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Board Ineffectiveness

The events at Satyam Computer Services are an outcome of a total break-down in controls and more importantly, personal values. They are, in the least, a sad reflection of incompetence by a supposedly eminent board of directors and possibly, even wilful oversight. The Satyam saga demonstrates how easy it is for a high profile public limited company to commit fraud and effectively deprive public shareholders of millions of dollars of their invested fortune.

Ramalinga Raju, Satyam’s erstwhile Chairman, declared in his letter to the board that the company had for several years misreported profits, a claim somewhat hard to swallow. The enormity of the sums in question would have made this quite impossible to achieve. Bank statements, deposit certificates or investment portfolio records are a simple indicator of a company’s cash reserves. The signing partner of the company’s auditors PricewaterhouseCoopers was either an integral part of a sinister conspiracy or incompetent to a degree hard to fathom. Either way, he failed utterly the trust placed upon him by Satyam’s shareholders and undermined the franchise of one of the world’s leading accounting firms. Over the next few months, investigations by the Serious Frauds Investigations Office (SFIO) may unravel what truly happened and more importantly, how the system’s checks and balances proved ineffective.

The debate will subsequently shift to the composition of boards, particularly nomination and other processes necessary to make them effective. In most companies, board appointments are really the prerogative of the promoter chairman. Often compensation and reimbursements are so large that independent directors may not always remain independent. In Satyam’s case, an independent director and Harvard professor, Krishna Palepu, received lucrative consulting contracts from the company, creating a serious conflict of interest. Mr Palepu was also a director on the board of failed Global Trust Bank and therefore, his very selection to the Satyam board should have raised questions.

Despite all the talk about independent directors and governance, the fact remains that nomination processes are not dissimilar to country club memberships. In the aftermath of the Satyam chronicle, the Securities and Exchange Board may be forced into introducing a set of director recruitment guidelines mandatory for publicly listed companies to follow. Companies may also be asked to revisit compensation doled out to independent directors. It must be reasonable and never embarrassingly large, as that in itself presents a conflict of interest. The argument that independent directors are sometimes highly paid professional consultants who bring tremendous business value cannot hold ground. If they are consultants then their engagement should be structured as such, not as directors. Finally, boards need to be more diverse – both in terms of professional experience and family background. If everyone is similar, there is a risk of the “Nigel’s and Mandy’s syndrome” setting in.

On the issue of processes, it is essential that audit committees are comprised entirely of independent directors who nominate their successors when they retire. This gives them absolute independence. Most importantly internal auditors must be appointed by audit committees, they should report to them and mandatorily retire every three years. Currently the practice of changing partners within an audit firm is considered acceptable. It should not be. The role of the board for privately held companies should involve risk mitigation and business strategy. However, for publicly limited ones the overriding responsibility should remain compliance and shareholder interest.

In the final count however, it all boils down to ethics and personal values. No amount of processes and controls can replace this essential ingredient. Corporate India can hardly complain about falling political standards when its own house is rooted in foundations that are wobbly. All issues are encapsulated in one simple question – how does one convince a ten-year old to tell the truth. The Satyam experience makes this simple phenomenon so very difficult.

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