Running head: CASE STUDY ANALYSIS AND REPORT FOR MANAGEMENT

CASE STUDY ANALYSIS AND REPORT FOR MANAGEMENT

ELISABETH J PAGE

SOUTHERN NEW HAMPSHIRE UNIVERSITY

INTRO TO FORENSIC ACCOUNTING AND FRAUD EXAMINATION

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Elements

According to the text, “under common law, fraud has four basic elements: a material false

statement or omission, the suspect had knowledge that the statement or omission was false, the

suspect intended to induce the victim to rely on the false statement or omission, [and] the victim

relied on the false statement or omission and suffered injury or damage as a result thereof” (Hahn

2015). Understanding the elements of fraud allows forensic accountants to anticipate, discover,

and deter financial crimes. The damage fraud inflicts on businesses and the economy necessitates

fraud prevention and detection techniques. The sooner a fraud may be staved off, the better for

all stakeholders, whether employees, customers, or shareholders.

Theories of Crime Causations

Fraudsters perpetrate financial fraud for many reasons. According to an article from

Managerial Finance, “the leading reasons cited for the expected increase in fraud are: a)

economic pressures, b) inadequate punishment of convicted [fraudsters], c) weakening of

society’s values, d) insufficient emphasis on prevention and detection, and e) more sophisticated

criminals… poor internal controls, management override of internal controls, and collusion

between employees and third parties are also seen as factors contributing to fraud” (Riahi-

Belkaoui 2000).Understanding the reasons a fraud was allowed to happen can help expose the

perpetrator and show investigators where to look to evaluate the extent of the damages.

Insufficient emphasis on prevention and detection, for example, creates an environment rife with

internal control weaknesses that create the opportunity for fraud.

Evidence

The fraud triangle illustrates the three factors always present in a fraud: pressure,

opportunity, and rationalization. Potential fraudsters may exhibit certain characteristics

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indicative of the different factors of the fraud triangle. To illustrate, “red flags identified by the

KPMG 1998 Fraud Survey were: personal financial pressure, vices, extravagant purchases or

lifestyle, real or imagined grievances against the company or management, ongoing transactions

with related parties, increased stress, internal pressure and short vacations/unexplained hours”

(Riahi-Belkaoui 2000). Financial problems and vices create the need for additional income

(pressure), ongoing transactions with related parties open the door for collusion (opportunity),

and real or imagined grievances with the company or management establish the belief that either

the perpetrator, the victim, or both deserve what is happening (rationalization).

Regulatory and Legal Factors

Regulatory and legal factors work to mitigate the impact of fraud on stakeholders; the

SEC regulates corporations and imposes penalties on companies that do not abide by disclosure

rules and deadlines. For example, “Satyam… has agreed to pay a $10 million penalty to settle the

SEC’s charges, require specific training of officers and employees concerning securities laws

and accounting principles, and improve its internal audit functions” (ACCOUNTING AND

AUDITING ENFORCEMENT release no. 3258) as the result of the SEC investigation.

In the wake of accounting scandals like those carried out at Enron and WorldCom, the

U.S. enacted the Sarbanes-Oxley Act of 2002 (SOX); while public corporations had already been

required to submit quarterly and annual financial statements to the SEC for years, SOX

mandated that these financial statements be subject to audit by independent accounting

professionals. Management, in addition to the auditor, must issue an opinion on the efficacy of

internal controls to which they will be held accountable.

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Recent Developments

The 2008 financial crisis prompted the enactment of Dodd-Frank, which expanded

whistleblower protections outlined by SOX. According to the 2016 Report to the Nations on

Occupational Fraud and Abuse, the most common concealment methods employed by fraudsters

are the fabrication and alteration of physical documents (utilized in approximately 50.7% and

49.3%, respectively, of the financial statement frauds studied). For this reason, a concerted effort

should be made to establish and enforce separation of duties to prevent the fabrication or

alteration of physical documents. Per the same study, “tips were the most common detection

method by a wide margin, accounting for 39.1% of cases… internal audit (16.5%) edged out

management review (13.4%) as the second-most common detection method” (2016 global fraud

study). Whistleblower hotlines act as a conduit for fraud tips from anonymous employees and

represent one of the simplest and most effective ways to detect fraud.

