What Happened at Satyam?Niti Dixit Satyam Computers Services Limited (Satyam) is one of India’s largest IT companies and is listed on the Indian and US stock exchanges. On 7 January 2009, the Chairman of Satyam, Mr. B. Ramalinga Raju issued a letter (the 7 January letter) to the Board of Satyam and the Indian stock exchanges and confessed that the books of Satyam reflected non-existent cash and bank balances, fictitious accrued interest, an overstated debtor position and understated liability in an aggregate amount of Rs.71,360 million (approximately US$1.5 billion). Additionally, the September 2008 quarterly accounts did not reflect the true position of the company’s revenues and operating margins and resulted in artificial cash and bank balances of Rs.5,880 million (approximately $120 million). Mr. Raju stated that the financial statements showed inflated profits over a period of several years. Satyam’s stock price had been under pressure since mid-December 2008, when its Board announced the proposed acquisition of two companies owned and controlled by Mr. Raju’s sons, Maytas Infra Limited (a listed company) and Maytas Properties Limited, for an aggregate purchase price of approximately US$1.6 billion. These two companies were in the infrastructure and real estate sectors and the proposed acquisition was of secondary shares held by the existing shareholders. The acquisition proposal was withdrawn after adverse investor reaction and four independent directors on the Board resigned subsequently. In the 7 January letter, Mr. Raju admitted that the proposed acquisition of the Maytas companies was an attempt to hide the gap in Satyam’s balance sheet by acquiring real assets. The stock market reaction to the 7 January letter was immediate. The share price fell from a high of Rs.188 to a closing price of approximately Rs.40 during the day. On 7 January 2009, the Indian stock market regulator, the Securities and Exchange Board of India (SEBI) commenced investigations under various SEBI regulations. The Ministry of Corporate Affairs of the Central Government separately initiated a fraud investigation through its Serious Fraud Investigation Office (SFIO). In addition, the Ministry of Corporate Affairs filed a petition before the Company Law Board (CLB) to prevent the existing directors from acting on the Board and to appoint new directors. On 9 January 2009, the CLB suspended the current directors of Satyam and allowed the Government to appoint up to 10 new nominee directors. Subsequently, the new, six-member Board has appointed a Chief Executive Officer and external advisors, including the accounting firms KPMG and Deloitte to restate the accounts of Satyam. Following the 7 January letter and in accordance with the requirements under the Indian and the United States accounting standards, PricewaterhouseCoopers (PwC), Satyam’s auditors, issued a letter stating that the audit reports and the opinion prepared by them for Satyam should not be relied upon. Mr. Raju, his brother (who was the Managing Director on the Board of Satyam) and the former Chief Financial Officer (CFO) have been arrested. Two PwC partners were also arrested in connection with the fraud. Their bail applications have been refused by the Metropolitan Magistrate’s court in Hyderabad and they continue to remain in police custody. The Institute of Chartered Accountants of India (ICAI), the body that regulates accounting firms in India, has also commenced an investigation of the auditors. Several class action suits have been filed in the District Court of the Southern District of New York, against Satyam, Mr. Raju, his brother and the CFO for violations of US federal securities laws. The members of the class have been identified as the purchasers of American Depositary Shares between 6 January 2004 and 6 January 2009. The US Securities and Exchange Commission (SEC) has also commenced its own investigation of Satyam. The SEBI and the SEC signed a non-binding memorandum of understanding in March 1998 for cooperation, coordination and the provision of technical assistance between the two regulators. These two agencies are also signatories to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information, which is a multilateral mechanism for sharing surveillance information between regulators. Legal and Regulatory Framework in India Action Taken by the Indian Government Section 388C of the Companies Act permits the CLB, if it is in the public interest, to issue interim orders and direct a person not to discharge his or her duties and appoint a suitable person in lieu thereof. Under Section 388C, the replacement person shall be deemed a “public servant” for purposes of the Indian Penal Code. Section 408 of the Companies Act permits the Central Government to take action against a company when there is an act of oppression against the minority shareholders under Section 397 of the Companies Act or an action of mismanagement of the company under Section 398 of the Companies Act. Section 403 permits the CLB to issue interim orders for any proceeding under Sections 397 or 398. Accordingly, the CLB invoked these provisions of the Companies Act to suspend the Satyam board and appoint new directors proposed by the Central Government. The SFIO was set up in 2003 under the Ministry of Corporate Affairs to investigate fraud and white collar crimes cases referred to it by the Central Government under Sections 235 and 237 of the Companies Act. This is in the case of circumstances suggesting, among others, that the affairs of a company are being conducted with the intent to defraud its shareholders, creditors or other persons or if the management has been guilty of fraud and misfeasance. The SFIO is conducting its investigation pursuant to Sections 235 to 247 of the Companies Act. In a separate investigation, the SEBI is considering initiating proceedings under the SEBI