Satyam Fiasco & Role of PwC as an Auditor
Raju Raju Yes baba Cheating us? No baba Telling lies? No baba Open the Balance Sheet? HA! HA! HA!
Aditya Zutshi Ambrish Mani Tiwari Piyush Anandani Ravinder Pal Singh Dhillon
From Group – I of Business Ethics Course 1
The Balance Sheet as of Sept 30, 2008 showed:-
◦ Inflated (non-existent) cash & bank balances of Rs 5,040 Crores (as against Rs 5312 Crores reflected in the books) ◦ An accrued interest of Rs 376 Crores which is non-existent ◦ An understated liability of Rs 1,230 Cr on account of funds arranged by BR Raju
◦ An over stated debtors position of Rs 490 Crores (as against Rs 2651 Crores reflected in the books) ◦ Revenue of Rs 2,700 Crores (Actual – Rs 2,112 Crores) and an operating margin of Rs 649 Crores (Actual Rs 61 Crores). i.e. only 3% of Revenue in comparison of 24%, as reported . ◦ Resulted in Artificial cash and bank balance going up by Rs 588 Crores in Q2 alone.
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On Dec 16, 2008, Satyam declared to buy entire stakes in Maytas Properties for $1.3 Billion & 51% stakes in Maytas Infra for another $300 Million
Investors were furious ◦ Move to invest in a promoter-related company ◦ Lack of prior consent of shareholders before deciding to invest
Investors‟ activism ◦ Deal had to be called off and Satyam stock plunges
◦ On December 29, reports surfaced that the Satyam promoters had pledged their shares followed by resignation of 3 independent directors.
◦ January 7, 2009: Ramalinga Raju resigns, admits to fraud. He says the company's cash and bank balance sheet has been inflated and fudged to the tune of Rs 5,040 crores.
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PwC’s Role as Satyam’s Statutory Auditor
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PricewaterhouseCoopers (PwC), one of the world's largest accountancy firms, missed a systematic £1 billion fraud at Satyam, the IT outsourcing giant, for as long as seven years. In contrast, Merrill Lynch, the US bank, became aware of the deception in just ten days. PwC's role in "India's Enron" comes under the spotlight amid allegations that large Indian companies regularly use misleading accounting techniques and bully analysts, accountants and auditors into staying quiet. The company's balance sheet as of March 31, 2008 was signed off by Srinivas Talluri, a partner of Price Waterhouse in Hyderabad, the southern Indian city where Satyam is based. PwC Response: "The audits were conducted by Price Waterhouse in accordance with applicable auditing standards and were supported by appropriate audit evidence.”
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On being asked about the irregularities then, PwC issued a statement saying "Given our obligations for client confidentiality, it is not possible for us to comment upon the alleged irregularities. Price Waterhouse will fully meet its obligations to cooperate with the regulators and others.” Analysts believed the reason why this happened was because India does not restrict auditors from carrying out consulting work for the companies they audit, while In most Western countries rules limit such activities, which could trigger conflicts of interest for
auditors. An industry insider was quoted as saying “Many Indian firms have become so convinced of their own invincibility that they do not even bother denying irregularities
when confronted with the evidence. They simply threaten you”
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ROLES AND RESPONSIBILITY OF STATUTORY AUDITORS • An Auditor has to be a Chartered Accountant under the Chartered Accountants Act, 1949. • He is the person appointed to examine the books of account and the accounts of a company registered under the Companies Act, and to report upon them to the company‟s shareholders. • Audit means the examination or assessment of a company‟s annual accounts, i.e. a balance sheet, profit and loss account and other financial statements as required by law. • Under the Companies Act, an auditor is required to express an opinion as to whether the annual accounts give a true and fair view of the company‟s state of affairs and financial position. • To formulate such an opinion, the auditor needs to examine the company‟s internal accounting system, inspect its assets, test-check of accounting transactions.
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ROLES AND RESPONSIBILITIES (Continued) The statutory duties of the auditor basically entail the following: 1. Duty to make certain inquiries 2. Duty to make a report to the company on the accounts examined by him 3. Duty to make a statement in terms of the provisions prescribed The auditor has a duty to inquire into certain matters and seek any information required for the audit, from the company. This could be in relation to security on loans and advances made by the company, any transactions entered into by the company and whether they are prejudicial to the interests of the company, whether personal expenses are recorded and charged to proper accounts, any transaction with respect to sale of shares and whether the position depicted in the books and balance sheet is correct, honest and proper.
