Corporate Governance

PROF SANJIV MITTAL

Corporate Governance
Corporate Governance is the application of best management practices, compliance of law in letter and spirit and adherence to ethical standards

for effective management and distribution of wealth

and discharge of social responsibility for sustainable development of all stakeholders The Institute of Company Secretaries of India

Present Corporate Governance In India

Principles of corporate governance

1.Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. 2. Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. 3.Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. 4. Integrity and ethical behavior: Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making.

Principles of corporate governance

5.Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. 6. Mechanisms and controls :Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection.

Internal corporate governance controls

1.Monitoring by the board of directors: The board of directors,
with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided.

2. Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors, audit committee, management, and other personnel to provide reasonable assurance of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. 3. Balance of power: The simplest balance of power is very common; require that the President be a different person from the Treasurer. 4. Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance.

External corporate governance controls

External corporate governance controls encompass the controls external stakeholders exercise over the organization. Examples include: Competition debt covenants demand for and assessment of performance information (especially financial statements) government regulations managerial labour market media pressure takeovers

POWERS

Board of Directors

1. The directors powers are normally set out in the articles. The shareholders cannot control the way in which the Board of directors act provided its actions are within the powers given to the Board.
2. Section 291 of Companies Act, General Powers Board is entitled to

exercise all such powers and do all such acts and things, subject to the provisions of the Companies Act, as the company is authorized to exercise and do. However, the Board shall not exercise any power which is required whether by the Act or by the memorandum or articles of the company or otherwise to be exercised or done by the company in general meeting.
3.

Power of the individual directors Unless the Act or the articles

otherwise provide, the decisions of the Board are required to be the majority decisions only. Individual directors do not have any general powers. They shall have only such powers as are vested in them by the Memorandum and Articles.

POWERS

Board of Directors

4.

Section 292(1) provides that the Board of directors of a company shall exercise the following powers on behalf of the company and it shall do so only by means of resolution passed at meeting of the Board:
the power to make calls on shareholders in respect of money unpaid on their shares; the power to authorize the buy-back referred to in the first proviso to clause (b) of sub-section (2) of section 77A; the power to issue debentures; the power to borrow moneys otherwise than on debentures; the power to invest funds of the company; and the power to make loan.

a. b.

c. d.
e. f.

DUTIES

Board of Directors

STATUTORY DUTIES
1. To file return of allotment: Section 75 .

2. Not to issue irredeemable preference share or shares or share redeemable after 20 years
3. To disclose interest (Section 299-300)

4. To disclose receipt of compensation from transferee of shares (Sec.320)

5. Duty to attend Board meetings 6. To convene statutory, Annual General meeting (AGM) and also extraordinary general meetings [ Section 165,166 &169]

DUTIES

Board of Directors

STATUTORY DUTIES
7. To prepare and place at the AGM along with the balance sheet and profit & loss account a report on the companys affairs including the report of the Board of Directors (Section 173, 210 & 217). 8. To authenticate and approve annual financial statement (Section 215). 9. To appoint first auditor of the company (Section 224). 10. To appoint cost auditor of the company (Section 233B).

11. To make a declaration of solvency in the case of Members voluntary winding up (Section 488

Board of Directors
GENERAL DUTIES
1. Duty of good faith 2. Duty of Care 3. Duty Not to Delegate LIABILITIES A. Liabilities to the Company Breach of fiduciary duty Ultra Virus Act Negligence Mala fide Acts

LIABILITIES

Board of Directors

B. Liabilities to third parties Liabilities under Companies Act Prospectus With regard to allotment Unlimited Liability Fraudulent Trading C. Liability for breach of Statutory Duties D. Liability for acts of co-directors E. Criminal Liability

Corporate Governance
CORPORATE GOVERNANCE is the system by which companies are directed and controlled by the management in the best interest of the shareholders and others ensuring greater transparency and better and timely financial reporting. The Board of Directors are responsible for governance of their companies. CORPORATE GOVERNANCE is needed to create a corporate culture of consciousness, transparency and openness. It refers to combination of laws, rules, regulations, procedures and voluntary practices to enable the companies to maximize the shareholders long-term value. It should lead to increasing customer satisfaction, shareholder value and wealth.

