Dreamer's Blog

“The directors (managers) of such companies, however, being managers of other people’s money than their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private co-partnery frequently watch over their own… Negligence and profusion, therefore, must always prevail more or less in the management of the affairs of such a company.”

• Adam Smith – An Inquiry into “The Nature and Causes of The Wealth of Nations”

The Corporate Governance, has never ever, since the Satyam Episode, become such a household word. A confessional letter from Mr. Ramalinga Raju, founder Chairman of Satyam, divulged the accounting scam of the order of US $ 1.6 billion, and shook the whole country with tremors felt throughout the globe. Mr. Ramalinga Raju can be credited as the only corporate fraudster to have admitted his misdemeanors – fudging of accounts, inflated revenues, non-existing profits, and the fraudulent bank deposits and audaciously sustaining it for seven long years. The Mr. Ramalinga Raju’s misdeeds, unfortunately had given negative publicity of India Inc so far a positive story. The fraud has undermined the trust in the government, companies, and markets alike. In India, nobody had ever imagined anything to go wrong at Satyam, one of India’s best known IT companies, which ironically had received the Golden Peacock Award for Corporate Governance in 2008.

This episode has led to debates in India, about inadequacies in the corporate governance norms. Questions have been raised about the performance/ effectiveness of board of directors, roles of auditors, the impact of regulations, disclosures, etc. However, the silver lining to this whole episode was the proactive role played first time ever in India by the shareholder activists in opposing the unanimously approved board’s resolution in acquiring a property of companies owned by the sons of Mr. Ramalinga Raju, which led to revelation of frauds being committed by promoter behind the scene. If a large company like Satyam could do it for years, what’s the guarantee more are not doing it? It is therefore, important that the Satyam fraud needs to fast track investigation and sentence the fraudsters swiftly and harshly to increase ‘deterrence value’.

The frauds of such magnitudes provide a good opportunity for introspection. These times also expose the shortcomings and vulnerabilities of the system. Conflicts always have hidden solutions. There are lessons to be learnt from Satyam’s nemesis too. It is one such great opportunity to reassess some of the existing framework on corporate governance, systems for better enforcements of regulations; effective roles and duties of directors, executives, regulators; ethics in businesses and empowerment of minority shareholders and whistle blowers.

OVERVIEW OF INDIAN CORPORATE GOVERNANCE

India’s corporate governance codes are on par with the best in the world, the importance of continuing 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 at Satyam.

The Indian corporate would appreciate the fact that the corporate governance in India has not been forced upon them by the government, but it was a voluntary and path-breaking initiative from the Indian industries association – Confederation of Indian Industry (CII). It was necessitated, for the fact that India Inc. was to move forward and globalize itself towards international 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 the process of building large global conglomerates. CII had vigorously lobbied and pressurized the government of India for its implementation.

Corporate governance initiatives began in 1998 with the “Desirable Code of Corporate Governance” – a voluntary code published by the CII, and the first formal regulatory framework for listed companies specifically for corporate governance, established by the SEBI, widely known as Clause 49 of the Listing Agreement – Aimed at improving corporate governance in the country. It was implemented in February 2000, following the recommendations of the Kumarmangalam Birla Committee Report.

Legal reforms has been ongoing, with SEBI in 2003 revised the Clause 49, as per the recommendations put forward by the committee and public comments received. Subsequently, the SEBI received a number of feedbacks/ representations, which were deliberated once again by the Narayana Murthy Committee and post discussion, SEBI directed further amendment to the Clause 49 in October, 2004. The amendment to Clause 49 of the Listing Agreement has been the topic of elaborate deliberations and discussions in the Indian corporate scene. The ease with which SEBI introduced mandatory corporate governance standards in India is unparallel.

The Companies Act, 1956 was undoubtedly a significant landmark in the development of Company Law in India. It consisted of 658 sections and fourteen schedules. The Act was enacted with the object of amending and consolidating the law relating to Companies and certain 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 its resources and energies for the optimum output. However, the working of the Companies Act brought to light several lacunae and defects in its provisions. Therefore, the Act was amended from time to time. But despite extensive changes the principal Act still suffers from certain defects. Moreover, after liberalization, the increasing number of options and avenues for international business, trade and capital flows had necessitated modernization of the regulatory structure 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 unlisted firms. The new Companies Bill has been based on best international practices and fosters entrepreneurship. As a result the Union Cabinet in August 2008 gave its approval for introduction of the Companies Bill, 2008 in the Parliament to replace the Companies Act, 1956. The bill had lapsed with the dissolution of the house in December 2008 and it has now been re-introduced in August, 2009. The Companies Bill seeks to enable the corporate sector in India to operate in a regulatory environment of best international practices. The provisions of Companies Bill are broadly considered to be suitable for addressing various contemporary issues relating to corporate governance, including those recently 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 a Parliamentary Standing Committee for recommendations. With the standing committee set with no time frame for giving its recommendations, the passage of the new law is likely to take over a year. It is quite sad that the amendment of the Company Act 1956 has been languishing for so many years now. It is earnestly hoped that speedy passage of the Companies Bill will now be ensured.

