Corporate accounting fraud: A case study of Satyam Computers limited.

Introduction:

“Fraud is a worldwide phenomenon that affects all continents as well as all sectors of the economy.  Fraud encompasses a wide range of illicit practices and illegal acts involving intentional deception or misrepresentation.
 

According to (ACFE) Association of certified fraud examiners, fraud is “adeception 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.

In other words, mistakes are not fraud, indeed in fraud group of unscrupulous individuals manipulate, or influence the activities of a target business with the intention of making money or obtaining goods through illegal or unfair” means, fraud cheats the target organization of its legitimate income and results in a loss of “goods, money and  even goodwill and reputation. 

Fraud often employee illegal or immoral or unfair means it is essential that organizations build processes, procedures and control that do not needlessly put employees in a position to commit fraud and that effectively detect” fraudulent activity if it occurs.

The fraud involving persons from the leadership level is known under the name managerial fraud and the one involving only entity’s employees is named “fraud of employees association”.

Magnitude of fraud losses: A Glimpse

“Organization 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, resulting  in turmoil in the capital markets, a loss of shareholder value, in some cases, the bankruptcy of” “the  company itself.

Although, it is generally accepted that the Sarbanes-Oley hasimproved corporate governance and decreased the incidence of fraud, recent studies and surveys indicate that investors and management continue to have concern about financial statement fraud. For example”

“The ACFE’s 2010 Report to the nations on occupational fraud and abuse found that financial statement fraud, while representing less than five per-cents of the cases of fraud in its report, was by far the most loses 5% of its revenues to fraudeach 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 out stud was $140,000.  More than one-fifth of these cases cause losses of at least $1 million. The frauds reported us lasted a median of 18 months before being detected.”

“Fraudulent Financing Reporting from 1998-2007 from the committee of sponsoring organizations of the Treadway commission analysed 347 frauds investigated by the US Securities and Exchange Commission (SEC) from 1998 to 2007 and found that he media”dollar amount of each instance of fraud had increase three times from the level in a “similar 1999 study, from a median o $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”

“A 2009 KPMG survey of 204 executives of US companies with annual revenues of $250 million or more found that 65 per-cent of the respondent considered fraud to be a significant risk factor to the organizations in the next year and more than one-third of those identified reporting fraud as one of the highest risk factor.”

“Fifty six per-cent of the approximately 2100 business professional surveyed during a Deloitte forensic centre webcast about reducing fraud risk predicted that more financial reporting fraud would be uncovered in 2010 and 2011 as compared to the previous three years. Almost half of those surveyed 46 per-cent pointed to the recession as the reason for this increase.”

“Moreover, financial statement fraud was a contributing factor to the recent financial crises and it also threatened the efficiency, liquidity and safety of both debt and capital markets. Furthermore, it has more significantly increased uncertainty and volatility in financial” “markets, shaking investors’ confidence worldwide. It also reduces the creditability of financial information the investors use in investment decisions. When taking into account the loss of investor confidence, as well as reputational damage and potential fines and criminal action, it is clear why financial misstatements should be every manager’s worst fraud related nightmare.”

1.3. Who Commits Frauds?

. Every day, there are more disclosures about organisations behaving in discreditable ways. Financial fraud is typically committed by three types of businesspeople. Senior management (CEO and CFO), middle and lower level management, and organisational criminals are among them. Accounting fraud is committed by CEOs and CFOs to conceal genuine business performance, maintain personal status and control, and keep personal income and wealth.

Employees at the mid- and lower-level falsify financial accounts linked to their area of responsibility (subsidiary, division, or other unit) in order to hide bad performance or receive performance-based bonuses. Financial statements are falsified by corporate criminals to obtain losses or to boost a stock they intend to sell in a pump and dump operation.

Despite the fact that significant modifications in financial auditing processes have resulted 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

Consequences of fraudulent reporting:

Periodic high-profile cases of fraudulent financial reporting raises concerns about the credibility of the US financial reporting process, and calls into question the role of management, auditors, regulators, and analysts, among others.Furthermore, corporate fraud has a substantial financial, operational, and psychological impact on enterprises.

While the monetary loss resulting from fraud is enormous, the total impact of fraud on an organisation can be startling. In fact, the damage to a company's reputation, goodwill, and customer relations can be severe. When financial reporting is falsified, there will be substantial consequences. The resulting harm is equally broad, with a potentially fatal ripple effect. Those who are affected may range from the immediate victims (thecompany’s, stockholder and creditors) to the more remote (those harmed when investor confidence in the stock market in 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 underwriters, auditors, attorneys and insurer and even honest competitors whose reputations suffer by association.”

