Business Ethics Assignment

SATYAM SCAM: A FAILURE OF CORPORATE GOVERNANCE

1. INTRODUCTION
Satyam fraud unfolded and so were the inherent weaknesses of Corporate Governance in India.
Ramalinga Raju, once a posture boy of India’s growing software sector who could find a seat
beside Bill Clinton on the dais, has become a villain in the corporate world for valid reasons.
His emotionally charged four and half page letter of startling revelations shook the entire
corporate world when he admitted of cooking the account and inflating the figure by Rupees
5040 crore. This scam is being equated with Enron of USA because here also the scam was
orchestrated by its Auditor, Arthur Anderson, in Satyam, Price Waterhouse cooper.
By the end of the 20th century, Satyam computers had made a name for itself on the globe and
had emerged as the 4th largest software in the country. The meteoric rise of the company can be
substantiated by the fact that it was established in 1987 as private company and got listed by
BSE in 1991. In 2001 its share was listed in NYSE and in 2004 it made its place in European
stock market. According to company’s statement, its revenue exceeds to 2 bn USD in 2008.
Similarly Raju’s son’s companies also were moving with leaps and bound. Maytas infra got the
ambitious Metro projects and bagged many tenders including one of construction of Technology
Park.
2. CORPORATE GOVERNANCE IN INDIA- REALITY AFTER SATYAM SCAM
Interestingly Satyam has bagged Golden Peacock award for best corporate governance by World
Council for Corporate Governance only a few years ago. The scam has raised many doubts about
the class of corporate governance in India. While speaking at a seminar on corporate governance
organized by CII, Ministry of Company affairs and National foundation of corporate governance,
C.B.Bhave, the chairman of SEBI said on 6th February, 2009 that the corporate governance is an
ongoing process. There is a retrospection everywhere that some concrete steps with respect to it
should be done.
There are few importance elements of corporate governance namely Auditing, Independent
Directors, Regulators and Finally the Board including CEO itself. If we examine these
constituents one by one, it would be crystal clear that all the constituents either failed or did not
act as was required.
The role of Price water house Coopers (PwC), the Auditing firm of Satyam has been dealt.
Institute of Chartered Accountants of India (ICAI) constituted under Charter Accountants Act,
1949 is the regulatory body of all the accounting and auditing firms across the countries.
According to a report there is acute shortage of qualified chartered accountants and auditors in
India and around the world also. The number of CAs passing every year is hopelessly small. It is
apprehended therefore that the auditing firms out source unqualified or semi-qualified commerce
graduates of Post graduates to do the auditing in the companies. The prestigious firms get the
assignment by virtue of their name and fame which they recklessly sell in the market by out
sourcing the auditors at a very low remuneration. In case of Satyam, the man who was supposed
to do audit was incidentally executive member in ICAI.
The independent directors have also failed to discharge their duties properly. Section 49 of SEBI
Act and section 229 A of Company Act, 1956 provides for appointment of Independent Directors
in the Companies for protecting the rights of public at large in general and shareholders in
particular. In the case of satyam T.R.Prasad, the retired Cabinet Secretary Govt of India was one
of the directors. It speaks a lot about the procedure of appointment of independent directors.
What kinds of people are being appointed in the company? Moreover, they are appointed by the
Companies themselves and pay hefty salaries and perks for virtually doing nothing. Under this
circumstance is it thinkable that these Independent directors would dare to peep into the affairs
of the company against the wishes of the CEOs? There are only two possibilities in Satyam with
respect to Independent directors. Either they connive with Raju and knew everything that was
going on, or they did not know. In both the cases they failed miserably to discharge their duties.
What is the need of such Independent Directors if they cannot do anything in this matter? One
unpalatable justification is given that the Independent Directors participate in the meeting and
are not concerned with autonomy of the company. It should be bone in mind the Enron scam was
exposed by Sherron Watkins, a women independent director.
Thirdly, the SEBI and Ministry of Company Affairs too have failed in their assigned jobs. SEBI
is the highest regulator and keeps eagle eye on the activities of the capital markets. When the
profits of this company were registering abnormal growth, thereby the prices of the shares were
soaring, what were these guys doing? There has been a lot of hue and cry with respect to insider
trading; a howl SEBI failed to listen to and it inflicted heavily on Satyam. Raju had pledged
almost all his shares so did many of the promoters. The newly appointed CEO Murthy is also
said to have sold about 3.14 lakhs shares including 40,000 in December itself belonging to him
and his family members. These are the insider trading. Although insider trading per se is not
illegal but it is unethical, moreover when Company’s high official who were on share selling
spree must had the idea of what was going in the company. All such transactions are needed to
be probed.
As a matter of fact the tax holidays for the IT-BPO companies also needs to be said goodbye.
Had Raju to pay the Income Tax according to the profits shown in the accounts, he would not
have fudged it to this scale. The ministry of Finance must deliberate upon the entire gamut of
issues related to tax heaven provisions.

