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The Satyam scandal: Offshore inmates

Jan 15th 2009 The Economist

India struggles to get to grips with a bewildering corporate fraud

In any software project, according to an industry adage, programmers think they are 90% done for about 50% of the time. That paradox will be familiar to the owners of Satyam Computer Services, which was once India’s fourth-biggest software and services firm. The scam perpetrated by its founder, B. Ramalinga Raju, and his brother is equally hard to fathom. On January 7th Mr Raju confessed to cooking Satyam’s books for years, and admitted that a $1 billion cash pile did not in fact exist.

But were there hands in the till?
But when a liar confesses, can you believe him?

Many suspect that even now only 50% of the truth is out. Cash, after all, is hard to fake. Satyam’s books were audited by PricewaterhouseCoopers. According to the Economic Times, an Indian newspaper, the auditor says it verified Satyam’s fixed deposits with the banks that held them. So perhaps the money did exist, but has since been spirited out of the company.

Such tricks are not unusual in India, even if the scale of the Satyam fraud is extraordinary. Indian “promoters” (who include business families and other corporate insiders) still hold almost half of the shares on the National Stock Exchange (NSE). But many family firms are evolving into widely held corporations. The danger is that as the stake held by insiders falls, they have an incentive to rip off other shareholders by siphoning off money.

Some of their favourite techniques were outlined in a report last month by Saurabh Mukherjea, who returned to India from Britain in May to scrutinise stocks for Noble, an investment bank. Managers might, for example, lend to a son’s firm, or overpay for a training weekend and take a cut from the hotelier. Manipulation of accounts in India is “ferocious”, says Mr Mukherjea, and not just by small firms.

Who will stand up for the minority shareholders? In America managers cower before pension funds and other powerful institutional investors. But India lacks a local equivalent. Its occupational pension funds hold assets worth 2.5 trillion rupees, only about 5% of GDP. They are permitted to invest only 15% of their holdings in shares, and actually invest even less.

Some hope that foreign investors might fill the gap. They hold about 10% of the shares on the NSE, more than Indian banks, insurance companies and mutual funds combined. They ought to be wary of inscrutable companies, giving the firms an incentive to change their ways. But foreign investors can only take big positions in the firms they buy. And since half of India’s shares are held by promoters, a foreign fund cannot take a worthwhile position without managers’ acquiescence. So funds are reluctant “to cheese off management too much” by complaining about corporate governance, says Mr Mukherjea.

That complacency has been shattered. Indeed, in the wake of the Satyam scandal, investors have been swift to punish even small infractions. The shares of Wipro, another computing giant, fell by 9% on January 12th after the World Bank revealed it had barred the firm from doing business with it until 2011. Wipro’s transgression was to invite bank officials to take part in an oversubscribed share offering in 2000. Many who did so lost money. “It is a real debate whether it was a benefit at all,” says Suresh Senapaty, Wipro’s finance chief.

Meanwhile Mr Raju, his brother, and Satyam’s chief financial officer are in custody, charged with criminal conspiracy, cheating and forgery. Satyam is in the hands of three directors appointed by the government. If they do not act swiftly, Satyam’s rivals may pick up its most lucrative customers and its best employees. But right now all that its Indian competitors want from Satyam is distance.

India police to grill Satyam founder over fraud revelations
AFP 17 Jan 2009

An Indian court on Saturday gave police the right to question fraud-hit Satyam's founder over his admission that he inflated the outsourcing giant's balance sheet by over a billion dollars.

A judge said police could question the software tycoon B. Ramalinga Raju, his brother B. Rama Raju and former chief financial officer S. Vadlammani for four days starting Sunday.

"The judge made a direction to the police not to resort to third-degree methods," Bharat Kumar, a lawyer for the Satyam Computer Services' founder, told reporters outside the court in the southern city of Hyderabad.

"They have also been told to give medical help to the accused when they are in custody" and only to question them during daytime hours, Kumar said.

The three men are currently being held in judicial custody in Hyderabad, where Satyam has its headquarters.

The questioning is to be done in the presence of lawyers for the accused, magistrate K. Ramakrishna ordered.

The disgraced former boss of India's fourth-largest outsourcing company was arrested last weekend, days after owning up to the fraud that has rocked corporate India.

Ramalinga Raju, one of the pioneers of India's outsourcing boom and once a darling of international investment funds, told Satyam's board he created a fictitious cash balance of more than one billion dollars and inflated profits for many years.

He is being held on accusations of cheating, forgery and breach of trust in India's biggest fraud.

Lawyers plan to seek bail for the three men on Monday, arguing that they do not need to be kept in custody as they have been cooperating fully with authorities.

However, market regulator the Securities and Exchange Board of India will ask for court permission on Monday to question Ramalinga Raju while he is in judicial custody.

The court decision came as Satyam's government-appointed board of directors was due to meet later on Saturday in Hyderabad to consider ways to fund the salaries of the company's tens of thousands of employees and other expenses.

See also
Will this become Wall Street's biggest fraud?
Hard times are back, and so are the fraudsters
Peter Schiff
Group of Thirty Recommendations 2009 [281KB PDF]

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