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Chapter 3 Codes of corporate governance & Implementation
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Chapter 3
Codes of Corporate Governance And Implementation
OVERVIEW
The present chapter describes the necessity of formulating the codes of
corporate governance. In brief, it describes the important global best practices.
The chapter describes different reports based on the codes of corporate
governance enforced in India. It covers major recommendations made by the
different committees set up by the various governing bodies like Stock
Exchange Board of India, Reserve Bank of India, Department of Company
Affairs and Confederation of Indian Industry. Lastly it studies the implementation
of codes suggested by the above-mentioned governing bodies in the financial
sector.
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3.1 Introduction Good corporate governance is the key to efficiency in a competitive
environment. Good corporate governance is not merely desirable but it is
essential for survival of a corporation. It is necessary not just because it is good
for the shareholders and other stakeholders, but it is in the interest of the
company itself. Good corporate governance emphasizes ethicality. Decision
making processes should be transparent, consistent with the need to protect the
interests of the company in competitive environment otherwise shareholders and
other stakeholders would lose out interest in the enterprise.
Internationally, corporate governance norms have been initiated
through a judicious mix of the three available routes: legislation, regulation, or
self-discipline and free volition. Often, a fourth one is also evident in the form of
societal pressures. In countries with well-developed economies, capital markets,
and commercial and citizen awareness, legislative interventions are minimal and
not the preferred option. Regulatory agencies such as capital market regulators,
professional bodies and central banks play an important role in bringing about
an orderly and disciplined regimen among their constituents. Self-regulation
through persuasion comes about through initiatives taken by industry chambers
and business associations, often also aided by globalization initiatives that
dictate adoption of international best practices. Societal pressures impact on
corporate social responsiveness and often manifest in corporate responses well
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beyond legislative demands concerning ecology, environment, community
development, and so on.
Numerous reports and studies across the world testify to this
pressing need. In the United Kingdom, while the pioneering foundations for
improving corporate governance were laid by the Cadbury Report in 1992, it was
followed by further extensions and revisions brought about by the Hampel
Committee, the Greenbury Report, and more recently the Turnbull Report. In the
United States, the early nineties saw the publication of the Treadway
Commission Report of the Committee of Sponsoring Organisations. It is indeed
quite revealing that in a country where, for example, Audit Committees were
mandated by the New York Stock Exchange as early as in 1973, a Blue Ribbon
report in 1999 was found necessary to explore ways of improving the
effectiveness of audit committees. Canadian initiatives on corporate governance
spearheaded by the Toronto Stock Exchange, led to the publication in 1994 of
the provocatively titled report, “Where were the Directors”, which was itself the
subject of a 1999 review of compliance and implementation in five years to the
Dey, appropriately named after the chair of the earlier 1994 committee. Similar
is the experience in many other countries where there is a felt need for ongoing
review and up gradation of the requirements.
In India, company legislation has until recently been the main
instrument for improving corporate governance. Tracing its origins to the mid-
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nineteenth century, and thereafter closely following similar developments in the
United Kingdom, the Companies Act 1956 was a consolidating legislation of
monumental proportions and far reaching impact that significantly altered the
structure of corporate management in India. Subsequently incorporating the
recommendations of the Bhabha Committee, this act legislated, among other
things, the abolition of the system of managing agencies, an institution that had
served the country truly and well during the early days of corporatization, but
fallen into disrepute through abuse and malpractice in its application by its latter
day exponents. With this, a pernicious vehicle for siphoning off corporate wealth
for the benefit of a few dominant and controlling shareholders was sought to be
destroyed. Subsequent amendments in the later part of the twentieth century
essentially built upon the basic structure of 1956, and usually attempted to plug
observed loopholes in practice. In-tune-with the times completely revised,
updated, and, abridged version of the legislation introduced in parliament to
meet the requirements of a changing business environment. The Amending Bill
introduced in late 1999 and modified in 2000 has recently been approved by
Parliament. This report aims to offer further inputs for improving standards of
corporate governance in the country.
Governance initiatives through regulation have also made
significant strides in the country. The Securities and Exchange Board of India
(SEBI) has an ongoing programme of reforming the primary and secondary
capital markets. The stock exchanges in the country also mandate several
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beneficial requirements through their listing agreements that every publicly
traded company has to comply with. Among the professions, The Institute of
Chartered Accountants of India (ICAI) has emerged as a mature body regulating
the profession of public auditors, and counts among its achievements the issue
of a number of accounting and auditing standards. Constitution of an
independent National Advisory Committee on Accounting Standards has been
legislated by the amending act of 1999. Other professional bodies such as the
Institute of Cost and Works Accountants of India and the Institute of Company
Secretaries of India (ICSI) have helped in promoting and regulating a well
trained and disciplined body of professionals who could add value to
corporations in improving their management practices. The ICSI has also taken
a major initiative in constituting a secretarial standards board comprising senior
members of eminence to formulate secretarial standards and best secretarial
practices and develop guidance notes in order to integrate, consolidate,
harmonise and standardise the prevalent diverse practices with the ultimate
objective of promoting better corporate practices and improved corporate
governance.
3.2 Global Best Practices
It is essential to outline few of the best international best practices in governing
the corporate sector. In May 1991, the London Stock Exchange set up a
committee under the chairmanship of Sir Adrian Cadbury in order to raise the
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standards of corporate governance and the level of confidence in financial
reporting and auditing. The resulting report, and associated “Code of Best
Practices,” published in December 1992, was generally well received. The
Cadbury Code of Best Practices had 19 recommendations. Being a pioneering
report on corporate governance, it is essential to make a brief reference to its
recommendations, which are in the nature of guidelines relating to the Board of
Directors, Non-executive Directors, Executive Directors and those on Reporting
& Control.
The Cadbury Report stipulated that the Board of Directors should
meet regularly, retain full and effective control over the company and monitor
the executive management. The report has clearly mentioned the division of
responsibilities at the head of the company. This ensures balance of power and
authority so that no individual has unfettered powers of decision. The board
should have a formal schedule of matters, which are specially reserved for
decisions. This ensures that the direction and control of the company is firmly in
its hands. There should also be an agreed procedure for directors in performing
their duties and to take independent professional advice. Any question of the
removal of company secretary should be a matter for the board as a whole.
Non-executive Directors should bring an independent judgement
on certain key issues. The majority of directors should be independent of the
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management and free from any business or other relationship, which could
materially interfere. They must be paid sitting fees. Non-executive directors
should be appointed for specified terms and reappointment should not be
automatic. This means that appointment of non-executive directors should be on
formal basis. Directors’ service contracts should not exceed three years without
shareholders’ approval. The total emoluments including pension contributions
and stock options of the Chairman and the highest-paid UK Directors should be
disclosed.
The Executive Directors’ service contracts should not exceed three
years without shareholders’ approval. There should be full and clear disclosure
of their total emoluments and those of the Chairman and the highest-paid UK
directors. Executive Directors’ pay should be subject to the recommendations of
a Remuneration Committee made up wholly or mainly of non-executive
directors.
