“fraud and deceit abound in these days more than in former times
TRANSCRIPT
66
CHAPTER 3
UPHEAVALS IN CORPORATE WORLD
“Fraud and deceit abound in these days more than in former times!” - Sir
Edward Cole (1602)
67
3.1 Introduction
Corporate Governance is a buzz word in the business and corporate circles
nowadays. A company is now considered a social institution, interacting with
the society in many ways and affecting its citizens. This institution should be
governed in a rational manner, is the concern of all conscious citizens-
shareholders, employees, creditors, customers and government.
Corporate governance indicates that it is primarily concerned with the “system
and process by which companies are directed and controlled” with the single
overriding objective of all publicly listed companies being “its preservation
and the greatest practical enhancement over time of their shareholders
investment”. For corporations the corporate governance system will involve
the entire network of formal and informal relations and interaction between
the board, management, shareholders, auditors, and other interested parties.
These relations and interactions will determine how controls are exercised
within a company and how risks and returns from corporate activities are
determined.1
The real genesis of the corporate governance lies in the business scams and
failures in India and abroad. Time to time several committees have been
formed and each of the reports recommended some code of practice targeted
towards avoiding similar incidences in future.2 A primary goal of existing
corporations laws is to promote honest and efficient markets and informed
investment decisions through full and fair disclosure. Transparency in
financial reporting plays a fundamental role in making our markets the most
efficient, liquid and resilient in the world. Transparency enables investors,
creditors and the market to evaluate an entity, helps investors make better
decisions and increases confidence in the fairness of the market.3
1 Barry Dunphy , “Corporate governance – liability issues arising out of directors responsibilities”
http://business.tafe.vu.edu.au/dsweb/Get/Document-
156601/Issues+arsing+out+of+directors+responsibility.pdf, Date:- 30th of May 2010, Time:-4.51 P.M. 2 Dr. Onkar Nath Dutta, “Corporate Governance-Codes and Ethics”, Growth, Volume 33 , No. 4, Jan-
Mar, 2006, p . 10. 3Jerry L. Turner , “Aligning Auditor Materiality Choice and the Needs of a Reasonable Person” p.
17 in pdf format file.
http://aaahq.org/audit/midyear/03midyear/papers/Session%2011-Jerry%20Turner.pdf Date:- 20th of
June 2010 , Time 1.23 P.M.
68
3.2 Some Recent Corporate Scams
The collapses of HIH Insurance Limited, Harris Scarfe Limited , Enron Inc.,
Xerox Corporation and WorldCom Inc. is the extent to which directors, senior
management or even auditors may have failed to pay due regard to proper
corporate governance practices. Conflicts of interest seem to have prevailed
over the proper and independent consideration of relevant issues to the
detriment of the company, the shareholders and other interested stakeholders.
What happened in these companies is as follows:-
3.2.1 Tyco Scam
Kozlowski Tyco’s Former CEO and Tyco’s former CFO Mark Swartz
were convicted of looting more than $600 million. Kozlowski and
Swartz were accused of enriching themselves by nearly $600 million by taking
unauthorized pay and bonuses, abusing loan programs and selling their
company stock at inflated prices after lying about Tyco’s finances. They hid
their alleged thefts by failing to disclose the bonuses and loan forgiveness in
company prospectuses and federal filings, and bought the silence of underlings
with outsized compensation. Both used Tyco’s money to buy extravagant
lifestyles that featured art, jewelry and real estate, prosecutors said.
Kozlowski threw $2 million for wife Karen’s 40th birthday in organising toga
party on the Mediterranean island of Sardinia, they said. Tyco paid about half
of the party’s cost4. They were sentenced to up to 25 years in prison for
stealing hundreds of millions of dollars from the company and were eligible to
parole after serving eight years and four months.5
3.2.2 Tagrus Group International Scam
Targus' then CFO, William Anthony Lloyd, embezzled over $40 million from
Targus by utilizing the company's credit facilities and cash for his personal
benefit. In connection with attempting to hide his embezzlement unknown to
the company, Lloyd created false and fraudulent entries on the company's
books and records, all of which went undetected by KPMG during numerous
4 http://www.msnbc.msn.com/id/8258729/#storyContinued Date:- 30th of May 2010, Time:-5:17 P.M. 5 http://www.msnbc.msn.com/id/9399803/#storyContinued Date:- 30th of May 2010, Time:-5:33 P.M.
69
audits for the company.6 Lloyd pleaded guilty in 2001 to 15 counts of wire
fraud and was sentenced to 37 months in federal prison. Targus claimed it lost
an additional $10 million in costs associated with the embezzlement.7
3.2.3 Smith Technologies Scam
Gilbert N. Holloway pleaded guilty to conspiracy to commit mail and wire
fraud. Among many things, he admitted that, as president of Basic, he began
raising investor funds even though he knew the company had assigned away
its rights to the so-called Smith technologies. He also knew that investor
funds had not been accounted for, and some had been diverted to
Hronopoulos, Smith, and Scheibe.8 Kirsten Hronopoulos, widow of
Hronopoulos, Patricia Smith Wife of Stephen Smith, Richard Boyer Former
CFO and Accountant, pleaded guilty last year to fraud. Lawrence Taggart , a
San Diego lawyer who solicited funds as president of Basic Research, later
became in –house legal counsel former California S&L Commissioner in the
1980s. He also pleaded guilty to tax conspiracy, mail and wire fraud.9
3.2.4 Computer Associate International Scam
Former chief of the California-based company, Sri Lanka-born Sanjay Kumar
was sentenced to 12 years in prison and fined $ 8 million in 2006 after being
charged with securities fraud and obstruction of justice following a 2-year
investigation of an improper accounting scheme. According to investigators,
the scheme resulted in a shareholder loss of more than $ 400 million. The
charge of obstruction of justice stemmed from Kumar tampering with a laptop
in an attempt to conceal evidence, lying to federal investigators and directing
company employees to also provide false information.10
6 http://www.accounting-malpractice.com/accounting-malpractice/news/kpmg-one.html , Date:- 30th
of May 2010, Time:-6:43 P.M. 7 http://ethisphere.com/page/4/?s=guilty , Date:- 30th of May 2010, Time:- 6.46 P.M. 8 http://www.sandiegoreader.com/news/2005/may/05/liars-paradise/ , Date:- 30th of May 2010,Time:-
7.30 P.M. 9 http://www.law.com/jsp/cc/PubArticleCC.jsp?id=1193821435642 , Date:- 30th of May 2010, Time:-
7.32 P.M. 10 Financial Express (Internet Edition) Friday, Jan 09, 2009 at 2157 hrs IST
http://www.financialexpress.com/news/they-took-people-for-a-ride/408380 , Date:- 30th of May
2010,Time :- 7.52 P.M.
70
3.2.5 Enron Scam
Enron was based in Houston, Texas and was the seventh biggest company in
United States in terms of revenue. Enron described itself as a provider of
products and services related to natural gas, electricity and communications to
wholesale and retail customers.11
Kenneth Lay, the former chairman of the board and CEO and Jeffrey Skilling,
former CEO and COO, went on trial for their part in the Enron scandal in
January 2006, that led to the downfall of the company. It admitted on
November 8, 2001 for overstating its earnings by $600 million in previous 4
years. Lay and Skilling were indicted for securities and wire fraud in July
2004, leading to a highly-publicised trial in which Lay was convicted on all
six counts and Skilling on 19 of 28 counts on May 25, 2006. On July 5, 2006,
Lay died at age 64 while vacationing in Colorado, after suffering a heart attack
on July 4. Skilling was convicted and sentenced to 24 years, 4 months in a
federal prison on October 23, 2006. As well as his sentence of 24 years, 4
months, he was ordered to restore the Enron pension fund with $26 million
out-of-pocket . In addition, the scandal caused the dissolution of Arthur
Andersen, which at the time was one of the five largest accounting firms in the
world .12
The heart of the Enron problem was the issue of transparency and adequate
disclosure. Enron filed for protection from creditors and is the biggest
bankruptcy in United States history. Enron’s stock was worth more than $80
per share in January 2001 and was worth less than a dollar per share in
December 2001. 13
3.2.6 Xerox Corporation Scam
From at least 1997 through to 2000, Xerox Corporation (“Xerox”) appears to
have pursued a scheme, directed and approved by its senior management, to
disguise its true operating performance by using undisclosed accounting
11 Barry Dunphy , “Corporate governance – liability issues arising out of directors responsibilities”
http://business.tafe.vu.edu.au/dsweb/Get/Document-
156601/Issues+arsing+out+of+directors+responsibility.pdf, Date:- 30th of May 2010. Time:-4.51 P.M 12 Supra n. 10. 13 Supra n. 11.
71
manoeuvres. The effect of these actions was to accelerate the recognition of
equipment revenue by over $3 billion and increase earnings by approximately
$1.5 billion. Xerox portrayed itself as a business that was meeting its
competitive challenges and increasing its earnings every quarter. Many of the
accounting actions taken by Xerox now appear to have violated the established
standards of General Accepted Accounting principles (GAAP). The Securities
and Exchange Commission of the United States filed a complaint against
Xerox Corporation for defrauding investors. The Securities Exchange
Commission has alleged that certain accounting standards of Xerox
Corporation defrauded the investors and led to non disclosure to true and fair
view of the state of affairs and of the operating results of the corporation.14
3.2.7 WorldCom Inc. Scam
WorldCom Inc. (“WorldCom”) is a major global communications provider
operating in more than 65 countries. WorldCom provides data transmission
and internet services for businesses and through its MCI unit provides
telecommunication services for businesses and consumers.
As the United States economy cooled in 2001 WorldCom’s earnings and profit
similarly declined, making it difficult for the company to keep its earnings in
line with the expectations of market analysts. Starting in 2001, it appears that
WorldCom engaged in an accounting scheme to manipulate its earnings and
thereby support WorldCom’s stock price.
WorldCom engaged in improper accounting scheme intended to manipulate its
earnings to keep them in line with wall street’s expectations and to support
World Com’s Stock Price. Thus it seems that WorldCom materially
understated its expenses and materially overstated it earnings. Action was
brought against WorlCom by U.S. Securities and Exchange Commission.
On one level WorldCom can be viewed as another example of a high profile
public company desperately trying to meet institutional expectations. Failures
to meet such projections are unmercifully punished by the market. This has
led some commentators to suggest that some of the blame should be accepted
by market analysts who have pushed for unrealistically high profit forecasts.
14 Ibid.
72
Such expectations put pressure on companies to strive to achieve these
financial goals or face the market’s brutal reckoning.15
3.2.8 HIH Insurance Limited Scam
HIH Insurance Limited (HIH) together with its group companies was the
second largest general insurance company in Australia. It consisted of 217
subsidiaries with operations in a number of countries. The last published
accounts for the HIH Group showed that as at 30 June 2000 it had net assets of
approximately $940 million. The HIH Group collapsed on 15 March 2001
when provisional liquidators were appointed to the main companies of the
group. The liquidators have now estimated the HIH Group deficiency at
between $3.6 billion and $5.3 billion. A Royal Commission was established
to provide a report on the collapse and is currently examining what caused
HIH to collapse.
Former HIH director, Rodney Adler, HIH Chief Executive Officer, Ray
Williams, and former HIH Chief Financial Officer Dominic Fodera have been
sued by ASIC in the Supreme Court of New South Wales. ASIC was
successful with Mr Justice Santow finding that all their officers had breached
their duties under the Corporations Act. Rodney Adler was found to have
breached his director’s duties under section 180 – duty of care and diligence,
section 181 – duty to exercise good faith, section 182 – duty not to improperly
use position and section 183 – duty not to improperly use information. Ray
Williams was found to have breached sections 180 and 182 and Dominic
Fodera was found to have breached section 180. The breaches related to a
payment of $10m by an HIH subsidiary, HIH Casualty and General Insurance
Ltd to a company of which Rodney Adler was a director.
In addition, the Court found that the payment of the $10m to a related party
breached the related party provisions and the provisions of the Corporations
Act 2001 dealing with providing financial assistance in the purchase of its
parent’s shares.16
15 Ibid. 16 Barry Dunphy , “Corporate governance – liability issues arising out of directors responsibilities”
http://business.tafe.vu.edu.au/dsweb/Get/Document-
156601/Issues+arsing+out+of+directors+responsibility.pdf, Date:- 30th of May 2010. Time:-4.51 P.M.
73
3.2.9 Harris Scarfe Limited Scam
Harris Scarfe Limited was a discount department store chain with a 150 year
history in the retail sector. Its collapse in April 2001 occurred after revelations
of serious financial irregularities over a six year period. The Harris Scarfe
accounts for December 31 2000 showed net assets of $108m. The correct
figure was close to $60m. Inventories were shown as $97m. The true figure
was between $75m and $78m. Trade creditors were shown as $64m but they
were closer to $90m. Operating cash flows for the half year to December 31
2000 were reported as $5.5m but were thought to be negative.
By its own admission, the Harris Scarfe board lost track of the group’s stock
position. Discrepancies were discovered in the company’s stock position in
March 2001 and the auditors were asked to investigate the deterioration of the
company’s net asset position. The auditors advised the board that the
irregularities had been occurring for up to six years. Neither the board nor the
auditors picked up on the irregularities during the prior six years. The board
announced that it was totally unaware of the irregularities and had acted in
good faith on financial information provided to it by senior management. The
end result was that the board appointed voluntary administrators to the
company in April 2001.17
3.2.10 Harshad Mehta Scam
Harshad Mehta known to be “Big Bull of the trading floor” was an Indian
stockbroker and is alleged to have engineered the rise in the BSE stock
exchange in the year 1992.He and his associates draw off funds from inter-
bank transactions and bought shares heavily at a premium across many
segments, triggering a rise in the Sensex. When the scheme was exposed, the
banks started demanding the money back, causing the collapse. The broker
was dipping illegally into the banking system to finance his buying. The
amount that was involved in this scam was approx. to Rs. 4000 crs.
Harshad Mehta worked on the mechanism of Ready Forward (RF) Deals . It's
a secured short-term (typically 15-day) loan from one bank to another. The
17 Ibid.
74
bank lends against government securities. The borrowing bank actually sells
the securities to the lending bank and buys them back at the end of the period
of the loan, typically at a slightly higher price. The deal was done between the
banks through brokers for commissions. In this settlement process, deliveries
of securities and payments were made through the broker. That is, the seller
handed over the securities to the broker, who passed them to the buyer, while
the buyer gave the cheque to the broker, who then made the payment to the
seller. Thus, both the parties may not know each other. It was this idea that
made the mind of Harshad to involve into the modus operandi. Harshad in his
scam took the help of Bank Receipts.18
3.2.11 M.S. Shoes (Insider Trading) Scam
Pawan Sachdeva, the promoter of M.S.Shoes, allegedly used company funds
to buy shares of his own company and rig prices, prior to a public issue. The
dominant shareholder of the firm, Pawan Sachdeva, took large leveraged
positions through brokers at both the Delhi and Bombay Stock Exchanges to
manipulate share prices prior to a rights issue. He is alleged to have colluded
with officials in the Securities Exchange Board of India and SBI Caps, which
lead-managed the issue, to dupe the public into investing in his Rs 699-crore
public-cum-rights issue. When the share prices crashed, the broker defaulted
and BSE shut down for 3 , days as consequence. 19
3.2.12 CRB Scam
C.R. Bhansali, a chartered accountant, created a group of companies, called
the CRB Group, which was a conglomerate of finance and non-finance
companies. The Bhansali scam resulted in a loss of over Rs 1,200 crore . He first
launched the finance company CRB Capital Markets, followed by CRB Mutual Fund
and CRB Share Custodial Services. He ruled like a financial wizard 1992 to 1996
collecting money from the public through fixed deposits, bonds and debentures. The
money was transferred to companies that never existed.
