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Business Continuity in the Face of Fraud and Organisational Change

Julie Margret, La Trobe University

Zahirul Hoque, La Trobe University

We examine business continuity in the context of fraud and accounting for an organisation as a going concern. The issues addressed are timely and focus on two points. First, fraudulent activities in business are increasing worldwide with related costs reaching trillions of US dollars. Second, the conventional accounting concept of a going concern that typically signifies business continuity is arguably formed on a static view of business. As such, this view does not help mitigate opportunities for fraudulent statements of account. We contribute to the accounting literature by emphasising the dynamic nature of business and in doing so extend the discussion on Type 1 and Type 2 going concern errors. In that context we provide evidence of a possible Type 3 going concern error in an organisation’s financial reporting. Drawing on an international fraud case involving an Indian company, Satyam, we illustrate the adaptive behaviour of resilient business organisations. The findings of our study show that even in the face of fraud dynamic, adaptive organisations can achieve business continuity.

I n this paper, we examine the notion of business con- tinuity in the context of fraud and accounting for an organisation as a going concern. Drawing on an

international fraud case involving an Indian company, Satyam, we investigate how a financially distressed or- ganisation can continue to operate as a going concern. We explore Satyam because it illustrates a case of business continuity achieved through structured organisational change from within the adversity of fraud. The issues addressed in this paper are timely on two fronts. First, fraudulent activities in business are increasing world- wide with related costs reaching trillions of US dollars (Hamlin 2012). Fraud and the cost of fraud have the ability to destroy a business both in a financial and non-financial capacity, as will be discussed later. The Association of Certified Fraud Examiners (ACFE 2012) estimates that occupational fraud incorporating areas of corruption, asset misappropriation and financial state- ment fraud (FSF) likely costs organisations around 5% of their annual revenues. As the ACFE (2012: 8) re- ports: ‘To illustrate the magnitude of this estimate, ap- plying the percentage to the 2011 estimated Gross World Product of [US]$70.28 trillion results in a projected global total fraud loss of more than [US]$3.5 trillion’. Subsequently such financial loss likely results in un- warranted hardship for communities across the globe. Second, the accounting concept of a going concern typ- ically signifies business continuity. Yet this concept has across time upheld an unchanging view of business (Yu 1971). As such it fails to explore the varying nature of

business and its reported financial outcomes, especially as business operations proceed into a future that is un- known (Sterling 1968).

This historical perspective is reviewed briefly in the following section. We consider it important because a going concern viewed from this perspective does not necessarily help to stifle opportunities for fraudulent statements of account. Further it opposes the commonly held view of an ongoing business that accommodates changing market demands. History shows that business is dynamic and business organisations are adaptive, flexible entities (Fremgen 1968; Eddie 1983; Hiles 2007; Martens et al. 2008; Margret 2012). Hence the financial accounting static view is arguably at odds with business concepts and activities generally.

The notion that business entities adapt to rapidly changing economic, social and legal environments ‘has been widely upheld in the literatures of economics and organizational behaviour’ (Tabart-Gay & Wolnizer 1997: 186).1 Nonetheless, financial accounting prac- tice based on assumptions of a going concern has for a long time enabled business organisations to be viewed and accounted for as mainly unchanging enti- ties. This debatable notion has underpinned financial

Correspondence: Julie Margret, Department of Accounting, Faculty of Business, Economics and Law, La Trobe University, Bundoora 3086, Victoria, Australia. Tel: + 61 3 9479 3587; email: [email protected]

Australian Accounting Review No. 76 Vol. 26 Issue 1 2016 doi: 10.1111/auar.12079 21

Business Continuity J. Margret & Z. Hoque

accounting practice for over 100 years (Dicksee 1976), though Eddie (1983) asserts that the notion was en- trenched in accounting much earlier. Nonetheless, this is a contentious point (for some) in financial account- ing and so remains of concern. Arguably, this view is at least sometimes problematic with regard to the pub- lished accounts of an organisation’s ongoing financial state.

Recent corporate crises such as Enron, Worldcom and Adelphia in the United States (US) and HIH, OneTel and WaterWheel, among others, in Australia, have shown that many traditional views of accounting for business as a somewhat inert system are inappropriate. Previously, accounting scholars like Chambers (1966) and Sterling (1979) advanced the idea that business organisations adapt to market changes in the normal course of con- ducting business. Loftus and Miller (2000) discuss the necessity for financial flexibility in business to better ac- commodate unexpected demands for cash and alleviate the likelihood of solvency crises. In this vein Margret (2012) explores problems of quantifying solvency and examines relevant deficiencies in conventional financial statements.

The financial outcomes of business entities’ flexible market behaviours are notably not commonly reflected in such financial statements that are typically based on historical costs and capitalised expenses. This likely in- creases opportunities for organisations to misrepresent their reported financials and heightens the possibility of fraud. Given, for instance, the difficulty of amassing precise statistics on the number and associated costs of fraud and FSF, this is important from a global public policy perspective.2

Through this study we contribute to the accounting literature by continuing to emphasise the dynamic na- ture of business and further illustrating the adaptive behaviour of resilient business organisations. Further, our study provides evidence on the relevance of the go- ing concern assumption as a fundamental financial ac- counting concept in signalling the likelihood of business continuity, which we label a ‘Type 3 error’.

In the management literature, focus on the concept of business continuity is mainly with regard to natural dis- asters and disaster recovery initiatives (see, for example, Hiles 2007). Missing however, are studies that juxtapose the notion of business continuity (adaptive behaviour) with the financial accounting concept of a going concern (static view) in regard to fraud and an organisation’s published reports on its financial transaction outcomes.