It is the board’s duty to present a balanced and understandable
assessment of the company’s position. The board should ensure that an
objective and professional relationship is maintained with the auditors. The
board should establish an Audit Committee of at least 3 non-executive directors
with written terms of reference, which deal clearly with its authority and duties.
The directors should explain their responsibility for preparing the accounts next
to a statement given by the auditors about their reporting responsibilities. The
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directors should report on the effectiveness of the company’s system of internal
control. The directors should report that the business is a going concern, with
supporting assumptions or qualifications as necessary.
On the report of Cadbury Committee, Ron Hampel Committee's
final report and the Greenbury Report (Greenbury Report, which was submitted
in 1995, addressed the issue of Directors' remuneration), the London Stock
Exchange appended The Combined Code to the listing rules for all listed
companies in the U.K. as a mandatory compliance.
Beside Cadbury committee, a number of supranational
organizations have drawn codes in response to growing awareness of the
importance of good corporate governance. The most well known is perhaps the
Organization for Economic Cooperation and Development (OECD principles
of corporate governance of 1999). The OECD Principles are the result of a
consensus between participating governments on minimum requirements for
best practice. Although they are non-binding, they provide a reference for
national legislation and regulation, as well as guidance for stock exchanges,
investors, corporations and other parties. It is useful to summarise the five basic
pillars of OECD code, viz.,
i. Protecting the rights of shareholders;
ii. Ensuring equitable treatment of all shareholders including having an
effective grievance redressal system;
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iii. Recognising the rights of stakeholders as established by law;
iv. Ensuring the timely and accurate disclosure regarding the corporation
including the financial situation, performance, ownership and governance of
the company; and
v. Ensuring the strategic guidance of the company, effective monitoring
arrangement by the board and the board’s responsibility to the company and
the shareholder.
The Financial Stability Forum named the OECD principles as one of the twelve
key standards for sound financial systems as they underpin the corporate
governance component of the World Bank/IMF Reports on Standards and
Codes (ROSC).
Following the OECD principles in emphasising the basic tenets of
corporate governance, it is the 1999 Bank for International Settlement (BIS)
paper that went specifically to the issue of enhancing corporate governance for
banking organisation. From banking industry perspective, BIS proposed seven
principles. These are:
i. Establishing strategic objectives and corporate values.
ii. Setting and enforcing clear lines of responsibility and accountability
iii. It ensure that the board members are qualified for their position and are
not subject to undue influence from the management or outside concerns;
iv. It ensure that there is appropriate oversight by senior management;
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v. The work conducted by internal and external auditors effectively utilized;
vi. It ensure that compensation approaches are consistent with the bank’s
ethical values, objectives, strategy and control environment;
vii. The corporate governance should be conducted in a transparent manner.
In the presence of several guidelines on corporate governance
among them some of the ranked best in the world the Enron debacle of 2001,
came in light followed by other scandals where US companies such as
WorldCom, Qwest, Global Crossing was involved. These have shaken the
foundations of business world and triggered another phase of reforms in
corporate governance, accounting practices and disclosures more
comprehensively than ever before. In July 2002, less than a year from Enron file
bankruptcy Sarbanes Oxley Act (SOX) was enacted in US. The act aims to
protect investors by improving the accuracy and reliability of corporate
disclosures and address all the issues associated with corporate failures to
achieve quality governance and to restore investors’ confidence. The act
contains number of provisions regarding – public company accounting oversight
board, auditor independence, corporate responsibility, enhanced financial
disclosures, analyst conflicts of interest, commission resources and authority,
studies and reports, corporate & criminal fraud accountability, white-collar crime
penalty enhancements corporate tax returns, corporate fraud and
accountability.
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The recent events also highlighted a number of areas to
strengthen the OECD Principles. The Principles already cover many of the
issues that have been at the center of recent corporate scandals. They included
recommendations on high quality standards of accounting and audit, the
independence of board members and the need for boards to act in the interest
of the company and the shareholders. Therefore, OECD invited comment on
Draft Revision of its Corporate Governance Principles on Jan.1, 2004.
OECD Secretary-General Donald J. Johnston said, "Once a new text is agreed,
it will be up to governments, companies, investor groups and others to
implement the recommendations and the OECD will follow this process closely."
The new draft text, in addition, sets more demanding standards in
a number of areas. It specifies that investors should have both the right to
nominate company directors and a more forceful role in electing them. It states
that shareholders should be able to express their views about compensation
policy for board members and executives and submit questions to auditors. It
calls on institutional investors to disclose their overall voting policies and how
they manage material conflicts of interest that may affect the way they exercise
key ownership functions, such as voting. The text also identifies the need for
effective protection of creditor rights and an efficient system for dealing with
corporate insolvency. It calls on rating agencies, brokers and other providers of
information that could influence investor decisions to disclose conflicts of
interest and how they are being managed. It also calls on boards to be more
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rigorous in disclosing related party transactions and to protect so-called "whistle
blowers" by allowing them confidential access to a contact at board level. It is
anticipated that a final revised version of the principles, which was submitted to
OECD governments may get approval at the annual meeting of the OECD
Council at Ministerial Level on May 2004.
3.3 Codes of Corporate Governance Recommended by Various
Committees in India
3.3.1 Confederation of Indian Industries Code of Corporate Governance
The initial formal moves towards corporate governance in India can be traced in
1997 with the voluntary code framed by the Confederation of Indian Industry
(CII). In 1996, CII took a special initiative on corporate governance. The
objective was to develop and promote a code for corporate governance to be
adopted and followed by Indian companies, be these in the private sector, the
public sector, banks or financial institutions, all of which are corporate entities. A
voluntary code published by CII in April 1998, under the committee headed by
Shri Rahul Bajaj. A number of companies over the next three years (nearly 30
large listed companies accounting for over 25 per cent of India’s market
capitalisation) voluntarily adopted the CII code. According to its
recommendations –
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• The full board should meet a minimum of six times a year with an interval of
two months. The listed company should have professionally competent and
acclaimed non-executive directors, with a composition of at least 30% of the
board if the chairman is a non-executive director, or at least 50% of the
board if the chairman is a full time director.
• No single person should hold directorships in more than 10 listed companies.
Companies should pay a commission of 1% of net profits (if the company
has a managing director) otherwise 3% above the sitting fees for the use of
the professional inputs. Stock can be offered as a reward to performance.
• While re-appointing members of the board, companies should give the
attendance record of the concerned directors. If a director has not been
present for 50% or more meetings, then this should be explicitly stated in the
resolution that is put to vote.
• Listed companies with either a turnover of Rs.100 crores or a paid up capital
of Rs.20 crores whichever is less should set up audit committees within two
years. Audit Committees must comprise of minimum of 3 non-executive
directors as a member, who should have adequate knowledge of finance,
accounts and basic elements of company law.
