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 On the basis of this new information about material errors and false representations, Price Waterhouse India has withdrawn its opinions on Satyam's financial statements ".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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Why Lehman Bros went bust; what it means for you

Lehman Brothers is no more. Merrill Lynch has gone down the Bank of America maw. AIG too could go belly up. With a doubt, these developments in America are the most shocking events to have hit global financial markets. So where did it all begin? And what does it mean for the Indian stock markets? Find out. . .
What is (or was) Lehman Brothers?
America's fourth-largest investment bank Lehman Brothers Holdings Inc has filed the biggest bankruptcy petition known to mankind.
The 158-year-old firm was founded by brothers Henry, Emanuel and Mayer Lehman, Jewish immigrants to the US from Germany, in 1850. Henry set up a general store in Alabama in 1844 and was later joined by his brothers. In 1850 they set up the merchant bank in New York after having made money in railway bonds. So what went wrong?

Lehman Bros, which till June 2008 had not reported a quarterly loss even once, had earlier survived many an economic crises, like railroad bankruptcies of the 1800s, the Great Depression in the 1930s, and the collapse of Long-Term Capital Management in the 1990s.
Thus the collapse of the giant investment bank came as a major shock for the entire world markets that plunged after Lehman filed a Chapter 11 petition with US Bankruptcy Court in Manhattan.
The $613 billion (some estimates put the size at $639 billion) bankruptcy thus throws up the question: why did the Wall Street giant go bust? Here's why. . .

Why did Lehman Brothers go bankrupt?
The giant investment bank succumbed to the sub-prime mortgage crisis that has rocked the United States and the global economy. Lehman was strangled by a massive credit crisis and fast plummeting real estate prices.
The gargantuan $60 billion loss in bad real estate loans forced the bank to file for bankruptcy.
However, the fall of the 158-year-year institution that started cotton trade in US before the American Civil War and financed the railroad that built a nation, got hit by a large dose of bad luck, pride, arrogance and greed. Primarily, the pride of its chief executive office Richard Fuld.
But there were more reason. Check out what they were. . .

Lehman's collapse was also triggered by the refusal of other banks to do business with it because of its complex and, at times, opaque ways of trading. Housing loans made by the bank to people with little support made these loans very risky, and when interest rates rose, these borrowers could no more repay Lehman. This led to huge losses, the extent of which is not yet clear.
Thus other banks stopped trading with Lehman. This led to it losing almost all business and triggered its fall.
The final straw for Lehman was the fact that both Barclays Plc of the United Kingdom and Bank of America Corp pulled out of takeover talks. BofA bought out Merrill Lynch for $50 billion.
However, Barclays has now said that it is in discussions with Lehman Brothers about buying certain assets of the stricken US investment bank.
"Barclays confirms that it is discussing with Lehman Brothers the possible acquisition of certain Lehman Brothers assets on terms that would be attractive to Barclay's shareholders," Britain's third largest bank said in a statement.

When other banks do not want to buy Lehman, why is Barclays interested?
Barclays wanted to buy Lehman out at a discount, so to speak. But when Lehman CEO Fuld decided that his bank was worth much more than what Barclays had apparently offered, Barclays stepped back.
Now that Lehman has filed for bankruptcy, its assets are available fairly cheap. However, the biggest problem is to take on Lehman's enormous liabilities.

How far is the CEO of the company responsible for Lehman's fall?
Wall Street analysts believe that it was the 'hubris' of Richard Fuld, the 62-year-old CEO of Lehman, who did not take the telltale signs of impending doom very seriously. Fuld, nicknamed The Gorilla for his foul temper, intimidating presence and tough talk, rejected many bids to save Lehman because he thought that the sinking giant was much bigger than Wall Street was giving it credit for, and wanted to get more price for the sale of the company.
Analysts say if the bank was sold just a week before it went kaput, it could have been saved the ignominy of a bankruptcy, but Fuld was far too adamant to see reason. Result: the end of a 158-year-old financial giant.

Could the United States government helped, like it helped Bear Stearns in May this year, and Fannie Mae and Freddie Mac earlier this month?
The US government could have helped, but US Treasury Secretary Henry Paulson said that it would not use up any more taxpayer dollars to bail out Lehman Brothers as it would lead to investment banks getting away with their gambling ways. Paulson had bailed out Fannie Mae, Freddie Mac and Bear Stearns, saying that if the government had not done so, the US housing loan market would have collapsed leading to gigantic losses for hundreds of banks all over the globe that have invested in US property.
Paulson, however, believes that a brokerage major like Lehman, which does not have a direct connection with ordinary people who have taken on home loans, need not be bailed out as it would not cause any systemic damage to the US economy.

Will the whole bank be liquidated?
Unlikely, at least for now. The US Chapter 11 that deals with bankruptcy says that PwC, the administrators, can go about taking its time to find good offers and buyers for Lehman's 'least affected businesses.'
The entire exercise can take months before all of Lehman's assets are sold, given the complexities linked to the bankruptcy

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