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Satyam Scam

Satyam Scam And Changes Introduced In Companies Act, 2013

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It is a general phenomenon in every legal system that whenever a new law is formulated there remains some shortcomings, which leads to the huge scams, which are then rectified by the amendments being made. Satyam Scam was not the first scam which shook the entire Indian financial market rather India has witnessed various scams viz., Harshad Mehta Scam and Ketan Parekh Scam that led to the amendments in Securities Exchange Board of India ( SEBI ) Act.

These scams questions the companies’ ethics and governance. Corporate governance, which is the core concept related to companies’ ethics and its policies in managing the company, has always been part of Indian Companies Act from its inception but there has always been a lack of attention being paid to it. But after the Satyam Scam, Corporate Governance came into the limelight and gained too much attention not only from the Indian government and academicians but also from the world at large. 

The core area for any developing nation, like India, to flourish and move towards achieving the developed nation status is the investment it receives from its own country as well as the outside world. No person would want to invest in the market where the chances of getting their investments turned into losses are high because of the malpractices adopted by the companies due to the lacuna in the law of that country. Hence, India had to come very hard after that huge scam and the result was there were major changes in India’s Corporate law framework especially Companies Act, 2013. 

History of Satyam Scam

The Satyam scam was the worst nightmare for India’s secondary market. It didn’t only tremble the Indian economy but also put forth the questions before the government for its laws regulating the corporate sector. It all started when the Founder & Chairman of the Satyam Computer Services’ Mr. Ramalinga Raju resigned from his post and confessed about the company’s false claims of its accounts for many years and also about the fake overstated revenues and inflating profits to attract the investors.

The company was between a deal to invest in Maytas Properties & Infrastructures but the investors were against that and hence various lawsuits were filed by the investors regarding the usage of companies’ funds. Due to this, Raju came up with the five-page confession stating all the malpractices done by the company.

Soon after the confession, CBI started investigating the case and it was found that the company was showing the fake value of the assets, revenue and profits. Even the figure of employees working in the company was shown wrongly. The company also created fake loan advancement to show fake interest income. 

There was a vital role played by the auditor firm of the company, Price Waterhouse Cooper CA firm, in letting those frauds happen without any hurdle. There were many fake bills and invoices created by the company which the auditor firm refrained to introspect for 7 long years. 

Mr Raju and several others were arrested and booked for their offences. The company was acquired by Tech Mahindra in April 2009 and renamed it to Mahindra Satyam and later in 2013 Tech Mahindra and Mahindra Satyam got merged. 

Post Satyam Scam Scenario

Due to the political pressure and worldwide image created by the scam of the Indian financial market condition various agencies got into question. The Confederation of Indian Industries ( CII ) set up a task force under the chairmanship of Naresh Chandra in 2009 to recommend necessary reforms on Corporate Governance. Back in 2002, there was a Committee set up for the reforms in Corporate Governance under the same chairmanship of Naresh Chandra, but not much attention was paid to that report. 

There was one more committee set up under the chairmanship of Narayan Murthy by the National Association of Software and Services committee to establish corporate governance and ethics of the company. 

SEBI also came with its committee which worked on disclosure and accounting standards wherein they introspect the necessary changes required in the Audit Committee, Shareholder Rights, Whistleblower Policy, etc. The committee issued a discussion paper in 2009 to discuss the focal points on :

  • the voluntary adoption of international financial reporting standards;
  • the appointment of chief financial officers by audit committees based on qualifications, experience, and background; and
  • the rotation of auditors every five years so that familiarity does not lead to corporate malpractice and mismanagement.1

In 2009, there were voluntary guidelines issued for Corporate Governance by the Ministry of Corporate Affairs on the following issues : 

  • Companies should issue formal letters of appointment to Non-Executive Directors (NEDs) and Independent Directors. The letters should specify the terms condition of appointment of the directors; their fiduciary duties, restrictions, ethics, remuneration, etc. The letter has to be in the public domain and be disclosed to shareholders. 
  • There has to be a clear distinction between the roles and responsibilities of Chairman of the Board and the Managing Director/Chief Executive Officer to avoid power in the hand of a single individual and to promote the balance of power.
  • Company may appoint a Nomination Committee consisting of Independent Directors to address evaluation and recommendation of appointment of Executive Directors and various other issues.
  • Roles and Responsibilities of the Board like training of Directors, Enabling quality decision making, Risk Management, etc. were determined.
  • There were guidelines for the Audit Committee of the Board as well. Its composition, powers, roles and responsibilities were laid down in the guidelines. 
  • The guidelines also dealt with the procedure for appointment of Auditors, rotation of Audit Partners and Firms, Certificate of Independence, Appointment of Internal Auditors, etc. 
  • The concept of Secretarial Audit and institution of Mechanism for Whistle Blowing was also laid down in the guidelines.2

The government introduced Company Law, 2013 which replaced the Companies Act, 1956. The new Companies Act heavily relied on the recommendations given by the above-mentioned committees and incorporated Corporate Governance as a core concept. 

