Satyam's "Vindaloo"

B. Ramalinga Raju, chairman and chief executive of Satyam Computer Services Ltd shocked the business world on 7 January 2009 after allegedly admitting that he had been manipulating the company's accounts for several years, resulting in a $1 billion hole in the company's accounts. As regulators in India move quickly to investigate, worldwide stakeholders, including the company's insurers and reinsurers, wait to see what the outcome will be on "India Inc".

The business world first realised something was wrong in mid-December 2008, when institutional shareholders rebelled against the board's approval of a takeover of Maytas, a company owned by Mr Raju's family. This prompted several board members to resign, and caused a significant drop in the company's share price on worldwide exchanges. But the full extent of the company's problems were not realised until Mr Raju's alleged confession that 94% of the cash recorded in the company's accounts was based on an accumulation of previous overstatements of the company's profit. This prompted NYSE Euronext to suspend the company's listing on both its exchanges. And, despite Satyam remaining listed on the Bombay Stock Exchange, within 2 days of the announcement, the company's value had fallen by nearly 90%.

Corporate governance regulation
A glance at India's Ministry of Corporate Affairs website shows over 50 statutes, rules and regulations relating to the governance of companies in India. No less than seven regulators operate within this framework. However, following the disclosure of this alleged fraud, serious questions are now being asked about the implementation of India's corporate governance regime.

Anxious to prove commentators wrong, SEBI (Securities and Exchange Board of India) and ICAI (The Institute of Chartered Accountants of India) have promised to investigate, report, and penalize guilty executives and auditors. The Indian government's first action was to replace the company's board with three well-respected Indian businessmen and a report into the company's accounts is due by the end of February. Following this report, it is likely that the matter will be passed to the recently formed Indian Serious Fraud Investigation Office, which will be given its first chance to fully flex its muscles.

Satyam's executives and auditors are also likely to face some tough questions from the US Securities Exchange Commission and Public Company Accounting Oversights Board given the company's listing on the NYSE.

If Satyam's directors and auditors are found guilty of providing false statements, they could face fines, disqualification and, ultimately, prison.

Related litigation
Perhaps of more concern to insurers/reinsurers is the securities litigation that is likely to ensue following the company's stock crash. Within a day of Mr Raju's announcement, US securities class action filings began pouring in against the company and its directors and officers. Also, the full extent of the company's fraud on its blue chip customers has not yet been determined. The company's management could face personal liability in India for these claims if the company goes into liquidation.

Although several securities class actions have been filed in the US, class actions are not currently allowed in India. This raises the interesting question of whether the defined classes will include Indian and other foreign investors? Recent US decisions have made it much more difficult for foreign investors in foreign companies to bring securities class actions in US courts¹, which could mean non-US investors would not be able to join any class settlement.

However, if the current Indian Companies Bill passes into law in full, class actions will be allowed to proceed in India. The loss suffered to Indian investors is likely to increase the country's support for the bill.

How will this affect insurers/reinsurers?
It has been alleged in the press that Mr Raju has publicly admitted fraud. Usually a directors & officers insurance policy will exclude cover for fraudulent, criminal or intentional misconduct. These exclusions typically do not apply until there has been an "adjudication/in fact". However, a written admission is usually considered sufficient, so it is unlikely that Mr Raju will be covered for his alleged admission.

It is also likely that the company's "severability of exclusions" provision will apply, so that even if cover is denied to some of the directors/officers for the above reasons, the exclusion would not apply to others who were uninvolved in the bad conduct.

Misrepresentation and rescission could also be an issue if the directors /officers/board knew of or suspected the fraud but failed to disclose it at the time of the underwriting.

Satyam's auditors and lawyers may also face negligence/malpractice claims under professional indemnity/errors & omissions policies. These policies are also likely to contain fraud exclusions, to the extent that they are relevant.

Satyam is the first big corporate fraud in India, and it certainly won't be the last. However, this scandal is the first high profile case which bears similarities to a number of frauds uncovered in other parts of the world. When placed into perspective, no matter how much due diligence is conducted by insurers/reinsurers one can never be alert to an individual(s) deliberately perpetrating a fraud. To that end insurers/reinsurers have seen some good results from their previous participation in the Indian D&O/financial lines market.

If you require further advice on Corporate Governance, D&O, or Financial Lines Insurance/Reinsurance issues in India, please contact either Nilam Sharma or Kirsten Addison-Smith.

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¹ See Morrison v. National Australia Bank, 547 F.3d 167, (2d Cir. 2008); In re Alstom SSA Securities Litigation, 253 F.R.D. 266 (S.D.N.Y. 2008); In re Vivendi Universal, S.A. Securities Litigation, 242 F.R.D. 76 (S.D.N.Y. 2007)