CORPORATE GOVERANCE UNDER SEBI COMMITTEE

INTRODUCTION Corporate Governance is essentially all about how corporations are directed, managed, controlled and held accountable to their shareholders. The objective of any corporate governance system is to simultaneously improve corporate performance and accountability as a means of attracting financial and human resources on the best possible terms and of preventing corporate failure. With the rapid pace of globalization many companies have been forced to tap international financial markets and consequently to face greater competition than before. Both policymakers and business managers have become increasingly aware of the importance of improved standards of Corporate Governance.

Corporate governance, in plain terms, refers to the rules, processes, or laws by which businesses are operated, regulated, and controlled. The term can refer to internal factors defined by the officers, stockholders or constitution of a corporation, as well as to external forces such as consumer groups, clients, and government regulations. However, enforced corporate governance provides a structure that, at least in theory, works for the benefit of everyone concerned by ensuring that the enterprise adheres to accepted ethical standards and best practices as well as to formal laws. To that end, organizations have been formed at the regional, national, and global levels. In recent times, corporate governance has received increased attention because of high-profile scandals involving abuse of corporate power and, in some cases, alleged criminal activity by corporate officers. An integral part of an effective corporate governance regime includes provisions for civil or criminal prosecution of individuals who conduct unethical or illegal acts in the name of the enterprise.

It is said that good corporate governance helps an organization achieve several objectives and some of the more important ones include:

Developing appropriate strategies that result in the achievement of stakeholder objectives Attracting, motivating and retaining talent

Creating a secure and prosperous operating environment and improving operational performance Managing and mitigating risk and protecting and enhancing the companys reputation. Some aspects covered in the poll include Corporate governance regulations in India Corporate governance concerns in India and role of independent directors and audit committees in addressing these concerns Board practices, board oversight of risk management and the importance given to integrity and ethical values Practices that is fundamental to improved corporate governance.

CORPORATE GOVERNANCE IN INDIA Corporate governance and financial regulation in India was generally considered quite poor until the economic reforms of the early 1990s. The Securities and Exchange Board of India (SEBI) was established in 1992 by an act of Parliament, and SEBI was given the job of regulating stock exchanges, brokers, fraudulent trade practices, and other areas of corporate activity. As its power grew over the decade, SEBI started to play a much more active role in setting minimum standards for corporate behavior. In addition, a voluntary code of corporate governance was developed by the Confederation of Indian Industry (CII), a group of wellregarded Indian firms. Near the turn of the century, SEBI commissioned a series of projects to improve Indian corporate governance by building on CIIs code (and by converting the voluntary code into a mandatory one). This work would eventually lead to the Clause 49 reforms. The first SEBI committee, comprised of 17 prominent business leaders and chaired by Kumar Mangalam Birla, advocated a variety of new governance requirements including a minimum number of independent directors, the creation of audit committees and shareholders grievance committees, and additional management disclosures on firm performance. These recommendations were soon adopted, but, importantly, they were not imposed on every public company through legislation (in contrast with Sarbanes Oxley in the United States). Instead, SEBI implemented the Birla Committee reforms by modifying the listing requirements for firms seeking to go public on an Indian stock exchange. Thus was born Clause 49, a new collection of corporate governance obligations that individual firms would agree to when they signed listing contracts with any stock exchange in the country. As part of a gradual roll-out process, the Birla Committee reforms were not imposed immediately on all public firms. Instead, they were made mandatory in 2001 for the largest Indian companies (and for newly listing firms), and then expanded to smaller public companies over the next few years. All of this seemed fine until 2002, when fallout from Enron, WorldCom, and other corporate governance catastrophes caused Indian regulators to wonder whether Clause 49 went far enough. SEBI decided to sponsor a second corporate governance committee chaired by Narayana Murthy, the renowned leader of Infosys Technologies. The Murthy Committee

went to work and released its additional recommendations in 2003. SEBI quickly adopted these suggestions and issued a revised Clause 49 in 2004. The Murthy Committee reforms expanded on the Birla Committees work in several areas. One main focus related to the qualifications for independent director status: a number of specific requirements were added to disqualify material suppliers and customers, recently departed executives, relatives, and other closely-related parties. A second set of changes affected the audit committee: it was now required to meet more frequently (four times per year), and members had to satisfy new financial literacy requirements. A third important change mandated CEO and CFO certification of financial reports and internal controls. And a number of additional shareholder disclosures, including expanded discussion of financial results, were added to the Clause 49 requirements. As before, these reforms were phased in gradually; all public firms were not required to comply with the Murthy Committee rules until January 1, 2006. The fruits of this labor were generally well-received, and Clause 49 seems to have improved the overall state of Indian corporate governance. For example, a recent study by Bernard Black and Vikramaditya Khanna argues that stock prices of imminently affected firms jumped almost four percent when SEBI announced its decision to pursue the initial Clause 49 reforms. Similarly, the World Bank as part of its 2005 standards and codes initiative benchmarked Indias regulatory framework to the OECD principles of corporate governance. It announced that India has indeed come a long way over the past decade, reporting that a series of legal and regulatory reforms have transformed the Indian corporate governance framework and improved the level of responsibility/accountability of insiders, fairness in the treatment of minority shareholders and stakeholders, board practices, and transparency. Clause 49 of the Listing Agreement to the Indian stock exchange came into effect from 31 December 2005. It was formulated for the improvement of corporate governance in all listed companies. Clause 49 of Listing Agreements, as currently in effect, includes the following key requirements:

