India's Madoff? Satyam Scandal Rocks Outsourcing Industry

On the morning of Jan. 7, Ramalingam Raju, the chairman of troubled Indian IT outsourcing company Satyam Computer Services (SAY), sent a startling letter to his board and the Securities & Exchange Board of India. Raju acknowledged his culpability in hiding news that he had inflated the amount of cash on the balance sheet of India's fourth-largest IT company by nearly $1 billion, incurred a liability of $253 million on funds arranged by him personally, and overstated Satyam's September 2008 quarterly revenues by 76% and profits by 97%. After submitting his resignation, Raju ended his letter by apologizing for his inability to close what began as a "marginal gap between operating profits and the one reflected in the books of accounts" but grew unmanageable. "I am now prepared to subject myself to the laws of the land and face the consequences thereof," he wrote.

The letter shocked and angered corporate India, which has looked to IT executives as role models for a new breed of Indian entrepreneur. The benchmark Sensex stock index dropped 7.3% and Satyam shares fell nearly 78% on the day as investors fled in droves. Goldman Sachs (GS) suspended its recommendations on Satyam "because there is not currently a sufficient basis for determining an investment rating or price target for this company," Goldman analysts Julio Quinteros Jr. and Vincent Lin told investors. Earnings per share, warned JPMorgan (JPM) analysts in a report, "may be 70%-80% lower than reported numbers and consensus estimates for '09-'10." Satyam had become "India's Enron," said CLSA India analyst Bhavtosh Vajpayee, calling the case "an accounting fraud beyond imagination [and] an embarrassing and shocking episode in Indian corporate governance."

As executives at other Indian outsourcing companies nervously assess what impact the scandal will have on them, many industry observers now argue that the Satyam case will damage India's reputation as a reliable provider of IT services. Because of the Satyam scandal, they say, Indian rivals will come under greater scrutiny by regulators, investors, and customers. "The bubble is going to burst in terms of trust," says a fund manager in Hong Kong who has followed Satyam closely. Doubts about the reliability of Indian outsourcers are especially important, since customers often allow the Indian companies access to sensitive systems. "This industry doesn't just make widgets," the manager explains. "It's an intimate relationship." Certainly, says Gartner (IT) analyst Diptarup Chakraborti, "there will be caution in the short term, skepticism, and questioning." After all, "no one wants to do business with a known fraudster."

Investors Want Answers

Industry executives are desperately trying to contain the fallout. "The decline in governance and institutions represents a serious challenge to India," says Rajeev Chandrashekhar, president of the Federation of Indian Chambers of Commerce and Industry. Wipro Technologies (WIT) Chief Financial Officer Suresh Senapaty, went on TV to say that Satyam's actions should not infect the entire Indian IT industry. And Mohandas Pai, head of human resources at Infosys (INFY) and the company's former chief financial officer, argued Satyam's behavior is atypical. "We wish the regulators will investigate and punish the guilty," he says. "But this is not representative of our industry." John McCarthy, vice-president of Forrester Research, allays some fears. "I look at Satyam as an isolated case, and don't think the developments would have any impact upon India's No. 1 position as an offshore location."

Still, investors and clients are going to want answers. For instance, they're demanding to know how Satyam's auditor, PricewaterhouseCoopers, endorsed the company's accounts. "Auditors' complicity in what seems to be a multiyear misstatement of financials will also be explored," said CLSA's Vajpayee in his Jan. 7 report. Already, India's Registrar of Companies had begun a probe into a failed acquisition last month by Satyam of companies run by Raju's two sons. Now the country's securities regulator will add its weight by investigating the PwC audit. PwC issued a statement saying it was examining the issue.

