Satyam fraud highlights need for vigilance on governance risks

According to George Dallas, Director of Corporate Governance at F&C, this week's announcement that a serious fraud had been perpetrated at India's Satyam Computer Services is a reminder of the governance risks that can occur when internal controls are weak and an owner/manager is inadequately overseen by independent board directors.

A letter dated 7 January by the company's former chairman, B. Ramalinga Raju, provided details on how financial fraud had been perpetuated at Satyam over several years without the directors or auditors having noticed a problem.

Dallas commented: "The revelation of this fraud has impacted the company's share price by almost 80% and casts doubt over Satyam's longer term future as an independent company. Satyam is already being referred to as India's ‘Enron' and this incident also raises broader concerns about corporate governance in India and the governance of family-controlled firms."

While there is no evidence that the Satyam incident will prompt identification of other frauds or governance failures in India, Dallas states that F&C is alert to corporate governance risks in India and emerging markets more broadly - "particularly those that relate to the abuse of minorities by controlling shareholders".

Indeed, just last month F&C published a report titled "Corporate Governance in Emerging Markets: an Investor's Roadmap" which includes a review of Indian corporate governance and outlines a range of key governance risks, warning indicators and recommended good governance practice measures that are relevant for emerging market companies. While the F&C report notes that controlling shareholders can be a positive force in many companies, it also focuses specifically on areas where controlling shareholders can negatively impact the company and the interests of minority shareholders. In particular, F&C's report provides guidance for investors and companies in areas that are relevant for family-controlled companies; these include related party transactions, management entrenchment, board independence and effectiveness, and audit, control and risk management.

Dallas concluded: "The Satyam case is very concerning, in part because the company appeared on the surface to have high governance standards, and had even received awards in this respect."

"While it would be inappropriate to infer that the fraud perpetuated at Satyam is typical of companies in India or other emerging markets, this incident serves to remind investors of the need to monitor corporate governance standards with diligence and to engage with companies to ensure that governance-related risks are appropriately managed and mitigated."