The Satyam Scandal Project - Research Paper Example

The Satyam Scandal Project Introduction Satyam was launched in 1987 by Mr. Ramalinga Raju, an Indian graduate from the University of Ohio. When Mr. Ramalinga Raju initially formed Satyam it was only aimed at tapping into the relatively new business of providing software and IT services to International clients from India. Therefore, in essence what Mr. Raju started was a software outsourcing company that was based in India but provided software solutions to people around the world. Satyam started in 1987 by offering services to the tractor maker firm John Deere and Co. it then grew over the next few years and in 1991 the company was listed on the Bombay Stock Exchange (Fraud at Satyam, Indian Outsourcing Company). Furthermore, in 1994 Satyam allied with Dun and Bradstreet Corporation, and the partnership was one of the success drivers for the firm. Although it was very short lived and ceased to function after a few years. But by time the partnership dissolved Satyam had gained a worldwide reputation for itself as the company that provided computer services to its clients offshore. With effort and hard work Mr. Raju built his empire from a small company that worked in the garage to a company that was ranked in the top five Indian IT firms, and which had clients in over 60 countries of the world. At a point in time it was said that the Satyam Computer Services served nearly one third of the Fortune 500 companies. As a result of its growth and success it was also listed on the New York Stock Exchange (NYSE) after being registered in the Bombay Stock Exchange.  What happened? It all started on the 7th of January 2009, when Mr. Ramalinga Raju, Chairman of the Satyam Computer Services resigned stating that he had over stated and falsified accounts in order to improve the credibility and the size of the firm. Hence, the growth that was being shown was not natural it was synthetic, and was formed by incorrect accounting records. His resignation ignited the downfall of the company, because it had shattered the confidence of the people who invested in it. It was named Satyam based on the fact that Satyam meant trust and after this incident the company lost whatever trust it had build over the past years. According to Mr. Raju the company’s accounting records were not accurate and 50.4 billion rupees, or $1.04 billion, of the 53.6 billion rupees in cash and bank loans the company listed as assets for its second quarter, which ended in September, were nonexistent. Other irregularities included incorrect reporting of revenues . The revenue for the last quarter of 2009 was actually 20 percent less than the stated amount of 27 billion rupees, hence, the company’s operations and profitability were exaggerated to attract consumers and investors likewise. The news came as a shock to a lot of clients. Satyam was amongst the leading IT service providers in India and served some of the largest banks, manufacturers, and health care and media companies in the world. They handled everything related to computers, from computer systems and software to customer service and repairs. They even provided accounting and financial services in the form of automated accounting and finance software. The most notable clients for Satyam Computer Systems included General Electric, General Motors, Nestlé and the United States government. The development had a massive impact upon the existing clientele of the company. Most of the clients migrated to other alternatives such as Infosys, TCS and Wipro. Satyam lost its share to its competitors and the situation for the company worsened when we look at its stocks. The shares went down by 75 percent after the news surfaced which consequently affected the India’s stock market and brought it down by 7 percent. When Mr. Raju was approached to describe about the fraud he stated that it started with a small discrepancy that grew beyond his control. According to his written document to the stock exchange it was stated, “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… It was like riding a tiger, not knowing how to get off without being eaten” (Financial Scandal at an Outsourcing Company Rattles a Developing Country ).He said that he had tried to bridge the gap in between the books but had failed to do so. The magnitude of the fraud raised a lot of questions about the state regulatory affairs, auditing practices and internal controls of the company. The concerns were not only voiced in India but in other countries around the world too, as Satyam was listed on the New York Stock Exchange and Euronext at the time when the news surfaced. There were concerns and corrective measures being taken around the world. For example, the company was banded from World Bank contracts for installing software and providing other services to the World Bank computers. Forrester Research analysts suggested to corporations that they should stop doing business with Satyam and should switch over to some other IT firm. The scandal also raised questions over accounting standards in India, and the role of the auditing firm Pricewaterhouse Coopers who were the external auditors for the Satyam Computer Company. The role of the auditors will be discussed in the following sections. It is debatable if Mr. Raju made a fortune for himself from the scam because he denies that he and his sons benefitted from the scam. On the other hand, according to the CBI the accused had made huge assets with the amount of the fraud. According to a report by the CBI, Mr. Raju had a total of over one thousand properties in his name, whose documented value accounts to about 3.5 billion rupees . It is still unclear why Mr. Raju fidgeted with the accounting books and what were his motives behind the fraud. Although some analysts say that his prime motive behind committing this scam was to keep up with the growing IT sourcing market in India. How was the fraud concealed? Amongst the numerous cases of financial frauds that have been witnessed around the world, the Satyam fraud case has its unique presence. It was a case where nearly $1.1 billion were reported incorrectly in the accounting statements and went on being unrecognized for quite some time. The