Corporate Governance

On account of unscrupulous management of the companies in the past that has raised capital from the market at higher valuation and had performed worse than the reported figures and thus had left the investors suffer huge losses.

Enough law exists, but corporate governance is considered as one of the important instrument for investors protection and was rated high in the priority on the SEBIs agenda for investors protection .

Corporate Governance

The basic objective of Corporate Governance would be "enhancement of the long-term shareholders value while at the same time protecting the interests of other stakeholders."

3 key constituents of Corporate Governance are :

1.the Shareholders, 2.the Board of Directors and 3.the Management.

Corporate Governance Steps taken by SEBI for strengthening corporate governance through the amendment of the listing agreement are:

Strengthening of disclosure norms for IPOs Providing

information in directors report for utilization and variation of funds of the company including the cash flow and fund flow statements in the annual reports.

Declaration of unaudited quarterly results;

Mandatory appointment of compliance officer for monitoring

the share transfer process and ensuring compliance with various rules, regulations;

Corporate Governance

Timely

disclosure of material and price sensitive information including details of all material events having a bearing on the performance of the company; of one copy of complete balance sheet to every household and abridged balance sheet to all shareholders. of guidelines for preferential allotment of shares at market related prices and of rules and regulations to ensure an fair and transparent framework for takeovers and substantial acquisition of shares

Dispatch Issue

Issue

6 principles of Corporate Governance

6 Ds 1.Diversity in composition of the board and 2.Differentiating the gene pool and gender; 3.encouragement of Dialogue as opposed to monologue; 4. valuing Dissent, 5.Dispersion of authority (separation of chairman and CEO is one example), 6. Disruption of status quo (critical to counter coziness) and fostering a culture of full disclosure to build trust.

Current status on corporate governance

It creates an open and transparent system It improves communication and breaks down systematic barriers to flow of information Good governance allows decision making based on data. It reduces risk Good governance helps in creating a brand and creates comfort for all stakeholders and society
Good governance leads to good performance

Governance, Risk Management, and Compliance or GRC

Governance describes the overall management

approach through which senior executives direct and control the entire organization, using a combination of management information and hierarchical management control structures.

Risk management is the set of processes through

which management identifies, analyses, and where necessary responds appropriately to risks that might adversely affect realization of the organization's business objectives.

Compliance means conforming with stated

requirements. At an organizational level, it is achieved through management processes which identify the applicable requirements (defined for example in laws, regulations, contracts, strategies and policies),

Effective corporate governance framework

The corporate governance framework in India primarily consists of the following legislations and regulations: 1. The Companies Act, 1956: Companies in India, whether listed or

unlisted, are governed by the Companies Act. The Act is administered by the Department of Companies Act (DCA). Among other things, the Act deals with rules and procedures regarding incorporation of a company; prospectus and allotment of ordinary and preference shares and debentures; management and administration of a company; annual returns; frequency and conduct of shareholders meetings and proceedings; maintenance of accounts; board of directors, prevention of mismanagement and oppression of minority shareholder rights; and the power of investigation by the government, including powers of the CLB. all types of tradable government paper, shares, stocks, bonds, debentures, and other forms of marketable securities issued by companies. The SCRA defines the parameters of conduct of stock exchanges as well as its powers.

2.The Securities Contracts (Regulation) Act, 1956: It covers

Effective corporate governance framework

3.The Securities and Exchange Board of India (SEBI) Act, 1992: This established the independent capital market regulatory authority, SEBI, with the objective to protect the interests of investors in securities, and promote and regulate the securities market. 4. The Depositories Act, 1996: This established share and securities depositories, and created the legal framework for dematerialization of securities. 5. Listing Agreement with stock exchanges: These define the rules, processes, and disclosures that companies must follow to remain as listed entities. A key element of this is Clause 49, which states the corporate governance practices that listed companies must follow.

Both DCA and SEBI have been conferred investigative powers.

