PROJECT REPORT

MONEY LAUNDERING

Atraeyee Purkait
 CONTENTS

PROJECT REPORT..............................................................................................1

Contents...........................................................................................................2

Introduction......................................................................................................3

Cashing up....................................................................................................... 3

Captive Business..............................................................................................4

Structuring....................................................................................................... 4

Placement.....................................................................................................5

Layering........................................................................................................6

Integration....................................................................................................6

Legislation.................................................................................................... 7

India................................................................................................................. 7

Security Scam................................................................................................10

Security Scam in India 1992.......................................................................12

Security Scam in India-2001.......................................................................15

UTI Scam.................................................................................................... 15

Satyam Computers.........................................................................................17

Proposing a selfish, high-risk acquisition....................................................18

Overvaluing the proposed acquisition........................................................19

Promoters Pledging their Entire Holdings...................................................19

Not being able to utilize cash effectively....................................................20

Messing up a sound company ...................................................................21

Problems of Corporate Governance in Finance..............................................21

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 INTRODUCTION

Money laundering is the practice of engaging in financial transactions to conceal the

identity, source, and/or destination of illegally gained money.

In the past, the term money laundering was applied only to financial transactions related
to organized crime. Today its definition is often expanded by government and
international regulators to mean any financial transaction which generates an asset or a
value as the result of an illegal act, which may involve actions such as tax
evasion or false accounting.

As financial crime has become more complex, and "Financial Intelligence" (FININT) has
become more recognized in combating international crime and terrorism, money
laundering has become more prominent in political, economic, and legal debate. Money
laundering is illegal; the acts generating the money almost always are themselves
criminal in some way (for if not, the money would not need to be laundered).

CASHING UP

A business taking large amounts of small change each week (e.g. a convenience store)
needs to deposit that money in a bank. If its deposits vary greatly for no obvious reason
this can draw suspicion; but if the transactions are regular and roughly the same the
suspicion is easily discounted. This is the basis of all money laundering, a track record of
depositing clean money before slipping through dirty money.

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In the United States for example, cash transactions and deposits of more than $10,000
must be reported by the cashier (the bank etc) as "significant cash transactions" to the
Financial Crimes Enforcement Network Fin CEN, with any other suspicious financial
activity identified as "suspicious activity reports”.

In other jurisdictions suspicion-based requirements may be placed on financial services

employees and firms to report suspicious activity to the authorities.

CAPTIVE BUSINESS

Another method is to start a business whose cash inflow cannot be monitored, and funnel
the small change into it and pay taxes on it. But all bank employees are trained to be
constantly on the lookout for transactions that seem to be trying to get around reporting
requirements. To avoid suspicion, shell companies should deal directly with the public,
perform some service (not provide physical goods), and have a business that reasonably
would accept cash as a matter of course. Dealing directly with the public in cash gives a
plausible reason for not having a record of customers.

For example, a hairstylist is paid in cash, and even if she knows her customers' names,
she does not know their bank details. A record of a haircut must ostensibly be accepted as
prima facie evidence. Service businesses have the advantage of the anonymity of
resources—but the disadvantage that they must deal in cash. A business that sells
computers has to account for the computers, whereas the hairstylist/ beauty parlors/ road
side food stalls/ sometimes grocery stores, etc. does not have to produce the receipt from
the computer, even if inflated, exists—that for the haircut probably does not. It is of
course also possible to invent customers, purely for the purpose of accepting money from
them.

STRUCTURING

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In Structuring, (also known as "smurfing"), money is put into the licit economy in such a
way as to avoid legal record keeping and reporting requirements. For example: deposits
of less than Rs.100000 are made into multiple bank accounts that are then withdrawn
after a sufficient amount of time has passed to avoid suspicion.

Money laundering happens through below financial product:

 Cash deposits
 Deposit accounts
 Client accounts
 Bank safety deposit boxes
 Wire transfers
 Correspondent bank accounts
 Omnibus accounts
 Bank bills
 Credit cards
 Back to back loans
 Letters of credit
 Bank accounts for legal entities
 Incorporating a bank
 Private Banking Services

Placement, layering and integration are terms used by law enforcement to describe
the three stages through which criminal proceeds are laundered.