In the following four sections we first present a brief historical review of the literature on the accounting con- cept of a going concern, which is included to highlight disparate views that have evolved across time. Hence the literature is in line with the purpose of the paper, in particular with regard to the second issue addressed. Contrasting ideas over a lengthy period is informative

and indicates the altering views within academe. Reasons for those dissimilarities vary from the quality (service- ability) of recorded accounting numbers, based on the perceived assumption of a going concern, to audit prac- titioners’ going concern qualifications, and increasing audit risks. Second, discussion on business continuity draws heavily on the definitive management collection in Hiles (2007). Lacking there are studies that link the dynamic nature of business with reported financials on business continuity. This gap signifies a possibly deficient management focus on how an organisation’s financials may be misrepresented, and if such misrepresentation is intentional it indicates fraud. The third section presents case analyses and the final section provides a discussion and concluding remarks.

The Accounting Going Concern

Assumption of a going concern (1959–1985)

Storey (1959), Fremgen (1968), Sterling (1968) and Yu (1971) questioned conventional accounting wisdom that continued to accept business as a going concern based on what was then considered an untested assumption, rather than evidence in each case. Yu (1971: 38) stated: ‘[t]he traditional version of the going concern . . . is a static one . . . ’. Earlier, Sterling (1968) explored the meaning of the concept and questioned the validity of historical cost valuations that underpinned financial ac- counting reports on the going concern. He explained that business clung to the historical cost model because that financial amount could be objectively verified. He also reminded us that the historical cost is a past fact. In turn that cost would have little if anything to do with the future financials as published in the entity’s financial statements. Still ‘we [continue to] allocate that purchase price on the basis of what the future holds . . . [although there is] uncertainty about what the future holds . . . ’ (Sterling 1968: 497, 501).

Fremgen (1968: 650) asserted ‘continuity should be a judgement based on evidence in the case . . . not an assumption’. He advocated ‘[c]ontinuity is a tenuous as- sumption at best’ (Fremgen 1968: 656). Yu (1971: 51) emphasised the going concern as a total concept of the operating cycle of business and stated ‘[t]he cycle of op- erations embraces all phases of the economic activity of a business enterprise . . . “orderly liquidation” of individ- ual assets does not interrupt the revolving nature of the cycle; rather, it generates power to the movement of the cycle’. In other words business organisations continually liquidate assets in the ordinary course of business. This is a very different concept to liquidating assets under duress. Yu investigated the theoretical facets of a go- ing concern and remarked on the confused status of the concept in accounting (1971: 38). Further, he suggested a

J. Margret & Z. Hoque Business Continuity

review of the historical development of the conventional notion of a going concern.

Largely owing to continued disagreement between and within academe, this line of reasoning and study seemed to cease. Further research continued with atten- tion on audits, audit opinions, bankruptcies and audit reports. A link is found in Belkaoui (1985: 221) who re- iterated: ‘The (going concern) postulate assumes either that the entity is not expected to be liquidated in the foreseeable future or that the entity will continue for an indefinite period of time . . . ’. More current references with regard to auditing standards and requirements therein are included later in this paper. This follows dis- course on academic views on the likely outcome of audit going concern opinions from the 1990s.

As we move forward in time the aforementioned his- torical notions that emphasised the assumption of a go- ing concern dissipate in the literature, but those views remain relevant to this story.

Audit and the going concern opinion (1990s–2006)

Moving into the 1990s, with a fix on increasing bankruptcy filings in the US, Chen and Church (1996) investigated associations between market price reactions and the audit opinions of going concern. Their results indicate the usefulness of the going concern opinions with regard to the ‘market’s reaction to bankruptcy fil- ings’ (1996: 118). Previously, research indicated public perception correlated an audit issued opinion on going concern with a prediction of bankruptcy (Altman 1982; Hopwood et al. 1989, 1994).

More recently the going concern concept has been ex- plored by examining audit reports that disclose going concern uncertainties. For instance, Jones (1996) found that mean abnormal returns surrounding the release of the auditor’s report (through 68 audit reports) were lower for going concern opinions than for clean opin- ions. He further concluded that the magnitude of the abnormal returns depended on the extent to which the opinion type was unexpected. Carcello and Neal (2003) investigated ‘the relation between the audit committee characteristics . . . and auditor dismissals following the issuance of new going-concern reports’ (2003: 96, em- phasis in original). Therein the going concern report referred to a clean report (unmodified report) received by the client the previous year (2003: 96). That study fol- lowed a renewed interest worldwide in the going concern concept after several unexpected corporate collapses in the new millennium.

Barnes (2004) recognised the importance of the audi- tor’s opinion and the related biasness arising from either Type 1 error or Type 2 error. He further concluded that legal costs when introduced are expected to cause bias, the extent of which ‘depends upon the auditor’s rela- tive bargaining power’ (2004: 415). Evidence from Hong

Kong by Lam and Mensah (2006) suggests that the use of the auditor’s disclaimer report in the going concern con- text tended ‘to signal [a] more extreme client firm finan- cial distress’ (2006: 706–7). Moreover they stressed that maintaining ‘a high litigation-risk environment does not appear to be a necessary pre-requisite for high quality au- dits’ (2006: 707). Seemingly that indicates a necessity to retain good, ethical auditor–client relationships.

With regard to audit firm size, Geiger and Rama (2006) investigated audit report accuracy focusing on both Type 1 and Type 2 going concern errors. Briefly, the former is that the financially stressed company with a going concern opinion issued does not end in bankruptcy, the latter that the financially stressed company does end in bankruptcy when no going concern opinion is issued. Herein, a Type 3 error may emerge where a company that is not apparently in financial distress does end in bankruptcy when no going concern opinion is issued. This notion explores the relevance of the going concern as- sumption as a fundamental financial accounting concept in signalling the financial capacity of the entity to adapt to changing circumstances and so its likelihood of busi- ness continuity. The latter intensifies when the financially stressed company is the victim of fraud.

