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Luthra & Luthra Law Offices 1
Mohit Saraf, Senior PartnerMohit Saraf, Senior PartnerLuthra and Luthra Law OfficesLuthra and Luthra Law Offices
Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
-A Comparative Analysis--A Comparative Analysis-
Presented to Presented to
Alliance IndiaAlliance India
1212thth August 2005 August 2005
Outline Outline
Section ISection I Conceptualizing Corporate Governance Conceptualizing Corporate Governance
Section II The Need for Corporate Governance Section II The Need for Corporate Governance
Section III Evolution of Corporate Governance in IndiaSection III Evolution of Corporate Governance in India
Section IV Clause 49 of the Listing AgreementSection IV Clause 49 of the Listing Agreement
Section V The Sarbanes Oxley Act, 2002Section V The Sarbanes Oxley Act, 2002
Section VI The Eighth Council Directive Section VI The Eighth Council Directive
Luthra & Luthra Law Offices 3
Section ISection IConceptualizing Corporate Conceptualizing Corporate
GovernanceGovernance Narrow DefinitionNarrow Definition
A set of relationships between the company and A set of relationships between the company and shareholders, directors and management.shareholders, directors and management.
Beneficiary of good governance- The ShareholderBeneficiary of good governance- The Shareholder
Broad DefinitionBroad Definition Looking to the implicit and explicit relationships of the Looking to the implicit and explicit relationships of the
company with employees, creditors, consumers, company with employees, creditors, consumers, distributors, local communities.distributors, local communities.
Beneficiary of good governance- Every StakeholderBeneficiary of good governance- Every Stakeholder
Luthra & Luthra Law Offices 4
Conceptualizing Corporate Conceptualizing Corporate Governance (Contd.)Governance (Contd.)
OECD DefinitionOECD Definition– System by which corporations are directed and controlled. System by which corporations are directed and controlled. – Spells out the rules / procedures for making decisions on Spells out the rules / procedures for making decisions on
corporate affairs. corporate affairs. – Provide the structure through which the company objectives Provide the structure through which the company objectives
are set, and the means of attaining those objectives and are set, and the means of attaining those objectives and monitoring performancemonitoring performance
– Specifies the distribution of rights and responsibilities Specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the among different participants in the corporation, such as, the board, managers, shareholders and other stakeholdersboard, managers, shareholders and other stakeholders
World Bank DefinitionWorld Bank Definition– Corporate governance is about promoting corporate fairness, Corporate governance is about promoting corporate fairness,
transparency and accountabilitytransparency and accountability
Luthra & Luthra Law Offices 5
Conceptualizing Corporate Conceptualizing Corporate Governance (Contd.)Governance (Contd.)
What constitutes shareholders’ interest? (sustainable What constitutes shareholders’ interest? (sustainable profitability)profitability)
Need for external regulationNeed for external regulation– FOR:FOR:
» Conflict of interest b/w Management/Promoters and other Conflict of interest b/w Management/Promoters and other constituenciesconstituencies
» To protect small investorsTo protect small investors» To account for ExternalitiesTo account for Externalities
– AGAINST:AGAINST:» Risk of excessive policingRisk of excessive policing» Increase costsIncrease costs
Luthra & Luthra Law Offices 6
Section IISection II The Need for Corporate The Need for Corporate
GovernanceGovernance
Responsibility to StakeholdersResponsibility to Stakeholders
Easier access to capital (FII, VCF, Foreign Easier access to capital (FII, VCF, Foreign Markets)Markets)
Efficiency (at the firm level) and Global Efficiency (at the firm level) and Global CompetitivenessCompetitiveness
Luthra & Luthra Law Offices 7
Section IIISection III The Evolution of Corporate The Evolution of Corporate
Governance in IndiaGovernance in India December 1995: CII sets up task force to design December 1995: CII sets up task force to design
voluntary code of corporate governancevoluntary code of corporate governance April 1998: CII releases “Desirable Corporate April 1998: CII releases “Desirable Corporate
Governance: A Code”Governance: A Code” May 1999: SEBI sets up the Kumar Mangalam Birla May 1999: SEBI sets up the Kumar Mangalam Birla
Committee Committee February 2000: Clause 49 introduced pursuant to KM February 2000: Clause 49 introduced pursuant to KM
