Security guards check a package being delivered to the headquarters of Satyam Computer Services Ltd. in Madhapur. (Photographer: Racha Ramesh/Bloomberg News)

The Undoing Of Price Waterhouse In The Satyam Scam Case

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Verify, verify, verify - is the lesson audit firms will learn from the accounting fraud at erstwhile information technology company Satyam Computer Services Ltd. According to SEBI, that was the recurring lapse in the auditing of Satyam’s financials by Price Waterhouse firms in Bangalore and Kolkata between 2000 and 2008.

“It is inconceivable that the attitude of professional skepticism was missing in the entire exercise spanning over 8 long years.”

The order, unprecedented in severity and scale, has barred all 11 Price Waterhouse accounting firms in India from issuing audit certificates and compliance certificates for listed companies and intermediaries for two years. The Securities and Exchange Board of India has also ordered the disgorgement of Rs 27 crore in wrongful gains by two PW partners and Price Waterhouse Bangalore.

It’s the first time SEBI has barred not just an entire audit firm but an entire network of firms.

The Satyam accounting fraud, by the admission of its own founder and chairman Ramalinga Raju, involved over Rs 7,000 crore in misstated financials.

Satyam Computers Chairman, Ramalinga Raju, speaks to Bloomberg in his Singapore office Thursday, February 27, 2003. (Photographer: Munshi Ahmed/Bloomberg News)
Satyam Computers Chairman, Ramalinga Raju, speaks to Bloomberg in his Singapore office Thursday, February 27, 2003. (Photographer: Munshi Ahmed/Bloomberg News)

What PW Did Wrong

SEBI examined Price Waterhouse’s audit work on five specific grounds to determine its role in the accounting fraud.

1. Non-existent cash/bank balances of Rs 5,040 crore

SEBI’s investigation and show cause notices found that PW did not independently verify bank statements and fixed deposit receipts nor disclose the lack of such verification in the audit report. PW argued that it had undertaken verification and that the fixed deposit receipts appeared to be genuine.

In one instance, SEBI has cited Satyam’s significant current account balances, Rs 1,782.6 crore in Sep. 2008, with Bank of Baroda’s New York branch. The regulator found that not once in eight and half years did PW request independent confirmation from the bank and instead relied on Satyam to source the confirmations from the bank.

In another instance, the regulator said a 2006 balance confirmation letter from ICICI Bank to PW did not contain even the name of the company for which the balance was being confirmed. PW said in its defence that there was no standard format for bank statements.

It was also found that two separate sets of fixed deposit balance confirmation letters were received by PW - one from banks and the other from Satyam.

The auditors ignored the first set of confirmations received directly from the banks and relied exclusively only on those received from the company, showing deposit balances which were tallying with what was shown in the books.
SEBI Order

And though PW argued that external confirmation was not mandatory, SEBI has reasoned that it would be in the case of materially large bank balances.

“... it is clear that PW had carried out verification of current account balances and fixed deposits in total disregard for the mandated procedures.”   

2. Inflated sales revenues using 7,588 fake invoices

SEBI’s order states that PW did not carry out any reconciliation between invoices and that it allowed receipts “represented by non-existent additional transactions in the monthly bank statements to be reported in the books of accounts without there being supporting invoices...”

PW argued that there was nothing distinguishable in the invoices that suggested they were fake. And that they were inserted in the billing system without the audit firm’s knowledge.

But the order points out that though Satyam was predominantly a services company, several of the fake bills related to products - and that should have alerted the audit firm.

SEBI also found that PW ignored red flags in the internal audit reports.

Thus, on an overall assessment, my view is that auditors: failed to do the walk through tests in respect of the invoices; feigned ignorance of the internal control mechanism including excel porting at IMS and OF stages; chose to ignore internal audit reports; relied on the ledger entries prepared by the company and did not conduct the Audit as mandated by the AS or the Guidance Note with bonafide intentions of doing an actual audit.
SEBI Order

3. Overstated debtors’ position by hundreds of crores of rupees

PW claimed that every year the client engagement team sought confirmations from a sample of debtors. Except for financial year 2008. Because of poor response rate in previous years.

SEBI’s order states that “fictitious sales would automatically result in fictitious debtors; it is but a natural corollary”.

Here too SEBI has underscored, several times, the importance of external confirmation, even though it is not the only mandated procedure.

I find that PW failed to perform the basic audit function of ensuring adequate external confirmations of debtor balances from the debtors in question, which in turn resulted in it failing to notice the inflated and false figures concerning SCSL.
SEBI Order

On two other grounds - variance in tax deducted at source benefits claimed versus as shown in the books and, failure to detect receipts of Rs 1,425 crore - SEBI did not find the charges sustainable.

In summary the order finds

  • gaping holes in the auditing process followed by the auditors
  • the attitude of professional skepticism was missing

It also mentions that PW ignored a whistle blower’s letter received on Dec. 23, 2008 by an independent director even though the director asked the audit firm to investigate it.

“...there has been a total abdication by the auditors of their duty to follow the minimum standards of diligence and care expected from a statutory auditor, which compels me to draw an inference of malafide and involvement on their part.”

Former president of the Institute of Chartered Accountants, Amarjit Chopra termed the SEBI order as unprecedented and agreed with SEBI’s decision to penalise the entire PW network.

There’s no point that we keep acting against a particular entity only and not against the other network firms. 
Amarjit Chopra, Former President, ICAI

Why Penalise The Entire PW Network?

Despite PW’s contentions that the standards of duty of an auditor are different from that of the firm and that all partners cannot be held liable for the actions of two, SEBI has penalised all 11 accounting firms operating under the PW brand in India.

The order explains that the

  • PW network firms in India are linked to each other
  • there are resource sharing agreements with each other
  • the Satyam engagement letter is signed only as ‘Price Waterhouse’
  • SEC and PCAOB also note failure of quality control systems of PW India
Having taken into account, all the factors relating to the manner in which various firms in India get registered with ICAI showing the name PW (bearing different registration numbers) and the nebulous way in which they are present in various parts of the country, it becomes difficult for me not to take note of the loss of faith of the investors in the brand name. Therefore I am of the view that the directions in the instant case ought to be aimed at the particular Network that was responsible for the fraud in SCSL. 
SEBI Order

The securities regulator noted that PW firms had collectively received a fee of Rs 23.31 crore between 2000-2008. Of this, Rs 13.09 crore was paid to PW Bangalore for the audit of Satyam. “This wrongful gain is liable to be disgorged.”

Along with 12 percent interest per annum starting Jan. 2009 upto the date of payment.

SEBI’s order comes into force with immediate effect but does not impact audit assignments for FY18.

PW has said in a statement to the media that it is confident of obtaining a stay against the SEBI order. Earlier it had, unsuccessfully, challenged the jurisdiction of SEBI in this matter, claiming only ICAL had the powers to regulate auditors.

Any appeal process will lead to the Securities Appellate Tribunal and thereafter to the Supreme Court.

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