Bruynseels (2006) investigated ‘the impact of mitigating management initiatives on the auditor’s going-concern decision and assessing the impact of several auditor characteristics on the likelihood of type II [Type 2] errors’ (2006: 2). Focusing on the financial aspects of going concern, findings by Bruynseels indicate that operating and strategic initiatives that likely pro- duce positive long-term cash flows ‘significantly increase the likelihood of receiving a going-concern opinion, whereas strategic initiatives that are likely to generate cash inflows in the short run significantly decrease the likelihood of receiving a going-concern opinion’ (2006: 102). This evidence re-emphasises that the focus on the accounting going concern is primarily short-term. Debatably this is not that helpful to managers, investors and other business stakeholders. Such findings highlight the risks of inaccurate going concern decisions that likely influence shareholders and other stakeholders’ assessment of an entity’s capacity for business continuity.

The following sub-section continues the time-line from 2006 that tends to highlight risk and the busi- ness risk approach to determining an entity’s capacity for business continuity. It concentrates on the content and applicability of related auditing standards with a focus on materiality, going concern and fraud.

Audit risk and implications of auditing standards (2006–2013)

International Standard on Auditing (ISA) 315 Identifying and Assessing the Risks of Material Misstatement through

Business Continuity J. Margret & Z. Hoque

Understanding the Entity and its Environment requires auditors to focus widely on client-specific business risks and how the entity communicates with and between those charged with governance and management of the entity.3 The aim is to mitigate the risks of material mis- statement in financial statement audits. ISA320 provides specifics on Materiality in Planning and Performing an Audit. The requirements of the Australian Auditing Stan- dard (ASA) 315 issued in April 2006 are equivalent to its international counterpart ISA315. ASA320 is the Aus- tralian equivalent of ISA320, and its operative date is January 2010.4

Notably, the Auditing and Assurance Standards Board (AUASB), which issues ASAs, is required by the Financial Reporting Council (FRC) to have regard for any revi- sions and changes made to the International Standards on Auditing (ISA) under programs generated by the International Auditing and Assurance Standards Board (IAASB). So the ASAs have, prior to and since at least 2010, been revised in accordance with their equivalent ISAs. Hence the discussion here has an international focus.

Redirecting attention to risk, the business risk ap- proach to auditing has implications for the implementa- tion of ISA570 Going Concern (ASA570 is its equivalent). For instance, the standard requires, especially in regard to planning and then performing the audit and afterward evaluating the results of the audit, that auditors consider the suitability of ‘management’s use of the going con- cern assumption in the preparation of the financial re- port’ (ASA570: para. 5). In terms of materiality auditors must note both the quantitative and qualitative aspects of the ‘misstatement’ in shaping their final decision. This is mainly a subjective decision that has regard for reason- ableness for users in making their economic decisions, as well as what commonly users may require with regard to financial details to inform them. So they are better prepared to make their own economic decisions.

With regard to fraud, ISA240 (ASA240), effective in Australia from January 2010, denotes The Auditors’ Re- sponsibilities Relating to Fraud in an Audit of a Financial Report. The standard explains the need to differentiate between fraud and error and the necessity for intent to be present in circumstances of fraud. In terms of fraud and misstatements the standard conveys attention to cer- tain risk factors (A23-33: para. 24, para. 26) converging on materiality in A33, para. 28. The standard continues to provide guidance related to ‘Fraud at the Assertion Level’ (A37-A40) and ‘Override of Controls’ (A41-A44), including other matters at A64 in terms of FSF. The stan- dard also elaborates on fraud risk factors and it is evident that external auditors are expected to act with duty of care and professional scepticism. Turning attention to internal controls and internal audit functions, ASA240 refers to ASA315 and ASA610 for further guidance for external auditors in relying on internal auditors’ work.

Arguably internal auditors are well-positioned to scru- tinise the organisation’s internal control environment, counsel and be a positive factor in good governance, and in lessening opportunities for fraud,5 albeit that the function of ‘[i]nternal audit is in a changing landscape’ (Leung et al. 2004: 65). Importantly, the internal audit function works within the business entity to add value to its operations, and in this vein must seek to remain an independent function. We clarify this with the (say) Chief Internal Auditor (CIA) reporting directly to the Audit Committee (that should comprise independent and/or non-executive directors only) or if the business has no audit committee, to the board of directors (BOD) directly. This is significant because an entity that has an audit committee does not necessarily establish a guaran- tee of ethical conduct, good management and the like. Enron and HIH, for instance, had audit committees and to no avail.6

Returning to academe and adding to earlier discus- sions on the financial accounting concept of a business as a going concern Martens et al. (2008: 765) remarked: ‘Statement on Auditing Standards (SAS) No.59 [1] re- quires that on every audit the auditor evaluates whether substantial doubt exists about the client entity’s ability to continue as a going concern’. Conventional financial statements based on a static view (an historical account that is not necessarily updated) of business and its fi- nancial wherewithal arguably provide little assistance. So auditors tend to seek examples that ‘cast doubt on the entity’s ability to survive [that may] include negative financial trends, defaults on loans or similar agreements, and nonfinancial internal and external matters such as work stoppages or substantial dependence on the success of a particular project’ (Martens et al. 2008: 765).

In part this is fine especially as both financial and non- financial concerns are emphasised. Together they high- light the organisation’s current and likely future business situation. Of concern is that the details do not necessarily indicate the entity’s bona fide financial state, except by chance.7 With a different perspective, the judgement of SAS 59 has been examined empirically through an ex- perimental economic test of a game-theoretic model by Tucker et al. (2003). Their experiment supports the pre- diction that the self-fulfilling prophecy and forecast accu- racy factors have significant effects on subject behaviour. In turn this may lead auditors ‘to express fewer going- concern opinions and . . . clients to switch auditors more frequently, particularly when the audit evidence has low forecast accuracy’ (Tucker et al. 2003: 401). Again this is of concern with regard to the predictive capabilities of numbers based on an assumption of a going concern in lieu of evidence (see 2.1 above).

