INDIA: CORRUPCION OUTSOURCING

Financial Scandal at Outsourcing Company Rattles a Developing Country

By HEATHER TIMMONS

Published: January 7, 2009

NEW DELHI — Ramalinga Raju was contrite, sort of.

Enlarge This Image

European Pressphoto Agency

Ramalinga Raju resigned from the outsourcing company he helped found, Satyam Computer Services, after an accounting scandal.

Related

Floyd Norris: A Corporate Hero Admits Fraud (January 7, 2009)

Company Statement (pdf)

brush,” said Lakshminarayana, the chief strategy officer for Wipro Technologies, which competes with Satyam.packages like those in China and the United States.

Outsourcing and information technology are crucial parts of the Indian economy. They provided local companies with $64 billion in revenues in 2008 and employed more than two million people directly, and millions more indirectly.

Mr. Raju said he had regularly falsified Satyam’s accounts as the company expanded from a small family-run firm into a back office giant with 53,000 workers in 66 countries.

Some of India’s biggest conglomerates started out as family-run companies, and analysts fear the taint of corruption from Satyam — poor governance, lax accounting controls and a lack of transparency — could sully any of those big companies for investors and customers.

Relatives often hold crucial management positions and sizable stakes in the companies. Foreign investors have begun to push for more outside representation on boards, and for families to give up controlling stakes they hold.

A huge piece of Satyam’s finances was a fantasy. Of the 53.6 billion rupees in cash and bank balances the company listed as assets at the end of its second quarter, 50.4 billion rupees ($1 billion), were nonexistent, according to Mr. Raju’s letter. Revenues for the quarter ended Sept. 30 were actually 20 percent lower than the 27 billion rupees reported, and the company’s profit for the quarter was just 10 percent of what it reported at the time.

Many analysts said it was unthinkable that Mr. Raju had acted without accomplices, and regulators in India, Europe and the United States were likely to take action against Satyam for false accounting. In addition to being listed in India, its shares have traded on the New York Stock Exchange since May 2001, and on Euronext since January 2008.

Satyam’s auditor, PricewaterhouseCoopers, which has audited the company since its NYSE listing, said it was “examining” Mr. Raju’s statement and could not comment further.

Many Satyam clients said they were studying the situation. Cisco said it did not expect any “material impact.”

The revelations could lead to a major shake-up in India’s outsourcing industry, as a nearly cashless Satyam struggles to meet payroll and other expenses. Satyam may be shut down, sold off in its entirety or broken into pieces, they say.

John C. McCarthy, an analyst with Forrester Research in New York, said Satyam’s clients were scrambling to find out “whether the fraud is intermingled” with their operations, and what their liabilities are.

“This happens like clockwork in the high-tech business,” he said. “Every three to four years there’s some financial scandal. It is because high-tech has traditionally been viewed by the financial analysts as a growth industry. There are huge pressures to maintain that growth, and not all companies have the management wherewithal to survive under those pressures.” In the short term, many Satyam clients will migrate to competition like Infosys and TCS, said analysts with Religare Hichens Harrison.

News of the scandal sent the Sensex index down 7 percent on Wednesday. Shares in Satyam fell about 78 percent. Trading in Satyam on the NYSE was suspended until further notice.

Though Mr. Raju’s announcement shocked most of the world, there had been signs for months that something was wrong at the top of Satyam.

The company came under close scrutiny after an October report on Fox News that it had been banned from World Bank contracts when spy software was installed on some computers. Satyam denied the accusation, but in December the World Bank confirmed it had been banned for giving improper benefits to bank staff, and for not accounting for all its fees.

In December, Satyam investors revolted after the company proposed buying two firms with ties to Mr. Raju’s sons.

On Dec. 30, analysts with Forrester Research warned that corporations that relied on Satyam might ultimately need to stop doing business with the company.

“Firms should take the initial steps of reviewing the exit clauses in their current Satyam contracts,” in case management or direction of the company changes, Forrester said.

Four of the company’s directors resigned recently and the company hired Merrill Lynch for strategic advice, a move that is generally a precursor to a sale.

On Wednesday, Merrill Lynch sent a letter to India’s stock exchanges, saying it had terminated its relationship with Satyam after the bank “came to understand that there were material accounting irregularities” at the company. Merrill Lynch officials declined to comment further.

Mr. Raju wrote in his confessional letter that neither he nor the managing director (his brother B. Rama Raju) had “taken one rupee/dollar from the company.” He said the board, his brother and their families had no knowledge of the situation, seeming to leave open the possibility that someone else did.

SEBI, India’s securities regulator, said it would investigate trading in Satyam’s shares. Mr. Raju could face up to 10 years in jail and fines of $5 million in India for the accounting fraud.

Claire Cain Miller contributed reporting from San Francisco.