Draft Report on Corporate Governance of the CII Task Force, November 2009

Neha Gupta

Vinod Kothari & Company neha@vinodkothari.com

The regulators of Indian environment have been continuously evolving the practices for good corporate governance. Clause 49 of the Listing Agreement details the various practices to be adopted in this sphere. The Confederation of Indian Industry has always been an important part of this movement. But inspite of all these efforts the Satyam debacle has rocked the confidence of the investors once again. Keeping this in mind, the CII set up a Task Force under Mr. Naresh Chandra in February 2009 to recommend ways of further improving corporate governance standards and practices. The recommendations outlined in this report are aimed at listed companies and wholly owned subsidiaries of listed companies. Corporate Governance is defined as the management of the companies in a legal, ethical and transparent manner such that the interests of all the stakeholders are served in the best profitable manner. But such practices cannot be imposed through laws and regulations; it has to come out voluntarily from the management. CII has come out with a voluntary set of measures for industries to adopt to strengthen the corporate governance practices.

Elements of Corporate Governance: The report is structured according to the different elements of corporate governance:

• The Board of Directors o Non-executive and independent directors o Committees of the board o Significant related party transactions

• Auditors o Independence of Auditors o Rotation of Audit Partners

• Regulatory Agencies o Legal and regulatory standards o Effective and credible enforcement

• External Institutions o Institutional investors o The Press

All these elements need specific disclosures in the Corporate Governance section of the Annual Report of the listed companies.

Recommendation 1: Nomination Committee The need of a well- organized Board can never be denied in ensuring good governance of the companies. In line with this, need of a Nomination Committee was felt necessary. All listed companies should have a well- functioning Nomination Committee, comprising of a majority of independent directors, including its chairman to give investors substantial comfort about the process of Board-level appointments. The Nomination Committee should also be the body that evaluates and recommends the appointment of executive, non- executive and independent directors, which is subsequently ratified by the shareholders in the next shareholders’ meeting.

Recommendation 2: Letter of Appointment to Directors The Task Force felt the need of some formal structure for the appointment of NEDs and independent directors. The Task Force recommends that listed companies should issue formal letters of appointment to NEDs and independent directors specifying the terms and conditions of appointment therein and the same must be ratified by the shareholders.

Recommendation 3: Fixed Contractual Remuneration The Task Force further recommends that the Companies Act, 1956, be amended so that companies have the option of giving a fixed contractual remuneration to NEDs and independent directors, which is delinked from profits, such that the proven talents of real experts do not go unpaid in absence of profits in the companies. Therefore, companies should be given the option to choose between paying a fixed contractual remuneration to its NEDs and IDs or continuing with the existing practice of paying out upto 1% (or 3%) of the net profits of the stand alone entity as defined in the Companies Act, 1956.

Recommendation 4: Structure of Compensation to NEDs The Task Force suggests that listed companies use the specified template in structuring their remuneration to NEDs and independent directors, categorized into: • Fixed component • Variable Component • Additional payments for the chairmanships, etc.

Recommendation 5: Remuneration Committee of the Board In terms of the Combined Code of the UK, the Task Force recommends that listed companies should have a Remuneration Committee of the Board, comprising of at least three members, majority of whom should be independent directors, to look after the policies on executive remuneration and for fixing the remuneration packages of individual directors.

Recommendation 6: Audit Committee of the Board The extant clause 49 permitted even executive directors to be part of the Audit Committee. But it is proposed that listed companies should have at least a three-member Audit Committee comprising entirely of non-executive directors with independent directors constituting the majority. However, the executive directors can be invited to attend the audit committee meetings to provide the necessary clarifications.

Recommendation 7: Separation of the offices of the Chairman and the Chief Executive Officer (CEO) The Task Force expressed its preference for separating the two offices, to ensure good corporate performance, however the negative side remains that it can add to a layer of potential conflict.

Recommendation 8: Attending Board and Committee Meetings through Tele-conferencing and video conferencing In line with the proposition in the Companies Bill, 2009, this report also promotes the e-presence of a director to ensure larger participation at Board/Committee meetings. The only additional requirement being that a minuted and signed proceeding of a teleconference should constitute proof of his or her participation and the minutes should be signed and confirmed by the attendee directors.

Recommendation 9: Executive Sessions of the Independent Directors Independent directors should have regularly scheduled executive sessions without the presence of any of the non-independent directors to promote open discussions among independent directors on the strategic issues.

