Imagine that you are on the board of directors of a company and you receive a letter from the chairman of the board that starts, "With deep regret and tremendous burden that I am carrying on my conscience1" and goes on to say that the company's balance sheet carries inflated cash of more than $1 billion, $77 million (m) of accrued interest that is nonexistent, $253m of understated liability arranged by the chairman, and overstated receivables of $101m and that the income statement shows overstated profits for the last several years. Imagine that you were the audit partner, or if you had just awarded the company your global award for excellence in corporate governance (since rescinded)! This is what happened on January 7, 2009, to the board of directors of Satyam Computer Services, its auditor Price Waterhouse India (PWI, the Indian arm of PricewaterhouseCoopers International, PwC), and Ola Ullsten, former Swedish prime minister and chairman of the Golden Peacock Awards.2 As for the shareholders, the value of shares dropped about $2 billion the very next week.
HISTORY OF SATYAM
Satyam, which means "truth" in Sanskrit, was founded by B. Ramalinga Raju in 1987 and grew to be a leading outsourcing firm used by major international companies. India's fourth-largest software and services firm, it reported revenue of $555m (actual revenue of $434m) and had 53,000 employees in 2008 (or did it? Stay tuned).
Chairman of the board Raju's confession seemed to spring from the board of directors' denial of the purchase of Maytas (Satyam spelled backward), a Raju family-controlled company owning thousands of acres of property. Apparently, Raju planned to use Maytas assets to offset the fictitious assets at Satyam.
The press had noted the company's related-party dealings. Raju's family members were on the Satyam board and friends were in senior management. Even though it was a large company, no financial experts were on the audit committee.
INDIAN ACCOUNTING ENVIRONMENT
Indian accounting standards are broadly similar to international standards, and the Indian accounting profession is largely self-regulated. Traditionally, general standards of corporate ethics and accounting have been suspect in India. Many companies had been created during License Raj, a period of government intervention in which businesses had to work with politicians and pay bribes. In India "promoters,"3 who include business families and other corporate insiders, held almost half of the shares on the National Stock Exchange. However, because of its listing on the NYSE, Satyam was subject to the Sarbanes-Oxley Act, which should have induced stricter governance.
Although the Big Four accounting firms have been eagerly touting the growth potential in India, development there has been hampered by heavy national restrictions on the size and number of audit clients a partner can serve. The relationship between PwC and PWI underlines what many see as the patchwork nature of the big accounting firms. Each is a collection of national partnerships under a global umbrella organization. The profession has tried to standardize practices and ethics across the firms, but senior partners privately admit that quality can still be patchy. Some say the Big Four firms in India rely on trainee chartered accountants and sometimes accountants simply copy the previous years' audits and the internal auditors' work because they have limited time to complete the current audit.
THE FRAUD
India's biggest corporate fraud apparently started in April 2002 when IT companies' American depository receipts (ADRs)4 were popular among foreign investors. At that time, Raju decided to maintain two subaccounts under a single company bank account. He and his cronies controlled the main bank account, and the statements of the subsidiary account were under the control of the company's finance and account reconciliation (FAR) team. The accounting team would receive two bank statements for the same account: a genuine set of statements from the bank and a second set of fictitious statements provided by Raju and his team. The FAR team had to accept the fictitious bank statements (and related interest accruals). Allegedly, even the auditors relied on the documents supplied by Raju instead of obtaining third-party verification. The CFO, Srinivas Vadlamani, who was arrested, said he had not been directly involved but knew there had been something suspicious for more than five years. He had been specifically asked not to look at deposits. Vadlamani said the plan was carried out by creating a paper trail of fabricated invoices, forged balance sheets, and counterfeit bank statements in a scheme involving about10 junior staff.
Page C27
Initial investigations have revealed that an in-house Satyam team developed software to generate altered invoices that included the genuine name of a client and of the client's project manager but with an overstated invoice amount. For example, a Satyam client, XYZ, pays 100 rupees to Satyam's bank account as fees. The original bank statement showed 100 rupees deposited by XYZ, but the statement provided by Raju overstated this figure. Year after year, altered invoices in the name of genuine clients and employees were created and went unnoticed by auditors.
The unrecorded liability of $253m was the amount that private companies owned by Raju lent to Satyam. To keep analysts and investors at bay, the loan amount was not shown in the books. Had it been shown, it would have raised eyebrows. After all, why would a company incur this liability when it had so much cash on its books? (Analysts already had been asking why the company kept so much cash in interest-free accounts.) As the chairman's letter mentioned, this amount had been arranged over the previous two years to fund Satyam's operations.
In addition, the public prosecutor noted that the CFO (Vadlamani) had admitted during interrogation that Satyam had just 40,000 employees versus the 53,000 officially claimed, and the fictitious wages were siphoned off. The prosecutor claims Raju used a fictitious name to divert $4m a month from the company's account for his personal wealth. India's Serious Fraud Investigation Office has found that $100m raised through the issuance of ADRs did not end up in the company's bank accounts and has still not been found.
