CATEGORY: EXPENSIVE COMPENSATION

CASE STUDY: DEBACLE AT ENRON

Background
Enron pioneered a successful energy futures trading strategy in the 1990s after
industry deregulation in the 1980s.Enron became the seventh-largest company
in the US, with 101 $billions in revenue and 20,000 employees. At its height,
Enron controlled a quarter of all gas business, and soon expanded into myriad
energy-related products.

ENRON BOARD

Enron’s Board had 15 members, including several outside directors. The Board
had 5 committees, including an Audit and Compliance Committee and a
Compensation committee. Arthur Andersen was Enron’s external auditor.

Unfolding of Events
From 1999 -Enron created a number of special purpose vehicles that resulted in
the transfer of $25b debt. Enron diversified into many businesses.

Oct 2001-Mr. Lay said in the news release that the company was “very
confident in our strong earnings outlook.”

Dec 2001-Enron declared bankruptcy.

Overview of CG Failures
1) Excessive Compensation
2) High-Risk Accounting
3) Extensive Undisclosed Activities
4) Conflicts of Interest
5) Fiduciary Failure
6) Ethical Procedures Breakdown

Excessive Compensation
Enron had excessive compensation plans that resulted in a major cash drain:
One executive accumulated enough stock options to leave the company in 2000
with $265m in cash. In 2000, Ken Lay’s compensation exceeded $140m. In
early 2001, the company paid $750m in bonuses for 2000, a figure close to
Enron’s 2000 net income of $975m.

The Board and the Compensation Committee essentially failed in their

oversight and, in some cases, knowingly approved lavish compensation
practices. For instance, the Board approved company loans to the CEO, which
he could repay with company stock ($81m)—a practice that amounts to
undisclosed stock sale.

Director compensation was higher than in comparable listed companies.

Incorrect understanding of the role of the Compensation Committee: Enron’s
stated philosophy was to attract talent and reward them generously.
Compensation levels were gauged not according to company interest but to
keep ahead of competitor’s pay.

Fiduciary Failure
Enron's Board clearly in its fiduciary duties to safeguard shareholders' interest.

It allowed Enron to engage in: High-risk accounting, Transactions carrying

obvious conflicts of interest, Off-the-book activities, and lavish compensation
policies. The Board may have been misled by Enron’s management and, in
some cases, by the Auditor.

However, not until November 2001 did the Board recognizes red flags such as:
Waiving the code of ethics to allow personal transactions, some with the CFO’s
personal involvement, the significance of CEO Skilling’s resignation in August
2001, Information about major problems provided by employees in October
2001.

High-Risk Accounting
Enron’s Audit Committee failed not only to guarantee the independence of the
external Auditor but also to maintain proper accounting practices in accordance
with the interest of the shareholders. It approved structured transactions
designed to hide debt and overstate revenues rather than outcomes based on
economic objectives.

The Audit Committee missed many red flags:

Signals from Andersen about the risk of non-compliance carried by some of

Enron’s novel accounting practices. Communication from Andersen that Enron
was“pushing the limits” as early as 1999. An incredible number of related
entities—3,000—of which 800 were organized in tax havens.

Extensive Undisclosed Activities

The Board knowingly:

Allowed Enron to carry out major off-the- books transactions. Failed to

guarantee proper disclosure while off-the-book operations made Enron’s
financial statements appear much better than they were. Nearly 50% of assets
($27b) were moved off the balance sheet. Enron created, from 1999, a number
of special purpose entities (SPEs), managed by Enron's personnel and dealing
exclusively with Enron. Their techniques involved: Buying Enron's assets with
borrowed money (calling into question the role of the banks). Using Enron’s
stock as collateral. Enron assumed increased company risk and liabilities,
without proper disclosure.

