MUMBAI BUSINESS COMMUNITY RAISES CHALLENGES TO IMPROVING

UNCLAS SECTION 01 OF 04 MUMBAI 000085

SENSITIVE
SIPDIS

USTR FOR AADLER

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV EAGR IN
SUBJECT: MUMBAI BUSINESS COMMUNITY RAISES CHALLENGES TO IMPROVING
CORPORATE GOVERNANCE IN THE WAKE OF THE SATYAM SCANDAL

REF: A. A: Delhi 241

B. B: CHENNAI 7

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1. (SBU) Summary: In meetings with Mumbai-based business
executives and corporate governance experts, CongenOff heard
that corporate governance is still at a nascent stage in India.
While most acknowledged that the size of the Satyam Computer
scandal was exceptional, interlocutors also believe that lapses
in corporate governance are common throughout India's publicly
traded companies, many of which are still family-run and
controlled. Many Indian interlocutors agreed that Indian
companies appear to follow the rules of good governance, but few
comply with the spirit of those standards; the biggest hindrance
is companies' reluctance to appoint truly independent directors
to corporate boards, who can challenge the management and
finances when questions arise. The Indian software lobby and
the Indian government have acted quickly to stem the damage
following the Satyam financial scandal and to attempt to restore
faith and confidence in corporate India (reftels). However, our
contacts felt that as long as promoters or majority shareholders
play a role in managing the company, true corporate governance
will likely remain an illusion rather than a reality. Without
a robust judicial system or a more powerful regulator, our
interlocutors expect little to change in the near-future. End
Summary.

Satyam Financial Scandal "Shocks" Corporate India and Throws the
Spotlight on Corporate Governance
--------------


2. (U) On January 7, Ramalinga Raju, the founder and chairman
of Satyam Computer Services, one of India's largest IT
companies, confessed to manipulating the financial accounts of
his company to the tune of over $1.6 billion (Ref B). Arrested
immediately after this disclosure, Raju is being investigated
for corporate fraud and for siphoning money from the company.
Most interlocutors in Mumbai expressed shock at the size and
nature of the fraud, as Satyam was considered a pioneer in
India's IT industry and had won numerous corporate governance
awards. Raju was a former Chairman of the National Association
of Software and Service Companies (NASSCOM),the Indian IT trade
association, and was himself a highly respected representative
of India's IT industry. Overall, our interlocutors believe that
the scandal has tarnished the image and reputation of corporate
India and adversely affected investor confidence.


3. (SBU) Rajiv Vaishnav, Regional Director of NASSCOM,
maintained that the Satyam fraud incident is an isolated one,
not only in the IT industry, but throughout corporate India. He
argued that Satyam represents a case of "intentional fraud"
rather than bad corporate governance. S. Mahalingam, Executive
Director and Chief Financial Officer at Tata Consultancy
Services (TCS)(the biggest IT service exporter),agreed, and
emphasized that the IT industry was generally "very well
behaved;" he acknowledged, however, that when suddenly about
$1.6 billion vanishes, it brings to light certain inherent
deficiencies in the corporate governance standards. He insisted
that this is a one-off case where an individual decided to act
fraudulently.


4. (U) Darius Shroff, Senior Partner of renowned corporate law
firm Crawford Bayley & Co, and one of Mumbai's most consistent
advocates for better corporate governance, noted that there are
now two extremes of corporate governance in the IT industry
spectrum: Satyam is at one end, and Infosys Technologies, a
"shining star" of corporate governance, is at the other. It is
because of Infosys that people will not brand the Indian IT
industry as a whole as "Satyam-infected," he said. Gopal Jain,
Managing Partner of Gaja Capital, a private equity fund, stated
that before the Satyam scandal, the IT sector was one of the few
areas investors would not have suspected corporate frauds. As a
result of the scandal, investors will take this as an additional
risk to be considered when investing in Indian IT companies.

Corporate Governance Rules "Robust" but Adherence and
Enforcement "Lacking"
--------------


5. (U) Sammy Medora, Executive Director of KPMG and the firm's
corporate governance expert, noted that corporate governance in
India can be traced to the inception of Clause 49 in the listing

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agreement prescribed by the Securities & Exchange Board of India
(SEBI) in 2000, which SEBI only started enforcing in 2006.
(Note: A listing agreement specifies the guidelines that
companies must follow to be publicly listed. End Note.) Clause
49 stipulates the minimum procedures a listed company should
follow to ensure transparency and good governance. This
includes the number of independent directors that should sit on
a company's board, the establishment of an audit and
shareholders' grievances committees, the disclosure of fees and
salary paid to the directors, and other basic principles that
ensure that the company is governed in the best interests of all
shareholders. According to Clause 49, every listed company has
to reserve half of the board for independent directors if the
chairman is an executive director. One-third of board members
have to be independent directors if the chairman is a
non-executive director. These independent or non-executive
directors should not have a pecuniary or business relationship
with the company, its promoters or management, and should not be
related to the promoters or senior management.


