The Largest Corporate Fraud in India: Satyam Computer Services Limited

Introduction Corporate governance has been a major issue for potential investors in economically developing countries. Fraud cases in developing countries such as India and Nigeria have alerted the investors all over the globe. Many studies have been done to recognize the failure of existing regulations in these countries, for example Samanta and Das (2009) and Enwezor (2010). This paper contributes to the emerging markets corporate governance literature. We provide an overview of the Indian financial market as a form of economically developing market and examine the fraud at Satyam Computer Services Limited (Satyam) through the lens of corporate governance. The corporate fraud at the fourth largest software firm in India, Satyam, occurred in 2009. Arguably, this fraud affected the firms across the board in India and possibly other emerging market countries (Chakrabarti and Sarkar 2010). A large amount of research has been done on this fraud and many related issues have been examined, such as, how this fraud was perpetrated over seven years, what are the lessons learnt from this fraud etc. Two significant issues have come out of this research. The first is that the independent directors at Satyam should have been held responsible. The board at Satyam was made up of renowned people with international credentials to their names. Therefore, many experts have questioned the effectiveness and ability of the board to prevent such a massive fraud, which was ongoing for seven years and ended with a confession letter from the Chairman and promoter B. Ramalinga Raju (Sharma, 2009). The second issue that has been discussed relatively less in the literature is the failure of the audit committee and the audit firm (PricewaterhouseCoopers in this case). Samanta and Das 1

(2009) provide that the auditors primary duties are to ensure that the audit is carried in such a way that enables the auditor to certify that the balance sheet and profit and loss account of the company gives a true and fair view of the companys financial affairs. They argue that clearly the auditors failed to achieve this objective. Ahmad et al (2010a) take a similar approach and question the effectiveness of audit team. In this paper, we synthesize prior research and provide reasoning for the ineffectiveness shown by the Board of Directors, the audit committee, and the auditors. We specifically argue that majority of these parties were carrying out their roles in the prescribed manner. However, the Indian regulatory system needs to bring some changes that can enhance the corporate governance mechanism. We do not know of any other paper that has done this. This issue is important because this is the largest fraud in the Indian economy to date. India has seen exponential growth over the last two decades and is regarded as one of the fastest growing economies globally (Afsharipour, 2010). The paper is divided into five sections. The next section provides a review of the literature and relates these two issues as examined in the prior research. The third section provides a brief overview of the Indian capital market, the fraud at Satyam and how it went on for seven years. The fourth section explores why the existing regulations failed to prevent such a fraud under the supervision of the Board of Directors and the audit committee. The fifth section provides recommendations to strengthen the corporate governance mechanism for the regulatory bodies in India and perhaps other countries where corporate governance is weak. This section also concludes the paper and discusses suggestions for further research.

Literature Review Afsharipour (2010) relates the expectations and challenges of Indias corporate governance. In the paper, the author introduces some of the corporate reforms that were initiated due to the Satyam fraud. She recognizes a need for governance in the Indian corporate world due to the expanding Indian economy, increased domestic and foreign investors, and the growth of Indian companies interested in accessing the global capital markets. As a backdrop to this discussion, Afsharipour (2010) portrays the condition of corporate governance before and after the corporate scandal involving Satyam. Although Mr. Ramalinga Raju (Chairman) and his family owned only 8% shares in the company, she states that the company, however had a majority independent Board of Directors, comprised of various luminaries in India, thus complying with the requirements of Clause 491. The Satyam Board of Directors included international elites such as Mangalam Srinivasan (advisor to the Kennedy School of Government, Harvard University), Vinod K Dham (founder of Pentium microprocessors), Krishna G. Palepu (Ross Graham Walker Professor of Business Administration and Senior Associate Dean for International Development at Harvard Business School), and M Rammohan Rao (Dean of Indian School of Business). Hence, following the exposure of fraud, questions have been raised as to how such a large-scale fraud had gone undetected among such an elite selection of independent Directors. Afsharipour (2010), based on the minutes of the board meeting, provides that on December 16, 2008, questions were raised against the proposed transaction2. Dr. Mangalam Srivasan had voiced concerns about the initiatives of the proposal whereas Professor M. Rammohan Rao and Vinod K. Dham had
1

The Securities and Exchange Board of India (SEBI) has implemented Clause 49, a regulation that strengthens the role of independent directors serving on corporate boards.
2