Corporate Governance

Corporate Governance in a general sense could be defined as a concept which ensures the application of best Management Practices with compliance of applied laws and regulations. It is an extensive concept which consists of transparency, accountability and fairness of all the stakeholders in the organization to achieve economic efficiency. 

Corporate Governance was not so prominent in India till the start of the 21st Century. It took a very long journey to establish itself in the Indian corporate sector. It was in the 1990s, this term was first used and in the year 1998, first-ever guidelines for Corporate Governance came. Afterwards, there were many committees set up to give recommendations for the Corporate Governance viz., Kumar Mangalam Birla report (2000), Narayana Murthy Committee (2002) and Naresh Chandra Committee (2002). 

But the major change in the concept of Corporate Governance came with the issuance of voluntary guidelines by the Ministry of Corporate Affairs in 2009 which has to be complied by the listed companies. With the introduction of Companies Act, 2013, Corporate Governance came up with a new and solid build-up having significant provisions being introduced in the Act. 

Changes Introduced in the Companies Act, 2013

There were many significant changes being made in the Companies Act, 2013. The Key changes are : 

Board Of Directors

  • Composition of Board

Section 149 of the Companies Act, 2013 provides for a minimum of two directors in a private company and three directors in a public company. Also, there is a cap on the maximum number of directors which is fifteen but the cap can be removed subject to special approval. 

  • Women Director

The proviso to Section 149(1) of Companies Act, 2013 provides for a mandatory requirement of at least one woman director on the board. 

  • Resident Director

Section 149(3) provides for a condition that the Board must have at least one director who has stayed in India for the total period of not less than 182 days in the previous calendar year. 

  • Independent Director

Companies Act, 1956 did not have provision for appointment of Independent Director on the Board. But after the Satyam Scam where the Board consists of Mr. Raju and his close aides, it became very important to have Independent Directors on the Board. It was hence set out in Clause 49 of SEBI Listing Agreement. By virtue of Section 149(4), it was incorporated in Companies Act, 2013 which provides that there has to be at least one-third of the total number of Directors as Independent Directors. Section 149(6) of the Act provides for the qualification for appointing an independent director in a public company. 

Committees Of The Board

There are four committees that is necessary to be constituted by the Board under Companies Act, 2013 :

  • Audit Committee

It is one of the most important committees as it looks after the financial reports and disclosure of a company. After the scam, which could have been avoided if there had been a fair and transparent audit of the company, many questions were raised for the fair audit of the company.

Section 177 of the Act provides for the companies to have an Audit Committee consist of at least 3 directors of which majority of them has to be Independent Directors.  

Various powers and duties were given to the Committee under Section 177 to maintain check and balance in the company and to ensure the smooth and fair transaction in the company. Establishment of Vigil Mechanism for directors and employees was made mandatory in the companies under Section 177(9). 

  • Stakeholder Relationship Committee

In the Satyam scam, the shareholders’ interests and their grievance were not taken into consideration at the time of acquisition of Maytas Properties and the deal was taking place. 

Hence to prevent this unfairness, this committee was set up under Section 178(5) which provides that, every company, having more than one thousand debenture holders, shareholders, deposit holders or any other security holders at any time in a financial year, has to constitute a Stakeholder Relationship Committee. The Chairperson of this Committee has to be a Non- Executive Director. The purpose of this committee is to address the grievances of the stakeholders.

  • Nomination and Remuneration Committee

The Companies Act, 1956 did not have provision for setting up this Committee, however, the 2013 Act under Section 178 came with the mandatory requirement to set up this committee consist of at least three non-executive directors out of which not less than one-half of them should be Independent Directors. 

The purpose of this Committee is to decide the selection criteria for the post in the company. Also, it is the duty of the Committee to evaluate the performance of the Directors and decide the remuneration and recommend it to the Board. 

The Companies Act,1956 did not have mandatory provision for the companies to have CSR, however, the 2013 Act requires certain companies to form a CSR committee of the Board consisting of three or more directors of which at least one has to be an Independent Director.

This committee’s main purpose is to recommend the CSR policy to the Board and also guide the board for the implementation of such policies. It is the provisional requirement that the company has to spend at least two percent of the average net profits of the last three preceding years towards its CSR policy. 

Auditors

There were many shortcomings in the Companies Act of 1956 related to the provisions for Auditors which led to the Satyam Scam. Many corporate professionals were of the view that if there had been stringent and transparent provisions for the Role of Auditors at that time, then the scam could have been avoided. 

To review the provisions of the Auditors, various committees were set up to recommend the government. The Naresh Chandra Committee gave various recommendations in its report which form the basis for the changes introduced in the provisions for Auditors. 