• Under “Additional Shareholder’s Information”, listed public companies should
give data on - High and low monthly averages of share prices in all the stock
exchanges where the company is listed for the reporting year.
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• Major Indian stock exchanges should gradually insist upon a compliance
certificate, signed by the CEO and CFO, which clearly states the
responsibility of the management in preparing financial statements & other
information in the annual report the accountability policies and principles
conform to standard practice.
3.3.2 Report of the SEBI Committee on Corporate Governance (1999)
The next major cornerstone in the Indian case has been the SEBI Committee
chaired by Shri Kumar Mangalam Birla on May 07,1999, as the first formal and
comprehensive attempt to evolve a Code of Corporate Governance, in the
context of prevailing conditions of governance in Indian companies and the state
of capital markets. The committee recommended that the fundamental objective
of corporate governance is the “enhancement of shareholder value, keeping in
view the interests of other stakeholder”. The committee made recommendations
of far-reaching implications for several issues, such as, the independence of
board, accounting standards and financial reporting, share-holders’ rights and
responsibilities, and formation of audit and remuneration committee. The
mandatory recommendations, applies to listed companies with paid up capital of
Rs.3 crore and above, which are as follows:
• Composition of board - The boards of a company have an optimum
combination of executive and non-executive directors. The board should
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comprise of 1/3 of independent director in case of non-executive chairman
and at least 1/2 when chairman is executive.
• Constitution of audit committee - The audit committee comprises of at least 3
independent directors with one having financial and accounting knowledge.
At least 3 meetings a year. It is responsible for review of financial
performance on half yearly/annually basis; appointment/
removal/remuneration of auditors; review of internal control systems and its
adequacy.
• Remuneration of directors – The remuneration of directors decided by the
board and details of remuneration package, stock options, performance
incentives of directors to be disclosed.
• Board procedures – The board procedures in which at least 4 meetings
should be held in a year with a maximum time gap of four months between
any two meetings as to review operational plans, capital budgets, quarterly
results, minutes of committee’s meeting. The director should not to be
member of more than 10 committees and chairman of more than 5
committees across all companies.
• Management discussion and analysis report - It should include industry
structure & developments, opportunities & threats, segment wise or product
wise performance outlook, risks & concerns internal control systems & its
adequacy, discussion on financial performance, and disclosure by directors
on material financial and commercial transactions with the company.
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• Shareholders information - A brief resume of new/re-appointed directors,
quarterly results to be submitted to stock exchanges and to be placed on
web-site.
• Shareholders’/investors grievance committee – The shareholders’/investors
grievance committee should be constituted under the chairmanship of
independent director to look into the complaints of shareholder and conduct
at least 2 meetings in a year.
• Report on corporate governance and Compliance - A separate section on
Corporate Governance in the annual reports of company certificate from
auditors on compliance of provisions of corporate governance should
according to clause 49 in the listing agreement.
The non-mandatory recommendations implies –
• Role of chairman: The chairman should be given expenses to maintain his
office, so that it enables him to discharge his duties well.
• Remuneration Committee: To set up remuneration committee by board on
their behalf as well on behalf of shareholders as to determine the
company’s policy on specific remuneration packages for executive directors.
• Shareholder Rights: The shareholders’ right for receiving half yearly financial
performance.
• Postal ballot system: The postal ballot covering critical matters like alteration
in memorandum etc, sale of whole or substantial part of the undertaking
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corporate restructuring, further issue of capital, venturing into new
businesses.
3.3.3 Report of the SEBI Committee on Corporate Governance (2003)
SEBI believes that efforts to improve corporate governance standards in India
must continue. This is because these standards are themselves evolving, in
keeping with market dynamics. Recent events worldwide, primarily in the United
States, have renewed the emphasis on corporate governance. These events
have highlighted the need for ethical governance and management, and for the
need to look beyond mere systems and procedures. This will ensure compliance
with corporate governance codes, in substance and not merely in form.
Again, one of the goals of good corporate governance is investor
protection. The individual investor is at the end of a chain of financial
information, stretching from corporate accountants and management, through
boards of directors and audit committees, to independent auditors and stock
market analysts, to the investing public. Many of the links in this chain need to
be strengthened or replaced to preserve its integrity. Therefore, SEBI believed
that a need to review the existing code on corporate governance arose from two
perspectives - to evaluate the adequacy of the existing practices, and to further
improve the existing practices.
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In the context of the above rationale, the SEBI committee on corporate
governance was constituted on February 08, 2003 under the chairmanship of
Shri N. R. Narayana Murthy, Chairman and chief mentor of Infosys
Technologies Limited. The terms of reference of the Committee are set out as
under:
• To review the performance of corporate governance
• To determine the role of companies in responding to rumour and other
price sensitive information circulating in the market, in order to enhance
the transparency and integrity of the market.
The issues discussed by the Committee primarily related to audit
committees, audit reports, independent directors, related parties, risk
management, directorships and director compensation, codes of conduct and
financial disclosures. They are:
• Audit committee - strengthening responsibilities of audit committee,
• Audit reports - to improve quality of financial disclosures,
• Independent directors – does not have any material, pecuniary
relationship or transaction with the company,
• Related parties - to disclose the related party transaction to audit
committee,
• Risk management - to assess & disclose business risks,
• Initial Public Offering - utilization of proceeds from IPO,
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• Director’s compensation - to fix the compensation of non-executive
directors by board of directors and disclose it on website,
• Code of conduct- to introduce the formal code of conduct for board,
• Whistle blower policy - to be place in a company providing freedom to
approach the audit committee,
• Subsidiaries - to be reviewed by audit committee of holding company.
The committee also discussed briefly certain recommendations
that were contained in the report of Naresh Chandra Committee on Corporate
Audit and Governance. It was therefore decided by the committee, that in
making the final recommendations to SEBI, the committee would also
recommend that the mandatory recommendations in the report of the Naresh
Chandra Committee, insofar as they related to corporate governance, be
mandatorily implemented by SEBI through an amendment to clause 49 of the
listing agreement.
3.3.4 Report of the Advisory Group on Corporate Governance The initial move towards corporate governance in banks can be traced in the
Reports of Advisory Group on Corporate Governance: Standing Committee on
International Financial Standards and Codes, chaired by Dr. R.H. Patil, for the
RBI in 2001. The Group has discussed models of corporate governance
prevailing in industrialized and emerging countries, the current status of the
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corporate governance in India in the private sector companies, the public sector
companies set up under the Companies Act, the banks and financial institutions
vis-à-vis the internationally accepted principles, codes and best practices in the
areas of corporate governance. The group adopted the OECD Principles of
corporate governance as the main benchmark for comparing the extent of
compliance by the Indian corporate entities. The Group has relied on the
Combined Code of London Stock Exchange, Cadbury Report, Green Bury
Report and Blue-Ribbon Committee to improve the effectiveness of corporate
audit committees.
