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ACCOUNTING

AND AUDITING
UPDATE
January 2011
Editorial
First of all, we would like to wish you all a happy new year 2011. It is with
immense pleasure we bring forth the January 2011 edition of the Accounting
and Auditing Update.

The Companies Bill, 2009 (Bill), which seeks to replace the age old
Companies Act, 1956 was introduced in the Lok Sabha on 3 August 2009 and
subsequently referred to the Standing Committee on Finance of Parliament
(Committee) for a detailed examination. The Committee, through its report
dated 31 August 2010, has made certain game changing recommendations
which include: (1) extending the need to appoint independent directors to Narayanan Balakrishnan
certain unlisted companies (2) mandating the selection of independent Executive Director
directors out of a databank to be maintained by the Ministry of Corporate KPMG in India

Affairs (3) restricting the tenure of office of an independent director to a


maximum of two tenures of six consecutive years each with a cooling-off
period of three years between the two tenures (4) prescribing a minimum
corporate social responsibility spend of 2 percent of net profits (5) specifying
auditor rotation once in five years; (6) recognising the Chief Financial Officer
as a key managerial personnel (7) prescribing rules for participation of
directors in board meetings through video conferencing and other electronic
means (8) abolition of stock options to independent directors and (8)
prohibition of a subsidiary from having step-down subsidiaries. The Ministry
of Company Affairs and the Law Ministry will incorporate these
recommendations, amend the Bill and place it for consideration in the
upcoming Budget session of the Parliament. We have attempted to provide
our perspective on the benefits and challenges emanating from the
recommendations of the Committee in this publication.

The IASB and FASB are jointly developing a standard on financial statement
presentation to address user concerns that the financial statements are
presented in an overly-aggregated fashion and often times inconsistently
presented across the various statements within a set of financial statements.
In this connection, the boards have issued a Staff Draft which proposes the
need to classify assets, liabilities, revenues and expenses under the
operating, investing, financing categories with separate sections for taxes
and discontinued operations. The Staff Draft also mandates the direct method
of preparing the cash flow statements and the need for presenting
disaggregated information on costs by function as well as the nature of the
financial statements. Preliminary estimates indicate that companies may
incur significant implementation costs to conform to the new format, as
changes to systems, processes, and internal control policies and procedures
are likely to be inevitable.

On 21 July 2010, the US President, Barack Obama signed into law the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 which is
acknowledged to be a sweeping overhaul of US financial regulation since the
1930s. Despite running into 2,300 pages, it leaves much to be fleshed out by
future rule making. Apart from significantly impacting the financial services
community, the Dodd Frank Act also enhances protection to whistle-blowers
and other informants of the Securities Law violations. Additionally, the Act
provides for a claw-back of compensation given to current and former named
executive officers in the event of a financial statement restatement
irrespective of whether the restatements arose as a result of misconduct. In
this publication, we have attempted to summarise the impact of Dodd Frank
Act specifically from the perspective of a Foreign Private Issuer.

We hope you enjoy reading this publication. We would look forward to


receiving your feedback on what you would like us to cover in our future
publications at aaupdate@in.kpmg.com.
Contents

Companies Bill 2009


An analysis of the report of Standing Committee 1

Future!
Financial statement presentation 13

Dodd-Frank Act
Snapshot of Implications for Indian Foreign Private Issuers 20

Regulatory Updates 25
An analysis of the
report of Standing
Committee on
Companies Bill,
2009
The Companies Bill, 2009 (Bill) was
introduced in Lok Sabha on 3 August 2009
and subsequently on 9 September 2009,
it was referred to the Standing Committee
on Finance of Parliament (Committee) for
its detailed examination and report.1 The
report of Standing Committee was
presented to the Lok Sabha on 31 August
2010 and laid in the Rajya Sabha on the
same date1.

A new legislation, rule or regulation in a


society usually seeks to ensure orderly,
consistent and equitable conduct of its
activities. Implementation of any new
legislation, rule or regulation may require
not only a radical change in the mindset of
people to overcome the human mind’s
resistance to change but it may also
require overcoming genuine bottlenecks
that arise during the implementation
process. Such implementation bottlenecks
may either pose challenges cost-wise or
unintentionally disturb an existing, well
laid out system.

1 Twenty-first report of Standing committee on


Finance, August 2010

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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
2

The essence of the Bill is to facilitate a changes therein as agreed to by the The report of the Standing Committee
comprehensive revision of the present Ministry of Corporate Affairs (MCA), on the Bill contains a large number of
Companies Act, 1956 with a view to seeks to bring about vis-à-vis the recommendations. It is not possible to
promote self-regulation, eradicate position obtaining as at present. The deal with each and every such
unwarranted regulatory approvals, vest focus is primarily on proposals which recommendation due to limitation of
shareholders with greater powers and have been significantly amended during space. The following discussion is,
encourage greater transparency in the the process of the Committee’s therefore, only with reference to some
disclosures by corporate entities. consideration. The analysis identifies of the major recommendations and is
Corporate governance is one aspect the proposed departures from the by no means exhaustive.
where heightened emphasis has been existing position, their potential
given to ensure accountability of benefits, and the challenges that those
individuals at the helm of affairs of a changes are likely to create. It may be
company. worthwhile to add that the Report
leaves many issues for further
In the following paragraphs, we have
consideration of the MCA and
attempted an analysis of some of the
therefore, there is a possibility of some
principal changes relating to corporate
further changes.
governance that the Bill, read with the

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with
KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
3

Appointment of independent directors

Recommendations • A panel or a databank should be maintained by the


MCA, out of which companies may appoint
• It is proposed that every listed public company having
independent directors.
prescribed amount of paid-up share capital should have
at the least one-third of the total number of directors as Departure from current practice
independent directors. The Central Government may
Appointment of independent directors is mandatory only
prescribe the minimum number of independent
for listed public companies and is made by the company.
directors in the case of other public companies and
subsidiaries of any public company.

Benefits Challenges
• Independent directors help to counterbalance the • The proposal seeks to strengthen the independence
natural potential for conflict between the interests of independent directors. However, the concept of
of executive directors and shareholders and other independence is multifaceted, judgmental and
stakeholders. highly subjective.
• A central databank will provide a readily accessible • Maintenance of a panel may give rise to concerns
pool of eminent qualified personnel and of favouritism and bureaucratic delays unless the
professional experts who would be able to share empanelment criteria are objective and publicly
their enriching knowledge and provide valuable known and other checks and balances are put in
insights based on their experience from other place.
reputed companies where they have served, or are • Evaluating a person's competence, integrity and
serving, as independent directors. This will also commitment is not always possible on the basis of
facilitate incorporation of best industry practices. information available in a databank.
• Whilst selection is to take place from the panel, the • It may so happen that certain highly reputed and
power to select or choose the independent eminent individuals fail to register their names
directors still vests with the company and to this either unintentionally or intentionally. This would
extent, there is no major change/dilution in the prevent companies to choose such people because
company’s powers. of the statutory requirement.
• Considering that the criteria for determining
independence have in any case been specified,
constitution of a panel may unduly complicate the
appointment process.

“Whilst having a panel to choose from provides increased flexibility and facilitates uniformity in
the selection process, whether such a benefit justifies a rigid appointment process is open to
debate”

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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
4

Tenure of independent directors

Recommendations Departure from current practice


Tenure of office of an independent director is proposed to • The Corporate Governance Voluntary Guidelines issued
be limited to a maximum of two tenures of six by the MCA permit three tenures (with similar
consecutive years each with a cooling-off period of three conditions) for an independent director.
years between the two tenures. During the cooling-off • Clause 49 of the Listing Agreement contains a non-
period, such a person can not be inducted in the same mandatory requirement to the effect that an
company in any capacity. independent director cannot serve for more than nine
years.

