Corporate Governance in India and Role of CA

- CA Rama Subbarao K

I.      Need for Corporate Governance

“Excellence” is the state everyone would dream of achieving and we also know that just dreaming is not going to achieve the excellence. So, there should be proper planning, procedures and continuous commitment towards it. This applies to an individual and what in case of big group of people or organization. There should be some rules and regulations, There should be some controls which can ensure that the activities are going in line with the objectives of the company. Along with the extensive development in the corporate field there is a tremendous growth in the investments in corporate sector against the traditional firm and proprietor culture in India. So, the need arise to make the investors feel safe about their investment, to ensure that the affairs of the company are in the best interest of the shareholders and stakeholders as they don’t play any active role in the day-to-day management of the Company. In other words, a company is run by a democratic body i.e. Board of Directors elected by the Shareholders and by the Officers duly appointed by such Board of Directors. As all the day to day affairs and decision making of the company are managed by the Board of Directors except those reserved for shareholders, it is therefore necessary to ensure that the company affairs are being managed in the best interest of the shareholders.

Corporate governance is about commitment to values and ethical business conduct. It is about how best an organization is managed for the benefit of shareholders. This includes its culture, policies and the manner it deals with various stakeholders. The most important part of corporate governance is timely and accurate disclosure of information regarding the financial position, performance, ownership and governance of the company.

II.      Corporate Governance in India

Various statues have been enacted around the world to protect the interests of the shareholders and reestablish the confidence of shareholders which is lost to due major corporate frauds like Enronby corporate governance like Sarbanes Oxley Act 2002 in USA, In India Clause 49 of Listing agreement with SEBI and companies act  deals with corporate governance requirement.

Companies Act 1956 takes care of corporate governance by inserting certain provisions like Director responsibility statement under Section 217(2AA), Audit committee under Section 292A and Cap on Managerial Remuneration through Schedule XIII etc.

Corporate governance is about how organizations are directed controlled and held accountable to the shareholders. SEBI is continuously working in regulating the corporates in India to protect the interest of various stake holders. A Voluntary disclosure started by some well-managed and socially concerned companies has become an order of the day in corporate reporting.

The benefits of compliance with corporate governance norms include

•       Improved Equity Price performance as the Investors will be willing to pay more price for a well governed company
•       Higher Valuations & Access to Global Markets
•       Increase in Investor Goodwill & Confidence which in turn increase the quantum of investment by the Investors.

III.      Evaluation of Clause 49

In India Clause 49 of the Listing agreement deals with corporate governance norms that a listed entity should follow, was first introduced in the financial year 2000-01 based on the recommendations of Kumar Mangalam Birla Committee. Post implementation of the clause 49 after 2 years SEBI in order to evaluate the adequacy of the existing practices and to further improve the existing practices setup a committee under the Chairmanship of Mr. Narayana Murthy during 2002-03. Mr.Narayana Murthy committee recommendations in August 2003 and informed stock exchanges to revise Clause 49 accordingly which led to protests and representations from the industry which forced Mr.Murthy committee to meet and revise the earlier recommendations and the same was kept on SEBI website for comments and finally on 29^th October 2004 SEBI announced revised Clause 49 which is to be implemented by the end of the financial year 2004-05.The revised recommendations have considerably diluted the original Murthy Committee recommendations which include. Independence of Directors, Whistle Blower policy, performance evaluation and training to non-executive directors which are included in Non-Mandatory requirements.

 IV.      Applicability and Requirements

It is very important to know the key applicability and requirements of Clause 49 which can help to understand the role of chartered accountant in corporate governance.

 

    A.    Applicablity

Every Listed company on listing with stock exchanges shall agree to comply with all the clauses in listing agreement. All the entities seeking listing for the first time after revision of clause 49 should adhere to the revised provisions of clause 49.   

                                   

Existing entities which are listed before revision of clause 49 should adhere to the revised provisions as per the schedule of implementation.

                       

It shall apply to entities other than companies to the extent it does not violate their respective statutes, and other guidelines issued by the regulatory authorities. The revised clause 49 is not applicable to Mutual Fund Schemes.

                       

    B.     Requirements of Clause 49

 

     1.      Board of Directors

Requirements in relation to Board of Directors are mainly in regard to composition of the board, Non-executive director’s compensation and disclosures, Provisions regarding Board and committee meetings and Code of conduct.