18 http://www.capitalvia.com/admin/report-id/upload/295.pdf , Date:- 18th of December 2011, Time :-
3:55 PM . 19 http://archives.digitaltoday.in/businesstoday/20020120/stockmarkets4.html, Date:- 18th of December
2011, Time :-3:36 PM.
75
CRB Capital Markets raised a whopping Rs 176 crore in three years. In 1994
CRB Mutual Funds raised Rs 230 crore and Rs 180 crore came via fixed
deposits. Bhansali also succeeded to raise about Rs 900 crore from the
markets. However, his good days did not last long, after 1995 he received
several jolts. Bhansali tried borrowing more money from the market. This led
to a financial crisis. It became difficult for Bhansali to sustain himself. The
Reserve Bank of India refused banking status to CRB and he was in the dock.
SBI was one of the banks to be hit by his huge defaults.20
Market manipulation
was an important focus of the activities of the group. The non-finance
companies routes funds to finance companies to manipulate prices . The
finance companies would obtain funds from external sources using
manipulated performance numbers. The CRB episode was particularly
important in the way it exposed failure of supervision on the part of RBI and
SEBI.
3.2.13 Ketan Parikh Scam
Ketan Parekh is a former stock broker from Mumbai, India, who was
convicted in 2008, for involvement in the Indian stock market manipulation
scam in late 1999-2001. He was involved in rigging up the stock prices. A
chartered accountant by training, Parekh came from a family of brokers, which
helped him create a trading ring of his own. Between 1999 and 2000, when
technology bubble was seen in the world, the Indian Markets at that time were
also flourishing, he started rigging up stock prices. He rigged up the prices by
borrowing from big banks and Investment firms. By the time he became
famous to rig the prices everyone be it investment firms, promoters of listed
companies, overseas corporate bodies etc , all were ready to hand the money
to him. Scrips like Visualsoft rose from Rs 625 to Rs 8,448 per share and
Sonata Software from Rs 90 to Rs 2,150. The inflated stocks had to be
dumped to someone in the end, and Parekh used the financial institutions like
the UTI to control the situations. This Scam know as Keitan Parikh Scam, was
triggered off by a fall in the prices of IT stocks globally, Ketan Parekh was
20 http://www.drishtikone.com/blog/indias-top-10-scams , Date:- 12th of December 2011,Time:-11:20
P.M.
76
seen to be leader of this episode, with leveraged positions on set of stocks
called the K-10 stocks. A bear cartel started disrupting Parekh's party by
hammering prices of the K-10 stocks, it was this that led to the collapse of the
market and the scam discovered.21
3.2.14 UTI Scam
The Unit Trust of India is the largest mutual fund in the country created in
1964. The UTI (of which the US-64 scheme is the largest) was set-up
specifically to channel small savings of citizens into investments giving
relatively large returns/interest. The investments of the individuals were
basically done in debt, but after the liberalization of the economy more
allocation was made to equity investments. The US-64 did not came under
SEBI regulations, its investment details were kept secret and the chairman has
arbitrary powers to personally decide its investment. This led Mr. P.S.
Subramanyam the chairman to involve himself in the fraud. Small investor's
funds were used to promote big business houses, shower favours to politicians,
and invest huge amounts in junk bonds all for a fat commission. He was a key
player in the Ketan Parekh scam. Huge amount of UTI funds were channelled
into the infamous K-10 list of Keten Parekh stock, such as Himachal
Futuristic, Zee Telefilims, Global Tele, DSQ, etc. The UTI continued to buy
these shares even when their market value began to crash in mid-2000, in
order to prop up the share values of these stocks. This whole story led to the
ultimate decline of the fund.22
3.2.15 Satyam Fraud
Chairman B. Ramalinga Raju’s admission that Satyam Computer Services
Ltd’s Balance Sheet was completely fabricated got the stock crashing down by
66.5 per cent to Rs 60 from Wednesday’s high of Rs 188.70. The share hit a
low of Rs 58, as details of the extent of fraud perpetrated by the promoters
shook the stock market and cast a grim cloud over the corporate practices of
companies. The BSE Sensex crashed 470.23 points or 4.55 per cent to
21 http://www.capitalvia.com/admin/report-id/upload/295.pdf , Date: - 18th of December 2011, Time:-
3:55 PM. 22 Ibid.
77
9,865.70, after rising to a high of 10,469.72 earlier Wednesday. Investors
aggressively cut their positions. The BSE IT Index plunged 7.70 per cent and
BSE Realty tumbled 11.20 per cent. IT and other sectoral stocks were beaten
down badly as the Satyam fraud raised question over corporate governance of
other companies also, especially IT.
Raju’s letter to the company board revealed a fraud of unprecedented
proportions. He states that Satyam’s balance sheet as on Sep 30, 2008, carries
an inflated (non-existent) cash and bank balances of Rs 5,040 crore as against
Rs 5,361 reflected in the books. Further, it carries an accrued interest of Rs
376 crore which is non-existent. The books carry an understated liability of Rs
1,230 crore on account of funds arranged by Raju, and an over stated debtors
position of Rs 490 crore as against Rs 2,651 crore in the books. This has
resulted in artificial cash and bank balances going up by Rs 588 crore in the
second quarter alone.23
3.3 Committees on Corporate Governance: Global Prospective
A number of Committees were set up to look into the various aspects
corporate governance. These include-
Cadbury Committee
King Committee
OECD Principles on Corporate Governance
Blue Ribbon Committee
CACG Guidelines-Principles for Corporate Governance in the
Commonwealth(1999)
Hampel Committee on Audit and Accountability
3.3.1 Cadbury Committee
The 'Cadbury Committee' was set up in May 1991 with a view to overcome
the huge problems of scams and failures occurring in the corporate sector
23
The Economic Times (Internet Edition) 7 Jan 2009 ,0034 hrs IST Time,
http://economictimes.indiatimes.com/Satyam_fraud_clouds_corporate_governance_of_India_Inc/articl
eshow/3946405.cms , Date:- 6th of June, 2010. Time:-5.14.
78
worldwide in the late 1980s and the early 1990s. It was formed by the
Financial Reporting Council, the London Stock of Exchange and the
accountancy profession, with the main aim of addressing the financial aspects
of Corporate Governance. Other objectives include: (i) uplift the low level of
confidence both in financial reporting and in the ability of auditors to provide
the safeguards which the users of company's reports sought and expected; (ii)
review the structure, rights and roles of board of directors, shareholders and
auditors by making them more effective and accountable; (iii) address various
aspects of accountancy profession and make appropriate recommendations,
wherever necessary; (iv) raise the standard of corporate governance; etc.
Keeping this in view, the Committee published its final report on 1st
December 1992.24
The report was mainly divided into three parts:-
Reviewing the structure and responsibilities of Boards of Directors and
recommending a Code of Best Practice The boards of all listed companies
should comply with the Code of Best Practice. All listed companies should
make a statement about their compliance with the Code in their report and
accounts as well as give reasons for any areas of non-compliance. The Code of
Best Practice is segregated into four sections and their respective
recommendations are:-
1. Board of Directors : The board should meet regularly, retain full and
effective control over the company and monitor the executive
management. There should be a clearly accepted division of
responsibilities at the head of a company, which will ensure a balance of
power and authority, such that no one individual has unfettered powers of
decision. Where the chairman is also the chief executive, it is essential that
there should be a strong and independent element on the board, with a
recognised senior member. Besides, all directors should have access to the
advice and services of the company secretary, who is responsible to the
Board for ensuring that board procedures are followed and that applicable
rules and regulations are complied with.25
24 http://business.gov.in/corporate_governance/cadbury_report.php , Date:- 12th of June 2010. Time
1:54 P.M. 25 Ibid.
79
2. Non-Executive Directors : The non-executive directors should bring an
independent judgment to bear on issues of strategy, performance,
resources, including key appointments, and standards of conduct. The
majority of non-executive directors should be independent of management
and free from any business or other relationship which could materially
interfere with the exercise of their independent judgment, apart from their
fees and shareholding.26
3. Executive Directors : There should be full and clear disclosure of
directors’ total emoluments and those of the chairman and highest-paid
directors, including pension contributions and stock options, in the
company's annual report, including separate figures for salary and
performance-related pay.27
4. Financial Reporting and Controls: It is the duty of the board to present a
balanced and understandable assessment of their company’s position, in
reporting of financial statements, for providing true and fair picture of
financial reporting. The directors should report that the business is a going
concern, with supporting assumptions or qualifications as necessary. The
board should ensure that an objective and professional relationship is
maintained with the auditors.28
Considering the Role of Auditors and Addressing a Number of
Recommendations to the Accountancy Profession
The Cadbury Committee recommended that a professional and objective
relationship between the board of directors and auditors should be
maintained, so as to provide to all a true and fair view of company's financial
statements. Auditors' role is to design audit in such a manner so that it
provide a reasonable assurance that the financial statements are free of
material misstatements. Further, there is a need to develop more effective
accounting standards, which provide important reference points against
which auditors exercise their professional judgment. Secondly, every listed
company should form an audit committee which gives the auditors direct
26
Ibid. 27 Ibid. 28 Ibid.
80
access to the non-executive members of the board. The Committee further
recommended for a regular rotation of audit partners to prevent unhealthy
relationship between auditors and the management. It also recommended for
disclosure of payments to the auditors for non-audit services to the company.
The Accountancy Profession, in conjunction with representatives of preparers
of accounts, should take the lead in:- (i) developing a set of criteria for
assessing effectiveness; (ii) developing guidance for companies on the form
in which directors should report; and (iii) developing guidance for auditors on
relevant audit procedures and the form in which auditors should report.
However, it should continue to improve its standards and procedures.29
Dealing with the Rights and Responsibilities of Shareholders
The shareholders, as owners of the company, elect the directors to run the
business on their behalf and hold them accountable for its progress. They
appoint the auditors to provide an external check on the directors’ financial
statements. The Committee's report places particular emphasis on the need for
fair and accurate reporting of a company's progress to its shareholders, which
is the responsibility of the board. It is encouraged that the institutional
investors/shareholders to make greater use of their voting rights and take
positive interest in the board functioning. Both shareholders and boards of
directors should consider how the effectiveness of general meetings could be
increased as well as how to strengthen the accountability of boards of directors
to shareholders.30
3.3.2 King Committee
In the year 1994, a committee was set up in South Africa consisting of 15
individuals who in their own right were all experts in the area of corporate
governance, with Merriyn King as the chairman. This committee was set up at
the instance of the Institute of Directors in South Africa, with support from the
South African Chamber of Business and the Chartered Institute of Secretaries
and Administrators, The South African Institute of Chartered Accounts, The
29 http://business.gov.in/corporate_governance/cadbury_report.php, Date:- 12th of June 2010.
Time 1:54 P.M. 30 Ibid.
81
Johannesburg Stock Exchange and the South African Institute of Business
Ethics. The King Committee’s term of reference were much wider than those
of the Cadbury Committee, as is evident from the following terms of
reference:
a) To consider and make recommendations on a code of practice on the
financial aspects of corporate governance in South Africa.
b) To recommend simpler reporting without sacrificing the quality of
information.
c) To lay down guidelines for ethical practices on business enterprises in
South Africa.
d) The committee was also asked to keep in view the special circumstances in
South Africa concerning entry of disadvantaged communities, into
business.
The King’s Committee recommended that-
i. The Boards should be balanced between executive and non-executive
directors
ii. Roles of chairperson and chief executive officer should be spilt and in
the absence of split, there should be at least two non-executive directors
iii. The director’s report should incorporate statements on their
responsibilities in respect of financial statements, accounting records,
accounting standards, internal audit, adherence to the code of corporate
practice and conduct and details of non-adherence
iv. Shareholders should properly use the meetings by asking questions on
the accounts for which forms should have an effective internal audit
function and establish an audit committee with written terms of reference
from the board
v. In respect of external audit, the Committee recommended observance of
highest level of business and professional ethics, legal backing from
accounting standards and it should be brought in line with international
standards etc.31
31D.K. Prahlada Rao , “Corporate Governance: A Multi-faceted Issue”, Charted Secretary, May 1997
p. A 105.
82
3.3.3 OECD Principles on Corporate Governance
The OECD (Organisation for Economic Co-operation and Development)
Principles of Corporate Governance were developed with a view to assist
OECD and non-OECD governments in their efforts to evaluate and improve the
legal, institutional and regulatory framework for corporate governance in their
countries, and to provide guidance and suggestions for stock exchanges,
investors, corporations, and other parties that have a role in the process of
developing good corporate governance. Although, these principles mainly
focuses on publicly traded companies both financial and non-financial, they
also act as a useful tool to improve corporate governance in non-traded
companies, for example, privately held and state owned enterprises.32
These principles majorly include:-
An effective corporate governance framework should be developed with a
view to its impact on overall economic performance, market integrity and
the incentives it creates for market participants as well as for the promotion
of transparent and efficient markets. The legal and regulatory requirements
that affect corporate governance practices in a jurisdiction should be
consistent with the rule of law, transparent and enforceable. They should
clearly articulate the division of responsibilities among different
supervisory, regulatory and enforcement authorities.33
The corporate governance framework should protect and facilitate the
exercise of basic shareholders’ rights, which should include the right to: (i)
secure methods of ownership registration; (ii) convey or transfer shares;
(iii) obtain relevant and material information on the corporation on a timely
and regular basis; (iv) participate and vote in general shareholder meetings;
(v) elect and remove members of the board; and (vi) share in the profits of
the corporation. Shareholders should have the right to participate in, and to
be sufficiently informed on, decisions concerning fundamental corporate
32 http://business.gov.in/corporate_governance/oecd_principles.php , Date:- 12th of June 2010,Time
2:39 P.M. 33 Ibid.
83
changes, such as, amendments to the statutes or articles of incorporation;
authorisation of additional shares; etc.34
Capital structures and arrangements that enable certain shareholders to
obtain a degree of control disproportionate to their equity ownership should
be disclosed. The rules and procedures governing the acquisition of
corporate control in the capital markets, and extraordinary transactions,
such as mergers and sales of substantial portions of corporate assets, should
be clearly articulated and disclosed so that investors understand their rights
and recourse. Transactions should occur at transparent prices and under fair
conditions that protect the rights of all shareholders according to their
class.35
All shareholders of the same series of a class, including minority and
foreign shareholders, should be treated equally. Within any series of a class,
all shares should carry the same rights. All investors should be able to
obtain information about the rights attached to all series and classes of
shares before they purchase. Besides, all shareholders should have the
opportunity to obtain effective redress for violation of their rights.36
Insider trading and abusive self-dealing should be prohibited.
