Emergence of Corporate Governance in India - Part-2

 4.     C G Naresh Chandra Committee of 2002

Consequent to the several corporate debacles in the USA in 2001, followed by the stringent enactments of Sarbanes Oxley Act, Government of India appointed Naresh Chandra Committee in 2002 to examine and recommended drastic amendments to the law pertaining to auditor-client relationships and the role of independent directors.

The report of the Naresh Chandra Committee on Corporate Audit and Governance had suggested that auditors should refrain from providing non-audit services to their audit clients and had recommended an explicit list of prohibited non-audit services

The main recommendations of the Committee are given below:

(a) The minimum board size of all listed companies as well as unlisted public limited companies with paid-up share capital and free reserves of Rs. 100 million and above, or turnover of Rs. 500 million and above, should be seven, of which at least four should be independent directors.

(b) No less than 50% 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 Rs. 100 million and above or turnover of Rs. 500 million and above, should consist of independent directors.

(c) In line with the international best practices, the committee recommended a list of disqualification for audit assignment which included prohibition of:

(i) Any direct financial interest in the audit client,

(ii) Receiving any loans and/or guarantees,

(iii) Any business relationship,

(iv) Personal relationship by the audit firm, its partners, as well as their direct relatives, prohibition of

(v) Service or cooling off period for a period of at least two years, and

(vi) Undue dependence on an audit client.

(d) Certain services should not be provided by an audit firm to any audit client, viz.:

(i) Accounting and book keeping,

(ii) Internal audit,

(iii) Financial information design,

(iv) Actuarial,

(v) Broker, dealer, investment advisor, investment banking,

(vi) Outsourcing,

(vii) Valuation,

(viii) Staff recruitment for the client etc.

(e) The audit partners and at least 50% of the engagement team responsible for the audit of either a listed company, or companies whose paid-up capital and free reserves exceeds Rs. 100 million or companies whose turnover exceeds Rs. 500 million, should be rotated every 5 years.

(f) Before agreeing to be appointed (Section 224 (i)(b)), the audit firm must submit a certificate of independence to the audit committee or to the board of directors of the client company.

(g) There should be a certification on compliance of various aspects regarding corporate governance by the CEO and CFO of a listed company.

It is interesting to note that majority of the recommendations of this committee are the culmination of the provisions of Sarbanes Oxley Act of the USA.

5.  Narayana Murthy Committee 2002

SEBI constituted this Committee under the chairmanship of N.R. Narayana Murthy, Chairman and mentor of Infosys, and mandated the Committee to review the performance of corporate governance in India and make appropriate recommendations. The Committee submitted its report in February 2003.

A bird’s eye view  of the  Committee recommendations are as follows:

(a) Persons should be eligible for the office of non-executive director so long as the term of office did not exceed nine years (in three terms of three years each, running continuously).

(b) The age limit for directors to retire should be decided by companies themselves.

(c) All audit committee members shall be non-executive directors. They should be financially literate and at least one member should have accounting or related financial management expertise.

(d) Audit committee of listed companies shall review mandatorily the information, viz.:

(i) Financial statements and draft audit reports,

(ii) Management discussion and analysis of financial condition and operating results,

(iii) Risk management reports,

(iv) Statutory auditors’ letter to management regarding internal control weaknesses, and

(v) Related party transactions.

(e) The audit committee of the parent company shall also review the financial statements, in particular, the investments made by the subsidiary company.

(f) A statement of all transactions with related parties including their bases should be placed before the independent audit committee for formal approval/ratification. Of any transaction is not on an arm’s length basis, management should provide an explanation to the audit committee, justifying the same.

(g) Procedures should be in place to inform board members about the risk assessment and minimisation procedures.

(g) Procedures should be in place to inform board members about the risk assessment and minimisation procedures.

(h) Companies raising money through an Initial Public Offering (IPO) shall disclose to the audit committee, the uses/application of funds by major category (capital expenditure, sales and marketing, working capital etc.) on a quarterly basis. On an annual basis, the company shall prepare a statement of funds utilized for purposes other than those stated in the offer document/prospectus. This statement shall be certified by the independent auditors of the company. The audit committee should make appropriate recommendations to the board to take up steps in this matter.

(i) It should be obligatory for the board of a company to lay down the code of conduct for all board members and senior management of a company. They shall affirm compliance with the code on an annual basis. The annual report of the company shall contain a declaration to this effect signed off by the CEO and COO.

(j) A director to become independent shall satisfy the various conditions laid down by the Committee.

(k) Personnel two observe an unethical or improper practice (not necessarily a violation of law) should be able to approach the audit committee without necessarily informing their supervisors. Companies shall take measures to ensure that this right of access is communicated to all employees through means of internal circulars etc. Companies shall annually affirm that they have not denied any personal access to the audit committee of the company (in respect of matters involving alleged misconduct) and that they have provided protection to whistle blowers from unfair termination and other unfair or prejudicial employment practices. Such affirmation shall form a part of the board report on corporate governance that is required to be prepared and submitted together with the annual report.

(l) For all listed companies there should be a certification by the CEO and CFO confirming, thefinancial statements as true and fair in compliance with the existingaccounting standards, effectiveness of internal control system, disclosure of significant fraud and significant changes in internal control and/or of accounting policies to the auditors and the audit committee. It is worth noting here that majority of the recommendations of this committee have been accepted by SEBI and thereby incorporated in the revised Clause 49 of the Listing Agreement in 2003 and 2004.

The major recommendations in 2002 caused SEBI  to revise Clause 49 , especially regarding

-Definition of independent directors

-Certificate by CFO & CEO

-Risk Assessment & Mitigation strategy of the company

            -Code of Conduct for top Management

On August 26, 2003, SEBI announced an amended Clause 49, of the listing agreement, a regulation that strengthens the role of independent directors serving on corporate boards,  which every public company listed on an Indian stock exchange is required to sign. The amended clauses come into immediate effect for companies seeking a new listing.