not be dishonesty or corruption.

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Human Failure - Indian psyche Contd……

Independent Directors & External Auditors were all GOOD Indians who

were the watch dogs of Corporate Governance in Satyam.

This is exactly what happened with all the eminent, honest

Independent Directors of Satyam and two senior partners of PWC , because they are all good Indians

After receiving lot of favors from Ramalingam Raju for past many years how can they disappoint him, hurt him, say “No” to him.

It is not enough to have Independent Director or Independent Auditor unless, they know why they are there.

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In Satyam, It appears different types of Auditors: internal, external, statutory or concurrent have followed the new abbreviations:

EBIT- Earnings Before Internal Tampering EBITDA- Earning before I Tricked Damn Auditor CEO- Chief Embezzlement Officer CFO- Corporate Fraud Officer NAV- Normal Andersen Valuation RONW- Return on Notional Worth GAAPs- Generally Agreeable Auditing Pampered

Standards IFRS- Internationally (Accepted) Fraud Related

Standards

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Suggested Remedies

Follow clause 49 by spirit and letter, more importantly, the SPIRIT of clause 49, which unfortunately few follow in the industry. Further amend the law to capture the spirit of Clause 49.

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Upon the collapse of Enron in December 2001, on July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002.

The law is intended to improve Corporate Governance, bolster public confidence in the capital markets and impose new duties and significant penalties for non compliance on public companies and their executives, directors, auditors, attorneys and security analysts.

In India - more than 2 years over, so far we have done nothing.

In USA Sarbanes-Oxley Act

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Realities of Indian Board. Truly independent Directors are a rare breed.

Non-Executive Directors less than 1/3 and comprise family members or recently retired Company ex-officials, friendly lawyers & Chartered Accountants.

In many cases agenda papers delivered to Directors either too late or at Board meeting.

Rarely Board meetings last more than half an hour. No doubt followed with sumptuous lunch many times in 5 Star Hotels.

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Realities of Indian Board Contd……

In many cases Management makes sure that outside Directors are docile or do not interfere through diplomatic selection and by not giving them sufficient information

In many Companies, Board of Directors is a nominal Board – they call it a Legal Board – Real Board is the Board of Management comprising Senior Executives headed by Managing Director.

Only matters requiring legal approval comes to Legal Board for rubber stamp.

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Realities of Indian Board Contd……

Most of important items slipped under omnibus item “other business with the permission of the Chair.”

Minutes list number of documents as placed before the meeting, mostly none was placed.

Agenda sent without explanatory note or relevant documents, they are given only at the meeting.

Many times half of the Board minutes contains matters never discussed. They were added after the Board meeting as the minutes was kept open until the next meeting. The Directors were only informed of these additions.

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Realities of Indian Board Contd……

Sometimes meeting held with hardly any notice or without written notice. (No provision under the law for length of the notice)

Foreign Directors many times never attend the Board Meetings. There are instances they have never seen India. This is possible by granting leave of absence at every meeting whether it was asked for or not.

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How we can change the present practice and improve the Corporate Governance?

Number of Non-Executive Directors should be increased.

They should be encouraged to assert their right. Today they are passive and inactive, nor they have time, nor the moral courage to say difficult “NO”.

Birla Report relies on Non-Executive Directors and Independent Directors to usher in good Corporate Governance. This will never happen unless they realise their role and responsibility.

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Improve the Corporate Governance Contd……

Non-Executive Directors should be made accountable for the decisions taken by Board and for the affairs of the Company.

Board should meet at least once a month to be effective and Directors should attend most of the meetings.

There should be structured performance appraisal of Managing Director and other Executive Directors by a Committee of the Board.

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Improve the Corporate Governance Contd……

In India Shareholders never make the Board accountable for the performance of the Company. Both Executive and Non-Executive Directors should pay for the failure to meet the goals of Company.

No law can imbibe ethics in unwilling Board. Law cannot be substituted for code of best practices, it can only supplement and support as it is sought to be done by Companies Act and SEBI Rules

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