Naresh Chandra reports: A pale shadow of SOX

Amit C. Kamath

IN THE last few months most business newspapers and magazines have been occupied with the reports of the Naresh Chandra Committee Report, also called the Committee on Corporate audit and Governance !hile ac"nowledging the efforts of the Committee and its implications in the area of corporate governance, financial reporting standards, compan# law, auditing, and business ethics, a million dollar $uestion is% &'re these recommendations good enough(& This $uestion is highl# relevant for if the media the business fraternit# and professional bodies appear to be showering praise on the Committee)s recommendations, the average ta*pa#er merel# e*pects to see an end to the saga of corporate scams being unearthed month after month +assive debacles in recent times involve a whole host of well,"nown companies including the +ardia Group, -l#ods, +odern, .athe/a Group, .arasrampuria Group, Core Healthcare, Ra/inder Group 0 all names that appear in the Reserve 1an" of India)s Rs 223,333,crore list of defaulters The 4epartment of Compan# 'ffairs !eb site, www.dca.nic.in, lists a set of companies, that had vanished after issuing shares to the general public for Rs 2256 76 crore 8as on 9ul# :7, :336; !hile the small fish have $uietl# disappeared, the larger ones are fighting length# court battles with ban"s, financial institutions and creditors to prevent seizure of assets, which has been made possible b# the <ecuritisation and Reconstruction of =inancial 'ssets and Enforcement of <ecurit# 'ct, :33: The end result in most cases is that ban" are re$uired to waive interest arrears and accept a paltr# sum per month towards principal repa#ment !hile the general public is further humbled with no return on the share capital or repa#ment of fi*ed deposits !hen somewhat similar events occurred in the >< 0 Enron !orldCom, ?ero* and so on 0 the response of the 'dministration came thic" and fast with the introduction of <arbanes,@*le# 'ct, :33: Considering the size of the scams and the nature of the corporations involved, economies world over followed the >< wa# b# reviewing their e*isting corporate legislation and reporting

standards This tas" needed to be underta"en with utmost care, as there was no standard formula, which would appl# to one and all Each econom# was re$uired to review its law and financial s#stem to identif# the loopholes @nce this was complete, a new set of rules was devised b# amending the provisions of the compan# law, accounting and auditing standards and so on !ith the <arbanes,@*le# 'ct, we will now attempt to understand the thin"ing that led to these changes in law and accounting practices in the ><, the >A and Canada The aim of this e*ercise is also to compare these findings with the Naresh Chandra Committee Report The <arbanes,@*le# 'ct contains four ma/or sections% B B B B Corporate Responsibilities of +anagement and 'udit Committees Enhancement of =inancial 4isclosure Independence of 'uditors and 'udit Committees Role of .ublic Compan# 'ccounting @versight 1oard

The interesting aspect of this 'ct is in its scope, which covers most parties involved in managing the affairs of a compan# 0 board of directors, auditors, attorne#s, emplo#ees or an#one appointed in a decision,ma"ing role !hile auditors have been made well aware about their duties and obligations, it is the board of directors and officers of companies who need to stand up and ta"e notice of their duties and obligations through the Compan# @versight 1oard <ection 63: re$uires the board to certif# that re$uired disclosures to independent auditors and audit committees about fraud, significant deficiencies and material wea"ness in financial statements have been made In failing to do so, the directors stand to be personall# liable for misleading users of annual reports In the >A, the amendment to the Companies 'ct provides imprisonment and fines to directors guilt# of misleading auditors In Canada, there is the Canada 1usiness Corporation 'ct, which outlines stringent penalties for directors guilt# of breaching their fiduciar# duties towards the compan# The Canadian 1an"ruptc# and Insolvenc# 'ct can also ma"e directors of defaulting companies /ointl# and severall# liable for compan# debts !hat has the Naresh Chandra Committee done( The Committee)s report contains the following% B The auditor,compan# relationship B 'uditing the auditors B Independent directors% Role, remuneration and training
Other recommendations

!hile it is worthwhile ac"nowledging that the Committee did come up with

some interesting findings despite being restricted in their scope of wor" which is &to e*amine if the present s#stem of regulation of the profession of Chartered 'ccountants, Compan# <ecretaries and Cost 'ccountants is sufficient and has served well the concerned sta"eholders, especiall# the small investors, and whether there is advantage in setting up an independent regulator 8along the lines of recentl# passed <arbanes,@*le# 'ct :33: in the ><; and if so what shape should the independent regulator ta"e & It has obviousl# missed the point when it comes to e*amining the ever, increasing international evidence on C4irector)s -iabilit#) and in considering the need for such provision in Indian legislation @n the topic of 4irectors -iabilit#, the report merel# adopts the definition for independent directors as given b# the Aumar +angalam 1irla Committee and proceeds to absolve independent directors of an# personal liabilit# This provision would have come as a surprise to India)s compan# law e*perts who will "now that independent directors are ones who do not have &an# material pecuniar# relationship or transactions with the compan#, its promoters, its management or its subsidiaries& !hile in the !estern world most compan# directors are trul# outsiders, in India the scene is different with most compan# boards dominated b# famil# members The true independent directors happen to nominees of ban"s and financial institutions who, however, can easil# be marginalised !hat happens to Cnon,independent) or Cnon,e*ecutive) directors in the event of an Enron, li"e situation in India( CNothing) would be the right answer In the light of this argument, the Committee)s recommendation have ver# little hope of safeguarding the interests of investors and in terms of finding a method of recovering crores of rupees that have been siphoned off from companies funds into the private poc"ets of its directors 'n opportunit# to undo the mista"es of the past has gone abegging >nless an alternative solution is shortl# found, the corporate world will /ust operate as it used to from the good old past b# either fighting investors in court or better still b# simpl# vanishing 8The author is a New Dealand based academic and freelance writer He can be contacted at amit"amathEnzF#ahoo co nz;

Executive Summary
The initial stimulus for corporate governance reforms came after the South-East and East Asian crisis of 1997-98. Governments multilateral institutions !an"s and #

