In the late 1990s, Satyam Computer Services (Satyam) was a relatively unknown, family-owned information technology (IT) company located in Hyderabad, India. All that changed when Satyam was awarded a contract to establish IT architecture at the World Bank. The selection of Satyam was, at the time, quite surprising given Satyam's relative size and obscure reputation. But the company's business continued to thrive as demand grew for IT outsourcing from Indian companies like Satyam. At the height of its success, Satyam employed about 50,000 employees and operated in 67 countries around the world. As it turns out, the reason for selecting Satyam for the World Bank contract was that Mohamed Muhsin, the chief information officer for the World Bank, was financially involved in Satyam. After suspicions of this became known in 2006, Muhsin retired and was subsequently banned from any further relationship with the World Bank. According to World Bank officials, they alerted the U.S. Department of Justice that Satyam top management engaged in fraudulent and corrupt business practices.
In October 2008 the World Bank fired Satyam, accusing the company of installing spy systems on its computers and of stealing assets from the World Bank. Also during October 2008, a stock analyst questioned Satyam's large cash balances during an earnings conference call. The stock analyst's questions were largely ignored, and the company's stock price continued to rise. Satyam continued to report record profits despite the worldwide economic downturn.
Responding to the resulting pressure, on January 7, 2009, Raju made a shocking revelation admitting to a massive fraud, in a letter addressed to Satyam's remaining board members. Portions of the letter are reproduced below (note that original typos are retained for accuracy):
It is with deep regret, and tremendous burden that I am carrying on my conscience, that I would like to bring the following facts to your notice:
1. The Balance Sheet carries as of September 30 2008
1. Inflated (non-existent) cash and bank balances of Rs. 5,040 crore (as against Rs. 5361 crore reflected in the books)
2. An accrued interest of Rs. 376 crore which is non-existent
3. An understated liability of Rs. 1,230 crore on account of funds arranged by me
4. An over stated debtors position of Rs. 490 crore (as against Rs.
2651 in the books)
2. For the September quarter (Q2) we reported a revenue of Rs.
2,700 crore and an operating margin of Rs. 649 crore (24% Of revenues) as against the actual revenues of Rs. 2,112 crore and an actual operating margin of Rs. 61 Crore (3% of revenues). This has resulted in artificial cash and bank balances going up by Rs. 588 crore in Q2 alone.
This gap in the Balance Sheet has arisen on account of inflated profits over a period of last several years (limited only to Satyam standalone, books of subsidiaries reflecting true performance). What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of company operations grew significantly.. Every attempt made to eliminate the gap failed. As the promoters held a small percentage of equity, the concern was that poor performance would result in a take-over, thereby exposing the gap. It was like riding a tiger, not knowing how to get off without being eaten.
Under the circumstances, I am tendering my resignation as the chairman of Satyam and shall continue in this position only till such time the current board is expanded. My continuance is just to ensure enhancement of the board over the next several days or as early as possible. I am now prepared to subject myself to the laws of the land and face consequences thereof. (B. Ramalinga Raju) Copies marked to:
1. Chairman SEBI
2. Stock Exchanges
Ultimately, it was revealed that assets on Satyam's balance sheet were overstated by about $1.5 billion, and that over $1 billion in bank loans and cash that the company claimed to own were nonexistent.
The fictitious assets accounted for 50% of the company's total assets. To accomplish the fraud, Raju and other individuals in top management (including the CFO, the head of internal audit, and Raju's brother) took the following actions:
● Created fictitious bank statements to inflate cash
● Reported fictitious interest income from the fictitious bank accounts
● Created 6,000 fake salary accounts and stole the money after Satyam deposited it
● Created fictitious customer identities and generated fictitious invoices against their names to inflate revenue
● Forged board of director resolutions to obtain loans for Satyam PricewaterhouseCoopers (PwC) was Satyam's auditor from 2000 to the time the fraud was revealed. PwC was criticized for failing to exercise professional skepticism regarding the $1.04 billion cash balance of non-interest-bearing deposits. Normally, companies would either invest that money in an interest-bearing account or disburse the money through dividends to shareholders.
It was later revealed that PwC did not independently confirm the cash accounts with the banks in which Satyam claimed to have accounts. Subsequent PCAOB and SEC investigations revealed that PwC allowed their audit clients to control the cash confirmation process and did not challenge management regarding the validity of confirmations. In fact, some banks sent PwC confirmations directly, and those confirmations contradicted the statements that management had provided. For example, one bank told PwC that the Satyam account had a balance of $11.2 million, but management reported a balance of $108.6 million. Another bank reported $330,172 in the Satyam account, but management reported a balance of $152.9 million. Further complicating matters, the PwC network firm partner reviewed the working papers for the 2008 audit one month before the audit report was issued. During the review, the partner noted the deficiencies in the confirmation process and advised the engagement team not to rely on confirmations that were not received directly from the banks. The engagement team ignored the review comment, taking no actions to address the confirmation process weaknesses. It is unclear whether the reviewing partner knew that the comments were left unaddressed, but in any case the partner should have followed up to make sure that the audit opinion was not issued until the confirmation process weaknesses were resolved.
Raju, his brother, the former managing director of the board, the head of internal audit, and the CFO were all arrested by Indian officials on charges of fraud. Indian officials also arrested two of the PwC auditors on charges of fraud. On April 5, 2011, the SEC settled a civil action with Satyam Computer Services, in which the company paid a penalty of $10 million (see Accounting and Auditing Enforcement Release No. 3258). On May 6, 2011, PwC and its Indian affiliates agreed to a $25.5 million settlement in a class action lawsuit. On October 12, 2011, the two PwC auditors were granted bail and left jail.
a. Aside from the shocking disclosure of the fraud and its magnitude, one of the most interesting comments in Raju's statement to the board of directors was "It was like riding a tiger, not knowing how to get off without being eaten." Speculate on why he may have stated that.
b. Describe why PwC's cash confirmation process was flawed.
Comment on why PwC may have had an incentive to not exercise professional skepticism in this situation.
c. Which management assertion did Raju's fraud violate?
d. What internal controls over cash appear to have been missing or violated based on the facts in this case?
e. Consider the situation of the PwC network firm partner. That individual correctly reviewed the workpapers and suggested that the engagement team should not have relied on the cash confirmations from management. Using the ethical decision making framework from Chapter 4, determine what next steps the audit partner should have taken upon making the review suggestions. Recall that the steps are as follows: (1) identify the ethical issue; in this case the ethical issue is how to properly ensure that the review comments are taken seriously and addressed; (2) determine the affected parties and identify their rights; (3) determine the most important rights for each affected party; (4) develop alternative courses of action; (5) determine the likely consequences of each proposed course of action on each affected party; (6) assess the possible consequences; and (7) decide on an appropriate course of action.

  • CreatedSeptember 22, 2014
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