The vast accounting scandal at Satyam Computer Services may increase investor nervousness about weak corporate governance and oversight in emerging markets.
Satyam founder and former chairman Ramalinga Raju admitted on Wednesday to inflating Satyam’s reported cash and bank balances by over Rs 50 billion ($1 billion), but little is known about how widespread the problem is and things could get worse if other frauds are uncovered.
The scandal, which is being dubbed by some analysts as “India's Enron” and compared to Bernard Madoff’s alleged $50-billion Ponzi scheme in the United States, comes at a bad time for emerging markets.
Benchmark emerging equities are down 52 per cent since the beginning of 2008 as investors fled risk and hopes of a “decoupling” from a slowdown in developed markets proved mostly unfounded.
“It’s got to shake confidence. And it is compounded in my mind by what I already call the fear complex that exists around all global markets,” said Lesley Hand, a partner in accounting firm KPMG LLP’s forensic practice.
“The thing you don't know here is how far reaching this is,” Hand said.
“I don’t know if it will be long, long-term. But you let another shoe or two drop and I would say it would be way worse.”
Raju’s revelation came after days of turbulence at the Indian outsourcing company that began with a botched attempt by Satyam to buy two infrastructure companies in which management held stakes. Satyam’s shares fell nearly 80 per cent in India and dragged down Bombay Stock Exchange benchmark index, Sensex, 7.3 per cent.
The Securities and Exchange Board of India (Sebi), the markets regulator, has already ordered an investigation into Satyam, and the scandal could lead to investor lawsuits in the US targeting various parties, from the company’s directors to its auditor, PricewaterhouseCoopers (PWC).
PWC has said it is examining Raju’s statement and would not comment further.
“One of the frustrating things about accounting issues is that it is often difficult for sophisticated investors or even outside directors of the company at issue to detect them,” said Michael Young, a partner at international law firm Willkie
Farr & Gallagher, who has written a book on financial fraud. “That’s why accounting problems tend to take almost everyone by surprise.”
The scandal underscores the risks that come with investing in a market with not enough regulatory oversight and protections.
“When you are dealing with riskier regulatory environments like India or other emerging markets there are real risks that the companies are being held to lower standard by their own internal regulators than companies in the West,” said Geoffrey Coll, co-head of law firm Dewey & LeBoeuf’s India practice group.
It also highlights cultural risks inherent in India’s family-owned businesses, which have long battled issues such as nepotism, mismanagement, weak boards and lack of transparency and professionalism.
About half the companies in the BSE’s benchmark 30-share Sensex are family controlled.
“The people who do this (fraud) are usually egocentric. They have an incredibly high IQ. They generally surround themselves with people that support their opinion about what they are doing,” Hand said.
“It’s almost cult-like.”
But the scandal should not have come as a total shock to investors, Dewey & LeBoeuf's Coll said.
“If I am an investor who is buying shares of companies from emerging markets, I am already going to have some degree of skepticism,” Coll said. And such scandals have hardly been confined to the developing world, with immense frauds such as Enron, WorldCom, Adelphia and now Madoff rocking the developed world in recent years. Some investors in Europe said they will wait for signs of widespread malfeasance among Indian companies before deciding whether to change their investment policy on India.
The Bank of New York Mellon’s sub index of Indian ADRs (American Depositary Receipts) slipped 5.2 per cent, but Satyam rival Infosys Technologies Ltd closed up 1.3 per cent on Nasdaq.
“Clearly, corporate governance was a worry, but it doesn’t appear, from the level of the ADRs here, that there is that much concern,” said John Ploscowe, executive director of Asian cash trading at JPMorgan Chase. “This is probably more a one- off sort of situation.”