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Calamitous confessions

Joe Leahy | January 14, 2009

In the hamlet of Garagaparru, about eight hours' drive towards the Bay of Bengal from the southern Indian city of Hyderabad, a farmer washes his water buffaloes in a muddy canal near a bridge. One of the villagers, Krishnan Raju, points from the bridge to where he and schoolmate B Ramalinga Raju swam as children.

"Ramalinga's father used to tell him not to jump into the canal from the bridge but to take the safe route and enter the water from the channel's banks," says the man who, like the information technology tycoon, bears the name of the local landowning caste.

With that letter, he exploded the myth of good governance in his own company and undermined the credibility of the wider Indian corporate sector - in particular the outsourcing industry that is one of the country's biggest export earners. India's cosy corporate culture, a world in which large families control the biggest companies and hobnob with politicians while regulators keep themselves busy elsewhere, was suddenly laid bare.

More than that, by claiming to have cheated in full view of PwC, Satyam's international auditor, as well as the company's banks and stock market authorities in India, the US and the Netherlands where Satyam is listed, he has raised the spectre of mass failure in the regulation of multinational companies. The scale and audacity of the scam has so threatened the standing of Indian business that Manmohan Singh, prime minister, personally intervened to get the company's board replaced, in order to try to stem the fallout.

"It will dent the image of the country if you can't trust the financials of a company that is listed on multiple exchanges," says Sandeep Parekh of the Indian Institute of Management and a former executive director of the Securities and Exchange Board of India, the market regulator. "It is a systemic danger."

This close relationship between politicians and businessmen is mirrored across India at state level and in New Delhi. The powerful can come from vastly different backgrounds - many politicians have working-class roots, while some tycoons are first-generation entrepreneurs. But they cement relationships at social occasions such as during the Hindu Diwali festival or wedding parties.

Although Mr Raju was hailed as an IT mogul, true to their ancestral origins the passion of the Raju family was always land. The Garagaparru villagers say Byrraju Satyanarayana Raju, his grape-farmer father, used his 100 acres as collateral to provide for the children's education and to help start their business ventures. After finishing his schooling in the village, where he studied by "kerosene lamp", Mr Raju gained an MBA from Ohio University in the US and in the 1980s set up Satyam, which means "truth" in Hindi.

His first big break came in 1991 when he signed up Deere, the tractor maker, to use the company's services. He listed Satyam the same year on the Bombay Stock Exchange and by 2000 boasted 10,000 employees. Six years later, annual revenue crossed the $1bn mark and last year, Satyam claimed to have $2bn revenue and nearly 53,000 staff.

Those who dealt with Mr Raju say he was as unlikely a hero as he was a villain. Soft-spoken, earnest, always neatly dressed in a suit, he was quiet to the point of being dull. He put money into corporate social responsibility, founding an ambulance service for which he drafted A.P.J. Kalam, India's revered former president, as chairman emeritus. The Satyam chairman also set up call centres in villages to boost local economies and loaded his board with prestigious independent directors.

Some say there were early signs that Mr Raju was crooked. Satyam paid a wildly overpriced valuation for a website in 2000 and undertook a merger the following year that critics said inordinately benefited the Raju family. An interview with the Financial Times in 2000 gave a hint of his way of thinking. A fan of Albert Einstein, Mr Raju said: "The theory of relativity teaches you so much about decision-making: about not choosing between black and white, but shades of grey."

But no one could have predicted what was to come. Last month, Mr Raju announced that Satyam would pay $1.6bn for Maytas Infra and Maytas Properties, two companies controlled by his family. The Maytas deal was perhaps meant to cover up the problems at Satyam. But it had to be abandoned after a rebellion by shareholders.

Unbeknown to investors, Mr Raju had pledged his family's stake in Satyam, of about 8 per cent, to lenders. After the company's share price collapsed last year in line with the Indian market, these lenders began selling his stake to recover their money.

Faced with the loss of control of his company, Mr Raju was forced to own up. He confessed he had manipulated the accounts to cover up a poor quarter, not to steal money. But the fraud had got out of control over the years. It had become like "riding a tiger" - impossible to get off without being eaten.

The task facing investigators now is to determine whether the letter is true. The answer is critical to establishing how deep the rot in the system is. If Mr Raju had been fiddling the accounts for seven years, including inventing cash deposits as he claims, how is it possible that Satyam's banks, which include HSBC and Citigroup, would not have noticed? How could PwC's internal checks not have picked up such a big fraud over such a long period?

"If you go down a certain route, it doesn't bear thinking about," says Hugh Young, managing director of Aberdeen Asset Management Asia, who has tracked Satyam since it was set up. "If you're suddenly saying all annual reports and audits are not worth the paper they're written on, there's no way can we do our job."