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ROLES AND RESPONSIBILITIES (Continued) If there are any suspicious circumstances or unusual transactions like unavailability of original documents, or sudden increase or decrease in shareholdings or debt, employees given the liberty to access unauthorized documents etc., then the auditor is under a clear duty to probe into these transaction and ensure that they are proper and legal. At all times, auditor has to act with care and skill of a professional of reasonable competence. The degree of care and skill required however, varies from case to case.
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Auditor’s Report Under Section 227 of the Companies Act, the auditor is supposed to report to the beneficiaries of the company i.e. the shareholders in the general meeting, about the books and accounts of the company, the balance sheet and profit and loss account on the basis of their assessment. They have to give their opinion on the financial position of the company and also make sure that it has been fairly, truly and honestly depicted. As per Section 227 of the Companies Act, the report should also state: 1. 2.
That the auditor has obtained all information and explanations, which are to the best of his knowledge and belief necessary for his purpose; Whether in his opinion, all the books of accounts and requisite documents necessary for the audit have been furnished by the company;
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Auditor’s Report (Continued) 3. 4.
Whether the balance sheet and profit and loss account comply with the books of accounts; Any observation and comments on the functioning of the company, especially, which may have an adverse effect on the company.
He is thus required to report not merely on the balance sheet but on the accounts he examines, and he also has to express his opinion whether the company has properly kept all the books as per law and whether the balance sheet and profit and loss account are in accordance with the accounting standards and procedures prescribed by the ICAI. The report should be complete, concise, clear and unambiguous and the auditor should be careful about the language used, as the readers of the report are all laymen.
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Duty to report fraud • During the course of the audit, the auditor could come across situations where he discovers that a senior employee is defrauding the company or using unfair practices, then an obligation arises of the auditor to report what he has discovered to the management immediately so that appropriate action can be taken.
Auditor’s duties to third parties • The courts have held that if the auditors know or have reason to believe that the accounts so prepared by them will be relied upon by third parties, they are under a duty to ensure that those accounts are carefully prepared and that they don‟t contain any false information or negligent misstatements and that they reflect a true and fair reflection of the company‟s financial position.
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Duty as to considerable accuracy The auditorâ€&#x;s function is not just to verify the arithmetical accuracy of the accounts; but that it includes all the particulars required by law and that it presents a correct and honest view of the companyâ€&#x;s financial standing. Detection and Prevention of Fraud The auditor needs to ensure that effective anti fraud programs are in place, which not only prevents fraud but also assists in its detection and cure by: 1. Observing the modus operandi of financial reporting; 2. Overseeing the internal audit and control system; and 3. Reporting findings to the management. The auditor is at all times, required to act with reasonable care and skill, but he is not required to always be on the lookout for fraud or a lie, unless he comes across such information or situation which is unusual and instigates him to act with suspicion. 13
Liabilities of an auditor • The auditor has a fiduciary relationship vis-à-vis the shareholders of a company, therefore he has a moral obligation to see that ensuring that the statements issued are made with the utmost skill safeguards their interests and care and depict the true and fair state of affairs of the company. • Section 233 of the Companies Act imposes a penalty for on the auditors for noncompliance of Sections 227(thorough checking) and 229(authorized signee) with payment of fine if there is willful negligence and default. • In order to hold the auditor liable for fraud, the following conditions must be satisfied:
1. That the statement signed by the auditor is untrue and false 2. That he knew it to be untrue either or did not apply reasonable care and skill 3. That he intended the report to be relied on by others 4. That the parties on relying upon the report suffered loss.
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Ethical principles used for the evaluation
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Right is an individual’s entitlement to act in a certain way have others act in a certain way toward him or her. Legal right Entitlement derived from a legal system
Moral rights Entitlement derived from a system of moral standards Moral rights are universal in nature
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Those activities or interests that the individual is empowered to pursue, or must be left free to pursue, or must be helped to pursue as he or she chooses; and they protect the individual‟s pursuit of those interests or activities within the boundaries specified by the rights Three important features of Moral Rights
Moral rights are tightly correlated with duties
Moral rights provide individuals with autonomy and equality in the free pursuit of their interests.
Moral rights provide a basis for justifying one‟s actions and for invoking the protection or aid of others.
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Negative rights- Duties others have to not interfere in certain activities of the person who holds a given right. Positive rights- Agents have the positive duty of providing the holder of the right with whatever he/she needs to freely pursue his/her interests.
