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EMERGING COMPANY LAW ISSUES GOVERNMENT COMMITMENT AND LEGISLATIVE INITIATIVES


INTRODUCTION

Company Law, an ever evolving subject, has undergone major transformation in the last decade. The impetus for such transformation germinated partially from the worldwide move for market oriented policies and partially by disquieting features of globalisation, resulting into focused attention on the need for Good Corporate Governance. The advancements in information technology and influence of faster means of communications over corporate operations have also provided impetus for such transformation. In other words, the paradigm shift witnessed in the global economy and corporate sector the worldover, have cumulatively presented various issues that have triggered debate and become important factors for initiating changes in Company Law in our country and abroad.


The post reforms corporate India has witnessed tremendous growth and expansion as a result of deregulation and procedural simplification of Company Law. The corporate India experienced multifaceted growth in terms of number, size, volume and extraterritorial reach. This growth can be gauged from the fact that there were 5,84,184 companies limited by shares with an estimated aggregate paid up capital of Rs. 3,39,801.6 cores. Today, the Indian corporate sector has spread its wings in other parts of the world also and even resorted to acquisitions abroad. The catalyst behind this growth has been Government’s commitment to provide growth oriented policy and regulatory framework for corporates. However, this corporate growth has been punctuated by incidences of corporate failures, securities scams, vanishing companies, mismanagement, growing shareholders dissatisfaction and unethical business practices. The Enron debacle and meltdown of certain once mighty US corporations have further aggravated the situation and raised various issues of Good Corporate Governance and attracted worldwide focus.


2. INITIATIVES FOR DEALING WITH ISSUES UNDER COMPANY LAW

With a view to deal with various issues that emerged in the wake of changing corporate paradigm, the government set up committees to suggest changes in regulatory framework.


(i) Joint Parliamentary Committee on Stock Market Scam

The Parliament constituted a Joint Committee on Stock Market Scam and matters relating thereto in April 2001 to go into the irregularities and manipulations in all their ramifications including insider trading relating to shares and other financial instruments and the role of banks, brokers and promoters, stock exchanges, financial institutions, corporate entities and regulatory authorities; to fix the responsibility in respect of such transactions; to identify misuse, if any, of and failures / inadequacies in the control and the supervisory mechanisms; to make recommendations for safeguards and improvements in the system to prevent recurrence of such failures; to suggest measures to protect small investors; and to suggest deterrent measures against those found guilty of violating the regulations. The Committee has since submitted its report.


(ii) Naresh Chandra Committee on Auditor Company Relationship

The Enron debacle of 2001 and subsequent scandals triggered another phase of reforms in company law with thrust on corporate governance, accounting practices and disclosures — this time more comprehensive than ever before. The Department of Company Affairs (DCA) appointed a High Level Committee headed by Shri Naresh Chandra to examine various corporate governance issues. The Committee in its report observed that while corporate governance reforms in India far outstrip that of many countries, the performance in either lags very much behind. The Committee inter alia recommended as follows:

Auditor-Company Relationship

The Committee in its report observed that there is a case for some judicious restrictions in order to ensure auditors independence. In this context, the recommendations include-


Disqualifications For Audit Assignments

The committee in line with international best practices recommended 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’; 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; prohibition of service or cooling off period; and prohibition of undue dependence on an audit client.

Prohibited Non-Audit Services

Generally agreeing with the Ramsay Report of Australia that there is no solid evidence of any specific link between audit failures and the provision of non-audit services, the Committee however, observed that certain types of non-audit services could impair independence and possibly affect the quality of audit. Thus the Committee recommended the prohibition of certain non-audit services, such as; Accounting and bookkeeping services, related to the accounting records or financial statements of the audit client; Internal audit services; Financial information systems design and implementation, Actuarial services; Broker, dealer, investment adviser or investment banking services; Outsourced financial services; Management functions, including the provision of temporary staff to audit clients; Any form of staff recruitment, and particularly hiring of senior management staff for the audit client; Valuation services and fairness opinion.

Management’s Certification in the Event of Auditor’s Replacement

With a view to make management more accountable to shareholders and audit committee in the matters of replacement of auditors and also to ensure that auditors work independently and fearlessly, the Committee recommended amendment to section 225 of the Companies Act requiring a special resolution of shareholders, in case an auditor, while being eligible to re-appointment, is sought to be replaced. The Committee further recommended that the explanatory statement accompanying such a special resolution must disclose the management’s reasons for such a replacement, on which the outgoing auditor shall have the right to comment. The Committee recommended that explanatory statement to be verified by Audit committee to the effect that it is ‘true and fair’


Auditor’s Annual Certification of Independence

The Committee believed that the independence of auditors must be renewed, even if shareholders and audit committee are satisfied about their independence. Therefore, the Committee recommended that the audit firm, before agreeing to be appointed must submit a certificate of independence to the audit committee or to the board of directors of the client company to the effect that the firm, together with its consulting and specialised services affiliates, subsidiaries and associated companies are independent and have arm’s length relationship with the client company; have not engaged in any non-audit services listed and prohibited and are not disqualified from audit assignments.


Appointment of Auditors

The Committee recommended that the audit committee of the board of directors to be the first point of reference regarding the appointment of auditors and with a view to discharge this fiduciary responsibility, the audit committee should discuss the annual work programme with the auditor; review the independence of the audit firm recommend to the board, with reasons, either the appointment/re-appointment or removal of the external auditor, along with the auditor’s remuneration. The Committee, however, excluded the Government companies and scheduled commercial banks from the application of this rule.


