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Lessons to learn from Satyam

By Vinod Dhall
January 17, 2009 12:35 IST

The unravelling of events at Satyam has, among other things, put the spotlight again on two key elements of a healthy corporate sector -- the framework of corporate governance and the role of company auditors.

The responses from the government and regulators to the malfeasance at the company must therefore encompass a look at these two critical areas as well.

The importance of corporate governance has been increasingly recognised by governments and corporate entities around the world.

At a conceptual level, the idea has expanded and matured considerably. It started out as an effort mainly to address the integrity of company financial statements.

Soon, it widened to include the fiduciary role and responsibilities of the board of directors. The work of bodies like the Organisation for Economic Co-operation and Development further expanded the concept to include the social responsibility of corporate entities.

Organisations such as the Commonwealth Association for Corporate Governance emphasised  the ethical dimension of the concept, highlighting the need for greater transparency and reduction in corruption.

According to the World Bank, the flow of investment capital into countries and companies is linked to their standards of corporate governance.

Former World Bank President James Wolfensohn reportedly remarked, "The proper governance of companies will become as crucial to the world economy as the proper governing of countries."

Sir Adrian Cadbury captured the spirit of corporate governance in a well-formulated definition: "Corporate governance is holding the balance between economic and social goals and between individual and communal goals. The governance structure is there for the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of the individuals, corporations and society."

In India, a number of distinguished committees have reported on the subject, including those headed by Kumar Mangalam Birla, Narayana Murthy, Naresh Chandra and J J Irani. The Department of Company Affairs (as it was then known) introduced measures like: The Audit Committee, Directors' Responsibility Statement, and director disqualification.

In 2003, it also set up the Serious Frauds Investigation Office and undertook the e-governance project, MCA21.

Sebi brought in Clause 49 of the Listing Agreement which stipulated a minimum number of independent directors on the Board and the Audit Committee, certification of the accounts by the CEO/CFO, and disclosures in respect of related-party transactions, accounting treatment, and directors' remuneration.

A slew of governance measures were included in the Companies Amendment Bill, 2003 to focus on the accountability of senior management, enhance almost non-existent penalties, strengthen the institution of independent directors, and reform statutory audit (and separately to reform the disciplinary processes for chartered accountants).

Unfortunately, that Bill fell through, and these reforms remained stillborn.

The Companies Act prescribes the powers and duties of the auditor, including his right to access relevant information and explanations.

He has to certify that the accounts present a true and fair view of the finances. The auditor is appointed by and reports to the shareholders, not to the management. Thus, in the scheme of things, the auditor is a watchdog (but he is not a forensic investigator).

In order to ensure the independence of the audit and prevent conflict of interest, more measures had been contemplated in the aborted Companies Amendment Bill, 2003, e.g., ban on the auditor undertaking certain consultancy assignments (like MIS, internal audit, designing of the accounting system, etc), compulsory rotation of audit partner/team, and that no auditor should depend on one client for more than a quarter of his revenues.

It was also provided that the auditor would be disqualified if he had certain kinds of connections or relationships with the audited company.

The Act requires every large company to have an Audit Committee, two thirds of whose members should be non-executive directors.

The Audit Committee is virtually the last word in financial matters and ordinarily its recommendations are binding on even the Board.

The Audit Committee must have discussions with the finance staff, and internal and external auditors, and is vested with the power to access any relevant information. The Committee chairman is mandated to attend the AGMs.

For listed companies, Clause 49 of the Listing Agreement further fortifies the Audit Committee's independence from management; two-thirds of its members must be Independent Directors, and they should all be financially literate, and at least one member should be a financial expert.

As part of the improvements made around 2003, the ICAI initiated a Peer Review system for auditors. At that time, the ICAI also issued a Guidance Note that advised what steps should be taken to prevent reliance on the audit report if the auditor finds out that the accounts have been compromised -- this has reportedly been done now by Price Waterhouse through its letter to the new Satyam Board.

Companies listed on the New York Stock Exchange (like Satyam) are, in addition, subject to the US rules; thus the US Public Companies Accounting Oversight Board inspects the accounting and audit arrangements of even foreign companies listed in the US. Additionally, large audit firms, including the Big Four (KPMG, E&Y, Price Waterhouse and Deloitte), are reported to have internal disciplines, such as rotation of partners and peer reviews.

This elaborate network of institutional arrangements and checks and balances is meant to guarantee the integrity of the company accounts and safeguard the interests of shareholders and other stakeholders.

These are also meant to instill confidence in the country's corporate sector, where the savings of millions of people are invested. Yet no arrangement is foolproof, and a smart enough crook can find ways to beat even a well-designed system.

It is still not clear how in the Satyam case, certain unscrupulous persons in control of the company, along with their cohorts, could pass muster with the members of the Board and the Audit Committee, and the auditors in respect of the accounts.

The stakes are very high -- for the investors, the corporate sector generally, and for the country at large. As often happens in such cases, there is much speculation, and many reputations are at stake.

It is important that the investigations are thorough, speedy and independent so as to inspire confidence both within and outside the country.

The process must succeed in rapidly identifying, nailing and punishing the real culprits and delivering quick and effective justice.

The same applies to the investigations by the state police. This is the very minimum that the public expects.

I have elsewhere expressed the view that the time has come to have a 'white collar crime law' which will incorporate deterrent penalties, and will integrate in one place the investigation and prosecution of such cases by a unified, empowered enforcement agency. As a systemic improvement, this reform must be revisited urgently.

As stated above, a number of improvements were contemplated in the aborted Companies Amendment Bill 2003. Many of these rightly find place in the new Companies Bill, 2008, though meanwhile much valuable time has been lost, making it easier for Satyams to happen. It is hoped that speedy passage of the Companies Bill will now be ensured.

The author is former secretary, Department of Company Affairs, and Member & Acting Chairman of the Competition Commission of India.

Vinod Dhall
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