In today's newsletter we talk about the bombshell allegations against Infosys CEO and the potential fallout from this mess.

The Story

The Whistleblower strikes again and it’s not just one person this time. It’s a group of people and they are calling themselves "ethical employees". Cool name that. Anyway, the whistleblowers wrote a letter directly accusing Infosys CEO Salil Parekh and the company CFO Nilanjan Roy of misreporting financials and lying to investors. The whistleblowers also state that they can back up all their claims with recordings and e-mail transcripts.

Funnily enough, the letter was first sent to the Infosys Board of Directors and when that did not elicit a response they sent it to the US Security & Exchange Commission (SEC), the body that’s responsible for regulating stock markets in the US.

Why US? We will get to that bit in a while. But before that, a brief on the allegations themselves.

The accusations are straightforward.

According to the letter

The CEO has deliberately tried to hide costs and boost revenue in a bid to prop up the stock price. These are in contravention of good auditing practices and he’s forcing everybody on the team to go along with this chicanery. Meanwhile he’s also referring to certain board members as Madrasis and Divas.

On the side, he’s also forcing sales members to inflate profits and show margin on sales when there is none. These are willful misstatements and it’s wrong. If that wasn’t bad enough, the letter also goes on to suggest that the CEO was using company money for his personal travels.

But here’s the thing. Outside of extracting company resources to further his personal agenda why would a CEO do such a thing? Cheat and lie to investors. All in an attempt to shore up stock price? It’s not like he owns the company. Why go through all this?

Well, in most cases a CEO’s salary is directly tied to the share price i.e. through stock options. If the company outperforms and the stock price keeps soaring, paychecks start looking extra lucrative i.e. CEOs get better compensation. Also, if the company does not do as well, the board might choose to replace the acting Chief Executive and get in somebody else. Nobody wants to lose their job.

But these are speculations and we don’t know if Salil Parekh has in fact circumvented rules and tried to fudge numbers. So let’s leave it at that. But considering the allegations are true, what’s the fallout here?

Well for one, until the Audit Committee completes its investigations, it’s difficult to say what happens to the CEO and the CFO. But we can try and assess the damage to Infosys, the company and the stock price.

One analyst proclaimed that Infosys would tank 10–15% when trading resumes tomorrow. But how does one make such an assessment based on a whistleblower letter devoid of any specifics on financials? I am not quite sure. But you could make a well-educated guess looking westwards.

I know it was a trading holiday for us here in India (because of the Maharashtra Elections and all that). But not for the folks in the US. And it’s possible for you to buy and trade Infosys (shares) in the United States thanks to a neat little device called the American Depositary Receipt (ADR). These receipts give you access to a fixed number of Infosys shares that are dollar-denominated i.e. you buy them by paying USDs and not Rupees. It helps Infosys access foreign investors and in turn, investors get access to foreign shares without having to go through the trouble of converting USDs into Rupees. But then Infosys will have to comply with US regulations. So now you can see why the second letter was addressed to the SEC.

And that brings us to a very interesting proposition. As I am writing this brief, Infosys ADRs are down 13%. This harps back to the idea of the wisdom of crowds.

Right now it’s very hard to ascertain what’s the exact cost of fudging numbers, but when you ask a large group of investors (a wise crowd, some say) what they think, they’ll offer you a pretty fair assessment. A 13% erosion in value might seem like a lot but you have to remember investors don’t take kindly to lying and misreporting numbers. And when Infosys starts trading in the Indian stock exchange today, it might be worse than the 13%. Who knows?

Hopefully, it won’t. But then there’s always a chance

So stay safe. Stay curious…

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Plis :P