How to steal a billion

The guys at Knowledge@Wharton – they have conducted an interesting postmortem on the Satyam disaster – beat me to the way I wanted to start this post-

When terrorists attacked Mumbai last November, the media called it “India’s 9/11.” That tragedy has been succeeded by another that has been dubbed “India’s Enron.”

What next, I add, that will fit the “India’s X” template? I did not write about it sooner because I was waiting for the government to intervene; the Indian government and its regulators work on the lines of a typical Bollywood movie – the cops arrive after everything has happened showing how regulations are utterly useless.

Notwithstanding the post title, I am not too interested in knowing how Raju managed to pull off this scam – there are a myriad ways to do it, as any accountant will tell you. He couldn’t have done it alone – there have to be people in the finance division who were aware of it, but who chose to keep quiet or even helped him; the CFO of the company has supposedly attempted suicide, and Raju did not mention his name in the list of those who were “not to blame”; perhaps that is a clue. Whether the auditors – PWC – colluded (more likely) or were duped (less likely, but it is possible), the fact is the Satyam balance sheet has a billion plus dollar hole in it. And some think that Raju has not yet told the truth and things are worse than they appear.

The typical response to any such disaster is a demand for tougher laws; the US enacted SOX – the Sarbanes-Oxley Act – in 2002 after the Enron-Arthur Andersen meltdown. But as Vipin points out in a post written much before the Satyam scam was revealed, Enron complied with every requirement of that act but it failed nonetheless. If someone really wants to do something, he will find a way to do it – where there is a will, there is a way. The only thing tough regulations do, particularly when it comes to equity listing agreements with stock exchanges, is that it raises compliance costs and small companies are not able to afford it. K@W has a couple of interviews on corporate governance (a new buzzword for everyone to remember), the first on SEBI’s Clause 49 of the Equity Listing Agreement that companies sign with stock exchanges, and the second on “independent directors”, and one of the interviewees, a professor at Wharton – Jitendra Singh – had this to say-

Just the other day, I was talking with a friend and colleague of mine who is a professor at the University of Toronto. He said he had just taken public a firm where he was the founder from the AIM (Alternative Investments Market) at the London Stock Exchange. This is a Canadian company that is going public in the U.K. This is a midsize company, [where] revenues may be less than $50 million a year. He said they did a very careful analysis of listing in New York, and found the cost of complying with Sarbanes-Oxley would be about $3 million. Now for the firm that has $50 million in revenue, this may be the better part of the profits it is making. So obviously this is a very serious consideration. They went to AIM and that’s where they listed it — and it’s a public company right now.

This time though, surprisingly, I have been reading views wherein “enforcement” of existing laws is demanded. That would be a good thing if we know what is it exactly that needs to be enforced? As I see it, regulations of a preventive nature are like a missile defense shield – they won’t work if the enemy launches a hundred missiles simultaneously at you. So it is pointless to have too much of them. What is needed here is a guaranteed second strike capability – that is, once a Satyam-like disaster occurs, those who suffered at the hands of people like Raju should be able to sue the pants off them, and the process should be a quick one. If it takes ten years, the laws are worthless.

About “independent directors” – and this is why most government regulations are useless, particularly the Clause 49 mandate, a variant of the “tragedy of the commons” applies to them. People who don’t have a material interest in something won’t bother about what happens to it. If a director does not own a substantial number of shares in a company, how does it matter to him how the business of a company is run? While an argument can be made that such a director has his reputation to worry about, and that reputation is more important than tangible wealth, I suggest that such a director will make himself believe that nothing will go wrong. To give an innocent example – I can think of worse things – how many of you believe that you will stub your toe tomorrow morning? Its only after the shit hits the fan that seers and pundits forecast the past. An example – the Economic Times which is setting its front page on fire with its coverage of the Satyam fiasco had nominated Ramalinga Raju’s BYR Raju Foundation for “Corporate Citizen of the year” for this year’s ET Awards.

In the case of Satyam, the aborted Maytas deal proved that the independent directors were all either asleep or were flying kites. I quote from the first K@W article I linked to-

Even if outside directors were unaware of the true state of Satyam’s finances, some red flags should have been obvious. According to Aron, Satyam is one of the world’s largest implementers of SAP systems. In an effort to compete against Satyam, HCL recently acquired Axon, an SAP consulting firm, at a cost of $800 million. (Editor’s note: See interview with HCL CEO Vineet Nayar.) Aron notes that any Satyam director should have been puzzled that the company was proposing to invest $1.6 billion in real estate at a time when a competitor as formidable as HCL was gunning for one of its most lucrative markets. “IT is a highly capital-intensive business, especially in India,” says Aron. “What on earth would compel Satyam to invest $1.6 billion in real estate at a time when competition with HCL was about to grow more intense? That is what the directors should have been asking.” Instead, he adds, like the dog that didn’t bark in the Sherlock Holmes story, the matter was allowed to slide.

So, instead of making foolish demands like specifying a minimum number of “independent directors”, shareholders should be allowed to elect whosoever they think is fit to represent their interests on the BoD.

The bottom line? Let Precrime remain confined to Philip K Dick’s sci-fi shorts; we cannot prevent every billion dollar heist. But as long as we have systems in place which allow victims to get their money back, we should be okay.

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Comments

  • Pramod Biligiri  On January 10, 2009 at 10:13 am

    Isn’t it nice that a shareholder revolt is what finally brought down the house of cards? So much for regulation!

  • Aristotle The Geek  On January 10, 2009 at 7:25 pm

    Read what this two-day old DNA piece says-

    Here is the macabre twist: had shareholders allowed the [Maytas] acquisitions to go through, things would not have come to such a pass.

