Transcript of "Satyam Lessons and Corporate Governance Reforms"
Satyam Lessons and Corporate Governance Reforms“The directors (managers) of such companies, however, being managers of other people’s money than their own, itcannot well be expected that they should watch over it with the same anxious vigilance with which the partners in aprivate co-partnery frequently watch over their own… Negligence and profusion, therefore, must always prevail moreor less in the management of the affairs of such a company.” - Adam Smith - An Inquiry into “The Nature andCauses of The Wealth of Nations”, p.31.INTRODUCTIONThe Corporate Governance, has never ever, since the Satyam Episode, become such ahousehold word. A confessional letter of 7th January 2009 from Mr. Ramalinga Raju, founderChairman of Satyam, divulged the accounting scam of the order of US $ 1.6 billion, and shookthe whole country with tremors felt throughout the globe. Mr. Ramalinga Raju can be credited asthe only corporate fraudster to have admitted his misdemeanors – fudging of accounts, inflatedrevenues, non-existing profits, and the fraudulent bank deposits and audaciously sustaining itfor seven long years. The Mr. Ramalinga Raju’s misdeeds, unfortunately had given negativepublicity of India Inc so far a positive story. The fraud has undermined the trust in thegovernment, companies, and markets alike. In India, nobody had ever imagined anything to gowrong at Satyam, one of India’s best known IT companies, which ironically had received theGolden Peacock Award for Corporate Governance in 2008.This episode has led to debates in India, about some of inadequacies in the corporategovernance norms. Questions have been raised about the performance/ effectiveness of boardof directors, roles of auditors, the impact of regulations, disclosures, etc. However, the silverlining to this whole episode was the proactive role played first time ever in India by theshareholder activists in opposing the unanimously approved board’s resolution of December 16,2008, in acquiring a property of companies (Matyas Properties and Maytas Infra) owned by theson of Mr. Ramalinga Raju, which led to revelation of frauds being committed by promoterbehind the scene. If a large company like Satyam could do it for years, what’s the guaranteemore are not doing it? It is therefore, important that the Satyam fraud needs to investigated andsentence the fraudsters swiftly and harshly to increase deterrent aspects’.The frauds of such magnitudes provide a good opportunity for introspection. These times alsoexpose the shortcomings and vulnerabilities of the system. Conflicts always have hiddensolutions. There are lessons to be learnt from Satyam’s nemesis too. It is one such greatopportunity to reassess some of the existing framework on corporate governance, systems forbetter enforcements of regulations; effective roles and duties of directors, executives,regulators; ethics in businesses and empowerment of minority shareholders.OVERVIEW OF INDIAN CORPORATE GOVERNANCEIndia’s corporate governance codes are on par with the best in the world, the importance ofcontinuing to assess it against international best practice, to suit to the Indian ethos & culture
with utmost sincerity and keenness in enforcement has been highlighted by the recent fraud atSatyam.The Indian corporate would appreciate the fact that the corporate governance in India has notbeen forced upon them by the government, but it was a voluntary and path-breaking initiativefrom the Indian industries association - Confederation of Indian Industry (CII). It wasnecessitated, for the fact that India Inc was to move forward and globalize itself towardsinternational standards in terms of disclosure of information by the corporate sector and,through all of this, to develop a high level of public confidence in business and industry in theprocess of building large global conglomerates. CII had vigorously lobbied and pressurized thegovernment of India for its implementation.Corporate governance initiatives in India began in 1998 with the “Desirable Code of CorporateGovernance” – a voluntary code published by the CII, and the first formal regulatory frameworkfor listed companies specifically for corporate governance, established by the SEBI, widelyknown as Clause 49 of the Listing Agreement – Aimed at improving corporate governance in thecountry. The latter was implemented in February 2000, following the recommendations of theKumarmangalam Birla Committee Report.Legal reforms has been ongoing, with SEBI in 2003 revised the Clause 49, as per therecommendations put forward by the committee and public comments received. Subsequently,the SEBI received a number of feedbacks/ representations, which were deliberated once againby the Narayana Murthy Committee and post discussion, SEBI directed further amendment tothe Clause 49 in October, 2004. The amendment to Clause 49 of the Listing Agreement hasbeen the topic of elaborate deliberations and discussions in the Indian corporate scene. Thedifficulties in achieving compliance prompted many apex chambers of commerce to appeal foran extension of the extended deadline of 31 December 2005, without success. The ease withwhich SEBI introduced mandatory corporate governance standards in India is unparallel.The Companies Act, 1956 was undoubtedly a significant landmark in the development ofCompany Law in India. It consisted of 658 sections and fourteen schedules. The Act wasenacted with the object of amending and consolidating the law relating to Companies andcertain other associations. The main object of the Act was to provide protection to investors,creditors and public at large and at the same time leaving management free to utilize itsresources and energies for the optimum output. However, the working of the Companies Actbrought to light several lacunae and defects in its provisions. Therefore, the Act was amendedfrom time to time. But despite extensive changes the principal Act still suffers from certainserious defects. Moreover, after liberalization, the increasing number of options and avenues forinternational business, trade and capital flows had necessitated modernization of the regulatorystructure for the corporate sector in a comprehensive manner.In 2004, the Indian Government took up a comprehensive review of the Companies Act, 1956.The aim was to strengthen compliance norms and to provide a governance structure for unlistedfirms. The new Companies Bill has been based on best international practices and fosters
