Shall we take PWC’s letter as an admission of foul play?

PWC, the auditors for Satyam, submitted a letter to the new Board of Directors of Satyam with copies marked to ROC,H’bad, SEBI,RBI, CBDT,BSE,NSE and NYSE, on 13th Jan 2009.There they make statements to the effect that their audit reports and opinions in relation to the financial statements for the audit period should no longer be relied upon. Many have started arguing that this is a proof that the auditors were negligent and might have been party to the forgery that has been going on. I beg to differ.This is because the auditor will only have to audit what the management provides and they very clearly state it.And PWC might not have found anything wrong too, till September 30th, 2008, audited statement(or unaudited if not audited by the firm)for the latest period that is available. But now, when the management itself claim that they had provided wrong information(in conjunction with many other parties like internal auditors, banks etc), why should and how can they contest? PWC was under pressure to respond immediately and they did what was best possible to meet the exigency. The declaration from the auditor shall in no way be taken as evidence that forgery has been happening for years. That conclusion will have to still wait. Forgery or siphoning of funds might have happened after September 30th,2008.

Satyam Part.3.Mr.CEO, we are anxiously waiting for your disclosure letter.After Raju, who is next?

Mr.K.V.Kamath ,CEO of ICICI Bank, while speaking on Satyam to a TV Channel( I don’t remember which but a busiess news channel), said that deliberate frauds created by management is very difficult to detect by others including auditors.That in effect means that shareholders of the company, potential investors,employees and other stakeholders have to wait for the CEO to make a confession, regarding the wrongdoings that he and his team committed in the  company.There are many important fall outs for this.One is, companies can now either dispense with auditors because that is only ornamental. The demand  for CAs and auditing function of the CA firms are going to face lesser demand in future as companies may go for the lowest quote as audit is conducted only because it is mandatory according to statute.Another one is the shareholders, potential investors , employees, other stakeholders and the general public have to wait anxiously for the CEO of the next company  to come out with disclosures of fraud committed by him,his family members or his team of management in the company.

Is it that Mr.Kamath giving an opportunity to the CEOs of companies who might have committed fraud, to form a queue and send a disclosure to their boards, SEs, SEBI and/or other regulators like RBI,IRDA,MCA etc? Or is it justifying the incapability of not only the auditors but that of the independent directors, SEBI etc too? Again, the assumption behind the comment is that whatever Mr.Raju proclaimed in the disclosure has been correct.

The Satyam Story:Part 2

The Satyam Story:A Different Perspective
Nobody has so far come out with any note of approval or dissent on the financial manipulation  claimed to have been purported by Mr.Ramalinga Raju in Satyam . Why everybody in the country show a tendency to believe blindly Mr. Raju’s admission to fraud, simply  relying on the contents of his disclosure?

Everybody in the country seem to believe blindly Mr.Ramalinga Raju’s confession about and admission to fraud, apparently relying on the contents of his disclosure. One has  to look at the issue with an open and inquiring mind. One will find it extremely difficult to convince oneself that the financial statements of Satyam has been forged and that the financial jugglery has been going on for some time. We have hard evidence that Satyam had strength in the two most important areas which are considered to be essential for success for a software solutions provider namely, a great clientele( a number of   Fortune 500 companies figure in Satyam’s  clients’ list)and a head count sufficient enough and capable of delivering quality solutions. Even if we assume that the costs of Satyam were higher compared to other software majors  whose margins ranged from about 17% for Wipro (including FMCG products) to about 26% for Infosys over the last few years, Satyam must have been able to earn decent margins from its projects, and hence definitely profitable. Hence, it is hard to believe that the company was not making money and that the financial statements required to be  forged to show “inflated” profits and strong financial position.

Mr.Raju’s claim that merging Satyam with the two Maytas companies was “the last straw” for Satyam to stay afloat  hence looks unbelievable and totally false. It must be the other way round only. The balance sheet figures as on 30^th September,2008 (if audited) must have been correct. The changes in the financial position might have happened post-September 30, 2008.It is at this time that the real estate  and infrastructure sector started facing serious  problems in India(even though they were making news abroad).Maytas companies might have also faced serious cashflow problems consequent to fall in demand and prices. Real estate companies which have been riding  on the euphoria of unabated rise in land and property prices immediately found themselves severely strapped for cash. Maytas companies might have been no exception. Rajus, who  wanted to save Maytas companies  siphoned off funds from Satyam after September 30, 2008 , tried to wisely play their cards by putting a strategic-looking  proposal to the board for acquiring the two Maytas companies, under the pretext of “derisking”, thereby enabling them to show the money siphoned off to help Maytas companies as paid for equity stake in them. And all these had to happen  before the board meet to consider the  third quarter results as the  Rajus were very much afraid that they could be caught by the outside directors and auditor and that their ploy could be exposed.