Recommendation 10: The role of the board and shareholders in related party transactions The Audit Committee members should pre- approve the contracts of all proposed related party transactions or any amendment of such related party transactions considering all relevant facts and circumstances.

Recommendation 11: Auditors’ Revenues from the Audit Client The Companies Bill, 2009 discussed the prohibitions to auditors from rendering certain services to their audit clients. No more than 10% of the revenues of an audit firm singly or taken together with its subsidiaries, associates or affiliates, should come from a single corporate client or group with whom there is also an audit engagement. However, flexibility has been given to newer and smaller audit firms.

Recommendation 12: Certificate of Independence Every company must obtain a certificate from the auditor certifying the firm’s independence and arm’s length relationship with the client company.

Recommendation 13: Audit Partner Rotation The Task Force has given rest to the on-going debate on the requirement of rotation of auditor versus rotation of audit partner after a specified period of time. In line with international practice, the Task Force recommended that the partners and at least 50% of the audit engagement team responsible for the audit should be rotated every six years. A cooling off period of 3 years should elapse before a partner can resume the same audit assignment.

Recommendation 14: Auditor Liability The firm, as a statutory auditor or internal auditor, has to confidentially disclose its net worth to the listed company appointing it. Each member of the audit firm is liable to an unlimited extent unless they have formed a limited liability partnership firm or company for professional services.

Recommendation 15: Appointment of Auditors The Audit Committee shall discuss the annual work programme, review the documentation and the certificate for proof of independence of the audit firm, and recommend the appointment/re-appointment or removal of the statutory auditor, along with the annual audit remuneration.

Recommendation 16: Qualifications Introduced by Statutory Auditors or Internal Auditors in their Audit Reports, Tax Audit Report or CARO Reports. Closing all escape routes for auditors for shirking off its liability, the Task Force recommends that the ICAI appoint a committee to standardise the language of disclaimers or qualifications permissible to the audit firms, any deviation from which would require sufficient explanation to sustain investors’ confidence.

Recommendation 17: Whistle Blowing Policy Clause 49 already contained a non- mandatory requirement of whistle bower policy but the same did not get any success on this front in corporate India. The policy should be made mandatory for all companies. A mechanism should be instituted which promotes and supports adequate safeguards of employees who come forward to report unethical

issues, frauds or violation of the company’s code of conduct and also allows direct access to the Chairperson of the audit committee in exceptional cases.

Recommendation 18: Risk Management Framework The Task Force felt that the board must be provided with information on the most significant risks and how they are being managed to integrate risk management in decision making activity.

Recommendation 19: Harmonization of Corporate Governance Standards Regulatory provisions under the Companies Law should be synchronized with the existing Listing Agreement and other SEBI legislations to achieve uniformity in corporate governance standards in the country.

Recommendation 20: Audit Oversight Mechanism: The Capability of Regulatory Agencies - Ensuring Quality in Audit Process The Task Force considered it imperative that the Quality Review Board (QRB) is made functional to ensure quality in the audit process by a critical review of the intensity and integrity of auditors by peer auditors on an annual basis.

Recommendation 21: Effective and Credible Enforcement Regulators under the Company Law, the Securities Laws and the SFIO should have an inter-se cooperation agreement. Instances of investigations of serious corporate fraud must be coordinated and jointly investigated. by the regulators On the lines of the recommendations of the Naresh Chandra Committee Report on Corporate Audit and Governance, a Task Force should be constituted for each case for expedite disposal of cases.

Recommendation 22: Cancellation of Fraudulent Securities If case of securities fraud perpetrated by a shareholder, the company should assist the regulators to take actions such as freezing the shares, intimating the stock exchanges of the details of the relevant securities and confiscation and cancellation thereof. A provision of confiscation and cancellation of securities ought to be prescribed for the protection of capital markets.

Recommendation 23: Liability of Directors & Employees Personal penalties should be imposed on directors and employees who seek unjust enrichment by committing offences. Non-executive directors cannot be penalized unless there is prima facie evidence for the same.

Recommendation 24: Shareholder Activism Nominees of the powerful stakeholders such as long term institutional investors, pension funds or infrastructure funds should come forward to agitate against fraudulent practices through active participation in internal and external proceedings.

Recommendation 25: Media as a stakeholder The Task Force recommends that media should invest more in analytical, financial and legal rigour and enhance their capacity for analytical and investigative reporting. This report is surely a welcome proposition in the move for strengthening corporate governance practices in India.