Gatekeepers of Governance

(Mr. U. K. Sinha, Chairman - November 28, 2014 – Corporate Governance Summit)

Corporate governance has always been a neglected area for long. It is only in the last 2-3
decades that its value and importance has been recongnised. It is even more so today, as
many around the world recognize the need to develop a more robust corporate governance
regime in the aftermath of the deepest financial crisis since the Great Depression. Although
the recent financial crisis has many fathers, there is ample evidence that poor corporate
governance, including weak risk management standards at many financial institutions,
contributed to the devastation wrought by the crisis.

The Financial Crisis Inquiry Commission in its final report, submitted in Jan 2011, concluded
that dramatic failures of corporate governance and risk management at many systemically
important financial institutions were one of the key causes of the financial crisis. While
authorities across the globe have given renewed attention in providing framework for
tackling corporate mis-governance, there is a still a long way to go as far as outcomes on the
ground are concerned. The issues with corporate governance seem more deep rooted,
in our culture, social value system and our ethics.

The financial crisis and analysis of its causes led to criticism of boards, regulators and
shareholders alike. Boards (the most important gatekeepers representing the interests of
all stakeholders in the entity), were held to be lacking in engagement, challenge and
diversity. Regulators were deemed to be incompetent and regulations too 'light touch' to
prevent abuses. Shareholders were criticized for not engaging with their boards on
governance, and not acting as responsible owners.
Good corporate governance standards are essential for the integrity of corporations,
financial institutions and markets. They also have a bearing on the growth and stability of
the economy. SEBI is of the view that any code of corporate governance must be dynamic,
evolving and should change with changing contexts and times. To keep pace with the
changing expectations of investors, shareholders and other stakeholders, necessary
amendments are carried out in the regulatory framework. Recent policy initiatives like
periodic disclosures of pledged shares, voting rights and agreements with media
companies will go a long way in further strengthening investor confidence in the market.
Broadly, the regulatory framework in India is in compliance with OECD principles, an
international benchmark used worldwide. As a part of a bilateral cooperation agreement
between SEBI and OECD in the area of corporate governance, a policy dialogue on 'Minority
Protection- Related Party Transactions (RPTs)’ was held in 2011 and a policy dialogue on
the role of institutional investors was held in 2014.

The enactment of the Companies Act, 2013, which replaced the Companies Act, 1956,
was a major development to improve governance standards, simplify regulations and
enhance the interests of minority shareholders. SEBI also reviewed Clause 49 of the
Listing Agreement during 2014 to align it with the provisions of the Companies Act, 2013
and to also prescribe additional conditions in this regard. The governance framework now
comprises of revised norms with regard to the board of directors, audit committee,
subsidiary companies, risk management, related party transactions and disclosures, a
compulsory whistle blower mechanism, requirement of at least one woman director on the
board, mandatory constitution of a nomination and remuneration committee, performance
evaluation of independent directors and prohibition of stock options to independent
directors, maximum tenure of independent directors and limit on the number of independent
directorships. These are some of the key provisions that were made applicable to all
listed companies. The scope of RPTs was widened to include elements of both the
Companies Act and Accounting Standards.

As a regulator, SEBI and its policy have always endeavored to communicate transparency
and ethical conduct at all levels for stakeholders. To ensure this, SEBI mandated the top
100 listed companies to include a Business Responsibility R, BPR, as a part of their annual
reports focusing on environmental, social and governance issues. It also implemented the
concept of general information document (GID) containing generic information thereby

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 eliminating the repetition of common information in the abridged prospectus thus helping
investors to better understand the nuances of public offers. To comply with the Government
of India (GoI) notification requiring g listed companies to achieve and maintain minimum
public shareholding (MPS) norms, SEBI specified various methods for ensuring timely
compliance by non-compliant companies. SEBI also initiated a consultative process with
companies which were not meeting the MPS requirement to impress upon them the
importance of achieving timely compliance and eliciting a concrete plan of action in this
regard. The companies were also made aware of the penal actions that might result in
case of non-compliance. With respect to non-compliant companies, SEBI issued interim
directions against the promoters/promoter groups and directors of 107 listed companies -
including one state PSU.

Further, to remain consistent with the broader market design, Securities Contracts
(Regulations) Rules, 1957 was amended during 2014 to bring the MPS requirement for
listed public and private sector companies at par at 25 percent. This was earlier 10 percent
in the case of public sector companies. One must acknowledge the positive and prompt
action taken by the Ministry of Finance in readily agreeing to the demand. The PSUs and
private companies each must have uniform rules on matter like this. Even as too many
stock exchanges fragment liquidity that might stifle growth and innovation, too frequent
exits of stock exchanges will jeopardize the interests of investors and disrupt the stability of
the markets. Further, technology has altered the marketplace so much that the need for
multiple stock exchanges has been reduced largely. In this regard, SEBI formulated an exit
policy keeping in mind the interests of shareholders of exclusively listed companies by
providing an exit option and by providing trading members a trading opportunity through
the subsidiary route. Subsequently, in 2014 SEBI introduced measures to facilitate the exit
of de-recognized/non-operational stock exchanges. Indian markets are vibrant and a timely
review of the corporate governance system is inevitable in the light of the new
technological developments, introduction of new products, growth of financial markets,
trade and capital flows and global integration.