companies recalled that the devil la$ in the details % the nitt$-gritt$ of transactions among companies !an"s financial institutions and capital mar"ets& corporate la's !an"ruptc$ procedures and practices& the structure of o'nership and cron$ capitalism& stoc" mar"et practices& poor !oards of directors 'ith scant fiduciar$ responsi!ilit$& poor disclosures and transparenc$& and inade(uate accounting and auditing standards. 2. )ndia has not !een in the middle of this glo!al and Asian reform movement as a reaction to corporate and financial crises. *irst unli"e South-East and East Asia this movement did not start !ecause of a national or region-'ide macroeconomic and financial collapse. )ndeed the Asian crisis !arel$ touched )ndia. Secondl$ unli"e other Asian countries the initial drive for !etter corporate governance and disclosure perhaps as a result of the 1992 stoc" mar"et +scam, and the onset of international competition conse(uent on the li!eralisation of econom$ that !egan in 199- came from all-)ndia industr$ and !usiness associations and in the .epartment of /ompan$ Affairs. Thirdl$ from April 2--1 listed companies in )ndia need to follo' ver$ stringent guidelines on corporate governance 'hich ran" among some of the !est in the 'orld. Sadl$ there is a 'ide gap !et'een prescription and practice. 0orse adverse legal conse(uences for the defaulters almost al'a$s get caught in the 'e! of inefficienc$ corruption and the intricate dilator$ legal s$stem. Thus 'hile corporate governance reforms in )ndia far outstrips that of man$ other countries the performance in either lags ver$ much !ehind. #. After the Enron de!acle of 2--1 came other scandals involving large 1S companies such as 0orld/om 2'est Glo!al /rossing and the auditing lacunae that eventuall$ led to the collapse of Andersen. These scandals triggered another phase of reforms in corporate governance accounting practices and disclosures % this time more comprehensive than ever !efore. )n 3ul$ 2--2 less than a $ear from the date 'hen Enron filed for !an"ruptc$ the Sar!anes-45le$ 6ill 7popularl$ called S489 'as enacted. The Act !rought 'ith it fundamental changes in virtuall$ ever$ area of corporate governance % and particularl$ in auditor independence conflicts of interest corporate responsi!ilit$ enhanced financial disclosures and severe penalties !oth fines and imprisonment for 'ilful default !$ managers and auditors. )t is fair to predict that the S48 Act 'ill do more to change the contours of !oard structure auditing financial reporting and corporate disclosure than an$ other previous la' in 1S histor$. :. 4n 21 August 2--2 the .epartment of /ompan$ Affairs 7./A9 under the ;inistr$ of *inance and /ompan$ Affairs appointed this <igh =evel /ommittee to

e5amine various corporate governance issues. Among others this /ommittee has !een entrusted to anal$se and recommend changes if necessar$ in diverse areas such as>

the statutor$ auditor-compan$ relationship so as to further strengthen the professional nature of this interface& the need if an$ for rotation of statutor$ audit firms or partners& the procedure for appointment of auditors and determination of audit fees& restrictions if necessar$ on non-audit fees& independence of auditing functions& measures re(uired to ensure that the management and companies actuall$ present +true and fair, statement of the financial affairs of companies& the need to consider measures such as certification of accounts and financial statements !$ the management and directors& the necessit$ of having a transparent s$stem of random scrutin$ of audited accounts& ade(uac$ of regulation of chartered accountants compan$ secretaries and other similar statutor$ oversight functionaries& advantages if an$ of setting up an independent regulator similar to the ?u!lic /ompan$ Accounting 4versight 6oard in the S48 Act and if so its constitution& and the role of independent directors and ho' their independence and effectiveness can !e ensured.

@. As is evident the terms of reference to this /ommittee 7Appendi5 19 lie at the heart of corporate governance. Given !elo' are the recommendations of the /ommittee.

Recommendations in Chapter 2: The Auditor Company Relationship

A. The /ommittee !elieves that the propriet$ of auditors rendering non-audit services is a comple5 area 'hich needs to !e carefull$ dealt 'ith "eeping in vie' the t'in o!Bectives of maintaining auditor,s independence and ensuring that clients get the !enefit of efficient high (ualit$ services. 7. <aving said this the /ommittee !elieves that certain t$pes of non-audit services could impair independence of the auditor and possi!l$ affect the (ualit$ of audit. )t also !elieves that given the times and the 'ell-pu!licised failure of an auditing firm as large as Andersen some Budicious prohi!itions are in order.

8. An auditor 'ho depends upon a single audit client for a siCea!le portion of annual revenues ris"s compromising his independence. The /ommittee therefore concluded that certain recommendations in this regard 'ere also in order. Recommendation 2.1: Disqualifications for audit assi nments In line with international best practices, the Committee recommends an abbreviated list of disqualifications for auditing assignments, which includes: Prohibition of any direct financial interest in the audit client by the audit firm, its partners or members of the engagement team as well as their direct relatives. This prohibition would also apply if any relative of the partners of the audit firm or member of the engagement team has an interest of more than per cent of the share of profit or equity capital of the audit client. Prohibition of receiving any loans and/or guarantees from or on behalf of the audit client by the audit firm, its partners or any member of the engagement team and their direct relatives. Prohibition of any business relationship with the audit client by the auditing firm, its partners or any member of the engagement team and their direct relatives. Prohibition of personal relationships, which would e!clude any partner of the audit firm or member of the engagement team being a relative of any of "ey officers of the client company, i.e. any whole#time director, C$%, C&%, Company 'ecretary, senior manager belonging to the top two managerial levels of the company, and the officer who is in default (as defined by section ) of the Companies *ct+. In case of any doubt, it would be the tas" of the *udit Committee of the concerned company to determine whether the individual concerned is a "ey officer. Prohibition of service or cooling off period , under which any partner or member of the engagement team of an audit firm who wants to ,oin an audit client, or any "ey officer of the client company wanting to ,oin the audit firm, would only be allowed to do so after two years from the time they were involved in the preparation of accounts and audit of that client. Prohibition of undue dependence on an audit client . 'o that no audit firm is unduly dependent on an audit client, the fees received from any one client and its subsidiaries and affiliates, all together, should not e!ceed ) per cent of the total revenues of the audit firm. -owever, to help newer and smaller audit firms, this requirement will not be applicable to audit firms for the first five years from the date of commencement of their activities, and for those whose total revenues are less than .s./) la"hs per year. This recommendation has to be read with .ecommendation .0 below.

Note: A direct relative is defined as the individual concerned, his or her spouse, dependent parents, children or dependent siblings. For the present, the term relative is as defined under Schedule IA of the Companies Act. o!ever, the Committee believes that the Schedule IA definition is too !ide, and needs to be rationalised for effective compliance .

9. Section 2-1 of the S48 Act has disallo'ed eight t$pes of non-audit services 'ith the provision to disallo' more as ma$ !e determined !$ the ne'l$ legislated ?u!lic /ompan$ Accounting 4versight 6oard. ;ost of these restrictions e5ist in )ndia. *or e5ample the )/A) prohi!its its mem!ers as auditing firms from offering services such as !oo""eeping maintaining accounts internal audit designing an$ information s$stem 'hich is a su!Bect of audit or internal audit !ro"ering investment advisor$ and investment !an"ing services. Even so the /ommittee !elieves that it is necessar$ to provide an e5plicit list of prohi!ited non-audit services Recommendation 2.2: !ist of prohi"ited non#audit ser$ices The Committee recommends that the following services should not be provided by an audit firm to any audit client: *ccounting and boo""eeping services, related to the accounting records or financial statements of the audit client. Internal audit services. &inancial information systems design and implementation, including services related to IT systems for preparing financial or management accounts and information flows of a company. *ctuarial services. 1ro"er, dealer, investment adviser or investment ban"ing services. %utsourced financial services. 2anagement functions, including the provision of temporary staff to audit clients. *ny form of staff recruitment, and particularly hiring of senior management staff for the audit client. 3aluation services and fairness opinion. Further in case the firm underta"es an# service other than audit, or the prohibited services listed above, it should be done onl# !ith the approval of the audit committee.

1-. The /ommittee has no (ualms per se a!out audit firms having su!sidiaries or associate companies engaged in consulting or other specialised !usiness services. )t ma"es a great deal of sense for good auditors to 'iden their horiCons !$ occasionall$ engaging in !usiness consulting Bust as it does for !usiness consultants to occasionall$ get involved in the nitt$-gritt$ of auditing. <o'ever it is also a fact that such affiliations could cause potential threats to auditor independence and therefore it 'ould !e prudent to create realistic safeguards against such contingencies. <ence the follo'ing recommendation.