Birla ReportBirla Report 2002: 2002: DCA sets up DCA sets up Naresh Chandra Committee- Naresh Chandra Committee-
Report recommends financial and non-financial Report recommends financial and non-financial disclosures and independent auditing and board disclosures and independent auditing and board oversight of management (Draft Companies Bill)oversight of management (Draft Companies Bill)
Luthra & Luthra Law Offices 8
Section IIISection III The Evolution of Corporate The Evolution of Corporate
Governance in IndiaGovernance in India 2002: Narayana Murthy Committee set up by SEBI to 2002: Narayana Murthy Committee set up by SEBI to
review clause 49review clause 49 2003: Clause 49 modified to reflect some of Narayana 2003: Clause 49 modified to reflect some of Narayana
Murthy’s recommendationsMurthy’s recommendations December, 2005: Deadline for compliance with December, 2005: Deadline for compliance with
modified Clause 49modified Clause 49
Luthra & Luthra Law Offices 9
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
Concerned with Independent Directors, Audit Committees, Concerned with Independent Directors, Audit Committees, Disclosures, CEO/CFO CertificationDisclosures, CEO/CFO Certification
Independent DirectorsIndependent Directors Half of Board with executive CM to be independent; third of Half of Board with executive CM to be independent; third of
board with non executive CM to be independent.board with non executive CM to be independent. Definition of independent directorDefinition of independent director
Non executiveNon executive No Material pecuniary relationships or transactions with company, No Material pecuniary relationships or transactions with company,
promoters, directors, senior management, holding company, promoters, directors, senior management, holding company, subsidiaries or associatessubsidiaries or associates
Luthra & Luthra Law Offices 10
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
Definition of independent Director (…contd.)Definition of independent Director (…contd.) Not related to promoters, to board members or to persons Not related to promoters, to board members or to persons
holding managerial positions one level below boardholding managerial positions one level below board Has not been an executive in company in preceding three Has not been an executive in company in preceding three
yearsyears Has not been a partner or executive in statutory audit Has not been a partner or executive in statutory audit
firm or internal audit firm firm or internal audit firm Has not been a partner or executive in law firm or Has not been a partner or executive in law firm or
consulting firm with material association to companyconsulting firm with material association to company Is not a material supplier, service provider, customer, Is not a material supplier, service provider, customer,
lessor or lessee of companylessor or lessee of company Does not hold more than 2% shares in companyDoes not hold more than 2% shares in company
Luthra & Luthra Law Offices 11
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
The Audit CommitteeThe Audit Committee Company to constitute an audit committee with Company to constitute an audit committee with
terms of referenceterms of reference At least three members- two thirds independentAt least three members- two thirds independent CM to be independent- must attend every AGM CM to be independent- must attend every AGM All members financially literate- at least 1 member All members financially literate- at least 1 member
to be expert- CS to be secretaryto be expert- CS to be secretary May meet with or without executivesMay meet with or without executives To meet at least 4 times a year- quorum = greater To meet at least 4 times a year- quorum = greater
of 2 members or 2/3of 2 members or 2/3rdrd and at least 2 independent and at least 2 independent
Luthra & Luthra Law Offices 12
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
The Powers of the Audit CommitteeThe Powers of the Audit Committee Investigate all matter within its terms of Investigate all matter within its terms of
referencereference Seek information from any employeeSeek information from any employee Obtain outside legal/ professional advice Obtain outside legal/ professional advice To invite outside experts To invite outside experts
Luthra & Luthra Law Offices 13
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
The Role of the Audit CommitteeThe Role of the Audit Committee Oversee financial reporting processOversee financial reporting process Recommend to the Board the hiring and firing of statutory auditors and Recommend to the Board the hiring and firing of statutory auditors and