In 2009 the AUASB in conjunction with the Australian Institute of Company Directors (AICD) published ‘Go- ing Concern Issues in Financial Reporting: A Guide for Companies and Directors’, the significance of which

J. Margret & Z. Hoque Business Continuity

underpins directors’ capabilities in assessing the likeli- hood of the company they direct continuing to operate as a going concern. In other words there is continued and increasing emphasis on company directors’ ability to evaluate the business they direct as a going concern, and, moreover, to report precisely on their entity’s finan- cial state as it conducts its business in a dynamic business environment.

Business Continuity

The concept of business continuity, as opposed to the financial accounting notion of a going concern, has been discussed throughout the management literature (for details, see Hiles 2007). As FSF is also called manage- ment fraud, the link is relevant to this paper and topical globally. Honour (2007: xvii) asserted that the concept of continuity in business and how to achieve this state is a serious consideration in management circles, and as a management discipline it is ‘taken seriously across all in- dustry sectors as well as in central and local government around the world’.

However, the link between business continuity and fraudulent behaviour was at first not clearly evident. In management, business continuity plans and actions were (are) broadly conceived with particular regard for disaster recovery. Fraud and its financial outcomes for business is a disaster. In financial accounting this especially concerns elements of business management because fraud and opportunities for fraud continue to escalate across the globe (see for instance the ACFE (2012) report).

Business continuity planning

Business continuity planning (BCP) enables organisa- tions to move forward and survive through a variety of disastrous circumstances or events. Such events may be environmental – such as fire, flood, hurricane, drought, earthquakes or a production waste hazard – or they may involve sabotage, terrorism, arson, theft, industrial dis- putes or fraud. O’Hehir (2007: 28) suggested that disas- ter recovery and BCP primarily ought to be dealt with through a well-prepared ‘disaster contingency and re- covery plan’.

Of the many possible disastrous circumstances or events, we focus herein on the potential for fraud and how best to mitigate the opportunities for fraud to prevail. On technically related financial matters O’Hehir (2007: 28) was specific in terms of financial accounting procedures and referred directly to ‘[f]inancial loss due to inability to process receivables, late payment penalties and missed discounts, inability to update account balances and lost or unrecorded sales’. Such concerns are management and internal control environment issues

Managing Risk to Enhance Value

Environment

Asset Management

Fraud

Fiscal Control

Source: Adapted from O’Hehir (2007, Figure 2.1: 32).

Figure 1 Active risk management

that, if unattended, are likely to increase opportunities for fraud. To lessen the risks of financial loss and to diminish opportunities for financial fraud, management at all levels require timely, current, relevant financial details. Focusing on risk and the integrity of data O’Hehir (2007: 32) identified 14 areas, financial and non-financial, within an organisation that necessitate ‘active risk management’.

Figure 1 specifies four areas that are linked and seem- ingly relevant to this paper in mitigating the opportunity for operational, financial and disclosure fraud: environ- ment, asset management, fraud and fiscal control. The diagram is included to explicate visually that fraud is of major concern in the management and business arena. As a potentially major financial risk to a business, fraud is directly linked to the business risk approach to manag- ing for business continuity in the face of a (or pending) disaster. Hence Figure 1 shows fraud in the context of re- lated financial and non-financial risk factors in the active risk management model.

O’Hehir (2007: 33) asserted that risk is a ‘perspective . . . It can mean any impediment, inside or outside the organization, to meeting business objectives’. Far more than a perspective in business management, fraud and fraudulent behaviour is an ever-increasing imped- iment to risk management and business continuity. Moreover, the statistics on monetary costs alone are problematic because not all frauds are discovered or reported, and so we are not privy to the exact nature of all adversity arising from fraudulent activities. We can determine that business continuity requires an organization to undertake dynamic endeavours in an ever-changing business environment. Arguably such endeavours are likely to be exacerbated in the face of fraud. So managing fraud risk becomes imperative in active risk management to lessen the likelihood of fraud occurring in the process of BCP.

An organisation’s ability to effectively manage fraud risk is part of its internal control environment. Within that environment it is crucial the organisation has the capacity to adapt, change its products and/or services

Business Continuity J. Margret & Z. Hoque

when necessary, cope with altering societal demands, and keep abreast of improving technologies to enable its continuity. Such a combination requires stability in the organisation’s financials and clarity in their disclo- sure. With regard to publicly reported financials this may be tricky. As Gul et al. (1991: 532) noted ‘the na- ture of the financial statements . . . [are a] mixture of recorded facts such as cash at bank; accounting conven- tions such as use of the lower of cost or net realisable value rule for inventory valuation; postulates such as the going concern postulate . . . and personal judgements applied to estimate the provision for doubtful debts or se- lect the method used in calculating depreciation of fixed assets’.

Such a conglomeration of numbers and possibilities for manipulation increases the risk of fraud occurring in financial statements, as it increases the opportunity for fraudulent behaviour. Any risk that threatens the in- tegrity of an entity’s financial accounts ultimately threat- ens the entity’s reputation and its capacity to continue its business. It is interesting that Gul et al. (1991: 532) men- tion cash because, as will be demonstrated, the appar- ently tangible and verifiable cash accounts of a business can be absolutely fictitious.

With an eye on the business and its continuing oper- ations, enterprise risk management (ERM) in conjunc- tion with well-managed attention to an organisation’s internal control environment is likely to further dimin- ish opportunities for fraud either for or against the entity. In regard to business continuity, ERM encourages a fo- cus on fraud and ‘business issues and technology with a perspective on the entire enterprise’ (von Rössing 2007: 339). In this context ERM intensifies management’s task as they seek to include all relevant factors in the organi- sation’s active risk management model.