Recommendation 2.%: &ndependence Standards for Consultin 'ntities that are Affiliated to Audit (irms

and Other

Prohibition of undue dependence. 4here an audit firm has subsidiary, associate or affiliated entities, yardstic" of no more than ) per cent of revenues coming from a single audit client stated in .ecommendation ./ should be widened to accommodate the consolidated entity. Thus, no more than ) per cent of the revenues of the consolidated entity should come from a single corporate client with whom there is also an audit engagement. The other prohibitions listed in .ecommendation ./ should also apply in full to all affiliated consulting and specialised service entities of any audit firm that are either subsidiaries of the audit firm, or have common ownership of over )5 per cent with the audit firm. *nd all the tests of independence outlined in .ecommendation ./ should be carried over to the consolidated entity. Therefore, this recommendation has to be read with .ecommendation ./.

Consolidation tests should test full#, line$b#$line, for all subsidiaries, !hether the audit firm, or its partners, o!n over %& per cent of e'uit#, or share of profit. 11. The /ommittee deli!erated at length the issue of rotation of auditors. )t heard the vie's of t'o distinct schools of thought> the minorit$ 'hich !elieved in the compulsor$ rotation of audit firms 7a nota!le proponent !eing the office of /AG9& and the maBorit$ 'hich 'as against it. Given international practice and the fact that there is no conclusive proof of the gains 'hile there is sufficient evidence of the ris"s the Committee decided not to recommend any statutory rotation of audit firms . However, in line with the SOX Act, the Committee is in favour of compulsory rotation of audit partners. Recommendation 2.): Compulsor* Audit +artner Rotation There is no need to legislate in favour of compulsory rotation of audit firms. -owever, the partners and at least )5 per cent of the engagement team (e!cluding article cler"s and trainees+ responsible for the audit of either a listed company, or companies whose paid#up capital and free reserves e!ceeds .s./5 crore, or companies whose turnover e!ceeds .s.)5 crore, should be rotated every five years. *lso, in line with the provisions of the $uropean 6nion and the I&*C, persons who are compulsorily rotated could, if need be, allowed to return after a brea" of three years.

12. )n ensuring rectitude nothing 'or"s li"e disclosures. The guidance D0hen in dou!t discloseE is pro!a!l$ the simplest and !est $ardstic" for evaluating good corporate governance. <ence the follo'ing recommendation.

Recommendation 2.,: Auditor-s disclosure of contin ent lia"ilities It is important for investors and shareholders to get a clear idea of a companys contingent liabilities because these may be significant ris" factors that could adversely affect the corporations future health. The Committee recommends that management should provide a clear description in plain $nglish of each material liability and its ris"s, which should be followed by the auditors clearly worded comments on the managements view. This section should be highlighted in the significant accounting policies and notes on accounts, as well as, in the auditors report, where necessary.

1#. A (ualification can !e a serious indictment of the financial affairs and management of a compan$. Fet far too fe' shareholders reall$ understand 'hat a (ualification means and companies are hardl$ ever (uestioned !$ regulators such as the SE6) and the ./A regarding such (ualifications. The /ommittee !elieves that this must change % and the onl$ 'a$ of doing so is !$ mandating disclosures to a greater degree. Recommendation 2..: consequent action Auditor-s disclosure of qualifications and

7ualifications to accounts, if any, must form a distinct, and adequately highlighted, section of the auditors report to the shareholders. These must be listed in full in plain $nglish 8 what they are(including quantification thereof+, why these were arrived at, including qualification thereof, etc. In case of a qualified auditors report, the audit firm may read out the qualifications, with e!planations, to shareholders in the companys annual general meeting. It should also be mandatory for the audit firm to separately send a copy of the qualified report to the .%C, the '$1I and the principal stoc" e!change (for listed companies+, about the qualifications, with a copy of this letter being sent to the management of the company. This may require suitable amendments to the Companies *ct, and corresponding changes in The Chartered *ccountants *ct.

1:. The /ompanies Act ma"es it more difficult to replace an auditor than to reappoint one. 0hile this is as it should !e the /ommittee felt that corporate governance 'ould !enefit from disclosing the reasons for replacement. The /ommittee felt that if the management 'ere to !e more accounta!le to the shareholders and the audit committee in the matter of replacing auditors this is li"el$ to ma"e the auditors more fearless.

Recommendation 2./: 0ana ement-s certification in the e$ent of auditor-s replacement 'ection ) of the Companies *ct needs to be amended to require a special resolution of shareholders, in case an auditor, while being eligible to re#appointment, is sought to be replaced. The e!planatory statement accompanying such a special resolution must disclose the managements reasons for such a replacement, on which the outgoing auditor shall have the right to comment. The *udit Committee will have to verify that this e!planatory statement is true and fair

1@. The /ommittee felt that it 'ill !e good practice for the audit firm to annuall$ file a certificate of independence to the Audit /ommittee andGor the !oard of directors of the client compan$. This 'ill help in ensuring that the auditors have retained their independence throughout their period of engagement. Recommendation 2.1: Auditor-s annual certification of independence 1efore agreeing to be appointed (along with 9(/+(b++, the audit firm must submit a certificate of independence to the *udit Committee or to the board of directors of the client company certifying that the firm, together with its consulting and specialised services affiliates, subsidiaries and associated companies: /. are independent and have arms length relationship with the client company: . have not engaged in any non#audit services listed and prohibited in .ecommendation . above: and 0. are not disqualified from audit assignments by virtue of breaching any of the limits, restrictions and prohibitions listed in .ecommendations ./ and .0. In the event of an# inadvertent violations relating to (ecommendations ).*, ).) and ).+, the audit firm !ill immediatel# bring these to the notice of the Audit Committee or the board of directors of the client compan#, !hich is e,pected to ta"e prompt action to address the cause so as to restore independence at the earliest, and minimise an# potential ris" that might have been caused. 1A. The /ommittee felt that audit committees should !e allo'ed to !e true to their name !$ ensuring that the$ have a larger role 'ith regard to audit. )n fact this should !e the starting point in empo'ering audit committees. Therefore it recommends Recommendation 2.2: Appointment of auditors