Although the company's bank balance was fictitious, the employees had to be paid real salaries. To meet these expenses, Raju and his family started pledging their stake in the company. The shares were pledged by a holding company, SRSR Holdings, which in turn had approximately 300 subsidiaries. India's Central Bureau of Investigation (CBI) has found that some of the documents of the companies created by Raju contained land records and names of land mafia agents,5 indicating that the case may be more than just an accounting fraud.
THE AUDITORS
Even though PWI had been Satyam's auditor since 2000, it resigned. Indian police have arrested two partners of PWI on charges of criminal conspiracy and cheating. PwC may also face class action suits in the United States.
PwC says, "The audits were conducted by PWI in accordance with applicable auditing standards."6 Vadlamani, the former CFO, said the auditors had not been complicit in cooking the books and had been given forged documents. The auditors had relied on documents provided by management such as account balance statements and letters of confirmation of account balances.
Dennis Nally, global leader of PwC, said to Business Today:
If our job was described as to provide a 100 per cent assurance that there have been no material mistakes and no frauds have been committed, that would require audit firms to significantly increase the amount of work we do today and have much more forensic and different types of auditing. As we all know, when there is a desire at the top of an organization to commit a massive fraud, individuals in the organization that have participated in the fraud can do a lot of different things to keep it away from individuals, including auditor firms, the Board of Directors and the analyst community.7
Page C28
FOLLOW-UP
Indian authorities arrested Raju and his brother Rama on complaints of cheating, forgery, breach of trust, and other charges. Police called in cyberforensic experts who can retrieve erased data from computers. In all, 10 people have been arrested for the fraud. All of them, including Raju, are out on bail.
PWI suspended its chief relationship partner and engagement leader on the Satyam audit, set up an advisory board, conducted a review of work and processes, and appointed a new head of quality assurance and risk management. While screening through the minutes of some of the board meetings, investigators found that the total audit fees paid to PWI for its domestic and international accounts was around $1.4m, almost double the figure mentioned in the balance sheet.
The information concerning the probe initiated by the Crime Investigation Department (CID), the Serious Fraud Investigation Office (SFIO), and Institute of Chartered Accountants of India (ICAI) was handed to the CBI in February 2009. The Securities and Exchange Board of India had its own investigation team go through the company's books.
A senior CBI official, who did not wish to be identified, confirmed toBusiness Today that Raju seems to have come clean in his confession letter except for his statement about not having benefited in financial terms as a result of inflated results. "We are yet to establish if there was any diversion of funds from Satyam to any of Raju's entities. This will take some time to investigate," added the CBI official.8 Decoding the biometric laptops used by Raju and his team, screening the internal financial software of the company and minutes of the board meetings for the final six years, scanning papers of the approximately 300 companies created by Raju and his family, and scrutinizing the land records under these companies was expected to keep the CBI busy for months.
During an interrogation session, Raju is believed to have said that he never did anything wrong because everyone else in the industry does it.
On April 5, 2011, the PCAOB and the SEC announced a joint penalty of $7.5m against the five firms composing PW India, a member of PwC. It is the largest such penalty ever assessed against a registered foreign accounting firm. The firms were also given other sanctions, including a six-month ban on accepting new SEC clients and the imposition of quality controls. In addition, the Institute of Chartered Accountants of India (ICAI) has barred two Indian auditors, Pulavarthi Siva Prasad and Chintapatla Ravindernath, from "the register of members permanently" for their role in the crisis.9
In the release of its findings, the PCAOB said the auditors had relied on management to send confirmation requests to Satyam's bank and to return responses to the auditors even though the audit programs "explicitly acknowledged that the engagement team should maintain control of the process of sending confirmation requests and receiving confirmation responses relating to the confirmation of cash."10 Moreover, a network firm partner reviewing the documentation "advised that the engagement team 'can only take credit for [cash] confirmations we send [to] and receive directly [from the banks].'" 11 The partner "noted that the Company had a significant balance of fixed deposits and advised the engagement team to 'document that confirmations have been received [from the banks] for such amounts.'" There had been similar shortcomings in the confirmation of accounts receivable, even though the firm had noted numerous internal control deficiencies. "These confirmation deficiencies contributed directly to the auditors' failure to uncover the Satyam fraud," said James R. Doty, PCAOB Chairman.12
DISCUSSION QUESTIONS
1. Do you agree with Dennis Nally's comments?
2. How do you think Raju could have used Maytas assets to cover up the fraud?
3. Why are related-party frauds more difficult to detect than frauds with no related parties
4. Should U.S. public accounting firms try to audit internationally in cultures they may not understand? If so, how can they maintain quality audits?
5. Can an international firm have one set of absolute ethics standards that must be followed at all times, or do ethics standards need to be flexible enough to account for variations in cultures?
6. How can auditors ensure they are receiving authentic documentation, not forgeries?
7. In your opinion, should PWI be subject to civil litigation?