Although business ethics or lack of it may be thought to have played a considerable part leading
to the financial crisis, the debate across jurisdictions has focused almost exclusively on
governance processes and procedures while discussion of what might be the 'right way to do
business'. In this context, the imperative for ethical behaviors and practices within the

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boardroom has arguably never been more important. Ethics & Corporate Governance” are not
just Moral or Compliance Issues. In the long term they are Essential Behavioral Traits for the
Organization that strengthen the Organizations’ “Brand Equity” and help ensure Stable
Sustainable Growth.

Ethics are hardly mentioned in the corporate governance codes, yet the examples corporate
mis-governance generally raise ethical issues. They concern the way those companies were
governed, how power was exercised over them, and the way business risks were taken. In
other words, business ethics are inherently part of corporate governance. They are not an
optional exercise in corporate citizenship.

Changing Regulatory Paradigm

1) Increasing demand for Continuous and Comprehensive Evaluation (CCE)

To borrow a term from pedagogy called Continuous and Comprehensive Evaluation (CCE),
society now is demanding CCE from the people who they have made in charge of the society,
their political life or for any assignment which they are giving to them. So, a person in charge of
an organization or any place of responsibility is being continuously evaluated. And because of
this, democracy is getting a new meaning.

2) Demand from new quarters

If we look at the developments during the last decade or so, both in India and outside, we will
discover that society has been in a flux. We will discover that both in social and political life,
demands for good governance are being made from completely unexpected quarters.
Questions are being raised from corners which nobody could have imagined even 5 years
earlier. The society seems to be in a state of turmoil and people are increasingly demanding
good governance.

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Declining tolerance for mis-governance

And what people are frowning upon is arbitrariness, they are frowning upon nepotism. Also the
comfort zone in which people in position used to find themselves, is no longer there. They are
getting challenged everywhere and are being challenged on a continual basis. Earlier, people
had to organize themselves to be on the streets in order to have their voices heard. Today that
is no longer necessary. A minor act of indiscretion, a solitary act of temporarily losing cool or
committing a transgression can go viral and be shared with hundreds of thousands along with
photographic/documentary evidence. Media is picking up these stories and courts are asking
questions. A women or dalit need not feel isolated and helpless.

3) The New Normal

Some of you must have seen the report submitted by the Financial Sector Legislative Reforms
Commission (FSLRC). It has made an important point in the report. As you may be aware, the
Capital Market Regulator or SEBI has the components of three arms of government?
Government has a legislative wing that looks into the legislation, another wing that looks after
the judicial part and the third is the policy execution part. The structure of law today is that SEBI
has all the three components. We are permitted by the parliament to frame regulation, and
those regulations have the force of law. Then we have got powers and responsibility to
investigate a matter, like a policeman investigates. And once the investigation is over, we also
have power to work in a quasi judicial capacity and pass orders. So, FSLRC has said that since
all these powers are in one place, it is important that it should be applied in a judicious way. So
the report says that regulation making should be in consultation with the wider society and has
emphasized that there should be very active consultations on regulations. As per the
recommendations, only in emergency, regulator can issue regulations without going through full
regulation-making process. However, these regulations would lapse within six months. The
report also recommends, for example, those of you who have been students of law. that not
only consultation, there should be a clause by clause statement of objects and reasons as to
why a particular clause has been provided for in the law, what is the intent, what is the objective,
what are the recommendations.

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4) New paradigm for corporate governance as well

The point is, if in our social and political life, if such established norms are getting challenged
with regularity and with intensity it is a logical extension of the same sociological process that
the actions of corporate leaders will get questioned more closely. This is all the more true
because shareholders have put their hard earned savings in these companies and they cannot
turn their eyes away when instances of misuse of position of power or of outright malpractices
are suspected. Corporate CEOs are now being subjected to very stern and serious share holder
questioning. Many of them are being asked to leave, the resolutions for their remuneration and
bonus are getting rejected and demands for return of surplus cash to shareholders are getting
lauder.

Concluding Remarks

Research shows that firms based in countries that provide weak legal protections to investors
need to adopt multiple governance mechanisms in order to achieve a high perceived value if
they want to list on a US stock exchange. Specific upgrades include a higher degree of board
independence, adjustment of executive equity-based incentives and evidence of backing by
venture capital firms. These improvements deliver a message that investors’ interests are
protected and that they are doing business in a fair and transparent way, thus earning longer
term legitimacy in the eyes of investors.

Therefore, while authorities in India are reviewing and upgrading the corporate governance
norms from time to have provided for a detailed corporate governance framework, it is ultimately
in the interest of companies to adhere to and demonstrate highest standards of governance to
survive and grow in the globally competitive environment.

The principles of accountability, transparency, and engagement apply equally to a myriad of

other corporate issues. As owners of public companies and the providers of capital,
shareholders have the right to know how their company is being managed, and to understand
the board’s rationale in overseeing management and in making decisions.

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I want to re-emphasize that good corporate governance is critical to the health of the business
sector, our financial system, and the wider economy. Our economy will be stronger if corporate
decisions are made with competence and integrity, and if shareholders and the public can
appropriately assess the profitability and riskiness of corporations' business activities.

I thank you for your attention.

*****