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Corporate Governance Voluntary Guidelines

CS Alka Kapoor & CS Banu Dandona

Good corporate governance practices are a sine qua non for sustainable business that aims at generating long term value to all its shareholders and other stakeholders.

-Mr. Salman Khurshid, Hon™ble Minister of Corporate Affairs

Adoption of best governance practices is imperative in today™s global environment. A well governed company has an edge over others in terms of attracting funds at the most competitive rates, attracting and retaining the best talent, the brand image enjoyed both in the society™s perception of the company and in the regulator™s perception etc.

Y C Deveshwar in one of his speeches has said that there are three kinds of businesses in the context of sustainable development:

One those that pursue shareholder value creation above all else. Such companies exist from quarter to quarter, focused solely on their incomes, leaving a deferred burden for somebody else to take care of.

Two those that pursue shareholder value and comply with Regulations. Compliance would ensure adherence to minimum acceptable standards. Such an approach can at best slow down damage to natural capital.

Three there are enterprises that are willing to go that Extra Mile. Go beyond the dictates of Regulation. Such companies do not view shareholder value as the end in itself. Shareholder value is deemed important to the extent required to attract financial capital- a necessity and a mere means to realizing the broader purpose of creating societal value. They are driven by a super-ordinate goal; by a Commitment beyond the Market. Their culture is imbued with values that are born out of a larger purpose.

A key ingredient towards judging the success of an organization is the time horizon over which society judges the worth of businesses. A quarterly approach would spawn the first kind of companies. A longer term approach can create businesses of the kind that can create much greater societal value through virtuous cycles of sustainable development.

Adoption of good corporate governance practices is in the self-interest of a company and research shows that those companies which are known for their good governance definitely have a competitive advantage over the others.

There is always a link between good governance and law. Good governance is not something that exists separately from the law. It is entirely inappropriate to unhinge governance from the law.

Corporate governance mainly involves the establishment of structures and processes, with appropriate checks and balances that enable directors to discharge their legal responsibilities. Criteria of good governance, governance codes and guidelines are relevant in the determination of what is regarded as an appropriate standard of conduct.

It is in this context that the Ministry of Corporate Affairs recently issued the Corporate Governance Voluntary Guidelines. These guidelines provide for a set of good practices which public companies and bigger private companies are encouraged to voluntarily adopt. The Voluntary Guidelines are not intended to be a substitute for or additional to the existing laws but are recommendatory in nature.

The Ministry of Corporate Affairs expects that more and more corporates should consider the adoption of the voluntary guidelines and in case for some genuine reasons a company is not able to comply with some of the guidelines, it is expected that the company should inform the shareholders the reasons for not being able to comply. The approach of the Ministry is very akin to the approach being followed in terms of the Combined Code in UK , i.e. the ˜Comply or Explain approach™.

Perhaps the premise for this approach by the Ministry is the recognition of the fact that one of the principles of good governance is acting in the best interests of the company. In an ˜comply or explain™ regime, the governance people in a company can conclude that to follow a practice recommended in the voluntary guidelines would not, at a particular time under the prevailing  circumstances, be in the best interests of the company and may therefore like to  apply another practice. The company must, however, in such a situation explain the practice it adopts other than the recommended one and the reasons for adopting it.

The Institute of Company Secretaries of India had constituted a Core Group to analyze the issues arising out of Satyam Episode and to inter alia make suitable recommendations for policy and regulatory changes in the legal frame work. The Core Group undertook a detailed study of the prevailing corporate governance practices across the world, the recommendations of various committees and corporate governance codes, the best practices adopted by the industry and after benchmarking the best practices that can be mandated, made its recommendations to strengthen the Corporate Governance Framework. These recommendations were submitted to the Ministry of Corporate Affairs which was placed on its website for public comments.

Around the same time, a Taskforce was constituted by the Confederation of India Industries (CII) under the chairmanship of Mr. Naresh Chandra. The Taskforce came out with its report titled Report of the CII Taskforce on Corporate Governance.

The Corporate Governance Voluntary Guidelines was were developed through a process of stakeholder consultation and drew upon the Report of the Taskforce and the ICSI Recommendations.

Voluntary Guidelines

The Corporate Governance Voluntary Guidelines are broadly divided into six heads, namely,

I.              Board of Directors

II.            Responsibilities of the Board

III.           Audit Committee of the Board

IV.          Auditors

V.           Secretarial Audit

VI.          Institution of Mechanism for whistle blowing

I.              BOARD OF DIRECTORS

The Head ˜Board of Directors™ is further divided into the following sub-heads :

  1. Appointment of Directors
  2. Independent Directors
  3. Remuneration of Directors

A.   Appointment of Directors

A.1 Appointments to the Board

The Voluntary Guidelines recommend that Companies should issue formal letters of appointment to Non-Executive Directors (NEDs) and Independent Directors – as is done by them while appointing employees and Executive Directors.