fundamental question still remains, how did they conceal the fraud for such a long time? There are numerous answers to these questions and we will discuss each one of them in detail. In order to detect a scam the first option is to compare the growth and performance of one firm with another in the same industry and within the same segment. Therefore, when a comparison of Satyam’s performance with its competitors in the Indian market was done it did not reveal any problems. The comparison proved that Satyam was behind its competitors in key performance metrics which include return on equity, receivables turnover and cash conversion cycle. Hence, when people compared the Satyam with its competitors they did not notice anything extra ordinary and the phenomenal growth and the over stated accounting heads went unnoticed. Another reason why the scam was kept hidden was improper disclosures made by the company. According to the accounting books, Satyam’s investments in bank deposits, as of March 31, 2008 were approximately $825 million of its $1.1 billion cash and bank balances as investments in bank deposits in its consolidated balance sheet. This head was first reflected in the consolidated financial statements in the year 2003 (How Satyam kept a major scandal under wraps). Therefore, it is evident that the disclosures made by the company about these deposits, lacked complete information about the banks where these deposits were being kept. Hence, they violated of the Generally Accepted Accounting Principles (GAAP) and failed to explain the reasons as to why a significant portion of the company’s assets were invested there. A point that needs to emphasized here is that, if they failed to comply with the GAAP, and their consolidated financial statements were published. What did the Indian regulatory authority do? Why did the auditors approve of such financial statements to be published? What was the role of the internal auditors in this scam? A plausible reason for the fraud being kept a secret for a long time is that members of the regulatory board in India might have been involved. According to some analysts, the significance of the numbers was such that corruption cannot be ruled out as a factor. It may be true that the regulatory authority or certain members of it were involved in the fraud and deliberately approved the publication of flawed financial statements. Satyam’s auditors were Pricewaterhouse Coopers (PwC), which itself is a well reputed organization. Even though PwC audited the records every year; the fraud still remained unseen is a question that is not yet answered. A logical solution to this would be that the PwC never bothered checking up the bank deposits as they were stated in the financial statements. Similarly, the internal controls of the company failed miserably. If only Mr. Raju is to be blamed to the entire fraud case, then what were the other employees’ doing when they found out about the fraud? Or if they did not find out about the fraud, then unfortunately, the internal control measures were all flawed. Another question, is that why did the board members approve of these financial statements? There are very notable and learned people on the board, and none of them objected on this subject is incomprehensible. Some of the members of the board were Vinod Dham of Intel, Krishna Palepu, a Harvard Business School professor and TR Prasad, former Cabinet Secretary (Accounting Fraud of Satyam, Indian Enron). If we say that the fraud was done by over stating the cash balances and the investments, there are other irregularities that would have been surfaced by they did not until Mr. Raju proclaimed about the fraud himself. In this case the income statement would have required a lot of alterations and even the simple income manipulation predictions would have caught it. But this was not the case; all the statements were beautifully forged so that they were not that easy to catch. Another reason why it could not be detected is that the use of Information Systems in this process is not stated. Being an IT outsourcing firm, Satyam itself should have had Information Systems for accounting and financial services. And it is not easy to create a large amount of cash from nowhere in an accounting system, as it looks into the different business processes and generates consolidated financial statements. The role of Information System in this fraud is not to seen. Neither does the Chairman say anything about it, nor did the press and other sources. Hence, it may be possible that people at the organization doctored the data fed into the systems and made sure that the systems complied with what was being reported. This again points out to the failure of internal controls within the organization. As a result, it is evident that careful measures were taken to make sure that the fraud was not evident to the public and to the regulatory affairs. Although there is no proof so far, of using unfair means to ensure that the details of the fraud remained inside the business. It is very hard to believe that the regulatory affairs, the board of directors, the audit firm PwC and the management all forgot to see the anomalies in the financial statements. Automated controls for preventing frauds The best automated control for preventing such a fraud would be to streamline the business processes and use a single information system to cater to the needs to the entire organization. Such information systems are known as Enterprise Resource Planning (ERP) systems and are capable of automating all the business processes from streamlining manufacturing data, to managing accounting information and supply chain. Therefore, the use of ERP systems would have prevented such a fraud. The ERP system would have helped in preventing the fraud by integrating all aspects of business together. In the finance and accounting module, it takes into account each head, i.e. be it accounts receivable, accounts payable, accruals, deferrals etc. All the accounting data is stored in a database, which is only accessible by authorized people, hence, forgery of the data can be prevented easily. Another salient feature of such systems is that all transactions that are performed have a timestamp and a