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    Corporate Governance

    PROF SANJIV MITTAL

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    The Institute of Company Secretaries of India

    CorporateGovernance is the application of best

    management practices, compliance of law in letter

    and spirit and adherence to ethical standards

    for effective management and distribution of wealth

    and discharge of social responsibility for sustainable

    development of all stakeholders

    Corporate Governance

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    Present Corporate Governance In India

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    Principles of corporate governance

    1.Rights and equitable treatment of shareholders:Organizations should respect the rights of shareholders andhelp shareholders to exercise those rights.

    2.Interests of other stakeholders: Organizations shouldrecognize that they have legal and other obligations to alllegitimate stakeholders.

    3.Role and responsibilities of the board: The board needs arange of skills and understanding to be able to deal with

    various business issues and have the ability to review andchallenge management performance.

    4.Integrity and ethical behavior:Organizations shoulddevelop a code of conduct for their directors and executives

    that promotes ethical and responsible decision making.

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    Internal corporate governance controls

    1.Monitoring by the board of directors: The board of directors,with its legal authority to hire, fire and compensate top management,safeguards invested capital. Regular board meetings allow potentialproblems to be identified, discussed and avoided.

    2.Internal control procedures and internal auditors: Internal controlprocedures are policies implemented by an entity's board of directors,audit committee, management, and other personnel to provide reasonableassurance of the entity achieving its objectives related to reliable financialreporting, operating efficiency, and compliance with laws and regulations.

    3.Balance of power: The simplest balance of power is very common;require that the President be a different person from the Treasurer.

    4. Remuneration: Performance-based remuneration is designed to relate

    some proportion of salary to individual performance.

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    External corporate governance controls

    External corporate governance controls encompass the controlsexternal stakeholders exercise over the organization.Examples include:

    Competition

    debt covenants demand for and assessment of performance information

    (especially financial statements)

    government regulations

    managerial labour market media pressure

    takeovers

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    1. The directors powers are normally set out in the articles. The

    shareholders cannot control the way in which the Board of directorsact provided its actions are within the powers given to the Board.

    2. Section 291 of Companies Act, General PowersBoard is entitled toexercise all such powers and do all such acts and things, subject tothe provisions of the Companies Act, as the company is authorized toexercise and do. However, the Board shall not exercise any powerwhich is required whether by the Act or by the memorandum orarticles of the company or otherwise to be exercised or done by thecompany in general meeting.

    3. Power of the individual directors Unless the Act or the articlesotherwise provide, the decisions of the Board are required to be themajority decisions only. Individual directors do not have any generalpowers. They shall have only such powers as are vested in them bythe Memorandum and Articles.

    Board of DirectorsPOWERS

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    4. Section 292(1) provides that the Board of directors of a

    company shall exercise the following powers on behalf ofthe company and it shall do so only by means of resolutionpassed at meeting of the Board:

    a. the power to make calls on shareholders in respect ofmoney unpaid on their shares;

    b. the power to authorize the buy-back referred to in the firstproviso to clause (b) of sub-section (2) of section 77A;

    c. the power to issue debentures;d. the power to borrow moneys otherwise than on

    debentures;

    e. the power to invest funds of the company; andf. the power to make loan.

    Board of DirectorsPOWERS

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    Board of DirectorsDUTIESSTATUTORY DUTIES

    1. To file return of allotment: Section 75 .

    2. Not to issue irredeemable preference share or shares orshare redeemable after 20 years

    3. To disclose interest (Section 299-300)

    4. To disclose receipt of compensation from transferee ofshares (Sec.320)

    5. Duty to attend Board meetings

    6. To convene statutory, Annual General meeting (AGM) andalso extraordinary general meetings [ Section 165,166 &169]

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    7. To prepare and place at the AGM along with the balancesheet and profit & loss account a report on the companysaffairs including the report of the Board of Directors(Section 173, 210 & 217).

