Did we refuse to see the Satyam lie?

In retrospect we are all wise. That is precisely what is happening with the Satyam scam as well.

The so-called experts are at it again, criticising Ramalinga Raju, his cronies and the auditors of Satyam, Price Waterhouse. But the irony isn’t to be missed, considering a large number of them were bullish on Satyam till about a month back. They can’t be faulted for venting there frustration at having been taken for a ride, of course. But they all got it wrong, right?

The question to ask now is how such a scam could go unnoticed for such a long time.
Now Satyam is no ordinary company listed just on some local stock exchange. It is listed on the Bombay Stock Exchange, the National Stock Exchange and even the New York Stock Exchange (NYSE).

Disclosure requirements for being listed on the NYSE are very strong. Also, the so-called experts, analysts and even journalists have been tracking the company very closely for long now.

As is well-known by now, Raju has said that the cash on the books of Satyam was overstated to the extent of Rs 5,040 crore.

Satyam’s balance sheet over the last six quarters clearly shows that the cash maintained as fixed deposit with banks was in the range of Rs 3,318-3,319 crore. Nobody raised eyebrows on the fact that over the last six quarters, the fixed deposits remained more or less constant.

Also, over the last six quarters, the company’s current account deposits went up from Rs 600 crore to Rs 1,841 crore. Experts and analysts could well have asked why the company needed to keep so much money in current accounts, which do not pay any interest.

Sure, I have the benefit of hindsight in writing this, but I don’t follow Satyam on a daily basis as the experts and analysts do. It’s surprising nobody questioned anything.
Charles Kindleberger’s all-time classic Manias, Panics and Crashes may have an explanation: “Commercial and financial crisis are intimately bound up with transactions that overstep the confines of law and morality, shadowy though these confines be. The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom. Crash and panic… induce still more to cheat in order to save themselves. And the signal for panic is often the revelation of some swindle, theft embezzlement or fraud.”

Mark the sentence in bold font, which suggests that when the going is good, promoters have an incentive to swindle and people who follow these companies tend to switch off their brains.

That seems to have happened in the Satyam case as well.  This was the case with Bernard Madoff, too.  In fact, the similarity between the two fraudsters is uncanny.
Madoff and Raju Madoff ran a Ponzi scheme for almost 50 years from 1960.

A Ponzi scheme is one where an illusion of successful performance is created by using the money brought in by newer investors to pay off existing ones. There is no business model in place to actually generate returns. So, a Ponzi scheme runs as long as the money entering the scheme is greater than the money leaving it.

And no one ever caught up with Madoff, until he admitted to it himself, last month. The losses on account of Madoff’s scheme are expected to be around $50 billion.
The returns Madoff delivered were superlative. In fact in November 2008, when the broader US market fell by almost 10%, Madoff’s scheme did not lose any money. The ‘good’ performance kept investors hooked and even elicited approval and appreciation from experts.

Nobody seriously questioned anything, though some people did question the methods he used in the late 90s. Some even went on record saying they had tried using the methods he claimed to be using, but could not generate the same kind of returns.
The same thing happened in case of the so-called experts following Raju and his company. They switched off their brains.

Why analysts fail to see it
Blame it on the ‘halo effect’, which the media builds up around businessmen and financial fraudsters.

Raju’s case was no different. Magazines and newspapers wrote stories on him and painted him as a person who could do no wrong. This blinded investors and experts who followed the company.

Nassim Nicholas Taleb’s book Fooled by Randomness offers some insight on the making of the halo effect: “We would get very interesting and helpful comments on his remarkable style, his incisive mind, and the influences that helped him achieve that success. Some analysts may attribute his achievement to precise elements among his childhood experiences. His biographer will dwell on the wonderful role models provided by his parents; we would be supplied with black and white pictures in the middle of the book of a great mind in the making.”

Take the case of Enron’s Kenneth Lay and Jeffrey Skilling. They couldn’t be seen doing any wrong. In fact the Fortune magazine rated Enron as the most innovative company in the United States for six years in a row. We now know what Enron was innovative at — accounting fraud.

Indeed, many cases of financial fraud involve individuals with charming and convincing personalities who have an ‘infectious optimism’ that makes people trust them.
Madoff, for example, was a family man who did a lot of philanthropy as well. He even donated money to lot of Jewish charities whose money he helped manage. He was also the non-executive chairman of the Nasdaq stock exchange for a few years in the early nineties. All this added to his credibility and ensured that the money kept coming into his investment scheme.

The halo effect was clearly at work in case of Satyam as well. Investors could see Raju doing no wrong, till sometime back. Raju even sold his shares in Satyam to fund social causes. How could such a man be a fraudster?

Turns out, there are black swans in this world, too, as Taleb would have us believe.