Now that Ramalinga Raju blew the lid off the biggest corporate scam (atleast of all the revealed ones, the word is that there are hell lot of them much bigger than Satyam) in the history of India, understanding how this scam was written over the years makes an interesting read. Until Ramalinga Raju himself revealed about the severe accounting frauds in the company, except for a few, no one knew about it. As usually the investigating agencies and the governing bodies (ICAI and SEBI in this case) are wondering how such a huge fraud went un-noticed all these years. There are quite a number of hints in the balance sheets Satyam was submitting to the board and the share holders, to identify that there is something seriously wrong with the accounts of the company. Business Today, a leading business magazine of the India Today group tried to probe through the last five years balance sheets and dug out some.
The most intriguing fact is, Business Today reports in its cover story, with almost $1.2 billion of cash, Satyam closed 2007-08 with $56 million of debt. An enormous amount of cash Rs 4,462 crore appeared to sit in the account unused. Excess cash is either paid back to shareholders in the shape of a dividend, or is earning valuable interest if it isn’t being utilized to pay debt or fund acquisitions. None of the independent board members or auditors thought to question any of this.
Satyam’s operating margin for the second quarter of 2008-09 was an abysmal 3 per cent, which is what forced him to pump the numbers up. That seems absurd, considering that Infosys recently reported a 33 per cent operating margin and Tata Consultancy Services a 37 percent operating margin and these firms compete for similar kinds of business in similar geographic locations. For a company like Satyam which has global operations spanning more than 40 countries and employees of more than 50,000, it is impossible to handle its day to day activities with such a low operating margin. Satyam has huge cash reserves, though not as high as reported, which were diverted without informing the investors and the board of directors which is unlawful. And where did the money go? As per the investigations and news coming out, it went into real estate investments in and around Hyderabad, Visakhapatnam, Vijayawada, Kakinada and Rajahmundry. When state governments including Andhra Pradesh are vying with each other to provide lands to Satyam at through away prices, what is the point in buying lands investing such a huge amount of money? Clearly, the effort to fudge revenue figures had less to do with corporate pressure and more to do with generating cash for all the other dubious deals that Raju could have been involved in over the years—including the funding of the two Maytas firms, paying off political dons as well as land acquisitions. How was he able to implement such a colossal fraud?
It is not like no one grew suspicious about the accounting practices of the company. Business Today reports, CLSA (an independent brokerage and investment group) had originally put out a report way back in 2001 on Satyam’s “dubious accounting practices”. Then, RPI MP Ramdas Athawale accused Raju and gang of tax fraud and insider trading in 2003. But clearly, the independent directors on the board, the external auditors, the banks and the stock exchanges were either napping or in collusion.
Employees speaking to the media and blogging about the crisis unfolding say they had scented a crisis in the making, though not of such a huge scale. A mail to employees from B. Rama Raju, then Managing Director, dated October 24, 2008 contained stern warnings of sacking or demotion in cases where 80 per cent of targets are not met, and laid down cutting variable pay for the last two quarters. There are quite a number of rumors in the media and inside the company that employee sacking is planned in a big way, which was continuously denied by the company’s spokespersons. In 2007 some of the Business dailies reported that Satyam is on the way for takeover by IBM.
A summary of the indicators of a serious scam unfolding in the company compiled by Business Today, which can also be used as a checklist for other public limited companies you have invested in:
Mismatch in balance sheet entries: Starting 2002-3, the company's reported cash and bank balance, continued to swell without matching the growth in cash flow. In fact, Satyam's cash flow was negative in two years.
Auditor fees shoots up: Auditor fees increased three times in the past couple of years though other leading IT companies like TCS, Infosys and Wipro continued to pay the same amount.
Non-payment of advance tax: Satyam did not pay advance tax in 2008-9. Payment of advance tax is an indicator of profitability and non-payment could imply that trouble has been brewing for some time.
Vanishing brass: In August 2008, many top officials left the company. This should have been a reason for further investigation.
