COMPARATIVE ANALYSIS OF ENRON AND SATYAM SCAM WITH

REFERENCE TO AUDITORS AND NEDS

(Assignment towards fulfilment of the assessment in the paper of Corporate Governance)

Submitted By:

Submitted To:

Divya Ramesh

Prof. Garima Dadich

Roll No. 429

Faculty of Law

Semester VII

National Law University, Jodhpur

Summer Session
(July November 2009)

The Enron scandal broke in late 2001 and created a furore internationally. When the Satyam
scam happened in early 2009, it was labelled Indias Enron. There were several similarities
seen between the two scandals, ranging from bribing government officials to get their favours
to showing independent companies which were actually controlled by the management.
The companies were guilty of impropriety, opacity, and creative accounting. The true assets
and liabilities of Enron and Satyam were opaque to investors. The clash of interests between
the company and its managers, some of whom made millions even as the company lost
similar with the Satyam case where most of the directors sold out their stocks before
Raju's confession. Enron admitted that, thanks to creative accounting, profits
since 1997 had been overstated by 20 per cent ($586 million) and Satyam($7000 crores).
Like Enron, Saytam perpetrated a balance-sheet scam with the support of supposedly worldclass auditors (Arthur Andersen for Enron, PWC for Satyam).1
This paper aims at looking at the similarities or differences in these two internationally
devastating scams with particular reference to the auditors and the non executive directors.
AUDITORS
The role of auditors is vital for the successful governance of companies. They play an
important role as regards the disclosure of financial information with respect to every phase
of working of a company. This financial information influences all the investment decisions
of the company. The auditor has an obligation to present the financial statements as per
statutory requirements and guidelines. Auditors have a critical role in checking financial
malpractices by qualifications and effectively disclosing all germane financial information
such as misutilisation of funds. Further to ensure transparency in the entire mechanism the
role of auditors is indispensable. Hence, the system of governance should be such that the
auditors are efficient enough to perform their tasks to the maximum of their capabilities.
The auditors for Enron were Arthur Anderson and those for Satyam were Price Waterhouse
Coopers, both part of the 5 top international audit firms, termed the Big 5.
Enron: Enron, while at the apparent peak of its success, began to use sophisticated
accounting techniques to keep its share price high, raise investment against it own assets and
stock and maintain the impression of a highly successful company. Enron lied about its
1

Corporate Governance :Satyam Vs Enron, http://freembastuff.com/readarticle.php?article=SATYAM

%20ENRON%20CORPORATE%20GOVERNANCE

profits and stands accused of a range of shady dealings, including concealing debts so they
didn't show up in the company's accounts. As the depth of the deception unfolded, investors
and creditors retreated, forcing the firm into bankruptcy in December 2001.2 The auditors,
Arthur Anderson, immediately fell under suspicion as it was hard to believe that such massive
losses could have been overlooked for such a long period of time.
Enron was the second largest client of Anderson and it had kept a whole floor
of auditors assigned at Enron year around. A company memo showed that Andersen knew
Enron was in trouble as early as February 2001, and Andersen debated dropping the collapsed
energy firm all together. Additionally, Andersen knew in mid-August of a senior Enron
employee's concerns about improprieties in the energy company's accounting practices.
Andersen confirmed that a memo dated February 6 recounted a meeting between Andersen
executives about whether Andersen should retain the now-bankrupt Enron as a client. The
memo said that Andersen executives discussed the amount kept off the books.3
It was found out that in January 2001, Anderson destroyed thousands of pages of Enron
documents. One of its former partners, in charge of the Enron audit, Mr Duncan pleaded
guilty to a single count of obstructing justice, relating to the accountancy group's shredding of
Enron audited documents in the weeks before the giant energy conglomerate filed for
bankruptcy on 2 December.4
Arthur Andersen was charged with and found guilty of obstruction of justice for shredding
the thousands of documents and deleting e-mails and company files that tied the firm to its
audit of Enron and thousands of e-mails and other electronic and paper files that could have
helped illuminate the actions and motivations of Enron executives. The conviction was later
overturned by the U.S. Supreme Court due to the jury not being properly instructed on the
charge against Andersen. Despite the reversal, Andersen had already lost the majority of its
clients and had been barred from auditing public companies. Although only a small amount
of Arthur Andersen's employees were involved with the scandal, the firm was closed and
resulted in the loss of 85,000 jobs.

