Monday, January 19, 2009

Price Watergate

"The chairman of one of India's largest technology companies said he concocted key financial results, including a fictitious cash balance of more than $1 billion, sending shock waves across India and likely prompting investors to question other corporate results as the once-hot economy slows. B. Ramalinga Raju, founder and chairman of Satyam Computer Services Ltd., [SCSL] said in a letter of resignation that he also overstated profits for the past several years, overstated the amount of debt owed to the company and understated the liabilities. Eventually, he said, the scheme reached 'simply unmanageable proportions' and he was left in a position that was 'like riding a tiger, not knowing how to get off without being eaten.' ... Satyam--the name means 'truth' in Sanscrit--was audited by PricewaterhouseCoopers [PWC] and has had high-profile independent directors, including a Harvard Business School professor on its board. With 49 world-wide offices including eight in the U.S., Satyam was also one of India's flagship technology companies that have come to define a new, modern Indian industry that competes on the world stage. [PWC] said it was examining Mr. Raju's statement and declined to comment further. ... Immediate comparisons were drawn to the watershed in U.S. corporate accounting and governance standards that stemmed from the Enron crisis a few years ago", my emphasis, Niraj Sheth, Jackie Range (JR) and Geeta Anand at the WSJ, 8 January 2009.

"The implosion of [SCSL] may batter the World Bank, which kept quiet until last month about its suspicions the firm engaged in bribery", Bob Davis at the WSJ, 8 January 2009.

"The huge accounting scandal at [SCSL], ... could lead to an overhaul of corporate-governance standards in the country and force changes in how Indian companies do business. ... Yet there is no indication it was detected by the company's auditors, [PWC]. 'It's kind of hard to miss $1 billion of cash,' said Dennis Beresford, a former chairman of the Financial Accounting Standards Board, a U.S. accounting watchdog. ... It also could embarass the World Council for Corporate Governance, a London-based organization that helped create the 'Golden Peacock Awards.' Satyam received a Golden Peacock Award for Corporate Governance last year", my emphasis, JR and Joann Lublin at the WSJ, 8 January 2009.

"[PWC], the long-standing auditor of stricken software company Satyam, faces the prospect of disciplinary action by market regulator SEBI if it is found that it failed to verify the autheticity of financial documents furnished by the company. ... Independent auditors feel the regulator's approach may be too harsh. Officials at audit firms say that if they start verufying the veracity of all documents given to them, would become a full-fledged investigation into the company. ... 'How can we verify the authenticity of millions of pages while auditing a company with a turnover of thousands of crores in a few days?' said an auditor working with one of the big four accounting firms, who asked not to be named. Auditors certify that the financial statement reflect a "true and fair" picture of the state of affairs of the company, and not an accurate picture", he added. The SEBI official, however, rubbished this argument", my emphasis, Junior, 8 January 2009 at http://jraccountant.blogspot.com/2009/01/pwc-epic-indian-failure.html.

"Debate in Mumbai is now focusing on whether Satyam, India's fourth-largest computer software company, or its multinational auditors [PWC], was more to blame for what is possibly corporate India's worst scandal. ... Contrary to perceptions that this is a brand new financial scandal, the Satyam fraud appears to be the latest variant of financial scams involving manipulating information with the aim of duping investors, while involving regulatory and accounting practices not traditionally used in India. ... The general verdict of accountants in Mumbai is that Satyam's auditors blew it big time, whatever fraud and forgery the management could have produced to hoodwink them in a scandal that is estimated to have cost Satyam investors $2 billion on January 7 alone as the stock plunged by 77% on news of the fraud. ... PWC, formed in 1998 through the merger of Price Waterhouse and Coopers & Lybrand of London, faces a choice of either being found so utterly incompetent that it could not spot a $1.5 billion-sized accounting crater, or that it was party to the investor fraud that presented an annual 24% growth rate in Satyam balance sheets instead of an actual 3% growth rate. ... In other words, Satyam auditors have not apparently undertaken what traditionallly would have been the minimum independent verification of the client's accounts as a chartered accountant firm is supposed to do", Raja Murthy, 9 January 209 at http://www.atimes.com/.

"[PWC] , which signed off on [SCSL] finances for several years without detecting the fraud by Satyam's founder and chairman, defended its procedures on Thursday. [PWC] said, in a statement send by email, 'The audits were conducted by [PWC] in accordance with applicable auditing atandards and were supported by appropriate audit evidence.' It said it is cooperating with regulators. ... A [PWC] spokesman declined further comment. Srinivas Talluri, the [PWC] partner who signed off on Satyam's most recent annual accounts in Hyderabad in April last year, couldn't be reached. ... Also in his letter, Mr. Raju said the company's cash and bank balances had been inflated by more than $1 billion dollars. 'This is the easiest thing to verify,' said Vinesh Chandok, national managing partner of accountant Grant Thornton", JR and Scott Patterson at the WSJ, 9 January 2009.