Not using cash to acquire: It was puzzling that the company was proposing to invest $1.6 billion in real estate at a time when HCL was trying to expand its presence in the SAP market, essentially Satyam's area of expertise.
Cash idling in Account: Economic Times reports that, in Oct 2008, analyst Kawaljeet Saluja of Kotak Securities almost blew the lid off the scam when he questioned the rationale for keeping $550 million idle in a current account, but no one cared a damn and it was forgotten as soon as it was raised.
One reason why no one thought Satyam could ever go wrong is its star studded Board of Directors. Ramalinga Raju chose them well. No one would even think of questioning such illustrious members of the business community as Harvard Professor and corporate governance expert Krishna Palepu, co-father of the Pentium processor, Vinod Dham and Dean of the Indian School of Business, Rammohan Rao. None of these board members ever thought of finding out why Satyam had so much underutilised cash reserves or why Raju family’s share in the company was falling so precipitously, even after meeting seven times in last year.
The other is his connections in the industry and politics. Remember Ramalinga Raju shared the dais with former US President Bill Clinton when he visited Hyderabad. Raju was among the select few invited to share the podium with Clinton and then Chief Minister N. Chandrababu Naidu, when the likes of Ratan Tata were in the audience.
Is there anyway changes can be made in the system so that the Satyam lie could have been caught before it was blown off? A senior level manager working with the company informed Andhra Jyothy, a leading Telugu Newspaper that the issue lies with Vaastu, the traditional Indian science of construction. Ramalinga Raju’s new corporate office had the Chairman sitting in a portion of the building that was suspended in the air and there was a water fountain below. The implication, he explains: “It is considered bad because such structures make you lose touch with the elements!”
If you look for some logical solution that makes sense, the answer lies in XBRL.The tech savvy accountants investigating the Enron scam in 1999 were faced with similar question. Yes, accounting frauds can be caught by properly leveraging the use of Information Technology. Few years after the Enron and World Tel scams, a new business reporting language was born. XBRL, which stands for extensible Business Reporting Language. The XML (extensible markup language) properties of XBRL make the information machine-readable. The addition of business rules to XML creates XBRL, creating information that is more easily read. XBRL greatly increases the speed of handling of financial data, reduces the chance of error and permits automatic checking of information. XBRL is adopted by more than 100 countries and India adopted it very recently. XBRL implementation is happening at BSE (Bombay Stock Exchange), NSE (National Stock Exchange), SEBI (Securities and Exchanges Board of India), RBI (Reserve Bank of India) and MCA (Ministry of Company Affairs), with each of them working to their own schedule. The ICAI (Institute of Chartered Accountants of India) has taken the leadership to form an XBRL jurisdiction in India. But could the adoption of XBRL have helped in the early detection of the Satyam fraud? The answer is no. However, the use of XBRL can now help investigators unravel the Satyam story quickly. After adopting XBRL the information becomes machines readable and information can be summarized into easily understandable tables and graphs which can catch mis-representation of data very easily.
Since the Satyam scam is out and investigation is on, can we now breathe easy and relax? The governing bodies might have learnt their lessons and everything is going to be fine from now. If you have any such ideas here are two facts that can startle and rather shock you. As per the write up in the online edition of Chip magazine, the figures for software imports from India are $1.6 billion in 2002-3 as reported by the US Department of Commerce. CII (Confederation of Indian Industry) and NASSCOM (National Association of Software companies) state that India's software exports to the US were $6.3 billion and $9.5 billion, respectively. Other than the $1.6 billion where is the huge cash flow coming from? Do you smell a huge scam for laundering money? After all, revenues earned on software exports are tax free.
If this piece of information did not scare you, here is one more. CLSA, the global brokerage house, has compiled a list of companies that had adopted what it calls “aggressive” accounting policies for April-June 2008. It had some of Indian Industry’s super stars, including Reliance Industries, Reliance Communications, Tata Motors and Tata Consultancy Services.
Inputs for this write up taken from News Reports published in Business Today, Economic Times, Times of India, Andhra Jyothy, Eenadu and Wikipedia.