    8. To authenticate and approve annual financial statement(Section 215).

    9. To appoint first auditor of the company (Section 224).

    10. To appoint cost auditor of the company (Section 233B).

    11. To make a declaration of solvency in the case of Membersvoluntary winding up (Section 488

    Board of DirectorsDUTIESSTATUTORY DUTIES

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    1. Duty of good faith

    2. Duty of Care

    3. Duty Not to Delegate

    Board of DirectorsGENERAL DUTIES

    LIABILITIES

    A. Liabilities to the Company

    Breach of fiduciary duty

    Ultra Virus Act

    Negligence

    Mala fide Acts

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    Board of DirectorsB. Liabilities to third parties

    Liabilities under Companies ActProspectusWith regard to allotmentUnlimited Liability

    Fraudulent Trading

    C. Liability for breach of Statutory Duties

    D. Liability for acts of co-directors

    E. Criminal Liability

    LIABILITIES

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    Corporate Governance

    CORPORATE GOVERNANCE is the system by which companiesare directed and controlled by the management in the bestinterest of the shareholders and others ensuring greatertransparency and better and timely financial reporting. TheBoard of Directors are responsible for governance of theircompanies.

    CORPORATE GOVERNANCE is needed to create a corporateculture of consciousness, transparency and openness. It refersto combination of laws, rules, regulations, procedures and

    voluntary practices to enable the companies to maximize theshareholders long-term value. It should lead to increasingcustomer satisfaction, shareholder value and wealth.

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    Corporate Governance

    The basic objective of Corporate Governance would be"enhancement of the long-term shareholders value while atthe same time protecting the interests of otherstakeholders."

    3 key constituents of Corporate Governance are:

    1.the Shareholders,

    2.the Board of Directors and3.the Management.

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    Corporate GovernanceSteps taken by SEBI for strengthening corporate

    governance through the amendment of the listingagreement are:

    Strengthening of disclosure norms for IPOs

    Providing information in directors report for utilization andvariation of funds of the company including the cash flow andfund flow statements in the annual reports.

    Declaration of unaudited quarterly results;

    Mandatory appointment of compliance officer for monitoringthe share transfer process and ensuring compliance withvarious rules, regulations;

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    Corporate Governance

    Timely disclosure of material and price sensitive informationincluding details of all material events having a bearing on theperformance of the company;

    Dispatch of one copy of complete balance sheet to everyhousehold and abridged balance sheet to all shareholders.

    Issue of guidelines for preferential allotment of shares atmarket related prices and

    Issue of rules and regulations to ensure an fair andtransparent framework for takeovers and substantialacquisition of shares

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    C t t t t

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    Current status on corporategovernance

    It creates an open and transparent system

    It improves communication and breaks downsystematic barriers to flow of information

    Good governance allows decision makingbased on data. It reduces risk

    Good governance helps in creating a brandand creates comfort for all stakeholders andsociety

    Good governance leads to good performance

    G Ri k M t d C li

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    Governance, Risk Management, and Compliance orGRC

    Governance describes the overall management

    approach through which senior executives direct and controlthe entire organization, using a combination of managementinformation and hierarchical management control structures.

    Risk management is the set of processes throughwhich management identifies, analyses, and where necessaryresponds appropriately to risks that might adversely affectrealization of the organization's business objectives.

    Compliance means conforming with statedrequirements. At an organizational level, it is achievedthrough management processes which identify the applicablerequirements (defined for example in laws, regulations,contracts, strategies and policies),

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    Effective corporate governance framework

    The corporate governance framework in India primarily consistsof the following legislations and regulations:

    1. The Companies Act, 1956: Companies in India, whether listed orunlisted, are governed by the Companies Act. The Act is administered by theDepartment of Companies Act (DCA). Among other things, the Act deals

    with rules and procedures regarding incorporation of a company; prospectusand allotment of ordinary and preference shares and debentures;management and administration of a company; annual returns; frequencyand conduct of shareholders meetings and proceedings; maintenance ofaccounts; board of directors, prevention of mismanagement and oppression

    of minority shareholder rights; and the power of investigation by thegovernment, including powers of the CLB.

    2.The Securities Contracts (Regulation) Act, 1956: It coversall types of tradable government paper, shares, stocks, bonds, debentures,and other forms of marketable securities issued by companies. The SCRA

    defines the parameters of conduct of stock exchanges as well as its powers.