The Guidelines further require that the letter should form a part of the disclosure to shareholders at the time of the ratification of appointment or re-appointment of the director to the Board and should also be placed by the company on its website. In case the company is a listed company, the appointment letter should also be available on the website of the stock exchange(s) where the securities of the company are listed.

A.2 Separation of Offices of Chairman & Chief Executive Officer

It is perceived that separating the roles of chairman and chief executive officer (CEO) increases the effectiveness of a company’s board.

It is the board’s and chairman’s job to monitor and evaluate a company’s performance. A CEO, on the other hand, represents the management team. If the two roles are performed by the same person, then it’s an individual evaluating himself. When the roles are separate, a CEO is far more accountable.

According to the OECD Principles, Separation of the two posts may be regarded as good practice, as it can help to achieve an appropriate balance of power, increase accountability and improve the board’s capacity for decision making independent of management. The designation of a lead director is also regarded as a good practice alternative in some jurisdictions. Such mechanisms can also help to ensure high quality governance of the enterprise and the effective functioning of the board.

The Guidelines recommends that the offices of Chairman of the board and the CEO should be separate in order to prevent unfettered decision making power with a single individual.

A. 3 Nomination Committee

Nomination Committee is regarded as an efficient mechanism for the detailed exam ination of selection and appointment practices of a company of its Board members.

Constitution of a Nomination Committee is mandated under the UK Combined Code, Australian Stock Exchange Corporate Governance Principles and the New York Stock Exchange Listing Rules.

The Voluntary Guidelines State that a company may have a Nomination Committee comprising of majority of Independent Directors with an independent director as its chairman and the committee should consider proposals for searching, evaluating, and recommending appropriate Independent Directors and Non-Executive Directors [NEDs], based on an objective and transparent set of guidelines which should be disclosed. This means that the Board should frame a set of guidelines for search and selection of independent directors. These guidelines should, inter-alia, include the criteria for determining qualifications, positive attributes, independence of a director and availability of time with him or her to devote to the job. The Committee should also evaluate and recommend the appointment of Executive Directors.

The Committee should also enable the Board to take proper and reasoned decisions with regard to a balanced composition of the Board.

The Committee should further recommend to the board the process for evaluating the skills, knowledge, experience and effectiveness of individual directors and the Board as a whole.

The Voluntary Guidelines also require that a separate section in the Annual Report should disclose the guidelines being followed by the Nomination Committee and the role and work done by it during the year under consideration.

A.4. Number of Companies in which an Individual may become a Director

With a view to ensuring better time commitment from the directors, the voluntary guidelines  restricts the number of directorships that an individual may hold. Accordingly, it states that In case an individual is a Managing Director or Whole-time Director in a public company the maximum number of companies in which such an individual can serve as a Non-Executive Director or Independent Director should be restricted to seven.

B.   Independent Directors

The Voluntary Guidelines suggest that the Board should put in place a policy for specifying positive attributes of Independent Directors such as integrity, experience and expertise, foresight, managerial qualities and ability to read and understand financial statements. It is further stated that the Independent directors should provide a Certificate of Independence at the time of their appointment, and thereafter annually which should also be placed on the website of the company/stock exchange in case of listed companies.

The guidelines further state that an Individual may not remain as an Independent Director in a company for more than six years. A period of three years should elapse before such an individual is inducted in the same company in any capacity and that no individual may be allowed to have more than three tenures as Independent Director.

In order to enable the Independent Directors to perform their functions effectively, the guidelines suggest that the Independent Directors should have the option and freedom to interact with the company management periodically.

As per the Combine Code, a director will not be considered to be independent if he has served on the board for more than nine years from the date of their first election. In terms of the non-mandatory recommendation under Claus 49 of the Listing Agreement, a maximum tenure of nine years is recommended.

C.   Remuneration of Directors

Directors™ compensation/remuneration has been attracting a lot of world attention. It is expected that the remuneration should be fair reasonable and clearly disclosed.

With regard to the remuneration of directors, the Voluntary Guidelines recommend that a company should have a Remuneration Policy for the members of the Board and Key Executives which should be disclosed. The guidelines suggest that in case of executive directors, the performance-related elements of remuneration should form a significant proportion of the total remuneration package and should be designed to align their interests with those of shareholders and to give these Directors keen incentives to perform at the highest levels.

