The Hindu Business Line : Inflated cash and bank balances, most shocking in Satyam

We rarely have accounting scandals where the cash is misrepresented. Most involve aggressive interpretation of accounting rules, or creating fictitious inventory and receivables.

Mr Siva Nathan, Georgia State University, US.

Could analysts have unearthed the malaise in the reported statements of Satyam? Or, at least, what lessons can they take away from this episode and apply to other statements?

Pose these questions to Mr Siva Nathan, Associate Professor, School of Accountancy, Robinson College of Business, Georgia State University, Atlanta, US, and this is what he has as answer: “I have looked at the Satyam financial statements carefully after the scandal broke. Looking at the same in hindsight I have made the following observations: Satyam reported operating margin of 24 per cent of revenues. Satyam generally quotes lower rates than competitors.”

Satyam’s competitors generally have operating margins of around 20 per cent, continues Mr Nathan, in the course of a recent email interaction with Business Line. Wondering, therefore, how Satyam could have an operating margin of around 24 per cent, he notes that Satyam’s operating margin should have been in the 15 per cent range.

Excerpts from the interview:

What were your first reactions to the startling disclosures by Raju?

If the Maytas scandal had not occurred a few weeks earlier I would have thought the resignation letter from Ramalinga Raju was some kind of joke that someone was playing on me. But given the Maytas scandal and the fact that several members of Satyam’s Board of Directors had already resigned, I was not surprised that now there was an accounting scandal. But even I was surprised at the extent of the scandal, the money that was involved and the extent of the misrepresentation.

Do the details of misreporting, as in the resignation letter, appear quite routine, as standard manipulation methods? Or, are there ‘innovations’ in Satyam’s case?

It is not really clear at this point, as we do not have any details as to how exactly they managed to create false financial statements. The non-existent accrued interest, the understated liability and the overstated debtors position are familiar accounting manipulations and we have seen these before in many accounting scandals. But we don’t know the details as to how exactly they did it and who were the guilty parties (was the auditor Price Waterhouse in on this misrepresentation?). However, the most shocking aspect of this scandal is the inflated cash and bank balances. The extent of the inflation is about $1 billion. This is shocking to me because this indicates that the auditors either did not follow even basic audit procedures in verifying bank balances or they were complicit in the misrepresentations. I suspect the former is true. This indicates pure incompetence on the part of the auditors.

We rarely have accounting scandals where the cash is misrepresented. Most accounting scandals are about aggressive interpretation of accounting rules, or creating fictitious inventory and receivables.

How do you find the media reactions to the incident (as you would have seen on the Net), in comparison to the way the US media reacts?

The media reactions on the Net have focused a lot on what impact this will have on attracting investment into India and the IT companies attracting new clients and keeping their existing clients. The media has made statements like “there are probably more Satyams out there.”

The media has also played up a lot on the fact that the word “Satyam” in Sanskrit means truth and that an accounting professor from Harvard University (Krishna Palepu) who is an expert on corporate governance, financial statement analysis and firm valuation was on the board of Satyam. The media has even gone to the extent of suggesting that this scandal means the end of outsourcing to India. Also there has been a call for other Indian publicly-traded companies to be very closely scrutinised.

Unlike an accounting scandal in the US where the country’s reputation is not at stake, here clearly the reputation of India as a future economic world power is at stake.

Also it is interesting how the reaction to this scandal is different from the many corporate scandals we have had with respect to Russian companies.

I think in the case of Russia, people already know that there is no transparency in the financial statements and it is “goonda” or crony capitalism in Russia. Because of India’s long tradition of domestic capitalism and democracy, and the wide use of the English language in business investors were lulled into a false sense of security about Indian companies.

People thought that the reporting system and the government regulations were fairly good in India. So I think people were shocked when the Satyam scandal broke. What really shocked people was that a fictitious cash balance of $1 billion was created.

Is the situation ripe enough for the Government to clamp down on the responsibilities of auditors and also the duties of the board, apart from prescribing tighter norms for reporting?

This scandal was not caused by any lack of regulation. The responsibilities of the auditors are very clear in the Indian regulations and are quite adequate. The problem is that the auditors had not fulfilled their responsibilities. If the auditors had done what they were supposed to do based on the regulations and the ethics and procedures of their profession this would not have happened.

Also the duties of the board are very clear in the Indian regulations and quite adequate. Again the board did not fulfil its responsibilities.

However, I would suggest some reforms for India in terms of corporate governance:

Do not allow the CEO to also hold the position of chairman of the board. The board chair has to be an independent director.

Have more restrictions on family members of the promoters or the CEO to be on the board.

There should also be more disclosures of transactions between related parties (see the Maytas fiasco).

Going forward, what are your suggestions on how corporate reporting can be made more effective and reliable?

We need much better regulations about promoters and their families being involved in the management of a publicly traded company. There is nothing wrong with the main promoter being the CEO of the company.

However, there should be an independent board, the CEO should not be the board chairman, there should be full disclosure on family members of the promoter working on the management team, and there should also be full disclosure on the shareholdings of the family members of the promoters (wife, husband, son, daughter, brother, sister).

There should be a board audit committee composed only of independent board members and the same for the compensation committee of the board.

Any other points of interest.

It looks like Ramalinga Raju was being less than truthful in his confessional letter. He says that Satyam’s operating margin was overstated as 24 per cent and that the true operating margin was 3 per cent. It is impossible that Satyam was operating on a true margin of 3 per cent. The true operating margin was probably around 15 per cent. In his letter Raju is trying to hide the fact that cash has been spirited out of the company to buy land in the personal account of Raju and his family.

In his letter Raju states that “neither me, nor the Managing Director took even one rupee/dollar from the company and have not benefited in financial terms on account of the inflated results.” This statement is not true. At one point Raju and his family owned about 25 per cent of the company. Before the scandal they owned about 8 per cent. This means that about 17 per cent of the company was sold by Raju and his family members when the share price was artificially high because of the false financial statements. Raju and his family donated crores of rupees to various charitable foundations. This money could only have come from sale of Satyam shares.

Raju states that “none of the board members, past or present, had any knowledge of the situation in which the company is placed.” This cannot be true. This financial statement misrepresentation could not have been pulled off without the co-operation of some board members.

The sheer arrogance of Raju is astounding. On page 5 of his confessional letter he suggests three steps that the board could take. He does not have the credibility to offer any suggestions as to how to tackle this problem.

It is surprising that the auditors have not yet been dismissed.

Anyway, it is good that the Indian government has dismissed the entire board and made its own appointments to the board who will then choose a new interim CEO.

The Indian government should be careful not to overreact and pass onerous regulations. India should learn from the experience of the 2002 Sarbanes-Oxley Act of the US, a regulation which was passed after the Enron scandal. It is not clear that SOX has been very beneficial to the investors, although it is very clear it has imposed lots of costs on the companies.

It looks to me that the Big 4 CPA firms are not enforcing the same standards outside the US as they do in the US. There was not enough oversight and control over the Indian office of PwC from the corporate office in the US. I do not think we would have a US company audited by a Big 4 CPA firm overstating its cash balance by $1 billion. So there has been massive audit failure in this case and clearly the Indian office of PwC is not of the same quality as its US offices.

D. MURALI

AccountSpeak.blogspot.com

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