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Corporate Governance & ID’s

By CS Mamta BinaniPast Chairperson (Year 2010), EIRC of ICSI

At ASSOCHAM

mamtab@mamtabinani.comdated : 14.01.2014

Corporate Governance

………………No More a Style Statement

Ancient Proverb•India’s situation is best explained by the proverb, “A fish rots from the head down.”

•When the head is putrid, the body politic/ company cannot be healthy.

Let us straight go to real and live cases-erstwhile SATYAM

• IT company Mahindra Satyam had filed a lawsuit against founder and former Chairman of Satyam Computer, Ramalinga Raju along with some ex-employees and former auditor Price Waterhouse in Hyderabad court seeking damages for committing fraud, breach of fiduciary responsibility, obligations and negligence in performance of duties

• Top corporate lawyers had termed that as “first of its kind”

• According to media reports, the damages sought was estimated to be as high as $200 million

Continued…•Leading corporate tax lawyer and

Supreme Court advocate, Mr H.P. Ranina, told Business Line that the main reason behind the suit seemed to be the new management's (led by the Mahindra Group) interest in recouping the losses incurred by the company due to the alleged accounting fraud.

WILL WE LIKE TO BE THE SCAPE GOAT!!??

• To quote further-Significantly, the other fall-out would be on directors. “Due to the possibility of such civil suits, not many people will now be ready to take up the offer of joining the board of companies as directors as these liabilities will be much more than the negligible amount that they are offered as fees.”

• Another corporate lawyer, speaking on condition of anonymity, said the case seems to be ‘unprecedented', adding that nothing in law stops the company from ensuring that it recovers all its money from the ‘fraudsters'.

Still find it SHOCKING!!• The scale of irregularities was and is indeed a

shock from which the financial world did take some considerable time to recover.

• Here was a company with more than 50,000 employees, offices in more than 60 countries, a multi-layered professional management, more than 650 clients (one third of which were Fortune 500 companies), a pedigreed Board

• A company that was very well tracked by sell-side and buy-side analysts, a stock listed in multiple global exchanges and to top it all, one that had Price Waterhouse as its auditor.

Companies Act, 2013• The new Companies Act promises greater share-

holder democracy and stricter corporate governance norms. The Act introduces for the first time in India the concept of class action suits, which would empower investors to sue a company for “oppression and mismanagement” and claim damages.

• The Act also proposes to tighten the laws for raising money from the public. It also seeks to prohibit insider trading by company directors or key managerial personnel by treating such activities as a criminal offence. Listed companies to have mandatory 33% independent directors and formation of a One Person Company has found its way, empowering the government to have a simpler compliance regime for small companies.

Independence-Truly??•Definition of Independence• The definition of an ID has been considerably

tightened. For example, if a director is a chief executive of an NGO that receives funding from the company to a certain extent, the person would not qualify as an independent director.

•Moreover, the definition now includes positive attributes of independence (that was not the case under clause 49): the candidate must be “a person of integrity and possess the relevant expertise and experience” in the opinion of the board.

What is the incentive….•Remuneration•Under the new Act, IDs are entitled

only to fees for attending meetings of the board, and commissions within certain limits.

•The new Act expressly disallows IDs from obtaining stock options in companies.

•Attempts to achieve a proper balance may be fraught with difficulties under the present dispensation.

Should we call it a Small Breather….??

• In order to balance the extensive nature of functions and obligations imposed on IDs, the Act seeks to limit their liability to matters directly relatable to them. The Act limits the liability of an ID “only in respect of acts of omission or commission by a Company which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently.”

• This again seems to be a reaction to specific instances in the recent past where IDs were subject to legal action for no fault of their own, as evident from the Nagarjuna Finance episode that occurred in 2009.

Some figures!• In 2009, the pendulum swung both the

ways for India Inc.

• 620 ID’s resigned from the Board of Indian Companies in 2009-a figure that was by far without precedent globally.

• The exodus of ID’s highlighted a deep discomfort within Corporate India with the very institution of ID, specially in the context of companies controlled, directly or indirectly, by corporate founders, or promoters.