The corporate governance framework should recognise the rights of
stakeholders established by law or through mutual agreements and
encourage active co-operation between corporations and stakeholders in
creating wealth, jobs and the sustainability of financially sound enterprises.
Further, it should be complemented by an effective, efficient insolvency
framework and by effective enforcement of creditor rights.37
Performance-enhancing mechanisms for employee participation should be
permitted to develop.
The corporate governance framework should ensure that timely and
accurate disclosure is made on all material matters regarding the
34
Ibid. 35 Ibid. 36 Ibid. 37 Ibid.
84
corporation, including the financial situation, operating results, objectives,
performance, ownership, remuneration policy and governance of the
company. Information should be prepared and disclosed in accordance with
high quality standards of accounting and financial and non-financial
disclosure.38
An annual audit should be conducted by an independent, competent and
qualified auditor in order to provide an external and objective assurance to
the board and shareholders, such that the financial statements fairly
represent the financial position and performance of the company in all
material respects. External auditors should be accountable to the
shareholders and owe a duty to the company to exercise due professional
care in the conduct of the audit.
The corporate governance framework should ensure the strategic guidance
of the company, the effective monitoring of management by the board, and
the board's accountability to the company and its shareholders. That is, the
Board members should act on a fully informed basis, in good faith, with
due diligence and care, and in the best interest of the company and the
shareholders. It should review and guide corporate strategy, major plans of
action, risk policy, annual budgets, business plans, performance objectives,
etc. as well as monitor the effectiveness of company's governance practices
and make changes, wherever needed.39
3.3.4 Blue Ribbon Committee on Improving the Effectiveness of Corporate
Audit Committees
On September 28, 1998, Arthur Levitt, chairman of the Securities and
Exchange Commission of United States of America presented an address at
the New York University Center for Law and Business entitled "The Numbers
Game." He discussed matters related to the issues involving the quality of
financial reporting e.g., earnings management, reserves, audit adjustments,
revenue recognition, creative acquisition accounting, in-process research and
development, and restructuring charges. Because these issues impact a firm's
38
Supra n. 32. 39 Ibid.
85
quality of earnings and market capitalization e.g., price-earnings ratios, Levitt
requested a response from the entire financial community.40
In response to Levitt's concerns, in October 1998, the New York Stock
Exchange and the National Association of Securities Dealers created the Blue
Ribbon Committee on Improving the Effectiveness of Corporate Audit
Committees. In February 1999, the committee issued its report, which contains
ten recommendations designed to (1) strengthen the independence of audit
committees; (2) increase the effectiveness of audit committees; and (3)
improve the relationship between boards and their audit committees the
activities of auditors and management. In December 1999, the SEC approved
changes to its rules to implement several of the Blue Ribbon Committee's
recommendations with respect to audit committee composition and practices.41
In view of the aforementioned recommendations of the Blue Ribbon
Committee, it is clearly evident that the scope for the responsibilities of audit
committees will significantly increase. Therefore, it is essential that audit
committees engage in an active continuous educational improvement program
to help their boards discharge their fiduciary responsibilities to share holders.42
The duties of the Audit Committee are:-
a. to recommend to the Board of Directors a firm of independent accountants
to perform the examination of the annual financial statements of the
Company.
b. to review with the independent accountants and with the Controller the
proposed scope of the annual audit, past audit experience, the Company's
internal audit program, recently completed internal audits and other matters
bearing upon the scope of the audit.
c. to review with the independent accountants and with the Controller
significant matters revealed in the course of the audit of the annual financial
statements of the Company.
40 http://www.enotes.com/business-finance-encyclopedia/audit-committees Date:- 12th of June 2011,
Time:-6.39 PM. 41 Ibid. 42 Ibid.
86
d. to review on a regular basis whether the company's standards of business
conduct and corporate policies relating thereto has been communicated by
the company to all key employees of the company and its subsidiaries
throughout the world with a direction that all such key employees certify
that they have read, understand and are not aware of any violation of the
standards of business conduct.
e. to review with the controller any suggestions and recommendations of the
independent accountants concerning the internal control standards and
accounting procedures of the company.
f. to meet on a regular basis with a representative or representatives of the
Internal Audit Department of the Company and to review the Internal Audit
Department's Reports of Operations. and
g. to report its activities and actions to the board at least once each fiscal
year.43
3.3.5 CACG Guidelines Principles for Corporate Governance in the Common
Wealth
The CACG44
was established in April 1998 in response to the Edinburgh
Declaration of the Commonwealth Heads of Government meeting in 1997 to
promote excellence in corporate governance in the Commonwealth
The CACG has two primary objectives:
to promote good standards in corporate governance and business practice
throughout the Commonwealth;
to facilitate the development of appropriate institutions which will be able
to advance, teach and disseminate such standards.45
The CACG Guidelines were agreed by the Commonwealth Business Council
(CBC) in 1999 and presented to Commonwealth Heads of Government at their
1999 Summit, which endorsed them. The guidelines have been designed with
particular focus on the emerging and transitional economies, making up a
large part of the Commonwealth, but also meet the needs of international
43 Ibid. 44 Common Association of Corporate Governance . 45 See CACG Guidelines Principles for the Corporate Governance in Common Wealth,1999,Common
Wealth Association for Corporate Governance, http://www.ecgi.org/codes/documents/cacg_final.pdf ,
Date:- 12th of June 2011, Times:- 7.46 PM.
87
investors and multilateral international agencies. The CACG Guidelines also
explore some of the complex issues relating to public and state enterprises,
business ethics and corruption, and the role of international professions
operating in emerging and transitional economies.46
The CACG Guidelines recommend that the board should
1. exercise leadership, enterprise, integrity and judgment in directing the
corporation so as to achieve continuing prosperity for the corporation and
to act in the best interest of the business enterprise in a manner based on
transparency, accountability and responsibility.
2. ensure that through a managed and effective process board appointments
are made that provide a mix of proficient directors, each of whom is able
to add value and to bring independent judgment to bear on the decision-
making process.
3. determine the corporation’s purpose and values, determine the strategy to
achieve its purpose and to implement its values in order to ensure that it
survives and thrives, and ensure that procedures and practices are in place
that protect the corporation’s assets and reputation.
4. monitor and evaluate the implementation of strategies, policies,
management performance criteria and business plans.
5. ensure that the corporation complies with all relevant laws, regulations and
codes of best business practice,
6. ensure that the corporation communicates with shareholders and other
stakeholders effectively,
7. serve the legitimate interests of the shareholders of the corporation and
account to them fully.
8. identify the corporation’s internal and external stakeholders and agree a
policy, or policies, determining how the corporation should relate to them.
9. ensure that no one person or a block of persons has unfettered power and
that there is an appropriate balance of power and authority on the board
which is, inter alia, usually reflected by separating the roles of the chief
46 Steve Godfrey, “Benchmarks and Indicators for Corporate Governance: A Private Sector
Perspective” African Security Review 11(4) 2002, p.26,
http://www.iss.co.za/pubs/ASR/11No4/Feature3.pdf , Date:-13th of June 2011, Time:-10:56 AM.
88
executive officer and Chairman, and by having a balance between
executive and non-executive directors.
10. regularly review processes and procedures to ensure the effectiveness of its
internal systems of control, so that its decision-making capability and the
accuracy of its reporting and financial results are maintained at a high
level at all times.
11. regularly assess its performance and effectiveness as a whole, and that of
the individual directors, including the chief executive officer.
12. appoint the chief executive officer and at least participate in the
appointment of senior management, ensure the motivation and protection
of intellectual capital intrinsic to the corporation, ensure that there is
adequate training in the corporation for management and employees, and a
succession plan for senior management.
13. ensure that all technology and systems used in the corporation are
adequate to properly run the business and for it to remain a meaningful
competitor.
14. identify key risk areas and key performance indicators of the business
enterprise and monitor these factors;
15. ensure annually that the corporation will continue as a going concern for
its next fiscal year.47
3.3.6 Hampel Committee on Corporate Governance
This Committee on Corporate Governance was established in November 1995
on the initiative of the Chairman of the Financia1 Reporting Council, Sir
Sydney Lipworth. This followed the recommendations of the Cadbury and
Greenbury committees that a new committee should review the
implementation of their findings.48
The main recommendations of committee are as follows:
1. Companies should include in their annual reports a narrative account of
how they apply the broad principles.
47 Supra n. 45. 48 http://www.ecgi.org/codes/documents/hampel22.pdf, Date:-13th of June 2011, Time:-11.35 AM.
89
2. Companies should be ready to explain their governance policies, including
any circumstances justifying departure from best practice.
3. Executive and non-executive directors should continue to have the same
duties under the law.
4. Management has an obligation to provide the board with appropriate and
timely information and the chairman has a particular responsibility to
ensure that al1 directors are properly briefed. This is essential if the board
is to be effective.
5. An individual should receive e appropriate training on the first occasion
that he or she is appointed to the board of a listed company , and
subsequently as necessary .
6. Boards should appoint as executive directors only those executives whom
they judge able to take a broad view of the company’s overall interests.
7. The majority of non-executive directors should be independent and boards
should disclose in the annual report which of the non-executive director-s
are considered to be independent . This applies for companies of al1 sizes.
8. Separation of the roles of chairman and chief executive officer is to be
preferred, other things being equal, and companies should justify a
decision to combine their roles .
9. Companies should set up a nomination committee to make
recommendations to the board on al1 new board appointments.
10. Al1 directors should submit themselves for re-election at least every three
years, and companies should make any necessary changes in their Articles
of Association as soon as possible .
11. Names of directors submitted for re-election should be accompanied by
biographical details .
12. Boards should establish a remuneration committee, made up of
independent non-executive directors, to develop policy on remuneration
and devise remuneration packages for individual executive directors.
13. Decisions on the remuneration packages of executive directors should be
delegated to the remuneration committee; the broad framework and cost of
executive remuneration should be a matter for the board on the advice of
the remuneration committee. The board should itself devise remuneration
packages for non-executive directors.
90
14. We agree that shareholder approval should be sought for new long-term
incentive plan.
15. Institutional investors have a responsibility to their clients to make
considered use of their votes; and we strongly recommend institutional
investors of al1 kinds, wherever practicable, to vote the shares under their
control. But it does not recommend that voting should be compulsory.
16. Institutions should make available to clients, on request, information on
the proportion of resolutions on which votes were cast and non-
discretionary proxies lodged .
17. Shareholders should be able to vote separately on each substantially
separate issue; and that the practice of ‘bundling’ unrelated proposals in a
single resolution should cease .
18. Notice of the AGM and related papers should he sent to shareholders at
least 20 working days before the meeting.49
19. Companies may wish to prepare a resume of discussion at the AGM and
make this available to shareholders on request .
20. Each company should establish an audit committee of at least three non-
executive directors, at least two of them independent . It does not favour a
general relaxation for smaller companies, but recommend shareholders to
show flexibility in considering cases of difficulty on their merits .
21. It does not recommend any additional requirements on auditors to report
on governance issues, nor the removal of any existing prescribed
requirements.
22. It suggest that the bodies concerned should consider reducing from 10%
the limit on the proportion of total income which an audit firm may earn
from one audit client .
23. It suggest that the audit committee should keep under review the overall
financial relationship between the company and its auditors, to ensure a
balance between the maintenance of objectivity and value for money .
24. It recommends the directors should report on the company’s system of
internal control’. We also recommend that the auditors should report on
49 Ibid.
91
internal control privately to the directors, which allows for an effective
dialogue to take place and for best practice to evolve .
25. Directors should maintain and review controls relating to al1 relevant
control objectives, and not merely financia1 controls .
26. Companies which do not already have a separate internal audit function
should from time to time review the need for one .
27. The requirement on directors to include a ‘going concern’ statement in the
annual report should be retained .
28. Auditors are inhibited from going beyond their present functions by
concerns about the law on liability. Account should be taken of these
concerns by those responsible for professional standards and in taking
decisions on changes in the law.50
3.3.7 Sarbanes Oxley Act
The Sarbanes Oxley Act was enacted in the year 2002 with a view to protect
investors by improving the accuracy and reliability of corporate disclosures
made pursuant to the securities laws and for other purposes.51
Some of the
main provisions of the Act are:-
1. The Act called for establishment of the Public Company Accounting
Oversight Board, whose duties are to:-
register and regulate all public accounting firms that prepare audit reports.
establish or adopt, or both, by rule, auditing, quality control, ethics,
independence, and other standards relating to the preparation of audit
reports,
conduct inspections of registered public accounting firms,
conduct investigations and disciplinary proceedings concerning, and
impose appropriate sanctions where justified upon, registered public
accounting firms and associated persons of such firms.
perform such other duties or functions as the Board determines are
necessary or appropriate to promote high professional standards among,
50 http://www.ecgi.org/codes/documents/hampel29.pdf , Date:- 27th of September 2010, Time:-10:34
AM. 51 http://business.gov.in/corporate_governance/sarbanes_act.php#top , Date:-13th of June 2010, Time
6:54 PM.
92
and improve the quality of audit services offered by, registered public
accounting firms and associated persons thereof, or otherwise to carry out
this Act, in order to protect investors, or to further the public interest.
enforce compliance with professional standards, and the securities laws
relating to the preparation and issuance of audit reports and the obligations
and liabilities of accountants with respect thereto, by registered public
accounting firms and associated persons thereof.
set the budget and manage the operations of the Board and the staff of the
Board.52
2. It prohibits any public accounting firm from providing non-audit services
while auditing firm. These services include:-
bookkeeping or other services related to the accounting records or
financial statements of the audit client;
financial information systems design and implementation;
appraisal or valuation services, fairness opinions, or contribution-in-kind
reports;
actuarial services;
internal audit outsourcing services;
management functions or human resources;
broker or dealer, investment adviser, or investment banking services;
legal services and expert services unrelated to the audit; and
any other service that the Board determines, by regulation, is
impermissible.53
3. The lead audit and reviewing partner must rotate off the audit every 5 years. It
shall be unlawful for a registered public accounting firm to provide audit
services to an issuer if the lead or coordinating audit partner (having primary
responsibility for the audit), or the audit partner responsible for reviewing the
audit, has performed audit services for that issuer in each of the 5 previous
fiscal years.54
52 Ibid. 53
Ibid. 54 Supra n. 51.
93
4. The Act calls for the formation of an independent and competent audit
committee, which is directly responsible for the appointment, compensation,
and oversight of the work of any registered public accounting firm and of
auditor's activities. It requires that each member of a firm’s audit committee be
a member of the board of directors and be 'independent'. In order to be
considered independent, a member of an audit committee may not accept any
consulting, advisory, or other compensatory fee from the issuer; or be an
affiliated person of the issuer or any subsidiary thereof.55
5. Each registered public accounting firm that performs for any issuer any audit
shall timely report to the audit committee of the issuer:- (i) all critical
accounting policies and practices to be used; (ii) all alternative treatments of
financial information within generally accepted accounting principles that
have been discussed with management officials of the issuer, ramifications of
the use of such alternative disclosures and treatments, and the treatment
preferred by the registered public accounting firm; and (iii) other material
written communications between the registered public accounting firm and the
management of the issuer, such as any management letter or schedule of
unadjusted differences.56
6. Each audit committee shall establish procedures for:- (i) the receipt, retention
and treatment of complaints received by the issuer regarding accounting,
internal accounting controls, or auditing matters; and (ii) the confidential,
anonymous submission by employees of the issuer of concerns regarding
questionable accounting or auditing matters.57
7. The Act requires that the principal executive officer or officers and the
principal financial officer or officers, or persons performing similar functions,
to certify that the financial statements accurately and fairly represent the
financial condition and results of operations of the company, in each annual or
quarterly report filed or submitted.58
55 Ibid. 56
Ibid. 57 Ibid. 58 http://business.gov.in/corporate_governance/sarbanes_act.php#top , 13th of June 2010, Time 6:54
PM.
