Case study: Satyam Computer Services Limited

1. Introduction

Fraud is a worldwide phenomenon that affects all continents and all sectors of the

economy. Fraud encompasses a wide-range of illicit practices and illegal acts involving

intentional deception or misrepresentation. According to the Association of Certified

Fraud Examiners (ACFE, 2010), fraud is "a deception or misrepresentation that an

individual or entity makes knowing that misrepresentation could result in some

unauthorized benefit to the individual or to the entity or some other party."Fraud cheats

the target organization of its legitimate income and results in a loss of goods, money,

and even goodwill and reputation. Fraud often employs illegal and immoral, or unfair

means.

2. Magnitude of Frauds

Organizations of all types and sizes are subject to fraud. On a number of occasions over

the past few decades, major public companies have experienced financial reporting

fraud, resulting in turmoil in the U.S. capital markets, a loss of shareholder value, and,

in some cases, the bankruptcy of the company itself. Although it is generally accepted

that the Sarbanes-Oxley Act has improved corporate governance and decreased the

incidence of fraud, recent studies and surveys indicate that investors and management

continue to have concerns about financial statement fraud. For example: The

Association of Certified Fraud Examiners'(ACFE) "2010 Report to the Nations on

Occupational Fraud and Abuse"found that financial statement fraud, while

representing less than five percent of the cases of fraud in its report, was by far the most

costly, with a median loss of $1.7 million per incident. Survey participants estimated

that the typical organization loses 5% of its revenues to fraud each year. Applied to the

2011 Gross World Product, this figure translates to a potential projected annual fraud

loss of more than $3.5 trillion. The median loss caused by the occupational fraud cases

in our study was $140,000. More than one-fifth of these cases caused losses of at least

$1 million. The frauds reported to us lasted a median of 18 months before being

detected. "Fraudulent Financial Reporting: 1998-2007,"from the Committee of

Sponsoring Organizations of the Treadway Commission (the 2010 COSO Fraud

Report), analyzed 347 frauds investigated by the U.S. Securities and Exchange

Commission (SEC) from 1998 to 2007 and found that the median dollar amount of each

instance of fraud had increased three times from the level in a similar 1999 study, from

a median of $4.1 million in the 1999 study to $12 million. In addition, the median size

of the company involved in fraudulent financial reporting increased approximately six-

fold, from $16 million to $93 million in total assets and from $13 million to $72 million

in revenues.

A "2009 KPMG Survey"of 204 executives of U.S. companies with annual revenues

of $250 million or more found that 65 percent of the respondents considered fraud to

be a significant risk to their organizations in the next year, and more than one-third of

those identified financial reporting fraud as one of the highest risks. Fifty-six percent

of the approximately 2,100 business professionals surveyed during a "Deloitte Forensic

Center"webcast about reducing fraud risk predicted that more financial statement fraud

would be uncovered in 2010 and 2011 as compared to the previous three years. Almost

half of those surveyed (46 percent) pointed to the recession as the reason for this

increase. According to "Annual Fraud Indicator 2012"conducted by the National Fraud

Authority (U.K.), "The scale of fraud losses in 2012, against all victims in the UK, is

in the region of 73 billion per annum. In 2006, 2010 and 2011, it was 13, 30 and 38

billions, respectively. The 2012 estimate is significantly greater than the previous

figures because it includes new and improved estimates in a number of areas, in

particular against the private sector. Fraud harms all areas of the UK economy."

3. Who Commits Frauds?

As Reuber and Fischer (2010) states: "Everyday, there are revelations of organizations

behaving in discreditable ways."Observers of organizations may assume that firms will

suffer a loss of reputation if they are caught engaging in actions that violate social,

moral, or legal codes, such as flaunting accounting regulations, supporting fraudulent

practices, damaging the environment or deploying discriminatory hiring practices.