PLACEMENT

Placement is the first stage in the money laundering process. It is during the
placement stage that physical currency enters the financial system and illegal
proceeds are most vulnerable to detection. When illicit monies are deposited at a
financial institution, placement has occurred. The purchase of money orders using

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 cash from a criminal enterprise is another example of placement. Accordingly, law
enforcement officials, working in cooperation with the financial industry, are in a
unique position to combat money laundering during this stage.

LAYERING
Layering describes an activity intended to obscure the trail which is left by “dirty”
money. During the layering stage, a launderer may conduct a series of financial
transactions in order to build layers between the funds and their illicit source. For
example, a series of bank-to-bank funds transfers would constitute layering.
Activities of this nature, particularly when they involve funds transfers between tax
haven and bank secrecy jurisdictions, can make it very difficult for investigators to
follow the trail of money.

INTEGRATION

During the final stage in the laundering process, illicit funds are integrated with monies
from legitimate commercial activities as they enter the mainstream economy. The illicit
funds thus take on the appearance of legitimacy. The integration of illicit monies into a
legitimate economy is very difficult to detect unless an audit trail had been established
during the placement or layering stages.

Placement Layering Integration

Stage Stage Stage

Cash paid into bank Wire transfers abroad (often False loan repayments or
(sometimes with staff using shell companies or forged invoices used as cover
complicity or mixed with funds disguised as proceeds for laundered money.
proceeds of legitimate of legitimate business).
business).

Cash exported. Cash deposited in overseas Complex web of transfers

banking system. (both domestic and

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 international) makes tracing
original source of funds
virtually impossible.

Cash used to buy high value Resale of goods/assets. Income from property or
goods, property or business legitimate business assets
assets. appears "clean".

LEGISLATION

INDIA

In India, a number of Acts have existed which played the role of prevention of money
laundering, though these were not so named. However, in India, we have certain statutes,
as given below that incorporate measures which attempt to address the problems of
money laundering:-

• The Conservation of Foreign Exchange and Prevention of Smuggling Activities

Act, 1974

• The Income Tax Act, 1961

• The Benami Transactions (Prohibition) Act, 1988

• The Indian Penal Code and Code of Criminal Procedure, 1973

• The Narcotic Drugs and Psychotropic Substances Act, 1985

• The Prevention of Illicit Traffic in Narcotic Drugs and Psychotropic Substances

Act, 1988

• Money-Laundering Act, 2002

The Prevention of Money-Laundering Act, 2002 came into effect on 1 July 2005. Section
3 of the Act makes the offense of money-laundering cover those persons or entities who
directly or indirectly attempt to indulge or knowingly assist or knowingly are party or are
actually involved in any process or activity connected with the proceeds of crime and
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projecting it as untainted property, such person or entity shall be guilty of offense of
money-laundering

Section 4 of the Act prescribes punishment for money-laundering with rigorous

imprisonment for a term which shall not be less than three years but which may extend to
seven years and shall also be liable to fine which may extend to five lakh rupees and for
the offences mentioned [elsewhere] the punishment shall be up to ten years.

Section 12 (1) prescribes the obligations on banks, financial institutions and

intermediaries

(a) To maintain records detailing the nature and value of transactions which may be
prescribed, whether such transactions comprise of a single transaction or a series of
transactions integrally connected to each other, and where such series of transactions take
place within a month;

(b) To furnish information of transactions referred to in clause (a) to the Director within
such time as may be prescribed and

(c) To verify and maintain the records of the identity of all its clients.

Section 12 (2) prescribes that the records referred to in sub-section (1) as mentioned
above, must be maintained for ten years after the transactions finished.

The provisions of the Act are frequently reviewed and various amendments have been
passed from time to time. The recent activity in money laundering in India is through
political parties’ corporate companies and share market.

The Act allows for confiscation of property derived from or involved in money
laundering. Co-operative banks, non-banking financial companies, chit funds and
housing financial institutions come under its ambit.

The Act also makes it mandatory for banking companies, financial institutions and
intermediaries to maintain a record of all transactions of a prescribed value and to furnish
information whenever sought within a prescribed time period. Thus, these entities are
required to maintain the record of the transactions for 10 years.

