Satyam Scandal: India’s Enron

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ABSTRACT

From Enron scandal to Satyam scandal, many ‘false creative accounting practices’ have been created. Corporate frauds are now becoming a center of attention like Tyco, Worldcom, Freedie Mac. According to researchers, these frauds are hindering public confidence by producing fake reports. This report analyzes the India’s major corporate fraud-‘Satyam Scandal’ and what auditing issues arose in that scandal. The Satyam Scandal bought light to the code of ethics when its CEO falsified the accounts and auditors chose to remain silent by monetary measure. The accounting fraud committed by the founders of Satyam in 2009 is a testament to the fact that “the science of conduct is swayed in large by human greed, ambition, and hunger for power, money, fame and glory.” Satyam fraud enabled the government to produce new regulations for public listed companies and imposing heavy penalties on audit firm for any misconduct as auditors are the ones who give public the true picture of the company. This report also examines how these auditing scandals are relevant to Australian auditors and what are the ways to avoid these frauds.

INTRODUCTION

Fraud involves a wide range of illegal practices and misrepresentations which affects the society as a whole. According to the Association of Certified Fraud Examiners (ACFE), 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”.

Fraudulent financial reporting is the misstatements of the financial reports involving alteration and alteration of accounting record, suppression of transactions, not reporting required disclosures and breaching accounting policies. Misstatements is a concern for investors and other stakeholders which ensue serious consequences to the organizations especially in capital markets leading to failure of public confidence. Corporate frauds are now becoming common and apart from the monetary losses, there are losses like goodwill and reputation. “With increasing trend in financial crimes across the globe, investors have lost their confidence, the creditability of financial disclosure is questioned and companies are also facing huge financial loss” (Reunirk, 2016).

Satyam Computer Services Ltd was formed in 1987 by Mr. Ramalinga Raju. The firm advanced promptly as a global business in the Indian IT industry, thus, becoming a ‘rising star’. It was once called the ‘crown jewel’ and the 4th largest company with high-profile customers winning the ‘Golden Peacock Award’ in 2007. But soon it was convicted for the massive accounting fraud which involved fudging the revenue, profits, inflated cash and bank balances and falsifying accounts for more than 5 years. The scandal has been named as “India’s Enron”.

SATYAM SCANDAL

The loss started on January 7, 2009 when Ramalinga Raju wrote a letter resigning and accepting the fraudulent financial reporting to Securities and Exchange Board of India (SEBI) and its board of directors. Number of bank accounts have been created by Mr. Raju which took fraud on the next level. It also involved falsifying the accounts which created balance which did not exist. Generating fake customer identities, making fake employee accounts and producing fake invoices just to show big amount of revenue and boosting up the company’s profile.

He accepted in his letter, “It was like riding a tiger, without knowing how to get off without being eaten”. Mr Raju has breached his duty of care and duty of negligence towards its shareholders. Along with him, many other auditors and directors have been convicted of criminal conspiracy, breach of trust and forgery. Right after that, government quickly appointed new 6 board of directors to bring the firm back in its place.

PriceWaterHouseCoopers (PwC), one of the best auditing firms, was the auditor of Satyam Computers and they failed to detect this fraud. Under the Indian Law, the PwC was responsible for the misstatements and the false representations. They failed to identify the red-flags which were accrued interest, drastic sales growth and the most important was the non-interest-bearing deposits. According to accounting professionals, “any reasonable company would 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. Furthermore, it appears that the auditors did not independently verify with the banks in which Satyam claimed to have deposits”. Compared to other auditing firms, PwC was being paid double for auditing fees. When investment bank Merrill Lynch was appointed, within 10 days they discovered the fraud under its due diligence. PwC auditors were required to act independently on the audits and verify with the banks for fixed deposits which they did not do.

AUDITING ISSUES

According to AASB 101 Presentation of Financial Statements, financial reports should provide true and fair view of balance sheet and income statement at the end of every fiscal year. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. The application of Australian Accounting Standards, with additional disclosure when necessary, is presumed to result in a financial report that achieves a fair presentation (AASB 101).

The auditing issues found in Satyam Scandal are as follows:

Ethics – Ethics are the principles and expectations which govern the behavior of auditors. According to ASA 200, the auditors are required to meet the ethical standards which comprises of:

Integrity- Auditors should be honest and perform their work with diligence and responsibility. Also, they are obliged to make appropriate disclosures.
Objectivity – Auditors should not indulge in any unbiased assessment and is obliged to disclose all material facts.
Confidentiality – In course of their duties, auditors are enforced are protect the client’s information and must not disclose it.
Professional competence and due care – They should continuously apply their knowledge, skills and experiences to perform the audit
Professional behavior – Auditors should adhere to relevant law and regulations.

The SFIO report stated that the auditors in PwC compromised with the auditing standards by using the firm’s investigative tool instead of independent testing mechanism. PwC chose to remain silent even after discovering the fraud and certified the company. PwC auditors failed to do their duties, neither they did match any invoices or debtors nor they independently verified the cash and bank accounts, which stated that the internal system was not in place. The statutory auditors did not check the assets physically nor the fixed deposits which were non-existent amounted to Rs. 5040 Crores. SFIO findings also indicates that company did not make true disclosures to the stock exchanges and public which lead to the loss of public confidence. EPS being the major factor riding the share prices was also false i.e actual was 1.93 per share but they reported 9.77 per share.

