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CHAPTER I SATYAM SCAM - AN EYE OPENER FOR INDIAN CORPORATE WORLD

Satyam Computer Services was among the top four information technology (IT) majors in the country. It played a crucial role in the stock market as one of the 3 largest and most actively traded stocks that determined the !om"ay Stock #$change%s (!S#) value&weighted inde$' Sense$. Industry analysts say Satyam promoter !. (amalinga (aju%s "iggest crime was perhaps in misleading investors completely. The scam at Satyam Computer Services' the fourth largest company in India%s much showcased and fiscally pampered information technology (IT) industry' has had an unusual trajectory. It "egan with a successful effort on the part of investors to thwart an attempt "y the minority& shareholding promoters to use the firm%s cash reserves to "uy out two companies owned "y them ) *aytas +roperties and *aytas Infra. That a"orted attempt at e$pansion precipitated a collapse in the price of the company%s stock and a shocking confession of financial manipulation and fraud from its chairman' !. (amalinga (aju. The whole story is now of facts and figures which have "een analysed "y corporate e$perts as well as various economists in India. The certain parties,issues which need to "e analysed to understand the nature of the fraud and its related pro"lems have "een highlighted which shall "e ela"orated later. Satyam Company and The Board- The event came to the light when !' (amalinga (aju' Chairman of Satyam Computer Services made a confession that took the nation as well as the world at large. "y surprise and every"ody listened with an awed e$pression as to what one was
.

The company offers information technology (IT) services spanning various sectors' and is listed on the /ew 0ork Stock #$change and #urone$t.Satyam1s network covers 23 countries across si$ continents. The company employs 4 ' IT professionals across development centers in India' the 5nited States' the 5nited 6ingdom' the 5nited 7ra" #mirates' Canada' 8ungary' Singapore' *alaysia' China' 9apan' #gypt and 7ustralia. It serves over 2:4 glo"al companies' .;: of which are <ortune : corporations. Satyam has strategic technology and marketing alliances with over : companies. 7part from 8ydera"ad' it has development centers in India at !angalore' Chennai' +une'

hearing. It is "elieved that (aju diverted Satyam funds to the companies headed "y his sons' !. Teja (aju (*aytas Infra) and !. (ama (aju 9r. (*aytas +roperties)' to "uy large tracts of land and win projects. 8e had chalked out a game plan to ac=uire the companies and in the process also reduce the alarming gap in Satyam%s accounts' "etween actual profit and the figure stated in the "ooks' and keep the wealth within the family. *uch like Satyam' (aju nurtured the two companies well and had am"itious plans for them' using his clout with the 7ndhra +radesh government' which "ent over "ackwards to patronise *aytas. >uring the past three years' *aytas Infra "agged projects worth (s.3 ' 34 crore on its own or in joint ventures and "ecame the ?fastest growing infrastructure company@ in the State. The projects covered areas such as irrigation' railways' roads and ports. The ?superfast growth@ of the company' which recorded a turnover of (s..'2 crore in A ; as against (s.. crore in A 3B the speed and ease with which it got projects' and the =uestiona"le role played "y the top political leadership' are all under the scanner now.

*um"ai' /agpur' >elhi' 6olkata' !hu"aneswar' and Cisakhapatnam.

The Dhonest% confessionA "rought many issues to the lime light along with the truth that the fraud committed "y The Chairman was not single&handed and also included other perpetrators. This issue of corporate fraud as most like to name it as the "iggest corporate fraud in Indian Corporate history contains such players as The 7uditors' The !ankers' The +romoters and also the investors.3

The letter written "y !' (amalinga (aju' Chairman of Satyam Computer Services to the Satyam !oard?It is with deep regret and tremendous "urden that I am carrying on my conscience' that I would like to "ring the

following facts to your notice.. The !alance Sheet carries as of Septem"er 3 ' A a. ". c. d. A. the "ooks)B 7n accrued interest of (s 332 crore' which is non&e$istent 7n understated lia"ility of (s .'A3 crore on account of funds arranged "y meB 7n overstated de"tors1 position of (s 4E crore (as against (s A'2:. reflected in the "ooks)B crore and an operating margin of (s 24E ;' Inflated (non&e$istent) cash and "ank "alances of (s :' 4 crore (as against (s :'32. crore reflected in

<or the Septem"er =uarter(FA) we reported a revenue of (s A'3

crore(A4 per cent of revenue) as against the actual revenues of (s A'..A crore and an actual operating margin of (s 2. crore (3 per cent of revenues). This has resulted in artificial cash and "ank "alances going up "y (s :;; crore in FA alone. The gap in the "alance sheet has arisen purely on account of inflated profits over several years (limited only to Satyam standalone' "ooks of su"sidiaries reflecting true performance). Ghat started as a marginal gap "etween actual operating profit and the one reflected in the "ooks of accounts continued to grow over the years. It has attained unmanagea"le proportions as the siHe of the company operations grew significantly (annualised revenue run rate of (s ..'A32 crore in the Septem"er =uarter' A ;' and official reserves of (s ;'3EA crore). The differential in the real profits and the one reflected in the "ooks was further accentuated "y the fact that the company had to carry additional resources and assets to justify a higher level of operations there"y significantly increasing the costs. #very attempt made to eliminate the gap failed. 7s the promoters held a small percentage of e=uity' the concern was tha poor performance would result in the takeover' there"y e$posing the gap. It was like riding a tiger' not knowing how to get off without "eing eaten. The a"orted *aytas ac=uisition deal was the last attempt to fill the fictitious assets with real ones. *aytas1 investors were convinced that this is a good divestment opportunity and a strategic fit.
3

Ine Satyam1s pro"lem was solved' it was hoped that *aytas1 payments can "e delayed. !ut that was not to "e. .. I would like the "oard to know-

Ghat followed in the last several days is common knowledge.

Auditors- Price Waterhouse Coopers- The incident also raised some serious =uestion a"out well& named "odies and organisations who were involved in the "usiness of managing the Dfraudulent% affairs of the Company. In this conte$t it is also necessary to note the role of the auditors as the whole affair was managed "y one of the "iggest names in the auditing "usiness& +rice Gaterhouse Coopers.

A. 3.

That neither myself' nor the *anaging >irector (including our spouses) sold any shares in the last eight years & e$cepting for a small proportion declared and sold for philanthropic purposes. That in the last two years a net amount of (s .'A3 crore was arranged to Satyam (not reflected in the "ooks of Satyam) to keep the operations going "y resorting to pledging all the promoter shares and raising funds from known sources "y giving all kinds of assurances (statement enclosed only to the mem"ers of the "oard).

4.

Significant dividend payments' ac=uisitions' capital e$penditure to provide for growth did not help matters. #very attempt was made to keep the wheel moving and to ensure prompt payment of salaries to the associates. The last straw was the selling of most of the pledged shares "y the lenders on account of margin triggers.

:. 2. 3.

That neither me nor the managing director took even one rupee,dollar from the company and have not "enefited in financial terms on account of the inflated results. /one of the "oard mem"ers' past or present' had any knowledge of the situation in which the company is placed. #ven "usiness leaders and senior e$ecutives in the company' such as' (am *ynampati' Su"u >' T ( 7nand' 6esha" +anda' Cirender 7garwal' 7 S *urthy' 8ari T' S C 6rishnan' Cijay +rasad' *anish *ehta' *urli C' Shriram +apani' 6iran 6avale' 9oe Jagioia' (avindra +enumetsa' 9ayaraman and +ra"hakar Kupta are unaware of the real situation as against the "ooks of accounts. /one of my or managing directors1 immediate or e$tended family mem"ers has any idea a"out these issues.

8aving put these facts "efore you' I leave it to the wisdom of the "oard to take the matters forward. 8owever' I am also taking the li"erty to recommend the following steps.. A. 7 task force has "een formed in the last few days to address the situation arising out of the failed *aytas ac=uisition attempt. This consists of some of the most accomplished leaders of Satyam- Su"u >' T.(. 7nand' 6esha" +anda and Cirendra 7garwal' representing "usiness functions' and 7 S *urthy' 8ari T and *urali C representing support functions. 3. 4. I suggest that (am *ynampati "e made the chairman of this Task <orce to immediately address some of the operational matters on hand. (am can also act as an interim C#I reporting to the "oard. *errill Jynch can "e entrusted with the task of =uickly e$ploring some merger opportunities.

7ccording to audited "alance sheet figures (if they are to "e trusted) availa"le from the C*I#%s data"ase' the paid&up e=uity in Satyam Computer Services rose from (s. :2.A4 crore in *arch A to just (s. 24.;E crore "y *arch A 2 and further to (s. .33.44 crore in *arch A . and Septem"er A 3. Iverall' the num"er of shares held "y the promoter group fell from 3..2 crore (AA.; per cent) to :.; crore (;.2 per cent) "etween Septem"er A ;. This points to a conscious decision "y the promoters to sell shares' which may have "een used to ac=uire assets elsewhere. The more inflated the share values' the more of such assets could "e ac=uired. It is =uite possi"le that the assets "uilt up "y the eight other (aju family companies under scrutiny' including *aytas +roperties and *aytas Infra' partly came from the resources generated through these sales. If true' this makes (aju%s confession suspect' since he stated that ?neither myself' nor the *anaging >irector (including our spouses) sold any shares in the last eight years ) e$cepting for a small proportion declared and sold for philanthropic purposes.@ +rice Gaterhouse Coopers has "een the statutory auditor for Satyam Computer services for last si$ years. 7uditorDs involvement is crystal clear. Satyam had paid twice the amount of what was charged "y other 7udit <irms. There was no cash within the company1s "anks and yet the auditors went ahead and
:. 0ou may have a 1restatement of accounts1 prepared "y the auditors in light of the facts that I have placed "efore you. I have promoted and have "een associated with Satyam for well over A years now. I have seen it grow from few people to :3' people' with .;: <ortune : companies as customers and operations in 22 countries. Satyam has esta"lished an e$cellent leadership and competency "ase at all levels. I sincerely apologise to all Satyamites and stakeholders' who have made Satyam a special organisation' for the current situation. I am confident they will stand "y the company in this hour of crisis. In light of the a"ove' I fervently appeal to the "oard to hold together to take some important steps. T( +rasad is well placed to mo"ilise a support from the government at this crucial time. Gith the hope that mem"ers of the Task <orce and the financial advisor' *errill Jynch (now !ank of 7merica)' will stand "y the company at this crucial hour' I am marking copies of the statement to them as well. 5nder the circumstances' I am tendering the resignation as the chairman of Satyam and shall continue in this position only till such time the current "oard is e$panded. *y continuance is just to ensure enhancement of the "oard over the ne$t several days or as early as possi"le. I am now prepared to su"ject myself to the laws of the land and face the conse=uences thereof. (! (amalinga (aju) Copies marked to.. Chairman S#!I A. Stock #$changes

