A file photo of Sebi headquarters. Lawyers specializing in securities market regulations say the new rules announced by Sebi and the government are aimed at enhancing transparency, keeping a strict vigil on related-party transactions and giving greater responsibility to independent directors and audit panels. Photo: Abhijit Bhatlekar/Mint
A file photo of Sebi headquarters. Lawyers specializing in securities market regulations say the new rules announced by Sebi and the government are aimed at enhancing transparency, keeping a strict vigil on related-party transactions and giving greater responsibility to independent directors and audit panels. Photo: Abhijit Bhatlekar/Mint

Enforcement key for tougher corporate governance laws

Despite concessions, the fear remains that firms will comply with regulations in letter but not in spirit

Mumbai: A little over a month back, the Securities and Exchange Board of India (Sebi) barred India’s largest real estate firm DLF Ltd from accessing the capital market for three years. A regulatory probe had found the company and its top officials guilty of violations which included the nondisclosure of related party transactions, nondisclosure of financial details related to subsidiaries and inadequate disclosure of outstanding litigation. The company has challenged the order at the Securities Appellate Tribunal (SAT).

In another instance, Financial Technologies (India) Ltd (FTIL) is under the scanner of Sebi and the ministry of corporate affairs for its alleged role in the 5,574.34 crore payment crisis at National Spot Exchange Ltd (NSEL), in which the company holds a 99.9% stake. Among the many allegations against FTIL and its management are charges of a number of related-party contracts executed that may not have been in the best interest of shareholders of its group entities such as Multi Commodity Exchange of India Ltd (MCX) with whom these contracts were signed.

The two examples are just some recent and well-publicized instances of poor corporate governance practices that have plagued corporate India over the years despite stringent regulations being put in places by agencies such as Sebi and strong legislation such as the new Companies Act.

“One cannot deny that in the past corporate governance regulations have been flouted by various companies in spite of they being stringent," says Neerav Merchant, partner, Majmudar and Partners, a corporate law firm. “Apparently, it has often been the case that promoters neglect their duties towards the best interests of shareholders, mainly by failing to adhere to transparent governance model," he says.

Merchant cites the cases of FTIL and DLF which, among many others, have been found to be in violation of disclosure requirements to the detriment of investors.

To be sure, corporate governance regulations in India are comparable to those in the best-regulated markets of the world. Yet, enforcement remains a weak link.

Lawyers specializing in securities market regulations say the new rules announced by Sebi and the government are aimed at enhancing transparency, keeping a strict vigil on related-party transactions and giving greater responsibility to independent directors and audit committees. In their intent, the rules are a step in the right direction, but companies often find ways around such rules and enforcing them is a time-consuming process, say experts.

“On paper, while the existing legal framework provides the best investor protection in the world, enforcement remains a major area of concern due to overburdened courts and the ineffectiveness of regulators and governments in displaying sufficient muscle," says Sandeep Parekh, founder of Finsec Law Advisors, a corporate law firm and a former Sebi executive director in charge of its legal department.

In April, Sebi had announced an overhaul of corporate governance norms for listed companies in an effort to improve transparency in their transactions and give minority shareholders a bigger say in management decisions. In September, however, it issued a circular saying it has received representations from market participants, including companies and industry associations, highlighting certain practical difficulties in ensuring compliance and seeking clarifications on certain provisions.

As a result, it relaxed its proposed corporate governance norms by bringing related-party transaction norms in line with the Companies Act, exempting smaller firms from complying with the new law and extending the deadline for listed firms to appoint women directors.

Merchant of Majmudar and Partners adds that there will always be some practical difficulty in implementing provisions pertaining to related party transactions, mandatory appointment of women and so on, but the broader regulatory framework is a reasonable one.

The regulations as they stand seem to be practical enough for implementation, more so after Sebi recently relaxed certain stringent norms and timelines for compliance, he says.

Among the changes made by Sebi is the definition of a related party. A party will be considered a related party only if it falls under the definition of related party under the Companies Act or the accounting standards. Under the original proposal, Sebi’s definition of related party was much tougher than what was prescribed by the Companies Act.

Sebi has also eased the benchmarks used to define “material related party transactions", bringing them in line with the Companies Act. Under the listing agreement, all material related-party transactions have to be approved by a majority of minority shareholders in order to ensure that business decisions taken by promoters or majority shareholders are not detrimental to the interests of small shareholders.

According to the new norms, material transactions will be defined as those that account for more than 10% of the annual consolidated turnover of an entity. The original provisions had set the cutoff at 5% of the annual stand-alone turnover or 20% of the stand-alone net worth. Importantly, Sebi has exempted related-party transactions between a company and its wholly owned subsidiary from minority shareholder approval.

The deadline for listed firms to appoint at least one woman director on their board has been extended from 1 October 2014 to 1 April 2015. As many as 755 out of a total 1,469 National Stock Exchange-listed companies or 51% of the companies were still to appoint a woman director as on 31 August, according to data from Indianboards.com, operated by corporate database provider Prime Database.

Despite the concessions given by Sebi, the fear remains that companies will comply with regulations in letter but not in spirit.

“Companies are trying to protect their self-interests without earning the wrath of Sebi. Hence, companies are willing to adhere to the rules although to the bare minimum. So, while a person may qualify as an independent director legally, for instance, the fact of the situation would ensure the person brings little by way of either independence or by way of competence," says Parekh.

“In the current regulatory environment, I don’t think that companies would deliberately focus on breaking the norms. Having said that, it is much evident, given the clarifications and amendments that Sebi and the ministry of corporate affairs have issued, that companies are indeed scanning the corporate governance regulations and thereafter identifying loopholes," says Merchant.

Policymakers, meanwhile, are continuously scanning the global regulatory environment and making all attempts to bring the best global practices in India. A case in point is the Whistle Blowers Protection Act, which was notified in May.

According to a PTI report in July, there has been a decline in the number of corruption complaints from whistleblowers during the past three years.

The report, quoting then minister of state for personnel, public grievances and pensions Jitendra Singh, said that the Central Vigilance Commission received 698 complaints under the public interest disclosure and protection of informers (PIDPI) resolution, also known as the whistleblower resolution, in 2013, against 804 in 2012 and 901 in 2011.

“Considering the whistleblower mechanism, our norms, when compared to the norms of other countries, are still at a nascent stage from a practical applicability perspective. US law has a policy where the whistleblowers will be rewarded in case of a voluntary disclosure of any violation of a regulation by the company he is working in. This is not so in India," said Parekh, adding that the scope of Indian securities laws, which have gradually evolved over time, is now quite pervasive and the problem lies mostly in enforcement of the laws.

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