 Board Independence: Boards of directors of listed companies must have a minimum number of independent directors. Where the Chairman is an executive or a promoter or related to a promoter or a senior official, then at least one-half the board should comprise independent directors. In other cases, independent directors should constitute at least one third of the board size. Audit Committees: Listed companies must have audit committees of the board with a minimum of three directors, two-thirds of whom must be independent. In addition, the roles and responsibilities of the audit committee are to be specified in detail. Disclosure: Listed companies must periodically make various disclosures regarding financial and other matters to ensure transparency. CEO/CFO certification of internal controls: The CEO and CFO of list ed companies must (a) certify that the financial statements are fair and (b) accept responsibility for internal controls. Annual Reports: Annual reports of listed companies must carry status reports.

THE SECOND PHASE: CORPORATE GOVERNANCE AFTER SATYAM Indias corporate community experienced a significant shock in January 2009 with damaging revelations about board failure and colossal fraud in the financials of Satyam. The Satyam scandal also served as a catalyst for the Indian government to rethink the corporate governance, disclosure, accountability and enforcement mechanisms in place. As described below, Indian regulators and industry groups have advocated for a number of corporate governance reforms to address some of the concerns raised by the Satyam scandal. Industry response shortly after news of the scandal broke; the CII began examining the corporate governance issues arising out of the Satyam scandal. Other industry groups also formed corporate governance and ethics committees to study the impact and lessons of the scandal. In late 2009, a CII task force put forth corporate governance reform recommendations. In its report the CII emphasized the unique nature of the Satyam scandal, noting that Satyam is a one-off incident . . . The overwhelming majority of corporate India is well run, well regulated and does business in a sound and legal manner.

In addition to the CII, the National Association of Software and Services Companies (NASSCOM, self-described as the premier trade body and the chamber of commerce of the IT-BPO industries in India) also formed a Corporate Governance and Ethics Committee, chaired by N. R. Narayana Murthy, one of the founders of Infosys and a leading figure in Indian corporate governance reforms. The Committee issued its recommendations in mid2010, focusing on stakeholders in the company. The report emphasizes recommendations related to the audit committee and a whistleblower policy. The report also addresses improving shareholder rights. The Institute of Company Secretaries of India (ICSI) has also put forth a series of corporate governance recommendations. Government response Satyam prompted quick action by both SEBI and the MCA.

In September 2009 the SEBI Committee on Disclosure and Accounting Standards issued a discussion paper that considered proposals for: Appointment of the chief financial officer (CFO) by the audit committee after assessing the qualifications, experience and background of the candidate; Rotation of audit partners every five years; Voluntary adoption of International Financial Reporting Standards (IFRS);

 Interim disclosure of balance sheets (audited figures of major heads) on a half-yearly basis; and streamlining of timelines for submission of various financial statements by listed entities as required under the Listing Agreement

In early 2010, SEBI amended the Listing Agreement to add provisions related to the appointment of the CFO by the audit committee and other matters related to financial disclosures. However, other proposals such as rotation of audit partners were not included in the amendment of the Listing Agreement. MCA actions inspired by industry recommendations, including the influential CII recommendations, in late 2009 the MCA released a set of voluntary guidelines for corporate governance. The Voluntary Guidelines address a myriad of corporate governance matters including: independence of the boards of directors; responsibilities of the board, the audit committee, auditors, secretarial audits; and mechanisms to encourage and protect whistle blowing.

Important provisions include: Issuance of a formal appointment letter to directors. Separation of the office of chairman and the CEO. committee for selection of directors. Limiting the number of companies in which an individual can become a director. Tenure and remuneration of directors. Training of directors. Performance evaluation of directors. Additional provisions for statutory auditors. Institution of a nomination

In discussing the voluntary nature of the guidelines, Corporate Affairs Secretary, R. Bandyopadhyay, stated that the MCA did not want to enact a rigid, mandatory law. However, the MCA also indicated that the guidelines are a first step and that the option remains open to perhaps move to something more mandatory. In fact, certain voluntary aspects of the

guidelines, such as the separation of the office of chairman and CEO, have now been recommended for enactment in amendments to the Companies Bill pending in Parliament.