the fixing of their feesthe fixing of their fees To review working of whistle blower mechanismsTo review working of whistle blower mechanisms Discussing significant findings and follow ups with internal auditorsDiscussing significant findings and follow ups with internal auditors Approval of payment to statutory auditors for any other services renderedApproval of payment to statutory auditors for any other services rendered Reviewing with the management annual/ quarterly financial statements Reviewing with the management annual/ quarterly financial statements
before they are vetted by board especially before they are vetted by board especially Reviewing the adequacy of structures, staffing etc. of internal audit Reviewing the adequacy of structures, staffing etc. of internal audit
departmentdepartment Other functions specified in terms of referenceOther functions specified in terms of reference
Luthra & Luthra Law Offices 14
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
Audit Committee to review following informationAudit Committee to review following information
Statement of significant related party transactions Statement of significant related party transactions submitted by managementsubmitted by management
Management letters and letters of internal control Management letters and letters of internal control weakness issued by the statutory auditorsweakness issued by the statutory auditors
Internal audit reports relating to internal control weaknessInternal audit reports relating to internal control weakness Review of appointment, removal and terms of Review of appointment, removal and terms of
remuneration of chief internal auditor remuneration of chief internal auditor Management discussion and analysis of financial condition Management discussion and analysis of financial condition
and result of operations and result of operations
Luthra & Luthra Law Offices 15
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
DisclosureDisclosure Related party transactions ~ Place before the audit Related party transactions ~ Place before the audit
committee:committee: - summary of transactions in the ordinary course of business - summary of transactions in the ordinary course of business
- details of transactions not in the ordinary course of business - details of transactions not in the ordinary course of business - details of transactions, with related parties or others, not on arms - details of transactions, with related parties or others, not on arms length basislength basis
If financial statements are prepared in a manner other than If financial statements are prepared in a manner other than that prescribed in an accounting standard has been used, that prescribed in an accounting standard has been used, the same has to be disclosed in them.the same has to be disclosed in them.
Disclose in the Annual Report all pecuniary relationship or Disclose in the Annual Report all pecuniary relationship or transactions of the non-executive directors with the transactions of the non-executive directors with the company; criteria for making payments to such directors company; criteria for making payments to such directors and number of shares and convertible instruments held by and number of shares and convertible instruments held by them.them.
Luthra & Luthra Law Offices 16
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
DisclosureDisclosure Disclose in the Annual Report all elements of remuneration Disclose in the Annual Report all elements of remuneration
package of independent directors; service contracts, notice package of independent directors; service contracts, notice period, severance fee and stock options detailsperiod, severance fee and stock options details
Senior Management shall make disclosures to the Board relating Senior Management shall make disclosures to the Board relating to all material financial and commercial transactions, where they to all material financial and commercial transactions, where they have a personal interest that may have a potential to conflict have a personal interest that may have a potential to conflict with the interests of the Companywith the interests of the Company
On appointment of a new director or re-appointment of a On appointment of a new director or re-appointment of a director, provide information to the shareholders with respect to director, provide information to the shareholders with respect to his expertise, about his membership/directorship in other his expertise, about his membership/directorship in other companies and his shareholding in case he is a non-executive companies and his shareholding in case he is a non-executive director.director.
Quarterly results and presentations made by the Company Quarterly results and presentations made by the Company to analysts shall be put on company’s website. to analysts shall be put on company’s website.