The Advisory Group has noted that the predominant form of
corporate governance in India is much closer to the East Asian ‘insider’ model
where the promoters dominate governance in every possible way. The group felt
that it is essential to bring reforms quickly and has suggested amendment of the
Companies Act in which the statutory framework for corporate governance has
already been enshrined for enforcing good governance practices in India. The
group made recommendations on the areas of –
• Responsibilities of the board of directors,
• Accountability to stakeholders/ shareholders,
• Selection procedures for the appointment of directors of the board,
• Size and composition and independence of the board,
• Constitution of committees like audit, nomination, remuneration and
shareholders redressal to oversee the practice of corporate governance,
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• Disclosure and transparency standards,
• Role of shareholders and auditors, etc.
The group looked into public sectors banks and noted that the first
important step to improve governance mechanism in these units is to transfer
the actual governance functions from the concerned administrative ministries to
the boards and also strengthen them by streamlining the appointment process of
directors. Furthermore, Group has underlined the need for public sector banks to
maintain a high degree of transparency in regard to disclosure of information.
3.3.5 Report of the Advisory Group on Banking Supervision
The advisory group on banking supervision for the Standing Committee on
International Financial Standards and Codes, under the chairmanship of Shri
M.S. Verma while looking into several areas in which internationally accepted
best practices are already in place, probed into corporate governance as well.
The minimum benchmarks noted by the Group relate to the following:
• Strategies and techniques basic to sound corporate governance;
• Organizational structure to ensure oversight by board of directors and
individuals not involved in day-to-day running of business;
• To ensure that the direct line of supervision of different business areas are
different;
• To ensure independent risk management and audit functions;
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• To ensure an environment supportive of sound corporate governance; and
role of supervisors.
Interestingly, with reference to public sector banks, the group
noted that the nature of a bank’s ownership is not a critical factor in establishing
sound corporate governance practices and concluded that, “the quality of
corporate governance should be the same in all types of banking organisations
irrespective of the nature of their ownership”. The group, however, felt that there
are some areas where practices in the Indian banking sector fell short of
international best practices, viz., constitutions of boards, their accountability, and
their involvement in risk management. The group gave special emphasis on
enhanced transparency in the constitution and structure of the board and senior
management and in public disclosures.
3.3.6 Report of the Consultative Group of Directors of Banks and
Financial Institutions
Taking this move towards corporate governance further, the Reserve Bank
constituted a consultative group of directors of banks and financial institutions
under the chairmanship of Dr. A.S. Ganguly, to review the supervisory role of
boards of banks and financial institutions. The Ganguly consultative group
looked into the functioning of the boards vis-à-vis compliance, transparency,
disclosures, audit committees and suggested measures for making the role of
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the board of directors more effective. The group submitted its recommendations
in April 2002. The major recommendations of the group are the following:
• The government while nominating directors on the boards of PSBs should be
guided by certain broad “fit and proper” norms for the directors, based on the
lines suggested by BIS.
• The appointment / nomination of independent / non-executive directors to the
board of banks (both public sector and private sector) should be from a pool
of professional and talented people to be prepared and maintained by RBI.
• It would be desirable to take an undertaking from every director to the effect
that they have gone through the guidelines defining the role and
responsibilities of directors, and understood what is expected of them.
• In order to ensure strategic focus it would be desirable to separate the office
of Chairman and Managing Director in respect of large-sized PSBs.
• The information furnished to the board should be wholesome, complete and
adequate to take meaningful decisions. The board’s focus should be devoted
more on strategy issues, risk profile, internal control systems, overall
performance, etc.
• It would be desirable if the exposures of a bank to stockbrokers and market-
makers as a group, as also exposures to other sensitive sectors, viz., real
estate etc. are reported to the board regularly.
• The disclosures of progress made towards establishing progressive risk
management system, the risk management policy, strategy, exposures to
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related entities, the asset classification of such lending / investments etc.
should be in conformity with corporate governance standards, etc.
The Ganguly Committee recommendations have been
benchmarked with international best practices as enunciated in the Basel Paper
as well as of other committees and advisory bodies to the extent applicable to
the Indian environment. RBI has also implemented most of the
recommendations. In general these regulations have created an enabling
framework for improving corporate governance in financial institutions.
3.3.7 Report of the Committee on Corporate Audit and Governance
On 21 August 2002, the Naresh Chandra Committee on Corporate Audit and
Governance appointed by the Department of Company Affairs (DCA) under the
Ministry of Finance and Company Affairs, after a series of corporate scandals in
the US, and the Tata Finance-Ferguson episode in India has come out with
comprehensive recommendations. The thrust of the recommendations is on
providing a greater role for the independent directors on the company boards,
disciplining the auditors, and making the Chief Executive Officer (CEO) and the
Chief Financial Officer (CFO) accountable for financial reporting and statements.
The major recommendations are given by the committee are as:
• A list of disqualifications for audit assignments like direct relationship with
company, any business relationship with client, personal relationship with
director.
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• The committee has, however, not recommended statutory rotation of audit
firms, but favoured compulsory audit partner rotation — a measure that is
in line with the recently enacted Sarbanes Oxley Act of the US.
• The audit firms should not provide services such as accounting, internal
audit assignments etc. to audit clients.
• The auditor needs to disclose contingent liabilities & highlight significant
accounting policies.
• The responsibilities of audit committee is to discuss the annual work
programme with the auditor; review the independence of the audit firm and
recommend to the board, with reasons, either the appointment / re-
appointment or removal of the external auditor, along with the annual audit
remuneration. But, this recommendation excludes government companies
(which follow section 619 of the Companies Act) and scheduled
commercial banks (where the RBI has a role to play).
• The management and directors should certify the accounts and financial
statements of all listed companies and public limited companies with paid
up capital of Rs.10crore and above.
• The redefinition of independent directors – does not have any material,
pecuniary relationship or transaction with the company.
• The composition of board of directors of all listed companies, as well as
unlisted public limited companies with a paid-up share capital of Rs.10
crore and above, or turnover of Rs.50 crore and above should be seven, in
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which at least four should be independent directors excluding the unlisted
public companies, which have no more than 50 shareholders and unlisted
subsidiaries of listed companies.
• Non-audit fees can be restricted, if it is necessary.
Apart from the above recommendations committee does not felt
any requirement for setting up an independent regulator similar to the Public
Company Accounting Oversight Board in the Sarbanes Oxley Act. However, the
committee felt the need to establish an efficient and professional body as to
provide transparent and expeditious auditing quality oversight. Therefore,
committee recommended the setting up of Quality Review Boards. The
recommendations have formed part of companies (amendment) bill, 2003.
