Pro Forma Distractions at Satyam

Despite U.S. GAAP reporting, pro forma performance measures and family ties made Satyam a black hole for ordinary investors.

Editor’s note:
The Kroll report cited below incorrectly reported that percent of Satyam shares held at the beginning of the year by family members was 36 percent. This story has been changed to reflect the correct amount, which was 9 percent.

Last February, Srinivas Vadlamani, the CFO of Satyam since 1994, boasted to CFO Europe magazine that his company had mastered U.S. GAAP accounting. “A few years back we were new to U.S. GAAP,” Vadlamani said at the time. “But now we can say with confidence that we can carry out U.S. GAAP accounting as perfectly as any other global corporation.”

Vadlamani, who was arrested earlier this month for his role in the growing Satyam accounting scandal, had also told CFO Europe last year that “as a foreign private issuer [in the U.S.], we learned to comply with SOX requirements well ahead of time [and] we have recently embarked on compliance with IFRS requirements.”

In fact, say experts, many Indian information technology companies have a number of financial reporting habits that can serve to distract investors and analysts alike from signs of fraud. A new report from Kroll says that Indian IT firms self-report a variety of operational metrics that are frequently opaque and provide a sense of accomplishment that may not be accurate.

“These firms have developed a sterling image as the best exemplars of corporate governance precisely because they volunteer these unaudited measures of their own invention,” says the report, written by Richard Dailly , managing director for Kroll’s office in Mumbai and Niren Shah, a Kroll analyst in Mumbai. Such measures include the billing rates per hour of trainees and experienced engineers, the percentage of revenue earned from top clients, and the geographic mix of the client base.

According to Kroll, a risk-management consultancy that is part of professional services firm Marsh & McLennan Cos., investors rarely scrutinize such measures carefully. “Accounting statements have not, as a matter of course, been compared against the reported performance metrics” by investors, says the report, adding it is also unclear whether auditors verify them.

Others have made similar charges that contradict Vadlamani’s confident comments about control and governance issues. One governance expert said that both governance and regulatory oversight in India need improving. “Corporate governance in India was late on the scene, it is more politically motivated than legally based, and regulatory laws and agencies are burdened with the complex, slow-moving legislative and judicial processes,” John Alan James, a governance expert and adjunct management professor at Pace University’s Lubin School of Business told CFO.com. “A governance disaster was predictable.”

The Kroll report also warns about the prevalence of family influence in emerging market companies and suggests that insiders used the first week of 2009 to unload millions in stock before Raju’s confession of accounting fraud on Jan. 7. At the beginning of the year, the founding family of Satyam almost 9 percent of the company’s shares. By the time Raju confessed, the report says, they held just over 3 percent.

“Although not limited to emerging markets,” notes Kroll, “the risk of another Satyam scandal is more prevalent in companies which are family-managed.”

Satyam, which was traded on the Bombay Stock Exchange, and which also had American Depository Receipts listed on the New York Exchange, saw its shares plunge more than 90 percent after CEO B. Ramalinga Raju, admitted on Jan. 7 that he inflated profits in recent years at the outsourcing giant, and was forced to inflate the balance sheet. In his letter, Raju said the “has attained unmanageable proportions in size.” He compared his own position as CEO of a fraud-infected company as having been “like riding a tiger, not knowing how to get off without being eaten.”

News of the fraud at the computer services company came at a time when outsourcing proponents were touting offshore services as a way for US companies to realize cost savings in the midst of financial crisis. The scandal has raised questions about that strategy. Companies such as Nestle SA, General Electric Co., Caterpillar Inc., Sony Corp., and Nissan Motor Corp. were all Satyam clients. In 2007, Satyam’s CFO told CFO Europe that 64 percent of its clients were U.S. companies, while 18 percent were were European companies.

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