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India scandal won't spark reforms

The $1 billion Satyam fraud shows again investors need to be exercise caution.

By John Elliott, contributor
Last Updated: January 23, 2009: 2:59 PM ET

NEW DELHI -- When a scandal the size of India's Satyam emerges, the flurry of reaction gives the appearance of major change in the works. B. Ramalinga Raju, who has admitted to inflating his software company's profits by around $1 billion in recent quarterly results, is India's version of Bernard Madoff. And people responded accordingly. Foreign investors and customers, for example, may be more cautious when choosing partners. The media and authorities will examine company results more closely, and this will make some auditors more cautious. India's SEBI, the stock market regulator, has strengthened disclosure requirements on family-controlled companies.

Despite all the hubbub, however, the sad truth is that few people in India believe that the Satyam scam will lead to any significant change in business and auditing practices. Business corruption seems here to stay. It is widely acknowledged that there is extensive fraud and corruption in many of India's family-controlled companies. And that politicians invest in fast-growing companies and help to deflect official inquiries, as is alleged to have happened at Satyam over the past decade.

"There is little integrity in financial reporting," said a top banker, who like many business leaders did not want to be named criticizing the system. Executives at Noble Group, a United Kingdom investment bank that last year opened a brokerage business in India, are the rare exception. "When we entered India we realized we had to gloss over facts with investors--or highlight them," says Saurabh Mukherjee, the firm's head of Indian equities. The firm decided it would be better to pull back the curtain on such practices.

Noble has published research which estimates that 20% of India's top 500 companies indulge in accounting malpractices such as recording revenue ahead of time, booking fictitious sales, and manipulating cash figures. Family-controlled groups also switch funds between their companies for personal gain or to improve stock prices. Noble says that family promoters "compromise the interests of shareholders in pursuit of immediate personal wealth accumulation".

Noble is not suggesting that such practices are unique to India, and it quotes research on U.S. companies to show that "creative accounting becomes more prevalent" at times of "rising economic stress" when it becomes difficult to generate growth.

It is not yet clear what legal action will be taken in India against anyone at Satyam, and any efforts to mount action are likely to be slowed down by political and bureaucratic interference and legal delays. Securities fraud class-action lawsuits have been filed in the U.S on behalf of Satyam shareholders on the New York Stock Exchange, where its depository receipts are listed.

Price Waterhouse, a local branch of PwC, the international accounting firm, is also being investigated for possible auditing lapses. If the firm is found guilty of negligence or collusion, it is likely that it will be penalized quickly because both India's banking and stock-market regulators have punitive powers, and the accounting firms do not carry as much political clout as many industrialists. Price Waterhouse was barred--"rested" is the official term-- by the Reserve Bank of India from auditing the balance sheets of banks for four years after a 2004 banking scam.

It is tempting to think that scams like Satyam's will lead to business being transferred out of India to foreign competitors, but that does not seem likely. Generally, the software-technology industry has higher governance standards than older family-controlled groups even though Wipro, another market leader, has been barred along with Satyam by the World Bank for selling stocks to the bank's employees.

Narayana Murthy, chairman of Wipro rival Infosys, says that in the past ten years businesses have generally been "evolving towards better governance and transparency and a realization that good governance is in your own interest." He says that corporate governance "is a mind set, not a check list--it's about culture, aspirations and striving for respectability."

Satyam's scam shows that India's culture has a long way to go before it achieves what Murthy calls "corporate democracy, pluralism and transparency." Satyam's Raju gathered in his board room impressive names who included a former top bureaucrat, a management school dean and a U.S.-based IT specialist. And he floated the company's stock in New York, which is regarded in India as another badge of respectability. He ticked the boxes on the good-governance check list, but did not have the culture. To top of page

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