The board shall have an optimum combination of executive and non-executive directors comprising a minimum of 50% by Non-executive directors of total board of directors.

If the chairman of the Board is a non-executive directors at least one-third of the Board should comprise of Independent directors and in case he is an executive director or a non-executive directors who is a promoter of the company or is related to any promoter of person occupying management positions at the Board level or at one level below the Board, at least half of the Board should comprise of independent directors.

Clause 49 prescribes some tests, which a non-executive director needs to pass to qualify as an Independent.

In general no one is invited to join a board to act as a non-executive director unless they are well known to promoter group as they need support from the promoter group for their reelection. So, the question is whether the independent directors are really independent in practice. Well, if a director is well eminent in his own field and a person of attitude and conscious about his responsibilities will always ask right questions at board meetings whether he holds the independent status or not.

The companies with independent and professional management have recorded a good success rate in the history which includes companies like L & T.

All the listed companies should obtain a declaration annually from all the independent directors confirming compliance with all six conditions of independence.

All the fees/compensation (other than sitting fees within the limits prescribed under the Companies Act, 1956), if any paid to non-executive directors, including independent directors, shall be fixed by Board of Directors with previous approval of shareholders in general meeting. If there is stock option, the limit for the maximum number that can be granted to non-executive directors in any financial year and in aggregate should be disclosed.

The Board shall meet at least four times a year with a maximum time gap of four months between each consecutive meeting. A director shall not be a member in more than 10 committees or act as Chairman of more than five committees across all companies in which he is a director and in addition every director need to inform all those companies about the committee positions he occupies in each company and changes in any takes place.

The Board shall lay down a code of conduct for all Board members and senior management of the company. The 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 the effect signed by the CEO

 

      2.      Audit committee

A qualified and independent audit committee shall be setup with minimum three directors as its members. Two-third of the members of Audit committee shall be independent directors and the chairman of the committee shall be an independent director. All the members of the committee shall be financially literate and at least one member shall have accounting or related financial management expertise. The audit committee should meet at least four times in a year and the gap between each meeting shall not be more than four months.

Role of Audit committee includes matters to be included in Director’s responsibility statement, reviewing the functioning of Whistle blower mechanism if existing and review of performance of statutory and internal auditors.

In addition to the above the audit committee reviews Management discussion and analysis of Financial condition and results of operations, statement of significant related party transactions, Management letter/ Letters of internal control weaknesses issued by the statutory auditors and Internal audit reports.

The commitment and ethical behavior of a person is more important than the qualifications and experience. One classic example of this could be Chairman of Enron’s audit committee who was a Stanford Professor with 30 years of experience in auditing and accounts.

      3.      Subsidiary companies

The requirements in relation to subsidiary of a holding company required to comply with clause 49 are as follows.

1.      At least one independent director on the Board of Directors of the holding company shall be a director on the Board of Directors of a material non listed Indian subsidiary company.

2.       The Audit Committee of the listed holding company shall also review the financial statements, in particular, the investments made by the unlisted subsidiary company.

3.      The minutes of the Board meetings of the unlisted subsidiary company shall be placed at the Board meeting of the listed holding company. The management should periodically bring to the attention of the Board of Directors of the listed holding company, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary company.

    4.      Disclosures

The following are the disclosure requirements to be complied with.

     1.      A statement on transactions with related parties in the ordinary course of business shall be placed before the Audit committee periodically.

     2.      Details of material individual transactions with related parties which are not in the normal course of business shall be placed before the audit committee.

     3.      Details of material individual transactions with related parties or others, which are not on an arm’s length basis, should be placed before the audit committee, together with Management’s justification for the same.

    4.      Financial statements should disclose together with management’s explanation any accounting treatment different from that prescribed in Accounting standard.

    5.      The company shall lay down procedures to inform Board members about the risk assessment and minimization procedures which shall be periodically reviewed by the Board.

     6.      The company shall disclose to the Audit committee on a quarterly basis the use of funds raised through public/rights/preferential issues. Annually a statement showing use of funds for purposes other than those stated in Offer document/prospectus should be placed before the Audit committee and the same is to be certified by the Statutory Auditors.

     7.      A detailed disclosure is to be given on criteria remuneration of directors which include criteria of making payments to non-executive directors, shares and convertible instruments held by non-executive directors, and shareholding (own, beneficial basis) of non-executive directors to be disclosed in the notice of general meeting called for approving appointment of such director.

