The Satyam fraud shows that corporate governance demands synchronization of various laws dealing with corporate fraud to make the practice of doing business cleaner and better? This article explores this and much more
Amongst various corporate scams in India, Satyam has its unique place. Satyam scam came into limelight via letter written by the CEO of the company to the SEBI and latter on explored by CID and other investigative wings. With a shocking confession that company’s balance sheet as on September 30, 2008 was carrying fictitious cash, bank balance and manipulated favourable debt account, it created havoc in the share market. Share prices of the company came down by 77.47 per cent in the market and people were shocked to see that their ideal company, the 4th largest software firm of India was crushing down.
After confession, criminal proceeding was initiated. B. Ramlinaga Raju was taken into police custody and latter on questioned along with other Raju brothers and former Satyam CFO Vadlamani Srinivas. Their e-mails and phone records were examined. Incriminating facts reported in the media were about the ‘manner’ in which the fraud was committed. Evidence of ‘insider trading’ by the promoters even before the scandal broke was explored by the investigators. The Registrar of Companies reported that the top management of Satyam, the directors and senior officials, sold shares ahead of the revelation. Report suggested that Satyam books had been overstated by Rs 5,000/- to Rs 6,000/- crore, leading to an inflated stock price that helped the top management make money. Though, company claimed that no one else in the company, except Ramalinga Raju, had privy to the fudging of accounts butinformation suggested insider trading. Bombay Stock Exchange (BSE) figures showed a number of senior people in the company, including Raju and CFO Vadlamani, were reportedly selling Satyam’s shares over the last 22 quarters. In June 2001, Raju had nearly 23 per cent shares. By 2007 it came in single digit i.e. by September 2008 Raju’s share was just 8.27 per cent. Not only this, BSE figure also showed Vadlamani sold 92,538 shares while the then CEO Ram Mynampati sold 700,000 shares plus 2,50,000 ADRs. Apart from these, other senior officials also reportedly sold large number of shares. It is now known through sources that one Kiran Cavale reportedly sold 400,000 shares and 10,000 ADRs and one Rajan Nagarajan reportedly sold 430,000 shares and 70,000 ADRs.
After the boom in the software industries, particularly since 1999, Satyam rode on the Y2K phenomena resulting into huge orders and good profits. Then thereafter, as suggested by SFIO report, the falsification of accounts started happening to keep Satyam’s share price high. Riding on the high price, Satyam promoters offloaded their shareholding in the market and used the proceeds to buy land. In fact, B. Ramalinga Raju had set up as many as 374 infrastructure firms and eight investment companies to help him become a land baron. This phase continued till 2004, but soon after things started going wrong. Finally, sometime in mid 2007 these falsifications surfaced. During this period, the company showed huge cash balances and fixed deposits in several banks of international repute. It was, however, actually starved of funds and the promoters were desperate to raise money to keep the company afloat. In fact, when Satyam board met and decided to acquire two group firms —Maytas Infra Ltd and Maytas Properties Ltd— independent director Krishna Palepu received an anonymous email describing bare the fraud. This email was forwarded to other directors including M. Rammohan Rao, who chaired the Satyam audit committee and S. Gopalakrishnan, partner at PriceWaterhouseCoopers, the company’s auditors. Gopalakrishnan told Rao overphone that there was no truth to the allegations and assured him of a detailed reply in a proposed presentation before the audit committee. However this meeting never took place. Raju knew that in the audit meeting, the committee members would pose tough questions and finally just three days before the meeting, he confessed.
Initially Raju said that he had been fudging the account books for ‘several years’ and despite this no one but he, and his brother, knew of this. After the arrest of two brothers along with the CFO, Vadlamani, experts pointed fingers at various people. In fact apart from Raju, there were others who were also culpable, if not by complicity then by negligence.