3.3.8 Report of the Task Force on Corporate Excellence through
Governance
The Department of Company Affairs in the Ministry of Law, Justice and
Company Affairs, Government of India, being the sort of Alma Mater of
corporate, and responsible for administering the working of companies as also
the companies act, has been working vigorously in the direction of putting in
place an altogether new company law to suit the modern requirements. The
department is very much determined to inculcate a high degree of ethics in the
corporate functioning. Along with the efforts of SEBI to frame a set of corporate
governance practices in the form of a corporate code by appointing the Kumar
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Mangalam Birla Committee and adopting and implementing some of its
recommendations swiftly, the department has gone a step further to transplant
the concept of corporate excellence through corporate governance as the
ultimate benchmark for corporate. ‘With the opening up of the economy and to
be in tune with the WTO requirements, if Indian corporate has to survive and
succeed amidst increasing competition from transnationals and foreign
corporates and it can only be through achieving ‘Excellence’ in their working.
Towards this direction of achieving excellence, in May, 2000 the DCA made
Task Force by inviting a group of leading industrialists, professionals, and
academics to study and recommend measures to enhance corporate excellence
in India. The recommendations of the task force have been grouped as
essential, to be introduced immediately by legislation and desirable, that can be
left to the discretion of the companies and their shareholders in their wisdom.
Given the challenges of managing change, the task force has recommended
phased implementation of the essential measures, depending upon the size and
capabilities of the companies on the one hand and on the other, the
requirements of the market place.
Internationally, thinkers advocate that corporate governance
measures should be more by self-discipline and market forces, rather than by
legislation and regulation. The task force is however convinced that the level of
non-legislative and non-regulatory intervention is a function of the maturity of the
market and the economy. However, emphasis continues to be on self-regulation.
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The desire for self-regulation should be enhanced by recognition of the
advantages of good governance in improving the company’s credibility and
market acceptance. The recommendations made in the report related to
corporate governance matters were legislative, regulatory and voluntarily. The
recommendations covered issues like general; company, boards, directors &
processes; audit accounts, ethics, disclosure and reporting; and shareholder
democracy & protection of minority interests. The major recommendations are:
• Companies at their option append a model code of best practices in
corporate governance to the companies act, on the lines of Table A, for
adoption with or without modification.
• The group made clear distinction of responsibilities like direction and
management between the board and the executive. Company board should
have a majority of independent non-executive directors. The positions of
Chairman and Managing Director of a listed company should be separated,
but the company may have the option to combine these with the disclosure
requirement.
• It is essential for listed company to constitute audit committee and a
compensation committee consisting of at-least three members, all of them
being independent non-executive directors.
• The executive director of a public company, listed or unlisted, shall not
accept a directorship in any other company, including private limited
companies, partnership, or, engaged in activities with the first company, in
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material lines of its business excluding where a prior approval of the board is
taken.
• Non-executive directors may accept non-executive directorships in other
competing companies but needs to made disclosure in the annual report.
• Every listed company shall constitute a nomination committee, consisting at
least three independent non-executive directors. The non-executive director
should not hold directorship in more than 10 committees or chairmanship of
more than 4 committees in other listed companies.
• The remuneration to executive director apart from monthly salaries and
perquisites should be given Executive Share Option Plan (ESOP) awards
whereas non-executive directors should be awarded Director Share Option
Plan (DSOP) besides sitting fees.
• Listed companies should publish their annual reports and accounts in a
prescribed form for circulation to shareholders. The CEO and CFO of all
public companies, listed and unlisted, should provide a statement in each
annual report to shareholders, acknowledging responsibility for the financials
and provide confirmation of strictly following accounting standards and
practices.
• The measures emphasized to introduce the concept of interested
shareholders in the scheme of voting on resolutions on specific matters by
shareholders in case of listed companies as to provide shareholder
democracy and protection of minority interests.
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• The annual reports to the shareholders should be disclosed each year.
Listed companies should provide user-friendly web sites and provide
information on an ongoing basis to shareholders and others.
3.4 Implementation of Codes of Corporate Governance in Indian Financial Sector
It is evident from the above recommendations that over the last few years, a
series of joint corporate governance committees were appointed by DCA and
SEBI. Their recommendations are reflected in amendments of Companies Act
1956, listing rules and SEBI regulations. The Kumar Mangalam Birla Committee
of the Indian jurisdiction outlined a code of good corporate governance, which
compared very well with the recommendations of the Cadbury Committee and
the OECD codes. The recommendations were implemented through Clause 49
of the Listing Agreements, in a phased manner by SEBI. They were made
applicable within financial year 2000-01, but not later than March 31, 2001 by all
entities, which are included in either in Group A of the BSE 200 or S&P C&X
Nifty indices as on March 31, 2001. The applicability of the recommendations
within financial year 2001-2002, but not later than March 31, 2002 by all entities
listed with paid up capital of Rs.10 crore and above, or networth of Rs.25 crore
or more any time in the history of the company; and within financial year 2002-
2003, but not later than March 31, 2003 by all the entities listed with paid up
share capital of Rs.3 crore and above.
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The accounting standards issued by the ICAI, which are applicable
to all companies under sub-section 3A of section 211 of the companies act,
1956, were specifically made applicable to all listed companies for the financial
year ended March 31, 2002, under the listing agreements.
i. Board of Directors
a. The boards of a company should have an optimum combination of executive
and non-executive directors. The board should comprise of 1/3 of independent
director in case of non-executive chairman and at least 1/2 when chairman is
executive.
b. The company should agree that all pecuniary relationship or transactions of
the non-executive directors vis-à-vis should be disclosed in the annual report.
ii. Audit Committee
A. 1. Composition The company should set up a qualified and independent
audit committee and that consists of:
a) Minimum of three members -all being non-executive directors.
b) Majority of the members to be independent.
c) One member must have financial and accounting knowledge.
d) Chairman of the committee shall be an independent director.
2. The Chairman should present in AGM to answer shareholders queries.
3. The committee should invite company executives as, it considers appropriate
(particularly the head of finance function) to be present in the meeting of the
committee.
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4. The committee may also meet without the presence of any executives of the
company.
5. When required, the representative of external auditor shall remain present in
the meeting.
6. Company secretary shall be the secretary of the committee
B. Functions of audit committee
1. Audit committee should meet at least thrice a year.
2. One meeting should be held before finalisation of annual accounts.
3. Other two meetings should be held at interval of six months.
4. The quorum should be either two members or one third of the members of the
audit committee whichever is higher and minimum of two independent
directors.
C. Power of the Audit committee
1. To investigate any activity within its terms of reference.
2. To seek information from any employee.
3. To obtain outside legal or other professional advice.
4. To secure attendance of outsiders with relevant expertise, if it considers
necessary.
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D. Role of audit committee
1. Oversee the company’s financial reporting process and the disclosure of its
financial information to ensure that the financial statement is correct,
sufficient and credible.
2. Recommending the appointment and removal of external auditor, fixation of
audit fee and also approval for payment for any other services.
3. Reviewing with management the annual financial statements before
submission to the board, focusing primarily on;
• Any changes in accounting policies and practices.
