Tax Law

The Satyam - PwC Scandal: The Bleak Road Ahead

Amidst the gloomy world economy and daily news of the global crisis, business closures and rising unemployment, the last thing one needed to hear was a financial fraud of mammoth proportions as the one exposed at Satyam Computer Services Limited, the fourth largest software company in India, ranked after Tata Consultancy Services, Infosys Technologies and Wipro. The fraud, amounting to $1.4 billion has sent shockwaves throughout the IT industry and is expected to create a ripple effect involving related parties, the extent of which cannot be estimated at this stage. Apart from the top brass at Satyam, who have been arrested and are in judicial custody after having confessed to the crime, the company’s statutory auditor, PwC India, has come under a microscopic lens and is certainly going to face harsh consequences for falsification of accounts and auditing of inflated cash reserves in the company. 

The world was in disbelief when news broke out on 7th January of the confession of the then Chairman of Satyam, Ramalinga Raju. In his confession, Raju had admitted that for the last seven years he had fabricated cash reserves and assets in the company amounting to about $1.4 billion, which saw the value of shares plummet to record lows resulting in elimination of about $2.2 billion of investor wealth. The motive expressed by him was “to show more income in the account to avoid others from involving in the company affairs and any other possible hostile takeover situation resulting in manipulations of balance sheets to attract more business and show unavailable amount as available cash in hand.”

Satyam was founded in 1987 by Ramalinga Raju. It earned a reputation by helping companies troubleshoot the famous Year 2000 (Y2K) computer virus. Following that success, the company expanded its services and earned substantial revenues through providing software support and programmes, some of which provided software solutions to companies to carry out internet based transactions. Gradually, the company’s success story grew rapidly and helped it earn prestigious clients such as General Electric, General Motors, Nestle, Telstra Corp to name a few. A scandal of such scale in a company which was considered the pillar of modern Indian IT industry was unimaginable, and has shaken investor and client confidence across the world. Today, the former chairman, his younger brother and former MD, B. Rama Raju, and the former CFO, Vadlamani Srinivas are languishing in the Central prison in Hyderabad, capital of Andhra Pradesh, awaiting a bail hearing which is slated for January 16.

In this entire saga of fraud, manipulations, confessions and arrest, a vital question that arose was with regard to the credibility of PwC auditors. Certainly, this incident has catapulted scores of angered reactions from shareholders, clients and the public at large against the auditors. The former CFO, Vadlamani Srinivas, in his confessional statement to the police, blamed PwC and B Ramalinga Raju for perpetrating the financial fraud. According to his statement, PwC never pointed out any deficiencies or irregularities in the accounts. One alarming disclosure by him was that the bank fixed deposits were fictitious and were manipulated by the management and the audit department. This naturally leads to a conclusion of a possibility of forgery in bank documents to reflect fictitious deposits, which also exposes the bankers of the company to questions on their involvement in the scam. The company’s main bankers are ICICI Bank, Bank of Baroda, BNP Paribas, Citibank, HDFC Bank and HSBC who will probably be next in line to investigations on their role.

As part of the audit process, PwC is cast with a responsibility to demand certificates from banks regarding cash balances of the company’s accounts. It will surely be investigated whether the banks did in reality certify the cash balances or whether forged documents and certificates were provided to PwC. This being the initial stage of the expose, it is premature to say which direction the investigations will take. But it seems to be a consolidated view that PwC could not have bypassed such a serious fraud without any wilful involvement. The accounting firm is already finding itself in the midst of an angry storm of attacks, investigations, lawsuits, claims and client withdrawals. Certain investors, who have lost millions in this scam, have already initiated lawsuits against it. The Institute of Chartered Accountants of India (ICAI), which is a statutory body established for the regulation of the profession of Chartered Accountants in India, will serve a show cause notice on PwC after collecting all necessary information from SEBI (Securities and Exchange Board of India) and ROC (Registrar of Companies). Action against the accountants who are involved in the scam and found guilty can result even in life long suspension of their practising certificates.

In the aftermath of this sordid expose, many listed companies who share a common factor with the defamed Satyam, its PwC auditors are finding themselves in a drastic situation of falling stock prices. Investors, having lost trust in companies having PwC as their auditors, are indulging in heavy sell out in anticipation of a further drop in share prices. The markets are witnessing investors selling off companies whose auditors are PwC -- and buying other companies in the same sectors, whose auditors are not PwC. This is a huge blotch on the reputation of the accounting major, which is being compared with the infamous Arthur Andersen, embroiled in the Enron controversy. The fall can be attributed only to PwC’s involvement, as the other companies in the same sector are faring well who do not have PwC as their auditors. Stock brokers are believed to be advising strongly to clients to sell off shares in companies having the firm as their auditors. Industry experts hold a view that this outcome is only expected and justified.  Certifying the existence of $1.4 billion in the books of Satyam is bound to cost investor confidence. In this entire episode, PwC has chosen to remain silent and has not commented. However, the role played by PwC in this story is crucial and it will be the subject matter of investigations in due course in order to get to the root of the matter.

One such issue that may be raised is the quantum of fees earned by PwC from Satyam as compared to the fees paid by its industry peers. Between 2003 and 2008, the audit fee earned by PwC from Satyam increased over 300 percent. Other companies in the information technology (IT) sector have not increased their payments to their auditors, to that extent. PwC earned an audit fee of Rs 4.3 crore (about $878,000 USD) for the financial year 2007-08, which is twice the amount spent by other IT companies in the same league towards audit fees. Even Tata Consultancy Services (TCS), the largest Indian IT company, had spent only Rs 2.77 crores (about $566,000 USD) as auditor remuneration in the year. This aspect will surely be the highlight of investigations. As far as PwC’s role in Satyam is concerned, the newly constituted three member board has announced that PwC is longer their auditor, and they are considering proposals from two accounting firms to have been finalised on January 14.

Kiran Karnik, former President of Nasscomm and one of the three members of the newly constituted board of the company held a view that the scam will not affect the Indian software industry. Commenting on the high standards of transparency and governance of the Indian IT industry, he expressed his faith in the industry and negated the apprehension of negative impact of this one as an unfortunate case on the entire IT industry. However, the Indian Prime Minister, concerned over the intensity of the financial fraud in Satyam and the possible harm to the image of the Indain IT industry in the world, is taking it seriously and taking stock of the situation. The Indian Prime Minister is meeting with senior SEBI officials and officials in the Finance Ministry to discuss and determine further steps to be taken in this regard.

In the meanwhile, Andhra Pradesh police have begun scrutiny of the records seized during the searches at the Satyam office premises and residences of the former Chariman, MD and CFO. A joint search operation was carried out by the AP CID, officials of SEBI, Serious Fraud Investigation Office (SFIO) and Registrar of Companies.

On January 13, Indian police also carried out a search in the office premises of PwC Hyderabad. In the wake of this controversy, the auditing firm issued a statement that theyhad worked "in accordance with applicable auditing standards and were supported by appropriate audit evidence." In the statement, they have also assured PwC will fully meet its obligations to cooperate with the regulators and others in the whole process of enquiry.

Satyam is being sued by investors in at least three class actions in the United States Federal Court, following the decline in its share prices. In the overall recessionary picture in the U.S. and European Markets, supplemented by the blow of the Satyam scam and the overall weakness in the Indian markets, it is a common sentiment shared by markets that Foreign Institutional Investors may pull out investments from Indian markets and reinvest in other emerging markets. However, the coming days will be significant in determining the fate of both Satyam and PwC, as well as the overall Indian IT sector, as the ramifications could last across continents and for a long period of time.