The Indian Hustler

Ramalinga_Raju_at_the_2008_Indian_Economic_SummitVivek Kaul

At the heart of it most scams are very simple—Satyam was no different. Sometime in 2003, B Ramalinga Raju, the founder and chairman of Satyam Computer Services started over-declaring revenues of the company. The process continued till 2008. On January 7, 2009, Raju in a letter to the board of directors of the company admitted to fudging the accounts of Satyam.
Between 2003 and 2008, Raju over-declared revenues of the company by creating fictitious clients. Once he had over-declared revenues he automatically ended up over-declaring profits. Over-declared profits had to be invested somewhere. This led to the creation of fictitious bank statements and fixed deposit receipts. With a rapid advancement in the quality of colour printers, creating fictitious bank statements wouldn’t have been very difficult.
In his letter to the board, Raju admitted that the cash and bank balances were hugely overstated. The cash and bank balances of the company as on September 30, 2008(the last time the company declared quarterly results) were at Rs 5,313 crore. Th actual number was at a much lower Rs 273 crore. More than half a decade of declaring fictitious profits had led to a massive jump in the cash and bank balances of the company. But the number, like the profits of the company, was fictitious.
The company was guzzling whatever “real” cash it had at a very fast rate. By the time January 2009 started, the company’s actual cash and bank balance of the company would have been much lower than Rs 273 crore.
One of the theories put forward after Raju admitted to all the wrongdoings in the letter was that only when he realized that the company wouldn’t have enough money to keep paying salaries to its employees did he decide to come out with the truth. As Raju said in his letter: “The company had to carry additional resources and assets to justify higher level of operations…It was like riding a tiger, not knowing how to get off without being eaten.”
The irony is that Raju had to get off the tiger, and he still hasn’t been eaten. Like all big businessmen in India, Raju is also a survivor. A special court in Hyderabad has found him and nine others guilty of cheating, criminal breach of trust, destruction of evidence and forgery. The court pronounced a seven year-jail term for the founder and also imposed a Rs 5 crore fine on him.
It took the judicial system six years and three months to sentence Raju. And this is not the end of it. The decision will be challenged in higher courts and the process will continue for a while.
The question I want to explore in this column is the timing of Raju’s confession. Raju sent a tell-all letter to the Satyam Board in January 2009. Why didn’t he do the same in January 2008? Or even earlier, for that matter, is a question worth asking.
The probable reason is that Raju was confident enough of pulling off the scam till he wasn’t. And why is that? It is worth remembering that between 2003 and 2008, the stock market in India had a huge bull run. The economy was also booming. And in such a scenario, when the financial system is flush with money, it is easy to keep a scam going.
As economic historian Charles Kindleberger writes in
Manias, Panics and Crashes: “The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom.” This precisely what Ramalinga Raju was busy doing.
The stock market started crashing from early 2008, due the advent of what we now call the global financial crisis. And because of this, money wasn’t as easy to raise as was the case earlier. Raju tried to plug the huge gap in Satyam’s balance sheet by buying out two real estate firms Maytas Properties and Maytras Infra. Both these firms were owned by his family (Maytas is the opposite of Satyam).
But by late 2008, an era of easy money had come to an end. And sham transactions were not as easy to pull through. The idea here was to use Satyam’s fake cash and bank balances to buy out the real estate firms and thus have “real” assets on the balance sheet. As Raju wrote in the letter: “ The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones…Once Satyam’s problem was solved, it was hoped that Maytas’ payments can be delayed.” But this deal fell through after the independent directors on the Satyam board raised issues about an IT company taking over real estate assets. In fact, if Raju had tried to push this deal through a year earlier, chances are that the board might have agreed, given that the going was good at that point of time. And when the going is good no one wants to spoil the party by asking inconvenient questions.
As the economist John Kenneth Galbraith writes in
The Great Crash 1929: “At any given time there exists an inventory of undisclosed embezzlement. This inventory – it should perhaps be called the bezzle – amounts at any moment to many millions of dollars. In good times people are relaxed ,trusting, and money is plentiful. … Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. … Just as the (stock market boom) accelerated the rate of growth (of embezzlement), so the crash enormously advanced the rate of discovery.”
Interestingly, the Satyam scam was the first of many scams that were to hit the nation starting in 2009. It was followed by the 2G, Commonwealth games and the coalgate scam. Sahara, Saradha, Rose Valley and many other big Ponzi schemes came to light. The National Spot Exchange scam came to light as well. These scams were mostly executed during the period between 2003 and 2008, when the economy was doing well and the stock market was going from strength to strength, but they were only revealed after the good days came to a stop.
In that sense Raju set the trend of things to come. We have to give him credit for at least that.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The article originally appeared in the Daily News and Analysis on April 12, 2015

Satyam scam: Ramalinga Raju, the man who knew too much, gets 7 years in jail

A special court in Hyderabad found all the ten accused in the Satyam scam guilty of cheating, forgery, destruction of evidence and criminal breach of trust. This includes the founder and the Chairman of the company B Ramalinga Raju.
The decision came more than six years after the scam first came to light. On January 7, 2009, Raju wrote a letter to the board of directors of Satyam Computer Services, in which he admitted to cooking the books of the company. A copy of the letter was sent to the stock exchanges as well as the Securities and Exchange Board of India.
In this letter Raju admitted to inflating the cash and bank balances of the company by Rs 5,040 crore. The company’s total assets as on September 30, 2008, stood at Rs 8,795 crore. 