94
8. The Act requires rapid disclosure of material changes in the financial
conditions or operations of the firm, which may include trend and qualitative
information and graphic presentations, as necessary or useful for the
protection of investors and in the public interest.59
9. It prohibits loans to any of the firm’s directors or executives. It shall be
unlawful for any issuer to extend or maintain credit, to arrange for the
extension of credit, or to renew an extension of credit, in the form of a
personal loan to or for any director or executive officer (or equivalent thereof)
of that issuer.60
10. It requires that each annual report contain an internal control report. This
report shall state the responsibility of management for establishing and
implementing adequate procedures for financial reporting, as well as contain
an assessment of effectiveness of internal control structure and procedures,
any code of ethics and contents of that code.61
3.4 Development of Corporate Governance in India
The present stage of corporate governance has reached after crossing a long
passage of time. The development of corporate governance in India can be
divided in two stages which are as given below:-
Pre Liberalization
Post Liberalization
3.4.1 Pre Liberalization
When India attained independence from British rule in 1947, the country was
poor, with an average per-capita annual income under thirty dollars. However,
it still possessed sophisticated laws regarding "listing, trading, and
settlements." It even had four fully operational stock exchanges. Subsequent
laws, such as the 1956 Companies Act, further solidified the rights of
investors.
59 Ibid. 60
Ibid. 61 Ibid.
95
In the decades following India's independence from Great Britain, the country
turned away from its capitalist past and embraced socialism. The 1951
Industries Act was a step in this direction, requiring "that all industrial units
obtain licenses from the central government." The 1956 Industrial Policy
Resolution "stipulated that the public sector would dominate the economy."
To put this plan into effect, the Indian government created enormous state-
owned enterprises, and India steadily moved toward a culture of "corruption,
nepotism and inefficiency." As the government took over floundering private
enterprises and rejuvenated them, it essentially "converted private bankruptcy
to high-cost public debt." One scholar referred to India's economic history as
"the institutionalization of inefficiency."62
The absence of a corporate-governance framework exacerbated the situation.
Government accountability was minimal, and the few private companies that
remained on India's business landscape enjoyed free reign with respect to most
laws; the government rarely initiated punitive action, even for nonconformity
with basic governance laws. Boards of directors invariably were staffed by
friends or relatives of management, and abuses by dominant shareholders and
management were commonplace. India's equity markets "were not liquid or
sophisticated enough" to punish these abuses.63
Scholars believe that "takeover threats act as a disciplining mechanism to
poorly performing companies" because as the stock price of poorly governed
firms decreases because disgruntled investors discard stock, the firms become
susceptible to hostile-takeover attempts. Thus, "the fear of a takeover is
supposed to keep the management honest." However, until recently, hostile
takeovers were almost entirely non-existent in India, and therefore, the poorly
governed Indian firms had little to worry about in terms of following corporate
laws once they had raised capital through their initial public offering. Thus,
corporate governance in India was in a dismal condition by the early 1990s.64
62 Varun Bhat, “Corporate governance in India: past, present, and suggestions for the future” ,Iowa
Law Review, May 01, 2007, http://www.accessmylibrary.com/article-1G1-167305801/corporate-
governance-india-past.html, Date:- 16th of June 2010, Time :- 8:34 PM. 63
Ibid. 64 Ibid.
96
3.4.2 Post Liberalization
The initiatives taken by Government in 1991, aimed at economic liberalization
and globalization of the domestic economy, enable it to suitably respond to the
developments taking place in the world over. On account of the interest
generated by Cadbury Committee Report, the Confederation of Indian
Industry (CII), the Associated Chambers of Commerce and Industry
(ASSOCHAM) and, the Securities and Exchange Board of India (SEBI)
constituted committees to recommend initiatives in Corporate Governance.65
CII took a special initiative on Corporate Governance, the first institutional
initiative in Indian Industry. The objective was to develop and promote a code
for Corporate Governance to be adopted and followed by Indian companies,
be these in the Private Sector, the Public Sector, Banks or Financial
Institutions, all of which are corporate entities. The final draft of the said Code
was widely circulated in 1997. In April 1998, the Code was released. It was
called Desirable Corporate Governance Code.66
Following CII’s Initiative, SEBI set up a Committee under the chairmanship
of Kumar Managlam Birla, to promote and raise standards of corporate
governance. The Committee in its Report observed that “the strong Corporate
Governance is indispensable to resilient and vibrant capital markets and is an
important instrument of investor protection. It is the blood that fills the veins
of transparent corporate disclosure and high quality accounting practices. It is
the muscle that moves a viable and accessible financial reporting structure.”
The recommendation of Kumar Manglam Birla Committee, led to inclusion of
Clause 49 in the Listing Agreement in the year 2000. These recommendations,
aimed at improving the standards of Corporate Governance, are divided into
mandatory and non-mandatory recommendations. The said recommendations
were made applicable to all listed companies with the paid-up capital of Rs. 3
Crore and above or net worth of Rs. 25 Crores or more at any time in the
history of the company. The ultimate responsibility of putting the
65 ICSI, “Corporate Governance Modules of Best Practices ”, (2008),p.4. 66 Ibid.
97
recommendations into practice lies directly with the Board of Directors and
the management of the Company.67
In May 2000, the Department of Company Affairs ( Now Ministry of
Corporate Affairs) formed a broad based study group under the chairmanship
of Dr. P.L. Sanjeev Reddy, Secretary, DCA. The group was given the
ambitious task of examining ways to “operationalise the concept of corporate
excellence on a sustained basis”, so as to “sharpen India’s global competitive
edge and to further develop corporate culture in the country”. In November
2000, a Task Force on Corporate Excellence set up by the group produced a
report containing a range of recommendations for raising governance
standards among all companies in India. It also suggested the setting up of a
Centre for Corporate Excellence.68
The Enron debacle of 2001 involving the hand-in-glove relationship between
the auditor and the corporate client, the scams involving the fall of the
corporate giants in the U.S. like the WorldCom, Qwest, Global Crossing,
Xerox and the consequent enactment of the stringent Sarbanes Oxley Act in
the U.S. were some of the important factors which led the Indian Government
to set up Naresh Chandra Committee, in the Year 2002 to examine and
recommend inter alia amendments to the law involving the auditor-client
relationship and the role of independent directors.69
In the year 2002 itself, SEBI analyzed the statistics of compliance with the
clause 49 by listed companies and felt the need to look beyond the mere
systems and procedures if corporate governance was to be made effective in
protecting the interests of investors. SEBI therefore constituted a Committee
under the Chairmanship of Shri N.R. Narayana Murthy, for reviewing
implementation of the corporate governance code by listed companies and
issued revised clause 49 based on its recommendations.70
In 2004, the Government constituted a committee under the Chairmanship of
Dr. JJ Irani, Director, Tata Sons, with the task of advising the Government on
67
Ibid. 68 Id. at 5. 69 Ibid 70 Ibid.
98
the proposed revisions to the Companies Act, 1956 with the objective to have
a simplified compact law able to address the changes taking place in the
national and international scenario, enable adoption of internationally accepted
best practices as well as provide adequate flexibility for timely evolution of
new arrangements in response to the requirements of ever-changing business
models.71
Dr. J.J. Irani Expert Committee on New Company Law submitted its report
charting out the road map for a flexible, dynamic and user- friendly new
company law. The Committee took a pragmatic approach keeping in view the
ground realities, and sought to address the concerns of all the stakeholders to
enable adoption of internationally accepted best practices. The Report of the
Committee also sought to bring in multifarious progressive and visionary
concepts and endeavored a significant shift from the “Government Approval
Regime” to a “Shareholders Approval and Disclosure Regime”72
The main recommendations of these committees are as given below:-
3.4.2.1 CII Desirable Code
In 1996, CII took a special initiative on Corporate Governance - the first
institutional initiative in Indian industry. The objective was to develop and
promote a code for Corporate Governance to be adopted and followed by
Indian companies, be these in the Private Sector, the Public Sector, Banks or
Financial Institutions, all of which are corporate entities. This initiative by CII
flowed from public concerns regarding the protection of investor interest,
especially the small investor; the promotion of transparency within business
and industry; the need to move towards international standards in terms of
disclosure of information by the corporate sector and, through all of this, to
develop a high level of public confidence in business and industry.
A National Task Force set up with Mr. Rahul Bajaj , Past President ,CII and
Chairman & Managing Director, Bajaj Auto Limited, as the Chairman
included membership from industry, the legal profession, media and academia.
This Task Force presented the draft guidelines and the code of Corporate
71 Id. at 6. 72 Ibid.
99
Governance in April 1997 at the National Conference and Annual Session of
CII. This draft was then publicly debated in workshops and Seminars and a
number of suggestions were received for the consideration of the Task Force.
Reviewing, these suggestions, and the development, which have taken, place
in India and abroad over the past year, the Task Force has finalised the
Desirable Corporate Governance Code.73
The main recommendations of the code are as following:-
There is no need to adopt the German system of two-tier boards to ensure
desirable corporate governance. A single board, if it performs well, can
maximise long term shareholder value just as well as a two- or multi-tiered
board. Equally, there is nothing to suggest that a two-tier board, per se, is the
panacea to all corporate problems.74
Any listed companies with a turnover of Rs.100 crores and above should have
professionally competent, independent, nonexecutive directors, who should
constitute
at least 30 percent of the board if the Chairman of the company is a non-
executive director, or
at least 50 percent of the board if the Chairman and Managing Director is
the same person.75
No single person should hold directorships in more than 10 listed
companies.76
For non-executive directors to play a material role in corporate decision
making and maximising long term shareholder value, they need to
become active participants in boards, not passive advisors;
have clearly defined responsibilities within the board such as the Audit
Committee; and
73 See CII Desirable Code,PDF File Format,
http://www.nfcgindia.org/desirable_corporate_governance_cii.pdf 20th of June 2010, Time:- 1:54 P.M. 74 Ibid. 75 Ibid. 76 Ibid.
100
know how to read a balance sheet, profit and loss account, cash flow
statements and financial ratios and have some knowledge of various
company laws. This, of course, excludes those who are invited to join
boards as experts in other fields such as science and technology.77
To secure better effort from non-executive directors, companies should:
pay a commission over and above the sitting fees for the use of the
professional inputs. The present commission of 1% of net profits if the
company has a managing director or 3% if there is no managing director
is sufficient.
consider offering stock options, so as to relate rewards to performance.
Commissions are rewards on current profits. Stock options are rewards
contingent upon future appreciation of corporate value. An appropriate
mix of the two can align a non-executive director towards keeping an
eye on short term profits as well as longer term shareholder value.78
While re-appointing members of the board, companies should give the
attendance record of the concerned directors. If a director has not been present
(absent with or without leave) for 50 percent or more meetings, then this
should be explicitly stated in the resolution that is put to vote. As a general
practice, one should not reappoint any director who has not had the time attend
even one half of the meetings.79
Key information that must be reported to, and placed before, the board must
contain:
Annual operating plans and budgets, together with up-dated long term
plans.
Capital budgets, manpower and overhead budgets.
Quarterly results for the company as a whole and its operating divisions or
business segments.
Internal audit reports, including cases of theft and dishonesty of a material
nature.
77 Supra n 73. 78 Ibid. 79 Ibid.
101
Show cause, demand and prosecution notices received from revenue
authorities which are considered to be materially important. (Material
nature is any exposure that exceeds 1 percent of the company’s net worth).
Fatal or serious accidents, dangerous occurrences, and any effluent or
pollution problems.
Default in payment of interest or nonpayment of the principal on any
public deposit, and/or to any secured creditor or financial institution.
Defaults such as non-payment of inter corporate deposits by or to the
company, or materially substantial non-payment for goods sold by the
company.
Any issue which involves possible public or product liability claims of a
substantial nature, including any judgment or order which may have either
passed strictures on the conduct of the company, or taken an adverse view
regarding another enterprise that can have negative implications for the
company.
Details of any joint venture or collaboration agreement.
Transactions that involve substantial payment towards goodwill, brand
equity, or intellectual property.
Recruitment and remuneration of senior officers just below the board
level, including appointment or removal of the Chief Financial Officer and
the Company Secretary.
Labour problems and their proposed solutions.
Quarterly details of foreign exchange exposure and the steps taken by
management to limit the risks of adverse exchange rate movement, if
material.80
Audit Committees should consist of at least three members, all drawn from a
company’s non-executive directors, who should have adequate knowledge of
finance, accounts and basic elements of company law.81
Under “Additional Shareholder’s Information”, listed companies should give
data on:
80 Ibid. 81 Ibid.
102
High and low monthly averages of share prices in a major Stock
Exchange where the company is listed for the reporting year.
Greater detail on business segments up to 10% of turnover, giving share
in sales revenue, review of operations, analysis of markets and future
prospects.82
For all companies with paid-up capital of Rs.20 crores or more, the quality
and quantity of disclosure that accompanies a GDR issue should be the norm
for any domestic issue.83
Government must allow far greater funding to the corporate sector against the
security of shares and other paper.84
If any company goes to more than one credit rating agency, then it must
divulge in the prospectus and issue document the rating of all the agencies
that did such an exercise. It is not enough to state the ratings. These must be
given in a tabular format that shows where the company stands relative to
higher and lower ranking. It makes considerable difference to an investor to
know whether the rating agency or agencies placed the company in the top
slots, or in the middle, or in the bottom.85
Companies that default on fixed deposits should not be permitted to
accept further deposits and make inter corporate loans or investments until
the default is made good; and
declare dividends until the default is made good. Both have been suggested
by the Working Group on the Companies Act, and are endorsed by CII.86
3.4.2.2 Kumar Mangalam Birla Committee
The Securities and Exchange Board of India appointed the Committee on
Corporate Governance on May 7, 1999 under the Chairmanship of Shri Kumar
Mangalam Birla, member SEBI Board, to promote and raise the standards of
82 See also CII Desirable Code ,PDF File Format,
http://www.nfcgindia.org/desirable_corporate_governance_cii.pdf, 20th of June 2010, Time:- 1:54
P.M.. 83 Ibid. 84 Ibid. 85 Ibid. 86
Ibid.
103
Corporate Governance. The report submitted by the committee is the first
formal and comprehensive attempt to evolve a ‘Code of Corporate
Governance', in the context of prevailing conditions of governance in Indian
companies, as well as the state of capital markets.