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    Effective corporate governance framework

    3.The Securities and Exchange Board of India (SEBI) Act, 1992: Thisestablished the independent capital market regulatory authority, SEBI, withthe objective to protect the interests of investors in securities, and promoteand regulate the securities market.

    4. The Depositories Act, 1996: This established share and securities

    depositories, and created the legal framework for dematerialization ofsecurities.

    5. Listing Agreement with stock exchanges: These define the rules,processes, and disclosures that companies must follow to remain as listedentities. A key element of this is Clause 49, which states the corporate

    governance practices that listed companies must follow.

    Both DCA and SEBI have been conferred investigative powers.

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    Basic shareholder rights

    include the right to:

    1. Secure methods of ownership registration;Registration indepository and the unique account number is proof of ownership forthe shareholders.

    2. Convey or transfer shares; There are no restrictions on thetransferability of shares. The free transferability of shares cannot berestricted by private contractual agreements.

    3. Obtain relevant information on the corporation on a timely andregular basis; Most of the financial and non-financial information onthe companies is available on their websites or other commercialwebsites free of cost like detailed annual accounts etc.

    4. Participate and vote in general shareholder meetings; Section166 of the companies Act states that every company must hold anAnnual General Meeting (AGM) every year. The gap between two AGMsshould not exceed 15 months. Once the requisition for the generalmeeting is received, the board of directors must send the notice of

    meeting within 21days to all members.

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    Basic shareholder rights

    5. Elect and remove members of the board; Section 257 of the Companies

    Act, 1956, enables shareholders to elect members of the Board of Directors.Section 284 of the Companies Act enables a company to remove a directorthrough an ordinary resolution.

    6. Share in the profits of the corporation. Section 205207A of theCompanies Act deals with declaration and distribution of dividends. A

    company has to compulsorily transfer a certain percentage of dividend toreserve subject to a maximum of 10 per cent as per Companies (Transfer ofDividend to Reserves) Rules, 1975. A company can also pay dividend bycapitalizing its reserves also known as bonus dividend within 30 days of itsdeclaration and approved by its shareholders.

    7.Shareholders should have the right to participate in, and to besufficiently informed on, decisions concerning fundamentalcorporate changes such as:

    A. Amendments to the statutes, or articles of incorporation or similargoverning documents of the company;

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    Basic shareholder rights

    B. The authorization of additional shares; i.e. issue of new shares

    C.Extraordinary transactions including the transfer of all orsubstantially all assets, that in effect result in the sale of thecompany : Section 293 restricts the Board of directors of a company to

    sell, lease or otherwise dispose of the whole, or substantially the whole, ofthe undertaking of the company without passing a resolution in a generalmeeting to this effect.

    8. Shareholders should have the opportunity to participate effectively

    and vote in general shareholder meetings and should be informedof the rules, including voting procedures that govern generalshareholder meetings:

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    Basic shareholder rights

    9. Opportunity should be provided for shareholders to ask questionsof the board, including questions related to the annual externalaudit, to place items on the agenda of general meetings, and topropose resolutions subject to reasonable limitations.

    10. Effective shareholder participation in key corporate governancedecisions, such as the nomination of and election of boardmembers, should be facilitated.

    11. Shareholders should be able to make their views known on the

    remuneration policy for board members and key executives. Theequity component of compensation schemes for board membersand employees should be subject to shareholder approval. Section309

    12. Shareholders should be able to vote in person or in absentia, and

    equal effect should be given to votes whether cast in person or inabsentia. Section 176 to vote in absentia

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    Basic shareholder rights

    13. All shareholders of the same class should be treated equally. Thecorporate governance framework should ensure the equitable treatment ofall shareholders, including minority and foreign shareholders. Allshareholders should have the opportunity to obtain effective redress forviolation of their rights.

    14. Minority shareholders should be protected from abusive actionsby, or in the interest of, controlling shareholders, acting eitherdirectly or indirectly, and should have effective means of redress.Section 397 of the Act deals with relief in the case of oppression and section398 with mismanagement.

    15. Insider trading and abusive self-dealing should be prohibited.While insider-trading regulations were framed in 1992, it was felt that therewas no framework for prevention of insider trading. Consequently, TheInsider Trading (Amendment) Regulations were notified on February 20,2002.