Of this cash and bank balances stood at Rs 5,313 crore which was nearly 60% of the total assets.  This was overstated by Rs 5,040 crore. The company basically had cash and bank balances of less than Rs 300 crore.
Raju also admitted to fudging the last financial result that the company had declared, for the period of three months ending September 30, 2008. The company had reported revenues of Rs 2,700 crore, with an operating margin of 24% of revenues or Rs 649 crore. These numbers were made up. The actual revenues were Rs 2,112 crore with an operating margin of Rs 61 crore or 3% of the total revenues.
So, Satyam had made a profit of Rs 61 crore but was declaring a profit of Rs 649 crore. The difference was Rs 588 crore. The operating profit for the quarter was added to the cash and bank balances on the balance sheet. Hence, cash and bank balances went up by an “artificial” Rs 588 crore just for the three month period ending September 30, 2008.
This was a formula that Raju had been using for a while. First Satyam over-declared its operating profit. Once this fudged operating profit was moved to the balance sheet, it ended up over-declaring its cash and bank balances. And this led to a substantially bigger balance sheet than was actually the case.
The company had total assets of Rs 8,795 crore as on September 30, 2008. Once the Rs 5,040 crore of cash and bank balances that were simply not there were removed from this, the “real” total assets fell to a significantly lower Rs 3,755 crore.
Raju went on to say that: “The gap in the Balance Sheet has arisen purely on account of inflated profits over a period of last several years (limited only to Satyam standalone, books of subsidiaries reflecting true performance). What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years.”
What was Raju upto? Raju’s fraud was no Enron, where complicated derivative transactions were used to boost revenues as well as profit. He had been cooking the books since 2003 by simply over-declaring revenues and profits. In the process he ended up boosting his balance sheet as the cash and bank balances kept going up.
So, how did Raju manage to boost revenues? In order to do this Raju created fictitious clients with whom Satyam had entered into business deals. This was again something akin to Enron, which essentially entered into business deals with its subsidiaries. The subsidiaries paid Enron for the deal by borrowing money. While the revenues brought in from the subsidiaries was recorded by Enron, the debt that they had taken on, wasn’t.
Getting back to Raju, in order to record the fake sales he introduced 7000 fake invoices into the computer system of the company. He couldn’t stop at this.
The clients were fake. Fake clients could not make real payments. Given this, the company kept inflating the money due from its clients (or what Raju called debtors position in his letter).
Further, once fake sales had been recorded, fake profits were made. And fake profits brought in fake cash which needed to be invested somewhere. This led to Raju creating fake bank statements(forged fixed deposit receipts) where all the fake cash that the company was throwing up was being invested.
Raju then tried to use this “fake cash” and buy out two real estate companies called Maytas Properties and Maytras Infra (opposite of Satyam and promoted by the family) for a total of $1.6 billion. But this did not work out. As Raju said in his confessional statement: “The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones. Maytas’ investors were convinced that this is a good divestment opportunity and a strategic fit. Once Satyam’s problem was solved, it was hoped that Maytas’ payments can be delayed.”
The idea was to have some “real” assets against all the “fake” cash that the company had managed to accumulate. But that did not happen and after this, Raju had no way out but to come clean.
The question is how could Raju run such a big scam for such a long period of time. Satyam’s accounts were audited by Price Waterhouse, a member-firm of PricewaterhouseCoopers International Ltd — since the financial year 2000-2001.
The auditor had no clue that Satyam’s assets were overstated by more than Rs 5,000 crore. When the scam first broke out a middle level executive from a Big 4 consulting firm told me: “All the auditor needed to ask was the bank statements of the various banks in which this (supposed) cash had been deposited or mutual funds it had been invested in. This is overstatement of Rs 5,000 odd crore we are talking about, not Rs 500.” The auditor clearly did not do that.
The auditor is paid to ask questions; in this case it seems to have been paid not to ask any. The company couldn’t have hoodwinked the investors without the auditor being on its side. This was no complicated accounting fraud like Enron was.
The many analysts who covered Satyam also did not have any clue about the fact that the profits as well as revenues of Satyam were fake. Brokerage analysts who follow companies need to keep companies in a good humour. Without that, they run the risk of being given limited or at times no access to the company, at all. This explains why none of the analysts caught on to what was happening at Satyam. It also explains why the number of sell recommendations on stocks put out by brokerage analysts are lower when compared to the number of buy recommendations that brokerages put out.
And finally we come to the media. It had no clue of what was happening at Satyam. One reason for this lies in the fact that the Indian media over the years has been extremely taken in by the IT companies and the people who run them.
The case with Satyam’s Raju was no different. Lot of magazines and newspaper wrote stories on him and painted him as a person who could do no wrong. This blinds investors, media and experts who follow a company. This comes from the need of the media to create a story around the individual.
As Nassim Nicholas Taleb writes in his book 
Fooled by Randomness on how the Halo effect around a CEO is built up by the media: “We would get very interesting and helpful comments on his remarkable style, his incisive mind, and the influences that helped him achieve that success. Some analysts may attribute his achievement to precise elements among his childhood experiences. His biographer will dwell on the wonderful role models provided by his parents; we would be supplied with black and white pictures in the middle of the book of  great mind in the making.”
Something similar had happened with Satyam as well. And given this the media expected Satyam to do no wrong. The Halo effect was clearly at work in case of Satyam as well. Investors could see Raju doing no wrong. Raju even sold his shares in Satyam to fund social causes. How could such a man be a fraud? When the Halo effect is at work, the ability to ask incisive pointed questions clearly goes down, and that’s what happened in Satyam’s case as well.
So, while Raju ran his fraud, the auditor slept, the analysts slept and so did the media. To be fair, the media did an excellent job of exposing Raju and his many other ‘shenanigans’ after he had confessed.
Now more than six years later, the first decision in the Satyam scam has been made. Of course, we haven’t seen the last of this case, given the slow pace at which our judicial system works.
Stay tuned.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column was originally published on Firstpost on Apr 9, 2015