Experts suggest that the Satyam scam was not an accounting or auditing failure, but one of corporate governance. As per this view, “there were promoter shareholders, executive directors and directors, and the auditors were the last rung. On the other side, there were independent directors, one of whom was the dean of the Indian School of Business, but no-body questions the role of independent directors.” This view emphasises about the role played by independent directors. In fact, ICAI had reportedly found two PriceWaterhouse auditors, the statutory auditor of Satyam, Gopalakrishnan and another TalluriSrinivas, prima facie guilty of professional misconduct. The CBI also charged the two auditors with “complicity in the commission” of the fraud by “consciously overlooking the accounting irregularities”. Now it is for these agencies to find out relevant evidence and handle the prosecution. But one thing which makes things interesting is to find out how the state agencies are going to establish joint or concerted culpability of all those who knowingly or with connivance involved in this corporate fraud.
Section 25 of Indian Penal Code, 1860 defines ‘fraudently’ as “A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise.” Such activities are also criminalised in Prevention of Corruption Act, Prevention of Money Laundering Act, The Companies Act 1956, Clause 49 of Listing Agreement, and Companies (Auditor’s Report) Order, 2003.
Chapter VA of The Securities and Exchange Board of India Act, 1992 entitled as “Prohibition of manipulative and deceptive devices, insider trading and substantial acquisition of securities or control” provides specific regulatory mechanism to prevent various corporate frauds and penalty therefore. It provides that “no person shall directly or indirectly …….(d) engage in insider trading; (f)acquire control of any company or securities more than the percentage of equity share capital of a company whose securities are listed or proposed to be listed on a recognized stock exchange in contravention of the regulations made under this Act.” These provisions, though seems to be sufficient, but, due to lack of sufficient mechanism, are proved ineffective.
How independent are the independent directors under the existing law, given the fact that independent directors still have to be nominated to the board, and shareholders merely confirm the nomination? Their ‘independence’ thus becomes suspect right from the start.
In the case of PSUs, the government is the majority shareholder and general public holds a minority stake. Non official parttime independent directors are appointed by the President of India for a specific term. In the Corporate Governance Guidelines issued by DPE, to be eligible to be appointed an independent director in a PSU , certain conditions are prescribed to ensure that he does not have material pecuniary relationship or transaction with the company which affects his independence as a director. Thus in case of PSUs, independence of independent directors can not said to be suspect, They do bring with them their vast experience, wisdom and distinct expertise which assists the board of PSUs.
How to compensate the independent directors so as to make them truly Independent?
In the case of PSUs, independent directors are paid sitting fees as fixed for attending the board / board appointed committees which is subject to DPE guidelines and Companies Act. Thus there seems to be no need to fix their remuneration to ensure their independence.
What is the extent of criminal liability of the independent directors in case they are found to be hand in glove with the executive directors of the company?
While recently a Supreme Court judgment has significantly narrowed down criminal liability of independent directors for dishonour of cheques, but, in case they are found to be hand in glove with executive directors of the company then as per sec 34 and 120A IPC, they would be equally liable for criminal conspiracy and common intention to commit criminal offence.
Corporate criminal frauds, even after having wider statutory definition, areunabated. Reasons may be many, but it is high time to propose that provisions under the existing and proposed company law pertaining to the requirement of independent directors, constitution of audit committee, and definition of independent director, promoter, and key managerial personnel should be aligned with the existing Listing Agreement and other SEBI legislations to achieve uniformity in corporate governance standards in the country. The existing regulations are proved ineffective because of prevailing confusion of SEBI regulations and Company Law provisions. They need to be in-sync with SEBI, as far as listed companies are concerned. One of such approach would be to setup an independent Quality Review Board (QRB), which could be entrusted to provide transparent and expeditious oversight.
One of the task forces constituted for suggesting reforms in the corporate governance suggested that “in case of securities related fraud by a shareholder or other securities holder, the company should aide the regulators (i.e. Ministry of Corporate Affairs and SEBI) as decided by an inter-se agreement between the two to take actions such as freezing the shares, intimating the stock exchanges of the details of the relevant securities and in case of physical share certificates, confiscation and cancellation thereof; as fraud conveys no title. The power of confiscation and cancellation in relation to securities fraud should extend to cancellation of such fraudulent securities, even if it concerns creation of one or more (multiple) pledges subsequent to the first act of securities fraud.”
