TOP FINANCIAL

SCANDALS

UID – 22MBA10278
NAME – UTKARSH SINGH
COVERED SCANDALS -
• ENRON SCANDAL (2001)
• LEHMAN BROTHERS SCANDAL (2008)
• SATYAM SCANDAL ( 2009)
WHAT IS ENRON SCANDAL?
The Enron Scandal involves Enron duping the regulators by resorting to off-the-
books accounting practices and incorporating fake holding. The company
utilized special purpose vehicles to hide its toxic assets and large debts from the
investors and creditors.
EXPLAINATION -
The Enron corporation was regarded as a corporate giant. The corporation had
massive debts in its name. It tried to conceal these with the help of special economic
entities and special purpose vehicles. But after a good run, it failed miserably and
ended up as a bankrupt business. The failure and bankruptcy of the Enron
Corporation jolted Wall Street and put several employees on the verge of a financial
crisis. Enron traded at the highest market price of $90.75 on December 2, 2001. And
when the accounting scandal emerged, stock prices went down to a record low of
$0.26 per share.
Summary of ENRON
SCANDAL
#1 – Business Background
The year was 1985, and Enron was incorporated as Houston Natural Gas
company, and Internorth Ince merged. In 1995, the business was recognized
as the most innovative business by Fortune, and it made a successful run for
the next six years. In 1998, Andrew Fastow became the CFO of the business,
and the CFO created SPVs to conceal the financial losses of Enron. During the
period 2000, the shares of Enron traded at the price level of $90.56.
#2 – Initial Ripples

On February 12, 2001, Jeffrey Skilling came in place of Kenneth as a chief executing
officer. On August 14, 2001, Skilling abruptly resigned, and Kenneth took over the
role again. Same period, the broadband division of the business reported a massive
loss of $137 million, and the market prices of stock fell to $39.05 per share. In
October, the CFO’s legal counsel instructed auditors to destroy the files of Enron and
asked to maintain only the utility or necessary information. The business reported a
further loss of $618 million and a write-off of $1.2 billion. The price of the stock
deteriorated to $33.84.
#3 – Fall of Giant

On October 22, the business got under a probe by the securities and exchange
commission. With this news, the stock of Enron further deteriorated and was
reported at $20.75. In November 2001, the business, for the first time,
admitted and made the revelation that it had inflated its income levels by
$586 million. Also that it has been doing so since 1997. On 2nd December
2001, the business filed for bankruptcy, and the stock prices ended up flat at
$0.26 per share.
#4 – Criminal Probe

On January 9, 2002, the justice department ordered a criminal proceeding

against the business. On January 15, 2002, the NYSE suspended Enron, and
the accounting firm, along with Arthur Andersen, was convicted of
obstruction of justice.
Enron Scandal Causes
• The creation of a special purpose vehicle for concealing financial losses and a pile
of financial debt;
• Mark-to-market accounting as an accounting concept is an excellent method to
value securities, but such a concept becomes a disaster when applied to the actual
business.
• Lapse of corporate governance in Enron Corporation.
• The Enron scandal resulted in a wave of new regulations and legislation designed
to increase the accuracy of financial reporting for publicly traded companies. The
Sarbanes-Oxley Act (2002) imposed harsh penalties for destroying, altering, or
fabricating financial records. The act also prohibited auditing firms from doing any
concurrent consulting business for the same clients.
Conclusion