Raju's confession is the latest in a rocky ride for Satyam, its shareholders, and its stakeholders over the past year. The company's clients include multinationals such as Nestl, General Motors (GM), and General Electric (GE). But in September, the World Bank banned Satyam from doing any of its work after it found Satyam employees had hacked into its system and gained access to sensitive information. It also did not renew their five-year contract. Satyam denied any wrongdoing. Then came a fresh blow on Dec. 16, when Raju announced the company would spend $1.6 billion to buy two infrastructure companies run by this sons, only to reverse the decision a few hours later under shareholder pressure. Satyam ADRs lost 50% of their value overnight. December also brought news of pending litigation by a former client, online mobile-payments service Upaid Systems, which filed a case of intellectual fraud and forgery against Satyam in 2007; a Texas court is scheduled to conduct a hearing on the case Jan. 7.

Tip of the Iceberg

In India, the Raju family's non-IT activities had already been viewed with some suspicion, in particular a free emergency ambulance service Raju began in Hyderabad, where Satyam is based. Last year, public-interest activists filed a petition challenging the lack of transparency and arbitrariness in the award of ambulance-services contracts in 12 Indian states—all of which had been awarded to Raju's operation. In November the Supreme Court of India questioned the contracts and demanded an explanation, which could result in the contracts being canceled.

With Satyam's management focused elsewhere, business suffered. Clients complained about lack of attention, and many professional managers began to leave.

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Inside the House of the Future

When the homebuilding industry descends on Las Vegas on Jan. 20 for its annual trade show, a highlight as always will be a project called the New American Home. This model house—a new one gets built each year—serves as a showcase for the industry's latest technology and trends. The massive four-bedroom, five-bath structure popping up in suburban Las Vegas this year may seem a little out of touch with the times as the nation suffers through the worst housing slump in decades. But out in the real world, architects and builders are busy trying to figure out how to put some of the same design features into new homes. Such trends are worth noting: Having amenities that appeal to buyers a decade or more after your house is built will help it hold its value. We list below some of the most important new design features you'll see in homes.

Indoor/Outdoor Living Just since 1992 the number of U.S. homes built with patios or porches has doubled. The New American Home in Las Vegas has a giant backyard that features a covered area with a flatscreen TV and pool table as well as a detached "rejuvenation room" for relaxing. New homes in warmer climates are being built with courtyards that provide a connection to the outdoors but also give shelter from wind and privacy from neighbors. This is critical as builders try to cram larger houses onto smaller lots to keep land costs down. And there's a history to them, notes Newport Beach (Calif.) architect David Kosco: "The courtyard goes back to Roman times."

The Return of the Basement With lot sizes limited, builders are looking for space underground. Once a typical feature of homes in the Northeast, basements are rising in popularity nationally as a way to create extra space. New technologies in insulation and waterproofing are allowing builders to add basements in any climate. They can serve as game rooms for kids, home theaters, or just the "man-cave" for Dad. Builders are even creating underground garages for homes and townhouses to free up space for living areas above, notes Irvine (Calif.) architect Rick Emsick.

The Death of the Living Room The kitchen, living, and dining areas are continuing to merge into a great room or family room. In a 2007 study conducted by the National Association of Home Builders, half of those surveyed said they would do without a formal living room if it meant a larger family gathering space. In some cases this is a refection of the connection to the outdoors as well, as home buyers want fewer walls and unobstructed views out into the backyard, says Craig Delahooke, director of custom development for John Laing Luxury Homes.

The Home Office No longer just a spare bedroom, the home office is evolving into an entirely separate structure such as a casita in the backyard or even a separate wing near the garage. Having a separate entrance for the home office allows today's increasingly mobile workforce to receive work-related visitors or hire an assistant at home without having these people traipse through the main house.

Wireless, but not Cordless With wireless laptops allowing people to carry their computer to any room, that little computer nook that was popping up at the top of the stairs in many new homes is starting to disappear. Instead you're likely to see a charging station or "Mom's Desk," a little space, typically in the kitchen, where cell phones, laptops, and other devices can be charged.

