In India, Clues Unfold to a Fraud’s Framework
NEW DELHI — How did B. Ramalinga Raju, the chairman of one of India’s largest information technology companies, carry out the biggest financial fraud in this country’s history? Apparently it does take a village.
And although the billion-dollar fraud at Satyam has been called this country’s Enron, an examination of the company’s accounting suggests the scandal may more closely resemble the fraud cases at HealthSouth and Peregrine Software.
A little over two weeks ago, Mr. Raju confessed to padding the company’s balance sheet by $1 billion in cash. But investigators now suspect he was less forthcoming than it first appeared.
According to a person involved in the case, investigators think at least some of Satyam’s cash reserves were genuine but were siphoned off to a web of companies controlled by Mr. Raju and his family.
This explanation is more plausible than Mr. Raju’s version of events, accountants and analysts said. Sales figures and earnings statements are relatively easy to manipulate, but lying about a company’s cash position is considered difficult.
“It is hard to believe that what he is saying is right,” said Saurabh Mukherjea, an analyst for the Noble Group, a British investment bank. “The scale of the cash manipulation is breathtaking and without precedent anywhere in the world.”
In September, Mr. Mukherjea used a computer model to examine India’s 500 largest public companies for signs of accounting manipulation. He found that more than 20 percent of them were potentially engaged in aggressive accounting, but Satyam was not on the list.
This is because the automated screens that analysts like Mr. Mukherjea use to pick up signs of fraud begin by searching for large discrepancies between reported earnings and cash flow. In Satyam’s case, the cash seemed to keep pace with profits.
But Kawaljeet Saluja, an analyst from Kotak Securities, an Indian investment bank, spotted a puzzling phenomenon. From December 2006 through September 2008, the company’s total Indian bank deposits remained more or less flat. But over that period the portion of that money kept in current accounts, which allow easy access to cash but earn little interest, increased more than sevenfold.
Mr. Saluja quizzed the company’s management during a September conference call. Satyam’s former chief financial officer, Srinivas Vadlamani, said the money would soon be transferred to higher-earning accounts.
Mr. Saluja pointed out that for the last four quarters “most of the incremental cash flows have been parked in current accounts” and asked Mr. Vadlamani again to “highlight a reason for it.” Mr. Vadlamani brushed the question aside.
Today, Mr. Vadlamani is in jail, charged along with Mr. Raju and his brother, B. Rama Raju, a former Satyam director, with conspiracy to commit fraud, cheating and forgery.
S. Bharat Kumar, the lawyer for the men, could not be reached for comment.
The presence of large sums of cash in current accounts could be further evidence money was being siphoned from the company, according to Mayur Joshi, an Indian forensic accountant.
The Satyam scandal bears only passing similarity to Enron, where top executives used a maze of special-purpose vehicles and related-party transactions to move liabilities off the company’s balance sheet.
Instead, Satyam may have more in common with HealthSouth, the rehabilitation services company that barely survived an accounting fraud uncovered in 2003, and Peregrine Software, which inflated revenue and earnings by hundreds of millions of dollars until prosecutors caught up with the company, also in 2003.
At HealthSouth, according to prosecutors, senior executives engaged in a conspiracy from 1996 through 2002 that inflated the company’s profits by $2.7 billion. Executives used a variety of techniques, including falsifying entries in the company’s accounting system. They also resorted to outright forgery, generating bank statements for 20 fake accounts that allowed the company to overstate cash reserves by more than $370 million. At Peregrine, prosecutors said, executives also falsified accounting entries to record nonexistent sales.
At Satyam, investigators say they are beginning to see signs of similar tactics.
K. Ajay Kumar, a public prosecutor, said that investigators had found one forged deposit receipt for an account with the Indian bank HDFC. Other forged bank statements also have been found, according to Indian news reports. Such forgeries may explain why Satyam’s auditors, Price Waterhouse, the Indian arm of the accounting giant PricewaterhouseCoopers, failed to raise the alarm.
In HealthSouth’s case, its auditor, Ernst & Young, contended it was duped by the company’s management, which presented it with fraudulent data. A number of investor groups, however, are still suing the accountants for failing to detect the scam.
Price Waterhouse has said it was unaware of Satyam’s inflated financial figures until Mr. Raju revealed them. Investigators are not so sure. Over the weekend, police arrested two Price Waterhouse accountants who oversaw the audit of Satyam’s books, charging them with criminal conspiracy and cheating.
Elaborate frauds like those at HealthSouth are extremely difficult for investors to detect simply by reading published financial statements. But when several accounting professors analyzed HealthSouth’s statements to the Securities and Exchange Commission after that scandal, they did find some irregularities — and some of these are present in Satyam’s S.E.C. filings, too. (Because its stock was listed on the New York Stock Exchange, as well as in India, Satyam had to file financial statements with the S.E.C.).
One is erratic fluctuations in the amount a company reserves for uncollectible credit sales. In 2005, according to Satyam’s S.E.C. filings, its revenue grew about 40 percent and its allowance for bad debts grew about 9 percent. The company reported similar numbers the next year. But in 2007, the company reported that revenue increased by a smaller amount — only 33 percent — and yet the company’s allowance for bad debt suddenly rose 19 percent. It leaped another 36 percent last year. The amount of bad debt the company actually wrote off annually varied wildly, but as with HealthSouth, it was always only a fraction of what the company had estimated.
Such data hints that at the very least Satyam’s management might have been massaging the company’s earnings to meet stock market expectations.
A footnote in Satyam’s 2007 and 2008 financial statements might have raised eyebrows too. It warned of an unquantified “increase in the collection period” for credit sales. The fraud at Peregrine began to unravel, in part, when the company, which had been booking fake credit sales, went to desperate lengths to conceal the growth in the amount of uncollectible revenue it was booking and the length of time customers were taking to pay.
There are other oddities in Satyam’s books, like fluctuations in the amount of unbilled revenue the company recorded. Unbilled revenue is work done for a customer but not yet invoiced. Analysts who follow outsourcing companies like to see unbilled revenue because it represents future earnings. But there is little documentation associated with the number, so unbilled revenue is easy to fudge.
One of the central pieces of the Peregrine fraud was the sale of receivables, many of them fraudulent, to banks. This technique, sometimes called factoring, generated cash on the company’s books. But in Peregrine’s case, the company was selling receivables it knew to be fake, and it often promised the banks to which it was selling them that it would cover any nonpayment from its customers. This meant the money the company received should have been booked as a loan and not as operating cash.
Again, at Satyam there is some evidence that factoring may have been used to inflate sales and profits as well as generate cash. Mr. Raju has told investigators that he had secretly pledged Satyam’s receivables from January to March 2009 to raise $245 million, according to accounts in the Indian press.
In his resignation letter, Mr. Raju took pains to say that Satyam’s directors and senior executives had no knowledge of the fraud. But if there is a final lesson of the HealthSouth and Peregrine scandals, it is that such elaborate financial games are usually the work of a large conspiracy. The chief executive or even the chief financial officer rarely acts alone. At Peregrine, the government ultimately charged 18 people with involvement in the scam. At HealthSouth, more than 17 executives, including five former chief financial officers, pleaded guilty to fraud-related charges.
In what might be an instructive tale for Mr. Raju, who is as politically connected in his home state of Andhra Pradesh as Richard M. Scrushy, HealthSouth’s charismatic founder, was in his home state of Alabama, Mr. Scrushy fought the fraud charges and was ultimately acquitted by a jury in 2005. But a year later, he was found guilty of bribing Alabama’s governor for a seat on a state hospital board and was sentenced to nearly seven years in prison.
Heather Timmons contributed reporting.