Benefits Challenges
• Having a limit on the tenure of office seems to have • Having a restricted tenure could prove to be
merit since the ability of an independent director to counter-productive since the knowledge gained
act independently may be impaired if the through experience may not be fully put to use in a
association with a company continues uninterrupted shortened tenure.
for a significant extended period. However, it is a • A restricted tenure could also affect the enthusiasm
moot point whether the limit of six years is the and effectiveness with which an independent
appropriate limit. director provides suggestions for high-level
• A new set of people would have a fresh perspective decisions to be taken by the Board.
and outlook to company’s issues and would also be • There exists no uniformity in various regulatory
more likely to objectively evaluate the practices guidelines with respect to maximum number of
being followed. years as tenure by an independent director and
there is genuine doubt on what is an appropriate
period.
• Given that a director would usually take a year or
two to be familiar with the dynamics of a company,
the functioning of the board etc., a term greater
than six years or a term which may be fixed (within
reasonable limits) by the company may be more
appropriate.

“There is a need to strike balance between maintaining the independence and ensuring
effectiveness of an independent director”

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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
5

Corporate social responsibility (CSR)

Recommendations position to spend prescribed amount on CSR activities,


the directors would be required to give suitable
Every company having net worth of INR 500 crores or
disclosure/ reasons in their report to the members.
more, or turnover of INR 1,000 crores or more or a net
profit of INR 5 crores or more during a year shall be Departure from current practice
required to formulate a policy to ensure that every year at
As per the Corporate Social Responsibility Voluntary
least 2 percent of its average net profits for the three
Guidelines, 2009 issued by the MCA, companies are
immediately preceding financial years are spent on the
encouraged to allocate specific amount in their budgets
CSR activities as may be approved and specified by the
for CSR activities. The Guidelines also suggest
company. Appropriate disclosures by directors to be made
disseminating information on CSR policy, activities and
in this regard in their report to members. In case any such
progress in a structured manner to all stakeholders and
company does not have adequate profits or is not in a
public at large.

Benefits Challenges
• This would ensure that a company spreads the • Companies do business to create value addition to
benefits generated from its operations across the their shareholders. This has to be the first and
overall society to which it belongs, thereby foremost objective for any company. Mandating the
achieving a macro level objective of contributing to CSR initiatives could result in conflict between the
the society. economic and social objectives of a company.
• This would facilitate effective initiatives by public- • Companies already cater to the needs of various
private enterprises jointly coming together instead sections of the society by providing employment,
of only the state being made responsible for the paying taxes to government, sustaining
welfare of society. developmental activities in the surrounding areas
• The requirement for a company to give adequate etc. To thrust more responsibility on them by way of
disclosures on its CSR initiatives or reasons for non- mandatory CSR initiatives could discourage
compliance would keep the shareholders and other corporate world.
users of financial statements sufficiently informed. • Effectively, this would amount to corporate income
tax rate going up by 2 percent.
• Mandating a specific budget for CSR initiatives may
be counter productive. Companies should be
encouraged to voluntarily adopt good governance
and corporate social responsibility practices, rather
than be legally compelled to do so.

“Imperative need to strike a balance between socially responsible behaviour and economic
objectives of the corporate world”

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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
6

Rotation of auditors

Recommendations acceptable level when using the same senior personnel


on an assurance engagement over a long period of
The Bill originally did not contain any proposal for rotation
time. For listed entities, it mandates that that the audit
of auditors. However, it is now proposed that audit partner
partner should be rotated after a pre-defined period,
and firm will be required to be mandatorily rotated once
normally not more than seven years.
every three and five years respectively with a cooling off
period of three and five years for the partner and firm • The voluntary guidelines on corporate governance
respectively. issued by the MCA require that to maintain
independence of auditors, audit partner and firm may
Departure from current practice
be rotated once every three and five years respectively
• ICAI Quality Control Standards require that an audit with a cooling off period of three and five years for the
firm should set out criteria for determining the need for partner and firm respectively.
safeguards to reduce the familiarity threat to an

Benefits • There is no empirical support for the argument that


rotation increases auditor independence by
The proponents of rotation argue that rotation
removing the incentive to sacrifice current
increases auditor’s independence and will .provide
judgments for the promise of long-term revenues
opportunities to a larger number of accounting
from a client.
professionals.
• If implemented, the provision will cause greater
difficulty for global corporates, as they will have to
Challenges
change their audit firm for their Indian subsidiary
• Experience with mandatory auditor rotation in while having a separate auditor for rest of the globe.
practice demonstrates that it reduces audit • Only a handful of countries (notably Indonesia, Italy,
effectiveness, increases the costs of doing business Poland, Saudi Arabia and Singapore) currently
and diminishes the quality of audit services. Audit require some form of audit firm rotation after a
firms may lose incentive to develop domain predefined period. Numerous examples of countries
knowledge and may not invest in related resources. introducing audit firm rotation only to reverse their
Compulsory firm rotation also increases the costs positions after implementation of the regime reveal
of doing business by distracting non-executive that rotation creates more problems than it solves.
directors and senior company management as new • In 2002, the Naresh Chandra Committee on
auditors must be familiarised and brought up to Corporate Audit and Governance had rejected the
speed on company operations. proposal for rotation of auditors and had instead
• Professional standards already provide strong recommended rotation of audit partners.
safeguards to address the threat of the auditor’s • The best alternative measure would be to legislate
over-familiarity with the client, including rotation of for audit partner rotation according to international
the lead partner on an audit as well as other norms and to introduce effective and independent
restrictions that enhance audit independence and auditor oversight, just as it occurs in the EU, the US,
quality in a more cost-effective manner. and around the world.
• In practice, such a measure may result in auditing
firms being split into smaller firms. This will
particularly militate against creation of vast
knowledge databases and specialised expertise.

“In the absence of a strong case for audit firm rotation, the international experience should be
leveraged to introduce alternative mechanisms to safeguard the independence of auditors”

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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
7

Independence of auditors to be ensured by audit committee

Recommendations Departure from current practice


The audit committee comprising independent directors be Whilst the existing law or regulation does not explicitly
made responsible to ensure that the auditor remain stipulate this requirement, one of the implied functions of
independent and are organisationally and professionally the audit committee is to ensure that auditors remain
competent to discharge their responsibility. independent of the company.

Benefits Challenges
The requirement would ensure that the audit Independence being a subjective concept is difficult to
committees develop procedures to regularly review establish. The ways and means by which audit
whether the auditor has remained objective and committee can ensure independence are limited.
independent in discharge of his duties. Many audit committees may just obtain a letter from
the auditor regarding compliance with independence
requirements.

“Increased emphasis on independence of auditors is a positive signal to the accounting


profession and corporate world. However, challenges exist in monitoring such independence”

Responsibilities of Chief Financial Officer (CFO)

Recommendations mechanism, and also ensure compliance of the


provisions relating to preparation and filing of annual
• It is proposed to recognise CFO as a key managerial
accounts of the company.
personnel. Companies belonging to such class or
description of companies as may be prescribed must
have whole-time key managerial personnel. Departure from current practice

• The CFO shall be responsible for the proper The present Act does not specifically recognise the
maintenance of the books of account of the company, position of the CFO. However, the SEBI listing
and shall ensure proper disclosure of all required requirements stipulate certain specific functions for the
financial information indicated in the prospectus or any CFO. In practice, CFO is responsible for most of the
other document, risk management, internal control above activities and reports to the Board.

Benefits to take decisions instead of merely being an


executor of directions given by the Board. It should
• Mandatory requirement for prescribed classes of
not so happen that the Board is vested with powers
companies to have a whole-time CFO is a
to make decisions and the CFO being held
recognition of importance of finance function. With
responsible for consequences of such decisions.
the aspects of internal control, risk management,
finance and accounts brought under the purview of • Functions such as risk management are areas
the CFO, a clear-cut definition of roles and wherein specialised expertise is required to mitigate
responsibilities of the CFO and appropriate the company’s business risks, market risks, etc. in
reporting structure would emerge in many addition to financial risks. In large organisations,
organisations. there exists a separate risk management
department headed by an expert who specialises in
• Presence of a whole-time CFO, with clearly defined
financial risk management. CFOs often place
roles and functions, would provide added comfort to
reliance on the work carried out by the risk
stakeholders.
management experts of the company based only on
a broad overview. The CFO may not be in a position
Challenges to exercise hands-on control in aspects such as risk
• Responsibility and authority complement each other. management as compared to that of functions like
The CFO would need to be adequately empowered accounting, finance and internal control.