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The *udit Committee of the board of directors shall be the first point of reference regarding the appointment of auditors. To discharge this fiduciary responsibility, the *udit Committee shall: discuss the annual wor" programme with the auditor: review the independence of the audit firm in line with .ecommendations ./, . and .0 above: and

recommend to the board, with reasons, either the appointment;re#appointment or removal of the e!ternal auditor, along with the annual audit remuneration. -,ceptions to this rule ma# cover government companies .!hich follo! section /*0 of the Companies Act1 and scheduled commercial ban"s .!here the (2I has a role to pla#1. 17. Section #-2 of the S48 Act specifies that the /E4 and /*4 of all listed companies must certif$ to the SE/ regarding the veracit$ of each annual and (uarterl$ financial report. The /ommittee e5amined the management certification issue in detail and concluded that it constitutes a good corporate governance practice. <o'ever it is not in favour of instituting criminal proceedings in the event of a misstatement. )nstead it felt that there should !e significantl$ enhanced penalties % ones that should act as credi!le deterrents. Recommendation 2.13: C'O and C(O certification of annual audited accounts &or all listed companies as well as public limited companies whose paid#up capital and free reserves e!ceeds .s./5 crore, or turnover e!ceeds .s.)5 crore, there should be a certification by the C$% (either the $!ecutive Chairman or the 2anaging <irector+ and the C&% (whole#time &inance <irector or otherwise+ which should state that, to the best of their "nowledge and belief: They, the signing officers, have reviewed the balance sheet and profit and loss account and all its schedules and notes on accounts, as well as the cash flow statements and the <irectors .eport. These statements do not contain any material untrue statement or omit any material fact nor do they contain statements that might be misleading. These statements together represent a true and fair picture of the financial and operational state of the company, and are in compliance with the e!isting accounting standards and;or applicable laws;regulations. They, the signing officers, are responsible for establishing and maintaining internal controls which have been designed to ensure that all material information is periodically made "nown to them: and have evaluated the effectiveness of internal control systems of the company. They, the signing officers, have disclosed to the auditors as well as the *udit Committee deficiencies in the design or operation of internal controls, if any, and what they have done or propose to do to rectify these deficiencies.

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They, the signing officers, have also disclosed to the auditors as well as the *udit Committee instances of significant fraud, if any, that involves management or employees having a significant role in the companys internal control systems. They, the signing officers, have indicated to the auditors, the *udit Committee and in the notes on accounts, whether or not there were significant changes in internal control and;or of accounting policies during the year under review. In the event of any materially significant misstatements or omissions, the signing officers will return to the company that part of any bonus or incentive# or equity#based compensation which was inflated on account of such errors, as decided by the *udit Committee.

Recommendations from Chapter : Auditin! the Auditors

18. The /ommittee deli!erated long and hard on the issue of 'hether it 'as necessar$ to esta!lish a ne' independent ?u!lic 4versight 6oard 7?469 for supervising the 'or" of auditors % such as the one proposed in the S48 Act. 4n !alance the /ommittee felt that there is no need at this point of time to set up $et another ne' regulator$ oversight !od$. <o'ever the /ommittee felt that there is a need to esta!lish an efficient and professional !od$ 'hich can !e entrusted to provide transparent and e5peditious auditing (ualit$ oversight. This 'ill !e in the interest of investors the general pu!lic and the professionals themselves. 0ith these considerations in mind the /ommittee has recommended the setting up of independent 2ualit$ Hevie' 6oards. Recommendation %.1: Settin up of independent 4ualit* Re$iew 5oard

There should be established, with appropriate legislative support, three independent 7uality .eview 1oards (7.1+, one each for the IC*I, the IC'I and IC4*I, to periodically e!amine and review the quality of audit, secretarial and cost accounting firms, and pass ,udgement and comments on the quality and sufficiency of systems, infrastructure and practices. In the interest of realism, the 7.1s should, for the initial five years, focus their audit quality reviews to the audit firms, which have conducted the audit for the top /)5 listed companies, ran"ed according to mar"et capitalisation as on 0/ 2arch. <epending upon the record of success of such reviews, the <C* may subsequently consider altering the sample si=e or criterion. Composition of "CA"#s $R%: The board shall consist of // members, including the chairman. The chairman shall be nominated by the <C*, in consultation with, but not necessarily from, the IC*I. &ive members of the board, e!cluding the chairman, shall be nominated by the <C* who will be people of eminence, professional reputation and integrity including, but not limited to, nominees of the Comptroller and *uditor#>eneral of India, .1I, '$1I, members or office# bearers of the 1ombay 'toc" $!change or the ?ational 'toc" $!change, the three ape! trade and industry associations (CII, &ICCI and *''%C-*2+, reputed educational and research institutions, ban"ers, economists, former public officials and business e!ecutives. The remaining five members of the 1oard will be nominated by the Council of the IC*I.

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Composition of "CS"#s $R%: * five#member board, including the chairman. The chairman shall be nominated by the <C*, in consultation with, but not necessarily from, the IC'I. Two members, e!cluding the chairman, shall be nominated by the <C*, who will have the same attributes suggested for IC*Is 7.1 above. The remaining two members will be nominated by the Council of the IC'I. Composition of "C&A"#s $R%: * five#member board, including the chairman. The chairman shall be nominated by the <C*, in consultation with, but not necessarily from, the IC4*I. Two members, e!cluding the chairman, shall be nominated by the <C*, who will have the same attributes suggested for IC*Is 7.1 above. The remaining two members will be nominated by the Council of the IC4*I. 'undin!: $ach of these 7.1s will be funded by their respective institutes in a manner that will enable it to discharge its functions adequately. Appellate forum: In the instance of a dispute between the findings of the 7.1s and reviewees, the matter should be referred to an appropriate appellate forum. This appellate forum should be the same as that suggested for disciplinary matters, which is discussed in .ecommendation 0. below.

19. The area of disciplinar$ mechanism of the audit profession re(uires careful consideration. According to man$ 'ho interacted 'ith the /ommittee the )/A) despite !est intentions seems to have !een una!le to adBudicate disciplinar$ cases 'ithin reasona!le time. Similar concerns 'ere e5pressed a!out the other t'o institutions though the num!er of cases is fe'er in their case. 2-. The pro!lems according to the /ommittee are not those of the la' !ut of la',s dela$s. ?rocedures framed under the /hartered Accountants Act have not !een a!le to cope 'ith the changed scenario that must deal 'ith comple5 !usinesses and over 7- --practicing mem!ers. The confidence of the investing pu!lic and other sta"eholders cannot !e nurtured unless disciplinar$ cases are dealt 'ith much more e5peditiousl$ and 'ith greater transparenc$. Accordingl$ the /ommittee recommends an entirel$ ne' disciplinar$ procedure 'hich 'hile "eeping the process 'ithin the frame'or" of the e5isting Acts 'ill !ring a!out greater independence and speed. Recommendation %.2: +roposed disciplinar* mechanism for auditors Classification of offences and mer!in! of schedules: *t present there are two schedules of offences and misconduct 8 with the second schedule requiring action by -igh Courts. These two schedules need to be merged, so that the Council is empowered to award all types of punishment for all types of offences. &urther, offences need to be categorised according to

