Satyam Overlooked Oversight

The $1 billion accounting scandal at India's Satyam Computer Services has raised several key governance questions about the company's board and its auditors. One of the most perplexing is: Where does the buck stop. That is, why didn't oversight mechanisms uncover the fraud sooner?

One governance expert claims that a lax regulatory system in India bears at least some of the blame. "Corporate governance in India was late on the scene, it is more politically motivated than legally based, and regulatory laws and agencies are burdened with the complex, slow-moving legislative and judicial processes," charges John Alan James, a governance expert and adjunct management professor at Pace University's Lubin School of Business. "A governance disaster was predictable."

James contends that until 1991, the attitudes and government policies in India toward capitalism and private businesses were "antagonistic and unhelpful," as state-owned banks limited borrowing to "national superstars," such as high-tech manufacturers or niche companies that helped satisfy central planning goals. But once capital markets became more liberalized, and the economy started to expand, India's position as an outsourcing leader took hold, with governance best practices lagging the economic explosion, adds James.

The fraud was astonishing when it came to light. Last week, Satyam, Indian's fourth largest computer software services outsourcer, revealed that its former chairman, CEO and founder, B. Ramalinga Raju, wrote a four-page letter to the Bombay Stock Exchange, confessing that he orchestrated a massive accounting scam and kept it alive for at least five years. In the letter, Raju admitted that he created at least $1 billion in fraudulent cash entries on the company's books that went undetected for years. Raju, his brother B. Rama Raju, and company CFO Srinivas Vadlamani were arrested.

Then this week, Indian press reports said that in a statement to the courts, Vadlamani claimed he was not involved in improper bookkeeping, but was aware of suspicious behavior at the company for more than five years.

Many experts cast partial blame for the scandal on Satyam's auditor Price Waterhouse India, because the fraud went undetected for so many years. Price Waterhouse India is a member company of the larger PricewaterhouseCoopers International network, but is legally separated from the larger organization. That legal "firewall" allows Big Four audit firms to have their cake and eat it too, says H. David Sherman, a former SEC academic fellow and current professor of accounting at Northeastern University.

Big four annual reports talk about one quality standard for the entire world network of offices, but that takes coordinated global training and quality assurance efforts. If the firms truly do create global training and coordinated quality standards, it could open up debate regarding the amount of liability protection that is or should be provided by the legal separation of offices in each country.

For its part, the Bangalore-based Price Waterhouse said it is working with Indian regulators and law enforcement agencies to sort out the accounting scam. It added that its auditors followed proper procedures and backed up their work with appropriate audit evidence. However, Price Waterhouse warned the Satyam board that the audits in question could no longer be relied upon. The audits span the period from the quarter ended June 2000 through the quarter ended Sept. 30, 2008, said Price Waterhouse.

So far, no legal action has been taken against Price Waterhouse. There's only been speculation about a lawsuit against the Indian auditor, probably sparked by the recent lawsuit filed against BDO Seidman in connection with the alleged $50 billion Ponzi scheme run by Bernard Madoff. Seidman was not the auditor for Bernard L. Madoff Investment Securities (the private accounting firm Friehling & Horowitz is the Madoff auditor). But BDO Seidman was the auditor for Ascot Partners, which invested heavily with Madoff's firm.

Despite the absence of a lawsuit, the audit firm is still left with a huge black eye. To be sure, the scandal does not seem to be a convoluted, off-balance-sheet, Enron-like scheme, but rather a straightforward overstatement of cash. That would sting the reputation of any accounting firm, considering that the first assignment any new auditor gets is to audit the client's cash accountants.

The basics of such an audit are also straightforward, although it can be incredibly time consuming for an operation as large as Satyam. In general, bank statements are collected from the client and the client's bank and matched up with entries, and cash accounts are rebalanced with respect to outstanding receivables.

To be fair, there were probably thousands of Satyam cash accounts that had to be confirmed by the auditor, as the outsourcer has nearly 700 customers — including 185 Fortune 500 companies — in 65 countries. The audits for a company of that size would have been staggered, with millions of dollars of outstanding receivables pouring in to different locations at any given time. So if the Raju brothers knew their auditor's routine, it would have been relatively easy to create phony entries throughout the system.

• 1
• 2
• next »

LinkedIn Company Connections:

• Satyam Computer Services |
• Price Waterhouse India |
• PricewaterhouseCoopers