The Enron corporation was formed to merge Houston’s natural gas company
and inter-north incorporation. After the merger, it grew rapidly and was
regarded as the most innovative company. However, it resorted to bad
accounting practices. It was involved in the creation of special purpose
vehicles, utilized to hide the rising debt of the Enron incorporation, which led
to the business’s failure and downfall.
LEHMAN BROTHERS
SCANDAL 2008
Too big to fail, is a prime case of Lehman Brothers Bankruptcy. In February of
2007, the fourth largest investment bank in the U.S, Lehman Brother, was
selling at $86 per share with a total market capitalization of nearly $60 billion.
With more than $4 billion in net income, it was soaring to higher highs.
However, in March of the same year, its share price fell by almost 50%. And in
June, reported a quarterly loss of $2.8 billion. Then on 15th September, 2008,
Lehman Brothers, the fourth-largest investment bank in the United States
filed for Chapter-11 bankruptcy. Within no time, the incorporation vanished
from the investment banking landscape.
HISTORY OF LEHMAN
BROTHERS
The foundation of the company dates back to a long time ago in the 1840s when
Henry Lehman and his brother Mayer established the firm. Initially, the company
started to sell local groceries, mainly in exchange for cotton that farmers produced.
This led the company and the brothers into the cotton trade business. The favorable
market condition then led the company towards many avenues in the journey of
finally making it the largest investment bank in the history of the U.S.The company
then entered into the New York Exchange market and started underwriting most
significant initial public offerings (IPOs) in the early 1900s as an investment bank. In
this journey, it partnered with Goldman and Sachs in the 1900s, started selling bonds
on behalf of the US government, entered the financial markets to raise funds for
business and started taking lead in underwriting business paving its way to become
the largest investment bank.
CAUSES OF LEHMAN’S
FAILURE
DEBT AND LIQUID INVESTMENT PROPORTION
Similarly, evaluating a few of the other causes minutely, we can see that the bank
was engulfed with too much risk. Given such risk, the ability of it to pay them as they
became due was deteriorating on a timely basis. It had $613 million in debt against
$639 million in assets. Surfacially, the equivalent amount of assets is more than the
amount of debt, right? However, the quality of its assets was highly illiquid. Illiquid
here means that the company could not sell off its assets readily in the market
whenever it wanted.
In addition, the increasing amount of debt in any company increases its risk of
financial distress as the claim of debt holders increases against the claim of the
shareholders and the company itself.
ACCOUNTING MANIPULATION AND
WINDOW DRESSING
Alongside, involvement in several accounting manipulation and corporate
governance issues was another reason. Several studies claim that the
company was involved in window dressing the financial statements. The
window dressing was done to manipulate to show a positive view to the
shareholders and potential investors a lucrative financial position. It
manipulated about $50 billion in its financial statements in 2008 which was
not acceptable by the laws.
HIGH LEVERAGE
Another important factor was its leverage position. Leverage means the amount of
debt you have for every amount of equity in your company. Lehman adopted a
strategy to borrow debt unnecessarily with an attempt to leverage its assets. In 2007,
its degree of leverage was 31. Although this may not seem significant, its largest
mortgage portfolio made it highly prone to the market condition prevailing then. A
year later on March 17, 2008, due to the same concern of high leverage, it was
predicted to see a similar fate as that of Bear Stearns collapse.
This speculation and investor pessimism led its shares to fall by nearly 48%. Investor
confidence declined even more as hedge fund managers started questioning the
valuation of Lehman’s mortgage portfolio with increasing inflation and interest rate
on the other hand.
THE AFTERMATH
The adopted measures did not serve well as it was already too late for them to work.
Due to continuous downfall in performance, its stock fell 77% in the first week of
September in 2008. The hope of relief for Lehman Brothers was a South Korean bank
who was trying to invest in Lehman’s stock. However, the bank ladder stepped back
which led Lehman’s stock to fall by an additional 45%. Now, the debt holders started
filing suit against the company for their payment. The company was already facing a
loss of $3.9 billion by now. It then announced a corporate restructuring strategy.
However this did not work out because the company rating firm, Moody’s, was
reviewing its credit rating given its increasing default chances. This news further
depleted the stock price with a plunge of 42%.
Now the company was not in the state of resurrection. It only had $1 billion in cash.
Finally on 12th September, 2008, it declared bankruptcy.
IMPACT OF LEHMAN’S COLLAPSE
The collapse of Lehman brought a significant ripple effect in the financial
sector of the U.S. as well as around the world. Its collapse on stock market
returns had a devastating impact on major stock indexes. In addition, it has a
huge number of employees who are working for it around the world. After its
failure, more than 25,000 employees lost their jobs. In addition, their
investment into the company as employee stock options was a major loss for
them. The fall of company’ stock price also shattered their bright
future.Lehman’s downfall also had a substantial impact on its creditors or
investors who had trusted the bank with their resources and were left empty
handed upon its failure. Its integration in the financial system was so
interrelated that more than 75 bankruptcy proceedings were recorded
following the bankruptcy of the company.
Satyam scam of corporate
governance
Introduction Satyam was established in 1987. 4 th fastest growing IT
Company in India. 40,000 employees Revenue $2.1 billion It is the first
company of India listed in three International Exchanges i.e. NYSE, DOW and
EURONEXT. Satyam Computer Services Ltd was founded in 1987 by
B.Ramalinga Raju. The company offers information technology (IT) services
spanning various sectors, and is listed on NSE, BSE, the New York Stock
Exchange and Euronext.
GOOD TIMELINE -
1987
Incorporated as private limited company in 1987
1991
Recognized as a public limited company; debuts on the Bombay Stock
Exchange (BSE)
IPO oversubscribed by 17 times
1993
Satyam signs joint venture with Dun & Bradstreet for IT Services
Joint venture with GE announced
1999
Satyam Infoway (Sify) becomes the first Indian Internet company listed on
NASDAQ
Satyam forms joint venture with TRW Inc.
Presence established in 30 countries
2007
Becomes the Official IT Services Provider for the FIFA World Cups 2010
(South Africa) and 2014 (Brazil) Becomes the first Asian company to feature
in the Training Magazine’s list of Top 125 companies for learning