The Committee's terms of the reference were to:
suggest suitable amendments to the listing agreement executed by the
stock exchanges with the companies and any other measures to improve
the standards of corporate governance in the listed companies, in areas
such as continuous disclosure of material information, both financial and
non-financial, manner and frequency of such disclosures, responsibilities
of independent and outside directors;
draft a code of corporate best practices; and
suggest safeguards to be instituted within the companies to deal with
insider information and insider trading.
The primary objective of the committee was to view corporate governance
from the perspective of the investors and shareholders and to prepare a ‘Code'
to suit the Indian corporate environment.
The committee had identified the Shareholders, the Board of Directors and
the Management as the three key constituents of corporate governance and
attempted to identify in respect of each of these constituents, their roles and
responsibilities as also their rights in the context of good corporate
governance.
Corporate governance has several claimants –shareholders and other
stakeholders - which include suppliers, customers, creditors, and the bankers,
the employees of the company, the government and the society at large. The
Report had been prepared by the committee, keeping in view primarily the
interests of a particular class of stakeholders, namely, the shareholders, who
together with the investors form the principal constituency of SEBI while not
ignoring the needs of other stakeholders.87
87 http://business.gov.in/corporate_governance/kumarmangalam.php , Date:- 17th of June 2010. Time: -
11:16 AM.
104
Mandatory and non-mandatory recommendations
The committee divided the recommendations into two categories, namely,
mandatory and non- mandatory. The recommendations which are absolutely
essential for corporate governance can be defined with precision and which
can be enforced through the amendment of the listing agreement could be
classified as mandatory. Others, which are either desirable or which may
require change of laws, may, for the time being, be classified as non-
mandatory.88
Mandatory Recommendations
The Committee recommends that the board of a company have an
optimum combination of executive and non-executive directors with not
less than fifty percent of the board comprising the non-executive directors.
The number of independent directors (independence being as defined in
the foregoing paragraph) would depend on the nature of the chairman of
the board. In case a company has a non-executive chairman, at least one-
third of board should comprise of independent directors and in case a
company has an executive chairman, at least half of board should be
independent.89
The Committee recommends that a qualified and independent audit
committee should be set up by the board of a company. This would go a
long way in enhancing the credibility of the financial disclosures of a
company and promoting transparency. 90
The composition of the audit committee is based on the fundamental
premise of independence and expertise. The Committee therefore
recommends that
the audit committee should have minimum three members, all being
non executive directors, with the majority being independent, and with
at least one director having financial and accounting knowledge;
88 Ibid. 89See also Report of Kumar Manglam Birla Committee on Corporate Governance,
http://business.gov.in/outerwin.php?id=http://www.sebi.gov.in/commreport/corpgov.html,
Date:-10th of January 2012. 90 Ibid.
105
the chairman of the committee should be an independent director;
the chairman should be present at Annual General Meeting to answer
shareholder queries;
the audit committee should invite such of the executives, as it
considers appropriate (and particularly the head of the finance
function) to be present at the meetings of the Committee but on
occasions it may also meet without the presence of any executives of
the company. Finance director and head of internal audit and when
required, a representative of the external auditor should be present as
invitees for the meetings of the audit committee;
the Company Secretary should act as the secretary to the committee.91
The Committee recommends that to begin with the audit committee should
meet at least thrice a year. One meeting must be held before finalisation of
annual accounts and one necessarily every six months. The quorum should
be either two members or one-third of the members of the audit
committee, whichever is higher and there should be a minimum of two
independent directors.92
Being a committee of the board, the audit committee derives its powers
from the authorisation of the board. The Committee recommends that such
powers should include powers:
To investigate any activity within its terms of reference.
To seek information from any employee.
To obtain outside legal or other professional advice.
To secure attendance of outsiders with relevant expertise, if it
considers necessary.93
As the audit committee acts as the bridge between the board, the statutory
auditors and internal auditors, the Committee recommends that its role
should include the following:-
91 Ibid. 92 Ibid. 93 Ibid.
106
Oversight of the company’s financial reporting process and the
disclosure of its financial information to ensure that the financial
statement is correct, sufficient and credible.
Recommending the appointment and removal of external auditor,
fixation of audit fee and also approval for payment for any other
services.
Reviewing with management the annual financial statements before
submission to the board, focusing primarily on:
Any changes in accounting policies and practices.
Major accounting entries based on exercise of judgment by
management.
Qualifications in draft audit report.
Significant adjustments arising out of audit.
The going concern assumption.
Compliance with accounting standards
Compliance with stock exchange and legal requirements
concerning financial statements.
Any related party transactions i.e. transactions of the company
of material nature, with promoters or the management, their
subsidiaries or relatives etc. that may have potential conflict
with the interests of company at large.
Reviewing with the management, external and internal auditors, the
adequacy of internal control systems.
Reviewing the adequacy of internal audit function, including the
structure of the internal audit department, staffing and seniority of the
official heading the department, reporting structure, coverage and
frequency of internal audit.
Discussion with internal auditors of any significant findings and
follow-up thereon.
Reviewing the findings of any internal investigations by the internal
auditors into matters where there is suspected fraud or irregularity or a
failure of internal control systems of a material nature and reporting
the matter to the board.
107
Discussion with external auditors before the audit commences, of the
nature and scope of audit. Also post-audit discussion to ascertain any
area of concern.
Reviewing the company’s financial and risk management policies.
Looking into the reasons for substantial defaults in the payments to the
depositors, debenture holders, share holders in case of non-payment of
declared dividends and creditors.94
The Committee recommends that the board of directors should decide the
remuneration of non-executive directors. 95
It is important for the shareholders to be informed of the remuneration of
the directors of the company. The Committee therefore recommends that
the following disclosures should be made in the section on corporate
governance of the annual report:
All elements of remuneration package of all the directors i.e. salary,
benefits, bonuses, stock options, pension etc.
Details of fixed component and performance linked incentives, along
with the performance criteria.
Service contracts, notice period, severance fees.
Stock option details, if any – and whether issued at a discount as well
as the period over which accrued and over which exercisable.96
The Committee therefore recommends that board meetings should be held
at least four times in a year, with a maximum time gap of four months
between any two meetings. The Committee further recommends that to
ensure that the members of the board give due importance and
commitment to the meetings of the board and its committees, there should
be a ceiling on the maximum number of committees across all companies
in which a director could be a member or act as Chairman. The Committee
recommends that a director should not be a member in more than 10
committees or act as Chairman of more than five committees across all
94 Supra n. 89. 95 Ibid. 96 Ibid.
108
companies in which he is a director. Furthermore it should be a mandatory
annual requirement for every director to inform the company about the
committee positions he occupies in other companies and notify changes as
and when they take place. 97
As a part of the disclosure related to Management, the Committee
recommends that as part of the directors’ report or as an addition there to,
a Management Discussion and Analysis report should form part of the
annual report to the shareholders. This Management Discussion and
Analysis should include discussion on the following matters within the
limits set by the company’s competitive position:
Industry structure and developments.
Opportunities and Threats
Segment-wise or product-wise performance.
Outlook.
Risks and concerns
Internal control systems and their adequacy.
Discussion on financial performance with respect to operational
performance.
Material developments in Human Resources /Industrial Relations front,
including number of people employed. 98
Good corporate governance casts an obligation on the management in
respect of disclosures. The Committee therefore recommends that
disclosures must be made by the management to the board relating to all
material financial and commercial transactions, where they have personal
interest, that may have a potential conflict with the interest of the company
at large (for e.g. dealing in company shares, commercial dealings with
bodies, which have shareholding of management and their relatives etc.) 99
97 Ibid. 98 Ibid. See also Report of Kumar Mangalam Birla Committee, for more details,
http://www.sebi.gov.in/commreport/corpgov.html , Date:- 20th of June 2010, Time:- 1:58 PM. 99 Ibid.
109
The Committee recommends that in case of the appointment of a new
director or re-appointment of a director the shareholders must be provided
with the following information:
A brief resume of the director;
Nature of his expertise in specific functional areas; and
Names of companies in which the person also holds the directorship
and the membership of Committees of the board.100
The Committee recommends that information like quarterly results,
presentation made by companies to analysts may be put on company’s
web-site or may be sent in such a form so as to enable the stock exchange
on which the company is listed to put it on its own web-site.101
The Committee recommends that a board committee under the
chairmanship of a non-executive director should be formed to specifically
look into the redressing of shareholder complaints like transfer of shares,
non-receipt of balance sheet, non-receipt of declared dividends etc. The
Committee believes that the formation of such a committee will help focus
the attention of the company on shareholders’ grievances and sensitise the
management to redressal of their grievances.102
The Committee further recommends that to expedite the process of share
transfers the board of the company should delegate the power of share
transfer to an officer, or a committee or to the registrar and share transfer
agents. The delegated authority should attend to share transfer formalities
at least once in a fortnight.103
The Committee recommends that there should be a separate section on
Corporate Governance in the annual reports of companies, with a detailed
compliance report on Corporate Governance. Non-compliance of any
mandatory recommendation with reasons thereof and the extent to which
the non-mandatory recommendations have been adopted should be
specifically highlighted. This will enable the shareholders and the
100
Ibid. 101 Ibid. 102 Ibid. 103 Ibid.
110
securities market to assess for themselves the standards of corporate
governance followed by a company. A suggested list of items to be
included in the compliance report is enclosed.104
The Committee also recommends that the company should arrange to
obtain a certificate from the auditors of the company regarding compliance
of mandatory recommendations and annex the certificate with the
directors’ report, which is sent annually to all the shareholders of the
company. The same certificate should also be sent to the stock exchanges
along with the annual returns filed by the company.105
The Committee mandatory recommends that while the recommendations
should be applicable to all the listed companies or entities, there is a need
for phasing out the implementation as follows:
By all entities seeking listing for the first time, at the time of listing.
Within financial year 2000-2001,but not later than March 31, 2001 by
all entities, which are included either in Group ‘A’of the BSE or in
S&P CNX Nifty index as on January 1, 2000. However to comply with
the recommendations, these companies may have to begin the process
of implementation as early as possible. These companies would cover
more than 80% of the market capitalisation.
Within financial year 2001-2002,but not later than March 31, 2002 by
all the entities which are presently listed, with paid up share capital of
Rs. 10 crore and above, or net worth of Rs 25 crore or more any time
in the history of the company.
Within financial year 2002-2003, but not later than March 31, 2003 by
all the entities which are presently listed, with paid up share capital of
Rs 3 crore and above.106
104 Supra n. 98 105 Ibid. 106 Ibid.
111
Non-Mandatory Recommendations
Given the importance of Chairman’s role, the Committee recommends that
a non-executive Chairman should be entitled to maintain a Chairman’s
office at the company’s expense and also allowed reimbursement of
expenses incurred in performance of his duties. This will enable him to
discharge the responsibilities effectively. The Committee believes that the
role of Chairman is to ensure that the board meetings are conducted in a
manner which secures the effective participation of all directors, executive
and non-executive alike, and encourages all to make an effective
contribution, maintain a balance of power in the board, make certain that
all directors receive adequate information, well in time and that the
executive directors look beyond their executive duties and accept full share
of the responsibilities of governance. The Committee is of the view that
the Chairman’s role should in principle be different from that of the chief
executive, though the same individual may perform both roles.107
The Committee was of the view that a company must have a credible and
transparent policy in determining and accounting for the remuneration of
the directors. The policy should avoid potential conflicts of interest
between the shareholders, the directors, and the management. The
overriding principle in respect of directors’ remuneration is that of
openness and shareholders are entitled to a full and clear statement of
benefits available to the directors. For this purpose the Committee
recommends that the board should set up a remuneration committee to
determine on their behalf and on behalf of the shareholders with agreed
terms of reference, the company’s policy on specific remuneration
packages for executive directors including pension rights and any
compensation payment.108
The Committee deliberated on the quorum for the meeting and was of the
view that remuneration is mostly fixed annually or after specified periods.
107 Ibid. See also Report of Kumar Manglam Birla Committee on Corporate Governance, for more
details, http://business.gov.in/outerwin.php?id=http://www.sebi.gov.in/commreport/corpgov.html,
Date:-10th of January 2012. 108 Ibid.
112
It would not be necessary for the committee to meet very often. The
Committee was of the view that it should not be difficult to arrange for a
date to suit the convenience of all the members of the committee. The
Committee therefore recommends that all the members of the
remuneration committee should be present at the meeting.109
The Committee also recommends that the Chairman of the remuneration
committee should be present at the Annual General Meeting, to answer the
shareholder queries. However, it would be up to the Chairman to decide
who should answer the queries.110
The Committee recommends that the half-yearly declaration of financial
performance including summary of the significant events in last six-
months, should be sent to each household of shareholders.111
As per the committee, the recommendations should be made applicable to the
listed companies, their directors, management, employees and professionals
associated with such companies, in accordance with the time table proposed in
the schedule given later in this section. Compliance with the code should be
both in letter and spirit and should always be in a manner that gives
precedence to substance over form. The ultimate responsibility for putting the
recommendations into practice lies directly with the board of directors and the
management of the company.112
The recommendations will apply to all the listed private and public sector
companies, in accordance with the schedule of implementation. As for listed
entities, which are not companies, but body corporates (e.g. private and public
sector banks, financial institutions, insurance companies etc.) incorporated
under other statutes, the recommendations will apply to the extent that they do
not violate their respective statutes, and guidelines or directives issued by the
relevant regulatory authorities .113
109 Ibid. 110 Ibid. 111 Ibid . 112 http://business.gov.in/corporate_governance/kumarmangalam.php Date:-17th of June 2010, Time :-
11:16 AM. 113 Ibid.
113
3.4.2.3 Executive Summary of Report of Task Force on Corporate Excellence
Through Governance
In May 2000, the Department of Company Affairs (Now Ministry of
Corporate Affairs) formed a broad based study group under the chairmanship
of Dr. P.L. Sanjeev Reddy, Secretary, DCA. The group was given the
ambitious task of examining ways to “operationalise the concept of corporate
excellence on a sustained basis”, so as to “sharpen India’s global competitive
edge and to further develop corporate culture in the country”. In November
2000, a Task Force on Corporate Excellence set up by the group produced a
report containing a range of recommendations for raising governance
standards among all companies in India.114
The main recommendation of task
force as are following:-
It recommends the greater role and influence for non-executive
independent directors, a tighter delineation of independence criteria and
minimization of interest-conflict potential, and some stringent punitive
punishments for executive directors of companies failing to comply with
listing and other requirements.115
The shareholders and stakeholders of the company appointing them as
their executives should have the benefit of their full attention and
accordingly, has suggested some limitations on the nature and number of
their other directorship.116
There should be a proper disclosure to the shareholders and the investing
community.117
Interested shareholders who would be required to abstain from voting on
specified matters that impact upon some but not all the shareholders. This
privilege should be limited to a few specific matters and even there with
suitable provisions for breaking stalemate situations.118
114http://www.acga-asia.org/content.cfm?SITE_CONTENT_TYPE_ID=12&COUNTRY_ID=264,
Date:- 10th of January 2012, Time:- 3:37 P.M. 115 Ibid. 116 Ibid. 117 Ibid. 118 Ibid.