“Striking the right chord between CFO’s responsibilities & powers vested in him is a need of
the hour”
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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
8

Auditors’ report

Recommendations INR 5 lakh in respect of every debtor, creditor, loan and


advance, investment and bank balance have been
• The Bill proposes that the audit report should explicitly
confirmed by the respective counterparty.
state compliance with auditing standards.
• Further, in case of the listed companies, the auditor
should also state whether the company has complied Departure from current practice
with the internal financial controls and directions issued
No such requirement exists under the current practice
by the Board.
both in terms of usage of language in the audit report on
• It is also proposed that the auditor’s report should compliance with auditing standards and on financial
specifically state whether the balances exceeding controls in case of listed companies.

Benefits • The scope of the expressions ‘internal financial


controls’ and ‘directions issued by the Board’ is too
Listed companies are expected to have robust internal
wide and needs to be restricted to those relating to
controls in place particularly over financial reporting. By
financial reporting and any other aspects which are
having the auditor report on company’s compliance
directly relevant to the functions of the auditor.
with the financial controls framed by the Board, an
independent evaluation of compliance with prescribed • As regards the proposed assertion relating to
internal controls would be done. confirmation of specified balances, auditing
standards (which are now proposed to be
recognised in the law itself) already lay down the
Challenges overall framework within which an audit needs to be
• Whilst ensuring compliance by a company with the conducted. Within this overall framework, the exact
internal controls framed by the Board of Directors is methods of obtaining sufficient appropriate audit
an effective governance measure, it would be useful evidence relating to an item in the particular facts
if the auditor’s are also asked to comment on and circumstances of a case should be left to the
whether the internal financial controls as prescribed professional judgement of the auditor rather than
by the Board of Directors are themselves adequate. being prescribed under law.
In other words, the design deficiencies in internal
financial controls as laid down by the Board should
also be required to be brought out.

“Whilst making the auditors comment on compliance with internal controls by listed companies
is a laudable step, scope for improvement does exist to have greater impact”

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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
9

Participation of directors in the meetings

Recommendations Departure from current practice


Provision is sought to be made for participation of At present, participation in a Board meeting can be only
directors in a Board meeting either in person or through by personal attendance.
video conferencing or such other electronic means as may
be prescribed which are capable of recording and
recognising the participation and for recording and storing
of such participation.

Benefits Challenges
Participating by video conferencing (or similar means) The Board meetings are forums where directors carry
is a very welcome step and would ensure greater out numerous discussions on the company, all of
participation of directors and also save time and cost. which may not be recorded for various reasons.

“Allowing effective use of technology without compromising confidentiality would be a welcome


step subject to certain exceptions regarding recording which should be permitted”

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with
KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
10

No employee stock options for independent directors

Recommendations prescribe different slabs/categories for payment of sitting


fees to different class or classes of companies on the
An independent director shall not be entitled to any
basis of net worth and/or turnover.
remuneration, other than sitting fee, reimbursement of
expenses and profit-related commission as approved by Departure from current practice
the members. Thus, stock options have been removed
Stock options can be given to directors including
from the allowable forms of compensation of independent
independent directors. The SEBI guidelines also permit
directors. It is proposed to allow payment of higher sitting
this subject to shareholders’ resolution.
fee to independent directors and to have Rules to

Benefits Challenges
• Stock-option compensation can have negative • The present practice is stringent enough, requiring
effects since it could compromise the wide-ranging disclosures in company’s financial
independence of independent directors by shifting statements and other public documents, for stock
their focus on short-term stock price movement options given to the directors including the
instead of promoting long-term interests of independent directors. More importantly, these
stakeholders. stock options are subject to approval of the
• The mechanism of stock options is such that lower shareholders of the company.
the stock price on the grant date, more likely the • If it is argued that independence is enhanced by
recipient would be to gain. This may lead in some preventing independent directors from having stock
cases to time the grants in such a way so as to suit options, questions arise as to why only
the convenience of directors. independent directors should be prevented from
having stock options and why not other directors
who form part of the board and who have greater
powers in driving the operating policy decisions of
the company.
• Various countries (USA, UK, Canada, Australia,
Singapore, Hong Kong to name some) do not
prohibit stock options for independent directors.
Considering that stock option consideration is
growing in popularity, it may be more appropriate
to place restrictions either on the total amount of
options or on the manner of vesting and exercise
of such options and sale of resultant shares.

“Restricting independent directors from being granted stock options needs further debate“

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with
KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
11

Uniform financial year

Recommendations Departure from current practice


All companies would have a uniform financial year which Presently, no requirement of a uniform financial year
would be ending 31 March, with the Company Law exists in the Companies Act.
Tribunal empowered to grant exemption to a company
upon application for following a different period as
financial year.

Benefits Challenges
• Brings about uniformity which would facilitate • Global companies generally follow calendar year as
better comparison of financial statements of their financial year. Also, Indian companies with
companies. subsidiaries across the world could have different
• The Income-tax Act, 1961 has already brought in financial years across these subsidiaries. The
the concept of a uniform financial year of April – proposed recommendation could lead to problems
March consequent to which most of the in consolidation process.
companies already have April–March as financial • The proposed change allows companies to make
year. an application to Tribunal and seek its approval for
following a different period. In today’s world,
companies look towards support from the state in
reducing administrative hassles involved in
obtaining approvals from government regulatory
bodies. This change would largely be looked upon
by the corporate world as increasing their burden.

“It would be necessary to lay down procedures whereby applications seeking approval in this
regard are processed expeditiously”

© 2011©KPMG,
2011 KPMG, an Indian
an Indian Partnership
Partnership and a member
and a member firm offirm of the KPMG
the KPMG network network of independent
of independent membermember firms affiliated
firms affiliated with with
KPMG KPMG International
International Cooperative
Cooperative (“KPMG(“KPMG International”),
International”), a Swissa entity.
Swiss entity. All reserved.
All rights rights reserved.
12

Restriction on step-down of subsidiaries

Recommendations Departure from current practice


With a view to prevent diversion of funds, it is proposed There is presently no such restriction on subsidiary having
to prohibit a subsidiary company from having its own further subsidiaries.
subsidiary.

Benefits • This could have severe impact on certain industries


such as infrastructure industry. The mechanism of
The intention of the proposed change is to prevent
investments in infrastructure industry is that a
siphoning-off of funds and protect interest of
holding company would invest in various projects
shareholders which should add the comfort level of
through various subsidiaries. This ensures separate
shareholders.
funding of different projects through a chain of
subsidiaries and step-down subsidiaries.
Challenges • The proposal would create problems for realty
companies where there is limitation on holding
• Most companies have already created structures to land beyond a specified limit as per the land
suit their operational convenience within the regulation statutes in India.
framework permitted so far. Foreign companies
• The proposal is too drastic to be enacted without
carry out their operations in India through the
adequate debate. It will have far-reaching
concept of step down subsidiaries in many cases.
consequences on foreign investment and growth
The concept of single tier of subsidiaries could lead
of industry.
to severe administrative hassles for both domestic
• The proposal would create almost impossible
and foreign players who intend carrying out
implementation issues particularly because at
business in India.
present, many large companies operate through
multiple tiers of subsidiaries.

“Restriction could prove to be counter-productive and act as an impediment to entry of global


players into the country”

Summary
Given the likely pervasive impact of the provisions
of the Bill, the need of the hour is to strike the
appropriate balance to achieve the twin objectives
of improving corporate governance without creating
undue bottlenecks. It is expected that the benefits
and challenges of the new proposals will be
appropriately deliberated and addressed prior to
enactment of the final legislation.