There are three groups of business people who commit financial statement frauds. They

range from senior management (CEO and CFO); mid- and lower-level management

and organizational criminals (Crumbley, 2003). CEOs and CFOs commit accounting

frauds to conceal true business performance, to preserve personal status and control and

to maintain personal income and wealth. Mid- and lower-level employees falsify

financial statements related to their area of responsibility (subsidiary, division or other

unit) to conceal poor performance and/or to earn performance-based bonuses.

Organizational criminals falsify financial statements to obtain loans or to inflate a stock

they plan to sell in a "pump-and-dump"scheme. Methods of financial statement

schemes range from fictitious or fabricated revenues; altering the times at which

revenues are recognized; improper asset valuations and reporting; concealing liabilities

and expenses; and improper financial statement disclosures (E&Y, 2009). Sometimes

these actions result in damage to an organization's reputation. While many changes in

financial audit processes have stemmed from financial fraud or manipulations, history

and related research repeatedly demonstrates that a financial audit simply cannot be

relied upon to detect fraud at any significant level. The Association of Certified Fraud

Examiners (ACFE) conducts research on fraud and provides a report on the results

biennially, entitled "Report to the Nation."The statistics in these reports (ACFE 2002,

2004, 2006) consistently states that about 10-12 percent of all detected frauds are

discovered by financial auditors (11.5 percent, 10.9 percent, and 12.0 percent,

respectively). The KPMG Fraud Survey (KPMG 1994, 1998, 2003) consistently reports

lower but substantively similar detection rates (5 percent, 4 percent, and 12 percent,

respectively). The dismal reliability of financial audits to detect fraud can be explained

very simply. They are not designed or executed to detect frauds. Statistically, one could

infer that about 10 percent of all frauds are material, and because financial audit

procedures are designed to detect material misstatements, then a 10 percent detection

rate would be logical.

4. Consequences of Fraudulent Financial Reporting Fraudulent financial reporting can

have significant consequences for the organization and its stakeholders, as well as for

public confidence in the capital markets. Periodic high-profile cases of fraudulent

financial reporting also raise concerns about the credibility of the U.S. financial

reporting process and call into question the roles of management, auditors, regulators,

and analysts, among others (Telberg, 2003). Moreover, fraud impacts organizations in

several areas: financial, operational and psychological. While the monetary loss owing

to fraud is significant, the full impact of fraud on an organization can be staggering. In

fact, the losses to reputation, goodwill, and customer relations can be devastating. When

fraudulent financial reporting occurs, serious consequences ensue. The damage that

results is also widespread, with a sometimes devastating 'ripple'effect. Those affected

may range from the 'immediate'victims (the company's stockholders and creditors) to

the more 'remote'(those harmed when investor confidence in the stock market is

shaken). Between these two extremes, many others may be affected: 'employees'who

suffer job loss or diminished pension fund value; 'depositors'in financial institutions;

the company's 'underwriters, auditors, attorneys, and insurers'; and even honest

'competitors'whose reputations suffer by association. As fraud can be perpetrated by

any employee within an organization or by those from the outside, therefore, it is

important to have an effective "fraud management"program in place to safeguard your

organization's assets and reputation. Thus, prevention and earlier detection of

fraudulent financial reporting must start with the entity that prepares financial reports.

The wave of financial scandals at the turn of the 21st century elevated the awareness of

fraud and the auditor's responsibilities for detecting it. The frequency of financial

statement fraud has not seemed to decline since the passage of the Sarbanes-Oxley Act

in July 2002 (Hogan et al., 2008). For example, The 4th Biennial Global Economic

Crime Survey (2007) of more than 3,000 corporate officers in 34 countries conducted

by PricewaterhouseCoopers (PwC) reveals that "in the post-Sarbanes-Oxley era, more

financial statement frauds have been discovered and reported, as evidenced by a 140%

increase in the discovered number of financial misrepresentations (from 10% of

companies reporting financial misrepresentation in the 2003 survey to 24% in the 2005

survey). The increase in fraud discoveries may be due to an increase in the amount of

fraud being committed and/or also due to more stringent controls and risk management