1#

the severity of misconduct, so that processes can be designed, and punishments awarded, according to the severity of the offence. (rosecution )irectorate: *n independent permanent directorate within the structure of IC*I shall be created, which shall act as the @rosecution <irectorate. This office will e!clusively deal with all disciplinary cases and, hence, e!pedite the process of enquiry and decision#ma"ing by fully devoting its time and energy towards processing these cases. The office should be headed by a person of the level of <irector, and should be one with a legal bac"ground and conversant with the provisions of The Chartered *ccountants *ct and its regulations. -e and his office shall be independent of the electoral process of IC*I. 'uitable regulations need to be framed to uphold the independence of this office. The @rosecution <irectorate shall have the same powers as are vested in a civil court under the Code of Civil @rocedure, /A5B, regarding (i+ the discovery and production of any document: and (ii+ receiving evidence on affidavit. (rocedure for dealin! *ith complaint cases /. The complaints received in the appropriate form, manner, and complete in all respects, shall be registered by the @rosecution <irectorate, and sent to the member or firm within /) days of registration of such a complaint. . <epending on the category of the complaint, the @rosecution <irectorate shall as" for and obtain necessary documents such as written statements, re,oinders, comments, and other evidence from the complainant as well as the respondent. The time frame for this should be, under normal circumstances, no more than C5 days. ?ot submitting such documents within the prescribed time shall be treated as an offence, ris"ing the initiation of additional obstruction of ,ustice proceedings. 0. %n receipt of the relevant documents, the complaint, along with the views, if any, of the @rosecution <irectorate, will be placed before the <isciplinary Committee. This has to be done within 5 days of receiving all relevant accompanying documents. (rocedure for dealin! *ith information cases /. Information received shall be e!amined by the @rosecution <irectorate. *fter forming his views, the <irector of the @rosecution <irectorate will place the matter before the 'ecretary of IC*I. . If the 'ecretary agrees with the view e!pressed by the <irector, then the information case will be placed before the <isciplinary Committee. 0. In the event of the 'ecretary differing with the views of the <irector, the matter would be placed before the @resident of IC*I and, thereafter, it would be discussed at a meeting between the @resident, 'ecretary and the <irector. If in this meeting, it is decided to refer the matter to the <isciplinary Committee, then reference be made accordingly. 6pon such referral, the @rosecution <irectorate shall argue the case before the <isciplinary Committee. If, however, the 'ecretary and @resident of IC*I decide that the information should be filed and closed, then the <irector of the @rosecution <irectorate will have the choice to either follow the ma,ority opinion, or dissent and refer such a case to the <isciplinary Committee, with his as well as the 'ecretarys and @residents opinion. In such instances, however, the @resident shall not function as the @residing %fficer of the <isciplinary Committee. &urther, if the <irector @rosecution does not feel that a reference to the <isciplinary Committee is warranted, the

1:

Institute would still be free to ta"e such cases to the Committee if it feels there is a need to do so. 9. *fter registering the information case, the procedure outlined for the complaint case may be followed mutatis mutandis.

)isciplinary Committee $nquiries in relation to misconduct of members shall be held by the <isciplinary Committee. To e!pedite decision#ma"ing, the Council of IC*I shall be empowered to constitute one or more bench of the <isciplinary Committees in cities where there are regional headquarters of IC*I.

Composition: $ach bench should consist of five members. The @resident or the 3ice#@resident of IC*I will be the @residing %fficer. -owever, in information cases put before the Committee by the @rosecution <irector after disagreeing with the views of the @resident and the 'ecretary, the @resident shall not act as the @residing %fficer. In such cases, the 3ice#@resident will perform this role. Two of the other four members will be nominees of IC*Is Council, while the remaining two will be nominees of the <C* vi=. people of eminence, professional reputation and integrity such as, retired ,udges, ban"ers, professionals, educationists, economists, business e!ecutives, former members of regulatory authorities and former public officials. *s far as practicable, members of the <isciplinary Committee should be from the regions other than the one in which it is being constituted. It needs to be stated that in terms of the e,isting re'uirement, a nominee of the Central 3overnment is re'uired to be nominated to the 4isciplinar# Committee. 5ntil ver# recentl#, such a nominee !as an official of the 4CA. o!ever, 4CA officials have rarel# had the time to attend the meetings of the 4isciplinar# Committee. Hence, the Committee recommends that, given their pre-occupation in the department, a sitting government official should not be nominated to the Disciplinary Committee. It is pointed out that for each stage in the process, strict time lines should be prescribed. 6his is especiall# important in respect of scrutin# of information cases. $uorum: Three of the five members. Tenure: Co#terminus with the duration of the IC*I Council. 'unctions: The <isciplinary Committees shall hear the complaint and information cases referred by the @rosecution <irectorate and record their decisions and conclusions in a report. This report shall also record the punishment to be awarded, if any, to the member, which can constitute (i+ reprimand, (ii+ removing the name of the member either permanently or for such a period as thought fit, (iii+ monetary penalty, and;or (iv+ a combination of any two.

Council *ny report submitted by the <isciplinary Committee should normally be considered by the Council within 9) days from the date of the report. It shall be the duty of the Council of IC*I to

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act upon the decisions of the <isciplinary Committee. 4hile performing such a duty, the Council can: /. $ndorse the decisions of the <isciplinary Committee, and implement them. . .efer any case bac" to the <isciplinary Committee for further enquiry, when it finds that certain issues need further enquiry. -owever, in doing so, the Council will have to frame the specific issues. 0. <irect the @rosecution <irectorate to place the case before the *ppellate 1ody, in the event of the Council deciding to appeal against the decisions of the <isciplinary Committee.

Appellate %ody -eadquartered in ?ew <elhi, the *ppellate 1ody shall consist of a @residing %fficer and four other members. The @residing %fficer shall be a retired ,udge of the 'upreme Court or a retired Chief Dustice of a -igh Court. Two members shall be @ast @residents of IC*I, nominated by the Council. The remaining two shall be persons of eminence nominated by the <C* (but e!cluding any officer of the <epartment or member of the Council+. The quorum shall be three. (u+lication of decisions of the )isciplinary Committee <ue publicity shall be given by the @rosecution <irectorate about the punishment ultimately awarded, through periodicals, newsletters, website and any other means considered appropriate. -owever, no decision ta"en by the <isciplinary Committee be published unless and until the punishment is endorsed and implemented by the Council. 'undin! /. *ppellate 1ody: .equired funding arrangements should be made by the Central >overnment. This is essential for ensuring independence, and on the ground that the -igh Court stage can be said to have been always funded by the >overnment. . <isciplinary Committee: The e!penses shall be borne by IC*Is Council, which shall also fi! the emoluments, sitting fees, allowances, and other e!penses of the members. 0. @rosecution <irectorate: *ll e!penses will be borne by the Council of IC*I. :. $very complaint, other than a complaint made by or on behalf of the Central or any 'tate >overnment shall be accompanied by a fee .s.),555, which will be returned as soon as the <isciplinary Committee recommends that case is not frivolous. &ees not refunded for frivolous cases will be used to partly defray the cost of investigation. 21. )ndependent disciplinar$ mechanisms ma$ !e designed along similar lines for the other t'o )nstitutes namel$ the )nstitute of /ompan$ Secretaries of )ndia and the )nstitute of /ost and 0or"s Accountants of )ndia.