114
It recommends the tougher listing and compliance regimen through a
centralized National Listing Authority.119
It recommends the application of the highest and toughest standards of
corporate governance to Listed Companies as a measure of investor
protection and general upgrading of the status of Listed companies both
internationally and domestically.120
Public Sector undertaking should be relieved from multiple surveillance
agencies and a commission should be appointed to draft a suitable code of
public behaviour.121
It’s recommendations emphasize corporate social responsiveness and
ethical business practices, seeking what might well turn out to not only the
first small steps for better governance on this front but also the promise of
a more transparent and internationally respected Corporate India of the
future.122
There is pressing need to set up an independent autonomous Centre for
Corporate Excellence that would function as a knowledge portal and
repository. It recommends the constitution of such a Centre with three
broad functions, Research and Studies, Education Promotion and
Development, and Accreditation with respect to matters bearing upon
corporate governance and excellence.123
After detailed consideration of alternative funding and siting options, the
Task force decided in favour of funding by the Government and industry
associations and professional bodies.124
The Task Force has recommended phased implementation of the essential
measures, depending upon the size and capabilities of the companies on the
one hand and on the other, the requirements of the market place.
119 Supra n. 114. 120 Ibid. 121 Ibid. 122
Ibid. 123 Ibid. 124 Ibid.
115
The Task Force is however convinced that the level of non-legislative and
non-regulatory intervention is a function of maturity of the market and the
economy. Until acceptable levels of such maturity and market influence are
reached, it may be necessary to support self discipline and self regulation with
appropriate legislative and regulatory support with a provision for review after
three years. However, emphasis continue to be on self regulation. The desire
for self regulation should be enhanced by recognition of the advantages of
good governance in improving the company’s credibility and market
acceptance. With competition now becoming a powerful force in the market
there should be increased recognition of the advantages of good corporate
governance. The recognition should be supported by education, promotion and
propagation.125
3.4.2.4 Naresh Chandra Committee
The high powered committee was constituted on 21st of August, 2002, by
Department of Company Affairs in Ministry of Finance and Company Affairs
headed by Naresh Chandra to examine various corporate governance issues
and recommend changes in diverse areas such as:
a. the statutory auditor-company relationship, so as to further strengthen the
professional nature of this interface.
b. the need, if any, for rotation of statutory audit firms or partners.
c. the procedure for appointment of auditors and determination of audit fees.
d. restrictions, if necessary, on non-audit fees.
e. independence of auditing functions.
f. measures required to ensure that the management and companies actually
present ‘true and fair’statement of the financial affairs of companies.
g. the need to consider measures such as certification of accounts and
financial statements by the management and directors.
h. the necessity of having a transparent system of random scrutiny of audited
accounts.
i. adequacy of regulation of chartered accountants, company secretaries and
other similar statutory oversight functionaries.
125 Ibid.
116
j. the role of independent directors, and how their independence and
effectiveness can be ensured.126
The committee submitted its report to the Finance Ministry on December 23,
2002. After a good deal of deliberations and inter-action with the trade
associations and professional bodies, the Committee made very significant
recommendations for changes, inter alia, in the Companies Act. They are as
following:-
Disqualifications for Audit Assignments
The committee recommends a list of disqualifications such as:
Prohibition of any direct financial interest in the audit client by the audit
firm, its partners or members of the engagement team as well as their
‘direct relatives’. This prohibition would also apply if any ‘relative’ of the
partners of the audit firm or member of the engagement team has an
interest of more than 2 per cent of the share of profit or equity capital of
the audit client.
Prohibition of receiving any loans or guarantees from or on behalf of the
audit client by the audit firm, its partners or any member of the
engagement team and their ‘direct relatives’.
Prohibition of any business relationship with the audit client by the
auditing firm, its partners or any member of the engagement team and their
‘direct relatives’.
Prohibition of personal relationships, which would exclude any partner of
the audit firm or member of the engagement team being a ‘relative’ of any
of key officers of the client company, i.e. any whole-time director, CEO,
CFO, Company Secretary, senior manager belonging to the top two
managerial levels of the company, and the officer who is in default (as
defined by section 5 of the Companies Act).
Prohibition of service or cooling off period, under which any partner or
member of the engagement team of an audit firm who wants to join an
126 D.K. Prahlada Rao, “Emerging Trends in Corporate Governance”, Charted Secretary, August
2003,p. A 263.
117
audit client, or any key officer of the client company wanting to join the
audit firm, would only be allowed to do so after two years from the time
they were involved in the preparation of accounts and audit of that client.
Prohibition of undue dependence on an audit client. So that no audit firm
is unduly dependent on an audit client, the fees received from any one
client and its subsidiaries and affiliates, all together, should not exceed 25
per cent of the total revenues of the audit firm.127
List of Prohibited Non-Audit Services
The following services should not be provided by an audit firm to any client:-
Accounting and bookkeeping services, related to the accounting records or
financial statements of the audit client.
Internal audit services.
Financial information systems design and implementation, including
services related to IT systems for preparing financial or management
accounts and information flows of a company.
Actuarial services.
Broker, dealer, investment adviser or investment banking services.
Outsourced financial services.
Management functions, including the provision of temporary staff to audit
clients.
Any form of staff recruitment, and particularly hiring of senior
management staff for the audit client.
Valuation services and fairness opinion.128
Auditor’s disclosure of contingent liabilities
Management should provide a clear description in plain English of each
material liability and its risks. This should be followed by the auditor’s clearly
worded comments on the management view and highlighted in the significant
127 Id. at A 264 128
Ibid.
118
accounting policies and notes on accounts as well as in the auditor’s report,
where necessary.129
Auditor’s Disclosure of Qualifications and Consequent Action
It should be mandatory for the audit firm to send separately a copy of qualified
report to Registrar of Companies, the Securities and Exchange and Board of
India and the Principal Stock-Exchange, with a copy of the letter sent to the
management of the company.130
Management’s certification in the event of auditor’s replacement
Committee recommends that Section 225 of the Companies Act,1956 needs to
be amended to require a special resolution of shareholders, in case an auditor,
while being eligible to re-appointment, is sought to be replaced. The
explanatory statement accompanying such a special resolution must disclose
the management’s reasons for such a replacement, on which the outgoing
auditor shall have the right to comment. The Audit Committee will have to
verify that this explanatory statement is ‘true and fair’.131
Auditors’ Annual Certification of Independence
Before agreeing to be appointed the audit firm must submit a certificate of
independence to the Audit Committee or to the Board of directors of the client
company certifying that the firm, together with its consulting and specialised
services affiliates, subsidiaries and associated companies:
1. are independent and have arm’s length relationship with the client
company.
2. have not engaged in any non-audit services.
3. are not disqualified from audit assignments by virtue of breaching any of
the limits, restrictions and Prohibitions.
In the event of any inadvertent violations, the audit firm will immediately
bring these to the notice of the Audit Committee or the board of directors of
the client company, which is expected to take prompt action to address the
129 Ibid. 130 Ibid. 131 Ibid.
119
cause so as to restore independence at the earliest, and minimise any potential
risk that might have been caused.132
Appointment of Auditors
The Audit Committee of the board of directors shall be the first point of
reference regarding the appointment of auditors. To discharge this fiduciary
responsibility, the Audit Committee shall:
discuss the annual work programme with the auditor;
review the independence of the audit firm in line
recommend to the board, with reasons, either the appointment/re-
appointment or removal of the external auditor, along with the annual audit
remuneration.
Government Companies may be exempted from this requirement.133
CEO and CFO certification of annual audited accounts
In the case of all listed companies and public limited companies whose paid
up capital and free reserves exceeds Rs. 10/- crores or turnover of Rs. 50/-
crores, there should be a certification by the CEO ( either the Executive
Director or the Managing Director) and the CFO(whole-time Finance Director
or otherwise) to the effect:-
They, the signing officers, have reviewed the balance sheet and profit and
loss account and all its schedules and notes on accounts, as well as the
cash flow statements and the Directors’ Report.
These statements do not contain any material untrue statement or omit any
material fact nor do they contain statements that might be misleading.
These statements together represent a true and fair picture of the financial
and operational state of the company, and are in compliance with the
existing accounting standards and/or applicable laws/regulations.
They, the signing officers, are responsible for establishing and maintaining
internal controls which have been designed to ensure that all material
information is periodically made known to them; and have evaluated the
effectiveness of internal control systems of the company.
132 Supra n. 126. 133 Ibid.
120
They, the signing officers, have disclosed to the auditors as well as the
Audit Committee deficiencies in the design or operation of internal
controls, if any, and what they have done or propose to do to rectify these
deficiencies.
In the event of any materially significant misstatements or omissions, the
signing officers will return to the company that part of any bonus or
incentive- or equity-based compensation which was inflated on account of
such errors, as decided by the Audit Committee.134
Auditing the Auditors
There should be established, with appropriate legislative support, three
independent Quality Review Boards (QRB), one each for the ICAI, the ICSI
and ICWAI, to periodically examine and review the quality of audit,
secretarial and cost accounting firms, and pass judgment and comments on the
quality and sufficiency of systems, infrastructure and practices. The
composition of the Committee and other details are also dealt with by the
Committee in its report.135
Independent Directors
In defining an independent director of a company, the committee has
recommend that he is a non-executive director who, apart from receiving
directors’ remuneration, does not have any material pecuniary relationship or
transactions with the company, its promoters, its senior management or its
holding company, its subsidiary and associated companies. Such a director:-
is not related to promoters or management at the board level, or one level
below the board(spouse and dependent parents, children or siblings).
has not been an executive of the company in the last three years.
is not a partner or an executive of the statutory auditing firm, the internal
audit firm that are associated with the company and has not been a partner
or an executive of any such firm for the last three years. This will also
apply to legal firms and consulting firms that have a material association
with the company.
134 Id. at A 265. 135 Ibid.
121
is not a significant supplier , vendor or customer of the company.
is not a substantial shareholder of the company i.e., owning two percent or
more of the block of voting shares.
has not been a director, independent or otherwise, of the company for more
than three terms of three years ( non-exceeding nine years in any case).
any employee, executive director or nominee of any bank, financial
institution, corporations or trustees of debentures and bond holders, who is
normally called ‘nominee director’ will be excluded from the pool of
directors in the determination of the number of independent directors.
Such a director will not feature either in the numerator or the denominator.
The committee also recommend that independent directors must have
adequate directors should not be less than 50% of the board of directors.
However, this requirement will not apply to unlisted public companies which
have no more than 50 shareholders and which are without debt of any kind
from the public, banks or financial institutions, so long as they do not change
their character.136
Minimum board size of listed companies
The minimum board size of all listed companies, as well as unlisted public
limited companies with a paid paid up share capital and free reserves of Rs.10
crore and above, or turnover of Rs.50 crore and above should be seven — of
which at least four should be independent directors. However, this will not
apply to: (1) unlisted public companies, which have no more than 50
shareholders and which are without debt of any kind from the public, banks, or
financial institutions, as long as they do not change their character, (2) unlisted
subsidiaries of listed companies.137
Tele-conferencing and Video conferencing
If a director cannot be physically present but wants to participate in the
proceedings of the board and its committees, then minute and signed
proceedings of a tele-conference or video conference should constitute proof
136 See Executive Summary of Naresh Chandra Committee, http://finmin.nic.in/reports/chandra.pdf,
Date:- 10th of January 2012, Time:-7:47 P.M. 137 Ibid.
122
of his or her participation. Accordingly, this should be treated as presence in
the meeting(s). However, minutes of all such meetings should be signed and
confirmed by the director/s who has/have attended the meeting through video
conferencing.138
The Committee also recommends that the aforesaid category
of public companies should transmit all press release and presentation to
analysts to all board members139
.
Audit Committee should consist exclusively of Independent Directors
This should apply to all listed and unlisted public companies with a paid up
share capital and free reserves of Rs. 10/- crores and more or turnover of Rs.
50/- crores and more. However, this will not apply to unlisted public
companies which have no more than 50 shareholders and which are without
debt of any kind from the public, banks or financial institutions as long as they
do not change their character and unlisted subsidiaries of listed companies.
The role and functions that an Audit Committee is suppose to discharge in a
company should be clearly laid out in an Audit Committee charter.
The Audit Committee should disclose the name of members of the Audit
Committee, the dates and frequency of meetings. The Chairman of the
Committee must certify whether and to what extent each of the functions listed
in the charter were discharged in the course of the year. This will serve as the
Committee’s action taken report to the shareholders.
The disclosure should also give a report of tasks performed by the Committee,
including among others, the Committee’s views on the adequacy of internal
control systems, perceptions of risks and in the event of any disqualification,
why the Audit Committee accepted and recommended the financial statement
with qualification. The statement should also certify whether the Committee
met with the statutory and internal auditors of the company without the
presence of management and whether such meetings revealed materially
significant issues or risks.140
138
Ibid. 139 Ibid. 140 Ibid.
123
Remuneration of non-executive directors
The statutory limit on sitting fees should be reviewed, although ideally it
should be a matter to be resolved between the management and the
shareholders. In addition, loss-making companies should be permitted by the
DCA to pay special fees to any independent director, subject to reasonable
caps, in order to attract the best restructuring and strategic talents to the boards
of such companies. The present provisions relating to stock options, and to the
one percent commission on net profits, is adequate and does not, at present,
need any revision. However, the vesting schedule of stock options should be
staggered over at least three years, so as to align the independent and
executive directors, as well as managers two levels below the Board, with the
long- term profitability and value of the company.141
Exempting non-executive directors from certain liabilities
Time has come to insert provisions in the definitions chapter of certain Acts to
specifically exempt nonexecutive and independent directors from such
criminal and civil liabilities. An illustrative list of these Acts are the
Companies Act, Negotiable Instruments Act, Provident Fund Act, ESI Act,
Factories Act, Industrial Disputes Act and the Electricity Supply Act.
Independent directors should also be indemnified from costs of litigation
etc.142
Training of independent directors
DCA should encourage institutions of prominence including their proposed
Centre for Corporate Excellence to have regular training programmes for
independent directors. In framing the programmes, and for other preparatory
work, funding could possibly come from the IEPF.
All independent directors should be required to attend at least one such
training course before assuming responsibilities as an independent director, or,
considering that enough programmes might not be available in the initial
years, within one year of becoming an independent director. An untrained
141 Supra n. 136. 142
Ibid.
124
independent director should be disqualified under section 274(1)(g) of the
Companies Act, 1956 after being given reasonable notice.
Considering that enough training institutions and programmes might not be
available in the initial years, this requirement may be introduced in a phased
manner, so that the larger listed companies are covered first. The executing
bodies must clearly state their plan for the year and their funding should be
directly proportionate to the extent to which they execute such plans. There
should be a ‘trainee appraisal’ system to judge the quality of the programme
and so help decide, in the second round, which agencies should be given a
greater role and which should be dropped.143
Corporate Serious Fraud Office
A Corporate Serious Frauds Office (CSFO) should be set up in the Department
of Company Affairs with specialists inducted on the basis of
transfer/deputation and on special term contracts. This should be in the form
of a multi-disciplinary team that not only uncovers the fraud, but is also able
to direct and supervise prosecutions under various economic legislations
through appropriate agencies. There should be a Task Force constituted for
each case under a designated team leader. In the interest of adequate control
and efficiency, a Committee each, headed by the Cabinet Secretary should
directly oversee the appointments to, and functioning of this office, and
coordinate the work of concerned departments and agencies. The Committee
also stated that good corporate governance is good business because it inspires
investors’ confidence, which is to essential to attracting capital.144
3.4.2.5 N.R. Narayan Murthy Committee
With the belief that the efforts to improve corporate governance standards in
India must continue because these standards themselves were evolving in
keeping with the market dynamics, the Securities and Exchange Board of
India had constituted a Committee on Corporate Governance in 2002 , in
order to evaluate the adequacy of existing corporate governance practices and
143 Ibid. 144 Ibid.
125
further improve these practices. It was set up to review Clause 49, and suggest
measures to improve corporate governance standards.
