Opinion: The Satyam fraud has important ramifications for outsourcers

The financial fraud perpetrated by Satyam Computer Services executives could trigger near-term disruptions across the outsourcing and IT industries. Ramalinga Raju, the company's founder and chairman, resigned last week. He has admitted to inflating Satyam's cash balances and the credit amounts it was owed while understating its liabilities. This scandal has many ramifications for Satyam's customers as well as those of other outsourcing companies.

1. The challenges of transitioning Satyam's services to new vendors

As of this writing, the viability of business-continuity efforts under way at Satyam (including a government takeover of the company's board and rumors of a bailout) remains highly uncertain. Following last week's announcement of the fraud, some Satyam customers have started shifting engagements to other outsourcing vendors. However, the inherent challenges of transferring processes between vendors — a complex undertaking under ordinary circumstances — will be compounded by the following potential conditions:

  • Transition timelines that are inordinately compressed because of Satyam's questionable longevity
  • Contractual disputes regarding the exercise of termination rights
  • Inaccessibility to a legacy vendor preoccupied with its preservation

Accordingly, customers should prepare for exceptional disruptions to steady-state services during vendor transition, particularly if Satyam had been the single source for such services. These challenges may be compounded further if Indian vendors observe recent requests from the influential trade organization Nasscom to refrain from hiring Satyam employees.

2. The emergence of build-operate-transfer programs in response to challenges with captive entities

Satyam customers that currently operate captive entities in India may wish to have these entities hire the Satyam personnel engaged on their accounts. However, such efforts may run afoul of the customers' contractual nonsolicitation obligations to Satyam, and renegotiations of these provisions, if protracted, would not be feasible.

Furthermore, Satyam customers that do not currently operate captive entities in India are likely to find that there is insufficient time to create such operations. In response to these limitations, the industry may turn to "build-operate-transfer" agreements, under which new outsourcing vendors would hire the Satyam employees (in a manner that does not breach their customers' nonsolicitation obligations) to operate the outsourced services for a defined period, after which the outsourced operations may be transferred to captive entities of the respective customers.

3. Disruptions to customers of other outsourcing vendors

The disruption of outsourced services will not be limited to Satyam's customers: Current customers of other outsourcing vendors can also expect near-term impacts on their outsourced operations. Apart from the inevitable strains to these vendors' infrastructures as they accommodate business from Satyam, customers may see the most experienced and skilled personnel on their engagements reassigned to the transition of former Satyam accounts. In addition to vigilantly monitoring service-level agreements, existing customers may mitigate such disruptions by exercising their contractual protections regarding personnel experience requirements, skill sets and attrition rates.

4. Opportunities for multinational vendors

Apprehensions regarding the financial standards of "India Inc." might benefit multinational outsourcing vendors, which are positioned to proffer outsourced services from India free of negative perceptions regarding that country's financial controls. Following Satyam's announcement, Indian vendors have taken measures to dispel customer concerns, and, in the long term, the scandal may benefit India's outsourcing industry by accelerating the maturation of financial controls. However, in the immediate aftermath of the scandal, the likes of IBM, Accenture, Oracle and SAP appear well positioned to acquire work from Satyam as well as newer customer opportunities.

5. Re-evaluation of Sarbanes-Oxley compliance by outsourcing customers

The Satyam developments may raise concerns for public-company filers regarding their compliance with Sarbanes-Oxley Act provisions pertaining to outsourced operations. Under guidance from the SEC and the Public Company Accounting Oversight Board (PCAOB), customers have generally relied upon SAS 70 reports prepared by the vendors' auditors in order to attest to the financial controls over the outsourced operations. The apparent failure of Satyam's internal controls may raise uncertainty regarding continued reliance on such reports, and with 10-K season approaching, outsourcing customers may seek further guidance from the SEC. It remains to be seen if these developments will, in the longer term, trigger a reassessment of the SAS 70 standard and reliance on same by the PCAOB and/or SEC.

6. The potentially misleading 'admission' letter may raise unwarranted concerns regarding the financial viability of offshore outsourcing

Apprehensions have been voiced regarding whether the Satyam scandal is a "one-off" or a precursor to future failures of outsourcing vendors. In his letter of resignation last week, Raju claimed that he inflated Satyam's earnings in order to conceal margins that were dramatically below industry norms. However, as many commentators have observed, there is reason to believe that this "admission" itself is misleading and that Satyam's cash shortfall will be traced not to any deficiencies in the company's revenue model, but rather to self-dealing. Accordingly, for all of the gratuitous disruptions it has caused to the outsourcing industry, it does not appear that the Satyam scandal will discredit the industry's financial viability.

Shaalu Mehra is a partner at law firm Perkins Coie LLP and chairman of the firm's outsourcing and India practices. He can be reached at SMehra@perkinscoie.com.

Copyright © 2009 IDG Communications, Inc.

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