Basic shareholder rights

include the right to:
1. Secure methods of ownership registration; Registration in depository and the unique account number is proof of ownership for the shareholders. 2. Convey or transfer shares; There are no restrictions on the transferability of shares. The free transferability of shares cannot be restricted by private contractual agreements. 3. Obtain relevant information on the corporation on a timely and regular basis; Most of the financial and non-financial information on the companies is available on their websites or other commercial websites free of cost like detailed annual accounts etc. 4. Participate and vote in general shareholder meetings; Section 166 of the companies Act states that every company must hold an Annual General Meeting (AGM) every year. The gap between two AGMs should not exceed 15 months. Once the requisition for the general meeting is received, the board of directors must send the notice of meeting within 21days to all members.

Basic shareholder rights

5. Elect and remove members of the board; Section 257 of the Companies Act, 1956, enables shareholders to elect members of the Board of Directors. Section 284 of the Companies Act enables a company to remove a director through an ordinary resolution. 6. Share in the profits of the corporation. Section 205 207A of the Companies Act deals with declaration and distribution of dividends. A company has to compulsorily transfer a certain percentage of dividend to reserve subject to a maximum of 10 per cent as per Companies (Transfer of Dividend to Reserves) Rules, 1975. A company can also pay dividend by capitalizing its reserves also known as bonus dividend within 30 days of its declaration and approved by its shareholders. 7. Shareholders should have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as: A. Amendments to the statutes, or articles of incorporation or similar governing documents of the company;

Basic shareholder rights

B. The authorization of additional shares; i.e. issue of new shares C. Extraordinary transactions including the transfer of all or substantially all assets, that in effect result in the sale of the company : Section 293 restricts the Board of directors of a company to sell, lease or otherwise dispose of the whole, or substantially the whole, of the undertaking of the company without passing a resolution in a general meeting to this effect. 8. Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures that govern general shareholder meetings:

Basic shareholder rights

9. Opportunity should be provided for shareholders to ask questions of the board, including questions related to the annual external audit, to place items on the agenda of general meetings, and to propose resolutions subject to reasonable limitations. 10. Effective shareholder participation in key corporate governance decisions, such as the nomination of and election of board members, should be facilitated. 11. Shareholders should be able to make their views known on the remuneration policy for board members and key executives. The equity component of compensation schemes for board members and employees should be subject to shareholder approval. Section 309 12. Shareholders should be able to vote in person or in absentia, and equal effect should be given to votes whether cast in person or in absentia. Section 176 to vote in absentia

Basic shareholder rights

13. All shareholders of the same class should be treated equally. The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights. 14. Minority shareholders should be protected from abusive actions by, or in the interest of, controlling shareholders, acting either directly or indirectly, and should have effective means of redress. Section 397 of the Act deals with relief in the case of oppression and section 398 with mismanagement.

15. Insider trading and abusive self-dealing should be prohibited. While insider-trading regulations were framed in 1992, it was felt that there was no framework for prevention of insider trading. Consequently, The Insider Trading (Amendment) Regulations were notified on February 20, 2002.

The rights of creditors

Creditors have the right to block dividend payments if their dues have not been paid. This involves all debt dues, including payment towards debentures or bonds; this right is enforced by petitioning the civil courts, the Company Law Board or High Courts. Creditors rights are supreme in bankruptcy restructuring or liquidation. Under the Companies Act, 1956, the Sick Industrial Companies Act, 1985, (SICA), and the Debt Recovery Act, 1992, creditors have the right to take a company to bankruptcy court, civil courts, High Courts or Debt Recovery Tribunals for securing their dues either through receivers, or via bankruptcy restructuring or winding up procedures. Recently, the Government of India enacted the Securitization Act where creditors have the right to foreclose on debt and its mortgaged assets in the event of the account becoming a non-performing loan defined as one in which payments have not been made for two successive quarters.

The rights of employees

All employees, workmen or otherwise, have the right to form trade unions. The Industrial Disputes Act, the Factories Act and the Contract Labour Act say that workers cannot be fired, retrenched or laid-off without due cause and without following due process. If anything, these processes are biased in favour of workers. In bankruptcy restructuring, representatives of workers have the legal right to participate in the proceedings.