The SEBI Committee was constituted under the Chairmanship of Shri N. R.
Narayana Murthy, Chairman and Chief Mentor of Infosys Technologies
Limited. The Committee comprised members from various walks of public
and professional life. This included captains of industry, academicians, public
accountants and people from financial press and industry forums.
The terms of reference of the committee were to:
review the performance of corporate governance; and
determine the role of companies in responding to rumour and other price
sensitive information circulating in the market, in order to enhance the
transparency and integrity of the market.
The issues discussed by the committee primarily related to audit committees,
audit reports, independent directors, related parties, risk management,
directorships and director compensation, codes of conduct and financial
disclosures. The committee's recommendations in the final report were
selected based on parameters including their relative importance, fairness,
accountability, transparency, ease of implementation, verifiability and
enforceability.145
The mandatory recommendations of the Committee are as
following:-
Audit committees of publicly listed companies should be required to
review the following information mandatorily:
Financial statements and draft audit report, including quarterly / half-
yearly financial information.
Management discussion and analysis of financial condition and results of
operations.
Reports relating to compliance with laws and to risk management.
Management letters / letters of internal control weaknesses issued by
statutory / internal auditors.
145 http://business.gov.in/corporate_governance/narayana_murthy.php , Date:- 17th of September
2010,Time:-11:35 PM.
126
Records of related party transactions.146
Financial literacy of members of audit committee
All audit committee members should be “financially literate” and at least
one member should have accounting or related financial management
expertise. The term “financially literate” means the ability to read and
understand basic financial statements i.e. balance sheet, profit and loss
account, and statement of cash flows.147
Disclosure of Accounting Treatment
In case a company has followed a treatment different from that prescribed
in an accounting standard, management should justify why they believe
such alternative treatment is more representative of the underlying
business transaction. Management should also clearly explain the
alternative accounting treatment in the footnotes to the financial
statements.148
Basis for Related Party Transactions
A statement of all transactions with related parties including their bases
should be placed before the independent audit committee for formal
approval / ratification. If any transaction is not on an arm’s length basis,
management should provide an explanation to the audit committee
justifying the same. The term “related party” shall have the same meaning
as contained in Accounting Standard 18, Related Party Transactions,
issued by the Institute of Chartered Accountants of India.149
Risk Management-Board Disclosure
Procedures should be in place to inform Board members about the risk
assessment and minimization procedures. These procedures should be
periodically reviewed to ensure that executive management controls risk
through means of a properly defined framework. Management should
place a report before the entire Board of Directors every quarter
146 http://www.sebi.gov.in/commreport/corpgov.pdf, Date:- 17th of September 2010.Time:-11:35 PM. 147 Ibid. 148 Ibid. 149 Ibid.
127
documenting the business risks faced by the company, measures to address
and minimize such risks, and any limitations to the risk taking capacity of
the corporation. This document should be formally approved by the
Board.150
Use of Proceeds of IPO
Companies raising money through an Initial Public Offering (“IPO”)
should disclose to the Audit Committee, the uses / applications of funds by
major category (capital expenditure, sales and marketing, working capital,
etc), on a quarterly basis. On an annual basis, the company shall prepare a
statement of funds utilised for purposes other than those stated in the offer
document/prospectus. This statement should be certified by the
independent auditors of the company. The audit committee should make
appropriate recommendations to the Board to take up steps in this
matter.151
Written Code of Conduct for Executive Management
It should be obligatory for the Board of a company to lay down the code of
conduct for all Board members and senior management of a company.
This code of conduct shall be posted on the website of the company. All
Board members and senior management personnel shall affirm compliance
with the code on an annual basis. The annual report of the company shall
contain a declaration to this effect signed off by the CEO and COO.152
Exclusion of nominee directors from the definition of independent
directors
There shall be no nominee directors. Where an institution wishes to
appoint a director on the Board, such appointment should be made by the
shareholders. An institutional director, so appointed, shall have the same
responsibilities and shall be subject to the same liabilities as any other
director. Nominee of the Government on public sector companies shall be
150 Supra n. 146. 151 Ibid. 152 Ibid.
128
similarly elected and shall be subject to the same responsibilities and
liabilities as other directors.153
Non-Executive directors Compensation-Limits on Compensation paid
to independent directors
All compensation paid to non-executive directors may be fixed by the
Board of Directors and should be approved by shareholders in general
meeting. Limits should be set for the maximum number of stock options
that can be granted to non-executive directors in any financial year and in
aggregate. The stock options granted to the nonexecutive directors shall
vest after a period of at least one year from the date such nonexecutive
directors have retired from the Board of the Company. Companies should
publish their compensation philosophy and statement of entitled
compensation in respect of non-executive directors in their annual report,
together with the details of shares held including on an ‘if converted
basis’. Non Alternatively, this may be put up on the company’s website
and reference drawn thereto in the annual report. Non-executive directors
should be required to disclose their stock holding both own and held on
beneficial basis in the listed company in which they are proposed to be
appointed as directors, prior to their appointment. This should accompany
their notice of appointment.154
Independent Directors-Definition
The committee has adopted the same definition of ‘independent director’
as formulated by the Naresh Chandra Committee. The only item that does
not find a place relates to maximum period for which the person has been a
director, independent or otherwise of the company for more than three
terms of three years duration each.155
Internal Policy on access to audit committees
Personnel who observe an unethical or improper practice (not necessarily a
violation of law) should be able to approach the audit committee without
153 D.K. Prahlada Rao, “Emerging Trends in Corporate Governance”, Charted Secretary, August
2003,p. A 267.. 154 Ibid. 155 Ibid.
129
necessarily informing their supervisors. Companies shall take measures to
ensure that this right of access is communicated to all employees through
means of internal circulars, etc. The employment and other personnel
policies of the company shall contain provisions protecting “whistle
blowers” from unfair termination and other unfair prejudicial employment
practices.156
Whistle blower policy
Companies shall annually affirm that they have not denied any personnel
access to the audit committee of the company in respect of matters
involving alleged misconduct and that they have provided protection to
“whistle blowers” from unfair termination and other unfair or prejudicial
employment practices. The appointment, removal and terms of
remuneration of the chief internal auditor must be subject to review by the
Audit Committee. Such affirmation shall form a part of the Board report
on Corporate Governance that is required to be prepared and submitted
together with the annual report.157
Subsidiary Companies-Audit Committee Requirements
The provisions relating to the composition of the Board of Directors of the
holding company should be made applicable to the composition of the
Board of Directors of subsidiary companies. At least one independent
director on the Board of Directors of the parent company shall be a
director on the Board of Directors of the subsidiary company. The Audit
Committee of the parent company shall also review the financial
statements, in particular the investments made by the subsidiary company.
The minutes of the Board meetings of the subsidiary company shall be
placed for review at the Board meeting of the parent company. The Board
report of the parent company should state that they have reviewed the
affairs of the subsidiary company also.158
156 Ibid. 157 Ibid. 158 http://www.sebi.gov.in/commreport/corpgov.pdf, Date:- 17th of September 2010.Time:-11:35 PM.
130
SEBI should make rules for the following:
Disclosure in the report issued by a security analyst whether the
company that is being written about is a client of the analyst’s
employer or an associate of the analyst’s employer, and the nature of
services rendered to such company, if any; and
Disclosure in the report issued by a security analyst whether the
analyst or the analyst’s employer or an associate of the analyst’s
employer hold or held (in the 12 months immediately preceding the
date of the report) or intend to hold any debt or equity instrument in the
issuer company that is the subject matter of the report of the analyst.159
3.4.2.6 Dr. Jamshed J Irani Committee
A Committee was constituted on 2nd
December 2004 under the chairmanship
of Dr. JJ Irani Director Tata Sons, with task of advising the Government on
the proposed revisions of Companies Act 1956.The Expert Committee consists
of 13 members and 6 special invitees drawn from various disciplines and
fields including trade and industry, chambers of commerce, professional
institutes, representatives of Banks and Financial Institutions, Sr. Advocates
etc. Government Ministries as well as regulatory bodies concerned with the
subject were represented through special invitees. The Committee thus brings
to bear a wide range of expertise and experience on the issues before it.160
The
main recommendations by committee are as following:-
Law and Adaptation to changing circumstances: The existing
Companies Act, 1956 is a voluminous document with 781 sections. It also
contains provisions that cover aspects which are essentially procedural in
nature. In certain areas, it prescribes quantitative limits which are now
irrelevant on account of changes that have taken place over a period of
time. This format has also resulted in the law becoming very rigid. The
law has failed to take in to account the changes in the national and
international economic scenario speedily. The committee recommends that
many essential features of corporate governance which are already
159 Ibid. 160 See Report of Dr. J.J. Irani Committee Report on Company Law, , PDF File Format,
http://www.icai.org/resource_file/8315announ854.pdf , Date 26th of June 2010.Time:-12:41 A.M..
131
recognized in the Companies Act, 1956 need to be retained and articulated
further.161
One Person Company (O.P.C): The committee also recommends that the
law should recognize the formation of a single person economic entity in
the form of ‘One Person Company’. Such an entity may be provided with a
simpler regime through exemptions so that the single entrepreneur is not
compelled to fritter away this time, energy and resources on procedural
matters.162
E-Governance: The e-Governance Project (MCA-21) taken up by the
Government promises significant efficiency and gains to companies in
compliance processes. All registration process and statutory filings should
be made compatible to the electronic medium. Such filings should be kept
secure and should be identifiable through digital signatures. Process of
registration should be speedy, optimally priced and compatible with e-
Governance initiatives. Companies should be required to make necessary
declarations and disclosures about promoters and directors at the time of
incorporation. Stringent consequences should follow if incorporation is
done under false or misleading information.163
Enabling of Registrars of companies to use suo moto powers to strike
off names of defunct companies : The law should enable Registrars of
Companies to use suo moto powers to strike off names of defunct
companies ( a company which is not carrying on business or any
operation) effectively. They should also be empowered to strike off the
names of companies from the Register of Companies on application for the
purpose by the company directors or majority of them.164
Minimum and Maximum Number of Directors : Law should provide
for minimum number of directors for various classes of companies. The
present prescribed requirement is considered adequate. However new
kinds of companies will evolve to keep pace with emerging business
161 Ibid. 162 Ibid. 163 Ibid 164 Ibid
132
requirements. Law should therefore include enabling provisions to
prescribe specific categories or companies for which a different minimum
number may be laid down. The obligation of maintaining the required
minimum number of directors on the Board should be that of the
Company.165
Ultimate responsibility to appoint/remove directors should be that of
the Shareholders: The committee recommends that the ultimate
responsibility to appoint/remove directors should be that of the Company
(Shareholders). If the Directors themselves are legally disqualified to hold
directorship, they should have an equal responsibility of disclosing the fact
and reasons for their disqualification. Government should not intervene in
the process of appointment and removal of Directors in non-Government
companies.166
Presence of Independent Directors : The committee is of the view that
given the responsibility of the Board to balance various interests, the
presence of Independent directors on the Board of a Company would
improve corporate governance. This is particularly important for public
companies or companies with a significant public interest. Independence is
not to be viewed merely as independence from Promoter Interests but from
the point of view of vulnerable stakeholders who can not otherwise get
their voice heard. Law should therefore recognise the principle of
independent directors and spell out their role, qualifications and
liability.167
Determination of Managerial Remuneration : The committee has also
recommended that the issue of managerial remuneration should be
determined by the shareholders only , the committee also felt that the
existing method of computation of net profits for the purpose of
managerial remuneration, in the manner laid down in Sections 349 and 350
of the Act, should be done away with since the current provisions of the
165 Supra n.160. 166 Ibid. 167 Ibid.
133
Companies Act adequately ensure that a true and fair picture of the
company’s profit is presented.168
Audit Committee for Accounting and Financial Matters : The
committee recommends that:-
(a) Majority of the Directors to independent directors if the Company is
required to appoint Independent Directors;
(b) Chairman of the Committee also to be independent;
(c) At least one member of Audit Committee to have knowledge of
financial management or audit of accounts;
(d) The Chairman of the Audit Committee should be required to attend the
Annual General Meeting of the Company to provide any clarification on
matters relating to audit. If he is unable to attend due to circumstances
beyond his control, any other member of the Audit committee may be
authorized by him to attend the Annual General Meeting on his behalf.
(e) The recommendations of the Audit Committee if overruled by the
Board, should be disclosed in the Director’s Report along with reasons for
overruling.169
Liabilities of Independent And Non- Executive Directors : A non-
executive/ independent director should be held liable only in respect of any
contravention of any provisions of the Act which had taken place with his
knowledge ( attributable through Board processes) and where he has not
acted diligently, or with his consent or connivance. If the independent
director does not initiate any action knowledge of any wrong, such director
should be held liable. Knowledge should flow from the processes for the
Board. Additionally, upon knowledge of any wrong, follow up action/
dissent of such independent directors from the commission of the wrong
should be recorded in the minutes of the board meeting.170
Rights of Independent/Non – Executive Directors : Independent/Non –
Executive Directors should be able to :-
168 Ibid. 169 Ibid. 170 Ibid.
134
Call upon the Board for due diligence or obtaining of record of seeking
professional opinion by the Board;
Have the right to inspect records of the company;
Review legal compliance reports prepared by the company; and
In cases of disagreement, record their dissent in the minutes’171
Director’s duty to disclose interest : The committee recommends that the
law should impose a duty on every director to disclose to the company, the
contracts or arrangement with the company, whether existing or proposed
or acquired subsequently, in which he, directly or indirectly, has any
interest or concern. Failure to make disclosure should treated as a default.
Director concerned should be held liable to penalties and he should be
deemed to have vacated his office. This should also be a condition of
disqualification to hold office of director of that company for prescribed
period. Interested director should abstain from participating in the Board
meeting during consideration of relevant agenda item in which he is
interested. The company should maintain a register, in which all
transactions above a prescribed threshold value in respect of
contracts/arrangements, in which directors are interested, should be
entered. The registered should be kept at registered office of the company
and should be open to inspection to all members.172
Remuneration of Auditors : The committee discussed the provisions
relating to the payment of remuneration of the Auditors and felt that this
should be subject to decision by shareholders and that the provisions in the
existing law provided a suitable framework for the purpose. However, the
Committee felt that basic remuneration to be termed as ‘Audit Fee’ should
be distinguished from reimbursement of expenses. Reimbursement of
expenses to Auditors should not form part of remuneration but should be
171 See Report of Dr. J.J. Irani Committee Report on Company Law, PDF File Format,
http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf , Date:- 20th of June 2010.