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The minimum threshold limit for certain categories of offences under the Indian Penal
Code and other legislations has been fixed at Rs 30 lakh in the Bill.This limit is further
likely to be reduced to Rs.10 lakh.

Thus, we can say Money Laundering' is the introduction of illegally gained assets into the
legal financial system with the aim of covering up its true origin.

Some estimate annual amounts of laundered money exceed $500 billion in the world.

Therefore, we can say that the major objectives of Money Laundering activities are:

(a) Concealing the true ownership of illegally-obtained money and

(b) Placement, layering and integration of such funds

The concept of Money Laundering can be traced back to the "Hawala" transactions well
known in India for long time now. Hawala mechanism facilitates the conversion of
money from black to white."Hawala" is an Arabic word meaning the transfer of money or
information between two persons using a third person.

The Hawala mechanism usually does not leave any paper trail and thus is a nightmare for
the investigative agencies. The profits generated from Hawala transactions are covertly
invested in real estate, films etc. so as to launder them.

But in simple terms it is the Conversion of Black money into white money. This takes
you back to cleaning the huge piles of cash. Indian newspapers frequently report the
money laundering scams perpetrated by the Political leaders and some of the prominent
stars are the chief ministers of UP, Punjab and Kerala. UP chief minister Ms. Mayawati
as per the Indian Express reports used some innovative techniques to launder the money
by avoiding the tax in legitimate manner. She accepted the donations from persons who
were road side heroes. When CBI raided these guys were found in no position to donate
huge sums for political motives.

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Other Indian star in the laundering Business is Ketan Parekh.It is believed that he shifted
the proceeds of money received from the BoI pay order scam to various tax heavens and
ultimately in the Swiss Banks. These transactions are believed to be just the tip of the
iceberg. If done successfully, it would allow the criminals to maintain control over their
proceeds and ultimately to provide a legitimate cover for their source of income. Money
laundering plays a fundamental role in facilitating the ambitions of the drug trafficker,
the terrorist, the organized criminal, the insider dealer, the tax evader as well as the
many others who need to avoid the kind of attention from the authorities that sudden
wealth brings from illegal activities. By engaging in this type of activity it is hoped to
place the proceeds beyond the reach of any asset forfeiture laws.

SECURITY SCAM

A security scam has the following features:

• Manipulation in share prices.

• Monopoly in dealing with a huge number of shares of a company.

• Money laundering-borrowing money to trade in securities but using the funds

for unconnected purposes.

According to the Securities Exchange Act (1934) SEA-

"It shall be unlawful for any person to engage in any act, practice or course of
action which operates or would operate as a fraud or deceit upon nay person in
connection with the purchase or sale of a security."

There is a certain systemic risk involved if brokers or banks get into settlement
problems during the process of transacting in securities. If so, it results in a
domino effect, which could create problems for other banks and brokers in the system.

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A systemic risk also can occur when there is not enough liquidity in the system due to
very few brokers, monopolizing in the transaction of a security. Also insider trading
is another problem when traders who are insiders to an organization trade when they
have superior knowledge which is considered unfair and an extension o f
asymmetric information.

Also c o n c e n t r a t i o n t e n d e n c i e s o f traders towards dealing in one security only

should be avoided. There is also a consumer protection to ensure that the price
formation process is efficient as possible and also to ensure sufficient competition
among traders, brokers and other market participants

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 Year Victim Perpetrator Mechanism Economics Of

Financial Market
Regulation
6
1991 Public buyers Harshad Mehta, Borrow money from banks Misdemeanor
Clearing and
of shares of Hiten Dalal, on a ready forward basis settlements
companies thus violating RBI problem(Systemic
dealt with by Batliwala guidelines and dealing in Risk),Money
manipulators, security transactions Laundering
& Karani
National with banks where issue
Housing M/s V.B. Desai, of bank receipts and
Bank(NHB) N.K. Aggarwala & SGL forms were not
State Bank Co., supported by genuine
holding of securities
Of Mukesh Babu etc.
Saurashtra
SBI Capital
Markets
Ltd(SBI
Caps)
Standard
Chartered
Bank
2001 Public, Buyer Ketan Parekh Same as above but in this Clearing and
of shares of case much of the Settlement
companies transactions had taken Problem,
dealt with by place through companies Money
manipulators, owned by Ketan Parekh, Laundering
UTI,MMCB, FII's(Foreign Institutional
Calcutta
Investors),Banks ,Unit
Stock

