The culpability of Satyam’s auditors
If Satyam Computer Services Ltd could show non-existent cash reserves of Rs 5,040 crore on its balance sheets and had been fudging its books for several years, it seems obvious that just one man, Raju alongwith his relatives, could not have done this by himself. There must be others in top management who were in cahoots with him because how could they not have asked questions about the fact that reserves and surplus of Rs 2,517 crore (March 2004) had almost tripled (Rs7221 crore) in just four years? Surely they must have asked how?
The company’s balance sheet has to be signed not just by the chairman and managing director but also by the company’s chief financial officer, and the independent directors are also supposed to ask questions. Okay, so the independent directors are often simply stooges, but what about the auditors who are the final stamp of authority?
Promoters and company owners can be greedy and dishonest, but that is exactly why there are auditors aren’t there, to protect the shareholders’ interests.
What were the auditors doing?
It is difficult to believe that proper accounting and auditing procedures were followed by Pricewaterhouse, the Indian arm of the global accounting firm PwC. Did the audit firm get a bank certificate confirming the actual cash balance? Clearly they didn’t get any such certificate directly from the bank. Instead, they could have relied on the company to provide it and if so, the certificate must have been forged. The ICAI (The Institute of Chartered Accountants of India) has made it mandatory that the audit firm should get verification of such a certificate by the bank, but this couldn’t have happened. The worst thing for Pricewaterhouse is if they did not get any bank certificate at all.
And then when it comes to tallying assets, or checking operating margins, these also need to be checked by looking at the paperwork from the company (often this is done on a sample basis) but Pricewaterhouse couldn’t have done this either.
But why was Pricewaterhouse negligent? Were they really negligent? After all, the discrepancy in the balance sheet is not small. In any case the job of an auditor’s firm is to be alert to fraud at all times and have plenty of what they call “professional skepticism.” Taking this into account, here are two scenarios:
- The auditors (or some employees of the audit firm) could have been taken into confidence by the management of the company and the books fudged with their full knowledge
- The auditing firm was inefficient and lazy
Exploring scenario 2 a little further, and assuming that a leading “professional” audit firm has been incompetent, we can think of some reasons for their incompetence:
- The audit firm was naive and stupid and trusted the management of Satyam completely and so neglected to do their job
- They were terrified of questioning the management for fear losing their business. They could also have been in complete awe of Satyam’s brand name and the promoters and dared not question anyone. Considering that ass licking is not something unknown, this could be so as well.
Although one cannot rule out scenario 2 (stupidity and asslicking), it seems more likely to me that scenario 1 (auditors knew what was going on) took place although the firm will try very hard to say they were incompetent.
Interestingly, the World Bank had pulled up Satyam as far back as 2006. It had informed the US Justice Department that it suspected Satyam of bribery and in 2007, the bank found some irregularities in the functioning of Satyam, but there is no reason to believe that the auditors were not made aware and asked to “help” with the problem, because as per World Bank rules, Satyam had the “chance to argue why it shouldn’t be banned” (from doing business with the WB.) And this happened as far back as 2007! And then in February 2008, the World Bank temporarily suspended Satyam from bidding on new contracts (with the WB), and then in September 2008 formally made the firm ineligible to bid on future contracts!! However none of this information was made public. Apparently, the World Bank debarment was for for ‘improper benefit to bank staff’ and ‘lack of documentation on invoices’. And this information was made public only on December 23rd when it was announced that Satyam was banned from doing any business with it for 8 years.
Problems in other parts of the world as well
That big reputed auditing firms get embroiled in accounting scandals is well known and this wiki list of accounting scandals illustrates this. Whether its Deloitte & Touche, Ernst & Young, KPMG or PricewaterhouseCoopers (the American mother of Pricewaterhouse in India), they have all been in deep waters. In fact PricerwaterhouseCoopers worldwide has been involved in scandals relating to Bristol Myers, HPL, JP Morgan Chase, Kmart, Lucent, MicroStrategy, Network Associates, NKFS and Tyco.
And our very own Indian Pricewaterhouse has been been in trouble earlier as well. Its auditing of the now defunct Global Trust Bank fell under suspicion. In that case, Pricewaterhouse was “unable” to detect huge levels of NPAs (Non-Performing Assets). And another entity of PricewaterhouseCoopers, Lovelock & Lewes, was found “guilty of manipulating share prices and falsification of accounts” of DSQ Software in India.
It’s surprising that despite its slip-up with Global Trust Bank, Pricewaterhouse did not lose its impressive roster of clients in India. Apeejay Tea, Bayer, Blue Dart, Bosch, Colgate Palmolive, Cummins India, Glaxosmith Pharma, Goodyear India, HCL Infosystems, HCL Technologies, Ingersoll-Rand, Marico, Maruti Suzuki, NDTV, Mastek and UTV Software are just some of them. Perhaps accounting scandals of the kind that happened with Global Trust and Pricewaterhouse are not a big deal in the accounting world?
In India it is thought that the controls on audit firms should be tighter. Rotation of auditors is a solution that has been bandied about for some years now. Finally this was okayed earlier this year (to come into effect by April 2009) by the ICAI. However, this requires the auditors to change only after seven consecutive years and that too this rule applies only to listed companies. One wonders whether the ICAI will now reduce this time period.
But even if the rotation idea is implemented, one has to be sure that loopholes are not taken advantage of. For example, audit firms could well be the sister firms of each other, and this defeats the very purpose of the rotation. Also, a minimum period before the same auditors re-join needs to be strictly implemented as otherwise this too will be defeating the very purpose of the regulation.
Perhaps India should should implement a “dual auditing pattern,” what they call a second audit, much like a second opinion. For example, in France and Denmark, there is the system of a joint audit, particularly for listed companies.
Other solutions that have been proposed are that audit firms should not be allowed to get more than half their fees from just one client, because this will tempt them to collude with the client.
Overall, there needs to be a greater scrutiny of the accounting firms, and their being blue chip should not come in the way! If they make some “mistake” all their clients need to be informed as to what exactly happened. Needless to say severe penalties even for small errors have to be implemented. Measures such as these will restore the confidence of the world in India’s accounting practices.
As for the erring firm Pricewaterhouse, well, the ICAI has promised strict action against any person in the auditing firm if found guilty. Disciplinary proceedings have already begun against the firm.
What’s the future for Satyam and Pricewaterhouse?
One wonders what will happen to Satyam. The company has already suffered a terrible beating at the stock market and the latest news is that the liquidity position is so bad that salaries may not be paid for January. Coupled with the ongoing recession, this scandal has affected business. So will there be a take-over by another company? Or will there be a new management which will restore confidence? I think everyone is looking to fresh faces in the top management. The worst thing that can happen is that the company goes bankrupt due to loss of business and law-suits. As for Raju and Co., they could face a jail term. As of now no one knows the full extent of his machinations. He has admitted only to cooking the books but more revelations could be in store.
Where Pricewaterhouse is concerned, it is believed that the investigations by Sebi, ICAI and the RBI (Reserve Bank of India) will take months and if the firm is found guilty, then it could even be de-barred from doing business, for good.
Like Satyam, Pricewaterhouse too could face lawsuits, particularly class-action suits. Already two such suits have been filed in the US against Satyam (Satyam is listed on the New York stock exchange.) Lawyers representing shareholders in a class action suit don’t charge their clients and get a percentage of damages awarded by the court.
(The cartoons are by Anshul of Brainstuck.com and specially made by him for this post. Thanks Anshul! Photograph of the Satyam building is copyrighted to me.)