Business continuity management

Business continuity management (BCM) advocates a practical approach to risk management that involves the entire organisation. It concentrates on identify- ing and managing those elements that are critical to keeping the business functioning effectively. O’Hehir (2007: 34, 35) identified the following five specific risk groups and reiterated the uncommon connection of each group:

(a) Strategic: the risk of plans failing or succeeding (b) Financial: the risk of financial controls failing or

succeeding (c) Operational: the risk of human error or achieve-

ment (d) Commercial: the risk of relationships failing or

succeeding (e) Technical: the risk of physical assets failing/being

damaged or enhanced

BCM Program

Management

Understanding the Organisa�on

Determining BCM

Strategy

Exercising, Maintaining and Reviewing

Developing and Implemen�ng BCM

Response

Source: Adapted from Cornish (2007: 107).

Figure 2 Business continuity management (BCM) lifecycle

As all facets of business do interconnect, BCM provides a framework to assist organisations and their management to identify, avoid or otherwise respond to business risks and the risk environment. BCM and BCP are cyclical processes that consist of understanding the organisation, developing and implementing reactions to its business strategies, and reviewing and maintaining those strategies (see Figure 2). As Cornish (2007: 106) emphasised, ‘business continuity management needs to be planned, implemented and improved on an ongoing basis’. It is a dynamic system and entails an understanding of business and its adaptive behaviour. It encompasses a practical, hands-on and flexible planning approach to the ever-changing economic, environmen- tal and social demands of a global community.

Moreover, O’Hehir (2007: 39) asserted: ‘If the plan is not up to date [or updated continually] and does not reflect the current business environment then you might as well not have a plan. The plan should allow for changes in the business environment, and procedures should be in place to ensure it is updated in a timely manner’. Like- wise, internal controls should adapt to cater for changes in the business entity and the changing environment. Such variations would include both financial and non- financial considerations. So, internal controls and the internal control environment would continuously be updated to guard against and stem opportunities for fraud and fraudulent behaviour. On an entity’s reported financials, it is conceivable that BCM and financial ac- counting practices converge to communicate changing business outcomes to shareholders and other stakehold- ers. It is inconceivable that they would converge without regard to ‘the current business environment’ (O’Hehir 2007: 39). Hence, it is plausible that they would produce financial reports to stakeholders on business entities’ up- to-date financial circumstances to better enable business continuity.

This idea is depicted diagrammatically in Figure 2. It shows the BCM lifecycle in a sphere of ‘[e]mbedding BCM in the organization’s culture’ (Cornish 2007: 107).

J. Margret & Z. Hoque Business Continuity

The figure demonstrates the inter-connectedness of the organisation’s lifecycle. It shows that continued attention to the force of the organisation’s culture throughout all spheres of the organisation’s business cycle is warranted. Hence the active risk management model is extended to diminish impediments to O’Hehir’s (2007) risk groups.

The BCM lifecycle model illustrates particular points where continuity of internal control, audits and risk management checks might converge. This would likely achieve business continuity in the normal course of events in addition to a disaster recovery plan. Von Rössing (2007: 339) considered BCM audit concerns and suggested ‘businesses should take adequate precautions to ensure that no going concern issues arise from crises or disasters’ [emphasis added]. Any financial crisis and the possibility that fraud might occur is an ongoing concern for current business operations and business continuity into the future.

Drawing on the case of Satyam in India, we now illustrate how management frameworks and government strategies can work in unison and be implemented to se- cure business continuity even during ongoing turmoil and in the aftermath of a major fraud.

Fraud: The Case of Satyam in India

Background

Satyam Computer Services Ltd was a global information technology services company first incorporated in In- dia in 1987. Its founder, Ramalinga Raju, was educated in both the US and in India. By 2008 Raju, who was Chairman of the Board of Satyam, admitted to orches- trating a massive FSF.8 The delinquent accounts included inflated cash balances, understated liabilities and fabri- cated accrued income. Initially, the total dollar amount under scrutiny was expected to be in excess of US$1.4 billion.9 The resulting figure however was US$3.01 bil- lion or the equivalent of 140 billion rupees (Rs 14,000 crore) ‘instead of the initial estimate of Rs 7,800 crore (Rs 78 billion)’.10

The point highlighted here is the size of discrepancies that can arise when trying to determine the actual amount of financial loss to an organisation due to fraudulent behaviour. Further and different to previous studies that focus on red flags, prediction models and corporate governance, this paper highlights certain financials relevant to FSF at Satyam that arguably warrant continued attention across corporates and published financial reports. It also explores the adaptive conduct at Satyam that facilitated organisational change and enabled business continuity.

In the first instance, certain cash and bank balances at Satyam were invented and subsequently those amounts

were fundamental to the enormity of the fraud and the total losses suffered by stakeholders. This is significant because cash is commonly considered to be an observ- able and tangible asset that can be verified indepen- dently and, as such, unlikely to be a source of fraud. Satyam, however, is not the only case where cash was a predominant element in FSF. Another was Parmalat in Italy, where false cash deposits totalled around 4 billion euros.11 Consequently it seems cash transactions and ac- counting for cash receipts are increasingly of interest to investigators, financial forensic experts and in forensic audits.

Remarkably, in Satyam’s case, post-fraud business continuity was achieved amidst the continuing scandal, notwithstanding that the company was re-born in a dif- ferent form and re-named. For Satyam, a new board of directors was appointed by the Company Law Board in India and they in turn ‘appointed Deloitte and KPMG to restate the accounts of Satyam and decided to focus on “business continuity” by arranging funds for expenses and vendor payments’ (Basilico et al. 2012: 156).