The Soft Loft The industrial look with concrete floors and exposed brick is over. Thousands of these pseudo SoHos popped up even in cities such as Dallas and Houston that lacked an industrial past. Downtown lofts have seen some of the steepest price declines in this bust. "Architects love to show these wide-open floor plans, but the reality is people want some privacy," says Los Angeles architect Jonathan Watts. He says new condos are returning to more traditional floor plans. Lofts are adding hardwood floors, sliding doors, even wall-to-wall carpeting to warm them up.

Say Bye to Bling As befits this economy, homes are getting less ostentatious. That means less ornate wood, stone, and iron work. No more grand entrances with curved-marbled staircases. The stairs are shifting to the side of the home and back to their utilitarian purpose. Even fireplaces are flickering. Only 46% of all new homes came with one in 2007, according the U.S. Census. That's down from 59% in 1996.

The Green Badge of Honor It almost goes without saying, but green continues to be in, despite the latest slide in gas prices. Even the giant New American Home promises to use "net-zero energy" thanks to devices such as solar panels and designs that let in natural light. Home buyers use to love wowing their friends with the size of their McMansions. Now, says Sean Degen, vice-president for architectural services at home building giant Pulte Homes, "you're going to see more people having a green badge of an honor."

Aging in Place Builders say it's rarely something they overtly try to sell, but consumers are responding to features such as wider doors that can accommodate a wheelchair or walker, master bedrooms on the first floor, and tasteful looking handrails in the shower—amenities that will help baby boomers stay in their homes as they grow old.

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Enron's Skilling Loses Appeal

A federal appeals court has upheld the conviction of former Enron CEO Jeffrey Skilling for his role in the energy firm's spectacular collapse. The court did, however, order that Skilling be resentenced, opening up an opportunity to reduce his sentence from its current 24 years.

Under federal guidelines, Skilling could see the recommended range of his sentence drop as much as 10 years, though U.S. District Court Judge Simeon Lake III, who presided over the trial, will have substantial discretion. A jury convicted Skilling in May 2006 for conspiracy, securities fraud, insider trading, and lying to auditors.

A three-judge panel of the U.S. Court of Appeals for the Fifth Circuit rejected all of Skilling's arguments to have his conviction overturned. In part he had pinned his hopes on the argument that the government relied on the invalid legal theory of "honest-services fraud." Based on a federal statute, that charge has been levied against executives who allegedly put their own interests ahead of their company's.

The Old Nigerian Barge Scam

At one time that statute "was almost unlimited in its potential application and prosecutors were using it in a wide array of cases," notes Alan Vinegrad, a white-collar defense lawyer and former U.S. Attorney in New York. But a series of court rulings have pared back its use.

One of those rulings involved another Enron prosecution related to sham Nigerian barge deals. In that case, the Fifth Circuit overturned the honest-services fraud conviction of Merrill Lynch executive James Brown, and Skilling contended his case was analogous. But the Fifth Circuit rejected that comparison, noting that Brown was acting with the approval of his employer.

"No one at Enron sanctioned Skilling's improper conduct," the court wrote in its 104-page ruling. Skilling also argued that the Houston jury that heard his case was not impartial, that jury instructions were improper, and that prosecutors intimidated witnesses.

Maybe a Decade Less

One potential piece of good news for Skilling was the court's order that he be resentenced. Judge Lake had increased Skilling's sentence under a federal sentencing guideline that calls for an "enhancement" for those convicted of "jeopardizing the safety and soundness of a financial institution." Judge Lake had concluded that Enron's retirement plans were financial institutions, a finding the appeals court rejected.

While judges are not bound to follow the guidelines, they provide an initial basis for calculating a range of prison time, and for Skilling, that range would drop about 10 years.

Skilling has already begun serving his sentence at a federal prison in Minnesota. His attorney did not respond to an e-mail request for comment on the Fifth Circuit's ruling.

