Ramalinga Raju cooked his books - and his goose - but India’s history of scams is long and innovative.
Until Ramalinga Raju made his confessional statement, his 2009 travel calendar had “Davos” marked on it. He was scheduled to give a lecture on “Financial Innovation” there this February. The WEF (World Economic Forum) has since decided to cancel that presentation.
While the cancellation was no surprise, it is perhaps unfortunate. Raju is better qualified to speak on the subject than any run-of-the-mill entrepreneur with a squeaky-clean balance sheet. If the WEF had any imagination, it would have requested him to put together a PowerPoint video presentation from his jail cell.
The SCS (Satyam Computer Services) story is full of such ironies. The Hyderabad-based IT services company was known for having developed tools that enabled businesses to generate more value. SCS was so highly respected for its probity that it won a major global award for corporate governance, even as it was reporting fictional results and composing imaginary balance-sheets. Surely that qualifies as financial innovation?
The SCS imbroglio is part and parcel of India Inc’s aspirations to achieve global competencies. India is a harshly Darwinian corporate environment and businesses that thrive in this country are tough enough to take on competition anywhere. All of India’s best and brightest entrepreneurs want global footprints. They strive to develop the competencies required to run businesses across multiple, diverse environments. Phrases like “emulating global best practices” trip fluidly off the tongues of Indian CEOs. In the past few years, several massive cross-border takeovers have been engineered by Indian firms.
There is a dark side to that drive. By emulating Enron and WorldCom, Satyam has conclusively demonstrated that India Inc has the intellectual wherewithal to rapidly adopt and improve global best practice in this somewhat specialised area. India’s codes of corporate governance are modelled on the American Securities and Exchange Commission’s (SEC’s) codes. These require the appointment of many independent directors and (supposedly) stringent financial reporting standards. Since India’s bigger businesses all aspire to overseas listings or External Commercial Borrowings (ECBs), they also prepare balance-sheets to comply with internationally-recognised Generally Accepted Accounting Principles (GAAP).
While adhering to these norms, Raju still managed to inflate key numbers by factors of 10 and to convince a “Big Four” auditor to endorse his creative fictions. It is being whispered that the same individual who signed off on the SCS balance-sheets used to sign off on the ill-fated Global Trust Bank’s accounts. No matter. A Rs 8,500 crore company’s (Satyam’s “official” 2007-08 turnover was Rs 8,473 crore) accounts cannot be prepared and audited by a single individual. Raju and his cohorts managed to convince the entire audit team from PwC to accept the results it cooked, year after year.
What is more, it convinced its own board, which had its fair share of independent directors, including IT luminaries and B-school professors. The concocted results were always believable. SCS claimed decent but not outstanding margins. A few IT firms (Infosys, Wipro and TCS among them) showed higher profitability and growth.
That made SCS’s claims all the more credible — so credible, in fact, that the numbers were re-arranged smoothly according to US and Indian GAAP without a single murmur. Even when the Maytas deal went bust, people believed that SCS had over Rs 5,000 crore in reserves on its balance-sheet. This takes twisted artistry of an order that even Picasso would have envied.
Satyam may have been a pure “valuation scam”. Raju invented non-existent profits but he might not have actually put his hand in the till, as indeed he claims he didn’t. It’s just that there was far less money in the till than he said there was.
The returns for the SCS scamsters came from elsewhere. By producing those credible balance sheets, they shored up valuations of their share-holdings; they made employees who had option-based compensation happy and they pleased investors.
It is not a victimless crime. The investors in the stock lost over 90 per cent of their capital and there are 50,000-odd jobs at stake. Also, there was a fair amount of insider trading in the last couple of sessions before the five-page confession-cum-resignation was aired.
But Satyam existed; it was in the business that it said it was and the scamster wasn’t a thief. In these respects, this scam is different from anything corporate India experienced earlier. Earlier financial sector scams have generally depended on direct misappropriation. There are many time-honoured ways to do this. Ponzi is the most traditional but while Ponzi is an element common to many scams, it is hardly noteworthy.
There is the CRB method, developed by C R Bhansali. Bhansali operated in the early 1990s, a time when controls had eased but regulations were evolving and there was a turf war raging between the upstart SEBI and the RBI. CRB took advantage of the loose IPO structure and the turf war to create a chain of some 100-odd companies called the CRB Group. Each company had a small equity base, all cross-invested in each other, and thus manipulated share prices up or down as the promoter desired.
What did the CRB companies actually do? They promised large returns without ever clarifying that little detail. Some claimed to be mutual funds, others to be investment vehicles of some other description. They are best described as financial entities that did something disastrously financial, with other people’s money.