http://news.bbc.co.uk/2/hi/business/1780075.stm

http://www.nysscpa.org/enron/overview.htm

http://www.independent.co.uk/news/business/news/andersens-former-partner-in-enron-audit-enters-guilty-

plea-in-court-656995.html

Enron employees, creditors and investors have sued Andersen for billions, charging that the
accounting firm colluded with the energy trader in the gut-wrenching scandal last year that
left thousands out of a job and usurped the retirement savings of many.5

Satyam: The scam of early 2009 involving one of Indias giants, Satyam shocked the nation.
It became clear that the founder, Ramalingam Raju, had for seven years been inflating profits
and fabricating revenues and other non-existent assets of more than 1bn.
The audit of Satyam, though claimed to have been carried out by PWC, was actually carried
out by a small subsidiary called Lovelock & Lewes. The subsidiary was part of the old
Coopers & Lybrand network swallowed up by PWC. Its role may have contributed to
confusion over whether PWC was responsible for signing off the accounts.
The accountant's London office said it deployed Lovelock & Lewes because, under Indian
law, audit firms cannot employ more than 20 people and are not allowed to use their
international brand name for audits. PWC argued that its Indian arm is a separate legal entity
from the global operation. Therefore, it said that the main firm would not be liable for any
damages linked to the Satyam collapse. However, the auditors, S Gopalakrishnan and
Srinivas Talluri were suspended and arrested6
Raju, told Satyams board that he had falsified accounts for several years to stave off a
takeover. More than $1 billion of cash and assets that were reported at the end of September
didnt exist, he said in a letter to the Bombay Stock Exchange.
Price Waterhouse in India said it received appropriate evidence to support Satyams accounts.
The audits were conducted by Price Waterhouse in accordance with applicable auditing
standards and were supported by appropriate audit evidence, it said in a Jan. 8 press release
issued by its public relations adviser, Edelman. 7 However, the audit firm, was not able to
explain how it missed the fraud, for several years.
1. The auditors (or some employees of the audit firm) could have been taken into
confidence by the management of the company and the books fudged with their full
5

http://news.cnet.com/2100-1017-955623.html

http://www.guardian.co.uk/business/2009/jul/05/pwc-audit-satyam-assets

http://www.bloomberg.com/apps/news?sid=aov_laRpSmno&pid=20601109

knowledge
2. The auditing firm was grossly inefficient.
The SFIO (Serious Fraud Investigation Office ) has suggested their connivance with the then
management of Satyam to carry out the fraud. The SFIO is pretty damning in its report. It
says the auditors did not understand complexities of electronic book keeping, which is a
glaring accusation and added that the auditors did not even check 1% of the invoices
submitted by the then management of Satyam, which again shows their whole callousness
towards verifying the accounts. 8
It was just needed to be proven that the auditor was a party to the fraud. If proven, he can be
booked under the Companies Act and the Chartered Accountants Act, and even in the case of
severe negligence, a substantial punishment is very likely.9
Two partners of Price Waterhouse, statutory auditors of Satyam Computer Services, were
arrested by the CID on charges of conspiracy, failure to scrutinise records and connivance on
charges of fraud (Section 420 of the IPC) and criminal conspiracy (120B) in the Rs 7,800
crore scam. PWC initially claimed client confidentiality, but later, sought to disassociate itself
of all the responsibility in scam.
In September, The Institute of Chartered Accountants of India (ICAI) Price Waterhouse prima
facie guilty in the Rs 7,800-crore fraud case of severe negligence and for failing to carry out
the internal audit of accounts of the Satyam and professional misconduct, thus prompting a
large settlement to be negotiated through the proceedings initiated by SEBI.10
Thus, while in the case of Enron, the auditors were clearly hand in glove with the
management of Enron and colluded with them to cover up their fraud, PWC in the end,
proved to be grossly negligent and inefficient in auditing the reports of Satyam over a period
8

http://www.rmdhar.com/index.php/2009/01/07/satyam-admits-fraud/

http://www.livemint.com/2009/01/07165018/ICAI-to-seek-explanation-from.html

10

PwC

wants

early

Satyam

settlement,

http://economictimes.indiatimes.com/infotech/software/PwC-wants-early-Satyamsettlement-/articleshow/5154850.cms