Contractual rights- Limited rights and correlative duties that arise when one person enters an agreement with another person ď ˝
Contractual rights attach to specific individuals and correlative duties are imposed only on other specific individuals
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Contractual rights arise out of specific transaction between particular individuals
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Contractual rights and duties depend on a publicly accepted system of rules that define the transactions that give rise to those rights and duties.
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Both of the parties to a contract must have full knowledge of the nature of agreement they are entering.
Neither party to a contract must intentionally misrepresent the facts of the contractual situation to the other party.
Neither party to the contract must be forced to enter the contract under coercion
The contract must not bind the parties to an immoral act.
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An action is morally right for a person in a certain situation if , and only if, the person‟s reason for carrying out the action is a reason that he/she would be willing to have every person act on, in any similar situation.
UNIVERSALIZABILITY- The person‟s reasons for acting must be reasons that everyone could act on at least in principle
REVERSIBILITY-The person‟s reasons for acting must be reasons that he/she should be willing to have all others use even as a basis of how they treat him or her.
An action is morally right for a person if, and only if, in performing the action, the person does not use others merely as a means for advancing his /her own interests, but also both respects and develops their capacity to choose freely for themselves
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Evaluation of the case
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An accounting failure can mean one of two things:
◦ either PwC was hand in hand with Satyam ◦ whatever documents provided to them were false and forged by Satyam honchos themselves.
The contract that the auditor has with the company is not a contract the shareholders or other stakeholders are privy to. Hence, under Indian law, it is difficult for the shareholders to take any action against the auditors under the Law of Contract.
Typically, auditors restrict the quantum of their liability to the extent of the fees that they receive from the company.
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Tri-Sure Vs A F Ferguson (the auditing firm), the high court held that the "auditor is required to employ reasonable skill and care but is not required to begin with suspicion and to proceed in the manner of trying to detect a fraud or a lie...”
The high court said that “while high standards needed to be maintained by an auditor, it would be difficult for an audit firm to be suspicious from the very beginning unless prima facie there is sufficient reason to doubt the company.”
Tort laws include what constitutes legal injury and establishes the circumstances under which one person may be held liable for another's injury. Torts typically cover intentional acts and accidents. But for this, the shareholders need to satisfy the court on whether the auditors owe a duty of care to the shareholders and that there was a breach of duty by the auditor. "Only then can a claim be made against the auditors.
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According to highly placed sources at ICAI, the report was handed over to CBI a couple of months ago, and has been signed by ICAI president Uttam Agarwal. The key findings of the report include:
Auditor PricewaterhouseCoopers did not follow auditing standards while conducting the audit of Satyam. Auditors ignored audit evidence that clearly showed discrepancy in bank account balances submitted by Satyam management and the bank confirmation obtained by the auditors from the banks. Auditors ignored audit evidence that suggested fraud at Satyam.
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.Bank balances • Certificates from banks confirming the amount balance as shown in the company account books, particularly the bank balance confirmation certificate that the auditor compulsorily has to seek from the client's bank by India's financial year end of March 31.
Cash in hand • The auditor has to physically check the client's cash reserves in sudden surprise inspections. Satyam reported a cash/bank balance of $1.09 billion, while it actually only had about $65 million as of September 30, 2008, a gaping hole that auditors using the supposedly superior IFRS mysteriously failed to see.
Outstanding debts • The chartered accountant corresponds directly to debtors, who confirm through a certificate that they owe such a sum to the firm. This outstanding-dues certificate from each debtor has to reach the auditor directly. Satyam auditors seemingly have failed to spot faked outstanding debts worth $99 million for the financial quarter ending September 2008, thereby showing fake profits and duping investors.
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This was not the PwC‟s first brush with corporate scams in India – or for that matter abroad. Earlier, the DSQ Software and Global Trust Bank scams had the same thread running through them – PwC (or Lovelock Lewis, also part of the same network) were the statutory auditors for both.
The Satyam case has a parallel in the 2005 book-keeping fraud at the Japanese cosmetics and textiles maker, Kanebo, where again the auditor was Chuo Aoyama PwC. In Japan Chup Aoyama PricewaterhouseCoopers was banned by the country‟s regulator. Then, PwC floated a new company called Arata to take up audit assignments with new partners.
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Accountants were emphatic that it was impossible for auditors using traditional Indian accounting practices to be unaware of financial irregularities of this magnitude, particularly over a period of years.