© 2011©KPMG,
2011 KPMG, an Indian
an Indian Partnership
Partnership and a member
and a member firm offirm of the KPMG
the KPMG network network of independent
of independent membermember firms affiliated
firms affiliated with with
KPMG KPMG International
International Cooperative
Cooperative (“KPMG(“KPMG International”),
International”), a Swissa entity.
Swiss entity. All reserved.
All rights rights reserved.
13

FUTURE!
FINANCIAL STATEMENT PRESENTATION

Financial statements are a principal means of communicating financial


information about an entity to those outside the entity. How an entity displays
information in its financial statements is of utmost importance for
communicating financial to make decisions on resource allocation. IASB and
FASB initiated the joint project on financial statement presentation to address
the users' concerns that existing standard permits too many options for
presentation and that information in financial statements is highly aggregated
and inconsistently presented making it difficult to understand the relationship
between the financial statements and the financial results of an entity.

The primary objective of this project is to establish a global standard that will On 1 July 2010 the IASB and the FASB
guide the organisation and presentation of information in the financial posted to their websites a staff draft of
statements. The boards' goal is to improve the usefulness of the financial proposed standard that reflect tentative
information to assist management to better communicate its financial decisions made to date, as a basis for
information to the users of its financial statements and to help them in decision extended stakeholder outreach
making. activities.
The financial statement presentation project is being conducted in three main However, work on the project is
phases as below: continuing, and the proposals are
subject to change before the boards
Phases Status decide to publish an exposure draft for
public comment.
Phase A: IAS 1 The IASB issued a revised version of IAS 1 in September 2007
Financial Statement
Presentation
completed

Phase B: In It addresses the more fundamental issues relating to financial


Progress statement presentation.
? A discussion paper Preliminary Views on Financial Statement
Staff
Presentation was published in October 2008
Q3 2010 Draft
? In May 2010, the Boards published separately the proposed
amendments to improve the presentation of items of other
comprehensive income (OCI). Next step is the staff draft in the
Boards work plan for this project.
? Discontinued operations: To develop a common definition of
discontinued operations and require common disclosures related to Exposure
disposals of components of an entity. In June 2010, the Boards Q1 2011 Draft
issued a progress report stating their decision for alignment of this
with the main financial statement presentation project. The Boards
plan to issue in the first quarter of 2011 an exposure draft on a
converged definition of discontinued operations and related
disclosures. Target
date
Q4 2011 IFRS
Phase C: yet to be This phase will consider the presentation and display of interim financial
Initiated information in US generally accepted accounting principles (GAAP). It is
also expected to address requirements in IAS 34 Interim Financial
Reporting
(Source: www.ifrs.org )
(Source: www.ifrs.org )

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14

Core principles of financial statement Disaggregation principle


presentation The aim of the disaggregation principle is that an entity
should separate resources by the activity in which they are
The staff draft proposes an entity to present information in
used and by their economic characteristics. The entity would
its financial statements in a manner that:
consider the following in determining the items to
Portrays a cohesive financial picture of the entity’s
? disaggregate and present in the financial statements:
activities and
The function, i.e. the primary activities in which an entity
?
Disaggregates information to explain the components of
? is engaged
its financial position and financial performance. The nature, i.e. the economic characteristics or attributes
?
The Boards are of the view that both these principles work that distinguish assets, liabilities and items of income,
together to enhance the understandability of an entity’s expense and cash flow that do not respond similarly to
financial statement information. similar economic events
The measurement basis, i.e. the method or basis used to
?
Cohesiveness principle
measure an asset or a liability and
The aim of the cohesiveness principle is that an entity The materiality of the items given the need to
?
should present information in the financial statements so disaggregate items of dissimilar nature, function or
that the relationship among the items across financial measurement unless they are immaterial.
statements is clear and that an entity's financial statements
complement each other as much as possible.
DISAGGREGATION
To present a cohesive set of financial statements, an entity
would present disaggregated information in the statements
of financial position, comprehensive income and cash flows MEASUREMENT BASIS
in a manner that is consistent across those three
statements.
NATURE
The cohesiveness principle responds to the existing lack of
consistency in the way that information is presented in an
entity's financial statements. FUNCTION
(Source: New on the Horizon: Financial
statement presentation)

WORK
TOGETHER

COHESIVENESS DISAGGREGATION Our comments:


(Source: New on the Horizon: Financial statement presentation)
The staff draft proposes disaggregation on
a line-by-line basis for the function, nature
and measurement basis of the items. This
may result in many more line items being
disclosed on the face of the financial
statements. In addition, there appears to be
no limit on the requirements for
disaggregation, resulting in possibly
excessive information on the face of the
financial statements.
Some may be concerned about the
consistency of the disaggregation of items
between similar entities, and whether these
will be comparable.

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15

Structure of the financial Statement of financial position Statement ofcomprehensive


income
Statement of cash flows

information Business section Business section Business section


A common structure is proposed for the
Operating category Operating category Operating category
statements of financial position,
comprehensive income and cash flows Operating finance subcategory Operating finance subcategory
in the form of required sections, Investing category Investing category Investing category
categories or subcategory and related
Financing section Financing section Financing section
subtotals.
- Debt category - Debt category
An entity's financial statements would
include sections, categories and - Equity category
subcategory (if applicable), as shown in Multi-category transaction Multi-category transaction
the adjacent table. section section

Income tax section Income tax section Income tax section


Discontinued operation section Discontinued operation section, Discontinued operation section
net of tax

Other comprehensive income,


It is not expected that an entity’s net of tax
financial statements would include (Source: Staff draft)
every section or category or
subcategory. An entity includes a includes the interrelated use of its subcategory include a net post-
section, category or subcategory when resources (business) and those that employment benefit obligation, a lease
its activities meet the criteria for generate a return from individual assets obligation, vendor financing and a
segregation in that section, category or (investing). decommissioning liability.
subcategory.
Examples of operating activities include: A liability would be presented
The order of presentation of sections or separately in the operating finance
the sale of services by a consulting
?
categories in the financial statements subcategory if it meets all of the
firm
would not be prescribed. In selecting following criteria:
the order of presentation of sections research, production and sale of
?
pharmaceuticals by a pharmaceutical the liability incurred in exchange for a
?
and categories, it is expected that the
company service, a right to use or a good, or is
entity would try to align the sectors and
incurred directly as a result of an
categories across the statements. deposit-taking and loan-making
?
operating activity
However, an entity shall choose an activities of a bank
order that produces the most the liability is initially long-term and
?
cash from customers
?
understandable depiction of its the liability has a time value for
?
costs associated with producing
?
activities and allows for presentation of money component that is evidenced
goods and rendering services
meaningful subtotals and totals. by either interest or an accretion of
cash paid for materials
? the liability attributable to the
An entity would also disclose in the
trade accounts receivable and trade
? passage of time.
notes to financial statements the basis
accounts payable
for its classification of line items within In its basis for conclusion, the Boards
the sections, categories and property, plant and equipment,
? mentioned that some liabilities (e.g., a
subcategory. In particular, an entity intangibles and other long-term net post- employment benefit liability
would disclose the relation between assets that are used as part of an and a decommissioning liability) are
the presentation of information in the entity's day-to-day business viewed by many users of financial
financial statements and its activities. depreciation and amortisation
? statements as an alternative source of
expense financing; however, those liabilities are
commodity-based contracts (e.g.,
? not part of an entity’s capital-raising
Business section forward, option or swap contract) that transactions. Although those liabilities
are related to operating assets or can be viewed as having a financing
An entity’s business section would
operating liabilities. component, the Boards concluded that
comprise its operating activities and its
they should not be classified in the
investing activities, which would be The operating category would include debt category or the financing section.
presented separately. This section an ‘operating finance’ subcategory, That is because those liabilities are
would include assets and liabilities that which would consist of liabilities related entered into in exchange for a service,
relate to an entity’s income generating directly to operating activities and a right of use or a good, or are incurred
activities. The Boards propose that an which some users view as an directly as a result of an operating
entity would segregate its business alternative source of financing. activity.
activities into those that generate Examples of liabilities that would be
revenue through a process that classified in the operating finance