SECURITY SCAM IN INDIA 1992

In April 1992, press reports indicated that there was a shortfall in the
Government Securities held by the State Bank of India. Investigations uncovered
the tip of an iceberg, later called the securities scam, involving misappropriation of
funds to the tune of over Rs. 3500 Crores. The scam engulfed top executives of
large nationalized banks, foreign banks and financial institutions, brokers,

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bureaucrats and politicians: The functioning of the money market and the stock
market was thrown in disarray. The tainted shares were worthless as they could not
be sold. This created a panic among investors and brokers and led to a prolonged closure
of the stock exchanges along with a precipitous drop in the price of shares.

Soon after the discovery of the scam, the stock prices dropped by over 40%, wiping out
market value to the tune of Rs.100, 000 crores. The normal settlement process in
government securities was that the transacting banks made payments and
delivered the securities directly to each other. The broker's only function was to
bring the buyer and seller together.

During the scam, however, the banks or at least some banks adopted an alternative
settlement process similar to settlement of stock market transactions. The deliveries of
securities and payments were made through the broker. That is, the seller handed over
the securities to the broker who passed them on to the buyer, while the buyer gave
the cheque to the broker who then made the payment to the seller. There were two
important reasons why the broker intermediated settlement began to be used in the
government securities markets

The brokers instead of merely bringing buyers and sellers together started taking
positions in the market. They in a sense imparted greater liquidity to the markets.

When a bank wanted to conceal the fact that it was doing a Ready Forward deal,
the broker came in handy. The broker provided contract notes for this purpose with
fictitious counterparties, but arranged for the actual settlement to take place with the
correct counterparty. This allowed the broker to lay his hands on the cheque as it
went from one bank to another through him. The hurdle now was to find a way of
crediting the cheque to his account though it was drawn in favor of a bank and
was crossed account payee. It is purely a matter of banking custom that an account
payee cheque is paid only to the payee mentioned on the cheque.

In fact, privileged (corporate) custome rs we re routinel y allowed to credit

account p ayee cheques in favor of a bank into their own accounts to avoid clearing
delays, thereby reducing the interest lost on the amount. The brokers thus found a
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way of getting hold of the cheques as they went from one bank to another and
crediting the amounts to their accounts. This effectively transformed an RF into a loan
to a broker rather than to a bank. But this, by itself, would not have led to the scam
because the RF after all is a secured loan, and a secured loan to a broker is still secured.
What was necessary now was to find a way of eliminating the security itself.

Three routes adopted for this purpose were:

• Some banks (or rather their officials) were persuaded to part with cheques without
actually receiving securities in return. A simple explanation of this is that the officials
concerned were bribed and/or negligent. Alternatively, as long as the scam lasted, the
banks benefited from such an arrangement. The management of banks might have been
sorely tempted to adopt this route to higher profitability

• The second route was to replace the actual securities by a worthless piece of paper –
a fake Bank Receipt (BR). A BR like an IOU has only the borrower's assurance that
the borrower has the securities which can/will be delivered if/when the need arises.

• The third method was simply to forge the securities themselves. In many cases,
PSU bonds were represented only by allotment letters rather than certificates on
security paper. However, it accounted for only a very small part o f t h e t o t a l
f u n d s m i s a p p r o p r i a t e d . During t h e s c a m t h e brokers perfected the art of
using fake BRs to obtain unsecured loans from the banking system. They persuaded
some small and little known banks – the Bank of Karad (BOK) and the Metropolitan
Cooperative Bank (MCB) - to issue BRs as and when required. These BRs could then
be used to do RF deals with other banks. The cheques in favor of BOK were, of
course, credited into the brokers' accounts. In effect, several large banks made huge
unsecured loans to the BOK/MCB which in turn made the money available to the
brokers.