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Tax Cuts Aren't Off Obama's Table

As the economy heads deeper into a recessionary abyss, business tax cut ideas that seemed to be nonstarters just a few short months ago are suddenly back on the table. Take the incoming Obama Administration's embrace of a measure that would lengthen the period for money-losing companies to write off net operating losses against profits from the current two years to four or five years.

The proposal, floated on Dec. 5 following a meeting between Obama and congressional leaders, was originally discussed last spring when the Bush Administration assembled a stimulus package. (The idea was modeled after a similar measure enacted after the September 11 terrorist attacks.) But the provision was viewed as a giant giveaway to banks and money-losing homebuilders and it was scrapped from the package.

Quick Cash

Now, with the incoming Administration looking to pump something close to $1 trillion into the economy, business and personal tax cuts of as much as $300 billion—with perhaps $100 billion aimed at business—are seen as quick ways to inject money. While infrastructure spending is getting a lot of attention, business groups note that this stimulus can go only so far. Aric Newhouse, senior vice-president for policy and government relations for the National Association of Manufacturers (NAM), said that he has heard projections of stimulus spending reaching $1.3 trillion over two years. "The idea of spending $1.3 trillion—it's hard to think about how you would spend that all on infrastructure alone," he says. "The last highway bill was about $270 billion for all highway projects, for five years total."

The business tax cuts would get strong political and business support—in particular, the net operating loss provision is favored by Max Baucus (D-Mont.), chairman of the Senate Finance Committee. Other business tax cuts Obama is considering would extend so-called bonus depreciation, which allows profitable companies to write off investments more quickly, and give companies that hire new workers a one-year tax credit at a total cost of $40 billion to $50 billion over two years.

But many around Washington are dubious about whether a new jobs tax credit would produce a lot of hiring that wouldn't take place otherwise. "I don't think a $2,000 or $3,000 credit will create a job," said John Engler, president of the NAM. "You need a business reason first. A job credit by itself is not a business reason."

The Obama team has not fixed a dollar figure on the net operating loss provision. When Congress considered the same idea last year, carrying back losses to offset profits in the previous five years would have provided businesses an estimated $25.5 billion in refunds.

Courting Republicans

"Extending bonus depreciation and extending net operating loss will help get Republicans on board," says Dan Clifton, head of policy research for Strategas Research Partners. "There's no question a stimulus bill will pass. The question is whether it looks bipartisan or not."

Clifton, in a report on the net operating loss provision, says it would be a "net positive" for homebuilders, regional banks, automakers, and other companies that made money in recent years but are now facing losses. Among companies Clifton thinks could potentially benefit from the stimulus provision are Sprint Nextel (S); General Motors (GM); Citigroup (C); CBS (CBS); Ford (F); MBIA (MBI); Coca-Cola Enterprises (CCE) and D.R. Horton (DHI).

"The government is just pouring money into these companies," Clifton says. "It remains to be seen if it will be enough to get them investing again—or it just stops further destruction of their financial position."

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Was Apple 'Adequate but Late' on Jobs?

Apple (AAPL) investors got answers to some of their nagging questions about the health of the company's chief executive, Steve Jobs, on Jan. 5 when Jobs disclosed in a letter that he is suffering from a hormone imbalance that has caused rapid weight loss over the past year.

In the letter, published on Apple's Web site, Jobs said doctors had determined the cause of his weight loss to be "a hormone imbalance that has been 'robbing' me of the proteins my body needs to be healthy." The remedy is "simple and straightforward," he said, adding that he's begun treatment and will remain CEO.

Some shareholders were cheered by the disclosure, and Apple shares rose 4.2%, to 94.58.

Late Spring Recovery Expected

But some corporate governance experts questioned whether Apple said as much—as early—as necessary. On Dec. 6, when Apple said Jobs would not make his customary speech at the annual Macworld Expo in San Francisco, the company didn't cite health as an issue. Instead, Apple said the company will not participate in future Macworld events and that Apple Vice-President Phil Schiller will deliver the Jan. 6 address. Earlier in the year, in a published interview, an Apple spokesperson attributed the executive's apparent weight loss to a "common bug," and the company later called Jobs' health a "private matter."