6. (SBU) Medora maintained that Clause 49 is a robust rule
"without the excesses" of the Sarbanes-Oxley legislation which
emerged following the financial and accounting scandals in the
U.S. Nevertheless, KPMG's Medora admitted that although Indian
listed companies adopt Clause 49 in practice, few companies
follow the "true spirit" of the law. In a more dire assessment,
Crawford Bayley's Shroff who is, himself, an independent
director on the board of several companies, claimed that many
Indian listed companies do not even comply with the "letter of
the law." Shroff estimates that 18 percent of the near 5,000
companies listed on the Bombay Stock Exchange are non-compliant
with the listing agreement. Several of these "non-conformers"
are large public sector companies who do not have any
independent directors on their boards, he continued. Shroff
claimed that the executive directors of these companies "resist"
appointing independent directors who may ask "inconvenient"
questions. These companies claim that they cannot find
independent directors who are willing to sit on their boards.
He admitted that most independent directors are not enthused to
attend board meetings of these government-owned companies, as
each meeting tends to be 6-7 hours long.


7. (SBU) SEBI is empowered to take punitive measures against
listed companies who do not comply with Clause 49. However,
the sheer volume of listed companies in India -- which at over
6,000 is one of the largest in the world -- makes enforcement
highly challenging, Medora admitted. SEBI's punitive power is
limited to de-listing of the non-compliant company which hurts
the minority shareholders and is not an effective deterrent, he
explained. Shroff pointed out that SEBI did not have the
resources of the U.S. Securities and Exchange Commission (SEC)
to conduct investigations and punish non-compliance. The
enforcement machinery in India can handle only 10 percent of
violations, he admitted. Jain pointed to the India's backlogged
courts as being responsible for the poor enforcement of
corporate governance standards (ref A). He believes that only
strong enforcement will deter executives tempted to commit fraud
in a company. Jain said that without a robust judicial system,
corporate fraud will continue to exist in India.

Truly Independent Directors an Illusion in India
--------------


8. (SBU) Many interlocutors agreed that the presence of
so-called independent directors on corporate boards did not mean
they were independent, or took an active role in directing the
company. TCS's Mahalingam and Medora both opined that while
Satyam's independent directors were not involved in the fraud
itself, they were definitely "not on the ball" and did not
conduct the required due diligence before vetting the financial
statements of the company. Shroff concurred and explained that
independent directors sitting on Satyam's audit committee were
responsible for verifying the financial statements of the
company, and they were negligent in discharging their
responsibility.


9. (SBU) Medora pointed out that most independent directors are
friends or acquaintances of the company's executive directors or
top management. While technically they meet the definition of
independent directors, they are not truly independent, he

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explained. He also maintained that many Indian corporate
leaders are "iconic" and other directors are wary about
questioning or challenging their business decisions. Shroff
agreed with Medora and added that compliance with Clause 49 is
often "illusionary."

Tale of One or Many Satyams?
--------------


10. (SBU) Unlike the U.S. and Europe, most public companies in
India are still controlled by families, or aligned families
(here, the controllers of a company -- which are sometimes
complicated, inter-family webs -- are known as "promoters.")
Indeed, according our interlocutors, there may be only two
prominent non-family controlled, professionally run companies:
the major construction company Larsen & Toubro and Infosys. In
many cases, families and promoters may only own a small
percentage of the company -- as was the case with Satyam -- but
actual control is still held tightly by the head promoter and/or
family head. Shishir Tamotia, CEO of Ispat Energy, (Note:
Tamotia is an outside executive who is CEO of Ispat Energy, a
subsidiary of leading integrated steel maker Ispat Industries
which is owned by steel magnate Lakshmi Mittal's brother. End
Note.) believes that corporate India has evolved its own model
of corporate governance which is different from the Western
model. Most Indian companies are family-owned and many have
been handed down from generation to generation. It is difficult
for the owners to manage the company at an "arms length," which
is what good corporate governance entails, he continued.
Company management should be "emotionally detached" from the
business for true corporate governance to succeed. Shroff
agreed and noted that there will always be a "conflict" between
independent directors and the executive management of a company
who are pressured by demands of stock options, profitability and
bonuses. Besides "unadulterated greed", he has heard of
promoters committing fraud to boost stock prices or to boost
market expectations or influence analyst expectations of future
earnings, he added.


