Reference no: EM131451421

Question: What should investors with Bernard Madoff have done differently here?

INDIA'S ENRON

In December 2008, one of the largest players in India's outsourcing and information technology sectors, Satyam Computer Services, fell from grace with such force and speed that the reverberations were felt around the globe. Ironically, the name Satyam means "truth" in Sanskrit, but the company, founded by brothers Ramalinga and Ramu Raju, now has a new nickname: India's Enron. Founded in 1987, Satyam was positioned to take full advantage of the capabilities of satellite-based broadband communications, allowing it to serve clients across the globe from its offices in Hyderabad. The rising demand for computer programmers to fi x code in software programs in advance of Y2K (the year 2000 problem) fueled an aggressive growth plan for the company.

It was listed on the Bombay Stock Exchange in 1991, and achieved a listing on the New York Stock Exchange in May 2001. By 2006, Satyam had about 23,000 employees and was reporting annual revenues of $1 billion. Growth continued as the company served expanding needs for outsourced services from U.S. companies looking to control and preferably reduce operating costs. By 2008, Satyam was reporting over $2 billion in revenue with 53,000 employees in 63 countries worldwide. This made the company the fourth-largest software services provider alongside such competitors as WiPro Technologies, Infosys, and HCL. It was serving almost 700 clients, including 185 Fortune 500 companies, generating more than half of its revenue from the United States.

Satyam's client roster included such names as General Electric, Cisco, Ford Motor Company, Nestlé, and the U.S. government. Prominence in the software services sector brought with it increased attention and a growing reputation. In 2007, Ramalinga Raju was the recipient of Ernst & Young's Entrepreneur of the Year award. In September 2008 the company received the Golden Peacock Award for Corporate Governance from the World Council for Corporate Governance, which endorsed Satyam as a leader in ethical management practices. Signs that there were problems at Satyam first appeared in October 2008 when it was revealed that the World Bank had banned the company from pursuing any service contracts after evidence was uncovered that Satyam employees had offered "improper benefits to bank staff" and "failed to account for all fees charged" to the World Bank. WiPro Technologies had also been banned by the World Bank in 2007 for "offering shares of its 2000 initial public offering to World Bank employees," so Satyam appeared to have some company in the arena of questionable business practices in the software solutions sector. However, the situation escalated in December 2008 after Satyam's board voted against a proposed deal for Satyam to buy two construction companies for $1.6 billion.

The Raju brothers held ownership stakes in both companies, and they were run by Ramalinga Raju's sons. Four directors resigned in response to the proposed deal, and Satyam stock was punished by investors, forcing the brothers to sell their own stock as the falling share price sparked margin calls on their investment accounts. The dire financial situation prompted Ramalinga Raju to confess in a four-and-a-half-page letter to the board of Satyam Computer Services that the company had been overstating profits for several years and that $1.6 billion in assets simply did not exist. It did not take long for investors to piece the information together that the proposed $1.6 billion purchase of the construction companies would have, conveniently, filled the $1.6 billion hole in Satyam's accounts. In his confession, Raju attempted to address accusations of a premeditated fraud by stating: "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." He wrote, "It was like riding a tiger, not knowing how to get off without being eaten."

The analogy of being eaten by a tiger certainly seems appropriate. The scandal has had repercussions for the software services sector as a whole, casting shadows on Satyam's competitors and also on India's corporate governance framework. As with Enron's collapse, attention immediately turned to the role of the accounting company responsible for auditing Satyam's accounts and, allegedly, failing to notice that $1.6 billion in assets did not exist. For Enron it was Arthur Andersen, and the accounting firm did not survive. For Satyam it was PricewaterhouseCoopers, which had certified that Satyam had $1.1 billion in cash in its accounts, when the company really had only $78 million. The response of Indian authorities was immediate-jail for the founders of Satyam, and the swift appointment of an interim board of more reputable businessmen as the country scrambled to restore its reputation and reassure investors and customers alike that Satyam was a regrettable exception rather than a common example of unethical business practices in the face of competitive pressures in a global market. In January 2009, the Securities and Exchange Board of India made it mandatory for the controlling shareholders of companies to disclose when they were pledging shares as collateral to lenders-a direct response to the Satyam scandal.

In April 2009, Tech Mahindra, the technology arm of Indian conglomerate Mahindra group, won an auction to buy the operations of Satyam at a price of less than one-third of the company's stock value before the confession of Ramalinga Raju. The justification for the bargain price lay in the loss of 46 customers, including Nissan, Sony, the United Nations, and State Farm Insurance, in the aftermath of the scandal. Analysts commented in response to the sale that the situation could have been much worse for Satyam were it not for the timing of the global recession. With so many other priorities to address, many customers elected to avoid the headaches of switching IT suppliers (with all the software and hardware changes that might entail) and give Satyam the opportunity to figure things out. It remains to be seen whether the extensive financial resources of Tech Mahindra and its parent company will be sufficient to allow Satyam to restore its tarnished reputation.