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 SECURITY SCAM IN INDIA-2001

In Spite of the recommendations made by the Janakiraman Committee Report in

1992 to prevent security scams from happening in the future another security
market took place in 2001. This involved the actions of one major player by the name
of Ketan Parekh. He manipulated a large amount of funds in the capital market though
a number of his own companies which is probably why the scam remained a mystery
for quite some time the RBI, SEBI and DCA (Department Of Company affairs) had
gone slack in their regulatory operations. During 1999 and 2000 the SENSEX
reached a high and after than the stock market crashed in 2001.Some of the major
companies he invested in were Nirma, Adani Group, Essel Group,DSQ and Zee Cadila.
Ketan Parekh manipulated the stock market through FII's (Foreign Institutional
Investors), OCB's (Overseas Commercial Borrowings),Banks and Mutual
Funds(Unit Trust Of India). In fact an important extension of this scam remains
the Unit Trust of India Scam.

UTI SCAM

Of all the recent encounters of the Indian public with the much-celebrated forces of
the market, the Unit Trust’s US-64 debacle is the worst. Its gravity far exceeds the
stock market downswing of the mid-1990s, which wiped out Rs. 20,000 crores in
savings. The debacle is part of the recent economic slowdown which has eliminated
one million jobs and also burst the information technology (IT) bubble. This has
tragically led to suicides by investors. There is a larger lesson in the US-64 debacle
for policies towards public savings and public sector undertakings (PSUs).

US-64 was launched as a steady income fund. Logically, it should have invested in
debt, especially low-risk fixed-income government bonds. Instead, its managers
increasingly invested in equities, with high-risk speculative r e t u r n s . In the late
1980s UTI was "politicized" with other financial institutions (FIs) such as LIC

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and GIC, and made to invest in certain favored scrips.

By the mid-1990s, equities exceeded debt in its portfolio. The FIs were also used
to "boost the market" artificially as an "endorsement” of controversial economic
policies. In the past couple of years, UTI made downright imprudent but heavy
investments in stocks from Ketan Parekh’s favorite K-10 portfolio, such as
Himachal Futuristic, Global Tele and DSQ. These "technology" investments took
place despite indications that the "technology boom" had ended. US-64 lost half its
Rs.30,000 crore portfolio value within a year. UTI sank Rs. 3,400 crores in just six out
of a portfolio of 44 scrips. This eroded by 60 percent. Early this year, US-64’s net asset
value plunged below par (Rs.10). But it was re-purchasing US-64 above Rs. 14! Today,
its NAV stands at Rs. 8.30 - a massive loss for 13 million unit -holders. It is
inconceivable that UTI made these fateful investment decisions on its own.

According to insiders, the Finance Ministry substantially influenced them: all major
decisions need high-level political approval. Indeed, collusion between the FIs,
and shady operators like Harshad Mehta, was central to the Securities Scam of
1992. The US-64 debacle, then, is not just a UTI scam. It is a governance scam
involving mismanagement by a government frustrated at the failure of its
macroeconomic calculations.

Amount payable by Ketan Parekh’s Entities to banks and

companies during security scam of 2001 in India

Amount (Rs. in crore) approx

Madhavpura Mercantile Co-operative bank 888.00

HFCL 550.00

Essel Group 450.00

Adani Group 132.00

DSQ Group 75.00

Shonkh Technologies 37.00

Kopran 28.00
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 Global Trust Bank 267.00

ICICI Bank/Centurion/Bank of Punjab, etc 66.00

OCBS (delivery of shares not given and 480.00

Total 3323

SATYAM COMPUTERS

The attachment of 287 properties worth Rs168 crore and 34 lakh Satyam shares by
Enforcement Directorate (ED) has been upheld by the adjudicating authority of the
department, which alleged that disgraced Satyam founder B Ramalinga Raju and his
associates were involved in money laundering.

The properties include over 34 lakhs shares of Satyam Computers (now Mahindra
Satyam) and 287 land assets in Andhra Pradesh and Maharashtra, estimated to be worth
Rs168 crore.

ED had attached these properties following investigation into the accounting fraud which
was admitted by Raju in his disclosure to market regulator SEBI on January 7, 2009.

The properties, which were attached under the various provision of the Prevention of
Money Laundering Act, 2002, will remain under the possession of the ED till the
disposal of cases against Raju and his associates in the trial court.

The ED in its 11,000 page complaint filed with the authority in September last year
against Raju and his 131 associates had alleged that properties were obtained through
the ill-gotten gains from Satyam fraud.

