Satyam Computers Services Limited (Satyam), India's fourth largest IT company, is in deep trouble. On 7 January, B Ramalinga Raju, CEO of Satyam, made a dramatic confession of inflating Satyam's profits for the past seven years: the Rs. 5040 crore that the company had shown as cash and bank balances was fictitious. So was the accrued interest of Rs.376 crore shown in the balance sheet. Debt was inflated by Rs.490 crore while Rs.1230 crore arranged as loans by the promoters was also not reflected in the balance sheet.

The balance sheet, therefore, was over Rs.7000 crore short. Raju also claimed that the net margins for the company in the September quarter was really three per cent against the 24 per cent shown in the P&L account.

Raju subsequently resigned from his post and recommended the appointment of Ram Mynampati as the interim CEO.

What triggered it?

On 16 December 2008, Satyam announced that its board had approved a proposal to buy Maytas Infrastructure and Maytas Properties for a total of $1.6 billion (Rs.8000 crore).

Maytas Infrastructure and Maytas Properties were run by sons of Ramalinga Raju and the investors suspected inflated valuations of both these companies. The same day Satyam's American Depository Receipts (ADRs) fell more than 50 per cent in the New York Stock Exchange (NYSE) and the management was then forced to withdraw the proposal. While questions were being raised about the valuation, Satyam's stock fell from over Rs.220 to around Rs.160 in the Indian markets.

Soon the promoters faced margin calls on shares pledged to financial institutions and were unable to meet this and some part of their stake was sold off. It became apparent that the promoter’s stake had fallen to less than five per cent in the company and institutional investors called for change of management and sale of the company to a strategic buyer and DSP Merrill Lynch was roped in to scout for such a buyer.

A closer examination of Satyam's books led to the discovery of the hole in the balance sheet which then forced Raju to come out in the open.

Government (re)action
Following Raju’s announcement, on 11 January, the Government of India invoked a rarely-used power to supersede the board of Satyam by appointing Deepak Parekh, chairman, HDFC, as the chairman of the new board, along with Kiran Karnik, former president, NASSCOM and C.K. Achuthan, former member Securities Appellate Tribunal, as members of the board.

On 15 January the board was expanded to include Tarun Das, chief mentor of the Confederation of Indian Industry, TN Manoharan, a past president of the ICAI and Suryakant Balakrishnan, a nominee of the Life Insurance Corporation of India. Ram Mynampati was fired as the CEO as the board started to hunt for a new CEO, a CFO and auditors. It also started to look for funding to continue operations.

The government has also asked the Serious Frauds Investigations Office (SFIO), which specialises in white collar crimes, to look into the case. SFIO is expected to submit its report in three months.

The Crime Investigation Department (CID) has started investigating the case. Ramalinga Raju and his brother Rama Raju surrendered to the police on 9 January, two days after Raju's confession. Raju was supposed to appear before a SEBI panel the next day.

CFO Srinivas Vadlamani was arrested on 10 January and presently, the CID has obtained the custody of all three accused. The CID has also raided the offices of Satyam and the residences of its directors.

Impact on Satyam’s businesses

The after effects in the business and investor circuits have been swift and ruthless. Satyam was removed from both the BSE Sensex and NIFTY. Trading on NYSE was suspended for a few days after Raju's confession. Soon after, Satyam’s stock crashed from Rs.178 to under Rs.7 before recovering to close at Rs.24.6 on Friday, 16 January.

Maytas Infrastructure (Maytas) is executing projects worth Rs.30,000 crore in the state of Andhra Pradesh, including the prestigious Hyderabad Metro project worth Rs.12,000 crore. The Andhra Pradesh government is currently reviewing projects that are being executed by Maytas and serious doubts have been expressed about the company’s ability to raise equity and debt for the Metro project. Maytas Chairman R.C.Sinha has resigned and Maytas has been locked at lower circuit at the stock exchange every day since the Satyam accounting scam broke out.

Skeletons in the closet

Satyam was reportedly among the K-10 pack – companies whose stock prices were ramped up by stock broker Ketan Parekh, with the tacit, if not explicit, support of their managements. While SEBI did not find any evidence against Satyam, the Department of Company Affairs found it violating listing agreement. But Satyam came out reasonably unscathed from this episode.

In the case of merger with its subsidiary, Satyam Enterprise Solutions (SES), Satyam did not cover itself with glory. A few months before the merger, Satyam had renounced eight lakh shares offered at par (Rs.10 per share) in a rights offering in SES, in favour of C.Srini Raju, the brother-in-law of Ramalinga Raju. Srini Raju was then an executive director of Satyam. When SES was merged with Satyam (then selling at Rs.1600 per share) in the ratio 1:1, it allowed Srini Raju to make a cool Rs.120 crore which should rightly have belonged to Satyam shareholders!