11. (SBU) For example, a senior manager at an Indian financial
services company - who is himself the son of the company's
founder, and whose family owns 51 percent of the company -
alleged financial inappropriateness in a large Indian company,
which recently purchased another company on which his company
served as broker. According to the senior partner, the
acquiring company publicly offered Rs. 1000 ($20) per share to
buy a majority stake in the company, but paid an additional Rs.
600 ($12) per share privately into a Swiss bank account to the
acquisition's owner, for a total of Rs. 1600 ($32) per share.
The two companies connived to do this, the partner claimed,
because SEBI rules require that companies buying a large block
of shares from a promoter must offer to buy an additional 20
percent of shares from other public shareholders at the same
price offered to the promoter (or large shareholder). The
acquiring company didn't want to buy an additional 20 percent of
shares at Rs. 1600, so ensured the publicly offered price was at
a much less attractive Rs. 1000 - thereby cheating the
shareholders of the purchase price, as well as the revenue
department. The senior partner claimed this was "common
practice" in such deals.


12. (SBU) Ispat Energy's Tamotia believes most businesses in
India are run like Satyam, with little regard for true
governance. Shareholders are unconcerned as long as the
company's stock continues to appreciate. Nevertheless, he does
not expect corporate fraud to be discovered in other companies
because there is too much at stake, and not because they are
without blame. The government, he said, is not prepared to take
the risk of more embarrassing disclosures. As long as
shareholders make money, no one cares, he added. KPMG's Medora
disagreed with Tamotia and said that while there may be a few
more deviant Indian companies, fraud is not endemic or
symptomatic in corporate India. In contrast, Shroff believes
that revenue fraud is "rampant" in companies. (Note: This
includes discrepancies in transfer pricing and asset valuation.
End Note). There is a thin line between tax evasion and tax
avoidance, he noted. He thought that other frauds like
defrauding minority shareholders and defrauding employees are
prevalent to a lesser extent. Shroff argued that if the CEO and
CFO of a company collude, neither the board nor the audit

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committee will find out about the fraud.

Going Forward~
--------------


13. (U) Shroff explained that corporate governance is an
evolutionary process and cannot be achieved overnight. Medora
believes that tweaking existing rules and enhancing enforcement
will help achieve better standards of governance, rather than
more regulation. There will be a renewed interest and increased
discussions on corporate governance in the months ahead, he
continued. Independent directors may re-think the number of
directorships that they hold. (Note: Currently, an individual
can hold up to 15 directorships at one time, which many feel is
too many to pay due attention. End Note). TCS's Mahalingam
added that there was a need for the Audit Committee executives
to be independent and more financially literate.


14. (U) SEBI is also considering the mandatory rotation of
auditors. Currently, auditors are required to rotate every four
years and two years in the banking and insurance industries,
respectively in India, but there are no rotation requirements in
other sectors. Representatives from the Big Four accounting
firms have naturally expressed their opposition to rotation
requirements, arguing that frequent rotations between firms
leads to major losses of knowledge about a company, which could
open the door to fraud or manipulation. In addition, Big Four
representatives note that most firms have an internal
requirement to rotate supervising partners every few years. On
the other hand, more frequent rotations might prevent auditors
from becoming overly familiar with the management of a company.
Medora believes that SEBI may also announce a peer review of
auditors. Currently, the Institute of Chartered Accountants of
India (ICAI) conducts peer reviews of audit firms, but SEBI
could decide the peer reviewer for each firm. Medora also
argued for a regulator for the auditing profession in India
which is currently under the ICAI, a self-regulatory
organization.

Comment:
--------------


15. (U) Mumbai's business community feels that the Satyam
financial scandal has highlighted the inadequacies of corporate
governance law but it has few answers (yet) on how to imbibe the
true "spirit" of corporate governance in India's largely
family-owned companies. As long as promoters of the company
play a direct role in management, Mumbai interlocutors view good
corporate governance as more of an illusion rather than a
reality. In older companies, where company heads are treated as
celebrities and heroes on par with film stars, movements to
force change at the top are unlikely to work. As Indian
companies increasingly aspire to be global companies, they face
the inconvenient fact that transparency and good governance
matter to investors. Whether the fallout of Satyam forces them
to concede this remains to be seen. End Comment.
FOLMSBEE