Cracking the Satyam case

It will take more than one winter for the investigators to piece together the disparate strands of the Satyam story. Despite our fascination for quick results this one will likely take time.
That is because the corporate fraud by the management of the IT company was a "control fraud". A control fraud is operated by the guy who runs the company: the CEO. In all control frauds the CEOs deceive the world into believing they run a superbly successful firm, but which is actually spectacularly insolvent. As we find it difficult to imagine what incentive a CEO could have to cheat his own company, it then becomes impossible for us to believe that he could have duped the best accountants and lawyers in the business and then proceeded to even tap the regulators in the process. But that is how control frauds unfold. This is how the Enron unfolded and much earlier, again in the US, the savings and loan scandal erupted in the 1980s; and I am sure this is how the Satyam saga too will unfold in the days to come.
William K Black ,who as regulator, fought off the savings and loan scandal, which too was built on the real estate bubble, was one of the first to explain control frauds. Explaining the mechanism on which these frauds are built, Black says control frauds routinely enlist top lawyers and academics to aid their frauds. Shopping for appraisers is even easier than shopping for auditors and attorneys. The grossly inflated valuations made by appraisers allow outside auditors to rely on them, which in turn provide the cover of apparent neutrality to the control fraud to carry out his loot. So in essence the regulators instead of defending the interests of the investors end up advocating the interest of the client. One should remember that no frauds, in India or abroad, perpetrated by company managements have ever been uncovered by external auditors. When the fraud unfolds auditors often seek reduced liability.
Already the signs are there. In a report to the stock exchanges and the new board of Satyam, the auditors for the last eight years, Price Waterhouse have sought this position. They have said " the representations made by the Chairman and other management to the auditors during the audit now appear to be false and therefore are no longer reliable. On the basis of this new information about material errors and false representations, Price Waterhouse India has withdrawn its opinions on Satyam's financial statements ". So, we have to conclude there is nothing unusual in the way Ramalinga Raju used his control over the firm to buy outside support in the form of influential members in the board of directors and also used the cover of audited records to develop the fraud.
But that does not answer the two big questions. Why did it come unstuck now? An obvious answer could be the developing global crisis that made it simply impossible to raise any loan even on a totally fictitious balance sheet to continue the game any longer. But if that were so, the company could have still survived if it had chosen to by making the gamble bigger. Sure, the later explosion would have been harder for the economy but then, one suspects Raju would not have factored that consideration into his plans. The other question is that of the rationale. In a control fraud the CEO bends the company's core business to develop his plans. Enron for instance was overstating profits where none existed in its energy business. But Satyam was by all accounts a superb provider of IT services. The clients have had little to complain even now. So, the financial fraud that Ramalinga Raju engineered would seem to run independent of the company's core business.
It is these issues which make me feel the questions will take a far longer time to unravel. India is a late entrant to the global market of frauds. We have been conned by share market frauds so far. Accounting fraud is a new game for all of us and most important for our investigating agencies. The tax sleuths who man agencies like the Serious Fraud Investigations Office do not know this business. The other agencies have even more learning to do including the Registrar of Companies. The best management or accounting institutes do not teach frauds with any degree of sophistication. It will, therefore, be a long learning experience for the officials as they try to piece together the trail of several years.
The one blow that control frauds inflict on business is on trust. A modern capitalist economy sees millions of daily transaction that are often based only on verbal and even non-verbal assurances. Economists have found while transforming a communist economy into a mature capitalist economy that while institutions develop, a full blown market economy needs a culture of trust to develop. This takes time to develop. Frauds of this scale hit at those very foundations and so weaken the very basis of an efficient market economy.

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