Assessing the fallout from the Satyam scandal

23rd February 2009

Assessing the fallout from the Satyam scandal

“The Indian outsourcing sector is very good at pulling together in times of stress,” says Anthony Miller, managing partner at analyst group TechMarketView. “They may be rubbing their hands together in private,” he adds, but with the help of NASSCOM (the National Association of Software and Service Companies), competitors have so far avoided the feeding frenzy that could have taken place.

“Wipro is not soliciting business at the expense of Satyam,” asserts Suresh Vaswany, joint CEO of Wipro, but it is not averse to “entering into a dialogue with Satyam clients”, if approached by them. This stance is echoed by competitors such as TCS Infotech (a Tata company), and Infosys. “Some of the Saytam clients have approached us,” reports Infosys director Mohandas Pai, “but we have not proactively approached any of their clients.”

Service providers can afford to be patient. State Farm Insurance may have terminated its outsourcing contract within days of Raju’s confession, but many Satyam clients can only contemplate the termination of their contracts, in the short term. As Miller observes: “Changing vendors is disruptive, and nobody is going to do it unless they absolutely have to.”

There is a chance that the Satyam debacle will taint other Indian service providers, but Miller believes that the effects will be short lived. “I don’t think it will have a broad or lasting impact,” he says, because India’s outsourcers will band together to turn the problem into an opportunity. “That’s what they’re good at,” he suggests, adding: “Before you know it, they will be demonstrating another 36 corporate governance requirements that they can meet.”

But Miller does expect the Satyam effect to have a negative impact outside India. “It will put added sensitivity on emerging economies and companies,” he predicts, “and smaller outsourcing operations and start-up companies will find the business climate a lot trickier.”  A lot of organisations will be re-assessing their exposure to risk and taking a more rigorous approach to due diligence.

Factors such as whether a company is owner-driven or dominated by one family (such as Satyam was), or run by ‘professionals’ is now more of an issue than it previously was, and the non-outsourcing business interests of controlling shareholders are also coming in for closer scrutiny. In the Financial Times, Ashutosh Gupta of research firm Evalueserve (which is also a knowledge process outsourcing firm) suggested that some “smart companies” are also hiring private investigators to “poke around and ask difficult questions”.

Inevitably, outsourcing service providers won’t be the only ones put under the magnifying glass. “Corporate governance has become the number one issue,” says Miller. “The audit figures for Satyam are clearly a worry,” he adds, and because it was one of the first Indian companies to report its audited results using International Financial Reporting Standards, these have been criticised. But according to Pai, who as well as being on the Infosys board is a trustee of the IASC Foundation, “What happened in Satyam was more to do with the failure of the auditing process.”

He seems to have a valid point: auditors are supposed to ask the banks for independent confirmation of bank balances (aren’t they?), not rely on the records of the client – even if its name means ‘trust’ in Sanskrit, as Satyam does. The Andhra Pradesh police have apparently arrested two of  PwC’s local auditors,  S. Gopalkrishnan and his deputy Talluri Srinvas. The Institute of Chartered Accountants in India (ICAI) is also investigating the conduct of PwC in relation to Satyam. “Strict action will be taken against auditors if found guilty,” vows Vewd Jain, ICAI president, and in theory the audit firm could loose its practice license temporarily or permanently in India.

The Enron fraud led to the very high-profile collapse of Arthur Andersen, but the Saytam debacle does not automatically sound the death knell for PwC International or any of its affiliates. In 2006, when the Japanese regulator banned ChuoAoyama PwC from auditing work for two months, for allegedly certifying false financial statements by Kanebo Ltd, PwC split the audit firm creating a ‘new and independent audit firm’ PwC Aarata, then carried on doing business.

The Satyam scandal could still prove costly for PwC though, thanks to a number of class action lawsuits filed in the United States. Pomerantz Haudek Block Grossman & Gross LLP, for instance, alleges that the global audit major, along with its Indian and international units, “was aware of or recklessly disregarded a multi-year massive fraud by former management of Satyam”, and that “PwC ignored red flags that should have alerted it to the fraud” and “failed to perform its audits in accordance with the requisite accounting principles.”

There is nothing unusual about lawsuits from disappointed ex-clients and disgruntled investors in the world of accounting. But none of the Big Four firms has yet been broken by the costs associated with denying liability then settling out of court.

So although the fallout from the alleged fraud could potentially spread far and wide, it could just as easily stay very close to where it originated. “It’s hugely problematic for Satyam,” says Miller, “and people inside the organisation must feel hugely betrayed.” But competitors, clients, potential clients, and even Satyam’s auditors look set to calmly reassess their options and their risk exposure, and then move on. “It may be India’s Enron, but this sort of thing has happened before and I am sure it will happen again,” he says, adding: “You have to be pragmatic.”