Recommendations from Chapter ,: "ndependent )irectors

1A

22. At the core of corporate governance is the !oard of directors. A Boint-stoc" compan$ is o'ned !$ the shareholders 'ho appoint a !oard of directors to supervise management and ensure that it does all that is necessar$ !$ legal and ethical means to e5pand the !usiness and ma5imise long-term corporate value. 2#. The first point to note is the one that is fre(uentl$ forgotten> the !oard is appointed !$ the shareholders and other "e$ sta"eholders. Simpl$ put directors are fiduciaries of shareholders, not of the management. This does not impl$ that the !oard must have an adversarial relationship 'ith the management. <o'ever in instances 'here the o!Bectives of management differ from those of the 'ide !od$ of shareholders the non-e5ecutive directors on the !oard must !e a!le to spea" in the interest of the ultimate o'ners discharge their fiduciar$ oversight functions& in short the$ should stand up and !e counted. This is 'h$ +independence, has !ecome such a critical issue in determining the composition of an$ !oard. /learl$ a !oard pac"ed !$ e5ecutive directors or friends of the promoter or /E4 can hardl$ !e e5pected to e5ercise independent oversight Budgement. 2:. After going through various international !est-in-class definitions of independence and "eeping in mind pragmatic factors the /ommittee came to the conclusion that the definition can !e made more precise than 'hat is contained in /lause :9 of the =isting Agreement 'ithout compromising the spirit or constraining the suppl$ of independent directors. Recommendation ).1: Definin an independent director /. *n independent director of a company is a non#e!ecutive director who: *part from receiving directors remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies: Is not related to promoters or management at the board level, or one level below the board (spouse and dependent, parents, children or siblings+: -as not been an e!ecutive of the company in the last three years: Is not a partner or an e!ecutive of the statutory auditing firm, the internal audit firm that are associated with the company, and has not been a partner or an e!ecutive of any such firm for the last three years. This will also apply to legal firm(s+ and consulting firm(s+ that have a material association with the entity. Is not a significant supplier, vendor or customer of the company: Is not a substantial shareholder of the company, i.e. owning per cent or more of the bloc" of voting shares: 17

. 0. 9.

). C.

E.

-as not been a director, independent or otherwise, of the company for more than three terms of three years each (not e!ceeding nine years in any case+: *n employee, e!ecutive director or nominee of any ban", financial institution, corporations or trustees of debenture and bond holders, who is normally called a nominee director will be e!cluded from the pool of directors in the determination of the number of independent directors. In other words, such a director will not feature either in the numerator or the denominator. 2oreover, if an e!ecutive in, say, Company F becomes an non#e!ecutive director in another Company G, while another e!ecutive of Company G becomes a non#e!ecutive director in Company F, then neither will be treated as an independent director.

The Committee recommends that the above criteria be made applicable for all listed companies, as well as unlisted public limited companies with a paid#up share capital and free reserves of .s./5 crore and above or turnover of .s.)5 crore and above with effect from the financial year beginning 550. 2@. The /ommittee felt that to !e reall$ effective independent directors need to have a su!stantial voice !$ !eing in a maBorit$. )t 'as felt that rather than the management or the promoters the /ommittee should put its 'eight !ehind minorit$ shareholders and other sta"eholders such as consumer or creditors. The committee therefore recommends that independent directors have ade(uate presence and strength on the 6oard especiall$ of the companies that are listed or !eing pu!lic companies a!ove a specific siCe. Recommendation ).2: +ercenta e of independent directors ?o less than )5 per cent of the board of directors of any listed company, as well as unlisted public limited companies with a paid#up share capital and free reserves of .s./5 crore and above, or turnover of .s.)5 crore and above, should consist of independent directors 8 independence being defined in .ecommendation 9./ above. -owever, this will not apply to: (/+ unlisted public companies, which have no more than )5 shareholders and which are without debt of any "ind from the public, ban"s, or financial institutions, as long as they do not change their character, ( + unlisted subsidiaries of listed companies. Nominee directors !ill be e,cluded both from the numerator and the denominator. 2A. /orporate governance norms re(uire companies to have a num!er of committees. 6oards of listed and large unlisted pu!lic limited companies also have greater fiduciar$ responsi!ilities. *or these reasons the committee felt that the la' should prescri!e a minimum !oard siCe as 'ell. Recommendation ).%: 0inimum "oard si6e of listed companies

18

The minimum board si=e of all listed companies, as well as unlisted public limited companies with a paid#up share capital and free reserves of .s./5 crore and above, or turnover of .s.)5 crore and above should be seven 8 of which at least four should be independent directors. -owever, this will not apply to: (/+ unlisted public companies, which have no more than )5 shareholders and which are without debt of any "ind from the public, ban"s, or financial institutions, as long as they do not change their character, ( + unlisted subsidiaries of listed companies. 27. The 6oards and their committees should not merel$ have meetings pro forma prior to a nice lunch. The shareholders have a right to "no' ho' much time the 6oard and its committees spent in discussing the shareholders, interest. The committee therefore recommends that duration of 6oardGcommittee meetings !e disclosed. Recommendation ).): Disclosure on duration of "oard meetin s 7 Committee meetin s The minutes of board meetings and *udit Committee meetings of all listed companies, as well as unlisted public limited companies with a paid#up share capital and free reserves of .s./5 crore and above or turnover of .s.)5 crore must disclose the timing and duration of each such meeting, in addition to the date and members in attendance. 28. The /ommittee feels that the (ualit$ of 6oard meetings is enhanced 'ith a fuller attendance. Since there are technological means availa!le to do so the /ommittee suggests that increased presence of mem!ers of the 6oard !e encouraged through tele and video conferencing su!Bect to certain safeguards. This might also reduce cost of 6oardG/ommittee meetings to the compan$. Recommendation ).,: 8ele#conferencin and $ideo conferencin If a director cannot be physically present but wants to participate in the proceedings of the board and its committees, then a minuted and signed proceedings of a tele#conference or video conference should constitute proof of his or her participation. *ccordingly, this should be treated as presence in the meeting(s+. -owever, minutes of all such meetings should be signed and confirmed by the director;s who has;have attended the meeting through video conferencing. 29. The /ommittee noted that !oth the 1997 Heport of the 0or"ing Group on the /ompanies Act and clause :9 of listing agreement list out ade(uatel$ the information that must !e placed !efore the !oard of directors. To ensure that as$mmetr$ of information for sta"eholders especiall$ shareholders is further reduced the committee recommends Recommendation )..: Additional disclosure to directors

19

In addition to the disclosures specified in Clause 9A under Information to be placed before the board of directors, all listed companies, as well as unlisted public limited companies with a paid#up share capital and free reserves of .s./5 crore and above, or turnover of .s.)5 crore and above, should transmit all press releases and presentation to analysts to all board members. This will further help in "eeping independent directors informed of how the company is pro,ecting itself to the general public as well as a body of informed investors. #-. )f audit committees are indeed to !e independent the$ should reall$ consist of onl$ independent directors. There 'ere dou!ts on the advisa!ilit$ of e5cluding nominee directors of financial institutions from audit committees. The /ommittee preferred to !e consistent in not considering directors 'ith a certain mandate to !e reall$ independent. Recommendation )./: &ndependent directors on Audit Committees of listed companies *udit Committees of all listed companies, as well as unlisted public limited companies with a paid# up share capital and free reserves of .s./5 crore and above, or turnover of .s.)5 crore and above, should consist e!clusively of independent directors, as defined in .ecommendation 9./. -owever, this will not apply to: (/+ unlisted public companies, which have no more than )5 shareholders and which are without debt of any "ind from the public, ban"s, or financial institutions, as long as they do not change their character, ( + unlisted subsidiaries of listed companies. #1. The committee has recommended that the role and functions that an audit committee is supposed to discharge in a compan$ is clearl$ laid out in an audit committee charter. Recommendation ).1: Audit Committee charter In addition to disclosing the names of members of the *udit Committee and the dates and frequency of meetings, the Chairman of the *udit Committee must annually certify whether and to what e!tent each of the functions listed in the *udit Committee Charter were discharged in the course of the year. This will serve as the Committees action ta"en report to the shareholders. This disclosure shall also give a succinct but accurate report of the tas"s performed by the *udit Committee, which would include, among others, the *udit Committees views on the adequacy of internal control systems, perceptions of ris"s and, in the event of any qualifications, why the *udit Committee accepted and recommended the financial statements with qualifications. The statement should also certify whether the *udit Committee met with the statutory and internal auditors of the company without the presence of management, and whether such meetings revealed materially significant issues or ris"s.