In April 2009 ‘Tech Mahindra . . . took over [the] reins of the company . . . after the government-appointed panel cleared sale. It later rebranded [the] fraud-hit company as Mahindra Satyam’.12 The Satyam saga is noteworthy on a global basis. At the time of its demise ‘Satyam was ranked as India’s fourth-largest information technology services group by revenues . . . Its clients in- cluded . . . companies such as Nestlé, General Electric and General Motors’.13 Its international reputation and status was profound. It had been given an international governance award and ‘was often recognized as a cen- ter of excellence on risk management’ (Basilico et al. 2012: 144). Nonetheless, as evidenced by many other global corporate failures, recognition and inclusion of relevant oversight bodies such as audit committees and internal audit departments do not ever “guarantee” or- ganisational behaviour of a high ethical and professional standard.

Fundamentally, Satyam was immersed in disclosure (non-disclosure) fraud. As the latter fixes on misrep- resentations, or omissions generally, in annual reports or other published statements of account on a com- pany’s financials, shareholders and other stakeholders at Satyam were unlikely to be well-informed about its con- dition generally or its financial condition specifically, details that would better inform stakeholders’ economic decisions about their organisation as a going concern. Reportedly, the company’s published financials were incorrect and intentionally so for some time. Yet the accounts and the financial statements had been audited by ‘Pricewaterhouse Coopers since 2001’ (Basilico et al. 2012: 146) without any apparent concern, and the com- pany continued operating as a going concern until its admission of fraud in 2009.

Business Continuity J. Margret & Z. Hoque

The tale in financials

Nature of the cover-up initiative

In April 2008 Satyam became the first company in India to publish IFRS audited financials; and by De- cember 2008 Satyam’s market capitalisation figure was reportedly US$3.2 billion (Bhasin 2012: 32). Previously, in 2006, its reported revenues alone were in excess of US$1billion. Satyam’s revenues are an important part of the story as ‘Ramalinga Raju claims . . . he was fudging revenue figures and since expenditure figures could not be fudged so easily, the gap between “actual” profit and “book” profit . . . widened every year’ (Bhasin 2012: 33). Raju’s way out of the mess was to promote a crafty acquisition that would likely lead to fraudulent activity.

Raju proposed that Satyam acquire a substantial share (51%) in both Maytas Infrastructure Limited and May- tas Properties (companies in which the Raju family had a 37% and 35% interest respectively) for US$1.6 billion to operate as a fully owned subsidiary and to bring ‘some real assets into the business’.14 Apparently this was Raju’s attempt to replace fictitious cash records with actual cash assets. For instance ‘[o]ne particularly troubling item concerned the [US]$1.04 billion that Satyam claimed to have on its balance sheet in “non-interest-bearing” de- posits’ (Bhasin 2012: 34), raising the question of why a company would hold such substantial cash deposits in- stead of investing the money to increase absolute earn- ings or returning (at least in part) the cash as dividends to shareholders. This question was apparently not asked or explored by the auditors.

The Satyam Board, including its independent direc- tors, approved the proposed Maytas acquisition, but the company’s shareholders did not. Therefore, the plan was dropped. The failed acquisition was the catalyst for Raju’s confession. As Bhasin (2012: 32) remarked ‘Raju con- fessed that Satyam’s balance sheet of September 30, 2008, contained . . . irregularities’ that largely involved ficti- tious cash and bank balances (Rs. 5,040 crore), accrued interest (Rs. 376 crore), inflated accounts receivable (Rs. 490 crore) and revenues (Rs. 588 crore). Seemingly Raju had commenced a cover-up initiative that became an increasingly uncontrollable activity that led to fraud.

Nature of the fraudulent activity

Bhasin (2012: 32) determined that ‘Raju: (a) inflated figures for cash and bank balances of US$1.04 billion vs. US$1.1 billion reflected in the books; (b) an accrued interest of US$77.46 million which was non-existent; (c) an understated liability of US$253.38 million . . . and (d) an overstated debtor’s position of US$100.94 million vs. US$546.11 million in the books’.

To many, the amount of the financial discrepancies as reported in Satyam’s financials was astounding. More important to some was the underlying catastrophe (financial and non-financial) for the company’s em- ployees, other stakeholders and the broader community. FSF and its outcomes always have an adverse affect on communities. Clearly there are continuing concerns for business and regulators. Broadly, there are governance matters with a focus on financials that demand the on- going attention of regulators, auditors, directors, senior company executives, financial analysts, shareholders and other stakeholders.

Strategy: Business continuity through acquisition and change

At Satyam, the solution was to prevent the company from collapsing under the weight of its fictitious financials and public disgrace. So it was re-constructed to prevent to- tal failure and to regain some dignity. Ultimately, with government intervention, it was consumed by Tech Mahindra and became Mahindra Satyam in June 2009. Bhasin (2012: 35) explained: ‘[i]mmediately after Raju’s revelation about the accounting fraud, “new” board members were appointed and they started working to- ward a solution that would prevent the total collapse of the firm’. Speed seemed essential as Satyam’s share price fell from 544 rupees in 2008 to 11.50 rupees in January 2009, and in New York from US$29.10 in 2008 to around US$1.80 by March 2009 (see Bhasin 2012: 34, 35).

At that time a number of parties showed interest in buying Satyam including ‘Larson & Toubro, B.K. Modi’s Spice Corp., Cognizant, Tech Mahindra, iGate, WL Ross, amongst others . . . ’ (Dagar 2009). Out-bidding the others in April, ‘Tech Mahindra bought Satyam for [US]$1.13 per share—less than a third of its stock market value before Mr Raju revealed the fraud—and salvaged its operations’ (Bhasin 2012: 35). As Dagar (2009) stated ‘Tech Mahindra is the winner, with a bid of Rs58, 26 per cent higher than that of the L & T’.

