Wednesday, January 7, 2009

Satyam Computers - "Admission" of mammoth "fraud" - discussion and some updates

Ramalinga Raju, Chairman, of Satyam Computers is reported to have "admitted fraud" of Rs. 5040 crores (see amongst numerous other reports, this report). Without intending to overstate, I think, for India, this episode may be bigger than what Enron was for US.

So many fundamental questions are likely to arise that the preliminary and obvious issues of corporate governance and role of independent directors will perhaps become side issues. Even the serious issue of the role of auditors would look smaller and bigger, more fundamental issues will need to be raised.

It is inevitable that this matter will be immensely sensationalised - very likely far, far more than the issue demands (the issue of course deserves wide and very serious publicity and debate). Some very basic and fundamental safeguards, whether of law or of institutions, will be questioned. When the alleged frauds were being perpetrated, what did the auditors do? What did the Independent Directors do? What did SEBI and Stock Exchanges do? What did other institutions, which may be appearing as periphery, but are equally powerful, such as Registrar of Companies and others, do? In fact, the question also would be, what did the shareholders do when they were being provided information which are now alleged to be basically and very substantially false? In particular, what did institutional shareholders, who are more far more financially literate and experienced, do? How did tax authorities accept such accounts? What are the legal provisions to prevent and punish frauds? What happened to the protection given by accounting standards and framework? And so on and on.

The related question is, if all or many of these failed, what are the changes required in law and related structures to prevent such things from happening again and to punish the wrong doers?

In this cacophony that will assuredly follow, it would be a worthwhile and a very learning exercise to take this episode as a case study to examine the issues raised at various places and examine this in the context of existing provisions. So for my own learning and, if I may be immodest enough to say, of yours, I propose to submit regular updates in this blog of how this episodes unfolds. I am sure, in the process, the wording and role of very many laws, and institutions would be questioned and it would be worth examining each of these issues calmly and objectively.

As a result of the inevitable sensationalised coverage, certain things will certainly happen Numerous gaps will be found in law, in institutions and otherwise. Suggestions will be made to change them as, e.g, US did through the Sarbanes-Oxley Act. The issue for debate would be, what of these changes are really needed and whether even the Sarbanes-Oxley Act was successful in preventing and/or punishing wrong doings. The question will also be whether laws and institutions, howsoever comprehensive and harsh, are capable of preventing, detecting and punishing such acts.

Such harsh and comprehensive paper laws and powerful institutions have often been found to make life difficult for the 95 other law abiding companies when 5 companies are found guilty. Particularly, when the other 95 companies play fair and abide the law in its letter and spirit - in fact, they may do this for their own reputation, whether such laws existed or not. I also talk of 5 companies instead of 1 since I am sure it is not just Satyam who is allegedly guilty.

The developments that have also to be seen is how the alleged wrong doers in Satyam are punished. It is almost inevitable that - particularly if there is, as reports suggest, a straight confession of fraud - that many top guys would even be imprisoned. The sheer press coverage and outrage will leave not scope for defence, whatever little that may be possible. However, would we be then satisfied and contented that the law has taken its due course. Then, of course, we are going in the other extreme and not learning from the exercise.

So, as I said, what I hope through here is to examine the episode as it unfolds in the form of facts coming out and issues and suggestions being raised.
Whether we learn or not from this exercise is to be seen, but I am sure I will be more informed when I narrate this story to my grandchildren!

Readers comments, informations and other input are welcome and are looked forward to.

- Jayant Thakur


Umakanth V said...

Mr. Thakur, thanks for your post. The Satyam episode does raise fundamental questions pertaining to Indian corporate governance, and the solutions may not be available that easily. One reaction that we could certainly expect in the near future is tighter laws relating to corporate governance. However, there is need for caution here. One finds a fundamental mismatch in the Indian approach to corporate governance that has possibly perpetuated mis-governances of this nature. Clause 49 of the listing agreement and other corporate governance norms have been largely borrowed from the Cadbury Committee recommendations in the UK and the Sarbanes-Oxley Act in the US. These include matters such as minimum number of independent directors, an independent audit committee, CEO/CFO certification of accounts, etc. However, these measures are more applicable in countries such as the UK and the US where the shareholding is diffused, and the incumbent managers wield strong powers over the shareholders. On the other hand, the Indian shareholding pattern is vastly different – with most listed companies being either family-owned or state-owned. Since the governance mechanisms are subject to the control of the dominant shareholder, they will necessarily fail. For example, there could be fundamental questions pertaining to the concept of independent directors in Indian companies – when the appointment, remuneration, tenure and removal are subject to the control of the major shareholders. How effective is the role of independent directors when the flow of information that enables discharge of their duties is subject to control by the major shareholders, as we have seen in Satyam’s case? This logic holds good in the case of the audit committee as well as CEO/CFO certification. What is more peculiar in the Indian context is that controlling shareholders are able to determine significant matters regarding the company by holding even minor stakes that are less than 10%, again as we saw in the case of Satyam. In short, the lesson from this episode is not to simply emulate corporate governance norms in other jurisdictions, but perhaps to devise specific measures that cater to protection of shareholders in family-owned and state-owned companies that are more prevalent in India.

Rahul Singh said...

I agree with Mr. Umakanth. Besides the Indian corporate governance being out of sync with shareholding patterns, I believe that businesses act as a vested interest group and thwart any robust regulation that genuinely empowers stakeholders.

It is trite to suggest that no Indian politician has ever been imprisoned for fraud. But, so is the case of business people! (Indeed, trial is so slothful that someone like Harshad Mehta escaped punishment by merely outliving the time period for trial.)

While Naresh Chandra committee was looking at corporate governance reform way back in 2002-03, it was clear that imprisonment of directors in undesirable as that would lead to a chilling effect on the pool of potential directors. Satyam scandal instantiates India's half-baked tryst with corporate governance norms.

A law reform program, is by definition in future, and would evidently be useless for Satyam's 55,000 odd employees and their family members who are undergoing a harrowing experience.

Jayant Thakur, CA said...

True, Rahul.

Also, while we are right in being concerned with the content of corporate governance norms in India, borrowed from inappropriate context of the US/Cadbury Committee, there would also be a concern about how they are brought about - particularly the legal status that they may have in India.

While India has heavily borrowed from US for may corporate governance requirements, the implementation seems to be similar to UK. Corporate Governance norms as contained in Clause 49 are, as we know, in the Listing Agreement and not in a separate statute such as Sarbanes Oxley.

Hence, the Satyam episode will now expose also this poor basis of law.The question will be whether the delinquent Promoters and Independent Directors can be punished for violation of the corporate governance requirements?

In this context, Mr. Umakanth, you have also rightly referred to the state-owned companies. We had discussed earlier in this blog recent orders for violation of corporate governance norms by public sector listed companies where, because of default/delay by the Promoter (Central Government), the Company ended up violating the norms. And the Adjudicating Officer had to excuse the company.

- Jayant