Corporate Governance: Clause 49 and Companies Act 2013 Provisions

Corporate Governance deals with how a corporate is governed. It is all about promoting corporate fairness, transparency and accountability. Some of the objectives of Corporate Governance are – attaining disclosure and transparency in the way corporate is governed; fixing accountability of controllers and managers towards other stakeholders; fixing corporate responsibility; integrity and probity in financial reports etc.

Corporate Governance: Rationale

A corporation includes various stakeholders’ viz. investors, share holders, customers, employees, vendor partners, government and society. Its objective should not be confined to maximizing the shareholder value but should be responsible to all stakeholders. Its governance should be fair and transparent to its stakeholders in all its transactions. Thus, corporate governance becomes imperative in today’s globalized world where corporations need to access global pools of capital, need to attract and retain the best human capital from various parts of the world, need to partner with vendors on mega collaborations and need to live in harmony with the community.

On the other hand, the Liberalization and related developments such as deregulation, privatization and extensive financial liberalization render the Corporate Governance very crucial. All the fruits of capital market reforms can be lost to corporate frauds, malpractices etc. Thus, Independent and effective corporate governance reforms are necessary to maintain the market credibility confidence.

Corporate Governance in India

Concept of corporate Governance in India is not very old. For the first time, the CII had set up a task force under Rahul Bajaj in 1995. On the basis of this CII had released a voluntary code called “Desirable Corporate Governance” in 1998. SEBI had also established few committees towards corporate governance of which the notable are Kumarmanlagam Birla report (2000), Naresh Chandra Committee (2002) and Narayana Murthy Committee (2002). While Kumarmangalam Birla committee came up with mandatory and non-mandatory requirements, Naresh Chandra committee extensively covered the statuary auditor-company relationship, rotation of statutory audit firms/partners, procedure for appointment of auditors and determination of audit fees, true and fair statement of financial affairs of companies. Further, Narayan Murthy Committee focused on responsibilities of audit committee, quality of financial disclosure, requiring boards to assess and disclose business risks in the company’s annual reports.

Clause 49 of SEBI Listing Agreement

As a major step towards codifying the corporate governance norms, SEBI enshrined the Clause 49 in the Equity Listing Agreement (2000), which now serves as a standard of corporate governance in India. With clause 49 was born the requirement that half the directors on a listed company’s board must be Independent Directors. In the same clause, the SEBI had put forward the responsibilities of the Audit Committee, which was to have a majority Independent Directors.

Clause 49 of the Listing Agreement is applicable to companies which wish to get themselves listed in the stock exchanges.  This clause has both mandatory and non-mandatory provisions. Key Mandatory provisions are as follows:

• Composition of Board and its procedure – frequency of meeting, number of independent directors, code of conduct for Board of directors and senior management;
• Audit Committee, its composition, and role
• Provision relating to Subsidiary Companies
• Disclosure to Audit committee, Board and the Shareholders
• CEO/CFO certification
• Quarterly report on corporate governance
• Annual compliance certificate

Key Non-mandatory provisions include the following:

• Constitution of Remuneration Committee
• Training of Board members
• Peer evaluation of Board members
• Whistle Blower policy

In 2014, the clause 49 was amended to include Whistleblower policy as mandatory provision.

Companies Act 2013

Despite of all the mandatory and non-mandatory requirements as per Clause 49, India was still not in a position to project itself having highest standards of corporate governance. Taking forward, the Companies Law 2013 also came up with a dedicated chapter on Corporate Governance. Under this law, various provisions were made under at least 11 heads viz. Composition of the Board, Woman Director, Independent Directors, Directors Training and Evaluation, Audit Committee, Nomination and Remuneration Committee, Subsidiary Companies, Internal Audit, SFIO, Risk Management Committee and Compliance to provide a rock-solid framework around Corporate Governance.

Summary of Major Provisions

The key provisions in Clause 49 and 2013 act are summarized as follows for quick overview:

ED,NED and ID

There are two kinds of directors in the companies’ viz. Executive Directors (ED) and Non-executive Directors (NED). The Non-Executive Directors are divided into two categories viz. Independent Directors (ID) and others. Thus, every listed company has Executive Directors, Non-Executive Directors and Independent Directors on its board.

Rationale behind Independent Directors

The Independent directors are primarily meant to oversee the functioning of the board and ensure that the decisions it makes do not hurt the interests of minority shareholders. The current norms demand that the two third members of the Audit Committee and the Chairman should also be Independent.

An independent director can server in the same capacity in maximum seven companies. Further, if a person is whole-time director, he cannot be an independent director in more than three listed firms. An Independent Director who has already served on a company’s board for 5 years can serve only one more term of 5 years. Companies are now required to disseminate Independent Director’s resignation letter to Stock Exchanges & on company website.

Women Directors

The Companies Act 2013 provides that every listed company has to appoint at least one woman director. Appointment of women directors was hitherto voluntary but making it mandatory in Companies Act would draw have more talented woman on the boards of their companies.

Related Party Transactions (RPTs)

To enhance the transparency, there are rules regarding RPTs (Relative Party Transactions). These rules make sure that in all material dealings by company promoters, business decisions are not against the interests of small and minority shareholders.

Top Level remuneration

To check the tendency of fixing unreasonably high compensations for promoters and top-level executives, the new norms have mandatory constitution of a nomination and remuneration committee with an independent chairman. Moreover, all companies will need to follow enhanced disclosures norms on remuneration. These disclosure norms mandate the company to disclose the ratio of remuneration of top executives to median remuneration.

Audit Committee and whistleblower mechanism

There are rules and norms which expand the role of audit committee in listed firms and direct them to adopt a compulsory whistleblower mechanism to curb unfair business practices and protect the interest of minority stakeholders.

Concluding Remarks

After the Satyam Scandal, SEBI became more and more strict towards disclosure norms and implementation of Clause 49 provisions to bring about sea changes in transparency and accountability in the country. The Companies Act gave these norms a proper statutory backing. Towards transparency and accountability, there are laws regarding compulsory rotation of auditors and audit firms. An auditor cannot perform non-audit services for a company. Auditors are required to report fraudulent acts noticed during performance of their duties. Further, the act mandates that at least one third of board of a company has to consist of independent directors. Independent directors have been prohibited from receiving stock options or remuneration. To ensure greater transparency, additional disclosure norms such as formal evaluation of performance of the board of directors, filing returns with the registrar of companies with respect to any change in share holding positions of the promoters has been mode mandatory. Adoption of new accounting system may also help to check any fraud in accounting. Also statutory status for Serious Fraud Investigation Office (SFIO) has been proposed. Investigation report of SFIO filed with court for framing charges shall be treated as report filed by police officer. With these steps in place, transparency and accountability of corporate governance in India stand at better position than before the Sat yam Scandal.