Industry-Specific Challenges

Competition among contenders in India’s IT sector is so fierce that competitive myopia

poses a tangible threat to companies operating on razor thin margins to remain viable.

Competitive myopia creates tunnel vision and exposes companies to unanticipated challenges

involving resource availability, evolving business models, and regulatory oversight. While

demand for IT services in India on the rise, the pool of talent available is comparatively limited.

According to an article from The IUP Journal of Business Strategy, “factors such as wage

inflation, skills shortages, rising attrition and operational complexity in managing a large

employee pool are making it difficult to source talent in the industry… these challenges are

forcing IT companies to re-calibrate their strategies and shift focus from cost-competitiveness to
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providing increased value in terms of domain expertise and efficiencies to customers” (Shetty

2012).

In addition to human capital difficulties, more recent challenges necessitate that

companies migrate from a linear to nonlinear business model (i.e. utilizing existing resources to

create new revenue streams as opposed to making expenditures achieve the same goal).

Regulatory oversight, while necessary to a healthy economy, whittle into what little profits

Indian IT companies earn in such a highly competitive industry. The cost of compliance cuts

further into profits. The business environment, coupled with the pressure to maintain the

appearance of financial prosperity at Satyam, triggered Raju to commit this massive financial

statement fraud over the course of a decade.

Behaviors

Suspicious events transpired over the years leading up to the detection of the massive

fraud at Satyam; according to Singh, “there was significant offloading of shares by Raju in the

period between January 2001 to January 2009, bringing down his stake in the company from

25.6% to 3.6%” (Singh 2010). Immediately prior to the market’s discovery and subsequent

reaction to the fraud, Raju convinced the board of directors to approve substantial investments in

companies controlled by Raju and his family members. The investment made no business sense

given the challenges facing India’s IT sector and Satyam’s financial position at the time; it was

apparently Raju’s final attempt at recovering Satyam’s financial situation.

In order to, “‘fill’ the company's fictitious assets with real ones, [Raju directed Satyam

to] acquire a controlling interest in Maytas Properties and Maytas Infra (Maytas), real estate and

infrastructure development companies then controlled by Raju and his brother, who was then the

Managing Director and Chief Executive Officer of Satyam… investors and analysts questioned
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the investment into unrelated businesses during a worldwide recession, as well as the transfer of

the majority of the company's liquid assets to the Raju family” ( U.S. SECURITIES AND

EXCHANGE COMMISSION 2011).

Internal Control Weaknesses

Poor corporate governance at Satyam set the stage for catastrophic fraud to occur;

“India’s lack of a broad culture of dissent is manifest in the hesitance of many shareholders and

independent directors to question the founders of a company—something cited as a possible

reason for the failure of regulatory oversight of Satyam in India” (Craig 2013). That Raju and his

accomplices presented falsified financial reports for years without detection indicates that the

Board of Directors was not fulfilling its duties to the shareholders of Satyam.

Further, the poor control environment at the top of Satyam affected lower echelons of

management. The fraud was largely perpetrated via collusion to falsify invoices and other

pertinent documents; “Satyam's then-senior management provided certain employees with an

administrative or ‘super user’ login identification and password in order to access the invoice

management system to record the false invoices. The ‘super user’ login ensured that the invoices

would be used in the calculation of revenue, but concealed the existence of the invoices from the

heads of Satyam's business units” (U.S. SECURITIES AND EXCHANGE COMMISSION

2011). This fraud may have been entirely preventable at an organization with a strong code of

ethics and tone at the top.

Internal Control Recommendations

According to the SEC complaint, “a complete failure of Satyam's internal controls over

its invoice management system, the company's books of account, and its reported financial

statements occurred during 2003 through September 2008… as a result, Satyam's then-senior
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management were able to knowingly, intentionally, and materially overstate revenue, income,

earnings per share, cash, and interest bearing deposits from 2003 through September 2008” (U.S.