The Companies Act of 2013 clearly defined the roles and responsibility of the Auditors. It also determined the accountability of the Auditors. Section 139(2) of the Act provides that there has to be a compulsory rotation of auditors and audit firms. It prescribed a statutory cooling-off period of five years following one term as an auditor.3

There were certain restrictions being imposed on the Auditor to prevent unfairness and any conflict of interest. An Auditor of the company cannot perform non-audit services for the company as well as its subsidiary and holding companies. 

The Companies Act, 2013 in addition to fines imposed on auditors, came up with criminal punishment for the officers of the Auditors in case of fraudulent activities done by them.  

Related Party Transactions

Related Party Transactions are those transactions which are undertaken between the Key Managerial Persons or Directors and their relatives. Satyam Scam is the best example of fraud being done due to the Related Party Transactions. To prevent this mishap to happen again, Companies Act, 2013 incorporated Section 188 which provides for certain conditions to be fulfilled to make transactions with the related parties. 

Class Action Suits

Class action suits permit a body of collected individuals with a similar complaint to document a collective suit against the organization. It permits the minority investors to file a suit against the organization and its administration in the National Company Law court (NCLT). Section 245 of Companies Act, 2013 permits suit to be initiated against its directors, the executives, inspectors and whatever other individuals who is liable for the deceitful, unlawful or unfair act. 

Other Significant Changes

Serious Fraud Investigation Office (SFIO)

In the Companies Act of 1956, there was no statutory provision for the SFIO. It used to work independently on the request of the Ministry of Corporate Affairs. But in the Companies Act 2013, it was given the Statutory Provision under Section 211 and 212 of the Act. 

SFIO is established by the Central Government to investigate the frauds relating to the company. It consists of the director as head and various experts from different fields. 

The whole and sole purpose behind the establishment of SFIO was the protection of interest of investors. Investors are the real owners of a company but the power of management of the company is vested in the Board of Directors. There are chances to abuse of power like committing fraud, by few directors of the company.4

Role of CEO and CFO

The case of Satyam Scam raised the question regarding the separation of role and powers of CEO and CFO. CEO and CFO instead of working towards the interests of the company worked towards a scam and thereby neglected their fiduciary responsibilities as well.

There were no checks and balances between the two. Hence in the Companies Act, 2013, separate provisions are laid down for the CFO. Also, the provisions are incorporated in such a way that there will be no overlap of powers and no chance of collusion between the two. 

CFO was included as Key Managerial Person and hence has to be appointed only through a board resolution. Also, being a KMP he cannot indulge with any other affairs of the company which ensures the fairness and transparency in the accounts and financial affairs of the company.5 

Conclusion

The Satyam scam has trembled the Indian financial market and the regulatory authorities by its large scale fraud without going noticed by anyone. But it has led to major changes being made in the Corporate Law Framework by way of giving protection to shareholders, greater transparency in decision making, changes in statutory audits and separation of the role of CEO and CFO, etc. 

The Companies Act, 2013 provided to the shareholders for the first time, the right to initiate class actions suits against promoters and auditors of a company for any wrongdoing. It also increased the levels of transparency and corporate governance and introduced a more stringent definition of an independent director. 

With the implementation of Companies Act, 2013, shareholders for the first time got the right to initiate class-action suits against promoters and auditors of a company guilty of wrongdoing. After the Satyam Scam Scandal, its US shareholders sued the company but Indian shareholders were unable to sue the company as there was no provision present in Indian domestic law.  

Although the Companies Act, 2013 is very comprehensive and covers every aspect of the law to prevent any mishap to happen, yet there have been corporate fraud cases in recent times. The reason could be that the implementation of the new rules is ineffective. 

There is also a lack of shareholders activism observed in the Indian secondary market. This leads to the conclusion that though India has come up with the more stringent laws to prevent the Indian market, it is high time that India should consider that there is a dire need of the collective conscience of all the stakeholders to end this capitalist practices. 

This has to be achieved with the awareness programmes highlighting the larger consequences of the malpractices adopted by the companies. Further, this becomes of greater importance in the ongoing condition of the market due to the global pandemic, where the companies are already at risk and try to make strategies and plans for a swift revival which could hamper the stakeholders.6 

Endnotes

  1. https://blog.ipleaders.in/satyam-scandal-effect-corporate-governance-strategies-india/
  2. https://www.mca.gov.in/Ministry/latestnews/CG_Voluntary_Guidelines_2009_24dec2009.pdf.
  3. https://taxguru.in/company-law/fraud-investigation-office-powers-companies-act-2013.html
  4. https://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=5639
  5. https://www.financialexpress.com/industry/satyam-scam-the-positive-fallout-better-laws-to-govern-corporates/62355/
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Archit Jain

Student, NLIU, Bhopal

Archit Jain is a 4th-year law student at National Law Institute University, Bhopal. He has developed his interest in corporate and commercial laws and is very enthusiastic and keen at making a career out of it. Apart from the corporate, he has an interest in Antitrust/Competition Law as well. For any Clarifications, feedback, and suggestion, you can reach him at archit.nliu@gmail.com

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