signed on the "alance sheets saying that the money was there. /ot just the cash' even they even signed off on the non&e$istent interest that accrued on the non&e$istent cash "alanceL 7uditors do "ank reconciliation to check whether the money has indeed come or not. They check "ank statements and certificates. So was this a total lapse in supervision or were the "ank statements forgedM /o one knows yet as everyone still awaits the investigation report regarding this issue. The company officials said they relied on data from the reputed auditors. !ut +ricewaterhouseCoopers' stung "y this insinuation hit "ack at Satyam.4 Satyam and Corporate Governance- 9ust three months ago' India1s fourth&largest software services e$porter' Satyam Computer Services received a Kolden +eacock Klo"al 7ward from a group of Indian directors for e$cellence in corporate governance. /ow that Satyam is in turmoil and its shares have plunged after a "otched attempt to "uy two infrastructure firms in which management held stakes' concerns over the conflict of interest and a lack of transparency are "eing raised. (amalinga (aju himself was the recipient of many an award for corporate governance and transparency' "ut the fraud has "rought to light the fact that in India the distinction "etween owners and management is still not very clear. Ghere the owners are also the managers' such frauds are always a possi"ility. In the Satyam case' of course' none is guiltier than the (ajus. This shows the status of Indian Corporate Kovernance and how it can easily fall prey to people like (ajus%. SEBI and its take on Satyam- The Securities and #$change !oard of India' which says it is Dhorrified at the magnitude of the fraud% had in >ecem"er given a clean chit to Satyam saying that it had not found any violation of norms relating to takeover and corporate governance in its preliminary surveillance of the deal involving the ac=uisition of *aytas Infra "y Satyam Computer Services. 7nalysts say the ?market watchdog@ lacks the teeth for ensuring compliance on governance. /ow' after so much water has flown under the "ridge' Se"i has moved to Dtake action% against the company.5

+rice Gaterhouse Coopers to the media- ?The audits were conducted "y +rice Gaterhouse in accordance with

applica"le auditing standards and were supported "y appropriate audit evidence. Kiven our o"ligations for client confidentiality' it is not possi"le for us to comment upon the alleged irregularities. +rice Gaterhouse will fully meet its o"ligations to cooperate with the regulators and others.N
:

Infra Chapter III ?Satyam Scam and S#!I- Gho is to "e "lamedM@

The Satyam episode has "rought out the failure of the present corporate governance structure. The present corporate governance structure hinges on the independent directors' who are supposed to "ring o"jectivity to the oversight function of the "oard and improve its effectiveness. Stakeholders place high e$pectation on them. !ut is the e$pectation misplacedM +erhaps' yes. 7n individual independent director cannot play an effective role in isolation. #ven if a particular independent director is highly committed' he can only watchD wrong doing and at "est initiate a discussion' "ut alone she cannot stop a decision even if it is detrimental to the interest of shareholders or other stakeholders. /either can she "low the whistle outside the "oard room (e.g. to regulators) "ecause "oard proceedings are considered confidential.6

CHAPTER II
SATYAM SCAM: ROLE OF AUDITORS AND BANKERS AS TO THEIR INVOLVEMENT
Ince the picture "ecomes clear as how the manipulation of funds were done and as to how the scam could "e caused in spite of so many regulations and statutory restrictions 3 present to cur" and check any deviation from the esta"lished duties and o"ligations that are essential and compulsory on nature. If one is to "lame the Satyam for instigating the corporate down&fall and rise of the =uestions as to corporate governance and similar concerns then there are others also involved who may "e said to have played a pivotal role in Daiding% *r. (aju in pulling off such a fraud and hood

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www.ndtv.com,convergence,ndtv,story.asp$MidO/#G#/A

3E42E & . .k

Infra Chapter C' ?Satyam Scam P Jegal +rovisions 5nder Companies 7ct' .E:2@B Chapter III' ?Satyam Scam and

S#!I- Gho is to "e "lamedM@

winked even the "est in the "usiness to prevent such mishaps.; 8ence' it is "emusing as to how Satyam could have indulged in accounts fudging without getting detected "y the auditors. Firstly one needs to speak a"out +rice Gaterhouse Coopers the auditors of Satyam Computer Services who should have caught it as "ecause Book sales belonging to the subsequent year in the current year by pre-dating the invoice. This is like catching the tiger "y the tail. 5nless the sales improve' the Company will have to follow the same thing in the su"se=uent years as well to ensure that the profit trend is maintained. (The auditors can detect this "y matching the dates of invoices' shipment advises' gate passes' delivery receipts' physical stock verification reports' de"tors% confirmation etc.) Book bogus sales to inflate profits in one year and show return sales in the subsequent year. This is again like catching the tiger "y the tail as the =uantum will have to "e increased each year to compensate for the additional charge coming in the su"se=uent year due to return sales. (The auditors can detect this "y checking the invoices' su"se=uent year sales returns' de"tor confirmations' stock tally etc.) Book bogus other income. This is done to inflate the profits and mostly to as a money laundering exercise: 5naccounted money is laundered into the "ooks "y showing income for no actual service rendered. (7uditors can detect this "y seeing the actual

!!!"e#pressindia"com$latest-ne!s$Satyam-%raud-&ot-a-one-man-sho!$'()**'$ reports ?6+*K' which audits the

accounts of IT majors like Infosys and Gipro' dou"ted the veracity of the confessional letter written "y ! (amalinga (aju' the founder&chairman of Satyam Computer' saying the financial "ungling cannot "e done only "y the head of the 8ydera"ad&"ased firm. ?It defies logic' one is not sure whether there is much more to it than is written in the letter and whether the letter contains all the facts'@ 6+*K Chief Iperating Ifficer (ichard (ekhy said here on the sidelines of a CII function. It is too simplistic at the moment to "elieve that the kind of thing that has happened in the company is done "y (aju alone' he said. ?It re=uires a whole "attery of people to advance those accounting entries and credit those "ecause you have to involve other people as well like "ankers to get those certificates'@ he said. Ghen asked whether (aju might have siphoned off funds and he is now admitting to lesser crime' he said it is =uite possi"le "ut it could "e known only after investigation of group companies@

documents supporting the other income and "y comparing with the e$pertise availa"le in the company to provide such services) By not booking purchases or overheads. Companies try to inflate profits by not booking purchase of material or overheads: This again has to "e covered up in the su"se=uent year when the creditors are to "e paid. (Some of the ways in which the 7uditor can find these include' comparison of the purchases with physical stock' =uantitative tally of stocks and consumption' trend analysis of overheads "etween two periods' o"taining creditor%s confirmation' "ank reconciliation statements to check for amounts paid "ut not accounted in "ooks which will "e hanging as a difference "etween "ank "alance as per "ooks and as per the "ank statements for a given cut&off date) In all the cases of inflation of sales in the "ooks' the company will credit the sales account to increase the sales and pass the de"it to a de"tor account to show receiva"les. The pro"lem here is that the receiva"les has to "e s=uared off either "y reversing the sale or "y writing off as most fraudulent companies do not introduce cash to s=uare of the receiva"les for "ogus sales. 8owever' *r. (amalinga (aju has introduced a new gam"it in this fraud committed "y him and his Dallies%. e booked bogus income! most likely with fictitious companies and cleared off the debtor balances by showing collections and there by increasing the cash and bank balances. In order to get actual collections from fictitious companies' he didn%t make any actual collections. 8e just got some more "ook entries made to clear the de"tors and transferred the de"its to "ank "alances. If something remains in de"tors' it will raise =uestions from many =uarters' starting from the auditors to the !oard of >irectors to the analysts to institutional investors to (at least) some of the intelligent retail investors. If the de"tor "alance is converted into !ank "alancesM /o one is going to dou"t. In fact' people will "ecome happier to see the swell of cash. The Company will "e valued higher it is sitting on a huge pile of cash. The pro"lem starts here. /ormally' auditors will ask for confirmation "alances for the "ank "alances shown "y the company. !ut then how did he get away for so many years without having actual "ank "alancesM Ir how did he produce the needed confirmation to the auditors for these "alancesM >id the auditors (one of !ig <our' mind you) overlook seeking confirmation of "alancesM This presumption seems to "e impossi"le. 7uditors though "y definition are not

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?"loodhounds@ "ut are ?watchdogs@' they minimum "ecome a nagging wife if confirmation for significant "alances are not received. They will =ualify such things in their audit report and also will draw the attention of lack of confirmations to the !oard of >irectors and 7udit Committee. So the "ig =uestion that arises here is ?8ow could *r. (aju convince the auditorsM@E There can "e only speculations as to how he could have hoodwinked his auditors "ut unless the S#!I or the administrators frame and deduce something definite in this regard speculations cannot "e the correct answer as to whether there was any involvement "etween the auditors and the perpetrator
E

Ine has to note that the 7uditors (eport re=uired under the Indian Companies 7ct' .E:2 is very different from the