SECURITIES AND EXCHANGE COMMISSION 2011). Clearly, more independence and

objectivity are needed from directors; a cultural overhaul is necessary to remedy the toxic control

environment that facilitated the management-approved practice of falsifying invoices and bank

records. A code of conduct and strict oversight should be the pillars upon which to build

stronger, more effective internal controls. An audit committee and, if possible, an internal audit

department, would also greatly improve Satyam’s internal controls.

Anomalies

Current assets increased over 205% between March 31, 2007 and 2008. This caused the

company’s current ratio to increase to 5.59 in 2008 from 2.88 in the prior year. Net capital spiked

an unbelievable 284% between Satyam’s 2007 and 2008 fiscal years. Other key metrics, like net

income, sales, and liabilities increased at suspiciously high rates (39.7%, 46.3%, and 50.7%

respectively). These findings are consistent with the fraud unraveling at Satyam; “an

unscrupulous corporate operator was able to siphon off thousands of crores of rupees by

falsification of accounts that included reporting non-existent bank balances, interest receipts that

were never received, fake customer billings, borrowings on fabricated board resolutions with

consequential reporting of non-existent assets” (Singh 2010).

Hypothesis Development

Raju and other key executives colluded to bypass internal controls on accounting to

falsify invoices and bank statements. Any number of frauds, whether financial statement fraud or

asset misappropriation, could have been perpetrated in the weak control environment at Satyam;

according to the SEC complaint, “a complete failure of Satyam’s internal controls over its

invoice management system, the company’s books of account, and its reported financial
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statements occurred during 2003 through September 2008” (U.S. SECURITIES AND

EXCHANGE COMMISSION 2011).The paltry internal controls at Satyam in combination with

the hyper competitive Information Technology industry in India at the time, created pressure on

Satyam’s executives to maintain the image of a healthy, successful company. In particular,

executives at Satyam feared a decrease in the stock price would result in loss of control of the

company; according to the fraud checklist, “potential risk factors for misstatements arising from

fraudulent financial reporting [include] threats of imminent bankruptcy, foreclosure, or a hostile

takeover” (Rubin 2007).

Ramalinga Raju, then-chairman, and his brother, then-managing director and CEO of

Satyam, wielded significant influence over the strategic decisions of the company. Raju and his

brother incorporated Satyam in 1973 and were heavily involved its management for over 30

years; despite holding less than a 10% ownership interest in the company, the brothers felt

immense pressure to keep up with other industry players so as to preserve the legacy of their

entrepreneurial success. Because Raju was chairman and his brother was CEO, they were able to

significantly influence the direction of Satyam and had the power to override internal controls.

The Rajus’ ability to direct business affairs at Satyam allowed the brothers to perpetrate

the fraud over a number of years; then-senior management also misled investors by

“intentionally provid[ing] materially false information on at least 20 occasions regarding

Satyam’s financial performance or the purpose of the failed Maytas acquisition to Wall Street

analysts during quarterly conference call; [the statements] made during the conference calls

made it appear to the analysts that Satyam was substantially more profitable than was actually

the case” (U.S. SECURITIES AND EXCHANGE COMMISSION 2011).

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Ramalinga Raju, his brother, and the Chief Financial Officer at Satyam had multiple

opportunities to commit financial statement fraud and were directly responsible for the

anomolies found in the financial statements. Specifically, “the ex-Chief Financial Officer (CFO)

of Satyam, Vadlamani Srinivas, has stated that the fake bank statements were produced by

Satyam to justify inflated sales revenes. Sales receipts of approximately 600 major clients were

doubled, a matter about which Vadlamani confessed he ‘abetted [Raju] in the planning, and [the

Vice President, Finance], G Ramakrishna in its execution’” (Craig 2013). Fake invoices were

fabricated using a special override key given by senior management; the fact that upper

management was actively involved in bypassing internal controls speaks to the poor control

environment and tone at the top of Satyam.