This transaction refers to Satyam making a proposal for acquisition of two Maytas companies for $1.6 billion in cash, which is a related party transaction. The board approved it on December 16, 2008.

concerns about the company getting into an unrelated business field. Meanwhile, other members had questions concerning the benefits these transactions would provide to the shareholders. However, despite these concerns, the Board adopted (without any dissent whatsoever) a unanimous resolution to proceed with the proposed acquisition (Afsharipour, 2010). The items came to surface only after the market started reacting. The company was compelled to withdraw the offer. This led to the confession by Satyams Chairman of the Board, Mr. Ramalinga Raju. Questions have been raised about how such highly qualified independent Board of Directors failed to prevent Satyam from making such an adverse decision. One of the reasons that Afsharipour (2010) pointed out is the ownership structure of firms in India. Due to the closely held nature of these firms, the companies seemed to lack proper disclosure and other governance requirements. In a similar context, Khanna and Matthew (2010) have concluded that there is no clear understanding among the board members as to what is expected from them. In their research study, they found that independent directors in India view their roles as strategic advisors. They do not see themselves as watchdogs. Their study suggested that the directors lack time and resources to review the management activities. The directors also have concerns over their influence and knowledge in certain plans pushed forward by the promoter. The research specifically concludes that although these findings are preliminary, they suggest that directors view their primary role as being strategic advisors and that imposing a serious monitoring duty on them would be almost unequivocally opposed and perceived as impractical, detrimental to board functioning, and, perhaps most importantly, contrary to the realities of modern board service.

One of the major findings in the study was that the directors expressed concerns that the auditors should be considered the watchdogs and not them. This leads to the study concerning how the external auditors failed to detect the fraud that perpetrated over the years. PricewaterhouseCoopers LLP, the audit firm with the engagement was unable to detect the fraud. Audits on companies should be conducted such that the auditors are in position to certify that the balance sheet and profit and loss account of a company give true and fair view of companys financials. Samanta and Das (2009) study the three different situations using Enron (US), Parmalat (Europe), and Satyam (India) as examples and compare the roles of the auditors in each of these fraud cases. Auditors are responsible to act as the senses for shareholders. According to the authors, auditors are important to instill confidence in market and to provide a true and fair account of the company. In Enrons case, Arthur Andersons independence was compromised due to the huge amount of non-audit related fees that Anderson received from Enron. In the case of Italian food giant Parmalat, the auditors aided the managers in the creating and hiding fraud. Samanta and Das (2009) provide that Enrons case showed that the mere existence of accounting standards does not hold sufficient for the prevention of fraud and Parmalats case showed that lack of law and enforcement system gives rise to lack of compliance and transparency, thus leading to fraud. The situation is different in the Indian perspective. In India, after the Companies Act3, the Audit Committee was introduced to strengthen the corporate governance. However, the audit committee at Satyam failed to perform its duties effectively. In addition to this committee, the internal auditor as well as statutory auditors who are required to attend each of the committee

See Indian Companies Act , 1956 , Section 292A

meetings failed to act promptly thus letting the fraud grow over years. However, the authors have indicated that Audit Committees are to be articulated by the Board of Directors themselves. A further study into the roles and duties of auditors and Board of Directors is done by Ahmad et al (2010a). The authors have divided their paper into the roles of Chairman, Independent Directors, and the Auditors. According to the authors, Mr. Ramalinga Raju, being the Chairman of the company is solely liable for his activities. However, questions arise as to how much and, in what context, the directors and the auditors were liable. In the study, the authors put the Indian law into perspective and related it to the duties of the Directors and Auditors. According to the paper, Clause 49, of the Indian listing agreement deals with the role of independent directors and assumes, that not being related to a promoter or having a direct economic benefit from a company, makes a director independent. The paper goes on to criticize how the current law does not require approval from the current or already elected directors to maintain independence from the management. In addition, the paper cites Satish Maneshinde, a criminal lawyer in India, as saying Under the SEBI and Companies Act 1956, all directors cannot be held responsible because institutional directors and independent directors are nominated directors of various financial institutions of the government nominees. They cannot be held responsible as nominated directors cannot be held legally liable. This clearly gives a wide room for the directors to breach their duties and still be exempt. This also shows a clear need for law that defines duties, qualifications, and the liabilities of the board members. Auditors hold fiduciary responsibilities to inquire about information and should take reasonable care to check to ensure the financials have been properly updated. It is their responsibility to make inquiries and find answers if certain issues do not pass the audit standards. However, Menon (2009) argues that there is a fundamental problem with the existing system of