 The auditors and the independent directors might  have been unaware of the transactions and the consequent changes in cash position happened after 30^th September. While the independent directors might have gone wrong in clearing the acquisition proposal, they might not have been party to any other wrong doings. But Mr.Raju has cunningly made the independent directors scapegoats  by saying that this forgery has been going on for some time  putting the very diligence and the commitment of independent directors to question. Public and media unfortunately  have started asking  for the blood of the independent directors and auditors, who might not have known what had happened and been involved at all in the whole episode because the whole manipulation and siphoning of funds must have happened in a matter of three months during which time no board meeting or no audit committee/auditor meeting have taken place.The only meeting that took place must have been the crucial and controversial meeting of December  16   , 2008 to discuss the proposal for acquisition of the Maytas companies. Mr.Raju must have been taking an anticipatory bail before the board meeting scheduled for considering the third quarter results, during which the real picture would have come to the knowledge of the Director  Board, and possibly the auditors.

Another question that puzzles many is why there was a delay of  three days in booking the Rajus even after Mr.Ramalinga Raju’s  admission that he committed himself to cheating (amounting to criminal offences under various provisions of law) by forging the financial statements to show profits inflated  by amounts in excess of Rs.5000 crores? Nobody  initiated any step to put him behind bars for the self-admitted criminal offences but waited for a full three days. Was he being given time to develop his story further?

Yet another question is about the role played by SEBI. Mr.Bhave, Chairman, said that the Satyam disclosure was of “horrifying magnitude”.But, has  SEBI, at least by now, studied the financials of Satyam for the last few years to verify any wrong doings or are they still blindly sticking to the disclosures of Mr.Raju? Prof.J.R.Varma, in his blog on financial markets (http://www.iimahd.ernet.in/~jrvarma/blog)  writing on the Satyam scam on 8^th  Jan, expresses a concern on the “willingness of  people to believe a liar’s confession blindly” . SEBI has the mandate to oversee  the governance of companies in addition to their role as a capital market regulator. And it is mandatory for listed companies  to submit their financial statements to SEBI.It is high time that SEBI randomly checks some of the financial reports so that they can take action against erring companies at an initial stage than waiting for a wholesale carnage of the market and investor confidence of the kind happened in the case of Satyam.Mr.T.T.Ram Mohan in an article(Time to rethink governance, ET,Jan 8,2008) suggested that a Board for Audit and Surveillance(BAS) be established with the authority to carry out surprise audit of any listed company above a certain size, on the lines of CAG which provides an additional layer of audit for the PSUs.I feel such a body can be attached to the SEBI considering it’s role in the regulation of corporate governance.

Last but not the least, nobody from SEBI, SEC of US, MCA, ICAI, Research arms of Brokers, investment banks, mutual funds, academics, investor associations, or audit companies has so far come out with any approval or dissent note on the financial manipulation  claimed to have been purported by Mr.Ramalinga Raju, even after five days apparently proving Mr.J.R.Varma correct.

End piece: Isn’t it premature on the part of  Dr.Reddy’s to ask Prof.Krishna Palepu to quit from directorship and on the part of Mr.T.T.Ram Mohan(http://www.ttrammohan.blogspot.com) to indulge in character assassination of him before ascertaining his  role in the whole Satyam scam?

The aSatyam Story of Satyam

I have been lying low due to certain personal issues I had to face during the past year.Eventhough I have not been able to fully recover from the issues which changed the course of my life, I have been slowly coming back to normal.Henceforth I would be more regular in putting the posts.

What else to restart with with?The Satyam Story has been making waves not only in India but also abroad.The first post would be something connected with the decision of the Satyam board to approve the acquisition of the two other companies promoted by the family and run by the relatives of the founder  in the housing and infrastructure sector. The promoter had to backtrack as investors raised a hue and cry against the proposal and the proposal had to be called off.