“As fraud can be perpetrated by an employee within an organisation 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. Given the current state of the economy and recent corporate scandals, fraud is still a top concern for corporate executives. In fact, the sweepingregulations of Sarbanes-Oxley, “designed to help prevent and detect corporate fraud, have exposed fraudulent practices” that previously may have gone un- detected.

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.” 

.Review of literature:

“Starting in the late 1990s, a wave of corporate frauds in the United States occurred with Enron’s failure on perhaps serving as symbol of a particular quality or concept.

For example Jeffords examined 910 cases of fraud submitted to the “Internal Auditors” during the nine” “year period from 1981 to 1989 to assess the specific risk factors cited in the Treadway commission Report. He concluded that approximately 63 per-cent of the 910 fraud cases are classified under the internal control risks.”

“”In addition, Smith offered a typology of individuals who embezzle. He indicated that embezzlers are opportunist type who quickly detects the lack of weakness in internal control and seizes the opportunity to use the deficiency to his benefit. Similarly Ziegenfuss performed a study to determine the amount and type of fraud occurring in state and local governments. His study revealed that the most frequently occurring types of fraud a misappropriation of assets, theft, false representation and false invoice.”

“On the other hand, Haugen and Selin in their study discussed the value of internal controls which largely depends on, management integrity and the ready availability of computer technology, which assisted in the commitment of crime. Sharma and Brahma emphasized” “on banker’sresponsibility of frauds, bank fraud could crop up in all sphere of bank’ dealing. 

Major causes for perpetration of fraud in laxity in observance in laid down system and procedures for supervising staff. Harris and William however examined the reason for loan” frauds in banks and emphasized on due diligence program. “Beirstaker, Brody, Pacini in their study proposed numerous fraud protection and detection techniques. Moreover, Willison examined the causes that led to breakdown of Barring bank. The collapse resulted due to the failures in management, financial and operational controls of Baring Banks.”

“Choo and Tan explained corporate fraud by relating the fraud triangle to the broken trust theory and to an American dream theory which originate from the sociological literature, while Schrand and Zechman related executive over-confidence to the commitment of” “fraud, moreever Bhasinexamined the reasons for check and frauds, the magnitude of frauds in banks by taking proactive steps to combat frauds.”

“Chen in his study examined unethical leadership in the companies and compares the role of unethical leaders in the variety of scenarios. Through the use of computer simulation models, he shows, how a combination of CEO’s narcissism, financial incentive, shareholders, expectations and subordinate silence as well as CEO’s dishonesty can do much to explain” “some off the findings highlighted in recent high-profile accounting scandals. According to a research study performed by Cechini et al, the authors provided a methodology for detecting management fraud using basic financial data based on support vectors machines.”

“From the above studies it is evident that majority of studies were performed in develop, western countries. However the manager’s behaviour in commitment has been relatively unexplored so far. Accordingly, the objective of this paper is to examine managers, unethical behaviour in Satyam Computer Limited, which constitutes an ex-post evaluation of alleged or acknowledged fraud case. Unfortunately, no study has been conducted to examine behaviour aspects of manager’s in the perpetuation of corporate frauds in the context of a developing economy like India; hence the present study seeks to fill this gap and contributes to the literature.”

.3. Research Methodology:

I have doctrinal form of research for completing this research paper, I have taken various secondary sources for supporting my instances. 

Objectives and Sources of Information 

In my project two issues are crucial first to understand why and how a “specific company is committed to fraudulent financial reporting practices an appropriate “interpretive “research is needed. Second, case study conducted as part of this study, looked specifically at the largest fraudulent case in India

Emergence of Satyam Computer Limited:

“Satyam Computer Services limited was a rising star in Indian outsourced IT services Industry, the company was formed in 1987 in Hyderabad by Ramalinga Raju.. The firm began withonly 20 employees but grew rapidly as a global business. It offered wide IT and business process outsourcing services spanning various sectors. Satyam was at a time example of India’s growing business. Satyam won numerous award for innovation, governance and corporate accountability.” In 2007 Ernst and Young award Mr. Ramlinam Raju with the Entrepreneur of the year award. On 14, April 2008 Satyam won award from MZ consults for being a leader in India in central government and accountability. In September 2008, the world council for corporate governance awarded Satyam with the Global peacock award for global excellence in corporate accountability. Unfortunately less than five month after winning the Global peacock award, Satyam computers became the centrepiece of massive corporate fraud.

“BY 2004, Satyam IT services include more than 13000 technical associates serving 300 computers worldwide. At that time, the world-wide IT services market was estimated at nearly $400 billion with annual compound growth rate of 6.4%. The market major drivers at that point in time were increased importance of IT services to businesses worldwide, the services industry in India and their methodologies, and the growing need of IT service provider who could provide a range of services to effectively compete both domestic as well as global competitors the company embarked on a variety of multi-pronged business growth strategies.”