Just like any other fraud or criminal conspiracy, it is tough to find out direct evidence in such cases. Investigating agencies, in such circumstances, must look towards circumstantial evidence indicating towards the guilt of the accused. This rule is well established under Indian criminal and evidentiary jurisprudence. As narrated above, Satyam case is also pointing towards the applicability of circumstantial evidence rule.
It is noteworthy that in a given case, any director or employee(s) of the company may be said to commit an offence when the same is committed with an intention to make personal monetary gains or profits, personal penalty should be imposed on such directors or the employees commensurate with the wrongful gains made in addition to disgorgement of wrongful gains. The ShardulShroff Committee constituted by the Department of Corporate Affairs has provided for consequences of repeat offences and ad valorem fines and penalties based upon the magnitude of unlawful or unjust enrichment and gains from a fraudulent or illegal act under the Company Law. With mega frauds, the financial penalty of Rs.25Crores prescribed under SEBI and Securities Laws are inadequate, and an ad valorem rate based upon the extent of the securities fraud may be considered.
The view over corporate fraud is that the collection of fines and penalties should be employed for restitution of those shareholders or the company which has been a victim of the fraud or the offence and should not be accumulated to government coffers. Not only this, the deterrence aspect of a serious fraud must be significant and serious and the victims who suffer such frauds must enjoy the benefits of distribution of such fines and penalties after the recovery of costs of the conduct of any trial to prove the offences or the recovery from the wrongdoer and the disgorgement of wrongful gains. However, if a director is not informed or does not possess any knowledge of any non-compliance on part of the company, he should not be held liable. In the case of HomiPhirozeRanina Vs. The State of Maharashtra, it was held that “nonexecutive directors cannot be made to undergo the ordeal of a trial for offence of non-compliance with a statutory provision unless it can be established prima facie that they were liable for the failure on part of the company”. Such observation is in line of argument that the presumption isabout liability unless director can prove lack of knowledge because existence or non-existence of any particular fact. In the case of Satyam scam, such presumption is substantiated by the facts inquired till date.
When an accounting fraud involves reporting cash that is not there, it is typically the result of adding fraudulent transactions. These types of transactions should have been audited to assure their legitimacy. In the case of Satyam, the auditors signed off on the financial reports, raising concerns that even the increased auditing standards imposed by SarbanesOxley may not be sufficient. Finally, there is a need for stiffer penalty. Simply put, “white collar” crime cannot be viewed as less of an evil than any other form of crime. The fact that white collar crime continues to occur, and seemingly at an increasing rate, suggests that the expected costs do not outweigh the expected benefits from cheating. Stronger penalties are needed.
In its present form, Clause 49 of the Listing Agreement contains detailed mandatory provisions for the Audit Committee of the Board. Failure to such responsibility would surely attract criminal negligence. The issue is not only about criminal negligence but also about basic audit arrangement. Under the present dispensation, two-thirds of the members of the Audit Committee must be independent directors as must the chairman, but the rest may be either NEDs or executive directors. This is clearly a mistake, and runs counter to a fundamental operating principle of good corporate governance,namely that the Audit Committee must comprise entirely of non-executive directors with independent directors forming the majority. Another issue is the presence of executive directors on the audit committee needs to be appreciated since they are well versed with the internal working of the company and bring first hand information to the table which helps an objective and meaningful analysis of the discussions by the Committee. For bolstering the independence of the internal as well as the external auditors and ensuring a free and frank discussion with the audit committee, it is important that the Audit Committee must necessarily constitute NEDs. The executive directors can be invited to attend the audit committee meetings to provide the necessary clarifications. The role of independent directors is being heavily scrutinized. Companies appoint such directors at their discretion though it is a requirement that at least one third of a company’s board be independent.