"Indian authorities moved to contain the fallout from the fraud at [SCSL] by arresting the company's founder, firing its remaining board members and launching an accounting review of India's biggest publicly traded companies. ... In an unprecedented action, the government also said it will install directors on a new 10-member Satyam board that will meet within one week. A board meeting that had been scheduled for Saturday was canceled. ... The Securities and Exchange Board of India [SEBI], the chief markets regulator, said Friday it will review auditors' working papers relating to companies in the Sensex and the National Stock Exchange 50-share index in a bid to boost investor confidence in financial disclosures. ... C.B. Bhave, SEBI's chairman ... said recent results for big companies would be subject to peer review by another auditor; other company results will be subject to peer review by accounting firms on a random basis", Eric Bellman and John Kumar at the WSJ, 10 January 2009.

"If this scandal proves anything to transnational investors and corporations it would be that doing business in India may be less risky than doing so in the more criminal friendly USA. India is demonstrating that it has very little tolerance for white collar fraud and they are showing that corporate criminals will be swifly punished. It is yet to be seen if most of those arrested will bribe themselves out of trouble but so far the punishment is more severe than aything we see in the U.S. In contrast to India, the U.S. coddles its corporate criminals by allowing them to stay on the job with big pay raises, or giving them golden parachutes so that they can retire in the Bahamas", Rob Sanchez, 12 January 2009 at http://blog.vdare.com/achieves/2009/01/12/satyam-scandal-wont-change-anything/

"Suresh Senapathy, the chief financial officer of Satyam rival Wipro (WIT) said it was 'impossible to imagine that this could happen. I can't believe that five or six years' worth of misappropriated books and accounts missed the scrutiny of auditors'," Elliot Wilson at Barron's, 12 January 2009.

"The board at troubled [SCSL], freshly appointed by the Indian government, said it is looking for a new auditor. ... 'New independent accountants that we appoint shortly will restate the numbers and confirm the veracity of those numbers,' [Deepak] Parekh told a news conference in Hyderabad following the first meeting of the government-appointed board", Eric Bellman and JR at the WSJ, 13 January 2009.

"Indian regulators and police are trying to unravel how the chairman of [SCSL], who has admitted to falsifying corporate figures, may have managed for years to fool his top financial officer and the company's audit committee. ... Satyam's chief financial officer, Srinivas Vadlamani, was arrested over the weekend on suspicion that he was involved with fraud, forgery and other charges. In a written statement, presented in the local courts Sunday, Mr. Vadlamani said that while he wasn't directly involved in fudging the company's accounts, he knew that there was something suspicious for more than five years. The statement didn't say why he didn't report the suspicions. He said he wasn't in charge of keeping track of the company's deposits. 'I was specifically asked not to look into that area of operations,' Mr. Vadlamani said in the statement. ... Mr. Vadlamani didn't admit to any crime in the statement. ... Sandeep Parekh, a professor at the Indian Institute of Management in Ahmedabad ... said another clue came when an analyst from Mumbai-based securities firm Kotak Securities Ltd. [KSL] raised questions about why the company was keeping such large amounts of money interest-free current accounts rather than a 9% fixed deposit with a bank. Kawaljeet Saluja, a senior research analyst with the institutional equities arm of [KSL], raised the question during an investor call with Satyam in April, a [KSL] spokeswoman said", my emphasis, Eric Bellman and JR at the WSJ, 14 January 2009.

"[SCSL] began a search Wednesday for a new chief executive and new chief financial officer, while the software exporter's board named Deloitte Touche Tohmatsu and KPMG as interim auditors to assess the company's financial health. ... The new board had said Monday it would name new auditors to assess the true financial condition of Satyam, based in Hyderabad, India. Satyam is India's fourth-largest software exporter by revenue. ... In a separate statement Wednesday, [PWC] said its audit opinion on the financial statements of the software exporter may be rendered inaccurate and unreliable. ... 'We placed reliance on management controls over financial reporting and the information and explanations provided by management and also the verbal and written representations made to us during the course of our audits,' the firm said", Romit Guha at the WSJ, 15 January 2009.

