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 sixfold, 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.
Source: Bhasin, M. L. (2013). Corporate accounting scandal at Satyam: A case study of India’s Enron. European Journal of Business and Social Sciences, 1(12), 25-47.
Explain the case as a report that address the following issues…
1. Conduct an ethical examination to describe the actions of Satyam Computers Limited executives.
2. Apply one ethical decision making to the approach that Mr. Raju may have used to justify his actions. Choose among (utilitarianism, deontological frameworks (universalism) or ethical relativism.
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 CSR Management systems for Satyam.
Note that you should research this case in more depth and not only rely on the case study. Use secondary research and also academic referencing to support your arguments