LESSONS FROM SATYAM EPISODE

The Satyam board in December 2008, had unanimously approved a proposal to acquire 100 percent of closely held Maytas Properties for Rs 6,240 crore ($ 1.3 billion) and 51 percent of Maytas Infra for Rs 1440 crore ($300 million), with a total expenditures of Rs 7680 crore ($1.6 million). The immediate reaction of institutional shareholders and investment analyst, as soon as the information become public the next day, was that it was daylight robbery and the promoters were siphoning money out of Satyam. They further vehemently reacted and said that they would go to any length to prevent this from happening. Mr. Ramalinga Raju was left with no option to abandon the plan at the first place, but also had to put in his papers, confessing cooking of the books for several years, on 7th January 2009, sending shockwave all throughout the corporate board. However, the silver lining to this whole episode was the ascendancy of the Shareholders Activism, one of the first times ever in India. But for the proactive role played by the shareholders and the institutional investors, the nefarious activities committed clandestinely by promoters would not have seen the light of the day.

The Satyam fraud has also posed serious questions concerning auditing and audit firm oversight. The very fact that a member of the elite Big Four auditors, Price Waterhouse Coopers was caught completely unaware of the reality as it existed from that presented in Satyam’s books of accounts indicates the need for more stringent checks on the role of auditors and to make them more accountable.

In the Indian context, it is well known fact that many of the companies are controlled by the families and would like these to be handed over to their sons and daughters. The promoters may pursue interests that are not necessarily desirable from the point of view of the commercial success of the company. The promoters are all powerful making even the academically well qualified 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 of independence. This has brought to attention once again the role of the independent directors and audit committee.

Timely regulatory action always helps, even if this action may seem to antagonize some of the players. More often, the pursuit of unprecedented growth leads some of the corporates to adopt sharp practices and the risks they carry. The genesis of these scams and scandals usually lies where there is either unregulated or lightly regulated. It is essential to watch out for such warning symptoms. These organizations need to be identified – in the present scenario state of art computer technology, it would not be difficult to keep a track off, cautioned and kept under careful scrutiny. Not only should their CEOs be interviewed periodically by the regulators, but their annual reports and periodic financial statements, where one can easily detect frauds should also be analyzed. It is important that the authorities ask the right questions at the right time.
The present crisis has taught lot of people a lot of lessons – we need stronger regulation, especially in the area of systemic risk, with such companies. The regulators instead of regretting their present failures review the practices and procedures being followed, address shortcomings, and implement the lessons learned to regulate markets and protect investors to bring back the lost trust and confidence.

It is one thing to have elaborate codes, but quite another for companies to follow them in letter and spirit. Yet another is the question of enforcement if companies do not adhere to the standards. Weakness of enforcement in India is a real issue. The unraveling of these events at Satyam has once again put spotlight on some of the corporate governance practices and has exposed the following weaknesses:

1. Lax Regulatory systems
2. The imperious and Machiavellians promoters/ CEOs and their unbridled greed
3. Connivance and collusion of Auditors and poor auditing practices
4. Timid and acquiescent independent directors
5. Shareholders activism and Empowerment of minority shareholders
6. Empowerment of Whistle blowers

We ought to refrain from taking short term regulatory measures. It would be worthwhile to search for holistic solutions to these issues; which are relevant in the Indian context. The choice of changes in the regulatory frame work should be compatible with the country’s own values and legal system, rather than plagiarizing from other countries. The system adopted should be agile enough to fore warn the early signals of a brewing crisis and take corrective measures. The system should encourage “proactiveness” rather than be a “reactionary”, otherwise reforms are not expected. With the present day state of art computer technologies, early warning system is not impossible.

One must, however, understand that no matter how strong a regulatory system is, it cannot always prevent frauds. Despite the enormous increase of disclosures and stringent risk management systems in US post the Sarbanes Oxley Act (SOX), inability of the system to read the early sign of impending recent Subprime crisis, Madoff’s Ponzi scheme and willingness to take corrective action is one such example. Moreover, strong measures often lead to expensive regulations and defiance. There are limits to legislations as a lot depends on the integrity and ethical values of various corporate players such as directors, promoters, executives and shareholders. The key lies in management decisions and its commitment to establish and follow rigorous governance systems. The implementation must be in the letter and spirit, and one should recognize the responsibility of the company towards its stakeholders.