As mentioned earlier, in winding up, workers have pari passu rights (along with secured creditors) to their unpaid wages.

Disclosure and transparency

Disclosure should include, but not be limited to, material information on: 1. The financial and operating results of the company. 2. Company objectives. 3. Major share ownership and voting rights. 4. Remuneration policy for members of the board and key executives, and information about board members, including their qualifications, the selection process, other company directorships, and whether they are regarded as independent by the board 5. Related party transactions 6. Material foreseeable risk factors. 7. Material issues regarding employees and other stakeholders. 8. Governance structures and policies, in particular, the content of any corporate governance code or policy and the process by which it is implemented.

Corporate Lessons to be learnt Rotation of auditing firms Joint auditors to audit a company beyond a certain size Strengthening of quality review Internal audit of financials by an external firm Composition of Boards and quality and qualification of independent directors Criteria for remuneration to key personnel

Satyam Scandal

Education on ethical values

Governance in banks and financial institutions.

Financial institutions undertake credit intermediation. Failures of financial institutions would thus impede the economic growth. Economies take longer time to rebound from financial crisis than the business cycle recessions. Financial institutions operate on a higher leverage. Higher leverage makes financial intermediaries more vulnerable to shocks. it is apparent that these financial institutions must be well governed for achieving financial stability. Financial institutions, especially banks, deal in peoples savings and trust of customers forms the cornerstone of their existence. Any breach of trust leading to loss of confidence is bound to lead to a run. Good governance ensures customers and other stakeholders trust in banks and non-banking financial intermediaries. Banks occupy a special place due to their centrality in the transmission of monetary policy and the functioning of the payment and settlement systems. Good corporate governance would ensure strong internal controls .

Governance in banks and financial institutions.

Basel Committee on Banking Supervision (BCBS) has revisited its 2006 guidance on corporate governance and brought out Principles for enhancing corporate governance(Oct 2010). The Financial Stability Board (FSB) has, in its progress report to the G20 Ministers and Governors (Nov 2012) also made recommendations relating to the corporate governance issues of systemically important financial institutions (SIFIs). Risk governance demands a holistic approach. Strong MIS facilitates risk reporting to the boards in an effective and comprehensive manner, which in turn enhances transparency and causes informed decision taking. The Board and the senior management oversight must be supplemented with effective leadership by the Chairman and the chief executive officer (CEO), and informed non-executive directors. Effective risk governance also demands that each director is aware of the breadth of risks faced by the bank. Directors add value to the Board when they have financial expertise, are aware of risk fundamentals and techniques, and are able to manage dynamics with executives.

Governance in banks and financial institutions.

Board level risk committees have an important role to play in the overall risk governance framework. Banks need establishing limit structures and risk policies for use within individual businesses. Presence of a Chief Risk Officer (CRO) is expected to strengthen the risk management framework in Banks. The CRO must report directly to the CEO and the Board and be responsible for all risks, risk management and control functions. The risk management systems must take into account the technical limitations of risk models, such as Value at Risk (VaR). Stress testing and scenario analysis .

Creation of the Financial Stability Board (FSB) to improve regulatory and supervisory oversight of risk governance at financial institutions is a welcome step.

Governance in banks and financial institutions

Banking regulation in India shifted from prescriptive mode to prudential mode in 1990s. This freedom necessitated tighter governance standards requiring bank boards to assume the primary responsibility and the directors to be more knowledgeable and aware and also exercise informed judgement on various strategies and policy choices. With a view to strengthen corporate governance, over a period of time, various guidelines have been issued in matters relating to the role to be played by the Board, fit and proper criteria for the directors of banks, bifurcation of the post of Chairman and Managing Director (CMD), remuneration etc. Recognising that ownership of banks by one or few individuals could be detrimental to the public interest, especially, depositors interests, it is stipulated that, in India, banks should have a diversified ownership model. To ensure that ownership and control of banks are well diversified, guidelines on ownership and governance in private sector banks were issued by the Reserve Bank in February 2005