audits and that is the auditors are engaged and paid by the same managers who may be responsible for misreporting. Moreover, the regulatory environment in India does not have strict penalties for auditors if they do not follow their duties accordingly. According to Sections 227 and 233 of the Indian Companies Act, there is a less than $250 (Exchange rate: $1 = 45.06 INR4) fine for failing to do a fair and diligent review and audit of the accounts. In addition, the monetary fines levied on the lead auditor of Satyam were less than $15,000 (Exchange rate: $1 = 45.06 INR). This penalty is almost negligible in comparison to the extent of the fraud. In addition, Ahmad et al. (2010b) argue that the contract that the auditor has with the company is not a contract the shareholders or other shareholders are privy to. Hence, under Indian law it would be difficult for the shareholders or any other stakeholder to take any action against the auditors under the Law of Contract. Shivanna (2010) uses the example of Satyam and studies the failures of corporate governance at various levels which led to this fraud. Shivanna (2010) argues that this fraud resulted from failures at the regulatory as well as at the executive level. He provides a list of corporate governance failures which should have alerted the regulatory authorities. For example, Satyam had admitted to the Securities and Exchange Commission (SEC) that they do not have anyone on the audit committee who has all the attributes as required by the SEC to be serving the committee as an Audit Committee Financial Expert. Therefore, none of the independent directors had a finance background that made them capable or experienced in checking the companys financials.5 The Asian Corporate Governance Association published a paper called ACGA White Paper on Corporate Governance in India (ACGA Report, 2010). This publication provides
4

INR stands for Indian Rupee and it is the Indian currency. As of December 31, 2009, 1 USD = Approx Rs. 45.06. See Shivanna (2010), page 5.

suggestions to officials, financial regulators, and investors to strengthen the corporate governance in India. The increase in the globalization of Indian companies due to the economic reform and development of India has increased the need for these reforms. This paper specifically identifies that corporate governance reforms such as greater disclosure by promoters were initiated by fraud cases in Satyam. However, the publication focuses on the need for more regulations from governmental as well as corporate parties. In an attempt to introduce these reforms, it puts forth five key issues and presents specific recommendations concerning these issues. These issues include shareholder meeting and voting rights, related-party transactions, preferential warrants, corporate disclosure, and the auditing profession. The publication recommends a modernized voting process that is transparent and reliable. With respect to related-party transactions, it recognizes a need for minority shareholders involvement and recommends creating a separate committee to ensure the transactions are performed fairly. The report emphasizes that the issuance of preferential warrants gives undue advantage to certain promoters, so only general meetings should be authorized to approve these. In addition, the publication states that the financial disclosures must be consistent, detailed, timely, and well formatted. Finally, it recognizes a need for unity in the auditing profession through consolidation and talent recruitment. The report asserts that the acceptance and implementation of these reforms would help strengthen Indias capital market.

Indian Financial Market and Fraud at Satyam Overview of Indian Financial Market In India, there are a total of 23 stock exchanges. Out of these, 21 are regional stock exchanges and the remaining two are national stock exchanges. They are Bombay Stock

Exchange (BSE) and the National Stock Exchange (NSE)6 and they are most relevant to our paper. Bombay Stock Exchange (BSE) is the oldest stock exchange in India as well as in Asia. It was established in 1875. After several decades, it became the first stock exchange to be officially recognized by the Indian government in 1956 under the Security Contracts (Regulation) Act, 1956.7 According to the World Federation of Exchanges (WFE) statistics, as of November 30, 2010, BSE has the most number (5,022 companies) of companies listed in the world and also ranked 10th in the world by the amount of market capitalization (U.S. $ 1,540 Billion).8 National Stock Exchange (NSE) was first organized in 1992. Within a year, this stock exchange received certification under Securities Contracts (Regulation) Act, 1956. It started trading in mid 1994. According to WFEs statistics as of November 30 2010, NSE is ranked right behind BSE (11th) in the world by the amount of market capitalization (U.S. $ 1,503 Billion). The Securities and Exchange Board of India (SEBI) is the regulatory authority that oversees the securities market in India. In April 1988, the SEBI was established as a non statutory administrative body to operate under the Ministry of Finance of the Central Government of India. It received its statutory status in January 1992 and was given more power through an ordinance to regulate the security market. The primary objectives of this board are to protect investors interest in securities, to promote security market development, to regulate the security market and create further rules and regulation as necessary to control the security market.9

http://www.sudhirlaw.com/chapter3.htm http://finance.indiamart.com/markets/bse/ http://www.world-exchanges.org/statistics/ytd-monthly http://finance.indiabizclub.com/info/securities_exchange_board_india

