Satyam fraud: Sebi penalty on Rajus is Rs 3,000 cr and counting but who will pay?

On 7 January 2009, B Ramalinga Raju told the stock exchanges and market regulator Sebi that he had overstated cash and bank balances by Rs 5,040 crore as on 30 September 2008, shown non-existent interest earnings of Rs 376 crore in his books, and invented debtors (those who owed Satyam money) worth Rs 490 crore – for a total misstatement of Rs 5,906 crore. He also claimed that the company owed him (and his promoter group) Rs 1,230 crore. In short, the net fraud was worth Rs 4,676 crore.

On 15 July 2014, a Sebi wholetime member and adjudicator in the Satyam fraud, Rajeev Kumar Agarwal, announced his verdict: a 14-year bar on Ramalinga Raju, his brother Rama Raju and three others (former CFO Vadlamani Srinivas, ex-Vice-President-Finance G Ramakrishna, and ex-head of internal audit VS Prabhakara Gupta) from buying or selling stocks for 14 years. No great shakes that. But they were also asked to disgorge a collective Rs 1,849 crore as penalty, with 12 percent simple interest. Add the interest, and the quintet would have had to pay up around Rs 3,070 crore on the day of the Sebi verdict.

None of the indicted five is, of course, going to be in a hurry to pay up. Especially since the main case, their prosecution in a special CBI Court, is still meandering inconclusively and shows no signs of an early finish. It is in the snail’s pace of justice movement that makes the Sebi order stand out. At last we have nailed their fraud.

Sebi’s verdict is on the limited point of violations of its fraudulent and unfair trading practices and insider trading laws. The CBI verdict, when it comes, will look at the criminality of their fraud too.

The Sebi order makes for interesting reading for it details how Ramalinga Raju, his brother and their partners in financial crime managed to pull wool over the eyes of millions of investors, accountants, bankers, auditors and regulators with impunity. It is frightening that such large-scale fraud, which is precisely the kind of thing our various watchdogs are meant to prevent, can be perpetrated so casually by just a few people at the top.

To show excess cash, several banks have to be fooled or asked to look the other way. They probably were. To show huge fake revenues, everyone, from sales teams to MIS managers to accountants, had to be kept in the dark or conscripted into the conspiracy. Some probably were. To hide it all from investors and analysts, auditors had to be fooled or roped in as co-conspirators. Some surely were.

The 65-page Sebi order is worth spending an hour on to learn how it happened, why it happened, and whodunit.

It’s clear that the scam was plotted at the top and driven by Ramalinga Raju and his brother. They were the key players in the plot to falsify the accounts and hide the bottomline truth from everyone. It is also clear that all the culprits – from Raju down to the finance guys – did everything possible to give Sebi a run-around and delay the verdict. This is what explains why it took five-and-a-half years to close an open-and-shut-case.

As the Sebi order itself explains, the first show cause notices were sent to the quintet in March 2009 – two months after the Ramalinga Raju confession in January 2009. All five declined to appear before Sebi offering various excuses at various stages.

The third and final show cause went a year later, and it was only when the Rajus failed to cooperate that Sebi went ahead and investigated their crimes on its own.

Even at the final stage, in May 2014, when the five were told that they would have one last chance to make their case before Sebi, they opted for another delaying tactic: they suddenly wanted to cross-examine Sebi’s witnesses.

As the Sebi order notes: “Even when the final and last opportunity of personal hearing in these proceedings was afforded to the noticees on May 12, 2014, they chose to avoid and evade the same…”. Rejecting the idea of holding a cross-examination, the Sebi wholetime member noted that for five years they had never once asked to cross-examine any witness and concludes that this “is also a device adopted to further delay the proceedings.”

The entire scam was operated by creating lots of fake invoices from fake clients, resulting in fake billing, fake receivables, fake fixed deposits, and fake reporting of profits. Little wonder, they had to invent fake excuses to avoid appearing before Sebi to explain their conduct.

The fake fixed deposits were directly known to Ramalinga Raju for the fixed deposit receipts were apparently kept in his office. Notes Sebi: “It was observed that the fixed deposit receipts (FDRs) were maintained in the office of the chairman of Satyam Computers and taken from there by a single designated official of the accounts wing and handed over to another official of the wing who would in turn show them to the auditors as and when requested. Further, from the records of Satyam Computers as well as the books held with the auditors, it was noted that two sets of letters of confirmation of balances of FDRs were available with the auditors.”