Joe Grundfest, co-director of the Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford University, says securities lawyers could "get a good debate going" over whether Apple was as forthcoming as necessary. "Some will say this is good enough, and some will argue that we finally have disclosure and that it's adequate but late," Grundfest said.

Another question raised by the disclosure is how much more Apple may be compelled to say on the issue. Will the company need to make regular updates on the executive's health? In his letter, Jobs writes that his doctors "expect it will take me until late this spring to regain" lost weight and body mass. What if it takes longer? Jobs didn't want to say even as much as he did. "I've said more than I wanted to say, and all that I am going to say, about this," he wrote at the conclusion of his letter.

Different Approaches by Grove, Buffett

Securities laws require that publicly traded companies disclose facts that are "material," but arguments rage over what constitutes material, Grundfest said. "Suppose Jobs were losing weight and it didn't interfere with doing his job, but he didn't know why he was losing weight," he says. "What's the board of directors to do? Say that the CEO is losing weight and it doesn't know why?"

Strictly speaking, Jobs isn't required to disclose much. The rules on disclosure of a key executive's illness, while arguably material information as far as investors are concerned, are weighed against privacy laws and standards. Various CEOs have acted differently over the years. When then-Intel (INTC) CEO Andy Grove was diagnosed with prostate cancer in 1995, the company didn't immediately disclose the fact, but Grove did so the following year by writing an article for Fortune magazine about his experience combating the disease. When Warren Buffett, CEO of Berkshire Hathaway (BRKA), underwent surgery to remove benign polyps from his colon in 1997, he chose to disclose the circumstances to his investors and release details of his succession plan.

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Luxury Management Remains in Style

Rupal Patel took a break from her career as a patent lawyer in Chicago to enroll in an MBA program with a luxury specialization this fall, trading in the Windy City for the sparkling shores of the French Riviera. A student at the International University of Monaco's business school in Monte Carlo, she is spending the year taking classes with titles such as "Luxury Consumer Behavior" and "Managing Luxury Brands," and is planning on a career in anti-counterfeiting.

Despite the hit the economy is taking on the luxury industry, Patel is optimistic her degree will give her an edge in the job market when she graduates, she says.

"I think being focused and having a specialization, especially in luxury, makes a person more marketable in this economic climate," Patel says. "The ultra-wealthy will always buy luxury goods, regardless of the fluctuations in the economy, so that kind of gives us some hope."

Patel is one of a growing number of students who, despite the uncertain times, are setting their sights on a career in the luxury sector. In the past decade or so, more and more schools, many based in Europe, have started to offer MBA degrees in luxury-brand management. The programs, which give students the chance to specialize in sectors such as fragrance and cosmetics and wine and spirits, have become increasingly popular as top luxury brands have seen double-digit increases in profits in recent years.

But with sales of big-ticket items such as Champagne, designer handbags, and watches expected to slide this year, the outlook is not quite as rosy. Analysts at Bain & Co. said in a recent report that global luxury sales could slide by as much as 7% in 2009, while analysts at UBS are predicting a 5% revenue decline. Despite these gloomy forecasts, applications to luxury MBA programs are on the upswing, with students betting the luxury industry will bounce back, according to a number of schools that specialize in the area.

"Spending Fatigue"

Indeed, the cyclical nature of the luxury markets makes it an ideal time for students to enroll in a luxury MBA program, says Milton Pedraza, chief executive of New York research firm the Luxury Institute. Luxury-goods companies tend to outperform when the economy is strong but do significantly worse than mainstream ones when the economy is down and unemployment is low.

"There is a lot of luxury fatigue on the part of consumers at all levels, and I think this spending fatigue will continue through the next few quarters," he says. "But because luxury is cyclical, it's a good time to get into a luxury MBA program. You'll be spending your time learning in what is a severe downturn, and you'll really understand the rough side of the industry.

