Failure of Corporate Governance at Satyam By Mr. Shardul S. Shroff, Amarchand Mangaldas Anatomy of the Satyam scam Satyam Computer Services Limited ( Satyam ) was incorporated in 1987. It is listed on the Bombay Stock Exchange, the National Stock Exchange and the New York Stock Exchange. Satyam carries on the business of providing information technology services. In December 2008, the promoter of Satyam, Mr. Ramalinga Raju, tried to divert funds upto $1.6 billion from Satyam into certain promoter group companies operating in the real estate sector without obtaining shareholder approval. The investment was abandoned due to opposition from certain institutional shareholders. On January 7, 2009, Mr. Ramalinga Raju admitted to the commission of a fraud of Rs. 70 billion (approx. $1.4 billion) involving manipulation of Satyam s accounts. As per the admission, the liabilities of Satyam were understated by Rs. 12.3 billion, the assets (cash, bank balances and sundry debtors) were overstated by Rs. 56 billion and false accounting was done in respect of non-existent assets to the extent of Rs. 3.8 billion. In the period close to the disclosure of the fraud (December, 2008- January 2009), shares of Satyam pledged by the promoters and promoter group companies with certain institutions were sold. The price of Satyam s shares dropped 80% after the disclosure of the fraud. The government replaced the board of directors of Satyam. Tech Mahindra Limited acquired a controlling stake in Satyam through an open auction under the takeover regulations and a subsequent preferential allotment. Criminal proceedings are pending against Mr. Ramalinga Raju, other promoters and 2 auditors belonging to PricewaterhouseCoopers, which is the statutory auditor for Satyam. Further, class action suits have been filed against Satyam in the United States of America. The Central Bureau of Investigation ( CBI ), the federal agency investigating the fraud, has recently assessed the amount of fraud to be around Rs. 14,000 crores. The CBI has found that an additional Rs. 12.21 billion of loans were raised by forging board resolutions, Rs. 7.48 billion of illicit gains were made by promoters and their relatives/associates from the sale of shares of Satyam, Rs. 2.3 billion in dividends were received by the promoters from inflated profits, 7 fake customers were created to book Rs. 4.3 billion of sales and the accounts of Satyam were falsified for about Rs. 1.8 billion in respect of acquisition of a subsidiary, Nipuna Services Limited. What has Satyam taught us? The most fundamental lesson learnt from the Satyam scam is the lack of effective laws relating to corporate governance in India. 1
The scam involved lack of effective oversight by the auditors over the financial statements of Satyam. The existing liability of auditors under the Companies Act, 1956, is limited to cases of willful default and to a maximum fine of Rs. 10,000 ($200). This does not deter negligent conduct on part of the auditors. Further, there is no prohibition on audit firms from providing non-audit services to a company. The law relating to independent directors is not workable in its existing form as it fails to impose a positive duty on the independent directors for effectively overseeing the actions of management. In the wake of Satyam, the Securities and Exchange Board of India ( SEBI ) has stipulated mandatory disclosure of pledges of shares of listed companies by promoters and enforcement of such pledges through amendments to the listing agreement and the takeover regulations. In respect of listed companies, shares with superior voting rights or dividend rights have been prohibited. The Ministry of Corporate Affairs (the MCA ) has initiated an early warning system ( EWS ) for detection of corporate frauds. The EWS has been launched in respect of 50 companies on an experimental basis in September 2009. Under the EWS, the MCA would assess the information provided by the companies in their e-filings through its MCA21 service on basis of certain identified parameters. Any unusual change in the identified parameters would trigger an alert within the MCA which would then seek more information from the company. The MCA has not officially disclosed the set of parameters but publicly available information points to the following relevant parameters: o any adverse remarks from auditors of the company; o change of auditors more than once in three years; o quantum of related-party transactions of a company exceeds 5 % of its domestic sales; o resignation of 50 % or more directors of the company in one year; o fluctuation in the earning per share of the company exceeds 25 % of the earning per share in the previous year; o presence of certain risk factors including failure to file annual accounts for two years, complaints received from shareholders against the affairs of the company, occurrence of losses where there has been profit in the last two years and continuous increase in capitalwork-in-progress for three consecutive years. Changes in pipeline 2