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16

Consistent with the cohesiveness Financing section • all changes in equity in the statement
principle, all related effects from those of changes in equity and
The financing section would include
liabilities would be classified in a similar • all cash flows related to equity
items that are part of an entity's
subcategory in the statement of transactions in the financing section
activities to obtain (or repay) capital.
comprehensive income. However, of the statement of cash flows.
The financing section is expected to
related cash flows would be presented
provide transparency about an entity's
in the operating category in the
capital structure and the financing
statement of cash flows which does
activities in which the entity engages.
not include an operating finance
The financing activities would be Our comments:
subcategory.
grouped into tow categories: debt and
It is not clear whether
The investing category would include equity in the statements of financial
transactions under IFRS 2,
assets or liability that an entity uses to position and comprehensive income.
Share-based Payment would
generate a return and any change in However, in the statement of cash
be classified under the debt
those assets or liabilities. No significant flows the financing activities will be
category. One could
synergies are created for the entity by separated into debt or equity.
understand that cash settled
combining an asset or a liability
The debt category would include: share-based payments
classified in the investing category with
should be shown in the debt
other resources of the entity. An asset • borrowing arrangements entered into
category whereas it is not
or a liability classified in the investing for the purpose of obtaining or
clear in which category
category may yield a return for the repaying capital and the related
expenses resulting from
entity in the form of, for example, income effects and
equity settled share-based
interest, dividends, royalties, equity • transactions involving an entity's own payments should be shown.
income, gains or losses. equity, including the assets, liabilities Further, these transactions
and related income effects that arise may not always be debt and
from these transactions. may instead meet the
Our comments: definition of equity in IAS 32,
Transactions involving entity's own
It is not clear from the equity would be presented separately Financial Instruments:
requirements of the staff draft from the borrowing arrangements with Presentation and IFRS 2 for
where goodwill should be the debt category. example, by delivering a
presented. It seems that fixed number of shares which
goodwill should be classified The equity category would include are equity-settled share-
in the operating category of • all equity items as determined in based payments.
the business section; however IFRS in the equity category of the
some may argue that it statement of financial position
should be classified in the
investing category of that
section.
There is a disconnect in
relation to the operating
finance subcategory in that it
appears in both the statement
of financial position and the
statement of comprehensive
income but not in the
statement of cash flows.
Some question if finance
lease will always be
classified as operating
finance lease liabilities. For
example, if an entity enters
into a sale and finance lease
back transaction as a means
of raising funds or for tax
planning purposes and such
property is not used in the
day-to-day business, would
the finance lease liability still
be classified in the operating
finance sub-category?

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17

Multi-category section Cash would be classified in the Classification as short-term or long-


operating category in the statement of term (which replaces current or non-
The multi-category transaction section
financial position. However, if current) would no longer take account
would include the net effects on
overdrawn, the balance is presented in of the entity’s normal operating cycle.
comprehensive income and cash flows
the debt category as short-term
of transactions that result in the Deferred tax assets and liabilities:
borrowing.
recognition or derecognition of assets Deferred tax assets and liabilities would
and liabilities in more than one section The proposed format would challenge be classified as short-term or long-term
or category in the statement of the way many have traditionally viewed according to the classification of the
financial position. the statement of financial position related asset or liability.
since it would no longer be classified
Statement of changes in equity Current IAS 1 prohibits classifying a
on the basis of elements (assets,
deferred tax asset or liability as current
The statement of changes in equity liabilities and equity).
and this proposed classification would
would not include the sections and
be a change in practice. The proposed
categories used in the statements
classification is consistent with US
because the statement presents Short-term and long-term
GAAP. The IASB concluded that this
information solely about changes in presentation
change in practice is consistent with
items classified in the equity category
Within each section, category and the Boards’ goal of aligning not only
in the statement of financial position.
subcategory, an entity would continue their presentation standards, but also
to have a choice between presenting the income tax standards.
short-term assets and liabilities
Statement of financial separately from long-term assets and
position liabilities, or presenting assets and Classification of financial liabilities
Presentation liabilities in order of liquidity.
IAS 1 and US GAAP include different
An entity would classify its assets and An asset or a liability would be guidance for the classification of
liabilities into the sections, categories classified as short-term if either its financial liabilities as current or non-
and subcategory on the basis of how contractual maturity or its expected current. The Boards will consider
those items relate to its major activities date of realisation or settlement is addressing those differences in a
or functions. Therefore, not all assets within on year of the reporting date; if separate project. Consequently, the
would be presented together and not not, the asset or liability is classified as staff draft retains the guidance in IAS 1
all liabilities would be presented long-term unless specified otherwise in on classification of financial liabilities.
together. In addition, assets and other IFRS or in special guidance for The requirements for the classification
liabilities also would be disaggregated deferred tax and financial liabilities. of financial instruments under IFRS is
by nature and/or measurement basis. mostly contained within IAS 32.

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18

Statement of related to the ordinary and typical


Our comments: activities of an entity, given the
comprehensive income environment in which the entity
Presentation Since the classification of operates.
income and expenses is
An entity would classify items of driven by the classification
income and expense that comprise of assets and liabilities in
profit or loss into the section, category the statement of financial Our comments:
and subcategory that are consistent position, the profit There could be diversity in
with the classification of the related subtotals may differ from the interpretation of
asset or liability in the statement of the amounts presented unusual, infrequent and
financial position and consistent with under the existing IAS 1. material. This may lead to
the related cash flows in the statement For example, interest may inconsistent application
of cash flows. An item of income or be classified in three between periods and
expense that is not related to an asset different categories, between similar entities. To
or a liability in the statement of financial whereas previously it avoid divergence in
position would be classified would have been disclosed practice, it may be useful
consistently with the activity as a single line item. This to have more detailed
generating the income, expense or would result in operating guidance.
cash flow. profit being calculated
differently to its previous Separate project on presentation of
method. other comprehensive income
Disaggregation by function and
nature Consistent with the proposal in a
Categories within other separate joint project on presentation
Unless it is not useful in understanding comprehensive income
the entity’s activities and the amounts, of other comprehensive income
timing and uncertainty of future cash An entity would indicate for each item (ED/2010/5), the statement of
flows, an entity would disaggregate its of other comprehensive income, except comprehensive income would be
income and expenses by function (i.e., for a foreign currency translation segregated into two parts: profit or loss
the entity’s primary activities, such as adjustment of a consolidated subsidiary (net income) and other comprehensive
selling goods, manufacturing, or a proportionately consolidated joint income. Items of other comprehensive
advertising or administration) in the venture, whether the item relates to an income would be grouped into those
statement of comprehensive income. operating activity, investing activity, that in accordance with other IFRSs
financing activity or a discontinued would be reclassified subsequently to
An entity would further disaggregate operation. profit or loss when specific conditions
those amounts by nature (e.g., are met and those that would not be
materials, depreciation, employee reclassified subsequently to profit or
benefits) and present that information Unusual or infrequently occurring loss.
in the statement of comprehensive items
income or in the notes to financial
statements. An unusual or infrequently occurring
event or transaction would be
An entity that does not present its presented separately in the appropriate
income and expenses disaggregated by section, category or subcategory in the
function would disaggregate and statement of comprehensive income. A
present its income and expenses by description of each unusual or
nature in the statement of infrequently occurring event or
comprehensive income. transaction and its financial effects
would be disclosed in the statement of
comprehensive income or in the notes
to financial statements. An entity
would present separately a material
event or transaction that is unusual or
occurs infrequently.
A transaction is infrequently occurring
when it is not reasonably expected to
recur in the foreseeable future given
the environment in which an entity
operates. An item is unusual if it is
highly abnormal and only incidentally