At Essec Business School in France, which has run an MBA program in International Luxury Brand Management since 1995, applications have doubled, to about 90, since last year, says Simon Nyeck, the program's academic director. The 11-month program, which costs €28,000, currently has about 40 students, representing 15 to 20 nationalities.

"I was a little surprised, to tell you the truth," Nyeck says of the strong application numbers. "I think most applicants are betting on the fact that by the time they graduate, things are going to be O.K."

Rising Enrollment

Applications have also doubled this fall at the International University of Monaco's Monaco Business School, which started a master's in luxury goods and services and an MBA with a specialization in luxury management several years ago. There are 38 students in the master's program and about 12 MBA students concentrating in luxury. Sandrine Ricard, the associate dean, says the school started the programs in part because a growing number of companies were demanding managers with more specialized skills and understanding of the luxury market.

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Behind the Russia-Ukraine Gas Conflict

[Ed. note: This is an updated version of a story originally published Jan. 3.]

It has become a New Year's tradition: With the clock inching closer to midnight, Russia and Ukraine trade threats and accusations as talks over the next year's gas contract come down to the wire. The two neighbors squabble over the price Ukraine will pay for Russian gas—and the tariffs Russia will pay Ukraine for the use of pipelines that cross its territory, sending Russian gas to Europe.

Only once before did the situation get so dire that Gazprom GAZP.RTS, Russia's state-run gas monopoly, followed through on threats to turn off the taps. That was in January 2006, when Russia sought to hike prices sharply in the wake of the Orange Revolution that ushered a Western-leaning government into power in Kiev. But once again, Gazprom cut gas transmission to its Ukraine market on New Year's Day, arguing that Naftogaz, Ukraine's state-run gas company, had failed to pay its gas bill in full and that talks on a price for 2009 had stalled completely.

What's behind the dispute? Gazprom maintains that the conflict is purely commercial. In fact, both economic and political considerations are at play in both countries. That makes it likely the fight will drag on for several days or longer—in contrast to 2006, when the neighbors found a resolution within three days. Coming less than five months after Russia's heavy-handed war with Georgia, the dispute will surely raise questions about Russia's intentions toward its ex-Soviet neighbors, as well as its ability to reliably supply gas to Europe. The European Union imports about a quarter of its gas from Russia, and 80% of that amount travels through pipelines that cross Ukraine. The conflict with Ukraine also comes at a time when Russia has been trying to increase its sway among global oil and gas players, regularly attending OPEC meetings and floating the idea of setting up an OPEC-style group for the global gas industry.

Ukraine's paralyzed politics

The stakes are high. "There is potentially a lot more at stake here than just money," says Chris Weafer, chief strategist at UralSib, a Moscow investment bank. "Russia needs to win the PR war on this issue as much as it needs the higher price." Russia, he says, needs the EU to help fund new projects in the Arctic and East Siberia, which are costly because of the difficult environmental conditions but necessary to boost Russia's lagging production. "Russia will not be able to do that alone and will need the EU both as a customer and an investor," Weafer adds.

Both Russia and Ukraine have been hit hard by the global financial crisis. Ukraine is one of the few countries that appealed to the International Monetary Fund for help, taking a $16 billion loan in November. Its currency has lost half its value since September, its economy is in deep recession, and thousands face layoffs as its mining industry grinds to a halt. The government, plagued by infighting between President Viktor Yushchenko and Prime Minister Yulia Tymoshenko, is paralyzed.

This state of affairs hasn't been lost on Russia, whose own economic miracle has been jeopardized as the financial crisis spreads to the real economy. The country's financial markets have lost three-fourths of their value since August. Industrial production slowed by 8.7% in November—the most since the 1998 financial crisis. And the ruble has lost over 15% of its value in a managed devaluation that has squandered over $160 billion in foreign reserves since mid-November. Russian officials expect economic growth, which averaged 7% over the past five years, to dip to 2% this year.

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