7uditors% certificate as per 5S7 and other country laws. 5nder those laws' much of the responsi"ility on the accounts is shifted to the management. Interestingly' this report doesn%t specify any such minute details to "e followed "ut simply asks auditors to look at all things that may re=uire a scrutiny' which is lucid and Dfle$i"le%. ""#. $owers and duties of auditors: +,- Every auditor o% a company shall have a ri.ht o% access at all times to the /ooks and accounts and vouchers o% the company !hether kept at the head o%%ice o% the company or else!here and shall /e entitled to re0uire %rom the o%%icers o% the company such in%ormation and e#planations as the auditor may think necessary %or the per%ormance o% his duties as auditor"
%

1+lA- Without pre2udice to the provisions o% su/-section +,- the auditor shall in0uire-

+a- !hether loans and advances made /y the company on the /asis o% security have /een properly secured and !hether the terms on !hich they have /een made are not pre2udicial to the interest o% the company or its mem/ers3 &b' whether transactions of the company which are represented merely by book entries are not pre(udicial to the interests of the company) +c- !here the company is not an investment company !ithin the meanin. o% section 456 or a /ankin. company !hether so much o% the assets o% the company as consist o% shares de/entures and other securities have /een sold at a price less than that at !hich they !ere purchased /y the company3 +d- !hether loans and advances made /y the company have /een sho!n as deposits3 +e- !hether personal e#penses have /een char.ed to revenue account3 +%- !here it is stated in the /ooks and papers o% the company that any shares have /een allotted %or cash !hether cash has actually /een received in respect o% such allotment and i% no cash has actually /een so received !hether the position as stated in the account /ooks and the /alance-sheet is correct re.ular and not misleadin."7 Jooking at the provisions of Section AA3 (.7) (") can it "e said that the auditors ensured as to whether it is not the same case with Satyam before certifying their accounts? If yes, how did they ensure? Difficult questions as the whole baloon of Satyam was blown up only with book entries. Instead of acting as book keepers, the Satyam finance department under instructions and intrusions of book cooked. In addition to the a"ove' su"section 3 of the same section AA3 warrants the auditor to report this+4- The auditor8s report shall also stater. !a"u, probably

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of the fraud' *r. (aju. 5nder S" 665 read with S" 644 of the #ompanies $ct, %&'( the auditors are
re=uired to accurately' fairly and diligently review and audit the accounts of the company "efore issuing the signed auditors% report.. <ailure to do so would result in a penalty under S"644 of (s. . ' . 5nder Sections *6 and *4 of the 7ct' any person issuing a prospectus that contains a false ... This statement may "e punished with up to A years imprisonment and fine up to (s.: '

includes directors' promoters and e$perts such auditors and investment "ankers. Satyam also had an 7>S listing in the 5S and filed a prospectus with the 5S S#C. 5nder (ule . "&: issued under Section . of the Securities 7ct of .E33' it is unlawful for any person to make any untrue statement of a material fact or to omit to state a material fact in connection with the sale of a security. 5nder Section .. of the Securities 7ct' the persons who signed the registration statement (directors and officers) are lia"le in addition to the underwriters' auditors and other e$perts. In addition' disciplinary proceedings,en=uiries could "e initiated "y the Institute of Chartered 7ccountants of India.A against the audit firm' which would "e a very serious implication for the audit firm' as it could have the immediate effect of dis=ualifying their eligi"ility to act as statutory auditors for several "anks and other institutions. Such an event could also result in suspension or de"arment of the audit firm if the IC7I.3 concludes that there were serious lapses on the audit firmDs part.
+a- !hether he has o/tained all the in%ormation and e#planations !hich to the /est o% his kno!led.e and /elie% !ere necessary %or the purposes o% his audit3 +/- !hether in his opinion proper /ooks o% account as re0uired /y la! have /een kept /y the company so %ar as appears %rom his e#amination o% those /ooks and proper returns ade0uate %or the purposes o% his audit have /een received %rom /ranches not visited /y him3
"

1+//- !hether the report on the accounts o% any /ranch o%%ice audited under section 66) /y a person other than the

company9s auditor has /een a!arded to him as en0uired /y clause +c- o% su/-section +4- o% that section and ho! he has dealt !ith the same in preparin. the auditor9s report37 +c- !hether the company8s /alance-sheet and pro%it and loss account dealt !ith /y the report are in a.reement !ith the /ooks o% account and returns3
*

1+d- !hether in his opinion the pro%it and loss account and /alance-sheet comply !ith the accountin. standards

re%erred to in su/-section +4C- o% section 6,,37 Then the o"vious =uestion arises in the mind of people that whether compliance was done "y SatyamM 7nd' if so done then to what respectM
. .. .A .3

See Sec. A33' Companies 7ct' .E:2 See Sec. 23' Companies 7ct' .E:2 IC7I' .E4E i"id

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Secondly and most importantly comes' the issue of independent directors%) and the shareholders. The role of the company1s directors' including independent directors' in the entire episode too has "een e$posed after the Satyam episode. *ost of them essentially remain Dnodders% in the "oardroom and agree to whatever the management or the promoters want to push through. The Satyam "oard' including its five independent directors.: had approved the founder1s proposal to "uy :. per cent stake in *aytas Infrastructure and all of *aytas +roperties' owned "y the family mem"ers of Satyam chairman ! (amalinga (aju. >espite the shareholders not "eing taken into confidence' the directors went ahead with the management1s decision. The decision of ac=uisition was' however' reversed .A hours later after investors dumped Satyam1s stock and threatened action against the management. !y any yardstick' the directors were men of eminence and learning who should "e independent. Clause 4E' of the Indian listing agreement deals with the role of independent directors and assumes' that not "eing related to a promoter or having a direct economic "enefit from a company' makes a director independent..2
In SatyamDs case' directors may have voted differently if they knew perhaps through such meetings the views of shareholders on the issue of unrelated diversification of the kind proposed "y the promoters. Shareholders on their part' have a right to know how their directors represent them. >etails of dissenting views' in a "oard can convey useful information a"out the various options considered at a meeting. Ghile detailed views cannot usually "e disclosed in the short term' it is possi"le to have minutes pu"liciHed after two&three years. This will not serve the immediate purpose of protecting present shareholders' "ut would impose pressure on independent directors to "e seen to "e fulfilling their duty of loyalty. If diligence was e$ercised at the "oard then it is to "e known as to
.4 .:

see Chapter III* +Satyam Scam And Se/i: Is Some/ody To Be Blamed., Satyams% independent directors includes) *angalam Srinivasan' Cinod >ham (#ntrepreneur) 6rishna +alepu (8arvard professor) *. (ammohan (ao (Indian School of !usiness dean) from C&&-IB& Pu/lished on Thu ;an () 6((< at ,4:,( =pdated at Thu ;an () 6((< at ,5:'6

.2

Supra note .4

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how independent directors voted on such issues' perhaps through a statement in the annual report. It would call in to =uestion' the real independence in a "oard' if persons of widely varying "ackgrounds were to always seem to agree' on every issue. !y resigning instead of coming up with an e$planation for what transpired at the "oard' some of the directors of Satyam' "eg the =uestion whether any meaningful de"ate took place at all' on this issue. It is not difficult for the regulators to "ring the sunlight of transparency to "oard discussions' through a few changes in their disclosure guidelines. 5nder the S+,I and #ompanies $ct %&'(' all directors cannot "e held responsi"le "ecause institutional directors and independent directors are nominated directors of various financial institutions or the government nominees. They cannot "e held responsi"le as nominated directors cannot "e held legally lia"le.

CHAPTER III SATYAM SCAM AND SEBI: IS SOMEBODY TO BE BLAMED?

The scam or fraud whatever one may term the incident as it caught the (egulatory "odies% off& guard and also pointed out the gaping holes e$isting in the legal framework to prevent such fraud from happening. The Satyam scam represents a lowering of guard and the throwing of esta"lished practices to the wind "y those who were e$pected to safeguard the interests of small investors. The auditors imagined the fi$ed deposit receipts were genuine' the company%s directors overly trusted (aju' S#!I mistakenly thought it could easily get at (aju with its wide& ranging powers' while the CI> was too protective a"out sharing information..3 T8# Securities and #$change !oard of India (S#!I) may not have foreseen' as e$perts claim' the fraud committed in Satyam Computer Services' "ut there is plenty the market regulator can do to ensure that another one like this does not occur in the country.

.3

?Far %rom the truth@ "y S. /agesh 6umar pu"lished in Dthe <rontline% Q-olume .( / Issue 0) ** 1eb. %)/.2,

.00&3

14

The S#!I wears several hats- it regulates the marketB facilitates information flow "etween the stock e$change' the listed companies and the investorsB and keeps ta"s on the operations of listed companies. Its responsi"ility towards investors is to ensure that any information regarding listed companies is placed in the pu"lic domain. If fraud e$ists in a listed company' S#!I%s jo" is to pro"e the matter to protect the investors. S1I4 and S+,I

7s soon as (amalinga (aju admitted to the fraud on 9anuary 3' the regulator' empowered "y the provisions of the S#!I 7ct' .EEA' ordered an investigation and sent its officials to 8ydera"ad to inspect the "ooks and records. The officials were' however' not allowed access to (aju as he had already surrendered "efore the 8ydera"ad police. It is essential for S#!I to interrogate (aju as he has insisted that only he was involved in the scam. 7 senior official said that perhaps (aju was advised well to get himself arrested in order to stall a pro"e "y S#!I. 7 lawyer said the police would not "e a"le to deny S#!I access to (aju as the regulator is armed with the provisions of the .EEA 7ct. S#!I moved a 8ydera"ad court seeking permission to interrogate (aju and his "rother (ama (aju. 8owever' on 9anuary A3' the court rejected the plea and refused to entertain another petition "y the Serious <raud Investigation Iffice. It was not until <e"ruary 4' A E that the Supreme Court came to rescue S#!I "y giving it permission to e$amine them in jail. Ghile the lower court had rejected its petition' while the 7ndhra +radesh 8igh Court asked it to wait for some more time. The interim report of the (egistrar of Companies ((oC) has' according to reports' confirmed falsification of "ooks of accounts and inflation of the company%s financial position to the e$tent of over (s.:' <raud Investigation Iffice (S<II)' set up under the *inistry of Corporate 7ffairs in A &2' 3. 7s crore "y Satyam Computer Services Jtd. The (oC report is the "asis for the pro"e "y the Serious the pro"e "y the S<II is the main lim" of the multi&pronged investigation into the fraud' a close look at what the S<II can achieve under the present legal and regulatory framework needs to "e e$amined.