“”From 2003-08 nearly in all financial metrics of interest to investors, the company grew measuredly, In 2008 Satyam IT services generated USD$467 million in total sales, and the company had grown its market to USD $2,1 billion. TH Company demonstrated an annual compound growth rate of 35% over the period. In the same year Operating profit averaged 21% earnings per share similarly grew from $0.12 to $0.62 at a compound annual growth rate of 40%.””

“Over the same period from 2003 to 2009, the company was trading at average trailing EBITDA multiple of 15.36 finally, beginning in January 2003, at a share price of 138INR, Satyam stock peak at 526 INR a 300% improvement in share price after nearly five years. Satyam clearly generated significant corporate growth and shareholder value.”

“Up to these years company was a leading star and a recognizable name in a global IT market place. The external environment in which Satyam operated was indeed beneficial to the company’s growth. But the number did not represent the full picture. At present the case of Satyam accounting fraud has been dubbed as India’s Enron”

Mr. Ramlingam Raju and the Satyam Scandal:

On January 7, 2009 Mr. Raju disclosed in a letter (annexure) to Satyam computer Limited Board of directors stating that hehas been manipulating company accounting numbers since many years. Mr. Raju claimed that he enhanced assets of Satyam’s balance sheet by $1.47 billion.
 

Nearly $.1.04 billion in bank loans and cash that the company claimed to be owned was in reality non-existent. Satyam also underreported liabilities on its balance sheet. In reality Satyam Overstated income nearly every quarter over the course of seveal years in order to meet analyst expectations. For example the result announced on 17 October 12009 overstated quarterly revenues by 75 per-cents and by 97 per-cents (profits). Mr.Raju and the company’s global head of internal audit used a number of different techniques to conceal the fraud. By his personal computer Mr. Raju created numerous bank statements to advance the fraud. Mr. Raju falsified the bank account also 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. Ramlingam Raju also revealed that he created 6000 fake salary accounts over the past few years   and appropriated money from various banks after the company deposited it. The company’s global head of internal audit created various fake customer identities and generated fake invoices against their names to inflate revenue. And none the less global head of internal audit also forge board resolutions and illegally obtained loans for the company.it also appeared that the cash raised by the company from American Depository Receipts in the United States never made it to the balance sheets.

“Greed for money, power, competition, success and prestige compelled Mr. Raju to “ride the tiger”, which led to violation of all duties imposed on them as fiduciaries—the duty of care, the duty of negligence, the duty of loyalty, the duty of disclosure towards the stakeholders”. “The Satyam scandal is a classic case of negligence of fiduciary duties, total collapse of ethical standards, and a lack of corporate social responsibility. It is human greed and desire that led to fraud. This type of behaviour can be traced to: greed overshadowing the responsibility to meet fiduciary duties; fierce competition and the need to im- press stakeholders especially investors, analysts, share- holders, and the stock market; low ethical and moral standard by the top management and greater emphasizes on short term performance.

The auditor’s role and factor contributing to fraud:

Global auditing  firm, Pricewater house coopers(PwC), audited Satyam books from June 2000 until the discoveries of the fraud in 209, Several commentaries as well as other auditing firms criticized PwC harshly for failing to detect the disastrous fraud. Indeed PwC signed satyam financial statement and was responsible for number of crimes under Indian law, One particle troubling item concerned the $1.04 billion that Satyam claimed to have on its balance sheet in “non-interest bearing” deposit. According to various accounting professionals any reasonable company have either invested the money into an interest bearing account or returned the excess cash to the shareholders. 

The large amount of cash thus should have been a ‘red-flag’ for the auditors that further verification and testing was necessary. Further- more, it appears that the auditors did not independently verify with the banks in which Satyam claimed to have depositories

Furthermore, the Satyam fraud lasted several years and involved both balance sheet and income statement falsification. Satyam simply generated "fictitious" sources whenever it needed additional money to match analyst projections, and it did so several times without the auditors noticing the fraud. Surprisingly, Satyam paid PwC twice as much for the audit as other corporations would, raising doubts about whether PwC was participating in the fraud. PwC audited the company for approximately nine years and failed to identify the fraud, whereas Merrill Lynch discovered the crime in just ten days as part of its due diligence. Missing these "red-flags" meant either great incompetence on the part of the auditors or complicity with the corporation in committing fraud.