Luthra & Luthra Law Offices 17
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
CFO / CEO certificationCFO / CEO certificationCEO = MD or Manager Appointed Under Companies ActCEO = MD or Manager Appointed Under Companies Act
CFO = Whole Time Finance Director or Other Person Heading the CFO = Whole Time Finance Director or Other Person Heading the Finance FunctionFinance Function
CEO and CFO to certify to the board CEO and CFO to certify to the board o that they have reviewed financial statements and the cash flow that they have reviewed financial statements and the cash flow
statements and to the best of their knowledge and belief:statements and to the best of their knowledge and belief: No materially untrue statement/ omission of material fact/ No materially untrue statement/ omission of material fact/
misleading statementmisleading statement Statements together present true and fair picture of company’s Statements together present true and fair picture of company’s
affairs and are in compliance with existing accounting standards, affairs and are in compliance with existing accounting standards, laws and regulationslaws and regulations
Luthra & Luthra Law Offices 18
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
CFO / CEO certificationCFO / CEO certification CEO/ CFO to certify the following CEO/ CFO to certify the following
No transactions entered into by company during the No transactions entered into by company during the year which are fraudulent, illegal or violative of the year which are fraudulent, illegal or violative of the company’s code of conductcompany’s code of conduct
Accept responsibility for internal control systems, Accept responsibility for internal control systems, have evaluated the effectiveness of the systems.have evaluated the effectiveness of the systems.
Have indicated to auditors and audit committeeHave indicated to auditors and audit committeei.i. Significant changes in internal control during the yearSignificant changes in internal control during the yearii.ii. Significant changes in accounting policies Significant changes in accounting policies iii.iii. Instances of significant fraud of which they have become awareInstances of significant fraud of which they have become aware
Luthra & Luthra Law Offices 19
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
Non Mandatory requirements of Clause 49Non Mandatory requirements of Clause 49
Only reporting required- compliance discretionaryOnly reporting required- compliance discretionary Whistle Blower Policy: mechanism to prevent Whistle Blower Policy: mechanism to prevent
victimization and provide direct access to CM of audit victimization and provide direct access to CM of audit committeecommittee
Independent directors may have tenure in aggregate of Independent directors may have tenure in aggregate of 9 years9 years
Half yearly declaration of performance to be sent to Half yearly declaration of performance to be sent to each shareholder householdeach shareholder household
Move towards unqualified financial statementsMove towards unqualified financial statements
Luthra & Luthra Law Offices 20
-Section IV--Section IV-Clause 49 of the Listing AgreementClause 49 of the Listing Agreement
Report and ComplianceReport and Compliance Separate section in annual report on Separate section in annual report on
compliance with corporate governance compliance with corporate governance Quarterly compliance report to stock Quarterly compliance report to stock
exchange signed by Compliance Officer or exchange signed by Compliance Officer or CEO CEO
Company to disclose compliance with non-Company to disclose compliance with non-mandatory requirements in annual reportsmandatory requirements in annual reports
Luthra & Luthra Law Offices 21
Clause 49 of the Listing AgreementClause 49 of the Listing Agreement--The pre and post Amendment positions compared-The pre and post Amendment positions compared-
Independent director before the Independent director before the amendmentamendment
Pecuniary relationship with Pecuniary relationship with company, promoters, management company, promoters, management and subsidiariesand subsidiaries
Board to determine whether director Board to determine whether director independent.independent.
Could be related to anyone in the Could be related to anyone in the companycompany
Silent about nominee directorsSilent about nominee directors
Independent director after the Independent director after the amendmentamendment
““management” substituted with management” substituted with “directors and senior management”; “directors and senior management”; prohibition extended to cover prohibition extended to cover holding company and associatesholding company and associates
Reference to Board’s judgment in Reference to Board’s judgment in this matter omittedthis matter omitted
