Current Public Administration Magazine (September - 2014) - Corporate governance: How new rules will change Indian companies

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Corporate governance: How new rules will change Indian companies

The issue of corporate governance in the private sector is a reality and it's time they live up to that," says Sachin Pilot, minister of corporate affairs. The 62-year old law that governs companies is on the cusp of being replaced by new rules, which the government says will usher in many good practices.

The big picture shows intent, but it's the small details, which will unravel in the coming year, that will show the government's seriousness to follow through.

Also, adds Jamil Khatri of KPMG: "The challenge is not to introduce new provisions, but implementation." As we wait for greater clarity, John Samuel Raja D breaks down the new legislation to show how things will change for companies—and, by extension, their stakeholders like investors, creditors, auditors and employees.

Disclose More Information

Information is a currency, and the new bill looks to put more of it in the public domain, particularly related to unlisted and privately-held companies. This set has reporting requirements that are much more lenient than their listed peers, which make up about 1% of the 1.06 million companies registered with the MCA. Lately, several transactions of private companies that, directly or indirectly, intersected with public interest—coal block allotments, business interests of BJP president Nitin Gadkari, real estate dealings of Congress Party president's son-in-law Robert Vadra with DLF—have made a case for this set of companies to put out more information.
The proposed law wants companies to give financial statements that consolidate the numbers of all their subsidiaries, including associates (at least 20% stake) and joint ventures. It also wants them to put out their cash-flow statement, which is the place to find how much of a company's cash came from operations and how much from external financing. Such disclosures will give a more holistic picture of an entity's business interests. Thanks to capital market regulator Securities Exchange Board of India, listed companies already present consolidated accounts, up to an extent, and cash-flow statement. Even they would have to make adjustments.

"Companies that previously reported consolidated annual numbers as per IFRS (International Financial Reporting Standards), which was permitted by Sebi, would now need to consider the need to again report consolidated numbers as per Indian accounting principles," says Jamil Khatri, global head of KPMG's accounting advisory services, who wants companies to do so on a quarterly basis. Other changes proposed include seeking shareholder approval when a related party (a director of the company, or its holding company or subsidiary) acquires assets from the company for a non-cash consideration.

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Remodel their Corporate Structure

The proposal with possibly the greatest import relates to how companies route their investments. In order to identify the ultimate beneficiary, the new legislation proposes to restrict the number of layers of investment companies to two. Take Chintamani Agrotech, where BJP president Nitin Gadkari served as director for a decade.

Two companies—Jinbhuvish Power and Aarya Agrotech—owned a majority stake in Chintamani, but their ultimate beneficiaries of these firms could not be determined. ET traced the ownership of Jinbhuvish to three layers, only to encounter new corporate entities at every level.

Says BP Inani, a chartered accountant with Swan Finance: "There are umpteen instances where big, known companies have used this myriad matrix to rob general investors. Consolidation of accounts and restricting the number of investment-holding companies to not more than two layers will improve corporate governance."

But there's a catch. The new rules don't yet specify the number of layers of subsidiaries the two investment-holding companies can have. N Venkatram, managing partner-audit, Deloitte Haskins & Sells, feels companies can circumvent the proposed changes. A company can, he adds, still invest less than 50% in two companies or trusts, which could together hold 100% shares in a downstream company, and escape the requirement for consolidation.

"Unless better regulated, the ownership structures will remain opaque," he says. Elsewhere, the rules give private firms more latitude to expand. The maximum number of shareholders in a private company is to be increased to 200, from 50. Not wanting to lose their private status, companies would rein in their ambitions.

Now, they can offer stock options to more employees and attract more investors. Similarly, the number of partners in a partnership firm has been increased to 100, from 20.

Be More Accountable to Shareholders

For an accounting fraud perpetrated by its original promoter, Satyam Computer Services, now known as Mahindra Satyam, paid $125 million to settle 'class-action suits' filed by shareholders in the US, where its shares were listed. Its auditors— Price Waterhouse Bangalore, PricewaterhouseCoopers Pvt Ltd, Lovelock & Lewes, along with PwC US and PwC International— shelled out $25 million to do the same in the US.
Indian shareholders of Satyam did not receive a penny from those or any other settlements as the country did not allow class-action suits. Under the new Companies bill, it will.

Under class-action suits, a shareholder group (as per the new bill, minimum of 100 or a percentage of shareholders to be specified later) can join hands to claim damages against the company, its auditor, consultants, experts or advisors for any "wrongful, fraudulent or unlawful" conduct.

The bill also aims to use independent directors and audit committee to protect external shareholders. While the current law does not define an independent director, the proposed one bars people related to promoters or directors from being classified as one.

Then, it specifies that independent directors should be in a majority in the audit committee and they should understand financial statements.

Further, the audit committee has to recommend auditors and monitor their performance, approve related-party transactions and value assets. Although it bars independent directors from availing stock options, the new bill lets them be paid a commission as a percentage of profit.

"Is it not a challenge to be seen as objective and independent when a substantial portion of personal income comprises of commission based on a company's net profit?" asks Venkatram of Deloitte.

Face Punishment for Frauds

The bill, for the first time, defines what constitutes a 'fraud': broadly, any omission or concealment with an intent to deceive and gain undue advantage from shareholders or creditors, whether or not there is any wrongful loss or gain.

So, for example, if the two former executives of Reebok India are found guilty of falsification of documents, under the new law, they could face arrest and have to pay fines. There are 18 situations in which the bill has prescribed frauds and penalties.

In several cases, the penalties have been increased, up to three times the amount involved; in select sections, imprisonment has been introduced, ranging from six months to 10 years. The bill also gives more teeth to the investigator. It proposes to create a new Serious Fraud Investigations Office (SFIO).

The new bill aims to give the SFIO statutory status, similar to the Central Vigilance Commission (CVC). This is not as good as making it a constitutional body, like the Comptroller and Auditor General (CAG)—a statutory body can be wound up by a simple majority of Parliament, whereas the Indian Constitution needs to be changed to do the same to a constitutional one—but it's better than what the SFIO currently is.

The current SFIO, which functions as an attached office of the MCA, has not had much impact. There has been no conviction in the 835 cases of prosecution filed in different courts following an investigation by the SFIO, according to the MCA's latest annual report. The new bill gives the SFIO the power to arrest and treats an SFIO investigation report as one filed by a police officer in courts.

Answer to New Regulatory Entities

In the Satyam accounting fraud, the company's audit firms were never booked. Only the partner who signed off the accounts and two employees were. It's a regulatory practice peculiar to India that makes partners of audit firms, not the firms themselves, liable for wrongdoing.

This could change, with the formation of the National Financial Reporting Authority (NFRA)—a quasi-judicial regulator that will replace the National Advisory Committee on Accounting and Auditing Standards. NFRA will recommend accounting and auditing standards, currently the domain of the Institute of Chartered Accountants of India (ICAI). "NFRA can take action against the audit firm," says Pilot.

Another change is the National Company Law Tribunal to replace the Company Law Board (CLB), which deals with corporate overhaul and disputes—like the standoff between Telenor and Unitech.

Although CLB has been reasonably efficient—in the nine-month period to December 2011, it had disposed off 10,434 cases and had 2,459 cases pending with it—NCLT is expected to do things faster and better. It will have to complete proceedings in three months.

Also, it will only have judges and advocates as members, as opposed to bureaucrats. "So, these bodies cannot be seen to be inadequately staffed or run by incompetent people," says Shriram Subramanian, founder and MD of InGovern Research Services, an independent proxy advisory firm.

(Courtesy- The Economic Times)

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