Malice in Blunderland - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
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17 JANUARY 2009

Source: clown-ministry.com
"Curiouser and Curiouser!" cried Alice (she was so much surprised, that for the moment she quite forgot how to speak good English.)"Now I'm opening out the largest telescope that ever was! Goodbye, feet!" (for when she looked down at her feet, they seemed to be almost out of sight..).. Alice in Wonderland by Lewis Carroll.

The story of Satyam Computers is getting curiouser and curiouser, with Ramalinga Raju having forgotten to speak good corporate governance and with his company's bank deposits seeming to be almost out of sight, in what could conceivably be titled Malice in Blunderland.

As time passes, the case does, indeed, seem to become more curious by throwing up more questions than answers. For example, the letter dated Jan 7 has not been signed by Raju. It has the common seal of the company alongwith a scrawled initial. If bank deposit receipts could be forged, can the common seal not be?

It all seems to have started about 4 or 5 years ago, when the two family promoted Maytas companies were set up to buy properties and undertake infrastructure projects, all of which require permission from politicians. To me, the crux of this problem lies in the continuing hold Governments have over people's lives. Until this is tackled, such scandals would recur.

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This is combined with shareholder capitalism going completely out of control. Up until the late 80s Japanese and German companies were gaining a lead, basing their success on 'stakeholder capitalism' which sought to protect interests of all stakeholders. America, threatened by this, countered with shareholder capitalism, which focuses on returns to stockholders, with those of others (customers, employees, suppliers etc) being subservient. The philosophy was epitomised by Gordon Gekko's statement 'greed is good' in the film Wall Street.

This philosophy worked to bring American companies back to the fore, but has now gone out of control.

Corporate management believe that they need to be in the top three of their business to be counted. Growth at any cost becomes a mantra. Senior management is energised to contribute through stock options; initially a good idea but later corrupted through things like repricing of options when the market price goes below the strike price. Grant of options reduces employee cost and hence boosts profits. Up until now the cost of granting the options was conveniently not debited to the P&L. The purpose of boosting profits is, of course, to boost valuations of the business.

Now we find that audited accounts by one of the big 4 accounting firms are unreliable! The auditors, PwC (that's Price Waterhouse Cooper and not partners without clues) apparently did not confirm balances, which is part of the audit process, but relied on forged certificates of deposits with banks. Bank balances are overstated by $1b.

Investors would now be justified in asking which audited accounts they could trust. The regulator, ICAI, appears to be easy on penalising member firms; it has not yet acted, after 4 years, against PwC, in the earlier, Global Trust Bank case (Ramesh Gelli). The regulator for capital markets, SEBI, has been beaten to the post by the State Government to become the lead investigator of Satyam. Both SEBI as well as the Company Law Board, are yet to get access to Ramalinga Raju or to documents! This is crazy and smells of political involvement.

Why is it not possible to have copies of documents, either xerox or electronically scanned copies, made available to different Government agencies investigating different aspects of the scam, via a document register?

The Union Government has, unwittingly, aided in accounting malpractice, by providing tax free status for software exports. Any such concessions are distorting and disrupt the correct play of market forces. Since income from software exports is tax free, since IT firms have a higher P/E multiple and since greed is unlimited, it becomes attractive to artificially boost sales and show fictitious profits on them, by laundering money! The fictitious profits are free of tax and the valuation of firms zooms. Instead of seeking to remove distorting fiscal concessions, the Finance Ministry has just extended them to SEZs promoted by big IT companies.

The role of independent directors is also coming into question. What would persons of the stature of Satyam's erstwhile directors have done, one wonders, to detect a fraud which auditors of the competence and renown of PwC were unable to discover? More worryingly, which honest person would now consider becoming an independent director if he is at risk to lose his reputation, his sleep and possibly his freedom for things he had nothing to do with? Perhaps the only ones who would now willingly become 'independent' directors would be those who would not display it.

What, for that matter, would private equity firms do? These invest in private companies, giving them seed money before they go public, thus developing promising ideas and technologies. They usually nominate directors on the board of the financed companies, to oversee their investments. Would they stop nominating directors, or would they stop investing? Both would be bad choices, for the system.

The rot can only be stemmed if everybody does his job properly, without fear or favour. For this, the clean up must start at the top, at the Government level, both Union and the States. The persons who pay the price for dereliction of duty are investors.

Results for the quarter ended Dec 08 from Infosys and from HDFC Bank were good, with PAT rising 33 and 45% respectively. But these two are well governed companies. Results for others would not be as good. Adding to the woes of poor demand and cost control, is the fall in yields of bonds which would, in turn, lead to larger pension provisioning, bringing down profits further.

Last week the BSE-Sensex lost 82 points to close at 9323 and the NSE-Nifty lost 44 to end at 2828.

In the coming week there would be two important events. One is the change in guard at the White House, with Barrack Obama taking over from George Bush, surely worth a couple of hundred points rise in the sensex in itself! Obama's election was certainly not a shoe in, and a lot of hope rests on his shoulders. The other is the likely judgement, in the Reliance v/s Reliance gas dispute. One hopes this paves the way for exploitation of huge gas reserves, which seems to be the main silver lining for India in 2009. Should a rally ensue, it would be advisable to get lighter in it.

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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