Role of an ID•What exactly is the appropriate role

of an ID. The academic literature suggests 2 (two) distinct roles:

a. ID may be seen as watchful monitors of promoters and management on behalf of public shareholders or

b. ID may be viewed as reservoirs of strategic advice intended to aid promoters & managers in maximising overall company value

Added confidence•The ID’s definitely aids to maintain standards of professionalism within the boardroom & promote adherence to best practices of Corporate Governance.

•This additional monitoring boosts public shareholders confidence that the company is not run informally and casually at the behest of the controlling shareholder.

The other angle…•The ID’s have the power to make public any wrongdoing and while the controlling shareholder could remove the director or take other retributive measures, such actions would likely cause unwanted public scrutiny.

Value of ID’s• In the US, studies have often found

little to no effect of board independence on firm value.

• In fact, some studies even demonstrate negative correlations.

•But for India, US centered studies may be of limited value because of the pre-ponderance of dispersely held firms in the US as compared to typically promoter-dominated companies in India.

Continued…..•In Russia & Korea, it appears that board independence is important to firm value.

•In India, studies have so far provided either somewhat or weakly positive or inconclusive results.

•In Brazil, it appears, there is either no effect or perhaps even a negative effect.

What does it suggests!•This suggests that one needs to examine the institutional and cultural context of a country before deciding what roles and liabilities ID’s should have and how ID’s may be of value to the companies.

A point that comes for thought!•Role of Institutional Investors The Satyam promoters effectively

controlled the company with only approx. 8% ownership of the company’s equity.

•This may have been enabled by a lack of pressure or effective oversight by institutional investors, while dispersed shareholders generally have little incentive to invest the significant resources required effectively to monitor managements.

Goes hand in hand!•When we assert our rights, we should see to it that others rights are also protected.

•It is good to be strong, when we connect ourselves with the responsibilities associated with the concept of being strong.

•Social responsibility is not just for the profit-making corporations, it applies to all of us who are capable and strong.

We are one family!!•‘Vasudhaiva Kutumbakam’ We should think and live like a family, which would require us to treat each other with equality and dignity, following the true spirit of democracy!

Hon’ble Ex-Minister said….it all•It becomes a prime focus for the share holders. We need to build corporate governance in the country, otherwise there is no future,” he warned.

Corporate Rating Index•He said the government, for the first

time, was working on developing corporate rating index. “We need to get to work in new area. We are working on our own Corporate Rating Index.” At present, India is following the Corporate Rating Index developed in other countries.

• India is ranked 163 in the Global Corporate Rating Index (2012) and 94 (out of 176 nations) on Corruption Perceptions Index (2012).

Greatest Obstacle!•Goldman Sachs, ranks, ‘Governance’

as the greatest obstacle to India’s reaching its economic potential.

•Corruption in its many forms costs India an estimated $170 billion annually (using the Asian Development Bank Guidelines of 17% of nation’s GDP)

(Just to mention 1 billion=more than Rs.6000 crores)

FOCAL SHIFT IN THOUGHTIn this context, Prof. O’Brien spoke

of the need to shift from: a. government to governance b. to accountability c. to responsibility d. finally to integrity, a process

which requires inter-disciplinary collaboration and an application of behavioural economics.

SATYAM WAS KILLING• The unraveling of the Satyam scam,

India’s fourth largest IT company, has put a big question mark on not only the role of corporate entities but also the urgent need for re-examining the issue of corporate governance and the role of the company auditors. Clearly, with competitiveness and the need for rapid growth becoming crucial better corporate governance has become imperative.

• Plainly, at Satyam the governance framework had not been effectively implemented

Hold the BalanceIn fact, Cadbury Chief Sir Adrian

Cadbury captured the spirit of corporate governance by stating: “Corporate governance is holding the balance between economic and social goals and between individual and communal goals.

Not only Satyam….but many

• Take the case of Nagarjuna Finance where its head was eventually arrested but that did not mean more than 85,000 depositors recovering their savings of Rs.100 crores.

• At Duncan Industries too, the depositors are running from pillar to post trying to make sense of the repayment scheme which is intended to fool them and inordinately defer payment.