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    The rights of creditors

    Creditors have the right to block dividend payments if their dues have notbeen paid. This involves all debt dues, including payment towardsdebentures or bonds; this right is enforced by petitioning the civil courts, theCompany Law Board or High Courts.

    Creditors rights are supreme in bankruptcy restructuring or liquidation.Under the Companies Act, 1956, the Sick Industrial Companies Act, 1985,(SICA), and the Debt Recovery Act, 1992, creditors have the right to take acompany to bankruptcy court, civil courts, High Courts or Debt RecoveryTribunals for securing their dues either through receivers, or via bankruptcyrestructuring or winding up procedures.

    Recently, the Government of India enacted the Securitization Act wherecreditors have the right to foreclose on debt and its mortgaged assets in theevent of the account becoming a non-performing loandefined as one inwhich payments have not been made for two successive quarters.

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    The rights of employees

    All employees, workmen or otherwise, have the right to formtrade unions. The Industrial Disputes Act, the Factories Act andthe Contract Labour Act say that workers cannot be fired,retrenched or laid-off without due cause and without followingdue process.

    If anything, these processes are biased in favour of workers. Inbankruptcy restructuring, representatives of workers have thelegal right to participate in the proceedings.

    As mentioned earlier, in winding up, workers have pari passurights (along with secured creditors) to their unpaid wages.

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    Disclosure and transparency

    Disclosure should include, but not be limited to, material informationon:

    1. The financial and operating results of the company.

    2. Company objectives.

    3. Major share ownership and voting rights.

    4. Remuneration policy for members of the board and key executives, andinformation about board members, including their qualifications, theselection process, other company directorships, and whether they areregarded as independent by the board

    5. Related party transactions

    6. Material foreseeable risk factors.7. Material issues regarding employees and other stakeholders.

    8. Governance structures and policies, in particular, the content of anycorporate governance code or policy and the process by which it isimplemented.

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    Satyam ScandalCorporate Lessons to be learnt

    Rotation of auditing firms

    Joint auditors to audit a companybeyond a certain size

    Strengthening of quality review

    Internal audit of financials by anexternal firm

    Composition of Boards and quality

    and qualification of independentdirectors

    Criteria for remuneration to keypersonnel

    Education on ethical values

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    Governance in banks and financial institutions.

    Basel Committee on Banking Supervision (BCBS) has revisited its 2006guidance on corporate governance and brought out Principles for enhancingcorporate governance(Oct 2010).

    The Financial Stability Board (FSB) has, in its progress report to the G20Ministers and Governors (Nov 2012) also made recommendations relating tothe corporate governance issues of systemically important financialinstitutions (SIFIs).

    Risk governance demands a holistic approach. Strong MIS facilitates riskreporting to the boards in an effective and comprehensive manner, which inturn enhances transparency and causes informed decision taking.

    The Board and the senior management oversight must be supplemented

    with effective leadership by the Chairman and the chief executive officer(CEO), and informed non-executive directors.

    Effective risk governance also demands that each director is aware of thebreadth of risks faced by the bank. Directors add value to the Board whenthey have financial expertise, are aware of risk fundamentals andtechniques, and are able to manage dynamics with executives.

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    Governance in banks and financial institutions.

    Board level risk committees have an important role to play in the overall riskgovernance framework. Banks need establishing limit structures and riskpolicies for use within individual businesses.

    Presence of a Chief Risk Officer (CRO) is expected to strengthen the riskmanagement framework in Banks. The CRO must report directly to the CEOand the Board and be responsible for all risks, risk management and controlfunctions.

    The risk management systems must take into account the technicallimitations of risk models, such as Value at Risk (VaR). Stress testing andscenario analysis .

    Creation of the Financial Stability Board (FSB) to improve regulatory andsupervisory oversight of risk governance at financial institutions is awelcome step.

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    Governance in banks and financial institutions

    Banking regulation in India shifted from prescriptive mode to prudentialmode in 1990s. This freedom necessitated tighter governance standardsrequiring bank boards to assume the primary responsibility and the directorsto be more knowledgeable and aware and also exercise informed judgementon various strategies and policy choices.