Fraud at Satyam Satyam, the fourth largest IT firm in India committed the biggest Indian corporate financial fraud that came in light to public in January 2009. This fraud is also known as Indias Enron. Until the last quarter of 2008, Satyam was an idol in the Indian IT industry. All problems started around October 2008. At this time the World Bank, one of the major clients of Satyam, banned Satyam from providing any service to itself and accused Satyam of hacking into their systems and accessing confidential information (Shivanna, 2010). Though Satyam refused to accept any blame, this negative publicity surely ruined Satyams reputation. While the company was still trying to overcome this issue, on December 16, 2008, the company board approved acquisition of privately held Maytas properties for $1.3 billion and 51% stake in publicly listed firm Maytas Infra for $300 million. Institutional shareholders resisted arguing that the transaction was an insider deal.10 Since both of these companies represented Raju familys businesses run by Ramalinga Rajus two sons, it seemed evident that the Satyam shareholders money was being used to save the two companies of a struggling industry. After this news went public, the tension/anger among the investors led Satyam ADRs (American Depositary Receipts) open 35% lower that morning at NYSE. A day after, on December 17, Satyam share price fell by 30.66% and Nifty Fifty11 by 2.87% (Chakrabarti & Sarkar, 2010). The Satyam management stepped back and canceled the Maytas deal almost immediately after it was sanctioned. But at this moment, the management retreat did not benefit Satyam because it had already impacted its reputation and had a severe negative effect on investors confidence level in the stock market.
10

Maytas is Satyam spelled backwards.

Nifty Fifty is the leading index for large companies on the National Stock Exchange of India

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10

While the company was struggling due to these reasons, only a few days later, on January 2, 2009, Mr. Raju revealed to the stock exchanges that his family had pledged all its shares held in its holding firm, SRSR Limited, to institutional lenders (Vohra, 2009). Following this event, within next two days Raju Family holdings of Satyam shares dropped to 3.6 percent from 8.6 percent. This prompted three of the independent directors to resign from Satyam (Vohra, 2009). Shockingly enough, but the investors, shareholders, and the company itself still had not seen the worst. On January 7, 2009, Mr. Raju wrote a letter to the Board of Directors, Stock Exchanges, and the SEBI, stating that Satyams balance sheet as of September 30, 2008 was carrying fictitious cash and bank balances up to 50.40 Billion INR, out of 53.61 Billion INR reported in the books and reported accrued interest of 3.76 Billion INR which did not exist. In addition, the liability of 12.30 Billion INR was understated on accounts of funds arranged by the chairman Raju and Debtors position of 4.90 Billion INR was overstated as against 26.51 Billion INR stated in the books. Overall reported revenue for the September quarter was 27 Billion INR and an operating margin of 24% of revenues as against actual revenues of 21.12 Billion INR and operating margin of only 3% of revenue (see Figure 1). Also in this letter, Mr. Raju mentioned that none of the board members or any immediate or extended family members had any idea about this accounting scam12. Even business leaders and senior executives in the company were unaware of the accounting scam in the company books. This event caused havoc in stock prices of Satyam that declined 77.47% after this news went public (Chakrabarti and Sarkar, 2010). As a result, the Satyam scandal became the biggest fraud in the Indian corporate history.

12

The full text of the letter can be downloaded from http://www.indianexpress.com/news/satyam-fraud-full-text-ofrajus-letter-to/407799/

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The letter by Mr. Raju claimed that he was the only one responsible for this fraud and no other party was involved. However, according to Ahmad et al. (2010a),

PricewaterhouseCoopers had been the statutory auditor for Satyam Computer services for last six years. Auditors involvement is crystal clear. Satyam had paid twice the amount of what was charged by other Audit Firms. Additionally, as per an Indian news media Express India, Andhra Pradesh polices Criminal Investigation Department (CID) stated that Mr. Raju had falsified the employee number at Satyam. According to the books, Satyam had about 52,000 employees, whereas the actual employees were only 40,000. The CID also stated that by inflating the employee number Mr. Raju was withdrawing about 200 Million INR per month as Staff cost. The Indian media has argued, therefore, that most likely Satyams Human Resource department, the payroll department, and Satyams bank were somehow involved in this criminal deed along with Mr. Raju.