2008

Awarded with golden peacock award for corporate governance by London

council
CONFESSION:
Ramalinga Raju, chairman “None of the board members, past or present, had
any knowledge of the situation in which the company is placed.” He
INFLATED (nonexistent) cash and bank balance of Rs 5,040 crore(as against
Rs 5,361 crore) reflected in the books. AN accrued interest of Rs 376 crore is
non-existent. He has understated liability to the tune of Rs1,230 crore in
accounts of funds arranged by me. He hasover-stated debtors position of Rs
490 crore (as against Rs 2,651 crore reflected in the books.) FOR sept 2008,
we reported Rs2,700 crore revenue and operating margin of Rs 649 crore
against actual revenue of Rs2,112 crore and margin of Rs 61 crore.
METHODLOGY USED BY THE
SATYAM :
• Senior Management allowed certain employees to have a super user login
password to access company’s billing system who created fake invoices for
services not provide and in some cases non existent customers. • After
creating fake invoices and generating false revenues ,it showed falsified bank
statements and interest income earned from deposits . • The scam team
forged invoices to show collection of revenue abroad, forged bank statement
to show inflow of money, showed transfer of money to fixed deposits (FDs)
through forged FD receipts and reflected all this in the final accounts. The
assets and liabilities are altered Q2Q to reflect rising income and rig share
price.
• Satyam did make money on export. Raju raised invoices for
export abroad; money did come through the banking channels and
was transferred to long term FDs and reflected in the books. Once
the FDs were recorded in the books the deposits were dissolved
and money transferred to multiple accounts. The books continued
to reflect the FDs as you don’t need to surrender certificate
anymore. Siphoned money was use to acquire land, property, pay
for political patronage for Maytas Infra and Maytas properties.
Aftermath of satyam
scandal:
On 9 January 2009, the CLB suspended the Current directors of Satyam and allowed
the Government to appoint up to 10 new nominee directors In April 2009, 46% stake
in Satyam was purchased by ‘Tech Mahindra’ and both the companies legally merged
in June 2013. Companies Act, 2013 incorporated new provisions:
Disclosure of Promoter’s Holding
Rotation Of Auditors
Limited or other prescribed companies must not appoint or re-appoint1. An
individual auditor for more than one term of five years. 2. An Audit firm of two terms
of five consecutive years. 3. The Joint Auditors in the manner they do not complete
their term in the same year.
Two days after the confession was made Raju was arrested and charged with
criminal conspiracy, breach of trust, and forgery. The shares fell to Rs.11.50 on
that day compared to heights of Rs.544 in 2008. The CBI raided the house of
the youngest Raju sibling where 112 sales deeds to different land purchases
were found. The CBI also found 13,000 fake employee records created in
Satyam and claimed that the scam amounted to over Rs. 7000 crores.
PwC initially claimed that their failure to catch the fraud was due to the
reliance placed by them on information provided by the management. PwC
was found guilty and its license was temporarily revoked for 2 years. Investors
too became vary of other companies audited by PwC. This resulted in
the share prices of these companies falling by 5-15%. The news of the scam
led to the Sensex falling by 7.3%
Closing Thoughts
There has been no scam that affected the CA and audit firms like
the Satyam Scam. The increasing nature of these scams has made
dependence on such professionals much more crucial highlighting
the importance of ethics and CG in their roles. White-collared
crimes like these do not only make the company look bad but also
the industry and the country. We hope you enjoyed our Satyam
Scam case study article, do let us know what you think in the
comments area below.
THANK YOU