Governance in banks and financial institutions

Another requirement of Reserve Banks is that prior approval for any acquisition of shares in private sector banks resulting in a shareholding of 5 per cent or more of the total paid up capital of the bank is needed. In the recent guidelines on new bank licenses wherein it is stipulated that Non-Operative Financial Holding Companies (NOFHC) which set up new banks should, after the initial lock in period of five years, bring down their equity capital of the bank from the minimum 40% while setting up to 15% within 12 years. To ensure Fit and Proper status of the groups that would set up new banks, it is also stipulated that entities / groups should have a past record of sound credentials and integrity, be financially sound with a successful track record of 10 years.

Governance in banks and financial institutions

As per Basel committee Report 1999, Banks have to display the exemplary of corporate governance practices in their financial performance, transparency in the balance sheets and compliance with other norms laid down by section 49 of corporate governance rules. Most importantly, their annual report should disclose accounting ratios, relating to operating profit, return on assets, business per employee, NPAs, maturity profile of loans, advances, investments, borrowings and deposits.
auditors should have the complete know how about all the features of the latest guidelines given by Reserve Bank of India (RBI) and ensure that the financial statements are made in a fraud free manner and should mirror the implementation of corporate governance. Private sector banks has to conform with standard of good banking practices like ensuring a fair and transparent relationship between the customer and bank

Governance in banks and financial institutions

Instituting comprehensive risk management system and its adequate disclosure Proactively handling the customer complaints and evolving scheme of redressal for grievances. Building systems and processes to ensure compliance with the statutes concerning banking.
The Securities and Exchange Board of India (SEBI) had constituted a Committee on Corporate Governance and circulated the recommendations to all stock exchanges for implementation by listed entities as part of the listing agreement vide SEBIs circular SMDRP/Policy/CIR-10/2000 dated February 21, 2000.

Corporate Governance of Non-Banking Finance Companies (NBFCs)

NBFCs have exposures to sensitive sectors such as real estate and capital markets and they also rely on wholesale funding, all of which point to the requirement of robust internal controls and governance framework to ensure their stability. Recognizing the significance of NBFCs in the overall financial system, measures were undertaken to strengthen the regulatory framework in terms of stipulation of capital adequacy and exposure norms in 2006. Subsequently in 2007, guidelines on corporate governance for NBFCs were issued by the Reserve Bank of India. The listed NBFCs were already required to comply with the provisions of the Listing Agreement of the Securities and Exchange Board of India (SEBI), others being governed by the relevant provisions in the Companies Act, 1956.

Corporate Governance of Non-Banking Finance Companies (NBFCs)

Companies Act does not differentiate between financial, non-financial companies and SEBI Guidelines are generally from the perspective of investor protection with emphasis on disclosure and transparency hence they apply to all financial institutions also. RBI being the prudential regulator of NBFCs, additionally lays emphasis on risk management framework and the business practices etc. and its framework is mainly from the angle of depositor / customer protection. The Guidelines address issues such as multiple directorships, continuing due diligence process with a reporting requirement to RBI, self certified fit and proper criteria and disclosures that are specific to NBFCs business, such as disclosures on provision coverage ratio. Asset Liability profile, movement of NPAs, off-balance sheet exposures, structured products issued by them etc. need to be properly reported to RBI.

Corporate Governance of Non-Banking Finance Companies (NBFCs)

Other requirements include prior approval of RBI for change in control of any registered NBFCs. It is indicated that big NBFCs with asset size of Rs. 1000 crore and above would require prior approval of RBI for appointment of CEO and would need to comply with Clause 49 provisions (of SEBI listing agreement) even if unlisted. NBFCs with asset size of Rs. 100 crore and above would be required to comply with the disclosure requirements specified in Clause 49 and of certain financial indicators. The guidelines are aimed at enhancing the self discipline principle in the NBFCs. Measures include pricing of credit, restricting lending to a borrower by not more than two MFIs, sharing credit information with a Credit Information Bureau, review of Fair Practices Code (FPC) etc. Global financial crisis has given us an opportunity for strengthening both the regulatory as well as governance frameworks.