15

The S<II is a non&statutory "ody and was set up on the "asis of the recommendations of the /aresh Chandra Committee.; on corporate governance in the "ackdrop of stock market scams' failure of non&financial "anking companies and the phenomena of vanishing companies and plantation companies. It is a multi&disciplinary organisation with e$perts on finance' capital market' accountancy' forensic audit' ta$ation' law' information technology' company law' customs and investigation. These e$perts are drawn from "anks' the Securities and #$change !oard of India (S#!I)' the Comptroller and 7uditor Keneral%s office and the organisations and departments concerned of the government. The S<II%s mandate is e$tremely focussed and' to some e$tent' limited "y Sections A3: to A43 of the Companies 7ct' .E:2. 7lthough the /aresh Chandra Committee envisaged a separate statute to ena"le the S<II (along the lines of the S<I in 5nited 6ingdom) to investigate all aspects of fraud and direct the prosecution in appropriate courts' the Central government' ine$plica"ly' did not find it necessary to simultaneously create a separate legislative framework for the S<II to function under. This has' according to o"servers' seriously compromised the S<II%s efficiency and effectiveness. S<II takes up investigations only into those cases of alleged fraud when referred to it "y the Central government under Section A3:,A33 of the Companies 7ct'
.E:2B.E

cases that su"stantially involve pu"lic interest' to "e judged "y siHe' either in terms of
monetary misappropriation or in terms of persons affected' or those cases that may lead to a clear improvement in systems' laws or proceduresB
.;

The /aresh Chandra (eport (A

3) seeks to enforce the guidelines laid down in 6umarmangalam (eport (.EE;)

and also lays stress on ?Independent >irectors@ which are to "e characterised in line withIndependence of judgment. /o material relationship.

/o pecuniary relationship
.E

These provisions ena"le the Central government to appoint one or more competent persons as inspectors to

investigate and su"mit a report on the affairs of a company if' in its opinion' or in the opinion of the (oC or the Company Jaw !oard' there are circumstances suggesting that the "usiness of a company is "eing conducted with the intention to defraud its creditors or mem"ers' or for a fraudulent or unlawful purpose.

16

the S<II may also take up cases on its own without them "eing referred to it "y the
>epartment of Company 7ffairs.A

7fter completing all the formalities for listing its securities' including of entering into listing agreement' the securities of the company are listed and traded at the concerned stock e$changes. !efore listing' the company enters into a listing agreement with the concerned stock e$changes. 7lmost all the stock e$changes have a standard listing agreement (which is amended from time to time "y issuing circulars "y each of the stock e$changes). Companies listed on stock e$changes have many o"ligations to discharge. These o"ligations are ela"orated in all the relevant clauses of the Jisting 7greement which the company has entered into with the Stock #$change(s). #lause )& and S+,I

Clause '< Back.round- S#!I had constituted a Committee on Corporate Kovernance under the chairmanship of / ( /arayana *urthy to improve standards of corporate governance in India. S#!I introduced some major amendments "ased on the report on this committee on A2th 7ugust' A 3' in clause 4E of its listing agreement.

Applica/ility o% Clause '<- 7ll companies which were re=uired to comply with the re=uirement of the erstwhile Clause 4E i.e. all listed entities having a paid up share capital of (s 3 crores and a"ove or net worth of (s A: crores or more at any time in the history of the entity' are re=uired to comply with the re=uirement of this clause. This clause does not apply to other listed entities' which are not companies' "ut "ody corporates' incorporated under other statutes. Clause '< will apply to these institutions as long as it does not violate their respective statutes' guidelines or directives.
#lause )& / #orporate 5o6ernance The company agrees to comply with the following provisions* I. ,oard of Directors

In these cases' the S<II >irector has to record the reasons in writing' and the decision will "e su"ject to review "y

a coordination committee set up for the purpose. It is to "e seen whether these aspects of its functioning have restricted its autonomy or operational efficiency.

17

7$8 #omposition of ,oard* (i) The !oard of directors of the company shall have an optimum com"ination of e$ecutiveA. and non&e$ecutiveAA directors with not less than fifty percent of the "oard of directors comprising of non&e$ecutive directors. (ii) Ghere the Chairman of the !oard is a non&e$ecutive director' at least one&third of the !oard should comprise of independent directors and in case he is an e$ecutive director' at least half of the !oard should comprise of independent directors. (iii) <or the purpose of the su"&clause (ii)' the e9pression :independent director; shall mean a non/e9ecuti6e director of the company whoa. 7part from receiving directorDs remuneration' does not have any material pecuniary relationships or transactions with the company' its promoters' its directors' its senior management or its holding company' its su"sidiaries and associates which may affect independence of the directorB ". Is not related to promoters or persons occupying management positions at the "oard level or at one level "elow the "oardB c. 8as not "een an e$ecutive of the company in the immediately preceding three financial yearsB d. Is not a partner or an e$ecutive or was not partner or an e$ecutive during the preceding three years' of any of the following.. The statutory audit firm or the internal audit firm that is associated with the company' and

A.

7n e$ecutive director is the senior manager or e$ecutive officer of an organiHation' company' or corporation. The

position is compara"le to a chief e$ecutive officer (C#I) or managing director. 7n e$ecutive director is usually remunerated for his or her work.
AA

7 non/e9ecuti6e director (/#>' also /R>) or outside director is a mem"er of the "oard of directors of a

company who does not form part of the e$ecutive management team. 8e or she is not an employee of the company or affiliated with it in any other way

18

A. The legal firm(s) and consulting firm(s) that have a material association with the company. e. Is not a material supplier' service provider or customer or a lessor or lessee of the company' which may affect independence of the directorB and f. Is not a su"stantial shareholder of the company i.e. owning two percent or more of the "lock of voting shares. There are several distinct "enefits in having an independent "oard of directors which they can "ring to a company' ranging from long&term survival to improved internal controls. Independent directors in the "oard can Counter/alance mana.ement !eaknesses in a company" Ensure le.al and ethical /ehaviour at the company !hile stren.thenin. accountin. controls" E#tend the >reach o% a company throu.h contacts e#pertise and access to de/t and e0uity capital" Be a source o% !ell-conceived /indin. lon.-term decisions %or a company" ?elp a company survive .ro! and prosper over time throu.h improved succession plannin. throu.h mem/ership in the nomination committee etc" Corporate Kovernance principles all over and listing re=uirements assign tasks that have a potential for conflict of interest to independent directors' e$amples of these are integrity of financial and non&financial reporting' review of related party transactions' nomination of "oard mem"ers and key e$ecutives remuneration. SatyamsD independent directors includes *angalam Srinivasan' Cinod >ham (#ntrepreneur)

19

6rishna +alepu (8arvard professor) *. (ammohan (ao (Indian School of !usiness dean) 3 did not name +alepu as independent 3 for say . hours of work hours per

The company in its corporate governance report for A

director' perhaps "ecause he received (s ;3 lakh from the company towards consultancy fees. #ach individual director received around (s .3 lakh for the year A (a survey in 5S reveals that independent directors in large companies devote : &.

annum to carry out "oard responsi"ilities). 6eeping in view the compensation levels in India' the compensation should "e considered good. It is not only in Satyam that independent directors showed lack of commitment. In the case of #nron' GorldCom and other companies in which corporate governance failed independent directors failed to perform effectively. If an individual considers certain responsi"ilities as peripheral and if the chance of failure in performing those duties coming to light is low' it is likely that he will shirk those responsi"ilities' "ecause in that case the cost of failure to the individual is low. Independent directors are human "eings and therefore' we should not e$pect them to "ehave differently from a rational human "eing. If the regulators fail to assess the performance of the "oard on regular "asis' al"eit indirectly through scrutiny of filings' and if law enforcement agencies fail to penaliHe errant independent directors' the present corporate governance structure will remain ineffective.A3 8owever' the solution is not simple. If independent directors are held lia"le for corporate fraud and severe penalties are imposed on them' it will "e difficult to induct right people as independent directors in the "oard and companies will "e deprived of the collective wisdom of people who can make a difference in the performance of companies.A4 The shareholders' especially the minority shareholders' also look to independent directors providing transparency in respect of the disclosures in the working of the company as well as providing "alance towards resolving conflict areas. In evaluating the "oardDs or management decisions in respect of employees' creditors and other suppliers of major service providers' independent directors have a significant role in protecting the stakeholders interests. Ine of the mandatory re=uirements of audit committee is to look into the reasons for default in payments to
A3 A4

news.outlookindia.com,item.asp$M2:3432 news$.com,tag,satyam&scam

20

deposit holders' de"entures' non&payment of declared dividend and creditors. <urther they are re=uired to review the functioning of the SGhistle !lower mechanism and related party transactions. These' essentially' safeguard the interests of the stakeholders. The changes in the
operating environment have raised the stakes on managing "usiness risks. Strong and effective Corporate Kovernance is no longer Da nice to have% "ut Da must have% clause. The shareholders and the !oard should decide as to how many of independent directors would "e ade=uate to have effective governance for their company. That apart' it has to "e appreciated that promoters who have majority stake in the "usiness and on whose confidence people have su"scri"ed in the company must have significant representation on the !oard. In this perspective' <ICCI is of the view that the limit of independent directors should not "e more than A:T including nominee directors. It is to "e recalled that as per the S#!I (egulations' companies will have to comply with the re=uirements of Clause 4E of the Jisting 7greement "y >ecem"er' A :' which provides for a minimum of : T independent directors on the !oard. It is' therefore' inevita"le that the decision on this aspect e$pedited to avoid confusion and uncertainty amongst corporates.

