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Mainstream, Vol XLVII, No 9, February 14, 2009

Analysing The Satyam Affair: Pointers to Business Fraud in India

Thursday 19 February 2009, by Arun Kumar

Business fraud is nothing new in India. Businessmen are known to go to great lengths to make money through legitimate and illegitimate ways. Clever accountants and lawyers are employed to devise ways to generate higher profits for the businessmen.

The Satyam affair stunned everyone when its supposedly ‘honest’ chairperson admitted to committing fraud over the last several years. Apparently, Satyam has been defrauded of Rs 7000 crores but the final tally could be larger. The loss to the shareholders and employees would be by a multiple of this sum. In comparison, the Harshad Mehta episode in 1991-92 was estimated by the Jankiraman Committee to be of the order of Rs 3900 crores even though others claimed it to be eight times bigger. Ketan Parekh’s manipulations led to massive losses for the entire community of stock investors. Collapse of the Global Trust Bank, Telgi scam and other such cases have erupted from time to time.

By one count, by the end of the 1990s, 2500 companies that had raised money in the Indian stock markets had disappeared with the share-holder’s money. The government did not act against these fraudsters and this emboldened the owners of businesses to commit more frauds.

Mostly, managements declare lower profits to escape paying taxes and that is how black incomes are generated. What is curious about the Satyam affair is that, according to its chairperson, Ramalingam Raju, it was supposedly doing the opposite: showing higher profits. That means that Satyam was paying more taxes than it needed to have—a double whammy for the shareholders. Not only was their company less profitable than they thought it to be but it lost money because of excess tax payments.

However, analysts have argued that Satyam could not have been showing higher than actual profits. If Raju is to be believed, Satyam was operating with margins of three to four per cent, and this cannot be correct since the margins of comparable software companies are in the range of 25 per cent. So, many believe that Raju is lying under the garb of telling the truth. The puzzle is that Satyam should have had higher profit margins but its owner, Raju, is claiming that it had lower margins and willingly implicating himself in fraud. Is he trying to cover a bigger fraud?

Why would an owner show higher profits? First, to manipulate the share price since it rises as declared and expected profits rise. This helps in raising the credibility of the company and its management and thereby enables it to raise more funds for further expansion of the company. Secondly, when there are concessions in taxation on profits, it may pay to divert profits from a company not entitled to tax concessions to a company that is entitled to tax concessions and thereby save on tax payments. There was concession under 80 HHC on profits earned in exports and later it was available under section 10A for exports from special zones. Since these provisions were/are for exports, exports have to be over-invoiced. Hence more foreign exchange has to be brought into the country than was earned and this way black wealth held outside and or profits of other companies siphoned out of the country through hawala are brought back—that is, reverse hawala.

Finally, Raju could be siphoning out funds from Satyam to sister concerns that were dealing in real estate. One can conjecture that given the recent collapse of real estate prices and slowdown of investments in this sector, the sister concerns were in need of funds and possibly in trouble.

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Major infrastructure deals had been signed in the last few years involving payment of large sums of money including in black and as cuts to politicians and bureaucrats. This could have been financed through drawing out of funds from the accounts of Satyam. These would have been recouped in the normal process when land was sold for commercial purposes and black funds obtained which would have been put back into the bank accounts and fixed deposits of Satyam. The crisis in real estate and fall in prices and drying up of investments in real estate would have meant that the funds were not coming back.

The purchase of the sister concerns at high and inflated prices would have meant that the fictitious accounts worth Rs 7000 crores would have been drawn down and money transferred to the owners of the sister concerns, that is, to themselves and then there would have been no one to ask where the money has gone. So, by book transfers, the earlier siphoning out of funds would have been covered up and the false entries of the bank balances and fixed deposits reversed/set right.

Raju thought that his prestige as the pride of Andhra and his political clout would enable him to commit the brazen act. These factors had earlier enabled him to obtain the silence of chartered accountants and the independent Directors on the Board of Satyam. The Satyam story would perhaps have not broken out as yet but for the crisis resulting from the failure of the attempt to buy the two sister companies.

The forced reversal of the decision to buy the sister companies and the investment bankers approaching SEBI with the story of the non-existent balance in the banks was the trigger to the realisation that the game was up. There was little time to bring back other black funds and perhaps due to the global crisis they had got stuck. Since the funds did not exist in the Satyam bank accounts he had to cover up by saying that the actual profitability of Satyam was lower and that he had been inflating profits for years—an attempt to portray honesty while committing a fraud. This line may also help in the cases in the US courts to reduce the severity of the fraud and penalties.

The involvement of the managers of banks where the non-existent funds were supposedly held is likely. Similarly, the auditors may have looked the other way rather than questioning why so much cash was being held in bank accounts. The independent Directors should have asked why the sum of Rs 5000 crores was held in savings accounts when in fixed deposits Rs 400 crores could have been earned.

The Board consisting of management gurus, former bureaucrats and businessmen could not have been so naïve as to not realise that something was remiss. How could they approve the purchase of two family companies at such exorbitant prices when it was apparent even to the layman that something was remiss? Why did they keep quiet as the cash in banks piled up? Perhaps, through cosy relationships, they benefited in political and financial terms.

It is now coming out that even employment was being fudged and profits so generated were siphoned out. Shady land deals and support from the various Chief Ministers are being talked about. How many skeletons will tumble out is not clear.

The Satyam affair points to the brazen practices adopted by crooked Indian businesses—siphoning out of profits, fudging of muster rolls, the cosy relationships with politicians and bureaucrats and, finally, manipulating bankers, ‘independent’ auditors and ‘independent’ Directors. All this is well known in the context of the rampant black income generation. Raju’s admission has brought into question the notion of a ‘respectable’ or ‘honest’ businessman. As the global crisis deepens and more frauds surface, more reputations maybe dented. In India we are used to the wrongs of the high-ups emerging with great regularity and then to having amnesia about them—perhaps a cynical view but not far from the reality.

(Courtesy: The Tribune)

Dr Arun Kumar is a Professor, Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University, New Delhi. He can be contacted at e-mail: arunkumar1000@hotmail.com

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