Satyam's "Ghost Employees" -- An Innovative Approach to Job Creation?

On the record so far, it is safe to predict that the legal and political maneuverings around India’s Satyam Computer Services will be continue to be noisy, protracted and inefficient. But the answer will come quickly to one question:

Did or did not former chairman Ramalinga Raju loot the company by diverting the payroll of 13,000 fictitious employees, out of some 53,000, as alleged by prosecutors and, as of today, at least, denied – or at least not admitted – by both Raju himself and the company.

Whatever the answer -- with its broad implications for the company and its shareholders and gate-keepers, as well as for Indian governance and regulation of companies and their auditors – the process to get there should be rapid.

The investigative work program to unpack such a charge could be written by a second-year auditor – once again exposing that the roadmapped mopping-up of “forensic accounting” relates to the challenges of contemporaneous financial auditing as does the slog of post-battle casualty clearance to the smoky uncertainty of real-time warfare.

Legitimate employees demonstrate their presence far beyond their ID numbers and payroll entries, however susceptible to manipulation those high-level records may be. There are company accruals and payment obligations for taxes, social charges, pensions and benefits. They create hiring and departure dossiers. They occupy real office space, work stations, telephones and computers – all requiring the documentation and outlay of considerable real sums. And as alleged, a 25% padding of their rosters would affect everything in a company environment from cafeteria turn-over to usage of paper towels to the frequency of parties for maternity leaves.

What would have been in it for Raju to bear the cost side of over-stating his employee head-count? All the associated expenses, if fictitious, could have been exposed by a walk through a job site or an expense ledger. While if real, they would have been an impossible drain on the company’s margins – not to mention requiring a team of co-fraudsters to dummy up the records.

Volume padding is one of the oldest corporate scams. Barry Minkow created bogus job locations in the 1980’s to boost the turn-over of ZZZZ Best – but that Ponzi scheme was aimed at inflating the public company’s stock price. And a decade earlier, the perpetrators at Los Angeles-based Equity Funding used the unusual device of over-stating liabilities (to pay death benefits on non-existent insurance policy holders) – but they found a way to extract a pyramid of real cash through the use of reinsurance.

So there was the rub for Raju, and the challenge to the prosecutor’s assertion: ghost employees don’t generate revenue.

Or do they?

Padded jobs rosters, inflated client billings and systematic over-charges are also devices as old as time, as any manager knows who has ever pushed back against a service provider’s generous billing.

To realize revenue on the scale alleged in Satyam, however, would require a massive fabrication of client billings, at the very least – even if disconnected from legitimate employee numbers and expenses – plus the possibility of warehouses full of bogus time records and other job-related footprints. Again, all of this was subject to ready exposure through the most elementary form of inquiry and verification – whether by a client, internal auditors or outside monitoring and scrutiny.

Or is it the case, despite the world’s largest companies on Satyam’s client roster, presumably exercising some level of due diligence in bench-marking Satyam’s staffing and employee productivity against its peers, that the entire Indian out-sourcing industry is so lacking in basic control and oversight mechanisms that irregularities so allegedly pervasive – and, necessarily, collusive – could escape detection for so long.

The implications of that speculation will await exploration when the post-battle forensic hyenas have finished their scavenging. For now, expect that the porous nature of the Indian investigative process, which has already furnished so much to chew on, will continue to serve up a buffet of future morsels.    

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Comments

[Edith Orenstein]

Jim, you're right, there are an array of simple procedures performed by first and second year auditors (like pulling a time card or payroll sheet and walking around to verify a sample of listed employees actually exist and are working) and complex (automated forensic data comparisons of records) to verify legitimate vs. phantom employees. The examples you give remind me of another example, where Enron had a pretend trading floor it showed off to analysts, as described in this article: http://www.click2houston.com/news/1248368/detail.html. (Shades of Madoff Investment Securities too, perhaps http://www.boston.com/business/articles/2009/01/15/madoff_might_not_have_made_any_trades/.)

[Mark Peecher]

Great example. While it will be interesting to watch how allegations align with facts in this sad case, your points about the criticality of digging into business realities, or, what my co-authors Tim Bell, Ira Solomon and I elsewhere have called "entity business states" as a means to cross-check and stop fraudulent management's representations, hits the bulls eye. What's more interesting here are the seemingly simple procedures that could have shed light on the mis-match between the management's asserted reality and actual business reality.

While watching from afar requires customary limitations and caveats to be noted (we surely don't have the whole story and I don't want to reach any conclusions about the degree to which audits were shoddy w/o more complete information), the early, emerging particulars of this case to date are worrisome.

See Bell, Peecher and Solomon 2005. The 21st Century Public Company Audit. KPMG International. Available at:

http://www.business.uiuc.edu/kpmg-uiuccases/monograph2.pdf