Time:- 2:48 P.M. 172 Ibid.
135
disclosed separately in the Financial Statements along with the Auditor’s
fees.173
Rotation of Auditors : The committee recommends that rotation of Audit
partner should place every five years in the case of all listed Companies
was also considered by the committee. However, the Committee thought it
fit that the matter of change of Auditors be left to the shareholders of the
Company and the Auditors themselves rather than be provided under
law.174
Provision of Non- Audit Services : The committee took note of the fact
that rendering on non-audit services by Auditors of the Company was is a
matter of general concern. The Committee was of the view that rendering
of all services by the Auditors which were not related to audit, accounting
records or financial statements, should not be prohibited from being
rendered by the Auditors subject to a prescribed threshold of materially.
All non audit services may however be pre-approved by Audit Committee
where such a committee is mandated or in existence.
An Audit firm should however be prohibited from rendering the following
non audit services to its audit client and its subsidiaries:
Accounting and book keeping services relating to accounting records
Internal Audit
Design and implementation of financial information system including
services related IT system for preparing financial or management
accounts and information flows of a company.
Actuarial services
Investment Advisory or Investment banking services
Rendering of outsourced financial services.
173 Ibid. 174 Ibid.
136
Management function including provision of temporary staff to audit
clients.175
Single Window Concept : The law should provide for a single forum
which would approve the scheme of mergers and acquisition in an
effective manner. The law should also provide for mandatory intimation to
regulators in respect of specified class of companies.176
Protection to Whistle Blowers : Law should recognize the “ Whistle
Blower Concept” by enabling protection to individuals who expose
offences by companies, particularly those involving fraud. Such protection
should extend to normal terms and conditions of service and from
harassment. Further , if such employees are themselves implicated, their
cooperation should lead to mitigation of penalties to which they may
otherwise be liable.177
3.4.2.7 Corporate Governance Voluntary Guidelines 2009
The Ministry of Corporate Affairs has examined committee reports as well as
suggestions received from various stakeholders on issues related to corporate
governance. Keeping in mind that the subject of corporate governance may go
well beyond the Law and that there are inherent limitations in enforcing many
aspects of corporate governance through legislative or regulatory means, it has
been considered necessary that a set of voluntary guidelines called “Corporate
Governance -Voluntary Guidelines 2009” which are relevant in the present
context, are prepared and disseminated for consideration and adoption by
corporate. These guidelines provide for a set of good practices which may be
voluntarily adopted by the Public companies. Private companies, particularly
the bigger ones, may also like to adopt these guidelines.178
The guidelines are
not intended to be a substitute for or addition to the existing laws but are
recommendatory in nature. The main guidelines are as following:-
175
Supra n. 171. 176 Ibid. 177 Ibid. 178 See Corporate Governance Guidelines, p.9, PDF File Format,
http://www.mca.gov.in/Ministry/latestnews/CG_Voluntary_Guidelines_2009_24dec2009.pdf , Date:-
28th of June 2010, Time:-12:58 A.M.
137
Board of Directors
Appointment of Non- Executive Directors
Companies should issue formal letters of appointment to Non- Executive
Directors (NEDs) and Independent Directors - as is done by them while
appointing employees and Executive Directors. The letter should specify:
- The term of the appointment;
- The expectation of the Board from the appointed director; the Board-
level committee(s) in which the director is expected to serve and its
tasks;
- The fiduciary duties that come with such an appointment alongwith
accompanying liabilities;
- Provision for Directors and Officers (D&O) insurance, if any,;
- The Code of Business Ethics that the company expects its directors and
employees to follow;
- The list of actions that a director should not do while functioning as
such in the company; and
- The remuneration, including sitting fees and stock options etc, if any.
Such formal letter should form a part of the disclosure to shareholders at
the time of the ratification of his/her appointment or re-appointment to the
Board. This letter should also be placed by the company on its website, if
any, and in case the company is a listed company, also on the website of
the stock exchange where the securities of the company are listed.179
Separation of Offices of Chairman & Chief Executive Officer
To prevent unfettered decision making power with a single individual,
there should be a clear demarcation of the roles and responsibilities of the
Chairman of the Board and that of the Managing Director/Chief Executive
Officer (CEO). The roles and offices of Chairman and CEO should be
separated, as far as possible, to promote balance of power.180
179 Id. at 10. 180 Ibid.
138
Number of Companies in which an Individual may become a Director
In case an individual is a Managing Director or Whole-time Director in a
public company the maximum number of companies in which such an
individual can serve as a Non-Executive Director or Independent Director
should be restricted to seven.181
For reckoning the maximum limit of
directorships, the following categories of companies should be included:-
• public limited companies,
• private companies that are either holding or subsidiary companies of
public companies.
Independent Director
The Board should put in place a policy for specifying positive attributes of
Independent Directors such as integrity, experience and expertise,
foresight, managerial qualities and ability to read and understand financial
statements. Disclosure about such policy should be made by the Board in
its report to the shareholders. Such a policy may be subject to approval by
shareholders.182
Detailed Certificate of Independence
All Independent Directors should provide a detailed Certificate of
Independence at the time of their appointment, and thereafter annually.
This certificate should be placed by the company on its website, if any,
and in case the company is a listed company, also on the website of the
stock exchange where the securities of the company are listed.183
Independent Directors to have the Option and Freedom to meet
Company Management periodically
In order to enable Independent Directors to perform their functions
effectively, they should have the option and freedom to interact with the
company management periodically. Independent Directors should be
provided with adequate independent office space and other resources and
support by the companies including the power to have access to
181 Id. at 11. 182 Id. at 12. 183 Ibid.
139
additional information to enable them to study and analyze various
information and data provided by the company management.
Tenure for Independent Director
An Individual may not remain as an Independent Director in a company
for more than six years. A period of three years should elapse before such
an individual is inducted in the same company in any capacity. No
individual may be allowed to have more than three tenures as Independent
Director in the manner suggested in 'i' and 'ii' above. The maximum
number of pubic companies in which an individual may serve as an
Independent Director should be restricted to seven.184
Remuneration of Directors
The companies should ensure that the level and composition of
remuneration is reasonable and sufficient to attract, retain and motivate
directors of the quality required to run the company successfully. It should
also be ensured that relationship of remuneration to performance is clear.
Incentive schemes should be designed around appropriate performance
benchmarks and provide rewards for materially improved company
performance. Benchmarks for performance laid down by the company
should be disclosed to the members annually.185
Remuneration of Non-Executive Directors (NEDs):
The companies should have the option of giving a fixed contractual
remuneration, not linked to profits, to NEDs. The companies should have
the option to:
pay a fixed contractual remuneration to its NEDs, subject to an
appropriate ceiling depending on the size of the company; or
pay up to an appropriate percent of the net profits of the company.
The choice should be uniform for all NEDs, i.e. some should not be paid a
commission on profits while others are paid a fixed amount. If stock
options are granted as a form of payment to NEDs, then these should be
184 Ibid. 185 Supra n. 178 p.13.
140
held by the concerned director until three years of his exit from the
Board.186
Remuneration of Independent Directors (IDs)
In order to attract, retain and motivate Independent Directors of quality to
contribute to the company, they should be paid adequate sitting fees which
may depend upon the twin criteria of Net Worth and Turnover of
companies. The IDs may not be allowed to be paid stock options or profit
based commissions, so that their independence is not compromised.187
Remuneration Committee
Companies should have Remuneration Committee of the Board. This
Committee should comprise of at least three members, majority of whom
should be non executive directors with at least one being an Independent
Director. This Committee should have responsibility for determining the
remuneration for all executive directors and the executive chairman,
including any compensation payments, such as retirement benefits or stock
options. It should be ensured that no director is involved in deciding his or
her own remuneration.188
Responsibilities of the Board
The board has the following responsibilities:-
Training of Directors
The companies should ensure that directors are inducted through a suitable
familiarization process covering, inter-alia, their roles, responsibilities and
liabilities. Efforts should be made to ensure that every director has the
ability to understand basic financial statements and information and related
documents/papers. There should be a statement to this effect by the Board
186 Ibid. 187
Id. at 14. 188 Ibid.
141
in the Annual Report. Besides this, the Board should also adopt suitable
methods to enrich the skills of directors from time to time.189
Enabling Quality Decision making
The Board should ensure that there are systems, procedures and resources
available to ensure that every Director is supplied, in a timely manner,
with precise and concise information in a form and of a quality appropriate
to effectively enable/ discharge his duties. The Directors should be given
substantial time to study the data and contribute effectively to Board
discussions.190
Risk Management
The Board, its Audit Committee and its executive management should
collectively identify the risks impacting the company's business and
document their process of risk identification, risk minimization, risk
optimization as a part of a risk management policy or strategy. The Board
should also affirm and disclose in its report to members that it has put in
place critical risk management framework across the company, which is
overseen once every six months by the Board. The disclosure should also
include a statement of those elements of risk, that the Board feels, may
threaten the existence of the company.191
Evaluation of Performance of Board of Directors, Committees thereof
and of Individual Directors
The Board should undertake a formal and rigorous annual evaluation of its
own performance and that of its committees and individual directors. The
Board should state in the Annual Report how performance evaluation of
the Board, its committees and its individual directors has been
conducted.192
189 See also Corporate Governance Guidelines, p.15, PDF File Format,
http://www.mca.gov.in/Ministry/latestnews/CG_Voluntary_Guidelines_2009_24dec2009.pdf , Date:-
28th of June 2010, Time:-12:58 A.M. 190 Ibid. 191 Id. at 16. 192 Ibid.
142
Board to place Systems to ensure Compliance with Laws
In order to safeguard shareholders' investment and the company's assets,
the Board should, at least annually, conduct a review of the effectiveness
of the company's system of internal controls and should report to
shareholders that they have done so. The review should cover all material
controls, including financial, operational and compliance controls and risk
management systems.193
Audit Committee of Board
The companies should have at least a three-member Audit Committee,
with Independent Directors constituting the majority. The Chairman of
such Committee should be an Independent Director. All the members of
audit committee should have knowledge of financial management, audit or
accounts.
Powers
The Audit Committee should have the power to -
- have independent back office support and other resources from the
company;
- have access to information contained in the records of the company;
and
- obtain professional advice from external sources.
The Audit Committee should also have the facility of separate discussions
with both internal and external auditors as well as the management.194
Role and Responsibilities
The Audit Committee should have the responsibility to -
monitor the integrity of the financial statements of the company;
review the company's internal financial controls, internal audit function
and risk management systems;
193 Ibid. 194
Supra n.189 p.17.
143
make recommendations in relation to the appointment, reappointment
and removal of the external auditor and to approve the remuneration
and terms of engagement of the external auditor;
review and monitor the external auditor's independence and objectivity
and the effectiveness of the audit process.
The Audit Committee should also monitor and approve all Related Party
Transactions including any modification/amendment in any such
transaction.195
Auditors
Appointment of Auditors
The Audit Committee of the Board should be the first point of reference
regarding the appointment of auditors. The Audit Committee should have
regard to the profile of the audit firm, qualifications and experience of
audit partners, strengths and weaknesses, if any, of the audit firm and other
related aspects. 196
Certificate of Independence
Every company should obtain a certificate from the auditor certifying
his/its independence and arm's length relationship with the client company.
The Certificate of Independence should certify that the auditor together
with its consulting and specialized services affiliates, subsidiaries and
associated companies or network or group entities has not/have not
undertaken any prohibited non-audit assignments for the company and are
independent vis-à-vis the client company.197
Rotation of Audit Partners and Firms
In order to maintain independence of auditors with a view to look at an
issue (financial or non-financial) from a different perspective and to carry
out the audit exercise with a fresh outlook, the company may adopt a
policy of rotation of auditors which may be as under:-
195 Ibid. 196 Id. at 18. 197 Ibid.
144
Audit partner - to be rotated once every three years.
Audit firm - to be rotated once every five years.
A cooling off period of three years should elapse before a partner can
resume the same audit assignment. This period should be five years for the
firm.198
Appointment of Internal Auditor
An order to ensure the independence and credibility of the internal audit
process, the Board may appoint an internal auditor and such auditor, where
appointed, should not be an employee of the company.199
Secretarial Audit
Since the Board has the overarching responsibility of ensuring
transparent, ethical and responsible governance of the company, it is
important that the Board processes and compliance mechanisms of the
company are robust. To ensure this, the companies may get the
Secretarial Audit conducted by a competent professional. The Board
should give its comments on the Secretarial Audit in its report to the
shareholders.200
Institution of Mechanism For Whistle Blowing
The companies should ensure the institution of a mechanism for
employees to report concerns about unethical behaviour, actual or
suspected fraud, or violation of the company's code of conduct or
ethics policy. The companies should also provide for adequate
safeguards against victimization of employees who avail of the
mechanism, and also allow direct access to the Chairperson of the
Audit Committee in exceptional cases.201
198 Id. at 19. 199 Ibid. 200 Id. at 20. 201 Ibid.
145
3.5 Review
We can conclude from the above discussions that the issue of corporate
governance has attracted explicit attention in India from academics,
government, the popular press and industry and capital markets with the
adoption of the structural adjustment and globalization policy by the
government in July 1991 when the economy opened up of its industrial and
financial sector to international competition and increased private ownership.
Various efforts have been taken at industry and government circles regarding
the formulation of a well-defined code of corporate governance in India since
the second half of the 1990s.
The term corporate governance broadly refers to the set of rules that are
designed to govern the behavior of firms. The governance mechanism, which
are normally considered pertain to the regulations monitoring product market
competition and industrial policy, the capital market, the market for corporate
control and institutional supervision through various government bodies like
Ministry of Corporate Affairs, Securities and Exchange Board of India, etc. as
in India and also the internal monitoring and control system of the firm headed
by the board of directors. Accordingly, there emerge different sets of rules to
handle the various dimensions of corporate governance issues.
Scams led the government and its authorities to constitute committee on issue
of corporate governance and development of code of corporate governance.
Cadbury Committee, King Committee, OECD Principles on Corporate
Governance, Blue Ribbon Committee, CACG Guidelines-Principles for
Corporate Governance in the Commonwealth(1999), Hampel Committee on
Audit and Accountability are the main committees appointed in world on issue
of corporate governance.
In India , the Government and its authorities has appointed Kumar Mangalam
Birla Committee, Naresh Chandra Committee, N.R. Narayana Murthy
Committee on Corporate Governance, Dr. JJ Irani Committee Report on
Company Law for giving the suggestion of code of corporate governance.
Ministry of Corporate Affairs Government of India has drafted the Corporate
Governance Voluntary Guidelines 2009.
146
Corporate governance extends beyond corporate law. Its fundamental
objective is not mere fulfillment of the requirements of law , but in ensuring
commitment of the Board in managing the company in a transparent manner
for maximizing long term shareholder value. Effectiveness of a system of
corporate governance can not be legislated by law nor can any system of
corporate governance be static. In a dynamic environment, system of corporate
governance need to continually evolve. There are several corporate
governance structures available in the developed world, but there is no one
structure, which can be singled out as being better than the others. There is no
“one size fits all” structure for corporate governance.