signature, i.e. the time of the transaction and the name of the person who initiated the change. As a result, tracking and controlling becomes a lot easier. Furthermore, an ERP system integrates all the financial information together and as it is linked with the other business functions such as sales, manufacturing etc all the information is interlinked and hence cannot be altered easily (Enterprise Resource Planning). Another reason to employ an ERP system would be to make sure that all financial statements are produced automatically by taking into account the data present in the database. Therefore, if the data is integrated and is being fed to the financial module from the other modules a discrepancy only in the financial module is not possible as the module only performs action based on the data received from other departments. Consequently, there are numerous controls that can be employed in an ERP. The most powerful ERP systems come along with a strong control options such as authorization for transactions based on user profiles, type checking, batch processing authorization, change control and management, log of errors and changes in the database, use of passwords for validating use of the software etc. As a result, by implementing the ERP system and by making sure that the controls are in place and that the internal audit department is doing its job well, it is extremely difficult to devise a fraud or to ignore one if it already occurs within the system. Another way to track such frauds is to use standalone financial systems. Such systems will take into account all the data related to the finance and accounting department and then use it to produce financial statements. These information systems are available in the market as products of different vendors and cannot be altered. Once they are deployed in an organization they function in a manner in which they were designed, there are also control mechanisms coded in such software that prevent the alteration of data. Hence, manipulating the data and creating cash out of nowhere will not be possible if these systems are implemented along with proper control and auditing mechanisms. These systems also come along with built in control features such as password protection, database views etc. As a result, they cannot be altered easily. In the case of failure of preventive controls, frauds can be detected within an organization by ensuring a proper IT audit of all the information systems in the organization. At first, an internal audit should be performed which should essentially be followed by an external audit. During an internal audit of the information systems, are checked to see if they maintain data integrity, safeguard assets, allow organizational goals to be achieved effectively, and use resources efficiently (Information Technology Audit). Performing internal audits will point out areas where there has been any mismanagement or areas where the records have been altered. In such cases preventive measures can be taken immediately by tracking down the source of the discrepancy and taking strict actions. Therefore, by performing internal audits discrepancies can be detected in a timely manner. But in order to make sure that this happens, the internal audit department must follow the controls. Controls in computer information terminology refer to policies, procedures, practices and objectives. There are two broad categories of controls in information systems. The first one is the general control category and the second one is the application control category. Some of the general control mechanisms are determining the use of computer and information system in the organization with respect to the current organizational structure, job description of computer users, physical access control, logging in profiles, limiting access to critical resources, computer systems security etc. On the other hand, some of the application controls are checking the integrity of the data in the application, analyzing output of the application, monitoring the accuracy of the output, monitoring schedules and productivity, checking for missing or incomplete data in the application, checking for type mismatch in the application etc. Consequently, if such controls and audits are employed and the management receives reports from the auditors such as there has been data tampering, data mismatch, manipulation of existing records in the database, violation of information security, accessing resources whose access is not permissible etc. The management can in this case know that there is something wrong with the business process and it needs to be sorted out before actual public statements are published. Once the management has gone through the internal audit and cleared any discrepancies in their records or in the reporting, they should hire external auditors to perform not only a financial audit but also an IT audit. As a result, it is obvious that an IT audit has numerous advantages and it can help in the prevention of frauds in organizations provided that an honest audit is carried out. Conclusion Satyam was one of the leading IT outsourcing companies in India and it catered to a lot of clients globally. But the tragic fall of the fourth largest IT outsourcing company in India, is associated with frauds and improper financial reporting by the Chairman of the Satyam computer services Mr. Ramalinga Raju. Although the fraud was hidden for a number of years it eventually surfaced causing immense losses to the Satyam brand name. With the case in mind, the importance of IT audit in preventing such frauds becomes more and more clear. If proper information systems are deployed in organizations and strict auditing controls are followed the prevention of such frauds will become exceedingly easier. Works Cited Accounting Fraud of Satyam, Indian Enron. 26 February 2010 . "Enterprise Resource Planning." www.csquareonline.com. 26 February 2010 . Financial Scandal at an Outsourcing Company Rattles a Developing Country . 26 February 2010 . Fraud at Satyam, Indian Outsourcing Company. 25 February 2010 . How Satyam kept a major scandal under wraps. 26 February 2010 . "Information Technology Audit." www.intosaiitaudit.org. 26 February 2010 . Read More