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Board of Directors, Auditors and Regulatory Environment After Mr. Ramalinga Rajus stunning confession in early 2009, it was not clear that how such a massive fraud could go undetected for seven years under the supervision of such able independent directors and auditors. Some experts have argued that the independent directors should be held responsible for this fraud. For example, Parekh (2009) states that the independent directors failed to perform their fiduciary duties even when they were well compensated. Parekh (2009) even argues that the independent directors and audit committee members should face civil consequences for their gross misbehavior. In addition, many other papers have questioned the ability and effectiveness of the Board of Directors to prevent a $1 billion fraud at the fourth largest IT firm in India. We argue that the independent directors were only performing their duties and responsibilities and they cannot be held legally responsible for this fraud. First, we examine the responsibilities of independent director in a publicly listed Indian company. There are some questions on what are the responsibilities of independent directors in a publicly listed company. According to Khanna and Mathew (2010), independent directors have at least two distinct but not necessarily mutually exclusive roles: (i) watchful monitors of promoters and management on behalf of shareholders, (ii) strategic advisors intended to aid management in business decisions. However, the regulatory authorities in India have not been clear in defining the roles of independent director. Therefore, Khanna and Mathew (2010) investigated the role of independent directors in Indian companies. They interviewed about 50 directors at leading Indian companies as well as a number of advisors to corporate boards and promoters. The preliminary

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findings of their interviews revealed many interesting findings and some of those findings that are particularly useful for this paper are13: (i) All of the independent directors interviewed viewed themselves as strategic advisors and not watchful monitors. One of the respondents stated that independent directors are not there to prevent management from taking decisions. (ii) The interviewees agreed that there was a huge uncertainty and confusion as to the proper role of independent directors. They emphasized that independent directors should be able to rely on the information provided by auditors and management. (iii) All the respondents agreed that the current compensation levels for independent directors were woefully inadequate as compared to the international standards. Therefore, when the roles and responsibilities of independent directors are not welldefined and there is a consensus that their role is of strategic advisors and not watchdogs, they cannot be held liable for such a fraud. The primary question that was asked in the literature immediately after this fraud was that how could independent directors approve a related party transaction valued at approximately $1.6 billion in Maytas Infrastructure. However, Afsharipur (2010) provides that in the board meeting prior to this decision, the directors did question the proposed transaction and the directors were concerned about the company venturing into a wholly unrelated business. However, eventually the board did approve the transaction which was later reversed after the public outcry. This decision and the finding in Khanna and Mathew (2010) that independent directors are not there to prevent management from taking decisions clearly provides evidence to the fact that the board was being used as rubber stamp to affirm the consequent or decision already reached (Afsharipur, 2010).

13

Khanna and Mathew (2010), page 62

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We argue that the regulatory authorities need to step up and clearly define the roles and responsibilities that should be carried by the Board of Directors. The evidence in this fraud provides that the regulatory authorities in India and the United States (U.S.) were unable to prevent the wrongdoings at Satyam. For example, Shivanna (2010) provides that the item 16A of the Form 20-F statement14 provided by Satyam clearly stated that they do not have anyone on the audit committee who has all the attributes required by the SEC to serve on the committee as a financial expert. Satyam had a board consisting of six non-management directors out of which four were academicians and one was a former Cabinet Secretary of the Indian Government. Therefore, none of the directors was qualified as a financial expert as defined by the SEC. Moreover, the Satyam board had separated the positions of CEO and Chairman but both positions were occupied by brothers. Finally, the Form 20-F also reported that Satyam lacks a Corporate Governance committee which could have prevented a fraud of this magnitude. Other parties that came under heavy questioning after this fraud were the auditors of Satyam (PricewaterhouseCoopers) and the audit committee. Samanta and Das (2009) provide that under the Indian companies Act, the auditors are required to accurately, fairly and diligently review and audit the accounts of the company before issuing the auditors report. According to the confession letter by Mr. Ramalinga Raju, approximately 50.40 Billion INR out of 53.61 Billion INR cash reported in the September 30, 2008 financial statements was non-existent. In the financial statements, this cash was reported as investments in bank deposits. Govindaraj and Sampath (2009) provide that the first time this line item appeared in Satyams consolidated financial statements was in fiscal year 2003. However, the disclosures that the company made about these deposits did not include the names of the banks where the deposits were invested,
14

All foreign companies listed in the U.S. are required to submit their annual financial statements on Form 20-F to the SEC.