These two sets included confirmations actually sent by banks directly to the auditors (the genuine ones) in the prescribed format, and confirmations through forged letters purportedly sent from various bank branches – but forged. Thus, as on 30 September 2008, while the actual FD balances with various banks was just under Rs 10 crore, fake FD receipts shown to the auditors totalled over Rs 3,300 crore. At HDFC Bank, for example, Satyam claimed Rs 704 crore in deposits without having a single rupee parked with the bank branch concerned. With Citi, it reported Rs 613.32 crore of FDs when it actually had just Rs 1.32 crore. And so on.

Fake FDs were had to be generated since fake business had to be shown to the stock markets – which meant the creation of fake customers and fake invoices from these businesses. The Sebi order says the Rajus and their co-conspirators “inflated sales of Satyam Computers by creating fictitious sales invoices in the names of actual customers and also in the names of fake customers.”

One such fake business and invoice involved a customer called “Cellnet.” Sebi decided to check if it existed and found out it didn’t. The fiction began with one Satyam official receiving an email form one John Elite of Cellnet, who wanted Satyam to design and create a product for his company. Sebi found all the details about this customer fictitious. It notes: “In order to find out about the existence of Cellnet Inc, for which the product was claimed to be developed by Satyam Computers, a search was made on the internet, which did not reveal the existence of any Cellnet Inc…Further, there did not exist the website www.cellnetinc.net, which has been given as the URL of Cellnet Inc in the email of the so-called Mr John Elite. Thus, this customer was fictitious.”

But revenues had to be shown higher, and so 27 invoices were raised in the name of Cellnet – which Sebi showed were false. And Cellnet wasn’t obviously enough to generate so many fake invoices to show thousands of crores of fake revenues. When Sebi questioned one employee, VVK Raju, former senior Vice President-Finance, he “furnished the details of 7,561 fake invoices (“S” Series) generated in the IMS (invoice management system of Satyam), out of which 6,603 invoices had been posted into the Oracle Financials.”

Fake businesses generated fake revenues which, in turn, created the illusion of fake profit margins, and, finally, fake cash in the bank. Satyam apparently was very poor on its business fundamentals – with margins being low in many quarters, including negative margins in some quarters.

The decline and fall of Satyam can be traced as far back as 2003-04, when the company reported operating margins of 27 percent; but after Sebi excluded the fake invoices, it found that the real margins were around 20.59 percent in that year. In 2004-05, the fake and real margins were 25.67 percent and 18.38 percent, followed by 25.75 percent and 13.38 percent in the next year, 24.55 percent and 15.21 percent in 2006-07, and 22.47 percent and a miserable 1.47 percent in 2007-08 – when the whole edifice of fraud was about to come crashing down.

For the entire period from 2003-04 to 2008-09, Sebi found that against reported operating margins of 24.58 percent, the actual margins were 10.4 percent – with most of the higher margins being earned in the earlier part of the period.

An understanding of the two sets of margin figures is vital for explaining how Sebi finally decided on the penalties for Raju had his quintet of fraudsters: Sebi’s key point is that these five knew about the fraud, and so they deliberately misstated accounts, and when they sold their own shares on the basis of known misstatements, they were essentially indulging in unfair trading practices and insider trading.

According to Sebi, by selling or pledging shares at inflated values when their real worth was known to them as being much lower, Ramalinga Raju and Rama Raju made “unlawful gains” of Rs 1,803 crore (including overvalued shares pledged for Rs 1,258 crore), Vadlamani made Rs 29.5 crore, Ramakrishna Rs 11.5 crore and Prabhakara Gupta 5.12 crore.

It is this “unlawful gain” they have been asked to return with 12 percent simple interest per annum from 7 January 2009 – which adds up to Rs 3,070 crore as of now.

Sebi is clear that Ramalinga Raju and his brother were the prime instigators of this fraud. It said: “Ramalinga Raju was the chief orchestrator of the fraud in this case. His role also emerges from his own statements dated February 4th, 5th and 6th, 2009. In view of the above observations and findings of investigation… Raju was responsible for the entire exercise of misreporting financial performance, fabrication and manipulation of the records of Satyam Computers, and deliberately conveying a false picture of Satyam Computers’ finances to the investing public and concerned authorities.”

Sebi deserves kudos for briging the Rajus to book, but there is little chance that the quintet is going to pay up. Remember, the Sahara fraud verdict of June 2011 is still doing the rounds of the Supreme Court even though the group boss Subrata Roy is in jail trying to furnish a hefty bail. What is the chance that the verdict in the Satyam case will still be around in 2017?