    With a view to strengthen corporate governance, over a period of time,various guidelines have been issued in matters relating to the role to beplayed by the Board, fit and proper criteria for the directors of banks,bifurcation of the post of Chairman and Managing Director (CMD),remuneration etc.

    Recognising that ownership of banks by one or few individuals could bedetrimental to the public interest, especially, depositors interests, it isstipulated that, in India, banks should have a diversified ownership model.To ensure that ownership and control of banks are well diversified,guidelines on ownership and governance in private sector banks were issuedby the Reserve Bank in February 2005

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    Governance in banks and financial institutions

    Another requirement of Reserve Banks is that prior approval for any

    acquisition of shares in private sector banks resulting in a shareholding of 5 percent or more of the total paid up capital of the bank is needed.

    In the recent guidelines on new bank licenses wherein it is stipulated thatNon-Operative Financial Holding Companies (NOFHC) which set up new banksshould, after the initial lock in period of five years, bring down their equity

    capital of the bank from the minimum 40% while setting up to 15% within 12years.

    To ensure Fit and Proper status of the groups that would set up newbanks, it is also stipulated that entities / groups should have a past record ofsound credentials and integrity, be financially sound with a successful track

    record of 10 years.

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    Governance in banks and financial institutions

    As per Basel committee Report 1999, Banks have to display the exemplary

    of corporate governance practices in their financial performance,transparency in the balance sheets and compliance with other norms laiddown by section 49 of corporate governance rules. Most importantly, theirannual report should disclose accounting ratios, relating to operating profit,return on assets, business per employee, NPAs, maturity profile of loans,advances, investments, borrowings and deposits.

    auditors should have the complete know how about all the features of thelatest guidelines given by Reserve Bank of India (RBI) and ensure that thefinancial statements are made in a fraud free manner and should mirror the

    implementation of corporate governance.

    Private sector banks has to conform with standard of good banking practices

    like ensuring a fair and transparent relationship between the customer andbank

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    Governance in banks and financial institutions

    Instituting comprehensive risk management system and its adequate

    disclosure Proactively handling the customer complaints and evolving scheme of

    redressal for grievances.

    Building systems and processes to ensure compliance with the statutesconcerning banking.

    The Securities and Exchange Board of India (SEBI) had constituted aCommittee on Corporate Governance and circulated the recommendationsto all stock exchanges for implementation by listed entities as part of thelisting agreement vide SEBIs circular SMDRP/Policy/CIR-10/2000 dated

    February 21, 2000.

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    Corporate Governance of Non-BankingFinance Companies (NBFCs)

    NBFCs have exposures to sensitive sectors such as real estate and capitalmarkets and they also rely on wholesale funding, all of which point to therequirement of robust internal controls and governance framework toensure their stability.

    Recognizing the significance of NBFCs in the overall financial system,measures were undertaken to strengthen the regulatory framework in termsof stipulation of capital adequacy and exposure norms in 2006.

    Subsequently in 2007, guidelines on corporate governance for NBFCs wereissued by the Reserve Bank of India.

    The listed NBFCs were already required to comply with the provisions of theListing Agreement of the Securities and Exchange Board of India (SEBI),others being governed by the relevant provisions in the Companies Act,1956.

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    Corporate Governance of Non-BankingFinance Companies (NBFCs)

    Other requirements include prior approval of RBI for change in control ofany registered NBFCs. It is indicated that big NBFCs with asset size of Rs.1000 crore and above would require prior approval of RBI for appointmentof CEO and would need to comply with Clause 49 provisions (of SEBI listingagreement) even if unlisted.

    NBFCs with asset size of Rs. 100 crore and above would be required tocomply with the disclosure requirements specified in Clause 49 and ofcertain financial indicators.

    The guidelines are aimed at enhancing the self discipline principle in theNBFCs. Measures include pricing of credit, restricting lending to a borrowerby not more than two MFIs, sharing credit information with a CreditInformation Bureau, review of Fair Practices Code (FPC) etc.

    Global financial crisis has given us an opportunity for strengthening both theregulatory as well as governance frameworks.

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    Investor Education and Protection Various kinds of investors are (i) investors in equity (ii) large institutional

    investors (iii) Foreign Investors (iv) investors in debentures and (v) smallinvestors/deposit holders etc. Their interest need to be protected.