Powers Report 2002:

Enron would…“use the value of Enron stock to offset losses in its investment
portfolio, and a highly complex accounting construct that was destined to
collapse.”
Conflict of Interest
An even more unusual case of SPE and related party transactions involved the
LJM private equity funds: Operated and partly owned by the CFO himself
(2000). Bought Enron’s assets at a discount—in one case, an 80% discount,
purportedly to protect Enron from losses. Some Board members expressed
doubt about the nature of the operation and tried to inquire properly into the
CFO’s compensation. The Board also waived the code of ethics to circumvent
the rule preventing employees from engaging in private deals with the
company. In the end, the Board failed to exercise its proper mandate,
despite doubts about transactions and the CFO’s
compensation.

Ethical Procedures Breakdown

The Board waived Enron code of ethics twice to allow the CFO to participate in
Special Purpose Entities. Waiving a code of ethics is unusual Corporate culture
did not allow dissent nor open or transparent debate.

Enron engaged in large-scale gift giving that resulted in many potential

conflicts of interest. For example, Enron gave to the prominent outside director
Dean Powers, whose school received $252,000. Overall, a misconception of
Enron social responsibility resulted in excessive and sometimes unethical
donations.

Lessons Learned from Enron Debacle

The lessons of Enron can be summarized as failures of diligence, ethics, and
controls. Fiduciary duties must not be neglected. The Board must be
independent from the corporation and its management. Related-party
transactions carry high risks. Conflict of interests need to be monitored closely.
External auditors must be independent. The accounting and auditing profession
must act competently. The corporate culture must be committed to integrity and
proper compliance procedures. Other market players, such as banks and
analysts, must play their own proper roles free of conflicts of interests.

Submit
ted by:
 Shashi
Minchael(2k92a38)
Praveen K
Singh(2k92a17)

CATEGORY : Bad corporate Governance

CASE STUDY : Satyam Failure of Corporate Governance

Satyam fraud is unfolding and so are the inherent weaknesses of Corporate

Governance in India. Ramalinga Raju, once a posture boy of India’s growing
software sector who could find a seat beside Bill Clinton on the dais, has
become a villain in the corporate world for valid reasons.

His emotionally charged four and half page letter of startling revelations shook
the entire corporate world when he admitted of cooking the account and
inflating the figure by Rupees 5040 crore.. He committed this fraud and tried to
hush up it by an abortive bid to purchase Maytas infra, a company created by
him and run by his son Teja Raju. The move was opposed by some of the
directors and thus last attempt of Raju to cover up the scam was thwarted. This
is the story in brief which all of us know.

This scam is being equated with Enron of USA because here also the scam was
orchestrated by its Auditor, Arthur Anderson, in Satyam, Price Waterhouse
cooper.

WHY DID RAJU UNFOLD THE SCAM HIMSELF-

There are two sets of serious questions which still desperately require answers.
Why did Raju, the mastermind of the entire fraud, accept the guilt? Why did he
choose to surrender before Police and not run away from India, which he could
have easily done? Why was this fudging done and for what? Secondly, what
were regulators and watch dogs like SEBI, ICAI, and independent directors
doing?
The question remained unanswered that whether this fraud shook the
conscience of Raju and he unraveled the truth out of sagacity, or he was simply
unable to hush up the matter which was increasing day by day assuming
insurmountable proportions? No simply not. It was a well calculated, well
strategized blended with legal opinion and well thought move to unfold the
story and surrender before the police.

Like many fathers, Raju too wanted to create two separate empires for his sons,
Teja Raju and Rama Raju jr. He subsequently formed Maytas infra and Maytas
info for Teja and Rama respectively. By the end of the 20th century, Satyam
computers had made a name for itself on the globe and had emerged as the 4th
largest software in the country. The meteoric rise of the company can be
substantiated by the fact that it was established in 1987 as private company and
got listed by BSE in 1991. In 2001 its share was listed in NYSE and in 2004 it
made its place in European stock market. According to company’s statement, its
revenue exceeds to 2 bn USD in 2008. Similarly Raju’s son’s companies also
were moving with leaps and bound. Maytas infra got the ambitious Metro
projects and bagged many tenders including one of construction of Technology
Park.