Investigation Planning

Assuming that the likelihood of fraud has been established and a preliminary hypothesis

developed, the fraud investigation should proceed with testing of the hypothesis via financial

statement analysis and journal entry testing. After these analyses, interviews with key individuals

will either sustain or conflict with the hypothesis, which may then be refined. Once satisfactory

evidence has been collected, conclusions and results should be conveyed to the appropriate

audience. This analysis should include an examination of all the roles, duties, and responsibilities

of Raju and the other key executives involved in perpetrating the fraud.

Records from Satyam’s electronic invoice management system should be reviewed;

according to the SEC complaint, “Satyam prepar[ed] invoices for the services that is provid[ed],

submit[ted] the invoices to its customers, and record[ed] the invoices in an electronic invoice

management system… the data from the invoice management system is exported into Satyam’s

financial system where the revenues are recorded in the company’s books of account… Satyam
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uses its books of account to prepare the financial statements that it submits” (U.S. SECURITIES

AND EXCHANGE COMMISSION 2011). In light of the fraudulent statements made to Wall

Street investors, the minutes from those quarterly conference calls should also be reviewed. Bank

statements, “reflecting materially false cash deposits in the company’s bank accounts at, among

other places, the Bank of Baroda (BOB) which were recorded within the cash and cash

equivalent balances in the publicly filed financial statements” (U.S. SECURITIES AND

EXCHANGE COMMISSION 2011) were fabricated by senior management to support fictitious

cash balances and so should also be reviewed and compared to the unaltered bank statements

from the same period.

Sarbanes-Oxley and SAS No. 99 created more stringent guidelines for internal controls

and auditors; this aids the forensic accounting investigation by increasing the amount of

documentation available surrounding assessments of a company’s internal controls. According to

an article from the Journal of Accountancy, “the discussion among engagement personnel in

planning the audit …including how and when the discussion occurred, the audit team members

who participated and the subjects discussed, the results of the procedures performed to further

address the risk of management override of controls, [and] the nature of the communications

about fraud made to management, the audit committee and others”(Ramos 2002) are all required

to be documented and would therefore be available to the forensic accountant for review.

Fraud risk inquiries other than into senior management should also be taken into account;

according to the Journal of Accountancy, “two primary objectives in making such inquiries [are]

to obtain first-hand knowledge of fraud [and]to corroborate or lend perspective to representations

of others”(Ramos 2002). Inquiries should be made with Bank of Baroda and any other financial
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institutions with which Satyam may have fabricated cash deposits as well as lower levels of

management at Satyam to understand the breakdown of internal controls that led to the fraud.

Report to Management

The appropriate parties to whom the findings should be addressed include Satyam’s

Board of Directors, successor Chief Executive Officers, and audit committee, if applicable. The

report to management delivers vital information that is relevant and critical to the operations and

day-to-day decisions of executive management; in particular, the findings indicate that executive

management poses the greatest fraud risk to Satyam and that the future of Satyam relies on

executive management’s ability to set an example of accountability for senior management and

lower level employees. The greatest obstacle to a strong control environment at Satyam is poor

tone at the top; moving forward, the Board and new Chief Executives must play a larger role in

establishing the standard of conduct expected of Satyam employees. An audit committee would

hold the Board of Directors and Chief Executives accountable and should ideally be instated as

soon as possible.

While poor internal controls contributed to the crime, economic pressures and collusion

between employees catalyzed the fraud. The Raju brothers, who filled the roles of Chairman and

Chief Executive Officer at Satyam while the fraud was occuring, founded the company in 1973.

Burdened with maintaining the pristine reputation of the family business, the brothers were under

significant pressure to report positive operating results year after year and resorted to collusion

with Satyam’s Chief Financial Officer and Vice President of Finance, G. Ramakrishna, to retain

the illusion of industry leadership in India’s tumultuous IT sector. The instatement of an audit

committee and a renewed tone of accountability at the top will strengthen the internal control

environment at Satyam and could have prevented the billion dollar fraud.
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While the fraud at Satyam was perpetrated in India, the New York Stock Exchange-

traded company was equally subject to the authority of United States’ regulatory agencies,

specifically the Securities and Exchange Commission (SEC). In particular, SOX mandates that

executive officers “sign-off” on the internal controls of their company as well as undergo annual

audits by an independent third-party. Because executive managers knowingly and willingly

signed off on internal controls they knew to be inferior or non-existent, they violated the

provisions in SOX.