    The Satyam share, which was quoting at Rs 226.50 on December 16 just before Raju announced his plan, is now down 82% at Rs 39.95. The Satyam ADR opened down 91% on Wednesday. Shankar Sharma of First Global says the share can go below Rs 10.

    Certainly, a case where shareholder activism backfired badly!

    Assuming Raju has not siphoned anything off, he was willing to put in 6,000 odd crores of his own money in Satyam by accepting dud checks for two of his companies. If only the shareholders had not raised a din…

  • Milena Thomas  On January 10, 2009 at 10:25 pm

    “The typical response to any such disaster is a demand for tougher laws;”

    I have a crazy idea. I’m just working on it though, so it’s efficacy is, of course, yet to be determined.

    What if, I’m just saying, we enforced laws currently in place? I mean, when fraud occurs, actually jailing the criminals, instead of letting them buy off judges and juries?

    I don’t know. It’s a crazy idea. Probably won’t work.

  • Aristotle The Geek  On January 11, 2009 at 12:34 am

    “I mean, when fraud occurs, actually jailing the criminals, instead of letting them buy off judges and juries?”
    Jailing people is not always the best way to do things. Every “crime” affects a victim. Sometimes, making the criminal make up the loss that the victim suffered is the best punishment. Islamic jurisprudence carries this notion a step further and is worth taking note of.

  • Gargi Dixit  On January 11, 2009 at 6:54 am

    Jailing people is not always the best way to do things. Every “crime” affects a victim. Sometimes, making the criminal make up the loss that the victim suffered is the best punishment. Islamic jurisprudence carries this notion a step further and is worth taking note of.

    What is the problem with market punishing the criminal?

    property loss should be compensated and a fine will do.

    Market won’t allow the corrupt stay any longer. The corrupt will end and others will take the hints
    I agree with you.

    In fact by this manner of market judgment, we can avoid a further fraud of collective state government mostly irrational jurisdiction.

  • Aristotle The Geek  On January 11, 2009 at 12:43 pm

    “What is the problem with market punishing the criminal?”
    It depends on what form the “punishment” takes. The free market works exceptionally well on a daily basis – it will value companies based on how they “smell” – the Satyam stock (and many other second and third tier IT stocks) has always traded at a discount to the Big Three. In cases of fraud however, the free market won’t be able to act on its own – people might stop doing business with a Raju but how do you make him pay compensation to shareholders who invested based on information present in falsified accounts? A court will have to step in.

    When I say jail is not the best way to go about it, what I mean is – let prison be the last option for every crime except heinous ones like rape and murder. For civil wrongs, and criminal fraud, the wrong doer or fraudsters should be offered a chance to make up the damage he has caused. If he refuses, send him to prison by all means. A free market can do everything except “force” people to act in a certain way. A court that has control over the application of force is suited for the job.

    The “Islamic jurisprudence” I refer to has similar provisions for murder and accidental death – a form of “blood money”. While I don’t agree with letting (willful) murderers go scot free, in cases of accidental and unintentional death, letting the “criminal” compensate the families of the victims based on terms agreed between the two is a much better option than sending him to prison.

  • Gargi Dixit  On January 11, 2009 at 6:32 pm

    When I say jail is not the best way to go about it, what I mean is – let prison be the last option for every crime except heinous ones like rape and murder.

    Imprisonment even in such cases can be well managed by free market. Although I do not like the term “Anarcho-Capitalism” but the reasonable base it represents is surely applicable and practical than governmental jails. Some initiatives are already gaining shapes in this regard.
    When I said I agree with you about market punishment, I essentially meant Private Judicial System.

    About punishments in cases of rape/murder etc. according to me, it should remain the freedom of the victim’s side to decide if they really want the criminal to suffer death penalty, or they want him to be given a second chance. About compensation, if crime is proven, the criminal looses his property rights, and his property either goes to victims side as it is, or through bankruptcy (whatever) they prefer.
    Rights are to be earned and defended.
    Even murders can be accidental,so death penalty cannot be made a definite law, every case needs special attention, and it should always be the decision of the victim’s side to allow forgiveness on certain terms, or to furiously demand for death penalty.

  • Aristotle The Geek  On January 11, 2009 at 11:15 pm

    “When I said I agree with you about market punishment, I essentially meant Private Judicial System.”
    My present position is neither here nor there when it comes to private law for “crimes”, not disagreements and wrongs; that is government as seen in practice doesn’t inspire any confidence in me, but I don’t see how private defense companies and private courts will deal with truly heinous cases. I have yet to read Rothbard’s argument on the issue, so I cannot comment much on how it would work.

    “About punishments in cases of rape/murder etc. according to me, it should remain the freedom of the victim’s side to decide if they really want the criminal to suffer death penalty, or they want him to be given a second chance.”
    Islamic jurisprudence has precisely this in mind. But consider this scenario-

    X is a criminally insane, all powerful psychopath who murders people who do not tow his line. One day he murders A, and threatens A’s family. Assuming X is hauled up in some private court and the crime is proven, X can always “make” A’s family “forgive” him. And then he kills some one else over some other issue.

    The government system is absolutely corrupted. But in cases where the criminal (not accused) is a threat to society as a whole, allowing the victim’s family to “forgive” him is dangerous. Basically it boils down to rights and the threat perception – white collar criminals and those who cause unintentional deaths can be nailed by hurting them financially – they are not a grave threat to society. The same cannot be said about criminals that use force against another human being.

    “Even murders can be accidental,so death penalty cannot be made a definite law”
    I am against the death penalty in any form; the reason is the chance of putting the wrong person to death is simply too great.
    About murder – a death caused by accident is not called murder. Murder is killing another human being being fully aware of the fact that you are killing him. The death of a pedestrian in a car accident, or a passenger because of drunken driving etc are not murders, but they do need to be punished.

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