Act, the FUTP Regulations, the Insider Trading Regulations, the Merchant Bankers Regulations the Takeover Regulations, the SCRA and the SCRR. The CBI, the Central Government’s principal criminal investigation agency (distinct from the local police), has registered a complaint (a first information report) against Mr. Raju, the directors and the auditors of Satyam and certain others under Sections 120-B (punishment for conspiracy) read with Sections 409 (criminal breach of trust), 420 (cheating), 467 and 468 (forgery), 471 (use of forged documents) and 477A (falsification of accounts) of the Indian Penal Code. The CBI has also constituted a multi-disciplinary investigation team comprising officers of the police, banking and other disciplines. The ICAI and the Institute of Cost and Works Accountants of India have also nominated members on the team. The High Court of the State of Andhra Pradesh has directed that necessary assistance should be provided to the CBI. The investigation of the regulators is ongoing and no definite report or conclusions have been made available to the public. Applicable Regulations Under the Companies Act, any person who makes a false statement or who omits any material fact knowing it to be material, in any return, report, certificate, balance sheet, prospectus, statement or other document may be held liable to a fine or imprisonment or both. The shareholders of a company also have the right to file a suit against the directors of a company on the grounds of oppression and mismanagement. Under the Indian Penal Code, any person who is a party to a criminal conspiracy, commits a criminal breach of trust, is guilty of cheating, falsifies accounts or forges documents is liable to a fine or imprisonment that may extend to 10 years or both. The SEBI has the powers to issue orders and suspend the trading of any security, restrain any persons from accessing or buying, selling or dealing in securities, impound and retain the proceeds of any transaction and attach bank accounts. The SEBI can also impose a penalty in the amount of the higher of Rs.250 million (approximately US$5.2 million) and three times the profit from transactions relating to insider trading, the substantial acquisition of shares or unfair and fraudulent trade practices. Additionally, the SEBI can initiate criminal prosecution for these offences and hold a person liable for imprisonment for up to 10 years or a fine of up to Rs.250 million or both. Further, under the SCRA, a company can be held liable to a penalty of up to Rs.250 million for the failure to comply with the listing conditions. The stock exchanges also have the power to suspend the dealings with respect to the securities of such company. There are also various liability provisions and penalties specified under the FEMA and the Income Tax Act and other legislations such as the EPF Act. Under the FEMA, the penalty is civil in nature and may be up to three times the sum involved in a contravention. Under the Income Tax Act, a person may be liable to fine or imprisonment or both for contravention of certain offences. The auditors may be liable under the Companies Act, the Indian Penal Code and the CA Act, including for failure to report material misstatements, lack of due diligence and gross negligence of professional duty. Recent Developments In order to facilitate the sale process, the CLB issued another order on 19 February 2009 permitting Satyam to increase its authorized share capital, amend its memorandum of association and issue new shares without seeking shareholder approval under the Companies Act. The order also permits the company to induct a strategic investor subject to a transparent and open sale process, in a competitive bid auction overseen by a retired judge of the Supreme Court of India and upon obtaining necessary approvals. The regulatory authorities in India have also initiated proceedings against Maytas Infra and Maytas Properties, including seeking the removal of their respective boards and replacing them with Government nominees. Effect on the Regulatory Framework To facilitate a potential sale to a strategic investor, the SEBI has also amended the Takeover Regulations to permit the regulator, upon an application filed by the listed company, to waive any requirement under the Takeover Regulations in circumstances where the Board of the listed company has been taken over by the Government and there is a plan for a transparent and competitive process for the operations of the company. It has also amended the preferential allotment guidelines to facilitate the issue of new shares by a listed company in such a situation. Conclusion Since Satyam has approximately 53,000 employees (based on publicly available information, although there has been some speculation that this may be an overstated number) and is a listed company with retail investors, there is public interest in ensuring that there is no additional value erosion in the company and the sale to a new strategic investor occurs smoothly. The Central Government has taken active steps (with the Ministry of Corporate Affairs taking the lead) to see that an otherwise successful business does not fail. It is early to determine whether or not the sale process will be successful. One issue that may be relevant to the purchasers of the American Depositary Shares is the enforcement of judgments against assets in India, if required. A United States court’s judgment is not directly enforceable in India and a fresh suit will need to be filed in India to enforce such a judgment. As such, whether or not any proceedings will be successfully enforced, and within a reasonable time period, remains to be seen. Some of the regulators investigating Satyam include
The courts and tribunals that may get involved include
The principal laws and regulations include
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