      8.      In addition to above disclosure is to be given in respect of Management Discussion and Analysis report which should form part of the Annual Report to the shareholders and In case of appointment of a new director or reappointment of an existing director the shareholders are to be provided with detailed information relating to the directors.

  

    5.      CEO\CFO Certification

This requirement is similar to that of Sarbanes Oxley Act. This requires CEO and CFO to certify to the Board the annual financial statements in the prescribed format regarding true and fair view of the company’s affairs and compliance with applicable accounting standards, Laws and regulations.

    6.      Report on Corporate Governance

The Company shall submit a quarterly compliance report to the stock exchanges within 15 days from the close of quarter in a specified format.

In addition to the quarterly compliance reportthere shall be a separate section on Corporate Governance in the Annual Reports of company with a detailed report on Corporate Governance. Reasons for Non-compliance of any mandatory requirements of this clause should be disclosed. Voluntary compliance with the Non-mandatory requirementsif any is to be specifically highlighted.

    7.      Compliance

The company shall obtain a certificate from either the statutory auditors of the company or from a practicing company secretary regarding compliance of conditions of corporate governance as stipulated in this clause and annex the certificate with the directors’ report, which is sent annually to all the shareholders of the company. The same certificate shall also be sent to the Stock Exchanges along with the annual report filed by the company.

    8.      Non-Mandatory Requirements

Some of the recommendations of Mr. Narayana Murthy committee were included in the Non-Mandatory requirements under this clause compliance of which is not mandatory but the company can highlight the same in its corporate governance reporting there by reflecting the company’s commitment towards Better Corporate Governance practice. The Important Non-Mandatory requirements under this clause include the following.

1.      Independent directors may not have tenure exceeding in the aggregate a period of nine years on the board of the company. The company may ensure that the persons being appointed as independent directors are persons possessing requisite qualifications and experience that enable him to contribute effectively to the company.

2.      The board may setup a remuneration committee consisting of all non-executive directors and chairman being an independent director to fix the remuneration packages on behalf of shareholders.

3.      A half-yearly declaration of financial performance including summary of the significant events in last six-months, may be sent to each household of shareholders.

4.      Company may move towards a regime of unqualified financial statements.

5.      A company may train its Board members in the business model of the company as well as the risk profile of the business parameters of the company, their responsibilities as directors, and the best ways to discharge them.

6.      Performance evaluation of non-executive directors by a peer group comprising the entire Board (excluding director being evaluated) and the evaluation could be the mechanism to determine whether to extend/ continue the terms of appointment of non-executive director.

7.      Last and the important requirement is Whistle Blower Policy. The Whistle Blower Policy may be established as a mechanism for employees to report the management concerns about unethical behavior, actual or suspected fraud or violation of the company’s code of conduct or ethics policy. This could also provide for adequate safeguards against victimization of employees who Blow the Whistle and also provide direct access to the Chairman of the Audit committee in exceptional cases.

V.      Role of Chartered Accountant in Corporate Governance

With the knowledge of requirements of clause 49 and Companies act we can say that the role of chartered Accountants in corporate governance is very exhaustive. We can be the outsiders to provide required guidance to achieve best practices in corporate governance or we can also be the part of the entity to implement those best practices. The role of a chartered account can involve any of the following activities.

1.       Developing a Corporate Governance Policy document for corporate Governance

2.      Guiding and Assisting the entity in Implementing required Internal Control Framework that takes care of corporate governance 

3.      Benchmarking and improving the Entities Governance procedures in line with the best practices

4.      Certification as require under the provisions of Clause 49 as explained above

5.      Internal audit to ensure the compliance of clause 49

6.      Confirmation that the entity has complied with the various statues that include corporate governance concepts like companies act as explained above.

7.      Lastly to comply with the requirements when acting as a director or CEO\CFO of the entity.

VI.      Conclusion

Corporate Governance has improved a lot by incorporating clause 49 in listing agreement but there is still confusion in the investors about the security and safety of their investments due to recent frauds like in case of Satyam computers in India. This confusion can be dealt by further refining the provisions like making the Non-Mandatory provisions Mandatory etc. And also, the Chartered accountants play a vital role in this aspect. As we are charged with a great responsible position out of all persons who are part of corporate governance, we should be awake all the time and use our professional skepticism to support the Corporate Governance.

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