In the case of Non-executive directors, the companies may opt to pay a fixed contractual remuneration to its NEDs, subject to an appropriate ceiling depending on the size of the company; or pay upto an appropriate percent of the net profits of the company. However, the choice should be uniform for all NEDs, i.e. some should not be paid a commission on profits while others are paid a fixed amount. Further, in case a company opts to pay a fixed contractual sum, then the NEDs should not be eligible for any commission on profits. NEDs may be granted stock options as a form of payment, however, these should be held by them until three years of his exit from the Board.

The Guidelines further suggest that the fixed component of the remuneration should be relatively low in the case of NEDs , not more than one-third of the total remuneration package. The variable component should primarily be based on the attendance in Board and Committee Meeting with additional variable payment on the basis of such considerations such as whether the NED is the Chairman of Board, Chairman of the Audit Committee, the membership of Board Committees.

As far as the remuneration of Independent Directors, the Voluntary Guidelines, suggests that in order to attract, retain and motivate them to contribute to the company, they should be paid adequate sitting fees which may depend upon the twin criteria of Net Worth and Turnover of  companies. Further, The IDs may not be allowed to be paid stock options or profit based commissions, so that their independence is not compromised.

The Australian Stock Exchange Corporate Governance Principles contains a principle to remunerate fairly and responsibly. In theUK under its Companies Act, there is a requirement of preparation and disclosure of remuneration report.

Remuneration Committee

The remuneration committee is established to ensure that remuneration arrangements support the strategic aims of the business and enable the recruitment, motivation and retention of senior executives while complying with the requirements of regulatory and governance bodies, satisfying the expectations of shareholders and remaining consistent with the expectations of the wider employee population.

The Guidelines require companies to constitute a remuneration committee comprising at least three members, majority of whom should be non-executive directors of which at least one should be independent director. Committee should have responsibility for determining the remuneration for all executive directors and the executive chairman, including any compensation payments, such as retirement benefits or stock options.

In terms of the Guidelines, the Committee should also be tasked with the laying down the principles, criteria and the basis of remuneration policy of the company which should be disclosed to shareholders and their comments, if any, considered suitably.

The OECD Principles recommend the constitution of Remuneration Committee and provides  ˜It is considered good practice in an increasing number of countries that remuneration policy and employment contracts for board members and key executives be handled by a special committee of the board comprising either wholly or a majority of independent directors.™

Constitution of remuneration committee is recommended under the UK Combined Code, the Australian Stock Exchange Corporate Governance Principles and the NYSE Listing Rules.

II.    RESPONSIBILITIES OF THE BOARD

The following aspects are covered under the head Responsibilities of the Board:

  1. Training of Directors
  2. Enabling Quality of Decision Making
  3. Risk Management
  4. Evaluation of Performance of Board of Directors, Committees thereof and of Individual Directors
  5. Board to place Systems to ensure Compliance with Laws

A.   Training of Directors

The Voluntary Guidelines require that companies should ensure that directors are inducted through a suitable familiarization process covering, inter-alia, their roles, responsibilities and liabilities and the Board should also adopt suitable methods to enrich the skills of directors from time to time.

It further suggests that efforts should be made to ensure that every director has the ability to understand basic financial statements and information and related documents/papers.

Training of Directors is considered an international best practice and is recommended in the OECD Principles,   UK Combined Code, Australian Stock Exchange Corporate Governance Principles and Recommendations. Under Clause 49 of the Listing Agreement training of directors is a non-mandatory requirement.

B.   Enabling Quality of Decision Making

The Guidelines task the Board with the responsibility of ensuring that there are systems, procedures and resources available to make sure that every Director is supplied, in a timely manner, with precise and concise information in a form and of a quality appropriate to effectively enable/ discharge his duties. Such information is supplied giving adequate time to directors to study and make effective contribution.

This is an important recommendation which the Guidelines have proposed as the accountability of a director can be fixed/ should be fixed only if the directors are facilitated to make informed decision based on facts and figures supplied to it.

C.   Risk Management

The sources of risk, and their magnitude, have changed dramatically. Due to globalisation, changing risks and their global dimension, pose challenges not only to business and governments but also to society and economies.

The Voluntary Guidelines cast the responsibility on the Board, its Audit Committee and its executive management to collectively identify the risks impacting the company™s business and document their process of risk identification, risk minimization, risk optimization as a part of a risk management policy; Further the Board should affirm in their Report that that it has put in place critical risk management framework across the company, which is overseen once every six months by the Board

D.   Evaluation of Performance of Board of Directors, Committees thereof and of Individual Directors

Board Evaluation, if conducted properly, can contribute significantly to performance improvements on three levels”the organizational, board and individual director level.  Boards who commit to a regular evaluation process find benefits across these levels in terms of improved leadership, greater clarity of roles and responsibilities, improved teamwork, greater accountability, better decision making, improved communication and more efficient board operations.

