ACC 241 ACC Ensuring No Fraud Within a Company Discussion Questions

Satyam Computer Services Ltd.—India’s Enron
Imagine that you are on the board of directors of Satyam Computer Services and you receive a letter
from the chairman of the board that starts, “With deep regret and tremendous burden that I am
carrying on my conscience” and goes on to say that the company’s balance sheet includes: 1) cash of
more than $1 billion; 2), $77 million (m) of accrued interest that is nonexistent; 3), $253m of
understated liability arranged by the chairman; 4), overstated receivables of $101m; and 5) overstated
income statement profits for each of the last several years. Next, imagine that you were the audit
partner for Satyam! This is exactly what happened in January 2009 to both the board of directors and its
auditor Price Waterhouse India (PWI).
HISTORY OF SATYAM
Satyam, which means “truth” in Sanskrit, was founded by B. Ramalinga Raju in 1987 and grew to be a
leading outsourcing firm used by major international companies. India’s fourth-largest software and
services firm, it reported revenue of $555m (actual revenue of $434m) and had 53,000 employees in
2008 (or did it? Stay tuned).
Chairman of the board Raju’s confession seemed to spring from the board of directors’ denial of the
purchase of Maytas (Satyam spelled backward), a Raju family-controlled company owning thousands of
acres of property. Apparently, Raju planned to use Maytas assets to offset the fictitious assets at
Satyam.
The press had noted the company’s related-party dealings. Raju’s family members were on the Satyam
board and friends were in senior management. Even though it was a large company, no financial experts
were on the audit committee.
INDIAN ACCOUNTING ENVIRONMENT
Indian accounting standards are broadly similar to international standards, and the Indian accounting
profession is largely self-regulated. Traditionally, general standards of corporate ethics and accounting
have been suspect in India. Many companies had been created during License Raj, a period of
government intervention in which businesses had to work with politicians and pay bribes. In India
“promoters,” who include business families and other corporate insiders, held almost half of the shares
on the National Stock Exchange. However, because of its listing on the NYSE, Satyam was subject to the
Sarbanes–Oxley Act, which should have induced stricter governance.
Although the Big Four accounting firms have been eagerly touting the growth potential in India,
development there has been hampered by heavy national restrictions on the size and number of audit
clients a partner can serve. The relationship between PwC and PWI underlines what many see as the
patchwork nature of the big accounting firms. Each is a collection of national partnerships under a global
umbrella organization. The profession has tried to standardize practices and ethics across the firms, but
senior partners privately admit that quality can still be patchy. Some say the Big Four firms in India rely
on trainee-chartered accountants, and sometimes accountants simply copy the previous years’ audits
and the internal auditors’ work because they have limited time to complete the current audit.
THE FRAUD
This fraud, which is India’s biggest corporate fraud, apparently started in April 2002 when IT companies’
American depository receipts (ADRs) were popular among foreign investors. At that time, Raju decided
to maintain two subaccounts under a single company bank account. He and his cronies controlled the
main bank account, and the statements of the subsidiary account were under the control of the
company’s finance and account reconciliation (FAR) team. The accounting team would receive two bank
statements for the same account: a genuine set of statements from the bank and a second set of
fictitious statements provided by Raju and his team. The FAR team had to accept the fictitious bank
statements (and related interest accruals). Allegedly, even the auditors relied on the documents
supplied by Raju instead of obtaining third-party verification. The CFO, Srinivas Vadlamani, who was
arrested, said he had not been directly involved but knew there had been something suspicious for
more than five years. He had been specifically asked not to look at deposits. Vadlamani said the plan
was carried out by creating a paper trail of fabricated invoices, forged balance sheets, and counterfeit
bank statements in a scheme involving about 10 junior staff accountants.
Initial investigations have revealed that an in-house Satyam team developed software to generate
altered invoices that included the genuine name of a client and of the client’s project manager but with
an overstated invoice amount. For example, a Satyam client, XYZ, pays 100 rupees to Satyam’s bank
account as fees. The original bank statement showed 100 rupees deposited by XYZ, but the statement
provided by Raju overstated this figure. Year after year, altered invoices in the name of genuine clients
and employees were created and went unnoticed by auditors.
The unrecorded liability of $253m was the amount that private companies owned by Raju lent to
Satyam. To keep analysts and investors at bay, the loan amount was not shown in the books. Had it
been shown, it would have raised eyebrows. After all, why would a company incur this liability when it
had so much cash on its books?
In addition, the public prosecutor noted that the CFO (Vadlamani) had admitted during interrogation
that Satyam had just 40,000 employees versus the 53,000 officially claimed, and the fictitious wages
were siphoned off. The prosecutor claims Raju used a fictitious name to divert $4m a month from the
company’s account for his personal wealth. India’s Serious Fraud Investigation Office has found that
$100m raised through the issuance of ADRs did not end up in the company’s bank accounts and has still
not been found.