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which is customary under Indian generally accepted accounting principles (GAAP), but not required. Various studies have argued that if the auditors were carrying their duties effectively, they should have been able to catch this fraud much earlier. For example, Sekhar (2009) questions the actions of auditors: Have they blindly trusted the account statements produced by the company or did they have substantial evidence to believe the numbers? Sekhar (2009) also argues that the auditing firm could have questioned the reasoning for holding such large amounts as short-term investments. The arguments in these papers imply that the officials in the audit firm colluded with the promoter to carry out this fraud. In fact, a criminal case was initiated against PricewaterhouseCoopers and its auditors for fraud and criminal conspiracy. Moreover, the Institute of Chartered Accountants of India (ICAI) has initiated disciplinary proceedings against the auditors of the firm for professional misconduct15. In the U.S., the Public Company Accounting Oversight Board (PCAOB) has barred two accountants responsible for the Satyam audit from being an associated person of a registered public accounting firm16. These two auditors worked for an Indian affiliate of PricewaterhouseCoopers called Lovelock & Lewes. According to the PCAOB, these two auditors had consented to the sanctions and had submitted settlement offers to the Board without confirming or denying their involvement in the fraud. While these proceedings are ongoing, it is unclear whether the audit firm was involved in this fraud or was unable to detect this fraud. We do not argue one way or the other. In this paper, we argue that the Indian auditing profession has some serious limitations which need to be overcome before another scam hits the Indian economy. The ACGA Report has some interesting findings in the context of this paper. This report provides that the Indian auditing profession is
15

HC rejects Satyam auditors plea to halt ICAI proceeding The Economic Times (November 23, 2010) US watchdog imposes sanctions on 2 Satyam auditors Oneindia News (March 18, 2010)

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highly fragmented. According to an estimate, there are 90-95% of auditing firms that would be classified as a small accounting firm. The small firm would typically be seen as one having less than five partners and would have a smaller number of employees and gross receipts of about 5 million INR (US$ 111,000). This report questions the ability of these smaller firms, given their geographical reach and depth of knowledge, to handle the accounts of companies that are becoming increasingly global. The evidence points that the large audit firms outsource most of the audit work to these firms and these small firms end up doing most of the audit work. This report provides that another shortcoming of the Indian audit industry is the artificial and restrictive caps placed on the number of new audit trainees that firms can hire each year. The purpose of these caps is to protect the smaller audit firms; otherwise the bigger audit firms will hire too many trainees. This quota system has affected the ability of big firms to employ a sufficient number of qualified auditors. Furthermore, there is no independent regulatory body in India to regulate the auditing profession17. The ICAI is a self-regulatory body established under the Chartered Accountants Act, 1949. The problem is that it is not independent from the profession that it regulates. There has been serious criticism in the past about ICAIs enforcement capabilities. Critics say that the penalties imposed by the ICAI over disciplinary actions are so minimal and take so much time to enforce that it renders the whole process meaningless. One of the criticisms that Satyams auditors faced was that the auditors failed to verify the cash balances with banks when Satyam was reporting cash, which was non-existent. According to the ACGA report, it is common practice in India for auditors not to independently verify the
17

Similar to PCAOB in the U.S.

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bank statements of client companies, but instead to rely on bank account information provided by clients. Auditors in India say that banks will not respond promptly or at all when asked for such information. One audit partner said that he has to send staff to banks to get company documents verified and instructs them to sit and wait until the work is done.18 Section 203 of the Sarbanes-Oxley Act requires mandatory rotation of the lead audit partner every five years. However, there is no such requirement in India. Therefore, the ACGA Report (2010) argues for a rule that requires mandatory rotation of audit partners because a long association between an audit firm and a listed company could lead to complacency and defeat the true sense of independence of the auditors. Another explanation of this fraud is provided by Govindaraj and Sampath (2009). They consider two possible scenarios that might have happened. In the first scenario, they assume that the unreported cash never existed. Therefore, Satyam must have artificially inflated the revenues and the cash and bank balances as a result. They argue, however, that this type of fraud is too difficult to sustain over a longer period of time (seven years in Satyams case) because the income statement would have required too much manipulation and even standard audit methods would have caught it. Moreover, they argue that it is almost impossible to create cash legitimately. In the second scenario, which is more likely according to them, they hypothesize that the cash was real because Satyam was a profitable company and cash flows from operating activities must have been the primary driver of its cash inflows with minimal long-term debt and equity financing. Other research corroborates this hypothesis. For example, Desai (2009) provides that the business model in the IT industry allows companies to grow on their own as