• Major accounting entries based on exercise of judgment by management.
• Qualifications in draft audit report.
• Significant adjustments arising out of audit.
• The going concern assumption.
• Compliance with accounting standards.
• Compliance with stock exchange and legal requirements concerning financial
statements.
• Any related party transactions i.e. transactions of the company of material
nature, with promoters or the management, their subsidiaries or relatives etc.
that may have potential conflict with the interests of company at large.
4. Reviewing with the management, external and internal auditors, the
adequacy of internal control systems.
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5. Reviewing the adequacy of internal audit function, including the structure of
the internal audit department, staffing and seniority of the official heading the
department, reporting structure coverage and frequency of internal audit.
6. Discussion with internal auditors any significant findings and follow up there
on.
7. Reviewing the findings of any internal investigations by the internal auditors
into matters where there is suspected fraud or irregularity or a failure of
internal control systems of a material nature and reporting the matter to the
board.
8. Discussion with external auditors before the audit commences nature and
scope of audit as well as has post-audit discussion to ascertain any area of
concern.
9. Reviewing the company’s financial and risk management policies.
10. To look into the reasons for substantial defaults in the payment to the
depositors, debenture holders, shareholders and creditors.
iii. Remuneration of directors
A. Remuneration of non-executive directors to be decided by the board of
directors.
B. Disclosures in relation to remuneration of the directors should be made in the
section on the corporate governance of the annual report.
1. Remuneration package such as salary, benefits, bonuses, stock options,
pension etc.
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2. Details of fixed component and performance linked incentives, along with the
performance criteria.
3. Service contracts, notice period, severance fees.
4. Stock option details, if any.
iv. Board procedures
1. The board meeting to be held at least four times a year,
2. The difference of two board meetings should not be more than four months.
3. A director should 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.
v. Management
A. The Management Discussion and Analysis report should form part of the
annual report to the shareholders. This should include discussion on the
following matters within the limits set by the company’s competitive position:
a. Industry structure and developments.
b. Opportunities and Threats.
c. Segment-wise or product-wise performance.
d. Outlook.
e. Risks and concerns.
f. Internal control systems and their adequacy.
g. Discussion on financial performance with respect to operational
performance.
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h. Material developments in Human Resources / Industrial Relations front,
including number of people employed.
B. Disclosures to be made to the board relating to all material financial and
commercial transactions, where they have personal interest, that may have a
potential conflict with the interest of the company at large (for e.g. dealing in
company shares, commercial dealings with bodies, which have shareholding of
management and their relatives etc.)
vi. Shareholders
A. The shareholders must be provided with the following information before
appointment of a new director or re-appointment of a director:
a. A brief resume of the director;
b. Nature of his expertise in specific functional areas; and
c. Names of companies in which the person also holds the directorship and the
membership of Committees of the board.
B. Quarterly results, presentation made by companies to analysts should be put
on company’s web-site.
C. A committee designated as ‘Shareholders/Investors Grievance Committee’
under the chairmanship of a non-executive director should be formed to
specifically look into the redressing of shareholder and investors complaints like
transfer of shares, non-receipt of balance sheet, non-receipt of declared
dividends etc.
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D. To delegate the power of share transfer to an officer or a committee or to the
registrar and share transfer agents. The delegated authority should attend to
share transfer formalities at least once in a fortnight.
vii. Report on Corporate Governance
The Annual report of the company should comprise a separate section on
Corporate Governance. Non compliance of any mandatory requirement i.e.
which is part of the listing agreement with reasons there of and the extent to
which the non-mandatory requirements (non-mandatory recommendations of
Kumar Mangalam as aforesaid above in 3.3.2) have been adopted should be
specifically highlighted.
viii. Compliance
The compliance of conditions of corporate governance is to be certified by
auditors of the company and the same is to be annexed with the directors’
report. The same certificate should also be sent to the Stock Exchanges along
with the annual returns filed by the company.
In terms of SEBI's circular no. SMD/Policy/CIR-03/2001 dated
January 22, 2001 all companies were required to submit a quarterly compliance
report to the stock exchanges within 15 days from the end of a financial
reporting quarter. The SEBI observed that the compliance with the requirements
in clause 49 of the listing agreement is, by and large, satisfactory. However, an
analysis of the financial statements of companies and the report on corporate
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governance discloses that there was variation in the quality of annual reports.
Variations in the quality of annual reports, including disclosures, raises the
question whether compliance is in form or in substance; and emphasized the
need to ensure that the laws, rules and regulations do not reduce corporate
governance to a mere ritual. Therefore, on August 26, 2003, the Security
Exchange Board of India (SEBI) revised Clause 49 of the listing agreement for
improving the standards of corporate governance.
In the above context, and the recommendations made by the
Naryana Murthy committee SEBI directed amendment to Clause 49 of the
Listing agreement through circular no. SEBI/CFD/DIL/2004/12/10 dated October
29, 2004. The revised clause 49 of the listing agreement relating to corporate
governance set forth a schedule for new listing companies and listed companies
to comply with the revisions. The companies complied with the revised clause by
March 31, 2005. However, in March 2005, SEBI extended the date set for
compliance with these new provisions to December 31, 2005, since a large
number of companies were unprepared to fully implement the changes. Major
changes in the clause include amendments/additions to provisions relating to
definition of independent directors, strengthening the responsibilities of audit
committees, and requiring boards to adopt a formal code of conduct. The
revised clause 49 includes:
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• Change in the definition of Independent Directors – who apart from
receiving director's remuneration does not have any material pecuniary
relationships or transactions with the company or any related party, which
may affect independence of the director.
• Non-Executive director's compensation and disclosures – It shall be fixed
by the Board of Directors and shall require previous approval of
shareholders in general meeting.
• Other provisions related to Board and Committees – The board shall
meet at least four times a year, with a maximum time gap of three months
between any two meetings. 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.
• Code of Conduct – 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.
• Composition of Audit Committee – The audit committee shall have
minimum three directors as members. Two-thirds of the members of audit
committee shall be independent directors. All members of audit
committee shall be financially literate and at least one member shall have
accounting or related financial management expertise.
• Meeting of Audit Committee – The audit committee should meet at least
four times in a year and maximum time gap between two meetings should
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be four months. At least minimum two independent members present in a
meeting.
• Subsidiary Companies – 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 unlisted Indian subsidiary company. The Audit
Committee of the listed holding company shall also review the financial
statements of its subsidiary company.
• Disclosures – The disclosures required as per the amended clause: basis
of related party transactions, disclosures of accounting treatment, board
disclosures, risk management, proceeds from public issues, rights issues,
preferential issues etc., remuneration of directors, management
discussion and analysis
• CEO/CFO Certification – The Chief Executive Officer and the Chief
Financial Officer should certify the validity of financial statement and cash
flow statement to the board.