In terms of the Guidelines, the Board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.  Further, the Board should state in the Annual Report how performance evaluation of the Board, its committees and its individual directors has been conducted.

In terms of Clause 49 of the Listing Agreement, it is a non-mandatory requirement. Performance Evaluation is recognized as a best practice and is recommended in the OECD Principles, UK Combined Code,  the Australian Stock Exchange Corporate Governance Principles and the NYSE Listing Rules.

E.   Board to place Systems to ensure Compliance with Laws

The Guidelines require Board to ascertain that proper systems are in place to ensure compliance of all laws applicable to the company and that there is an adequate internal control system to safeguard shareholders™ investment and the company™s assets. This should be reported to the shareholders.

By making the board responsible for ensuring that systems are in place to ensure compliance of laws makes the board accountable for its compliance. This will make compliance systems a part of the Board Agenda.

In addition, the guidelines suggests that for every agenda item at the Board meeting, there should be attached an Impact Analysis on Minority Shareholders proactively stating if the agenda item has any impact on the rights of minority shareholders.

III. AUDIT COMMITTEE OF THE BOARD

The voluntary guidelines provide for the constitution of Audit Committee with at least three members having a majority of Independent Directors. The Audit Committee under the chairmanship of an Independent Director shall have all members well conversant with financial management, audit or accounts.

The guidelines have granted certain enabling powers to the Audit Committee which include: to have independent back office support and other resources from the company; have access to information contained in the records of the company; obtain professional advice from external sources. The Audit Committee should also have the facility of separate discussions with both internal and external auditors as well as the management.

These enabling powers granted to the Audit Committee is a welcome step as it will help the Audit Committee to perform far more effectively, at the same time it will make them more accountable.

The Audit Committee constituted under the Guidelines shall be responsible for monitoring the financial statements and reviewing the company™s internal financial controls, internal audit function and risk management systems of the company. The Audit Committee shall be responsible for approving the terms of appointment, removal and remuneration of external auditors. The guidelines further recommend that it shall be the responsibility of the committee to review and monitor the external auditor™s independence and objectivity and effectiveness of the audit process. The committee shall monitor and approve all related party transactions including any modifications in such transactions. Guidelines further provide that a statement in a prescribed format detailing the related party transactions in a particular year shall be included in Board™s report for that year for disclosure to various stakeholders.

As far as related party transactions are concerned, Clause 49 of the Listing Agreement mandates a disclosure which the Audit Committee has to review in the financial statements before submission to the board for approval. The Voluntary Guidelines on the other hand suggests that the Audit Committee should monitor and approve all related party transactions.

IV. AUDITORS

The Audit Committee shall be the first point of reference for the appointment of the auditors. It shall have regard to the profile of the audit firm, qualifications and experience of audit partners and other related aspects while appointing such auditors. The committee shall ensure itself of the independence of the auditor and auditor™s arm™s length relationship with the company.

The guidelines further recommend that the company shall obtain a Certificate of Independence from the appointed auditor thereby certifying its independence.

The guidelines recommend that a company may adopt a policy of rotation of auditors to maintain their independence while discharging their duties. The audit partner may be rotated once every three years and where there is an audit firm appointed the rotation shall take place once in every five years. A period of three years should elapse before the audit partner takes up the same audit assignment and for the audit firm such time period is for five years. For ensuring, proper and accountable audit, guidelines suggest that the auditor should have access to all relevant information and records.

The Guidelines recommend that the auditor should be under obligation to certify whether he obtained all information he had sought from the company or not. In case of non- receipt of information on financial statements he shall make a specific indication of the effects of such non- receipt of information. Guidelines further recommend that the internal auditor to be appointed shall not be the employee of the company and such appointment shall be made by the Board of the Company.

V. SECRETARIAL AUDIT

The introduction of the concept of Secretarial Audit is indeed a welcome step in the direction of ensuring compliance of the laws. The Secretarial audit gives an independent assurance by a competent professional with regard to the status of compliance. It is an assurance to the board of directors that the company is compliant with various laws.  A Secretarial Audit will serve as an assurance to the prospective directors to render their expertise to the companies that there as a mechanism in place to check legal and procedural compliances.

The guidelines lay down the importance of Secretarial Audit thereby ensuring transparent, ethical and responsible governance of the company. Guidelines recommend that Secretarial Audit of company be conducted by competent professional. The Board should give its comments on the Secretarial Audit in its report to the shareholders.

