One letter is all it takes to turn trust to rust - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
One letter is all it takes to turn trust to rust A  A  A

10 JANUARY 2009

On Jan 7, Chairman Ramalinga Raju wrote a letter to his Board, admitting that the account books of Satyam Computers Ltd., India's largest but three IT services company, had falsified its accounts. Some Rs 5,040 crores stated to be in the bank were non existent, hence interest supposedly earned on this fictitious balance, amounting to Rs 376 crores was not there; liabilities were understated to the extent of Rs 1230 crores and debtors overstated by Rs 490 crores. All this adds up to Rs 7136 crores (US $ 1.4b.) This one letter did what the removal of the first, from trust, does to it.

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The stock collapsed 78% on Wednesday and the ADR by 90%. Two class action suits have been filed in the US, where Satyam is listed on both the Nasdaq and the NYSE and where legal prosecution is stricter. Under the Sarbanes-Oxley Act both the company and its auditors can be prosecuted, including criminally, for falsified accounts. By comparision, in India, the ICAI (Institute of Chartered Accountants of India) maintained that only those who signed off the accounts could face action. SEBI maintained that, in itself, the letter of the Chairman was insufficient to arrest him! It took 3 days for the Chairman to be arrested after a self admitted fraud of this magnitude, the largest in Indian corporate history! India is an extremely soft state which does more to protect the 'interests' of wrongdoers (witness the unbelievable assertion of the Chief Justice of India that Kasab may be acquitted if not provided a lawyer!) and unless we start to punish them effectively we will be more susceptible to attacks.

Indeed, the only logical explanation for this 'non existent bank balances and the delay in arrest' seems to be large payoffs, probably to get allotment of infra projects. The scary thing is that this may be an all India phenomenon and hence lead to more such disclosures. Master Card may, perhaps, consider bringing out an ad with the tag line 'there are some things only cash can buy; for everything else theres Master Card'

Basically the whole politico-corporate-financial world is incestuous. Companies start by raising money from the public, using investment banks to market their IPOs and, once listed, broking houses to market and mutual funds to prop up the shares. Once they become successful they use the same firms to find targets for M&A. If not quite successful, to sell their stakes. So it is, indeed, rare, for shenanigans of corporate management to be exposed, since they are generating fees. Investment banks, whose clients they are, have broking arms to sell their stock and mutual funds to manage money, representing huge conflicts of interest which need management.

Merrill Lynch, assigned the task of scouting for a buyer for Satyam after the aborted takeover of family controlled firms, reportedly relinquished the assignment a day prior to the Chairman's letter, stating financial irregularities. Poser: how could it have discovered them, in a few days, when PwC, a leading accounting firm that has been auditing the books, were unable to, over several years?

Poser: would this episode, combined with that of Nagarjuna Finance, (in which the AP police are seeking to arrest reputed investment banker, Nimesh Kampani, who resigned as independent director of Nagarjuna Finance, an NBFC, purportedly for acts of omission committed after his resignation) not result in a further shortage of eminent persons willing to accept the responsibilities of such directorships? The website of Institute of Directors, New Delhi, a 'non profit' organisation trying to promote good corporate governance, has a blurb on its website urging people to 'become independent directors. Earn millions!'

Poser: If the driver for promoting independent directorships is for them to earn millions, where does good governance figure in the gamut of things?

In Dec, when the Raju **** was hitting the fan, in the aborted merger of two family controlled companies with Satyam, several fund houses (HDFC 50 lac shares, Sundaram BNP 53 lac, ICICI Pru 35 lac and Franklin Templeton 15 lac) were increasing their holdings in the company! This column has earlier pointed to the folly of disallowing fund managers holding more than a certain percentage of their fund in cash if it is to retain tax advantages of an equity fund, which gives them an excuse for poor performance (some 80% of funds underperform an index says)

Poser: Whom does an investor trust? Audit firms like PwC (no, it does not stand for partners without clues, as a wag says)? Analyst reports generated by brokerages that also have to maintain relationships with corporate clients in their investment banking business? Fund managers who do not exit at peaks, on the basis that exiting is a decision the investor has to make and not they; and who increase their stakes in such companies even after scandalous corporate governance? Regulators who claim that self admission of fraud is an inadequate ground for arrest?

Nor is the incestuousness of the politico-corporate-financial community a preserve of India; it is an international phenomenon. An article "The End of the Financial World as we Know It" by Michael Lewis (author of Liar's Poker, the New New Thing and other excellent books) and David Einhorn in the New York Times talks of the heads of enforcement of SEC, the US regulator, getting plum assignments later at JP Morgan, Deutsche Bank and Credit Suisse. Which perhaps explains why, despite complaints against him nine years prior to the eruption of the scandal, Bernie Madoff evaded probes by US SEC!

Last week the BSE-Sensex, after a promising start (it rose 317 points on Monday and another 60 on Tuesday) lost 551 points over the week to end at 9406. The Satyam letter bomb resulted in a 749 point fall on Wednesday followed by a 180 point fall on Friday, with an intervening holiday. The NSE-Nifty ended at 2873, down 173.

What now?

The global crisis is far from over. A little bit of optimism vests in the fact that George Bush would, in less than a fortnight, be giving up the power that has resulted in a lot of the world's problems, ushering in Barrack Obama as a beacon of hope. That, combined with the $ 8.6 trillion in liquidity with American institutions, could result in a global rally. Obama is expected to immediately announce a large ($300b.) tax giveaway. Part of the resultant investment of the mountain of cash would, irrespective of the damage done by Satyam, find its way to India. Should this happen, the ensuing rally ought to be taken as an exit opportunity.

According to an article by Venram in Barrons, India won't rebound soon. He quotes respected India strategist at Morgan Stanley, Ridham Desai, saying that the forward P/E based on expected earnings for the next 12 months, is still 60% higher than emerging markets as a whole and that price/book ratio is 72% higher. With general elections looming in May, the composition of the future government, and its commitment to economic reform and to growth is unknown. Selling on any rally that may ensue would be advisable. Neither the world's, nor India's, economic woes, are over; not by a long shot.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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