In yet another instance, Satyam Infoway, another former group company, purchased IndiaWorld Communication’s web portal for an astonishing Rs.499 crore in November 1999. IndiaWorld had in the previous year reported a profit of Rs.27 lakh on a turnover Rs.1.3 crore. This huge over-valuation, even by dot.com standards, was probably in hindsight a neat way of siphoning money from the company or of hiding losses.

What were the auditors doing?

Understandably, PricewaterhouseCoopers (PWC), the auditor for Satyam for the last eight years, has a lot of questions to answer. Were the cash balances cross-checked with the banks? How did the auditors miss-noticing inflation of revenues? The competence and the credibility of the auditors have been called into question.

This is not the first time that PWC finds itself in the limelight for the wrong reasons. PWC was also the auditors for the failed Global Trust Bank. In 2004, RBI had banned the firm from auditing banks and non-banking finance companies (NBFCs) until further notice; this ban was revoked only on 1 April 2008. The ICAI, however, is yet to act on the RBI complaint filed in 2004.

Raju had claimed that one of the ‘big four’ firms was involved in the valuation of Maytas, while all the big firms have denied being involved. Former CFO Vadlamani has now confirmed that it was Ernst & Young (E&Y) that was involved. E&Y, however, confirms that it had done a valuation of Maytas for share transactions involving existing shareholders. There does not seem to be any reason why Maytas would be valued differently for acquisition by Satyam

Satyam’s board also boasted of highly-qualified ‘independent’ directors which included, among others, Krishna Palepu, Professor at the Harvard Business School; Vinod Dham, ace venture capitalist and the ‘father’ of Pentium; Ram Mohan Rao, the (now former) dean of India's premier business school, ISB; Mangalam Srinivasan, a well-known US-based academic; and T.R Prasad, former cabinet secretary in the Indian government.

It is surprising that none of these professionals had any inkling of the fraud and that no one thought it fit to publicly question the valuation of Maytas when the merger with Satyam was proposed. The rubber stamping of the Maytas merger has raised questions on the concept of independent directors in all company boards and whether they are really independent.

Other allegations

Ramdas Athawale, Member of Parliament (Pandharpur), had alleged in a letter in 2002 to SEBI that the income tax department found benami bank deposits worth Rs.20 crore in various banks in and around Hyderabad without proper documents and with form 15-H filed for non-deduction of TDS on the interest.

Finding this odd, IT officials traced the fixed deposits to Satyam promoters and their family members. IT officials saw a possibility of massive manipulation in the register of members through various benami accounts, frequent trading of shares, possibly insider trading and profits from such trading finding its place in such benami fixed deposits. IT officials had a feeling that promoter holdings in the company through benami holding could be more than those disclosed to various authorities. But no action was taken on these complaints.

E.A.S.Sarma, former energy secretary, has alleged that Satyam was given 50 acres of land by the AP government) at a price of Rs.20 lakh an acre. This, when the market value of the land was ruling at around Rs.12 crore an acre.

Raju appears to be close to both the TDP and the Congress regimes. If Athawale's allegations are true, Raju used his political connection to stall the IT department probe against benami accounts traceable to Satyam promoters.

His good relationship with the Congress government has ensured that Maytas is executing Rs.30,000 crore worth of projects for the Andhra Pradesh government. Some of these contracts are alleged to have been awarded even without competitive bidding. And in our system of institutionalised corruption, competitive bidding has become a farce with the cartelisation of contracts.

Discrepancy in confession

In his confession, Raju noted that neither he nor his brother had benefited from inflating the profits of Satyam. A closer examination of the promoters, shareholding from 30 June 2005 to 30 June 2006 shows that the promoter shareholding fell from 4.86 crore shares to 2.99 crore shares, ie a total sale of 1.87 crore shares. The lowest price of Satyam stock in that period was Rs.475.65. So the promoters sold shares worth at least Rs.890 crore. There is no way this large sum can be passed off as not benefiting the promoters.

Theories on what happened

The most plausible theory right now is that most of the missing Rs.7000 crore did exist, but was diverted by the promoters to fund their various land acquisitions. The fall in real estate prices and the stock prices proved to be a double whammy for the promoters. The fall in stock prices meant margin calls. The real estate assets could not be sold to meet these margin calls as the market was illiquid.

Incidentally, if this theory were true, then it would be the best news for the Satyam employees (incidentally, this number was also allegedly overstated as 53,000 when there were only around 40,000 ‘actual’ employees). It means that Satyam has a viable and profitable business model. If its clients and employees can be retained, then Satyam can possibly be revived.

The Central government also seems to be thinking along these lines. In an interview given on 18 January, P.C. Gupta, minister for Company Affairs, said prima facie it looked like a diversion of funds issue.

The lessons for investors from this sordid episode is that there is no substitute for due diligence. Satyam had enough issues on corporate governance in the past, which alert investors could easily have detected. Investors need to avoid parking their money in any business where corporate governance is not of the highest quality.