The best way to prevent a fraud, outside of effective internal controls, is to educate the

workforce about fraud prevention and detection. Whistleblower hotlines have proven incredibly

effective as a detective measure against fraud, especially considering that, “tips [are] the most

common detection method by a wide margin, accounting for 39.1% of cases” (2016 global fraud

study). Educate senior management and lower level employees about corporate abuse and

provide a whistleblower hotline to cut the risk of this type of fraud happening at Satyam again.
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Exhibit

(in millions) Year Ended 3/31/2008 Year Ended 3/31/2007 % Change

Net income $417.0 $298.4 39.7%
Sales $2,138.1 $1,461.4 46.3%
Current assets $1,862.5 $609.2 205.7%
Total assets $2,243.3 $1,624.1 38.1%
Accounts receivable $508.4 $364.2 39.6%
Current liabilities $333.1 $211.2 57.7%
Total liabilities $381.5 $253.1 50.7%

Ratios:
Return on sales 19.5% 20.4% -4.5%
Return on assets 18.6% 18.4% 1.2%
Total asset turnover 0.95 0.90 5.9%
Total A/R turnover 4.21 4.01 4.8%
Average A/R days 87 91 -4.6%
Debt to assets 17.0% 15.6% 9.1%
Current ratio 5.59 2.88 93.8%
Net working capital $1,529.4 $398.0 284.3%
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References

ACCOUNTING AND AUDITING ENFORCEMENT release no. 3258. (2011). Retrieved

January 13, 2019, from https://www.sec.gov/litigation/litreleases/2011/lr21915.htm

Craig, R., Mortensen, T., & Iyer, S. (2013). Exploring top management language for signals of

possible deception: The words of satyam’s chair ramalinga raju. Journal of Business

Ethics, 113(2), 333-347. doi:10.1007/s10551-012-1307-5

Hahn, Miller, & Rufus. (2015). Forensic Accounting. Upper Saddle River, NJ: Pearson

Education, Inc.

Ramos, M. (2002). Auditor's responsibility for fraud detection. Journal of Accountancy, 195(1),

28-36. Retrieved from

http://ezproxy.snhu.edu/login?qurl=https%3A%2F%2Fsearch.proquest.com%2Fdocview

%2F206736159%3Faccountid%3D3783

Riahi-Belkaoui, A., & Picur, R. D. (2000). Understanding fraud in the accounting environment.

Managerial Finance, 26(11), 33-41. Retrieved from

http://ezproxy.snhu.edu/login?qurl=https%3A%2F%2Fsearch.proquest.com%2Fdocview

%2F212674188%3Faccountid%3D3783

Rubin, G. A. (2007). Fraud risk checklist.

http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&A

N=230241

Shetty, A. S. (2012). From trailblazing to trailing. The IUP Journal of Business Strategy, 9(4),

24-34. Retrieved from http://www.econis.eu/PPNSET?PPN=737962267

CASE STUDY ANALYSIS AND REPORT FOR MANAGEMENT 15

Singh, J.P., Kumar, Naveen, Uzma, Shigufta. (2010). Satyam fiasco: Corporate governance

failure and lessons therefrom. IUP Journal of Corporate Governance, 9(4), 30. Retrieved

from ABI/INFORM Global (Corporate) database. Retrieved from

https://search.proquest.com/docview/759597771

U.S. SECURITIES AND EXCHANGE COMMISSION Plaintiff, v. SATYAM COMPUTER

SERVICES LIMITED (2011). Retrieved from

https://www.sec.gov/litigation/complaints/2011/comp21915.pdf

2016 global fraud study. (2015). https://www.acfe.com/rttn2016/docs/2016-report-to-the-

nations.pdf