Case 8-3
Satyam: India’s Enron
Satyam Computer Services, now Mahindra Satyam, is an India-based global business and
information technology services company that specializes in consulting, systems integration, and
outsourcing solutions. The company was the fourth largest software exporter in India until
January 2009, when the CEO and co-founder, Ramalinga Raju confessed to inflating the
company’s profits and cash reserves over an eight-year period. The accounting fraud at Satyam
involved dual accounting books, more than 7,000 forged invoices and dozens of fake bank
statements. The total amount of losses was Rs (Rupees) 50 billion (equal to about $1.04 billion).
This represented about 94 percent of the company’s cash and cash equivalents. The global scope
of Satyam’s fraud led to the labeling of it as “India’s Enron.” Ironically, the name “Satyam” is
derived from the Sanskrit word “satya” which translates to “truth.”
Although headquartered in Hyderabad, India, Satyam’s stock was listed on the New York
Stock Exchange since 2001. When the news of the fraud broke, Satyam’s stock declined almost
90 percent in value on both the U.S. and Indian stock exchanges. Several top managers either
resigned or were fired and jail terms were given to Ramalinga Raju, the co-founder and CEO and
Sirinivas Vadlamani, the CFO. The auditors – PricewaterhouseCoopers (PwC) – were also
implicated in the fraud and investigations against it are continuing by the Securities and
Exchange Board of India (SEBI). As of May 2013 PwC was cooperating with the investigation
in an attempt to fast-track a settlement ahead of protracted legal cases against the firm that are
expected to take years to unravel because Satyam was India’s largest-ever accounting fraud.
Fraudulent Actions by Raju
Raju stepped down in early January 2009, admitting to falsifying financial figures of the
company with respect to non-existent cash and bank balances. Stunning his well-wishers and
investors, Raju revealed the real motive behind the December 16 bid to acquire Maytas
companies for $1.6 billion: to swap the fictitious cash reserves of Satyam built over years with
the Maytas assets. Raju thought the payments to Maytas could be delayed once the Satyam’s
problem was solved. What had started as a marginal gap between actual operating profit and the
one reflected in the books continued to grow over the years. It had attained unmanageable
proportions as the size of the company’s operations grew over the years. One lie led to another.
The problem further worsened as the company had to carry additional resources and assets to
justify higher level of operations, leading to increased costs.
As things went out of hand, Raju was forced to raise Rs 1.23 billion (approximately
$25.58 million) more by pledging the family-owned shares to keep the operations going. His
woes were compounded with amounts due to vendors, fleet operators and construction
companies. The offloading of the pledged shares by IL&FS Trust and others brought down the
promoters’ stake from 8.65 per cent to a fragile 3.6 per cent. By the end of the day, Raju was left
facing charges from several sides. The Ministry of Corporate Affairs, the State Government, and
the market regulator, SEBI, decided to probe the affairs of the company and Raju’s role, as well
as corporate governance issues.
Going by his confessional statement to the board of Satyam in January 2009, what Raju
had done over the years appears to be rather simple manipulation of revenues and earnings to
show a superior performance than what was actually the case. For this, he resorted to the time-
tested practice of creating fictitious billings for services that were never rendered. The offset was
either an inflation of receivables or the cash in bank balance. The following is a summary of the
way financial statement amounts were manipulated:
94 percent (Rs 5.04/approximately $10.5 million) of the cash in bank account balance in
the September 30, 2008 balance sheet was inflated due largely to inflated profits and
fictitious assets.
An accrued interest of Rs 376 million (approximately $7.82 million) was nonexistent.
An understated liability of Rs 1.23 billion (approximately $25.58 million) resulting from
Raju’s infusion of personal funds into the company was recorded as revenue.
Inflated revenues of Rs 588 million (approximately $12.23 million) that went straight to
the bottom line.
Acquisition of Maytas Properties and Maytas Infrastructure
In December 2008, Raju tried to buy two firms owned by his sons, Maytas Properties and
Maytas Infrastructure, (Satyam spelled backwards is Maytas) for $1.6 billion. Raju tried to
justify the purchase stating the company needed to diversify by incorporating the infrastructure
market to augment its software market. However, many investors thought the intended purchases
of two firms were intended to line the pockets of the Raju family. Raju owned less than 10
percent of Satyam whereas Raju’s family owned 100% of the equity in Maytas Properties and
about 40 percent of Maytas Infrastructure. Stock prices plunged dramatically after the
announcement so Raju rescinded his offer to buy the two companies.
With the prices of Satyam stock and the health of the company declining, four members
of the board of directors of Satyam resigned within one month. In his confession, Raju took full
responsibility for the accounting fraud and stated that the board knew nothing about the
manipulation of financial statements. He indicated a willingness to accept the legal consequences
of his actions.
An important question is how independently did the “independent” directors of Satyam
act in the now highly questioned and failed decision to acquire the Maytas companies? One
board member, Prof. M. Rammohan Rao, dean of the prestigious Indian School of Business
(ISB) with campuses in Hyderabad and Mohali, claimed the board had taken an independent
view and raised concerns about the unrelated diversification, valuation and other issues. Two
views emerged. The first was, why not stick to our core competencies and why venture into a
risky proposition? The second issue was related to the valuation of the companies. Maytas
Properties was valued much higher than $1.3 billion, the amount that Satyam’s management
came up with for the acquisition price. When asked whether the fact that the target companies
— Maytas Properties and Maytas Infrastructure — were led by the two sons of Mr. Ramalinga
Raju made any difference to the board, Prof Rao said “We felt the valuation proposed by the
Satyam management was lower and conservative, despite the family ties. We took an
independent view on this.”