S+,I and <=#*

The !om"ay 8igh Court issued its judgment in the case of Price Waterhouse @ Co"+PWC- v" Securities and E#chan.e Board o% IndiaA: where the court ruled that S#!I possesses necessary powers to initiate investigations against an auditor of a listed company for alleged wrongdoing. In this case the contention was filed "y the +GC and its partners and affiliates challenging a show cause notice issued to them "y S#!I pertaining to audit of Satyam Computers and their alleged failure to detect financial wrongdoing within the company of significant magnitude that in turn resulted in severe losses to Satyam shareholders. The financial wrongdoing included overstatement of cash and "ank "alances' non&e$istent accrued interest' overstated de"tor position and the like. S#!I%s show cause notice sought to initiate action against +GC under Sections ..' ..! and ..(4) of the S#!I 7ct and (egulation .. of the S#!I (+rohi"ition of <raudulent and 5nfair Trade +ractices (elating to Securities *arkets) (egulations' A 3. 7lthough +GC raise o"jections regarding jurisdiction of S#!I "efore its mem"er' no order was
A:

http-,,indiacorplaw."logspot.com,A . , ;,se"is&domain&over&auditors&of&listed.html

21

passed on jurisdiction' which then prompted +GC to file the writ petition "efore the !om"ay 8igh Court for =uashing the pending proceedings "efore S#!I. The key =uestions "efore the court werei.whether the show cause notice issued "y S#!I was without jurisdiction so as to re=uire =uashing of such proceedingsB and ii.whether the proceedings initiated "y S#!I amount to an encroachment of the powers of the IC7I under the Chartered 7ccountants 7ct. The court analyHed the powers of S#!I under various provisions of the S#!I 7ct. It found various measures were availa"le to S#!I that could "e employed in regulating the securities markets. Those powers were of wide amplitude which would ?take within its sweep a chartered accountant if his activities are detrimental to the interest of the investors or the securities market@. The court found that "y taking remedial measures to protect the securities markets' it cannot "e said that S#!I is regulating the accounting profession. S#!I%s general domain e$tends to protecting investors of listed companies and the securities markets. In e$ercise of such powers' there is no reason why S#!I cannot prevent any person from auditing a pu"lic listed company. #ven though the auditors are not directly involved in the securities markets' the court found that since investors rely heavily on the audited accounts of the company' the statutory duty of the auditors and discharge thereof ?may have a direct "earing in connection with the interest of the investors and the sta"ility of the securities markets@. The court finally ruled that the powers of S#!I are independent of those held "y the IC7I and hence S#!I cannot "e said to encroach upon the powers of the IC7I under the Chartered 7ccountants 7ct.A2 The judgment is important as it esta"lishes the regulatory domain of S#!I over auditors of listed companies. The court largely arrives at its conclusions "ased on an analysis of S#!I%s powers to regulate the securities market' which is then contrasted with IC7I%s powers to regulate the accounting profession.
A2

i"id

22

it esta"lishes the role of an auditor to "e closely linked with the functioning of the securities markets. Inherent in this analysis is the fact that proper performance of audit role in listed companies is a prere=uisite for investor protection which is crucial to maintain ro"ust securities markets. If audit and investor protection are said to "e interconnected' it then takes us to a fundamental legal =uestion- do auditors o!e a duty to shareholders$investorsA The !om"ay 8igh Court' in this case' appears to answer in the affirmative.

The last word is yet to "e spoken in the matter' since the judgment itself indicates that +GC has sought to file a special leave petition "efore the Supreme Court "ut the affirmation given "y the !om"ay 8igh Court clearly shows that even the Indian 9udiciary is also willing to take strict actions against those who may have had any correspondence with the Satyam as they are also not outside the scope of judicial as well as D=uasi&judicial% scrutiny so that what is seeming to "e a "ottom&less trench' at least the depth and what is the nature of the issue lying in that trench can "e grasped.

23

CHAPTER IV SATYAM SCAM & LEGAL PROVISIONS UNDER COMPANIES ACT, 195
Section 6<, of Companies Act ,<B* provides for general powers of the !oard of directors. It mandates that the !oard is entitled to e$ercise all such powers and do all such acts and things' su"ject to the provisions of the Companies 7ct' as the company is authoriHed to e$ercise and do. 8owever' the !oard shall not e$ercise any power and do any act or things which is re=uired whether "y the 7ct or "y the memorandum or articles of the company or otherwise to "e e$ercised or done "y the company in general meeting. 7s to power of the individual directors' unless the 7ct or the articles otherwise provide' the decisions of the !oard are re=uired to "e the majority decisions only. Individual directors do not have any general powers. They shall have only such powers as are vested in them "y the *emorandum and 7rticles. Section 6<6+,- of the Companies Act ,<B* provides that the !oard of directors of a company shall e$ercise the following powers on "ehalf of the company and it shall do so only "y means of resolution passed at meeting of the !oard.. The power to make calls on shareholders in respect of money unpaid on their sharesB A. The power to authoriHe the "uy&"ack referred to in the first proviso to clause (") of su"&section (A) of section 337B 3. The power to issue de"enturesB 4. The power to "orrow moneys otherwise than on de"enturesB

24

:. The power to invest funds of the companyB and 2. The power to make loan. >5TI#S .. Statutory >utiesa. >o file return of allotment- Section 5B of the Companies Act ,<B* re=uires a company to file with the (egistrar' within a period of 3 days' a return of the allotments stating the specified particulars. <ailure to file such return shall make the directors lia"le as .officer in default. 7 fine up to (s. : ,& per day till the default continues may "e levied.

". ?ot to issue irredeemable preference share or shares or share redeemable after .0 years- Section )(' as amended "y Amendment Act ,<<*' for"ids a company to issue irredeema"le preference shares or preference shares redeema"le "eyond A su"ject to fine up to (s. . ' ,&. years. >irectors making any such issue may "e held lia"le as .officer in default. 7nd may "e

c. >o disclose interest +Section 6<<-4((-: In respect of contracts with director' Section AEE casts an o"ligation on a director to disclose the nature of his concern or interest (direct or indirect)' if any' at a meeting of the !oard of directors. The said Section provides that in case of a proposed contract or arrangement' the re=uired disclosure shall "e made at the meeting of the !oard at which the =uestion of entering into the contract or agreement is first taken into consideration. In the case of any other contract or arrangement' the disclosure shall "e made at the first meeting of the !oard held after the director "ecome interested in the contract or arrangement. #very director who fails to comply with the aforesaid re=uirements as to disclosure of concern or interest shall "e punisha"le with fine' which may e$tend to (s. : ' ,&.

d. >o disclose receipt from transfer of property +sec" 4,<-- 7ny money received "y the directors from the transferee in connection with the transfer of the company property or undertaking must "e disclosed to the mem"ers of the company and approved "y the company in general meeting. Itherwise' the amount shall "e held "y the directors in trust

25

for the company. This money may "e in the nature of compensation for loss of office "ut in essence may "e on account of transfer of control of the company. !ut if it is "ona fide payment of damages for the "reach of contract' then it is protected "y Section 46,+4-. #ven no director other than the managing director or whole time director can receive any such payment from the company itself. e. >o disclose receipt of compensation from transferee of shares +Sec"46(-: If the loss of office results from the transfer (under certain conditions) of all or any of the shares of the company' its directors would not receive any compensation from the transferee unless the same has "een approved "y the company in general meeting "efore the transfer takes place. If the approval is not sought or the proposal is not approved' any money received "y the directors shall "e held in trust for the shareholders' who have sold their shares. 7ny such director' who fails to take reasona"le steps as aforesaid' shall "e punisha"le with fine' which may e$tend up to (s. A: ,&.

f. Duty to attend ,oard meetings QSection 6)4+,- +.-U- 7 num"er of powers of the company are e$ercised "y the !oard of directors in their meetings held from time to time. 7lthough a director may not "e a"le to attend all the meetings "ut if he fails to attend three consecutive meetings or all meetings for a period of three months whichever is longer' without permission of the !oard' his office shall automatically fall vacant. g. >o con6ene statutory, $nnual 5eneral meeting 7$5 8 and also e9traordinary general meetings QSection ,*B ,** @,*<U- It is the duty of every company to hold a statutory meetingA3 and also forward a reportA; at least A. days "efore the meeting is to "e held which shall contain all the details as to the issued shares and their valuation along with the details of the issuer i.e. the directors' the auditors' and the promoters and such other managerial persons involved in the issue of those shares and raising the capital of
A3

S. .2: (.)- #very company limited "y shares' and every company limited "y guarantee and having a share capital'

shall' within a period of not less than one month nor more than si$ months from the date which is the company is entitled to commence "usiness' hold a general meeting of the mem"ers of the company' which shall "e called Cthe statutory meetin.D"
A;

S. .2: (A)- Cthe statutory reportD means that which the !oard of directors shall' at least twenty&one days "efore

the day on which the meeting is held' forward to every mem"er of the company

26

the company. The details of the a"ove&mentioned persons shall also "e incorporated in the report. The report is to "e signed "y at least two directors of the company and at least one should "e a managing director. 7ny contravention to this provision may also lead to a penalty of fine "eing imposed up to five thousand rupees upon the director or such other officers of the company. h. >o prepare and place at the $5 (Section ,54 6,( @ 6,5). i. >o authenticate and appro6e annual financial statement (Section 6,B)- #very "alance sheet and every profit and loss account of a company shall "e signed on "ehalf of the !oard of directors either "y the people mentioned in the su/-section +6- o% section 6< o% the ,anking #ompanies $ct, %&)& 7in case of "anking companies) or "y the manager or secretary along with not less than A,3rd of the directors present of whom one should "e a managing director if present (in any company other than a "anking company). j. >o appoint first auditor of the company (Section 66')' to appoint cost auditor of the company (Section 644B)' to make a declaration of sol6ency in the case of certain duties upon the directors and the officers of the company. JI7!IJIT0 a. <rospectus- <ailure to state any particulars as per the re=uirement of the section embers and 6oluntary winding up (Section '))) are also some of the provisions that "estow along with the balance sheet and profit @ loss

account a report on the companyDs affairs including the report of the !oard of >irectors

B* and Schedule II of the act or mis&statement of facts in prospectus renders a director personally lia"le for damages to the third party. Section *6 provides that a director shall "e lia"le to pay compensation to every person who su"scri"es for any shares or de"entures on the faith of the prospectus for any loss or damage he may have sustained "y reason of any untrue or misleading statement included therein. ". Gith regard to allotment- >irectors may also incur personal lia"ility for-

27

i.

