Role of Sebi in Corporate Governance and Finance

The burgeoning economic growth that corporate India witnessed since the 1990s brought to the forefront the need for Indian companies to adopt corporate governance practices and standards, which are consistent with international principles. Industry groups, notably the Confederation of Indian Industries (“CII”), spearheaded the move to bring corporate governance issues to the attention of Indian companies and also led to the introduction of legislative reforms prescribing the manner in which Indian companies could implement effective corporate governance mechanisms. The legal framework relating to corporate governance is broadly covered in the Indian Companies Act, 1956 (“Companies Act”) and the regulations/ directives that are issued by the Securities and Exchange Board of India (“SEBI”), the securities market regulator in India. The Companies Act is administered by the Ministry of Corporate Affairs (“MCA”) and the provisions of the Companies Act are enforced by the Company Law Board. Regulators such as the Reserve Bank of India (“RBI”) and the Insurance Regulatory Development Authority (“IRDA”) also prescribe corporate governance guidelines applicable for banking and insurance companies, respectively. The establishment of SEBI has also played a significant role in establishing norms for corporate governance in India.

Over the years, SEBI constituted two committees to make recommendations relating to corporate governance in India, viz., the Kumar Mangalam Birla Committee (which submitted its report in 2000) and the Narayana Murthy Committee (which submitted its report in 2003). These committees made various recommendations relating to the composition of the Board of directors (“Board”) of listed companies, procedures for a meeting of the Board, the formation of an audit committee, the disclosure of relevant information to the shareholders, etc. The MCA also appointed the Naresh Chandra Committee on Corporate Audit and Governance in 2002 in order to examine various corporate governance issues in India and make recommendations on two key aspects of corporate governance, i.e., financial and non-financial disclosures, and independent auditing and board oversight of management. Subsequently, the MCA also appointed the J.J. Irani Committee in 2004 to review the international best practices in corporate governance, in light of the growing needs of the Indian economy and corporates. The recommendations of these committees form the bedrock of the legal regime for corporate governance in India.

This paper seeks to provide a broad overview of the legal framework governing corporate governance and the various mechanisms set out in the Companies Act and by SEBI, as applicable to listed companies in India.

Corporate Governance Under the Companies Act

The fundamental principles of corporate governance have been enshrined in the Companies Act, which contains various provisions relating to shareholder rights, disclosure and transparency and Board responsibility. Some of the relevant provisions have been highlighted below:

a. Shareholder Rights

The Companies Act requires every company to conduct an annual general meeting and provides an effective mechanism for the shareholders to participate and vote at general meetings. In the interests of investor awareness, the Companies Act also requires continuous dissemination of information to the shareholders in the form of a number of corporate documents such as: annual reports, minutes of general meetings and Board meetings, auditor’s report, Board’s report, etc.

b. Disclosure and Transparency Requirements

The Companies Act affirms that disclosure and transparency form an integral part of corporate governance and thus, information about the company and its activities has to be provided to the shareholders, registrar of companies and to the stock exchanges in the form of annual report and other corporate documents mentioned above. The annual accounts of the company are required to be certified by auditors, who are appointed at the general meetings.

c. Responsibilities of the Board

The Board of a company is appointed at the general meeting, with each director’s appointment to be approved by majority of the shareholders present and voting. Similarly, the shareholders can remove a director by way of simple majority of shareholders. The whole time directors along with managing directors, manager, and secretary are classified as officers in default by the Companies Act. Even though the Board has general powers, consent of shareholders has been made mandatory for certain corporate decisions such as, further issue of capital, issuing shares at a discount, buy back of shares, reissuing of redeemed debentures, change of registered office within the state and issuing of inter-corporate loans. The Companies Act also contains provisions safeguarding the interests of shareholders in the event of oppression and mismanagement in the company.

Corporate Governance Mechanism Prescribed by Sebi

SEBI, being the securities market regulator in India has primary oversight on investor protection and its establishment played a significant role in establishing norms for the corporate governance in India. The SEBI Act, 1992 (“SEBI Act”) empowers SEBI to frame regulations, pursuant to which the regulator has introduced a comprehensive set of guidelines on insider trading, mergers and takeovers, fraudulent practices, etc all of which have a significant impact on corporate governance in the country.SEBI, as a market regulator, also decides the terms and conditions of listing agreement which govern the arrangement between stock exchanges and companies listed on the stock exchange. The listing agreement usually requires disclosures to be made by the company to the stock exchange. For instance, in terms of Clause 41 of the listing agreement, a company is required to submit quarterly financial results to the recognized stock exchange and these results are required to be approved by the Board of a company or by a committee (other than the audit committee). While doing this, the Chief Executive Officer and Chief Financial Officer of the company, (by whatever name called), is required to certify that the financial results do not contain any ‘false or misleading statement or figures and do not omit any material fact which may make the statements or figures contained therein misleading.’ The corporate governance standards are elaborated in Clause 49 of the listing agreement.Clause 49 of the listing agreement is the most significant recent development in Indian legal regime relating to corporate governance. This clause, introduced in 2000 and subsequently revised, details the standards of corporate governance which every listed company is required to adopt and follow. Clause 49 of the listing agreement prescribes various corporate governance mechanisms in the following subject areas:

a. Board of Directors and Independent Directors

The Board of a listed company is required to have an optimum number of executive and non-executive directors, with at least half of the Board comprising of non-executive directors. The clause defines an independent director and specifies the conditions which determine independence. Thus, the independent director is a person who:i. apart from director’s remuneration, does not have any material pecuniary relationships or transactions with the company, promoters, directors, senior management or the holding company, subsidiaries and associates;ii. is not related to the promoters or persons occupying management positions at the Board level or at one level below the Board.iii. has not been an executive of the company for immediately preceding three financial years or who is not a partner or an executive or was a partner or an executive during the preceding three years, of the statutory audit firm, internal audit firm, legal firm, consulting firm associated with the company.

The independent director is also not permitted to be a substantial shareholder of the company, i.e., owns two percent or more of the block of voting shares of the company. With respect to the composition of the Board, Clause 49 mandates that at least one third of the Board should comprise of independent directors, when the Chairman of the Board is a non-executive director or alternatively, at least half of the Board should comprise of independent directors, if Chairman of the Board is an executive director. Checks have also been placed on the scope of the power of directors by limiting the number of committees a director can be part of. Additionally, the listing agreement requires the company to adopt a code of conduct laid down by the Board, and ensure that such code is adhered to by the Board members and senior management of the company. SEBI is also fairly vigilant of the activities of independent directors and in a recent case, has also held that independent directors can be held liable for the misleading and fictitious financial statements published by the company. While responding to the argument that independent directors are not involved or aware of the day-to-day functioning of the company, SEBI observed that “the institutions of independent directors and audit committee have been established to promote corporate governance and enhance the protection of interests of investors”.

The SEBI order also states that:“While the extent of responsibility of an independent director may differ from that of an executive director, an independent director has a duty of care. This duty calls for exercise of independent judgment with reasonable care, diligence and skill which should be reasonably exercised by a prudent person with the knowledge, skill and experience which may reasonably be expected of a director in his position ….By failing to ask the right questions at the right point of time, I find that the notices have failed in their duty of care as an independent director."

b. Audit Committees

The audit committee, which oversees companies’ financial reporting process and necessary financial disclosures, is required to be helmed by an independent director. In order to ensure that the audit committee functions in an independent manner, two–thirds of the directors on the committee have to be independent directors.

c. Subsidiary Companies

The presence of at least one independent director of the holding company, on the Boards of a material non-listed subsidiary company has been made compulsory by Clause 49. The financial statements, particularly investments made by the unlisted subsidiary company are also required to be reviewed by the above mentioned audit committee.

d. Disclosures

Clause 49 of the listing agreement requires listed companies to make periodical disclosures of related party transactions, accounting treatment, risk management, remuneration of directors, management related matters, appointment and reappointment of directors and utilization of proceeds from public issues, rights issues, preferential issues etc.

e. Report on Corporate Governance

A separate section, with a detailed compliance report on corporate governance, is required to be included in the annual reports of the company. A quarterly compliance report, as per the format in the listing agreement, is also required to be submitted to the stock exchange within 15 days from the close of quarter as per a specific format.

f. Compliance

Lastly, the company is required to obtain an annual certificate from either the auditors or practicing company secretaries regarding compliance of conditions of corporate governance, which is then sent to the shareholders and stock exchanges.

Governmental Initiatives – Measures by MCA

MCA is the executive arm which regulates the functioning of the corporate sector. It primarily administers the Companies Act and other allied acts, such as the Competition Act, 2002, Partnership Act, 1932, Companies (Donations to National Funds) Act, 1951 and Societies Registration Act, 1860. The MCA also exercises supervision over three separate bodies, established by the Parliament, concerned with the professions of Chartered Accountants, Company Secretaries and Cost Accountants respectively. As the primary government body, MCA has taken a number of steps in establishing the standards for corporate governance in the country. Some of the key initiatives taken by MCA are highlighted below:

a. Voluntary Guidelines on Corporate Governance

MCA introduced the Voluntary Guidelines on Corporate Governance in 2009 (“Guidelines”), a set of best practices to develop ethical and responsible standards in the Indian industry. The Guidelines are completely voluntary in nature but are strongly recommended by the government to all public companies and large private companies as well. The guidelines relate to various issues such as: the constitution of Board (appointment, role of independent directors, remuneration); the responsibilities of the Board (training, enabling quality decision making, risk management, evaluation of performance, compliance); audit committees of Board (constitution, enabling powers, role and responsibilities); and auditors (appointment, certificate of independence, rotation); secretarial audit; whistle blowers, etc.

b. Green Initiatives

A number of green initiatives have also been recently introduced, such as: (i) service of documents through electronic mode to increase the speed of delivery, (ii) participation of directors and shareholders through video conferencing to provide larger participation and for curbing the cost borne to attend various meeting , (iii) secure electronic voting in the general meetings of the company and (iv) issuance of digital certificates and standard letters by the Registrar of Companies (“ROCs”) to reduce the delay.