 

 

Part 1.Corporate Governance: Initial Lessons from Satyam After The Acquisition Decision and Subsequent Calling-off

 

 

 

The Satyam Computers episode has opened up new debates on the roles of the boards, independent directors and has also established the roles institutions and markets can play. But the question of whether a smaller stake of the promoters forced the company to backtrack still remains

Mr.Ramalinga Raju was hailed on calling-off the plan to acquire Maytas companies because he chose a path which is different from what the Indian promoters usually adopt. He admitted that it was a mistake on his part as well as the company’s Board of Directors to pursue such takeovers antagonizing the feelings of investors. Indian promoters have usually shown a tendency to stick to their guns in the face of such criticisms because of their out-sized egos.

But many would fail to admire him for the decision his company and the board would take on the previous day to take over two companies in totally unrelated areas and presumably in trouble. His continued assertion that the company wanted to tap the huge opportunities in the infrastructure sector in his communication to the employees of Satyam again made him less admirable. Many would not give him any marks because even while he retracted, he said that he was upset at the investors’ reaction but still felt that investors would have seen a lot of increased share holder value had the investors waited for some time. Many also felt hoodwinked by the statement by Mr. Raju that the deal would help de-risk the core IT business in times of recession. The CFO went even further by stating that the company saw no reason in buying another IT company in the depressed conditions explaining the rationale behind the decision.

Concerns: While the dust thrown up by the takeover decision settled barely twenty four hours later, the larger sets of concerns continue to haunt us. Is it another exhibition of blatant greed guiding corporate decisions( by siphoning funds from a widely held public company to fully owned family enterprise and a company where promoters hold major stake) ? How does taking over companies, which fall into a severely troubled sector, enable the company to de-risk its operations? Focus being the mantra for rewards from the investors and the market, how did it occur to the management and board to think of diversifying into totally unrelated areas? Did the board evaluate other opportunities for acquisition in the infrastructure and real estate sector itself and/or options in other sectors like FMCG which are rather recession-proof?  Wouldn’t it have been better to acquire firms in IT sector itself considering the current lower valuations? Was it the kind of “out-of-the-box thinking” for growth in challenging times like now as was described by an Independent Director, who wouldn’t want to be identified? Would the Board have valued the companies higher if Satyam had more cash in its kitty? Why didn’t they consider minority investments in equity of these companies instead of taking over them if the intention was diversification to reduce risk? Were the board consulted before the deal was called off? Did the promoters retract because they had a minority holding compared to the total holding of the institutions that raised concerns? Can similar reactions happen in the case of companies where promoters hold majority stake in the companies?

 Lessons:

·        Agency issues continue to threaten the very foundation of good governance. The decision of the management(which apparently was vetted by the Board) of Satyam holding just 8.6%(on paper, as majority of these shares were pledged with financial institutions, which were not to be disclosed due to loopholes in the regulations) to force acquisition of two family controlled companies in troubled sectors show that they considered their own private interests rather than the interests of the company or outside investors who held much larger stake together.

·        Institutional and market reaction. While in general, institutional investors support the decisions of the incumbent management, even when not conducive for better governance, suddenly they seem to have woken up to the reality of ticklish governance issues. Market also seems to have reacted vehemently to a governance issue by beating the stock price down by more than 30%.

·        The role of the non-promoter members of the Board. The board of Satyam includes eminent personalities as independent directors. They were reported to have had a “threadbare” discussion on the proposal of the acquisition (ISB dean chaired controversial meeting, Economic Times, December 18, 2008). Whether the proposal was discussed from the delicate angle of corporate governance is anybody’s guess. It is also not clear as to what merits led them to endorse the deal. Or was it that they endorsed the proposal of the promoters without looking at the issue from an independent perspective? Was it prudent to put almost the entire cash of the company into companies in an industry currently facing problems and which may have long gestation periods? Apparently the independent directors did not think really independently and simply sided with the promoters ignoring the interests of majority investors.

·        Promoters and promoter families in India have to sit up and take note that even if they are able to take boards along with them, their plans may get torpedoed by outside investors and market reaction. Please note that some of the institutional investors have even questioned the very intention of the management. This could be a pointer to the future that gone are the days when investors blindly went along with the promoters or the incumbent management.

·        The deal has also given rise to customer-related fall-outs. High valued customers not only look at the financials of the service provider but their integrity too. Why place orders with somebody who is not in pursuit of improving skills and capabilities in meeting and delivering its customer needs better and who, by their acts have proven that they don’t show high integrity and hence can’t be trusted?  

Notwithstanding the positive development in the case of Satyam,  where promoters had a low stake, one is not clear how institutional investors and markets would have reacted at a governance issue in the case of companies where promoters held major stakes.