Irregular allotment' i.e.' allotment "efore minimum su"scription is received (Section *<)' or without filing a copy of the statement in lieu of prospectus (Section 5() & QSection 5,+4-U & 5nder section 3.(3)' if any director of a company knowing contravenes or willfully authoriHes or permits the contravention of any of the provisions of section 2E or 3 with respect to all allotment' he shall "e lia"le to compensate the company and the allottee respectively for any loss' damages or costs which the company or the allottee may have sustained or incurred there"y.

ii.

<or failure to repay application monies in case of minimum su"scription having not "een received within .A days of the opening of the issue- 5nder section *<+B- read with S#!I guidelines' in case moneys are not repaid within .3 days from the date of the issue of the prospectus' the directors of the company shall "e jointly and severally lia"le to repay that money with interest at the rate of 2 T per annum on the e$piry of .3 th day. 8owever' a director shall not "e lia"le if he proves that the default in repayment of money was not due to any misconduct or negligence on his part.

iii.

<ailure to repay application monies when application for listing of securities are not made or is refused- 5nder section 54+6-. where the permission for listing of the shares of the company has not "een applied or such permission having "een applied for' has not "een granted' the company shall forthwith repay without interest all monies received from the applicants in pursuance of the prospectus' and' if any such money is not repaid within eight days after the company "ecomes lia"le to repay' the company and every director of the company who is an officer in default shall' on and from the e$piry of the eighth day' "e jointly and severely lia"le to repay that money with interest at such rate' not less than four per cent and
not more than fifteen per cent' as may "e prescri"ed' having regard to the length of the period of delay in making the repayment of such money.

c. Anlimited liability- >irectors will also "e held personally lia"le to the third parties where their lia"ility is made unlimited in pursuance of section 466 (i.e.' vide

28

*emorandum) or section 464 (i.e.' vide alterations of *emorandum "y passing special resolution). !y virtue of section 3AA' the *emorandum of a company may make the lia"ility of any or all directors' or manager unlimited. In that case' the directors' manager and the mem"er who proposes a person for appointment as director or manager must add to the proposal for appointment as a statement that the lia"ility of the person holding the office will "e unlimited. /otice in writing to the effect that the lia"ility of the person will "e unlimited must "e given to him "y the following or one of the following people' namely- the promoters' the directors' manager and officers of the company "efore he accept the appointment. <urther' in case of limited lia"ility Company' the company may' if authoriHed "y the articles' "y passing resolution alter its *emorandum so as to render the lia"ility of its directors or of any director or manager unlimited. !ut the alteration making the lia"ility of director or directors or manager unlimited will "e effective only if the concerned officer consents to his lia"ility "eing made unlimited. This alteration also' unless specifically consent to "y any or all directors will not have any effect until e$piry of the current term of office. d. 1raudulent trading- >irectors may also "e made personally lia"le for the de"ts or lia"ilities
of a company "y an order of the court under section B'6. Such an order shall "e made "y the court where the directors have "een found guilty of fraudulent trading. Section B'6+,-' in this regard' provides that if in the course of the winding up of a company' it appears that any "usiness of the company has "een carried on' with intent to defraud creditors of the company or any other person' or for any fraudulent purpose' the court' on the application of the Ifficial Ji=uidator' or the li=uidator or any creditor or contri"utory of the company may if it thinks it proper so to do' declare that any persons who were knowingly parties to the carrying on "usiness in the manner aforesaid shall "e personally responsi"le without any limitation of lia"ility' for all or any of the de"ts or other lia"ilities of the company as the court may direct. <urther' section B'6+4- provides that every person who was knowingly a party to the carrying on of the "usiness in the manner aforesaid' shall "e punisha"le with imprisonment for a term which may e$tend to two years' or with fine which may e$tend to fifty thousand rupees' or with "oth.

JI7!IJIT0 I< (7*7JI/K7 (795 7S 7 >I(#CTI(

29

Criminal Charges against (aju- Satyam founder (amalinga (aju and his "rother (ama (aju were arrested as part of the crackdown "y state authorities and the central government' which dis"anded the tainted IT firmDs "oard on a day of fast&paced developments. (aju was arrested and has "een "ooked in a case of financial irregularities' 7dditional >irector Keneral of C!&CI> 7.S. Shivnarayan said minutes after the police action. S "oth are in our custody. 7 case has "een registered and we will produce them "efore the court within A4 hours' 6aumudi told reporters outside the office >irector Keneral of +olice' 7ndhra +radesh. The :4&year&old (aju' who stepped down as chairman after admitting to the fraud and (ama (aju' who resigned as C#I and *> of the company' were arrested under five sections of the
Indian +enal Code)section .A ! for criminal conspiracy' section 4A for cheating' section 4 E for criminal "reach of trust' section '*) for forgery and also section '5, for falsification of records. 7ll the charges are non&"aila"le offences.AE In addition' under the Companies 7ct' >epositories 7ct and the Jisting 7greement' S#!I will have a cause of action for violation of mailing a false annual report to the shareholders. 7s Satyam%s 7>Ss are listed on the /ew 0ork Stock #$change' action may also "e taken in the 5S' including "y the S#C. The company may face a class action lawsuit "y its 5S shareholders. 3 *r. (aju and his "rother could "e proceeded against under the various provisions under the Companies 7ct' .E:2 and the Indian +enal Code for fraud' falsification of accounts and "reach of fiduciary duties as a director. In addition' they could also "e proceeded against for having violated the rules' regulations' laws and "ye& laws of the stock e$changes and S#!I & in particular' the Jisting 7greement. Since Satyam is listed on the /ew 0ork Stock #$change' they could also "e prosecuted under applica"le law of the 5nited States of 7merica. In addition to the a"ove' there could also "e criminal proceedings and civil shareholder lawsuits that could "e "rought against him and his "rother in India and in the 5S. <urther' the news reports seem to suggest that the Kovernment is considering referring the matter to the Serious <rauds Investigation Iffice and also mulling a concerted series of actions involving the S#!I' stock e$changes' Company Jaw !oard etc.3

*r. (aju and his "rother could "e prosecuted under S" '55A of the Indian <enal #ode, %B(0 for falsification of accounts and under S" ',) and S"'6( of the Indian +enal Code' .;2 for cheating
AE 3

http-,,www.livemint.com,A http-,,satyamscam.in,A

E, ., EAA:.3E,Satyam;A.3s&(aju&"rothers&a.html

E, .,satyam&scam&and&its&legal&implications,

30

with knowledge that wrongful loss may ensue to person whose interest offender is "ound to protect. In addition to the a"ove&mentioned provisions' certain other provisions of the Companies 7ct to provide for imprisonment for violations "y the directors and officers in default may "e attracted. In addition' they could also possi"ly "e prosecuted under Section '(* of the I+C for criminal "reach of trust. 5nder Section *6, of the 7ct' violations of the sections of the 7ct are cogniHa"le offenses and are therefore "aila"le. 8owever' the offenses may "e compounded which may lead to more serious charges. The offence under S" '55A of the I+C carries a ma$imum punishment of 3 years imprisonment and, or fine and is non& "aila"le. The offence under S" ',) of the I+C carries a ma$imum punishment of 3 years imprisonment and, or fine and is "aila"le. The offence under S" '(* carries a ma$imum punishment of 3 years imprisonment and is a non&"aila"le offence. The sons do not seem to "e directly implicated since they are involved with *aytas and not with Satyam. (aju in his letter states that none of his immediate family mem"ers had any knowledge of the fraud. The entire "oard of Satyam will share lia"ility. 7lthough (aju in his letter states that the other "oard mem"ers were not aware of the fraud' the independent directors will still face lia"ility =uestions "ecause they will have to prove that they were not in "reach of fiduciary duty. The independent directors also owe a duty of care and a fiduciary duty to the shareholders of the Company. 5nless the facts on record indicate that they were aware of the fraud or that they were "latantly and grossly negligent in their duties' it may not "e possi"le to "ring any proceedings against the independent directors. If they had not "een aware of the falsification of the financial records of the company' one could not hold them responsi"le for relying on the genuineness of the accounts as provided to them' as they had "een audited "y a reputed accounting firm.

