RIDING A TIGER: A BILLION DOLLAR FINANCIAL FRAUD CASE
A billion dollar financial fraud, an admission by the former chairman and the seizure of the company by the government followed by criminal charges against the senior officers and auditors forms the backdrop of the SEC’s latest financial fraud case. Satyam Computer Services Ltd. of India conducted an IPO in 2001. Now it has delisted its securities. In the intervening years there was a huge financial fraud. SEC v. Styam Computer Services Ltd., Case No. 1:11-cv-00672 (D.D.C. Filed April 5, 2011); In the Matter of Lovelock & Lewes, Adm. Proc. File No. 3-14321 (April 5, 2011).
The fraud: Over a five year period beginning in 2003 the senior management of the company overrode the internal controls to insert false financial information into the system. Using what they called a “super user” login identification and password to access the invoice management system, the group inserted false invoices. The “super user” login allowed the group to enter the system without detection.
Over a five ear period beginning in 2003 2008 6,603 false invoices were put in the system through the “super user” login. The phony documents inflated revenue for fiscal year 2004 through the end of the second quarter of 2009 by $1.1 billion. In 2007 an additional $58.1 million was added to revenue by recording 27 additional fake invoices outside the “super user” login. To support the fraudulent revenue the group fabricated corresponding bank records. The false financial information was included in the financial statements of the company as well as press releases.
The confession: Then Chairman B. Ramalinga Raju prepared a letter admitting the fraud. It was filed with the SEC on January 7, 2009. The letter outlined the fraud and admitted that although the balance sheet showed over $1 billion in cash the company actually had only $66 million. The fraud was maintained according to Mr. Raju because Satyam’s promoters held a small percentage of equity and public knowledge of the poor performance would result in a take over of the company, exposing the fraud. He said maintaining the fraud “was like riding a tiger, not knowing how to get off without being eaten.”
The government of India: Shortly after the fraud was exposed and the share price plummeted, the government assumed control of the company. A new board of directors was appointed. Subsequently, a new strategic investor acquired 42% of the company and a senior management team was installed. The company is still registered to do business in New York but its shares are no longer listed for trading. It has cooperated with the Commission’s investigation.
The resolution: The company settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). The company is also required to retain an independent consultant, comply with certain undertakings and to pay a $10 million civil penalty.
The related administrative proceeding was also settled. The action centered on claims of improper professional conduct by PW India. PW Five PWC affiliated entities were named as Respondents. Essentially the Order alleges that from 2005 through 2009 the auditors failed to retain control of the confirmation process with respect to cash and cash equivalents, rarely questioning the information they obtained. The Order alleges violations of Exchange Act Sections 13(a) and 13(b)(2)(A) as well as Section 10A(a) and Rule 102(e). The proceeding was resolved with the Respondents implementing a series of undertakings including one which prohibits them from accepting new SEC clients for six months, the entry of a cease and desist order based on the sections cited in the Order and the payment of a $6 million penalty and the creation of a fair fund.
The five PWC related firms also settled with the PCAOB. The proceeding is based on essentially the same conduct as the SEC administrative action. Two of the firms will pay a civil penalty of $1.5 million which is the largest levied in a Board proceeding. In addition, the firms will implement an extensive series of undertakings.