SEBI-Review Audit• SEBI has vide its circular

no.CIR/CFD/DIL/7/2012 dated August 13, 2012 mentioned about carrying out the review audit of listed companies and laid out guidelines in this regard.

• The investor protection funds to be used to carry out this review audit.

• The review audit could also be funded by the companies themselves.

This is startling!!• According to a report prepared by the Pune-

based Indiaforensic Consultancy Services (ICS) at least 1200 companies listed on the domestic stock exchanges had forged their financial results in recent times.

• The ICS study had alleged that such improper accounting includes deferring revenue and inflating expenses. The figure includes 20-25 firms whose stocks make the benchmark Sensex.

• Obviously keeping this in view, the Government had decided to inspect the books of as many as 150 companies under section 209A of the Companies Act to review whether the accounts are in order. 

UK Bribery Act, 2010•A leap in the right direction!

•The UK Bribery Act has come into force on 1 July, 2011.

• It amends and reforms the UK criminal law and provides a modern legal framework to combat bribery in the UK and internationally.

TRUE, Believe it!• The Bribery Act creates the following

offences:

• Active bribery: promising or giving a financial or other advantage.

• Passive bribery: agreeing to receive or accepting a financial or other advantage.

• Bribery of foreign public officials.

• The failure of commercial organisations to prevent bribery by an associated person (corporate offence).

Some more details• Penalty Imprisonment for up to ten years with unlimited

fine will increase.

• Jurisdiction The scope of the law is extra-territorial. Under

the Bribery Act, a relevant person or company can be prosecuted for the above crimes if the crimes are committed abroad.

• Application The Bribery Act applies to UK citizens, residents

and companies established under UK law. In addition, non-UK companies can be held liable for a failure to prevent bribery if they do business in the UK.

Some of the bold steps taken in the new Companies Act, 2013• If a Company, with intent to defraud, issues a

DUPLICATE Certificate of shares, the Company shall be punishable with fine:

• Which shall not be less than 5 times the face value of the shares involved

• But which shall extend to 10 times the face value of such shares or Rs.10.00 crores, whichever is higher.

• Stringent penalties have also been imposed for defaulting officers of the Company.

Quantification to be done Where the Financial Statements do not

comply with the applicable AS as specified in section 129(1), the Company will have to disclose:

- the deviation from the AS - the reasons for such deviation - financial effects, arising out of such

deviation After obtaining approval of the Tribunal,

provision of voluntary revision of financial statements or Board’s Report has been included in the Bill (section 131)

Directors’ Report• The Director’s Report shall have to provide

various types of additional information:• number of meetings of the Board • company’s policy on directors’ appointment

and remuneration • formal annual evaluation of its own

performance (listed company and other public company having a paid up share capital of Rs.25 crores or more, calculated as at the end of the preceding FY shall incl a statement indicating the manner in which evaluation made)• risk management policy• explanation by the Board on every

qualification etc. made by the CS in its secretarial audit report and in the auditors report• particulars of loans, guarantees or

investments etc.• specify reasons for not spending specified

amt in CSR

New provision for D/ReportEvery listed Company shall disclose in

the Board’s Report, the ratio of the remuneration of each director to the median employee’s remuneration and such other details as may be prescribed

The Directors responsibility statement in case of listed company shall also include additional statement related to internal finance control and compliance of all applicable laws.

CSR-Creative Capitalist Solution• Provisions related to Corporate Social

Responsibility (CSR). Activities that can be undertaken given in Schedule VII.

• For CSR, Net worth criteria >= Rs.500 crore or Turnover criteria >= Rs.1000 crore or Net profit criteria >= Rs.5 crore or more during

any financial yr.