c. Serious Fraud Investigation Office (“SFIO”)

In 2003, SFIO was set up in the backdrop of stock market scams, failure of non-financial banking companies, phenomena of vanishing companies and plantation companies. The office investigates cases which have inter-departmental and multi-disciplinary ramifications or public interest at stake or the possibility of investigation contributing towards an improvement in systems, laws or procedures. The investigation is carried out only when it has been referred by the Central Government under section 235 and 237 of the Companies Act.

d. Investor Grievances Management Cell (“IGMC”)

IGMC, earlier known as the Investor Protection Cell, was set up by the MCA in 1993 with the objective of resolving the grievances of investors’ through the jurisdictional ROCs. IGMC coordinates with the RBI, SEBI and Department of Economic Affairs and broadly, deals with issues like non receipt of annual report, non- receipt of dividend amount, non- refund of application money, etc. Recently, MCA has also permitted the use of MCA-21, an online portal, to receive grievances online.

e. National Foundation for Corporate Governance (“NFCG”)

NFCG, the national apex platform on corporate governance issues, was established in 2003 by the MCA to act as a platform for deliberation on issues relating to corporate governance and sensitize corporate leaders on the importance of “good corporate governance, self-regulation and directorial responsibilities”. Along with MCA, the other stakeholders in NFCG are: Confederation of Indian Industry, Institute of Chartered Accountants of India, Institute of Company Secretaries of India, Institute of Cost and Works Accountants of India and National Stock Exchange of India Limited.

Changes on the Anvil

The MCA is proposing to replace the extant Companies Act with the Companies Bill, 2011 (“Companies Bill”), which is currently under the review of the Union Cabinet. The Companies Bill substantially reworks the framework of Companies Act and places greater emphasis on corporate governance norms and shareholder interests.

Some of the key features of the Companies Bill have been highlighted below:

(i) The Companies Bill contains provisions relating to roles and responsibilities of independent directors, whose roles and responsibilities are currently featured only in Clause 49 of the listing agreement. Under the Companies Bill, one third of the directors of a company are required to be independent directors.

(ii) The Companies Bill also proposes to empower the Central Government to prescribe minimum number of independent directors in case of public companies and subsidiaries of any public company which are not listed.

(iii) The Companies Bill recognizes the importance of disclosures in corporate governance and hence, provides for additional disclosures by the Boards such as disclosure relating to directors’ remuneration, shareholding pattern, etc.

(iv) Additionally, the Companies Bill also proposes to introduce the concept of class action suits, which would empower member shareholders associations or group of shareholders to take legal action in case of any fraudulent action on the part of a company.

That said, the Companies Bill has not yet been tabled before the Parliament and will only come into force once it has been passed by both Houses of Parliament in India, i.e., the Lok Sabha and the Rajya Sabha. Recently, the Union Cabinet deferred a decision on the Companies Bill due to various existing open issues in the provisions of the Companies Bill.As is the case globally, even in India, compliance of corporate governance norms by a company is often a matter of subjective analysis and companies routinely have to face various practical constraints in implementing the applicable corporate governance framework. That said, although implementation of the Companies Bill is still a distant development, Clause 49 of the listing agreement, coupled with SEBI’s regulatory oversight, continue to serve as the underpinnings of corporate governance in India.In a discussion paper on October 4, 2016, the markets regulator had proposed that such agreements should have prior approval of the company’s board as well as shareholders through an ordinary resolution. It also provided for continuation of such existing arrangements on dissemination of information to stock exchanges, besides seeking shareholder nod at the following general meeting. All such agreements would have to be discontinued if shareholders did not agree to the agreement.Commenting on the issue UK Sinha, Chairman, SEBI, had then said: “We came across an instance... if the price goes up beyond a certain level then the managing director would be given an incentive.... it was like a private benefit in a listed company. That we plan to attack. We are concerned about such kind of agreements. We will come out with a discussion paper soon."

Angel funds Easing the procedures for angel investment in India is also likely to come up. This will include relaxation of lock-in period of investment to one year from three years, increasing the maximum age of investee companies to five years from three. There are plans to amend the upper limit of the number of angel investors in a scheme to 200. Currently, the upper limit is 49.FPIs: unlisted securitiesThe regulator may allow angel funds to make overseas investments of up to 25 per cent of their investible corpus, in line with other Alternative Investment Funds (AIFs).The move will help such funds spread their risk by investing across geographies. Rules governing FPI investment in unlisted securities are also likely to be discussed at the SEBI meet. It may be recalled that SEBI, at its board meeting in September, had allowed FPIs to directly trade in corporate bonds, without going through any broker or other intermediary.Norms for portfolio managersAlso on the anvil are additional disclosures in scheme-related documents, such as the scheme’s top holdings, tenure of the fund manager managing the concerned scheme, portfolio turnover ratio of the scheme and investments by key personnel in concerned schemes by the fund house.