Thus, the Securities and Exchange Board of India in conjunction with Tech Mahindra effectively sealed the continuity of Satyam’s business. Stock prices stabilised. In terms of business operations business continuity was achieved through acquisition and organisational change. The corporate entity and business applications of Satyam were to continue albeit in changed form as ‘Tech Mahin- dra purchased 51% of Satyam on April 16, 2009 . . . saving the firm from a complete collapse’ (Bhasin 2012: 36).

The rush to implement such dynamic strategies and effect change to quickly salvage the company’s diminish- ing financial state worked, but it was just the beginning. The newly formed organisation had to swiftly but with

J. Margret & Z. Hoque Business Continuity

determined direction move to execute further organisa- tional changes to enable business continuity.

Organisational change

The re-organisation of Satyam under the umbrella of Mahindra Satyam was initially a rocky path. By June 2009 there was discontent and confusion amongst the employees due to lack of information about the restruc- ture. Employees were despondent about the number of people who had been relocated, downgraded or effec- tively dismissed. In one instance the roles of many senior leaders (about 70 to 80) were scrutinised (Mohan 2009). The company sought new talent from within the organi- sation but also drew on those with flair at Tech Mahindra. Hence, at Mahindra Satyam dissatisfaction grew and focused on a perceived overly zealous and aggressive attention to organisational change by management.

Under the new regime, employees at Mahindra Satyam were known as ‘associates’. Although the associates were assured that the company and their future were on track to achieve positive outcomes, employee morale remained low. Evidently a problem emerged in the discourse be- tween those in control and employees who felt they were under-informed and out of control. For instance, a letter to the associates from the new CEO did not address the uneasiness of company employees (see Mohan 2009).

Morgan and Sturdy (2000: 18) explained the signifi- cance of discourse and its relevance to ‘the way in which individuals explain themselves, their actions and orga- nizations’. From a company’s perspective there is seem- ingly little if any difference. After an acquisition it is not unusual for the newly formed organisation to undergo change and to implement new processes. During such a transformation it is likely that some employees will feel despondent or insecure. This is especially the case when employees perceive they are left out of the discursive process. In March 2012 it was reported that ‘[f]or 75,000 employees of Tech Mahindra and Mahindra Satyam, the news about the imminent merger brought both excite- ment and a sense of fear and concern . . . because they [the employees, were] . . . afraid of change of roles and loss of jobs in case of redundancies’ (Kurmanath 2012).

Apparently Tech Mahindra’s task was to secure a future for Mahindra Satyam as a functioning contributor to the group. Hence, their changing processes post-acquisition were focused on how best to achieve business continu- ity post the disaster and in the face of perceived public shame. By late 2010 Mahindra Satyam was set to submit revised financial accounts to stakeholders. One point of concern at that time was the recorded debt in the re- structuring package. Maytas Infra wanted the return of Rs.323 crore that had been earlier transferred to Satyam Computers. The transfer had occurred, arguably, prior to the fraud being revealed. As such ‘Maytas Infra . . .

expressed hopes that Mahindra Satyam would reflect [on] its liability of Rs.323 crore, [that was previously] transferred as inter-corporate deposits (ICDs), when the firm declares its results on September 29 after restate- ment of accounts’ (Special Correspondent 2010).

The plan for Tech Mahindra was ‘to create a feder- ated structure for its two merged entities—Tech Mahin- dra and Mahindra Satyam—much along the lines of the parent Mahindra group, most of which would be completed by December . . . [2013]’.15 The group’s or- ganisational changes proposed to include a management restructure that formed small divisions, accountable for their own profit or loss. This move sought to increase autonomy, innovative development and improve the de- livery of outsourced and related services. New business ventures would likely include enterprises ‘such as tele- com, manufacturing, healthcare and BFSI’.16 Reportedly, the organisation planned to position itself in the top three IT companies in India ‘by 2021 . . . [and] Tech Mahindra [would hope] to double its revenues to [US]$5 billion by 2015, from the [then] present [US]$2.5 billion . . . ’ (Business Line 2013). The aim of the organisational change was to enhance efficiencies throughout the group and so improve its internal control environment.

On 25 June 2013 Kurmanath (2013a, 2013b) reported that the merger of Tech Mahindra and Mahindra Satyam was complete. The continuity of business for the re- shaped Satyam seemed somewhat assured, albeit in a changed form. The law had provided an opportunity to the merged businesses to move forward and with alacrity they adapted quickly to the changed circumstances and implemented a disaster recovery plan to achieve business continuity.

Concluding Remarks

Circumstances that evolved at Satyam resulted in the birth of Mahindra Satyam, which illustrates a case of business continuity in the face of disaster. An absolute catastrophe was avoided through the implementation of a thoughtful and rapidly formed disaster recovery plan. Deliberate actions taken to alleviate repercussions from the fraud on a local, national and global front were essential. The Indian government, regulators and other stakeholders cleverly intervened to realise this. That such calamities occur in business is not altogether unusual, but active risk management to mitigate the opportunity for fraud to occur is, seemingly, far too unusual. This is evident from continuing fraudulent activity that ends all too frequently in unexpected business failure and economic, social and environmental calamaties.

The findings presented in this paper suggest that fraud is a core concern in an organisation’s risk management. Moreover, the inherent dynamic nature of business high- lights the necessity for active risk management, partly to

Business Continuity J. Margret & Z. Hoque

help develop and implement controls to diminish risks in business, including the opportunity for fraud to occur ei- ther for or against the business organisation. Commonly, perpetrators of FSF do so in an attempt to embellish the reported financial state of the organisation for share- holders, analysts and potential investors. Hence, fraud is often committed for (or on behalf of ) the organisation rather than against it, as in a direct embezzlement.