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PwC uses IFRS and its client Satyam was one of India's first companies to keep accounts in this format.
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The September quarterly auditing is somewhat cursory and less detailed as the financial year-end auditing, but the possibility of cursory auditing does not apply in this case as the confession has been of the fraud going on for years. In other words, Satyam auditors have not apparently undertaken what traditionally would have been the minimum independent verification of the client's accounts as a chartered accountant firm is supposed to do.
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ď ˝
In both the two past Indian cases and in Satyam, PWâ€&#x;s partner S Gopalakrishnan was signatory to the audit report. Gopalakrisnan was also a central council member of the Institute of Chartered Accountants of India (ICAI). Another official, who did not wish to be named in ICAI report to CBI, said that after the Global Trust Bank fiasco, some of the partners had sought a probe against Gopalkrishnan, a demand that the company managed to stave off.
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We don‟t know nearly as much as we think we do, and that revamping compliance policies and systems for enforcement nationwide and worldwide needs to be top of mind for every business. The Satyam scandal will simply add one more layer of distrust to be overcome for effective business-to-business relationships, and for investor confidence. The best case scenario is that people are so conditioned to expect this type of thing that we just stay floating in the status quo. Problematic aspects of auditor‟s job: Auditing companies that then go bust Cross-selling of consulting services to audit clients Long-term relationships with clients Size of the accounting firm Increase in competition between auditing firms
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How can we now prevent another Satyam?
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Codes of ethics Organisational or corporate codes of ethics Professional codes of ethics Industry codes of ethics Programme or group codes of ethics
Effectiveness of a code is in the implementation and administration Successful implementation of code of ethics Maximise participation of organisation members in development stage to encourage commitment and „buy in‟ Discipline employees found in breach Follow-through Global codes should define minimum ethical standards.
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Internal controls and internal auditors
Independence of the entity's external auditors
Oversight and management of risk
Oversight of the preparation of the entity's financial statements
Review of the compensation arrangements for the chief executive officer and other senior executives
The resources made available to directors in carrying out their duties
The way individuals are nominated for positions on the board
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Internal Mechanisms Monitoring by the board of directors Internal control procedures and internal auditors Balance of power Remuneration
External Mechanisms Competition Debt covenants Demand for performance information Government regulations Media pressure Takeovers 33
◦ The CFO appointment needs the audit panel‟s approval ◦ Rotation of audit firm partner every five years ◦ Audit panel in charge of audit firm independence
◦ Not wise for external firm to do internal audit ◦ If 50% of total revenue from overseas arm can voluntarily submit their financial results in IFRS
◦ Half yearly disclosure of audited figures ◦ Streamline the timelines for submission of results Quarterly n YTD within 45 days of quarter end
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Need to strengthen regulators and company laws to improve corporate governance, by the corporate ministry
Peer review and rating of auditors
◦ The ICAI should regularly review and rate all auditors ◦ Listed companies to appoint auditors who satisfy some minimum requirements
Make additional monetary benefits to independent directors illegal
◦ Independent shareholders should have no professional or businesses relationship or dealings with the company or its promoters ◦ Ensure commitment to values, ethical business conduct
Role of Audit Committee
Regulatory regime built on senior management responsibilities
Whistle blowing policy be made compulsory to all companies 35
[1] Nine theories of Ethics to Rule the world, Univ of Cal, Journal 182, Page 37-39 [2] Satyam scandal could be 'India's Enron' - World business- msnbc.com (updated 11:42 a.m. ET Jan. 7,2009 [3] Grand Jury meeting of GOLDEN PEACOCK AWARDS 2008 - 8th September 2008, New Delhi Announcement of results [4] Satyam stripped off Golden Peacock Global Awards - Software-Infotech-The Economic Times (8 Jan 2009, 0118 hrs IST, PTI) [5] NYSE halts trading in Satyam stock - (Wednesday, 7 January 2009, 23:02) Sify.com [6] Satyam Computer Services Ltd (SAY.N) Key Developments (Stocks) Reuters.com [7] Indian IT scandal boss arrested - 9 January 2009 - Business - BBC NEWS [8] Price Waterhouse says its Satyam audits relied on company information, could be wrong[dead link] - 14 January 2009 - Associated Press [9] Satyam fudged FDs, has 40,000 employees: , Satyam Prosecution Case Documents, Public prosecutor [10] Www.wikipedia.com
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