• Report on Corporate Governance – a separate section on Corporate
Governance in the Annual Reports of company, with a detailed
compliance report on Corporate Governance and shall submit a quarterly
compliance report to the stock exchanges within 15 days from the close
of quarter and should be signed either by the Compliance Officer or the
Chief Executive Officer of the company.
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• Compliance –To obtain a certificate from either the Auditors or practicing
Company Secretaries regarding compliance of conditions of corporate
governance as stipulated in this clause and the non-mandatory
requirements may be implemented as per the discretion of the company.
In addition to the initiatives taken by SEBI regarding
implementation of the recommendations, DCA has also accepted most of the
suggestions of the Naresh Chandra Committee on `Corporate Audit &
Governance'. The recommendations of Naresh Chandra Committee on
‘Corporate Audit & Governance' form part of the two proposed Bills —
Companies (Amendment) Bill, 2003 and the Bill to amend the Chartered
Accountants Act. Many recommendations of the report were incorporated in the
Companies (Amendment) Bill 2003, which is currently being reviewed. The
amendment would possibly focus on reforming the audit process and the board
of directors:
• In order to reform the audit process, the bill is expected to make the
provisions for:
1. Laying down the process of appointment and qualification of auditors.
2. Prohibiting non-audit services by the auditors.
3. Prescribing compulsory rotation, at least of the Audit Partner.
4. Requiring certification of annual audited accounts by both CEO and CFO.
5. Providing an expeditious disciplinary mechanism for the auditors.
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• In order to reform the boards, following major initiatives are being proposed:
1. The expression ‘Independent Director’ would be defined. Among other
requirements, an independent director should not have substantial
pecuniary interest or hold more than 2% of the company’s shares.
2. Remuneration of non-executive directors can be fixed only by
shareholders and must be disclosed. A limit on the amount, which can be
paid would also be laid down.
3. It is also envisaged that the independent directors should be imparted
suitable training.
In the way of initiating steps towards implementation of corporate
governance principles RBI also played a major role. On the basis of various
recommendations given by the Report of Consultative Group of Directors of
Banks/Financial Institutions (Chairman Dr A S Ganguly), RBI addressed a
circular letter to all the scheduled commercial banks (excluding foreign banks,
regional rural banks and local area banks) bearing DBOD. No.BC. 116 /
08.139.001/2001-02 dated June 20, 2002. Incidentally, certain
recommendations of the group require the approval of the government or
legislative amendments and hence they referred to government for
consideration. In view of the importance of the recommendations made by the
group for effective functioning of banks, the RBI has implemented most of the
recommendations, which are as follows:
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• Recommendations implemented to all banks
i. Responsibilities of the Board of Directors: to oversee the risk profile,
monitoring, integrity control mechanisms; to ensure expert management,
maximization of interests of stakeholders, delegation of powers, strategic
planning, organizational structure, financial and economic features of the
market and competitive environment.
ii. Role and responsibility of independent and non-executive directors: to
circulate among the new directors a brief profile of the bank, the sub
committees of the board, their role, details on delegation of powers, the
profiles of the top executives etc. Training facilities for directors: Need-
based training programmes / seminars/ workshops may be designed by
banks. While RBI can offer certain training programmes/seminars in this
regard at its training establishments, large banks may conduct such
programmes in their own training centres.
iii. Submission of routine information to the Board: To review various
performance areas that may be put up to the Management Committee of
the board and only a summary on each of the reviews may be put up to
the board of directors at periodic intervals.
iv. Agenda and minutes of the board meeting The draft minutes of the
meeting should be forwarded to the directors, preferably via the
electronic media, within 48 hours of the meeting and ratification obtained
from the directors within a definite time frame.
v. Committees of the Board
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a. Shareholders' Redressed Committee: The banks, which have
issued shares/debentures to public, may form a committee under
the chairmanship of a non-executive director to look into redressed
of shareholders' complaints.
b. Risk Management Committee: In pursuance of the Risk
Management Guidelines issued by the Reserve Bank of India in
October 1999, every banking organization is required to set up risk
management committee. The formation and operation of such
committee should be speeded up and their role further
strengthened.
c. Supervisory Committee: The role and responsibilities of the
supervisory committee as envisaged by the group viz., monitoring
of the exposures (both credit and investment) of the bank, review
of the adequacy of the risk management process and upgradation
thereof, internal control system, ensuring compliance with the
statutory / regulatory framework etc., may be assigned to the
management committee/ executive committee of the board.
vi. Disclosure and Transparency: The disclosures regarding putting in place
a progressive risk management system, and risk management policy
and strategy followed by the bank, exposures to related entities of the
bank, viz. details of lending to/investment in subsidiaries, the asset
classification of such lending/investment, etc. and conformity with
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corporate governance standards should be reported to the board of
directors at regular intervals.
• Recommendations applicable only to public sector banks
i. Information flow: A summary of key observations made by the directors,
which should be submitted in the next board meeting and a more detailed
recording of the proceedings, which will clearly bring out the
observations, dissents, etc. by the individual directors, which could be
forwarded to them for their confirmation.
ii. Company Secretary: All banks should consider appointing qualified
Company Secretary as the Secretary to the Board and have a
Compliance Officer (reporting to the Secretary) for ensuring compliance
with various regulatory / accounting requirements.
• Recommendations applicable only to private sector banks
i. Eligibility criteria and ' fit and proper' norms for nomination of directors:
The Government while nominating directors on the Boards of public
sector banks should be guided by certain broad "fit and proper" norms
for the directors. The criteria suggested by the BIS may be suitably
adopted for considering 'fit and proper" test for bank directors.
ii. Commonality of directors of banks and non-banking finance companies:
Directors on the boards of NBFCs may be permitted to become
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independent / non-executive directors on the boards of banks, subject to
certain conditions.
iii. Composition of the Board: Boards of banks more contemporarily
professional by inducting technical and specially qualified personnel.
Efforts should be aimed at bringing about a blend of 'historical skills' set,
i.e. regulation based representation of sectors like agriculture, SSI,
cooperation etc. and the 'new skills' set, i.e. need based representation
of skills such as, marketing, technology and systems, risk management,
strategic planning, treasury operations, credit recovery etc.
3.5 Discussion
In the light of the above reports it is, not surprising that all committees set up in
India for reforming and improving corporate governance practices have given a
lot of weightage to improving the boards. This includes independent directors,
separating the role of the CEO and board chairman, setting up of board sub-
committees, and regulations on board size and meeting frequency are some
interventions for promoting board effectiveness.
Independence of director is often considered to be the universal
remedy for board problems. One of the main recommendations of the Birla
Committee was that board with an executive chairman, at least half the
members should be independent. In case of a non-executive chairman, one-
third of the board members should be independent. This was suggested to keep
away promoter-directors from dominating the function of the board. Going a step
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further, the Naresh Chandra committee made no distinction between a board
with an executive chairman and a non-executive chairman. However raised the
level of independent directors to 50% and also made the definition of
independence stricter. The Narayana Murthy Committee further upheld that
board independence is crucial for its effectiveness. While independence is
necessary, it too is not enough. The directors should have a strong business
sense, as well as the capability and the willingness to contribute to strategic
decision-making. Therefore, training of board members were made
recommendatory by the committee.To attract quality independent directors, the
Naresh Chandra further recommended that these directors should be exempt
from criminal and civil liabilities.