Although the company’s bank balance was fictitious, the employees had to be paid real salaries. To meet
these expenses, Raju and his family started pledging their stake in the company. The shares were
pledged by a holding company, SRSR Holdings, which in turn had approximately 300 subsidiaries. India’s
Central Bureau of Investigation (CBI) has found that some of the documents of the companies created
by Raju contained land records and names of land mafia agents, indicating that the case may be more
than just an accounting fraud.
THE AUDITORS
Even though PWI had been Satyam’s auditor since 2000, it resigned. Indian police have arrested two
partners of PWI on charges of criminal conspiracy and cheating. PwC says, “The audits were conducted
by PWI in accordance with applicable auditing standards.” Vadlamani, the former CFO, said the auditors
had not been complicit in cooking the books and had been given forged documents. The auditors had
relied on documents provided by management such as account balance statements and letters of
confirmation of account balances.
More specifically, Dennis Nally, then global leader of PwC, said to Business Today:
If our job was described as to provide a 100 per cent assurance that there have been no material
mistakes and no frauds have been committed, that would require audit firms to significantly increase
the amount of work we do today and have much more forensic and different types of auditing. As we all
know, when there is a desire at the top of an organization to commit a massive fraud, individuals in the
organization that have participated in the fraud can do a lot of different things to keep it away from
individuals, including auditor firms, the Board of Directors and the analyst community.
FOLLOW-UP
Indian authorities arrested Raju and his brother Rama on complaints of cheating, forgery, breach of
trust, and other charges. Police called in cyberforensic experts who can retrieve erased data from
computers. In all, 10 people have been arrested.
PWI suspended its chief relationship partner and engagement leader on the Satyam audit, set up an
advisory board, conducted a review of work and processes, and appointed a new head of quality
assurance and risk management. While screening through the minutes of some of the board meetings,
investigators found that the total audit fees paid to PWI for its domestic and international accounts was
around $1.4m, almost double the figure mentioned in the balance sheet.
The information concerning the probe initiated by the Crime Investigation Department (CID), the Serious
Fraud Investigation Office (SFIO), and Institute of Chartered Accountants of India (ICAI) was handed to
the CBI. After some initial work, the CBI confirmed to Business Today that Raju seems to have come
clean in his confession letter except for his statement about not having benefited in financial terms as a
result of inflated results. “We are yet to establish if there was any diversion of funds from Satyam to any
of Raju’s entities. This will take some time to investigate,” added the CBI official. Decoding the biometric
laptops used by Raju and his team, screening the internal financial software of the company and
minutes of the board meetings for the final six years, scanning papers of the approximately 300
companies created by Raju and his family, and scrutinizing the land records under these companies was
expected to keep the CBI busy for months.
In fact, during an interrogation session, Raju is believed to have said that he never did anything wrong
because everyone else in the industry does it.
On April 5, 2011, the PCAOB and the SEC announced a joint penalty of $7.5m against the five firms
composing PW India, a member of PwC. At the time, it was the largest such penalty ever assessed
against a registered foreign accounting firm. The firms were also given other sanctions, including a sixmonth ban on accepting new SEC clients and the imposition of quality controls. In addition, the Institute
of Chartered Accountants of India (ICAI) has barred two Indian auditors, Pulavarthi Siva Prasad and
Chintapatla Ravindernath, from “the register of members permanently” for their role in the crisis.
In the release of its findings, the PCAOB said the auditors had relied on management to send
confirmation requests to Satyam’s bank and to return responses to the auditors even though the audit
programs “explicitly acknowledged that the engagement team should maintain control of the process of
sending confirmation requests and receiving confirmation responses relating to the confirmation of
cash.” Moreover, a network firm partner reviewing the documentation “advised that the engagement
team ‘can only take credit for [cash] confirmations we send [to] and receive directly [from the banks].’”
The partner “noted that the Company had a significant balance of fixed deposits and advised the
engagement team to ‘document that confirmations have been received [from the banks] for such
amounts.’” There had been similar shortcomings in the confirmation of accounts receivable, even
though the firm had noted numerous internal control deficiencies. “These confirmation deficiencies
contributed directly to the auditors’ failure to uncover the Satyam fraud,” said James R. Doty, PCAOB
Chairman.
DISCUSSION QUESTIONS
1. Do you agree with Dennis Nally’s comments?
2. How do you think Raju could have used Maytas assets to cover up the fraud?
3. Why are related-party frauds more difficult to detect than frauds with no related parties?
4. Should U.S. public accounting firms try to audit internationally in cultures they may not understand?
If so, how can they maintain quality audits?
5. Can an international firm have one set of absolute ethics standards that must be followed at all
times, or do ethics standards need to be flexible enough to account for variations in cultures?
6. How can auditors ensure they are receiving authentic documentation, not forgeries?
7. In your opinion, should PWI be subject to civil litigation?
Source:
Auditing and Assurance Services 7e, Louwers, Blay, Sinason, Strawser and Thibodieau, Mcgraw-Hill
Education, 2018.