entrepreneurship. As a result the Union Cabinet on 29th August 2008 gave its approval forintroduction of the Companies Bill, 2008 in the Parliament to replace the Companies Act, 1956,the existing statute for regulation of companies in the country and considered to be in need ofcomprehensive revision in view of the changing economic and commercial environmentnationally as well as internationally. The bill had lapsed with the dissolution of the house inDecember 2008 and it has now been re-introduced on 3rd August, 2009. The Companies Billseeks to enable the corporate sector in India to operate in a regulatory environment of bestinternational practices. The provisions of Companies Bill are broadly considered to be suitablefor addressing various contemporary issues relating to corporate governance, including thoserecently noticed during the investigation into the affairs of erstwhile Satyam.The bill has now been re-christened as Companies Bill 2009, and will be forwarded to aParliamentary Standing Committee for recommendations. With the standing committee set withno time frame for giving its recommendations, the passage of the new law is likely to take over ayear. It is quite sad that the amendment of the Company Act 1956 has been languishing for somany years now. It is earnestly hoped that speedy passage of the Companies Bill will now beensured.LESSONS FROM SATYAM EPISODEThe Satyam board on December 16, 2008, had unanimously approved a proposal to acquire100 percent of closely held Maytas Properties for Rs 6,240 crore ($ 1.3 billion) and 51 percentof Maytas Infra for Rs 1440 crore ($300 million). The latter acquisition was proposed to be donein two stages: first, Satyam would acquire 31 percent from the promoters at Rs 475 a share, andin the second, it would buy another 20 percent from the market through an open offer at Rs 525.The two acquisitions would have totals expenditures of Rs 7680 crore ($1.6 million).The immediate reaction of institutional shareholders and investment analyst, as soon as theinformation become public the next day, was that it was daylight robbery and the promoterswere siphoning money out of Satyam. They further vehemently reacted and said that they wouldto go to any length to prevent this from happening. Mr. Ramalinga Raju was left with no optionto abandon the plan at the first place, but also had to put in his papers, confessing cooking ofthe books for several years, on 7th January 2009, sending shockwave all throughout thecorporate board. However, the silver lining to this whole episode was the ascendancy of theShareholders Activism, one of the first times ever in India. But for the proactive role played bythe shareholders and the institutional investors, the nefarious activities committed clandestinelyby promoters would not have seen the light of the day.In the Indian context, it is well known that the many of the companies are controlled by thefamilies and would like these to be handed over to their sons and daughters. The promotersmay pursue interests that are not necessarily desirable from the point of view of the commercialsuccess of the company. The promoters are all powerful making even the academically wellqualified Independent Directors, as in the case of Satyam having people like; Vinod K Dham,
Mendu Rammohan Rao, Krishna G Palepu, Mangalam Srinivasan…, appear dwarfs and not ofindependence. This has brought to attention once again the role of the independent directors.As a consequence of the fallout, all the independent directors resigned one after another. Theseincluded Mangalam Srinivasan, Vinod K Dham, Krishna G Palepu, T R Prasad, Prof. V S Rajuand M Rammohan Rao.It is one thing to have elaborate codes, but quite another for companies to follow them in letterand spirit. Yet another is the question of enforcement if companies do not adhere to thestandards. Weakness of enforcement in India is a real issue. The unraveling of these events atSatyam has once again put spotlight on some of the corporate governance practices and hasexposed the following weaknesses:1. Lax Regulatory systems2. The imperious and Machiavellians promoters/ CEOs and their unbridled greed3. Connivance and collusion of Auditors and poor auditing practices4. Timid and acquiescent independent directors5. Shareholders activism and Empowerment of minority shareholders6. Empowerment of Whistle blowersWe ought to refrain from taking quick-fix regulatory measures. It would be worthwhile to searchfor holistic solutions to these issues; which are relevant in the Indian context. The choice ofchanges in the regulatory frame work should be compatible with the country’s own values andlegal system. The system adopted should be agile enough to fore warn the early signals of abrewing crisis and take corrective measures. The system should encourage “proactiveness”rather than be a "reactionary", otherwise status will not change. With the present day state of artcomputer technologies, this is not impossible.One must, however, understand that no matter how strong a regulatory system is, it cannotalways prevent frauds. Despite the enormous increase of disclosures and stringent riskmanagement systems in US post the Sarbanes Oxley Act, inability of the system to read theearly sign of impending recent Subprime crisis, Madoffs Ponzi scheme, and willingness to takecorrective action is one such example. Moreover, strong measures often lead to expensiveregulations and defiance. There are limits to legislations as a lot depends on the integrity andethical values of various corporate players such as directors, promoters, executives andshareholders. The key lies in management decisions and its commitment to establish and followrigorous governance systems. The implementation must be in the letter and spirit, and oneshould recognize the responsibility of the company towards its stakeholdersFirst published on the blog on 31st August 2009:http://footprints-carbon.blogspot.in/2009/08/satyam-lessons-and-corporate-governance.html