Closing the barn door of governance

India passes a transparency law to boost corporate accountability a year after the Satyam fraud.

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MUMBAI // The Indian government has introduced a draft law to avert corporate upheavals almost a year after the nation's business community was rocked by the Satyam fraud scandal. The legislation would make it mandatory for companies to operate more transparently. It would also, for the first time, enable investors to file a class action against unscrupulous companies where fraud is suspected. It would force companies to pay damages to shareholders if found guilty.

"We will now provide stricter penalties, greater disclosures, greater participation of shareholders in terms of scrutiny of company records," Salman Khurshid, the Indian minister for corporate affairs, said last week. "We have taken considerable steps forwards so that we can avoid something like Satyam happening again." The Satyam affair, known as "India's Enron", tarnished the country's image overseas as an outsourcing powerhouse.

The legislation is the first attempt by the Indian government to protect investors and allay investor concerns over unchecked corporate fraud. The Enron affair involved the seventh-largest US company lying about profits and concealing debts, leading to a bankruptcy filing and the jailing of its top executives. Ramalinga Raju, the founder of Satyam Computer Services, last January admitted to concocting key financial results of the company for years while overstating revenues and bank balances by US$1 billion (Dh3.67bn).

The magnitude of the incident, the worst in the history of corporate India, sent shock waves across the country. Particularly unpalatable was the fact that Mr Raju was no ordinary fly-by-night cash embezzler, but the chairman of one of India's largest outsourcing companies, which boasted of being the back office of more than 185 Fortune 500 firms. Before he fell from grace, Mr Raju was lionised by investors as a business visionary who shepherded his company to post profit margins exceeding 20 per cent every year. Declaring a 28 per cent revenue gain in the second quarter of last year compared with the previous year, he gloated before the Indian media that it had been achieved despite a challenging global macroeconomic environment.

As it turned out, Satyam's revenues had been overstated by 76 per cent and its profits by 97 per cent. Its stated operating margin of 24 per cent actually stood at 3 per cent. Mr Raju and B Rama Raju, his brother and the Satyam managing director, are in jail on charges of criminal breach of trust, criminal conspiracy, cheating, falsification of records and forgery. The fraud, analysts say, is symptomatic of India's lackadaisical attitude towards corporate sector law enforcement which would hobble economic development. The Indian government is trying hard to change that image.

The Central Bureau of Investigation (CBI), a federal agency making inquiries in the case, said last month the Satyam fraud amounted to $3bn and that the figure was only likely to rise. It claimed this month that PricewaterhouseCoopers (PwC) failed to apply certain audit standards to the company, giving enough leeway to Mr Raju and others to perpetuate the accounting fraud. The auditors "relied upon forged bank confirmation letters supplied by the other accused while conducting the statutory audit", the CBI said, thereby failing to verify the company's current account balances.

The "blatant deviations", the investigative agency said, showed PwC's "underlying conspiracy" with the other key accused. The CBI also said PwC "paid no heed to" the findings of Satyam's system process audit team, which had pointed out "several IT system control deficiencies" and warned the auditors that they were significant enough to "affect the genuineness of the financial statements of the company".

Despite the warnings, the CBI said, the auditors wrongfully told the audit committee that the deficiencies were "insignificant". Two PwC auditors based in Hyderabad have been arrested by the CBI and are behind bars. PwC, India's largest accounting firm with annual revenues exceeding 10bn rupees (Dh787 million), has run into trouble because of the Satyam investigation. After the CBI allegations were made public, PwC India announced the resignation of Ramesh Ranjan, its chairman, who stepped down before the end of his term.

Meanwhile, Satyam, which was acquired by Tech Mahindra in April, dropped PwC and appointed Deloitte Haskins and Sells as its statutory auditor for this fiscal year and next. Analysts say an accounting scandal of this magnitude was just waiting to happen considering the poor standard of Indian accounting, which makes manipulation of figures possible without being detected by regulators. "Our daily encounters with listed Indian companies suggest that there are more Satyams in the pipeline thanks to enfeebled regulation, weak accounting discipline and aggressive promoter behaviour," said Saurabh Mukherjea, the head of Indian equities at Noble, an investment bank based in London.

In his dealings with Indian companies listed on the Bombay Stock Exchange BSE 500 index, Mr Mukherjea says he has discovered several fraudulent and unethical corporate practices in recent years. He has found at least 10 companies in the BSE 500 that have manipulated finances by "shifting expenses away from the current period by significantly reducing depreciation rates", he says. At least 15 companies have brazenly "disbursed the bulk of their loans and advances to companies in which directors have an interest", he says. Waking up to this reality, the Indian government has announced a slew of high-profile corporate investigations since the Satyam affair came to light.

India's Serious Fraud Investigation Office in October began looking into the iron ore exporter Sesa Goa for alleged "mismanagement, malpractices, financial and other irregularities". In the same month, it began investigating the finances of Reliance Telecom and Reliance Communications Infrastructure, owned by the Reliance-Anil Dhirubhai group of companies. Last week, A Raja, the Indian telecommunications minister, told parliament the group had underreported revenues by as much as 15bn rupees during the 2007 and 2008 fiscal years.

The fraud, the minister said, was allegedly perpetuated to avoid payment of a government licence fee, resulting in the state losing revenue worth 2.5bn rupees. The Indian government is expected to initiate action against the group for fudging its accounts in an attempt to demonstrate such blatant fraud will no longer be tolerated.