To achieve business continuity, determining the quality (serviceability) of an organisation’s reported financials is important and it is an ongoing concern for directors, senior executives, regulators, shareholders, employees, creditors and all stakeholders. Arguably, a concentrated effort to identify and debate how an organisation’s financials may be misrepresented is lacking. So, the opportunities for fraudulent behaviour continue to increase. A major challenge for business is to diminish those opportunities and lessen work-related pressures for employees. To accomplish this, an inspired and implemented internal control system backed by an ethical internal control environment within the organisation is warranted.

The operating activities of business organisations across industries, and the outcome of those activities, and how those outcomes affect the environments of and across nations, is also important and newsworthy. Inter- nationally, business operates in a money economy and financial matters are an ongoing concern. The outcome of fraudulent activity in business, against individuals, or, for or against organisations, adversely affects the econ- omy and social environments worldwide. In terms of business continuity Von Rössing (2007: 343) explained that ‘maturity and expectations may change consider- ably. In some countries, business continuity may be a highly regulated professional discipline, whereas in oth- ers the situation requires day-to-day survival rather than elaborate planning and continuity management. “Matu- rity” is therefore a relative term that cannot be assessed without the cultural and regulatory system of reference’.

Nonetheless, knowledge of the financial state of a business in its endeavour to continue its operations is a constant. All businesses across industries require the financial capacity to be able to continue their business activities. As organisations change, their operating processes alter, their business activities may expand or contract, and available products and services may be modified or transformed. Such dynamics necessitate a proactive and adaptive management. As Armit (2007: 336) asserted: ‘Plans and strategies, once implemented, reflect the requirements of the business at that time. These requirements . . . are not constant . . . A business continuity change management process covering [financial and non-financial] maintenance and review changes is required’.

This paper examined the notion of business continu- ity in the context of organisational change. It did so with

regard to the accounting notion of a going concern mainly because the former indicates that business is dy- namic and the latter primarily depicts business as static. The difference is significant from a public policy perspec- tive, as business continuity juxtaposed with the account- ing notion of a going concern has underpinned financial accounting practice for over 100 years. At times, the re- sults are confusing or misleading published financials.

Based mostly on the assumption of continuity, finan- cial accounting statements on the financial condition and financial performance of business organisations are published. Such financial statements sometimes show distressed business organisations as financially sound. This is evident as unexpected business failures and unex- pected corporate collapses persist. All too frequently, this occurs subsequent to an organisation’s financial state- ments being audited and published without qualifica- tion (Clarke et al. 2003; Clarke and Dean 2007; Clarke et al. 2008; Margret 2012).

The findings of this study emphasise the dynamic nature of business and the proactive and adaptive be- haviour of its participants. The study indicates that the static view that underlies conventional financial account- ing statements is sometimes problematic. It stresses that continued debate on the quality of an organisation’s pub- lished financials is warranted. Further, this study suggests that a Type 3 error in a financial reporting context is ev- ident. The somewhat habitual practice of relying on a going concern assumption that underpins a capitalisa- tion of expenses model to project business continuity is questionable.

Limitations and further research

This study lacks interview analysis and quantitative data to support the likelihood of the proposed Type 3 er- ror in financial reporting and as such is limited in its extent and its findings. Future studies might accumu- late and analyse data empirically through a survey in- strument or an interview process. The focus might be twofold. First, senior executives’ attitudes toward fraud risk and the internal audit function within their organ- isation can be examined. In addition, this could be en- hanced in conjunction with a perceived linkage to the internal control environment within their organisation. Second, the study may be extended to deliberate on the internal audit functions’ contribution to organisational change and mitigating opportunities for fraud within the business.

Notes

1 Historically, for instance, Sprague (1907); Canning (1929); Cyert and March (1963); Simon (1976); Aaltio-Marjosola (1994); Tuttle and Heap (2008).

J. Margret & Z. Hoque Business Continuity

2 Williams (2011: 13). 3 Effective for audits beginning on or after 15 December 2009 and

also (revised) on or after 15 December 2013. 4 Details of which, for instance, may be accessed in Kemp (2010). 5 For related survey results on internal audit objectives see Leung

et al. (2004: 17, 18). 6 In terms of Enron see: http://bodurtha.georgetown.edu/enron/

Enron%20Audit%20Panel%20Is%20Scrutinized%20For%20Its %20Cozy%20Ties%20With%20the%20Firm.htm. For HIH see the report of the Royal Commission on Enron.

7 Numerous case examples may be found in Clarke et al. (2003); Clarke and Dean (2007); and Margret (2012).

8 Refer to Basilico et al. (2012: 142.75) for further discourse on Raju, Satyam, financial and non-financial red-flags; and where the authors ‘apply five financial fraud prediction measures and examine corporate governance elements’ within the case (2012: 143).

9 For further details refer to: http://www.rediff.com/money/ satyam.html and http://business.rediff.com/report/2009/nov/25/ satyam-plunges-11-pc-as-cbi-pegs-scam-loss-at-rs-14000-cr. htm?

10 Ibid. 11 ASIC (2005) Financial Statement Fraud Corporate Crime of the

21st Century, KPMG Centre. AICD NSW Division Directors Briefing, Wednesday, 8 June: 5.

12 See ‘Satyam reports Rs 125 cr loss in FY10’ at: http:// business.rediff.com/report/2010/sep/29/satyam>

13 Refer to ‘India.s Satyam fraud trial to begin soon’ at:http://news. smh.com.au/action/printArticle?id?929040

14 Ibid. 32, 33. 15 See Business Line (Mumbai, February 14, 2013), available at

http://www.thehindubusinessline.com/industry-and-economy/ info-tech/tech-mahindra-chalks-out-strategy-to-be-among- top-3-it-companies/article4415446.ece

16 Ibid.

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