3. THE LESSONS – RECOMMENDATIONS:

Taxonomy
It is important to lay out the taxonomy of corporate frauds and governance failures. In
jurisdictions such as the US and UK, managers (such as the CEO, CFO and other senior
executives) are compensated through stock options and equity and hence there is a strong
incentive to inflate earnings. On the other hand, in countries such as India where there is
concentrated shareholding, the critical actor is not the senior management but the controlling
shareholder (a.k.a. the promoter). In such a scenario, where fraud is involved, it usually does not
result in an inflation of earnings, but in related party transactions whereby assets of a company
are siphoned out to other companies owned by the controlling shareholder. In that sense, and in
drawing international parallels, although the media has called Satyam “India’s Enron”, this case
is more akin to the Parmalat case which also involved affiliated transactions and misstatement of
financials. The regulatory response in terms of reforms will have to take into account the
differences in the systems where diffused shareholding is the norm (US and UK) and where
concentrated shareholding is the norm (e.g. India).

Audit Process
There is clearly a case for reforms in the audit system.
- The appointment of auditors ought to be shifted from the purview of the controlling
shareholders to the independent audit committee so that auditors do not owe any allegiance
whatsoever to the controlling shareholders, and that the process of appointment and removal of
auditors is effected in a manner that is truly independent of controlling shareholder influence.
- There is a case for the establishment of a body such as the Public Company Accounting
Oversight Board (PCAOB) (that was established in the U.S. a few years ago), as that body would
review the intensity and the integrity of audits by auditors on an annual basis.
- There is need for auditor rotation as it prevents creation of any affinity between auditors and
controlling shareholders, and avoids “capture” of the audit process by insiders in companies.
- Auditor liability is currently an unresolved question, and the affixation of liability for
malfeasance needs to be clearly defined. In some countries, the public regulatory authorities
(such as the securities regulator) could directly initiate action against auditors and the merits of
such an approach require careful consideration.

- Other precautionary processes may help as well. This could include meetings between audit
committee members and auditors without the presence of management.

Independent Directors
Independent directors tend to be in an unenviable position. Unless there are any red flags or
warnings in a company’s operations, it is difficult to pinpoint board failure per se. For example, a
board that receives false information, without any other warnings, is in a tough spot. Further, in
controlling shareholder situations, the independent directors are often appointed by the
controlling shareholders, and may hence owe a sense of responsibility to those shareholders.
Having said that, the current norms on corporate governance in India do not go far enough to
deal with independence of the board in controlling shareholder situations. Some of the possible
reforms are as follows:
- Making nomination committees mandatory for Indian companies. Currently, there is no
requirement to have nomination committees, although several companies have established such
committees voluntarily. When independent directors are chosen by an independent nomination
committee and without the influence of controlling shareholders, there is a sense that it would
instill greater independence of such directors from the controlling shareholders
- Other processes relating to the functioning of independent directors may induce greater
credibility in board decision making. These include:
-The requirements of lead independent directors
- Executive sessions among independent directors without the presence of management
- Appointment of advisors (such as lawyers and accountants) by independent directors to advise
them on significant transactions involving a company. Such advice would be provided
independent of the management or controlling shareholders.
- More fundamentally, there needs to be a re-evaluation of who appoints independent directors.
Under the current system, they are appointed by the shareholder body as a whole, which is often
considerably influenced by the controlling shareholder. What is required is a reform to consider
other methods of appointing independent directors. For instance, they can be appointed by a
majority of the minority shareholders, whereby the controlling shareholders do not have a say on
the matter. Alternatively, there may be proportionate representation on boards of listed company
where all shareholders have some level of say in appointment of directors and that the board is
not dominated by controlling shareholder nominees. For example, in such a system, the minority
shareholders obtain the right to elect such number of directors in proportion to the percentage
holding of such minority shareholders. [Note: The system of proportional representation is
already available under the Companies Act, in Section 265, but is only optional]
- Moving from a regulatory perspective into standards of conduct and ethics, perhaps it would be
useful for industry bodies such as the Confederation of Indian Industry (CII) to draw up guidance
for directors that would help independent directors clearly determine what is expected of them in
the boardroom.
Investor Activism

There is greater need for activism on the part of the investors directly. Often, that is not possible
because of the lack of coordination among various investors, referred to as the collective action
problem. One method by which this has been resolved in the U.S. is through the existence of
proxy consultants such as Institutional Shareholder Services or Risk Metrics who knit together
coalitions of investors to actively play a role in significant decisions involving a company.
Similarly, an active business press would also play an important role in enhancing governance
practices.
These are some of the key recommendations emanating from the panel discussion. Clearly, there
is recognition that none of these systems will be failsafe. However, the solution in these
circumstances is that if a number of such systems are put in place, it would reduce the statistical
likelihood of things turning sour from a governance standpoint.