C87+T#( C

31

SATYAM SCAM: LEADING THE PATH FOR MORE SUCH FRAUDS

In India the Satyam scam may "e gra""ing the headlines' "ut corporate frauds are likely to "e uncovered in many countries. In the leading capitalist economy' the 5nited States' such corporate frauds have "een rising sharply in recent years' according to data from the official investigating agency' as the accompanying chart shows. !etween A . and A 3' the num"er of corporate fraud cases that were opened "y the <!I (covering "oth corporate fraud per se and securities and commodities fraud) increased "y 43.3 per cent' even though convictions "arely increased. 7nd in A ;' the num"er of scandals that has come to light' and the sheer e$tent and audacity of several of them' almost defy description. 7 =uick look #nron case can help one understand how these frauds have started to occur or happen. +nron* The scandal of #nron was the gigantic scam that has unfortunately set the "ar for all the other scandals that have followed since A .. This was a financial scandal that could occur "ecause energy sector li"eralisation and financial deregulation in the 5S allowed for trading in electricity and natural gas futures' partly "ecause of intense lo""ying "y #nron and similar firms. Ghile the resulting energy price volatility adversely affected consumers' it delivered high speculative profits to what was originally a power generation firm "ut rapidly "ecame dominantly an energy trading firm. #nron then created as num"er of offshore su"sidiaries' which provided ownership and management with full freedom of currency movement. This also allowed any losses in such trading to "e kept off the "alance sheets. 7s a result' #nron appeared to "e much more profita"le than it actually was. /aturally its share price also Hoomed' allowing the managers to "enefit from the capital gains that they received from their employee&stock options and performance&related "onuses. It is easy to see how this created a dangerous spiral- those handling the finances had major incentives (and then increasingly felt e$treme pressure)

32

to cook the "ooks so as to show growing profits' even as the company was actually losing money. 7s the dotcom "oom in the 5S finally went "ust in A ' it "ecame even harder for

#nron%s managers to carry own with this creative accounting' until at last it "ecame impossi"le to keep up the pretence. 5ltimately the company could not even "e restructured "ut had to "e li=uidated. Thousands of #nron employees lost not only their jo"s' "ut also their savings and pensions' which were tied up in company stock. <ourteen of the company%s managers were accused' faced trial and sentenced on various charges of fraud' misleading the pu"lic' insider trading and other malfeasance. The role of the auditing company V 7rthur 7ndersen' one of the then !ig&<ive accounting companies V o"viously came under scrutiny. (emarka"ly' however' it was found that it could not "e held legally responsi"le for what was clearly criminal negligence and dereliction of duty over a prolonged period. Instead' the only charge that could "e "rought against it was o"struction of justice' for shredding documents related to its audit of #nron. 7nd even that was overturned "y the Supreme Court in A : on grounds of flaws in the instructions to the juryL 8owever' "ecause the 5S Securities and #$change Commission did not allow it to audit pu"lic companies' it could not retain via"le "usiness and the company collapsed. $delphia #ommunications #ompany* 7nother scandal of that period that has even more similarities to the Satyam case is that of 7delphia Communications Company' which was earlier cele"rated as a rags&to&riches story of two "rothers (9ohn and Timothy (igas) who had originally founded the company on the "asis of a W3 ca"le license. Ghen the company declared "ankruptcy in A 3 "ecause it was forced to disclose more than WA "illion in off&"alance&sheet de"t' it emerged that the (igas "rothers had used comple$ financial and cash management practices to transfer money to various other family&owned entities. In addition' federal prosecutors successfully accused them of salting away at least W.
31

million personally.3.

http-,,www.networkideas.org,news,fe"A

E,news AXCorporateX<rauds.htm

33

!efco* Similarly' the (efco case related to what would earlier "e called straightforward em"eHHlement "ut is now seen as a comple$ system of sophisticated financial irregularities. (efco' a finance company that specialised in commodities and futures contracts' was a private company that went pu"lic in the 7ugust A profita"ility. In Icto"er A :. Its share prices immediately rose "y more than A: per cent "ecause of its apparent history of high :' just "efore its collapse' it was the largest "roker on the Chicago *ercantile #$change. (efco%s downfall came a"out when it emerged that its Chief #$ecutive Ifficer' (ichard !ennett' had hidden a"out W43 million of "ad de"ts from "oth the rest of the company%s "oard and its auditors. 8e was a"le to do this through the simple and ridiculous e$pedient of "uying "ad de"ts from (efco' so as to prevent the company from having to write them off' and then paying for these "ad loans with money "orrowed "y the company itselfL Ghat is most e$traordinary a"out the (efco case is that this fraud was revealed only a few months after the company had made its first initial pu"lic offering (I+I) of shares. !efore such a pu"lic listing' due diligence and detailed e$amination of accounts are re=uired of the investment "anks that manage the I+I. In (efco%s case' the I+I was handled "y the top names in "anking- Koldman Sachs' Credit Suisse <irst !oston' and !ank of 7merica. 0et none of them had uncovered this huge hole of W43 million in "ad de"t that the C#I declared within a couple of months' nor had they even noticed the peculiar practice that the C#I had used to cover it up. So in this instance it was not just the auditors (the smaller accounting company Krant Thornton) that were found to "e la$ and inade=uate to the task. Ghile (ichard !ennett was sentenced to .2 years in prison in A ;' no action was taken against any of the others involved who had "een at "est very derelict in their duty.

Carious e$amples of past and present show that there are "right chances of the corporate fraud even after Satyam incident as they are neither new nor they are going to "ecome new "ecause the procedure may "e different from time to time "ut it is the investors who to "ear the "runt. #om6erse >echnology *

34

In A

2' Comverse1s founder and former Chairman and C#I' 9aco" ?6o"i@ 7le$ander

and two other former e$ecutives' former chief financial officer >avid 6rein"erg and lawyer Gilliam Sorin reported manipulated stock options for their personal gain and operated slush funds. 7s part of the scheme' the former e$ecutives misguided investors a"out /ew 0ork&"ased Comverse1s stock option grants. The result' Comverse' a maker of software' systems and related services for multimedia communication and information processing applications overstated its net income and earnings per share "etween .EE. and at least A A.

The three former e$ecutives allegedly earned millions of dollars and face multiple charges of conspiracy' securities fraud' wire fraud' mail fraud' money laundering and making false filings to the Securities and #$change Commission (S#C).3A !ack dating of stock options is reported to have victimised Comverse shareholders and prospective investors. 7le$ander' an Israeli citiHen' was arrested in /ami"ia in Septem"er A 2. 8e is free on

"ail while the 5S awaits his e$tradition to try him on account of 3: criminal counts related to securities fraud' including stock&option "ackdating. 7le$ander reportedly plans to plead not guilty to these charges. 8e recently won a /ami"ian court "id to postpone an e$tradition hearing until *arch 4' A Siemens* In A 2' (einhard SiekacHek' a former senior manager of the Kerman group Siemens received a two&year suspended prison sentence and was fined W.A;'34E for creating slush funds and companies to ac=uire contracts a"road. Siemens accepted that the scandal involved nearly W..; "illion descri"ed as unclear payments. SiekacHek admitted to his crime and told the court that although he tried to stop the organised "ri"ery' top managers did not take action. The judge said it was not clear whether those e$ecutives were also involved or had received the payments. 8einrich von +ierer' the former chairman' and 6laus 6leinfeld' who took office as chief e$ecutive' lost their jo"s following the scandal' E.

3A

http-,,sec.gov,news,press,A

2,A

2&.33.htm

35

which surfaced in /ovem"er A

2. 8owever' they denied any involvement and were not

charged with any misappropriation. #omputer $ssociates* In A 4' Sanjay 6umar' former C#I of Computer 7ssociates was found guilty of "eing

part of a WA.A "illion accounting scandal. 8e was tried for charges including conspiracy' securities fraud and hindering justice. 6umar was accused of developing a company practice called the ?3:&day month@' in which the sales people were asked to complete the deals after the =uarter and take out the timestamp from papers. This was done with the intention of inflating the company%s software sales figures to meet analyst e$pectations. 7ccording to charges against 6umar' he also encouraged the company%s employees to misinform the prosecutors and the S#C lawyers when the government "egan the investigations in A A. 6umar was sentenced to .A years and was fined W; million for false reporting software licence revenues and for lying to investors. <ive other former e$ecutives of the company also pleaded guilty to charges of fraud. Computer 7ssociates entered into a deal "etween Computer 7ssociates and government investigators to protect the company against prosecution. =orld#om* The former C#I of GorldCom' !ernard #""ers' was found guilty of the W.. "illion scam that led to the fall of the company in A A. This is considered the "iggest corporate fraud and "ankruptcy in the history of the 5S. #""ers was "lamed for "eing over& enthusiastic a"out maintaining the company%s share price high. 7ccording to the 5S government' #""ers instructed chief financial officer Scott Sullivan to conceal "illions of dollars in unmanagea"le e$penses and recogniHe illegal revenue from A to the S#C' which can "ring imprisonment of up to ;: years. Interestingly' the Satyam saga is similar to the 5lobal >rust ,ank' whose rise and fall was a story in itself.33 The edifice of KT! was "uilt on falsified accounts in an attempt to shore up valuations. The scandal surfaced when its then head (amesh Kelli tried to
33

to mid&A

A.

#""ers faces charges of securities fraud' conspiracy and charges of making false filings

http-,,www."ullrider.in,satyam&scam&raju&pwc,

36

diversify into insurance "y making an honoura"le e$it from the "ank. !ut that did not happen and KT! was ultimately merged with the Iriental !ank of Commerce. #ven in the Klo"al Trust !ank case' the auditors were none other than +ricewaterhouseCoopers and the (eserve !ank of India had then imposed a "an on their auditing "ank accounts. Ghat (amalinga (aju attempted and failed is e$actly the same. Ghatever "e his pu"lic pronouncements' the promoters tried to maintain a high valuation for the company and to ensure this the "ooks were fudged. 9ust as Kelli tried' he sought to wriggle himself out "y moving into real estate and infrastructure "y "uying the two *aytas companies. Ghen the deal was stalled' his fate was sealed. The other interesting element in the story is that "oth these shares V KT! and Satyam V figured among the . scrips that were operated "y 6etan +arekh (named as 6+ . ) in the infamous stock market scandal years ago. 7ccording to a 6+*K survey' India <raud Survey A ;' the trend of corporate fraud and

misconduct is likely to continue. The respondents of the survey "elieved that the ma$imum potential of committing fraud e$isted within the organiHations including the senior management and the employees. 7ccording to the survey' the inherent responsi"ilities and trust associated with senior positions' a"ility to override internal controls' internal knowledge and access to confidential company information that came with managerial position created a risk that of fraud. The survey found that the most prevalent form of theft would "e I+ or frauds related to e& commerce and IT. Gith the overall incidence of frauds rising in corporate India' there is a need for India Inc to deal with fraud risks firmly. ?The overall incidence of fraud is rising in corporate India in the last two years'@ the 6+*K <raud Survey (eport A . said. Survey responses' specifically from the financial services and consumer markets industry segments' see a higher level of fraudulent activities within their industry. The survey indicates Dprocurement% and Dsales and distri"ution% as the most vulnera"le areas across industries suscepti"le to fraud risk. ?The need of the hour is for organisations to realise the importance of putting effective internal control mechanisms in place' so as to manage risks'@ 6+*K <orensic 8ead' >eepankar Sanwalka' said. ?7ccounta"ility is no longer restricted to a

