Hyderabad/Bangalore: In a startling confession that shocked his peers and sent the stock market tumbling, Satyam Computer Services Ltd chairman Byrraju Ramalinga Raju confessed to cooking the company’s books over several years to the extent that Rs5,040 crore of cash on the company’s balance sheet doesn’t exist.

The move, the letter says, was the last-ditch attempt to get some real assets into Satyam’s books in place of virtual money.

Later in the day, Raju’s brother and the company’s managing director B. Rama Raju also resigned.

The confession and the magnitude of the accounting irregularities point to serious lapses in corporate governance and raise questions about the role of Satyam’s external auditor Price Waterhouse and of the board and especially the independent directors of the company, many of whom have resigned in the past weeks.

C.B. Bhave, the head of India’s stock market regulator Securities and Exchange Board of India, or Sebi, and Prem Chand Gupta, the minister for corporate affairs, both said separately that they would launch an investigation into the matter and take “co-ordinated action".

Since Satyam is listed on the New York Stock Exchange, the US Securities and Exchange Commission, too, could take action against the company. The US listing also makes Satyam and its directors vulnerable to lawsuits in that country. It also means that Satyam’s CEO and CFO (Srinivas Vadlamani) signed off on the accounts in keeping with the US Sarbanes-Oxley Act. The violation of this is punishable by fines and imprisonment for up to 20 years.

Analysts were unclear on the future of the company, although some said it could be taken over by a rival or a private equity firm—either as a whole or in parts.

Even as the firm’s interim chief executive Ram Mynampati sent out a mail reassuring employees, research firm Forrester said up to 50% of Satyam’s clients could chose to take their business elsewhere, a move that will likely benefit Satyam’s rivals such as Infosys Technologies Ltd, Wipro Ltd and Tata Consultancy Services Ltd.

And recriminations were quick to flow. Speaking on television channel CNBC TV18, Mahindra and Mahindra Ltd’s vice-chairman Anand Mahindra said the Satyam incident had damaged India’s image globally. Brokerages downgraded the stock and one of them, Credit Suisse Group AG, suspended its coverage of the stock. The National Stock Exchange, or NSE, dropped Satyam from its benchmark Nifty Index and the Bombay Stock Exchange, or BSE, is expected to follow suit by dropping the stock from its Sensex index.

India’s Enron

In a scam that analysts and journalists have been quick to dub “India’s Enron", Satyam’s main promoter and chairman Raju admitted to fudging the company’s account books to the tune of at least Rs7,136 crore, over a period of “several years".

Raju’s letter reveals that the gap between real numbers and imagined ones on the company’s books finally forced him to propose the controversial $1.6 billion plan to acquire infrastructure firms Maytas Properties and Maytas Infrastructure, promoted by his sons, to “fill the fictitious assets with real ones".

In the letter, copies of which were also sent to the stock exchanges and Sebi, Raju confessed that, as on 30 September, Satyam’s books were fudged to show bank balance of Rs5,040 crore, accrued interest of Rs376 crore, an understated liability of Rs1,230 crore, and an overstated debtors position of Rs490 crore.

While the exact reason for the timing of Raju’s confessional statement isn’t known, it may have have been prompted by DSP Merrill Lynch, which found “material accounting irregularities" in Satyam’s account books.

Merrill Lynch was hired on 6 January as an adviser for finding strategic options to enhance shareholder value of the company in the wake of the aborted $1.6 billion acquisition plan, which attracted the ire of investors and led to steeply lower valuation of the company’s shares on the stock markets.

Merril Lynch president Kevin Watts informed Sebi, BSE and NSE on Wednesday of the accounting irregularities and his firm’s decision to pull out of the advisory engagement with Satyam.

Shares of the company closed 77.9% down on the BSE, while in pre-market trading on the New York Stock Exchange, the company’s shares were down by 84%.

For the September 2008 quarter alone, Satyam reported an inflated operating profit of Rs649 crore against an actual operating profit of only Rs61 crore.

Raju’s resignation letter confirmed that the fraud has been going on for “several years".

“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 the company operations grew significantly," Raju said. “Every attempt made to eliminate the gap failed."

Ending the mystery over why the company’s promoters had to pledge their shares, Raju wrote in his resignation letter that in the past two years, “Rs1,230 crore was arranged to Satyam (not reflected in the books of Satyam) to keep the operations going..."