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19

Statement of cash flows Notes to the financial Conclusion


A statement of cash flows would statements It is evident from the above
present information about the change The notes to the financial statements that the proposals will result in
in cash during the reporting period in a would include new or additional the financial statements being
manner that relates the cash receipts disclosure requirements. An entity presented very differently to
and cash payments to information would be required to provide an the many alternative types of
presented in the statements of analysis of the changes between the presentation permitted by the
financial position and comprehensive opening balance and closing balance of existing requirements. It is
income. asset and liability line items that are also evident that much more
An entity would use the direct method important for understanding the current disaggregated information will
to present cash flows in each of its period change in the entity’s financial be required than is currently
sections and categories, i.e., gross position. As part of that analysis, an the case. Whilst users of
cash receipts and gross cash entity would present separately the financial statements may find
payments. change related to cash transactions, that the enhanced
non-cash transactions (e.g., cohesiveness and
reclassifications), accounting allocations disaggregation may permit
Our comments: (e.g., depreciation), write downs or improved analysis, of and
impairment losses, acquisitions or insight into, an entity’s
There may be dispositions, and other financial position and
implementation issues with remeasurements (e.g., fair value performance, preparers may
regard to the use of the direct changes). encounter costs and systems
method for cash flow challenges in presenting
statements since an entity financial statements on the
will be required to obtain Our comments: proposed basis and may be
information on a transaction concerned that excessive
by transaction basis. Further, This proposed disclosure disclosure may obscure
the proposals are expected may have more than important information. As the
to lead to a different financial statement classification to sections and
classification of items in the disclosure implications for categories is mainly
statement of cash flows than entities. For instance, there dependent on the individual
under the current IAS 7, may need to be a change in activities of the entity, there
Statement of Cash Flows. For accounting systems to may be some sacrifice of
example, cash flows related capture this information, as comparability between
to capital expenditures are information on a transaction- entities.
currently presented in the by-transaction basis is
investing category. An entity required to properly track the The staff drafts have been
would most likely present remeasurements for made available publicly for
those cash flows in the disclosure purposes. information of constituents
operating category using the and to form a basis for the
proposed definitions. Boards’ outreach activities.
Although the Boards are not
inviting formal comments on
An entity would also be required to the staff drafts, they welcome
reconcile operating income to operating input from interested parties
cash flows as an integral part of the and will consider whether to
statement of cash flows. In the basis change any of their tentative
for conclusion the Boards mentioned decisions in response to the
that users of the financial statements input received. They will
observed that having this information review the tentative decisions
as part of the statement is most useful reached to date in the light of
because an analysis of the statement the feedback received with the
of cash flows would be incomplete view to publishing an
without it. exposure draft; currently
expected in early 2011.

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20

Dodd-Frank Act
Snapshot of Implications for Indian
foreign private issuers
Economic growth results in an inevitable need for legislators to formulate
new legislations and laws to adapt to the changing environment and to
ensure that its constituents do not attempt to take advantage of lacuna in the
prevailing compliance framework. In today’s world, cutting edge competition
in corporate sector coupled with misplaced priorities on economic values over
ethical values have led to numerous corporate scandals being witnessed
across the globe.
The prevailing laws and legislations in a society get outgrown over time which
necessitates introduction of newer and more effective legislation to suit the
evolving needs. The introduction of the Dodd-Frank Act is yet another step in
this direction in an endeavor to redefine the concept of ‘regulations and
reforms’ not only in financial services sector but also in all other sectors both
within United States and to a lesser extent outside the US as well.

What is Dodd-Frank Act?


‘Dodd-Frank’ to begin with, is the shorter form for the ‘Dodd-Frank Wall Street
Reform and Consumer Protection Act’ (the Act or the Dodd Frank Act)
introduced as law in July 2010 in the United States of America (US). Like its
predecessor, the Sarbanes Oxley Act of 2002 (SOX), this Act has been named
after its founders – Chris Dodd & Barney Frank. The Act is expected to
facilitate sweeping changes to the concept of financial regulations in the US
and is expected to have far reaching consequences on the financial services
sector in the US.
Does this mean Dodd-Frank would only affect financial institutions and US
companies? – The answer is a big ‘No’. Whilst the main objective of Dodd-
Frank is to ensure that high level of regulation persists in the financial
services sector, it does have implications on companies from all sectors and
applicable for foreign private issuers across the globe.
Let us first understand who these foreign private issuers are before analysing
the impact and implications on such issuers consequent to the Dodd-Frank Act.

Foreign private issuer:


A foreign private issuer (FPI) is defined in accordance with the Rule 3b-4 of
the Securities Exchange Act of 1934 as any foreign issuer other than a foreign
government except for an issuer meeting the following conditions as of the
last business day of its most recently completed second fiscal quarter:
More than 50 percent of the issuer’s outstanding voting securities are
?
directly or indirectly held of record by residents of the US and
Any of the following:
?

The majority of the executive officers or directors are the US citizens or


?
residents
More than 50 percent of the assets of the issuer are located in the US
?

The business of the issuer is administered principally in the US.


?

For example, a company domiciled in India and listed in the US stock


exchange will be referred to as a foreign private issuer if the specified
conditions are met.

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21

Implications of the Dodd-Frank Act


on FPIs
Dodd-Frank Act has wide ranging implications for the
Companies in US. We have only attempted to highlight
certain significant matters impacting the FPIs:

1. Corporate whistle-blower protection


The existing SOX Act intends to extend protection to
employees acting as whistle-blowers upon meeting
traded company even though the whistleblower was
specified conditions laid down by the Act. The Dodd-Frank
employed by a subsidiary company of the publicly traded
Act seeks to enhance flexibility at the hands of such
company.
whistle-blowers to enable them to report more freely
without any fear of retaliatory action by the employer. We Impact of the Dodd-Frank [section 922(b) and 929A]
have discussed below some of the notable changes carried
Explicitly includes both public traded companies and “any
out consequent to the Dodd-Frank Act on aspects relating to
subsidiary or affiliate whose financial information is included
corporate whistle-blower protection mechanism:
in the consolidated financial statements of such company.
“Act enhances flexibility in provisions to induce whistle- Some court rulings in the past have taken a position that the
blowers to report without undue hesitation ” employees of non-publicly traded companies were not to be
covered by the SOX Act unless substantial nexus could be
established between the parent and subsidiary company.
A. Grounds of reasonable belief: The said amendment would cast the net wide open in terms
of coverage of claims which could result in more instances
Current practice being reported.
The whistle-blower provision under the SOX Act requires
‘reasonable belief’ condition to be fulfilled by individuals
acting as whistleblowers to seek protection. i.e., such C. Bounty provisions:
individual ought to have reasonable belief that the
information he/she reports constitutes violation of Current practice
company’s policy on fraud or any other statutory provisions Currently, the SEC has a monetary reward program to pay
relating to fraud. rewards to informants in insider trading, which is not very
widely publicised or frequently applied by the regulator.
Impact of the Dodd-Frank [section 922(a)]
Unlike SOX, the Dodd-Frank Act extends its protection to Impact of the Dodd-Frank [section 922]
whistle-blowers regardless of whether they reasonably The Dodd-Frank Act includes provisions for establishment of
believe that the information being reported constitutes bounty program at the SEC to reward those reporting
violation of fraud related provisions. The Act prohibits any securities law violations based on original information. Such
action of retaliation against whistleblowers who (i) provide whistle-blowers may be awarded between 10 percent to 30
information to SEC (ii) initiate, testify or assist in any SEC percent of the fines and penalties received by the US
investigation or legal action related to information provided government pursuant to any action brought by the SEC
by the whistleblower or (iii) make disclosures that are under the securities laws that results in monetary sanctions
required or protected under SOX or the Securities Exchange exceeding USD 1,000,000.
Act of 1934.
Bounty provisions emanating from the Dodd-Frank Act could
result in likely abuse since employees would be keen on
overlapping the reporting hierarchy set within the
B. Coverage of claims from subsidiary companies:
organisational authority chain and escalating the matter
Current Practice directly to the regulatory authority. This would affect the
fundamentals of authority chain framework set within
There exists a lot of confusion in determining the
organisations and would give very little time for
applicability of provisions relating to whistle-blowing process
organisations to react, even for baseless false claims.
for an employee of a parent company vis-à-vis a subsidiary
company. In the past, there have been claims dismissed
because the said whistleblower did not work for a publicly
“Incentivising employees for fraudulent reporting to
regulator is a good step but would require companies
to revamp their internal compliance reporting
framework to balance the requirement of the Act and
suitability to their organisation”