18

ACGA Report (2010), page 45.

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retained earnings are sufficient to finance growth and no external cash is needed for this purpose. Another paper lists the five business acquisitions that Satyam made from April 2005 until April 2008 that were all cash deals for a total of $177.3 million (Monga and Behl, 2009). Therefore, Govindaraj and Sampath (2009) provide that Mr. Raju likely used this cash to finance personal investments (probably risky ventures). However, when the economy went into recession, his personal investments could not sustain, forcing him to bring the fraud public. Govindaraj and Sampath (2009) argue that the standard audit models would not be able to catch this fraud because they focus more on the income statement and the balance sheet rather than the cash flow statement. They provide that the weaknesses in the corporate governance mechanisms and the internal control systems at Satyam enabled this fraud.

Conclusion and Recommendations Prior research has questioned the role of Board of Directors and auditors in preventing this fraud at Satyam. This paper documents the evidence that shows that at least, the Board of Directors were following the rules and regulations and carrying out their responsibilities in the prescribed manner. It is unclear at this point whether the auditors were involved in this fraud; however, the research clearly shows that the audit environment in India has room for improvement. Post (2009) argues that a genuine crisis permits an executive, or a community to take bold, transformative action with maximum support and minimum objection. Borrowing from Mr. Rahm Emanuel, President Obamas Chief of Staff, Post (2009) asserts that it is important to never waste a crisis. Indian economy and the regulatory authorities must draw their lessons from this fraud. The roles and responsibilities of independent directors must be clearly defined

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and clause 49 of the SEBI needs to be strengthened to ensure that the Board includes truly independent directors. It appears that the Board of Directors at Satyam had their doubts about the Maytas acquisitions but they still approved the deal because they viewed their role as mere advisors and not watchdogs. The directors must include some members that meet the definition of a financial expert. Even though the SEC requires the existence of a financial expert on the board, Satyam was operating without one. Therefore, quick action must be taken against the companies which are not following the regulations. Although all the recommendations in the ACGA Report (2010) are important but the ones relating to the auditing profession in India are particularly relevant to this paper. The accounting firms in India are highly fragmented and they would definitely benefit from consolidation. Therefore, arbitrary caps on the number of audit trainees and audit partners must be removed. The ICAI licenses the Chartered Accountants (CA) and is a self-regulatory body. However, the penalties imposed by ICAI are so small and the time taken on these irregularities is so high that renders the whole process meaningless. The ICAIs case against the two auditors involved in the Satyam scandal is still ongoing at the time of this writing. Indian auditing profession would definitely benefit from a regulatory body which is independent (for example, the PCAOB in the U.S.). The penalties should be substantial enough to have a deterrent effect on the individuals and the company (Shivanna, 2010). The banking regulations in India have room for improvement as well to prevent future scams like this. One of the comments in the ACGA Report (2010) mentioned that it is very difficult and almost impossible to receive bank confirmations of the companys accounts, which is a standard audit practice. In the U.S., there is a standard bank confirmation letter that the bank

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manager needs to sign. A similar regulation could be introduced in India to prevent such frauds in future. After the fraud at Satyam, Tech Mahindra acquired a 51% stake in Satyam on April 16, 2009 successfully saving it from a complete collapse. Unexpectedly, this fraud at Satyam did not adversely affect the IT business in India. In fact, Desai (2009) provides that recession in the U.S. economy had a lager impact on the business. The stock market in India has recovered from this scandal and currently at its all time high. However, the regulatory authorities in India, such as the SEBI and Reserve Bank of India (RBI) will do well to not forget this fraud (as usually happens) and take proactive measures to prevent such scandals. When the civil and criminal lawsuits against the auditors and Mr. Raju are settled, future research should re-examine this case.

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