Secretarial Audit can be an effective multi-pronged weapon to assure the regulator, generate confidence amongst the shareholders, the creditors and other stakeholders in companies, assure FIIs/FIs/SFCs/SIDCs/Banks and instill self regulation and professional discipline in companies.  It is a tool of risk mitigation and will allow companies to effectively address compliance risk issues.

Introduction of Secretarial Audit is an important step towards ensuring good governance in companies. Once the Secretarial Audit Report is submitted by the Secretarial Auditor, the Government as well as other stakeholders can gauge in first instance the level of compliances or non compliances by the company concerned. It can then immediately take suitable corrective measures under the specific applicable legislations. The measure would act as a check on frauds as well as reduce the number of prosecutions by Government and consequent litigation on account of non-compliance with the provisions of corporate and securities laws, thereby resulting in healthy and orderly development of the corporate sector. This would in turn lead to reduction of investor grievances and enhance various stakeholders™ confidence.

In addition to Government and shareholders, introduction of Secretarial Audit would be in the interest of companies themselves.

Secretarial Audit besides ensuring due compliance of the statute, will act as an aid to the management by proving to be a strong internal control device. It can relieve the company and their directors from consequences of unintended non-compliance of law. Independent Directors and Nominee Directors can be assured that the affairs of the company are being conducted as per law.  Besides the Secretarial Auditor can act as a fearless adviser to the company so that the mistakes and lapses if any could be rectified well in time and management is reassured that internal systems are guarded.

A Company Secretary in practice being a specialist in corporate laws is the competent professional to conduct secretarial audit.

VII.         INSTITUTION OF MECHANISM FOR WHISTLEBLOWING

Whistle Blower is a person who publicly complains concealed, misconduct concerning unethical behaviour, actual or suspected fraud or violation of the company™s code of conduct or ethics policy, on the part of an organization or a group of people within the same organization. The guidelines provide for adequate safeguard mechanism to be provided by the company to such whistle blowers who avail the mechanism, and also allow direct access to the chairperson of the Audit Committee in exceptional cases.

Role of Practising Company Secretary

The recent corporate history all across the world has been intermittently littered with corporate disasters and each of the recent corporate disaster drives home the point that companies to survive, grow and sustain have to adopt good governance practices.

Good governance is driven by people as much as, if not more, than by procedures and systems. At the centre of good Corporate Governance is the people; the company secretary has been recognized as a key governance professional in various international codes and reports. The Combined Code in UK, which is applicable to listed companies, recognizes the role of company secretary in promoting good governance as:

˜Under the direction of the chairman, the company secretary™s responsibilities include ensuring good information flows within the board and its committees and between senior management and non-executive directors, as well as facilitating induction and assisting with professional development as required.

The company secretary should be responsible for advising the board through the chairman on all governance matters.

All directors should have access to the advice and services of the company secretary, who is responsible to the board for ensuring that board procedures are complied with.™

An immense prospect and challenge – has presented itself to the profession of Company Secretaries, who can lead the way as an adviser to the companies in the adoption of best governance practices.

More and more companies, both public limited and private companies are expected to adopt Voluntary Guidelines. Company Secretaries in practice have a huge role to play in encouraging and guiding the companies with which they are associated to adopt and comply with these Guidelines.

The requirement of Secretarial Audit envisaged in these guidelines opens a huge door of opportunity to the profession. It is the company secretary with her exhaustive exposure provided by the Institute through compulsory coaching, exam inations, rigorous training and continuing education programmes who is most competent to conduct Secretarial Audit.  The members of the Institute are not only conversant with the technicalities and provisions of the corporate legal areas but are highly specialized professionals in the matters of procedural and practical aspects involved in the compliances  enjoined under  various   statutes and the rules,   regulations bye-laws and guidelines made there under.

Conclusion

Strong governance standards focusing on fairness, transparency, accountability and responsibility are vital not only for the healthy and vibrant corporate sector growth, but also for inclusive growth of the economy. The Voluntary Guidelines provide corporate India a framework to govern themselves voluntarily as per the highest standards of ethical and responsible conduct of business. The profession of Company Secretaries should lead this initiative from the front and be part of the national movement for inclusive growth.

 

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About eMinds Legal

eMinds Legal

eMinds Legal is a Corporate Law Firm based in Gurgaon, India specializing in Corporate Legal, Corporate Secretarial and Compliance. The Firm comprises of a team of Corporate Lawyers and Company Secretaries with in-depth subject matter knowledge and participative industry experience of over 15 years.

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