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#2. The ma5imum sitting fee permitted !$ the ./A is Hs.@ ---. The committee 'as repeatedl$ reminded that peanuts fetch mon"e$s. The /ommittee !elieves that companies cannot hope to get the !est talent unless the$ ma"e it 'orth'hile for professionals to e5tend their time and e5pertise. The committee 'as cautioned that far too much pa$ment ma$ itself impair independence Bust as over-reliance on a single client compromises the independence of auditors. <o'ever the committee felt that advantages of ade(uate remuneration re(uire government to revie' the position.

Recommendation ).2: Remuneration of non#e9ecuti$e directors The statutory limit on sitting fees should be reviewed, although ideally it should be a matter to be resolved between the management and the shareholders. In addition, loss#ma"ing companies should be permitted by the <C* to pay special fees to any independent director, sub,ect to reasonable caps, in order to attract the best restructuring and strategic talent to the boards of such companies. The present provisions relating to stoc" options, and to the / per cent commission on net profits, is adequate and does not, at present, need any revision. -owever, the vesting schedule of stoc" options should be staggered over at least three years, so as to align the independent and e!ecutive directors, as well as managers two levels below the 1oard, with the long#term profitability and value of the company.

##. Iot even the most stringent international tenet of corporate governance and oversight assumes that an independent director % 'ho interfaces 'ith the management for no more than t'o da$s ever$ (uarter % 'ill !e in the "no' of ever$ technical infringement committed !$ the management of a compan$ in its normal course of activit$. )ndeed ma"ing independent !oard mem!ers criminall$ lia!le for such infringements is a"in to assuming that the$ are no different from e5ecutive directors and the management of a compan$. This is certainl$ not so. )n fact the principle is (uite the opposite> independent directors are not managers& the$ are fiduciaries 'ho perform 'ider oversight functions over management and e5ecutive directors. #:. At a more practical level the /ommittee is of the opinion that it 'ould !e ver$ difficult to attract high (ualit$ independent directors on the !oards of )ndian companies if the$ have to constantl$ 'orr$ a!out serious criminal lia!ilities under different Acts.

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Recommendation ).13: '9emptin non#e9ecuti$e directors from certain lia"ilities Time has come to insert provisions in the definitions chapter of certain *cts to specifically e!empt non#e!ecutive and independent directors from such criminal and civil liabilities. *n illustrative list of these *cts are the Companies *ct, ?egotiable Instruments *ct, @rovident &und *ct, $'I *ct, &actories *ct, Industrial <isputes *ct and the $lectricity 'upply *ct. Independent directors should also be indemnified, as outlined in paragraph 9.)9 of the report, from costs of litigation etc. #@. A professional ma$ give e5cellent corporate advice that ma5imises long-term shareholder value !ut ma$ not !e a'are of the rights responsi!ilities duties and lia!ilities of a legal recognised fiduciar$. 1nderstanding such issues re(uires training. The /ommittee feels that if companies can afford to compensate their independent directors 'ell then the$ should !e a!le to provide them 'ith good training too. ./A has a special role in encouraging and promoting training programmes in leading )ndian institutions such as the )ndian )nstitutes of ;anagement and in the /entre for /orporate Governance that the$ intend to set up. Recommendation ).11: 8rainin of independent directors <C* should encourage institutions of prominence including their proposed Centre for Corporate $!cellence to have regular training programmes for independent directors. In framing the programmes, and for other preparatory wor", funding could possibly come from the I$@&. *ll independent directors should be required to attend at least one such training course before assuming responsibilities as an independent director, or, considering that enough programmes might not be available in the initial years, within one year of becoming an independent director. *n untrained independent director should be disqualified under section E9(/+(g+ of the Companies *ct, /A)C after being given reasonable notice. Considering that enough training institutions and programmes might not be available in the initial years, this requirement may be introduced in a phased manner, so that the larger listed companies are covered first. The e!ecuting bodies must clearly state their plan for the year and their funding should be directly proportionate to the e!tent to which they e!ecute such plans. There should be a trainee appraisal system to ,udge the quality of the programme and so help decide, in the second round, which agencies should be given a greater role and which should be dropped. Recommendations from Chapter 5: Other Recommendations

22

#A. The /ommittee 'as repeatedl$ reminded to !e careful not to increase compliance cost to companies as ultimatel$ not onl$ is this against the interest of shareholders !ut it has the danger of ma"ing )ndian industr$ uncompetitive. )n this connection a serious unnecessar$ cost noticed !$ the committee 'as the overlap and duplication !et'een the SE6) and ./A. The /ommittee has recommended removal of this overlap "eeping in mind t'o other principles. *irst su!ordinate legislation cannot override provisions enacted !$ ?arliament. Secondl$ the doctrine of +occupied space, needs to !e respected and complied 'ith. Recommendation ,.1: S'5& and Su"ordinate !e islation

'$1I may refrain from e!ercising powers of subordinate legislation in areas where specific legislation e!ists as in the Companies *ct, /A)C. If any additional requirements are sought to be prescribed for listed companies, then, in areas where specific provision e!ists in the Companies *ct, it would be appropriate for '$1I to have the requirement prescribed in the Companies *ct itself through a suitable amendment. In recognition of the fact that '$1I regulates activities in dynamic mar"et conditions, the <C* should respond to '$1Is requirements quic"ly. In case the changes proposed by '$1I necessitate a change in the Companies *ct, the <C* should agree to the requirement being mandated in clause 9A of '$1I regulation until the *ct is amended. It would be appropriate for '$1I to use its powers of subordinate legislation, in consultation with the <C*, and vice versa. *ll committees set up either by '$1I or <C* to consider changes in law, rules or regulations should have representatives of both '$1I and <C*. * formal structure needs to be set up to ensure that the <C*, which regulates all companies, and '$1I, which regulates only listed companies, act in coordination and harmony.

#7. Even 'hile 'e tr$ to move our econom$ and our companies to the 21 st centur$ the .epartment 'hich deals 'ith companies seems to !e firml$ moored in the past. )ts ph$sical strength and e(uipment have simpl$ not "ept pace 'ith either the times or 'ith the increased strength of companies in )ndia. The /ommittee therefore recommends a paradigm shift in the approach to staffing and e(uipping the .epartment of /ompan$ Affairs. /ompanies pa$ largel$ !$ 'a$ of fees appro5imatel$ Hs. #-- crores annuall$. )n recommending these increases the /ommittee is onl$ as"ing that services !e commensurate 'ith the income from fees charged. Recommendation ,.2: &mpro$in facilities in the DCA offices The >overnment should increase the strength of <C*s offices, and substantially increase the quality and quantity of its physical infrastructure, including computerisation.