It is in this perspective, the question that everyone is willing to ask is that when
everything was fit and fine then why did Raju fudge the account of the
company and commit countries biggest fraud.

The fudging of account had started when the Maytas were formed. Raju started
diverting the cash from Satyam into Maytas and many other companies which
he had formed either in his own name or benami like Godavari bio, Godavari
agro etc. In fact such practices are very common and prevalent in many Indian
companies and it would not be a matter of surprise it similar frauds are
unravelled more in future. They do it for simple reasons, to help establish their
kiths and kin. This ‘drain of wealth theory’ is substantiated by the fact that the
share of Promoters in the company which was 25.6% in 2001, diminished to
3.6% in January, 2009. Similarly by 2008 Raju had pledged almost all his
shares and had thus siphoned off most of his shares. In fact according to
information retrieved from NSE, not only Raju but CFO V.Srinivas,
A.S.Murthy, V. Murli etc has sold shares of 3,6500, 3,14,000, 1,83,000
respectively. Raju inflated the account for increasing the price of shares so that
he and his accomplices get maximum profits, in which he succeeded also. The
day this news broke, the Satyam’s share was soaring. He wanted to hush up the
matter in December, 2008, when he made a desperate but unsuccessful bid to
purchase his son’s Maytas. It was vehemently opposed by one of the
independent directors Mangalam Srinivas, he subsequently resigned. Thus the
entire game plan of Raju was shattered. He, by now had come to know that he
is not going to succeed in his plan. He therefore, wrote an emotional letter and
confessed him fraud.

How did he do it? - As per the accounting practice the Bank accounts are
presented before the Auditors of the company by the CFO after its verification.
It seems that the fraud was initially connived by Raju and CFO Vadalamani
Srinivas. Later this nexus might have widened after possible inclusion of
auditors and the Bankers. The continuous inflating and cooking of accounts,
that too on such a big scale was going unnoticed and unchecked by the auditors
and the Bankers sounds absurd, therefore, the possibility of a connivance of
bankers and the auditors cannot be ruled out. CID has claimed that Raju had
inflated the numbers of the employees also, if it goes true, the involvement of
Banks would be proved beyond a shadow of doubt.

WHY DID RAJU SURRENDER AND NOT ESCAPE?- a very pertinent

question arises but surprisingly a very few is asking as to if Raju was aware of
the magnitude of his crime as well as quantum of its punishment then why did
he not escape and choose to surrender before the police.

Reasons are not far to search. The crime he has committed would attract
sections 406,409,420,465,471, etc of IPC and section 628 of Company Act,
1956 and can undergo imprisonment up to more than 7 years. He was fully
aware of it but at the same time he also knew that he would be sued in USA
under provisions of Security and Exchange Commission Regulation rule 10-5
B. These suits are called Class law suits and the compensation awarded under
this is huge. Raju knew it and thought that his entire earnings and his family
would be taken away and would be left with naught. On the other hand, he fully
understood the loopholes in the Indian Criminal Justice system which hardly
punishes white collar criminals. Ketan Parikh scam still is sub-Judice and is
expected to go years and years. It is this scam which ruined hundreds of
Cooperative Banks across Nation and plummeted Unit-64 a popular mutual
fund scheme of the UTI, India’s largest mutual fund company. Harshad Mehta
died without being finally convicted. Global trust Bank scam is still under the
labyrinth of law. Examples are many, results are same. He therefore preferred to
surrender than to face class law suits in USA.

IS CORPORATE GOVERNANCE IN INDIA NOT WORLD CLASS? -

Interestingly Satyam has bagged Golden Peacock award for best corporate
governance by World Council for Corporate Governance only a few years ago.
The scam has raised many doubts about the class of corporate governance in
India. While speaking at a seminar on corporate governance organised by CII,
Ministry of Company affairs and National foundation of corporate governance,
C.B.Bhave, the chairman of SEBI said on 6th February, 2009 that the corporate
governance is an ongoing process. There is a retrospection everywhere that
some concrete steps with respect to it should be done.