There was a Ponzi element since older FD investors were paid their returns with the cash of new subscribers. CRB did IPOs, offered fixed deposit schemes and mutual fund schemes that together picked up over Rs 900 crore in corpus and played complicated games with it. Eventually it all fell apart when CRB had over 400 cases filed against him.
There were several positive outcomes to the CRB business, though Rs 900 crore is a large price tag. SEBI and RBI had to sort out respective jurisdictions after an entertaining sideshow that consisted of a long run of daily briefings blaming each other. SEBI also tightened IPO norms and banned guaranteed returns in equity-based schemes.
Another form of chicanery is fuelled by cash accessed from the banking and co-operative banking system. Co-ops are a black hole in Indian banking with much looser regulation than scheduled commercial banks. The regulatory gaps cannot be plugged because most political parties in western India use co-ops as investment vehicles. Co-ops featured in the two most famous scams of modern India — the Harshad Mehta affair of 1991-92 and the Ketan Parekh affair of 1997-2000.
Harshad bhai scaled up a well-known system of informal credit that is much favoured by traders. The modus operandi is like this. Get friendly with a bank teller. Borrow Rs 1 lakh or so every morning and use that as trading capital. Return at end-of-day with a small token of appreciation (Rs 200/lakh when I last checked) for the teller.
Harshad’s brainwave was to get friendly with bank chairmen rather than tellers. That multiplied both the credit amount and the time period since a bank has to report its cash balances only once a fortnight to the RBI. It is even easier to extend the credit cycle if you have a co-op in your pocket, as Harshad did, to pay off inconvenient losses.
HM took this cash out of the banking system and invested it in shares. His unrestrained buying sent the Sensex up 200 per cent in just two months. He thundered “I am long on India” from various forums.
He would never have been caught except for a perfect storm of bad luck. SBI had a special audit, which meant an unexpected demand to return the cash he had “borrowed” (from banks that owed SBI money). The BSE was on strike in protest at that instant due to the appointment of the new regulator, SEBI. Harshad couldn’t sell his shares and return the cash. Or else, he may still have been operating.
KP used different methods to tap into the banking system. He formed a network of brokers that worked as a cartel to drive up prices by circular trading: A buys from B and sells to C, who sells back to A and so on, each time at a small profit. The KP minting machinery was available to select promoters. He focussed on a group of scrips that became known as the K-10 and his operations contributed to the Internet boom of 1999 and early 2000.
KP had two key credit lines. One was of at least Rs 1,000 crore from the Madhavpura Mercantile Co-op, the other was of around Rs 250 crore from Global Trust Bank. Both were in blatant violation of banking norms. In addition, various K-10 companies probably lent him cash to bump up their valuations.
KP eventually lost the game of stock-market poker to a bunch (Shankar Sharma, Nirmal Bang) known as the “Bear Cartel”. KP bought, they sold more than KP could buy. Prices fell. Tehelka happened. The US dotbust happened. The GTB and Madhavpura cash evaporated. GTB imploded. L K Advani had to use his influence to bail Madhavpura (which fell in his parliamentary constituency) out.
An earlier scam involving stocks also had a larger political dimension in that it caused a famous rift between Nehru and his son-in-law, Feroze Gandhi. In 1957, Sheth Haridas Mundra induced LIC to invest in the shares of six companies he controlled, “somehow” bypassing the normal channels, and charging higher-than-market prices.
In 1958, Feroze, who tracked the insurance sector, highlighted the case. Feroze had earlier been the whistle-blower in the R K Dalmia case, which led to the nationalisation of the insurance industry. Dalmia had an insurance company from which he siphoned off cash. The fallout from the Mundra scandal included the indictment of the then-finance secretary and the resignation of Finance Minister T T Krishnamachari and frigid silence amongst the residents of Teen Murti.
Of course, it’s not as though financial scams have only come into being after Independence. They have been happening since time immemorial. My personal favourite is the Bombay Backbay Reclamation Scam, Part I and Part II. The BBR Company was first formed in 1864 when Bombay was riding high on the cotton bubble caused by the US Civil War. BBR sold 1,000-odd acres of saltwater and then collapsed into liquidation before it could turn them into land.
Revived in 1917, it did sterling work in reclaiming approximately 500 acres of what is now prime seafront south Mumbai property. Only this time, it sold some 1,500-odd acres — considerably more than it reclaimed. It also “bought” and “deployed” much more machinery than it possessed.
The man who nailed the Backbay scam was a certain Khurshed F Nariman, who now has the honour of “Point” and a road named after him on some of those acres. I doubt that KPMG will receive that honour for decoding Raju’s methods of financial innovation.