Listed companies in India are governed by the provisions of the Companies Act and the Listing Agreement. Clause 49 of the latter sets out a requirement for each listed company to set up an audit committee which is responsible for the proper preparation of accounts and for overseeing corporate governance. It is the duty of the auditors to highlight any noncompliance or discrepancies in the accounts and accordingly qualify their audit report. As auditors to Satyam, PriceWaterhouseCoopers has received unwanted press recently, though it is adamant it carried out its audit in accordance with accounting standards issued by the Institute of Chartered Accountants of India.
Is it correct to say that an auditor is supposed to check the company’s financial records to see if they are consistent with the prevalent laws and accounting standards and that they give a true and fair view of the financial position of the company. He is not supposed to go hunting for a financial fraud and its perpetrators. What do you suggest as a solution for such a tricky situation like Satyam ?
Certainly auditor is required to express an opinion as to whether the annual accounts give a true and fair view of the company’s state of affairs and financial position and whether the same are in compliance with the applicable law and accounting standards. As held by courts in India and overseas, auditor is required to employ reasonable skill and care, but is not required to begin with suspicion and to proceed in the manner of trying to detect a fraud or a lie unless he comes across such information or situation which is unusual which instigates him to act with suspicion of a professional man of reasonable competence. The solution to avert Satyam kind of episode should be multi prone such as effective internal audit mechanism, mandating whistle blower policy and protecting whistle blowers, introducing severe penalties for breach of duty by directors and auditors and, most importantly, effective enforcement and quick punishment to the wrong doers.
Would full convergence with the International Financial Reporting Standards (IFRS) improve the situation which was witnessed in the Satyam Case?
IFRS has emerged as gold standard for accounting and accepted across globe. IFRS brings in more transparency and will increase credibility of foreign investors in financial statements of Indian companies and also helps India Inc, to tap into the global pool of capital. Convergence to IFRS will indeed be a step forward in the process of better accounting and reporting, and it will certainly improve a situation that existed in the case of Satyam. However, only time can validate this.
Even the report of the Naresh Chandra Committee on Corporate Audit and Governance has suggested that auditors should refrain from providing non-audit services to their audit clients and has recommended an explicit list of prohibited non-audit services. The recommendation was endorsed by the Ministry of Corporate Affairs and has also been proposed under the Companies Bill, 2009. Apart from this, the firm, as a statutory auditor or internal auditor, has to confidentially disclose its networth to the listed company appointing it. Each member of the audit firm is liable to an unlimited extent unless they have formed a limited liability partnership firm or company for professional services as permitted to be incorporated by therelevant professional disciplinary body (ICAI). Even in the case of a limited liability firm undertaking audit in the future, under the new law, the individual auditor responsible for dereliction of duty shall have unlimited liability and the firm and its partners shall have liability limited to the extent of their paid-in capital and free or undistributed reserves.
It is suggested by all corporate experts that companies must establish a mechanism for employees to report to the management about unethical behaviour, actual or suspected fraud or violation of the company’s code of conduct or ethics. Even though companies have adopted and communicated the existence of a whistleblowing policy, but without sign of any success on this front. In fact adoption and encouragement of the whistle blowing policy should be made mandatory for all listed companies. This will send a positive signal to employees that the management is willing and able to prevent any illegal activity and also ensure that there is aprocess by which the individuals can expose the problem to the appropriate authority who can take action. Since whistleblowers need to be provided high degrees of protection, the Listing Agreement should consider providing statutory protection from dismissal or wrongful termination for acting as a whistle blower. Example from USA and European Union may be considered as guiding line for such protection policy.
The aspect of criminal fraud and other violations are still under investigation. Even after confession of CEO, many things are yet to be explored. Corporate governance demands synchronization of various laws dealing with corporate governance specifically corporate fraud. This is strongly suggested that ICAI should be allowed to proceed against companies against which cases of repeated misconduct are reported. Under the current law, the ICAI can only proceed against individuals. International standards such as the “International Financial Reporting Standards (IFRS)” must be implemented in the corporate governance. Apart from this country should think about specials agency dealing with corporate fraud to strengthen business regulations and confidence of shareholders.
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