It took the Securities and Exchange Board of India (Sebi) five years and a great deal of effort to design and institute corporate governance reforms consisting some of the best practices in leading equity markets around the world. Clause 49 of the standard listing agreement with the stock exchanges, which is the outcome of Sebi’s efforts, was formally instituted with all its reforms in 2005 and all listed companies were expected to comply with its provisions by 1 January 2006.
The clause, initially based on the recommendations of the Kumar Mangalam Birla Committee, was amended keeping in view the fast changing global scenario and the introduction of the Sarbanes-Oxley Act in the US. The reforms it introduced were quite radical and invited a great deal of resistance from companies.
Apart from giving leeway on the issue of whistle-blowers, Sebi ignored opposition to the core provisions on the appointment of independent directors, plugged most of the loopholes therein and finally instated the revised clause. All listed companies were to compulsorily adhere to its provisions by 1 January 2006.
Where the teeth are located
Initially it was considered to be quite harmless, as it did not have the powers to prosecute, unlike the Sarbanes-Oxley Act of the US, under which the chief executive officer and the chief financial officer of a defaulting company can be penalized and prosecuted.
However on a careful examination by various trade organizations, it has been found that the Clause has some real sharp teeth after all. Some of the consequences of non-compliance are:
• Possible delisting under Sec 21(A) of the Securities Contracts (Regulation) Act, 1956
• A person convicted for infringement can be jailed for up to 10 years or fined up to Rs25 crore or both, under Section 23. The offence is cognizable and non-bailable under the Criminal Procedure Code.
• Under the CrPC, the police can also arrest, without a warrant, an offender of the provisions, and can search and raid his official and residential premises.
A recent ruling of the Bombay High Court confirmed the powers of the police referred to above.
There is a flip side to this authority. The police could be influenced by vested interests to harass the directors and other employees of the company. Section 26 of the Sebi Act, 1992 attempts to addresses this issue. Under the section, an offence is deemed cognizable only if the complaint is filed by Sebi. The Act does not talk of any other authority in this respect, including the Central Government.
But since Section 25 of the SCRA is mum on whether Sebi is the only authority or not, there is scope for misuse of the powers vested with the keepers of the law.
A question of effectiveness
Improvements in corporate governance in India have been more voluntary than enforced. Business houses like Infosys, Tata Group and the Birlas had instituted ethical and transparent governance mechanisms much before Clause 49 came into existence.
Globalization and the sudden surge of India on the world stage have indeed driven several companies seeking listing on bourses overseas, wanting to attract foreign capital and otherwise seeking to establish a global footprint to adopt sound corporate governance practices.
Unfortunately, the voluntary part is limited to only a few companies and corporate governance in the broader context has not yet percolated through the entire Indian corporate structure. There are a host of reasons for this to happen.
Limited scope. Clause 49 applies only to entities listed on Indian stock exchanges and leaves out several other that have not gone public, although Sebi chief M. Damodaran did indicate last year that the regulator was considering similar regulations for unlisted companies.
Too many regulators ... While the Ministry of Corporate Affairs oversees the activities of all companies under the Companies Act, Sebi is the market regulator and supervises listed companies. While IRDA is the insurance regulator, the Reserve Bank of India oversees banking. A bank listed on a stock exchange comes under the purview of the RBI, MCA and Sebi simultaneously making it difficult to determine whose scope and responsibility it is to ensure corporate governance.
...Not enough regulation. None of the insurance companies in India is listed. As a result, all insurance companies fall outside Sebi’s corporate governance norms. With a lax judicial system, and lack of pension reforms, shareholder activism is almost unheard of in India. In the US, funds like Calpers with their significant holdings in companies are instrumental in bringing about governance reforms.
Lax Surveillance. Despite its teeth, Clause 49 seems to lack bite due to the regulator’s lenient approach towards ensuring surveillance and enforcement of law. Under the Clause, all listed companies are required to file a quarterly compliance report with the stock exchange, which in turn, is then required to file an annual compliance report with Sebi.
This compliance report is a document with objective questions to indicate compliance or non-compliance. Only if a company is non-compliant, the stock exchange raises questions, not otherwise. Deviant companies could take advantage of this loophole and mark themselves as compliant.
Now here is a catch. The stock exchanges, though responsible for monitoring, can’t initiate action against aberrant companies. That power lies with Sebi, which can penalize companies through fines of up to $5.5 million or delisting.
According to HDFC chairman Deepak Parekh, who is also the chairman of the Primary Markets Committee of SEBI, the regulator seldom imposes fines. Delisting has also not found favor with the regulator as it may hurt minority investors and take away their ability to exit the stock.
The regulator cannot impose criminal liability, as that power lies solely with the Ministry of Corporate Affairs. As a result, around 50% of the listed companies are yet to file compliance details with stock exchanges, unmindful of the regulator’s incessant demands.
From a broader perspective, the following initiatives might be considered
• Sebi takes the onus of monitoring companies, as no authority can be vested with the stock exchanges because of the sheer number of companies
• Sebi becomes more expeditious in prosecuting non-compliant companies and impose fines
• The regulator is empowered to initiate criminal proceedings
• Separate norms are introduced for banks, insurers and unlisted companies under the ambit of a single regulator. Since Sebi regulates listed companies only, a different regulator for each of these may be introduced, or a suitable amendment to the Companies Act made.
• Representations have already been made regarding the issue of potential misuse of Section 25 of the SCRA. While there’s hope of a suitable amendment to address these fears, the consequences of non-compliance must nevertheless be reiterated so that Clause 49 isn’t seen as toothless.
Vikas Verma is the president and CEO of Nirvana Advisory Group Pvt. Ltd, a New Delhi-based consulting organization focused on corporate governance