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22

2. Claw-back provisions The SEC provisionally allowed non-accelerated filers to


postpone their compliance with these requirements. Non-
The term ‘claw-back’ is used to denote the phenomenon of accelerated filers were permitted to defer compliance with
recovering back the compensation erroneously awarded to the requirement of Section 404(a)’s requirement to provide
executives. management’s report on ICOFR until their annual report
filed for year ending on or after December 15, 2007.
Current practice Subsequently, the SEC required all non-accelerated filers to
Section 304 of the Sarbanes-Oxley Act provides for recovery include an auditor’s attestation report filed for a fiscal year
of certain compensation from the CEOs and the CFOs (but ending on or after June 15, 2010.
not from any other officers or employees) in the event of
financial restatements resulting from misconduct. Further, Impact of the Dodd-Frank [section 989G]
such claw-backs were restricted to a period of one year from The Dodd-Frank Act provides that a new subsection 404 (C)
the date of misstated financial filing. Some companies as a be added to the SOX Act, which states that the auditor
measure of sound corporate governance or on account of attestation requirement as required by Section 404(b) will
pressure from their shareholders include certain other permanently apply only to accelerated filers and large
executives under their compensation claw-back policies accelerated filers. Even though relief from 404(b) is provided
though not mandated by the SOX Act. However, this varies consequent to the Act, the requirement to comply with
from company to company in the absence of a uniform 404(a) still persists. However, this relaxation is expected to
requirement. result in significant reduction in compliance costs for such
non-accelerated filers.
Impact of the Dodd-Frank [section 954]
“Exemption for non-accelerated filers to result in
The coverage of the Dodd-Frank Act is much wider in this
reduction of compliance costs for such companies”
regard since it includes within its ambit, all present and
former executive officers and not merely the CEO and the
CFO. Moreover, it applies to restatement due to company’s
material non-compliance with financial reporting
4. Private placement exemption
requirements and not just restatements consequent to Current practice
misconduct. The period has also been extended from one
year to three years from the date of mis-stated financial Typically, smaller companies go through the route of the
filing. Given that the likelihood of restatements occurring in Regulation D offerings to have access to capital markets
the financial statements of foreign private issuer companies which otherwise would involve the costs of a normal SEC
when compared to domestic issuers are less, these FPIs registration. Most of the hedge funds and private equity
may be provided with a relief if not an exemption in future. funds rely on the Regulation D offerings. These offerings are
Until then, these companies ought to revisit their executive only made to investors who qualify as ‘accredited investors’
compensation plans and their nexus with the financial in order to be exempt from specific disclosure requirements
statement numbers. which are applicable for unaccredited investors. The
determination of ‘accredited status’ is done at the time of
“Expanded coverage beyond the CEOs & the CFOs investment.
would imbibe collective responsibility in corporate
sector” Impact of the Dodd-Frank [section 413(a)]
The Dodd-Frank Act excludes the value of an individual’s
primary residence as an asset in calculating whether a
3. Exemption for non-accelerated filers natural person meets the threshold of USD 1 million under
from SOX provisions the net worth test, for qualifying as an ‘accredited investor’
under the Federal Regulation D. Accordingly, the issuer of
Current practice the Regulation D offerings currently in process should
Non-accelerated filer, simply defined, is an Exchange Act determine whether potential investors and existing
reporting company with market capitalisation of less than investors who choose to make additional investments will
USD 75 million. There are also other conditions laid down qualify as an ‘accredited investor’, resulting in revision in
under the Rule 12b-2 of the Securities Exchange Act of 1934 their subscription documents or other disclosures related to
which if a company fails to achieve, qualifies it as a non- an ongoing offering.
accelerated filer.
Section 404(a) of the Sarbanes-Oxley Act of 2002 requires
annual reports on the Form 10-K filed under the Securities
Exchange Act of 1934 to contain a report from management
on the effectiveness of a company’s internal control over
financial reporting (ICOFR). Further to this, Section 404(b)
requires the company’s regular auditor to attest and report
on management’s assessment.

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23

5. Extraterritorial jurisdiction is 10 days.) Copies of such reports and related amendments


will also no longer be required to be provided to the issuer
Section 929P of the Dodd-Frank Act grants US courts or the stock exchange on which the shares are listed.
jurisdiction over any action or proceeding brought by the
SEC or the US government involving: (1) conduct within the
US that constitutes significant steps in furtherance of a 8. Credit rating agency reforms
violation of the anti-fraud provisions of the Securities Act,
the Exchange Act or the Investment Advisers Act, even if The Dodd-Frank Act has also resulted in bringing the
the securities transaction occurs outside the US and nationally recognised statistical rating organisations
involves only foreign investors or (2) conduct outside the (NRSRO) under the scope of governance and compliance
United States that has a foreseeable substantial effect requirements to be laid down by SEC, considering the
within the US. pivotal role such organisations play in capital markets.

The Dodd-Frank Act seeks to curtail application of the recent Key provisions relate to setting up of a board to ensure
Supreme Court decision in the US in Morrison vs National governance, documentation and implementation of effective
Australia Bank Ltd., in which it was held by the court that system of internal controls for determining ratings,
the anti-fraud provisions laid down in the Section 10 of the requirement for a compliance officer and fixation of their
Exchange Act were not applicable to private actions by compensation independent of organisation’s financial
foreign investors arising from purchases and sales of performance, establishment of rules on reporting of
securities that occurred outside the US. In essence, this employments of senior officers associated with the rating
would have considerable effect with respect to foreign agencies, ensuring greater transparency in rating
cubed cases. i.e., cases involving non-US investors who procedures and methodologies etc.
have purchased non-US securities on non-US stock “Provisions in the Act would prevent mushrooming of
exchanges, so long as there exists significant steps in undesirable practices in such ratings organisations”
furtherance of violation within the US. Thus, the Act could
results in extension of the Federal district courts’ jurisdiction
and allows enforcement actions to be brought in US courts 9. Independent compensation
for such foreign cubed cases also if the criteria stipulated in committee
the Act are fulfilled.
The Dodd Frank Act has focused on addressing the norm
“Whilst the extraterritorial jurisdiction casts the net surrounding independence and functions of compensation
wide open across non US countries, practical committees. Even though the Nasdaq/NYSE rules require
application remains to be seen as it depends on that executive compensation at listed companies get
flexibility provided by statutes of non US countries” determined or recommended to the full board for
determination solely by independent directors or an
independent compensation committee, no provision in the
6. Disclosure of internal pay ratio Exchange Act or any SEC rule mandated full independence
The Dodd-Frank Act directs SEC to amend Item 402 of of compensation committee.
Regulation S-K requiring companies to disclose the median Section 952 stipulates that this requirement relating to
of the annual total compensation of all employees of the independent compensation committee is not applicable to
company (other than the CEO) as well as the annual total FPIs that provide their shareholders with annual disclosure
compensation of the CEO. Companies must then also of the reasons why they do not have a fully independent
provide a ratio comparing those two figures. compensation committee. Therefore, to this extent, this
There exists some bit of confusion on whether this amendment by the Dodd-Frank Act has limited applicability
disclosure requirement applies for a foreign private issuer or to FPIs.
not. However, the Act directs the SEC to amend Item 402 to “Necessitating independence of compensation
require this disclosure in any filings “described in Section committee is a right step in the right direction”
10(a)”, which goes beyond proxy statements and annual
reports on Form 10-K. i.e., it also include annual reports filed
under Form 20-F by foreign private issuers.
“SEC’s course of action on this disclosure requirement
for foreign private issuers is awaited in this regard ”