"Minutes from a crucial December board meeting at [SCSL] shed light on how the giant outsourcer's directors would up approving two deals that were a key part of the massive fraud that has since engulfed the company. ... The deals at issue were the acquisition by Satyam of two infrastructure companies--Maytas Properties Ltd. and Maytas Infra Ltd.--that are run by the sones of the founder and then-chairman of Satyam, B. Ramalinga Raju. Mr. Raju also had a financial interest in the companies. ... In a prepared statement, Ernst & Young said it had prepared the valuation for another purpose and was 'not given to understand by any party, explicitly or implicitly, during the valuation exercise, about Satyam's plans to acquire Maytas Properties.' ... 'The proposed acquisitions have two complicated aspects--unrelated diversification, and realted party transcation,' said Krishna Palepu, a Satyam director and a Harvard Business School professor of corporate governance,who participated in the meeting by telephone conference, according to the minutes", Niraj Sheth and JR at the WSJ, 16 January 2009.

Shut the World Bank.

It is difficult to miss $1 billion in cash. I must hand it to PWC. I noted PWC avoided the ITF scandal in my 1 January 2009 post, http://skepticaltexascpa.blogspot.com/2009/01/cpa-triple-header.html, Not to be slighted, it gives us Satyam. Great going fellas.

This is too rich, a Big 87654 Indian Chartered Accountant doesn't think his clients financials need be stated accurately. He exposes a dirty secret of the CPA business, i.e., given the Big 87654's time constraints, many times they can't finish the work. It would take something lacking in Big 87654 partners to tell the SEC we can't finish audits when you want, a backbone. The damn SEC keep moving up SEC registrant filing deadlines. That's crazy. Indians use crores, 10 million and lakhs, 100,000 as counting units. 10 million rupees is $208,000 at R48.1 = $1.

Good luck PWC, fool or knave? Satyam's audited 31 March 2008 financials show $2,243 and $827 million of total assets and "investment in bank deposits" respectively. Were 65% of these assets fictitious? What did PWC look at? Who at PWC did this audit? The AIG audit team?

Chandok is correct. Auditing cash is simple.

Compare India's actions to those of US regulators. What would happen to: Mozzillo, Blankfein, Pandit, Fuld et. al., if they were in India.? I have bad news for Bhave. US peer review was a fraud. Why will India's chartered accountant peer review be anything else? SEBI's review of auditors' workpapers is nice. Will SEBI have its Meaghan Cheung (MC) do it? Will MC, who is currently "available" fly to Hyderabad and offer to do it pro bono to atone for her sins?

Sanchez has got it. Now if we can only find a way to ship say Bernie Madoff, Lloyd Blankfein, Richard Fuld, et. al. to China or India.

I can't believe it either.

We'll see if the new auditors conclude PWC's audit was deficient.

I find PWC's being unaware of this fraud inconceivable. Saluja asked a question any CPA should have asked during an audit as part of "analytic review". As for CFO Vadlamani, under US law he said enough to be convicted. US law has a "wilful blindness" concept, i.e., when you ignore the obvious, knowledge may be imputed to you. In criminal law, the judge gives the jury an "ostrich instruction". If Indian law follows the US, Vadlamani is going to prison. In all likelihood, along with many others. See West's criminal law key 772(5).

Isn't PWC wonderful? It now admits its opinions may be unreliable. What audit work did PWC do? SCSL's board should not hire any Big 87654 firm to do anything. Why? These firms cover up for each other whenever possible.

Now E&Y is in the pool too! All the Big 87654 are here. What was the valuation's purpose, if not in connection with a proposed merger? Satyam was smart. It had a corporate governance professor on its board. Governance, bah humbug! See my 10 August 2008 post; http://skepticaltexascpa.blogspot.com/2008/08/is-anyone-surprised.html.

10 comments:

Printfaster said...

Given that AA was ridden out of town on a rail for Enron, fun to see that poor oversight is endemic. Perhaps the remaining 4 are infested with ex-AA accountants.

More than likely it is simply accounting capture, where the accountants are captured into the business practices of the host. Once the accountant starts to look at the company as another employee, it all looks great on the inside. Accountants behave as insiders and want to keep the gravy train on track.

If this is not true, how do you explain level 3 assets? Another reason to keep banks unattached to companies, ala Glass-Steagel; with a bank in the mix, you really get strange accounting on what is cash and what is vapor.

I do not see any cure for this, other than new accounting firms that are known for aggressive behavior, or requiring switching auditors every year.

I think a rule that you cannot have the same auditor year after year would do a lot to mitigate nonsense. Hey, I would make it that you could not have the same auditor within 5 years. That would make it fun for the remaining 4.

Independent Accountant said...