Role of Audit committee – The audit committee is set up by board of directors as a sub-committee which focuses on problems related to financial reporting and promoting audit quality. ASX Listing Rule 12.7 stated that all entities listed under S&P 500 must have an audit committee. The objectives of audit committee are :

Reporting financial information to financial report users and providing true and fair view
Complying with accounting policies, laws and regulation
Risk management system
Maintenance of independence of external auditor

Under Satyam Scandal, the audit committee failed to comply with the rules and regulation and adherence to its objectives. As per the SFIO findings, when one of the senior executive of the company discovered this fraud and e-mailed it to the independent directors of the company who then forwarded it to the chairman of audit committee. This acted as an whistle blower and could help in saving the company but instead they chose to remain silent. No one reported it to higher authorities and regulatory authorities.

Abnormal audit fees – Section 331 states that the company is obliged to pay auditor’s fees and expenses. The auditing fee is set by the company’s independent director and the audit committee and they need to ensure that it meets the requirements so that the audit quality is not negotiated. Also, taking into account the economic conditions.

PwC, who was the auditor of Satyam computers received an annual fee which is twice of other firms like Infosys. Over the period of 4 years, 2004-2008 the increase in Satyam’s income was only 2.7 times whereas the PwC received auditing fees of 5.7 times which increased year after year. To hide the cooked and fabricated financial statements, Satyam used the monetary incentive for auditors and auditors did not act independently, hence dismissing from their duties.

IMPORTANCE OF SCANDALS TO AUSTRALIAN AUDITORS

As audit has been a statutory requirement and after looking at the scandals happening, the main role of audit is being compromised. Enron, America’s fifth largest company, got bankrupt and caused dissolution of Arthur Anderson, one of the biggest auditing firms. They started relying on false accounting practices, the operations of the companies were transferred to SPEs. On 2nd December 2001, the Enron became bankrupt which gave rise to new rules and regulations for financial reporting. The main problem was the failure of board members to follow the regulation and auditors can improve this by focusing on areas:

Leadership – Chairman of audit committee should be leader having proper experience so that they can take proper decisions.
Independence – The audit committee and auditor should be independent and need to follow the ethical and objective approach to audit process.
Rotation of auditors – Auditors should be rotated every few years to prevent collusion with the client and improve auditor independence.
Professionalism – Every few years, audit review should be done by some other audit firm so that audits are done with independence and professionalism.
The audit committee should ensure that information disclosed is appropriate and meeting the accounting standards with required disclosures.
Audit fees – After these scandals, on the basis of insurance hypothesis, auditors increased their fees depending on risk the client has.
Audit firm need to focus on audit instead giving them their clients advisory services as this increase’s independence and creditability.
Audit report – the most important responsibility of auditor is to provide audit report to every member at AGM. The report should provide a true and fair view of the financial reports. If the company is not keeping books in order, they need to notify the company.
All inaccuracies should be investigated be it small or big.

Auditor’s responsibility is to give opinion on the reports to forming the reports. They are entitled to collect proper evidence that the report is free from any material misstatement and gives faithful representation to obtain reasonable assurance. If the regulations and legislation are strict enough and auditors adhere to their duties then their will not be any scandals like this anymore.

CONCLUSION

After Raju confessed of the fraud, the only question arises is “how did this continue for 5 years?” The Satyam Scandal is perfect example of fraudulent reporting where auditors chose to remain silent as well. After the Enron’s case, Sarbanes-Oxley Act,2002 came into action who objective is to protect public confidence by preventing frauds. Such kind of acts are required to keep organization under control and prevent any fraudulent activities. The actions which can be taken to strengthen the regulations are:

Rotation of auditors
Code of ethics for all listed companies
Auditor and audit committee should be acting independent
Formation of new audit standards
Criminal and civil charges should be strict
Whistleblower system is must
Corporate social responsibility should be mandatory
Conducting risk assessment before taking new client

We can say that auditors are the gatekeepers of the company who provide public with the true and fair representation of the financial statements, hence, keeping the public confidence as they do have a duty of care towards the clients and the public. But we have seen in the above cases, some audit firms and audit do collude with their clients resulting in fraud. To ensure greater accountability and less chances of collusion, shareholders can assist the work of auditors. So, Satyam Scandal tells us the importance of ethics, fraudulent reporting and how it is relevant to public and auditors. Therefore, auditors should their responsibilities by adhering to their role, finding out material misstatements, fraud etc.

REFERNCES

https://en.wikipedia.org/wiki/Satyam_scandal
https://pcaobus.org/Standards/Auditing/Pages/AS2401.aspx
https://www.academia.edu/29708409/Fraudulent_Reporting_Practices_The_Inside_Story_of_Indias_Enron?email_work_card=view-paper
http://www.iodonline.com/Articles/Inst%20of%20Directors-WCFCG%20Global%20Covention-Paper%20Prof%20J%20P%20Sharma-What%20Went%20Wrong%20With%20Satyam.pdf
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https://journals.sagepub.com/doi/pdf/10.1177/0256090920090106
https://www.outlookindia.com/newswire/story/sfio-submits-satyam-fraud-report/658186

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