• In every financial yr, atleast 2% of the average NP made during the 3 immediately preceding financial years

• Preference to local areas where it operates

• Average NP shall be in accordance to section 198

Auditor’s Appointment• Appointment of Auditor in listed and specified

class of companies

• Appointment Period of appointment

Individual 1 term of 5 consecutive years

Audit Firm 2 terms of 5 consecutive years

• Cooling off period of 5 years before next appointment

Additional disqualifications for Auditors

• i.  Holding any Security, by himself/ his relative/ partner/ in the Company, its Subsidiary/ Holding/ Associate Company/ a Subsidiary of such Holding Company

But the relative may hold security or interest in the Company of face value not exceeding Rs.1,00,000

ii. Clause of Indebtedness, in excess of Rs.1.00 lac

iii. Clause of giving Guarantee or providing any security in connection with the indebtedness of any third person for an amount excess to Rs.1.00 lac;

    

Continued… iv. Clause of business relationship v.  A person whose relative is a Director

or is in the employment of the Company as a director or KMP

vi. Clause of conviction by Court for an offence involving fraud and a period of 10 years has not elapsed from the date of such conviction

Internal Audit(a) Every listed company; (b) every public

company having paid up share capital >= Rs.10 crores; (c) every public company which has any outstanding loans from banks or public financial institutions >= Rs.25 crores; (d) which has accepted deposits >= Rs.25 crore at any point of time during the last FY

To conduct internal audit of the functions and activities of the Company

This internal auditor could be a CA or a Cost Accountant or such other professional, as may be decided by the Board

Appointment to be done by the Board

Duties of Directors-Carved• In line with the UK Companies Act,

2006

• In accordance with the Company’s AoA

• To act in good faith, to promote objects of the company for benefit of members and the best interest of the company, employees, community and environment

•To exercise duties with due & reasonable care, skill and diligence

•Not to achieve any undue gain/advantage

Independent Directors• Listed companies to have 1/3 ID’s

• Central Government to prescribe for others

•Nominee Director/ Representative Director not to be considered as ID’s (in conflict with existing clause 49)

• ID’s to abide by a detailed code (Schedule IV)

• Issue of letter of appointment to ID mandatory

• Letter to contain terms of appointment, Board’s expectations, fiduciary duties etc.

•Will not retire by rotation

Independent Directors• ID’s to hold 1 separate meeting in a

year without other directors and management

•Tenure restricted to 2 terms (5+5)

•Second term to require Special Resolution

•Then cooling period of 3 years

•Tenure served by ID before commencement of new Act not to be counted

•Stock options not permitted for ID (inconsistent with Listing Agreement)• Profit related commission and sitting fees

allowed

Prior notice-Board Meeting (written)

Atleast 7 days notice is requiredThe notice may be sent by electronic

means Meeting may be called at shorter noticeCondition that atleast 1 independent

director, if any, shall be present at the meeting

In the absence of the independent director from such a meeting, decisions of the meeting will be final only on ratification by atleast 1 independent director

Remodel the Corporate Structure• It is seen how discreetly Companies route

their investments by forming a myriad matrix

• The Act restricts the number of layers of investment Companies to 2. This will help in identifying the ultimate beneficiary

Case for study• Chintamani Agrotech

• 2 Companies – Jinbhuvish Power and Aarya Agrotech owned a majority stake in Chintamani, but the ultimate beneficiary of these Companies was very hard to determine

•Upto 3 layers, the ownership was tried to be traced but only to encounter new corporate entities at every level

Class Action Suits• A minimum of: -100 members or (even depositors) -not less than 10% of the total number of its members

(whichever is less) or -any member(s) singly or jointly holding not less than 10%

of the issued share capital; can join hands to claim damages against the:

* Company * Auditors * Consultants * Experts or Advisors for any ‘wrongful, fraudulent or unlawful’ conduct!!

• A weapon in the hands of the investors to save their common interest.

Case for reference• Satyam Computer Services now known as

Mahindra Satyam paid $125 million to settle ‘class-action’ suits filed by shareholders in the US, where its shares were listed.

• Its auditors shelled out $25 million to do the same in the US.

• Indian shareholders did not receive a penny from any such settlement as the Country did not allow class-action suits.

‘Fraud’ defined• Broadly:

‘Any omission or concealment with an INTENT to deceive and gain undue advantage from shareholders or creditors, whether or not there is any wrongful gain or loss’

So, for example, if the 2 former executives of Reebok India are found guilty of falsification of documents, under the proposed new law, they could face arrest and pay fines.