Early whistle blowing could have saved Satyam

January 15, 2009

The rescue operation to salvage a beleaguered Satyam – its 53,000 employees, its clients, its shareholders and creditors -is now in full swing. But did things have to reach this stage? Why did none of the many systemic checks and balances – board, auditors, regulator – work to prevent such a massive fraud and collapse? Surely, prevention at an early stage of trouble is better than the ongoing resuscitation from near-death, which is more costly to implement and less likely to succeed.

But the fact is that prevention didn’t work. Internal and external auditors ought to have spotted and stopped the fraud; they ended up in likely collusion with Raju. Even if the auditors failed, market regulators ought to detect fraud perpetuated over such a long period of time – seven years by Raju’s own admission. But they did not.

Finally, when all else failed, the brutal logic of a market economy exposed the fraudsters. The financial crisis and slowdown resulted in a massive credit and cash squeeze. With no easy source of funds, it becomes impossible for firms with hollow balance sheets to survive. Satyam tried the bungled merger with Maytas, and then tried to sell out – neither worked.

The problem with the punishment meted out by free markets is that it creates massive collateral damage. Employees, investors and creditors who had nothing to do with the fraud all suffer terrible consequences. Yet the fact of the matter is that very few cases of fraud ever get detected in good times. It takes a bust to expose fraud and excess.

Are there, then, any additional checks and balances which can help catch fraud, especially in boom times? What about individual whistleblowers, who may be conscientious employees or auditors?

Some systems do indeed throw up successful whistleblowers. Most famously and commendably, Cynthia Cooper and her team of internal auditors at WorldCom uncovered a massive $3.8 billion dollar accounting fraud in 2002. They were honest and competent enough to find all the evidence and present it directly to the company’s board and audit committee. Needless to say, WorldCom’s top executives went to jail.

The role of Sherron Watkins, the Enron “whistleblower” is less clear. In fact, her case reveals some of the difficulties of being a whistleblower. As a senior accountant in the firm, she was aware of the massive fraud and imminent collapse of the firm. There were no clear guidelines on how to register a warning. So, she wrote a letter to Chairman Kenneth Lay, detailing the fraud. However, she chose not to present the letter to the board or to make it public – it became common knowledge after Enron filed for bankruptcy. In the end, she didn’t really end up preventing Enron’s shocking disintegration and the massive losses incurred by all the stakeholders. Watkins, in fact, profited from selling her stock options while the going was good. In her defence, she argued that she assumed that Lay was being duped by his CEO and CFO, and that he would protect the company’s interests, but the reality as it emerged later was that he was involved too.

Clearly, it’s not easy to be a whistleblower. First, in the absence of a firm law there may be no established procedures for reporting fraud (as Watkins found). Second, a corporation is always more powerful than an individual, and a whistleblower could face retaliation (especially if the senior management is involved in a cover-up) and lose her job, which could also affect future employment prospects. Then, there is the difficult matter of collecting evidence. There may be issues of loyalty – how easy it is to actually act against your bosses or even colleagues. Then there are selfish reasons – you stand to lose financially if you expose fraud and the company collapses. Also if there is no clear law on whistleblower protection, you may find yourself being prosecuted as well. Last, but not least, if you are involved in blowing the cover off unsavoury characters, like say the murdered Indian Oil executive Manjunath was, there is a real threat to personal safety.

Some of the problems faced by a potential whistleblower can be addressed by suitable legal protection. The Sarbanes-Oxley Act in the US, enacted in the aftermath of the Enron and WorldCom scandals, makes it compulsory for audit committees of boards to establish procedures to receive anonymous complaints and reports from whistleblowers. Senior management is forbidden from discriminating against whistleblowers. Any retaliation against a whistleblower is a criminal offence, which can be punished with up to ten years in prison.

India has fairly weak whistleblower protection laws. The Securities and Exchange Board of India (Sebi) initially made it mandatory (under ‘clause 49’) for all listed companies to establish procedures (including reporting directly to the audit committee of a board) for the reporting of irregularities and fraud, much like Sarbanes-Oxley. But it was later made non-mandatory, when Sebi accepted the argument made by the corporate sector that the regulation would lead to too many frivolous complaints.

Unlike the private sector, the government quickly adopted a whistleblower protection resolution (Public Interest Disclosure Resolution) after the murder of engineer Satyendra Dubey who had exposed massive corruption in the construction of national highways. The CVC is the nodal agency to receive complaints about irregularities, fraud and corruption in government agencies/projects. However, the resolution only applies to, and protects, government employees – as Deepak Kumar, the DDA whistleblower now facing prosecution, has discovered to his peril – and not to the private sector.

There is a very urgent case to introduce a strong whistleblower protection law applicable to both the private and public sector – a good law must protect the identity of the whistleblower, prevent any discrimination or harassment and offer immunity from prosecution. A well-functioning market economy needs checks and balances and whistleblowers are an important part of the many layers of checks, especially when auditors and regulators fail to pick fraud. The Satyam scandal ought to prompt the government into exploring such a law.

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