    The interface between the companies and its stakeholders includinginvestors is regulated through the legislative framework of the CompaniesAct and other civil and criminal laws of the country as well as by differentregulators such as SEBI, RBI, etc. as well as institutions such as the StockExchanges through their rules of operation.

    In particular, the capital market regulator, SEBI has a significant role to playin safeguarding the interest of investors.

    It is the responsibility of the shareholders of the company who shouldcharge company management with the responsibility coupled with adequateauthority to ensure prudent and proper use of fundscollected from thepublic.

    The credit rating needs to be done to enable protection of investor interests.

    There is however, no need to mandate credit rating by law except for

    companies accepting public deposits.

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    Investor Education and Protection Risk cover for depositors :Depositors, being in the nature of unsecured

    creditors, also do not get adequate protection under law in the event ofliquidation or winding up of the company. The credit-worthiness of thecompanies by the insurance companies will be in the interest of thedepositors and hence is recommend for the same.

    Companies accepting public deposits should be required to appointindependent directors; appoint audit / remuneration / stakeholdersrelationship committees; under take deposit insurance; undertake creditrating; create adequate cash reserves being set aside for repayment ofdeposits as may be prescribed by the rules;

    Be subjected to close monitoring in respect of implementation of anyscheme for repayment of deposits that may be sanctioned by

    CLB/Tribunal/Court; be subjected to a stringent disclosure regime; and be subjected to stringent penalties for irresponsible / fraudulent behaviourby the companies.

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    Investor Education and Protection Investor Grievance Redressal :An effective investor grievance redressal

    mechanism at the corporate level could ensure protection of the interest ofinvestors through timely interventions. The Committee recommends thatStakeholders Relationship Committee should be mandatory for a companyhaving a combined shareholder/deposit holder/debenture holder base of1000 or more.

    Consumer courts / Capital Market Ombudsman: Since shares and securitiesare also legally deemed to be goods under the Consumer Protection Act,1986, investors have the option to approach Consumer Courts under theConsumer Protection Act as a forum to redress their complaints. In thiscontext, the institution of Ombudsman for Capital Market set up by SEBIshould also be strengthened.

    Investor Education and Protection Fund : The Government has establishedan Investor Education and Protection Fund (IEPF) under Sec. 205 C of theCompanies Act, 1956 under which unclaimed funds on account of dividends,matured deposits, matured debentures, share application money etc. aretransferred through the IEPF to the Government by the company on

    completion of seven years.

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    Investor Education and Protection Role of NGOs in Investors education : Many problems relating to investors,

    particularly, small investors, can be tackled by educating the investors.Small investors should be encouraged to either invest through Mutual Fundmechanisms, or should take investment decisions only after gettingadequate information about risks and rewards. The help of various NGOsengaged in investor protection activities should also be taken for thispurpose.

    Disclosures and Investor Protection : proper and timely disclosures arecentral to safeguarding investor interests. Capital market regulator andstock exchanges have a significant role to play in ensuring that suchinformation is accessible by all market participants rather than a few select

    market players. There should be a regime of stringent penalties, both civiland criminal for default in disclosure.

    CG Reforms After Satyam Scandal

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    CG Reforms After Satyam ScandalCompany Bill 2011

    The new companies bill 2011 proposes fundamental changes in

    the way companies are run in India. Lesson has been learnt from Satyam Scam and the gaps in the

    governance systems that led to this historical scam are thought tobe filled.

    1. Governance Reform Independent Directors

    2. Disclosure of Pledged Securities

    3. Increased Financial Accounting Disclosures

    4. IFRS (Adoption of International Standards)

    5. Strict civil and criminal laws

    Major Challenges in the Future

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    The major challenges to corporate governance reforms in Indiaare:

    Power of the dominant shareholder

    Lack of incentives for companies to implement corporategovernance reforms

    Underdeveloped external monitoring systems

    Shortage of real independent directors

    Weak regulatory oversight including multiple regulators

    Major Challenges in the Future

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    Dream Is Not What You See In

    Sleep

    Is The Thing Which

    DoesNot Let You Sleep.

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    The Biggest RiskIn

    Life Is Not TakingOne.

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