When asked if the board had taken into consideration the possible impact of the purchase
of the two companies on shareholders’ interests and the market reaction, the ISB dean said
“There were concerns on these grounds as well, especially the market reaction for such an
unrelated diversification”. However, according to the Rao, there was no way we could gauge the
market reaction at first, so we decided to take a risk. But the way the market reacted was a bit
unanticipated, he added.
Questions can be raised about corporate governance with respect to the failed acquisition
of the Maytas companies. A conflict of interest arose when Satyam’s Board of Directors agreed
to invest $1.6 billion to acquire a 100 percent stake in Mayta’s Properties and a 51 percent stake
in Mayta’s Infrastructure. The Raju family, which ran the Mayta companies also invited family
or close friends to serve on the board of directors. These bonds created independence issues and
questions about whether directors would be confrontational with top management when
warranted.
Litigation in the U.S.
Securities fraud class action lawsuits were filed on behalf of a class of persons and entities who
purchased or acquired the American Depositary Shares (“ADSs”) of Satyam on the New York
Stock Exchange and/or were investors residing in the United States who purchased or acquired
Satyam common stock traded on Indian exchanges between January 6, 2004 and January 6, 2009
(the class period).
The complaint alleged that Satyam, certain of its directors and officers, and the
Company’s outside auditors (PwC) made false and misleading public statements regarding
Satyam’s financial condition and performance, which artificially inflated the stock price. On
January 7, 2009, Satyam’s chair, Ramalinga Raju, sent a letter to the company’s board confessing
to a massive accounting fraud. Raju admitted that the company’s balance sheet and other public
disclosures contained numerous false statements. For example, Raju wrote that as of September
30, 2008, the Company overstated revenue by approximately 22 percent, and reported cash and
bank balances of Rs 5.61 billion (approximately $1.1 billion), of which Rs 50.4 billion (over $1
billion) did not exist.
Reports issued since the January 7 confession indicate that Raju likely understated the
scope of the fraud, and that he and members of his family have engaged in widespread theft of
Satyam’s funds through a complex web of intermediary entities.
The complaint also asserts claims against PricewaterhouseCoopers International Ltd. and
its Indian partners and affiliates including Price Waterhouse Bangalore, PricewaterhouseCoopers
Private Limited, and Lovelock& Lewes (PW India firms). Satyam’s outside auditors from the
PW India firms were aware of the fraud but still certified the company’s financial statements as
accurate. A document (the “Charge Sheet”) filed in a Hyderabad court by the Indian Central
Bureau of Investigation (the equivalent of the U.S. Federal Bureau of Investigation), detailing
charges against numerous Satyam employees and two partners of PW India firms, alleged that
the auditors received documentation from Satyam’s banks that showed that the company’s
disclosed assets were greatly overstated. The charge sheet further alleges that these auditors
received fees from Satyam that were exorbitantly higher than the fees similarly situated Indian
companies paid to their outside auditors; the Central Bureau of Investigation cited these fees as
evidence of a “well-knit criminal conspiracy” between Satyam and the auditors.
The complaint asserted claims against other defendants as well. In particular, the
complaint alleged that members of the audit committee of the Satyam board of directors—who
were responsible for overseeing the integrity of the company’s financial statements, the
performance and compensation of the outside auditors from PW India firms, and the adequacy
and effectiveness of internal accounting and financial controls—were responsible for the
publication of false and misleading public statements due to their extreme recklessness in
discharging their duties and their resulting failure to discover and prevent the massive accounting
fraud. The complaint also alleges that Maytas Infra and Maytas Properties and Raju’s two sons
were responsible for the false and misleading public statements. The Raju sons’ false and
misleading statements concerning Satyam’s financial condition and performance artificially
inflated the prices of the company’s publicly-traded securities during the class period, and caused
significant damages to investors when the prices of the company’s securities both in the United
States and in India experienced severe declines as a direct result of disclosures regarding
Satyam’s true condition.
Actions Against PwC
PwC and its Indian affiliates initially hid behind “client confidentiality” and stated that it was
“examining the contents of the statement”. Realizing that this was not enough, PwC came up
with a second statement claiming that “the audits were conducted in accordance with applicable
auditing standards and were supported by appropriate audit evidence.” This is somewhat
troublesome since an audit in accordance with generally accepted auditing standards (GAAS)
calls for examining the contents of the financial statements. Given that the firm did not identify
the financial wrongdoing at Satyam, it would appear that the firm, at the very least, was guilty of
professional negligence. At a minimum, the firm missed or failed to do the following:
Fictitious invoices with customers recorded as genuine.
Raju recorded a fictional interest credit as income
The auditors didn’t ask for a statement of confirmation of balance from banks (for cash
balances) and debtors (for receivables), a basic procedure in an audit.
On January 26, 2009, Indian police arrested two partners of the Indian arm of
PwC on charges of criminal conspiracy and cheating in connection with the fraud
investigation at Satyam. Furious Indian investors had pressured the authorities to take such
an action in light of the more than $1 billion fraud. Investors couldn’t understand how a
reported $1 billion in cash was really only $78 million, and how it wasn’t detected by PwC.
The company’s financial statements were signed off by PwC on March 31, 2008.