CEO and CFO Certification of Annual Audited Accounts

While deliberating upon this issue, the Committee referred to Section 302 of the Sarbanes Oxley Act which requires CEO & CFO of all listed companies to certify to SEC about the veracity of each annual and quarterly financial reports. The Act also provides for enhanced criminal penalties for any false certification. In this context the committee rejected the institution of criminal proceedings. The Committee thus recommended for certification by the CEO (either the executive chairman or the managing director) and the CFO (whole-time finance director or otherwise) of all listed companies as well as public limited companies whose paid-up capital and free reserves exceeds Rs.10 crore, or turnover exceeds Rs.50 crore. This certification to state that they, 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 directors’ report and statements do not contain any material untrue statement or omit any material fact nor do they contain statements that might be misleading. Further these statements together represent a true and fair picture of the financial and operational state of the company, and are in compliance with the existing accounting standards and/or applicable laws/regulations and that they are responsible for establishing and maintaining internal controls which have been designed to ensure that all material information is periodically made known to them; and have evaluated the effectiveness of internal control systems of the company.


Independent Quality Review Board

The Committee emphasized on the need for quality of fiduciary intermediaries, such as Chartered Accountants, Company Secretaries and Cost Accountants and observed that until recently most countries felt no need for any kind of public oversight board as an independent organisation to regulate the conduct of fiduciary intermediaries, however, the US Corporate scandals have changed all that, raising demand for credible public oversight bodies. The Committee in this context referred to SOX Act, which requires for setting up of Public Company Accounting Oversight Board (PCAOB). The Committee deliberated upon desirability of a PCAOB like body in India and recommended the setting up of independent Quality Review Boards (QRB) one each for ICAI, ICSI and ICWAI, with appropriate legislative support.

While suggesting the disciplinary mechanism the Committee observed that the proposed mechanism is realistic and should work, given adequate funding and determination. This should bring to bear a transparent and expeditious disciplinary procedure enhancing the prestige and public trust of all the three Institutes.


LEGISLATIVE INITIATIVES FOR COMPATIBLE COMPANY LAW

Company Law in India has been undergoing a phase of transition over the last 25 years. More than a dozen major legislative initiatives have been introduced or attempted in Indian Company Law. The prime mover for this high level of company law reforms process has been the changing corporate landscape and internationalisation of business. However, with the initiation of market oriented policies in July 1991, the Government has expedited the process to modify the company law in line with policy objectives and to harmonise it with the international developments.

In the year 1996, a Working Group was constituted to re-write the Companies Act, to facilitate healthy growth of Indian corporate sector under a liberalised, fast changing and highly competitive and contestable business environment. Based on the Report prepared by the Working Group and taking into account the developments that had taken place in corporate structure, administration and the regulatory framework the world over, the Companies Bill, 1997 was introduced in Rajya Sabha on August 14, 1997 to replace the Companies Act, 1956. Since the Bill of 1997 was under consideration and an urgent need was felt to amend the Companies Act, the President of India promulgated the Companies (Amendment) Ordinance, 1998 which was later replaced by the Companies (Amendment) Act, 1999 to surge the capital market by boosting morale of national business houses besides encouraging FIIs as well as FDI in the country.

The amendment of 1999 brought about a number of important changes to tailor the Companies Act in consonance with the then prevailing economic environment and to further Government policy of deregulation and globalisation of economy.

The corporate sector was given the facility to buy-back company’s own shares, provisions relating to investments and loans were rationalised and liberalised besides the requirement of approval of the Central Government on investment decisions was dispensed with, and companies were allowed to issue “sweat equity” in lieu of intellectual property. With a view to ensure standardization of accounting practices of financial reporting, the compliance of Indian Accounting Standards was made mandatory. Accordingly, a National Committee on Accounting Standards was set up. The Investor Education and Protection Fund was constituted to educate the investors to enable them to take well informed and considered investment decisions.

With a view to expedite the harmonization process, the Companies Act was further amended in the year 2000 to provide certain measures of good corporate governance and for ensuring meaningful shareholders’ democracy in the working of companies. The amendments effected in the year 2000, included inter alia setting up of Audit Committee, introduction of Postal Ballot and Shelf Prospectus, abolition of the office of the Public Trustee, abolition of the concept of “Deemed Companies”, appointment of auditors in the Government companies directly by the Comptroller and Auditor General of India, restricting a person to become director in more than 15 companies, prohibiting an auditor to hold securities carrying voting rights, introduction of secretarial compliance certificate to ensure better compliance of Companies Act by smaller companies, deletion of redundant provisions relating to managing agents, secretaries and treasurers and increase in penalties by way of fine to ten fold.

Thus with the globalization and growing competition and emerging new opportunities the Companies Act, 1956 is undergoing frequent changes in the last few years. The Act has been amended in 1996,1999, 2000, 2001, 2002 (twice) and Companies (Amendment) Bill, 2003 is pending with the Parliament. Various issues have been realized and new concepts and innovative provisions have been recently introduced through amendment in the Act, such as buy-back of securities, sweat equity shares, passing of resolutions by postal ballot, shares with differential rights, audit Committee, directors’ responsibility statement, shelf prospectus, establishment of National Company Law Tribunal, liquidators from panel of professionals, producer companies and Compliance Certificate.


By Siddhant Trivedi, Law Student


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