Corporate Fraud

What Frank Abagnale Jr.(Remember Catch Me if You Can) achieved in the space of ten years around the world, does indeed look completely out of a Hollywood script, except for the fact that it wasn’t fiction. To some, fraudsters evoke an image of street-smart brilliance unless of course you are one of three lakh investors who woke up one Wednesday morning on 7th January 2009 to find that they have been rewarded for their trust on Satyam Computer Services by stripping them of almost 90% of their investment in the company’s Sensex listing.
Mr. Ramalinga Raju confessed to fudging up Satyam’s balance sheet to the tune of Rs 5040 crores and other excesses which add up the total amount to about Rs.7000 crores.(a fraud larger than all of Indian politicians’ creative advances added up together). Mr Raju of course surrendered to the police and Satyam was stripped off Golden Peacock Global Award for for Corporate Governance under Risk Management and Compliance Issues. To quote Rahul daCunha, the brain behind the creative Amul Girl quotes ,“Satyam Sharam Scandalam” !! Mr. Raju employed a very simple technique to create the balance sheet misbalances. A company balance sheet has two basic divisions : liabilities and assets. He interchanged the liabilities and assets by 600 cr each quarter. It’s like changing the negative and positive signs of an integer. Only this time it involved investor’s hard earned money. On top of one “inflated” bank balance he was forced to add another since otherwise it would expose the previous fraud and make the company suspect as well as open to an acquisition which also would expose the fraud. This continued for some time with shareholders investing on false notions of a profitable balance sheet until recession struck and FIIs withdrew money , share prices dipped and Raju was forced to buy back his own shares and with his assets’(read: real estate) valuation decreasing, he ran out of ideas on how to control the fraud which had already assumed giant proportions. As a last ditch attempt he tried to acquire Maytas Infra(Note the palindrome) his family real estate concern owned by his sons ,which would induct fresh capital into Satyam and help sustain the fraud till the economic crisis ended; but due to large investor and Board of Directors’ dissent, cancelled the deal at the eleventh hour. By then the Satyam stock was already poorer by Rs 3400 crore due to panic selling. During the whole course he was helped by the blind sight of his auditors PriceWaterHouse Cooper (PwC), which is still under investigation not just by ICAI but by the CBI as well.
Corporate fraud is not a new phenomenon . Incidentally the largest ever investor fraud was revealed very recently in December last year when by one Bernie Madoff , an ex chairman of NASDAQ , finally plead guilty to defrauding many thousands of investors. Federal prosecutors estimated client losses which included fabricated gains of almost $65 billion. His asset management firm Bernard L. Madoff Investment Securities LLC was used to attract billions of investor money and he fabricated the returns from his investment in various securities and siphoned out the funds from his firm to his own account through huge salary paychecks. He marketed his investment method as “too complicated for outsiders to understand”, was secretive about the firm’s business, and kept his financial statements closely guarded. It was a neat ploy but faced with severe credit crunch coupled with the market mayhem , when investors demanded their money back he couldn’t pay back and his fraud was officially apprehended.
The Enron scandal was one of the longest running and complicated corporate fraud subject to constant media glare due to its magnitude and elaborate scheme. The mastermind, one Kenneth Lay, has confessed that the scam goes as back as 1985 when Enron was formed as a result of a merger between Omaha based Internorth and a Houston based Houston Natural Gas with Mr. Lay as the new CEO. No sooner was Lay at helm of affairs , than Enron plunged into debts and layoffs and asset sales followed. The following years were tumultuous years for Enron with regulation battles with Peru government and money laundering scandals . Many top brass people like Lou Borget took the hit but Lay survived. In the early 90’s the Congress of the United States of America passed legislation deregulating the sale of electricity. It marked the turnaround of Enron , which further thrived creating offshore entities, units which may be used for planning and avoidance of taxes, raising the profitability of a business. The names of these SPEs, or special purpose entities, were Bob West Treasure, Jedi and Hawaii .This provided ownership and management with full freedom of currency movement, and full anonymity, that would keep, losses the company was taking, off of the balance sheets. These entities made Enron look more profitable than it actually was, and created a dangerous spiral in which each quarter, corporate officers would have to perform more and more contorted financial deception to create the illusion of billions in profits while the company was actually losing money. In simple language in a world where Enron was swimming in debts and huge losses balance sheets were shown in green thanks to unloading these losses on these SPEs which were conveniently offshore. While of course the investors were kept in the dark the top officials rewarded themselves with millions of dollars of revenue. The vicious cycle continued until on August 14, 2001, Jeffrey Skilling, the chief executive of Enron, resigned citing personal reasons,selling