The Companies Bill, 2009, which is awaiting approval of the Indian Parliament, proposes to make the following changes to strengthen corporate governance after Satyam: o listed companies to have at least one-third of their directors as independent directors (section 132); o prohibition on statutory auditors to provide services like internal audit, investment advisory services, management services etc., which conflict with their duties as auditors (section 127); o stricter liability regime for auditors (a) any default by auditors to attract a penalty of minimum fine of US$500 and maximum fine up to US$10,000; (b) willful default by auditors to attract an aggravated penalty of imprisonment for a term up to 1 year and a minimum fine of US$2000 and a maximum fine up to US$50,000; (c) auditors can be sued for damages by the company or third parties for loss arising out of incorrect or misleading statements in the audit report. o limited private enforcement regime enabling any creditor or shareholder to sue the company for mismanagement of its affairs (section 216); o mandatory approval of the board of directors for all related party transactions by a public company. In addition, mandatory shareholder approval by a special resolution would be required for certain companies having paid-up share capital, or transactions involving sums, as prescribed by the government through rules (section 166); The SEBI Committee on Disclosures and Accounting Standards has recently suggested the following changes for listed companies: o mandatory rotation of partners of the statutory auditor firm every five years; o appointment of Chief Financial Officer to be approved by the audit committee; and o audited figures of the major heads of the balance sheet to be disclosed on a half-yearly basis. The MCA is in the process of formulating a code of corporate governance which is scheduled to be released by the end of December 2009. The code would be voluntary for the first year. December 3, 2009 3
CHRYSLER: EVOLUTION OF A CRISIS AND A SOVEREIGN RESCUE By Corinne Ball, Jones Day, USA The U. S. Automotive Task Force that was appointed by President Obama to work through the auto rescue began its mission with the following statement of objectives: 1. avoid adding further systemic risk to the economic crisis affecting the country; 2. maintain jobs and benefits through actions directed at creating viable companies that would provide continuing employment, thereby creating a privatized source of economic recovery; and 3. effect dramatic cultural change to address the patent failure of management of the domestic auto industry and its "self-inflicted" injuries. With respect to Chrysler, the U.S. Automotive Task Force concluded there were only two acceptable resolutions: 1. The U.S. Government was prepared not simply to facilitate, but actually required a change in control transaction and was willing to do so over the objection of the financial community and without specific legislation; or 2. Allow Chrysler to fail as in independent auto manufacturer. I. The seeds of failure took root under the Daimler acquisition period (commencing May, 1998), and thrived through the Daimler divestiture to Cerberus(consummated May, 2007): A. Daimler never integrated Chrysler and made limited contributions to its product line; B. A once profitable Chrysler Corporation began to lag behind competitors, ultimately leading to mounting losses and unprofitable operations; and C. Daimler could not find a buyer for Chrysler at any price, but instead packaged and realigned the captive auto finance company (Chrysler financial) as the primary asset sold to Cerberus with Chrysler's automotive segment being included in the sale for a nominal price.
II. Cerberus' Chrysler Parallel structures for what had been a single-integrated business A. Segregation of investment (paid for Chrysler financial and essentially received Chrysler automotive free of charge); B. Segregation of lenders and credit lines; C. Separate corporate governance structures and boards: 1. Chrysler automotive board had one Daimler representative, three independents, a CEO and four Cerberus representatives; D. Transformation Plan (turnaround plan for Chrysler automotive) creates issues with Daimler; E. No common interest between objectives of Chrysler financial and Chrysler automotive; and F. Business relationships between Chrysler financial and Chrysler automotive favor returns and protection of Cerberus' investment in Chrysler Financial Master Auto Financing Agreement over those of Chrysler automotive. III. The Credit Crisis A. Chrysler financial contracts but unable to refinance asset backed security and commercial paper conduits from July 2008 forward B. Chrysler has almost $9 billion in cash at end of Q2 2008 C. Collateral demands D. Severe limitations on financing available to dealers/customers and inability to plan production E. Chrysler explores merger with General Motors and its finance arm, GMAC F. Chrysler's cash dwindles to approximately $3 billion by the middle of Q4 2008 G. Fiat approaches and commences diligence in preparation for strategic alliance. IV. Sovereign Loans and Equity Ownership A. Bush Administration 1. Imposition of severe limits on executive compensation and benefits. 2. Primary focus is on General Motors and its finance arm, GMAC. B. Obama Administration
1. Executive change is demanded (a) (b) General Motors CEO Rick Wagoner must resign Fiat must control Chrysler 2. Boards reconstituted (a) Chrysler Group LLC o 3 directors appointed by Fiat; o 1 director appointed by UAW o 1 director appointed by Canadian Government, o 4 directory appointed by U.S. Treasury (initial appointments last one year, with directors appointing successors) (b) General Motors Corporation o 1 director appointed by UAW o 1 director appointed by Canadian Government o 11 directors appointed by U.S. Government (60% equity owner). 3. U.S. Government reconstitutes GMAC as auto lender to both General Motors and Chrysler Group 4. U.S. and Canadian Governments act as a social investor to both Chrysler and General Motors by conditioning assistance with change and vitality covenants being paramount to traditional commercial investment covenants. C. Agendas 1. Sovereign as lender 2. Sovereign as owner D. Mission of U.S. Treasury hands off on day to day management, but closely monitor company performance and only get involved with major transactions like sale of controlling share of company December 10, 2009