In recent years, more and more Indian companies have been raising capital overseas by getting themselves listed on international stock exchanges. These efforts have been accompanied by the Indian government's drive to attract more Foreign Direct Investment (FDI). Both factors have gone hand in hand with the realization that if Indian companies want more access to global capital markets, they will need to make their operations and financial results more transparent. In other words, they will need to improve their standards of corporate governance. The Securities and Exchange Board of India (SEBI), which regulates India's stock markets, took a major step in this direction a year ago. It asked Indian firms above a certain size to implement Clause 49, a regulation that strengthens the role of independent directors serving on corporate boards.

CRITICAL ANALYSIS In May 2011, the Supreme Court has given a very fair judgment, with far-reaching implications both for the government and India Inc., in the Reliance Industries Limited (RIL) vs RNRL gas pricing case. It has established unequivocally that the production sharing contract between the government and RIL overrides any private memorandum of understanding arrived at between two individuals. In short, it refused to give sanctity to the Memorandum of Understanding (MoU) signed between the two Ambani brothers. This principle had to be established in the interest of corporate governance or it would have created havoc in the corporate world with promoters of public limited, quoted companies coming together and signing MoUs without a care for the shareholders and other stake holders in the company. Till today the shareholders have not okayed the MoU entered into between Mukesh and Anil Ambani when they divided between themselves the empire created by their father, Dhirubhai Ambani.The second important aspect of the judgment is that the natural resources of a country belong to the government and the government has the right to price it and prioritize the beneficiaries. While it is a well known fact, even internationally, that natural resources belong to the government, the government as a monopoly has the sacred responsibility to put the interest of the nation before everything else when deciding on its use and sale price. This is where the judgment has implications that go beyond the Ambani brothers. The petroleum minister has expressed his happiness that the apex court has upheld his contention that the gas in this case belongs to the government and RIL is only a contractor 8

who can market the product. But it will be the government that will decide at what price it should market it, and to whom it should market it. This is a double-edged sword.

The problem in the Indian corporate sector (be it the public sector, the multinationals or the Indian private sector) is that of disciplining the dominant shareholder and protecting the minority shareholders. Aboard which is accountable to the owners would only be one which is accountable to the dominant shareholder; it would not make the governance problem any easier to solve. Clearly, the problem of corporate governance abuses by the dominant shareholder can be solved only by forces outside the company itself.

Corporate governance abuses perpetrated by a dominant shareholder pose a difficult regulatory dilemma in that regulatory intervention would often imply a micro-management of routine business decisions. The regulator is forced to confine to broad proscriptions which leave little room for discretionary action. Many corporate governance problems are ill suited to this style of regulation.

The capital market on the other hand lacks the coercive power of the regulator. What it has however is the ability to make business judgments and to distinguish between what is in the best interests of the company as a whole as against what is merely in the best interests of the dominant shareholders. The only effective sanction that the market can impose against an offender is to restrict his ability to raise money from the market once again. Denial of market access is a very powerful sanction except where the company is cash rich and has little future needs for funds.

The past few years have witnessed a silent revolution in Indian corporate governance where managements have woken up to the power of minority shareholders who vote with their wallets. In response to this power, the more progressive companies are voluntarily accepting tougher accounting standards and more stringent disclosure norms than are mandated by law. They are also adopting more healthy governance practices. It is evident that these tendencies would be strengthened by a variety of forces that are acting today and would become stronger in years to come:

Economic reforms have not only increased growth prospects, but they have also made markets more competitive. This means that in order to survive companies will need to invest continuously on a large scale.

Meanwhile, financial sector reforms have made it imperative for firms to rely on capital markets to a greater degree for their needs of additional capital. Simultaneously, the increasing institutionalization of the capital markets has tremendously enhanced the disciplining power of the market. Globalization of our financial markets has exposed issuers, investors and intermediaries to the higher standards of disclosure and corporate governance that prevail in more developed capital markets.

Tax reforms coupled with deregulation and competition have tilted the balance away from black money transactions. This makes the worst forms of misgovernance less attractive than in the past.

While these factors will make the capital markets more effective in disciplining the dominant shareholder, there are many things that the government and the regulators can do to enhance this ability: Disclosure of information is the pre-requisite for the minority shareholders or for the capital market to act against errant managements. The regulator can enhance the scope, frequency, quality and reliability of the information that is disclosed. Regulatory measures that promote an efficient market for corporate control would create an effective threat to some classes of dominant shareholders as discussed earlier Reforms in bankruptcy and related laws would bring the disciplining power of the debt holders to bear upon recalcitrant managements. Large blocks of shares in corporate India are held by public sector financial institutions who have proved to be passive spectators. These shareholdings could be transferred to other investors who could exercise more effective discipline on the company managements. Alternatively, these institutions could be restructured and privatized to make them more vigilant guardians of the wealth that they control.

10