7. Beneficial ownership reporting


The Act empowers the SEC to accelerate the deadline by
which certain acquisitions of more than five percent of the
shares of public companies, including foreign private
issuers, must be reported to the SEC. (The current timeline

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24

10. Broker discretionary voting The Dodd-Frank Act further limits discretionary voting by
brokers, by requiring all national securities exchanges to
The Dodd-Frank Act has introduced additional limits on the adopt standards prohibiting discretionary broker voting in
ability to vote shares in the absence of direction from elections, as well as in connection with executive
beneficial owners. Shares which brokers hold on behalf of compensation or any other significant matter, as determined
beneficial owners are generally voted by such brokers in by SEC rulemaking. This empowers the SEC to determine
accordance with the instructions given by the beneficial other matters where it would want the brokers to not
owners. When such beneficial owners do not provide any exercise their discretionary voting rights.
instructions on voting, the New York Stock Exchange (NYSE)
rule 452 permits member firms to vote in their discretion on
certain routine matters. Subsequently, the NYSE rule 452
was amended effective January 2010 to prohibit broker
discretionary authority to vote on director elections, even if
uncontested.

Conclusion

Having discussed some of the significant impact on foreign private issuers pursuant
to Dodd-Frank provisions, it is to be seen how future rulemaking will set the tone.
The application of provisions laid out by the Dodd-Frank Act would not only require
various federal agencies to adopt new rules and amend existing ones, but also might
pose implementation challenges. Consequently, the world needs to await whether
the rules implementing the Act in the days to come, would also include exemptions
and relaxations for specific category of companies such as foreign private issuers
and smaller reporting companies to facilitate effective implementation.
Even though, there exists shades of difficulties which might be encountered upon
implementation of some of the provisions of the Dodd-Frank Act, the larger truth
lays in understanding the essence of the Act and the spirit it manifests. Like its
predecessor ‘the Sarbanes-Oxley Act’, the Dodd-Frank Act is here to stay for more
than one reason and it would augur well for the corporate sector and its participants
to understand this not-so bitter truth and welcome it wholeheartedly.

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25

REGULATORY UPDATES

Audit committee – calendar of reviews An invitation to FII - Investment limits in


government securities and corporate bonds
The Reserve Bank of India (RBI) vide notification dated 10
increased
November 2010 has consolidated the circulars issued by it
on additional reviews by the audit committee of all The Ministry of Finance has issued a press release,
commercial banks. The notification includes a calendar notifying increase in the current limit of Foreign Institutional
which outlines the critical minimum requirements of review Investors (FII) investment in the Government Securities and
by the audit committee. The Boards will have discretion to corporate bonds, which is summarised below:
prescribe additional reviews.
Investments in Amount in USD millions
The notification also emphasises that the audit committee
should monitor the work done by concurrent audit, internal
Current limit Revised limits
audit, statutory audit and compliance of the RBI inspection
very closely and should play an active role in the Government securities 5 10
appointment of the statutory auditors. The audit committee
reviews should include review of: Corporate bonds (incremental 15 20
amount of USD 5 million is
Compliance in respect of the Annual Financial Inspection
? required to be invested in the
conducted by the RBI corporate bonds with residual
maturity of over five years issued
Audit plan and status of achievement thereof
? by companies in the infrastructure
sector)
Significant audit findings
?

Report on compliance of clause 49 and other guidelines


? The enhancement of the FII investment cap is with the
issued by the Securities and Exchange Board of India objective to provide avenues for increased FII investments
(SEBI) from time to time in debt securities, help investment in infrastructure sector
and the development of the government securities and
Report on compliance of the regulatory requirement of
?
corporate bond markets in the country. The policy has been
the Regulators in the host countries in respect of
reviewed in the context of India’s evolving macroeconomic
overseas branches
situation, its increasing attractiveness as an investment
Material change in accounting policy and practices
? destination and need for additional financial resources for
India’s infrastructure sector while balancing its monetary
Confirmation that accounting policies are in compliance
?
policy.
with accounting standards and the RBI guidelines
One may refer to www.pib.nic.in for further details.
Information security audit policy
?
(Source: PIB Press release dated – 23 September 2010)
Transactions with related parties.
?

The introduction of notice has further enhanced the growing


importance of the corporate governance in the banking
sector. The notice also suggests a significant shift in the
efforts to be made by the members of the audit committee
to monitor audits of the bank and compliance with the
regulatory requirements.
One may refer to www.rbi.gov.in for further details.
(Source: DBS.ARS.BC. No. 4/ 08.91.020/ 2010-11 issued by the RBI dated
10 November 2010)

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SEBI (Issue of Capital and Disclosure Sale of investments held under Held to
Requirements) (Fourth Amendment) Maturity (HTM) category
Regulations, 2010 As per the existing requirements, if the value of sales and
Securities Exchange Board of India (SEBI) has introduced a transfers of securities to/from HTM category exceeds 5
requirement to publish proforma financial statements, if: percent of the book value of investments held in HTM
category at the beginning of the year, banks are required to
an acquisition
? or divestment is made by the issuer after
disclose the market value of the investments held in the
the end of the latest disclosed annual financial results in
HTM category and indicate the excess of book value over
the offer document, due to which certain companies
market value for which provision is not made.
become/cease to be direct or indirect subsidiaries of the
issuer and With regard to the above, the RBI has clarified that the
following would be excluded from the prescribed cap (i.e.,
the financial
? statements of such acquired or divested
five percent of the book value of investments):-
entity is material to the financial statements of the issuer
company. one-time transfer of securities to/from HTM category
?
permitted by the Board of Directors to be undertaken by
Where the said acquisition or divestment does not fulfil the
banks at the beginning of the accounting year and
tests of materiality, the fact of the acquisition or divestment
along with the consideration paid/received and the mode of sales to the Reserve Bank of India under pre-announced
?
financing such acquisition shall be disclosed. The above open market operation auctions.
information shall be certified by the statutory auditor of the
The clarification is effective from 1 April 2011.
issuer. These Regulations are effective from 12 November
2010. The circular intends to reduce the disclosure requirements
of the banks when such transfers are on account of
The said disclosure requirement is in the wake of SEBI’s
startegic decision made by the Board at the beignning of
hardened stance on disclosure requirements of keeping the
the accounting year or at the direction of the RBI.
prospective investors informed about the significant
changes in the financial positions of the company post the (Source: DBOD. No. BP.BC. 56 /21.04.141/2010-11 issued by RBI, dated
date of offer document. This will give additional qualitative 1 November 2010)
factors to the prospective investors for making investments
decision before close of the offer.
One may refer to www.sebi.gov.in for further details.
(Source: notification dated 12 November 2010 issued by SEBI)

Prudential norms on investment in zero coupon


bonds – a check by RBI
It has come to the notice of the RBI that banks are investing
in long term zero coupon bonds (ZCBs) issued by the
corporates including those issued by Non-Banking Financial
Companies (NBFCs). In the case of ZCBs, the issuers are
not required to pay any interest or installments till the
maturity of bonds. As a result, the credit risk in such
investments would go unrecognized till the maturity of
bonds and this risk could especially be significant in the
case of long-term ZCBs. Such issuances and investments if
done on a large scale could pose systemic problems.
Hence, the RBI has decided that banks should henceforth
not invest in ZCBs unless the issuer builds up sinking fund
for all accrued interest and keeps it invested in liquid
investments/securities (Government bonds), and also that
banks should put in place conservative limits for their
investments in ZCBs. The banks are advised to take
immediate action to adhere to the above instructions.
The will reduce exposure to credit risk and enhanced
transparency.
One may refer to www.rbi.gov.in for further details.
(Source: DBOD No. BP.BC. 44/21.04.141/ 2010-11 issued by RBI, dated
29 September 2010)

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should act on such information without appropriate professional advice after a thorough examination of the particular
situation.

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