2#

This should be accompanied by increased outsourcing of wor", contractual appointments of specialists and computerisation 8 all of which will reduce, though not eliminate, the need to increase the officer#level strength of the <epartment. The inspectionHcapacity of the <epartment needs to be increased sharply: inspections should be a regular administrative function, carried out largely on random basis. %fficers of the <C* need to go through refresher and training courses regularly. In view of the very dynamic world in which they function, continuous upgrading of their s"ills is essential

#8. *raudsters are enemies of !oth the sta"eholders that the$ cheat directl$ and of the corporate sector 'hich loses !ecause the fraudsters scare a'a$ e5isting and potential investors. /orporate frauds are so intricate that the$ can onl$ !e unravelled !$ a multidisciplinar$ tas" force. The /ommittee therefore suggest setting up a /orporate Serious *raud 4ffice 7/S*49 'ithout at this stage ta"ing a'a$ the po'ers of investigation and prosecution from e5isting agencies. A corporate frauds tas" force has !een set up recentl$ in the 1S. Recommendation ,.%: Corporate Serious (raud Office * Corporate 'erious &raud %ffice (C'&%+ should be set up in the <epartment of Company *ffairs with specialists inducted on the basis of transfer;deputation and on special term contracts. This should be in the form of a multi#disciplinary team that not only uncovers the fraud, but is able to direct and supervise prosecutions under various economic legislations through appropriate agencies. There should be a Tas" &orce constituted for each case under a designated team leader. In the interest of adequate control and efficiency, a Committee each, headed by the Cabinet 'ecretary should directly oversee the appointments to, and functioning of this office, and coordinate the wor" of concerned departments and agencies as described in paragraphs )./E and ). 5. Iater, a legislative framewor", along the lines of the '&% in the 6J, should be set up to enable the C'&% to investigate all aspects of the fraud, and direct the prosecution in appropriate courts.

#9. Good corporate governance is good !usiness !ecause it inspires investor confidence 'hich is so essential to attracting capital. All the confidence ho'ever that the good companies !uild and the good 'or" that the$ do over time can !e largel$ undone !$ a fe' unscrupulous !usinessmen and fl$-!$-night operators. Such e5ceptions re(uire to !e handed out deterrent punishments. The /ommittee felt that in doing so the ./A is hampered as there are several 'ea"nesses in la' 7the /ompanies Act 19@A9 2:

'hich the /ommittee feels need to !e rectified as an important step to'ards !etter corporate governance in )ndia. The principle that ill-gotten gains must !e disgorged from the 'rongful gainer needs to !e enshrined in the /ompanies Act. Recommendation ,.) @enalties ought to be rationali=ed, and related to the sums involved in the offence. &ees, especially late fees, can be related to the si=e of the company in terms of its paid#up capital and free reserves, or turnover, or both. <isqualification under section E9(/+(g+ of the Companies *ct, /A)C should be triggered for certain other serious offences than ,ust non#payment of debt. -owever, independent directors need to be treated on a different footing and e!empted as in the case of nominee directors representing financial institutions.

* stricter regime should be prescribed for companies registered as bro"ers with '$1I. >reater accountability should be provided for with respect to transfer of money by way of Inter Corporate <eposits, or advances of any "ind, from listed companies to any other company, as a necessary concomitant of the liberalisation that section 0E * of the Companies *ct, /A)C provides. <C*s prosecution wing needs to be considerably strengthened. 'treamlined procedures be prescribed in the Companies *ct, on the lines of the recent amendments to the Code of Civil @rocedure. To ensure that proceeds from illegal acts and frauds do not escape recovery, Companies *ct needs to be amended to give <C* the powers of attachment of ban" accounts etc., on the lines of the powers recently given to '$1I. Ill#gotten gains must be disgorged. 2anagers;promoters should be held personally liable when found guilty of offences. In such cases, the legal fees and other charges should be recovered from the officers in default, especially if the offences pertain to betrayal of shareholders trust, or oppression of minority shareholders. It is patently unfair that the shareholder is penalised twice, once when mulcted, and again to have to incur the legal e!penses to defend the fraudster. Consolidated &inancial 'tatements should be made mandatory for companies having subsidiaries.

:-. =ac" of !asic statutor$ compliance li"e filing returns 'ith the H4/ is a source of concern as it prevents the sta"eholders from discovering corporate mis-governance. The ina!ilit$ of H4/ offices to regularl$ file all the documents received !$ them ma"es the situation 'orse. Strengthening of H4/ offices to ensure !etter compliance has !een recommended else'here !$ this /ommittee. The converse side of increasing strength of H4/ offices is reduction in the 'or"load at these offices. The /ommittee recommends outsourcing of non-statutor$ 'or" and tightening the la' regarding lapses in secretarial compliance !$ inserting a section analogous to section 2##A 7'hich permits the

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government to order special audits9 to allo' the government to order special compliance audits. Recommendation ,., <C* should consider reducing wor"load at offices of .%Cs by providing for a system of pre# certification by company secretaries: the system should provide for monetary and other penalties on company secretaries who certify incorrectly, even through error or oversight The Companies *ct be amended to enable the <C* to order a compliance audit, much in the same manner as it can order special audits under section 00#* of the Companies *ct. :1. The /ommittee also recommends a num!er of other steps that it feels 'ould contri!ute to !etter corporate governance regime& these have !een grouped under the head +miscellaneous, to'ards the end of chapter @. 6roadl$ these cover areas such as preventing stripping of assets random scrutin$ of accounts !etter training for articles and propagation of an internal code of ethics for companies. Recommendation ,..

2*%C*.% should be amended to provide that auditors report certain violations, such as those listed in paragraph ).0A. 'ection A0(/+(a+ should be strengthened to prevent any unnatural stripping of assets, or sale of shares by management;promoters To reduce wor"load in .%C offices, as well as to improve auditing standards, the government should consider introducing a system of random scrutiny of audited accounts, in the same way as is done by the *ccountancy &oundation in the 6J, or is proposed to be done by the @ublic %versight 1oard in the 6'*. -owever, this recommendation should be implemented only if, and after, <C* can ta"e care of concerns such as the genuineness of randomness, client confidentiality etc., and is confident of its own manpower strengths and s"ills IC*I should re#consider the limits it has set on the number of articles that a partner can train: something that has the unintended consequence of denying young prospective accountants the chance to train with the best in the profession. Companies should be required to establish, and publish, an KInternal Code of $thicsL. <C* should sponsor, and financially support, from the I$@&, research on corporate governance and allied sub,ects that have a bearing on investor;shareholder well# being.

:2. The profession of accountanc$ in )ndia is dominated !$ small firms. This has not onl$ opened them to threats of competition from larger !etter organised international firms !ut has also limited their a!ilit$ to fund top class human resource development. The /ommittee feels that in the long run )ndian audit firms 'ill have to consolidate and

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gro' if the$ are to compete especiall$ in non-statutor$ functions internationall$. The /ommittee ma"es t'o recommendations in this regard. Recommendation ,./ IC*I should propose to the >overnment a regime and a regulatory framewor" that encourages the consolidation and growth of Indian firms, in view of the international competition they face, especially with regard to non#audit services. The >overnment should consider amending the @artnership *ct to provide for partnerships with limited liability, especially for professions which do not allow their members to provide services as a corporate body.

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