In something of a cautionary tale for outsourcing services providers, Satyam Computer Services, the fourth largest Indian outsourcing company that currently serves more than a third of the Fortune 500 companies, confessed this week that it had significantly inflated its earnings and assets for years. On Jan. 7, a report in The New York Times said the company’s chairman, Ramalinga Raju, had “resigned after revealing he had systematically falsified accounts as the company expanded from a handful of employees into a back-office giant with a work force of 53,000 and operations in 66 countries. The news set off a ruckus in Indian stock markets and cast a shadow of doubt on the Indian outsourcing industry.

Raju admitted that 50.4 billion rupees, or $1.04 billion, of the 53.6 billion rupees in cash and bank loans the company listed in assets for its second quarter, which ended in September, were nonexistent. In addition, revenues for the quarter were 20 percent lower than the 27 billion rupees reported, and the company’s operating margin was a fraction of what it declared, he said in a letter to directors that was distributed by the Bombay Stock Exchange.

Satyam clients have included General Electric, General Motors, Nestlé and the United States government, with the company handling finances and accounting for many of these organizations.

According to the story in The NY Times, analysts at Religare Hichens Harrison said, “This development is going to have a major impact on Satyam’s business with its clients.” Those analysts expect to see a lot of Satyam’s clients migrating to such competing firms as Infosys, Tata Consultancy Services, and Wipro, the top three companies in Indian outsourcing.

Raju described a small discrepancy that grew beyond his control, beginning with a marginal gap between actual operating profit and the one reflected in the books of accounts, which continued to grow over the years. He tried to bridge the gap but failed. He claimed that neither he nor co-founder and managing director B. Rama Raju had “taken one rupee/dollar from the company.”

But while this massive fraud was gathering steam, were the company’s compliance and governance officers sound asleep? Satyam has been listed on the New York Stock Exchange since 2001, and on Euronext since January of 2008. The company has been audited by PricewaterhouseCoopers since its listing on the New York Stock exchange.

Satyam has been under scrutiny in the last few months of 2008, after an October report that the company had been banned from World Bank contracts for installing spy software on some World Bank computers. On Dec. 30, analysts with Forrester Research warned that corporations that rely on Satyam might ultimately need to stop doing business with the company. Which means not only that other providers stand to gain some very important clients, but also that the onus will be on them to keep their noses demonstrably clean.

According to the story in the Times, the scandal raises questions over accounting standards in India as a whole, as observers ask whether similar problems might lie buried elsewhere. The risk premium for Indian companies will rise in investors’ eyes, said Nilesh Jasani, India strategist at Credit Suisse.

News of the scandal — quickly compared to the collapse of Enron — sent jitters through the Indian stock market, and the benchmark Sensex index fell more than 5 percent. Shares in Satyam fell more than 70 percent.