systems being implemented,"(PricewaterhouseCoopers 2005). The high incidence of

fraud is a serious concern for investors as fraudulent financial reports can have a

substantial negative impact on a company's existence as well as market value. For

instance, the lost market capitalization of 30 high-profile financial scandals caused by

fraud from 1997 to 2004 is more than $900 billion, which represents a loss of 77% of

market value for these firms, while recognizing that the initial market values were likely

inflated as a result of the financial statement fraud. No doubt, recent corporate

accounting scandals and the resultant outcry for transparency and honesty in reporting

have given rise to two disparate yet logical outcomes. First, 'forensic'accounting skills

have become crucial in untangling the complicated accounting maneuvers that have

obfuscated financial statements. Second, public demand for change and subsequent

regulatory action has transformed 'corporate governance'(henceforth, CG) scenario.

Therefore, more and more company officers and directors are under ethical and legal

scrutiny. In fact, both these trends have "the common goal of addressing the investors'

concerns about the transparent financial reporting system."The failure of the corporate

communication structure has made the financial community realize that there is a great

need for 'skilled'professionals that can identify, expose, and prevent 'structural'

weaknesses in three key areas: poor CG, flawed internal controls, and fraudulent

financial statements. "Forensic accounting skills are becoming increasingly relied upon

within a corporate reporting system that emphasizes its accountability and

responsibility to stakeholders"(Bhasin, 2008). Following the legislative and regulatory

reforms of corporate America, resulting from the Sarbanes-Oxley Act of 2002, reforms

were also initiated worldwide. Largely in response to the Enron and WorldCom

scandals, Congress passed the Sarbanes-Oxley Act (SOX) in July 2002. SOX, in part,

sought to provide whistle-blowers greater legal protection. As Bowen et al. (2010)

states, "Notable anecdotal evidence suggests that whistle-blowers can make a

difference. For example, two whistle-blowers, Cynthia Cooper and Sherron Watkins,

played significant roles in exposing accounting frauds at WorldCom and Enron,

respectively, and were named as the 2002 persons of the year by Time magazine."

Given the current state of the economy and recent corporate scandals, fraud is still a top

concern for corporate executives. In fact, the sweeping regulations of Sarbanes-Oxley,

designed to help prevent and detect corporate fraud, have exposed fraudulent practices

that previously may have gone undetected. Additionally, more corporate executives are

paying fines and serving prison time than ever before. No industry is immune to

fraudulent situations and the negative publicity that swirls around them. The

implications for management are clear: every organization is vulnerable to fraud, and

managers must know how to detect it, or at least, when to suspect it.

5. Frauds Scenario in India: A Case Study of Satyam Computer Services Limited.

Economic Crime continues to be pervasive threat for Indian Companies, with 35

percent of the organizations reporting having experienced fraud in the past two years

according to PwC "The 4th Biennial Global Economic Crime Survey 2007."The survey

covering 152 organizations in India concluded as: "There is a dramatic drop in the

percentage of companies that reported to be victims of fraud in 2005 survey, where 54

percent of respondents reported suffering from economic crime. However, in most

categories of fraud, the respondents'perception of fraud was substantially higher than

the actual incidents reported. This mismatch may imply that incidents of fraud are going

unreported."Similarly, another survey entitled "Economic Crime: People, Culture and

Controls,"found that economic crime is all but universal, affecting companies of all

sizes and in all industries. According to the India findings: (a) Corruption and Bribery

continues to be the most common type of fraud reported by 20 percent of the

respondents; (b) The average direct financial loss to companies was INR 60 Million