Cannot be related to promoters, Cannot be related to promoters, persons occupying management persons occupying management positions in board or at one level positions in board or at one level below the board below the board
Nominees of public financial Nominees of public financial institutions and corresponding new institutions and corresponding new banks deemed independentbanks deemed independent
Luthra & Luthra Law Offices 22
Clause 49 of the Listing AgreementClause 49 of the Listing Agreement--The pre and post Amendment positions compared-The pre and post Amendment positions compared-
Independent director before the Independent director before the amendmentamendment
Could have been an Could have been an executive of the company in executive of the company in the previous yearsthe previous years
Could have been executive Could have been executive of professional firms of professional firms associated with companyassociated with company
Other interested parties Other interested parties could have qualifiedcould have qualified
Could have been interested Could have been interested as a shareholderas a shareholder
Independent director after the Independent director after the amendmentamendment
Can not have been an executive Can not have been an executive in company in the immediately in company in the immediately preceding 3 yearspreceding 3 years
Cannot be (have been) an Cannot be (have been) an executive in internal or external executive in internal or external auditor firm auditor firm
Can’t be a “material supplier, Can’t be a “material supplier, service provider or customer or service provider or customer or a lessor or a lessee of the a lessor or a lessee of the company company
Cannot hold 2% or more of the Cannot hold 2% or more of the voting sharesvoting shares
Luthra & Luthra Law Offices 23
Clause 49 of the Listing AgreementClause 49 of the Listing Agreement--The pre and post Amendment positions compared-The pre and post Amendment positions compared-
Audit Committee before the Audit Committee before the Amendment to Clause 49Amendment to Clause 49
At least 3 directorsAt least 3 directors All directors non-executiveAll directors non-executive Majority have to be Majority have to be
independent independent At least one member to have At least one member to have
financial and accounting financial and accounting knowledgeknowledge
Meet at least thrice a yearMeet at least thrice a year
Audit Committee after the Audit Committee after the Amendment to Clause 49Amendment to Clause 49
At least 3 directorsAt least 3 directors No such requirement No such requirement Two-thirds have to be Two-thirds have to be
independent independent All members to be “financially All members to be “financially
literate”; At least one member literate”; At least one member to be an expertto be an expert
Meet at least four times a yearMeet at least four times a year
Luthra & Luthra Law Offices 24
-Section V--Section V-The Sarbanes Oxley Act, 2002The Sarbanes Oxley Act, 2002
Concerned with Auditor independence, the Public Companies Concerned with Auditor independence, the Public Companies Accounting Oversight Board, Disclosures and corporate fraudAccounting Oversight Board, Disclosures and corporate fraud
Applies toApplies to:: Companies listed or traded in the U.S (including non U.S Companies listed or traded in the U.S (including non U.S
Companies)Companies) Subsidiaries of U.S Companies in India (provided they Subsidiaries of U.S Companies in India (provided they
have a business connection in the U.S)have a business connection in the U.S) Foreign accounting firms that prepare or furnish audit Foreign accounting firms that prepare or furnish audit
report for an issuer must comply with SOX report for an issuer must comply with SOX Compliance usually expected by U.S Companies from Compliance usually expected by U.S Companies from
business partners in India (implications for BPO sector)business partners in India (implications for BPO sector)
Luthra & Luthra Law Offices 25
-Section V--Section V-
The Sarbanes Oxley Act, 2002The Sarbanes Oxley Act, 2002
Salient Features of the SOX ActSalient Features of the SOX Act
Primary concern- integrity of audit reports- issue Primary concern- integrity of audit reports- issue in Enron and Worldcom debacles- requirement of in Enron and Worldcom debacles- requirement of independent directors comes from outside SOXindependent directors comes from outside SOX
Inroad into Attorney Client privilegeInroad into Attorney Client privilege Protects Whistleblower- restitution and penalties Protects Whistleblower- restitution and penalties
for victimizationfor victimization CEO-CFO certification of compliance CEO-CFO certification of compliance
Luthra & Luthra Law Offices 26
-Section V--Section V-The Sarbanes Oxley Act, 2002The Sarbanes Oxley Act, 2002
Salient features of the SOX Act (…contd.)Salient features of the SOX Act (…contd.)