“As the promoters held a small percentage of equity, the concern was that poor performance would result in a take-over, thereby exposing the gap," Raju said.

“Stern action"

Although Raju’s letter sought to absolve Satyam’s employees and other board members of the blame, the ministry for corporate affairs said the matter would be referred to Serious Fraud Investigation Office.

“Stern action under the law would be taken against the guilty after verifying the facts," minister Gupta said.

While declining to comment on what action will be taken, spokesperson for the New York Stock Exchange, Christiaan Brakman said that they were “closely monitoring the situation, including the latest developments".

Satyam spokesperson said that “its immediate priorities are to protect the interests of its shareholders, protect the careers and security of its approximately 53,000 associates, and meet all its commitments to its customers and suppliers".

Following the revelations the spotlight is now sharply focused on the auditors for the company, Price Waterhouse as well as Satyam CFO Vadlamani.

“It is a monumental fraud. How can Rs7,000 crore be hidden in the books without the knowledge of CFO and statutory auditors?" asked Omkar Goswami, an independent director on Infosys’ board and chairman of that company’s audit committee.

“We have learnt of the disclosure made by the chairman of Satyam Computer Services and are currently examining the contents of the statement. We are not commenting further on this subject due to issues of client confidentiality," a PricewaterhouseCoopers spokesperson said.

Price Waterhouse is one of the audit arms of audit and consulting firm PricewaterhouseCoopers.

However, Ved Jain, the president of the statutory body that regulates the profession of chartered accountants in India, the Institute of Chartered Accountants of India, said the audit firm will be banned from practising in India if it was found to be involved in this fraud.

Shock and disbelief

National Association of Software and Services Companies, or Nasscom, the industry grouping of the software sector, expressed its shock at the disclosures made by Raju.

“While the law will take its course, this incident is particularly unfortunate as the Indian IT-BPO (information technology and business process outsourcing sector) industry had set very high standards of ethics and corporate governance," Nasscom said in a statement released on Wednesday hours after Raju’s resignation news hit the street. “This is a stand-alone case of failure of corporate governance and it is critical that it be viewed in this light."

“What is happened is very sad, shocking, and truly unbelievable. I will hope the authorities in India (act) pretty quickly, investigate it, and then punish the guilty," chairman of Infosys N.R. Narayana Murthy said.

“If the Securities Exchange Commission acts quickly and our authorities don’t, it won’t look good on India. So, it is extremely important that authorities investigate and take appropriate action before the US SEC. India would score few brownie points in the eyes of FIIs."

Suresh Senapathy, executive director and chief financial officer of Wipro, sought to emphasize that the Satyam development was an isolated incident.

“Wipro strongly condemns any attempt to mislead stakeholders. Global standards of corporate transparency are very high and we are confident that this is an isolated case and not representative of the IT industry. We think a detailed investigation of this incident is urgently called for and needs to be undertaken by the authorities without delay."

Industry lobby group Confederation of Indian Industry (CII) said in a statement on Wednesday that Satyam development underscores the “need to immediately examine the loopholes in regulation, accounting, audit and governance that allowed such lapses to occur and address them with urgency."

CII maintained that “it would be inappropriate for this to be the basis of questioning of general governance standards in other companies."

Sector-wide pain

Still, some experts and analysts said the Satyam incident would hurt other Indian companies, especially those in the software and back office services space.

“If a company’s chairman himself says they built fictitious assets, who do you believe here? Not only Satyam, this has put a question mark on the entire corporate governance system in India," said R.K. Gupta, managing director of the New Delhi-based Taurus Asset Management.

Avinash Vashista, chief executive of Tholons Inc., an offshore advisory firm, said that he was surprised by the extent of revelations.

“The extend of fraud...will have a big impact on the IT Indian industry," he said. “The only way to manage this thing is for Sebi, Nasscom, investors of Satyam and work together to merge it with a large IT firm; that needs to happen."

Satyam employees Mint spoke to said they were “completely shocked" and “felt insecure" abut their jobs. “We have received communication from the new chief executive, asking for our commitment to reach out to customers and regain their confidence and trust in the company," said an employee who asked not to be named.

“We are hoping that a new management will be able to revive the company," another employee said.


Graphics by Ahmed Raza Khan / Mint