The Chandra committee has also built the concept of the audit
committee made up of board members, which was earlier recommended by the
Birla committee. The Birla committee recommended that audit committee should
have three non-executive directors as members with at least two independent
directors, and the chairman of the committee should be an independent director.
This had led to the possibility of a promoter-director without an executive role in
the company becoming a member of the audit committee. But the Chandra
committee seems to be keen on its recommendation that all audit committee
members should be independent directors.
It is evident that in April 1998, India produced the first substantial
code of best practice on corporate governance after the start of the Asian
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financial crisis in mid-1997. The CII began working on "Desirable Corporate
Governance: A Code prior to the financial crisis. All the recommendations of CII
explicitly discusses domestic corporate governance problems and seeks to
apply best-practice ideas to their solution.This code was voluantarily adopted by
the companies before clause 49 came into existence.
In February 2000, the Securities and Exchange Board of India
(SEBI) revised its Listing Agreement to incorporate the recommendations of the
country’s new code on corporate governance, produced in late 1999 by the Birla
Committee. These rules—contained in a new section, Clause 49, of the Listing
Agreement, which took effect in phases over 2000-2003.The mandatory and
non-mandatory recommendations of the committee were adopted in clause 49.
This included the recommendations of the committee regarding composition of
board, constitution of audit committee, remuneration of directors, board
procedures, management discussion & analysis report, shareholders
information, shareholders / investors grievances committee and report on
compliance of provision.
In late 2002, the Securities and Exchange Board of India
(SEBI), in response to rapidly evolving international standards and corporate
collapses in the US and elsewhere, formed a new committee to "evaluate the
adequacy of existing corporate governance practices and further improve these
practices" was chaired by Shri N.R Narayana Murthy. The report of the
committee shows that significant progress was made by the corporate sector
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after introduction of clause 49. It then made a series of recommendations that
aim to encourage companies to follow the substance, not just the form, of good
governance. The committee's report was released on February 8, 2003. The
intention was to incorporate its main recommendations relating to audit
committees and reports, independent directors, related party transactions, risk
management, director compensation, codes of conduct and financial disclosure
into SEBI's Listing Agreement.
Given the overlap with the Naresh Chandra Committee formed by
the then Department of Company Affairs (discussed below), the Murthy
Committee suggested that the mandatory recommendations of the Chandra
Committee, as they relate to corporate governance, should also be incorporated
into SEBI's Listing Agreement. In October 2004, the Securities and Exchange
Board of India (SEBI) published a revised Clause 49 of the Listing Agreement
relating to corporate governance, setting forth a schedule for newly listing
companies and listed companies to comply with the revisions. However, in
March 2005, SEBI extended the date set for compliance with these new
provisions to December 31, 2005, since a large number of companies were
unprepared to fully implement the changes. Major changes in the clause include
amendments/additions to provisions relating to definition of independent
directors, strengthening the responsibilities of audit committees, and requiring
Boards to adopt a formal code of conduct.
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It is evident that a Consultative Group was constituted by Reserve
Bank of India (RBI) in November 2001 under the Chairmanship of Dr. A.S.
Ganguly: basically, with a view to strengthen the internal supervisory role of
Boards of banks and financial institutions. An Advisory Group on Corporate
Governance under the chairmanship of Dr. R.H. Patil had earlier submitted its
report in March 2001, which examined the issues relating to corporate
governance in banks in India including the public sector banks and made
recommendations to bring the governance standards in India on par with the
best international standards. There were also some relevant observations by the
Advisory Group on Banking Supervision under the chairmanship, Shri M.S.
Verma, who submitted its report in January 2003. Keeping all these
recommendations in view and the cross-country experience, the Reserve Bank
initiated several measures to strengthen the corporate governance in the Indian
banking sector.
The Ganguly Group made its recommendations within three
months after a comprehensive review of the existing framework as well as of
current practices and benchmarked its recommendations with international best
practices as enunciated by the Basel Committee on Banking Supervision, as
well as of other committees and advisory bodies, to the extent applicable in the
Indian environment. In June 2002, the report of the Ganguly Group was
transmitted to all the banks for their consideration while simultaneously
transmitting it to the Government of India for appropriate consideration.
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It may be noted here that a basic difference between the private
sector banks and public sector banks as far as the Reserve Bank’s role in
governance matters relevant to banking is concerned. The current regulatory
framework ensures, by and large, uniform treatment of private and public sector
banks by the Reserve Bank in so far as prudential aspects are concerned.
However, some of the governance aspects of public sector banks, though they
have a bearing on prudential aspects, are exempt from applicability of the
relevant provisions of the Banking Regulation Act, as they are governed by the
respective legislations under which various public sector banks were set up. In
brief, therefore, the approach of RBI has been to ensure, to the extent possible,
uniform treatment of the public sector and the private sector banks in regard to
prudential regulations. In regard to governance aspects relevant to banking, the
Reserve Bank prescribes its policy framework for the private sector banks while
suggesting to the Government the same framework for adoption, as appropriate,
consistent with the legal and policy imperatives.
As a follow-up of the Ganguly Committee report, in Mid-Term
Review of the Monetary and Credit Policy in November 2003, the concept of ‘fit
and proper’ criteria for directors of banks was formally enunciated, and it
included the process of collecting information, exercising due diligence and
constitution of a Nomination committee of the board to scrutinise the
declarations made by the directors of the banks.
Chapter 3 Codes of corporate governance & Implementation
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Moving ahead, Department of Company Affairs (DCA)
constituted committee in May 2000, under Dr. P.L. Sanjeev Reddy, Chairman.
The group was given the ambitious task of examining ways to "operationalise
the concept of corporate excellence on a sustained basis", so as to "sharpen
India's global competitive edge and to further develop corporate culture in the
country". In November 2000, a task force set up by the group produced a report
containing a range of recommendations for raising governance standards
among all companies in India. It also suggested the setting up of a Centre for
Corporate Excellence. Later in in August 2002, Naresh Chandra Committee
was set up by DCA. The committee has given recommendations regarding
relationship between the auditor and the client, norms for financial reporting,
definition of an independent director and other related issues, which are under
implementations as certain amendments in the Companies Act and the
Chartered Accountants Act are required. The recommendations regarding non-
audit services to audit clients, rotation of auditors and qualified audit opinions
are included in the Companies (Amendment) Bill 2003. It is important that this
legislation should go forward. In order to enhance the quality of auditing
practice, policymakers should consider options to establish a monitoring and
enforcement arrangement in line with recent international developments and the
recommendations of Naresh Chandra.