Audit Committee to be composed entirely of independent Audit Committee to be composed entirely of independent directorsdirectors
Ban on loans to executive officers and directorsBan on loans to executive officers and directors Accelerated filings of periodic reportsAccelerated filings of periodic reports Filing of change of beneficial ownership within 2 daysFiling of change of beneficial ownership within 2 days Reimbursement by CEO/CFO upon restatement of Reimbursement by CEO/CFO upon restatement of
financial statements due to misconductfinancial statements due to misconduct Bonus/other incentive based compensation Profits from sale of securities
Luthra & Luthra Law Offices 27
-Section V--Section V-The Sarbanes Oxley Act, 2002The Sarbanes Oxley Act, 2002
Independence of Board of Directors/ Committees
Enhanced Criminal Penalties (upto $5 million fine for individuals, $25 million for entities, prison terms upto 20 years)
Strict Reporting of illegal or unethical behavior Audit Committee
Independent Financial Literacy of members At least one financial expert
Luthra & Luthra Law Offices 28
-Section V--Section V-The Sarbanes Oxley Act, 2002The Sarbanes Oxley Act, 2002
Audit Committee (…contd.) Responsible for appointment, compensation &
oversight of auditor & approval of audit/non audit services
Create compliant mechanism regarding accounting and auditing
Approve all related party transactions Implementation of a ‘Whistleblower’ policy
Luthra & Luthra Law Offices 29
-Section V--Section V-The Sarbanes Oxley Act, 2002The Sarbanes Oxley Act, 2002
Additional Disclosures – Off Balance Sheet Items & transactions that may
have material current/future effect on financial condition/results of operations
– Pro forma Information must conform to financials prepared under GAAP - No untruth/omission
– All fees billed by auditors in annual report– Audit Partner Rotation– Registration with Public Company Accounting
Oversight Board (including foreign audit firms that audit Issuers)
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IssuesIssues
Rationale for deeming nominees of public financial Rationale for deeming nominees of public financial institutions and corresponding new banks as independent institutions and corresponding new banks as independent directors unclear- conflict of interest ?directors unclear- conflict of interest ?
Shareholders not sole beneficiary of corporate governance Shareholders not sole beneficiary of corporate governance norms- other stakeholders need protection toonorms- other stakeholders need protection too
Mr. Rahul Bajaj- Mr. Rahul Bajaj- Indian companies being promoter controlled Indian companies being promoter controlled need no outside monitoringneed no outside monitoring- NASDAQ and NYSE Listing - NASDAQ and NYSE Listing Manual exempt companies with 50% holding in one group from Manual exempt companies with 50% holding in one group from requirement of independent directorsrequirement of independent directors
Clause 49 disqualifies holder of more than 2% stake from being Clause 49 disqualifies holder of more than 2% stake from being independent directorindependent director
Luthra & Luthra Law Offices 31
IssuesIssues
Audit Committees Required to review various legal requirements with the
management. Required to ensure adequacy of internal control systems Efficacy?
Chairman of Enron’s audit committee was a Stanford professor with 30 years experience in auditing and accounts
Requirement of financial literacy only just been introduced Is remuneration of members an issue?
Luthra & Luthra Law Offices 32
ConclusionConclusion
Good corporate governance – means to the end of sustainable wealth creation
The positive side of adherence to most rigorous standards in governance for corporations:
- Increased importance of corporate governance as an investment criteria among large investors
- Improved Equity Price Performance
- Higher Valuations
- Access to global markets
- Increased investor goodwill & confidence
Balance between ‘enterprise’ and ‘constraints’
Luthra & Luthra Law Offices 33
Our Contact DetailsOur Contact Details
Luthra & Luthra Law OfficesLuthra & Luthra Law Offices
Mumbai OfficeMumbai Office Delhi OfficeDelhi Office
704-706, 7704-706, 7thth Floor, 103, Ashoka Estate, Floor, 103, Ashoka Estate,
Embassy Center, Nariman Point, 24, Barakhamba Road, Embassy Center, Nariman Point, 24, Barakhamba Road,
Mumbai – 400 021Mumbai – 400 021 New Delhi - 110 001. New Delhi - 110 001.
Tel : (91) (22) 5630 3600 Tel : (91) (22) 5630 3600 Tel: (91) (11) 51215100 Tel: (91) (11) 51215100
Fax: (91) (22) 2287 3700Fax: (91) (22) 2287 3700 Fax: (91) (11) 2372 3909 Fax: (91) (11) 2372 3909
Email - Email - msarafmsaraf@@luthraluthra.com.com
Mobile: 9810266448