In its report, ED had alleged that Raju's brothers Rama Raju and Suryanarayan Raju, their
wives, sons, other family members and employees were among the 133 people in whose
names these properties were registered.

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ED was represented by its counsel Rajeev Awasthi before the adjudicating authority. The
ED stated that Raju had floated five investment firms and stocked Satyam shares there.

Whenever market was on the high, "Raju and his family members sold their shares
through these companies deriving undue higher value." Citing their modus operandi, ED
said Raju sold his shares to one dummy firm SRSR Holding when Satyam shares were
"unrealistically high" and made huge gains. Later, they pledged their shares with NBFC
and took huge loans "which ultimately were utilized for acquiring properties in the name
of the dummy companies and trusted individuals," it said. "These companies which were
having 14 common residential addresses were floated by these persons only for the
purpose of channelizing the proceeds of crime," it told the authority. As if being sued
by a UK company for fraud and forgery wasn’t enough, Raju shot himself in the foot by
attempting to push through two unrelate d acquisitions of family-run companies . Then it
came to light that the promoters ’ shares had been pledged with lenders. In between,
Satyam found itself being banned by World Bank for eight years for alleged
malpractices. End result? Satyam at the time of writing didn’t have enough directors to
fill up a boardroom , what with four of them resigning. A change in management l o o k s
inevitable, as reports of investors (strate gic and financial) lining up to buy into Satyam
were floating around when this magazine went to press. BT takes a look at how the
promoter s of Satyam undid 21 years of endeavor in less than a fortnight

PROPOSING A SELFISH, HIGH-RISK ACQUISITION

On December 16, Raju announce d the board’s approval for two proposed
acquisitions: “To acquire 100 per cent share- holding in Maytas Properties and a 51 per
cent controlling stake in Maytas Infra. The two companies being acquired in the
challenging market offer potential for significant upside in the future,” is how
the board apparently saw it.

Unfortunately , investors didn’t see the proposed acquisitions the same way, and duly
beat the stock to pulp. Foreign institutional investors (FIIs), mutual funds and insurance
companies own a little over 60 per cent of the company. They were quick to
protest what they interprete d as sheer brazenness of the promoter s to push through non-
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synergistic acquisitions of family-promoted companies, ostensibly to transfer money from
a cash-rich company (Satyam) to the other family-owned ones. The Raju family owned
(till the news came of pledged shares having been sold) barely 8.6 per cent of the
company but over 30 per cent in the two infra- structure companies. The $1.6 billion (Rs
8,000 crore) proposed acquisitions of Maytas Properties and 51 per cent in Maytas
Infra would have used up the company’s entire cash. Evidently, the company’s
rationale of this being a diversification and growth opportunit y found few takers and the
stock prices of all three companies went into a free fall.

OVERVALUING THE PROPOSED ACQUISITION

Even if you buy the argument that the acquisitions made strategic sense,
what analysts consider dishonest is the price the cash-rich Satyam was willing to pay
for the two Maytas firms. Consider Maytas Properties, for which Raju was willing to
pay $1.3 billion (Rs 6,500 crore). Some brokerage firms estimate the net worth of the
company to be $225 million (Rs 1,125 crore). On what basis was the price tag for the
buyout reached? The deal translates into a valuation of Rs 1 crore per acre . This ,
Satyam CFO Srinivas Vadlaman i thinks, is reasonable. His reasoning: DLF has got
a land bank of 10,000 acres and the valuation of DLF is roughly Rs 60,000 crore!
The mystery shrouding the valuation only intensified the feeling that Raju was trying to
suck money out of Satyam and bail out firms promote d by his sons.

PROMOTERS PLEDGING THEIR ENTI RE HOLDINGS

On December 29, after reports surfaced that the Satyam promoter s had pledged their
shares, the company issued a press release that stated: “The promoter s informed Satyam
that all their shares in the company were pledged with institutional lenders, and that some
lenders may exercise or may have exercised their option to liquidate shares at their
discretion to cover margin calls.” Following this belated disclosure, three independen t
directors, Vinod Dham , Krishna Palepu and M. Rammohan Rao, resigned. This
raises the question: Were these directors kept in the dark about the pledging of these

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shares? Surely, some may want to debate whether it is mandatory or not for Indian
promoter s to disclose to the board whenever they pledge shares . However, one of
the independent directors on the board of another leading company says it is
impor tant that such matters be disclosed; according to him this is a clear breach of
corporat e governance. The other question being raised is: For what purpose had Raju
pledged their shares—could it be that he was keen to use the proceeds to fund non-
related businesses?

