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A clause to make companies accountable, keep fraud at bay

A clause to make companies accountable, keep fraud at bay
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First Published: Mon, Oct 01 2007. 12 31 AM IST

Ground Rules | Ketan Dalal
Ground Rules | Ketan Dalal
Updated: Mon, Oct 01 2007. 12 31 AM IST
Ground Rules | Ketan Dalal
Corporate governance by its narrow definition is a set of relationships between the company and shareholders. The broad definition covers the explicit relationships of the company with employees, creditors, consumers, distributors, government authorities and local communities, and the beneficiary of good governance is every stakeholder.
In recent years, corporate governance has been a matter of concern, globally and in India. A spate of corporate frauds and collapses in the US has sparked off debate by investors and regulators on the need for protection through statutes that mandate corporate governance structures to be put in place.
The UK was one of the first countries that codified corporate governance by way of the Turnbull Guidelines in 1999. This was followed by the Sarbanes-Oxley Act in the US in July 2002 and the OECD Principles for Europe in 2004. In India, a significant measure that was taken was in terms of an amendment to Clause 49 of the Listing Agreement by a circular issued by the Securities and Exchange Board of India (Sebi) on 29 October 2004. Clause 49 of the Listing Agreement signed between a listed company and the stock exchange was amended with effect from 31 December 2004, prescribing a large number of requirements. But, though listed companies have been submitting the certificate and report required on a quarterly basis, several companies have not implemented the guidelines. Sebi has recently pulled up 20 companies for violation of Clause 49, including five public sector companies.
In the light of the recent Sebi action, this seems to be a good time to step back and look at the requirements of Clause 49 and the challenges companies face in implementing its norms.
The amended Clause 49 seeks to incorporate a corporate governance structure for listed companies. The building blocks of this structure are an independent board of directors, a system to ensure statutory compliance and catch and rectify exceptions, a vigilant and finance-savvy audit committee, a documented risk management framework, certification by the CEO and CFO of effective internal controls on financials, a code of conduct for senior management and a currently optional whistle-blower policy.
For the board of directors, requirements include the need for 50% of the board to comprise of independent directors if there is an executive chairman. Disclosure of non-executive directors’ compensation and the minimum amount of information to be made available to the board at board meetings are prescribed. The board has to also ensure that a statutory compliance framework is in place to ensure compliance with all laws and catch and rectify instances of non-compliance.
A minimum of three directors have to be members of the audit committee, of which two-thirds shall be independent directors. The members of the audit committee should be “financially literate”, with at least one member having accounting or related financial management expertise. The chairman of the audit committee has to be an independent director. The audit committee is supposed to “have oversight of the company’s financial reporting process” and be the bridge between the board on the one hand and the statutory auditors and internal auditors on the other. There are a large number of disclosures mandated by Clause 49, including disclosure to the board about setting up a risk management framework which gives the risk management and minimization procedures.
The CEO and CFO have to certify that they have reviewed the financial and cash flow statements and there are no fraudulent transactions. They have to also personally take responsibility for reviewing the effectiveness of the internal controls on the financials.
A detailed report on corporate governance has to be given in the annual report. Non-compliance, if any, needs to be highlighted with reasons. A quarterly compliance report of Clause 49 needs to be filed with the stock exchange.
A certificate has to be obtained from auditors or a practising company secretary on compliance with the conditions of Clause 49. This certificate has to be annexed to the directors’ report that is sent annually to shareholders.
Clearly, with so many onerous provisions, there are many issues that arise when a company sets out to meet the requirements prescribed in Clause 49.
The first issue is of a huge additional cost that can cross Rs1 crore for a medium-sized company. Setting up each of the structures, be it the risk management framework or the internal controls or the statutory compliance reporting system, entails detailed study—and professional expertise and both these come with costs in terms of professional fees, salaries and time of the company’s senior executives.
The next issue is a paucity of competent finance professionals who can man these systems and their retention.
Then there is the struggle to find competent, financially literate independent directors. The risks associated with directorship and a lack of time due to professional commitments deter successful professionals from accepting this position. It often becomes a sinecure for retired bureaucrats and family and friends of promoters, and this takes away from the basic objective of independent directors being watchdogs for the shareholder. CEO and CFOs are finding the personal sign offs a huge risk and this is adding to their costs in terms of compensation and insurance.
Ensuring that a system is in place to monitor statutory compliance for a multi-location and multi-business company in India is a challenge by itself due to the large number of laws and their frequent changes. These issues result in the tendency of “ticking the box” rather than substantively complying with the provisions prescribed and increase the risk of non-compliance.
The penalties for non-compliance are heavy fines and fears of delisting. But it would be better if Sebi can prescribe specific penal provisions for each requirement with a mere warning for first-time offenders and heavier penalties on habitual offenders.
The issues coming up in the initial years will slowly be resolved with costs reducing as prescribed structures are set up. The use of information technology to enable processes of risk management, internal controls and statutory compliance will further ease pressures on time and cost.
A breed of professional independent directors is emerging and hopefully, some of the restrictions of a company’s professional advisers being independent directors may get reduced. The benefit of good corporate governance in terms of increasing efficiencies of processes, easier access to funds and increase in the brand value for companies will make the initial birth pain worthwhile.
To sum up, as corporate India gears up to become a successful global player, it has no options but to have a robust corporate governance ethos as its calling card.
Ketan Dalal is executive director of PricewaterhouseCoopers. Your comments and feedback are welcome at groundrules@livemint.com
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First Published: Mon, Oct 01 2007. 12 31 AM IST