24

Oct

2009,

of seven years. Its hard to decide among which was the worse among the actions of PWC
and Anderson, participating in massive fraud or being so negligent as to be unaware of
massive financial mismanagement over a period of seven years.
NON EXECUTIVE DIRECTORS
Over the years, an NED has come to be understood as a director who is not burdened with
administering the daily business of the organization.11 The role of such directors is more of
stewardship aimed at ensuring that the Board acts in the interest of the company as opposed
to that of particular members. An important subset of NEDs are independent directors.
In Enrons case, the independent directors were in on the fraud, In fact, a couple of them
resigned before the company went bust, getting their sotck options and making a decent profit
to boot. That was the difference between Enron and Satyam with regard to independent
directorsSatyam had several eminent and distinguished individuals on its board who were
unaware of frauds all the while. For example:

Prof. Krishna G Palepu (Harvard Proffessor)

Vinod K Dham (Inventor Pentium)

M. Rammohan Rao (ISB Dean)

M Srinivasan (another academic)

V S Raju (former director of IIT Delhi)

11

Justice YV Chandrachud & DR. SM Dugar, A Ramaiya Guide to the Companies Act, (Wadhwa & Company,

Nagpur, 16th Edn.) p. 1831.


T R Prasad (former union cabinet secretary)
There were 5 out of 9 directors who were independent directors. The function of independent
directors in board matters is to exercise their expertise and provide an unbiased, clear opinion
and take the necessary steps required to uphold both shareholder and stakeholder interest a nd
to guide the management.
When Ramalingam Raju proposed to purchase the twin Maytas companies in order to cover
up his botched bookkeeping, the directors should have investigated the manner and only then
given an opinion after discussing the merits and demerits of the same. However, they blindly
accepted the proposal. Only due to this did the shareholders revolt, causing the whole long
winded fraud to be discovered.
Therefore, the Satyam-Maytas fiasco has drawn the attention of Government towards the role
of independent directors.It questioned the actual independence of independent directors and
stressed on the function of the same. It turned out that the board was not in fact aware of the
fraud perpetuated by Raju, but they had to face a lot of heat because they did not oppose the
Maytas investments and there is a presumption that if they provided no resistance in that
instance, they could not have been effective generally. Had any of the independent directors
opposed that move, it is possible that they would have been given the benefit of the doubt in
respect of the accounting fraud.
Independent Directors, who are appointed by shareholders at the behest of the board, are
selected on the basis of their reputation, knowledge, and wisdom. They are the first defense
of minority shareholders. Generally they bring specialized expertise. Independent directors
have to meet standards set by stock exchanges too. The Indian Government specifically
delineates the role of independent directors in safeguarding the interests of the organization
and the shareholders.12 However, Independent directors of Satyam Computers, who agreed to
the company's proposal of buying out two promoter-related companies, failed to be
independent in 'spirit'. The role of Satyam's independent directors is termed as
`unpardonable. Acting against the interest of larger shareholders especially when the
12

http://media.www.harbus.org/media/storage/paper343/news/2009/02/17/News/The-

Satyam.Scandal.Explained-3633696.shtml

promoters themselves owned a little more than 8 per cent stake in the company and
institutional investors owned more than 45 per cent.13
Non-executive directors will need to spend more time learning about the company, talking to
employees and shareholders and reading up about the industry and exercising more
independent thought control and management control, in order to serve their purpose.

13

http://www.slideshare.net/aseemsidhu/satyam-fiasco