minimum 450,000 shares of Enron at a value of around $33 million. It led to widespread speculation on Enron’s accounting but Lay managed to ward off all fears. However it was enough to send Enron’s stock into a dizzying fall and by October it had reached $20 levels from $80 levels in just a space of two months.By this time speculations were strife about the clarity of Enron’s balance sheets ,its many suspicious deals and fudged valuations. Lay did his best to allay investor worries and bought back commercial papers from banks to improve the credit crisis but its credit rating continued to dip and by the end of October it had been downgraded to just above junk bond, meaning it was only marginally profitable to invest. It was at this juncture that Dynegy another Houston based energy firm offered to buy Enron; however with news that Enron’s top officials had continually withdrawn company stocks to the tune of millions and with further downgrading of its credit rating coupled with the stock price falling to as low as $7,Dynegy finally called of the deal on November 28,2001.Its debts were vastly in excess of of its available cash and and the stock price fell to $0.61 by the end of the day. Enron filed for bankruptcy two days later, the biggest in US history at that time. Kenneth Lay was convicted with 11 counts of corporate fraud and falsifying accounts and securities
There are remarkable similarities between the Satyam and the Enron scandals. Both were extremely elaborate schemes with long timelines of account falsifying. They were both characterized by rapid falls in stages, of their share prices and while the Satyam fiasco comes as a blow to the Indian IT industry already reeling under the effects of recession, the Enron scandal was large enough to send the state of California into a full-fledged energy crisis. However there were notable differences ; while Lay managed to drive Enron to bankruptcy, Raju was conscious enough to come out with a disclosure before it was all over. Enron’s modus operandi was to siphon out all debts and losses to its off-shore entities which Raju could not manage after a failed attempt to acquire Maytas Infrastructure. One can only think what would have surfaced had the deal gone through.
As you can see, corporate fraud can have a devastating effect on the lives of people. A dangerous aspect is that often there are thousands of people affected , their life savings vanishing overnight .There was a lot of praise on the Indian Government when the Indian banks managed to stay shielded from the effects of the sub-prime crisis thanks to good regulation but the Satyam scam shows that India never learnt from the Enron scam. A big reason was maybe because it thought corporate fraud was unthinkable of in a third-world country such as ours. But we have to realize that India Inc. has come of age. We have giant MNCs and millions of dollars in FII and FDI investment each year and investors have millions at stake. That itself asks for a lot of regulations. Scams of such a magnitude can seriously dent FII and FDI confidence in our nation and they may abstain from investing in India . It hurts investor sentiments badly to say the least. Our government can no longer run away from it. “Keep IT Simple” should be the watch word.
In India, we have a system of Public Issue of shares with ‘Red Herrings Prospectus’. If you are a commoner like me you probably may not be aware of the meaning of ‘red herring’.Even a decade back ,by looking into the offer document of a public issue, an investor could get an idea of how much amount has been invested by the promotor of the company in the business and how many shares he had acquired with that amount. In the present system the ‘red herring prospectus’ is a very bulky document which does not reveal these basic data to the investor. This opens up a very easy way of laundering money by fooling investors through mere speculation. What is required is to restore INTEGRITY in our economy . The Govt can start with the following steps.
1. Congress needs to draft and implement basic reasonable and prudent regulations to establish corporate adherence to sound business principles as a legal requirement.
2. The financial auditing firms should be required to report infractions against the regulation standards to the oversight authorities.
3. Any CEO, CFO or corporate upper management or individuals in financial auditing firms who violate the regulations and standards should be prosecuted to the FULLEST extent of the law to provide deterrents for corruption.
4. The penalties and punishments for “white collar crimes” needs to be commensurate with the crimes; not just a token slap on the wrist or short sentences in “country club” detention centers or “white collar prisons”.
5.The CEOs and other corporate management are quite adept at setting up “fall guys” to take the rap for such illegal and fraudulent actions. The guilty parties should be prosecuted to the fullest possible extent; prosecutors should certainly look beyond “token fall guys” as a screen for upper management.

In its most simple and basic form, none of this is difficult. It is the “politics” and “creative accounting practices” that pervert the INTEGRITY of our economic systems, corporations and stock markets.But at the same time, there is only so much the regulators can do. Our corporates need to be more responsible and transparent with its record books to its investors. We are a growing economy and are going through a very rough patch what with recession and the Chinese intrusion into our markets. We can ill-afford these body blows if we are to grow unhindered.