(US $ 1.5 million) during the two year period. In addition the average cost to manage

economic crime in India was INR 40 Million (US $ 1 Million), which is close to double

that of the global and Asia-Pacific average; (c) In 36 percent of cases companies took

no action against the perpetrators of fraud; and (d) In 50 percent of the cases frauds

were detected by chance. Satyam scam has been the greatest scam in the history of the

corporate world of the India. The case of Satyam accounting fraud has been dubbed by

the media as "India's Enron". In order to evaluate and understand the severity of Satyam

fraud, it is important to understand the factors that contributed to the 'unethical'

decisions made by the company's executives. Therefore, it is necessary to examine in

detail the rise of Satyam as a competitor within the global IT services market-place. In

addition, it is also helpful to evaluate the driving-forces behind Satyam's decisions

under the leadership of Mr. Ramalinga Raju (Chairman). Finally, attempt may be made

to draw some broad conclusions and to learn some 'lessons'from Satyam fraud.

Ironically, Satyam means "truth"in the ancient Indian language "Sanskrit"(Basilico et

al., 2012). Satyam won the "Golden Peacock Award"for the best governed company

in 2007 and in 2009. From being India's IT "crown jewel"and the country's "fourth

largest"company with high-profile customers, the outsourcing firm Satyam Computers

has become embroiled in the nation's biggest corporate scam in living memory

(Ahmad, et al., 2010). Mr. Ramalinga Raju (Chairman and Founder of Satyam;

henceforth called 'Raju'), who has been arrested and has confessed to a $1.47 billion

(or Rs. 7,800 crore) fraud, admitted that he had made up profits for years. According to

reports, Raju and his brother, B. Rama Raju, who was the Managing Director, "hid the

deception from the company's board, senior managers, and auditors."The case of

Satyam's accounting fraud has been dubbed as "India's Enron". In order to evaluate

and understand the severity of Satyam's fraud, it is important to understand factors that

contributed to the 'unethical'decisions made by the company's executives. First, it is

necessary to detail the rise of Satyam as a competitor within the global IT services

market-place. Second, it is helpful to evaluate the driving-forces behind Satyam's

decisions: Ramalinga Raju. Finally, attempt to learn some 'lessons'from Satyam fraud

for the future.

On January 7, 2009, Mr. Raju disclosed in a letter, to Satyam Computers Limited Board

of Directors that "he had been manipulating the company's accounting numbers for

years."Mr. Raju claimed that he overstated assets on Satyam's balance sheet by $1.47

billion. Nearly $1.04 billion in bank loans and cash that the company claimed to own

was non-existent. Satyam also underreported liabilities on its balance sheet. Satyam

overstated income nearly every quarter over the course of several years in order to meet

analyst expectations. For example, the results announced on October 17, 2009

overstated quarterly revenues by 75 percent and profits by 97 percent. Mr. Raju and the

company's global head of internal audit used a number of different techniques to

perpetrate the fraud. As Ramachandran (2009) pointed out, "Using his personal

computer, Mr. Raju created numerous bank statements to advance the fraud. Mr. Raju

falsified the bank accounts to inflate the balance sheet with balances that did not exist.

He inflated the income statement by claiming interest income from the fake bank

accounts. Mr. Raju also revealed that he created 6,000 fake salary accounts over the

past few years and appropriated the money after the company deposited it. The

company's global head of internal audit created fake customer identities and generated

fake invoices against their names to inflate revenue. The global head of internal audit

also forged board resolutions and illegally obtained loans for the company."It also

appeared that the cash that the company raised through American Depository Receipts

in the United States never made it to the balance sheets.

Answer all the questions. Each question carries 15 Marks

1. Conduct an ethical examination to describe the actions of Satyam Computers

Limited executives.

2. Apply teleological frameworks (at least three in this case). Choose among

(Ethical egoism, utilitarianism, Sidgwick's dualism, deontological frameworks

(existentialism, Kant's ethics, contractarianism)

3. Analyze the consequences of unethical action of various stakeholders. Apply

the triple bottom line in this case.

4. Evaluate the main ethical issues regarding financial reporting in this case.

5. Analyze how ethical leadership could have averted this situation.

6. Evaluate the application of strategic ethical decisions to build character in the

case Satyam. Analyze the importance of a code of ethics and ethical guidelines

for Satyam.