Dr Mangala m Srinivasan, 69, took the lead and quit the board of the company.
Srinivasan had been on the board of Satyam since July 1991 as an independent director.
Later, three more independen t directors quit, leaving Satyam with just five directors.
The bigger question, however, is should the management itself have resigned, given the
huge breach of corporate governance at the company. After all, shareholde r wealth
has been depleted, credibility damaged, employee morale puncture d and a cloud of
seemingly enduring disrepute hovers over the company. “This will continue to hound
Satyam for quite some time and put a lot of competi tive pressures and pricing
pressures from clients,” says Sudin Apte, Senior Analyst and Country Head,
Forrester Research. Raju, however, is in no mood to resign. In a note to employees
last fortnight , he pleaded: “Please be assured that the board and the leadership
team are doing everything possible to get Satyam back on track.” Can the
employees believe him now?

NOT BEING ABLE TO UTILIZE CASH EFFECTIVELY

The surprising bit about the acquisition s announce d by Satyam was that the promoter s
were keen to deploy money in unrelate d businesses at a time when liquidity is scarce
and conserving cash is the mantra globally. As of the half year ended September 2008,
Satyam had cash of Rs 5,300 crore on its balance sheet, which it did not seem to be
utilizing as effectively as some of its competitor s were do- ing. Take the case of HCL.
Says Apte: “Interestingly , the announcemen t of Satyam’s plan happened withi n 24
hours of the formal finalization of the largest acquisition so far by any Indian IT

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company— HCL buying debt to strengthen its IT services business through a stronger
SAP cap- ability, and incumbent SAP services leader Satyam wanted to spend its
mountain of cash to diversify out of the IT services business.”

MESSING UP A SOUND COMPANY

Most analysts feel Satyam is still financially sound . For instance - according to Angel
Broking: “Satyam’s business is characterized by strong cash flow generation , low capex
intensity, high return ratios and a good percentage of repea t business...” But there are
problem s on the horizon. Edelweiss Research, says: “Satyam is still fundamentall y sound
but its business is getting impacted more by weakness in SAP and vendor
rational ization in favor of the larger players. Fiscal 2010 is going to be a more difficult
year for Satyam than it will be for its larger Indian peers.” Yet Satyam is India’s fourth-
larges t IT services exporter with revenues of $2.14 billion (Rs 10,700 crore ) and
51,217 people (for the year ended March 2008). It has some 690 clients and 28
developmen t centers around the world.

PROBLEMS OF CORPORATE GOVERNANCE IN

FINANCE

First, banks and other intermediaries are more opaque, which fundamentally
intensifies the a g e n c y p r o b l e m . Due to greater information asymmetries
between insiders and outside investors in banking, it is (i) more difficult for equity
and debt holders to monitor managers and use incentive contracts, (ii) easier for
managers and large investors to exploit the private benefits of control, rather than
maximize value, (iii) unlikely that potential outside bidders with poor information will
generate a sufficiently effective takeover threat to improve governance substantially,
and (iv) likely that a more monopolistic sector will ensue and will generate less
corporate governance through productmarket competition, comparedwith an
industry with less informational asymmetries. Second, banks, like most

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intermediaries, are heavily regulated and this frequently impedes natural corporate
g overnance me ch an isms.

For instance,

Deposit insurance reduces monitoring by insured depositors, reduces the desirability

of banks to raise capital from large, uninsured creditors with incentives to monitor,
and increases incentives for shifting bank assets to more risky investments.

R egulatory restrictions on the concentration of ownership interfere with one of the

main mechanisms for exertingcorporate governance around the world.

R egulatory restrictions on entry, takeovers, and bank activities reduce competition,

which reduce market pressures on managers to maximize profits.

Bank regulators and supervisors frequently have their own incentives in influencing
bank managers that do not coincide with value maximization.

Finally, government ownership of banks fundamentally alters the corporate

governance equation. Since state ownership of banks remains large in many
countries, this makes corporate governance of the banking industry very different from
other industries.

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