Prof. Jayanth R. Varma's Financial Markets Blog

Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

jrvarma@iima.ac.in

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Wed, 18 Feb 2009

# SEC confirms Dalmady analysis on Stanford

Within hours of my posting about Dalmady’s analysis of possible fraud at Stanford International Bank, I received a comment on my blog telling me that I was spreading lies and that I should recant:

Try to do some investigative work instead of building upon lies ... When you want something successful to fail you present the perception, associate it with something negative (Madoff) and watch the masses panic ... You have now created the reality ... I hope you put as much energy in recanting this story as you do posting them ...

I did not lose sleep over this comment because by the time I read that comment, the SEC had filed its complaint against Stanford confirming most of what Dalmady had surmised.

I found the SEC complaint short on hard facts. Did I really know anything more on reading this complaint than I did after reading Dalmady? I am not sure.

And, there were some things in the complaint that did not sound right to me like the assertion that it is “impossible” for a large portfolio to produce identical returns of exactly 15.71% in two successive years. If exact means that there was no rounding at all in arriving at 15.71%, then it is in fact almost impossible. But then it is quite improbable that a really large portfolio would produce a return which is exact to two decimal places (with no rounding error) in even one year. The return on a \$8 billion portfolio at around 15% would be over a billion dollars and would therefore have twelve significant digits when measured in dollars and cents. Suppose that the return in percent is also computed to twelve significant digits. The probability that only the first four significant digits (1, 5, 7, 1) are non zero and the other eight significant digits are zero would then be about 10^(-8) or about 1 in 100 million. Quite improbable!

But if what they mean is that the return rounded to two places was 15.71%, then that is not impossible at all. If the range of returns is say 5% (500 basis points), then the probability of the return being the same as the previous year’s return to two decimal places (one basis point) is 1/500 or 0.2%. Since the SEC examined at least 10 years of data (their example is of 1995 and 1996 returns), the probability that they would find at least one year in which this happened is 1/50 or 2%. Certainly, 2% is not my idea of impossible or even improbable.

Posted at 16:33 on Wed, 18 Feb 2009     View/Post Comments (2)     permanent link

# Replacing the Maytas board is not warranted

I was interviewed by CNBC Awaaz today on the government decision to move the Company Law Board to replace the Maytas Board in connection with the Satyam scandal. I disagreed with the move though I was among the first to argue that the government should replace the Satyam board early last month (see here and here). The Maytas situation is different both because the urgency of the Satyam case is lacking and because there are serious conflict of interest issues.

Satyam presented a complete governance vacuum: the Chairman had confessed to a fraud, the promoters probably no longer held much of their shares, and the independent directors had lost all credibility. This is not the case in Maytas. Second, Satyam had value only as a going concern as the tangible assets were a small fraction of its enterprise value. Maytas on the contrary is in real estate which is almost as valuable in liquidation as it is on a going concern basis.

More importantly, the prime allegation in respect of Maytas is that money looted from Satyam ended up in Maytas. This means that the stage is set for litigation between Maytas and Satyam. The government by taking over both these companies is interposing itself into a commercial dispute between two companies. Since Satyam is a much more high profile case, the temptation would be there for the government to favour the Satyam shareholders over the Maytas shareholders. This alone is a strong argument for not allowing the government to appoint a new Maytas board.

What does make sense is for the Company Law Board (CLB) to forbid any mortgage or sale of property by Maytas. The CLB could also order an emergency meeting of the shareholders to elect a new board. This was not a feasible option in the Satyam case because of the urgency emanating from the intangible nature of its assets.

The power to replace the board is an extraordinary power to be exercised only in extraordinary situations. Power has a tendency to become addictive; having used it once, the temptation is to use it again and again even when the circumstances do not warrant it. This temptation must be resisted.

Posted at 07:25 on Wed, 18 Feb 2009     View/Post Comments (2)     permanent link