Initially, PWC said that all of the company's audits were completed in compliance with applicable auditing standards. The Satyam fraud was caused by a number of factors. None of the independent Satyam board members, institutional investors, the SEBI, retail investors, or the external auditor, including professional investors with detailed information and models at their disposal, discovered the fraud. The following is a list of contributing reasons to the fraud: Greed, aggressive corporate growth, deceptive reporting practices—lack of transparency, excessive interest in maintaining stock prices, executive incentives, stock market expectations, nature of accounting rules, ESOPs issued to those who prepared fake bills, high-risk deals that went sour, audit failures (internal and external), aggressiveness of investment and commercial banks, rating agencies' aggressiveness and investors, weak independent directors and audit committee and whistle blower policy not being effective.

Investigation: Criminal and Civil Charges  

      The investigation that followed the revelation of the fraud led to charges against several different groups of people involved in Satyam scandal case. Indian authorities arrested Mr. Raju and Mr. Raju’s brother, B. Ramu Raju, its former managing director, Srinivas Vdlamani and the company head of internal audit and it’s CFO on criminal charges of fraud. Indian authorities also arrested and charged several of the company auditors of PwC with fraud. The ICAI ruled that the CFO and the auditors were guilty of professional misconduct. The Central bureau of investigation is also in the course of investigating the CEO overseas assets. Apart from them there were several civil charges filed in the US against Satyam by the holder of ADRs. The investigation also implicated several Indian Politicians. Both civil and criminal litigation cases continue in India and Civil litigation continue in the United States. Some of the main victim of this fraud was employees, clients, shareholders, banker and especially the Indian government.

In the aftermath of Satyam, India’s market recovered and Satyam now lives on. India’s stock market is currently trading near record highs, as it appears that a global economic recovery is taking place. Civil litigation charge continues against Satyam. Tech Mahindra purchased 51% of Satyam Stake in 2009 successfully.

Conclusion:

     Recent corporate financial fraud and the turmoil of honesty and transparency in reporting have given rise to two important outcomes. First forensic accounting skills  have become unalienable in untangling the complicated accounting manoeuvre’s that have obscured financial statement, Second public demand for change and subsequent regulatory action has transformed central government scenario across the globe.  Both of these trends have the similar goal of addressing the investor concerns about the honest and transparent financial system. The failure of corporate communication structures, therefore has made the financial community realize that there is a great need for skilled professionals that can identify, expose and prefer structural weakness in three important key areas, poor corporate governance, obscure and flawed internal controls and fraudulent financial statements in addition the central government framework needs to be first of all strengthened and then implemented in letter as well as in right spirit. The increase rate of white collar crimes really demands harsh penalties and punishments. 

References:

1. Abuse,” The Association of Certified Fraud Examiners, 2010. www.acfe.com 

2. COSO, “Fraudulent Financial Reporting: 1987-2007,” Committee of Sponsoring Organizations of the TreadwayCommission, 2010. http://www.coso.org 

3. KPMG Fraud Survey 2009, 2003, 1998, 1994. www.kpmginstiutes.com 

4. Deloitte Forensic Center, “Fraud, Bribery and Corruption Practices Survey,” 2011. http://www.deloitte.com. 

5. National Fraud Authority, “Annual Fraud Indicator,” 2012. www.homeoffice.gov.uk 

6. W. K. Black, “Epidemics of Control Fraud Lead to Re-current, Intensifying Bubbles and Crises,” University of Missouri, Kansas City, 2010. 

7. Ernst & Young, “Detecting Financial Statement Fraud: What Every Manager Needs to Know,” E & Y LLP, London, 2009, pp. 1-8. www.ey.com 

8. A. R. Reuber and E. Fischer, “Organizations Behaving Badly: When Are Discreditable Actions Likely to Dam- age Organizational Reputation?” Journal of Business Ethics, Vol. 93, No. 1, 2009, pp. 39-50. doi:10.1007/s10551-009-0180-3 

9. D. L. Crumbley, L. E. Heitger and G. S. Smith, “Forensic and Investigative Accounting Chicago: CCH Incorpo- rated,” 2003. 

10. C. E. Crutchley, M. R. H. Jensen and Marshall, “Climate for Scandal: Corporate Environments that Contribute to Accounting Fraud,” The Financial Review, Vol. 42, No. 1, 2007, pp. 53-73. 

11. R. Jeffords, “How Useful Are the Treadway Risk Fac- tors?” Internal Auditor, Vol. 49, No. 3, 1999, pp. 12-30. 

12. E. R. Smith, “A Positive Approach to Dealing with Em- bezzlement,” The White Paper, August/September 1995 pp. 17-18. 

13. D. E. Ziegenfuss, “State and Local Government Fraud Survey for 1995,” Managerial Auditing Journal, Vol. 11 

WRITTEN BY:

Priyanshu Jain.