Investor Education and Protection

Various kinds of investors are (i) investors in equity (ii) large institutional investors (iii) Foreign Investors (iv) investors in debentures and (v) small investors/deposit holders etc. Their interest need to be protected. The interface between the companies and its stakeholders including investors is regulated through the legislative framework of the Companies Act and other civil and criminal laws of the country as well as by different regulators such as SEBI, RBI, etc. as well as institutions such as the Stock Exchanges through their rules of operation. In particular, the capital market regulator, SEBI has a significant role to play in safeguarding the interest of investors. It is the responsibility of the shareholders of the company who should charge company management with the responsibility coupled with adequate authority to ensure prudent and proper use of funds collected from the public. The credit rating needs to be done to enable protection of investor interests. There is however, no need to mandate credit rating by law except for companies accepting public deposits.

Investor Education and Protection

Risk cover for depositors :Depositors, being in the nature of unsecured creditors, also do not get adequate protection under law in the event of liquidation or winding up of the company. The credit-worthiness of the companies by the insurance companies will be in the interest of the depositors and hence is recommend for the same. Companies accepting public deposits should be required to appoint independent directors; appoint audit / remuneration / stakeholders relationship committees; under take deposit insurance; undertake credit rating; create adequate cash reserves being set aside for repayment of deposits as may be prescribed by the rules; Be subjected to close monitoring in respect of implementation of any scheme for repayment of deposits that may be sanctioned by CLB/Tribunal/Court; be subjected to a stringent disclosure regime; and be subjected to stringent penalties for irresponsible / fraudulent behaviour by the companies.

Investor Education and Protection

Investor Grievance Redressal :An effective investor grievance redressal mechanism at the corporate level could ensure protection of the interest of investors through timely interventions. The Committee recommends that Stakeholders Relationship Committee should be mandatory for a company having a combined shareholder/deposit holder/debenture holder base of 1000 or more. Consumer courts / Capital Market Ombudsman: Since shares and securities are also legally deemed to be goods under the Consumer Protection Act, 1986, investors have the option to approach Consumer Courts under the Consumer Protection Act as a forum to redress their complaints. In this context, the institution of Ombudsman for Capital Market set up by SEBI should also be strengthened. Investor Education and Protection Fund : The Government has established an Investor Education and Protection Fund (IEPF) under Sec. 205 C of the Companies Act, 1956 under which unclaimed funds on account of dividends, matured deposits, matured debentures, share application money etc. are transferred through the IEPF to the Government by the company on completion of seven years.

Investor Education and Protection

Role of NGOs in Investors education : Many problems relating to investors, particularly, small investors, can be tackled by educating the investors. Small investors should be encouraged to either invest through Mutual Fund mechanisms, or should take investment decisions only after getting adequate information about risks and rewards. The help of various NGOs engaged in investor protection activities should also be taken for this purpose. Disclosures and Investor Protection : proper and timely disclosures are central to safeguarding investor interests. Capital market regulator and stock exchanges have a significant role to play in ensuring that such information is accessible by all market participants rather than a few select market players. There should be a regime of stringent penalties, both civil and criminal for default in disclosure.

CG Reforms After Satyam Scandal Company Bill 2011

The new companies bill 2011 proposes fundamental changes in the way companies are run in India. Lesson has been learnt from Satyam Scam and the gaps in the governance systems that led to this historical scam are thought to be filled.

1. 2. 3. 4. 5.

Governance Reform Independent Directors Disclosure of Pledged Securities Increased Financial Accounting Disclosures

IFRS (Adoption of International Standards)

Strict civil and criminal laws

Major Challenges in the Future

The major challenges to corporate governance reforms in India are: Power of the dominant shareholder Lack of incentives for companies to implement corporate governance reforms Underdeveloped external monitoring systems Shortage of real independent directors Weak regulatory oversight including multiple regulators

Dream Is Not What You See In Sleep

Is The Thing Which Does Not Let You Sleep.

The Biggest Risk In Life Is Not Taking One.