Printfaster:
I have seen the lack of oversight for 32 years and have some posts on it referring to a 1760-page 1976 green book Congress produced about the then Big Eight. In the real world there will always be audit failures. The most we can hope to do is reduce their frequency. How? By increasing their "cost". If you increase the likelihood of an audit failure being exposed and/or the payout when it is exposed, youll get fewer of them. My first step: repeal 1995's Litigation Reform Act and Stoneridge.
AA was no worse than any of the other major CPA firms when it was in business. It just had the bad luck to draw Enron. What will be the fate of the CPAs of: Freddie, Fannie, Lehman, Countrywide, Wachovia, etc.?
It's not accounting "capture". but misplaced incentives that we face, i.e., the classical agency problem. I have toyed with the notion of forced auditor rotation, but never favored it. Suppose Megabank replaces PWC with KPMG, will KPMG tell the world PWC's audit was defective and Megabank's books cooked? Very unlikely. Why? What will happen when Begabank replaces KPMG with PWC? Changing stationery from E&Y to D&T through forced CPA rotation is a waste of time in my opinion.
I don't understand your comment about Level 3 assets. Please elaborate.

Anonymous said...

Hi Printmaster and IA:

>> I've heard that A. Anderson was the loosest girl on the block... if you needed some accounting whoopee they would be the most likely to come through. I guess that was sort of Enron's corporate culture... ie energy trading...

>> Auditor rotation... hard to say... what does it get you? Fresh eyes? That is only valuable if someone will out the offenders...

>> Aggressive top tier accounting firms would be good...

>> Level 3 valuations? Well someone held RBS' feet to the fire... we're talking explosion!

Independent Accountant said...

Anonymous:
I've seen Big 87654 work done by each firm. I think the best audit work in the group was done by AA and D&T. That AA drew the Enron "short straw" was just bad luck. $52 million in fees was a big incentive for AA to close its eyes to Enron's problems. Look at KPMG at Citigroup. In 2007 it got $88 million from Citigroup. What did KPMG look at for $88 million?

Anonymous said...

IA:

I got my AA opinion secondhand from someone who had used most of the firms... it's only a second hand "opinion"...

But more interestingly your question...

"What did KPMG look at (Citigroup) for $88 million?" ... yeah exactly... Sar-Box II coming up?

Printfaster said...

IA
Level 3 assets were a creation of the accounting industry. My point is that the accounting industry is close to the interests of the customers that they serve, they will happily change the rules if needed.

Even if they act unethically, they will make the unethical into ethical to solve the problem of ethics.

Then as someone pointed out, they enact Sarbox to provide more layers of paper to cover over the hideous facts from view. Sarbox, the reward for AAs unethical behavior at Enron: full employment for accountants. In the end nothing changes, except lawyers and accountants get richer.

Independent Accountant said...

Anonymous:
Merrill paid D&T $57 million in 2007 for an audit. So? You can go on and on with audit fees of $40-$100 million and ask, "What did these clowns do for this money"?
As for Sarbox, I opposed it from the start because Sarbox never addressed CPA firm incentives. It is just more paperwork created by lawyers to enable lawyers and CPAs to run up big fees. We may be in for a Sarbox II. It is not likely to address the real problems either.

Independent Accountant said...

Printfaster:
That's what I thought you were referring to, i.e., the Basel II risk classes. I think the banking industry and its lapdog regulators created them. The CPA firms went along for the ride. Why not? They could charge big fees for Basel II compliance tests.
You write, "the accounting industry is close to the interests of the customers they serve". I've said this for over 30 years. If say, Exxon wants a change in accounting for oil and gas interests, it can release a press release to that effect, or have PWC do a "study" indicating the proposed change is desirable. Yves Smith at Naked Capitalism has been very critical of "experts" who draw conclusions at client request. She's a McKinsey alumus and has appaently seen this first hand. Yes, Sarbox is a "CPAs and attorneys full-employment act". Sarbox is a joke.

Anonymous said...

If one believes PWC's claim that its work applied all necessary standards and was supported by appropriate evidence, yet it missed a phoney $1B cash account, then it should painfully obvious that audits as presently done are a complete waste of time and resources. If they can't verify cash, they can't verify anything. As an investor (and former Big87654 auditor) I place zero confidence on the audit opinion.

Independent Accountant said...

Anonymous:
You may have understood me. With apologies to WIlliam Shakespeare, "Julius Caesar", Act 3, Scene 2:
"Friends, Americans, blogosphere readers, lend me your eyes;
I come to bury PriceWaterhouseCoopers, not to praise it,
The evil that CPA firms do lives after them,
The good is oft interred with their fees,
So let if be with PWC ... The noble Hyderabad prosecutor
Hath told you PWC was ambitious:
If it were so, it was a grievous fault,
And greviously PWC should answer for it".