Another theory is that Mr Raju stole the cash only last year, after his family land deals ran into trouble when real estate prices crashed and invented the account set out in the letter to make his crime look less serious.

E.A.S. Sarma, a former senior civil servant in Andhra Pradesh, has long been critical of what he alleges is too close a relationship between the state government and Satyam, Maytas and other companies. Maytas Infra and Maytas Properties have a number of government-awarded flagship projects, including the proposed Hyderabad metro, a port and a power plant.

"There is crony capitalism in India, where the government gives cheap land to its business associates," says Mr Sarma, who is calling for a review of all land deals in the state. Maytas describes such allegations as "false and baseless" and says it is co-operating with a government review of its projects following the Satyam scandal.

Of wider concern is how many more Satyams India may yet see. The country's "promoter system" of ownership, under which many companies are controlled by a powerful family, makes it difficult for the normal mechanisms of corporate governance to function. Few independent directors have the courage to stand up to the country's corporate titans. Most of them are carefully chosen friends or associates anyway.

Authorities are also not geared to deal with white-collar crime. When Mr Raju confessed, it took two days for the regulator to get a team to Hyderabad. He surrendered to police on Friday, three days after the letter was sent.

Loopholes in accounting standards and lax enforcement are another part of the problem. Companies get away with filing incomplete and late balance sheets. The books of subsidiaries are often not provided on a quarterly basis, while off-balance sheet debt disclosures are weak. Nilesh Jasani from Credit Suisse in Mumbai says the government needs urgently to tighten regulations, forcing promoters to reveal the losses in many parts of their group structure.

With the end of India's fiscal year in March, further shocks seem inevitable as promoters who borrowed heavily during the boom times reveal their losses and auditors grow less willing to sign off on fuzzy accounts. "These losses cannot remain hidden forever," says Mr Jasani.

As for Mr Raju, he is in police custody along with his brother Rama Raju and Srinivas Vadlamani, chief financial officer, while the authorities comb through Satyam's books. But in his home village he remains a favourite son - one who may have stolen from strangers but who looked after his own people.

"He's guilty for taking money and that's bad," says Yaswanth Varma, an IT student playing cricket at a field provided by the Raju family. "However, he remains an inspiration for us. I still want to work for Satyam one day and become as successful as Raju."

Asian markets: Governance concerns extend a regional retreat

The Satyam revelations cap a torrid few weeks for minority investors in listed companies across Asia, writes Sundeep Tucker.

Regional markets had until last year benefited from strong portfolio inflows as institutional investors sought exposure to some of the world's fastest-growing companies. But the global financial crisis sparked a capital flight - and investor groups warn that a succession of corporate governance-related problems will make it harder for many markets to recover.

In October, Citic Pacific revealed more than $2bn in potential losses on foreign exchange contracts. The Hong Kong-listed conglomerate waited weeks to announce the gap in its accounts, prompting a probe by the local securities regulator. The investigation is ongoing.

A month later shares in Gome, the Chinese electrical retailer, were suspended after it emerged that Huang Guangyu, its major shareholder and one of China's richest people, had been arrested by mainland police in connection with the suspected share price manipulation of two small companies. His whereabouts remain unknown, sending the share price tumbling and casting a shadow over the company's very existence.

In Indonesia, shares in Bumi Resources - a former favourite of foreign investors - are being shunned after the miner in recent days made several opaque acquisitions that appeared linked to its dominant shareholder, the powerful Bakrie family. David Webb, a Hong Kong-based investor activist, says: "These headline cases serve as a reminder of the risks investors face in the region, even in jurisdictions such as Hong Kong."

Governance campaigners say the majority of Asian markets need to improve corporate disclosure requirements relating to price-sensitive information and strengthen shareholder rights so that they can, for instance, call extraordinary meetings.

The ability of shareholders to vote at annual meetings in Asia is also limited, with widespread difficulty reported in voting by proxy. Indian management rarely allows a show of hands at company meetings, common in countries such as the UK.

Above all, says Jamie Allen, secretary-general of the Asian Corporate Governance Association, investors are most concerned about the integrity and quality of the audit.

The rapid pace of growth of the largest Indian and Chinese companies alone has placed enormous strain on the ability of Big Four accounting firms to ensure an even quality across audits. "The accounting firms are running fast to try and keep up but even they admit that there is a limit to the depth of their expertise," says Mr Allen.

Ultimately, unless issuers with perceived corporate governance failures remedy the situation, they can look forward to being shunned by all but the riskiest investors. "These companies will have to accept lower share prices because of the corporate governance discount," says Mr Webb.


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