There are few important elements of corporate governance namely Auditing,

Independent Directors, Regulators and Finally the Board including CEO itself.
If we examine these constituents one by one, it would be crystal clear that all
the constituents either failed or did not act as was required.

The role of Price waterhouse Coopers(PwC), the Auditing firm of Satyam has
been dealt. Institute of Chartered Accountants of India (ICAI) constituted under
Charter Accountants Act, 1949 is the regulatory body of all the accounting and
auditing firms across the countries. According to a report there is acute shortage
of qualified chartered accountants and auditors in India and around the world
also. The number of CAs passing every year is hopelessly small. It is
apprehended therefore that the auditing firms out source unqualified or semi-
qualified commerce graduates of Post graduates to do the auditing in the
companies. The prestigious firms get the assignment by virtue of their name and
fame which they recklessly sell in the market by out sourcing the auditors at a
very low remuneration. In case of Satyam, the man who was supposed to do
audit was incidentally executive member in ICAI.
In a startling revelation, the auditors say that they approved the accounts
because of Raju’s ‘towering presence’ suggests how ridiculously the auditing
was being done. Thus if Scam occurred, the onus would undoubtedly go on the
firm. The kind of attitude which is adopted here in India in doing auditing is
certainly not in congruent with the standard of world class corporate
governance. In fact if we look at the functioning of institutions like ICAI, we
would come to know that they are in a way hijacked by a group of people. They
have the vast statutory powers but without any responsibilities. Over a period of
time so many extra constitutional authorities have come up in India and have
taken up the State’s role and act as per their own framed regulations. This needs
to be changed. This is the need of hour.
Secondly, the independent directors have also failed to discharge their
duties properly. Section 49 of SEBI Act and section 229 A of Company Act,
1956 provides for appointment of Independent Directors in the Companies for
protecting the rights of public at large in general and shareholders in particular.
In the case of Satyam T.R.Prasad, the retired Cabinet Secretary Govt of India
was one of the directors. It speaks a lot about the procedure of appointment of
independent directors. What kinds of people are being appointed in the
company? Moreover, they are appointed by the Companies themselves and pay
hefty salaries and perks for virtually doing nothing. Under this circumstance is
it thinkable that these Independent directors would dare to peep into the affairs
of the company against the wishes of the CEOs?

There are only two possibilities in Satyam with respect to Independent

directors. Either they connive with Raju and knew everything that was going
on, or they did not know. In both the cases they failed miserably to discharge
their duties. What is the need of such Independent Directors if they cannot do
anything in this matter? One unpalatable justification is given that the
Independent Directors participate in the meeting and are not concerned with
autonomy of the company. It should be bone in mind the Enron scam was
exposed by Sherron Watkins, a women independent director.

Thirdly, the SEBI and Ministry of Company Affairs too have failed in their
assigned jobs. SEBI is the highest regulator and keeps eagle eye on the
activities of the capital markets. When the profits of this company were
registering abnormal growth, thereby the prices of the shares were soaring, what
were these guys doing? There has been a lot of hue and cry with respect to
insider trading; a howl SEBI failed to listen to and it inflicted heavily on
Satyam. Raju had pledged almost all his shares so did many of the promoters.
The newly appointed CEO Murthy is also said to have sold about 3.14 lakhs
shares including 40,000 in December itself belonging to him and his family
members. These are the insider trading. Although insider trading per se is not
illegal but it is unethical, moreover when Company’s high official who were on
share selling spree must had the idea of what was going in the company. All
such transactions are needed to be probed.
 As a matter of fact the tax holidays for the IT-BPO companies also needs to be
said goodbye. Had Raju to pay the I.Tax according to the profits shown in the
accounts, he would not have fudged it to this scale. The ministry of Finance
must deliberate upon the entire gamut of issues related to tax heaven provisions.

Submitted By:
Pulkit Thakral(2k92a20)
Rohit Srigyan(2k92a29)
Umesh Gupta(2k92a47)