37

company as a whole "ut also streams down to each and every individual. It has "ecome imperative for companies to "e vigilant and aware and not just act when fraudulent situations arise'@ he said. <inancial statement fraud emerges as a major issue for investors. 7n overwhelming ;. per cent of the respondents of the survey perceive financial statement fraud as a major issue in India. Ineffective whistle&"lowing systems' inade=uate oversight of senior management activities "y the audit committee and weak regulatory oversight mechanisms are the reasons for the growing worries as well as the increase in the num"er of frauds that one can see in the industry today' the report said. ?*anaging the risk of fraud is essentially no different to managing any other type of "usiness risk. 7ll that it re=uires is resilience to com"at that fraud'@ 6+*K <orensic #$ecutive >irector' (ohit *ahajan' said. !ri"ery and corruption have come to "e viewed as an inevita"le aspect of doing "usiness in India "y many Indian companies' the report said. 7lmost 3; per cent of the respondents "elieve that "ri"ery is an integral feature of industry practises and is most rampant in seeking routine regulatory approvals and to win new "usiness from prospective clients' it revealed. 7ccording to :3 per cent of the respondent companies' e&commerce and computer&related fraud will "e a source of major concern in the coming years with supply&chain fraud' a close second followed "y "ri"ery and corruption and intellectual property fraud' the report said. 8owever' whatever "e the type of fraud' 3: per cent of the respondents indicate that' e$cept intellectual property (I+) fraud' fraudulent activities were perpetrated "y employees' reaffirming that the enemy within poses the highest risk' it said. These events in history show a deceitful tendency spurred "y e$cessive pressure to meet ?analyst e$pectations@. The =uestion is whether the Satyam episode will make other e$ecutives focus on productivity rather than resorting to such malpractices' or whether stringent regulations are re=uired to protect investors.

PART D

38

SATYAM SCAM: C!"#$%&'"( R)*+,-. !" /REFORMS0 OR /NO REFORMS0?

Companies !ill' A ; points to a new era when may"e it will "e easier to tackle frauds like

Satyam as the cru$ of the +roposed !ill is to strengthen the position of DIndependent >irectors% and at the same time also enforce stringent norms for corporate governance issues. In this respect certain key areas of the !ill have "een highlighted "elow The !ill re=uires pu"lic listed companies a"ove a prescri"ed siHe to reserve a third of all seats on the "oard for independent directors. It re=uires that independent directors (or their relatives) not do "usiness with the company which amounts to more than . T of the turnover of the company in the past two years. +ermitting financial transactions with the company up to this point creates a potential conflict of interest. The listing agreement under the S#!I 7ct prohi"its independent directors from a material financial relationship with company "ut does not define the term Dmaterial%. 5nlike the .E:2 7ct' the !ill limits the num"er of directors on the "oard of a company to twelve' e$cluding the nominees of lending institutions. Specifying a cap goes against the stated o"jective to ?provide a framework for responsi"le self&regulation@ "y allowing decisions to "e left to shareholders. The !ill prohi"its auditors from providing certain services' such as accounting and financial servicesB to companies they audit in order to prevent conflict of interest. Ghile prohi"iting the same range of services as specified in the !ill' the A The A services. The .E:2 7ct restricts transactions "etween a company and its directors' and certain other entities' on the grounds of possi"le conflict of interest. Kovernment approval is re=uired in most cases. The !ill restricts such transactions only for pu"lic companies "ut 3 7mendment !ill (now withdrawn) also allowed the government to add to the list of prohi"ited services. ; !ill does not give the government the fle$i"ility to notify other prohi"ited

39

"roadens the definition of a related party to include managers of the company. The approval of shareholders' rather than the government is now re=uired which means that share&holders have more say in these matters now. The !ill does not re=uire that the partners of a firm which audit the company "e rotated on a periodic "asis. The /aresh Chandra Committee had recommended compulsory rotation of audit partners of a company every five years. The Irani Committee' however' had suggested that such decisions "e left to shareholders of the company34 The !ill re=uires all listed companies a"ove a prescri"ed siHe to reserve a third of all seats on the "oard for independent directors. Clause 4E of the listing agreement under the S#!I 7ct' which companies sign with stock e$changes' re=uire those companies with a non&e$ecutive chairman to reserve one third of all seats on the "oard for independent directors. Those companies with an e$ecutive chairman must reserve half of all seats on the "oard for independent directors Thus' it can "e seen that the government is also striving hard to maintain status&=uo in the market of India and at the same time protect the interest of the investors "ut not at the cost of placing unreasona"le restrictions upon the !oard and its mem"ers e$cept to the e$tent of placing only certain restrictions which are necessary. In comparison with developed countries that impose stringent penal and criminal conse=uences for poor corporate governance' penalty levels in India are considered to "e inade=uate to enforce good governance. 3. percent of the respondents considered penalty levels to discipline poor and unethical governance to "e low. AA percent of the respondents were either undecided or did not know if the penalty levels are low.3: These statistics reflect the minds and thoughts of the legislators and the need of the hour to "ring some new laws to effectively cur" these economic offences. The Satyam scam may "e gra""ing the headlines in India' "ut corporate frauds are likely to "e uncovered in many countries. In the leading capitalist economy' the 5nited States' such corporate frauds have "een rising sharply in recent years' according to data from the official investigating agency' as the accompanying chart shows. !etween A
34 3:

. and A

3' the num"er of

Clause ,65 of Companies !ill A

E ;@ (eport availa"le at ?in.kpmg.com@

?The State of Corporate Kovernance in India- A

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corporate fraud cases that were opened "y the <ederal !ureau of Investigation (covering "oth corporate fraud per se and securities and commodities fraud) increased "y 43.3 per cent' even though convictions "arely increased. 7nd in A ;' the num"er of scandals that have come to light and the sheer e$tent and audacity of several of them almost defy description. This is remarka"le "ecause after the huge corporate accounting scandals of the early part of the decade' e$emplified "y the #nron scandal and the su"se=uent e$posure of significant firms such as GorldCom' 7delphia and +eregrine Systems' the 5.S. government took steps to enact legislation that would regulate corporate markets specifically to prevent such frauds. The Sar"anes&I$ley 7ct' which was passed "y the 5.S. Congress in A A and is officially A' was

known as the +u"lic Company 7ccounting (eform and Investor +rotection 7ct of A

meant to strengthen and tighten corporate accounting procedures. It esta"lished a new =uasi& pu"lic agency to oversee' regulate' inspect and discipline accounting firms in their roles as auditors of pu"lic companies. It also specified tighter rules for corporate governance' including internal control assessments and enhanced financial disclosure. 7ll this' it could "e supposed' would operate to prevent any #nron&type scandals from occurring at all. Indeed' those who opposed the 7ct argued that it created a comple$' over&regulated environment for 5.S. companies and that it reduced their competitive edge over foreign firms. It now turns out that far from "eing too restrictive' if anything the Sar"anes&I$ley 7ct was not effective enough. 7fter the spate of corporate financial scandals that actually resulted in the collapse of several companies in the early part of the decade' corporate fraud has apparently continued almost una"ated even in the 5.S. Ine reason for this may have "een in the design and implementation of the law' which did not take into account the crucial features of such scams' and the structure of incentives that "oth allowed and encouraged such malpractices to occur.32 It
32

?Ghile corporate fraud can impose significant costs on the economy when left unchecked' the evidence shows

that market mechanisms discipline much "ad "ehaviour while the criminalisation of corporate "ehaviour' coupled with "ringing highly comple$ cases "efore juries that can neither understand the issues nor their instructions' imposes significant costs on the economy "y deterring socially efficient risk&taking "ehaviour "y corporations and their e$ecutives.... The result is harm to the general pu"lic' whose mem"ers depend on a dynamic' competitive economy for their welfare.@ (8oward 8. Chang and >avid S. #vans' ?8as the pendulum swung too farM@ Ee.ulation' Colume 3 ' /o. 4' Ginter A 3&A ;.) availa"le at <rontline C?all o% shame internationalD "y 9ayati Khosh Q-olume .( / Issue 0C ** Dan. C%/1eb. %C, .00&3

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may "e also thus concluded that looking for a solution in line with the laws of the developed countries may not "e truly fruitful in nature as it might not lead to the desired result or even prevent such corporate frauds. <inancial crimes are no less heinous than the crimes dealt with "y the Code of Criminal +rocedure. /eed a new law to tackle such financial crimes is inevita"le. It is a sad fact of life that the #conomic Iffences Courts' set up with much fanfare two decades "ack' have proved a damp s=ui". The IC7I has "een dormant for several decades as can "e seen from the fact that in the first two decades of the formation of the accounting standards "oard' the IC7I issued only .: accounting standardsB it woke up in the past two years and rushed with .A more standards and more are in the offing. Ghereas these standards were not mandatory in the initial years S#!I has made it compulsory for the entire corporate sector to fall in line and comply with these accounting standards. It is in this conte$t that the need for internalising our accounting standards arises. Ine can also emulate the 5S e$ample (though their scenario is also writ with numerous scams and frauds) and esta"lish a permanent +u"lic 7ccounta"ility !oard. It is also necessary that S#!I is vested with powers similar to those enjoyed "y the S#C in the 5S.